UK Financial Services, regulations and ethics
2.3 Asset classes - equities
In this section, we aim to understand the main features, types of potential returns, key factors affecting price, volatility, access, taxation issues and variations of equities as an investment asset class.
Equities share some distinct features when defining the types of returns available.
All share classes will provide the ability to receive a dividend in some form, which will be dependent upon profits made. A dividend is a form of income, which i...
Shortened demo course. See details at foot of page....s buyers and sellers wishing to make a trade.
History indicates that people wanting to achieve long-term real returns of income and capital but who are willing to accept the volatility surrounding returns, should consider investing in equities.
The expectations of the markets as a whole and investor sentiment in ter...
Shortened demo course. See details at foot of page....d upon the quality of the management team in charge of the organisation.
Share price movements in the short term can go quickly up or down.
A lot will depend upon the class of a share and its behavioural features (see variations later on).
A lot wil...
Shortened demo course. See details at foot of page....ied out various past studies and have concluded that there will be a finite point where further diversification above a certain number of different shares will have a limited effect.
Theoretically, most shar...
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All dividends are paid by companies out of post tax reserves.
UK dividends will be received by investors with a 10% tax credit. This will be sufficient to cover any tax liability for investors paying up to basic rate tax. Non taxpayers will not be able to reclaim the tax credit.
Higher rate taxpayers will suffer a further 22.5% income...
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We shall now go on to look at the main varieties of share available on the open market before finally discussing various investment ratios that are available in order to analyse company and share performance.
Ordinary shares are the most common forms of tradable equities
They give shareholders the right to all profits that exist after tax and preference shareholders’ dividends ...
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There are several types of ordinary share categorised by the varying rights to participate in profits and control of a company.
These shares usually pay a fixed half yearly dividend. Whilst this is similar to the principle of paying interest to loan stock holders, unlike debt interest which has to be repaid, a preference share dividend is only paid out if the company has generated sufficient profi...
Shortened demo course. See details at foot of page....nce shares which carry the right to convert into ordinary shares at pre determined dates and terms. The price on the latter types of share tend to behave both inline with bonds and ordinary shares depending upon whether or not conversion rights look likely to be taken up.
These ratios get used by investors to determine whether a particular type of share is worth buying, holding on to or selling. As much of the information viewed is historical, they should not be looked at in isolation as for instance, management may change, different accounting policies could be used, economic trends may have caused figures to look better or worse than they really were.
By analysing ratios and percentage returns, an investor will be able to see whether the share is good value for the risks it poses compared to other shares in the market. Performance can be assessed against the market as a whole or against similar shares within the same sector.
The following are some...
Shortened demo course. See details at foot of page....ndication of the amount they may receive (or a proportion thereof) when the company is wound up.
This measures the amount of debt that a company has. Two ways in which it can be calculated are shown below:
Long-term debt/Total capital employed x 100
This looks at the relationship of all company debt including loan stock and preference shares against all capital funds used in the business.
Long-term debt/Ordinary shareholders’ funds (capital and reserves minus preference shares) x 100
Where this ratio indicates high borrowings against equity, then the company may be vulnerable if there is a downturn in profits and/or an increase in interest payments.
The London Stock Exchange
The London Stock Exchange (LSE) is one of the oldest and largest exchanges in the world. It was formed in 1773 by stockbrokers who used to gather in a nearby coffee house.
In total, there are over 3,000 companies listed on the exchange that are traded either on the main market or via the Alternative Investment Market.
Following the “Big Bang” in the 1980s the current structure of primarily computer based dealing facilities was put in to place. This was a big change compared to the previous system where traders operated on an open trading floor.
The LSE is now completely electronic but different shares are traded on different systems. The most liquid shares are traded using the Stock Exchange Electronic Trading Service (SETS) automated system which is order-driven.
Less liquid shares are traded via...
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New York Stock Exchange
The NYSE is the largest stock exchange in the world.
It is an order driven market with brokers dealing with one another to match trades on behalf of investors.
Dealing either takes place on the floor of the exchange or via a computer system known as SuperDot .
Shares can be held by investors personally, nominees or in a central depository called the Depository Trust Corporation (DTC) .
NASDAQ is a US screen based, quote-driven market operating in a similar way to SEAQ in the UK.
Companies listed on NASDAQ tend to be newer, higher growth and more volatile stocks.
The exchange is well known for the holding of technology stocks.
It is a quote driven market with trades still carried out through market makers albeit predominantly via an electronic exchange.
Stock market indices are designed to bring together the movements in price of individual shares and show how a particular market is behaving over a period of time.
They provide a way of measuring performance of a group of shares in the market.
The index number is used to compare the value of the selected companies in the index at different points in time.
They also provide a benchmark of performance allowing investors to compare their own individual portfolios with the index that would be most relevant and closely associated with their investments.
Usually the constituents of the main indices are the biggest companies, ranked by their value (market capitalisation). However, certain indices track more ...
Shortened demo course. See details at foot of page....SDAQ Composite tracks the NASDAQ market and is often used as a guide to the performance of US technology shares.
The CAC 40 is an index of the 40 largest French stocks. It is a real time index weighted by value.
The XETRA DAX consists of the 30 largest German quoted companies. Again, it is a real time index weighted by value. Unusually for an index it includes reinvested income.
The NIKKEI 225 is the most widely used measure of share movements on the Tokyo Stock Exchange.
It is not strictly an index but is based on the average values of 225 stocks. However, it is not weighted according to market capitalisation so small firms can move the index just as much as larger ones.
Unlisted securities in the UK comprise shares in companies that are unquoted on the main market of the London Stock Exchange (LSE) – the Official List.
The largest market for unlisted securities is the Alternative Investment Market (AIM). The ...
Shortened demo course. See details at foot of page....quickly. This is counterbalanced however, with those companies that will produce very inconsistent returns or even no returns at all!
They are less liquid than listed shares, suffer higher volatility in price and often transaction costs are higher.
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