Equity shares
Also written Equity share
Ownership in a company entitling holders to a share in profits and a vote on its affairs; equity holders are residual owners after all contractual claims, rewarded by dividend and capital appreciation.
In plain language
Lend money to a company and you are owed a fixed amount. Buy its equity shares and you own part of it.
The workbook's definition has four parts, and each is examinable:
- Ownership in the company.
- A share in profits.
- The right to vote on the company's affairs.
- Residual ownership — equity shareholders get what is left after other contractual claims on the firm are satisfied, and they have ultimate control over how the firm is operated.
An equity investor is rewarded in two ways: dividend and capital appreciation. Neither is promised. That is the price of standing last in the queue — and the reason the upside is unlimited.
How it works
Time diversification. The workbook says equities have proven time diversification benefits: fluctuations in returns tend to cancel out over time, so more risk is diversified away over longer holding periods, and equities offer better risk-adjusted return if held for long periods.
Listed versus unlisted equity — Table 2.2:
| Characteristic | Listed | Unlisted |
|---|---|---|
| Shareholding | Diversified: promoters, institutions, foreign and public investors | Promoters and family; possibly associates, AIFs, HNIs |
| Listing | On a recognised stock exchange | Not listed; OTC only; articles often restrict transfer |
| Liquidity | Highly liquid (unless infrequently traded) | Illiquid — bilateral OTC trades only |
| Counterparty risk in trading | No — the clearing corporation is the counterparty | Yes |
| Regulation | Highly regulated | Less regulated |
| Management control | Depends on shareholding pattern | Usually with family shareholders |
| Valuation | Market price or last traded price | A valuation process |
That last row is why Chapter 12 exists. An AIF holding unlisted equity has no screen price; it has to value the shares — by book value per share, DCF or relative multiples.
Equity in AIF strategies. Chapter 10's Category III strategies are built from long and short positions in equity shares — convertible arbitrage shorts the issuer's shares against a convertible bond; merger arbitrage goes long the target's shares.
A worked example
Company, prices and dividend are illustrative.
Anjali invests Rs 5,00,000 in a listed Indian FMCG company at Rs 500 a share:
Shares bought = 5,00,000 ÷ 500 = 1,000
During the year the company declares a dividend of Rs 10 a share, and she sells at Rs 560.
Dividend = 1,000 × 10 = Rs 10,000
Capital appreciation = 1,000 × (560 − 500) = Rs 60,000
Total return = Rs 70,000 → 70,000 ÷ 5,00,000 = 14%
Both rewards the workbook names are in the answer.
Now the bad year. Suppose the company's lenders are owed interest of Rs 40 crore and operating profit falls to Rs 42 crore. Lenders are paid first; equity shareholders, as residual owners, share what is left — about Rs 2 crore before tax. Nothing in the definition promises her a dividend, and the share price can fall. Had Anjali bought unlisted shares of a similar company instead, she would also have faced the Table 2.2 problems: no exchange to sell on, counterparty risk, and a price set by valuation rather than by the market.
Why NISM asks about it
Chapter 2, section 2.2.1 (Equity Shares), and Table 2.2 give the definition, the two rewards and the listed-versus-unlisted comparison. Chapter 2 sample question 1 is the definition itself. Chapter 10 uses equity shares throughout the arbitrage strategies, and Chapter 12 values them (book value per share, break-up value, DCF). Expect the definition, the two sources of reward, and a Table 2.2 row such as counterparty risk.
Common exam traps
- Equity shareholders are residual owners — paid after all other contractual claims, not before.
- Rewards are dividend and capital appreciation — neither is contractual.
- Listed equity carries no counterparty risk in trading because the clearing corporation is the counterparty; unlisted equity does.
- Unlisted equity is valued through a valuation process, not by a market price.
- Time diversification is the workbook's claim that equities give better risk-adjusted returns over long holding periods — not that they cannot lose money.
- Debt and equity are the two generic types of financial instrument; bonds and commercial papers are debt.
Where this is taught
- Series III-A · Chapter 1: Introduction to the Financial Systemintroduced here
- Series XIX-E · Chapter 2: Types of Investmentsintroduced here
- Series XIX-D · Chapter 2: Types of Investmentsintroduced here
Related terms
- Capital appreciationThe gain made when the market value of an investment rises above what you paid for it — as distinct from income, which is the interest or dividend the investment pays you along the way.
- Final dividendA dividend declared at the AGM, taxable in the shareholder's hands in the year it is declared — unlike an interim dividend, which is taxed only in the year it is actually made available to the shareholder.
- Preference shareA share carrying a pre-defined rate of dividend, paid before any equity dividend, with priority over equity in return of capital on winding up — but normally no voting rights.
- Financial assetsClaims on future cash flows such as shares, debentures, bank deposits, PPF and mutual fund units, as opposed to real or physical assets like gold, diamonds, infrastructure and real estate.
- Time diversificationReducing the risk of an equity investment by holding it across many time periods rather than across many securities, on the belief that bad periods are cancelled out by good ones.
- Traditional investmentInvestment in financial securities — listed stocks and bonds, general mutual fund units and ETFs — whose shared feature is liquidity; distinct from savings such as bank deposits or ornamental gold.
- Book value per shareEquity shareholders' funds as per the balance sheet divided by the number of equity shares issued and paid up — normally treated as the floor value of a going-concern business.
- Bonus sharesAdditional shares issued free to existing shareholders in proportion to their holding — no tax at allotment, a nil cost of acquisition, and a fresh holding period from the allotment date.
- Stock Lending and BorrowingA screen-based scheme under which an investor lends securities to a borrower through an Authorized Intermediary for a fee — and, under section 47(xv), it is not a transfer.
- Unlisted equity sharesShares not listed on any recognised stock exchange in India: the long-term holding period is 24 months rather than 12, long-term gains are taxed at 12.50%, and short-term gains at normal rates.
- Residual claimThe equity shareholder's place at the back of the queue: entitled only to profits and assets left after government, lenders, employees and preference shareholders have been paid.
- Cumulative preference shareA preference share whose unpaid dividend is not lost: it is carried forward to later years and paid when there are profits, if the terms of issue allow.
- SecuritiesFinancial instruments — shares, bonds, derivatives, mutual fund units, government securities and more — issued to raise funds, as defined in Section 2(h) of the Securities Contracts (Regulation) Act, 1956.