Chapter 2 Flashcards

Question

Explain briefly what is meant by default risk in relation to corporate bonds (3 marks)

Answer 1

• Default risk is the risk of the bond not being redeemed • or the company missing a coupon payment • on the due dates.

Answer 2

• Interest rate risk. • Liquidity risk. • Inflation risk. • Tax change risk. • Credit risk

Answer 3

• Redemption yield is a more accurate calculation of the true rate of return from a bond. • It takes into account all the cashflows from the bond including capital repayments. • It also makes adjustments for the time taken until each cashflow is received.

Answer 4

• Measure of price sensitivity to changes in interest rates. • Expressed as time period. • Measured in years. • Taking account of all cashflows including coupons and return of capital. • For capital / initial investment to be returned.

Answer 5

• Interest earned. • From the last coupon date up to the date of purchase. • It would be added to the purchase price of the bond.

Answer 6

Offers for sale o Shares are marketed to the general public, with the share price set lower than optimum to encourage demand. o The price can be: ▪ fixed upfront, usually for large stable companies such as with privatisations. ▪ determined via a tender process where bids are obtained before the share price is set. ▪ offers for subscription which is a kind of tender process but with no commitment to go ahead with the issue if the demand isn’t high enough

Answer 7

Placings o A cheap and fast way to get shares to market, often used by smaller companies o It is a ‘pitch’ directly to big institutions, such as investment banks or pension funds, to buy the shares. o As the general public aren’t involved, there are no expensive marketing or printing of detailed prospectuses involved.

Answer 8

- it’s an offer for sale, but the existing shareholders are at the front of the queue. They get the option to buy the shares first; additional shares are offered to them in proportion to their existing shareholding. - The subscription price is always pitched below the current market price, this discount makes the offer attractive, and the company most likely to raise the required funds. - By issuing more shares at a lower price, this will affect the overall share price post issue.

Answer 9

- Bonus issues are where a company issues new shares, paying for them out of their reserves. This is sometimes known as a scrip issue. This effectively dilutes the existing market price of a share, making it more attractive to investors. It can also change the proportion of the company owned by existing shareholders.

Answer 10

A share split is where shares in issue are split into a greater number of shares, each with a smaller nominal value.

Answer 11

- Shows trend in profitability - All companies list their EPS. - Shows the amount per share, in pence, that the company has earned during the year. - Widely used to make comparisons from year to year and with other companies. - Best looked at as a trend over time.

Answer 12

profit after tax and preference dividends / number of ordinary shares

Answer 13

Shows the true value of a share’s dividend • Result shown as a percentage. • Yields fluctuate with share price. • Unreliable in forecasting future returns. • A low dividend yield may indicate an overvalued share. • A high yield may indicate low growth or that it is underrated by the market.

Answer 14

dividend per share / current share price x 100

Answer 15

Shows how many times the dividend could be paid out of available current earnings • The higher the figure, the better. • A high figure, e.g. ‘10 x’, shows that profits are being retained rather than shared. • The higher the dividend cover, the less likely it is that a company will have to reduce dividends if profits fall.

Answer 16

EPS / dividend per share

Answer 17

- compares companies in same sector - relationship between share price and earnings - meaningless on its own, better for comparing companies or time periods - measures how highly investors value company and its ability to grow income stream - higher P/E ratio, the more the shares are in demand, and the more the earnings are expected to grow.

Answer 18

share price / EPS

Answer 19

Establishes whether a company’s P/E ratio is justified • A number of less than 1 would indicate that the shares are potentially attractive.

Answer 20

P/E ratio / estimate of companies average earnings growth for next 5 years

Answer 21

Shows the amount available to shareholders if the company were to close down, sell all its assets and distribute the balance • The value of the tangible assets attributable to ordinary shareholders. • Often used to price collective investment schemes and show the minimum value that the shares would be worth on wind-up of the company / collective.

Answer 22

net assets attributable to ordinary shareholders / number of ordinary shares in issue

Answer 23

Measures the relationship between the company’s share price and the net book or asset value per share attributable to its ordinary shareholders • If ratio shows share price is lower than its book value, this can indicate that it is undervalued, or that market perceives that it will remain a stagnant investment. • If share price is higher than book value, this suggests investors view it as a company which has above-average growth potential

Answer 24

share price / NAV

Answer 25

A simplified model for calculating a share price. • Assumes constant dividend growth, and dividend payments made at the end of each period. • Helps place a price on the value of an ordinary share. • Simplistic, and only suitable for mature shareholdings with track records. • Crude and simplistic formula. • Can give an idea on the current share price against future expected growth.

Answer 26

dividend / (return required - dividend growth)

Answer 27

- Different accounting procedures can apply, which can make the figures unreliable. - If the company has altered its share capital, for example via share splits or share consolidations, this can alter these ratios. - They often use historical data, sometimes over a year out of date. - The ratios are only as good as the source of information used, financial statements can contain subjective elements, which can distort the calculations. - The impact of inflation, interest rates, and taxation may be different year on year. - Often, they are useless on their own and need to be compared to a similar business or over different time periods. - Ratios shouldn’t be used in isolation. They provide only part of the story, and often riase more questions than answers. - Other factors would need to be considered.

Answer 28

• Liquidity Risk: the ability to sell at a given time or realise cash quickly. • Management Risk: skills and funds required to run the business. • Void Risk: the risk that the property will be vacant.

Answer 29

- must be owners main residence - one exempt amount per residence - must not be self-contained - must be furnished - owner must also be resident - must be in the UK

Answer 30

- can provide diversification - may not be correlated with existing investments - does not provide income - returns often exceed inflation - commodities high risk / more volatile

Answer 31

• Each investor has a unique ‘blockchain’ which identifies them as an investor. • No formal logging of ownership is taken; each investor simply has their own password and unique log in. This has led to accusations of them being a tool that can be easily used for money laundering. • Currency is often purchased via an online website such as CoinCorner and paid for by a credit card. • Once confirmed or mined, you instantly own part of that currency. • The currency purchased is electronic and not influenced by any bank or government. • These investments have proved volatile with often huge sways of gains and losses being evident, they are also unregulated, so not for the faint-hearted.