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FCA 1: Securities > Asset Classes > Flashcards

Asset Classes Flashcards

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SIE Exam flashcards
1
Q

what categories can equities be divided into?

A

ordinary shares and preference shares

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2
Q

what are redeemable shares?

A

shares offered by a company to shareholders which can then be bought back by the company at its election

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3
Q

what are preference shares?

A

slightly less risky than ordinary shares, lower level of return, less risk due to dividend policy and rank above ordinary shares in the case of bankruptcy. Hybrid securities (have characteristics of equities and bonds)

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4
Q

what are the features of ordinary shares?

A

face the greatest risk, will only receive payment if there is money left over after all others ranked above them have been paid. may receive dividends if the company is sufficiently profitable

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5
Q

what is the nominal value of a share?

A

the minimum amount that the company must receive from subscribers on the issue of a share

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6
Q

what is a cumulative preference share?

A

they will not only be paid this years dividend before any ordinary shareholders and also any unpaid dividends from previous years

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7
Q

what is a participating preference share?

A

offer the opportunity to participate in higher distributions and can participate in additional distributions in the event of liquidation

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8
Q

what are convertible preference shares?

A

shareholder has the right but not the obligation to convert the preference shares into a predetermined number of ordinary shares, method of avoiding the lack of upside potential in preference shares

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9
Q

what are zero coupon preference shares?

A

preference shares that pay no dividend but offer an upside to the shareholder in that they redeem at a price above which they are issued

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10
Q

what are the downsides to preference shares?

A

often less liquid, not actively monitored, may underperform ordinary shares in the market

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11
Q

what is the nominal value of a bond?

A

par value. the amount that the borrower will pay back to the holder on the bond upon maturity

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12
Q

what must an issuer do to try draw more bond investors?

A

increase the interest rate

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13
Q

what is the redemption date?

A

the date at which the borrower agrees to pay back the nominal value of the bond

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14
Q

what are FRNs?

A

floating rate notes- bonds that adjust the coupon and the principal amount to the prevailing rate of inflation- also referred to as index linked e.g., CPI

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15
Q

what is the bond yeild?

A

measures the percentage return that an investment provides

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16
Q

what is the flat yeild?

A

only consider the coupon and ignores the existence of of any capital gain (or loss)- ignores any gains or loss that will arise if the bond is held through maturity

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17
Q

what is the flat yield calculations?

A

flat yield = (annual coupon/price) x 100

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18
Q

how can yield help investors analyse?

A

how a change interest rate will affect the price of a bond- i.e., if the interest rate rises investors will want the yield to rise in line with this but because the coupons are generally fixed, the only way yield can increase is if the interest rate rises.

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19
Q

what is the GRY/YTM?

A

Gross redemption yield, Yield to maturity
takes both the coupon and any gain through to maturity into account- considers the gain or loss if the bond is held until it matures- presents a more complete picture than the flat yield but ignores taxation

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20
Q

what is the IRR?

A

Internal rate of return- discount rate that, when applied to the future cash flows of the bond, produces the current price of the bond

it is the interest rate minus the amount lost as a result of the purchase of the bond- distributed over however many years the bond is held for

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21
Q

what is the NRY?

A

Net Redemption Yield- takes both the annual coupons and the profit/loss made through maturity into account- looks at the after tax cashflows rather than the gross cash flows

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22
Q

what is the relationship between bond coupons and volatility?

A

lower-coupon bond will be more volatile to changes in interest rates as opposed to higher-coupon bonds. similarly to

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23
Q

why would investors invest in fixed rate securities if the interest rate falls?

A

the price of the securities will rise, meaning they have a greater ROI- some are more responsive than others

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24
Q

what types of bonds are more responsive to interest rate changes?

A

lower coupon bonds and long-dated bonds

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25
Q

what is modified duration?

A

a measure of volatility- shows the expected change in price given a specified change in interest rates. approximate percentage change in price, given a 1% change in interest rate

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26
Q

how is corporate debt serviced?

A

by making regular interest payments on the debt- interest is calculated by reference to the coupon rate, frequency and nominal value

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27
Q

what is a convertible bond?

A

bond that gives the holder the right but not the obligation to convert the bond into a predetermined number of ordinary shares of the issuer- generally traded at a premium

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28
Q

what is the advantage of convertible bonds?

A

the value if the share price rises and that there is a downside protection provided by the redemption value if the shares don’t perform well

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29
Q

how are convertible bonds issued(price)?

A

where the price of each share is set at the outset and that price may be adjusted to take into account any subsequent bonus or rights issues

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30
Q

what is the conversion ratio and how is it calculated?

A

number of shares that each nominal value of the bonds can convert into.

nominal value/conversion price of shares

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31
Q

what is the flat yield?

A

looks at the annual cash return (coupon) generated by an investment as a percentage of the cash price- regular annual return that is generated on the money invested

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32
Q

how is flat yield calculated?

A

flat yield %= (annual coupon rate/market price)x 100

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33
Q

what are the drawback of flat yield?

A
  • often gives an incomplete view as it only takes into account the coupon and ignores capital gain
  • completely ignores the timing of any cash flow
  • if the bond is an FRN, the return changes so the flat yield becomes random (doesn’t take into account the variables)
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34
Q

what is accrued interestand how is it calculated?

A

interest that has been earned but not paid

= coupon payment x (number of days since last payment/number of days between payments)

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35
Q

what is the dirty/clean price?

A

clean price= flat price, doesn’t include interest accrued
dirty price- clean price plus accrued interest

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36
Q

what are the common day count conventions?

A
  • ACT/360
  • 30/360
  • ACT/365
  • ACT/ACT
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37
Q

What is a spread in bond trading?

A

the difference between two yields, usually expressed in basis points- each basis point representing 1/100 of 1%

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38
Q

how are spreads used?

A

to compare instruments against one another or to a benchmark such as gov’t bond yields or swap rates- spread between the given instrument and the benchmark represents the risk of holding compared with that of the comparison. greater the risk, larger the spread

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39
Q

what are securities usually compared to when looking at spreads?

A
  • gov’t bond yields
  • swap rates
  • published reference rates
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40
Q

what is the yield curve?

A

visual representation of the term structure of interest rates - the relationship between yields on financial instruments from the same issuer

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41
Q

what does the normal yield curve show?

A
  • y axis: GRY, X axis: term to maturity, upward sloping

shape captures that investors have a liquidity preference, so they will prefer more rather than less liquidity- from this they’re willing to accept a lower yield on short-dated bonds and demand a higher yield for longer-dated bonds

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42
Q

what does the inverted yield curve show?

A
  • y axis: GRY, X axis: term to maturity, downward sloping

occurs when there’s an expectation of a significant reduction in interest rates at some point in the future- investor is willing to accept a lower yield for long-term investments that will last till the future so they can weather the reduction in interest rates- removes liquidity preference

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43
Q

why are investors willing to buy bonds with negative yields?

A

they want to preserve most of their capital. this requirement surpasses their wish to generate a positive return

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44
Q

how should yields react to inflation?

A

if inflation is expected to increase, yields demanded by investors need to reward them for the anticipated inflation

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45
Q

how can central banks impact the inflation/yields through interest rates?

A

increases in short-term interest rates to counter inflation can lead to lower yields on medium/long-term bonds- because investors have confidence that in the medium term, inflationary pressure will be removed

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46
Q

how is the current value of a bond calculated?

A

1/(1+r)n

to arrive at the present value of a single sum receivable after n years when the prevailing rate of interest is r.

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47
Q

what is ex-dividend/ cum-dividend?

A

ex: bond is dealt without entitlement to the impending coupon payments

cum: remainder of the time after the bond is traded cum-dividend.

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48
Q

what are index linked bonds?

A

bonds where the coupon payments and principal amount are adjusted to take into account inflation

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49
Q

how does inflation affect the nominal amount of an index linked bond?

A

assuming inflation is positive, the nominal amount outstanding on an index-linked bond is less than the redemption value the government will pay at maturity (real amount paid will be higher than the nominal amount as it takes into account for inflation)

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50
Q

how is the effect of deflation accounted for in index-linked bonds?

A

in periods of deflation, some bonds have a ‘deflation floor’ ensuring that the redemption payment will not be less than the original par value

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51
Q

how is the real interest rate calculated?

A

real ir= [(1+nominal interest rate)/ (1+inflation rate)]- 1

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52
Q

what are zero coupon bonds?

A

bonds that pay no interest, instead they promise to pay just the nominal value at redemption- investors will be less than the nominal value and there return comes from the difference between the discounted price and the amount received when the bond is redeemed

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53
Q

what are STRIPs?

A

separated trading of registered interest and principal of securities

stripping involves trading the interest (each individual coupon) and the nominal (principal) value separately. each strip trades at a discount to its face value, size of the discount determined by prevailing interest rates.

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54
Q

how is the trading of STRIPs facilitated?

A

each STRIP has it’s own registered entity for each cash flow that allows different owners to hold each individual STRIP

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55
Q

what are the benefits of STRIPs?

A

investors can match their liabilities, which removes any reinvestment risk which is faced when covering liabilities with coupon-paying bonds.

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56
Q

who is allowed to reconstitute STRIPs?

A

in the UK only HM Treasury and BoE are allowed to reconstitute stripped GILTS, UK DMO is counterparty to the deal if anyone wants to reconstitute with them.

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57
Q

why is debt finance less risky than equity finance?

A

because investing in debt finance is less risky for the same company- more certainty for the lenders in receiving payments and if the company ever went into liquidation.

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58
Q

what is secured debt?

A

where the debt offers assets of the company as a guarantee

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59
Q

what are ABSs?

A

asset backed securities

bonds that are backed by a particular pool of assets e.g., mortgage loans, receivables, car loans. assets provide bondholders with security and cash flows from the securities are used to service the bonds and repay the principal sum.

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60
Q

what is securitisation?

A

where financial instruments are packaged together and used to obtain funds from the investors.

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61
Q

what are MBS?

A

Mortgaged-backed securities

example of ABS. created from mortgage loans made by financial institutions like banks and buildings societies- loans are packaged for sale to investors. As the underlying mortgage loans are paid off by the homeowners, the investors receive payments of interest and principal.

62
Q

what are covered bonds?

A

asset-backed bonds

62
Q

what is a secured debt transaction known as in the UK/

A

debenture

62
Q

why do ABS use SPVs?

A

special purpose vehicles. lessen the default risk that investors face when investing in securities. separate entity from the originator of the assets

62
Q

what is the precise payment date for interest and principal dependent on?

A

on the anticipated and actual payment stream generated by the underlying assets and the needs of investors.

63
Q

what is the mechanics of the process when a trustee is appointed?

A

the property of the company is mortgaged to the holders of the security to secure the payment of the money owed as outlined by the trust deed. Trustee holds the covenant to repay the money held by the trust to the holders of the security

64
Q

what are the main trustee roles for a UK debenture?

A

note trustee: represents the interests of the holders of the securities

security trustee: security is charged in favour of the trustee for the benefit of the various secured parties

share trustee: holds shares in an issuing SPV to ensure off-balance sheet treatment

successor trustee: provided for banks which need to resign due to conflicts of interest.

65
Q

what are the benefits of a trust deed?

A
  • coherent enforcement procedure
  • securities are vested in the trustee as a single PAOBO
  • organised action and parity of treatment
  • everyone is paid proportionately.
66
Q

how do trustees make bonds more marketable?

A

trustees are assigned to represent the interest of the bondholders. they also keep track of the bonds sold, verifying that the amount issued is not greater than what is stated in the indenture

67
Q

what are the three layers of debt?

A
  • senior debt (ranks above all debt and equity capital, more secure, lower interest rate)
  • subordinated debt (subordinated to senior debt, less security)
  • mezzanine debt (usually high-risk subordinated debt, interest tends to be higher to reflect risk profile)
68
Q

what is unsecured debt?

A

not secured against any of the company’s assets, typically subordinated debt, coupon will be higher to represent risk

69
Q

what is guaranteed debt?

A

guarantee is provided by someone other than the issuer, usually the parent company

70
Q

what are the market interest rates used when looking at FRNs?

A

Sterling Overnight Index Average (SONIA)
Secured Overnight Financing Rate (SOFR)

71
Q

what are cash assets?

A

cash deposits and short-term instruments that are issued with less than one year to maturity e.g., T-bills by gov’ts and commercial paper issued by companies.

72
Q

what do cash deposits comprise of?

A

accounts held with banks or other savings institutions, return comprises interest income with no potential for capital growth, amount invested is repaid in full at the end of the investment term.

73
Q

what are the advantages of investing in cash?

A

liquidity, interest, safety

74
Q

what are the disadvantages of investing in cash?

A
  • varying degrees of creditworthiness
  • inflation reduces the real return earned
  • interest rates vary, returns vary
75
Q

what do investors need to consider when they invest overseas?

A
  • cost of currency conversion
  • creditworthiness of the banking system
  • tax treatment
  • exchange controls
76
Q

what are T-Bills?

A

Treasury bills

short-term instruments, issued and guaranteed by the government, pay no coupon, issued as discount to their nominal value- the difference between this and the par value is the return to the investor

77
Q

what is the advantage of T-bills?

A

provide a very secure investment for market participants with short-term investment horizons, often represents a risk-free investment

78
Q

what is CP?

A

commercial paper

unsecured short-term promissory note issued primarily by corporations and municipal corporations, largest segment of the money market through banks , issued at discount to its nominal value

79
Q

what is an asset-backed CP?

A

Short-term investment vehicle with a maturity between 90-180 days , issued by a bank/FI, backed by assets such as receivables

80
Q

what are the two methods of issuing CP?

A

Issuer can market directly to buy-and-hold investors as with most money-market funds

can also sell the paper to a dealer who then sells the paper onto the market

81
Q

how does CP issue differ from other bond/indebtness issuances?

A

issuer maintains an ongoing program rather than having it all brought to the market at once

82
Q

what is a repo?

A

sale and repurchase agreement, involves initial sale of a financial instrument and at the same time, a contractual agreement that the seller will subsequently buy back the same amount for a specified price at a future date, legally binding

83
Q

how does the effective interest of a repo transaction come about?

A

the amount paid to the initial seller when they are repurchasing the securities at the end of the transaction will be greater than the amount paid to the initial buyer at the start of the transaction, the difference between the two is the essential interest of the transaction to the initial seller for loaning out the securities.

84
Q

what are eurobonds?

A

bonds that are issued and sold outside of their home country. can be issued in any currency as long as it is different to that of where they are issued. i.e., issued in the UK has to be anything other than £

85
Q

how are eurobonds issued?

A
  • issuer appoints a lead manager
  • lead manager establishes a syndicate
  • syndicate distributes the bond to their client base
86
Q

how are eurobonds stored?

A

they are held in bearer certificate form, certificates themselves are needed to prove ownership

87
Q

what is the organisation that self-regulates eurobonds?

A

ICMA (international capital markets association)

88
Q

what are the settlement and interest conventions on the secondary market for eurobonds?

A

settlement is T+2 and accrued interest is calculated on the basis of 30 days per month and 360 days per year.

89
Q

what are Depository receipts?

A

negotiable certificates evidencing ownership of shares in a corporation from a country outside the US. Typically sponsored by the the foreign corporation.

90
Q

how is grey-trading involved in depository reciepts?

A

they are considered pre-release by investors who can purchase receipts which entitle them to all the benefits of the DR that will be held on deposit in the future.

91
Q

what is the role of the depostiory bank with ADRs?

A

act as a go-between for the investor and the company issuing the receipts. dividend is paid into the bank and then this is converted into the relevant currency and passed onto the ADR holders. they also exercise votes on behalf of the receipt holders.

92
Q

what is a warrant?

A

instrument issued by a company that allows the holder to subscribe for shares in that company at a fixed price over a fixed period- listed and traded on exchanges

93
Q

what are the advantages of warrants to companies?

A

will raise cash for the company along with further capital if the warrants are exercised

94
Q

what is a covered warrant?

A

warrants issued by firms, offer the option to put (sell) or call (buy)

95
Q

what is the conversion premium?

A

way of looking at the price of one warrant relative to another. (share price of the warrant + exercise price required to buy underlying shares)- prevailing share price.

96
Q

what are the distinguishing features of property as an asset class?

A
  • each property is unique
  • valuation is subjective
  • complex legal considerations
  • diversification is difficult
  • supply of land is finite
97
Q

what are the negatives of property investment?

A
  • lack of liquidity
  • significant maintenance costs
  • high transaction costs
98
Q

what are REITs?

A

real estate investment trusts.

listed investment companies that pool investors funds to invest in commercial and possibly residential property.

99
Q

what are the advantages of REITs?

A
  • provide access to property returns without the disadvantage of double taxation
  • under the rules of REITs no corporate tax is payable.
100
Q

what are the requirements of REITs?

A
  • the property rental business must contain at least three single rental properties
  • for each accounting period the REIT must distribute at least 90% of its rental profits by way of dividend
101
Q

what type of funds are REITs?

A

close ended funds quoted on stock exchanges, shares are bought and sold in the same way as other listed company shares

102
Q

what are open-ended funds?

A

collective funds that pool the money of investors to buy portfolios of investments, investors are given units of the fund in return. open-ended because they can grow by selling more units or shrink by buying back/cancelling units- attraction of liquidity

103
Q

what is a spot transaction?

A

immediate currency deal that is settled within two working days

104
Q

what is a forward transaction?

A

currency deal that is agreed for a future date at a rate of exchange which is fixed now

105
Q

how are FX rates quoted?

A

both types are quoted by dealers in the form of a buying rate (the bid) and selling rate (the offer)- spread between these two prices enables the FX dealer to make a profit.

106
Q

what are the two ways the FX market is driven?

A
  • driven by international trade
  • driven by speculation
107
Q

what are the most commonly quoted currency pairs?

A

USD/JPY
EUR/USD
USD/CHF
GBP/USD

108
Q

how are currencies quoted?

A

first currency is the base currency, second is the counter or quote currency.

109
Q

how are quotes in the forward market quoted?

A

state how much has to be added to or taken away from the present spot rate

110
Q

what does pm stand for in a forward rate quote?

A

premium. used when the dollar is going to be more expensive relative to the sterling in the future, deducted from the quoted spot rate to get the forward rate- quoted in cents.

111
Q

what does dis stand for in a forward rate quote?

A

discount. used when the dollar is going to be cheaper relative to the sterling in the future. added to the quoted spot rate to get the forward rate

112
Q

what is rational pricing?

A

assumption that asset prices will reflect as they should be (arbitrage-free) as any deviation from this will be arbitraged away.

113
Q

what is arbitrage?

A

taking advantage of a pricing anomaly between a security trading on two markets- mismatch in the pricing can be exploited to ‘lock in’ a risk free profit

114
Q

what is interest rate parity and how does it link to arbitrage and rational pricing?

A

helps in determining the exchange rate between currencies, arises from recognising a possible arbitrage situation and arbitraging it away.

115
Q

how does interest rate parity relate to spot and future prices?

A

says that the spot and future prices for currency trades incorporate any interest rate differences between the two currencies. if this relationship didn’t exist then an arbitrage opportunity would arise between the spot and forward rate.

116
Q

what is PPP and what does it concern?

A

concerns the rate to which exchange rates tend to move in the long term. predicts currencies should have an equal purchasing power. related to the value of a basket of goods in one currency versus another and then this may have an impact on the exchange rate.

117
Q

what are cryptocurrencies?

A

virtual or electronic currencies which use encryption technology to control the amount of currency issued as well as to record ownership and payments.

118
Q

how can investors acquire cryptocurrencies?

A

purchasing them in exchange for regular currencies
earning them
mining them by solving mathematical problems

119
Q

what are the risks of cryptocurrencies?

A
  • volatility
  • decentralisation
  • lack of regulation
  • security
  • scalability
  • susceptibility
120
Q

what is a CIS?

A

collective investment scheme- way of investing money with other people to participate in a wider range of investments than those feasible for most individual investors.

121
Q

what are regulated v unregulated CISs?

A

regulated= authorised by the local financial regulator
unregulated= not authorised/recognised by the local financial regulator

122
Q

what restrictions are UCISs subject to?

A

marketing restrictions, in relation to retail investors due to their lack of regulation and high levels of leverage

123
Q

what are the risks of UCISs?

A
  • may not offer daily liquidity
  • fixed or long-term commitment
  • no guarantee of capital or income return
  • high charges
  • gearing
  • currency/locational risk
  • single asset
124
Q

what are the two main forms of open-ended CISs?

A

unit trusts, OEICs (open-ended investment companies)/SICAVs

125
Q

what is a unit trust?

A

professionally managed collective investment fund.

Investors buy units, trust holds a portfolio of securities, assets of the trust are held by trustees and invested by managers

126
Q

what is an AUT?

A

Authorised unit trust. unit trust that’s allowed to be marketed to the public, must be constituted by a trust deed between manager and the trustee

127
Q

what is the role of the trustees in a unit trust?

A

protect the interests of the unitholders, effectively the beneficiaries of the trust, must be authorised by the FCA, trust deed outlines strategy and objectives (investment mandate)

128
Q

what is the role of the manager in a unit trust?

A

authorised by the FCA, responsible for marketing, managing assets, maintaining records, supplying information and ensuring regulatory adherence.

129
Q

how can investors buy/sell units of a unit trusts?

A

buy via newspaper advertisement/phone call. can sell the same way they were bought or contact the fund manager.

130
Q

what are the three different charges on a unit trust?

A
  • initial charge
  • annual management charge
  • exit charge when selling
131
Q

what is an OEIC?

A

open-ended investment company. formed as a corporation under the OEIC regulations of the UK, aka ICVC (investment companies with variable capital)

132
Q

what is an investment trust?

A

form of collective investment, pool the funds of many investors and spread their investments across a range of securities. are companies not trusts despite the name.

133
Q

how is the price of investment trusts quoted and bought?

A

higher price is the offer price (how much to buy)
lower price is the bid price (how much they’re willing to sell for)

bought through a stockbroker

134
Q

what is NAV?

A

Net Asset Value

essentially the net worth of an investment trust company’s equity

calculated by adding together;
- value of all holdings at mid-market prices
- value of unlisted holdings at the director’s valuation
- cash and other net current assets
(liabilities deducted from this figure)

135
Q

what can close-ended funds do compared to open-ended ones?

A
  • invest in private companies
  • provide venture capital
  • borrow money
136
Q

what are ETFs?

A

investment funds that contain a basket of investments, bought and sold by manager, passively managed

137
Q

how are ETF shares bought and sold?

A

only authorised participants (large institutional investors) can buy/sell shares of an ETF, act as market makers on the open market. can be bought by retail investors on the secondary market

138
Q

what are the benefits of ETFs?

A

easier to trade, lower operating costs, can be tax advanataged

139
Q

what is a physical versus synthetic ETF?

A

physical will replicate the index’s performance by buying and selling most or all of the constituent holdings- labour intensive and costly

synthetic will mean the ETF provider enters into a contract with a counterparty to deliver the return of the funds benchmark index in exchange for a fee- they won’t actually hold any stocks at all

140
Q

what is an ETN?

A

exchange-traded note, track indices, structured products, senior debt notes issued by banks, entail counter party risk and tax consequences

141
Q

what are specialist funds?

A

close-ended funds that invest in areas such as PE, property or infrastructure, classed as alternative assets - long term investment strategies, may not be traded on exchanges

142
Q

what are structured products?

A

investments which provide a return based on the performance of an underlying asset, mainly issued by banks and insurance companies. split into structured deposits and structured investments

143
Q

what are structured deposits?

A

cash-based products offered by deposit taking institutions. the asset in question is a cash deposit, returns may be linked to another asset e.g., FTSE 100

144
Q

what are structured investments?

A

generally pre-packaged investment, based on derivatives, a single security, basket of securities or foreign currencies

145
Q

what is the principal guarantee function?

A

offers protection of the principal if the structured product is held to maturity.

146
Q

what are the uses and benefits of structured products?

A

created to meet the specific needs of HNWIs and retail investors that can’t be met by standardised financial instruments

147
Q

what are the three types of pay-out structures of structured products?

A

capital at risk
capital-protected
capital at risk with a buffer

some may let the investor take a regular income, whether the principal is returned may depend on how the stock market index has performed.

148
Q
A

FCA 1: Securities (7 decks)

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