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R02 Investment Principles & Risk > 1 Cash investments & fixed-interest securities > Flashcards

1 Cash investments & fixed-interest securities Flashcards

1
Q

What are the major cash deposit takers?

A
  1. Banks
  2. Building societies
  3. Credit unions
  4. Govt. via NS&I
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2
Q

What are the risks of cash investment?

A
  1. Default
  2. Inflation
  3. Interest rate
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3
Q

How much cash does the FSCS cover?

A

£85k per person per authorised UK institution

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4
Q

What is reinvestment risk?

A

At the end of a fixed term, it may be impossible to reinvest with a decent interest rate

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5
Q

Do notice accounts typically have fixed or variable interest rates?

A

Variable

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6
Q

What is a typical notice period for a notice account?

A

30-120 days

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7
Q

Do small banks/building societies offer higher or lower interest rates on term accounts?

A

Higher, but with more restricted choice of terms

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8
Q

Term deposit accounts are sometimes referred to as…

A

Bonds, not to be confused with investment bonds or corporate bonds

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9
Q

What are some other terms for structured deposits?

A
  1. Guaranteed investment account
  2. Deposit plan
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10
Q

What does a typical structured deposit offer?

A

The greater of:
1. The original investment
2. A % of the change in FTSE 100

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11
Q

What are the drawbacks of structured deposits?

A

The typical term is 5+ years, during which inflation takes a toll, and the only guarantee is the original sum

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12
Q

What are the similarities between structured deposits and structured products?

A
  1. Capital protection
  2. Index-linked returns
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13
Q

What is the difference between structured deposits and structured products?

A

Structured products use derivatives = counterparty risk, whereas deposit-takers have obligation to repay investor

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14
Q

What is a typical minimum balance for a foreign currency deposit?

A

$10k

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15
Q

What are the optional ISA flexibility rules?

A

Withdrawals can be made & replaced within the same tax year without affecting subscription limit

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16
Q

What are eligible investments for cash ISAs?

A
  1. Bank & building society accounts
  2. Money market unit trusts & OEICs
  3. UCITS or life policies likely to return 95% within 5 years
  4. NS&I Direct ISA
  5. Stakeholder cash deposit products
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17
Q

What ISAs does NS&I offer?

A
  1. Direct ISA
  2. Junior ISA
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18
Q

Does the NS&I Direct ISA use the ISA flexibility rules?

A

No

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19
Q

NS&I income bonds have a minimum age of..?

A

16

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20
Q

What is the notice period for NS&I income bonds?

A

None

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21
Q

What do NS&I income bonds offer?

A

Variable monthly interest with no risk to capital

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22
Q

What are the two types of NS&I bank accounts?

A
  1. Investment Account
  2. Direct Saver
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23
Q

Who is eligible for NS&I Savings Certificates?

A

Those with maturing certificates

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24
Q

What is the difference between Guaranteed Growth/Income Bonds?

A

Growth = interest paid annually
Income = interest paid monthly

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25
Q

What is the minimum amount for Guaranteed Growth/Income Bonds?

A

£500

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26
Q

What are the characteristics of Green Savings Bonds?

A
  1. Fixed interest of 1.3%
  2. Fixed term of 3 years
  3. Interest added annually
  4. Available online to those aged 16+
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27
Q

What are the money markets?

A

Wholesale markets where banks, the Govt. etc. lend to each other

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28
Q

What is traded on the money markets?

A

Short-term debt instruments

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29
Q

How can private investors participate in the money markets?

A

Via specialist collective investment vehicles

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30
Q

Why are the money markets attractive to lenders?

A
  1. Low credit risk
  2. Liquid – securities can be sold
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31
Q

Why are the money markets attractive to borrowers?

A

Fixed, low interest rates

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32
Q

What are the three main types of money market instruments?

A
  1. Treasury bills
  2. Commercial bills
  3. Certificates of deposit
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33
Q

What does the Debt Management Office do?

A

Uses Treasury bills to manage Government’s daily cash flow needs

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34
Q

How are Treasury bills routinely issued?

A

Weekly auctions

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35
Q

What are usual terms for Treasury bills?

A

1, 3, 6 or 12 months

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36
Q

What is the minimum investment for Treasury bills?

A

£500k

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37
Q

How are Treasury bills occasionally issued outside weekly auctions?

A

On an ad hoc basis, with maturities from 1 to 365 days

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38
Q

How can members of the public buy Treasury bills?

A

Through an arrangement with one of the Treasury Bill Primary Participants (banks)

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39
Q

What is the coupon on Treasury bills?

A

Zero

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40
Q

What is the return on Treasury bills?

A

Maturity value (e.g. £1m) - purchase price (e.g. £999k)

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41
Q

What are the benefits of Treasury bills?

A
  1. Very low risk
  2. Highly liquid
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42
Q

What is often used as the benchmark risk-free rate of return?

A

The prevailing rate of return on Treasury bills

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43
Q

What is a certificate of deposit?

A

Receipt from a bank for a fixed-term deposit

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44
Q

How do CDs compare with ordinary deposits?

A

More liquid = lower return

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45
Q

What is a typical term for a CD?

A

1-3 months

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46
Q

How is interest paid on a CD?

A

On maturity

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47
Q

Is interest on a CD fixed or flexible?

A

Fixed

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48
Q

Why are CDs more liquid than ordinary term deposits?

A

They can be traded on money market

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49
Q

How do commercial bills differ from Treasury bills?

A

Less liquid + more risk = higher yield

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50
Q

What is a typical term for a commercial bill?

A

30-90 days

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51
Q

What are the two types of money market funds?

A
  1. Short-term
  2. Standard
52
Q

What are the requirements for short-term money market funds?

A
  1. Weighted average maturity up to 60 days
  2. Weighted average life up to 120 days
53
Q

What are the requirements for standard money market funds?

A
  1. Weighted average maturity up to 6 months
  2. Weighted average life up to 12 months
54
Q

How do money market funds compare to cash investments?

A

Diversification can reduce default risk, but overall risk depends on credit rating of issuers

55
Q

What are PIBS?

A

Permanent interest-bearing shares, a type of fixed-interest investment issued by building societies

56
Q

What are PSBs?

A

Perpetual subordinated bonds, a type of fixed-interest investment issued by demutualised building societies

57
Q

What is the position of PIBS and PSBs?

A

They cannot be issued as they no longer meet regulatory requirements, but can be traded on stock exchange

58
Q

What are fixed-interest securities?

A

Negotiable fixed-interest long-term debt instruments

59
Q

What are other terms for fixed-interest securities?

A
  1. Bonds
  2. Debentures
  3. Loan stock
  4. Loan notes
60
Q

What are typical terms for fixed-interest securities?

A

2-30 years

61
Q

Why might institutions use bonds instead of borrowing from banks?

A
  1. Choice of term + amount
  2. Choice of lenders
  3. Often cheapest way to borrow
62
Q

How is bond interest paid?

A

Gross, calculated as simple interest on the nominal price

63
Q

How often is bond interest paid?

A

Once or (more commonly) twice per year

64
Q

What bond prices are quoted in the press?

A

Clean mid-market prices

65
Q

What does it mean when a bond is cum dividend?

A

The buyer receives the full period interest, so dirty price > clean price

66
Q

What does it mean when a bond is ex dividend?

A

The buyer will not receive any period interest, so dirty price < clean price

67
Q

When does a bond become ex dividend?

A

Seven working days before interest payment date

68
Q

What is a eurobond?

A

A bond issued in a currency other than that of the country where it’s issued, e.g. eurodollar or eurosterling

69
Q

What bold yields are regularly published in the press?

A
  1. Interest yield
  2. Redemption yield
70
Q

What are other terms for the interest yield?

A
  1. Running yield
  2. Flat yield
  3. Income yield
71
Q

What is the formula for interest yield?

A

(coupon / clean price) x 100

72
Q

Define the interest yield

A

The annual income as a percentage of the purchase price

73
Q

What is the formula for simplified redemption yield?

A

interest yield + (((gain to maturity/years to maturity)/clean price) x 100)

74
Q

What is the income tax treatment of bonds?

A

Applies to all bonds & gilts

75
Q

What is the CGT treatment of bonds?

A

All gilts and most corporate bonds are exempt

76
Q

What limits the usefulness of the redemption yield?

A

It ignores tax

77
Q

What happens to demand for bonds when the Bank of England base rate falls?

A

Demand rises, as cash deposit interest rates become less attractive

78
Q

Which has more volatile capital value: long- or short-term bonds?

A

Long-term

79
Q

What are the two main types of factors that affect bond prices?

A
  1. Specific commercial risks to the issuer
  2. Market/systematic risks affecting bonds generally
80
Q

What are the S&P investment grade ratings?

A

AAA to BBB-

81
Q

What are the S&P non-investment grade ratings?

A

BB+ to D

82
Q

What are Moody’s investment grade ratings?

A

Aaa to Baa3

83
Q

What are Moody’s non-investment grade ratings?

A

Ba1 to C

84
Q

What does increasing inflation mean for bond prices?

A

Prices will fall as demand falls (except index-linked bonds)

85
Q

Which has more volatile capital value: high- or low-coupon bonds?

A

Low-coupon bonds

86
Q

Which has more volatile capital value: investment grade or non-investment grade bonds?

A

Non-investment grade bonds

87
Q

What can be compared using yield curves?

A

The yield on bonds of different maturities

88
Q

What are the three main types of yield curve?

A
  1. Normal
  2. Flat
  3. Inverted
89
Q

What do yield curves indicate?

A

The market’s expectations for interest rates + therefore required future yields

90
Q

What is a yield curve?

A

A graph of the relationship between redemption yield and period to redemption

91
Q

What is a normal yield curve?

A

A rising positive curve, as investors demand higher yields for longer holding periods

92
Q

What causes a steeper rise in a yield curve?

A

Expectations of high inflation and interest rates

93
Q

What causes a flat yield curve?

A

Expectations of stable economic conditions

94
Q

What causes an inverted yield curve?

A

Expectations of falling inflation and interest rates

95
Q

What does an inverted yield curve mean for long-term bond yields?

A

They are lower than short-term bond yields

96
Q

Does the classification of gilts reflect their original or current life?

A

Current life

97
Q

How does the DMO classify shorts/mediums/longs?

A

<7 years / 7-15 years / >15 years

98
Q

How does the financial press classify shorts/mediums/longs?

A

<5 years / 15-15 years / >15 years

99
Q

For index-linked gilts, what changes with inflation – the coupon or the redemption value?

A

Both

100
Q

How do index-linked gilt coupons compare with conventional gilt coupons?

A

They are significantly lower

101
Q

What index are index-linked gilts linked to?

A

RPI, until 2030 when it will change to CPIH

102
Q

What does ‘repo’ mean (as in ‘repo market’)?

A

Sale and repurchase agreement

103
Q

What is a repo agreement?

A

One party agrees to sell gilts, then repurchase equivalent securities at a set date & price

104
Q

How is a repo used in practice?

A

As a form of short-term loan with the gilts as security

105
Q

What is the usual repo buyback period?

A

Two weeks

106
Q

What does the Bank of England use the repo market for?

A

Influencing interest rates

107
Q

What does ‘strips’ mean (as in ‘strips market’)?

A

Separate trading of registered interest & principal securities

108
Q

Which has more volatile capital value: gilts or corporate bonds?

A

Corporate bonds

109
Q

Which is more liquid: gilts or corporate bonds?

A

Gilts

110
Q

Which has a greater spread between buying and selling price: gilts or corporate bonds?

A

Corporate bonds

111
Q

What does it mean if a corporate bond is secured?

A

There is a charge on certain assets, which can be seized to repay the loan if needed

112
Q

What does it mean if a corporate bond is unsecured?

A

The holder ranks for repayment alongside ordinary creditors

113
Q

What is a debenture?

A

A secured loan using business assets as security

114
Q

What is a fixed charge debenture?

A

The charge is over a specific, identifiable asset which cannot be sold without the debenture holder’s permission

115
Q

What is a floating charge debenture?

A

The charge isn’t for any specific asset and has a lower priority for repayment than a fixed charge

116
Q

What are convertible bonds?

A

Usually unsecured loan stock with the option to convert to ordinary shares

117
Q

What is the exception to bonds’ CGT exemption?

A

Convertible bonds

118
Q

What is a FRN?

A

Floating rate note, a bond with coupon linked to a money market rate e.g. SONIA

119
Q

How much is one basis point?

A

0.01%

120
Q

What are the available terms for Guaranteed Growth Bonds?

A

1, 2, 4, or 5 years – with different interest rates for each

121
Q

When the price of a bond falls, what happens to its yield?

A

It adjusts upwards, as the coupon is fixed

122
Q

True or false: companies may always continue to issue more bonds

A

True

123
Q

Index-linked gilts use RPI from how long before each payment date?

A
  1. Eight months (issued before Sept 2005)
  2. Three months (issued from Sept 2005)
124
Q

Does CGT exemption apply to index-linked gilts?

A

Yes

125
Q

Does income tax apply to interest on index-linked gilts?

A

Yes

R02 Investment Principles & Risk (11 decks)

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