Ch10: Equity and property markets

Question 1

SYSTEM T for equity

Answer 1

Security
* Security of dividend income will depend on the company issuing shares (stability of profits and ratio of earnings to dividends)
* Depend on nature of business (defensive or cyclical)
* If company is wound up - shareholders will receive residual assets after all creditors have been paid

Yield
* Equities generally provide a real yield over the long term - company profits tend to rise with inflation and economic growth and hence do dividends (however no guarantee)
* Equities are more risky and expected to give a higher return to compensate

Spread
* Both equity prices and dividends can be volatile
* Price determined by supply and demand
* Most important basis for buyers and sellers when deciding price is based on PV of future dividends

Term
* Equities can generally be held in perpetuity

Expenses
* Cost of dealing expenses liked to marketability - spread between buying and selling prices
* Generally greater than for bonds

Exchange rate - currency risk
* Many available in overseas markets - currency risk for invester who invests in equities denominated in one currency but who has liabilities denominated in another

Marketability
* Varies between companies
* Larger company -> greater the marketability

Tax
* Income and capital gains from quoted and un-quoted shares may be taxed differently

Question 2

Equity categorisation by industry

Answer 2

Practicality
* Investment analysts generally specialise within a particular investment sector:
* Factors affecting one company in a sector are likely to be relevant to other companies in the same sector
* Much of the information for companies in the same industry will come from a common source and presented in a similar way
* No single analyst can expect to be an expert in all areas
* Grouping of equities according to a common factor gives structure to the decision-making process - assists in portfolio classification and management

Correlation of investment performance
* Share price movements of companies within industrial groupings tend to correlate more closely with each other than with companies in other industries
* Factors affecting one company in a sector that are relevant to other companies in the same sector include:
* Resources - similar input costs
* Markets - similarly affected by changes in demand
* Structure - Similar financial structures -> similarly affected by changes in interest rates

Question 3

Prime property factors (6)

Answer 3

• Location
• Age and condition
• Quality of tenant
• Number of comparable properties available to determine the rent at rent review and for valuation purposes
• Lease structure
• Size

Question 4

SYSTEM T for direct property

Answer 4

Security
* Security of income depends on quality of tenant
* Risk of voids - where property is not let
* Obsolescence - Buildings can suffer from obsolescence and expenditure on modernisation becomes necessary otherwise suffer slowdown in relative rate of growth
* Government intervention - Rent and planning controls

Yield
* Rents increase broadly in line with inflation over long term
* Less marketable and secure -> investors require higher return from property

Spread
* Capital values on buildings can be volatile over longer term, however infrequent valuations and stable valuation methods reduce short-term volatility
* As land is indestructible - good site always likely to have some value

Term
* Leases are for fixed terms with relatively infrequent rent reviews

Expenses
* Property management costs are high, tenant may be responsible for building maintenance and insurance

Marketability
* Very unmarketable - long time to buy or sell and dealing costs are high
* Because of:
* Unit size - in general indivisible
* Uniqueness
* Valuation - matter of professional judgement, no central market with quoted prices; lack of information and variability in valuations

Question 5

Disadvantages of direct property (5)

Answer 5

• Size - too big to afford for many
• Diversification - many properties needed; impractical for small investor
• Lack of marketability
• Valuation of property values never known until sale - estimates can be expensive
• Expertise needed - much of profit to be made comes through detailed local knowledge