Question

Collin has been listening to the business news and his interest was piqued when he heard about the idea of investing in stocks and bonds. He was however a bit confused when he heard about ordinary shares, preference shares and debentures. As a financial advisor, please advise Collin on two benefits and two drawbacks of investing in each type of instrument mentioned above. Please ensure that you state the instrument to which you are making reference.

Answer 1

Ordinary Shares

Advantages:

Ordinary Share holders have the ability to vote at company's annual general meeting and elect the board of directors.

They are the owners of the business and will receive dividends from the company earnings.

Disadvantages:

Ordinary Shares are risky investments, because there is no gurantee of steady payments like dividends.

If there is an issue of new shares, it may result in the dilution of shares held by existing shareholders.

Preference Shares

Advantages:

Owners of preference shares receives fixed dividends. If there is no payment of dividends in an year, there also will be accumulation of unpaid dividends, which will be paid later, when there is a rebound in company business.

In the event of bankruptcy and a liquidation of company becase of that, Preference shareholders have higher claim on company's assets than ordinary shareholders.

Disadvantages:

They dont have same voting rights as that of ordinary shareholders.

If interest rates rise, the advantage of having fixed dividends may not longer look beneficial.

Debentures

Advantages:

Debenture holders needs to be reimbursed before there is a dividend payment to shareholders.

Ownership will not be diluted in the company as the case in shareholding.

Disadvantages:

Debenture holders do not have voting rights or get a share in profits.

If the debenture is secured, the company will have lesser freedom to sell certain assets.