Questions Flashcards

1
Q

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

A
  • 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.
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2
Q

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

A

• 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.

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3
Q

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

A
  • 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.
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4
Q

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

A
  • 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.
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5
Q

Describe briefly Macaulay duration.

A
  • Weighted;
  • average term/number of years;
  • discounted/present value of;
  • all cash flows/coupons + redemption value;
  • from a bond.
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6
Q

Explain briefly what is measured by modified duration.

A
  • Measures sensitivity of;
  • a bond’s price;
  • yield to maturity/redemption yield/interest rates.
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7
Q

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

A

Increase duration

Decrease high yield

Increase investment grade/gilts/cash/short dated bonds.

Use derivatives.

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8
Q

Describe briefly what standard deviation measures.

A
  • Volatility/dispersion of returns;
  • through variation in;
  • actual return;
  • against mean return.
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9
Q

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

A
  • 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.
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10
Q

Identify four drawbacks of using a Stochastic modelling tool.

A
  • 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.
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11
Q

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.

A

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

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

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12
Q

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

A
  • Investments/assets.
  • Loans/borrowing.
  • Foreign currency reserves.
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13
Q

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

A
  • To finance/fund;
  • a current account;
  • deficit.
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14
Q

Describe briefly what is meant by the term ‘Beta’ according to CAPM

A

Beta measures the sensitivity to market risk of a share or portfolio

The market has a beta of 1.0

According to CAPM, the average beta of shares in the market is 1 and would be expected to move exactly in line with the market

A share with a beta of less than 1 will rise and fall more slowly than the speed of the market

A share with a beta of more than 1 is more volatile than the market

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15
Q

Outline the assumptions that CAPM is made on

A

Investors are rational and risk averse

All investors have the same holding period

The market comprises of many buyers and sellers and no individual can affect market price

Information is free and simultaneously available to all investors

Unlimited amounts of money can be borrowed or lent by investors at the risk free rate

All investments are liquid

There are no taxes, no transaction costs and no restrictions on short selling

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16
Q

Outline why investors sometimes behave irrationally as explained by behavioural finance

A

Loss aversion/prospect theory

Investors take profits

Reluctance to realise losses

Made more distressed by prospective losses than they are made happy by equivalent gains

Reluctance to accept an error of judgment has been made

Tendency to believe current trends will continue indefintely

Fear of missing out/the herd instinct

Over confidence/under reaction

Emotional reasons/attachment

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17
Q

Unit Trust assets held by? and managed by?

A

Held by Trustees and invested by managers

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18
Q

OEIC assets held by?

A

Independent Depositary

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19
Q

Describe the four main stages of the business cycle and the effects of these on businesses and unemployment.

A

Recession

Unemployment is near its peak as businesses have contracted
Entrants to the labour market find it hard to find jobs.

Expansion or upswing

Sales start to rise
Unemployment falls.

Boom or peak

Businesses are operating at full capacity
Unemployment is at its lowest

Contraction or slowdown

Sales are falling
Unemployment is rising

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20
Q

State and briefly explain the three different types of unemployment

A

Frictional - caused by changes in the economy that lead to qualified jobseekers being
temporarily unmatched with jobs because of lack of knowledge, time needed to arrange
interviews etc.

Structural - caused by structural changes to the economy such as declines in industries
leaving people unemployed and not qualified for other jobs.

Cyclical - caused by changes in the overall level of economic activity and often associated
with the business cycle.

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21
Q

State four ways a company can return money to investors other than paying an annual dividend.

A

Special dividends

Share buy backs via the market

Tender issue to repurchase shares

Wind up/sell company

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22
Q

Explain the purpose of using a benchmark in the investment process

A

Sets asset allocation

Independent agreed basis

To manage risk expectations

To measure relative performance to benchmark/performance or added value by the fund manager

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23
Q

Describe briefly four main elements of fundamental analysis and technical analysis

A

Fundamental analysis

Analyse company.

Analyse industry.

Analyse accounting ratios.

Calculate whether share is over or under valued.

Technical analysis

Analyse past share prices.

Identify trends /patterns in share prices.

Using charts or mechanical trading rules.

Make decisions independent of other information about company.

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24
Q

Explain why the Bank of England may not raise interest rates even if inflation exceeds their target

A

Future economic uncertainty

High levels of debt, both corporate and personal

Exchange rate concerns/effect on trade

Increase in inflation deemed to be temporary

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25
Q

Explain the longer-term effects on the economy if the Government eased monetary policy to reduce short-term interest rates.

A

Long-term interest rates should reduce

Asset (bond, equities & property) prices should increase

Lower interest rates will mean more people are willing to spend and borrow

People dependent on interest income will become worse off

Borrowers will become better off

Businesses will invest more as the margin between their investment returns and interest rates payable widens

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26
Q

Explain what is meant by inelastic demand

A

Changes in price have little or no effect on the levels of demand

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27
Q

Explain the implication of elastic demand for the profitability of goods

A

When goods have elastic demand a small price decrease would lead to a large increase in demand

Assuming adequate supply for the product and a reasonable profit margin

Then profitability should increase substantial with a small price decrease

Or should decrease substantially with a small price increase

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28
Q

List five characteristics of perfect competition

A

All firms in the market produce identical products

Large number of firms in the market

Each firm is small in relation to the market

No exit or entry barriers

The market is transparent and all transactions are known

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29
Q

Explain how the Bank of England generally sets short term interest rates

A

The BoE raises interest rates by selling Treasury Bills and Gilts via the repo market

this withdraws physical money from the financial system

They cut interest rates by buying back bonds and bills

This injects money into the financial system

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30
Q

Describe how the BoE eases monetary policy and the effect this has on the economy

A

The BoE reduces short term interest rates to ease monetary policy

This should bring down long term interest rates

This will lease to rising asset prices, increasing wealth of people and increasing their willingness to spend and borrow

The result of this is increased economic activity

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31
Q

Describe the four main performance measures used when analysing company accounts

A

Profitability - measures the rate of profits being earned in relation to sales, assets and equity invested

Volatility - measures how sensitive profits are to change in markets

Liquidity - measures wether the company can easily pay its way

Operational efficiency - measures weather the management are making efficient use of the company’s resources

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32
Q

Explain the term capacity for loss

A

The ability/degree/level/scope;

to absorb/withstand;

any negative investment event.

Adverse effect/materially detrimental;
on lifestyle/standard of living.

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33
Q

List the non financial factors that can influence an investors attitude to risk

A

Previous experiences.

Time horizon/age/state of health/dependants.

Client objectives/ethical/religious views.

Investor psychology/perception.

Framing.

Society/collective mood/political/economic environment.

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34
Q

Describe the key principles of Modern Portfolio Theory, in respect of the construction of an investment portfolio.

A

A diversified portfolio;

of non/un/imperfectly correlated.

Investors are risk adverse.

Maximum return;

for given/set risk.

Efficient frontier;

uses expected return of each asset.

Standard deviation/normal distribution (of each asset);

to produce optimal portfolio.

Systematic risk cannot be removed/can be reduced.

Non-systematic risk can be removed.

Sensitivity to the market is expressed by beta is market risk.

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35
Q

Five benefits and five drawbacks of transferring assets to a platform compared to holding directly

A
Benefits
Everything in one place/consolidated valuations/reporting.
Less admin/paperwork.
Income flexibility.
I pre-funding/cash account.
Access to institutional/clean share classes.
Access to tools.
Discounted/lower fund charges.

Drawbacks
May pay exit charges.
Additional platform charges/pay for services not used.
Unnecessary functionality/too complex solution.
May have to sell assets.
Time out of market.
Risk of platform failure/outage.
Unable to hold alternative income products.

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36
Q

Identify the three main categories of benchmark used by fund managers

A

Constraint

Target

Comparator

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37
Q

Key differences between M0 and M4 as measures of money supply

A

M4 includes deposits created by lending/all bank accounts.
MO includes operational deposits at the Bank of England

M4 is broad money.
MO is narrow money.

M4 is indicator of economy.
MO is indicator of consumer spending/retail sales.

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38
Q

Describe the general limitations of using investment ratios when analysing a company’s financial performance

A

Credibility of the source of information/manipulation.

Use different accounting policies/conventions/company may change accounting policy.

Masked by exceptional/one-off items.

Data may be obsolete/historical/not reflect current/future trading.

Affected/masked by macro trends.
Not considered in isolation/other factors.

Can’t compare across sectors.

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39
Q

Identify factors that could affect a companies share price

A
Economic outlook.
Political/changes in legislation/tax/regulation changes.
Investor sentiment/broker or credit rating change/demand & supply.
Takeover activity.
Profit/earnings expectation.
Capital event.
Dividend expectation!
Quality/change of management.
Competitors.
Fraud.
Inclusion/removal from index.
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40
Q

Describe what a momentum investment style is

A
Identify trend. 
Trend accelerating/continuing.
Sell before trend ends.
Ignores intrinsic value/fundamentals.
Generally, short term.
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41
Q

Describe what a contrarian investment style is

A

Consensus usually wrong.
Returns from going against the herd/ market sentimen
Positive when outlook negative/out of favour.
Price less than intrinsic value/undervalued.
Generally, long term.

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42
Q

Explain three main differences between sharpe ratio and the information ratio

A
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.
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43
Q

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

A
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.
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44
Q

Briefly describe sequencing risk

A
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.
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45
Q

Identify three implications to a company paying out an uncovered dividend

A

May have to cut/reduce dividend;
unless one off/bad year.

Use reserves/future profits.

May borrow/raise capital.

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46
Q

State the main forms of ethical investment

A

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

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47
Q

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

A

At least 60%; of income:
from exempt property business.

Value of property assets must be at least 60% of total assets.

Shares widely held.

No corporate investor;
holding 10% (or more of net asset value).

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48
Q

Explain four potential drawbacks of using Socially Responsible Investing other than investment performance.

A

Less diversification due to avoiding certain areas/fewer investment opportunities.

More expensive.

Approach differs/not consistent/not aligned with John’s Socially Responsible Investment (SRI) view.

Less research available.

Higher risk/higher tracking error/risk not aligned with John’s attitude to risk.

Screening rules out growth/income.

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49
Q

Describe briefly what is meant by current account and capital account

A

Current account

Imports minus;
exports/balance of payments;
in goods & services;
plus receipt from overseas income generating assets.

Capital account

Movement of all monies/assets;
into country;
out of country.

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50
Q

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

A

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.

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51
Q

Explain what is meant by the standard deviation of returns

A

It is a measure of the volatility of returns

It measures how widely the actual return of investment varies around its average return

An investment which stays close to its expected return is said to have a low standard of deviation

An investment which fluctuates wildly has a high standard of deviation

It is a measure based on past experience

And a useful tool to identify the range of returns investments are likely to make in the

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52
Q

Explain the term active investment management and state two advantages and two disadvantages of this type

A

An investment strategy using analysis

In an attempt to achieve above average or superior risk adjusted returns

Advantages

Informed investment decisions based on expierence and analysis of market

Possibility of higher returns than index which portfolio benchmarked against

Disadvantages

Higher fees and operating costs

Stock/sector analysis may not produce the right selections and portfolio could outperform

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53
Q

The benefits of diversification within a portfolio

A

Reduces the risk of any one particular investment

Spreads the opportunity for potential return across asset classes

Minimises the risk of the overall portfolio suffering a significant downturn

Increases the possibility of stable returns through all economic cycles

54
Q

Explain briefly what passive management means

A

An investment strategy that should not require active intervention but will be self- maintaining.
Passive management does not attempt to outperform the market

55
Q

Outline the two main methods of passive management

A

Buy and hold; buy investments and hold them

Indexation; tracks an index (either fully, via a representative sample, based on a computer/statistical model or through derivatives, or a combination)

56
Q

State four advantages and four disadvantages of index tracking

A

Index tracking - advantages

Lower cost than actively managed funds
Returns in line with the index
Lower portfolio turnover
Few active investment managers consistently outperform the index

Index tracking - disadvantages
Index trackers should, by definition, underperform the index after charges
Index tracker funds will track the index down (as well as up)
Increased merger activity increases the concentration of the fund
Actively managed funds offer specialism, e.g. catering for different risk profiles, that tracker funds cannot

57
Q

Explain four advantages of ETFS as a possible alternative to active funds

A

(iv) ETFs - advantages
ETFs are efficient index trackers used to track the performance of an index

ETFs Generally have lower costs than actively managed funds with particularly low expense ratios

Dividends received by ETFs are reinvested immediately and so suffer no cash drag

ETFs are free of stamp duty for funds registered outside of the UK and since April 2014
UK domiciled ETFs have been treated in the same way.

58
Q

Describe the tracking method of synthetic replication giving one advantage and one disadvantage of a synthetic fund

A

Fund manager enters into a swap with a market counterparty to exchange returns on the index for a payment

Unfunded or funded swap

Counterparty undertakes to deliver the performance of the index the ETF is tracking

Responsibility for tracking index performance is passed on to the swap provider and costs are lower.

Downside is investor is exposed to counterparty risk

59
Q

Identify the reasons why you should not solely rely on a risk-profiling tool to clarify Amanda’s attitude to risk.

A

Different tools produce different results

may not be able to relate to content of questionnaire

Potential to misinterpret/misunderstand question

Doesn’t allow her to express her views/ethical/does not take into account past experience

Will be unsuitable if she has a zero capacity for loss

Different risk may be in evidence for different objectives/timescales

60
Q

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

A

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.

61
Q

List four open ended fund structures that could be used to invest in UK equities

A

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.

62
Q

Advantages of holding gilts in an OEIC

A

Greater diversification

Smaller minimum investment level

Professional fund managers will make the underlying investment decisions

63
Q

Explain tax position if holding gilts directly or via an OEIC

A

Gilt tax position -held directly
Interest received from Gilts is normally payable gross but taxable at a rate of 20% for a
basic rate taxpayer (can be set against the PSA).
Capital gains on gilts are tax-free to individual investors

Held via an OEIC

Sarah will receive interest payments from fixed interest funds gross but will be liable tr
income tax at basic rate (can be set against the PSA)
Internal gains within an OIC are exempt from capital gains tax (CGT)
Sarah will incur a personal liability to CGT, if the gains are in excess of her CGT annual
exempt amount, in the event of the sale of the OIC or a switch in class of fund

64
Q

Explain briefly what a derivative is and the key difference between investing in derivatives and investing directly in an asset

A

A derivative is a financial instrument based on some other asset

The key difference in buying a derivative rather than the asset itself is that the cost of buying the derivative is a fraction of the cost of buying the asset

65
Q

Describe five uses of derivatives within portfolio management

A

Asset allocation

Capturing volatility

Anticipating cash flows

Increasing returns by investing in cash

Portfolio insurance using a put option

Currency and interest rate plays

Writing options

Increasing returns by increasing risk

66
Q

Describe briefly three benefits and three drawbacks of investing directly in derivatives

A

Derivative benefits

Leverage - potentially high return for low outlay
Futures specify a specific grade / quality
Daily returns locked in through daily calls

Derivative drawbacks

Risk of losing more than initial investment
Must honour on expiry of contract
Risk of physical delivery
Very high risk - increases and falls in underlying assets are fully reflected

67
Q

Describe a unit trust equalisation payment and state its income tax treatment.

A

An equalisation payment is part of the first distribution received after an investor has bought a unit trust.

It is a partial return of capital which enables a proportional income payment to be made.

It is not subject to income tax.

68
Q

Describe forward pricing within a unit trust and the implications of this

A

The unit price which applies to a purchase is the next one calculated after the transaction is made. They will not know the number of units bought or the price at the
time of dealing.

69
Q

List four factors which influence the size of discount in an investment trust

A

Supply and demand

The reputation/past performance of the fund manager

The provision of warrants

Whether there is currently a share buy-back

70
Q

Explain what is meant by gearing and how it affects the risk to the investor

A

The investment trust borrows money to fund further investment opportunities.

If the cost of borrowing is greater than the investment return, then the performance is reduced.

If the market falls, gearing exaggerates the loss.

Highly geared investments are more volatile.

71
Q

State four ways in which an open-ended fund structure could respond to a liquidity crisis following substantial redemption requests.

A

Open-ended/OEIC/ETF
• Dilution levy/exit penalty.
• Switch pricing/swing-pricing/offer to bid price/fair value price.
• Borrow to fund redemptions.
• Gated/limited redemptions/change dealing frequency.
• Suspend redemptions.
• Forced sale of property(ies).

72
Q

State four ways in which a closed-ended fund structure could respond to a liquidity crisis following substantial redemption requests.

A
  • Borrow.
  • Move to discount/widen spread/match buyers and sellers.
  • Suspend dealing.
  • Rights issue.
  • Sell property.
73
Q

Explain the effects of the higher level of cash within the direct property OEIC.

A
  • Drag on performance.
  • Reduces risk/protects in falling market.
  • Dilutes yield.
  • Reduces risk of forced sales/buying opportunities.
74
Q

State the three inputs required to produce an efficient frontier curve.

A
  • Expected return.
  • Standard deviation/level of risk.
  • Correlation.
75
Q

Explain how the efficient frontier is used in investment planning.

A
  • To set (optimum) asset allocation.
  • To show best/highest return;
  • given level of risk.
76
Q

State five limitations of using the efficient frontier.

A
  • Assumes standard deviation as measure of risk.
  • Does not take into account attitude to risk/capacity for loss.
  • Uses historic data to predict expected returns.
  • Excludes impact of costs and charges.
  • Assumes portfolio uses passive funds/cannot factor Alpha.
77
Q

State five main risks you are exposed to if investing in high yielding alternative income products

A
Liquidity risk
Accessibility risk
Interest rate risk
Default risk
Diversification / correlation risk
Valuation risk
78
Q

State the information you would have to provide when requesting an Additional Permitted Subscription ISA

A
NI number
Date of birth / birth certificate
Date of death / death certificate
Proof of marriage 
Full name
Address
79
Q

State the qualifying investments that may be held within an Innovative Finance ISA.

A

Debt based securities / bonds and debentures / loans to companies

Cash

Peer to peer lending

80
Q

State five factors that should be considered before accepting or rejecting the rights issues.

A

Why is the ompany making a rights issue?

What is the discount on offer - is it attractive?

Does David want more shares/will his personal circumstances impact any decision?

How will the market react?

What are the future prospects for the company?

81
Q

Describe what might happen to a post-rights share price after a rights issue.

A

The pre-rights share price is likely to fall towards the rights-price.

The post-rights price is likely to rise towards pre-rights share price.

Both prices are likely to become the weighted average price, (although in reality, this depends on market reaction).

82
Q

Explain to Louise what is meant by a normal yield curve and what it means for an investment in fixed-interest securities.

A

The yield curve shows how the yield of bonds vary with periods to redemption

In normal circumstances investors demand higher yields for longer term bonds to cover the increased risk and uncertainties over time

The yield curve in normal circumstances is a rising and positive curve - the more pessimistic the future prospects are for inflation the steeper the curve is.

A normal yield curve means more capital will be needed to get the same income in short dated bonds than for longer dated bonds.

83
Q

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

A

Covariance/relationship between;

a pair/two assets;

adjusted for the risk.

84
Q

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

A

Goods.

Services.

Investment income/overseas earnings.

Transfer payments/capital and asset movement.

85
Q

Describe briefly the objective of Stochastic modelling.

A
Estimate/forecast/predict the;
probabilistic/potential/likely;
range of;
returns/outcomes and;
volatility/standard deviation.
Under different outputs/scenarios/simulations.
86
Q

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

A

Returns.
Volatility/standard deviation.
Time period.

87
Q

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

A
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.
88
Q

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

A
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
89
Q

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.

A
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.

90
Q

Differences between ROE and ROCE

A

ROCE considers all assets used in business/return for all sources of capital;

including debt/borrowings
profit measured as earnings before interest and tax/operating profit.

ROCE useful to compare individual companies and their efficiency.

ROE based on equity investment only/shareholder return/funds.

91
Q

Main differences between strategic and tactical asset allocation

A
Strategic
Fixed weightings/allocation;
long term;
with occasional/infrequent rebalancing.
Little variation from objective.
No response to market changes.
Tactical
Varying weightings/allocation;
short term;
with frequent rebalancing.
Substantial variation from objective.
Take advantage of market changes.
92
Q

Outline what would cause a normal yield curve to invert

A
Expectation that;
long term interest rates will fall;
short term interest rates will rise;
long term inflation will fall.
Economic outlook pessimistic/low growth/recession.
93
Q

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

A

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.

94
Q

Cash / fixed interest / bonds subject to what risks?

A

Interest Rate - when interest rates fall capital values rise and vice versa

Liquidity - trade infrequently

Inflation - erodes capital values (bond prices tend to fall if rate of inflation is speeding up)

Currency - exchange rate movements for global bonds

Default - Issuer may not pay interest or capital at maturity (Governments are most secure due to
creditworthiness and ability to raise money to pay debt)

Credit ratings: investment grade (S&P BBB- or higher /Moody’s Baa3 or higher)
Sub-investment grade (junk bond) (volatile)

Market/Systematic Risk - economic factors or government actions

95
Q

Type of preference shares

A

Cumulative

Non cumulative

Participating

Redeemable

Convertible

96
Q

Risks of hedge funds

A

Gearing

Hedge fund of fund

Manager risk

Liquidity risk

Encashment risk

Regulatory risk

97
Q

Behavioural finance types

A

Regret

Over confidence

over and under reaction

Mental Accounting

Herd Behaviour

Emotional Gap

Anchoring

Self Attribution

Confirmation Bias

Experential Bias

Loss Aversion

Hindsight Bias

Familiarity Bias

98
Q

Explain four benefits of using the Capital Asset Pricing Model (CAPM) in
assessing the potential suitability of a fund.

A

Easy to calculate/uses widely available information.

Takes account of systematic/market risk.

Reflects fact most portfolios are diversified to remove unsystematic risk.

Robust/trusted.

Gives an expected return/benchmark.

99
Q

List four fees that are included within the OCF figure

A

Management fee/ Annual Management Charge.

Administration fees/secretarial/directors fees/insurance

Marketing.

Audit/tax compliance fees.

Registration/regulatory fees.

Custody/depositary/trustee.

100
Q

State four costs that may be paid when investing in a fund

A

Transactions fees/initial charge/spread/Stamp Duty.

Performance fees.

One off legal/professional charges.

Interest/gearing costs.

Adviser charge.

101
Q

Explain briefly what is meant by a deep value investment strategy

A

Investing for long term;
in undervalued/out of favour stocks.

Price less than net asset value/book value.

Contrarian view/buying what others are selling.

Buy and hold/low turnover.

Limited downside/greater upside/mean reversion.

102
Q

Bottom up investing

A

Stock selected purely on basis of own criteria

Usually dependent on style or approach of fund manager

Focuses on how individual company performs

Looks at financial ratios

o Value/buy & hold strategy to earn higher
return than market average
o Growth At A Reasonable Price/find
companies with lorg-term sustainable
advantages
o Momentum/uses analysis to be ahead of
latest swing in opinions, e.g., sector
rotation
o Contrarianism/high returns can be
achieved by going against trend (found
most often in hedge funds)
103
Q

Top down investing

A
  • focuses on bigger picture
  • overall economy and macroeconomic factors
  • performance of sectors and industries
  • looks at monetary policy and GDP
104
Q

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

A

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

105
Q

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.

A

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

Modified
Reduce duration/interest rate risk.

106
Q

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

A

Minimum £500;
Maximum £1 million.
No minimum term/Instantaccess/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.

107
Q

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

A

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

108
Q

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

A

Maximum deposit £50,000.

Interest rate notional/may not win any prize/erosion of money in real terms.

109
Q

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

A
Prices adjust/reflect/respond to;
all;
public information;
rapidly and;
unbiased.
No excess return/cannot outperform market:
Includes past prices and;
company information.
110
Q

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

A

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

111
Q

Offshore funds - reporting / non reporting

A

Reporting funds

  • income declared to HMRC, investor taxed as income arises
  • taxes like UK dividends or interest for UK investor

Non reporting funds

  • mainly rolls up funds, no income distributed
  • gain calculated using CGT principles
  • however, gain taxes as income @ 20,40,45
  • PSA available at £1000 or £500 on savings income
112
Q

Types of risk

A
Market risk
Equity risk
Accesibility
Interest rate risk
Currency risk
Liquidity risk
Concentration risk
Credit risk
Reinvestment risk
Systematic/unsystematic
Inflation risk
Horizon risk
Longevity risk
Political risk
Counterparty risk
113
Q

Weak form efficiency

A
  • current security prices fully reflect all past price and trading volume information
  • future prices cannot be predicted by analysing this type of historical dates
  • technical analysis is of NO use in deterring future prices and can’t produce returns
114
Q

Strong form efficiency

A
  • security prices reflect all information that any investor can acquire
  • includes all information such as public and private information
115
Q

Drawbacks of money weighted return

A

Strongly influenced by timing of cashflow

Outside fund managers control

Difficult to distinguish performance from manager or cashflow input

116
Q

Explain briefly the potential causes for an ETF tracking error

A
Inaccuracy of tracking
Management fee.
Other expenses/costs.
Currency hedging.
Cash drag/uninvested cash.
Dividend reinvestment lag.
Tax/withholding tax.
Securities lending.
117
Q

Duration (Macaulay)

A

Period of time it will take to repay initial outlay (in terms of
interest and capital)

Used to measure sensitivity of fixed interest investment to changes in interest rates

Modified Duration estimates the change in a bond’s value if there is a change in interest rate (and thus yields)

118
Q

Active management strategies

A

Top down

  1. Asset allocation (strategic and tactical)
  2. Geographical distribution
  3. Sector selection
  4. Stock selection ( fundamental and technical analysis)

Bottom up

  1. Value
  2. GAARP
119
Q

What is the CAPM?

A
  • model that shows relationship between expected return and risk of a security
  • helps investors understand the returns they can expect with a given level of risk
120
Q

Arbitrage Pricing Theory

A

APT states risk premium is based on a number of independent factors i.e. multi factor

Can be market or industry related

Can include macroeconomic variables e.g. Interest rates, inflation
industrial production

Each factor taken into account and extent risk will affect that security.

121
Q

Thematic investing explained

A
  • investors can invest in long- term ideas and trends
  • aims to identify macro-level trend
  • aims to generate long term growth
122
Q

Growth vs Value

A

Growth stocks are those companies that are considered to have the potential to outperform the overall market over time because of their future potential.

Value stocks are classified as companies that are currently trading below what they are really worth and will thus provide a superior return.

123
Q

Three main ways in which a stock market is weighted

A

Value/market capitalisation.
Price.
Equal/unweighted.

124
Q

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

A

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

125
Q

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

A

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

126
Q

Describe the main features of an MPS

A

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.

127
Q

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

A

Target;
measure/calculate performance/fee.

Comparator;
comparison of performance.

Constraint;
limit portfolio construction/asset allocation.

128
Q

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.

A

Fixed interest/green bonds/charity bonds.

Infrastructure/renewable energy.

P2P/social impact.

Property/social housing/education.

129
Q

Explain three reasons why an equity based ethical investment strategy could put perform an equity based non ethical strategy

A

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.

130
Q

State four fund specific factors that an adviser would consider when researching ethical funds

A

Appropriateness of benchmark.

Ethical criteria/mandate of the fund/UnitedNationsSustainableDevelopment Goals.

Manager’s skill/track record/experience.

Ethical stance of management group itself.

Is it aligned with client’s ethical views?