ell securities on their behalf, in which case they deal with RSPs. And dual capacity stockbrokers/dealers, however they will buy and sell shares on their own account, and may act as both agent and principal in carrying out clients buy and sell instruction. Unfortunately the integration of the broking and dealing functions within the same financial grouping can give rise to conflict of interest, and this has made it essential to create a protective regulatory framework both within and between financial institutions.
But some companies are not suitable for a full Stock Exchange listing and the Alternative Investment Market (AIM), setting up by the Stock Market Exchange in 1995, is a more suitable for unknown and risky companies.Its main features are:
- no formal limit on company size;
- ₤500.000 capitalization (full listing ₤3-₤5 million);
- no minimum trading record (full listing five years);
- 10% of the equity capital must be in public hands (full listing 25%)
- no entry fee is required, but a annual listing fee of ₤2.500 in year 1, rising to ₤4.000 in year three is payable.
- Procedure for an Issue of Securities
All arrangements made by an Issuing House, which specialized in this work. The procedure would be probably as follows:
- an evaluation by the Issuing House of the companys financial standing and future prospects;
- an assessment if the finance required, and advise regarding the most appropriate package to finance to meet the need;
- advice of the timing of the issue;
- agreement with the Stock Exchange on the method of issue (sale by tender, SE placing etc);
- completion of an underighting agreement;
- preparation of the prospectus and other documents required by the Stock Exchange in the initial application for the quotation;
- advertising the offer for sell and the publication of the prospectus;
- arrangements with the bankers to receive the amounts payable;
- the issue price of the share to be agreed at a level to ensure a success of the issue;
- final application for the Stock Exchange quotation, and signing of the listing agreement, which binds the company to maintain a regular supply of information to the Stock Exchange and shareholders.
- Equity Share Futures and Options
These are traded at the London International Futures and Options Exchange (LIFFE), which was established in 1982.
Both futures and options are used by investors for:
- hedging i.e. protecting against future capital loss in their investments;
- speculation i.e. gambling on forecasts of favorable movements in future Stock Market prices.
The main differences between futures and options is that futures contracts are binding obligation to buy or sell assets, whereas options convey rights to buy or sell assets, but not obligations. Futures are agreed, whereas options are purchase.
Equity Share Futures
The only equity futures dealt in on LIFFE are those based on the FTSE 100 and MID 250 Stock Indices.
Futures contracts may b used to protect an expected rise in the market before funds are available to an investor. For example, an investor expecting a large cash sum in three months time could protect his position by buying FTSE 100 Index futures contract now, and selling futures for a higher sum when the market rises. The profit made on the futures position would then compensate him for the higher price he has pay for his investments when the expected cash sum arrives.
Equity Share Options
An option is the right to buy or sell something at an agreed price (the exercise price) within a stated period of time. As applied to shares, a payment (a premium) is made through or to a stockbroker for a call option, which gives the right to buy shares by a future date; or for a put option, which gives the right to sell shares by future date. And the holder may exercise the option, or late it lapse. However the giver (the writer) of the option, i. e. the dealer to whom the premium has been paid, is obliged to deliver or buy the shares respectively, if the option holder exercises his rights.
Traditional options have been dealt in for over 200 years, and are usually written for a date three month hence, when either the shares are exchanged, or the option lapses. The disadvantage of the traditional option is that it cannot be traded before the exercise date, and it was because of this inflexibility that the traded options market was created in the UK in 1978.
Equity options were first traded on LIFFE in 1992, and currently (1997), options are available on 73 large companies shares. Because traded options cost much less then the underlying shares, an investor is able to back an investment opinion without risking too much money.
II. Dividend Policy and Share Valuation
- Dividends as a Residual Profit Decision
It would seem sensible for a company to continue to reinvest profit as long as projects can be found that yield returns higher than its cost of capital. In this way, the company can earn a higher return for shareholders than they can earn for themselves by reinvesting dividends. Such a policy can be optimal, however, only if the company maintains its target-gearing ratio by adding an appropriate proportion of borrowed funds to the retained earnings. If not, the companys coast of capital would increase because of its disproportionate volume of higher-cost equity capital; this would be reflected share price.
The LTD Company has the chance to invest in the five projects listed below:
ProjectsCapital outlay, ₤Yield rate, %A70.00018B100.00017C130.00016D50.00015E100.00014The company cost of capital is 16% its optimal debt to net assets ratio is 30% and the current years profit available to equity shareholders is ₤350.000.
- State which projects would be accepted, and what is the total finance requires for those projects.
- Assuming that the company wishes to maintain its gearing ratio, how much of the required finance will be borrowed?
- How much of this years profit can be distributed?
- A, B and C, with yield greater than or equal to the companys cost of capital; total finance required ₤300.000.
- Amount to be borrowed: 30% of ₤300.000=₤90.000.
- This years profit:₤350.000
less amount to be reinvested ₤300.000-₤90.000: 210.000
Profit for distribution: 140.000Companys shareholders obtain the best of both words. They can invest the ₤140.000 received as dividends to earn a higher rate of return than the company could earn for them; and the ₤210.000 retained by the company is reinvested to shareholders advantage. Shareholders wealth is optimized, and the dividend paid is simply the residual profit after investment policy has been approved.
If companies look upon dividend policy as what remains after investments are decided then the search for an optimum dividend policy is pointless. Shareholders wanting dividends can always make them for themselves by selling some of their shares.
Further support for the residual theory of dividends, and the argument that the change in dividend policy does not affect share values, was advanced by Modigliani and Miller in 1961. They contended that in a perfect market the increase in total value of a company after it has accepted an investment projects is the same, whether internal or external finance is used.
One deficiency in the Modigliani and Miller hypothesis, however, is that they ignore costs associated with an issue of shares, which can be quite considerable.
- Costs Associated with Dividend Policy
Capital floatation costs are a deterrent substituting external finance for retained earnings but there are other costs affected by the dividend decision.
If shareholders are left to make their own dividends by selling some shares, this involves brokerage and other selling costs that, on a small number of shares, can be extremely an economic. In addition, if they have to be sold during a period of low share price, capital losses may be suffered.
Another important factor is taxation. First, when the company distributes dividend it has to pay an advance installment of corporation tax (ACT), currently one quarter of the amount paid. But the offset against mainstream liability to pay corporation tax will be delayed by at least one year. Indeed, if the company does not currently pay this type of tax, the delay in setting off ACT will be even longer, and this will tend to restrain extravagant dividend distributions.
Second, from the investors viewpoint profitability invested retained earnings should increase share values, enabling shareholders to create their own dividends. Selling shares creates a liability to capital gains tax, currently 20%, 23% or 40%, but subject to a fairly generous exemption limit. By comparison, dividends in the hands of shareholders attracthigher rate of income tax (up to 40%). Thus higher-rate taxpayers may prefer comparatively low dividend payouts to minimize their tax burden.
Third, financial institutions confuse the taxation picture even more, through their major holdings in the shares of quoted companies. They are able to set off dividends recei