Chapter 8
The S&P/TSX 60 is an example of which of the following type of index? a)Price-weighted index b)Value-weighted index c)Market average d)Volume-weighted index
b)The S&P/TSX 60 Index is an example of a value-weighted index. All the stocks listed on this index must be included in the S&P/TSX Composite Index.
What are shares called in a company which has another class of shares which have greater voting rights on a per share basis? A. Non-voting. 0% B. What What are shares called in a company which has another class of shares which have greater voting rights on a per share basis? A. Non-voting. B. Restricted voting. C. Subordinated voting. D. Multiple voting.
c Subordinate voting shares are shares in a company which has another class of shares which have greater voting rights on a per share basis.
What is the payback period for a convertible preferred share with a 35.1% conversion cost premium, a dividend yield of 4.5% and whose common shares have a dividend yield of 1.5%? A. 7.8 years. B. 8.6 years. C. 11.7 years. D. 20.4 years
c The payback period is 11.7 years = 35.1% / (4.5% - 1.5%). The premium on the preferred shares is usually offset by their higher yield compared to that of the underlying common shares. Over a period of years, the preferred's higher yield will "pay back" to the investor the purchase premium of the preferred.
How are stocks different from bonds?
Investors purchase common shares to profit from the issuing company's success; the return is through capital gains. Investors generally purchase bonds and preferred shares for the regular income stream they provide, through coupon income on bonds and through dividends on preferred shares. Bondholders are essentially the company's creditors, whereas the common shareholders are the company's owners. There are different types of preferred shares, just as there are different types of bonds. Some preferred shares correspond to particular types of bonds.
Which of the following is not a type of restricted share? 1.Non-voting 2. Preferred voting 3. Subordinate voting 4. Restricted voting
2.Restricted shares are shares which have the right to participate to an unlimited degree in the earnings of a company and in its assets on liquidation, but do not have full voting rights. There are three categories of restricted or special shares: * Non-voting - shares that are not voting, except perhaps in certain limited circumstances; * Subordinate voting - shares in a company which has another class of shares which have greater voting rights on a per share basis; and * Restricted voting - shares that have a limit on the number or percentage of shares that may be voted by a person, company or group.
Jesse owns 2,000 shares of OOP Inc. currently trading at $1.25. OOP implements a 1:8 reverse stock split (consolidation). Which statement is correct about the impact of this reverse stock split? A. The value of Jesse's investment has not changed because of the consolidation. B. The value of Jesse's investment has increased because of the consolidation C. The value of Jesse's investment has decreased because of the consolidation. D. Jesse's investment is not affected as the consolidation applies only to a new issue of shares.
a If a reverse split of one new share for four old were implemented after shareholder approval, a shareholder owning 100 shares of stock would own only 25 new shares after the split. The total dollar value of the holdings should theoretically not be affected. If the shares were selling at $0.25 before the split, the new shares would probably trade near $1.00 per share. Jesse's investment has not changed in value due to the reverse stock split or consolidation.
Companies include protective provisions in preferred share offerings to make the issue more saleable by safeguarding the preferred shareholder. Which of the following might be a restriction on common dividends? A. Common dividends may be paid only if the company maintains a specified working capital level. B. Common dividends may only be paid if approved by the preferred share trustees. C. Common dividends are paid ahead of preferred purchase funds. D. Common dividends may not be paid for 3 years after the issue of the preferred shares.
a One restriction on common dividends is the requirement that a specified working capital amount or working capital ratio be maintained before common dividends can be paid
Calculate the pre-tax yield for a 6% $100 p.v. retractable preferred purchased for 99.25 and retractable at the holder's option in 5 years. Calculate the pre-tax yield for a 6% $100 p.v. retractable preferred purchased for 99.25 and retractable at the holder's option in 5 years. A. 6.17% B. 6.05% C. 6.02% D. 5.87%
a The approximate yield to maturity formula is used for the calculation: (annual dividend income + annualized capital gain) / average price. For this preferred, ($6 + 0.15) / 99.625 = 6.17%.
ABC Co. has 50 million shares outstanding and trades at a price of $75. DEF Co. has 100 million shares outstanding and trades at a price of $50. Both companies trade on a price-weighted index. Based on this information, which company has the higher weighting in the index? a)ABC b)DEF c)The companies have equal weighting d)Price and outstanding shares do not impact market weighting
a)ABC's share price is higher than DEF's, thus its influence on the index is higher.
John Smith holds 100 preferred shares of DDF Canada Inc. He purchased his shares two years ago at $25.00. The shares have not yet paid dividends. Which of the following statements best describes his holding? a)If this situation continues, John can expect to have voting privileges automatically assigned to his preferred shares. b)John is owed the cumulative preferred dividends in arrears plus interest at the rate specified in the trust indenture. c)John could gain a small premium associated with a call but potentially lose his claim on the dividends in arrears if DDF redeems these preferred shares. d)John could sell his preferred shares at a loss but basically have his investment made whole, if and when DDF makes a complete repayment of arrears.
a)John can expect to have voting privileges automatically assigned to his preferred shares. A common provision in the trust indenture is for preferred shareholders to be automatically assigned voting privileges once a stated number of dividend payments have been missed. Most Canadian preferred shares carry a cumulative dividend feature, but no interest is paid on any arrears. Many, if not most, Canadian preferred shares carry a right of redemption, usually at a specified small premium. However, any dividends in arrears would have to be fully paid before the company could redeem a specific preferred issue. John might be able to sell his downgraded securities, but he would not be entitled to any dividend arrears subsequently paid; they would be paid to the speculator who purchased his securities.
What type of preferred share gives the shareholder certain rights to share in corporate earnings over and above their specified dividend rate? A. Structured preferreds B. Participating preferreds. C. Variable rate preferreds. D. Retractable preferreds.
b A participating preferred share has rights to share in the earnings of the company over and above their specified dividend rate. For example, the participating shareholder might receive a dividend of $0.25 per share plus be entitled to also receive 50% of the dividends paid to common shareholders.
Mamood just received a stock dividend from a company in which he owns shares. He is upset that it is a stock dividend rather than a cash dividend. He knows he has to pay tax on this dividend but is worried he won't have the money to pay the tax. Recommend what Mamood should do? A. He can contact the company and request a cash dividend instead. B. He can sell the shares he received from the stock dividend to obtain cash. C. He can request that he not be taxed until he actually sells the shares. D. He is worried needlessly as it will be considered a capital gain so will not be taxed as highly.
b Stock dividends are taxed in the same manner as cash dividends. If he needs the money, he can sell the shares to obtain the cash.
Evan is a passive investor looking for some exposure to the stock market in the United Kingdom. Which of the following investments should he purchase? a)DAX Index Fund b)FTSE 100 Index Fund c)Value Line Composite d)CAC 40 Share Price Index Fund
b)Evan should purchase the FTSE 100 Index Fund. The FTSE 100 Index consists of the 100 largest listed companies by market capitalization in the United Kingdom.
XYZ Corporation is considering expanding its operations and requires additional capital. Why would XYZ choose to issue preferred shares as opposed to bonds? a)Debt levels are quite low compared to the sector. b)Current market conditions are just not receptive to a new debt issue. c)XYZ's issuance costs will be less for preferreds than for bonds. d)Preferred shares are easier to sell to the market than bonds.
b)Market conditions are sometimes not favourable for a new bond issue (e.g., if a number of very large bond issues are currently being marketed), and if a corporation needs additional new financing, a bond issue may not be the best alternative. Issuer costs are usually more expensive because bond interest is a pre-tax expense, while dividends are paid from net earnings. The attractiveness of a preferred share issue over a bond issue is difficult to determine because there are many factors (features, for example) that can make a new issue attractive or not.
XYZ Corporation, a heavily-traded large-cap stock, is considering expanding its operations and requires additional capital. a)To avoid any possible commitments to repayment of this additional corporate financing. b)To ensure that control of the company remains with existing shareholders. c)To increase the liquidity of its shares. d)To provide relatively quick access to capital.
b)That's correct.An additional equity financing of common shares reduces the proportionate share of existing shareholders (unless they take up additional shares) and their control of the company. A major advantage of an additional offering of common shares, as opposed to other possible alternatives, is that there is no need to generate periodic cash flow to repay this type of corporate financing. Increasing the public float and liquidity of its shares may have a significant positive effect on the value accorded XYZ shares by investors. XYZ shares are a familiar security with known acceptance and thus can provide relatively quick access to capital.
Denise is retired and spends her winters in Florida with her husband in their mobile home. She would like her investments to generate steady revenue with the lowest risk possible. What kind of investment would you recommend to her? a)Government of Canada bonds b)Foreign-pay preferred shares c)Floating rate preferred shares d)Common shares
b)The foreign-pay preferreds would best suit Denise's situation as these shares virtually eliminate foreign exchange risk. She receives fixed US dollar payments as a source of income and the shares are entitled to the dividend tax credit. Government of Canada bonds are very secure investments but since interest payments are paid in Canadian currency, Denise is still exposed to foreign exchange risk and no tax advantage is attached to interest payments. Floating rate preferreds expose Denise to interest rate and foreign exchange risk.
DDR Inc. and FFD Inc. are both part of a stock index. DDR, trading at $40 a share, has a market capitalization of $240 million while FFD, trading at $20 a share has a market capitalization of $1.4 trillion . At the end of the trading day, FFD has gone up by 10%, while DDR has gone down in price by 10%. If you assume that all other stocks in the index didn't move that day, where will the index close? A. The index will close at the same level as the day before as the two securities will cancel each other out. B. The index will close down from the day before because DDR has a higher per share price than FFD. C. The index will close up from the day before as FFD has a higher market capitalization. D. The index will close down from the day before as DDR has a lower market capitalization.
c In a value-weighted index, such as the S&P/TSX Composite Index or the S&P 500, companies with large market capitalizations dominate changes in the value of the index over time. Thus a change in the market capitalization of a large company will have a greater impact on the value of the index than a comparable change in the market capitalization of a smaller company. Score: 1/1
Jenny owns 1,000 shares of EXY Inc. EXY is currently trading at $100 a share. She receives a notice stating that EXY is implementing a 5:1 stock split. Which statement is correct about the impact of this split? A. Jenny will own 200 shares worth $20 a share. B. Jenny will own 200 shares worth $500 a share. C. Jenny will own 5,000 shares worth $20 a share. D. Jenny will own 5,000 shares worth $500 a share.
c With a stock split, the market price of the new shares reflects the basis of the split. For example, in a four-for-one split, the market price of shares selling at $100 (pre-split basis) will sell somewhere in the $25 range after the split. An investor who owned 1,000 shares of the company would now own 4,000 shares.
Which of the following statements about dividends is false? a)Reinvested dividends in a dividend reinvestment plan are taxable to the shareholder as ordinary cash dividends even though the dividends are not received as cash. b)Stock dividends are treated as regular cash dividends for tax purposes. c)Once a company pays an extra dividend, shareholders can expect this extra payment to become part of a higher regular dividend. d)Dividends on preferred shares are usually paid before dividends on common shares.
c)An extra dividend is paid at the discretion of the company, usually at the end of the company's fiscal year. The extra is a bonus paid in addition to the regular payout, but, the term extra cautions investors not to assume that the payment will be repeated the following year. If the company's earnings are maintained, the extra may be repeated. However, directors can omit the extra at their discretion just as they can make changes to regular dividends. A dividend reinvestment plan (DRIP) gives shareholders the option of participating in an automatic reinvestment plan. In a DRIP, the company diverts the shareholders' dividends to the purchase of additional shares of the company. Reinvested dividends are taxable to the shareholder as ordinary cash dividends even though the dividends are not received as cash. Stock dividends are paid from time to time by rapidly growing companies that need to retain a high degree of earnings to finance future growth. The advantage to the company is that cash is conserved for expansion purposes while shareholders receive additional shares, which can be sold if they require the cash. However, stock dividends are treated as regular cash dividends for tax purposes.
Which of the following investments offers the potential for the highest total returns? a)Canada Savings Bonds b)Preferred shares c)Common shares d)Guaranteed investment certificates
c)Common shares offer the potential for highest total return. Potential returns from an investment in common shares include significant tax-advantaged capital gains and tax-advantaged dividends. However, this full participation in a company's growth and profitability comes with an ultimate risk of complete loss if the business fails. Canada Savings Bonds are fixed-income securities issued by the Government of Canada, thus default risk is almost non-existent. On the other hand, earned interest on CSBs is relatively low. GICs are fixed-income securities issued by banks and other financial institutions for terms up to 10 years. They have a guarantee up to a certain amount provided by the Canada Deposit Insurance Corporation and thus have very low default risk; however, earned interest on GICs is also relatively low.
Juan is established in his career and does not have an immediate need for a regular income stream from his investments. What type of preferred share investment would you recommend? a)Straight preferred b)Convertible preferred c)Deferred preferred d)Floating rate preferred
c)Deferred preferred shares do not pay a dividend until a preset maturity date, thus deferring taxes. If held to redemption, the accrued dividends are fully taxable as interest income, making them suitable for registered accounts. The other preferred shares listed here pay a regular dividend payment and would be unsuitable for Juan at this time.
What is the advantage of a foreign-pay preferred to an investor? A. The foreign dividend rate will increase if foreign rates increase. B. The dividend rate is based on the rate structure of the foreign country. c. It provides protection against a decline in the value of the Canadian dollar. D. It provides protection against an increase in the value of the Canadian dollar.
c)Foreign-pay preferred dividends are payable in or related to a foreign currency. If the value of the Canadian dollar decreases, the value of the dividend will increase in Canadian dollars. Thus, the investor has some protection against a decline in the value of the Canadian dollar.
John Smith holds 100 common shares of ABC Inc. He purchased his shares two years ago at $37.50. Which of the following statements about his shareholding is true? a)ABC is legally obligated to pay out surplus earnings as dividends to registered shareholders. b)John can sell those shares only if the company announces a share buyback. c)If ABC splits its shares on a 2-for-1 basis, John would hold 200 shares. d)If ABC splits its common shares on a 2-for-1 basis, the price of ABC shares would rise by at least 50% of their pre-split value.
c)In a 2-for-1share split, ABC would provide existing shareholders with one additional share for each share held. John would therefore hold 200 shares. The share price would also decline to one-half of its pre-split value. ABC is not legally obligated to pay out surplus earnings as dividends. Dividend payments on common shares are entirely discretionary. A portion of the company's earnings may be used for this purpose, with the remainder being retained earnings. John can sell his shares at any time. ABC common shares may be sold in the secondary market, meaning through stock exchanges and over-the-counter. Securities are first issued as a primary offering to the public and they are subsequently traded in these secondary markets. If ABC splits its common shares, share prices would not rise by at least 50%. The analogy often used to explain stock splits to clients is that "the pizza" is now cut (split) into 8 slices instead of 4. There are more slices and maybe more people can eventually share it, but the pizza is still the same size. Two slices now equal one pre-split fair share. A stock split leaves the existing shareholder financially whole but holding additional shares.
Which of the following is a factor contributing to the general risk of both preferred shares and bonds? a)Redemption privilege b)Dividend payment flexibility c)Interest rate risk d)Claim on assets
c)Interest rate risk is inherent in both bonds and preferred shares: both types of securities will increase in value with declines in interest rates and decrease in value with increases in interest rates. A redemption privilege introduces reinvestment risk to preferred shares. The investor may have his preferreds called when interest rates fall significantly and then be forced to seek an investment alternative in a low-rate environment. Preferred share dividend payments may be deferred; timely bond interest payments are legally required. The company's ability and willingness to pay preferred dividends is a significant risk factor. In the event of business failure, bondholders' claims precede those of holders of preferred shares.
Domenic owned a car dealership and his plan was to run the business until he retired. However, he received an offer he could not refuse and sold his business. He needs to invest the proceeds of the sale in an investment that will offer a tax-efficient return at the lowest level of risk possible. What kind of investment would best suit Domenic's needs? a)Government bonds b)Common shares c)Preferred shares d)GICs
c)Preferred shares represent a long-term tax-advantaged income-producing opportunity with safety in a quality issuer. It is reasonable to assume that Domenic has accumulated significant personal assets with the sale of his business. GICs and government bonds provide safety but at the expense of relatively low after-tax returns. On the other hand, while Domenic could use common shares for his income needs (because of his favourable financial circumstances), he would need to accept the risk that markets might not be favourable when he needs that additional cash.
Which of the following statements about restricted shares is false? a)Some restricted shares carry no voting rights, except in certain limited circumstances. b)Some restricted shares carry a voting right but another class of shares carries a greater voting right on a per share basis. c)Some restricted shares carry a right to vote, but shareholders of any class of restricted shares are not entitled to dividends. d)Some restricted shares carry a right to vote, subject to a limit or restriction on the number or percentage of shares that may be voted by a person, company or group.
c)Some restricted shares carry a right to vote, subject to a limit or restriction on the number or percentage of shares that may be voted by a person, company or group.
Which of the following index or average is the main gauge for measuring the investment performance of institutional investments in the United States? a)S&P/TSX Composite Index b)Dow Jones Industrial Average (DJIA) c)S&P 500 Index d)NYSE Composite Index
c)The S&P 500 is a broad-based, value-weighted index that is used as an indicator of market performance. The DJIA, in contrast, includes only 30 large, blue-chip stocks and so is not used to gauge the performance of the broader market.
Calculate the dividend tax credit on a $1,000 dividend received from a Canadian company. A. $133.33 B. $167.00 C. $275.50 D. $450.00
c)The dividend tax credit for dividends from Canadian companies is calculated by first grossing up the actual dividend by 45%. This grossed up amount (or the taxable amount of Canadian dividends) is then multiplied by 19% to determine the dividend tax credit. In the example, the gross up is $1,450 ($1,000 x 1.45) and the dividend tax credit is $275.50 ($1,450 x 19%).
Which of the following is not a factor to consider when evaluating a convertible preferred? A. Is the life of the conversion privilege long enough? B. Is the outlook for the company's common stock positive? C. Is the conversion cost premium reasonable? D. Is the payback period long enough?
d An investor would prefer a short payback period so that the conversion premium will be returned through the higher preferred dividend yield.
Jarod is planning on buying 1,000 shares of WIT Inc. On Monday morning he reads that WIT just announced a dividend with a record date of the following Monday. Jarod is hoping to earn capital gains from this investment rather than dividends. When should he buy the shares? A. Monday B. Tuesday C. Wednesday D. Thursday
d To determine whether the seller or the buyer is entitled to the dividend when a sale takes place around the time of the dividend payment, the stock exchange names an ex-dividend date. On and after this date, the stock sells ex-dividend; that is, the seller retains the dividend and the buyer is not entitled to it. The ex-dividend date is set at the second business day before the dividend record date. Since trades settle on the third business day after a trade, a purchaser of shares two days before the record date would not have the trade settle until the day after the record date, and would therefore not be a shareholder of record for purposes of receiving the dividend. If Jarod does not want the dividend he should buy them on the ex-dividend day - Thursday as he will not own them until the following Tuesday and will not be eligible for the dividend.
What is the credit position of preferred shareholders? A. After common shareholders. B. Before creditors. C. After creditors and common shareholders. D. After creditors and before common shareholders.
d Typically preferred shareholders rank after the company's creditors and debt holders and before common shareholders.
How does a purchase fund on preferred shares benefit the investor? a)It allows existing shareholders to subscribe to additional shares of this issue at par value. b)It ensures that preferred shareholders will receive par value for all of their preferred shares in the event of business failure. c)It permits preferred shareholders to participate in corporate growth and profitability through a deferred payout. d)It supports the market price of the preferred shares.
d)A purchase fund supports the market price of preferred shares. A purchase fund provision attached to a preferred share issue requires the issuing company to allocate earnings each year to a fund, which may be used to later redeem a portion of the outstanding shares at the market price or the sinking fund price (usually par), whichever is lower. As the total number of outstanding shares is reduced, the position of the remaining shareholders is strengthened.
For which of the following reasons might an investor purchase straight preferred shares? a)There is potential for long-term price appreciation. b)The investor wants to avoid any reinvestment risk. c)The shares generally present very low liquidity risk. d)The dividend payments are relatively stable.
d)Dividends on preferred shares are generally fixed. Payments may be suspended under dire circumstances, but this is an unlikely occurrence. Conversion privileges, redemption privileges and other special features may enhance the potential for share price increases, but otherwise there will not be significant long-term price appreciation. Reinvestment risk is inherent in most preferred shares because of the issuer's callable privilege. While preferred shares are exchange-listed, many issues are relatively small (compared to common share issues) and trading tends to be thin.
Why would a young investor with $1,000 to invest benefit from investing in common shares? a)An investment in quality common shares represents an opportunity for significant capital gain with no real downside risk. b)The share certificate with the investor's name will provide a real sense of participation in the capital markets. c)Dividends can be counted on to enhance total returns from an investment in common shares. d)Over the long term, common shares have proven to be the best opportunity for capital gain.
d)hat's correct.Historically, an investment in common shares has represented the best investment alternative for long-term capital appreciation. Common shares represent an opportunity for participation in the growth and profitability of a company, but not without risk. Common shares represent the risk capital of the company and could be entirely lost if the company were to fail. Share certificates are really a thing of the past. They can often be requested from the issuer at a small cost ($30 to $50) to the investor, but the standard today is computer-based registration of securities in street name, which is indirect registration of ownership through an investment dealer and the Canadian Depository for Securities Limited. Dividend payments on common stocks are entirely discretionary, even though they are made regularly by many mature businesses. A dramatic example of the effects of a dividend reduction occurred in December 1999 when TransCanada Pipelines (now TransCanada Corporation: TRP/TSX) reduced its generous regular quarterly dividend by almost one-third despite its repeated assurances that it would not do so. The price of TRP dropped 15% the next day and drifted lower for months, falling to a point where it was virtually cut in half.
