Chapter 10 (4marks) - clearing and settlement

Question 1

Difference between Clearing & Settlement is the process of formally agreeing the obligations on each party to a transaction, and settlement is the process of transferring ownership of securities from the seller to the buyer, and transferring cash from the buyer to the seller

Answer 1

Clearing = the process of formally agreeing the obligations on each party to a transaction,

settlement = the process of transferring ownership of securities from the seller to the buyer, and transferring cash from the buyer to the seller. Settlement in the UK is done via CREST.

Question 1

So far, we have looked at how securities are first issued in the primary market and then subsequently traded in the secondary markets. This next chapter will cover how the clearing and settlement process works i.e. when and how we pay for the securities that we have bought and the different ways in which they can be held, in both the UK and international markets.

Question 2

10.1: Clearing and Settlement

Question 3

When shares and bonds are issued, they can be either registered or bearer securities.

Answer 3

registered =
The investor’s name appears on the share register.
Share certificates may be issued with the shareholder’s name on.
Uncertificated holdings will have no physical certificate.
Ownership is transferred by updating the electronic records held at the central securities depository and the share register.

Bearer =
The owner of the shares is whoever holds the certificate.
Ownership is transferred by passing the certificate to the new owner.
If the share certificate is lost, so is your investment.
Think of them like a £10 note. Whilst you’ve got it, it’s yours!

Bearer shares are very rare these days. Most have been converted to registered shares, due to the rise of their use in money laundering activities and the massive risk of losing the physical certificates.

Question 4

Nominee accounts

Firms will establish a nominee company for the purpose of holding and administering client’s assets. The nominee is the legal owner of the assets which they hold in safekeeping on behalf of their clients who are the beneficial owners.

There are two different types of nominee accounts: pooled or omnibus accounts, or designated accounts.

omnibus accounts =
designated accounts =

Answer 4

Omnibus accounts = Individual clients are pooled together and held in one nominee account,

Advantage = Client orders can be aggregated and only one transaction needs to be settled for many clients.
Disadvantage = if the nominee defaults, then investors only have claim to the pool of assets and could be affected by any shortfall.

Designated account = The nominee has unique account names for each client e.g. ABC Nominees Account 1, Account 2 and so on.
Advantages = Easy to identify the beneficial owners
Easier to see who holds what in the event of the nominee defaulting.

Disadvantages = administratively it is more cumbersome for the investment firm.

Question 5

10.1.2: Clearing and Settlement process

There are three stages, known collectively as clearing and settlement:

Confirmation
Clearing
Settlement

Tell me about each

Question 6

GILTS settle on a T+1 basis

Corporate bonds & equities trade on a T+2 basis

Question 7

10.1.6: Central Securities Depositories (CSDs) (for example CREST)

The CSD holds an electronic record of share ownership (along with the share register held by the issuer) which enables ownership of shares to be transferred by book-entry transfer.

Every country has its own CSD for settling domestic trades. There are also two international CSDs (ICSDs) that settle international trades.

In addition to settling transactions by book-entry and on a DvP basis, the main functions of a CSD include (remember ICSD):

Immobilisation: holding share certificates in a vault, so no physical movement when ownership is transferred.
Corporate actions: processing corporate actions in accordance with the issuer.
Safekeeping of securities.
Distribution of income from the issuer.
They will also look to liaise with CSDs in other countries to facilitate any cross-border transactions.

Answer 7

settlement in the UK is via CREST’ the CSD for the UK.

Question 8

10.1.7: Trade failures

What happens when a trade fails?

Answer 8

Sometimes a trade fails, and settlement does not take place on the intended settlement date.

This can be for a variety of reasons; maybe there was a problem with inputting the trade details and it didn’t match, or the buyer doesn’t have sufficient cash, or the seller has insufficient stock.

Continued
What happens in this case?

Let’s say Chloe doesn’t have enough cash to pay for the stocks. What options are open for John?

He could wait until Chloe finds the cash and then charge her a penalty payment for late settlement, or
He could institute selling-out procedures at the LSE. This involves selling the shares to another buyer and passing any additional costs back to Chloe.
Alternatively, what if Chloe has the money but John doesn’t have the shares to deliver?

She could wait until John has the shares and charge him a penalty payment, or
She could institute buying-in procedures where she will buy the shares from another seller and pass on any additional costs to John.

Question 9

10.2: UK Settlement

Question 10

10.2.1: CREST structure

How does CREST work

Trades can only be settled through CREST members. Each member has their own participant ID and at least one member ID. Within each member account, there will be different securities accounts which record the holdings in the shares of different companies. There are 3 categories of membership:

Direct members
Sponsored members
Nominee members

Question 11

10.2.2: Settlement in Crest

There are 4 stages to settlement in CREST.
Trade Matching
Stock Settlement
Cash Settlement
Register Update

Answer 11

Tr

Question 12

10.2.3: Shares held in certificated form

For shares that are held in certificated form then the process is a little more convoluted.

The seller will need to complete a CREST stock transfer form, and this will be deposited along with the physical share certificate (known together as a deposit set) at a regional CREST counter. An electronic CREST record will then be created.

The deposit set will be sent to the company registrar who will delete the securities registered in the name of the seller and input the name of the buyer on the share register.

The securities will be credited to the CREST account so that they trade can settle electronically. The new owner will then hold the shares in electronic form.

This process takes much longer and so trades in certificated form settle in T + 10.

It is also possible for the reverse to happen if an investor wishes to hold shares in certificated form rather than electronic form.

Answer 12

This process takes much longer and so trades in certificated form settle in T + 10.

Question 13

10.2.4: Stamp duty reserve tax (SDRT) and stamp duty

SDRT is payable on the purchase of shares in electronic form via CREST. It is charged at 0.5% and rounded up to the nearest penny. AIM shares, ETF shares, and the LSE High Growth segment are exempt from SDRT.

Stamp duty (rather than SDRT) is chargeable on the purchase of shares in certificated form, but only if the value is over £1,000. The rate of 0.5% is the same but it is rounded up to the nearest £5.

Question 14

AIM shares, ETF shares, and the LSE High Growth segment are exempt from SDRT.

Question 15

10.3: International Settlement

Answer 15

10.3.1: Operational risks

Dealing in overseas markets brings about some operational risks. Some of these are fairly obvious, such as currency risks, but there are other factors that need to be taken into considerations.

For example:

Do we need to be authorised to trade in overseas markets?
Are there any restrictions in place for foreign investors?
Are there different rules compared to UK exchanges that we need to be aware about, such as short selling rules?
There may be delays due to time differences either between placing orders and them being executed or in the settlement of trades.
We also need to ensure that we make arrangements to safeguard our assets by appointing a local / global / regional custodian.
What are the penalties for settlement delays? Will settlement delays result in compulsory buy ins?
How will the company communicate any corporate actions?

Question 16

10.3.2: International settlement (LIKELY TO BE IN EXAM!!!)

The most important things to know in this section for the J12 exam are the exchanges, depositories and settlement periods for each country shown below. (LOOK AT GRAPH)

Take some time to learn these, as questions are highly likely in your exam.

Question 17

10.4: Client Assets and Money

Let’s say that you use the services of an investment firm. You invest a substantial amount, and they invest this in a variety of different securities as well as keeping a bit aside in cash. They agree to hold the assets and money on your behalf. How do you feel about this? A little nervous maybe? What happens if the company becomes insolvent? Will your assets disappear along with those of the investment firm?

Answer 17

the answer is no, they don’t.
The FCA require that all authorised firms that are holding client assets or money must put arrangements in place to safeguard those assets.

Rules are laid down in CASS – the FCA’s Client Assets Sourcebook that ensure that client assets are protected against insolvency of an authorised firm or from the misuse of client assets by the firm or one of its employees. Clients must also be informed of the arrangements that are in place.

10.4.1: Client money

Client Money = Client money must be segregated from any other money held by the firm. The account must have a distinct title so that it is easy to distinguish it from other accounts.
The bank must send confirmation of this arrangement before funds can be deposited.

10.4.2: Client Assets

Firms can safeguard assets under its own control or by using a custodian. Regular reconciliations between the firm and custodians / nominees must take place as frequently as is necessary and any shortfall that is the firm’s responsibility should be made good by the firm.

Both above do not relate to DvP transactions.

Question 18

10.5: Custodians

Firms can choose to use either a:
Local custodian
Regional Custodian (Europe)
Global Custodian

Answer 18

the primary function of a custodian is to look after investor’s assets. They must ensure that the assets are held entirely separately from their own and that investments are only released following instruction from the client.

Local custodian = provides services in the local domestic market. Firms can become members of the CSD in each of the markets that it invests in.

Regional custodian = Alternatively, they could employ the services of a regional custodian who will operate across the markets in a particular region. They won’t have quite as much knowledge of the local market, but it would likely be more cost effective.

Global custodian = who provides services across all markets. They may do so by having a large network of global branches or by employing a sub-custodian such as a local or regional custodian. The custody market is dominated these days by a small group of global custodians, who are mainly divisions of the large investment banks.

Question 19

10.6: Stock Lending and Prime Brokerage

Why would someone lend their stocks / securities to someone else?

Answer 19

The simple answer is the person lending the stocks will earn something from it, whilst the person borrowing them will be able to use them to achieve a particular aim.

10.6.1: Stock lending

Stock lending serves several purposes:

If a trade fails because there is a shortage of stock to deliver, this can have a huge knock-on effect on the market. The stock lending process helps firms who have found themselves ‘short’ on stock to be able to borrow it to make good their settlement obligations. If we have an active stock lending market, then this should reduce the number of trade fails in that market.
It allows investors to be able to use securities that they are not intending to sell, to earn a fee from them.
If an investor believes that the market is going to fall, then they can employ a short selling strategy, whereby they sell securities they don’t own in the hope that the price will fall, and then hopefully buy them back at a cheaper price.

Question 20

Let’s say a hedge fund decides to short XYZ shares and a pension fund is willing to lend them out.

Answer 20

The pension fund lends the shares in XYZ to the hedge fund for a set period.

Although we use the term lend here, full legal title passes from the pension fund to the hedge fund, however the lender (pension fund) will retain full economic benefit of owning the shares.

If a dividend payment is made over the life of the agreement, then the borrower (hedge fund) is obliged to pass it back to the lender in what is termed a manufactured dividend.

The same does not occur, however, with voting rights and so lenders need to ensure that under the agreement they are able to recall securities so that they can exercise their vote.

The pension fund runs the risk that the hedge fund doesn’t return the shares as agreed on the termination date. They will therefore ask the hedge fund to provide collateral as a form of security. That way, if the hedge fund does not return the shares (i.e. they default), then the pension fund can use the proceeds from liquidating the collateral to replace the shares in the market.

The collateral that is acceptable to the pension fund is strictly defined in the agreement drawn up between the pension fund and the hedge fund (known as a Global Master Securities Lending Agreement or GMSLA

Acceptable collateral usually constitutes:
Cash
T-Bills
Government Bonds

There is a further risk to the pension fund that the value of the collateral falls between the value date and the termination date and so to guard against this, the pension fund will require a greater amount of collateral than the value of the shares being lent out.

This is known as a haircut.

The value of the collateral will be regularly compared against the market (‘marked to market’) over the life of the loan.

If the value of the collateral falls, the pension fund will ask the hedge fund to provide more by what is known as a collateral call.
If the value of the collateral rises, the hedge fund can request that the pension fund returns the excess amount.

Question 21

10.6.2: Prime brokerage

The main aim of a hedge fund is to manage investment portfolios on behalf of their client, often employing complex strategies.

So that they can concentrate on these activities, they will often outsource a range of back-office operations to a prime broker.

Prime brokerage services are provided by some of the largest financial services firms such as Goldman Sachs or UBS. Services include custody, securities lending, trade execution and settlement, cash management, and financing for leverage. Let’s look at some of these in more detail.

Answer 21

Custody = Prime brokers will hold the hedge fund’s investments and act as a custodian.
A separate custodian may also be used

Settlement = Trades are ‘given up’ to the prime broker who then settles the trade with the counterparty.

Securities lending = The prime broker will arrange for stocks to be borrowed to cover short positions.
They will also lend out stocks to earn additional income.

Leveraged Financing =
Hedge funds often employ high amounts of leverage.
This means they will borrow several times as much as the value of the fund.
The typical range is between 2:1 and 10:1, but some hedge funds have run leverage as high as 100:1.
A leverage of 2:1 would mean that if the hedge fund had £100 million of assets, they would look to borrow a further £200 million, which they could then use to buy more assets.
This is very risky and so it is unlikely that a bank would be willing to lend them that amount with only the investment portfolio for collateral.
The hedge fund will draw up an agreement with their prime broker, setting borrowing limits and collateral required, which will be monitored on an ongoing basis.
The agreement will likely include a ‘right of rehypothecation’.
This means that the prime broker may use the collateral provided by the hedge fund.
I.e. they could sell it or they could lend it on in either a securities lending or repo transaction, and keep the fee.

Synthetic financing =
Exposure to securities is gained using derivatives instead of physically buying the underlying securities.
As we discovered in chapter 5, this is usually much cheaper than buying the securities outright.

Question 22

10.7: Corporate Actions (COMMONLY ASKED EXAM QUESUTIONS. particularly calculating theoretical ex rights prices.)

Corporate actions are actions taken by companies that affect its existing shareholders.

There are three categories of corporate action:
Mandatory
Mandatory with options
Voluntary

Answer 22

Mandatory = happens automatically with no action required from shareholder (e.g, dividends being paid)

Mandatory with options (where the action will take place but the shareholder has choices about what to do (rights issues (keep or sell)

Voluntary = where the shareholders decide if the action takes place or not (e.g a takeover bid)

Question 23

10.7.2: Dividends

As we have seen, dividends are paid to shareholders out of net realised profits. The directors decide on the amount of dividend that is to be paid, and the shareholders get to vote on it at the AGM.

Companies may pay dividends annually, semi-annually or quarterly; they are made up of interim dividends and a final dividend.

Companies paying dividends must follow a strict timetable order, laid down by the LSE, so that shareholders and companies are aware of who is entitled to receive the dividend: (see table)

Question 24

Dividends with options

Most dividends are paid in cash, but often companies may give shareholders to receive their dividends in the form of shares in the company instead. There are two ways in which they can do this;

SCRIP or DRIP

What is the difference and how is either taxed?

Answer 24

Scrip dividends =

With a scrip dividend, rather than the shareholder receiving cash, they receive an allocation of newly created shares issued by the company instead. This will dilute existing shareholders’ holdings. 

Income Tax = taxed in the same way as cash dividends.
CGT = When shares are sold, the original cash dividend is used as the acquisition price for CGT purposes.
But… if market value of the shares on the first trading day is more than 15% higher than the cash dividend, the market value will be used as the acquisition price.

Dividend Reinvestment Plan (DRIP) =
the company pays a cash dividend, but the investor can ask the company to buy shares in the market using the cash instead. Main difference to above, is that no new shares are issued so no dilution of existing shareholders’ holdings

Question 25

10.7.3: What are Capital events

Capital events include bonus issues, stock splits and consolidations.

They each affect the number and value of the shares being held by shareholders.

Question 26

Do NOT confuse a Script Issue with a Scrip Dividend

Answer 26

Bonus Issue

A bonus issue, also known as a capitalisation or scrip issue (not to be confused with scrip dividends) is where a company issues a quantity of new shares to existing shareholders ‘pro-rata’, so based on their holdings, without any demand for payment. They give them shares for free! Market value of shares change, however nominal value stays the same

In the UK, Europe and Asia the securities ratio shows the number of shares you’ll get, based on how many you hold. For example, a 3:2 bonus issue means they get 3 shares for every 2 they hold.

Question 27

Bonus issues are used in order to reduce the share price, so although the shareholder gets more shares, the fall in the share price means that the value of their portfolio will stay the same.

What is the purpose of this?

Answer 27

Companies do this because the bonus issue results in more shares in issue at a lower share price. (imagine if you couldnt trade in fractional shares!)

This increases the liquidity of the shares, making them easier to buy and sell.

Question 28

10.7 CORPORATE ACTIONS
Following a bonus issue / script issue / capitalisation the share price in the market will fall this price is known as the theoretical ex-bonus price, and we need to know how to calculate it.

Remember nominal value stays the same

How do you calc the theoretical ex-bonus price?

Answer 28

the total value of the shares does not change, so all we need to do is to divide this total by the new total number of shares.

LOOK AT EXAMPLE 10.5 and DO activity 10.1

Question 29

What are Stock Splits?

ALSO KNOWN AS SUBDIVISIONS

Answer 29

A stock split or subdivision divides one share in to more shares.

The ratio here is expressed differently from the bonus issue securities ratio, in that a 2:1 stock split will result in you having 2 shares where you previously had 1. Essentially, we are splitting one share to make 2.

The nominal value is reduced in a stock split

Question 30

Bonus issue = market value changes, nominal value stays the same

Stock Split = Nominal value changes

What is the benefit for a company in respect to above to using a stock split?

Answer 30

By using a stock split, the share capital remains the same on the balance sheet meaning the company does not need to draw on reserves

This differs to bonus issues

Question 31

Consolidation

A consolidation or reverse split is the opposite of a stock split.

Tell me above this

Answer 31

The number of shares is reduced, which increases the share price.

Companies may look to do this if they are looking to raise finance by issuing shares via a rights issue

Rights issues involve issuing shares at a discount to the current share price.

If the current share price is trading close to its nominal value, then it will make a rights issue difficult, as shares cannot be issued below their nominal value. A consolidation would therefore increase the nominal price, making it easier for the company to undertake a rights issue.

Question 32

10.7.4: Capital raising

What are pre-emptive rights?

What is the benefit of this?

Answer 32

Where a company first must offer shares to existing shareholders if they are looking to raise further capital

pre-emptive rights prevent dilution of existing shareholders holdings

Question 33

There are two ways in which capital can be raised once capital has already been raised previously : rights issues and open offers.

IMPORTANT FOR EXAM

Answer 33

Rights issue =
The company offers existing shareholders the right to buy new shares at a reduced share price, pro-rata to their existing holdings.

They will be expressed as something like: 1-for-5 or 2-for-1.

The share price will fall following the rights issue, the new price being known as the theoretical ex-rights price or TERP.

It is essential that you learn how to calculate this as it is a very common question in the J12 exam. (look at example, 10.7)

Open offers =
These are similar to rights issues except they cannot be sold on the market. If the shareholder chooses not to take up their rights, then they will lapse. Because of this, the discount to the full share price is limited by the Listing Rules to 10%

Open offers can sometimes allow for shareholders to buy more than their pro-rata entitlement, although the issuer has the right to scale this back if it becomes oversubscribed.

They can also be structured so that any shares not taken up are sold in the market, with the proceeds being distributed. These are known as open offers with compensation.

Question 34

The share price will fall following the rights issue, the new price being known as the theoretical ex-rights price (TERP)

Why is it theoretical?

Answer 34

As the name suggests, this price is only theoretical. The post rights price may differ from the TERP due to market sentiment.

Question 35

Does an investor always buy the shares in a rights issue?

Answer 35

Not always. There are several options:

Take up the rights. In our example pay the £460 and buy the additional 200 shares.

Sell your rights. You can sell some or all of your rights in the market.

Tail swallowing. Sell some of the rights and use the proceeds to buy the remaining rights.

Lapse. Do nothing. The company will sell the rights on your behalf, and distribute the proceeds to you. The price at which you can sell your rights is known as the rights premium or nil-paid price and is the difference between the TERP and the subscription price.

Question 36

Following a rights issue the investor decides to let the offer lapse (do nothing) meaning the company will sell the rights on the investor behalf and then they will receive the proceeds

Answer 36

The price at which you can sell your rights is known as the rights premium or nil-paid price and is the difference between the TERP and the subscription price.

In example 10.7 the nil-paid price would be 282.5p-230p = 52.5p.

If someone paid 52.5p for the right and then bought the shares at the rights price of 230p then they would pay 282.5p which is the theoretical price of the shares following the rights issue.

Question 37

10.7.5 Takeovers and mergers

What is the difference

Answer 37

Takeovers

One company (predator) will look to take over another company (target) by acquiring more than 50% of its shares. Takeovers can be friendly or hostile.

Ultimately the aim of the predator will be to own all the shares in the target company using either cash or shares or commonly a mix of both.

Mergers

Mergers are where 2 similar sized companies merge to form a larger company. One company will usually exchange their shares for the shares of the other company. 

Question 38

Clearing and settlement

Shares can be held in bearer form or registered.
Firms will hold shares on behalf of investors in a nominee account.
Omnibus accounts pool all investors holdings into one account; designated accounts have separate accounts for each investor.
Trades are settled according to periods set by each market.
The clearing process involves legally fomalising the obligations of each party to the trade.
Settlement occurs via Delivery versus Payment where stocks are transferred by book-entry and a simultaneous and irrevocable instruction is sent to pay the cash.
Central Counterparties and clearing houses help reduce the risk due to settlement failures.
Central Securities Depositories hold electronic records of shares and facilitate settlement by book-entry transfer.
UK settlement

The CSD in the UK is CREST; they hold the Operator Register of Securities.
There are 3 membership categories of CREST: direct, sponsored and nominee.
The issuer holds the Issuer Register of Securities.
The settlement stages in CREST are trade matching, stock settlement, cash settlement, register update.
Stock and cash settlement happen simultaneously.
For shares in certificated form, a deposit set consisting of the share certificate and stock transfer form must be deposited at a regional CREST counter.
International settlement

In the USA, the main depositories are the Depository Trust Company (DTC) and the Federal Reserve Bank.
In Japan, they are the Japan Securities Depository Centre (JASDEC) and the Bank of Japan.
Germany use Clearstream Banking as their central depository.
France use Euroclear France.
There are a variety of operational risks when dealing in overseas markets.
Client assets and money

Where firms are holding assets or money for their clients, they must put in place arrangements to safeguard those assets.
Client money must be held separately from the money of the firm so that if the firm fails, the client money will not be used to repay its creditors.
Similarly, client assets must be held in separate accounts from the assets of the firms.
Where a third-party custodian is used, the firm must ensure that they undertake regular reconciliations, and make up any shortfall where they are responsible.
Custodians

Custodians look after investor’s assets as well as providing settlement services, income collection and distribution, and monitoring corporate actions.
Custodians can be local, regional or global.
Stock lending and prime brokerage

Stock lending enables large institutions to lend out securities and earn a fee.
Stock may need to be borrowed due to a failed settlement or a short sale.
Stock lenders are at risk of the borrowers not retuning the stock and so they require collateral to guard against this.
As the value of collateral may fall, stock lenders may ask for a greater amount of collateral to cover this, known as a haircut.
Prime brokers offer a range of services to hedge funds including custody, settlement, borrowing and securities lending and borrowing.
Corporate actions

Corporate actions can be mandatory, mandatory with options or voluntary.
There is a timetable regarding the payment of dividends to ensure that it is clear as to who will receive the dividend payment.
If a stock is traded on or after the ex-dividend date, then the seller will receive the next dividend; if it is traded cum-dividend (before the ex-div date) the buyer will receive it.
Scrip dividends are dividends paid in shares instead of cash. The company issues new shares so they are dilutive.
DRIP dividends are paid in cash and the company uses the cash to buy shares in the market. They are not dilutive.
Bonus issues give shareholders free shares pro-rata their holdings.
Their purpose is to increase liquidity and reduce the share price. The nominal share value stays the same.
Stock splits split one share into several.
They also reduce the share price and increase liquidity but the nominal value also reduces.
Rights issues and open offers raise capital by issuing new shares to investors prorata to their existing holdings.
Rights can be sold in the market whereas open offers cannot.
Takeovers occur where one company (predator) acquires more than 50% of another company’s (target) shares. They can be hostile or friendly.

Question 39

In the UK, the settlement period for equity trades is:

T+1.

Incorrectly selected
T+2.

Incorrectly unselected
T+3.

Correctly unselected
T+4.

Answer 39

T+2.

All equities in the UK settle on a T+2 period.

(LEARN DIFFERENCE BETWEEN ALL SETTLEMENT PERIODS)

Question 40

CREST notifies Anne-Marie of a rights issue in ABC plc. This means that she must own:

Registered shares.

Bearer shares.

Preference shares.

Redeemable shares.

Answer 40

Registered shares.

Rights issue give ordinary shareholders the right to buy further shares pro-rata their existing holdings.

There is no record of bearer shares, so CREST would have no idea who owns them!

So, these shares must be registered.

Question 41

A UK company’s shares go ex-dividend on 3rd August. If Jared buys shares from Molly on the 2nd August, who will receive the dividend on 25th August?

Jared but he has to give it to Molly.

Jared and he can keep it.

Molly but she must pass it back to Jared.

Molly but she can keep it.

Answer 41

Jared and he can keep it.

Jared has bought the shares cum dividend as it is before the ex-dividend date. This means that his name will be on the record. He will receive the full dividend to which he is entitled

(LOOK INTO HOW THIS RELATES TO SETTLEMENT DATES IF IT DOES AT ALL, I think there were others where it did matter?)

Question 42

The main difference between a stock split and a bonus issue is:

Money is raised with a bonus issue, but not a stock split.

The nominal value of the share stays the same after a bonus issue but reduces with a stock split.

Funds are moved from capital reserves for a stock split but not for a bonus issue.

A bonus issue is dilutive, but a stock split is not.

Answer 42

The nominal value of the share stays the same after a bonus issue but reduces with a stock split.

There is no money raised with either a bonus issue or a stock split. They are both ways of increasing the liquidity of shares by increasing the number of shares in issue and lowering the price. Neither are dilutive as shareholders receive additional shares pro-rata to their existing holdings.

With a bonus issue, the nominal value stays the same. It is reduced for a stock split. That means that funds need to be moved from capital reserves for a bonus issue in order for the balance sheet to balance.

Question 43

The depository for Japanese Government Bonds is:

DTC.

JASDEC.

Bank of Japan.

Clearstream.

Answer 43

Bank of Japan.

JASDEC is the depository for equities. The Bank of Japan is the depository for JGBs and T-Bills.

Question 44

The depository for equites is: WHAT?

Answer 44

JASDEC

NOTE:
The Bank of Japan is the depository for Japanese Government Bonds and T-Bills.

Question 45

A company announces a 1 for 2 rights issue at a subscription price of £3. If the current share price is £4, what is the theoretical ex rights price?

Answer 45

Before the rights issue we have 2 shares worth £4 each = £8

With the rights issue we buy 1 share at £3

We have a total of 3 shares at a value of £11 so the TERP = 11/3 = £3.67

To then calc the Nil-Rate Price (required if they are letting the issue lapse) it is the difference between TERP and the subscription price. (0.67p) - this is the proceeds that will be paid to the existing shareholder who let the rights issue lapse

Question 46

The simultaneous transfer of cash and securities in CREST is known as:

electronic transfer of title.

book entry transfer.

register update request.

delivery versus payment.

Answer 46

delivery versus payment.

Electronic transfer refers to when legal title passes from seller to buyer.

Book-entry transfer describes the process of changing the electronic record to reflect the change in ownership.

Register update request is where CREST sends a request to the issuer to change the Issuer Register of Securities.

Delivery versus payment describes the process whereby securities are transferred and, at the same time, an irrevocable payment instruction is sent to transfer the cash on CREST

Question 47

Tell me what each of these are:

electronic transfer of title.

book entry transfer.

register update request.

delivery versus payment.

Answer 47

Electronic transfer refers to when legal title passes from seller to buyer.

Book-entry transfer describes the process of changing the electronic record to reflect the change in ownership.

Register update request is where CREST sends a request to the issuer to change the Issuer Register of Securities.

Delivery versus payment describes the process whereby securities are transferred and, at the same time, an irrevocable payment instruction is sent to transfer the cash on CREST

Question 48

Legal title passes from the seller to the buyer when:

the Operator Register of Securities is updated.

the Issuer Register of Securities is updated.

the trades have been confirmed and matched in CREST.

the cash is received by the seller.

Answer 48

the Operator Register of Securities is updated.

Once the Operator Register of Securities is updated in CREST then full transfer of legal title from the seller to the buyer has occurred.

Question 49

A hedge fund has employed the services of a prime broker who requires the right to rehypothecation. What does this mean?

Collateral held on behalf of the hedge fund must be marked to market on a regular basis.

They will require a greater amount of collateral from the hedge fund than the value of the securities being lent.

They can lend out the securities being held as collateral and keep the fee.

Exposure to securities can be created by using derivatives.

Answer 49

They can lend out the securities being held as collateral and keep the fee.

A,C and D are all true but it’s not what rehypothecation means. (LEARN EACH)

Question 50

How much stamp duty / stamp duty reserve tax would be payable in total on the following transactions: £35,000 of paperless FTSE 100 equities, £13,500 of certificated FTSE 250 transactions and £10,000 of FTSE High Growth shares?

£292.50.

£242.50.

£225.00.

£245.00.

Answer 50

£245.00.

0.5% SDRT on £35,000 of FTSE 100 equities = £35,000 x 0.5/100 = £175.

0.5% stamp duty on £13,500 FTSE 250 equities = £13,500 x 0.5/100 = £67.50, round up to nearest £5 gives £70.

FTSE High Growth shares exempt.

Total = £175 + £70 = £245.