Chapter 4: Equities: Types and Features

Question 1

What is an ordinary shareholders?

Answer 1

• An investor who buy shares in companies, known as ordinary shareholders.
• Ordinary shareholders have an ownership stake in a company, giving them the right to a variable share in the profits of the company, known as a dividend.
• The have the right to vote on decisions about the company made at company meetings.
• Ordinary shareholders may be involved in the day-to- day management of a company, but normally this responsibility is delegated to the company directors.

Question 2

What are preference shares?

Answer 2

Shares with no voting rights, but they pay a fixed rate dividend to compensate for the lack of voting rights.

Question 3

What are American depositary receipts?

Answer 3

• They are documents held in the US representing shares in overseas companies

Question 4

Why are American depositary receipts attractive to investors?

Answer 4

Investors do not like buying shares in a non-US company as it means they have different tax rules to follow and have to pay for the shares and receive dividends in foreign currencies.

Question 5

What is Gordon’s growth model used for?

Answer 5

Estimating the value of a share based on dividend pay-out.

Question 6

What is incorporation?

Answer 6

The process whereby a company comes into existence as a separate legal entity.

Question 7

What are the two types of UK companies?

Answer 7

• Private
• Public

Question 8

What are the 3 distinctions between private and public companies?

Answer 8

1. Name: the name of a public company must include ‘public limited company’ or ‘plc’. A private limited company’s name must only include ‘limited’ or ‘Ltd’.
2. Share capital: the minimum allotted share capital for a public company is £50,000. There is no minimum capital requirement for a private company.
3. Transferability of shares: Public companies are permitted to freely trade their shares in the secondary markets to the general public. Private companies may not.

Question 9

What is a close company?

Answer 9

A company that is under the control of five or fewer persons or is under control of the directors alone.

Question 10

What are the two other names for shareholders?

Answer 10

• Equity holders
• Members

Question 11

What are shareholders?

Answer 11

Owners of the company. They invest capital into a business and receive shares in return. The more shares an investor holds, the greater proportion of the company he or she owns. For instance, if the company has issued 100 shares and an investor holds 60, then the investor owns 60% of the company.

Question 12

Explain ownership vs. management.

Answer 12

Shareholders are the owners of the company. It is, however, directors that manage the day-to-day affairs of the company on the shareholders’ behalf. Executive directors are appointed, and may also be removed, by the shareholders of the company.

Question 13

What is the authorised share capital?

Answer 13

Authorised share capital is the maximum number of shares a company is permitted to issue, based on the shares’ nominal value. For example, if the authorised share capital is £1,000,000, the company could issue 2,000,000 50p nominal value shares.

Question 14

What is the nominal value of a share?

Answer 14

The nominal value of a share is the fixed legal value; it is not the market price. For example, the nominal value of Tesco shares is 5p. This is well below the market price.

Question 15

How can authorised share capital be changed?

Answer 15

Authorised share capital can only be changed on approval by the shareholders in a general meeting.

Question 16

What is Issued share capital?

Answer 16

Issued share capital is the number of shares the company has allotted to shareholders, based on nominal value. For instance, in our example the company has authorised 2,000,000 shares, but only 500,000 may have actually been issued. Therefore, should the company require additional capital, it can issue up to another 1,500,000 shares.

Question 17

How can issued share capital be divided?

Answer 17

Issued share capital can be divided into paid-up share capital – the amount that has been paid for by shareholders – and called-up share capital – the amount of share capital still to be paid.

Question 18

What is the issued share capital never allowed to exceed?

Answer 18

The issued share capital is never allowed to exceed the authorised share capital.

Question 19

What is the common form of equity?

Answer 19

Ordinary shares

Question 20

What is another name for ordinary shares?

Answer 20

common shares

Question 21

Why is ordinary share capital usually referred to as equity capital?

Answer 21

Because the return derived from ordinary shares varies with performance (an ‘equity’ return).

Question 22

What basic rights do ordinary shares give to shareholders?

Answer 22

Right to vote
Ordinary shares usually grant the right to vote in general meetings (although non-voting ordinary shares do exist).

Right to a dividend

• A dividend is a share in the profits of the underlying company.
• Dividends payable to ordinary shareholders can only be paid after all interest and preference dividends have been satisfied. Therefore, if a company is unprofitable, the ordinary shareholders are most likely to lose out.
• However, should the company generate profits, ordinary shareholders may receive a good return in order to compensate for this risk, although payment is at the discretion of the directors.

Right to a surplus on winding up
In the event of the winding up of a company, ordinary shareholders are entitled to a share of the remaining (i.e. surplus) assets of the company on a pro rata basis, but only after all other liabilities have been paid. This may result in ordinary shareholders receiving more than their nominal, or face, value.

Question 23

What are deferred shares?

Answer 23

Shares which typically have one or all rights deferred. During the deferral period these shares are often worthless.

Question 24

Who are deferred shares often issued to and why?

Answer 24

The shares are often issued to founders, new board members and employees as incentives. The incentive is that given a specific event, such as profits hitting certain targets or company flotation, the deferred shares will be converted into standard ordinary shares in the company.