Topic 7: Other Direct Investments

Question 1

Direct investment in shares is low risk for individual investors because, over the long term, equity markets have outpaced inflation. True or false?

Answer 1

False. Direct investment in shares is regarded as high risk because if the company fails, the entire investment is at risk. It is difficult for most investors to spread the risk effectively between a large number of companies and sectors.

Question 2

Name three factors that can affect share prices

Answer 2

Factors include company profitability, the strength of the global and UK economy, the strength of the market sector and the supply of and demand for shares

Question 3

What are the implications for the purchaser of buying shares ex‑dividend?

Answer 3

They will not be eligible for a dividend payment in the first distribution of shares following their acquisition of the shares. The previous owner of the shares will receive this dividend payment.

Question 4

A share with a low P/E ratio is likely to be more expensive than other shares in the same market sector. True or false?

Answer 4

False. A low P/E ratio indicates that the share is not in high demand and it is likely to be less expensive than other share

Question 5

If a company distributes 25 per cent of its profits in the form of dividends to its shareholders, what would the dividend cover be?

a) 4
b) 8
c) 10
d) 25

Answer 5

4 – the profit is four times the dividend paid out.

Question 6

What is the difference between a rights issue and a scrip issue?

Answer 6

A rights issue involves offering existing shareholders the opportunity to buy additional shares in order to raise additional capital. A scrip issue involves issuing additional shares to shareholders free of charge, the effect being to increase the number of shares in issue and reduce the share price proportionately; no additional funds are raised.

Question 7

Elliott is considering investing in a buy‑to‑let property. He thinks this is a good way to achieve a high return. What are the main drawbacks that Elliott should be aware of?

Answer 7

1. Suitable tenants may be hard to find.
2. Properties must be in desirable locations (eg good transport links, access to local amenities, etc).
3. In times of recession, letting properties may be difficult and property prices may fall.
4. Property is less easy to realise than most other forms of investment.
5. Investment costs tend to be high and can include management fees, legal charges and stamp duty.
6. Government measures to discourage BTL have made the tax position less advantageous

Question 8

How can a buy‑to‑let investor claim relief for wear and tear on furniture?

Answer 8

They are allowed a furniture replacement relief, which allows the actual cost of replacing furnishings to be offset against profits.

Question 9

Treasury bills are zero‑coupon securities. What does this mean?

Answer 9

They do not pay interest; instead they are issued at a discount to their par value.

Question 10

Commercial paper is generally issued for a term of between three and six months. True or false?

Answer 10

False. Commercial paper is generally issued for between 5 and 45 days, with 30–35 days being typical. Certificates of deposit are generally issued for between three and six months