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C38Fm Financial Markets Theory Tutorial Problem Set 1

Jim bought 1000 shares in AllLife Insurance for £5,000 a year ago. He recently received a £400 dividend, an 8% return. However, shares now trade for £4 due to a scandal. Jim says the investment is still successful as he won't sell at a low price and shares fluctuate. Gary argues the scandal impacts fundamentals and it has been an unsuccessful investment. While Jim received a good dividend, the share price decline from £5 to £4 represents an unrealized loss, so both perspectives have merit depending on the time horizon and whether the price recovers.

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Xiang Chin NG
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106 views

C38Fm Financial Markets Theory Tutorial Problem Set 1

Jim bought 1000 shares in AllLife Insurance for £5,000 a year ago. He recently received a £400 dividend, an 8% return. However, shares now trade for £4 due to a scandal. Jim says the investment is still successful as he won't sell at a low price and shares fluctuate. Gary argues the scandal impacts fundamentals and it has been an unsuccessful investment. While Jim received a good dividend, the share price decline from £5 to £4 represents an unrealized loss, so both perspectives have merit depending on the time horizon and whether the price recovers.

Uploaded by

Xiang Chin NG
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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C38FM FINANCIAL MARKETS THEORY

TUTORIAL PROBLEM SET 1

1. What is the difference between a real and a financial asset?

 Real assets (physical, tangible asset, can be consumed) determine the productive
capacity and net income of the economy. For example: land, buildings, machines,
knowledge used to produce goods and services.
 Financial asset is a claim on real assets. (cannot be consumed, can get any benefits
by consuming asset, shareholder entitled to received dividend)

2. Do we need capital markets? What roles do they perform?

Yes. Capital market is a centralised market for bringing together in which funds are
transferred from people who have an excess of available funds to people who have a
shortage of funds.
 For investing excess funds in capital market for future investment.
 capital market is the place which for raising capital.
 Through selling government bonds for raising capital, therefore government be able to
 allocate and transfer risk to delay our consumption. Without capital market, we have
surplus capital and cannot be able to generate more capital. Allocate cash for better
consumption in future.

3. Describe the process of asset transformation as performed by financial


intermediaries.

Household save their money in the bank and the bank take some portion of their money to
invest, to buy bonds and others.

 Three aspect: size (transforming small size to large size entity by providing loans),
maturity (bank transformed short term asset into long term asset by giving loans and
interest -deposit in bank), risk (bank collected deposit money-asset for transferring low
risk to high risk because it
 discuss about How bank transformed asset in three aspect.

4. What is the difference between debt and equity?

 debt (liability) (e.g debenture)


 equity (share of equity)
 e.g. preferred stock (mix featured of debt and equity)
Total asset (finance by liability and equity which is called as equity financing) =
liability + equity
 Difference:
Equityinterest payment (fixed, periodic, compulsory that firms has to pay interest to
bank.
Liability pay dividends (but not compulsory for giving to shareholders)
shareholders own company and has the voting rights to vote for determing the future of
company but bank does not have right for deciding the future of company.
C38FM FINANCIAL MARKETS THEORY
TUTORIAL PROBLEM SET 1

5. Why, for the same share at the same point in time, is the price available to an
investor wanting to sell a share different from the price at which they can buy it?

 Bit price (buying price, the price which buyer willing to pay)

 Ask price (the buyer willing to sell)

If buyer bit at £ 10, buyer just wait it another buyer willing to sell at £10. If buyer insist to
buy at £11 which is called participants price.

Factors determine bit and ask price:

 if stock are liquid (convert asset into cash by without losing little money) (if buyer
don’t want to wait at £10 then £10.5 is fine), the spread are very narrow.

 if the price is volatile, the spread is larger.

 Demands and supply determine price but not really affecting the spread increasing or
decreasing)

 Information Asymmetry: Different content/information/interpretation from buyer and


seller will lead to spread become larger. Price reflects to information.

 Competition in market capital, spread become narrow. (e.g maxis, digi, ppl can enjoy
better price)
C38FM FINANCIAL MARKETS THEORY
TUTORIAL PROBLEM SET 1

6. Jim Brown bought 1000 shares in AllLife Insurance a year ago at a price of 500p each.
Jim has just received a dividend of 40p on each share. He is very pleased at this 8% return
on his investment – much more than most shares have been paying, Jim points out.

Jim’s friend, Gary, points out that AllLife Insurance has been at the centre of a scandal
since Jim bought the shares. It missold a lot of personal pensions and is going to have to
pay compensation to policyholders who were the victims of its poor advice. The shares
now have a price of 400p. ‘It has been an unsuccessful investment’ says Gary.‘Not at all’
says Jim. ‘The only share price that matters to me is the price at which I eventually sell
the shares. And I am certainly not going to sell when the price is depressed as it is today. I
would not accept that there is anything unsuccessful about my investment. All shares
have their ups and downs. They don’t matter to a long-term investor like me.’

Who is right, Jim or Gary?

- From £5 drop to £4 -unrealised loss


- Jim argued that the profit or loss can only be determined at the time he is selling at
specific price.
- Depends at which price he is selling.

Jim
- The stock is paying dividend and as long-term investor, he will view this scandal to
last for short-term.
- In long term, the price might go up
- Since Jim received dividend of £400 and he can used it to buy additional shares (100
new shares @ 400p per share)
- Averaging purchase price – using dividend to buy new shares will pull down the price
of purchase (strategy to suppress initial purchase price)
- *(Jim is kind of a confirmation buyers – people are finding information to support his
belief regardless of negative news).

Gary
- The scandals affect the fundamental of the company and the impact could be in long-
term.
- In this case, Jim may be considered to sell the stock.

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