Learning Outcome 1

Question 1

Properties of cash investments

Answer 1

• less risky than investments
  -You are lending them (banks/ building societies) your money in return for interest

Types of risk:
- default risk
- interest rate risk
- inflation risk

Question 2

What are the 3 Types of cash accounts

Answer 2

• instant access, generally lower aer

-notice accounts, higher aer, give notice to take withdrawals, penalties can be deducted

-term deposits, highest aer, money set aside for a fixed term, penalties for early withdrawal

Question 3

The return on a two year fixed term deposit account is shown below, what is the early withdrawal penalty if fully encashed after 1 year of investment?

£20k invested, 1.25% gross interest p/a penalty is 30 days loss

Answer 3

1. Work out the interest earned, 20,000x 1.25% = £250 interest without penalty
2. 30 days penalty / 365 days in a year x £250 interest = £20.55 penalty if withdrawn after 1 year.

Question 4

Properties of ISAs

Answer 4

• a wrapper as opposed to a product
• interest and capital gains tax free

Question 5

Properties of NS&I savings

Answer 5

-government backed
-all cash based savings, no investments
-not backed by the fscs (£85k protection)
- Premium bonds, cash/ junior ISA, direct saver, investment account, income bond

Question 6

Properties of offshore bank accounts

Answer 6

-deposit accounts based offshore, usually Channel Islands or Isle of Man
-interest still taxable in the uk
-no FSCS protection

Question 7

Properties of money markets

Answer 7

-wholesale cash market where banks lend to eachother
-used for short term borrowing by the government and companies
-private/ direct investment, high entry levels, minimum deposit amount

Question 8

What are certificates of deposit

Answer 8

-fixed term cash deposits
-traded on stock markets globally
-issued by banks to raise capital for day to day operations

Question 9

What are treasury bills

Answer 9

-fixed term cash deposits
-issued under par value, no real interest, returned at face value
-traded on stock markets
-issued by the government to meet short term cash flow

Question 10

What are commercial bills?

Answer 10

-fixed term cash deposits
-issued under par value, redeemed at value to get return (same as treasury bills)
-traded on stock markets
-issued by companies to meet short term cash flow

Question 11

Features of short term money market funds

Answer 11

-collective investment scheme eg. Unit trust
-wide range of options
-weighted avg. maturity no more than 60 days
- weighted avg. life not exceeding 120 days

Question 12

Features of standard money market funds

Answer 12

-collective investment scheme
-wide range of options
-weighted average maturity not exceeding 6 months
-weighted avg. life not exceeding 12 months

Question 13

Taxation of interest on cash investments

Answer 13

-all interest paid is gross
-taxable to income tax where not in a tax free account (ISA)
PSA-
-£1000 basic rate taxpayers, £500 higher rate taxpayers

Question 14

What is a gilt?

Answer 14

A loan to the government, can be sold to someone else via the secondary market

Question 15

What is a corporate bond?

Answer 15

A loan to companies, long term lending

Question 16

Characteristics of fixed interest securities (bonds and gilts)

Answer 16

• can be traded on the stock market
  -fixed interest repayments (often provided a coupon upon purchase, that is the interest amount that will be paid)
  -gilts run between 2-30 years

Question 17

Characteristics of primary market

Answer 17

This is the method of raising the capital
-Gilts, bought through the DMO
- corporate bonds, bought through the London stock exchange

Question 18

Characteristics of secondary market

Answer 18

• where subsequent trading takes place after initial purchase, on the London stock exchange for both gilts and corporate bonds

Question 19

Yields

Answer 19

-return on a fixed interest security relevant to the price paid

-interest yield, annual income % based on price paid

-gross redemption yield, annual income % based on price paid. accounts for loss/ gain at redemption

Question 20

Interest yield calculation

Answer 20

Coupon/ clean price x 100

Question 21

Redemption yield calculation

Answer 21

1. Calculate the interest yield
2. Profit or loss to redemption/ no of years at redemption
3. / clean price x100

Question 22

Relationships of yields with inflation, interest rates, market price

Answer 22

• increase in inflation = increase in interest rates and increase in yields, drop in market price
• drop in market price = increase in inflation, interest rates and yields

“The price is right, that’s why it moves in opposite direction to others”