Chaper 1 Flashcards
Reasons for holding cash deposits
Liquidity, security and low level of risk
Interest rates
Usually paid as a percentage of capital in the account, usually receiving better rates for higher amounts and longer deposits.
This isn’t always true as sometimes long deposits have less interest if banks believe the market will fall.
Gross and net interest rates
Gross = the contractual rate of interest paid before tax is factored in. This is what is used to calculate their tax liability.
Net = this is what the saver will receive after the effect of income tax. The rate depends on their tax status/ rate.
Compounding interest
This is where interest is earns on interest ie compounding the return. Savers should then consider if interest is paid more frequently does the actual compounded interest rate equal more in comparison to less frequent interest payments.
Compounded interest calculation (Terminal wealth generated)
Capital x (1 + (annual rate / number of payments per year))
AER
Annual equivalent rate, used to compare accounts and is always gross.
Real returns.
This can measure the rate of return on a cash deposit by comparing a nominal interest rate with the expected future rate of inflation. Calculation:
Real rate of return = nominal rate - rate of inflation
Requirement linked accounts
These are simply bank accounts that offer higher interest if certain conditions are meant usually meaning a certain balance is held elsewhere of a certain amount is deposited into a current account a month.
Risk of deposits
Default risk = if the bank fails
Inflation/ deflation risk = if inflation goes to high then real return is negative.
Interest rate risk = risk that rate is lower than other similar products savers could access.
Operational risk = the deposit taker has bad services.
Cost charges and penalties
Charges deposit takers usually charge:
Overdraft charges
ATM charges
Fx fees
Regulation
PRA & FCA.
PRA = two focuses promote safety and soundness of industry and get degree of protection for savers, inventions and policy holders.
Statutory protection
Savers can determine a deposit takers safety by researching their credit rating. These are done by independent bodies that monitor big firms and rate them.
FSCS
85k per person per account ie joint = 170k deposits up to 1m that have only just been deposited also covered.
Main types of deposit accounts
Current
Instant access
Notice
Fixed term
Fixed rate
Money market.
NS&I
The governments department which is an executive agency of the chancellor, offer deposit taking feature 100% backed by the government. Also all products are exempt form CGT
Money market funds
These are a collective investment fund that invest in cash assets ie short term bank deposits or near cash assets. Bonds or commercial papers.
Main type of money market funds
Constant net asset value = the maintain an stable net asset value (NAV) regardless of market conditions
Accumulating net assets value = roll up funds they operate the same as above but the income is daily. Income isn’t distributed but reflects in the funds value.
Low volatility net asset value = same as top but with slight movement 0.2% each way.
Variable net asset value = market to market to value assets and ANV will change.
Braking the buck
This is where a MM Fund will fall below the NAV IE £1
Money markets liquidity
They are consider very liquid as the spas sets are cash based or short term t-bills or company papers.
Money market comparison
MM are given credit ratings just like deposit takers and saver should compare returns alongside with safety/ credit rating.
MM portfolio construction
This is the most complex part of comparing funds as you have to judge protection based of constructions and how sensitive or not it is to the market.
Fund management
The comparison process also includes looking at a funds management operations, looking at front, middle and back offices
Key areas include: experience, objectives, techniques and risk aversion stratergies
Post rating inspection
Funds must supply portfolio fund values portfolio details for constant fund surveillance.
Benchmarks for money market funds
MM Funds use different benchmarks to compare performance. Including:
(SONIA) = sterling overnight index average.
(€STR) = Europe’s short term rate.
(SOFR) = Secured overnight rate
(SARON) = Secured overnight financing rate
(TONAR) = Tokyo overnight average rate
Cost charges and penalties of MM
Investor will need to pay the expenses of the fund. Some of these can reduce the NAV the investor receives.
These costs can be splits into loads and expense ratios:
Loads = a front end load that may be charged when in Italy investing. Or a back end charge (differed sales charge) is levied when the money is finally redeemed out of the fund.
Expense = annual operating expense for using the fund and I lived against the growth of the funds.
P2P lending
= peer to peer lending.
Began in 2005 this is where people receive lending but not from financial institutes but groups or individuals investors.
P2P risks
The main risk is for a person to default on there payments, however usually interdimeries underbite each borrow to gage risk for the lender.
Another is is liquidity for the lender.
P2P returns and taxation
Interest is taxed the same as with bank accounts however there is a P2P isa that can be used.
Fixed income securities
General feature = also know as debt securities these can be gilts, T-bills or commercial papers. The name comes from as the issues isssues debt for a fixed income/ return later down the line.
Fixed income securities - investment grade and high yield
High credit rating bonds are worthy of investment grade classification
High yield = regarded below investment grade as the issues credit rating is below BBB meaning they trade at lower prices and offer higher coupons.
Nominal value (NV)
All bonds are issues with a nominal value ie £100 for uk bonds which is what they will be Baugh back for/ investors will be paid at their maturity.
Bond price
This is what you pay for at the time of purchase for the bond. Clean price excludes the incurred interest and is what is quoted to investors however the dirty price includes the incurred interest.
Time for a classification for bonds
Under 5 years = shorts
5-15 years = medium term
15 + = longs
Double dated bonds
Gives issuers the option to extend term or pay on the first date.
Coupon of bonds/ gilts
The coupon is the amount of interest that an investor will receive each year on the nominal value.
Frequency is typically quarterly or six. Monthly
Coupons are considered savings income and falls within an individuals personal allowance.
Floating- rate notes (FRN)
Fluctuations in relation to interest and bonds called the floating rate. They are usually tied to a short term market rate. And hence are adjusted regularly. The coupon on these consist of two main parts:
The reference index rate
A quoted margin.
Inflation linked bonds
Fluctuations tied to specific measures of inflation. The interest and capital repayment rely on the inflation and vary in accordance with this. Meaning that they provide a degree in protection.
Zero coupon bonds
Where there is no coupons and investors simply make their money back at maturity date. These are taxed on income as well as capital as tax authorities deem there to be a notional income gain.
Who issues Government bonds and what does this form
In the uk the DMO issues bonds on behalf of the treasury (GILTS) this money forms parts of the governments public sector net cash requirement (PSNCR)
Uk local authority bonds
Corporation stocks issued by local authorities. And secured against the assets of the issuer. They are divided into two categories:
Local authority fixed stocked = fixed rate investments which once bought cannot be traded again and must be held until maturity.
Local authority negotiable loans = life no longer than 2 years and marketed at par.
Corbin government bonds
T- notes US and Cananda
T-bills US
Germany = bearer bonds
Cooperate bonds
Issues by companies that can be backed by security but not always. CGT is not applicable.
Cooperate bonds, either debentures or convertibles
Debentures = are backed by security
Convertible = is a bond which is converted later either into another type of bond or into stock ie equity and the difference between the equity price and market price is the premium.
Permanent interest baring shares. (PIBS)
Issued by building societies with the following feature:
Interest is paid gross at a fixed rate
Provides no obligation to the issuer to pay interest if under financial pressure. If interest rate rises then the trading price will fall
No CGT
Traded on the stock market
Family liquid.
Convertible loan stocks/ bonds
For much of their lives they are ordinary loan stocks but can be converted into shares at a later date. Featuring:
Fixed interest
Provides holder right to convert
Conversion rights are pre agreed.
Set date for conversion
Why are they issued:
Very attractive to investors because they combine certainty of income and growth.
Better chance of raising the capital
Lesser net cost for the company.
Contingent convertibles (CoCos)
This is a debt instrument that is set to convert to equity when a specific event occurring. Ie financing issues meaning debt can’t be serviced.
Supranational bonds
These are entities formed by multiple countries to promote economic development for the members.
Asset backed securities (ABS)
This is where the coupon of the bond is backed by some security, they mean that usually non-tradable assets can be brought tougher and traded on.
Sukuk
Bond like instruments that comply with shariah law.
ESG
Ethical social and governance
Green bonds
Funds raised are specifically for green projects benefiting the environment
Blue bonds
Similar to green bonds but focus on the sea and marine based projects
Investment return in debt securities
Yield refers to the returns investors make on a particular investment. Income yield is annualised.
Yield is quoted gross or net of tax.
The two main influences on yield for a bond is the interest rate and time till maturity.
Running yield calculation
Also known as the interest yield on a band expresses the income received on it as a percentage of the investors outlay.
Running yeild% = gross coupon/ market price.
Capital returns and holding period return calculation?
Above par at purchase = capital loss and visa eras.
Thus we can use holding period return (HPR) to calculate the total return from the holding.
= price received at maturity - price purchased/ price purchased.
Annualised capital gain or loss. Calculation
From the HPR we can calculate = holding period return/ number of years until maturity.
What is the Gross redemption yield (GRY) and it’s made up of
This assumes the investor will hold the bond until maturity. This then uses the coupon, bond price and maturity to calculate the GRY but in two parts.
Interest yield and capital appreciation.
Annualised return from capital growth or loss formula
Holding period return/ number of years to maturity
Tax paying structure (bands)
Basic rate = 20%
Higher = 40%
Additional rate = 45%
What causes Bond volatility in price
There is an invert relationship between bond price and their yield.
Greater price volatility can be expected:
Bonds - of lower credit worthy
Low coupon bonds
Longer dated bonds
What factors should be considered when investing in bonds
Before investing investors need to consider influences that can effect prices of bonds:
Currency interest
FX rates
Credit rating of issuer
Economic factors
Coupon redemption date
How interesting effects bonds
Coupon can become less attractive with rates increasing and other options are better.
Bond price falls as interest rates increase.
What errors Bonds real returns
Real return can be eroded by inflation.
Bond risks for investors
Liquidity
Issuer risk
Credit risk
Credit enchantments (third parties arranging the issue of debt)
Dealing in debt securities primary and secondary market
A new bond can be issues in multiple ways:
Offer for sale - a syndicate will buy a bloc of the bonds from issuer. Then sell to investors.
Fixed price re-offering - when syndicates and lead managers agree to sell at same price.
Competing auction
Private place
Government bonds
Can be bought using a broker at best price or at limit
Government bonds bought directly form the government
To deal you must:
Become a approved investor
Complete relivant forms
Send payment with the dealing form.
Gilts at auction and types of bids
Competitive bids & non- competitive bids
Retail and wholesale bonds market
Wholesale is much bigger
Retail are usually offered through intermediary.
Bond indices and its issues
A bond index composites listing of bonds to provide statistics used for comparison however it is quite heard because:
Bond market very big
Issuance weighted indices
Bonds have clauses.
New bonds change the indices.
Types of indices and their focuses
There are two types mainly:
Income focused or capital focused.
Weighting of bond indexes
Most bond indexes are weighted by total issuance value.
Additional calculations for bond indexes
Average coupon
Average gross redemtion
Average time to maturity
Average duration
Average convexity
Selecting bond funds based on its benefits
Bond funds can be done either directly or indirectly depending if you purchase yourself or through a fund manager. These bond funds provide greater liquidity and their fund is pooled together to access a variety of bonds.
Bond strategy (active)
Duration switching
Riding the yield curve
Bond switching
Bond strategy (passive)
Cash flow matching
Laddering
Bullet portfolio
Social bonds
The proceeds are for eligible projects ie housing
Sustainability bonds
Used for green and social projects
Sustainability linked bonds (SLB)
Definition - any type of bond instrument where the issuer must achieve a predefined social/ ESG GOAL.
Social impact bonds
Financing raising projects aimed at achieving social goals? They are focused on the social goal not investor returns meaning payouts only usually occur when the goals are hit.
What are equities
Companies issues these to raise capital through either ordinary shares or loan stocks (bonds)
Ordinary shares = have a nominal a value
Common shares dont have a nominal value
Differ at types of shares
Ordinary = people who have these own part of the company and their value is a part of the financial accounts for that company.
They provide capital growth and income in the form dividend if applicable to that company.
Ordinary shares can have different class systems to distinguish their owners rights.
Redeemable shares
This is part of a company repurchasing shares back form the market or it can retire the shares. Redeemable shares come with an agreement to buy them back at an event or date.
Dual-classed shares
This is where a share is both class a and b
Differed dividend shares
They have voting rights but there right to dividend is delayed until specific condition are met.
Preference shares
These have elevated preference and rights over ordinary shares when it comes to payments and payment of capital.
They usually have increased prices though to reflect the security.
Private equity
This provides the capital to invest into unquoted companies. Two main parts of the market = venture capital and development capital/ buyouts. Leveraged buyouts are the most common tactic.
Leveraged buy out (LBO)
This is where the financial sponsor agrees to acquiring a business without committing all the capital requirements and will raise the funds using cash flow to fund.
Venture capital
Investment in les mature companies to help grow them. Usually in new tech.
Growth capital
Referees to equity investment in mature companies but in a minority share enabling the company to expand using the capital received.
Distressed investments
Investment into financially stressed companies
Mezzanine capital
Buying the most junior part of a companies capital but still more senior to the companies common equity. Used by Smaller companies.
Ie bridging finance
Investment risk and shares
Liquidity
Credit rating
Returns may not grow in capital or income.
Cooperate actions and there impacts
This is the term for action companies can take to effect their holdings positively or negatively ie capitalisation, share splits and rights issues.
Bonus/script/ capitalisation issues
Sometimes companies want to increase share count but not raise capital so they will issues new shares to existing holders.
They do this to make their financial statement simpler/ cleaner. It can also increase marketability of shares as they are valued at less. This is a bonus issue.
Bonus issues are positives news.
Share splits (stock splits)
Reduces nominal value per share without altering overall nominal value of holding.
Rights issues
This is when a company needs to raise more capital once it is up and running. Rights issues give pre-standing investors the opportunity to invest more money into the company. By buying more shares. The share holds are right to do this second subscription to avoid their holding be diluted but they don’t have to accept the right given to them.
Dividend right will be the same, initial will be sold cheaper.
Liquidation
Business ceases trading either voluntarily or involuntarily
Factors effecting share price
Performance of the company
Supply and demand, which is effected by:
Financial results
Stockbroker opinion
Rumours
Political environment
Levels of disposable income
Share dealing
Discretionary services - a broker of fund manager will purchase shares on behalf of the investors.
Non-discretionary - advice is given but the call ultimately remains with the investor
XO is where the client is completely investing on there own, no input is given.
Market makers vs brokers
Brokers act as their clients agent and place deals with market makers
Market makers are a type of stock exchange member firm. They offer the buy and sell prices to brokers.
Nominal value and market price for shares
Nominal This is the price at which the shares are issued and is calculated against how much capital is needed.
Market price is what they trade for on the secondary markets.
Market capitalisation
Number of shares x the price of the shares.
Fair value calculation and theroy Gordon growth model
One way of calculating fair value for a share is the Gordon growth model
Share price = dividend / (return required - dividend growth)
Different dates concerning dividence
Dividend have many different dates asscitoted with them ie:
Declaration date = the date the company directors announce if dividend will be paid
Ex-dividend date = this is the date investors must have purchased the stock to receive dividend.
Record date = the date owners must have registered their ownership to be compensated
Payment date
Equity indices
These typically include large companies without regard for where they are domiciled ie ftse 100 of global S&P index.
Measuring the performance of shares
Can be done with investor rations profitability ratios, gearing ratios and liquidity ratios
Investors ratios
This tells investors what the return can be for their investment.
Dividend yield
This is a comparison tool showing the dividend paid in respect of the preceding financial year as a gross percentage
Gross dividend yield = gross dividend paid in year/ current market price of share
Earning per share (EPS) and earning yield
This shows growth separate to dividend if the company doesn’t pay it it can show strength still. It shows the amount of profit allocated to each share.
EPS = Profit attributed to ordinary shareholders/ number of ordinary shares.
Earning yield calculation (earning of each share in relation to the price of that share)
Earnings per share / market price of share
PRICE to EARNINGS ratio (calculation)
Current market price of share / EPS
P/E ratio usefulness
Relevance - more relevant information
Comparison - comparing similar companies is easier
Risk - shows how Ricky the market thinks the business is.
PEG ratio
Can be used to cover the issues with just using P/E ratios
PEG = PE ration / EPS growth rate
Dividend cover calcultation
EPS / dividend per share
Cover above x2 is considered good.
Price of shares to cash flow of shares ratio calculation
This measures the expectations on a companies financial health
(P/CF) ration = current market price of share/ operating cash flow per share
Net asset value
NAV = assets - liabilities
NAV per share = assets - liabilities / number of shares in issue.
Enterprise value (EV)
This measures what the market believes the ongoing companies operations are worth and is equivalent to the market cap plus debt
EV = market cap + debt - cash - cash equivalent
Profitability ratios return on equity ROE calculation
Return on equity (ROE)
Roe = profit after tax and preference dividends/ capital and reserves
Return on capital employed (ROCE)
This is a better comparison the ROE due to the company structuring effecting roe
ROCE % = profit before interest and tax/ capital employed
Capital employed calculations
Equity + non current liabilities
Or
Total assets + current liabilities
Gearing rations
This is the proportion of a companies long term debt relative to the equity
Gearing % calculation
Long term liabilities/ capital employed
Or
Earnings before interest and tax/ interest payable
Working capital ratio (current)
The purpose of this is to determine current assets recoverable in one year. And make sure they are sufficient to cover liabilities.
= current assets/ current liabilities
Quick (acid test) ratio solves problem with current ratio
This issues in using current ratio is that it includes stock which don’t always sell quickly in practise.
The quick test only measures assets that can be sold quickly.
= current assets - inventory/ current liabilities.
Past performances
Investors will always consider past performances despite warning. However investors should also consider:
Performance of market as a whole
The shares total return
The volatility of the share.
Selecting equities and equity funds
To select appropriate fund investors should consider their requirements in terms of income, capital growth and tolerance to risk and the attitude of the fund manager. Also should be noted if they want a passive fund or an active fund.
Equity funds strategy
Active management usually sees the best returns and these funds can be constructed in one of two ways:
Top down = involves considering the overall economic environment and base allocation based on sector performance.
Bottom up = involves first selecting specific stocks not just the sector they pick to stock not the industry.
Equity diversification
Geographical
Market sectors
Market cap differences
Growth and dividend prospects - investors should consider.
This is how investors can judge likely hood of dividend. Historic rate of growth & dividend payout ratio.
Costs of investment funds for investors
Initial charge
Annual management charge
Ongoing charge
Performance charge
Exit charge
Unquoted charge
Portfolio turnover
This refers to the rate at which equities are sold within a portfolio this can affect the overall performance.
The reason for listing equities
Raise capital
Place value on a firm
To create market in a company shares
To allow the company to acquire other companies
To enhance creditability
Deffierance between listed, admission to trading & quoted
Listed = the company shares meets requirements to be traded on a certain stock market.
Admission to trade = mean three are admitted to trade on a stock market without having to follow all listing procedures.
Quoted means they are actually availed for trading.
official markets vs open market
Regulated by public law and companies listed on them.
Open market is easier to be listed on.
Dark pools
This is where traders can run large orders without running the risks others will see their activity. Meaning the market can less likely affect your price.
Agency and principle dealing
Agent buys on behalf of someone. They do not own the stock themselves.
Principle means purchasing for themselves and actually owning it.
Unquoted shares
Shares that are not traded on any stock exchange.
Property and the types of it
Residential, commercial and agricultural.
This is a way investors can diversify their portfolios. Physical assets can also hedge against inflation.
GDPeffect on property
The gdp cycle can affect property and its value, performance.
Best scenario - low inflation and high growth
Worst scenario- high inflation and low growth
Beneficial scenario- high gdp growth.
Characteristics for different properties
Residential - buy 2 lets through leveraged purchases.
Commercial - retail, office, industrial are the main types of space. The value of the property is usually calculated in multiples of yearly income.
Agricultural - land or pasture as well as the buildings.
Key risks for property
Capital is locked away
Not being able to find tenants
Bad tenants
Maintenance cost
Loss of capital in terms of market prices fall
Ownership structures for properties in the uk
Freehold
Leasehold
Rental yield calculation
Rental yield % = gross rent - exspenses/ cost of property (including purchase price)
Tax treatment for rental income
B2L is different to holiday let’s
Expenses can be deducted from profit from rentals
Very low rental income under rent a room schemes are tax free up to 7.5K pa
Commercial rent
Is classed as business income
Factors to consider when letting
Quality of tenants
Void periods
Capital returns
Property costs
Transaction costs - agent and legal fees.
Stamp duty levied tax (SDLT)
Stamp duty
0% up to 250k
5% for the next 675k
10% for the next 575k
15% for whatever is above 1.5m
Management costs
Letting agents will usually charge 10-20% the gross income.
Conveyancing
The legal process where buy and seller solicitors will arranging the paperwork and exchange contracts to eventually complete the purchase. Once you have exchanged then you cannot go back.
Association of real estate funds code of practice
AREF = is a quality mark for property funds that are achieving high standards.
Cash flow and average yield
Initial herald can be used to measure a value for a property
Current annual rent/ value of property, inc price.
Capatlisation rate of income producing properties
This is used to estimate the value of income producing properties.
Net operating income/ sales price or value of property
Retail reviews of leases
In commercial properties it is USA,my agreed at certain points the rent will be reviewed to see if it need increasing to keep it in line with the market.
Indirect property investment
Collective investment schemes offer investors exposure to a variety of asset classes including property.
This can be done property company shares, these are listed on stock exchanges and can be focused on property development or simply running a portfolio.
Property authorised investment trust (PAIF)
These funds invest primarily in in property and have a special tax treatment.
In order to qualify as a PAIF:
Fund has to be structure as open ended investment company
60% of fund is property
60% of value must be from property
The funds shares must be equally shared no one major owner.
Real estate investment trusts (REITS)
The trusts must have 100 share holders and they must be transferable and 75% of the assets must be in real estate.
Reasons for investing in property funds
Diversification
Professional management
Liquidity
Pricing and fair value for commercial property is harder because
In commercial property value is usually decided by players in the market and is less regulated/ regid.
ESG in property
Developers can focus on ESG factors to make the property more desirable to people and some GOV regs mean they have to especially following on from COP26
Market trends effecting property
COVID affected commercial property massively. Also people view residential property differently now that there is much more hybrid working.
Other assets
Art
Cars
Precious metals
Features of other assets
Less reliant on market trends
Difficult to value
Don’t correlate to traditional return
Come with low liquidity
Less regulated
Fees are usually higher
Two types of Commodities
Hard = relate to materials and require substantial capital outlay and finite recourses.
Soft = these are agricultural products including wood and cotton and can be renewable.
Ways to invest in gold
Tangible coins and bars
Certificates
Mutual funds
Stock in mining comapnaies
Gold and metal features
Cryptocurrencies and non-fungible tokens (NFT)
Cryptocurrencies:
These are virtual currencies not managed by a central government you can purchase these by:
Purchasing them
Earning them through companies that pay in crypto
Mining them through solving the math anti cal problems to find them.
Cryptocurrencies risks
Viotility
Decentralised
Unregulated
Not reserve backed
Human error, glitches and crime are higher.
NFTs
Digital collector items/ tokens in blockchain and they cannot be replaced by something else. They also usually include a physical perk with them that only the usurer can access.
Risks:
Similar to crypto
Seller may not own the rights to the nft
Not regulated
Aloe is hard to calculate
No legal definition.
