CP1 Acronyms Part 1 - 4 Flashcards
FIR
Different Types of Advice (Ch.2 External Environment)
FIR
- Factual - based on research of facts
- Indicative - opinion without full investigation
- Recommendation - fully researched and modelled
Different Types of Advice (Ch.2 External Environment)
CREATE GRAND LISTS
External Environment (Ch.2 External Environment)
CREATE GRAND LISTS
- C - Corporate Governance: Differences between mutual and proprietary companies in structure, financing, and profit distribution.
- R - Regulation and Legislation: Mandated products like motor insurance and their impact on customer needs and product sales.
- E - Environmental Issues: Climate change risks, urbanization challenges, ESG priorities, and uninsurability concerns.
- A - Accounting Standards: Impacts of reporting on employer/insurer benefits and investment classifications.
- T - Tax: Influences on savings, product design, and inheritance planning through taxation policies.
- E - Economic Outlook: Shifts in demand for products during economic growth or recession cycles.
- G - Governance: Ensures companies prioritize stakeholder interests and incentivize impartial management.
- R - Risk Management Requirements: Monitoring and controlling risks to meet regulatory expectations.
- A - Adequacy of Capital: Solvency regulations requiring firms to maintain minimum capital levels.
- N - New Business Environment: Impact of economic cycles on insurance underwriting and banking products.
- D - Demographic Trends: Aging populations, healthcare costs, and migration influencing financial products.
- L - Lifestyle Considerations: Financial needs varying by age, from mortgages to retirement savings.
- I - International Practice: Challenges in replicating financial products due to regulatory differences.
- S - State Benefits: Reducing self-provision needs but discouraging savings through state-provided benefits.
- T - Technology: Growing use of digital platforms for insurance and banking services.
- S - Social and Cultural Trends: Changing societal norms impacting product demand, like homeownership.
External Environment (Ch.2 External Environment)
GRIP
Aims of Regulation (Ch.2 External Environment)
GRIP
- Give confidence in the financial system
- Reduce financial crime
- Inefficiencies can be corrected, and orderly / efficient markets promoted
- Protect consumers
Aims of Regulation (Ch.2 External Environment)
CACIES
How regulators help maintain confidence in the system (Ch.2 Ext Env)
CACIES
- Capital requirements on providers
- Accurate models in place to monitor risk levels
- Competence of financial practitioners (qualifications, membership of professional body, ‘fir and proper’)
- Industry compensation schemes
- Ensure market is transparent and orderly
- Stock exchange requirements regarding financial stability, disclosure, and takeovers
How regulators help maintain confidence in the system (Ch.2 Ext Env)
DEPRICR
How regulators help reduce asymmetries of information (Ch.2 Ext Env)
DEPRICR
- Disclosure of full information in simple language
- Education of consumers
- Price controls
- Regulation of sales practices, including cooling off periods
- Insider trading regulation
- Consumer protection legislation to put aside ‘unfair’ contract terms or to ‘treat customers fairly’
- Require the setting up of Chinese walls
How regulators help reduce asymmetries of information (Ch.2 Ext Env)
SERVICE
Functions of a regulator (Ch.2 Ext Env)
SERVICE
- Setting sanctions
- Enforcing regulations
- Reviewing and influencing government policy
- Vetting and registering firms and individuals
- Investigating breaches
- Checking prudential management and conduct of providers
- Educating consumers and the public
Functions of a regulator (Ch.2 Ext Env)
SYSTEM T for MMI
Characteristics of money market instruments (Ch.8 Bond and Money Market)
SYSTEM T for MMI
- Security - Low default risk (due to short term)
- Yield - Return usually known in nominal terms
- Spread - May provide good diversification, low volatility of price
- Tax - The capital gain at maturity is often treated as income
- Expenses / exchange rate (overseas assets) - Very low dealing/maintenance expenses
- Marketability / liquidity - Marketability (Bought and sold quickly and easily): Not all instruments are tradable, Liquidity (Marketable and stable price OR close to cash in nature): Highly liquid
- Term to maturity: Short-term, typically a year or less
Characteristics of money market instruments (Ch.8 Bond and Money Market)
POURS & GRID
Reasons for holding money market instruments (Ch.8 Bond & Money Market)
POURS & GRIDS
P - Potential: Protect value and preserve capital in uncertain times.
O - Outcome: Ensure liquidity and stability during volatility.
U - Use: Utilize liquid assets for short-term financial needs.
R - Risk: Low returns if the market stabilizes quickly.
S - Strategy: Shift to safer, liquid assets to reduce exposure.
Institutional investors also hold money market instruments when they take the view that other assets such as bonds and equities may fall in value, scenarios that this would happen would include:
G - Goals: Protect capital and maintain financial flexibility.
R - Risks: Missed opportunities for higher returns.
I - Issues: Balancing safety with growth potential.
D - Drivers: Economic uncertainty and market downturns influence decisions.
S - Success Factors: Effective timing and strategic allocation of assets.
Reasons for holding money market instruments (Ch.8 Bond & Money Market)
SYSTEM T for conventional government bonds
Characteristics of conv. gov bonds (Ch.8 Bond and Money Market)
SYSTEM T for Conv. gov bonds
- Security - Default risk depends on the security of the issuing country (e.g. as measured by its credit rating)
- Yield - o Expected return if held to redemption = GRY, GRY is known in nominal but not in real terms
- Spread - May provide diversification from other asset classes (because prices are not perfectly correlated), Long-term bonds have more volatile prices than short-term bonds
- Tax - Depends on the territory concerned (E.g. in the UK, individuals pay tax on income but capital gains are tax exempt)
- Expenses / exchange rate (overseas assets) - Very low dealing costs/ Risk for bonds issued in a foreign currency
- Marketability / liquidity - High marketable, Large issue size, frequently traded, Listed on the stock exchange
- Term to maturity: Short-term, medium-term, long-term, irredeemable (undated)
Characteristics of conv. gov bonds (Ch.8 Bond and Money Market)
SYSTEM T for index-linked government bonds
Characteristics of index-linked gov bonds (Ch.8 Bond and Money Market)
SYSTEM T for Index-linked gov bonds
- Security - Default risk depends on the security of the issuing country (e.g. as measured by its credit rating)
- Yield - GRY is known in real but not in nominal terms (because depends on what inflation actually turns out to be), Holding period return if not to be held to redemption depends on sale price
- Spread - May provide diversification from other asset classes, More volatile prices than conventional government bonds due to longer discounted mean term (because the cashflows on an index-linked bond are more heavily weighted to the later durations due to their indexation)
- Tax - Depends on the territory concerned (E.g. in the UK, individuals pay tax on income but capital gains are tax exempt)
- Expenses / exchange rate (overseas assets) - Very low dealing costs/ Risk for bonds issued in a foreign currency
- Marketability / liquidity - High marketable, Large issue size, frequently traded, Listed on the stock exchange
- Term to maturity: Short-term, medium-term, long-term, irredeemable (undated)
Characteristics of index-linked gov bonds (Ch.8 Bond and Money Market)
SYSTEM T for investment that affects its price
Characteristics of inv that affect its price(Ch.8 Bond and Money Market)
SYSTEM T for Index-linked gov bonds
-
Security -
o Issuer’s credit rating
o Level of income/asset cover that the issuer provides: The higher the ratio of the incomes receives, and assets held to the amounts that need to be repaid, the less likely the issuer is to default (bonds would then be higher priced because more secure)
o Asset-backed / secured: Assets can be sold to meet the bond payment if needed
o Ranking of repayment: Higher ranking, better
o Parental guarantees
o Country of issue - Yield - Coupon level, Coupon frequency
- (No Spread, No Tax)
- Expenses / exchange rate (overseas assets) - Exchange rate: currency
- Marketability / liquidity - Issuer, Size of issue (larger better), Listed is more marketable
- Term to maturity: Short/medium/long (lower price for same redemption amount)
Characteristics of inv that affect its price(Ch.8 Bond and Money Market)
SYSTEM T for Equities
Characteristics of equities (Ch.9 Equity and Property Market)
SYSTEM T for Equities
-
Security - Depends on the security of the issuing company, accessed using:
Accounting ratios (dividend cover, gearing), company accounts, credit rating etc -
Yield - o Increasing dividends should offer a real return
o Riskier than bonds so expect higher return -
Spread - o Volatile capital values
o Cyclical industries are more sensitive to the economic cycle and more volatile, e.g. airline industry
o Defensive industries are less sensitive to the economic cycle and have more stable returns (e.g. utility industry) -
Tax - o Income and capital gains may be taxed differently
o Dividends paid from post-tax profits (franked) so no further tax payable for most investors
o Capital gains are taxed when realised -
Expenses / exchange rate (overseas assets) - o Dealing costs including the margin between the purchase and sale price
o Higher dealing costs than bonds
Exchange rates: if equity purchased overseas
-
Marketability / liquidity - o Varies by company, large companies more marketable than small companies
o Unlisted companies have very low marketability
Listed companies complies to the stock exchange regulation and disclosure requirements, gives investors more security and increases marketability of the share - Term: o Can be held in perpetuity
Characteristics of equities (Ch.9 Equity and Property Market)
CALL ST
Factors that would constitute a prime property (Ch.9 Equity & Property)
- Comparable
- Age and condition
- Location
- Lease structure
- Size
- Tenant quality
Factors that would constitute a prime property (Ch.9 Equity & Property)
SYSTEM T for Property
Characteristics of property (Ch.9 Equity and Property Market)
SYSTEM T for Property
-
Security - o Depends on tenant quality
Profitability compared to rental income
o Risk of voids
o Obsolescence
When a building becomes out of date and is no longer of use to potential tenants
o Government intervention (e.g. rent or planning controls) - Yield - Running (rental) yield = net rental income/gross purchase price
-
Spread - o Volatile capital values in the longer term
o Infrequent valuation reduces short-term volatility
o Cyclical, related to economic situation
o But lags behind -
Tax - o Stamp duty on purchase
o On rental income
o Tax on capital gain on sale -
Expenses / exchange rate (overseas assets) - o Management costs
o Purchase costs
Exchange rates: if property purchased overseas
-
Marketability / liquidity - o Very unmarketable (high dealing cost)
o Large unit size
o Often indivisible
o Uniqueness makes property hard to value
o Valued infrequently
o Valuing requires expertise - Term: o Very long-term investment
Characteristics of property (Ch.9 Equity and Property Market)
MID
Reasons for overseas investment (Ch.10 Other investment classes)
Reasons for overseas investment “MID”
-
Matching overseas liabilities
o If assets and liabilities are not matched by currency, there will be a risk to the investor from adverse currency movements -
Increase expected return
o Overseas assets might be expected to earn a higher return on domestic assets because they are higher risk OR
o Investors may be trying to take advantage of inefficiencies in market where assets are undervalued.
o Inefficiencies and high growth rates are more likely to be found in emerging markets. These markets can offer the potential for high returns due to the rapid increase in the levels of industrialisation in the country -
Diversification benefit
o Diversification by country or economy should reduce the risk within an investor’s portfolio from a downturn in the market of a single country.
o It may also give an opportunity to invest in companies or industries not available in the investors domestic market
Reasons for overseas investment (Ch.10 Other investment classes)
MTV CATERPILLAR
Problems with overseas investment (Ch.10 Other investment classes)
Problems with overseas investment “MTV CATERPILLAR”-
-
Mismatching assets and liabilities
o If only have domestic liabilities, overseas assets will give a currency mismatch, therefore exposure to the risk of adverse currency movements -
Tax issues
o Less tax efficient, e.g. investor may be taxed in a foreign country, and it may not be possible to recover these taxes in a domestic currency -
Volatility of potential returns
o Due to fluctuations, e.g. in exchange rates (however, the exchange risk can be hedged against) -
Custodian may be required
o Custodians will use their local knowledge to manage the investment on behalf of an overseas investor, including dealing with voting rights, receiving dividend payments, and holding the stock certificates -
Additional administration
o Include recruiting additional staff to deal with the overseas assets and currency requirements -
Time delays
o Due to time zone, which could delay communication and making completing transactions more difficult -
Expertise required
o May be required to buy in expertise from consultant, which adds further expense to the cost - Regulation may be poorer, leading to additional risk
-
Political changes – adverse
o E.g. change of government could prohibit overseas investment, restrict repatriation of funds, or change the tax payable by overseas -
Information – less available
o More difficult to assess the level of risk in the market, and can lead to market inefficiencies
o The way the information is presented may be unfamiliar -
Liquidity lower
o Particularly emerging markets, may not be as liquid as more developed markets, maybe because smaller in size, thus do not have many participants, making it difficult to trade assets -
Language barriers
o However, many large companies publish their accounts in English to remove this barrier to investment
o Alternatively, can use translator but will lead to additional costs - Accounting practices differ
- Restriction on ownership
Problems with overseas investment (Ch.10 Other investment classes)
LIME
Yield curve theories (Ch.11 Behaviour of the markets)
Yield curve theories “LIME”
-
Liquidity preference theory
o Liquidity preference theory says that, in general, investors prefer liquid stocks to illiquid ones. Long-dated stocks are less liquid than short-dated stocks
o Therefore, investors required a liquidity risk premium to compensate them for investing in less liquid stocks
o According to liquidity preference theory, the yield curve should be more upward sloping (or less downward sloping) than that predicted by the pure expectations theory alone -
Inflation risk premium theory
o Under the inflation risk premium theory the yield curve will tend to slope upwards, or be less downward sloping, because investors need a higher yield to compensate them for holding longer-dated stocks which are more vulnerable to inflation risk than shorter-dated stocks. -
Market segmentation theory
o Market segmentation theory says that yields at each term to redemption are determined by supply and demand from investors with liabilities of that term -
Expectations theory
o Expectations theory describes the shape of the yield curve as being determined by economic factors, which drive the market’s expectations for future short-term interest rates
o If future short-term interest rates (= forward rates) are expected to rise, the yield curve will slope upwards
Yield curve theories (Ch.11 Behaviour of the markets)
SHAM FADS
Valuation methods (Ch.12 Valuation of Investments)
Valuation methods “SHAM FADS”
-
Smoothed market value / Current market value
o “Smoothed” usually means some kind of moving average value over a year or several years
o Most common method in valuing assets because most traded assets have a price that can be taken from a stock market or exchange
Values are objective and cannot be manipulated by the valuer
Normally relatively easy to obtain
Should also be accurate if we believe the concept of efficient market applies
However, quoted prices can be volatiles and although market values exists for assets, they seldom exists for liabilities, and that can lead to consistency problems further down the line
o Smoothing the market value can reduce some of the volatility that leads to a value that cannot be easily compared to that of a liability
o E.g. taking an average over 3 months -
Historic book value
o Price for which the asset was purchased
o Sets of accounts often use historical cost as a measure of certain assets, such as inventory or land
o But it is of little use when the purpose of the valuation is to compare with a liability -
Adjusted book value
o An adjustment to the historic book value method
o Involves reassessing the book value from time to time and adjusting it upwards or downwards when necessary - Market value
-
Fair value
o The amount for which an asset could be exchanged, or a liability settled between knowledgeable, willing parties at arm’s length -
Arbitrage value
o Normally used in pricing derivatives
o Assumes two portfolios give the same cashflows must have the same value -
Discounted cashflow (DCF)
o Main advantage: Same method can be applied to liabilities to make a consistent valuation. However, it does rely on assumptions which can be criticized as being subjective - Stochastic model
Valuation methods (Ch.12 Valuation of Investments)
IRR
Factors affecting inv strat. for institutions (Ch14 Choosing inv strat.)
Factors affecting investment strategy for institutions “IRR”
-
Institutional objectives
Level of risk: - Probability of failing to meet objectives
- Risk of underperforming competitors
-
Risk appetite
Risk measures: - Shortfall probability
- Maximum variance of return
- Value at Risk
- Tracking error
Risk appetite depends on - Nature of the institution
- Any constraints set by institution’s documentation
- Any constraints set by statutory bodies
-
Required return
Maximise return subject to constraints - Minimise tax
- Income vs gains
- Diversification of assets to give a stable return
Factors affecting inv strat. for institutions (Ch14 Choosing inv strat.)
BILE
Main investment considerations (Ch.14 Choosing inv strategy)
Main investment considerations “BILE”
-
Benchmarks and restrictions
Investment restrictions on what it can and can’t do
Impact of its competitors
Statutory and solvency restrictions and accounting requirements
Environmental, social and governance (ESG) considerations -
Investor’s particular circumstances
Size of assets (absolute and relative to liabilities, i.e. funding level)
Existing portfolio
Risk appetite
Stated objectives
Needs for diversification -
Liabilities of the investor
Act as a constraint, in particular, the nature, term, currency and uncertainty of those liabilities, and future accrual of liabilities (if applicable) -
Expected return
Returns from different assets
Impacts of tax: Tax treatment of the assets together with the tax status of the investor
Main investment considerations (Ch.14 Choosing inv strategy)
A SAD CUTER INVESTOR
Factors influencing investment strategy (Ch. 14 Choosing inv strategy)
Factors influencing investment strategy “A SAD CUTER INVESTOR”
o Accounting regulations
o Size of the assets (absolute/relative)
o Accrual of future liabilities
o Diversification
o Currency of the liabilities
o Uncertainty of the liabilities
o Tax treatment of the assets / investor
o Environmental / social / governance issues
o Risk appetite
o Institution’s objectives
o Nature of the liabilities
o Voluntary and legal restrictions
o Existing portfolio
o Solvency requirements
o Term of the liabilities
o Other funds’ strategies (competition)
o Return (expected long-term)
Factors influencing investment strategy (Ch. 14 Choosing inv strategy)
TECH SCAM
Helpful Acronym Mismatching Assets (Ch.15 Asset-liability management)
Helpful Acronym Mismatching Assets “TECH SCAM”
Types of assets that can be invested in
Extent of mismatching allowed
Currency match between assets and liabilities
Hold certain proportion of total assets in particularly class, e.g. gilts
Single counterparty exposure maximum
Custodianship of assets
Amount of any asset allowed to demonstrate solvency
Mismatch reserve
Helpful Acronym Mismatching Assets (Ch.15 Asset-liability management)
