October 2020 Flashcards
Calculate, showing all your workings, the Sharpe ratio for the REIT.
8.5 - 0.35/1.97 = 4.137055 = 4.14
Explain three main differences between the Sharpe ratio and the Information
ratio.
- 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.
State four drawbacks of using the Sharpe ratio in investment planning.
- 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.
State the main rules that a fund must adhere to in order to qualify as a REIT.
- 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.
Irma receives an income payment of £2,950 from the REIT, consisting of £750
property income distribution and a £2,200 dividend.
Calculate, showing all your workings, her Income Tax liability on this payment.
Assume Irma is a higher rate taxpayer and this is the only dividend she receives.
PID
£750/80 x 100 = £937.50 x 20% = £187.50
Dividend
£2,200 - £2,000 = £200
£200 x 32.5% = £65
Total £187.50 + £65 = £252.50
Given their previous experience of equity-based investing, Irma and Christopher
decide to invest the £190,000 equally across three UK equity funds.
(i) Identify four main risks relating to the achievement of their objective to which
Irma and Christopher would be exposed.
- Market/systematic/volatility.
- Shortfall.
- Inflation.
- Concentration/all in UK equities/lack of diversification.
- Accessibility/liquidity.
- Fund specific event.
Given their previous experience of equity-based investing, Irma and Christopher
decide to invest the £190,000 equally across three UK equity funds.
From a behavioural finance perspective:
State three main biases that may have influenced their investment decision and
provide one justification for each bias.
- Hindsight
- UK equites have done well in the past.
- Mental accounting
- Their money for their objective/known target value.
- Endowment effect/divestiture aversion
- Already own equities/why change.
- Overconfidence
- Market timing/they know best/UK equities will be best asset class.
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.
- 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.
List four open-ended fund structures that could be used to invest in UK equities.
Exclude OEICs from your answer.
- 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.
Explain three relative differences between what is measured by alpha and beta.
- 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.
Calculate, showing all your workings, the time-weighted rate of return (TWR)
for the GIA over the twelve-month period shown in Table 1.
Period 1
(£15,470 - £5,000 - £10,000)/£10,000 = 0.047 = 4.7%
Period 2
(£16,800 - £15,470)/£15,470 = 0.08597 = 8.6%
(1 +0.047) x (1 + 0.08597) - 1 = 0.13701 x 100 = 13.7%
Explain briefly why Irma and Christopher would use the TWR, rather than
the money-weighted rate of return (MWR), when evaluating the performance
of the GIA.
- TWR not influenced by money added/new investment.
- TWR focuses on individual manager skill/performance.
- TWR compounds multiple periods/shows change over entire period.
Identify two aspects of personal taxation that would change if Irma and Christopher
were to get married and state how each could result in potential tax savings.
- Inheritance Tax;
- unlimited spousal exemption/transferable nil rate band.
- Capital Gains Tax;
- inter spousal disposal exempt.
- Income Tax;
- marriage allowance/transfer of £1,250/10% of Personal Allowance.
Explain briefly the main drawbacks of holding a fund that invests on a single theme or
thematic basis.
- 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
Identify the due diligence factors solely relating to meeting Catherine’s income
needs that the adviser would consider when assessing a potential platform.
- 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.
Calculate, showing all your workings, the shortfall in Catherine’s target income
based upon her current pension and ISA income.
£90,000 x 4.2% = £3,780
£3,780 + £19,500 = £23,280
£25,000 - £23,280 = £1,720
Describe how the investment bond could be used to generate the figure in your
answer in part (b) (Shortfall income of £1,720)
- Take withdrawals;
- of up to 5%/£2,000 per annum;
- of original investment.
- Tax deferred/no immediate Income Tax liability;
- up to initial 10 years/up to 20 years/surrender/death.
Calculate, showing all your workings, the dividend yield for Azure Tree plc.
7.9/151 = 5.23%
Calculate, showing all your workings, the dividend cover for Azure Tree plc.
7.6/7.9 = 0.96
State two reasons for the difference in dividend cover between Azure Tree plc
and Sienna Wall plc.
Azure - 0.96
Sienna - 1.87
- Sienna Wall earnings more than dividend/retaining more profit.
- Azure Tree earnings less than dividend/maintaining dividend.
From the financial information for each company contained in Table 1:
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.
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/undervalued.
* Share price supported by income available/greater upside.
Gregor believes that the economy is moving into the latter stages of the business cycle.
State two reasons why this view would likely have a positive impact on Sienna
Wall plc’s share price in the short to medium term.
- Defensive/low P/E stocks become more attractive/increased demand.
- Relative value of dividend/yield increases/well-covered.
Gregor believes that the economy is moving into the latter stages of the business cycle.
State two reasons why this view would likely have a negative impact on Azure
Tree plc’s share price in the short to medium term.
- Growth/high P/E stocks become less attractive/falling demand.
- Equity risk premium reduces/share price too high/mean reversion.
- Future profits/growth less certain.
