Introduction Flashcards
Direct investment
Buying financial securities directly
Indirect investment
Holding financial securities indirectly through managed funds. Most common for retail investors.
Retail investors
Individual people who invest their own money in the market, rather than institutions or organizations.
Direct investment :
Money market securities
Short-term debt securities which mature n less than one year. E.g. treasury bills, certificates of deposit, commercial paper.
Direct investment:
Capital market securities
common stock (equity) and debt securities which mature linger than one year. E.g. ordinary shares which trade on the stock exchange.
Main stock exchanges UK
London stock exchange (LSE)
Additional Investment Market
Direct investment:
Bonds
Debt securities issued by companies or governments or transnational organisations.
Characteristics of a Bond
Usually have a fixed life and make regular coupon payments
Repay the face value of the bond (£100 in the UK) when the bond matures
Direct Investment:
Derivative securities
Securities where the security payoff depends on another asset. E.g. options
Call option
This is the right to buy an asset at a fixed price at a future date.
Indirect investment:
Retail funds
Designed for individual investors. Include mutual funds.
Mutual funds
A fund that pools money from shareholders to invest to purchase diversified portfolio of stocks, bonds, or other securities.
Priced once a day when the stock market closes.
Mutual funds characteristics
Offers diversification
Can be actively managed
Less liquid
Higher minimum investment required
What are open-ended funds in the U.K called?
Unit trusts or open ended investment companies (OEICs)
How is the price of an open ended fund determined?
By the Net Asset Value (NAV) which is calculated daily
What is the NAV?
A per-share value representing the value of a fund’s assets minus its liabilities
Do open end funds trade on financial markets?
No they are instead priced at the portfolios NAV at the end of each day.
Fama and Jensen (1983)
Argue that open end funds have lower agency costs as a result of not trading in financial markets.
Gruber (1996)
Argues that in open-end funds, any performance ability by the fund managers is not priced
How does the number of units in an open end fund change?
It fluctuates daily with investor demand.
When investors want to buy the fund will issue new units. When they want to sell the fund will buy those units back.
Main costs associated with an open end fund?
Up-front sales charged, annual expenses, and trading costs.
What is liquidity based trading?
When fund managers trade to meet investor redemptions (investors selling) or purchases.
Liquidity based trading analogy: Smoothie shop
If lots of people come in asking for smoothies (investors buying the fund), the shop needs to buy more fruit (buy investments).
If people start asking for refunds (investors selling the fund), the shop has to sell fruit quickly to get the money to give back.
Downsides of liquidity based trading?
It can hurt fund performance (Edelen (1999) and can force funds to sell assets in times of market turmoil.
Exit charges
Some open-end funds include exit charges (aka redemption fees) when an investor chooses to sell their shares of withdraw investment.
What’s the point of exit charges?
To cover costs associated with processing the redemption.
Can protect the fund from losses due to premature withdrawal.
What are closed-end funds (CEF) also known as in the UK
Investment trusts
How do CEFs differ from open-end funds?
CEFs trade on stock exchanges and have a fixed number of shares.
What happens when CEF price doesn’t equal NAV?
It trades at a premium or discount.
*Premium when CEF price > NAV
*Discount when CEF price < NAV
Trading at Premium
Means investors are paying more than the actual value of the assets
Why would a fund be trading at a premium?
*Skilled manager
*Fund holds hot assets
*Strong demand
Trading at a discount
Investors are paying less than the actual value of the assets.
Why would a fund be trading at a discount?
*Poor performance
*Low demand
*High fees
*Management concerns
CEF advantages?
Provides liquidity
Use leverage
Can hold less cash
Hold illiquid assets
Avoids liquidity trading
CEF disadvantages?
Higher agency costs
Difficult to manage fund manager performance.
Exchange traded funds (ETFs)
A collection of assets.
Instead of buying 500 individual stocks, you buy a share of one ETF that contains all of them.
Priced multiple times a day.
How are ETFs similar to CEFs?
They trade on stock exchanges.
How do ETFs differ from CEFs in pricing?
ETFs are less subject to CEF discount/premium as they have mechanisms to keep the price close to the NAV.
Are EFTs actively or passively managed?
Mostly passively managed, but some active EFTs exist.
Main ETF costs?
Annual expenses
Trading costs
Institutional funds
Investment vehicles specifically designed and accessible for large institutional investors
5 types of institutional funds?
.Pension funds
.Insurance companies
.Hedge funds
.Private equity funds
.Sovereign wealth funds
