Income Growth Bonds, Funds and SEIS

Question 1

Tax Treatment of Annuities

Answer 1

Purchased Life annuity - Capital element can be returned tax free if annuitant dies before the period in which there capital was being returned is less than the payout. Difference is paid.

2. Pension annuity - whole amount is treated as earned income. Tax deductions are deducted under PAyE
3. For beneficiary under will or trust. - Taxed as savings income unless
4. Personal injury case then may be tax exempt.

Question 2

Relative merits of open and closed ended funds?

Answer 2

Open - Can grow / contract depending on demand.
Authorised by the FCA
In the case of ETFs no stamp duty is payable
AMC can be expensive
Borrowing is limited or generally not accessible.

Closed - Number of shares is fixed
Governed by the companies act
IT’s is a company so has board of directors.
Can borrow or raise capital by bond issue.
Can trade at a premium or discount to NAV
Can only increase capital base by issue of new shares.

Question 3

Appraise Income and guaranteed growth bonds and unit linked bonds?

Answer 3

A single premium bond issued by life insurance companies
Classified as low risk.
1 to 5 years with capital returned at maturity
Income is paid either monthly or annually
Minimum Investment of £5k up to £1m max
Income - paid net of BRT non reclaimable so no further liability for BRT.
Heavy penalties for early encashment.

Growth - receive guaranteed capital sum at maturity and BRT have no further liability.
HRT payers can use tax planning to have a bond mature at retirement when they become a BRT payer to have no additional tax liability.

SPLA Policy - whole of life but may have a small amount of life cover maybe 101% of the bid value. Typically structured for investment. Allows for typical 5% withdrawals. Basically a SPLAB

Question 4

Under COBS 2 when is receipt of non monetry benefit acceptable?

Answer 4

Direct from client =Only acceptable if it is a fee, commission or other benefit.
Third party = only acceptable if it will not impair on the compliance and duty to act in a clients best interest and they are fees for investment business services.
- It should not conflict the firms duty to act honestly and fairly in the interest of its clients.

Question 5

Principles of business requirement to ensure suitability. Appraise:

Answer 5

Suitability reports should:

• Explain the risk relative to the designated investment.
• Explanation of leverage and chance of losing entire investment.
• Price volatility and market limitations
• Any margin requirements.

Question 6

Eurobond Market vs domestic bond market advantages?

Answer 6

Denominated in a different currency to that of the financial centre in which they are issued.
Eurosterling = denominated in sterling and issued outside the UK.
Issues often being made in bearer form increases anonymity.
Taps into international investors base.
Choice of innovative products to meet issuer needs
Lower funding costs due to competitive nature
Greater liquidity
Less regulation and disclosure
Short notice bond issues are available.

Question 7

What is a fund of funds?

Answer 7

A portfolio of retail collective investment schemes. One overall manager seeks to harness the best investment management talent.
Component funds are run by managers external to the fund itself.
Funds like these implicitly pick up the charges of underlying funds and will have its own charge.
Fettered (one companies funds) and unfettered (external company funds utilised)

Question 8

What is a Manager of Mangers fund?

Answer 8

The fund does not invest in other schemes.
It arranges segregated mandates and appoints best in field fund managers to manage each sector.
Access to institutional investment which is often cheaper than retail management.
Usually requires a large initial investment.
If a manager under performs just change the man rather than selling units.
Segregated mandates can cause over diversification which can turn funds into expensive trackers.

Question 9

What is an approved person?

Answer 9

Under section 59 of FSMA 2000 inidivuals must receive prior approval from their regulator in order to fulfil their role.
Individuals must be fit and proper with the FCA taking note of honesty, integrity, competence and financial soundness.

Question 10

What are the types of fixed income risk?

Answer 10

Inflation risk on the ‘real value’ of the coupon
Credit risk - certainty of the bond being honoured. Gilts OK.
Market/price risk - Interest rate changes. Inversely proportional.
Liquidity risk
Seniority risk - In case of liquidation
Exchange risk - other currency issues
Early redemption risk - callable bonds

Question 11

What is a variable rate bond?

Answer 11

Floating rate notes - Interest rate is linked to a benchmark such as LIBOR usually plus a quoted margin.

Question 12

Exam hint

Answer 12

State time frames ie how many years will capital last with the clients current lifestyle.
Use of laddered bomd portfolios to diversify and mitigate duration and reinvestment risk.

Question 13

Appraise zero dividend preference shares

Answer 13

Issued by ITC's 
No voting rights
Board of directors
No income paid = only liable to CGT 
Receive a one time payment at the end of the investment term.

Stamp duty on purchase
Fairly liquid as listed on a stock exchange
Returns affected by Investment Trust performance

Question 14

Appraise Index Linked Gilts

Answer 14

Income tax payable on coupons
No CGT payable
Little to no growth on investment and low yielding atm.
Very low risk AA rated Uk Govt
Very liquid.
Usually linked to RPI or LIBOR so inflation protected.

Question 15

Appraise Private Equity

Answer 15

Equity capital that is not quoted on a public exchange.
Investors and funds make investments directly into private companies.
Capital gain tax on exit.
Illiquid investment
Higher risk through lack of regulation and lack of transparency.
Very high charges. Usually 1.5-2% I management fee and 20% of profit.
Not drip feedable.
Investment trusts - 3i and Electra

Question 16

Who can Unregulated CIS’s be marketed to?

Answer 16

A firm is permitted to issue an invitation to invest in an UCIS provided thy are in the below permitted catagories:

• A person already participating in an unregulated CIS or was in the previous 30 months.
• A person who has received a suitability report.
• A participant under the Charities Act.
• Employees of the firm provided it is shares or bonds in that company.
• A Lloyd’s member for limited partnership schemes used for Lloyds udnerwriting.
• An exempt person
• An elegible counterparty
• A professional client
• A person the firm has assessed as understanding the risks

Question 17

Hedge fund characteristics

Answer 17

Unauthorised unregulated CIS.
Not generally marketable to private individuals.
High initial investment levels £50k up £1m
Seeking absolute returns through use of almost all types of assets including currency/short/commodity/derivates.
CAN gear
Lock in periods of 1 - 3 months
High fees often up to 20% performance fee.

Question 18

Appraise immediate needs/care annuities

Answer 18

Benefits are guaranteed to be paid for life.
Prevent depletion of capital and ensures continuity of care.
Peace of mind
Money paid direct to care homes so no income tax liability. (tax free)
Early death can cause capital loss.
Indexed annual benefits may not suffice if care home fees increase faster.
Option for escalating benefits on some policies.
Can help ensure an inheritance.
Holding a SPLAB can move assets outside the councils asset calculation.

Question 19

Elements of a deposit account?

Answer 19

Savings or current accounts available.
Covered £85k by fscs
Fixed or variable interest rate?
Withdrawals per year
Easily accessible via branch or online?
Penalties for breaking fixed term deposits?

Question 20

Ways to reduce a IHT bill?

Answer 20

The Nil Rate Band is at £325,000.
Above this you pay 40% (reduced to 36% if you gift 10% of the value above the NRB to charity)
- £3k can be given away annually and one year carried forward (£6k total)
- £250 gift to everyone you know is excluded from IHT - - - - Gifts out of surplus income provided it leaves you with enough to maintain your lifestyle. Unconditional so cannot stipulate its use. (1. habitual, 2. after tax income not capital, 3. able to maintain donors normal standard of living)
- Gift on consideration of marriage = £5k from parents and £2.5k from grandparents and £1k to anyone is exempt transfer
- Gift to charity or political party is exempt transfer.
- Purchase of AIM/EIS/SEIS shares held for 2 years
- Woodland - Timber on land is exempt but not the land itself.
- A whole of life policy can be written in trust to cover a IHT bill for reasonable premium cost.

Question 21

What is an exempt transfer?

What is a PET?

Answer 21

These are tax exempt transfers usually to spouse, civil partner or charity.

PET - These are tax exempt transfers to an individual subject to surviving 7 years. 20% annual taper relief available from 3rd to 7th year.

Question 22

What is a chargeable lifetime transfer?

Answer 22

Any value above the NRB has an immediate 20% tax charge when gifted into a trust. If the Settlor dies within 7 years with applied taper relief the remaining tax liability is checked at 40% if the figure is less than the initial 20% already paid then there is no additional tax to pay. If more then the difference is paid. Settlor can take out life insurance against possible IHT bills.

Question 23

What is a gift with reservation?

Answer 23

Gifting a flat and continuing to live in it for nothing means it will still be chargeable to full IHT.
Gifts with reservation require full market rent payable to disqualify it from IHT.

Question 24

What is joint tenancy?

Answer 24

With joint tenants each person owns the WHOLE property. If one of you dies then the whole property automatically passes to the other joint tenants. Known as ‘right of survivorship’ which takes presedence over any ‘will’ provisions.
Unity of title required - joint tenants must hold the property under one document.
Unity of time - The joint tenancy must start and end on the same date.
Unity of possession - no more than 4 unities can constitute a joint tenancy.
The right of survivorship under joint tenancy takes precedence over any will provisions.

Question 25

What is tenancy in common?

Answer 25

Each person owns a ‘specified portion’ of a property 30% or 22% etc.
If you die then your specified portion will be distributed in accordance with your will.
If no will then intestacy laws apply..
Beneficiaries under tenancy in common can ‘force a sale’ in which case they need to be bought out.

Question 26

Key ETF Risks

Answer 26

Synthetics are high risk
Judge a book by its cover risk - 1500 choices
Exotic exposure risk - outside vanilla efts things get complicated.
Crowded trade risk - (eg. US interest High Yield ETFs occurrence)
Hot new thing risk - they say you should invest inversely with the amount of new press an etc gets.

Question 27

Equities vs bonds

Answer 27

Equities are on a forward yield of 3.9%
Interest rates seem as though they will remain low’
Inflation risks - what could contribute cost push inflation factors such as increase in commodity prices etc making equities favourable as they can pass on factor prices to clients. Adverse to this is it can squeeze purchasing power of companies in the near term.
Low interest rates could be good for bonds if they remain low.
Mention the state of the economy. Infrastructure projects etc.

Question 28

Circumstances a suitability report must be applied to retail clients?

Answer 28

States how recommendation is suitable to their needs with possible disadvantages.
Needs to be sent before the contract is concluded.
Required to retail clients if investing in:
Regulated CIS’s
IT’s saving schemes
IT’s in an ISA
Purchase of short term annuities
Buy/sell/surrender of rights in personal pension schemes

Question 29

Risks to AIM IPO’s

Answer 29

The board pick the selling price.
Low demand could see sharp falls on IPO day.
AIM companies can be hard to value
Less tightly regulated / growth
Total return of 1.6% pa over 20 years
UK small caps have typically performed better.
Possible tax exemption through bpr for IHT purposes.

Question 30

What are 4 types of life assurance policy?

Answer 30

• Level term assurance - Pays a tax free non changing level sum if the person dies before the expiry date. Usually for main breadwinner and can be for long periods to provide peace of mind and cash to generate income for family. (cheapest after FIB)
• Renewable term assurance - renewable at the expiry date usually without additional evidence of health. Useful if you don’t know your option at each renew date. Can be expensive to set up if you are older.
• Convertible term assurance - Before expiry will allow the holder to convert to a whole of life or endowment policy. (without evidence of health) usually more expensive premiums. More expensive. Not suitable to old clients.
• Decreasing term assurance - similar premiums to level term. The assured amount decreases by a regular amount (monthly or yearly) usually to cover debt repayment periods such as mortgages. Usually premiums for a 20 year policy may be required to be paid in 15 years to stop policy holders lapsing policies early.
• Increasing term - Inflation adjusted and premiums increasing too.
  FIB - Pays out regular tax free capital to a predetermined term. The cheapest cover. More suitable for young families.

Question 31

What are the tax benefits of a SEIS?

Answer 31

100k maximum annual investment
If held for 3 years then 50% tax relief on the cost of shares can be used as a credit on a tax bill. Regardless of marginal rate.
Capital gains tax exempt if disposed after 3 years.
Loss relief.
If gain is reinvested back into another SEIS then 50% tax exemption applies.
BPR so no IHT

Question 32

How may a company qualify for SEIS investment?

Answer 32

Assets less than 200k you can receive up to £150k through SEIS scheme.
Investors stake less than 30% of share capital.
Less than 2 years old.
Less than 25 employees
Issued shares must be ordinary and NON preferential
Shares only be issued after payment is received for them.

Question 33

Passive investment points

What was Eugenes Hypothesis

Answer 33

Eugene Fama EMH - strong / semi strong / weak. Alpha hard to achieve.
Warren Buffet and Anthony Bolton outperformed market by 20% for 6 out of 7 five year periods between 1965 and 2000
ETFs re financial stability report are increasing in complexity and opaqueness.
Synthetics are risky - tracking error - trade close to nav - open ended - No Stamp duty - smart beta
DOUBLE SPACE ANSWERS

Question 34

What was Harry Markowitz theory

Answer 34

Modern portfolio theory - Diversification
‘seeking assets with pairwise covariance as low as possible. Seeking maximum risk adjusted returns on the efficient frontier.’
15 - 30 stocks can diversify away from idiosyncratic risk 95%
Assumes Investors are risk averse and prefer higher returns for less risk.

Question 35

what are preference shares?

Answer 35

Non voting unless dividend is not paid
Pay a preset dividend each year
Rank ahead of ordinary shares in a pay out.
Convertible preference shares carry option to convert to ordinary shares.

Question 36

What is the data protection act 1998?

Answer 36

Data should be:
- processed lawfully and fairly
- for lawful specified purposes
- Accurate and up to date
- Not kept for longer than neccessary
- Remain within the EEA.
To be replaced by the GDPR regulation.

Question 37

What is the FCA’s current view of UCIS’s?

Answer 37

Proposals to ban promotion to the vast majority of retail clients.

• Restricted to sophisticated investors.
• Risks are higher and productsmore opaque.
• Can currently be marketed to a retail client if an adviser assess’s the suitability.
• Follows poor advice for pension funds recommended to hold wealth in a single illiquid UCIS.

Question 38

Factors to consider when choosing a deposit account?

Answer 38

• Deposit size - Min/Max and additional deposits possible?
• Withdrawals - Any time? Penalties for fixed term deposits.
• Interest - Fixed or Variable interest and frequency of payment.
• FSCS £85k compensation scheme. Offshore wont be.
• Operation - Use of an app and branch for assistance.