Canadian Securities Course (CSC) Level 1 Practice Exam

How does a stock split work?

1. It decreases the number of outstanding shares and decreases the stock price

2. It increases the number of outstanding shares and increases the stock price

3. It increases the number of outstanding shares and decreases the stock price

4. It decreases the number of outstanding shares and increases the stock price

The correct answer is: It increases the number of outstanding shares and increases the stock price

A stock split is a corporate action where a company divides its existing shares into multiple new shares, thereby increasing the number of outstanding shares. The primary purpose of a stock split is to make shares more affordable for investors by reducing the price per share, while keeping the overall market capitalization of the company the same. After a stock split, although there are more shares available, the total value of the shares remains unchanged. For example, in a 2-for-1 split, an investor who had one share worth $100 will now have two shares worth $50 each. This means that the price per share decreases, not increases, which is an essential characteristic of a stock split. Thus, a stock split increases the number of outstanding shares and decreases the stock price, making the correct understanding of the mechanics and outcomes of a stock split crucial for investors and those studying financial principles.