Topic 6 - Direct Investments: cash and fixed-interest securities

Question 1

What are the 5 main financial asset classes?

Answer 1

1. cash
2. fixed interest securities (gilts, corporate bonds)
3. equities (shares)
4. property
5. alternative investments (fine wine, antiques)

Question 2

Why are investors advised to diversify their holdings between different asset classes?

Answer 2

To balance the risk as different asset classes may perform better at different stages of the economic cycle

Question 3

Why do people choose deposit-based investments?

Answer 3

• security of capital

- convenience

Question 4

Name 5 different types of bank/ building society accounts.

Answer 4

1. Traditional current account
2. Basic bank account
3. Interest-bearing current account
4. Instant access savings accounts
5. Restricted access accounts

Question 5

What restrictions may be placed on a restricted access account?

Answer 5

• limiting the number of withdrawals each calendar year
• requiring a minimum notice period for withdrawals
• creating a term account (a specified period where the saver cannot access their money)

Question 6

What are National Savings & Investment products?

NS & I

Answer 6

Savings and investment products backed by the government. Risk is low.

Question 7

Name 5 types of NS & I products.

Answer 7

1. Direct Saver
2. Income Bonds
3. Direct ISA
4. Premium Bonds
5. Junior ISA

Question 8

Which 3 NS & I products are tax free?

Answer 8

1. Direct ISA
2. Premium Bonds
3. Junior ISA

Question 9

What is the minimum age for an NS & I product?

Answer 9

16 years

Question 10

What is an offshore account?

Answer 10

An investment medium held outside the UK

Offers more advantageous taxation of investments

Question 11

Why do offshore accounts pose greater risk?

Answer 11

• might not be denominated in sterling -value might be affected by exchange rates
• may not be protected by investor protection schemes

Question 12

Is the interest on offshore accounts taxable?

Answer 12

It must be declared to the HMRC and may be taxable

Question 13

What are gilts?

Answer 13

Gilt-edged securities are a fixed-interest security

Form of borrowing by the UK government

Safe investments as government is not expected to default on capital payments or interest

Question 14

What is the redemption date and what does ‘coupon’ mean?

Answer 14

The redemption date is when the government must redeem the gilt and pay back its value or par value.

The coupon is the interest rate of a gilt. Fixed rate, paid half -yearly, gross but taxable

Question 15

Explain the meaning of this example of a gilt;

‘Treasury 5% 2021’

Answer 15

Treasury 5% 2021

A gilt with a coupon (interest rate) of 5% and a redemption date in 2021

Question 16

What are the 3 categories of gilts?

Answer 16

Short-dated gilts- less than 5 years

Medium -dated gilts - 5-15 years

Long dated gilts - More than 15 years

Question 17

The UK Debt Management Office defines short dated gilts as what?

Answer 17

Less than 7 years

Question 18

What are index-linked gilts?

Answer 18

The interest payments and capital move in line with inflation

Question 19

Can gilts be redeemed early?

Answer 19

No. They can be sold to other investors

Question 20

What is the difference between cum-dividend and ex-dividend?

Answer 20

cum-dividend - the stock is bought with the entitlement to the next interest payment

ex-dividend - the next interest payment will be payable to the previous owner (the seller)

Question 21

Is capital gains tax (CGT) payable on the redemption of gilts?

Answer 21

No. They are entirely free of capital gains tax

Question 22

How do you calculate the running yield of a gilt?

Answer 22

running yield = coupon / price paid

e.g. £5 / £130.73 = 3.82%

Question 23

Name 4 other kinds of fixed-interest stocks.

Answer 23

1. Local authority bonds
2. Permanent interest -bearing shares
3. Corporate bonds
4. Eurobonds

Question 24

What is a corporate bond?

Answer 24

Similar to gilts
A way for companies to raise capital
Bond is issued with a promise to pay a fixed-rate of interest
Stated redemption date
Secured (backed by company assets) or unsecured

Question 25

What is a ‘debenture’?

Answer 25

A corporate bond that is backed by security

a charge over company assets

Question 26

What is a ‘loan stock’?

Answer 26

An unsecured corporate bond

not backed by security

Question 27

Which pose more risk - corporate bonds or gilts?

Answer 27

Corporate bonds.

Gilts are government backed.

Question 28

Explain what a Eurobond is.

Answer 28

A Eurobond is a bond traded or issued in a country that uses a currency other than the one in which the bond was denominated

Question 29

Are fixed-interest stocks taxable?

Answer 29

Any interest is payed gross and classed as savings income.

If it falls outside of the starting-rate band for savings, then it will be taxable at the appropriate rate

Question 30

What is the benefit of a structured deposit?

Answer 30

The investor will always get their initial investment back.

The reduction in risk is offset by a lowered potential for reward.

They are complex and not normally purchased via a financial adviser.

Question 31

What is Peer 2 Peer (P2P) lending?

Answer 31

This is also called alternative finance.

A saver places their money with a P2P lender who then lends out the money to businesses.

Regulated by the FCA.

High risk. Not covered by the Financial Services Compensation Scheme.