Exam Questions Flashcards
(272 cards)
1
Q
Identify four benefits of investing via a GIA compared to an onshore investment
bond. (4 marks)
A
• Wider range of investments.
• No internal/underlying taxation.
• Gains assessed to CGT/CGT rate lower than IT rate.
• CGT annual exemption.
• CGT liability extinguished on death.
• Auto ISA available.
• Simple to understand.
2
Q
Describe briefly what is measured by Macaulay duration. (6 marks)
A
• Weighted;
• average term;
• in years;
• for purchase price to be paid back;
• by cash flows/coupons;
• and redemption value.
3
Q
Explain briefly how Macaulay duration would be used within a fixed interest
portfolio. (2 marks)
A
• Portfolio immunisation/liability matching.
• Predict returns.
• Hedge out interest rate risk.
4
Q
Explain briefly how modified duration would be used within a fixed interest
portfolio (2 marks)
A
• Reduce/measure interest rate risk/sensitivity.
• Reduce/manage duration risk
5
Q
Identify five economic or market factors that would likely cause an increase in the
duration of a fixed interest fund. (5 marks)
A
• Peak interest rates/rates expected to fall.
• Peak inflation/expected to fall.
• Bond yields high/equity risk premium low.
• Attractive entry point/institutional flows.
• Reduction in net/new issuance.
• Central bank action.
6
Q
Describe the main characteristics of growth and value investment strategies. (10 marks)
A
Value
• Aims to identify undervalued stocks/value is less than intrinsic value.
• Considers out-of-favour stocks/takes contrarian view.
• Places greater emphasis on dividends/high dividend coverage.
• Looks at fundamentals of company/tends to focus on low P/E or PEG.
• Assumes market is not efficient.
• Assumes mean reversion/mispricing will correct over time.
• Tends to be longer term.
Growth
• Aims to identify stocks with potential for above average share price growth.
• Higher growth rate in EPS/competitive advantage/high free cash flow/high growth
sectors.
• Tends to ignore valuation/fundamental analysis.
• Tends to focus on high P/E or PEG;
• Places lower reliance on dividends/low dividend coverage.
7
Q
Explain the objective of regression analysis and identify two ways in which it can be applied in investment planning. (4 marks)
A
• Predict;
• one variable;
• based upon information;
• from another variable.
• Calculate historical data/beta within multi-factor portfolio.
• Calculate correlation/covariance of relationship.
• Calculate impact of economic changes.
• Analyse portfolio performance to identify investment style.
8
Q
Explain what is measured by the r-squared value in respect of the fund. (4 marks)
A
• The percentage;
• changes in the fund;
• that can be explained by movement;
• in the benchmark/index.
• Identifies suitability/fit of a benchmark.
• Can identify beta and alpha derived from fund’s composition.
9
Q
State three drawbacks of using the MWR. (3 marks)
A
• Influenced by cashflows/timing of new money;
• that are outside of manager’s control.
• Not suitable for comparing portfolios.
• Does not show fund manager’s skill.
10
Q
Identify four main risks of investing in structured products and state one example of each type of risk. (8 marks)
A
• Accessibility
• Can not sell/unable to withdraw money for 2 years.
• Counterparty
• Derivatives provider may default.
• Index
• May not provide expected returns/may fall immediately before maturity
• Reinvestment
• May have to reinvest on worse terms/can’t reinvest on similar terms.
• Capital
• Return may be less than amount invested.
• Income
• No income/participation in dividends.
11
Q
Outline the main features of NS&I Income Bonds. (7 marks)
A
• Paid gross;
• monthly;
• but taxed as savings income/PSA available.
• Minimum investment £500.
• Maximum investment £1,000,000.
• Can invest jointly/maximum amount is per person.
• Instant access/penalty free.
• Interest must be paid out/cannot accumulate.
• Interest rate is variable.
12
Q
State three reasons why NS&I Income Bonds may be more suitable than NS&I
Green Savings Bonds for Cassie and Tasuku. (3 marks)
A
• Income Bond maximum investment higher/Green Savings Bond lower.
• Income Bond interest rate higher/Green Savings Bond lower
• Income Bond interest is paid out/Green Savings Bond interest is rolled-up.
• Income Bond instant access/Green Savings Bond fixed term/cannot access until
maturity.
• Income bond interest taxed in year of receipt/Green Savings Bond interest all
taxed in final tax year.
• Income Bond interest rate variable/Green Savings Bond rate fixed.
13
Q
State four benefits of using the CAPM. (4 marks)
A
• Model is easy to use/calculate.
• Robust/proven.
• Accounts for systematic risk/beta.
• Assumes non-systematic risk has been removed.
• Output is the expected return/can be used to compare funds.
14
Q
Outline three main differences between a fund of funds (FoF) service and a
managed portfolio service (MPS). (3 marks)
A
• FoF is one fund/MPS is a collection of funds.
• FoF trades within the fund/MPS trades as the investor.
• FoF does not create CGT on fund switches/MPS creates CGT on fund switches.
• FoF investor has control/MPS investor has no control over CGT.
15
Q
Identify five provider-related factors that an adviser would take into
consideration when evaluating a DIM service. (5 marks)
A
• Past performance/track record.
• Investment objective/style.
• Manager expertise/reputation.
• Cost.
• Minimum investment.
• Size/financial strength.
• Use of high risk/illiquid assets.
• Choice of custodian.
16
Q
Identify four main risks of using a DIM service compared to investing in a FoF. (4 marks)
A
• Overtrading/higher costs.
• Service may incur tax liability.
• Overlap/duplication with non-DIM portfolio/concentration risk.
• DIM acts outside its mandate/deviation from benchmark/style drift.
• Regulatory issues/basis of contract/DIM can make decisions without client’s
permission.
17
Q
Identify and explain briefly the four main investor return objectives. (8 marks)
A
• Capital Preservation
• Minimise loss;
• after inflation.
• Capital Appreciation
• through capital gains.
• Current Income
• Focus on investments that generate interest/dividend.
• Total Return
• through combination of income and capital gains.
18
Q
State five main client-related factors that impact investment returns and a
portfolio’s capability to achieve its objectives. (5 marks)
A
• Time horizon/expected Investment term.
• Requirement for income/capital/emergency fund.
• Tax Position.
• Availability of allowances and reliefs.
• AtR/CfL.
• Investor psychology/behavioural biases.
19
Q
State the three main types of benchmark and describe briefly the purpose of each
type. (6 marks)
A
• Constraint
• Used to limit the construction of a portfolio.
• Target
• Used to match/exceed performance.
• Comparator
• Used to compare performance/risk.
20
Q
Outline briefly the main differences between current and non-current assets on a company’s balance sheet. (3 marks)
A
• Current short-term/within 12 months/Non-Current long term/more than 12
months.
• Current used for day-to-day operations/Non-Current for longer term revenue
generation.
• Current easier to value at market value only/Non-Current valued at cost less
depreciation.
• Current taxed as revenue/Non-Current taxed as capital.
21
Q
State two categories of assets that would be found under each of the Current and
Non-Current headings of a company’s balance sheet. (4 marks)
A
Current
• Stock/inventory.
• Cash/bank deposits/short term investments.
• Trade receivables/debtors.
Non-Current
• Tangible.
• Intangible.
• Investments.
22
Q
Identify three differences in the main listing criteria between AIM and the UK
main market. (3 marks)
A
• AIM no minimum market capitalisation/Main market £30 million.
• AIM no minimum earnings/Main market 3 years revenue record.
• AIM no minimum free float/Main market minimum 10%.
• AIM no admission document/prospectus (unless shares issued to public)/Main
market prospectus.
• AIM nominated adviser/Main market listing sponsor.
23
Q
Describe briefly how a market capitalisation-weighted index is constructed. (4 marks)
A
• Sum of;
• share price multiplied by;
• shares outstanding;
• of all constituents/companies in the index;
• adjusted for free float.
24
Q
State two asset types that are permissible investments within an IFISA. (2 marks)
A
• Cash/deposit.
• Peer to peer loans.
• Crowdfunding debentures/debt/bonds issued by charities.
• Alternative finance arrangements/Sharia accounts.
25
Identify three main risks specific to investing in an IFISA. (3 marks)
• Credit/default.
• Institutional/provider.
• Accessibility.
• Event.
26
Outline nine factors that Silvia would take into consideration when conducting the
annual review with Tadeusz. (9 marks)
• Change in needs/objectives/circumstance/income & expenditure.
• Change in health/marital status/dependents/vulnerability.
• Value of industrial unit/other assets/emergency fund.
• Liabilities.
• Any gains/use of CGT annual exemption/ISA allowance/ AA/DA/PSA availability.
• Changes in legislation/Budget/taxation.
• Performance against benchmark/target.
• On-going suitability.
• AtR/CfL.
• ESG/ethical considerations.
• Level of service/advice proposition/adviser charges.
• Market/economic outlook.
• Any additional capital/money to invest/inheritances.
27
Describe what beta represents and what it measures. (4 marks)
• Beta represents market/systematic risk;
• a measure of volatility;
• movement/correlation/sensitivity;
• relative to/explained by the market.
28
Explain briefly the limitations of using beta as a measure of risk. (3 marks)
• Measures market risk/return alone/ignores other factors.
• Assumes risk-free rate is correct/suitable.
• Not stable/not consistent over time.
• Not an accurate predictor of future return/based on historical data.
29
Identify the main differences between GAARP and growth investing. (3 marks)
• Lower P/E /PEG ratios than growth.
• Avoid excessive valuation/only pay fair price.
• Not pure growth/mix of value and growth.
30
State the two main risk-adjusted ratios used to analyse an actively-managed fund and explain briefly what each ratio measures. Exclude alpha from your answer. (6 marks)
• Sharpe Ratio
• Excess return for every unit of risk/risk-free rate.
• Excess return over standard deviation.
• Information Ratio
• Excess return over benchmark/in relation to tracking error.
• Consistency of manager.
31
State the main rules that a fund must adhere to in order to qualify as a real estate investment trust (REIT). (8 marks)
• UK resident/listed.
• Closed-ended/only one share class.
• Property rental/ring-fenced business;
• at least 75%;
• of total gross profits;
• of total value of assets.
• Interest on borrowing covered;
• at least 125%;
• by rental profits.
• Distributes;
• at least 90% of exempt profits;
• within 12 months of accounting period.
32
Outline four benefits of introducing commercial property to the asset allocation of Tadeusz's GIA portfolio. (4 marks)
• Increase diversification/reduced systematic risk.
• Reduced positive correlation/increased negative correlation/move toward non-
correlation.
• Reduced equity market/volatility risk.
• Increased income.
• Hedge against inflation/real asset.
33
Identify four main risks when investing in physical commercial property through
open-ended collective funds and state one reason for each risk. (8 marks)
• Liquidity
• Fund forced to sell properties/limited cash within OEIC/properties hard to sell.
• Accessibility
• Unable to access money/fund gated/dealing suspended.
• Pricing
• Swing pricing/pricing basis changes/dilution levy applied.
• Valuation
• Material uncertainty/unable to provide NAV.
• Void
• Loss of tenant/property empty
• Income
• Loss of yield/unable to collect rent/reduction in rent.
34
State four of the main assumptions used in portfolio optimisation. (4 marks)
• Risk.
• Historical data.
• Forecasts.
• Costs.
• Implementation.
35
Describe briefly the objective of Stochastic modelling. (5 marks)
• Forecast/predict the;
• probabilistic/potential;
• range of;
• returns/outcomes;
• using volatility/standard deviation;
• under different scenarios/simulations.
36
Identify four main drawbacks of using Stochastic modelling. (4 marks)
• Assumptions unrealistic/highly sensitive to changes in inputs.
• Over-reliance/over-confidence in output.
• Output unrealistic/unattainable.
• Difficult to understand/too complex.
• Not client-specific.
37
Describe what is meant by GDP and what it measures. (5 marks)
• Monetary value/total;
• of all final goods/output;
• and services;
• of an economy/a country;
• over a quarter/year.
• Measure of the size;
• and growth of the economy.
38
Explain briefly from an investment perspective the consequences of
globalisation. (4 marks)
• Increased interconnectivity of trade/economies.
• Increased correlation of equity markets.
• Market risk harder to diversify/reduced diversification of equities.
• International exposure through domestic listed companies.
• Increased volatility risk.
• Greater sensitivity to political policy/events.
• Markets increasingly efficient/harder to generate alpha/greater index investing.
• Increased competition for/allocation of investment capital.
39
Explain briefly the tax treatment of friendly society policies within the fund and in the hands of the investor. Exclude the contribution limits from your answer. (4 marks)
Within the fund
• Interest/dividends;
• capital gains;
• are tax-free.
Hands of the investor
• Investment growth is tax-free/free of personal taxation.
40
Identify five benefits of investing in a frontier markets equities fund, compared
to holding direct UK equities. (5 marks)
• Reduction in systematic risk.
• Reduction/removal of non-systematic risk.
• Geographical diversification.
• Exposure to higher growth economies/potentially higher returns.
• Potential returns from currency movements.
• Professional management.
• Potential for alpha/frontier markets not efficient.
• FSCS/investor protection.
• Reduced administration/less involvement.
41
State the main stages of the top-down investment process for a frontier
markets equities fund. (3 marks)
• Geographical allocation.
• Sector weightings.
• Individual stock/security selection.
42
Explain briefly the main investment-related factors that George and Rosemary
would take into consideration when deciding whether to choose active or
passive strategies for the investment into a collective fund. (7 marks)
Active
• Fund style/objective/mandate.
• Manager track record/expertise.
• Alpha/IR/Sharpe/does active justify the cost?
Passive
• Replication strategy/tracking error.
• Is market efficient?
• Counterparty risk.
Either
• Costs/charges.
• Choice/use of index/benchmark.
43
State four main benefits and four main drawbacks of using a stocks and shares ISA as a long-term savings vehicle for retirement, compared to a personal pension plan. (8 marks)
Benefits
• Accessible at any time/before age 55/57.
• 100% tax-free lump sum.
• No need for/not linked to earnings.
• No tax on any income withdrawal.
Drawbacks
• No Income Tax relief/employer contributions.
• Lower investment limit/no carry forward/AA is £60,000.
• Part of estate/can’t write under trust.
• Funds not ‘earmarked’ for retirement/can spend at any time.
• ISA limited to £85,000 FSCS.
44
State three ways in which an investment trust can raise capital. (3 marks)
• Rights issue/open offer.
• Placement.
• Borrowing/gearing.
• Issue bonds
45
Describe briefly the concept of dilution in relation to the investment trust. (3 marks)
• Company issues new shares/number of shares increase.
• Existing shareholders;
• own less of company/shares worth less/NAV per share falls;
• unless buy additional/new shares.
46
State the time limits for reinvestment of the proceeds into an EIS within which
CGT deferral relief would be available to Kambiz. (3 marks)
• Up to 3 years;
• after sale
• Up to 1 year;
• before sale.
47
Outline the main differences between the tax treatment of an EIS and a VCT, if Kambiz wanted to invest some of the sale proceeds into either product. (5 marks)
• VCT no CGT deferral relief/EIS CGT deferral relief.
• VCT dividends tax free/EIS dividends taxable.
• VCT new gain exempt CGT immediately/EIS gain exempt after 3 years.
• VCT no loss relief/EIS loss relief available.
• VCT no business relief/EIS business relief available.
• VCT minimum period to retain Income Tax relief 5 years/EIS 3 years.
• VCT no carry back/EIS carry back available.
48
Identify three main benefits of investing into an EIS portfolio compared to a single
company EIS. (3 marks)
• Non-systematic risk can be reduced.
• Can invest across multiples sectors.
• Professional manager expertise/experience.
• All research, selection and investment decisions made by manager.
• Invest across different stages of underlying companies.
49
Identify three main drawbacks of investing into an EIS portfolio compared to a single company EIS. (3 marks)
• Investment not pooled/not technically a fund.
• Less visibility.
• Increased paperwork/administration/HMRC reporting.
• Low number of investment companies/non-systematic risk not removed.
• Additional layer of charges/discretionary management expensive.
50
Explain briefly the aim of Modern Portfolio Theory (MPT) and how it is achieved. (5 marks)
• Maximum return;
• for given risk;
• via diversification;
• of imperfectly correlated;
• asset classes.
51
State the key assumptions upon which MPT is based. (5 marks)
• Investors are rational;
• and risk adverse.
• Returns are normally distributed.
• Based on historical data.
• Investors have access to all information.
• Market is efficient/no one investor can influence market.
• Unlimited borrowing at risk-free rate.
• No costs/tax.
52
Explain briefly to Mitchell four main benefits of diversification within an investment portfolio. (4 marks)
• Reduce systematic/volatility risk.
• Can remove/reduce non-systematic/specific risk.
• Gain exposure to different asset classes/markets/sectors.
• Optimise/increase stability of returns.
53
Describe briefly what is measured by standard deviation. (4 marks)
• Volatility/dispersion;
• through variation in;
• actual return;
• against mean
54
Outline the main differences between the Consumer Prices Index (CPI) and Retail
Prices Index (RPI) measures of UK inflation. (5 marks)
CPI
• Key inflation measure/BoE target.
• National statistic.
• Geometric/lower than RPI.
• Used by government in payment of state pension/benefits.
• Excludes housing costs/mortgage interest payments.
RPI
• Used for index-linked gilts/planned to be replaced by 2030.
• Not a national statistic.
• Arithmetic/higher than CPI.
• Includes housing costs/mortgage interest payments.
55
Describe briefly the main differences between broad and narrow money. (4 marks)
• Broad includes;
• lending activities;
• and accounts;
• of UK residents.
• Narrow includes;
• operational deposits with the BoE.
• Broad indicator of economy.
• Narrow indicator of consumer confidence.
56
Identify the likely economic consequences of a sustained increase in the UK money
supply. (3 marks)
• Greater velocity/transmission of money.
• Increased borrowing/spending/economic growth.
• Increase in prices/inflation.
• Tightening monetary policy/rise in interest rates.
57
State three drawbacks that Mitchell should consider when using ROE as a measure of a company’s performance. (3 marks)
• Only shows return on shareholder equity/funds.
• Ignores borrowing/other sources of capital.
• Difficult to compare with different companies.
58
State five non-financial factors that could influence Mitchell’s attitude to risk. (5 marks)
• Expertise/experience/knowledge/understanding.
• Age/state of health/his dependents.
• Parents/the business’ position.
• Investor psychology/framing.
• Society/collective mood/friends/peers/media.
• Political/economic outlook/environment.
59
State four ways in which capacity for loss can be mitigated. (4 marks)
• Invest only what he can afford to lose/invest less.
• Reduce AtR/lower risk investments.
• Hold sufficient cash to cover the potential loss.
• Discussion and understanding in advance.
• Establish the actual risk he is able to take/not focus on outcome.
• Avoid over-reliance on tools/questionnaires.
60
State four ways in which an Enterprise Investment Scheme (EIS) could provide Mitchell with greater tax planning opportunities compared to his stocks and shares ISA. (4 marks)
• Higher investment limit/can invest up to £1m/£2m if Knowledge Intensive Company.
• Can carry back to previous tax year.
• 30% Income Tax relief.
• CGT deferral relief available.
• IHT/business relief available.
• Loss relief available
61
Describe briefly the objective of gearing within an investment trust. (3 marks)
• To increase available funds/make investments;
• without using cash/going to shareholders/selling assets.
• To increase exposure to other assets.
• To increase returns.
62
Explain briefly the possible consequences that could result from an investment
trust increasing its level of gearing. (4 marks)
• Higher volatility/standard deviation.
• Gains/losses magnified.
• Increased sensitivity to interest rates/interest rate risk.
• Increased borrowing costs/returns eroded by interest costs.
• Forced seller if borrowing limits/covenants exceeded.
• Change in investor sentiment/supply & demand/NAV.
63
Describe briefly what is meant by an investment trust trading at a discount. (3 marks)
• Share price;
• below;
• NAV.
64
Identify five possible reasons for the current level of discount at which Strategic Long View plc is trading. (5 marks)
• Holds unlisted securities.
• Sector out of favour/institutional shareholders selling.
• Manager out of favour.
• Poor recent trust performance.
• Ejection from index.
• Level of gearing/impact of higher borrowing costs.
65
Identify the three main income options that could be available on the platform’s cash account to support Patrick in meeting his income need (3 marks)
• Ability to pay just dividends/natural income.
• Ability to pay fixed/regular levels of income.
• Ability to pay ad-hoc/one-off withdrawals.
66
Explain briefly to Patrick how tactical asset allocation differs from strategic asset allocation. (4 marks)
• Strategic is long term / Tactical is short term.
• Strategic has a fixed asset-allocation / Tactical varies the asset-allocation.
• Strategic reviewed less frequently / Tactical reviewed more frequently.
• Strategic trades less frequently / Tactical trades more frequently.
• Tactical aims to take advantage of market movement.
67
State three client-related factors that could impact upon Patrick’s income
requirement in retirement. Exclude attitude to risk and capacity for loss from your answer. (3 marks)
• Health condition/state of health/ life expectancy.
• Marital status/dependents.
• Other income sources.
• Other assets/liabilities/emergency fund.
68
Describe five actions that Patrick could take to mitigate the effects of sequencing
risk. (5 marks)
• Work longer/defer retirement date.
• Reduce level of income.
• Take natural income only.
• Change the frequency of income.
• Purchase annuity/secure proportion of income.
• Reduce equities/holding in Strategic Long View.
• Buy higher yield assets/fixed interest/diversify asset allocation.
• Hold sufficient cash.
69
State three main benefits of owning a gilt-based collective fund compared to
owning Gilts X and Y on a direct basis. (3 marks)
• Invest across range of maturities/durations.
• Invest across range of coupons.
• Fund manager expertise/potential for outperformance.
• Less administration/knowledge required.
• Able to access gilts at issue/not available directly.
70
State three main drawbacks of owning a gilt-based collective fund compared to
owning Gilts X and Y on a direct basis. (3 marks)
• Higher on-going charges.
• Annual interest/redemption yield not known.
• Less/no control.
• Potential CGT liability on sale.
• Manager may underperform/not add value.
• Investor protection limited to £85,000/subject to FSCS limit.
71
Identify three reasons why index-linked gilt prices would fall when inflation itself is rising. (3 marks)
• Interest rates increase faster than inflation/real yields increase.
• Actual inflation exceeds expected inflation.
• Expectation of lower inflation in future/inflation transitory.
• Indexation lag.
• UK downgraded.
• Index-linked coupons small part of overall return/not being compensated for inflation
increase.
• Increased supply/issuance.
72
Outline the effects of increases in interest rates on conventional fixed interest
securities. (4 marks)
• Fixed coupon less attractive;
• so price/capital value falls.
• Yield rises/new bonds issue with higher coupon.
• Longer dated bonds see larger falls.
• Lower coupon bonds see larger falls.
73
State the main objectives of quantitative tightening (QT). (3 marks)
• Slow economy down/reduce consumer spending.
• Reduce liquidity/withdraw money from circulation.
• Raise interest rates/make monetary policy restrictive.
• Reduce inflation.
74
Explain briefly to Tommaso the consequences of a central bank implementing QT (3 marks)
• Increased supply of bonds causes prices to fall;
• and yields to rise.
• Borrowing becomes more expensive/less disposable income.
• Savings rates increase/become more attractive.
• Inflation comes down/reduces.
• Lenders unable to lend as much/less credit available.
75
Identify four main factors that would cause the UK yield curve to steepen. (4 marks)
• Sell-off in long dated gilts/increased demand for short dated gilts.
• Expectation of higher inflation/interest rates in future.
• Excessive economic growth.
• Expansionary fiscal policy.
• QT.
• Market shock.
76
Comment on the investor protection when investing in gilts and state, giving your reasons why, whether all of Tommaso’s portfolio is protected. (4 marks)
• Gilt fund covered by FSCS;
• up to £85,000/not fully protected if investment above this.
• Direct gilts backed by government;
• without limit;
• however not guaranteed/still subject to credit risk.
77
Identify six main risks of investing in a global emerging markets equities fund and provide one reason for each risk. (12 marks)
• Currency
• Adverse exchange rate movement/lack of/cost of hedging.
• Economic
• Different stage of business/economic cycle at same time/reliance upon foreign
currency/capital flight.
• Concentration
• Index composition/weighting may be different.
• Political
• Political decisions/instability.
• Liquidity
• May not be able to divest quickly/at fair price.
• Governance/legal/regulatory
• Lower accounting standard/less transparency/less corporate governance.
• Manager
• May not have local knowledge/experience in geography.
78
State the options that are available to Johanna at the forthcoming maturity of the issue
of Index-Linked Savings Certificates. (3 marks)
• Renew at a new term of same length.
• Renew at a new term of different length.
• Cash it in.
79
Explain briefly to Johanna how the total maturity value of the Index-Linked Savings Certificates is calculated. No calculations are required. (4 marks)
• The original value;
• plus, interest;
• plus, inflation.
• using CPI.
80
Identify four main benefits of investing in NS&I products. (4 marks)
• No market risk.
• Accessible/highly liquid/deposit-based.
• Guaranteed/government backed/low default risk;
• without limit/above £85,000/FSCS limit.
• No charges.
81
Outline the tax treatment of Johanna’s holding of NS&I Green Savings Bonds. (3 marks)
• All/3 years’ interest;
• taxable at 45%/additional rate;
• at maturity/end of term.
• Taxed as savings/income tax/PSA not available.
82
Explain briefly why Mathieu and Johanna would use the TWR rather than the money weighted return (MWR) when evaluating the performance of the fund. (3 marks)
• Better for comparing funds.
• Not influenced by cash flow/timing;
• as outside of manager control.
• Focuses on individual manager/performance.
• TWR compounds multiple sub-periods/shows change over entire period.
83
Describe briefly the main functions of the authorised corporate director (ACD) in
respect of the structure and operation of an OEIC. (4 marks)
• Compliance and regulatory reporting.
• Responsible for pricing/valuations.
• Appoints/oversees manager.
• Buys/sells shares.
• Maintains shareholder register.
• Maintains liquidity/imposes dilution levy.
• Prepares accounts.
84
Describe briefly the main functions of the depositary in respect of the structure and
operation of an OEIC.(4 marks)
• Acts as custodian;
• safeguards assets.
• Collects/pays income distributions.
• Monitors ACD;
• on investment/borrowing limits.
• Deals with any wind-up of fund.
85
Explain briefly the tax treatment of dividends paid from a VCT and from a SEIS. (3 marks)
VCT
• Tax-free
SEIS
• Dividend allowance available/ first £2,000 taxed at 0%.
• 8.75% / 33.75% / 39.35%.
86
Explain briefly reinvestment relief in respect of investment into a new SEIS. (3 marks)
• 50% of gain;
• exempt;
• up to maximum £100,000.
• Must receive/qualify for Income Tax relief.
87
Explain briefly disposal relief in respect of investment into a new SEIS. (3 marks)
• Gain exempt;
• if shares held for/after 3 years.
• Must have qualified for Income Tax relief/relief not withdrawn.
• Applies to loss or gain/loss relief.
88
Outline the main benefits to Syed offered by segmentation of the onshore
investment bond. (5 marks)
• Can encash whole segment/segments in full/all segments.
• May keep Syed as BRT/prevents HRT/maximises any top-slicing.
• Defers gains/chargeable event for longer.
• Takes into account investment performance/actual gain or loss.
• Can reduce chargeable gains/more tax efficient.
• Can assign/gift segments.
89
Describe the regular withdrawal facility of the onshore investment bond
including the tax treatment based upon Syed’s Income Tax position. (6 marks)
• Up to 5% pa;
• of original investment/£75,000
• Cumulative/unused 5% carried forward.
• Deemed as return of capital.
• Tax-deferred;
• to 20 years/surrender/death.
• Corporation Tax paid internally.
• 20% BRT deemed paid/additional 20% if becomes HRT.
90
Describe briefly the basic principle and objective of top-slicing relief. (4 marks)
• Divides excess/gain;
• by number of policy years;
• in order to give average yearly gain;
• in order to reduce/mitigate;
• higher rate tax liability/keep Syed as basic rate taxpayer.
91
Identify the main differences between an unfettered fund of funds and a manager of managers fund. (4 marks)
• FoF is multiple funds/MoM is single fund.
• FoF has additional charges/layer of AMC/MoM does not.
• FoF has to sell the fund/ MoM switches only manager.
• FoF has no control over mandate /MoM has more control.
• FoF is less transparent/MoM is more transparent.
• FoF affected by capacity/MoM does not impact external manager’s capacity.
92
State the main component parts of the UK’s current account. (4 marks)
• Goods/visible trade.
• Services/invisible trade.
• Plus investment income/primary income/overseas earnings;
• transfer payments/secondary income/capital and asset movement.
93
State the main component parts of the UK’s capital account. (3 marks)
• Foreign investments/ assets.
• Foreign loans/borrowings.
• Foreign currency/reserves.
94
Describe briefly three ways in which a current account deficit could be
balanced out. (3 marks)
• Met by capital account surplus.
• Foreign investments/loans.
• Sale of foreign currency reserves.
• Central bank intervention.
95
Explain the limitations of Reg relying on the dividend cover and yield from Tall
Curve plc when considering his income need. (6 marks)
• Dividend info is historical/income need is for future.
• Dividend cover is low/dividend is at risk/not sustainable.
• Dividend not fixed/can change.
• Can be distorted by other/one-off factors.
• Will be affected/reduced by share buybacks.
• Dividend allowance about to reduce/excess subject to dividend rate of tax/
dividend tax rate can increase.
• Focuses on/ignores capital value.
96
Identify eight main factors that could affect the share price of Tall Curve plc. Exclude market movement from your answer. (8 marks)
• Economic outlook/stage of economic cycle.
• Changes in legislation/regulation.
• Change in sector sentiment/competition/business risk.
• Corporate event/profit warning/guidance/dividend cut.
• Investor or market sentiment/broker or credit rating change.
• Takeover speculation/activity.
• Change in/bad management.
• Accounting issue/fraud/scandal.
• Inclusion/removal from an index.
97
State three advantages to Reg of owning a direct equity compared to his collective
funds. (3 marks)
• Greater potential growth/no loss of return through diversification.
• No on-going costs/AMC.
• Greater control/involvement/voting rights.
• Direct link between share price and return/can trade real time.
98
Explain the main objectives of the rebalancing process for an investment portfolio
where the client has an income need. (6 marks)
• Realign/return portfolio to original;
• asset allocation/weighting;
• to match AtR/CfL.
• Correct portfolio style/drift.
• Take profits/sell outperforming funds.
• Top up/buy underperforming funds.
• Invest inflows/new money.
• Maintain/increase cash.
• Ensure income can be maintained/is sustainable against target.
• Utilise tax allowances.
99
Describe the main characteristics of a value-based investment style. (7 marks)
• Bottom-up;
• uses fundamental analysis to find;
• stocks that are under-valued/out of favour/mis-priced.
• Low P/E;/P/B;
• or high dividend yield.
• Potential for re-rating/mean reversion.
• Often contrarian.
• Long-term view.
100
State and explain briefly the two central principles of the CAPM. (4 marks)
• Non-systematic/specific risk can be eliminated/diversified;
• is not rewarded.
• Sensitivity to systematic/market risk;
• dictates expected return.
101
State four benefits and four drawbacks of using the CAPM. (8 marks)
Benefits
• Easy to use/calculate.
• Robust/proven/trusted.
• Allows for systematic/market risk.
• Ignores non-systematic risk/assumes it has been removed.
• Output is the expected return/easy to compare
Drawbacks
• Risk-free rate may not be suitable/correct.
• Assumptions can be unrealistic/the market return may be different.
• Assumes beta as the correct/suitable measure of market risk.
• Beta is unstable.
• Doesn’t include costs and charges.
• Assumes single holding period/one-size fits all.
• Theoretical/single factor/simplistic.
102
Describe briefly what is measured by Macaulay duration. (5 marks)
• Weighted
• average term;
• in years;
• for purchase price to be repaid;
• by cash flows/coupons
• and redemption value.
103
Describe briefly what is measured by modified duration. (3 marks)
• Sensitivity;
• of bond’s price;
• to changes in interest rates/yield to maturity.
104
State three factors Edyta should be aware of when assessing Macaulay duration
figures across different bond funds. (3 marks)
• Macaulay is relative/can be used to compare funds.
• Affected by coupon/price.
• Becomes less accurate as change in yield increases.
• Assumes linear relationship between interest rate and bond price.
• May not reflect fund style/mandate.
105
List three Investment Association (IA) sectors that may be suitable benchmarks
to use solely for the UK sterling fixed interest asset allocation of the portfolio.
Assume there is no exposure to gilts. (3 marks)
• Sterling Corporate Bond.
• Sterling Strategic Bond.
• Sterling High Yield.
106
Identify five main economic factors that may result in an increase in interest rates. (5 marks)
• Business/economic cycle.
• Expansionary fiscal policy.
• Tightening monetary policy.
• QT/unwinding QE.
• Rising inflation.
• Currency weakness/economic imbalance.
• Market forces/credit spreads widening/UK downgraded.
107
Identify three main risks specific to investing in equities on a passive basis using ETFs and state one reason for each risk identified. (6 marks)
• Market/Systematic Risk.
• Limited protection in falling market/will follow market down/cannot hold
cash. or No ability to outperform in rising market/will only deliver market
return.
• Style Risk.
• Replication strategy may cause underperformance/tracking error/drift from
index return.
• Counterparty Risk.
• Failure of counterparty provider.
108
State six fund-related factors that Edyta would consider when deciding whether
to invest solely on an active basis. (6 marks)
• Costs/charges.
• Fund/ style/objective/mandate.
• Alpha/outperformance/past performance.
• Volatility/standard deviation.
• Sharpe/Information ratio.
• Investment house reputation/financial strength.
• Manager experience/track record.
• Dividends/yield.
109
Identify five potential economic consequences of the current account and capital account being in deficit over the medium to long-term. (5 marks)
• Rising interest rates.
• Economy growth falls.
• Currency devaluation.
• Capital flight out of UK.
• Unemployment rises.
• Increase borrowing/debt-dependence/reliance on foreign currency reserves.
• Inflation increases.
110
State the main conditions that must be met for a property fund to qualify as a property
authorised investment fund (PAIF). (7 marks)
• At least 60% of net income;
• from exempt property business/ringfenced.
• Value of property must be at least 60%;
• of total assets.
• Must pay 3 types of income.
• Shares widely held.
• No corporate investor;
• holding 10% or more of NAV.
111
Describe briefly the investor biases of;
(i) herding;
(ii) the endowment effect.
Herding
• Follow others/crowd.
• Fear of missing out.
• Ignore price/greater fool theory.
Endowment effect
• Greater value as inherited/already owned.
• Retain unsuitable investments/emotional attachment.
• Fear of selling.
112
Identify three benefits of investing in a thematic-based specialist fund. (3 marks)
• Potential higher returns.
• Expertise of fund manager/scope for alpha/outperformance.
• Invest in early-stage companies/start of trend/long time horizon.
• Lower/negative/non-correlation to other equities/diversification.
113
Identify five likely reasons for the level of fall in value of the NextGen Payment
Solutions fund over the most recent statement period. (5 marks)
• Economic/business cycle downturn.
• Increase in interest rates/inflation/discount rates.
• Higher beta/volatility/standard deviation.
• Poor stock-picking by manager.
• Tech/growth out of favour/sector rotation.
• Exposure to unlisted companies/deemed illiquid.
• One off event causes write-down/devaluation of underlying assets.
114
List four main types of socially responsible investing. Exclude environmental, social
and governance (ESG) from your answer. (4 marks)
• Positive screening/engagement.
• Negative screening/ethical.
• Impact/microfinance.
• Sharia-complaint/religious.
115
State two examples within each category of the Environmental, Social and
Governance (ESG) criteria for investing. Exclude the terms environment, social and
governance from your examples. (6 marks)
Environmental
• Reduction of Pollution/waste/recycling.
• Climate Change/decarbonisation/ renewable energy use.
• Conservation/treatment of wildlife.
Social
Social:
• Human rights/education.
• Employee working conditions/benefits/diversity.
• Charities/community/affordable housing.
Governance
• Accounting practices.
• Board diversity/gender equality.
• Conflicts of interest/bribery/corruption.
116
State two benefits and two drawbacks of using the Sharpe Ratio in investment
planning. (4 marks)
Benefits
• Compare different funds/managers.
• Shows risk-adjusted return.
• Identify if returns are from excess risk/beta or manager/stock-picking.
Drawbacks
• Need to consider other factors/trends over time/do not consider in isolation.
• Can be distorted by fund/manager’s strategy/higher risk.
• Assumes normal distribution of returns/standard deviation as measure of risk.
• Doesn’t take into account trading/turnover/costs.
117
Describe briefly the definition and objective of a volatility managed fund. (3 marks)
• Target a specified return/maximise returns;
• while limiting volatility/to specified volatility target;
• using correlation/diversification;
• of asset classes/lower risk assets;
• to produce higher risk-adjusted returns.
118
Outline why a volatility managed fund could be a suitable investment for
Martim. (3 marks)
• In line with AtR.
• Provides diversification within a small portfolio.
• Could reduce market/volatility risk/hedge against market fall.
• Sufficient time horizon.
• Known/target level of volatility.
119
State five main administration benefits to Sandra of consolidating her existing
investment assets onto a platform. (5 marks)
• In one place/single view.
• Access to tools.
• Auto ISA.
• Consolidated tax statement/voucher.
• Less administration.
• 24 7/on demand access/view online.
120
Explain briefly the drawbacks of Sandra using ROCE as a metric when comparing
Best Guest and Rockflour Boutique. (3 marks)
• ROCE is a single metric/single period/need to compare over time/doesn’t
factor in when funds are raised over period
• Affected by one-off factors/distorted by high cash/doesn’t account for current
liabilities/doesn’t account for depreciation or amortisation.
• Sandra is a shareholder only/ROCE calculates return for all
sources/shareholders and creditors.
121
Identify two main differences between an interim and a final dividend. (4 marks)
• Interim declared during financial year/before AGM
• Final declared after financial year/at AGM
• Interim declared by board.
• Final declared by shareholders.
• Interim can be revoked.
• Final cannot be revoked.
• Interim only if Articles expressly permit.
• Final not subject to Article/right of shareholders.
122
Outline the potential tax benefits to Sandra of receiving a dividend on her new
shareholding compared to receiving a bonus in addition to her salary. (3 marks)
• Can use dividend allowance
• Not subject to National Insurance.
• Taxed at 33.75% compared to 40%.
123
Describe the tax benefits and qualifying rules of an EIS, including the time limits
for deferral relief. Exclude Income Tax relief from your answer. (8 marks)
• for up to 1 year before;
• 3 years after;
• sale of the business/disposal.
• Can invest up to £1,000,000/if knowledge intensive £2,000,000.
• Original gain deferred;
• without time limit.
• Gain on EIS exempt from CGT;
• if held for 3 years.
• Loss relief available;
• against capital or income.
• Exempt from IHT/qualifies for business relief;
• if held for 2 years.
124
State four limitations of using alpha to measure a fund’s performance. (4 marks)
• Doesn’t explain source/reason for outperformance.
• Assumes CAPM/market/benchmark/risk-free rate/ is suitable/correct.
• Relative to beta/assumes beta is correct measure of risk.
• Ignores costs/charges.
• Only suited to comparing equity/similar funds.
125
State the information that an ISA administrator would require in order to process
an additional permitted subscription (APS) request by a surviving civil partner. (6 marks)
• Deceased’s;
• name;
• address/proof of residency;
• NI number;
• date of birth;
• date of death;
• date of partnership.
126
Describe the main differences in the structure of an OEIC and an Investment Trust. (8 marks)
OEIC
• Unlimited shares/can create new shares.
• Redeems shares linked to NAV.
• May be standalone or sub-fund of ICVC.
• Must appoint an ACD.
• Assets held by depositary.
• Can borrow on temporary basis/up to 10%.
Investment Trust
• Fixed number of shares/finite share capital.
• Shares bought/sold independent of NAV.
• Listed company.
• Has board of directors.
• Can borrow on permanent basis/unlimited.
• May have fixed life/winding up date.
127
Describe the main differences in the pricing of an OEIC and an Investment Trust. (8 marks)
OEIC
• Daily pricing/pricing point;
• Based upon NAV.
• Single priced;
• May apply swing pricing/dilution levy.
Investment Trust.
• Real-time pricing;
• determined by market/supply and demand.
• Dual pricing/bid/offer spread.
• Can trade at discount/premium/independent of NAV.
128
Identify three advantages and three disadvantages of using a GIA for retirement
planning, compared to a workplace pension, to meet Lucy and Clara’s needs. (6 marks)
Advantages
• Accessible at any time/before age 55.
• No limit on contributions/not part of Annual Allowance.
• No limit on future investment value/not part of Lifetime Allowance.
Disadvantages
• No Income Tax relief.
• No employer contribution.
• Taxation within GIA/funds/subject to CGT.
• Part of estate/subject to IHT.
129
Identify six main benefits to Anshul of consolidating his existing collective funds onto a platform. (6 marks)
• Single point of access/all information in one place.
• Multiple tax-sheltered products.
• Less/easier administration.
• Income flexibility/consolidated payment.
• Access to planning tools/bed & ISA, etc.
• Transaction/account history.
• Migration to cheaper share classes/lower fund charges.
130
Explain briefly the CGT rules of any new investment into an EIS, if the investment
were made with the proceeds from the sale of the shares. (8 marks)
• Existing gain;
• deferred until disposal;
• without limits/unlimited;
• can be deferred again.
• New gain;
• exempt from CGT;
• after 3 years;
• if Income Tax relief obtained.
• Loss relief available;
• offset against income or gains.
131
Describe briefly the objective of Stochastic modelling. (5 marks)
• Estimate/forecast/predict the;
• probabilistic/potential/likely;
• range of;
• returns/outcomes and;
• volatility/standard deviation.
• Under different outputs/scenarios/simulations.
132
State the three main inputs required to generate an optimal portfolio via a
Stochastic modelling tool. (3 marks)
• Returns.
• Volatility/standard deviation.
• Time period.
133
Identify four drawbacks of using a Stochastic modelling tool. (4 marks)
• Assumptions/inputs not correct/unrealistic.
• Ignores sequencing risk.
• Over-reliance/over confidence.
• Difficult to understand/too complex.
• Output is unrealistic/unattainable/expected return not accurate.
• Doesn’t factor in client circumstance.
134
Describe briefly what is measured by the ROE metric. (4 marks)
• Ability to generate;
• profit.
• How efficiently it uses;
• shareholders’ funds/capital.
• Relative performance within sector/against peers.
135
State the two main Asset headings within the balance sheet of a company’s
accounts and list two categories of assets that would be found under each
heading (6 marks)
• non-current assets
• Tangible (plant, buildings etc.).
• Intangible/goodwill.
• Investments.
• Current assets
• Stock/inventory.
• Cash.
• Trade receivables/debtors/prepaid expenses.
136
State the three main components of the UK’s capital account. (3 marks)
• Investments/assets.
• Loans/borrowing.
• Foreign currency reserves.
137
State the principal purpose of a capital account surplus within the UK’s balance
of payments (3 marks)
• To finance/fund;
• a current account;
• deficit.
138
Explain briefly the macro-economic role of financial investment within the
economy. (4 marks)
• Stimulates demand/spending;
• by increasing aggregate demand.
• Increases productivity/output;
• and business investment.
139
Describe briefly what is meant by the OCF in respect of a collective fund. (4 marks)
• Single;
• percentage figure;
• that shows the;
• annual cost of;
• investing in/owning a fund.
140
Explain why UK Government Treasury bills are a suitable measure of risk-free
return to use in the CAPM equation. (4 marks)
• Minimal/no default risk;
• Short duration/less than 3 months;
• minimal inflation and;
• interest rate sensitivity
141
State seven main assumptions upon which the CAPM equation is based. (7 marks)
• Investors are rational and risk averse.
• Single/identical holding period.
• No individual can affect the market price.
• Ignores charges/tax.
• Market is liquid.
• Information is fully available to all investors.
• Risk-free rate/treasury bills are suitable to use.
• Investors can lend/borrow;
• unlimited amounts.
• Beta is correct measure of risk.
142
Describe briefly Macaulay duration. (5 marks)
• Weighted;
• average term/number of years;
• discounted/present value of;
• all cash flows/coupons + redemption value;
• from a bond.
143
Explain briefly what is measured by modified duration. (4 marks)
• Measures sensitivity of;
• a bond’s price;
• yield to maturity/redemption yield/interest rates.
144
State one reason why a fixed interest fund manager would use Macaulay duration and one reason why a fixed interest fund manager would use modified duration
within a bond fund. (2 marks)
Macaulay
• Portfolio immunisation/liability matching/hedging out interest risk/predict returns
Modified
• Reduce duration/interest rate risk.
145
State the technical definition of a recession in the UK economy. (5 marks)
• Two;
• consecutive;
• quarters of;
• negative/declining/falling;
• GDP growth.
146
Describe briefly the four main factors that cause UK interest rates to reduce. (4 marks)
• Fiscal surplus/reduction in gilt issuance.
• Monetary policy loosening.
• Reduction in inflation expectations.
• Quantitative easing (QE).
• Credit crisis/safe haven appeal/demand for sterling.
147
State four changes that could be made within the client’s fixed interest portfolio
in the event of an anticipated recession. (4 marks)
• Increase duration.
• Decrease high yield.
• Increase investment grade/gilts/cash/short dated bonds.
• Use derivatives.
148
State the main product features of NS&I Income Bonds. (6 marks)
• Minimum £500;
• Maximum £1 million.
• No minimum term/Instant access/no notice withdrawal/penalty.
• All/100% protected without upper limit.
• Backed by Government.
• Can use personal savings allowance/taxable but paid gross.
• Pay monthly/income must be paid out.
149
List three benefits of investing in NS&I Income Bonds. (3 marks)
• Provides diversification.
• Could invest more than £85,000/higher level of investor protection.
• No volatility/default/market/investment risk.
150
Identify two limitations on the use of NS&I Premium Bonds within the client’s
portfolio. (2 marks)
• Maximum deposit £50,000.
• Interest rate notional/may not win any prize/erosion of money in real terms.
151
Describe briefly what standard deviation measures. (4 marks)
• Volatility/dispersion of returns;
• through variation in;
• actual return;
• against mean return.
152
State the percentage of returns that fall within one and two standard deviations,
based upon the normal distribution of returns of a bell curve. (2 marks)
• 65-70% for 1SD.
• 94-98% for 2SD.
153
Describe the semi-strong form of efficient market hypothesis (EMH). (7 marks)
• Prices adjust/reflect/respond to;
• all;
• public information;
• rapidly and;
• unbiased.
• No excess return/cannot outperform market;
• Includes past prices and;
• company information.
154
State how the semi-strong form of EMH considers technical analysis and
fundamental analysis. (2 marks)
• Fundamental analysis ineffective;
• technical analysis ineffective.
• Neither adds outperformance.
155
Identify five factors that should be taken into consideration if it is agreed at the meeting
to rebalance the portfolio. (5 marks)
• Marital status/dependents/children.
• State of health.
• Other assets.
• Liabilities.
• Provision of emergency fund.
• Ethical/socially responsible investments preferences.
• Capacity for loss.
156
Explain the tax treatment of any investment that Fenna might make into a new VCT. (8 marks)
• For investment of up to £200,000;
• 30%;
• Income Tax relief;
• up to Fenna’s tax liability;
• if held for 5 years.
• Gains exempt from CGT/CGT-free;
• with no minimum period.
• No loss relief/deferral relief.
• Dividends tax-free
157
Identify four additional risks to which Fenna would be exposed if she invested
into a VCT in comparison to her AIM shareholding. (4 marks)
• Accessibility/unable to sell underlying assets.
• Liquidity.
• Manager breaches qualifying rules.
• Manager risk/change in gains or income profile.
• May hold cash/not invest for a while.
158
Compare the main differences in the tax treatment of the gains and withdrawals from onshore and offshore investment bonds, based upon Fenna’s investment needs. (10 marks)
Onshore
• Corporation Tax paid;
• on capital gains made/investment income;
• deemed UK basic rate tax/20% tax paid.
• Chargeable gains subject to 20%.
• Taxed as top part of income/after dividends.
Offshore
• Withholding tax;
• not subject to UK tax internally/gross roll-up.
• Subject to 40% on gains.
• Taxed as savings income.
• No chargeable event on death if on capital redemption basis.
159
State whether strategic or tactical asset allocation would be more suitable for Fenna
given her objectives and give two reasons for your choice. (3 marks)
• Strategic
• Investing for the long-term.
• Objectives known at outset/future target income.
160
Identify the main benefits of owning a gilt-based collective fund in comparison to
a single gilt on a direct basis. (4 marks)
• Active management.
• Diversification;
• across yield curve/maturities/durations.
• Can invest in new gilts at issue.
• Access to market participants.
161
Identify the main drawbacks of owning a gilt-based collective fund in comparison
to a single gilt on a direct basis. (4 marks)
• Exposed to duration risk/manager gets it wrong.
• Loss of known redemption date/yield/coupon.
• Investor protection limited to £85,000.
• Subject to CGT upon disposal.
• Daily dealing.
• Fund charges.
162
State the three types of credit risk that apply to owning direct gilts. (3 marks)
• Default.
• Downgrade.
• Credit spread.
163
State the two options available to the client other than taking up the rights issue in full. (2 marks)
• Do nothing/ignore the issue.
• Sell the rights.
164
List four main smart beta strategies that may be suitable based upon the client’s
objectives. (4 marks)
• Earnings growth.
• Dividend cover.
• Style (growth/value/momentum/quality/low volatility).
• Weighting.
165
Explain three main differences between the Sharpe ratio and the Information
ratio. (6 marks)
• IR uses benchmark;
• Sharpe uses risk-free return.
• IR is relative/can compare funds;
• Sharpe is absolute.
• IR measures consistency over time;
• Sharpe does not.
• IR uses tracking error;
• Sharpe uses standard deviation.
166
State four drawbacks of using the Sharpe ratio in investment planning. (4 marks)
• Need to consider other factors/trends over time/do not consider in isolation.
• Can be distorted by fund/manager’s strategy.
• Assumes normal distribution of returns/reliant upon standard deviation.
• Can be distorted by illiquidity/volatility/trading frequency/costs.
167
State the main rules that a fund must adhere to in order to qualify as a REIT. (8 marks)
• UK resident/listed.
• Closed-ended/only one share class.
• At least 75% of profits;
• at least 75% of total assets;
• relate to property rental/ring-fenced business.
• Interest/borrowing coverage;
• at least 125%.
• At least 90% of profits;
• paid out/distributed;
• within 12 months/one year.
168
Outline six main reasons why a financial adviser would use an investment trust
rather than an open-ended investment company (OEIC) when investing in the
same sector of the market. (6 marks)
• Charges likely to be lower.
• Gearing/borrowing.
• Discount/price arbitrage/higher running yield.
• More flexible/less diversification.
• Ability of board to change/select manager.
• Greater accessibility/liquidity/do not have to sell underlying investments.
• More suitable structure to hold specialist/niche investments/wider range of
investments.
• Dealing frequency/real-time pricing.
169
List four open-ended fund structures that could be used to invest in UK equities.
Exclude OEICs from your answer. (4 marks)
• Unit trust.
• Undertakings for Collective Investment in Transferable Securities
(UCITS)/Société d'Investissement à Capital Variable.
• Exchange-Traded Fund.
• Non-UCITS Retails Schemes.
• Life fund/investment bond.
170
Explain three relative differences between what is measured by alpha and beta. (6 marks)
• Beta measures market risk;
• alpha measures difference between actual return and expected return (implied
by Beta)/not explained by CAPM.
• Beta explained by movements/correlation/in relation to market;
• alpha not explained by movements in market.
• Beta measures volatility;
• alpha measures manager value/stock-picking.
171
Explain briefly the main drawbacks of holding a fund that invests on a single theme or thematic basis. (5 marks)
• Smaller investment universe/fewer managers with experience.
• Costs likely to be higher.
• Dealing frequency of fund/illiquidity of underlying holdings.
• Lack of common terminology/inconsistent application.
• Higher volatility/beta.
• Lack of diversification/greater non-systematic risk.
• Risk of fund closure/short lived/implementation risk/theme being closed.
172
Identify the due diligence factors solely relating to meeting Catherine’s income
needs that the adviser would consider when assessing a potential platform. (4 marks)
• Ability to hold existing assets/equities.
• Ability to continue existing income uninterrupted.
• Cash account minimum balance/interest rate.
• Charging structure.
• Range of income yielding funds available.
173
Identify the main income options available via the cash account that would enable a platform to meet Catherine’s income needs. (3 marks)
• Ability to pay natural income.
• Ability to pay regular income/fixed income.
• Ability to pay ad-hoc/one-off withdrawals.
174
Briefly describe sequencing risk. (6 marks)
• Effect of volatility/fluctuation;
• on the order;
• and timing/frequency of withdrawals;
• and sustainability of income;
• and impact on capital value.
• Effect greater in early years.
175
State five actions that could be taken to mitigate the effects of sequencing risk. (5 marks)
• Reduce/suspend the level of income.
• Change the frequency/order of income.
• Take only natural income.
• Extend time horizon.
• Secure proportion of income/purchase annuity.
• Diversification/change asset allocation/buy higher yielding assets.
• Hold more/at least 6 months in cash.
176
Identify the main differences between an interim and a final dividend. (6 marks)
• Interim declared during financial year/before AGM.
• Final declared after financial year/at AGM.
• Interim declared by board.
• Final declared by shareholders.
• Interim can be revoked.
• Final cannot be revoked.
• Interim only if Articles expressly permit.
• Final not subject to Articles/right of shareholders.
177
Describe briefly what it meant by the term ‘correlation’ in relation to investment planning. (3 marks)
• Covariance/relationship between;
• a pair/two assets;
• adjusted for the risk.
178
Identify the four components of an economy’s current account. (4 marks)
• Goods.
• Services.
• Investment income/overseas earnings.
• Transfer payments/capital and asset movement.
179
State the main forms of ethical investment.
Exclude negative screening from your answer. (3 marks)
• Positive screening/engagement.
• CSR/SRI/Sharia finance/responsible.
• ESG.
• Impact.
180
Identify which other non-equity asset classes could be used for the new money,
to diversify the existing portfolio while maintaining an overall ethical approach. (4 marks)
• Fixed interest/green bonds/charity bonds.
• Infrastructure/renewable energy.
• P2P/social impact.
• Property/social housing/education.
181
Explain three reasons why an equity-based ethical investment strategy could
out-perform an equity-based non-ethical investment strategy. (3 marks)
• Small cap focus shown to outperform.
• Greater concentration.
• Invest at the start of a trend/increase in demand.
• Government subsidies/support/less political/legal risk.
182
State four fund-specific factors that an adviser would consider when researching
ethical funds for potential inclusion in the portfolio. (4 marks)
• Appropriateness of benchmark.
• Ethical criteria/mandate of the fund/United Nations Sustainable Development
Goals.
• Manager’s skill/track record/experience.
• Ethical stance of management group itself.
• Is it aligned with client’s ethical views?
183
Identify three implications to a company of paying out an uncovered dividend. (3 marks)
• May have to cut/reduce dividend;
• unless one off/bad year.
• Use reserves/future profits.
• May borrow/raise capital.
184
Identify one ratio that would appeal to a growth-orientated fund manager and one
ratio that would appeal to a value-orientated fund manager and state two reasons for each selection. (6 marks)
Growth
• P/E ratio.
• High P/E suggests profits expected to rise quickly/future growth.
• Share price increase.
Value
• Dividend yield or dividend cover or low P/E ratio.
• High dividend gives high income/high cover gives consistency to income/under-
valued.
• Share price supported by income available/greater upside.
185
Explain to the client the main differences between ROE and ROCE. (5 marks)
• ROCE considers all assets used in business/return for all sources of capital;
• including debt/borrowing;
• profit measured as earnings before interest and tax/operating profit.
• ROCE useful to compare individual companies and their efficiency.
• ROE based on equity investment only/shareholder return/funds.
186
State three benefits and three drawbacks, of using a stocks and shares ISA as a
long-term investment vehicle for Nicolas and Alessandra’s retirement, compared to a personal pension. (6 marks)
Benefits
• Accessible at any time/open-ended/before age 55.
• Tax free on any withdrawals/income.
• Not subject to earnings/annual allowance.
• Not subject to lifetime allowance.
Drawbacks
• No tax relief.
• £20,000/lower investment limit.
• Part of estate/cannot write under trust.
• Funds not ‘earmarked’ for retirement/temptation to access early.
187
Explain the diversification rules for a retail Undertakings for the Collective
Investment of Transferable Securities (UCITS) OEIC, based upon the minimum
number of permissible holdings and their respective percentages. (5 marks)
• 16 holdings.
• Maximum 10%;
• in up to four companies.
• Maximum 5%;
• for rest/other companies.
188
State the maximum exposure a retail UCITS OEIC may hold in unlisted securities. (2 marks)
• 10%;
• of total assets/fund.
189
Explain to Nicolas and Alessandra the term ‘capacity for loss’. (4 marks)
• The ability/degree/level/scope;
• to absorb/withstand;
• any negative investment event.
• Adverse effect/materially detrimental;
• on lifestyle/standard of living.
190
List the non-financial factors that can influence an investor’s attitude to risk. (6 marks)
• Previous experiences.
• Time horizon/age/state of health/dependants.
• Client objectives/ethical/religious views.
• Investor psychology/perception.
• Framing.
• Society/collective mood/political/economic environment
191
Explain why Nicolas’ attitude to risk may be higher for a personal pension
compared to a stocks & shares ISA. (5 marks)
• Longer term investments/higher risk more likely to achieve objective.
• Impact of short-term volatility less.
• Not accessible till age 55.
• Effect of tax relief/employer contributions.
• Consideration given to capacity for loss different.
192
Describe the key principles of Modern Portfolio Theory, in respect of the construction of an investment portfolio. (10 marks)
• A diversified portfolio;
• of non/un/imperfectly correlated.
• Investors are risk adverse.
• Maximum return;
• for given/set risk.
• Efficient frontier;
• uses expected return of each asset.
• Standard deviation/normal distribution (of each asset);
• to produce optimal portfolio.
• Systematic risk cannot be removed/can be reduced.
• Non-systematic risk can be removed.
• Sensitivity to the market is expressed by beta is market risk.
193
Outline to Nicolas and Alessandra why their financial adviser is considering using
a discretionary fund manager (DFM) service as well as passive funds. (5 marks)
• Active management/alpha.
• Wider range of asset/funds.
• Time markets/hold cash/speed of transaction.
• Bespoke.
• Influence asset allocation/core and satellite.
• Tax planning service.
194
State the potential risks of using a DFM service. (6 marks)
• Financial Services Compensation Scheme (FSCS) limit exceeded/not available.
• Discretionary fund manager (DFM) uses unsuitable assets.
• Duplication with non-DFM portfolio.
• DFM acts outside its mandate/deviation from any benchmark/style drift.
• Regulatory issues.
• Overtrading/higher costs.
• Service may incur tax liability.
• Underperformance/negative alpha/does not add valu
195
State five main risks to which Efekan may be specifically exposed to if he invests in
high yielding alternative income products. ( 5 marks)
• Liquidity risk.
• Accessibility risk.
• Interest rate/gearing risk.
• Valuation risk.
• Diversification/correlation risk.
• Default/credit risk.
196
State the four main types of preference share and identify the key characteristic for each type. (8 marks)
• Cumulative.
• Has right to any unpaid dividend/arrears carried over.
• Participating.
• Additional dividend linked to company profits.
• Redeemable.
• Repayable by company.
• Convertible.
• Convertible to ordinary shares on pre-set terms.
197
Identify four important considerations that could impact Efekan achieving his income objective in retirement. (4 marks)
• Changes in health/life expectancy.
• Changes in taxation.
• Changes in inflation.
• Market volatility/returns.
• Sustainability of income.
• Other savings.
198
State five benefits and five drawbacks to Efekan of transferring his existing assets to a platform, compared with holding them directly. (10 marks)
Benefits
• Everything in one place/consolidated valuations/reporting.
• Less admin/paperwork.
• Income flexibility.
• Pre-funding/cash account.
• Access to institutional/clean share classes.
• Access to tools.
• Discounted/lower fund charges.
Drawbacks
• May pay exit charges.
• Additional platform charges/pay for services not used.
• Unnecessary functionality/too complex solution.
• May have to sell assets.
• Time out of market.
• Risk of platform failure/outage.
• Unable to hold alternative income products.
199
Identify the three main categories of benchmark used by fund managers. (3 marks)
• Constraint;
• target;
• comparator.
200
Describe the key differences between M0 and M4 as measures of money supply. (4 marks)
• M4 includes deposits created by lending/all bank accounts.
• M0 includes operational deposits at the Bank of England.
• M4 is broad money.
• M0 is narrow money.
• M4 is indicator of economy.
• M0 is indicator of consumer spending/retail sales.
201
Explain briefly how the Bank of England could reduce the money supply and
state the effect on interest rates. (4 marks)
• Selling securities;
• reduces velocity of money/increasing supply of securities;
• reduces purchasing power/prices of securities.
• Interest rate rise/higher yields.
202
State two reasons why the money supply is not suitable as a benchmark for
Efekan’s investment portfolio. (2 marks)
• Economic not financial/stock market and GDP different.
• Not a measure of return/performance.
203
Describe the general limitations of using investment ratios, such as P/E or ROE/ROCE, when analysing a company’s financial performance. Exclude any limitations that are unique to a specific ratio. (5 marks)
• Credibility of the source of information/manipulation.
• Use different accounting policies/conventions/company may change accounting
policy.
• Masked by exceptional/one-off items.
• Data may be obsolete/historical/not reflect current/future trading.
• Affected/masked by macro trends.
• Not considered in isolation/other factors.
• Can’t compare across sectors.
204
Identify eight main factors, excluding ‘market movement’ that could affect Watenova plc’s share price. (8 marks)
• Economic outlook.
• Political/changes in legislation/tax/regulation changes.
• Investor sentiment/broker or credit rating change/demand & supply.
• Takeover activity.
• Profit/earnings expectation.
• Capital event.
• Dividend expectation.
• Quality/change of management.
• Competitors.
• Fraud.
• Inclusion/removal from index.
205
Explain briefly how Kathryn could use a Seed Enterprise Investment Scheme (SEIS)
to mitigate her Capital Gains Tax liability. (4 marks)
• 50% relief;
• up to £200,000;
• must be held for three years.
• Relief up to tax liability/paid in tax year;
• can go back one tax year.
206
Describe what is meant by a momentum investment style. (4 marks)
• Identify trend.
• Trend accelerating/continuing.
• Sell before trend ends.
• Ignores intrinsic value/fundamentals.
• Generally, short term.
207
Describe what is meant by a contrarian investment style. (4 marks)
• Consensus usually wrong.
• Returns from going against the herd/ market sentiment.
• Positive when outlook negative/out of favour.
• Price less than intrinsic value/undervalued.
• Generally, long term.
208
Explain the purpose of the information ratio to Beth. (4 marks)
• Compare against sector/benchmark.
• Assess risk adjusted returns.
• Out performance/added value/alpha.
• Consistency of the manager
209
State six reasons how city office REIT may have achieved the highest information
ratio (6 marks)
• Sub-sector/commercial office out-performance against sector.
• Consistency of the fund manager.
• Manager’s skill in office purchases;
• and disposals.
• Lowest level of cash.
• Trading at premium/closing discount.
• Use of gearing/leverage.
• Tax structure/status/efficiency.
210
Explain the potential reasons why the direct property OEIC has a higher level of
cash. (5 marks)
• Inflows into the fund.
• Manager unable to make new investments/deal flow slowed down.
• To cover redemptions.
• Just about to purchase/just sold property.
• Rental income.
211
State four ways in which an open-ended fund structure could respond to a
liquidity crisis following substantial redemption requests. (4 marks)
Open-ended/OEIC/ETF
• Dilution levy/exit penalty.
• Switch pricing/swing-pricing/offer to bid price/fair value price.
• Borrow to fund redemptions.
• Gated/limited redemptions/change dealing frequency.
• Suspend redemptions.
• Forced sale of property(ies).
212
State four ways in which a closed-ended fund structure could respond to a
liquidity crisis following substantial redemption requests. (4 marks)
Closed-ended/REIT
• Borrow.
• Move to discount/widen spread/match buyers and sellers.
• Suspend dealing.
• Rights issue.
• Sell property.
213
State the three inputs required to produce an efficient frontier curve. (3 marks)
• Expected return.
• Standard deviation/level of risk.
• Correlation.
214
Explain how the efficient frontier is used in investment planning. (3 marks)
• To set (optimum) asset allocation.
• To show best/highest return;
• given level of risk.
215
State five limitations of using the efficient frontier. (5 marks)
• Assumes standard deviation as measure of risk.
• Does not take into account attitude to risk/capacity for loss.
• Uses historic data to predict expected returns.
• Excludes impact of costs and charges.
• Assumes portfolio uses passive funds/cannot factor Alpha.
216
Describe the weak form of EMH. (6 marks)
• Current prices;
• fully reflect;
• all past prices/trading information.
• Prices cannot be predicted;
• by analysing historic data.
• Technical analysis does not work/fundamental analysis does work.
217
List three Investment Association sectors that could be suitable to provide the funds to construct the UK equity component of the investment portfolio to meet Beth’s
objectives. (3 marks)
• UK Equity Income.
• UK All Companies.
• UK Smaller Companies.
• UK Equity & Bond Income.
• Mixed 0-35%/20-60%/40%-85%/Flexible.
218
Explain the main differences between strategic and tactical asset allocation. (8 marks)
Strategic
• Fixed weightings/allocation;
• long term;
• with occasional/infrequent rebalancing.
• Little variation from objective.
• No response to market changes.
Tactical
• Varying weightings/allocation;
• short term;
• with frequent rebalancing.
• Substantial variation from objective.
• Take advantage of market changes.
219
Explain a normal yield curve to Beth. (4 marks)
• Longer dated bonds;
• yield more;
• than shorter dated ones.
• Economic optimism/long term interest rates/inflation will be higher.
220
Outline what would cause a normal yield curve to invert and explain the potential
implications for Beth’s portfolio (8 marks)
• Expectation that;
• long term interest rates will fall;
• short term interest rates will rise;
• long term inflation will fall.
• Economic outlook pessimistic/low growth/recession.
• More capital will be needed to provide income/longer bonds more expensive.
• Change duration of bonds purchased.
• Asset allocation may need to be changed/revised.
221
State what is meant by credit quality. (2 marks)
• Measure of credit worthiness/risk of default.
• Determined by rating agencies/credit rating.
222
State and explain briefly the three other methods that an equity ETF would use to
track its underlying index. Exclude full replication from your answer. (6 marks)
• Sampling/stratification.
• Buys some/a sample of index constituents.
• Optimisation.
• Uses computer model/algorithm.
• Futures/synthetic.
• Uses derivatives
223
State four possible consequences for GDV Trust plc of an increase in its
borrowings. (4 marks)
• Increases profit.
• Increases losses.
• Increase financial risk/interest rate sensitivity
• Share price more volatile/discount may change.
224
Explain briefly what is meant by a deep value investment strategy. (4 marks)
• Investing for long term;
• in undervalued/out of favour stocks.
• Price less than net asset value/book value.
• Contrarian view/buying what others are selling.
• Buy and hold/low turnover.
• Limited downside/greater upside/mean reversion.
225
what would be included in an OCF (4 marks)
• Management fee/Annual Management Charge.
• Administration fees/secretarial/directors fees/insurance.
• Marketing.
• Audit/tax compliance fees.
• Registration/regulatory fees.
• Custody/depositary/trustee.
226
what additional charges in addition to OCF could be payable (4 marks)
• Transactions fees/initial charge/spread/Stamp Duty.
• Performance fees.
• One off legal/professional charges.
• Interest/gearing costs.
• Adviser charge.
227
State the main conditions that must be met for a property fund to qualify as a
property authorised investment fund (PAIF). (6 marks)
• At least 60%;
• of income;
• from exempt property business.
• Value of property assets must be at least 60% of total assets.
• Shares widely held.
• No corporate investor;
• holding 10% (or more of net asset value).
228
Explain to John four potential drawbacks of using Socially Responsible Investing
other than investment performance. (4 marks)
• Less diversification due to avoiding certain areas/fewer investment opportunities.
• More expensive.
• Approach differs/not consistent/not aligned with John’s Socially Responsible
Investment (SRI) view.
• Less research available.
• Higher risk/higher tracking error/risk not aligned with John’s attitude to risk.
• Screening rules out growth/income.
229
Explain to John the main features of preference shares compared to ordinary
shares. (3 marks)
• Fixed dividend.
• Higher priority in payment/winding-up.
• Non-voting.
230
Explain six relative differences between standard deviation and Beta in terms of
how they measure risk. (6 marks)
Measure
• Beta measures market risk;
• standard deviation measures fund risk/does not measure market risk.
How they measure
• Beta measures volatility;
• standard deviation does not/measures total risk.
Benchmark
• Beta is relative to market;
• standard deviation is not/is based upon actual return.
231
Outline four potential economic consequences of the current account and capital account being in deficit over the medium to long-term. (4 marks)
• Rising interest rates.
• Economy growth falls.
• Currency devaluation.
• Capital flight out of UK.
• Unemployment rises.
• Inflation increases.
232
Describe briefly what is meant by current account and capital account. (6 marks)
Current account
• Imports minus;
• exports/balance of payments;
• in goods & services;
• plus receipt from overseas income generating assets.
Capital account
• Movement of all monies/assets;
• into country;
• out of country.
233
Explain to Ben what is meant by a composite benchmark. (5 marks)
• A single indicator of performance/enables comparison with benchmark.
• Made up from elements of a number of different indices/sectors/asset
classes.
• In a fixed proportion.
• Dependent on the fund's objectives;
• and risk profile.
234
Explain to Ben the main differences between undertakings for collective investment
in securities (UCITS), and unregulated collective investment schemes (UCIS) that can
result in UCIS having higher risk. (8 marks)
• Undertakings for Collective Investments in Transferable Securities (UCITS)
authorised/recognition by EU.
• For retail distribution/UCIS not retail.
• UCITS benefit from better Liquidity.
• UCITS regulated/UCIS not regulated.
• Compensation/investor protection.
• Transparency (of underlying assets/literature)/valuation basis).
• Diversity.
• Borrowing restrictions
235
State five types of investor to whom UCIS may be promoted. (5 marks)
• Existing holders.
• Certified High Net Worth investors.
• Enterprise and Charitable.
• Eligible Employees of the Fund.
• Eligible Counterparty or Professional/institutional Client (non-retail).
• Certified Sophisticated Investors.
• Self-Certified Sophisticated Investors.
236
Explain to Ben the safeguarding regulations in place that govern UCITS in respect of:
(i) diversification; (6 marks)
• Not more than 10% value of fund;
• in any one company.
• No more than four companies at maximum/holdings over 5% cannot exceed
40% in total.
• Remainder, maximum 5% of fund value;
• Resulting in minimum of 16 holdings.
• Max 10% unquoted companies.
237
Explain to Ben the safeguarding regulations in place that govern UCITS in respect of:
(ii) borrowing. (4 marks)
• Borrowing only/normally not permitted;
• up to 10%;
• on a temporary basis/up to three months:
• if supported by expected receipts.
238
Explain briefly the terms fettered and unfettered. (4 marks)
Fettered
• Only/solely/exclusively;
• in-house range funds.
Unfettered
• Unfettered funds can use funds from other managers/third party;
• as well as their own.
239
Explain to Ben how the Multivest manager of managers fund arrangement works. (5 marks)
• Overall manager decides on asset allocation.
• Appoints manager for each sector/objective/proportion of the fund;
• and monitors its performance.
• Can replace managers/new manager takes over the existing assets.
• Funds are segregated;
• and discretionary.
240
Identify two advantages and two disadvantages of the manager of managers
arrangement in comparison to the fund of fund arrangement. (4 marks)
Advantages
• Bespoke mandate/overall manager has say in investments.
• No requirement to sell a fund and buy a new one.
• Can replace managers.
Disadvantages
• The new manager, is however, left with whatever his predecessor chose to buy;
• limited number of managers willing to run mandate.
241
State to Atique six benefits and four drawbacks of gold coins as a component of his portfolio. (10 marks)
Benefits
• Diversification.
• Reduce overall risk/volatility.
• Negative correlation with equities and bonds.
• Hedge against inflation.
• Hedge against political/financial uncertainty/safe haven.
• Capital Gains Tax free.
Drawbacks
• No income.
• Storage/insurance costs/could get stolen.
• Price affected by intangible factors/supply and demand.
• Wide buy/sell spreads/high transaction costs.
242
State the main difference between a physical gold exchange traded commodity (ETC) and a synthetic gold ETC. (2 marks)
Physical
• Allocated/owns gold/bullion.
Synthetic
• Purchases futures/swaps/derivatives.
243
Explain why the price of a synthetic gold ETC would differ from the spot price of
gold. (6 marks)
• Uses futures/swaps/derivatives.
• Futures/derivative prices are higher than spot prices/contango.
• To reflect costs of storage/insurance/interest.
• Over the 3-month period.
• Ongoing charges/rollover cost.
• Market expectations.
244
State the type of futures contract Atique should enter into to compensate for a
fall in the price of gold and explain how it achieves this objective. (7 marks)
• Short futures contract.
• Involves obligation.
• To sell;
• at a specific price/price set at outset/strike price;
• at a certain date/three months ahead.
• If price falls can sell gold at higher price as per contract/earns profit;
• effectively buying it back for delivery/ covering any losses/closing out the contract
for cash.
245
Explain to Atique why a three month’s futures contract might not be the best
way to hedge his position. (6 marks)
• Margin calls if market moves against him.
• Volatility of underlying commodity.
• Need for constant monitoring.
• Usually limited to professional/institutional investors.
• Complex investment/special broker test before dealing.
• Possibility of unlimited loss.
• Underlying must be delivered.
246
State five other types of derivative or instrument that could be used to hedge
Atique’s gold sovereign exposure. (5 marks)
• Spread betting.
• Contract for difference.
• Options (Not call)/forwards.
• Short exchange traded commodity (ETC)/Exchange Traded Fund (ETF)/Exchange
traded notes (ETN).
• Covered warrant.
247
State the three elements that make up the definition of ‘equity’ for the return on
equity formula. (3 marks)
• Shareholders’ capital/funds.
• Reserves.
• and retained profits.
248
Describe the main drawbacks in using price-to-book (P/B) when valuing a company as a potential investment. (6 marks)
• Book value of assets may differ from market/sale value.
• Current valuation/does not factor in future cash flow/earnings.
• Not suitable for companies with intangible assets/only measures tangible
assets.
• Can be easily distorted by share price movement.
• Not suitable for comparing companies in different sectors.
• Output not robust/low price-to-book (P/B) ratios does not automatically mean
undervalued.
• Low P/B may be function of terminally falling share price
249
Explain why the Bank of England may not raise interest rates even if inflation increases
significantly and exceeds their target. (4 marks)
• Deemed to be temporary/factors causing inflation will fall out of the annual
calculation and it will return to target of its own accord.
• Future economic uncertainty e.g. BREXIT/to ensure economic stability.
• High levels of corporate and personal debt/risk to debtors.
• Exchange rate concerns and the effect on trade.
• Increasing interest rates may not impact on some types of inflation (e.g. caused by
rising commodity prices).
250
State six possible drawbacks should Peter decide to invest in the hedge fund,
ignoring investment performance. (6 marks)
• May be illiquid;
• strategy not transparent/limited information on how strategy will be
achieved
• High minimum investment/high proportion of new investment in one fund.
• High charges/performance fees.
• Fund manager’s strategy might not work.
• Less regulation or investor protection/no Financial Services Compensation
Scheme (FSCS).
251
Explain why you have recommended the portfolio of ETFs to Peter rather than the
hedge fund. (5 marks)
• Traded throughout the day/better liquidity.
• Underlying assets transparent/easier to benchmark performance
• Low minimum investment.
• Low charges/no performance fee.
• Passive funds not relying on a manager strategy/methodology.
• Regulated by the Financial Conduct Authority (FCA)/consumer protection.
252
Explain to Peter what the information ratio measures and its limitations if used in isolation (6 marks)
• Relative performance.
• Compared to benchmark.
• Adjusted for risk.
• Historical/no guide to future.
• Need to compare to similar funds.
• Need to look at trends/different time periods.
• Need to consider other factors/not give full picture.
253
Explain briefly the potential causes of an ETF tracking error. (7 marks)
es would have gained full marks for any seven of the following:
• Inaccuracy of tracking/method used (i.e. sampling).
• Management fee.
• Other expenses/costs.
• Currency hedging.
• Cash drag/uninvested cash.
• Dividend reinvestment lag.
• Tax/withholding tax.
• Securities lending.
254
Explain briefly the purpose of using a benchmark in the investment process. (4 marks)
• Sets asset allocation/starting point.
• Independent/neutral agreed basis.
• To manage risk expectations.
• To measure relative performance to benchmark/value added or
performance by the fund manager
255
State the main criticisms of the Capital Asset Pricing Model (CAPM) and explain
why each of the three factors chosen are included in multi-factor models:
• momentum;
• size;
• value.
(7 marks)
• Assumes can borrow unlimited funds at risk free rate.
• Assumes no taxes/charges.
• Assumes investors’ are rational and risk adverse.
• Assumes market is efficient/all information available to everybody.
• Single factor model/only uses beta.
• Based on historical data.
• Difficult to identify risk free rate of return.
• Not a good predictor in practice/doesn’t work in the real world/inaccurate.
• Momentum: Shares of companies that have increased in price over the past
6-12 months tend to continue to outperform and this is not explained by
Capital Asset Pricing Model (CAPM).
• Value: Undervalued company shares measured by price to book and similar
ratios tend to outperform.
• Size: Smaller company shares tend to outperform larger companies.
256
State two other measures in relation to employees that you would look at to
assess quality of management. (No calculation required). (2 marks)
• Staff turnover.
• Absenteeism.
• Profit per employee.
257
Explain what is meant by quality of earnings. (4 marks)
• Accurately represents trading performance of business.
• Not manipulated by accounting policies
• Strong cash generation.
• Performance repeatable.
258
State three ways a company can return money to investors, other than the
annual dividend payment. (3 marks)
• Special dividends.
• Share buy backs via the market.
• Tender issue to repurchase shares.
• Wind up/sell company.
259
Identify seven factors in relation to the underlying investments that determine the
return on a commercial property fund. (7 marks)
• Location/geographical spread.
• Type of holdings/sector (office, retail, industrial).
• Size of properties/liquidity.
• Rental yield.
• Tenant quality.
• Length of lease.
• Basis of rent/lease reviews.
• Void/occupancy rate.
• Development opportunities.
260
261
State four ways in which a low Bank of England base rate may stimulate
consumer spending. (4 marks)
• Savings interest rates are low.
• Reduces incentive to save.
• Cheaper borrowing/lower mortgage costs.
• Gives more disposable income/encourages borrowing.
• Increases asset prices increasing wealth/feel good factor.
262
Explain why, as interest rates approach zero, this policy may fail to
stimulate spending. (4 marks)
• Those relying on savings have less to spend
• Debt interest may not fall/falls may be relatively small.
• Banks less willing to lend due to lower margins.
• Debt maybe repaid instead of spending.
• Other political or economic factors could outweigh/lower consumer
confidence
• There may be time lags due to fixed term debts/savings.
263
The 0.125% Index-linked Treasury Gilt 2037 has a three month
indexation lag.
Explain to Paul how the amount of the next coupon will be determined. No calculations required. (5 marks)
• Take RPI value.
• 3 months prior to coupon date.
• Divide by RPI set at issue date.
• Apply to the coupon.
• Divided by two/paid half yearly.
264
Explain briefly what a flat yield curve implies for future interest rates and the
prospects for the economy. (3 marks)
• Longer dates bonds have same interest rates as shorter dated/interest rates not
expected to rise.
• Expected that inflation will not increase.
• Slow economic growth/Low economic growth.
265
Explain briefly to Paul how both the interest and any capital gains on his
UK Gilts are taxed. (3 marks)
• Coupons taxed as income.
• Basic rate taxpayer has £1,000 tax free interest/personal savings allowance.
• Capital gains tax free.
266
State four ways the Bank of England may use to issue Gilts into the market. (4 marks)
• Auction.
• Tender.
• Conversion.
• Tap.
• Syndication.
• Repo.
267
State the factors that determine the price of an option. (Ignoring fees or
commission.) (4 marks)
• Market value of the underlying asset/spot price.
• Strike price/in or out of the money.
• Expiry date/time to expiry.
• Expected volatility.
• Type of option American or European.
268
Explain five risks of lending money via a peer to peer lending platform compared to using a savings account. (5 marks)
• No Financial Services Compensation Scheme (FSCS) protection.
• Lack of liquidity/may not have immediate access to money.
• Default/credit risk/difficult to assess lending criteria/lack of transparency
• Counterparty/platform solvency risk.
• New industry so no experience of how it may withstand an economic downturn.
269
Explain briefly to David what is meant by a fund’s alpha. (4 marks)
• Difference between expected return and actual return.
• Return not explained by market movements and beta.
• Risk adjusted return measure.
• Value added/stock picking ability of manager/out performance of manager.
270
Explain briefly what the price earnings ratio measures and factors that could
influence the market’s views. (4 marks)
• Number of years/number of times (multiple)
• to return investors capital from earnings.
• Future profits/earnings expectations/company’s ability to grow its
profits/earnings
• Quality and consistency of earnings.
271
Explain briefly what is meant by a forward and a trailing price earnings ratio
together with the main drawback of using each measure. (4 marks)
• Trailing P/E uses last 12 months earnings/profit.
• Past performance is not necessarily a guide to future.
272
Explain how technical analysis is used to make investment decisions. (4 marks)
• Based only on share price/excludes fundamental analysis.
• Uses charts of past share price.
• Identifies patterns/trends that predict future performance
• assumes these are repeated.
