Topic 9 - Performance, Risk Profile and Correlation of investment types in a portfolio

Question 1

What are the three risks of holding equities?

Answer 1

Price Risk - Share price may fall

Liquidity Risk - May be difficult to sell at convenient time to investor.

Issuer Risk - Issuing company of equity goes bankrupt so asset beocmes worthless.

Question 2

What additional risk is involved in derviatives that isn’t with some other investment types?

Answer 2

Counterparty Risk

The risk to each party of the contract that the other party (the counterparty) will not live up to their contractual obligations. This is also known as ‘default risk’.

Question 3

In Foreign Exchange markets, what is the difference between Spot & Forward Rates?

Answer 3

Spot transactions - Immediate currency deals and are settled within two working days (T+2, ie two business days after the trade date).

Forward transactions - involve forex deals that are agreed for any future date at a rate of exchange fixed now. This can be hugely beneficial for businesses to plan their cash flows with certainty.

Question 4

What are the two types of hedge fund investments available and who are they designed for?

Answer 4

Absolute Return Funds - Aims to minimise risk with stedy returns. Suitable for more conservative investor .

Directional Funds - Maximise returns by exploiting market movements. Suitable for more aggressive investor.

Question 5

What are risks associated for advisers using Platforms?

Answer 5

• Unneccessary high platform costs for same level of service offered at lower cost.
• Model portfolios as default position and failing to bespoke to individual clients.
• Failing to consider costs and performance when transferring
• Services of platform not being provided
• Adviser not using platofrm to client’s best advantage

Question 6

What are Penny Shares?

Answer 6

Penny Share

Low value share with speculative appeal and high risk strategy with high potential for reward. They are shares in developing companies such as AIM.

Question 7

What are Contracts for Difference?

Answer 7

Instrument linked to market instrument such as share price. Provides access to markets and instruments otherwise inaccessible for example if the share price was too high for their capital.

For experienced and professional investors as high risk with high reward. Due to leveraged trading - position being opened with an initial margin of total value such as 5%. As such can lose more than their initial deposit.

Question 8

What are EIS and what are the pros and cons?

Answer 8

• EIS & VCT offer big tax breaks
• Should still be suitable outside tax breaks
• Invests in unquotes companies or EIS fund
• SEISs offer greater tax advantages geared towards riiskier start up companies.
• High risk with potential for large gains & losses.
• Can be illiquid so long time frame needed

Question 9

What are VCTs and what are some of the key features, pros and cons?

Answer 9

• Pooled investment so some diversification against EIS
• Unlike EISs, VCTs are listed on stock exchange
• Some reduce risk by investing in compaines with relatively low gearing or through convertible loan instruments rather than shares.
• No tax relief on second hand VCTs so can be illiquid
• High risk with potential for high gains & losses

Question 10

What are the key difference between EISs and VCTs?

Answer 10

Min Investment - EIS £1m - VCT £200k

Tax Relief - 30% for both

Holding Period - EIS 3 Yr - VCT 5 Yr

Dividends - EIS Taxed - VCT Not Taxed

CGT - EIS Exempt after 3 Yrs - VCT Exempt

IHT - EIS Exempt after 2 Yrs - VCT - Not Exempt