Week 8 - Equities (Common/Preferred Shares + Equity Transactions) Flashcards
Whats the diff. between common vs. preferred shares?
Common:
- Ownership in a company
- Value of each share changes with changes in total value of company’s equity and total shares outstanding
Preferred
- Provides a cash payment / dividend – often viewed as FIXED INCOME and not equity
- Most attractive to an investor wanting steady income and more security that their investment will not be volatile
What are “Stock Splits”
A company “splits” its shares thereby doubling its shares outstanding
- If the stock split is 2 for 1; the share price is halved. If you have 100 shares priced at $50 each, after a 2-for-1 split, you’ll have 200 shares, but the price of each share will be $25.
- IMPORTANT: A stocks plit does not increase a company’s market capitalization. Even though the company’s number of shares doubles, the price per share halves, so the total market value of the company stays the same.
How is market capitalization calculated?
= Share Price * Total Outstanding Shares (total amt of shares that a company has issued and are currently being held by all of its shareholders)
Why would a company split its shares?
- To make the stock price more attractive (cheaper, more accessible)
- To increase liquidity (more sales, therefore higher trading volume)
What’s up with dividends regarding common shares?
Companies can, but don’t have to, pay dividends.
How is retained earnings used? Also, Why Do Companies Pay Dividends vs. Retain Earnings?
Retained Earnings – keep the profits in the company to reinvest in its business or for other purposes.
Mature, stable companies (like large utility or consumer goods companies) tend to pay dividends because they often generate stable profits with limited need for reinvestment.
Growth companies (especially in technology, biotech, or startups) usually retain earnings to fund expansion, research, or innovation.
Explain the ex-dividend date, and the record date which occurs after purchasing a stock?
If you make a purchase before the ex-dividend date, you will be eligible for payment of dividends from company.
On the ex-dividend date, the stock price drops by the amt of dividend
- Ex. Stock value before was $86.64, dividend amount is $1.05. Therefore new stock price is $86.64- $1.05 = 85.59
- Price drop reflects dividend payment
On the record date, the company looks at its records to determine who will receive the dividend. If purchased before ex-dividend date, individual will receive dividend. After the drop in stock price to $85.59, you receive the dividend payment of $1.05, effectively returning your wealth to the original amount before the price drop.
*** Therefore, wealth is the same whether you buy the shares before or after the ex-dividend date date.
Explain how wealth is the same whether you buy the shares before or after the ex-dividend date date.
Before ex-dividend date:
If you purchase stock price for $5, and there is $1 in dividends, in total, amount of money lost is: (-$5) + $1 dividends = $4 lost
After ex-dividend date:
Since stock price is lowered using dividends amount, new stock price is: (initial) $5 - $1 dividend paid = $4.
And if purchasing stock after ex-dividend date, you will be purchasing a $4 stock. Therefore $4 lost.
What is a Dividend Reinvestment Plan (DRIPs)
The investor decides to receive a stock, rather than a cash dividend.
Who gets paid first? Common or preferred shareholders?
Preferred shareholders. Also considered a fixed income investment – limited opportunity for price increase vs. common shares
Are dividend payments tax deductive?
No, investors receive dividend tax credit and pay less tax rate than if interest received.
Investors receive a dividend tax credit to encourage investment in stocks and to prevent double taxation of corporate profits.
How should you treat preferred shares?
Like a bond, without a maturity date.
Its Value = PV of future cash flows.
Theyre in perpetuity
How is the pricing calculated for preferred dividends (that are in perpetuity)
Pv0 = C ÷ r
C = preferred dividend received
r = rate of return required on the preferred (for the investor)
r = cost of funding the preferred (for the issuer)
r is the discount rate or rate of return.
How does preferred dividends change?
In the formula, Pv0 = C ÷ r.
C aka the preferred dividend receive DOES NOT change.
the r, does change. If interest rates increase or decrease.
What are other terms for “rate of return” regarding preferred dividends?
- Market
- Dividend “yield”
Why is dividend yield so important?
It allows us to compare dividends on an apple-to-apple basis through percentages.
Ex.
- Co. A: Trades for $50 - dividend yield = $5 / $50 = 10%
- Co. B trades for $10 - dividend yield = $2 / $10 = 20%
What is a “Market order?”
An order that is executed at best available price.
What is a “Limit order?”
An order executed only if a specific price can be obtained
- Ex. Current price $58; place a limit buy order at $55 – stock will only be bought if price declines to $55
What is a “Day order?”
An order that is valid for the current day – cancelled if not executed by end of day.
What is an “Open or Good Till Cancelled (GTC) order?”
They are limit orders that remain open until executed or specific date.
What is an “All or None (AON) order?”
It is an order that is only executed if total # of shares can be bought or sold.
Alternatively, a minimum # of shares can be specific.
Which one is price weighted, and which one is value weighted? DIJA vs S&P500 vs TSX
Price: DIJA
Value: S&P and TSK
What is coupon value?
Percentage of face value that is paid back per year
