1
Q
Calculate, showing all your workings, the price earnings (P/E) ratio for Submersh
plc
A
£35,400,000 / £28,000,000 = 1.264285 = 126.43p
448p / 126.43p = 3.54
2
Q
Compare the P/E ratio of Submersh plc, (3.54) to its sector average and explain briefly the possible reasons for the difference.
A
- P/E is lower.
- Undervalued/out of favour.
- Bad management/decline in business.
- Event causing a one-off increase in earnings.
3
Q
Calculate, showing all your workings, the dividend cover for Submersh plc.
A
16.2p x £28,000,000 = £4,536,000
£35,400,000 / £4,536,000 = 7.804232 = 7.8
Alternative
£35,4000,000 / £28,000,000 = 1.264285 = 126.43p
126.43p / 16.2p = 7.8
4
Q
Comment briefly on what can be deduced from the dividend cover of 7.8
A
- High coverage/dividend well-covered.
- Retaining majority of profits.
- Company financially stable/dividend secure/sustainable.
- Low growth/ex-growth business.
5
Q
State the four main types of index replication strategy and describe briefly how
each strategy works.
A
- Physical/Full Replication
- Buys all stocks within index in correct weighting.
- Stratified/Simplified Sampling
- Buys subset/selection/sample of stocks within index.
- Optimisation
- Buys computerised model of index.
- Synthetic
- Uses derivatives/swaps.
6
Q
Identify five specific investment risks to which Edward may be exposed within his
investment portfolio and state one reason for each risk.
A
- Currency
- Exposed to Dollar/Yen/exchange rate movement.
- Concentration/Overlap
- Composition/market weighting of index/duplication/same stocks held in more
than one fund. - Market/Volatility
- NASDAQ/Japan Small Cap/beta likely to be greater than 1.
- Counterparty
- Failure of ETF.
- Passive/Product
- Replication style causes underperformance/underperforms index.
7
Q
State the three main ways in which a stock market index is weighted.
A
- Value/market capitalisation.
- Price.
- Equal/unweighted.
8
Q
Identify four events that can cause a constituent company to enter or leave the
FTSE 100 at a periodic rebalancing.
A
- New listing/IPO.
- Delisting/switch to another market/becomes ineligible.
- Merger/acquisition/takeover.
- Change in share price/market cap.
9
Q
Explain briefly what is meant by ‘free float’ and how it affects a company’s
weighting in FTSE UK indices.
A
- Proportion/percentage of shares;
- traded on market.
- Companies with less than minimum free float;
- have weighting reduced.
10
Q
State three main metrics that would be used to measure the risk-adjusted return of an
actively-managed fund and outline two distinct purposes of each metric.
A
- Alpha
- Stock-picking/value added by manager.
- Excess return not explained by beta.
- Sharpe
- Excess return for every unit of risk/risk-free rate.
- Excess return over standard deviation.
- Information Ratio
- Consistency of manager.
- Excess return over benchmark.
11
Q
State the maximum Financial Services Compensation Scheme (FSCS) compensation
limits that would apply to Edward’s pension and investment assets. Exclude the money
accumulated within the cash account from your answer.
A
Investment;
* £85,000;
* per firm.
* Shares;
* no protection.
Pension;
* 100%;
* without limit.
* per provider.
* SIPP;
* £85,000;
* per operator/firm.
12
Q
State the options that are open to Edward in respect of generating the income
stream that he is considering from his personal pensions. Assume that the
provider(s) offers all of the available options.
A
- Drawdown/FAD.
- PCLS only.
- UFPLS.
- Phased retirement.
- Buy short-term/fixed term annuity.
13
Q
Describe the actions that Edward could take to mitigate the effects of sequencing
risk, if he were to consider drawing the income stream from his overall portfolio
over the medium to long term.
A
- Reduce the level of initial withdrawal.
- Change the timing/frequency of withdrawals.
- Stick to his original retirement plan/date.
- Alter asset allocation/reduce equity/market/volatility risk.
- Invest in fixed interest/diversification across asset classes.
- Increase cash/hold sufficient level of cash/take withdrawals from cash.
- Take natural income/dividends.
- Secure income through annuity.
14
Q
Calculate, showing all your workings, the Stamp Duty Reserve Tax and any levy that Edward would pay if he used the cash from the accumulated dividends to purchase more shares in Submersh plc. Assume that the number of shares owned by Edward and the dividend per share have remained unchanged for the past four years.
A
SDRT
16.2p x 18,000 x 4 = £11,664
£11,664 x 0.5% = £58.32
PTM levy
£1
Total = £59.32
15
Q
State four areas that the advisory firm would need to consider, in respect of the
potential impact of the platform’s change in technology provider on the advisory
firm.
BOAT FIT
A
- Ownership of technology provider/conflict of interest/financial stability of
tech provider. - Ability to meet existing clients’ needs/expectations.
- Timescale for upgrade/testing/phasing of migration.
- Business continuity plan during upgrade/reliance on sole platform.
- Front/back office compatibility/loss of functionality/tools/reporting.
- Impact on firm’s advice proposition/reputation.
- Time/cost to firm.
16
Q
The platform on which the client’s assets are held has recently communicated that it plans a significant technology upgrade that will mean migrating the platform to a new technology provider.
State four main risks to the client that could arise during the migration process.
A
- Loss of service/outage/access.
- Loss of income payments.
- Unable to trade/buy/sell/out of market.
- Data breach/loss.
- Loss of transaction history/legacy data.
- Increase in costs.
17
Q
Magda is an investment adviser within an authorised advisory firm. She is reviewing the portfolio of a retail client who has recently been taken on by the firm. The client’s only income is a salary of £35,000 per annum and their primary objective is to generate a high level of additional income from their capital assets.
State the tax treatment of the income generated from the funds held in the GIA
and ISA, based upon the client’s tax position.
A
ISA
* Dividends;
* and interest/distributions;
* free of personal taxation/not subject to Income Tax.
GIA
* Dividends;
* taxed at 7.5%;
* once DA/£2,000 used.
* Interest/Distributions;
* taxed at 20%;
* once PSA/£1,000 used.
18
Q
Calculate, showing all your workings, how much of the income generated by the
overall portfolio is subject to the client’s personal taxation.
Based on a basic rate tax payer
A
GIA
£110,000 x 2.1% = £2,310
less £2,000 = £310.
£95,000 x 3.5% = £3,325
less £1,000 = £2,325.
19
Q
Identify three main risks to which the client would be exposed if they invested in
high income alternative investments and outline each risk.
A
- Income
- May be unsustainable/cut/not paid.
- Unregulated
- Not subject to FSCS/investor protection.
- Accessibility
- Unable to sell underlying assets.
- Liquidity
- Wide price spread/hard to sell.
- Capital loss/Valuation
- Assets may be written down/down-valued.
- Correlation
- May not be uncorrelated/may be more correlated with equities.
- Interest rate/Gearing
- Sensitive to interest rate rises/cyclical.
20
Q
Identify three factors that could impact on the potential to hold alternative assets
on a platform.
A
- Asset may not be eligible/not available to retail clients.
- Dealing infrequent/not readily realisable/unable to sell.
- Additional costs of ownership.
- May require third party to transact/may have to trade manually.
- Valuation/price may not show automatically/may have to input manually.
21
Q
Describe briefly what is meant by the term ‘capacity for loss’.
A
- The ability;
- to absorb;
- any negative investment event;
- without an adverse/detrimental effect;
- on lifestyle/standard of living
22
Q
Outline three ways in which the effects of capacity for loss can be mitigated.
A
- Reduce portfolio risk/AtR.
- Hold sufficient cash to cover potential loss/event.
- Invest less/only invest what client can afford to lose.
- Discuss and agree CfL with client in advance.
- Establish the actual risk the client is willing to take/not focus on the outcome.
- Avoid overreliance on tools/simplified questions/inappropriate assessment of
information.
23
Q
Calculate, showing all your workings, the information ratio for Risk III fund.
A
10.7 - 10.4 = 0.3
0.3 / 1.65 = 0.181818 = 0.18
24
Q
Comment on what can be deduced about Risk III fund’s performance based upon the information ratio figure from your answer 0.18
A
- Value added by manager/outperformance.
- Low risk-adjusted return/information ratio.
- Similar return could have been achieved through passive/tracker fund/active
management not worth the cost.
25
Describe briefly the main features of an MPS.
* Collectives-based.
* Low minimum investment.
* Asset allocation/fund selection determined centrally/by external
manager/investment committee.
* Portfolio changes can result in client CGT liability.
* Range of risk-adjusted portfolios.
* Portfolios not bespoke to client/limited choice.
* Low cost.
26
Identify six main factors that Priya would take into consideration when evaluating
a DIM service for Abeo.
CROP BICCO
* Charges.
* Overlap with existing/non-DIM assets.
* Regulatory permissions/reputation/financial strength.
* Past performance/track record.
* Investment style/strategy.
* Client’s AtR/use of unsuitable/high risk assets.
* Conflict of interest.
* Basis of agreement.
* Ownership of client.
27
Identify the main phases of the economic cycle, in the order that they occur, starting
with the recession phase.
* Recovery.
* Boom/expansion.
* Contraction.
* [Correct order of phases].
28
State the main difference between the definitions of the M0 and M4 measures of
money supply.
* M0 excludes/M4 includes;
* bank/building society accounts;
* of UK residents.
29
Identify which money supply measure best indicates overall economic growth
and state two reasons why.
* M4.
* Broader/wider scope.
* Reflects borrowing/lending.
* Reflects velocity/transfer of money.
30
Explain briefly the likely monetary policy response to a sustained increase in
money supply in the UK economy.
* Reduce/cease;
* QE.
* Sell bonds back to market/QT.
* Increase interest rates.
31
State the three main types of benchmark and describe briefly the purpose of each type.
* Target;
* measure/calculate performance/fee.
* Comparator;
* comparison of performance.
* Constraint;
* limit portfolio construction/asset allocation.
32
Abeo would like to discuss a potential investment that he saw online. The investment offers a 9% per annum fixed yield but makes little reference to capital. He says that his own research into investments has been successful in the past and he believes this particular one can deliver the stated income. In a previous conversation, Priya has outlined that the investment is highly sensitive to the economic cycle in general and money supply in particular. Abeo has said that he would like to understand more about these factors.
From a behavioural finance perspective, identify two biases that relate to Abeo's view
of the potential online investment and state one reason to explain each bias.
* Anchoring;
* fixated on 9%.
* Overconfidence;
* believes own research is best/overreliance on own knowledge.
* Misunderstanding Of Probability;
* too focused on yield at expense of potential risk to capital.
33
Calculate, showing all your workings, the alpha for the Value Opportunities Fund.
5.1 - [0.1 + 1.3 (4.5 - 0.1)] = -0.72
34
State four limitations of using alpha to measure a fund’s performance.
* 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.
35
Identify and explain briefly four main types of investment risk that would be
relevant to Clara’s investment in the Value Opportunities Fund. Exclude market
risk from your answer.
* Volatility;
* Greater degree of movement.
* Manager;
* Stock-picking/negative alpha/underperforms.
* Shortfall;
* Returns less than needed/target.
* Style/Concentration;
* Value out of favour/growth outperforms.
* Non-systematic/specific;
* Corporate event.
36
Identify and explain briefly four additional main types of investment risk that
would be relevant to Clara investing in Tech Trust plc.
* Liquidity;
* Unable to sell/achieve fair price.
* Pricing;
* Trades at discount/premium to NAV.
* Currency;
* Returns affected by currency movement.
* Gearing/Interest Rate;
* Equity returns affected by borrowing/interest rates.
* Sector;
* Lack of information/early stage/speculative investment.
37
Calculate, showing all your workings, the overall return of Tech Trust plc.
UK 15% x 12% = 1.8%
North America 25% x -9% = -2.25%
Asia 40% x -6% = -2.4%
Frontier 20% x 8% = 1.6%
Total = -1.25%
38
Calculate, showing all your workings, the relative performance of each of Tech
Trust plc’s geographical allocations against their respective benchmark returns.
UK 1.5% vs 1.8% = +0.3%
North America 4% vs -2.25% = -6.25%
Asia 5% vs -2.4% = -7.4%
Frontier 6% vs 1.6% = -4.4%
39
Identify the geographical allocation that has made the greatest impact on Tech
Trust plc’s performance relative to its benchmark
* Asia.
* Highest allocation.
40
Lucy and Clara are new retail clients of an authorised advisory firm. Lucy, aged 38, is a basic rate taxpayer and Clara, aged 40, is a higher rate taxpayer.
Lucy and Clara have been in a civil partnership for several years. They would like to purchase a property together in three years’ time. Both are employed and members of workplace pensions via auto-enrolment, although they would like to consider non-pension products to meet their long-term investment needs.
Lucy contributes £100 per month to a Help to Buy ISA and the current value of the plan is £8,000. Clara invests equally in two collective funds within a general investment account (GIA).
State the maximum amount that Lucy and Clara could each contribute to a
Lifetime ISA in its first year and any Government bonus that may be payable.
Lucy
* £4,000.
* Up to 25%/£1,000 bonus.
Clara
* Nil/£0
41
Lucy and Clara are new retail clients of an authorised advisory firm. Lucy, aged 38, is a basic rate taxpayer and Clara, aged 40, is a higher rate taxpayer.
Lucy and Clara have been in a civil partnership for several years. They would like to purchase a property together in three years’ time. Both are employed and members of workplace pensions via auto-enrolment, although they would like to consider non-pension products to meet their long-term investment needs.
Lucy contributes £100 per month to a Help to Buy ISA and the current value of the plan is £8,000. Clara invests equally in two collective funds within a general investment account (GIA).
Explain the main contribution and withdrawal rules for a Lifetime ISA.
* Part of £20,000/overall ISA allowance.
* Must be 18 or over;
* and under 40/make first contribution before 40;
* can contribute until/must cease at 50.
* 25% withdrawal charge unless/no withdrawals in first 12 months;
* buying first home;
* £450,000 or less;
* aged 60 or over;
* terminally ill/less than 12 months to live.
* Bonus not payable if HTB ISA bonus used.
42
Lucy and Clara are new retail clients of an authorised advisory firm. Lucy, aged 38, is a basic rate taxpayer and Clara, aged 40, is a higher rate taxpayer.
Lucy and Clara have been in a civil partnership for several years. They would like to purchase a property together in three years’ time. Both are employed and members of workplace pensions via auto-enrolment, although they would like to consider non-pension products to meet their long-term investment needs.
Lucy contributes £100 per month to a Help to Buy ISA and the current value of the plan is £8,000. Clara invests equally in two collective funds within a general investment account (GIA)
Outline the options available to Lucy in respect of her existing Help to Buy ISA
* Increase contribution;
* by up to £100 pm/to £200 pm.
* Stop/decrease contribution.
* Withdraw/close.
* Transfer into a LISA/ISA.
* Transfer into a different rate/provider
43
State the information that an ISA administrator would require in order to process
an additional permitted subscription (APS) request by a surviving civil partner.
* Deceased’s;
* name;
* address/proof of residency;
* NI number;
* date of birth;
* date of death;
* date of partnership.
44
Describe the main differences in the structure of an OEIC and an Investment Trust.
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.
45
Describe the main differences in the pricing of an OEIC and an Investment Trust.
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.
46
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.
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.
47
Identify six main benefits to Anshul of consolidating his existing collective funds onto a
platform.
* 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.
48
State the time limits within which CGT deferral relief would be available to Anshul
on a new investment into an EIS. Assume that the sale of his shares completes in
May 2022.
* Up to 3 years;
* after/following/May 2025.
* Up to 1 year before/from now/May 2021.
49
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.
* 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.
50
Calculate, showing your workings, the Income Tax and CGT reliefs that could be
claimed by Anshul if he invested the maximum amount into a new SEIS.
Income Tax relief
£100,000 x 50% = £50,000
Carry back = £50,000
CGT reinvestment relief
£50,000 x 20% = £10,000
CGT deferral relief
£50,000 x 20% = £10,000
51
Anshul, aged 63, is a director and majority shareholder in a manufacturing business. He is considering partial retirement and has received an offer to sell one third of his shareholding for £500,000. In recent years, Anshul has been receiving dividends declared by the business at a level of 7% per annum. As Anshul has become used to receiving this level of dividend income, his main objective is to generate a high level of income from any sale proceeds.
Identify two factors that are relevant to Anshul, from a behavioural finance perspective
and give one reason for each of these two factors.
* Anchoring;
* 7% yield/£500,000 capital sum.
* Endowment effect;
* ‘His’ company/emotional attachment/retains shareholding.
* Mental accounting;
* Compartmentalising capital for income/used to receiving income.
52
Describe briefly the objective of Stochastic modelling.
PERRUS
* Estimate/forecast/predict the;
* probabilistic/potential/likely;
* range of;
* returns/outcomes and;
* volatility/standard deviation.
* Under different outputs/scenarios/simulations.
53
State the three main inputs required to generate an optimal portfolio via a
Stochastic modelling tool.
* Returns.
* Volatility/standard deviation.
* Time period.
54
Identify four drawbacks of using a Stochastic modelling tool.
* 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.
55
Calculate, showing all your workings, the return on equity (ROE) for Forest View
plc.
£18,500,000 - £2,000,000 - £4,200,000 = £12,300,000
£35,000,000 + £9,700,000 - £22,600,000 = £22,100,000
(£12,300,000 / £22,100,000) = 0.556561 x 100
= 55.66%
56
Describe briefly what is measured by the ROE metric.
* Ability to generate;
* profit.
* How efficiently it uses;
* shareholders’ funds/capital.
* Relative performance within sector/against peers.
57
Calculate, showing all your workings, the quick ratio for Cloud Formation plc.
(£3,800,000 + £2,150,000) = £5,950,000 / £1,400,000 = 4.25
58
Explain briefly what the ratio shows about Cloud Formation plc’s current financial
position - quick ratio = 4.25
* Company in strong position.
* Can easily repay short-term/current debts from cash/most liquid assets;
* without use of other assets/external resources.
59
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.
* Fixed/non-current assets
* Tangible (plant, buildings etc.).
* Intangible/goodwill.
* Investments.
* Current assets
* Stock/inventory.
* Cash.
* Trade receivables/debtors/prepaid expenses.
60
State the three main components of the UK’s capital account.
* Investments/assets.
* Loans/borrowing.
* Foreign currency reserves.
61
State the principal purpose of a capital account surplus within the UK’s balance
of payments.
* To finance/fund;
* a current account;
* deficit.
62
Explain briefly the macro-economic role of financial investment within the
economy.
* Stimulates demand/spending;
* by increasing aggregate demand.
* Increases productivity/output;
* and business investment.
63
Describe briefly what is meant by the OCF in respect of a collective fund.
* Single;
* percentage figure;
* that shows the;
* annual cost of;
* investing in/owning a fund.
AF4 Pass Papers
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