1. Analyse the characteristics, features, behaviours and risks of securities and equities in the context of the market for these products (39)

Question 1

Types of physical replication

Answer 1

• full replication
• stratified sampling - sample
• optimisation - complex sampling
• synthetic - swaps

Question 2

UK Gov bonds

Answer 2

• Treasury bills - short term funding (1 3 and 6 m)
• Gilts - fixed coupon and maturity date
• Index-linked Gilts - RPI (future maybe CPH)

Question 3

Gilts terms

Answer 3

• Shorts - up to 7
• Mediums - 7 to 15
• Longs - 15 and more

Question 4

US Gov bonds

Answer 4

• Treasury bills - short term funding. less than a year. 28 - 182 days
• Treasury notes - fixed coupon and maturity date. 2 to 10 years
• Treasury bonds - notes but, 10 to 30 years

Question 5

Jap Gov bonds

Answer 5

• short - no interest. 6 and 1 year
• medium - fixed coupon and maturity. 2 and 5 years
• long - 10 years
• super long - 20, 30 and 40. 15 year w floating interest
• individual investor - conventional and floating. up to 10 years
• inflation indexed - CPI. principal is inflation adjusted. coupon paid on inflation adjusted amount

Question 6

DR - roles

Answer 6

• Issuer - meets ongoing listing obligations
• Depositary bank - makes a market. Holds shares as trustee. Converts and pays dividends
• Custodian - holds shares on behalf of bank

Question 7

Non current assets

Answer 7

• Tangible - held for production or supply of goods. i.e. property and plant
• Intangible - patents and trademarks
• Long term investments - available for sale

Question 8

Current assets

Answer 8

• Inventories
• Trade receivables - debtors who owe the company for goods or services
• Cash

Question 9

Calculating depreciation

Answer 9

original cost-expected residual value
/
expected useful life

Question 10

Accounting for stock

Answer 10

• FIFO - first purchased and sold
• LIFO - most recent purchased first sold
• weighted average

Question 11

Characteristics of unit trusts

Answer 11

• Legal structure - trust
• Management - manager and trustee (legal owner)
• Authorisation & supervision - FCA
• Pricing and valuation - Daily / NAV; Single or dual
• Charges - Initial; dual pricing may have AMC
• Units - Income or ACC
• Dealing and settlement - market provided by manager

Question 12

Characteristics of OEICs

Answer 12

• Legal structure - company
• Management - ACD (management) and depository (legal owner)
• Authorisation and supervision - FCA
• Pricing and valuation - Daily / NAV; most uses single
• Charges - initial; dilution levy for buys over certain amounts
• Units - established under umbrella fund
• Dealing - ACD provides market

Question 13

Dual pricing

Answer 13

• Bid - Price investor receives to sell
• Offer - Price investor pays to buy

Question 14

Risks associated with equities

Answer 14

Price risk
* share prices may fall (capital loss)
* disclosure of bad news
* tech companies (more volatile)

Liquidity risk
* difficuilt to sell at a resoanble price
* price spread from falling value
* smaller companies

Issuer risk
* company collaspes rednering shares worthless

Question 15

Non current liabilties

Answer 15

Non-current
* borrowing that are not repayable in the next 12 months
* additional source of capiatal over and above shareholer capital
* debentures and unsercured loan capital / loans from banks etc.

Question 16

Current liabailties

Answer 16

Current liabailties
* payble within 12 months of statement date
* owed to suppliers, trade creditors, overdraft, dividends and tax

Question 17

Types of share capital and reserves

Answer 17

Share capital
* No of shares in issue
Capital reserves
* Revaluation reserve
* Share prem reserve
* Capital redemption reserve
Retained earnings - revene reserve

Question 18

Key busines terms

Answer 18

• Revenue - sales generated
• Cost of sales
• Gross profit - revenue, minus cost of sales
• Operating profit - gross profit, minus distrubition costs and admin expenses

Question 19

REIT

Answer 19

Tax exempt
* Distripute at least 90% of their net rental income
* Free of internal income tax and CGT
* Free of corp tax

Taxbale

Question 20

REIT distributions

Answer 20

Tax exempt
* classed as property income and paid net of 20% tax
* non tax payers can reclaim
* ISA investors can claim to have paid gross

Taxable
* Dividend payment taxed as normal
* Gains are subject to CGT

Question 21

Index linked bonds

Answer 21

• Interest payments and redmeption are uplifted by inflation
• RPI gilts / CPI corp bonds
• Maturity increase depends on time at redemption

Question 22

Bond credit ratings

Answer 22

Investemnt garde
* triple B
* Baa

Question 23

Impact of econmic factors

Answer 23

• Per capita income - larger potential tax base
• GDP growth - higher better. decrease debt burden
• Inflation - low means stable monetary and excchange policies
• Economic developemnt
• Current account - large acount. less dependent on foregin countries
• Foriegn debt/ GDP
• Real exchange rate
• Default history
• Ratio debt/ GDBP
• Ratio reserves/import

Question 24

Unit trust or OEIC charges

Answer 24

• Intial
• AMC
• Performance
• Exit

Question 25

Top down active management

Answer 25

1. Asset allocation 2. Sector selection 3. Stock selection

Question 26

Bottom up active management

Answer 26

* Value - deep value through analysis * GAARP - long term sustainable advantages * Momentum - continue trend * Cotranism - against trend

Question 27

Characteristics of ETF

Answer 27

* Legal structure - company * Management - ICVC * Authorisation & supervision - by regulator of domicle conuntry * Pricing and valuation - Daily / NAV; Single or dual * Charges - no intial & SDRT. lower TER. However, brokerage charges * Units - directly share * Dealing and settlement - stock exchange. trade close to NAV

Question 28

Fund of fund

Answer 28

Fund of funds * one overall manager * unferrered - undelrying external managers * fettered - same management group Manager of managers * segregated mandates with appopinted managers

Question 29

Charectristics of the money market

Answer 29

Short term * less than one year * most between overnight and one week Transactions * high volume, low risk and short term Particpiants * gov, company Instruments * low risk, low yield, high liquidity

Question 30

covered warrant

Answer 30

similar to option but traded on stock exchange * call covered - right to buy at strike on expiry * put covered - right to sell at strike on expiry * expiry date - date after you can no longer excercise * strike price - excercise price for security amercian or european * american - excervice up to and including expiry date * european - excervice only on expiry day

Question 31

Impact of economic factors

Answer 31

* per capita income - larger potential tax base * GDP growth - economic growth. lower intr for borrower * inflation rate - sustainable monetary and exchnage rate policies * economic development - developed countries * current account - deficit implies reliance on foreign creditors * foreign debt/GDP - proportion of foreign debt to GDP indicates stability * real exchange rate - trade competitiveness * default history - affects reputation * ratio: debt/ GDP - greater ratio, greater compensation demanded * ratio: reserves/ imports - greater ratio, greater reserves to service foreign debts * ratio: investment/GDP - growth ability. larger potential tax revenue * rule of law - evaluting country governance and willingness to pay

Question 32

Types of ordinary shares

Answer 32

reedemable * part of return to capital to shareholders * b shares a shares * profs and divs as normal * no voting rights deffered shares * issued to founders * pay div after a certain period of years / other divs paid

Question 33

Types of shares

Answer 33

* ordinary * Preference - div payment before all others * cumilitive pref - if unable to pay divs, carried forward * reedemable - company will buy pack after period or date

Question 34

Types of pref shares

Answer 34

non Cumulative pref share - fixed div. if not paid right is lost Cumulative - if unable to pay divs, carried forward. arrears paid before all other divs participating divs - additional divs if profs exceed certain level reedemable - company buy back period or date convertible - rights to convert pref shares to oridinary

Question 35

Ranking in liquidation

Answer 35

1. secured creditors with fixed charge 2. fees & charges of insolvency 3. employees 4. unsecured creditors - up to £600k ring fenced 5. creidtors with floating charges (general not specific assets) 6. unsecured - trade creditors, tax and unsecured loans 7. sharegolders, pref first

Question 36

Role of DRs

Answer 36

* issuer - lists and meets ongoing obligations * depositiary - makes market. holds shares as bare trustee (unless custodian). converts and pays dividends * custodian - holds undelrying shares on behalf bank

Question 37

Main types of corp bonds

Answer 37

* med term notes - 9 ms to 5 years * fixed rate bonds - convential bonds with fixed rates * floating rate notes - variable rates linked to SONIA * convertible bonds - right to convert to ordinary shares * zero coupon bonds - no coupon, issued at a par for capital gain * PIBS - irredeemable. high semi annual coupons issued by bs. non cumilative. turn into PSBS after demutilisation. rank behind all other creditors

Question 38

STRIPS

Answer 38

Seperate trading of registered interest and principal

Question 39

Bond redemptions

Answer 39

* call proviosions - issuer option to buy back (Call to return) * put provisions - holder option to sell back (Put for sale )

Question 40

Yield curves

Answer 40

* normal yield curve - higher yield for longer bonds. compensate uncertainty * flat yield curve - no percieved risk over time. no compensation * inverted yield - omptimsitic inlfation. long yields below short

Question 41

Credit spread

Answer 41

Additonal yield demanded for an investor purchasing a corp bond rather than gov

Question 42

Risks associated with bonds

Answer 42

* credit risk - interest and repyament deafualt * market or price risk - movements on intr have significant impact on bond value * unantciapited inflation risk - rising inflation erodes coupon and redemption payments * liquidity risk - difficult to realise at short notice. suffer wider than average dealing spreads * exchange rate risk - adverse currency moves for diff domicile bonds * early redemption risk - issuer may invoke call provision * senirotiy risk - ranking in issuers liquidation

Question 43

NS&I tax free products

Answer 43

* Direct ISA - variable interest * Prem bonds - £50k max * Fixed interest savings certifcate - fixed return paid. up to 5 years * Index-linked savings certificate - as above. RPI linked * Childrens bonds

Question 44

Growth income bonds

Answer 44

paid net of tax * guaranteed growth * guaranteed income paid gross * income bonds

Question 45

Assesing default risk

Answer 45

* credit rating * tier one capital rato - regulator use to judge adequacy of the banks capital position * creidt default swap (CDS) rates - pays out in the event of default by company or gov. compare against competitors

Question 46

Taxation of offshore funds

Answer 46

* little to no tax internally reporting - taxed as UK * 60% holding in intr bearing. fund taxed as intr * does not have to distribute * normal CGT rules non reporting funds * roll up funds. income and divs accumulated * gain taxed as income * non domiciled. free of uk tax.escape IHT

Question 47

relationship betwen intetrest rates and bon prices

Answer 47

intr rise > prices fall intr fall > price rise