Mutual Funds

1.      Mutual Funds

According to www.investopedia.com mutual fund is an investment where different investors pool together their money and hire a manager who will be keeping the portfolio of their investment once they have been invested as bonds, shares or securities.

There are different types of Mutual funds such as :-

Open ended mutual fund, this is where share are issued in or sold back to the fund whenever they are wanted by anyone.

Close ended mutual fund, this is when there is a limit of certain number of shares which can be issue to a particular fund and these number of shares can be sold back only when the fund terminates itself, however this type of mutual fund can sold to other investors through secondary share market.

Equity mutual fund, this is where the mutual fund company invest more than 50% of the total fund in to stock market by either buying shares or stocks. 

Bond fund, this is where the mutual fund company invest the fund in to a range of debt instrument such as municipal bond, corporate bond and convertible bonds.

Money market funds, this is where the mutual fund company invest the fund for the purpose of earning the investors interest from their investments by investing in banks or by purchasing treasury bills.

No loan mutual fund, this is where no fee or commission is charged when buying or redeeming the shares of the mutual funds.

Structured fund, this is when a company invest in a bond which has both combination of fixed income products and equity product in order to give investors the advantage of capital protection and appreciation.

Exchange traded fund, this is an investment vehicles which consist of assets or number of securities and traded in a stock exchange market like normal stocks.

S & P 500 fund, this represents the most widely cited equity benchmark in the United States of America. Investors are advised to follow certain steps when choosing mutual funds since they can invest in mutual funds for at least $100 without any trading cost. First, they should try to avoid sales charge which incurred during buying or selling of the fund since this will reduce their return on investment. Second, they should look for investment with low expense ratio since these ratios represents the annual fees charged on mutual funds and if possible they should look for investment with expense ratio with percentage less than one percent. Third, they should look for investment with low turnover since the longer the fund is held by mutual fund, the lower trading and hence low turnover. Turnover of 50% or less is advised. Next, investors should look for investment with consistency in their returns year after year. Next, investors should look for mutual fund manager who has the longevity with the fund and the company. Last but not least, investors should ask experts such as financial planners, mutual funds companies and investment advisors. Lastly, investors should review regularly the investment by setting up a regular review schedule for the purpose of checking the performance of the fund if it is consistent with the investor’s level of investment risk and investment objectives. Some of the companies/ institutions dealing with mutual funds are LIC Mutual fund, principal mutual fund, HDFC mutual fund, Birla Sun Life mutual fund, Franklin Templeton Investments, SWIP UK equity funds, AXA investment managers and Jupiter growth Funds.

Financial management- CAPM

Qns:

Discuss the problems that may be encountered in applying the CAPM in investment appraisal.

Ans:

Problems that could have been discussed in connection with applying the CAPM in investment appraisal include:

Ø  Determining the excess market return

Ø  Determining the risk-free rate of return

Ø  Estimation of the equity and overall betas of a company

Ø  Determination of the beta for a project

Ø  The CAPM is a single-period model

Ø  The CAPM is an ex-ante model

Ø  National surrogates for market return may be intentionally inappropriate

Royal Bank of Scotland pays £375m to 323 key staff

The bank announced that it paid a total of £375m to 323 people designated as "code" or key staff.
RBS, 83%-owned by the taxpayer after a government bail-out in 2008, made a £1.67bn loss in 2010, after losses of £3.6bn in 2009 and £35bn in 2008.
RBS has already disclosed that chief executive Stephen Hester received a pay package worth £7.7m for 2010.

Mr Hester said in the bank's annual report that its recovery was "ahead of schedule", highlighting the fact that the bank had returned to operating profit. Before restructuring costs, strategic disposals, bonus tax, fair value changes and a host of other exclusions, this operating profit came in at £1.9bn.
"We have much work still to do and there are significant obstacles still to overcome," Mr Hester warned.
Pay restraint?

The BBC's business editor, Robert Peston, points out that the "code" staff, as defined under rules set by the Financial Services Authority, earned, on average, £1.2m each.

• Robert Peston's latest blog

They are those executives who are perceived to do things that have a bearing on the risks that banks takes.

However, he adds that this definition excludes other RBS staff, such as traders, who earned even more than this. "For what it's worth, RBS's code staff earn less than Barclays' code staff, whose average pay was £2.4m per head," our business editor adds. "So presumably the chancellor of the exchequer will point to this disparity as proof that taxpayer-owned RBS is showing restraint."

Although the RBS pay undercut Barclays' figure, it was higher than that of HSBC, which said it paid 280 staff an average of just over £1m each. Banks have been releasing this information in accordance with new EU rules on disclosure of remuneration.  Publication of the figures also follows the banking sector's Project Merlin agreement with the UK government, aimed at curbing high pay and boosting bank lending.


Source: http://www.bbc.co.uk/news/business-12778142

Financial Management- Capital structure

What is gearing?

•          The mixture of debt finance relative to equity finance that a company uses to finance its business operations

•          Gearing ratios assess financial risk:

•          Debt/equity ratio:           D/E

•          Capital gearing: D/(D+E)

•          Market values preferred to book values

•          Should D include short-term debt?

Implications of High gearing

•          Increased volatility of equity returns arises with high gearing since interest must be paid before paying returns to shareholders.

•          Increased risk of bankruptcy also occurs.

•          Stock exchange credibility falls as investors learn of company’s financial position.

Short-termism moves managers’ focus away from maximisation of shareholder wealth

Optimal capital structure

Key question:

•          Does the mix of debt and equity finance used by a company affect its weighted average cost of capital?

•          Is there a mix of debt and equity that will minimise the average cost of capital?

•          Minimum cost of capital will maximise market value of company and hence maximise shareholder wealth.

Simplifying Assumptions

•          No taxes exist.

•          Financing choice is between ordinary shares and perpetual debt.

•          Capital structure changes incur no cost and entail replacing debt with equity or vice versa.

•          All earnings are paid out as dividends.

•          Business risk is constant over time.

Earnings and hence dividends are constant

Traditional approach

•          Cost of equity increases as gearing increases due to rising financial risk and, later, bankruptcy risk.

•          Cost of debts rises at high levels of gearing due to bankruptcy risk.

•          As company starts to replace expensive equity with cheaper debt, WACC falls.

•          As gearing continues to increase, cost of equity and cost of debt increase, offsetting the benefit of cheap debt.

Miller and Modigliani 1 (1^st Proposition)

•          Capital markets are assumed to be perfect.

•          No risk of bankruptcy so cost of debt curve is flat.

•          Linear increase in cost of equity due to increasing financial risk.

•          As company gears up and replaces equity with debt, benefit of cheaper debt is exactly balanced by the increasing cost of equity.

No optimal capital structure is found

Example

Assume you own 1% of B’s shares:

(1) Sell your shares for £77.27

(2) Borrow £30 to copy B’s gearing

(3) Buy 1% of A’s shares (surplus of £7.27)

•          Return on B’s shares: 11% × £77.27 = £8.50

•          Return on A’s shares: 10% × £100 = £10

•          Less interest: £30 × 5% = £1.50 leaves £8.50

•          Same return but you now have £7.27 surplus

Arbitrage proof using companies A and B:

                                                                     A                               B

Net income                                       1000                        1000     

Interest at 5%                                        Nil                       150

Earnings                                               1000                       850

Divide by cost of equity                      10%                         11%

MV of equity                                  10 000                        7 727

MV of debt                                         Nil                          3 000

Total market value                        10 000                      10 727

NB:

•          Selling will cause B’s share price to fall and buying will cause A’s share price to rise.

•          Return on B’s shares will rise and return on A’s shares will fall.

•          WACC of A (10%) will fall and WACC of B (9.3%) will rise, and WACCs will converge until any arbitrage opportunity is eliminated.

•          The claim that identical business risk will have an identical WACC is shown to be true.

Miller and Modigliani II (2^nd Proposition)

•          M&M adjusted their first model to reflect the tax deductibility of interest payments.

•          Tax efficiency implies that gearing up by replacing equity with debt gives benefit of a tax shield, increasing the value of company.

•          Cost of debt curve falls from before-tax to after-tax level, so WACC curve slopes downwards.

This implies an optimal capital structure does exist: i.e. gear up with as much debt as possible

Market Imperfection

•          M&M relaxed assumption of perfect capital market by considering corporate taxation.

•          If we relax perfect market assumption further by considering bankruptcy risk, an optimal capital structure emerges.

•          Companies have to balance the tax efficiency of debt with the risk of bankruptcy.

Conclusions:

•          Traditional approach: Optimal Capital Structure (OCS) exists

•          Miller and Modigliani I: no OCS is found

•          Miller and Modigliani II: OCS is 100% debt

•          Market imperfections: OCS exists

In practice, rather than one optimal capital structure existing for each firm, a range of optimal capital structures may exist.

BP set to pay first dividend since Gulf oil disaster

 Bob Dudley, BP 's chief executive, is set to announce a resumption of dividend payments on Tuesday as a signal to investors that the UK oil group is recovering after last year's Gulf of Mexico spill .

BP was one of the biggest dividend payers in the UK before the accident, distributing about £7bn to investors in 2009. It suspended the pay -out for the first three-quarters of last year as part of a series of steps to stabilise its financial position in the wake of the mounting costs from the oil spill on April 20 2010 . Any pay -out, however, will be at about half the previous level with analysts expecting the fourth quarter dividend to be 7 cents a share.

The reinstatement will be a key element of Mr Dudley's inaugural presentation to the investment community alongside BP 's full-year results and an update on strategy. The company's profits will have been buoyed by strong oil and natural gas prices, with analysts forecasting clean replacement cost profit, which strips out changes in the value of oil inventories and exceptional charges, of $4.9bn for the fourth quarter, up 11 per cent on the same period in 2009.

Mr Dudley is expected to give an update on the cost of the accident to BP . It has so far made provisions of $39.9bn but still faces a number of claims and potential lawsuits. It has raised about $21bn (£13.2bn) from disposals, close to its $30bn target set after the spill to help pay for claims.

The market will be keen to hear how Mr Dudley sees BP 's future in the US, which before the accident had been its principal strategic focus. Analysts said they did not expect a radical departure from BP 's current strategy but more emphasis on how it will be a smaller, faster-growing company with an increased focus on exploration and production. Jon Rigby, analyst at UBS, said he believed "the core business contains one of the most attractive asset portfolios in the integrated industry".

Investors are also keen to hear more about BP 's alliance with Russian state oil company Rosneft. BP 's billionaire partners in its other Russian venture, TNK- BP , have claimed the UK group has breached the conditions of their shareholder agreement.

One person close to the situation said the partners, represented by AAR, believed BP may have failed to disclose to the Russian government and to Rosneft the terms of its shareholder agreement with AAR for TNK- BP . "There is a question about how forthcoming BP has been with [Igor] Sechin [the Russian deputy prime minister] about their obligations over TNK- BP ," the person said.

Speaking at the World Economic Forum in Davos on Thursday, Mr Sechin, who also chairs Rosneft, said BP had assured Rosneft there were no problems with its contract with AAR.

Additional reporting by Catherine Belton in Moscow

Source: Financial Times(UK)