CHP 15

Question 1

1. Basic features of ordinary shares (equities)

Answer 1

Held by the owners of the organization.
Holders of ordinary shares have the right to receive all distributable profits (after debt holders and preference shares) and can vote.

Question 2

Equity Cashflows

Answer 2

No fixed rate, only share in company profits.
This is done via dividend payments that are variable. It is expected that company profits will increase over time and thus dividends will also increase.
In order to predict cashflows, an assumption regarding div growth is required. The cashflows are uncertain.
The relationship between div and price is not simple, companies can hold back for projects or even out div payments over time.
Other methods of profit distribution is also possible, e.g. share buyback.
Since there is no end date, the possibility the company may fail is important. (dividends will cease) Thus the cashflows are uncertain and could be lower than the initial cashflow (ordinary shares gets what is left after creditors and pref shares).

Question 3

1.4. Quoted/listed shares

Answer 3

In order to get listed, the companies must comply with certain standards, this gives the investor some protection.
Listed shares are generally more marketable than unlisted shares and hence easer to value.

Question 4

2. Equity categorization

Answer 4

Shares may be classified by size of company or by expected profits growth or by industry.

Question 5

2.1. Categorization by industry

Answer 5

Equity analysts usually specialize in a certain industry and confine their research and advice to that for two reasons: practicality and correlation of investment performance.

Question 6

2.1. Categorization by industry

Practicality:

Answer 6

• Factors affecting one company in an industry is likely to affect the others
• Information for companies will likely come from a common source
• Specialization – hard to be an expert in too many fields
• Grouping of equities in some common factor gives structure to decision making and assists in portfolio classification and management.

Question 7

2.1. Categorization by industry

Correlation of investment performance

Answer 7

There is higher correlation of investment performance of companies within the industry than with others.
Share price reflect changes in the operating environment. This affects companies in the industry similarly.
For this reason, listing shares are divided into industries and subsectors.
Factors to affect companies in the same sector include:
• Resources
• Markets
• Structure (financial structure is similar thus effects of tax and interest rate is similar)

Question 8

2.1. Categorization by industry

Problems with industry groupings

Answer 8

Companies operating in more than one industry, differences in the industry e.g. size or operating in different niches.

Question 9

2.2. Preference shares

Answer 9

Ranks ahead of ordinary shares.
Entitled to a specified dividend but not to residual profits.
Although a part of share capital, it is more like fixed interest bonds.