Formulas + Chapter 2 exam questions (sort when can be bothered ) Flashcards
Annual Equivalent Rate
Used to compare accounts between different providers with different terms
this is for Interest calcs (for loans/savings)
AER = ((1 + r/n)^n - 1) x 100
r is the nominal rate expressed as a percentage
n is the number of interest payments in a year.
future value
This lets us calculate how much a capital amount would be worth if it received a rate of interest at a certain rate over a certain period.
this is for Interest calcs (for loans/savings)
FV = CV (1 + r)^n
FV is future value
CV is current value
r is the nominal rate expressed as a percentage
n is the number of interest payments in a year.
Real return
Used to calculate the effects of inflation on a cash investment
Real return = nominal return - inflation
2.6: Foreign Exchange
FX forward rate
If not given payment conventions and number of days then assume d/b is:
1/12 for a monthly forward rate
1/4 for a 3 monthly forward rate
1/2 for a 6 monthly forward rate
1 for a 12- month forward rate
You need to make sure that you learn this for your exam.
FX forward rate =
spot rate x (1 +(quote currency interest rate x d/b)) /
(1 + (base currency interest rate x d/b))
2.6.4: Settlement
What is settlement?
What is Herstatt risk?
What is Continuous Linked Settlement (CLS)?
18 currencies are currently eligible for CLS settlement which works on a payment versus payment (PvP) basis.
Foreign Exchange
The FX markets trade 24 hours a day 5 days a week.
Currencies are traded in pairs, most frequently against the US dollars. If you are buying one currency you will always be selling another.
Rates are displayed as the amount of the quote currency versus one unit of the base currency.
If exchange rates rise, then it means the base currency is appreciating relative to the counter currency and vice versa if exchange rates fall.
The spot market is for immediate delivery, usually on a T+2 basis.
A forward trade is an agreement for a transaction to take place at a point in the future at a rate agreed today. Forwards are useful for both hedging and speculation.
The forward rate is calculated using the principles of interest rate parity, and is set by the interest rate differentials between the two currencies.
If the counter currency interest rate is higher than the base currency interest rate, the forward will trade at a premium to the spot rate. If the base currency interest rate is higher than the counter currency interest rate the forward will trade at a discount.
Settlement is on a payment-versus-payment basis to avoid Herstatt risk.
Jack and his wife Cassandra have three children, Jonah aged 18 months, Sian aged 4 and Chloe aged 17. What is the maximum they can put into standard Cash ISAs?
£20,000.00
£40,000.00
£60,000.00
£72.360.00
Peter, a higher rate taxpayer, has £90,000 of savings in his only building society account. Karen, an additional rate taxpayer, has £101,000 in her only bank deposit account. Both accounts provide the same interest rate. In comparing the two accounts you would note…
Karen would have a higher level of protection from the FSCS.
Peter’s account must have exit penalties, as building societies always pay higher returns.
both accounts would have the same level of tax deducted automatically at source.
the maximum Peter can deposit in a building society account is £100,000.
Both would be protected by the FSCS up to the £85,000 limit. All interest from bank and building society accounts is paid gross irrespective of the tax status of the depositor, so no tax deducted.
When depositing cash into a bank account, an investor should be aware that…
the only return will be interest, the capital will not grow.
all accounts are obliged to pay an interest return.
protection from the FSCS is £85,000 per account.
a term account is more likely to pay a lower rate than an instant access account.
the only return will be interest, the capital will not grow.
Capital growth is not possible from bank accounts. The only return comes via interest distributions. Accounts paying no or little interest are quite common.
Interest is paid gross to all investors.
FSCS protection applies to the first £85,000 of an investor’s deposit in any organisation that qualifies, but if they had 2 accounts in the same organisation they would still only qualify for £85,000.
Jessica and Troy have their savings of £50,000 each in a NS&I investment account and a building society account respectively. When comparing the two accounts…
both are protected under the FSCS rules.
Troy will usually receive lower rates of interest.
both accounts will pay interest net of basic rate income tax.
Jessica can put a maximum of £1,000,000 in her account and Troy has no maximum.
Jessica can put a maximum of £1,000,000 in her account and Troy has no maximum.
NS&I is the Government’s banking arm, so investors are technically lending their money to the government by saving with NS&I. They are government, not FSCS protected. Both pay gross interest.
The investment account has a £1m maximum deposit and pays its interest gross but taxable. There is not usually an upper limit on building society accounts unless it is something like a Cash ISA.
Gladys has a low attitude to risk. She currently holds £20,000 on deposit with her local Building Society, and £10,000 in Premium Bonds. She has just received an inheritance from her mother and has another £60,000 that she wishes to place on deposit. When considering Premium Bonds as an investment, Gladys would be correctly advised that…
she can contribute a maximum of £50,000 per annum.
she is not guaranteed any return from her investment, but the capital is secure.
Premium Bonds have different issues, with different returns on each one.
the minimum purchase is £50.
Answer = she is not guaranteed any return from her investment, but the capital is secure.
Premium bonds have a total limit of £50,000 not an annual limit. Investment starts at £25.
Harry is 15, and has just started a Saturday job for the summer holidays. He will earn £40 per day, but will only be working for 7 weeks. His grandmother wants to encourage him to save, so has said that she will give him £1,000 to add to whatever he saves from his wages. As Harry is a new saver, he is asking about deposit accounts. You can correctly tell him…
normally, the longer the notice period, the higher the interest.
banks pay higher rates than building societies.
building societies have more choice of accounts.
he qualifies for a stocks and shares ISA.
normally, the longer the notice period, the higher the interest.
The longer you keep your money under wraps, the better your rate should be.
Banks and building societies have little between their rates and products and you need to be 18 to qualify for an investment ISA.
Sapna has invested £25,000 into a NS&I Income Bond. Which one of the following statements is TRUE?
Income bonds are tax-free.
Income is paid every 6 months.
Income is paid net of the basic rate of tax with no further tax liability.
The minimum investment amount for income bonds is £500.
Answer = The minimum investment amount for income bonds is £500.
Income bonds are paid gross but taxable, with interest paid every month.
Gina and Tom have a joint savings account in a building society with a balance of £225,000. If the building society were to become insolvent, how much of their savings would be protected under the FSCS?
£85,000.00
£100,000.00
£170,000.00
£225,000.00
£170,000.00
The FSCS compensates deposit holders up to a maximum of £85,000 per financial institution per person. This equates to £170,000 for a joint account.
Account A pays a nominal rate of interest of 5.1% p.a. with interest paid every 6 months.
Account B pays a nominal rate of interest of 5.3% p.a. with interest paid every month.
What are the AERs of the 2 accounts?
Account A: 5.1%, Account B: 5.3%
Account A: 5.17%, Account B: 5.43%
Account A: 5.25%, Account B: 5.5%
Account A: 10.5%, Account B: 8.6%
Answer = Account A: 5.17%, Account B: 5.43%
Account A: AER = (1+(0.051/2)2-1 = 5.17%
Account B: AER = (1+(0.053/12))12-1 = 5.43%
