Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

J10 - Discretionary Investment Management > 2. Main Asset Classes - Cash, Bonds, Equities & Property > Flashcards

2. Main Asset Classes - Cash, Bonds, Equities & Property Flashcards

1
Q

A. Cash assets (page 2)

A

Used to describe:

  • Any savings account or similar arrangement that promises to pay a rate of interest whilst returning the original investment intact

There are two segments to this sector:

  1. Savings Accounts
  2. Money Markets
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

A1. Saving accounts (page 2)

A

Main deposit takers: banks, building societies

Main depositors: public, corporate sector, financial institutions

Main characteristics of savings account:

  • Capital is NOT exposed to INVESTMENT RISK
  • Capital and any accrued return ARE exposed to DEFAULT RISK
  • NO potential for CAPITAL GROWTH
  • ONLY RETURN IS INTEREST
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

A1A. Returns (page 2)

A

When comparing returns it is important to consider:

  • How the returns are being calculated (is it the using the same method?)
  • What charges apply
  • How long do the rates last for (is it just for the first few months for example?)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

A1B. Annual equivalent rate (AER) (pages 2, 3 & 4)

A

The AER or effecrive rate is something deposit takers have been required to quote since 1999.

Key point: Given identical nominal interest rates, the more freqently interest is compounded the more advantageous it is to the investor

Formula for AER:

Annual rate = (1 + r)n

r = nominal rate of interest
n = number of periods in which interest will be paid
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

A1C. Tax (page 4)

A

Tax needs to be taken into consideration too.

Personal Savings Allowance:

Basic rate taxpayer = £1,000
Higher rate taxpayer = £500
Additional rate taxpayer = Nil

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

A1D. Charges (page 4)

A

Higher-rate deposits typically involve penalties on early access.

Not all fees are explicit. Some accounts require a minimum balance in order to acheive the high-rate of interest.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

A1E. Extension rates (page 4)

A

This a rate of interest (usually much lower than the initial rate) which applies after a period of time.

For example, an account pays 5% AER for the first two years, which then defaults to an extension rate at a much lower AER of 0.10%

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

A1F. Risks (page 5)

A

Savings account have the following risks:

  • Default risk (instituion collapses / credit risk)
  • Inflation risk (negative real return)
  • Interest rate risk (interest rates change)
  • Currency risk (exchange rates changing)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

A1F. Risks (page 5)

CONTINUED

A

Savings account do not fall under FSMA 2000, with the exception of money market funds and Cash ISAs.

The PRA and FCA do regulate banks and other deposit-takers.

The FSCS covers depositors in the UK.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

A1F. Risks (pages 5 & 6) - CREDIT RISK

CONTINUED

A

CREDIT RISK is the risk that a bank or building society defaults.

Investors should consider:

  • the CREDITWORTHINESS of the institution
  • the extent to which any COMPENSATION SCHEME will protect the deposits made
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

A1F. Risks (pages 5 & 6) - CREDIT RISK

CONTINUED

A

Assessing the CREDITWORTHINESS of an institution requires a judgement to be made about it’s capital strength. Can be assessed by one of the following:

  • TIER ONE CAPITAL RATIO (used to judge a bank’s capital adequacy and is expressed as a %; the higher the % the greater the strength of the bank).
    …This absorbs lossess without the bank having to cease trading
    …Under Basel III, large banks must maintain ratios of between 8.5% and 11%
  • CREDIT RATINGS (used to assess the stability and ability to repay debts)
  • CREDIT DEFAULT SWAP (CDS) RATES (the cost of insuring a bank against default by using a CDS. The CDS is a deriviative that enables the institution to protect itself against the risk of default by passing that exposure onto someone else)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

A1F. Risks (pages 5 & 6) - CREDIT RISK

A

FSCS provides protection of up to £85,000 of deposits.

The limit is 100,000 Euros across Europe.

The PRA (under the European Deposit Guarantee Schemes Directive) recalculates the £85,000 limit in sterling every 5 years.

FSCS can take one to six months to resolve matters.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

A1F. Risks (pages 6 & 7) - INFLATION

A

If an investor is locked in for a considerable time, the final return may be unsatisfactory in real terms if inflation has risen unexpectidly.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

A1F. Risks (page 8) - INTEREST RATE RISK

A

FIXED INTEREST DEPOSITS - Can suffer from REINVESTMENT RISK where the interest rates may be lower on the deposit maturing and therefore not being able to secure the same rate on reinvestment.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

A1F. Risks (pages 8 & 9) - OFFSHORE ACCOUNTS

A

Three common dangers when investing in offshore accounts:

  1. High rates of interest are usually offered by high-inflation countries with potentially collapsing currencies
  2. Currencies regarded as strong may not rise enough to compensate for their lower interest rates
  3. Many foreign countries do not have the same level of supervisory structures as the UK
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

A2. Money market investments (page 9)

A

The money markets are where short-term debt instruments are traded.

They are wholesale markets where banks, building societies and others lend to and borrow from one another.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

A2A. Types of money market instrument (pages 9 & 10)

A

Money market instruments allow issuers to raise funds for short-term periods at relatively low interest rates.

Issuers include: Governments, banks and companies
Duration of issue: usually 90 days or less

Cash instruments traded in the money market include:

  • Time deposits
  • Treasury Bills
  • Certificates of Deposit
  • Commercial Paper
  • Banker’s acceptances
  • Bills of Exchange
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

A2A. Types of money market instrument (pages 9 & 10) - TREASURY BILLS

A

Treasure Bills:

  • Issued by governments to finance their short-term needs
  • In the UK, the issue of Treasury Bills is managed by the Debt Management Office (DMO) which uses the bills to manage the Government’s daily cash flow needs
  • Treasury Bills are issued at weekly auctions and have maturities of one, three or six months
  • Members of the public can purchase them with a minimum buy of £500,000
  • They are backed by the UK Government and seen as risk-free investments (highly liquid)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

A2A. Types of money market instrument (page 10) - CERTIFICATES OF DEPOSIT (CDs)

A

Certificates of Deposit (CDs) are receipts from banks for deposits places with them.

  • Maturities of one to three months
  • Interest is paid on maturity
  • CDs have fixed-rate interest usually related to a reference rate such as the Sterling Overnight Interest Average (SONIA)
  • Cannot be withdrawn before maturity
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

A2A. Types of money market instrument (page 10) - COMMERCIAL PAPER

A

Commercial Paper is a short-term money market funding instrument.

  • Issued by companies to fund their day-to-day cash flows
  • Typical maturities of 30 - 90 days
  • Unsecured (unlike Treasury Bills) and so rates of return of higher due to the risks involved
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

A2B. Investment vehicles (pages 10 & 11)

A

After the 2008 crash and money market funds ‘breaking the buck’, the European Securities and Markets Authority (ESMA) set out a two-tiered approach to defining European money market funds:

  1. Short-term money market funds which provide a return in line with money market rates; and
  2. Money market funds which have fluctuating NAVs
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
22
Q

A2C. Returns (pages 11 & 12)

A

Charges: No initial charge and an AMC of around 0.15% p.a.

Returns: Will be higher for those that use commercial paper and short-term debt over pure cash

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
23
Q

A2D. Risks (page 12)

A

Money market funds carry the same four risks as cash investments:

  • Credit risk, inflation risk, interest rate risk and currency risk

Both cash and money market funds carry credit risk, but with money market funds it is diversified over several providers rather than a single institution.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
24
Q

B. Bonds (page 12)

A

Bonds are debt investments where the owner is given rights to interest and the repayment of capital on loans made to governments and companies.

Companies and governments use bonds to raise long-term finance.

  • Mainly fixed rate
  • Issued for periods up to 30 years, or sometimes even 50 years
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
25
Q

B1. Characteristics (page 12)

A

Governments and companies often raise the long-term finance they need from the capital markets in the form of BONDS.

This provides competition with other lenders (such as banks):

  • banks may not be able to lend for a long enough period
  • bond markets off a wider range of lenders
  • bonds are often the cheapest way of borrowing money

HENCE why lots of large companies use the bond markets to raise money rather than taking out loans with their banks.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
26
Q

B1A. Definition of bonds (page 13)

A

Bonds are known as:

  • Negotiable (can be sold to the secondary markets)
  • Fixed-interest (borrower/issuer committed to paying interest for the duration of the bonds term)
  • Long-term (issued for 5 - 30/50 years)
  • Debt instruments (bonds represent financial debt)

However some bonds are variable, are index-linked and pay no interest at all.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
27
Q

B1B. Bond titles (page 13)

A

UK Government Bonds: GILTS
International Bonds: EUROBONDS
Corporate Bonds: DEBENTURES, LOAN STOCK, LOAN NOTES

Title of Bonds has three components:

  • ISSUERS NAME
  • COUPON
  • MATURITY DATE

INTEREST:

Most bonds pay the coupon twice yearly, regardless of interest rate changes.
Interest is paid gross.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
28
Q

B1C. Bond pricing (pages 13 & 14)

A

Bonds are traded by their nominal value, otherwise known as ‘par’ or ‘face’ value.

Prices are quoted in the Financial Times but these are not what the investor would pay for two reasons:

  1. These are mid-market prices. Buyers would actually pay a higher price (the offer price), and receive a lower price on sale (the bid price) on sale
  2. They are clean prices, which means that they do not include any interest. To determine the full price of the bond the interest (which accrues daily) needs to be added to work out the ‘dirty price’
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
29
Q

B2. Types of bond (page 14)

A

Bonds are usually classified according to:

  • their issuer
  • their structure or characteristics
  • what market they are issued in
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
30
Q

B2A. Government bonds (pages 14, 15 & 16)

A

Goverment bonds are issued by governments to raise finance.

They are issued in that country’s own domestic currency.

Are usually ‘risk-free’ but not always (Russia in 1998, Greece in 2000s).

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
31
Q

B2A. Government bonds (page 15) - CONVENTIONAL GILTS

A

Conventional gilts carry a:

  • Fixed Coupon (i.e. 2%)
  • Single repayment date (i.e. 2025)
  • Interest is paid every six months until maturity, at which point the holder receives the final interest payment and the return of capital
  • Usually issued with coupon dates of 7 March & September or 7 June and December

Conventional gilts represent 70% of UK Government bonds in issue.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
32
Q

B2A. Government bonds (page 15) - INDEX-LINKED GILTS

A

Index-linked gilts are where:

  • the interest payments and capital increase by inflation over the term of the bond
  • interest is paid every six months with capital returned at maturity, except these payment are adjusted to take account of inflation over the bond term
  • inflation adjustment in line with RPI
  • no deflation floor, so the redemption amount could be less than the face value

The inflation uplift is calculated at different period before rdemption as follows:

Issues prior to July 2005: Eight months before
Issues after July 2005: Three months before

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
33
Q

B2A. Government bonds (pages 15 & 16) - GILT STRIPS

A

STRIPS: Seperate trading of registered interest and principle securities

A stripped gilt is:

  • one that is seperated into it’s indiviual coupon payments and redemption payment
  • each of these payments can then be seperately traded as a zero-coupon bond with a known redemption value
  • the entire return is in the form of a capital gain
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
34
Q

B2A. Government bonds (page 16) - DOUBLE DATED GILTS

A

Carry a fixed coupon but have two dates in which they can be repaid: 2% Treasury 2020-25

NOT CURRENTLY IN ISSUE

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
35
Q

B2A. Government bonds (page 16) - UNDATED GILTS

A

Carry a fixed coupon but have no remption date: 2% Treasury

NOT CURRENTLY IN ISSUE

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
36
Q

B2A. Government bonds (page 16) - GILT CLASSIFICATIONS

A

UK Government bonds are classed by the DMO according to their TIME LEFT to maturity:

  • SHORTS: 0-7 years left to run to redemption
  • MEDIUMS: 7-15 years left to run to redemption
  • LONGS: 15+ years left to run to redemption

The Financial Times classifies shorts as 0-5 years

Gilts with 50 year redemptions can be referred to as ultra-long

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
37
Q

B2B. Corporate bonds (pages 16 & 17) - CHARACTERISTICS

A

Corporate bonds are usually secured on a company’s assets by either:

  • FIXED CHARGE: a legal charge (or mortgage) placed on one or a number of the company’s fixed assets
  • FLOATING CHARGE: places a more general charge on assets which continually flow through the business such as the company’s stock-in-trade
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
38
Q

B2B. Corporate bonds (pages 16 & 17) - CHARACTERISTICS

CONTINUED

A

Some corporate bonds are issued with CALL provisions:

  • enables the issuer to buy back all or some of the issue before maturity
  • attractive to the issuer because the bond can be refinanced when interest rates are lower than that being paid on the bond
  • investor will probably demand a higher yield as compensation
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
39
Q

B2B. Corporate bonds (pages 16 & 17) - CHARACTERISTICS

CONTINUED

A

Some corporate bonds are issued with PUT provisions:

  • give the bondholder the right to require the issuer to redeem early
  • makes the bond more attractive to bondholders
  • increases the risk of refinancing the bond at an unplanned time (bad for the issuer)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
40
Q

B2B. Corporate bonds (page 17) - MEDIUM-TERM NOTES

A
  • standard corporate bond issues

- maturities ranging from 9 months to 5 years

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
41
Q

B2B. Corporate bonds (page 17) - FIXED-RATE BONDS

A
  • are conventional bonds that have fixed coupons
  • interest paid half-yearly or annually
  • have predetermined redemption dates
42
Q

B2B. Corporate bonds (page 17) - FLOATING RATE NOTES (FRNs)

A
  • have a variable rate of interest
  • the rate of interest is linked to a benchmark
  • was LIBOR but now SONIA
43
Q

B2B. Corporate bonds (page 17) - CONVERTIABLE BONDS

A
  • carry the right to be converted into ordinary company shares
  • conversion can take place at predetermined points during the life of the bond
  • if the conversion rights are not used then it becomes a conventional bond that repays on a fixed date
44
Q

B2B. Corporate bonds (page 17) - ZERO COUPON BONDS

A
  • pay no interest
  • issued at a discount and redeemed at its par value
  • all of the return is capital growth
45
Q

B2B. Corporate bonds (page 17) - PIBS AND PSBs

A

Permanent interest bearing securities (PIBS):

  • irredeemable
  • fixed interest
  • issued by building societies
  • pay 6 month coupons GROSS
  • PIBSs holders rank behind everyone in liquidation

Perpetual subordinated bonds (PSBs):
- this is a PIB where the building society has demutualised. The PIBS are reclassified as PSBs

46
Q

B2C. Eurobonds (pages 17 & 18)

A

Eurobonds are large international bond issues made by governments and suprantional organisations.

47
Q

B2D. Foreign bonds (page 18)

A
  • issued by foreign borrowers/issuers

- denominated in the currency of that country

48
Q

B2E. Convertible bonds (pages 18 & 19)

A

This is where bonds can be converted into ordinary shares of the issuing company.

Buying at a premium is a more expensive way of obtaining the shares.

Buying at a discount is a cheaper way.

49
Q

B3. Bond markets (page 19)

A

The issuing and selling of ORIGINAL bonds takes place in the PRIMARY MARKET.

Any trading thereafter takes place in the SECONDARY MARKET.

50
Q

B3A. The primary market (pages 19 & 20)

A

UK Government issues gilts via the DMO which does this weekly and uses an auction process:

  • large investors put in bids at the price and for the quantity of stock they want
  • successful bidders pay the price they bid
  • non-competitive bids can be made for amounts up to £500,000. If successful they pay an average of accepted prices
51
Q

B3A. The primary market (pages 19 & 20)

CONTINUED

A

Other organisations or companies issue bonds less frequently. They appoint an investment bank to manage the issue:

  • the issue and prospective coupon are marketed to potential investors
  • indicative bids are placed at a certain price
  • final terms are agreed and issued to prospective investors, who have 24 hours to make firm bids
52
Q

B3B. The secondary market (page 20)

A

The trading of bonds after their original issue does not affect the original issuer or change the terms of the bond.

There is substantial trading activity in four major markets in the UK:

  • the government sector
  • the corporate sector
  • sterling loans to foreign borrowers
  • the Eurobond market
53
Q

B4. Returns (page 20)

A

Bonds are measured by the returns they provide as a percentage of the investment made: The YIELD

54
Q

B4A. Interest yield (page 20 & 21)

A

Interest yield is the return as investor gets on the purchase price of a bond. It is also known as the:

  • running yield
  • income yield
  • flat yield

Calculation:
Coupon
Interest Yield = ——————- x 100
Clean price

55
Q

B4B. Redemption yield (pages 21 & 22)

A

Redemption yields take into account any gain or loss that will be made if the bond is held until maturity.

When a bond is held to maturity, only its nominal value is repaid. So if a bond is purchased for £127.86, yet the face value was £1,000, then a loss of £278.60 is made:

£1,000 x £127.86 / 100 - £1,000 = £278.60

If the coupon is above current interest rates, the bond will trade above par (will result in capital loss), and if the coupon is below current interest rates, the bond’s price will be below par.

56
Q

B4B. Redemption yield (pages 21 & 22)

CONTINUED

A

Redemption yields take into account any gain or loss that will be made if the bond is held until maturity.

Calculation:
(par - mp) / years to redemption)
Interest yield + ( ———————————————- x100)
mp

mp = market price

Steps are detailed in the calculation flash cards as it involved the interest yield, market price and redemption yield.

57
Q

B4C. Yield curves (pages 23, 24 & 25)

A

One of the major relationships tracked by analysts is the redemption yields for bonds of varying maturities.

This is normally presented as a Yield Curve.

58
Q

B4C. Yield curves (pages 23 & 24) - NORMAL YIELD CURVE

A

In normal circumstances, investors demand higher yields over the longer term to cover the increased risks and uncertainties that the longer term to redemption brings.

This is known as ‘liquidity preference’ - where investors need to be rewarded to tie up their capital.

The yield curve is then a rising ‘positive’ curve.

59
Q

B4C. Yield curves (pages 23 & 24) - FLAT YIELD CURVE

A

A flat yield curve can come about where there is no perceived reinvestment risk. This comes about when investors do not expect interest rates to change in the future and do not demand a premium (or accept a discount) for investing long-term.

60
Q

B4C. Yield curves (pages 23 & 24) - INVERTED / REVERSE YIELD CURVE

A

This is where the yield is the opposite shape to that of a normal yield curve.

This is because the yield on longer-term bonds is less than that of shorter-term bonds.

Caused by investors expecting interest rates to rise in the short term.

61
Q

B4D. Past performance (page 25)

A

Equities usually outperform bonds, except for the last two decades where bonds have outperformed equities.

62
Q

B5. Risks (pages 25 & 26)

A

Main risks associated with bonds:

  • Credit Risk (interest / capital payments may not be made)
  • Market or Price Risk (movement in interest rates has significant affect on bond values)
  • Unanticipated Inflation Risk (it rising sharply)
  • Liquidity Risk
  • Exchange Rate Risk
  • Early Redemption Risk (issuer may invoke a call option)
  • Seniority Risk (ranked low in respect of issuer’s liquidity)
63
Q

B5A. Credit risk (pages 26 & 27)

A

When bonds are first issued they are assigned a credit rating by an agency - this will affect the initial pricing and yield of the bond.

Investment Grade Bonds: have a rating (highest liquidity and quality)

Non-Investment Grade (Junk Bonds): lowest ratings, speculative, less liquidity

64
Q

B5A. Credit risk (pages 26 & 27)

CONTINUED

A

Usual order of creditworthiness:

  1. Governments
  2. Supranationals (World Bank / European Bank)
  3. Local government institutions
  4. Large international companies and major banks
  5. Smaller listed companies

Worth credit ratings normally means a higher yield to compensate for the risk being taken.

65
Q

B5B. Market or price risk (pages 27 & 28)

A

When Interest Rate RISE:

  • Prices of outstanding bonds fall
  • to bring the yield of older bonds into line with the new higher interest rate

When interest rate FALL:

  • Prices of outstanding bonds rise
  • until the yield of older bonds is low enough to match the lower interest rate
66
Q

B5C. Volatility (pages 28, 29 & 30)

A

All bonds react differently to changing market conditions; this is known as VOLATILITY.

  • Longer the period to redemption - MORE volatile
  • lower the coupon - MORE volatile
67
Q

B5C. Volatility (pages 28, 29 & 30) - DURATION

CONTINUED

A

Duration allows the sensitivity of one bond verses another to be compared:

E Net present value of the cash flows to be received

68
Q

B5C. Volatility (pages 28, 29 & 30) - MODIFIED DURATION

CONTINUED

A

Modified Duration allows us to compare the sensitivity of a bond to changes in interest rates.

  • This estimates how much a bond’s price will change if there is a change in interest rates
            Duration --------------------------------------- (1 + Gross Redemption Yield)
69
Q

B5C. Volatility (pages 28, 29 & 30) - MODIFIED DURATION

CONTINUED

A

Can calculate what effect a % rise (say 1%) in yields will be on the bond’s price.

Our Duration of 2.74 means that the price should change by 2.74%.

A bond priced at 97.28 would therefore fall (because the yield has risen) by:

97.28 - (97.28 x 0.0274) = 94.61

70
Q

C. Equities (page 30)

A

Over 2,000 companies (including 300 foreign ones) are listed on the London Stock Exchange (LSE)

71
Q

C1. Characteristics (page 30)

A

A company is a legal entity formed to conduct business or other activities in the name of its members.

72
Q

C1A. Types of share (page 30)

A

Two types of share can be created, ORDINARY and PREFERENCE.

73
Q

C1A. Types of share (page 30) - ORIDINARY SHARE

A
  • represent the risk capital of the company
  • last to be paid out in the event of liquidation
  • holders have a right to dividends
  • holder have a right to vote at company meetings

A Shares: participate in profits and dividends but are non-voting
B Shares: usually redeemable shares and issued as part of a capital return to investors
Deferred Shares: often paid to founders and only pay a dividend after a period of time

74
Q

C1A. Types of share (page 30) - PREFERENCE SHARE

A
  • less risky than ordinary shares
  • company does not have to pay a dividend
  • but when it does, they are paid to preference holders before ordinary share holders
  • no voting rights
  • pay out first in the event of liquidation

Preference Shares: carry a fixed dividend but if is not paid the right is lost
Cumulative PS: if the dividend is not paid the right rolls over and arrears have to be paid before any ordinary dividends
Participating PS: additional dividends may be payable if profits allow
Redeemable PS: issued with a certain lifespan by which the company will buy them back at nominal value
Convertible PS: can be converted to ordinary shares

75
Q

C1B. Shareholder rights (page 31)

A

Shareholder’s rights fall into two categories:

  • Basic Rights
  • Statutory Rights
76
Q

C2. Primary markets (page 31)

A

Primary market is where the shares are first listed on a stock market.

Once issued, the trading afterwards takes place in the secondary market (such as the London Stock Exchange).

Listing process is regulated by the UK Listing Authority (UKLA) which is part of the FCA.

When a company obtains a stock market listing, this is now known as an Initial Public Offering (IPO) of which there are three main types:

  • Offers for sale
  • Placings
  • Introductions
77
Q

C2A. Offers for sale (pages 31 & 32) - FIXED PRICE

A

Offer for sale is the most common form of issuing new shares.

Fixed Price:

  • Can be offered when the compnay is large and stable
  • Shares offered at a pre-determined price
  • The issue is underwritten (banks agree for a fee to buy unsold shares)
  • Offer price set under the technical optimum to encourage overscription which puts upward pressure on the share after issue (growth)
78
Q

C2A. Offers for sale (page 32) - TENDER PRICE

A

Tender Price:

  • this involves getting bids from potential investors to try and gauge a sensible price and establish interest in a share before setting a ‘strike’ price
  • once bids are in a strike price is decided
  • shares are then sold to all those who have bid at or above the strike price
79
Q

C2A. Offers for sale (page 32) - OFFERS FOR SUBSCRIPTION

A

Offers for subscription:

  • is a special form of tender price
  • the issuer seeks bids above a minimum ‘subscription level’
  • but does not commit to go through with the issue until a certain level of deman is met
  • commonly used for new investment trusts
80
Q

C2B. Placings (page 32)

A

Placings are the fastest and cheapest method of issuing new shares. Very popular for smaller companies.

Process:

  • the issuing company decides on a suitable price for the shares
  • the company calls on directly on big institutions (pension funds, banks) and makes a presentation
81
Q

C2C. Introductions (page 32)

A

This is where established companies want to list their shares on a stock market.

No new shares are listed and no new money raised, the shares are just made available on a stock market.

The shares can now be traded through the exchange rather than being sold privately.

82
Q

C2D. Special share issues (page 33)

A

In the 1980s and first half of the 1990s many issues were via PRIVATISATION and DEMUTUALISATION:

Privatisation: Many UK Government assets were sold off to reduce Government debt

Demutualisation: Mutual companies do not have shareholder or pay dividends. They are owned by their members and offer them preferntial rates.
- demututalisation is where the mutual company becomes privatised to more easily raise capital for growth

83
Q

C3. Secondary markets (pages 33 & 34)

A

Main secondary markets in the UK are:

  • London Stock Exchange (LSE)
  • NEX Exchange
84
Q

C3. Secondary markets (pages 33 & 34)

CONTINUED

A

BEST EXECUTION

  • when placing trades on behalf of a client, firms have to meet their duty of best execution (as per COBS)

General regulatory obligations - first must take all reasonable steps to obtain the best possible result for the client

Retail clients - a best possible result is determined in terms of ‘total consideration’ which takes account of price, execution costs and any expenses

Professional clients - total consideration is the benchamark for standards

Execution venues - firms must trade at a venue which can obtain the best result for the client. Under FCA rules a firms is now required to:

  • have an ‘execution policy’ which covers the venue being used and what factors used when carrying out the trade(s)
  • inform clients about the execution policy
  • assess the execution venues annually
  • monitor the effectiveness of the execution arrangements
  • if requested, show the client that their order has ben executed in line with the execution policy
85
Q

C4. Corporate actions (page 34)

A

Once listed, a company may choose to be involved in a takeover or merger. These are coporate actions and there are over 150 different types.

86
Q

C4A. Rights issue (pages 34, 25 & 36)

A

When companies come back to the stock market to raise additional capital, three main methods are used:

  1. Placings (smaller capital raising events)
  2. Open offer (existing shareholders offered the chance to subcribe to new shares on a pro-rata basis at a discount)
  3. Rights issues
    - offered to existing sharholders first to ensure no dilution
    - used to fund specific expansion plans
    - strengthen the balance sheet
    - refinance the company after a crisis
    - rights issue expressed as ‘1-for-3’ or ‘2-for-5’
    - discounts of 20% - 50% are common
87
Q

C4A. Rights issue (pages 34, 25 & 36) - THEORETICAL EX-RIGHTS PRICE and RIGHTS PREMIUM

CONTINUED

A

Rights issues lead to changes in the share price. The price to which the original shares will fall is know as the theoretical ex-rights price.

Once the rights issue has been announced investors have four options:

  1. Take up
  2. Sell the rights in the market
  3. Sell sufficent to take up the balance (sell some of the rights to generate cash to pay to take up the remainder)
  4. Lapse

Rights Premium is the difference between the new share price and the ex-rights price.

88
Q

C4B. Adjustments issues (pages 36 & 37)

A

Sometimes shares are issued for other reasons than raising capital:

  1. Bonus issues
  2. Share splits
89
Q

C4B. Adjustments issues (pages 36 & 37) - BONUS ISSUES / BONUS SHARES

A

This is where further shares are issued to existing shareholders without raising further funds.

COMPANY HAS RETAINED PROFITS.

It helps reduce the price per share without reducing the market holding of the investor.

Brings the company’s share capital more in line with its real worth.

Reduces the share price to make it more marketable.

90
Q

C4B. Adjustments issues (pages 36 & 37) - SHARE SPLITS

A

This allows an existing share to be split.

For example, a £1 ordinary share is split into two 50p ordinary shares.

COMPANY DOES NOT TRANSFER REVENUE FROM RESERVES, UNLIKE BONUS ISSUES / BONUS SHARES.

91
Q

C4C. Capital reorganisations and shareholder returns (pages 37 & 38)

A

Companies restructure their share capital as a way of returning excess capital to shareholders.

92
Q

C5. Returns (page 38)

A

Returns from equity holdings come from dividens and capital growth.

Either Historic or Prospective date may be used when calculating measures of share value:

  • Historic date comes from actual past returns
  • Prospective data comes from projective results
93
Q

C5A. Dividends (page 38)

A

Shareholders are ENTITLED to a share of company profits in the form of dividends, however they do not have a RIGHT to a dividend. Whether one is payable is decided by the board of directors.

94
Q

C5B. Capital growth (page 38)

A

The other key component of returns from equities is that of Capital Growth.

95
Q

C5C. Past performance (page 38)

A

To understand risk and return we must examine long periods of past performance.

96
Q

C6. Risks (pages 38 & 39)

A

Risks associated with investing in equities:

  • Price Risk: share prices may fall (loss of capital value)
  • Liquidity Risk: shares may be difficult to sell at reasonable prices depending on when they need to be sold
  • Issuer Risk: the risk that the issuing company collapses and the shares becomes worthless
97
Q

D. Property (page 39)

A

It is one of the main assets held my private individuals.

98
Q

D1. Characteristics (page 39)

A
  • property is an asset-backed investment
  • can provide long-term protection against inflation
  • in locations where businesses flourish, more people live so demand for property rises as do rents
  • commercial property values follow business profitiability
  • tenants of commercial have to pay a rent even when they make a loss, unless the property becomes vacant and a tenant cannot be found (property becomes a drain)

Commercial property sectors: offices, retail, indusutrial

99
Q

D2. Returns (pages 39 & 40)

A

Returns on an investment in property are meansured by an INITIAL YIELD (which is a %) as follows:

                       Annual rental income Initial Yield =  ----------------------------------- x 100
                       price of the property

Returns on property can be judged by looking at an appropriate index, such as the Investment property Databank (IPD).

100
Q

D3. Risks (page 40)

A

Main risk is LACK OF LIQUIDITY:

  • property is relatively expensive to buy and sell
  • can take time to sell (and to buy)
  • not possible to sell in segments
  • cannot use the annual CGT examption
101
Q

Chapter 2 Key Points (page 41)

A

CASH ASSETS

  • quoted rates for cash deposits may not reflect the true rate (need to consider tax, charges etc)
  • cover provided by the FSCS should not stop an investor from checking the creditworthiness of an institution
  • money market is for professional investors but can be accessed by mutual funds

INDEX LINKED BONDS

  • these provide protection against inflation
  • amount of capital returned depends on inflation 3 - 8 months before redemption
  • no protection against deflation

BONDS

  • bonds are measured by the returns they provide as a % of the investment made (the yield)
  • Interest Yield and Redemption Yield are the most important measures
  • bonds may trade above or below par
  • the lower the bond’s credit rating the higher the yield

EQUITIES

  • to be listed on a stock exchange a company must be authorised by the UKLA
  • bonus issues and share splits can reduce the initial price of a share to make it more marketable

PROPERTY

  • property can add diversification to a portfolio but it is not readily realisable
  • the high level of expenses can impact on the yield

J10 - Discretionary Investment Management (15 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions