Future Business Leaders of America (FBLA) Securities and Investments Practice Test

What characterizes common stock in relation to the liquidation hierarchy?

1. It ranks first in line at liquidation

2. It ranks last in line at liquidation

3. It has a guaranteed return on investment

4. It is the most stable form of security

The correct answer is: It ranks last in line at liquidation

Common stock is characterized by its position in the liquidation hierarchy, ranking last in line when a company is liquidated. This means that if a company goes bankrupt and its assets are sold off, the proceeds will first be used to pay off debt holders, such as bondholders and other creditors, before any distribution is made to common stockholders. Once all liabilities and obligations are settled, any remaining assets may then be distributed to common shareholders. However, due to the priority given to debt and preferred stockholders, common stockholders often receive little to nothing in a liquidation scenario. This inherent risk is why investing in common stock is associated with higher potential returns, as investors are compensated for their risk with the possibility of capital appreciation and dividends during the company's profitable periods, rather than guaranteed returns.