April 2019 Flashcards
State the additional information that the financial adviser would require from Beth in order to establish her investment needs.
- Attitude to risk.
- Capacity for loss.
- State of health.
- Emergency fund.
- Other assets/ liabilities.
- Ethical/Socially Responsible Investment preferences.
- Future lump sums required.
Explain the purpose of the information ratio to Beth.
- Compare against sector/benchmark.
- Assess risk adjusted returns.
- Out performance/added value/alpha.
- Consistency of the manager.
Calculate, showing all your workings, the information ratio for the direct property OEIC. Assume a benchmark return of 40%.
48 - 40 / 7.2 = 1.11
State six reasons how city office REIT may have achieved the highest information
ratio.
- Sub-sector/commercial office out-performance against sector.
- Consistency of the fund manager.
- Manager’s skill in office purchases;
- and disposals.
- Lowest level of cash.
- Trading at premium/closing discount.
- Use of gearing/leverage.
- Tax structure/status/efficiency.
Explain the potential reasons why the direct property OEIC has a higher level of cash.
- Inflows into the fund.
- Manager unable to make new investments/deal flow slowed down.
- To cover redemptions.
- Just about to purchase/just sold property.
- Rental income.
Explain the effects of the higher level of cash within the direct property OEIC.
- Drag on performance.
- Reduces risk/protects in falling market.
- Dilutes yield.
- Reduces risk of forced sales/buying opportunities.
State four ways in which an open-ended fund structure could respond to a liquidity crisis following substantial redemption requests.
Open-ended/OEIC/ETF
* Dilution levy/exit penalty.
* Switch pricing/swing-pricing/offer to bid price/fair value price.
* Borrow to fund redemptions.
* Gated/limited redemptions/change dealing frequency.
* Suspend redemptions.
* Forced sale of property(ies).
State four ways in which a closed-ended fund structure could respond to a liquidity crisis following substantial redemption requests.
Closed-ended/REIT
* Borrow.
* Move to discount/widen spread/match buyers and sellers.
* Suspend dealing.
* Rights issue.
* Sell property.
The financial adviser uses an efficient frontier curve when evaluating the portfolio’s asset allocation.
State the three inputs required to produce an efficient frontier curve.
- Expected return.
- Standard deviation/level of risk.
- Correlation.
The financial adviser uses an efficient frontier curve when evaluating the portfolio’s asset allocation.
Explain how the efficient frontier is used in investment planning.
- To set (optimum) asset allocation.
- To show best/highest return;
- given level of risk.
The financial adviser uses an efficient frontier curve when evaluating the portfolio’s asset allocation.
State five limitations of using the efficient frontier.
- Assumes standard deviation as measure of risk.
- Does not take into account attitude to risk/capacity for loss.
- Uses historic data to predict expected returns.
- Excludes impact of costs and charges.
- Assumes portfolio uses passive funds/cannot factor Alpha.
Incorporating passive funds within the investment portfolio assumes the efficient market hypothesis (EMH) applies in one of its forms.
Describe the weak form of EMH.
- Current prices;
- fully reflect;
- all past prices/trading information.
- Prices cannot be predicted;
- by analysing historic data.
- Technical analysis does not work/fundamental analysis does work.
List three Investment Association sectors that could be suitable to provide the funds to construct the UK equity component of the investment portfolio to meet Beth’s objectives.
Beth, aged 46, has just inherited £230,000 following the death of her widowed mother and is looking to invest the money over the long term. She has been self-employed for the past few years with an average net profit of £40,000 per annum.
Beth would like to invest the inheritance to generate a gross income of £6,000 per annum and would also like to see some capital growth.
- UK Equity Income.
- UK All Companies.
- UK Smaller Companies.
- UK Equity & Bond Income.
- Mixed 0-35%/20-60%/40%-85%/Flexible.
Explain the main differences between strategic and tactical asset allocation.
Strategic
* Fixed weightings/allocation;
* long term;
* with occasional/infrequent rebalancing.
* Little variation from objective.
* No response to market changes.
Tactical
* Varying weightings/allocation;
* short term;
* with frequent rebalancing.
* Substantial variation from objective.
* Take advantage of market changes.
State, giving two reasons why, which type of asset allocation would be most suitable for Beth.
Beth, aged 46, has just inherited £230,000 following the death of her widowed mother and is looking to invest the money over the long term. She has been self-employed for the past few years with an average net profit of £40,000 per annum.
Beth would like to invest the inheritance to generate a gross income of £6,000 per annum and would also like to see some capital growth.
- Strategic.
- Investing for long term.
- Objective known at outset.
- More suitable in income generating portfolio.
Outline what would cause a normal yield curve to invert and explain the potential implications for Beth’s portfolio.
Beth currently holds three funds in the commercial property sector on a direct basis, as shown in Table 1. She invested into these several years ago with the proceeds from her divorce. Beth is pleased with the performance of her existing investments but was concerned in the summer 2016 when she received some correspondence from one of the fund managers stating that she would not be able to withdraw her capital for a period of time.
- Expectation that;
- long term interest rates will fall;
- short term interest rates will rise;
- long term inflation will fall.
- Economic outlook pessimistic/low growth/recession.
- More capital will be needed to provide income/longer bonds more expensive.
- Change duration of bonds purchased.
- Asset allocation may need to be changed/revised.
Explain four benefits of using the Capital Asset Pricing Model (CAPM) in assessing the potential suitability of the Myriad fund.
- Easy to calculate/uses widely available information.
- Takes account of systematic/market risk.
- Reflects fact most portfolios are diversified to remove unsystematic risk.
- Robust/trusted.
- Gives an expected return/benchmark.
Calculate, showing all your workings, the beta for the Myriad fund using the CAPM.
4 = 0.75 + beta (6 - 0.75)
(4 - 0.75)
= beta (5.25)
3.25 / 5.25 = beta
Beta = 0.62
Comment on how the Myriad fund would be expected to perform compared to
its benchmark index in both rising and falling markets based on your answer to
part (a)(ii) above.
Beta = 0.62
- Less volatile/sensitive;
- so is likely to underperform in rising markets;
- so is likely to outperform in falling markets.
State four costs in addition to those in your answer to part (b)(i) above that may be paid when investing in the Myriad fund.
- Management fee/Annual Management Charge.
- Administration fees/secretarial/directors fees/insurance.
- Marketing.
- Audit/tax compliance fees.
- Registration/regulatory fees.
- Custody/depositary/trustee.
- Transactions fees/initial charge/spread/Stamp Duty.
- Performance fees.
- One off legal/professional charges.
- Interest/gearing costs.
- Adviser charge.
Identify eight factors the Myriad manager would consider when deciding whether to invest in OEICs or ETFs.
- Charges.
- Tracking error/benchmark.
- Standard deviation/risk.
- Dealing frequency.
- Alpha/stock-picking/performance/reputation.
- Duplication/concentration risk.
- Dividends.
- Mandate/style/passive/active.
- Counterparty risk.
Calculate, showing all your workings, the undiluted net asset value per share for GDV Trust plc and its discount/premium.
£73,400,000 - £18,000,000
= £55,400,000 / 22,000,000
= £2.51818181 = £2.52
Undiluted
£2.52 - £2.28
= 24p/9.5% discount
Calculate, showing all your workings, the diluted net asset value per share for GDV Trust plc. Assume that all the warrants are exercised at the subscription price.
650,000 x £0.89 = £578,500
+ £55,400,000
= £55,978,500 / (22,000,000 + 650,000)
= 2.4714570 = £2.47
Identify the implications for Haymi if she chooses not to exercise the warrant
- Her existing shareholding will be diluted.
- Share price/investment value will fall.
- She could sell warrant(s) for cash/warrant(s) could expire.
Calculate, showing all your workings, GDV Trust plc’s net gearing ratio.
(73,400,000 - 18,000,000) = 55,400,000
18,000,000 / 55,400,000 x 100 = 32.49%
State four possible consequences for GDV Trust plc of an increase in its borrowings.
- Increases profit.
- Increases losses.
- Increase financial risk/interest rate sensitivity
- Share price more volatile/discount may change.
Calculate, showing all your workings, the basic earnings per share (EPS) for Aviation Alloys plc.
£34,000,000 - £5,900,000
= £28,100,000 / 80,000,000
= 35.125p
Calculate, showing all your workings, the dividend cover on an individual share basis for Aviation Alloys plc.
£17,000,000 / 80,000,000 = 21.25p
35.125 / 21.25 = 1.652941 = 1.65x
Based upon the description in the case study, list the three main risks that are specific to Aviation Alloys plc’s business and give one example for each of the three risks.
- Economic risk.
- Aviation sector cyclical.
- Currency risk.
- Earnings on overseas sales/exports impacted by currency volatility.
- Political risk.
- Effect of tariffs/trade sanctions.
- Costs of responding to Brexit.
- Effect of emissions regulations.
