Overview of Equity Securities (Reading 49)

Exercise Problems:

1.      The type of voting in board elections that is most beneficial to shareholders with a small number of shares is best described as:

A. statutory voting.

B. voting by proxy.

C. cumulative voting.

Ans: C;

C is correct. Cumulative voting allows shareholders to direct their total voting rights to specific candidates, as opposed to having to allocate their voting rights evenly among all candidates. Thus, applying all of the votes to one candidate provides the opportunity for a higher level of representation on the board than would be allowed under statutory voting.

2.      A U.S. institutional money manager prefers to invest in depository instruments of non-domestic equity securities that are privately placed in the U.S. and not subject to the foreign ownership and capital flow restrictions. The type of security that is most appropriate for this investor is:

A. global registered shares.

B. global depository receipts.

C. American depository shares.

Ans: B;

B is correct. Global depository receipts (GDRs) meet the investor preferences. 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. GDRs cannot be listed on U.S. exchanges, but they can be privately placed with the institutional investors based in the United States.

3.      The advantages to an investor owning convertible preference shares of a company most likely include:

A. less price volatility than the underlying common shares.

B. preference dividends that are fixed contractual obligations of the company.

C. an opportunity to receive additional dividends if the company’s profits exceed a pre-specified level.

Ans: A;

Convertible preference shares tend to exhibit less price volatility than the underlying common shares because the dividend payments are known and more stable

4.      A company has issued only one class of common shares and it does not pay dividends on them. It has also issued two types of preference shares – one that is putable and the other callable – and both have a non-cumulative feature. Which of these securities will most likely offer the lowest expected return to the investor?

A. Common shares.

B. Putable preference shares.

C. Callable preference shares.

Ans: B;

Putable preference shares are less risky than their callable counterparts. They give the investor the option to put the shares back to the company. Because of the lower risk they will provide a lower expected rate of return. Common shares are the most risky, whether or not they are dividend paying, and are likely to offer the highest expected return.

5.      Returns from a depository receipt are least likely impacted by which of the following factors?

A. Exchange rate movements

B. Analysts' recommendations

C. The number of depository receipts

Ans: C;

The price of each depository receipt (and returns in turn) 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. The number of depository receipts issued affects their price, but does not impact the returns.

6.      Firms with which of the following characteristics are most likely candidates for a management buyout (MBO)?

A. High dividend payout ratios

B. Large amounts of overvalued assets and low debt levels

C. Large amounts of undervalued assets and high levels of cash flow

 Ans: C;

Companies with large amounts of undervalued assets (which can be sold to reduce debt) and which generate high levels of cash flow (which is used to make interest and principal payments on the debt) are likely candidates for MBO transactions.