quiz 2 Flashcards
Role of funds managers?
How they contribute to functions of finance?
Cost involved?
Who has the investment risk?
Pool investor funds and arrange collective investment
Contribute to flow of funds function through direct financing
Cost = fees paid to funds manager
Risk remains with contributor
Main groups of fund managers?
supperannuation, life insurance, public unit trusts
Asset classes for funds management investments
equities and units in trusts interest earning securities cash and deposits overseas assets alternative investments
Supperannuation... Long or short term? two types of schemes? Which has higher impact: Contributions or rate of return and compounding? Two types of asset classes? Two types of investment strategies?
Long-term
Accumulation schemes = produce lump sump dependant on contribution sizes and rate of earnings
Defined benefit schemes = pay specified benefit (either as lump sum or pension) to retiree
Rate of return and compounding
Growth assets = equity and property securities with high risk and high return
Defensive assets = low risk and low return bonds, bank deposits and money market securities = rarely experience negative returns
Balanced portfolios = balanced mix between growth and defensive assets
Growth portfolios = favour growth assets
Supperannuation…
Three groups comprising the supperannuation industry
What are trustees?
NFP schemes by employers (corporate or public service schemes) and trade unions (industry schemes) (APRA)
FP schemes = professional fund managers (retail schemes = also have lower returns due to higher fees) (APRA)
self managed funds = operate under ATO rules) ( invest less in equities and more in bank accounts)
Trustee = have fiduciary duty of care to a schemes members and are licensed and supervised by APRA. they ensure investment managers allocate funds according to each contributors choice and in a manner consistent with the trust deed to maximise accumulated sum.
Public unit trusts... regulator? what? how it works? Purpose? costs? benefits?
regulator = ASIC what = collective investment schemes that raise funds by selling units to the public, which represent a share of their assets works = funds allocated by trust investment manager = assets specified by trust deed = trustee oversees Purpose = established by financial institutions to earn fees costs = entry and exit fees and management fees benefits = provide investors with access to whiolesale markets + expertise of professional managers + provide liquidity through ASX listing or trading with investors
types of Public units trusts…
Two types
Two sub types for each type + outline
traditional public unit trusts + alternative investments
Traditional PUT = property or equity
AI = hedge funds or private equity funds
Property trusts = established by financial institution or property developer to acquire large properties = most ASX listed = close ended (set number of units) = unit holders get revenue less fees = debt funds which expose unit holders to interest rate risk and funding risk
Equity trusts = invest in shares = income, balanced or growth objectives = open-ended = usually unlisted
Hedge funds = complex investment strategies and high levels of debt = charge performance fees and management fees = aggressive managers seeking high returns and taking large risks = long or short strategies, derivatives, high frequency trading. = small in AUS and ASIC regulated = Funds of hedge funds are hedge funds investing in hedge funds to diversify investment.
Private equity funds = aqcuire companies to improve their financial performance and then resell for profit = large debt = lack liquidity
4 benefits of collective investment?
Access to wholesale investments
Economies of scale that lower transaction costs, such as research and trading commissions
Diversified investments that lower risk for an expected rate of return
Investment expertise
Outline two approaches to investment management?
Active = not consistent with EMH = seek to outperform market through asset selection and timing of trades = higher costs = identify under or over valued assets to buy former and sell latter = technical analysis (historical data + not strong evidence, yet still widely used + momentum or contrarian investors: M - buy when price rises believing will continue to do so C - buy when price falls believing it has fallen too much believe markets overreact to news) or fundamental analysis (calculate PV of expected future payments)
Passive = consistent with EMH = seek to form index funds that aim to replicate the return on a benchmark index = lower costs = for even lower costs hold fewer shares and accept small tracking error = management expense ratios usually half of active funds.
How to assess performance of fund managers?
Why use fund rating agencies?
How fund ratings agencies work?
Can higher-rated managers continue to outperform always?
Contrast performance of active and passive investments.
assessed in terms of the returns achieved given the risks taken = comparisons between managers in the same asset class Fund rating agencies = because returns are unstable and past returns are not usually a good indicator of future returns Fund ratings agencies = managers rated on quantitative risk and return history and qualitative assessment of managers abilities No = they can continue to outperform, but not consistently. Passive = achieve higher after-fess returns Active = Some active can outperform passive for a number of years, or within a particular asset class
Who is the venture capital market for?
Who invests capital?
Business angels?
Venture capital fund managers?
Who = Emerging firms aspiring to grow into large companies
Who = Patient, risk-taking investors
Business angels = participate in running of firm during development stage
venture capital fund managers = raise funds from super funds, insurance companies, banks and wealthy individuals = invest across multiple new businesses to spread risk = usually represented on the board = harder to attract this type of investment capital (many firms fail to appeal to CVFMs)
When is a firm considered investment ready?
What does this mean for the firm and alternatively for capital investors?
Are Venture capital investments low risk low return?
Achieved substantial size
effective management structure
produce regular financial reports
history of profitability
Firm can now raise capital through IPO and IPO can allow venture capital investors to exit
No they are high risk and high return = can completely loose amount invested
7 features of ordinary shares?
represent ownership of company no maturity date can have ownership transferred limited liability entitle owner to share of profits entitle owners to vote in company elections potential for capital gains
4 features of preference shares?
represent ownership of a company
pay promised dividend which have priority over ordinary dividends
have restricted voting rights
variety of features like non-participating, cumulative, converting, redeemable
is assessing a shares value easy? Approaches for doing so? How to interpret P/E ratio? What does P/E ratio reflect? Industry P/E's? Assumptions of P/E future share price estimation technique?
No = uncertainty of future payments
technical analysis or fundamental analysis
fundamental analysis = factor in risks to determine share present value = top-down assessment (global economy»_space; economy»_space; sector»_space; industry»_space; firms management) = bottom-up (P/E ratios and/or gordon’s dividend growth model)
High P/E = may mean expected earnings will grow quickly
Low P/E = may mean earnings are risky
P/E ratios = reflect market’s assessment of the future growth rate in the firm’s earnings and the riskiness of that growth.
Industry P/E’s provide a benchmark against which individual shares can be compared
Assumptions = change in earnings is permanent + P/E ratio is unaffected by changed earnings.
Under the capital asset pricing model explain each of the three terms?
Return on Risk-free = current risk-free rate, such as yield on treasury bills
Return on market = return on the market protfolio
Beta = systematic risk = riskiness of share relative to riskiness of market
IPO?
Are institutional investors only interested in small IPOs?
Who arranges IPOs and are they expensive?
3 advantages of an IPO and 4 disadvantages
IPO = first issue of shares to the public by a company for the purpose of posting on an exchange = raises additional capital to fund growth and/or allows some or all of the owners to sell some or all of their investment.
No = they are interested in large IPOs
yes expensive and investment banks and stockbroking firms arrange them
Advantages = additional equity, provides liquidity, enhances company capacity to remunerate management and employees
disadvantages = expensive, ownership dilution of continuing owners, agency costs from separation of ownership and management, encourage a short-term performance bias
4 steps of an IPO? Rules for a prospectus are set by who? Purpose of a prospectus? 3 marketing phases? Can a conflict of interest occur between financial analysts and IPO managers?
Firm selects a manager (arranger) for the IPO
The issue documents including the prospectus are prepared
financial statements are prepared and audited
Due diligence is performed - meaning any claims made in the prospectus are verified
Rules = ASIC (and ASX) Prospectus = provide potential investors with accurate and comprehensive information + to help in marketing of the shares
marketing phases = pre-marketing, Road shows (presentation of securities to potential buyers) and the taking of orders via the bookbuild (support price discovery by recording investor demand for shares), determination of issue price and allocation of shares
Yes = because their recommendations may be biased
Contrast 3 elements of the pricing and timing of smaller and larger IPOs
Underpricing occurs because…?
small = setting price is difficult because less IPOs to compare with large = usually have better information
small = conducted on best-efforts basis (gives managing bank incentive to set a low price large = use the bookbuild process to set the price
small = little choice about timing large = time issues with bull markets
Under-pricing = desire for successful IPO, benefit retaining owners, provide buyers of IPO with capital gain to encourage further equity investment, etc…
3 ways of raising additional equity through shares for a firm
1 way of raising new equity not through shares
Private placement = quick and cheap = higher price per share received usually = can be made to those who support current board = dilute existing shareholder ownership and are limited by ASX rules
Rights issues = rights in proportion to shares held = rights allocated on ex-rights date = subscription price below current share price = usually renounceable (can sell, trade, etc.) = raise large amounts = risk of failure if current price falls below subscription (can be underwritten to prevent loss) = requires prospectus and is expensive.
Dividend reinvestment schemes =
not through shares = retained earnings
Role of ASX?
Role of ASX as a secondary market?
ASX = determines and enforces rules for listed securities + trades ordinary and preference shares, units in listed trusts, corporate bonds, options, warrants and CFDs
ASX as secondary market = performs price discovery, provides investors with liquidity, develops pool of investors.
4 features of price discovery in the share market?
Determines entry and exit value for investors
Values the equity of listed companies
helps determine the price for newly listed securities
has indices that reveal general movements in equity values
Explain the market for corporate control and its effect on economy?
Corporate governance?
In which way is the markets assessment of a companys management reflected?
market discipline?
low share price = company bought out = new management is better = company becomes successful = promotes efficiency in economy.
corporate governance = management of a business, supervision and accountability of that management , and ways stakeholders can influence decisions.
reflected = in share price
market discipline = occurs when changes in share price influence the behaviour of senior management.
Who is responsible for ensuring market efficiency and fairness in the share market? Who is the supervisory body? How are opening and closing prices set? Open from when to when? Trades conducted by who?
ASX ASIC Auctions 10am - 4pm Trades by brokers who act as agents for their clients
Outline 6 admission rules for a company to list their securities
And 1 continuing rule (important 1)
Constitution new issues cant disadvantage existing security holders Prospectus lodged with ASIC Trusts registered minimum number of shareholders satisfy profits or assets test
Continuous disclosure of price sensitive information
Three parts of ASX Trade?
Limit vs at-market orders?
How are unfilled limit orders processed?
Tradematch - the main trading platform
Volumematch - for high volume orders
Purematch - for high frequency algorithmic trading
Limit = set a specific value and wait for order to be filled at that value
At market = buy or sell however much you want of whatever is currently available.
unfilled limit orders go to the central order limit book where they are ranked by price and time at each price
What is the transfer and settlement system used by the ASX?
Outline transfer and settlement on the ASX?
What is a share register?
CHESS
Changes in share ownership are recorded electronically and settlement occurs in T+2 days
Companies must keep a register of their shares to communicate with shareholders, to verify voting rights and to pay dividends. However most companies outsource this duty to service providers such as ComputerShare
is there a relatively low turnover of shares in the share market? if so what does this reflect?
Which types of companies listed have the highest liquidity?
Yes, reflecting a buy-and-hold attitude
Large-cap companies are much more liquid = represented by supperior price resilience, narrower spreads, and a greater daily turnover
what does SPI stand for?
How do SPIs contribute to price discovery
Two features of most SPI?
How to calculate market capitalisation?
How does an SPI work?
Which factor must be neutralised for an SPI to correctly reflect share price movements?
Why would an accumulation index be a better benchmark for investment returns?
Share Price Index
They reveal general price movements in share markets against which the performance of individual shares and active fund managers can be measured
They are broad (include many shares) and are Weighted by value
Market capitalisation = share price x shares
SPI works by showing the increase in the indices’ market capitalisation over a base period for a particular subset of listed shares
Must neutralise company’s listing more shares as this does not accurately represent a value change even tho it represents a market capitalisation change.
Accumulation = because SPIs do not include dividends paid whereas an accumulation index would.
What is intermediation?
Two distinguishing features of intermediation?
Indicator for the cost of intermediation?
Intermediation = traditional role of ADIs to accept deposits in order to fund loans
1 = seperate contracts with surplus and deficit units 2 = net interest income = difference between interest income from supplying funds to deficit units and the interest paid to surplus units.
Indicator = net-interest rate margin = difference between average interest rate earned and average interest paid by ADIs on their funds
Five subgroups of ADIs as per APRA?
Credit unions Australian owned banks Foreign subsidiary banks Branches of foreign banks Building societies
5 sources of bank funding in order of size largest to smallest?
What impact did the GFC have on how banks source funds?
domestic retail deposits short term securities (wholesale) long term securities (bonds) equity securitisation
GFC = change in major source of funds from the financial markets to domestic retail deposits (more reliable) = banks started paying higher interest rates to attract more deposits
Three characteristics of retail deposits?
Three types of accounts?
1 = very safe (APRA constrains risk taking by ADIs and government guarantees deposits of up to 250,000) 2 = they are liquid 3 = pay interest and/or provide non cash benefits such as payment services
at call accounts (complete access), savings accounts and fixed term accounts
How do banks raise funds in the domestic financial markets (2 ways)
Calculate value of an NCD? Calculate value of an NCD when sold?
in the money market through negotiable certificates of deposit (NCD) = NCD: wholesale deposit that has a fixed term with an agreed interest rate that can be traded in the money market = can be traded but not withdrawn before maturity
in the bond market through unsecured bonds
NCD = simple interest so simply use F = P(1 +(r x n/365)
NCD when sold = P = F/(1 + (r x remaining n / 365))
How do banks raise funds in the overseas wholesale markets?
Also note that overseas funds are greater than domestic funds for the major banks and overseas-owned banks.
How do banks hedge the exchange rate risk?
- Unsecured medium term bonds
- Long term covered bonds (bonds collatorallised by a parcel of bank assets)
Hedge risk = they swap the issued bonds (mostly in USD) into AUD
3 uses of funds in order of dominance?
Loans and advances = loans for housing and business purposes have the variable rate set so as to cover the cost of funds, operating costs, and profit margin.
Securities
Other assets
What are the types of loans made by ADIs in order of dominance?
What is a reducible structure and where is it used? How would you calculate loan repayments under a reducible structure?
Are housing loans standardised, if so what does this mean?
What constitute the liquid securities held by banks?
Why do banks hold liquid securities as a use of funds (3 reasons)?
Housing loans»_space; Business loans»_space; Personal loans and credit card debt (secured or unsecured)
Reducible structure = for house loan repayments = loan is repaid over its term. Whereas for investors the loan will be interest-only and will be repaid at maturity = to calculate loan payments simply use the PV annuity formula.
yes they are = a standardised product with standard features and interest rates for all borrowers
money-market securities, government bonds, notes and coins, ES fund and loans to the overnight market
1 = as a store of liquidity 2 = to trade in markets 3 = as secure (low-risk interest earning investments
For housing loans Australia has high lending standards which have resulted in low loan losses (including during the GFC). What are the four components of our lending standards?
1 = secured by a mortgage 2 = not more than 80% of the propertys value (LVR cant exceed 80%) 3 = made to borrowers with the capacity to repay 4 = supported by documentary evidence
Mortgages provide lenders the right to take possession and sell an asset if the borrower defaults on loan payment. This results in 4 advantages, what are they?
1 = helps lenders to avoid adverse selection 2 = shifts the default risk from the lender tot he borrower 3 = reduces the amount of a lenders loss given default 4 = lowers interest rate for borrowers
What are the differences between loans to small businesses by ADIs and large value loans?
smaller loans = standardised and usually secured
Larger loans = commonly term loans using a revolving credit facility + security provisions such as negative pledges, loan covenant and mortgages.
What is a bill of exchange?
What is bill acceptance?
What risk is involved in bill acceptance?
Outline the arrangements between the three parties to a BAB
How to calculate BPS?
How to calculate acceptance fee?
bill of exchange = promise by borrower to pay the bills face value at the specified future date
bill acceptance = a promise by a bank to redeem a commercial bill (a bill of exchange) if the borrower defaults on this payment
Banks are exposed to borrowers credit risk
A borrower draws a bill, an ADI accepts the bill, an investor purchases the bill from the ADI, the ADI supplies the borrower with their funds from having just sold the bill less the fees they charge
BPS = 0.0001 x amount i.e. 130 bps = 1.3% = 0.0130
To calculate acceptance fee first find the price paid by the buyer using simple interest formula then subtract this amount from the amount received by the borrower which is calculated using the simple interest formula but (1 + r x n/365) becomes (1 + (r + BPS) x n/365)
What is a bill facility?
What payments are made at each rollover date?
What is securitisation?
Who conducts the process of securitisation?
An agreement by the acceptor to rollover bills on their maturity date for an agreed period = new bills are issued to raise funds to repay the maturing bills
Interest payments = equal to face value less the proceeds from the replacement bill
Securitisation = process of assigning cash flows from illiquid assets to securities that are sold to investors
Special purpose vehicles who issue mortgage-backed securities = Essentially bank sells a parcel of loans to the SPV who securitises the loans as an MBS to be sold to investors. The funds made from selling the MBS fund the purchase of the loans in the first place.
mortgage originators?
outline the process or mortgage origination
non bank lenders who arrange housing loans with funds that are raised through the issue of mortgage backed securities
Loan originator (aussie home loans) makes a loan to a housing loan home borrower with funds supplied from a securitizer (Trustee, investment manager) whos funds are come from selling the security to an investor. loan repayments travel back to the investor.
Listed vs unlisted trusts
listed = listed on exchange = liquidity + price discovery = closed-ended (fixed number of units are traded between investors
unlisted = open ended = entry and exit values determined by the trust rather than by market
