Unit 1 - Topic 7 Other Direct Investments

Question 1

What are the 2 main rights of company shareholders?

Answer 1

1) they receive a share of the distributed profits of the company in the form of dividends
2) They participate in decisions about how the company is run, by voting at shareholders’ meetings

Question 2

What are securities?

Answer 2

Financial assets that can be traded - falling into 2 main categories

1) those that represent ownership (equities)
2) Those that represent debt (gilts and corporate bonds)

Question 3

What are dividends?

Answer 3

A portion of a company’s profits that is distributed to shareholders.

Question 4

What 2 factors affect the level of dividends payable?

Answer 4

1) the profitability of the company

2) Strategic decisions such as the need to reinvest profits to expand the business.

Question 5

Why is direct investment in shares considered to be high risk?

Answer 5

Because the failure of the company can result in the loss of all capital invested.

Question 6

What 4 factors affect share prices?

Answer 6

1) Company profitability
2) Strength of the market sector
3) Strength of the UK and global economy
4) Supply and demand for shares and other investments

Question 7

What are the two markets for buying and selling shares on the London Stock Exchange?

Answer 7

1) The main market - market for world’s leading companies

2) The Alternative Investment Market - market for smaller and growing companies

Question 8

What has to happen in order for a company to be listed on the main market in the London Stock Exchange?

Answer 8

1) Accurate financial and other information must be disclosed
2) The company must have been trading for at least 3 years
3) At least 25% of its issued share capital must be in the hands of the public

Question 9

What is the primary market of the London Stock Exchange?

Answer 9

(part of the main market) the primary market is where companies can raise finance by selling securities to investors - either by coming to the market for the first time (going public) or by issuing more shares to the market (flotation)

Question 10

What is the secondary market of the London Stock Exchange?

Answer 10

(part of the main market) the secondary market is where investors buy and sell existing securities

Question 11

What are the benefits for a company joining the AIM?

Answer 11

• allows them to raise capital by issuing shares

- companies can enjoy a wider public audience and enhance their profits

Question 12

What are share indices?

Answer 12

A way in which you can measure the overall performance of shares

Question 13

Outline the main 4 share indices

Answer 13

1) FTSE 100 - index of the top 100 companies (in terms of market capitalisation)
2) FTSE 250 - the next (after the FTSE 100) 250 companies (by market capitalisation)
3) FTSE 350 - the FTSE 100 and FTSE 250 companies combined
4) FTSE All-Share Index - an index of around 600 shares, split into sectors.

Question 14

What is market capitalisation and how can it be measured?

Answer 14

The market value of a company - calculated by multiplying the number of shares in issue by the share price

Question 15

What are ex-dividend shares?

Answer 15

Ex-dividend describes a stock that is trading without the value of the next dividend payment. The ex-dividend date or “ex-date” is the day the stock starts trading without the value of its next dividend payment.

Question 16

What is cum-dividend?

Answer 16

A share that is purchased before it goes ex-dividend - the purchaser will receive the next dividend payment.

Question 17

What are the two forms of financial returns that shareholders hope to receive?

Answer 17

1) the growth of the share price (capital growth)

2) the dividends they receive

Question 18

What are the 3 different ways of measuring the success of investment in a company’s shares?

Answer 18

1) earnings per share
2) dividend cover
3) price/earnings ratio

Question 19

What are earnings per share?

Answer 19

The company’s post-tax net profit/number of shares.

Question 20

What is dividend cover?

Answer 20

A factor to indicate how much of a company’s profits are paid out as dividends in a particular distribution. If 50% of the profits are paid in dividends, the dividend is said to be covered twice.

Question 21

What is price/earnings ratio?

Answer 21

Calculated as the share price/the earnings per share.

Question 22

What taxes are applicable in terms of shares/dividends?

Answer 22

Tax is payable on dividends above the available dividend allowance - IMPORTANT - DA should be included in the hierarchy transaction of calculating tax at the different tax rates. It should not be deducted first.

Tax is payable on the realisation of gains made by the sale of shares (CGT) however this can be offset against their annual CGT exemption.

Question 23

What are right issues?

Answer 23

Rights by which when a company decides to issue more shares, rules require the company to offer these shares first to the existing shareholders. They are offered at a discounted price to which the new shares are expected to commence trading.

Question 24

What can a shareholder do if they are offered a rights issue but do not want to buy more shares?

Answer 24

They can sell the shares to somebody else, in which case the sale proceeds from selling the rights compensates for any fall in value of their existing shares

Question 25

What are scrip issues?

Answer 25

An issue of additional shares, free of charge to existing shareholders. The company does not raise any additional capital by doing this, and the effect is to increase the number of shares and to reduce the share price.

Question 26

What are preference shares?

Answer 26

Similarly to ordinary shares, preference shareholders are entitled to dividends. The difference is they are generally paid at a fixed rate. Preference shareholders are also eligible for dividend payouts before ordinary shareholders. Preference shareholders hold higher in rank than ordinary, in regards to the company being wound up and needing to repay their debts. They do not get voting rights.

Question 27

What are convertible preference shares?

Answer 27

Convertibles are securities that carry the right to be converted at some later date to ordinary shares of the issuing company.

Question 28

What are warrants?

Answer 28

Warrants give the holder the right to buy shares at a fixed price at an agreed future date. The attraction is that they give the holder rights at a fraction of the cost of the shares themselves. It will be exercised as long as the share price is above the price at which the shares can be purchased under the terms of the warrant, at the date of the warrant.

Question 29

What are the benefits of investing in property?

Answer 29

• Property is a very acceptable form of security for borrowing purposes
• The UK property market is highly developed and operates efficiently and professionally

Question 30

What are the disadvantages of investing in property?

Answer 30

• location is very important and a badly sited development may prove a problem
• the property market is affected be overall economic conditions - in times of recession, letting properties may be difficult and property prices may fall
• property is a less liquid form of investment than most others

Question 31

What are the benefits of buy-to-let investment?

Answer 31

• Regular and increasing income stream can provide a hedge against inflation
• Easy access to ancillary services eg letting and property management agents
• Well-developed market
• Easy access to BTL mortgages

Question 32

What are the risks of investing in buy-to-let property?

Answer 32

• costs are high and there are additional costs for mortgages, legal fees and SDLT
• property is an illiquid investment meaning that it may be difficult to generate funds if they are required at short notice
• There may be periods where the property is untenanted, meaning that income is reduced or ceases
• There is a risk that tenants may damage the property, leading to additional costs
• Legal fees may be incurred to remove unsatisfactory tenants
• The property will require ongoing management and maintenance - more costs

Question 33

What measures has the government put in place to reduce the attractiveness of BTL as an investment?

Answer 33

1) Tax relief - before, landlords could deduct the full cost of mortgage interest payments from their BTL income when calculating profits - giving them a tax relief at the landlord’s highest tax rate. Now they can claim a tax credit at the basic rate only
2) Wear and tear - before landlords were able to claim an annual wear-and-tear allowance of the cost of furnishings. This is now a furniture replacement relief that only allows the actual cost of replacing furnishings to be offset against profits
3) Stamp Duty Land Tax

Question 34

What are some examples of commercial property?

Answer 34

• Retail units
• Offices
• Shopping arcades and shopping centres
• Industrial units
• hotels/leisure facilities
• mixed use property (offices with some residential)

Question 35

What are the advantages of investing in commercial property?

Answer 35

• regular rent reviews
• longer leases
• more stable and long-term tenants
• lower initial refurbishment costs

Question 36

What are the disadvantages of investing in commercial property?

Answer 36

• the higher the average value means that spreading the risk is more difficult
• doesn’t show the same growth in value that can often be achieved with residential
• if investment is needed to be funded by borrowing, interest rates are higher for commercial properties

Question 37

Name 3 Money-Market Instruments

Answer 37

1) Treasury Bills
2) Certificates of deposit
3) Commercial Paper

Question 38

What are treasury bills?

Answer 38

Short term redeemable securities issued by the DMO

They are:

• short term (normally issued for 91 days)
• they are zero-coupon securities. Instead they are issued at a discount to their par value
• low risk (gov guarentee)

Question 39

What are certificates of deposit?

Answer 39

• Issued by banks and building societies
• a receipt to confirm that a deposit has been made with the institution for a specified period of time
• interest is paid with the capital at the end of the term (typically 3-6 months)

Question 40

What are bearer securities?

Answer 40

Securities that are deemed to be owned by whoever physically possesses the document that confers ownership, rather than ownership being determined by an entry on a register

Question 41

What is commercial paper?

Answer 41

An unsecured promissory note - a promise to repay funds that have been received in exchange for the paper. - companies use these to raise shorter term funds that what might be gained from issuing corporate bonds.