CH:11 Other investment classes

Question 1

6 Features of Investment trust companies (ITCs)

Answer 1

• Stated investment objectives
• Funds are closed-ended
• investors buy shares in an ITC, priced by supply and
• demand
• Public companies, governed by company law
• Gearing is allowed
• Share price often stands at a discount to net asset
  value (NAV) although it can stand at a premium

Question 2

6 Key features of Unit Trusts

Answer 2

• Stated investment objective
• investors buy units in a UT, priced at a net asset value
• (NAV).
• Funds are open-ended
• They are trusts, governed by trust law
• Limited power to use gearing (ie to borrow)
• Guaranteed marketability

Question 3

Disadvantages of collective investment schemes vs direct investment (5)

Answer 3

• Lack of diversification away from equities
• Loss of control
• Management charges incurred
• Extra volatility caused by gearing / discount to NAV (ITCs only)
• Tax disadvantages are possible

Question 4

Advantages of CIS over direct investment

7

Answer 4

• useful for obtaining specialist expertise
• easy way of obtaining diversification
• some of costs of direct investment are avoided
• holdings are divisible
• tax advantages
• marketability advantage
• track return on specific index

Question 5

What are the differences between closed-ended and open-ended CIS’s

7

Answer 5

• marketability of shares of closed-ended is less than the marketability of their underlying assets. Marketability of unit is open-ended is gauranteed
• gearing of closed-ended funds can make their share price more volatile than the underlying equity. Most open-ended funds cannot be geared
• it may be possible to buy assets at less than net asset value in a closed-ended scheme
• increased volatility of closed-ended funds mean higher expected returns
• may be uncertainty of true value of net asset value of closed-ended as investments could be unquoted
• closed-ended may be able to invest in a wider range of assets
• tax differences

Question 6

Uses of Derivatives (4)

Answer 6

• Reduce risk (hedging)… market or credit risk
• aid in asset allocation
• speculation… increase risk to enhance returns
• arbitrage

Question 7

Functions of the exchange

Answer 7

• Set the details of standardised contracts
• Authorise who can trade on the exchange
• Bring buyers and sellers together
• Operate sub-institution called the clearing house

Clearing house guarentees each side of the original deal, removes credit risk to both parties.

Question 8

Why would the share price be at a discount to NAV in an Investment Trust Company (ITC)

Answer 8

• Shares in the ITC are less marketable than the underlying assets
• Investors do not rate the managers very highly
• Reflection of ITC charges
• investors get access to underlying assets cheaply
• market sentiment

Question 9

Name four ways to gain access to overseas markets

Answer 9

1. invest in the multinational country based in the domestic country
   - Easy investment
   - Expertise in overseas markets (they will invest in the profitable areas)
   - Overseas earnings are diluted by domestic earnings
   - No investment control on where the company invest
   - Effectively a domestic company, so shares are expected to move in line with domestic market
2. Invest in domestic companies with large amount of export trade
3. Collective investment schemes specialising in overseas investment
4. Derivatives based on overseas assets

Question 10

Factors to consider of investing in emerging markets

10

Answer 10

• current market valuation
• possibility of high economic growth rate
• currency stability and strength
• level of marketability
• degree of political stability
• market regulation
• restrictions of foreign investment
• range of companies available
• communication problems
• availability and quality of information

Question 11

What are the problems with overseas investment

Answer 11

• mismatching risk
• currency fluctuation risk
• increased expertise needed
• additional administration functions: custodian, dividend tracking and collection
• different tax treatments
• different accounting practises
• less information may be available
• language problems
• time delays
• poorer market regulation in some countries
• risk of adverse political developments
• liquidity
• restrictions on ownership of certain shares