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Introduction to Investment

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Title: Introduction to Investment


1
Introduction to Investment
  • Bruce Viney
  • Director 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/Syllabus
plus/minus 2
4
Introduction
  • CHAPTER 1
  • The Role of the Financial Markets
  • Financial Institutions
  • Londons Markets
  • The Bank of England
  • The UK Economy

5
The Role of Financial Markets
Companies
Governments
Savers
6
The Role of Financial Markets
BANKS
SHARE MARKETS
Companies
Governments
BOND MARKETS
Savers
Borrowers
7
Financial Market stages
onward trading of shares at market price
issue shares at 2.20 each
8
Financial Institutions
  • Retail banks and building societies
  • Investment banks
  • Pension funds
  • Insurance companies
  • Fund managers
  • Stockbrokers
  • Custodians
  • Credit card companies

9
Londons Markets
UK equities and corporate bonds Gilts Overseas
equities and bonds
Insurance market
Soft commodities Financial futures Traded Options
Non-ferrous Non-precious
Brent crude Gas oil Natural gas
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 Exchange
11
The Lloyds Market
15m
15m
10m
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
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

16
Balance of Payments
  • Measures the difference between money flowing
    into and out of the country

Imports
Exports
17
Inflation
  • What is it?
  • Problems caused by inflation
  • Measurement
  • headline RPI
  • underlying RPIX
  • harmonised HICP
  • Caused by an increase in the money supply?

18
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 UKs
    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)

19
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
    Englands dealings with banks

20
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 Classes
  • CHAPTER 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.

Equities
Bonds
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
24
Equity types
  • 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
Yes
Fixed, not guaranteed (can be cumulative)
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

28
Calculating the ex price
A company announces a 15 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?
Number of shares
Price per share
Total value
Before
5
4.00
20.00
Rights
1
3.50
3.50
6
After
3.92
23.50
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?

30
Calculating the ex price
There is a 11 bonus issue. The market price of
the shares before the capitalisation is
12.00. What is the theoretical ex price of the
shares?
Number of shares
Price per share
Total value
Before
1
12.00
12.00
Scrip
1
0.00
0.00
2
After
6.00
12.00
31
Cash dividends
  • What is a dividend
  • Payment/distribution to shareholders from
    realised profits
  • Interim and final dividend
  • Timetable

32
Listing on the Stock Exchange
  • The main advantages are

Capital - access to a large pool of capital
Status/prestige assist companys trading
prospects
Takeovers using shares to fund the acquisition
of other cos
Employees stock options can be used to retain
key staff
The main disadvantages are
Regulations disclosure requirements are more
stringent
Threat of takeover anyone can become a part
owner
Short termism impatience and emphasis on short
term goals
33
Listing
34
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

35
FTSE Indices
FTSE 100
FTSE 250
FTSE Small Cap
36
World Markets
  • Securities
  • New York
  • NASDAQ
  • London
  • Euronext (Paris)
  • Tokyo
  • Deutsche Borse
  • Hong Kong
  • Indices

Dow Jones
SP 500
NASDAQ Composite
CAC 40
Nikkei 225
Xetra DAX
Hang Seng
37
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

39
SETS
  • Buy sell orders displayed (price/time priority)
  • Standard settlement
  • Visible to all but only member firms can input
    and delete orders

40
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41
SEAQ
  • Market makers show prices and sizes
  • Two way prices (bid, offer, spread)
  • Touch strip

42
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43
Equity Settlement
Trade
Buy me 1000 PJC plc shares
Settlement
44
  • CREST is an electronic settlement system
  • Mainly settles UK equities, corporate loan stock
    and gilts
  • Dematerialised/uncertificated settlement

45
Crest Structure
Investors
Regulators
Member
Bank
Revenue(s)
Registrar
Companies
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
48
Other bonds - features
  • Zero Coupon Bonds
  • Convertibles

49
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

Date Issue Term Mar 2006 100m 6mth Apr
2006 50m 3mth Oct 2006 75m 6mth Jan
2007 75m 3mth
CP programme issue limit 150m end date 2008
54
Certificates of Deposit (CD)
55
Company types
All companies
56
Company Administration
Memorandum
Articles
Executive Non-executive
Meeting types AGM EGM
57
Derivatives
  • CHAPTER 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

61
An example of an Equity Call Option
Writer
Call Option (10p per share)
Holder
Option Premium
62
Options terminology
  • Consider an equity call option with a strike
    price of 100p and premium of 10p. The underlying
    share is currently valued at 105p

63
Options Terminology
  • Call Option
  • Put Option
  • In the money
  • At the money
  • Out of the money
  • Breakeven

64
Financial Products
  • CHAPTER 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 effective
  • Quoted expressed as a decimal
  • Divided by number of periods per year
  • Added to one
  • To the power of the number of periods per year
  • 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 Gross but taxable.
Paid Gross But taxable
Tax free.
Paid on maturity Tax free up to 15,000 per
issue.
Taxable, Paid net of 20
70
Pooled Funds
  • CHAPTER 5
  • Unit Trusts
  • OEICs
  • Investment Trusts

71
Rationale of Collective Investment
Ive got a spare five thousand, I think Ill
invest in a UK equity fund.
Advertise
Fund Manager
72
Role of the FSA
  • Authorised v unauthorised
  • Onshore v offshore

73
Unit Trusts - Basics
Investors (1,000)
Legal owner of the trust property Safeguards
assets Monitors the manager
Fund Manager
Makes investment decisions Prices the units Deals
with investors
74
Types of Unit Trust
Authorised/regulated funds
  • Securities Funds - most common
  • Money Market funds
  • Futures and Options funds
  • Geared FO
  • Warrant funds
  • Property funds
  • Fund of funds
  • Feeder Funds
  • Umbrella Funds
  • Limited issue funds
  • Principal protected funds
  • Mixed funds

75
Buying more Units
FM prices Bid Offer UK
Equity 485 515
Another 1,000 units created (open ended)
Fund Manager
76
Creation of more units?
Buyers
Sellers
Fund Manager
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 its 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

80
Investment Trusts
Investors
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
Investment Trust
81
Exchange Traded Funds (ETFs)
  • Index tracking funds
  • Open ended
  • Structured as a company
  • Listed on exchanges (such as the LSEs extraMARK)
  • Trade at net asset value

82
Collective investments comparison
83
Hedge Funds
  • Unregulated schemes
  • High investment entry levels
  • Flexible investment style, including gearing
  • Fees are performance related

84
Investment Wrappers
  • CHAPTER 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

86
ISA limits
Mini ISA
Maxi ISA
Stocks shares
no limit
Cash
3,000 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
Regulation
  • CHAPTER 7
  • FSMA 2000
  • Money Laundering
  • Insider Dealing and Market Abuse
  • Takeovers and Mergers

89
UK Financial Regulation
  • The UKs 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 FSAs 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

93
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 gt MLRO gt SOCA

94
Insider Dealing
If an individual who possesses inside information
from a primary or secondary insider
95
Market abuse
Offence under FSMA 2000
Regular user test employed to establish guilt or
innocence
Includes Using information not generally
available to others
96
Takeovers and Mergers
  • 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?

Competition Commission
Panel on Takeovers and Mergers
97
Takeovers and Competition
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
OFT
The Competition Commission decides on whether the
takeover should be allowed to proceed, any
restrictions required and the like
CC
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
  • Dont 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
100
  • SARs prevent the following
  • 10 or more
  • Within 7 calendar days
  • From more than one source
  • Resultant shareholding is 15 or more

0
100
Takeover of a Listed Company
0
Bid announced through Stock Exchange
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
Taxation
  • CHAPTER 8
  • Income tax
  • Capital Gains Tax
  • Inheritance Tax
  • Stamp Duty

103
Taxation
Paid on income, potentially including investment
income
  • Income tax
  • Capital gains tax
  • Inheritance tax

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 or partnerships
From companies
From banks/building societies/bonds
105
Income Tax
40
Higher rate
33,301
22
Basic rate
33,300
10
Lower rate
2,150
5,035
Personal allowance
Income
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 Gains
  • Shares
  • Bonds (some)
  • Property
  • Antiques
  • Exemptions
  • 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 investors 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 gt120,000
  • 3 on homes gt250,000
  • 4 on homes gt500,000

111
End of Course
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