Topic 6 Flashcards
Offshore accounts
Deposit accounts or investments based outside the UK, eg the Channel Islands, Isle of Man and Luxembourg, offering tax advantages compared to the UK.
Permanent interest-bearing shares (PIBS)
Similar to corporate bonds, issued by building societies. Pay fixed interest but have no redemption date.
Structured deposits
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.
Main asset classes
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)
CAPITAL
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
Why do people choose deposit‑based investments?
Security of capital
Convenience
Bank and building society accounts
current accounts, for everyday money needs;
savings accounts, where money not required for day‑to‑day spending is set
aside
PACKAGED CURRENT ACCOUNTS
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.
DEPOSITOR PROTECTION
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.
What is National Savings and Investments?
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
HMRC AND OFFSHORE ACCOUNTS
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.
Offshore investment can potentially expose an investor to greater risk than a
similar onshore investment:
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.
What are gilts?
‘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
REDEMPTION DATE
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.
COUPON
The interest rate payable on the par value of a gilt. It is a fixed rate, paid
half‑yearly, gross but taxable.
The UK Debt Management Offic
issue Gilts
CATEGORIES OF GILT
Short‑dated gilts: less than 7 years.
Medium‑dated gilts: 7–15 years
Index‑linked gilts
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.
Gilts
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
Gilt prices
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)
Guilts pay out
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
Guilts pay out
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
Guilts
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).
BUYING AND SELLING GILTS
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
HOW DO INTEREST RATE MOVEMENTS AFFECT GILT YIELDS?
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.
CALCULATE
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
Local authority bonds
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
Permanent interest‑bearing shares
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
Corporate bonds
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.
Corporate Bonds
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
debenture
A bond that is backed by security is typically referred to as a debenture. The
security is provided by a charge over company assets.
Loan stock
A bond that is not
backed by security is generally referred to as loan stock.
Convertable bonds
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.
Interests
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
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?
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
Eurobonds
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
Taxation of income
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
What is a structured deposit?
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
What is ‘alternative finance’?
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
1) A bank deposit account is a good place to hold a ‘rainy day
fund’. True or false?
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
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
b) 16
interest on NS&I Income Bonds is tax‑free. True or false?
False, interest is paid gross but is taxable.
State two reasons why offshore bank accounts might be more
risky than similar UK deposit accounts.
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
In relation to gilts, what is the ‘coupon’?
The coupon is the interest rate payable on the par value of a gilt
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
a) The gilts will have a redemption date within the next seven years
Rubina is considering buying a gilt, 3% Treasury 2025. The gilt
is currently trading at a price of £107. What is the running yield?
The running yield is £3 (coupon) ÷ £107 (price paid) = 2.8%.
Running yield = coupon ÷ price paid
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.
d) Corporate bonds are considered to be higher‑risk investments.
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
b) A debenture is usually secured on the assets of the company
A Eurobond is the equivalent of a gilt, but issued by a
government within the eurozone. True or false?
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
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.
c) A basic bank account
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.
b)
a debenture.
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%.
b)
3.8%.
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.
b)
Overdraft facility
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.
d)
not protected by the Financial Services Compensation Scheme.
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.
a)
guaranteed growth bond.
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.
a)
personal savings allowance.
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.
c)
she has no guarantee that her original investment will be repaid.
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.
a)
will receive 100% of the next due income payment.
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.
c)
runs for a fixed term.
Income from an offshore deposit account is tax free for a UK resident.
Question 10 options:
a) True
b) False
b) False
