2. PRINCIPLE ASSET CLASSES Flashcards

Question 1

Q

Benefits/risks
of cash deposits

Answer

A

BENE
- security - FSCS protection up to 85k
- accessibility - usually immediate unless term deposit
- liquidity - instant access to deposits 2nd only in liquidity to cash

RISKS
- interest rates may not keep up with inflation
-inflation eroding value
- portfolio cash accounts - not protected by FSCS

types of cash acc - instant access, notice account, term deposit and money market acc

Question 2

Q

6 Characteristics of money

Answer

A

DIVIDIBILITY - can be split into smaller denominations
DURABILITY - durable, easily replaceable
TRANSPORTABILITY - easy to carry
LIMITED SUPPLY - supply must be controllable (by the gov)
ACCEPTABILITY - must be widely accepted in exchange for goods. Declaration of legal tender by govs makes the currency acceptable to baso anyone
UNIFORMITY - uniform - all £5 notes worth the same amount

Question 3

Q

Simple Mac and Mod Dur calc

Question 4

Q

Blockchain

Answer

A

cryptocurrencies use blockchain tech = system of recording information that makes it difficult/impossible to change = digital leger of transactions duplicated and distro across entire network

Question 5

Q

Crypto
- issues with using crypto as money

Answer

A

Digital currency designed to work on blockchain tech as a medium of exchange

anonymous nature of transactions (illegal/immoral activities)
potential for gov to ban/regulate their use
periodic failure of some currencies
multiplicity of currrency makes it hard to understand pros and cons of each
not FSCS protected whereas cash is
ease with which new cryptos can be set up

Question 6

Q

Crypto regs

Answer

A

largely unregulated
Feb 23 - UK gov published plan for regulatory framework tgar it will apply to crypoassets

regulators in diff countries have conflicting views on crypto - may create regulatory loopholes

in UK - crypto assets cannot be promoted to retail clients

Question 7

Q

Tax treatment of crypto

Answer

A

gains typically subject to CGT even tho crypto is digital and therefore intangible

losses allowable to offset against gains tho may have to provide proof it is arises as result of destruction of private encryption key

Question 8

Q

what does FSCS cover

Answer

A

compensate customers of fin. services firms in case of insolvency
covers deposits, credit unions, insurance pols, pensions, insurance brokering, endowments, investments, mortgages, debt management

key provision is to protect cash deposits up to 85k per person per authorized instit
- originally under EU directive 100k eur rebal every 5 years

doesnt cover deposits outside of EEA

temp large balances protected for 6 months up to 1mn (e.g. proceeds from house sale, insurance payout, inheritance etc)

Question 9

Q

Risks and adv of offshore banking

Answer

A

RISKS
Security - main risk. may be little or no compensation offered for deposit loss.
deposit - sometimes large min deposit - could be at risk in war/coup/currency devaluation
access -usually straightforward btut could be as issue in dev countries where transactions are slower
compliance standards - offshore banks that comply with high standards must take extra steps to ensure this so often charge higher fees. lax banks spose their own issues - attract high risk customers, scrutiny from regs, can result in bank failure
professional advice - often needed when setting up offshore acc due to complicated tax structures
may attract criminals - can be opened without full declaration of beneficial ownership (money laundering/tax evasion)

ADV
security - some countries bank deposits may not be secure - so offshore banking may actually offer a more secure alternative
service - often very personalised with relationship managers
convenience and access - worldwide access for individuals whose home gov imposes capital controls
tax - tax advantages will depend on investors domicile. IHT planning (legal or otherwise)
investing - may offer access to different investment funds
FX - may be cheaper
flexible lending and credit
fees, interest and charges - may offer higher rates due to lower overheads and reduced govi control. interest almost always gross
economic protection - for investors facing deterioration at home

Question 10

Q

FSCS global alts

Answer

A

FDIC - deposits in US insit up to $250k (SVB more)
PBOC - 500k yuan per depositor
SARB - 100k rand per depositor per bank

Question 11

Q

deposit acc types

Answer

A

instant access - cash immediately accessible (can be limits on withdrawals e.g. x amount/day)

notice accounts - depositor must give notice of intent to withdraw or suffer interest penalty - higher interest than instant access due to less liquidity

term deposit - cash deposited over predefined period for enhances rate. early withdrawal prob not permitted or allowed with big penalty
- often provided as fixed rate bond by bank

money market accounts
- certain banks offer money market deposits for deined periods, rates and currencies - IR reflects the current MM rates
- call account allows invest to access money on working day and by a specific time (close to instant access and offers rat aligned to base rate)

Question 12

Q

tax treatment of cash deposits

Answer

A

gross interest (from April 2017)
first 1k (500 higher) tax free
no CGT

Question 13

Q

what is an ISA]
types?

Answer

A

tax efficient wrapper for residents
no income tax or CGT

types
-cash
-stocks and shares
-LISA
-flexible ISA
-innovative finance ISA
JISA
H2B ISA

Question 14

Q

risks and advantages of offshore banking

Answer

A

RISKS
Security - main risk. may be little or no compensation offered for deposit loss.
deposit - sometimes large min deposit - could be at risk in war/coup/currency devaluation
access -usually straightforward btut could be as issue in dev countries where transactions are slower
compliance standards - offshore banks that comply with high standards must take extra steps to ensure this so often charge higher fees. lax banks spose their own issues - attract high risk customers, scrutiny from regs, can result in bank failure
professional advice - often needed when setting up offshore acc due to complicated tax structures
may attract criminals - can be opened without full declaration of beneficial ownership (money laundering/tax evasion)

ADV
security - some countries bank deposits may not be secure - so offshore banking may actually offer a more secure alternative
service - often very personalised with relationship managers
convenience and access - worldwide access for individuals whose home gov imposes capital controls
tax - tax advantages will depend on investors domicile. IHT planning (legal or otherwise)
investing - may offer access to different investment funds
FX - may be cheaper
flexible lending and credit
fees, interest and charges - may offer higher rates due to lower overheads and reduced govi control. interest almost always gross
economic protection - for investors facing deterioration at home

Question 15

Q

money markets

Answer

A

financial instit and dealers inc ash/credit who borrow/lend for ST usually up to 12 months

no centralised XC, decentralised similar to FX market

benchmarking to LIBOR

ST instruments commonly commercial paper, REPOs or similar

convention is to issue in bearer form

highly liquid

often no coupon - discounted secs which redeem @ par

Question 16

Q

money market participants

Answer

A

central bank - to conduct monetary policy not to paise finance + lender of last resort if systemic risk

commercial banks
maintain liquidity for capital adequacy requirements

companies
short term flexible finance, hedge IR rate exposure

instits (pensions funds, fund managers) -
maintain portion of fund in cash, MM allow generation of return

intermediaries - arbitrage ops between buyer and seller. most important in MM are IDB

Question 17

Q

short dated bonds

Answer

A

technically <5 yrs but definition can vary
sovereign risk in MM is country specific
usually ST govis

also FRNs - linked to ST MM rates
ZCBs - issued @ discount and redeemed at par

Question 18

Q

commercial paper

Answer

A

issued by corp - equivalent to short dated IG gov bond
typically zero coup and issued @ discount
no security
life of around 3 months

issued by large comps to assist in liqudiity management - placed w/ instit investors
(minimum denomination is 100k)

asset backed CP, 90-180 days, issue dby banks or financial instit with and notes backed by physical assets

finance comps use receivables from loans provided to customers as collateral for raising money in C market

Question 19

Q

Treasury bills

Answer

A

ST loan instruments guaranteed by gov
maturity <1 yr @ issue
1, 3, 6 month maturities in UK
no coupon - issued @ discount (tho can have negative yields and be issued at prem)
issued by DMO in UK
can be held in CREST and Euroclear
issued @ weekly auctions (tenders) - competitive 500k min NV bid, multiples of 50k
subsequent trading min denomination is 25k
tenders are on fri - eligible bidders are large financial instits including all major banks

not risk free because of inflation risk

Question 20

Q

T bill yield

Answer

A

yield % = (100-price)/(price x days/360)

days = days to maturity

Question 21

Q

Annualization and decompounding

Annualise: 4.8% annual interest paid quarterly
Decompound: 25% return over 7 yrs

Answer

A

A = (1+r)^n -1
A = (1.012)^4 -1 = 0.0489

0.25 = (1+r)^7 -1
1.25 = (1+r)^7
1.25^1/7 -1 = r

Question 22

Q

Bond characteristics

Question 23

Q

Risks associated with bonds

Answer

A

INTEREST RATE - rates expected to rise, price falls so yield rises to reflect increased rates. heavily impacted by inflation expectations
CREDIT RISK - risk of issuer defaulting on payment of coup or principle. ratings agencies help tho they are not super trustworthy
INFLATION - risk inflation will undermine returns through decreased purchasing power
LIQUIDITY - ease with which issue can trade effects its risk and therefore the yield required
ISSUE SPECIFIC - eg embedded options, callable bonds etc
FISCAL - risk witholding taxes will be increased

Question 24

Q

Macauly duration

Answer

A

= Economic life of the bond
How long it years it takes for the price of the bond to be repaid by its cash flows
= weighted average term to maturity of the cash flows from a bond
= elasticity of a bond’s price in relation to interest rates
= higher duration = more sensitive to rates (as well as lower coupon and yield and longer time to maturity - all more sensitive to rates)

Question 25

Q

Determinants of mac duration

Answer

A

Coupon - higher = lower duration

Time to maturity - higher = higher duration

Yield - higher = lower duration

Question 26

Q

How to calculate Macauly duration

Answer

A

Value each CF using YTM as discount rate
x each value by the period and sum

MD = Sum of PV x period /price

Question 27

Q

Modified duration

Answer

A

= - Mac duration / (1+ yield)

Gives approx for how much bond’s price will move for 1% change in yield

-ve value since price has inverse relationship with rates

only an approximation due to convexity because mod duration implies linear price yield relationship

Question 28

Q

IRR

Uses and limitations

Answer

A

R1 = lower rate
R2 = higher rate
N1 = NPV with R1
N2 = NPV with R2

Calc N1 and N2
N2 should be neg
Use interpolation formula

IRR = discount rate that makes NPV of future cash flows = 0
is annual growth rate investment is expected to generate

-useful for comparing projects - choose one with higher IRR
- should choose investment with higher NPV @relevant cost of capital
- negative cFs result in multiple IRRs
- assumes all CFs invested @ IRR rate

Question 29

Q

Meaning of cost of capital

Answer

A

= min return necessary to justify undertaking project

Question 30

Q

Convexity

Answer

A

actual relationship isnt linear - increases in yields results in prices dropping at reducing rate - but relationship is actually convex

mod dur - will overstate fall in price and understate rise

longer maturity = higher convexity
lower coupon = higher convexity
lower yield = higher convexity
if same mod duration - higher coup = greater convexity

Convexity = (Total convexity calculation / bond price) / coupon frequency²

Formula for convexity adjustment = 0.5 x Convexity x Yield change² x Bond Price

Question 31

Q

Gordon’s growth model

Answer

A

Values shares based on NPV of future dividends
Purchasers of a share are discounting the expected future growth in
earnings and dividends

PROBLEM - what is comp doesnt pay out divi because it is reinvesting profits into future growth?
- investors will tolerate this more with younger, higher growth comps than with mature

For pref shares: P/r (r and g are in decimals)

Question 32

Q

Bene and drawbacks of discount model

Answer

A

BENE
- simple and easy to understand and apply
- focuses on most visible form of returns to SH (divi)
- relies on only a few parameters

DRAWBACKS
- doesnt deal well when req rate of return is lower than divi growth
- canr value firms who dont pay divi
- narrow range of parameters, may not capture firm value

Question 33

Q

Complicated Gordon’s growth
£1 divi last year
Grows @ 10% for 3 years
Then 4% constant after that
9% req rate of return

Answer

A

Value each CF like a bond

Last CF = Grow divi by perp growth rate for numerator

Denominator = (r-g) x 1.09^3 as in 3y time

Question 34

Q

Influences on share price movements

Answer

A

*Earnings prospects and asset value of company
*Board membership
*Adverse factors affecting company - e.g. legal action, loans being called in etc.
*Industry or economic surveys
*tips in financial media
*research ratings (upgrades/downgrades)
*Macro economic developments e.g. interest rate expectations, inflation reports etc (some more than others, e..g house builders)
*Changes in government policy e.g. fiscal and monetary policy
*Movements in global markets
*Geo-political developments including wars, terrorism etc.
*takeover/merger rumours
*deviations from traditional divi patterns
*earnings reports (missing/beating expectation, anticipation of earnings)

Question 35

Q

Equities in a multi asset portfolio

Answer

A

Expected to provide long term growth
Can provide hedge against inflation since comp revs should rise with inflation and thus so should share price
equity risk premium is high
No guaranteed returns
Diversification - within sector, between sectors and geogs helps reduce unsystematic risk
Want combo of shares with low correlation to eachother (in short term, over LT shares prices will be broadly correlated)

Question 36

Q

Equity vol

Answer

A

Considered riskier than FI counterparts
CBOE VIX index - measures short term 30 day market vol of S&P option prices
VIX itself is volatile
discourages investment in periods when market concerns are rife (COVID, GFC)
if you remain invested and can withstand vol - equities can produce substantial risk adjusted returns

Question 37

Q

Perf of equities

Answer

A

Have provided best real returns of all main asset classes over LT
10.1% pa S&P500 since 1928

Question 38

Q

Price/earnings multiples (divi val)

Question 39

Q

Ord vs pref shares

Answer

A

Ord shares = most common type, represent permanent capital for a company. risk capital - last to be paid if comp goes into liquidation (typically nothing left
Preference shares: stock with divi paid to shareholders before common stock dividends are paid out

VOTING RIGHTS
ord - voting rights
pref - usually no voting rights (typically exception if havent received divi in 5 + years)

DIVI
ord - variable (discretionary, only paid out of profits and distributable reserves after prev divi)
pref - fixed

pref shares preferred because
- divi is paid in full before ord divi
- on wind up - higher repayment priority than ord

pref :( because
= divi fixed so wont benefit from sig increase in profit but more downside divi protection than ord

Question 40

Q

Types of ord shares

Answer

A

Ord shares = most common type, represent permanent capital for a company. risk capital - last to be paid if comp goes into liquidation (typically nothing left
Preference shares: stock with divi paid to shareholders before common stock dividends are paid out
Ord shares carry voting rights
Variable, discretionary divi paid after pref shares
Lower priority than pref shares in repayment

‘A’ SHARES
- non voting ord shares - issued often by family companies to avoid loss of control
- likely trade at discount to voting shares

GOLDEN SHARES
- special voting rights, can outvote other shareholders in certain circumstances
often introduced by founders - ‘founder shares’
often used by comps that the government privatized, held by gov giving effective control
used in brazil to maintain control of state run companies

DEFERRED
- not entitled to divi payment until certain condition met
e.g.
- time elapsed since issue
- profits exceeding certain level
-other classes paid x level of divi

REDEEMABLE
- can issue so long as comp has at least one other share class
-may be bought back by the comp either at option of comp or holder on specified date

Question 41

Q

Types of pref shares

Answer

A

Pref shares pay fixed rate of divi which is paid before ord shares
Repaid on wind up before ord shareholders
No security attached
Usually no voting rights (exception if no divi for 5 years)

CUMULATIVE - most pref shares = this
- if divi not paid due to insufficient profits - next divi cant be paid to ord shareholders until any pref arrears have been made up - divi rights baso carried forwards

NON CUMULATIVE
- divi rights not carried forward -arrears dont have to be made up

PARTICIPATING
- right to receive additional divi when profits exceed certain level - participate in good performance
- additional amount usually expressed as % of ord divi

REDEEMABLE
- will be bought back by company at agreed price on agreed date (in title)

CONVERTIBLE
- option to convert to ord shares

Question 42

Q

Limited comps

Answer

A

public limited companies(plc) - limited liability of the shareholders
insolvency - shareholders not liable to pay off debt

For private comps - often loans provided require personal guarantee against owners so they do incur liability for company

Question 43

Q

ROE

Answer

A

ROE = net income/book val of SH equity - pref shares

gauge of profitability and how efficiently profits are generated

Question 44

Q

Yield curve and equity value vs growth

Answer

A

RISING RATES - value outerperforms
Bear flattening = ST rates rise faster than LT
Bear steepening = LT rates rise faster than ST rates

FALLING RATES - growth and high divi outperform
Bull flattening = LT rates fall faster than ST
Bull steepening= ST rates fall faster than LT rates

Question 45

Q

PE ratio

Answer

A

P / E ratio (x) =Current share price / Earnings per share
valuation based on profitability prospects

Looks at how many x share price exceeds level of profits per fshare - indicator as to level on confidence market has

Historic = using actual last 12m EPS or last financial year EPS
forwards - EOY forecasted figure

Question 46

Q

P /B ratio

Answer

A

P /B ratio (x)= Current share price / Book value

Alternative to PE - used often where company is loss making or asset heavy
Not great where comp has more intangible assets (copyrights, goodwill, patents) or if comp has large amounts of debt which negate value of tangible assets

BV = (assets - intangible - value of all liabilities) / number of ord shares in issue
P/B <1 = market valuing comp at less than the value of its assets
- may indicate share undervalued or that assets assumed to be overvalued or some other factor depressing share price

High P/B = investors willing to pay more as they think comp will generate sufficient profits from assets/that investor considers assets to be undervalued

Question 47

Q

Price to sales (P/S)

Answer

A

P/S ratio (x) =Market capitalisation / Total sales or revenue over the past 12 months

shows how much the market values every pound/dollar of sales
if comp doesnt earn profit yet - investors can use P/S to determine if stock is over/under valued vs peers

Question 48

Q

Divi yield

Answer

A

Dividend yield (%) = Dividend per share / Share price

not directly comparable between companies as divi payout ratio is v individual
growth stocks tend to have low or zero divi yields as profits reinvested but low yield doesnt defo mean company will grow
high yield could signal company is insecure - so must pay high divi to compensate or could be comp just has v strong CFs

Question 49

Q

Divi cover

Answer

A

Dividend cover (x) = Earnings per share / Dividend per share

Looks @ ability to maintain current level of divi
2x or higher generally considered prudent
unusually high implies most of profits are reinvested for future growth
<1.5x may suggest not sustainable
<1 - divi funded in part using retained earnings and divi is uncovered which is likely to be concerning to investors

Question 50

Q

BENE AND LIMITS OF ACTIVE MANAGEMENT

Answer

A

BENE
- can tailor strat to meet specific goals
- allows specialist investment strats
- have potential to generate better performance relative to benchmark index over time post fees
- investors have flexibility to choose assets that they believe will outperform
- many active managers are supported by big team of analysts = extensive research to find investment ops

DRAWBACKS
- better performance not guaranteed, can lag benchmarks
- many fail to beat benchmark consistently over long periods tho there are exceptions
- can be hard work and time consuming
- fees can be high which has compounding effect over time, an have exit and perf fees
- top managers can be selective as to who they take on and may have high initial min thresholds
- some actively managed funds are closet trackers

Question 51

Q

BENE AND LIMITATIONS OF PASSIVE

Answer

A

BENE
- lower fees (reduced marketing, distro, accounting, investment costs)
- liquid
- v transparant, clear which holdings are in portfolio
- frequently rebalanced, so investing in passives requires minimal trading
- wide variety of indices avail to suir broad range of styles
-common ETF structure means they are more tax efficient than mutual funds

LIMITATIOS
- when adjusting portfolios to reflect constituent changes, may end up over paying when buying and selling @ depressed prices
- cash drag and internal costs can effect perf and cause tracking error
- can be overly concentrated
- buy and sell decisions based on index not on research

Question 52

Q

Core satellite approach

Answer

A

Designed to minimise cost, vol and tax while allowing for outperformance

Incorp trad secs in passively managed funds (Core) to be held LT (70-80%)
minimises risk of outperformance

Balance held in a number of specialist actively managed funds/individually selected secs (satellite) comprising holdings that investor expects will outperform market

Core can be run on enhanced index basis where techniques included to add value (stock lending, anticipating index entry/exit)
Also can have semi active index

Question 53

Q

Smart beta

Answer

A

emphasizes capturing investment factors or market inefficiencies in a rules-based and transparent way

SMart bets = fund objective is to overcome main drawback of passive funds (automatically following market down and inability to avoid troublesome holdings)

Smart Beta investing follows an index but also considers alternative factors in choosing the stocks from the index

e.g. equal weighted, factor based, low vol

combinebenefits of passive and active

Question 54

Q

Hard and soft commodities

Answer

A

a raw material or primary agricultural product that can be bought and sold = relatively homogenous allowing standardized contracts

HARD
- metals and energy =most common
- natural resource that must be mined/extracted
- finite resources
-mental prices influenced by supply and demand, precious metals benefit from flight to safety, act as store of value
- Copper, lithium and cobalt key for net zero transition (Cu wind turbines and Li/Cu for batteries)
- demand for oil generally driven by consumption tho OPEC have recently controlling supply to support price
-

SOFT
-agricultural prods or livestock
- naturally renewable on annual cycle
- many are perishable both before and after harvest which can make prices volatile
- effected by harvest qual, disease, weather, climate events

Question 55

Q

Direct commodity investment

Answer

A

CASH MARKET (physical purchase)
- expensive to store and insure
-large min quantities
-risk of deterioration (especially for softs)
-standard contract size with gradings to specify quality
-gives fungibility to wholesale market
-more for whole/industry than investors

FUTURES MARKET
- contract to buy/sell set quant of asset on fixed future date @ price agreed today
- delivery is deferred
- no need to take delivery
-standardised parcels (contracts) e.g. 25 tonnes of copper
- must trade in whole numbers of contract (limitation that favours OTC swaps)
-homogenous specified asset

FORWARDS/SWAPS
- forward = private customisable, OTC
-commodity swap (floating commodity price vs fixed) = used to hedge against swings in market and lock in price

AVD/DISADV
- returns historically diversifying vs trad asset classes
- tend to be inputs to manufacturing process so can be a hedge against inflation as prices should rise alongside

-prices tend to be extremely volatile as driven by supp/demand
- heavily influenced by macro favours
- storage costs can be v high with physicals

Question 56

Q

Indirect commodity Invesment

Answer

A

Shares of commodity comps
- e.g. miners/oil producers, revenues and therefore share price linked to commodity price
-correlation not perfect as there are many other factors + hedging costs

Commodity funds
- hedge against inflation, more cap growth focused>income
-retail UCITS cant invest in commodities, but nonretail and QIS can (UCITS can use derivs to invest in commodity index)
- commodity ETF = provide exposure to commodities/basket by buying UL commodities/futures/shares in comps
-ETCs typically track a single commodity, share price moves with spot/futures price of UL

ADV/DISADV
- not closely correlated with trad asset classes
- ETCs and ETFs are v liwuid
- some funds pay divi unlike physical commodity investment
- low storage costs
- more reasonable minimum dealing size

Physically backed ETCs only give exposure to one commodity or small handful
Funds may buy shares of comps which are influenced by other factors

Question 57

Q

advantages and disadv of property investment

Answer

A

ADV
- historically attractive absolute returns
-diversification (low corr to trad investments)

DISADV
- liquidity
- lumpy returns
-transaction and maintenance costs
-effect of gearing
-correlation with economic prosperity
- risk of void periods

Question 58

Q

Types of direct investment in property

Answer

A

COMMERCIAL

retail = shopping centres, shops, supermarkets etc - usually lowest yielding
offices - highly correlated with economy, tenant usually responsible for repairs, long term contacts, most return via rental income. expensive so limited to comps/instits
industrial - estates and distro warehouses etc, long term lease and higher cost of refit so likely lower rental income

agricultural - wide variation of tenancy lengths, expensive, rental income and land appreciation

RESIDENTIAL - typically short, renewable leases, landlord resp for repairs, rental income and price appreciation

Question 59

Q

Rental yield

Answer

A

Gross rent should be adjusted to include void periods

Expenses includes agents costs, insurance, renewals of furnishings (not mortgage interest tho)

Purchase cost includes agents charges, surveys, initial cost of furnishings

Rental yield will depend on demand, property quality, terms
Also affected by vacant periods, previous tenants

Question 60

Q

bond covenants

Answer

A

baso just conditions that protect holders

covenants limiting further debt and priority -
negative pledge clause
- prevent issuer from reducing val of bond by issuing additional debt @ higher priority or
pari passu clause
- only allowing debt to be issued at higher priority is existing bonds are upgraded to have equal priority

covenants restricting divi payment
- excessive divis could negatively impact bond value - covenants frequently restrict payment of cash divi based on earnings and cash
- can also restrict buyback facility

covenants restricting sale of assets
- to prevent val falling due to asset sale - often assets only permitted for sale if proceeds used to buy new fixed assets or retire debt
- can prohibit transfer of whol bis or require new owner to assume all obligations of bond

breach of covenants is a default event - if no solution is found afer engagment period post default - bond becomes immediately repayable

Question 61

Q

green bonds?
GBP?

Answer

A

conventional debt where proceeds used to finance/refinance new/existing green projects
- w/ positive environmental or climate benefits e.g. energy efficiency, transportation

additional transaction costs - issuer must track, monitor and report on funds
- issuers think this is offset by benefits (diversifying investor base, highlighting greenness etc)

lack of standardization as to what makes a green bond - can lead to greenwashing, green label can confer pricing advantage

GBP - green bonds principal dev by ICMA - completely voluntary recommendation of guidelines + transparency and disclosure, promoting integrity etc

fall from green grace - bonds losing green status -reputational and price damage - could put cap at risk due to downward pressure.
canlead to ‘green default’ - investors seeking penalties for breaking green clauses even if bond is paid in full

Question 62

Q

social bonds

Answer

A

bond with proceeds used to fund projects with non environmental but beneficial theme - typically with social objectives in mind

e.g. basic infrastructure, affordable housing, health services - particularly to benefit those livign below poverty line

first ever - Asia 2018 - to provide stable LT housing in Korea

like green bonds - ICMA has issues SBP (social bond principles) - voluntary guidelines where issuers may align framework to market expectations = market confidence

Question 63

Q

sustainability bonds

Answer

A

funds used to finance or refinance combo of green and social project - ICMA has issued SBG - sustainability bond guidelines - promoting integrity etc, voluntary

Question 64

Q

sustainability linked bonds (SLBs)

Answer

A

any bond instrument where financial and structural characteristics vary depending on whether issuer has achieved ESG/sustainability objectives

more flexi than green/social/sustainability bonds which can only be used to finance specific projects
- no specific use of proceeds - but issuer must define/commit to sustainability path over years

ICMA has vol SLBP guidelines = sets out best practise for launching credible slb

SLBs are complimentary financing to green/social/sustainability bonds

Answer 62

A

proceeds used for protection and conservation of marine ecosystems

generally issued by low-income countries that are heavily reliant on oceans and their resources

first sovereign blue bond: 2018 Republic of Seychelles - $15mn to support expansion of marine protected areas, fisherie governance
coupons partically guaranteed by world bank and concessional loan from GEF

Answer 63

A

main goal is to achieve social objectives not investmentreturns

very diff from conventional bonds - focus is on social benefit > investment potential

payouts based on specific social criterias being met
dont offer fixed return

used by govt to address issues e.g. homelessness, youth unemployment, children in care etc

BASO
contract with GOV/pub sector issue, whereby it pays for better social outcomes + passes on part of the savings achieved to investors.

Answer 64

A

rates (up P down) - investors need higher ROR as rates rise
inflation (up price down) - investors need higher ROR as inflation rises, for ILB price tends to rise as higher inflation expected - both prevailing and expected rates impact
liquidity - more liquid = more expensive
exchange rates
issuer specific factors
- credit rating - higher = higher price - lower yield
- structure and seniority of bond - higher = higher price
bond derivs

Answer 65

A

gives holder right not obligation to conert bond into predetermined no. of ordinary shares of issuer @ fixed price @ set time @predetermined conversion ratio e.g. (25 shares per 100 NV)

holders only exercise if share price more attractive than prevailing market price

exposes holder to growth potential in rquity while retaining safety of bonds - trade at prem to shares they can convert into

Answer 66

A

until converted or maturity - react to changes in yield and IR like other bonds

employed as deferred shares - issuers expect conversion @ conversion date/period

predefined conversion ratio - e.g 25 per 100 NV (maybe with price per convert too)

conversion right may only be on maturity or may exist for period of time

lower coup than straight corp

subordinated debt instruments

poss additions
- put rights - to force early redemption normally at premium to par
- call rights - under certain conditions @ certain price

Answer 67

A

Advantages
- lower coupon issuance
- no immediate dilution of shareholder control
- no assets required to secure straight finance
- good for finance projects with LT payback
- less EPS dilution than normal share/bond issue
- interest payments tax deductable unlike equity finance

Disadvantages
- coupon payments required even if comp makes no profit unlike divi payments
- if poor performance - would have to redeem for cash if holder chooses not to convert
- cannot be sure firm is issuing deferred share cap as may not convert
- future dilution of shareholders

Answer 68

A

advantages
- security of fixed income with downside protection if shares fall with option to participate in uplift from + share price performance
- higher coupon vs divi yield (lower than straight corp)
- very liquid vs straight corp
- above shares in liquidation

disadv
- unsecured, lower ranking debt - lower repayment piroiry
-often callable
-dilution of existing shareholding on conversion
-if cshares go down - yield sacrified vs corp with no benefit
- lower yield than corp (higher than corresponding eq)

Answer 69

A

no. of shares the bond can be converted into
e.g. x shares per £100 NV

ratio = NV/conversion price

Answer 70

A

convertible price/no. of shares

can use NV if converting at maturity

Answer 71

A

current share price x conversion ratio

conversion ratio = NV/conversion price

Answer 72

A

conversion price - share price /share price

Answer 73

A

liquidity pref theory
- longer term commitment = higher compensation required - explains upward sloping curve
- people desire liquidity so must be compensated more if they are lending for longer(3 motives)
- spot rates are the egg - forward rtaes and yields derived from them

pure expectations theory
- shape varies according to rate expectations
-steep upwards = expecting rate rising, increased demand for ST bonds
-downward = rates expected to fall, want to lock current rates in now
-flat curve - no expected change in rates
- argues that curve is reflection of spot rates which are reflection of forward rates (yield = weighted avg of spot rates which are geometric mean of forward rates)
- yield curve reflection of spot rates and spot rates reflection of forward rates (egg)

preferred habitat/segmentation - different investors in different segments of maturity spectrum
- pensions/insurance companies at long end
- banks in short end
- 2 nds of curve have life of their own since they react differently to same data

Answer 74

A

= potential that a change rates will reduce the value of a bond

prob most important risk factor - due to relationship between rates and bond prices

can be mitigated by matching macaulay duration with liability

or with FRNs or step up bonds to mitigate effect of rate changes or ILBs

Answer 75

A

risk that inflation will undermine the performance of an investment

linked to IR risk as rates will rise to compensate bondholders for decline in purchasing power

may be reduced with ILBs

Answer 76

A

risk of issuer defaulting on obligations to pay coupons and repay principal

ratings help to assess this risk - though reputational damage caused during financial crisis due to ratings of MBS

mitigated by investing in highly rated bonds

Answer 77

A

loss incurred when a market participant wants to execute a trade or to liquidate a position immediately while not hitting the best price - i.e. ease with which asset can be sold for best price

worse for smaller issues and off the run stocks (not most recent issue)

Answer 78

A

exposure to losses/gains in the value of currency when converting CFs

can be mitigated by buying bonds in investors home currency

Answer 79

A

risk that witholding tax will increase

or risk of capital controls locking money into market with foreign bonds

Answer 80

A

risk arising due to specific bond issue e.g. call rights

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