Equities Flashcards
1
Q
What is an ordinary share? (5)
A
- The most common type of equity - often called ‘common shares’
- Gives ordinary shareholders the right to:
1. Vote - in general meetings
2. Dividends - once interest has been paid and preference dividends have been satisfied. If a company is unprofitable, shareholders will lose out
3. Surplus on winding up - surplus shares are allocated amongst shareholders once liabilities have been paid in the winding up of a company - Deferred shares - shares are worthless during deferral period - then converted into standard ordinary shares during specific events e.g company hitting targets or company floatation
2
Q
What is a preference share? (3)
A
- Fixed dividends. Dividends are paid after interest but before ordinary dividends and can also be rolled up (cumulative preference shares) and converted into common share (convertible preference shares). Others include redeemable and participating shares
- No voting rights - no decision making power given to shareholders
- A company cannot pay ordinary shares without paying off any preference dividends due first - preference shares take preference over ordinary shares
3
Q
What is the process of incorporation for public and private companies? (5)
A
- When a company comes into existence as a separate legal entity
- Companies may be private or public companies
- Name: public company - public limited company - PLC. Private - must include Ltd
- Share capital: min allotted share capital for a PLC is £50,000. There is no min for private companies
- Transferability of shares: public companies are permitted to freely trade in secondary markets to the public. Private companies cannot
4
Q
What is a close company? (1)
A
- One that is under the control of 5 or fewer persons or is under control of the directors alone
5
Q
What is a shareholder? (3)
A
- Also known as a equity holder or owners of the company
- They invest capital into a business and receive shares in return - greater the shares held, larger the proportion of the company they hold
- Shareholders own the business, but director manage the day-to-day of the company. Executive directors are appointed and can be removed by shareholders by way of voting
6
Q
What is authorised share capital? (4)
A
- The max number of shares a company is permitted to issue based on the shares nominal value
- e.g. if a companies share capital is £1,000,000 it could issue 2,000,000 50p nominal share values
- The nominal value is the fixed legal value - not the market price
- This can be changed by approval of shareholders at general meetings
7
Q
What is issued share capital? (5)
A
- The number of shares the company has allotted to shareholders based on nominal value
- e.g. a company has authorised 2,000,000 but only 500,000 has been issued, therefore additional capital is required up to 1,500,000
- Issued share capital can be divided into paid up share capital - the amount that has been paid for by shareholders
- Called up share capital - the amount of share capital still to be paid
- Issued share capital is never allowed to exceed authorised share capital
8
Q
What is a participating preference share? (3)
A
- Fixed rate dividend - percentage of the nominal value of the share e.g. 5% of £1m NPV will entitle the shareholder to 5p dividend each year for every share held
- Participating rights - additional dividends may be paid over and above the fixed rate, should the company be particularly profitable
- Calculated according to a profit related formula
9
Q
What problem do American Depositary Receipts seek to resolve? (1)
A
- US investors often like to buy dollar denominated shares and receive dollar dividends. Unless a non-US company issues dollar denominated shares, they might lose out on potential US investors
10
Q
What are the features of an ADR? (3)
A
- Used by non-US companies in order to encourage US investors to buy an equity stake
- Created and issued by US banks on behalf of the company
- Represents shares and is denominated in US dollars
11
Q
What is a global depositary receipt? (4)
A
- Created and issued by non US banks
- May be denominated in a currency other than USD
- Marketed primarily to non-US investors
- Traded on non-US exchanges
12
Q
What are the privileges of ADRs? (2)
A
- Receive most privileges of underlying shares including voting rights and dividends. Dividends will be paid in dollars
- E.g. Brit plc will pay dividends in GBP to Bank A. Bank A will convert them into USD and pass them on to the investor/ADR holder
13
Q
What is nominal value? (1)
A
- Face or par value - does not represent the market value of the share
14
Q
What is market price? (3)
A
- The price of the share e.g. it’s value. Should a company issue shares at a value above nominal, the excess is called the share premium
- Total market cap = shares issued x share price. Within this figure is the free float market cap - market cap solely based on the percentage of share freely available for trading on the open market
- A company can reduce its free float without affecting its overall market cap
15
Q
What are dividends? (3)
A
- Distribution of profits to shareholders - are variable for ordinary shares and fixed for preference shares
- Dividends paid to invidious - company pays dividends from profits after tax, dividends paid to individuals are considered gross income - therefore dividend income tax is paid on this
- Dividends paid to corporate entities - where dividends are paid to other UK companies, it is received as franked investment income (FII) which is deemed as tax paid - no income tax liability. This applies to all organisations that paid corporate tax - ICVCs, unit trusts, etc
16
Q
What is dividend policy? (4)
A
- Directors will look at the performance of their company and decide what divided to pay out
- Manay companies will have dividend policies in place to suggest how directors will decide this
- The more a company pays out in dividends, the less there could be to reinvest
- Payment of dividends today could reduce the potential for future dividends
17
Q
What is dividend signalling theory? (4)
A
- A change in a firm’s dividend policy can have an effect on its share price
- A rise in dividend payment is viewed positive - shows confidence in future earnings, results in increase in share price
- A reduced in dividend is viewed negative - lack of confidence, decrease in share price
- Theory that could lead a company to pay out an uncovered dividend - where a company distributes dividend greeted than the current earnings per share in order to signal that although times are rough, profits are expected to improve
18
Q
What is a stable dividend? (5)
A
- Some companies seek to attract income seeking investors such as pension funds by offering consistent levels of dividends
- Can lead to steady growth in the company share price - surplus profits are reinvested into the company
- Investors can use the dividend cover ratio to identify whether the level of dividend paid is sustainable
- Dividend cover = EPS/dividend per share
- A dividend cover above 1 is sustainable, above 2 is more than comfortable
19
Q
What is an uncovered dividend? (3)
A
- When a company distributes dividends greater than the current EPS
- To do this a company must use the previous years earnings
- Unsustainable and is used to maintain an expected level of dividend to shareholders or signal that, during tough time, that profits are expected to improve
20
Q
What is the differences between absolute and relative valuation models? (2)
A
- Absolute - based on absolute returns and discounting techniques. These are used to estimate an intrinsic value of equity as the present value of future returns
- Relative - estimate the value of equity as some measure of earnings power (e.g. profit) times an appropriate multiple. Other examples of earning power includes sales, net assets (book value) and cash flow
21
Q
What is the total holding period return? (1)
A
- The holding period return from a share over a given period is calculated as the capital gain plus income received, all divided by the original amount invested
22
Q
What is a preference share valuation? (4)
A
- Applies principle of discounted cash flows
- The relevant cash flows are the future dividend receipts
- Dividend streams are constant
- Perpetuity formula is used
23
Q
What is Gordon’s Growth Model? (4)
A
- The predictability of a future dividend with ordinary shares is uncertain, as the level of dividends depends on performance
- GGM factors in to the calculation a change in the dividend - assumes that the level of dividends paid over time by a company increases at a constant rate (g)
- GGM calculates the ex-dividend price of a share, assuming constant dividend growth and payments made at the end of each period in perpetuity.
- Ex dividend share price = D0 (1+g)/(r-g)
24
Q
What are some limitations of Gordon’s Growth Model? (3)
A
- Too simple
- Purely quantitative model and does not take into consideration aspects such as company or industry trends
- Focuses on constant dividend growth and ignores factors such as the possibility of high initial growth that levels off as the company matures
25
Q
What are warrants? (4)
A
- Securities issued by a company
- Give the own the right to subscribe for new shares in the company at a fixed price (exercise price) on a future date (expiry date)
- Typically issued to make a security look more attractive - detachable (can become separate traceable instruments) and non detachable (permenantly fixed to the asset)
- Warrants are some of the riskiest investment available on the LSE.
26
Q
What are the 2 types of warrant values? (2)
A
- Formula value - the built in profit - intrinsic value. Formula value can only be positive or 0. It can never be negative, as a warrant is a right to buy at a set price, not an obligation. If you were not going to make money on the exercise of you r right, you would not exercise it. Formula value = current share price - exercise price
- Premium value - is the remained of the warrant value - sometimes called time value. Premium value = warrant price - formula value
27
Q
What is percent premium? (1)
A
- Premium value is expressed as a percentage of the current share price
28
Q
What’s the difference between a call option and warrant? (5)
A
- Both are very similar - high risk and in the way they work
- A warrant gives the holder the right to buy new shares in a company - options is the right to buy shares in the secondary market. When warrants are exercised, the company’s share capital increases and the company delivers shares to the investor
- A warrants life tends to be a number of years, whilst options are shorter term to a matter of months
- The seller of an option is always responsible for delivering the shares if it is exercised. The seller of the warrant sells a right to buy shares from the company and is not responsible for delivering shares
- Equity warrants are traded on stock exchanges whilst equity options are traded on derivatives markets
29
Q
What are covered warrants? (6)
A
- Issued by investment banks not companies
- Existing shares are delivered
- Maturity is 6 to 12 months
- Traded on the LSE
- Calls and puts are available
- Cash
