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AFM 121 > Chapter 8: Common & Preferred Shares > Flashcards

Chapter 8: Common & Preferred Shares Flashcards

1
Q

what are common shares

A
  • Ownership in a company
  • Value of each shares changes with changes in the total value of company’s equity and it’s
    total shares outstanding
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2
Q

what do preferred shares provide

A
  • Provides a cash payment / dividend
  • These cash payments / dividends are “fixed”; hence preferred shares are often viewed as
    fixed income and not equity
  • Most attractive to an investor wanting a steady income and more security that their
    investment will not be volatile
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3
Q

What has the potential for the greatest increase (or decrease) in value – common or preferred shares?

A

common shares; greater risk, greater reward

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3
Q

what is the potential for common shares

A
  • Potential for significant gains and losses (you can lose it all without any compensation for your total loss)
  • since you wont get dividends
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4
Q

what is a stock split

A
  • when a company “splits” their shares by doubling (or tripling or more) its shares outstanding
  • it doesn’t increase a company’s market capitalization
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4
Q

what is market capitalization

A
  • total equity value
  • total shares outstanding x share price
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5
Q

what does happens to the share price if the stock split is 2 for 1

A

the share price is halved

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6
Q

how do you calculate a stock split

A
  • # for
  • like 2 for 1
  • would divide the share price by 2 and multiply by 1
  • would multiply share amount by 2 divide by 1
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6
Q

why would a company split its shares if it has no effect on the overall equity value/market capitalization?

A
  • liquidity: makes the stock more affordable for smaller investors, and easier to buy and trade the stocks
  • can make it seem more affordable and attractive to investors
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6
Q

what are dividends

A

cash payments to shareholders

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7
Q

is issuing dividends required

A

no, they can but they don’t have to

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7
Q

how much of net income do canadian banks typically pay as dividends

A

40-50% of net income

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7
Q

why would some companies retain all of their net income instead of paying dividends

A

they may see opportunities to invest their net income in

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7
Q

what is the timing of dividends like (what are the different dates related to dividends)

A
  • declaration date
  • purchase date
  • ex dividend date
  • record date
  • payment date
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8
Q

what happens on the purchase date

A

it is the day the actual stock was purchased

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8
Q

what happens on the ex dividend date

A
  • always happens 1 business day before the record date
  • the share price goes down by the dividend paid amount on this date
  • need to be a shareholder before this date to get the dividends
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9
Q

when do you have more wealth, buying shares before the ex dividend date or after

A
  • its the same
  • if you buy the shares before the ex dividend date, the share price will decrease by the dividend payment amount, which you will receive
  • if you buy the shares after the ex divided date, you will be able to buy the shares for a cheaper amount, but you won’t be getting the dividends
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9
Q

what happens to the company value when dividends are paid

A
  • goes down by the amount of dividends paid
  • ex. company value = $2M, they pay $0.5M in dividends, the company value becomes $1.5M
10
Q

what are stock dividends

A
  • when the COMPANY decides to issue a stock dividend instead of a cash dividend
  • so you would receive additional company shares (that you would get taxed on)
11
Q

The share price is $50, the dividend amount is $0.25, and you own 600 shares. if a company is issuing stock dividends, how many stocks would you get

A

600 (amount you have) x $0.25 (dividend amount) = $150 (dollar amount of dividends you are owed)
$150 (how much you are owed) / $50 (the price of 1 stock) = 3 shares

11
Q

what are dividend reinvestment plans (DRIPs)

A
  • when the INVESTOR decides to receive a stock dividend instead of cash
  • the investor receives more stocks of the company instead of cash
  • calculated the same way for stock dividends
12
Q

what is the tax treatment for capital gains on common shares

A
  • capital gains = increases in share price
  • are taxed at 50% of the tax rates on interest or employment income
  • ex. your income tax is 30%, then your tax on capital gains is half of that, 15%
  • you are only taxed on the capital gains and not the price you paid for the stocks or the market value
12
Q

what are voting privileges like in common shares

A
  • most times you get to vote
  • sometimes there are restricted voting shares that restrict the rights/votes of shareholders
  • but there are voting shares
13
Q

what are multi-voting shares

A
  • shareholder has more rights
  • when each share = multiple votes
  • ex. 1 share has 10 votes, instead of being 1 share = 1 vote
14
Q

what are stock quotes

A

provide different information about stocks on financial publications

14
Q

what is the tax treatment for dividends of common shares

A
  • dividends receive tax credits
  • ## they reduce the amount of tax paid compared to interest or employment income
15
Q

what are examples of information provided on stock quotes

A
  • high/low; the highest or lowest price during the period stated (can be the highest/lowest of the day, week, month, or 52 week period)
  • close; the last trading price of the day
  • change; the change from the previous day’s closing price
  • volume; the # of shares traded during the period
  • dividends; the total dividends per share paid over the past 52 weeks
16
Q

what are preferred shares

A
  • Ranked behind debt holders in front of common shareholders
    Dividend payments are not obligatory (like interest payments) but preferred dividends must be paid before common share dividends can occur
  • Primarily a fixed income instrument – limited opportunity for price increases vs. common shares
17
Q

what is the tax treatment for preferred shares

A

Payments are not tax deductive; investors receive dividend tax credit and, hence, pay less tax rate than if interest received

18
Q

what are fixed rate (straight) preferreds

A
  • have a stated par value (often $25) and a fixed dividend
  • are like every other instrument in finance where the value is the pv of future cash flows
  • there is no maturity date
  • the dividends are in perpetuity
19
Q

what is perpetuity

A
  • like indefinite cash flows
  • dividends for preferreds are in perpetuity (they always get paid the same amount every year)
20
Q

what is the formula for perpetuity pricing

A

PV = C / r
- C = preferred dividend received
- r (in the POV of the investor) = the rate of return required on the preferred
- r (in the POV of the issuer) = cost of funding the preferred

21
Q

Ex. what is the price of a preferred share with a dividend of $4 and a required rate of return of 10%

A

PV = C/r
PV = $4 / 10% = $40

22
Q

Ex. what is the rate of return of a preferred with a price of $30 and a dividend of $2

A

PV = C/r
r = C/PV
r =$2 / $30 = 6.67%

23
Q

what is rate of return also known as

A

market/dividend yield

24
Q

how do you calculate dividend yield

A

dividend yield = dividend/price

25
Q

why is looking at dividend yield important

A
  • allows us to compared dividends more comprehensively
  • ex. if you receive a $5 dividend from company A and a $2 dividend from company B, is company A better?
  • depends on what you are paying for the stock
  • if company A price is $50, and company b price is $10, then comparing their dividend yields, 10% vs 20% respectively, company b is actually better
26
Q

what is a stock index/average

A
  • used like a dividend yield
  • so you can compare the performance of all companies and gauge overall market movements
27
Q

how are stock indexes calculated

A
  • they are typically value weighted
  • each stock in the index is weighted based on its equity value / market capitalization
  • so if a company is worth more, it is weighted more in the index
28
Q

how are stock averages calculated

A
  • add each stock price and divide it by the # of stocks
  • if the stock price is higher, it will be worth more
29
Q

do stock indices or stock averages make more sense and should give a better gauge of market movements

A
  • stock indices
  • stock averages don’t accurately gauge market movements
30
Q

what is the dow jones industrial average (DJIA)

A
  • a large stock average
  • Average based 30 stocks that is price weighted (add up the share prices and
    divided by 30)
31
Q

why does the dow jones industrial average get so much attention

A
  • Old habits are difficult to break – it has been used for over 100 years
  • The 30 stocks are bellweather stocks for the U.S. economy (American Express, Wal-
    Mart, Home Depot)
  • the Dow Jones company also previously owned the Wall Street Journal which would emphasize DJIA movements
32
Q

what are major stock indices

A
  • U.S. – S&P 500
  • Canada - S&P / TSX Composite
  • Japan – Nikkei Stock Average
  • United Kingdom - FTSE 100 (pronounced “footsie”)
  • Germany – DAX
  • France – CAC 40

All are market or value weighted except the Nikkei

AFM 121 (12 decks)

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