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8.5 Summary

An in-depth look at key concepts of common and preferred shares, including their benefits, rights, and different types.

8.5 Summary

Summary

In this chapter, we discussed the following aspects of common and preferred shares:

  • Benefits of Common Share Ownership: These can include:

    • Capital Appreciation: The value of common shares can increase over time, providing an opportunity for capital gains.
    • Dividend Income: Companies may distribute a portion of their profits to shareholders in the form of dividends.
    • Voting Privileges: Shareholders often have the right to vote on important company matters such as electing the board of directors.
    • Favourable Tax Treatment: In some jurisdictions, dividends received by shareholders may be taxed at a lower rate than other forms of income.
    • Easy Marketability: Common shares are traded on stock exchanges, providing liquidity to investors.
    • Access to the Board of Directors: Shareholders can influence the company’s strategy and policies by voting on board members.
    • Limited Liability: Shareholders are not personally liable for the company’s debts beyond their investment in the company’s shares.
  • Stock Splits and Consolidations:

    • Stock Split: A stock split increases the number of shares outstanding, which can make shares more affordable to smaller investors.
      • Example: A 2-for-1 stock split will double the number of shares while halving the price per share.
    • Consolidation (Reverse Split): A consolidation reduces the number of shares outstanding, which can raise the per-share price.
      • Example: A 1-for-2 consolidation will halve the number of shares but double the price per share.
    • In both cases, the market price changes, but the overall value of the investors’ ownership remains unchanged.
  • Preferred Shareholders’ Rights:

    • Liquidation Preference: In event of liquidation, preferred shareholders rank below the company’s creditors but above common shareholders.
  • Why Investors Buy Preferred Shares:

    • Income Flow: Preferred shares provide regular income through dividend payments.
    • Preferential Tax Treatment: Dividends from preferred shares may enjoy favourable tax rates compared to other income types.
  • Why Companies Issue Preferred Shares Rather Than Bonds:

    • Unfavorable Market Conditions: When the market is unreceptive to new debt.
    • High Debt-to-Equity Ratio: When a company’s existing debt levels are too high.
    • Avoid Legal Obligations of Debt: Bonds create legal obligations; preferred shares do not.
    • Feasibility Under Tax Conditions: Preferably in situations where paying dividends from after-tax profits is more tax-efficient.
  • Callable vs. Non-Callable Preferred Shares:

    • Callable Preferred Shares: Issuers can redeem them at a predetermined time and price.
    • Non-Callable Preferred Shares: Cannot be redeemed as long as the company exists.
  • Types of Preferred Shares:

    • Straight Preferred Shares: Have fixed dividend rates and preference in asset and dividend entitlement.
    • Convertible Preferred Shares: Allow the holder to convert into common shares at a predetermined price and period.
    • Retractable Preferred Shares: Shareholders can compel the company to repurchase at specified dates and prices.
    • Floating Preferred Shares: Dividends fluctuate based on interest rate changes.
    • Foreign-Pay Preferred Shares: Dividends are paid in or tied to foreign currencies.
    • Participating Preferred Shares: Have rights to additional earnings beyond the specified dividend.
    • Deferred Preferred Shares: Dividends are paid upon maturity.

Frequently Asked Questions

  1. What is the difference between common and preferred shares?

    • Common shares provide voting rights and potential for capital gains but are riskier. Preferred shares offer fixed dividends and higher claim on assets but usually don’t carry voting rights.
  2. How does a stock split affect my investment?

    • A stock split increases the number of shares you own but reduces the price per share, leaving the overall value of your investment unchanged.
  3. Why would a company issue preferred shares instead of taking on more debt?

    • Issuing preferred shares helps maintain a healthier debt-to-equity ratio, avoids legal debt obligations, and can be more favorable under certain tax conditions.

Key Takeaways

  • Common shares offer benefits like capital appreciation, dividend income, voting rights, and favourable tax treatment.
  • Stock splits and consolidations alter share count and price but not the investor’s total holding value.
  • Preferred shares come with specific rights and are issued for reasons such as avoiding additional debt or leveraging tax advantages.
  • Various types of preferred shares, including callable, convertible, and floating-rate shares, provide different features and benefits to cater to diverse investor needs.

Feel free to refer to the Chapter 8 Review Questions for self-assessment, or consult the online Chapter 8 FAQs for additional queries.


📚✨ Quiz Time! ✨📚

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Welcome to the Knowledge Checkpoint! You’ll find 10 carefully curated quizzes designed to reinforce the key concepts covered. These questions will help you gauge your grasp of the material, identify areas that need further review, and ensure you’re on the right track towards mastering the content for the Canadian Securities certification exams. Take your time, think critically, and use these quizzes as a tool to enhance your learning journey. 📘✨

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## What is one of the main benefits of common share ownership? - [ ] Guaranteed fixed income - [ ] Higher ranking than preferred shareholders - [x] Voting privileges - [x] Limited liability > **Explanation:** Common shareholders have voting privileges and limited liability, but they do not have guaranteed fixed income and do not rank higher than preferred shareholders. ## What happens to the number of shares outstanding and the market price in a stock split? - [ ] Number of shares decreases, market price increases - [ ] Number of shares decreases, market price remains the same - [x] Number of shares increases, market price decreases - [ ] Number of shares remains the same, market price increases > **Explanation:** In a stock split, the number of shares outstanding increases, but the market price per share decreases. The total value of shares owned by an investor remains the same. ## How do preferred shareholders rank in the right to receive payment if a company is liquidated? - [ ] Above both creditors and common shareholders - [ ] Below both creditors and common shareholders - [ ] Above creditors and below common shareholders - [x] Below creditors and above common shareholders > **Explanation:** Preferred shareholders rank below the company’s creditors but above common shareholders in the event of liquidation. ## Why might a company issue preferred shares instead of bonds? - [ ] To increase the company's debt-to-equity ratio - [ ] Because issuing preferred shares imposes legal obligations similar to those of debt - [ ] To reduce marketability of the shares - [x] When market conditions are unreceptive to new debt issues or to avoid high debt obligations > **Explanation:** Companies might issue preferred shares instead of bonds when market conditions are unreceptive to new debt issues, to avoid increasing their debt-to-equity ratio, or to avoid assuming the legal obligations of debt. ## What is a key feature of callable preferred shares? - [x] Issuers can redeem them at a stated time and price - [ ] They cannot be redeemed under any circumstance - [ ] They convert automatically into common shares - [ ] They always offer a floating dividend rate > **Explanation:** Issuers of callable preferred shares have the right to redeem these shares at a stated time and at a stated price. ## What is the main advantage of convertible preferred shares? - [ ] They offer the highest dividend rate - [x] They can be converted into common shares - [ ] They are non-callable - [ ] They offer guaranteed dividends > **Explanation:** Convertible preferred shares enable the holder to convert the preferred shares into common shares at a predetermined price and for a stated period of time. ## What type of preferred shares allows shareholders to force the company to buy back the shares? - [ ] Callable preferred shares - [ ] Convertible preferred shares - [x] Retractable preferred shares - [ ] Participating preferred shares > **Explanation:** Retractable preferred shares give shareholders the right to force the company to buy back the shares on a specified date and at a specified price. ## What feature is associated with floating preferred shares? - [ ] Fixed dividend rate - [x] Dividends fluctuate with interest rates - [ ] Can be converted to bonds - [ ] Guaranteed redemption by the issuer > **Explanation:** Floating preferred shares have dividend amounts that fluctuate to reflect changes in interest rates. ## What is unique about foreign-pay preferred shares? - [ ] They mature every year - [ ] They have guaranteed high returns - [x] Dividends are paid in a foreign currency or in relation to a foreign currency - [ ] They cannot be converted to common shares > **Explanation:** Foreign-pay preferred shares receive dividends paid in a foreign currency or in relation to a foreign currency. ## What is a key characteristic of participating preferred shares? - [ ] They offer a fixed amount of dividends - [ ] They must be redeemed after a specific period - [x] They may have rights to a portion of company earnings beyond the specified dividend rate - [ ] They can only be issued by foreign companies > **Explanation:** Participating preferred shares have rights to a portion of company earnings beyond the specified dividend rate.

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