Topic 7 Flashcards
What are equities?
Equities, also known as ordinary shares, are securities issued by companies, representing ownership in the company.
What are the two main rights of equity holders?
- Equity holders have the right to receive dividends (a share of the company’s profits)
AND
- To vote on decisions about how the company is run.
Why is direct investment in shares considered high risk?
Direct investment in shares is high risk because if the company fails, shareholders can lose all the capital invested.
Why might an investor want to invest across a range of shares instead of just one?
Investing across a range of shares reduces risk by diversifying across different companies and sectors, helping to mitigate the impact of any single company’s failure.
How do share prices fluctuate in the short term, and what factors influence these fluctuations?
Share prices can fluctuate due to factors like:
- Company profitability
- Supply and demand for shares
- The strength of the UK and global economy
- Market sector performance.
What long-term advantage do equities provide over deposit-based savings?
In the long term, equities generally offer higher growth than deposits and outpace inflation, despite short-term price volatility.
Where can investors find the rights associated with a particular share?
The rights are set out in the company’s articles of association, which can be examined at the company’s registered office or Companies House.
How does investing in equities compare with deposit-based savings over the long term?
In the long term, equities tend to provide higher growth than deposit-based savings and outperform inflation, although they are subject to greater short-term volatility.
Why is it important for investors to understand the rights attached to a particular share before investing?
Different shares may have varying rights, and understanding these helps investors know their entitlements, such as dividend payments and voting rights, which can impact their investment returns.
What are some products that help investors diversify their equity investments to reduce risk?
Products like unit trusts allow investors to spread risk by investing across a range of companies and sectors, reducing the impact of poor performance from any single company.
What is the London Stock Exchange (LSE)?
The LSE is the UK’s market for trading stocks, shares, gilts, corporate bonds, and options, and it has existed for hundreds of years.
What are the two markets for shares on the LSE?
The two markets are the main market and AIM (Alternative Investment Market).
What are the requirements for a company to be listed on the main market?
To be listed, a company must conform to the FCA’s Listing Rules, including having traded for at least three years and ensuring that 25% of its issued share capital is held by the public.
What is the primary market on the LSE?
The primary market is where companies raise finance by selling securities to investors, either by going public or issuing more shares.
What is the secondary market on the LSE?
The secondary market is where investors buy and sell existing securities, and it is larger in terms of daily traded securities than the primary market.
Why might a company choose to list on the main market of the LSE?
Listing on the main market offers advantages such as greater liquidity, which makes it easier for investors to buy and sell shares;
and,
Greater access to capital, allowing companies to raise additional funds more easily.
What role does the FCA play in the listing of companies on the LSE?
The FCA, as the UK Listing Authority (UKLA), ensures that companies meet stringent requirements under the Listing Rules, including financial disclosures and public shareholding thresholds.
What is the main difference between the primary and secondary markets on the LSE?
The primary market is where companies issue new securities to raise funds, while the secondary market is where investors trade existing securities.
What advantages do companies gain by conforming to the LSE’s main market requirements?
Companies gain access to a larger pool of investors, improved visibility, and the ability to raise funds more easily due to the increased credibility and transparency associated with a listing on the main market.
Who oversees the Listing Rules for companies on the LSE?
The Financial Conduct Authority (FCA), acting as the UK Listing Authority (UKLA), oversees the Listing Rules for companies on the LSE.
How long must a company have been trading to qualify for a full listing on the LSE?
A company must have been trading for at least three years
What percentage of a company’s issued share capital must be in public hands to be listed on the main market of the LSE?
At least 25% of the company’s issued share capital must be in the hands of the public.
Why might investors prefer the secondary market over the primary market?
Investors may prefer the secondary market because it allows them to buy and sell existing securities more frequently, offering greater liquidity and flexibility compared to the primary market.
What are the advantages for a company of going public on the LSE’s primary market?
The main advantages include raising capital by selling shares;
and,
Increased visibility in the financial market, which can attract more investors and create better liquidity for the company’s shares.
What is the main purpose of AIM?
AIM’s main purpose is to enable new and small companies with growth potential to raise capital by issuing shares and allowing those shares to be traded.
What types of companies are AIM primarily intended for?
AIM is primarily intended for new, small companies with the potential for growth.
How do the rules for joining AIM compare to the official list?
The rules for joining AIM are fewer and less rigorous compared to those for joining the official list, making it easier for smaller companies to join.
What are two key benefits for companies joining AIM?
The two key benefits are:
- Access to public finance.
and
- An enhanced public profile.
Why might smaller companies prefer AIM over the main market?
Smaller companies might prefer AIM because the requirements are less rigorous, making it easier and more affordable for them to raise capital and gain public exposure.
What advantage does joining AIM provide besides raising capital?
Besides raising capital, joining AIM allows companies to enhance their public profile and reach a wider audience.
How does AIM support small companies in their growth?
AIM supports small companies by giving them access to public finance through share issuance and providing a platform for their shares to be traded.
What is the FTSE 100 Index?
The FTSE 100 Index, commonly known as the Footsie, is an index of the top 100 companies in the UK by market capitalisation, where each company is weighted according to its market value.
What companies are included in the FTSE 250 Index?
The FTSE 250 Index includes the next 250 companies by market capitalisation, following the top 100 companies listed in the FTSE 100.
How are companies weighted in the FTSE 100 Index?
Companies in the FTSE 100 are weighted according to their market value or capitalisation.
What is the FTSE 350 Index?
The FTSE 350 Index combines the companies listed in the FTSE 100 and FTSE 250 indices, covering the top 350 UK companies by market capitalisation.
How many companies are included in the FTSE All-Share Index?
The FTSE All-Share Index includes around 600 companies, split into different sectors.
What does the FTSE All-Share Index measure?
The FTSE All-Share Index measures price movements of shares across various sectors.
Why might investors choose to track the FTSE All-Share Index?
Investors might track the FTSE All-Share Index to get a broad overview of the entire UK stock market, as it represents a wide range of sectors and company sizes, giving a more comprehensive picture than narrower indices like the FTSE 100 or 250.
What is meant by ‘Market Capitalisation’?
The market value of a company, calculated by multiplying the number of
shares in issue by the share price.
Who are the individual and institutional investors in the financial market?
Individual and institutional investors include entities such as pension funds and life assurance companies that invest money in the market.
What role do banks and other traders play in the financial market?
Banks and other traders issue, buy, or sell shares or derivatives.
What type of securities can governments and corporations issue in the market?
Governments, public institutions, and corporations issue securities such as gilts, corporate bonds, and local authority bonds.
What is the role of investment banks in the market?
Investment banks facilitate the issue of new securities.
What type of investors might invest in pension funds and life assurance companies, and how do they participate in the financial markets?
Institutional investors such as pension funds and life assurance companies invest on behalf of individuals, pooling large sums of money to invest in stocks, bonds, and other financial products, contributing significantly to market liquidity.
Why are banks and traders key participants in the issuance and trading of shares and derivatives?
Banks and traders provide the necessary infrastructure for the issuance and trading of shares and derivatives, creating liquidity and enabling price discovery in financial markets.
How do governments and corporations use bonds and gilts in the market, and what purpose do these securities serve?
Governments and corporations issue bonds and gilts to raise funds for various projects or operational needs, offering investors a fixed income and a relatively low-risk investment.
Why might institutions prefer to engage in OTC trading rather than on a formal exchange?
Institutions may prefer OTC trading because it allows them to trade large blocks of securities with little publicity, avoiding significant market movements that might result from public trades.
What is OTC trading?
OTC trading refers to the trading of large blocks of securities between institutions, often outside of formal exchanges, with limited publicity about the price or the companies involved.
Is OTC trading common among individual private investors?
No, OTC trading is not very common among individual private investors but is more common between institutions.
What is another term used to describe OTC trading involving large blocks of securities?
OTC trading involving large blocks of securities is sometimes referred to as ‘dark pools’.
How does OTC trading differ from traditional exchange trading in terms of transparency?
OTC trading is generally less transparent than exchange trading, as the details of the trades (such as the price and the companies involved) are not as widely publicized, making it more difficult for outsiders to assess market conditions.
What might be the advantage for institutions trading in ‘dark pools’?
Trading in ‘dark pools’ allows institutions to execute large trades without significantly affecting the market price of the securities, which could happen if the trades were made in a more public forum like a traditional stock exchange.
What risk do shareholders in a limited liability company face?
Shareholders risk losing the value of their investment if the company goes into liquidation, though they are not liable for the company’s debts.
Why might investors expect higher returns from shares compared to deposit-based investments?
Investors expect higher returns from shares because equities are riskier, with the potential to lose all their investment, unlike deposit-based investments where capital is protected.
What does ‘ex-dividend’ mean?
‘Ex-dividend’ refers to shares that are traded without the entitlement to the next dividend because the administrative process of paying dividends has already begun.
What happens to the share price when it becomes ex-dividend?
The share price typically falls by approximately the dividend amount when it becomes ex-dividend.
What does ‘cum-dividend’ mean?
‘Cum-dividend’ means the shares are purchased before they go ex-dividend, and the purchaser is entitled to the next dividend payment.
Why would an investor prefer to buy shares cum-dividend?
An investor might prefer to buy shares cum-dividend because they will receive the upcoming dividend, providing additional income from their investment.
What could cause the price of a share to drop on the day it becomes ex-dividend?
The price drop is due to the fact that new buyers of ex-dividend shares are not entitled to the upcoming dividend, so the share price typically falls by approximately the dividend amount to reflect this.
In what situation might an investor choose to invest in equities despite the risk of losing their entire investment?
An investor might choose to invest in equities because, over the long term, equity markets have generally provided higher returns than safer, deposit-based investments.
What happens if an investor purchases shares after the ex-dividend date?
The investor will not receive the upcoming dividend payment; it will go to the previous owner of the shares.
Why do equity investors run the risk of losing their entire investment?
If a company goes into liquidation, shareholders may lose all their invested capital, as they rank last in terms of repayment.
How does the risk level of equity investments compare to that of deposit-based investments?
Equity investments are generally riskier because the company’s performance can fluctuate, potentially leading to losses, while deposit-based investments provide more security for capital.
Why might equity markets provide higher returns over the long term compared to other investments?
Equity markets tend to grow with the overall economy, leading to potential capital appreciation and dividends over time, whereas deposit-based investments offer lower returns but more security.
What are the two primary rights of a shareholder in a limited company?
Shareholders have the right to receive dividends;
and,
The right to participate in company decisions, typically by voting in shareholder meetings.
What is the formula for Earnings Per Share (EPS)?
EPS = Net profit / Number of shares
What is Dividend Cover?
How much of a company profits are paid as dividend
What is the formula for Price to Earnings ratio (P/E ratio)?
Share price / earnings per share
What are the two primary forms of financial returns shareholders seek from their shares?
The two forms are capital growth (increase in the share price) and dividends (income from distributable profits).
How does a company’s decision to retain profits rather than distribute them as dividends affect shareholders?
When a company retains profits for expansion, shareholders may not receive higher dividends immediately, but it could lead to long-term capital growth if the business expands successfully.
What is earnings per share (EPS), and how is it calculated?
EPS is the company’s post-tax profit divided by the number of shares. It shows how much profit each share contributes but is not necessarily the dividend amount paid to shareholders.
What does dividend cover measure, and why is it important to investors?
Dividend cover measures how many times a company’s earnings can cover its dividend payments.
A dividend cover of 2.0 or more is generally seen as healthy, indicating that the company is not paying all its profits as dividends, which allows it to retain profits for future growth.
What would it mean for investors if a company’s dividend cover is below 1.0?
If dividend cover is below 1.0, it means the company is paying more in dividends than it earned in profits, potentially using retained earnings from previous years.
This may signal financial instability.
How is the price/earnings (P/E) ratio calculated, and what does it signify?
The P/E ratio is calculated by dividing the share price by earnings per share.
It indicates the market’s expectations for a company’s future earnings growth.
Why is it not always a good idea to buy a share with a high P/E ratio?
A high P/E ratio could mean that future earnings expectations are already factored into the share price, meaning the stock might be overvalued.
It is essential to consider other indicators before investing.
What does a low P/E ratio suggest about a company’s shares?
A low P/E ratio indicates that the share may be undervalued or not in high demand, but this doesn’t necessarily mean it’s a bad investment.
It could signal an opportunity if the company’s prospects improve.
How are dividends taxed?
Dividends are paid without the deduction of tax but are subject to income tax if they exceed the individual’s dividend allowance (DA). The tax rate depends on the tax band into which the dividend income falls.
What is the dividend allowance (DA)?
The dividend allowance (DA) is the amount of dividend income that is exempt from tax. If total dividends are within this allowance, no tax is payable.
How are gains from the sale of shares taxed?
Gains realized on the sale of shares are subject to capital gains tax (CGT).
However, the gain may be offset against the annual CGT exempt amount, reducing the taxable amount.
What happens if an individual’s dividend income exceeds the dividend allowance?
If dividend income exceeds the dividend allowance, the excess is taxed at rates that depend on the individual’s tax band, which may be basic, higher, or additional rate.
Can an individual avoid paying tax on dividends altogether?
If the total dividend income falls within the dividend allowance for that tax year, no tax is payable. Any amount exceeding the allowance is taxable.
What role does the capital gains tax exempt amount play in the taxation of shares?
The capital gains tax exempt amount allows individuals to offset gains made from the sale of shares, reducing the amount of gain that is subject to capital gains tax.
Does dividend income covered by the dividend allowance still affect the basic-rate band?
Yes
Even if dividend income is covered by the dividend allowance and not taxed, it still reduces the portion of the basic-rate band available.
Why might more dividend income be taxed at the higher rate despite the dividend allowance?
The dividend allowance uses part of the basic-rate band, meaning any remaining dividend income above the allowance could fall into the higher-rate band and be taxed at a higher rate.
What do Stock Exchange rules require when a company with existing shareholders wants to raise further capital?
Stock Exchange rules require that the company must first offer any new shares to existing shareholders.
