Share, Bond
and Debenture issued by companies are taken as different tools of
investment for the investors. Each of these tools of investment used as sources
of investment has its individual features, advantages and disadvantages.
Expected income and risks of the investors from these tools of investment are
different. So, an investor should know about different sides of each of these
tools of investment before taking his decision for investment. In this chapter
we shall be able to know about these tools of investment from the perspectives
of the investors.
After we have studied this chapter, we will be able to
* Describe the concepts of share, bond
and debenture. Classify different types of shares.
* Identify the comparative differences among different types
of shares. Be able to describe the differences between bond and debenture.
* Be able to explain dividend policy.
Introduction
In the previous chapters you have known about general
share, priority share, bond and debenture as sources
of financing in business firms. These tools of financing
issued by companies are considered as sources of investment for the investors.
An investor can invest his money in different sectors. Assume your father has
10 thousand dollar. He can, according to his wish, put it in a bank as fixed
deposit or he can invest it in one or more tools of investment – general share,
priority share, bond and debenture issued by companies. As sources of
investment, each of these has its own special features. Expected income and
risks of the investors from each of these tools of investment are different.
Special features and advantages-disadvantages of each of these as source of
investment and their comparative
evaluation have been discussed in the following paragraphs.
General Share
Selling of shares is an important source of gathering fund
for public
limited companies. The voluminous total capital of the company is divided
into small (equal) units and those are sold as shares. After gathering minimum
capital with the approval of the government, applications are invited from the
public through giving an advertisement in the newspaper with publishing a paper
of statement with information about the company. When applications submitted
are numbered compared to shares distributable, shares are distributed by
lottery. As a result, small investors also can participate in investment by
buying shares. They are indeed the owners of the company. If the company earns
profit, it is distributed among them as dividend. The invested money of the
shareholders is not refundable. However, if the liquid money is needed, the
shareholders can sell these shares in the secondary market (such as: New York Stock Exchange) and if the price
is increased there they get profit. Usually, in the cases of profitable
companies, shareholders get dividend on regular basis. However, the rate of
giving dividends is not pre-fixed. Giving dividend is also not mandatory for
the company. If no profit occurs, dividend is not usually given. And even if
the company makes profit, total amount of profit is not distributed as
dividend. If the company wishes, it can give dividend at any rate, besides it
can give no dividend also. But in that case, if the company cannot give
dividend to the shareholders, the price of the shares is decreased in the
secondary market, which is not good for the company.
Buying shares is a risky investment for the investors. Share
issuing companies are not always bound to give dividends to the shareholders.
If the company cannot make sufficient profit in any year, no dividend is given
to the shareholders that year. Besides, when the company is closed,
shares of the general shareholders are met after meeting the dues of the
debtors and priority shareholders from the money got by selling the properties
of the company. As a result, if there is no money left after paying all dues
general shareholders may have the risk of getting no money back for their
investment. For these reasons, investment in general shares is considered as
the most risky investment. However, as it is a risky investment so there is
also possibility of making more profit from such shares. If an investor decides
to invest with clear knowledge and good calculations, general shares may have
been a good source of investment for him. As a tool of investment, general
shares have some special features. Those are described below:
1. General shares provide ownership
to the share investors. As a result, as an owner he has the legal rights on its
profits earned and its properties.
2. General shares give full authority to its owners to
control the company. Shareholders control the company by applying their voting
right in taking important decisions.
3. General shares are easily transferable. The investor
according to his wish can handover the shares at his ownership at any time.
As a tool
of investment general shares have some advantages and disadvantages:
Advantages
More Income: General shares can be a source of good
income if an investor invests his money with clear knowledge and good
calculations. The income earned by the investor from other tools of investment
like priority shares, bonds and debentures is fixed. But income from general
shares is not fixed. As a result, when the company earns more, the income of
the investors also increases.
Limited Liability: The owners of the general shares
jointly bear the risks of the company. The total risks of an investor
are at no circumstances bigger than his invested money. For example, suppose an
investor has bought 100 shares of a company and the face value of each share
was 10 dollar, so his total liabilities may be at best 10 x 100 = 10,000 dollar.
Liquidity: General shares are well considered by the
investors as liquid money. The investor according to his wish can
collect money at any time by selling the shares at his possession. However, the
liquidity of shares of all companies is not equal. Usually, the liquidity of
shares of big and good companies is higher than that of other companies.
Disadvantages
Risk: Investment in general shares is comparatively
more risky. There are many speculating investors in the share
market. As a result, there is risk of doing loss if the investment is not
guided by knowledge and good calculations.
Rights in Profit and Property Distribution: In
distribution of profits, the company has to pay first all the
liabilities payable to the owners of priority shares, bonds and debentures; and
the general shareholders have rights on the remaining profits (if any). In this
way, when the company is closed, after paying all the liabilities of the
company with the money got by selling its properties, the shareholders will
distribute among themselves the rest of the money (if any). That is, in both
the cases the rights of the owners of priority shares, bonds and debentures get
priority over the rights of the general shareholders.
Priority Share
Investment in priority shares is considered a good tool of
investment for those investors who expect income at a certain rate from their
investment in shares. Like that of general shares priority shares also have
some own features and characters:
1. Ownership:
Priority shareholders are not told full owners
of the company. They are considered in between the owners of general shares
and the owners of bonds and debentures.
2. Transformability:
For many priority shares alternative options are there to transform them into
general shares. So, if the investor wishes, he can change his status to an
owner of general shares.
From the perspective of the investors, priority shares have
some advantages and disadvantages. The advantages and disadvantages of priority
shares are discussed below:
Advantages
1. Income at Certain
Rate: The owners of priority shares get dividend at some certain rate. As a
result, the shareholders have less uncertainty of income.
2. Priority on Profit
Income: While giving dividend, owners of the priority shares get priority
over the owners of the general shares.
3. Claims on the
Properties: At the time of liquidation or closure of the company, claims of
the owners of priority shares are first considered before meeting the claims of
the owners of general shares. But of course, their claims are met after
fulfilling the claims of the owners of debentures.
Disadvantages
1. Control: The
priority shareholders do not have any voting right. So they have no control
over the company.
2. Limited Income:
Priority shareholders’ rate of income is fixed. Hence, priority shareholders do
not get any share of extra profits made by the company.
System of Investment in Shares
Investors can invest in share
markets in two ways:
1. Through Primary Market
2. Through Secondary Market.
Primary Market
Primary market means that market
where a company announces the initial public offering (IPO) for selling its
shares. When a company sells its shares in the market
for the first time, that offer for selling is called IPO. If an investor buys
shares by participating in the IPO offered by any company, it is considered
that he has bought primary shares.
Secondary Market
After selling shares for the first time by a company to the
investors, the investors can buy and sell shares among themselves. The market
where investors buy and sell shares among themselves is called a secondary
market.
Dividend and Dividend Policy
The gains or profit of a company is the deserving income of
the shareholders. So, the gains or profit is distributed among the
shareholders. Usually, a company does not distribute the full amount of gains
or profit among the shareholders. It retains a portion of the gains and profit
for financing in the affairs of business in future, and distributes the rest
amount among the shareholders. The portion of gains or profit which is
distributed among the shareholders is called dividend. A company can give dividend
usually in two ways:
1. Cash Dividend
2. Stock Dividend or Bonus Share
Cash Dividend
The dividend which is paid in cash money is called cash
dividend. For example: suppose, a company announces 10% cash dividend. An
investor holds 500 shares
of that company of each share priced 10 dollar. That investor will get 1 x
500 or 500 dollar as cash dividend.
Stock Dividend
Many a time, a company gives stock dividend instead of cash
dividend or stock dividend side by side with cash dividend. The company usually
gives stock dividend in proportion with shares issued at present. As a result,
the number of shares of the company increases. Suppose, a company has at
present 10 million shares of face value 10 dollar. The company announces 50% or
2:1 portion of stock dividend. As a result, if an investor has 500 shares at
present, after getting the dividend the number of his shares will be 750. In
this way, total shares issued by the company will be 15 million.
Dividend Policy
A company has to take dividend-related various decisions
every year, for example, what portion of profit will be given as dividend,
whether cash dividend or stock dividend will be given, etc. For taking these decisions,
every company has particular policy which may give directions to give dividend.
These policies are called dividend policies. Usually, three types of dividend
policies are found, such as:
1. Fixed Money
Dividend Policy: According to this policy, every year equal amount of money
is given as dividend. For example, if a company gives 10 dollar dividend per
share every year, it will be called fixed dividend policy. Whatever more amount
of money a company may earn, it gives same amount of dividend as was given in
previous years. However, in this system the amount of dividend usually does not
decrease.
2. Dividend Payment
Ratio Policy: According to this policy, a company decides what portion of
its profit it will give as dividend. As per the decision, every year the
company gives dividend proportionately. For example, suppose a company decides
to give at 50% proportional rate. As a result, if in one year the company earns
20 million dollar, then it will give the shareholders 20 million x 50% or 10
million dollar as dividend.
3. Fixed Dividend
along with Additional Dividend Policy: This is an ideal dividend policy for
those companies which have no fixed or regular income. According to this
policy, a company gives an additional dividend every year in addition to a
minimum fixed dividend. As this dividend policy is much flexible than other
dividend policies, many companies adopts this policy.
End
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