General

Question 1

State three reasons which may cause the share price of an investment trust company to trade at a
premium to its net asset value (NAV).

Answer 1

i. When an investment trust company (ITC) is paying a high and growing dividend.
ii. Where an ITC’s assets are rising quickly in value.
iii. When an ITC is the subject of a potential takeover or reorganisation.

Question 2

Give two examples of the economic consequences of high unemployment.

Answer 2

i. Loss of output.

ii. Increase in government expenditure to support the unemployed.

Question 3

State two differences between currency swaps and interest rate swaps.

Answer 3

Currency swaps are in different currencies unlike interest rate swaps which are in the same currency.

ii. Currency swaps involve exchanges of principal amounts at both the start and the finish of the swap, conversely with interest rate swaps, there is no
exchange of principal either at the start or the end of the swap period.

Question 4

Explain, using an example from the London Stock Exchange, how an order-driven market works.

Answer 4

An example of an order driven market as used on the London Stock Exchange would be SETS (Stock Exchange Trading System). (1)

Buyers and sellers enter the price and quantity of a security they are willing to buy or sell. (1)

If a buyer enters details that can be matched by a seller, a deal is executed.

If the price entered by the buyer is too low, the order will remain on the screen until either the seller lowers the price or alternatively, a new seller places an order that matches the price of the buyer.

A buyer may not be able to complete the purchase if the seller was only offering a smaller quantity at the buyer’s price. In such a situation, the buyer
could only purchase the quantity on offer.

Question 5

List six potential risks of investing in fixed-interest securities.

Answer 5

i. Default risk. (1)
ii. Inflation risk. (1)
iii. Issue-specific risk. (1)
iv. Market risk. (1)
v. Event risk. (1)
vi. Currency risk. (1)

Question 6

Explain the advantages and disadvantages of purchasing covered warrants based on equities
rather than direct investment in equities.

Answer 6

Advantages include:
 The initial outlay is only a fraction of buying the underlying assets (equities).

 Stamp duty is not applicable because trades are cash-settled. (1)

 Covered warrants provide holders with the ability to hedge in either rising or falling markets. (1)

Disadvantages include:
 Covered warrants cannot be short sold. (1)

 After their expiry date, the covered warrant becomes worthless. (1)

 Covered warrants cannot be held in an ISA. (1)