Types Of Investments

Question 1

What is a real asset?

Answer 1

It’s a physical asset such as land, buildings, gold that has value

Question 2

What is a financial asset?

Answer 2

These are claims representing the right to some return such as a bank deposit or a bond or to ownership of physical assets

Question 3

What are the two different types of financial assets?

Answer 3

1. Debt claims
2. Equity Securities

Question 4

Debt claim is a type of financial asset. Define debt claim

Answer 4

1. Loans made by lenders to borrowers
2. Lenders expect borrowers to repay the loan and to make interest payments until it’s repaid
3. Most debt claims are tradable e.g bond (except bank deposits)

Question 5

What is a tradable claim with regards with debt claims?

Answer 5

1. Tradable claim is also referred to as a security
2. Bonds are issues by the government and companies and generally pay a fixed rate of interest
3. Due to this, they’re referred to as fixed-income securities

Question 6

Bonds vs shares

Answer 6

Bonds are FI securities

Shares are equity securities

Both bonds and shares are tradable securities

Question 7

Equity securities is a type of financial asset. Define equity securities

Answer 7

1. Equity securities are also known as shares
2. These are tradable securities
3. Shareholders have ownership of these shares in the company they invested in
4. Company has no obligation to repay the money invested by shareholders or make regular payments
5. Investors/ shareholders who buy shares are expected to sell them at a higher price than what it was bought at to make a return

Question 8

What are the advantages of indirect investments made by savers through intermediaries such as: insurance companies, pension funds and pooled investment vehicles?

Answer 8

Overall reduction in risk due to:

1. Greater diversification
2. Reduced transaction costs as the intermediary can trade at a lower cost than the individual saver
3. Access to specialist expertise in the financial assets being invested in
4. Ability to invest in assets that would not be available to an individual investor e.g. commercial property

Question 9

What is a unit trust?

Answer 9

1. Specialises in UK equities and this is an example of a pooled investment vehicle
2. They are open-ended I.e new and existing investors can invest or withdraw whenever they need

Question 10

What are the three parties to a unit trust?

Answer 10

1. Manager - operates the trust fund, responsible for investing cash contributions from the investor
2. The trustee - trusted with the custody of the investments held within the trust on behalf of the unit holders. MUST BE UNCONNECTED TO THE MANAGER
3. Unit holders - trusted beneficiaries

Question 11

What is the main role of a trustee in a unit trust?

Answer 11

To ensure that the fund manager runs the trust following the fund’s investment goals and objectives

Question 12

What is a derivative?

Answer 12

A financial contract “derived” from an underlying asset in such a way that the price movements of the derivative and the underlying asset will be highly correlated over time.

Question 13

What are derivative contracts used for? (2 uses)

Answer 13

1. To make gains from anticipated movements in price of an index/ asset
2. If the underlying asset is difficult to buy or has high costs associated with investing, purchasing a derivative contract is less costly e.g. for oil

Question 14

Explain foreign exchange market transactions

Answer 14

1. When a UK based fund manager wants to purchase US securities
2. They would need to convert £ to $
3. Transaction will be carried out in the foreign exchange markets/ currency markets
4. Large value transactions - a dealer would quote bid/offer price to buy and sell dollars in relation to pounds
5. For small value transactions - a broken will arrange dollars to be purchased