Cash and fixed interest securities

Question 1

Cash characteristics

Answer 1

Security but no inflation protection 
Pays interest gross
No investment risk 
No capital growth 
Liquid 
Higher rate for reduced access
Remember rate calculation 1+r^n

Question 2

Cash risk

Answer 2

Creditwortiness of Banks (can check ratings and look at tier one capital) 
FSCS scheme is £85,000 
Inflation
Interest rates change
Exchange rate risk

Question 3

Help to buy ISA

Answer 3

• £200 gets £50 bonus - maximum of £3000
• for homes to £450k in London and £250k elsewhere
• max initial is £1200 - max monthly is £200
• closes off at 30.11.2019

Question 4

NS&I cash accounts

Answer 4

Tax Free = ISA and Premium Bonds
Growth= 1 or 3 year fixed term
Income=1 or 3 year fixed term
Savings accounts

Question 5

Treasury bills

Answer 5

Issued by government to
finance daily cash flow
Routinely issued at weekly auctions
1, 3 & 6-month maturities (also 12 months but so far, no 12- month bill tenders have been held)
No interest paid - issued below par and repaid at par on maturity
Government backed and highly liquid

Question 6

Certificates of Deposit

Answer 6

Receipts from banks for
deposits placed with them
Fixed rates of interest & fixed term (can trade prior to maturity)
Interest paid at maturity
Interest rate depends on market rates & bank’s credit rating

Question 7

Commercial Bills

Answer 7

short-term negotiable debt
instruments issued by companies
Issued at discount to maturity value
Typical maturities of between 30 and 90 days
Unsecured Reduced liquidity

Question 8

Fixed Interest Securities

Answer 8

• Issued by government, companies or other bodies to raise money for long-term borrowing
• Bond owner receives regular interest and repayment of capital at maturity
• Negotiable - can trade
• Fixed interest - borrower pays fixed rate for duration of loan
• Debt instrument

Question 9

Characteristics of fixed interest securities (bonds)

Answer 9

• Fixed rate of interest
• Fixed redemption value (par)
• Fixed redemption date
• Pricing - traded on par value, mid-market price quoted in FT (represents mid-point between
buying & selling)
• Clean price - ignores accrued interest

Question 10

Accrued Interest

Answer 10

• Interest is paid twice yearly, but accrues daily
• Cum dividend - purchaser receives full 6 months’ interest (but pays accrued interest up to
settlement date to seller)
• Ex-dividend - where seller receives 6 months’ interest (but price adjusted to reflect this)
• Dirty price is the clean price +/- interest adjustment

Question 11

Bond title

Answer 11

Name of issuer, coupon, maturity

Question 12

Bond markets (primary, secondary, other currency market)

Answer 12

• Primary
o Government issue new gilts weekly
o Investors submit bids for price & quantity
o Other companies issue less frequently & use investment banks to manage
• Secondary
o Used for subsequent trading after issue
o Three sterling markets; Government sector, Corporate sector, Sterling loans to foreign
borrowers
• Other currency market
o Eurobond market (international bonds)

Question 13

Types of risk (fixed interest)

Answer 13

Interest rate, liquidity, inflation, currency, default, market risk.

Question 14

Three types of yield curve

Answer 14

Normal - Rising positve curve, higher yields for longer terms.

Flat curve - income similar for a long and short term, when economy is stable and no radical change expected.

Inverted curve - yields on longer term bonds are lower. Casued when investors expect short term rises to interest rates but lower long term rats.

Question 15

DMO definitions

Answer 15

Short - less than 7
Medium - 7 to 15
Long 15 years plus

Question 16

Index linked gilts

Answer 16

• Interest & capital repayment adjusted with inflation (using RPI)
• Lower yields than conventional stock
• Profits on disposal are CGT exempt but interest is taxable

Question 17

Repo Market

Answer 17

• Sale & repurchase agreement
• One party agrees to sell gilts to another party
• With a formal agreement to repurchase equivalent securities at an agreed price on a specified
future date
• Transfer of assets - but operates as form of short-term lending
• Bank of England uses repo market to influence interest rates

Question 18

Strips Market - Gilts

Answer 18

• Separating conventional gilts into interest (coupon) and redemption payments
• Which are then traded in their own right
• A 5-year gilt can be stripped to make 11 separate securities (5 x 2 coupon payments + 1
redemption payment = 11)

Question 19

Corporate Bonds

Answer 19

• Allows companies to borrow money for long periods at fixed rate of interest o Greater risk than gilts so higher yields
o Prices typically more volatile
o Liquidity issues for lower quality bonds
o Wider spread on buying & selling prices o Credit ratings can change/affect prices

THINK RISKS

Question 20

Debentures

Answer 20

• Written acknowledgment of debt
• Established by trust deed
• Fixed - charged over a specific asset
• Floating - general charge over company asset

Question 21

Convertible Loan Stock

Answer 21

• Offers holders the option of converting to ordinary shares
• Conversion dates and rates are specified.
• In the event of conversion CGT is chargeable.