Primary Difference between Ordinary and Preference Shares - Assignment Example

ASSIGNMENT 1. Outline primary difference between ordinary and preference shares. (10 Marks) Solution: A share is a financial asset that provides for equal distributions of profits if any, usually paid in the form of dividends. Ordinary shares are also known as the common shares. They have a lower priority when it comes to company assets in the case of insolvency and the shareholders of these shares are only entitled to one vote per share. Dividends under ordinary shares are paid dependent on the company manager’s discretion and if the company makes any profits. They represent an equity ownership in a company. Preference shares also called the preferred shares, have a higher priority on the company’s assets. This is in the case of insolvency of the company. Preference shares are paid before common shares are paid. Shareholders of preference shares are entitled to a fixed dividend without any voting rights. Their dividends are usually set at a rate specifically established. Preference shares can also be converted to common or ordinary shares. These types of shares are commonly used by capitalists as a startup for many companies. Further on, preference shares can either be cumulative or non-cumulative. Pending dividends are owed in the future when it comes to cumulative shares. That is the shares accumulate the outstanding dividends. However, for non-cumulative shares, dividends not paid are referred as lost. In the case of bankruptcy or liquidation of a company, preference shares are paid in accordance with their per value after payments of outstanding bonds are made. Preference shares are also divided into another type known as the participatory shares. They include an additional dividend payment when a corporation attains a certain performance aim set out. 2. Explain the concept of risk in finance. (10 marks) Solution: A risk is an expectation of an unexpected occurrence or negative outcome after having engaged in something. A business risk in finance is therefore associated with the negative occurrence of financial losses to a firm. This type of risk emerges from instability and losses in the financial markets which is caused by varying interest rates, currencies among others. The types of financial risks include the following: a) Credit risk – Arises when one party fails to pay money borrowed or goods and services offered on credit terms as an obligation of an agreement. This type of risk is further classified into settlement risk and sovereign risks. b) Market risk – The regular fluctuation of prices in instruments of finance is the major cause of market risks. Directional risks and non-directional risks fall under this umbrella. Directional risks are those that are caused by movement in stock exchange prices and interest rates while non-directional are those that are volatile in nature. c) Operational risks – Arises from mismanagement and technical failures in a firm. The day to day operation activities may be mismanaged thus causing a finance loss. This risk is further classified into model and fraud risks. d) Risk in Liquidity – Inability to transact is the major force behind liquidity risks. They can either be asset liquidity risk which is caused by insufficient buyers or sellers against sell orders and buying orders or funding liquidity risk that is defined as incapability to settle obligations such as debt or rent when it or they are due. e) Legal risks – Arises whenever a company is charged in a court of law and required to follow legal proceedings. The costs and charges incurred are a risk to the financial state of the firm. 3. Differentiate passive and active fund management styles. (10 marks) Solution: Passive Passive fund management is also called passive strategy, index investments or passive investing. It is associated with exchange traded funds and mutual funds. The fund’s portfolio usually reflects a specific market index. A manager, in this case, will try to counter the market with investment strategies of his or her like as well as use trading decisions of a portfolio’s security. This type of management assumes that the markets incorporate and reflect all information which renders an individual stock picking irrelevant. This makes investments in index fund the best strategy of investments. Active Active fund management refers to a management style where a manager makes only distinguished investments with the aim of outdoing an investment benchmark index. Such managers are usually flexible. The management involves exploiting market inefficiencies by purchasing market securities that undervalued. The management may also short sell market securities that have been overvalued. Strategies such as price-earnings ratios are used to build portfolios in an attempt to anticipate long term macroeconomics trends. 4. The significance of the loan-to-valuation ratio adopted for marginal lending to the borrower. (10 marks) Solution: The loan to valuation ratio refers to the ratio used to evaluate the amount of loan equivalent the asset purchased. Used by lenders in the bank and mortgage fields in order to represent the first mortgage line as a percentage of total appraised value of real property. The risk ratio is used to qualify borrowers for a mortgage. Higher loan to value ratios are reserved for borrowers with a good mortgage history and those with higher credit scores and vice versa for the low loan to valuation ratios. Full financing (100% loan to valuation ratio) privilege is assigned to the most credit worthy borrowers. It enables a borrower to know his or her repayment terms of a mortgage loan taken. The ratio, in this case, is obtained by the formula: Total balance of the mortgage taken Total purchase price or appraisal value of the home purchased 5. A) Purpose of the introduction of compulsory superannuation contributions and the government’s superannuation guarantee scheme (5 marks) Solution The purpose of the scheme was to ensure that every worker saves for their retirement in order to reduce the Australia’s age pension. It was a result of financial challenges of an expanding aged population in the country. This is through accumulation fund and benefit superannuation. B) Significant contributions of the scheme to its objective (5 marks) Solution The superannuation guarantee scheme has contributed to its objective because it has enabled the working population to save and invest in their future after retirement as well as diversify the investment. 6. Six positive characteristics of an investment in the property market (10 marks) Solution: The characteristics include: a) Durable – Investments in property markets are usually on a long term basis and therefore the returns are almost forever. An example is the real estate investment in buildings. b) Illiquid - Investment is such that there is a continual high demand for the property involved and investment cannot be sold without a loss in value. c) Heterogeneous - Investment in each property is different from the other. This thus makes it difficult to obtain a uniform market value in investments. d) No transparency – Real estate investments are such that there is the risk of information withheld or unawareness of problems when buying a real estate. e) High startup costs – Costs associated with investing in property markets is usually very high as compared to other investments. Such costs include financing, purchase and closing costs. f) Vulnerability of investment – The risks associated with this type of investment makes it highly profitable where there is a good plan. 7. Outline benefits investing in property funds. (10 marks) Solution: Property investments refer to the act of funding projects relating to long term market benefits such as buildings and taxi cars. The key advantages of such property investments are; a) Stable investment – Compared to other markets, property is one among the stable investments and is less volatile. This is due to the fact that property will always be on demand and that it takes a longer period before property is sold. With property investments, the returns are long term. b) Positive cash flows – The ability to rent out property enables an owner to cover his or her expenses and eventually earn profit from the property. This is common in mortgages and rentals through passive income. Over a period, one is able to gain positive cash flows of the property. For some, these cash flows are used to finance their lifestyles. c) Long term investments – Property investments are of a long term basis. By securing your land properties, one is able to accumulate benefits in the future for a long period. Over time, the positive cash flows can be used to fund other property investments hence creating a chain of lifetime investments. An example is building houses for rentals. d) Leverage – With property investments, one can purchase more with less. In property, it occurs when an investor puts down a deposit on the property and the bank loans the rest amount. This helps to maximize the investment returns during growth. e) Tax benefits – Property investment may offer one tax benefits. One can claim a number of tax benefits when investing in property funds. When experiencing negative gearing (losing money on your investment property), one can get a tax saving and offset the loss of their income. Moreover, one can also claim depreciation on fixtures and fittings to gear on their tax savings. 8. Calculate the price – earnings ratio Price – earnings ratio = Market value per share Earnings per share OR Price per share Earnings per share Where earnings per share (EPS) = earnings / total shares outstanding Total revenue = $13.8 M - $10.0 M = $3.8 M EPS = $7.5 M / $3.8 M = $ 1.974 PER = $ 21.60/ $ 1.974 = $ 10.944 Price-earnings ratio = $10.944 The company’s growth prospect shows that the company’s EPR is lesser than that of the industry and that its growth rate is slow. 9. Calculating unit price Book value Market value Details $million $million Cash and deposits 25 28 Bonds 65 59 Equities 135 296 Property 100 112 Trade creditors 45 45 Mortgage loans 167 167 Unit price = total fixed costs + total variable costs Total units Total units given = 63 million units For book value: $537,000,000/63,000,000 = $8.5 unit price For market value: $707,000,000/63,000,000 = $11.2 unit price 10. Calculate the net tangible asset price per unit A) NTA = Total assets – Intangible assets – liabilities $80,000,000 - $50,000,000 - $20,000,000 = $10,000,000 NTA = $10,000,000 B) Market price = 10% of $10,000,000 = $1,000,000 Market price = $1,000,000 The values are different as the market price is trading at a discount. Read More