4. Equities

Question 1

By law, what form of shares must a company have?

4.1 The basics

Answer 1

Ordinary Shares

Question 2

Which documents disclose the type and number of shares in issue for a company?

There are two

4.1 The basics

Answer 2

• Memorandum of association – a legal statement signed by all initial shareholders
  or guarantors agreeing to form the company
• Articles of association– written rules about running the company agreed by the
  shareholders or guarantors, directors and the company secretary.

Question 3

How can the number of shares in issue be varied?

4.1 The basics

Answer 3

• Share split - Increases number of shares whilst decreases the value of each share proportionally (greater liquidity + ease of sale)
• Script issue - Company offers new shares to shareholders at a discounted price

Question 4

Limited liable companies?

4.1 The basics

Answer 4

• Listed on the stock market
• Shareholders have no liabilities to creditors/debts
• When the company makes a profit, the directors may recommend the payment of a dividend to shareholders
• Dividends can be paid interim (partway through the year) or final (end of trading year)

Question 5

Cum and ex-divident

Answer 5

Like with bonds and interest payments, equities can be sold including the right to receive the next dividend payment

• the record-date is the cut‑off date whereby any investor buying shares after that date will not be entitled to
  the forthcoming dividend.

Question 6

Issuing shares - why are they issued? When are they issued?

4.2 Issuing shares

Answer 6

Shares are issued to rasie capital for the company.
1. Initial public offering (IPO) - Issued when the business first lists as a public company
2. When a company wishes to raise captial - often called a secondary public offering

Question 7

IPO - What are the two ways that this is arranged?

What is a requirement?

4.2 Issuing shares

Answer 7

• Offer for sale - Fixed price, Tender (which works well for smaller companies - effectively an aution), Subscription (Similar to Tender, but company is not compelled to accept low offers and is therefore not underwritten…making it cheaper)
• Placing - Company offers shares directly to stockbroker
• It is a requirement that 25% of a companies shares be owned by the general public

Question 8

There are 2 main ways an existing company can raise capital - placing, and …

What is ‘tail swallowing’

4.2.2 Raising capital

Answer 8

A rights issue
* Offer to exisiting shareholders to buy new shares in proportion to the number of shares they already held. These are offered at a discount.
* The shareholder does not pay any money to obtain the right to buy the shares, but will have to pay the quoted rights price to exercise it - therefore this right has value and can be traded.
* Most rights issues are fully underwritten to ensure the required capital is raised, although this can add significantly to the cost of raising the capital.

‘Tail swallowing’ is a term used when the shareholder sells enough nil-paid rights to pay
for them to exercise some of their rights to buy new shares.

Question 9

Adjustment issues - what? list the two kinds?

Answer 9

And adjustment of the share capital - either to expand or to improve liquidity (i.e. one share of £50 is harder to sell than five shares of £10).
* Share split
* Scrip issue

Question 10

What is a Share split?

Answer 10

Where a company wishes to adjust its share capital:

A share split is used to lower a company’s share price to make it more attractive to investors and improve liquidity. In a share split, each existing share is divided into multiple smaller shares, reducing the par value but not affecting the total value of the investment.

For example, a share with a 20p par value might be split into four shares with a 5p par value each.

Question 11

What is a Scrip Issue?

Answer 11

Where a company wishes to adjust its share capital:

A scrip issue allows a company to transfer money from shareholders’ reserves to its share capital by issuing new shares at no cost to shareholders. These new shares are issued in a set ratio, like “one for one,” meaning shareholders receive additional shares but maintain the same proportion of ownership

The share price adjusts downward proportionally to the new number of shares, so the total value of each investor’s holding remains unchanged.

Question 12

Types of share - Ordinary Shares

Answer 12

• Basic Share Type: Ordinary shares are the default type every company must issue.
• Voting Rights: Usually, one vote per share at the annual general meeting (AGM).
• Dividends: Shareholders may receive dividends if declared, but no guarantee of payment or the amount.
• Winding Up: Ordinary shareholders are paid last if the company is wound up, and only if there are funds remaining.
• Liquidation: Shareholders have no further liability unless shares are only part-paid; they must then pay the remaining balance (unpaid call).
• Incentives: Shareholders may receive discounts on company products.

Question 13

Types of Shares - preference shares

Dividends compared to ordinary shares

Answer 13

• Preference Shares: Issued in addition to ordinary shares, similar to loan stock.
• Dividends: Pay fixed dividends, usually every six months, if enough profit after tax is available.
• Winding UpRank ahead of ordinary shares for dividend payments and repayment if the company is wound up.

Fixed Dividend: Lower than ordinary share dividends, making preference shares less risky.
* Capped Dividend: Fixed dividend is beneficial when profits are low, but not ideal when profits are high since it doesn’t increase.

• Non-Cumulative:If there isn’t enough profit, no dividend is paid, and the missed dividend is lost.
• No Voting Rights: Preference shareholders don’t usually have voting rights unless dividends are in arrears.

Question 14

Cumulative, Participating, and Convertible preference shares:

Answer 14

Cumulative Preference Shares: Pay the current year’s dividend plus any missed dividends from previous years.
* Priority: Missed and current dividends are paid before ordinary shareholders receive any dividend.

Participating Preference Shares: Pay a fixed dividend plus an additional dividend based on a portion of the company’s profits.
* Extra Dividend: Usually linked to a percentage of the ordinary share dividend.

Convertible Preference Shares: Offer lower dividends than regular preference shares.
* Conversion Right: Can be converted to ordinary shares at a set price and date.
* Higher Price: Typically trade at a higher price than ordinary shares.
* Limited Option: If not converted by the set date, the option expires.

Question 15

What is a warrant?

Answer 15

Gives the owner the right to subscribe for a given number of ordinary shares

Warrant holders do not have rights to dividends because they do not own any shares.

Question 16

The main market and the AIM - main points

4.4 The markets

Answer 16

Main Market - allowas companines to be quoted on the Stock exchange
* Requirements: Companies must meet strict FCA rules on prospectus, listing, and transparency.
* Full Listing: Requires at least 3 years of trading and 25% of shares in public hands.
* Free Float: Refers to publicly traded shares not held by insiders or controlling investors, and it’s used to help calculate market capitalization.

AIM Overview: a separate market on the London Stock Exchange, mainly for small, growing companies.
Purpose:** Helps companies raise capital through share issuance and provides a platform for trading shares while boosting their public profile.
**Less Stringent Rules: AIM has fewer regulations than the main market, but is more suitable for experienced investors due to higher risks.

Question 17

What are unlisted securities? And what are the benefits of them to an investor?

3 forms of relief

Answer 17

Shares in companies too small even for the AIM

• Capital Loss Relief: Losses from unlisted securities can be set against other income if shares were subscribed to, not transferred. Shares must be in qualifying trading companies for EIS relief (since 6 April 1998).
• Interest Relief: Tax relief is available for loans used to buy shares in close companies if the investor owns more than 5% of shares or works in management. Relief is not available if EIS tax relief has been claimed on those shares.
• Inheritance Tax Relief:100% business property relief applies to shares in unlisted or AIM-listed companies held for at least two years.

Question 18

What are the 4 features that determine a shares value to an investor?

Answer 18

• Dividend yield – an indication of the income;
• Price–earnings ratio – an indication of growth;
• Net asset value – an indication of the risks underlying the company;
• Dividend cover – an indication of continuing dividends.

Question 19

What is a share’s dividend yield? and how is it calculated?

Answer 19

A measure of income received vs share’s current market price.

Calculation

(net dividend ÷ share price) x 100

Example: Net dividend 5p per share; current price £1.45. = 3.45%

Useful, but based on historical data - last years divs.

Question 20

What is a share’s dividend cover? and how is it calculated?

Answer 20

Dividends and EPS: Dividends are paid from profits, often expressed as earnings per share (EPS). For example, £1m profit with 10m shares gives an EPS of 10p.

Dividend Cover: This shows how many times profits can cover the dividend. It’s calculated by dividing EPS by the net dividend. For example, with 10p EPS and a 2.5p dividend, the dividend cover is 4.

Indicator of Stability: A high dividend cover means the company is likely to continue paying dividends. A low cover, especially below 1, suggests dividends might come from reserves, putting future payments at risk.

Calculated by dividing the EPS by the net dividend

Question 21

What is a share’s price per earning ratio? What does it show?

Answer 21

P/E Ratio: The price/earnings (P/E) ratio is the share price divided by earnings per share (EPS). It shows how much investors are paying for each unit of earnings.

High P/E: A higher P/E suggests greater market expectations for future growth (growth stocks), but doesn’t necessarily mean the share is a better investment—optimism may already be priced in.

Sector Comparison: P/E ratios should be compared within the same sector, as different industries have varying levels of confidence and growth expectations.

Question 22

Price earnings to growth ratio (PEG) - what is the limitation with P/E? What does PEG show and how is it calculated?

Answer 22

PE Ratio Limitation: Companies with higher growth rates often have higher PE ratios, which can suggest overvaluation, but this isn’t always true.

PEG Ratio: The PEG ratio compares price, earnings, and expected growth to determine the true value of a stock. A PEG of 1 indicates the stock is fairly priced for its growth, while a PEG below 1 suggests the stock may be undervalued.

Negative PEG: A negative PEG might signal a decline in earnings, though there could be other valid reasons.

Calculated by:
Price per earnings ÷ Annual Earnings per share

Question 23

What is Net asset value? what does it show? How is it calculated? When is it particularly important?

Answer 23

Net asset value (NAV) is the market value of all of a company’s assets, less liabilities, divided by the number of shares issued.

Shows general reliability and trustworthiness of a company - unlike to default.

NAV helps investors determine whether a share is trading at a discount (below NAV) or a premium (above NAV) relative to its intrinsic value - and hence shows investment oppurtunty.

Importance of NAV: NAV is particularly significant for investment trusts and property companies.

Question 24

What is gearing? Give an example. What is the implication of high gearing?

Answer 24

Gearing: This measures a company’s long-term borrowing relative to its shareholder capital and reserves. It is calculated by dividing long-term debt by capital and reserves.

Example: If a company has £100,000 in long-term borrowing and £200,000 in capital and reserves, its gearing is 50%.

Components of Long-Term Borrowing: This includes loans with terms over 12 months, preference shares, debentures, and loan stock.

Implications of High Gearing: A highly geared company relies heavily on borrowing, which can be risky if interest rates rise or profits fall. However, it can also enable investment and potentially enhance performance if the company succeeds.

Question 25

What 4 things can affect share prices?

Answer 25

• Market confidence
• External factors - such as the state of the economy, interest rates, and inflation
• The company’s performance
• Supply and demand

Question 26

Nominal value vs real terms?

Answer 26

Nominal value is the value of an asset without taking inflation into account.

Real terms - the true value; taking into account inflation over a time period.

Question 27

What is mean by the ‘spread’ when buying and selling shares?

4.8 Dealing in shares

Answer 27

The spread is the diffence between the selling price and the buying price.
* This represents the profit (margin) gained by market makers.

Question 28

When UK shares are purchased, what tax is applied?

Answer 28

Stamp Duty

— Stamp duty is payable on purchases using a stock transfer form.

— Stamp duty reserve tax is payable on the purchase of shares via the CREST
(paperless) system. The tax is rounded up to the nearest penny and is payable
on all transactions regardless of value.

Question 29

How are dividend payments taxed?

4.9 Taxation of shares

Answer 29

• Dividends are paid without tax deducted (ie gross) – what the investor receives is the
  amount that is subject to tax.
• A dividend allowance enables investors to receive a certain amount of dividends tax‑free
  and then, once the dividend allowance has been used, dividends are taxed at a marginal
  rate depending on the holder’s income tax band.

Current (2024/2025) allowance = £500
Rates
Basic rate = 8.75%
Higher rate = 33.75%
Additional rate = 39.35%

Question 30

Important point about the Dividend allowance

Answer 30

Dividends within the dividend allowance are not taxable, however, they are included as part of the individuals basic or higher-rate tax abnd to work out the rate of tax to be paid on dividends in excess of this allowance or other income.

The dividend allowance is really a nil-rate band for dividends

Current (2024/2025) allowance = £500

Question 31

Taxation of shares?

Answer 31

• Dividends subject to dividend tax on the amount exceeding the allowance
• Stamp duty may be paid when purchasing
• CGT may be paid when disposing of shares - when an individual sells shares at a price in excess of the price paid for them (taking into acquisition and disposal costs etc).

Question 32

Save‑as‑you‑earn‑linked (SAYE‑linked) share option
schemes - what is it?

4.11 Employee share schemes

Answer 32

Option given to employees to save between £5 and £500 each month in a SAYE contract.
* Contract is between 3-5 years
* When in force, tax-free interest or bonuses on the shares

At the end of the contract, the employee has the option to buy a set number of shares at a discount

For CGT purposes, the acquisition cost of the shares is taken to be the actual price paid
by the employee, not the market price at the date of acquisition.

The employee can transfer the shares into an ISA or a pension plan within
90 days of acquiring them. Such a transfer is free from CGT.

Question 33

Taxation of employee share schemes?

3 points

Answer 33

• No Capital Gains Tax (CGT) if shares are kept in the scheme until sold.
• CGT applies if shares are withdrawn from the scheme and sold, based on value increase from the withdrawal date.
• Shares can be transferred into an ISA or pension within 90 days of leaving the plan, free of CGT.

Question 34

Share incentive plans

Share Incentive Plans (All-Employee Share Schemes):

Answer 34

Also known as an all-employee share scheme, is a program that allows companies to distribute shares their shares to their employees under similar terms (same for everyone)

Introduced in 2000: Applies to all employees under similar terms.
Shares must be ordinary shares: In companies not controlled by another company or close companies (where directors control over 50% of voting shares).
Held in a trust: Shares must be placed in a trust set up for the share plan.
No income tax or NICs: If shares are held in the plan for at least 5 years.
Tax charge applies: If shares are withdrawn before 5 years.

Question 35

Share incentive plans - organsised as Free shares

4.11.2 Share incentive plans

Answer 35

Free shares can be awarded based on criteria like salary, length of service, or performance against targets.
* The maximum free shares an employee can receive is** £3,600 per tax year.**

Shares are held in trust for 3 to 5 years. If the employee leaves, the shares must be taken out of the plan.
If shares are withdrawn between 3 and 5 years,** income tax is due **on the lower of:
* The market value when shares were awarded.
* The market value at withdrawal.

No tax charge if the employee forfeits the shares or leaves due to being a “good leaver” (e.g., death, disability, redundancy, retirement) or due to a company event (e.g., takeover).

Question 36

Share incentive plans - Partnership shares

4.11.2 Share incentive plans

Answer 36

Employees can give up up to 10% of their salary (max £1,800/year) to buy partnership shares through a trust.

No tax or National Insurance Contributions (NICs) on the salary sacrificed, and the company gets a tax deduction.
Shares can be withdrawn anytime, but if the employee leaves the employer, they must take or forfeit their shares.

If shares are withdrawn within 5 years, a tax charge applies:
* Up to 3 years: Income tax and NICs on the value of the shares.
* 3 to 5 years: Tax and NICs on either the salary used to buy shares or their market value at withdrawal, whichever is lower.

No tax charge for “good leavers” (e.g., due to death, illness, or company events).

Question 37

Share incentive plans - Matching, Dividend, Unapproved share option schemes

Answer 37

Matching Shares:
* Employers can offer matching shares for employees who buy partnership shares, on a 1:1 or 2:1 basis.
* Shares are held in trust for 3 to 5 years.
* If the employee leaves within 3 years, the matching shares can be forfeited.
* Taxation is the same as for free shares.

Dividend Shares:
* Employees can reinvest dividends from partnership or matching shares.
* No tax is payable on reinvested dividends.

Unapproved Share Option Schemes:
* Share options can be granted without HMRC approval.
* Income tax may apply either when the option is granted or exercised, depending on the scheme.