Chapter 2 - Main asset classes - cash, bonds equities and property

Question 1

normal yield curve

Answer 1

• investors require higher yields for longer term bonds to cover the increased risks and uncerstanties
• more capital is required to achieve the same income in short-dated bonds than longer varieties

Question 2

flat yield curve

Answer 2

• where there is no perceived risk and thus no premeium required for longer term investing
• flat yield curve will appear when the market is influx, moving from a normal curve to an inevreted one (or vice versa)

Question 3

inverted yeild curve

Answer 3

• yield on longer term bonds is less than on shorter term bonds
• expectataions that interest rates will rise in the short term, while long term rates are expected to be lower

Question 4

scrips issue

Answer 4

• company issues new shares and pays for them out of its revenue reserves. known as a scrip dividend as its issued in its stead
• increases shares in circulation, but not their value. share price will subsuquently ‘rebalance’
• shown as, for example, 1:3 - this means, for every three shares an investor holds, they recive one extra for free

Question 5

rights issue

Answer 5

• existing shareholders are offered a chance to subscribe to new shares on a pro-rata basis at a discount
• value of shareholders investment is diluited if they are not offered first before a thirdy party
• number of shares you can subscribe to is in proportion to existing holdings. expressed as, for example, ‘1-for-3’ - meaning 1 new share for every 3 held

Question 6

initial yield

calculation

issues

Answer 6

• how return on an investemnt property is measured - used as measure against other investment opportunties
• (annual rent income / price of property) x 100
• inaccurate because it does not allow for the rental growth a lease provides through rent reviews

Question 7

tier one capital ratio

Answer 7

• ratio that regulatory authorities use to judge the adequacy of a banks capital position
• it absorbs losses without a bank being required to cease trading
• consists of share capital and equity reserves

Question 8

preference shares
types

Answer 8

• less risky but potenially less profitable
• entitled to receive a fixed dividend each year as long as the company feels it has sufficent profits - dividends to be paid before ordinary share holders
• do not have voting rights, although are entitled to be paid first in the event of liquidation

types

• preference - carry a fixed dividends, if it’s not paid the right is lost
• cumulatuve - if the dividend is not paid, the right rolls over into arrears that have be paid
• participating - additional dividends may be paid if the company exceeds certain profit levels
• redeemable shares - issued with a specified redemption date when the company will pay the nominal value
• convertaible - able to convert to ordinary shares
• many contain a series of the above options

Question 9

equity risks

Answer 9

• price risk - risks that price may fall and result in a loss of capital, even though dividends may continute to be paid. volatlity varies between sectors
• liquidity risk - shares may be difficult to sell at a reasonable price. usually occures when share prices are falling, and the spread between bid (purchase price) and offer (sell price) widens.
• issuer risk - risk that the company collapses and the oridnary shares become worthless. risk is more substantial with smaller companies

Question 10

flat yield (interest yield or running yield)

=

redemption yield

=

Answer 10

flat

• income return an investor gets on the purchase price of a bond.
• (coupon / price) x 100

redemption

• captures the effect of the redemption payemnt on the overall bond return

gain (or loss) / years

interest yield + or -________________ x 100

clean price

Question 11

modified duration

=

Answer 11

• how sensitive a bond is to changes in interest rates. estimates how much a bonds price will chnage if there is a change in interest rates and thus yields
• duration / (1 + GRY).

Question 12

adjustment issues

bonus issues (scrips/capitalisation)

Answer 12

bonus issues

• issuing further shares to the existing holder without raising new funds. brings the companies share capital more in line with it’s real worth, and reduces it’s share price making it more marketable
• the same profitability that increased it’s retained profit may have also pushed the share price to a high level - broadly deemed to be over £10 - puts off certain buyers