Topic 8

Question 1

Offer and bid price

Answer 1

Offer price – the price the manager/stockbroker sells the unit trust/share.
Bid price – the price the manager/stockbroker buys back the unit trust/share from the investor.

Question 2

Bid–offer spread

Answer 2

The spread (difference) between the bid and offer prices of unit trusts and other investments. It includes any initial charge and some of the trust’s costs for making the investment.

Question 3

Net asset value (NAV)

Answer 3

The underlying value of an investment trust share, based on the trusts’ assets. It is the net value of the trust’s assets divided by the number of shares issued. The shares can trade at a discount to NAV – the market price is lower than the NAV, or a premium to NAV – the market price is more than the NAV

Question 4

Top slicing

Answer 4

An income tax calculation for investment bonds, to allow for the fact that any gain occurs over the life of the bond. The gain is divided by the number of complete policy years to determine the slice, which is then added to income to calculate the tax payable. It avoids the whole gain being taxable for those where the whole gain would lift them into a higher tax bracket.

Question 5

Structured capital-at-risk products (SCARP

Answer 5

A fixed term investment that provides an agreed return over the term – eg annual income or capital growth. The original capital is at risk, because how much is returned depends on the final value of a stated stock market index or a number of indices. If the index falls by more than a specified amount, some of the capital is lost.

Question 6

Why do collective investments appeal to investors?

Answer 6

The main legal forms of collective investment vehicles and products are:
„ unit trusts;
„ investment trusts;
„ investment bonds; and
„ OEICs.

Question 7

Actively managed funds

Answer 7

(sometimes referred to simply as ‘managed funds’)
use the services of a fund manager(s) to make decisions on asset selection
and when holdings should be bought or sold.

Question 8

Passively managed or tracker funds

Answer 8

will seek to replicate the performance
of a particular stock market index, such as the FTSE All‑Share. A manager
may be used but it is also possible that asset selection is computerised

Question 9

Unit trust

Answer 9

A unit trust is a pooled investment created under trust deed.

Question 10

Equity trust

Answer 10

A unit trust is categorised as an equity trust where the underlying assets
are mainly shares

Question 11

fixed‑income trust

Answer 11

where investment is mainly in
interest‑yielding assets. An equity trust pays a dividend, while a fixed‑income
trust pays interest

Question 12

Units

Answer 12

A unit trust is divided into units, with each unit representing a fraction of
the trust’s total assets. It is ‘open‑ended’, so if lots of investors want to buy
units in it, the trust manager can create more units. (

Question 13

Accumulation units

Answer 13

Accumulation units automatically reinvest any income generated by the
underlying assets. This would suit someone looking for capital growth

Question 14

Distribution or income units

Answer 14

Distribution or income units split off any income received and distribute
it to unit holders. The units may also increase in value in line with the value
of the underlying assets

Question 15

WHAT IS A TRUST?

Answer 15

In general law a trust is an arrangement whereby one person
gives assets to another (the trustees) to be looked after in
accordance with a set of rules (specified in the trust deed).
A unit trust is similar in that the trust deed details the
investment rules and objectives of the scheme. The investor
effectively gives their money to the trustees who will in turn
allow the fund manager to use it to meet the trust’s objectives.
The trustees will ensure that the manager is fulfilling their
obligations under the trust deed.

Question 16

Unit prices

Answer 16

Unit prices are directly related to the value of the underlying securities
that make up the fund

Question 17

There are four important prices in relation to unit trust transactions:

Answer 17

„ The creation price is the price at which the trustee/depositary creates
units on behalf of the unit trust manager.
„ The offer price is the price at which investors buy units from the managers.
„ The bid price is the price at which the managers will buy back units from
investors who wish to cash in all, or part, of their unit holding.
„ The cancellation price is the minimum permitted bid price, taking into
account the full costs of buying and selling. At times when there are both
buyers and sellers of units, the bid price is generally above this minimum
level, since costs are reduced because underlying assets do not need to be
traded.

Question 18

SINGLE PRICING – UNIT TRUSTS

Answer 18

In a single‑price system the price is arrived at through
consideration of the net flows of the fund – in other words
whether, on a net basis, more subscriptions are being made
into the fund or whether more redemptions are being taken
from the fund. Where the value of subscriptions is greater than
redemptions, the fund is said to be in net inflow. Similarly,
where redemptions are greater than subscriptions, the fund is
said to be in net outflow

Question 19

How are units bought and sold?

Answer 19

Unit trust managers are obliged to buy back units when investors wish to sell
them. There is consequently no need for a secondary market in units and they
are not traded on the Stock Exchange. This adds to the appeal of unit trusts to
the ordinary investor, because the buying and selling of units is a relatively
simple process

Question 20

The contract note

Answer 20

The contract note – this specifies the fund, the number of units, the unit
price and the amount paid. It is important because it gives the purchase
price, which will be needed for capital gains tax (CGT) purposes when the
units are sold

Question 21

The unit certificate

Answer 21

The unit certificate – this specifies the fund and the number of units held,
and is the proof of ownership of the units.

Question 22

CHARGES

Answer 22

Two types of charges are applied to unit trusts:
„ The initial charge covers the costs of purchasing fund
assets. The initial charge is typically covered by the bid–
offer spread.
„ The annual management charge is the fee paid for the use
of the professional investment manager. The charge varies
but is typically between 0.5 per cent and 1.5 per cent of
fund value. Although it is an annual fee, it is commonly
deducted on a monthly or daily basis.

Question 23

How are unit trusts taxed?

Answer 23

Authorised unit trusts fall into two main categories:
„ If more than 60% of the underlying investments within a unit trust are
cash or fixed‑interest securities, such as UK gilts or corporate bonds, the
fund will be classed as a fixed‑income or non‑equity fund and any income
distributions will be treated as interest payments.
„ If less than 60% of the underlying investments are cash or fixed‑interest
securities, the fund will be classed as an equity fund and all income
distributions will be treated as dividends

Question 24

Equity‑based funds

Answer 24

For equity‑based unit trust funds, the tax treatment is the same as for shares.
Income is paid without deduction of tax. Where an investor’s total dividend in
a tax year is less than the dividend allowance (DA), there is no income tax on
the dividend.
Where dividend income is in excess of the DA, then the income is taxed at
different rates based on which tax band it falls into

Question 25

Fixed‑income (or non‑equity) funds

Answer 25

Interest from a fixed‑income fund is classed as savings income. The income
is paid gross, without deduction of tax. Where the interest is received by a
non‑taxpayer, falls within the starting‑rate band for savings, or falls within the
PSA of a basic‑ or higher‑rate taxpayer, then no tax is payable. Taxpayers who
have used their PSA are taxed on the excess income and are required to declare
the income to HMRC through self‑assessment.

Question 26

What are investment trusts?

Answer 26

Investment trusts are collective investments but, unlike unit trusts, they are
not unitised funds. In fact, despite their name, they are not even trusts. They
are public limited companies whose business is investing (in most cases) in
the stocks and shares of other companies. As a company, an investment trust
is established under company law and operates as a listed plc; its shares are
listed on the stock exchange. A unit trust and an OEIC (see section 8.4) must be
FCA authorised. An investment trust, by contrast, must meet FCA requirements
to gain a stock market listing, and it is governed by rules in its memorandum
and articles of association.
As with all companies, shares are sold to investors. The number of shares
available remains constant – the company does not create more just because
investors want them – so an investment trust is said to be ‘closed‑ended’ (in
contrast to the open‑ended nature of unit trusts and OEICs)

Question 27

NET ASSET VALUE PER SHARE

Answer 27

Total value of the investment fund
divided by the number of shares
issued.

Question 28

Gearing

Answer 28

Gearing
Because investment trusts are constituted as companies, they can borrow
money to take advantage of investment opportunities – this is known as gearing
or leverage. This facility is not open to unit trusts or OEICs, which are only
permitted to borrow money over the short term and against known future cash
inflows

Question 29

Gearing

Answer 29

Some investment trusts are
described as being ‘highly geared’ or
‘highly leveraged’, which means they have a high level of borrowing relative
to the assets they hold; the investment trust will be pursuing high returns
but there is the risk of being unable to service interest and/or repayments on
borrowings.

Question 30

What is a split‑capital investment trust?

Answer 30

Sometimes known as split‑level trusts or simply as splits, split‑capital
investment trusts are fixed‑term investment trusts offering two or more
different types of share. The most common forms of share offered are:
„ income shares – these receive the whole of the income generated by the
portfolio but no capital growth;
„ capital shares – these receive no income but, when the trust is wound up at
the end of the fixed term, share all the capital growth remaining after fixed
capital requirements have been met

Question 31

What is a real estate investment trust?

Answer 31

Real estate investment trusts (REITs) are tax‑efficient property investment
vehicles that allow private investors to invest in property while avoiding
many of the disadvantages of direct property investment (see Topic 7). One
particular advantage is that stamp duty reserve tax is charged at 0.5 per cent
on purchase; the rates of stamp duty for direct property purchase are much
higher.
REITs (pronounced “reets” to avoid confusion with rights) became available

In the UK, REITs pay no corporation tax on income or growth for the property
rental portion of their income,

Question 32

What is an OEIC?

Answer 32

An OEIC is an ‘open‑ended investment company’ – a limited liability company
that pools the funds of its investors to buy and sell the shares of other
companies and deal in other investments.

Question 33

OEIC

Answer 33

To invest in an OEIC, the investor buys shares in the company; there is no limit
to the number of shares that can be issued, which is why it is described as
‘open‑ended’. The open‑ended nature of an OEIC means that the fund can expand
or contract, depending on whether new shares are being issued in response to
demand, or being redeemed if investors wish to sell. The value of the shares
varies according to the market value of the company’s underlying investments

Question 34

Unit trusts, investment trusts and open‑ended investment
companies are most suitable for which profile of investor?
a) A long‑term investor who would like reasonably easy access to
their funds.
b) A long‑term investor who is happy to give notice to withdraw
funds.
c) A low‑risk investor who requires a guaranteed income.
d) A high‑risk investor who likes to play the stock marke

Answer 34

he correct answer is a). Answer
b) is incorrect because there is no
requirement to give notice to withdraw money from unit trusts, investments
or OEICS. Answer c) is incorrect because, although collective investments
offer reduced risk, they cannot be considered ‘low risk’. They are ‘medium
risk’. Answer d) is incorrect because investors who like to ‘play the stock
market’ will usually buy and sell shares directly in their own name

Question 35

Endowments

Answer 35

Endowments are a type of investment based on life assurance. They combine
life assurance and regular savings. A lump sum is either paid if the life assured
dies during the term or, if they survive to the end of the term, it is paid at
maturity

Question 36

Friendly society plans

Answer 36

Friendly societies date from the eighteenth century when they were established
as mutual self‑help organisations. Over time they have evolved, with many
now offering a range of financial services.
A friendly society is able to market a tax‑exempt savings plan, effectively an
endowment with tax benefits, because the friendly society pays no tax on its
investment returns. This can be compared with a conventional endowment on
which the life assurance company would pay tax on some income and gains
within the fund.
As there is preferential tax treatment, the amount that can be saved is limited
to £270 per year (as a lump sum),£25 per month or £75 per quarter. The plan
is set up over an initial ten‑year term and there is no tax upon encashment.
Friendly society plans are often marketed as savings plans that enable parents
and grandparents to save on behalf of their children and grandchildren.

Question 37

Investment bonds

Answer 37

Investment bonds are collective investment vehicles based on unitised funds;
although they often appear similar to unit trusts because of their unitised
structure, they are actually very different.
Investment bonds are available from life assurance companies and are set up
as single‑premium, whole‑of‑life assurance policies. An individual who wants
to invest does so by paying a single (lump sum) premium to the life company

Question 38

QUALIFYING AND NON‑QUALIFYING LIFE POLICIES

Answer 38

Life assurance policies are designated as ‘qualifying’ or
‘non‑qualifying’ policies for tax purposes. The benefit of
a qualifying policy is that there is no tax liability on the
proceeds of the plan on death or maturity; a non‑qualifying
plan may result in a tax liability for higher‑ and additional‑rate
taxpayers

Question 39

Non‑mainstream pooled investments

Answer 39

Collective investment schemes may only be sold to the general public in the UK
if they adhere to regulations relating to investment and promotion set out in
the FCA Handbook

Question 40

With regard to unit trusts, what does the term ‘open‑ended’ mean?
a) Clients can buy more units.
b) The fund manager can create an unlimited amount of units
according to demand.
c) The fund manager does not need to value the units.
d) There is flexibility in the taxation of units

Answer 40

b) The fund manager can create an unlimited amount of units according
to demand.

Question 41

A unit trust fund’s assets are owned and controlled by the
fund manager. True or false?

Answer 41

False. They are owned and controlled by the trustees

Question 42

Who is responsible for payment of capital gains tax on any
gain realised on the encashment of a unit trust?
a) The unit holder.
b) The trustees.
c) The unit trust company.
d) The fund manager

Answer 42

a) The unit holder

Question 43

An investment trust is best described as:
a) a unit‑linked, single‑premium whole‑of‑life policy investing
solely in shares.
b) a trust that invests solely in fledgling companies.
c) a company that invests in the shares of other companies.
d) a partnership that invests in gilts

Answer 43

c) A company that invests in the shares of other companies.

Question 44

How can a private individual invest in an investment trust?
a) The investment trust manager creates more units.
b) By purchasing shares of the investment trust company on
the stock exchange.
c) The fund manager issues new sharesBy completing an application form for a share account and
submitting it to the investment trust trustees.

Answer 44

b) By purchasing shares of the investment trust company on the stock
exchange

Question 45

What potential benefit does gearing offer to an investment
trust that is not available to a unit trust or OEIC?

Answer 45

An investment trust can borrow in order to take advantage of investment
opportunities. Unit trusts and OEICs cannot do this

Question 46

How are shares in an open‑ended investment company priced?
a) There is a bid and offer price based on the underlying value
of the shares.
b) Shares are based on a historic valuation.
c) There is one price, based on the value of the assets divided
by the number of shares.
d) There is a cancellation price at which all shares are traded.

Answer 46

c) There is one price, based on the value of the assets divided by the
number of shares

Question 47

What rate of tax is deemed to have been deducted from the
investment fund underlying an investment bond?
a) 0 per cent.
b) 10 per cent.
c) 20 per cent.
d) 40 per cent.

Answer 47

c) 20 per cent is deemed to have been taken within the investment with a
potential further liability of 20 per cent for higher‑rate taxpayers or 25
per cent for additional‑rate taxpayers.

Question 48

Investment bonds are attractive to investors because
withdrawals are tax‑free. True or false?

Answer 48

False. The investor may withdraw up to 5 per cent of the value of the original
investment per annum without paying tax at the time of withdrawal but a
tax liability may arise when the bond matures, on encashment of the bond
or on death of the bondholder

Question 49

Noah is a higher‑rate taxpayer and is considering a range of
investments. He wants to know which investment, out of unit
trusts, investment trusts or OEICS, would be most likely to
help him meet his objective of achieving capital growth. What
would you advise?
a) A unit trust.
b) An investment trust.
c) An OEIC.
d) Any of the above

Answer 49

d) Noah could choose any of the above. The fact that he is a higher‑rate
taxpayer has no bearing on his decision – they are all taxed in the same
way

Question 50

Understanding

Answer 50

A unit trust is constituted as a trust; an investment trust is actually a
company.
 A unit trust is subject to FCA rules on diversification; an investment
trust is not.
 A unit trust issues units to customers and these represent the customers’
holdings of the assets in the pooled fund. An investment trust issues
shares in a fund.
 Units must be bought back by the fund manager so no secondary
market is needed; shares in an investment trust must generally be sold
via a stockbroker

Question 51

Understanding

Answer 51

An investment trust can borrow funds to take advantage of investment
opportunities whereas a unit trust cannot.
 Unit trusts are open‑ended (ie the unit trust manager can create more
units to meet demand); an investment trust is closed‑ended (ie the
number of shares available is fixed).
 A unit trust can be established as an equity trust paying dividends
or a fixed‑interest trust paying interest. As an investment trust is a
company, it only issues shares and pays income as dividends

Question 52

Which function is responsible for overseeing the operation of an open-ended investment company and safeguarding investor interests?

Question 1 options:

a)

The authorised corporate director.

b)

The trustee.

c)

The manager.

d)

The depositary.

Answer 52

d)

The depositary.

Question 53

What percentage of a unit trust’s fund must be in cash or fixed-interest investments for distributions to be treated as interest payments?

Question 2 options:

a)

At least 50%.

b)

Up to 60%.

c)

More than 60%.

d)

At least 75%.

Answer 53

c)

More than 60%.

Question 54

The aim of investment diversification is to:

Question 3 options:

a)

increase investment performance.

b)

increase income from investments.

c)

reduce investment administration and documentation.

d)

reduce investment risk.

Answer 54

d)

reduce investment risk.

Question 55

Which of the following is true in relation to unit trusts?

Question 4 options:

a)

The trustee decides on appropriate investments for the trust.

b)

Distribution unit trusts pay regular capital amounts to investors from profits.

c)

The manager can create units to meet demand.

d)

The manager is responsible for holding and controlling the fund’s assets.

Answer 55

c)

The manager can create units to meet demand.

Question 56

Which of the following is true in relation to real estate investment trusts?

Question 5 options:

a)

At least 80% of the profit must result from property rentals.

b)

At least 90% of profits must be distributed to shareholders.

c)

They cannot be held in an ISA.

d)

Corporation tax is payable on profits from property rentals.

Answer 56

b)

At least 90% of profits must be distributed to shareholders.

Question 57

Alan has an investment that guarantees a specific return over a five-year period, but some of his initial capital could be lost if the FTSE 100 fails to achieve a certain level by the end of the term. His investment is a:

Question 6 options:

a)

structured deposit.

b)

structured derivative product.

c)

structured capital‑at‑risk product.

d)

non-structured capital‑at‑risk product.

Answer 57

c)

structured capital‑at‑risk product.

Question 58

A friendly society tax-exempt savings plan:

Question 7 options:

a)

offers similar taxation benefits to endowment policies.

b)

has a maximum annual savings limit of £270.

c)

is offered by proprietary organisations.

d)

has a term between 10 and 25 years.

Answer 58

b)

has a maximum annual savings limit of £270.

Question 59

Which of the following is false in relation to qualifying life assurance policies?

Question 8 options:

a)

Premiums cannot vary beyond specified limits.

b)

They must have a minimum term of 10 years.

c)

Premiums must be payable at least annually.

d)

The death benefit must be at least 101% of the bid value of the policy.

Answer 59

d)

The death benefit must be at least 101% of the bid value of the policy.

Question 60

In relation to investment trusts, which of the following is true?

Question 9 options:

a)

The net asset value is the price shares are trading at.

b)

The trust can borrow for investment purposes.

c)

Shares trading at a premium can be bought at below their net asset value.

d)

The trust deed outlines the trust’s investment objectives.

Answer 60

b)

The trust can borrow for investment purposes.

Question 61

Jason wishes to cash in his unit trust holding. Which unit price will he receive in normal market conditions?

Question 10 options:

a)

Creation price.

b)

Bid price.

c)

Cancellation price.

d)

Offer price.

Answer 61

b)

Bid price.