Investments Topic 4 - Equities

Question 1

What is the definiton of equity

Answer 1

Equities means the gap between the value of an asset and any liabilities attached to it

Question 2

By law, a company must have ordinary shares

The amount and type of shares must be written down in 2 documents

Answer 2

• Memorandum of association – legal statement signed by all initial shareholders or guarantors agreeing to form the company
• Articles of association – written rules about running the company agreed by the shareholders or guarantors, directors and the company secretary

Question 3

Any companies listed on recognised UK stock markets are…companies

Answer 3

Limited liability

Question 4

How often can dividends be paid and what are the technical names for these timeframes

Answer 4

Interim – dividends paid every half-a-year
Final – dividends paid at end of trading year

Question 5

Important terms in relation to dividends:
* Record date
* Payment date
* ex-dividend date
* cum dividend

Answer 5

• Record date – Cut-off date where if an investor buys shares after that date they will not be entitled to the next set of dividends
• Payment date – date where dividends are paid out
• Ex-dividend date – usually 2 days before the record date, if holders or buyers have shares before this date, they qualify to receive the dividend that has been declared
• Cum dividend – if you buy before the ex-dividend date

Question 6

2 circumstances where a company will issue shares

Answer 6

• When the business first registers as a public company – known as initial public offering (IPO)
• When they need capital – sometimes known as secondary public offering

Question 7

Company’s IPO must be arranged in 2 ways

Answer 7

offer of sale or a placing

Question 8

Offer for sale – offered in 3 ways:

Names and descriptions

Answer 8

• Fixed price – shares sold at a fixed price, just below predicted market value. Offer is underwritten, which means large banks and companies agree to buy any remaining shares – this is good but costs the company millions, so dilutes the cash flow.
• Tender – used for smaller companies in which investors have uncertainty. Bids are made for the shares, then once they all come in, advisers decipher a ‘strike price’ which is a fair price based on all the bids and the predicted market price. Anyone who bid on or over the strike price will then most likely receive shares for the strike price. Sometimes, if they bid over the strike price they will pay the amount they bid for their shares.
• Subscription – a form of tender where bids must be at the minimum price (subscription price) and the number of bids must meet a predetermined number of shares. If there are not enough bids, the shares are not issued.

Question 9

What is Placing

Answer 9

Company offers its shares to bigger institutions through stockbrokers or advisers. This is most common for smaller companies due to the big charge on marketing and administrating shares to the public.

Question 10

Building societies could change to being a public company by either:

Answer 10

• IPO
• Converting reserves they have into share capital (creatin shares from their own reserves and giving them out for free to existing members).

Question 11

What is a rights issue

Answer 11

A rights issue is when the company will offer existing holders the opportunity to buy new shares in proportion to the number of shares they already hold. Or, they can take a cash amount that is equal to the share price

Question 12

‘Tail swallowing’ is a term used when

Answer 12

sells enough nil-paid rights for them to make most of their rights and buy more new shares without investing any money

Question 13

What is a scrip issue

Answer 13

where a company will redistribute some of its reserve money into newly formed shares. These shares will not change the value of the holder’s holdings but will give them 1 new share in a 1-for-1 scenario. This is done so that the company can gain funds from its reserves and put it into its share capital.

Question 14

What are share splits

Answer 14

when a company will change the par value of shares to make the shares cheaper to buy for secondary market investors. If they divide the par value by 4, existing shareholders will have 4x the amount of shares they had before, this making each individual share worth ¼ of the price.

Question 15

Ordinary shares:

Answer 15

• Most common type, carry voting rights
• Dividends available
• If company is wound up, they will be the last to be paid back
• Must have them by law

Question 16

Preference shares:

Answer 16

• Similar to loan stock but they pay dividends every 6 months
• Rank ahead of ordinary shares to repayment
• They pay a fixed dividend payment providing there is enough money to pay it
• Dividend is usually lower than that of an ordinary share due to it being less risky
• Do not carry voting rights
• Fixed dividends are good for if profits are low, bad if profits are high

Question 17

Cumulative preference shares

Answer 17

This is when current year’s dividends plus unpaid previous year’s dividends are paid, this takes priority over ordinary shares payment too.

Question 18

Participating preference shares

Answer 18

This is when you receive your fixed dividend but may also receive additional dividend which is a limited share of the company’s profits. Usually worked out as a percentage of the ordinary share’s dividends

Question 19

Convertible preference shares

Answer 19

Usually pay lower dividends but have the chance to convert to ordinary shares for a fixed price at a fixed date. This type of share usually costs more to buy, and if you miss the date, you have no option to change

Question 20

Warrants

Answer 20

issued by companies (usually investment trust companies) and give them the right to subscribe for a given number of ordinary shares. No dividends received as they hold no shares.

Question 21

what 2 markets are there to be traded on (equities)

Answer 21

the main market (LSE) and the alternative instrument market (AIM)

Question 22

Main market (LSE) key points (for companies that are listed on here)

Answer 22

• Will be on the stock exchange if the company meets very strict rules
• Large amount of financial information must be accurately disclosed
• Must have been trading for at least 3 years, and 25% of shares held by public
• ‘free float’ or ‘public float’ refers to shares that are readily able to be sold, and not held by shareholders who cannot/do not want to sell their shares

Question 23

alternative instrument market (AIM) key points

Answer 23

• Mainly intended for smaller companies – additional, separate market on the LSE
• Enables these smaller companies to have a bigger audience and offers a platform for shares to be bought and sold
• Rules for joining are much less strict
• Investors should be much more knowledgeable to trade in this market

Question 24

Shares can be bought through a

Answer 24

stockbroker

Question 25

Unlisted securities refer to shares in companies that are not

Answer 25

listed on stock exchange due to not being big enough or wanting to stay private.

Question 26

Investors in unlisted securities can benefit from a number of tax advantages, such as:

Answer 26

• Capital losses – if shares are bought (not transferred) and make a loss, they can be offset against other income. The issuing companies must qualify for the EIS to be able to receive this relief
• Interest relief – this is relief on the interest of loans used to buy shares in a close company, can claim tax relief at their highest rate. Investor must own 5% of shares or work for majority of their time in management. Relief not available if EIS income tax relief has already been paid.
• IHT business property relief available on 100% of shareholdings in unlisted or AIM-listed companies if shares have been held for at least 2 years

Question 27

4 key measures when assessing the value of a share

Answer 27

• Dividend yield
• Price-earnings ratio
• Net asset value
• Dividend cover

Question 28

Dividend yield

Answer 28

• Measure of income received in relation to the current share price
• Yield will fluctuate up and down

Question 29

Dividend cover

Answer 29

• Dividends paid out of profit, usually expressed as earnings per share (EPS)
• Some profits kept in the business; dividend cover is the amount of times that the dividends COULD be paid from their profit
• It is calculated by dividing the EPS by the net (paid out) dividend
• The higher the number, the higher confidence holders have that they will be paid

Question 30

Price/earnings ratio

Answer 30

• P/E is the share price divided by the earnings per share
• P/E shows how expensive a share is to buy compared to how much you will earn from it
• The higher the P/E, the more confidence the market has in the company

Question 31

Net asset value:

Answer 31

The NAV is the market value of all of a company’s assets, less liabilities, divided by the number of shares issued. This gives you the notional value of each share if the company was to be wound up.

Question 32

Gearing

Answer 32

Gearing - the extent of the company’s long-term borrowing, calculated by dividing the long-term debt by shareholder capital and reserves.

If the company has a higher gearing percentage, then it is using borrowing to fund the majority of its spending, which can be a red flag to investors.

Question 33

Factors affecting share prices:

Answer 33

• S&D
• Performance of the company
• External factors – Interest rates, economy, government policies etc.
• Market sentiment – the market as a whole sometimes tends to shuffle going up or down in response to worldwide issues etc

Question 34

Costs involved in shares

Answer 34

• The spread – difference between buying price and selling price (profit)
• Commission
• Stamp duty – payable whenever shares are bought
• Panel of takeovers and mergers levy – charged on sales over a certain threshold

Question 35

Save-as-you-earn-linked (SAYE-linked) share option schemes

Answer 35

• Offers employees and directors the opportunity to save over a fixed period
• At the end of the period, they can use the savings to buy shares in the company at a good price
• Can save between £5-£500 per month
• Contributions deducted from pay but don’t have tax relief
• Contract for 3-5 years
• Price of shares must not be less than 80% of market value
• No income tax arises when shares are exercised
• Employee can take saved cash or buy shares
• Can transfer shares into ISA or stakeholder pension scheme within 90 days

Question 36

Free shares

Share incentive plans

Answer 36

• Employer defines criteria on which free shares are awarded – e.g. salary, length of service or performance target
• Evidence must be supported for performance-based reward
• Max. amount annually granted is £3,600
• Shares must be held for the minimum of 3 years up to 5 years, otherwise income tax is payable on the lower market value of the shares on the exit date

Question 37

Partnership shares

Share incentive plans

Answer 37

• Employees can sacrifice up to 10% of their salary – max. of £1,800 annually
• In return, they get partnership shares
• No income tax or NICs paid on salary sacrificed
• Shares can be withdrawn at any time, but charges apply if you take them out before 3 or 5 years

Question 38

Matching shares

Share incentive plans

Answer 38

• Employer can offer to pay matching shares for employees who buy partnership shares and are held in trust for the employees
• Must be held for 3 to 5 years
• Taxation of these is the same as free shares

Question 39

CGT on these schemes is only payable if you withdraw the shares…

Answer 39

before they are sold