Business Management 142
Chapter 1 - Investment concepts
Terminology
Gambling: no knowledge of outcome of decision
Speculation: promise of great returns but high risk
Investments: reasonable return, less risky
Di erence between investments and speculations
- Term: Investment = long term/5+ years, Speculation = short term/1-2 years
- Motive: Investment = require a reasonable return, Speculation = require a considerable
return
Objectives of investments
1. Speculation: Buying asset (property, stocks, options, cattle) with a goal to sell it for a
substantial pro t within 1 year
2. Income: Buy asset with aim to generate income (property – rental, shares – dividend,
xed deposit – interest)
3. Capital Growth: e.g. Buy a house and sell after 10 years for more, capital increased by
the di erence. Purpose is to protect purchasing power of capital
4. Take overs and mergers: e.g. Buy a neighbouring farm – farm more e ectively
5. Control over raw materials or a distribution channel: Set of interdependent organisations
involved in the process of making a product/service available for use/consumption
Financial Instruments
- Collective term for all tradable assets or units of capital
- Ability to transfer ownership is a requirement
Financial Securities
- a nancial instrument that represents:
1. Investment as an owner in corporation (share)
2. Creditor relationship with corporation or governmental body (bond)
3. Rights to ownership (option)
Shares
Shares: Small units of ownership that the capital of a company consists of
- Originated due to companies seeking limited liabilities and seeking lots of capital
Share certi cate: document issued to prove ownership of a share
Dematerialisation: Switching from paper-based to electronic
Bonds & Gilts
Bonds: tradable debt instruments
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, - Can be issued by corporations (debentures) or Governments (gilts)
- Loans that must be paid by the maturity date
- Fixed interest must be paid periodically to owner
- Market price of bonds that can be sold depends on interest rates
e.g. Eskom has gilts
Securities exchange
Company that creates a platform/opportunity for buyers and sellers to trade shares/bonds
e.g. Johannesburg Stock Exchange
STRATE
STRATE = share transactions totally electronic
- O er trading of securities on JSE facilitated by a stockbroker
- Ownership is transferred between buyers and sellers
- Record keepers
Money market and capital market
Money market: Market for all short term funds traded
- Surplus or short falls in uence money market interest rates
e.g. short term loans, money market funds
Capital market: Market of all long term funds traded
- in uences long term interest rates
e.g. xed deposits, mortgages, debentures
Primary and Secondary markets
Primary market: Where listed companies and governments sell securities for the rst time
- Initial issue value: nominal value / par value
- Average issue price is used instead in South Africa
- Prospectus: Information on new issues of shares and invitation to subscribe
Secondary market: Trading takes place in this market after shares have already been
bought initially
- Market price: determined by supply and demand
Share price
Share price/market price: Price at which shares are traded in the secondary market
- Bid: buyers price, highest they’re willing to pay
- O er: sellers price, lowest they’ll sell at
- Last: market price, last traded price of a share
These prices help to see trends e.g. 620 bid, 630 o er, 610 last has un upward trend
Blue chips: Ordinary shares that have elite investment status
- good reputation over a long period because they maintain: stable and sound pro t /
dividend history & have healthy growth prospects
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, Portfolio and diversi cation
Portfolio: composition of a persons investments e.g. shares, bonds, properties, options etc.
Diversi cation: Investing in di erent companies and / or sectors
- Include investments that have di erent risk pro les in the portfolio
Even if company A goes wrong your
diversi ed portfolio can still make a pro t
Risk: Possibility that the actual returns realised on an investment may be lower than the
expected return
Institutional investors and trusts
Institutional investors: enterprises investing with large units capital e.g. insurance
companies, pension funds, mutual funds
Unit trusts: pooling of money - collect small amounts of savings from individuals and
companies and invest large amounts in a diversi ed portfolio
- Advantage: managed by trained investment professionals
Listing
Listing: Right a company obtains to trade its shares on a stock exchange after certain
requirements are met
IPO: Initial public o ering
Pre-listing statement: Document issued after a company complied with all JSE listing
requirements. It is a source of information about a proposed listing and not an invitation to
buy additional shares.
Arbitrage
Arbitrage: product traded on 2+ markets, risk-free pro t made from short term price
di erences on the di erent markets. E.g. buy product on the cheaper market and sell it on
the more expensive market.
Steps:
1. Determine whether a mis-pricing exists
2. Determine how to exploit the mis-pricing
3. Determine the pro t to be made
Example: JSE: Share worth R140, NYSE: Share worth $7.85, exchange rate $1 = R17.40
Q: Which exchange should you buy shares? What will the pro t be?
A: JSE: R140 per share, NYSE: 7.85 x 17.40 = R136.59 per share
Buy on the NYSE, sell on the JSE
Pro t = R3.41
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, Bull and bear markets
1. Bull market: Period of continuous price increase over the long-term. Strong buying
pressure / demand. Prices of most shares increase
Bull: Buys shares at low price, keeps them for a long period and sells after a few years to
make a pro t
Bull speculator: Sell shares to obtain funds to purchase shares, achieve short term capital
gain
2. Bear market: Period of mainly price decrease over the long term
Bear speculator: Sells shares not in their possession, hoping prices will continue to drop
(shorting / short sales)
e.g. I sell 1000 shares I don’t own for R5 per share to X, share price drops and I buy 1000
shares from somewhere else for R4 per share and give the shares to X. (Pay 4000, sold for
5000, keeps 1000 pro t)
Stag: Speculator who makes a quick pro t from a new listing or a rights issue (company
gives shareholders the option to buy more shares)
Corporate actions
Corporate actions: Decisions made by management that have e ect on securities issued
Mandatory corporate actions: participation of shareholders is mandatory e.g. dividend,
capitalisation (bonus) issues, subdivision (stock splits) and mergers
Voluntary/elective corporate actions: Shareholders elect to participate e.g. rights issues and
share buy-backs
INVOLUNTARY
1. Dividends:
Dividends: portion of pro t after tax, subdivided amongst shareholders
- preference share and ordinary shares
- Interim after 6 months + nal dividend = total dividend for year
Timeline of dividends
1. Announcement/Declaration - 13 days before record date
2. Cum-Dividend - Buy shares cum dividend: including right to dividends
3. Ex-Dividend: 1 business day after end of cum-dividend payment date
4. Record date: Company closes register on a Friday for mandatory corporate actions
5. Payment date: Dividends paid into account
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