Question

A) Explain why preference shares are considered hybrid capital

b) Distinquished between the following:
i. Present value interest factor and Present value interest factor of annuitY
ii. Ordinary annuity and annuity due
c) Enyonam’s capital is three times more than Elikplime’s capital. Elikplime invested her capital at 25% per annum for 3 years (compounded semi-annually). At what rate percent p.a. simple interest should Enyonam invest her capital so that after 3 years, they both have the same amount of capital?
d) What value of rate (r ) and period ( n ) should be used in time value of money calculations?
i. if 15% interest is paid on a deposit account, compounded quarterly, for 15 years
ii. If 15% interest is charged on a credit card balance, compounded monthly, for 15 years.
e) Explain financial market and discuss the different types of financial markets.

Answer 1

Preference shares are considered hybrid capital because they embody aspects of both equity and debt. The Present Value Interest Factor (PVIF) is distinct from the Present Value Interest Factor of Annuity (PVIFA) in their different applications for present value calculation. Financial markets facilitate the exchange of assets and can vary, including stock, bond, commodity, currency, and derivatives markets.

Step-by-step explanation:

Understanding Hybrid Capital and Interest Calculations in Finance

Preference shares are considered hybrid capital because they possess characteristics of both debt and equity. Just like debt, preference shares typically provide a fixed dividend, and in case of company liquidation, preference share holders are paid out before common shareholders, though after debt holders. However, like equity, preference shares may also come with no maturity date and can have the potential to provide dividends in perpetuity, if the company chooses to do so.

b) The distinction between Present Value Interest Factor (PVIF) and Present Value Interest Factor of Annuity (PVIFA) lies in their applications. PVIF is used to calculate the present value of a single future sum of money, whereas PVIFA is used to calculate the present value of a series of future annuities. An ordinary annuity is when the payments or receipts occur at the end of each period, whereas in an annuity due payments or receipts are at the beginning of each period.

c) To calculate the rate of simple interest that Enyonam should invest, we first find the future value of Elikplime's investment through compound interest formula, and then use the formula for simple interest to find the rate needed for Enyonam, ensuring their capitals equate after 3 years. The detailed calculations, however, are beyond the scope of this summary.

d) Time value of money calculations for an interest rate of 15% compounded quarterly for 15 years would use a rate (r) of 3.75% (15% divided by 4) and 60 periods (n) (15 years times 4 quarters). For an interest rate compounded monthly, rate (r) would be 1.25% (15% divided by 12) and 180 periods (n) (15 years times 12 months).

e) A financial market is a platform where buyers and sellers participate in the trade of assets such as equities, bonds, currencies, and derivatives. There are different types of financial markets, including stock markets for trading shares of companies; bond markets for debt securities; commodity markets for raw materials; currency markets for foreign exchange; and derivatives markets for contracts like options and futures.