Introduction to Investment Bruce Viney Director of Training and Client Services Template slide pack Prepared October 2006 By Bruce Viney

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

Programme/Syllabus * plus/minus 2 Workbook Chapter Content Questions in exam* 1 Financial Services in the UK 8 2 Asset Classes 13 3 Derivatives 4 Financial Products 6 5 Pooled Funds 9 Investment Wrappers 7 Financial Services Regulation Taxation Total 50 * plus/minus 2

Introduction CHAPTER 1 The Role of the Financial Markets Financial Institutions London’s Markets The Bank of England The UK Economy

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

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

Financial Market stages onward trading of shares at market price SECONDARY MARKET PRIMARY MARKET Company issue shares at £2.20 each

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

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 London Stock Exchange

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

World Securities Markets NYSE Nasdaq Euronext Japan Deutsche Borse

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

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

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

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

Inflation What is it? Problems caused by inflation Measurement headline RPI underlying RPIX harmonised HICP Caused by an increase in the money supply? What is money?

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 MPC control this rate LIBOR 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 Bank of England MPC control this rate % % % bank bank bank % % LIBOR % customer

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

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

Part ownership = shares Security General term for any type of financial instrument (usually) traded on an investment exchange. Equities Bonds Part ownership = shares 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

Variable, not guaranteed 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 Preference Yes Variable, not guaranteed No Fixed, not guaranteed (can be cumulative)

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

Corporate Actions Types of action Examples 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)

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

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 of shares Price per 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?

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 of shares Price per 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 ex div Feb Dividend announced Wed 8 March Ex-dividend day Fri 10 March Record Day (Books closed day) Dividend Payment date Fri 10 May AGM Tues 7 May

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

Alternative Investment Market Listing Full list Alternative Investment Market Trading history Minimum 3 years No minimum Market capitalisation Minimum £700,000 ‘Public’ holding At least 25%

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

FTSE Indices 1 FTSE 100 100 FTSE 250 FTSE All Share 350 FTSE Small Cap

World Markets Securities Indices 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

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

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

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

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

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

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

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

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

Corporate Bonds Domestic Foreign Eurobond 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

Other bonds - features Zero Coupon Bonds Convertibles

Gilts bid basis (auction to those on an Approved List) Interest (coupon) gross annual interest on the nominal value (£100) paid semi annually Repayment (redemption) Classification by DMO Short Less than 7 years Medium 7-15 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

Yields Flat Yield 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% annual coupon x 100% ---------------------- market price

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

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

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 Date Issue Term Mar 2006 £100m 6mth Apr 2006 £50m 3mth Oct 2006 £75m 6mth Jan 2007 £75m 3mth CP programme issue limit £150m end date 2008

Certificates of Deposit (CD) Investor A Bank Investor B

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

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

CHAPTER 3 Derivatives Futures Options

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

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

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

An example of an Equity Call Option Writer Call Option (10p per share) I grant you The right to buy 1,000 PJC plc shares From me At a price of 100p Within 3 months PJC plc 1000 shares Market price 105p Holder (£100) Option Premium

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 Time “in the money” breakeven 110p 105p strike 100p “at the money” “out of the money”

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

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

Deposits and loans Deposits Loans 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

Interest Rates Quoted rate v Effective rate Steps to turn quoted into effective Quoted expressed as a decimal Divided by number of periods per year Added to one To the power of the number of periods per year Subtract one and times by 100

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

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

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%

CHAPTER 5 Pooled Funds Unit Trusts OEICs Investment Trusts

Rationale of Collective Investment I’ve got a spare five thousand, I think I’ll invest in a UK equity fund. Advertise Shares/units in collective inv’t £5,000 Fund Manager

Role of the FSA Authorised v unauthorised Onshore v offshore

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

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

Another 1,000 units created (open ended) Buying more Units FM prices Bid Offer UK Equity 485 515 1 000 units x 515p per unit £5,150 Another 1,000 units created (open ended) Fund Manager Trustee Investments

Creation of more units? Sellers Buyers 9,000 units 10,000 units Fund Manager “Create 1,000 units” Investments Trustee Investments Markets

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

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

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

Investment Trusts Trade Investors 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 5 million £1 ord shares £5,000 x 1,000 Investment Trust Investments Depository Investments Markets

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

Collective investments comparison Feature Unit Trust Invt Trust OEIC/ ICVC ETF Open/ closed ended open closed Legal structure/ Investment unit Trust/ unit Company/ share Price based on Net asset value Demand and supply Bid/offer or single price Bid/offer Single price Investments purchased from Fund manager Stock market Authorised corporate director Investments held by Trustee Authorised depositary Custodian

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

CHAPTER 6 Investment Wrappers ISAs/PEPs Child Trust Funds

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

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

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

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

The FSA’s four objectives Maintaining confidence Promoting public awareness Appropriate protection for consumers Reduce scope for financial crime

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

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

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 Deals Tell others the information

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

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? Are shareholders treated fairly? Competition Commission Panel on Takeovers and Mergers

Takeovers and Competition 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 OFT The Competition Commission decides on whether the takeover should be allowed to proceed, any restrictions required and the like CC

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

Takeovers – key %’s 100% 0% Must make a bid for the remaining shares in the company 50% Actual control 30% Effective control SARs – prevent the following: 10% or more Within 7 calendar days From more than one source Resultant shareholding is 15% or more 0%

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

Other Regulations Data Protection Act Complaints Compensation 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

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

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

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

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

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

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

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%

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%

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

End of Course