Chapter 15: Equity Markets

Question 1

Ordinary Share

Answer 1

share in the ownership of a company

Question 2

Investment and risk characteristics of equities

Answer 2

• Security depends on profitability of the company
• Provide a long-term real yield as companies grow in line with inflation, dividends tend to grow in line with GDP
• Higher expected returns than government bonds
  over the long term
• Income and capital values can be volatile
• Equities can generally be held in perpetuity
• Dealing expenses are linked to marketability
• Marketability depends on the size of the company

Question 3

Quoted shares

Answer 3

Listed on a stock exchange and make up the majority of available equity investment.

Question 4

Investment characteristics of quoted shares

Answer 4

• more marketable
• more secure
• easier to value than non-quoted shares.

Question 5

Why are shares grouped by industry sectors

Answer 5

• practical for analysts to specialise in one area

- share prices of companies in the same sector tend to be correlated

Question 6

It is practical for analysts to specialise in one area of industry because

Answer 6

• Factors affecting one company within an industry are likely to be relevant to other companies in the same industry
• Information for companies in the same industry will come from a common source and be presented similarly.
• No one analyst can expect to be an expert in all areas, so specialisation is appropriate.
• The grouping of equities according to some common factor gives structure to the decision-making process. Assists in portfolio classification & management

Question 7

Shares of companies in the same sector are correlated because… (3)

Answer 7

• Use the same resources, have similar input costs
• supply to the same market, similarly affected by demand
• Similar financial structures, ie influenced by changes in interest rates.

Question 8

Preference share

Answer 8

A particular class of share that generally ranks ahead of ordinary shares.
Normally entitled to a specified rate of dividend, and, unlike ordinary shareholders, not to residual profits.

Question 9

Typical features of preference shares

Answer 9

• dividend on a preference share is usually a fixed percentage of the par value and is always paid before any distribution to ordinary shareholders.
• dividend on preference shares is normally treated in the same way as ordinary shares for tax purposes
• Dividend rate is quoted net of tax
• Dividends don’t have to be paid if profits are insufficient
• Generally cumulative
• Mostly no final redemption date
• Normally don’t carry voting rights

Question 10

Cumulative property of preference shares

Answer 10

If a dividend is unpaid, the arrears must be paid off before any payment is made to ordinary shareholders.

Question 11

Payout Ratio

Answer 11

Dividends per share/Earnings per share

Question 12

Reasons for buying back shares

Answer 12

• Excess cash that cannot be used profitably and is
  returned to shareholders
• Excess cash may only earn deposit rate of interest,
  thus improves earning per share for remaining shares
• May be more tax-efficient than dividends
• Company may wish to change capital structure from
  equity financing to debt financing