Equities and Equity-Linked Products
This domain tests entitlement, dilution and the distinction between owning a company and owning a claim on its shares.
Core features
Ordinary shares carry votes and residual dividends; preference shares rank ahead for dividends but usually carry limited votes. A rights issue offers existing holders new shares pro rata, normally below market, so holders who do not participate are diluted. Bonus issues and splits change the share count without raising cash. Warrants are call options issued by the company; convertible bonds are debt that can convert into shares. Both dilute on exercise and blend credit and equity risk. ETFs and depositary receipts wrap underlying shares and add tracking, custody or currency risk.
Worked example
A company has four shares trading at 10.00 and announces a 1-for-4 rights issue at 6.00. TERP = (4 x 10.00 + 1 x 6.00) / 5 = 46.00 / 5 = 9.20. The theoretical value of one right is 9.20 - 6.00 = 3.20. The issue adds one share and 6.00 of cash, so total value rises by 6.00 while the share count rises by one; the average price must fall.
Traps that cost marks
Ignoring dilution when a client declines a rights issue; confusing a company-issued warrant with an exchange-traded derivative; buying cum dividend and expecting the seller's dividend; forgetting that a convertible's price is sensitive to both interest rates and the share price.