BRING DIVERSITY INTO PLAY

A: There are two main types of investments: fixed income (e.g. bonds) and equities (stocks). Fixed income is generally an investment, which has some form of guarantee as to your rate of return and the length of time one is invested. The risk associated with this product is usually lower than stocks. Equity, shares or stock is part ownership of a company, where share price movement determines your rate of return; some companies may also pay a dividend but are not obligated to do so.

From these main types spawn an almost infinite number of investment vehicles in which one can invest. The oldest and most marketed product is the mutual fund. This is a product that gives small investors exposure to a well-diversified portfolio of stocks, bonds and other financial products. It is a good tool for a new investor to limit his/her downside risk. One of the latest developments within the financial world are "options."

An option is a contract sold by one party to another, giving the holder the right to buy (call option) or sell (put option) an asset at a pre-determined price (strike/exercise price) on a pre-determined date. Options come in many forms and for many asset classes. There is a lot of risk associated with them and are only recommended for very sophisticated investors.

One should note there are many types of financial investments, too much to answer in one forum. They however are all related or fall under one of the two main categories and all have some form of risk associated with them. The management of these risks is what will determine the outcome of one’s investments.

Q: I often hear people talk of a stock as a good buy because it is trading at a low P/E.

What is the P/E ratio?

A: The price to earnings ratio or "P/E" or earnings multiple is simply the price at which the share or industry is trading (the market price) divided by the earnings per share or EPS. This ratio is a valuation method used by market participants to determine whether a share is under-valued, fairly valued or over-valued. One would base their valuation decision on three main factors: the P/E of the industry in which the company operates, the earnings multiple of its competitors and one’s outlook for earnings growth.

Based on the EPS used and the time period, one can have many P/E ratios. The main types are the running P/E, the last audited or historic P/E, and the forward P/E. The running P/E is the current price divided by the cumulative EPS for the last four reporting periods. The last audited or historic P/E is the current price divided by the EPS reported on the last audited financials or fiscal year end EPS. The forward P/E is current price divided by the projected or forecasted EPS, this tends to be the most important as equity investing is about predictions and expectations.

Q: What is the difference between a bond and a loan?

A: Technically speaking a bond is a loan made by the public (or lender) to some entity (the issuer) that being a corporation, an institution or a government, for a specified time period and at a stated rate of return or coupon rate. Similar to the way a bank or lending institution gains a rate of return by taking the risks with an individual or company when extending a loan facility, the investor obtains a rate of return by taking the risk of buying a bond.

There in lies the biggest difference between the two instruments. The lending institution undertakes all the risks associated with the loan, whereas the risks surrounding the bond are generally spread over a number of entities. Thus giving rise to the secondary bond market, a vehicle by which investors can now price, transfer and/or dispose of these risks based on market expectations. The other differences between the two are mainly the terms one uses to describe the details of the issue.

For a loan, there is the interest rate and the length of time one is given to repay the loan. For a bond the interest rate is termed the coupon rate, or simply coupon. It is paid to the investors or a timely basis or accumulated to the end, as is the case with specific bond issues. Bonds generally have a maturity date, which implies the length of time to repayment.

All advice offered here by Republic Securities Limited is of a general nature and is intended for guidance only. It is offered without any legal responsibility. You should always consult a financial adviser either at Republic Securities or elsewhere before making any investment decision.

If you have an investment question you would like to put to Republic Securities then send us an email at rslinfo@republictt.com . We cannot guarantee an answer to any question, but a selection will be put to our team of Investment Advisors to answer accordingly.