TOPIC 6- OTHER TYPES OF INVESTMENTS

6.1 Warrants

A warrant is an option to purchase within a specified time period , a stated number of shares at a specified price.

The important differences between options (calls) and warrants.

i. Warrants are issued by corporations whereas puts and calls are created by investors.
ii. Warrants typically have maturities of at least several years whereas calls expire within 9 months.
iii. Warrant terms are not standardized. Each warrant is unique.

The characteristics of warrants:-

• Provides the owner with an exercisable option on the underlying common shares.
• The warrant holder receives no dividends and has no voting rights.
• All conditions of a warrant are specified at issuance.
• Warrants often provide a one-to-one ratio in conversion.
• Exercise price as per share amount to be paid by the warrant holder on exercise which is specified at issuance.
• The exercise price always exceeds the market price of the stock at te time the warrant is issued.

The determinants of the premium of a warrant

i. The larger the remaining life of a warrant, the more valuable it is. Most Investors are well advised not to purchase a warrant with less than 3 years remaining to maturity.
ii. Price volatility of the common share. The more volatile the price of the underlying share, the more likely the warrant is to appreciate during a given time period.
iii. The dividend on the underlying common share. Inverse relationship exist between the warrant premium and the expected dividend on the share.
iv. The potential leverage of the warrant. Warrant prices rise/decline faster in percentage term than the price of the share.



6.2 Preference Shares

Preference share is an equity security with an intermediate claim on a firm’s assets and earnings. It is a hybrid security because it resembles both fixed-income and equity instruments. It is more income oriented than capital gains-oriented.


Different types of preference shares :-

i. Cumulative preference shares.
Unpaid dividends may accumulate as dividends in arrears before any dividends can be paid to the ordinary share holders.

ii. Redeemable or callable preference shares.
It can be redeemed or recalled by the company. The investors will receive a pre-determined sum of money, usually includes any unpaid dividends.

iii. Convertible preference shares.
It gives the holder the privilege to convert it into ordinary shares at specified prices. It gives advantage to the share holder when the market price of ordinary shares increases.

iv. Participating preference shares.
It gives its owner the right to share both the fixed dividend and earnings of the company after all senior securities have been paid.


The main characteristics:-

i. Limited ownership rights.
i.e no voting rights.

ii. Fixed dividend
Annual dividend payments are fixed at a certain percentage of the par value of the shares.

iii. Dividend priority over ordinary shares.
Fixed dividends are paid before dividends are paid to ordinary shareholders.

iv. Priority in asset claims.
Referred as senior securities. In the case of the liquidation of the company preference shareholders have a prior claim on the company’s assets over the ordinary shareholders.



6.3 Futures Markets

Futures markets are organized and standardized forward market. It serves a valuable economic purpose by allowing hedgers to shift price risks to speculators.

Futures Contracts:-

Futures Contracts are standardized, transferable agreements providing for the deferred delivery of either a specified grade and quantity of a designated commodity within a specified geographical area or of a financial instrument (or its cash value).

It is a commitment to buy or sell at a specified future settlement date a designated amount of a commodity or asset.

The futures price at which this exchange will occur at contract maturity is determined today. Futures contract are not securities. The commitments that have been made by the buyers and sellers are binding. Futures contract are legal contracts. The buyer and seller can avoid them by taking an opposite position in the same commodity or financial instrument for the same futures month.

Short Position (seller)

An agreement to sell an asset at a specified future date at a specified price. It commits a trader to deliver an item at contract maturity.

Long Position (buyer)

An agreement to purchase an asset at a specified future date at a specified price. It commits a trader to purchase an item at contract maturity.

Futures contract can be settled by delivery or offset. Delivery or settlement of the contract occurs in months that are designated by the various exchanges for each of the item traded. It occurs in less than 2% of all transactions.

Offset is a typical method of settling contract. It is a liquidation of a futures position by an off setting transaction. It means buyer sell their positions and sellers buy their positions. The investor does the reverse of what was done originally to eliminate a futures market position.

If a futures contract is not offset, it must be closed out by delivery.


The users of futures contract :-

a) Hedgers
Buy or sell futures contracts in order to offset the risk in a cash position.

How to hedge :_

i. The short (sell) hedge

A cash market inventory holder must sell (short) the futures to protect the value of their assets. Investors are holding the securities, they are long in cash position and need to protect themselves against a decline in prices.

ii. The long (buy) hedge

An investor who currently holds no cash inventory (holds no commodities or financial instruments) is short in the cash market. Therefore to hedge requires a long futures position. By establishing a long position today, the investor makes a commitment to buy in the futures at a price determined today.

b) Speculators

Speculators buy or sell futures contracts in an attempt to earn a return. They are willing to assume the risk of price fluctuations, hoping to profit from them. They contribute to the liquidity of the market and reduce the variability in prices over time.

Cash market

It is a typical trading for physical commodities and financial instruments. A cash contract means calls for immediate delivery and is used by those who need a commodity now. A cash contract cannot be canceled unless both parties agree.

Spot market is a market where current market price of an item available for immediate delivery.

Forward market is a market for deferred delivery.

Forward price is the price of an item for deferred delivery.


6.4 Options

Options represent claims on an underlying common shares, created by investors and sold to other investors. It gives the right to the holder to buy or sell shares within a specified period at a specified price.

The corporation involves in the underlying shares has no direct interest in the transaction and also has no responsible for the creation , termination or execution of the contracts.

Types of option :-

i. Call option
An option to buy a specified number of shares at a stated price within a specified period of months.

ii. Put option
An option to sell a specified number of shares at a stated price within a specified period of months.

Investors purchase calls if they expect the share price to rise. Therefore calls permit investors to speculate on a rise in the price of the underlying share without buying the share itself.

Investors purchase puts if they expect the share price to fall. Therefore puts allow investors to speculate on a decline in the share price without selling the share short.

Why do investors buy options:-

i. In the case of calls, an investor can control (for a short period) a claim on the underlying common share for a much smaller investment than required to buy the share itself.
In the case of puts, an investor can duplicate a short sale without a margin account.
ii. The buyer’s maximum loss is known in advance.
iii. Options provide leverage. i.e magnified gains in relation to buying the share.
iv. Options can reduce total portfolio transaction costs.

Terminology:-

1. Exercise (strike ) Price
The per share price at which the common share may be purchased from or sold to a writer.

2. Expiration Date
The last date at which an option can be exercised.
3. Option Premium
The price paid by the option buyer to the seller of the option.

How options work

The buyer and the seller have opposite expectations about the likely performance of the underlying share and therefore the option itself.

The call writer expects the price of the share to move down. The call buyer expects the price of the share to move up.

The put writer expects the price to move up. The put buyer expects the price to move down.

The styles of the options

i. American Style
The option can be exercised any time before the expiration date.

ii. European Style
The option can only be exercised on the expiration date.


Relationship between the exercise price of the option and the current stock price

Exercise price – E
Current stock price – S

For a call option ; If :-

S > E – The option is in the money.
S < E – The option is out of the money

E slightly greater than S – the option is near the money.

S= E the option is at the money.

For a put option; If :-

S < E – The option is in the money.
S > E – The option is out of the money

S slightly greater than E – the option is near the money.

S= E the option is at the money

6.5 Black-Scholes Model

It was developed by Fischer Black and Myron Scholes for valuation of call options.It is widely accepted and used in the investment community.

It uses 5 variables to value the call option of a nondividend-paying stock:-

i. The price of the underlying stock.
ii. The exercise price of the option .
iii. The time remaining to the expiration of the stock.
iv. The interest rate.
v. The variability of the underlying stock price.

Definisi (DBP):-

Model Opsyen Black-Scholes – Model untuk menentukan harga opsyen yang memberikan kadar pulangan tanpa risiko kepada pelabur yang menggunakan opsyen untuk mewujudkan kedudukan terlindung nilai bebas risiko.

Model Harga Opsyen Binomial – Model penilaian harga opsyen ala Amerika atau ala Eropah yang mendapati bahawa nilai opsyen yang diperlukan untuk mendapatkan pulangan tanpa risiko kepada kedudukan perlindungan ialah dengan mengandaikan bahawa terdapat dua pulangan yang mungkin bagi setiap tempoh.