Chaper 1 Flashcards
Reasons for holding cash deposits
Liquidity, security and low level of risk
Interest rates
Usually paid as a percentage of capital in the account, usually receiving better rates for higher amounts and longer deposits.
This isn’t always true as sometimes long deposits have less interest if banks believe the market will fall.
Gross and net interest rates
Gross = the contractual rate of interest paid before tax is factored in. This is what is used to calculate their tax liability.
Net = this is what the saver will receive after the effect of income tax. The rate depends on their tax status/ rate.
Compounding interest
This is where interest is earns on interest ie compounding the return. Savers should then consider if interest is paid more frequently does the actual compounded interest rate equal more in comparison to less frequent interest payments.
Compounded interest calculation (Terminal wealth generated)
Capital x (1 + (annual rate / number of payments per year))
AER
Annual equivalent rate, used to compare accounts and is always gross.
Real returns.
This can measure the rate of return on a cash deposit by comparing a nominal interest rate with the expected future rate of inflation. Calculation:
Real rate of return = nominal rate - rate of inflation
Requirement linked accounts
These are simply bank accounts that offer higher interest if certain conditions are meant usually meaning a certain balance is held elsewhere of a certain amount is deposited into a current account a month.
Risk of deposits
Default risk = if the bank fails
Inflation/ deflation risk = if inflation goes to high then real return is negative.
Interest rate risk = risk that rate is lower than other similar products savers could access.
Operational risk = the deposit taker has bad services.
Cost charges and penalties
Charges deposit takers usually charge:
Overdraft charges
ATM charges
Fx fees
Regulation
PRA & FCA.
PRA = two focuses promote safety and soundness of industry and get degree of protection for savers, inventions and policy holders.
Statutory protection
Savers can determine a deposit takers safety by researching their credit rating. These are done by independent bodies that monitor big firms and rate them.
FSCS
85k per person per account ie joint = 170k deposits up to 1m that have only just been deposited also covered.
Main types of deposit accounts
Current
Instant access
Notice
Fixed term
Fixed rate
Money market.
NS&I
The governments department which is an executive agency of the chancellor, offer deposit taking feature 100% backed by the government. Also all products are exempt form CGT
Money market funds
These are a collective investment fund that invest in cash assets ie short term bank deposits or near cash assets. Bonds or commercial papers.
Main type of money market funds
Constant net asset value = the maintain an stable net asset value (NAV) regardless of market conditions
Accumulating net assets value = roll up funds they operate the same as above but the income is daily. Income isn’t distributed but reflects in the funds value.
Low volatility net asset value = same as top but with slight movement 0.2% each way.
Variable net asset value = market to market to value assets and ANV will change.
Braking the buck
This is where a MM Fund will fall below the NAV IE £1
Money markets liquidity
They are consider very liquid as the spas sets are cash based or short term t-bills or company papers.
Money market comparison
MM are given credit ratings just like deposit takers and saver should compare returns alongside with safety/ credit rating.
MM portfolio construction
This is the most complex part of comparing funds as you have to judge protection based of constructions and how sensitive or not it is to the market.
Fund management
The comparison process also includes looking at a funds management operations, looking at front, middle and back offices
Key areas include: experience, objectives, techniques and risk aversion stratergies
Post rating inspection
Funds must supply portfolio fund values portfolio details for constant fund surveillance.
Benchmarks for money market funds
MM Funds use different benchmarks to compare performance. Including:
(SONIA) = sterling overnight index average.
(€STR) = Europe’s short term rate.
(SOFR) = Secured overnight rate
(SARON) = Secured overnight financing rate
(TONAR) = Tokyo overnight average rate
Cost charges and penalties of MM
Investor will need to pay the expenses of the fund. Some of these can reduce the NAV the investor receives.
These costs can be splits into loads and expense ratios:
Loads = a front end load that may be charged when in Italy investing. Or a back end charge (differed sales charge) is levied when the money is finally redeemed out of the fund.
Expense = annual operating expense for using the fund and I lived against the growth of the funds.
P2P lending
= peer to peer lending.
Began in 2005 this is where people receive lending but not from financial institutes but groups or individuals investors.
P2P risks
The main risk is for a person to default on there payments, however usually interdimeries underbite each borrow to gage risk for the lender.
Another is is liquidity for the lender.
P2P returns and taxation
Interest is taxed the same as with bank accounts however there is a P2P isa that can be used.
Fixed income securities
General feature = also know as debt securities these can be gilts, T-bills or commercial papers. The name comes from as the issues isssues debt for a fixed income/ return later down the line.
Fixed income securities - investment grade and high yield
High credit rating bonds are worthy of investment grade classification
High yield = regarded below investment grade as the issues credit rating is below BBB meaning they trade at lower prices and offer higher coupons.
Nominal value (NV)
All bonds are issues with a nominal value ie £100 for uk bonds which is what they will be Baugh back for/ investors will be paid at their maturity.
Bond price
This is what you pay for at the time of purchase for the bond. Clean price excludes the incurred interest and is what is quoted to investors however the dirty price includes the incurred interest.
Time for a classification for bonds
Under 5 years = shorts
5-15 years = medium term
15 + = longs
Double dated bonds
Gives issuers the option to extend term or pay on the first date.
Coupon of bonds/ gilts
The coupon is the amount of interest that an investor will receive each year on the nominal value.
Frequency is typically quarterly or six. Monthly
Coupons are considered savings income and falls within an individuals personal allowance.
Floating- rate notes (FRN)
Fluctuations in relation to interest and bonds called the floating rate. They are usually tied to a short term market rate. And hence are adjusted regularly. The coupon on these consist of two main parts:
The reference index rate
A quoted margin.
Inflation linked bonds
Fluctuations tied to specific measures of inflation. The interest and capital repayment rely on the inflation and vary in accordance with this. Meaning that they provide a degree in protection.
Zero coupon bonds
Where there is no coupons and investors simply make their money back at maturity date. These are taxed on income as well as capital as tax authorities deem there to be a notional income gain.
Who issues Government bonds and what does this form
In the uk the DMO issues bonds on behalf of the treasury (GILTS) this money forms parts of the governments public sector net cash requirement (PSNCR)
Uk local authority bonds
Corporation stocks issued by local authorities. And secured against the assets of the issuer. They are divided into two categories:
Local authority fixed stocked = fixed rate investments which once bought cannot be traded again and must be held until maturity.
Local authority negotiable loans = life no longer than 2 years and marketed at par.
Corbin government bonds
T- notes US and Cananda
T-bills US
Germany = bearer bonds
Cooperate bonds
Issues by companies that can be backed by security but not always. CGT is not applicable.
Cooperate bonds, either debentures or convertibles
Debentures = are backed by security
Convertible = is a bond which is converted later either into another type of bond or into stock ie equity and the difference between the equity price and market price is the premium.
Permanent interest baring shares. (PIBS)
Issued by building societies with the following feature:
Interest is paid gross at a fixed rate
Provides no obligation to the issuer to pay interest if under financial pressure. If interest rate rises then the trading price will fall
No CGT
Traded on the stock market
Family liquid.
Convertible loan stocks/ bonds
For much of their lives they are ordinary loan stocks but can be converted into shares at a later date. Featuring:
Fixed interest
Provides holder right to convert
Conversion rights are pre agreed.
Set date for conversion
Why are they issued:
Very attractive to investors because they combine certainty of income and growth.
Better chance of raising the capital
Lesser net cost for the company.
Contingent convertibles (CoCos)
This is a debt instrument that is set to convert to equity when a specific event occurring. Ie financing issues meaning debt can’t be serviced.
Supranational bonds
These are entities formed by multiple countries to promote economic development for the members.
Asset backed securities (ABS)
This is where the coupon of the bond is backed by some security, they mean that usually non-tradable assets can be brought tougher and traded on.
Sukuk
Bond like instruments that comply with shariah law.
ESG
Ethical social and governance
Green bonds
Funds raised are specifically for green projects benefiting the environment
Blue bonds
Similar to green bonds but focus on the sea and marine based projects
Investment return in debt securities
Yield refers to the returns investors make on a particular investment. Income yield is annualised.
Yield is quoted gross or net of tax.
The two main influences on yield for a bond is the interest rate and time till maturity.
Running yield calculation
Also known as the interest yield on a band expresses the income received on it as a percentage of the investors outlay.
Running yeild% = gross coupon/ market price.
Capital returns and holding period return calculation?
Above par at purchase = capital loss and visa eras.
Thus we can use holding period return (HPR) to calculate the total return from the holding.
= price received at maturity - price purchased/ price purchased.
Annualised capital gain or loss. Calculation
From the HPR we can calculate = holding period return/ number of years until maturity.
What is the Gross redemption yield (GRY) and it’s made up of
This assumes the investor will hold the bond until maturity. This then uses the coupon, bond price and maturity to calculate the GRY but in two parts.
Interest yield and capital appreciation.
Annualised return from capital growth or loss formula
Holding period return/ number of years to maturity
Tax paying structure (bands)
Basic rate = 20%
Higher = 40%
Additional rate = 45%
What causes Bond volatility in price
There is an invert relationship between bond price and their yield.
Greater price volatility can be expected:
Bonds - of lower credit worthy
Low coupon bonds
Longer dated bonds
What factors should be considered when investing in bonds
Before investing investors need to consider influences that can effect prices of bonds:
Currency interest
FX rates
Credit rating of issuer
Economic factors
Coupon redemption date
How interesting effects bonds
Coupon can become less attractive with rates increasing and other options are better.
Bond price falls as interest rates increase.
What errors Bonds real returns
Real return can be eroded by inflation.
Bond risks for investors
Liquidity
Issuer risk
Credit risk
Credit enchantments (third parties arranging the issue of debt)
Dealing in debt securities primary and secondary market
A new bond can be issues in multiple ways:
Offer for sale - a syndicate will buy a bloc of the bonds from issuer. Then sell to investors.
Fixed price re-offering - when syndicates and lead managers agree to sell at same price.
Competing auction
Private place
Government bonds
Can be bought using a broker at best price or at limit
Government bonds bought directly form the government
To deal you must:
Become a approved investor
Complete relivant forms
Send payment with the dealing form.
