Chapter 8 - Equity Securities: Common & Preferred Shares

Question 1

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

Answer 1

Senior creditors, bond and debenture holders, and preferred shareholders all have prior claims over common shareholders.

Question 2

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

Answer 2

Common share dividends are payable at the discretion of the board of directors. No guarantee.
Preferred shareholders are usually entitled to a fixed dividend expressed either as a percentage of the par or stated value or as a stated amount of dollars and cents.

Question 3

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

Answer 3

A standard trading unit is a unit whose size has been agreed upon by the exchanges. Usually 100 shares.
A group of shares traded in less than a standard trading unit is called an odd lot.

Question 4

Can you list nine benefits of common share ownership?

Answer 4

• potential for capital appreciation
• can receive dividend payments
• voting privileges
• favorable tax treatment in Canada of dividend income and capital gains
• get copies of annual reports
• right to question management at shareholder’s meetings
• limited liability
• marketability - the shareholdings of most public companies can easily be increased, decreased, or sold

Question 5

Can you list three risks of common share ownership?

Answer 5

• issuer has no obligation to pay dividends
• usually have very little influence over day to day operations of a company
• share prices can be volatile
• in terms of claims to assets, common shareholders fall behind everyone

Question 6

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

Answer 6

Capital appreciation is any increase in the value of a company’s assets including the value of its common shares.

Question 7

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

Answer 7

A regular dividend - company specifies amounts to be paid each year and barring any major collapse in earnings, those payments will be maintained.
An extra dividend is sometimes paid at the end of the company’s fiscal year. A bonus payment.

Question 8

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

Answer 8

Ex-dividend date is set at one business day before the dividend record date. Before this date, share are sold cum dividend (with dividend). On an after this date, shares are sold ex-dividend.

Question 9

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 9

The last day a stock trades cum dividend is the second business day before the business record date (so Monday). Yes, shareholder would be entitled to dividend.

Question 10

How does a dividend reinvestment plan work?

Answer 10

Some companies give DRIP as an option. The company diverts the dividends to the purchase of additional shares rather than a cash payment.

Question 11

Can you define dollar cost averaging?

Answer 11

A DRIP is an automatic savings plan that allows investors to reinvest small amounts of cash. Participating shareholders acquire a regular, gradually increasing share position in the company at a reduced average cost per unit.

Question 12

How do cash dividends compare to stock dividends?

Answer 12

Stock dividends are typically paid by rapidly growing companies that must retain a high proportion of earnings to finance future growth. Shareholders can sell if they need the cash.

Question 13

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

Answer 13

• Non-voting shares
• subordinate voting shares carry a right to vote
• restricted voting shares carry a right to vote subject to a limit or restriction on the number or percentage of shares that may be voted by a person, company or group

Question 14

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

Answer 14

• must be identified by the appropriate restricted share term
• disclosure documents must be sent to restricted shareholders
• restricted shares must be identified in the press with a code
• literature must properly describe the shares
• shareholders must be given notice of shareholders meetings
• minority approval required if new restricted shares are to be created

Question 15

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 15

Stock split - number of shares increases, stock’s price decreases
Reverse stock split - number of shares decreases, stock’s price increases
Value stays the same.

Question 16

Why do companies issue preferred shares compared to debt?

Answer 16

Preferred’s do not create the demands that a debt issue creates. They don’t usually have a maturity date (some may have a purchase or sinking fund). Company has flexibility in deciding whether or not to declare a preferred dividend

Question 17

Why do companies issue preferred shares compared to common shares?

Answer 17

Stock market might be falling or inactive or business prospects may be uncertain. Preferreds also offer the advantage of avoiding the dilution of equity that results from a new issue of common shares.

Question 18

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

Answer 18

Unpaid dividends accumulate in arrears. All arrears of cumulative preferred dividends must be paid before common dividends are paid or before the preferred are redeemed.
Non-cumulative no arrears accrue. Shareholder is not entitled to catch-up payments.

Question 19

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

Answer 19

Callable preferred shares can be called on by the issuer at a stated time and stated price. Shareholder will receive small premium.
Non-callable preferreds cannot be called on. Rarely used.

Question 20

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

Answer 20

A retractable preferred shareholder can force the company to buy back retractable preferreds for cash on a specific date at a specific price.
Soft retractable preferred refers to those retractables where the redemption value may be paid in cash or in common shares.

Question 21

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

Answer 21

Floating rate preferreds pay dividends in amounts that fluctuate to reflect changes in interest rates. If interest rates are high it is an advantage to the shareholder.

Question 22

What are the two circumstances in which an issuer would issue floating-rate preferred shares?

Answer 22

• during a period in the market when a straight preferred is hard to sell and the issuer does not want to make the issue convertible or retractable
• when the issuer believes that interest rates will not go much higher than the rate on the new issue date.

Question 23

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

Answer 23

Dow Jones Industrial Average.

The NASDAQ Composite Index.

Question 24

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

Answer 24

A stock index is a time series of numbers used to calculate a percentage change of this series over any period of time.
A stock average is the arithmetic average of the current prices of a group of stocks designed to represent the overall market or some part of it.

Question 25

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

Answer 25

It measures changes in the market capitalization of the stocks in the index. A stock’s weight within the index changes if its price or the number of shares outstanding changes.