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CeMAP 1 - UKFR > Topic 6 > Flashcards

Topic 6 Flashcards

Direct investments: cash and fixed‑interest securities

1
Q

What are the four main asset classes?

A

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

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2
Q

What is the relationship between investment risk and potential return?

A

The greater the risk, the greater the potential return. Different asset classes offer varying levels of risk and return.

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3
Q

How do cash and shares differ in terms of investment risk and return?

A

Cash offers variable but generally low levels of return through interest, with limited risk to capital.
Shares offer no guarantee of income or future capital value, and an investor could potentially lose all their money.

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4
Q

Why is diversification recommended in investing?

A

Diversification helps balance different risk and reward profiles, as different asset classes perform better at different stages of the economic cycle.

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5
Q

What is the most widely used type of direct investment?

A

A deposit account, such as a bank or building society savings account.

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6
Q

Why do investors choose deposit-based savings accounts?

A

Investors choose deposit-based savings accounts for:

Security of capital – To avoid putting capital at risk, though inflation can erode value over time.
Convenience – Banks and building societies are easily accessible, and inertia often prevents investors from seeking more rewarding alternatives.

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7
Q

What is an emergency fund in investment terms?

A

A portion of an investment portfolio kept in an easily accessible no-notice deposit account to cover unexpected expenses.

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8
Q

How does ‘capital’ in a savings account differ from ‘money’?

A

Capital in a savings account is used to generate wealth, whereas money is generally used to purchase goods and services.

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9
Q

What are the two basic categories of bank accounts?

A

Current accounts – for everyday money needs.
Savings accounts – for setting aside money not required for day-to-day spending.

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10
Q

How do savings accounts and some current accounts pay interest?

A

Interest rates vary based on the amount invested and whether there are restrictions on access to the money.

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11
Q

What is a traditional current account?

A

A traditional current account is a transactional account where salaries/wages can be paid in and money can be accessed through debit cards, cheque books, and electronic transfers like standing orders and direct debits.

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12
Q

What are the key features of a basic bank account?

A

Designed for people on low incomes or receiving benefits.
Can receive money via various methods.
Limited withdrawal options (ATM or over-the-counter).
No cheque books or overdraft facility.

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13
Q

What is an interest-bearing current account?

A

An account that allows immediate access to funds while earning interest, often requiring a minimum deposit and regular direct debits.

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14
Q

How do high-interest current accounts work?

A

They offer higher rates of interest but typically require a minimum monthly deposit and may limit interest payments to a set amount.

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15
Q

What are packaged current accounts?

A

Packaged accounts provide additional benefits like breakdown cover, mobile phone insurance, and travel insurance in exchange for a monthly or annual fee.

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16
Q

What is an instant access savings account?

A

An account that can be opened with as little as £1, allowing immediate access to savings but offering low interest rates linked to the bank’s base rate.

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17
Q

Why do instant access accounts typically have lower interest rates?

A

Because they have few limitations on withdrawals, making funds readily available to the account holder.

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18
Q

How can instant access accounts offer higher interest rates?

A

By requiring account operation online, via an app, ATM, by post, or phone, reducing administrative costs.

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19
Q

What are restricted access accounts?

A

Accounts where withdrawals are limited, offering higher interest rates as banks can hold funds for a longer period.

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20
Q

What are the three types of restricted access accounts?

A

Limited withdrawal accounts – restrict the number of withdrawals per year.
Notice accounts – require a minimum notice period before withdrawals.
Term accounts – lock money away for a set period (e.g., 1 to 5 years).

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21
Q

Can notice accounts allow emergency withdrawals?

A

Yes, but they usually charge a penalty, such as reduced or zero interest.

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22
Q

What is a fixed-term bond?

A

A savings product offering a fixed rate of return for a set period, typically with no access to funds during the term.

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23
Q

Why do fixed-term bonds offer higher interest rates?

A

Because the money is locked away, providing the bank with certainty over fund availability.

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24
Q

What is NS&I (National Savings and Investments)?

A

A government-backed savings provider offering low-risk savings and investment products.

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25
Why are NS&I products considered low risk?
Because the UK government guarantees the return of capital invested.
26
What are the tax implications of a Direct Saver account?
Interest is taxable and paid gross (without tax deduction).
27
What is the minimum and maximum investment for a Direct Saver account?
£1 to £2 million.
28
How are Income Bonds different from Direct Saver accounts?
They require a minimum investment of £500, pay interest monthly, and have a maximum limit of £1 million.
29
What is a Direct ISA?
A tax-free savings account with a limit of £20,000 per tax year, available only to UK residents aged 18 or over.
30
How do Premium Bonds generate returns?
Instead of earning interest, they offer a monthly prize draw, with a maximum prize of £1 million.
31
What is the investment range for Premium Bonds?
£25 to £50,000.
32
What is the main restriction of a Junior ISA?
No access to funds until the account holder turns 18.
33
What is unique about Green Savings Bonds?
They have a fixed 3-year term, interest is taxable at maturity, and the funds support government green projects.
34
What is the minimum investment for Green Savings Bonds?
£100
35
What is the key feature of Guaranteed Income Bonds?
They provide fixed monthly interest over 1-year or 3-year terms.
36
How do Guaranteed Growth Bonds differ from Guaranteed Income Bonds?
Instead of monthly interest, they offer fixed annual growth.
37
Are new Guaranteed Income and Growth Bonds available for sale?
No, but existing bondholders can renew or cash them in.
38
What does the term "offshore" refer to in investments?
Any investment medium (e.g., bank accounts, investments) based outside the UK in a country with more favourable tax treatment.
39
Name three common offshore tax havens.
Channel Islands, Luxembourg, Cayman Islands.
40
How does HMRC track offshore accounts?
British Crown dependencies and overseas territories exchange financial information with HMRC, including names and financial details.
41
Since when has offshore financial information been exchanged with HMRC?
Since 2016, following the implementation of the US Foreign Account Tax Compliance Act.
42
What are two risks associated with offshore investments?
They may not be denominated in sterling, leading to potential exchange rate fluctuations. They may not be covered by investor protection schemes.
43
Why might an investor consider an offshore investment?
If they own property abroad or plan to move abroad, offshore accounts allow easy access to money outside the UK.
44
How is interest on offshore deposits treated for UK residents?
Interest is paid gross, but UK residents must declare it to HMRC and may owe tax on it.
45
What is a double taxation arrangement?
A reciprocal tax treaty between two countries that prevents the same income from being taxed twice.
46
What should investors check before opening an offshore account?
Whether the country offers investor protection schemes and if there are double taxation arrangements with the UK.
47
Why is it important to determine UK tax residence status for offshore investments?
Because UK tax liability depends on residence status, and different rules apply to UK vs. non-UK residents.
48
What are gilts?
Gilts, or gilt-edged securities, are a type of fixed-interest investment where the UK government borrows money from investors.
49
Why are gilts considered safe investments?
Because the UK government is unlikely to default on its interest payments or capital repayments.
50
What is the redemption date of a gilt?
The date when the government repays the original par value (usually £100) to the investor.
51
What is the coupon on a gilt?
The fixed interest rate payable on the par value of a gilt, paid half-yearly on a gross but taxable basis.
52
How are gilts categorised by their time to redemption?
Short-dated gilts: Less than 5 years (or 7 years by the DMO). Medium-dated gilts: 5–15 years (or 7–15 years by the DMO). Long-dated gilts: More than 15 years.
53
What are index-linked gilts?
Gilts where interest payments and capital value are adjusted for inflation, protecting the investor’s purchasing power.
54
Can investors sell gilts before the redemption date?
Yes, investors can sell gilts to other investors, but they cannot redeem them early with the government.
55
What factors influence the price of gilts on the market?
Market interest rates. Time left until redemption. Supply and demand.
56
What is the difference between ‘cum dividend’ and ‘ex dividend’ when buying gilts?
Cum dividend: Buyer receives the next interest payment. Ex dividend: Seller keeps the next interest payment.
57
How is gilt interest taxed?
It is classed as savings income and may be taxed at 20%, 40%, or 45%, depending on an individual’s total income and allowances.
58
Are capital gains on gilts taxable?
No, any gains made on the sale or redemption of gilts are free from Capital Gains Tax (CGT).
59
Why do some investors buy gilts without intending to keep them until redemption?
To speculate on interest rate movements and sell for a profit. To buy below par value and gain on redemption.
60
What are local authority bonds?
Fixed-interest securities issued by local authorities, secured on their assets, offering a guaranteed half-yearly interest rate but without a government guarantee.
61
How do local authority bonds compare to gilts in terms of security?
They are less secure than gilts because they lack a government guarantee, though capital return at maturity is promised.
62
What are Permanent Interest-Bearing Shares (PIBS)?
Fixed-interest securities issued by building societies to raise capital, paying interest gross but taxable as savings income.
63
What happens to PIBS if a building society demutualises?
They convert into Perpetual Subordinated Bonds (PSBs), which have no redemption date and provide a fixed income stream.
64
How can companies raise money apart from issuing corporate bonds?
Issuing shares Borrowing from banks or lenders
65
How risky are PIBS?
Higher risk than savings accounts because PIBS holders rank below depositors if a building society becomes insolvent.
66
What are corporate bonds?
Fixed-interest securities issued by companies to raise long-term finance, promising interest payments and repayment of the loan at redemption date.
67
What is the difference between a secured and an unsecured corporate bond?
Secured bond (debenture): Backed by company assets, meaning the investor has a claim on those assets if the company defaults. Unsecured bond (loan stock): No asset backing, making it riskier.
68
What are convertible corporate bonds?
Bonds that allow the holder to convert them into ordinary shares in the issuing company, though this is optional.
69
Why do corporate bonds offer higher interest rates than gilts?
Because they are riskier, as they depend on the financial stability of the company rather than the government.
70
What are Eurobonds?
Bonds issued in a currency different from the country of issue, often used by multinational organisations and governments.
71
Do Eurobonds relate to the euro currency?
No, the term "Eurobond" refers to bonds issued outside the jurisdiction of a domestic central bank, not the euro currency.
72
How are local authority bonds, corporate bonds, PIBS, and Eurobonds taxed?
They pay interest gross (without tax deduction). Interest is classed as savings income and may be taxed at 20%, 40%, or 45% depending on the investor's total income.
73
What is a structured deposit?
A bank deposit where returns are linked to a stock market index (e.g. FTSE 100) rather than a fixed interest rate.
74
How does a structured deposit differ from a fixed-rate savings account?
Unlike fixed-rate accounts, structured deposits offer variable returns based on stock market performance.
75
What is the key benefit of a structured deposit?
Investors get equity-linked returns with a guarantee that their initial deposit will be returned regardless of market performance.
76
What are the risks and limitations of structured deposits?
Limited upside: Investors may not get the full benefits of stock market gains. No dividends: Investors do not receive dividend payments from the underlying index. Complexity: Often requires a financial adviser to purchase.
77
What is alternative finance?
Any financial activity or lending that takes place outside of traditional banks, such as crowdfunding.
78
What are the two unregulated types of crowdfunding?
Donation-based: Contributors expect nothing in return. Reward-based: Contributors receive a reward, such as a product trial.
79
Which types of crowdfunding are regulated by the FCA?
Loan-based crowdfunding (P2P lending) Investment-based crowdfunding
80
Who can invest in regulated crowdfunding?
Experienced or sophisticated investors Ordinary investors (if they confirm they won’t invest more than 10% of their net investable assets).
81
What is peer-to-peer (P2P) lending?
A saver lends money via a P2P platform, which is then loaned to businesses seeking funding.
82
How is P2P lending similar to deposit-based savings?
Funds are aggregated and distributed. Available as easy access or fixed-rate investments over an agreed term.
83
What are the risks of P2P lending?
Loan defaults: Borrowers may miss repayments, reducing returns. No FSCS protection: Funds are not covered by the Financial Services Compensation Scheme.
84
What is investment-based crowdfunding?
Investors provide funds in exchange for a share of a company or a return on investment.
85
What warning does the FCA give about investment-based crowdfunding?
Investors are very likely to lose their money because start-ups often fail, making shares worthless.

CeMAP 1 - UKFR (25 decks)

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