R49 Overview of Equity Securities

8/19/2019 R49 Overview of Equity Securities

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Level I – Equity Investments

Overview of Equity Securities

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Introduction and Contents

1. Introduction

2. Equity Securities in Global Financial Markets

3. Types and Characteristics of Equity Securities

4. Private versus Public Equity Securities

5. Investing in Non-Domestic Equity Securities

6. Risk and Return Characteristics of Equity Securities

7. Equity Securities and Company Value

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2. Equity Security in Global Financial M

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• Equity markets are very large

Exhibit 1: Regional contributions to global GDP and equity market capitalizations

Exhibit 2: Equity market capitalizations at the end of 2008

• Historically equity markets have offered high returns relative to govern

and T-bills, but at higher risk

Exhibit 3: Return numbers across countries

Exhibit 4: Return numbers in three different time periods

Exhibit 5: Extreme losses

Exhibit 6: Stock ownership in different countries

• Bottom line: equity securities are a key asset class for global investors


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3. Types and Characteristics of Equity Secu

• Common shares represent an ownership interest in a company and giv

claim on its operating performance, the opportunity to participate in d

making, and a claim on the company’s net assets in the case of liquidat Statutory voting versus cumulative voting

Different classes (Class A and Class B)

Callable common shares

Putable common shares

• Preference shares are a form of equity in which payments made to preshareholders take precedence over payments to common shareholders

Cumulative and non-cumulative preference shares

Participating and non-participating preference shares

Convertible preference shares

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4. Private versus Public Equity Securi

• Private equity securities are issued primarily to institutional i

private placements and do not trade in secondary equity ma

Company’s management can focus on long term value creation

Highly illiquid

Potentially high returns

• Types of private equity

Venture capital Leveraged buyout

Management buyout

Private investment in public entity (PIPE)

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5. Investing in Non-Domestic Equiti

• Technological innovations have accelerated the integration a

of global financial markets

• Increased integration makes it easier for

companies to raise money and expand internationally

investors to invest internationally

• Some countries impose foreign exchange restrictions

• Direct investing versus depository receipts

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Depository Receipts

• A depository receipt (DR) is a security that trades like an ordinary share

exchange and represents an economic interest in a foreign company

Equity shares are deposited in a bank (depository) in the country on whose excha

will trade; depository bank issues receipts that represent deposited shares

A DR can be sponsored or unsponsored

GDR is issued outside the company’s home country and outside the U.S.

ADR is a USD denominated security that trades like a common share on U.S. exch

types are shown on the next slide

GDRs and ADRs are not subject to foreign ownership and capital flow restrictions

imposed by issuing company’s home country

• A global registered share (GRS) is traded on different stock exchanges i

currencies

• A basked of listed depository receipts (BLDR) is an ETF that represents a

depository receipts

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American Depository Receipts

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Level I

(Unlisted)

Level II

(Listed)

Level III

(Listed)

Ru

(Un

Objectives

Raising Capital on US

Markets?

SEC Registration

Trading

Listing fees

Size and earnings

requirements


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6. Risk and Return Characteristics of Equity Sec

• Return Characteristics of Equity Securities

Capital gains and dividend

Foreign exchange gain

• Risk of Equity Securities

Risk is based on uncertainty of future cash flows

• Compare the risk/return characteristics of

Common shares vs. preference shares

Cumulative vs. non-cumulative preference shares

Callable vs. non-callable shares

Putable vs. non-putable shares

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7 E i S i i d C V


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7. Equity Securities and Company Va

• Companies issue equity to raise capital and increase liquidity

Finance revenue generating activities

Acquisitions

Option-based incentives for employees

• Management goal is to increase book value and maximize market value

Management actions can directly influence book value

Management actions have an indirectly impact on market value

Book value and market value are seldom the same

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A ti R t E it


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Accounting Return on Equity

ROE is an important measure to determine whether manageme

effectively using capital

ROE = Net Income / Average BVE

Sometimes beginning BVE is used

ROE increases if income increases at a faster rate than equity

Is increasing ROE always good?

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Th C f E i d I ’ R i d R f


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The Cost of Equity and Investors’ Required Rates of

• When investors purchase company shares, their minimum required rat

is based on the future cash flows they expect to receive

• Cost of equity is the minimum expected rate of return that a company

its investors to purchase its shares (not easily determined)

Cost of equity may be different from investor’s required rate of return

Because companies try to raise capital at the lowest possible cost, the cost of equ

used as a proxy for the investors’ minimum required rate of return

If expected rate of return is not maintained share price falls

• Cost of equity can be estimated using

Dividend Discount Model (DDM)

Capital Asset Pricing Model (CAPM)

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S


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Summary

• Importance of equity securities

• Characteristics of various types of securities

Risk-return• Public versus private securities

• Voting rights

• Non-domestic securities

• Financing a company’s assets

• Market value versus book value

• Return on equity

• Cost of equity and required rates of return

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C l i


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Conclusion

• Read the summary

•

Review learning objectives

• Examples

• Practice problems

• Practice questions from other sources

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R49 Overview of Equity Securities

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