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IAI Actuarial Core Principles · Actuarial Mathematics for Modelling · Financial instruments and insurance contracts as cashflow models

Which statement best describes how an ordinary equity share differs from a fixed-interest bond as a cashflow model?

An ordinary share gives uncertain dividends and an uncertain sale or liquidation value, with no fixed term, and shareholders rank after creditors on winding up. A bond, in contrast, has contractually fixed coupons and redemption amounts and ranks ahead of shareholders.

  1. AIts future dividends and any sale proceeds are uncertain in amount and timing, and it ranks after creditors on winding upCorrect
  2. BIts future dividends are contractually fixed and it ranks ahead of creditors
  3. CIt pays a fixed redemption amount on a fixed date
  4. DIt has a fixed term and must be repaid by the company
  5. Its holder receives guaranteed index-linked coupons

Explanation

Equity cashflows (dividends and sale price) are uncertain and the shareholder is a residual claimant, ranking after creditors. Bonds have contractual coupons and redemption, and equities have no fixed term or guaranteed payments.

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