Types of Securities

Question 1

What are the voting rights of ordinary shares?

Types of Securities

Answer 1

• 1 share = 1 vote
• Some have varying degree of voting rights in order to retain control
• Shares with different voting rights should be priced differently

Question 2

What are preference shares?

Types of Securities

(6)

Answer 2

1) Higher priority to claim than ordinary shareholders in dividend payment and in the event of liquidation
- They get in full before ordinary shareholders

2) Owning a preference share does not entitle you to more dividends, just ensures that you get the dividends first
3) Amount of dividend is fixed
4) Usually no voting rights

5) Cumulative vs non-cumulative
> Cumulative: Dividends not paid will be carried over to the next payment (usually the following year)
> Non-Cumulative: If cannot pay that year, the amount will not be carried over, you will still be paid at the same rate

6) Participating vs non-participating
> Participating: Possibility of higher dividends.
- There is a chance that the company may pay more than the stated amount
- Especially when the company wants to pay the common shareholders more dividends in good times
> Non-participating: If company states the dividend rate for preferred shares, they will strictly pay that amount and nothing more

Question 3

What are Depository Receipts (DRs)?

Types of Securities

(3)

Answer 3

1) Negotiable/transferable securities which represent FOREIGN FIRMS’ publicly traded equity (not the actual public equity)
2) We trade DRs because the shares are locked up
3) Allow investors in one country to invest in the securities of another country

Question 4

How are DRs traded?

Types of Securities

(4)

Answer 4

1) The foreign firms’ shares in the firm’s home market are purchased and placed in a custodian bank
2) A depository bank (located in the investors’ country) purchases the DRs from the custodian banks
3) They then issue the DRs in the investors’ country
- Depository receipts are traded in the investors’ local exchanges or OTC
4) Dividends are paid in the local currencies of the investors

• Bank does the currency conversion
• Holders of the receipt bear the currency risk (in investors country)
• Very low transaction costs involved

Question 5

What are ADRs?

Types of Securities

(6)

Answer 5

1) American DRs.
2) Price and dividends are in US$.
3) Easy way for US investors to own foreign stocks as they do not need to deal with foreign currency or brokers.
4) ADR trades like any ordinary stocks
5) A US bank buys a bulk of shares from the firm, rebundles and reissues them on NYSE, AMEX or Nasdaq.
6) Prices of ADRs depends on the demand and supply in the US market
- Normally traded close to the prices in the home market after taking into account the exchange rate to prevent arbitrage opportunity

Question 6

What are the risks involved in trading ADRs?

2

Answer 6

1) Political Risk (Between 2 countries, got to look at both countries and the r/s between them as you will be affected if you purchase ADRs)
2) Exchange rate risk (Borne by holders of ADR since Depository banks only do the conversion for you, they do not bear the currency conversion risks)
* Note: There will not be much counterparty risks because if both banks go bankrupt, the value of the ADR is still there (nothing happens to the shares as the firm issuing the shares are not bankrupt)

Question 7

What are EDRs?

Answer 7

European depository receipts

• Denominated in euro
• Located in Europe

Question 8

What are GDRs?

Answer 8

Global depository receipts

• Enables investors to raise capital in more than 1 country
• Usually, one offering is in the US market
• The second offering is in a second country which is normally in Europe

The 2 securities are separate and distinct.
Cannot inter-trade that spans 2 countries.

Question 9

Why did SGX wanted to cross-list ADRs?

Answer 9

> SG wanted to borrow ADRs to trade in SG
SG wanted more IPO investment in the country
Therefore, they buy ADRs from 19 Big Chinese firms

1) SG and China same timezone: SG investors can react faster - advantageous over US market
2) 19 chinese firms combined for 1 day > whole SG market for a year –> wanted to increase trading volume

Question 10

What are ETFs?

Answer 10

`1) Open-ended investment funds listed and traded on a stock exchange.

2) Aim to track the performance of an underlying index (e.g. STI) or asset class (e.g. commodities)

3) A hybrid of open- and closed-end funds.
> Trade like a stock with fixed number of units (closed-end) and tracks NAV and no fixed number of units (open-end)

4) Less costly than index mutual funds due to no loadings involved.

Question 11

How do retail investors handle ETFs?

Answer 11

They can only buy and sell the ETFs like stocks.

> Trade like individual stocks (closed end fund)

Question 12

How do institutional investors handle ETFs?

Answer 12

They can trade through creation and redemption process.
> As number of shares fluctuate, they trade ETFs like an open-ended fund
> Creation and redemption is done in creation units (block size of say 100,000 shares) and through designated brokers or dealers
> Arbitrage through these prices keeps the price close to NAV

*Only institutional investors can change the number of ETFs in the market

Question 13

What is the Creation process that institutional investors take when investing in ETFs?
(3)

Answer 13

1) Buy a basket of securities
2) Create ETFs through their brokers or fund managers
3) They deposit a portfolio of the composition stocks and receive ETF shares (AN EXCHANGE)

> Happens when price of ETFs are higher than the basket of securities

Question 14

What is the Redemption process that institutional investors take when investing in ETFs?
(2)

Answer 14

1) Buy ETFs from market & exchange
2) Redeem ETFs for a basket of securities from the broker/dealer
3) Sell the basket of securities

> Exchanging ETF shares for the portfolio of composition stocks
Happens when price of ETFs are lower than the basket of securities

Question 15

Why was SGX cross listing of ADRs not successful?

4

Answer 15

1) Not enough awareness of ADRs
2) Not enough discussions and surveys and research about it
3) Because it is traded in USD, the advantage of DRs are gone –> Not convenient for SG traders
4) Cannot exercise voting rights unless you have a US trading account –> And if have a US trading account, might as well trade ADRs directly in the US, and not in SG

Question 16

How are ETFs traded in Singapore?

4

Answer 16

1) Bring broker/dealers to Singapore to create local ETFs
2) If index interest rates increase by 1%, a normal ETF will increase by 1%
3) If index interest rates increase by 1%, a 2 x ETF will increase by 2%
4) If index interest rates increase by 1%, an inverse ETF will decrease by 1% (similar to shorting)

Question 17

What are the differences between ETF and ETN (Exchange traded notes)?

Answer 17

ETF: Backed by real securities.
> Even if brokers go bankrupt, still have the securities

ETN: Not backed by securities
> If brokers go bankrupt, you may lose everything

*Note: In other countries, ETF and ETN may not be separated

Question 18

What are REITS?

Answer 18

Real Estate Investment Trusts.

1) Funds that invest in a PORTFOLIO of income generating real estate assets
Example: 
- Shopping malls 
- Offices 
- Hotels

2) Usually with a view to generate income for unit holders of the fund
3) No double taxation

4) Pass-through entities
- -> Therefore, pays more dividends (interest) than ordinary stocks (bonds)

5) Can be traded like any ordinary shares in exchanges –> More liquid than real estate properties

6) Historically less volatile and less correlation with other assets –> Very good for diversifying portfolios
(But during sub-prime crisis, risks were very volatile, even more volatile than the general market)
> Stable income source
» Income stream come from underlying real estate

Question 19

What are pass-through entities in REITS?

Answer 19

1) Passing through most of the profits (dividends) to investors

2) Pass through more than 90% of income as dividends
> Pays more dividends (interest) than ordinary stocks (bonds)

Question 20

Why is there an avoidance of double taxation at both corporate and individual level?

Answer 20

Pass through entities do not have to pay corporate tax since they are not retaining any part of the profit.
- They are just passing the profits to the investors

In Singapore: There are no tax on dividends –> REITS are tax free