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Question

Difficulty: MediumCapital Market: Institutions and Instruments

An investor who requires a fixed rate of return and priority claims on earnings during dividend distribution, but does not exercise voting rights in corporate decisions, holds which of the following instruments?

  1. Preference sharesAnswer
  2. B
    Treasury bills
  3. C
    Ordinary shares
  4. D
    Commercial papers

Answer

Preference shares
Preference shares are capital market instruments that combine features of debt and equity. Holders are entitled to a fixed percentage dividend payout before any dividends can be distributed to ordinary shareholders. In exchange for this income security and preferential treatment, preference shareholders generally surrender voting rights at annual general meetings.

Step-by-Step Solution

1
Analyze the financial characteristics specified in the stem
Identified requirements: fixed dividend return, preferential payout hierarchy, and absence of voting rights.
Different securities confer distinct rights regarding governance, income certainty, and priority of payment.
2
Distinguish between money market and capital market instruments
Treasury bills and commercial papers are short-term money market instruments, whereas preference shares and ordinary shares are long-term capital market securities.
The question specifies long-term investment characteristics typical of capital market securities.
3
Compare equity security features
Preference shares guarantee a fixed dividend rate prior to ordinary shareholders, but lack voting rights, unlike ordinary shares which carry residual risk and voting power.
Preference shares match all three criteria given in the stem.

Key Concept

Characteristics of Preference Shares vs Other Financial Instruments
Estimated Time:1m 0s
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Topics

Capital Market: Institutions and Instruments

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