Library/CFA (Chartered Financial Analyst)/JuiceNotes 2024: Equity (CFA Level I)/Overview of Equity Securities

Overview of Equity Securities

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Characteristics of Equity Securities5 min

Equity securities represent ownership in a company. Common shares typically carry voting rights and entitlement to variable dividends, which are a function of profitability. Voting systems can be statutory (one vote per share per seat) or cumulative (votes can be pooled for a single candidate), the latter benefiting minority shareholders. Preference shares combine features of debt and equity, usually offering fixed dividends and priority over common shares in liquidation. They can be cumulative (unpaid dividends accrue) or non-cumulative, and participating (share in extra profits) or non-participating. Callable shares give the issuer the right to buy back shares, making them riskier for investors, whereas putable shares allow investors to sell shares back to the issuer, reducing investor risk.

Key Points

Common shares: Ownership, voting rights, variable dividends.
Statutory voting: Votes distributed evenly per seat.
Cumulative voting: Votes can be concentrated; favors minority shareholders.
Preference shares: Fixed dividends, priority in liquidation, usually no voting rights.
Callable shares: Issuer can repurchase; higher risk for investor.
Putable shares: Investor can sell back; lower risk for investor.

Private vs. Public and Foreign Equity6 min

Public equity markets provide liquidity and price transparency but require strict financial disclosures. Private equity (PE) involves less liquidity and disclosure but allows management to focus on long-term goals without quarterly public pressure. Major types of PE include Venture Capital (early-stage) and Leveraged Buyouts (mature companies). For foreign investment, investors use Global Depository Receipts (GDRs) or American Depository Receipts (ADRs). ADRs are denominated in USD and trade on US markets. They are categorized into Levels 1, 2, and 3, and Rule 144A, varying by listing location (OTC vs. Exchange) and ability to raise capital. Global Registered Shares (GRS) trade on multiple exchanges in different currencies.

Key Points

Public equity: High liquidity, transparency, reporting costs.
Private equity: Illiquid, long-term focus, includes VC and LBOs.
Depository Receipts (DRs): Represent ownership in foreign firms.
ADRs: USD-denominated, trade in US. Levels 1-3 determine listing and capital raising.
GDRs: Issued outside the company's home country and outside the US.
BLDR: ETF-like basket of depository receipts.

Risk, Return, and Valuation Concepts5 min

Equity returns come from dividends, capital gains, and currency fluctuations. Risk is measured by standard deviation. In terms of risk hierarchy, callable common shares are the riskiest, while putable preference shares are generally the least risky among equities. Book value represents the accounting value of equity (Assets - Liabilities), reflecting past decisions. Market value represents the share price multiplied by the number of shares, reflecting future expectations. Management creates value when the Return on Equity (ROE) exceeds the Cost of Equity (the investor's required return). If ROE is less than the Cost of Equity, the market value may drop below book value.

Key Points

Total Return = Dividends + Capital Gains + Currency Effects.
Callable shares are riskier than non-callable; Putable shares are less risky.
Book Value: Historical financial position.
Market Value: Future expectations of cash flows.
Value Creation: Occurs when ROE > Cost of Equity.
Cost of Equity: Minimum rate of return required by investors.

Questions

Question 1

Which type of equity security typically provides the holder with voting rights?

Overview of Equity Securities

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