R02

Question 1

Cash? (5)

Answer 1

• Interest
• No capital growth
• Easy access
• Greater security
• Low return

Question 2

Cash

Investment risks? (5)

Answer 2

• Default risk - credit worthiness of firm and compensation it has
• Inflation
• Interest rate - especially when variable
• Currency - if invested in other currency
• Re-investment - if original high interest but end of fixed period interest rate may have decreased

Question 3

Cash

FSCS compensation limit?

Answer 3

£85,000 per person per institution - parent company only

Question 4

Cash

Types of accounts? (4)

Answer 4

• Current
• Instant access
• Notice (30 - 120 days) - penalty for early access. Often interest paid penalty
• Term Deposit (1 - 5 years) - fixed interest rate during term

Question 5

Cash

Structured Deposits (SD)?

How do they differ to Structured Products (SP)?

Answer 5

SD: Pay interest based on performance of index

SP: Fixed term greater of original investment / % change index

SD: Capital Protection provided by deposit taking firm

SP: Capital Protection provided by third party

Question 6

National Savings and Investments (NS&I)

Which products have tax free returns? (4) (P.I.C.K)

Answer 6

• Premium Bonds
• ISAs
• Fixed and IndexLinked Savings Certificates
• Children’s Bonds

Question 7

National Savings and Investments (NS&I)

Which products are paid gross but are taxable? (4) (G.I.I.D)

Answer 7

• Guaranteed Growth/ Income Bonds
• Income Bonds
• Investment Account
• Direct Saver

Question 8

Money Market Instruments? (3)

Answer 8

• Treasury Bills - minimum £300,000
• Certificates of deposit
• Commercial Bills - short term loans to Government / bank for lower interest rates

Question 9

Money Market Instruments

Treasury Bills

How does it work? (4)

Answer 9

• Issued by Debt Mananagement Office
• Weekly auctions
• Bought at lower face value and sold at above face value - no interest rate but provides growth
• Risk Free, short term (maximum 6 months)

Question 10

Money Market Instruments

Treasury Bills

Access for private investors?

Can invest in?

Answer 10

Collective investment vehicles - offers diversification i.e. lower default risk

Short term Money Markets fund

WAM = lower 60 days life = lower 120 days

Standard Money markets fund, weighted average maturity = 6 months life = 12 months

Question 11

Money Market Instruments

Certificates of Deposit (CD)

How do they work? (4)

Answer 11

• Issued by banks
• Fixed term and fixed return - usually relate to LIBOR
• Returns higher than Treasury Bills as no guarantees
• Can’t withdraw early but can sell on stock market

Question 12

Money Market Instruments

Commercial Bills

How does it work?

Answer 12

• Issued by companies
• 30 - 90 day loans
• Bought lower than face value, sold higher than face value
• Returns greater than Tresury Bills & Certifictes of Deposit as higher risk
• Are tradeable as proof of ownership can be sold on stock market

Question 13

ISAs

Max age for JISA?

If 17?

Answer 13

• Below 18
• If 17 - can have adult ISA, only hold cash and JISA, can hold other asset classes

Question 14

ISAs

5% rule?

Answer 14

If investment likely return + 95% of investor’s money in a 5 year period from initial investment date - can be included in Cash ISA

Question 15

ISAs

Flexible ISA rules?

Answer 15

If take money out you can add that money back in in the same tax year, without it impacting your allowance

Question 16

Indirect Investments

Examples of income? (4)

Answer 16

• Pension Income
• Distribution from FI Collectives
• Distribution from EQ Collectives
• Investment Bonds

Question 17

Tax Wrappers

3 Stages?

Answer 17

• How initial investment treated
• How funds are taxed within wrapper
• How proceeds are taxed on investor

Question 18

ISAs

How are proceeds taxed on the investor?

Answer 18

Interest and dividends are paid gross, no capital gains tax

Question 19

Child Trust Funds (CTFs)

Desrcibe? (4)

Answer 19

• Available 2002 - 2011
• Government contribution £250 initially - increased to £500
• Savings/ Shares / Stakeholder options
• Additionally investments permitted of £4,668

Question 20

JISA

Describe? (2)

If 17?

Answer 20

• Eligible if born after January 2011
• Max per year £9,000

At 17, can get £20,000 plus £9,000

Question 21

Children’s savings

£100 rule?

Answer 21

Interest earned from the total amount gifted is less than £100 a year, it will be treated as the child’s

If it is greater it will be treated as the parents for income tax purposes

JISAs and CTFs are exempt

Question 22

Fixed Interest Securities

What are they?

Answer 22

Way of institutions funding longer term requirements

Question 23

Fixed Interest Securities

Investors entitled to?

Answer 23

Interest payments and return of capital at end of term = PAR value

Question 24

Fixed Interest Securities

Know as?

Terms?

Tradeable?

Answer 24

Negotiable fixed interest, long-term debt instruments

2 - 30 years

Can sell to third party

Question 25

Fixed Interest Securities

What is their nominal value?

How are they taxed?

Answer 25

£100

Income tax, no capital gains tax unless sold on stock market

Question 26

Fixed Interest Securities

Must show? (3)

Answer 26

• Issuer’s name
• Coupon - amount of interest you receive
• Maturity date

Question 27

Fixed Interest securities

Price quoted on FT?

Seller receives and buyer receives?

Answer 27

Mid/ clean price - price paid if no adjustments are made for interest due

Seller gets lower mid price and buyer receives lower mid price

Question 28

Fixed Interest Securities

When does interest accrue and when is it paid?

This creates what problem?

Answer 28

Accrued daily and paid half yearly

when buying and selling who gets the interest - agreement needs to be made

Question 29

Government Bonds

Also know as?

Are they risk free?

Answer 29

Gilts - Government Invested Long Term Security

No but low risk

Question 30

Government Bonds (Gilts)

Classification?

Answer 30

Classified by term until redemption

Shorts = < 5 years

Medium = 5 - 15 years

Longs = > 15 years

Question 31

Government Bonds (Gilts)

Index Linked bond?

Coupon normally?

Issued before Sep-05?

After Sep-05?

Know as?

Answer 31

Interest payment and redemption price adjusted with RPI

Coupon normally lower

Before Sep-05: RPI from 8 months prior ro coupon date

After Sep-05: RPI from 3 months

Indexation lay

Question 32

Repo Market

Aim?

Answer 32

Improve liquidity of gilt market - traders can use gilts as securities for transactions

Used by the Bank of England to influence interest rates

Question 33

Repo Market

What is it?

Answer 33

Sale and Repurchase Agreement Market

Question 34

Repo Market

Buy back period?

Answer 34

Usually 2 weeks but range from overnight to several months

Question 35

Repo Market

Strips Market?

Referred to as?

Answer 35

Separate Trading of Registered Interest and Principal Securities

Separates Gilts into interest (coupon) and redemption payments.

E.G. 20 strips of coupon 1/2 yearly for 10 year gilt - 1 strip for redemption payment

Zero coupon instruments - pay no regular interest

Question 36

Bonds

Sensitive to? (2)

Answer 36

Sensitivity determines how an investment changes with fluctuations in outside factors

Bonds - changes in interest rates and inflation

Question 37

Bond sensitivity

Duration?

Answer 37

A bond’s duration reflects changes in the bond’s price for each 1% fluctuation of the interest rate. For example, a bond with a duration of 4 means the bond price decreases/increases 4% for every 1% increase/decrease in interest rate. A bond with a long maturity and low coupon has a longer duration and therefore is more sensitive to rate fluctuations

Question 38

Bond sensitivity

The lower the coupon?

Longer its period to redemption?

Answer 38

The higher the volatility:

• as a higher coupon leads to a higher return in short run
• as bond holder receives a return sooner

Question 39

Convertible Bonds

What are they?

Answer 39

Unsecured loan stock - can convert bond into ordinary shares

Question 40

Convertible Bonds

Characteristics - explain?

• Coupon
• Conversion Rights
• CGT

Answer 40

• Coupon - Interest paid in usual way but lower coupon
• Conversion rights vary - either time period for conversion / specific date
• CGT - not exempt

Question 41

Convertible Bonds

If conversion date expires?

Fluctuates in value?

Answer 41

Turns into conventional bond

Normally with issuers share price i.e. higher share price - higher bond price

Question 42

FRN

What does it stand for?

Definition?

Answer 42

Floating Rate Notes

Securities issued by companies where interest rate linked to a money market rate e.g. LIBOR

Question 43

FRN

Coupon paid?

Answer 43

1/2 yearly / quarterly

Question 44

FRN

Price?

Answer 44

Normally close to nominal value

Change in interest rate - security itself will change

But likely to alter with change in credit worthiness of company

Question 45

PSB

What does it stand for and is it?

Answer 45

Perpetual Subordinated Bond

A PIBS but issued by Bank not a Building Society

Question 46

PIBS

What is it?

Answer 46

Permanent Interest Bearing Share - high yielding Fixed Interest issued by Building Societies

Question 47

PIBS

Qualities? (4)

Answer 47

• Fixed rate of interest
• Building Society do not have to redeem them
• Interest is taxable, paid gross, twice yearly
• Free of CGT

Question 48

Stock dividend

What is it?

Answer 48

Company offers shareholders the choice of receiving new shares instead of a cash dividend

Question 49

Interest yield

What is it?

What is it also know as?

Answer 49

Looks at income

Income yield, running yield, flat yield

Question 50

Interest yield

Calculation?

Answer 50

Annual coupon /clean price x 100

Question 51

Gross Redemption Yield

What is it?

Answer 51

Measure of the rate of return offered by an investment up until the date it matures i.e. overall return

Question 52

Gross Redemption Yield

Equation?

Answer 52

Interest yield + Gain or loss to maturity divided by number of years to maturity / clean price x 100

Question 53

Gross Redemption Yield

Doesn’t take into account?

Answer 53

Individual’s tax position - most investors target bonds for income rather than overall return

To calculate overall return - tax, need to calculate net redemption yield

Question 54

Cum dividend

What is it?

If owned for less than the whole period?

Answer 54

Full 6 months interest received

If sold purchaser must compensate buyer for interest occured but not received

Question 55

Ex-dividend

What is it?

If purchased after that?

Answer 55

Interest payments usually made 7 working days before payment date

Price for buyer lower than this

Question 56

Dirty price

What is it?

Answer 56

Clean price +/- interest adjustment

Question 57

Bond prices

Adjusted for? (7)

Answer 57

• Income need/want
• Credit rating of issuers
• Future interest rates trends
• Changes to inflation
• Government finances conduct
• International and soci-political tensions
• Attraction of other assets

Question 58

Bonds

Risks? (5)

Question 59

Bonds

Yield curves - explain? (3)

Answer 59

• Normal - greater return in exchange for greater risk as greater exposure to risk
• Flat - stable economy
• Inversion - Expectation of increasing interest rates followed by falling interest rates

Question 60

Corporate Bonds

Riskier?

Bid/ Offer spread?

Yields?

Answer 60

Riskier than gilts as greater chance of default, more volatile

Bid Offer spread is greater

Yields are higher than gilts

Question 61

Corporate Bonds

Can be either………..or………………?

Explain?

Answer 61

Secured - charge is taken over firm’s assets and in the event of default assets used to pay loan

Unsecured - rank alongside normal creditors, higher yield

Question 62

Corporate Bonds

Charge?

2 types?

Answer 62

Established by trust deed

Secured by fixed (secured to fixed asset of company, therefore sale of asset is restricted) or floating charge (general charge over companies assets)

Question 63

Equities

For companies to issue shares to publish? (2)

Answer 63

• Must be listed on stock exchange
• 25% minimum for sale

Question 64

Equities

Why list on AIM? (2)

Regulated by?

Answer 64

• Main market listing is expensive
• Many rules

UK Listing Authority (UKLA)

Question 65

Ordinary Shares

What are they? (3)

Answer 65

• Confer an ownership stake in a company
• Represent the risk capital, are the last to be paid out in the event of liquidation
• Holders have a right to share in the profits of the company (through dividend payments), a right to attend and vote at company meetings

Question 66

Ordinary Shares

Why keep profits back?

Answer 66

Profit held back to increase the value of the company therefore increase value of shares - capital growth for investors

Question 67

Ordinary shares

Other types? (2)

Answer 67

Non-voting ordinary shares

Deferred ordinary shares - don’t receive a dividend until pre-determined level reached/ specific period

Question 68

Preference shares

Characteristics? (3)

Answer 68

Fixed annual dividend - every 6 months and only paid if profit made

Typically no voting rights unless company falls behind on dividend payments

Paid before dividends to other stakeholders

Question 69

Preference shares

Risks? (8)

Answer 69

• Equity capital risk
• Market risk
• Share dividend volatility
• Liquidity
• Currency
• Counterparty risk
• Regulatory
• Fund managers and insurance companies

Question 70

Preference shares

Types? (5)

Explain

Answer 70

• Cumulative - any missed dividend made up in future years
• Non-cumulative - any missed dividend doesn’t need to be made up
• Participating - fixed rate dividend paid and participate in ordinary share dividend as well
• Redeemable - temporary source of finance, dividends paid until company repurchases shares

Question 71

Stamp duty

When is stamp duty payable and at what rate?

Answer 71

Payable when paper transaction of shares

0.5% of value of share (rounded up to nearest £5)

Question 72

Stamp duty

Who pays it?

Answer 72

The purchaser

Question 73

Stamp duty

What is it not paid on? (5)

Answer 73

• AIM
• UK domicilied ETFs
• If < £1,000
• Gilts/ corporate bonds
• OEICS/ unit trusts

Question 74

Stamp duty

What is stamp duty reserve tax paid on?

How is it rounded off?

Who pays it?

Answer 74

Paid on paperless transactions of shares on CREST

Rounded to the nearest penny

Paid by the stockbroker on behalf of the purchaser

Question 75

Stamp duty

For CGT?

Answer 75

Stamp duty and stamp duty reserve tax can be deducted

Question 76

Stamp duty

PTM levy is payable on? (3)

Answer 76

• Listed shares
• Investment trusts
• REITS

Question 77

Factors affecting share prices? (7)

Answer 77

• Economic
• Polictical
• Investor sentiment
• Profit expectations
• Dividend expectations
• Takeover activity
• Quality and track record of management

Question 78

Private equity

What is it?

Typically refers to provision of? (2)

Answer 78

Acquiring shares/ stake in a company not traded on stock exchange

• Venture capital
• Management buy-outs/ buy-ins

Question 79

Private equity

Private equity firms looks to make capital gain by? (4)

Answer 79

• Selling shares back to management
• Selling shares to another investor
• Trade sale - company-company
• Floated on stock exchange

Question 80

Private equity

Can invest in private equity through? (3)

Answer 80

• Funds - typically hold shares for 3-7 years, aim to return original investors money and any additional returns. Have the potential for high returns but high risk
• Listed private equity companies - invest directly into unlisted companies. Invest in funds that invest in unlisted companies
• EIS, SEIS & VCTs

Question 81

Equity Investment Ratios

Earnings per share (EPS)

Formula?

Answer 81

Profit after tax LESS preference dividends

DIVIDED BY

Number of ordinary shares in issue

Question 82

Earnings per share (EPS)

Characteristics (4)

Answer 82

• Shows trend in company’s profitability
• Widely used in company performance analysis - usually only compare companies rather than sectors
• All companies list EPS
• Result shows amount per share in pence that the company has earned during the year

Question 83

Dividend yield

Formula?

Answer 83

Net dividend per share

DIVIDED BY

Current share price

MULTIPLE BY 100

Question 84

Dividend yield

Characteristics? (3)

Answer 84

Shows true value of share’s dividend

Same as interest yield on bonds

Not necessarily a reliable indicator as dividend and share price fluctuate

Question 85

Dividend cover

Formula for total basis?

Answer 85

Earnings per share

DIVIDED BY

Dividend per share

Question 86

Dividend cover

Formula for individual basis?

Answer 86

Profit attributed to ordinary shares

DIVIDED BY

Dividend paid to ordinary shareholders

Question 87

Dividend cover

What does the formula show?

The higher the figure shows?

Answer 87

How many times the dividend could be paid out of available current earnings

If figure is really high this shows profits being maintained rather than shared

Question 88

Dividend cover

Uncovered dividends?

Answer 88

If company draws on reserves to pay dividend

Question 89

Price Earnings Ratio (P/E)

Formula?

Answer 89

Current share price

DIVIDED BY

Earnings per share

Question 90

Price Earnings Ratio

If the formula produces a high figure what does this mean?

What can it be used for?

Answer 90

Better as more shares in demand

A comparison between companies in same sector

Question 91

Net Asset Value (NAV)

Formula?

Answer 91

Total capital employed

LESS

Claims + loans + preference shares

Question 92

Net Asset Value (NAV)

Measures?

Answer 92

Amount available to shareholders if the company were to close down, sell all its assets and distribute balance. Value of tangible assets attributable to ordinary shares

Question 93

Net Asset Value (NAV)

Useful for?

Answer 93

Takeover bid and liquidation - compare bid price to NAV

Question 94

Investment ratios

What are their limitations? (3)

Answer 94

• Differing accounting policies can be used to calculate profits so difficult to compare
• Management can change accounting period
• Ratios use historical data therefore no guide to future performance

Question 95

Property

Demand is driven by?

Answer 95

Changing economic circumstances and desire to move

Question 96

Residential property investment

What is it?

Answer 96

Buying a property with the express priority of letting it out for income or selling it at a profit

Question 97

Residential property investment

Risks? (3)

Answer 97

• Liquidity risk - initial cost
• Management risks - need to run property, agency fees
• Void risk - if property is vacant and no rent

Question 98

Residential property investment

Choosing a property? (4)

Answer 98

• Location
• Tenants
• Age and condition of property
• Diversification - buying more property

Question 99

Rental yields

What is the headline gross rental yield formula?

What should price include?

Answer 99

Yearly rental income

DIVIDED BY

Purchase price of home

MULTIPLIED

100

Price should include any expenses of purchase

Question 100

Rental yields

What is the net rental yield formula?

What is the difference between the two yields?

Answer 100

Yearly rental income LESS letting expenses

DIVIDED BY

Original purchase price PLUS charges

MULTIPLIED

100

Net yeild is after any letting expenses

Question 101

Stamp Duty Land Tax

Due on?

Must be paid within?

Answer 101

Individuals who purchase land

Due within 14 days of effective date of transaction i.e. completion date/ date of payment

Question 102

SDLT

Non-residential rates?

Paid via?

Answer 102

£0 - £150,000 = 0%

£150,000 - £250,000 = 2%

> £250,000 = 5%

Paid via self assessment

Question 103

SDLT

Is it charged on leasehold property?

Is it charged on additional properties?

Answer 103

Charged at 1% on present value of rent over lease term if value > £125,000 for residential or > £150,000 for non-residential

If you’re buying a second home, you’ll still pay Stamp Duty on a property costing more than £40,000 at the normal rates – plus surcharge of 3%

Question 104

Net Present Value (NPV)

Formula for calcuating SDLT on leasehold property?

Answer 104

Annual rent

MULTIPLED BY

Lease term

Question 105

Property income allowance

What is it?

Answer 105

If rental income is lower than £1,000 don’t need to be declared to HMRC

If rental icome is greater than £1,000 can deduct allowance from gross rent rather than deducting expenses

Question 106

Non-residential

What type of property is classed as non-residential? (5)

Answer 106

• Commercial property
• Agricultural land
• Forests
• Any other land or property not used as residence
• 6 or more residential properties bought in a single transaction

Question 107

Rent a room relief

What is it?

CGT payable?

Answer 107

Income from renting a furnished room in your main residence up to £7,500 tax free or £3,750 per person if joint

If yearly rental is greater than £7,500 can either be taxed on excess over £7,500 but no expenses or normal basis income less expenses

No CGT payable as main residence

Question 108

Rent a room relief

If rental received exceeds linit of £7,500?

Answer 108

If yearly rental is greater than £7,500 can either be taxed on excess over £7,500 but no expenses or normal basis income less expenses

Question 109

Rent a room relief

Conditions? (3)

Answer 109

• Must be in UK
• Doesn’t apply to self contained unit or unfurnished
• Must not be used as a residence i.e. an office

Question 110

REITS

What are they?

Answer 110

Closed ended companies listed on stock exchange

Question 111

Real Estate Investment Trust (REITS)

Conditions? (5)

Answer 111

• 75% of assets and gross profits must be in investment property
• Income must cover gearing by 125%
• 90% of rental profits must be paid as dividends within 12 months of end of accounting period
• Listed on recognised stock exchange
• At least 3 properties and held for 3 years

Question 112

REITS

How are they taxed?

• ring-fenced (RF)?
• non ring-fenced (NRF)?

Answer 112

Ring Fenced:

Within Fund: Exempt from corporation tax

Income: Property income paid net of 20%, can reclaim if non tax-payer

CGT: Fully liable

Non-Ring Fenced

Within Fund: Subject to corporation tax

Income: Dividend income, usual dividend rules

CGT: Fully liable

Question 113

PAIF

What is it?

Answer 113

Property authorised investment fund, is an OEIC

Question 114

Commercial property

Types? (3)

Answer 114

• Retail - lowest yield
• Office building - most competition in terms of supply
• Industrial property - higher yields

Question 115

Commercial property

Characteristics? (5)

Answer 115

• Move in different ways to equities - good for diversification as often invest in all 3 types
• More secure income as longer leases - residential 6-12 months; commercial 10 years
• Valuation - multiple of rent
• Values cyclical - rent paid every 3-5 years
• Usually pass insurance and maintenance costs to tenant

Question 116

Commerial property

Drawbacks? (5)

Question 117

Alternative investments

Examples?

Answer 117

Art, commodities, collectables

Question 118

Alternative investments

Drawbacks? (6)

Answer 118

• Don’t produce income
• Heavily reliant on investor sentiment - need to be an expert
• Often cost money to upkeep - e.g. repair, insurance premiums
• Limited supply and fluctuating demand
• Price between buying and selling can be higher
• Authenticity important

Question 119

Commodities

Hard and soft?

Answer 119

Hard: typically mined e.g. oil, gold, precious stones

Soft: typically grown e.g. coffee

Question 120

Commodities

Why do they make a good investment?

Answer 120

Low correlation with other assets

Question 121

Commodities

Invest in commodities through? (3)

Answer 121

• Companies that produce commodities
• Funds thta invest in commodities
• Exchange Traded Commodities (ETCs)

Question 122

Cryptocurrencies

What is blockchain and mining?

Answer 122

Digital ledger processing transactions using encryption technology

Computer accounting solving math problems

Confirms transaction is legit

Creates new digital currencies - pays miners with % of transaction fee charged to user

Question 123

Blockchain and mining

Other details? (3)

Answer 123

• Transactions annoymous
• Not regulated by FCA
• Not backed by government or central banks

Question 124

Indices

What are they?

Answer 124

Shows the way markets have moved over time

Question 125

Indices

Are used to what? (2)

Answer 125

• Compare a share with performance of sector or market
• Compare performance of fund manager with market

Question 126

Indices

Performance of portfolios can be measured against? (3)

Answer 126

• An index reflecting whole market
• Largest companies/ smaller companies
• Particular sectors

Question 127

Indices

What are they weighted on?

• impact of larger companies?

Answer 127

Market capitalisation

Larger companies impact the index more

Question 128

Free float adjustment

What is it?

Answer 128

Free float of stock equals the portion of shares available for trading therefore weighting of company with lower than 75% shares available are adjusted for free float

Question 129

Indices

Limitations? (3)

Answer 129

• Can be heavily impacted by larger companies
• Not as good as fundamentally weighted index - weighted on revenue, earnings, employees and dividends
• Ignores dividends, costs of buying and selling, CGT and management expenses

Question 130

The macro economic environment

Greater Good theory?

Therefore overestimate and underestimate leads to?

Answer 130

Buying assets as expect prices to continue to rise - bubbles

Overestimate expected returns and underestimate competitive pressures leads to excess liquidity in markets

Question 131

The macro economic environment

Why can the government no longer use interest rates effectively?

Government must use what instead?

Answer 131

Interest rates are so low

Government use fiscal policy instead

Question 132

The macro economic environment

What does government policy affect? (5)

Answer 132

• Interest rates and currencies
• Business and competition
• Economic cycles and inflation
• International relations - greater inportnace due to globalisation
• Elections - ease policy to increase votes

Question 133

Socio-economic challenge

What is it? (3)

Answer 133

• People are living longer - more people at retirement, strain on, services investment markets and state pension
• Birth rates are declining
• Ageing population and workforce - increased strain on financial services and healthcare

Question 134

Socio-economic challenge

Technology

What has this meant? (4)

Answer 134

Fast growing industries

• Mobile communications
• Mew generation of digital metrics
• Increased globalisation - lead to investment in foreign markets and low skilled workers competing with developed countries

Question 135

6 stages of economic cycle?

What are they?

How does it affect demand, inflation, interst rates, unemployment in each case?

Answer 135

• Boom
• Slow down - falling demand, increase interest rates and inflation and increase in unemployment
• Recession - falling demand, profits and output, lower interest rates, inflation and increase in unemployment
• Bust
• Recovery - Increased demand, lower inflation and interest rates, equity growth increases as interest rates low
• Acceleration - increase demand, inflation and interest rates

Question 136

GDP

What is it and when is it measured?

What does a change in GDP help to show?

Answer 136

Total value of goods and services produced each year measured quarterly

Show where company is on business cycle

Question 137

PSNCR

What does it stand for?

Answer 137

Public Sector Net Cash Repayment

Question 138

PSNCR

What is it?

What does it indicate - how is this impacted by a boom or recession?

Answer 138

Difference between government spending and revenue

Indicates how much the government need to borrow - higher in recession and lower in a boom

Question 139

Bank of England

What does it set?

Answer 139

Base rate - rate C

Question 140

Bank of England

When do changing interest rates have the largest impact?

Answer 140

18 months - 2 years after change therefore Bank of England targets future rather than present inflation

Question 141

Interest rates

If interest rates are low what impact does this have on fixed interest and property?

Answer 141

Increases asset prices for fixed interest and property

Question 142

Balance of payment

What is it and how is it measured?

Answer 142

(BOP) is an accounting of a country’s international transactions for a particular time period. Any transaction that causes money to flow into a country is a credit to its BOP account, and any transaction that causes money to flow out is a debit

Question 143

Balance of payments

UK has a what?

Answer 143

Trade Gap M > X

Question 144

Balance of payments

Made up of? (2)

Answer 144

• Current account
• deals with X, M, interest, dividends & rent
• Visible trade (goods) and invisible trade (tourism)
• divided into trade in goods and services, investment income and transfer payments
• Capital account
• foreign investments and loans in UK and abroad
• If overdrawn Bank of England reserves used to finance it

Question 145

Money Supply

Made up of? (4)

Includes?

Answer 145

• Narrow Money - M0 = level of notes and coins in circulation + banks operational balances at the Bank of England
• Broad money - M4 = money supply is defined as a measure of notes and coins in circulation (M0) + bank accounts (deposits created by banks and BS through lending activities and savings deposits

Question 146

Money suppply

What does it indicate?

Answer 146

Economic situation and changes in economic cycle

E.G. Rising interest rates indicates lower demand for money

E.G. Rising M4 indicates higher demand for loans, rapid increase may indicate rising inflation

Question 147

Money supply

How can the Bank of England influence money supply?

How does this work?

Answer 147

Selling/ purchasing treasury bills/ gilts

E.G. to lower money supply sell securities at attractive rates - money being removed from circulation

Question 148

Inflation

4 types?

Answer 148

• RPI
• CPI
• CPIH - CPI and includes owner occupiers housing costs
• RPIY - RPI, excludes mortgage interest payments

Question 149

Inflation

What is disinflation?

What is deflation?

Answer 149

Disinflation - reduction in rate of inflation

Deflation - when inflation turns negative

Question 150

Inflation

Expectation of increased inflation leads to? (2)

Answer 150

• Reduction in price of future interest
• Reduction in value of equities

Question 151

Interest rates

Rising interest rates leads to? (4)

Answer 151

• Higher return on cash based deposits
• Reduction in price of fixed interest, higher yield for new bonds which leads to increase value of £
• Reduced equities as increase in cost of borrowing
• Increase foreign investors due to increased value of £

Question 152

Modern Portfolio Theory

What is it? (3)

What is the best portfolio to provide high returns with least amount of volatility?

Answer 152

• Maximise returns and minimise risk
• Investors are risk averse
• Diversified portfolio of imperfectly correlated asset classes can reduce risk through lower volatility

Imperfectly correlated asset classes

Question 153

Standard deviation

What does it measure?

Answer 153

How far from the average expected return an investment performs

Question 154

Standard deviation

For investors what does standard deviation mean?

Answer 154

How widely the actual return on an investment varies around its average/ mean return

Question 155

Standard deviation

What is the normal distribution of data?

Answer 155

The return expected to fall within one standard deviation of the average return 68% of the time and within two standard deviations 95% of the time

Question 156

Diversification

What is it?

Answer 156

Holding a range of imperfectly correlated asets in a portfolio to smooth out fluctuations caused by economic and financial events

Question 157

Reduction of risk

Can reduce the risk on portfolios by? (2)

Answer 157

Diversification

Hedging - taking a position where if one asset value falls another one increases

Question 158

Diversification

How does it impact systemic and systemic risk?

Answer 158

Lowers systemic risk but not systemic risk

Question 159

Diversification

Is achieved by? (3)

Answer 159

• Holding different asset classes
• Companies in different sectors
• Overseas companies

Question 160

Correlation

3 types?

Answer 160

• Positive correlation - profits and share values move in same direction
• Negative correlation - profits move in appropriate direction to values
• No correlation - profits and shares have no relationship

Question 161

Efficient frontier

To plot efficient frontier need to know? (3)

Answer 161

• Return of each investment
• Standard deviation of each assets return
• Correlation between assets return

Question 162

Efficient frontier

What are the limitations?

Answer 162

• Assumes investment returns follow normal distribution pattern
• Standard deviation correct level of risk?
• Doesn’t factor in e.g. ethical preferences
• Works on historial data
• Doesn’t take into account charges - transaction costs
• Assumes underlying funds are index funds

Question 163

Non-systemic risk

What is it and what is it independent of?

Answer 163

Investment specific risk - risk that affects a particular company

Independent of economic, social and policitical factors e.g. new competitor

Question 164

Non-systemic risk

How many securities needed to eliminate most of non-systemic risk?

Answer 164

Need 15-20 randomly selected securities - however the rate of risk diminshes the more securities are added

Question 165

CAPM

What does it stand for?

Answer 165

Capital Asset Pricing Model

Question 166

CAPM

Definition?

Answer 166

To consider a riskier asset an investor would want a return that is equal to the risk-free return plus a risk premium for taking on the additional risk of that asset

Question 167

CAPM

What is normal risk-free return?

Answer 167

Usual return you would get in cash / 91 day treasury bills

Question 168

CAPM

Measures?

Expressed?

Answer 168

The riskiness of a security by comparing it to the market

Expressed in terms of its beta ß

Question 169

Beta ß

Definition?

Answer 169

The market has a beta of one, and the beta of an individual security reflects the extent to which the security’s return moves up or down with the market

Question 170

Beta ß

If security has ß of 1?

Answer 170

Has matched market historically - if market moves by 10%, the security’s price will be expected to also move by 10%

Question 171

Beta ß

A security with ß more than one?

Answer 171

Exaggerates market movement and is more volatile than the market - by how much depends on the ß - aggressive securities

Question 172

Beta ß

Security with ß less than one and more than zero?

Answer 172

Usually more stable than the market, move less than the market but in the same direction - defensive securities

Question 173

CAPM Equation

Equation?

Answer 173

E(Ri) = Rf + ßi (Rm – Rf)

E(Ri) is the expected return on the risky investment;

Rf is the rate of return on a risk-free asset;
Rm is the expected return of the market portfolio;
ßi is the measure of sensitivity of the investment to movements in the overall market;
(Rm – Rf) is the market risk premium, the excess return of the market over the risk-free rate; and ßi (Rm – Rf) is the risk premium of the risky investment

Question 174

CAPM

Assumptions? (6)

Answer 174

• All investors have an identical holding period
• Many buyers and sellers
• No taxes / short selling restrictions
• All info available
• Liquidity ignored - quantity of risky securities fixed in market
• Investors can borrow at risk free rates and make decisions based on risks and return alone

Question 175

CAPM

Limitations? (3)

Answer 175

• Finding risk free rate difficult
• Choosing market portfolio can be difficult as ß varies - typically uses FTSE 100
• ß assured to be stable and calculated on historical data

Question 176

Multi factor models

A further limitation of CAPM?

Answer 176

Only concerned with security’s sensitivity to market therefore single factor model

Question 177

Multi factor models

What are they?

Answer 177

Attempts to describe security returns as a function of a limited number of factors - adds to risk premium for each sector

E(Ri) = Rf + ßGDP (risk premium GDP) + ßIR (risk premium IR) = minimum return + risk premium

Question 178

Multi factor models

What is Fama and French model?

Findings? (2)

Answer 178

Add factors for company size and value

• Small cap stocks tend to outperform large cap stocks
• Value stocks tend to outperform growth stocks

Question 179

Arbitrage pricing theory (APT)

What is it?

Answer 179

A security’s return can be predicted using the relationship between the security and a number of common risk factors - sensitivity to changes in factor is represented by a factor - specific ß

Question 180

Arbitrage pricing theory

If price diverges?

Answer 180

Abritrage activities should bring it back in line so not possible for a security to yeidl better returns than indicated by its sensitivity to the various factors

Question 181

Arbitrage pricing theory

What is arbitrage?

Answer 181

Practice of taking advantage of security mis-pricing to make a risk-free profit

Question 182

Arbitrage pricing theory

How does it differ to CAPM? (2)

Answer 182

• Belief that asset prices determined by more than one type of market risk
• Each investor holds a unique portfolio rather than identical portfolios

Question 183

Arbitrage pricing theory

Limitations? (3)

Answer 183

• APT is general - doesn’t tell us which factors are relevant
• Number and nature of factors likely to change over time and between economies
• Also need to calculate multiple betas

Question 184

Multi-factor models

Characteristics of all? (2)

Answer 184

• Investors require extra return for taking risk
• Pre-dominantly concerned with risk that can’t be eliminated by diversification i.e. systemic risk

Question 185

Arbitrage pricing theory

Factors that influence security returns? (4)

Answer 185

• Unanticipated inflation
• Change in expected level of industrial production
• Change in default risk premium on bonds
• Unanticipated change in return of long term government bonds over treasury bills (shifts in yield curve)

Question 186

EMH

What is it? (3)

Answer 186

Efficient market hypothesis

• Share prices move based on info such as profits
• Share price you see equals fairest price
• Not possible to outperform market by choosing undervalued shares because market reacts before investors

Question 187

EMH

Buying and selling shares is more about….?

Answer 187

Chance than skill

Question 188

EMH

Favours what funds?

Answer 188

Tracker funds

Question 189

EMH

3 forms?

How do they differ?

Answer 189

Same premise but different level of info available:

• Weak-form efficiency - curernt share price fully reflects all past price and trading info
• Semi-strong efficiency - share prices adjust to all publicly available info, done rapidly and unbiased (all past-trading info, accounts and other economic factors)
• Strong-form efficiency - share price reflects all public and private info, including insider trading

Question 190

Behavioural finance

What is it?

Answer 190

Aims to explain market anomalies not explained by traditional finance models

Question 191

Behavioural finance

They believe?

Answer 191

Psychological factors, behavioural biases affect investors therefore investors are irrational - as shown by bubbles and crashes

Differ from MPT and EMH that say investors are rational

Question 192

Prospect theory/ loss aversion

What is it? (2)

Answer 192

• Investors more distressed by a loss than they are pleased by the same level of gain
• People play safe when protecting gains but often take riskier decisions aimed at loss aversion e.g. reluctance to realise a loss therefore hold onto a losing investment for too long hoping it will make a gain - avoiding feeling of regret

Question 193

Overconfidence and over and underreaction

What is it? (3)

Answer 193

• Investors overestimate their own skills and predictions - leads to bubbles and underestimate the likelihood of bad outcomes
• More optimistic when market goes up and more pessimistic when markets go down
• Often give too much weight to recent experience which often run contrary to long-run averages

Question 194

Criticisms of behavioural science

What are they? (3)

Answer 194

• Can’t predict the effect on the market of human behaviour
• No doubt this impacts investors but hard to/ cannot be quantified
• Only look at anomalies which will eventually be priced out of the market

Question 195

The time value of money

Key concepts? (2)

Answer 195

• Money received now is more valuable than money received in future years
• A rate of interest received monthly is more valuable than the same rate of interest received quarterly/ annually

Question 196

Time value of money

Key terms and definitions - PV?

Answer 196

Present value (PV) - amount of capital invested today, known as principal

Question 197

Time value of money

Key terms and definitions - n?

Answer 197

Time period (n) - time period capital is invested - The number of time periods interest is paid denoted by n, e.g. if paid twice a year, n = 2, quarterly, n = 4

Question 198

Time value of money

Key terms and definitions - r?

Answer 198

Interest rate (r) -quoted as a %, expressed as a decimal, r. e.g. interest rate of 7% is written r = 7 ÷ 100 = 0.07

Question 199

Time value of money

Key terms and definitions - FV?

Answer 199

​Future value (FV) - accumulated value of an amount of money invested for n time periods, at a rate of interest r

Question 200

Time value of money

FV calculation?

Answer 200

The basic formula for calculating compound interest is:

FV = PV (1 + r)n

Question 201

Time value of money

EAR formula?

Answer 201

Effective Annual Rate - takes into account the interest rate if compounded more than once a year

(1 + r/n) n - 1

Question 202

Interest payable at more frequent intervals

Difference between EAR/ APR/ AER?

Answer 202

No difference in formula

EAR used for loans and deposits

APR (annual percentage rate) used for loans

AER (annual equivalent rate) used for deposits

Question 203

Interest payable at more frequent intervals

What if compounded monthly rather than annually?

Answer 203

n increased by number of times compounded e.g. 12 for monthly in 1-year or 24 for monthly in 2-years

r is decreased by n

Question 204

PV

How do you calculate - i.e. what amount has to be invested now to receive x in ..yrs?

Answer 204

PV = FV/ (1 + r) n

annual interest = number of times compounded in year

Question 205

FV

Formula to calculate FV if regular investment?

Answer 205

FV = P ((1 + r)n - 1 / r)

Question 206

FV

What is a discounted cash flow useful for?

Basic formula?

Answer 206

Calculate PV of an investment’s future cash flow to arrive at a fair value for current price

Calculating PV of FI

PV = FV/ (1 + r) n

where PV is present value of cash flow

Question 207

Theoretical price of a bond

Calculate?

Annual coupon = 6.5%

PAR in 2 years = £100

IR = 5%

Answer 207

PV = £6.50/(1+ 0.05)1 + £106.50/ (1+ 0.05)2

PV = £6.19 + £96.60

Therefore, the theoretical present value of the bond = £102.79.

Question 208

Annuity

What is it?

Answer 208

The sum of money needed now to make regular payments and interest over fixed term at fixed interest rate

Question 209

Annuity

Formula?

Answer 209

A = P (1 - (1 + r) - n / r

Question 210

Real Returns

Formula?

Answer 210

The real return is approximately the nominal return from an investment minus the inflation rate:

RREAL = RNOM – RINF
where:
RREAL is the real return;
RNOM is the nominal return;

RINF is the inflation rate.

Question 211

Assessing risk

Inflation particularly bad for? (2)

Answer 211

• Cash deposits
• Fixed interest

Question 212

Inflation risk

Causes of inflation? (11)

Answer 212

• expanding money supply
• bottlenecks in production cause prices to rise and imports to flood into the economy
• the government and the financial markets respond with rising interest rates
• cuts in public expenditure, as well as tax increases to dampen down demand
• the economy enters recession and prices steady, or perhaps fall, as the supply of goods and services exceeds economic demand.
• Some cycles are further exacerbated by external events such as:
• war or shortages;
• prices of imported goods rising as overseas countries experience inflation and commodity prices also increase
• currency devaluation
• high wage demands, which can be affected by trade union policies
• Investor sentiment

Question 213

Interest rate risk

Mainly effects?

Answer 213

Fixed interest securities - sensitive to the rises and falls in interest rates. When Interest rates fall, bond holders capital value will rise and when interest rates rise, capital value will fall, as investors can get greater returns elsewhere

Question 214

Interest rate risk

How can a bond manager lower interest rate risk?

Answer 214

By holding shorter dated stock / cash

Question 215

Interest rate risk

Factors affecting interest rate moves? (5)

Answer 215

• Economic cycle
• Fiscal policy - issuing gilts will push up long term yields
• Monetary policy - QE reduces short term rates
• Inflation - expectations
• Preference for liquid securities - in uncertain times prefer instant access

Question 216

Credit risk

Maninly affects what?

Answer 216

Bonds and cash deposits

Question 217

Credit risk

4 types?

Answer 217

• Default risk
• Downgrade risk - credit rating lowered
• Credit spread risk - gap between yields of gilts and corporate bonds get wider due to lack of confidence in corporate bonds - concern they can’t service their debt
• Counterparty risk - a counterparty will not pay what it is obliged to

Question 218

Currency risk

What is it?

Answer 218

Investment made overseas / in a foreign company profits impacted by change in exchange rates

Question 219

Liquidity risk

What is it?

Answer 219

Property and private equity vulnerable and may have to sell assets at a discounted price

Question 220

Event risk

What is it?

Answer 220

E.G. Natural disasters

Question 221

Political risk

What is it?

Answer 221

Changes in government / unrest

Question 222

Operational risk

What is it?

Answer 222

Internal errors in company

e.g. reporting error, fraud, regulatory risk, systems failure

Question 223

Bail-in risk

What is it?

Answer 223

Where financial assistance comes from existing capital base e.g. the institution’s shareholders, bondholders and depositors

Question 224

Diversification

Advantages of diversifying a portfolio? (4)

Answer 224

• Reduces the risk of one investment
• Spreads the opportunity for potential return across asset classes
• Minimises risk of the overall portfolio suffering downturn
• Increases possibility of stable returns through all economic cycles

Question 225

Gearing

What is it?

What does it magnify?

Answer 225

Borrowing money in a client’s portfolio with objective of increasing exposure to other assets

Magnifies positive and negative portfolio returns

Remember - borrowing costs

Question 226

Collective Invesments

Are popuar because? (6)

Answer 226

• Invest small sums of money, because the investor’s cash can be ‘pooled’ into a much larger fund
• Professional fund managers make the underlying investment decisions
• Investor can achieve a balanced portfolio with spread of investments
• Offer the ability to pursue particular objectives or specialise
• Investor’s risk is reduced by the wide spread of investments in the underlying portfolio
• Lower dealing costs

Question 227

Collective investment schemes

Total of everyone’s shares must equal?

Answer 227

Must equal NAV - Net Asset value - total value of assets held

Question 228

Unit trusts and OEICs

Characteristics? (4)

Answer 228

• Investor participate in a large portfolio of shares
• Units or shares, each unit representing a small but equal fraction of a portfolio of perhaps 50 or 100 different shareholdings
• Assets of a unit trust are held for investors by trustees, invested by managers, whereas the assets of an OEIC are held by an independent depositary
• Initial charge, which covers setting up costs and also an annual management fee. If no initial charge, an exit charge may be applied

Question 229

Unit trust and OEICs

OEIC and UT are protected by?

Answer 229

OEIC: independent depository therefore protected by company law and depository

UT: protected by trust deed and trustees

Both: protected by FCA and FSCS

Question 230

Unit trusts and OEICs

IA categories broad sectors? (4)

Answer 230

• Capital protected
• Income
• Growth
• Specialist
• Targeting an outcome

Question 231

Unit trusts and OEICs

To be included in IA sector must have and performance is measured by?

Answer 231

Must have at least 80% or more of its assets invested in the relevant sector

Income fund must achieve a yield of not less than 90% of the relevant index

Performance measurement companies such as Lipper or S&P

Question 232

Unit trusts

Constituted by?

Answer 232

Signing a trust deed

Question 233

Unit trusts

Who are trustees? (2)

Answer 233

• Large banks / insurers
• Must be independent of management group

Question 234

Unit trusts

Trustee roles? (5)

Answer 234

• Must report issues if unhappy with how fund managed
• Audit fund
• Issuing info to unit holders who must be registered
• Arrange meetings of unit holders
• Distribute income

Question 235

Unit trusts

Register must contain? (3)

Can it be closed?

Answer 235

• Name and address of unit holder
• Number of units held
• Date unit holder registered

Can be closed mo more than 30-days per year

Question 236

Unit trusts

Main role of the fund manager in return for…?

Answer 236

To manage fund in return for AMC

Question 237

Unit trusts

Manager’s duties? (5)

Answer 237

• Authorised person
• Adequate financial resources
• Manage assets according to regulations, the trust deed and scheme particulars
• Supply information to the trustee
• Maintain a record of units for inspection by the trustee
• Notify the trustee and/or the FCA if breach in rules

Question 238

Unit trusts

How is fund taxed?

Answer 238

Do not pay tax on capital gains nor income or gains derived from options or futures

Corporation tax - allowable expenses

Question 239

Unit trusts

Internal fund taxation - income if equity and if non equity?

Answer 239

• Interest and rental income are subject to corporation tax at a special rate of 20%.
• Dividends are received as franked investment income and flow through to dividend distributions payable by the unit trust with no tax liability.
• Foreign dividends may have had tax deducted at source (withholding tax), which may not be reclaimable.
• Funds that distribute interest rather than dividends can deduct the interest as an expense for corporation tax purposes to ensure there is no double taxation

Question 240

OEICs

Authorised as?

To comply with regulations must be? (2)

Answer 240

Investment companies with variable capital (ICVCs)

Incorporated and authorised

Question 241

OEICs

Fund manager is know as?

Answer 241

ACD - Authorised Corporate Director

Question 242

OEICs

ACD is responsible for? (4)

Answer 242

• OEIC compliance and protection
• Preparation of accounts
• Register of shareholders
• Day to day management

Question 243

OEICs

Operated by Independent depository - role? (4)

Answer 243

• Valuation, pricing and dealing
• Keeping ACD in check
• Collection of income
• Safekeeping assets

Question 244

OEIC vs Unit trust

Structure - similar?

Disadvantages? (2)

Answer 244

Both open-ended

• If multiple people want to sell may have to sell positions
• If fund grows too much and can’t cope

Question 245

OEIC vs Unit trust

Differences? (2)

Answer 245

• OEIC - limited company and issues shares, has one constitutional document and holds AGM - annual audited accounts, cost of creation may be met by fund
• Unit Trust - Trust structure and issues units - must be approved by meeting of unit holders. If it wants to increase charges must give 60 days notice

Question 246

OEIC vs Unit trust

Contribution similariities? (2)

Answer 246

• Both accept minimum and maximum
• Both accept single and regular

Question 247

OEIC vs Unit trust

For large contributions OEICs have?

Answer 247

Dilution levy - levy if large investor makes money and then leaves - ensures charging is fair for all

Question 248

OEICs vs Unit trusts

What is equalisation for unit trusts?

Answer 248

When a unit is bought it includes income accrued from previous distribution up to date of purchase

Question 249

OEICS vs Unit trusts

What makes up a unit trusts first distribution?

Answer 249

Income accrued from date of purchase plus equalisation payment

Question 250

Unit trusts

How is equalisation payment taxed?

Answer 250

Represents a partial refund of capital invested so no income tax but deducted from purchase price to identify acquistion cost for CGT

Question 251

Unit trusts

Aim of equalisation payment? (2)

Answer 251

• Fairness between unit holders
• Allow same price per unit dividend payment to all unitholders

Question 252

Unit trusts

Income tax on dividend distributions from equity unit trusts?

Answer 252

First £2,000 of dividend income in 2020/21 is tax free. Sums above that will be taxed at the following rates:

7. 5% for basic-rate taxpayers;
8. 5% for higher-rate taxpayers; and
9. 1% for additional-rate taxpayers.

Taxpayers must use self-assessment to pay any tax due

Question 253

Unit trusts

Taxation of dividend distribution from equity fund paid to trustees? (2)

Answer 253

Trustee is liable to tax at 38.1%

£2,000 tax-free dividend allowance does not apply, although dividends that fall within the standard band of £1,000 will only be taxed at 7.5%

Question 254

Unit trusts

Income tax on distributions from non-equity unit trusts? (2)

Answer 254

• Paid gross
• Under PSA, BRT can earn £1,000 in savings income tax free, HRT £500, additional rate no allowance

Question 255

Unit trusts

Income tax on distributions from non-equity unit trusts - Trustees? (2)

Answer 255

• Income tax at 45%
• First £1,000 (standard rate band) taxed at 20%

Question 256

Unit trusts

Income tax if reinvestment of dividends and interest?

Answer 256

Still counts as income for the investor, so same tax treatment as dividend that is distributed

Question 257

Unit trusts

Capital gains tax for investor? (3)

Answer 257

• Capital gains may be payable on any profits on disposal
• Losses can be offset
• Annual exemption

Question 258

OEICs & Unit trusts

If umbrella fund with sub-funds, is a fund switch taxed? What is exempt from this?

Answer 258

A switch from one sub fund to another is a disposal for CGT

FOF exempt

Question 259

OEICs vs Unit trusts

Advantages of OEICs? (4)

Answer 259

• OEICs more EU friendly for operating and marketing in EEA
• More flexible charging structure as can invest in multiple share classes
• Easier to run under umbrella structure e.g. platform
• Easier to create new funds - wider fund choice

Question 260

Multi-manager funds

Types? (2)

Answer 260

• Fund of Funds (FOF)
• Manager of Manager (MOM)

Question 261

Multi-manager funds

Explain types of FOFs? (2)

Answer 261

Fettered funds - only uses funds of host provider - correlation and diversification considered

Unfettered funds - can use funds from other companies - additional expense of charges of underlying fund

Question 262

Multi-manager funds

What is a tax advantage of FOFs?

Answer 262

Provides a CGT shelter, because switching between funds by the manager does not create any CGT liability

Question 263

Multi-manager funds

MOM fund describe? (3)

Answer 263

• Overall manager appointed to source best fund manager in each sector
• Rather than selling assets can just be assigned to new manager
• Cost transparency is greater for MOM than FOF

Question 264

Offshore Funds

Categories? (3)

Answer 264

• UCITS funds
• S.270 designated territories funds
• S.272 non-designated territories funds

Question 265

Offshore Funds

UCITS?

Answer 265

Receive automatic recognition from FCA as authorised by EU

Question 266

Offshore funds

S.270?

Answer 266

Protection equivalent to FCA as satisified country has similar rules to UK

Question 267

Offshore funds

S.272?

Answer 267

Not recognised by FCA and marketing prohibited in UK

Question 268

Offshore collectives

Tax treatment of investors - reporting funds? (5)

Answer 268

• Dividends and interest same as UK and normal CGT rules
• Dividends from funds constituted as companies is taxed as foreign dividend
• Must be declared to HMRC
• UK investor willl be taxed on their share ofthe income even if distribution is not received
• If fund has > 60% of interest bearing assets, distribution will be treated as interest and taxed at 0%, 20% 40% or 45%

Question 269

Offshore collectives

Tax treatment of investors - non-reporting funds?

Answer 269

• Often accumulative funds therefore no dividend or income (if equities dividends have to pay withholding tax
• CGT on CGT principles BUT chargeable as income tax therefoe higher rates
• No allowances

Question 270

Offshore collectives

Non-reporting funds - advantages? (2)

Answer 270

• Grow faster as low tax environment
• If non-UK domicile - no IHT

Question 271

Offshore funds

Taxation treatment? (3)

Answer 271

• If equity - dividends subject to non-reclaimable withholding tax
• If fixed interest - tax free income as income is paid gross
• May be small amount of tax e.g. Jersey funds are subject to small flat annual corporation tax charge

Question 272

AIFs

What can they be elected to be taxed as?

What does this mean? (2)

Answer 272

Tax-elected fund (TEF)

• Required to make a dividend and non-dividend (interest payment)
• Moves point of tax from TEF to investor

Question 273

Share exchange facility

What is it?

Answer 273

Investors can exchange shareholdings on stock exchange for units/shares in fund

Question 274

Share exchange facility

Why do this?

Answer 274

Cheaper for disposing of small shareholdings

Question 275

Share exchange facility

Minimum?

CGT exemptions?

Answer 275

• Either accepts shares and adds into fund or
• Disposes of shares and buys new units

Question 276

Share exchange facility

Minimum?

CGT exemptions?

Answer 276

£1,000

No investor CGT exemptions

Question 277

Pricing

What are the two methods of fair value pricing a unit trust manager can elect to use? (2)

Answer 277

• Dual pricing
• Single pricing

Question 278

Pricing

What is dual pricing?

Answer 278

Determines:

The highest price at which units can be sold to investors (offer)

The lowest price a manager can repurchase from investors (bid)

Difference = bid-offer spread

Question 279

Pricing

What is single pricing?

Answer 279

Uses mid market pricing therefore incoming and outcoming investors deal at same price

Question 280

Pricing

Single Pricing - each share price reflects?

Answer 280

Total net value of fund’s assets

Question 281

Pricing

Single Pricing - no allowance for?

Answer 281

Dealing costs and charges are shown separately

Question 282

Pricing

Single Pricing - shares purchased at?

Answer 282

Single price and initial charge

Question 283

Pricing

How to calculate buying or offer price? (5)

Answer 283

• market buying value of underlying securities;
• add costs of buying securities in the market;
• add on all the other property of the trust, such as uninvested cash and any accrued income less tax, fees, charges and expenses;
• divide the total by the number of units issued;
• add on the initial charge and express the price to four significant figures

Question 284

Pricing

How to calculate selling or bid price? (6)

Answer 284

• value underlying securities at the best market selling prices;
• deduct the dealing costs that would be incurred if the securities were to be sold;
• add in any uninvested cash;
• add any accrued income after deduction of any annual management fees, trustees’ fees, audit fees and outstanding tax;
• divide the total by the number of units in issue;
• express to four significant figures

Question 285

Pricing

Bid offer spread is and expressed as?

Answer 285

Difference between buying and selling prices, expressed as a % of the buying price

Question 286

Pricing

What does the bid offer spread include? (2)

Answer 286

• Dealing costs
• Initial costs

Question 287

Pricing

Bid offer spread varies depending on what? (3)

Answer 287

• Type of asset
• How easy it is to buy or sell
• How liquid the asset is

Question 288

Pricing

What is the usual bid offer sread for the following:

• Equity funds?
• No load index trackers?
• Smaller companies and emerging markets?
• Cash?

Answer 288

• 5% to 7%
• >1%
• >10%
• Often no spread at all

Question 289

Pricing

If demand is high for units what happens to the unit buying price?

Answer 289

Manager sets buying price at offer end

Question 290

Pricing

If demand is low for units what happens to the unit buying price?

Answer 290

Manager sets buying price at bid end

Question 291

Pricing

What is the box?

Answer 291

Manager holds new units or units that have been repurchased from investors

Question 292

Pricing

What is Box management?

Answer 292

Stock control mechanism applied by managers in buying and selling of units

Question 293

Pricing

Why decide to hold units in a ‘box’? (3)

Answer 293

• Fund is expanding as investors are buying, the manager will create units at the creation price
• Fund is contracting, there are more sellers than buyers, the manager will cancel units at the cancellation price
• Weighing up the risk of the market turning and expected future demand

Question 294

Forward and historic pricing

What is it?

Answer 294

Forward - price calculated at next valuation

Historic - price calculated at last valuation

Question 295

Forward and historic pricing

When must managers go from historic to forward?

Answer 295

If value has changed by 2% or more since last valuation, and if the investor requests it

Question 296

Forward and historic pricing

Most managers deal on what pricing basis?

Answer 296

Forward basis

Question 297

Authorisation of collective investment funds

What is COLL?

Answer 297

FCA detailed framework for authorisation and operations of collective investment schemes

Question 298

Charges

Investors in unit trusts incur different types of charges, what are they? (5)

Answer 298

• Initial charge
• Annual management fees
• Performance fees
• Exit charges
• Other charges - e.g. legal and audit fees

Question 299

Investment Trusts

Formed under what Act?

Subject to regulations from? (2)

Answer 299

Companies Acts

• FCA - FSMA 2000
• HMRC - s.842 approval - Income and Corporation Taxes Act 1988

Question 300

Investment Trusts

Can invest in? (3)

Answer 300

• Any kind of company, whether its shares are quoted, unquoted, private company
• Provide venture capital to new firms or firms that want to expand
• Any country in the world

Question 301

Investment Trusts

Who do they cater for?

Answer 301

Extremely adventurous investors

Question 302

Investment Trusts

Traded as?

Answer 302

PLCs on LSE

Question 303

Investment Trusts

How do they work? (5)

Answer 303

• Structured as a normal company with directors and shareholders
• Issue a fixed number of shares (close-ended)
• Regulated by company law
• As PLCs they can borriw to ‘gear up’
• Shares are traded on LSE

Question 304

Investment Trusts

Directors can employ a fund manager in two ways?

Answer 304

• Salaried fund manager - self managed trust
• Contract a external fund mangement group

Question 305

Investment Trusts

Operate what kind of pricing?

Answer 305

Dual-pricing known as market makers spread or turn

Question 306

Investment Trusts

Advantages of the fixed capital structure? (3)

Answer 306

• Managers can take a longer term view
• Not forced to sell assets to pay investors as secondary market
• Can gear portfolios

Question 307

Investment Trusts

To not be liable to CGT, what must the company do? (3)

Answer 307

• Resident in the UK
• Listed on the LSE
• Doesn’t retain >15% of gross income

Question 308

Investment Trusts

Premiums?

When does it occur?

Answer 308

If share price is higher than the NAV per share, then the IT is trading at a premium

e.g. If share price is 210p, NAV is 200p, the premium is 5%

Occurs when high demand for IT

Question 309

Investment Trusts

Discounts?

Occurs when?

Answer 309

Share price is lower than NAV per share - trading at a discount, as buying underlying assets at lower price than if bought directly

e.g. Share price is 180p, NAV is 200p, the discount is 10%.

Occurs when more sellers than buyers

Question 310

Investment Trusts

Narrowing discounts?

Answer 310

Provides better returns on share price than underlying assets

Question 311

Investment Trusts

Widening discounts?

If stock market falls at same time?

Answer 311

They reduce the gain an investor could potentially receive

If stock market falls as well, investor loses > reduction in value of a trusts investments

Question 312

Investment Trusts

NAV of trust equals..?

Answer 312

Total value of all the investments held less any liabilities

Question 313

Investment Trusts

Calculating NAV per share? (5)

Answer 313

• total value of a trust’s listed investments at mid-market prices;
• plus unlisted investments as valued by the directors;
• plus cash and any other assets;
• less nominal value of loans, debenture stock and preference shares
• resulting figure is known as shareholders’ funds

Question 314

Investment Trusts

Why is the NAV calculation misleading?

What should you use instead?

Answer 314

• Many ITs issue warrants or loan stocks with option to convert to ordinary shares
• Diluted NAV - assumes all options are exercised

Question 315

Investment Trusts

Capital structure? (2)

Answer 315

• Conventional
• Split capital

Question 316

Investment Trusts

What is a Conventional trust?

Answer 316

Issue one main class of equity share (ordinary share) - investors entitled to all income and capital, indefinite term

Question 317

Investment Trusts

What is a limited life investment trust? (3)

Answer 317

• Fixed initial term
• On maturity investors vote whether to wind up trust or contine - typical term is 3 years
• Closer to date the narrower the discount as investors can obtain full value of assets if wound up

Question 318

Investment Trusts

What is the advantage of a limited life investment trust to the investor?

Answer 318

Helps to reduce the discount

Question 319

Investment Trusts

What is a split capital investment trust? (4)

Answer 319

• One portfolio of investments produces both growth and income
• Issue multiple classes of equity shares with different priorities on wind up
• Limited life span 5-10 years
• Investors are not locked in

Question 320

Investment Trusts

Split capital investment trust - important rates? (3)

Answer 320

• Redemption yields - told return on maturity
• Hurdle rate - rate the investment must grow in order to replay each class of share at the wind up date
• Wipe out rate - annual rate of decrease in gross assets - no capital payment on wind up

Question 321

Investment Trusts

Asset cover?

Answer 321

Way of measuring the company’s ability to meet or cover, from current assets, the liability to share classes with a pre-determined redemption price

Question 322

Investment Trusts

Asset cover - what is taken into account first?

Answer 322

Any shares ranking for prior payment

Question 323

Investment Trusts

Asset cover - what does a cover of 1 mean?

Answer 323

Assets exactly cover the redemption price.

A cover of 50% or 0.5 means that half of the redemption price is covered

Question 324

Investment Trusts

Share classes? (3)

Answer 324

• Ordinary shares - entitled to all income and growth
• Preference shares - fixed dividend,
• Split capital shares - income shares, capital shares, packaged units, zero dividend preference shares

Question 325

Warrants

What are they? (5)

Answer 325

• Right to buy shares at a fixed price at pre-determined date or within a specified period
• No income is produced
• Price is a fraction of the share price
• Potentially high risk and high reward
• Bought and sold on LSE upto final exercise date

Question 326

Warrants

Tax? (2)

Answer 326

• No income tax liability - as no dividends
• CGT on gain in excess of annual exemption

Question 327

Warrants

Typically issued as …? (2)

Answer 327

• Sweeteners - when new shares issued e.g. one warrant given for every 5 shares purchased
• Newly opened ITs usually trade at a discount, immediate loss due to launch costs - so they need a sweetener

Question 328

Warrants

How can they dilute NAV?

Answer 328

If warrants are exercised and more shares created, there will be a dilution in the NAV per share of existing shares

Question 329

Warrants

What can companies do to stop dilution of NAV?

Answer 329

Repurchase their warrants to reduce the dilution effect

Question 330

Share buybacks

What are they?

Answer 330

When investment trusts buy their own shares

Question 331

Share buybacks

What are they used for? (2)

Answer 331

• To return money to shareholders
• Reduce discounts

Question 332

Share buybacks

Gives the board greater control of what?

Answer 332

Balance supply and demand and help reduce the discount

Question 333

Share buybacks

To carry out need permission from?

Answer 333

Shareholders

Question 334

Gearing

Equation?

Answer 334

Total gross assets

DIVIDED BY

Net assets

MULTIPLIED

100

Question 335

Gearing

If 100 - what does this mean?

Answer 335

No gearing

Question 336

Gearing

If 120 - what does this mean?

Answer 336

Fund is 20% geared (20% of the total assets are borrowed funds)

Question 337

Gearing

What is it?

Answer 337

Fund borrows money to buy shares and other assets, if they do not have sufficient free capital

Question 338

Gearing

What does it relate to? (3)

Answer 338

• Financial gearing (e.g. bank loans and debentures)
• Structural gearing (in case of splits)
• Investing in other geared investments e.g. warrants

Question 339

Gearing

What is structured gearing for ITs?

Answer 339

Is inherent in the nature of split capital ITs, each share class has varying risk

Question 340

Gearing

What are the effects of structured gearing for ITs? (3)

Answer 340

• returns on each class of share are affected by the entitlements of other share classes that rank for prior payment;
• number of share classes and their particular entitlements determine the level of structural gearing involved;
• classes of shares that are lower down the order of entitlement are higher risk as a result of the capital structure

Question 341

Geared investment trusts

When must enhanced risk warnings be given to clients? (3)

Answer 341

• an investment trust uses gearing as an investment strategy
• it invests in other investment trust companies that use gearing as an investment strategy
• exposure to gearing subjects value to significant fluctuations compared with the underlying investment

Question 342

Geared investment trusts

Definition of significant?

Answer 342

If no underlying or structural gearing and financial gearing is below 30%, investors do not need to be given enhanced risk warnings

Question 343

Investment trusts charges

What is the typical AMC?

Answer 343

Lowest on older ITs - 0.5%

New, specialist ITs - 1 to 1.5%

Question 344

Investment Trust charges

OCF adds %?

Includes?

Answer 344

+ 0.2 to 0.5%

Includes all other expenses of running the fund

Question 345

Investment trust charges

Difference between OCF and TER?

Answer 345

TER includes performance fees

Question 346

Investment trust charges

What do OCF and TER not include? (4)

Answer 346

• Entry or exit fees
• Interest on borrowing
• Brokerage charges
• Dealing costs

Question 347

Investment trusts

Taxation of IT companies? (3)

Answer 347

• Approved by HMRC - not subject to CGT on gains
• No additional tax on franked income (franked income is the dividend income that investment trusts receive from their shareholdings in UK companies)
• Corporation tax payable on unfranked income, for example, interest from gilts and bank deposits. Can reduce by offsetting expenses – interest paid on borrowings and management fees

Question 348

Investment trusts

Taxation of the investor? (4)

Answer 348

• First £2,000 dividend income annually is tax free.
• Sums above this are taxed as any other dividend
• Investors are liable to CGT on any profit - total gains on all disposals, after deduction of losses, exceeds an investor’s CGT annual exempt amount.
• If held in an ISA, all dividends and capital gains are tax free

Question 349

Investment trusts

Advantages over unit trusts and OEICs? (5)

Answer 349

• Cost of purchasing shares usually lower
• AMC cheaper for older contracts
• Higher risk but potential higher reward - trading at discount and gearing
• Can provide higher levels of income
• Some ITs can’t be accessed as OEICs and unit trusts e.g. guaranteed or protected funds

Question 350

UCITS

What does it stand for?

Answer 350

Undertakings in Collective Investment and Transferrable Securities

Question 351

UCITS

To meet FCA rules? (4)

Answer 351

• No more than 10% in any one share
• Only 4 companies can have 10%
• Any other holdings must not exceed 5%
• Minimum of 16 holdings

Question 352

UCITS

If replicating tracker fund?

Answer 352

Hold up to 20% of the value of the fund in the shares of one company and, where justified by exceptional circumstance, up to 35%

Question 353

UCITS

Maximum holding in unlisted securities?

Maximum holding in another collective investment?

Answer 353

10%

20%

Question 354

UCITS

Borrowing - retail and non retail?

Answer 354

• Retail can’t borrow on permanent basis, but can can borrow up to 10% fund on temporary basis against future cash flows
• Non-retail can borrow 10% on permanent basis

Question 355

UCIS

Stands for?

Answer 355

Unregulated Collective Investment Schemes

Question 356

UCIS

Can they be marketed to UK retail investors?

Answer 356

No

Question 357

UCIS

Fit into which category?

Includes?

Answer 357

Non-mainstream pooled investments (NMPI)

Qualified Investor Schems (QIS)

Traded life policy investments

Question 358

Life assurance based investment

3 types?

Answer 358

• With Profit - same as non-profit but bonuses added annually in arrears
• Unitised with profit
• Unit linked

Question 359

Non-profit policy

What is it?

Answer 359

If certain criteria is met by the policy holder eg regular premiums or lump sum paid the sum assured paid to the policy holder.

Sum assured is the notional intrinsic underlying value

Question 360

With-profits bonuses

Investment performance is reflected in bonuses - explain? (3)

Answer 360

• Added to the value of the policy annually. Based on companies profits, not guaranteed but, once added, cannot be taken away.
• Annual bonuses based on performance of fund, expressed as % of sum assured and calculated on a simple or compound basis.
• Final bonuses paid on maturity, death, sometimes surrender. Represent fund capital growth over entire period. More volatile, directly affected by changes in markets, not guaranteed

Question 361

Closed with-profit funds

What is asset allocation and what does this mean?

Answer 361

Most hold higher fixed interest and lower equities

Usually mean lower performance over long-term

Question 362

Closed with-profit funds

Problem with remaining in fund when others leave on MVR free days?

Answer 362

Fund becomes weaker - decreases value of underlying assets

Question 363

Conventional with profits

Advantages? (5)

Answer 363

• Suitable for risk averse
• Bonuses paid from firm’s reserves
• Smoothed return - makes feel safer
• Attraction of terminal bonus
• Final return often greater than inflation

Question 364

Conventional with profits

Disadvantages? (4)

Answer 364

• Difficult to understand
• Difficult to appraise underlying investment performance
• MVR can reduce liquidity
• Bonus rates have decreased in recent years

Question 365

MVR

What is it?

When is it not applied? (2)

Answer 365

Market Value Reduction - can reduce the amount payable on surrender

Not applied on death or maturity

Question 366

MVR

Why is applied?

Answer 366

Applied so value leaving fund doesn’t exceed value of underlying assets

Question 367

Unitised with profits

Describe?

Answer 367

With profit investment expressed as unit-linked policy. Premiums buy units in the unitised with profit fund. Unit price is guaranteed not to fall

Question 368

Unitised with profits

Type? (2)

Answer 368

• Fixed priced - unit price never varies, bonus adds units, cannot be taken away by the life office. Increase units daily by % of annual bonus set
• Variable price - unit price is increased through addition of regular bonuses, guaranteed not to fall

Question 369

Unitised with profits

Advantages? (5)

Answer 369

• Bonus rate declared annually in advance
• Easier to understand current value
• Switches can be made with other unit-linked funds
• Involves the insurance company in less initial commitment of reserves than traditional with profits
• Final bonus usually paid on death or maturity

Question 370

Unit linked funds

How is policy value measured?

Answer 370

By number of units allocated

Question 371

Unit linked funds

Surrender value at start?

Answer 371

Lower than the premium paid due to initial charge, usually 5%, and early termination charge

Question 372

Unit linked funds

Policy returns depend on? (2)

Answer 372

• Fund performance
• Exact days which the policy is set up and cashed in

Question 373

Life assurance investments

Use of? (5)

Answer 373

• Unique types of product available
• Some regulated products
• Property fund with actual property not property shares
• Favourable tax treatments
• Funds switched without cost or tax consequences

Question 374

Qualifying policies

Qualification test? (6)

Answer 374

• Term must be at least ten years
• Premiums must be payable annually or more frequently for at least ten years (or until a claim on death or disability)
• Minimum level of life cover is 75% of the total premiums payable
• Premiums payable in any one year must not be more than double those payable in any other year
• No premium is to be more than one-eighth of the total premiums payable over the term of the policy
• Annual limit for premiums is £3,600

Question 375

Chargeable events for non-qualifying policies

Chargeable events? (5)

Answer 375

D.A.M.P.S

• Death of life assured
• Assignment for money or money’s worth
• Maturity
• Part surrenders
• Surrender or final encashment

Question 376

Chargeable gains

Formula at maturity?

Answer 376

Maturity Value + partial surrender in 5% rule

MINUS

Premiums paid + premiums chargeable gains

Question 377

Investment bonds

What are they? (5)

Answer 377

S.P N.Q WOL N.R

• Single premium
• Non-qualifying
• Whole of life policy
• Nominal life cover usually 101% of value of the units
• Regular withdrawals are return of capital rather than income

Question 378

Investment bond

Advantages? (3)

Answer 378

• Can switch fund with no CGT
• For higher rate tax payer lower tax
• Can withdraw 5% annually

Question 379

Investment bonds

Disadvantages? (4)

Answer 379

• Not tax free but deferred
• Paid on income tax rather than CGT so can’t use annual exemption amount
• If investor’s tax rates likely to increase
• Any chargeable gain could remove MCA/ child benefit

Question 380

Investment bonds?

Types? (7)

Answer 380

• Guaranteed income bonds
• High income bonds
• Guaranteed growth bonds
• Distribution bonds
• Guaranteed protectd equity bonds
• With profit bonds
• Unit-linked bonds

Question 381

Guaranteed income bond

Explain?

Good for?

Answer 381

Guaranteed income each year for specified term (payable in arrears, up to 5 years). On maturity capital is returned

Good for BRT as no additional tax

Question 382

High income bonds

Characteristics? (3)

Answer 382

Based on package of derivatives -

• Offer a high level of income, e.g. 10%, for five years, but do not guarantee return of capital
• Return of capital depends on performance of one stock market index, or average of two or three.
• Provided the index meets a pre-set performance target, capital is returned in full. If less maturity will be less than original investment

Question 383

Guaranteed growth bond

Explain?

Answer 383

Similar to guaranteed income bond but pay no income, free of CGT, usually invested in gilts

Question 384

Unit linked bond

Explain?

Answer 384

Liability to basic rate income tax is covered by tax paid within the fund, take 5% tax deferred withdrawals each year for 20 years or until the original capital has been returned

Good for higher rate tax payers

Question 385

Distribution bonds

Explain?

Answer 385

Distinguishes between capital and income. Income paid = income generated

Question 386

Guaranteed equity bonds

Explain?

Answer 386

Guaranteed return of capital plus % of growth of index to which it is linked. Guarantee generally operates on a fixed date

Question 387

Protected equity bond

Explain?

Answer 387

Quarterly guaranteed level of protection between 95-100% of capital - protected against this level of fall in market - if 95% can still lose 20% a year

Question 388

Bonds as trust investments

Why are they used? (5)

Answer 388

• Variety of funds available to meet requirements of trust
• No taxable income generated therefore less admin and expenses
• Life fund pays less corporation tax than if trustees paid on income generated
• Policies can be assigned to beneficiary with no tax charge on transfer
• Up to 5% can be withdrawn without a tax liability

Question 389

Bonds as trust investments

Liability for chargeable gain on trust - if individual who created trust alive and living in the UK?

Answer 389

Treated as part of individual’s income

Question 390

Bonds as trust investments

Liability for chargeable gain on trust - if individual dead or living abroad?

Answer 390

Trustees chargeable on gain and no top slicing relief

Question 391

Bonds as trust investments

Liability for chargeable gain on trust - if all trustees not resident in UK?

Answer 391

Beneficiary taxed and no top slicing relief

Question 392

Offshore bonds

Benefit from?

Answer 392

Gross roll-up - as not taxed until chargeable event

Question 393

Offshore bonds

How to calculate chargeable gain?

Answer 393

Total gain

multiplied by the following fraction

number of days policyholder resident in UK

divided by

number of days policy has run

Question 394

Offshore bonds

What circumstance would lead to a chargeable gain being zero?

Answer 394

If policy holder was outside the UK, for the whole time

Question 395

Offshore bonds

When is chargeable gain top-sliced back to if full surrender?

If partial withdrawal?

Answer 395

Always top-sliced back to the start date

Depends if time apportionate relief applies - if no, back to last chargeable gain. If yes, back to start date, but reduced for periods not UK resident

Question 396

Offshore and onshore bonds compared

Are charges higher on offshore or onshore bond?

Answer 396

Offshore, which reduces the final net return received by an investor

Question 397

Offshore and onshore bonds compared

Reasons why onshore bonds may be preferrable to offshore on encashment?

Answer 397

Onshore bond gains benefit from indexation relief up to 31.12.17, net gain taxed at 20% or 25%, whereas offshore gains for higher and additional rate taxpayers are taxed at 40% and 45%, no indexed relief

Question 398

Offshore and onshore bonds compared

Reasons why onshore bonds may be preferrable to offshore on investment income?

Answer 398

Some investment income received by an offshore fund may be received after deduction of non-reclaimable withholding tax, reducing the effect of the gross roll-up. In addition, there would be no credit for this in the chargeable gain, leading to possible double taxation

Question 399

Personal portfolio bond

What is it?

What is the deemed gain?

Answer 399

If an investor has a portfolio of shares and wants to manage it themselves rather than life office

Deemed gain is 15% of the total premiums paid at end of the year plus total deemed gains from previous years

Question 400

Traded endowment policies (TEP)

Can they be bought and sold?

How does it work for the seller and buyer?

Answer 400

Yes - original owner can assign product to someone else for a payment normally higher than surrender value

Buyer - although future premiums have to be paid, maturity value may be high, early profit if life assured dies

Question 401

Traded endowment policies

Taxation on the seller?

Answer 401

Qualifying policy is sold after ten years, or three-quarters of the term, it is not a chargeable event, no income tax.

If sold < ten-year or three-quarter term, it is chargeable event, and selling a non-qualifying policy is always a chargeable event.

Higher or additional-rate taxpayer, the gain is subject to 40% or 45% tax. Gain is subject to top-slicing relief

No CGT liability on seller, provided they are the original beneficial owner

Question 402

Friendly societies

What do they sell?

Answer 402

Qualifying policies with limited premiums

Question 403

Friendly societies

Limits on premiums?

Answer 403

£270 per year or £25 per month

Question 404

Friendly societies

Can children under 18 take out these policies?

Answer 404

Yes - known as baby bonds

Question 405

Friendly societies

What are FS policies free of?

Answer 405

Free of UK tax on investment income and capital gains

Question 406

Friendly societies

What is the life cover amount?

Answer 406

Minimum amount is 75% of total premium

Question 407

Exchange traded funds (ETFs)

What are they and what are they similar to?

Answer 407

Index trading funds listed and traded on stock markets

Similar to index-tracking pooled funds but traded like a single share through stcokbrokers

Question 408

Exchange traded funds (ETFs)

Broker fees, stamp duty, management charge?

Answer 408

Yes broker fees

No stamp duty

Less than 0.5%

Question 409

Exchange traded funds (ETFs)

Usually track by?

Answer 409

Fully replicating index - buy exactly same investments and rebalance when index rebalanced

Question 410

Exchange traded funds (ETFs)

Tax on investor?

Answer 410

Income tax on dividend payments

CGT on gains arising from disposal

Question 411

Exchange traded funds (ETFs)

Are ETFs usually held offshore or onshore?

Answer 411

Offshore - check fund prospectus to ascertain tax treatment

Question 412

Exchange traded commodity

What is it?

Answer 412

Similar to ETF, tracks performance of an underlying commodity or basket of commodities, or index designed to measure value of that commodity

Question 413

Exchange traded notes (ETNs)

What are they and how does they differ to ETFs?

Answer 413

Similar to ETF, traded on stock exchange, performance tracks movement of an index.

It is a type of bond issued by a bank, maturity date, do not pay interest and there is no portfolio of investments, they use derivatives to track the index

Question 414

Exchange traded notes (ETNs)

What is the additional risk?

Answer 414

As they are unsecured bonds, their value will be affected by credit rating of the issuer & potential default risk

Question 415

Property based investments

What are the types of indirect property investment? (4)

Answer 415

• Shares in listed property companies
• Property unit trusts and investment trusts
• Insurance company property funds
• Real estate investment trusts (REITs)

Question 416

Shares in listed property companies

How does it differ to direct property investment? (5)

Answer 416

• Diversified over a number of properties
• Share prices are affected by management and borrowing, as well as asset value
• Property shares can be highly geared - more volatile
• Share prices will rise and fall independently of the underlying asset values - supply and demand: stock market and company risk
• Company liable to corporation tax on capital gains and rental income

Question 417

Property unit trusts and investment trusts

Required to hold..?

Answer 417

Invest primarily in shares and securities of property companies, can hold small % in direct property

Question 418

Property unit trusts and investment trusts

Price of units is linked to..?

Answer 418

Value of the investments held in the fund

Question 419

Property unit trusts and investment trusts

Capital gains tax?

Answer 419

No tax on gain within fund

Investor is subject to CGT when gains realised on disposal

Question 420

Property authorised investment funds (PAIFs)

What are the main conditions PAIFs have to meet? (3)

Answer 420

At least 60% net income from exempt property investment business

Value of property investment business must be at least 60% of the total assets

No corporate investor can hold 10% or more of the fund’s NAV

Question 421

Property authorised investment funds

What is it? (3)

Answer 421

• FCA authorised OEIC that invests mainly in property
• Taxation moves from fund to investor
• Property income is ring-fenced as ta exempted in fund, but other income 20% corporation tax

Question 422

Property authorised investment funds

How are distributions made to investors? (3)

Answer 422

• Property income - paid net of 20% income tax
• Interest income - paid gross
• Dividends - paid gross

Question 423

Insurance company property funds

What are they?

Answer 423

• Funds which specialise in direct holdings of commercial property
• Available as regular and single premium

Question 424

Insurance company property funds

Main features? (4)

Answer 424

• Unit value linked to property value
• Cannot borrow
• Liquidity is higher than direct property investment
• Income and capital gains are subject to up to 20% tax within the fund

Question 425

REITs

What is the aim of a REIT? (3)

Answer 425

• Provides a liquid market in property investment
• Widely accessible
• Tax treatment is closely aligned to direct investment in property

Question 426

REITs

Structure?

Answer 426

• Must be closed ended, so not an OEIC
• UK resident for tax
• Ony issue one class of ordinary share
• Listed on recognised stock exchange (includes AIM)

Question 427

REITs

Tax structure? (2)

Answer 427

• Ring-fenced property letting business, corporation tax exempt
• Non-ring-fenced business, other activities, e.g. property management services – profits and gains are subject to corporation tax

Question 428

REITs

Conditions to qualify as a REIT? (3)

Answer 428

• At least 75% gross profits from the property rental (tax-exempt part)
• Value of the assets in the tax-exempt part must be at least 75% of the total value of the assets (ignoring secured loans)
• REITs cannot have an excessive amount of debt financing – interest on borrowings has to be at least 125%, covered by rental profits

Question 429

REITs

Investor tax? (3)

Answer 429

• Distribution from ring-fenced part - paid of 20% income tax - HRT and ART will have to pay extra income tax
• Distribution from no-ring fenced part - treated as other UK dividends - investor tax will depend on individual position
• Gains subject to CGT

Question 430

Private Equity

What is it?

Answer 430

Investor provides medium to long term finance in return for an equity stake in an unquoted company

Question 431

Private equity

How can investment in this asset classed be acheived? (3)

Answer 431

• EIS
• SEIS
• VCT

Question 432

EIS

Tax relief? (4)

Answer 432

• Income tax relief at 30% given for qualifying investments
• Up to £2 million - if £1 million is invested in knowledge intensive companies
• Investor must have income tax liability of at least amount being claimed
• Relief is given as reduction to investor’s tax liability

Question 433

EIS

Current tax regime charateristics? (2)

Answer 433

• Relief withdrawn if shares are disposed of within three years, except to spouse and not on the death of investor
• Investor - carry back income tax relief to previous tax year

Question 434

EIS

What are the conditions to defer CGT through EIS investment? (5)

Answer 434

• Reinvest capital gain within 1 year and 3 years after disposal
• Deferred gain is bought into charge on diposal of EIS, unless reinvest
• CGT rate is current rate
• Gains on the disposal of EIS that qualified for income tax relief are exempt from CGT, as long as the shares are held for 3 years
• Losses are allowable, and can be set against chargeable gains or income

Question 435

EIS

If shares held for at least 2 years , what do they qualify for?

Answer 435

100% business relief for IHT purposes as unquoted companies

Question 436

EIS

Qualifying company? (6)

Answer 436

• Unlisted and no plans to become listed
• Fewer than 250 employees (500 if knowledge intensive (KIC))
• Gross assets less than £15m before shares issued and £16 m after
• Raised less than £5m under VCT in 12 months (£10m if KIC), less than £12 m in lifetime
• Must be made within 7 years of company’s first commerical sale, (10yrs is KIC)
• Qualifying trade with permanent UK base

Question 437

EIS

Qualifying individual?

Answer 437

• Not connected to company
• Non-UK resident is elgible, but can only claim tax relief on income tax liability

Question 438

EIS

Risks?

Answer 438

• Company may fail
• Held for 3 years
• May be difficult to dispose of shares, as the market is illiquid

Question 439

SEIS

Main conditions for a company? (5)

Answer 439

• Unquoted at the time of issue of the shares
• Employ 25 people or less
• Less than two years old
• Less than £200,000 in gross assets
• Meet the qualifying trade rules

Question 440

SEIS

Income tax relief?

Answer 440

50% of share cost up to a maximum of £100,000 a year

Question 441

VCTs

Further rules? (7)

Answer 441

• All money raised must be used in 2 years
• Income must be wholly or mainly derived from shares or securities and retain 15%
• At least 80% in qualifying holdings
• Not more than 15% in a single company
• At least 70% in new ordinary shares
• At least 10% in ordinary, non-preference shares
• Exempt from corporation tax on disposal of investments - can be distributed as dividends with no tax liability for investor

Question 442

VCTs

What are they and what does the investor buy?

Answer 442

Listed fund with pooled characteristics

Investor buys fund shares

Question 443

VCTs

Annual investment limit and tac relief?

Answer 443

£200,000

30%

Question 444

VCTs

What is the holding period for the retention of income tax relief?

Answer 444

5 Years - only available on subscription of new shares

Question 445

VCTs

Is reinvestment relief and business available available?

Answer 445

No

Question 446

VCTs

Tax treatment? (4)

Answer 446

• Tax free dividends
• Tax free CGT
• No loss relief
• No corporation tax on gains on disposal

Question 447

Knowledge Intrinsic Company (KIC)

What is it? (4)

Answer 447

• Carrying out research, development or innovation
• At leasts 10% of operating costs spent on this and at least 15% in one of past 3 years
• Creating intellectual property
• 20% of employees carrying out reserach and development

Question 448

ISAs

Eligible investments for stocks and shares ISA? (2)

Answer 448

• Normally must be listed on recognised stock exchange
• Shares acquired with previous 90 days from SAYE or share incentive plan

Question 449

ISAs

Investor eligibility? (5)

Answer 449

• Resident in the UK for tax purposes
• Crown employee or spouse or civil partner if they don’t live in the UK
• 18 or over - stocks and shares ISA or innovative finance ISA
• 18 or over but under 40 - Lifetime ISA
• 16 or over - cash ISA

Question 450

ISAs

Main types of ISA? (10)

Answer 450

• Unit trust and OEIC
• Investment trust
• Managed
• Self-select
• Corporate
• Derivative-based
• Cash
• Help to buy
• Innovative finance
• Lifetime

Question 451

ISAs

What are self-select?

Answer 451

Select own holdings sometimes restricted to FTSE 100

Question 452

ISAs

What are corporate ISAs?

Answer 452

Only invest in one company - charges are generally lower

Question 453

ISAs

What are deriative based ISAs?

Answer 453

Offer stock market index-linked capital return at the end of 3 - 5 years - a fixed income or a minimum maturity guarantee

Question 454

ISAs

What is an Innovative ISA?

Answer 454

Peer-to-peer lending

Question 455

ISAs

Transfers between ISA Managers take how long? (2)

Answer 455

15 working days - Cash and Cash lifetime

30 working days - Stocks and shares, innovative and lifetime

Question 456

ISAs

Termination of ISA - death?

Answer 456

Becomes a continuing account of a deceased investor

No funds can be added, income and gains remain tax free until estate administered and ISA closed, or 3 years from date of death

Question 457

ISAs

If spouse inherits ISA?

Answer 457

Spouse inherits one-off additional ISA allowance to reinvest into their ISA set at higher of value at date of death or investment value when passed on

Question 458

ISAs

Stakeholder -deposit acount? (5)

Answer 458

• No charges on stakeholder cash ISA
• Minimum deposit can not be higher than £10
• Unlimited withdrawals paid 7 days or less
• Interest rate no less than 1% below BoE base rate
• If BoE increases, rate must follow within 1 month

Question 459

ISAs

Stakeholder stocks and shares - annual charge?

Answer 459

Limited to 1.5% of fund during first 10 years and 1% thereafter

Question 460

ISAs

Stakeholder stocks and shares - minimum investment and % risk?

Answer 460

Can not be higher than £20

No more than 60% in riskier assets (shares and property)

Question 461

ISAs

Stakeholder smoothed MTIP - extra terms?

Answer 461

• Some of return in good years into smoothing account
• If smoothed account is low, policyholders can be charged extra
• Managers must make info available about smoothing policies
• Whole of with profit fund and smoothing account are for benefit of policyholders

Question 462

Derivatives

What are they? (2)

Answer 462

• A financial contract whose value is derived from the value ofan underlying asset
• Allowing exposure of underlying asset without ownership

Question 463

Deriatives?

Two ways of buying derivatives? (2)

Answer 463

• Bought and sold on recognised exchange - exchange traded - standard terms and conditions therefore cheaper and easier to trade
• Over the counter (OTC) - created bespoke for a customer’s needs and sold directly to them

Question 464

Deriatives?

What is standardised on exchange? (4)

Answer 464

• Quality
• Quantity
• Delivering date
• Delivery price

Question 465

Futures

What are they? (2)

Answer 465

• Exchange traded forward contract
• Buy and sell at specified future date at price agreed when contract made

Question 466

Futures

What is consideration?

Answer 466

Required to establish a contract - initial margin i.e. a deposit

Question 467

Futures

What is variation margin?

Answer 467

Daily price changes - if fails to pay exchange close all client’s open positions by buying equal but opposite contracts

Question 468

Futures

Marketing to market?

Answer 468

Revalued on daily basis - takes into account any movement in prices and closely mirrors change in price of underlying asset

Question 469

Futures

Buyer is hoping for..and this is know as?

Answer 469

Long view - market price increase therefore on agreed date can buy at a lower price than market

Question 470

Futures

Seller is hoping for…amd this is know as?

Answer 470

Short view - hoping the market price falls, therefore they can sell at a higher price than the market

Question 471

Futures

Role of London Clearing House (LCH)?

Answer 471

Pays profits to one side of contract and receive losses from other -

at expiry of contract client will already have been credited with profit

Question 472

Futures

If physically settled?

EDSP?

Answer 472

Seller delivers to buyer and buyer pays seller the exchange delivery settlement price (EDSP)

Question 473

Options

What are they - buyer?

Answer 473

An option gives the buyer the right, but not obligation to buy or sell

Question 474

Options

Paying for options - buyer? (2)

Answer 474

• Buyers pays premium - cost of option plus additional commission
• Does not have to make margin payments

Question 475

Options

Paying for options - seller? (2)

Answer 475

• Receives premium, pays commisison and makes margin payment
• Initial and variation margin

Question 476

Options

What is a call option?

Answer 476

Agreed to buy at

Question 477

Options

What is a put option?

Answer 477

Agreed to sell at

Question 478

Options

What is fixed price?

Answer 478

Strike price or exercise price

Question 479

Options

Choices? (3)

Answer 479

• Exercise it
• Sell it
• Let it expire - worthless

Question 480

Options

European style?

American style?

Answer 480

European - can only be exercised at expiry

American - can be exercised at any time

Question 481

Options

Intrinsic value for call options?

Answer 481

Current price of the underlying asset is above the option’s strike price

Question 482

Options

Intrinsic value for put options?

Answer 482

Current price of the underlying asset is below the option’s strike price

Question 483

Options

Intrinsic value is referred to as what? (3)

Answer 483

• In the money - have intrinsic value
• Out of the money - no intrinsic value
• At the money - strike price equals current price

Question 484

Options

Intrinsic value calculation and what do you ignore?

Answer 484

Current price against exercise price

Ignore the premium paid

Question 485

Options

Time value? (2)

Answer 485

• Amount an investor is willing to pay for an option above its intrinsic value, in the hope its value will increase before it expires - favourable change in underlying asset value
• Directly related to how much time until expiry - erodes throughout option’s life

Question 486

Hedging

What are the major uses? (2)

Answer 486

• Protect an existing exposure against future adverse price movements
• Try to profit by correctly forecasting future price movements

Question 487

Hedging

Hedging a future purchase - if fund manager is expecting to receive a large amount of capital in few months but expects market to rise? (3)

Answer 487

• Wait until money received and buy at higher price
• Borrow to invest immediately and repay interest
• Use derivatives - futures or call options

Question 488

Hedging a future purchase

Risk for the fund manager?

Answer 488

If market falls is limited to the premium paid for the option plus transaction costs

Question 489

Hedging

If a fund manager believes there will be a sharp downturn in the market and wants to protect value of fund? (2)

Answer 489

• Sell part of the portfolio but if market rises they could lose out - may be restrictions if mandated to hold small amounts of cash
• Could use derivatives - selling futures or buying put options

Question 490

Hedging

If fund manager wants to protect fund value - and sold futures - want would happen if market fell and if market rose?

Answer 490

Market fell - profit on futures used to offset losses on portfolios

Market rose - loss on futures will offset gain on portfolio

Question 491

Hedging

If fund manager wants to protect fund value - and bought put options - want would happen if market fell and if market rose?

Answer 491

Market fell - gain on option used to offset loss

Market rose - let option expire and pay premiums and transaction costs

Question 492

Asset allocation

If manager has 65:35 equity:fixed interest and expects equities to fall - what can they do?

Answer 492

• Trade underlying physical assets
• Sell futures on 10% of portfolio abd buy long gilt futures

Question 493

Asset allocation

Using futures offers significant benefits in terms of? (3)

Answer 493

• Lower dealing costs
• Speed of dealing
• Liquidity

Question 494

Speculation

If speculator expects change in interest rates will lead to change in bond yields - whatcould thye do? (2)

Answer 494

• If rising interest rates, bond prices would fall - sell long gilt futures
• If falling interest rates, bond prices would rise - buy long gilt futures

Question 495

Writing options

Sellers of options known as - risks?

Answer 495

Writers - risk is unlimited in return for premium received - most writers are banks or specialist traders

Question 496

Writing options

Why fund manager may write a call option?

Covered?

Uncovered?

Answer 496

Increase income to fund by receiving premiums paid

Covered if underlying stock is owned

Uncovered if not owned

Question 497

Writing options

Why a fund manager writes a put option? (2)

Answer 497

Receives premium income but has obligation to purchase an asset at a fixed price.

Hope the option will not be exercised - occurs if asset has a price above the exercise price at expiry

Question 498

Taxation of derivatives

CGT?

How does this differ if classed as a trader?

Answer 498

Profits from futures and options usually chargeable to CGT

If classed as trader, their profits taxed as income

Question 499

Taxation of derivatives

Buying options (3)

Answer 499

• If call option exercised - cost of option treated as cost of purchase
• If put option exercised - cost of option is allowable deduction
• If option expires - treated as disposal for CGT therefore loss

Question 500

Taxation of derivatives

Futures? (2)

Answer 500

• If position closed - money received treated as considration for disposal and money paid = cost
• If position not closed -any payment made or received treated as consideration or cost of disposal

Question 501

Hedge funds

What are they?

Answer 501

Pooled investments, fund manager invests in traded securities. Actively managed to seek positive returns

Question 502

Hedge funds

Strategies? (3)

Answer 502

• Hedge against market downturns
• Invest in asset classes, that are trading below their true value
• Use return enhancing tools, e.g. gearing, derivatives and arbitrage

Question 503

Hedge funds

Aim?

Answer 503

Give an absolute return with limited volatility rather than trading n index and can even have negative correlation to the market

Question 504

Hedge funds

Invest in?

Answer 504

Currencies and shares believed to be trading below their market value

Question 505

Hedge funds

Fund of hedge funds?

Answer 505

Made up of multiple hedge funds

Question 506

Hedge funds

Investment strategy? (4)

Answer 506

• Long/short funds - equities and bonds
• Relative value funds - market neutral - rely on arbitrage
• Event driven funds -uncorrelated with markets, lower volatility
• Tactical trading fund - similar to hedge. Trade in currencies, bonds, equities and commodoties - use long/short approach

Question 507

Hedge funds

Relative value funds - what is relying on arbitrage to produce returns?

Answer 507

Identify and exploit pricing anomalies between similar investments

Question 508

Hedge funds

Risks? (3)

Answer 508

• Risks are dependent on strategies adopted by fund manager - lack transparency and difficult to assess
• If highly geared - risks magnified if things go wrong
• Very expensive - high annual charge, c. 2% plus c.2% manager fee

Question 509

Structured products

Designed to?

Answer 509

Acheive a specific set of investment objectives with a speficied risk and reward profile

Question 510

Structured products

Combines?

Answer 510

An element of riskier or higher performing asset with element of capital protection

Question 511

Structured products

Characteristics? (9)

Answer 511

• Fixed term
• No early withdrawals (some may allow partial)
• Return of capital or income
• Low fixed interest yields = mechanisms such as caps on growth, kick out clauses, capital protection lost if barrier is crossed, used
• Minimum or maximum returns are pre-specified
• Kick out clause - product matures earlu if performance threshold reached
• No secondary market
• Offer guarantees
• Returns based on index

Question 512

Structured products

Structure types? (4)

Answer 512

• 100% capital protected
• Partial capital protection/ soft protection
• No protection
• Investment notes

Question 513

Structured products

If a structured product, 5 year term, 100% protection and participation in growth FTSE 100 index up to a specified limit - what instruments would the wrapper contain? (2)

Answer 513

Zero-coupon bond - fixed interest no income, sold at a discount to its par value, providing known amount at maturity - to provide the capital protection

Call option - OTC five year on FTSE 100, capped at specified limit - provide return on FTSE 100

Question 514

Structured products

Partial capital protection explain?

Answer 514

Protection only provided if index doesn’t fall below a certain level - this is know as soft protection or contingent capital protection. FCA classes these as SCARPs - structured capital at risk products

Question 515

Structured products

Investment notes explain?

Answer 515

• Once issued listed on London Stock Exchange
• Investor can sell note and take profits early if markets rise before maturity
• Underlying investment choice is wider
• Typically provided by investment banks and more complex than retail packaged products

Question 516

Structured products

Risks? (5)

Answer 516

• Return - how is it calculated
• Risk profile - underlying asset
• Costs
• Encashment penalties
• Credit/counterparty e.g. Lehman Brothers

Question 517

Structured products

Benefits? (3)

Answer 517

• Wide range of underlying assets
• No exposure to managers
• Capital protection - know gain or loss

Question 518

Structured products

Drawbacks? (6)

Answer 518

• Caps on participation rates limit return if market rises
• Kick-out feature lead to missing out on future growth
• Averaging of index measurements may dilute returns in rising markets
• If product can be not be sold on sceondary market, maturity could take place during market fall, profits reduce
• Falls in equity and market could lead to lose in capital protection, which can not be regained
• Not suitable for funds needed at short notice

Question 519

Direct investments vs collectives vs investment trusts

Benefits of direct investment? (6)

Answer 519

• Lower costs
• Portfolio can be tailored to client’s needs
• Increased transaparency of costs
• Can exclude holdings for specific reason (e.g. ethical)
• Gains subject to CGT but often avoided due to annual exemption
• Larger portfolios can enjoy economies of scale

Question 520

Direct investments vs collectives vs investment trusts

Drawbacks of direct investment? (6)

Answer 520

• Greater volatility as usually fewer investments held
• For smaller portfolios higher costs
• Requires high involvement from investment manager
• Maybe greater admin
• VAT on management fees

Question 521

Direct investments vs collectives vs investment trusts

Benefits of collective investment? (5)

Answer 521

• Wide variety
• Spread of risk
• Can give exposure to markets not available through direct investment
• No CGT in Trust/ VAT
• No stamp duty

Question 522

Direct investments vs collectives vs investment trusts

Drawbacks of collective investment? (5)

Answer 522

• Greater management fees
• Changes to funds can be expensive
• Little direct involvement for investor

Question 523

Direct investments vs collectives vs investment trusts

Benefits of investment trusts? (4)

Answer 523

• Cost of purchasing shares is often lower
• Higher reward - trade at discount and gearing
• Can provide high income

Question 524

Direct investments vs collectives vs investment trusts

Drawbacks of investment trusts? (1)

Answer 524

Higher risk as trade at discount and gearing

Question 525

Sharia compliant investments

Three common types?

Answer 525

• Equity funds - returns generated through capital gains, alhtough dividends are permissable if approved by Sharia board
• Commodity funds - Halal commodities bought at fixed price to re-sell for profit - no futures as deemed to be gambling
• Ijarah funds - hold tangible assets provide rent. Sukuk is issued to subscriber, represents proportionate beneficial ownership in asset

Question 526

Investment advice Process

What is the process? (5)

Answer 526

• Determine client’s requirements
• Analyse client’s financial position
• Formulate a strategy to meet objectives
• Produce recommendations and implement
• Revisit investments, objectives and strategy

Question 527

Investment advice process

Know your customer process? (5)

Answer 527

• Knowledge and experience
• Financial situation
• Investment objectives
• Attitude to risk
• Capacity for loss

Question 528

Establishing the client relationship

Disclosure document includes? (5)

Answer 528

• How financial adviser will be paid
• The service that will be provided
• Timescales involved
• Duration of agreement
• Frequency of the contract

Question 529

Client agreement

Purpose for the client? (3)

Answer 529

Client has understanding of:

• Amount of reporting on investments
• Frequency of reviewing client’s circumstances and plans
• Adviser alerting client to changes

Question 530

Gathering client data

What included in fact find? (7)

Answer 530

• Hard facts - e.g. salary
• Soft facts - e.g. needs, wants, desires
• Client’s real objectives - motivation for investing
• Level of risk they are comfortable with
• Amount they want/ should save
• How long they need to invest for
• Any ethical considerations

Question 531

Gathering client data

What are other important factors? (5)

Answer 531

• Needs and obectives
• Assets and liabilities
• Income and expenditure
• Priorities
• Attitude to risk

Question 532

Gathering client data

Most important outcome of the fact find? (1)

Answer 532

Clear understanding of client’s goals and expectations

Question 533

Attitude to risk

What is it?

Answer 533

How much risk they are willing to take

Question 534

Tolerance for risk

What is it?

Answer 534

How much variance from their goal they can manage

Question 535

Capacity for loss

What is it?

Answer 535

How much they can afford to lose

Question 536

Analysing and evaluating a client’s financial status? (3)

Answer 536

• Asset allocation
• Ethical investment
• Taxation as a factor for investment choice

Question 537

Suitability Report

What is included? (7)

Answer 537

• Overview of customer’s circumstances
• Summary of needs
• Summary of recommendation
• Details of their risk profile
• Details of asset allocation and wrapper
• Reason why recommendation suitable
• Costs and risk summary

Question 538

Investment objectives

Considerations? (4)

Answer 538

• Capital preservation
• Capital appreciation
• Current income
• Total return - long term asperations for growth and income

Question 539

Asset allocation

Other considerations before applying? (5)

Answer 539

• Time horizon - if short horizon need greater capital preservation
• Liquidity - money needed in emergency
• Tax
• Legal and regulatory
• Unique needs and preferences

Question 540

Principles of investment planning

Theoretical approach? (3)

Answer 540

• Backward looking - modern portfolio theory
• Uses mathematical analysis based on risk/reward
• Uses efficient frontier

Question 541

Theoretical approach to asset allocation

Returns and volatility depend on?

Answer 541

Correlation between assets

Question 542

Pragmatic approach to asset allocation?

What is it? (4)

Answer 542

• Forward looking
• Uses avaerage rates of return
• Uses historical data on long time periods
• Pays attention to recent volatility

Question 543

Decumulation

Important factors? (4)

Answer 543

• Initial yield on investments
• Overall rate of income generated
• Level of inflation or interest rate
• Rate of growth in company dividends

Question 544

Sequencing risk

What is it?

Answer 544

Withdrawing too much capital during a market downturn - drag on investment growth

Question 545

Stochastic modelling

What is it? (3)

Answer 545

• Set up on set of standard assumptions
• Apply assumptions to a particular asset allocation
• Results plaotted graphically showing the statisical distribution of possible outcomes

Question 546

Stochastic modelling

Criticism?

Answer 546

• Uses a mathematical technique to generate a problematic assessment of returns and volatility
• Greater dependence of assumptions than optimisation models - often a small change in assumption will reslut in large change in output

Question 547

Portfolio optimisation

Key considerations (5)

Answer 547

• Risk
• Historical data
• Forecasts
• Costs
• Implementation

Question 548

Portfolio optimisation

Assumptions and weakness for risk?

Answer 548

Returns do not always follow normal distribution

Question 549

Portfolio optimisation

Assumptions and weakness for historical data?

Answer 549

Maybe a poor guide for future performance

Question 550

Portfolio optimisation

Assumptions and weakness for forecasts?

Answer 550

May be inaccurate

Question 551

Portfolio optimisation

Assumptions and weakness for costs?

Answer 551

Assumes rebalancing which doesn’t take into account transaction costs

Question 552

Portfolio optimisation

Assumptions and weakness for implementation?

Answer 552

May use different specific assets

Question 553

Portfolio construction

When making portfolios need to think about? (3)

Answer 553

• Return required
• Volatility accepted
• Correlation of assets

Question 554

Portfolio construction

Top-down portfolio construction? (4)

Answer 554

• Determine asset allocation
• Allocate geographical spread
• Choose sector weightings
• Choose stocks

Question 555

Portfolio construction

Bottom up portfolio construction?

Pays no attention to?

Answer 555

Select stocks on own criteria - reverse of top-down

No attention to index benchmarks

Question 556

Fund management styles?

What are they? (4)

Answer 556

• Value - company’s value is higher than price placed on market
• GAARP - companies with long sustainable advantages e.g. quality of management
• Momentum - being ahead of latest swing of opinions
• Contrarianism - going against the trend

Question 557

Fund selection

When selecting fund need to consider? (7)

Answer 557

• Fund objectives
• Costs and charges
• Strength and reputation of management group
• Skill and reputation of fund manager
• Type and structure of fund e.g. open-ended, geared….
• Fund performance
• ESG - transparent, diverse?

Question 558

Fund selection

Strength, skill and reputation of fund manager criteria? (6)

Answer 558

• Relevant experience
• Structure and style of investment
• Size and access to resources
• Quality of staff
• Administration
• Consistency in strategy

Question 559

Selection of tax wrappers

When determining tax wrappers need to consider? (2)

Answer 559

• Client’s individual tax and financial circumastances
• Underlying assets in tax wrapper

Question 560

Selection of tax wrappers

Benefits of wrap (platform) account? (6)

Answer 560

• Hold all investments in one place
• Less paperwork and admin
• Lower costs and transparent
• Automatic rebalancing
• Access to various tax wrapper
• Asset allocation across wrappers

Question 561

Discretionary management services

Advantage? (1)

Answer 561

Have permission to trade without seeking permission on every trade

Question 562

Recommendations and suitability

Need to include? (6)

Answer 562

• Explanation of client’s risk profile and recommended portfolio
• Fund selection method
• Explanation of tax wrappers
• Future reviews
• Costs
• Summary of features

Question 563

Portfolio reviews

Investment policy statement includes? (3)

Answer 563

• How portfolio will be managed
• Overall investment objective
• Classification of risk

Question 564

Portfolio reviews

Factors affecting investment strategy? (4)

Answer 564

• Legal constraints - e.g. trust deeds
• Nature of liabilities - proce inflation
• Cash flow
• Taxation

Question 565

Portfolio reviews

Reviewing investment policy statement? (4)

Answer 565

• Client circumstances
• Regulation and taxation
• Market environment
• New products and services

Question 566

Portfolio reviews

Client reporting - items reported by investment manager? (4)

Answer 566

• Purchases and sales
• Summary portfolio valuation
• General market commentary
• Recommended changes in strategy

Question 567

Portfolio reviews

Client reporting - timing and frequency of reports under Mifid II? (2)

Answer 567

• Under Mifid II every 3 months and breakdown of costs?
• If portfolio falls by 10%

Question 568

Portfolio reviews

Client reporting - reasons for suitability? (4)

Answer 568

• Change in client’s objectives
• Market conditions
• Client instructions from client
• Consistent underperformance

Question 569

The performance of investments

Important to know past performance for? (4)

Answer 569

• Understanding investment markets generally
• Assessing competence of fund managers
• Rewarding investment managers
• Charging performance related fees

Question 570

Past performance

Limitations of using past performance for predictive purposes? (3)

Answer 570

• Equities tend to outperform fixed interest but periods when this isn’t the case
• When predictions more specific, the value of past performance seems to diminish
• Most systems use past performance to select funds but depends on future correlation and volatility

Question 571

Performance measurement

What is it?

Answer 571

Calculation of the investment return over a stated period

Question 572

Performance evaluation

What is it concerned with? (2)

Answer 572

• Has the investment manager added value by meeting or outperforming a suitable benchmark
• How the investment manager achieved the calculated return (e.g. by taking high or low risks, or having a particular stock or asset strategy

Question 573

Holding period return

What does it calculate?

Answer 573

Calculates return on an investment over period of time it is held, expressed as a % of initial investment

Question 574

Holding period return

Formula?

Answer 574

R = D + V1 -V0 / V0

R = rate of return

D = Income paid to the investor during the term

V1 = value at end

V0 = value at start

Question 575

Money weighted return

What is it?

Answer 575

Calculates return on investment over a period if new money is added or taken away

Question 576

Money weighted return (MWR)

Formula?

Answer 576

D + V1 - V0 - C

Divided by

V0 + (C x n + 12)

C = cash withdrawn or introduced

n = number of months remianing in the year after cash added or withdrawn

Question 577

Money weighted return

Drawback?

Answer 577

Not appropriate when comparing different portfolios

• because strongly influenced by timing of cash flows
• this is outside fund managers control

Question 578

Time weighted return

What is it?

Answer 578

Attempts to eliminate distortions caused by timing of new money by breaking period down to sub-periods for each contribution or withdrawal

Question 579

Time weighted return

Formula?

Answer 579

1 + R = (1 + r1) (1 + r2) (1 + r3)……(1 + rn)

R = TWR and

ri = holding period return in each sub period

TWR = V1/ V0 x V2/ (V1 + C) - 1

Question 580

Sharpe ratio

What does it measure?

Answer 580

Excess return for every unit of risk that is taken to achieve return

Question 581

Sharpe ratio

Used to compare?

Answer 581

Active funds against each other - only funds with similar objectives

Question 582

Sharpe ratio

Formula?

Answer 582

Return on the investment - risk-free return

Divided by

Standard deviation of the return on the investment

Question 583

Sharpe ratio

Desirable to measure over what period?

Answer 583

Over shorter periods (e.g. monthly)

Question 584

Sharpe ratio

Interpreting the ratio - the greater a sharpe ratio?

Answer 584

Better return on investment compared to risk

Question 585

Alpha

What is it?

Answer 585

Difference between the return you would expect from a security, given its ß, and the return it actually produced

Question 586

Alpha

Measures what part of return?

Answer 586

Cannot be explained by movements in overall market

Question 587

Alpha

Quantifies?

Answer 587

Value added or taken away by a manager through active management

Question 588

Alpha

Formula?

Answer 588

a = actual portfolio return - [Rf + ßi (Rm - Rf)]

Rf is the risk-free rate of return;
Rm is the market return; and
ßi is the beta of the fund or portfolio

(Calculate the inner brackets first)

Question 589

Information ratio

Evaluates?

Answer 589

Portfolio performance in relation to performance of a benchmark

Question 590

Information ratio

Is often used to do what?

Answer 590

Gauge the skill of fund managers and shows the consistency with which a manager beats a benchmark index

Question 591

Information ratio

Formula?

Answer 591

Rp - Rb

Divided by

tracking error

Question 592

Information ratio

If positive information ratio?

If negative information ratio?

Answer 592

Positive - Performance better than benchmark, higher value added by active management

Negative - Investor would have been better off matching index using a tracker or index fund

Question 593

Performance attribution

What is it?

Answer 593

Evaluates how managers achieve returns

Question 594

Performance attribution

Factors? (4)

Answer 594

• Asset allocation
• Stock selection
• Market timing
• Risk - may take more or less risk than the benchmark depending on market view

Question 595

Performance evaluation

Steps? (5)

Answer 595

• Establish benchmark
• Benchmark asset allocation
• Benchmark returns - return it would achieve if performed in line with index
• Comparison of asset allocation
• Stock selection or sector choice - compare index performance for each asset class with managers actual performance

Question 596

Indirect investments

Examples of income? (4)

Answer 596

• Pension income
• Distribution from fixed interest collectives
• Distribution from equity collectives
• Investment bonds

Question 597

Tax Wrappers

3 stages?

Answer 597

• How initial investment treated
• How funds are taxed within wrapper
• How proceeds are taxed on investor

Question 598

Taxation

ISAs?

Answer 598

Interest and dividends paid gross

No CGT

Question 599

Tracker funds

Types? (3)

Answer 599

• Full replication - fund fully replicates the index
• Stratified sampling - fund holds a sample of shares in index as not suuficent assets for full replication therefore holds specific company in each sector
• Optimisation/ synthetic - fund buys and sells shares as index using computerised model

Question 600

Tracker funds

Advantages? (3)

Answer 600

• Lower costs
• Hard to beat index
• If fund managers do beat index it’s usually often by taking more risk

Question 601

Tracker funds

Disadvantages? (3)

Answer 601

• Following market can be a rollercoaster
• Can never index - costs/ tracking error
• Mergers can distort index

Question 602

Ethical funds

Types? (3)

Answer 602

• Negative screening - fund will avoid certain unethical practices
• Positive screening - fund allows for some tolerance to unethical practice but will seek out ethical options
• Neutral approach - firms considered to be socially responsible