REDO QUIZ AND DECK. VERY USELFUL Read over 1.1.4 before exam) Chapter 1 – (28 marks and multi choice) Analyse The Characteristics Inherent Risks Behaviour And Correlation Of Asset Class

Question 1

What is the advantage and disadvantage of investing in cash?

Answer 1

Advantages: Capital is secure. High flexibility

Disadvantage: Little protection from inflation, no capital growth

Question 1

Cash is not exposed to investment risk. What does this mean?

Answer 1

Investment risk is the risk presented to the capital

For cash the capital value can not go down so it has no investment risk.

Question 2

Cash has no investment risk but there is a number of other types of risk that cash is subject to. These are:

Default risk
Inflation risk
Interest-rate risk
Currency risk
Reinvestment risk

Tell me about each:

Answer 2

Default risk: the creditworthiness of the firm you save with.

Inflation risk: the impact of inflation.

Interest-rate risk: the uncertainty of interest rate movements.

Currency risk: exchange rate movements (if saving overseas)

Reinvestment risk: the likelihood of ‘similar deals’ being available at the end of a fixed term investment. This is low because rates constantly change.

All the above should be considered when deciding on cash as an investment over other types

Question 3

Some banks offer accounts in foreign currencies and/or in sterling but held overseas (typically in the Channel Islands).

Like UK saving accounts these account pay their interest gross.

Is the interest earned taxable for non UK based/non Stirling saving accounts like it is for UK based accounts?

Answer 3

Yes, the interest is taxable whether it is based in UK or not in the same way as UK based accounts.

It must be declared through an individual’s self-assessment in the same way

Question 4

Cash ISA’s are available to those 16 or older

What must be taken into account if the capital that the child will be investing is provided to them by their parent?

Answer 4

If the capital is provided by a parent, the interest will be deemed to be that of the parent if it is more than £100 per year. This interest should be declared by the parent on their self-assessment form.

Question 5

Cash ISAs are not restricted ONLY to holding cash. They can have certain investments as long as they adhere to the 5% rule. What is this?

Answer 5

5% RULE: A non cash investment can be included in a Cash ISA if it is expected to return at least 95% of initial capital within a 5-year period.

For example, units in a low risk unit trust may be invested into a cash ISA

If the investment cannot meet this guarantee it must instead only be invested using a stocks and shares ISA. Therefore, you will never find something like equities being invested into a cash ISA because they are too high risk and will likely not meet the 5% rule requirements

Question 6

In relation to deposit protection, what is the advantage of NS&I products?

Answer 6

Because NS&I is backed by the government, your cash will always be 100% protected no matter how much you pay in.

At time of writing, the NS&I website’s welcome page states: ‘Most banks only guarantee your savings up to £85K. We’re the only provider that secures 100% of your savings, however much you invest.’

Question 7

NS&I options are all deposit-based and savings accounts are too. If a form of investment is deposit based, what does that actually mean?

Answer 7

It means that the product involves placing money into an account or instrument where the principal (original investment)/capital is preserved and where there is usually some guaranteed return (through interest)

Question 8

For deposit based investments interest is paid gross. What does this mean?

Answer 8

It means that the interest is paid without any tax being deducted

Question 8

New investments into NS&I products have interest paid gross (paid without the deduction of tax), but can be split into two groups in terms of taxation of their returns: Tax free or taxable

Tell me which NS&I products have tax free returns and which ones have taxable returns

Answer 8

TAX FREE:

NS&I Direct ISA & Junior ISA (NOTE these are the NS&I version of the Cash ISA & Junior ISA, except that these are not flexible ISAs)

Premium Bonds

Fixed-interest savings certificates (Lump sum investment with a guaranteed fixed rate over a set term.)

Index-linked savings certificates (Lump sum investment with an index-linked return over a set term)

Children’s Bond

TAXABLE:

Income Bonds
Investment account
Direct Saver

(The 3 above are basically variable interest saving accounts and the 3 below are fixed interest)

Guaranteed Income Bonds
Guaranteed Growth Bonds
Green Savings Bonds

Question 9

All of the tax free NS&I accounts. See images

Answer 9

Question 10

All of the taxable NS&I accounts. See image.

Answer 10

Question 11

What are Money market investments?

Why are individuals typically not able to invest in to money market instruments?

See images of Money Market Investments being used in real life

Answer 11

There are 3 types of money market investments:

Treasury Bills, Certificates of Deposit & Commercial Bills

They are used by institutions such as governments, banks and building societies to lend to and borrow from each other, over a short term.

They are not used by individuals typically because the money market involves huge amounts of money and is generally not within the reach of an individual investor. £500,000 would be the minimum investment for an individual.

Question 12

There are 3 types of money market investments:

Treasury Bills, Certificates of Deposit & Commercial Bills

Tell me about each:

Which ones are tradable?

Answer 12

Summed up:

Treasury Bills =
Issued by government. No coupon. Bought below PAR and repaid at PAR on redemption (where the investor makes their money) Short term - max 12 months

Certificates of Deposit
issued by banks. fixed term and fixed return. Interest payable on maturity. Investor cannot withdraw cash but the CD is tradable on stockmarket.

Commercial Bills
Issued by companies. Very short term (30 - 90 days normally). Work in same way as treasury bills…bought below PAR

Question 13

There are 3 types of money market investments:

Treasury Bills, Certificates of Deposit & Commercial Bills

Which ones are tradable?

Answer 13

All 3 are tradable so the original investor can sell to receive monies earlier rather than waiting until the redemption date

Question 14

What risks are money market Instruments subject to?

Answer 14

All the same risks associated with cash… ie

Default risk
Inflation risk
Interest-rate risk
Currency risk
Reinvestment risk

Question 15

What are fixed-interest securities?

Answer 15

Fixed-interest securities or ‘bonds’, are issued by governments and companies as a way of raising money to finance their longer-term borrowing requirements.

Basically, they are asking investors to loan them money for a specified period and a specified return.

Question 16

In relation to Fixed Interest Securities investors are entitled to receive interest payments, and usually a return of capital at the end of a fixed term.

The fixed value that investors will receive at the end of the term is known as?

Answer 16

The Price At Redemption (PAR) value
or
The nominal value.

Question 17

Examples of corporate bonds in action (this is also basically how GILTS work too)

Answer 17

Since fixed interest securities are tradable, if Emily were to need her capital back prior to 2035 she could decide to sell her entitlement to the interest and nominal value on the Stock Market

She may even get a better deal originally depending on how a 5% yield compares to prevailing rates at the time she sells, as she may find that someone is willing to pay her more than the amount she invested in the first place, (higher than par). She could also get less money back if other bonds are better as she will have to sell lower than par

Question 18

Why are corporate bonds typically lower-risk than shares?

Answer 18

In the event of default by the issuing company, the corporate bond owner is classed as a creditor of the business rather than an investor

Therefore, they have a higher claim on their money than all the shareholders

Question 19

Bonds and GILTS are ‘negotiable fixed-interest long-term debt instruments’.

What does this mean?

Answer 19

This means they are tradable investments (negotiable), that pay a fixed return (fixed interest), over a period of up to 30 years (long-term) and are really just a loan to someone (debt instruments).

Question 20

What am I talking about when I refer to something as being one of the following:

stock, loan stock, debentures, securities or loan notes

Answer 20

All of those terms are types of fixed-interest security

Question 21

Look at the image. Tell me what you see

Answer 21

The investment is a corporate bond, as it is a loan to Sainsbury

Has a ‘coupon’ of 6% per year. A coupon is the annual interest rate paid by the bond issuer to the bondholder expressed as a percentage of the bond’s Par value/face value/nominal value

The maturity date is 2029: also known as the redemption date

The amount of money that will be repaid in 2029 is £100. This is the PAR value or Nominal Value of the stock

Question 22

NOTE: All bonds start with a ‘nominal value of £100. True or false

Answer 22

True

Question 23

Most bonds redemption dates are fixed. However, some bonds have a range of dates where the bond is redeemable. Explain this?

Answer 23

Some bonds, however, have a range of dates during which they are redeemable, e.g. 2027 – 2029. The issuer can choose when they pay the bonds back, within the date range. In our example, this means the earliest redemption date will be 2027 and the latest 2029, as long as the issuer gives the investor a minimum 3 months’ notice.

Some bonds are even ‘undated’ and are redeemable whenever the issuer wants.

These above are more rare though but can make a bond more desirable so the issuer may choose to add it as a feature

Question 24

Although the face value/par value of a bond never changes, its ‘real-time’ value does.

What does this mean?

Answer 24

This refers to a bonds tradability. It can be sold ‘over par’ if it is appealing or it can be sold ‘under par’ if its not appealing

A bond that is paying a guaranteed 8% annually until 2025 whilst normal savings rates are at 2% will be extremely appealing and therefore can be sold ‘over PAR’ meaning the original owner will make a very nice capital gain which the otherwise wouldn’t get if they waited until redemption. On the contrary, it is likely better to hold onto your bond if it is likely to be sold below PAR

Bonds are sensitive to interest rate changes and the price they sell at depends on supply and demand

Question 25

What is the mid-price of the bond?

What is this also known as?

Answer 25

The price that is paid when a bond is traded where no adjustments for the next interest payment is due.

This rarely happens as bonds are sold at different times and therefore an adjustment is normally made to ensure buyers don’t receive accrued interest from a time they didn’t actually own the bond

Sellers receive less than mid price whereas buyers will pay more than the mid-price. The extra amount that buyers pay to the seller is the interest that is due to the seller. Because of this, buyers are said to pay a ‘dirty price’ which is the (price + interest adjustment)

Mid price is also called clean price

REMEMBER: On bonds, Interest accrues daily and is then distributed every six months.
That means that (unless the bond is only sold the day after interest has been paid out) the price paid for the bond will need to reflect who will receive the next interest payment. SEE IMAGE FOR EXAMPLE

IN THE ABOVE EXAMPLE THE STOCK IS TRADED AS ‘CUM DIVIDEND’ BECAUSE THE BUYER IS RECIEVING THE NEXT INTEREST PAYMENT

Question 26

If a bond trades as ‘cum dividend’ or ‘ex dividend’ what does this mean?

Answer 26

Cum dividend (with dividend): Where the buyer receives the next interest payment

Ex dividend (ex dividend): Where the seller receives next interest payment even though they no long own the bond (occurs where a trade is happening very close to the interest payment

Question 27

With interest rates being low at present, many GILTS are trading above their PAR value. For those buying above PAR, they will make a capital loss if they then retain the bond until maturity.

See example

Answer 27

Question 28

Tell me about the bond market itself (ie, where bonds are traded and issued)

Answer 28

Primary Market (GILTS)

GILTS are issued weekly via the Debt Management Office (DMO) of HM Treasury. Large investors, such as pension companies, banks, and investment houses put in bids at the price and quantity they want. If successful, they pay the price they bid.

Primary Market (Corporate Bonds)

Corporate Bonds are typically issued less frequently, and are arranged by banks. Rather like new share issues, a prospectus is produced to attract investors, who then place indicative bids to buy the stock at a certain price. This determines a final price, and the buyer has 24 hours to confirm their bids and trade.

Secondary Market

Once issued through the primary market, all bonds are then traded in the secondary market. Trading is brisk with prices fluctuating all the time. As with shares, a lot of factors influence the price, not just supply and demand, such as interest rate movements, government policy, inflation rates etc.

Question 29

What are Eurobonds?

Answer 29

Eurobonds are bonds denominated in a currency other than that of where they are issued and their name changes to reflect the currency zones, so a bond issued in American dollars by Japan would be a Eurodollar bond.

(They are nothing to do with Europe!)

Question 30

You must know this for the exam

To calculate a bonds returns there are 2 main ways:

The interest yield & the Redemption yield

The former calculates the income return (not taking into account any capital gains or losses) and the latter calculates the overall return, including any capital gains or losses.

Tell me how both work:

Answer 30

The interest yield = (Coupon X 100) / Clean price

The Redemption yield =
Interest yield +/- (gain or loss to maturity / number of years until maturity) / clean price x 100

SEE IMAGE

Question 31

If i were to say the income yield/running yield/flat yield of a bond is this, what do I mean?

Give an example

Answer 31

Those 3 terms are another way to say ‘The interest Yield’

The interest yield calculates the income return of a bond. It is basically like the AER of the bond

It is:
(Coupon X 100) / Clean price

See example in Image.

In the above examples it didn’t mention the actual prices that Keira or Connor paid. That is because it is irrelevant. Interest Yield is purely the coupon expressed as a percentage of the current clean price.

Question 32

Note: Interest Yield is purely the coupon expressed as a percentage of the current clean price.

True or false

Answer 32

True

It does not take into account the ‘current price’ of the bond

Question 33

How can the Interest yields sometimes be misleading?

Answer 33

Doesn’t account for any capital losses or gains if the bond is kept until maturity

See example image: This will be £27.86 per bond in Keira’s case and £16.85 per bond in Conor’s

The gross redemption yield takes account any gain or loss so it is more accurate.

Question 34

Tell me the steps to calculate the redemption yield:

See image for equation

Note this is the ‘gross redemption yield’ as the calculation is a value before any tax has been deducted. Therefore, an individuals may be lower if they have a tax liability. This is an issue with using the ‘gross redemption yield’ calculation as seen above. Some individuals use the ‘net redemption yield’ calculation so their tax liability is taken into account (you do not need to know this for R02. Just know the difference.

Answer 34

The steps involved in this calculation are:

Step 1: Work out the ‘normal’ interest yield (you may be provided this in the exam)

Step 2: Work out the capital gain or loss at redemption

Step 3: Work out the gain or loss per year by dividing the capital gain or loss by the number of years until redemption

Step 4: Convert the yearly gain or loss into an income yield (positive or negative)

Step 5: Add or subtract the gain or loss to the ‘normal’ interest yield

See image for it being calculated in an example

NOTE: The interest yield = (Coupon X 100) / Clean price

If the redemption yield is less than the interest yield, that indicates there will be a capital loss if the bond is held until its redemption date.

Question 35

If the redemption yield is less than the interest yield, what does this mean?

Answer 35

There will be a capital loss if the bond is held until its redemption date.

The opposite is true also

Question 36

What is the main issue with the gross redemption yield calculation? (see image)

The clue is in the name

What can be done to combat this issue?

Answer 36

The ‘gross redemption yield’ calculation shows the return value of a bond before any tax is deducted.

Therefore, an individuals may have a lower return on their bond due to their tax liability but the calculation will not show this which is an issue. To tackle this some individuals use the ‘net redemption yield’ calculation so their tax liability is taken into account (you do not need to know how to do this for R02. Just know the difference between both calculations)

Question 37

Are bonds subject to CGT?

Answer 37

Bonds are not subject to CGT

Question 38

LEARN THIS. You must know both equations

Involves calculating the interest yield and the gross redemption yield

Answer 38

Question 39

Tell me the different types of risk that fixed interest securities present and what they all mean

Very similar to cash beside one of them

Answer 39

Default risk: The creditworthiness of the firm you save with.

Inflation risk: The impact of inflation.

Interest rate risk: The uncertainty of interest rate movements.

Currency risk: Exchange rate movements if saving overseas.

Liquidity risk: The ability to sell at a given time.

SEE IMAGE

Question 40

How can a rise in interest rates affect the prices of bonds?

Answer 40

When interest rates rise, people can get decent returns from their bank savings. They are less inclined to save in non-cash investments, so the demand for other investments fall

This means there is less demand for bonds, and their price drops.

The opposite is also true. If Interest rates fall, demand for bonds rise and so does their price, but demand for savings accounts will fall

This shows a correlation between one asset class (cash) and another (fixed interest securities)

Question 41

How does a general drop in bond prices increase existing bonds yields?

Answer 41

The coupon stays the same at all times, therefore a falling price actually increases the yield, as shown in the following example.

This obvs assumes the owner doesn’t sell the bond, keeping it until redemption, and therefore not realising any loss from selling below PAR

Question 42

There are two types of risk that mainly impact the supply and demand price of bonds. What are they?

Answer 42

‘Specific risk’ or ‘commercial risk’ that affect a particular stock. Also known as unsystematic risk.

Risks that affect the whole market. Known as ‘market risk’ or ‘systematic risks’

Question 43

There are two types of risk that are the main impact on the supply and demand price of bonds.

1st type: ‘Specific risk’ or ‘commercial risk’ that affect a particular stock. Also known as unsystematic risk.

2nd type: Risks that affect the whole market. Known as ‘market risk’ or ‘systematic risks’

Tell me in more detail about ‘specific risk’

Answer 43

See image

Basically specific risk is micro factors that affect a particular/specific bond supply and demand such as the organisation/company who issued the bond.

Question 44

What are junk bonds?

Answer 44

Bonds from issuers who have a high risk of default

Question 45

Answer 45

It drives up the yield because the real time value of the bonds will fall as less people will want them

Question 46

Why do bonds with far longer redemption dates are higher market or systematic risk?

Answer 46

The longer the period until redemption, the more likely it will be affected by systematic risk such as world events and companies running into difficulty.

Basically, the longer the term, the more things that could happen to adversely affect the bond = higher risk

Question 47

What is the yield curve?

Answer 47

The yield curve is a graph that allows investors to work out what bond is best for them by comparing other bonds on the market with different redemption dates.

The graph compares the redemption yields of similar bonds with different redemption periods. It helps answer questions like: Should I go for a longer-term bond in the hope of getting a better yield?

The yield curve can be in 3 main forms. What are they?

-The normal yield curve
-The flat yield curve
-The inverted yield curve

Just remember: normal, flat and inverted.

The shape of the curve on any one day (whether normal, flat and inverted) gives an indication of the market’s expectations of changes in interest rates and future yields.

Question 48

The yield curve graph (the tool investors use to compare bonds) can be in 3 main forms. They are:

-The normal yield curve
-The flat yield curve
-The inverted yield curve

Just remember: normal, flat and inverted.

What is the differences between each?

Answer 48

The flat yield curve is just a flat line

-The normal yield curve (what the graph looks like in normal conditions)
Where investors expect higher yield the longer the term due to the higher risk presented by longer term bonds. It levels out because when it gets to very long term bonds because If you want a 10% yield, it doesn’t really matter if the term is 24 or 25 years

-The flat yield curve (The flat yield curve is just a flat line)
It is When the economy is relatively stable and no changes to interest rates or inflation are expected, then there is less risk to be taken in buying longer-term stocks. The curve becomes flat. Investors are prepared to accept a lower yield and pay relatively more for longer-dated bonds)

-The inverted yield curve
(Occasionally the curve can invert, so that the yield expected on longer-term bonds is lower than on short-term bonds. An expectation of rising interest rates in the short-term followed by a reduction in rates thereafter can drive this.)

Question 49

What is GILTS short for?

There are 3 types. Longs, Mediums & Shorts. What are the differences

Answer 49

Government-Invested Long-Term Security

The press and the DMO define GILT types differently

Question 50

What are index linked GILTS?

What is the downside of this type of stock?

Answer 50

With index-linked GILTS, both the interest payments and the capital at redemption are adjusted, in line with inflation. The index used is the Retail Prices Index.

If RPI falls, then the interest and capital will also fall and vice versa.

Coupons on index linked GILTS tend to be much lower than on non- index linked stocks.

Question 51

With index-linked GILTS, both the interest payments and the capital at redemption are adjusted, in line with inflation.

Considering GILTS only make the interest payments twice yearly, how is the rate of inflation that is applied to the GILT calculated and applied since the index changes on a daily basis and the GILT coupon is twice yearly?

What is this also known as?

Answer 51

When calculating the actual rate of inflation

GILTS use RPI figures from the period 3 months prior to the coupon payment date.

This is known as ‘indexation lag’.

Question 52

What is the REPO market?

Its real name is the sale and repurchase agreement market

NOTE: JUST BE AWARE OF THIS. YOU DONT NEED TO KNOW IF LOADS OF DETAIL

Answer 52

The repo market increase liquidity of GILTS as it allows owners to use their GILTs as security to take out a short term loan to buy whatever is needed

Loans tend to vary between overnight arrangements to several months.

Basically it is for those who are low on cash but own GILTS

SEE EXAMPLE IN IMAGE

Question 53

What is The strips market?

What is its real name?

NOTE: JUST BE AWARE OF THIS. YOU DONT NEED TO KNOW IF LOADS OF DETAIL

Answer 53

The Separate Trading of Registered Interest and Principal Securities market

It strips a gilt down into 2 things:

a series of interest payments and
a redemption payment which can be sold separately.

Question 54

Corporate bonds (CBs) are either secured or unsecured

Tell me the difference

Answer 54

Secured CB-
where a charge is taken over the firm’s assets and in the event of default the assets can be used to repay the loan (lower risk) - Known as a ‘debenture’

Unsecured CB -
No assets secured (higher risk) - known as ‘loan stock’

Question 55

What is a debenture?

Debentures can be secured by either a fixed charge or a floating charge.

Which one does the investor prefer and which one does the company prefer

Answer 55

It is a secured corporate bond

(where a charge is taken over the firm’s assets and in the event of default the assets can be used to repay the loan)

Fixed Charge = Company cannot sell the secured asset. preferred by investors as its a better security for them

Floating Charge = The company can still sell their assets. Preferred by companies as its less restrictive on them

Question 56

Although corporate bonds are very similar to GILTS, there are differences that an investor needs to consider

Give some examples:

Answer 56

They are riskier, with a higher chance of default.

Prices are more volatile.

They can be more difficult to trade, particularly smaller company bonds.

The difference between the buying and selling price is greater.

The creditworthiness of the companies changes more regularly.

Yields are often greater to reflect the higher risks being taken.

Question 57

What are Convertible Loan Stock?

What are Floating Rate Notes?

Answer 57

They are both types of corporate bonds

Convertible Loan Stock -
Unsecured corporate bonds that allow the holder to convert the loan into company shares for a set time period. If the time period expires it just becomes a normal loan stock. It has low coupon rates

Floating Rate Stocks -
Issued by banks. Interest return is linked to money markets. Because Money markets are linked to SONIA or LIBOR it is effectively linked to both these

Question 58

What are Permanent Interest Bearing Shares (PIBS)

What are Perpetual Subordinated Bonds? (PSBs)

Answer 58

They are both types of corporate bonds

PIBS - Undated stocks (no redemption date) and no obligation from building society to make up for any missed payment (high risk CBs)

PSBs - Previous Building Society PIBS that have been converted since the BS has demutualised

Question 59

What does it mean if a building society demutualises?

Answer 59

It means that it becomes a PLC and issues shares, therefore losing its mutual status

Question 60

What is ‘loan stock’

Answer 60

An unsecured corporate bonds

Question 61

What is a ‘debenture’

Answer 61

A secured corporate bond

Question 62

Every company issues shares, but for shares to be offered to the general public the company must meet what requirements?

Answer 62

They must gain a listing on a stock exchange (where the share price is published and shares become more liquid (easier to buy and sell).

And offer a minimum 25% of their ordinary share capital for sale. (to be a PLC)

Question 63

Where are shares mainly traded in the UK?

Answer 63

The London Stock Exchange (LSE)

Question 64

Shares will generally be listed on one of two main markets within the The London Stock Exchange:

What are they and describe the differences

Answer 64

The main market
(Stringent rules, expensive to gain listing, where larger companies are found)

The Alternative Investment Market (AIM)
(for smaller and newer companies, less expensive, less stringent rules)

Question 65

When buying/selling shares what are some of the associated costs and who is share dealing conducted with?

Answer 65

Dealing in shares is often conducted through stockbrokers

The associated costs of share dealings (buying or selling shares):

Commission - This is charged by the broker for their service

Stamp Duty (paper) / Stamp Duty Reserve Tax (paperless) - These are taxes paid on the purchase of shares. Both charge 0.5% of the purchase price.

Panel on Takeovers and Mergers (PTM) levy -
This is a flat £1 fee, applied to all trades (both purchases and sales) of more than £10,000. This levy funds the takeover panel

Question 66

What is Stamp Duty (paper) / Stamp Duty Reserve Tax (paperless) in relation to share dealing?

Answer 66

These are taxes paid on the purchase of shares.

Stamp Duty applies to paper transfers (using stock transfer forms

Stamp Duty Reserve Tax applies to electronic transfers

Costs differ depending on whether purchase is via paper transfer (smaller companies mainly) or electronic transfer using CREST’s paperless method .

Both charge 0.5% of the purchase price, with SD (paper) being rounded up to the next £5 and SDRT (paperless) being rounded to the nearest penny.

(just remember, paper method is more expensive so rounding is worse)

SEE IMAGE FOR CALCULATION IN CONTEXT

Question 67

Answer 67

Question 68

Stamp Duty & Stamp Duty Reserve Tax is ONLY payable on the purchase of shares

Stamp Duty & Stamp Duty Reserve Tax is ONLY payable on the sale of shares

Stamp Duty & Stamp Duty Reserve Tax is payable on both the sale of shares and purchase of shares

Stamp Duty & Stamp Duty Reserve Tax are payable on both paper and electronic (through CREST) purchases

Answer 68

True

False (It is only payable on the purchase)

False

False. Stamp Duty is payable on paper purchases (using Stock transfer forms) and SDRT is payable on electronic (through CREST) purchases. Both charge 0.5% on the purchase price, but SD is then rounded up to the next £5 and SDRT is rounded to the nearest penny.

Question 69

CONTEXT of share prices in relation to interest rates

Answer 69

Question 70

There are two main classes of shares

The main difference between the two is that they offer different rights to the shareholder in areas such as dividend rights, control of the company and return of capital if the company goes into liquidation.

Outline and explain both

Answer 70

Ordinary & Preferential

Ordinary Shares gives owners:

-Right to share in the profits of company (via dividends, which are optional).

-Right to vote at company meetings (Annual General Meetings: AGMs).

-ownership of a portion /share of the company along with the other shareholders

Preferential Shares gives owners:

Question 71

What are dividends paid from?

Who decides the amount of dividends to be paid?

The board of directors decides the amount of dividends to be paid.

Do companies always pay out all their profits as dividends?

What might a company do with profits instead of paying them all out as dividends?

What happens to the retained profits in terms of shareholder value?

Retained profits can increase the company’s value, leading to increased share value and capital growth for investors.

Answer 71

Dividends are paid from company profits.

The board of directors of the company decides the amount of dividends to be paid.

No, companies do not always pay out all their profits as dividends.

A company might retain some profits for business needs or reinvestment.

Retained profits can increase the company’s value, leading to increased share value and capital growth for investors.

Question 72

What is the tax treatment of shares?

Answer 72

There is a dividend allowance (DA) of £1,000 (no tax on first £1000 received from dividends in a year)

If you exceed the dividend allowance the following rates apply. SEE IMAGE

Dividends are paid gross, but are taxable as the top slice of the investor’s income, sitting on top of any earned income and savings income.

SEE INTEREST RATES ON LEFT FLASHCARD. SEE EXAMPLES OF CALCUATIONS IN RIGHT FLASHCARD

Question 73

Ordinary shareholders are the last people to be paid when a company goes into liquidation. True or false

Answer 73

True

Question 74

Some companies offer Alphabet Shares. What is this?

Answer 74

Most companies have one class of ordinary share, but some firms issue ordinary shares with different rules.

These shares are known as ‘alphabet shares’ as they often use letters to denote their category, for example:

‘A’ ordinary shares where no voting rights are available

‘B’ shares are usually redeemable by the company, as a form of capital shareholder return

and so on

Question 75

Preference shares rank above ordinary shares in the event of liquidation.

True or false

Answer 75

True

Question 76

What are preference Shares?

Answer 76

They pay a fixed rate of return (via dividends) every six months

(This works in a similar way to loan stock except loan stock pay out regardless of profits and obvs pay interest, not dividends)

No voting rights initially, but voting rights can be made available if the company falls behind on its dividend payments.

Question 77

There are several types of preference Shares. What are they?

Answer 77

Cumulative - Where missed dividend payments are made up in the future

Non-Cumulative - Where missed dividend payments are NOT required to be made up

Participating - fixed dividend + a share in company profits (a proportion of what an ordinary shares receive)

Redeemable - Undated so company can buy back when they want. Dividends are stopped when company buys back the shares. Used as short term finance for companies

Convertible - Can be converted into ordinary company shares (used often where the ordinary share price is rising)

Question 78

All of the below are risks associated with investing in equities:

Equity capital risk
Market risk
Share dividend volatility
Liquidity risk
Currency risk
Counterparty risk
Regulatory risk.

Tell me about each:

Answer 78

Equity capital risk: Risk to capital, due to market forces.

Market risk: The impact of ‘wider market forces’.

Share dividend volatility: Dividends are uncertain.

Liquidity risk: The ability to sell at a given time.

Currency risk: Exchange rate movements, if dealing in overseas equities.

Counterparty risk: The risk that a counterparty will not pay what it is obliged to.

Regulatory risk: Issues causes by too strict or too slack regulations (such as what led to the 2008 crash)

Question 79

Diversification reduces unsystematic or specific risk. It has little or no effect on systematic or market risk.

True or false

Answer 79

True

Question 80

What is private equity?

Answer 80

Where investors purchase shares in a company or acquire companies that are not listed on the Stock Exchange (private firms)

They aim to invest their money that they will ‘exit’ in the future after a certain event occurs, such as the firm becoming public and gaining a listing.

Most investments in this area are made by institutional firms or ‘Dragons’ on ‘Dragons’ Den’ (thats a jk but they do do private equity)

Question 81

What are investment ratios?

Answer 81

They are used to help decide whether it is worth investing in any firm, big, small, established, or new. This includes both private and public investing

For example, they can be used to know whether to buy HSBC or Lloyds Bank shares

They include the following:
Earnings Per Share
Dividend Yield
Dividend Cover
Price Earnings ratio (P/E)
Net Asset Value (NAV)

Question 82

The 5 main investment ratios that are used to help investors know whether to invest into a firm are:

Earnings Per Share
Dividend Yield
Dividend Cover
Price Earnings ratio (P/E)
Net Asset Value (NAV)

Tell me briefly what each is used for:

SEE BOTH IMAGES

In your exam you will get questions where you have to; apply the calculations, work out which ratios you can calculate from information provided, and explain what each ratio tells us.

Answer 82

Earnings Per Share - Shows trends in companies profitability

Dividend Yield - Shows the value of a shares dividend

Dividend Cover - Shows how many times a dividend can be paid out of available earnings

Price Earnings ratio (P/E) - Shows the demand of shares when compared with other firms

Net Asset Value (NAV) - Shows what is available to shareholders in event of company closing down and selling everything

Question 83

The various investment ratios in action

In your exam you will get questions where you have to; apply the calculations, work out which ratios you can calculate from information provided, and explain what each ratio tells us.

Answer 83

Question 84

How does FTSE 100 and other indices work?

Answer 84

Indices combine the movements of individual share prices into one figure, designed to show how the market has moved over a period of time

Note: Most types of investment, such as property, fixed-interest securities, or shares have an index, and they are used worldwide.

Question 85

A companies share is ‘against market movements’

How was the spotted by the potential investor and what does this mean?

Answer 85

The investor would have looked at the relevant index, for example FTSE 100 if they are investing a top 100 company

They would have seen that the index is going up, but the share they are considering is going down,

Therefore the share is ‘against market movements’

The investor will then check why and assess if their investment is a good choice.

Question 86

Some equity indices are ‘capital weighted’ such as FTSE 100. What does this mean

Answer 86

The larger the company (measured via market cap), the bigger its weighting in the index.

Question 87

What are the four 4 main FTSE indices?

Answer 87

Question 88

As well as the 4 main indices FTSE has 3 ‘Smaller’ FTSE Indices tailored more for smaller companies.

What are they?

Answer 88

Question 89

WORLDWIDE INDICIES. JUST BIEFLY KNOW 2 OR 3

Answer 89

QUESTION

Question 90

Property investments can be direct or indirect

What does this mean?

Answer 90

Direct: the purchase of actual ‘bricks and mortar’

Indirect: investing in property via the use of collective investments

Question 91

What are the main risks associated with property investment?

Answer 91

Liquidity Risk: The ability to sell at a given time or realise cash quickly.

Management Risk: Skills and funds required to run the business.

Void Risk: The risk that the property will be vacant.

Question 92

What are rental yields?

There are two types. What are they?

Answer 92

They show the value of the rental income as a percentage of the total property price paid.

Two types:
Gross rental yield
Net yield

Question 93

There are two rental yields. These show the landlord the value of the rental income as a percentage of the total property price paid.

Two types:
Gross rental yield
Net yield

Tell me about both

Answer 93

Gross rental yield = gross rent achieved / the market price paid or Cost Of Purchase (SEE IMAGE ON LEFT)

Net yield (more accurate) = Takes into account associated cost (SEE IMAGE ON RIGHT)

Question 94

Rental Yields Calculations

Answer 94

Question 95

What is Stamp Duty Land Tax (SDLT)

Answer 95

It is a tax on land transactions and is payable by the individual who acquires the land.

It is often shortened to ‘stamp duty’

Question 96

Tell me the difference between

Stamp Duty Land Tax
Stamp Duty Reserve Tax
Stamp Duty

Answer 96

Stamp Duty Land Tax (often shortened to stamp duty) - It is a tax on land transactions and is payable by the individual who acquires the land.

Stamp Duty Reserve Tax is payable on the purchase of shares that are bought electronically (via CREST)

Stamp Duty is payable on the purchase of shares that are bought with paper (stock transfer forms)

JUST REMEMBER: ‘STAMP DUTY’ could be referring to two different taxes

Question 97

Stamp duty Land Tax transactions fall into two categories:

What are they?

Answer 97

Leasing/renting land or premises (extra threshold applies to this)

Buying land or premises

Question 98

REMEMBER: Stamp Duty Land Tax (SDLT) on purchases is often tested by the R02 examiner.

Question 99

Tell me about Stamp Duty Land Tax

Your tax tables include a lot of information on SDLT. Make sure you know what is and is not on there, ahead of your exam.

Answer 99

Like with share stamp duty, no SDLT is paid on a sale. It is only paid on the property purchase

It is payable on the land, therefore not due on the ‘fixtures and fittings’ that may come with purchasing a property (such as carpets, domestic appliances etc.).

It is tiered depending on value of property
(see image)

Any second home or buy-to-let residential property purchased for £40,000 + pays an extra 3% SDLT on top of the usual tiered rates (inc. the first bands, which are normally SDLT free (so if your in the lower bands you may have to pay 3%).

A 2% surcharge applies for non-UK residents purchasing residential property for over £40,000 i

Question 100

If a non UK resident purchases a residential property for over £40,000 what happens in relation to SDLT?

If you buy a second home or buy-to-let residential property purchased for £40,000 whether UK resident or not, what happens?

Answer 100

A 2% surcharge applies (2% on top of any other stamp duty )

Any second home or buy-to-let residential property purchased for £40,000 + pays an extra 3% SDLT on top of the usual tiered rates (inc. the first bands, which are normally SDLT free (so if your in the lower bands you may have to pay 3%))

Question 101

Stamp Duty Land Tax In Context 1/3

Answer 101

Question 102

Stamp Duty Land Tax In Context 2/3

Answer 102

Question 103

Stamp Duty Land Tax In Context 3/3

Answer 103

Question 104

Stamp Duty Land Tax can be avoided by exchanging properties

True or false

Answer 104

False

Question 105

What are the reliefs in relation to SDLT that are available to first time buyers

Answer 105

First time buyers have discounted rates up to £625,000

The rates paid by qualifying first time buyers is:

0% SDLT up to £425,000

5% SDLT on the portion from £425,001 to £625,000

Question 106

Who pays Stamp Duty Land Tax (SDLT) when purchasing a property?

Does the seller of a property pay SDLT?

Can SDLT be avoided through property exchange?

What happens to SDLT rates when a property value exceeds a threshold by £1?

If a property is exactly on a threshold, into which SDLT rate band does it fall?

What SDLT rate applies to a property valued at £250,000?

What SDLT rate applies to a property valued at £250,001?

Do different SDLT rates apply to residential and non-residential property purchases?

What special SDLT rules apply to first-time buyers?

Answer 106

The purchaser of the property.

No, the seller does not pay SDLT.

No, SDLT cannot be avoided through property exchange.

The property falls into the higher SDLT rate.

It falls into the lower rate band.

0% band.

5% band.

Yes, different rates apply, but the calculation is the same.

New rules apply for first-time buyers who buy property below £625,000.

Question 107

Answer 107

Question 108

What is Rent a Room relief?

The criteria for this is strict (see left image)

Answer 108

It is tax breaks available to anyone who takes a lodger. It allows first £7500 that is earnt from rent to be tax free.

A lodger is someone who rents a room in someone’s house and share common facilities

In relation to example:

Mary has two options when it comes to declaring the additional annual income of £9,600 to HMRC:

She can pay income tax on the full amount, and claim back expenses, or

She can claim RAR relief. The first £7,500 is tax-free and she then pays tax at her highest marginal rate on the excess of £2,100.

Question 109

Can you claim expenses through the Rent A Room Relief?

Answer 109

No expenses are claimable using rent a roof!

RAR allows £7500 to be earnt tax free from lodger

Question 110

The commercial property sector is divided into 3 main sections. What are they?

Answer 110

Retail

Offices

Industrial

Question 111

Very few individual investors buy commercial property to rent out. True or false?

Answer 111

True, because it is so risky

it is instead mainly institutional investors such as pension funds, insurance companies and collective investment schemes

Question 112

Benefits and Disadvantages of property investments

Answer 112

Question 113

Why can alternative investments (investments outside the 4 main asset classes) be useful to include in your portfolio?

Answer 113

For diversification

For example, commodities continued to rise through the credit crisis whilst all other assets were affected by systematic (market) risk.

Question 114

Name some common types of alternative investments and add a downside of each

Answer 114

Works of art and collectables-
includes things like wine, books, paintings, stamps and coins. Almost anything can become a collectable.

Downside: Specialist knowledge is required, no income produced, high associated costs such as insurance

Hard Commodities - where mining or other extractive processes take place

Downside: Direct investment is difficult (you cant store gas or oil as an individual) besides small amounts like GOLD, silver. Unethical views

Soft commodities - Things that are grown rather than mined/extracted

Downside: Direct ownership is difficult- individuals don’t just have acers of storage space and prices also fluctuate widely, and particular expertise is required.

Cryptocurrency:
Highly volatile, unregulated

Question 115

What are hard commodities?

What are soft commodities?

Answer 115

Hard commodities are the products of mining and other extractive processes

These include gold, silver, minerals, crude oil, and natural gas.

Soft commodities are typically grown rather than mined.

They include coffee, cocoa, sugar, corn, wheat, and livestock.

Commodities are now very popular as collective investments, with many pension funds, OEICs and unit trusts investing to diversify their funds.

Question 116

What are some risks associated with alternative investments?

Answer 116

Currency Risk: Most commodities originate from overseas, so currency exchange can be a big factor.

Political Risk: Many commodity-rich countries have a somewhat chequered present, past, and no doubt future. Diamonds in Rwanda and South Africa, oil in Iraq, to name but just two.

Question 117

Do cash deposits expose an investor’s capital to investment risk?

What is the only return for cash deposits?

What factor often erodes the interest earned on cash deposits?

How can an investor achieve higher interest rates on cash deposits?

How much protection does the FSCS provide for cash deposits per person per organisation?

Which organization backs all National Savings products, making them considered risk-free?

Why do banks and building societies want to attract deposits?

What can fixed-interest securities provide for investors?

What can happen to the value of fixed-interest securities if sold before expiry?

Answer 117

No, cash deposits do not expose an investor’s capital to investment risk (ie, the capital is secure)

Interest is the only return for cash deposits. (no capital growth)

Inflation

Higher rates are sometimes available by agreeing to leave the money untouched for a longer period of time via notice accounts or fixed accounts

The FSCS protects 100% of cash deposits, capped at
£85,000 per person per organisation.

All National Savings products are backed by the UK Government and so are considered risk-free for 100% of investment.

Banks and building societies want to attract deposits so they can lend to others at a higher rate.

Fixed-interest securities can provide a secure income.

If sold before expiry, their value can go down as well as up depending on supply and demand

Question 118

What are the main factors that affect bond prices?

What types of risks affect individual bonds and the market as a whole?

Which type of fixed-interest security is guaranteed by the Government and free of default risk?

What potential do equities offer and how are they characterized in terms of risk?

What are the two types of equities?

What tools allow investors to analyze and compare investments in equities?

What do stock market indices provide?

How does property serve as an investment in relation to inflation?

What is a significant drawback of investing in property in terms of liquidity?

How do property returns vary?

What are some expenses associated with property investment?

What special reliefs apply to property for rent-a-room lodgers?

What is a typical characteristic of alternative investments in terms of income?

What are some costs associated with alternative investments?

What level of expertise is needed for alternative investments?

Are alternative investments suitable for direct investment?

Answer 118

Many factors affect bond prices, but mainly interest rates and inflation.

Specific risk affects individual bonds, while systematic risk/market risk affects the market as a whole.

Gilts are guaranteed by the Government and so are free of default risk.

Equities offer potential for long-term growth, but are arguably the riskiest asset class.

The two types of equities are Ordinary and Preference shares.

Investment ratios allow investors to analyze and compare investments in equities.

Stock market indices provide a general overview of the markets as a whole and also provide benchmarks.

Property is an asset-backed investment that can provide a good foil against inflation.

Property is not very liquid, and can be difficult to realize.

Returns vary greatly between cities, towns and even streets.

Expenses associated with property investment can be high.

Special reliefs apply for rent-a-room lodgers. (First £7500 in rent from lodger is tax free)

Alternative investments typically provide no income.

Alternative investments have high costs such as insurance, valuations, maintenance, and shipping.#

A high level of expertise is needed for alternative investments.

Alternative investments are not suitable for direct investment.

Question 119

Joanne is looking at ways of using a bedroom in her house for additional income. As she lives in an area popular with commuters, Joanne hopes to obtain rent of £600 per month. Which of the following is not a criterion in qualifying for rent-a-room relief?

The property must be in the UK

There is no need for Joanne to claim the relief

The property must be unfurnished

The room must not be self-contained

Answer 119

The property must be unfurnished

To qualify for rent-a-room relief the property must be furnished, not unfurnished. All the other criteria are correct. Option B does not fit the definition of ‘criteria’, but you will see anomalies like this in the exam.

Question 120

What is a self contained room?

One of the criteria for rent a room is that the room must not be self containd

Answer 120

A self-contained room is a living space within a larger property that includes its own essential facilities, enabling the occupant to live independently from the rest of the property. These facilities typically include: bathroom, kitchen etc

Therefore, to satisfy the rent a room criteria the lodger must have a room and use common facilities outside of their room that everyone uses

Question 121

To qualify for rent-a-room relief the property must be furnished. True or false

Answer 121

True

It does not qualify if the property is unfurnished

Question 122

Jack and his wife Cassandra have three children, Jonah aged 18 months, Sian aged 4 and Chloe aged 17. What is the maximum they can put into standard Cash ISAs?

£20,000

£40,000

£60,000

£72,360

Answer 122

£60,000

Both adults can now contribute £20,000 into the Cash ISA. As Chloe is 17, she can also contribute to one. The other two children would only qualify for the Junior ISA (not standard ISAs as the question asks)

Question 123

purchased a Treasury 6% 2034 Gilt. The clean price that was published was £105 but Peter paid £110 dirty price to enable him to receive the next coupon distribution. The par value is £100.

What running yield will Peter receive on his investment?

6.19%

6.00%

5.71%

5.45%

Answer 123

The dirty price paid is not used in a running yield calculation, as it is simply an extra payment to secure all of the next coupon distribution.

The running yield is the coupon ÷ the clean price, so £6 ÷ £105 = 5.71% running yield.

Remember
Running yield = Interest yield = Flat Yield

Question 124

Derek recently bought shares in 3 different banks as per the table below. Assuming all transactions were completed on CREST, how much Panel on Takeovers and Mergers (PTM) levy will he have paid?

Bank / Amount subscribed
A = £20,000
B = £11,000
C = £9,000

£0

£1

£2

£3

Answer 124

A PTM levy of £1 is paid on each transaction above £10,000 so he would have paid £1 when buying shares A & B

Therefore £2

For this question you must know the Takeovers and Mergers (PTM) levy

Question 125

Christopher has carried out several share deals this year. What is the total Stamp Duty/Stamp Duty Reserve Tax he would have paid on the following?

Bought £10,000 company A shares using CREST.

Sold £5,000 company B shares using CREST.

Bought £7,500 company C shares using a paper-based system.

Bought £2,500 company D shares using a paper-based system.

Possible Answers:
£100

£105

£125

£130

Answer 125

Stamp Duty / Stamp Duty reserve tax is paid at 0.5% on purchases only:

Bought £10,000 company A shares using CREST: £10,000 x 0.5% = £50

Sold £5,000 company B shares using CREST: £0 no stamp duty on sales because it was SOLD

Bought £7,500 company C shares using a paper-based system: £7500 x 0.5% = £37.50 but rounded up to £40 as paper transactions are rounded up to nearest £5

Bought £2,500 company D shares using a paper-based system: £2500 x 0.5% = £12.50 but rounded up to £15 as paper transactions are rounded up to nearest £5

ANSWER: Total = £50 + £40 + £15 = £105

READ QUESTIONS CAREFULLY AS TO WHETHER IT WAS BOUGHT OR SOLD

Question 126

Jack holds shares with three different companies, and has just received a dividend from each as shown below.

Which of these has given Jack the greatest dividend yield?

Company / Share Price / Dividend Paid / Profits attributable to shareholders

A / £6.30 / 35p / £500,000

B / £1.20 / 10p / £620,000

C / £0.90 /5p / £850,000

Answer 126

Dividend yield is calculated by dividing the dividend by the share price x 100.

‘Profits attributable to shareholders’ would be needed to calculate Dividend Cover, but not dividend yield.

Company A = 5.56% dividend yield
Company B = 8.33% Dividend yield
Company C = 5.56% dividend yield

Company B gave Jack the highest dividend yield

Question 127

Jager has little investment experience but wants to get into shares. He is happy to pay a premium for growth shares.

Using the price/earnings ratio only, which of the following shares would you suggest he buys?

Company / Earnings per share / Share price

A / 75p / £5.50

B / 50p / £6.15

C / 20p / £2.25

D / 10p / £1.25

Answer 127

The price earnings ratio gives the formula in its title. Price/Earnings= P/E ratio.

A high ratio usually indicates that investors are confident about future earnings growth.

Company A = 7.33
Company B = 12.3
Company C = 11.25
Company D = 12.50

Company D has highest Price/Earnings so to answer question it is D. In real life other factors will be taken into account

Question 128

Chad, a first-time buyer, has just bought a flat in Wolverhampton for £500,000. His brother Dave, also a first time buyer, has bought a house in Solihull for £650,000. What is the total Stamp Duty Land Tax that they will pay?

£15,000

£20,000

£23,750

£32,500

Answer 128

Answer = £23,750

Chad’s purchase price is £500,000, so he qualifies for the first time buyer rates.

£0 - £425,000 x 0% = £0
£75,000 x 5% = £3,750

Because of the purchase price of Dave’s house, he cannot qualify for first time buyer rates, and will instead be subject to normal rates. He will pay:

£0 - £250,000 x 0% = £0

£250,001 - £650,000 x 5% = £20,000

Total £3750 + £20000 = £23,750.

Question 129

Gerald owns a retail shop of 125 square metres that he previously rented out for £2,000 per month, providing a 6% annual yield. Earlier this year he purchased the shop next door, which he has combined with the existing property to create a new retail space of 225 square metres. The purchase and improvements cost £250,000.

How much rent must he charge to achieve the same yield?

£3,250 per month

£2,800 per month

£3,600 per month

£3,000 per month

Answer 129

The annual rental income previously was £2,000 x 12 = £24,000. If the yield was 6%, the cost of the original property was £24,000 / 0.06 = £400,000.

Therefore the total cost of the combined retail space is £650,000.

To achieve the same yield, the rent required is £650,000 x 6% = £39,000 per annum or £ 3,250 per month.

The information about the size of the property was a red-herring, as the question was not asking you to express it as ‘£ per square metre’.

Question 130

An investor pays a clean price of £114.60 for £100 nominal value of stock, with a 6% coupon. Assuming the stock has exactly seven years to run until maturity, what will the simplified gross redemption yield be?

3.42%

2.09%

5.24%

6.00%

Answer 130

ANSWER = 3.42%

Calculate the running yield/interest yield/flat yield first by dividing the coupon by the clean price then use the gross redemption yield equation.

£6 ÷ £114.60 x 100 = 5.24%

Then calculate the loss or gain that would be made at redemption: £114.60 – £100 = £14.60.

This would be a loss, as they are paying over par to buy it. Divide this loss by the number of years remaining. £14.60 ÷ 7 years = £2.09 annual loss.

Divide this annual loss by the clean price: £2.09 ÷ £114.60 x 100 = -1.82%

Deduct this figure from the running yield: 5.24% – 1.82% = 3.42%

You must know both the gross redemption yield equation and interest yield equation

Question 131

Joanne is buying a property for £275,000 and Kai is buying a property for £375,000. Joanne is also paying an additional £15,000 for items of furniture that the current vendor is willing to leave in the property. How much more Stamp Duty Land Tax will Kai pay than Joanne, assuming neither are first time buyers?

£3,000

£4,250

£5,000

£6,250

Answer 131

Answer: Kai pays £5,000 more

Stamp Duty is paid at a rate of 0% of on the first £250,000, and 5% on £250,001 to £925,000.

There is no stamp duty on the money that Joanne is paying for the furniture items, therefore:

For Joanne:

£250,000 has no stamp duty

£25,000 has 5% stamp duty = £1,250

For Kai:

£250,000 has no stamp duty

£125,000 has 5% stamp duty = £6,250

= £5,000 bigger bill for Kai

Question 132

A limited company has 5,000 ordinary shareholders. In the current financial year, the company made profits of £1,090,000. The company has just declared a dividend of £84 per ordinary share and a total dividend of £190,000 is due to preference shareholders. What is the dividend cover?

2.14

2.60

1.76

1.46

Answer 132

Answer = 2.14

Dividend cover is calculated by dividing the profits attributed to ordinary shareholders by the dividend payments to ordinary shareholders. The dividend payments are £84 x 5,000 = £420,000.

Profit attributed to ordinary shareholders is £1,090,000 - £190,000 (the dividend due to preference shareholders) = £900,000

The dividend cover is therefore: £900,000 ÷ £420,000 = 2.14

The company could pay the dividend distributed 2.14 times from the profits available for distribution.

Question 133

Martin is a high rate taxpayer. He has just purchased an investment property for £190,000. The transaction costs add up to £3,000. If the rent is £700 per month, with 20% earmarked for expenses, what will be the net yield that Martin will receive on this property?

4.42%

4.35%

3.48%

2.09%

Answer 133

The overall acquisition price, taking into account the costs, needs to be established first. £190,000 + £3,000 = £193,000.

The rent needs annualising as before, so £700 x 12 = £8,400 and this is adjusted to reflect the expenses. £8,400 x 20% = £1,680.

So, overall annual rental income is £8,400 - £1,680 = £6,720.

Then calculate as before so £6,720 ÷ £193,000 x 100 = 3.48%.

Martin’s tax rate is not relevant here, as net property yield is pre-tax.

Question 134

The share price of company X is 285p and the earnings per share are 15p. The share price of company Y is 181p and the earnings per share are 34p. The price earnings ratio of companies’ X and Y respectively, would be:

5.26 and 1.88

19 and 5.32

6.35 and 0.44

1.57 and 2.27

Answer 134

19 and 5.32

The P/E ratio is the price ÷ earnings so:

Company X = 285 ÷ 15 = 19

Company Y = 181 ÷ 34 = 5.32

Question 135

A limited company has purchased a residential property in Kensington for £1,650,000. What would the Stamp Duty Land Tax be on this transaction?

£65,000

£72,000

£111,750

£247,50

Answer 135

£1,650,000 x 15% = £247,500

Question 136

When considering the price of a conventional GILT…

you will always receive £100 per gilt at redemption

a price of £109.50 is said to be below par value

a purchaser of a gilt will usually pay a lower price than the seller will receive

a purchase of a bond between coupon payment dates will be transacted at the clean price

Answer 136

you will always receive £100 per gilt at redemption

All GILTS pay back the £100 nominal or par value at maturity and costs are inevitably involved in the transaction, meaning that the seller will not get all of the value of the sale.

Anything above £100 is trading over par, not under par. Most transactions occur at the dirty price, taking into account the interest adjustment.

Question 137

Tabatha, who usually invests in equities, is looking to diversify her portfolio by investing in commercial property. You should advise her that…

any transaction is likely to be slower, and more complex, than she is used to

she is unlikely to pay Stamp Duty Land Tax

the income yields will be higher from more expensive properties

the commercial property sector is more liquid than the equity markets

Answer 137

any transaction is likely to be slower, and more complex, than she is used to

Any kind of direct property transaction is slow to complete and the market, even at its most buoyant, is somewhat illiquid. Stamp Duty Land Tax is payable.

Question 138

Ibrahim is looking to invest in commodities to further diversify his investment portfolio. If he proceeds… SELECT ALL THAT APPLY

he will only be able to trade directly in hard commodities

the expected returns would be higher than any normal asset class

he could invest in a commodities OEIC or Unit Trust

commodities should diversify his equities well, as they are negatively correlated to them and move in different cycles

Answer 138

2 Answers:
He could invest in a commodities OEIC or Unit Trust

Commodities should diversify his equities well, as they are negatively correlated to them and move in different cycles

Explanation:

In theory, anyone can hold both direct and indirect commodities but in reality, it is impractical, with storage of the commodities being the biggest issue. So, many investors invest via funds.

Commodities have performed well and do work as a perfect foil against equities, but it is impossible to say that they will, or should, outperform other ‘normal’ asset classes.

Question 139

Peter, a higher rate taxpayer, has £90,000 of savings in his only building society account. Karen, an additional rate taxpayer, has £101,000 in her only bank deposit account. Both accounts provide the same interest rate. In comparing the two accounts you would note… SELECT ALL THAT APPLY

Karen would have a higher level of protection from the FSCS

Peter’s account must have exit penalties, as building societies always pay higher returns

both accounts would have the same level of tax deducted automatically at source

Karen’s account is less likely to provide voting rights

the maximum Peter can deposit in a building society account is £100,000

Answer 139

ANSWER: both accounts would have the same level of tax deducted automatically at source

Karen’s account is less likely to provide voting rights

EXPLANATION:

Both would be protected by the FSCS up to the £85,000 limit. Building societies can have voting rights through their share accounts, but these do not guarantee better rates.

All interest from bank and building society accounts is paid gross irrespective of the tax status of the depositor. They both have £0 deducted at source because interest is paid gross

Question 140

Theresa, an experienced investor, has diversified her portfolio by buying some shares in Bovis Homes. She should be aware that listed property company shares… SELECT ALL THAT APPLY

offer greater diversification than direct property investment

will not be eligible to put into a ISA

will be less volatile than direct property investment

are affected by the quality of the company management

will be easier to sell than direct property investment

Answer 140

ANSWERS: offer greater diversification than direct property investment, are affected by the quality of the company management & will be easier to sell than direct property investment

EXPLANATION:

Shares in property companies are a good indirect way of investing in the property market. A buoyant housing market should boost share prices across the industry, assuming that good company management is in place.

Housing companies will build and maintain many properties in different locations, diversifying their own portfolios. The shares are as readily saleable as any other stock, which can mean that they are actively traded, so their price will fluctuate, making them a more volatile investment than the value of a property owned directly.

Listed shares are eligible investments for an ISA. (its irrelevant whether property is involved, just that they are listed shares)

Question 141

When depositing cash into a bank account, an investor should be aware that… SELECT ALL THAT APPLY

the only return will be interest, the capital will not grow

all accounts are obliged to pay an interest return

interest payments to non-taxpayers are always made without tax being deducted

protection from the FSCS may apply within certain limits

a term account is more likely to pay a higher rate than an instant access account

Answer 141

a, c, d & e are correct

Explanation:

Capital growth is not possible from bank accounts with the only income coming via interest distributions.

Accounts paying no or little interest are quite common

Interest is paid gross to all investors, not just non tax payers although the it is still correct given what the question is asking

FSCS protection applies to the first £85,000 of an investor’s deposit in any organisation that qualifies.

Question 142

Jessica and Troy have their savings of £50,000 each in a NS&I investment account and a building society account respectively. When comparing the two accounts… SELECT ALL THAT APPLY

Jessica is effectively lending her money to the Government

both are protected under the FSCS rules

Troy will usually receive lower rates of interest

both accounts will pay interest net of basic rate income tax

Jessica can put a maximum of £1,000,000 in her account and Troy has no maximum

Answer 142

Answers: Jessica is effectively lending her money to the Government and Jessica can put a maximum of £1,000,000 in her account and Troy has no maximum

EXPLANATION

NS&I is the Government’s banking arm and so investors are technically lending their money by saving with them.

They are government, not FSCS protected so only one is FSCS protected

Both pay gross interest.

The investment account has a £1m maximum deposit and pays its interest gross but taxable. There is not usually an upper limit on building society accounts unless it is something like a Cash ISA.

Question 143

When comparing Richard’s preference shares and Rebecca’s ordinary shares in the same company, you would correctly note that… SELECT ALL THAT APPLY

only Richard will have voting rights

Rebecca will have less protection in the event of the company liquidating

both of them have less protection than any corporate bond holders

both of them can choose whether to have their dividends on a cumulative or non-cumulative basis

Answer 143

Answers:
Rebecca will have less protection in the event of the company liquidating & both of them have less protection than any corporate bond holders

Explanation:
Ordinary shareholders are at the end of the queue for payment in the event of a company’s liquidation. Preference shareholders are one in front of them, with corporate bond holders being in front of both because CB holders are classed as creditors

Voting rights exist in ordinary shares but are rare in preference shares, as they only get the right to vote if a dividend (or a series of them) is missed

Question 144

Mark invests in several GILTS and corporate bonds. When comparing these…

GILTS are less volatile than corporate bonds

corporate bonds are sub investment grade, whereas GILTS are investment grade

if a higher yield is sought, a corporate bond is likely to be a better solution

corporate bonds are easier to trade than GILTS

GILTS are only available on the primary market

Answer 144

Correct Answers:
if a higher yield is sought, a corporate bond is likely to be a better solution & GILTS are less volatile than corporate bonds

EXPLANATION:

This question is all about the hierarchy of risk in bonds.

GILTS, with their government guarantee are the most secure, but offer the lowest returns. As a result, their value tends to be less volatile than corporate bonds.

Both GILTS and corporate bonds are often relatively liquid but smaller companies can be harder to trade.

Sub -investment is a term for lower-rated corporate bonds, however many of them are investment grade, as all GILTS are.

Question 145

George has a portfolio of shares comprised of AIM-listed shares, FTSE100-listed shares, and FTSE 250-listed shares. He is unsure about the differences that the various listings make, and has asked you to explain this to him. You can correctly state that an AIM listed company is likely to be…

smaller than a company listed on the FTSE 100 index

less volatile than a FTSE 250 share listing

a newer company with more risks than an established company

less affected by rules when going through the listing process

Answer 145

Correct Answers: A, B & D

Explanation:
AIM is the easier to access, smaller company listing that many companies use as a stepping stone to full listing. They are typically more volatile than FTSE listed shares, due to their size and often infancy.

Question 146

Gladys has a low attitude to risk. She currently holds £20,000 on deposit with her local Building Society, and £10,000 in Premium Bonds. She has just received an inheritance from her mother and has another £60,000 that she wishes to place on deposit. When considering Premium Bonds as an investment, Gladys would be correctly advised that…

she can contribute a maximum of £50,000 per annum

she is not guaranteed any return from her investment, but the capital is secure

Premium Bonds have different issues, with different returns on each one

the minimum purchase is £25

Answer 146

Answers are B & C

EXPLANATION:
Premium bonds have a total limit of £50,000 not an annual limit. Investment starts at £25. They cant guarantee a return because they use a prize draw system

Question 147

Harry is 15, and has just started a Saturday job for the summer holidays. He will earn £40 per day, but will only be working for 7 weeks. His grandmother wants to encourage him to save, so has said that she will give him £1,000 to add to whatever he saves from his wages. As Harry is a new saver, he is asking about deposit accounts. You can correctly tell him…

normally, the longer the notice period, the higher the interest

term accounts usually pay higher interest

banks pay higher rates than building societies

building societies have more choice of accounts

Answer 147

Answers are A & B

explanation:

The longer you keep your money under wraps, the better your rate should be.

Banks and building societies have little between their rates and products

You need to be 18 to qualify for an investment ISA. For cash ISA its 16

Question 148

What are the usual characteristics of a company listed on the Alternative Investment Market compared to shares of a FTSE 100 company?

It will have a wider share spread

It will have larger market capitalisation

Less Stamp Duty Reserve Tax will be payable on purchase

It will have lower returns

Answer 148

Answers: A & C

Explanation.
AIM Shares are smaller companies with lower market cap. It is impossible to say that they will have lower returns or higher returns.

The difference between the buying and selling price i.e. the spread will be wider

No SDRT is payable on AIM shares but is on FTSE100 shares.

Question 149

No SDRT is payable on AIM shares but it is on FTSE100 shares.

True or false

Answer 149

True!

Question 150

When is the PTM levy payable?

Answer 150

On share purchases of more than £10000

Question 151

When is the PTM levy payable?

Answer 151

On share purchases of more than £10000

Question 152

What is a shares spread

Answer 152

The difference between the buying and selling price

Question 153

What is ‘internal rate of return’?

Answer 153

Another name for money weighted return

Question 154

What is ‘internal rate of return’?

Answer 154

Another name for money weighted return