FIN 430 - Chapter 47 Overview of Equity Securities

Blue chip stocks

(widely held large market capitalization companies that are considered financially sound and are leaders in their respective industry or local stock market)

Describe the three reasons studying equity securities is important

- First, the decision on how much of a client's portfolio to allocate to equities affects the risk and return characteristics of the entire portfolio. - Second, different types of equity securities have different ownership claims on a company's net assets, which affect their risk and return characteristics in different ways. - Finally, variations in the features of equity securities are reflected in their market prices, so it is important to understand the valuation implications of these features

Private equity usually comes through private placement. What is required for these investors?

- Must be accredited or institutional. - Accredited require $250k a year and $1mm in liquid assets -Institutional examples: banks, credit unions, hedge funds, mutual funds, ect

Note some benefits of investing in international equities

- increase investor awareness about the company's products and services - enhance the liquidity of the company's shares - increase corporate transparency because of the additional market exposure and the need to meet a greater number of filing requirements - Lower cost of capital (Possible cheaper rates with non-domestic investors) - Diversify risks from domestic exposure

Summary of 4 kinds of ADR's

-High Listing Fees: 2 and 3 -Low Listing Fees: 1 and 4 -Raise capital in US markets: 1 and 2 (no), 3 and 4 (yes, 3 public and 4 private) -1 OTC, 2 and 3 NYSE and NASDAQ, 4 Private listings -1 2 3 develop and broaden US investors with existing shares (3 has new shares too). 4 is to access qualified buyers

Define Statutory Voting

1 share = 1 vote Example: You have 100 shares and there are 4 director positions open, you have 100 votes

Preferred Stock, Common Stock, Both or Neither? 1. Voting Rights 2. Share in the operating performance of a company 3. Paid a fixed dividend 4. Highly Liquid 5. Cannot miss a dividend payment 6. Claim on company assets in the event of liquidation

1. Common 2. Common 3. Preferred 4. Common 5. Neither (Preferred will eventually be paid out at a later date and must be paid in full before common can receive any dividends) 6. Both (But preferred has claim over common shareholders)

Note the three reasons why preferreds are less risky than common shares

1.) Dividends on preference shares are known and fixed, and they account for a large portion of the preference shares' total return. Therefore, there is less uncertainty about future cash flows. 2.) Preference shareholders receive dividends and other distributions before common shareholders. 3.) The amount preference shareholders will receive if the company is liquidated is known and fixed as the par (or face) value of their shares. However, there is no guarantee that investors will receive that amount if the company experiences financial difficulty

Detail some reasons for foreign restriction placed on investors in many countries

1.) The first is to limit the amount of control that foreign investors can exert on domestic companies 2.) The second is to give domestic investors the opportunity to own shares in the foreign companies that are conducting business in their country 3.) The third reason is to reduce the volatility of capital flows into and out of domestic equity markets

Define the benefits of convertible preference shares

1.) They allow investors to earn a higher dividend than if they invested in the company's common shares. 2.) They allow investors the opportunity to share in the profits of the company. 3.) They allow investors to benefit from a rise in the price of the common shares through the conversion option. 4.) Their price is less volatile than the underlying common shares because the dividend payments are known and more stable

Historically, what has the global Market Cap to GDP ratio been?

50%

What % and below represents an undervalued Market Cap to GDP ratio?

< 50%

Define ADS's (American Depository Share)

A depository share is a security that is actually traded in the issuing company's domestic market. That is, while American depository receipts are the certificates that are traded on US markets, American depository shares are the underlying shares on which these receipts are based

18 Which of the following statements is most accurate in describing a company's book value? A Book value increases when a company retains its net income. B Book value is usually equal to the company's market value. C The ultimate goal of management is to maximize book value.

A is correct. A company's book value increases when a company retains its net income

Which of the following statements is least accurate in describing a company's market value? A Management's decisions do not influence the company's market value. B Increases in book value may not be reflected in the company's market value. C Market value reflects the collective and differing expectations of investors.

A is correct. A company's market value is affected by management's decisions. Management's decisions can directly affect the company's book value, which can then affect its market value.

When investing in unsponsored depository receipts, the voting rights to the shares in the trust belong to: A the depository bank. B the investors in the depository receipts. C the issuer of the shares held in the trust.

A is correct. In an unsponsored DR, the depository bank owns the voting rights to the shares. The bank purchases the shares, places them into a trust, and then sells shares in the trust—not the underlying shares—in other markets

3 All of the following are characteristics of preference shares except: A They are either callable or putable. B They generally do not have voting rights. C They do not share in the operating performance of the company.

A is correct. Preference shares do not have to be either callable or putable

From an investor's point of view, which of the following equity securities is the least risky? A Putable preference shares. B Callable preference shares. C Non-callable preference shares

A is correct. Putable shares, whether common or preference, give the investor the option to sell the shares back to the issuer at a pre-determined price. This pre-determined price creates a floor for the share's price that reduces the uncer-tainty of future cash flows for the investor (i.e., lowers risk relative to the other two types of shares listed)

Calculate the book value of a company using the following information: Number of shares outstanding 100,000 Price per share $52 Total assets $12,000,000 Total liabilities $7,500,000 Net Income $2,000,000 A $4,500,000. B $5,200,000. C $6,500,000.

A is correct. The book value of the company is equal to total assets minus total liabilities, which is €12,000,000 - €7,500,000 = €4,500,000.

If a US-based investor purchases a euro-denominated ETF and the euro subse-quently depreciates in value relative to the dollar, the investor will have a total return that is: A lower than the ETF's total return. B higher than the ETF's total return. C the same as the ETF's total return.

A is correct. The depreciated value of the euro will create an additional loss in the form of currency return that is lower than the ETF's return

Calculate the total return on a share of equity using the following data: Purchase price: $50 Sale price: $42 Dividend paid during holding period: $2 A -12.0% B -14.3% C -16.0%

A is correct. The formula states Rt = (Pt - Pt-1 + Dt)/Pt-1. Therefore, total return = (42 - 50 + 2)/50 = -12.0%.

With respect to Level III sponsored ADRs, which of the following is least likely to be accurate? They: A have low listing fees. B are traded on the NYSE, NASDAQ, and AMEX. C are used to raise equity capital in US markets.

A is correct. The listing fees on Level III sponsored ADRs are high.

Define Depository Receipt

A security that trades like an ordinary share on a local exchange and represents an economic interest in a foreign company. It allows the publicly listed shares of a foreign company to be traded on an exchange outside its domestic market.

A key measure that investors use to evaluate the effectiveness of management in increasing the company's book value is...

Accounting Return on Equity

What are the responsibilities of the Depository Bank?

Act as custodian and as a registrar. This entails handling dividend payments, other taxable events, stock splits, and serving as the transfer agent for the foreign company whose securities the DR represents

What happens after an LBO or MBO?

After the shares are purchased, they cease to trade on an exchange and the investor group takes full control of the company. In other words, the company is taken "private" or has been privatized

Book Value =

Assets - Liabilities

Calculate the 2009 return on equity (ROE) of a stable company using the following data: Total sales $2,500,000 Net income $2,000,000 Beginning of year total assets $50,000,000 Beginning of year total liabilities $35,000,000 Number of shares outstanding at the end of 2009 1,000,000 Price per share at the end of 2009 $20 A 10.0%. B 13.3%. C 16.7%.

B is correct. A company's ROE is calculated as (NIt/BVEt-1). For 2009, the BVEt-1 is equal to the beginning total assets minus the beginning total liabilities, which equals £50,000,000 - £35,000,000 = £15,000,000. Therefore, ROE 2009 = £2,000,000/£15,000,000 = 13.3%

A company's cost of equity is often used as a proxy for investors': A average required rate of return. B minimum required rate of return. C maximum required rate of return.

B is correct. Companies try to raise funds at the lowest possible cost. Therefore, cost of equity is used as a proxy for the minimum required rate of return

5 Which of the following statements about private equity securities is incorrect? A They cannot be sold on secondary markets. B They have market-determined quoted prices. C They are primarily issued to institutional investors.

B is correct. Private equity securities do not have market-determined quoted prices.

Which of the following statements most accurately describes one difference between private and public equity firms? A Private equity firms are focused more on short-term results than public firms. B Private equity firms' regulatory and investor relations operations are less costly than those of public firms. C Private equity firms are incentivized to be more open with investors about governance and compensation than public firms

B is correct. Regulatory and investor relations costs are lower for private equity firms than for public firms. There are no stock exchange, regulatory, or share-holder involvements with private equity, whereas for public firms these costs can be high.

The type of equity voting right that grants one vote for each share of equity owned is referred to as: A proxy voting. B statutory voting. C cumulative voting

B is correct. Statutory voting is the type of equity voting right that grants one vote per share owned.

23 Which of the following measures is the most difficult to estimate? A The cost of debt. B The cost of equity. C Investors' required rate of return on debt.

B is correct. The cost of equity is not easily determined. It is dependent on investors' required rate of return on equity, which reflects the different risk levels of investors and their expectations about the company's future cash flows

What Market Cap to GDP ratio reflects a fairly valued market? A. 10-90% B. 50-90% C. 75-90%

B. 50-90%

Define Cumulative Voting

Better serves shareholders with a small amount of shares. # of shares x positions open = votes Example: You have 100 shares and there are 4 director positions open, you have 400 votes

Are both ways acceptable for calculating ROE?

Both formulas are appropriate to use as long as they are applied consistently. For example, using beginning of the year book value is appropriate when book values are relatively stable over time or when computing ROE for a company annually over a period of time. Average book value is more appropriate if a company experiences more volatile year-end book values or if the industry convention is to use average book values in calculating ROE

Define Direct Investing

Buying into a country (Done in currency of the country). Investing directly often results in less transparency and more volatility because audited financial information may not be provided on a regular basis and the market may be less liquid. Also has exposure to currency exchange rates)

22 Holding all other factors constant, which of the following situations will most likely lead to an increase in a company's return on equity? A The market price of the company's shares increases. B Net income increases at a slower rate than shareholders' equity. C The company issues debt to repurchase outstanding shares of equity.

C is correct. A company's ROE will increase if it issues debt to repurchase out-standing shares of equity.

A basket of listed depository receipts, or an exchange-traded fund, would most likely be used for: A gaining exposure to a single equity. B hedging exposure to a single equity. C gaining exposure to multiple equities

C is correct. An ETF is used to gain exposure to a basket of securities (equity, fixed income, commodity futures, etc.)

Which of the following is not a primary goal of raising equity capital? A To finance the purchase of long-lived assets. B To finance the company's revenue-generating activities. C To ensure that the company continues as a going concern.

C is correct. Capital is raised to ensure the company's existence only when it is required. It is not a typical goal of raising capital

Which of the following is least likely to be a reason for a company to issue equity securities on the primary market? A To raise capital. B To increase liquidity. C To increase return on equity

C is correct. Issuing shares in the primary (and secondary) market reduces a company's return on equity because it increases the total amount of equity capi-tal invested in the company (i.e., the denominator in the ROE formula)

Participating preference shares entitle shareholders to: A participate in the decision-making process of the company. B convert their shares into a specified number of common shares. C receive an additional dividend if the company's profits exceed a pre-determined level.

C is correct. Participating preference shares entitle shareholders to receive an additional dividend if the company's profits exceed a pre-determined level.

14 Which of the following is incorrect about the risk of an equity security? The risk of an equity security is: A based on the uncertainty of its cash flows. B based on the uncertainty of its future price. C measured using the standard deviation of its dividends.

C is correct. Some equity securities do not pay dividends, and therefore the standard deviation of dividends cannot be used to measure the risk of all equity securities

Which of the following is not a characteristic of common equity? A It represents an ownership interest in the company. B Shareholders participate in the decision-making process. C The company is obligated to make periodic dividend payments.

C is correct. The company is not obligated to make dividend payments. It is at the discretion of the company whether or not it chooses to pay dividends.

Emerging markets have benefited from recent trends in international markets. Which of the following has not been a benefit of these trends? A Emerging market companies do not have to worry about a lack of liquidity in their home equity markets. B Emerging market companies have found it easier to raise capital in the mar-kets of developed countries C Emerging market companies have benefited from the stability of foreign exchange markets

C is correct. The trends in emerging markets have not led to the stability of foreign exchange markets

Venture capital investments: A can be publicly traded. B do not require a long-term commitment of funds. C provide mezzanine financing to early-stage companies

C is correct. Venture capital investments can be used to provide mezzanine financing to companies in their early stage of development

True or False Callable shares have less risk than non-callable shares and putable shares have less risk than non-putable shares

Callable common or preference shares are riskier than their non-callable counterparts because the issuer has the option to redeem the shares at a pre-determined price. Because the call price limits investors' potential future total return, callable shares generally pay a higher dividend to compensate investors for the risk that the shares could be called in the future. Similarly, putable preference shares have lower risk than non-putable preference shares. Cumulative preference shares have lower risk than non-cumulative preference shares because the cumulative feature gives investors the right to receive any unpaid dividends before any dividends can be paid to common shareholders

CAPM meaning

Capital Asset Pricing Model (useful to find cost of equity)

the decision-making process that companies use to evaluate potential long-term investments?

Capital budgeting

What companies are most likely to be bought out in an LBO or MBO?

Companies with large amounts of undervalued assets (which can be sold to reduce debt) and generate high levels of cash flows (which are used to make interest and principal payments on the debt)

What do investors that only consider price appreciation overlook an important source of return?

Compounding that results from reinvested dividends. Reinvested dividends are cash dividends that the investor receives and uses to purchase additional shares. In the long run total returns on equity securities are dramatically influenced by the compounding effect of reinvested dividends

When a company issues debt, the cost it incurs for the use of these funds is called the....

Cost of debt

Preferred stock prices are based on ________________

Current dividend yield (Ex: Interest rates go down, preferred prices go up)

Preferreds are priced like ________ and payed like ____________

Debt, Equity

Are newer companies or distinguished/mature companies more likely to pay dividends?

Distinguished/Mature companies (less growth and more excess cash flows)

Define Convertible preference shares

Entitle shareholders to convert their shares into a specified number of common shares. This conversion ratio is determined at issuance. Use is a popular financing option in venture capital and private equity transactions in which the issuing companies are considered to be of higher risk and when it may be years before the issuing company "goes public"

True or False An increase is ROE is always preferred

False "it depends." One reason ROE can increase is if net income decreases at a slower rate than shareholders' equity, which is not a positive sign. In addition, ROE can increase if the company issues debt and then uses the proceeds to repurchase some of its outstanding shares. This action will increase the company's leverage and make its equity riskier. Therefore, it is important to examine the source of changes in the company's net income and shareholders' equity over time

True or False Price-to-book ratio is one of few measurements that can be helpful in comparing companies in different industries

False It is not appropriate to compare the price-to-book ratios of companies in different industries because their price-to-book ratios also reflect investors' outlook for the industry. Companies in high growth industries, such as technology, will generally have higher price-to-book ratios than companies in slower growth (i.e., mature) industries, such as heavy equipment.

Review: True or False Preference shares are a form of equity in which payments made to preference shareholders come just after payments made to common stockholders

False Paid first

True or False Book value and market value will normally be equal (or close to equal)

False. market value of the company's equity, however, reflects the collective and differing expectations of investors concerning the amount, timing, and uncertainty of the company's future cash flows.

True or False When management is accomplishing its objective of increasing the company's book value, this is reflected in the market

False. this increase may not be reflected in the market value of the company's equity because it does not affect investors' expectations about the company's future cash flows

True All GDR's are ADR's and all ADR's are GDR's

False. An ADR is one form of a GDR; however, not all GDRs are ADRs because GDRs cannot be publicly traded in the United States

True or False Management can only indirectly affect book values, as they cannot directly act on them

False. management actions can directly affect the book value of the company (by increasing net income or by selling or purchasing its own shares), they can only indirectly affect the market value of its equity

Review: True or False Putable common shares give shareholders the right to sell the shares back to the issuer at a market price when the shares are originally issued

False. At a Specificed price

Review: True or False Putable common shares give the issuer the right to buy back the shares from shareholders at a price determined when the shares are originally issued

False. Callable

Callable and putable preference shares provide issuers and investors with the same rights and obligations as their preference share counterparts

False. Common share counterparts

Review: True or False A company's accounting return on equity is the minimum rate of return that stockholders require the company to pay them for investing in its equity

False. Cost of equity not ROE

True or False: When a company looks to raise capital, they may either issue debt or equity securities. Both of these result in a liability for the company.

False. Equity issued is not a liability. When the company issues equity securities, it is not contractually obligated to repay the amount it receives from shareholders, nor is it contractually obligated to make periodic payments to shareholders for the use of their funds

The private equity market has experienced considerable shrinking during the last 3 decades

False. Growth, even though it is a small market

True or False: because the uncertainty surrounding the total return of preference shares is less than common shares, preference shares have lower risk and higher expected return than common shares

False. LOWER expected returns

True or False: Unsponsored DR's have greater reporting requirements than Sponsored DR's and must be registered in the US

False. Sponsored have greater reporting requirements and must be registered in US

True or False: A DR always represents one share of the underlying stock

False. The number of receipts issued and the price of each DR is based on a ratio, which specifies the number of depository receipts to the underlying shares. Consequently, a DR may represent one share of the underlying stock, many shares of the underlying stock, or a fractional share of the underlying stock

Review: True or False A company's accounting return on equity is used to determine how capital should be raised

False. the total return that it earns on shareholders' book equity

What are the two types of DR's?

Global Depository Receipts (GDR) and American Depository Receipts (ADR)

If preferreds are convertible, they may be forced to convert if common share prices are (greater than or less than) the conversion price

Greater than

Total Return = Price Appreciation + _______________? *Note: Price Appreciation is selling something for more than you bought it for

Income (Example: Dividends)

What is the Accounting Return on Equity or (ROE) for?

It measures the total amount of net income available to common shareholders generated by the total equity capital invested in the company

Describe the 4 primary types of ADR's

Level I Sponsored ADRs trade in the over-the-counter (OTC) market and do not require full registration with the Securities and Exchange Commission (SEC). Level II and Level III Sponsored ADRs can trade on the New York Stock Exchange (NYSE), NASDAQ, and American Stock Exchange (AMEX). Level II and III ADRs allow companies to raise capital and make acquisitions using these securities. However, the issuing companies must fulfill all SEC requirements. he fourth type of ADR, an SEC Rule 144A or a Regulation S depository receipt, does not require SEC registration. Instead, foreign companies are able to raise capital by privately placing these depository receipts with qualified institutional investors or to offshore non-US investors

Shareholders have a residual claim on a company's assets after ________ have been paid

Liabilities. This residual claim is what allows shareholders to be considered owners of a company

Because of private equity, management has been able to focus more efforts on (long or short) term value creation

Long. In public companies, Management usually feels pressured to focus on short-term results (e.g., meeting quarterly sales and earnings targets from analysts biased toward near-term price performance) instead of operating the company to obtain long-term sustainable revenue and earnings growth. This is not necessary in private equity

The more earnings and the greater amount of cash flow that the company has had, or is expected to have, the (higher or lower?) the uncertainty and risk associated with its ability to pay future dividends

Lower

Besides being able to focus more on long term value creation, what is another benefit of private equity?

Lower costs due to lack of filing requirements (audits), listing fees, regulatory costs

Commonly referred to as "market cap," how do you calculate Market Capitalization?

Multiplying a company's shares outstanding by the current market price of one share

Equity securities represent ownership claims on a company's ......

Net assets

Market capitalization refers to the total dollar market value of a company's ......

Outstanding Shares

What are two main sources of equity securities' total return?

Price change (capital gain) and dividend income

Calculate total return

Price return + Income Return ((Ending Stock price - Starting stock price)+Dividends) / Starting stock price

Equation for price-to-book ratio

Price-to-book ratio = Market price per share/Book value of equity per share or Market Cap/Book Value

Do public or private companies rank higher in corporate governance effectiveness?

Public This is because private companies are not under public scrutiny and have no incentive to be open about their organization

Companies issue equity securities on primary markets to....

Raise capital and increase liquidity. This additional liquidity also provides the corporation an additional "currency" (its equity), which it can use to make acquisitions and provide stock option-based incentives to employees. The primary goal of raising capital is to finance the company's revenue-generating activities in order to increase its net income and maximize the wealth of its shareholders

Discuss depository receipts and global registered shares when related to direct investing

Represent the equity of international companies and are traded on local exchanges. With these securities, investors have to worry less about currency conversions (price quotations and dividend payments are in the investor's local currency), unfamiliar market practices, and differences in accounting standards

What is the ultimate goal of a buyout? (LBO or MBO)

Restructure the acquired company and later take it "public" again by issuing new shares to the public in the primary market

Expected Return =

Risk Free Rate + Beta *Beta (Equity risk premium)

Describe the dividends preferred stockholders receive

Similar to the interest payments on debt securities, the dividends on preference shares are fixed and are generally higher than the dividends on common shares. However, unlike interest payments, preference dividends are not contractual obligations of the company. Similar to common shares, preference shares can be perpetual (i.e., no fixed maturity date), can pay dividends indefinitely, and can be callable or putable

Summarize Sponsored vs. Unsponsored DR's

Sponsored: Company is in partnership with bank (Ex: JP Morgan and Toyota) and sponsor (Toyota) has voting rights Unsponsored: Just the bank. Bank has the voting rights

When does shareholder voting normally take place?

The Company's annual meeting

What are the benefits of callable common shares?

The company benefits because it can buy back its shares below the current market price and later resell them at a higher market price, and it can also reduce dividend payments to preserve capital, if required. Investors benefit because they receive a guaranteed return when their shares are called

True or False The cost of debt is difficult to estimate

The cost of debt is relatively easy to estimate because it reflects the periodic interest (or coupon) rate that the company is contractually obligated to pay to its bondholders (lenders)

What does a Market Cap to GDP ratio > 100% mean?

The market is overvalued

What affects the price of a DR?

The price of each DR will be affected by factors that affect the price of the underlying shares, such as company fundamentals, market conditions, analysts' recommendations, and exchange rate movements

What are some effects of private equity securities not being listed on public exchanges

They do not have "market determined" quoted prices, are highly illiquid, and require negotiations between investors in order to be traded. In addition, financial statements and other important information needed to determine the fair value of private equity securities may be difficult to obtain because the issuing companies are typically not required by regulatory authorities to publish this information

Review: True or False American depository receipts are US dollar-denominated securities trading much like standard US securities on US markets. Global depository receipts are similar to ADRs but contain certain restrictions in terms of their ability to be resold among investors

True

Review: True or False Common shares represent an ownership interest in a company and give investors a claim on its operating performance, the opportunity to participate in the corporate decision-making process, and a claim on the company's net assets in the case of liquidation

True

Review: True or False Cumulative preference shares are preference shares on which dividend payments are accrued so that any payments omitted by the company must be paid before another dividend can be paid to common shareholders. Non-cumulative preference shares have no such provisions, implying that the dividend payments are at the company's discretion and are thus similar to payments made to com-mon shareholders

True

Review: True or False Depository receipts are securities that trade like ordinary shares on a local exchange but which represent an economic interest in a foreign company. They allow the publicly listed shares of foreign companies to be traded on an exchange outside their domestic market

True

Review: True or False Private equity securities are issued primarily to institutional investors in private placements and do not trade in secondary equity markets. There are three types of private equity investments: venture capital, leveraged buyouts, and private investments in public equity (PIPEs)

True

Review: True or False Underlying characteristics of equity securities can greatly affect their risk and return

True

Review: true or False The objective of private equity investing is to increase the ability of the company's management to focus on its operating activities for long-term value creation. The strategy is to take the "private" company "public" after certain profit and other benchmarks have been met

True

Review: true or false Participating preference shares allow investors to receive the standard preferred dividend plus the opportunity to receive a share of corporate profits above a pre-specified amount. Non-participating preference shares allow investors to simply receive the initial investment plus any accrued dividends in the event of liquidation

True

True or False Book value and return on equity are useful in helping analysts determine value but can be limited as a primary means to estimate a company's true or intrinsic value, which is the present value of its future projected cash flows

True

True or False Different accounting methods can make it difficult to compare the return on equity of companies even if they operate in the same industry. It may also be difficult to compare the ROE of the same company over time if its accounting methods have changed during that time

True

True or False ROE can increase if net income increases at a faster rate than shareholders' equity or if net income decreases at a slower rate than shareholders' equity

True

True or False he book value of a company's equity reflects the historical operating and financing decisions of its management. The market value of the company's equity reflects these decisions as well as investors' collective assessment and expectations about the company's future cash flows generated by its positive net present value investment opportunities. If investors believe that the company has a large number of these future cash flow-generating investment opportunities, the market value of the company's equity will exceed its book value.

True

True or False: Because of the longer holding periods, more private equity firms are issuing convertible preference shares because they provide investors with greater total return potential through their dividend payments and the ability to convert their shares into common shares during an IPO

True

True or False: Exit return in venture capital is based on share price of securities after IPO or selling to other investors

True

True or False: Studies have shown that reducing restrictions on foreign ownership has led to improved equity market performance over the long term

True

True or False: The type of equity security, as well as its characteristics, affects the uncertainty of its future cash flows and therefore its risk

True

True or False: global capital markets have expanded at a much more rapid rate than global GDP in recent years

True

True or False: Common shares are callable or putable

True

True or False: Investors who purchase equity securities are seeking total return (i.e., capital or price appreciation and dividend income), whereas investors who purchase debt securities (and hold until maturity) are seeking interest income. As a result, equity investors expect the company's management to act in their best interest by making operating decisions that will maximize the market price of their shares (i.e., shareholder wealth)

True

True or False the cost of equity can be thought of as the minimum expected rate of return that a company must offer its investors to purchase its shares in the primary market and to maintain its share price in the secondary market. If this expected rate of return is not maintained in the secondary market, then the share price will adjust so that it meets the minimum required rate of return demanded by investors

True For example, if investors require a higher rate of return on equity than the company's cost of equity, they would sell their shares and invest their funds elsewhere resulting in a decline in the company's share price. As the share price declined, the cost of equity would increase to reach the higher rate of return that investors require.

True or False: specific class of ETF security that consists of an underlying portfolio of DRs and is designed to track the price performance of an underlying DR index

True For example, the Asia 50 ADR Index Fund is a capitalization-weighted ETF designed to track the performance of 50 Asian market-based ADRs

True or False: For investors who purchase depository receipts or foreign shares directly, there is a third source of return: foreign exchange gains (or losses)

True Foreign exchange gains arise because of the change in the exchange rate between the investor's currency and the currency that the foreign shares are denominated in. For example, US investors who purchase the ADRs of a Japanese company will earn an additional return if the yen appreciates relative to the US dollar. Conversely, these investors will earn a lower total return if the yen depreciates relative to the US dollar. For example, if the total return for a Japanese company was 10 percent in Japan and the yen depreciated by 10 percent against the US dollar, the total return of the ADR would be (approximately) 0 percent.

True or False The more net income that is earned and retained, the greater the company's book value of equity.

True Because management's decisions directly influence a company's net income, they also directly influence its book value of equity

True or False: Putable common or preference shares are less risky than their callable or non-callable counterparts

True. they give the investor the option to sell the shares to the issuer at a pre-determined price. This pre-determined price establishes a minimum price that investors will receive and reduces the uncertainty associated with the security's future cash flow. As a result, putable shares generally pay a lower dividend than non-putable shares

True or False: DR's can bring about arbitrage opportunities

True. Any short-term valuation discrepancies between shares traded on multiple exchanges represent a quick arbitrage profit opportunity for astute traders to exploit.

What is the normal time to "exit" the investment for venture capital

Usually between 3 and 10 years (Example: 3-5 year investment period, IPO, then liquidate investment) (Venture Capitalists do not want to hold investments long-term)

The cost of debt (after tax) and the cost of equity (i.e., the minimum required rates of return on debt and equity) are integral components of the capital budgeting process because they are used to estimate a company's

WACC

What does the WACC represent?

WACC represents the minimum required rate of return that the company must earn on its long-term investments to satisfy all providers of capital. The company then chooses among those long-term investments with expected returns that are greater than its WACC

Define Management Buyout (MBO)

When the group of investors acquiring the company is primarily comprised of the company's existing management

Define ADR's (American DR)

a US dollar-denominated security that trades like a common share on US exchanges. Most commonly traded DR. Enable foreign companies to raise capital through US investors

Note three trends that have come up over the last two decades for international equities

a) an increasing number of companies have issued shares in markets outside of their home country b) the number of companies whose shares are traded in markets outside of their home has increased c) an increasing number of companies are dual listed, which means that their shares are simultaneously issued and traded in two or more markets. Companies located in emerging markets have particularly benefited from these trends because they no longer have to be concerned with capital constraints or lack of liquidity in their domestic markets

Define cumulative preference shares

accrue so that if the company decides not to pay a dividend in one or more periods, the unpaid dividends accrue and must be paid in full before dividends on common shares can be paid

Define proxy voting

allows a designated party—such as another shareholder, a shareholder representative, or management—to vote on the shareholders' behalf.

Basket of Listed Depository Receipts (BLDR's)

an exchange-traded fund (ETF) that represents a portfolio of depository receipts. An ETF is a security that tracks an index but trades like an individual share on an exchange

Define non-cumulative preference shares

any dividends that are not paid in the current or subsequent periods are forfeited permanently and are not accrued over time to be paid at a later date. However, the company is still not permitted to pay any dividends to common shareholders in the current period unless preferred dividends have been paid first

Define GRS (Global Registered share)

common share that is traded on different stock exchanges around the world in different currencies. Currency conversions are not needed to purchase or sell them, because identical shares are quoted and traded in different currencies. Thus, the same share purchased on the Swiss exchange in Swiss francs can be sold on the Tokyo exchange for Japanese yen

What cost is incurred when companies raise capital by issuing equity?

cost of equity. Unlike debt, however, the company is not contractually obligated to make any payments to its shareholders for the use of their funds. As a result, the cost of equity is more difficult to estimate

What do cash or stock dividends (Dt) represent?

distributions that the company makes to its shareholders during period t

Define non-participating preference shares

do not allow shareholders to share in the profits of the company. Instead, shareholders are entitled to receive only a fixed dividend payment and the par value of the shares in the event of liquidation. The use of participating preference shares is much more common for smaller, riskier companies where the possibility of future liquidation is more of a concern to investors

Define participating preference shares

entitle the shareholders to receive the standard preferred dividend plus the opportunity to receive an additional dividend if the company's profits exceed a pre-specified level. In addition, participating preference shares can also contain provisions that entitle shareholders to an additional distribution of the company's assets upon liquidation, above the par (or face) value of the preference shares.

Define Putable common shares

give investors the option or right to sell their shares (i.e.,"put" them) back to the issuing company at a price that is specified when the shares are originally issued. Investors will generally sell their shares back to the issuing company when the market price is below the pre-specified put price

Define Callable Common Shares

give the issuing company the option (or right), but not the obligation, to buy back shares from investors at a call price that is specified when the shares are originally issued. It is most common for companies to call (or redeem) their common shares when the market price is above the pre-specified call price.

The ultimate job of management

increase the book value (shareholders' equity on a company's balance sheet) of the company and maximize the market value of its equity

Define Venture Capital

investments provide "seed" or start-up capital, early-stage financing, or mezzanine financing to companies that are in the early stages of development and require additional capital for expansion. These funds are then used to finance the company's product development and growth

Define a GDR (Global DR)

issued outside of the company's home country and outside of the United States. The depository bank that issues GDRs is generally located (or has branches) in the countries on whose exchanges the shares are traded

Define Private equity securities

issued primarily to institutional investors via non-public offerings, such as private placements. Because they are not listed on public exchanges, there is no active secondary market for these securities.

Public shares are (riskier or less risky) than private shares

less risky

the company's cost of equity is often used as a proxy for the investors' _____________ required rate of return

minimum

Calculate ROE

net income available to ordinary shareholders (i.e., after preferred dividends have been deducted) divided by the average total book value of equity *Note the second kind of formulas just use shareholder's equity from beginning of year in the denominator

Define Leveraged Buyout (LBO)

occurs when a group of investors (such as the company's management or a private equity partnership) uses a large amount of debt to purchase all of the outstanding common shares of a publicly traded company

Benefits of GRS's

offer more flexibility than depository receipts because the shares represent an actual ownership interest in the company that can be traded anywhere and currency conversions are not needed to purchase or sell them

Preferred stocks (Preferreds)

rank above common shares with respect to the payment of dividends and the distribution of the company's net assets upon liquidation. However, preference shareholders generally do not share in the operating performance of the company and do not have any voting rights, unless explicitly allowed for at issuance

What is price-to-book ratio useful for?

ratio provides an indication of investors' expectations about a company's future investment and cash flow-generating opportunities. The larger the price-to-book ratio (i.e., the greater the divergence between market value per share and book value per share), the more favorably investors will view the company's future investment opportunities

Define Private Investment in Public Equity (PIPE)

sought by a public company that is in need of additional capital quickly and is willing to sell a sizeable ownership position to a private investor or investor group.

What does price change represent?

the difference between the purchase price (Pt-1) and the sale price (Pt) of a share at the end of time t - 1 and t

When investors purchase the company's debt securities, their minimum required rate of return is...

the periodic rate of interest they charge the company for the use of their funds. Because all of the bondholders receive the same periodic rate of interest, their required rate of return is the same. Therefore, the company's cost of debt and the investors' minimum required rate of return on the debt are the same.

What are the benefits of putable common stock?

the put option feature limits the potential loss for investors. From the issuing company's perspective, the put option facilitates raising capital because the shares are more appealing to investors

Define the risk of an equity security

the uncertainty of its expected (or future) total return

What is an Unsponsored DR?

the underlying foreign company has no involvement with the issuance of the receipts. Instead, the depository purchases the foreign company's shares in its domestic market and then issues the receipts through brokerage firms in the depository's local market. In this case, the depository bank, not the investors in the DR, retains the voting rights

What are some advantages of GDR's

they are not subject to the foreign ownership and capital flow restrictions that may be imposed by the issuing company's home country because they are sold outside of that country. The issuing company selects the exchange where the GDR is to be traded based on such factors as investors' familiarity with the company or the existence of a large international investor base

What are the three primary types of private equity investments?

venture capital, leveraged buyouts, and private investment in public equity

How is a Depository Receipt (DR) created?

when the equity shares of a foreign company are deposited in a bank (i.e., the depository) in the country on whose exchange the shares will trade. The depository then issues receipts that represent the shares that were deposited

What is a Sponsored DR?

when the foreign company whose shares are held by the depository has a direct involvement in the issuance of the receipts. Investors in sponsored DR's have the same rights as the direct owners of the common shares (e.g., the right to vote and the right to receive dividends).