Week 9 - Topic 8 - Equity securities

Question 1

What are the 2 main types of shares?

Answer 1

1. Ordinary or common shares
2. Preference shares (AKA Hybrid Securities)

Question 2

What are the 3 main characteristics of an ordinary/common share?

Answer 2

1. Limited liability
2. Voting rights from ordinary shareholders in an Annual General Meeting, consisting of executives who sit on the Board of Directors.
3. Residual/leftover claim from normal business owners, or in the event of company liquidation

Question 3

What are the 3 main characteristics of a preference share?

Answer 3

1. Fixed dividends paid before ordinary shares
2. No voting rights
3. Residual claim before Ordinary Shares in the event of liquidation (preference shareholders get paid first before ordinary shareholders)

Question 4

What is a ‘Dividend’?

Answer 4

a profit split/share.

Question 5

What are the 3 possible reasons why no dividend/regular dividend is paid?

Answer 5

1. Business earnings are poor/uncertain. There is little or no residual cash flow available for shareholders.
2. Business earnings are good, however, residual cash flow is being reinvested further into the business.
3. Business earnings are currently good but uncertain in the future.

Question 6

What are ‘Blue-chip companies’?

Answer 6

Large, established companies that tend to aim for stable, progressive dividend payments.

Question 7

Why do young, growth companies such as tech startups tend not to pay dividends?

Answer 7

They’d rather reinvest that residual cash flow to maximise growth and earnings.

Question 8

Define the term ‘Share Index’?

Answer 8

A collection of stocks that provides a representative sample of the share market.

Question 9

In terms of shares, what is the ‘Primary market’?

Answer 9

Companies sell new shares to investors to raise money.

Question 10

In terms of shares, what is the ‘Secondary market’?

Answer 10

Outstanding shares are bought and sold among investors

Question 11

What are the 4 types of secondary markets?

Answer 11

1. Direct search
2. Brokered
3. Dealer
4. Auction

Question 12

Define the term ‘Bid price’?

Answer 12

The price at which they buy

Question 13

Define the term ‘Offer (ask) price’?

Answer 13

The price at which they sell

Question 14

How do you calculate the dividend yield?

Answer 14

Calculated by dividing the annual dividend payout by the current share price.

Question 15

Define ‘Relative Valuation’?

Answer 15

Compares a share’s value and growth potential to another using metrics like the P/E ratio

Question 16

Define ‘Discounted Cash Flow (DCF) Valuation’?

Answer 16

Estimates a share’s dollar value by discounting future cash flows to the present, aiding investment decisions.

Question 17

What is the formula to calculate the P/E ratio?

Answer 17

P/E Ratio = Share Price / (Earnings/share)

Question 18

Fill in the following one-word gaps: ↑ PE ratio, the more ________ the share.
↓ PE ratio, the ________ the share.

Answer 18

expensive, cheaper

Question 19

Fill in the following one-word gap: Shares which have a high P/E ratio (e.g. Apple) are _______ stocks.

Answer 19

growth

Question 20

Fill in the following one-word gap: Shares which have a low P/E ratio (e.g. BHP) are ______ stocks.

Answer 20

value

Question 21

Define ‘Systematic risk’?

Answer 21

is uncertainty which comes from factors that affect the entire share market, e.g. inflation, interest rates and taxes affect all companies and would be systematic risk factors.

Question 22

Define ‘Unsystematic risk’?

Answer 22

factors are those which do not affect all companies but a subset of the market. For example, the iron ore price would have an important impact on BHP’s share price, but wouldn’t affect Woolworths’ share price.