Introduction to
Investment
Bruce Viney
Director of Training and Client Services
1
Why we are here….
• Exam (syllabus valid from 1 October 2006)
– 60 minutes
– 50 Questions
– Multiple choice
– Pass mark is 70%
2
Programme/Syllabus
Workbook
Chapter
Content
Questions
in exam*
1
Financial Services in the UK
8
2
Asset Classes
13
3
Derivatives
2
4
Financial Products
6
5
Pooled Funds
9
6
Investment Wrappers
2
7
Financial Services Regulation
8
8
Taxation
2
Total
50
* plus/minus 2
3
CHAPTER 1
Introduction
• The Role of the Financial Markets
• Financial Institutions
• London’s Markets
• The Bank of England
• The UK Economy
4
The Role of Financial Markets
Companies
Governments
Savers
Borrowers
Surplus capital,
looking for a return
Need capital
The Role of Financial Markets
BANKS
Financial Markets
Savers
SHARE
MARKETS
Companies
BOND
MARKETS
Governments
Borrowers
Money Markets
Capital Markets
Financial Market stages
onward trading of
shares at market
price
Company
PRIMARY
MARKET
SECONDARY
MARKET
issue
shares
at
£2.20 each
7
Financial Institutions
• Retail banks and building societies
• Investment banks
• Pension funds
• Insurance companies
• Fund managers
• Stockbrokers
• Custodians
• Credit card companies
8
London’s 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
London Stock Exchange
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
10
The Lloyds Market
Syndicate
Policy £60m
Broker
Synd A £20m
£15m
£15m
£10m
Syndicate
Syndicate
Syndicate
Members
Clients
World Securities Markets
• NYSE
• Nasdaq
• Euronext
• Japan
• Deutsche Borse
12
Economics
• Categorising Economies
• Gross Domestic Product
• Gross National Product
• Balance of Payments
• Inflation
• PSNCR
State controlled
Market
Mixed
Open
13
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
14
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
15
Balance of Payments
Current
account
•
Measures the difference between money flowing into
and out of the country
Imports
Exports
visible
visible
invisible
invisible
Inflation
• What is it?
• Problems caused by inflation
• Measurement
–headline
–underlying
–harmonised
RPI
RPIX
HICP
What is money?
• Caused by an increase in the money
supply?
17
Bank of England
• Three core purposes:
– maintain integrity and value of the currency
– maintain stability of financial system
– seek to ensure the effectiveness of the UK’s financial
sector
• Intervenes in the forex market (in accordance with
govt policy)
• Bank for
– Commercial banks
– Government
• Sets interest rates through the Monetary Policy
Committee (MPC)
•
•
•
Interest Rates
Short term interest rates are set by the MPC
MPC are to use interest rates to meet a set inflation target
(currently 2.5%)
Interest rates are changed as a result of Bank of
England’s dealings with banks
MPC control this rate
Bank of England
%
%
%
bank
%
%
bank
%
LIBOR
customer
bank
Government Borrowing
• Government income from taxation
• Government expenditure
• Difference is called:
Public sector net cash requirement (PSNCR)
Foreign Exchange
• Market in currencies
• No central market
• London is the largest centre
• Dominated by banks
• Types of contract
–spot
–forward
21
CHAPTER 2
Companies, Capital and Asset
Classes
• Equities
• Corporate actions
• LSE trading and settlement
• Bonds
• Money market instruments
• Company administration
22
Security
General term for any type of financial instrument (usually)
traded on an investment exchange.
Equities
Part ownership = shares
Bonds
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
23
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
Equity
type
Voting rights
Dividend
Ordinary
Yes
Variable, not guaranteed
Preference
No
Fixed, not guaranteed
(can be cumulative)
Why own shares?
• Voting
• Income – dividends
• Capital growth
• Trade perks
Risks
• Price
• Liquidity
• Issuer
25
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)
26
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
27
Calculating the ex price
A company announces a 1:5 rights issue at £3.50.
If the cum market price of the underlying shares is £4.00,
what is the theoretical ex price of the shares?
23.50
6
Number Price per
of shares
share
Total
value
Before
5
£4.00
£20.00
Rights
1
£3.50
£3.50
After
6
£3.92
£23.50
How much is the right to buy a share worth?
Bonus Issues
• Free shares
• The effect on share price?
• Why would a company do it?
29
Calculating the ex price
There is a 1:1 bonus issue.
The market price of the shares before the capitalisation is
£12.00.
What is the theoretical ex price of the shares?
£12
2
Number Price per
of shares
share
Total
value
Before
1
£12.00
£12.00
Scrip
1
£0.00
£0.00
After
2
£6.00
£12.00
Cash dividends
• What is a dividend
–Payment/distribution to shareholders from
•
•
realised profits
Interim and final dividend
Timetable
cum div
Feb
ex div
Wed 8
Fri 10
March
March
Fri 10
Tues 7 May
May
AGM
Dividend
announced
Record
Ex-dividend
Day
day
(Books closed day)
Dividend
Payment
date
31
Listing on the Stock Exchange
The main advantages are:
Capital - access to a large pool of capital
Status/prestige – assist company’s trading prospects
Takeovers – using shares to fund the acquisition of other co’s
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
Listing
Full list
Trading history Minimum 3
years
Market
capitalisation
Minimum
£700,000
‘Public’ holding At least 25%
Alternative
Investment
Market
No minimum
No minimum
No minimum
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
34
FTSE Indices
1
FTSE 100
100
FTSE 250
FTSE All Share
350
FTSE Small Cap
c900
World Markets
Securities
• New York
• NASDAQ
• London
• Euronext (Paris)
• Tokyo
• Deutsche Borse
• Hong Kong
Indices
Dow Jones
S&P 500
NASDAQ Composite
CAC 40
Nikkei 225
Xetra DAX
Hang Seng
36
Domestic Equity Market
Order driven
Seller
Broker
Buyer
Broker
Quote driven
Seller
Broker
Market Maker
Buyer
Broker
37
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
38
SETS
Buy & sell orders displayed (price/time priority)
• Standard settlement
• Visible to all but only member firms can input and
delete orders
39
40
SEAQ
• Market makers show prices and sizes
• Two way prices (bid, offer, spread)
• Touch strip
41
42
Equity Settlement
Buy me 1000 PJC
plc shares
Trade
£
Contract Note
Broker
shares
Market
Maker
Settlement
43
• CREST is an electronic settlement system
• Mainly settles UK equities, corporate loan
•
stock and gilts
Dematerialised/uncertificated settlement
44
Crest Structure
Investors
Regulators
Member
Bank
Revenue(s)
Registrar
Companies
45
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
46
Corporate Bonds
Domestic
Foreign
Issued by home
company to home
investors in home
currency
Issued by overseas
company to home
investors in home
currency
Eurobond
Issued to many
investors in any
currency –
international issues
47
Other bonds - features
• Zero Coupon Bonds
• Convertibles
48
Gilts
•
Interest (coupon)
•
•
Repayment (redemption)
Classification by DMO
•
•
– gross annual interest on the nominal value (£100)
– paid semi annually
– Short
– Medium
– Long
Less than 7 years
7-15 years
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
Yields
•
Flat Yield
annual coupon
---------------------market price
x 100%
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%
50
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
51
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
52
Commercial paper
• Short term unsecured debt
• Usually zero coupon therefore issued at a discount
• Usually high nominal value
• A CP programme specifies a total amount that can be
issued and may have an end date
CP programme
issue limit £150m
end date 2008
Date
Mar 2006
Apr 2006
Oct 2006
Jan 2007
Issue
£100m
£50m
£75m
£75m
Term
6mth
3mth
6mth
3mth
53
Certificates of Deposit (CD)
Investor A
Bank
Investor B
54
Company types
All companies
public
(plc)
fully
listed
AIM
listed
private
(ltd)
unquoted
Company Administration
Memorandum
Company
Articles
Company Directors
Executive
Non-executive
Meeting types:
AGM
EGM
ARTICLES:
Shareholders rights
Borrowing powers
Dividends
Meetings
Directors
Winding
up
Shareholders
MEMORANDUM:
Name of Co
Domicile
Authorised Share Capital
Statement of liability
Objects
PLC or not.
56
CHAPTER 3
Derivatives
• Futures
• Options
57
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
58
Futures Terminology
• Long = buy a future
• Short = sell a future
• Open = enter into a futures position
• Close = trade out of a futures position
59
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
60
An example of an Equity Call Option
Writer
Call Option (10p per share)
PJC plc
1000 shares
Market price 105p
I grant you
The right to buy
1,000 PJC plc shares
From me
At a price of 100p
Within 3 months
(£100)
Option Premium
Holder
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
Price
110p
breakeven
“in the money”
105p
100p
strike
“at the money”
“out of the money”
Time
Options Terminology
• Call Option
• Put Option
• In the money
• At the money
• Out of the money
• Breakeven
63
CHAPTER 4
Financial Products
• Deposits and loans
• Interest rates
• Mortgages
• Insurance and Pensions
• National Savings and Investments
64
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
65
Interest Rates
•
•
Quoted rate v Effective rate
Steps to turn quoted into effective
1. Quoted expressed as a decimal
2. Divided by number of periods per year
3. Added to one
4. To the power of the number of periods per
year
5. Subtract one and times by 100
66
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
67
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
68
National savings products
• National Savings accounts:
– Easy Access a/c (instant access)
– Investment a/c (one month notice)
• Premium bonds
•
– Random prize
Paid Gross
but taxable.
Paid Gross
But taxable
Tax free.
Paid on maturity
Other products
Tax free up to
Fixed Interest Savings Certs £15,000 per issue.
–
– Fixed Rate Savings Bonds
Taxable,
Paid net of 20%
69
CHAPTER 5
Pooled Funds
• Unit Trusts
• OEICs
• Investment Trusts
70
Rationale of Collective Investment
I’ve got a spare five thousand,
I think I’ll invest in a UK equity fund.
Shares/units in
collective inv’t
Advertise
Fund Manager
£5,000
Role of the FSA
• Authorised v unauthorised
• Onshore v offshore
72
Unit Trusts - Basics
Investors
(1,000)
1 million units
x 500p per unit
£5,000 x 1,000
Legal owner of the trust property
Safeguards assets
Fund Monitors
Manager the manager
Makes investment
Trusteedecisions
Markets
Investments
Prices the units
Investments
Deals with investors
Types of Unit Trust
Authorised/regulated funds
• Securities Funds - most common
• Money Market funds
• Futures and Options funds
• Geared F&O
• Warrant funds
• Property funds
• Fund of funds
• Feeder Funds
• Umbrella Funds
• Limited issue funds
• Principal protected funds
• Mixed funds
Buying more Units
1 000 units
x 515p per unit
FM prices
Bid
Offer
UK Equity
485
515
£5,150
Fund Manager
Trustee
Investments
Another 1,000 units
created (open
ended)
Creation of more units?
Sellers
Buyers
9,000 units
10,000 units
Fund Manager
Trustee
Investments
Markets
Investments
“Create 1,000 units”
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
77
What is an OEIC ?
• Open Ended Investment Company
• Also known as an ICVC (Investment Company
•
with Variable Capital)
Invests money on behalf of it’s shareholders in
shares and bonds
78
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
79
Investment Trusts
Trade
Investors
Price tends to be at a discount to the
5 million £1 ord shares
net asset value of the company. This £5,000 x 1,000
discount narrows in a bull market and
widens in a bear market
Investment Trust
Depository
Markets
Investments
Investments
Exchange Traded Funds (ETF’s)
• Index tracking funds
• Open ended
• Structured as a company
• Listed on exchanges (such as the LSE’s
•
extraMARK)
Trade at net asset value
81
Collective investments comparison
Feature
Unit Trust
Invt Trust
OEIC/
ICVC
ETF
Open/
closed ended
open
closed
open
open
Legal structure/
Investment unit
Trust/
unit
Company/
share
Company/
share
Company/
share
Price based on
Net asset
value
Demand and
supply
Net asset
value
Net asset
value
Bid/offer or single
price
Bid/offer
Bid/offer
Single price
Bid/offer
Investments
purchased from
Fund manager
Stock market
Authorised
corporate
director
Stock market
Authorised
depositary
Authorised
depositary
Custodian
Investments held by Trustee
82
Hedge Funds
• Unregulated schemes
• High investment entry levels
• Flexible investment style, including
•
gearing
Fees are performance related
83
CHAPTER 6
Investment Wrappers
• ISAs/PEPs
• Child Trust Funds
84
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
85
ISA limits
Mini ISA
Stocks &
shares
£4,000 p.a.
Maxi ISA
Stocks &
shares
Cash
£3,000 p.a.
no limit
£7,000 p.a
Cash
£3,000 p.a
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
87
CHAPTER 7
Regulation
• FSMA 2000
• Money Laundering
• Insider Dealing and Market Abuse
• Takeovers and Mergers
88
UK Financial Regulation
•
•
•
•
•
The UK’s main financial regulator is the Financial
Services Authority (FSA)
The FSA operates under the Financial Services and
Markets Act 2000 (FSMA 2000)
The Act states that any person (firm) conducting
regulated activities in the UK must be authorised by the
FSA or exempt
Certain individuals within the firm must also be approved
by the FSA for their roles
The FSA have written a handbook which must be
complied with to avoid prosecution
89
The FSA’s four objectives
• Maintaining confidence
• Promoting public awareness
• Appropriate protection for consumers
• Reduce scope for financial crime
90
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
91
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
92
•
•
•
•
•
Money Laundering
Definition
3 stages
ML Regs 2003: Financial institution procedures :
– identify new clients
– record keeping
– internal reporting
– internal controls to prevent the firm being used for
money laundering
POCA ’02 Offences:
– concealing; arrangements that you know or suspect is
to acquire, retain, use/control criminal property;
acquire, use or possess criminal property; failure to
report; tipping off
Suspicion reporting process
– Employee => MLRO => SOCA
Insider Dealing
If an individual who
possesses inside
information from a
primary or secondary
insider
Encourages
others to deal
Tell others the
information
Deals
Market abuse
Offence under FSMA 2000
Includes : Using
information not
generally available to
others
Regular user test
employed to establish
guilt or innocence
95
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?
Competition Commission
• Are shareholders treated fairly?
Panel on Takeovers and Mergers
96
Takeovers and Competition
OFT
CC
The Office of Fair Trading considers
whether a proposed takeover might be anticompetitive.
The OFT could result in the bid being
referred to the Competition Commission
The Competition Commission decides on
whether the takeover should be allowed to
proceed, any restrictions required and the
like
97
Takeovers and shareholders
•
•
•
The Panel on Takeovers and Mergers (POTAM or
PTM) ensures that all shareholders are treated
fairly
Their rulebook is known as the Takeover Code or
Blue Book
The rulebook principles state:
– Shareholders of a target company must be treated
equally in all respects during an offer
– Don’t bid for a company unless you intend to, and
can afford to, go through with the bid
– Directors should make decisions by considering
what is best for shareholders, not themselves
98
Takeovers – key %’s
100%
Must make a bid for the remaining
shares in the company
SARs – prevent the following:
(1) 10% or more
(2) Within 7 calendar days
(3) From more than one source
(4) Resultant shareholding is 15% or more
Actual
control
50%
Effective
control
30%
0%
99
Takeover of a Listed Company
28
days 0
21
39
46
60
Offer
document
dispatched
Bid
announced
through
Stock Exchange
First
closing
Final
Final
revision
target
company
announcements
Final
closing
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
101
CHAPTER 8
Taxation
•
•
•
•
Income tax
Capital Gains Tax
Inheritance Tax
Stamp Duty
102
Taxation
• Income tax
Paid on income, potentially
including investment income
• Capital gains tax
• Inheritance tax
Potentially payable on the
sale of an investment
Potentially payable on
investments held at death
103
Income Tax
• Salary
From an employer
• Profits from running a business
Individuals or
partnerships
• Dividends
From companies
• Interest
From banks/building societies/bonds
104
Income Tax
Higher rate
40%
£33,301
Basic rate
22%
£33,300
Lower rate
10%
£2,150
Personal allowance
£5,035
Income
105
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
106
Taxation (CGT)
• Capital Gains
– Shares
– Bonds (some)
– Property
– Antiques
• Exemptions
– Main home
– Gilts
– Cars
107
Taxation (CGT)
• Allowance of £8,800 for the year
• CGT only paid on gains above the allowance
• Any losses can be carried forward
• Paid at the investor’s marginal rate of 10%, 20%
or 40%
108
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%
109
Stamp Duty/SDRT/SDLT
• 0.5% on the purchase of shares
• 1% on homes >£120,000
• 3% on homes >£250,000
• 4% on homes >£500,000
110
End of Course
111