2.) Cash and Tax-Free Investments Flashcards
In terms of considerations, briefly describe the questions a should a person ask themselves in order to decide how much of their overall portfolio they should place in cash investments
How much do I need as liquid asset?
How much can I afford to keep in cash?
Have I adequate savings to cover emergency and day-to-day cash requirements?
Define the two things that an investor should look for in order to determine how safe a financial institution is to deposit their funds into
After the 2008 credit crunch, the environment relating to cash investments changed significantly, with more emphasis now placed on:
The Credit Rating of the financial institution being considered
Whether there is a Depositor Protection Scheme active in the jurisdiction of the financial institution being considered
Briefly describe how the environment relating to cash investments changed after the 2008 credit crunch
After the 2008 credit crunch, the environment relating to cash investments changed significantly, with more emphasis now placed on:
The Credit Rating of the financial institution being considered
Whether there is a Depositor Protection Scheme active in the jurisdiction of the financial institution being considered
Define Credit Ratings Agency
A company that assigns credit ratings for issuers of certain types of debt of debt obligations.
A credit rating for an issuer takes into consideration the issuer’s credit worthiness, I.e. it’s ability to pay back a loan.
Credit ratings are used by investors, issuers, investment banks, broker-dealers and governments to assess the financial soundness and stability of an institution
Examples of credit rating agencies are:
Fitch
Moody’s
Standard and Poor’s
Define who uses credit ratings, and why
Credit ratings are used by investors, issuers, investment banks, broker-dealers and governments to assess the financial soundness and stability of an institution
Define depositor protection scheme
A scheme implemented to ensure that, in the event of the failure of a bank within the country, each depositor would receive some form of payout
Define when and how the UK set up its depositor protection scheme
Via the 1979 Banking Act
When did the crisis with Northern Rock take place?
2007
Briefly describe the terms of the UK’s Depositor Protection Scheme as they were BEFORE the Northern Rock crisis
BEFORE the Northern Rock crisis in 2007:
100% of the first £2,000 of deposits, then 90% of the next £33,000 was protected.
Briefly describe the terms of the UK’s Depositor Protection Scheme as they have been SINCE the Northern Rock crisis
SINCE the Northern Rock crisis in 2007:
On 1st October 2007, the UK’s Depositor Protection Scheme was extended to include 100% of the first £35,000 per bank per customer
AT PRESENT, (since 7th October 2008) the U.K’s Depositor Protection Scheme includes 100% of the first £50,000 per bank per customer
Briefly describe the present terms of the UK’s Depositor Protection Scheme
Since 7th October 2008, the U.K’s Depositor Protection Scheme includes 100% of the first £50,000 per bank per customer
Define cash investment and its features
A loan made by an investor to a financial institution. The loan is repayable either in demand or after a relatively short period of notice. Other features include:
Capital guaranteed - customer can’t make a capital loss unless the institution with which they invest becomes insolvent
Usually no cost to the investor in placing the investment
Non-marketable - there’s no need to find a buyer in order to realise funds
Return is usually interest-based and varies from institution to institution
Funds kept for any length of time will suffer in future value due to inflation
Briefly describe the key features of the Jersey Depositors Compensation Scheme (DCS)
Provides protection of up to £50,000 per person, per Jersey banking group, for local and international depositors, in line with international standards
In the unlikely event of a Jersey bank failing, an interim payment of up to £5,000 will be made within 7 working days p, and the balance of compensation within 3 months
The £50,000 limit will apply per person, so a £100,000 deposit held in a joint account by 2 people would be completely covered
The maximum liability of the DCS will be capped at £100 million in any 5 year period, in line with the Guernsey scheme
What does DCS stand for?
Depositors Compensation scheme
Briefly describe the key features of the Guernsey Depositors Compensation Scheme (DCS)
Came into force 26 November 2008
Covers all ‘qualifying deposits’ (mainly those from personal retail depositors, wherever they live)
In the event of failure of a Guernsey bank after the effective date, it provides compensation of up to £50,000 per qualifying deposit in respect of that bank
It aims to pay compensation within 3 months of a bank failure
It is operated by an independent statutory Board which is separate from both the Guernsey Financial Services Commission and the States of Guernsey
Maximum total amount of compensation is capped at £100 million in any 5 year period. If claims exceed this cap, compensation will be reduced pro-rata. The cap also means that compensation in respect of any one bank cannot exceed £100 million
It will be paid for by the Guernsey banks through annual charges and special charges in the event of a bank failure
Briefly describe what an investor should look for when checking the accessibility of their investments
The period of notice required for the withdrawal of funds should be minimal in order to ensure that the investor has instant spending power to provide for sudden, unexpected expenditure
Briefly describe what an investor should look for when checking what rate of return their investments will earn
Rate of return is linked to risk and time horizon
Ideally, the rate of interest should be greater than the annual rate of inflation, otherwise the investment won’t maintain its value
Investors should be seeking real returns wherever possible: nominal (advertised) rate minus the rate of inflation
The investor also needs to consider whether the investment is tax free, paid gross but taxable, or paid with tax deducted at source, as this will affect the rate they receive
What is the rate of return linked to?
Risk and time horizon
Define and briefly describe the three different ways that, depending on the product, interest received from a bank or building society can be treated, in relation to tax
Tax free - UK capital and income tax is not payable on the interest received, therefore all interest is free from UK tax
Gross interest - Interest is received without the deduction of tax, but it is still taxable and must be declared on an individual’s annual tax return
Net interest - interest is received after the deduction of tax whereby 20% tax has been deducted at source
Briefly describe the income tax payable on interest earned on deposits with UK banks and building societies:
By default
If the depositor is a lower/basic rate taxpayer
If the depositor is a higher rate taxpayer
Deposits with UK banks and building societies have the interest paid net of income tax at 20% on the amount of interest paid
If the depositor is a lower/basic rate taxpayer, no further tax is payable on the interest
If the depositor is a higher rate taxpayer, an additional 20% is due to the Inland Revenue, satisfying the total income tax liability on the interest earned of 40%
Briefly describe the income tax payable on interest earned on deposits with UK banks and building societies if the depositor is a lower/basic rate taxpayer
Deposits with UK banks and building societies have the interest paid net of income tax at 20% on the amount of interest paid
If the depositor is a lower/basic rate taxpayer, no further tax is payable on the interest
Briefly describe the income tax payable on interest earned on deposits with UK banks and building societies if the depositor is a higher rate taxpayer
Deposits with UK banks and building societies have the interest paid net of income tax at 20% on the amount of interest paid
If the depositor is a higher rate taxpayer, an additional 20% is due to the Inland Revenue, satisfying the total income tax liability on the interest earned of 40%
Define the ‘flat rate’ of interest
The rate of interest quoted by institutions, usually a percentage per annum of the capital on the account, and usually calculated on a daily basis.
Note that this rate doesn’t take into account how often interest is paid
What does CAR stand for?
Compounded Annual Rate
What does AER stand for?
Annual Equivalent Rate
Define and briefly describe the rates by which some banks and building societies now quote interest rates, and why these rates are useful
Compounded Annual Rate (CAR)/Annual Equivalent Rate (AER)
This rate provides a true rate of return to a depositor as it takes into account how frequently interest is paid during a 12 month period.
It allows the depositor to compare the interest rates on accounts, which may offer different interest rates according to the frequency of the interest payments.
For example, a 180 day Notice Account pays 1.35% annually, 1.21% quarterly (AER) and 1.11% monthly (AER), thus giving the investor the information to compare different interest rates for different interest payment frequency
Define the key features of current accounts
Money available on demand
Low interest rate
Features include: cheque book, standing orders, direct debit, Visa card linked
Define the key features of Instant Access Savings Accounts
Money available on demand (sometimes subject to maximum number of withdrawals)
Access via branch, telephone, Internet and postal
Longer term and balance, the better the interest rate paid
Usually variable interest rate
Define the key features of Notice Accounts
Require notice before withdrawing funds
Usually periods include 7/30/50/60/90/180 days
Withdrawals usually subject to a penalty equal to the interest earned during the notice period
Usually variable interest rate
Define the key features of Money Market Deposits
Period of investment is agreed at the outset, usually 1/3/6/12 months
Interest rate return is fixed for that period
Usually minimum deposit of £25,000
Define the various types of savings accounts
Most banks and building societies offer savings products that are similar in nature, but with minor differences on features e.g. number of withdrawals, how and when interest will be paid, etc:
Current Accounts
Instant Access Savings Accounts
Notice Accounts
Money Market Deposits
Define who provides national Savings and Investment products, and why
The U.K. Government provides national Savings and Investment products in order to raise finance for it to help meet expenditure
