1 Cash investments & fixed-interest securities Flashcards
What are the major cash deposit takers?
- Banks
- Building societies
- Credit unions
- Govt. via NS&I
What are the risks of cash investment?
- Default
- Inflation
- Interest rate
How much cash does the FSCS cover?
£85k per person per authorised UK institution
What is reinvestment risk?
At the end of a fixed term, it may be impossible to reinvest with a decent interest rate
Do notice accounts typically have fixed or variable interest rates?
Variable
What is a typical notice period for a notice account?
30-120 days
Do small banks/building societies offer higher or lower interest rates on term accounts?
Higher, but with more restricted choice of terms
Term deposit accounts are sometimes referred to as…
Bonds, not to be confused with investment bonds or corporate bonds
What are some other terms for structured deposits?
- Guaranteed investment account
- Deposit plan
What does a typical structured deposit offer?
The greater of:
1. The original investment
2. A % of the change in FTSE 100
What are the drawbacks of structured deposits?
The typical term is 5+ years, during which inflation takes a toll, and the only guarantee is the original sum
What are the similarities between structured deposits and structured products?
- Capital protection
- Index-linked returns
What is the difference between structured deposits and structured products?
Structured products use derivatives = counterparty risk, whereas deposit-takers have obligation to repay investor
What is a typical minimum balance for a foreign currency deposit?
$10k
What are the optional ISA flexibility rules?
Withdrawals can be made & replaced within the same tax year without affecting subscription limit
What are eligible investments for cash ISAs?
- Bank & building society accounts
- Money market unit trusts & OEICs
- UCITS or life policies likely to return 95% within 5 years
- NS&I Direct ISA
- Stakeholder cash deposit products
What ISAs does NS&I offer?
- Direct ISA
- Junior ISA
Does the NS&I Direct ISA use the ISA flexibility rules?
No
NS&I income bonds have a minimum age of..?
16
What is the notice period for NS&I income bonds?
None
What do NS&I income bonds offer?
Variable monthly interest with no risk to capital
What are the two types of NS&I bank accounts?
- Investment Account
- Direct Saver
Who is eligible for NS&I Savings Certificates?
Those with maturing certificates
What is the difference between Guaranteed Growth/Income Bonds?
Growth = interest paid annually
Income = interest paid monthly
What is the minimum amount for Guaranteed Growth/Income Bonds?
£500
What are the characteristics of Green Savings Bonds?
- Fixed interest of 1.3%
- Fixed term of 3 years
- Interest added annually
- Available online to those aged 16+
What are the money markets?
Wholesale markets where banks, the Govt. etc. lend to each other
What is traded on the money markets?
Short-term debt instruments
How can private investors participate in the money markets?
Via specialist collective investment vehicles
Why are the money markets attractive to lenders?
- Low credit risk
- Liquid – securities can be sold
Why are the money markets attractive to borrowers?
Fixed, low interest rates
What are the three main types of money market instruments?
- Treasury bills
- Commercial bills
- Certificates of deposit
What does the Debt Management Office do?
Uses Treasury bills to manage Government’s daily cash flow needs
How are Treasury bills routinely issued?
Weekly auctions
What are usual terms for Treasury bills?
1, 3, 6 or 12 months
What is the minimum investment for Treasury bills?
£500k
How are Treasury bills occasionally issued outside weekly auctions?
On an ad hoc basis, with maturities from 1 to 365 days
How can members of the public buy Treasury bills?
Through an arrangement with one of the Treasury Bill Primary Participants (banks)
What is the coupon on Treasury bills?
Zero
What is the return on Treasury bills?
Maturity value (e.g. £1m) - purchase price (e.g. £999k)
What are the benefits of Treasury bills?
- Very low risk
- Highly liquid
What is often used as the benchmark risk-free rate of return?
The prevailing rate of return on Treasury bills
What is a certificate of deposit?
Receipt from a bank for a fixed-term deposit
How do CDs compare with ordinary deposits?
More liquid = lower return
What is a typical term for a CD?
1-3 months
How is interest paid on a CD?
On maturity
Is interest on a CD fixed or flexible?
Fixed
Why are CDs more liquid than ordinary term deposits?
They can be traded on money market
How do commercial bills differ from Treasury bills?
Less liquid + more risk = higher yield
What is a typical term for a commercial bill?
30-90 days
What are the two types of money market funds?
- Short-term
- Standard
What are the requirements for short-term money market funds?
- Weighted average maturity up to 60 days
- Weighted average life up to 120 days
What are the requirements for standard money market funds?
- Weighted average maturity up to 6 months
- Weighted average life up to 12 months
How do money market funds compare to cash investments?
Diversification can reduce default risk, but overall risk depends on credit rating of issuers
What are PIBS?
Permanent interest-bearing shares, a type of fixed-interest investment issued by building societies
What are PSBs?
Perpetual subordinated bonds, a type of fixed-interest investment issued by demutualised building societies
What is the position of PIBS and PSBs?
They cannot be issued as they no longer meet regulatory requirements, but can be traded on stock exchange
What are fixed-interest securities?
Negotiable fixed-interest long-term debt instruments
What are other terms for fixed-interest securities?
- Bonds
- Debentures
- Loan stock
- Loan notes
What are typical terms for fixed-interest securities?
2-30 years
Why might institutions use bonds instead of borrowing from banks?
- Choice of term + amount
- Choice of lenders
- Often cheapest way to borrow
How is bond interest paid?
Gross, calculated as simple interest on the nominal price
How often is bond interest paid?
Once or (more commonly) twice per year
What bond prices are quoted in the press?
Clean mid-market prices
What does it mean when a bond is cum dividend?
The buyer receives the full period interest, so dirty price > clean price
What does it mean when a bond is ex dividend?
The buyer will not receive any period interest, so dirty price < clean price
When does a bond become ex dividend?
Seven working days before interest payment date
What is a eurobond?
A bond issued in a currency other than that of the country where it’s issued, e.g. eurodollar or eurosterling
What bold yields are regularly published in the press?
- Interest yield
- Redemption yield
What are other terms for the interest yield?
- Running yield
- Flat yield
- Income yield
What is the formula for interest yield?
(coupon / clean price) x 100
Define the interest yield
The annual income as a percentage of the purchase price
What is the formula for simplified redemption yield?
interest yield + (((gain to maturity/years to maturity)/clean price) x 100)
What is the income tax treatment of bonds?
Applies to all bonds & gilts
What is the CGT treatment of bonds?
All gilts and most corporate bonds are exempt
What limits the usefulness of the redemption yield?
It ignores tax
What happens to demand for bonds when the Bank of England base rate falls?
Demand rises, as cash deposit interest rates become less attractive
Which has more volatile capital value: long- or short-term bonds?
Long-term
What are the two main types of factors that affect bond prices?
- Specific commercial risks to the issuer
- Market/systematic risks affecting bonds generally
What are the S&P investment grade ratings?
AAA to BBB-
What are the S&P non-investment grade ratings?
BB+ to D
What are Moody’s investment grade ratings?
Aaa to Baa3
What are Moody’s non-investment grade ratings?
Ba1 to C
What does increasing inflation mean for bond prices?
Prices will fall as demand falls (except index-linked bonds)
Which has more volatile capital value: high- or low-coupon bonds?
Low-coupon bonds
Which has more volatile capital value: investment grade or non-investment grade bonds?
Non-investment grade bonds
What can be compared using yield curves?
The yield on bonds of different maturities
What are the three main types of yield curve?
- Normal
- Flat
- Inverted
What do yield curves indicate?
The market’s expectations for interest rates + therefore required future yields
What is a yield curve?
A graph of the relationship between redemption yield and period to redemption
What is a normal yield curve?
A rising positive curve, as investors demand higher yields for longer holding periods
What causes a steeper rise in a yield curve?
Expectations of high inflation and interest rates
What causes a flat yield curve?
Expectations of stable economic conditions
What causes an inverted yield curve?
Expectations of falling inflation and interest rates
What does an inverted yield curve mean for long-term bond yields?
They are lower than short-term bond yields
Does the classification of gilts reflect their original or current life?
Current life
How does the DMO classify shorts/mediums/longs?
<7 years / 7-15 years / >15 years
How does the financial press classify shorts/mediums/longs?
<5 years / 15-15 years / >15 years
For index-linked gilts, what changes with inflation – the coupon or the redemption value?
Both
How do index-linked gilt coupons compare with conventional gilt coupons?
They are significantly lower
What index are index-linked gilts linked to?
RPI, until 2030 when it will change to CPIH
What does ‘repo’ mean (as in ‘repo market’)?
Sale and repurchase agreement
What is a repo agreement?
One party agrees to sell gilts, then repurchase equivalent securities at a set date & price
How is a repo used in practice?
As a form of short-term loan with the gilts as security
What is the usual repo buyback period?
Two weeks
What does the Bank of England use the repo market for?
Influencing interest rates
What does ‘strips’ mean (as in ‘strips market’)?
Separate trading of registered interest & principal securities
Which has more volatile capital value: gilts or corporate bonds?
Corporate bonds
Which is more liquid: gilts or corporate bonds?
Gilts
Which has a greater spread between buying and selling price: gilts or corporate bonds?
Corporate bonds
What does it mean if a corporate bond is secured?
There is a charge on certain assets, which can be seized to repay the loan if needed
What does it mean if a corporate bond is unsecured?
The holder ranks for repayment alongside ordinary creditors
What is a debenture?
A secured loan using business assets as security
What is a fixed charge debenture?
The charge is over a specific, identifiable asset which cannot be sold without the debenture holder’s permission
What is a floating charge debenture?
The charge isn’t for any specific asset and has a lower priority for repayment than a fixed charge
What are convertible bonds?
Usually unsecured loan stock with the option to convert to ordinary shares
What is the exception to bonds’ CGT exemption?
Convertible bonds
What is a FRN?
Floating rate note, a bond with coupon linked to a money market rate e.g. SONIA
How much is one basis point?
0.01%
What are the available terms for Guaranteed Growth Bonds?
1, 2, 4, or 5 years – with different interest rates for each
When the price of a bond falls, what happens to its yield?
It adjusts upwards, as the coupon is fixed
True or false: companies may always continue to issue more bonds
True
Index-linked gilts use RPI from how long before each payment date?
- Eight months (issued before Sept 2005)
- Three months (issued from Sept 2005)
Does CGT exemption apply to index-linked gilts?
Yes
Does income tax apply to interest on index-linked gilts?
Yes
