IAD Level 2 - Mock 3

Question 1

Which of the following is not a category of bias within behavioural finance theory?

A. Hindsight bias
B. Cognitive bias
C. Survivorship bias
D. Confirmation bias

Answer 1

C. Survivorship bias is linked to performance evaluation issues rather than behavioural finance.

Question 2

An advisor has recently completed a fact-find document on three of his clients. All three clients are in their mid-twenties and have between £150,000 to £200,000 to invest for several years.

Paul shares a rented flat with two housemates, and earns a modest income as a teacher
Denise works as an Investment Banker in the financial services industry, and owns a mortgage free property
Floella recently changed careers, and is retraining as a dentist, funding her studies using much of the capital from money saved in her previous job as a stock market analyst

Based solely on this information, it is reasonable to assume that:
A. Floella is the one likely to have the greatest risk appetite
B. Paul and Floella are likely to place income as priority over capital growth
C. Denise is the one to choose the longest investment timescale
D. Only Denise is likely to place capital growth as priority over accessibility

Answer 2

B. Paul and Floella are likely to place income as priority over capital growth.

Both Paul and Floella require regular income from their portfolio. Paul needs to supplement his modest income from teaching, and Floella needs help funding her dentistry studies. Income must take priority over capital growth for these clients.

All clients are of similar age, and therefore their investment timescale is also likely to be similar. Denise is the client with the greatest risk appetite, as she is likely to have the greatest disposable income given her job and mortgage-free property.

All clients would likely place growth of the portfolio over accessibility, as they need to invest for several decades and would want to ensure that their portfolio grows in real terms.

Question 3

A high-net-worth client is keen to avoid paying a bid-offer spread in any investment recommendation. Which of the following options would be suitable to discuss in more detail with the client?

I. ETF
II. OEIC
III. Unit Trust
IV. Investment Trust

A. I & II
B. II only
C. III & IV
D. I, II & IV

Answer 3

B. II only.

Only the OEIC has no bid/offer spread - all the others do have one.

Question 4

Which of the following is NOT a measure of total return?

A. Beta weighted rate of return
B. Holding period yield
C. Money weighted rate of return
D. Time weighted rate of return

Answer 4

A. Beta weighted return may sound plausible but is not a return method.

Question 5

A portfolio manager has a liability in ten years time. She creates a portfolio of two assets one with a duration of 5 years and the other with a duration of 15 years. Which of the following best describes the portfolio?

A. Bullet portfolio
B. Barbell portfolio
C. Ladder portfolio
D. Diversified portfolio

Answer 5

B. Barbell portfolio.

She has a barbell portfolio i.e. one bond with a short duration and one with a long duration with the average duration matching the liability.

Question 6

Henry dies leaving most of his assets, totalling £550,000 to his spouse, Margaret, and a smaller amount, £65,000, to his only daughter Annabelle. The nil-band rate is £325,000. How would this be considered for inheritance tax (IHT) purposes?

A. No IHT is due, and Margaret receives 100% of Henry’s nil-rate band
B. No IHT is due, and Margaret receives 80% of Henry’s nil-rate band
C. £116,000 IHT is due, so that Margaret can receive 100% of Henry’s nil-rate band
D. £26,000 IHT is due on the gift to Annabelle, and Margaret receives 80% of Henry’s nil-rate band

Answer 6

B. No IHT is due and Margaret receives 80% of Henry’s nil-rate band.

The transfer between spouses is totally exempt from IHT and would not be included in the estate. This means the estate is valued at £65,000 only, which is well below the nil-rate band, so clearly no IHT is due.

However, the £65,000 gift on death is part of the estate and uses up some of the nil-rate band:
£65,000 / £325,000 x 100 = 20%
This leaves 80% of the nil-rate band remaining, which can be passed on to Margaret.

Question 7

An investor comes across a dilution levy when reading a key information document. Which of the following is true of a dilution levy?

A. It applies to dual priced funds
B. It applies to single priced funds
C. It applies to closed ended funds
D. It applies to offshore funds only

Answer 7

B. It applies to single priced funds.

Dilution levy is a charge imposed by a manager to cover dealing costs. It only affects single priced funds as dual priced funds will cover this within the spread.

It is designed to ensure that existing investors do not suffer costs associated with new investors subscribing or redeeming shares. There is no dilution levy for closed ended funds.

Question 8

• Jason, a higher-rate taxpayer, invests in a qualifying policy with Prudence Life and encashes his investment ten years later making a healthy gain.
• Susan, a higher-rate taxpayer, invests in a non-qualifying policy with Windsor Life and encashes her investment ten years later making a healthy gain.
• Nathan, a higher rate taxpayer, invests in an OEIC with Abbey Investment Management and encashes his investment ten years later making a healthy gain.

In relation to these three investors, and ignoring CGT allowances, which of the following will be liable for capital gains tax?
A. Jason, Susan and Nathan
B. Susan and Nathan
C. Nathan only
D. Susan only

Answer 8

C. Nathan only.

Gains on insurance bonds incur income tax rather than CGT. Only Nathan’s gain will attract CGT.

Question 9

What does a low R-squared indicate?

A. A lower risk adjusted return compared to the benchmark
B. A low degree of diversification compared to the benchmark
C. A less reliable beta
D. A lower degree of systematic risk

Answer 9

C. A less reliable beta.

The R-square measures the degree of correlation between a fund and a benchmark. An R-square of 100 would indicate that a fund and a benchmark are perfectly correlated. A low R-square means that little of the funds returns can be explained by changes in the benchmark.

Generally a higher R-square will indicate a more reliable beta.

Question 10

Cognitive bias is a major part of behavioural finance. One element of this bias is the endowment effect. Which of the following investors displays this effect?

A. Nikolai has a tendency to place a great deal of importance on director’s selling shares in their own company, often at the expense of any other information available
B. Aksana has never made a bad investment - or so she would argue
C. Pavel is more willing to invest money in low-priced shares than he is in high-priced shares, irrespective of whether the share is over- or under-priced
D. Luka tends to have over-expectations of the price at which she can sell, often missing a peak in her investments by waiting for that extra tick

Answer 10

D. Luka tends to have over-expectations of the price at which she can sell, often missing a peak in her investments by waiting for that extra tick.

The endowment effect is that people often demand much more to give up an object than they would be willing to pay for it. This could be attributed to Luka.

Nikolai’s behaviour is more related to the focusing or framing effect.
Aksana’s behaviour shows a choice-supportive bias.
Pavel’s behaviour reflects the denomination effect.

Question 11

Consider the following events regarding a country’s economy:

Event A: Less money is spent by the government on unemployment benefits
Event B: More money is collected by the government in income tax and VAT
Event C: Prices start to fall

Which of the following is true?
A. Events A and B reflect an expansionary fiscal policy
B. Events A and B would be indicators of a booming economy
C. Events B and C are symptoms of an economy in recession
D. Event C is likely to increase a current account deficit

Answer 11

B. Events A and B would be indicators of a booming economy.

Events A and B are indicators of a booming economy, with many people employed, so paying more income tax, and buying more goods and services, with VAT payment as a result.

Events A and B could also be seen as a contractionary policy (reducing the money supply through increases in tax and reduction of government spending).

Event C is a symptom of an economy in recession. It is also likely to reduce any current account deficit, as goods will appear cheaper to overseas buyers increasing exports and money supply within the economy.

Question 12

Samuel and Ollie are discussing portfolio performance assessment and the use of GIPS. Samuel has stated that GIPS represent a way of benchmarking performance, with Ollie convinced that GIPS were established by MSCI. Which statement is correct?

A. Both Samuel and Ollie are correct
B. Both Samuel and Ollie are incorrect
C. Samuel is correct, but Ollie is incorrect
D. Samuel is incorrect, but Ollie is correct

Answer 12

B. Both Samuel and Ollie are incorrect.

Global Investment Performance Standards (GIPS) are not a way of benchmarking performance but are global standards for calculating and presenting performance figures.

Originally established in 1999 by the CFA Institute, GIPS were significantly enhanced in 2005 and have been voluntarily adopted by industry representative organisations in many countries in order to help promote best standards.

Question 13

Which of the following statements about inflation is/are TRUE?

I. If prices rise faster than is expected, borrowers gain at the expense of lenders
II. If inflation is fully anticipated, the real rate of interest equals the nominal rate
III. If the money supply is rising in line with real economic growth there will be no change in price level
IV. A rise in inflation is likely to cause the exchange rate to appreciate

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

Answer 13

A. I only.

If inflation rises quickly, borrowing will be cheap until interest rates are adjusted upwards to compensate.

If the change in money supply equals the change in real growth, then inflation is stable, but there is still inflation.

Higher inflation is likely to depreciate the exchange rate (PPP).

Question 14

Jimi, a fund manager, was instructed by his manager to increase the risk of his fund’s portfolio. Which of the following actions would BEST achieve this goal?

A. Shifting the portfolio’s weight AWAY from assets that have high positive correlation with the existing portfolio
B. Shifting the portfolio’s weight TOWARDS assets that have low negative correlation with the existing portfolio
C. Shifting the portfolio’s weight AWAY from assets that have a negative correlation with the existing portfolio
D. Shifting the portfolio’s weight TOWARDS assets that have a high negative correlation with the existing portfolio

Answer 14

C. Shifting the portfolio’s weight AWAY from assets that have a negative correlation with the existing portfolio.

Increasing the weight of assets with negative correlations with the existing portfolio would reduce risk, so doing the opposite would increase risk.

Question 15

Which of the following is/are true of the Global Investment Performance Standards (GIPS)?

I. GIPS standards are compulsory for firms that publish investment statistics
II. GIPS standards are set by Combined Actuarial Performance Services (CAPS)
III. GIPS provide a way of benchmarking investment performance

A. I & III
B. II & III
C. III only
D. None of the above

Answer 15

D. None of the above.

GIPS are voluntary standards that are published by the CFA Institute.
GIPS are not a way of benchmarking performance but global standards for calculating and presenting performance statistics.

Question 16

The following transactions occur:
Martin buys 5000 shares in a FTSE100 index company and the transaction settles through CREST.
Hilary buys 1000 dematerialised shares in a small UK company.
Fiona buys £10,000 nominal value gilts that settle through CREST
Harold buys 1000 units in an FCA authorised unit trust.

With regard to stamp duty and stamp duty reserve tax (SDRT), which of the following is true?
A. Martin and Hilary pay SDRT
B. Harold and Martin pay SDRT and Hilary pays stamp duty
C. Martin and Fiona pay SDRT and Harold pays stamp duty
D. Martin, Fiona and Harold pay SDRT and Hilary pays stamp duty

Answer 16

A. Martin and Hilary pay SDRT.

SDRT is payable on the purchase of dematerialised shares that settle through CREST, so Martin and Hilary would have to pay this.

There is no stamp duty liability on the purchase of gilts or unit in a unit trust (although the unit trust itself will be paying SDRT on all of the purchases within the fund).

Question 17

An experienced investor is bullish about the UK equity market and buys a long call option on the FTSE100 index. They subsequently change their view and become bearish. Adding which position to their long call will effectively create a long put?

A. Long FTSE100 Future
B. Short FTSE100 Future
C. Short FTSE100 Call
D. Short FTSE100 Put

Answer 17

B. Short FTSE100 Future.

Adding a short future to a long call creates a long put. If the market rises we are now neutral (win on our call & lose on our future - just like a long put). If the market falls we win on our short future (just like a long put).

Question 18

Which of the following is/are correct regarding buying gilts direct from the DMO at Auction?
I. With a non-competitive bid the price is not known in advance
II. With a successful non-competitive bid the investor’s application will be met in full

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

Answer 18

C. Both.

Price is not known, and if successful, full allocation.

Non-competitive bids state volume, NOT price, between £1,000 and £500,000 nominal value (par value).

Question 19

Consider the following UK residents:

• David owns a business in USA that paid him an income of £25,000 last year
• Magnus receives distributions from offshore funds based in Germany, Ireland and France
• Sandy receives coupons from a Eurobond issued by a South African company
• Wayne runs a company that receive franked investment income from another UK company

Which of the following is true?
A. Both David and Sandy would suffer withholding tax on their income
B. Wayne only would need to report his income to the National Crime Agency
C. Magnus and Sandy would benefit from double tax relief
D. David, Magnus and Sandy only would be liable for UK tax on their income

Answer 19

D. David, Magnus and Sandy only would be liable for UK tax on their income.

Wayne’s company would not be liable for tax. The income is franked, and, as such, ‘tax paid’.
David would be subject to withholding tax and could benefit from double tax relief.
Magnus may also be in this situation, depending on the fund.
Sandy will receive gross coupons but will need to pay tax.

Question 20

Jemima is a fund manager for an investment firm and is responsible for managing the following funds:
Fund 1- S&P 500 Tracker fund
Fund 2- Small Cap Fund
Fund 3- Asian equities Fund
Fund 4- Special Situations Fund

Which of the following statements is true?
A. Where optimisation is used, this is most likely to apply to Fund 1
B. Where deterministic modelling is used, this is most likely to apply to Fund 2
C. Where bottom-up active management is used, this is most likely to apply to Fund 3
D. Where core-satellite management is used, this is most likely to apply to Fund 4

Answer 20

A. Where optimisation is used, this is most likely to apply to Fund 1.

Since the S&P 500 Tracker Fund is typically a passive fund, it is most likely to utilise one of three methods to track the benchmark; full replication, stratified sampling, or optimisation.

Choice B is incorrect, as deterministic modelling could be used be any of the funds.
Choice C is incorrect, as the bottom-up approach is most likely to apply to Fund 4.
Choice D is incorrect, as the core-satellite approach could describe any or none of the funds.

Question 21

Angela is 28 years old. She is looking to allocate money within her pension fund and is planning to retire at 60 years old.
Mary is 40 years old. She requires investments that will provide sufficient funds to pay for her son’s university fees. Her son is currently 13 years old.

Which of the following best reflects the attitudes of the two investors?
A. Mary is likely to have a more positive attitude to risk than Angela
B. Both Mary and Angela are saving to meet real liabilities
C. Neither Mary nor Angela are interested in growth
D. Tax efficiency of the investments is a greater concern for Angela than for Mary

Answer 21

B. Both Mary and Angela are saving to meet real liabilities.

Most of this is thinking about the time horizons of the investors.
Angela obviously has the longer horizon. This would suggest a greater willingness to take on risk, and a greater emphasis on real investments and growth.
Mary has a shorter investment horizon. This suggests less willingness to take on risk. Nevertheless, her potential liability is still some way in the future, so the impact of inflation needs to be considered.
Angela is less concerned about the tax implications of the investments, as she is allocating them within her pension, where they would be tax exempt. Tax will be a concern to Mary; income tax during the life of the investment and capital gains tax on maturity of the investment.

Question 22

Which of the following is true of ETF shares and stamp duty?

A. ETF shares incur stamp duty at 0.5% rounded to the nearest pound
B. ETF shares incur stamp duty at 0.5% rounded to the nearest penny
C. ETF shares incur stamp duty at 1.5% rounded to the nearest penny
D. ETF shares do not incur stamp duty

Answer 22

D. ETF shares do not incur stamp duty.

Question 23

An investor makes capital gains within an OEIC of £8,000 in year one, £10,000 in year two and £13,000 in year three. Ignoring the CGT allowance and assuming the investor is a higher-rate taxpayer what is the closest estimate to the CGT due in year three assuming the funds remain invested?

A. £6,200
B. £4,600
C. £2,600
D. £0

Answer 23

D. £0.

Funds grow free from CGT within OEICs. It is only when the investor disposes of (sells) the investment that the gains are potentially liable for CGT.
In this case, the investment has not been sold so there is no CGT due on the unrealised gains.

Question 24

The board of an investment trust company are able to:
I. Carry out a rights issue
II. Borrow funds
III. Arrange for the company to be ‘split capital’ in structure

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

Answer 24

B. I, II, and III.

Split capital means that the company issues two types of share; those entitled to the fund’s income and those entitled to its capital gains.

Question 25

You are analysing four government bonds and have compiled the following data. For which of the bonds will the gross redemption yield be higher than the flat-yield?

Bond A: Coupon 13%, Price £126, Nominal Value £100
Bond B: Coupon 6%, Price £87, Nominal Value £100
Bond C: Coupon 8%, Price £98, Nominal Value £100
Bond D: Coupon 10%, Price £111, Nominal Value £100

I. Bond A
II. Bond B
III. Bond C
IV. Bond D

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

Answer 25

B. II and III.

Bonds priced below par will have a higher gross redemption yield than the flat-yield because the GRY also incorporates the capital gain.

Conversely, bonds priced above par will have a lower GRY compared to the flat-yield because the GRY also incorporates the capital loss.

Question 26

Tommy and Gina are married with two grown-up children. Their adviser Marina Jenkins estimates that their joint estate for IHT is £1.6m and notes that the clients have made a will providing that all assets pass to each other on first death. In their financial planning discussions, Marina talks through the difficult scenario of the IHT position on either Tommy or Gina’s early death in the current tax year. Marina assumes for the analysis that the survivor then ultimately dies ten years later.

Marina uses the following assumptions:
- Both clients have not used the nil rate band
- The nil rate band in 2021/22 is £325,000
- The nil rate band in 2031/32 is £500,000 (including residence nil rate band)

Assume that the death of the first client occurred in 2021/22 and then the survivor died some years later in 2031/32. What is the best estimate of IHT that would be payable?
A. £240,000
B. £310,000
C. £340,000
D. £440,000

Answer 26

A. £240,000.

Given the scenario in the question, the surviving spouse inherits the total estate and the nil rate band. This means on the ultimate death of the second spouse, the taxable estate is:

1,600,000 - (500,000 x 2) = 600,000
IHT due = 600,000 x 0.4 = 240,000

Remember, it is the percentage of the nil rate band that is transferred rather than the monetary value.

Question 27

If the economic climate sees an increase in inflation but a decrease in interest rates, which of the following would be a major reason for NOT putting your money on deposit?

A. Risk to capital
B. Difficulty in withdrawing the funds once deposited
C. Reduction in purchasing power
D. Real returns

Answer 27

C. Reduction in purchasing power.

If inflation is high and interest rates are low an investor will not make a real return on deposits. Instead, the real value (or purchasing power) of their money will decrease.

Question 28

Jason has an adjusted income of £280,000 and is considering making personal pension contributions.

Which of the following is/are correct?
I. Jason will not receive the personal allowance
II. Jason will receive income tax relief on £20,000 only
III. Jason will pay tax at 45% on his entire pension contribution

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

Answer 28

A. I and II.

Pensions attract tax relief at either 20%, 40%, and 45% depending on the marginal rate of tax.

As an additional rate taxpayer, Jason will get relief at 45%. However, the annual allowance of £40,000 is lost at a rate of £1 for every £2 of adjusted income above £240,000. Jason is £40,000 above that limit so loses £20,000, leaving only £20,000 on which he gets tax relief.

Note, the lowest the annual allowance can be is £4,000. The personal allowance starts to be taken away at a rate of £1 for every £2 earned above £100,000.

Question 29

Kate is the holder of a put option on stock ABC. The option has a strike of 120 and a premium of 25. At what price of the underlying is Kate’s breakeven?

A. 25
B. 95
C. 120
D. 145

Answer 29

B. 95.

Kate has paid a premium of £25 so the underlying needs to fall to 95 from 120 for her to make back her premium and breakeven.

Question 30

Which one of the following would also be referred to as the ‘headline’ rate of inflation within the UK?

A. RPI
B. CPI
C. RPIX
D. HICP

Answer 30

A. RPI.

The RPI is sometimes referred to as the ‘headline’ rate of inflation. The CPI is a relatively recent introduction to UK measures of inflation while the RPI has been around for some years.

The standardised European inflation measure, the harmonised index of consumer prices (HICP), began to be used as the basis for the UK’s inflation target in 2003. In the UK, it is now more commonly known as the consumer prices index (CPI).