unit 8 | common & preferred shares

Question 1

Common Shares

Answer 1

• Ownership in a company
• Value of each shares changes with changes in the total value of company’s equity & its total shares outstanding
  Arbitrary → Not necessarily paid

Question 2

Which type of share is more volatile?

Answer 2

Common shares → potential for significant gains & losses

Question 3

Stock Splits

Answer 3

A company “splits” its shares thereby doubling (or tripling or more) its shares outstanding
- If the stock split is 2 for 1 (2:1), the share price is halved (Pre 100 → Post 200)
> Shares: Multiply then divide
> Share price: Divide then multiply
- Does not increase a company’s market capitalization

Question 4

Why does companies do stock splits? Especially if it has no effect on its equity value/market capitalization?

Answer 4

• Done b/c company does not want high share price
• To encourage more people to buy their stocks at a lower price > increase liquidity

Question 5

Dividends

Answer 5

• Can but is not required to pay dividends (cash payments) to shareholders
• Canadian banks typically pays 40-50% of NI as dividends
• Big corporations don’t pay dividends (need to keep cash to invest in products & markets)

Question 6

Timing of Dividends: When does Ex-Dividend Date happen?

Answer 6

1 business day before Record Date

Question 7

What happens on Ex-Dividend Date?

Answer 7

• Share prices declines by dividend amount on ex-dividend date
• Your wealth is the same whether you buy the shares before or after the ex-dividend

Question 8

Stock Dividends

Answer 8

The company decides to issue a stock, rather than a cash, dividend
- You receive additional company shares
- Ex. share price = $50; dividend = $0.25; you own 600 shares → you would receive 3 additional shares:
- 600 x $0.25 = $150/$50 share price

Question 9

Dividend Reinvestment Plans (DRIPs)

Answer 9

The investor decides to receive a stock, rather than a cash, dividend
- You receive additional company shares
- Same math as stock dividends

Question 10

Voting Privileges within shares

Answer 10

• In most circumstances, investor gets voting rights
• May be restrict voting rights to restrict rights/votes of shareholders to retain control
• Shareholders with multi-voting shares have greater rights
  
  • Each share owned comes with 10 votes instead of 1

Question 11

Tax treatment with dividends

Answer 11

Dividends receive tax credits → reducing the tax paid vs interest or employment income

Question 12

Tax treatment with capital gains

Answer 12

Capital gains (increase in share price) are taxed at 50% of tax rates on interest or employment income

Question 13

Preferred Shares

Answer 13

• Provides a cash payment/dividend
• These cash payments/dividends are “fixed”; hence preferred shares are often viewed as fixed income and not equity
• Most attractive to an investor wanting a steady income & more security that their investment will not be volatile
• Primarily a fixed income instrument → limited opportunity for price increases vs common shares

Question 14

Are dividends an obligation in preferred shares

Answer 14

Dividend payments are not obligatory (like interest payments) but preferred dividends must be paid before common share dividends can occur

Question 15

Are preferred shares tax deductive

Answer 15

Payments are not tax deductive; investors receive dividend tax credit & pay less tax rate than if interest received

Question 16

Preferred Dividends (Valuation)

Answer 16

• Fixed rate (straight) Preferreds:
  
  • Stated par value (often $25) & a fixed dividend
• Preferreds are like every other instrument in finance:
  
  • Value = PV of future cash flows
• With preferreds, there is no maturity date like a bond
• Dividends are in perpetuity

Question 17

Perpetuity (Price of preferred) formula for pricing:

Answer 17

PV0 = C / R

C → preferred dividend received
r → rate of return required on the preferred (for investor)
r → cost of funding the preferred (for issuer)

Ex: C = $4.00, r = 10%
Price of preferred = $4/10% = $40

• Also known as the market/dividend yield

Question 18

Importance of Yield

Answer 18

• Do not focus on the $ amount of dividend or price of stock

If Co. A trades for $50 → dividend yield = $5/$50 = 10%
If Co. B trades for $10 → dividend yield = $2/$10=20%
- Company b has higher dividend yield (better option)

Dividend yield allows us to compare dividends on an apple-to-apple basis

Question 19

What are stock indexes & averages used for?

Answer 19

A stock index or average is used for the same purpose: performance comparison & to gauge overall market movements
- Calculated differently

Question 20

How are stock indexes calculated?

Answer 20

A stock index is typically value-weighted
- Each stock in the index is weighted according to its equity value/market capitalization

Question 21

How are averages calculated?

Answer 21

Averages are calculated by adding each stock price & dividing by the # of stocks

Question 22

What is market capitalization?

Answer 22

Total equity value = Total # of shares * Share price

Question 23

Dow Jones Industrial Average (DJIA)

Answer 23

Average based 30 stocks that is price weighted (add up the share prices & divided by 30)

Question 24

Why does DJIA get so much attention?

Answer 24

• Old habits are hard to break → it’s been used for 100+ years
• The 30 stocks are bellwether stocks for the US economy (American Express, Walmart, Home Depot)
• Dow Jones company previously owned the Wall Street Journal → which would emphasize the DJIA movements

Question 25

Major Stock Indices

Answer 25

US → S&P 500 Canada → S&P TSX Composite Japan → Nikkei Stock Average UK → FTSE 100 (pronounced “footsie”) Germany → DAX France → CAC 40 All are market or value weighted except Nikkei