Investment Flashcards
Saving
The setting aside of income for future use.
Investment
Capital formation. “Additions to the nation’s stock of buildings, equipment and inventories.”
The act of investing
The use of resources that have been freed from current consumption to develop goods or assets that will produce earnings or add to future production.
What must be done in order for saving to be economically valid?
Money must be invested
Two types of investment (from an individual)
- Investment in the means of production
- Purely financial investment
Explain: Investment in the means of production
Providing money to a company who will invest the money.
Explain: Purely financial investment
Only title transfers without constituting an addition to productive capacity.
Two primary ways in which an investment can increase
- Payments in return for the use of money. (Interests or dividends)
- Increase in the capital value of the asset.
Two ways in which governments borrow:
- Bonds (Long term)
- Bills (Short term)
Primary distribution (of securities)
The issue of shares or bonds to the public. (This first sale of shares or bonds is in the primary market, and the money received goes to the company.)
A secondary market
A market that comes into existence when investors in the primary market need to sell their shares or bonds.
Different types of investments
- Property
- Corporate bonds
- Government bonds
- Equities and equity-based investments
- Money market instruments
Key characteristics of an asset:
S: Security
Y: Yield (Return):
- Nature of return (real, nominal, fixed or linked to inflation)
- Expected return vs other asset classes
- Correlation of returns with other asset classes
- Currency of returns
S: Spread/volatility
T: Term
E: Expenses
M: Marketability (and Liquidity)
T: Tax (amount and timing)
“Real” asset
An asset who’s returns are linked to inflation
“Fixed” asset
An asset whose returns are fixed in absolute money terms
Term of an asset
Timing of proceeds expected from an asset: The later the proceeds are expected to be received, the longer the term.
Marketability of an asset
How quickly it can be sold without moving the price
Liquidity of an asset
How quickly and easily an asset can be converted to cash
Two types of government bonds:
- Fixed interest bonds
- Index-linked bonds
Fixed interest bonds
Provide payments that are fixed in monetary terms
Index-linked bonds
Provide payments that increase in line with changes in an inflation index.
Gross redemption yield
The internal rate of return gross of tax that will be earned by holding the bond until maturity.
Loan capital
Long-term borrowings of a company.
Debentures
Part of the loan capital of companies.
The bond-issuing company provides some form of security to holders of the debenture.
Money-market instruments
Tradable, short-term debt issued by governments, banks of companies.
Equities
A.k.a. ordinary shares.
Securities, issued by companies, which entitle their holders to receive all the net profits of the company after interest on loans and fixed interest stocks has been paid.
Preference Shares
Shares that offer a fixed stream of investment income.
Other than ordinary shares, preference share dividends are limited to a set amount which is almost always paid.
Convertible preference shares
Preference shares that give their holders the right to convert their preference share into ordinary shares on fixed terms on certain dates.
Direct property investment
The investor buys the physical properties which must be maintained and tenants found in order to produce a rental income.
A disadvantage of direct property investment is the large unit size, which limits the scope for diversification.
Indirect property investment
Participation in pooled property investment vehicles.
The investor buys units or shares.
Derivative
A financial instrument with a value dependent on the value of some other, underlying asset.
Futures contract
A standardised, exchange tradable contract between two parties to trade a specified asset on a set date in the future at a specified price.
Option
Gives an investor the right to buy or sell specified asset on a specified future date for a specified price.
Call option
Gives the right to buy a specified asset on a set date in the future for a specified price.
Put option
Gives the right to sell a specified asset on a set date in the future for a specified price.
American style option
An option that can be exercised on any date before its expiry.
European style option
An option that can only be exercised at expiry.
Yield curve
A plot of gross redemption yield on coupon paying bonds against terms of redemption.
Expectations theory
Describes the shape of the yield curve as being determined by economic factors which drive the market’s expectations for future short-term interest rates.
Liquidity Preference Theory
Base don the generally accepted belief that investors prefer liquid assets to illiquid ones.
Inflation Risk Premium theory
The risk premium should be greater for longer-dated stock to compensate investors for the fact that long-term estimates of inflation are much less certain than short-term estimates.
Market Segmentation Theory
Yields at each term to redemption are determined by supply and demand from investors with liabilities of that term.
Two fundamental ideas of market segmentation
- Different investors have different needs (liabilities of different terms). Therefore they are active at different terms of the yield curve.
- Price is a function of supply and demand, and yields are simply a function of price. Hence supply and demand determine yields.
Risk (Investment management term)
Expected variability of the return from an investment as measured by standard duration or volatility. (For investors with liabilities this definition needs to be broadened to include the probability of not having sufficient assets to meet their liabilities in the future.)
Investment strategy
The activity of choosing appropriate assets for an individual or institution.
It is largely a matter of choosing assets whose expected proceeds match the amounts, term, nature and currency of the liabilities, taking account of any expected future premium or contribution income.
Name three factors that affect the level of security of corporate bonds
Type of bond
Issuer
Term of the bond
Why are corporate bonds less marketable than government bonds?
Sizes of issues are much smaller
Name eight types of money market instruments
Treasury bill Local authority bill Bill of exchange Commercial paper Call deposit Term deposit Notice deposit Certificate of deposit
Rank the risk of preference shareholders not getting their dividends
Greater than the risk of loan stockholders not getting paid but less than the risk of ordinary shareholders not being paid.
Volatility of capital concerning LISTED pooled property vehicles
HIGHER than direct investment (despite diversification)
Who is the long party in a call option?
The buyer of the call option.
Buyer of the asset
Who is the long party in a put option
The buyer of the put option
Seller of the asset
Define a swap
A contract between two parties under which they agree to exchange a series of payments according to prearranged formula.
Two kinds of risks involved in a swap
- Market risk
- Credit risk
Name one of the biggest influences on investors expectations of future short-term interest rates
Inflation
Why does inflation have such a large impact on investors views of future interest rates?
If inflation is high the government is likely to reduce short-term interest rates in an attempt to reduce future inflation.
Define risk for common investors
The probability of not having sufficient assets to meet their liabilities in future
Name the 4 distinct asset classes
- Equities
- Property
- Bonds
- Cash
Which of the four main asset classes has the highest long term return and volitality
Equities
Which of the four main asset classes has the lowest expected long term return and volatility
Cash (Money-market instruments)
11 factors affecting investment strategy
- Nature of existing liabilities: fixed in monetary terms or real;
- Currency of existing liabilities;
- Term of the existing liabilities;
- Level of uncertainty (amount, timing) of the existing liabilities;
- Tax: position of investor and treatment of investments;
- Statutory, legal or voluntary restrictions;
- Size of the assets (relative to liabilities and absolute terms);
- Expected return, volatility, correlations for various asset classes;
- Future accrual of liabilities;
- Need for diversification;
- Institution’s objectives and risk appetite
2 Ways in which governments get money:
- Taxation
- Borrowing (issue bonds or bills)
2 Ways in which companies raise money
- Borrow (long or short term)
- Issue shares
A share decreases or increases in value for the following 3 reasons:
- the general economic and business climate
- the type of industry represented by the share
- the success of the issuing company
