ASX the Ordinary Shares I

ASX

The ordinary shares I have selected for this study are Telstra's regular shares, which trade under the symbol TLS on the Australian Stock Exchange. These shares carry the basic rights and responsibilities of all ordinary shares.

The preference shares I have selected for this study are the ANZ preference shares A, which are a convertible preference share issued by the Australian and New Zealand Banking Group. These are listed as CPS2. The shares will convert to regular ANZ shares in 2016 but until that point are considered to be preference shares. Their value will be tied therefore both to the preference share dividend and the relationship between the conversion price and the price of the regular shares.

The convertible notes I have selected for this study are the Resolute Mining convertible notes. These were issued in 2009 and carry a face value of $0.50. The notes have an exercise price of $0.60, allowing for the conversion at a price of $0.10 per option on a 1 for 3 basis. The notes have an expiry of December 31st (Business Spectator, 2009).

The rights I have selected for this study are the Pryme Oil and Gas Limited rights that were announced on August 31, 2010 for trade on the ASX. The rights were announced to raise $1.7 million for the company. The rights are 1 for 8 non-renounceable rights that are provided to allow existing shareholders to acquire additional shares of the company (Pettett & Messer, 2010). A total of 21.25 million shares will be issued at $0.08 per share as part of the rights issue, which is intended to help finance an oil drilling project.

These different securities cut across a cross-section of the Australian Stock Exchange. Telstra is a government entity that is subject to a highly regulated environment, which will impact on the value of its ordinary shares. ANZ is a banking concern, and its convertible preference shares represent a unique structuring of a preference share. Resolute and Pryme are two exploration companies. The Australian Stock Exchange competes vigourously with the Toronto Stock Exchange for listings from mining firms, in particular small exploration-oriented firms. The ASX is therefore one of the world leaders in issues for small mining companies and provides a highly-sophisticated market for these sorts of products (convertible notes, rights) for small mining concerns.

2. The Telstra regular shares give the shareholder a stake in ownership of Telstra. The price of Telstra shares at market close August 31, 2010 was $2.75 per share, which is below the 52-week low. The shares trade with heavy volumes, typically landing in the top 10 or 20 in daily volume on the ASX, in part due to their low value. The company does not currently offer a dividend to investors (Yahoo7 Finance, 2010).

The ANZ preference shares CPS2 ended August 31st with a market value of $103.20 per share. The underlying asset, shares in ANZ, ended August 31st with a value of $22.59. The convertible shares were issued in late 2009 and will convert to full ANZ shares on December 15, 2016. The company estimates that the conversion will deliver "approximately $101.01 worth of ordinary shares," according to the company's website (Shareholder.anz.com, 2010). The conversion is subject to three mandatory conversion conditions. These are that the VWAP of the ordinary shares on the 25th business day before possible conversion is greater than 56% of the issue date VWAP; that VWAP of the ordinary shares on the 20th business day before possible conversion is greater than 50.51% of issues date VWAP; and that the ordinary shares remain listed and trading on the ASX (Ibid). As with other preference shares, the ANZ preference shares pay a dividend to the shareholders. The current rate for these shares is 3.1% per annum, but the dividend rate for each period will be set using a set formula (Ibid).

The Resolute Mining convertible notes have a face value of 50 cents. The option has an exercise price of 60 cents. The option expires on December 31, 2011. There were two tranches to this issue, but the terms did not change between the two tranches. The price per option is 10 cents, and they are attached on a one-for-three basis to existing shares. These convertible notes trade as RSGO and the last trade was at $0.33. The underlying asset, Resolute Mining ordinary shares, closed at $0.84 on August 31, 2010 (Yahoo 7, 2010).

The Pryme Oil and Gas rights were a 1 for 8 non-renounceable rights issue that allows existing shareholders to acquire additional shares in the company. The placement shares are to be issued on September 6, 2010 and the record date for the rights issue is to be September 14, 2010. The rights issue is believed to be fully subscribed, though some shares may be traded on the ASX prior to the issue being completed. The closing price on August 31, 2010 of the underlying asset was $0.08, the same as the price at which the shares are available as a result of the rights issue.

3. With each of these investments, there is the possibility that the investor could lose his or her entire investment. Each of these investments is an equity investment, and equity investments inherently bear the risk of loss of value. Some of these investments, however, should be considered to be riskier than others. There is significant risk with the Telstra investment, because there is no floor for the value of ordinary shares. Should Telstra be forced into bankruptcy, the company's shares would probably become worthless. There is the chance that they would be able to retain some value should a government restructuring take place that cashes out existing equity investors to a small degree, but the returns would be nominal at best.

The ANZ preference convertibles have the lowest risk. There are two reasons for this. The first is that they pay a dividend, which is something that none of the other investments do. Most preference shares entitle the shareholder to dividends. There is a risk that the company will be unable to pay the dividends to the preference shareholders, but that risk is low. That risk is dependent on the subordination structure of the preference shares. Standard and Poor's rated the preference shares at A+, meaning that there is relatively low risk of default on payments. The preference convertibles also come with franking credits, and these are estimated to be 100% (Prospectus CPS2, 2009). Any dividends paid before the mandatory conversion date will offset the risk of default, however the full value of these preference convertibles is tied to the value of the underlying asset.

Both the Resolute convertibles and the Pryme rights have a risk level that is directly related to the underlying asset, since both convertibles and rights are eventually turned into ordinary shares of these companies. Both of these companies are focused on exploration, but the low share prices of these companies indicate that they possess little in the way of economic assets. As a result, both are high-risk securities. If the properties that these companies possess do not have resources that can be extracted, then the companies would be forced to acquire new exploration rights in order to remain economically viable. Mining exploration companies are high-risk investments. The Australian investment community, however, has significant knowledge about the risks associated with such mining and exploration firms. This level of sophistication can help such investors defray the risks associated with investing in such companies. However, the risk remains strong that either of these companies, or both, could become bankrupt, meaning that equity investors will lose all of their investment. For the moment, the convertibles and rights have value, and are likely to retain this value until the point where they are converted into ordinary shares. The rights in particular will allow the holder to purchase shares very soon, which means that the rights themselves are low risk, but the investment as a whole remains risky because it is essentially an investment in ordinary shares of Pryme Oil and Gas.

4. There are a number of factors that need to be taken into account when choosing an investment. The first is the risk associated with that investment, in particular relative to the risk tolerance of the investor (No author, 2010). Each of these investments, for example, bears a significant amount of risk. An investor must understand that any equity-based investment could go to zero, meaning that the entire investment would be lost. The investor needs to be willing to accept this risk. Risk tolerance is related to the age of the investor, the eventual use of the money, the amount of wealth the investor has and the investor's personality (Ibid).

In addition to risk, the investor needs to consider the issue of diversification. One of the most important principles of investing is to hold a diversified portfolio, as the risk to the investor is spread among a number of different securities, preferably different types of securities in different industries. For example, two exploration companies in a portfolio of four securities is poor diversification. It is also important to consider that convertibles and rights will eventually turn to ordinaries, meaning that those forms of equity do not diversify the risk away from ordinary shares.

Time horizon is another consideration to take into account (No author, 2010). The time horizon of an investment is in part related to the risk of that investment, as some risk is related to time. Also, the investor should be wary of investing in securities with a long time horizon for returns if the investor may have a need for that money in the short-term. The time horizon of the investment should match the time horizon of the investor's needs (Ibid).

Finally, the investor should consider the nature of the investment itself and whether they have a full understanding of how that investment works. The ASX and the two mining companies selected are a perfect example of this. While the ASX is home to many sophisticated exploration and mining investors who can understand adequately understand the risks inherent in investing in these companies, not all investors can. These types of companies in particular produce reports heavy on geological analysis that cannot be understood without a background in geology or extensive experience with mining and exploration stocks. Investing in these companies without understanding the nature of the company's business and the risk factors inherent in this business is a poor investing strategy. Diversification across industries can offset some of this risk, but the individual investment in an unfamiliar industry is little more than a trip to the casino.

If I had 5000 Australian dollars and wanted to resell in a month, I would invest in the ANZ preference convertibles. The reason for this is that the short time horizon is inappropriate for investments in risky securities. Both of the mining exploration investments are risky -- the payoff for these investments could be months or years later. Short-term movements are speculative at best. Telstra, unfortunately, is also a risky investment. It has declined steadily in value and with the government efforts to undermine its business at every turn there is little reason to believe that Telstra shares will bounce back in the next month. This leaves the ANZ preference convertibles, by default. However, preference shares are not good short-term investments either. There is unlikely to be significant movement in the price of these shares in the short-term, because the short-term price of preference shares is tied to the dividends that are paid out. Those dividends are known, and therefore are included in the price of the shares. Thus, even this investment is inappropriate for a short-term purchase. While the risk is very low, the potential return over a one-month time frame is also very low.