Chapter 5: Investment Products

Question 1

Which of the following investments can trade at a premium or at a discount?

I. Unit Trust
II. Venture Capital Trust
III. Investment Trust

A. I and II only
B. II and III
C. III only
D. II only

Answer 1

B. II and III.

Investment trust companies and venture capital trusts are similar in that they trade on the LSE. This means that there is no direct link between the pricing of the share and the net asset value of the fund. Instead the share’s value will be determined by supply and demand, which could lead to them trading at a premium or discount.

Question 2

Which of the following is NOT a feature of exchange-traded funds (ETFs)?

A. ETFs are open-ended
B. ETFs follow the performance of an index closely
C. ETFs use forward-pricing
D. ETFs are not subject to stamp duty

Answer 2

C. Exchange-traded funds, as the name suggests, trade on the secondary markets, such as the London Stock Exchange. This allows investors to make purchases and sales at the current market price.

Question 3

A downward sloping yield curve means what?

A. Short term yields are lower than long term yields
B. A flat level of yields across all maturities
C. Long term yields are higher than short term yields
D. Short term yields are higher than long term yields

Answer 3

D. Short term yields are higher than long term yields.

A downward sloping yield curve is sometimes called inverted or abnormal. It shows the market offering investors a higher yield (or return) on short dated assets and a lower yield on long dated assets. This is not what a rational investor would normally expect.

Question 4

Ring of Gold plc design and make quality wedding rings. They regularly need to purchase quantities of gold and are concerned about its rising price. Which is the following is/are correct in relation to using a gold future/forward contract?

I. Ring of Gold should take a long position in gold futures
II. Futures in general are less standardised than forwards

A. I only
B. II only
C. Both
D. Neither

Answer 4

A. I only.

Long futures position benefit from price rises. Any profit from the long future can be used to compensate Ring of Gold for the increasing price of gold.

• Futures are standardised by the exchanges that they trade on.
• Forwards trade over the counter and can be tailored to the needs of the investor.

Question 5

What is the maximum tax efficient annual investment that can be made in new shares of a Seed Enterprise Investment Scheme (SEIS), and what is the maximum income tax relief that can be obtained in any one fiscal year?

A. £500,000 max investment £150,000 max income tax relief
B. £200,000 max investment £60,000 max income tax relief
C. £100,000 max investment £30,000 max income tax relief
D. £100,000 max investment £50,000 max income tax relief

Answer 5

D. £100,000 max investment; £50,000 max income tax relief.

April 6 2012, saw the launch of the EIS and the VCTs little cousin, the Seed Enterprise Investment Scheme (SEIS). It complemented the EIS scheme and was predominantly designed to stimulate entrepreneurship and to help small, early-stage companies to raise equity finance.

The measure supported the coalition government’s growth agenda by helping smaller, riskier, early-stage UK companies, which may face barriers in raising external finance, to attract investment, making it easier for these companies to become established and grow.

It applies to smaller companies, under two years old, with 25 or fewer employees and assets of up to £200,000, which are carrying on or preparing to carry on a new business. It enables individual investors with opportunities to get a range of tax reliefs by investing in new shares of companies in the SEIS. The scheme makes available tax relief to investors who subscribe for shares and have a stake of less than 30% in the company.

The relief will apply to investments made on or after 6 April 2012. SEIS investors can put in up to £100,000 in a single tax year and this investment can be spread over a number of SEIS-eligible companies. Investors can get up to 50% tax relief in the tax year the investment is made, regardless of their marginal tax rate.

Question 6

Which of the following is/are traded on the London Stock Exchange?

I. Unit trusts
II. OEICs
III. Investment Trusts

A. I and II
B. II and III
C. III only
D. I, II, and III

Answer 6

C. Investment trusts are traded on the LSE.

The units in a unit trust and the shares in an open ended investment company can only be bought from and sold to the manager/authorised corporate director. Investment trust (companies) are genuine companies, the shares in which are freely transferable on the secondary markets.

Question 7

Which of the following statements is the BEST description of the way in which diversification and risk reduction are related?

A. Diversification and risk reduction is achieved by combining assets whose returns are not perfectly negatively correlated with one another
B. Diversification and risk reduction is achieved by combining assets whose returns are not perfectly positively correlated with one another
C. Diversification and risk reduction is achieved by combining assets whose returns are not correlated at all with one another
D. Diversification and risk reduction are not related to the idea of correlation between assets

Answer 7

B. Diversification and risk reduction is achieved by combining assets, whose returns have not moved in perfect step, or are not perfectly positively correlated with one another.

Question 8

What type of option can only be exercised at expiry?

A. Asian
B. American
C. European
D. Bermudian

Answer 8

C. European options can only be exercised at expiry.

Question 9

Following the Retail Distribution Review (RDR), which of the following correctly explain the resurgence in interest in investment trust companies?

I. The elimination of provider commission for open-ended funds
II. The greater level of FCA regulation for open-ended funds
III. The greater level of PRA regulation for closed-ended funds
IV. Compared to open-ended funds, closed-ended funds are less likely to become too large for effective management

A. I and II only
B. III and IV only
C. II and III only
D. I and IV only

Answer 9

D. I and IV only.

Investment trust companies are regulated by the UKLA, HMRC, and Companies Act 2006, not the PRA.

Question 10

Which of the following would increase the value of a call option?

A. A rise in interest rates and an increase in the exercise price
B. A fall in interest rate and an increase in the exercise price
C. A rise in interest rates and a decrease in the exercise price
D. A fall in interest rates and a decrease in the exercise price

Answer 10

C. A call option value will increase with a rise in interest rates and a decrease in the exercise price.

Question 11

What is the maximum subscription per subscription year into a child trust fund or Junior ISA?

A. £3,600
B. £4,368
C. £9,000
D. £20,000

Answer 11

C. Contributions of up to £9,000 pa can be made to a child’s CTF or Junior ISA. The ‘subscription year’ for a CTF runs from the child’s birthday to the next. For Junior ISAs it is based on the fiscal year.

Question 12

Kate is the holder of a put option on stock ABC. The option has a strike of 120 and a premium of 25. At what price of the underlying is Kate’s breakeven?

A. 25
B. 95
C. 120
D. 145

Answer 12

B. Kate has paid a premium of £25, so the underlying needs to fall to 95 from 120 for her to make back her premium and breakeven.

Question 13

What may be the rationale for a hedge fund strategy to take a long/short position?

A. Lower transaction costs
B. To follow a passive investment strategy
C. To create a market-neutral position
D. To benefit from falls in the market

Answer 13

C. To create a market-neutral position

Long/short funds do not look at the market as a whole, hoping for market rises or falls. Instead, they are more likely to look for under-priced/over-priced stocks and to buy or short sell these accordingly with the intention that, irrespective of the market movements, they will make a profit.

Question 14

What is the maximum percentage holding by a single shareholder in a REIT?

A. 5%
B. 10%
C. 15%
D. 20%

Answer 14

B. 10%.

The 10% maximum stake in a REIT is intended to prevent tax avoidance, primarily by property management companies who were given the opportunity to convert into REITs.

Question 15

Which of the following is true of ETF shares and stamp duty?

A. ETF shares incur stamp duty at 0.5% rounded to the nearest pound
B. ETF shares incur stamp duty at 0.5% rounded to the nearest penny
C. ETF shares incur stamp duty at 1.5% rounded to the nearest penny
D. ETF shares do not incur stamp duty

Answer 15

D. ETF shares do not incur stamp duty.

Question 16

Jim is the holder of a put option on XYZ stock that expires in three months time. The option has a strike of 80p and a premium of 10p. Assuming a current share price of 90p which of the following is true?

A. Jim’s option is in the money
B. Jim’s option is at breakeven
C. Jim’s option has time value
D. Jim runs the risk of the price falling

Answer 16

C. Jim’s option has time value.

Jim’s option is currently out of the money so his option has no intrinsic value but as it still has 3 months to maturity it does have time value.

Question 17

A 90 day notice account would require the holder to:

A. Wait 90 days from depositing funds before a withdrawal could be made
B. Withdraw funds for 90 days at a time
C. Give notice to withdraw funds 90 days before they do, with no waiver from the provider
D. Give notice to withdraw funds 90 days before they do, with a waiver possibility

Answer 17

D. Give notice to withdraw funds 90 days before they do, with a waiver possibility.

The provider could allow the notice period to be waived, but penalties may be applied.

Question 18

Which of the following statements is incorrect in relation to options?

A. Call options rise in value when the underlying rises
B. Put options fall in value when the underlying rises
C. The option holder has less risk than the option writer
D. Option holders need to deposit margin with their broker

Answer 18

D. The option holder will pay the premium on the option, and this represents his maximum loss, so there is no need to post margin. The option writer is exposed to further losses, so will need to post margin to his broker in order to cover the broker’s exposure to credit risk.

Question 19

You are holding a meeting with your client, during which you are explaining to her the benefits of diversifying into different asset types and classes. With regard to diversification benefits, which of the following statements is least likely to be true?

A. If the investments are company shares, there is little benefit in diversifying between British and international equity markets
B. As property has gained in popularity, it has become recognised as a core asset class in its own right
C. Assets with a low or negative correlation tend to be attractive to investors since when one asset is performing badly, the other asset is rising in value
D. There is a predictably strong positive correlation between investor returns from equities, and investor returns from government bonds

Answer 19

D. Globalisation has reduced diversification benefits from holding a mixture of both UK and international shares in a portfolio, since returns from different equity markets tend to be strongly positively correlated to one another.

By contrast, returns from shares and government bonds tend to move in opposite directions in times of equity market stress, there is often a ‘flight to quality’ effect as investors sell shares and move into bonds instead.

Question 20

In relation to OEICs, which of the following is INCORRECT?

I. Investors buy shares in the OEIC
II. OEICs usually have a dual price system

A. I only
B. II only
C. Both
D. Neither

Answer 20

B. OEICs are usually single priced and investors do buy shares in the OEIC.

Question 21

REGULAR bonuses paid with-profits policies issued by Life Companies are called:

A. Terminal bonuses
B. Reversionary bonuses
C. Special bonuses
D. Annual bonuses

Answer 21

B. Reversionary bonuses.

Life company bonds that are issued ‘with profits’ have a basic sum assured plus a share in any investment profits made by the company. These profits can be shared through reversionary bonuses - which are added each year and once paid cannot be taken away - and terminal bonuses - which are awarded on maturity of the policy or the death of the policy holder.

Question 22

Which of the following is/are CORRECT provisions of UCITS III?

I. 100% of a UCITS Fund can be invested in other UCITS funds
II. Up to 10% of the NAV of the fund can be invested in one issuer
III. The use of derivatives is limited to 10% of the NAV of the fund

A. I and II
B. II and III
C. I and III
D. I, II, and III

Answer 22

A. I and II.

There is a restriction on how much exposure a UCITS fund can have to derivatives, but this is 20%.

Question 23

What is the most accurate definition of a future?

A. A right via an agreement to buy or sell a given quantity of a particular asset at a set future date and at a pre-agreed price
B. A binding agreement to buy or sell a variable quantity of a particular asset at a set future date and at a pre-agreed price
C. A right via an agreement to buy or sell a variable quantity of a particular asset at a set future date and at a pre-agreed price
D. A binding agreement to buy or sell a given quantity of a particular asset at a set future date and at a pre-agreed price

Answer 23

D. A future is a binding agreement to buy or sell a given quantity of a particular asset at a set future date and at a pre-agreed price.

Futures are binding agreements or a contract. By definition, a future is traded on exchange and subject to significant contract specifications.

Question 24

With regard to Venture Capital funds, financial bootstrapping refers to:

A. Private equity capital provided to small growing companies
B. Leveraged purchases of companies
C. Minority purchase of a business via co investment
D. A collection of methods used to minimise external equity and debt financing

Answer 24

D. A collection of methods used to minimise external equity and debt financing

This method will allow the founders the freedom to develop the company as they see best. The other methods refer to venture capital, leveraged buy-outs, and equity co investments.

Question 25

Which of the following is/are CORRECT in relation to contracts for difference (CFD)?

I. CFDs are not subject to capital gains tax
II. CFDs are not subject to stamp duty

A. I only
B. II only
C. Both
D. Neither

Answer 25

B. II only.

CFDs are cash settled so do not incur stamp duty, but they are subject to CGT.

Question 26

Venture capital trusts (VCT) are most similar in structure to which other collective investment vehicle?

A. Open-ended investment company
B. Investment trust company
C. Unit trust
D. Enterprise investment scheme

Answer 26

B. Investment trust company.

Venture capital trusts are constituted very much like an investment trust. However, their investment focus is specifically on smaller, higher-risk companies. Although the target investments are similar to an EIS, the structure is very different.

Question 27

A put option on XYZ plc is bought for a £1 premium. The strike price is £2 and currently XYZ is trading at £2.50. Which of the following is CORRECT?

I. The option is out of the money
II. The time value is £1, the intrinsic value is zero

A. I only
B. II only
C. Both
D. Neither

Answer 27

C. Both are correct.

Intrinsic value = amount in the money i.e. nil
Time value = Premium - Intrinsic Value i.e. £1 - 0 = £1.

Question 28

In the private equity industry, which of the following is best description of carried interest?

A. The share of the proceeds from the fund paid to the Limited Partners
B. The share of the investment from Limited Partners that is paid to the General Partners
C. The share of the fund proceeds that are paid to the General Partners
D. The interest that must be paid on the debt funding from bank

Answer 28

C. The share of the fund proceeds that are paid to the General Partners

General Partners (GP) will receive a management fee from the Limited Partner’s (LP) capital contribution.
Historically, annual management fees have been approximately 2% of the fund size. In addition to the management fee, the GPs also receive a portion of the proceeds from the fund. The portion of the proceeds in an investment that go to a GP are known as carried interest.

Question 29

Which of the following is a feature of a covered warrant?

A. Holding a put and a call warrant
B. Holding cash to cover exposure
C. Holding other securities to cover exposure
D. Holding the underlying asset to cover exposure

Answer 29

D. Holding the underlying asset to cover exposure.

Covered warrants are rights to buy or sell shares. However, the issuer of these covered warrants, typically investment banks, must cover the position they create by writing a warrant through holding a position in the underlying asset.

Question 30

A call option on ABC plc is bought for a £1 premium. The strike price is £2 and currently ABC is trading at £2.50. Which of the following is correct?

I. The option is in the money
II. The option has an intrinsic value of 50p, but no time value

A. I only
B. II only
C. Both
D. Neither

Answer 30

A. I only.

Intrinsic value = the amount in the money i.e. £2.50 - £2 =0.50p
Time value = Premium - Intrinsic Value, so £1 - £0.50 = £0.50 or 50p

Question 31

Which of the following would NOT hold land or buildings as investments directly?

A. Unit Trust
B. Life Fund
C. UCITS Fund
D. Investment Trust Company

Answer 31

C. Although non-UCITS retail schemes (NURS) are permitted to invest directly in immovable property, UCITS funds are not.

Question 32

Farmer Giles grows wheat during the growing season and sells it at harvest time. He wants to hedge price risk using futures contracts. Which of the following is/are correct?

I. He should take a long position in wheat futures
II. His main concern is of prices falling

A. I only
B. II only
C. Both
D. Neither

Answer 32

B. II only.

His concern is clearly of prices falling. If they do, he will get less for his wheat come harvest time. To protect himself against this he needs an investment that will make money in a falling market. This is what a short future does, so sell futures, i.e. go short.

Essentially, the farmer will be agreeing to sell wheat come harvest time at a price that he agrees to today.

Question 33

Which of the following represent common risks faced by investors IN BOTH physical and synthetic ETFs?

I. Gearing of the fund
II. Failure of the counterparty of the ETF provider
III. Poor quality collateral held by the ETF provider
IV. Increasing regulation of derivatives

A. I and II only
B. I and III only
C. II and III only
D. II and IV only

Answer 33

C. II and III only.

A synthetic ETF would gain exposure to the required assets through derivatives, such as a total return swap. The ETF provider would invest the cash obtained from investors in collateral. The returns on the collateral would be swapped with a counterparty for returns on the required asset. If the counterparty defaults, then the ETF provider would not be able to make the required payments to the ETF. If the collateral is illiquid, then the ETF provider may fail to return the capital to investors.

A physical ETF provider would use the cash obtained from investors to buy the underlying assets. To boost returns, the ETF provider would likely lend the assets to a counterparty in return for collateral. The investor faces the risk that the counterparty defaults and fails to return the assets borrowed, and they also face the risk that if the collateral is of poor quality, then their capital would be at risk.

The gearing of the fund, and the increasing regulation of derivatives, would impact synthetic ETFs, NOT physical ETFs.

Question 34

Which of the following is NOT the responsibility of the unit trust manager?

A. Creation of new units upon demand
B. Buying/Selling units from/to investors
C. Investment decisions
D. Unit pricing

Answer 34

A. Creation of new units is the responsibility of the trustee, at the request of the manager.

Question 35

In order to be exempt from certain requirements imposed by the Pensions Act 2004, a small self-administered scheme must have no more than which of the following number of members?

A. 10
B. 11
C. 15
D. 20

Answer 35

B. 11.

An SSAS is a company scheme where the members are usually all company directors or key staff.

Where schemes have fewer than 12 members, and where all decisions are made unanimously or have an independent trustee, are exempt from the trustees’ knowledge and understanding requirements of the Pensions Act 2004 and the member-nominated trustee requirements.

Question 36

With a money purchase pension which is the most likely?

A. The pension will be determined by the interest rates on encash
B. The amount deployed will be dependent on the tax rate paid
C. The pension depends on the current LIBOR rate
D. The pension is guaranteed regardless of payments

Answer 36

A. With a money purchase pension, an investor / and or employer pays pension contributions into a chosen pension fund, also known as defined contributions. The ultimate value of the fund at retirement is unknown as it will depend upon how much is paid in each year, and on investment returns.

At retirement the investor has a number of options for their pension fund. The main one is the Open Market Option (OMO), which gives the investor the right to shop around on the open market to compare annuity rates i.e. compare the levels of pension offered by various companies that can be bought with the pension fund. These annuities are heavily influenced by interest rates.
The pension will be determined by the interest rates on encash’ reflects this idea.
Other factors that affect the level of annuity are your age, sex and health.

The budget of 2015 now allows retirees to be able to take the balance of their pension fund, post tax-free cash, as a further lump sum taxable at their highest marginal income tax rate. This eliminates the need to buy an annuity or set up drawdown arrangements.

Question 37

Which of the following investments typically has the highest level of gearing?

A. Unit Trusts
B. Life Company Funds
C. OEICs
D. Investment Trusts

Answer 37

D. Investment Trusts.

• Unit trust and OEICs are restricted in their investment in derivatives and cannot borrow to gear up the fund.
• Life company funds are liability matching funds and are unlikely to be heavily geared.
• An investment trust is a company, and like any other company can borrow to gear up the business. There are no definitive guidelines on the amount of gearing an investment trust can engage in.

Question 38

Who supervises an OEIC’s management?

A. Trustees
B. Director
C. Depository
D. Fund Managers

Answer 38

C. Depositary.

The depository not only becomes the legal owner of the assets (the custodian) held by the fund but is also responsible for overseeing the management of the fund. They perform much the same role as a trustee for a unit trust.