Chapter 1 - Investment concepts Flashcards
gambling
person makes a decision/execute an activity without knowledge of the outcome
speculation
person ventures his money on an activity with the expectancy of a large return after a very short period of time.
degree of knowledge
very risky
investments
purchasing assets with the purpose of retaining it for a considerable period of time so that it can increase in value and provide a reasonable return.
Investments vs. speculation
speculation - the idea is to realise the return within a short period of time
investment- minimum time is 5 years, fair and reasonable returns a return equal to inflation rate or a return 5% to 10%
real return
return after inflation has been considered
most important reasons for investing
speculation income capital growth take-overs and mergers control over a raw material/distribution channel
capital growth
Buy house R500 000 and sell after 10 years for R5.5m (R5m capital growth). Purpose = protect purchasing power of capital. ( emphasis on individual decision making).
original investment eventually increases
income
Buy asset with aim to generate income (property – rental; shares – dividend; fixed deposit – interest)- ( long term investment objective)
Take overs and mergers
Buy a 2nd neighbouring farm – farm more effectively (eventually increase income)
raw materials and distribution channels
Set of interdependent organizations involved in the process of making a product/service available for use/consumption.
financial instruments
all assets or units of capital of any kind that are tradable
Emphasis is on tradability of the value paper (ability to transfer ownership)
real or virtual documents represent a legal agreement
financial security
type of financial instrument which can be traded on the securities exchange.
• investment as an owner in corporation (stock), or
• creditor relationship with corporation or governmental body (bond), or
• rights to ownership (option)
• Emphasis is on the guarantee function of the value paper
security
financial instrument that represents an investment as an owner in a corporation, creditor relationship
emphasis placed on the guarantee function of financial and there assets
shares
small units of ownership
share certificates - document issued by a company to its SH to serve as proof of the no. of shares owned by the purchaser.
originated due to seeking large amounts of money and limited liability
Bonds
bonds are traceable debt instruments issued by corporations and governments/ quasi-government institutions
•Loans that must be repaid on future date (maturity date)
•Fixed interest must be paid periodically to owner
•Market price dependent on fluctuations in interest rates
Gilts
debt instruments issued by state and semi0state institutions
securities exchange
is a company that creates the opportunity for potential buyers and sellers of a security to come together for trading
JSE
what is Strate and dematerialisation
trading of securities on the stock exchange through the intervention of a stockbroker
when a deal is struck the ownership of the security must be transferred and the payment must be effected
stockbroker
a regulated professional individual who buys and sells stocks and other securities for both individual and institutional clients through a securities exchange or over the counter in return for a commission fee.
Strate (pty) Ltd
South Africa’s central securities depository
Central Securities depository
an organisation tasked with keeping the records of ownership for financial instruments such as shares
dematerialisation
refers to the process where paper share certificates are replaced by electronic records
The money market
total market of all short term funds traded (short term loans, money market funds)
the surplus or shortfall of short term funds influence money market interest rates
The capital market
long term securities are bought and sold (fixed deposits, mortgages and debentures)
influences long term interest rates
Primary market
where listed companies and governments sell securities for the first time.
initial issue value = par value/ nominal value
companies act prescribes all ordinary shares after 1 May 2011, no longer have a par value and will be referred to as the average issue price of the shares
•Additional capital required – additional shares issued through a rights issue
•Prospectus – information on new issue of shares and invitation to subscribe
secondary market
once new shares have been issued and bought by investors, these investors can decide whether to keep or trade them.
the market price is determined by supply and demand
Share price
price at which share is traded
-the bid to buy price - highest price that buyers are willing to pay for the share
-offer to sell price - lowest price the sellers are willing to accept for their shares
- market price - the last traded price
these prices help identify price trends
Blue Chips
ordinary shares of companies with elite investment status
good reputation over the long term by maintaining a stable and sound profit and dividend history
as well as healthy growth prospects
portfolio
composition and totality of a persons investments (shares, bonds property, options)
diversification
based on not placing all your eggs in one basket
purchase shares from various companies
protects against risk
risk
an investor views risk as the possibility of an actual return he realises will be lower than expected
institutional investors
enterprises with large amounts of capital at their disposal which they use to purchase shares or other investments
Unit trust
pooling of money: collect small amount of savings from individuals and enterprises and use the large collected amount to purged and manage a diversified portfolio of shares and financial instruments on behalf of the small investors
Listing
the right the company obtains to trade its shares in a stock exchange after certain prerequisites are met.
Pre listing statement
must be first issued by the company - primarily a source of information about the proposed listing and not an invitation to buy additional shares
Arbitrage
product is traded on two or more markets
risk free profit made from short term price differences
buying a product on a cheaper market and selling it on a more expensive market
1. Determine whether a mispricing exists
2. Determine how to exploit the mispricing
3. Determine profit to be made
Bull market
a period of continuous price increases over the ling term
strong buying pressure (demand)
prices of most shares will increase
bear market
a period of mainly price decreases over the long term
Bull investor
purchases shares during a bull market to achieve capital gain
buys shares at a low price, keep for long term, sell at high price for profit
Bull speculator
achieve capital gain in short term
does not have the available funds to pay for purchase
Sells shares to obtain funds to pay for purchase of shares
Bear speculator
Sells shares not in his possession; hoping prices will continue to drop (short sales)
stag
makes quick profit from new listings and rights issues
shares listed for the first time MP increases stag tries to obtain shares before they are listed to sell them from a profit immediately after listing
corporate actions
mandatory or voluntary events by management that have an effect on the securities issued
A mandatory corporate action
an event initiated by the board of directors of a corporation that affects the SH
participation of SH is mandatory
E.g. dividends, capitalisation (bonus) issues, subdivisions (stock splits) and mergers
Voluntary corporate action
SH can elect to participate in the action
A response from SH is required for the corporation to process the action.
E.g. rights issues and share buy-backs
Dividends
are that portion of the profit after the payment of tax that is distributed to the SH.
retained earnings
preference and ordinary SH
Interim (after 6 months) + Final dividend = Total dividend for the year
Timeline of dividends in JSE
directors announce the dividend amount (at least 13 days before record date)
the record date - the day on which the Company closes share register; always on a Friday for mandatory corporate actions
cum dividend - Buy shares cum-dividend: including right to dividends, ends on last day to trade CD, 3 days before record date
ex dividend: One business day after end of cum-dividend until payment date
Can buy shares but is not entitled to dividends
payment date: dividends payed electronically into account
capitalisation issue (bonus share issue)
SH receive additional shares in the company for free
at current MP in a specific ratio
the purpose;
•Provide shareholders with opportunity to share in the prosperity of the company, especially if there is insufficient cash to pay dividends
•Company finance issue from distributable reserves
•Shareholder can keep or sell the shares
subdivision and share consolidation
during a stock split these shares are subdivided into 2 or more shares.
Shareholders receive more shares, but with a lower average issue value
No inflow of capital
Make shares more affordable (lower market price of shares)
Prevent hostile takeovers- Opposite: Share consolidation
Rights issue
present SH obtain the rights to purchase additional shares in the company
a) exercise the rights
b) sell the rights
c) do nothing
purpose is to obtain additional capital, Issue at price lower than market price – issue price
Exercise the rights
the SH must give notice that he or she intends to exercise the rights. Sh will have to pay for new shares but will pay discounted price.
sell the rights
the rights received by the SH have a financial value and trade on the JSE like shares. SH receive the price the rights are trading for that that time. once sold the SH no longer can exercise their rights to buy more shares at a discounted price.
Do nothing
the rights lapse after the closing date
Timeline of the rights issue
- Announcement
- Announce planned issue: Issue ratio, issue price, record date, closing date
- Cum-rights trading
- Buy shares cum-rights: including right to the new shares
- Ex-rights trading
- From day after end of cum-rights until closing date
- Exclude right to new shares
- Record date
- Company closes share register, sends Nil Paid letters of allocation (NPL) to existing shareholders
- Closing date / election deadline
- Shares allocated to applicants that gave instruction to exercise right
Share buy backs
legislation changed in 1999 to allow companies to buy back their own shares.
• Purpose:
• Accounting advantage
• Transaction can lead to increase in EPS of remaining shares (number of issued shares decrease)
• Use excess cash
companies act no.71 of 2008
- Directors do not require permission from shareholders to do buy-back, unless bought from director
- Company must be liquid and solvent after distribution (buy-back)
JSE listing requirements of share buy backs
•Limited to max 20% of issued shares at authorisation time
•No buy-backs at price exceeding weighted average of market price, 5 business days preceding buy-back by more than 10%
- the quantity and the price at which the buy backs were done must be announced every 3% that is bought back.
Savings
portion of income not spent
economic investment
use of purchasing power of capital to obtain assets to be used in the productive process
financial investment
purchasing power of capital reaches third party directly or indirectly via the financial intermediaries,
