Chapter 1: Asset Classes Flashcards
Consider the following scenarios:
- Harvey invests in a short-dated, AAA rated government bond
- Sonia invests in a high yield bond
- Fiona invests in a secured corporate bond
- Peter invests in a floating rate note
Using only the information available, which of the following is NOT true?
A. Both Fiona and Harvey have a claim on the issuers’ assets in the case of default
B. Of the four investors, Harvey and Fiona are more likely to receive income until redemption
C. The issuer of Sonia’s investment has a high probability of default
D. Of the four investors, Harvey and Peter are exposed to lower levels of capital fluctuations
A. is the correct answer.
Due to the short life of the government bond and the floating coupon on Peter’s bond, these two will have very low price volatility.
Only Fiona, with a secured bond, has a claim on the issuers’ assets. This makes it less likely that the issuer will default - a case that is also evident in the AAA rated government bond.
Sonia’s bond is high risk and more likely to default than any other here.
According to market convention, what is the official classification of gilt maturities into Shorts, Mediums and Longs?
A. 1 - 5 yrs, 6 -15 yrs, 15 yrs +
B. Less than 7 yrs, 7 -15 yrs, 15 yrs +
C. 1 - 5 yrs 6 -10 yrs, 10 yrs +
D. 1 - 7 yrs, 8 -12 yrs, 12 yrs +
B. Less than 7 yrs, 7 - 15 yrs, 15 yrs+
The Debt Management Office (DMO) sets out this official classification.
If you chose 1 - 5 yrs, 6 -15 yrs, 15 yrs +, you were thinking of the classification according to the London Stock Exchange where these gilts can be traded. Although an acceptable definition, it is not the official classification.
Which of the following is the best definition of a non-fungible token?
A. A homogenous tangible asset
B. A homogenous intangible asset
C. A unique tangible asset
D. A unique intangible asset
D. A NFT is a unique intangible asset.
Generally, with alternative investments, investors end up with a tangible item such as a painting, an antique or a collection of coins. Non-fungible tokens (NFTs) are like physical collectors’ items, except they are digital. More specifically, NFTs are unique digital tokens in the blockchain network. Each NFT can be associated with a particular digit asset and a licence to use that asset for a specific purpose.
Cryptocurrencies are tokens as well; however, the key difference is that two cryptocurrencies from the same blockchain are interchangeable—they are fungible. Two NFTs from the same blockchain can look identical, but they are not interchangeable.
All of the following statements are true with regard to settlement of trades in the secondary market EXCEPT:
A. UK corporate bond trades settle 3 business days after trade
B. UK equity trades settle 2 business days after trade
C. UK spot foreign exchange trades settle after 2 business days
D. UK Gilt trades settle after 1 business day
A. Prior to October 2013, the settlement time for corporate bonds and equity was 3 business days after trade. This was reduced to 2 business days, in line with EU requirements in the Central Securities Depositary Regulation (CSDR).
Rights issues still have a settlement time of 1 business day.
Permanent interest bearing shares are issued by what type of organisation?
A. Banks
B. Building Societies
C. Insurance Companies
D. Open Ended Investment Companies
B. Building societies issue PIBS.
A building society is a mutual fund and does not offer genuine shares. Permanent interest bearing shares (PIBS) are a form of fixed-income security and can be traded on the London Stock Exchange (LSE). They rank lower than other creditors of the building society and are perpetuities (they have no redemption date).
Value and growth approaches to investing in equity tend to be considered as alternative and incompatible approaches.
However, there is a reconciling approach that attempts to capture both aspects in the approach to stock selection. What is this approach commonly known as?
A. GARP
B. Quantitative investing
C. CAPM
D. Long/short strategies
A. Growth at Reasonable Price.
GARP is an acronym for ‘Growth At a Reasonable Price’ and commonly uses the P/E ratio combined with growth to compare available shares using PEG ratios.
CAPM is short for Capital Asset Pricing Model.
What measure of inflation is used currently with index-linked gilts?
A. CPI 3 months prior
B. RPI 3 months prior
C. CPI 8 months prior
D. RPI 8 months prior
B. Index-linked gilts use RPI 3 months prior.
Index-linked gilts are linked to the retail prices index (RPI). However, to give an element of predictability about the cash flows an investor will receive, the RPI measure used is the one 3 months prior to the payment.
It should be noted that before 2004 the government used an RPI measure 8 months prior to the payment date, and gilts issued before this time still use this method.
Which of the following bonds is likely to display the least volatility?
A. Longer dated
B. Zero coupon
C. Non-investment grade
D. High coupon
D. High coupon bond is likely to display the least volatility.
Long dated, low coupon and junk bonds are all higher volatility bonds.
Bonds with lower coupons have more price volatility than bonds with higher coupons.
- When interest rates rise, both high coupon and low coupon bonds will fall in value; the low coupon will fall further in value as it yields less interest to reinvest back into the market at the new, higher rate of interest.
- Likewise, when interest rates fall, both high coupon and low coupon bonds will rise in value; the high coupon will rise further in value as it yields more interest to reinvest back into the market.
What is the best definition of a Eurobond?
A. A bond issued in the home country of its issuer and in a currency other than that of the issuer’s home currency
B. A bond issued outside the home country of the issuer and in the currency of the country of issue
C. A bond issued in the home country of the issuer and in the same currency as the issuer’s home currency
D. A bond issued outside the home country of the issuer and in a currency other than that of the country of issue
D. A eurobond is issued through international placing, therefore is issued in more than one country at the same time.
It is also issued in a eurocurrency. A eurocurrency is not necessarily the Euro, and is not necessarily a European currency. A eurocurrency can be any currency held on deposit in a country from where it does not originate, for example Sterling held in the US or US Dollars held in Japan.
Hence a bond issued outside the issuer’s home country in a currency other than that of the country of issue is the best definition of a eurobond.
Which of the following best describes the relationship between LIBOR and IBID?
A. LIBOR is always higher than IBID
B. IBID is always higher than LIBOR
C. Both rates are at a similar level
D. Either rate could be higher
A. LIBOR is always higher than IBID.
IBID is typically set to be 1/8th of a percent lower than LIBOR.
A pension fund manager is concerned about the negative impact of interest rate risk on her portfolio.
She estimates that the fund will need to start buying annuities in roughly 30 years.
Which of the following bond purchases will enable her to best immunise her portfolio from uncertainty in interest rates?
A. 30 year 6%coupon gilt
B. 30 year 4% coupon gilt
C. 30 year 2% coupon gilt
D. 30 year zero coupon gilt
D. 30 year zero coupon gilt.
Zero coupon bonds have some intriguing properties that are much valued by pension funds and risk managers who use these bonds to get more effective immunisation against interest rate risk, by matching the duration of their assets with the duration of their liabilities.
The duration of a zero coupon bond is the same as its maturity. Hence, a 30 year liability can be immunised with a 30 year zero coupon bond. Since the DMO does not issue zero coupon gilts, it is necessary for dealers to create them synthetically (STRIPS).
Conventional coupon bearing bonds, even with low coupons and ultra-long maturities, have durations that are limited to around 18 years.
James Knight sees a quoted rate of 6% pa for a deposit account that has interest paid quarterly. What is the annual equivalent rate?
A. 1.06%
B. 1.06136%
C. 6%
D. 6.136%
D. 6.136%
Any rate quoted pa is a simple interest rate for the year. This interest rate is paid quarterly, so to calculate the annual equivalent rate (AER) we would need to work out the period rate and then compound the rate for the year.
Period rate - There are 4 three-month periods in a year, so:
6% / 4 = 1.5%
Compound rate:
(1.015^4) - 1 = 0.06136 or 6.136%.
Which of the following are the two main types of money market fund?
A. Constant Net Asset Value and Constant Net Repayment
B. Accumulating Net Asset Value and Accumulating Net Repayment
C. Constant Net Asset Value and Accumulating Net Asset Value
D. Constant Net Repayment and Accumulating Net Repayment
C. Constant Net Asset Value (CNAV) and Accumulating Net Value are the two types of money market fund.
An investor makes a sale of 20,000 UK shares at a quoted price (in pence) of 210/220 on the London Stock Exchange. The broker charges 0.25% commission (or a minimum of £10) per trade.
Taking into consideration these charges and any other taxes or levies, how much will the INVESTOR receive on settlement?
A. £41,895
B. £41,894
C. £43,669
D. £44,331
B. £41,894
Sale proceeds = 20,000 x £2.10 = £42,000
Broker’s commission = £42,000 x 0.0025 = (£105)
Takeover Panel levy = (£1)
TOTAL = £41,894
Jason Knight, a higher rate tax payer has made a capital gain on a holding of corporate bonds. What is his tax position on the gain?
A. He will be liable for 40% Capital Gains Tax on the gain
B. He may use his CGT allowance (if available) and then be liable to 40% on the balance
C. He may use his CGT allowance (if available) and then be liable to 20% Capital Gains Tax on the balance
D. He has no tax to pay
D. He has no tax to pay.
Generally speaking there is no capital gains tax on corporate bonds. If the examiner had specified ‘convertible loan stock’ there would be CGT to pay.
If the government issues a 2.5% index-linked gilt, how would the coupon paid be assessed?
A. The coupon plus the change in the RPI
B. The coupon only - it is the capital that is adjusted for inflation
C. The change in the RPI up to the coupon rate
D. The coupon less the change in the RPI
A. The coupon plus the change in the RPI.
The coupon is adjusted upwards by the change in the RPI, as well as the capital.
Alexis, a private investor, is quoted £94 for a gilt with a coupon of 6.5%.
Assuming she buys it 54 days after the last payment of interest, what is the dirty price of the gilt assuming 365 days in the year?
A. £94.96
B. £95.06
C. £95.16
D. £95.26
A. £94.96
Dirty price = clean price + accrued interest
Clean price = £94
Accrued interest = 54/365 x £6.5 = £0.96
Dirty price = £94.00 + £0.96 = £94.96.
Which of the following statements are TRUE regarding the retail bond market?
I. They are traded in units up to £50,000
II. They are sold directly to clients by investment bank sales teams
III. They are sold to clients by wealth management firms
IV. Maturities range from 10 to 15 years
A. I, II only
B. II, IV only
C. I, III, IV only
D. I, III only
D. I, III only.
The retail bond market has been steadily growing in recent years, and investors can expect to invest in these bonds via their market intermediaries, such as wealth managers. In contrast, the wholesale bond market would involve direct selling by the sales teams of investment banks.
They are traded in units up to £50,000. The institutional bond market would trade in units above £50,000.
Typical maturities would be between 5 and 10 years.
Gilts are issued by the UK Government to fund which requirement?
A. GEMMS
B. LGNCR
C. PWLB
D. CGNCR
D. CGNCR
The central government net cash requirement is a deficit created through the central government spending more on running the country (state benfits, road-building, etc) than it raises through tax, duties, etc. It is funded through the issue of gilts.
Public sector net cash requirement (PSNCR) = CGNCR + LGNCR + PCNCR
How much would an investor pay to buy £50,000 nominal of a gilt at a price of £103.75?
A. £103.75
B. £50,000
C. £51,875
D. £5,187,500
C. The nominal value (NV) is the amount that an investor is deemed to have lent the government, but rarely reflects the actual price of the gilt.
In the exam, we always assume £100NV per gilt, so this investor is buying 500 gilts. Each gilt is priced at £103.75, so the total amount payable would be:
£103.75 x 500 gilts = £51,875
