Wrong Mock Exam 2 Questions

Question 1

Stanley identifies three investments with the following features:
Investment A: Direct investment in property Investment B: A long dated UK government gilt Investment C: Equity in a FTSE 100 index company
Which of the following, with regard to risk, is true?
AInvestment A has less inflation risk that investment B BInvestment B has more income risk that investment C CInvestment A has less liquidity risk than investment C DInvestment B has more issuer risk than investment C

Answer 1

The correct answer is: A - Investment A has less inflation risk that investment B
Explanation
Property is considered a real asset, and so suffers less from inflation risk than bonds. It is, however, quite illiquid.
Gilts are considered to be default risk free, so the income and the redemption is guaranteed by the UK government. This results in no income or issuer risk.
FTSE 100 index shares are quite liquid, and also give reasonable protection against inflation in the long run. Income is not, however, guaranteed and even these companies can become insolvent and go into liquidation.

Question 2

An investor wishes to directly hold a property through a trust. Which of the below investments will allow this?
AProperty investment trusts BProperty company shares CProperty unit trusts DProperty fund of funds

Answer 2

The correct answer is: C - Property unit trusts
Explanation
The investor has a direct interest in a property held in a property unit trust, so that would be the best answer here. Property investment trusts can not hold property directly. Property company shares are shares of property development companies. Property fund of funds is where a fund has invested in other property funds, so this would be indirect investment.

Question 3

Which of the following is likely to worsen the UK’s balance of trade deficit?
IA rise in interest rates
IIAn increase in capital investment in the UK from foreign investors
IIIA fall in the value of the pound
AI and II BI only CII only DI, II and III

Answer 3

The correct answer is: A - I and II
Explanation
An increase in interest rates may lead to increases in foreign investment in the UK which increases the demand for sterling, increasing the value of sterling, making UK exports more expensive for foreign buyers, reducing UK exports and worsening the UK balance of trade.
An increase in capital investment in the UK has the same effect, causing an increased demand for sterling, etc.
A fall in the value of the pound has the opposite effect. UK exports become relatively cheaper and so exports increase, so reducing the balance of trade deficit.

Question 4

Renuka wishes to buy 1,000 Topbrass plc shares at 300p each. She expects the price to increase to 500p, but decides that she will take the profit when the shares reach 450p. Renuka also decides to place a stop-loss order at 250p to protect against any unforeseen sudden drops in share price.
What is Renuka’s risk/reward ratio?
A0.25 B0.33 C3.00 D4.00

Answer 4

The correct answer is: B - 0.33
Explanation
The downside risk with the stop loss in place is 50p (300p – 250p). Therefore the risk is 50p.
For the reward, although the price is expected to increase by 200p to 500p, Renuka will take her profit at 450p, meaning the actual reward is 150p.
We are asked for the Risk/Reward ratio, which is 50/150 = 0.33 (Risk divided by Reward to find the ratio)

Question 5

An investment fund valued at £50 million is 75% invested in equity and 25% in bonds. The benchmark for the fund is based on a 50/50 allocation between equity and bonds.
After 6 months the investment fund is valued at £46.875 million, a fall of 6.25%. In the same period equities have produced a negative return of 10% and bonds a negative return of 5%.
Therefore, the investment fund has:
AGood stock selection, and good asset allocation BGood stock selection, but poor asset allocation CPoor stock selection, and poor asset allocation DPoor stock selection, but good asset allocation

Answer 5

The correct answer is: B - Good stock selection, but poor asset allocation
Explanation
Starting with £50 million over the six-month period the fund has lost £3.125 million (or 6.25% of its value) to end the period with £46.875 million.
Over the same period, we are told equities are down 10% and bonds down 5%. If we assume the benchmark has a starting value of £50 million split equally between equity and bonds, then £25 million is equally invested in equity and bonds. If equities are down 10%, then the equity part of the benchmark will have lost £2.5 million (£25 million X -10% = -£2.5 million) and the bonds part of the benchmark will have lost £1.25 million based on a fall of 5% (£25 million x -5% = -£1.25 million). Therefore, the value of the benchmark will be: £46.25 million.
We can therefore state that the fund has out-performed the benchmark as it has not lost as much. If we now assume that the benchmark had the same asset allocation as the fund the performance would be calculated as: Equity: (75% x £50 million) X -10% = -£3.75million. Bonds: (25% X £50 million) X -5% = -£0.625 million. This gives us: £50 million - (£3.75 million + 0.625 million) = £45.625 million.
Therefore, based on asset allocation alone, the fund has underperformed the benchmark by -£0.625 million (£46.25 million - £45.625 million = £0.625 million).
However, as the fund has out-performed the benchmark overall, the stock selection must have been good, generating £1.25 million (£46.825 million (actual) minus £45.625 million (based on benchmark)).

Question 6

Sandra Dupont is considering giving some money to her daughter Rose, aged 5. What is the income tax position of this gift?
AIf the income from the gift is above £100 per year the income will be treated as though it belongs to Sandra BIf the income from the gift is above £300 per year the income will be treated as though it belongs to Sandra CIf the income from the gift is above £500 per year the income will be treated as though it belongs to Sandra DRose has her own personal allowance and tax bands even as a child and will pay whatever income tax is due

Answer 6

The correct answer is: A - If the income from the gift is above £100 per year the income will be treated as though it belongs to Sandra
Explanation
Parental gifts to their children resulting in interest over £100 are assessed upon the parent.

Question 7

Which of the following is true of quantitative easing?
IIt acts as a lever pushing down borrowing costs
IIIt involves selling bonds to the markets
IIIIt has a long-term threat of rising interest rates
AI and II BII and III CI and III DI only

Answer 7

The correct answer is: C - I and III
Explanation
Quantitative easing does act like a lever to push down borrowing costs and does carry the long-term risk that interest rates may rise. It involves buying bonds i.e. adding cash into the markets rather than selling bonds which effectively takes cash from the markets.

Question 8

Gonzalo invested a lump sum in to a portfolio some time ago. He has since made no further contributions or withdrawals.

Jorge invests different amounts of money in investments that he identifies as being underpriced or as having excellent growth potential in order to create his own fund.

Sergio has a standing order with a fund management group and pays in a set amount every quarter.

When considering the methods of calculating the return on the investments for the three investors, which of the following is true?

ASergio is more likely to use the time-weighted rate of return than Jorge BJorge is more likely to use the holding period rate of return than Gonzalo CGonzalo is more likely to use the money-weighted rate of return than Sergio DTime-weighted and money-weighted rates of return would give the same results for Gonzalo and Sergio

Answer 8

The correct answer is: A - Sergio is more likely to use the time-weighted rate of return than Jorge
Explanation
The holding period return is often referred to as a total return, and is useful where there are no additional contributions or withdrawals. This method best suits Gonzalo’s investment.
The money-weighted and time-weighted rates of return are useful for when there are injections and withdrawals. However, they do not tell the same story.
The time-weighted rate of return is not distorted by the weighting and timing of the cash flows invested. As market timing is not an aspect of Sergio’s investment strategy (he has a standing order that pays no regard to current market performance), he would not want his return distorted by this factor, so this would be better suited to his fund.
Jorge has a very active investment strategy. He places a lot of emphasis on the timings and amounts being invested, so his return should show this. The money-weighted rate of return would allow these factors to be included in the performance figures.

Question 9

There are many sources from which economic growth can come. In the long run, the rate of sustainable or trend rate of growth will ultimately depend upon all of the following EXCEPT:
AThe growth and productivity of the labour force BThe rate at which an economy efficiently channels its domestic capital into new and innovative technology CThe extent to which an economy’s infrastructure is maintained and developed DThe rate at which an economy efficiently channels its domestic savings and capital attracted from overseas into new and innovative technology and replaces obsolescent capital equipment

Answer 9

The correct answer is: B - The rate at which an economy efficiently channels its domestic capital into new and innovative technology
Explanation
In the long run the rate of sustainable or trend rate of growth will ultimately depend upon the rate at which an economy efficiently channels its domestic savings and capital attracted from overseas into new and innovative technology.

Question 10

Which of the following is the most common form of financial bootstrapping?
AMaking the decision to involve outside equity investors as a way to inject the capital needed for growth BBorrowing funds from a private equity investor CUsing a credit card DBorrowing using mezzanine capital finance

Answer 10

The correct answer is: C - Using a credit card
Explanation
Financial Bootstrapping involves avoiding using outside investors. The most common method is using a credit card.

Question 11

What type of national insurance contributions are paid by employers?
AClass 1 Primary BClass 2 Primary CClass 1 Secondary DClass 2 Secondary

Answer 11

The correct answer is: C - Class 1 Secondary
Explanation
Employer’s pay class 1 secondary contributions.

Question 12

Frankie is assessing the degree to which various fund managers skill and knowledge has enhanced the returns. To do this he is using both the information ratio and R-squared. For which one of the following funds can Frankie be confident that the fund manager has demonstrated good skill and knowledge:
AFund 1: Information Ratio 0.75 and R-squared 0.75 BFund 2: Information Ratio 0.75 and R-squared 0.25 CFund 3: Information Ratio 0.25 and R-squared 0.75 DFund 4: Information Ratio 0.25 and R-squared 0.25

Answer 12

The correct answer is: A - Fund 1: Information Ratio 0.75 and R-squared 0.75
Explanation
The Information ratio assesses the degree to which a fund manager uses skill and knowledge to enhance returns. It is generally considered that the higher the number the better, with 0.75 reflecting a very good performance, with the caveat that the R-squared correlation between the fund and its benchmark must be strong if any reliance is to be placed upon the information ratio.
R-squared is a measure of the percentage of a fund’s movements that can be accounted for by changes in its benchmark index. An R-squared of 100 indicates that a fund’s movements are perfectly correlated with its benchmark.

Question 13

What happens to a bond if its credit-rating changes from sub-investment grade to investment grade?
APrice increases, coupon increases BPrice increases, coupon stays the same CPrice decreases, coupon increases DPrice decreases, coupon stays the same

Answer 13

The correct answer is: B - Price increases, coupon stays the same
Explanation
The price of the bond will increase (because we will be discounting at a lower rate). The coupon will stay the same but the yield (return on the bond) will fall. This is to reflect the lower risk due to the increase in the credit rating.

Question 14

The best measure to use for the client’s risk where the investment in question is only part of their much larger equity portfolio is:
AStandard deviation BBeta CThe risk free rate DCovariance

Answer 14

The best measure to use for the client’s risk where the investment in question is only part of their much larger equity portfolio is:
AStandard deviation BBeta CThe risk free rate DCovariance

Question 15

Which of the following is not an assumption of the CAPM?
AAll participants can borrow and lend at the risk-free rate BAll participants have both systematic and non-systematic risk CNo taxes or transaction costs DAll participants have the same expectations

Answer 15

The correct answer is: B - All participants have both systematic and non-systematic risk
Explanation
The assumption should be that only systematic risk remains.

Question 16

An investor invests £20,000 into an onshore Single Premium Investment Bond. The investment grows to £40,000 over the next ten years at which point the investor surrenders the bond.

Evaluate the following two scenarios.

A. The investor has taxable income £2,000 below the HRT threshold
B. The investor has taxable income £1,000 below the HRT threshold

Based upon the above, which of the following is/are correct?

IScenario A will result in no additional income tax to be paid
IIScenario B will result in additional income tax of £2,000 to be paid
AI only BII only CBoth DNeither

Answer 16

The correct answer is: C - Both
Explanation
Higher rate taxpayers are due extra income tax on gains made from investment bonds. Basic rate taxpayers can benefit from top slicing relief as follows.

The gain is £40,000 - £20,000 = £20,000. This is divided by the number of full years that the bond has been held, i.e. £20,000 / ten years = £2,000.
This £2,000 is then added to the individual’s income for the tax year. Any income below the higher rate threshold has no extra income tax due. Any income above the threshold will incur an extra 20% income tax. This tax liability on the ‘top slice’ will then be multiplied again by ten to cover the full ten years of gain.

Scenario A
Adding the extra £2,000 to their other income does not breach the HRT threshold so there is no additional income tax to pay on their investment bond.

Scenario B
Adding the extra £2,000 to their other income leaves £1,000 above the HRT threshold. Therefore:
£1,000 x 20% x 10 = £2,000 additional income tax to pay.
Note that the Life Fund has already incurred tax at 20% on gains, leaving a higher rate taxpayer with an additional 20% to pay.

Question 17

Which of the following bond features would most likely create the least price volatility?
ALong dated BLow coupon CNon-investment grade DHigh coupon

Answer 17

The correct answer is: D - High coupon
Explanation
High coupon, short dated bonds display lower volatility.

Question 18

If a basic rate taxpayer encashes a life assurance investment bond, what further tax may be due?
AA capital gains tax liability of 18% BAn income tax liability of 20% CNo further tax is due DAn income tax liability of 10%

Answer 18

The correct answer is: C - No further tax is due
Explanation
Encashing a life assurance bond may cause an income tax liability for higher and additional rate taxpayers. However, since the life fund has paid 20% of tax on income and gains at source, a basic rate taxpayer has nothing further to pay.

Question 19

An investor pays £100,000 into an investment bond with an insurance company. Assuming no earlier withdrawals are made, what sum can be withdrawn from the bond at the end of year three without incurring a chargeable event?
A£5,000 B£10,000 C£15,000 D£100,000

Answer 19

The correct answer is: C - £15,000
Explanation
The 5% rule allows 5% of the original capital to be taken from a life bond per year on a cumulative basis. This means that 3 x £5,000 i.e. £15,000 can be taken without incurring a chargeable event.

Question 20

A fund manager manages a £10m portfolio of blue chip stocks and is worried that the FTSE 100 will fall by 3% in the next couple of weeks. The fund manager would like to hedge the market risk of the portfolio during this period of uncertainty. The fund manager should:
ABuy FTSE 100 stock index futures BBuy calls on the FTSE 100 future CSell puts on the FTSE 100 future DSell FTSE 100 stock index futures

Answer 20

The correct answer is: D - Sell FTSE 100 stock index futures
Explanation
The fund manager is exposed to the FTSE 100 index falling. To hedge, the fund manager will sell a FTSE 100 stock index future. If the market falls, the fund manager’s portfolio will lose money, but the fund manager will make a profit from the short futures position.

Question 21

Which of the following is TRUE with respect to the flat-yield and gross redemption yield on a bond trading BELOW par?
IThe GRY will be higher than the flat-yield
IIThe GRY will be lower than the flat-yield
IIIThere will be a capital gain on the bond
IVThere will be a capital loss on the bond
AI and III BI and IV CII and III DII and IV

Answer 21

The correct answer is: A - I and III
Explanation
As the bond is trading below par and the bond is redeemed at par, there will be a capital gain on the bond.
The capital gain will mean that the GRY is higher than the flat-yield.

Question 22

Which of the following is false of the Ongoing Charges Figure (OCF) and the Reduction in Yield (RIY) statistics?
IThe OCF takes into account initial charges
IIThe RIY takes into account initial charges
IIIThe OCF takes into account ongoing charges
IVThe RIY takes into account ongoing charges
AI & IV BII & III CI only DII, III & IV

Answer 22

The correct answer is: C - I only
Explanation
The OCF ratio only includes ongoing charges, whereas the RIY includes both initial and ongoing charges.
/nOCF was previously referred to as the total expense ratio (TER).

Question 23

Which of the following risk measures incorporates the beta of a firm within the calculation?
ISharpe ratio
IITreynor measure
IIIJensen measure
IVInformation ratio
AI and II BII and III CII, III and IV DII only

Answer 23

The correct answer is: B - II and III
Explanation
The Treynor measure and the Jensen measure look at the risk adjusted return of fully diversified portfolios. Hence they use Beta as their risk measure.
Sharpe uses standard deviation of the market (for total risk) and the information ratio used the standard deviation of excess returns.

Question 24

An investor approaches you looking for an investment that can provide capital growth over a long period and the possibility of some income. They are also happy to take on a high-level of risk. What would you recommend?
AUK Gilts BAA-rated corporate bond CDeposit account DEquity in a newly-formed AIM company

Answer 24

The correct answer is: D - Equity in a newly-formed AIM company
Explanation
Equity in a newly-formed AIM company best fits the investment profile - it offers high potential growth, with a possibility of income (although this is unlikely in the early years). It also offers the highest level of risk in the choices available.

Question 25

Jeremy Sellers has taxable earned income of £37,200 (after taking into account his personal allowance). He has realised a capital gain of £14,600 before using his CGT allowance.
How much CGT is due on this gain?
A£410 B£460 C£594 D£644

Answer 25

The correct answer is: A - £410
Explanation
Jeremy’s capital gain is partly covered by the annual exemption of £12,300, leaving £2,300 as the chargeable gain. The basic rate band ends at £37,700. Jeremy’s gain moves beyond this band.
For this reason he will be taxed on the gain partly at the basic rate (£500 x 10% = £50) and partly at the higher rate (£1,800 x 20% = £360). Total CGT = £360 + £50 = £410
The first £500 of the gain is taxed at 10%: £500 x 0.10 = £50 The remaining £1800 is taxed at 20%: £1800 x 0.20 = £360 The tax due on the gain is: £50 + £360 = £410

Question 26

Susan’s primary residence is a £350,000 house in Staffordshire. She buys a holiday home in West Cumbria for £120,000. The holiday home is for her own and her families use only. What rate of stamp duty will Susan pay on the holiday home?
A0% B2% C3% D5%

Answer 26

The correct answer is: C - 3%
Explanation
This is a second residential property, who uses it is irrelevant, so an additional 3% needs to be paid. SDLT on properties under £125,000 is 0%, so Susan will pay 3% on top of that; this makes a total of 3%.

Question 27

An investor is fully paid up on 1,000 £1 par value shares of a XYZ plc. If XYZ plc goes into liquidation, what is the most the investor could lose?
A£1,000 BAll the cost of buying the shares CExcess of the amount incurred above £1,000 DMarket price of the shares at the time of liquidation

Answer 27

The correct answer is: B - All the cost of buying the shares
Explanation
Since the full amount of what is paid can be lost, this would include the price at purchase and all costs of buying the shares, like brokers’ commissions and taxes.

Question 28

Which of the following is the recommended approach for estimating total returns involving cash flows in or out of an investment fund?
AMoney weighted rate of return BTime weighted rate of return CInternal rate of return DInterim internal rate of return

Answer 28

The correct answer is: B - Time weighted rate of return
Explanation
Time weighted rate of return is the recommended method as it adjusts the return for cash flows into and out of the fund.

Question 29

Most market cap weighted index are done on a free float adjusted basis. The reason for this is to ensure that the index meets which one of the following basic requirements for a benchmark?
AUnambiguous BMeasurable CInvestable DAppropriate

Answer 29

The correct answer is: C - Investable
Explanation
An index will use a free-float to ensure that a true investable opportunity is represented within the index fulfilling the basic requirements for a benchmark to be investable.
Investable – it is possible to forego active management and hold this benchmark as a passively managed portfolio.
Measurable – the returns and risk of this portfolio can be calculated quickly and frequently.
Appropriate – the benchmark is consistent with the manager’s investment style or area of expertise.
Unambiguous – the identities and weights of the securities or factor exposures constituting the benchmark are clearly defined.

Question 30

If you have to explain to an investor the protection offered in the foreign exchange market against counterparty default risk, what system would refer to?
ACHAPS BCREST CTRAX DCLS

Answer 30

The correct answer is: D - CLS
Explanation
CLS (continuous linked settlement) offers investors in the foreign exchange market payment versus payment protection to their trades.

Question 31

Which of the following risk measures is used to assess the accuracy of a multi-factor model?
ABeta BStandard Deviation CRisk / Reward Ratio Dr-squared

Answer 31

The correct answer is: D - r-squared
Explanation
The r-squared measures the accuracy of a model. A high r-square indicates an accurate model.

Question 32

Consider the following economic indicators:
Indicator 1: stock market returns increase.
Indicator 2: gross domestic product increases.
Indicator 3: unemployment figures increase.
Indicator 4: applications for building permits increase.
Which of the following is true?
AIndicators 1 and 3 can be used to predict that the economy is on the way to recovery BIndicators 2 and 4 would be a result of an economy already in recovery CIndicators 1 and 4 are leading indicators of economic recovery DIndicators 2 and 3 are coincident indicators of economic recovery

Answer 32

The correct answer is: C - Indicators 1 and 4 are leading indicators of economic recovery
Explanation
Leading indicators include: stock market returns, consumer expectation, building permits and money supply. These are used to predict where the economy is heading. Coincident indicators include: gross domestic product, industrial production, and retail sales. These are used to identify where an economy is in the economic cycle. Lagging indicators include the unemployment rate. These can be used to identify trends in the economy.