Learning Module 1 of Equities 11–14% of the exam

Equity Instrument Features

2 lessons. About 11 minutes in cram mode, 52 minutes in full.

Start with lesson 1 Learn with Sensei Read the module summary Practice this module

Lessons

1
Common shares and preference shares
describe 6 min cram, 28 min full
2
Public vs private equity: venture capital, buyouts and PIPEs
compare 5 min cram, 24 min full

What the exam expects you to do

Describe basic features and types of equity instruments.Common shares and preference shares
Contrast features of publicly listed versus private equity securities.Public vs private equity: venture capital, buyouts and PIPEs

Module summary

The whole module on one sheet, organised by lesson: what to memorize, how the ideas fit together, the formulas and the key terms. No paragraphs, just what you need to revise.

Hide what I know

How deeply to learn each part

Know the idea: Understand it in general. It frames other topics, but you will not calculate with it.
Use it: Understand it well enough to solve a question with it. Recognize when it applies.
Memorize: Learn it by heart. The exam will not give it to you.

Common shares and preference shares

Known

MemorizeCommon, preference and debt

	Common	Preference	Debt
Contractual obligation	no	no	yes
Claim	residual, paid last	ahead of common	ahead of preference
Payoff uncertainty	highest	lower; dividends more debt-like	lowest
Votes	yes	rarely	no
Maturity	none	none	finite

Memory hook Common owns the leftovers and the vote. Debt owns a contract. Preference sits between: a fixed payment that cannot force a default.

Know it cold Only debt has a contractual obligation and a finite maturity.

MemorizeThe six rights of a common shareholder

Right	What it gives
Voting	a proportional say in governance decisions
Dividend	a proportional share of any regular or extraordinary distribution
Conversion	any right to swap one class or type of equity for another
Liquidation	a proportional claim on net assets left after higher claims
Split, subdivision or combination	how the claim adjusts when shares are split or combined
Preemptive	first call on new shares or securities convertible into shares

Memory hook Vote, Dividend, Convert, Liquidate, Split, Preempt: "Very Dull Companies Lose Shareholders' Patience".

Know it cold Preemptive right = first call on new shares, so a holder can keep the same percentage.

MemorizePreference features: who benefits

Feature	Who holds the right	What it does
Cumulative	investor	missed dividends accrue
Participating	investor	upside: extra dividend above a profit level
Convertible	investor	upside: switch into common, in return for a lower dividend
Putable	investor	downside protection: sell back at the put contingency price
Liquidation preference payout	investor	downside protection: set cash before common in liquidation
Callable	issuer	issuer may buy back at a set price

Memory hook Ask who holds the option. Upside or protection for the investor, flexibility for the issuer.

Know it cold Dividends due on cumulative shares = (years missed + 1) × rate × par.

Key terms

equity instruments Know the idea
economic, voting and legal rights Memorize
indefinite life Use it
residual claim Use it
dividends Know the idea
company life cycle Know the idea
equity prospectus Know the idea
offering memorandum Know the idea
common shares Use it
rights of common shareholders Memorize
preemptive rights Memorize
proxy vote Know the idea
equity exchange Know the idea
preference shares Use it
cumulative preference shares Memorize
non-cumulative preference shares Use it
dividends in arrears Use it
contingency provisions Use it
participating preference shares Memorize
callable preference shares Memorize
putable preference shares Memorize
put contingency price Memorize
liquidation preference payout Memorize
convertible preference shares Memorize

What an equity instrument gives its holder

Equity instrumenta fractional ownership claim with no maturity

Common shares Memorize residual claim, votes, highest payoff uncertainty
- Economic rights a proportional share of dividends and of net assets in liquidation
- Voting rights board elections, mergers, auditors; in person or by proxy
Preference shares Memorize senior to common, junior to debt; fixed dividend; rarely vote
- Standard features fixed percentage of par, often cumulative, no maturity
- Contingency features upside, downside protection or an issuer right

The six rights of a common shareholder

Common shareholdereach right is proportional to the shares held, unless the terms say otherwise

Voting Memorize a proportional say in governance decisions
Dividend Memorize a proportional share of any regular or extraordinary distribution
Conversion Memorize any right to swap one class or type of equity for another
Liquidation Memorize a proportional claim on net assets left after higher claims
Split, subdivision or combination Memorize how the claim adjusts when shares are split or combined
Preemptive Memorize first call on new shares or securities convertible into shares

Features of a preference share

Preference share featuresmix and match, for example cumulative and putable

Missed dividends Memorize what happens to a skipped dividend
- Cumulative Memorize accrue; paid before any common dividend
- Non-cumulative Memorize lost for good
Upside for the investor Memorize a share of better results
- Participating Memorize extra dividend when profits pass a set level
- Convertible Memorize switch into a set number of common shares
Downside protection for the investor Memorize a safety net if results are weak
- Putable Memorize sell back to the issuer at the put contingency price
- Liquidation preference payout Memorize a set cash amount before any common holder in liquidation
Right for the issuer Memorize flexibility for the company
- Callable Memorize issuer may buy back at a set price

Formulas

Dividend due on cumulative preference shares Use it

D = (n + 1) \times r \times \text{par}

Quick example

6% cumulative preference shares, par USD 25, one year missed. (1 + 1) × 0.06 × 25 = USD 3.00 per share before any common dividend.

On your calculator

1+1=×0.06×25= 3

1ENTER1+0.06×25× 3

ENTER enter (on the HP, puts the number on the stack)

Public vs private equity: venture capital, buyouts and PIPEs

Known

MemorizePublicly listed vs private equity

	Publicly listed	Private
Owners	widely spread, individuals and institutions	few, with majority or large minority stakes
Life-cycle stage	mostly mature	start-up, growth or decline (and mature buyouts)
Liquidity	high, traded every day	low, negotiated sales, sale restrictions
Prices	observable every day	negotiated, rarely updated
Disclosure	standardized, audited, periodic	limited
Owners and managers	separate	often the same people
Control	dispersed	concentrated

Memory hook Private equity trades liquidity and transparency for control.

Know it cold Long-horizon investors can hold illiquid private shares if they earn a higher return on average.

MemorizePrivate equity over the life cycle

Stage	Kind of private equity	What it does
Start-up	venture capital	funds a young company with little or no revenue
Growth	growth equity	funds profitable expansion, lets early investors reduce stakes
Mature	buyout (LBO, MBO)	buys control, often with debt, takes the company private, restructures and sells
Decline	special situations	invests in distress or event-driven change, including PIPEs

Memory hook Venture, Growth, Buyout, Special: one for each stage, start to decline.

Know it cold PIPE: the issuer is listed, the sale is private, the price is discounted, so existing holders are diluted.

Key terms

publicly listed equity Know the idea
private equity securities Use it
private placement Know the idea
listing requirements Know the idea
owner-manager overlap Use it
venture capital Memorize
growth equity Memorize
buyout equity Memorize
leveraged buyout (LBO) Memorize
management buyout (MBO) Memorize
take-private transaction Memorize
special situations Memorize
private investment in public equity (PIPE) Memorize
dilution Use it

Private equity across the company life cycle

Private equityunlisted ownership capital, held for several years and sold to new investors

Venture capital Memorize start-up: founders, friends and family, and venture funds back a company with little or no revenue
Growth equity Memorize growth: new investors fund profitable expansion while the company stays private, and early backers can reduce their stakes
Buyout equity Memorize mature: buy control, restructure, then sell or relist; the target can also be a private company
- Leveraged buyout (LBO) Memorize all the shares of a listed company, often with heavy debt: a take-private
- Management buyout (MBO) Memorize an LBO in which existing managers are among the buyers
Special situations Memorize decline: companies in financial distress or facing event-driven change
- PIPE Memorize a listed company in restructuring sells new shares privately, usually at a discount

Formulas

Value per share after a PIPE Use it

V_{\text{post}} = \dfrac{N_{\text{old}} \times P_{\text{mkt}} + N_{\text{new}} \times P_{\text{PIPE}}}{N_{\text{old}} + N_{\text{new}}}

Quick example

4.5 million shares at 40.00, plus 0.5 million new shares sold at 36.00: (180.0 + 18.0) ÷ 5.0 million = 39.60 a share.

On your calculator

4.5×40+(0.5×36)=÷5= 39.6

4.5ENTER40×0.5ENTER36×+5÷ 39.6

ENTER enter (on the HP, puts the number on the stack)