Chapter 21: Investment Categories Flashcards
Investment categories / asset classes
- Liquidities
- Real estate
- bonds
- shares
- derivatives
- investment objects
Direct return
Earings derived by investor from ownership of the investment after the cost of ownership
Indirect return
change in value of the envestment between purchase and sale of the item (% of original value)
Liquidities
- Can be converted into cash on short notice without additional costs
- Market for these investments is the money market
- Two-year term or less deposit accounts fall into this category
- IR is the direct return on liquidities
Real Estate
- Collective term for buildings
- Most real estate is put on the property market via property developers
- Capital is often too high for direct investment, Consumers can invest indirectly in real estate investment funds
- Direct return is the difference between retal income and operating costs
- Direct return paid out to investors of real estate investment fund via dividends
- Risk is relatively low
- Indirect return is differene between purchase price and sales price minus fees
- real estate investment has fewer risks than shares bt more than bonds
- Residential housing is lower risk than commercial real estate
Bonds
Certificate of debt
* Bond holder has lent money to an institution i.e. a business or government
* minimum term of 2 years
* Bonds have a nominal value of EUR 1000, thus if an institution wants to raise 20 mil, they need 20,000 bonds
* Issuance on the primary market to raise long-term loan capital
* Bond holders can trade bonds on the secondary market
* Price that bonds are traded will depond on the coupon rate of the bond + current IR of CM
* High IR in capital market = less demand for bonds
* Issuing company has obligation to repay the bold holder at end of term + fee (fee = coupon rate, coupon for short) Coupon = % per year on nominal value
Risk and return on bonds
Direct return = is the coupon, very low risk but there is default risk
Indirect return is any change in the market price of the bond, this can be negative.
effective return or redemption yield = Combined indirect and direct return
Investor who holds onto bond for entire term will not get indirect return
Example: Stock exchange will show prices for bonds as a % of the nominal value. List price of 105 - bond with a nominal value of 1000 EUR is being traded at 1050 EUR
Bonds considered safe investment category e.g. Dutch government bonds
Shares
Shares are a certificate of ownership, shareholder is a co-owner of the equity of a company
* Company issues new shares to raise equity capital
* Bank usually handles issuance for a company
* Shares are traded on the stock market, market is divided into primary CM and secondary CM. Shareholders trade on the secondary CM.
* When shares are issued on primary market, issuing institution gets sales proceeds. First price upon circulation - issue price
* Supply and demand depends on factors incl. current IR. Higher IR = more attractive to invest in liquidities since they offer similar return w/ lower risk. Also causes price of shares to drop
* List price more important than nominal value
* Shareholders have right to vote on comapny decisions as co-owner
* Entitled to dividends
Risk and Return on Shares
- Direct returns = dividends (in form of cash or shares or combo). Low risk since worst case = dividend of 0
- Indirect return is difference between buy and sell price of the share. Risk is considerable since share prices fluctuate and sometimes by huge percentages
- On average, shares go up by 8% each year over span of 20 years. However the changes are very unpredictable.
Derivatives
Financial products that are derived from other traditional financial products.
Most well-known is the “option”
Options
Two types:
* Call option = gives the option holder the right to buy a share at a predetermined price during a set period. Counterparty is the writer of the option, obligation to sell.
* Put option = gives the option holder the right to sell a share at a predetermined price during a set period. Writer has obligation to buy.
= conditions to buy or sell set in adance
Risk and return on derivatives
Call option
* Best time to use is when the price of the option is lower than the listed price of the share, then sold at a higher price
Put
* Best time to use is when the price of the option is higher than the share list price, option holder can sell shares at a higher price
In NL, most of these happen on the options exchange “Euronext Amsterdam Derivatives Markets”
Investment Objects
An object/right on an object or right on whole/partial return in money from an object
