October 2023 Flashcards
Explain briefly the aim of Modern Portfolio Theory (MPT) and how it is achieved. (5 marks)
• Maximum return;
• for given risk;
• via diversification;
• of imperfectly correlated;
• asset classes.
State the key assumptions upon which MPT is based (5 marks)
• Investors are rational;
• and risk adverse.
• Returns are normally distributed.
• Based on historical data.
• Investors have access to all information.
• Market is efficient/no one investor can influence market.
• Unlimited borrowing at risk-free rate.
• No costs/tax.
Explain briefly four main benefits of diversification within an investment portfolio (4 marks)
• Reduce systematic/volatility risk.
• Can remove/reduce non-systematic/specific risk.
• Gain exposure to different asset classes/markets/sectors.
• Optimise/increase stability of returns.
Describe what is measured by standard deviation (4 marks)
• Volatility/dispersion;
• through variation in;
• actual return;
• against mean.
Identify six risks of an investment portfolio and one reason for each risk (12 marks)
Mitchell holds a house builder fund and direct shares in a construction company
• Geographical
• 100% in equities.
• Non-systematic/Concentration
• Only holds direct equities/only holds 2 stocks/lack of diversification.
• Sector
• All in same sector.
• Interest rate/Economic
• Sensitive to monetary policy/interest rates/exposed to economic cycle.
• Accessibility
• Capital in private company/may be unable to realise capital.
• Liquidity
• No market for private/unlisted shares.
• Investor protection
• No FSCS protection.
Outline the main differences between CPI and RPI (5 marks)
CPI
• Key inflation measure/BoE target.
• National statistic.
• Geometric/lower than RPI.
• Used by government in payment of state pension/benefits.
• Excludes housing costs/mortgage interest payments.
RPI
• Used for index-linked gilts/planned to be replaced by 2030.
• Not a national statistic.
• Arithmetic/higher than CPI.
• Includes housing costs/mortgage interest payments.
Describe main differences between broad and narrow money (4 marks)
• Broad includes;
• lending activities;
• and accounts;
• of UK residents.
• Narrow includes;
• operational deposits with the BoE.
• Broad indicator of economy.
• Narrow indicator of consumer confidence.
Identify the likely economic consequences of a sustained increase in the UK money supply (3 marks)
• Greater velocity/transmission of money.
• Increased borrowing/spending/economic growth.
• Increase in prices/inflation.
• Tightening monetary policy/rise in interest rates.
State three drawbacks of using ROE (3 marks)
• Only shows return on shareholder equity/funds.
• Ignores borrowing/other sources of capital.
• Difficult to compare with different companies.
State five non-financial factors that could affect attitude to risk (5 marks)
• Expertise/experience/knowledge/understanding.
• Age/state of health/his dependents.
• Parents/the business’ position.
• Investor psychology/framing.
• Society/collective mood/friends/peers/media.
• Political/economic outlook/environment.
State four ways in which capacity loss can be mitigated (4 marks)
• Invest only what he can afford to lose/invest less.
• Reduce AtR/lower risk investments.
• Hold sufficient cash to cover the potential loss.
• Discussion and understanding in advance.
• Establish the actual risk he is able to take/not focus on outcome.
• Avoid over-reliance on tools/questionnaires.
State four ways in which an EIS could provide greater tax planning opportunity compared to an ISA (4 marks)
• Higher investment limit/can invest up to £1m/£2m if Knowledge Intensive Company.
• Can carry back to previous tax year.
• 30% Income Tax relief.
• CGT deferral relief available.
• IHT/business relief available.
• Loss relief available
Describe briefly the objective of gearing within an investment trust (3 marks)
• To increase available funds/make investments;
• without using cash/going to shareholders/selling assets.
• To increase exposure to other assets.
• To increase returns.
Candidates
what does a negative alpha mean?
• Manager has not added value/underperforming market/returns in excess of
CAPM.
• Poor asset allocation/stock picking.
• Better off investing on passive basis/tracking index.
Explain briefly the possible consequences that could result from an investment trust increasing its level of gearing (4 marks)
• Higher volatility/standard deviation.
• Gains/losses magnified.
• Increased sensitivity to interest rates/interest rate risk.
• Increased borrowing costs/returns eroded by interest costs.
• Forced seller if borrowing limits/covenants exceeded.
• Change in investor sentiment/supply & demand/NAV.
Describe what is meant by an investment trust trading at a discount (4 marks)
• Share price;
• below;
• NAV.
Identify five reasons why an investment trust could be trading at a discount (5 marks)
• Holds unlisted securities.
• Sector out of favour/institutional shareholders selling.
• Manager out of favour.
• Poor recent trust performance.
• Ejection from index.
• Level of gearing/impact of higher borrowing costs.
Identify three main income options that could be available on the platforms cash account to support an income need (3 marks)
• Ability to pay just dividends/natural income.
• Ability to pay fixed/regular levels of income.
• Ability to pay ad-hoc/one-off withdrawals.
Explain how tactical asset allocation differs from strategic allocation (4 marks)
• Strategic is long term / Tactical is short term.
• Strategic has a fixed asset-allocation / Tactical varies the asset-allocation.
• Strategic reviewed less frequently / Tactical reviewed more frequently.
• Strategic trades less frequently / Tactical trades more frequently.
• Tactical aims to take advantage of market movement.
State three client-related factors that could impact upon retirement income in retirement (exclude ATR and CFL) (3 marks)
• Health condition/state of health/ life expectancy.
• Marital status/dependents.
• Other income sources.
• Other assets/liabilities/emergency fund.
Describe five actions to mitigate the effects of sequencing risk (5 marks)
• Work longer/defer retirement date.
• Reduce level of income.
• Take natural income only.
• Change the frequency of income.
• Purchase annuity/secure proportion of income.
• Reduce equities/holding in Strategic Long View.
• Buy higher yield assets/fixed interest/diversify asset allocation.
• Hold sufficient cash.
three benefits of owning a gilt-based collective fund compared to owning on a direct basis (3 marks)
• Invest across range of maturities/durations.
• Invest across range of coupons.
• Fund manager expertise/potential for outperformance.
• Less administration/knowledge required.
• Able to access gilts at issue/not available directly.
three drawbacks of owning a gilt-based collective fund compared to owning on a direct basis (3 marks)
• Higher on-going charges.
• Annual interest/redemption yield not known.
• Less/no control.
• Potential CGT liability on sale.
• Manager may underperform/not add value.
• Investor protection limited to £85,000/subject to FSCS limit.
Identify three reasons why index-linked gilt prices would fall when inflation itself is rising (3 marks)
• Interest rates increase faster than inflation/real yields increase.
• Actual inflation exceeds expected inflation.
• Expectation of lower inflation in future/inflation transitory.
• Indexation lag.
• UK downgraded.
• Index-linked coupons small part of overall return/not being compensated for inflation
increase.
• Increased supply/issuance.
outline the effects of increases on conventional fixed interest securities (4 marks)
• Fixed coupon less attractive;
• so price/capital value falls.
• Yield rises/new bonds issue with higher coupon.
• Longer dated bonds see larger falls.
• Lower coupon bonds see larger falls.
state the main objectives of quantitative tightening (3 marks)
• Slow economy down/reduce consumer spending.
• Reduce liquidity/withdraw money from circulation.
• Raise interest rates/make monetary policy restrictive.
• Reduce inflation.
Explain consequences of central bank implementing QT (3 marks)
• Increased supply of bonds causes prices to fall;
• and yields to rise.
• Borrowing becomes more expensive
• Savings rates increase
• Inflation comes down.
• Lenders unable to lend as much
Identify four factors that would cause UK yield curve to steepen (4 marks)
• Sell-off in long dated gilts/increased demand for short dated gilts.
• Expectation of higher inflation/interest rates in future.
• Excessive economic growth.
• Expansionary fiscal policy.
• QT.
• Market shock.
