Chapter 8 - Equity Securities: Common and Preferred Shares (Done)

Question 1

How do common shares compare to preferred shares in terms of asset claims in the case of bankruptcy?

Answer 1

In the event of bankruptcy, preferred shareholders have a higher claim on the company’s assets than common shareholders. Preferred shareholders are paid out after debt holders but before common shareholders. Common shareholders are last in line and may receive nothing if the company’s assets are fully claimed by creditors and preferred shareholders.

Question 1

How do common shares compare to preferred shares in terms of dividend payments?

Answer 1

Preferred shares typically offer fixed dividend payments, which are paid out before any dividends are paid to common shareholders. Common shares, on the other hand, have variable dividend payments that can fluctuate based on the company’s profitability and dividend policy. Common shareholders may receive higher dividends in prosperous times but might receive nothing if the company is not performing well.

Question 2

Can you describe the difference between a standard trading unit and odd lots?

Answer 2

A standard trading unit, or round lot, refers to a normal unit of trading, usually 100 shares or a multiple thereof. An odd lot consists of fewer than 100 shares. Trading odd lots can sometimes be more costly because they may incur higher commission fees, and they are typically traded less frequently than standard trading units.

Question 3

Can you list nine benefits of common share ownership?

Answer 3

• Capital Appreciation: Potential for share price increase.
• Dividend Income: Possible regular income from dividends.
• Voting Rights: Ability to vote on important company matters.
• Liquidity: Easier to buy and sell compared to other investments.
• Ownership: Direct ownership stake in a company.
• Profit Sharing: Participation in company profits.
• Limited Liability: Loss limited to the amount invested.
• Marketability: Shares can be publicly traded.
• Portfolio Diversification: Helps in spreading investment risk.

Question 4

Can you list three risks of common share ownership?

Answer 4

• Market Risk: Share prices can fluctuate significantly.
• Dividend Uncertainty: No guaranteed dividend payments.
• Last Claim in Bankruptcy: Lowest priority in asset claims in case of company liquidation.

Question 5

Can you define capital appreciation and explain the role it plays in the value of common share ownership?

Answer 5

Capital appreciation refers to the increase in the value of an asset over time. For common shares, it is the rise in the stock price, contributing to the overall return on investment. It plays a critical role in the value of common share ownership as investors seek to buy shares at a lower price and sell them at a higher price, thereby realizing a profit.

Question 6

Can you describe the difference between a regular dividend and an extra dividend?

Answer 6

A regular dividend is a periodic payment made to shareholders, typically quarterly, and is part of the company’s ongoing dividend policy. An extra dividend, also known as a special dividend, is a one-time distribution of additional profits to shareholders. It is not part of the regular dividend schedule and is usually declared during periods of exceptionally high earnings or when the company wants to distribute surplus cash.

Question 7

Can you compare the cum-dividend period and the ex-dividend period?

Answer 7

• Cum-Dividend Period: This is the period during which a stock is trading with the declared dividend. If you buy the stock during this period, you will receive the upcoming dividend.
• Ex-Dividend Period: This is the period starting from the ex-dividend date, where the stock is trading without the right to the declared dividend. If you buy the stock during this period, you will not receive the upcoming dividend.

Question 8

If you purchased shares on a Monday, would you be able to describe the ramifications of a dividend record date on Wednesday of that same week?

Answer 8

To receive the dividend, you must own the stock before the ex-dividend date. Typically, the ex-dividend date is one business day before the record date. If the record date is Wednesday, the ex-dividend date would be Tuesday. Therefore, to receive the dividend, you would need to have purchased the shares by Monday at the latest. If you buy the shares on Monday, you will be a shareholder of record on Tuesday and will receive the dividend.

Question 9

How does a dividend reinvestment plan work?

Answer 9

A Dividend Reinvestment Plan (DRIP) allows shareholders to reinvest their cash dividends into additional shares or fractional shares of the company’s stock, often without paying brokerage fees. This can be an efficient way to accumulate more shares over time, as dividends are automatically used to purchase additional stock, potentially leading to compounding returns.

Question 10

Can you define dollar cost averaging?

Answer 10

Dollar cost averaging is the practice of investing a fixed dollar amount on a regular basis, regardless of the share price. It’s a good way to develop a disciplined investing habit, be more efficient in how you invest and potentially lower your stress level—as well as your costs.

Question 11

How do cash dividends compare to stock dividends?

Answer 11

• Cash Dividends: These are payments made in cash to shareholders, usually out of the company’s profits or reserves.
• Stock Dividends: These are payments made in the form of additional shares of the company’s stock. Stock dividends increase the number of shares owned but do not increase the total value of the holdings immediately, as the stock price typically adjusts downward to reflect the increased share count.

Question 12

Can you name the three categories of restricted shares and describe each category?

Answer 12

• Employee Stock Options: Shares given to employees as part of their compensation package, often subject to vesting periods.
• Founder Shares: Shares held by the company’s founders, which might have restrictions on transfer or sale for a specified period.
• Private Placement Shares: Shares issued to a select group of investors through private placement, usually with restrictions on resale for a certain period.

Question 13

Can you list the stock exchange and securities commissions regulations regarding restricted shares?

Answer 13

• Lock-up Periods: Time during which restricted shares cannot be sold or traded.
• Insider Trading Restrictions: Rules preventing insiders from trading based on non-public information.
• Registration Requirements: Requirements for shares to be registered with the securities commission before they can be publicly traded.

Question 14

How do stock splits and reverse stock splits affect the number of shares an investor owns, the price of the shares, and the shareholder’s investment value?

Answer 14

• Stock Split: Increases the number of shares owned by an investor while reducing the price per share. The total investment value remains the same. For example, in a 2-for-1 split, an investor with 100 shares priced at $50 each will end up with 200 shares priced at $25 each.
• Reverse Stock Split: Decreases the number of shares owned by an investor while increasing the price per share. The total investment value remains the same. For example, in a 1-for-2 reverse split, an investor with 100 shares priced at $10 each will end up with 50 shares priced at $20 each.

Question 15

Why do companies issue preferred shares compared to debt?

Answer 15

Preferred shares provide companies with a way to raise capital without increasing their debt levels. Unlike debt, preferred shares do not require regular interest payments and do not have a maturity date. Issuing preferred shares can also be more flexible as dividends can be deferred without causing a default, unlike interest payments on debt.

Question 16

Why do companies issue preferred shares compared to common shares?

Answer 16

Preferred shares allow companies to raise capital without diluting the voting power of existing common shareholders since preferred shares typically do not carry voting rights. Preferred shares also provide fixed dividend payments, which can be more attractive to certain investors and help stabilize the company’s stock price.

Question 17

Can you describe how cumulative and non-cumulative features work?

Answer 17

• Cumulative Preferred Shares: These shares accumulate unpaid dividends. If the company misses a dividend payment, it must pay the missed dividends in the future before any dividends can be paid to common shareholders.
• Non-Cumulative Preferred Shares: These shares do not accumulate unpaid dividends. If the company misses a dividend payment, it is not obligated to pay it in the future.

Question 18

Can you describe how a callable and non-callable feature works?

Answer 18

• Callable Preferred Shares: These shares can be redeemed by the issuing company at a predetermined price after a specified date. This feature allows the company to repurchase the shares, usually when interest rates fall, to save on dividend payments.
• Non-Callable Preferred Shares: These shares cannot be redeemed by the issuing company, providing more stability for investors as they cannot be forced to sell their shares back to the company.

Question 19

What is a retractable preferred share? Can you describe what a soft retractable preferred share is?

Answer 19

• Retractable Preferred Shares: These shares give shareholders the right to sell them back to the issuing company at a specified price after a certain date.
• Soft Retractable Preferred Shares: These shares have a retractable feature, but the company can choose to pay the retraction price in cash, shares, or a combination of both, providing more flexibility for the issuing company.

Question 20

What is the advantage to an investor who owns a floating-rate preferred share?

Answer 20

Floating-rate preferred shares offer dividend payments that are adjusted periodically based on a benchmark interest rate. This provides protection against interest rate fluctuations, as the dividends will increase when interest rates rise, ensuring that the investor continues to receive competitive returns.

Question 21

Can you name a U.S. stock index and a U.S. stock average?

Answer 21

• U.S. Stock Index: S&P 500 Index.
• U.S. Stock Average: Dow Jones Industrial Average (DJIA).

Question 22

What is the mathematical difference between a stock average and a stock index?

Answer 22

• Stock Average: It is the arithmetic mean of the prices of a selected group of stocks. For example, the DJIA is calculated by adding the prices of its 30 constituent stocks and dividing by a divisor.
• Stock Index: It is a weighted average of the prices of a selected group of stocks. For example, the S&P 500 is a market-capitalization-weighted index, where larger companies have a greater impact on the index’s value.

Question 23

What does the S&P/TSX 60 Index measure?

Answer 23

The S&P/TSX 60 Index measures the performance of 60 large, established, and prominent companies listed on the Toronto Stock Exchange (TSX). It represents leading companies in key industries, providing a benchmark for Canadian equity markets.