Topic 6

Question 1

Offshore accounts

Answer 1

Deposit accounts or investments based outside the UK, eg the Channel Islands, Isle of Man and Luxembourg, offering tax advantages compared to the UK.

Question 2

Permanent interest-bearing shares (PIBS)

Answer 2

Similar to corporate bonds, issued by building societies. Pay fixed interest but have no redemption date.

Question 3

Structured deposits

Answer 3

Deposit based accounts with a fixed term. The original capital is guaranteed to be returned but any additional return is linked to the performance of a stock market index or indices and so is variable.

Question 4

Main asset classes

Answer 4

Cash (ie money
held in deposit
accounts
Equities (company
shares, held
directly or via a
collective
investment)
Fixed interest
securities (eg gilts,
corporate bonds)
Property
(eg buy-to-let)

Question 5

CAPITAL

Answer 5

In the case of a savings
account, capital is the cash that
is deposited. It differs from
‘money’ in the sense that it is
being used to generate wealth
rather to purchase goods and
services

Question 6

Why do people choose deposit‑based investments?

Answer 6

Security of capital
Convenience

Question 7

Bank and building society accounts

Answer 7

current accounts, for everyday money needs;
„ savings accounts, where money not required for day‑to‑day spending is set
aside

Question 8

PACKAGED CURRENT ACCOUNTS

Answer 8

A packaged current account offers the holder a range of
ancillary benefits such as breakdown cover, mobile phone
insurance and travel insurance in return for a monthly or
annual fee. A packaged current account may also enable the
holder to open other accounts that offer preferential rates of
interest.

Question 9

DEPOSITOR PROTECTION

Answer 9

Savings in bank and building society accounts are protected
by the FSCS, up to a level of £85,000 per investor per financial
services provider.

Question 10

What is National Savings and Investments?

Answer 10

National Savings and Investments (NS&I) offers a range of saving and investment
products backed by the government. The risk associated with the products is
very low because the government guarantees the return of capital invested

Question 11

HMRC AND OFFSHORE ACCOUNTS

Answer 11

Offshore accounts are often perceived as a vehicle to hold
monies that are not declared to the tax authorities. Under
legislation introduced to support implementation of the US
Foreign Account Tax Compliance Act, and effective from 2016,
British Crown dependencies and overseas territories exchange
financial information with HMRC. This includes the names and
financial details of those holding accounts.

Question 12

Offshore investment can potentially expose an investor to greater risk than a
similar onshore investment:

Answer 12

„ The account might not be denominated in sterling; if the investment is to
be converted back to sterling at some point, its value might be affected by
unfavourable exchange ratesNot all offshore accounts are protected by investor protection schemes.
Investors should check what protection is available through local regulatory
regimes.

Question 13

What are gilts?

Answer 13

‘Gilts’ belong to a category of direct investment called ‘fixed‑interest securities’.
Their full name is ‘gilt‑edged securities’, and they are a form of borrowing
by the UK government. Gilts are regarded as safe investments because the
government is not expected to default on capital repayments or interest

Question 14

REDEMPTION DATE

Answer 14

The date on which the government must redeem the gilt by paying back
its original issue value or par value, normally quoted as a nominal £100.
This works in the same way as redeeming an interest‑only mortgage.

Question 15

COUPON

Answer 15

The interest rate payable on the par value of a gilt. It is a fixed rate, paid
half‑yearly, gross but taxable.

Question 16

The UK Debt Management Offic

Answer 16

issue Gilts

Question 17

CATEGORIES OF GILT

Answer 17

Short‑dated gilts: less than 7 years.
„ Medium‑dated gilts: 7–15 years

Question 18

Index‑linked gilts

Answer 18

Index‑linked gilts are gilts where the interest payments and the capital value
move in line with inflation. For the investor, this means that the purchasing
power of their capital and interest received remain constant, unlike all other
fixed‑interest investments where inflation erodes the purchasing power of
fixed‑interest payments.

Question 19

Gilts

Answer 19

When a new issue is made,
investors can purchase those gilts. Once issued, gilts cannot be redeemed by
investors prior to the redemption date but can be sold to other investors. The
price at which they are sold depends on a number of factors:
„ the level of market rates of interest;
„ the amount of time left to the redemption date;
„ supply and demand

Question 20

Gilt prices

Answer 20

are quoted either ‘cum dividend’ or ‘ex dividend’. If a stock is bought
‘cum dividend’, the buyer acquires the stock itself and the entitlement to the
next interest payment. If, however, the stock is bought ‘ex dividend’, then
Short-dated
gilts
* Also known as ‘shorts’
* Less than 5 years to run to redemption
Medium-dated
gilts
* ‘Mediums’
* 5–5 years to run to redemption
Long-dated
gilts
* ‘Longs’
* More than 15 years to redemption while the buyer acquires the stock itself, the forthcoming interest payment
will be payable to the previous owner of the stock (ie the seller)

Question 21

Guilts pay out

Answer 21

Gilt interest is normally paid gross without deduction of tax, although investors
can elect for net payment. The income is classed as savings income so would
be tax free if it fell within an individual’s starting‑rate band for savings income
or their personal savings allowance

Question 22

Guilts pay out

Answer 22

if the interest, when added to other savings income, falls outside the
starting‑rate band for savings and exceeds an individual’s personal savings
allowance it will be taxed at 20 per cent, 40 per cent or 45 per cent with the
actual rate determined by the individual’s gross income

Question 23

Guilts

Answer 23

Many investors who buy gilts do not intend to keep them until their redemption
date. They buy them because they believe that, by speculating on future
movements in interest rates, they can sell them for a profit. Alternatively,
they may be able to buy gilts for less than par and then make a gain upon
redemption. Any capital gains made on the sale or redemption of gilts are
entirely free of capital gains tax (CGT).

Question 24

BUYING AND SELLING GILTS

Answer 24

A higher‑rate taxpayer buys £100,000 par value of Treasury
5% 2025 at a price of 80.0, ie she pays £80,000 for the stock.
She receives half‑yearly interest of £2,500 (ie £5,000 annually),
which represents a yield of 6.25 per cent on her investment of
£80,000.
The interest is paid gross but she must pay tax of 40 per cent
on any interest in excess of her personal savings allowance of
£500.
Later she sells the stock for £90,000. There is no capital gains
tax to pay on her gain of £10,000

Question 25

HOW DO INTEREST RATE MOVEMENTS AFFECT GILT YIELDS?

Answer 25

Rising interest rates Robert owns £10,000 of gilts with a coupon of 3 per cent. This means that he receives £300 per year interest.

Question 26

CALCULATE

Answer 26

Mark is considering buying gilts and is attracted to 5% Treasury 2025. He finds that this gilt is currently trading at a price of £130.73. Mark understands that, should he buy this gilt, he will get income of £5 per year (par value of £100 x 5%) every year to 2025. He also understands that, should he hold the gilt until redemption date, he will suffer a loss of £30.73 on each one as only £100 will be paid on redemption.To understand whether the income offered is a good rate it is necessary to calculate the running yield as follows. Running yield = coupon ÷ price paid £5 ÷ £130.73 = 3.82% The 3.82% rate of income looks attractive, based on current interest rates, but it should be remembered that if the gilt is held to redemption it will lose £30.73 of capital value, which reduces the overall return

Question 27

Local authority bonds

Answer 27

Like the government, local authorities can borrow money by issuing stocks or bonds, which are fixed‑term, fixed‑interest securities. They are secured on local authority assets and offer a guaranteed rate of interest, paid half‑yearly. The bonds are not negotiable and have a fixed return at maturity. Return of capital on maturity is promised, but these are not quite as secure as gilts since there is no government guarantee

Question 28

Permanent interest‑bearing shares

Answer 28

Permanent interest‑bearing shares (PIBS) are issued by building societies to raise capital. They pay a fixed rate of interest on a half‑yearly basis. Interest is paid gross, although it is taxable as savings income according to the investor’s tax status. Investors should note that PIBS rank below ordinary accounts in priority of payment, should a building society become insolvent. As a result, they are higher risk, because depositors will be paid before shareholders. If a building society converts to a bank by ‘demutualising’, the PIBS it has issued are converted to perpetual subordinated bonds (PSBs). Perpetual subordinated bonds have similar characteristics to PIBS in that they have no redemption or maturity date and will provide a fixed income stream

Question 29

Corporate bonds

Answer 29

Corporate bonds Generally, a company will seek to finance its activities by using its profits, but there are situations in which profits, even if retained over many years, will not be sufficient to meet the company’s requirements and it has to seek other sources of finance. The two main ways in which a company might seek to raise additional money are by issuing shares and/or by borrowing. It can, of course, borrow from banks or other lenders. It can also issue corporate bonds to meet. its long‑term financing needs, or commercial paper if funds are needed over a shorter period.

Question 30

Corporate Bonds

Answer 30

Corporate bonds are similar to gilts issued by the government. The bond is issued with the promise to pay a fixed rate of interest until redemption date, with the loan repaid in full at redemption date. The borrowing is usually over the longer term, which helps the company to make long‑term business plans. The bonds can be bought by institutional investors (such as life companies and pension funds) and by private investors. A bond may be secured or unsecured. If it is secured, a charge is made on company assets. This means these assets could be taken by the creditor and sold in the event that the company defaults on interest payments or repayment at redemption date

Question 31

debenture

Answer 31

A bond that is backed by security is typically referred to as a debenture. The security is provided by a charge over company assets.

Question 32

Loan stock

Answer 32

A bond that is not backed by security is generally referred to as loan stock.

Question 33

Convertable bonds

Answer 33

Some corporate bonds are convertible, giving the holder the right to convert the loan into ordinary shares of the issuing company. There is no obligation to do so and if the option is not exercised, the loan continues unchanged.

Question 34

Interests

Answer 34

Interest, rather than dividends, is payable and the company is obliged to pay the interest promised, whether or not sufficient profit has been made by the company. Whether the bond is secured or not, the holder is a creditor of the company so, in the event of the company being wound up, would have priority over shareholders. If the lending is unsecured, the bondholder ranks with ordinary creditors. As mentioned, a corporate bond that is secured on company assets is referred to as a debenture and the holder has the extra security of the assets on which it is secured

Question 35

Why does the fact that corporate bonds are regarded as riskier than gilts mean that they generally pay higher rates of interest than similar gilts?

Answer 35

Corporate bonds pay higher rates of interest than similar gilts because of the relationship between risk and reward – the more risky the investment is considered to be, the greater the reward the investor expects

Question 36

Eurobonds

Answer 36

A Eurobond is a bond issued or traded in a country that uses a currency other than the one in which the bond is denominated. This means that the bond operates outside the jurisdiction of the central bank that issues that currency. Eurobonds are a form of borrowing used by multinational organisations and governments. For example, a UK company might issue a Eurobond in Germany, denominating it in US dollars. It is important to note that the term has nothing to do with the euro currency, and the prefix ‘euro’ is used more generally to refer to deposits outside the jurisdiction of the domestic central bank

Question 37

Taxation of income

Answer 37

Local authority bonds, corporate bonds, PIBS and Eurobonds pay interest gross (without deduction of tax). The income is classed as savings income so would be free of tax if it fell within an individual’s starting‑rate band for savings income or their personal savings allowance (see Topic 3, section 3.4.4). If the gross interest, when added to other savings income, falls outside the starting‑rate band for savings and exceeds an individual’s personal savings allowance it will be taxed at 20 per cent, 40 per cent or 45 per cent with the actual rate determined by the individual’s gross income. Where tax has been taken at source, this can be deducted from the amount owed

Question 38

What is a structured deposit?

Answer 38

With a structured deposit, the return paid is linked to the performance of an index measuring the performance of equities, such as the FTSE 100. The investment is normally arranged over a fixed term, five years for example

Question 39

What is ‘alternative finance’?

Answer 39

Alternative finance or peer‑to‑peer lending (P2P) involves a saver placing their money with a P2P lender who will then lend the money out to businesses thatare seeking funding. This type of lending is usually arranged via aggregating companies, examples of which include Wellesley & Co, Zopa and Funding Circle. P2P lending is not a deposit proposition but has a number of elements in common with deposit‑based savings, notably that funds are aggregated and distributed, normally for a return, and it is possible to arrange both on an easy access and fixed‑rate basis over an agreed term. P2P lenders are regulated by the FCA. In some cases, returns can be very competitive with traditional deposits but there are more risks. While the lender will perform due diligence on the businesses to which funds are being lent, there is a risk that loan repayments might be missed, in which case the returns to the saver would reduce. Importantly, P2P lenders are not covered by the Financial Services Compensation Scheme

Question 40

1) A bank deposit account is a good place to hold a ‘rainy day fund’. True or false?

Answer 40

True. Deposit accounts allow instant access to funds and they are low risk because savings are protected by the Financial Services Compensation Scheme up to a limit of £85,000

Question 41

What, if any, is the minimum age at which a person can take out an NS&I Direct Saver? a) There is no minimum age. b) 16. c) 18

Answer 41

b) 16

Question 42

interest on NS&I Income Bonds is tax‑free. True or false?

Answer 42

False, interest is paid gross but is taxable.

Question 43

State two reasons why offshore bank accounts might be more risky than similar UK deposit accounts.

Answer 43

If the investment is held in a currency other than sterling, its value might be affected by adverse exchange rates if it has to be converted to sterling. Accounts held offshore might not be covered by investor protection schemes to the same extent as onshore UK investments

Question 44

In relation to gilts, what is the ‘coupon’?

Answer 44

The coupon is the interest rate payable on the par value of a gilt

Question 45

Jane has invested in short‑dated gilts. According to the UK Debt Management Office (DMO) definition, this means that: a) the gilts will have a redemption date within the next seven years. b) interest on the gilts will not be paid to her until the end of the term. c) the gilts will have a redemption date within the next ten years. d) she will be unable to access her capital until the end of the term

Answer 45

a) The gilts will have a redemption date within the next seven years

Question 46

Rubina is considering buying a gilt, 3% Treasury 2025. The gilt is currently trading at a price of £107. What is the running yield?

Answer 46

The running yield is £3 (coupon) ÷ £107 (price paid) = 2.8%. Running yield = coupon ÷ price paid

Question 47

The main difference between corporate bonds and gilts is that corporate bonds: a) usually pay a variable rate of interest. b) are usually for larger amounts of money. c) normally have no specified redemption date. d) are considered to be higher‑risk investments.

Answer 47

d) Corporate bonds are considered to be higher‑risk investments.

Question 48

The main difference between a debenture and other types of corporate bond is that a debenture: a) carries the right to vote at the company’s annual general meeting. b) is usually secured on the assets of the company. c) can be converted to ordinary shares of the company. d) pays a fixed rate of interest

Answer 48

b) A debenture is usually secured on the assets of the company

Question 49

A Eurobond is the equivalent of a gilt, but issued by a government within the eurozone. True or false?

Answer 49

False. A Eurobond is a bond issued or traded in a country that uses a currency other than the one in which the bond is denominated, and they can be issued by large companies, not just governments

Question 50

Jack opens an account so that his wages can be paid into it. He can use his account to pay bills such as utilities and rent via direct debit, and he can use his debit card to make purchases online and in shops, but he cannot have an overdraft. What kind of account does Jack have? a) Packaged account. b) An interbank account. c) A basic bank account. d) A debit account.

Answer 50

c) A basic bank account

Question 51

Jerry has a corporate bond secured on the company's assets. This is referred to as: Question 1 options: a) an investment bond. b) a debenture. c) loan stock. d) a perpetual subordinated bond.

Answer 51

b) a debenture.

Question 52

Kimberley's paid £105 for a 4% Treasury gilt with a par value of £100. What is the running yield of the gilt? Question 2 options: a) 2.5%. b) 3.8%. c) 4%. d) 5%.

Answer 52

b) 3.8%.

Question 53

Joanne has a basic bank account. Which feature is her account unlikely to offer? Question 3 options: a) Direct debits. b) Overdraft facility c) Cash withdrawals from a Post Office. d) ATM card.

Answer 53

b) Overdraft facility

Question 54

Which of the following is true? Peer-to-peer lending is: Question 4 options: a) co-ordinated by banks and building societies. b) a direct contract between one lender and one borrower. c) regulated by the Prudential Regulation Authority. d) not protected by the Financial Services Compensation Scheme.

Answer 54

d) not protected by the Financial Services Compensation Scheme.

Question 55

Sally has a National Savings and Investment (NS&I) product, but her friend Sarah cannot open a similar account because new issues of the product are no longer available. This means Sally has an NS&I: Question 5 options: a) guaranteed growth bond. b) investment account. c) premium bond. d) income bond.

Answer 55

a) guaranteed growth bond.

Question 56

ncome from a Eurobond received by a higher-rate taxpayer qualifies for: Question 6 options: a) personal savings allowance. b) capital gains tax exemption. c) the annual dividend allowance. d) tax-free status.

Answer 56

a) personal savings allowance.

Question 57

Amanda has a permanent income-bearing shareholding. This means: Question 7 options: a) the investment is lower risk than a deposit account. b) the issuing organisation is now a bank. c) she has no guarantee that her original investment will be repaid. d) she has a corporate bond holding.

Answer 57

c) she has no guarantee that her original investment will be repaid.

Question 58

An investor has bought a gilt 'cum dividend'. This means they: Question 8 options: a) will receive 100% of the next due income payment. b) will not receive any of the next due income payment. c) and the seller will each receive 50% of the next due income payment. d) will be entitled to a bonus dividend on the next due income date.

Answer 58

a) will receive 100% of the next due income payment.

Question 59

A structured deposit account: Question 9 options: a) provides a guaranteed fixed return. b) places the original capital at risk. c) runs for a fixed term. d) matches the return from an associated stock market index.

Answer 59

c) runs for a fixed term.

Question 60

Income from an offshore deposit account is tax free for a UK resident. Question 10 options: a) True b) False

Answer 60

b) False