CMFAS Module 6 Key Note Set 1
An investment is a commitment of funds to a specific asset to generate a favourable future return. Investments can be made in financial assets or real assets.
2. What are the differences between financial assets and real assets?
A financial asset represents a financial claim that is documented and represented in a legally enforceable form e.g. a stock, or a bond. On the other hand, real assets are claims on physical asset e.g. real estate or gold.
3. How can investments be made?
Investments can be made in various instruments that are also called securities. These include equity securities such as shares and unit trusts, and debt securities such as short-term money market paper or long-term fixed income bonds. More sophisticated investors may invest in derivative securities such as equity options and futures
4. How does one classify a financial asset?
Financial assets may be broadly classified under broad asset classes such as debt, equity funds and derivative instruments or securities.
5. Are debt securities limited only to bonds?
Because they are interest-bearing instruments debt securities can also include treasury bills, fixed rate bonds, certificates of deposit, commercial paper and debentures.
6. Are treasury bills only issued by international banks?
Treasury bills are issued by central banks on behalf of the government to raise short-term funds to finance government expenditure.
They are considered to be free of default as it is obligated by the government. As such, they are normally used as a proxy for the risk-free rate of return. They are issued on a discounted basis by tender and payable or redeemable, at face value on maturity date.
7. Are commercial papers similar to treasury bills?
Commercial papers refer to short-term unsecured promissory notes issued by a corporation. Like Treasury bills, commercial papers are discounted money market instruments.
8. Who can issue a certificate of deposit (CD) ?
A certificate of deposit (CD) is a certificate that is issued by a bank in exchange for a deposit of funds placed with the bank. Yields on the CDs are quoted on an interest-bearing basis.
9. Can Singapore offer various bonds to investors?
Singapore is considered to have one of the most developed bond markets in all of Asia. Investors can choose from various types
of local currency bonds such as Singapore Government securities, statutory board securities, supranational bonds and corporate bonds.
10. Are there any differences between Yankee bonds and domestic bonds?
Yankee bonds are sold in the United States and denominated in US dollars, but are issued by foreign corporations or governments.
Domestic bonds are bonds sold by an issuer within its own country in that country’s currency.
No, that would be an option. A warranted however would give a right to buy a given number of shares from the issuing company at a specified priced over a given time period (usually over a number of years).
12. Are future contracts only availalble for commodities?
Futures contracts are available on commodities and also financial instruments that includes equity market indices, currencies and fixed income securities.
13. Are investros and issuers the only participants in the financial market?
Participants in financial markets include:
• Investors – retail investors, private bank investors, institutional investors (including fund management companies)
• Issuers – public and private sector companies
• Intermediaries –broker/dealer firms and market makers
• Regulators
• Electronic exchanges – for equities, debt, derivatives, and commodities
• Infrastructure providers – clearing house, central depositary, communications networks, trade repositories
• Financial institutions in distributing and underwriting initial public offerings (IPOs), and in maintaining the secondary markets
14. What distinguishes a good market from another?
Investors should consider the following when evaluating the quality of a financial market:
- Availability of information
- Liquidity
- Transaction cost
- Bid-offer spread
- Information efficiency
- Price Discovery
The Eurobond market remains a very important market for investors who are interested in foreign currency bonds, particularly over the last few years when Quantitative Easing (QE) by central banks has resulted in very low interest rates, leading investors to seek higher returns through long-term bond issues.
16. Is the size of the equity market same in any country?
No, as the equity markets in different countries not only vary in terms of their size, but also liquidity, degree of regulation, trading and settlement systems, and restrictions on foreigners in buying equities.
Investors have a wide range of financial products to choose from and often hold multiple products in their investment portfolio.
Therefore licenced representatives and financial advisors should be familiar with the fund management process, which aims to manage clients or investors’ portfolios in line with their clients’ investment objectives.
18. How many components are comprised in a total return (on a pre-tax basis) on an investment?
Total return (on a pre-tax basis) on an investment comprises two components:
a. Current income. This is income received from the investment during the period in which the investment is held, such as dividends from shares and interest income from fixed income securities or fixed deposits.
b. Capital gain or loss. The prices of equity securities and bonds may either appreciate or decline resulting in capital gain or loss.
19. Investors should be cautious and look at what types of investments risks involved?
- Counterparty Risks
- Market Risks
- Liquidity Risks
- Operational Risks
20. How should investors evaluate their investments?
When evaluating investments with varying rates of return and standard deviation, the coefficient of variation, a relative risk measure, is required. It measures the risk per unit of return.
21. How should financial analysis be employed?
Fundamental analysis often employs a “top-down” approach where the analysis is done in three stages:
• Economic analysis
• Industry analysis
• Company analysis
22. Should the balance sheet only show assets and liabilities?
The balance sheet shows the financial condition of a company at a point in time, typically the company’s financial year-end. There are three parts in the balance sheet:
- assets,
- liabilities and
- shareholders’ equity
23. What is the profitability of investments in real assets?
• Return on assets
• Return on equity
• Gross profit margins
• Net profit margins
• Earnings per share
24. How is the company financing itself with regards to financial ratios?
• Debt to Equity ratio
• Debt to Total Assets ratio
• Interest Coverage ratio
• Current ratio
• Quick ratio
25. How efficiently is the firm utilising its assets in regards to financial ratios?
• Total Assets Turnover
• Inventory Turnover
• Receivables Turnover
• Collection period of receivables
26. What are some of the signs of a strong balance sheet or high quality financial statements?
Signs of a strong balance sheet or high quality financial statements are:
1. Limited use of debt or leverage
2. Assets that are generally carried below market values i.e. underpriced.
3. Conservative revenue recognition policies and principles, that do not change just to reflect higher sales, as well as conservative accounting of unrealized income by deferring its recognition until the income is realized in cash and generally adequate provisioning for losses and expenses.
4. Realistic recognition of bad debts or trade receivables.
5. Absence of off-balance sheet activities.
27. How long should the financial statement analysis be carried out for acquirng market trends?
The analysis of the financial statements of a company should always be carried out not just using one year’s data, but with data over say 5 years, so that trends which are more important than one snapshot picture at a specific point in time, can be identified.
Valuation ratios such as
- Price/Earnings ratio,
- Price/Book Value ratio,
- Price/Cash Flow ratio and
- Price/Sales ratio
are relative valuation techniques that compare the value of one stock against another in regard to how the market values the stock compared to the firm’s own numbers such as earnings, book value, cash flow and sales.
29. How do you determin the Gross Domestic Product (GDP) as a measure of economic performance?
To determine the GDP, four basic components need to be considered, namely:
i. Consumption expenditures of individuals on goods and services;
ii. Private investments in capital goods
iii. Government spending that includes both investment and consumption services.
iv. Net exports i.e. total exports less total imports.
Market observers also use other economic indicators to assess their impact on the financial markets. These include the following, other than the GDP:
- Unemployment Rate
- Consumer Price Index
- Foreign Exchange Reserves
- Trade Account
- Manufacturing Purchasing Managers Index (PMI)