Very Short Question Answer
1. List out the pros and cons of stock ownership.
The pros or advantages of stock ownership are as follows:
- It offers substantial return opportunities.
- It is easily marketable.
- The market information on common stock is easily accessible.
- Common stock investment requires lower investment outlay.
The cons or disadvantages of stock ownership are as follows:
- It involves higher risk to investor.
- It has uncertain income.
- It is difficult to determine appropriate value of common stock.
2. Explain briefly any two advantages of stock ownership.
One basic advantage of stock ownership is that it offers substantial return opportunities to investors. The rate of dividend is usually higher than the rate of interest and also the value of stock grows over the period. Similarly, another advantage of stock ownership is that it is easily marketable than other securities. Investors can buy and sell common stock quickly in the secondary market.
3. Write any two differences between small-cap and mid-cap stocks.
Small-cap stocks are the stocks of the companies with small size of market capitalization whereas mid-cap stocks represent the relatively large size of market capitalization than small-cap stocks. Small-cap stocks have usually lower number of shares outstanding than mid-cap stocks.
3. How do you differentiate stock dividend from stock split?
Stock dividend refers to the dividend paid to stockholders in the form of shares of common stock. Company utilizes the retained earnings to pay stock dividend. On the other hand, stock split is simply to increase the number of outstanding shares by declining proportionately the par value. Stock split does not affect retained earnings.
4. Suppose currently you are holding 100 shares of ABC stock and its market price per share is Rs 120. If the company declares a 20 percent stock dividend, what would happen to your number of shares and market price per share?
Number of shares held (N) = 100
Current market price per share (MPS) = Rs 120
Rate of stock dividend (r) = 0.2
Number of shares after stock dividend = N x (1 + r) = 100 (1.2) = 120 shares
Market price per share after stock dividend = MPS x 1 / 1 +r
= Rs 120 × 1/ 1.2 = Rs 100
5. You are holding 100 shares of a company and the prevailing market price is Rs 300 per share. What will be your number of outstanding shares and market price per share after 3-for-1 split?
Number of shares held (N) = 100
Prevailing market price per share (MPS) = Rs 300
Stock split = 3 for 1.
Number of shares after split = N * = 100 x3 /1 = 300
Market price per share after split = MPS × 1/3 = 300 x 1/3 =100
Short Question Answer
1. Theoretical arguments and empirical research support the case that stock dividend and stock split do not enhance shareholder wealth. However, corporations continue to declare stock dividends and splits. Give arguments for and against stock dividends and splits from the perspective of the shareholder.
Stock dividend and stock split do not affect the total equity capitalization of a company. Stock dividend is simply a book keeping transfer of retained earnings to capital stock and additional paid in capital account. Stock dividend does not result into any cash outflow from and cash inflow to the company. The company generally uses stock dividend as a way to conserve cash for additional investment opportunity. Stock split also does not result into any change in total equity position of the company. It is simply to increase the number of outstanding shares by proportionately reducing the par value per share.
By stock dividend and stock split, there is no change in proportionate ownership of the stockholders to the company and there is no change in the total wealth position of stockholders. Therefore, in a perfect market, stock dividend and stock split has no economic significance. Despite of this fact, many companies prefer to announce stock dividend and stock split. One reason for stock dividend is to conserve the cash available with company for newer or additional investment opportunity. Due to this reason, the company may prefer paying stock dividend than the cash dividend. Companies may also use the stock split as a way to maintain stock market active and liquid. Especially when company’s stock price reaches a very high value in the market, the trading slows down due to the higher stock price. In this situation, to maintain the price of stock at tradable level, the company announces stock split, which brings down the market price of stock to a reasonable size for trading.
Companies also prefer to announce stock dividend and split simply because they may create psychological value among investors. In an imperfect market, it is possible that investors think stock split and stock dividend as a way of increasing their number of stock holdings in the company. Similarly, if stock dividend and stock split are accompanied by increased cash dividend, this results into higher dividend income to the investors after stock dividend and split. In other words, the stockholders may perceive favourably the stock dividend and stock split carrying a message about higher future dividends and cash flows so they may add psychological value to the company’s stock.
2. Consider the following price quotation for a corporate bond from a financial newspaper.
Long Question Answer
2. M Publishing Company’s stock currently sells for Rs400 per share. The company has 120,000 shares outstanding. What would be the effect on the number of shares outstanding and on the stock price of the following:
- Fifteen percent stock dividend.
- Four-for-three stock split.
- Why do companies give stock dividend instead of cash dividend?
- Give reasons for stock split.
3. Information are given below.