Cash, bonds, and Gilts Flashcards
(48 cards)
How is the Annual Percentage Rate (APR) calculated if the monthly rate is known and how would it be calculated on a monthly basis if the annual rate was already known?
What is the AER/APR?
APR = (1+monthly rate)^12 -1
Monthly rate = 12sqr(1+APR)-1)
The annualised rate allowing for the frequency at which interest is paid is referred to as the AER or the effective annual rate
Features of NS&I Direct ISA
- NS&I Direct ISAs can only be opened and managed online or by phone.
- Junior ISAs can only be opened and managed online.
- The Direct ISA is not a flexible ISA, i.e. NS&I has not adopted the flexible ISA rules
Features of NS&I Income Bonds
- Pay a monthly income at a variable rate of interest with no risk to capital.
- Investors must be aged 16 or over.
- NS&I Income Bonds can be cashed in at any time with no notice period or penalty.
- Interest is paid gross but is taxable and can be set against the personal savings allowance.
Features of NS&I bank accounts
- an Investment Account managed by post only; and
- a Direct Saver that can be opened online or over the phone.
Features of NS&I Savings Certificates
Only available to customers who have maturing certificates. They are not on general sale.
Those customers can renew up to the total value of their maturing certificate, including earned interest.
Or they can cash in some of the investment and renew the balance
Features of NS&I Guaranteed Income Bonds
- investors must be aged 16 or over;
- there is a fixed term of one year;
- the minimum investment amount is £500;
- interest is paid gross but is taxable and can be set against the personal savings allowance
- interest is paid once a month.
Features of Guaranteed Growth Bonds
- investors must be aged 16 or over;
- there is a fixed term of one year;
- the minimum investment amount is £500
- interest is paid gross but is taxable and can be set against the personal savings allowance.
Features of Green Savings Bond
- investors must be aged 16 or over;
- issue 4 fixed interest of 4.20%;
- three-year fixed term;
- invest up to a total of £100,000 per person;
- interest is added on each anniversary;
- interest is paid gross but is taxable and can be set against the personal savings allowance.
What are government T-Bills
Via the DMO the government borrows money from mainly 3 months, but can be 1 month or 6 months.
Routinely issued at weekly auctions and have maturities of one, three or six months.
their rate of return is used to benchmark risk-free rate of return.
What is inflation risk?
Risk of losing value as inflation increases.
What is interest rate and reinvestment risk?
The risk that the return earned will vary depending on movements in interest rates.
Reinvestment risk. The original investment may be made at a time when interest rates are high, but following maturity of the original deposit, rates may have fallen and it may not be possible to secure the same level of interest.
What is deflation and what are the key points surrounding it?
A decrease in the price level of goods and services, or when the annual inflation rate is below 0%.
Fall in demand/reduction in economic activity.
Greater tendency to save/borrow less.
Debt increases in value.
If the supply of goods rises faster than the supply of money, the purchasing power of money increases and the general price level of goods falls.
Consumers become reluctant to buy expensive items, such as cars and homes, as they know these will be cheaper in the future.
Once deflation occurs, it is self-perpetuating, as reduced output and profits will lead to businesses cutting their workforce, creating unemployment.
State and describe the type of money market funds
Short-term money market funds
Invested in short-term debt and money market instruments and have a weighted average maturity of no more than 60 days and a weighted average life of no more than 120 days.
Standard money market funds
Aim to make slightly higher returns and therefore invest in assets with extended maturity periods of six and twelve months.
What are the uses of a money market fund?
- a short-term home for cash in times of market volatility;
- an alternative to savings accounts, but not while short-term interest rates are kept deliberately low; and
- a home for the cash element within a portfolio’s asset allocation strategy.
What are the risks posed by money market funds and how are these somewhat mitigated?
Money market funds carry many of the same risks as other cash investments: credit risk, inflation risk and interest rate risk, and may also have currency risk.
Holding funds in a cash investment exposes the investor to the risk of failure by the bank or savings institution.
Money market funds invest in a range of instruments from many providers, diversifying the risk of a single institution failing.
Risk depends on the types of instrument invested and the credit rating of issuing institutions.
How is the following bond name interpreted:
‘2% Treasury Gilt 2025
The title tells us that the issuer is the UK Government (HM Treasury) and that the bond will mature in the year 2025.
The 2% coupon means that for a £1,000 nominal holding of this bond, the Government will pay £10.00 every six months until it is finally repaid in 2025
What is the key factor of Eurobonds?
The defining characteristic of Eurobonds is that they are denominated in a currency different from the financial centre (or centres) in which they are issued
What is the break-even inflation rate?
the rate of inflation that gives the same real net redemption yield for an index-linked gilt and a comparison conventional gilt of similar maturity for investors in a given tax rate, 20%, 405 45%.
Above the break even rate, the index linked gilt gives the better return.
Below the break even rate, the conventional gilt gives the better return.
What is a convertible bond?
They give the investor the right to convert the bond into a pre-defined number of ordinary
shares in the issuing company, on a set date or dates or between a range of set dates, prior
to the bond’s maturity
How do you calculate the conversion premium/discount?
(market price of convertible stock / (conversion ratio x market price of shares) - 1) x 100
calculate the conversion premium/discount where:
A company has issued a 5% convertible unsecured loan stock at £100 nominal. This can be converted into the company’s ordinary shares at a rate of 25 ordinary shares for every £100 nominal of the loan stock.
Let’s assume that the bond is trading at 110p to yield 4.5% and that the ordinary shares are priced at 400p:
bond = £100 (parr) x £1.10 = £110 market value
shares = 25 x £4,00 = £100 market value
conversion premium:
£110 / (25 x £4.00) - 1 x 100 = 10%
the convertible is at a premium to the ordinary shares, and so buying the convertible bond is a more expensive route than buying the ordinary shares directly. The higher the premium, the more the convertible loan stock will behave like a conventional stock.
If the price of the convertible stands at a discount to the price of the ordinary shares, then it would be a less expensive way of buying into the company’s ordinary shares or may be worth converting.
The lower the premiums, the nearer the loan stock will be to conversion and therefore, the closer its price movements will be to that of the company’s equity.
What are the risks of buying foreign bonds?
Credit/default risk
Economic risk
Foreign Exchange risk
Interest rate risk
Liquidity risk
Political risk
What are the main risks of holding either corporate or government bonds?
Credit risk - payment of coupon and capital may not be made
Market risk - inverse relationship between bond prices and interest rates
Inflation risk - real value of bond coupon and redemption repayment
liquidity risk - bond not easily traded
exchange rate risk
State the 3 types of credit risks for bonds
Default.
Downgrade.
Credit spread.
