Direct Investments Flashcards
Cash - basic features
- no capital growth
- £85,000 FSCS limit per person per institution
- temporary high balance limit of £1mn for inheritance, sale of house etc
risks:
- default
- inflation
- interest rate
- Exchange rate (FX accounts)
Cash - T Bills features
- minimum investment £500k
- 90 day holding
- issues at discount to redemption value
- issues as £100 bill
- issues by DMO
- risk free / government backed
Cash - certificates of deposit features
- bank to bank lending
- £500k minimum
- 30 days to 5 years
- risk is higher as not government backed so coupons are higher
- rates based on libor
- offer at discount to PAR (price at redemption)
Cash - commercial bills features
- short term lending to companies
- discount to par
- £500k minimum
- higher risk than T bills
- less liquid than T Bills
Cash - peer to peer lending
- can be used against PSA
- since 6/4/16 has been covered by FSCS but only in certain circumstances and if done on an advised basis
Fixed interest - gilts - characteristics
- coupon (interest) paid every 6 months e.g. 6% = 3% per 6 months
- £100 denominations
- issues by DMO at discount to PAR
- then bought/sold on secondary market
- before redemption date
- Interest is taxable
- can be used against PSA
- exempt from CGT if held directly
- can’t claim losses
- same for corporate bonds
Clean price = market value not including accrued interest
Dirty price = market price + accrued interest
C&D prices used to split CGT and Income
F.I. Interest/running/income/flat yield
- coupon /clean price x 100
- good to show income but takes no account for gains or losses
F.I. Gross Redemption yield
- first calculate interest yield
- (then profit or loss at redemption /number or years to redemption) / clean (market) price
E.g. coupon is 5% and clean price is £107.50
Interest yield = 4.65%
Redemption yield = (if 5 years to redemption) = -(£7.50 /5) / £107.50. X 100 = -1.4%
Therefore Gross redemption yield = 4.65% - 1.4% = 3.25%
F.I. Risks
- interest rate
- liquidity
- reinvestment
- inflation risk
- currency
- default
- systematic / market risk
- non systematic (specific ) risks
F.I. Volatility of bonds
Most volatile = undated stocks
For Dated stocks the most volatile are:
- Lower coupon
- longer period to redemption
Most of return comes from a bond in the later stages so is more volatile if longer dates as exposed to interest rate changes for longer
The holder of a bond with a higher coupon will receive return on a bond more quickly than those of a low coupon bond.
The holder of a shorter dated bond will receive a return on the bond earlier than the holder of a longer dated bond. Also it is exposed to Interest rate movements for a shorter time
What is meant by Duration / Macauley’s duration of bond? (5)
Duration
- period of time
- in years
- taking account of all coupons and capital
- to repay the initial outlay
-used to measure sensitivity of FI investment to changes in interest rates
F.I. Modified Duration
(Macaulay’s) duration / (1+GRY)
To show effect of 1% change in interest rates on bond =
Modified duration x 0.01 x clean price
- shows change in bond value in £’s
- if interest rate increases then value will be a negative figure
Bond yields - what does a flat yield curve show? (3)
- longer dates bonds have same interest rates as shorter dated
- interest rates are not expected to rise
- inflation is expected to remain the same
- low economic growth expected
Explain 5 risks of peer to peer lending (5)
- no FSCS protection
- lack of liquidity
- default / credit risk
- lack of transparency
- counterparts/ platform solvency risk
- new industry so no experience of how it may withstand an economic downturn
Main differences between the listing requirements of AIM and main market (6)
- no minimum capitalisation requirement for AIM
- no minimum amount of shares in public hands for AIM / 25% for main market
- No trading history required for AIM / main market 3 years trading history required
- broader range of accounting standards applicable
- AIM has a more relaxed reporting timeframe
- AIM is higher risk
3 advantages and 3 disadvantages of investing in art (6)
Advantages:
- pride in possession
- uncorrelated to other assets
- diversification
- large gains possible
Disadvantages:
- don’t unusually generate income
- storage/ insurance costs
- value dependant on supply and demand
- demand driven by personal tastes
- uncertainty of if art is genuine / fraud risk
- specialist knowledge often needed
Bond yields - what does a normal yield curve show?
- uncertainty over future interest rates
- interest rates expected to increase
- inflation expected to increase
- think in terms of mortgage interest rates
Bond yields - what does an inverse / reverse yield curve show
- short term interest rates likely to be high
- longer term interest rates are expected to be lower
- inflation is expected to be lower in future
Factors effecting price of equities (6)
- supply/demand
- expected dividends
- interest rate changes (IR goes up then prices go down)
- market sentiment
- profit expectations
- mergers and acquisitions (company buying will see a short term price fall, company selling will see a short term price increase)
- systematic risk
- non systematic risk
- systemic risk
Factors effecting price of equities (6)
- supply/demand
- expected dividends
- interest rate changes (IR goes up then prices go down)
- market sentiment
- profit expectations
- mergers and acquisitions (company buying will see a short term price fall, company selling will see a short term price increase)
- systematic risk
- non systematic risk
- systemic risk
Structure of preference shares
- fixed dividend paid half yearly
- priority to dividends over ordinary shares
- no voting rights
- tank ahead of ordinary shares in liquidation
Types of PS:
- cumulative
- non cumulative
- participating
- redeemable
- convertible
Ordinary shares / A shares / deferred shares
- bulk of company share
- right to profits after preference shareholders
- vote at AGM
- last in line for assets on liquidation
- after all debts paid
- and other shareholder paid
A shares = as above but non voting
Deferred shares = no dividend until XYZ happens
Why would an investor invest in several bonds with different times to redemption? 6)
- reduces reinvestment risk
- reduces interest rate risk
- reduces default risk
- to meet future liabilities
- provide regular cash flow / spread out coupons
- diversification
Why may a bond be trading under par? (4)
- company may be struggling
- may default in coupon
- may not pay redemption value
- in a sector which is struggling/out Of favour
What is ‘accused interest ’ of a bond? (3)
- amount of interest earned
- since last coupon date
- it is added to purchase price of the bond
Why buy shares in a company rather than a bond and what are the additional risks? (9)
Why:
- higher yield
- potential for capital gain
- potential for increasing dividend
- open ended timeframe / avoids reinvestment risk
- diversification
- potential tax advantages
Risk factors:
- dividend not as secure
- share price could fall more than bond
- share price more volatile
- Lower priority on liquidation
Main differences in listing requirements between AIM and the main market and explain the risk implications (6)
- no minimum capitalisation with AIM
- no minimum percentage of shares in public hands / 25% with main market
- AIM no trading history required / 3 years with main market
- AiM has broader range of accounting standards / main market IFRS
- AIM has more relaxed reporting timeframe
- aim higher risk
Likely impact on bond in the event of a 1% increase in interest rates (5)
- bond prices will fall
- roughly 1% per year of duration
- coupons stay the same
- yields will go up
- bonds with shorter duration will fall less
- bonds with longer duration will fall more
5 benefits of Investing in commercial property (5)
- diversification
- uncorrelated
- can use gearing
- regular income from rents
- potential for real growth on income and capital
- possible to offset I come against borrowing costs for tax purposes
3 risks of commercial property in times of recession
- increases risk of void periods
- increases liquidity risk
- harder to attract tenants at a competitive rent
Main features of preference shares compared to ordinary shares 3
- fixes divs
- higher priority of payment of divs
- higher priority on wind up
- no voting rights
