C8,9 - Bond, Money and Eq, Property Market Flashcards
Who Issues MMI?
- Government (treasury bills)
- Regional government bodies (local authority bills)
- Companies (bills of exchange, commercial paper)
- Banks (different types of deposit)
Types of bank deposits
Cash On Deposit
1. Instant deposit – depositor has ‘instant access’ to withdraw the money at any time
2. Notice deposit – depositor has to give a period of notice before withdrawal
3. 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
List the main players in money market
- Clearing Banks
Lend and borrow via short-term deposits (often overnight) to control their liquidity levels - 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 - Other financial and non-financial institutions
Lend and borrow short term funds
Why hold MMI or Cash
- 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 - Diversification
- Poor prospects of other assets : DIRE
Domestic currency expected to depreciate
Interest rates expected to rise
Recession expected
Economic uncertainty
Why not hold MMI
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
Asset Characteristics (SYSTEM T)
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)
Investor Characteristics (TRAITOR)
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
What is ‘Bond’
Bond:
- Fixed interest or Index linked security
- Described by the type of organisation issuing the security : Govt, Local authority, corporate
- Also call ‘gilts’
3 Types of bond market
- Government bond markets, listed in their country of origin
- Corporate bond markets, listed in their country of origin
- Overseas government and corporate bond markets, listed in other than the ‘home’ country. National vs listed country’s currency
Investment & Risk Characteristics of Conventional Government Bonds
Income = coupons (usually semi-annual) fixed in nominal terms
Capital = redemption (usually at par) fixed in nominal terms
S: Virtually zero default risk if a developed country
Y:
- Lower expected return than expected return than equities and property (long term)
- Higher running yield than equities and property
- Provides a fixed nominal return. Real return eroded by actual inflation.
S: Volatility of capital values higher for long-term than short-term bonds
Term: short, medium, long, irredeemable
E: Very low dealing costs if in a developed country,
M: Very marketable if a developed country.
Tax treatment depends on the territory
Cashflows in a conventional nominal bond
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
Cashflows of index linked bond
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
Nominal vs. Real Yields
Nominal yield = risk-free real yield + expected future inflation + inflation risk premium
Inflation Risk Premium
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
Relative attractiveness of index-linked vs conventional bonds
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)
Define Ordinary shares
- 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
Cashflows of Ordinary shares (Equities)
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
Listed vs. unlisted shares
Greater marketability
Easy to value
Greater security (from stock exchange regulations)
3 ways in which Equity shares can be categorised
3 ways in which Equity shares can be categorised
1. Size of the company
2. Expect profit growth
3. Industrial sector
Reasons for specialisation in a sector by Equity analysts : Practicality
FIES:
- Factors affecting one company are likely to affect other companies in same industry
- Information - same source, same presentation, industry statistics
- Expertise – no analyst can be an expert in all areas
- Structure added to decision making-process
Reasons for specialisation in a sector by Equity analysts : Co-relation of performance
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 input costs
Structure – companies in the same sector often have similar financial structures and will therefore be similarly affected by changes in interest rates
Problems with industry groupings
Two particular difficulties relate to:
1. Companies that operate throughout several sectors – ie conglomerate companies.
This is becoming more of an issue as companies increasingly diversify into new sectors by means of mergers and take-overs and leads to particular
difficulties where the sectors involved are very different. A similar issue relates to multinational companies that may operate in several very different marketplaces.
2. The heterogeneity of companies within particular sectors.
Companies may differ greatly even within the same sector – eg due to size, or because they operate within different niches of the market
Features of property investment
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
Leasehold Ownership
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
Evaluating a leasehold ownership
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
Vehicles for pooled property investment
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
Freehold Ownership
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.
Merits of investment in property company share
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
