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Equity and property markets (Investment and risk characteristics of direct…
Equity and property markets
Ordinary share/ equities (UK)/ common stock (USA)
Securities held by the owners of an organisation
Shareholders have the right to receive all distributable profits of a company (normally in the form of dividends) after debtholders and preference shareholders have been paid. they also have the right to attend and vote at general meetings of the company.
Investment and risk characteristics of ordinary shares
Income = dividends = share in company profits
Capital gain may arise on sale of shares
Default (of income) risk depends on security of issuing company
Security of capital depends on NAV, level of gearing and risk profile of the issuing company
higher long-term expected return than government bonds
expected to provide a real return over the long term
potential for volatile market values (and dividends)
Term: no fixed redemption date, generally considered long-term
Dealing costs higher than on conventional goverment bonds
marketability depends on issuing company and whether listed or not- marketability generally worse than for government bonds
tax treatment depends on the territory
Cashflows- ordinary share
Share purchase
an initial lump sum negative cashflow equal to the price paid for the share plus dealing expenses.
Dividend payments
a regular series of positive cashflows representing a share in the company's profits. The timing of these payments is generally known. the amount is variable and is unknown. Over time profits and hence dividends, are expected to increase broadly in line with growth in GDP. However, the company may choose not to distribute all of its profits but retain some for new projects, expansion to subsidise dividends in poorer years.
final payment
there is no redemption payment- dividends can be assumed to continue indefinitely. However, there will be a final positive cashflow, which is unknown in amount and timing if:
the investor sells the share or the company buys it back
the company winds up and there are residual funds to distribute
Advantages of listed shares over unlisted shares
Greater marketability
Easier to value
Greater security (from stock exchange regulations)
More information is available (due to disclosure requirements)
Greater divisibility
Practical reasons for analysing shares by industry
Most companies within an industry are affected by similar factors.
the information about these companies tends to come from a common source and is presented in a similar way.
No-one can be an expert in all areas.
It adds a structure to the decision-making process.
Correlation of performance of shares within the same industry
Resources
companies in the same sector will use similar resources (e.g. labour, land and raw materials), and will therefore have similar input costs.
Markets
companies in the same sector supply the same markets, and will therefore be similarly affected by changes in demand.
Structure
companies in the same sector often have similar financial structures will therefore be similarly affected by changes in interest rates.
Why market movements are the biggest influence on a share's price
most companies are affected by macro-economic factors (e.g. interest rates, growth and inflation) and the political climate in similar ways.
most companies' costs are affected by similar factors, e.g. tax, labour market, cost of borrowing and fuel
Many investors are interested in equities as a whole rather than in specific shares, e.g. because
the equity marker appear attractive compared to another market
investors have real liabilties
regulation and tax breaks favour equities
Many investors invest passively in instruments covering a broad range of equities rather than actively seeking our specific shares, e.g. because:
They believe the costs of active management are not compensated for by sufficient extra returns
they lack the expertise.
Investment and risk characteristics of direct property
Risk of voids (periods where property not let) and tenant default
Risk of political inteference
RIsk of obsolescence and need for refurbishment
Real return, broad inflation hedge
Higher expected return than government issued bonds
Income forms a 'stepped' pattern over time
Running (rental) yield varies by the type of property
Volatile capital values in long term, stable capital values in short term
Subjective, infrequent valuations, lack of information
High dealing costs and management costs
Very unmarketable
Large unit size, indivisibility
Uniqueness
Characteristics can be changed by owner, e.g. redevelopment
Prime property
(CALL ST)
Comparable properties for rent reviews and valuations
Age, condition and flexibility of use
Location
Lease structure
Size
Tenant quality
Freehold property ownership
(in perpetuity)
Rights are:
to occupy the building or let it out
to refurbish the property or develop it (subject to planning restrictions)
Restrictions include:
covenants
easements such as right of way
planning and building regulations
statutory requirements not to cause a nuisance to others
Leasehold property ownership
An agreement which allows the leaseholder the use of a specified portion of a building owned (or sometimes itself leased) by other party for a specified period in return for some payment (an annual ground rent),
Leasehold differs from freehold as, typically, leasehold:
has a fixed term
involves a capital loss to the leaseholder at the end of the lease
has a higher initial rental yield
Leases of 99 or 999 years can be treated as being close to freehold interests, save the need to pay the ground rent to the freeholder
Indirect property investment
open-ended schemes, such as property unit trusts
closed-ended schemes, such as property investment trust companies
shares in property (development/ investment) companies