Equity Investments, Commodities and Property Flashcards
Characteristics of Ordinary Shares?
Confer an ownership stake in the company.
Represent the risk capital of the company and are the last to be paid out in the event of liquidation.
Holders of ordinary shares have a right to share in the profits of the company – dividends – and a right to attend and vote at company meetings.
Characteristics of Preference Shares?
Less risky than ordinary shares but are potentially less profitable.
Entitled to receive a fixed dividend each year as long as the company feels it has sufficient profits.
These dividends must be paid before any dividends to ordinary shareholders. Holders of preference shares do not have the right to vote on company affairs but, they are paid out before ordinary shareholders in the event of liquidation.
Type of preference share
Cumulative preference shares:
If the dividend is not paid, the right rolls over and arrears have to be paid before any ordinary dividends.
Participating preference shares:
Additional dividends may be paid if the company exceeds certain levels of profit.
Redeemable shares:
Most preference shares have an indefinite life, but they may be issued with a specified redemption ate when the company will pay the nominal value.
Convertible shares:
These have conversion rights allowing the preference shares to be converted into ordinary shares.
What is the difference between primary market and secondary market?
Primary market is the market for equities which are sold or issued for the first time.
Secondary market is the market on which existing shares are traded e.g. LSE.
Advantages and disadvantages of investing in the primary market
Advantages are investing in an IPO:
- Shares priced at attractive level to ensure good take-up.
- Transaction costs will generally be lower.
- May be a limited supply of shares, forces price up in the future.
Disadvantages:
- No track record for the company’s business.
- Companies generally list via IPO at times when it is favourable - accounting window dressing.
- Shares may be scaled-back if the issue is over-subscribed.
- initial share price may be high and volatile.
What is an offer for sale?
Issuing house (Investment bank) will buy the shares from the company at a lower price than it intends to sell them, so they can make a profit.
Company directed will prepare a detailed prospectus called an offer document, which needs to be assessed by an independent.
An advert called a formal notice will be placed.
Describe the two methods of pricing.
Fixed price: Fixed price is stated and offered to encourage purchase, hard to get the balance correct.
Tender: Investors make bids for amounts of stock and the price they are willing to pay. Based on the bids a strike price is set, with anyone who bid above the strike price paying the strike price for the stock. advantage is the market has had an input into the pricing of the share.
Placement: shares are marketed directly to preferred, specially selected institutional investors.
Introductions: No new shares issued, provides foreign companies new markets to sell their shares on and domestic investors access to shares of foreign companies.
List five benefits and five drawbacks of investing in a personally selected portfolio of direct equities compared to a discretionary managed portfolio.
Benefits
* No advice charges/management charges.
* Dealing costs can be kept to a minimum.
* Greater personal control of investments/bespoke.
* Share voting rights/additional benefits.
* Speed.
Drawbacks
* Less access to professional management/information.
* Limited access to institutional funds/esoteric investment areas/funds.
* No netting of trades/lower spreads.
* Time required to manage.
* Lack of regulatory oversight/protection.
How do you calculate the value of a company (market cap)
Shares issued x market value = capitalisation
What is Gordon’s Growth Model (GMM)
method for calculating a share price. It helps place a price on value of an ordinary share with reference to the dividend.
Most recent dividend / (investors required return - growth rate of dividend)
Problems of the GMM?
If the required return is less than the growth rate of the dividend, the model gives a negative share valuation.
If the required return is equal to the growth rate of the dividend, formula collapses as the result approaches infinity.
its only valuing the share based on dividend, and this fundamental needs to be considered against other factors such as how much retained earnings the company has.
What is a rights issues and how are they calculated?
An invitation to shareholder to buy new shares in proportion to their existing holdings, ensuring existing shareholders are given first refusal. Typically not good news and done to raise funds to pay a debt or refinance the company.
Expressed as a ratio and offered at a discount.
Theoretical ex-rights = price of the share after the rights issue, which will be lower.
A company with £4m existing shares undergoes a 1:4 rights issue. The subscription price is £1.80. The share price of the existing shares before the rights issue is £2.00; calculate the theoretical ex-rights price:
4m shares x £2.00 = £8m
1m shares x £1.80 = £1.8m
5m shares = £9.8m
£9.8m / 5m = £1.96 per share. = new price
What is the theoretical nil paid price
The price an investor would (theoretically) pay for the right to buy a discounted share (in the rights issue).
Selling price (rights subscription) = £1.80
ex-rights price (new share price) = £1.96
difference, theoretical nil paid price = £0.16 - the price an investor would pay for the right to purchase the discounted share.
What is Swallowing the tail and how is it calculated?
Investors sell some of their rights and take up the offer with the money they make.
number of rights x subscription price / theoretical ex-rights price.
say an investor had 4000 rights..
4000 x £1.80 / £1.96 = 3673
If you sold 3673 rights at the nil-paid price of £0.16, you would have £588. This would allow you take up the remaining 327 rights at the subscription price of £1.80.
£588 / £1.80 = 327 rights
327 rights x £1.80 = £588
What is a bonus issue and how is it calculated.
Method of issuing new shares to existing shareholders at no cost. Has the effect of reducing the value of the share price, but the value of the company is split over a large number of shares.
company offers a 1 for 2 bonus issue, with the current share price £8; calculate the theoretical ex-bonus price.
Before: 2 shares x £8 = £16
After: 3 shares = £16
share price after the bonus (ex-bonus price) = £16/3 = £5.33
Company has the same market cap:
2 x £8 = £16
3 x £5.33 = 1£6
What is a share split and how is it calculated?
Shares in issue are split into a greater number, each with a smaller nominal value: one £2 ordinary share is split into two £1 ordinary shares.
The total value of the company is split over a larger number of shares, with a lower market price.
Bray PLC has 1m shares in issue. Each share is worth £10. A 5:1 share split is declared. if your client holds 1,000 shares, what is the effect on the share price?
Client will have 5 shares for every 1.
Client had 1,000 shares valued at £10 = £10,000
they now have 5,000 shares valued at £2 = £10,000
£10,000 / 5,000 shares = £2
What is an Equity warrant and how is it calculated?
Warrants give the owner of the share the right, but not an obligation, to purchase new shares at a fixed price in the future.
The expiry date is usually months or years in the future. Warrants are issued by companies to raise money.
The value of a warrant is made up of two items: strike/exercise price and premium.
If the strike price is £5 and the market value of the share is £4, the premium will be £1- positive so it has an intrinsic value.
premium = (strike price + cost of warrant) - market price / market price
Identify three main risks specific to investing in equities on a passive basis using ETFs and state one reason for each risk identified.
Market/Systematic Risk.
* Limited protection in falling market/will follow market down/cannot hold cash. or No ability to outperform in rising market/will only deliver market return.
Style Risk.
* Replication strategy may cause underperformance/tracking error/drift from index return.
Counterparty Risk.
* Failure of counterparty provider.
What is earnings per share (EPS) and how is it calculated?
Profit that could have been paid as an ordinary dividend, calculated after all expenses have been deducted.
Could be distorted by accounting policy or where share issues/buy backs have taken place.
(net income - preference div) / number of ordinary shares
What is Price Earnings Ratio (PE ratio) and how is it calculated?
Measures how highly investors value a company as a multiple of its earnings. It is the time, in years, it would take the current EPS to repay the share price.
A high PE ratio indicates a greater perceived ability to grow EPS compared to competitors, producing a higher quality earnings, being a potential takeover target or experiencing a temporary fall in profits.
A high PE ratio (relative to other companies) shows that investors expect the company to achieve above average performance and growth.
PE = share price / EPS
High PE = market expects high growth
Low PE = market expects low growth
Failings of PE ratio
Will generally be based on historic data
its only One number and rather simplistic
PE ratio levels must be considers relative to sector and competitors
PE levels should be compared to past levels and trends in industry sector
Share price is set by the issuer and not dictated by the market.
Share price may change significantly after listing/volatility of share price around IPO.
Only one factor/leaves out other information.
What is the Price Earnings Growth (PEG) ratio and how is it calculated?
More accurate form of PE ratio. Shows projected growth in earnings per share in relation to a company’s share price. Indicates a share is expensive and has limited growth.
PEG = PE ratio / earnings growth rate.
PEG higher than 1 are generally considered overvalued.
What is dividend yield and how is it calculated?
Provides indication of the dividend income return on a share. Can compare dividend with other against other investments.
Low dividend yield may indicate an overvalued share price.
High yields may indicate low growth or underrated by the market.
Dividend yield = DPS / Market price per share
What is dividend cover and how is it calculated?
Shows how many times a company could have paid out its dividends based on the profit for the year; a measure of strength of dividend payment relative to the earnings.
dividend cover = EPS / DPS
Higher the dividend cover, less likely that dividends will reduce if profits fall,
Cover between 1.5 and 2 is often considered healthy. Cover less than 1 means not covered.
