Section 1 Flashcards
what are financial intermediaries?
indirect investing
why may savers use financial intermediaries?
- more liquid and lower risk assets
- lower transaction costs (search, monitoring, due diligence and enforcement)
- borrower will usually have better information about risk and return on an investment project
what does an intermediaries size allow them to do?
spread risk and take advantage of economies of scale when transacting their assets
what are the three basic types of intermediary?
1) Banks - lends directly to borrowers
2) contractual savings institutions - pension and life funds
3) Investment intermediaries - unit trust and hedge funds
in practice what three types of transformation between savers and borrowers do intermediaries bring about?
1) Size transformation - small sums from savers can be converted into larger size investments required by end-users
2) Maturity transformation - short term liquid savings can be pooled to make longer-term investments
3) Risk transformation - through portfolio diversification and analysis of the ultimate investments
what are advantages of collective investment vehicles?
- The pooling of investments enables the investment vehicle to make investments at lower cost
- Professionally managed investments (greater expertise and time saved rather than monitoring)
- Greater diversification benefits achieved
- Achieve specialisation is possible
- Possible to gain exposure to foreign investments which could otherwise be costly
what are the disadvantages of a collective investment vehicle?
- Individual cannot choose the individual investments
- Fund manager performance varies widely across particular funds and over time
what are the 4 main times of collective investment vehicles?
1) Open-ended investment companies (OEICs) - also known as investment companies with variable capital
2) Unit trusts
3) Investment trusts
4) Life assurance-based schemes
What are OEICS and unit trusts and what does this mean?
they are open ended so they can expand by issuing new units at the same price as existing units when new investors subscribe.
Or shrink when unitholders sell their units back to the managers of the fund at prevailing price.
What are Investment trusts
close ended funds - which means they can not increase the size of the fund and new investors must buy shares in the investment trust from existing shareholders who wish to sell
who regulates Collective investment schemes?
THE FCA
what are collective investment schemes generally?
Arrangements in which members participate in, or receive income from, the acquisition, holding management or disposal of assets of any description
what are CISs often referred to?
Funds and if they are located outside the UK then offshore funds
In the UK what makes a unit trust scheme authorised?
If they are constituted under a trust and have a seperate trustee
In the UK what is a regulated CISs?
- An ICVC also known as an OEIC
- A authorised unit trust
- A recognised scheme permitted to operate in the UK
who can unregulated schemes not be regulated to?
Retail investors
What can authorised schemes further be separated into?
- An undertakings for Collective In Transferable Securities (UCITS) scheme
- A qualified investor scheme
- An non-Undertakings for the collective investment of transferable securities (non-UCITS) retail scheme
what must UCITS Schemes all meet in terms of conditions?
the conditions of the UCITS directives
What may qualified investor schemes only be promoted to?
professional investors
what are the three distinct roles involved in the activities of a unit trust?
Unit trust manager
Trustee
Investment manager
What is the role of a unit trust manager in a unit trust?
Defines the terms of the trust markets the trust requests that the trustees create and redeem units receives payments from investors appoints the trustee
what is the role of a trustee in a unit trust?
Owns the underlying investments and holds these (usually a trust corporation, such as a bank or insurance company)
what is the role of the investment manager a unit trust?
arranges the purchase and sale of securities
arranges the provision of valuations for the trustee
in a unit trust can the unit trust manager and the investment manager be part of the same firm?
yes
what happens when an investor subscribes to a unit trust?
the money is sent to the unit trust manager who credits the investor with units held in an inventory of units.
If no units are held or additional units are required for inventory purposes the manager requests the trustee to create units
what happens if new units are created within a unit trust
If units are created the trustee authorises the investment manager to purchase the required volume of securities that underlie the new units.
What can the trustee in a unit trust request if they belive creation or cancelation of units is not in the best interest of the investors? When may this occur?
If the trustee believes that it is not in the best interest of the investors to create or cancel units they can refuse to do so.
The trustee must give notice to the investment manager to be relieved of the duty of creating or cancelling units
Occur if the trustee suspected or knew that the manager had made a serious breach of the regulations
what book sets out the terms of the trust dead
COBS (conduct of business sourcebook)
in terms of pricing their units what may authorised unit trusts choose between?
Dual pricing or single pricing
explain dual pricing of units
Consumers can purchase units at a higher offer price and redeem them at a lower bid price.
The price at which new units are sold or redeemed depends on the value of the securities held in the unit trust.
Although there can be a gap of up to 9% between the bid and offer price due to commission, dealing charges, stamp duty, VAT etc..
explain single pricing of units
the investor pays none of the dealing costs associated with the investment backing their shares or units and saves half the dealing price spread (means that buyers will match sellers)
However, if either buyers or sellers predominate, existing unit-holders subside the net purchases or new sales. E.g. the costs involved with altering the underlying assets of the fund (e.g. stockbroker commission) may have a negative effect on the shares held by existing investors. This is a problem for the fund manager, who has to go into the market to buy/sell the underlying assets, thus incurring costs. These costs can be recouped by the used of a dilution levy or swing to the single price
in a unit trust who applies for FCA authorisation?
THe manager and the trustee - jointly
how long does the FCA have to notify a unit trust of their authorisation? what happens if authorisation is refused and what is authorisation?
6 months
if refused the applicants have 28 days to refer the case to the Upper Tribunal (tax and chancery chamber)
Decision is discretionary
What conditions must be met for a unit trust to be authorised?
The manager and the trustee must
- be independant of each other
- each be a company incorporated in the UK or other state within the EU
- Each have a place of business in the UK
- Each be an authorised person
who is responsible for the regulation of authorised unit trusts and what do they set rules covering?
The FCA
- the constitution of the trust
- Restrictions on managers
- meetings of holders
- the manager’s investment and borrowing powers
- The issue and redemption of units
- the pricing of units
what grounds may the FCA revoke the authorisation of an authorised unit trust on?
- any of the requirements for authorisation are no longer satisfied
- It is undesirable in the interests of the participants that the trust should continue to be authorised
- the manager or the trustee has contravened any provision of the FCA
how are OEICS similar to unit trusts?
the number of units can vary from day to day (they are open ended)
- their price will directly reflect the value of the fund’s portfolio
how are OEICS similar to investment trusts?
- They have a company structure
- The assets of the fund are looked after by a depository and not a trustee (although role is similar)
In an OEIC what must a depository be? and what is their role?
A firm (usually a bank) authorised by the FCA and must be independant of the OEIC
They likely hold the OEIC’s investments which have legal title to them
how are shares bought and sold in an OEIC? what does this mean in terms of charges?
Unlike unit trusts there is a single price at which shares are brought and sold - an OEIC will thus attract entry and exit charges
Talk through charges of an OEIC
Entry and exit charges
other charges must be set out clearly
as with unit trusts annual management charges will be levied on a % basis, reflecting the value of the portfolio under management
What sets out the investment powers of authorised unit trusts and OEICs?
and what does this incorporate?
The FCAs collective investment schemes sourcebook (COLL)
Incorporates UCITS
Under UCITS what most the property (investments) of a scheme consist of usually?
- Transferable securities
- Approved money market instruments
- Units in collective investment schemes
- Derivatives and forward transactions
- Deposits
- For an ICVC scheme, movable and immovable property
what is a transferable security defined as
Securities to which title can be freely transferred
give e.g.’s of transferable securities
shares, debentures, government or public securities, warrants or certificates representing securities
what would not be considered a transferable security
a security that would need the consent of a third party to be transferred
when is a transferable security an approved security?
when it is admitted to the official list in a member state of the EU or is traded on an eligible market
under UCITS what % of investments of the scheme may consist of transferable securities or approved money-market instruments held by one issuer
Up to 5%
This may be increased to 10% in respect of up to 40% of the value of the fund i.e. up to four holdings with up to 10% each
under UCITS what is the limit on the amount invested in government and public securities
no limit - provided that no more than 35% of the scheme’s assets are invested in the issues of one body.
This 35% may be breached providing:
- the fund manager consults first with the depositRY
- No more than 30% of the scheme is invested in a single issue
- the scheme’s assets comprise at least 6 different government and public securities issues from issuers
- relevant disclosures are made
Under UCITS what % of a fund may the scheme borrow?
Only up to 10% of the net asset value of the fund
Under UCITS what % of the total investments can be in any one scheme?
20%
Under UCITS to avoid the risks that arise from over-concentration what can a scheme not hold more than?
- 10% of the non-voting shares issued by a body corporate
- 10% of the debt securities issued by a single issuer
- 10% of the money-market instruments issued by a single body
- 25% of the units in a collective investment scheme
What is an ETF
funds that are traded on a stock exchange and who’s assets mirror the price movements of the underlying index, sector or commodity
How does one invest in an ETF?
The investor buys shares in an ETF to own a proportion of some pooled assets
who manages an ETF>
INvestment managers for a fee
Who regulates ETFs?
The FCA
How do ETFs differ from Unit Trusts or Mutual funds?
They are traded in continuous global exchanges and can be brought or sold like shares through brokerage accounts, with continuous pricing an liquidity throughout the trading hours on an exchange
What are ETFs often similar to and in which way? But what are also the differences here?
Similar to tracker funds in that they aim to mirror an underlying index
Crucially, however an ETF can be traded at any time of the trading day - whereas an index tracker fund is a unit trust that can only be traded at one point in the trading day
What do ETFs disclose at the start of every trading day and why?
Typically disclose their investment holdings at the start of every trading day so hat potential buyers and sellers can evaluate the traded ETF price versus the value of the underlying assets.
How are ETF market prices kept close to fair value
Specialised traders can create and redeem shares for NAV
Compare charges between an ETF and Index tracker funds and explain why this is
ETFs incur fewer charges than index tracker funds.
ETFs pay a stockbroker’s commission but are not liable to stamp duty whereas the costs for an index tracker fund include both initial and annual management charges, as well as stamp duty being charged within the fund itself.
Are ETFs open or close ended?
Open ended
What is the price to buy or sell an ETF close to?
Close to the value of the underlying assets of the share
What can investment trusts trade at?
Discount to the value of their underlying assets
To create an ETF what is required by FCA?
The FCA requires a review of the fund to make sure it is UCITS compliant and to obtain recognition status.
The FCA performs the review upon submission of the UCITS prospectus by the firm to the FCA.
Companies acting for the fund (fund manager and custodian) need to seek before conducting business in the UK
Fund will have to seek a listing on the LSE
What does recognition status of an ETF allow?
Allows the fund to be marketed to private investors
What are the advantages of an ETF?
- Diversification
- Tradeable - so can be sold short and bought on margin
- Liquidity
- Low cost
- Transparency
Explain diversification as an advantage of an ETF
Can be obtained with a single ETF transaction. There are a wide range of ETFs covering a range of asset classes.
Explain tradability as a advantage of an ETF
Even though they represent interests in a basket of investments they are traded like a share. This means they can be sold short and bought on margin.
Explain liquidity as a advantage of an ETF
They are traded throughout the day at market prices rather than once a day at closing at closing market prices. Therefore they offer greater liquidity than unit trusts.
why do ETFs trade close to their NAV throughout the day?
Because investors can arbitrage between the ETF itself and the underlying securities. This facilitates price discovery for the ETFs as a variety of intermediaries use them for arbitrage and hedging purposes.
Explain low cost as a advantage of an ETF
Usually passively managed
limited number of counter-parties to deal with
Explain transparency as a advantage of an ETF
Greater than traditional unit trusts who only have to disclose their holdings with a considerable time lag
what are disadvantages of an ETF?
- ETFs can take investors into new asset classes and there may be a lack of understanding of the drivers of risk and return
- They may offer leveraged investments, which are not well understood by investors
- Investors need to understand the different costs associated with ETFs, such as bid-offer spreads, commissions and the possibility of premia and discounts to the NAV
Talk about buying or selling existing shares in an ETF vs. creating or redeeming new shares
Buying and selling existing shares is no different from a normal share transaction
Redeeming new shares an only be done by authorised participants (APs). They create new shares by transacting with the ETF manager/sponsor.
In an ETF what is an AP
Authorised Participant - market makers who are authorised by the issuer to take part in the process.
What does the ETF manager do daily and what does this trigger for the AP
The ETF manager publishes a list of securities it wants to own in the fund called the creation basket and is the basis for determining the NAV of the ETF.
To create shares the AP then goes into the market and buys the components in the right proportions as per the creation list, or uses some from its own inventory. The AP then delivers this basket of securities to the ETF manager in exchange for an equal value of shares of the ETF.
The AP then sells these shares in the open market to investors
when an AP and ETF exhange shares what is this called?
Creation units
what is the redemption basket
If the AP has a block of ETF shares to get rid of the AP presents the shares for redemption to the ETF issuer and receives in return the underlying basket of securities which the AP then sells in the open market - this is known as the ‘redemption basket’
when does the actual exchange of baskets happen in an ETF
At the end of the day - but the AP will quote bid-offer spreads and execute trades throughout the day because it knows the composition that will be needed for delivery or redemption. This will be based on the APs net long or short exposure after providing markets for the ETF that day.
What is key to keeping the ETF price in a tight range around the NAV of the portfolio of securities it holds?
The back and fourth redemption / creation process
What factors in an ETF drive the width between the bid-ask spread and trading range around the NAV
- the cost of buying and selling the securities (abitrage)
- The volatility of prices
- The liquidity of markets for these securities
What is a synthetic ETF
These do not involve the purchase of the underlying assets but rather the commitment of (typically) an investment bank to meet the returns on a chosen index through the use of derivative contracts with a third party.
Provider holds a basket of assets as collateral in case the parent investment bank goes bust.
What are synthetic ETFs especially popular for tracking?
Less liquid benchmarks such as equity indices of emerging countries.
What is an Exchange Traded commodity
Is an exchange traded note that tracks either individual commodities or broader-based commodity indices.
What does an Investment Trust Company offer?
ITCs offer both corporate and individual private investors a convenient way to purchase a diversified portfolio of securities.
What are investment trusts not?
Trusts - they are limited liability companies with ordinary shares listed on the LSE
What are investment trusts regulated by
LSE
and
Companies act (2006)
What is an Investment Trust Company?
A bundle of securities, or a portfolio, overseen by the ICTs board of directors who determine the ITCs investment strategy, which is carried out by the management of the ITC.
Is an ITC closed or open ended? and how can they raise capital?
Close ended - and are able to raise more capital by having a rights issue or by borrowing
What does an ITC not have to maintain?
Compared to pension / insurance companies it is not faced with the need to maintain cash flows to meet liabilities.
What is the objective of an ITC
ti maximise the value of its portfolio and share price for its shareholders.
What rules are in place surrounding ITC investments
The amount that can be invested in any one company is limited to 15%
Why can an ITC make gains and losses that are much bigger than the underlying assets it holds
Their ability to borrow allows the firm to gear itself up at fixed rates of interest.
What does MIFID II require in terms of charges
Required fund mangers to disclose full charges, including an ‘un-bundled’ charge for research.
What are private client funds
funds managed by professional stockbrokers for individual investors.
What are the four main services a private client fund can provide?
- Execution only services
- Advisory dealing services
- Portfolio advisory service
- Portfolio discretionary service
In terms of a private client fund what is execution only services
- no advice or recommendations
- means of buying or selling assets for a commission
In terms of a private client fund what is Advisory dealing services
- Stockbroker executing business on behalf of a client
- In addition can involve advice about the proposed transaction
In terms of a private client fund what is portfolio advisory service
- Broker tries to identify the client’s overall financial position and needs
- Broker gives advice about the construction of a portfolio of assets for the client along with the appropriate investment strategy
- Broker at liberty to call client with advice the client still has the final say
In terms of a private client fund what is portfolio discretionary services
- Stockbroker has responsibility for the portfolio and is at liberty to buy and sell assets on behalf of the client according to market conditions
what is the main advantage of discretionary services
the broker doesn’t have to waste potentially valuable time in seeking the client’s permission to act on a piece of market information
What is a limit order service in terms of private client funds?
The client will instruct the broker to buy or sell an asset if it reaches a certain price during the day without having to refer to the client.
What is a nominee account facility in terms of private client funds?
The shares brought by a client are actually registered in the name of thee stockbroking company - as this simplifies the paperwork for the client and can speed up the execution of transactions.
what is a structured product?
An investment that has a well-defined objective in terms of risk and return which is usually defined by reference to a specific underlying asset such as the FTSE 100 index.
Talk about objectives of private client funds
will vary a lot dependant on the clients situation and objectives
In terms of time referencing what is special about a structured product?
they will usually be defined by reference to a specific calendar time period.
what do investors of a structured product usually forgo? And what are they usually created using
Dividend or other yields
these products are usually created via derivative investment strategies.
What is the maturity period in the UK of most structured products?
between 3 and 6 years and may often be cashed in, subject to a penalty, prior to maturity
What are the three main types of structured product?
- Structured deposits
- Structured capital
- Structured capital at risk
What is a structured deposit?
Fixed term deposit accounts with the ‘interest’ being determined by reference to the performance of an underlying asset.
This is often based on an investment index, with at least the initial investment guaranteed at maturity.
If the issuer is a deposit-taker as is common then the deposit is also secured by the usual bank deposit insurance.
Who are the two distinct parties involved in the creation of a structured product and what are their roles?
- A plan manager - who takes care of product creation, selling and marketing
- Counter-party or deposit-taker - who supplies the underlying investment
What is a structured capital product?
Structured capital protected products are similar to structured deposits, except they do not offer the benefit of the guarantee of the insured deposit if the counter-party/ provider defaults.
What is a structured capital-at-risk product?
the full original investment capital sum is at risk if certain levels of the underlying asset(s) are breached at certain points over certain periods of time.
How can structured products be invested in?
Directly as cash investments through an ISA or SIPP or as an investment bond
What are the key dates in a structured product
- ‘offer period’ - one or two months before strike date where offer is marketed
- ‘strike’ date - when the investment will go live and from that date capital will be at risk with reference to the relevant index value or the ‘strike level’ from which any change will be measured
- ‘investment term’ - life of the investment
- ‘final index date’ - when the final reference level of the index will be calculated
- ‘maturity date’ - when clients receive their money (usually about 2 weeks after final index date)
What are structured product subject to?
Capital gains tax
unless held within a tax-exempt structure, such as an ISA
How are structured products constructed to give guarantees?
Guaranteed capital sum is typically achieved by investing in a zero-coupon bond appropriate to the sum protected at the end of the investment period.
The remainder is then split between the management charges and a call option on the underlying index, to provide exposure if the index rises with the strike price set at the initial value of the index.
If the index falls, the zero coupon bond will return the assured capital sum and the call option is worthless.
If it rises the investor receives both the aforementioned bond plus the proceeds of the call option
What are barrier levels in a structured product?
Key index levels below which the index must not fall
These can refer to the maturity date or throughout the life of the product.
who may structured products appeal to
Because they allow exposure to the upside without risk of the downside of a market these may appeal to investors for whom capital preservation is a priority.
what is life assurance?
in exchange for a premium, purchasers can buy a lump sum pay-out at time of death (whole life policy), or a capital sum at the end of a specified period (endowment policy).
In a life assurance policy how can the amount paid out vary?
Can be set at the time the contract is taken out or can be allowed to depend on investment returns (so called ‘with profits’), with a basic sum assured enhanced by an investment return related bonus
How do you pay into a life assurance policy
Most involve regular premium payments but single premium bonds exist for those with a capital sum to invest
What is the nature of a DC pension scheme
Contributions may be fixed but benefits depend on the investment performance of the fund.
What happens at retirement to a DC pension scheme
The accumulated sum is converted into an annuity or into alternative mechanisms for drawing down income.
What determines the pension of a DC scheme?
Fund performance and annuity rates at retirement
What risk is involved with a DC pension scheme
Longevity risk
the possibility of running out of money - the choice of converting this into an annuity payment removes this risk
Who do the liabilities of a DB scheme belong to?
THe sponsoring employer/ company
what is the liability and risk of a DB scheme
The valuation of the liability is inversely related to the general level of interest rates: therefore in an era of very low interest rates, the liabilities of a DB scheme will rise possibly making that scheme no longer viable in terms of promised payments
DC scheme involves no such liability to the employing company
