Chapter 5: Other Financial Assets Flashcards
What are Cash Deposits?
Investors keep wealth in cash, deposited with a bank or other savings institution to earn interest.
What are the main characteristics of Cash Deposits?
- Return is interest income with no potential for capital growth.
- Amount invested (capital) is repaid in full at the end of the investment term or when withdrawn.
What are different types of accounts?
- Instant access.
- Fixed term
What are Instant Access accounts?
Money can be withdrawn at any time.
What are Fixed Term accounts?
Takes a year or more for money to be withdrawn.
For the interest rate on these accounts, what does it depend on?
Amount of money deposited and the time for which they money is tied up.
* Large deposits = more economical for bank or building society to process and will earn a better rate.
* Rate varies because of competition, as deposit-taking institutions will compete intensely with one another to attract new deposits.
Is interest received liable to income tax?
Yes, but is paid in gross (without deduction of tax) to investors.
Until April 2016, how did tax on cash deposits work?
Interest used to be paid net of tax as deposit-takers were required to deduct tax before it was paid to depositor and then account for tax to HM Rev & Customs (HMRC).
How does tax on cash deposits work now?
Personal savings allowance removes tax on up to £1000 of savings income for basic rate taxpayers, and up to £500 for higher rate taxpayers. As part of this change, since April 2016, banks and building societies have been required to stop automatically taking 20% in income tax from interest earned on non-ISA savings.
What are the benefits of investing in cash?
- Liquid - most investors need to have cash at short notice in case of emergency.
- Savings vehicle that returns interest.
- Cash instruments are safe and not exposed to market volatility.
What are the cons of investing in cash?
- Deposit-taking institutions are of varying creditworthiness - risk they may default needs to be assessed and taken into account.
- Inflation reduces real return being earned on cash deposits and could mean real return after tax is negative.
- Interest rates vary so returns from cash-based deposits also vary.
- Currency risk, and different regulatory regimes to take into account, where funds are invested offshore or in a different currency.
What is a bank compensation scheme?
Repay any deposited money lost, up to a max, as a result of collapse of a bank or building society. The sum is fixed so has to be of meaningful protection to most retail investors, although it would be of less help to very substantial depositors.
Are cash products regulated?
No, but the Prudential Regulatory Authority (PRA) regulates banks and other deposit-takers.
What is the FSCS?
Financial Services Compensation Scheme - provides protection for first £85k of deposits per person with an authorised institution.
What are Cryptocurrencies?
- Type of digital currency or asset that can be traded, stored and transferred electronically.
- Virtual currency represented by a digital record, is not issued by a CB or similar institution, is not legally established currency and can be used as an alternative to money.
What’s the best known Crypto?
Bitcoin - uses blockchain to build a decentralised network that has no central trusted authority and which is open to anyone t participate.
According to the FCA, what are the 3 main kinds of crypto assets?
- Exchange tokens - e.g. Bitcoin and other currencies.
- Security tokens - has features similar to general investments such as asset ownership right entitlement to a share of future profits, repayment of a specific sum of money, or tradability.
- Utility tokens - gives access to services and products.
What 3 functions does money serve?
- Store of value
- Medium of exchange with which to make payments
- Unit of account with which to measure the value of any particular item that is for sale.
Why are cryptocurrencies not accepted as money?
Despite meeting some definitions of money, they’re not money according to G20 Finance ministers, BoE and CB governors (FMCBGs) - they’re to volatile to be a good store of value, not widely accepted as a means of exchange and not used as a unit of account.
What are Money Markets?
Wholesale or institutional markets for cash and are characterised by the issue, trading and redemption of short-dated negotiable securities. These usually have maturity of up to one year, though more typically three months or less.
What are Capital Markets?
Long-term providers of finance for companies through investments either in bonds or shares.
Due to short-term nature of money markets, how are most instruments issued?
Bearer form at a discount to their face value to save on administration associated with registration and the payment of interest. Instruments used to be issued in bearer form, but it’s usual to issue them in electronic form to enable electronic book transfer and custody of securities.
Why are money markets more suitable for institutional investors than retail investors?
Direct investment in money market instruments is often subject to relatively high minimum subscription.
What are the similarities between cash deposits and money markets?
- Provide low-risk way to generate an income or capital return, while preserving nominal value of amount they invested.
- Play valuable role in times of market uncertainty.
But
*Unsuitable for anything other than short term as they have underperformed most asset types over medium and long term. - Long-term returns from cash deposits, once tax and inflation have been taken into account, have barely been positive.
What are the main types of money market instruments?
- Treasury bills
- Certificates of Deposit (CDs)
- Commercial paper (CP)
