CH 11: Other investment classes Flashcards
Collective investment schemes (CIS)
2
- Provide structures for the management of investments on a grouped basis.
- Provide an opportunity for investors to achieve a wide spread of investments and therefore to lower portfolio risk.
Types of CIS
2,2
Closed ended schemes:
* Once the initial tranche of money has been invested, the fund is closed to new money.
* Only way of investment is to purchase shares from sellers. eg investment trusts
Open ended schemes:
* Managers create/cancel units as new money is invested/disinvested
* eg Unit- trusts
Regulation aspects of CISs
4
- Categories of assets held eg bonds,equities,property etc
- Whether unquoted assets
- Maximum level of gearing
- Any tax reliefs available
Investment Trust Companies
4
- Public companies that manage shares and other investments
- Able to raise/borrow capital through debt/equity
- Close ended, price of shares determined by supply and demand
- NAV used to determine trades at premium or discount
Public company therfore shareholders,board,investment managers etc.
Unit Trusts
5
- Open ended investment vehicle
- Buy units priced at NAV= assets/#units (bid/offer value of assets? charges taken from units?
- Limited borrowing power
- Management company: setup trust and invest funds.
- Trustees: ensure management obeys trust deed and price units
Open ended Investment Company
3
- Structure of a company with the open end of a unit trust
- Manager create shares when new money is invested and redeem shares when shareholders disinvest
- Single price added as initial charge for purchase no bid/offer
Differences between Closed and Open ended CIS’
2,2,4
Marketability:
* Shares CE less than under actual asset
* Units OE are guaranteed by managers
Gearing:
* CE can make share price more volatile than under asset. (higher return req via gearing)
* OE cannot be geared limited borrowing power
CE
* Buy assets @ discount to NAV on CE, OE unit price set directly using NAV no discount
* CE provides higher return due to higher volatility
* CE invest in wider range of assets
* Uncertainty in NAV of CE(unlisted assets)
Reasons for discounted NAV in ITC’s
- Management charges
- Concerns over marketability
- Concerns over the quality of management
- Market sentiment/fashion (out of fashion by investors)
CIS’ vs Direct Investment
6,3
Advantages:
* Specialist experience
* Diversification access larger amount of investments
* Avoid direct management costs
* Divisible holdings
* Tax advantages
* Index tracked returns
Disadvantages:
* Lose control of selected investments
* Management charges incurred
* Tax disadvantages
Derivative
2
- A financial instrument whose value is dependent on the value of another underlying asset.
- Used to control risk by hedge or speculation
Forward contract
4
- A contract to buy (or sell) an asset on an agreed basis
in the future. - Non-standardised so can be tailor made
- Can be traded Over-the-counter (no quoted price)
- Credit risk dependent on the creditworthiness of the counterparty.
Futures contract
5
- STANDARDISED contract, to buy (or sell) an asset on an agreed basis in the future.
- Exchange traded: sets terms of contract (excl price) and creates market
- Liquid market due to a high amount of identical futures
- Clearing house removes default risk by acting as counter party to every transaction.
- Initial margin paid by both parties then variation margin along duration.
More liquid than forwards
Options
5
- Gives the holder the right - but not the obligation - to buy/sell a specified asset on a specified future date.
- Call: right to buy ST>K
- Put: right to sell ST<K
- Can be exchange traded or OTC
- European vs American
Warrant
4
- Option issued by a company over its own shares. (short call)
- The holder has the right to purchase shares at a specified price at specified times in the future.
- No rights to share until maturity, protection from price changes
- Bond warrants do exist as well
Outline the main uses of derivatives
3,1
- Providing protection against the risk of adverse market movements:using futures contacts to set the price of assets in advance
- Aiming to achieve higher returns / profits through speculation
- Allowing financial institutions to alter the structures of their portfolios without needing to trade in the underlying assets
Closing out a contract:
* By taking out an equal but opposite contract. Only receive profit/loss
E.g. buy a 3-month future (the price of X will be paid) and 3 months later, just before delivery, sells identical future at price Y. Therefore the profit or loss is Y-X.
