2024-25 Chapter 2: Cash, Money Markets and Foreign Exchange (39 questions) Flashcards
These deposit-taking institution must be formally authorised to be able to accept deposits under the Banking Act 1987 and the Financial Services and Markets Act 2000 (FSMA 2000).
As long as the saver’s money is held with an authorised deposit-taker then it will qualify for the Financial Services Compensation Scheme (FSCS).
Cash is a stable, fixed-value asset. Its face value doesn’t increase, unlike stocks or real estate that can appreciate over time.
You don’t “sell” cash for more than you bought it, so there’s no opportunity for capital appreciation. Hence no capital growth for cash
One of the key differentiators, when comparing savings accounts, is whether they are instant access or restricted access accounts, or structured accounts. This will affect the rate offered by the provider.
Structured deposits/accounts
Rather than offering a set interest rate, structured deposits link the return on a deposit to the performance of a stock market index, such as the FTSE 100 index.
Accounts cannot be classified as instant-access unless they truly offer instant access to monies deposited.
They can offer ‘teaser rates’ where they have higher rates for an initial period, after which rates are reduced, or rates that are only higher whilst other ‘conditions’ are fulfilled. This is ‘frowned upon’ by the regulator.
What is the 5% rule for cash ISA
the investment must return at least 95% within a 5 year period. Otherwise it must be held in a stocks and shares ISA
EXAMPLE :
Suitable cash ISA investments include:
UK bank and building society deposit accounts.
Units or shares in authorised collective investment schemes such as unit trusts, OEICS, UCITS and life assurance policies (more about these in Chapter 6).
NS&I Cash ISA products.
Stakeholder cash deposit (short term) products.
Tax free NS&I
Remember PICK
Premium bonds
ISA
Saving certificates
Kid accounts
Everything else is taxable and pays interest gross
2.4: Risks associated with Cash Investments
Outline and explain each
Default risk: the creditworthiness of the firm you save with.
Inflation risk: the impact of inflation.
Interest-rate risk: the uncertainty of interest rate movements.
Currency risk: exchange rate movements, if saving overseas.
Reinvestment risk: the likelihood of ‘similar deals’ being available at the end of a fixed term investment.
What is the money market?
What is a money market investment?
A place where institutions such as governments, banks and building societies, and companies lend to and borrow from each other.
They are usually high-value transactions, over relatively short terms, typically less than one year.
A ‘money market investment’ is therefore essentially a short-term loan to the Government, a bank or some other company or organisation. ie, an investment on the money market
What is the The Interbank Market
A specialised market where commercial banks lend and borrow between each other for periods of up to 1 year in a variety of different currencies. The market is key for a smooth-running financial system as it allows banks to manage their daily liquidity positions easily. basically a members only version of the main money market
In the London interbank market, interest on loans is charged at the Sterling Overnight Index Average Rate or SONIA.
2.5.2: Money Market Instruments
The main types of money market instruments are:
LEAST RISKY - Repos
-Treasury Bills
-Bankers Acceptances
-Certificates of deposits
MOST RISKY - Commercial Paper
2.5.2 included description of each
Most money market instruments are issued in ‘bearer’ form.
The original investor or ‘lender’ will receive a confirmation of their investment / loan in the form of a bill or certificate. That proof of ownership means that they will be the person who receives the money back at the end of the loan term.
If they want money back before the end of the term, they can sell the proof of ownership to someone else on the secondary market. The new owner, if they don’t sell on again, will be the one who receives the funds at the end of the loan term.
The money market involves huge amounts of money and is generally not within the reach of an individual investor. What is the minimum investment?
So, how do individual investors still get involved in the money markets?
£500,000 would be the minimum investment for an individual. Most often it is banks, insurance companies, and pension / collective investment funds that invest in money market investments.
Individual investors can get involved through ‘collectives’. These collectives are known as money market funds
What is the difference between money market funds and money market accounts?
Money market funds - a type of collective investment that allows individual investors to invest into different money market instruments without having to commit a huge amount of cash themselves
Money market accounts - Set up by banks and offer individuals competitive interest rates linked to money market returns. Usually fixed term and have high minimum investment levels (ie £50k)
In relation to money market funds, In 2012, new rules were brought in to ensure clients are clear about the type of money market fund they are investing in, details of which can be found in the FCA’s Collective Investment Scheme Sourcebook (COLL).
Money market funds are now split into two types:
Money market funds & Short term Money market funds
Money market funds - changing NAV - income received by fund can be used to increase price of units
Short term Money market funds - Fixed NAV. To keep NAV constant accrued income must be paid out to investors or are used to buy more units in the scheme
Money market investments are subject to the same risks as all cash investments. True or false
True
The fact that money market funds are generally well-diversified can lessen overall default risk, but the actual extent will depend on the individual credit ratings of the institutions offering each type of money market instrument. The term for this is ‘Credit Risk’. It applies to the individual companies the money is lent to.