Exam Questions And Explanation Flashcards
- If Helen invests in shares that are quoted in the Alternative Investment Market (AIM), her shares:
are likely to be in new, small companies with growth potential.
have a minimum guaranteed capital value.
must be held by her for at least one year before they can be sold.
will provide a fixed income for the first five years
Are likely to be in new, small companies with growth potential
E = There are two main markets for trading shares. The main market (which is made up of ‘The Primary Market’ and ‘The Secondary Market’ ) and AIM
Rules for joining the AIM are fewer and less rigorous than those for joining the official list (the main market). It is designed with smaller companies in mind allowing them to raise funds or capital by issuing shares
A new gilt issue has received wide publicity in the financial press, in which it has been referred to as ‘medium-dated’. However, the UK Debt Management Office has described it as ‘short-dated’.
It will therefore be for which of the following terms?
Two years.
Four years.
Six years.
Eight years
6 years
E = How the financial press categorise GILTS
Short-Dated = Less than 5 years until redemption
Medium-Dated = 5 - 15 years until redemption
Long-Dated = 15 years + until redemption
The UK Debt Management Office, which issues gilts, defines short and medium gilts differently to the financial press
Short = Less than 7 years
Medium = 7 - 15 years
Hence answer
What are GILTS?
They are a type of direct investment called ‘fixed-interest securities’ . They are a form of borrowing by the government
If a GILT is designated as Treasury 5% 2025, what does this mean?
It is a GILT with a coupon of 5 per cent and a redemption date in 2025
What is the ‘par value’ of a GILT?
The Par Value is another name for the issue value. This is normally quoted as nominal £100
The government must pay this back on the redemption date of the GILT
What is the Coupon of a GILT?
When is it paid?
The interest rate payable on the par value or issue value of a gilt.
It is a fixed rate, paid half-yearly, gross but taxable
The interest is classed as savings income…
What is the other type of GILT beside Fixed-interest?
What is the benefit of this other type of GILT compared to the Fixed-interest version?
Index-Linked
Index-linked gilts are gilts where the interest payments and the capital value move in line with inflation. This means that the purchasing power of their capital and interest received remain constant, unlike all other fixed-interest investments where inflation erodes the purchasing power of fixed-interest payments
Gilt prices are quoted either ‘cum dividend’ or ‘ex dividend’
What does it mean if a GILT is priced as Cum Dividend
What does it mean if a GILT is priced as Ex Dividend?
If a gilt is bought ‘cum dividend’, the buyer acquires the gilt itself and the entitlement to the next interest payment
If the gilt is bought ‘ex dividend’, the buyer acquires the gilt, but the forthcoming interest payment will be payable to the previous owner of the gilt (ie the seller)
Many investors who buy gilts do not intend to keep them until their redemption date.
Explain why this is
Holders of GILTS can sell their GILTS to other investors priced as being either Cum Dividend or Ex Dividend
ANSWER: Investors generally buy GILTs for two reasons
They believe the future movements in interest rates will be beneficial to them, so they can sell the GILTS for a profit
Or, They may be able to buy gilts for less than par and then make a gain upon redemption.
A higher-rate taxpayer buys £100,000 par value of Treasury 5% 2025 at a price of 80.0
Later she sells the stock for £90,000
Will she need to pay CGT?
GILTS are not subject to CGT so no
E= The first line means she bought a GILT with an issue value (par value) of £100k and a coupon of 5% and a redemption date of 2025, for £80k
James owns £10K of Treasury 3% 2026
Interest rates have risen so now newly issued GILTS redeeming in 2026 are being offered with a coupon of 5%
Why will no-one buy James’s GILTS given these interest rises?
Give an example of what someone might offer if they do decide to buy his GILT
No-one will buy James’ GILT for 10k because they can buy a newly issued GILT for 10k with a 5% coupon instead of 3%, meaning they will get £500 in interest a year instead of £300 from James’s
Although this is the case, Emily may buy his GILT if James’ offers it at less than the par value, 9K for instance.
In this case, Emily can then wait until the redemption date and get 1k
In short:
Rising interest rates = Existing GILT holders need to sell their Gilts are a lower price
How do rising interest rates affect GILTs?
Bad for existing GILT holders
It will mean existing holder of GILTs will need to sell their GILT at a lower par value (no-one will buy it otherwise because they could simply buy a newly issued GILT with the same redemption date and par value but at a higher coupon rate)
James owns £10K of Treasury 3% 2026
Interest rates have lowered so now newly issued GILTS redeeming in 2026 are being offered with a coupon of 2%
Why is the good for James?
Give an example of what someone might offer if they do decide to buy his GILT
This is good for James because the newly issued GILTs are less desirable than his
His GILT offers £300 in interest a year, whereas the newly issued GILTs offer £200 for the same redemption date and par value.
This means if someone wants to buy James’s Gilt they will need to offer James much more than the par value ( to account for the higher interest they will be earning with James’s GILT compared to newly issued GILTS until the redemption date)
This means James will make a profit upon selling
How do decreasing interest rates affect GILTs?
Great for existing GILT holders
It means existing GILT holders can sell their GILTs at a higher par value
(people will want to buy their GILT because newly issued GILTs with the same redemption date and par value are at a lower coupon rate, so it will earn less interest)
How is running yield of a GILT calculated?
Running Yield =
Coupon / Current Trading Price Paid for Gilt
ie a Gilt may have a par value of 100 and 5% coupon. However its trading price may be £130. This means the running yield is 5/130 = 3.85% . Ie still a good rate but since the gilt has gone up it price its yield is lower than before
Mark is considering buying gilts and is attracted to 5% Treasury 2025. He finds that this gilt is currently trading at a price of £130.73.
The Par Value of this GILT is £100
What is the income generated from this GILT per year?
What happens if Mark decides to keep this GILT until redemption date?
What is the running yield of this GILT?
What happens if interest rates rise?
What happens if interest rates decrease?
What is the income generated from this GILT per year?
£5 a year
(5% of £100)
He will take a loss of £30.73 as he bought the GILT above Par Value
The running yield of this Gilt = 3.82%
Running yield = Coupon/price paid
This is good when comparing with interest rates of savings accounts but if he keeps it until redemption date he will take a big loss
A public limited company wishes to raise additional finance by issuing more shares to its existing shareholders.
It is taking which of the following actions?
A) Arranging a commercial loan.
B) Delaying dividend payments.
C) Making a rights issue.
D) Making a scrip issue.
C
A rule of the stock exchange is that when a company who has existing shareholders wishes to raise capital by issuing more shares the shares must first be offered to existing shareholders
How do companies do this?
What if a a shareholder doesn’t want the new shares?
Through a ‘Rights Issue’
(gives an existing shareholder the ‘right’ to buy the newly issued shares before anyone else. If they choose not to buy, they will be compensated for any drop in the value of their shares as a result of the company issuing more shares
Tell me the key differences between a rights issue and a script issue
Script Issue = A company issues additional shares to increase its number of shares and decrease share price proportionately, NOT TO RAISE CAPITAL. The newly issued shares are given free of charge, to existing shareholders.
Rights Issue = A company issues additional shares in order TO RAISE CAPITAL. Existing shareholders are given first dibs on the new shares to buy/sell before they are released to others.
What are Preference shares?
Literally normal shares but the holders are given ‘preference’ on some things over normal shareholders but they don NOT have voting rights like ordinary shareholders
They are given preference with the following:
Dividend pay-outs are ahead of ordinary shareholders
If a company is wound up, they are ahead of ordinary shareholders in getting their money back ( so less risk )
Do holders of preference shares get voting rights like ordinary shareholders do?
No (the only exception is if the preference shareholder dividend payment is delayed then they may get temp voting rights)
Many preference shares are cumulative preference shares
What does this mean?
Same features as preference shares but an added feature where if dividends are not paid, entitlement to dividends is accumulated until they can be paid
What are convertible preference shares?
What are Script Issues also known as?
bonus issue or a capitalisation issue
