Chapter 1: Analyse the characteristics, inherent risks, behaviour and correlation of asset classes. Flashcards
In exam - Approx 17 standard questions, 11 multiple choice
Name the 4 main types of asset classes
Cash
Fixed interest securities
Equities
Property
What are the personal savings allowance (PSA) for:
- Basic rate taxpayer
- Higher rate taxpayer
- Additional rate taxpayer
Basic - £1,000
Higher - £500
Additional - £0
What is a money market investment?
A ‘money market investment’ is essentially a short-term loan to the Government, a bank or some other organisation. These investments often pay very low rates of interest because of their short-term nature.
What is a fixed-interest security?
Fixed-interest securities or ‘bonds’, are issued by governments, companies and other official bodies as a way of raising money to finance their longer-term borrowing requirements.
What does Price at redemption (PAR) mean?
The fixed value that investors will receive at the end of the term
What are Bonds and GILTS?
Negotiable fixed-interest long-term debt instruments…
- tradable investments (negotiable)
- that pay a fixed return (fixed interest)
over a period of 20 to 30 years (long-term) - A loan to someone (debt instruments).
Explain the 4 parts of the below stock certificate:
Sainsbury’s 6% 2029 £100
1) The investment is a corporate bond, as it is a loan to
Sainsbury’s.
2) There is 6 % interest payment per year. This is referred to as
the stock’s coupon
3) The maturity date is 2029: also known as the redemption
date
4) The amount of money that will be repaid in 2029 is £100.
This is the PAR value or clean price
What is the formula to calculate the interest yield?
Coupon ÷ Clean Price x 100
Keira is buying some Tesco 4% with 16 years left to run. The current clean price is £127.86.
What is the interest yield?
The interest yield is:
4 x 100
/
12.86
= 3.13%
Connor is buying some Guinness 8% with six years left to run. The current clean price is £116.85
What is the interest yield?
The interest yield is:
8.0 x 100 ÷ 116.85
= 6.85%
What is the difference between redemption yield and interest yield?
The redemption yield takes into account the gain or loss that would be experienced by the holder of the bond at maturity.
How do you work out the redemption yield? (5 steps)
The steps involved in this calculation are:
- Work out the ‘normal’ interest yield (you may be provided this in the exam)
- Work out the capital gain or loss at redemption (-100)
- Divide the capital gain or loss by the number of years until redemption, to work out the gain or loss per year
- Convert the yearly gain or loss into an income yield (positive or negative)
- Add or subtract the gain or loss to the ‘normal’ interest yield
Keira has an interest yield of 3.13% from her Tesco 4% stock.
The clean price is £127.86 & there are 16 years to redemption,
What is the redemption yield?
There are 16 years to redemption, so the capital loss each year is £27.86 / 16 = £1.74.
As a percentage of the price paid, the loss is -1.74 x 100 / 127.86 = -1.36%
Subtracting this from the interest yield of 3.13% means the redemption yield is: 3.13% -1.36% = 1.77%.
Conor has an interest yield of 6.85% from his Guinness 8% stock.
We also know that he would make a loss of £16.85 at maturity as the clean price is £116.85. There are 6 years to redemption
There are 6 years to redemption, so the loss each year is 16.85 / 6 = £2.81.
As a percentage of the price paid, the loss is -2.81 x 100 = -2.40%.
116.85
Subtracting this from the interest yield of 6.85% means the redemption yield is: 6.85% - 2.40% = 4.45%.
Using the information below, calculate the income (or running) yield and redemption yield.
Tessa has just bought a gilt, Treasury 5% with four years remaining until redemption. The clean price is £113.87.
Income Yield:
£5 ÷ £113.87 x 100 = 4.39% Income Yield
Redemption yield :
£113.87 - £100.00 = £13.87 loss,
divided by 4 years remaining = -£3.47 per annum
-3.47 ÷ £113.87 x100 =3.05%
4.39% - 3.05% = 1.34%
What are the risks associated with fixed interest securities?
- Default risk: The creditworthiness of the firm you save with.
- Inflation risk: The impact of inflation.
- Interest rate risk: The uncertainty of interest rate movements.
- Currency risk: Exchange rate movements if saving overseas.
- Liquidity risk: The ability to sell at a given time.
What are the 2 types of risks that generally impact on the supply and demand price of bonds?
- Unsystematic risk; Specific or commercial risk that affect a particular stock.
- Market or systematic risk; Risks that affect the whole market.
What sort of events drive systemic/market risk?
- Economic issues: for example the credit crisis.
- Economic growth: fuelling inflation and rising interest rates.
- World events: 9/11 or the covid-19 outbreak.
- Natural disasters: tsunami in Asia.
- Elections or political turmoil.
Who issues GILTS
The Debt Management Office (DMO)
What timeframe does the The Debt Management Office (DMO) classify the following GILTS:
Shorts
Mediums
Longs
Shorts - Less than 7 years
Mediums - Between 7-15 years
Longs - Over 15 years
What index is used in regard to ‘Index linked GILTS’?
Retail Price Index (RPI)
With index-linked GILTS, what is adjusted, in line with
inflation?
Interest payments and the capital at redemption. Should RPI fall, then the interest and capital will also fall. Investors are protected against the value of their investments being eroded by inflation, however coupons on index linked GILTS tend to be much lower than on non- index linked stocks.
What are the 2 categories that bonds are generally split into?
- Investment grade bonds:
anything higher than BBB- from Standard & Poor’s, or BaaB from Moody’s, are considered to have an extremely low risk of default. - Sub-Investment grade bonds:
These are below the above thresholds and therefore considered to have a significantly higher risk of default. These are often termed as ‘junk bonds’ or high-yield bonds.
If a company’s credit rating is marked down, what do you think would happen to the market price of its bonds?
They will fall, as they are seen as riskier investments.
This will drive up the yield, rewarding investors for taking the added risk.