5 -Investments Prods

Question 1

types of collective investment scheme

Answer 1

Unit trusts
- open ended (no restriction on size can adjust to meet demand), legally a trust
- 20% CT

OEIC/ICVC
- open ended, legally a company
- PAIF = type of OEIC with 60% property allocation
- 20% CT

ITC - investment trust company
- legally a company, trades on LSE, closed ended
- VCT = venture capital trust - 75% EIS investment, REIT - 75% physical property investmnet

Question 2

adv and disadv of collectives

Answer 2

adv
most investors dont have time to allocate to investment management - funds are ready maid portfolios
economies of scale
diversified
admin handled by funs

dis adv
entry, annual, performance charges, custodian fees
risk
lack of control
star managers may move

Question 3

Unit trusts/ OEICs
tax?
NAV?

Answer 3

20% CT on income

both bond and equity funds pay savings income/divi gross
no stamp duty for investor
possible CGT on sale (eq)

OEICs - daily NAVV calc for pricing of unit
+ dilution levy to cover dealing costs
unit trusts - bid offer pricing

single pricing funds (OEICS and some UTs) can take advantage of UCITS dirctvie to market in europe

Question 4

European funds

Answer 4

SICAV - open ended fund that can gain UCITS compliancy similar to ICVC

FCP - open ended funds establed between investor and manager, neither trust nor sompany
more like an open partnership

Question 5

UCITS directives
how can a CIS qualify?

Answer 5

CISs are regulated by the UCITS directive in the EU

to qualify CIS must
obtain passport from home regulator, be open ended, not invest in prohibited asset classes (property or commodity) + single pricing

UCITS III
product directive expands range of financial instruments permitted in UICTS funds, gearing restrictions (max 10% NAV)

UCITS IV
passporting rules, KIID, supervision

Question 6

Money market funds
what?
objective?
types?
benchmark?

Answer 6

invest in short term cash or near cash assets (1 year maturity money market prods)
In Europe set up as UCITS schemes

cash, commercial paper, short term gilts, T-bills

objectives - preservation of capital, liquidity, sector concerns

types
constant NAV- income paid out or reinvested
accumulating NAV - income not distributed but added to value of shares

benchmark
- LIBID - london interbanj bid rate
- SONIA - sterling overnight interbank average - avg interbank unsecured overnight deposites min deal size 25mili (bofE)
- EONIA - euro overnigh avg - weighted avg of unsecured euro overigh deposits (ECB)

Question 7

ITCs

Answer 7

company not a trust, closed ended, trades on secondary market
can leverage which unit trusts and ICVCS cannot
usually hit share volume limit at IPO
19% CT on income
not direct holdings
no CGT

divi paid gross, investor pays stamp duty and potential CGT’

prices dictated by supply and demand - can trade at prem or disocunt to NAV
gearing risk

Question 8

2 types of ITC

packaged units?

Answer 8

conventional and split capital

conventional - run like normal company with indefinite life
2 classes of share: ordinary and preference

split cap
set up for specified period (5-10) years after which porfolio is liquidated

3 basic types of share
zero divi - 1st shareholder paid in liquidation, redemed at pre secified value
income - regular distributions, typically pre specificed redemption val, 2nd paid @ liquidation
capital - typically no income, last shareholder paid, receive any residual funds

can also get packaged units that represent a hydrbid of above

other share types
A shares - ordinary with no voting rights and highest right to divi
stepped preference - income grows at predetermined rate and predetermined mat value
income and resiudal cap shares - issued by ITC with high levels of borrowing - high risk

Question 9

Packaged unit shares in split capital ITC

Answer 9

packaged units that represent a hybrid of (zero divi, income and capital) typical shares

A shares - ordinary with no voting rights and highest right to divi
stepped preference - income grows at predetermined rate and predetermined mat value
income and resiudal cap shares - issued by ITC with high levels of borrowing - high risk

Question 10

REITS key differences to ITC

Answer 10

> 75% property allocation
more tax efficient - no CT when 90% of income is distributed
divi taxed as property income (20, 40, 45)

Question 11

VCT - venture capital trusts

Answer 11

tax incentives in start ups and small companies
no tax on divi
30% income tax relief up to max investment of 200k
5 year holding to quali of income tax relief
no CGT

Question 12

ETF

adv?

Answer 12

listed and traded on LSE, no stamp duty, low charges, real time pricing
tracker fund - follows performance of an index

adv
exposure to variety of markets
high liquidity
can be held in ISA
gearing + long/shorting allowed

dont trade at discount/prem - only creates units on being given underlying basket of index

Question 13

physical vs synthetic ETF

Answer 13

physical - investors use cash to buy underlying

synthetic - use deriv contracts to gain expose (e.g. total return swaps)
counterparty and collateral risk
stock lending in phsyical ETFs can expose to these risks also

Question 14

Offshore funds - reporting vs non reporting

Answer 14

reporting funds
- must report income to HMRC and investors
- prepares accounts using GAAP format
- gives HMRC info on request
investor taxed as if onsure fund

non reporting
- income and gains taxed as income not at CGT rates
no annual CGT exemption
losses not offset against grains

Question 15

Offshore funds - reporting vs non reporting

Answer 15

reporting funds
- must report income to HMRC and investors
- prepares accounts using GAAP format
- gives HMRC info on request
investor taxed as if onsure fund

non reporting
- income and gains taxed as income not at CGT rates
no annual CGT exemption
losses not offset against grains

Question 16

tax summary for funds

Answer 16

Income tax - 20% CIS, 19% ITC, VCT, not for REITS (so long as +90% income paid out)
no CGT
Stamp duty - yes on equity and SDLT for REIT

Question 17

tax summary for investor

Answer 17

income - equity CIS (div), debt CIS (savings), ITC (div) REIT (non savings as if direct rental income), VCT = NO
CIS and ITC - no witholding tax, paid gross
REIT = witholding tax
CIS, ITC, REIT - CGT (not for VCT if held over 5 years)
no stamp duty for open CIS

Question 18

What is a hedge fund
why is it risky

Answer 18

UCIS - unregulated collective investment scheme typically offshore
low correlation with markets due to unregulation and variety of strats available
cannot be marketed to retail clients (only wealthy, sophisticated RI)
managers invest in own fund

risk:
larger positions, less diversified, long/short strat
leveraged, aggressive
little supervision
high initial investment and lock in periods
high management fees and performance fees
no FOS or FSCS

Question 19

Measuring hedge fund performance and benchmarking
types of bias?

Answer 19

Investment association (IA) review of ARFs (absolute return funds)
diff because diverse objectives and lack of transparency
no mandatory reporting standard - creates biases

self selection - only those who want to report will - typically not v top or v bottom
backfill bias - funds just joining dont have to report past performance
survivorship bias - failing funds drop out of bench

Question 20

Measuring hedge fund performance and benchmarking

Answer 20

Investment association (IA) review of ARFs (absolute return funds)
different because diverse objectives and lack of transparency
no mandatory reporting standard - creates biases

self selection - only those who want to report will - typically not v top or v bottom
backfill bias - funds just joining dont have to report past performance
survivorship bias - failing funds drop out of bench

Question 21

PE investments

what is PE?
4 types of investment

Answer 21

PE invest in companies not listed on a stock exchange - more hands on w/ active involvement
aim to turn company around and take to IPO

venture cap - start ups and new tech with no track record. equity cap and strategic help (dragons den vibes)

mezzanine cap - subordinated debt, high risk/return unsecured lending

leverage dbuy out - established plc to private firm, acquisition debt

distressed debt - distressed comapnies, equity or debt, vulture funds may lookto buy and asset strip

Question 22

EIS

Answer 22

enterprise investment scheme - aimed at helping smal high risk tradinc ompanies
500 - 1 mili investment size

income tax relief
30% cost of ordinary shares up to 1mili - max relief = 300k
must hold for 3 years from issue
can caryr back relief to previous issues

no CGT provided EIS held for 3 years
can offset losses againstincome tax relief for tax year

startups can apply for EIS status to incentivize

Question 23

EIS company requirements

Answer 23

unlisted (AIM and ISDX growth is allowed)
<250 employees
<£12mili raised in total or <£5mili from VCT in any year
<7 years old

knowledge intensive = <10 years, <500 employees, funding cap is £20mili

Question 24

life company investment bonds

Answer 24

not a debt security - bond like ‘my word is my bond’
typically used as investment not as life policy

benefits paid on death orencashment

qualifying policies - HMRC satis that bond in valid assurance product so taxed as such - no more tax to pay (fund already paid 20%)

non qualifying policies - on chargeable event extra income tax for HRT,ART

5% rule
life company bonds aren’t qualifying investments - tax can be deferred til death or encashment on a withdrawal of up to 5%

Question 25

derivatives

what are they?
types

Answer 25

financial instrument that derives its val from some other asset
used to gain (speculation)or limit (hedging) exposure to asset (indirectly)

futures and forwards
options
contracts for differences

dont create or destroy risk just transfer from person to person

Question 26

the long and short in derivatives

Answer 26

Long – the buyer of the future. The long is committed to buying the underlying asset at the pre-agreed price on the specified future date.

Short –the seller of the future. The short is committed to delivering the underlying asset in exchange for the pre-agreed price on the specified future date

Question 27

futures

Answer 27

XC traded agreement to buy/sell given quant of given asset at set future date
closing out - taking equal opposite position in order to crystallise profit/loss or prevent delivery of asset when speculating

used when hedging and speculating

M2M - calculating unrealised profits and losses in open positions to allow margining - this margining allows clearing house to call collateral from firms for its operating costs

Question 28

futures vs forwards

Answer 28

forward = OTC future

-less regulated as OTC
-counterparty risk as OTC (not guaranteed by CH)
currencies traded with forwards not financial futures

Question 29

option?

Answer 29

gives the holder the right but not the obligation to buy/sell an asset at an agreed price on (or before in US) a set date

Question 30

call and put options

Answer 30

call - gives holder (buyer/long) the right to buy underlying from seller/writer/short
put- gives the seller/writer/short the right to sell the underlying
@agreed price on agreed date

Question 31

strike price?
in/at/out of the money

Answer 31

strike/exercise price = price agreed in options market at which underlying is bought or sold

call option = strike price is below market price - option is in the money - long would exercise
strike price is above the market price - option is out of the money (exercising would result in loss) - option is out of the money

put option = strike price is below market price - holder would abandon - out of the money - exercising would result in a loss
strike price above market price - holder would exercise - contract is in the money

at the money = strike price = market price

Question 32

warrants and covered warrants

Answer 32

Security not a derivative - but functions like a call option
warrants - issued by company giving investor right to buy a set no. of newly issued company shares
right to buy only
typically 4-5 yeards - baso long dated call options
LSE traded (derivs trade on deriv exchange)

covered warrants - can be call or put - ‘securitized derivatives’ - true options
issued by investment bank
traded on LSE - short term (1yr)
warrant is cash settled and investment dooesnt buy the shares
can only be bought not sold

Question 33

Structured products

Answer 33

no FSCS
create dby combining 2+ financial instruments to meet specific type of financial need

features
- income or grwoth
- defined risk and returns (linked to external measure eg index)
typical fixed terms (5-7 years)
risk based on issuer not just underlying investments

Question 34

types of structured prod

Answer 34

principal protected investments
- full downside protection of bond with upside potential of equity
- good for those unwilling to risk principal or lt financial obligations
- e.g. £1000: £800 ZCB 5yr £1000 NV, £200 5yr OTC call on FTSE100 - worst case capital is returned

buffer zone investments
-cap at risk but moderated/capped losses
- increased upside potential to relatively protected principal
-typically shorter maturity
- good for moderate risk, but want buffer to mitigate potential losses

return enhanced investments
- upside leveraged 2/3x - losses also magnififed
- full downside exposure in underlying, offers leveraged equity returns up to pre specified max
- good for big risk appetite

Question 35

Pension schemes and tax allowances

Answer 35

2 major types

occupational - tax breaks for employer and employee
- salary related - DB = avg salary/final sal
- money purchase - DC e.g 5% of sal

personal pensions, stakeholder, SIPP
- money purchase schemes

income tax relief
- max annual allowance = 40k
max lifetime = 1,073,100

tapered annual allowances for high earners
- reduce dby £! for ever £2 annual income over £240k
min allowance = 4k - £312k

Question 36

money purchase pension choices @ retirement

Answer 36

25% tax free lump su
buy annuity with all or part (lifetime or short term)
flexi access draw down (first 25% tax free if no lump sum)
mix of options

rest is taxable at marginal rate