CH9 - Equity and property markets

Question 1

Investment and risk characteristics of equities (7)

Answer 1

An ordinary share is a share in the ownership of a company.

Characteristics include:

1. security depends on the profitability of the company
2. provides a long-term real yield (i.e. the return tends to move in line with inflation)
3. higher expected returns than government bonds over the long term
4. income (dividends) and capital values (prices) can be volatile
5. equities can generally be held in perpetuity
6. dealing expenses are linked to marketability
7. marketability depends on the size of the company

Question 2

Characteristics of quoted shares (3)

Answer 2

Quoted shares are listed on the stock exchange and make up the majority of available equity investment. Quoted shares are generally:
- more marketable
- more secure
- easier to value
than non-quoted shares

Question 3

Why use industry groupings to categorise shares? (2)

Answer 3

Shares are grouped by industry sectors because:

1. it is practical for analysts to specialise in one area
2. the share prices of companies in the same sector tend to be correlated.

Question 4

Reasons of why it is practical for investment analysts to specialise in one area (4)

Answer 4

1. the factors affecting one company within an industry are likely to be relevant to other companies in the same industry
2. much of the information for companies in the same industry will come from a common source and will be presented in a similar way
3. no one analyst can expect to be an expert in all areas, so specialisation is appropriate
4. the grouping of equities according to some common factor gives structure to the decision-making process. It assists in portfolio classification and management.

Question 5

Reasons of why share prices of companies in the same sector are correlated

Answer 5

Share prices of companies in the same sector are correlated because such companies:

1. use the same resources and so have similar input costs
2. supply to the same markets and so are similarly affected by changes in demand
3. have similar financial structures, and so are similarly affected by changes in interest rates.

Question 6

A prime property will score highly on all of the following factors (6)CALL ST

Answer 6

1. location
2. age and condition
3. quality of tenant
4. the number of comparable properties
5. lease structure
6. size

Question 7

Investment and risk characteristics of property (16)

Answer 7

1. void and default risk
2. obsolescence, deterioration and refurbishment costs
3. susceptible to political risk
4. long-term real returns (i.e. move in line with inflation)
5. expected return higher than that on index-linked government bonds
6. stepped income stream
7. running yield varies with the type of property
8. can provide high utility (feel good factor) to the investor
9. long-term volatility of capital values but short-term stability due to infrequent valuations
10. high dealing and management costs
11. possibility for investment characteristics to be changed by the investor, e.g redevelopment
12. unmarketable
13. large unit size
14. indivisibility
15. uniqueness
16. subjective valuations

Question 8

Freeholder vs leaseholder

Answer 8

The freeholder of property is the absolute owner of it in perpetuity. The freeholder can let the property to a third party (a leaseholder) in return for an annual ground rent.
Compared with freehold investment, a leasehold is shorter-term and provides a higher initial rental yield and a capital loss if the lease is held to the termination date.

Question 9

Indirect property investments

Answer 9

Indirect property investments in pooled property funds and property share companies may also be available. They help overcome some of the key problems with direct property investment (e.g. lack of marketability and large indivisible units). However, they are not without their own problems.

Question 10

Key issues to consider when comparing direct and indirect property investments (8)

Answer 10

1. control
2. discount to NAV
3. diversification
4. divisibility
5. expenses
6. expertise
7. marketability
8. valuation