Topic 6 Flashcards
1
Q
What are the four main financial asset classes?
A
The four main asset classes are:
- Cash
- Fixed interest securities (e.g., gilts, bonds)
- Equities (shares)
- Property (e.g., buy-to-let).
2
Q
What are examples of fixed interest securities?
A
Examples include government bonds (gilts) and corporate bonds.
3
Q
What is the main characteristic of cash as an asset class?
A
Cash offers low returns through interest but carries minimal risk to capital.
4
Q
What is the risk associated with equities?
A
Equities (shares) have higher risk, and there is no guarantee of income or capital value; an investor could lose all their money.
5
Q
What is considered a fifth, alternative asset class?
A
Alternative investments such as fine wine, art, and antiques are considered a potential fifth asset class.
6
Q
Why is it important to diversify between different asset classes?
A
Diversifying between asset classes helps balance risk and reward, reducing exposure to volatility in any single asset class and smoothing overall returns.
7
Q
Why do different asset classes perform better at different stages of the economic cycle?
A
Each asset class reacts differently to economic conditions; for example, equities may perform well in times of economic growth, while fixed interest securities may provide stable returns during downturns.
8
Q
How do fixed interest securities compare to equities in terms of risk and return?
A
Fixed interest securities generally offer lower risk and stable income, whereas equities offer higher potential returns but come with greater risk.
9
Q
What is the key advantage of cash as an asset class during periods of economic uncertainty?
A
Cash provides capital security and is easily accessible, making it a safe option during economic downturns, though it offers lower returns.
10
Q
What is the typical return and risk profile of property as an asset class?
A
Property provides rental income and potential capital appreciation, but it comes with higher liquidity risk and is sensitive to economic conditions.
11
Q
What type of returns do alternative investments typically offer?
A
Alternative investments, such as fine art and collectibles, can provide higher returns, but they tend to be illiquid and high risk.
12
Q
What is meant by “liquidity” in the context of asset classes?
A
Liquidity refers to how easily an asset can be converted to cash without significantly affecting its price. Cash is highly liquid, while property and alternative investments are typically less liquid.
13
Q
Why might an investor choose fixed interest securities over equities?
A
An investor might choose fixed interest securities for their stability and predictable income, as they tend to be less volatile compared to equities, which have more growth potential but higher risk.
14
Q
How do changes in interest rates affect fixed interest securities?
A
Rising interest rates generally reduce the value of existing fixed interest securities because new bonds offer higher returns, making older bonds with lower rates less attractive.
15
Q
Why might an investor include alternative investments in their portfolio?
A
Investors might include alternative investments to diversify risk and gain exposure to non-traditional assets that do not always correlate with the performance of traditional markets.
16
Q
What impact does inflation have on cash as an asset class?
A
Inflation reduces the purchasing power of cash, meaning the real value of cash returns can decrease over time, especially in periods of high inflation.
17
Q
Why do people choose deposit-based investments like savings accounts?
A
People choose deposit-based investments for the security of capital and convenience. Banks and building societies are accessible, and investors seek the low-risk nature of these accounts.
18
Q
How does inflation affect deposit-based investments?
A
Inflation erodes the real value of capital in deposit-based investments, especially during periods of high inflation, reducing purchasing power over time.
19
Q
What happens to deposits if a bank or building society becomes insolvent?
A
In case of insolvency, investors may be able to reclaim some of their funds through the Financial Services Compensation Scheme (FSCS), which provides protection up to certain limits.
20
Q
Why are deposit accounts useful for short-term savings?
A
Deposit accounts are ideal for short-term savings, such as a holiday or a new car, because they offer easy access and liquidity.
21
Q
What is the purpose of maintaining an emergency fund in a deposit account?
A
An emergency fund in a deposit account ensures easy access to funds for unexpected expenses, providing liquidity and security.
22
Q
Why might investors prefer deposit-based investments over higher-risk options?
A
Investors may prefer deposit-based investments for the low-risk nature and security of capital, even though these accounts typically offer lower returns compared to higher-risk investments like equities.
23
Q
How does the FSCS protect depositors in case of bank insolvency?
A
The FSCS provides protection by compensating depositors up to a certain limit (currently £85,000 per individual, per institution), mitigating the risk of total loss in the event of a bank failure.
24
Q
Why might inertia keep some investors from exploring other investment options?
A
Inertia can prevent investors from seeking more rewarding opportunities, as banks and building societies are familiar and accessible, making it convenient to leave money in low-risk accounts despite potential for better returns elsewhere.
25
Why do institutional investors hold part of their funds in deposit-based accounts?
Institutional investors, like pension funds or insurance companies, keep part of their assets in liquid form (e.g., deposit accounts) to ensure they can meet short-term obligations or take advantage of investment opportunities.
26
What role does liquidity play in deposit-based investments?
Deposit-based investments offer high liquidity, meaning funds can be easily accessed without delay, making them ideal for emergency funds or short-term savings.
27
How much protection does the Financial Services Compensation Scheme (FSCS) provide for deposit-based accounts?
The FSCS protects deposits up to £85,000 per individual, per institution, in case of a bank or building society becoming insolvent.
28
What are no-notice deposit accounts?
No-notice deposit accounts allow depositors to access their money at any time without penalties or waiting periods, making them suitable for emergency savings.
29
Why do some investors prioritize the security of capital in deposit-based accounts despite lower returns?
Some investors value capital preservation over returns, especially in uncertain markets, as deposit-based accounts protect their principal, even if the returns are lower.
30
How do deposit-based investments compare to equities in terms of risk?
Deposit-based investments have lower risk as they safeguard the principal amount, unlike equities which carry higher volatility and the potential for loss of capital.
31
Why might institutional investors hold part of their portfolio in deposit-based investments?
Institutional investors may keep a portion of their portfolio in liquid and low-risk deposit-based investments to meet immediate obligations and maintain financial flexibility.
32
What are the 2 main types of accounts offered by banks and building societies?
The two main types of accounts are:
1. Current accounts (for everyday money needs)
and
2. Savings accounts (for setting aside money not required for day-to-day spending).
33
What are the key features of a traditional current account?
Traditional current accounts allow individuals to receive salary payments, use debit cards, and pay bills via standing orders and direct debits. Cheques and overdrafts may also be available.
34
What is a basic bank account, and who is it aimed at?
A basic bank account is a simplified account designed for individuals, typically those with low incomes or receiving state benefits, who might not qualify for regular current accounts.
It provides access to cash and payments via direct debit but does not offer an overdraft or cheques.
35
What makes interest-bearing current accounts different from traditional accounts?
Interest-bearing current accounts offer the usual banking features along with interest payments on the balance. Higher interest rates and cashback options may be available, but these accounts often require meeting certain conditions, such as a minimum monthly deposit.
36
What is an instant access savings account?
An instant access savings account allows immediate access to funds, often with low or tiered interest rates.
These accounts are commonly used for short-term savings or as an emergency fund.
37
What is a restricted access savings account?
A restricted access account limits the number of withdrawals or requires notice before withdrawals.
In return, it typically offers higher interest rates compared to instant access accounts.
38
How does the Financial Services Compensation Scheme (FSCS) protect depositors?
The FSCS protects deposits up to £85,000 per investor, per financial institution, in case of bank or building society insolvency.
39
Why might someone choose a basic bank account over a traditional current account?
A basic bank account is suitable for individuals who may have difficulty qualifying for a traditional current account due to low income or poor credit history, providing them with essential banking services without the risk of overdraft debt.
40
How do notice and term accounts differ from instant access savings accounts?
Notice accounts require the saver to give notice before withdrawing funds;
while term accounts lock funds for a set period. Both offer higher interest rates than instant access accounts due to restricted access.
41
Why are higher interest rates typically offered on restricted access accounts?
Banks and building societies offer higher interest rates on restricted access accounts because they can use the funds for a longer period, providing them with more certainty.
42
Why might someone choose a packaged current account?
A packaged current account offers additional benefits such as insurance or breakdown cover for a fee, making it attractive for those who would otherwise purchase these services separately.
43
How do high-interest current accounts attract customers?
High-interest current accounts offer competitive interest rates to attract customers, but they often require meeting conditions like minimum monthly deposits or setting up direct debits.
44
What are the advantages of an instant access savings account for short-term savings?
Instant access savings accounts provide flexibility and liquidity, making them ideal for short-term savings or emergency funds, even though they offer relatively low interest rates.
45
What are packaged current accounts?
Packaged current accounts are current accounts that offer additional benefits like travel insurance, mobile phone insurance, or breakdown cover for a monthly or annual fee.
46
How do fixed-term bonds work in restricted access accounts?
Fixed-term bonds lock funds for a specified term (e.g., 1-5 years) with a fixed interest rate. During this term, no access to the funds is allowed, but the trade-off is a higher interest rate.
47
What is the main difference between a notice account and a term account?
A notice account requires you to give notice (e.g., 30 days) before withdrawing funds, while a term account locks the funds for a specific period without access until the term ends.
48
Why might someone prefer an interest-bearing current account?
Interest-bearing current accounts offer the benefit of earning interest on balances, making them attractive for individuals who maintain a higher balance and wish to earn a return on their money while having access to current account features.
49
How does the convenience of mobile banking apps benefit current account holders?
Mobile banking apps provide easy access to funds, enabling users to manage finances (e.g., transfers, direct debits, bill payments) on-the-go without needing to visit a branch.
50
Why might a saver choose a fixed-term bond over an instant access account?
A saver might choose a fixed-term bond for the higher interest rates offered, as they are willing to lock away their money for a longer period in exchange for better returns compared to instant access accounts.
51
What is the difference between a passbook and a cash card in savings accounts?
A passbook is a physical record of deposits, withdrawals, and interest for traditional savings accounts;
whereas a cash card allows the account holder to withdraw money from ATMs and sometimes make purchases directly from the savings account.
52
Can you earn interest on a basic bank account?
Basic bank accounts generally do not pay interest on balances.
Their primary function is to offer access to banking services for those who might otherwise be unable to open a current account.
53
What happens if you breach the withdrawal limit on a restricted access savings account?
If you breach the withdrawal limit on a restricted access savings account, you may be charged a penalty in the form of reduced interest or no interest for the month or year.
54
How does the FSCS protect joint accounts in case of bank insolvency?
For joint accounts, the FSCS provides protection up to £170,000 (i.e., £85,000 per person), which can offer additional security for couples or business partners sharing an account.
55
What is the minimum and maximum investment for NS&I Direct Saver?
The minimum investment is £1, and the maximum is £2 million.
56
What is the tax treatment for NS&I Income Bonds?
The interest on Income Bonds is taxable, paid gross, and interest is paid monthly.
57
What is the minimum and maximum investment limit for a Direct ISA?
The minimum investment is £1, and the maximum is £20,000 per year, with tax-free interest.
58
What are the key features of Premium Bonds?
Premium Bonds are tax-free, with a minimum investment of £25 and a maximum of £50,000.
Instead of earning interest, holders participate in a monthly prize draw with a chance to win up to £1 million.
59
What is the investment range for Junior ISA?
The minimum investment is £1, and the maximum is £9,000 per tax year, with the account being tax-free.
60
How long is the term for NS&I Green Savings Bonds, and what is the tax status?
NS&I Green Savings Bonds have a 3-year term, with interest being taxable and paid at maturity. The investment range is £100 to £100,000.
61
Why might an investor choose Premium Bonds over other NS&I products?
Premium Bonds offer the opportunity for tax-free winnings through a monthly prize draw, with the potential to win large prizes, up to £1 million, although no interest is paid.
62
What is the minimum investment required for NS&I Income Bonds?
The minimum investment for Income Bonds is £500.
The maximum is £1m
63
At what age can you invest in a Junior ISA, and what is the maximum investment limit?
A Junior ISA can be opened for those under 18 (but bought by someone aged 16 or over), and the maximum investment limit is £9,000 per tax year.
64
What is the investment term for NS&I Green Savings Bonds?
The investment term for NS&I Green Savings Bonds is 3 years.
65
What tax treatment applies to NS&I Green Savings Bonds?
The interest earned on NS&I Green Savings Bonds is taxable at maturity.
66
What is the maximum prize for NS&I Premium Bonds?
The maximum prize for Premium Bonds is £1 million in the monthly prize draw.
67
Why might someone choose NS&I Green Savings Bonds over other products?
Someone might choose NS&I Green Savings Bonds because they offer a fixed interest rate for 3 years and support the government’s green spending projects, aligning with ethical investment preferences.
68
What makes Premium Bonds appealing for investors despite not paying interest?
Premium Bonds are appealing due to the monthly prize draw, with the potential to win tax-free cash prizes up to £1 million, while the investment remains safe with no risk to the initial capital.
69
What is the advantage of Direct ISAs compared to taxable savings products?
The advantage of Direct ISAs is that the interest earned is tax-free, making them a preferred option for individuals who want to maximize returns without paying tax on their savings.
70
Why might someone invest in a Guaranteed Income Bond over a Direct Saver?
Someone might choose a Guaranteed Income Bond for the fixed monthly income it provides, especially if they need a reliable source of regular income, whereas a Direct Saver has a variable interest rate.
71
What restrictions apply to a Junior ISA that don't apply to other NS&I products?
A Junior ISA restricts access to the funds until the child reaches 18 years of age, providing a long-term savings option for future use, such as for education or other major expenses.
72
What is the minimum age requirement for NS&I Green Savings Bonds?
The minimum age for investing in Green Savings Bonds is 16.
73
What happens at the maturity of Green Savings Bonds?
At maturity (after 3 years), the investment in Green Savings Bonds is repaid with the accumulated taxable interest.
74
How are returns on Guaranteed Growth Bonds paid?
The returns on Guaranteed Growth Bonds are paid as a fixed rate of annual growth over the 1 or 3-year term.
75
What is the maximum investment limit for NS&I Guaranteed Income and Growth Bonds?
The maximum investment for both Guaranteed Income Bonds and Guaranteed Growth Bonds is £10,000.
76
Why are Direct Savers managed primarily online or by phone?
Direct Saver accounts are managed online or by phone to keep administrative costs low, allowing NS&I to provide competitive interest rates with flexible access to funds.
77
How does the lack of access during the investment term affect Green Savings Bonds?
Investors in Green Savings Bonds cannot access their money until the end of the 3-year term, making it a suitable option for those who can afford to lock away their funds for a longer period in exchange for fixed returns.
78
What are Cash ISAs?
Individual savings accounts (ISAs) are a form of tax-free personal savings scheme.
One form of ISA is cash (also known as a cash ISA): It is a means of obtaining tax-free interest on a bank or buildibg society deposit acount, subject to certain limits and regulations.
79
What is an offshore account?
An offshore account refers to any investment medium (such as a bank account) that is based outside the UK, typically in countries offering more favorable taxation on investments, such as the Channel Islands, Luxembourg, or the Cayman Islands.
80
Why are offshore accounts perceived negatively in terms of taxation?
Offshore accounts are often associated with tax evasion, as people may attempt to hide funds from tax authorities.
However, recent legislation ensures that British Crown dependencies and overseas territories exchange financial information with HMRC to prevent tax evasion.
81
What are the risks associated with offshore accounts?
Risks include currency fluctuation if the account is not denominated in sterling and potential lack of investor protection schemes.
Investors should confirm protection under local regulations before investing.
82
How is interest on offshore deposits treated in the UK?
Interest on offshore deposits is usually paid gross.
UK residents must declare this income to HMRC and may need to pay tax on it, unless they are eligible for tax relief under a double taxation agreement.
83
Why might offshore accounts be useful to some investors?
Offshore accounts can be useful for individuals who need money available outside the UK, for example, those owning property abroad or planning to move overseas in the future.
84
Why might an investor choose an offshore account instead of a UK-based account?
An investor might choose an offshore account for tax advantages or because they need foreign currency accounts for international transactions, such as property ownership abroad or future relocation plans.
85
How do recent regulations affect offshore accounts in terms of transparency?
Recent regulations, such as the implementation of the US Foreign Account Tax Compliance Act (FATCA), have increased transparency by requiring British Crown dependencies and overseas territories to exchange financial information with HMRC, reducing the opportunity for tax evasion.
86
What should investors check before opening an offshore account?
Investors should confirm whether the offshore account is covered by any investor protection scheme in the country where it is based and be aware of currency risk if the account is not denominated in sterling.
87
What is the impact of reciprocal tax treaties on offshore accounts?
Reciprocal tax treaties (or double taxation agreements) allow UK residents to claim tax relief on offshore investment income if it has already been taxed in the country where the investment is held, preventing the same income from being taxed twice.
88
How does residency status affect tax liabilities on offshore accounts?
An individual’s residence status determines their UK tax liability on offshore accounts. UK residents must declare all offshore income.
While non-UK residents may have different tax obligations based on their status and any reciprocal agreements between countries.
89
What are gilts?
Gilts are government-issued bonds with fixed interest, regarded as low-risk investments.
90
How are gilts categorized by redemption period?
Short-dated: Less than 5 years.
Medium-dated: 5-15 years.
Long-dated: Over 15 years.
91
What are index-linked gilts?
Gilts where interest and capital are adjusted for inflation.
92
How are gilt prices determined?
Prices depend on interest rates, time to redemption, and supply/demand.
93
Is interest on gilts taxed?
Yes
Interest is taxable but paid gross.
It may be subject to income tax depending on your savings allowance.
94
Are capital gains on gilts subject to CGT?
No, capital gains from gilts are exempt from capital gains tax (CGT)
95
What are Green Gilts?
Green Gilts are government bonds funding environmental projects under the Green Financing Framework.
96
What is the purpose of gilts for investors?
Investors buy gilts for steady income, low risk, and potential speculation on interest rates.
97
What determines the price of gilts in the secondary market?
Gilt prices depend on market interest rates, time to redemption, and supply and demand.
98
Why are gilts considered low-risk investments?
Gilts are seen as low-risk because they are backed by the UK government, which is unlikely to default on its interest or capital payments.
99
Why might an investor choose index-linked gilts?
Investors choose index-linked gilts to protect their purchasing power against inflation, as the interest and capital value rise in line with inflation.
100
How do gilts perform when market interest rates rise?
When interest rates rise, the price of existing gilts falls because newer gilts offer better returns, making older ones less attractive.
101
What is the benefit of holding gilts until redemption?
Holding gilts until redemption provides fixed interest payments and ensures the full capital repayment at the end, reducing risk from price fluctuations.
102
How do tax-free capital gains make gilts attractive for investors?
Gilts are attractive because capital gains on their sale or redemption are exempt from capital gains tax (CGT), allowing investors to keep all profits.
103
What factors make Green Gilts appealing to ethical investors?
Green Gilts appeal to ethical investors because they fund projects aimed at combatting climate change, including renewable energy and cleaner transportation initiatives.
104
What does 'cum dividend' mean when buying gilts?
'Cum dividend' means that when you buy a gilt, you are entitled to receive the next interest payment due on it.
104
What does 'ex dividend' mean when buying gilts?
'Ex dividend' means that the previous owner of the gilt will receive the next interest payment, not the buyer.
105
How do dual-dated gilts differ from fixed redemption gilts?
Dual-dated gilts allow the government to choose a redemption date within a specified range, whereas fixed redemption gilts have a specific date.
106
How are gilts issued and traded after the initial issue?
After the initial issue, gilts are traded in the secondary market, where their price fluctuates based on interest rates and other factors.
107
Why might an investor sell gilts before the redemption date?
Investors may sell gilts early to capitalize on changes in their price, especially if they anticipate a rise in interest rates,
or
They might need liquidity before the redemption date.
108
How do index-linked gilts protect against inflation better than standard gilts?
Index-linked gilts adjust their interest payments and capital value in line with inflation, ensuring the investment's real value isn't eroded by rising prices.
109
Why might the government issue Green Gilts?
The UK government issues Green Gilts to fund projects that address environmental challenges like climate change, promoting a green economy.
110
How does the UK's Debt Management Office (DMO) manage gilt issuance?
The DMO is responsible for issuing gilts on behalf of the UK government, typically through auctions. They regularly issue new gilts to meet the government’s borrowing needs.
111
What would happen if market interest rates rose during the time she held the gilt?
If market interest rates rose, the price of the gilt would likely decrease, as newer gilts would offer better returns, making her gilt less attractive to other investors.
112
Why is there no capital gains tax on the sale of gilts?
Gilts are exempt from capital gains tax, meaning any profit made on their sale is not taxed, unlike other types of investments like shares or property.
113
John, a basic-rate taxpayer, purchases £50,000 of Treasury 4% 2028 at a price of 90.0, meaning he pays £45,000 for the gilts. He receives £2,000 annually in interest payments, resulting in a yield of 4.44% on his investment. After holding the gilt for two years, John sells the gilts for £55,000.
How much tax will John pay on his profits and interest?
Answer: £400 (£200 x 2 years) income tax + No capital gains tax.
Calculation:
John receives £2,000 annually in interest, which is gross, meaning no tax is deducted at the source.
As a basic-rate taxpayer, he can use his £1,000 personal savings allowance, meaning he only pays tax on £1,000 of the interest. The tax rate is 20%, so his tax liability on the interest is £200 annually.
When John sells the gilts for £55,000, he makes a capital gain of £10,000 (£55,000 sale price - £45,000 purchase price). However, since gilts are exempt from capital gains tax (CGT), no tax is payable on this gain.
114
Sarah, a higher-rate taxpayer, invests £200,000 in index-linked gilts with a 2.5% coupon, which adjusts annually for inflation.
In the first year, inflation is 3%, increasing the coupon rate and the capital value. She receives £5,150 in interest for the year.
How much tax will Sarah owe on the interest, and what happens to the inflation-adjusted capital?
Answer: £1,860 tax due on interest + No CGT.
Calculation:
Sarah receives £5,150 in interest after the inflation adjustment. As a higher-rate taxpayer, she has a £500 personal savings allowance, so she will pay 40% tax on £4,650 of her interest income (£5,150 - £500). The tax due on her interest is £1,860.
The capital value of Sarah’s investment also increases in line with inflation, but there is no capital gains tax due on the increase in the gilt's value because gilts are exempt from CGT, even when inflation adjustments are applied.
115
Mark, an additional-rate taxpayer, buys £100,000 of Treasury 6% 2035 gilts for £110,000, paying a premium above the par value.
He receives £6,000 annually in interest but later sells the gilts for £90,000 after market interest rates rise.
How much tax does he owe on the interest, and is there any tax liability on the capital loss?
Answer: £2,700 tax due annually on interest + No CGT.
Calculations:
Mark receives £6,000 annually in interest, paid gross. As an additional-rate taxpayer, he has no personal savings allowance and will pay 45% tax on the entire £6,000 interest, resulting in a tax liability of £2,700 annually.
When Mark sells the gilts for £90,000, he incurs a capital loss of £20,000 (purchase price of £110,000 - sale price of £90,000).
However, since gilts are exempt from capital gains tax, this capital loss cannot be used to offset other gains for CGT purposes, and no CGT is payable.
116
Laura, a basic-rate taxpayer, buys £75,000 of Treasury 4% 2032 gilts at par value. Over five years, she receives £3,000 in annual interest payments from the gilts.
She also has other savings income of £500 each year.
How much tax will Laura pay on her interest income from the gilts over the five-year period?
Laura’s total savings income each year includes £500 from other savings and £3,000 from the gilts. As a basic-rate taxpayer, Laura has a £1,000 personal savings allowance (PSA) each year.
Here’s the breakdown:
£500 of her PSA is used to cover her other savings income, leaving £500 PSA for her gilt interest.
Therefore, £500 of her gilt interest is covered by the remaining PSA, and the remaining £2,500 gilt interest is taxable at the basic rate of 20%.
Annual Tax Calculation:
Taxable gilt interest: £2,500.
Tax due on gilt interest: 20% of £2,500 = £500 tax annually.
Total Tax Over 5 Years:
Tax due annually: £500.
Over 5 years, Laura will pay £2,500 in total tax (£500 × 5 years).
117
Sarah is interested in purchasing gilts with a 4% coupon rate with a face value of £100. She finds that the gilt is trading at £120.
If Sarah buys the gilt, what is her running yield, and what should she consider if holding the gilt until redemption?
Answer:
To calculate the running yield, Sarah can use the formula:
Running yield = coupon ÷ price paid
= £4 ÷ £120
= 3.33%
While a running yield of 3.33% might seem attractive, Sarah should be aware that she will lose £20 on each gilt if she holds it until redemption, as she will only receive £100 back at maturity, reducing her overall return.
118
John buys a gilt with a 6% coupon rate for £110.
If he holds it until redemption, how much will he lose in capital, and what is his running yield?
Answer:
If John holds the gilt until redemption, he will lose £10 in capital (since he paid £110 but will only receive £100 at maturity).
His running yield is calculated as:
Running yield = coupon ÷ price paid
= £6 ÷ £110
= 5.45%
Though his running yield is 5.45%, John should account for the £10 capital loss on redemption, which will lower his overall return.
119
Lisa is considering buying a gilt with a 5% coupon at £135.
What will be her running yield, and how much capital will she lose if she holds it to maturity?
Answer:
Lisa's running yield is:
Running yield = coupon ÷ price paid
= £5 ÷ £135
= 3.70%
If Lisa holds the gilt to maturity, she will lose £35 in capital, as the gilt will be redeemed at its par value of £100.
This capital loss will reduce her total return, despite the annual interest payments.
120
James bought a gilt with a 3% coupon for £90.
If he holds it to maturity, what will his capital gain be, and what is his running yield?
Answer:
If James holds the gilt to maturity, he will make a £10 capital gain (since he paid £90 and the gilt will be redeemed at £100).
His running yield is:
Running yield = coupon ÷ price paid
= £3 ÷ £90
= 3.33%
James benefits from both a 3.33% yield and a £10 capital gain at redemption, increasing his overall return.
121
Michael is looking at a gilt with a 4% coupon that is trading at £95.
If he buys and holds it to maturity, how much will he gain or lose in capital, and what is his running yield?
If Michael holds the gilt to maturity, he will make a £5 capital gain (since he paid £95 and will receive £100 at redemption).
His running yield is:
Running yield = coupon ÷ price paid
= £4 ÷ £95
= 4.21%
Michael will enjoy both a 4.21% running yield and a £5 capital gain, enhancing his total return.
122
What are local authority bonds?
Fixed-interest securities issued by local authorities, secured on local assets, offering a guaranteed interest rate with a fixed return at maturity.
They are NOT government backed.
123
How secure are local authority bonds compared to gilts?
Less secure, as they lack government guarantees.
124
What are permanent interest-bearing shares (PIBS)?
PIBS are fixed-interest shares once issued by building societies to raise capital.
They pay a fixed interest rate, gross of tax, but rank below depositors in the event of insolvency, making them higher risk.
125
How often is interest paid on local authority bonds, and how secure are they?
Interest on local authority bonds is paid half-yearly, and while they promise a return of capital at maturity, they are less secure than gilts due to the absence of a government guarantee.
126
What happens to PIBS when a building society demutualises?
They convert to perpetual subordinated bonds (PSBs).
127
Why are local authority bonds considered riskier than gilts?
They are not backed by the government.
128
What should investors know about PIBS in terms of risk?
PIBS rank below depositors in insolvency, making them riskier.
129
How are PSBs similar to PIBS?
Both offer no maturity date and provide a fixed income stream.
130
What is the frequency of interest payments for local authority bonds?
Interest is paid half-yearly.
131
Are local authority bonds negotiable?
No, they are not negotiable.
132
Do PIBS have a fixed maturity date?
No, PIBS have no fixed maturity date and are perpetual.
133
How is interest paid on PIBS taxed?
Interest is paid gross but is taxable as savings income.
134
What risk do PIBS investors face in the event of a building society's insolvency?
PIBS rank below depositors, meaning depositors will be paid before shareholders, making PIBS riskier in case of insolvency.
135
Why might investors prefer PIBS over other forms of building society investments?
Investors might prefer PIBS for their fixed interest payments, which are often higher than typical savings accounts, despite the added risk.
136
What happens to the interest-bearing shares when a building society converts to a bank?
The PIBS are converted into perpetual subordinated bonds (PSBs), which continue to provide a fixed income without a maturity date.
137
Sarah buys PIBS from a building society but learns later that it’s about to demutualise and become a bank.
How will her investment change?
Sarah’s PIBS will be converted into perpetual subordinated bonds (PSBs), which will continue to pay a fixed income but with no maturity date.
138
John invests in local authority bonds because they promise a fixed interest rate.
However, he wants to sell the bonds before maturity. Can he do so?
No, local authority bonds are not negotiable, so John must hold them until maturity.
139
What are corporate bonds?
Corporate bonds are loans issued by companies to meet long-term financing needs.
The bondholder is paid a fixed interest rate until the redemption date, at which point the loan is repaid.
140
What is the main difference between secured and unsecured corporate bonds?
Secured bonds are backed by company assets, while unsecured bonds (loan stock) are not, making them riskier.
141
What are debentures?
Debentures are corporate bonds secured on company assets, providing extra security for the bondholder.
142
What makes convertible corporate bonds unique?
Convertible bonds give the holder the option to convert the loan into ordinary shares of the issuing company.
143
Why do companies issue corporate bonds instead of borrowing from banks?
Companies issue corporate bonds to meet long-term financing needs, allowing them to make long-term business plans and often avoid the limitations of bank borrowing.
144
What is the risk associated with investing in corporate bonds compared to gilts?
Corporate bonds are riskier than gilts because they are not backed by the government.
Therefore, they pay higher interest rates to compensate for the greater risk.
145
What happens to a corporate bondholder if the issuing company is wound up?
The bondholder, as a creditor, has priority over shareholders in the event of a company being wound up.
If the bond is secured, they have extra security from company assets.
146
Why might an investor choose a convertible corporate bond over a regular bond?
An investor might choose a convertible bond because it offers the option to convert into shares, potentially benefiting from share price growth while still earning interest from the bond.
147
Alex buys a corporate bond that is unsecured. The company defaults on repayment.
What risk does Alex face compared to if the bond had been secured?
As the bond is unsecured, Alex faces a higher risk of losing his investment compared to if it had been secured, as there are no company assets backing the bond.
148
Emma buys a debenture from a company.
What added protection does she have in case the company is unable to pay back the bond?
Emma has extra protection because a debenture is secured on company assets, meaning these assets could be sold to repay her if the company defaults.
149
What is the primary reason companies issue corporate bonds instead of shares?
Companies issue corporate bonds to raise funds without diluting ownership, as issuing bonds does not involve giving up equity like issuing shares does.
150
What kind of investors typically buy corporate bonds?
Corporate bonds are typically bought by institutional investors like pension funds and life insurance companies, as well as private investors.
151
Are corporate bonds riskier than government gilts?
Yes
Corporate bonds are riskier than gilts because they are not backed by the government, making the financial strength of the issuing company crucial to the bond's security.
152
What obligation does a company have toward bondholders in terms of interest payment?
A company is obliged to pay the interest on corporate bonds, regardless of whether it is making a profit or not.
153
Why might a secured bond (debenture) offer lower interest rates than an unsecured bond (loan stock)?
A secured bond offers lower interest rates because the backing by company assets reduces the risk for the investor, unlike an unsecured bond.
154
What happens if a bondholder does not exercise their option to convert a convertible bond?
If the bondholder does not exercise the option to convert a convertible bond into shares, the bond continues as a normal loan, and the holder will continue to receive interest payments.
155
What factors should an investor consider when purchasing a corporate bond?
Investors should consider the financial stability of the issuing company, whether the bond is secured or unsecured, the interest rate offered, and the bond's maturity date.
156
What are Eurobonds?
Eurobonds are bonds issued in a currency different from the one in the country where they are issued, typically used by multinational organizations and governments for borrowing.
157
Does the term 'Eurobond' refer to the euro currency?
No
'Eurobond' refers to bonds issued outside the jurisdiction of the domestic central bank and has nothing to do with the euro currency.
158
Why might a UK company issue a Euroyen bond?
A UK company may issue a Euroyen bond to raise capital in Japanese yen for expanding its business in Japan, as it might be more cost-effective than borrowing directly from a Japanese bank.
159
Why do multinational companies and governments often use Eurobonds?
Multinational companies and governments use Eurobonds to raise funds in foreign currencies more cost-effectively than borrowing from local banks.
160
What advantage does issuing a Eurobond provide to a company?
Issuing a Eurobond allows a company to access foreign currency markets, potentially with lower borrowing costs compared to domestic loans in foreign currencies.
161
How do Eurobonds differ from traditional bonds issued domestically?
Eurobonds differ in that they are issued in a currency different from the local currency of the country where the bond is issued, while traditional bonds are issued in the local currency.
162
A UK-based multinational wants to raise capital to fund a new project in the U.S. and considers issuing a Eurodollar bond. Why might they choose this option instead of borrowing from a U.S. bank?
The UK company may issue a Eurodollar bond to access U.S. dollars for the project, potentially at a lower cost than borrowing directly from a U.S. bank. This could also allow them to tap into a broader pool of international investors.
163
How is interest from local authority bonds, corporate bonds, PIBS, and Eurobonds paid?
Interest from these bonds is paid gross, without deduction of tax.
164
What tax treatment applies to bond interest if it falls within the starting-rate band or personal savings allowance?
The interest would be tax-free if it falls within the starting-rate band for savings or the personal savings allowance.
165
At what rates is bond interest taxed if it exceeds the personal savings allowance?
Bond interest exceeding the personal savings allowance is taxed at 20%, 40%, or 45%, depending on the individual’s gross income.
166
Why is the interest from local authority bonds, corporate bonds, PIBS, and Eurobonds not subject to tax at the time of payment?
The interest is paid gross, meaning no tax is deducted at source; any tax due is paid based on the individual's total income and tax status.
167
How does an individual's total savings income affect the tax treatment of interest from bonds?
If the total gross interest, when combined with other savings income, exceeds the personal savings allowance or the starting-rate band, the interest is subject to taxation at the applicable income tax rate.
168
Emma receives £2,000 in gross interest from corporate bonds. Her total savings income exceeds her personal savings allowance.
How will her bond interest be taxed?
Emma's bond interest will be taxed at 20%, 40%, or 45%, depending on her total gross income, as it exceeds her personal savings allowance.
169
John's gross income falls within the starting-rate band for savings. He receives £500 in interest from Eurobonds.
What tax will John pay on this income?
John will not pay any tax on the bond interest, as it falls within the starting-rate band for savings income.
170
What is a structured deposit?
A structured deposit is a type of savings product where the return is linked to the performance of a stock market index, such as the FTSE 100, over a fixed term.
171
How does the return on a structured deposit differ from a traditional fixed-rate savings account?
The return on a structured deposit is variable and linked to the performance of a stock market index, while a traditional fixed-rate savings account offers a fixed interest rate.
172
What is the main benefit of using a structured deposit?
The main benefit is that the depositor's initial investment is guaranteed, even if the stock market performs poorly.
173
Do structured deposit investors receive dividend payments?
No, structured deposit investors do not receive dividend payments.
174
Why might someone choose a structured deposit over a traditional savings account?
Someone might choose a structured deposit because it offers the potential for higher returns linked to stock market performance while ensuring their initial investment is protected.
175
How does a structured deposit reduce risk for investors?
A structured deposit reduces risk by guaranteeing that the investor will receive their initial investment back, regardless of stock market performance.
176
What trade-off do investors face when using a structured deposit?
Investors face the trade-off of having limited potential for reward, as they likely won’t receive the full benefit of any index rise, and they also won’t receive dividends.
177
Why are structured deposits considered complex financial products?
Structured deposits are complex because their returns are tied to stock market indices, and understanding how these indices affect returns often requires financial advice.
178
John is deciding between a traditional savings account and a structured deposit. He’s looking for stability but would also like some exposure to the stock market.
Why might a structured deposit be a good choice for him?
A structured deposit could be a good choice for John as it offers potential equity-based returns while still guaranteeing his initial investment, providing a balance of stability and growth potential.
179
What is alternative finance?
Alternative finance refers to financial activities or lending that occur outside of the traditional banking system, such as crowdfunding.
180
What are the two unregulated types of crowdfunding?
Donation-based crowdfunding and reward-based crowdfunding are unregulated by the FCA.
181
Which types of crowdfunding are regulated by the FCA?
Loan-based crowdfunding (P2P lending) and investment-based crowdfunding are regulated by the FCA.
182
Who can invest in loan-based or investment-based crowdfunding?
Only experienced or sophisticated investors, or ordinary investors who confirm they won’t invest more than 10% of their net investable assets, can invest in loan-based or investment-based crowdfunding.
183
What is P2P lending?
P2P lending involves a saver placing their money with a P2P lender, who then lends it out to businesses seeking funding, usually through a crowdfunding platform.
184
Why are donation-based and reward-based crowdfunding not regulated by the FCA?
These types of crowdfunding do not involve financial returns or lending, so they are not regulated by the FCA.
185
What are the risks associated with P2P lending?
1. The risks include businesses missing loan repayments, which would reduce returns for the saver.
2. P2P lending is not covered by the Financial Services Compensation Scheme (FSCS).
186
What is the main difference between donation-based and investment-based crowdfunding?
In donation-based crowdfunding, contributors do not expect any financial return.
While in investment-based crowdfunding, contributors invest money in exchange for a share of a company or return on their investment.
187
Emily places her savings in a P2P lending platform that offers attractive interest rates.
What are the potential risks compared to traditional bank deposits?
Emily’s risks include the possibility of businesses missing loan repayments, reducing her returns.
Additionally, her funds are not protected by the FSCS if the P2P platform fails.
187
What is the key difference between donation-based and reward-based crowdfunding?
Donation-based crowdfunding does not expect anything in return, while reward-based crowdfunding offers contributors a reward, such as a product trial.
188
Are P2P lenders covered by the Financial Services Compensation Scheme (FSCS)?
No, P2P lenders are not covered by the FSCS.
189
What is the main risk associated with investment-based crowdfunding?
The main risk is that investors could lose their investment, especially if the start-up company goes bust and the shares become worthless.
190
Describe the four main asset classes – and a possible fifth one?
Cash: Money held in deposit accounts. Low risk, but offers low returns and is vulnerable to inflation.
Fixed Interest Securities: Bonds such as gilts or corporate bonds. Offer a fixed rate of return, but come with some risk depending on the issuer.
Equities: Company shares. These offer potential for high returns, but come with a high risk of losing the capital invested.
Property: Real estate investments such as buy-to-let properties. Relatively stable with potential for income and capital growth, but can be illiquid.
Alternative Investments (5th class): Includes assets like fine wine, art, or antiques. These are generally higher-risk, less liquid, and may require specialized knowledge.
191
Explain why deposit‑based savings might appeal to an investor over other forms of investment?
1. Security: The capital is protected, often by government guarantees (like FSCS in the UK).
2. Liquidity: Easy access to funds, ideal for short-term needs or emergency savings.
3. Low Risk: Unlike stocks or bonds, there's minimal risk of losing the principal, although inflation can erode value over time.
192
Explain why an offshore investment is potentially riskier than an onshore one?
1. Currency Risk: Offshore accounts might not be in sterling, so exchange rates can affect the value when converted back to local currency.
2. Regulatory Risk: Investor protection schemes may be less robust or non-existent compared to domestic regulations.
3. Taxation Complexity: There are additional tax obligations, and failure to report offshore income correctly can lead to penalties.
193
Explain how a structured deposit differs from an ordinary bank or building society deposit account?
A structured deposit ties its returns to the performance of an index, like the FTSE 100, rather than paying fixed interest.
It offers the benefit of equity-like returns with the guarantee of returning the initial deposit, but typically caps potential gains and does not provide access to dividends, unlike an ordinary deposit account that provides regular, predictable interest.
194
How does the UK Debt Management Office (DMO) define short-dated gilts?
Short-dated gilts are defined as those with less than 7 years until redemption.
195
What is the time range for medium-dated gilts according to the UK DMO?
Medium-dated gilts have a redemption period of 7–15 years.
196
Why might investors choose short-dated gilts over medium- or long-dated gilts?
Investors may choose short-dated gilts for lower risk and quicker access to their capital, as they have less time until redemption compared to medium- or long-dated gilts.
196
A bank deposit account (instant access savings) is a good place to hold a rainy day fund.
True or false?
True
They allow instant access and are protected up to £85,000.
197
What, if any, is the minimum age at which a person can take out an NS&I Direct saver?
A) there is no minimum age.
B) 16.
C) 18.
Answer: B) 16
198
Interest on NS&I income bonds is tax free.
True or false?
False.
Interest is paid gross but taxable.
199
State two reasons why offshore bank accounts might be more risky than similar UK deposit accounts?
1. If held in currency other than sterling the exchange rates may affect the investment.
2. The investment may not be protected by an investor protection scheme like in the UK.
200
In relation to gilts, what is the coupon?
The coupon is the interest rate payable on the par value of the gilt.
201
Jane has invested in short-dated gilts. According to the UK Debt Management Office (DMO) definition, this means that:
A) the gilts will have a redemption date within the next seven years.
B) interest on the gilts will not be paid to her until the end of the term.
C) the gilts will have a redemption date within the next ten years.
D) she will be unable to access her capital until the end of the term.
Answer: A) the gilts will have a redemption date within the next seven years.
202
Rubina is considering buying a gilt, 3% Treaury 2025. The gilt is currently trading at a price of £107.
What is the running yield?
Answer: 2.8%
Calculation:
The running yield is £3 ➗ £107 = 2.8%
203
The main difference between corporate bonds and gilts is that corporate bonds:
A) usually pay a variable rate of interest.
B) are usually for larger amounts of money.
C) normally have no specified redemption date.
D) are considered to be a higher risk investment.
Answer: D) are considered to be a higher risk investment.
204
The main difference between a debenture and other types of corporate bond is that a debenture:
A) carries the right to vote at the companys annual general meeting.
B) is usually secured on the assets of the company.
C) can be converted to ordinary shares of the company.
D) pays a fixed rate of interest.
Answer: B) is usually secured on the assets of the company.
205
A eurobond is the equivalent of a gilt but issued by a government within the eurozone.
True or false?
False.
A eurobond is a bond issued or traded in a country that uses a currency other than the one in which the bond is denominated. Can be issued by large companies not just governments.
206
Jack opens up an account so his wages can be paid into it. He can use his account to pay bills such as utilities and rent via direct debit. And he can use a debit card to make purchases online and in shops. But he can not have an overdraft. What kind of account does Jack have?
A) packaged account.
B) an interbank account.
C) a basic bank account.
D) a debit account.
Answer: C) a basic bank account.
