IAD Level 2 - Mock 2

Question 1

If you have to explain to an investor the protection offered in the foreign exchange market against counterparty default risk, what system would refer to?

A. CHAPS
B. CREST
C. TRAX
D. CLS

Answer 1

D. CLS.

CLS (continuous linked settlement) offers investors in the foreign exchange market payment versus payment protection to their trades.

Question 2

Zorba Gera, a client, buys 500 shares for £1.90 each ex-dividend (broker’s commission is 1.5%) and settles through CREST. Nine days later a dividend of £0.05 per share is paid. At a later date, the shares are sold for £2.30 each. The return to the investor including SDRT and commissions will be:

A. £181
B. £185.75
C. £163.75
D. £200

Answer 2

C. £163.75.

Sales proceeds = 500 x £2.30 = £1150.
Less commission = 1150 x 0.985 = £1132.75.

Since the shares are ex div the dividend is not received.

Original cost = 500 x £1.90 = 950.
Plus commission = 950 x 1.015 = 964.25.
Plus SDRT = 0.5% x 950 = 4.75.

Total cost = 964.25 + 4.75 = 969.
Return = 1132.75-969 = £163.75.

Question 3

Frank works for Earth’s Core Oil on one of their drilling platforms in the Atlantic Ocean. Marion is a lorry driver working for We Supply plc, a company that specialises in the transportation of refined oil products.

With reference to sectors of the economy, which of the following is true?

A. Both Frank and Marion work in the primary sector
B. Frank works in the primary sector and Marion works in the secondary sector
C. Frank works in the primary sector and Marion works in the tertiary sector
D. Frank works in the secondary sector and Marion works in the tertiary sector

Answer 3

C. Frank works in the primary sector and Marion works in the tertiary sector.

The primary sector is concerned with the production of raw materials. This is the sector for Frank’s company.
The secondary sector is concerned with the manufacturing or the processing of raw materials into other goods.

Although neither works in this sector, Frank’s company is likely to supply a company from this sector and Marion is likely to collect goods to transport from this sector.

The tertiary sector is concerned with the distribution of goods and provision of services. Marion’s company is in this sector.

Question 4

Jeremy Sellers has taxable earned income of £37,200 (after taking into account his personal allowance). He has realised a capital gain of £14,600 before using his CGT allowance.

How much CGT is due on this gain?
A. £410
B. £460
C. £594
D. £644

Answer 4

A. £410.

Jeremy’s capital gain is partly covered by the annual exemption of £12,300, leaving £2,300 as the chargeable gain. The basic rate band ends at £37,700. Jeremy’s gain moves beyond this band.

For this reason, he will be taxed on the gain partly at the basic rate (£500 x 10% = £50) and partly at the higher rate (£1,800 x 20% = £360). Total CGT = £360 + £50 = £410

The first £500 of the gain is taxed at 10%: £500 x 0.10 = £50 The remaining £1800 is taxed at 20%: £1800 x 0.20 = £360 The tax due on the gain is: £50 + £360 = £410

Question 5

A client focuses on nominal returns and ignores the effects of inflation. What is the name of the behavioural finance trait that they are displaying?

A. Outcome bias
B. Omission bias
C. Money illusion
D. Selective perception

Answer 5

C. Money illusion is about ignoring inflation.

Question 6

What is the correct definition of a Eurobond?

A. A bond issued in the home country of its issuer and in a currency other than that of the issuer’s home currency
B. A bond issued outside the home country of its issuer and in the same currency of the issuer’s home currency
C. A bond issued in the home country of its issuer and in the same currency of the issuer’s home currency
D. A bond issued outside the home country of its issuer and in a currency other than that of the issuer’s home currency

Answer 6

D. A bond issued outside the home country of its issuer and in a currency other than that of the issuer’s home currency.

Outside the home country, outside the home currency.

Question 7

Which of the following bond features would most likely create the least price volatility?

A. Long-dated
B. Low coupon
C. Non-investment grade
D. High coupon

Answer 7

D. High coupon.

High coupon, short-dated bonds display lower volatility.

Question 8

The best measure to use for the client’s risk where the investment in question is only part of their much larger equity portfolio is:

A. Standard deviation
B. Beta
C. The risk-free rate
D. Covariance

Answer 8

B. Beta.

The question indicates that the client has a diversified portfolio. The only risk they are therefore exposed to is SYSTEMATIC risk (measured by Beta).

NB: If the portfolio was not diversified - standard deviation would be the best measure of risk.

Question 9

The governor of the Bank of England issues a statement stating that the MPC is concerned: ‘the balance of risks for inflation in the next 12 months is upwards from current levels’.

This comes as a surprise to participants in the gilt market. What would be the effect on gilt yields and gilt prices?

A. Gilt yields down; gilt prices down
B. Gilt yields up; gilt prices up
C. Gilt yields down; gilt prices up
D. Gilt yields up; gilt prices down

Answer 9

D. Gilt yields up; gilt prices down

There is an inverse relationship between gilt prices and their yields. As the yield or required rate of return of an investor increases, the price of the gilt decreases. In this scenario, a surprise increase in inflation will lead to a higher nominal yield (i.e. nominal return) required by investors for gilts, and therefore gilt prices will fall.

Question 10

A father gives his son a gift of equities with a market price of £1,250. What ad valorem stamp duty reserve tax would be payable?

A. £5
B. £6.25
C. £10
D. There is no stamp duty reserve tax liability

Answer 10

D. Stamp duty (and stamp duty reserve tax (SDRT)) is not payable on gifts.

Question 11

Which of the following best describes arbitrage?

A. Simultaneously entering into a long contract and a short contract on the same exchange to maximise profits
B. Entering into a long positions on a particular asset to ensure delivery of the asset
C. Going long a contract on one market and later going short on another to manage risk exposure
D. Simultaneously entering into a long and short contract on different but related asset where there seems to be mispricing due to a market inefficiency

Answer 11

D. Simultaneously entering into a long and short contract on different but related asset where there seems to be mispricing due to a market inefficiency.

Arbitrage takes advantages of mispricing in different but related markets.

Question 12

An investor is fully paid up on 1,000 £1 par value shares of a XYZ plc. If XYZ plc goes into liquidation, what is the most the investor could lose?

A. £1,000
B. All the cost of buying the shares
C. Excess of the amount incurred above £1,000
D. Market price of the shares at the time of liquidation

Answer 12

B. All the cost of buying the shares.

Since the full amount of what is paid can be lost, this would include the price at purchase and all costs of buying the shares, like brokers’ commissions and taxes.

Question 13

Growth plc issue a rights issue at £4 on a 1 for 2 basis. Miranda Meadows holds 50 shares in Growth plc and the current share price is £5. What is the theoretical ex-rights price?

A. £5.26
B. £5.06
C. £4.86
D. £4.66

Answer 13

D. £4.66.

Existing holding = 50 x £5 = £250
New shares +25 x £4 = £100 = £350
Total no of shares is now 50 + 25 = 75
Therefore £350/75 = £4.66 per share.

Question 14

Sandra Dupont is considering giving some money to her daughter Rose, aged 5. What is the income tax position of this gift?

A. If the income from the gift is above £100 per year the income will be treated as though it belongs to Sandra
B. If the income from the gift is above £300 per year the income will be treated as though it belongs to Sandra
C. If the income from the gift is above £500 per year the income will be treated as though it belongs to Sandra
D. Rose has her own personal allowance and tax bands even as a child and will pay whatever income tax is due

Answer 14

A. If the income from the gift is above £100 per year the income will be treated as though it belongs to Sandra.

Parental gifts to their children resulting in interest over £100 are assessed upon the parent.

Question 15

An investor invests £20,000 into an onshore Single Premium Investment Bond. The investment grows to £40,000 over the next ten years at which point the investor surrenders the bond.

Evaluate the following two scenarios:
A. The investor has taxable income £2,000 below the HRT threshold
B. The investor has taxable income £1,000 below the HRT threshold

Based upon the above, which of the following is/are correct?
I. Scenario A will result in no additional income tax to be paid
II. Scenario B will result in additional income tax of £2,000 to be paid

A. I only
B. II only
C. Both
D. Neither

Answer 15

C. Both.

Higher-rate taxpayers are due extra income tax on gains made from investment bonds. Basic rate taxpayers can benefit from top-slicing relief as follows.

The gain is £40,000 - £20,000 = £20,000. This is divided by the number of full years that the bond has been held, i.e. £20,000 / ten years = £2,000.
This £2,000 is then added to the individual’s income for the tax year. Any income below the higher rate threshold has no extra income tax due. Any income above the threshold will incur an extra 20% income tax.

This tax liability on the ‘top slice’ will then be multiplied again by ten to cover the full ten years of gain.

Scenario A
Adding the extra £2,000 to their other income does not breach the HRT threshold so there is no additional income tax to pay on their investment bond.

Scenario B
Adding the extra £2,000 to their other income leaves £1,000 above the HRT threshold. Therefore:
£1,000 x 20% x 10 = £2,000 additional income tax to pay.
Note that the Life Fund has already incurred tax at 20% on gains, leaving a higher-rate taxpayer with an additional 20% to pay.

Question 16

Stanley identifies three investments with the following features:

Investment A: Direct investment in property
Investment B: A long dated UK government gilt
Investment C: Equity in a FTSE 100 index company

Which of the following, with regard to risk, is true?
A. Investment A has less inflation risk than investment B
B. Investment B has more income risk that investment C
C. Investment A has less liquidity risk than investment C
D. Investment B has more issuer risk than investment C

Answer 16

A. Investment A has less inflation risk than investment B.

Property is considered a real asset, and so suffers less from inflation risk than bonds. It is, however, quite illiquid.

Gilts are considered to be default risk free, so the income and the redemption is guaranteed by the UK government. This results in no income or issuer risk.

FTSE 100 index shares are quite liquid, and also give reasonable protection against inflation in the long run. Income is not, however, guaranteed and even these companies can become insolvent and go into liquidation.

Question 17

If a basic rate taxpayer encashes a life assurance investment bond, what further tax may be due?

A. A capital gains tax liability of 18%
B. An income tax liability of 20%
C. No further tax is due
D. An income tax liability of 10%

Answer 17

C. No further tax is due.

Encashing a life assurance bond may cause an income tax liability for higher and additional rate taxpayers. However, since the life fund has paid 20% of tax on income and gains at source, a basic rate taxpayer has nothing further to pay.

Question 18

Natasha Deville holds a 13% Exchequer Stock 2049 trading at a price of £118. What is the running yield?

A. 5.5%
B. 6.5%
C. 11%
D. 13%

Answer 18

C. 11%.

Running (i.e. flat) yield = £13/£118 x 100% = 11%.

Question 19

Most market cap weighted index are done on a free float adjusted basis. The reason for this is to ensure that the index meets which one of the following basic requirements for a benchmark?

A. Unambiguous
B. Measurable
C. Investable
D. Appropriate

Answer 19

C. An index will use a free-float to ensure that a true investable opportunity is represented within the index fulfilling the basic requirements for a benchmark to be investable.
Investable – it is possible to forego active management and hold this benchmark as a passively managed portfolio.
Measurable – the returns and risk of this portfolio can be calculated quickly and frequently.
Appropriate – the benchmark is consistent with the manager’s investment style or area of expertise.
Unambiguous – the identities and weights of the securities or factor exposures constituting the benchmark are clearly defined.

Question 20

If more British people take holidays abroad, there will be:

A. A worsening of the capital account balance
B. An improvement in the capital account balance
C. A worsening of the UK visible trade balance
D. A worsening of the UK invisible trade balance

Answer 20

D. A worsening of the UK invisible trade balance.

When British people go abroad on holiday the UK is importing tourism. This is because UK citizens’ money leaves the country. Overseas tourism is an ‘invisible’ import and an increase in overseas tourism will worsen the invisible trade balance.

Question 21

Which of the following is likely to worsen the UK’s balance of trade deficit?

I. A rise in interest rates
II. An increase in capital investment in the UK from foreign investors
III. A fall in the value of the pound

A. I and II
B. I only
C. II only
D. I, II and III

Answer 21

A. I and II.

An increase in interest rates may lead to increases in foreign investment in the UK which increases the demand for sterling, increasing the value of sterling, making UK exports more expensive for foreign buyers, reducing UK exports and worsening the UK balance of trade.
An increase in capital investment in the UK has the same effect, causing an increased demand for sterling, etc.
A fall in the value of the pound has the opposite effect. UK exports become relatively cheaper and so exports increase, so reducing the balance of trade deficit.

Question 22

An investor looking for an investment that provides long-term capital growth, regular, and predictable income should invest in which of the following?

A. A long-dated bond trading above par
B. Commercial property
C. Equities
D. Warrants

Answer 22

B. Commercial property.

Commercial property is the best answer here as equities do not necessarily provide a regular income. A bond trading above par will ultimately give a capital loss as it will be redeemed at par.

Question 23

Your client is aged 39, is not risk-adverse, and wishes to capture long-term capital growth over the investing horizon.

Based on the following portfolio, which course of action would you consider suitable?

Cash £70,000
Equities £100,000
Fixed-Interest Bonds £30,000
Total £200,000

A. Reduce the cash and increase equities
B. Reduce the fixed interest and increase cash
C. Reduce the cash and increase fixed interest
D. Leave the portfolio unchanged

Answer 23

A. Reduce the cash and increase equities.

Since the client desires long-term capital growth, and is not risk-adverse, we can assume that a high equity allocation is necessary and suitable to achieve the objective.
The current allocation to cash (35%) is too high, and thus we would reduce the cash allocation and increase the equity allocation from its current level of 50%.
We would not increase allocation to fixed-interest bonds since the portfolio focus is long-term capital growth not income.
We would not increase allocation to cash as it is already too high; the portfolio focus is long-term capital growth not liquidity.

Question 24

Which of the following is true in relation to the quantity theory of money?

A. The total amount of money in the economy multiplied by the average price equals the velocity of circulation of money multiplied by the total number of transactions
B. The total amount of money in the economy multiplied by the number of transactions equals the average price multiplied by the velocity of circulation
C. The real money supply equals the number of transactions divided by the velocity of circulation
D. The real money supply equals the velocity of circulation divided by the number of transactions

Answer 24

C. The real money supply equals the number of transactions divided by the velocity of circulation.

The real money supply is the total amount of money in the economy, adjusted for inflation by dividing by the average price of each transaction (M/P).

If the quantitative theory of money states MV = PT then M / P = T / V.

Question 25

Which of the following is the recommended approach for estimating total returns involving cash flows in or out of an investment fund?

A. Money weighted rate of return
B. Time weighted rate of return
C. Internal rate of return
D. Interim internal rate of return

Answer 25

B. Time weighted rate of return is the recommended method as it adjusts the return for cash flows into and out of the fund.

Question 26

Which of the following best describes an option writer’s position, ignoring any transaction costs?

A. Their maximum loss cannot exceed their premium
B. Their maximum loss can exceed their premium
C. Their maximum profit can exceed their premium
D. They will always profit due to their premium

Answer 26

B. Their maximum loss can exceed their premium.

The writer of an option’s maximum gain is limited to the premium but if markets move against them, they can lose more than what they received in premium.

Question 27

Which of the following risk measures is used to assess the accuracy of a multi-factor model?

A. Beta
B. Standard Deviation
C. Risk / Reward Ratio
D. r-squared

Answer 27

D. r-squared

The r-squared measures the accuracy of a model. A high r-square indicates an accurate model.

Question 28

Which of the following represent a key characteristic of a money market account, as opposed to other types of deposit accounts?

A. Longer-term deposits
B. Notice to withdraw funds required
C. Higher value deposits
D. Higher frequency of deposit required

Answer 28

C. Higher value deposits.

A money market account is where the deposit provider invests the cash into short-term debt products like treasury bills.

Money market products are generally very high value and thus the account deposit also needs to be high value.

Question 29

Martin places a sum of money on deposit in a 30-day notice account offering 4.5% pa. Interest on the notice account accrues monthly. Fiona places a sum of money on deposit in a three-month fixed-term account offering 4.4% pa. Interest on the term account accrues daily. Assume 365 days in a year.

Assuming both Martin and Fiona hold their money on account for a full three months, and both withdraw their funds according to the conditions of the account (incurring no penalties), which of the following is true?

A. Taking into consideration compounding, Fiona will have received a better return on her money than Martin
B. At inception, Martin benefited from a greater flexibility regarding access to his money without penalty
C. If the rate of inflation during the period was an annualised 3.5%, neither made a real return on their deposit
D. The longer Fiona held the money in her account, the less liquid her account would be

Answer 29

B. At inception, Martin benefited from a greater flexibility regarding access to his money without penalty.

At inception, Martin has the greater flexibility to gain access to his money without penalty. He only needs to give 30 days’ notice. Fiona needs to wait until the maturity of the account in three months. However, the longer Fiona holds the money in the account, the closer the maturity date and the more liquid the account becomes.

Even taking compounding into consideration, Martin gets a better rate of return than Fiona.

Martin gets 4.5% pa. To calculate the annual effective rate (AER), we would do as follows:
4.5 / 12 = 0.375
This is the period rate for Martin.
Martin’s AER is:
(1.00375^12) - 1 = 4.59% AER
Fiona gets 4.4% pa. To calculate the AER, we do as follows:
4.4 / 365 = 0.01205
This is the period rate for Fiona.
Fiona’s AER is:
(1.0001205^365) - 1 = 4.5% AER
Clearly given these rates of return, both make a real return: i.e. one that beats the inflation rate.

Question 30

An annuity pays £150 per year in arrears for 7 years. What is the present value of this annuity assuming a discount rate of 6%?

A. £807.23
B. £817.52
C. £837.36
D. £887.60

Answer 30

C. £837.36.

Use the annuity formula to solve:
PV = PMT x 1/r x (1 - 1/(1+r)^n)
…where PV is the answer we seek, PMT is the payment received, r = 6% and n = 7 years.
PV = £150 x 1/0.06 x (1 - 1/(1.06)^7)
PV = £837.36

Question 31

[1079535] There are many sources from which economic growth can come. In the long run, the rate of sustainable or trend rate of growth will ultimately depend upon all of the following EXCEPT:

A. The growth and productivity of the labour force
B. The rate at which an economy efficiently channels its domestic capital into new and innovative technology
C. The extent to which an economy’s infrastructure is maintained and developed
D. The rate at which an economy efficiently channels its domestic savings and capital attracted from overseas into new and innovative technology and replaces obsolescent capital equipment

Answer 31

B. Growth and productivity of the labour force and the extent to which an economy’s infrastructure is maintained and developed both contribute to sustainable growth.

The rate at which an economy effectively channels its domestic savings and capital attracted from OVERSEAS into new and innovative technology and replaces obsolescent capital equipment contributes to sustainable growth, NOT the rate at which an economy effectively channels its DOMESTIC capital into new and innovative technology.

Question 32

Consider the following economic indicators:

Indicator 1: stock market returns increase.
Indicator 2: gross domestic product increases.
Indicator 3: unemployment figures increase.
Indicator 4: applications for building permits increase.

Which of the following is true?
A. Indicators 1 and 3 can be used to predict that the economy is on the way to recovery
B. Indicators 2 and 4 would be a result of an economy already in recovery
C. Indicators 1 and 4 are leading indicators of economic recovery
D. Indicators 2 and 3 are coincident indicators of economic

Answer 32

C. Indicators 1 and 4 are leading indicators of economic recovery.

Leading indicators include: stock market returns, consumer expectation, building permits and money supply. These are used to predict where the economy is heading.
Coincident indicators include: gross domestic product, industrial production, and retail sales. These are used to identify where an economy is in the economic cycle.
Lagging indicators include the unemployment rate. These can be used to identify trends in the economy.

Question 33

Which ONE of the following would have a direct impact on the price of UK government gilts?

A. Interest rates
B. Inflation
C. Public sector net cash requirement
D. Retail sales figures

Answer 33

A. Interest rates.

The others would have an INDIRECT effect due to pressures on interest rates and demand and supply factors.

Question 34

An investor wishes to directly hold a property through a trust. Which of the below investments will allow this?

A. Property investment trusts
B. Property company shares
C. Property unit trusts
D. Property fund of funds

Answer 34

C. Property unit trusts.

The investor has a direct interest in a property held in a property unit trust, so that would be the best answer here.
Property investment trusts can not hold property directly.
Property company shares are shares of property development companies.
Property fund of funds is where a fund has invested in other property funds, so this would be indirect investment.