Overall AF4

Question 1

Describe Strategic asset allocation

Answer 1

Strategic asset allocation is a portfolio strategy whereby the investor sets target allocations for various asset classes and rebalances the portfolio periodically. The target allocations are based on factors such as the investor’s risk tolerance, time horizon, and investment objectives

Question 2

Top Down Method

Answer 2

the process where deciding on asset allocation before stock selection and market timing
Asset allocation
sector selection
stock selection

Question 3

Tactical Allocation

Answer 3

Ranges are specified around the strategic level to enable market timing adjustments to be made by the manager (e.g fixed interest 40-85%)
the fund manager changes the asset allocation of the fund in order to take advantage of short term market shifts

Question 4

Fundamental Analysis

Answer 4

process of identifying stocks that are undervalued by looking at underlying investment

Question 5

Technical Analysis

Answer 5

focuses on the market rather than the stock

Seek to identify trends and by predicting these trends will aim to beat the market (chartists)

Question 6

Value Funds

Answer 6

Aim to identify undervalued shares.

low price earnings ratio. High Dividend yields

Question 7

Advantages of Value Funds

Answer 7

Optimal strategy for those with long horizons (pension funds)

Question 8

Growth Funds

Answer 8

Manager is looking for companies with high growth prospects
High P/E

Question 9

Mandatory points for Growth Funds

Answer 9

Growth in EPS for at least 4 out of last 5 years
Low P/E relative to growth
Good cashflow (low gearing, high liquidity)

Question 10

Momentum Investing Advantages

Answer 10

Managers tend to be influenced by momentum because clients like to see investments that are showing good news and results.

Question 11

Momentum Investing

Answer 11

Momentum investing is a trading strategy in which investors buy securities that are rising and sell them when they look to have peaked. The goal is to work with volatility by finding buying opportunities in short-term uptrends and then sell when the securities start to lose momentum.

Question 12

Momentum disadvantages

Answer 12

demands a much higher level of trading.
it incurs high transaction costs
highly sensitive to the luck of trading

Question 13

Contrarianism

Answer 13

betting against the herd
into out of fashion holdings

Question 14

(Active) EMH Weak form

Answer 14

Active Managers
they believe they can beat the market over the long term
they believe in a weak form EMH
they believe they know more and can act on information to add value to investment return
Weak form demonstrates that all information reflects historic information
past data

Question 15

Passive - Strong form EMH

Answer 15

Passive investment mangers believe that it is difficult to beat the market - that the market is strong

Question 16

Liquidity risk

Answer 16

is being able to buy or sell at a fair market price
the liquidity of any market is determined by the number of buyers and sellers at any time.
in a liquid market it is easy to sell and buy and obtain a fair market price

Question 17

How does Diversification eliminate specific risk (non systematic)

Answer 17

because the positive and negative individual characteristics of each asset tend to cancel each other out.
studies show that approximately 20-30 securities are required in a portfolio to eliminate specific risk

Question 18

Limitations of CAPM

Answer 18

single period - one year model
only applicable to diversified portfolios
the model assumes that the overall portfolio held is diversified and equates to the market as a whole.
if we were dealing with a small undiversified portfolio then this model would not work.
Difficult to determine Beta

Question 19

Standard Deviation

Answer 19

takes into account the risk of each share and the covariance of returns when combining them in the same portfolio
the standard deviation is the square root of the variance

Question 20

Covariance

Answer 20

the extent to which returns vary with another security

Question 21

how to calculate standard deviation

Answer 21

1. calculate the difference between the actual return and expected return
2. square the differences to eliminate the minuses
3. multiply the squared answers by the probability
4. sum the result, this sum is called the variance

Question 22

the information ratio

Answer 22

compares the excess return achieved by the fund over a benchmark portfolio to the funds tracking error
it is a risk-adjusted return measured to evaluate the funds managers relative experience
the higher the positive IT ratio the better the risk adjusted return based on performance relative to the benchmark

Question 23

tracking error

Answer 23

gives us an estimate of the risks the manager takes in deviating from the benchmark, The excess return element tells us how well the fund manager did compared to the benchmark.

Question 24

Sharpe Ratio

Answer 24

adjusts rates of return to take account of the riskiness of the investment or fund.
measures the excess returns for every unit of risk, measured by the standard deviation (total risk)

Question 25

limitations of the Sharpe ratio

Answer 25

*SD assumes that equity/investment returns are normally distributed when they ARE NOT
*the SR can be manipulated by changing the measurement interval
* It is simplistic, a single figure
*it ignores investment charges and costs
*it uses historic data

Question 26

Treynor Ratio

Answer 26

similar to the sharpe ratio but uses beta as the divider and measures returns earned in excess of that which could have been earned on a riskless investment per each unit of market risk.

Question 27

Alpha

Answer 27

is a measure of return that is independent of the underlying market or benchmark - it is a measure if the mangers stock picking skills.

it is the return that is not explained by the CAPM

sometimes called Jensen alpha

Question 28

Volatility

Answer 28

in the exam we may get a question to calculate the annual volatility, this is simply the variance squared root

Question 29

When selecting a benchmark with a client, we need to take into account

Answer 29

should be specified and agreed with the client in advance
should priced at suitable periods
how has the benchmark performed in the past
how is it calculated/ has to be transparent
benchmark must be relevant to the investment fund/ i,e you would not place a bond fund against the FTSE 100

Question 30

Benchmark provides 3 key factors

Answer 30

measure to compare the performance of different types of funds
a basis for reviewing the asset allocation and structure of your portfolio
benchmark for assessing and comparing the performance of your DFM

Question 31

Benchmark comparison Step 1

Answer 31

choose an appropriate benchmark to compare the portfolio
Not much to do here but check it fits client ATR

Question 32

Benchmark comparison Step 2

Answer 32

tabulate the asset allocation or check the asset allocation of the benchmark.

Question 33

Benchmark comparison Step 3

Answer 33

calculate the return that each asset class in the benchmark portfolio would have achieved in line with appropriate index for its sector.

Question 34

Benchmark comparison Step 4

Answer 34

compare this benchmark performance with the fund mangers performance in terms of asset allocation.

Question 35

Benchmark comparison Step 5

Answer 35

compare the fund managers % returns in asset classes with the relative index return
The aim is to see how the managers selection of investments within each asset class performance relative to appropriate index

Question 36

Advisory Management

Answer 36

suggests a course of action
the clients accepts or rejects
usually lower charges than DFM
priority is for maximum return within appropriate risk profile

Question 37

DFM

Answer 37

once investment objectives agreed
prior consultation with the client is not required to buy/sell investments
usually higher charges than Advisory
priority is for maximum return within appropriate risk profile

Question 38

4 key investment decisions DFM/Advisory

Answer 38

Investment Style (absolute returns or benchmarking)
Active vs Passive
Management approach
types of asset used

Question 39

Bespoke segregated portfolio

Answer 39

tailored to the individual client
can be operated on a discretionary or advisory basis
Bespoke portfolio management is offered by stock brokers and private client investment managers

Question 40

Discretionary Investment Management

Answer 40

client gives discretion to the investment firm to manage their investments on their behalf
regulatory requirement that there is a 2 way client agreement

Question 41

Advisory investment service

Answer 41

offered by investment managers that recognises that some clients don’t want to give up on the decision making and want to remain actively involved in the management of their portfolio.

Question 42

Managed portfolios

Answer 42

structured to match particular risk profiles
target at particular set of clients to which the profile applies to
diversified and managed to a known objective

Question 43

Centralised Investment Propositions

Answer 43

standardised approaches to investment to investment advice
include model portfolios and DFM
without specifically and clearly outlining the advice, why they are suitable to the client

Question 44

advantages of CIP

Answer 44

removes portfolio drift
removes any adviser/ bias/ behavioural bias
keeps portfolio in line with client ATR via regular rebalancing

Question 45

Disadvantages of CIP

Answer 45

NOT client specific
May be higher costs
assumptions based on historic data

Question 46

DFM Reporting and fees

Answer 46

a 2 way client agreement must be entered for a Discretionary investment services between client and adviser
must provide regular reports on investment performance

Question 47

DFM fees

Answer 47

AMC & Ongoing charges
Dealing commission / bid offer spread
panel on takeover and merger
stamp duty reserve tax
initial set-up fees/ exit fees
one off valuation charges
VAT
custodian/platform/ wrapper fees

Question 48

Not included in OCF

Answer 48

performance fees
platform/adviser charge
brokerage charges
panel on takeover and merger
stamp duty reserve tax

Question 49

Investment Mandates

Answer 49

specific instructions that guide the investment manager in the management of a clients investment portfolio
purpose of their objectives
on the other hand it can be seen as the operational detailed instructions to the investment manager on how the portfolio should be managed

Question 50

Disadvantages of rebalancing

Answer 50

winning investments may be sold that may continue to produce higher returns
losing investments could be bought and continue to fall
there will charges incurred when rebalancing
there may be tax liabilities incurred

Question 51

Strategic CII

Answer 51

Fixed weighting/ asset allocation
Long term
With occasional/infrequent rebalanced
Little variation from objective
No response to market changes

Question 52

Tactical CII

Answer 52

Varying weighting/ asset allocation
Short term
Frequent rebalanced
Substantial variation from objective
Take advantage of market movements

Question 53

Normal yield curve

Answer 53

Rising positive curve
Longer term gilts should produce a higher return/yield to compensate the risks of erosion and longevity of the redemption

Question 54

Flat curve

Answer 54

When there is no perceived investment risk then the yield will be flat
This occurs in stable economic situations where there are no significant changes expected to interest rates or inflation

Question 55

Reverse/downward inverted curve

Answer 55

Investors optimism on inflation
Shorter term bonds have a higher yield than longer term bonds
Seen as an indicator of recession
Effectively investors demanding a higher return for the perceived risk to shorter dated bonds compared to long dated bonds

Question 56

Benefits of CAPM

Answer 56

Easy to calculate/ uses widely available information
takes into account systematic risk/market risk
reflects fact that most portfolios are diversified to remove unsystematic risk
robust/trusted
provides an expected return

Question 57

Fees included in OCF

Answer 57

Management fee/Annual Management charge
administration fees
Marketing fees
audit/ tax compliance
registration/regulation fees
custody/depositary/trustee

Question 58

Other Investment Charges

Answer 58

transaction fees/initial fee/spread/stamp duty
performance fees
one of legal/professional charges
interest/gearing costs
adviser charges

Question 59

Credit Quality

Answer 59

Default Risk/ credit worthiness
credit rating

Question 60

3 other types of ETF (other than full replication)

Answer 60

Synthetic - uses derivatives
Optimisation - computer model/ algorithm
sampling - uses a sample of the market/index

Question 61

Undiluted NAV formula

Answer 61

No O/S in issue

Question 62

NAV Discount Formula

Answer 62

NAV Per Share

x100

Question 63

Diluted NAV Formula

Answer 63

O/S plus warrant shareholders

Question 64

Gearing ratio formula

Answer 64

net assets

Over 1 is high

OR

net assets (total assets - total liabilities)

Question 65

EPS ratio

Answer 65

No of O/S in issue

remember answer is in p
x100 to get 2 decimal places in pence

Question 66

Why would a company make a rights issue

Answer 66

To fund expansion/acquisition
Strengthen the balance sheet
To refinance company
To reduce share price

Question 67

4 options regarding rights issue

Answer 67

Take up the rights issue
Sell the rights on the open market
Sell some of the rights on the market and take up the remainder
Do nothing and let the rights lapse/the company will then sell the rights and distribute the proceeds After costs

Question 68

ROCE formula

Answer 68

Operating profit / capital employed
X100

Question 69

What Is a Real Estate Investment Trust (REIT)

Answer 69

A real estate investment trust (REIT) is a company that owns, operates, or finances income-generating real estate.

Question 70

Key facts REIT

Answer 70

A real estate investment trust (REIT) is a company that owns, operates, or finances income-producing properties.
REITs generate a steady income stream for investors but offer little in the way of capital appreciation.
Most REITs are publicly traded like stocks, which makes them highly liquid (unlike physical real estate investments).
REITs invest in most real estate property types, including apartment buildings, cell towers, data centers, hotels, medical facilities, offices, retail centers, and warehouses.

Dividends from the ring fenced element are taxed as rental income with 20% taxed at source.

Can be held in a ISA or SIPP and can be tax free

Question 71

requirements to qualify as a REIT

Answer 71

Invest at least 75%of total assets in real estate, cash, or U.S. Treasuries

Derive(gain) at least 75%of gross income from rents, interest on mortgages that finance real property, or real estate sales

Pay a minimum of 90% of taxable income in the form of shareholder dividends each year

Be an entity that’s taxable as a corporation

Be managed by a board of directors or trustees

Have at least 100 shareholders after its first year of existence

Have no more than 50% of its shares held by five or fewer individuals

Question 72

REIT benefits

Answer 72

Liquidity

Diversification

Transparency

Stable cash flow through dividends

Professional management

Partial sale / CGT benefit

Attractive risk-adjusted returns

Question 73

Reit drawbacks

Answer 73

Low growth

Dividends are taxed as regular income

Subject to market risk

Potential for high management and transaction fees

Question 74

Patent settlement rules/ Bare trust

Answer 74

A gift from a parent would fall under the parental settlement rules. If annual income exceeds £100 the full amount of income will be assessed against the receiver. Vice versa is less than £100 it will be assessed against the sender

Question 75

Top down method

Answer 75

Choosing asset allocation
Then geographical areas
Sectors
Style (growth-value)
Individual stocks

Question 76

Perpetual subordinated bonds

Answer 76

Fixed rate of interest (bonds)
Undated (perpetual)
Low priority on wind up (subordinated)
Interest not guaranteed
Non cumulative
Not covered FSCS
high risk high coupon
High minimum investment

Question 77

Return on Equity formula

Answer 77

Net profits / Shareholders fund
X100

Question 78

What does ROE measure

Answer 78

The return on investment made by shareholders
Indication of the firm’s efficiency at generating profits
It is used as a measure of earnings growth

Question 79

Dividend cover formula

Answer 79

EPS/DPS

Question 80

EPS formula

Answer 80

Net profit/ number of shares in issue
X100 as pence

Question 81

DPS formula

Answer 81

Dividend paid/number of shares in issue
X100 in pence

Question 82

130/30

Answer 82

100% of the fund is invested in long only stocks that are favoured by the manager
30% of the value of the fund goes short
The proceeds from the 30% short selling of unflavoured stocks allows the fund manager to buy an additional 30% of favoured stocks
The end result is 130% long 30% short

Question 83

Advantages/disadvantages 130/30 fund vs hedge funds

Answer 83

130/30 funds are authorised by FSCS
Hedge funds are not covered under FSCS
short positions which are high risk are limited by the proportion oh short to long holdings
Hedge funds can generally short sell whatever they like

130/30 funds cannot go 100% short
Hedge funds can go 100% short

Question 84

Leverage in the futures markets

Answer 84

Is exposure to a contract of greater value than the initial payment required to secure it, in expectation of better returns
It is generally acquired by physically borrowing the money or assets to invest or sell back at a later date
Can be achieved by investing in gold mining shares rather than physical gold

Question 85

Value investor

Answer 85

Research On companies and sectors
To attempt to identify and invest in securities which are trading below their fair market value
Superior growth can be achieved as the market catches up and realises the share is undervalued

Question 86

How does a bond ETF work

Answer 86

It uses a swap
For a fee
And collateral
An investment bank/ the swap provider will pay the fund the return on the relevant index
The risk is counterparty risk
Which is the risk that the investment bank / swap provider fails in their obligation to pay the return on the Index

Question 87

What does Bias towards growth stocks mean

Answer 87

This means the fund primarily invests in companies with above market average earnings growth potential.
Growth stocks tend to retain earnings rather than pay dividends which allows them to reinvest into the company

Question 88

DFM Charges/fees/taxes

Answer 88

Fund manager fee/OCF
income tax on dividends and other investment income
CGT on any capital gains
Vat
Stamp duty/SDRT
PTM levy
Platform/wrapper charge
Performance fee
Entry/ exit charges

Question 89

What is crypto currency

Answer 89

A digital commodity/ asset/ currency
Which operates independently of a central bank
It uses encryption techniques/ blockchain
To regulated the issue of new units
And transfer of existing ones

Question 90

What is a CFD

Answer 90

Contract for difference
Between investor and investment bank
At end of the contract the investor and investment bank will exchange the difference between the opening and closing values of the investment
It allows investors to invest in assets without owning them
Geared investments
Purchase takes place on margin
The investor only deposits an initial outlay (10% or 20% or thr full value of the investment) and borrows the rest of money from the CFD investment bank
Not covered by FSCS
Potentially subject to CGT

Question 91

Current account

Answer 91

Imports minus
Exports/balance of payments
In goods and services
Plus receipt from overseas income generating assets

Question 92

Capital account

Answer 92

Movement of all monies / assets
Into country
Out of country

Question 93

What could cause Current and capital account in a deficit for long period

Answer 93

Rising interest rates
Economy growth falls
Currency devaluation
Unemployment rises
Inflation increases

Question 94

Drawbacks SRI

Answer 94

Less Diversification
More expensive
Less research available
Higher risk
Screening rules out Growth

Question 95

Investments that can be held in a innovative ISA

Answer 95

Debt based securities
Bonds and debentures
Loans to companies
Cash
Peer to peer lending

Question 96

Differences between preference shares and ordinary

Answer 96

Fixed dividend
Higher priority in payment/ wind up
Non voting

Question 97

EIS subscription rules and tax treatment

Answer 97

Can invest up to £1 million
If excess over £1million up to £2 million but the balance must be in knowledge intensive companies

30% income tax relief
Up to client income tax liability
Can carry back income tax relied to previous tax year

Re investment relief I’d available if invests within 3 years of sale of business
Exempt from CGT upon sale if held for 3 years

Qualify for business relief
Exempt from inheritance tax if held for 2 years

Question 98

Price to book ratio

Answer 98

Share price ÷ NAV

Question 99

What are two differences between company warrants and covered warrants

Answer 99

Company warrants is issued by a company and relates to itself

Covered warrant is issued by a financial institution and relates to other companies than the issuer

Company warrant is based on one company
Covered warrant maybe issued on one underlying security, indices, sectors

Company warrants are call options
Covered warrants can be calls and puts

Covered warrants risks are reduced because the issuer must hold the underlying security but the issuer can still fail

Question 100

Offer for sale

Answer 100

Is where the company sells new shares to an issuing house which then markets the shares to the public based on guidelines in the offering document
This is prepared by the company directors and assessed by an independent sponsor who also confirms the company’s capital adequacy by letter to UKLA
A formal notice will be placed in the paper
The share price will be slightly higher than the price the company sold the shares to the issuing House in order to make a profit
The offer to the public can either be fixed or tender

Question 101

IPO fixed rate

Answer 101

Is where the shares are offered to investors at a fixed price as a price just below what can be expected for the offer to be fully subscribed
This to encourage an active secondary market

Question 102

IPO tender price

Answer 102

Investors specify amounts of shares they’d like to purchase and amount they are willing to pay
A strike price is then determined with all successful bidders who bid at/above this strike paying the strike price for the shares
The strike price is generally set low enough to ensure an active secondary market

Question 103

Offer for subscription

Answer 103

An offer for subscription is an IPO that can be written on either a fixed or tender basis
It involves the issuing house underwriting the offer to ensure any unsold shares are bought
A detailed prospectus is produced and put on the issuers website

Question 104

Why ROE and ROCE are used to evaluate a shares return

Answer 104

Both ratios measures the efficiency of profit generation
ROE is better for comparing different investments/ Assets but is affected heavily by differences in company capital structure and therefore not suitable as ROCE when comparing companies

Question 105

Interest cover formula

Answer 105

Profit before tax and interest ÷ interest paid x100

Question 106

Interest cover explained

Answer 106

The interest coverage ratio is used to measure how well a firm can pay the interest due on outstanding debt.
The interest coverage ratio is calculated by dividing a company’s earnings before interest and taxes (EBIT) by its interest expense during a given period.
Some variations of the formula use EBITDA or EBIAT instead of EBIT to calculate the ratio.

Question 107

What is sequencing risk and what affect does it have on an investment portfolio

Answer 107

Impact of volaity on the order and timing frequency of withdrawals
And sustainability of future income
Long term impact on capital value and this is greater in early years

Question 108

Main objectives of rebalancing

Answer 108

Realign portfolio to its original asset allocation / weighting to match attitude to risk and capacity for loss
Review of individual funds/ correct any style drift
Invest cash
Adjust portfolio to deal with any change in their circumstances/ income level/ objectives

Question 109

Potential issues when rebalancing

Answer 109

Trading costs
Whether to retain or alter benchmark
Potential tax liabilities
Regulatory/ legislation issues
Is rebalancing auto or manual
Frequency of rebalancing
Existing income be effected?
Liquidity / ability to rebalanced EIS etc
Market timing
Suitability of existing funds / allocation

Question 110

Main conditions for a property fund to qualify as a property authorised investment fund (PAIF)

Answer 110

At least 60% of income must come from the exempt property business.
Value of property assets must be at least 60% of total assets.
Shares must be widely held.
No corporate investor can hold more of 10% or more of net asset value

Question 111

Tax treatments of the three components of a PAIF (Higher rate tax payer) if PAIF is used to generate income

Answer 111

Dividend income paid gross and taxable at 33.75% once Dividend allowance exceeded

Property income distribution exempt
Paid net of basic rate tax/ 20%
And taxable further at 20%/40% in total once personal savings allowance exceeded

Interest/other income paid gross but taxable at marginal rate

Question 112

What is meant by growth investment style and good indicator of a good growth stocks

Answer 112

Involves investing in securities with above average earnings potential
Typically growth investors favour smaller companies with the ability to grow more quickly in size reinvesting their earnings back into themselves to deliver capital growth to investors with the share price
It’s higher risk than value investing because growth managers are not relying on investing in undervalued stock
Growth investors need to consider more qualitative measures such as the ability and efficiency of the management team to run the business in the most profitable way

Question 113

Key indicators of growth stocks

Answer 113

Eps growth for 4 years out of last 5
A low P/E relative to growth
Optimistic annual statement from the company chairman
Strong liquidity (High cash flow low borrowing)
Competitive advantage

Question 114

Value investment style

Answer 114

Believes that through vigorous research they can discover stocks undervalued by the market which will allow them to profit on the upside
Believe that markets are inefficient and investors under and over react to new information
The value investor aims to take advantage of these reactions
Value investment involves using fundamental analysis in order to identify securities that are undervalued
Investing in them and selling them once thr market has caught back up

Question 115

Indicator of value stock

Answer 115

Solid value indicators include a low P/E ratio
High dividend yield
Low price to book ratio

Question 116

Momentum investing

Answer 116

Identifying trends using technical analysis
Going long in investments likely to continue growing
And/or going short in investments likely to continue failing
And selling/ closing out the position before before the security changes direction
It’s a risky strategy as knowing when to sell has proved difficult

Question 117

Contrarian investment style

Answer 117

This simply involves betting against the herd
They invest in assets which are out of fashion or have recently fallen
They need a fairly accurate valuation of the security they’re investing in (the investment may have fallen for a good reason)

Question 118

Key differences between fundamental and technical (momentum) analysis

Answer 118

Fundamental analysis uses qualitative and quantitative research into a company and its sector / geography in order to establish the value of an investment- specifically whether it is undervalued or over valued
Research will consider company’s balance sheet: profitability, profit volatility, liquidity, and operational efficiency. It is used predominantly by value investors and contrarians

Technical analysis is most often used by momentum investors
It looks at charts to attempt to identify trends in the market and bases future buy/sell decisions on past share price movements

Question 119

Tax treatment of REIT

Answer 119

Income from ring fenced lettings element is treated as rental income and paid net 20% tax. But can be reclaimed by non taxpayers including ISAs and SIPPs.
Basic rate and additional taxpayers must pay an additional 20/25%
Income from the non ring fenced element Is a normal dividend. The first £2,000 of dividend income for investors is tax free. Any dividend income in excess of the allowance is taxed at 8.75% 33.75% 39.35%
REIT shares are subject to CGT on any gains in excess of the tax free CGT annual exempt amount at 10 or 20%
No relief is available for IHT / NO business relief

Question 120

Key differences in EIS vs VCT

Answer 120

Max investment
£200,000 VCT
£1,00,000 EIS

Tax relief
30% for both

Holding period
EIS 3 years
VCT 5 years

One year carry
EIS yes
VCT no

Dividend
EIS taxable
VCT exempt

CGT
EIS gains exempt after 3 years
VCT gains exempt

CGT TAX DEFERAL RELIEF
EIS yes
VCT no

Question 121

Bottom-up approach

Answer 121

Pay no attention to index benchmarks
they select stocks based on their own criteria (value, GAAR etc)

Question 122

What are the money markets

Answer 122

they are the markets for short term borrowings.
An original maturity of less than 1 year.
Intuitions borrow funds to help with cash flow problems or deposit if they have a surplus

Question 123

what is the Inter-bank market

Answer 123

is a market where two-way prices are made between participating banks.
the difference between the two is called the spread

Question 124

UK Treasury Bills

Answer 124

A way of the government to borrow money
short term - mainly 3 months but can range from 1-6 months
usually minimum investment pf £500,000
Highly liquid
Issued at a discount of £100 nominal

Question 125

What is Commercial Paper

Answer 125

companies issuing unsecured short dated debt
maturities between 30-90 days
issued via the money markets

Question 126

What are certificate of deposits (CD)

Answer 126

A CD is issued when an investors places some money for a given term with a bank at an agreed interest rate
but with a discount as they are tradeable
they represent a deposit (not a loan)
pay interest at the end of the term
maturities between 1-3 months

Question 127

Risks of the Money Markets

Answer 127

Credit Risk
Inflation Risk
Interest rate Risk
Currency Risk

Question 128

what are debt securities

Answer 128

they are financial instruments that give the owners the right interest and repayment of capital on loan made to the government and companies

Question 129

Gilts Description

Answer 129

shorts - 7 years to redemption
medium 7-15 years
Long 15 years plus
Interest rate is the coupon described as an annual % of the nominal value £100 which is paid 6 monthly and paid gross of income tax

Question 130

Index Linked Gilts

Answer 130

have coupons and redemption values (par value) linked to the UK RPI or CPI index

Question 131

Break even inflation rate

Answer 131

the break-even inflation rate is the rate of inflation that gives the same real net redemption yield for an index linked gilt and a comparison conventional gilt of similar maturity for investors of a given tax rate

above the break even rate the index linked gilt gives the better return

below the break even rate the conventional gilt provides the better return

Question 132

The strips market

Answer 132

Separate trading of registered interest and principal of securities

these gilts can be stripped into their coupons and final redemption amount, both traded separately.

each strip forms the equivalent of a zero coupon bond. it will trade at a discount to its face value with the size of the discount being determined by prevailing interets rates and time.

Question 133

The strips market

Answer 133

Separate trading of registered interest and principal of securities

these gilts can be stripped into their coupons and final redemption amount, both traded separately.

each strip forms the equivalent of a zero coupon bond. it will trade at a discount to its face value with the size of the discount being determined by prevailing interets rates and time.

Question 134

Overseas government bonds

Answer 134

overseas governments bonds and trade vary from country to country
but effectively all operate on the same basic principle

there are 3 major bond markets in the UK;
gilts issued through the treasury by DMO
sterling loans to foreign borrowers
eurobond market which deals with foreign currency loans to UK and foreign governments and companies

Question 135

The repo market

Answer 135

a repurchase agreement that allows the borrower to use a financial security (gilt) as collateral for a cash loan at a fixed rate of interest.

(think of pawn broker lending money against the collateral of the goods and return at some point in the future)

Question 136

Eurobond market

Answer 136

Eurobonds are international bond issues outside any particular jurisdiction.

E.G a US dollar Eurobond could be issued anywhere in the world except for the US

Question 137

Corporate Bonds

Answer 137

are debt securities where the issuing companies promises to repay the capital at the end of the term and interest to the holders throughout the term.

these are very much like a gilt with interest fixed or variable rate and terms of redemption and provisions for early redemption/demand for early repayment or convertibility is set out within the terms of issue.

Question 138

Domestic Bonds

Answer 138

refers to one in which the nationality of the issuer, the denomination of the bonds and the country are the same.

Question 139

Foreign Bonds

Answer 139

is one in which the nationality of the issuer is different to that of the denomination of the bond and country of issue

Question 140

Risks of Foreign Bonds

Answer 140

Credit/ default risk: non-payment of interest or capital at redemption
Economic risk: different countries= different risks (greece vs germany)
Interest rate risk: the inverse relationship between bond prices and interest rates
Liquidity risk: it is possible to sell a specific amount at the price you want and at the time you want
Politcal Risk: political instability can be a major factor

Question 141

Security of Bond

Answer 141

a debenture is a document which acknowledges a company’s indebtedness to a third party and in particular to a secured debt instruments.
secured corporate bonds would be called debentures
the term loan stock refers to unsecured corporate bonds

Question 142

Asset-backed securities/Investments

Answer 142

an ABS is a financial instrument secured by a pool of assets such as property or loans.
they are issued by companies specially created for the purpose and are a separate legal entity form the original owner of the underlying assets.
this leaves them unaffected by any bankruptcy risk in the original owner.

Question 143

Mortgage Backed Securities

Answer 143

is a securitized pool of underlying home loans
they are used by retail banks to securities the cash flows from mortgages that would otherwise be receivable over normally a 25 year term.

Question 144

Risk Management Main Risk (Bonds)

Answer 144

credit risk - interest payments and repayment of the bond may not be made
market risk - inverse relationship between bond prices and interest rates
inflation risk - real value of bond coupon & redemption repayment
liquidity risk: bonds not easily traded
Exchange rate risk - bonds denominated in different currencies

Question 145

Bond Credit Risk

Answer 145

credit rating agencies make an assessment when first issued (and throughout the term of the bonds) and are divided into investment grade or non investment grade

Question 146

Bond Market Risk

Answer 146

the income/coupon from a bond remains unchanged throughout the term
Yields vary to reflect interest rates rising or falling by a fall or rise in its capital value

Question 147

Bond Volatility/Sensitivity

Answer 147

Bond prices will not all change by the same amount when interest rates or yields change
they are all made up of different coupons and terms #
the measure used to calculate how sensitive the bond is to changes in interest rates or yields is known as duration or modified duration

Question 148

When the bond is trading above par will the GRY be less or more than the flat yield

Answer 148

LESS because there will be a capital loss

Question 149

Are Gilts exempt from CGT

Answer 149

Yes

Question 150

Difference between the clean price and dirty price

Answer 150

the actual price paid in the market for a bond is called the dirty price
the difference between the clean price and the dirty price is the accrued interest that the bond holder becomes entitled to on the distribution date
OR the seller is losing by selling before the distribution date and the dirty price compensates for this loss

Question 151

The dirty price is?

Answer 151

clean price (what you pay for it) + accrued interest at point of sale

Question 152

Bonds Coupon Sensitivity

Answer 152

the smaller the coupon the more the bonds price will move for a given interest rate change :
low coupon bonds are more volatile than high coupon bonds

Question 153

Bonds sensitivity to redemption date

Answer 153

for two bonds with the same coupon, it will be the longer dated that is most volatile
Long dated and low yield bonds are the most volatile or sensitive to price movements

Question 154

Duration

Answer 154

reflects the time it would take for the investor to get back his purchase price in present value money

Question 155

Modified Duration

Answer 155

estimates how much a bonds price will change if there is a change in interest rates/yields

it quantifies the sensitivity of the bonds price to changes in GRY

Question 156

Flat Curve

Answer 156

where there is no perceived investment risk the yield curve can be flat,
this occurs in a stable economic situation where no significant changes are expected to interest rates or inflation

Question 157

Reverse/downward curve

Answer 157

investors optimism on inflation
a falling ‘reverse’ or inverted yield curve is where shorter term bonds have a higher yield than longer term bonds
and is seen as an indicator of recession with investors effectively demanding a higher return for the perceived higher risk of short term bond compared to that of a longer term bond

Question 158

Preference Shares

Answer 158

Do not normally carry the right to vote
but carry an expectation of a dividend
payable after interest payments (bondholders)
but before O/S

Question 159

Cumulative preference shares

Answer 159

where the company does not pay a dividend the right to receive that dividend is rolled into the next period
O/S cannot be paid until ALL cumulative preference shares have been paid

Question 160

Participating preference shares

Answer 160

where additional dividends could be paid,
over and above the fixed rate
then participating preference dividends (extra dividend) could be paid

Question 161

Convertible preference shares

Answer 161

rights to convert into O/S

Question 162

Redeemable preference shares

Answer 162

they carry a specified redemption date when the company will refund the nominal value

Question 163

Zero dividend preference share

Answer 163

have a fixed maturity date and also provide a fixed return
they get paid out before O/S
often referred to as low risk
have no voting rights
subject to CGT

Question 164

American Depositary Receipts

Answer 164

used by British companies
to encourage US investors
to buy an equity stake in a UK company
gives them opportunity to buy into a UK company but receive dividends in dollars

Question 165

AIM features

Answer 165

launched in 1995
currently lists circa 1,000 companies with a total market capitalization of £93billion
many AIM companies lack true liquidity
lower listings standards and lighter touch regulation than LSE markets (major critism of AIM)
lower listing fees and ongoing costs than for the main LSE

Question 166

advantages of investing in an IPO

Answer 166

the shares may be priced at an attractive level to ensure good take-up
transaction costs will generally be lower

Question 167

disadvantages of investing in an IPO

Answer 167

no track record for the company’s commericail (business)/ investment (share price) performance
less stringent reporting requirements at the time of IPO
investors in a IPO may get less shares than they applied for

Question 168

Offer for sale

Answer 168

involves the compnay issuing the new shares, selling the issue to a company called an issuing house
the issuing house initially buys up new shares from the issuing company before re-selling them
the issuing house will buy the shares from the company at a lower price than it intends to sell them

Question 169

Fixed price Pricing

Answer 169

a fixed price is stated and offered on that basis
sometimes this initial price is set low to encourage take-up

Question 170

tender pricing

Answer 170

investors make bids for amounts of stock and the price they’re willing to pay.
based on the bids, a strike prices et
with anyone who bid above the strike price paying the strike price for the stock

Question 171

Offer for subscription

Answer 171

involves a company issuing shares directly to the general public
and offering them for sale direct
this method involves an issuing house underwriting the offer, meaning they’ll agree to purchase any unsold shares for a fee

Question 172

Placement/selective marketing

Answer 172

the shares are marketed directly to preferred, specially selected institutional investors
these include pension funds, investment banks and life funds

Question 173

Introductions

Answer 173

involve a company already listed on one exchange the ability to seek an introduction to sell shares on another exchange.

Question 174

Gordons growth Model formula

Answer 174

most recent dividend/
investors required return-
growth rate of dividend

Question 175

FTSE 100

Answer 175

top 100 uk companies based on market capitilisation

Question 176

FTSE 250

Answer 176

The index provides a benchmark for the next 250 biggest companies in the UK

Question 177

FTSE 350

Answer 177

combination of ftse 100 and ftse 250

Question 178

FTSE All-Share

Answer 178

a weighted arithmetic index covering approximatley 800 companies

Question 179

Rights Issue

Answer 179

Is an invitation to shareholders to buy new shares in proportion to their existing holding of shares
A rights issue ensures that existing shareholders are always given first refusal on new shares.
rights issues are often not good news and are typically done in order to repay a debt or refinance the company

Question 180

Theoretical ex-rights price

Answer 180

is the price of the shares after the rights issue has taken place

Question 181

Theoretical nil paid price

Answer 181

is the price an investor would (theoretically) pay for the right to buy a discounted share (in the rights issue)
It is the difference between the new price and old price

Question 182

Swallowing the tail

Answer 182

some investors may want to sell some of their rights and take up the offer with the money they make.

Question 183

Bonus Issue

Answer 183

is a method of issuing new shares to the existing shareholders where new shares are issued without cost
the effect of a bonus issue is to dilute the existing market price of a share and has the effect of reducing the price and making it more attractive to investors

Question 184

Share splits and consolidations

Answer 184

a share split is where shares in issue are split into a greater number, each with a smaller nominal value
i.e one £2 O/S split into two £1 O/S

Question 185

Share Buy - Back

Answer 185

the purchase by a company of its own shares is called share buy back.
Regulatory as well as shareholder approval is required before a company is allowed to buy back its shares
Business protection policies on director/shareholders for company share buy back can be put in place

Question 186

Equity Warrants

Answer 186

give the owner the right but not the obligation to purchase shares at a fixed price in the future

Question 187

Equity warrants vs Options

Answer 187

one major difference is the expiry date
equity warrants expiry date id sometimes months or years
Options are traded on the exchange
Warrants are issued by a company to raise money

Question 188

Gearing ratio formula

Answer 188

Long term debt + preference shares
÷
Shareholders fund + capital reserves

Question 189

Interest cover formula

Answer 189

Profit before interest and tax
÷
Gross interest payable

Question 190

ROE VS ROCE

Answer 190

ROE is ideal for comparing Equities with other assets
ROCE is better for comparing between individual companies//efficiencefficiencof

Question 190

Mechanism by which a synthetic ETF secures its returns

Answer 190

Uses a swap contract
Where counterparty (investment bank) agrees to pay the index return
In exchange for a fee

Question 190

Main risks of synthetic ETF and how to reduce the risk

Answer 190

Counterparty risk
The risk that the investment bank may not be able to return the agreed index
Buy/hold collateral
Review collateral periodically

Question 190

What do ETF managers typically engage in to increase returns above that of the index they track

Answer 190

Stock lending
In exchange for a fee and collateral

Question 191

What Alpha measures and what it indicates

Answer 191

measure of risk adjusted return
above expected market return
return not explained by the CAPM
the managers ability to add value
through stock picking

Question 192

What is meant by value fund management style

Answer 192

An active management strategy
where a manager selects shares trading at low valuations
that he considers undervalued or under-priced
compared to its sector - market or fundamentals
potential for re-rating
low PE, low price to book, low price earnings to growth ratio

Question 193

Covered Warrants

Answer 193

issued by financial institutions
such as investment banks
listed on the stock exchange
classed as derivatives
Are issued by someone other than the company
and they cover the warrant by owning shares in the company

Question 194

EPS explain

Answer 194

The profit that could have been paid as an ordinary dividend
calculated after all expenses including preference shares
The trend of the EPS over time is probably more useful for company comparative performance measure
but must be companies in the same business

Question 195

EPS Ratio

Answer 195

Profit attributable to O/S / No of O/S in issue

Question 196

Price earnings ratio - Facts

Answer 196

provides an indication of the markets expectation of the company’s earnings growth potential
it is the time in years, it would take the current EPS to repay the share price
a high P/E indicates a greater perceived ability grow EPS compared to to competitors
The P/E ratio measures how highly investors value a company as a multiple of earnings
it is calculated by dividing the market price by the EPS
investors pay more for shares if they expect the earnings to rise

Question 197

Drawbacks of P/E ratio

Answer 197

based upon historic data
only one number and rather simplistic
must be relative to the sector and company competitors
PE ratio level should be compared to past levels and trends within industry sector

Question 198

P/E ratio calculation

Answer 198

Share Price / EPS

Question 199

PEG ratio explained

Answer 199

shows the projected growth in earnings per share in relation to a company’s share price

Question 200

What might a high PEG ratio indicate

Answer 200

a share is expensive
the share has limited growth potential
PEG ratio higher than 1 are generally considered unfavourably (overvalued)
PEG ratio lower than 1 are generally considered favourably (undervalued)

Question 201

what are the disadvantages of using PEG ratio

Answer 201

it is based on projected date
forecasts
opinions

Question 202

PEG ratio calculated

Answer 202

P/E ratio / earnings growth rate

Question 203

state the principles functions of a central bank

Answer 203

use interest rates to meet inflation target
to act as bank of last resort
banker to the government and other banks #
control money supply
supervise banks and other financial institutions

Question 204

Limitations of using simple ratios to analyse a business

Answer 204

Accounting policies change over time.
uses historic data
need to look at trends over time
only uses one piece of information, need to use a more comprehensive analyse of the company

Question 205

What is the Efficient Market Hypothesis

Answer 205

it hypothesises that the investment markets are efficient and that it is impossible to beat the market long term
and any outperformance is due to luck rather than skill

Question 206

EMH weak form

Answer 206

believes that
all current market prices are fair
it is impossible to consistently and accurately predict future share prices movements based on past movements
the only thing that can significantly impact share prices is new information
and this happens randomly
no one knows what it is or when it will happen

Question 207

EMH Semi strong

Answer 207

share prices reflect all public information available
it is not possible to gain an advantage by either fundamental or technical analysis
because share prices adjust to new information within an incredibly short amount of time

Question 208

EMH Strong

Answer 208

Share prices reflect all information possible
both public an private
this is unlikely true for many markets as insider trading laws prevent insiders from trading on private information
this would undermine investor confidence in the markets

Question 209

Describe Growth Investment management style

Answer 209

Involves investing in securities with above average earnings potential
Growth investors favour small companies
with the ability to grow in size more quickly
they look for companies that reinvest their profits which in turn will be passed onto the share price in terms of growth
This investment style is typically more risky than value investing
Growth investors need to consider more measures such as the efficiency and management of the company

Question 210

Key indicators of Growth Investor

Answer 210

EPS growth for 4 out the last 5 years
a low P/E relative to growth
an optimistic annual statement from the company chairman
Strong liquidity

Question 211

Describe Value Investment style

Answer 211

Values investor believe that by undertaking intensive research they can discover stocks that are undervalued by the market which will allow them to make a profit on the upside
Value investors believe that the market is inefficient and investors under and overreact to new information.
the value investor aims to take advantage of these reactions

Question 212

Main indicators of a good value stock

Answer 212

Solid value indicators include low P/E ratio
high dividend yield
low price to book ratio

Question 213

explain momentum investing

Answer 213

identifying trends using technical analysis
going long on investments that are likely to continue to grow
short on investments likely to fall
selling/closing out the position before the security changes direction
risky strategy knowing when to sell

Question 214

Explain Contrarian investing

Answer 214

Basically going against the trend
betting against the herd
invest in assets that are out of fashion
or have recently fallen
similar to a value investment style
although the asset may have fallen for a very good reason - contrarians need accurate information

Question 215

What is the security markets line

Answer 215

The expected return as predicted by the CAPM for any given beta
Investments above the SML have alpha
and are therefore undervalued
Investments below the SML have negative alpha
and therefore, over valued
the higher the alpha in the portfolio, the more additional return has been achieved by the fund manager

Question 216

Four ways that a passive investment manager may track an index

Answer 216

Physical replication - fund manager physically buys and holds the stocks in the index
Synthetic replication - the fund manager enters into a swap contract with an investment bank - the investment bank will pay the return on the index
Sampling - Stratified - representative sample of the index is chosen and is tracked rather than that of the full index
Optimisation - uses computer programs to trade automatically on the index

Question 217

What is fundamental analysis

Answer 217

It uses qualitative and quantitative research into a company and its sector/geography
in order to establish the value of an investment
specifically, to attempt to identify if the asset is undervalued or overvalued

Question 218

what is technical analysis

Answer 218

it is the most often used my momentum investors
it looks at charts to attempt to identify trends in the market
and bases future buy/sell decisions on past share price movement

Question 219

What is the income tax treatment of the income payment that can be made by a REIT within a GIA

Answer 219

*Exempt/PID/Ring fenced
Paid net of 20%
Subject to further 20%/marginal rate tax
PSA not available/ non savings income

*Dividend
Paid Gross
Taxed at marginal rate (8.25/33.75/39.35)
Dividend allowance available £2,000

Question 220

Tax benefits of holding a REIT within an ISA

Answer 220

ISA manager
can reclaim 20%
income/PID/dividend/ not subject to income tax
gains are tax free / not subject to CGT

Question 221

List 4 types of fund structure that a retail client can gain access to the commercial property sector

Answer 221

PAIF
UCITS
ETF
Investment Trust
Pension / Life fund
Unit Trust

Question 222

main stages of the top-down investment process

Answer 222

Asset allocation
Geographical allocation
Sector weighting
Stock selection

Question 223

Explain GAARP Growth at a reasonable price

Answer 223

Pay a premium/ higher price for
stock with specific advantages / qualities
mix/combination of value and growth
longer term

Question 224

Momentum investing

Answer 224

Trend/ price movement
likely to continue / further gains to come
sell before trend ends / reverses
ignores fundamental/ intrinsic value
shorter term

Question 225

What does the EMH believe

Answer 225

Stock picking does not work
Not possible to outperform market/ generate alpha
Market is efficient / market prices in all information
technical analysis does not work
transaction costs offset performance /outweigh benefit

Question 226

what are two types of bonus for a with profits policy

Answer 226

*Annual / reversionary
regular
variable
once applied cannot be removed

*Terminal/ Final
one-off
paid on maturity
death
surrender/ redemption
not guranteed

Question 227

Differences between Conventional & Variable unitised with profits funds

Answer 227

UWP has units
CWP does not

UWP bonus is in advance
CWP is in areas

UWP bonus can be changed
CWP cannot be changed

UWP bonus applied to unit price
CWP bonus added to sum assured

UWP easier to switch fund
UWP easier to calculate current value/ more transparent

Question 228

State the main money market funds

Answer 228

Short term
Upto 60 days maturity
Upto 120 days life

Standard
Upto 6 months maturity
Upto 12 months life

Question 229

What is CAPM?

Answer 229

single factor
financial model
which projects an expected return for an asset
as the combination of return of a risk free asset
plus the risk premium of a risky asset

Question 230

Limitations and problems with CAPM

Answer 230

Market risk can be difficult to establish
what to use as risk free asset? is there an actual risk free asset?
What is the market portfolio?
Studies from Fama and French show that actual returns have no relation to those predicted by CAPM
The suitability of beta, Betas need to be stable

Question 231

Explain diversification rules a retail UCITS

Answer 231

Minimum 16 holdings
Maximum up to 10%;
in four companies
Maximum/ up to 5%
in twelve/ rest/ others

Question 232

limitations of beta as a measure of risk

Answer 232

Measure of market risk alone;
ignores others factors/ risks
assumes risk-free rate is correct/ suitable
not stable or accurate predictor of future beta

Question 233

explain briefly the main investment related factors that you would take into account when choosing either active or passive strategies for collective’s funds

Answer 233

Active
Fund objective/ mandate/ strategy
manager experience/ reputation
Alpha/ IR/ Share/ performance/ track record

Passive
Replication strategy/ tracking error
is market efficient?
counterparty risk

Either
Diversification/ asset allocation
costs/ charges
choice / use of benchmark

Question 234

Four stages of the investment process

Answer 234

Client objectives - risk and or return
Investment strategy- active passive or both
Stock selection
Performance analysis

Question 235

What is a top down approach

Answer 235

When focusing on asset allocation rayher than stock selection and market timing

Asset allocation
Geographical areas
Sector selection
Stock selection

Question 236

Bottom up approach process

Answer 236

Some managers avoid making a conscious decision on asset allocation and move straight into choosing individual shares and bonds that suite thier investment needs. This is called a bottom up approach

Question 237

Tactical allocation

Answer 237

Is where ranges are specifies around the strategic level to enable market timing adjustments
Example fixed interest 40-50

Question 238

Disadvantage of Value Investment style

Answer 238

The remit of the fund manager to beat the market
this index may have moved ahead
may have a bigger weight in certain shares
the manager has to keep up with the market regardless of value

Question 239

Momentum advantages

Answer 239

tend to be influenced by momentum because clients like to see good news and results favored by the news, TV and press
conversely, they are disappointed to hold those that are criticized

Question 240

Momentum disadvantages

Answer 240

demands a much higher level of trading
a typical funds annual turnover could be 100% plus
high transaction costs
Momentum investing is highly sensitive to luck of timing
whether going into the trend or exiting

Question 241

Explain Contrarianism investing

Answer 241

Betting against the herd
investing in out of fashion holdings
in 2014 George Osborne famously quoted that no one will need to buy an annuity again
thereafter share prices in Just Retirment fell
This was a good buying opportunity for contrarian investors
who could profit from the market’s overreaction
similar to value investing

Question 242

Present Bias

Answer 242

Present bias is the tendency to rather settle for a smaller present reward than to wait for a larger future reward, in a trade-off situation

Question 243

Overconfidence

Answer 243

Ones belief to ah e the ability to pick winning stocks

Question 244

Reference dependence and
loss aversion

Answer 244

where a real or potential loss is perceived by individuals as psychologically or emotionally more severe than an equivalent gain. For instance, the pain of losing $100 is often far greater than the joy gained in finding the same amount

Question 245

Regret and other emotions

Answer 245

Less willing to sell investment at a loss

Question 246

Over-extrapolation

Answer 246

extrapolating from just a
few years of investment returns
to the future

Question 247

Projection bias

Answer 247

taking out a payday loan
without considering payment
difficulties that may arise in the
future

Question 248

Framing, salience and
limited attention

Answer 248

overestimating the value
of a packaged bank account
because it is presented in a
particularly attractive way

Question 249

Mental accounting and
narrow framing

Answer 249

Mental accounting refers to the different values a person places on the same amount of money, based on subjective criteria, often with detrimental results. Mental accounting is a concept in the field of behavioral economics. Developed by economist Richard H. Thaler, it contends that individuals classify funds differently and therefore are prone to irrational decision-making in their spending and investment behavior

Question 250

Decision-making rules
of thumb

Answer 250

investment may be split
equally across all the funds
in a pension scheme, rather
than making a careful
allocation decision

Question 251

Persuasion and social
influence

Answer 251

following financial advice
because an adviser is likeable

Question 252

Arbritage pricing theory

Answer 252

Measures the expected return on a security like the CAPM
but takes account of all risk specific to the security
its an alternative theory to the CAPM
CAPM measures prices that are determined solely by market risk
APT takes into account a series of risk premiums that can be specific to that particular security
APT takes into account systematic ris as well as unsystematic risk

Question 253

Explain non - systematic risk

Answer 253

Nonsystematic risks are specific to a particular business
all businesses are unique and have their own specific risk factors

Question 254

explain systematic risk

Answer 254

Systematic risk is the risk that affect the financial system as a whole

Question 255

Explain Active fund management

Answer 255

The strategy is exact opposite to a passive one
aim is to outperform a benchmark
described as beating the market
actively managed portfolios are either constructed using a top down or bottom up method

Question 256

What are ETFs

Answer 256

ETF often hold a portfolio of shares
or derivatives
that are selected to track the performance of an index
they offer exposure to many other markets
ETFs are usually open - ended
traditional ETF are available in hundreds of varieties, tracking nearly every index, commodity, currency or exchange you can imagine
low turnover, low cost, broad diversification
expense ratios can be significantly lower

Question 257

Disadvantages of tracker funds

Answer 257

no opportunity to design a portfolio specific to client requirements
no opportunity to outperform the benchmark
the benchmark/index can be influenced by a small number of stocks/sector
tracking error can and will occur

Question 258

advantages of tracker funds

Answer 258

many active managers fail to beat the market
tracker funds generally have much lower costs than active funds
simple to understand

Question 259

Why a close ended fund is potentially more volatile than an open ended fund with similar underlying investments

Answer 259

Units are cancelled, and underlying investments sold in proportion to the disposal, unless inflow us received when cash can be withdrawn

Possible difficulty in disposing of underlying assets/liquidity

Doesn’t trade at net asset value

Trades at a discount/premium which will widen/narrow

The effects of gearing/increased sensitivity to interest rate changes

Question 260

State 5 advantages and 5 disadvantage of investing in commercial property via an open ended investment company ra5her than directly

Answer 260

Advantages
Liquid investment
Greater Diversification than investing directly
Lower risk
No responsibility for maintenance/ insurance/ health and safety
Professional management
Accessibility to smaller investment funds/ economies of scale
Enables greater control of CGT planning.

Disadvantages
Don’t fully own the underlying investments
Reliant on fund manager to make right investment decision
Lack of control over fees and costs
Can impose a deferment period
Less scope for gearing
No tax relief on borrowing

Question 261

State the three main ways in which a stock market index is weighted

Answer 261

Value/ market capitalisation
Price
Equal / unweighted

Question 262

Identify four events that can cause a constituent company to enter or leave the FTSE 100 at a periodic rebalancing

Answer 262

New listing/ IPO
Delisting / switch to another market / becomes ineligible
Merger / acquisition takeover
Change in share price / market cap

Question 263

Explain briefly what is meant by free float and how it affects a company’s weightingin FTSE UK indices

Answer 263

Proportion/ percentage of shares
Traded on market
Companies with less than minimum free float;
Have weighting reduced

Question 264

State three main metrics that would be used to measure the risk adjusted return of an actively managed fund and outline two distinct purposes of each metric

Answer 264

Alpha
Stock picking/ value added by manager
Excess return not explained by Beta

Sharpe ratio
Excess return for every unit of risk/ risk free rate
Excess return over standard deviation

Information ratio
Consistency of manager
Excess return over benchmark

Question 265

State the maximum FSCS limits that would apply to ETF’S, pensions and shares

Answer 265

ETF
£85,000
Per firm

Shares.
No protection

Pension
100%
Without limit
Per provider

SIPP
£85,000
Per operator / firm

Question 266

What does a strong pound mean

Answer 266

Exports are expensive for other currencies
So consumers and businesses in other countries are not as inclined to buy goods and services from the Uk

However this would also make imports cheaper so UK consumers and businesses will be inclined to import goods and services from abroad

Question 267

What does a weak pound mean

Answer 267

Imports are expensive into the UK
so they’re more than likely to buy goods and services domestically
Exports are very cheap for other currencies
So consumers and businesses in other countries are more inclined to buy goods and services from the UK

Question 268

Explain briefly the concept (process) of dilution in respect of the exercising
Of warrants

Answer 268

A company issues new shares.
Existing shareholders;
Subsequently own less of company/ shares worth less.
Unless they buy additional/new shares

Question 269

Identify the main differences between conventional and index linked gilts

Answer 269

Conventional
Coupon fixed
Fixed capital redemption value 100p

Index linked
Coupon variable
Linked to inflation/ RPI
three / eight months before payment
Capital repayment / redemption linked to inflation

Question 270

Explain briefly what is meant by the term breakeven inflation rate and state what it measures

Answer 270

Difference/ gap / spread between
Nominal yield
On conventional gilts
And real yield
On index linked gilts.
Expectation of inflation / future inflation rate
To breakeven on purchase price

Question 271

Describe two main differences between investment grade and sub investment grade bonds

Answer 271

Investment grade rated BBB- / Baa 3 or higher
Investment grade lower default risk
Investment grade lower Coupon/ yield
Investment grade longer issue
Investment grade lower correlation with Equities

Question 272

State three investment based actions that the manager of a UK strategic bond fund would most likely take in anticipation of a sustained economic recovery

Answer 272

Increase high yield / sub investment grade
Move down credit spectrum/ sell gilts / increase credit risk
Reduce interest rate risk / shorten duration
Reduce inflation risk / buy index linked
Increase equity correlation/ buy convertible bonds
Increase Beta/ Reduce cash

Question 273

State the main risk that a client would be exposed to if they invested in a synthetic ETF rather than a physical ETF and how the manager could reduce this risk on an ongoing basis

Answer 273

Counterparty risk
Hold collateral
Review collateral on an ongoing basis

Question 274

Explain briefly what activity ETF managers typically engage in to increase returns above that of the index they track

Answer 274

Stock lending in exchange for a fee and collateral

Question 275

State and explain briefly the two central principles of the CAPM.

Answer 275

• Non-systematic/specific risk can be eliminated/diversified;
• is not rewarded.

• Sensitivity to systematic/market risk;
• dictates expected return.

Question 276

State four benefits and four drawbacks of using the CAPM.

Answer 276

) Benefits

• Easy to use/calculate.
• Robust/proven/trusted.
• Allows for systematic/market risk.
• Ignores non-systematic risk/assumes it has been removed.
• Output is the expected return/easy to compare.

Drawbacks

• Risk-free rate may not be suitable/correct.
• Assumptions can be unrealistic/the market return may be different.
• Assumes beta as the correct/suitable measure of market risk.
• Beta is unstable.
• Doesn’t include costs and charges.
• Assumes single holding period/one-size fits all.
• Theoretical/single factor/simplistic.

Question 277

Describe briefly what is measured by Macaulay duration.

Answer 277

Weighted
• average term;
• in years;
• for purchase price to be repaid;
• by cash flows/coupons
• and redemption value.

Question 278

Describe briefly what is measured by modified duration

Answer 278

• Sensitivity;
• of bond’s price;
• to changes in interest rates/yield to maturity.

Question 279

State three factors you should be aware of when assessing Macaulay duration figures across different bond funds.

Answer 279

Macaulay is relative/can be used to compare funds.
• Affected by coupon/price.
• Becomes less accurate as change in yield increases.
• Assumes linear relationship between interest rate and bond price.
• May not reflect fund style/mandate.

Question 280

List three Investment Association (IA) sectors that may be suitable benchmarks to use solely for the UK sterling fixed interest asset allocation of the portfolio.
Assume there is no exposure to gilts.

Answer 280

• Sterling Corporate Bond.
• Sterling Strategic Bond.
• Sterling High Yield.

Question 281

Identify five main economic factors that may result in an increase in interest rates.

Answer 281

• Business/economic cycle.
• Expansionary fiscal policy.
• Tightening monetary policy.
• QT/unwinding QE.
• Rising inflation.
• Currency weakness/economic imbalance.
• Market forces/credit spreads widening/UK downgraded.

Question 282

Comment on the alpha of the UK Opportunities OEIC fund and state four likely reasons to explain the figure.

Answer 282

• Manager has not added-valued/active management not justified/better off
passive.
• Investment style/underlying stocks out of favour/poor stock selection.
• Annual/short-term measure/calculation period for alpha.
• High PTR/transaction charges.
• One-off event.
• Smaller companies/sector has higher volatility.

Question 283

Comment on the correlation figure for the two OEIC funds and its impact upon the equity component of the portfolio.

Answer 283

Correlation is strong;
• positive.
• Will increase returns in rising market.
• Will increase volatility/market risk;
• as betas are more than 1.
• Will reduce diversification.

Question 284

Identify three main risks specific to investing in equities on a passive basis using ETFs and state one reason for each risk identified.

Answer 284

) • Market/Systematic Risk.
• Limited protection in falling market/will follow market down/cannot hold cash. or No ability to outperform in rising market/will only deliver market return.

• Style Risk.
• Replication strategy may cause underperformance/tracking error/drift from index return.

• Counterparty Risk.
• Failure of counterparty provider.

Question 285

State six fund-related factors that you would consider when deciding whether to invest solely on an active basis.

Answer 285

Costs/charges.
• Fund/ style/objective/mandate.
• Alpha/outperformance/past performance.
• Volatility/standard deviation.
• Sharpe/Information ratio.
• Investment house reputation/financial strength.
• Manager experience/track record.
• Dividends/yield.

Question 286

Identify five potential economic consequences of the current account and capital account being in deficit over the medium to long-term.

Answer 286

• Rising interest rates.
• Economy growth falls.
• Currency devaluation.
• Capital flight out of UK.
• Unemployment rises.
• Increase borrowing/debt-dependence/reliance on foreign currency reserves.
• Inflation increases.

Question 287

State the main conditions that must be met for a property fund to qualify as a property authorised investment fund (PAIF).

Answer 287

• At least 60% of net income;
• from exempt property business/ringfenced.
• Value of property must be at least 60%;
• of total assets.
• Must pay 3 types of income.
• Shares widely held.
• No corporate investor;
• holding 10% or more of NAV.

Question 288

Describe briefly the investor biases of;
(i) herding;
(ii) the endowment effect.

Answer 288

(i) Herding
• Follow others/crowd.
• Fear of missing out.
• Ignore price/greater fool theory.

(ii) Endowment effect
• Greater value as inherited/already owned.
• Retain unsuitable investments/emotional attachment.
• Fear of selling.

Question 289

Identify three benefits of investing in a thematic-based specialist fund.

Answer 289

*Potential higher returns.
• Expertise of fund manager/scope for alpha/outperformance.
• Invest in early-stage companies/start of trend/long time horizon.
• Lower/negative/non-correlation to other equities/diversification.

Question 290

Identify five likely reasons for the level of fall in value of the NextGen Payment Solutions fund over the most recent statement period.

Answer 290

Economic/business cycle downturn.
• Increase in interest rates/inflation/discount rates.
• Higher beta/volatility/standard deviation.
• Poor stock-picking by manager.
• Tech/growth out of favour/sector rotation.
• Exposure to unlisted companies/deemed illiquid.
• One off event causes write-down/devaluation of underlying assets.

Question 291

Calculate, showing all your workings, the compound annual return of NextGen Payment Solutions for the period from Martim’s original investment into the fund until the latest end valuation.
Assume Martim made a £5,000 initial investment 4 years ago

Answer 291

(£11,780 / £5,000) = 2.356
∜ 2.356 or 2.356 ^1/4 or 0.25 = 1.23892159
-1 x 100 = 23.89%

Question 292

List four main types of socially responsible investing. Exclude environmental, social and governance (ESG) from your answer.

Answer 292

• Positive screening/engagement.
• Negative screening/ethical.
• Impact/microfinance.
• Sharia-complaint/religious.

Question 293

State two examples within each category of the Environmental, Social and Governance (ESG) criteria for investing. Exclude the terms environment, social and governance from your examples.

Answer 293

) Environmental
• Reduction of Pollution/waste/recycling.
• Climate Change/decarbonisation/ renewable energy use.
• Conservation/treatment of wildlife.

Social
• Human rights/education.
• Employee working conditions/benefits/diversity.
• Charities/community/affordable housing.

Governance
• Accounting practices.
• Board diversity/gender equality.
• Conflicts of interest/bribery/corruption.

Question 294

Calculate, showing all your workings, the Sharpe Ratio for NextGen Payment Solutions fund for the period shown in Table 1.

Answer 294

[(£11,780 - £19,000) / £19,000] x 100 = -38%
(-38% - 0.9%) = -38.9%
(-38.9 / 10.4) = -3.7403846 = -3.74

Question 295

State two benefits and two drawbacks of using the Sharpe Ratio in investment planning.

Answer 295

Benefits

• Compare different funds/managers.
• Shows risk-adjusted return.
• Identify if returns are from excess risk/beta or manager/stock-picking.

Drawbacks

• Need to consider other factors/trends over time/do not consider in isolation.
• Can be distorted by fund/manager’s strategy/higher risk.
• Assumes normal distribution of returns/standard deviation as measure of risk.
• Doesn’t take into account trading/turnover/costs.

Question 296

Describe briefly the definition and objective of a volatility managed fund.

Answer 296

• Target a specified return/maximise returns;
• while limiting volatility/to specified volatility target;
• using correlation/diversification;
• of asset classes/lower risk assets;
• to produce higher risk-adjusted returns.

Question 297

Outline why a volatility managed fund could be a suitable investment for Martim

Answer 297

In line with AtR.
• Provides diversification within a small portfolio.
• Could reduce market/volatility risk/hedge against market fall.
• Sufficient time horizon.
• Known/target level of volatility.

Question 298

State five main administration benefits of consolidating existing investment assets onto a platform.

Answer 298

• In one place/single view.
• Access to tools.
Bed to ISA
transfer of products with ease
• Consolidated tax statement/voucher.
• Less administration.
• 24 7/on demand access/view online.

Question 299

Calculate, showing all your workings, the return on capital employed (ROCE) for Best Guest.

Answer 299

£2,955,000 + £3,735,000 = £6,690,000
(£620,000 / £6,690,000) = 0.09267
x 100 = 9.27%

Question 300

Best Guest ROCE 9.27%

Comment, based upon the answer above, on the ROCE for Best Guest compared to that of Rockflour Boutique and identify two factors that would contribute to the difference in ROCE figures. Assume that Rockflour Boutique has a ROCE above 20%.

Answer 300

• Rockflour has used capital more efficiently/Best Guest has used capital less efficiently.
• Rockflour has higher operating profit/Best Guest has lower operating profit.
• Rockflour has lower long-term liabilities/Best Guest has higher long-term
liabilities.

Question 301

Explain briefly the drawbacks of using ROCE as a metric when comparing Best Guest and Rockflour Boutique.

Answer 301

• ROCE is a single metric/single period/need to compare over time/doesn’t factor in when funds are raised over period
• Affected by one-off factors/distorted by high cash/doesn’t account for current liabilities/doesn’t account for depreciation or amortisation.
• If a investor is a shareholder only/ROCE calculates return for all
sources/shareholders and creditors.

Question 302

Identify two main differences between an interim and a final dividend.

Answer 302

• Interim declared during financial year/before AGM
• Final declared after financial year/at AGM

• Interim declared by board.
• Final declared by shareholders.

• Interim can be revoked.
• Final cannot be revoked.

• Interim only if Articles expressly permit.
• Final not subject to Article/right of shareholders.

Question 303

Outline the potential tax benefits for an investor if they receive a dividend on their new shareholding compared to receiving a bonus in addition to their salary. Assume they are a higher rate tax payer

Answer 303

• Can use dividend allowance/first £2,000 tax-free.
• Not subject to National Insurance.
• Taxed at 33.75% compared to 40%.

Question 304

Calculate, showing all your workings, how much of a £120,000 chargeable gain an investor could invest into a new EIS to maximise the Income Tax relief available in the current tax year. Assume the investor has the full personal allowance available and the dividends they receive are less than their dividend allowance.
Assume their salary is currently £70,000

Answer 304

£12,570 x 0% = £0
£37,700 x 20% = £7,540
£19,730 x 40% = £7,892
Total/Income Tax liability = £15,432
Maximum investment = (£15,432 / 30) x 100 = £51,440

Question 305

Describe the tax benefits and qualifying rules of an EIS, including the time limits for deferral relief. Exclude Income Tax relief from your answer.

Answer 305

Deferral/rollover relief;
• for up to 1 year before;
• 3 years after;
• sale of the business/disposal.
• Can invest up to £1,000,000/if knowledge intensive £2,000,000.
• Original gain deferred;
• without time limit.
• Gain on EIS exempt from CGT;
• if held for 3 years.
• Loss relief available;
• against capital or income.
• Exempt from IHT/qualifies for business relief;
• if held for 2 years.

Question 306

Outline nine factors that you would take into consideration when conducting the annual review meeting with a client.

Answer 306

Any change in needs/objectives/requirements/circumstances/State of health/
dependents/marital status.
• Any changes in assets & liabilities/income & expenditure/emergency fund
• Any capital gains made/unused gains/use of CGT/ISA allowance.
• Any changes in legislation/Budget/products.
• Review of investment performance against goals/target/benchmark.
• Rebalance of portfolio.
• On-going suitability.
• Any change in ESG/ethical considerations.
• Re-establish AtR/CfL.
• Level of service/advice proposition/adviser charges.
• Market/economic outlook/sentiment.

Question 307

Calculate, showing all your workings, the money-weighted rate of return (MWR) for the global managed fund.

Answer 307

£700 + £38,200 - £25,000 - £10,000 = £3,900
£25,000 + (£10,000 x 7/12) = £30,833.33
(£3,900 / £30,833.33) x 100 = 12.648648 = 12.65%

Question 308

State the Income Tax treatment of the two types of income payment that can be made by a real estate investment trust (REIT) if held within a GIA.

Answer 308

Exempt/PID/Ring-fenced
• Paid net of 20%/BRT.
• Subject to further 20%/marginal rate tax.
• PSA not available/non-savings income.

Dividend
• Paid gross.
• Taxed at 32.5%.
• Dividend allowance/£2,000 available

Question 309

Outline the tax benefits and an investor were to hold a REIT within their stocks and shares ISA compared to within his GIA.

Answer 309

• ISA manager;
• can reclaim 20%.
• Income/PID/dividend/not subject to Income Tax.
• Gains is tax free/not subject to CGT.

Question 310

List four types of fund structure with which a retail client could gain access to the commercial property sector. Exclude open-ended investment companies (OEICs) and REITs from your answer.

Answer 310

• Unit trust.
• Investment trust.
• PAIF.
• UCITS/SICAV.
• Exchange traded fund.
• Life/pension funds.

Question 311

Identify four main types of investment risk that would be relevant to open-ended direct commercial property funds and describe briefly each of these main types of risk.

Answer 311

• Accessibility
• Unable to withdraw funds/dealing gated/suspended.
• Liquidity/pricing
• Fund unable to sell assets at fair price/bid price/dilution levy/hard to sell.

• Valuation
• Material uncertainty/unable to provide NAV.

• Void
• Loss of tenant/property empty.

• Income
• Loss of yield/unable to collect rent/reduction in rental income.

• Economic
• Assets cyclical/sensitive to business cycle.

Question 312

State the main stages of the top-down investment process of a global managed fund.

Answer 312

Asset class allocation.
• Geographical allocation.
• Sector weightings.
• Individual stock/security selection.

Question 313

Explain briefly the momentum investment style.

Answer 313

• Trend/price movement;
• likely to continue/further gains to come.
• Sell before trend ends/reverses.
• Ignores fundamental/intrinsic value.
• Shorter term.

Question 314

Explain briefly the growth at a reasonable price (GAARP) investment style.

Answer 314

• Pay premium/higher price for;
• stock with specific advantages/qualities.
• Mix/combination of value and growth.
• Longer term.

Question 315

Identify the three main forms of the efficient market hypothesis (EMH).

Answer 315

• Weak.
• Semi-strong.
• Strong.

Question 316

State whether an active or a passive investment strategy would be most effective for an equity-based investor if EMH is deemed to be correct and explain the reasons why.

Answer 316

• Passive.
• Stockpicking does not work.
• Not possible to outperform market/generate alpha.
• Market is efficient/market prices in all information.
• Technical analysis does not work.
• Transaction costs offset outperformance/outweigh benefit.

Question 317

State the two types of bonus for a with-profits policy and describe briefly each type, including when they can be applied.

Answer 317

Annual/reversionary
• Regular;
• variable.
• Once applied cannot be removed.

• Terminal/Final
• One-off;
• paid on maturity;
• death;
• surrender/redemption.
• Not guaranteed.

Question 318

Explain briefly the main differences between conventional and variable unitised with-profits funds.

Answer 318

UWP has units/CWP does not.
• UWP bonus in advance/CWP bonus in arrears.
• UWP bonus can be changed/CWP cannot.
• UWP bonus applied to unit price;
• daily/over course of year.
• CWP bonus added to sum assured.
• UWP easier to switch fund.
• UWP easier to calculate current value/more transparent.

Question 319

State the two main types of money market fund and identify the key differences in the maturity and life of their respective assets.

Answer 319

• Short-term
• Up to 60 days maturity.
• Up to 120 days life.

• Standard
• Up to 6 months maturity.
• Up to 12 months life.

Question 320

State five investment-related factors that an adviser would take into consideration when assessing a sustainable withdrawal rate.

Answer 320

• Initial yield/natural income.
• Expected return/growth rate.
• Taxation.
• Asset allocation.
• Charges.
• Inflation/interest rate outlook.
• Sequencing/volatility risk.
• Time horizon.

Question 321

Identify four client-related factors that would be relevant when considering an investment strategy.

Answer 321

• Age/state of health.
• Marital status/any dependants.
• Any other assets/liabilities.
• Any emergency fund.
• ESG/ethical preferences.
• AtR/CfL.

Question 322

Describe briefly four changes that Damba may consider when constructing a portfolio designed for an outlook of a sustained rise in inflation, compared with Trevor’s current asset allocation.

Answer 322

• Reduce/hold less cash.
• Diversify into real asset classes.
• Hold inflation-linked bonds.
• Own equities with rising/sustainable dividends.
• Set aside initial income requirement in cash/take profits/use gains to support
income.

Question 323

Identify five benefits of using collective funds, compared to holding direct equities. Assume that the funds would be held within an ISA and exclude taxation from your answer.

Answer 323

• Access different asset classes.
• Reduction in systematic risk.
• Minimisation of non-systematic risk.
• Access to different sectors/styles/niche.
• Professional management.
• FSCS/investor protection.
• Less admin/involvement.

Question 324

Explain the diversification rules for a retail Undertakings for the Collective Investment of Transferable Securities (UCITS) OEIC, based upon the minimum number of permissible holdings and the relevant percentages.

Answer 324

• Minimum 16 holdings.
• Maximum/up to 10%;
• in four companies;
• Maximum/up to 5%;
• in twelve/rest/others.

Question 325

Calculate, showing all your workings, the beta for the multi-factor fund.

Answer 325

Beta = 4.7 - 0.2 /(5 -0.2)
Beta = (4.5 / 4.8)
Beta = 0.9375/0.94

Alternative:
4.7 = 0.2 + Beta (5 - 0.2)
4.7 = 0.2 + Beta (4.8)
4.5 = Beta x 4.8
(4.5 / 4.8) = Beta
0.9375/0.94 = Beta

Question 326

State the two common principles that apply across multi-factor models.

Answer 326

• Investors require extra return;
• for extra risk.
• Focus on risks that cannot be eliminated by diversification.

Question 327

Explain briefly the limitations of beta as a measure of risk

Answer 327

• Measure of market risk alone/ignores other factors/risks.
• Assumes risk-free rate is correct/suitable.
• Not stable or accurate predictor of future beta.

Question 328

Explain briefly the main investment-related factors that an investor would take into consideration when deciding whether to choose active or passive strategies for the collective funds.

Answer 328

Active
• Fund objective/mandate/strategy.
• Manager experience/reputation.
• Alpha/IR/Sharpe/performance/track record.

Passive
• Replication strategy/Tracking error.
• Is market efficient?
• Counterparty risk.

Either
• Diversification/asset allocation.
• Costs/charges.
• Choice/use of benchmark.

Question 329

Explain briefly the concept of dilution in respect of the exercising of warrants

Answer 329

• Company issues new shares.
  • Existing shareholders;
  • own less of company/shares worth less;
  • unless buy additional/new shares.

Question 330

Calculate, showing all your workings, the diluted net asset value (NAV) per share.
Assume all of the warrants are exercised.

Answer 330

(49,000,000 – 8,500,000) = 40,500,000
720,000 x 0.7 = 504,000
40,500,000 + 504,000 = 41,004,000
36,000,000 +720,000 = 36,720,000
(41,004,000 / 36,720,000) = £1.1167/111.67p

Question 331

List three types of preference share and state one principal characteristic of each type.

Answer 331

• Cumulative/non-cumulative;
• Missed payments carried / not carried forward.
• Participating/non-participating;
• May / may not pay additional dividend.
• Convertible
• Right to convert to ordinary shares
• Redeemable/non-redeemable;
• Repaid at a set date or by company / no redemption date/undated.

Question 332

Calculate, showing all your workings, the operating profit margin for Cantilever Growth Trust.

Answer 332

(26,200,000 – 9,600,000) = 16,600,000
(16,600,000/ 26,200,000) = 0.63359
x 100 = 63.36%

Question 333

Calculate, showing all your workings, the dividend cover for Cantilever Growth Trust prior to the conversion of any warrants

Answer 333

5,450,000 – 2,100,000 = 3,350,000
36,000,000 x 0.08 = 2,880,000
(3,350,000 / 2,880,000) = 1.163194 = 1.163x

Alternative:
5,450,000 – 2,100,000 = 3,350,000
(3,350,000 /36,000,000) x 100 = 9.30556
(9.30556 / 8) = 1.163x

Question 334

Identify the main differences between conventional and index-linked gilts.

Answer 334

Conventional
• Coupon fixed.
• Capital repayment/redemption at par/100p.

Index-linked
• Coupon variable;
• linked to inflation/RPI;
• three/eight months before payment.
• Capital repayment/redemption linked to inflation

Question 335

Explain briefly what is meant by the term ‘breakeven inflation rate’ and state what it measures.

Answer 335

• Difference/gap/spread between;
• nominal yield;
• on conventional gilts;
• and real yield;
• on index-linked gilts.
• Expectation of inflation/future inflation rate;
• to breakeven on purchase price

Question 336

Describe two main differences between investment grade and sub-investment grade bonds.

Answer 336

• Investment grade rated BBB- /Baa 3 or higher.
• Investment grade lower default risk.
• Investment grade lower coupon/yield.
• Investment grade longer issue.
• Investment grade lower correlation with equities.

Question 337

State three investment-based actions that the manager of a UK strategic bond fund would most likely take in anticipation of a sustained economic recovery.

Answer 337

• Increase high yield/sub-investment grade.
• Move down credit spectrum/sell gilts/increase credit risk.
• Reduce interest rate risk/shorten duration.
• Reduce inflation risk/buy index-linked.
• Increase equity correlation/buy convertible bonds.
• Increase beta/reduce cash.

Question 338

Calculate, showing all your workings, the price earnings (P/E) ratio for Submersh plc.

Answer 338

£35,400,000 / £28,000,000 = 1.264285 = 126.43p
448p / 126.43p = 3.54

Question 339

Compare the P/E ratio of Submersh plc (3,54), to its sector average and explain briefly the possible reasons for the difference.

Assume The sector average price earnings ratio for Submersh plc is 9.8.

Answer 339

• P/E is lower.
• Undervalued/out of favour.
• Bad management/decline in business.
• Event causing a one-off increase in earnings.

Question 340

Calculate, showing all your workings, the dividend cover for Submersh plc.

Answer 340

16.2p x £28,000,000 = £4,536,000
£35,400,000 / £4,536,000 = 7.804232 = 7.8

Alternative
£35,4000,000 / £28,000,000 = 1.264285 = 126.43p
126.43p / 16.2p = 7.8

Question 341

Comment briefly on what can be deduced from the dividend cover figure

Dividend Cover = 7.8 times

Answer 341

High coverage/dividend well-covered.
• Retaining majority of profits.
• Company financially stable/dividend secure/sustainable.
• Low growth/ex-growth business.

Question 342

State the four main types of index replication strategy and describe briefly how each strategy works.

Answer 342

• Physical/Full Replication
• Buys all stocks within index in correct weighting.
• Stratified/Simplified Sampling
• Buys subset/selection/sample of stocks within index.
• Optimisation
• Buys computerised model of index.
• Synthetic
• Uses derivatives/swaps.

Question 343

Identify five specific investment risks to which Edward may be exposed within his investment portfolio and state one reason for each risk.

Answer 343

• Currency
• Exposed to Dollar/Yen/exchange rate movement.
• Concentration/Overlap
• Composition/market weighting of index/duplication/same stocks held in more than one fund.
• Market/Volatility
• NASDAQ/Japan Small Cap/beta likely to be greater than 1.
• Counterparty
• Failure of ETF.
• Passive/Product
• Replication style causes underperformance/underperforms index.

Question 344

State the three main ways in which a stock market index is weighted.

Answer 344

• Value/market capitalisation.
• Price.
• Equal/unweighted.

Question 345

Identify four events that can cause a constituent company to enter or leave the FTSE 100 at a periodic rebalancing.

Answer 345

• New listing/IPO.
• Delisting/switch to another market/becomes ineligible.
• Merger/acquisition/takeover.
• Change in share price/market cap..

Question 346

Explain briefly what is meant by ‘free float’ and how it affects a company’s weighting in FTSE UK indices.

Answer 346

• Proportion/percentage of shares;
• traded on market.
• Companies with less than minimum free float;
• have weighting reduced.

Question 347

State three main metrics that would be used to measure the risk-adjusted return of an actively-managed fund and outline two distinct purposes of each metric.

Answer 347

• Alpha
• Stock-picking/value added by manager.
• Excess return not explained by beta.

• Sharpe
• Excess return for every unit of risk/risk-free rate.
• Excess return over standard deviation.

• Information Ratio
• Consistency of manager.
• Excess return over benchmark.

Question 348

State the maximum Financial Services Compensation Scheme (FSCS) compensation limits that would apply to Edward’s pension and investment assets. Exclude the money accumulated within the cash account from your answer.

Answer 348

Investment;
• £85,000;
• per firm.
• Shares;
• no protection.

Pension;
• 100%;
• without limit.
• per provider.
• SIPP;
• £85,000;
• per operator/firm.

Question 349

State the options that are open to an investor in respect of generating the income stream that they are considering from their personal pensions. Assume that the provider(s) offers all of the available options.

Answer 349

• Drawdown/FAD.
• PCLS only.
• UFPLS.
• Phased retirement.
• Buy short-term/fixed term annuity.

Question 350

Describe the actions that an investor could take to mitigate the effects of sequencing risk, if they were to consider drawing the income stream from their overall portfolio over the medium to long term.

Answer 350

• Reduce the level of initial withdrawal.
• Change the timing/frequency of withdrawals.
• Stick to his original retirement plan/date.
• Alter asset allocation/reduce equity/market/volatility risk.
• Invest in fixed interest/diversification across asset classes.
• Increase cash/hold sufficient level of cash/take withdrawals from cash.
• Take natural income/dividends.
• Secure income through annuity.

Question 351

Calculate, showing all your workings, the Stamp Duty Reserve Tax and any levy that Edward would pay if he used the cash from the accumulated dividends to purchase more shares in Submersh plc. Assume that the number of shares owned by Edward and the
dividend per share have remained unchanged for the past four years.

Answer 351

SDRT
16.2p x 18,000 x 4 = £11,664
£11,664 x 0.5% = £58.32

PTM levy
£1
Total = £59.32

Question 352

State four areas that the advisory firm would need to consider, in respect of the potential impact of the platform’s change in technology provider on the advisory firm.

Answer 352

• Ownership of technology provider/conflict of interest/financial stability of tech provider.
• Ability to meet existing clients’ needs/expectations.
• Timescale for upgrade/testing/phasing of migration.
• Business continuity plan during upgrade/reliance on sole platform.
• Front/back office compatibility/loss of functionality/tools/reporting.
• Impact on firm’s advice proposition/reputation.
• Time/cost to firm.

Question 353

State four main risks to the client that could arise during the migration process.

Answer 353

• Loss of service/outage/access.
• Loss of income payments.
• Unable to trade/buy/sell/out of market.
• Data breach/loss.
• Loss of transaction history/legacy data.
• Increase in costs.

Question 354

State the tax treatment of the income generated from the funds held in the GIA and ISA, based upon the client’s tax position.

Client earns £35,000 only income

Answer 354

ISA
• Dividends;
• and interest/distributions;
• free of personal taxation/not subject to Income Tax.

GIA
• Dividends;
• taxed at 7.5%;
• once DA/£2,000 used.
• Interest/Distributions;
• taxed at 20%;
• once PSA/£1,000 used.

GIA
£110,000 x 2.1% = £2,310
less £2,000 = £310.
£95,000 x 3.5% = £3,325
less £1,000 = £2,325.

Question 355

Identify three main risks to which a client would be exposed if they invested in high income alternative investments and outline each risk.

Answer 355

• Income
May be unsustainable/cut/not paid.
• Unregulated
Not subject to FSCS/investor protection.
• Accessibility
Unable to sell underlying assets.
• Liquidity
Wide price spread/hard to sell.
• Capital loss/Valuation
Assets may be written down/down-valued.
• Correlation
May not be uncorrelated/may be more correlated with equities.
• Interest rate/Gearing
Sensitive to interest rate rises/cyclical.

Question 356

Identify three factors that could impact on the potential to hold alternative assets on a platform.

Answer 356

• Asset may not be eligible/not available to retail clients.
• Dealing infrequent/not readily realisable/unable to sell.
• Additional costs of ownership.
• May require third party to transact/may have to trade manually.
• Valuation/price may not show automatically/may have to input manually.

Question 357

Describe briefly what is meant by the term ‘capacity for loss’.

Answer 357

• The ability;
• to absorb;
• any negative investment event;
• without an adverse/detrimental effect;
• on lifestyle/standard of living.

Question 358

Outline three ways in which the effects of capacity for loss can be mitigated.

Answer 358

• Reduce portfolio risk/AtR.
• Hold sufficient cash to cover potential loss/event.
• Invest less/only invest what client can afford to lose.
• Discuss and agree CfL with client in advance.
• Establish the actual risk the client is willing to take/not focus on the outcome.
• Avoid overreliance on tools/simplified questions/inappropriate assessment of information.

Question 359

Calculate, showing all your workings, the information ratio for Risk III fund.

Answer 359

10.7 - 10.4 = 0.3
0.3 / 1.65 = 0.181818 = 0.18

Question 360

Comment on what can be deduced about Risk III fund’s performance based upon the information ratio 0.18

Answer 360

• Value added by manager/outperformance.
• Low risk-adjusted return/information ratio.
• Similar return could have been achieved through passive/tracker fund/active management not worth the cost.

Question 361

MO

Answer 361

Narrow Money
the notes and coins in circulation
Banks operational deposits in the BoE

Question 362

M4

Answer 362

Broad Money
The notes and coins in circulation
Money in savings and time deposits accounts of
UK residents in UK Banks and building societies

Question 363

What is Narrow Money (M0)

Answer 363

Reflets but does not influence the economy
has limited impact on national output and inflation
Growth in M0 indicates consumer spending increasing;
while a reduction in M0 indicates consumers aren’t spending as much

Question 364

What is Broad Money (M4)

Answer 364

Influences the economic cycle
Growth in M4 indicates increased lending activity from banks
and that inflation is likely to rise with fast growth in money circling around the economy

Question 365

What is a financial bubble?

Answer 365

A financial bubble occurs when investors stop paying attention to the fundamental indicators of an investment
and invest speculatively
simply because they think the asset will continue to grow in value
this is what is known as the greater fool theory
Investors overestimate potential returns
and underestimate competitive pressures

Question 366

What is a crash?

Answer 366

a crash occurs when investors sell investments quickly
because they believe the price will continue to fall
or perhaps because they are forced sellers

Question 367

Describe briefly the main features of an MPS.

Answer 367

• Collectives-based.
• Low minimum investment.
• Asset allocation/fund selection determined centrally/by external
manager/investment committee.
• Portfolio changes can result in client CGT liability.
• Range of risk-adjusted portfolios.
• Portfolios not bespoke to client/limited choice.
• Low cost.

Question 368

Identify six main factors that an adviser would take into consideration when evaluating a DIM service

Answer 368

• Charges.
• Overlap with existing/non-DIM assets.
• Regulatory permissions/reputation/financial strength.
• Past performance/track record.
• Investment style/strategy.
• Client’s AtR/use of unsuitable/high risk assets.
• Conflict of interest.
• Basis of agreement.
• Ownership of client.

Question 369

Identify the main phases of the economic cycle, in the order that they occur, starting with the recession phase.

Answer 369

• Recovery.
• Boom/expansion.
• Contraction.
• [Correct order of phases].

Question 370

State the main difference between the definitions of the M0 and M4 measures of money supply

Answer 370

• M0 excludes/M4 includes;
• bank/building society accounts;
• of UK residents

Question 371

Identify which money supply measure best indicates overall economic growth and state two reasons why.

Answer 371

M4.
• Broader/wider scope.
• Reflects borrowing/lending.
• Reflects velocity/transfer of money.

Question 372

Explain briefly the likely monetary policy response to a sustained increase in money supply in the UK economy.

Answer 372

• Reduce/cease;
• QE.
• Sell bonds back to market/QT.
• Increase interest rates.

Question 373

State the three main types of benchmark and describe briefly the purpose of each type.

Answer 373

• Target;
• measure/calculate performance/fee.
• Comparator;
• comparison of performance.
• Constraint;
• limit portfolio construction/asset allocation.

Question 374

From a behavioural finance perspective, identify two biases that relate to Abeo’s view of the potential online investment and state one reason to explain each bias.

Answer 374

• Anchoring;
• fixated on 9%.
• Overconfidence;
• believes own research is best/overreliance on own knowledge.
• Misunderstanding Of Probability;
• too focused on yield at expense of potential risk to capital.

Question 375

Calculate, showing all your workings, the alpha for the Value Opportunities Fund.

Answer 375

5.1 - [0.1 + 1.3 (4.5 - 0.1)] = -0.72

Question 376

State four limitations of using alpha to measure a fund’s performance.

Answer 376

• Doesn’t explain source/reason for outperformance.
• Assumes CAPM/market/benchmark/risk-free rate/ is suitable/correct.
• Relative to beta/assumes beta is correct measure of risk.
• Ignores costs/charges.
• Only suited to comparing equity/similar funds.

Question 377

Identify and explain briefly four main types of investment risk that would be relevant to Clara’s investment in the Value Opportunities Fund.
Exclude market risk from your answer.

Answer 377

• Volatility;
• Greater degree of movement.

• Manager;
• Stock-picking/negative alpha/underperforms.

• Shortfall;
• Returns less than needed/target.

• Style/Concentration;
• Value out of favour/growth outperforms.

• Non-systematic/specific;
• Corporate event.

Question 378

Identify and explain briefly four main types of investment risk that would be relevant to Clara investing in Tech Trust plc.

Answer 378

• Liquidity;
• Unable to sell/achieve fair price.

• Pricing;
• Trades at discount/premium to NAV.

• Currency;
• Returns affected by currency movement.

• Gearing/Interest Rate;
• Equity returns affected by borrowing/interest rates.

• Sector;
• Lack of information/early stage/speculative investment.

Question 379

Calculate, showing all your workings, the overall return of Tech Trust plc.

Answer 379

UK 15% x 12% = 1.8%
North America 25% x -9% = -2.25%
Asia 40% x -6% = -2.4%
Frontier 20% x 8% = 1.6%
Total = -1.25%

Question 380

Calculate, showing all your workings, the relative performance of each of Tech Trust plc’s geographical allocations against their respective benchmark returns.

Answer 380

UK 1.5% vs 1.8% = +0.3%
North America 4% vs -2.25% = -6.25%
Asia 5% vs -2.4% = -7.4%
Frontier 6% vs 1.6% = -4.4%

Question 381

State the maximum amount that Lucy and Clara could each contribute to a Lifetime ISA in its first year and any Government bonus that may be payable.

Answer 381

Lucy
• £4,000.
• Up to 25%/£1,000 bonus.

Clara £0 - you must make at least one payment into an LISA before you turn 40

Question 382

Explain the main contribution and withdrawal rules for a Lifetime ISA.

Answer 382

• Part of £20,000/overall ISA allowance.
• Must be 18 or over;
• and under 40/make first contribution before 40;
• can contribute until/must cease at 50.
• 25% withdrawal charge unless/no withdrawals in first 12 months;
• buying first home;
• £450,000 or less;
• aged 60 or over;
• terminally ill/less than 12 months to live.
• Bonus not payable if HTB ISA bonus used.

Question 383

Outline the options available to Lucy in respect of her existing Help to Buy ISA.

Answer 383

• Increase contribution;
• by up to £100 pm/to £200 pm.
• Stop/decrease contribution.
• Withdraw/close.
• Transfer into a LISA/ISA.
• Transfer into a different rate/provider.

Question 384

State the information that an ISA administrator would require in order to process an additional permitted subscription (APS) request by a surviving civil partner.

Answer 384

• Deceased’s;
• name;
• address/proof of residency;
• NI number;
• date of birth;
• date of death;
• date of partnership.

Question 385

Describe the main differences in the structure of an OEIC and an Investment Trust.

Answer 385

OEIC
• Unlimited shares/can create new shares.
• Redeems shares linked to NAV.
• May be standalone or sub-fund of ICVC.
• Must appoint an ACD.
• Assets held by depositary.
• Can borrow on temporary basis/up to 10%.

Investment Trust
• Fixed number of shares/finite share capital.
• Shares bought/sold independent of NAV.
• Listed company.
• Has board of directors.
• Can borrow on permanent basis/unlimited.
• May have fixed life/winding up date.

Question 386

Describe the main differences in the pricing of an OEIC and an Investment Trust.

Answer 386

OEIC
• Daily pricing/pricing point;
• Based upon NAV.
• Single priced;
• May apply swing pricing/dilution levy.

Investment Trust.
• Real-time pricing;
• determined by market/supply and demand.
• Dual pricing/bid/offer spread.
• Can trade at discount/premium/independent of NAV.

Question 387

Identify three advantages and three disadvantages of using a GIA for retirement planning, compared to a workplace pension, to meet Lucy and Clara’s needs.

Answer 387

Advantages
• Accessible at any time/before age 55.
• No limit on contributions/not part of Annual Allowance.
• No limit on future investment value/not part of Lifetime Allowance.

Disadvantages
• No Income Tax relief.
• No employer contribution.
• Taxation within GIA/funds/subject to CGT.
• Part of estate/subject to IHT.

Question 388

Identify six main benefits of an investor consolidating their existing collective funds onto a platform

Answer 388

• Single point of access/all information in one place.
• Multiple tax-sheltered products.
• Less/easier administration.
• Income flexibility/consolidated payment.
• Access to planning tools/bed & ISA, etc.
• Transaction/account history.
• Migration to cheaper share classes/lower fund charges.

Question 389

State the time limits within which CGT deferral relief would be available to a investor on a new investment into an EIS. Assume that the sale of the shares completes in May 2022.
Assume current date October 2021

Answer 389

Up to 3 years;
• after/following/May 2025.
• Up to 1 year before/from now/October 2021.

Question 390

Explain briefly the CGT rules of any new investment into an EIS, if the investment were made with the proceeds from the sale of the shares.

Answer 390

• Existing gain;
• deferred until disposal;
• without limits/unlimited;
• can be deferred again.
• New gain;
• exempt from CGT;
• after 3 years;
• if Income Tax relief obtained.
• Loss relief available;
• offset against income or gains.

Question 391

Calculate, showing your workings, the Income Tax and CGT reliefs that could be claimed by Anshul if he invested the maximum amount into a new SEIS.

Answer 391

Income Tax relief
£100,000 x 50% = £50,000
Carry back = £50,000

CGT reinvestment relief
£50,000 x 20% = £10,000

CGT deferral relief
£50,000 x 20% = £10,000

Question 392

Identify two factors that are relevant to Anshul, from a behavioural finance perspective and give one reason for each of these two factors.

Answer 392

Anchoring;
• 7% yield/£500,000 capital sum.
• Endowment effect;
• ‘His’ company/emotional attachment/retains shareholding.
• Mental accounting;
• Compartmentalising capital for income/used to receiving income.

Question 393

Describe briefly the objective of Stochastic modelling.

Answer 393

• Estimate/forecast/predict the;
• probabilistic/potential/likely;
• range of;
• returns/outcomes and;
• volatility/standard deviation.
• Under different outputs/scenarios/simulations

Question 394

State the three main inputs required to generate an optimal portfolio via a Stochastic modelling tool.

Answer 394

• Returns.
• Volatility/standard deviation.
• Time period.

Question 395

Identify four drawbacks of using a Stochastic modelling tool.

Answer 395

• Assumptions/inputs not correct/unrealistic.
• Ignores sequencing risk.
• Over-reliance/over confidence.
• Difficult to understand/too complex.
• Output is unrealistic/unattainable/expected return not accurate.
• Doesn’t factor in client circumstance.

Question 396

Calculate, showing all your workings, the return on equity (ROE) for Forest View plc.

Answer 396

£18,500,000 - £2,000,000 - £4,200,000 = £12,300,000
£35,000,000 + £9,700,000 - £22,600,000 = £22,100,000
(£12,300,000 / £22,100,000) = 0.556561 x 100
= 55.66%

Question 397

Describe briefly what is measured by the ROE metric.

Answer 397

• Ability to generate;
• profit.
• How efficiently it uses;
• shareholders’ funds/capital.
• Relative performance within sector/against peers.

Question 398

Calculate, showing all your workings, the quick ratio for Cloud Formation plc

Answer 398

(£3,800,000 + £2,150,000) = £5,950,000 / £1,400,000 = 4.25

Question 399

Explain briefly what the ratio shows about Cloud Formation plc’s current financial position,

Based on Cloud Formation quick ratio 4.25

Answer 399

• Company in strong position.
• Can easily repay short-term/current debts from cash/most liquid assets;
• without use of other assets/external resources.

Question 400

State the two main Asset headings within the balance sheet of a company’s accounts and list two categories of assets that would be found under each heading.

Answer 400

• Fixed/non-current assets
• Tangible (plant, buildings etc.).
• Intangible/goodwill.
• Investments.

• Current assets
• Stock/inventory.
• Cash.
• Trade receivables/debtors/prepaid expenses.

Question 401

State the three main components of the UK’s capital account.

Answer 401

Investments/assets.
• Loans/borrowing.
• Foreign currency reserves.

Question 402

State the principal purpose of a capital account surplus within the UK’s balance of payments.

Answer 402

• To finance/fund;
• a current account;
• deficit.

Question 403

Explain briefly the macro-economic role of financial investment within the economy.

Answer 403

• Stimulates demand/spending;
• by increasing aggregate demand.
• Increases productivity/output;
• and business investment.

Question 404

Describe briefly what is meant by the OCF in respect of a collective fund.

Answer 404

• Single;
• percentage figure;
• that shows the;
• annual cost of;
• investing in/owning a fund.

Question 405

Using the Capital Asset Pricing Model (CAPM) equation, calculate, showing all your workings, the expected return for the client’s portfolio.

Answer 405

(3.3-0.2)
0.91 x (3.1)
0.2 + 2.821 = 3.021 = 3.02

Question 406

Explain why UK Government Treasury bills are a suitable measure of risk-free return to use in the CAPM equation.

Answer 406

• Minimal/no default risk;
• Short duration/less than 3 months;
• minimal inflation and;
• interest rate sensitivity.

Question 407

State seven main assumptions upon which the CAPM equation is based.

Answer 407

• Investors are rational and risk averse.
• Single/identical holding period.
• No individual can affect the market price.
• Ignores charges/tax.
• Market is liquid.
• Information is fully available to all investors.
• Risk-free rate/treasury bills are suitable to use.
• Investors can lend/borrow;
• unlimited amounts.
• Beta is correct measure of risk.

Question 408

Describe briefly Macaulay duration.

Answer 408

• Weighted;
• average term/number of years;
• discounted/present value of;
• all cash flows/coupons + redemption value;
• from a bond.

Question 409

Explain briefly what is measured by modified duration.

Answer 409

• Measures sensitivity of;
• a bond’s price;
• yield to maturity/redemption yield/interest rates.

Question 410

State one reason why a fixed interest fund manager would use Macaulay duration and one reason why a fixed interest fund manager would use modified duration within a bond fund.

Answer 410

Macaulay
• Portfolio immunisation/liability matching/hedging out interest risk/predict returns.

Modified
• Reduce duration/interest rate risk.

Question 411

State the technical definition of a recession in the UK economy.

Answer 411

• Two;
• consecutive;
• quarters of;
• negative/declining/falling;
• GDP growth.

Question 412

Describe briefly the four main factors that cause UK interest rates to reduce.

Answer 412

• Fiscal surplus/reduction in gilt issuance.
• Monetary policy loosening.
• Reduction in inflation expectations.
• Quantitative easing (QE).
• Credit crisis/safe haven appeal/demand for sterling

Question 413

State four changes that could be made within the client’s fixed interest portfolio in the event of an anticipated recession.

Answer 413

• Increase duration.
• Decrease high yield.
• Increase investment grade/gilts/cash/short dated bonds.
• Use derivatives.

Question 414

State the main product features of NS&I Income Bonds.

Answer 414

• Minimum £500;
• Maximum £1 million.
• No minimum term/Instant access/no notice withdrawal/penalty.
• All/100% protected without upper limit.
• Backed by Government.
• Can use personal savings allowance/taxable but paid gross.
• Pay monthly/income must be paid out.

Question 415

List three benefits of investing in NS&I Income Bonds.

Answer 415

• Provides diversification.
• Could invest more than £85,000/higher level of investor protection.
• No volatility/default/market/investment risk.

Question 416

Identify two limitations on the use of NS&I Premium Bonds within the client’s portfolio.

Answer 416

• Maximum deposit £50,000.
• Interest rate notional/may not win any prize/erosion of money in real terms

Question 417

Calculate, showing all your workings, the portfolio’s standard deviation using the returns data for the past two years.

Answer 417

(-0.4 + 7.3)/2 = 3.45
(-0.4 – 3.45) + (7.3 - 3.45)
(-3.85)2 + (3.85)2
14.8225 + 14.8225
29.645/2 = 14.8225 = 3.85

Question 418

Describe briefly what standard deviation measures.

Answer 418

• Volatility/dispersion of returns;
• through variation in;
• actual return;
• against mean return.

Question 419

State the percentage of returns that fall within one and two standard deviations, based upon the normal distribution of returns of a bell curve.

Answer 419

• 65-70% for 1SD.
• 94-98% for 2SD.

Question 420

Describe the semi-strong form of efficient market hypothesis (EMH).

Answer 420

• Prices adjust/reflect/respond to;
• all;
• public information;
• rapidly and;
• unbiased.
• No excess return/cannot outperform market;
• Includes past prices and;
• company information.

Question 421

State how the semi-strong form of EMH considers technical analysis and fundamental analysis.

Answer 421

• Fundamental analysis ineffective;
• technical analysis ineffective.
• Neither adds outperformance.

Question 422

Identify five factors that should be taken into consideration if it is agreed at the meeting to rebalance the portfolio.

Answer 422

• Cost.
• Potential tax liability.
• Impact/interruption to existing income.
• Attitude to risk/capacity for loss.
• Suitability of funds/asset allocation.
• Retention/change of benchmark.
• Time out of market.

Question 423

List seven additional pieces of information relating to a clients financial situation that a financial adviser would consider when determining a clients objectives and needs.

Answer 423

• Marital status/dependents/children.
• State of health.
• Other assets.
• Liabilities.
• Provision of emergency fund.
• Ethical/socially responsible investments preferences.
• Capacity for loss.

Question 424

Calculate, showing all your workings, the most recent dividend Fenna received, net of any tax, from her technology company shares.
Assume this is the only dividend Fenna receives and that she is a higher rate tax payer (2021)

Answer 424

22,000 x 12.5p = £2,750
£2,750 - £2,000 = £750
£750 x 32.5% = £243.75
£2,750 - £243.75 = £2,506.25

Question 425

Explain the tax treatment of any investment that an investor might make into a new VCT.

Answer 425

• For investment of up to £200,000;
• 30%;
• Income Tax relief;
• up to investors tax liability;
• if held for 5 years.
• Gains exempt from CGT/CGT-free;
• with no minimum period.
• No loss relief/deferral relief.
• Dividends tax-free.

Question 426

State two potential drawbacks that Fenna’s financial adviser would draw to her attention in respect of the proposed level of investment, if she wanted to invest £95,000 in a new VCT at issue.

Answer 426

• Not covered at all by Financial Services Compensation scheme/£95,000/all capital at risk.

• May not receive full Income Tax relief/level of tax relief may exceed tax paid.

Question 427

Identify four additional risks to which Fenna would be exposed if she invested into a VCT in comparison to her AIM shareholding.

Answer 427

• Accessibility/unable to sell underlying assets.
• Liquidity.
• Manager breaches qualifying rules.
• Manager risk/change in gains or income profile.
• May hold cash/not invest for a while.

Question 428

Compare the main differences in the tax treatment of the gains and withdrawals from onshore and offshore investment bonds, based upon Fenna’s investment needs.

Answer 428

Onshore
• Corporation Tax paid;
• on capital gains made/investment income;
• deemed UK basic rate tax/20% tax paid.
• Chargeable gains subject to 20%.
• Taxed as top part of income/after dividends.

Offshore
• Withholding tax;
• not subject to UK tax internally/gross roll-up.
• Subject to 40% on gains.
• Taxed as savings income.
• No chargeable event on death if on capital redemption basis.

Question 429

State whether strategic or tactical asset allocation would be more suitable for Fenna given her objectives and give two reasons for your choice.

Answer 429

• Strategic
• Investing for the long-term.
• Objectives known at outset/future target income.

Question 430

Calculate, showing all your workings, the redemption yield for Gilt X. You should
use the simplified method in your answer.

Answer 430

£132.56 – £100 = £32.56
£32.56/12 = £2.713333333
(2.7133/132.56) x 100 = 2.0468718%
£1.45 x 2 = £2.9
(£2.9/£132.56) x 100 = 2.1876885%
(2.1876885% - 2.0468718%) = 0.14%

Question 431

Calculate showing all your workings, the difference between the running yield and the redemption yield 0.14% of Gilt X

Answer 431

2.19 - -0.14 = 2.05%

Question 432

Explain what can be identified about Gilt X from the information contained in Table 1 and your answer from part (a)(ii) below.
(difference in redemption yield and running yield is 2.05%)

Answer 432

• A medium.
• Trading above par.
• Capital loss;
• if held to redemption/maturity.
• Running yield lower than annual coupons/issue yield.
• Running yield higher than redemption yield.

Question 433

Identify the main benefits of owning a gilt-based collective fund in comparison to a single gilt on a direct basis.

Answer 433

• Active management.
• Diversification;
• across yield curve/maturities/durations.
• Can invest in new gilts at issue.
• Access to market participants

Question 434

Identify the main drawbacks of owning a gilt-based collective fund in comparison to a single gilt on a direct basis.

Answer 434

• Exposed to duration risk/manager gets it wrong.
• Loss of known redemption date/yield/coupon.
• Investor protection limited to £85,000.
• Subject to CGT upon disposal.
• Daily dealing.
• Fund charges.

Question 435

State the three types of credit risk that apply to owning direct gilts.

Answer 435

• Default.
• Downgrade.
• Credit spread.

Question 436

Calculate, showing all your workings, the theoretical ex-rights price of the client’s holding in Garden Finch, assuming that the client exercises their rights in full.

Answer 436

(9,500/5) x 2 = 3,800
3,800 x 71p = £2,698
£8,284 + £2,698 = £10,982
(£10,982/13,300) = 0.82571428 = 82.57p

Question 437

State the two options available to the client other than taking up the rights issue in full.

Answer 437

• Do nothing/ignore the issue.
• Sell the rights.

Question 438

List four main smart beta strategies that may be suitable based upon the client’s objectives.

Answer 438

• Earnings growth.
• Dividend cover.
• Style (growth/value/momentum/quality/low volatility).
• Weighting.

Question 439

Calculate, showing all your workings, the Sharpe ratio for the REIT.

Answer 439

8.5 - 0.35/1.97 = 4.137055 = 4.14

Question 440

Explain three main differences between the Sharpe ratio and the Information ratio.

Answer 440

• IR uses benchmark;
• Sharpe uses risk-free return.
• IR is relative/can compare funds;
• Sharpe is absolute.
• IR measures consistency over time;
• Sharpe does not.
• IR uses tracking error;
• Sharpe uses standard deviation.

Question 441

State four drawbacks of using the Sharpe ratio in investment planning.

Answer 441

• Need to consider other factors/trends over time/do not consider in isolation.
• Can be distorted by fund/manager’s strategy.
• Assumes normal distribution of returns/reliant upon standard deviation.
• Can be distorted by illiquidity/volatility/trading frequency/costs.

Question 442

State the main rules that a fund must adhere to in order to qualify as a REIT.

Answer 442

• UK resident/listed.
• Closed-ended/only one share class.

• At least 75% of profits;
• at least 75% of total assets;
• relate to property rental/ring-fenced business.

• Interest/borrowing coverage;
• at least 125%.

• At least 90% of profits;
• paid out/distributed;
• within 12 months/one year.

Question 443

Irma receives an income payment of £2,950 from the REIT, consisting of £750 property income distribution and a £2,200 dividend.
Calculate, showing all your workings, her Income Tax liability on this payment.

Assume Irma is a higher rate taxpayer and this is the only dividend she receives.
(2021-22 Tax rates)

Answer 443

PID
£750/80 x 100 = £937.50 x 20% = £187.50

Dividend
£2,200 - £2,000 = £200
£200 x 32.5% = £65
Total £187.50 + £65 = £252.50

Question 444

Given their previous experience of equity-based investing, Irma and Christopher decide to invest the £190,000 equally across three UK equity funds.

Identify four main risks relating to the achievement of their objective to which Irma and Christopher would be exposed.

Answer 444

• Market/systematic/volatility.
• Shortfall.
• Inflation.
• Concentration/all in UK equities/lack of diversification.
• Accessibility/liquidity.
• Fund specific event.

Question 445

Given their previous experience of equity-based investing, Irma and Christopher decide to invest the £190,000 equally across three UK equity funds.

From a behavioural finance perspective:

State three main biases that may have influenced their investment decision and provide one justification for each bias.

Answer 445

• Hindsight
• UK equites have done well in the past.

• Mental accounting
• Their money for their objective/known target value.

• Endowment effect/divestiture aversion
• Already own equities/why change.

• Overconfidence
• Market timing/they know best/UK equities will be best asset class.

Question 446

Outline six main reasons why a financial adviser would use an investment trust rather than an open-ended investment company (OEIC) when investing in the same sector of the market.

Answer 446

• Charges likely to be lower.
• Gearing/borrowing.
• Discount/price arbitrage/higher running yield.
• More flexible/less diversification.
• Ability of board to change/select manager.
• Greater accessibility/liquidity/do not have to sell underlying investments.
• More suitable structure to hold specialist/niche investments/wider range of investments.
• Dealing frequency/real-time pricing.

Question 447

List four open-ended fund structures that could be used to invest in UK equities. Exclude OEICs from your answer.

Answer 447

• Unit trust.
• Undertakings for Collective Investment in Transferable Securities
(UCITS)/Société d’Investissement à Capital Variable.
• Exchange-Traded Fund.
• Non-UCITS Retails Schemes.
• Life fund/investment bond.

Question 448

Explain three relative differences between what is measured by alpha and beta.

Answer 448

• Beta measures market risk;
• alpha measures difference between actual return and expected return (implied by Beta)/not explained by CAPM.

• Beta explained by movements/correlation/in relation to market;
• alpha not explained by movements in market.

• Beta measures volatility;
• alpha measures manager value/stock-picking.

Question 449

Calculate, showing all your workings, the time-weighted rate of return (TWR) for the GIA over the twelve-month period shown in Table 1.

Answer 449

Period 1
(£15,470 - £5,000 - £10,000)/£10,000 = 0.047 = 4.7%

Period 2
(£16,800 - £15,470)/£15,470 = 0.08597 = 8.6%

(1 +0.047) x (1 + 0.08597) - 1 = 0.13701 x 100 = 13.7%

Question 450

Explain briefly why an adviser would use the TWR, rather than the money-weighted rate of return (MWR), when evaluating the performance of an investment.

Answer 450

• TWR not influenced by money added/new investment.
• TWR focuses on individual manager skill/performance.
• TWR compounds multiple periods/shows change over entire period.

Question 451

Identify two aspects of personal taxation that would change if 2 clients were to get married and state how each could result in potential tax savings

Answer 451

• Inheritance Tax;
• unlimited spousal exemption/transferable nil rate band.
• Capital Gains Tax;
• inter spousal disposal exempt.
• Income Tax;
• marriage allowance/transfer of £1,250/10% of Personal Allowance.

Question 452

Explain briefly the main drawbacks of holding a fund that invests on a single theme or thematic basis.

Answer 452

• Smaller investment universe/fewer managers with experience.
• Costs likely to be higher.
• Dealing frequency of fund/illiquidity of underlying holdings.
• Lack of common terminology/inconsistent application.
• Higher volatility/beta.
• Lack of diversification/greater non-systematic risk.
• Risk of fund closure/short lived/implementation risk/theme being closed.

Question 453

Identify the due diligence factors solely relating to meeting Catherine’s income needs that the adviser would consider when assessing a potential platform.

Answer 453

• Ability to hold existing assets/equities.
• Ability to continue existing income uninterrupted.
• Cash account minimum balance/interest rate.
• Charging structure.
• Range of income yielding funds available.

Question 454

“Catherine has sufficient money in her current account to cover her short-term expenditure but may require occasional capital from her portfolio to meet unplanned or discretionary expenditure.”

Identify the main income options available via the cash account that would enable a platform to meet Catherine’s income needs

Answer 454

• Ability to pay natural income.
• Ability to pay regular income/fixed income.
• Ability to pay ad-hoc/one-off withdrawals.

Question 455

Calculate, showing all your workings, the shortfall in Catherine’s target income based upon her current pension and ISA income.

Answer 455

£90,000 x 4.2% = £3,780
£3,780 + £19,500 = £23,280
£25,000 - £23,280 = £1,720

Question 456

Describe how the investment bond could be used to generate the shortfall of £1,720 and state the basic tax treatment of this figure.

Answer 456

• Take withdrawals;
• of up to 5%/£2,000 per annum;
• of original investment.
• Tax deferred/no immediate Income Tax liability;
• up to initial 10 years/up to 20 years/surrender/death.

Question 457

Briefly describe sequencing risk.

Answer 457

• Effect of volatility/fluctuation;
• on the order;
• and timing/frequency of withdrawals;
• and sustainability of income;
• and impact on capital value.
• Effect greater in early years.

Question 458

State five actions that could be taken to mitigate the effects of sequencing risk.

Answer 458

• Reduce/suspend the level of income.
• Change the frequency/order of income.
• Take only natural income.
• Extend time horizon.
• Secure proportion of income/purchase annuity.
• Diversification/change asset allocation/buy higher yielding assets.
• Hold more/at least 6 months in cash.

Question 459

Identify the main differences between an interim and a final dividend.

Answer 459

• Interim declared during financial year/before AGM.
• Final declared after financial year/at AGM.

• Interim declared by board.
• Final declared by shareholders.

• Interim can be revoked.
• Final cannot be revoked.

• Interim only if Articles expressly permit.
• Final not subject to Articles/right of shareholders.

Question 460

Describe briefly what it meant by the term ‘correlation’ in relation to investment planning.

Answer 460

• Covariance/relationship between;
• a pair/two assets;
• adjusted for the risk.

Question 461

Identify the four components of an economy’s current account.

Answer 461

• Goods.
• Services.
• Investment income/overseas earnings.
• Transfer payments/capital and asset movement.

Question 462

State the main forms of ethical investment.
Exclude negative screening from your answer.

Answer 462

• Positive screening/engagement.
• CSR/SRI/Sharia finance/responsible.
• ESG.
• Impact.

Question 463

Identify which other non-equity asset classes could be used for the new money, to diversify the existing portfolio while maintaining an overall ethical approach.

Answer 463

• Fixed interest/green bonds/charity bonds.
• Infrastructure/renewable energy.
• P2P/social impact.
• Property/social housing/education.

Question 464

Explain three reasons why an equity-based ethical investment strategy could out-perform an equity-based non-ethical investment strategy.

Answer 464

• Small cap focus shown to outperform.
• Greater concentration.
• Invest at the start of a trend/increase in demand.
• Government subsidies/support/less political/legal risk.

Question 465

State four fund-specific factors that an adviser would consider when researching ethical funds for potential inclusion in the portfolio.

Answer 465

• Appropriateness of benchmark.
• Ethical criteria/mandate of the fund/United Nations Sustainable Development Goals.
• Manager’s skill/track record/experience.
• Ethical stance of management group itself.
• Is it aligned with client’s ethical views?

Question 466

Gilts description

Answer 466

Shorts <7 years to redemption, Medium 7-15 and Long >15

Nominal (par) value (=£100 on redemption)

Interest rate (coupon described as an annual % of nominal value £100 paid semi-annual

6 months apart and paid gross of income tax)
Redemption date (year £100 capital is repaid) with undated/irredeemable gilts effectively
being cashed in by the government at any time.

Question 467

Eurobond market (Government Issue)

Answer 467

Eurobonds are international bond issues outside any particular jurisdiction.

For example, a
US dollar Eurobond could be issued anywhere in the world, except for the US.

They are a way for an organisation to issue debt without being restricted to their own domestic market.

Question 468

Foreign bonds

Answer 468

A foreign bond is one in which the nationality of the issuer is different to that of the
denomination of the bond and the country of issue, for example, a sterling bond issued in London by a US company (known as BULLDOGS on the UK market).

Question 469

the principal risks associated with buying foreign bonds (from the perspective of a UK
investor):

Answer 469

 Credit / default risk: non-payment of interest or capital at redemption
 Economic risk: different countries = different economies = different risks (Greece
versus Germany?)
 Foreign exchange / currency risk: negative currency exchange movements
 Interest rate risk: the inverse relationship between bond prices and interest rates
 Liquidity risk: is it possible to sell a specific amount, at the price you want and at the
time you want to?
 Political risk: political instability can be a major factor (Venezuela?)

Question 470

Mortgage backed securities (MBSs)

Answer 470

A mortgage backed security (MBS) is a securitised pool of underlying home loans. They are used by retail banks to securitise the cash flows from mortgages that would otherwise be receivable over, normally, a 25 year term.

Question 471

The main risks associated with holding either government or corporate bonds are:

Answer 471

 Credit risk: interest payments and repayment of the bond may not be made
 Market risk: inverse relationship between bond prices and interest rates
 Inflation risk: real value of bond coupon & redemption repayment
 Liquidity risk: bonds not easily traded
 Exchange rate risk: bonds denominated in different currencies

Question 472

Credit Risk
Relating to a Bonds Price

Answer 472

Credit rating agencies make an assessment when first issued (and throughout the term of the bond) and are divided into Investment Grade (various grades) or Non-Investment
Grade (junk bonds). For example, using S&P ratings, anything less than a BBB is junk.

Question 473

Market Risk
relating to a bonds price

Answer 473

The income/coupon from a bond remains unchanged throughout the term. Yields vary to reflect interest rates rising or falling by a fall or rise in its capital value (par=100).

Question 474

Volatility/Sensitivity Risk
relating to a Bonds price

Answer 474

Bond prices will not all change by the same amount when interest rates or yields change –
they are all made up of different coupons and terms. The measure used to calculate how sensitive the bond is to changes in interest rates or yield, is known as duration or modified duration

Question 475

How the coupon affects the Sensitivity of bond prices:

Answer 475

The smaller the coupon the more the bond’s price will move for a given interest rate change:
low coupon bonds are more volatile than high coupon bonds.

Question 476

How the redemption period affects the sensitivity of bond prices

Answer 476

For two bonds with the same coupon it will be the longer dated that is most volatile.
Long (dated) and low (yield) bonds are the most ‘volatile’ or sensitive to price movements.

Think long and low for bigger swings, more volatility and more sensitivity to change (or the see-saw movements).

Question 477

Modified duration (MD)

Answer 477

This is the most important and often quoted (MD), used to quantify sensitivity.
The modified duration (MD) of a bond estimates how much a bond’s price will change if
there is a change in interest rates/yields; it quantifies the sensitivity of the bond price to
changes in GRY:

Question 478

Reverse/downward (inverted) curve:

Answer 478

investor optimism on inflation, a falling ‘reverse’ or
inverted yield curve is where shorter-term bonds have a higher yield than longer-term bonds, and is seen as an indicator of recession, with investors effectively demanding a higher return for the perceived higher risk of a short-term bond compared to that of a longer-term bond.

Question 479

Hurdle Rate (to Redemption):

Answer 479

 Is the annual growth rate required in the assets
 To cover the zeros
Thus, a Hurdle Rate of 9% means that the assets need to grow by 9% and the zero would still be repaid.

Hurdle Rate (to Wipeout):
At what point will zero dividend preference shareholders receive NOTHING?
Thus, a Hurdle Rate (to Wipeout) of 90% means that the assets would have to fall by 90%
before zero holders received nothing.

Negative Hurdle Rate:
This is the amount that the assets can fall each year and still be sufficient to repay the zeros in full.

Question 480

Statutory rights for shareholders in the UK

Answer 480

o companies must hold AGMs at least once per year
o shareholders with more than 10% of voting rights can call EGMs
o shareholders with more than 5% of voting rights can propose resolutions
o any shareholder can petition the court on grounds of the affairs of the
company that are unfairly prejudicial to the interests of some or all of
shareholders.

Question 481

Principal features of AIM are:

Answer 481

 Launched in June 1995
 Currently lists circa 1,000 companies with a total market capitalisation of £93bn
 Many AIM companies lack true liquidity (sometimes ANY liquidity!)
 Lower listing standards and “lighter touch” regulation than for the main LSE market –
which has been a major criticism of the AIM
 Lower listing fees and ongoing costs than for the main LSE market

Question 482

The Share price and valuation

Answer 482

Shares have a nominal/face/par value shown on the face of the share certificate.

This is the par value and is virtually irrelevant in normal trading conditions.

The market value is the trading price of the share on the market. This is the capital value of that share in the market and used to provide the total ‘capitalised’ value of the company:
shares issued x market value = capitalisation.

Question 483

Gordon’s Growth Model

Answer 483

(GGM) is recognised, widely used and simplified model for
calculating a share price:
It calculates the (ex-dividend) price of a share, assuming constant dividend growth and
dividend payments made at the end of each period.

It helps place a price on value of an ordinary share with reference to the dividend. But, it is simplistic and only really suitable for mature shareholdings with track record.

Most recent dividend / investors required return - growth rate of dividend

Question 484

Some of the problems with GGM include:

Answer 484

• If the required return is less than the growth rate of the dividend, the model gives a
  negative share valuation.
• If the required return is equal to the growth rate of the dividend, the formula collapses
  as the result approaches infinity.
• It’s only valuing the share based on dividend, which is a single fundamental, and any
  value investor worth their salt will tell you that fundamentals need to be considered as
  a whole rather than in isolation. What if the company is very profitable, but it’s retaining
  its earnings and using them to invest back into the company?

Question 485

Market indices:

Answer 485

The markets use a range of indices to track the performance of the stocks and shares traded on a daily basis across the world. For example, in a weighted-index a 1% change in the price of a large company (higher market capitalisation) will have a proportionately greater effect on the index than a 1% change in the price of a smaller company.

Question 486

Current account vs Capital Account

Answer 486

The current and capital accounts represent two halves of a nation’s balance of payments. The current account represents a country’s net income over a period of time, while the capital account records the net change of assets and liabilities during a particular year.