Topic 7

Question 1

Market capitalisation

Answer 1

The ‘market’ value of a company, calculated by multiplying its current share value by the number of shares issued. Not very precise, but gives investors an idea of a company’s size and the risk involved in buying its shares compared to other companies in the same sector

Question 2

Over the counter (OTC)

Answer 2

Institutional investors trade large blocks of securities with each other outside the normal markets. There is little publicity about the shares traded or prices paid. ‘Under the counter’ might be a more appropriate term!

Question 3

Treasury bills

Answer 3

Issued by the Treasury Debt Management Office (DMO) to provide short term government borrowing. Short-term – usually 91 days, no interest is paid but the bills are zero-coupon, which means they are issued at a discount to the face (par) value repaid at the end of the term

Question 4

Bearer instrument

Answer 4

A fixed-income security with paperwork to indicate the investment, but no owner is recorded. Whoever holds the instrument is deemed to be the owner and will be entitled to the coupon payments and the redemption amount. They can be sold on by simply giving the instrument to the buyer

Question 5

Certificates of deposit

Answer 5

Effectively a fixed interest deposit issued by banks and building societies, with a certificate issued to verify the investment. Interest is paid at the end of the term, which is typically 3 or 6 months, although it can usually be rolled over into a new term at the end. There are heavy penalties for early withdrawals, but as bearer instruments they can be sold during the term.

Question 6

Commercial paper

Answer 6

Unsecured debt (borrowing) instruments issued by a company to fund short term needs, such as working capital. The paper promises to repay the debt at the end of the term – typically 3 to 45 days. The paper can be rolled over at the end of the term to extend the borrowing if necessary. Interest rates depend on the borrower’s credit rating, although a bank guarantee can improve the rate for those with lower ratings.

Question 7

Shareholders

Answer 7

Holders of ordinary shares (shareholders) are in effect the owners of the
company. The two main rights that they have are to:
„ receive a share of the distributed profits of the company as income in the
form of dividends; and
„ participate in decisions about how the company is run, by voting at
shareholders’ meetings

Question 8

SECURITIES

Answer 8

Financial assets that can be traded. They can be divided into two
broad classes: those that represent ownership (equities) and those that
represent debt (such as gilts and corporate bonds

Question 9

The rights attaching to shares

Answer 9

The rights attaching to shares of the same class can sometimes differ from
company to company, even though the shares normally have the same major
characteristics. It is therefore prudent for investors to find out precisely what
rights attach to a particular share. These rights are set out in the company’s
articles of association; this is a public document and can be examined at the
registered office of the company or at Companies House

Question 10

How are shares bought and sold?

Answer 10

The Stock Exchange has been London’s market for stocks and shares for
hundreds of years. Shares, issued by UK and overseas companies, gilts,
corporate bonds and options are all traded on this market. There are two
markets for shares: the main market (for which full listing is required) and the
Alternative Investment Market

Question 11

The main market

Answer 11

To be listed on the main market, companies must conform to the stringent
requirements of the Listing Rules laid down by the Financial Conduct Authority
(FCA), acting in its capacity as the UK Listing Authority (UKLA).
Company
profitability
SHARE
PRICES
Strength of the
UK and global
economy
Supply and
demand for shares
and other
investments
Strength of the
market sector

Question 12

Requirements to be on the main market

Answer 12

For a full listing, a considerable amount of accurate financial and other
information must be disclosed. In addition:
„ the applicant company must have been trading for at least three years;
„ at least 25 per cent of its issued share capital must be in the hands of the
public

Question 13

The primary market

Answer 13

The primary market is where companies and financial organisations can
raise finance by selling securities to investors. They will either be coming
to the market for the first time, through the process of ‘going public’ or
‘flotation’, or issuing more shares to the market. The main advantages of
listing include greater ease with which shares can be bought or sold, and
the greater ease with which companies can raise additional funds

Question 14

The secondary market

Answer 14

The secondary market is where investors buy and sell existing securities.
It is much bigger than the primary market in terms of the number of
securities traded each day

Question 15

Alternative Investment Market

Answer 15

The Alternative Investment Market (AIM), which started in 1995, is mainly
intended for new, small companies with the potential for growth

Question 16

SHARE INDICES

Answer 16

SHARE INDICES
It is possible to measure the overall performance of shares by
using one or more of the various indices that are produced

Question 17

FTSE 100 Index

Answer 17

FTSE 100 Index (commonly known as the Footsie) – this is
an index of the top 100 companies in capitalisation terms;
each company is weighted according to its market value.

Question 18

FTSE 250 Index

Answer 18

FTSE 250 Index – the next 250 companies by market
capitalisation after the FTSE 100

Question 19

FTSE 350 Index

Answer 19

FTSE 350 Index – the FTSE 100 and FTSE 250 companies
combined

Question 20

FTSE All‑Share Index

Answer 20

FTSE All‑Share Index – this is an index of around 600
shares, split into sectors. It measures price movements and
shows a variety of yields and ratios as well as a total return
on the shares.

Question 21

EX‑DIVIDEND SHARES

Answer 21

Dividends are usually paid half‑yearly. Because of the
administration involved in ensuring that all shareholders
receive their dividends on time, the payment process has to
begin some weeks before the dividend dates. A ‘snapshot’
of the list of shareholders is made at that point, and anyone
who purchases shares between then and the dividend date
will not receive the next dividend (which will be paid to the
previous owner of the shares). Once the date has passed when
the administrative process of paying the dividend starts, the
shares are said to be ex‑dividend (or xd). The share price would
normally be expected to fall by approximately the dividend
amount on the day it becomes xd.
Alternatively, a share may be paid cum‑dividend, which means
that it is purchased before it goes xd, and the purchaser
receives the next dividend payment.

Question 22

Assessment of returns

Answer 22

The financial returns that shareholders hope to receive from their shares take
two forms:
„ the growth in the share price (capital growth); and
„ the dividends they receive as their share of the company’s distributable
profits (income).

Question 23

Dividend cover

Answer 23

This factor indicates how much of a company’s profits are paid out as dividends
in a particular distribution. If, for example, 50 per cent of the profits are paid
in dividends, the dividend is said to be covered twice. Cover of 2.0 or mores generally considered to be acceptable by investors, whereas a figure below
1.0 indicates that a company is paying part of its dividend out of retained
surpluses from previous years

Question 24

Price/earnings ratio

Answer 24

As its name suggests, the price/earnings (P/E) ratio is calculated as the share
price divided by the earnings per share

Question 25

Earnings per share (EPS)

Answer 25

Earnings per share (EPS) = post‑tax net profit ÷ number of
shares

Question 26

Dividend cover

Answer 26

Dividend cover = how much of company profits are paid as
dividends

Question 27

Taxation

Answer 27

dividends are paid without deduction of tax but are
subject to income tax.

Question 28

CGT

Answer 28

Gains realised on the sale of shares are subject to capital gains tax (CGT),
although investors may be able to offset the gain against their annual CGT
exemption

Question 29

Rights issues

Answer 29

Stock Exchange rules require that, when an existing company that already has
shareholders wishes to raise further capital by issuing more shares, those
shares must first be offered to the existing shareholders. This is done by
means of a rights issue offering, for example, one new share per three shares
already held, generally at a discount to the price at which the new shares are
expected to commence trading. Shareholders who do not wish to take up this
right can sell the right to someone else, in which case the sale proceeds from
selling the rights compensate for any fall in value of their existing shares (due
to the dilution of their holding as a proportion of the total shareholding)

Question 30

Scrip issues

Answer 30

Scrip issue, also known as a bonus issue or a capitalisation issue, is an issue
of additional shares, free of charge, to existing shareholders. No additional
capital is raised by this action – it is achieved by transferring reserves into the
company’s share account. The effect is to increase the number of shares and
to reduce the share price proportionately

Question 31

Preference shares

Answer 31

As with ordinary shares, holders of preference shares are entitled to dividends
payable from the company’s profits. They differ from ordinary shares in
that they are generally paid at a fixed rate, and holders of preference shares
are eligible for any dividend payout ahead of ordinary shareholders. Many
preference shares are cumulative preference shares, which means that if
dividends are not paid, entitlement to dividends is accumulated until such a
time as they can be paid.
Preference shares do not normally carry voting rights, although in some cases
holders may acquire voting rights if their dividends have been delayed

Question 32

Convertible preference shares

Answer 32

Convertibles are securities that carry the right to be converted at some later
date to ordinary shares of the issuing company. Traditionally they were issued
as corporate bonds (with a lower rate of interest than conventional corporate
bonds because of the right to convert to equity). In recent years, they have
been increasingly issued as convertible preference shares

Question 33

Warrants

Answer 33

Warrants give the holder the right to buy shares at a fixed price at an agreed future
date

Question 34

property bonds

Answer 34

the underlying
fund is invested in a range of properties and shares in property companies

Question 35

Income from property

Answer 35

Income from property, after deduction of allowable expenses, is subject
to income tax. It is treated as non‑savings income for tax purposes. On the
disposal of investment property, any gain is liable to CGT, but any capital
expenditure on enhancement of the property’s value can be offset against
taxable gains.

Question 36

agricultural property

Answer 36

One of the benefits of owning agricultural property is
agricultural relief for inheritance tax. This relief applies to
the land, growing crops and farm buildings. Relief is available
for up to 100 per cent of the inheritance tax liability for
owner‑occupied farms, or 50 per cent where the owner has let
out the land

Question 37

Money‑market instruments

Answer 37

‘Money‑market instruments’ is a generic term used to describe a number of
forms of short‑term debt. Interest is not normally paid during the term of the
transaction, the rate of interest being determined by the difference between
the amount invested/borrowed and the amount repaid.
In order to illustrate the nature of these instruments, we will describe three of
them: Treasury bills, certificates of deposit, and commercial paper.

Question 38

Treasury bills

Answer 38

Treasury bills are short‑term redeemable securities issued by the Debt
Management Office (DMO) of the Treasury. Like gilts, they are fundraising
instruments used by the UK government, but they differ from gilts in a number
of ways. Two major differences are:
„ Treasury bills are short term, normally being issued for a period of 91
days, whereas gilts can be long term or even undated;
„ Treasury bills are zero‑coupon securities, ie they do not pay interest.
Instead, they are issued at a discount to their face value or par value (the
amount that will be repaid on their redemption date

Question 39

Certificates of deposit

Answer 39

Certificates of deposits (CDs) are issued by banks and building societies.
They are in effect a receipt to confirm that a deposit has been made with the
institution for a specified period at a fixed rate of interest. The interest is paid
with the return of the capital at the end of the term. Terms are typically three
months or six months, although depositors who require a longer term can
often obtain CDs that can be ‘rolled over’ for a further three or six months on
specified terms. The amounts deposited are typically £50,000 or more

Question 40

COMMERCIAL PAPER

Answer 40

An unsecured promissory note – ie a promise to repay the funds that
have been received in exchange for the paper.

Question 41

WORKING CAPITAL

Answer 41

Funds available for the day‑to‑day running of the business, calculated as
current assets minus current liabilities

Question 42

Direct investment in shares is low risk for individual investors
because, over the long term, equity markets have outpaced
inflation. True or false?

Answer 42

False. Direct investment in shares is regarded as high risk because if the
company fails, the entire investment is at risk. It is difficult for most investors
to spread the risk effectively between a large number of companies and sectors

Question 43

Name three factors that can affect share prices

Answer 43

Factors include company profitability, the strength of the global and UK
economy, the strength of the market sector and the supply of and demand
for shares

Question 44

What are the implications for the purchaser of buying shares
ex‑dividend

Answer 44

They will not be eligible for a dividend payment in the first distribution
of shares following their acquisition of the shares. The previous owner of
the shares will receive this dividend payment

Question 45

A share with a low P/E ratio is likely to be more expensive than
other shares in the same market sector. True or false?

Answer 45

False. A low P/E ratio indicates that the share is not in high demand and it
is likely to be less expensive than other shares

Question 46

If a company distributes 25 per cent of its profits in the form
of dividends to its shareholders, what would the dividend
cover be?
a) 4.
b) 8.
c) 10.
d) 25

Answer 46

a) 4 – the profit is four times the dividend paid out

Question 47

What is the difference between a rights issue and a scrip issue?

Answer 47

A rights issue involves offering existing shareholders the opportunity to
buy additional shares in order to raise additional capital. A scrip issue
involves issuing additional shares to shareholders free of charge, the
effect being to increase the number of shares in issue and reduce the
share price proportionately; no additional funds are raised.

Question 48

Elliott is considering investing in a buy‑to‑let property. He
thinks this is a good way to achieve a high return. What are the
main drawbacks that Elliott should be aware of?

Answer 48

Suitable tenants may be hard to find.
 Properties must be in desirable locations (eg good transport links,
access to local amenities, etc).
 In times of recession, letting properties may be difficult and property
prices may fall.
 Property is less easy to realise than most other forms of investment.
 Investment costs tend to be high and can include management fees,
legal charges and stamp duty.
 Government measures to discourage BTL have made the tax position
less advantageous.

Question 49

How can a buy‑to‑let investor claim relief for wear and tear on
furniture?

Answer 49

They are allowed a furniture replacement relief, which allows the actual
cost of replacing furnishings to be offset against profits

Question 50

Treasury bills are zero‑coupon securities. What does this
mean?

Answer 50

They do not pay interest; instead they are issued at a discount to their par
value

Question 51

Commercial paper is generally issued for a term of between
three and six months. True or false?
?

Answer 51

False. Commercial paper is generally issued for between 5 and 45 days,
with 30–35 days being typical. Certificates of deposit are generally issued
for between three and six months

Question 52

A share’s price/earnings ratio is:

Question 1 options:

a)

the share’s dividend as a percentage of the share price.

b)

the number of times the dividend is covered by the company’s profits.

c)

the share price divided by the earnings per share.

d)

the company’s net profit divided by the number of shares.

Answer 52

C

Question 53

Market capitalisation is a key factor when analysing shares. It represents the:

Question 2 options:

a)

annual profit figure shown in the company’s last annual accounts.

b)

current share value multiplied by the number of shares issued.

c)

number of shares the company has issued.

d)

value of the company’s assets and reserves.

Answer 53

B

Question 54

What percentage of a company’s share capital must be in public hands for its shares to have a full listing on the main London Stock Exchange?

Question 3 options:

a)

10%.

b)

25%.

c)

33%.

d)

49%.

Answer 54

25%

Question 55

Karen is a higher-rate taxpayer who owns a buy-to-let flat. What is the position with tax relief on her mortgage? She will:

Question 4 options:

a)

not qualify for any tax relief.

b)

receive tax relief at her marginal income tax rate.

c)

receive a basic-rate income tax credit.

d)

receive higher-rate tax relief.

Answer 55

c)

receive a basic-rate income tax credit

Question 56

Today is the ex-dividend date for Acme Ltd shares. The share price is most likely to:

Question 5 options:

a)

increase slightly.

b)

remain stable.

c)

decrease slightly.

d)

become more volatile.

Answer 56

c)

decrease slightly.
A share price typically decreases roughly by the value of the dividend when it reaches its ex-dividend date

Question 57

The FTSE 350 Index includes companies listed on the London Stock Exchange. It comprises:

Question 6 options:

a)

the largest 350 companies by capitalisation.

b)

the largest 350 companies by capitalisation outside the FTSE 100.

c)

the largest 350 companies by capitalisation outside the FTSE 100 and 250 indices.

d)

350 smaller companies who do not meet the AIM criteria.

Answer 57

A

Question 58

Bow Ltd has just issued three free shares for every one share a shareholder owns. This is referred to as a:

Question 7 options:

a)

proportional share issue.

b)

scrip issue.

c)

rights issue.

d)

dividend share issue

Answer 58

B

Question 59

Buy-to-let property has the advantage of liquidity.

Question 8 options:
a) True
b) False

Answer 59

B

Question 60

A preference share:

Question 9 options:

a)

receives interest payments rather than dividends.

b)

ranks ahead of ordinary shares for repayment if the company is wound up.

c)

is guaranteed to receive a dividend every year.

d)

always carries voting rights.

Answer 60

B

Question 61

Certificates of deposit:

Question 10 options:

a)

have a minimum 12-month term.

b)

pay interest monthly.

c)

are bearer securities.

d)

allow penalty-free access at any time.

Answer 61

c)

are bearer securities.