Other Markets and Investments

Question 1

What are cash deposits?

Answer 1

Cash deposits comprise accounts held with banks or other savings institutions. They are held by a wide variety of depositors – from retail investors through to companies, governments and financial institutions.

Question 2

What are the main characteristics of Cash Deposits?

Answer 2

1. The return simply comprises interest income with no potential for capital growth, and
2. The amount invested (the capital) is repaid in full at the end of the investment term.

Question 3

What are the advantages of investing in cash:

Answer 3

1. One of the key reasons for holding money in the form of cash deposits is liquidity. Liquidity is the ease and speed with which an investment can be turned into cash to meet spending needs. Most investors are likely to have a need for cash at short notice and so should plan to hold some cash on deposit to meet possible needs and emergencies before considering other less liquid investments.
2. The other main reasons for holding cash investments are as a savings vehicle and for the interest return that can be earned on them.
3. A further advantage is the relative safety that cash investments have and that they are not exposed to market volatility, as is the case with other types of assets.

Question 4

What are the disadvantages of investing in cash?

Answer 4

1. Banks and savings institutions are of varying creditworthiness and the risk that they may default needs to be assessed and taken into account.
2. Inflation reduces the real return that is being earned on cash deposits and often the after-tax return can be negative.
3. Interest rates vary, and so the returns from cash-based deposits will also vary.
4. During periods of low global interest rates, charges on money market accounts or funds can result in negative or flat returns.

Question 5

What are Cryptocurrencies?

Answer 5

Cryptocurrencies are a type of digital currency or asset that can be traded, stored and transferred electronically. There is no single definition of cryptocurrencies, but one from the European regulatory authorities is that they are a virtual currency that is represented by a digital record and is not issued by a central bank or similar institution.

Question 6

What are the main kinds of crypto assets?

Answer 6

1. Payment tokens such as Bitcoin and other cryptocurrencies.
2. Security/asset/investment tokens which have features similar to general investments such as asset ownership rights, entitlement to a share of future profits, repayment of a specific sum of money, or tradability.
3. Utility tokens that give access to services and products.

Question 7

What are the three functions of money?

Answer 7

1. A store of value.
2. A medium of exchange with which to make payments.
3. A unit of account with which to measure the value of any particular item that is for sale.

Question 8

What are money markets?

Answer 8

The money markets are the wholesale or institutional markets for cash and are characterised by the issue, trading and redemption of short-dated negotiable securities. These can have a maturity of up to one year, though three months or less is more typical.

Question 9

What is the FX market?

Answer 9

The FX market refers to the trading of one currency for another. It is by far the largest market in the world.

Question 10

What is the Bretton Woods Agreement?

Answer 10

Historically, currencies were backed by gold (as money had ‘intrinsic value’). This prevented the value of money from being debased and inflation being triggered. This gold standard was replaced after the Second World War by the Bretton Woods Agreement, which aimed to prevent speculation in currency markets by fixing all currencies against the US dollar and making the dollar convertible to gold at a fixed rate of US$35 per ounce. Under this system, countries were prohibited from devaluing their currencies by more than 10%, which they might have been tempted to do to improve their trade position.

Question 11

Spot Transactions

Answer 11

The spot rate is the rate quoted by a bank for the exchange of one currency for another with immediate effect. However, it is worth noting that, in many cases, spot trades are settled – that is, the currencies actually change hands and arrive in recipients’ bank accounts – two business days after the transaction date (T+2).

Question 12

Forward Transactions

Answer 12

In this type of transaction, money does not actually change hands until some agreed future date. A buyer and seller agree on an exchange rate for any date in the future, for a fixed sum of money, and the “transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be a few days, months or years.

Question 13

Futures

Answer 13

Foreign currency futures are standardised versions of forward transactions that are traded on derivatives exchanges in standard sizes and maturity dates. The average contract length is roughly three months.

Question 14

Swaps

Answer 14

A common type of forward transaction is the currency swap. In a currency swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not exchange-traded contracts and, instead, are negotiated individually between the parties to a swap. They are a type of OTC derivative.

Question 15

Forward Exchange Rates

Answer 15

A forward exchange contract is an agreement between two parties to either buy or sell foreign currency at a fixed exchange rate for settlement at a future date. The forward exchange rate is the exchange rate set today, even though the transaction will not settle until some agreed point in the future, such as in three months’ time.

Question 16

How would you expect the interest payable on an instant access account to compare to a fixed-term account?

Answer 16

In normal circumstances, the interest rate paid on deposits will vary with the amount of money deposited and the time for which the money is tied up. Fixed-term accounts involve the investor tying up their money for a fixed period of time so the investor will demand a higher rate of interest than would be available in accounts that permit immediate access.

Question 17

Why should the risk of a default by a bank be taken into account when considering a deposit?

Answer 17

Although banks and savings institutions are licensed, monitored and regulated, it is still possible that such institutions might fail. An investor therefore faces the risk of losing some or all their money. The risk of default should therefore be considered as should the amount of any compensation that might be payable from a government sponsored compensation scheme.

Question 18

According to economic theory, what are the three functions that money should serve?

Answer 18

Economic theory holds that money serves three functions- a store of value; a medium of exchange with which to make payments ; and a unit of account with which to measure the value of any particular item that is for sale.

Question 19

What instrument issued by a company is the corporate equivalent if a treasury bill?

Answer 19

Commercial paper is issued by companies to finance their short-term borrowing needs and is the corporate equivalent of a Treasury bill issued by a government.

Question 20

How is the return on a Treasury bill paid?

Answer 20

As Treasury bills are short-term instruments, they do not pay interest and instead the investor buys the Treasury bill at a discount to par- ie, a price of less than US $100 per US $100 nominal. The difference between the price paid and the amount paid at maturity represents the return on the Treasury bill.

Question 21

What are the advantages and disadvantages of investing in property?

Answer 21

Property is a real asset and can grow in value; however, property prices can fall and the costs of buying and selling are significant.

Question 22

What is the settlement period for a spot forex trade?

Answer 22

A spot forex trade is one that settles two business days after the trade. So, for example, a spot undertaken on Monday would normally settle by Wednesday.

Question 23

A company has entered into a foreign exchange transaction to exchange US dollars for their own currency in one month’s time. What type of forex transaction is this?

Answer 23

This is a forward transaction. in this type of transaction, money does not actually change hands until some agreed future date.