Unit 2 - Extra Flashcards
Which of the following would account for UK government debt being considered risk free?
A The Bank of England is a reputable body B The UK is part of NATO C The UK itself controls the printing of money D The UK has an established Keynesian economic policy
The correct answer is: C - The UK itself controls the printing of money
Explanation
The yield available on UK gilts is considered the risk-free rate for sterling-denominated bonds - after all, it is the UK government that ultimately controls the printing of sterling, so the UK gilts are effectively credit risk-free.
What is a key benefit of using an Inter-Dealer Broker (IDB)?
A Liquidity B Anonymity C Tighter dealing spreads D Creates larger Normal Market Sizes
B - Anonymity
Explanation
An IDB allows market makers to trade with each other without revealing their identity.
Why would an underwriting firm performing an offer for sale decide to use a fixed price rather than a tender?
A To ensure that the issue is fully subscribed B To allow investors to set the price C To provide more efficient form of pricing D To ensure everyone pays the same price
To ensure that the issue is fully subscribed
Explanation
When a fixed-price offer is made, the price is usually fixed just below that at which it is believed the issue should be fully subscribed, so as to encourage an active secondary market in the shares. A tender offer is a more efficient method of pricing, allowing investors to set the price through a bidding process. Both issues allow the investors to pay the same price.
What BEST describes the settlement process of UK government debt held within CREST?
A
Settlement would take place on the bargain date
B
Settlement would take place the day after the bargain
C
Settlement would take place during the third day after the bargain has been agreed
D
Settlement would take place 10 days after the bargain date
Settlement would take place the day after the bargain
Explanation
Here bargain simply means trade and is only used to confuse. Dematerialised gilts (held in CREST) settle T+1.
Which ONE of the following is a criteria for entry on to a junior market of the exchange?
A Minimum trading history B All shares in public hands C All shares freely-transferable D Nominated broker or adviser required, but not both
All shares freely-transferable
Explanation
The entry requirements for AIM are much lighter than for the official list.
When a company announces its intention to pay a specified dividend on a specified future date this is called the dividend declared date. What is the minimum number of business days between the declaration and the proposed record date?
A 1 B 2 C 6 D 10
6
Explanation
The declaration must occur at least six clear business days before the proposed record date, although it usually occurs well before this date (perhaps a month or two earlier).
A UK government bond sale takes place 2 days before the ‘coupon paid date’. The trade is known as:
A Ex-coupon B Special ex-coupon C Cum-interest D Cum-coupon
Ex-coupon
Explanation
The gilt was bought during the 7-day ‘ex-coupon’ period. The buyer would therefore not be entitled to receive any of the coupon.
ADR dividends are paid to the holder in:
A US dollars B the domestic currency of the sponsor company C either Euros or US dollars as specified by the prospectus D the home currency of the depositary bank
US dollars
Explanation
When the company pays a dividend, it is paid in the company’s domestic currency to the bank, which then converts the dividend into dollars and passes it on to the DR holders. The US investors therefore need not concern themselves with currency movements. Furthermore, when a DR holder decides to sell, the DRs will be sold on in dollars. This removal of the need for any currency transactions for the US investor is a key attraction of the DR.
Which of the following is the lowest form of debt?
A Floater B Asset back security C PIK D Subordinated debt
PIK
Explanation
Payment in kind (PIK) if it exists will be even more risky than the subordinated debt. It will rank below other forms of debt but above the equity in a liquidation.
An investor has placed their money into an infrequent actively managed account. Which of the following is most likely?
A
In the long run the investor could see enhanced returns to the benchmark
B
The manager will be using strategies like optimisation to enhance returns
C
The beta will allow the investor to determine the performance of the manager
D
They would be subject to much higher charges than a passive fund
The correct answer is: A - In the long run the investor could see enhanced returns to the benchmark
Explanation
Active fund management strategies will try to achieve the goal of outperforming a designated benchmark. Those that involve frequent trading generate higher transaction costs which diminish the fund’s return. With an infrequently managed account, this will be less of an impact.
A company wishes to raise capital cheaply. From the company’s point of view, which of the following would be seen as the BEST advantage of issuing warrants?
A
It helps raise the company’s profile as it indicates future financial stability
B
To delay the payment of dividends until some time in the future
C
To make a floating charge over assets more attractive to investors
D
To improve the earnings per share
The correct answer is: B - To delay the payment of dividends until some time in the future
Explanation
The sale of warrants for cash will raise money for the company, and, if the warrants are exercised, further capital will be raised by the company. Holding the warrant does not entitle the investor to receive dividends or to vote at company meetings, so the capital raised, until the warrant is exercised, could be considered as free.
Which of the following is not a consideration in order priority for execution on an exchange order driven system?
A Volume B Price C Date D Time
Volume
Explanation
The order priority is by price and then time (date is also captured under time for orders that are instructed to remain on the system after close of day). Volume is not considered for order priority.
Which of the following ratios would allow an investor to determine the income returned from equity over the current share price?
A Dividend yield B Return on capital employed C Asset turnover D Dividend cover
Dividend yield
Explanation
The dividend yield expresses the total dividends per share paid out over the last year as a percentage of the current share price.
In terms of the degree of risk, where does mezzanine debt rank in the order of payment should a company be in liquidation?
A
Between preferential creditors and floating charge holders
B
Between floating charge holders and subordinated debt
C
Between subordinated debt and preference shareholders
D
Between preference shareholders and deferred shareholders
Between subordinated debt and preference shareholders
Explanation
Mezzanine debt ranks just below subordinated debt in the order of payment for a company in liquidation.
A prime broker provides a number of services for institutional investors, what would be the purpose of stock lending and borrowing?
A Cash management B Liquidity C Securities purchased become property of the fund D Reduction of costs
Liquidity
Explanation
If an institutional investor wishes to take advantage of pricing variations but does not have the stock then they can borrow it and return it at a later date.
Why would an investor want to deal special-ex?
A To avoid Capital gains tax. B To reduce regulatory reporting requirements C To receive a dividend that they would otherwise be not entitled to D For tax planning purposes
For tax planning purposes
Explanation
By dealing special ex the investor does not receive the dividend they are entitled to this may reduce income but not capital gains tax.
A Global custodian finds itself in financial difficulty. What should it do to protect its client’s assets?
A
Continue as before segregating its clients’ assets in internal accounts
B
Ask client how to proceed with their assets and follow their instructions to move assets in accordance with the claimants’ wishes
C
Seek permission to legally segregate client assets depending on the outcome of the financial difficulties
D
Use the clients’ assets to provide a capital buffer against the firm’s financial difficulties
Continue as before segregating its clients’ assets in internal accounts
Explanation
If the custodian has properly segregated the assets, they are protected from the financial difficulties of the custodian. This is a fundamental obligation of custodians.
Which of the following would explain why a company would buy shares in another company to forge a strategic link?
A To expand the company B Shared corporate ethos C Protect supplies D To benefit from dividend income
Protect supplies
Explanation
Strategic stakes may be accumulated in order to prevent a company being taken over by a competitor and to influence the company concerned. This may be in order to protect supplies. The company may be a key supplier of raw materials to the strategic stakeholder, without which the strategic stakeholder may have difficulty obtaining the quantity and quality of raw materials it seeks.
An investor wishes to spend £15,000 on the purchase of Exchequer 8% 2028 priced at £96. What will be the nominal value of stock purchased?
A £16,350.00 B £15,625.00 C £15,000.00 D £14,400.00
£15,625.00
Explanation
To answer this question we need to work out the nominal value from the market price or consideration paid.
To calculate the market price we use the following formula:
Market price = Nominal value x (Price/£100n.v.)
So to get the nominal value, we use the following formula:
Market price or price paid / (Price/£100n.v.)
£15,000 / 96 x 100 = £15,625.
Which of the following would not be found on the statement of financial position under intangible non-current assets?
A Goodwill B Capitalised development costs C Work in progress D Patents
Work in progress
Explanation
Work in progress will be shown as a current asset.
Participants in a dark pool are MOST LIKELY to have chosen this type of execution venue because of:
A Lack of pre-trade transparency B Ability to execute trades at efficient prices C Ability to hide the dealer's identity D Lower costs
Ability to execute trades at efficient prices
Explanation
Dark pools offer institutions a facility to deal large blocks of shares anonymously, typically using algorithm driven trading. The size of these orders would make it very difficult to achieve efficient pricing on more traditional venues but the dark pool allows them to do so. Although anonymity is an advantage, this is also available on many other systems, including exchanges.
In normal market conditions which of the following statements about interest rates and inflation is most likely?
A
Inflation would be expected to be higher than interest rates
B
Inflation would be expected to be the same as interest rates
C
Inflation would be expected to be lower than interest rates
D
Inflation and interest rates are not linked together
Inflation would be expected to be lower than interest rates
Explanation
The interest rate itself is heavily impacted by inflationary expectations. Simplistically, if inflation is expected to be at 4% per annum, the interest rate will have to be greater than this in order to provide the investor with any real return.
Which of the following is not associated with order-driven trading systems?
A Orders are displayed by priority of price and time B Trade anonymity C Firm quotes during the MQP D Automatic execution of trades
Firm quotes during the MQP
Explanation
Market makers have to provide quotes during the mandatory quote period on quote-driven systems, such as SEAQ.
Why would a lead manager be LEAST likely to go through a syndication process and, instead, take responsibility for the entire process themselves?
A It is a bought deal B It is a fixed price re-offer C There is a back stop price D It is a placing
It is a placing
Explanation
A placing is where a company simply markets the issue directly to a broker, an issuing house or other financial institution, which in turn places the shares with selected clients. A bought deal is a fully underwritten issue and the lead manager would often enlist the help of a syndicate to do this this. The back-stop price is limit placed on the members of a syndicate limiting the price at which the shares can be sold. Whilst a Fixed Price Re-offer is NOT on the current syllabus, it is synonymous with syndication.
A Depositary Receipt may be pre-released however the issuer must deliver the underlying shares for deposit within:
A One month B Three months C Six months D Nine months
Three months
Explanation
The issuer of DRs must deliver the underlying shares within three in order to satisfy the rules of the pre-release issue. During the pre-release period the position must be collateralised with cash.
A company announces an increase in the dividend that it will pay out to shareholders in response to continued profit growth. Assuming all of the following securities are in issue, which of the following is most likely to benefit from this increase in income?
A Depositary receipt holder B Equity warrant holder C Cumulative preference shareholder D Floating rate bond
Depositary receipt holder
Explanation
A depositary receipt is a certificate that represents ordinary shares in a company. The benefit of a higher dividend will be passed on to them. Warrants do not pay dividends and cumulative preference shares pay a fixed dividend. Floating rate bond are debt instruments and receive their payment irrespective of profits (unless default occurs).
Which of the following is the best definition of a bond ‘on the run’?
A
One that trades in an unpopular sector of the market
B
A bond that has suffered a series of downgrades and is heading for default
C
One that is popular with investors due to an unexpectedly positive forecast
D
The most recently issued Treasury bond
The most recently issued Treasury bond
Explanation
On the run bonds refer to those that are most recently issued by the issuer. Those previously issued are often referred to as off the run bonds.
‘Over the counter’ (OTC) markets in recent times seem to be converging with exchange traded markets, which of the following is the most likely explanation?
A Greater demand for OTC products B Electronic trading C Regulatory changes D Straight through processing
Regulatory changes
Explanation
This is not specifically mentioned in the manual, so perhaps a trial question, however regulatory requirements in the OTC market are bringing them very much in line with exchange traded markets.
If an investor has diversified their risk exposure by asset class, they have:
A entered into derivative positions B increased the number and range of their holdings C increased their specific risk exposure D eliminated systematic risk
The correct answer is: B - increased the number and range of their holdings
Explanation Diversification by asset class is achieved by holding a combination of different kinds of asset within a portfolio, possibly spread across cash, fixed-interest securities, equity investments, property-based investments, and other assets.
If an investor is interested in dark liquidity on the London Stock Exchange, on which platform would they be looking to trade?
A Order driven B Quote driven C Hybrid system D Voice broking systems
Order driven
Explanation
Dark pools refer to the non-displayed or hidden nature of the buy and sell orders that reside in a crossing platform. The term dark liquidity can also be applied to all forms of non-displayed liquidity such as the order blotters of buy-side dealing desks.
Even though there are few organised dark pools within Europe, there is dark liquidity. Dark liquidity is provided when exchanges offer iceberg orders which enable traders to have a lot more available to trade than is currently displayed on the screen or in an order book at any moment in time. The biggest sources of dark liquidity are within the investment banks and major brokers.
A broker holds the shares of a client in a pooled nominee account. Which of the following would be true?
A
The shares will be registered in the broker’s name
B
The shares will be pooled with the firm’s shares
C
The issuer of the shares will pay any dividends to the client
D
The client is entitled to receive the benefits of ownership
The client is entitled to receive the benefits of ownership
Explanation
The share will not be registered in the broker’s name, but a nominee name. Although the account is referred to as a pooled account, this does not mean that the shares are pooled with those of the firm; instead it means that the shares will be pooled with those of other clients. The issuer will pay any dividends to the broker, as it will not know who the underlying client is. However, the client is entitled to any benefits.
Which of the following would be considered an advantage, for the nominee, of individual registration within designated nominee accounts?
A
There are fewer additional costs for the custodian
B
It helps with aspects of auditing and good control mechanisms, where identical trades are executed for different clients
C
Where a company offers extra incentives these can always be received by the beneficiary
D
It will not give rise to additional transactional costs imposed by the custodian for pooled accounts
It helps with aspects of auditing and good control mechanisms, where identical trades are executed for different clients
Explanation
Designation or individual registration can help some aspects of auditing and it affords a good control mechanism where identical trades may have been executed for different clients (for example on the same date, for the same number of shares and for the same settlement consideration).
The price of shares in Firm A change relative to those in Firm B. What risk would this represent?
A Market Risk B Systematic Risk C Specific Risk D Non-systemic Risk
Specific Risk
Explanation
Specific risk relates directly to the price movement of a single share.
Debt with a high interest cover will subsequently affect:
A The ability to meet liabilities should they fall due B Market valuation C Securitisation D Growth prospects
Market valuation
Explanation
Interest cover is used to determine how easily a company can pay interest on its outstanding debt. Similar to dividend cover a ratio of lower than 1 means that the company is not generating sufficient revenues to satisfy its interest expense, therefore a measure of risk. The greater the risk, the higher the yield the cheaper the price and visa versa.
A bond with a 2-10 year maturity is created from securitised public sector loans and mortgages, where the investor has recourse against the issuer should default occur. The assets backing the bond remain on the issuer’s consolidated statement of financial position (balance sheet). This would BEST describe which of the following bonds?
A Medium term note B Asset backed security C Covered bond D Guaranteed bond
Covered bond
Explanation
In instances when no SPV is created, the asset-backed bonds are simply referred to as ‘covered bonds’, referring to the pool of assets that provide the ‘cover’ to the bondholder. So, with covered bonds, the assets are retained on the statement of financial position of the issuing entity, such as a bank, rather than transferred to an SPV.
What is the repo rate?
A
The implied interest paid for borrowing securities
B
The implied interest paid for borrowing gilts
C
The implied interest paid for borrowing money
D
The implied interest paid for lending stock
The implied interest paid for borrowing money
Explanation
A repo is an alternative way to borrow money. As.repos settle T+0 they are a means of raising quick cash.
At what percentage of share ownership would an investor be forced to make a mandatory bid?
A 10% B 20% C 30% D 50%
30%
Explanation
If a predator acquires influence over 30% or more of voting rights of a company, it must make an offer for all the remaining shares of the company.
