1

Introduction to
Investment
Bruce Viney
Director of Training and Client Services
http://www.sqa.org.uk/files_ccc/
Training_Presentation.PPT
2
Why we are here.
Exam (syllabus valid from 1 October 2006)
60 minutes
50 Questions
Multiple choice
Pass mark is 70%
3
Programme/Syllabus
Workbook
Chapter
Content Questions
in exam*
1 Financial Services in the UK 8
2 Asset Classes 13
3 Derivatives 2
4 Financial Products 6
5 Pooled Funds 9
6 Investment Wrappers 2
7 Financial Services Regulation 8
8 Taxation 2
Total 50
* plus/minus 2
4
Introduction
CHAPTER 1
The Role of the Financial Markets
Financial Institutions
Londons Markets
The Bank of England
The UK Economy
The Role of Financial Markets
Savers
Borrowers
Companies
Governments
Surplus capital,
looking for a return
Need capital
The Role of Financial Markets
Savers
Borrowers
Companies
Governments
Capital Markets Money Markets
BANKS
Financial Markets
SHARE
MARKETS
BOND
MARKETS
7
Financial Market stages
onward trading of
shares at market
price
Company
issue
shares
at
2.20 each
PRIMARY
MARKET
SECONDARY
MARKET
8
Financial Institutions
Retail banks and building societies
Investment banks
Pension funds
Insurance companies
Fund managers
Stockbrokers
Custodians
Credit card companies

Londons Markets
Soft commodities
Financial futures
Traded Options
Non-ferrous
Non-precious
Brent crude
Gas oil
Natural gas
UK equities and corporate bonds
Gilts
Overseas equities and bonds
Insurance market
10



Date Event
1773 Brokers create The Stock Exchange
1986 Big Bang - major reforms
1995 Tradepoint starts in competition with LSE
1997 SETS - electronic order book
2001 Listed as a quoted company





London Stock Exchange
Policy 60m
Synd A 20m
The Lloyds Market
Syndicate
Clients
Broker
Members
15m
15m
10m
Syndicate
Syndicate
Syndicate
12
World Securities Markets
NYSE
Nasdaq
Euronext
Japan
Deutsche Borse
13
Economics
Categorising Economies
Gross Domestic Product
Gross National Product
Balance of Payments
Inflation
PSNCR
Market
Mixed
Open
State controlled
14
Gross Domestic Product
Market value of goods and services
produced in a country
Measure of the level of economic
activity
Three ways of representing:
Total GDP
GDP per head (per capita)
GDP growth
15
Gross National Product
GNP for the UK is the GDP:
Plus interest, profits, and dividends
received from abroad by UK residents
Less income earned in the UK by overseas
residents
Balance of Payments
Measures the difference between money flowing into
and out of the country
Imports Exports
visible
invisible invisible
visible
C
u
r
r
e
n
t

a
c
c
o
u
n
t

17
Inflation
What is it?
Problems caused by inflation
Measurement
headline RPI
underlying RPIX
harmonised HICP
Caused by an increase in the money
supply?
What is money?
Bank of England
Three core purposes:
maintain integrity and value of the currency
maintain stability of financial system
seek to ensure the effectiveness of the UKs financial
sector
Intervenes in the forex market (in accordance with
govt policy)
Bank for
Commercial banks
Government
Sets interest rates through the Monetary Policy
Committee (MPC)

Interest Rates
Short term interest rates are set by the MPC
MPC are to use interest rates to meet a set inflation target
(currently 2.5%)
Interest rates are changed as a result of Bank of
Englands dealings with banks
customer
bank
Bank of England
bank bank
%
%
%
%
% %
MPC control this rate
LIBOR
Government Borrowing
Government income from taxation
Government expenditure
Difference is called:

Public sector net cash requirement (PSNCR)
21
Foreign Exchange
Market in currencies
No central market
London is the largest centre
Dominated by banks
Types of contract
spot
forward
22
Companies, Capital and Asset
Classes
CHAPTER 2
Equities
Corporate actions
LSE trading and settlement
Bonds
Money market instruments
Company administration

23
Security
General term for any type of financial instrument (usually)
traded on an investment exchange.
Bonds
Equities
Part ownership = shares Debt in the form of IOUs
In the UK, capital market securities are generally held in
registered form whilst money market instruments are
issued in bearer form
Equity types
Equity
type
Voting rights Dividend
Ordinary
Preference
The two main equity types in the UK are ordinary and
preference shares
Preference shares have preference over ordinary
shares in terms of:
Dividend payment
Repayment on winding up
Variable, not guaranteed
Fixed, not guaranteed
(can be cumulative)
Yes
No
25
Why own shares?
Voting
Income dividends
Capital growth
Trade perks
Risks
Price
Liquidity
Issuer
26
Corporate Actions
Types of action
mandatory
voluntary
mandatory with options
Examples
bonus issue (to increase the liquidity of shares)
dividend (to distribute profits)
takeover offer (to acquire the shares)
rights issue (to raise funds)

27
Rights Issues
Company raising additional finance
new shares are issued
existing shareholders can buy them first
(pre-emptive rights)
Upon receipt of a rights letter a shareholder
has to decide upon their course of action
Calculating the ex price
A company announces a 1:5 rights issue at 3.50.
If the cum market price of the underlying shares is 4.00,
what is the theoretical ex price of the shares?
Before
Rights
After
Number
of shares
Price per
share
Total
value
5
1
6
4.00
3.92
3.50
20.00
3.50
23.50
23.50
6
How much is the right to buy a share worth?
29
Bonus Issues
Free shares
The effect on share price?
Why would a company do it?

Calculating the ex price
There is a 1:1 bonus issue.
The market price of the shares before the capitalisation is
12.00.
What is the theoretical ex price of the shares?
Before
Scrip
After
Number
of shares
Price per
share
Total
value
1
1
2
12.00
6.00
0.00
12.00
0.00
12.00
12
2
31
Cash dividends
What is a dividend
Payment/distribution to shareholders from
realised profits
Interim and final dividend
Timetable

Feb
Dividend
announced
Wed 8
March
Ex-dividend
day
Fri 10
March
Record
Day
(Books closed day)
Dividend
Payment date
Fri 10
May
ex div cum div
AGM
Tues 7
May
Listing on the Stock Exchange
The main advantages are:
Takeovers using shares to fund the acquisition of other cos
Employees stock options can be used to retain key staff
Capital - access to a large pool of capital
The main disadvantages are:
Short termism impatience and emphasis on short term goals
Regulations disclosure requirements are more stringent
Status/prestige assist companys trading prospects
Threat of takeover anyone can become a part owner
Listing
Full list Alternative
Investment
Market
Trading history Minimum 3
years
No minimum
Market
capitalisation
Minimum
700,000
No minimum
Public holding At least 25% No minimum
34
Indices
Indices enable investors to:
measure performance of a market
use as a benchmark to judge actively managed
portfolios
trade futures and options based on them
The main indices on LSE equities are:
FTSE 100
FTSE 250
FTSE Actuaries 350
FTSE All Share Index


FTSE Indices
1
100
350
c900
FTSE 100
FTSE 250
FTSE Small Cap
FTSE All Share
36
World Markets
Securities

New York
NASDAQ
London
Euronext (Paris)
Tokyo
Deutsche Borse
Hong Kong


Indices
Dow Jones
S&P 500
NASDAQ Composite
Nikkei 225
CAC 40
Xetra DAX
Hang Seng
37
Broker
Broker
Buyer
Seller
Order driven
Buyer
Seller
Broker
Broker
Market Maker
Quote driven
Domestic Equity Market
38
Domestic Equity Market
SETS
FTSE 100; FTSE 100 reserve stocks; stocks removed from FTSE
100.
SETSmm
FTSE 250 shares not on SETS, order book plus one or more
market makers
SEAQ
fully listed shares, not on SETS or SETSmm, with two or more
market makers
AIM shares with two or more market makers
39
SETS
Buy & sell orders displayed (price/time priority)
Standard settlement
Visible to all but only member firms can input and
delete orders
40
41
SEAQ
Market makers show prices and sizes
Two way prices (bid, offer, spread)
Touch strip

42
43
Equity Settlement
Broker
Market
Maker

shares
Settlement
Trade
Buy me 1000 PJC
plc shares
Contract Note
44
CREST is an electronic settlement system
Mainly settles UK equities, corporate loan
stock and gilts
Dematerialised/uncertificated settlement
45
Member
Crest Structure
Investors
Companies
Bank
Registrar
Regulators
Revenue(s)
46
Bonds
A bond is a tradeable loan
Issuer promises to:
repay the loan at a future date (on
maturity)
pay interest at a defined rate (usually fixed)
Issuer might be the British government
bonds are called gilt edged securities
Issuer might be a company

47
Corporate Bonds
Domestic Foreign Eurobond
Issued by home
company to home
investors in home
currency
Issued by overseas
company to home
investors in home
currency
Issued to many
investors in any
currency
international issues
48
Other bonds - features

Zero Coupon Bonds
Convertibles

Gilts
Interest (coupon)
gross annual interest on the nominal value (100)
paid semi annually
Repayment (redemption)
Classification by DMO
Short Less than 7 years
Medium 7-15 years
Long More than 15 years
Issue by DMO
bid basis (auction to those on an Approved List)
individuals may submit non-competitive bids (up to 500,000)
Secondary Market
GEMMS or DMO/Computershare service
50
Yields
Flat Yield


Example: Treasury 2006 6% is currently
trading at 102, calculate the flat yield
A 3.6%
B 4.9%
C 5.9%
D 6.0%




annual coupon x 100%
----------------------
market price
51
Money market instruments
Money market instruments are forms of
short term tradeable debt. The products you
need to be aware of are:
Treasury bills
Commercial paper
Certificates of Deposit



52
Treasury bills
Short term zero coupon bonds
Maturities generally after 3 months
Issued weekly by the DMO on behalf of the
Treasury
Sold at a discount to their face value
53
Commercial paper
Short term unsecured debt
Usually zero coupon therefore issued at a discount
Usually high nominal value
A CP programme specifies a total amount that can be
issued and may have an end date
CP programme
issue limit 150m
end date 2008
Date Issue Term
Mar 2006 100m 6mth
Apr 2006 50m 3mth
Oct 2006 75m 6mth
Jan 2007 75m 3mth
54
Certificates of Deposit (CD)
Investor A
Investor B
Bank
Company types
All companies
public
(plc)
private
(ltd)
fully
listed
AIM
listed
unquoted
56
Company Administration
Company
Shareholders
Memorandum
Articles
Company Directors
Executive
Non-executive
Meeting types:
AGM
EGM
ARTICLES:
Shareholders rights
Borrowing powers
Dividends
Meetings
Directors
Winding up
MEMORANDUM:
Name of Co
Domicile
Authorised Share Capital
Statement of liability
Objects
PLC or not.
57
Derivatives
CHAPTER 3
Futures
Options
58
Futures
An agreement to buy or sell a specified
quantity of a specified asset at an
agreed price on an agreed date
Exchange traded and on standardised
terms
For example: Futures on metals, oil,
agricultural products
Motives: Hedge or Speculate
59
Futures Terminology
Long = buy a future
Short = sell a future
Open = enter into a futures position
Close = trade out of a futures position
60
Options
A contract that gives the right but not
the obligation to buy or sell a specified
quantity of an underlying asset at a
specified price within a specified period
Call option = the right to buy
Put option = the right to sell
An example of an Equity Call Option
PJC plc
1000 shares
Market price 105p
I grant you
The right to buy
1,000 PJC plc shares
From me
At a price of 100p
Within 3 months
Writer
Holder
Option Premium
Call Option (10p per share)
(100)
Options terminology
Consider an equity call option with a strike price of 100p and
premium of 10p. The underlying share is currently valued at
105p
strike 100p
Price
Time
105p
breakeven 110p
in the money
out of the money
at the money
63
Options Terminology
Call Option
Put Option
In the money
At the money
Out of the money
Breakeven

64
Financial Products
CHAPTER 4
Deposits and loans
Interest rates
Mortgages
Insurance and Pensions
National Savings and Investments
65
Deposits and loans
Deposits
Fixed term v Instant access
Interest
Gross v Net
R85 enables payment gross
Loans
Bank loans
Secured v Unsecured
Overdrafts
Authorised v Unauthorised
Credit cards
66
Interest Rates
Quoted rate v Effective rate
Steps to turn quoted into effective
1. Quoted expressed as a decimal
2. Divided by number of periods per year
3. Added to one
4. To the power of the number of periods per
year
5. Subtract one and times by 100
67
Mortgages
Secured loan on property
Mortgage types
Repayment
Interest only
Mortgage interest
Fixed
Capped
Discounted
Variable
Redemption penalties
Other types
Endowment
Pension linked
ISA
Unit linked
Flexible
68
Insurance and Pensions
Life policies
Term v Whole of life
With profit (incl unit linked) v non profit
Pensions
State
Basic v Second
Occupational
Defined benefit v defined contribution
Private/Personal
Stakeholder
69
National savings products
National Savings accounts:
Easy Access a/c (instant access)
Investment a/c (one month notice)
Premium bonds
Random prize
Other products
Fixed Interest Savings Certs
Fixed Rate Savings Bonds

Paid Gross
but taxable.
Paid Gross
But taxable
Tax free.
Paid on maturity
Tax free up to
15,000 per issue.
Taxable,
Paid net of 20%
70
Pooled Funds
CHAPTER 5
Unit Trusts
OEICs
Investment Trusts
Rationale of Collective Investment
Fund Manager
Advertise
5,000
Ive got a spare five thousand,
I think Ill invest in a UK equity fund.
Shares/units in
collective invt


72
Role of the FSA
Authorised v unauthorised
Onshore v offshore
Unit Trusts - Basics
Investors
(1,000)
Fund Manager
5,000 x 1,000
1 million units
x 500p per unit
Investments
Trustee
Investments
Markets
Makes investment decisions
Prices the units
Deals with investors
Legal owner of the trust property
Safeguards assets
Monitors the manager
Securities Funds - most common
Money Market funds
Futures and Options funds
Geared F&O
Warrant funds
Property funds
Fund of funds
Feeder Funds
Umbrella Funds
Limited issue funds
Principal protected funds
Mixed funds
Types of Unit Trust
Authorised/regulated funds

Buying more Units
Fund Manager
Trustee
Investments
FM prices Bid Offer

UK Equity 485 515

5,150
1 000 units
x 515p per unit
Another 1,000 units
created (open
ended)
Creation of more units?
Fund Manager
Trustee
Investments
10,000 units 9,000 units
Buyers Sellers
Create 1,000 units
Investments
Markets
77
How to price a unit
Prices calculated by the managers
FSA rules
prices based on net asset value at the most
recent valuation
calculate separate bid and offer prices although
single pricing is possible
maximum offer price = creation price plus initial
charge
Offer price tend to include an initial charge - around
5-6% on top of allowances for stamp duty and
brokerage

78
What is an OEIC ?
Open Ended Investment Company
Also known as an ICVC (Investment Company
with Variable Capital)
Invests money on behalf of its shareholders in
shares and bonds
79
Key elements of an OEIC
Variable capital base
Shareholders are direct owners of the company
Shares are traded at a single price (at NAV)
Authorised Corporate Director instead of Manager
Depository instead of Trustee
An OEIC is a UK company that can repurchase its own shares
on demand
Investment Trusts
Investors
Investment Trust
5,000 x 1,000
5 million 1 ord shares

Investments
Depository
Investments
Markets
Trade
Price tends to be at a discount to the
net asset value of the company. This
discount narrows in a bull market and
widens in a bear market
81
Exchange Traded Funds (ETFs)
Index tracking funds
Open ended
Structured as a company
Listed on exchanges (such as the LSEs
extraMARK)
Trade at net asset value
82
Collective investments comparison
Feature Unit Trust Invt Trust OEIC/
ICVC
ETF
Open/
closed ended
open closed open open
Legal structure/
Investment unit
Trust/
unit
Company/
share
Company/
share
Company/
share
Price based on Net asset
value
Demand and
supply
Net asset
value
Net asset
value
Bid/offer or single
price
Bid/offer Bid/offer Single price Bid/offer
Investments
purchased from
Fund manager Stock market Authorised
corporate
director
Stock market
Investments held by Trustee Authorised
depositary
Authorised
depositary
Custodian
83
Hedge Funds
Unregulated schemes
High investment entry levels
Flexible investment style, including
gearing
Fees are performance related
84
Investment Wrappers
CHAPTER 6
ISAs/PEPs
Child Trust Funds
85
ISAs
Designed to replace PEPs
no tax on income or capital gains
An ISA is a tax free wrapper that can be
applied to a wide range of products
Up to 2 components as follows
Cash
Stocks & Shares

ISA limits
Mini ISA
Stocks &
shares
4,000 p.a.
Cash
3,000 p.a.
Maxi ISA
Stocks &
shares
no limit
Cash 3,000 p.a
7,000 p.a
87
Child Trust Funds
For children born on or after 1 Sept 2002
Money cannot be withdrawn until child turns
18 (child can manage from 16)
Government starts CTF with 250 (500 for
lower income families)
Can add up to 1200 per annum
Savings, shares or stakeholder accounts
No tax on income or gains
88
Regulation
CHAPTER 7
FSMA 2000
Money Laundering
Insider Dealing and Market Abuse
Takeovers and Mergers
89
UK Financial Regulation
The UKs main financial regulator is the Financial
Services Authority (FSA)
The FSA operates under the Financial Services and
Markets Act 2000 (FSMA 2000)
The Act states that any person (firm) conducting
regulated activities in the UK must be authorised by the
FSA or exempt
Certain individuals within the firm must also be approved
by the FSA for their roles
The FSA have written a handbook which must be
complied with to avoid prosecution
90
The FSAs four objectives
Maintaining confidence

Promoting public awareness

Appropriate protection for consumers

Reduce scope for financial crime


91
Approved persons regime
Certain people working for an authorised person
(firm) must be approved by the FSA for their role.
The 27 separate controlled functions (jobs) that
require approval are grouped under five categories:
Governing functions (e.g. Directors)
Required control functions (e.g. MLRO)
Systems and controls functions
Significant management functions
Customer functions
92
Key statutes governing financial services
Financial Services and Markets Act 2000
Proceeds of Crime Act 2002 and ML Regs 2003
Anti-money laundering
Criminal Justice Act 1993

Money Laundering
Definition
3 stages
ML Regs 2003: Financial institution procedures :
identify new clients
record keeping
internal reporting
internal controls to prevent the firm being used for
money laundering
POCA 02 Offences:
concealing; arrangements that you know or suspect is
to acquire, retain, use/control criminal property;
acquire, use or possess criminal property; failure to
report; tipping off
Suspicion reporting process
Employee => MLRO => SOCA

Insider Dealing
If an individual who
possesses inside
information from a
primary or secondary
insider
Deals
Encourages
others to deal
Tell others the
information
95
Market abuse
Offence under FSMA 2000
Includes : Using
information not
generally available to
others
Regular user test
employed to establish
guilt or innocence
96
There are two main concerns regarding a
takeover and different regulatory bodies are
in place to address each concern:
Is the takeover anti competitive?


Are shareholders treated fairly?
Takeovers and Mergers
Competition Commission
Panel on Takeovers and Mergers
97
Takeovers and Competition
CC
The Office of Fair Trading considers
whether a proposed takeover might be anti-
competitive.
The OFT could result in the bid being
referred to the Competition Commission
The Competition Commission decides on
whether the takeover should be allowed to
proceed, any restrictions required and the
like
OFT
98
Takeovers and shareholders
The Panel on Takeovers and Mergers (POTAM or
PTM) ensures that all shareholders are treated
fairly
Their rulebook is known as the Takeover Code or
Blue Book
The rulebook principles state:
Shareholders of a target company must be treated
equally in all respects during an offer
Dont bid for a company unless you intend to, and
can afford to, go through with the bid
Directors should make decisions by considering
what is best for shareholders, not themselves
99
Takeovers key %s
30%
Effective
control
50%
Actual
control
Must make a bid for the remaining
shares in the company
0%
100%
SARs prevent the following:
(1) 10% or more
(2) Within 7 calendar days
(3) From more than one source
(4) Resultant shareholding is 15% or more
Takeover of a Listed Company
Offer
document
dispatched
28
days
Bid
announced
through
Stock Exchange
21
First
closing
39
Final
target
company
announcements
46
Final
revision
0
Final
closing
60
101
Other Regulations
Data Protection Act
8 principles especially adequate, relevant and not
excessive
Complaints
System required and Financial Ombudsman
Service can compel firms to pay up to 100,000
Compensation
Financial Services Compensation Scheme payout
maximum of 48,000
102
Taxation
CHAPTER 8
Income tax
Capital Gains Tax
Inheritance Tax
Stamp Duty
103
Taxation
Income tax

Capital gains tax

Inheritance tax
Paid on income, potentially
including investment income
Potentially payable on the
sale of an investment
Potentially payable on
investments held at death
104
Income Tax
Salary

Profits from running a business

Dividends

Interest
From an employer
Individuals or
partnerships
From companies
From banks/building societies/bonds
105
Income Tax
Income
5,035
10%
22%
40%
Personal allowance
Lower rate
Basic rate
Higher rate
2,150
33,300
33,301
106
Taxation (Income)
Tax is usually deducted at source.
salaries PAYE
savings income (interest)
basic rate of 20% is automatically deducted
dividend income
basic rate of 10% is automatically deducted
107
Taxation (CGT)
Capital Gains
Shares
Bonds (some)
Property
Antiques
Exemptions
Main home
Gilts
Cars
108
Taxation (CGT)
Allowance of 8,800 for the year
CGT only paid on gains above the allowance
Any losses can be carried forward
Paid at the investors marginal rate of 10%, 20%
or 40%
109
Inheritance Tax
A certain amount is exempt
threshold of 285,000
anything left to a spouse
anything left to a charity
items given away more than seven years before
death
IHT charged at 40%


110
Stamp Duty/SDRT/SDLT
0.5% on the purchase of shares
1% on homes >120,000
3% on homes >250,000
4% on homes >500,000
111
End of Course