Mock Exam 3 wrong questions

Question 1

[1017267] In relation to P/E ratios and dividend yields, which of the following statements is/are correct?
IA low P/E ratio for a company may indicate a low perceived level of risk
IIA high dividend yield may indicate an above average level of risk
AI only BII only CBoth DNeither

Answer 1

The correct answer is: B - II only
Explanation
Low P/E - high risk; high dividend yield - high risk.

Question 2

Jason, a higher rate taxpayer, invests in a qualifying policy with Prudence Life and encashes his investment ten years later making a healthy gain.
Susan, a higher rate taxpayer, invests in a non-qualifying policy with Windsor Life and encashes her investment ten years later making a healthy gain.
Nathan, a higher rate taxpayer, invests in an OEIC with Abbey Investment Management and encashes his investment ten years later making a healthy gain.
In relation to these three investors, and ignoring CGT allowances, which of the following will be liable for capital gains tax?
AJason, Susan and Nathan BSusan and Nathan CNathan only DSusan only

Answer 2

The correct answer is: C - Nathan only
Explanation
Gains on insurance bonds incur income tax rather than CGT. Only Nathan’s gain will attract CGT.

Question 3

You are a Client Relationship Manager to many high net worth private clients. In your dealings with an existing client you suspect that they are not reporting all their overseas income to the UK tax authorities.
Which of the following is correct?
AYou must not breach client confidentiality and so not report your client BYou must report your client to the National Crime Agency CYou must report your client to the firm’s Money Laundering Reporting Officer DYou cannot report the client without direct evidence

Answer 3

The correct answer is: C - You must report your client to the firm’s Money Laundering Reporting Officer
Explanation
You must report your suspicions to the firm’s MLRO - even if you suspect tax evasion.

Question 4

Which one of the following would also be referred to as the ‘headline’ rate of inflation within the UK?
ARPI BCPI CRPIX DHICP

Answer 4

The correct answer is: A - RPI
Explanation
The RPI is sometimes referred to as the ‘headline’ rate of inflation. The CPI is a relatively recent introduction to UK measures of inflation while the RPI has been around for some years.
The standardised European inflation measure, the harmonised index of consumer prices (HICP), began to be used as the basis for the UK’s inflation target in 2003. In the UK, it is now more commonly known as the consumer prices index (CPI).

Question 5

Geoffrey is 66 years old, recently retired with no dependents other than his wife. Paul is 37, currently in full-time employment, with a wife and three young children.
Which of the following would best summarise the investment objectives of these two clients?
AGeoffrey would be more interested in growth than Paul BPaul would not be as interested in life assurance as Geoffrey CGeoffrey would be more interested in retirement planning than Paul DPaul would not be as interested in generating income as Geoffrey

Answer 5

The correct answer is: D - Paul would not be as interested in generating income as Geoffrey
Explanation
Geoffrey, being retired, would be far more interested in generating income from his investments to tide him through his retirement. Paul, in full-time employment, would be less interested in his income generating income and more interested in growth. Paul would also be interested in retirement planning - hopefully, Geoffrey has this covered. Paul is much more likely to be interested in life assurance in order to protect his dependents should something unfortunate happen to him.

Question 6

An advisor has recently completed a fact-find document on three of his clients. All three clients are in their mid-twenties and have between £150,000 to £200,000 to invest for several years.
Paul shares a rented flat with two housemates, and earns a modest income as a teacher Denise works as an Investment Banker in the financial services industry, and owns a mortgage free property Floella recently changed careers, and is retraining as a dentist, funding her studies using much of the capital from money saved in her previous job as a stock market analyst
Based solely on this information, it is reasonable to assume that:
AFloella is the one likely to have the greatest risk appetite BPaul and Floella are likely to place income as priority over capital growth CDenise is the one to choose the longest investment timescale DOnly Denise is likely to place capital growth as priority over accessibility

Answer 6

The correct answer is: B - Paul and Floella are likely to place income as priority over capital growth
Explanation
Both Paul and Floella require regular income from their portfolio. Paul needs to supplement his modest income from teaching, and Floella needs help funding her dentistry studies. Income must take priority over capital growth for these clients. All clients are of similar age, and therefore their investment timescale is also likely to be similar. Denise is the client with the greatest risk appetite, as she is likely to have the greatest disposable income given her job and mortgage free property. All clients would likely place growth of the portfolio over accessibility, as they need to invest for several decades and would want to ensure that their portfolio grows in real terms.

Question 7

The goal of an immunisation strategy is to protect a portfolio from which risk?
AEquity risk BInterest rate risk CCurrency risk DCredit risk

Answer 7

The correct answer is: B - Interest rate risk
Explanation
Immunisation’s aim is to protect against interest rate risk.

Question 8

Angela is 28 years old. She is looking to allocate money within her pension fund and is planning to retire at 60 years old. Mary is 40 years old. She requires investments that will provide sufficient funds to pay for her son’s university fees. Her son is currently 13 years old.
Which of the following best reflects the attitudes of the two investors?
AMary is likely to have a more positive attitude to risk than Angela BBoth Mary and Angela are saving to meet real liabilities CNeither Mary nor Angela are interested in growth DTax efficiency of the investments is a greater concern for Angela than for Mary

Answer 8

The correct answer is: B - Both Mary and Angela are saving to meet real liabilities
Explanation
Most of this is thinking about the time horizons of the investors.
Angela obviously has the longer horizon. This would suggest a greater willingness to take on risk, and a greater emphasis on real investments and growth.
Mary has a shorter investment horizon. This suggests less willingness to take on risk. Nevertheless, her potential liability is still some way in the future, so the impact of inflation needs to be considered.
Angela is less concerned about the tax implications of the investments, as she is allocating them within her pension, where they would be tax exempt. Tax will be a concern to Mary; income tax during the life of the investment and capital gains tax on maturity of the investment.

Question 9

Which of the following statements about inflation is/are TRUE?
IIf prices rise faster than is expected, borrowers gain at the expense of lenders
IIIf inflation is fully anticipated, the real rate of interest equals the nominal rate
IIIIf the money supply is rising in line with real economic growth there will be no change in price level
IVA rise in inflation is likely to cause the exchange rate to appreciate
AI only BII and III CI and III DAll

Answer 9

The correct answer is: A - I only
Explanation
If inflation rises quickly, borrowing will be cheap until interest rates are adjusted upwards to compensate. If the change in money supply equals the change in real growth, then inflation is stable, but there is still inflation. Higher inflation is likely to depreciate the exchange rate (PPP).

Question 10

Samuel and Ollie are discussing portfolio performance assessment and the use of GIPS. Samuel has stated that GIPS represent a way of benchmarking performance, with Ollie convinced that GIPS were established by MSCI. Which statement is correct?
ABoth Samuel and Ollie are correct BBoth Samuel and Ollie are incorrect CSamuel is correct, but Ollie is incorrect DSamuel is incorrect, but Ollie is correct

Answer 10

The correct answer is: B - Both Samuel and Ollie are incorrect
Explanation
Global Investment Performance Standards (GIPS) are not a way of benchmarking performance but are global standards for calculating and presenting performance figures. Originally established in 1999 by the CFA Institute, GIPS were significantly enhanced in 2005 and have been voluntarily adopted by industry representative organisations in many countries in order to help promote best standards.

Question 11

Which of the following would lead to indirect taxation?
AClaire has inherited £1,000,000 from her Aunt BNathan earns £55,000 as an MP CNicky has made a capital gain of £50,000 from the sale shares DMohinda buys a laptop for £500

Answer 11

The correct answer is: D - Mohinda buys a laptop for £500
Explanation
VAT is payable on the laptop.

Question 12

Which of the following is a leading economic indicator?
AThe unemployment rate BGDP CBuilding permits DIndustrial Production

Answer 12

The correct answer is: C - Building permits
Explanation
Building permits are a leading indicator. The unemployment rate is a lagging indicator. GDP and Industrial Production are Coincident indicators.

Question 13

In which of the following situations may shareholders in a mutual fund face a tax liability?
IIncome received from the mutual fund
IIIncome re-invested by the mutual fund
IIIOn the increase in the share price beyond the annual exemption
IVOn a sale of the shares held by the investor in the mutual fund
AI and IV only BI and II only CI, II and IV only DI, II, III and IV

Answer 13

The correct answer is: C - I, II and IV only
Explanation
Note that income is taxable even if re-invested. Investors are not liable to tax on gains unles these are are realised through the tranfer of the asset, for example by selling the shares.

Question 14

Frank and Stacy are discussing the different inflation measures used in the UK. Frank tells Stacy that in the UK, index linked gilts are based on RPI. Stacy responds by saying that she believes state pensions are typically linked to CPI.
ABoth Frank and Stacy are correct BBoth Frank and Stacy are incorrect CFrank is correct, but Stacy is incorrect DFrank is incorrect, but Stacy is correct

Answer 14

The correct answer is: A - Both Frank and Stacy are correct
Explanation
Frank is correct in saying that the RPI is used within the UK as the basis for calculating coupons on index-linked gilts. Stacey is also correct since state pensions in the UK are linked to CPI (they rise at the highest of earnings growth, CPI or 2.5%).

Question 15

Which of the following statements is FALSE of holding a REIT?
AThe shares are liquid BBasic rate taxpayers pay tax at 8.75% on dividends received CThey may be held inside an ISA DThe REIT is exempt from corporation tax under certain circumstances

Answer 15

The correct answer is: B - Basic rate taxpayers pay tax at 8.75% on dividends received
Explanation
Basic rate tax payers pay tax at 20% on dividends received from a REIT. On all other dividends basic rate tax payers pay 8.75% not 20%. The shares are liquid, unlike directly holding the actual property, which is illiquid by comparison. REITs are ISA compliant, which means any dividends or capital gains are tax-free when held within an ISA. The REIT is exempt from corporation tax if it distributes 90% of its income to shareholders (they are often referred to as ‘pass through’ companies in this regard).
Feedback from recent exams suggest that a question has appeared on REITs.

Question 16

Consider the following UK residents:
- David owns a business in USA that paid him an income of £25,000 last year - Magnus receives distributions from offshore funds based in Germany, Ireland and France - Sandy receives coupons from a Eurobond issued by a South African company - Wayne runs a company that receive franked investment income from another UK company
Which of the following is true?
ABoth David and Sandy would suffer withholding tax on their income BWayne only would need to report his income to the National Crime Agency CMagnus and Sandy would benefit from double tax relief DDavid, Magnus and Sandy only would be liable for UK tax on their income

Answer 16

The correct answer is: D - David, Magnus and Sandy only would be liable for UK tax on their income
Explanation
Wayne’s company would not be liable for tax. The income is franked, and, as such, ‘tax paid’. David would be subject to withholding tax and could benefit from double tax relief. Magnus may also be in this situation, depending on the fund. Sandy will receive gross coupons but will need to pay tax.

Question 17

Tommy and Gina are married with two grown-up children. Their adviser Marina Jenkins estimates that their joint estate for IHT is £1.6m and notes that the clients have made a will providing that all assets pass to each other on first death. In their financial planning discussions, Marina talks through the difficult scenario of the IHT position on either Tommy or Gina’s early death in the current tax year. Marina assumes for the analysis that the survivor then ultimately dies ten years later. Marina uses the following assumptions:

• Both clients have not used the nil rate band
• The nil rate band in 2021/22 is £325,000
• The nil rate band in 2031/32 is £500,000 (including residence nil rate band)

Assume that the death of the first client occurred in 2021/22 and then the survivor died some years later in 2031/32. What is the best estimate of IHT that would be payable?

A£240,000 B£310,000 C£340,000 D£440,000

Answer 17

The correct answer is: A - £240,000
Explanation
Given the scenario in the question, the surviving spouse inherits the total estate and the nil rate band. This means on the ultimate death of the second spouse, the taxable estate is:

1,600,000 - (500,000 x 2) = 600,000
IHT due = 600,000 x 0.4 = 240,000

Remember, it is the percentage of the nil rate band that is transferred rather than the monetary value.

Question 18

Which of the following characteristics of bonds make them more sensitive to interest rate changes?
ILow-yields
IILong-maturities
IIILow-coupons
IVHigh-credit quality
AI, II & III BII & III CII, III & IV DI, II, III & IV

Answer 18

The correct answer is: A - I, II & III
Explanation
Low-yields, long-maturities and low-coupons all contribute to a higher duration indicating an increased sensitivity to interest rate changes.

Question 19

What does a low R-squared indicate?
AA lower risk adjusted return compared to the benchmark BA low degree of diversification compared to the benchmark CA less reliable beta DA lower degree of systematic risk

Answer 19

The correct answer is: C - A less reliable beta
Explanation
The R-square measures the degree of correlation between a fund and a benchmark. An R-square of 100 would indicate that a fund and a benchmark are perfectly correlated. A low R-square means that little of the funds returns can be explained by changes in the benchmark.
Generally a higher R-square will indicate a more reliable beta.

Question 20

Gylfi is an investment adviser for a financial firm. He has recently been asked by his retail clients about unregulated collective investment schemes (UCIS), such as hedge funds. Previously, Gylfi had never advised his clients on UCIS, but he is considering whether to extend his advice scope to include such funds. He is MOST likely to decide against including UCIS in his product range because UCIS:
AAre too complex to understand for any retail client BFall outside the scope of retail investment products CHave FCA restrictions placed on their advice DWould be unsuitable and too risky for his clients

Answer 20

The correct answer is: D - Would be unsuitable and too risky for his clients
Explanation
The Retail Distribution Review (RDR) undertaken by the FCA extended the scope of pre-RDR packaged products to include UCIS, investment trust shares, and retail structured products. However, retail advisers are not required to include UCIS in their product range unless they feel the product is suitable in terms of their client needs and risk tolerance. Whilst it is true to say the FCA places restrictions on which clients can have UCIS promoted to them, this is not the same thing as saying that the FCA places restrictions on their advice - assuming the client receiving such advice is allowed to be promoted to.

Question 21

The annual equivalent rate for an investment is quoted as being higher than the annual stated rate of interest. Which of the following is the most likely reason for this?
AA reversionary bonus is payable at the end of the investment horizon BInterest is payable at various periods during the year CInterest is calculated on a simple interest basis DThe AER is a gross rate and the stated rate has income tax deducted

Answer 21

The correct answer is: B - Interest is payable at various periods during the year
Explanation
Due to the effects of compounding when an interest rate is paid more than annually the compounded overall return will be higher. This compounded annual return is the AER.

Question 22

Which of the following is/are true of the Global Investment Performance Standards (GIPS)?
IGIPS standards are compulsory for firms that publish investment statistics
IIGIPS standards are set by Combined Actuarial Performance Services (CAPS)
IIIGIPS provide a way of benchmarking investment performance
AI & III BII & III CIII only DNone of the above

Answer 22

The correct answer is: D - None of the above
Explanation
GIPS are voluntary standards that are published by the CFA Institute.
GIPS are not a way of benchmarking performance but global standards for calculating and presenting performance statistics.

Question 23

Jemima is a fund manager for an investment firm and is responsible for managing the following funds:
Fund 1- S&P 500 Tracker fund
Fund 2- Small Cap Fund
Fund 3- Asian equities Fund
Fund 4- Special Situations Fund
Which of the following statements is true?
AWhere optimisation is used, this is most likely to apply to Fund 1 BWhere deterministic modelling is used, this is most likely to apply to Fund 2 CWhere bottom-up active management is used, this is most likely to apply to Fund 3 DWhere core-satellite management is used, this is most likely to apply to Fund 4

Answer 23

The correct answer is: A - Where optimisation is used, this is most likely to apply to Fund 1
Explanation
Since the S&P 500 Tracker Fund is typically a passive fund, it is most likely to utilise one of three methods to track the benchmark; full replication, stratified sampling, or optimisation.

Choice B is incorrect, as deterministic modelling could be used be any of the funds. Choice C is incorrect, as the bottom-up approach is most likely to apply to Fund 4. Choice D is incorrect, as the core-satellite approach could describe any or none of the funds.

Question 24

An investor comes across a dilution levy when reading a key information document. Which of the following is true of a dilution levy?
AIt applies to dual priced funds BIt applies to single priced funds CIt applies to closed ended funds DIt applies to offshore funds only

Answer 24

The correct answer is: B - It applies to single priced funds
Explanation
Dilution levy is a charge imposed by a manager to cover dealing costs. It only affects single priced funds as dual priced funds will cover this within the spread. It is designed to ensure that existing investors do not suffer costs associated with new investors subscribing or redeeming shares. There is no dilution levy for closed ended funds.

Question 25

Which of the following is incorrect in relation to Permanent Interest Bearing Shares?
APIBS have a fixed redemption date BPIBS holders are not covered by the Financial Services Compensation Scheme CPIBS are traded on the London Stock Exchange DPIBS can be converted into a Perpetual Subordinated Bond on demutualisation

Answer 25

The correct answer is: A - PIBS have a fixed redemption date
Explanation
PIBS are non redeemable.

Question 26

Jason has an adjusted income of £280,000 and is considering making personal pension contributions. Which of the following is/are correct?
IJason will not receive the personal allowance
IIJason will receive income tax relief on £20,000 only
IIIJason will pay tax at 45% on his entire pension contribution
AI and II BI and III CI only DII only

Answer 26

The correct answer is: A - I and II
Explanation
Pensions attract tax relief at either 20%, 40% and 45% depending on the marginal rate of tax. As an additional rate taxpayer, Jason will get relief at 45%. However, the annual allowance of £40,000 is lost at a rate of £1 for every £2 of adjusted income above £240,000. Jason is £40,000 above that limit so loses £20,000, leaving only £20,000 on which he gets tax relief. Note, the lowest the annual allowance can be is £4,000. The personal allowance starts to be taken away at a rate of £1 for every £2 earned above £100,000.

Question 27

An investor makes capital gains within an OEIC of £8,000 in year one, £10,000 in year two and £13,000 in year three. Ignoring the CGT allowance and assuming the investor is a higher rate taxpayer what is the closest estimate to the CGT due in year three assuming the funds remain invested?
A£6,200 B£4,600 C£2,600 D£0

Answer 27

The correct answer is: D - £0
Explanation
Funds grow free from CGT within OEICs. It is only when the investor disposes of (sells) the investment that the gains are potentially liable for CGT.
In this case, the investment has not been sold so there is no CGT due on the unrealised gains.

Question 28

Cognitive bias is a major part of behavioural finance. One element of this bias is the endowment effect. Which of the following investors displays this effect?
ANikolai has a tendency to place a great deal of importance on director’s selling shares in their own company, often at the expense of any other information available BAksana has never made a bad investment - or so she would argue CPavel is more willing to invest money in low-priced shares than he is in high-priced shares, irrespective of whether the share is over- or under-priced DLuka tends to have over-expectations of the price at which she can sell, often missing a peak in her investments by waiting for that extra tick

Answer 28

The correct answer is: D - Luka tends to have over-expectations of the price at which she can sell, often missing a peak in her investments by waiting for that extra tick
Explanation
The endowment effect is that people often demand much more to give up an object than they would be willing to pay for it. This could be attributed to Luka.
Nikolai’s behaviour is more related to the focusing or framing effect.
Aksana’s behaviour shows a choice-supportive bias.
Pavel’s behaviour reflects the denomination effect.

Question 29

The goal of an immunisation strategy is to protect a portfolio from which risk?
AEquity risk BInterest rate risk CCurrency risk DCredit risk

Answer 29

The correct answer is: B - Interest rate risk
Explanation
Immunisation’s aim is to protect against interest rate risk.