Introduction Flashcards
Direct investment
Buying financial securities directly
Indirect investment
Holding financial securities indirectly through managed funds. Most common for retail investors.
Retail investors
Individual people who invest their own money in the market, rather than institutions or organizations.
Direct investment :
Money market securities
Short-term debt securities which mature n less than one year. E.g. treasury bills, certificates of deposit, commercial paper.
Direct investment:
Capital market securities
common stock (equity) and debt securities which mature linger than one year. E.g. ordinary shares which trade on the stock exchange.
Main stock exchanges UK
London stock exchange (LSE)
Additional Investment Market
Direct investment:
Bonds
Debt securities issued by companies or governments or transnational organisations.
Characteristics of a Bond
Usually have a fixed life and make regular coupon payments
Repay the face value of the bond (£100 in the UK) when the bond matures
Direct Investment:
Derivative securities
Securities where the security payoff depends on another asset. E.g. options
Call option
This is the right to buy an asset at a fixed price at a future date.
Indirect investment:
Retail funds
Designed for individual investors. Include mutual funds.
Mutual funds
A fund that pools money from shareholders to invest to purchase diversified portfolio of stocks, bonds, or other securities.
Priced once a day when the stock market closes.
Mutual funds characteristics
Offers diversification
Can be actively managed
Less liquid
Higher minimum investment required
What are open-ended funds in the U.K called?
Unit trusts or open ended investment companies (OEICs)
How is the price of an open ended fund determined?
By the Net Asset Value (NAV) which is calculated daily
What is the NAV?
A per-share value representing the value of a fund’s assets minus its liabilities
Do open end funds trade on financial markets?
No they are instead priced at the portfolios NAV at the end of each day.
Fama and Jensen (1983)
Argue that open end funds have lower agency costs as a result of not trading in financial markets.
Gruber (1996)
Argues that in open-end funds, any performance ability by the fund managers is not priced
How does the number of units in an open end fund change?
It fluctuates daily with investor demand.
When investors want to buy the fund will issue new units. When they want to sell the fund will buy those units back.
Main costs associated with an open end fund?
Up-front sales charged, annual expenses, and trading costs.
What is liquidity based trading?
When fund managers trade to meet investor redemptions (investors selling) or purchases.
Liquidity based trading analogy: Smoothie shop
If lots of people come in asking for smoothies (investors buying the fund), the shop needs to buy more fruit (buy investments).
If people start asking for refunds (investors selling the fund), the shop has to sell fruit quickly to get the money to give back.
Downsides of liquidity based trading?
It can hurt fund performance (Edelen (1999) and can force funds to sell assets in times of market turmoil.
