Unit 1 - Topic 6 Direct Investments: Cash and fixed-interest securities

Question 1

What are the main financial asset classes?

Answer 1

1) Cash (ie money held in deposit accounts)
2) Fixed Interest securities (eg gilts, corporate bonds)
3) Equities (company shares)
4) Property (eg buy-to-let)
(5) Alternative investments (fine wine, antiques, works of art)

Question 2

What is capital?

Answer 2

In the case of a savings account, capital is the cash that is deposited. It differs from ‘money’ in the sense that is is being used to generate wealth rather to purchase goods and services.

Question 3

Why do investors place money in deposit-based savings accounts?

Answer 3

1) Security of capital - investors do not want to put their capital at risk (however inflation can reduce the value of capital, as can the institution becoming insolvent)
2) Convenience - banks and building societies are readily accessible

Question 4

What is a traditional current account?

Answer 4

A transactional account where an individual can have their salary or wages paid. There are also a range of ways that money can be drawn or used to pay regular bills. Overdrafts are possible.

Question 5

What is a basic bank account?

Answer 5

A simplified current account. Aimed at people (typically those on low income or receiving state benefits) who might not otherwise be able to open a current account. Methods of withdrawing are limited and there is no overdraft facility.

Question 6

What is an interest-bearing current account?

Answer 6

Accounts that provide investors with instant access to their funds without loss of interest. They work in the same way as a standard current account.

Question 7

What is a packaged current account?

Answer 7

Offers the holder a range of ancillary benefits such as breakdown cover, mobile phone insurance and travel insurance in return for a monthly or annual fee.

Question 8

What is an instant-access savings account?

Answer 8

Where an account holder can have instant access to their savings. The interest paid is comparatively low and interest rates are usually variable.

Question 9

What are restricted access accounts?

Answer 9

An account where interest rates are usually higher because the provider has certainty that funds are available to them for a longer period. Access may be restricted by:

• limiting the number of withdrawals that can be made each calendar year
• requiring minimum period of notice before funds can be drawn (notice account)
• specifying an agreed period during which the saver may not access their money (a term account)

Question 10

What is depositor protection?

Answer 10

Savings in bank and building society accounts are protected by the Financial Services Compensation Scheme (FSCS) up to a level of £85,000 per investor per financial services provider.

Question 11

What is National Savings and Investments?

Answer 11

NS&I offers a range of savings and investment products backed by the government. The risk associated with the products is low because the government guarantees the return of capital invested.

Question 12

What is a cash ISA?

Answer 12

An individual savings account. They are tax-free and can take many forms

Question 13

What are offshore accounts?

Answer 13

A bank/building society account or other form of investment, which is based outside the UK in a country that offers a more advantageous taxation of investments.

Question 14

What risks are involved to investors in regards to offshore investments?

Answer 14

1) if an investment is made and needs to be converted back to sterling, its value might be affected by unfavourable exchange rates
2) Not all offshore accounts are protected by investor protection schemes

Question 15

Why might offshore investing be useful to an investor?

Answer 15

An investor might need money to be available outside of the UK, for example someone who owns a property abroad or plans to move abroad.

Question 16

Do you have to pay tax on offshore investment gains?

Answer 16

Yes, the interest on an offshore deposit is paid gross. A UK resident must declare the income to HMRC and may have to pay tax on it. If the country has a reciprocal tax treaty with the UK, tax relief may be available for any taxes already paid in the other country.

Question 17

What are gilts?

Answer 17

A gilt is a fixed-interest security’. Their full name being ‘gilt-edged securities’. They are a form of borrowing by the UK government.

Question 18

What does redemption rate mean?

Answer 18

The date on which the government must redeem the gilt by paying back its original issue value or par value, normally quoted as a nominal £100.

Question 19

What is a coupon?

Answer 19

The interest rate payable on the pay value of a gilt. It is a fixed rate, paid half-yearly, gross but taxable.

Question 20

According to the UK Debt Management Office, what is a ‘short-dated gilt’?

Answer 20

A gilt with a redemption date within 7 years

Question 21

What are the typical categories of gilts as used in the financial press?

Answer 21

Short-dated gilts/shorts - Less than 5 years to run to redemption

Medium-dated gilts/mediums - 5-15 years to run to redemption

Long-dated gilts/longs - more than 15 years to redemption

Question 22

Once a gilt has been issued, it cannot be redeemed prior to the redemption rate. It can however be sold to other investors. What factors affect the price at which they are sold?

Answer 22

1) the level of market rates of interest
2) the amount of time left to the redemption date
3) supply and demand

Question 23

Explain the difference between ‘cum-dividend’ and ‘ex-dividend’

Answer 23

Cum-dividend - the buyer acquires the stock itself and the entitlement to the next interest payment.
Ex-dividend - while the buyer still acquires the stock, the forthcoming interest payment will be payable to the previous owner of the stock (the seller)

Question 24

Do you pay tax on interest from gilts?

Answer 24

Yes, interest is paid gross but is taxable. Investors can however elect for net payment. The interest is taxed in line with normal savings income, outside of starting rate banks and savings allowance at a rate dependent on the income band that their gross income falls/

Question 25

Do you pay CGT on capital gains made from selling or redeeming a gilt?

Answer 25

no, capital gains made on the sale or redemption of a gilt is entirely free of capital gains tax.

Question 26

How does a rising interest rate affect gilt yields?

Answer 26

A rising interest rate would result in the bond prices to fall, and the bond yield to increase

Question 27

How does a falling interest rate affect gilt-yields?

Answer 27

A falling interest rate would cause the bond price to increase, and bond yields to decrease

Question 28

What is a local authority bond?

Answer 28

Whereby local authorities borrow money by issuing stocks or bonds, which are fixed-term, fixed-interest securities. Return of capital on maturity is promised, but this is not quite as secure as gilts as there is no government guarentee.

Question 29

What are permanent interest-bearing shares?

Answer 29

PIBS are issued by building societies to raise capital. They pay a fixed rate of interest on a half-yearly basis.

Question 30

What is a corporate bond?

Answer 30

A company might issue corporate bonds to meet its long-term financial needs. They are similar to gilts - it has a redemption date and a promise to pay a fixed rate of interest until redemption.

Question 31

What is a debenture?

Answer 31

A bond (corporate) that is backed by security.

Question 32

What is a loan stock?

Answer 32

A bond (corporate) that is not backed by security.

Question 33

Which is riskier, corporate bonds or gilts?

Answer 33

Corporate bonds because there is no government guarantee. Corporate bonds risks are associated with the viability of the issuing company, its prospects and financial strength.

Question 34

What is a Eurobond?

Answer 34

A bond issued or traded in a country that uses a currency other than the one in which the bond is denominated. The bond operates outside the jurisdiction of the central bank that issues that currency.

Question 35

What is a structured deposit?

Answer 35

Structured deposits are similar to fixed term deposit accounts, in that they have a fixed term and they are a deposit with a bank. However, structured deposits sacrifice guaranteed interest payments for higher interest payments that are conditional on the performance of a stock market index

Question 36

What is ‘alternative finance’?

Answer 36

Also known as ‘peer-to-peer’ lending. Involves a saver placing their money with a P2P lender who will then lend the money out to businesses that are seeking funding.
There is risk involved and P2P lenders are not covered by the Financial Services Compensation Scheme.