Ch 11: Other investment classes Flashcards
Outline the purpose of collective investment schemes from the perspective of both the investor and the management of the CIS
From the investor’s perspective:
- Diversification and lower portfolio risk
- Access to expertise
- Access to larger / unusual investments
- Economies of scale (reducing investment expenses)
- Possible tax advantages
From the management of the CISs perspective:
- To follow the stated investment objective
- To create return for investors commensurate with the level of risk taken
Define closed-ended in the context of CISs
In a closed-ended scheme, such as an investment trust company (ITC), once the initial tranche of money has been invested the fund is closed to new money. After launch, the only way of investing in the ITC is to buy shares from a willing seller.
Define open-ended in the context of CISs
In an open-ended scheme, such as a unit trust or open-ended investment company, managers can create or cancel units in the fund as new money is invested or disinvested.
Define net asset value (NAV) per share for an ITC
Net asset value per share is equal to the value of the underlying assets of the company divided by the number of ordinary shares.
If gearing is allowed, the underlying assets would be net of the debt liabilities
Outline ten investment and risk characteristics of an investment trust company
- Stated investment objectives written into prospective / offer for sale document
- Closed-ended
- Public company, governed by company law
- Often quoted on an exchange
- Can raise both debt and equity capital
- Operated by company directors and investment managers
- Directors and investment managers receive fees
- Investors buy “shares” in the ITC
- Share price is determined by supply and demand
- Share price often stands at a discount to the company’s NAV per share
Outline nine investment and risk characteristics of a unit trust
- Stated investment objective
- Open-ended
- Trust, governed by trust law
- Limited ability to gear
- Operated by trustees and management company / investment managers
- Trustees ensure UT is managed legally in accordance with the trust deed, hold assets and oversee the calculation of the bid and offer prices and the administration of the UT
- Trustees and UT managers receive fees
- Investors buy “units” in the UT
- Unit price is based on NAV per share
Outline the advantages of investment in CISs compared with direct investment
- Access to larger / more unusual investments
- Discount to NAV – assets may be bought cheaply
- Diversification
- Divisibility
- Economies of scale in the case of larger collective schemes
- Expected return higher due to the extra volatility associated with gearing and changes to the discount to NAV
- Expertise of investment managers
- Index-tracking of a quoted investment index is possible
- Marketability (possibly)
- Quoted prices make valuation easier
- Suitable for small investors
- Tax advantages (possibly)
Outline the disadvantages of investment in CISs compared with direct investment
- Loss of control
- Additional layer of charges: Management fees for investment managers
- Need to hold some cash for liquidity which reduced expected exposure / return (UT ONLY)
- Extra volatility caused by gearing / discount to NAV changing (ITC ONLY)
- Tax advantages (possibly)
List nine differences between CE and OE collective investment schemes
- Shares in CE CISs are often less marketable than the underlying assets. Marketability of units in OE CISs is usually guaranteed by the managers.
- Some OE CISs need to hold cash to maintain liquidity => lower expected returns but greater price stability
- CE CISs can gear, leading to extra volatility. OE CISs cannot be geared or have limited gearing.
- Shares in CE CISs are also more volatile than the prices of the underlying shares because the size of the discount to NAV per share can change. The price volatility of units in an OE fund should be similar to that of the underlying assets.
- Increased volatility of CE CISs => higher expected return
- There may be uncertainty as to the true level of NAV per share of a CE CIS, especially if the investments are unquoted.
- CE CISs can invest in a wider range of assets
- May be possible to buy assets at less than NAV in a CE CIS
- They may be subject to different tax treatment
Define a futures contract
A standardized, exchange-traded contract to buy (or sell) a specified asset at a specified price on a specified date in the future
Define a forward contract
A non-standardized, OTC traded contract to buy (or sell) a specified asset at a specified price on a specified date in the future
Features of a futures contract
Standardized Exchange traded Clearing house removes default risk Margin paid to clearing house More liquid than forward Quoted price Often closed out before delivery
Features of a forward contract
Tailor made, non-standardized OTC traded Default risk depends on counterparty No margin paid as traded OTC Less liquid than future No quoted price as traded OTC Often results in delivery
Define a long and short position in relation to futures and forwards contracts
Having a long position in an asset means having positive economic exposure to the asset. In futures and forward dealing the long party is the one who has contracted to take delivery (to buy) of the asset in the future
Having a short position in an asset means having negative economic exposure to the asset. In futures and forward dealing the long party is the one who has contracted to deliver (to sell) the asset in the future
Define the term ‘warrant’
A warrant is an option issued by a company over its own shares. The holder has the right to purchase shares at a specified price at specified times in the future from the company.
