Untitled2_31 - Chapter 2: Introduction to financial systems...

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Equity represents claims to shares in the net income and assets of a firm, and they do not have a maturity date. In terms of economic rights, equity claims differ from debt instruments for several reasons. • First, firms are not contractually obliged to make periodic payments to equity holders: the payment of dividends is a discretionary decision of the firm. • Second, firms must pay all their debt holders before they make any payment to equity holders: therefore equity holders are residual claimants. As a result, equity claims are riskier than debt instruments. In addition to economic rights, equity claims confer ownership rights to equity holders. The presence of ownership rights is in contrast with bondholders, who have no ownership interest but are rather creditors of the firm. Ownership rights have two main implications. • First, equity holders can benefit from any increase in the income or asset value of the company. In case of stock price increases (decreases)
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