by rastariza

Understanding Investment Banking: Grasping the Language of Investment

Fixed interest investments

These are investments where the income is a fixed amount, at least for the time being. Usually the capital value is also fixed, although in some cases it can change, too. However, either income or capital are fixed and in many cases both.

Equities

These are investments in ordinary shares of companies, where both the income and the capital can vary up or down. They can be bought and sold on a stock exchange and they participate in profits (after any preference dividend is paid) and receive dividends, usually paid half yearly.

Shares have a par value – usually £1 or 50p – but this bears no relationship to their market value and can be ignored.

Fixed interest versus equities

All statistics show that in the long run, due to capital growth, equities beat fixed interest by a big margin, whereas fixed interest may not even beat inflation

Here is another comparison. If you invested £1,000 in 1973, 20 years later, in 1993, it would have grown to:

- building society (average) £43,000

- shares (FTSE 100) £297,000

Even after allowing for inflation, the equity investment would have risen to £56,000, whereas the building society would not have kept pace with inflation and would have fallen to £8,700.

Although the income on equities is less than on fixed interest to start with, it catches up and passes it in the long run. Over the past 30 years or so, income from equities has on average doubled every seven years

But to achieve the best returns on equities it is necessary to have flexibility in the timing of both buying and selling and an ability to remain invested for the long term say five years at least.

Risk

The more you have invested and the longer you can leave it alone, the more risk you can afford to take with some of it to achieve a higher reward. The most important thing is to recognise the existence of risk and to take appropriate steps.

Spread your investments over a number of different categories, having perhaps more than one investment in each category. Consider pooled investments such as unit trusts

In this connection, some advisers suggest that you should take into account your income from earnings (or from your pension if you are retired), which they capitalise and call your lifetime capital. The relative steadiness of this income can mean that you can take more risk with your investments.

Always look at the downside risk of each investment and decide whether you are happy with it. However, to achieve higher returns in the long run, you need to take some risk.

Shares have three opportunities/risks:

- the individual company,

- the market sector (such as stores, banks); and

- the overall market.

The volatility of individual shares has increased significantly in recent years and the potential to lose money is something like three times as great as 30 40 years ago. This applies in particular to shares in the FTSE 100 index (smaller companies are less volatile). In very recent times this increased volatility is due to the Internet linked companies.

Events in the lifecycle of shares

New issues

New shares sometimes come to the market as a result of de nationalisation and de mutualisation but any company coming to the market for the first time is a new issue. Application forms are printed in newspapers and are available on request. You fill in the form and send it off with a cheque.

You may not get all the shares you ask for. Some people apply for more than they expect to get. Stags are people who aim for a quick profit, applying for a large number of shares with the intention of selling them as soon as they are received.

There is no commission or stamp duty payable on new issues and the full amount may be payable in instalments.

Rights issues

This is where a company raises further capital by offering existing shareholders the right to apply for more shares. The price is usually set below the current market price so that the rights themselves have a market value.

Shareholders can decide whether to take up their rights, so investing more money in the company, or to sell them. Those taking no action usually have the rights sold for them.

There is a third way, called tail swallowing, which is particularly appropriate if your investment is in a PEP or ISA. If you wish to take up the rights but have insufficient cash in the account, you can sell enough rights to bring your cash available up to the amount required for the remaining rights.

Bonus issues

This is a misnomer: there is no bonus! A better term is scrip issues (or capitalisation issues) and it is where existing shares are subdivided into, say, two new shares, thus doubling the number of shares and halving their value. No new money passes, the action being taken usually because the share price has risen to a level which is considered too high for an effective market.

Scrip dividends

This is where companies offer shareholders the opportunity to take new shares instead of a cash dividend. It is a cheap way to invest more money in a company but it complicates capital gains tax calculations.

Share buy backs

A company sometimes buys back shares, usually because it has surplus cash which cannot be invested more profitably elsewhere. The effect should be an increase in the share price.

Take over bids

From time to time one company will attempt to take over another by offering an attractive price for the shares. It is worth waiting for a competitive offer, even if the directors recommend acceptance. Newspapers and investment magazines will comment on the offer.

If the buying company is successful it can force the purchase against reluctant sellers.

Receivership and liquidation

If a company fails to pay debts a lender of money to it can appoint a receiver to manage its affairs (or have one appointed by the creditors) or the company can be put into liquidation. In either case, it is unlikely that the equity shareholders will get much, if anything they are at the end of the queue.

Tags: 50p, Banking, Capital Growth Equities, Dividend, Dividends, Equity Investment, Fixed Interest Investments, Flexibility, Grasping, Inflation, Investment, Investment Banking, Language, Ordinary Shares, Pace, Par Value, Preference, Profits, Relationship, risk, Seven Years, Statistics, Stock Exchange, Understanding