INVESTMENTS

Question 1

What is an equity fund?

Answer 1

• A mutual fund that specialises in stocks.
• Buys ownership in a company In the form of stocks
• Therefore also know as a stock fund
• Focuses investments on countries, regions and investment styles to diversify and mitigate risk

Question 2

What is a mutual fund?

Answer 2

• A mutual fund is an investment fund that pools money from many other investors to purchase securities.
• UK name is OEIC
• Reminder: securities are fungible/ tradable financial assets that hold some type of monetary value

Question 3

What is a security?

Answer 3

Securities are fungible/ tradable financial assets that hold some type of monetary value

Question 4

Define: Fungible

Answer 4

Fungiblity is the property of a good or commodity whose individual units are essentially interchangeable because they are identical to each other for practical purposes.

Examples:
- Commodities
- Common Shares
- Currency
- Options

Question 5

What is an option?

Answer 5

• A financial instrument that is based on the value of underlying securities such as stocks
• a contract which gives the holder the right, but not the obligation, to buy or sell an asset at some predetermined price within a specified period of time.

The owner can ‘exercise’ (to buy or sell) the option, receive a cash pay out, or to allow the option to lapse - losing the premium paid for the option but not committing to either buy/sell.

Question 6

What are shares?

Answer 6

• also known as equity
• a security that represents ownership of a fraction ofthe issuing corporation.
• entitles the owner to a proportion of the corporation’s assets and profits equal to how much stock they own.
• Units of stock are call ‘Shares’

Question 7

What’s the difference between stocks and Shares?

Answer 7

A stock is a financial instrument representing ownership in a single or multiple organisations.

A share is a single unit of stock.

Terms can be used somewhat interchangeably, however, shares is typically used to describe ownership ownership in a specific company

Question 8

What is meant by purchasing power?

Answer 8

A way of expressing the ‘value’ of a currency in terms of the goods or services that can be bought with one unit of that currency.

Inflation decreases purchasing power
Deflation increases purchasing power

Nominal value remains the same, its ‘value’ decreases

Question 9

Bull market

Answer 9

A period where investors are confident that prices will rise.

Adopting a ‘bullish’ approach to the market, by buying stocks to hold long term

Question 10

Bear market

Answer 10

Term to describe a period where investors are pessimistic about the market.

Looking to sell stock in the short term

Question 11

Interest rates affect on Investments.

Answer 11

Low interest = Good for equities

businesses pay less to borrow, public has more to spend increases sales and profit increase in share prices

High interest = Bad for equities

inverse of above
if investors can receive good interest rates from deposit accounts, they may not take the risk in equities

Fixed-rate Securities
High interest = bad

reduces the overall real return
if inflation increases, the value of gilts will fall

Question 12

Dividends from Credit Unions

Answer 12

Although members receive ‘dividends’ on their shares, distributions are treated as interest and are paid without the deduction of income tax.

Question 13

Calculating the level of PSA (tax)

Answer 13

Personal Savings allowance - the amount of interest from savings an individual can earn without incurring tax charge.

£1000 for basic rate
£500 for higher rate
£0 for Additional rate

Above this it’s charged at marginal tax rate.

When calculating threshold, the net adjusted income is used, this is their income less any reliefs:

• Pensions paid net of basic-rate tax relief – the net contribution is grossed up (divided by 0.8) and then deducted from non-savings income;
• Occupational pensions contributions paid gross – the gross payment is deducted from income;
• Trading losses
• Charitable donations - gift aid - contribution is grossed up (divided by 0.8) and deducted from income

Question 14

PSA and income tax band

Answer 14

The PSA is included in the individual’s basic‑rate tax band.

These means that whilst the income from interest may not be taxable, it is included in tax band calculations

Question 15

National savings Products

Answer 15

• Direct ISA
• Direct Saver
• Income bonds
• Investment account
• Junior Account
• Premium Bonds

Question 16

NS Investment account

Answer 16

• Variable Rate of Interest
• Min deposit £20, Max £1m.
• Age 16 to open, or Parent/guardian to open
• Postal account (Applications, withdrawals, deposits done by post).
• No notice for withdrawals, no penalties
• Interest is paid on 31 Dec and is taxable

Question 17

Premium Bonds

Answer 17

Deposit account where a monthly prize-draw is offered to investors.

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Question 18

Ordinary Shares

Answer 18

Basic type of share.

Issued with Par Value (Purely notional for accounting)

Owner holds voting rights in company matters at Annual General meeting (AGM).

Ordinary Shareholders are entitled to dividends

No liability for company debts (unless only part-paid shares, on which case they must pay the difference if the company winds up - known as unpaid call)

On winding up of the company, ordinary shareholders are last to be paid back their capital.

Question 19

Preference shares

Answer 19

Preference shares are similar to loan stock but pay dividends (typically every 6 months)

PS are ahead of OS for dividend payment order

PS less risky than OS, and as such, receive a lower amount of dividends at a Fixed amount.

PS holders do not have voting rights (unless dividend payments in arrears) but rank ahead of OS in terms of repayment should the company be wound up

Question 20

Cumulative preference shares

Answer 20

Pay the current year’s dividend plus dividends not paid in a previous year because profits were insufficient.

Question 21

EPS

Answer 21

Earnings per share.

Dividends are paid to shareholders from company profits.

Example:
If the company made £1m profit and 10m shares, the EPS would be 10p

Question 22

What is a Derivative?

Answer 22

A derivative is an investment vehicle that derives it’s value from another underlying asset, such as commodities.

Types include:
- Options
- Warrants
- Futures
- Contracts of difference

Question 23

Commodity

Answer 23

Refers to goods that come from the ground or grow on it.

Hard commodities include gold, silver, aluminium.

Soft commodities include salt, wheat, soya

Commodities buyers tend to use commodity derivatives rather than buying the commodity
itself.

This allows them to hedge against future price increases and secure future supplies.

Question 24

Shorting

Answer 24

Refers to the process where hedge fund managers make a profit from put options.

(Make a profit from shares dropping in price)

Question 25

Put option

Answer 25

A put option gives the holder the right to sell at a fixed price - known as the strike price.

Question 26

Call Option

Answer 26

A call option gives the holder the right to buy the asset at a fixed price – known as the strike price.

Question 27

What is the difference between European and American Styles of Option?

Answer 27

European Options can only be exercised on the expiry date of the option

Whereas American options can be exercised at any time

Question 28

Futures

Answer 28

Similar to Options in principle, however, the right to buy/sell must be exercised on a certain date.

There is no choice to lapse the contract

Futures can be arranged in commodities and financial instruments such as bonds, currency, and shares

Unlike options, both parties are obliged to complete
the agreement on the expiry date.

Question 29

What are the two main measures of market volatility?

Answer 29

Alpha

Beta

Question 30

What is Alpha?

Answer 30

A measure of market volatility.

Alpha measures the level of return in relation to the risk taken.

Question 31

What is Beta?

Answer 31

A measure of market volatility.

Beta shows how a share or fund fluctuates against the market

Question 32

Compound interest calculation on principle sum, annual interest

Answer 32

N(1+R)^y

N= principle sum
R = interest rate (decimal)
Y = number of years

Question 33

Compound interest calculation on monthly contributions

Answer 33

PMT = monthly payments
R = annual interest rate (decimal)
N = number of times compounded
T = Number of years invested

Question 35

What is holding period return?

Answer 35

Also known as money-weighted return:

• Is a way to express the total investment return provided from income and capital growth over a specified timescale
• this timescale is known as the holding period