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CP1 B3 > C8,9 - Bond, Money and Eq, Property Market > Flashcards

C8,9 - Bond, Money and Eq, Property Market Flashcards

1
Q

Who Issues MMI?

A

Government (treasury bills)
Regional government bodies (local authority bills)
Companies (bills of exchange, commercial paper)
Banks (different types of deposit)

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2
Q

Features of bank deposits

A

Cash On Deposit
Instant access – depositor can withdraw the money at any time
Notice deposit – depositor has to give a period of notice before withdrawal
Fixed term – depositor cannot access the capital until the end of the fixed term.
Certificates of Deposit
– tradable notes that state how much has been deposited

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3
Q

List the main players in money market

A
  1. Clearing Banks
    Lend and borrow via short-term deposits (often overnight) to control their liquidity levels
  2. Central Bank
    Acts a lender of last resort
    Standing by to provide liquidity to the clearing banks
    Sets short term interest rates via repo arrangements and sale and purchase of bills
  3. Other financial and non-financial institutions
    Lend and borrow short term funds
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4
Q

Why hold MMI or Cash

A
  1. Liquidity: POURS
    Protection of monetary value
    Opportunities to invest in other assets can easily be exploited
    Unexpected liabilities to meet
    Recently received cashflow
    Short-term liabilities to meet
  2. Diversification
  3. Poor prospects of other assets : DIRE
    Domestic currency expected to depreciate
    Interest rates expected to rise
    Recession expected
    Economic uncertainty
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5
Q

Why not hold MMI

A

Lower expected return than other, riskier asset classes
Poor match for longer-term liabilities
Reinvestment risk, i.e. proceed will have to be reinvested on unknown terms
Short-term interest rates move broadly in line with price inflation
But not a good match for salary-linked liabilities
May be a limited supply

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6
Q

Asset Characteristics (SYSTEM T)

A

Security (default, other risks)
Yield (real/nominal, running yield, expected return)
Spread (volatility of market values, diversification)
Term (Short/Med/Long/Irredeemable)
Expenses and exchange rate (dealing costs, ongoing mgmt costs)
Marketability (size of issue/divisibility, liquidity, uniqueness, valuation, freq of dealing, listed)

Tax (capital gains, income)

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7
Q

Investor Characteristics (TRAITOR)

A

Tax (status, rates, allowance)
Regulation (solvency, legislation, voluntary, trust deeds)
Assets (existing pf, expertise, direct/indirect)
Income requirement (liabilities, income/capital gains, current/future)
Tastes (education/fashion/utility)
Objectives/Alternatives/Expenses)
Risk appetite

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8
Q

What is ‘Bond’

A

Bond:
- Fixed interest or Index linked security
- Described by the type of organisation issuing the security : Govt, Local authority, corporate
- Also call ‘gilts’

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9
Q

3 Types of bond market

A
  1. Government bond markets, listed in their country of origin
  2. Corporate bond markets, listed in their country of origin
  3. Overseas government and corporate bond markets, listed in other than the ‘home’ country. National vs listed country’s currency
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10
Q

Investment & Risk Characteristics of Conventional Government Bonds

A
  1. Income = coupons (usually semi-annual) fixed in nominal terms
  2. Capital = redemption (usually at par) fixed in nominal terms
  3. Virtually zero default risk if a developed country
  4. Lower expected return than expected return than equities and property (long term)
  5. Higher running yield than equities and property
  6. Provides a fixed nominal return. Real return eroded by actual inflation.
  7. Volatility of capital values higher for long-term than short-term bonds
  8. Term: short, medium, long, irredeemable
  9. Very low dealing costs if in a developed country
  10. Very marketable if a developed country
  11. Tax treatment depends on the territory
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11
Q

Cashflows in a conventional nominal bond

A

CONVENTIONAL
Bond purchase
-Initial lump sum negative cashflow equal to the price paid for the bond plus dealing expenses
Coupon payments
-Regular series of positive cashflows.
-Timing is known (usually semi-annual or annual)
-Amounts are known in monetary terms
-Total payment term is known
Redemption payment
-Lump sum positive cashflow on the redemption date
-Timing is known
-Amount is known

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12
Q

Cashflows of index linked bond

A

INDEX-LINKED
Bond purchase
-Initial lump sum negative cashflow equal to the price paid for the bond plus dealing expenses
Coupon payments
-Regular series of positive cashflows.
-Timing is known (usually semi-annual or annual)
-Amounts are known in real terms
-Total payment term is known
Redemption payment
-Lump sum positive cashflow on the redemption date
-Timing is known
-Amount is known is real terms

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13
Q

Nominal vs. Real Yields

A

Nominal yield = risk-free real yield + expected future inflation + inflation risk premium

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14
Q

Inflation Risk Premium

A

Reflects additional yield required by investors with real liabilities for bearing risk of uncertain future inflation.

Size of the premium is therefore determined by:
1. Degree of uncertainty over inflation
2. Balance between the numbers of investors requiring a fixed return and those requiring a real return

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15
Q

Relative attractiveness of index-linked vs conventional bonds

A

Relative attractiveness of index-linked vs conventional bonds
-If investor has real liabilities and hence requires inflation protection
-If investor expects future inflation to be higher than predicted by the market
-If investor expects the inflation risk premium to be higher than predicted by the market
(Note the above two reasons mean that, in the investor’s eyes, nominal yields will rise and the price of conventional bonds will fall. But this could occur with minimal effect on real yield and on index-linked bond prices)

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16
Q

Define Ordinary shares

A
  • Ordinary shares (equities or common stock) are securities held by the owners of an organisation
  • Equity shareholders own the company that issued the shares
  • Equity shares do not earn a fixed rate of interest as with fixed interest. Shareholders are entitled to a share in the company’s profits, in proportion to the number of shares owned
17
Q

Cashflows of Ordinary shares

A

Share purchase
-Initial lump sum negative cashflow equal to the price paid for the share dealing expenses

Dividend payments
-Regular series of positive cashflows representing a share in the company’s profits
-Timing of payments is generally known
- Amount is variable and unknown
- Profits and hence dividends are expected to increase broadly in line with growth in GDP
- Company may choose not to distribute all of its profits but retain some for new projects, expansion or to subsidise dividends in poorer years

Final payment
- No redemption payments
- Dividends are assumed to continue indefinitely
- Will be a final positive cashflow which is unknown in amount and timing if:
Investor sells the share or the company buys it back
Company winds up

18
Q

Listed vs. unlisted shares

A

Greater marketability
Easy to value
Greater security (from stock exchange regulations)

19
Q

3 ways in which Equity shares can be categorised

A

3 ways in which Equity shares can be categorised
1. Size of the company
2. Expect profit growth
3. Industrial sector

20
Q

Reasons for specialisation in a sector by Equity analysts : Practicality

A

FIES:

  1. Factors affecting one company are likely to affect other companies in same industry
  2. Information - same source, same presentation, industry statistics
  3. Expertise – no analyst can be an expert in all areas
  4. Structure added to decision making-process
21
Q

Reasons for specialisation in a sector by Equity analysts : Co-relation of performance

A

MRS :
Markets – companies in the same sector supply the same markets and will therefore be similarly affected by changes in demand
Resources – companies in the same sector will use similar resources and will therefore have similar output costs
Structure – companies in the same sector often have similar financial structures and will therefore be similarly affected by changes in interest rates

22
Q

Features of property invvestment

A

Security
-Risk of voids and tenant default
-Risk of political interference
-Risk of obsolescence and need for refurbishment
Yield
-Real return, broad inflation hedge
-Higher than expected return than government conventional bonds
-Income forms a “stepped” pattern over time
-Running yield greater than equities and less than conventional bonds
Spread
-Volatile capital values in long term, stable capital values in short term
-Subjective, infrequent valuations, lack of information
Term – long term
Expenses
-High dealing costs and management costs
Marketability
-Unmarketable
-Large unit size, indivisibility
-Uniqueness
-Characteristics can be changed by owner

Tax
Depends on fiscal policy in country

23
Q

Leasehold Ownership

A

Lease is an agreement which allows one of the parties the use of a specified portion of a building owned by another party for a specific period in return for some payment
Leasehold differs from freehold:
has a shorter term and a fixed end
is less marketable
involves a capital loss to the leaseholder at end of the lease
has a higher initial rental yield

24
Q

Evaluating a leasehold ownership

A

Evaluating a leasehold ownership
The parties to the agreement
The commencement date of the lease
The length of the lease
A clear description of the property
The amount of rent to be paid and how frequently it is to be paid
Whether the rent is to be reviewed and if so when and how and what is to be done if the parties cannot agree a new rent
The use to which the property is to be put
Who is responsible for repairs, insurance and other expenses
Whether break clauses may be included

25
Q

Vehicles for pooled property investment

A

Vehicles for pooled property investment
1. Open-ended unitised funds
2. Close ended investment trusts

Constitutions that specify:
1. Type of property that they can invest in
2. Limits on liquidity
3. Mgmt charges that can be deducted from the fund

26
Q

Freehold Ownership

A

Ownership in perpetuity

Rights
To occupy the building or let it out
To refurbish the property or develop it
Restrictions
Covenants
Easements such as rights of way
Planning and building regulations
Statutory requirements not to cause a nuisance to others
Requirement to reinstate/refurbish property on reversion at the end of a lease before the property can be let
Requirement to put property back into good condition if it has been polluted or is not environmentally sound.

27
Q

Merits of investment in property company share

A

Merits of investment in property company share
1. Exposure to real property
2. No restriction on investment
3. Large companies
- No cap on charges
- New developments carry more risks

CP1 B3 (4 decks)

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