Advanced Diploma of Financial Planning (ADFP) Practice Test

What type of equity security provides an ownership interest in a corporation?

1. Preferred stock

2. Convertible bonds

3. Common stock

4. Debentures

The correct answer is: Common stock

Common stock is the type of equity security that provides an ownership interest in a corporation. When an individual purchases common stock, they are essentially buying a share of the company, which gives them a claim on a portion of the company's assets and earnings. Common stockholders are often entitled to vote on key corporate matters, such as electing the board of directors, which further emphasizes their ownership stake in the company. Preferred stock, while also an equity security, typically does not offer the same voting rights as common stock and is structured more as a debt instrument, where dividends are paid at a fixed rate. Convertible bonds and debentures are types of debt securities, not equity. These instruments represent loans made by the investor to the corporation, and while they may have certain features that allow for conversion into equity, they do not inherently provide an ownership interest. Thus, the defining characteristic of common stock is that it represents direct ownership in the corporation, distinguishing it from other securities that do not carry this feature.