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Question

Difficulty: HardCapital Market: Institutions and Instruments

An institutional investor seeking a financial instrument that offers fixed priority claims on corporate earnings before dividend payments to equity holders, while also avoiding the short-term maturity structure of money market debt instruments, would most appropriately invest in which of the following?

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

Answer

Preference shares represent long-term capital market securities that grant investors a fixed dividend payout with priority claims on corporate earnings over ordinary shareholders.
Preference shares are hybrid capital market securities that grant investors long-term ownership while providing a fixed dividend rate that takes priority over dividend payouts to ordinary shareholders.

Step-by-Step Solution

1
Analyze the investor's structural requirements.
The investor requires a long-term capital market security that provides fixed priority income ahead of variable dividend distributions.
Different financial instruments carry distinct maturity profiles, risk attributes, and payout priorities.
2
Distinguish between short-term money market instruments and long-term capital market securities.
Commercial papers and Treasury bills operate in the money market with short-term maturities (up to one year), failing the long-term criterion.
Money market tools raise short-term operational funds, whereas capital markets handle long-term funding needs.
3
Compare the remaining capital market instruments on payout structure.
Preference shares offer fixed dividends and preferential claims over ordinary shares.
Ordinary shareholders hold residual rights, receiving variable payments only after preference claims are fully satisfied.

Key Concept

Distinction between Capital Market Instruments (Preference Shares) and Money Market Debt Tools
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Topics

Capital Market: Institutions and Instruments

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