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1 Introduction to Investment Bruce Viney Director of Training and Client Services.

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1 1 Introduction to Investment Bruce Viney Director of Training and Client Services

2 2 Why we are here…. Exam (syllabus valid from 1 October 2006) – 60 minutes – 50 Questions – Multiple choice – Pass mark is 70%

3 3 Programme/Syllabus Workbook Chapter ContentQuestions in exam* 1Financial Services in the UK8 2Asset Classes13 3Derivatives2 4Financial Products6 5Pooled Funds9 6Investment Wrappers2 7Financial Services Regulation8 8Taxation2 Total50 * plus/minus 2

4 4 Introduction CHAPTER 1 The Role of the Financial Markets Financial Institutions Londons Markets The Bank of England The UK Economy

5 The Role of Financial Markets Savers Borrowers Companies Governments Surplus capital, looking for a return Need capital The City

6 The Role of Financial Markets Savers Borrowers Companies Governments Capital MarketsMoney Markets BANKS Financial Markets SHARE MARKETS BOND MARKETS Deposits Buys shares Loans and overdrafts Issues shares Issues bonds Buys bonds

7 7 Financial Market stages onward trading of shares at market price Company issue shares at £2.20 each PRIMARYMARKET SECONDARYMARKET

8 8 Financial Institutions Retail banks and building societies Investment banks Pension funds Insurance companies Fund managers Stockbrokers Custodians Credit card companies

9 Londons Markets Soft commodities Financial futures Traded Options Non-ferrous Non-precious Brent crude Gas oil Natural gas UK equities and corporate bonds Gilts Overseas equities and bonds Insurance market

10 10 DateEvent 1773Brokers create The Stock Exchange 1986Big Bang - major reforms 1995Tradepoint starts in competition with LSE 1997SETS - electronic order book 2001Listed as a quoted company London Stock Exchange

11 Policy £60m Synd A £20m The Lloyds Market Syndicate Clients Broker Members £15m £10m Syndicate

12 12 World Securities Markets NYSE Nasdaq Euronext Japan Deutsche Borse

13 13 Economics Categorising Economies Gross Domestic Product Gross National Product Balance of Payments Inflation PSNCR Market Mixed Open State controlled

14 14 Gross Domestic Product Market value of goods and services produced in a country Measure of the level of economic activity Three ways of representing: – Total GDP – GDP per head (per capita) – GDP growth

15 15 Gross National Product GNP for the UK is the GDP: – Plus interest, profits, and dividends received from abroad by UK residents – Less income earned in the UK by overseas residents

16 Balance of Payments Measures the difference between money flowing into and out of the country ImportsExports visible invisible visible Current account

17 17 Inflation What is it? Problems caused by inflation Measurement – headlineRPI – underlyingRPIX – harmonised HICP Caused by an increase in the money supply? What is money?

18 Bank of England Three core purposes: – maintain integrity and value of the currency – maintain stability of financial system – seek to ensure the effectiveness of the UKs financial sector Intervenes in the forex market (in accordance with govt policy) Bank for – Commercial banks – Government Sets interest rates through the Monetary Policy Committee (MPC)

19 Interest Rates Short term interest rates are set by the MPC MPC are to use interest rates to meet a set inflation target (currently 2.5%) Interest rates are changed as a result of Bank of Englands dealings with banks customer bank Bank of England bank % % % % % MPC control this rate LIBOR

20 Government Borrowing Government income from taxation Government expenditure Difference is called: Public sector net cash requirement (PSNCR)

21 21 Foreign Exchange Market in currencies No central market London is the largest centre Dominated by banks Types of contract – spot – forward

22 22 Companies, Capital and Asset Classes CHAPTER 2 Equities Corporate actions LSE trading and settlement Bonds Money market instruments Company administration

23 23 Security General term for any type of financial instrument (usually) traded on an investment exchange. Bonds Equities Part ownership = sharesDebt in the form of IOUs In the UK, capital market securities are generally held in registered form whilst money market instruments are issued in bearer form

24 Equity types Equity type Voting rightsDividend Ordinary Preference The two main equity types in the UK are ordinary and preference shares Preference shares have preference over ordinary shares in terms of: Dividend payment Repayment on winding up Variable, not guaranteed Fixed, not guaranteed (can be cumulative) Yes No

25 25 Why own shares? Voting Income – dividends Capital growth Trade perks Risks Price Liquidity Issuer

26 26 Corporate Actions Types of action – mandatory – voluntary – mandatory with options Examples – bonus issue (to increase the liquidity of shares) – dividend (to distribute profits) – takeover offer (to acquire the shares) – rights issue (to raise funds)

27 27 Rights Issues Company raising additional finance – new shares are issued – existing shareholders can buy them first (pre-emptive rights) Upon receipt of a rights letter a shareholder has to decide upon their course of action

28 Calculating the ex price A company announces a 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? Before Rights After Number of shares Price per share Total value £4.00 £3.92 £3.50 £20.00 £3.50 £ How much is the right to buy a share worth?

29 29 Bonus Issues Free shares The effect on share price? Why would a company do it?

30 Calculating the ex price There is a 1:1 bonus issue. The market price of the shares before the capitalisation is £ What is the theoretical ex price of the shares? Before Scrip After Number of shares Price per share Total value £12.00 £6.00 £0.00 £12.00 £0.00 £12.00 £12 2

31 31 Cash dividends What is a dividend – Payment/distribution to shareholders from realised profits Interim and final dividend Timetable Feb Dividend announced Wed 8 March Ex-dividend day Fri 10 March Record Day (Books closed day) Dividend Payment date Fri 10 May ex divcum div AGM Tues 7 May

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

33 Listing Full listAlternative Investment Market Trading historyMinimum 3 years No minimum Market capitalisation Minimum £700,000 No minimum Public holdingAt least 25%No minimum

34 34 Indices Indices enable investors to: – measure performance of a market – use as a benchmark to judge actively managed portfolios – trade futures and options based on them The main indices on LSE equities are: – FTSE 100 – FTSE 250 – FTSE Actuaries 350 – FTSE All Share Index

35 FTSE Indices c900 FTSE 100 FTSE 250 FTSE Small Cap FTSE All Share

36 36 World Markets Securities New York NASDAQ London Euronext (Paris) Tokyo Deutsche Borse Hong Kong Indices Dow Jones S&P 500 NASDAQ Composite Nikkei 225 CAC 40 Xetra DAX Hang Seng

37 37 Broker Buyer Seller Order driven Buyer Seller Broker Market Maker Quote driven Domestic Equity Market

38 38 Domestic Equity Market SETS – FTSE 100; FTSE 100 reserve stocks; stocks removed from FTSE 100. SETSmm – FTSE 250 shares not on SETS, order book plus one or more market makers SEAQ – fully listed shares, not on SETS or SETSmm, with two or more market makers – AIM shares with two or more market makers

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

40 40

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

42 42

43 43 Equity Settlement Broker Market Maker £ shares Settlement Trade Buy me 1000 PJC plc shares Contract Note

44 44 CREST is an electronic settlement system Mainly settles UK equities, corporate loan stock and gilts Dematerialised/uncertificated settlement

45 45 Member Crest Structure Investors Companies Bank Registrar Regulators Revenue(s)

46 46 Bonds A bond is a tradeable loan Issuer promises to: – repay the loan at a future date (on maturity) – pay interest at a defined rate (usually fixed) Issuer might be the British government – bonds are called gilt edged securities Issuer might be a company

47 47 Corporate Bonds DomesticForeignEurobond Issued by home company to home investors in home currency Issued by overseas company to home investors in home currency Issued to many investors in any currency – international issues

48 48 Other bonds - features Zero Coupon Bonds Convertibles

49 Gilts Interest (coupon) – gross annual interest on the nominal value (£100) – paid semi annually Repayment (redemption) Classification by DMO – Short Less than 7 years – Medium7-15 years – Long More than 15 years Issue by DMO – bid basis (auction to those on an Approved List) – individuals may submit non-competitive bids (up to £500,000) Secondary Market – GEMMS or DMO/Computershare service

50 50 Yields Flat Yield Example: Treasury % is currently trading at £102, calculate the flat yield A 3.6% B 4.9% C 5.9% D 6.0% annual coupon x 100% market price

51 51 Money market instruments Money market instruments are forms of short term tradeable debt. The products you need to be aware of are: – Treasury bills – Commercial paper – Certificates of Deposit

52 52 Treasury bills Short term zero coupon bonds Maturities generally after 3 months Issued weekly by the DMO on behalf of the Treasury Sold at a discount to their face value

53 53 Commercial paper Short term unsecured debt Usually zero coupon therefore issued at a discount Usually high nominal value A CP programme specifies a total amount that can be issued and may have an end date CP programme issue limit £150m end date 2008 DateIssueTerm Mar 2006£100m6mth Apr 2006£50m3mth Oct 2006£75m6mth Jan 2007£75m3mth

54 54 Certificates of Deposit (CD) Investor A Investor B Bank

55 Company types All companies public (plc) private (ltd) fully listed AIM listed unquoted

56 56 Company Administration Company Shareholders Memorandum Articles Company Directors Executive Non-executive Meeting types: AGM EGM ARTICLES: Shareholders rights Borrowing powers Dividends Meetings Directors Winding up MEMORANDUM: Name of Co Domicile Authorised Share Capital Statement of liability Objects PLC or not.

57 57 Derivatives CHAPTER 3 Futures Options

58 58 Futures An agreement to buy or sell a specified quantity of a specified asset at an agreed price on an agreed date Exchange traded and on standardised terms For example: Futures on metals, oil, agricultural products Motives: Hedge or Speculate

59 59 Futures Terminology Long = buy a future Short = sell a future Open = enter into a futures position Close = trade out of a futures position

60 60 Options A contract that gives the right but not the obligation to buy or sell a specified quantity of an underlying asset at a specified price within a specified period Call option = the right to buy Put option = the right to sell

61 An example of an Equity Call Option 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 Writer Holder Option Premium Call Option Call Option (10p per share) (£100)

62 Options terminology Consider an equity call option with a strike price of 100p and premium of 10p. The underlying share is currently valued at 105p strike100p Price Time 105p breakeven 110p in the money out of the money at the money

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

64 64 Financial Products CHAPTER 4 Deposits and loans Interest rates Mortgages Insurance and Pensions National Savings and Investments

65 65 Deposits and loans Deposits – Fixed term v Instant access – Interest Gross v Net – R85 enables payment gross Loans – Bank loans Secured v Unsecured – Overdrafts Authorised v Unauthorised – Credit cards

66 66 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

67 67 Mortgages Secured loan on property Mortgage types – Repayment – Interest only Mortgage interest – Fixed – Capped – Discounted – Variable Redemption penalties Other types – Endowment – Pension linked – ISA – Unit linked – Flexible

68 68 Insurance and Pensions Life policies – Term v Whole of life – With profit (incl unit linked) v non profit Pensions – State Basic v Second – Occupational Defined benefit v defined contribution – Private/Personal – Stakeholder

69 69 National savings products National Savings accounts: – Easy Access a/c (instant access) – Investment a/c (one month notice) Premium bonds – Random prize Other products – Fixed Interest Savings Certs – Fixed Rate Savings Bonds Paid Gross but taxable. Paid Gross But taxable Tax free. Paid on maturity Tax free up to £15,000 per issue. Taxable, Paid net of 20%

70 70 Pooled Funds CHAPTER 5 Unit Trusts OEICs Investment Trusts

71 Rationale of Collective Investment Fund Manager Advertise £5,000 Ive got a spare five thousand, I think Ill invest in a UK equity fund. Shares/units in collective invt

72 72 Role of the FSA Authorised v unauthorised Onshore v offshore

73 Unit Trusts - Basics Investors (1,000) Fund Manager £5,000 x 1,000 1 million units x 500p per unit Investments TrusteeInvestments Markets Makes investment decisions Prices the units Deals with investors Legal owner of the trust property Safeguards assets Monitors the manager

74 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 Types of Unit Trust Authorised/regulated funds

75 Buying more Units Fund Manager TrusteeInvestments FM prices Bid Offer UK Equity £5, units x 515p per unit Another 1,000 units created (open ended)

76 Creation of more units? Fund Manager TrusteeInvestments 10,000 units 9,000 units BuyersSellers Create 1,000 units Investments Markets

77 77 How to price a unit Prices calculated by the managers FSA rules – prices based on net asset value at the most recent valuation – calculate separate bid and offer prices although single pricing is possible – maximum offer price = creation price plus initial charge Offer price tend to include an initial charge - around 5-6% on top of allowances for stamp duty and brokerage

78 78 What is an OEIC ? Open Ended Investment Company Also known as an ICVC (Investment Company with Variable Capital) Invests money on behalf of its shareholders in shares and bonds

79 79 Key elements of an OEIC Variable capital base Shareholders are direct owners of the company Shares are traded at a single price (at NAV) Authorised Corporate Director instead of Manager Depository instead of Trustee An OEIC is a UK company that can repurchase its own shares on demand

80 Investment Trusts Investors Investment Trust £5,000 x 1,000 5 million £1 ord shares Investments DepositoryInvestments Markets Trade Price tends to be at a discount to the net asset value of the company. This discount narrows in a bull market and widens in a bear market

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

82 82 Collective investments comparison FeatureUnit TrustInvt TrustOEIC/ ICVC ETF Open/ closed ended openclosedopen Legal structure/ Investment unit Trust/ unit Company/ share Company/ share Company/ share Price based onNet asset value Demand and supply Net asset value Bid/offer or single price Bid/offer Single priceBid/offer Investments purchased from Fund managerStock marketAuthorised corporate director Stock market Investments held byTrusteeAuthorised depositary Custodian

83 83 Hedge Funds Unregulated schemes High investment entry levels Flexible investment style, including gearing Fees are performance related

84 84 Investment Wrappers CHAPTER 6 ISAs/PEPs Child Trust Funds

85 85 ISAs Designed to replace PEPs – no tax on income or capital gains An ISA is a tax free wrapper that can be applied to a wide range of products Up to 2 components as follows – Cash – Stocks & Shares

86 ISA limits Mini ISA Stocks & shares £4,000 p.a. Cash £3,000 p.a. Maxi ISA Stocks & shares no limit Cash£3,000 p.a £7,000 p.a

87 87 Child Trust Funds For children born on or after 1 Sept 2002 Money cannot be withdrawn until child turns 18 (child can manage from 16) Government starts CTF with £250 (£500 for lower income families) Can add up to £1200 per annum Savings, shares or stakeholder accounts No tax on income or gains

88 88 Regulation CHAPTER 7 FSMA 2000 Money Laundering Insider Dealing and Market Abuse Takeovers and Mergers

89 89 UK Financial Regulation The UKs main financial regulator is the Financial Services Authority (FSA) The FSA operates under the Financial Services and Markets Act 2000 (FSMA 2000) The Act states that any person (firm) conducting regulated activities in the UK must be authorised by the FSA or exempt Certain individuals within the firm must also be approved by the FSA for their roles The FSA have written a handbook which must be complied with to avoid prosecution

90 90 The FSAs four objectives Maintaining confidence Promoting public awareness Appropriate protection for consumers Reduce scope for financial crime

91 91 Approved persons regime Certain people working for an authorised person (firm) must be approved by the FSA for their role. The 27 separate controlled functions (jobs) that require approval are grouped under five categories: – Governing functions (e.g. Directors) – Required control functions (e.g. MLRO) – Systems and controls functions – Significant management functions – Customer functions

92 92 Key statutes governing financial services Financial Services and Markets Act 2000 Proceeds of Crime Act 2002 and ML Regs 2003 – Anti-money laundering Criminal Justice Act 1993

93 Money Laundering Definition 3 stages ML Regs 2003: Financial institution procedures : – identify new clients – record keeping – internal reporting – internal controls to prevent the firm being used for money laundering POCA 02 Offences: – concealing; arrangements that you know or suspect is to acquire, retain, use/control criminal property; acquire, use or possess criminal property; failure to report; tipping off Suspicion reporting process – Employee=> MLRO => SOCA

94 Insider Dealing If an individual who possesses inside information from a primary or secondary insider Deals Encourages others to deal Tell others the information

95 95 Market abuse Offence under FSMA 2000 Includes : Using information not generally available to others Regular user test employed to establish guilt or innocence

96 96 There are two main concerns regarding a takeover and different regulatory bodies are in place to address each concern: Is the takeover anti competitive? Are shareholders treated fairly? Takeovers and Mergers Competition Commission Panel on Takeovers and Mergers

97 97 Takeovers and CompetitionCC The Office of Fair Trading considers whether a proposed takeover might be anti- competitive. The OFT could result in the bid being referred to the Competition Commission The Competition Commission decides on whether the takeover should be allowed to proceed, any restrictions required and the like OFT

98 98 Takeovers and shareholders The Panel on Takeovers and Mergers (POTAM or PTM) ensures that all shareholders are treated fairly Their rulebook is known as the Takeover Code or Blue Book The rulebook principles state: – Shareholders of a target company must be treated equally in all respects during an offer – Dont bid for a company unless you intend to, and can afford to, go through with the bid – Directors should make decisions by considering what is best for shareholders, not themselves

99 99 Takeovers – key %s 30% Effective control 50% Actual control Must make a bid for the remaining shares in the company 0% 100% 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

100 Takeover of a Listed Company Offer document dispatched 28 days Bid announced through Stock Exchange 21 First closing 39 Final target company announcements 46 Final revision 0 Final closing 60

101 101 Other Regulations Data Protection Act – 8 principles especially adequate, relevant and not excessive Complaints – System required and Financial Ombudsman Service can compel firms to pay up to £100,000 Compensation – Financial Services Compensation Scheme payout maximum of £48,000

102 102 Taxation CHAPTER 8 Income tax Capital Gains Tax Inheritance Tax Stamp Duty

103 103 Taxation Income tax Capital gains tax Inheritance tax Paid on income, potentially including investment income Potentially payable on the sale of an investment Potentially payable on investments held at death

104 104 Income Tax Salary Profits from running a business Dividends Interest From an employer Individuals or partnerships From companies From banks/building societies/bonds

105 105 Income Tax Income £5,035 10% 22% 40% Personal allowance Lower rate Basic rate Higher rate £2,150 £33,300 £33,301

106 106 Taxation (Income) Tax is usually deducted at source. – salaries PAYE – savings income (interest) basic rate of 20% is automatically deducted – dividend income basic rate of 10% is automatically deducted

107 107 Taxation (CGT) Capital Gains Capital Gains – Shares – Bonds (some) – Property – Antiques Exemptions Exemptions – Main home – Gilts – Cars

108 108 Taxation (CGT) Allowance of £8,800 for the year CGT only paid on gains above the allowance Any losses can be carried forward Paid at the investors marginal rate of 10%, 20% or 40%

109 109 Inheritance Tax A certain amount is exempt – threshold of £285,000 – anything left to a spouse – anything left to a charity – items given away more than seven years before death – IHT charged at 40%

110 110 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

111 111 End of Course

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