R02 Flashcards
Cash investments accounts
Cash is liquid, no capital appreciation - pays interest
Fixed term accounts - leave in there for 1-2 years and offer fixed rate of return
Notice accounts - have to give 30-60 days notice before withdrawal
Structured deposits - pay interest based on performance of an index and will pay capital return on maturity ‘guaranteed investment account’
Cash and ns&i
Cash can be held in ns&I for tax free investments think PICK
Money as an investment
Treasury bills - short term money market instrument managed by DMO
Used by government to raise cash- they don’t pay interest but bills issued are at below par and redeemed at face value
Money market funds
Two types of money market funds
Short term - weighted average maturity of no more than 60 days and weighted average life of no more than 120 days
Standard term funds - weighted average maturity of no more than 6 months and a weighted average maturity of no more than 12 months
Can invest in a combination of cash, cash deposit/Treasury bills
Fixed interest securities
Long term investment between 2-30 yrs: a loan from the investor and pay return for having access to capital
All share the same characteristics
Fixed redemption value, repaid after set period, set return known as coupon
Risks associated with fixed interest securities
There is an inverse relationship between the price of the bind and interest rates
Main risks associated with bonds:
Commercial/specific - risk for indiv issues
Market/systematic - risk to asset class as a whole
Liquidity risk - some bonds can be hard to sell
Default risk - chance a issuer cannot pay the interest or capital back
Bond volatility
Bonds with lower coupons and longer redemption periods are more volatile because coupon payments exposed to movements in interest rates for longer periods
Gilts and classification
They are classified by there time to redemption
Shorts DMO less than 7yrs
Shorts financial press less than 5yrs
Mediums DMO 7-15yrs
Mediums financial press 5-15yrs
Longs over 15yrs
Undated - ni specific redemption date
Undated gilts work like other but with one difference -
if gilt issues before 2005: the value of rpi is taken 8 months prior to each payment date
If issued post Sept 2005 then it is taken 3 months prior
Repo and repo rate
The amount paid to the investor investing in GILTS essentially the rate of interest paid
The repo rate is used by the BoE to help set interest rates
To help increase liquidity the repo was created (sale and repurchase) - sold from one to another with promise to buy back at future date and price
Tax on GILTS
Cgt Free but fully liabke to income tax
Strips market
For the fixed interest market to help makes gilts more liquid
Separated out the coupons and redemption value and both are sold separately.
Strips do not pay interest instead investors receive face value on maturity - prior to this they would trade at discount
Corporate bonds - loans to companies
Risk - greater chance of default - larger to company lower the risk
It is an alternative for companies to raise capital than going to the bank
Where a secured loan uses assets as fall back this is known as a debenture
Another type of bond is a convertible bond - option to revert to shares, these bonds trade at a premium if share price doing well and vice versa
Permanent interest bearing shares (PIBS) and Perpetual subordinated Bond (PSB)
Offered by building societies and traded on stock market, no longer available, where building society demutualises a PIBS becomes a PBS
Trading fixed interest securities
Bond trading at par it is trading at nominal value - where above nominal value this is above par and below, below par
Clean prices - the quoted mid market price - price between buying and selling and do not include interest accrued
Interest is paid twice yearly and where a bond is sold the timing of the next payment determines the position
Cum (with) dividend - the purchaser receives full interest even tho the bind has not been held for 6 months, to compensate the buyer will pay clean price plus an amount of interest, typically paid 1 working day after purchase
Ex (without) dividend - where bond is sold within 7 days of next coupon payments the seller will receive full coupon payments, to compensate the price paid will be adjusted
The actually price paid is the ‘dirty’ price
The bonds market
Primary market - where initial sale takes place, DMO issue gilts weekly via auction. Noy usually possible for indiv investors to take part. If they do they put a bid in and if successful pay average of bid prices. For large inv they bid prices and if successful pay the bid price
Secondary market - where stock are traded, each company has a credit rating via standard & poors and Moody’s - e.g. AAA anything below BBB is a sub investment grade bond
Bond yields
Running yields - what return is it currently offering (interest yield) -
coupon/clean price X 100
Redemption yield - works out gain or loss at maturity as a % of current price. Measure of performance of held to maturity
((Nominal price - clean price)/clean price) x 100%
Equity and shares
This is part owning the capital of a company, there’s a primary and secondary market for shares
The main market - company is listed and is listed to the public in the main market i.e LSE - there are a lot of requirements for this
The alternative investment market - regulated by LSE - for smaller firms with lower barriers to entry
Types of shares
Ordinary shares - tank behind preference shares in receiving dividends
Preference shares - fixed rate of return similar to bonds - hey rank higher in event company went bust.
Different type of preference shares:
Cumulative - if payment missed paid back in times if higher profit
No cumulative - not clawed back
Participating- as well as fixed div, share if wider profits in good yrs
Redeemable - firm can buy back shares where desired
Convertible - convert to ordinary
Cost of buying and selling shares
Commission to dealer, stamp duty it SDRT
Risks of investing in equities
Volatility of dividends, capital loss, third party failure, currency risk, liquidity risk, regulator risk
Important to diversify- invest in different shares, industries, geography
Earning per share
Remember it is profit after Corp tax, minority interest and pref shareholders
Profit to ordinary shareholders / number of ordinary shares in issue
Price/earnings ratio (P/E)
How the company is valued
Current share price / earnings per share
Dividend per share
Return received from share on annual income
(dividend per share / current share price) x 100
Dividend covers
How many times dividend paid out from periods of profit
Earnings per share / dividends per share
Net asset value
Value of a company
Net asset attributable to ordinary shareholders / number of ordinary shares in issue
Liquidity
Business ability to meet debt
Current assets - stock / liabilities
Gearing
Measure of borrowing
Long term debt / shareholders funds
Grouping and watching equity indicies
Allows investors to see movement in markets as a whole. Problem is weighted to market capitalisation, large companies have heavy impact on effect of indicies
Property
Very illiquid, needs to be managed, void periods, increased tax
Stamp duty lank tax due 14 days after transaction has taken place
Renting out part of your home
7500 household relief
Property income allowance - no tax is income less than 1k
Property rental yields
Rent per month x 12 / cost on property x 100
True rental yields
Rent per month - monthly fees x 12 / cost of property + SDLT + solicitor fees x 100
Alternative investments
Works of art, collectables
Commodities
Hard - mined stuff, gold, oil, gas
Soft - grown stuff, coffee, wheat
Quantitative easing
Print money to stimulate economy
What is the interest rate target
2%
Impact of trends on macro economic environment
Trends have a big impact, investors stop looking at fundamentals and follow trends which inflates price creating a bubble…
Political impact on economy
American sneeze what happens in America then follow worldwide
The human factor - aging population
The economic cycle
Expansion: strong demand for goods, growth in sales and profitability, demand starts to overtake supply, prices start to rise (inflation) economy starts to overheat and interest rates start to rise
Boom: highest point in cycle, economy growing at its fastest, interest rates increase again, demand will start to fall
Slowdown/contraction: inflation could still be high as demand starts to fall, business sales start to decrease and unemployment starts to rise, interest rates start to fall
Recession: seceerve economic downturn, profits are weak, people aren’t spending as much, inflation falls, interest rates fall
Gross domestic product GDP
Common way to illustrate how an economy is doing, one quarter economy shrinks is known as a contraction, two successive is a recession
Public sector net cash requirement
What comes in and out of a countries economy - is there more coming in than out, if there is a recession the PSNCR will grow and vice versa
How much cash is needed to function
How does the economic cycle effect our investment decisions
Fixed interest - inverse relationship with interest rates and inflation
Equities - inflation high, equities to well as more people buying and vice versa
Government policies and the economic cycle
Fiscal policies - government spending more of cutting tax in times of economic downturn. Gov increase tax and decrease spending in times of boom
Gov Spending money will have more impact then cutting tax rates… Gov spending goes in economy whereas cutting tax people could save it…
Monetary policies - controlling interest rates
Easing monetary policy - short term reduction in interest rates followed by long term
Tightening - opposite of above
What is SONIA
the rate at which banks lend to each other and the rate in which they do
Money supply - how.mich money there is in the economy
2 common measures
M0 - notes and coins plus banks operational money held with BoE - this shows stonf consumer spending and retail sales
M4 - inc all deposits created from lending banks plus money held by savers and banks and coins - suggests more lending is taking place
How can central banks influence the amount of money in the economy
Buying and selling bonds
Selling bonds reduces amount of money as people invest
Buying increases amount as it puts more money in ppls hands
Inflation
This is the price of goods and services on a month to month basis
There are a number of ways this can be measured
Retail price index - used for index linked Gilts
Consumer price index - allows comparison across European counties
Types of inflation
Disinflstion - where inflation rises at a slower rate then they have been
Deflation - where prices actually start to fall
Stagflation - inflation is high but growth is flat
Exchange rates
Based on supply and demand - where a country is producing goods, people need their currency to buy it, increase demand increase price… It strengthens the currency against other currencies
Equally if interest rates in a country are high, people will want to invest in cash deposits in that country, increasing demand for currency
Real exchange rates
Allows us to measure how competitive one country is compared to another accounting for inflation
Balance of payment
Money in vs money out of a economy, deficit shows more money going out, surplus shows more money coming in
Capital account
Measures financial flows and investment in and out if an economy
Major investment theories - modern portfolio theory
Modern portfolio theory - diversification
Standard deviation - the extent the return varies from the expected return. A higher SD would indicate more volatility
Reducing risk with MPT
By holding different investments within a portfolio will reduce the risk, it is important to consider the correlation between the assets to see how diversified the portfolio is
Correlation can be measured on a scale from +1 to -1
Positive correlation if one stock moves 10% the over moves 10% in the same direction
Negative correlation if one moves up 10% the other moves down 10%
Options and futures
Options - gives option to sell but do not have to if don’t want to (it can expire)
Futures - have to sell at agreed price
Efficient Frontier
Represents the best return for the risk taken, an investor would not vary from this as it would mean taking extra unneeded risk
Think of the graph in your head now
Shortcomings of SD
Not a precise tool, relies on past performance, doesn’t include costs or charges, assumes portfolio made up of index funds
Different type of risks for shares
Systematic (market risk)
Non systematic risk (specific risk)
Capital asset pricing model - CAPM
Considers the risk free return plus extra return for additional risk taken, the measure of systematic risk is known as beta
The non systematic risk is ignored as it is diversified away
The market and it’s relationship with BETA
The market always has a beta of 1, a beta of 1 means the security will move exactly like the market does
A beta below 1 but above 0 means the security will move at a slower rate e.g. if beta was 0.5 if the market moves by 10% the security will move by 5%
A beta of above 1 would move the security would move up and down at a higher rate then the market e.g. a beta of 1.5 would mean if the market moves 10% the security move 15%
CAPM equation
Risk free return + Beta x (market return - risk free return)
The model assumes: same holding periods rational, rf rate is available, open market
CAPM is a singular factor model
There are multi factor models
Efficient market hypothesis
How markets act based on information
Weak form - all info inc in price, no outperformance possible
Semi-strong - any info in public domain is inc in price
Strong- price inc all info not just financial info but also private info
Time value of money equations
PV = amount x (1+r)N
FV = amount / (1+r)N
Working out rate of return
FV/PV then number of years square root ans
Changing interest rates part way through
FV = PV(1+(r/n))N1 X (1+r)N3
Interest paid at different intervals i.e more than annually
EAR (1+(R/N))N -1
Regular premiums
FV= P {(1+R)N - 1 /R}
What are the risks in investing
Credit risk - impact bonds
Default risk
Downgrade risk- bonds rank more riskier, prices decrease
Currency risk
Bail in risk
Event risk
Political risk
Liquidity risk
RPI included increases in interest unless it is stated as RPIX
There is an international RPI known as RPIJ
What is generally always higher RPI or CPI
RPI
Collective investments
Unit trusts and OEICS open ended investments
The fca regulates collective investments
Collective investments categorized into the following categories:
UK UCITs (comply and can be sold to retail investors)
UK non UCITs (do not comply but can be sold to uo retail investors)
Qualified investments schemes (not to be marketed to anyone other than pro or sophisticated investors)
UK collectives diversification rules
Portfolio must not hold more than 10% of a stock and no more than 4 x 10%, rest have to be less than 5%
No more than 20% in one group of companies
Funds holding more than 35% in gov fixed interest must have least 6 different issues if that stock, no more than 30% in fund
10% can be held in unlisted UCITs and 20% for non-UCITSs
Borrowing / gearing for collectives
UCITs are not permitted to borrow to gear up, they can borrow up to 10% in the short term to cover payments such as dividends so they do not have to sell assets
UCIS collectives
Unauthorized un regulated schemes known as UCIS - not authorized by fca and can only be taken out by high net worth and sophisticated investors
Unit trusts
Are actually a trust.
Trustee - typically bank/building society; responsibility inc: monitor, manage, set up, hold up to date, ensure assets invested as per objectives
The trust deed - legally binding, strategy, aims/objectives, limitations
Unit trust manager - manage assets in accordance with regulation and trust deed, invest in the funds, sufficient resource to operate, keep register of units issued, inform of any breaches
Unit trusts are open ended
Pricing and valuing unit trusts
Pricing on unit trusts - offer price is the price the manager offers units to investors at. The bid price is the investors selling price. The difference is the charge to investor.
Valuing funds -
Forward pricing - setting price at the next valuation point, if the fund has moved more than 2% since the last valuation the manager must move to forward pricing - pay price at next valuation point
Historic pricing- set price at last valuation point
Structure of OIECs
Very similar to unit trusts but they are structured as a company, depositary owns assets, auth company director performs same tile as manager
Accessing unit trusts and OEICs
Many different types of management available:
Multimanager products- hold broad range of assets through:
Funds of funds: a fund that invests in other funds
Manager of managers funds: different fund managers liik after different part of the investment they specialize in
Offshore funds
Gross roll up
Tax treatment, reporting and non reporting
Automatic exchange of information
Stops tax havens, government communicate
Investment trusts
Closed ended investments - trading at net asset value, can trade at discount or premium, if all those who sell cal this is known as diluted nav. If not it is known as undiluted nav
Structure of investment trusts
Two primary capital structures:
Standard or conventional - one class of shares under which the investor gets any income or gains produced
Split capital - inv trusts with limited lifespans and different shares classes, distributed differently
What is an investment trust Warrant?
Right to buy shares at a set price at a set point in time
Investment trust - Share buy back
As Investment trusts are closed ended, supply and demand can be limited so 10% shares can be hold as buy back to control S&D
Investment trust and gearing
Borrowing to invest, investors can benefit from the growth on the borrowing
Investment trust can be held y retail investors in ISAs
Life assurance products
With-profits : smooths out the investment
Unit-linked : policy holder given units in a fund
Regular premiums contracts- qualifying and non qualifying
Lumo sum contracts non-qual example: guaranteed income, growth bonds, unit linked bonds, dist bonds
Tax on onshore life contracts- 20% paid in fund rest tax on indiv as appropriate…
Non qualifying and qual can 5% unral investment withfre tax differed
Pound cost averaging
Problem with unit linked - if invest at bad time… Pound cost averaging averages out timing to market
Top slicing
Traded endowment policies
Some policies especially with profit may not be needed, and do not want to surrender to lose bonus, can sell one second hand market, the buyer will pay cgt on payment price and premiums paid take sale price
Friendly society policies
Offshore bonds
Gross role up, there is time appointment relief
Equation - number of days UK resident - number says policy ran, x answer by chargeable gain
Offshore bonds, personal portfolio bind charges 15% tax
Bonds and child benefits
If between 50 and 60k reduced
Bonds and trusts
25% tax liability if settlor pays into trust
Exchanged traded fund
Index tracking funds listed on the stock exchange, do not own stock but track indicies through derivatives
Property based investments
Listed priority companies - investors but shares in a portfolio that comprises I’d property
Property authorized investment fund PAIF - example of OIC fund
Tax on the investor - income paid net 20%
To qualify: 60% income must come from property element
No investor hold more than 10%
Real estate investment trust REIT
Closed ended companies listed on recognized stick exchange
To qualify: 75% profit come from profit, 90% paid to shareholders, borrowing covered 125% rental
Remember non property = div
Property = interest
Private equity
Eis
Seis
Vct
Isa’s
ISA
LIFETIME ISA
HELP TO BUY
CTF
JUNIOR ISA
Stakeholder product rules
Can be sold via simplify advice process
Derivatives and how can they be used
Where agreed directly between 2 parties known as over the counter
How can derivatives be used?
To hedge future prices
To hedge a portfolio
Achieve different asset allocation
Speculation
No cgt for derivatives in GILTs or Corp bonds
Derivatives: futures
Legally binding for one party to sell and one to buy, buyer holds ‘long’ position, seller has ‘short’ position - most do not actually involve a transfer just the margin
Where exchange does take place it is called - exchange delivery settlement price ‘EDSP
Derivatives - options
Options: do not have obligation but have the option to sell, if do not exercise option it expires, can sell prior to expirer date, an option price is known as the ‘strike price’ a call option is the right to buy, a put option is the exercise the right to sell
Hedge funds
Higher charges
Cayman Islands
Absolute fund returns
Rely on skill if the manager to achieve positive return in all market conditions
Structured products
Offer 100% capital protection
Investment advice process
Consider: need = want - got
6 step process.
1- establishing and defining the client and personal financial planner relationship
2- gather client data and determining goals and expectations
3- analysing and evaluation the clients financial status
4- developing and presenting the financial plan
5- implementing the financial plan and recommendations
6- monitor the plan and relationship
Investment planning principles
Scientific/theoretical approach- highest return on line with risk profile, MPT, efficient Frontier
Pragmatic approach - ignores all mathematical theory that underpins MPY and uses what has happened in the past in combination with the thoughts of the adviser on what will happen in the future
Stochastic profiling approach - uses complex.mathematics moddelled by actuaries - example returns between 5-15% or -5 - 20%
How to construct a portfolio
Top down - asset allocation, geography, industry, stock
Bottom up - picking stocks to build up the portfolio
Different fund managers styles
Employ different styles of stock selection
Value, growth at a reasonable price (GARP), contrarianism - what has the market missed, momentum
Selecting a fund manager
Think about the: objective of the fund, costs and charges, the group fund, risk, the fund manager , performance
Economic,social, governance when picking stock
Economic - waste, pollution
Social - diversity of workforce
Governance - bond, corruption
There is positive and negative screening, positive good
Active vs passive funds
Passive - use the fund to track the market
Active - actively seek to outperform the benchmark
Selecting an investment wrapper
Pension, isa, collective funds, onshore vs offshore, vct, eis, seis
Attitude for risk vs capacity for loss
Attitude for risk- how someone feels about risk
Capacity for loss- how much someone can actually afford to lose
Holding period return
Value at the start and end and any money paid out between start and end as a % of value at start
R = D + (V1-V0)/V0
Money weighted rate of return
Takes into consideration money paid in or taken out
D + (V1-V0) - C / V0 + (C x n/12)
Time weighted rate of return
Breaks down returns in a set period
(V1/V0 x V2/(V1+c)) -1
The sharoe ratio
Measures excess return over risk free rate of each unit of risk taken
Return on investment - risk free return / Stand deviation of the return of the investment
Information ratio
Looks at consistency of performance against the benchmark: shows.effectiveness of the fund manager over passive funds
Rp- Rb / tracking error
Alpha
The actually performance, the performance difference from expected Beta
Actual portfolio performance - (Rf + B(Rm-Rf))
Benchmarking
Limitations to benchmarking when comparing fund manager performance to benchmark of indicies, as they only reflect movement in capital value, no accounting for cash balancing, weighting cap can cause distortion
Selecting a fund manager
Performance, risk, size, experience, ESG, charges, staff turnover
Portfolio reviews
Changes in tax, regulation, personal situation, any changes in strategy, details of holdings
How many good and serviced make up the CPI measure if inflation in the uk
700
IT - what is it?
Information ratio, how well a investor performs, higher it the better against benchmark
Derivatives are financial contracts whose value is derived from, at least in part from what?
The underlying asset
What % of a unitsl trusts assets must be held in UK equities with the primary objective of achieving capital growth?
80%
ISA
You can now withdraw and reinvest
Who owns the assets of a unit trust
The trustee
What does the European savings directive achieve
Sharing of information regarding income payments to EU residents
What is the isa minimum deposit
£10
A put option gives the investor the right to
Sell within a specified period at a predetermined price
The depositary in a OEIC is the equivalent role to a trustee of a unit trust
What rights do investors have when purchasing an option contract
The right but not the obligation, to buy or sell copper in the future
What name is used for portfolios that use combined active and passive techniques
Core-satellite management
Time weighted rate of return Vs money weighted rate of return
Time weighted rate of return allows comparisons to be made of the performance of one fund manager with another
Money weighted rate of return measures the overall return in capital invested over a specific period
Client objectives and their individual constraints on how their portfolio will be managed are set out in what document
The investor policy statement
