Chapter 7 Flashcards
[1017619] In relation to ethical and socially responsible investment, which of the following are correct?
IBoth types of investing decrease the risk of a portfolio
IIBoth types of investing increase the returns of a portfolio over the short- to medium-term
AI only BII only CBoth DNeither
The correct answer is: D - Neither
Explanation
Ethical and socially responsible investments limit the range of companies that can be included in a portfolio, potentially increasing risk through lack of diversification. Over the short- to medium-term, returns are unlikely to be positively affected. SRI is, after all, generally basing decisions on non-investment criteria. However, advocates of SRI believe that these companies will be better managed and better run, with a view to long-term sustainable growth, claiming that in the long-run SRI will outperform the less responsible companies.
[1047097] If a financial advisor works purely on commission generated on the selling of new financial products to professional clients, when would this commission be generated?
AUpon first meeting the client BUpon the sale of new products CPaid monthly in arrears over a 4 year period DPaid annually in arrears over a 4 year period
The correct answer is: B - Upon the sale of new products
Explanation
The RDR review has banned provider and product commission, but this only applies to advice given to retail clients. The syllabus also refers to understanding problems of product and provider bias, and so an understanding of how commission-based advice is still required.
Given that a commission can be generated both upfront and/or during the life of the product, the best answer here is upfront, since no specific time frame is given for commission generation in arrears by the syllabus
[1017696] Which of the following is not one of the FCA principles?
ACustomers’ interests BData protection CConflicts of interest DFinancial prudence
The correct answer is: B - Data protection
Explanation
The principles are as follows:
1. Integrity: A firm must conduct its business with integrity.
2. Skill, care and diligence: A firm must conduct its business with due skill, care and diligence.
3. Management and control: A firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems.
4. Financial prudence: A firm must maintain adequate financial resources.
5. Market conduct: A firm must observe proper standards of market conduct.
6. Customers’ interests: A firm must pay due regard to the interests of its customers and treat them fairly.
7. Communications with clients: A firm must pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading.
8. Conflicts of interest: A firm must manage conflicts of interest fairly, both between itself and its customers and between a customer and another client.
9. Customers’ relationship of trust: A firm must take reasonable care to ensure the suitability of its advice and discretionary decisions for any customer who is entitled to rely on its judgment.
10. Clients’ assets: A firm must arrange adequate protection for clients’ assets when it is responsible for them.
11. Relationship with regulators: A firm must deal with its regulators in an open and cooperative way, and must disclose to the FCA appropriately anything relating to the firm of which the FCA would reasonably expect notice.
[1040952] Which of the following does not represent a method of indexing?
AFull expectation BFull replication COptimisation DStratified Sampling
The correct answer is: A - Full expectation
Explanation
Full replication will make for an accurate portfolio representation but can be expensive, especially where the securities are illiquid. Also, costs of rebalancing the fund will lead to tracking error. Stratified sampling relies on representative samples, which can lead to bias. Optimisation relies on sophisticated computer techniques, but this can be difficult to use.
[1040171] After establishing the personal details of an investor, what is the first thing you should do before recommending any investment products?
AEstablish current income and expenditure BExplain the technical jargon related to the investment products CExplain the general state of the economy DDetermine the financial situation of the investor
The correct answer is: D - Determine the financial situation of the investor
Explanation
This is the best answer. Establishing the investor’s current financial situation gives the financial advisor a basis on which to move forward. This would look at their current investments and their current liabilities - such as mortgages, overdrafts and credit cards.
After this, the advisor is likely to look at the income and expenditure of the client.
[1040943] Which of the following represents one of the main principles regarding usury/interest in Islamic finance?
AFixed interest on borrowing and lending should be set appropriately BVariable interest is preferable to fixed interest on borrowing and lending CAll forms of interest are forbidden, money transfer is to be based on the principle of profit sharing DAll forms of interest are forbidden, money transfer is to be based on the principle of tax sharing
The correct answer is: C - All forms of interest are forbidden, money transfer is to be based on the principle of profit sharing
Explanation
The customer and the bank share the risk of the investment, and divide profits between them.
[1049230] Which of the following is an example of positive screening?
AEnvironmental improvement BTobacco CNuclear power DGambling industries
The correct answer is: A - Environmental improvement
Explanation
Positive screening is selecting only those investments that are aligned to a set of socially responsible standards. The other answers are all examples of negative screening: i.e. identifying what you do not want to invest in.
[1017615] Lorna Wilson wants to ensure that her investment of £15,000 is not invested in tobacco companies.
Jack Bond wants to ensure that his £15,000 investment is invested in wind farm projects.
Which of the two statements below are correct in describing Lorna and Jack?
ILorna is interested in socially responsible investing
IIJack is interested in ethical investment
AI only BII only CBoth DNeither
The correct answer is: D - Neither
Explanation
Ethical investment seeks to negatively screen those companies that are to the detriment of the environment or society. This reflects Lorna’s position. Socially responsible investment is where investors positively include those companies that actively benefit the environment or society. This reflects Jack’s position.
[1049229] Which of the following is NOT an objective factor in assessing a client’s attitude to risk?
AStage in the life cycle BTheir commitments CTimescale DClient’s view
The correct answer is: D - Client’s view
Explanation
The client’s view is a subjective factor rather than an objective factor.
[1035745] To ensure a client understands, you:
AAsk them questions BGet them to ask you questions CAsk them to explain the product solution to you DSend them a suitability report
The correct answer is: B - Get them to ask you questions
Explanation
Getting the investor to ask you questions is the best answer. You should check whether the client has read and understood the report and ascertain whether they has any questions about it.
[1017683] Jonathan Hart is single, aged 40, and earns £70,000 pa as a self employed management consultant. He has a mortgage of £200,000 and personal loans of £10,000. Jonathan is concerned about becoming ill and not being able to continue to meet his commitments.
Which policy would you recommend for this client as most suitable for his circumstances?
ACritical illness cover BLife assurance and critical illness CIncome replacement DMedical insurance
The correct answer is: C - Income replacement
Explanation
Income protection insurance can be a valuable form of protection for a client with dependants, to protect them against their loss of income if he cannot work. Although Jonathan is single, he states that he wishes to continue to meet his commitments.
Critical illness insurance (CII) pays out a lump sum on diagnosis of certain serious conditions, including cancer and certain heart conditions. However, there is no ongoing protection from these policies.
[1017693] What is the most important reason for presenting recommendations face to face at a client meeting?
ASigning the forms BVerifying status CAnswering client questions DGiving the client the report
The correct answer is: C - Answering client questions
Explanation
One of the most important elements of financial advice is to create a trusting relationship, where the client knows the adviser understands the products he sells and has the client’s interests at heart. One of the ways an adviser can do this is by answering the client’s questions, and a client is more likely to ask questions face-to-face.
All of the other elements do not necessarily require face-to-face meetings.
[1056997] You are the financial adviser of a new client. After carrying out a thorough fact-finding exercise, you have established that your client has strong ethical beliefs that he would like to be reflected within the portfolio you are constructing on his behalf. Your client would also like an international mix within his portfolio. In order to produce a valid benchmark to which you can compare the portfolio’s performance, which of the following is NOT an index that you might use?
AThe FTSE 4Good Index BThe FTSE KLD400 index CThe EIRIS index DThe Calvert index
The correct answer is: C - The EIRIS index
Explanation
The Ethical Investment Research Service (EIRIS) provides research and guidance to organisations and investors interested in such an investment approach. It is an organisation, not an index - though it can offer assistance to firms wishing to construct composite indices to assess performance. The other three indices mentioned are specifically designed to capture shares of companies with strong social, environmental and ethical credentials.
[1040954] In core satellite management, the correct description would be that:
AThe core portfolio is managed actively, and the satellites passively BThe core portfolio is managed semi-actively, and the satellites passively CThe core portfolio is managed passively, and the satellites actively DThe core portfolio is managed passively, and satellites passively
The correct answer is: C - The core portfolio is managed passively, and the satellites actively
Explanation
The core can also be managed semi-actively.
[1056996] The RDR requirements of the FCA changed the nature of the way in which advisers are paid for giving investors advice. Which of the following statements is FALSE regarding the new remuneration regime for advisers?
ANew RDR requirements are specifically aimed at addressing the potential for adviser remuneration to change consumer outcomes. BAdvisers should disclose those charges to consumers up front, using some form of price list or tariff and confirming the specific amount to be paid later on CThe new RDR remuneration regime applies equally to both advised and non-advised services DThe new remuneration regime is specifically intended to reduce the threat of product or provider bias to the suitability of the advice being sold to the investor
The correct answer is: C - The new RDR remuneration regime applies equally to both advised and non-advised services
Explanation
Non-advised services, or execution-only sales, where no advice or recommendation is given, fall outside of the adviser-charging regime.
