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IMC UNIT 2 - Chapter 11 > Chapter 11 > Flashcards

Chapter 11 Flashcards

1
Q

What are features of an ordinary share (common stock)?

A
  • Part-owner of the company (voting rights)
  • Variable profit distribution (dividends) - no guarantee
  • Rank after debt providers and preference shares if company folds
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2
Q

What are features of preference shares (preferred stock)?

A
  • Normally no voting rights (sometimes if dividends not given for a while voting rights given)
  • Fixed dividend (not certain on receiving)
  • Rank after debt providers but before ordinary shares if company folds
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3
Q

What is a fixed dividend based on

A

Fixed % of the face value / nominal value on the certificate

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4
Q

What is the feature of a cumulative preference share?

A

If a dividend can-not be paid one year then the Dividends are back paid from the last missed period

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5
Q

Why may a participating preference share be needed and what is the features of this

A

If one year is exceptionally good (variable dividend receivers would receive a lot more) – thus in a participating preference share the company will make up towards the variable dividend amount

If the company folds then can expect more than the nominal value if the company folds

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6
Q

What is a convertible preference share?

A

have a preference share that can become an ordinary share (one time movement)

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7
Q

Why may a convertible preference share be wanted?

A

Allows to move away from creditor role and partake in voting

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8
Q

what are shares normally in terms of time duration

A

perpetual (until company folds)

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9
Q

How does an American Depository Receipt (ADR work?)

A

Non-US subsidiary usually of a US bank purchases a number of non-US shares, then sells a certificate of beneficial ownership

If dividend paid these are paid to the US company. The US company will then exchange this to $ and then send this to those who have the beneficial ownership.

But inherent FX risk

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10
Q

What is and American Depository Receipt (ADR)?

A

A stock that trades in the US but represents a specified number of shares in a non-US company

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11
Q

What are ADRs traded on and what currency?

A

Traded on NYSE and NASDAQ in US$

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12
Q

What are ADR dividends paid in

A

Dividends paid in US$

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13
Q

Are ARDs available in other currencies?

A

yes e.g. global depository receipts

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14
Q

What are ADR receipts not?

A

Not ‘pure’ bearer

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15
Q

What are the main methods of equity issuance?

A
  • Placing
  • Offer for sale
  • Intermediaries offer
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16
Q

What is placing

A

New shares placed with institutional investors by an issuing house (investment bank)

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17
Q

Why is placing cheaper?

A

Marketing - as don’t really need a prospectus or road show etc. – lighter / no marketing.
Regulation - less regulation as selling to institutional.

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18
Q

What is an offer for sale also known as?

A

An I.P.O

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19
Q

what is an offer for sale?

A

New shares offered by an issuing house (investment bank) to the general public

20
Q

What are the two types of offer for sale? And features?

A

o Offer for sale by tender

  • Issuing house invites offers from the public
  • Maximum and minimum guide price – giving the issuing house a good method of finding the optimum price for shares

o Offer for sale by subscription

  • Underlying company offers the issue to the public
  • Widely known to public company and one with experience
21
Q

What is an intermediaries offer?

A

A number of brokers place an issue with their clients

22
Q

What can happen post an initial issuance

A

Follow on issues

23
Q

What are follow on issues - in reference to original share holders?

A

Dilutive

24
Q

What is a rights issue?

A

Existing shareholders have the right to subscribe for news shares in proportion to their current holdings, at a discount to current market price

25
Q

What are the three options in response to a rights issue?

A
  1. Lapse aka do nothing (companies sell to someone who is interested and gain something of the proceeds on the sold rights)
  2. Take up rights – pay subscription price before the cut-off date
  3. Nil-pay price – sell the rights yourself
26
Q

What is a scrip (‘bonus’ / ‘capitalisation’ issue?)

A

Existing shareholders have the right to subscribe for news shares in proportion to their current holdings for free

27
Q

How is a stock split different from a scrip issue

A

Stock split will not be reflected on the balance sheet. A stock split is creating something new. Increasing the number of shares in issue will decrease the nominal value but there is no change to the share premium.

Not recorded. Just included in the footnotes to the account

28
Q

What is the purpose of a scrip issue usually

A

To create liquidity - in the UK don’t like share prices getting too high

29
Q

In a rights issue what will happen to the balance sheet

A

The number of shares issued (in the called up share capital) and the share premium would increase on the bottom

on the tip the cash entry would increase

30
Q

In a rights issue what will happen to the balance sheet

A

The number of shares issued (in the called up share capital) would increase and the share premium would decrease on the bottom

Cash would not increase on the top but the share premium account will decrease as much as the called up share capital increases

31
Q

How does a scrip issue affect EPS (earnings per share)?

A

Number of shares has increased so earnings per share will be diluted

32
Q

what does a dividend yield summarise?

A

The current income level from shares

33
Q

What are the limitations of dividend yield?

A
  • Ignores the capital change (share price) - is simply a snapshot
  • Based on current year dividends (that may change in future)
34
Q

What is the holding period return?

A

The return from holding ordinary shares comes from dividends and capital gains (or losses)

35
Q

What does dividend cover indicate?

A

whether a firm will be capable of maintaining its current level of dividend

36
Q

what is the assumption of the dividend discount growth model (gordon’s growth model)?

A

the assumption that there is a constant dividend growth rate

  • this is because dividend policy and growth rates might fluctuate with the economic environment or with the investment policy of the firm and therefore this assumption might be entirely inappropriate
37
Q

List shortfalls of using earnings per share as a method for equity valuation

A

1) where dividends per share are dependent upon the availability of sufficient cash flows to meet the payment, EPS is based on accounting earnings. Earnings are an accounting definition and may be distorted by accounting standards and policies, one-off purchases and write-offs.

For this reason EPS is not indicative of a firm’s ability to meet or maintain current dividend levels

2) it is also an absolute (i.e. monetary) measure, and so is not useful for inter-company comparisons
3) EPS can be analysed over time as growth in the EPS from one year to the next indicates better performance. But any growth may be as a result of the number of shares in issue changing. (rise due to a fall in the number of shares and vice versa).

38
Q

what is a diluted EPS

A

when a company reports its EPS figure, it must also disclose a ‘diluted’ EPS, which is a hypothetical EPS figure.

This is based on the new number of shares that would have been in issue if stock options had been exercised.

The idea is that with more shares in issue the EPS will fall, and the company must make all current shareholders aware of the potential effect this will have on the EPS

39
Q

when must diluted EPS be disclosed

A

diluted EPS must be disclosed alongside EPS, if there would be reduction in future EPS due to stock options and other potentially dilutive securities in issue e.g. convertible bonds and warrants

40
Q

what are the two major potential problems with the Price-earnings ratio?

A

1) if a company has negative earnings this will make the PE negative and therefore not useful. The negative earnings may be due to the cyclical nature of the industry and the current state of the economy. Equity valuation should be based on long term prospects, not the current state of the economy.
2) The ratio is based on accounting figures (earnings) which are subject to various accounting standards and policies. When comparing companies need to be aware that different companies adopt different accounting policies, even if following the same standards. Cross-border comparisons are even tougher when you bring in conflicting standards of accounting practice.

41
Q

what is a potential problem with the price to book ratios for a company

A

must be aware of possibly accounting distortions. A company with older assets than other companies in the same industry will have a lower book value and thus a higher PB ration

42
Q

what is a potential problem with the price to sales ratio for evaluating a company?

A
  1. Sales do not necessarily mean profits for the shareholders. Valuation techniques should be closely linked to returns to the investors, not the top line of the profit and loss account
  2. the sales of the company are not just generated by equity capital but also by debt i.e. the PS ignores gearing (proportion of the company assets that are funded through debt)
43
Q

drawbacks to using the price to cash flow ratio

A

1) The cash flow measure in the denominator can be calculated in several ways to reflect different types of cash flows with free cash flow to equity holders, for example, being calculated differently from cash flow to the shareholders
2) It neglects the impact of non-cash components, such as deferred revenue, which will eventually be realised as a tangible / measurable cash item
3) like all multiple valuation techniques, the PCF ratio is a rather simplistic approach to comparing firms or sectors and should be complimented with discounted cash flow techniques

44
Q

what is financial gearing

A

the level of a company’s debt relative to its equity capital, usually expressed as a %

it is a measure of a company’s financial leverage and shows the extent to which its operations are funded by lenders versus shareholders

45
Q

a higher gearing will be associated with

A

lower price or lower firm equity value

IMC UNIT 2 - Chapter 11 (1 decks)

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