a.   Equity securities are the shares that represent the claim on their proportional shares in a company’s net assets and profits. They represent equity ownership in a company and provide voting rights and other financial and non-financial privileges, e.g. rights issue, bonus issue, etc. to the other holders. These shares represent the residual claim on the firm’s earnings.

b.  The companies usually have two components in their capital structure: debt and equity. Debt is the liability owed by the company and is usually compensated in the form of interest. Equity, on the other hand, has the residual claim on the asset and is compensated through capital gains and dividends.

c.  The ratio of equity market capitalization forms around 50% of the GDP in the long run. And the data from the year 1900-2011 shows that the inflation-adjusted returns on the government bonds and bills were around 2% per annum, while that on the equity markets was around 4%. This means that the returns on equity markets were almost double the returns on bonds. This may be regarded as the risk premium, as the equity investments are considered riskier than bonds and government securities.

d.  Equity ownership in the developed countries is held by around 20-50% of the population.

1.1.         Common Equity

a.  The common stock is security that represents ownership in a company. The owners of equity shares get a share in the operating performance of the companies (i.e. capital appreciation and dividends), and participate in the governance process through the process of statutory/cumulative voting, for the major corporate decisions and election of the board of directors.

b.  The common shares have different classes, each with differential ownership and voting rights and even differential claims on the net assets in the case of liquidation of a company. For example, a company can have two classes of shares, one held by the public and the other held by the insiders. These two classes may have fixed voting rights or may have a different share at the time of liquidation, etc.

c.  The common shares may be callable as well as putable. The shares are callable if the issuer has the right to buy back shares at a predetermined call price. And, the shares are putable has the right to sell back to the company at a pre-determined put price.

1.2.         Preference Shares

a.  Preference shares are the shares that have preferred rights over the dividends of the company. These shareholders receive dividends before the common stocks, and these dividends are fixed and stated as a percentage yield on the par value.

b.  The rate of interest, despite being fixed, the dividends can be canceled by the board of directors. Thus the dividends on the preferred shares are discretionary.

c.  The preference shareholders do not participate in the operating performance, and also do not have any voting rights unless it is for a decision that directly affects the shareholders.

d.  On liquidation, the preferred shares have higher priority over the net assets of the company than the common stock.

e.   The preferred stocks are priced in the market like a debt instrument, but make the payment in form of dividends like equity. Thus, if the investor is in a jurisdiction where dividends attract lower taxes than interest, then the preferred stocks are definitely a more desirable investment option than a debt instrument.

f.  The preference shares are of different types. They can be perpetual, having no maturity date; convertible, which can be converted into common stock after a certain time period; callable, which can be repurchased by the issuer at a predetermined call price after a certain date; or putable, which can be redeemed by the holder to the company at a predetermined put price, at the option of the investor, after a certain time.

g.  The preference shares may be cumulative or non-cumulative. A cumulative preference share is a share on which the unpaid dividends accrue over time. And these accrued dividends must be paid in full before any common dividends can be paid. A non-cumulative preference share is the one, on which the unpaid dividends do not accrue. The unpaid dividends on such shares get forfeited permanently.

h.  The preference shares can also be participating or non-participating. The participating preference shares are those shares that offer special rights to the holders of these shares to participate in the increase in their share of dividend, if the company profits exceed a certain level, or if the company issues some special dividends. These share-owners also get to participate in proceeds from a liquidity event, if the contract so mentions. The non-participating shares only have regular rights, to participate in the stated preferred dividends only plus a par value.

i.  The convertible preference shares are the shares, which can be converted into common stock after a certain time period. These shares receive a participation in the equity of the company while getting a higher yield on investment. This type of issue is common in the private equity or venture capital, as these shares get fixed yield and a benefit of not having to re-price the common stock at the time of exit or otherwise. These shares usually have a forced conversion clause, where if the price of the common stock is greater than the conversion price, then the companies have the option to force the conversion by calling the shares at a very low price. This helps in avoiding the overhanging convertibles.