past paper bank Flashcards

Question

What is the difference between direct and indirect quotes? Give examples. easyw ay to remeber it?

Answer 1

Direct Quote: 👉 “How much of my currency do I need to buy 1 unit of foreign currency?” ✅ You’re given the price in your home currency. 📍 Example (UK): £0.80 = $1 → Direct quote in the UK 🔹 Indirect Quote: 👉 “How much foreign currency can I get for £1 (my money)?” ✅ You’re given the price in the foreign currency. 📍 Example (UK): $1.25 = £1 → Indirect quote in the UK 🔑 EASY WAY TO REMEMBER: Direct = Domestic comes out of your wallet (You're paying in your home currency) Indirect = Incoming foreign cash (You're seeing how much foreign money you get)

Answer 2

A cross-rate is the exchange rate between two currencies, calculated using a third currency — usually the US dollar (USD). cross-rates are almost always expressed as "1 unit of foreign currency = ? units of domestic" “Cross the bridge through the dollar.”

Answer 3

Interest Rate Parity is a theory that says: 💡 The difference in interest rates between two countries is exactly offset by the expected change in exchange rates between their currencies.

Answer 4

Income bonds are called that because the coupon payments depend on the issuer’s income. If the company doesn’t have enough profit or earnings in a given year, it can skip the interest payment — and that’s not considered a default.

Answer 5

Interest rates on different bonds move together over time. 👉 Suggests common macroeconomic influences like inflation expectations and monetary policy. Short-term rates are more volatile than long-term rates. 👉 Short-term bonds react more quickly to changes in monetary policy or market sentiment. The yield curve is usually upward-sloping (long-term rates > short-term rates), but it can invert. 👉 Reflects expectations about future rates, inflation, and economic growth. ✅ Three Theories That Explain These Facts 1. Expectations Theory Assumes long-term interest rates reflect average of expected future short-term rates. Explains why rates move together and why the yield curve slopes up when future rates are expected to rise. Fails to explain why the curve is usually upward-sloping (doesn't account for risk premiums). Supports fact #1, partially fact #3. 2. Liquidity Premium Theory (or Preferred Habitat Theory) Builds on Expectations Theory but adds a risk/liquidity premium for long-term bonds. Investors require extra compensation to hold longer-maturity assets. Explains why the yield curve is usually upward-sloping, even if future short rates are flat. Explains all 3 facts, especially fact #3. 3. Segmented Markets Theory Assumes short and long-term bonds are not substitutes; they’re in different markets. Supply and demand in each maturity bucket determine its rate. Explains why short-term rates can be more volatile, and yield curves can take different shapes. Explains fact #2, but not great for facts #1 or #3.

Answer 6

What is an ETF? (2–3 marks) An Exchange Traded Fund (ETF) is an investment fund that holds a basket of assets (like stocks, bonds, or commodities) and trades on a stock exchange like a regular share. It usually aims to track an index (e.g. S&P 500). ✅ Why are ETFs popular? (7–8 marks) 1) Low Fees – Passively managed, so much cheaper than mutual funds or active managers. 2) High Liquidity – Traded throughout the day on exchanges, so investors can buy/sell at live market prices. 3) Diversification – One purchase gives exposure to a broad set of assets, reducing risk. 4) Transparency – Holdings are often published daily, unlike traditional funds. 5) Tax Efficiency – In some jurisdictions, ETFs are more tax-efficient due to “in-kind” transactions. 6) Access – Easy access to sectors, countries, or commodities that would otherwise be hard to invest in. 7) Less Time-Intensive – Ideal for passive investors who don’t want to actively pick stocks.

Answer 7

📌 Fact 1: Yield curves tend to slope upwards Liquidity Premium Theory: investors demand extra yield for holding long-term bonds Market Segmentation Theory: higher demand for short-term bonds lowers short yields Expectations Theory: only explains this if future short-term rates are expected to rise 📌 Fact 2: Yields of all maturities tend to move together Expectations Theory: all bond yields reflect expected future short-term rates Liquidity Premium Theory: same as above but includes a term premium 📌 Fact 3: Short-term yields are more volatile than long-term yields Expectations Theory: short rates change more with policy shifts Market Segmentation Theory: long bonds less affected due to investor time preferences Liquidity Premium Theory: long-term yields are smoothed by term premium

Answer 8

Correlation analysis measures how asset classes move in relation to one another, and is critical for building a well-diversified portfolio. It involves considering risk/return profiles, sensitivity to economic factors, and especially how assets are correlated. Importantly, correlations are not fixed — they fluctuate over time based on market conditions. Assuming they are stable risks underestimating portfolio risk and overestimating diversification benefits

past paper bank Flashcards

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