1 introduction to investment bruce viney director of training and client services
TRANSCRIPT
1
Introduction to Introduction to InvestmentInvestment
Bruce VineyDirector of Training and Client Services
2
Why we are here….
• Exam (syllabus valid from 1 October 2006)
– 60 minutes
– 50 Questions
– Multiple choice
– Pass mark is 70%
3
Programme/SyllabusWorkbook
Chapter
Content Questions in exam*
1 Financial Services in the UK 8
2 Asset Classes 13
3 Derivatives 2
4 Financial Products 6
5 Pooled Funds 9
6 Investment Wrappers 2
7 Financial Services Regulation 8
8 Taxation 2
Total 50
* plus/minus 2
4
IntroductionIntroduction
CHAPTER 1CHAPTER 1
•The Role of the Financial Markets•Financial Institutions•London’s Markets•The Bank of England•The UK Economy
The Role of Financial Markets
SaversBorrowers
Companies
Governments
Surplus capital, looking for a return
Need capital
The C
ity
The Role of Financial Markets
SaversBorrowers
Companies
Governments
Capital MarketsMoney Markets
BANKS
Financial MarketsSHARE
MARKETS
BOND MARKETS
Deposits
Buys shares
Loans and
overdrafts
Issues shares
Issues bondsBuys bonds
7
Financial Market stagesonward trading of shares at market
price
Company
issueshares
at£2.20 each
PRIMARYPRIMARYMARKETMARKET
SECONDARYSECONDARYMARKETMARKET
8
Financial Institutions
• Retail banks and building societies
• Investment banks
• Pension funds
• Insurance companies
• Fund managers
• Stockbrokers
• Custodians
• Credit card companies
London’s Markets
Soft commoditiesFinancial futuresTraded Options
Non-ferrousNon-precious
Brent crudeGas oilNatural gas
UK equities and corporate bondsGiltsOverseas equities and bonds
Insurance market
10
Date Event
1773 Brokers create The Stock Exchange
1986 Big Bang - major reforms
1995 Tradepoint starts in competition with LSE
1997 SETS - electronic order book
2001 Listed as a quoted company
London Stock ExchangeLondon Stock Exchange
Policy £60mSynd A £20m
The Lloyds Market
Syndicate
Clients
Broker
Members
£15m£15m
£10m
SyndicateSyndicate
Syndicate
12
World Securities Markets
• NYSE
• Nasdaq
• Euronext
• Japan
• Deutsche Borse
13
Economics
• Categorising Economies
• Gross Domestic Product
• Gross National Product
• Balance of Payments
• Inflation
• PSNCR
Market
Mixed
Open
State controlled
14
Gross Domestic Product
• Market value of goods and services produced in a country
• Measure of the level of economic activity
• Three ways of representing:
–Total GDP
–GDP per head (per capita)
–GDP growth
15
Gross National Product
• GNP for the UK is the GDP:
–Plus interest, profits, and dividends received from abroad by UK residents
–Less income earned in the UK by overseas residents
Balance of Payments• Measures the difference between money flowing into
and out of the country
Imports Exports
visible
invisibleinvisible
visible
Cur
rent
acco
unt
17
Inflation
• What is it?
• Problems caused by inflation
• Measurement
–headline RPI
–underlying RPIX
–harmonised HICP
• Caused by an increase in the money supply?
What is money?
Bank of England• Three core purposes:
– maintain integrity and value of the currency
– maintain stability of financial system
– seek to ensure the effectiveness of the UK’s financial sector
• Intervenes in the forex market (in accordance with govt policy)
• Bank for
– Commercial banks
– Government
• Sets interest rates through the Monetary Policy Committee (MPC)
Interest Rates• Short term interest rates are set by the MPC
• MPC are to use interest rates to meet a set inflation target (currently 2.5%)
• Interest rates are changed as a result of Bank of England’s dealings with banks
customer
bank
Bank of England
bankbank%
%%%
%%
MPC control this rate
LIBOR
Government Borrowing
• Government income from taxation
• Government expenditure
• Difference is called:
Public sector net cash requirement (PSNCR)
21
Foreign Exchange
• Market in currencies
• No central market
• London is the largest centre
• Dominated by banks
• Types of contract
–spot
–forward
22
Companies, Capital and Asset Companies, Capital and Asset ClassesClasses
CHAPTER 2CHAPTER 2
• Equities• Corporate actions• LSE trading and settlement• Bonds• Money market instruments• Company administration
23
Security
General term for any type of financial instrument (usually) traded on an investment exchange.
BondsEquities
Part ownership = shares Debt in the form of IOUs
In the UK, capital market securities are generally held in registered form whilst money market instruments are issued in bearer form
Equity types
Equity
type
Voting rights Dividend
Ordinary
Preference
• The two main equity types in the UK are ordinary and preference shares
• Preference shares have preference over ordinary shares in terms of:
• Dividend payment• Repayment on winding up
Variable, not guaranteed
Fixed, not guaranteed(can be cumulative)
Yes
No
25
Why own shares?• Voting
• Income – dividends
• Capital growth
• Trade perks
Risks
• Price
• Liquidity
• Issuer
26
Corporate Actions
• Types of action– mandatory
– voluntary
– mandatory with options
• Examples– bonus issue (to increase the liquidity of shares)
– dividend (to distribute profits)
– takeover offer (to acquire the shares)
– rights issue (to raise funds)
27
Rights Issues
• Company raising additional finance
–new shares are issued
–existing shareholders can buy them first (pre-emptive rights)
• Upon receipt of a rights letter a shareholder has to decide upon their course of action
Calculating the ex price
A company announces a 1:5 rights issue at £3.50. If the cum market price of the underlying shares is £4.00, what is the theoretical ex price of the shares?
Before
Rights
After
Numberof shares
Price per share
Total value
5
1
6
£4.00
£3.92
£3.50
£20.00
£3.50
£23.50
23.506
How much is the right to buy a share worth?
29
Bonus Issues
• Free shares
• The effect on share price?
• Why would a company do it?
Calculating the ex priceThere is a 1:1 bonus issue.The market price of the shares before the capitalisation is £12.00.What is the theoretical ex price of the shares?
Before
Scrip
After
Numberof shares
Price per share
Total value
1
1
2
£12.00
£6.00
£0.00
£12.00
£0.00
£12.00
£122
31
Cash dividends• What is a dividend
–Payment/distribution to shareholders from realised profits
• Interim and final dividend
• Timetable
Feb
Dividendannounced
Wed 8March
Ex-dividendday
Fri 10March
RecordDay
(Books closed day)
DividendPayment date
Fri 10May
ex divcum div
AGM
Tues 7May
Listing on the Stock ExchangeThe main advantages are:
Takeovers – using shares to fund the acquisition of other co’s
Employees – stock options can be used to retain key staff
Capital - access to a large pool of capital
The main disadvantages are:
Short termism – impatience and emphasis on short term goals
Regulations – disclosure requirements are more stringent
Status/prestige – assist company’s trading prospects
Threat of takeover – anyone can become a part owner
Listing
Full list Alternative Investment
Market
Trading history Minimum 3 years
No minimum
Market capitalisation
Minimum £700,000
No minimum
‘Public’ holding At least 25% No minimum
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Indices
• Indices enable investors to:–measure performance of a market
–use as a benchmark to judge actively managed portfolios
– trade futures and options based on them
• The main indices on LSE equities are:–FTSE 100
–FTSE 250
–FTSE Actuaries 350
–FTSE All Share Index
FTSE Indices
1
100
350
c900
FTSE 100
FTSE 250
FTSE Small Cap
FTSE All Share
36
World Markets
Securities
• New York
• NASDAQ
• London
• Euronext (Paris)
• Tokyo
• Deutsche Borse
• Hong Kong
Indices
Dow JonesS&P 500NASDAQ Composite
Nikkei 225
CAC 40
Xetra DAX
Hang Seng
37
Broker
Broker
Buyer
Seller
Order driven
Buyer
Seller
Broker
Broker
Market Maker
Quote driven
Domestic Equity Market
38
Domestic Equity Market
• SETS– FTSE 100; FTSE 100 reserve stocks; stocks removed from
FTSE 100.
• SETSmm– FTSE 250 shares not on SETS, order book plus one or more
market makers
• SEAQ– fully listed shares, not on SETS or SETSmm, with two or more
market makers
– AIM shares with two or more market makers
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SETS
Buy & sell orders displayed (price/time priority)
• Standard settlement
• Visible to all but only member firms can input and delete orders
40
41
SEAQ
• Market makers show prices and sizes
• Two way prices (bid, offer, spread)
• Touch strip
42
43
Equity Settlement
BrokerMarket Maker
£
shares
Settlement
TradeBuy me 1000
PJC plc shares
Contract Note
44
• CREST is an electronic settlement system
• Mainly settles UK equities, corporate loan stock and gilts
• Dematerialised/uncertificated settlement
45
Member
Crest Structure
Investors
Companies
Bank
Registrar
Regulators
Revenue(s)
46
Bonds
• A bond is a tradeable loan
• Issuer promises to:–repay the loan at a future date (on
maturity)
–pay interest at a defined rate (usually fixed)
• Issuer might be the British government
–bonds are called gilt edged securities
• Issuer might be a company
47
Corporate Bonds
Domestic Foreign Eurobond
Issued by homecompany to homeinvestors in homecurrency
Issued by overseascompany to homeinvestors in homecurrency
Issued to manyinvestors in anycurrency – international issues
48
Other bonds - features
• Zero Coupon Bonds
• Convertibles
Gilts• Interest (coupon)
– gross annual interest on the nominal value (£100)
– paid semi annually
• Repayment (redemption)
• Classification by DMO– Short Less than 7 years
– Medium 7-15 years
– Long More than 15 years
• Issue by DMO
– bid basis (auction to those on an Approved List)
– individuals may submit non-competitive bids (up to £500,000)
• Secondary Market– GEMMS or DMO/Computershare service
50
Yields
• Flat Yield
Example: Treasury 2006 6% is currently trading at £102, calculate the flat yield
A 3.6%
B 4.9%
C 5.9%
D 6.0%
annual coupon x 100%---------------------- market price
51
Money market instruments
• Money market instruments are forms of short term tradeable debt. The products you need to be aware of are:
–Treasury bills
–Commercial paper
–Certificates of Deposit
52
Treasury bills
• Short term zero coupon bonds
• Maturities generally after 3 months
• Issued weekly by the DMO on behalf of the Treasury
• Sold at a discount to their face value
53
Commercial paper
• Short term unsecured debt
• Usually zero coupon therefore issued at a discount
• Usually high nominal value
• A CP programme specifies a total amount that can be issued and may have an end date
CP programmeissue limit £150m
end date 2008
Date Issue TermMar 2006 £100m 6mthApr 2006 £50m 3mthOct 2006 £75m 6mthJan 2007 £75m 3mth
54
Certificates of Deposit (CD)
Investor A
Investor B
Bank
Company types
All companies
public
(plc)
private
(ltd)
fully
listed
AIM
listed unquoted
56
Company Administration
Company
Shareholders
Memorandum
Articles
Company Directors
ExecutiveNon-executive
Meeting types:AGMEGM
ARTICLES:Shareholders rightsBorrowing powersDividendsMeetingsDirectorsWinding up
MEMORANDUM:Name of CoDomicileAuthorised Share CapitalStatement of liabilityObjectsPLC or not.
57
DerivativesDerivatives
CHAPTER 3CHAPTER 3
•Futures•Options
58
Futures
• An agreement to buy or sell a specified quantity of a specified asset at an agreed price on an agreed date
• Exchange traded and on standardised terms
• For example: Futures on metals, oil, agricultural products
• Motives: Hedge or Speculate
59
Futures Terminology
• Long = buy a future
• Short = sell a future
• Open = enter into a futures position
• Close = trade out of a futures position
60
Options
• A contract that gives the right but not the obligation to buy or sell a specified quantity of an underlying asset at a specified price within a specified period
• Call option = the right to buy
• Put option = the right to sell
An example of an Equity Call Option
PJC plc 1000 shares
Market price 105p
I grant youThe right to buy1,000 PJC plc sharesFrom meAt a price of 100pWithin 3 months
WriterWriter
HolderHolder
Option PremiumOption Premium
Call Option Call Option (10p per share)
(£100)
Options terminologyConsider an equity call option with a strike price of 100p and premium of 10p. The underlying share is currently valued at 105p
strike100p
Price
Time
105p
breakeven110p“in the money”
“out of the money”
“at the money”
63
Options Terminology
• Call Option
• Put Option
• In the money
• At the money
• Out of the money
• Breakeven
64
Financial ProductsFinancial Products
CHAPTER 4CHAPTER 4
•Deposits and loans• Interest rates•Mortgages• Insurance and Pensions•National Savings and Investments
65
Deposits and loans
• Deposits– Fixed term v Instant access
– Interest• Gross v Net
– R85 enables payment gross
• Loans– Bank loans
• Secured v Unsecured
– Overdrafts• Authorised v Unauthorised
– Credit cards
66
Interest Rates
• Quoted rate v Effective rate
• Steps to turn quoted into effective1. Quoted expressed as a decimal
2. Divided by number of periods per year
3. Added to one
4. To the power of the number of periods per year
5. Subtract one and times by 100
67
Mortgages
• Secured loan on property• Mortgage types
– Repayment– Interest only
• Mortgage interest– Fixed– Capped– Discounted– Variable
• Redemption penalties• Other types
– Endowment– Pension linked– ISA– Unit linked– Flexible
68
Insurance and Pensions
• Life policies– Term v Whole of life
– With profit (incl unit linked) v non profit
• Pensions– State
• Basic v Second
– Occupational• Defined benefit v defined contribution
– Private/Personal
– Stakeholder
69
National savings products
• National Savings accounts:
– Easy Access a/c (instant access)
– Investment a/c (one month notice)
• Premium bonds
– Random prize
• Other products
– Fixed Interest Savings Certs
– Fixed Rate Savings Bonds
Paid Grossbut taxable.
Paid GrossBut taxable
Tax free.
Paid on maturityTax free up to
£15,000 per issue.
Taxable,Paid net of 20%
70
Pooled FundsPooled Funds
CHAPTER 5CHAPTER 5
•Unit Trusts•OEICs• Investment Trusts
71
Rationale of Collective Investment
Fund Manager
Advertise £5,000£5,000
I’ve got a spare five thousand, I think I’ll invest in a UK equity fund.
Shares/units in Shares/units in collective inv’tcollective inv’t
72
Role of the FSA
• Authorised v unauthorised
• Onshore v offshore
73
Unit Trusts - Basics
Investors(1,000)
Fund Manager
£5,000 x 1,000£5,000 x 1,0001 million units1 million unitsx 500p per unitx 500p per unit
InvestmentsInvestments
Trustee
InvestmentsInvestments
Markets
Makes investment decisions
Prices the units
Deals with investors
Legal owner of the trust propertySafeguards assetsMonitors the manager
• Securities Funds - most common• Money Market funds• Futures and Options funds• Geared F&O• Warrant funds• Property funds• Fund of funds• Feeder Funds• Umbrella Funds• Limited issue funds• Principal protected funds• Mixed funds
Types of Unit Trust
Authorised/regulated funds
Buying more Units
Fund Manager
Trustee
InvestmentsInvestments
FM prices Bid Offer
UK Equity 485 515
£5,150£5,1501 000 units1 000 unitsx 515p per unitx 515p per unit
Another 1,000 units created (open
ended)
Creation of more units?
Fund Manager
Trustee
InvestmentsInvestments
10,000 units10,000 units9,000 units9,000 units
BuyersBuyersSellersSellers
“Create 1,000 units”
InvestmentsInvestments
Markets
77
How to price a unit
• Prices calculated by the managers
• FSA rules
– prices based on net asset value at the most recent valuation
– calculate separate bid and offer prices although single pricing is possible
– maximum offer price = creation price plus initial charge
• Offer price tend to include an initial charge - around 5-6% on top of allowances for stamp duty and brokerage
78
What is an OEIC ?
• Open Ended Investment Company
• Also known as an ICVC (Investment Company with Variable Capital)
• Invests money on behalf of it’s shareholders in shares and bonds
79
Key elements of an OEIC
• Variable capital base
• Shareholders are direct owners of the company
• Shares are traded at a single price (at NAV)
• Authorised Corporate Director instead of Manager
• Depository instead of Trustee
• An OEIC is a UK company that can repurchase its own shares on demand
Investment Trusts
Investors
Investment Trust
£5,000 x 1,000£5,000 x 1,0005 million £1 ord shares5 million £1 ord shares
InvestmentsInvestments
Depository
InvestmentsInvestments
Markets
Trade
Price tends to be at a discount to the net asset value of the company. This discount narrows in a bull market and widens in a bear market
81
Exchange Traded Funds (ETF’s)
• Index tracking funds
• Open ended
• Structured as a company
• Listed on exchanges (such as the LSE’s extraMARK)
• Trade at net asset value
82
Collective investments comparison
Feature Unit Trust Invt Trust OEIC/
ICVC
ETF
Open/
closed ended
open closed open open
Legal structure/
Investment unit
Trust/
unit
Company/
share
Company/
share
Company/
share
Price based on Net asset value
Demand and supply
Net asset value
Net asset value
Bid/offer or single price
Bid/offer Bid/offer Single price Bid/offer
Investments purchased from
Fund manager Stock market Authorised corporate director
Stock market
Investments held by Trustee Authorised depositary
Authorised depositary
Custodian
83
Hedge Funds
• Unregulated schemes
• High investment entry levels
• Flexible investment style, including gearing
• Fees are performance related
84
Investment WrappersInvestment Wrappers
CHAPTER 6CHAPTER 6
• ISAs/PEPs•Child Trust Funds
85
ISAs• Designed to replace PEPs
– no tax on income or capital gains
• An ISA is a tax free wrapper that can be applied to a wide range of products
• Up to 2 components as follows
–Cash
–Stocks & Shares
ISA limits
Mini ISA
Stocks &shares
£4,000 p.a.
Cash£3,000 p.a.
Maxi ISAStocks
&shares
no limit
Cash £3,000 p.a
£7,000 p.a
87
Child Trust Funds
• For children born on or after 1 Sept 2002
• Money cannot be withdrawn until child turns 18 (child can manage from 16)
• Government starts CTF with £250 (£500 for lower income families)
• Can add up to £1200 per annum
• Savings, shares or stakeholder accounts
• No tax on income or gains
88
RegulationRegulation
CHAPTER 7CHAPTER 7
•FSMA 2000•Money Laundering• Insider Dealing and Market Abuse•Takeovers and Mergers
89
UK Financial Regulation
• The UK’s main financial regulator is the Financial Services Authority (FSA)
• The FSA operates under the Financial Services and Markets Act 2000 (FSMA 2000)
• The Act states that any person (firm) conducting regulated activities in the UK must be authorised by the FSA or exempt
• Certain individuals within the firm must also be approved by the FSA for their roles
• The FSA have written a handbook which must be complied with to avoid prosecution
90
The FSA’s four objectives
• Maintaining confidence
• Promoting public awareness
• Appropriate protection for consumers
• Reduce scope for financial crime
91
Approved persons regime
• Certain people working for an authorised person (firm) must be approved by the FSA for their role. The 27 separate controlled functions (jobs) that require approval are grouped under five categories:
–Governing functions (e.g. Directors)
–Required control functions (e.g. MLRO)
–Systems and controls functions
–Significant management functions
–Customer functions
92
Key statutes governing financial services
• Financial Services and Markets Act 2000
• Proceeds of Crime Act 2002 and ML Regs 2003
– Anti-money laundering
• Criminal Justice Act 1993
Money Laundering• Definition• 3 stages• ML Regs 2003: Financial institution procedures :
– identify new clients– record keeping– internal reporting– internal controls to prevent the firm being used for money
laundering• POCA ’02 Offences:
– concealing; arrangements that you know or suspect is to acquire, retain, use/control criminal property; acquire, use or possess criminal property; failure to report; tipping off
• Suspicion reporting process– Employee => MLRO => SOCA
Insider Dealing
If an individual who possesses inside information from a
primary or secondary insider
Deals
Encourages others to deal
Tell others the information
95
Market abuse
Offence under FSMA 2000
Includes : Using
information not
generally available to
others
Regular user test employed to establish guilt or innocence
96
• There are two main concerns regarding a takeover and different regulatory bodies are in place to address each concern:
• Is the takeover anti competitive?
• Are shareholders treated fairly?
Takeovers and Mergers
Competition Commission
Panel on Takeovers and Mergers
97
Takeovers and Competition
CCCC
The Office of Fair Trading considers whether a proposed takeover might be anti-competitive.The OFT could result in the bid being referred to the Competition Commission
The Competition Commission decides on whether the takeover should be allowed to proceed, any restrictions required and the like
OFTOFT
98
Takeovers and shareholders
• The Panel on Takeovers and Mergers (POTAM or PTM) ensures that all shareholders are treated fairly
• Their rulebook is known as the Takeover Code or Blue Book
• The rulebook principles state:–Shareholders of a target company must be treated
equally in all respects during an offer–Don’t bid for a company unless you intend to, and
can afford to, go through with the bid–Directors should make decisions by considering
what is best for shareholders, not themselves
99
Takeovers – key %’s
30%Effectivecontrol
50%Actualcontrol
Must make a bid for the remainingshares in the company
0%
100%
SARs – prevent the following:(1) 10% or more(2) Within 7 calendar days(3) From more than one source(4) Resultant shareholding is 15% or more
Takeover of a Listed Company
Offerdocumentdispatched
28days
Bid announced
through Stock Exchange
21
Firstclosing
39
Finaltarget
companyannouncements
46
Finalrevision
0
Finalclosing
60
101
Other Regulations
• Data Protection Act– 8 principles especially ‘adequate, relevant and not
excessive’
• Complaints– System required and Financial Ombudsman
Service can compel firms to pay up to £100,000
• Compensation– Financial Services Compensation Scheme payout
maximum of £48,000
102
TaxationTaxation
CHAPTER 8CHAPTER 8
• Income tax• Capital Gains Tax• Inheritance Tax• Stamp Duty
103
Taxation
• Income tax
• Capital gains tax
• Inheritance tax
Paid on income, potentially including investment income
Potentially payable on the sale of an investment
Potentially payable on investments held at death
104
Income Tax
• Salary
• Profits from running a business
• Dividends
• Interest
From an employer
Individuals orpartnerships
From companies
From banks/building societies/bonds
105
Income Tax
Income
£5,035
10%
22%
40%
Personal allowance
Lower rate
Basic rate
Higher rate
£2,150
£33,300
£33,301
106
Taxation (Income)
• Tax is usually deducted at source.
– salaries PAYE
– savings income (interest)• basic rate of 20% is automatically deducted
– dividend income • basic rate of 10% is automatically deducted
107
Taxation (CGT)
• Capital GainsCapital Gains– Shares
– Bonds (some)
– Property
– Antiques
• ExemptionsExemptions– Main home
– Gilts
– Cars
108
Taxation (CGT)
• Allowance of £8,800 for the year
• CGT only paid on gains above the allowance
• Any losses can be carried forward
• Paid at the investor’s marginal rate of 10%, 20% or 40%
109
Inheritance Tax
• A certain amount is exempt
– threshold of £285,000
–anything left to a spouse
–anything left to a charity
–items given away more than seven years before death
–IHT charged at 40%
110
Stamp Duty/SDRT/SDLT
• 0.5% on the purchase of shares
• 1% on homes >£120,000
• 3% on homes >£250,000
• 4% on homes >£500,000
111
End of Course