Chapter 2: Sources of Corporate Finance
Select the correct answer from the options given below and rewrite the statement.
______ is a smallest unit in the total share capital of the company.
Options
Debenture
Bonds
Share
Solution:
Share is a smallest unit in the total share capital of the company.
The benefit of Depository Receipt is ability to raise capital in ______ market.
Options
National
Local
International
Solution:
The benefit of Depository Receipt is ability to raise capital in International market.
______ are residual claimants against the income or assets of the company.
Options
Bondholders
Equity Shareholders
Debenture holders
Solution:
Equity Shareholders are residual claimants against the income or assets of the company.
______ participate in the management of their company
Options
Preference shareholders
Depositors
Equity shareholders
Solution:
Equity shareholders participate in the management of their company
______ shares are issued free of cost to existing equity shareholders.
Options
Bonus
Right
Equity
Solution:
Bonus shares are issued free of cost to existing equity shareholders.
The holder of preference share has right to receive ______ rate of divided.
Options
fixed
fluctuating
lower
Solution:
The holder of preference share has right to receive fixed rate of divided.
Accumulated dividend is paid to ______ preference shares.
Options
redeemable
cumulative
convertible
Solution:
Accumulated dividend is paid to cumulative preference shares.
The holder of ______ preference shares have right to convert their shares into equity shares.
Options
cumulative
convertible
redeemable
The holder of convertible preference shares have right to convert their shares into equity shares.
Debenture holders are ______ of the company.
Options
creditors
owners
suppliers
Solution:
Debenture holders are creditors of the company.
______ is paid on borrowed capital.
Options
Interest
Discount
Dividend
Solution:
Interest is paid on borrowed capital.
Debenture holders get fixed rate of ______ as return on their investment.
Options
Interest
Dividend
Discount
Debenture holders get fixed rate of Interest as return on their investment.
Convertible debentures are converted into ______ after a specific period.
Options
equity shares
deposits
bonds
Solution:
Convertible debentures are converted into equity shares after a specific period.
Retained earnings are ______ source of financing.
Options
internal
external
additional
Retained earnings are internal source of financing.
The holder of bond is ______ of the company.
Options
secretary
owner
creditor
Solution:
The holder of bond is creditor of the company.
Company can accept deposits from public, minimum for ______ months.
Options
six
nine
twelve
Solution:
Company can accept deposits from public, minimum for six months.
Company can accept deposits from public, maximum for ______ months.
Options
12
24
36
Solution:
Company can accept deposits from public, maximum for 36 months.
A depository receipt traded in ______ is called American Depository receipt.
Options
London
Japan
U.S.A
Solution:
Company can accept deposits from public, maximum for U.S.A months.
Match the pairs.
Solution:
Write a word or a term or a phrase which can substitute the following statement.
The ‘real masters’ of the company.
Solution:
The ‘real masters’ of the company. - Equity shareholders
A document of title of ownership of shares.
Solution:
A document of title of ownership of shares. - Share Certificate
The holders of these shares are entitled to participate in the surplus profit.
Solution:
The holders of these shares are entitled to participate in the surplus profit. - Participating Preference Shares
A party through whom the company deals with debenture holders.
Solution:
A party through whom the company deals with debenture holders. - Debenture trustees
Name the shareholders who participate in the management.
Solution:
Name the shareholders who participate in the management. - Equity Shareholders
The value of share which is written on the share certificate.
Solution:
The value of share which is written on the share certificate. - Face value
The value of share which is determined by demand and supply forces in the share market.
Solution:
The value of share which is determined by demand and supply forces in the share market. - Market Value
The value of share which is determined by demand and supply forces in the share market.
Solution:
The value of share which is determined by demand and supply forces in the share market. - Retained earnings
It is an acknowledgement of loan issued by company to depositor.
Solution:
It is an acknowledgement of loan issued by company to depositor. - Deposit Receipt
A Dollar denominated instrument traded in USA.
Solution:
A Dollar denominated instrument traded in USA. - American Depository Receipt (A.D.R.)
The Depository Receipt traded in country other than the USA.
Solution:
The Depository Receipt traded in country other than USA. - Global Depository Recipient (G.D.R.)
Money raised by company from public for minimum 6 months to maximum 36 months.
Solution:
Money raised by company from public for minimum 6 months to maximum 36 months. - Public Deposits
Credit extended by the suppliers with an intention to increase their sales.
Solution:
Credit extended by the suppliers with an intention to increase their sales. - Trade Credit
The credit facility provided to a company having current account with bank.
Solution:
The credit facility provided to a company having current account with bank. - Overdraft
State whether the following statement is true or false.
Equity share capital is known as venture capital.
True
False
Equity shareholders enjoy fixed rate of dividend.
True
False
Equity shareholders are described as ‘shock absorber’ when company has financial crisis.
True
False
Debenture holders have right to vote at general meeting of the company.
True
False
Bond holders are owners of the company.
True
False
Depository bank stores the shares on behalf of GDR holder.
True
False
Financial institutions underwrite the issue of securities.
True
False
Cash credit is given against hypothecation of goods or any security
True
False
Trade credit is major source of long term finance.
True
False
Find the odd one.
Debenture
Public deposit
Retained earnings
Face value
Market value
Redemption value
Share Certificate
Debenture Certificate
ADR
Trade Credit
Overdraft
Cash Credit
Complete the sentence.
The finance needed by business organisation is termed as ______
Solution:
The finance needed by business organisation is termed as Capital
The convertible preference share holders have a right to convert their shares into ______
Solution:
The convertible preference share holders have a right to convert their shares into Equity shares.
Equity shareholders elect their representatives called ______
Solution:
Equity shareholders elect their representatives called Board of Directors.
Bonus shares are issued as gift to ______
Solution:
Bonus shares are issued as gift to Equity shareholders.
The bond holders are ______ of the company.
Solution:
The bond holders are creditors of the company.
Depository receipt traded in a country other than USA is called ______
Solution:
Depository receipt traded in a country other than USA is called Global Depository Receipt.
First Industrial policy was declared in the year ______
Solution:
First Industrial policy was declared in the year 1948
When goods are delivered by supplier to customer on basis of deferred payment it is called as ______
Solution:
When goods are delivered by supplier to customer on basis of deferred payment it is called as Trade Credit.
Select the correct option from the bracket.
(Fluctuating rate of dividend, Preference shares, Interest at fixed rate, Retained earnings, Short term loan)
Answer in one sentence.
What is a share?
Solution:
Share is the smallest unit of the capital of the company.
What are Equity Shares?
Solution:
Equity shares are ordinary shares which are not preference shares. Equity share is a risky capital.
What are preference shares?
Solution:
Preference shares are those shares which carry preferential rights to receive dividend and return of capital.
What are retained earnings?
Solution:
Retained earnings are the earnings of the company which are retained (reinvested) in the business.
What is a debenture?
Solution:
Debenture means acknowledgment of debt. Debenture is a borrowed capital.
What is a bond?
Solution:
Bond is an interest bearing certificate issued by the government.
In which country can ADR be issued?
Solution:
American Depository Receipt (ADR) can be issued in USA.
In which country can GDR be issued?
Solution:
Global Depository Receipt (GDR) can be issued in any country other than USA.
What are convertible debentures?
Solution:
The debentures which are converted into equity shares are known as convertible debentures.
What are cumulative preference shares?
Solution:
Cumulative preference shares are those shares on which dividend goes on accumulating (adding).
Correct the underlined word and rewrite the following sentence.
Owned capital is temporary capital.
Solution:
Owned capital is permanent capital.
Equity shares get dividend at fixed rate.
Solution:
Equity shares get dividend at fluctuating rate.
Preference shares get dividend at fluctuating rate.
Solution:
Preference shares get dividend at fixed rate.
Retained earnings is an external source of finance.
Solution:
Retained earnings is an internal source of finance.
Debenture holder is owner of the company
Solution:
Debenture Holder is creditor of the company.
Bond is a source of short term finance.
Solution:
Bond is a source of long term finance.
Depository Receipt traded in USA is called as Global Depository Receipt.
Solution:
Depository Receipt traded in USA is called as American Depository Receipt.
Explain the following term/concept.
Borrowed Capital
Solution:
(a) Borrowed capital is that capital that is borrowed from creditors. It is also known as debt capital. Interest has to be paid on borrowed capital whether the company makes a profit or not.
(b) The company borrows capital when the owned capital is not sufficient. The company can raise borrowed capital in the form of: Debentures, Public Deposits, Bonds, etc.
Owned capital
Solution:
(a) The capital raised by the company with the help of owners (shareholders) is called owned capital or ownership capital. Owned capital is regarded as permanent capital, as it is returned only at the time of winding up of the company.
(b) Owned capital can be raised in the form of Shares, i.e, Equity and Preference Shares, and Retain Earning.
Ploughing back of profit
Solution:
(a) Retained earnings are the earnings of the company which are retained (reinvested) in the business. The sum of those profits accumulated over years is re-invested in the business, rather than distributing it as a dividend to shareholders.
(b) It is the simple and cheapest method of raising funds. It is an important source of internal financing. Thus, it is also known as 'Self Financing' or 'Ploughing Back of Profits'.
Overdraft
Solution:
(a) An overdraft implies only to the existing current account holder. Therefore, it is a credit facility granted by a bank to current account holders. Under an overdraft facility, the bank allows its customer to overdraw an amount, up to a particular limit, i.e. to withdraw more than the amount of credit balance in his current account.
(b) Generally, a low rate of interest is charged by bank, and collateral securities usually accepted for an overdraft facility.
Trade credit
Solution:
(a) Trade Credit refers to the facilities or credit extended by the manufacturer, wholesalers, and suppliers of goods to the purchaser but receives payment after the credit period from the date of purchase. Manufacturers, wholesalers, and suppliers of goods or materials are called Trade Creditors'.
(b) This practice is done by a business concern with an intention to increase its sales or turnover, generate additional business and maintain good relations with the purchasers.
Study the following case/situation and express your opinion.
The Balance-sheet of a Donald Company for the year 2018-19 reveals equity share capital of Rs. 25,00,000 and retained earnings of Rs. 50,00,000.
Is the company financially sound?
Can the retained earnings be converted into capital?
What type of source retained earning is?
Solution:
As per the Balance Sheet of a Donald Company, it has sufficient equity share capital and retained earnings. Thus, the company is financially sound. There is no financial problem of the company.
Yes. the Company has a sufficient amount of retained earnings. Therefore, the retained earnings of the company can be converted into capital.
Retained earnings is owned or internal source of financing. Every year the company keeps aside some part reserve out of profit which is used by the company. Thus, retained earnings is also known as 'ploughing back of profit.
Mr. Satish is a speculator. He desires to take advantage of growing market for company's product and earn handsomely
According to you which type of share Mr. Satish will choose to invest?
What does he receive as return on investment?
State any one right which he will enjoy as a shareholder.
Solution:
According to me, Mr. Satish should invest in Equity shares. So that he can take the overall benefit of the profits and also enjoy all the rights and can participate in the management of the company.
He may receive the dividend as a return on investment. But, the dividend received by the equity shareholder is fluctuating. It depends on the profit of the company.
The right which he will enjoy as a shareholder are as follows:
Right to vote: It is the basic right of equity shareholders through which they elect directors, alters Memorandum and Articles of Association, etc.
Right to share in profit: It is an important right of equity shareholders. They have the right to share in profit when distributed as dividends.
Right to inspect books: Equity shareholders have the right to inspect statutory books of their company.
Right to transfer shares: Equity shareholders enjoy the right to transfer the shares as per the procedure laid down in the Articles of Association.
Mr. Rohit, an individual investor, invests his own funds in the securities. He depends on investment income and does not want to take any risk. He is interested in definite rate of income and safety of principal.
Name the type of security that Mr. Rohit will opt for.
What does he receive as return on his investment?
The return on investment which he receives is fixed or fluctuating?
Solution:
Mr. Rohit, an individual investor, invests his own funds in the securities. He depends on investment income and does not want to take any risk. So according to me, he should opt for preference shares.
He will receive the dividend as a return on investment. The dividend received by preference shareholders is fixed. They get dividends prior to equity shareholders.
Return on investment on preference shares is always fixed, regular, and steady. But they don't have the right to participate in the management of the company. Only equity shareholder has the rights as they are the real owner of the company.
Distinguish between the following.
Equity shares and Preference shares.
Shares and Debentures
Owned capital and borrowed capital.
Answer in brief.
What is public deposit?
Solution:
Public deposits are an important source of financing short term requirements of a company. When companies generally receive deposits from the public for the period ranging from 6 months to 36 months, it is known as Public Deposits'.
Under this method, the general public is invited to deposit their savings with the company for a varied period. Interest is paid by companies on such deposits. The rate of interest is higher than those allowed by commercial banks.
The company issues 'Deposit Receipt to the depositor. The term deposit is mentioned in the Deposit Receipt'. A deposit Receipt is an acknowledgement of the debt by the company.
Deposits are unsecured loans offered to the company.
It is considered a risky investment but investors can earn a high return on public deposits. Deposits are either secured or unsecured loans offered by the company.
What is Global Depository Receipt?
Solution:
Global Depository Receipt (GDR) is an instrument in which a company located in a domestic country issues one or more of its shares or convertible bonds outside the domestic country.
The issue of Global Depository Receipt is one of the most popular ways to tap the global equity markets. A company can raise foreign currency funds by issuing equity shares in a foreign country.
Indian company issues shares to an intermediary called Depository'. This depository bank issues GDR to investors against these shares.
The GDR represents a fixed number of shares. This GDR is then sold to people in a foreign country. The GDR is traded like regular shares. The prices fluctuate depending upon demand and supply and it is listed on a stock exchange.
The exchange on which GDR is traded are as follows:
• London Stock Exchange
• Luxembourg Stock Exchange
• NASDAQ
• Singapore Stock Exchange
• Hong Kong Stock Exchange
Following are the advantages of GDRs:
(a) GDR provides access to foreign capital markets.
(b) A company can get itself registered on an overseas stock exchange or over the counter and its shares can be traded in more than one currency.
(c) GDR increases the shareholders base of the company,
(d) With GDR, the non-residents can invest in shares of the foreign company. It can be freely transferred.
Following are the disadvantages of GDRs:
(a) Violating any regulation can lead to serious consequences against the company.
(b) Dividends are paid in domestic countries' currency which is subject to volatility in the forex market.
(c) It is mostly beneficial to High Net Worth Individual (HNI) investors due to their capacity to invest a high amount in GDR.
(d) GDR is one of the expensive sources of finance.
What is trade credit?
Solution:
Trade Credit refers to the facilities or credit extended by the manufacturer, wholesalers, and suppliers of goods to the purchaser but receives payment after the credit period from the date of purchase.
Trade credit is not a cash loan. It results from a credit sale of goods/services, which has to be paid at a future date after the sales take place.
This practice is done by a business concern with an intention to increase its sales or turnover, generate additional business and maintain a good relationship with the purchasers.
Suppliers sell the goods and allow 30 days or more for the bill to be paid. They even offer a discount, if bills are cleared with 30 days.
Following are the advantages of Trade Credit:
It is the cheapest and easiest method of raising short term finance. The terms and conditions are not rigid, i.e, they are flexible.
The supplier (creditor) is able to generate a higher volume of sales. The flexibility in purchasing encourages customers to make larger purchases when prices are right.
Trade credit allows the purchasers to place purchase orders without the need to pay upfront. This allows purchasers to use funds to pay long term debts and other critical payments.
Trade credit has no cost involved, no interest is payable for using the credit.
Due to the business relationship involved, the terms and conditions attached to trade credit are simple and not rigid. Also, there is no need for an agreement for trade credit.
What are the schemes for disbursement of credit by bank?
Solution:
(a) Commercial banks play an important role in providing short term finance to business concerns. They have become the primary source of financing working capital of the business.
(b) In India, the primary source of financing working capital is bank credit and trade credit.
(c) Commercial bank assists corporate enterprises:
• By granting term loans to companies
• By underwriting the issue of securities of the company.
• By subscribing to shares and debentures of the company.
Disbursement of credit by bank
Overdraft
Cash credit
Cash loans
Discounting of Bills of Exchange
The above disbursement of credit by commercial banks are as follows:
(a) Overdraft: An overdraft implies only to the existing current account holder. Therefore, it is a credit facility granted by a bank to current account holders. Under an overdraft facility, the bank allows its customers to overdraw an amount, up to a particular limit, i.e. to withdraw more than the amount of credit balance in his current account.
Generally, a low rate of interest is charged by a bank, and collateral securities usually accepted for an overdraft facility.
(b) Cash credit:
It is an important form of providing finance to business organisations. Cash Credit is given against the pledge of goods or by providing alternative securities. A cash Credit account is operated on similar lines as the overdraft facility. On the security margin, the amount of cash credit is sanctioned by the bank and the borrower can withdraw the amount from his current account up to this limit as and when the company needs.
Interest is charged on the actual amount outstanding and not the amount of credit limit sanctioned by the bank.
(c) Cash loans: Commercial Banks credit the account of the borrower with the amount of loan. The borrower has to pay interest on the entire amount sanctioned by the bank as a loan. If the amount of loan is paid in installments, the interest to be paid will be on the actual balance outstanding.
(d) Discounting of Bills of Exchange: Bills of Exchange is an acknowledgment received by the seller (drawer) from the buyer (drawee) promising to pay him a certain amount on a specific date. The drawer of the bill can receive money from drawee on the due date. The drawer can receive money before the due date by discounting bills. This is nothing but selling the bills to the bank.
The drawer gets money immediately from the bank against the bill. The bank gives money to the drawer less than the face value of the bill. The amount received less is called a discount. They are accepted by banks and cash is advanced against them. Thus, the Bill of Exchange is Trade Bills.
State the features of Bonds.
Meaning:
A bond is a debt security. It is a loan. A bond is a formal contract to repay the borrowed money with interest. It is an interest bearing certificate issued by the government, semi-government, or business firms to raise capital. The person holding such an instrument is known as a bondholder. He becomes the creditor of the company.
Definition:
According to Webster Dictionary,
"A bond is an interest bearing certificate issued by the government or business firms, promising to pay the holder a specific sum at a specified date".
Features of Bonds are as follows:
(a) Nature of finances: A bond is a debt or loan finance. It represents long term finance of the company.
Generally, the bonds are issued for a long period. For instance, 5 years, 10 years, and so on.
(b) Status of investor: The bond holders are the creditors of the company. Being creditors and non-owners, they do not enjoy any voting rights.
They are not entitled to participate in general meetings and in the management of the company.
(c) Return on bonds:
Bonds are issued bearing a fixed rate of interest. So, the bondholders get a fixed rate of interest.
It is payable at regular intervals, but it may be paid on maturity also.
(d) Repayment: Bonds have a specific maturity date because a bond is a formal contract to pay the borrowed money. Thus, the repayment of the principal amount is due on the maturity date.
Justify the following statement.
Equity shareholders are real owners and controllers of company.
Solution:
Justification:
Equity shares are ordinary shares.
These are the shares that constitute the major part of the total share of the company. The person holding equity share is known as 'Equity Shareholder'.
Equity Shareholders are the real owners of the company and bear the ultimate risk associated with ownership.
They are often described as "Real Master of the company. They enjoy control over the company. They have voting rights and can participate in the management of the company.
Thus, it is rightly justified that equity shareholders are the real owners and controllers of the company.
Preference shares do not carry any voting rights.
Solution:
Justification:
Preference Shares are those shares which enjoy certain privileges and preferential rights over equity shares. The person holding preference share is known as 'Preference Shareholder'.
Preference Shareholders do not have normal voting rights like equity shares.
However, they can vote on any such matter which directly affects their interest as investors.
Thus, it is rightly justified that, preference shares do not carry any voting right.
The debentures are secured by a charge on assets of the company
Solution:
Justification:
Secured debentures are the debentures which are secured by some charge on the assets or property of the company.
The charge may be either a fixed charge or a floating charge.
In case of a fixed charge, specific assets are mortgaged as security for the debentures.
Under floating charges, the debenture holders have a claim overall assets of the company.
Thus, it is rightly justified that debentures are secured by a charge on assets of the company.
Retained earning is simple and cheapest method of raising finance.
Solution:
Justification:
Retained earnings are the earnings of the company which are retained (reinvested) in the business.
The sum of those profits accumulated over years is re-invested in the business, rather than distributing it as a dividend to shareholders.
The company can utilize such reserves for financing various projects such as expansion, diversification, etc.
It is an important source of internal financing. Thus, it is also known as 'Self Financing' or 'Ploughing Back of Profits'.
Thus, it is rightly justified that, retained earnings is the simple and cheapest method of raising finance.
Public deposit is good source of short term financing.
Solution:
Justification:
Public deposits are an important source of financing short term requirements of the company. In other words, the company accepts public deposits for meeting short term needs.
When companies generally receive deposits from the public for the period ranging from 6 months to 36 months, it is known as 'Public Deposits'.
It is considered a risky investment but investors can earn a high return on public deposits. Deposits are either secured or unsecured loans offered by the company.
Thus, a public deposit is a good source of short term financing
Bond holder is creditor of the company.
Solution:
Justification:
A bond is a debt security. It is a loan. A bond is a formal contract to repay the borrowed money with interest.
It is an interest bearing certificate issued by the government, semi-government, or business firms to raise capital.
The person holding such an instrument is known as a bond holder. He becomes the creditor of the company.
As a bond holder is the creditor of the company, he does not enjoy any voting rights and cannot participate in the management of the company.
Thus, it is rightly justified that, the bond holder is a creditor of the company
Trade credit is not cash loan.
Solution:
Justification:
Trade Credit refers to the facilities or credit extended by the manufacturer, wholesalers, and suppliers of goods to the purchaser but receives payment after the credit period from the date of purchase.
Manufacturer, wholesalers, and suppliers of goods or materials are called "Trade Creditors'
Trade credit is not a cash loan. It results from a credit sale of goods/services, which has to be paid at a future date after the sales take place.
This practice is done by a business concern with an intention to increase its sales or turnover, generate additional business and maintain a good relationship with the purchasers.
Thus, it is rightly justified that, trade credit is not a cash loan.
Different investors have different preferences.
Solution:
Justification:
The investors are the persons who invest the capital in the company. They can invest in equity share capital or preference share capital.
The investors who can take the risk, invest in equity shares. They are known as the ultimate risk bearer.
The investors who are cautious, conservative, interested in the safety of capital, generally invest in preference shares.
Thus, it is rightly justified that, different investors have different preferences.
Equity share capital is risk capital.
Solution:
Justification:
The person holding equity share capital is known as 'Equity Shareholder'.
The dividend received by equity shareholders is fluctuating. Also, if a company does not earn profit in a particular year then equity shareholders will not get any dividend.
Hence, Equity shareholders bear the maximum risk in the company. They are described as 'Shock absorbers' when a company has a financial crisis.
Thus, it is rightly justified that, equity share capital is risk capital.
Answer the following question.
What is share and state its features?
Solution:
Meaning:
The share capital of a company is divided into many units of small denominations. Each such unit is called as a share.
In other words, a share is a small part of the total capital of a company. A person holding such shares is known as shareholders.
Definition:
According to section 2 (84) of the Companies Act, 2013 "Share means a share in the share capital of the company and includes stock".
Following are the features of Shares:
1. Meaning: Share is the smallest unit in the total share capital of a company.
2 Ownership: The owner of the share is called a shareholder. It shows the ownership of a shareholder in the company
3 Distinctive Number: Unless dematerialised, each share has a distinct number for identification. It is mentioned in the Share Certificate.
4. Evidence of title: A share certificate is issued by a company under its common seal. It is a document of title of ownership of shares. A share is not any visible thing. It is shown by share certificate or in the form of Demat share.
5. Each share has a value expressed in terms of money. There may be:
(a) Face value: This value is written on the share certificate and mentioned in the Memorandum of Association.
(b) Issue price: It is the price at which the company sells its shares.
(c) Market Value: This value of a share is determined by demand and supply forces in the share market. Rights A share confers certain rights on its holder such as the right to receive the dividend, the right to inspect statutory books, the right to attend shareholders' meetings, and the right to vote at such meetings, etc.
7. Income: A shareholder is entitled to get a share in the net profit of the company. It is called a dividend.
8. Transferability: The shares of a public limited company are freely transferable in the manner provided in the Articles of Association
9. Property of Shareholder: Share is a movable property of a shareholder.
10. Kinds of Shares: A Company can issue two kinds of shares:
(a) Equity shares.
(b) Preference shares.
What is an equity share? Explain it’s features.
Solution:
Meaning:
Equity shares are also known as 'ordinary shares'. For legal reasons, a company can not exist without equity shares.
Definition:
Companies Act 1956 defines equity share as "those shares which are not preference shares."
Features of Equity shares are as follows:
1. Permanent capital:
Equity shares are irredeemable shares. The amount received from Equity Shares is not refundable by the company during the lifetime. Equity shares become redeemable only in the event of winding up of the company. Equity shareholders provide long term and permanent capital to the company.
2. Fluctuating Dividend:
Equity shares do not have a fixed rate of dividend. The rate of dividend depends upon the amount of profit earned by the company. If the company earns more profit, the dividend is paid at a higher rate. On the other hand, if there is insufficient profit, the Board of Directors may postpone the payment of dividends. The shareholders can not compel them to declare and pay the dividend. The income of equity shares is irregular and uncertain. They get dividends which are always fluctuating.
3. No preferential right:
Equity shareholders do not enjoy preferential rights with respect to the payment of dividends. It means equity shareholders are paid dividends only after the dividend on preference shares has been paid. At the time of winding up of the company also, the equity shareholders are paid in the last. They are the last claimants. If no surplus amount is available after paying debts and preference shares, equity shareholders will not get anything. Thus, equity shareholders stand second in case of getting dividends on their shares as well as getting back their capital at the time of liquidation of the company.
4. Rights:
Equity shareholders enjoy certain rights. These include
The right to share in profit, when distributed as a dividend, is the most important right of equity shareholders. If the company is successful and makes a handsome profit, they have the advantage of a large dividend.
The right to vote is the basic right of equity shareholders by which they elect directors, amend Memorandum, Articles, etc.
Right to inspect books of account of their company of which they are owners.
The right to transfer shares is one of the most important rights of the shareholder.
5. Control:
The control of the company is vested in equity shareholders. They are often described as real masters of the company. It is because they enjoy the exclusive voting rights. The voting rights of equity shareholders are protected as far as possible. Equity shareholders may exercise their voting rights by proxies, without attending a meeting in person. The Act provides the right to cast vote in proportion to the number of shareholdings.
Equity shareholders participate in the management of the company. They elect their representatives called Directors on the Board for the management of the company.
6. Risk:
Equity shareholders bear maximum risk in the company. They are described as ‘shock absorbers’ when a company has a financial crisis. If the income of the company falls, the rate of dividends also comes down. Due to this, the market value of equity shares goes down resulting in capital loss. Thus, equity shareholders are the main risk-takers.
7. Residual claimants:
Equity shareholders are owners and they are residual claimants to all earning after expenses, taxes, etc. have been paid. Although equity shareholders are the last claimants they have the advantage of receiving entire earnings that are leftover.
8. Face value:
The face value of equity shares is low, in comparison to preference shares. It is generally Rs.l0/- per share or even Rs.1/- per share.
9.Market Value :
There is more fluctuation in the market value of equity shares in comparison to other securities. Therefore, equity shares are more appealing to the speculators.
10. Bonus Issue:
Bonus shares are issued as a gift to equity shareholders. These shares are issued free of cost to existing equity shareholders. These are issued out of accumulated profits. Bonus shares are issued in proportion to the shares held. Thus capital investment of (ordinary) equity shareholder tends to grow on its own. This benefit is available only to the equity shareholder.
Define preference shares. What are the different types of preference shares?
Solution:
As the name Indicates, these shares have certain privileges and preferential rights distinct from those attaching to equity shares. The shares which carry the following preferential rights are termed as preference shares.
A preferential right as to the payment of dividends during the lifetime of the company.
A preferential right as to the return of capital in the event of winding up of the company.
1. Cumulative preference shares:
Cumulative preference shares are those shares on which dividend goes on accumulating until it is fully paid. This means, if the dividend is not paid in one or more years due to inadequate profit, then such unpaid dividend gets accumulated. The accumulated dividend is paid when the company performs well. The arrears of dividends are paid before making payment to equity shareholders The preference shares are always cumulative unless otherwise stated in the Articles of Association. It means that if the dividend is not paid in any year or falls short of the prescribed rate, the unpaid amount is carried forward to next year, and so on until all arrears have been paid.
2. Non-cumulative preference shares:
Dividend on these shares does not accumulate. This means the dividend on shares can be paid only out of profits of that year. The right to claim dividends will lapse if company does not make a profit in that particular year. If the dividend is not paid in any year, it is lost.
3.Participating preference shares:
The holders of these shares are entitled to participate in surplus profit besides preferential dividends. The surplus profit which remains after the dividend has been paid to equity shareholders up to a certain limit is distributed to preferenCe shareholders.
4.Non-participating preference shares:
The preference shares are deemed to be non-participating if there is no clear provision in the Articles of Association. These shareholders are entitled only to a fixed rate of a dividend prescribed in the issue.
5. Convertible preference shares:
These shareholders have a right to convert their preference shares into equity shares. The conversion takes place within a certain fixed period.
6. Non-convertible preference shares:
These shares cannot be converted into equity shares.
7. Redeemable preference shares:
Shares that can be redeemed after a certain fixed period are called redeemable preference shares. A company limited by shares, if authorized by Articles of Association, issues redeemable preference shares. Such shares must be fully paid. These shares are redeemed out of divisible profit only or out of a fresh issue of shares made for this purpose.
8. Irredeemable preference shares:
Shares that are not redeemable i.e. payable only on the winding up of the company are called irredeemable preference shares. As per the Companies Act (Amendment made in 1988), the company can not issue irredeemable preference shares.
What is Debenture? Discuss the different types of debentures.
Solution:
Meaning:
Debentures have occupied a significant position in the financial structure of the companies. It is one of the main sources of raising debt capital to meet long term financial needs. Debentures represent borrowed capital. The debenture holders are creditors of the company. The debenture holder gets a fixed rate of interest as a return on his investment. The Board of Directors has the power to issue debentures.
The term ‘debenture’ has come from Latin word ‘debare’, which means to ‘owe”.
Definition:
Palmer defines a debenture as -
“an instrument under seal evidencing debt, the essence of it being admission of indebtedness”.
Types of Debentures:
Secured debentures :
The debentures can be secured. The property of the company may be charged as security for a loan. The security may be for some particular asset (fixed charge) or it may be the asset in general (floating charge). The debentures are secured through ‘Trust Deed’.
Unsecured debentures :
These are the debentures that have no security. The issue of unsecured debenture is now prohibited by the Companies (Amendment) Act, 2000
Registered debentures :
Registered debentures are those on which the name of holders are recorded. A company maintains a register of debenture holders in which the names, addresses, and particulars of holdings of debenture holders are entered. The transfer of debentures, in this case, requires the execution of regular transfer deed.
Bearer debenture :
Name of holders are not recorded on the bearer debentures. Their names do not appear on the register of debenture holders. Such debentures are transferable by mere delivery. Payment of interest is made by means of coupons attached to the debenture certificate.
Redeemable debentures :
Debentures are mostly redeemable i.e. payable at the end of some fixed period, as mentioned on the debenture certificate. Repayment can be made at a fixed date at the end of a specific period or by installments during the lifetime of the company. The provision of repayment is normally made in a trust deed.
Irredeemable debentures :
These kinds of debentures are not repayable during the lifetime of the company. They are repayable only after the liquidation of the company, or when there is a breach of any condition or when some contingency arises.
Convertible debentures :
Convertible debentures give the right to the holder to convert them into equity shares after a specific period. Such right is mentioned in the debenture certificate. The issue of convertible debenture must be approved by special resolution in a general meeting before they are issued to the public. These debentures are advantageous for the holder. Because of this conversion right, the convertible debenture holder is entitled to equity shares at a rate lower than market value, and even he participates in the profit of the company.
Non-convertible debentures:
Non-convertible debentures are not convertible into equity shares on maturity. These debentures are normally redeemed on the maturity date. These debentures suffer from the disadvantage that there is no appreciation in value.
Define Debenture and explain the features of debentures.
Solution:
The word debenture is derived from the Latin word, ‘Debare’ which means to owe something to someone’. A debenture is an acknowledgement of debt issued by a company under its common seal" It also means that debenture is a proof of loan taken by the company on certain terms and conditions.
Features of Debentures are as follows:
Promise :
Debenture is a written promise by the company that it owes a specified sum of money to ' holder of the debenture.
Face value :
The face value of debenture normally carries high denomination. It is Rs.100/— or multiples of Rs.100.
Time Of repayment :
Debentures are issued with the due date stated in the ‘Debenture Certificate’. A debenture provides for the repayment of the principal amount on the maturity date.
Interest :
A fixed-rate of interest is agreed upon and is paid periodically in case of debentures. The rate of interest that the company offers depends upon the market conditions and nature of the business.
Assurance of repayment :
Debentures constitute a long term debt. They carry an assurance of repayment on the due date.
Parties to debentures:
There are certain parties to debentures such as-
a) Company :
This is the entity that borrows money.
b) Trustee :
This is a party through whom the company deals with debenture holders. The company makes an agreement with trustees and debenture holders. It is known as ‘Trust Deed’. It contains the obligations of the company, the rights of debenture holders, etc.
c) Debenture holders :
These are the parties who provide loans and receive a ‘debenture certificate’ as evidence of participation.
Rights Of Rights of Debenture holder:
Debenture holders have no right to vote at the general meetings of the company.
Terms of issue of debentures :
a) Debentures can be issued at par, at a premium, and even at discount.
b) According to the Companies Act, a company can not issue debentures carrying voting rights.
c) According to the Companies Act, Sec 292 (1), the Board of Directors has the power to issue debentures.
Security:
Debentures can be secured with some property of the company.
Listing:
Debentures must be listed with at least one recognized stock exchange.
