Ch 4 - Specialist Asset Classes (2) Flashcards

1
Q

Securitisation

A

Issue of securities, usually bonds, where the bonds are serviced and repaid exclusively out of a defined element of future cashflow owned by the issuer

Therefore converts a portfolio of often unmarketable assets into a structured financial instrument which is then negotiable

The key requirement for an asset to be used as the basis of a securitisation is that it generates a reasonably predictable income stream

The bondholders have no claim on any other cashflows or assets of the issuer (due to SPV)

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2
Q

Classes of Securitised Assets:

A
MBS
CCABS
CLS
CLO
CDO
Insurance securitisations
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3
Q

Risks with securitisation

A

Prepayment risk

Credit risk

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4
Q

SPV

A

Original owner of the assets sells those assets that are to be the basis of the securitisation to a corporate entity called a SPV

SPV raises funds to purchase the assets by issuing debt securities (ABS) to investors

The cashflows received on the secured assets (the receivables) are transferred into the SPV and used to meet the principle and interest payments on the debt

SPV is a separate legal entity – usually a company in its own right

SPV structured to be “bankruptcy remote” in the vent of the failure of the borrower (or in event of default of SPV)

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5
Q

Structure of CLOs, CBOs and CDOs + 2 advantages

A

Pool of securitised assets are used to back several different tranches of ABS

Cashflows from the portfolio are divided up into tranches and assigned to the different new securities created

Thus the cashflows from the underlying portfolio might be used to create:

  • Bond with a fixed coupon. Most senior security and its coupons are paid first. It is termed senior debt and might carry a AAA rating
  • Bond whose coupons are paid as long as there is enough left after the payments to the senior debt is made. BB rating. Known as the mezzanine piece or tranche
  • Claim on the residual cashflows.

Thus new securities have different credit risk features by construction and appeal to a wider range of investors

This could thus reduce the overall cost of borrowing

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6
Q

Private Equity

A

Is investment in unquoted companies that are not listed on a stock exchange (thus, there is no immediate exit route via the secondary market )

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7
Q

Forms of Private Equity

A
Venture capital
Leveraged buy-outs
-management buy-outs
-management buy-ins
Development capital
Restructuring capital
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8
Q

Advantages of taking a Public Company into Private Ownership (5)

A

Fewer regulatory restrictions

Closer relationship with small number of sophisticated investors who may provide management input

Incurs lower costs (less reporting for example)

Lack of a quoted market share price - management takes a longer-term view

Possibly may be able to reduce cost of capital under private ownership

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9
Q

Advantages of Private Equity (as an asset class)

A

Out-perform

Loosely correlated asset - diversification

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10
Q

Disadvantages of PE to II

A

VRRIL CEP

Valuation can be difficult
Regulatory constraints
Risk = high
Information = lack of reliable info
Liquidity = lack of
Costs = high
Expertise = needed
Performance = past record is variable and is impacted by survivorship bias
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11
Q

Ways to invest in PE

A

Directly by purchasing shares in private companies

Pay a private equity firm to invest for you

Invest in a private equity collective vehicle – investment trust

Invest in a fund-of-funds

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12
Q

Cashflows of a PE fund

A

Prior to the fund launch there will be a 3 to 6-month initial fund raising

Initial/first closing date

Final closing date

Investment period

Typical investment is held for 3-5 years

End of funds life - distribution/extension/etc of fund

Annual fee

Performance bonus/carried interest/carry/profit share

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13
Q

Hedge fund definition

A

Investment fund that aims to meet high or absolute returns by investing across a number of asset classes or financial instruments.

It is a type of collective investment vehicle.

Aren’t restricted to a long-only, non-leveraged investment strategy and thus typically have less restrictions on:

  • Borrowing
  • Short-selling
  • Derivatives
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14
Q

General features of hedge funds (in addition to 3 obvious ones)

A

FFML RLS

Freedom
Fees for performance
Minimum investment amount = high
Limits on total size of fund

Risk tolerance is higher
Lock-up periods
Strategies are best executed with relatively small amounts

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15
Q

Classes of Hedge Funds

A

Global tactical asset allocation funds
Event-driven funds
Market-neutral funds
Multi-strategy funds

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16
Q

Global tactical asset allocation funds

A

Concentrate on economic changes around the world and sometimes make extensive use of leverage and derivatives

Therefore will be a combination of short and long positions that reflect the manager’s views on how macroeconomic factors such as levels of international asset markets, interest rates and currencies will move

17
Q

Event-driven funds

A

These trade securities of companies in reorganisation and/or bankruptcy (“distressed” securities)

Or companies involved in merger or acquisition (risk arbitrage)

18
Q

Market-neutral funds

A

Designed to be market-neutral (beta or currency)

  • long portfolio beta is equal to short portfolio beta
  • thus performance of the fund is not affected by general market movements
  • just focus on stock selection profits by exploiting market inefficiencies
19
Q

Multi-strategy funds

A

Invest in a range of investment strategies to provide a level of diversification and help smooth returns

E.g. Might short-sell equities, invest in more property, whilst simultaneously focusing on event driven strategies for its property portfolio

20
Q

Past performance of hedge funds can be affected by 3 types of biases:

A

Survivorship Bias
Selection Bias
Marking to Market Bias

21
Q

Other problems when looking at past performance (returns) of hedge funds:

A

Practical problems (lack of data/too short a time period)
Returns that are negatively skewed
- thus sharpe ration (which uses standard deviation) will be biased upwards

22
Q

2 types of infrastructure

A

Social

Economic

23
Q

Characteristics of infrastructure

A

High development costs (high barrier to entry)

Long lives

Non-recourse (or limited) financial structure

Single purpose in nature (assets)

Natural monopolies (usually)

Private investor’s participation in the asset is often finite

24
Q

Risks of infrastructure investment can be divided into:

A

Asset specific risks

  • Market/economic risk
  • Regulatory and Political Risk
  • Operating Risk

Broader risks

  • Interest rate risk
  • Foreign exchange risk
25
Q

How to invest in Infrastructure

A

Be very rich

Invest directly in a company whose sole purpose is an infrastructure project

Invest in a unit trust

Invest in shares of a company that heavily invests in infrastructure

Form a syndicate to fund the investment

26
Q

Benefits of Commodity Investment (5)

A

Real returns
Diversification
-counter-cyclical
Level of predictability to returns - returns have been based on real underlying economics
Supply squeeze - should see rising prices in future
Commodities are concerned with short-term supply and demand and short-term risk

27
Q

Arguments against Commodity investment

A

No strong historical evidence for a real return from commodities

Markets are volatile

High level of specialist expertise required to trade profitably

28
Q

Insurance-linked securities

A

Securities whose return depends on the occurrence of a specific insurance event, which can either be related to non-life (cat bonds) or life risks

29
Q

Why would the banking and capital markets be prepared to buy a cat bond (or ILS)?

A

Diversify portfolio

Capital markets may have the capacity to accept the risk

May perceive the return to be adequate compensation for the risk

-but beware! need expertise to understand the underlying risks and structure can be complex

30
Q

Advantages of transferring risk through an ILS

A
Available when reinsurance is not 
Cheaper
Effective 
Tax advantages
"Taylormade" solution
Can reduce capital requirements
Accelerated profit emergence (depends on structure)
31
Q

A typical structured product will consist of two components:

A

A Note
+
Derivate component

32
Q

Advantages of structured products

A

RAT PAL

Return/risk profile is favourable
Accounting
Tax

Practical (i.e. not allowed to trade derivatives by themselves, and costs may be less through this product)
Active intervention = not required by investor (saves time and costs)
Legal

33
Q

Risks of structured products

A

CC TALL

Counterparty risk
Complexity

Tax
Accounting
Legal
Liquidity risk

34
Q

Index Funds:

A

Is an ‘open-ended’ unitised collective investment scheme that attempt to mimic the performance of a particular index

35
Q

Advantages of index funds include (4):

A

Low expertise
Low dealing costs
Simplicity
No “style drift”

36
Q

Disadvantages of index funds include:

A

Tracking error

No outperformance

Reduced return due to index changes

37
Q

Differences between ETFs and Unit Trusts and Investment Trusts:

A

Costs (annual fees)

  • Lower fund management fees (or annual management fees) than the other two (usually)
  • Because they are usually tracker funds, which can be run very cheaply

Costs (commission)

  • ETFs incur commissions and stock exchange trading fees, similar to an investment trust
  • No bid/offer spreads set by the managing company, as is the case for unit trusts

Tradability

  • Traded like shares
  • Whereas unit trusts, the manager will generally trade only once a day

Diversification

38
Q

Contracts For Difference:

A

Is a contract stipulating that the seller will pay (if negative difference then receive) to the buyer the difference between the current value of an asset and its value at contract time

39
Q

Risks of CFDs:

A

Counterparty risk

Market risk

Liquidity risk