Week 6

Question 1

How do individuals in the retail market access the debt market?

Answer 1

By borrowing money and taking out

a loan.

Question 2

What does a loan allow individuals to overcome?

Answer 2

Equity constraints and bring forward future consumption to the present as a cost.

Question 3

3 types of retail lending:

Answer 3

1. credit cards.
2. personal loans.
3. mortgage finance.

Question 4

Who are the main providers of such loans? (2)

Answer 4

Financial intermediaries such as banks and credit unions.

Question 5

To the lender the loan is an ….

Answer 5

asset

Question 6

To the borrower the loan is a …

Answer 6

Liability

Question 7

What is the interest charged on retail loans influenced by?

3

Answer 7

• the availability and cost of funds
• what the loans is used for.
• the credit worthiness of the borrower and collateral (if any) held against the loan.

Question 8

The most common type of loan taken out is?

Answer 8

Home loan

Question 9

5 types of loans

Answer 9

1. Interest-only loans.
2. Fully amortising loans.
3. Partly amortising loans.
4. Fixed rate loans.
5. Variable rate loans.

Question 10

Interest-only loans (2)

Answer 10

• Each loan repayment is interest only.

- The entire loan principle is due upon loan maturity.

Question 11

Fully amortising loans

Answer 11

• each loan repayment comprises of interest and principle so that by the final repayment, the entire loan principle is paid off.

Question 12

Why do banks want to lend you fully amortising loans?

Answer 12

It’s less risky! That’s why there are lower interest rates.

Question 13

Partly amortising loans (2)

Answer 13

Each loan repayment comprises of interest and principle. However, by the final repayment, there is a loan principle balance remaining to be paid off.

Question 14

Fixed rate loans

Answer 14

Interest cost of loan is fixed, usually over a term of 1-5 years.

Question 15

Variable rate loans

Answer 15

Interest cost is subject to change depending on how banks price credit and changes in the official cash rate.

Question 16

3 things the creator of the home loan can do with the asset

Answer 16

1. Keep the mortgage till maturity.
2. Sell the mortgage.
3. Securitise the mortgage.

Question 17

Securitisation

Answer 17

The pooling of financial assets and non-liquid, real assets, into a portfolio, which is the converted to multiple units/shares (called securities) that are serviced with the cash flows of the original assets.

Question 18

What happens to securitisation units/shares?

Answer 18

They are sold to investors and are often publicly traded.

Question 19

5 examples of securitisation

Answer 19

1. Company shares.
2. Units in managed funds; real estate investment trusts.
3. Exchange traded funds; commodity funds.
4. Mortgage backed securities.
5. Collateral debt obligations.

Question 20

Can almost any asset be securitised?

Answer 20

Yes

Question 21

What is an important characteristics to remember with securitisation?

Answer 21

The originators of the asset can earn a fee from selling the securities and then pass on the risk and return of the original asset to the new owners of the security.

Question 22

What does securitisation benefit? What would we not have without it?

Answer 22

It benefits flow of funds, company shares.

Question 23

What is important to know when assessing the risk of securities? (2)

Answer 23

They firstly need to know that the risk and return of the original asset is being passed on to them and knowing what the original assets are to properly assess their risk.

Question 24

What did mortgage backed securities cause at one point?

Answer 24

the global financial crisis

Question 25

How did the GFC happen? (3)

Answer 25

Sub-prime (bad credit) home loans were issued by US banks who then securitised them into mortgage backed securities and sold them to investors, earning a fee and passing on the bad credit risk. The risk was not correctly reported to investors as the credit rating agencies in charge of assessing the security risk measured the risk inaccurately. When the sub-prime loans defaulted investors lost their capital.

Question 26

Who are managed funds popular with?

Answer 26

Uniformed, retail investors (ordinary people without a financial education).

Question 27

3 reasons managed funds are popular (benefits of intermediation)

Answer 27

1. The investment decision making is handled by a informed professional investment manager, allowing access to a more diverse range of assets and investment strategies. 2. There is a low barrier to entry as the minimum capital required by many funds is easily affordable. 3. Many managed funds are listed on the stock exchange, making them highly liquid where capital can be redeemed quickly, easily and cheaply.

Question 28

3 disadvantages of managed funds

Answer 28

1. Fund managers may not be as competent as advertised, only 1/3 of money managers beat the market. 2. Agent-principle problems where fund mangers do not act in the best interest of their client. 3. Investors may incur high entry, exit and management fees, charged by the fund manager.

Question 29

What are managed funds?

Answer 29

- combine capital from retail and wholesale investors which is invested by a fund manager.

Question 30

Are managed funds listed or unlisted?

Answer 30

can be both

Question 31

Do managed funds operate under a company or trust structure?

Answer 31

Either

Question 32

2 types of fund strategies

Answer 32

1. Active management. | 2. Passive management.

Question 33

Active management

Answer 33

Fund managers seek to 'outperform' the market by proactively trading between asset classes and individual investments to maximise fund returns based on expectations of the market.

Question 34

2 key attributes of active management

Answer 34

1. Market timing | 2. Market selection

Question 35

Passive management

Answer 35

A buy and hold strategy: fund managers are not interested in market timing, asset selection or trading to maximise returns, instead their objective it to follow or mimic the market.

Question 36

6 types of investment funds

Answer 36

1. Growth funds. 2. Agressive growth funds. 3. Balanced funds. 4. International and global equity funds. 5. Socially responsible investment funds. 6. Income funds.

Question 37

What are returns driven by?

Answer 37

The type and amount of risk taken.

Question 38

Sharpe ratio

Answer 38

A formal measure of the risk-premium adjusted return.

Question 39

What are the 6 main categories of funds?

Answer 39

1. Statutory funds of Life Insurance Offices. 2. Superannuation funds. 3. Public unit trusts. 4. Cash management trusts. 5. Exchange traded funds. 6. Hedge funds.

Question 40

What is the main distinction between funds?

Answer 40

Open vs close-end funds.

Question 41

Open-ended funds

Answer 41

Where capital invested may be redeemed at any time, these are the funds listed on the stock exchange, you can buy and sell.

Question 42

Close-ended funds

Answer 42

Where there are restrictions of capital redemptions

Question 43

Would you require a higher return for open or close-ended funds?

Answer 43

A close-ended fund, because there is higher liquidity risk involved.

Question 44

Superannuation funds

Answer 44

A specific type of managed fund where the objective is to save and invest over one's working life to provide a means of income during retirement.

Question 45

Are super funds the most common type of Aussie fund?

Answer 45

Yes - because of the superannuation guarantee scheme.

Question 46

How can annuity financial math play an important role in super fund planning? (3)

Answer 46

- The FV of the fund can be calculated to determine if sufficient wealth will be accumulated to pay for the desired retirement lifestyle. - the periodic salary contribution needed to accumulate a target fund FV can be calculated. - annuity maths can be used to determine the size of the annuity payments and how long the payments can last, given the accumulated fund value.