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The Australian Stock Exchange Essay, Research Paper

The Australian Stock Exchange Assignment for year 11 Economics

By David Jones

Part 1

Telstra- 2272 shares @ $4.40 each = $99998.80, yield 2.5% (fully franked)

Telstra has been very strong on the market recently, as brokers have come out with increasingly positive assessments of it’s worth. Telstra is one of the few full service telecommunication companies in the world. After applying “indicative valuation parameters” to all of Telstra’s businesses, one broker told me that Telstra is undervalued relative to international peer telecommunication companies. The defensive, stable nature of Telstra’s earnings stream, combined with its pure domestic earnings focus, is considered a very attractive investment featured in the context of a deteriorating domestic economic environment, continued turmoil in Asia and a global non-inflationary environment. Taking into account that Telstra share prices have doubled in the last 6 months, being one of the two largest profit making companies in Australia (the other being National Australia Bank), I believe my prediction of Telstra shares quadrupling over the next 5 years is very minimal.

National Australia Bank- 4464 shares @ $22.40 each = $99993.60, yield 4.6% (fully franked)

In a special report, “The Emerging Global Player”, it recommends NAB as a strong long term outperformer. One broker I spoke to says NAB holds the most robust positioning of Australian banks to respond to global changes in the provision of financial services. Its recent alliance with BancOne in the United states signals that NAB is emerging as a global player. NAB’s current price is based on the Australian market. But as it becomes more global, I expect it to be re-rated towards global pricing multiples. Over the past decade NAB has successfully expanded overseas. It has targeted regional retail banking in countries with cultures and regulatory environments similar to Australia’s. Offshore businesses now represent 50% of NAB’s asset base and contribute 46% of profit. The recent weakness of the Australian Dollar has demonstrated one positive impact of the diversification. NAB’s two latest acquisitions (country investment management in Australia and Homeside in the United States) have given NAB a broadening of it’s scope. They reflect the move wider financial services, now one of the driving stratergies of most banks and insurers. All of the above have shown the impressive performance of NAB and I believe NAB will continue to pull desirable figures. NAB is one of the two largest profit making companies in Australia (the other being Telstra) and with future expansion and with the experience it is now receiving from overseas, I expect the price of $22.40 to double.

Australian Gas Light Company- 4587 shares @ $10.90 each = $49998.30, yield 3.4% (fully franked)

AGL’s share price has fallen from $11.78 since the release in may by the Australian Consumer and Competition Commission and the Victorian Office of the Regulator general of draft decisions on access arrangements for natural gas transmission pipelines and distribution networks in Victoria from 2001. The report concludes that the current rate of return for Australian gas and electricity utilities is too high. The environment of low interest rates and inflation suggests that future real pre-tax rates of return, currently regulated at 10.9%, should be lowered to 7%. Although they have no immediate impact on AGL’s gas distribution business in New South Wales, or the electricity distribution in Victoria, the rulings do provide a guide as to how tariffs are likely to be determined under the National Access Code. Despite not taking effect for some time, and the NSW regulator using different pricing formulae, the reports implications have had their effect on market valuations of utilities. I believe that AGL’s successful diversification from it’s traditional NSW gas and nationwide transmission businesses into Victoria, together with the recent completion of the Bellara-Mount Isa gas line, the start up of the Roma-Brisbane line, and a possible PNG-Queensland line, all combine to strengthen the group by increasing the levels of gas throughput and enlarging the number of energy customers. Greater competition from a deregulated market provides further opportunities as gas prices fall, demand increases, volume rise, and gas haulage revenues rise. As expansion and high profit making is to come in the future, I would buy now while the price is at a low. This investment is still a risky one and there are no foundations from which we can give fact that the price will definitely rise. Since this is only a 5 year investment, the full impact of the rise in the share prices will not be felt so I expect a price of $15.50 per share.

B.T. Hi Yield- return rate of 3.97% per annum = $250009.30

This particular cash trust seems to give the highest rate of return. It is very low risk, I have a guaranteed return of 3.97% per year.

Portfolio

Initially?

Shares

SecurityPriceNumber HeldValue

Telstra$4.4022727$99,998.80

National Australia Bank$22.404464$99,993.60

Australian Gas Light Co.$10.904587$49,998.30

Cash Trusts

Trust NameReturn RateMoney InvestedYears Invested

B.T. Hi Yield3.97$250,009.305

?After 5 years

Shares

SecurityPrice Number HeldValueGross ProfitNet Profit

Telstra$17.6022727$399,995.20$399,995.20$299,996.40

National Australia Bank$44.804464$199,987.20$199,987.20$1,899,993.40

Australian Gas Light Co.$15.504587$71,098.50$71,098.50$21,100.20

Cash Trusts

Trust NameReturn RateMoney InvestedYears InvestedGross ProfitNet Profit

B.T. Hi Yield3.97$250,009.305$303,735.88$53,726.58

Total Net Profit$2,274,816.50

My total profit after expenses are taken into account is $2,274,816.50. One requirement to be met was my expected return rate must average out to in excess of the current government bond interest rate. The government bond rate today is 5.75%, my portfolio has over 5 years matured to 401%, a very successful investment portfolio indeed. My investments are diversified and 20% of my securities can be easily converted into cash. I have invested 50% of my money into B.T. Hi Yield Cash Funds which is a low risk investment and have met all the requirements my portfolio was expected to obtain.

Part 2

Industrial shares, Mining and oil shares, Company debentures and Government bonds

(a) Industrial shares

(b) Mining and oil shares

(c) Company debentures

(d) Government bonds

What effect will an increase in the general level of interest rates have on a, b, c and d.

When interest rate levels rise, companies tend to borrow less. This cause them to invest less in themselves and on employee wages, in some extreme cases employee wages can drop or employees can be sacked. The demand will decrease for a, b, c and d.

What effect will a general downturn in economic conditions have on a, b, c and d.

When this happens the economy is obviously not producing enough and therefore supply for all will go down. Demand will also decrease because investors do not want to invest in poor producing companies.

What effect will an increase by Japan in it’s economic output of manufactured goods have on a, b, c and d.

There will be an increase in demand of Japanese goods. Therefore we must export more to repay our debts, demand and supply both increase for a, b, c, and d.

What effect will a marked improvement in our balance of payments have on a, b, c and d.

All will have an increase in demand. An improvement in the balance of payments mean that the whole economy is doing well.

What effect will a rapid increase in the world price of gold have on a, b, c and d.

As gold value has increased there will be a decrease in demand for a, c and d. Mining and oil shares (b) will increase in demand, because obviously to obtain gold it must be mined.

Part 3

Buy And Sell Theories Of Shares

The Fundamental Approach

Economics, financial management and accounting from the basis of this approach, but don’t let that deter you from using it as an investment strategy . The details of this approach can be learnt, yet all one really needs is an advisor with a strong company research to support his or her recommendations.

A practical procedure for the investor is to learn enough to recognize why an investment has been recommended, to cultivate the ability to ask the right questions, and to delve into the reasons for the recommendation.

With the fundamental approach, the emphasis is on the company: it’s past, present and potential performance. With this approach, the analyst or investor seeks companies which are undervalued. A major objective is to determine the long term value of particular securities. Put simply, it’s a matter of working out what is a cheap price to pay for a security.

The search involves examining company details which may indicate that a company is currently undervalued in the marketplace: balance sheets, auditor’s reports, profit and loss statements, annual reports, half-yearly reports, sales growth, earnings, management ratios, capital structure ratios, market performance ratios, and so on.

Fundamental analysts usually declare their findings as ratios which have been calculated using the balance sheet or profit and loss statement. An examination of the industry, cyclical industry or recessive industry? The fundamentalist is seeking companies that have been ‘mispriced’ in the market. This type of investor works on the proposition that if you study the market, study industry and study individual company’s ratios and statistics, such as earnings per share and net tangible assets per share, such mispriced companies can be found.

The Technical or Chartist’s Approach

There is no siren that sounds or light that flashes when it’s a good time to buy or sell a security. There is, however, a series of devices that one can use to select particular securities. By matching the prospects of these securities with your own investment objectives, there is a far greater chance of being a far greater investor.

The technical analyst (chartist) relies on the stock market to reflect the true worth of a share using charts as forecasting tools. Unlike the Fundamentalists the technical analyst believes that an individual company’s share price and indeed the total market can be predicted or at least anticipated by studying by studying past trends in market price and/or the number of shares traded.

It has been said that the chartist looks backwards, while the fundamentalist looks forward (with an occasional glance over the shoulder). This is not quite correct because both approaches require an element of prediction; both look at the data of the past in an attempt to predict the future.

Technical analysts produce charts to study daily through to monthly price and volume changes in securities. They record the price, or index if they are plotting general market or industry movement, and volume of transactions on the vertical scale, with the horizontal scale recording time (except in the case of point and future charts). When examining charts and the recorded volume and price changes, the aim is to gauge the strength of demand and supply, and then on the basis of such observations to predict future performances.

Chartists believe supply exceeds demand when particular shapes, patterns and formations are evident. Other patterns suggest supply and demand are more or less equal, or demand exceeds supply. There are probably as many different charts as there are chartists. However, it is recommended that both index charts and charts on individual companies be used if adopting the chartists approach.

Index charts give a broad view of the market. Examples of indices which are often charted are the All Ordinaries Index (Australia), Dow Jones Index (USA), Hang Seng Index (Hong Kong) and Barclays Index (New Zealand).

The Contrarian or Psychological Approach

It has been said that there are two major emotions that drive many an investment decision-GREED and FEAR. Historically investors have failed to learn from their previous mistakes, still preferring to follow the crowd buying when the market is booming and selling everything when it crashes. This is mass psychological or herd mentality at work.

For those wishing to avoid following the leader, an alternative approach is that of the contrarian. The contrarian buys the security that are out of fashion. This approach has been around for the last fifteen years. Put it simply, it proposes as an investment strategy not to what everybody else is doing. Avoid the crowd mentality or, specifically, the ‘public phase’ of the market cycle.

phrases describing this approach are: ‘Buy straw hats in winter’; ‘buy when blood is running on the streets’; ’swim against the tide’; ‘Sell in strength buy in weakness’.

This approach sounds easy in theory yet it is very hard to sell when everybody else believes the near future will provide higher prices and greater profits. It is also hard to by today’s bargain when everybody else feels it will be a better bargain tomorrow. There is more to this approach then simply being contrary. Some strategies associated with this approach are:

1) choose only larger companies that are financially sound, with debt to equity ratios of no more than one.

2) Make your selections from the top 150 companies, ranked by market capitalization.

3) Narrow your selection down to thirty companies with the lowest price/earning ratios.

4) Buy shares with high dividends, preferably fully franked ( that is, potentially tax free).

5) Seek out companies with an increasing earnings pre share.

6) Select a verity of industries. It’s the total portfolio that should perform, not just securities.

7) Select companies with a proven track record of sound management.

So although it is the alternative approach, it can still rely on ‘fundamentals’.

Part 4

Rules and Regulations of the ASX

The principles on which the listing rules are based embrace the interests of listed entities, maintenance of investor protection and the need to protect the reputation of the market. The principles are as follows:

-Minimum standard of quality, size, operations and disclosure must be satisfied.

-Sufficient investor interest must be demonstrated to warrant an entity’s participation in the market by having it’s securities quoted.

-Securities must be issued in circumstances which are fair to new and existing security holders.

-Timely disclosure must be made of information which may affect security values or influence investment decisions, and information in which security holders, investors and ASX have a legitimate interest.

-Information must be produced according to it’s highest standards and, where appropriate, enable ready comparison with similar information.

-The highest standards of integrity, accountability and responsibility of entries and their offers must be maintained.

-Practices must be adopted and pursued which protect he interests of security holders, including ownership interests and the right to vote.

-Security holders must be consulted on matters of significance.

-Market transactions must be commercially certain.

ASX has an absolute discretion concerning the admission of an entity to the official list (and it’s removal) and quotation of it’s securities (and their suspension). ASX also has discretion whether to require compliance with the listing rules in a particular case ( i.e., apart from waiving the rules). In exercising it’s discretion, ASX takes into account the principals on which the listing rules are based.

ASX may waive compliance with a listing rule, or part of a rule, unless the rule in question says otherwise. The listing rules necessarily cast a wide net. However, ASX does not want to inhibit legitimate commercial transactions that do not undermine the principles on which the listing rules are based.

If ASX decides to grant a waiver, it may do so on conditions. The conditions must be complied with for the waiver to be effective. Waivers are published by ASX periodically and are also advised to the ASC.

The listing rules themselves are to be interpreted:

-In accordance with their spirit, intention and purpose;

-by looking beyond form to substance; and

-in a way that the best promotes the principles on which they are based.

Once again if any entity does not comply with the listing rules, it’s securities may be suspended from quotation or it may be removed from the official list. An entity seeking listing must be admitted to the official list of the ASX and then, for trading in its securities must be granted an official quotation. There are prerequistis for both admission to the official list and official quotation. When applying for admission to the official list an entity must provide the prescribed documentation to the ASX, demonstrate compliance with the listing rules and pay a listing fee.

As you can see the ASX has strict control and regulation of its members. Many types of problems can occur within the stock exchange, for example an entity could list on the ASX without meeting a requirement for general admission which must be met to the ASX’s satisfaction. One particular requirement for general admission is No.8. The entity must satisfy either the profit test or the applicable net tangible assets test.

THE PROFIT TEST

To meet the profit test, the listing rules require that an entity must satisfy each of the following.

1) The entity must be a going concern, or the successor of a going concern.

2) The entity’s main business activity at the date it is admitted must be the same as it was during the last 3 full financial years.

3) An entity must provide to ASX financial statements for the last 3 full financial years which are prepared to Australian Accounting Standards. Financial statements for foreign entities may be prepared and audited to other standards acceptable to ASX. The financial statements must be qualified in a way that goes to whether the entity can continue as a going concern or has satisfied the profit levels required.

4) The entity’s aggregated profit from continuing operations for the last 3 full financial years must have been at least $1 million.

5) The entity’s profit from continuing operations for the last full financial year must have been at least $400,000.

6) If the entity’s financial statements for the last full financial year cover a period that ended more than 2 months before the date it applied for admission, the listing rules require the entity to give ASX each of the following.

a) Financial statements for the period since the end of that financial year dated no more than 2 months before the date it applied for admission, reviewed by a registered auditor (or overseas equivalent), showing that the entity is making profit from continuing operations. The financial statements must have been prepared to Australian Accounting Standards. Financial statements for foreign entities may be prepared and audited to other standards acceptable to ASX. This rule does not apply if the financial statements would cover a period of less than 2 months.



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