Week 3 Flashcards
Principles of Investment: Investment objectives
represents the desired outcome in a specified time frame:
people differ in their objectives
people’s objectives can be influenced by many factors (eg. culture, age, attitude to risk)
guiding principle when setting objectives:
understand your client’s needs so you provide investment services they will value and appreciate
Principles of Investment: Investment strategies
is the means used to achieve the investment objectives:
investor allocates funds between asset classes; or
purchases products where this decision is made for them
Examples of Investment Objectives
Access Income Capital Growth Combination of income and capital growth Speculative Tax Driven Investments Philosophical Investing eg/Ethical/Environmental Educational Reasons- Investment Clubs
Principles of investment: Direct vs. Indirect
Direct investment occurs when investors make their own decisions where funds are ultimately placed.
Indirect investment involves investors placing their funds with fund managers.
Direct investment is very popular in Australia.
It is important to appreciate the nature and structure of the relevant markets
The choice of asset classes consists of the following:
cash
interest bearing deposits (domestic and international)
shares (domestic and international)
property
Selection into particular investments can be made directly or indirectly The selection of the appropriate asset class and mix of assets will depend on a number of factors relating to the client’s circumstances
Cash & Interest bearing investments (most familiar)
Commercial banks provide both at call deposit accounts and Term Deposit Accounts to all clients.
Subject to PDS, at call deposit accounts allow you to access your funds at any given time.
Term Deposit Accounts are deposits where if you leave your funds in the account for a fixed term you will earn a fixed rate of interest.
Asset classes: Cash & Interest bearing investments (most familiar)
current brands include:
Trust account, Cheque account, At Call investment account, Term Deposit Account
Asset classes: Non-Cash Payment Services
Online banking (Internet banking & Mobile banking) Rapid Response telephone banking BPAY bill paying service Visa Debit card Personal cheques Regular payments, Direct debit Customer loyalty schemes
Asset Classes: Types of fixed interest investments
Term deposits Treasury notes and bonds Indexed/adjustable rate bonds State/semi/local Government bonds Corporate bonds Bank and non-bank bills Promissory notes Convertible notes and hybrids Debentures Unsecured notes Fixed interest managed investments
Participants in cash and fixed-interest securities
Non ADI- Finance companies insurance companies funds managers private individuals ordinary businesses governments
Asset Classes: Bonds
Corporate bonds are long-term securities that pay regular interest at fixed rates on face value.
Government and semi-government bonds enjoy very good security ratings.
Trading of securities occurs in the primary market initially and later in the secondary market.
There is an inverse relationship between the price of a bond and interest rates.
The difference between selling price and the face value is the interest, hence bonds can be traded at a discount or at a premium.
The Nature of Markets-Fixed Interest
Essential features
Interest rate set at start of loan period
Fixed face value (principal)
All interest rates are based on cash rate which is the interest rate paid on money lent between commercial banks overnight.
Margins added to compensate lenders for increased risk and increased time to maturity.
The cash rate is managed by the RBA by manipulation of the money supply to inject or withdraw funds by buying or selling securities.
Fixed-interest investments can vary from immediate access to up to 20 years.
Two types of fixed-interest markets:
Money market (short term) - Discount
Capital market ( long term) - Bonds
Risks of Bonds
Credit risk
This is the risk that the issuer may not be able to pay back the money they owe on the bonds they have issued (also called ‘default’ risk).
Interest rate risk
This is the risk that the market value of the bonds will go up and down as interest rates go up and down. For example, if interest rates go up, the market value of corporate bonds will generally go down.
Liquidity risk
This is the risk that you won’t be able to sell your bonds when you want to at the price you want to because there aren’t many buyers for the bonds
.
Prepayment (or early redemption) risk
This is the risk that the issuer will redeem the bonds early if interest rates fall and the market price goes up. If this happens, you will be paid the face value of the bonds (you may have paid more for them or they may be worth more on the secondary market)
Example
A security with a face value of $1000 has 180 days to maturity and sells now for $970. What is the discount at which the security is sold and the yield on the investment?
Discount= % below face value = 30/1000 x 365/180 = 6.08%
Yield= % return from an investment = 30/970 x 365/180 = 6.27%
Note : Fixed-term investments appeal to more risk-averse people because:
There are guaranteed interest payments at a given level.
The level of capital remains fixed which means there is a low risk of loss.
Asset Classes: Property
In Australia the rate of home ownership is one of the highest in the world.
As an investment, property can offer:
A stable income stream
Capital growth in excess of inflation over the long term.
Participants in the property market include: Investors as owners Residential tenants Commercial tenants Valuers, brokers and agents
Qualities and characteristics of property
solid form of investment land is scarce generally illiquid form of investment returns comprise both income and capital entry and exit costs may be high management and maintenance costs can be expensive high level of gearing possible taxation advantages prices less volatile property market cycles do not necessarily coincide with the share market — can offer diversification.
There are number of classes of property:
residential, commercial, industrial and rural
property Returns are dependent on
Type of property
Position of property
Continuity of rental stream
Cost of upkeep
TAXATION OF PROPERTY
Rental income is assessable income Legitimate expenses are deductible Investment in property has both CGT implications, and GST implications
Asset Classes: Shares or Equity
Represents an interest in / ownership of a firm.
Can share in a company’s successes and failures.
No guarantee of return on capital.
Payment by companies of dividends is optional.
Normally ranks last in event of liquidation.
Shares
Shares have historically offered higher returns than other asset classes, over the long term.
They can offer regular income.
They can provide strong capital growth.
Australian shares can offer the added tax benefit of dividend imputation.
Shares offer an investment of with limited liability.
Participants in the equities market include
Listed corporations Investors Brokers Hedgers Speculators Arbitrageurs
