Topic 9 Flashcards
(61 cards)
How does a private company issue capital through stocks?
It undertakes an initial public offering (IPO) in the primary market.
Underwriters
Financial institutions who are experts at raising capital (mostly investment banks.
Who uses underwriters? And what for?
Companies that are not familiar with how to access the stock market and its regulations.
To manage an IPO.
Why is a company considered public upon IPO?
Because members of the public are welcome to partake in ownership through its listing on the stock exchange.
What type of finance (direct or indirect) are shares considered to be?
Direct finance.
Which bank is most likely to be an underwriter?
JP Morgan.
What does it mean for the investor when they buy shares?
They join the ownership of the company in return for capital provided.
Owning 1 share out of 100 means?
Owning 1% of the company.
What are the 2 main types of shares?
- Ordinary or common shares.
2. Preference shares.
3 important characteristics of ordinary shares?
- Limited liability.
- Voting rights.
- Residual claim.
Limited liability of ordinary shares
The most a shareholder can lose in their investment in the firm - if losses are incurred that exceed total equity, the further loss cannot be claimed against the private wealth of shareholders.
Voting rights of ordinary shares
Ordinary shareholders can vote in the Annual General Meeting for executives who sit on the Board of Directors (shareholder who owns 51% of shares effectively controls management of company).
Residual claim of ordinary shares
Ordinary shareholders are entitled to any residual (left-over) cash flow from normal business operations or in the event of company liquidation, after payments, creditors and other obligations are paid first.
How can investors benefit from capital gain through shares?
- Dividends (income paid for holding shares).
2. Trading shares.
Why does company management not mandate a fixed dividend for shareholders?
Due to residual claim risk.
What is the implication of residual claim risk?
Management does not have to pay ordinary shareholders a fixed dividend or any dividend because it is uncertain whether there will be sufficient residual cash flow to commit to a dividend payment.
3 reasons no dividend may be paid?
- Business earnings are poor and uncertain.
- Business earnings are good and there is ample residual cash flow.
- Business earnings are currently good, but uncertain in the future.
Business earnings are poor and uncertain
There is little, if no, residual cash flow available to shareholders after paying all creditors, liabilities and obligations.
Business earnings are good and there is ample residual cash flow
Rather than pay a dividend, residual cash flow is reinvested by purchasing productive assets that will increase future earnings growth.
Business earnings are currently good, but uncertain in the future
Management is unwilling to commit to a fixed, high dividend payment now, given the uncertainty of sustaining it in the future.
What type of companies tend to aim for stable, progressive dividend payments?
Large, established (blue chip) companies.
What type of companies tend not to pay dividends, but rather reinvest residual CF to maximise growth in future earnings?
Young, growth companies.
What is the style of dividend payments called?
The company’s dividend policy.
What are preference shares also known as?
Hybrid securities.
