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R02 - Investment Principles and Risk > Cash Investments and Fixed-Interest Securities > Flashcards

Cash Investments and Fixed-Interest Securities Flashcards

1
Q

What are the main characteristics of cash deposits

A
  • Investors receive regular interest on their deposit at a prevailing rate
  • Investor’s capital is not exposed to investment risk
  • The return comprises interest with no potential for capital growth
  • Cash is a liquid asset that can be easily accessed
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2
Q

What are the risks of cash deposits

A
  • Deposit-taking institutions are of varying creditworthiness - insolvency/defaulting
  • Inflation reduces returns - real return could be negative
  • Interest rates may fluctuate - returns vary over time
  • Deposits in foreign currencies are subject to exchange rate movements
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3
Q

Instant Access Accounts

A

Give investors immediate access to their funds. Operated through branches, post, phone & online.

Characteristics:

  • Investor can withdraw cash immediately via branch/card
  • Rates are variable
  • Highest rates are usually found on online accounts
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4
Q

Restricted Access Accounts

A
  • Generally higher rates than for IAAs (highest available on cash investments)
  • Higher risks due to restricted access (situations change)
  • Main Types: Notice accounts, Term Deposit Accounts (Time deposits)
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5
Q

Foreign Currency Deposits

A
  • Savings accounts denominated in a currency other than sterling
  • Interest paid reflects prevailing market rate for the denomination currency
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6
Q

Offshore Sterling Deposit Accounts

A
  • UK Branches of banks situated in tax havens
  • Vary from variable rate instant access and notice accounts to term deposit accounts
  • May pay higher interest rates than UK equivalent
  • Not covered by FSCS
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7
Q

NS&I Direct ISA

A
  • Only opened and managed online/by phone
  • JISAs available
  • Direct ISA is not flexible
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8
Q

NS&I Income Bonds

A

Pay a monthly income at a variable rate of interest with no risk to capital:

  • Investors 16+
  • Can be cashed at any time with no notice period or penalty
  • Interest paid gross - taxable and can be set against a taxpayer’s PSA
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9
Q

NS&I Bank Account:

A

2 Types:

  1. Investment account managed by post only
  2. Direct saver that can be opened online/over the phone
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10
Q

NS&I Savings Certificates

A
  • Only available to customers who have maturing certificates
  • Not on general sale
  • Can renew up to the total value of maturing certificate
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11
Q

Guaranteed Income Bonds

A

Characteristics:

  • Fixed terms of 1, 2, 3 or 5 years - differing fixed rates for each
  • Only available to customers renewing a maturing bond
  • Minimum renewable amount is £500
  • Interest paid gross and taxable - set against PSA
  • Interest paid monthly
  • Renewable by online/phone/post
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12
Q

Guaranteed Growth Bonds

A

Characteristics:

  • Fixed terms of 1, 2, 3 or 5 years - different fixed rates for each
  • Only available to customers renewing a maturing bond
  • Minimum renewable amount is £500
  • Interest paid gross and taxable - set against PSA
  • Interest paid monthly
  • Renewable by online/phone/post
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13
Q

Money Markets

A

Wholesale markets where banks, building societies, the Government etc lend and borrow from each other.

Short/Long term lending using short-term debt instruments.

Limited private investor involvement.

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14
Q

Types of Money Market Instruments

A
  • Treasury Bills - issued by governments to finance short-term cash needs. Issued at a price that is less than their par/face value. Government pays holder full par value on maturity.
  • Certificates of deposits - receipt from banks for deposits placed with them. Carry a fixed rate of interest (usually related to Sterling Overnight Index Average (SONIA)). Have fixed term to maturity. Can be traded in money markets.
  • Commercial bills - short-term negotiable debt instruments issued by companies to fund their day-to-day cash flows. (Similar to TBs but less liquid).
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15
Q

Fixed-interest Securities

A
  • Issued by Governments as a method of raising money to finance longer-term borrowing
  • Owners are entitled to receive regular interest payments + a repayment of their capital at the end of a pre-determined period
  • Cannot be cashed in before official maturity date - can be sold on the stock market

‘Negotiable fixed-interest, long-term debt instruments’

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16
Q

General characteristics of bonds

A
  • Carry a fixed rate of interest (coupon)
  • Fixed redemption value (par value)
  • Repaid after a fixed period (redemption date)
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17
Q

Bond Yields

A
  • All FIS bear a nominal rate of interest (the coupon)
  • Yields measure the returns bonds provide in relation to their market price
  • Interest yield & Redemption yield
18
Q

Interest Yield

A

Expresses the annual income from a bond as a percentage of the price an investor would have to pay for the bond:

Coupon / Clean Price x 100

Aka: Running yield, flat yield, income yield.

19
Q

Redemption Yield

A
  • More accurate calculation of a bond’s yield
  • Takes into account both income payments from the bond and capital gain/loss from holding the bond until maturity
  • Adjusts value of each payment according to when it is received

IY +/- [(Gain/Loss to Maturity/Years to Maturity)/Clean Price x 100]

20
Q

Risks of bonds

A
  • Interest rate risk
  • Liquidity Risk
  • Inflation Risk
  • Currency Risk
  • Default Risk
21
Q

Factors affecting bond prices

A
  • Interest rate rises: bond prices fall due to a reduced demand. Coupon is fixed - yield adjusts upwards
  • Interest rate falls: Price of bond rises due to increased demand - yield adjusts downwards.
  • Price movements result in investors making capital gains/losses if they opt to sell before redemption
22
Q

Volatility of bonds

A
  • Bonds are sensitive to interest rate movements
  • Lower the coupon, the more volatile the bond
  • Longer the period to redemption, the more volatile the bond

Rationale: A greater amount of the cash flow from the more volatile bonds is received later in the bond’s life and is exposed to interest rate movements for a longer period.

23
Q

Yield curves

A
  • Provide a means for comparing yields on bonds of different maturities
  • Give an indication of the market’s expectation of changes in interest rates (required future yields)
  • Graph of the relationship that exists between a bond’s redemption yield and the period to redemption
24
Q

Types of yield curve

A
  • Normal yield curve
  • Flat yield curve
  • Inverted/reverse yield curve
25
Q

Normal yield curve

A

Investors demand higher yields for holding longer-term bonds to cover the increased uncertainties over time.

Rising positive curve

26
Q

Flat yield curve

A
  • Economic factors deemed to be stable
  • No radical changes to inflation/interest rates expected
  • Investors prepared to accept a lower yield and pay relatively more for longer-dated bonds
  • Can buy income income at almost any redemption period - no significant penalty for switching from longer-dated to shorter-dated bonds.
  • Flat curve
27
Q

Inverted or reverse yield curve

A
  • Yield on longer-term bonds is less than on short-term bonds
  • Expectations that interest rates will rise in the short-term, but will fall substantially in the future.
  • Result of supply/demand that reduce yields on longer-dated bonds.
28
Q

Gilts

A
  • Fixed-interest securities issued by the UK government (via the DMO).
  • Used to borrow money
  • Categorised according to their time to redemption: (shorts, mediums and longs).
29
Q

Index-linked gilt

A
  • Differs from a conventional gilt in that the coupon payments and capital repayment are adjusted in line with inflation (measured by the RPI)
  • Exempt from CGT however interest is taxable (including inflation uplift)
  • Coupons & yields tend to be lower than conventional bonds
  • Pre-September 2005 - Use RPI 8 months before each payment date
  • Post September 2005 use RPI three months before each payment date
30
Q

Repo market

A
  • Where gilts are bought & sold
  • Repo = Sale and repurchase agreement
  • One party agrees to sell gilts to another with a formal agreement to repurchase equivalent securities at an agreed price on a specified future date.
31
Q

Strips market

A
  • ‘Separate trading of registered interest and principal securities’
  • Process of separating a conventional interest-bearing gilt into its individual interest (coupon) and redemption payments
  • Can be separately held and traded in their own right
32
Q

Corporate fixed-interest securities

A

Companies can issue fixed-interest securities to borrow money at fixed rates of interest for long periods of time.

33
Q

Corporate bonds vs Gilts

A
  • CBs are riskier
  • CBs are typically more volatile
  • Lower quality bonds (smaller companies) may be difficult to trade
  • Larger buy/sell spread for CBs
  • Company creditworthiness constantly changes, unlike Government
  • CB prices can very even with interest rates/inflation constant
  • CBs have generally higher yields - reflect their increased credit risk/lower liquidity
34
Q

Types of corporate bond

A
  • CBs may be secured or unsecured:
  • Secured CB: Charge on certain assets of the issuing company. If the company falls into arrears with interest payments/defaults, assets can be seized and sold to repay the loan.
  • Unsecured CB: No asset acting as collateral. Holder ranks for repayment alongside ordinary creditors.

Secured loans rank above unsecured loans when winding up.

35
Q

Debentures

A

A secured loan agreement between a lender and a borrower with business assets used as a security.

Agreement includes:

  • Interest rate, payment dates and redemption date
  • Assets backing the debenture
  • Any conditions imposed on the borrower (e.g. restricting the total amount of money the company can borrow by imposing a maximum ration of debt to share capital etc)

Secured by one/both of the following:

  • A fixed charge
  • A floating charge
36
Q

Convertible bonds

A

Usually unsecured loan stock that offers the holder the option of converting the bond into ordinary shares of the issuing company under specified terms and conditions

37
Q

Floating rate notes

A
  • Bonds issued by companies (banks/financial institutions) which pay a rate of interest that is not fixed but instead linked to a money market (e.g. SONIA)
  • Coupon is reset every quarter to a specified level over the reference rate
  • If interest rates rise, FRN also rises
38
Q

Difference between NS&I Income Bonds vs Guaranteed Income Bonds

A

Variable interest rates

39
Q

Bonds - Cum Dividend

A
  • Purchaser receives the full six months’ interest
  • Buyer compensates seller by paying more
  • Pays clean price + accrued interest up to date of purchase (dirty price)
40
Q

Bonds - Ex Dividend

A
  • Interest payments made to whoever holds the bond 7 days before the interest payment date
  • Bonds purchased after interest payment dates
  • ## Price adjusted to reflect no interest

R02 - Investment Principles and Risk (3 decks)

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