Question

Discuss the importance of stocks to both a company and a shareholder.

1. Include why companies issue stocks and what is the importance of intrinsic value of a stock?

2. List one pro and one con of why a company would issue stock compared to a company issuing bonds - provide examples.

Answer 1

For companies, the issue of shares is an important method to raise capital without incurring too much debt. Shareholder investment need not be repaid at a later date unlike debt.

For shareholders : They can enjoy capital growth by selling the shares at a higher price. Another benefit is dividends as part of the profit made by the company at the end of each financial year. Moreover the equity shareholders can enjoy voting right and thus participate in management

Question 1

Companies issue stocks for raising capital from the general public. It is an important method to raise capital without incurring too much debt. Share capital need not be repaid at a later date unlike debt. And the dividends for shareholders are to be paid only when the company makes profits. That is why the companies prefer stocks.

Intrinsic value means fundamental and objective value contained in an asset, or financial contract. It is the anticipated value of a stock, currency or financial product calculated through fundamental analysis. The investment decision is taken by the investors by comparing the intrinsic value with market price. If the intrinsic value is more than the market price, the investor can buy since it is underpriced and vice versa. If the stock has good intrinsic value, it will ensure fair return to the stocks

Question 2

Issue of shares by the company has pros and cons.

Pros

• The equity shares need not be repaid at a later date unlike debt.
• Dividends are to be paid only if there are profits

Cons

• The cost of issuing shares is more compared to issuing debt and it is a liability for the company till winding up.
• Dilution of ownership is the another advantage of issue of equity shares

Example : If a company has issued bonds, the company has to pay interest to them irrespective of profits. But the dividends are to be paid only when there are profits.