Investment Planning

Lecture 12

What is an investment?

• “Make our money work for us”

• It is a commitment of funds to one or more assets that will be held over some future time period, in the hope that it will generate more income.

• Could be tangible, i.e., real estates or intangible, i.e., securities.

Types of Investments

• Equities - Stocks or ordinary share

• Unit trusts – including

• Futures and Options

• Bonds

• Hybrid Investments

• Real Estate

Stocks and Shares

• When you buy stocks and shares, you own part of the company and have the right to vote at general meetings.

• Each share is a small stake in a company and you can buy a large number of lots.

• As a shareholder you can benefit from the profits earned by the company in the form of dividends, and also from the growth in the value of the company

Why do companies issue shares?

• The company benefits by raising funds to operate and expand its business without having to borrow the money from other sources such as banks.

Risks in buying shares

• Shares may fall in value due to company’s performance as well as the economic condition

• Thus it is important to know what the company is doing, how well the business is, its financial strength, price-earning ratio and dividend yield, earning growth prospect and competitive edge

Types of Share Issues

• Bonus issues– Issue of new ordinary shares at no cost to the

existing shareholders but out of the company’s reserves and given in direct proportion to the number of shares owned.

– Used to enlarge the capital base of the company and may also be used as a means of rewarding its existing shareholders.

– Ex-date, Cum-dividend, cum-rights and cum-bonus

Types of Share Issues

• Rights Issues– Gives the existing shareholders the right to

subscribe for new ordinary shares at an issue price lower than the prevailing market price and at a ratio equivalent to their existing shareholding.

– Companies carry out a rights issue when they want to raise additional funds to finance their capital requirement.

Unit Trusts

• An investment scheme that pools money from many investors who share the same financial objectives.

• The fund issues units to investors who are known as unit holders

Managing Unit Trust Fund

• The fund is managed by a group of professional managers or unit trust company who will invest the pooled money in a portfolio of securities such as shares, bonds and money market instruments

Income earned by unit trust

• The unit trust earns its income from its varied investments in the form of dividends, interest income and capital gains.

• Income is distributed to the unit holders in proportion to the units they hold, in the form of dividends or bonus units.

Types of Unit Trusts

• Income funds• Capital growth funds• Aggressive growth funds• Balanced funds• Index funds• Money market funds• Islamic funds• State funds

Advantages of Unit Trusts

• Ready affordability

• Instant diversification

• Liquidity

• Continuous professional management

• Reduced stress

• Access to broader array of financial assets

Disadvantages of Unit Trusts

• Subject to market risks• Not suitable for short-term investment• No custom-made service• Hidden costs involved

– Initial service charge– Repurchase fee– Management fee– Trustee fee– Brokerage fee

Futures and Options

• Basic derivative instruments whose values are dependent on the value of an underlying assets such as common stocks, bonds, indices, currencies or commodities

Forward Contract• An agreement to buy or sell an asset at an

agreed price and specified date

• Similar to forward contract but traded on an exchange (MDEX)

• Main purpose is not to buy or sell the physical goods but to manage the risk of price changes for hedgers and for speculators, to profit from the changes

Futures Contract

Options

• Give the buyer/holder of the option the right, but not the obligation, to buy or sell a specified assets at a specified price, at or before the specified date from the seller, for which the buyer pays a premium.

• Options that give the buyer the right to buy are Call Options.

• Options that give the buyer the right to sell are Put Options.

Warrant

• Also knows as Transferable subscription rights (TSR) which gives the holders the right but not the obligation, to subscribe for new ordinary shares at a pre-determined exercise price within a stipulated validity time frame

Bonds

• IOU, a debt instrument issued by a borrower

• Basic characteristics:– A maturity date or identifiable term– A fixed rate of interest payment (coupon)– A fixed face value redeemable on maturity

• Always referred to as fixed income securities

Who Sell Bonds?

• Government bonds – Malaysian Treasury Bills (MTB)– Bank Negara Bills (BNB)– Malaysian Government Securities (MSG)– Government Investment Certificates (GIC)

• Private or corporate bonds– Debt instruments issued by corporations

Who Buys Bonds?

• Mainly institutional investors

• Retail or individual investors can invest in bond funds.

1. Stability of income flow

2. Opportunities of capital gains

Popular with investors for two reasons:

Why invest in Bonds?

1. Less risky than shares

2. More returns than fixed deposits

How risky are bonds?

• Credit risk – The risk that the issuer will default– Thus bonds are rated– Less risky if issued by government

• Interest rate risk– Inverse effect on bonds if bondholder sells

before maturity

How do bonds rate with shares?

Advantages• Investor receives periodic

fixed or variable interest income, irrespective whether company is doing or not.

• Bondholders have the right over ordinary shareholders on the distribution of earnings in the event of bankruptcy.

Disadvantages• Bondholders get fixed

income even though the company may be making more profit

• No voting rights

How are bonds traded?

• When the issuer first offers new issues, that first trading is done at the primary market, i.e., the issuer is able to raise for its own use and the money raised from the sale of bonds come directly to the issuer.

• Subsequently, bonds can be bought and sold at the secondary market.

• Trading of bonds in the secondary market creates a market pricing for the bonds.

Pricing of bonds

• When market price of bond is less than its par value, the bond is considered as being sold at a discount.

• When the market price of bond is more than its par value, the bond is considered as being sold at a premium.

Different types of bonds

• Bonds are classified according to: – Maturity terms, such as short-term, medium-

term or long-term. – Issuer, i.e., government bonds, corporate

bonds or private debt securities, quasi-government bonds, i.e., Cagamas bonds and Islamic private debt securities or Islamic bonds.

Government Bonds

• Government Investment Issues (GII)

• Malaysian Government Securities (MGS)

Corporate Bonds

• Straight bonds

• Convertible bonds

• Bonds with warrants

• Floating rate bonds

• Zero coupon bonds

• Mortgage bonds

• Islamic bonds

• Secured and unsecured bonds

• Guaranteed bonds

Common terms associated with bonds

• Nominal value

• Coupon rate

• Term-to-maturity

• Trust deed

• Trustee

• Type of issuer

• Yield

• Call provision

• Sinking fund