Chapter 11 - Other Investment Classes Flashcards
(27 cards)
Define closed-ended in the context of CISs
In a closed-ended scheme, such as an investment trust company (ITC), once the initial tranche of money has been invested the fund is closed to new money. After launch, the only way of investing in the ITC is to buy shares from a willing seller.
Define open-ended in the context of CISs
In an open-ended scheme, such as a unit trust or open-ended investment company, managers can create or cancel units in the fund as new money is invested or disinvested.
Define NAV per share for an ITC
Net asset value per share is equal to the value of the underlying assets of the company devided by the number of ordinary shares.
If gearing is allowed, the underlying assets would be net of the debt liabilities
Outline 10 investment and risk characteristics of an investment trust company
Stated investment objectives written into prospective / offer for sale document
Closed-ended
Public company, governed by company law
Often quoted on an exchange
Can raise both debt and equity capital
Operated by company directors and investment managers
Directors and investment managers receive fees
Investors buy “shares: in the ITC
Share price is determined buy supply and demand
Share price often stands at a discount to the company’s NAV per share
Outline 9 investment and risk characteristics of a unit trust
Stated investment objective
Open-ended
Trust, goverend by trust law
Limited ability to gear
Operated buy trustees and management company / investment managers
Trustees (insurance company / large bank) ensure UT is managed legally in accordance with the trust deed, hold assets and oversee the calculation of the bid and offer prices and the admin of the UT
Trustees and UT managers receive fees
Investors buy “units” in the UT
Unit price is based on NAV per share
Outline the advantages of investment in CISs compared with direct investment
Access to larger / more unusual investments
Discount to NAV - assets may be bought cheaply
Diversification
Divisibility
Economies of scale in the case of larger collective schemes
Expected return higher due to extra volatility associated with gearing and changes to the discount to NAV
Expertise of investment managers
Index-tracking of a quoted investment index possible
Marketability (possibly)
Quoted prices make valuation easier
Suitable for small investors
Tax advantages (possibly)
Outline the disadvantages of investment in CISs compared with direct investment
Loss of control
Additional layer of charges: Management fees for investment manager
Tax disadvantages (withholding tax which cannot be claimed)
List 9 differences between CE and OE CISs
Shares in CE CISs are often less marketable than the underlying assets. Marketability of units in OE CISs usually guaranteeed by the managers.
Some OE CISs need to hold cash to maintain liquidity => lower expected returns but greater price stability
CE CISs can gear, leading to extra volatilty. OE CISs cannot be geared or have limited gearing.
Shares in CE CISs are also more volatile than the prices of the underlying shares because the size of the discount to NAV per share can change. The price volatility of units in an OE fund should be similar to that of the underlying assets.
Increased volatility of CE CISs => higher expected return
There may be uncertainty as to the true level of NAV per share of a CE CIS, especially if the investments are unquoted.
CE CISs can invest in a wider range of assets
May be possible to buy assets at less than NAV in CE CIS
They may be subject to different tax treatment
Define a futures contract
A standardized exhange-traded contract to buy (or sell) a specified asset at a specified price and specified date in the future
Define a forward contract
A non-standardized, traded over-the-counter (OTC) contract to buy or sell a specified asset at a specified price on a specified date in the future
Featured of a futures contract
Standardized
Exchange traded
Clearing house removes default risk
Margin paid to clearing house
More liquid than forward
Quoted price
Often closed out before delivery
Featured of a forward contract
Tailor made, non-standardized
OTC traded
Default risk depends on the counterparty
No margin paid as traded OTC
Less liquid than future
No quoted price as traded OTC
Often results in delivery
Define a long and short position in relation to futures and forwards contracts
Having a long position in an asset means having positive economic exposure to the asset. In futures and forward dealing the long parTy is the one who has contracted to take delivery (buy) of the asset in the future
Having a short position in an asset means having negative economic exposure to the asset. In futures and forward dealing the short party is the one who has contracted to deliver (sell) the asset in the future
Define the term “warrant”
A warrant is an option issued buy a company over its own shares. The holder has he right to purchase shares at a specified price at specified times in the future from the company.
Outline the main uses of derivatives
Providing protection against the risk of adverse market movements:
-using futures contracts to set the price of input goods in advance
-E.g. using put option to protect asset portfolios against significant market value falls
Aiming to achieve higher returns / profits through speculation
Allowing financial institutions to alter the structures of their portfolios without needing to trade in the underlying assets
Outline 3 main reasons for investing overseas
Matching liabilities dominated in a foreign currency
Diversification by:
-Country
-Economy
-Stock market
-Currency
-Indusrty
-Company
Higher expected return:
-As fair compensation for higher risk involved
-as a result of exploiting inefficiencies
What are the practical problems with overseas investment?
CATERPILLAR MC
Custodian (protection) needed
Additional admin required
Time delays
Expenses incurred / expertise needed
Regulation poor
Political instability
Information harder to obtain (and less of it)
Language difficulties
Liquidity problems
Accounting differences
Restrictions on foreign ownership / repatriation problems
Market performance overseas may be different from the domestic performance
Communication problems
Outline 3 different ways of indirectly investing in overseas assets
Investment in multinational companies based in the home market
Investment in collective investment schemes specializing in overseas investment
Investment in derivatives based on overseas assets
Discuss the advantages and disadvantages of investing indirectly overseas by investment in multinomial companies based in the home market
Advantages:
* Easier to deal in familiar home market
* Multinationall companies will have expertise and tend to conduct their business in the most profitable areas overseas
* Gives access to areas where direct investment may be difficult
Disadvantages:
* Overseas earnings are diluted by domestic earnings
* Investor has no choice in where the company transacts its business
List 13 factors to consider when investing in emerging markets
Higher expected return due to higher risk (and possible market inefficiencies)
Extra diversification (less correlated than larger developed economies)
Possibility of high economic growth
Current market valuation of assets
-Inefficient markets: Buy cheaply
-Perceived to be risky: Buy cheaply
Currency stability and strength
Level of marketability (may be less)
Degree of political stability (volatility of returns)
Market regulation (insider trading, fraut)
Restrictions on foreign investment
Range of companies avialable
Communcation problems
Avialability and quality of information
Markets in small countries are highly influenced by swings in international investor sentiment and a sudden big flow of cash
24
4 Regulation aspects of CISs
Categories of assets held
Whether unquoted assets can be held
Maximum level of gearing
Any tax reliefs available
Key parties involved in ITCs
board of directors
Investment managers
shareholders
Key parties in unit trusts
Trustees (e.g. insurance company or bank)
Management company (e.g. merchant bank)
unitholders
Reasons for discounted NAV in ITC’s
Management charges
Concerns over marketability
Concerns over the quality of management
Market sentiment / fashion (out of fashion by investors)
