Topic 7: Equity Markets Flashcards
Preference Shares Definition and key features
Sometimes referred to as preferred stock, are shares of a company’s stock with dividends that are paid out to shareholders before common stock dividends are issued.
Features:
Preference claim over assets in the event of liquidation
Typically provides no involvement in corporate decision making
Gives a contractual right to dividends, typically a fixed amount.
Provides an opportunity for gain or loss depending on the risk of the company.
Preference Shares Variations
Cumulative: The dividend entitlement accumulates if not paid in a particular year.
Redeemable: Preference shares that allow the company to buy back the shares and return to shareholders
Convertible: Gives share holders the right to convert shares into a specified number of ordinary shares.
Current Yield formula
Annual Coupon / Price
Required Return on Equity
like the YTM it is the risk adjusted rate of return that the market expects from an equity given its dividend level and expectations for future capital growth.
Components of the required return on equity
Dividend Yield + Capital Gains Yield = Total Return
Where:
Dividend yield = An equity’s expected cash / current price i.e (D1/P0)
Capital gains yield = The Dividend growth rate, g. Or the rate at which the value of an investment grows.
Required rate of return formula
R = (D1/P0) + g
Where:
D1/P0 = The dividend Yield (Next period’s dividend/Current price of an equity)
g = growth rate or capital gains yield
i.e R = Dividend yield + Capital gains yield
Price-earnings ratio (PE ratio)
Share price / earnings per share
used to evaluate equity due to its simplicity and comparability in many industries.
High PE = High growth in company
Low PE = Low growth in company
Equity Markets
Primary Market: New securities are sold to investors
Secondary Market: The market in which previously issued securities are traded among investors.
Dealer
An agent who buys and sells securities from investors
Broker
An agent who arranges security transactions among investors
Equity Transaction process
1) Equity is sold by companies to investors (primary market).
2) Then investors sell to each other (Secondary Market)
These investors consist of: Individual retail investors as well as large investors such as; banks, insurance companies pension funds, investment funds and hedge funds.
Trade in equity markets means the transfer of an equity from a buyer to a seller (In exchange for money). - This needs both parties to agree. The agreements are settled by equity traders known as dealers or brokers.
Bid Price
The price the dealer is willing to pay for securities.
Ask Price
The price the dealer is willing to sell the securities
The Spread
The difference between the bid price and ask price. This represents the profit for the dealer.
Equity Valuation Practice
Review notes and practice questions
