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Bus Man 142 Note Pack PDF
Business Management (Universiteit Stellenbosch)
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BusMan 142
Chapters 1 – 7
Chapter Summaries + Extra Notes
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BUSMAN 142
CHAPTER 1
CONTENT: How to create wealth?
Sound investments provide potential to accumulate wealth
Gambling
•
•
•
•
Person makes a decision/executes activity without any knowledge of what outcome
will be
Possibility of large return
No guarantee, no certainty
All comes down to guesswork
Speculation
•
•
•
Person ventures money (or others9 money) on activity with expectancy of large return
after short period of time (<1 year)
A degree of knowledge applicable
Holds promise of great returns but is very risky
Investments
•
Purchasing of assets with purpose of retaining it for considerable period of time (>1
year) – aim for it to increase in value/provide reasonable return
Term
Motive
Investment
Long term (+5 years)
Requires reasonable return
Speculation
Short term (1-2 years)
Requires considerable
return
Investment objectives: reasons for investing
•
•
•
•
•
Speculation
o Buying asset (investment instruments) with goal to sell it for substantial profit
within 1 year
o High risk
Income
o Buying asset with aim generate income
o Property → rental; shares → dividend; fixed deposit → interest
Capital growth
o Buying house for R500 000, sell it after 10 years for R5.5m
o R5m capital growth
o Pay capital gains tax
o Purpose = protect purchasing power of money = current inflation
Takeover & merger
o Buying neighbouring farm to farm more effectively
o Takealot/Kalahari, Vodacom/Neotel, MTN/Telkom
Control over raw material/distribution channel
o Set of interdependent organisations involved in process of making
product/service available for use/consumption
o Farmer buys neighbouring farm to get access to river
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o
Shoe manufacturer buys number of retail shoe stores to sell exclusively to
them
NB: options are contracts through which a seller gives a buyer the right but not the obligation
to buy/sell a specified number of shares at a predetermined price within a set time period
Financial instruments & financial securities
Financial instruments
•
Monetary contract between parties & collective term for all assets/units or capital that
are tradeable
o Emphasis = tradability of value of paper that serves as security
o E.g. ability to transfer ownership of asset from 1 person to another (virtual/real
document)
Financial securities
NB:
equity-based financial security = shares
debt-based financial security = bonds
•
Financial instrument that can represent:
o Investment as owner (share)
o Creditors relationship with company/governmental body (bonds/debenture)
o Rights to ownership as represented by an option
o Emphasis = guarantee function of financial/other assets
o E.g. to serve as guarantee/security when you apply for loan/overdraft facilities
o Equity-based financial security includes = shares
o Debt-based financial security includes = bonds
Shares
•
•
•
•
Small units of ownership that capital of company consists of
Companies issue shares:
o Raise money from investors to expand/merge/acquire/settle debt/buy
equipment
o Limited liability
Investors buy shares:
o Stake in company9s equity
o Share in its profits in form of dividends
o Aptitude to vote at general meetings of shareholders
Share certificate
o Proof of ownership – paper document – disappear due to dematerialisation
o Purchase electronically & held in electronic account
Bonds & gilts
•
•
•
Bonds: tradable debt instruments issued by corporations; debentures
Gilts: tradable debt instruments issued by state/semi-state institutions; Eskom Gilts
Characteristics:
o Loans that must be repaid on future date (maturity date)
o Fixed interest must be paid periodically to owner
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o
Market price varies around issue price (par value) as market interest rates
rise/fall; offer little opportunity to make capital gains, still included in portfolio
because it provides investor with constant, fixed income
Securities exchange
Company that creates opportunity for potential buyers & sellers of a security to come
together for trading → JSE
STRATE & dematerialisation
STRATE
•
•
•
•
•
Share Transactions Totally Electronic
Trading of securities on JSE, facilitated by stockbroker
Regulated professional who buys/sells stocks for clients through JSE/over the
counter in return for commission
When 8deal is struck9, ownership must be transferred between buyer & seller;
payment must be made
STRATE performs function with help of specific authorised organisations to act as
CSDP
o CSDP = Central Securities Depository Participants
o Keeps records of ownership of shares
Dematerialisation
•
•
2001
Process whereby paper share certificates were converted to electronic format
Money Market & Capital Market
NB:
Money Market = short-term = savings/loans
Capital Market = long-term = investments/loans
Money Market (MM)
•
•
Total market (mechanism) of all short-term funds traded (securities <1 year maturity)
o Short-term savings accounts → day deposits, cheque → earn interest
o Short-term loans → overdrafts, instalment credit → pay interest
Surplus/shortfall of short-term funds can influence MM interest rate
Capital Market (CM)
•
•
Market (mechanism) where long-term funds are traded (securities >1 year maturity)
o Long-term investments → fixed deposits, participation bonds → earn interest
o Long-term loans → mortgages, debentures → pay interest
Surplus/shortfall of long-term funds can influence CM interest rate
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Capital Market: Primary & Secondary Markets
Primary Market
•
•
•
Key function:
o Facilitates growth by enabling individuals to convert savings into investments
o Facilitates companies to issue new stocks to raise money directly from
households for business expansion/to meet financial obligations
o 1st time → listed companies/governments sell securities for 1st time → non-par
value shares
o Average issue price → value per share
Rights issue:
o When additional capital is required at later stage → pay off debt, purchase
equipment/other company → more shares can be issued
o Issue price → price for new share < market price
Prospectus:
o To issue new shares
o Info on new/current shareholders & parties interested in purchasing new
shares
Secondary Market
•
•
•
After new shares have been issued, investor can decide whether to hold or trade
shares
Market price:
o Value of share
o Determined by supply/demand
o Can trade at price </> than original issue price
Value of share determined by:
o Company success
o Quality of management decisions
o Future prospects of company
Share price
Share price/market price → price at which shares are traded in secondary market
3 types of prices:
1. Bid to buy (buyer9s price) → bid: highest price buyers will pay
2. Offer to sell (seller9s price) → offer: lowest price sellers will sell at
3. Market price → last: last traded price, price at which last transaction took place
Price trends → determined through 3 values (bid; offer; last)
e.g. bid = 620c; offer = 630c; last = 610c
•
Price is under upward pressure → next transaction likely to happen at price above
610 cents
Market price & movements of previous day → published in newspapers
•
•
•
Closing price
Price movement
Highest/lowest prices for day
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•
Volume traded
Blue chips
NB: Blue chips have elite investment status – reputation, status, long-term
•
•
•
Ordinary shares of companies with elite investment status
Status built up over long period
Good reputation over long-term by maintain:
o Stable & sound profit
o Stable & sound dividend history
o Still offers good growth prospects for future
Portfolio & diversification
NB: portfolio = composition & totality of person’s investments (a.k.a. investment portfolio)
Investment portfolio
•
•
Composition & sum total of person9s investments
May consist of stocks, bonds, real estate, cash, gold, vintage cars, paintings,
jewellery, options
Diversification
•
•
Based on principle: 8do not put all your eggs in one basket9
Invest in different companies & sectors
NB: sectors in SA: agriculture, finance, government, mining, electricity, transport etc.
•
•
NB:
Risk-averse investor will purchase shares of various companies – place them in his
share portfolio
Investment portfolio includes instruments with different risk profiles:
o Some companies fail (loss on shares), other shares might increase in value
greater the spread of the portfolio over different investment instruments, the lower the
risk for the investor → higher spread, lower risk
sensible to diversify investment portfolio
Risk
•
The possibility that the actual return he realises on investment could be lower than
return he expected to realise
Institutional investors
Enterprises with large amounts of capital at their disposal – mainly purchase shares & other
investments
•
•
Discovery, Sanlam, Liberty
o Pension funds, insurance companies, unit trusts
Collect large amounts per individual
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•
o R2 000 x 2 000 individuals = R4m
Use large amounts of capital to acquire mainly shares
NB:
Institutional investors are companies or organizations, with large amounts
of capital at their disposal, which have considerable cash reserves that
need to be invested. They buy, sell, and manage stocks, bonds, and other
investment securities on behalf of their clients, customers, members, or
shareholders. There are, broadly speaking, six types of institutional
investors namely: endowment funds, commercial banks, hedge funds, pension
funds, insurance companies and mutual funds (such as unit trusts).
Unit trust
Function is to collect small amounts of savings of individuals & enterprises – then use large
collected amount to purchase & manage diversified portfolio of shares
•
•
•
•
•
Un-incorporated mutual fund structure → allows funds to own assets & provide
profits that go directly to individual unit owners, instead of reinvesting them in a fund
On behalf of small investors
Collect & combine small amounts of savings from thousands of individuals &
companies
Use large collected amount – purchase/manage diversified portfolio of shares on
behalf of investors
o R50 x 40 000 individuals = R2m
Benefit: managed by specialised, sensible investments specialists
Institutional investor → large amounts, few individuals
NB:
Unit trust → small amounts, thousands of individuals
Unlike the other types of institutional investors, unit trusts, as unincorporated mutual
fund structures, provide profits that go straight to individual unit owners instead of
reinvesting them back into the fund. Units are bought and sold through the
management company and not by stockbrokers.
Listing
•
•
•
•
Process of taking over privately owned organisation → transition to publicly owned
entity
Right that company obtains to trade its shares on stock exchange after certain
prerequisites are met
Company listed in certain sector according to its primary activities (core business)
If company meets minimum listing requirements → issued a 8pre-listing statement9:
o Document = source of information regarding planned listing
o Not invitation to buy additional shares (in the case of a prospectus)
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Arbitrage
Process of buying product on cheaper market & selling it on more expensive market
•
•
•
E.G.
Product traded on 2/more markets → short-term price differences can develop
between different markets – make profit from short-term price differences
o 2/more markets → e.g. JSE vs LSE
o R17: £1
▪ JSE speculators buy shares @ cheaper price → 3 300c
▪ LSE speculators sell shares @ 220GBp x 17 → 3 740c
▪ LSE profit of 440c per share (minus transaction costs)
More speculators will see this opportunity & follow:
o Because of their actions; increase demand shares on JSE = increase in
market price
o At same time; increase offer/supply on LSE as more shares sold = decrease
in market price on LSE
o Market price on JSE & LSE will more/less reach equilibrium
Steps:
o Determine whether a mispricing exists
o Determine how to exploit the mispricing
o Determine profit to be made
Exchange rate: £1: R21.55
JSE: 89 608c
LSE: 4 640 GBp → 99 992c (4 640GBp x 21.55)
Buy on JSE
Sell on LSE
Profit: 99 992 – 89 608 = 10 384c p.s. = R103.84
Bulls, Bears & Stags
Bull market: bull thrusts horns upwards → price increases over long-term
NB:
Bear market: bear swipes claws down → price decreases over long-term
Bull market
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•
•
•
•
•
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Period of continuous price increase over long-term
Strong buying pressure (demand)
Prices of most shares will increase
Optimism
Bull investor buys to keep it for long-term:
o Stock market is in long-term price increase phase, he hopes to sell later at
profit
Risk = price decrease = loss
Bull speculator buys to make profit in short-term
o Does not have funds to pay for purchase – must sell shares quickly to obtain
funds
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Bear market
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Period of mainly price decreases over long-term
Pessimism
Bear speculator sells shares he does not own
o Hopes that price will decreases so he can, in order to deliver shares to person
to whom he sold them, purchase required shares at lower price
Risk = transactions are risky, there are requirements by JSE to conduct transactions
Stags
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•
•
•
Speculator endeavours to make quick profit out of new listings as well as during
rights issue
When shares are listed for 1st time, increase in market price due to greater
marketability, prominence, status & more potential buyers
Try to get shares of unlisted companies just before they are listed & sell at a profit
immediately after having been listed
Risk = price decrease = loss
Bull Investor
▪ Buy share today @ R100
▪ Sell share in 5 years @ R130
Profit R30
Corporate Actions
Bear Speculant
▪ Mr. P sells 1,000 shares (which he
does not have) to Mr. J at R5 per
share.
▪ Share price drops and after a few
days Mr. P buys the shares (which
he promised to Mr J) from Mrs G at
R4 per share. Mr P then delivers
them to Mr J.
▪
▪
Different decisions made by management of company –
have effect on securities issued by company
•
•
Mandatory events:
▪
o Initiated by board of directors – affects all
▪
shareholders
o Participation of shareholders is
mandatory/compulsory
o E.g. cash dividend: all shareholders
entitled to receive dividend payments; do
not need to do anything to get dividend
o E.g. capitalisation (bonus) issues,
subdivisions & mergers
o Mandatory = shareholder does not need to do anything; is a passive
beneficiary
Voluntary (elective) events:
o Shareholders elect to participate in action
o Response from shareholders is required to process action
o E.g. rights issues & share buy-backs
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Dividends
Portion of profit after tax that is distributed to shareholders
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Preference shareholders receive first dividends; followed by ordinary shareholders
Directors decide whether company pays dividends & what dividend per share will be
Remainder of earnings will be reinvested in company as reserves
Total Dividend for year (two dividends combined):
o Interim Dividend – declared when financial results of 1st 6-months are known
o Final Dividend – declared @ end of financial year
Capitalisation (bonus) Issue
Shareholders receive additional shares in company for free
e.g. for every 100 shares they possess, they will receive 10 shares free
•
•
•
•
•
Capitalisation issue takes place at current market price of shares
Shareholders do not have to apply for shares, do not have to pay for shares
E.g. company will hand out further 100 shares for free
8Financing9 for 100 shares given away come from company9s reserves
Purpose:
o Provide shareholders with opportunity to share in prosperity of company
o Company lacks required cash to pay out dividends
o Wants to sidestep payment of dividend withholding tax
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•
•
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Shareholder can decide whether to keep bonus shares/sell shares
To keep voting power in company, have to keep bonus shares
Market price of ordinary shares will drop slightly → totally value of company is spread
over larger number of shares
E.g.
In a specific ratio (for every 100 shares SH owns, he will receive 10 additional shares
@ MP of R2/share)
Takes place at the current market price (MP) (assume MP = Average Issue Price =
R2)
Financing of 100 free shares comes from distributable reserves (retained
earnings)
e.g. R200 (100 shares @ MP of R2/share) will be transferred from Reserves to
Ordinary Share Capital
Subdivision (stock split) & Share Consolidation
Stock split → existing shares subdivided into two/more shares
•
•
•
•
Shareholders receive more shares but with lower average issue price per share
E.g. one ordinary share with average issue price of R2 can be split into 10 ordinary
shares of 20c each
Total value of shares is still R2 (1 x R2 = 10 x 20c)
Purpose:
o Make shares more affordable
o Lower the market price of shares
o More investors will be able to afford shares = increase tradability of shares
o Wider spread of shares could prevent possible hostile (unwanted) take-overs
Share consolidation → opposite to stock split
•
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•
•
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When market price of share becomes very low; directors worried low price may come
across as result of badly run company
Consolidate number of shares into 1 new share
Applied when company has too many small shareholders
Large number of shareholders = high administrative costs (distribution of notices &
financial statements)
Share consolidation = number of issued shares decreases = average issue price &
market price per share increases
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Rights issue
Present shareholders obtain right to purchase additional shares in company
e.g. for every 100 shares shareholder owns, may purchase another 15 shares at R1.8 (issue
price) per share
•
•
•
•
Exercise the rights:
o Shareholder must give notice that they intend to exercise rights; will have to
pay for new shares but will pay discounted price for share (issue price)
Sell the rights:
o Rights received by shareholders have financial value & trade on JSE just like
shares
o Shareholder will receive price rights are trading for → once sold, shareholder
no longer has option to exercise rights to buy more shares at discounted price
Do nothing:
o Rights will lapse after closing date
Purpose:
o Obtain additional capital (financing)
o Essential for shareholder to purchase additional shares if they wish to
maintain voting percentage
NB: Voting Power:
If shareholders wants to retain % voting rights, he must buy new shares
Supposing shareholder owns 300 of 1000 issued ordinary shares (30% voting rights) →
must buy 45 new shares (300/100 x 15) so that his new 345 shareholding continues to
constitute 30% of the 1 150 new total number issued
(1000x2.00) + (150x1.80)
Rights Issue – Underwriting
•
Assume company requires additional R60m capital to finance an expansion
o Consider issuing an additional 10m new shares @ 650c by means of rights
issue (R65m)
o Current market price = 690c
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•
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•
•
Plan to invite current shareholder + public to purchase new shares by publishing a
prospectus
Want to ensure that the required funds will be obtained & decide to have the rights
issue underwritten (insured)
o Large financial institution undertakes to buy all shares not sold during the
rights issue @ issue price & charges an underwriters fee for the service
o Amount of the Fee = function of probability (risk) that all shares will not be
bought
Assume only R40m were sold to current shareholder & public – underwriter required
to buy the remaining shares to value of R25m
If shareholder & public buy all shares to the value of R65m, underwriter will receive
the underwriter9s fee without having to provide any service
Share Buy-backs
Opportunity for companies to buy-back their own shares
Buying back its shares provides company with accounting advantage
•
•
•
•
•
•
•
Transaction could lead to increase in earnings per share of remaining shares without
company working any harder to generate profit
Principle:
o Company should use its excess cash
Directors do not need permission from shareholders to do buy-back of shares →
unless shares bought back are from director
Requires company to be liquid & solvent after buy-back
Companies cannot buy back all shares that are in issue
Buy-back is limited:
o Maximum 20% per financial year
Price requirements:
o No buy-backs may be done at price that exceeds weighted average of market
price of company9s shares on JSE for five business days after buy-backs by
more than 10%
o
Quantity & price at which buy-backs are done must be announced with every
3% that is bought back
Cannot buy-back @ a price higher than:
Days
Preceding
Fri
Thurs
Wed
Tues
Mon
Price (R)
9
8
7
8
9
(9+8+7+8+9) / 5 = R8.20 = 8.2(1.1) = R9.02
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Fundamental & Technical Analysis
Fundamental Analysis
Technical Analysis
Concerned with WHAT to
purchase
Concerned with WHEN to
purchase (correct timing)
Helps investor to distinguish
which companies are potentially
sound & which to avoid
Economy & markets move in diff
cycles of up/down swings
Determine the value of company
& shares by using ratios (rate of
return, liquidity, solvency)
Investors wish to purchase before
Price↑; sell before Price↓
ADDITIONAL EXERCISE
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Final answers:
See written notes
for explanation +
answers
BUSMAN 142
CHAPTER 2
CONTENT: Statement of financial position
Fundamental Analysis
•
Entails determining intrinsic (calculated/real/fair) value of shares by considering
current & future financial performance of company
•
By discounting expected future income & dividends
o
it is possible to determine what present value of shares should be,
o
& to compare this value with current market value
▪
If current market value < intrinsic value: undervalued
▪
If current market value > intrinsic value: overvalued
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•
To evaluate financial position of a company, it is necessary to –
o
analyse financial statements using financial ratios
Stakeholders in Financial Analysis
4 Groups Stakeholders:
•
•
Shareholder:
o
interested in ability to generate income
o
interested in risk associated with income – profit, EPS & DPS
Debt Capital Providers:
o
•
•
current amount of debt capital in capital structure & business9s ability to settle
capital & interest repayments - solvency & liquidity
Management:
o
ensure efficient decision-making, need to be continuously informed about
financial position of company
o
Employees – interested in firm9s ability to survive over long-term
Diverse groups:
o
not directly involved in activities of business
o
also interested in financial performance – clients, providers, stockbrokers,
competitors
Financial Statements
Financial Statements/Reports = formal records of financial activities & position of a
business
PS:
•
Statement of Financial Position (balance sheet) – assets, liabilities & owners'
equity
•
Statement of Profit/Loss & Comprehensive Income (income statement) – income,
expenses & profits
For purposes of this chapter, focus is placed only on Statement of Profit or Loss,
since it contains information required for financial analysis
Summary of a company9s financial position on specific date (year-end)
•
Reports on assets, liabilities & equities
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•
Lists resources, obligations, & ownership details of a company on a specific
day
2 Sections
•
Summary of capital obtained by, & application thereof in a company
ADDITIONAL EXERCISE
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Assets
Capital investment to generate income
Non-current
•
•
•
NB:
Long-term assets used for longer than 1 year
Cannot be converted to cash within 1 year
Part of fixed property/infrastructure
PPE - Property, Plant, Production @ cost price
o
Physical assets (property, equipment, vehicles, buildings)
o
Usually shown @ original cost price
o
Weakness of SFP - if assets (machinery) are in use for long period of time, they
become part of fixed infrastructure:
▪
cost price no longer reflects replacement (current) value of asset
o
Solution: include replacement value as revaluation reserve
o
Difference between cost price & market value appears as part of ordinary
shareholder equity as revaluation reserve
Accumulated Depreciation
o
All depreciation provided for in Statement of Profit Loss, is accumulated in SFP,
to form accumulated depreciation
o
Indicates the total depreciation provided for PPE
PPE at Carrying Value
o
By subtracting accumulated depr from PPE @ cost price, indicates the value of
assets
o
When PPE items are sold, the proceeds from the sale, are compared to the
carrying value to determine profit or loss
Intangible Assets
o
Goodwill & Patents
o
Problem = valuation - difficult to allocate monetary value
o
Is remains property of enterprise & is used to generate an income
Financial Assets
o
Investments (shares in other companies, listed/delisted)
▪
o
Indicated at original price
Loans to other parties (employees, board members, other businesses)
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Current
•
•
•
NB:
Short-term assets used for less than 1 year
Can be converted to cash within 1 year
Part of physical production process
Current Assets
o
Used during the 1st 12 months
o
Usually part of the production process - from raw material to the finished product
o
Can be easily sold or consumed & further lead to the quick conversion of liquid
cash
o
They are important to cash flow management & forecasting, because they are the
assets that a business uses to pay its bills & dividends & repay borrowings.
Inventories
o
All items necessary for the continuous operation of business
o
Different items will be included, depending on the type of business.
▪
Production – raw material, components, work-in-process, finished
product & supplies
▪
Retail – finished products that are sold in outlets
Trade Receivables
o
Credit sales – a portion will still be outstanding on the date that statement is
compiled. Outstanding amount then included in trade receivables.
Cash
o
All cash held on the premises - petty cash (day-to-day expenses)
o
Cash deposited into bank accounts
o
Cash equivalents – short-term investments
Prepayments
o
Those expenses they paid before payment was required
o
Since statement of financial position is compiled at a specific point in time, these
items usually refer to payment made for transactions that will only occur in the
next accounting period.
o
Although these items will not lead to future revenue, it represents a decrease in
future liabilities
Difference between Non-current & Current:
•
•
•
Turnover period of capital → how long asset is used for
Ease of realisation → how easy to convert into cash
Physical characteristics → fixed vs non-fixed
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Equity & Liabilities
•
All different forms of capital obtained
•
3 Types Capital - based on providers of capital & period available – shareholder
equity, non-current-liabilities & current liabilities
Equity
1. Ordinary Share Capital
•
Proceeds from the sale of ordinary shares
o
•
Represents shareholder9s stake in management of organization
Calculate = # of ordinary shares x average issue price
2. Non-Distributable Reserves
•
Reserves that cannot be paid out, as dividends, to ordinary shareholders
o
Revaluation Reserve
o
Capital Redemption Reserves (buy-back of own shares)
3. Distributable Reserves
Can be paid out to ordinary shareholders as dividends
•
General Reserve - amount kept aside from the profit to meet future needs (e.g.
contingencies, strengthening the company9s financial position, increasing working
capital, paying dividends, offsetting specific future losses)
•
Retained Earnings – amount of net income left over after it has paid out
dividends, but can also be reinvested back into the company for growth purposes
4. Ordinary Shareholder Equity
•
Total shareholding in the company
o
ordinary share capital
o
non-distributable reserves
o
distributable reserves
5. Preference Share Capital
•
Capital obtained by selling of preference shares to investors
•
Preference shares provide the shareholders with a preference right above the
ordinary shareholders to receive dividend payments.
o
It may entitle the shareholders to a fixed dividend proceed
o
Guarantees shareholders that dividends will be paid before an ordinary
dividend is considered
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6. Shareholders’ Equity
•
Total LT capital provided by shareholders (ordinary + preference)
Liabilities
Non-current
•
•
•
NB:
Long-term debt capital
Long-term liabilities with amounts to be paid to creditors after period of 1 year
Types:
o Long-term loans
o Mortgage loans
o Debentures
Non-current
Long-term Debt Capital - financial obligations that are not due for settlement within
accounting year
Mortgage Loan
o
Type of bond that is secured by some kind of collateral, (e.g. equipment) that
borrower is obliged to pay back with a predetermined set of payments. The
remaining principal amount is reported in SFP
LT Interest-Bearing Loans
o
Large amounts of capital borrowed that are yet to be paid off in multiple
instalments over a long period of time
Debentures
o
o
Type of bond that is not secured by collateral, but secured only on borrower9s
creditworthiness & reputation
It is a document that grants lenders a charge over a borrower's assets, giving
them a means of collecting debt if borrower defaults
Shares
Ordinary Shares
•
•
•
•
•
•
•
•
Co-owners of company
Voting power (1 share = 1 vote):
o Vote on take-overs, mergers but not amount of div they will receive
Receive dividends → no legal right but entitled to claim to profits
Pre-emptive right to new shares (to maintain their % interest in company)
Limited liability → only lose the value of shares
Shares are negotiable & very liquid
Potential to generate capital gains
Last claim to assets & profit (after creditors, SARS, preference shareholders)
Preference Shares
•
Voting power is limited or non-existent
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•
•
•
Fixed dividend guaranteed (% par value)
Market price is more stable than ordinary shareholder
Types:
o Cumulative: dividends accumulate and will be paid when funds are available
o Non-cumulative: No outstanding dividends from previous years will be paid
back
o Participating: SH may receive a higher dividend if company experiences a
larger profit than expected
o Convertible: Shares can be converted into a fixed number of ordinary shares
o Redeemable: Shares bought back at par value on a certain future date
Current
•
•
•
NB:
Short-term debt capital
Short-term liabilities with amounts to be paid to creditors within 12 months
Types:
o Trade payables
o Bank overdraft
o Short-term loans
o Dividends payable
o Current tax liabilities
Current
ST Debt Capital - all liabilities that are to be settled in cash within 12 months
Trade Payables
o
When items are purchased on credit & payment only takes place after some time
o
Represents thus future financial obligations that have yet to be made
Bank Overdraft
o
In order to finance short-term capital requirements, company can negotiate for an
overdraft facility on its bank account
o
Usually make use of it only over short-term, due to high finance costs
Short-Term Loans
o
All loans or portions of long-term debt expected to be redeemed within the
following financial year
▪
e.g. a portion of debentures to be redeemed
Dividends Payable
o
Dividends declared now for end of year and therefore not yet paid – cash amount
still to be paid is recorded in SFP
Current Tax Liabilities
o
If amount of tax that must be paid is known (calculated), but payment has not yet
been made….
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Statement of Profit or Loss
•
Summary of company9s financial performance (income, costs, expenses):
o
Specific time period (usually 1 year)
•
Revenue is allocated to various interest groups of undertaking to point where only
retained earnings remain
•
Does not represent cash-flows → non-cash flow items are included:
NB:
o
depreciation
o
credit sales
o
credit purchases
compare statements of different accounting periods, as changes in revenue,
operational costs & net earnings over time are more meaningful than numbers
themselves
E.G.
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Financial Statements (SPL & SFP)
Financial statements used for fundamental analysis
Imperative that statements comply with requirements:
1.
2.
3.
4.
5.
6.
Relevant & must contain necessary information that is required
Information - reliable & complete
Statements must be understandable for the users
Objective version of company9s financial situation
Timely (up to date) because since outdated information is of no value
Statements must be comparable & therefore information should be dealt with in a
consistent manner
Financial Ratios
•
•
•
•
Evaluate company's performance
Compare performance to other similar businesses in industry
Measure relationship between 2/more components of financial statements (SPL &
SFP)
Used most effectively when you compare results over several periods
Ratios & Ratio Categories
To evaluate financial performance, use ratios:
•
When calculating a ratio, examine a relationship between items on statements
To effectively investigate financial performance, ratios must meet requirements:
•
•
•
•
Comparison/relationship to be meaningful - e.g.
not meaningful to compare goodwill with salaries
Only relevant amounts must be included
Ratio value must be true indication of financial
performance
Value of ratio must be comparable over a
period of time → to be calculated in consistent
way
Can be split into different categories, which are measured in specific units.
Ratios & Averages Values
Average values → to eliminate changes that occur during financial year to obtain
meaningful comparison between SFP & SPL items
Cost of Sales
o
Average
Inventory
o
e.g. if company has paid back a large portion of debt capital, it is more
sensible to compare average debt (not final balance) with finance costs
Numerator = Annual Statement of Profit/Loss → 365-days Year
120 000
0,5 (24 000 +
18 000)
= 5.71 times
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Return on Total Assets
•
•
•
How effective managers & employees
use total assets/capital to generate
income
Income (before Interest & Tax (EBIT))
relative to total net assets
Applicable income items = operating
+ investment income → revenue
generated by total assets
Return on Equity
•
•
How effective managers & employees
use total equity to generate income
(return shareholders received on
investments)
Since objective of a company =
maximise shareholder value → ratio
makes a valuable contribution to
financial evaluation of company
Costs of Debt
•
•
•
Average cost of debt capital used by company
Finance costs = interest payments on
debt capital → overdraft bank,
debentures, loans
Debt Capital = non-current plus current
liabilities:
o Non-current liabilities → longterm loans, mortgage loans,
debentures
o Current liabilities → short-term
loans, creditors, overdraft, div payable, current tax liability
Return on Financial Assets
•
Average return earned on the company9s external investments
•
Investment income:
•
o
Dividends received
o
Interest received
Financial Assets:
o
Share investments (listed + not
listed)
o
Loans granted
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Profit Margins
Mark-up vs Price vs Gross Profit Margin
Liquidity
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BUSMAN 142
CHAPTER 3
CONTENT: Technical Analysis
Fundamental Analysis
•
•
•
•
Financial Statements
Try to determine a <realistic= value for shares
Compare this <realistic= value to actual market price (MP)
MP < realistic value = BUY
Technical Analysis
•
•
•
•
Market price = reflects <realistic= value
Study market movements: share prices, indices, volumes
Look at price movements – ID trends (ST/LT)
Basic philosophy: trends tend to repeat (Dow Theory)
Assumptions:
1. Market price is determined by the interaction of the supply & demand
2. Supply & demand influenced by various factors → rational & irrational factors
3. Prices tend to form certain trends, & these trends will continue for a reasonable long
time
4. A trend will change due to changes in supply & demand
Share Price Indexes
Charles H Dow co-founded Dow Jones & Company
•
•
•
Founded The Wall Street Journal
Developed the Dow Theory
Invented the Dow Jones Industrial Average (DJIA) → share price index
Uses of Share Price Indexes
1. To forecast economic cycle
Economic indicator (leading indicator ±6 months – 2 years)
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2. Timing of purchases & sales
3. Evaluating performance of portfolio
4. Quantification risk → Beta analysis
• Beta analysis – quantify the sensitivity of a share9s price relative to a sector or the
general market
• Higher beta = higher risk
5. Determine speculative activities
• By viewing the market index along with the volume & Rand-value of shares
traded, one can determine if the activities & movement are purely speculative
Calculations of Share Price Indexes
3 Techniques:
a)
Price weighting → Companies with high share prices carry bigger weight
b)
Equal weighting
c)
•
Eliminate the disadvantages of price weighting.
•
Each share is given a weight in relation to the number of shares that can be
purchased on the base date with a given amount e.g. R1000.
•
The influence of all companies on the index is now the same
Market capitalisation → = MP x number of issued shares
*Share prices always given in cents
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FTSE/JSE Africa Index
Charts & Technical Indicators
Technical analysts:
•
•
Focus on past trading activities and price movements to forecast future price
movements.
Use charts and technical indicators to identify trends in the market and to assist
with trading activities and timing.
DOW-theory (origin of technical analysis)
1. Primary trend
2. Secondary trend
3. Short-term fluctuations
Primary Trends: Long-term Trends
Bull market
•
•
Period of long-term upward price movement in the market
New high points & troughs are higher than the previous
ones
Bear market
•
•
Period of long-term downward price movement
New high points & troughs are lower than previous ones
Secondary Trends
•
•
•
•
Long-term trend interrupted by periods in which price moves
in the opposite direction
A secondary trend during a bull market – a reasonable period of prices declining
(Point A – Point C)
Guidelines that will confirm a secondary trend:
o 3 weeks - 3 months
o Must cancel at least one-third of previous price movement
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Short-term Fluctuations
Study daily fluctuations
Bar Charts
•
•
Price of the share = vertical axis
Time = horizontal axis
Point-&-Figure Graph
Chart used by technical analysts to assist them in analysing price trends of shares
One-dimensional graph:
•
•
•
•
Vertical Axis: Price or Index Value
Horizontal Axis: No Value or <Time Dimension=
o The lack of a time dimension gives point-and-figure charts the advantage of
being able to reveal the nature of share price movements over extended time
periods.
X = Price Increase
O = Price Decrease
Formations:
Double top
Quadruple
Buy
Buy
top
Quadruple
Double bottom
bottom
Sell
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Scale & Point Indication
•
•
Scale: size of each block on chart
Point indication (Reversal scale): number of
blocks that the price must move in opposite
direction before it will be indicated on the chart
→ e.g. one-point, two-point etc.
Trends
Lines that indicate long-term price trends
•
Support Lines:
At the bottom of most formations a support line can be identified
If the price falls through the support line, it is a signal to sell, & one can expect the
price to stabilise at a new lower level
•
Resistance Lines:
At the top of most formations a resistance line can be identified
If the price breaks through the resistance line, it is a signal to purchase, & one can
expect the price to stabilise at a new higher level
Moving Averages
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Buy & Sell Signals
The movement of the 200-day average can be utilised as follows to indicate purchase & sell
signals:
•
Purchase signals:
❖ If the 200-day average flattens or
starts rising after a decline, & the
daily share price breaks through
the average line in its upward
movement
❖ If the share price is above the 200day line and starts to drop towards
the average line but does not cross
it, & then starts rising again
•
Sell signals:
❖ If the 200-day average flattens or starts declining after a rise, & the daily share
price breaks through the average line in its downward movement
❖ If the share price is below the 200-day line & starts to rise towards the average
line but does not cross it, & then starts dropping again
Market Breadth
•
•
•
•
Measures direction of
overall market
Some indices (like the DJIA)
reflect only the price
movement of a small
number of selected
companies:
o Is this representative
of the whole market?
Even in Market Cap Indices,
bigger companies influence
the value of the index much
more than the small companies
Plot values of Cumulative change column together with values of the FTSE/JSE
ALSI on a graph:
o
Moving in same direction: market is technically strong (relative certainty
about direction of market movement)
o
Opposite directions: market is technically weak (uncertainty about
direction of market movement)
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Relative Strength Index
•
•
•
•
•
•
Momentum indicator
Fluctuates between 0 & 100
Used to identify buy & sell
signals
RSI value of 30 = oversold
→ buy signal
RSI value of 70 =
overbought → sell signal
Formula: RSI = 100 – [100
÷(1 + RS)]
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14-day trading period
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Check Week 7 Lecture 2 for
exercise/explanation of Chapter 3 content
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BUSMAN 142
CHAPTER 4
CONTENT: The JSE
The History of the JSE
The Role of the JSE in South Africa
• Initially founded to attract finance
for mining sector with 2 main
functions:
o Primary market
o Secondary market
Secondary market action requirements:
1) Information on companies must be quickly & freely available
2) Information on markets must be quickly & freely available
3) Large number of potential buyers and sellers for each share
4) Low transaction costs
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Control over the JSE
Listing of Shares
•
Company must apply for listing at JSE
o
Prerequisites
o
Company must appoint a sponsoring broker
o
Link between company and JSE
o
Application presented to listing committee
•
Listing committee makes recommendation to board
•
Board makes final decision
Most Important Pre-Requisites for Listing
•
Any listed company must
make provision for:
o
Shares must be freely
transferable
o
Minimum 4 directors
o
1/3 of directors retire
on annual basis
o
Amount directors may
borrow – limited
o
Audited fin
statements presented
to shareholders 21
days before AGM
o
Audited financial
statements available within 6 months from end of financial period
o
Preliminary statements within 3 months
o
Interim results within 3 months after half year
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o
Publish pre-listing statement
Worked Examples
Advantages for Listing for the company
•
•
•
•
•
Provides status & prestige
Ensures national & international publicity
Attract additional debt capital easily & cheaply
Planned mergers & take-overs can be achieved more easily
Hostile take-overs can be more easily prevented
Listing benefits:
Access to capital for growth: listing gives you the opportunity to raise capital to fund
acquisitions as well as growth.
Boost your profile: listing generally heightens your company’s public profile with customers,
suppliers, the media and investors. As a result more business opportunities become
available to you.
Create value and liquidity for shareholders: because your company’s value is independently
assessed, shareholders can realise their investment, liquidity is stimulated and your
shareholder base may be broadened.
A listing allows you to facilitate broad-based black economic empowerment (BEE) deals, a
prerequisite to effective corporate citizenship in South Africa.
You may offer share incentives to employees to encourage commitment and improve the
quality of recruits.
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Advantages for Listing for the shareholders
•
Listed shares:
o Are much more tradable than unlisted shares
o Are more easily accepted as guarantee for short term loans
o Market prices higher than unlisted shares
o Valuation easier
o Portfolio management easier
Membership of the JSE
•
Before 1996 restructuring, membership limited to natural persons (stockbrokers)
•
After 1996 restructuring membership allocated to institutions/enterprises
Categories of Membership
•
Corporate entity (unlimited liability)
o
•
Private company (all shareholders are stockbrokers)
Corporate entity (limited liability)
o
Private or Public company
o
Only stockbrokers are shareholders; OR
o
Non-stockbroker shareholders with minimum of 3 stockbroker as Directors
Pre-Requisites for Membership
Only members of the JSE may buy/sell shares on behalf of clients:
•
•
•
Must be incorporated and registered as a domestic company under the companies
act
Sufficient liquid capital to meet base requirement and risk requirement
Appoint a compliance officer & settlement officer
Trading Capacity for Members
Since restructuring members - dual trading capacity:
o
Agent for client: intermediary
o
As principal: member sells some of their own shares to the client and/or
purchase shares directly from client.
Members must inform client beforehand in which capacity they are acting
Otherwise assumed: as agent
Stockbrokers on the JSE
•
Can provide knowledgeable advice with regards to investments on the JSE
•
Link between client & JSE
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Pre-Requisites for Brokers
•
•
•
•
•
21 years of age
Pass Exam of SA Institute of Stockbrokers
Member of Institute
Not have been expelled from the JSE/other financial market worldwide
Pay entrance fee & annual subscription
Obligations of Buyers & Sellers of Shares
Controlled broker client
•
Stockbroker has control over and access to client9s funds and shares
•
Stockbroker works with own CSDP
Non-Controlled broker client
•
Client appoint CSDP
•
CSDP custodian of his shares; funds in his own account
•
Notify broker of CSDP
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BUSMAN 142
CHAPTER 5
CONTENT: Trading Securities on the JSE
Trading in an Open Outcry Market
Open outcry market (1887-1996):
•
•
•
What?
o Market participants (e.g. brokers) gathered at a specific location
o Called out the name of the company in which they wanted to buy/sell shares
o Within 7 business days: Share certificate and signed transfer forms;
payment
Disadvantages:
o Limited number of shares could be traded on a daily basis
o Misunderstandings amongst brokers
Trading signals:
Electronic Trading
•
•
•
•
1996: JET-system (Johannesburg Equities Trading system)
o Continuous screen trading
o Computer program connects executable requests
o Passive orders on order book
2002: JSE-SETS (Stock exchange trading system)
o London trading system
o Two ways of trading:
▪ Continuous trading (similar to JET)
▪ Auctions certain times of the day
2007: JSE TradElect system
o Trading platform was based in London
o Considerable increase in trading volumes
2013: Millennium Exchange
o Trading platform moves to Johannesburg
o Trading 400 times faster than with TradElect
o Increased market liquidity
o 3 auctions; rest of the day trading takes place on continuous basis
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Instructions to Brokers
Market order:
•
Simplest order that client can give to broker
•
Only specifies the number of shares that should be bought/sold
•
Example: Buy 1 000 ABSA shares
•
Broker obtains shares at the best possible price
o
Buy @ lowest possible price
o
Sell @ highest possible price
Orders to Brokers
Limit order:
•
Number of shares and price limit are
specified
•
Broker buys/sells shares at the
prescribed price or better
•
Buy order: Highest price that client is
willing to pay
•
Sell order: Lowest price that seller is
willing to accept
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Bear Transactions (Short Sales)
•
•
Traditional bear transaction:
o
Person sells shares that he/she does not own
o
Hope that share price will decrease in order to buy shares at a lower price to
deliver it to the buyer
o
Could profit from price decrease
o
Risk: Should still deliver shares if price increases; could possibly result in a
loss
Electronic trading:
o
Negotiate beforehand with loan agent (usually CSDP) to borrow shares
o
Pay loan fee to loan agent
o
Provide security (guarantee) to loan agent
o
Bear receives money for transaction on T+3 days
o
Bear should buy shares to replace loan agent’s shares
Execution Constraints
•
•
Execute and eliminate:
o
Order must be matched
immediately; as completely as
possible
o
Remaining unexecuted volume will
be immediately removed from the
order book
Fill or kill
o
Order must be matched
immediately, in full with existing
orders in order book
o
OR complete order will be cancelled
Further Limitations
•
Further limitations = validity constraints
o
Good for day: Order will expire at
the end of the current trading day
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o
Good till date: Order will expire at the end of a specific day
o
Good till time: Order will expire on a specific time on the current trading day
o
Good till date/time: Order will expire on the specific date/time
JSE Trading: Millennial Exchange System
•
Three auctions: opening (8:30-9:00), intraday (12:00), closing(16:50-17:00)
•
Rest of the day: continuous trading
•
Passive orders: Appear in price/time priority during continuous trading
The Trading Day
Continuous Trading
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The Trading Day
Various phases of JSE auction
Call Phase ➔ Random end ➔ Price determination period
•
•
•
•
Call phase
o
Order books frozen and all trading stops
o
All orders from market are collected
o
Enter new orders (no execution constraints)
o
Existing orders could be adapted/removed
o
No trading takes place during this phase
o
Order book is continuously updated
Call phases:
o
Opening auction (8:30 – 9:00): 30 minutes
o
Closing auction (16:50 – 17:00): 10 minutes
o
Intraday auction (12:00 – 12:15): 15 minutes
Random end:
o
Call phase ends with a random period of 0 to 30 seconds
o
Impossible to enter new orders/change existing orders
o
Makes any attempt for spoofing (manipulation) more difficult
Price determination period
o
Principles for determining the auction price (specific order):
1. Maximum execution principle: price that will create the highest
executable trading volume
2. Minimum surplus: the price that will result in the smallest surplus
3. Market pressure of the surplus
▪
Buy side: Take the highest price
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▪
Sell side: Take the lowest price
4 steps:
1. Rank prices from highest to lowest (decide on price interval)
2. Buy side: Start at top and work down
3. Sell side: Start at bottom and work up
4. Use cumulative volumes to determine maximum execution volume at each price
Maximum execution
principle:
Order book at end of call
phase
Steps:
▪ Arrange the prices from
the highest to the lowest
(increments)
▪ Volumes and
corresponding prices
▪ Market order sell side:
adds volume to lowest price
▪ Market order buy side:
adds volume to highest
price
▪ Determine cumulative
volumes
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Application of market pressure
principle
• If there is more than one valid
price after the minimum surplus
principle was applied, the market
pressure principle will be applied
as follows:
• Auction price is the highest
acceptable price if surplus is on the
buy side (surplus of demand)
• Auction price is the lowest
acceptable price if the surplus is on
the sell side (surplus of supply)
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Additional Exercise
Cost of Share Transaction
Brokerage
•
Easy Equities
Investor protection levy
•
Levied by the JSE to monitor transactions; ensure that transactions are not based on
insider information
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•
0,0002% of transaction amount
•
Minimum R0,01
Value added tax (VAT)
•
15% VAT on brokerage, Strate
settlement cost and investor
protection levy
•
Paid to state
Securities transfer tax (STT):
•
Only applicable to buyer
•
0,25% of transaction amount
Additional Exercise
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Question 3:
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BUSMAN 142
CHAPTER 6
CONTENT: Risk & Return
Risk & Return
Rational investors require the highest possible return with the lowest possible risk
Positive relationship between risk and return:
Lose sales, lose profits → shares are worth less
→ investors start selling shares (risk = own
shares with a value that is decreasing)
Return
Expected benefits that will be earned from an investment
To determine what the return is:
•
•
e.g.
What is the profit (meaningless)
Calculate the rate of return
buy share A @ R2 (MP = market price)
(new value – original price) / original price →
Single period return
You retain share for a specific period of time → during this
period, 2 main assets are used to determine the return
• Dividend income: if you retain shares for a year or
longer, you may receive dividends from the company
• Capital gain/loss: refers to profit or loss you make when
you sell the share you own (purchase price – selling price)
e.g. dividend income is broken down into interim & final
→ add them together before filling in the formula
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Advantages & disadvantages of single period return
Advantages of single period rate of return:
•
•
Simple to calculate
Simplifies comparison
Disadvantages of single period rate of return:
•
Does not take the time value of money into consideration
Internal rate of return
Advantages of using IRR:
•
•
Take time value of money into consideration
Makes provision for more than one period
(don9t need to know formula)
Risk
•
Risk → probability that the actual performance may differ from the expected return
•
Unexpected deviation from the expected return
•
2 types of risk:
o
Systematic risk → occurences in financial market, economic changes
•
o
Affects all companies, but not at the same intensity
Unsystematic risk → actions of enterprise itself
•
Refers to actions in enterprise (lot of debt/ethics/public opinion)
If rate of return is calculated → there is always a risk that rate could decrease to a lower rate
of return
Systematic risk
1. Interest rate risk
•
The probability that the change in interest rates will have a negative effect on the
return of an investment.
•
Inverse relationship
o
Decrease in interest rate is good for borrowers (decreases monthly instalment
you have to pay)
o
Decrease in interest rate is bad for investments (lower interest rate means
lower profits/income)
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•
Methods to reduce interest rate risk:
o
Buy securities with short remaining term
o
Hold fixed income securities until maturity date
o
Conducting a thorough analysis of variables that influence interest rate
decisions, such as the variables considered by monetary authorities
2. Cyclical risk
•
The probability that share prices will be
negatively influenced by changes in the
economic cycle
•
Methods to reduce cyclical risk:
o
Diversification over time → if the value of one investment decreases, the
value of another increases or stays the same
o
Diversification between different types of investments
o
Timing
3. Inflation risk
•
Value of money declines due to inflation – negative impact on returns
•
Real vs Nominal rates of return
Real rate of return =
e.g.
(1 + nominal rate of return)
−1
(1 + Inflation rate)
How do I hedge against inflation risk?
•
International diversification
•
Balanced diversified portfolio
•
Timing
•
Inflation linked securities
4. Exchange rate risk
•
Uncertainty regarding returns for investors that are exposed to foreign securities
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•
How do I hedge against exchange rate risk?
o
Exchange rate cover
o
Thorough analysis of company
o
International diversification
If the Rand is weak, it means you have to pay more on imports → so you will have to
increase domestic prices to ensure you make profits
5. Market risk
•
Probability that the market price of the investment will differ from the intrinsic value
due to irrational investor behaviour
•
Based on difference between market price & intrinsic value
•
How do I hedge against market risk?
•
o
Timing
o
Longer investment term
o
International diversification
o
Thorough analysis of the share
MP > Intrinsic = overvalued → intrinsic value of share is determined by the
company9s statements (excludes external environment)
•
MP < Intrinsic = undervalued → rather buy market shares that are undervalued
because once the market starts to rise, you will make greater profit
Non-systematic risk
1. Operating risk
•
Influenced by the nature of a company9s activities and the effect of operating gearing
•
Related to company9s income levels → the more volatile the income level, the more
volatile the operating profit will be
•
Effect of changing market conditions on operating profit
o
If operating profit is low, dividends will also be low
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•
An enterprise with a large component of fixed costs in its costs structure
•
Highest for enterprises with:
o
Unsteady revenue streams
o
Large % of fixed costs in the cost structure
(don9t have to calculate)
2. Financial risk
•
Company must first repay debt each month
before they offer dividends
•
High debt = risk to invest in company
•
High debt linked to interest rate risk → when
interest rate increases, company will have to pay
more per month
(don9t have to calculate)
Methods to decrease exposure to financial risk:
•
•
Analysis of a company9s capital structure
Monitor market interest rates
3. Industry risk
•
Some risks limited to specific industries
•
Relates to dependence on certain industry resources
o
E.g. if coal runs out, mine will have to close
•
Different factors that might give rise to this risk → for example dependence on
specific raw material, high labour intensity, capital intensity, technological changes
•
Hedging against risk:
o
Thoroughly informed about situations that may occur within a specific industry
o
Thorough investigation of the branch of industry
4. Other risk factors
•
Bad inventory control
•
Changes in top management (causes uncertainty about company9s future)
•
Legal actions taken against the enterprise
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•
Weak liquidity
•
New competitors
•
Outdated technology
Quantification of risk
Beta-analysis
•
Beta-indicates how sensitive a share9s
price is relative to the price of other
shares in the specific market (risk
measure)
•
Determines how a share9s price will
react to changes in a specific sector or
the market as a whole
Beta > 1 = 1.75 → share price is more sensitive
than the market
10% change in market x Beta
A decrease in the market means that there will
be a negative sign in front of the change in share
price
•
•
The type of share and the specific beta that is preferred depends on the economic
cycle
o Bull market – prefer high beta → prices increase in bull market so we would
prefer a higher beta because it means our share prices will increase even
more
o Bear market – prefer low beta → prices decrease in a bear market so we
would prefer a lower beta because it means our share prices will decrease by
less than the market
An investor will consider a number of factors before an investment decision is made,
for example:
o Beta in combination with market value and intrinsic value
o Always consider the intrinsic value to determined whether stock is over- or
undervalued
e.g. A portfolio manager uses the following methods to make his investment decisions:
1. The Barra system to calculate the Beta9s of shares
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2. The comparison between the market value and intrinsic value of shares in order to
determine premiums/discounts.
The following beta9s, market prices and intrinsic values are provided:
Asked:
2.
3.
4.
1.
Calculate the expected
changes in the market prices of
the shares if the market increases
with 10%. (use beta to determine
what the change in market prices
will be).
Which of the above shares will a portfolio manager purchase during a bull
market? (during a bull market, we want to purchase shares with a higher beta)
Which of the above shares will a portfolio manager purchase during a bear
market? (during a bear market, we want to purchase shares with a lower beta)
Given the original market prices, with what percentage are the market prices
overvalued or undervalued? Also indicate whether it is an overvaluation or
undervaluation → (current market price – intrinsic value) / intrinsic value x 100
Overvalued = current market price > intrinsic value
Undervalued = current market price < intrinsic value
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BUSMAN 142
CHAPTER 7
CONTENT: Portfolio Management
Risk & Return
•
At this stage, potential investor knows:
•
Various investment instruments to consider investing in
•
Investment instruments provide different levels of return and risk, and are prone
to different risks:
o
Some investments – provide an income on continuous basis (dividends, i,
rent)
o
Other investments – provide capital growth (gain)
•
Risks – also differ from investment to investment
•
Investor should realize that, when combining certain investments → he should
have greater certainty over his income & the risk of all investments together
•
Key to success - Diversification over different asset classes during construction of
portfolio
Asset Classes & Investment Instruments
As soon/early as possible create a diversified portfolio → spread investments across asset
classes
2 investment instruments:
•
•
Real/non-monetary (usually physical items, difficult to convert to cash)
Financial/monetary (usually a piece of paper/computer entry, easily converted into
cash)
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Risk & Return
Will not have to do calculations but must know:
•
Interest rate x probability = return on specific investment
In previous chapter on risk & return, the concept of determining <betas= to quantify risk was
discussed.
3 Measures to Determine Risks:
•
•
Calculate the variance or standard deviation of expected returns (statistically
determine the spread of the returns around the expected value).
o The greater the variance/standard deviation, the greater the uncertainty that
the expected return will be realised, & thus the greater the risk. Problem =
based on historical data.
Determine the range of returns – difference between the highest & lowest expected
return.
o The larger the range, the greater the uncertainty of what the expected return
will be & therefore the greater the risk.
o
View only the returns lower than the expected return (lower that the
mean). Implies the calculation of the semi-variance.
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Return
increases
as risk
increases:
directly
proportional
relationship
Investment Life Cycle (Individual)
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Portfolio Management Process
4 steps:
1. Potential investor determines his investment policy (must be revised & changed as
investment needs change over time) → indicates 2 aspects:
a. Objectives of investment
b. Constraints of investment
2. Potential investor evaluates all economic & financial circumstances (tries to forecast
future trends)
3. Portfolio is compiled in line with investment policy, considering current economic
climate → determine how he will spread his available funds across asset classes to
satisfy his return expectations
4. Potential investor continuously monitors his investment needs & the state of the
economy → performance of portfolio is evaluated regularly
Constraints of the Portfolio
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Passive & Active Management
Top-to-Bottom vs Bottom-to-Top
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EXTRA NOTES
Chapter 3: Technical Analysis
Historic & current market data is studied
Shares are assumed to represent all the important information about a company
Rational factors: financial information about a company
Irrational factors: news, social media & emotions
Trends in share prices are believed to repeat themselves → trends will change according to
changes in supply & demand
Share price index = a portfolio of shares that represents a specific market or a part of a
market → easy way to evaluate overall performance of the market (like the JSE) or a part of
the market (like the industrial sector)
Upswing leads to increases in sales & profits of companies which lead to an increase in
dividends
Increase in share buying activity increases share prices → leads to an increase in the All
Share Index on the JSE (upward movement)
Upward movement in ALSI is often followed with upward movement in economy
Buy low & sell high
To evaluate how your portfolio is performing, you can compare your portfolio return to the
return of the benchmark (like ALSI) → goal is to outperform the benchmark
Base date = date on which index is created
Price weighting
•
•
•
•
•
•
Adding together market prices of the companies on the base date
Adding together new prices of the companies on the second date
Use these total market price values to calculate index values
Index value will always be 100 on base date
Calculate new index value on second date: new total market price/base date total
market price x base value on base date
Compare 2 index values → see whether there was an increase or decrease
Equal weighting
•
•
•
•
•
Each share carries equal weight irrespective of market price
Need portfolio value to calculate weight for each company included in index
Add portfolio values together to calculate index values
Add together portfolio values on base date → index value is always base value of
100 on base date
Weight per company: portfolio value/market price for company on base date
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•
•
•
Can use weights to calculate new portfolio values on new date → weight x new
market price = new portfolio value
Then add new portfolio values together to get new total portfolio value & base total
portfolio value
Index value = new total portfolio value/base total portfolio value x base value
Market capitalisation
•
•
•
•
•
Market price per share x number of issued shares
Market capitalisation for each company is calculated & then added together
Total market capitalisation on base date is compared to total market capitalisation on
new date
Calculate new index value: new market capitalisation total/base date market
capitalisation total x base value
% change in index = (new market cap total – base date market cap total) / base date
market cap total x 100
Main technique used today to represent the South African stock market is the FTSE/JSE
ALSI
Scale & Point
You can only move over to another column if reverse in share price is big enough to indicate
it on the chart
-
-
If price increases for 20 consecutive days, you stay in same column & use crosses to
indicate increases in share price
When price starts to decrease (moving in opposite direction) & you use a 3 point
scale, only move over to next column if reverse in share price is big enough to draw
at least 3 circles/crosses
Crosses = price increases
Always start at block lower than the cross we have drawn → indicate that price is
decreasing
Moving averages
Help analysts find trends in price fluctuations of companies/indexes
Indicate average price of a company/sector/market over given time interval
Especially useful in cases where share prices are very volatile → provides smoother version
of price movement
The longer the time interval, the smoother the line is
Simple, weighted, exponential moving averages
Calculation for simple moving average: companies share prices for 5 days (for example) are
added & then sum is divided by 5
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Share price graph & moving averages graph do not begin at same point because it takes at
least 5 days (for example) for moving averages to be calculated & graphed
-
When current share price cuts through the moving average in an upwards direction =
buy signal → shift from falling to rising trend
Momentum in share price will continue for a while until something significant occurs
that causes a reverse in the price (therefore, buy now before prices increase further)
When share price cuts through the moving average in a downwards direction = sell
signal → indicates a declining momentum in share price
When the share price moves above moving average & starts to drop towards moving
average line but starts to increase again before it cuts the moving average line = buy signal
→ moving average serves as a support (price doesn9t break through it in a downwards
direction)
When the share price is below the moving average & starts to increase towards moving
average line but starts to decrease again before it cuts the moving average line = sell signal
→ moving average serves as a resistance (price doesn9t break through it in an upwards
direction)
Market breadth
Market breadth looks at entire market, not just one company
Indicates the extent to which the movement in the market are reflected in movements in
individual security
Are the movements in the ALSI really representative of the entire stock market?
-
-
If ALSI moves up, it is because some of the largest companies are moving in an
upwards direction → but this is not to say that the majority of the companies on the
JSE are also moving upwards
Solution to this problem is the market breadth index → shows direction of overall
market
Each day, number of companies that experienced increase in share prices, decrease in
share price & no change is counted → used to calculate cumulative sum of daily differences
(Advanced Decline line)
Compiled on basis of one company = one vote
Each company contributes to index irrespective of their market capitalisation
Advance = increase in share price
Decline = decrease in share price
Net change = advance – decline (can be a negative or positive value)
Cumulative change (AD line) for first day = net change on first day
Next day9s cumulative change: previous day9s cumulative change -/+ current (next) day9s net
change
Cumulative change column values plotted together with values of FTSE/JSE ALSI on a
graph → AD line should move with ALSI line
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Both lines moving up or both moving down = technically strong market → relative
certainty about direction of movement in market
Lines are moving in opposite directions = technically weak market → uncertainty
about direction of movement in market
Market breadth graph can be identified by 2 y-axes
RSI
Oversold
Over-supply of share resulted in price decline = falling trend is likely to reverse → bullish
signal → region between 0-30 indicates a buy signal
Overbought
Market for security is oversaturated & demand for company9s shares resulted in upward
trend/increase in price = price becomes vulnerable to price reversal = increasing trend will
reverse → region between 70-100 indicates a sell signal
RSI
1. Calculate daily price change
a. Need 2 closing prices to calculate daily change in price
b. Difference between current day9s closing price & previous day9s closing price
2. Calculate gain/loss
a. If change is positive = change value entered into gain column, 0 in loss
column
b. If change is negative = change value entered (as positive value) into loss
column, 0 in gain column
1st average gain/loss → calculated using simple average
-
Since it9s a 14-day RSI, first 14 gains/losses are added & then divided by 14
2nd & subsequent average gains/losses → calculated using exponential averages
-
All data is included in this calculation
[(Previous day9s average gain x 13) + current gain for day]/14
[(Previous day9s average loss x 13) + current loss for day]/14
RS value = average gain/average loss
RSI value = 100 – [100 / (1+RS)] → 14-day RSI values in last column that are plotted on
graph
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Chapter 5: Trading Securities on the JSE
Market order
Simplest order to broker: investor simply tells broker how many shares to buy/sell
Only specifies number of shares
Table given = order book:
-
Selling side indicating volume (how many shares are available at various prices)
If your order to your broker is to buy 2 000 shares, add 2 000 shares on buying side
Optimally, your broker buys as many shares as possible at best price & the rest of
the shares you want at the second best price
In price column on buying side, write 8market9 because shares are bought at
whatever price the market price for the shares is
Limit order
Specifies number of shares & price limit you are willing to pay
Buy order: you are not willing to pay any higher than the price limit you have given your
broker
Sell order: you are not willing to sell any less than the price limit you have given your broker
If you requested a certain number of shares with a price limit:
-
You get as many shares as possible at that price
Any other shares that still make up the number of shares you want but are too
expensive become a passive order
As soon as anyone is willing to sell those shares at the price you required, those
shares will go through to you & the order will be processed
Stop order
You instruct your broker to buy/sell shares when a specific price/% change is reached
-
-
Protect profits
o You buy shares at 500c & current market price is 600c = you made a profit
o If share prices are starting to drop & you don9t want to lose profits, you
implement a stop order
o Tell your broker to sell shares as soon as current market price hits 580c
Limit loss
o Or, if you buy shares at 500c & current market price is 600c but the current
market price is decreasing
o You will put a stop order at 480c to at least limit your loss
Bear transaction
Sell shares you do not yet own with the hope that the price will fall in the period between
selling the shares to the person & buying the shares to transfer to this person
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Aim is to sell these shares that you don9t yet own to someone, so that by the time you have
to transfer the shares, you have bought them at a price lower than what you sold them at
Market/limit order + Execution constraints
Execute & eliminate
The order should be matched immediately as completely as possible & all remaining
unexecuted volumes should be removed/eliminated from the order book
-
If you tell broker to purchase 2 000 shares at 160c each with the constraint, he will
input your order on the JSE, try to match your order as completely as possible
No passive order for the unexecuted shares should remain in the order book
Fill or kill
You tell your broker to match the order immediately, 100% in full, but if this is not possible,
then cancel the order completely
Remove your request completely from the order book + no passive orders
Entire transaction is rejected if it is not met in entirety
Trading on the JSE: Millennium trading
3 auction times
Continuous trading through the rest of the day
Orders that are not executed remain as passive orders in the order book
Opening & closing auctions ensure that there is a fair way of determining an opening market
price & a closing market price
All orders that are placed overnight or in the morning before the opening auction are pulled
into the JSE system → system runs an algorithm & based on the orders placed, a new
market price is generated for the day
No transactions occur during auction periods
Passive orders have time & price priority
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