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1. F105 - Finance and Investment Principles > Chapter 4: Specialist asset classes (2) > Flashcards

Chapter 4: Specialist asset classes (2) Flashcards

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1
Q

List 8 Specialist Asset Classes

A
  1. Asset-backed securities and securitisations
  2. Venture capital
  3. Hedge Funds
  4. Currency
  5. Infrastructure
  6. Commodities
  7. Structured products
  8. New ways of investing in old asset classes.
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2
Q

Define Securitisation

A

Securitisation is the issue of securities, usually bonds, where the bonds are serviced and repaid exclusively out of a defined element of future cashflow owned by the issuer.

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3
Q

The main classes of asset-backed securities (ABS) (3)

A
  1. residential and commercial mortgage-backed securities (MBS)
  2. credit card receivables (CCABS)
  3. collateralised loan, bond and debt obligations (CLO, CBO and CDOs)
  4. insurance securitisations
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4
Q

Format of the asset-backed securities (the borrowings format):

A
  1. The borrowings are normally made in a multi-tranche format involving several differently ranking levels of debt.
  2. e.g. senior, mezzanine and equity.
  3. with credit ratings or credit default protection obtained for (at least) the major tranches.
  4. This is done so as to appeal to the various risk/ return preferences of different investors, thereby reducing the overall cost of capital.
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5
Q

Describe Private equity

A

Private equity is the provision of equity capital where there is no immediate exit route via the secondary market, i.e. investment in unquoted securities.

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6
Q

List the forms of private equity (4)

A
  1. venture capital
  2. leveraged by-outs
  3. development capital
  4. restructuring capital
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7
Q

Describe “venture capital”

A

capital for businesses in the conceptual stage or where products are not developed and revenues and/or profits may not have been achieved

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8
Q

Describe “leveraged buy-outs”

A

equity capital for acquisition or refinancing of a larger company.

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9
Q

Describe “development capital”

A

growth or expansion working capital for mature businesses in need of product extension and/or market expansion

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10
Q

Describe “restructuring capital”

A

new equity for financially or operationally distressed companies

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11
Q

What are management buy-outs

A

Management buy-outs are a form of leverage buy-out in which the existing management buy-out the existing owners of the company.

Similarly, a management buy-in occurs when the buyer is an external management team.

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12
Q

Define commodities

A

Commodity can be defined as any products that can be used in commerce, ie any goods that are traded.

For example:

  • traded agricultural goods such as coffee,
  • fuels such as oil
  • raw materials such as copper
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13
Q

Commodity futures contract specifications (7)

A
  1. contract size
  2. delivery dates
  3. quality of the product
  4. method of packaging
  5. package size
  6. delivery site
  7. method of resolving disputes about quality
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14
Q

Commodity futures and forward contracts are used for risk management by:

A
  1. commodity producers who wish to reduce uncertainty in the future cash flows that they will receive for their product
  2. commodity consumers who wish to reduce the uncertainty in the amount they will have to pay for their future supplies
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15
Q

Investment characteristics of commodities

A

They are real assets whose value is determined by short-term economic factors rather than expectations over the longer term.

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16
Q

For commodities futures - discuss the cost of carry and a contango market

A

The cost of carry is the financing cost of holding the underlying, plus storage costs. Because the cost of carry is positive, the futures price is normally above the spot price. This is know as a contango market

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17
Q

Define the convenience yield

A

the convenience yield is the positive value to ownership of the physical commodity, e.g. as protection against future shortages or in order to be able to take advantage of them by selling at a high price.

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18
Q

Backwardation

A

When the convenience yield is higher than the cost of carry the futures prices will be below the spot price, a situation known as backwardation.

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19
Q

Traders in Forex

A
  1. large banks
  2. central banks
  3. currency speculators
  4. multinational corporations
  5. governments
  6. other financial markets and institutions
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20
Q

Define prepayment risk

A

the risk that the loan may be repaid earlier than originally anticipated because the underlying assets have been redeemed.

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21
Q

How are securitisations usually structured

A

Securitisations are usually structured around a special purpose vehicle (SPV), which is typically set up to be bankruptcy remote with regard to the original company

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22
Q

Define “carried interest”

A

Carried interest refers to the profit share arrangement in a private equity investment which exists as an incentive to achieve strong performance.

23
Q

Describe infrastructure investment

A

Infrastructure investment entails financing long-term infrastructure, industrial and / or public services projects based on a non-recourse or limited resource financial structure, where the project debt and equity used to finance the project is repaid from cash-flows generated by the project.

24
Q

List examples of economic infrastructure (4)

A
  1. highways
  2. water and sewerage facilities
  3. energy distribution
  4. telecommunication
25
Q

List examples of social infrastructure (5)

A
  1. schools
  2. universities
  3. hospitals
  4. public housing
  5. prisons
26
Q

Characteristics that distinguish infrastructure assets from more traditional equity or debt investments: (6)

A
  1. The assets themselves tend to be single purpose in nature.
  2. The private investor’s participation in the assets is often for a finite period.
  3. Infrastructure assets are characterised by their long lives. “patient capital”.
  4. Initial development involves high upfront capital costs with payback occurring over the asset’s lengthy life.
  5. They tend to be or exhibit the characteristics of natural monopolies.
  6. Due to monopolistic characteristics they tend to be subject to varying degrees of government regulation, depending on the degree of natural monopoly.
27
Q

Private equity funds may be appropriate owners of businesses where: (3)

A
  1. the risk profile is unsuitable for public ownership
  2. the cost of capital may be reduced under private ownership
  3. where the valuation is difficult in the public arena for any other reason.
28
Q

Proponent of private equity investment claim that: (2)

A
  1. private equity outperforms (over the long term)
  2. it is a loosely correlated asset which may be able to enhance portfolio performance without materially increasing risk.
29
Q

Private equity investment options (for diversifying risk): (3)

A
  1. Investment trusts
  2. Having segregated funds managed for them by private equity firms
  3. Funds of funds
30
Q

Define hedge funds

A

A hedge fund can be defined as an investment fund that aims to meet high or absolute returns by investing across a number of asset classes or financial instruments

31
Q

Hedge funds typically have less restrictions on (3)

A
  1. borrowing
  2. short-selling
  3. the use of derivatives
32
Q

Outline hedge fund investment strategies (4)

A
  1. global tactical asset allocation funds - concentrate on macroeconomic changes around the world.
  2. event-driven-funds - trade either distressed securities or securities of companies involved in mergers and acquisitions
  3. market-neutral - enter simultaneously into long and short positions, whilst taking no overall exposure to the market, and trying to exploit individual security price movements
  4. multi-strategy funds - a combination of the above
33
Q

Measuring and interpreting hedge fund past performance is not straight forward due to: (3)

A
  1. survivorship bias - when the data does not realistically reflect survivors and failures.
  2. selection bias - funds with good history are more likely to apply for inclusion. Backfilling will then cause a significant upward bias
  3. marking to market - whereby the use of “stale” prices can lead to underestimation of true variances and correlation
34
Q

Define insurance-linked securities (ILS)

A

securities whose return depends on the occurrence of a specific insurance event. Examples include catastrophe bonds and bonds related to life risks.

35
Q

The process for creating a catastrophe bond: (5 steps)

A
  1. An SPV is established in a tax efficient jurisdiction
  2. The SPV establishes a reinsurance agreement with the company
  3. The SPV issues a bond to investors with default provisions that mirror the terms of the reinsurance agreement
  4. The proceeds from the bond sale are invested in a segregated account.
  5. If default occurs, the assets of the SPV are used to meet the insurer’s losses.
36
Q

Structured products

A

A structured product is a pre-packaged investment strategy in the form of a single investment.

37
Q

Two components of a typical structured product

A
  1. A note - essentially zero-coupon debt security that provides capital protection.
  2. A derivative component that provides exposure to one or several underlying assets such as equities, commodities, FX or interest rates.
38
Q

Index funds

A

An index fund is an ‘open-ended’ unitised collective investment scheme that that attempts to mimic the performance of a particular index.

39
Q

Describe ETFs

A

ETFs exhibit features that are like investment trusts in some ways and unit trusts in others. They trade at NAV. and rarely at discount, yet they are quoted on the stock market and can be traded in real time

40
Q

Contract for Difference (CFD)

A

A CFD is a contract stipulating that the seller will pay the buyer the difference between the current price of an asset and its value at a specific time.

41
Q

The different types of infrastructure projects: (2)

A
  1. Social

2. Economic

42
Q

Disadvantages of private equity to institutional investors (7)

A
  1. lack of liquidity and marketability
  2. variable past performance record
  3. difficulty in valuation
  4. need for specialist investment advice
  5. high costs
  6. lack of reliable information
  7. regulatory constraints
43
Q

The risks of an investment in infrastructure may be generally divided into: (2)

A
  1. those specific to the infrastructure asset and

2. those affecting the broader asset class

44
Q

Asset specific risks to an infrastructure investment: (3)

A
  1. market/ economic risk
  2. regulatory risk and political risk
  3. operating risk
45
Q

Energy commodities: (3)

A
  1. Crude oil
  2. Heating oil
  3. Natural gas
46
Q

Precious metals: (3)

A
  1. Gold
  2. Platinum
  3. Silver
47
Q

Base metals: (7)

A
  1. Aluminium
  2. Al Alloy
  3. Copper
  4. Lead
  5. Nickel
  6. Tin
  7. Zinc
48
Q

Agricultural commodities: (6)

A
  1. Cocoa
  2. Coffee
  3. Sugar
  4. Potatoes
  5. Wheat
  6. Barley
49
Q

Meat & livestock: (3)

A
  1. Live cattle
  2. Lean hogs
  3. Pork Bellies
50
Q

Carbon credits

A

Carbon is a regulatory derived commodity.

51
Q

Advantages of structure products: (5)

A
  1. Practical
  2. Legal
  3. Tax
  4. Accounting
  5. Favourable expected return/risk profile
52
Q

undrawn commitments:

A

undrawn commitments include amounts committed to investments but not yet drawn.

53
Q

Distinguishing characteristics of Infrastructure assets: (4)

A
  1. The assets themselves tend to be single purpose in nature, such as a gas pipeline, toll road or hospital
  2. The private investor’s participation in the asset is often for a finite period.
  3. Infrastructure assets are characterised by their long lives - high upfront capital costs with payback occurring over the asset’s lengthy life.
  4. They tend to be, or exhibit the characteristics of natural monopolies.
54
Q

Distinguishing characteristics of Infrastructure assets: (5)

A
  1. The assets themselves tend to be single purpose in nature, such as a gas pipeline, toll road or hospital
  2. The private investor’s participation in the asset is often for a finite period.
  3. Infrastructure assets are characterised by their long lives - high upfront capital costs with payback occurring over the asset’s lengthy life.
  4. They tend to be, or exhibit the characteristics of natural monopolies.
  5. Subject to varying degrees of government regulation.

1. F105 - Finance and Investment Principles (24 decks)

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