LM 4: Overview of Equity Securities

Question 1

What are 2 ways companies can finance operations?

Answer 1

issuing debt or equity

Question 2

What are common shares?

Answer 2

Common shares: represents an ownership position, get residual claim

Question 3

What is the difference between statutory voting and cumulative voting?

Answer 3

statutory voting grants one vote for each share owned

cumulative voting allows shareholders to get more than one vote, vote amount based on how many board directors they’re voting for.

Question 4

What is cumulative preference shares?

Answer 4

any dividend payments that have been missed in the past, must be paid out to cumulative preference shareholders first.

Question 5

What is non-cumulative preference shares?

Answer 5

type of preferred stock that doesn’t pay stockholders any unpaid or omitted dividends.

Question 6

What is participating preference shares?

Answer 6

receive dividends, surplus profits if profits exceed a specified amount, and receive additional distributions over face value in event of liquidation.

Question 7

What is non-participating preference shares?

Answer 7

no compensation beyond fixed dividend payments and claim for face value in event of liquidation.

Question 8

What is a convertible preference share?

Answer 8

a type of preferred share that pays a dividend and can be converted into common stock at a fixed conversion ratio after a specified time.

Question 9

What are 3 types of private equity investments, describe them? VLP

Answer 9

1. venture capital (provide start-up capital)
2. leveraged buyouts ( investors raise large amounts of debt to purchase all of a public company’s outstanding common stock.)
3. private investments in public equity. (the purchase of publicly traded stock at a price below the current market value (CMV) per share.)

Question 10

LBO and MBO work well for companies that have…

Answer 10

undervalued assets and high cash flows to support debt obligations

Question 11

What are 2 methods to invest in non-domestic equity securities?

Answer 11

1. direct investing
2. depository receipts (DR)

Question 12

What is the difference between sponsored DR & unsponsored DR?

Answer 12

Sponsored DR: Issued directly by the foreign company and investors receive the same dividends and voting rights as other common shareholders.

Unsponsored DR:foreign company no involvement. depository bank purchases company’s shares, issues DRs, and retains the voting rights.

Question 13

What are global depository receipts (GDR’s)?

Answer 13

issued outside the company’s home country, usually on exchanges in London or through private placements but not US exchanges (but in US denomination)

Question 14

What is an American depository receipts (ADR’s)?

Answer 14

receipts in foreign companies that are held by US depositary banks and can be traded in the US, including on US major exchanges

Question 15

What are American Depository Shares (ADS’s)

Answer 15

the underlying securities for American depository receipts, traded in company’s domestic market

Question 16

What is global registered shares (GRS’s)?

Answer 16

ownership shares traded on different stock exchanges around the world in different currencies, which eliminates the need for currency conversions.

Question 17

What are the 4 types of ADR’s, describe them.

Answer 17

Level 1: trade OTC market
Level 2 & 3: trade on US exchanges (have high listing fees)
Level 4: sold to qualified investors through private placements

Question 18

What is a Basket of Listed Depository Receipts?

Answer 18

exchange-traded fund that represents a portfolio of depository receipts.

Question 19

What are three potential sources of equity returns?

Answer 19

1. Price change
2. Dividend income
3. Currency exchange gains or losses

Question 20

How is risk measured for equity securities?

Answer 20

often measured by the standard deviation

Question 21

What data is used as a proxy for expected volatility?

Answer 21

historical data

Question 22

What are 2 disadvantages of direct investing in non-domestic equities?

Answer 22

1. more volatility
2. less transparency

Question 23

What are 2 reasons companies issue equity?

Answer 23

1. raise capital
2. increase liquidity

Question 24

What is accounting return on equity formula and use?

Answer 24

measures management’s efficiency in using capital.

ROE = net income to ordinary shareholders/ average total book value equity

ROE = NI / Average BVE (Ending BVE- Begin BVE / 2)

Question 25

What is WACC, and what does it tell us?

Answer 25

weighted average cost of capital

tells us minimum required rate of return a company needs to earn on its long-term investments

Question 26

What is book value of company formula?

Answer 26

Book value = total assets - total liabilities

Question 27

Cost of equity is used as a proxy for the… in terms of return?

Answer 27

Minimum required rate of return

Question 28

What’s the difference between callable common shares and putable common shares?

Answer 28

Callable common shares give issuer right to buy back share

Putable common share gives shareholder right to sell share back to the issuer

Question 29

Do stocks that have an embedded call option increase value or decrease value for the investor?

Answer 29

Decrease value to investors since embedded call option gives issuer not investor right to exercise early.

Question 30

Why is ROE calculated with book value to equity instead of market value?

Answer 30

since management doesn’t have control over market value but they have control over book value to equity.