Chapter 4: Equities

Question 1

What is Incorportation?

Answer 1

The process whereby a company comes into existence as a separate legal entity

Question 2

Difference between private & public companies (3)

Answer 2

• PLC for public, LTD for private
• Minimum share capital for public = £50k, no minimum for private
• Public are permitted to freely trade their shares in the secondary market to the general public. Private companies cannot

Question 3

Who are the owners of a company?

Answer 3

The Shareholders

Question 4

Authorized share capital

Answer 4

The maximum number of shares a company is permitted to issue based on the shares nominal value

Question 5

Issues share capital

Answer 5

The number of shares the company has allocated to shareholders based on nominal value

Question 6

Basic rights of ordinary shares

Answer 6

• Right to vote
• Right to a dividend
• Right to a surplus on winding up

Question 7

Preference shares

Answer 7

• no voting right
• expectation of fixed rate dividend payable after interest but before ordinary dividends

Question 8

What are American depositary receipts (ADR)

Answer 8

• used by non-US companies, denominated in US dollars
• typically represent several underlying securities
• holders receive most privileges of the underlying shares including voting rights

Question 9

Total market capitalization is calculate by

Answer 9

number of shares in issue * market value of each share

Question 10

Dividends are payed out before or after tax?

Answer 10

after

Question 11

Dividend cover calculation & use

Answer 11

• to identify whether the level of dividend paid is sustainable
• Earnings per share / dividend per share
• above 1 = sustainable, more than 2 = comfortable

Question 12

Uncovered dividend

Answer 12

• when company distributes dividend greater than the current earnings per share

Question 13

Absolute vs. relative valuation techniques

Answer 13

• Absolute = based on absolute returns, used to estimate an intrinsic value of equity as the present value of future returns
• Relative = estimates the equity value as some measure of earnings power times an appropriate multiple

Question 14

Total return calculation

Answer 14

(End val - Start val) + Dividends received / Start val

Question 15

Preference share valuation, fair value of each share calculation

Answer 15

Price = Dividend / return

Question 16

Gordon’s growth model

Answer 16

• calculates the ex-dividend price of a share, assuming constant dividend growth and dividend payments at the end of each period in perpetuity
• Ex div share price = The next dividend/(return rate - growth rate)

Question 17

Growth rate calculation

Answer 17

retention ratio x return on equity

Question 18

Retention ratio calculation

Answer 18

(net income - dividends) / net income

Question 19

Return on Equity

Answer 19

net income/shareholder funds

Question 20

Warrant Definition

Answer 20

Securities issued by a company giving the owner the right to subscribe to new shares in the company at a fixed price on a future date

Question 21

Warrant value calculation

Answer 21

Formula value + Premium value

Question 22

How is the formula value of a warrant calculated

Answer 22

Current share price - warrant exercise price

Question 23

How is the premium value of a warrant calculated

Answer 23

warrant price - formula value

Question 24

Percent premium calculation

Answer 24

warrant price - formula value / number of shares created x current share price

Question 25

Difference between call options and warrants

Answer 25

• Warrant gives right to buy new share, option gives right to buy share in secondary market
• warrant life tend to be longer than option life
• seller of options is responsible to deliver the shares, the seller of a warrant is not
• Equity warrants are traded on stock exchange whilst equity options are traded on derivative markets

Question 26

Covered warrants

Answer 26

a securitized derivative trading on the LSE giving the investor right to buy or sell an asset at a specific price on or before a specific date
* issues by investment banks
* calls and puts (warrants are only calls)

Question 27

What are deferred shares?

Answer 27

Ordinary share that delays the payment of dividend