Reading 39: types of equity investments

Question 1

The advantage of participating preferred shares versus non-participating preferred shares is that participating preferred shares can:
obtain voting rights.
receive extra dividends.
be converted into common stock.

Answer 1

Participating preferred shares can receive extra dividends if firm profits exceed a pre-specified level and a value greater than the par value if the firm is liquidated. (LOS 39.a)

Question 2

Which of the following best describes the benefit of cumulative share voting?
It provides significant minority shareholders with proportional representation on the board.
It prevents minority shareholders from exercising excessive control.
If cumulative dividends are not paid, preferred shareholders are given voting rights.

Answer 2

Cumulative voting allows minority shareholders to gain representation on the board because they can use all of their votes for specific board members. (LOS 39.b)

Question 3

Compared to public equity, which of the following is least likely to characterize private equity?
Lower reporting costs.
Potentially weaker corporate governance.
Lower returns because of its less liquid market.

Answer 3

Private equity has less liquidity because no public market for it exists. The lower liquidity of private equity would increase required returns. (LOS 39.c)

Question 4

Global depository receipts are most often denominated in:
the currency of the country where they trade and issued outside the United States.
U.S. dollars and issued in the United States.
U.S. dollars and issued outside the United States.

Answer 4

Global Depository Receipts are not listed on U.S. exchanges and are most often denominated in U.S. dollars. They are not issued in the United States. (LOS 39.d)

Question 5

Which of the following types of preferred shares has the most risk for investors?
Putable shares.
Callable shares.
Non-putable, non-callable shares.

Answer 5

Callable shares are the most risky because if the market price rises, the firm can call in the shares, limiting the investor’s potential gains. Putable shares are the least risky because if the market price drops, the investor can put the shares back to the firm at a predetermined price. The risk of non-putable, non-callable shares falls in between. (LOS 39.e)

Question 6

Which of the following best describes the book value of equity?
Management should attempt to maximize book value of equity.
Book value of equity decreases when retained earnings increase.
Book value of equity reflects investors’ perceptions of the firm’s future.

Answer 6

The primary goal of firm management is to increase the book value of equity. It increases when retained earnings are positive. The market value of equity reflects the collective expectations of investors about the firm’s future performance. (LOS 39.g)

Question 7

Which of the following causes of an increase in return on equity is most likely a positive sign for a firm’s equity investors?
A firm issues debt to repurchase equity.
Net income is increasing at a faster rate than book value of equity.
Net income is decreasing at a slower rate than book value of equity.

Answer 7

Net income increasing at a faster rate than book value of equity generally would be a positive sign. If a firm issues debt to repurchase equity, this decreases the book value of equity and increases the ROE. However, now the firm becomes riskier due to the increased debt. Net income decreasing at a slower rate than book value of equity would increase ROE, but decreasing net income is not a positive sign. (LOS 39.h)