Chap 14: Equity

Question 1

What is the definition of ordinary shares/common stock?

Answer 1

• a common stock is an equity investment that represents ownership in a corporate form of business
• each share represents a fractional ownership interest in the firm
• key attributes of this investment security is that it enables investors to participate in the profits of the firm
• represents equity or ownership of the company

Question 2

What are the features of ordinary shares?

Answer 2

1. Residual claim
2. Voting rights
3. No maturity
4. Election on BOD
5. Authorisation to issue new common stock
6. easy to buy and sell, transactions costs are modest
7. Price and market information is widely disseminated in the news and financial media

Question 3

What are the advantages of common stock from investor’s viewpoint?

Answer 3

1. No limit to a stock’s capital gains potential
2. Dividend yield
3. Highly liquid and easily transferable
4. Market information is readily available
5. Voting rights
6. Pre-emptive rights
7. No maturity date

Question 4

What are the disadvantages of common stock to investor?

Answer 4

1. Risky
2. As residual owners of the firm, no return is guaranteed
3. Dividend is not guaranteed
4. Acquisition of common stock may result in ownership control

Question 5

What is preference shares?

Answer 5

Preference share is known as a hybrid security because it has both debt and equity characteristics

Question 6

What are the features of preference shares?

Answer 6

1. Fixed dividend
2. Omission
3. Cumulative dividends
4. Convertibility
5. No voting rights

Question 7

What are the advantages of preference shares?

Answer 7

1. Help increase the firm’s financial leverage
2. Can pass a dividend payment without putting the company into bankruptcy
3. Avoid cash flow drain

Question 8

What are the disadvantages of preference shares?

Answer 8

1. The presence of preferred stock in a sense jeopardises common stockholders’ returns
2. Preferred stock dividends are not deductible to the issuer