Please enable JavaScript.
Coggle requires JavaScript to display documents.
Other investment classes (2) (Factors to consider when investing in…
Other investment classes (2)
Differences between closed-ended and open-ended CISs
Shares in closed-ended CISs are often less marketable than the underlying assets. Marketability of units in open-ended CISs is usually guaranteed by the managers
Some open-ended CISs (e.g. property UTs) need to hold cash to maintain liquidity
Lower expected returns but greater stability
Closed-ended CISs can gear => extra volatility. Open-ended CISs cannot be geared or have limited gearing.
Share prices in closed-ended CISs are also more volatile than the pices of the underlying assets because the size of the discount to NAV per share can change. The price volatility of units an open-ended fund should be similar to that of the underlying assets.
Increased volatility of closed ended CISs => higher expected return.
There may be uncertainty as to the true level of NAV per share of a closed-ended CIS, especially if the investments are unquoted.
Closed-ended CISs can invest in a wider range of assets
May be possible to buy assets at less than NAV in a closed-ended CIS.
They may be subject to different tax treatment
Futures and forwards
Futures contract
Standardised, exchange-traded contract to buy (or sell) a specified asset at a specified price on a specified date in the future.
Forward contract
A non-standardised, OTC traded contract to buy (or sell) a specified asset at a specified price on a specified date in the future.
Future/ forward differences
Standardised/ Tailor-made, non-standardised
Exchange-traded/ OTC traded
Clearing house removes default risk/ Default risk depends on counterparty
Margin paid to clearing house/ No margin paid as traded OTC
More liquid/ less liquid
Quoted price/ No quoted price as traded OTC
Often closed out before delivery/ Often results in delivery
Long and short positions
Long
Having a positive economic exposure to the asset. In futures and forward dealing the long party is the one who has contracted to take delivery of the asset in the future.
Short
Having a negative economic exposure to the asset. In futures and forward dealing the short party is the one who has contracted to deliver the asset in the future.
Options
Call option
the right, but not the obligation, to buy a specified asset for a specified price on a set date or dates in the future
Put option
the right, but not the obligation, to sell a specified asset for a specified price on a set date or dates in the future
Option writer
the seller of the option )opposite of the option holder)
Option premium
the price paid for the option to the option writer
Exercise price (or strike price)
the price at which an underlying security can be sold to (for a put) or purchased form (for a call) the writer of an option
traded option
an option contract with standardised features actively traded on organised exchanges
American option
an option that can be exercised on any date before expiry
European option
an option that can be exercised only at expiry
Warrant
A warrant is an option issued by a company over its own shares. The holder has the right to purchase shares at a specified price at specified times in the future from the company.
Main uses of derivatives
Providing protection against the risk of adverse market
e.g. using futures contracts to set the price of input goods in advance
e.g. using a put option to protect asset portfolios against significant market value falls
Aiming to achieve higher returns/ profits through speculation
Allowing financial institutions to alter the structure of their portfolios without needing to trade in the underlying assets
Main reasons for investing overseas
Matching liabilities denominated in a foreign currency
Diversification by country, economy, stock market, currency, industry, company, which serves to reduce portfolio risk.
Higher expected return:
as fair compensation for the higher risks involved
as a result of exploiting inefficiencies, e.g. an undervalued stock, an undervalued market or an undervalued currency.
Fundamental problems with overseas investments
Mismatching domestic liabilities
Taxation (may not be able to recover witholding taxes paid)
Volatility of currency
Practical problems with overseas investment
Custodian needed
Additional admin required
Time delays
Expenses incurred/ expertise needed
Regulation poor
Political instability
Information harder to obtain (and less of it)
Language difficulties
Liquidity problems
Accounting differences
Restrictions on foreign ownership/ repatriation problems
Methods of indirect overseas investment
Investment in multinational companies based in the home market
Advantages
Easier to deal in the familiar home market
Multinational companies will have expertise and tend to conduct their business in the most profitable areas overseas
Gives access to areas where direct investment may be difficult
Disadvantages
Overseas earnings are diluted by domestic earnings
Investor has no choice in where the company transacts its business
Investment in collective investment schemes specialising in overseas investment
Investment in derivatives based on overseas assets
Factors to consider when investing in emerging markets
Higher expected return due to higher risk (and possible market inefficiencies)
Extra diversification (less correlation than larger developed markets)
Possibility of high economic growth
Current market valuation of the asset
Currency stability and strength
Level of marketability
Degree of political stability
Market regulation
Restrictions on foreign investment
Range of companies available
Communication problems
Availability and quality of information
Markets in small countries are highly influenced by swings in international investor sentiment and a sudden big flow of cash