Chapter 2: Asset Classes - Other, FX, CIS, Structured Prods Flashcards
CASH ASSETS
Cash assets - definition and 2 main types
Short term instruments issued with less than 1 year to maturity. 2 main types:
* T bills - issued by govts
* Commercial papers - issued by corps(pay higher interest as tehy have longer time to maturity
Cash deposits - characteristics
Cash held in banks or savings institutions
* Returns are basic interest
* Amount invested is repaid in full at the end of the inv. term
*
Types of cash deposit
- Large deposits - more economical for banks to process andearn a better rate
- fixed term accounts - money is locked up for a set time period and in return the investor recieves higher interest
- Instant access deposit account - low interest yield
- Current/checking accounts - generate an even lower rate
positives of cash
- Liquidity -
- Interest - predictable return from interest
- Safety - cash is not exposed to market volatility
Negatives of cash
- Risk of banks defaulting and losing cash deposits - however the government FSCS protects investors up to a certain amount
- inflation erodes the real value of cash
- IRs vary so cash returns will also vary
Considerations of depositing cash overseas
- Exchange rate risk
- credit worthiness of the foreign banking system/firm - if it has a protection scheme
- how any interest is taxed
- If there are any exchange controls that will limit access to money
Treasury bills (T-bills)
fund government’s long term borrowing needs.
* T bills are short term bonds with maturity dates of 1-12 months
* Pay no coupon so are issued at a discount to par value so nominal value-purchase price=return
* Very secure investment as they are guaranteed by teh govt.
Commercial papers and asset backed CPs
Issued at premium/discount, time line for maturity, why do large corps use them
Unsecured short term bond issued by corps (also some sovereign issuer)
* Issued at discount to par
* 1 year max maturity in EU and 270days in the US
* Large corps use them to manage liquidity
Asset backed CPs=dated between 90 and 180 days. Use recieveables (loans, credit card debt etc) as funding for CPs.
Missing payment of CPs by just 1 can can lead to bankruptcy proceedings for the issuer
How commercial papers are issued and the role of dealers
2 methods of issuing CPs
1. issuer can market the CP directly to an investor
2. It can sell the CP to a dealer who resells the CP on the market. Dealers are typically investment banks and fin svs firms like bond dealers.
Issuers issue CPs into the market continually at set intervalls and not all at once.
* Programs can be promoted by dealers and are then labelled dealer papers.
* Large fin firms have the reach to issue directly to investors=direct papers
Rollover/refinancing risk
As commercial papers have a rolling issuance, new issues typically finance the repayment of old issues so rollover risk is when companies can’t issue new CPs.
Repo markets
- A lender gives a borrower government bonds (sells them effecitively) in return for cash collateral from the borrower.
- At the end of the date the borrower returns the govt bonds (lender buys them back) and the lender returns the cash collateral minus an agreed rate (repo rate) for the service.
Benefits of repo markets
REVISIT
- Lender (A) - gets cash that can be used to finance the trading book
- Borrower (B) - might be a market making firm that needs govt bonds to fill an order. raise finance against the govt bonds by using them as collateral. Bonds can also just be used for security of funds
EUROBONDS
What are eurobonds
Bonds issued and sold outside of their home country
* Can be issued in any currency as long as it is different to the currency of the place where they are issued.
* Allow firms to issue debt outside of their domestic market and expand into new markets
Process of issuing Eurobonds
- Issuer appoints a lead manager (an investment bank) who work together to determine the maturity date and coupon. The lead manager will underwrite and guarantee the bonds raise a certain amount for a fee.
- Lead manager will establish a syndicate of banks who agree to sell the euro bond to their client and all accept responsibility for part of the issue and underwriting
- The syndicate sells the eurobonds to their clients
Eurobond features
Format of issue, tax rules, trading system and type.
- Issued in bearer share form
- pay interest in a gross payment
- taxable but are not taxed at the source due to general lack of national regulation on eurobonds
- Trades are matched through TRAX and settled through Euroclear/clearstream
- Settlement period is T+2 days
- Traded over the counter (OTC)
OTHER SECURITIES
Depositary reciepts - 2 main forms
- American depository receipts (ADRs) - allow for non-US firms to raise finance from US investors.
- Global depositary receipts (GDRs) - same as ADRs but not limited to the US.
* Both are negotiable certificates that evidence ownership of stock in a firm.
Depositary receipts creation process 1.
DRs are created (sponsored) by the foreign corp which work with an investment bank to set the structure ofthe DR e.g. the number of shares represented by each DR. A depository bank will then accept a certain number of shares from the issuer, create the DRs to represent them and then make them available to investors.
Depositary receipts creation process 2. ADR specific
- Issuer liases with investment bank and determines ADR structure
- Issuer supplies the underlying shares to the depository bank
- The depository bank sells the ADR to US investors (via US brokers)
- Cash proceeds are paid to the issuer.
Additional depository receipt characteristics
Tax rules, issue format, grey mkt trading
- Pre release/grey market trading - when the depository bank recieves notification a DR is being created it can sell teh DR before it exists (as long as it holds cash collateral). The DR can be treated this way for 3 months.
- The DR is registered in the name of the depository bank and the DRs are transfereable bearer shares. Traded in USD
- Depository bank acts as an intermediary between teh investor and the firm by collecting and passing on funds from both parties
- The ADR is always purchased and sold in USD so investors need to be aware of FX risk. They are attractive to US investors as this exchange rate risk is not a concern. Some ADRs have in built currency hedges.
- Exposed to UK stamp duty. For DRs traded outside the UK, HMRC charges a one off 1.5% tax at creation.
- Entitled to vote with shares
- Can be sold to another investor directly as a DR or the shares can be sold as shares on an exchange (involves cancelling the DR and recieving the shares).
Warrants - what are they
Instrument issued by a corp allowing the holder the right but not obligation to subscirbe for shares at a fixed price in a defined period. Typically have a life of severa years.
Traded and listed on exchanges.
Highly leveraged that are often issued alongside other instruments.
Advantages to corps of issuing warrants
- Sale of warrants raises money for the corp
- If warrants are exercised (holder pays for the shares) additonal capital is raised for the corp. (ie holder buys the warrant for 50p and exercises to buy shares at £1 the corp makes £1.50)
- Holding a warrant does not entitle the investor to recieve dividends/vote so the corp raises capital without loss of voting rights etc.
Covered warrants - what are they
Issued by corps (typically invest. banks) rather than the company who’s shares are involved in the warrant agreement - JPM issues apple warrants.
Offered in the form of call or put warrants. Traded on exchanges
Price behaviour of warrants and conversion premium calculation
Highly leveraged investments = high risk for loss/gain.
Value is derived from the length of time which they are valid for and teh value of the underlying security.
Conversion premium=mkt price - conversion price
If this is negative the warrant would be trading at a conversion discount.premium calc
PROPERTY
