Chapter 1 Asset Classes 14 questions
1.1 The Role and Characteristics of Cash Deposits Liquidity and rates of interest • Why hold cash? - Liquidity – instant access • Emergency funds, planned spending - ‘Safe’ • Capital unlikely to be lost - No capital gain • Interest is paid - Real return • Rates of interest - Interest is a percentage of funds deposited • The higher the deposit, the higher the rate - Longer-term deposits • Generally higher rates (not always the case – if rates falling) - Fixed or variable interest rates www.fitchlearning.com
1.2.1 Gross and Net Interest Gross and net interest • Gross (typical) - Paid before the deduction of income tax • Net (e.g. distributions from bond funds) - After tax at 20% Example • A building society is quoting 6.4% gross on a deposit account - What is the effective after-tax rate for a BRT and a HRT? www.fitchlearning.com
Annual equivalent rate (AER) • Annual equivalent rate (AER) - True rate of return to compare ‘like for like’ (12-month period) - AER is usually quoted gross - Example : an interest rate of 6% is paid quarterly – what is the AER? - Example : an interest rate of 6% is paid monthly – what is the AER? • Compounding - Interest can be paid at differing time intervals - The more frequent the payment, the more benefit from compound interest • If compounding periods are discrete, CF = (1+(r / j)) n*j • If compounding periods are continuous, CF = e rt www.fitchlearning.com
1.5 Statutory Protections The Financial Services Compensation Scheme • If deposit taker fails – Financial Services Compensation Scheme - Administered jointly by the FCA and PRA - Maximum protection of £75,000 per account holder (UK sterling deposits only) - Maximum payouts are per person, per institution • Financial Ombudsman Service (FOS) - Complaints against regulated financial services providers - Free dispute resolution service - Can award compensation up to £150,000 www.fitchlearning.com
1.7.1 National Savings and Investment Products NS&I products offered by the Government • Overview - The only truly risk-free deposits – government backed - NS&I is an agency of the Chancellor, accountable to the Treasury • Summary National Savings and Investment Products Interest Net of 20% Gross but taxable Tax free • Guaranteed growth • Investment account • Index-linked savings bond* • Direct saver account certificate* • Guaranteed income bond • Income bond • Fixed interest savings • 65+ bonds* • Guaranteed equity bond certificate* Products • Children’s bonus bond • Direct ISA • Premium bond * Not currently available www.fitchlearning.com
1.9 Peer to Peer Lending What is peer to peer lending? • Lending to individuals without using a financial intermediary - Independent companies match borrowers and lenders online in return for a fee - Also called Crowdfunding • Risks - Default by borrowers - Loans sometimes pooled to diversify risk • Returns and taxation - High APR compared to high street banks - Interest is received gross and must be declared in full to HMRC • Possible to hold P2P ISA from April 2016 • Regulation - Depositors have no recourse to the FSCS for losses they incur - Firms that operate in this market must be FCA registered - FCA undergoing a full review of the market www.fitchlearning.com
2. Fixed Income Securities Gilts: UK Government bonds Name Redemption The name The year when • Features of gilts given at the gilt is repaid issue Coupon Expressed as an 122 122 122 annual % of the Security Code Security Code Security Code 6½ PER CENT TREASURY STOCK 2018 6½ PER CENT TREASURY STOCK 2018 6½ PER CENT TREASURY STOCK 2018 GBX00001144KK00 GBX00001144KK00 GBX00001144KK00 Nominal value nominal value Principal and interest charged on the National Loan Fund, with r Principal and interest charged on the National Loan Fund, with r Principal and interest charged on the National Loan Fund, with r ecourse to the Consolidated Fund of the United Kingdom ecourse to the Consolidated Fund of the United Kingdom ecourse to the Consolidated Fund of the United Kingdom Repayable at par on the 7 December 2018 Repayable at par on the 7 December 2018 Repayable at par on the 7 December 2018 The capital payment Interest payable half Interest payable half Interest payable half -yearly on 7 June and 7 December -yearly on 7 June and 7 December -yearly on 7 June and 7 December HOLDING NUMBER HOLDING NUMBER HOLDING NUMBER CERTIFICATE NUMBER CERTIFICATE NUMBER CERTIFICATE NUMBER 555-XZ333333 555-XZ333333 555-XZ333333 555-XZ333333 555-XZ333333 555-XZ333333 The holder receives £100.00****** £100.00****** £100.00****** at redemption MR FREDERICK BLOGGS MR FREDERICK BLOGGS MR FREDERICK BLOGGS 24a ACACIA AVENUE ARBINGER SURREY SSY 345 24a ACACIA AVENUE ARBINGER SURREY SSY 345 24a ACACIA AVENUE ARBINGER SURREY SSY 345 THIS IS TO CERTIFY THAT THE ABOVE THIS IS TO CERTIFY THAT THE ABOVE THIS IS TO CERTIFY THAT THE ABOVE THIS IS TO CERTIFY THAT THE ABOVE -NAMED IS/ARE THE REGISTERED HOLDER(S) OF -NAMED IS/ARE THE REGISTERED HOLDER(S) OF -NAMED IS/ARE THE REGISTERED HOLDER(S) OF -NAMED IS/ARE THE REGISTERED HOLDER(S) OF ONE HUNDRED POUNDS 61/2 PER CENT TREASURY STOCK 2018 ONE HUNDRED POUNDS 61/2 PER CENT TREASURY STOCK 2018 ONE HUNDRED POUNDS 61/2 PER CENT TREASURY STOCK 2018 ONE HUNDRED POUNDS 61/2 PER CENT TREASURY STOCK 2018 17 JUNE 2002 17 JUNE 2002 17 JUNE 2002 17 JUNE 2002 CHIEF REGISTRAR CHIEF REGISTRAR CHIEF REGISTRAR CHIEF REGISTRAR BANK OF ENGLAND BANK OF ENGLAND BANK OF ENGLAND BANK OF ENGLAND IMPORTANT: The Bank of England should be notified immediately of IMPORTANT: The Bank of England should be notified immediately of IMPORTANT: The Bank of England should be notified immediately of IMPORTANT: The Bank of England should be notified immediately of any change of address of any of the above stockholders any change of address of any of the above stockholders any change of address of any of the above stockholders any change of address of any of the above stockholders No transfer in whole or part of this holding represented by this No transfer in whole or part of this holding represented by this No transfer in whole or part of this holding represented by this No transfer in whole or part of this holding represented by this certificate will be registered until this certificate has been certificate will be registered until this certificate has been certificate will be registered until this certificate has been certificate will be registered until this certificate has been delivered to the Bank of England delivered to the Bank of England delivered to the Bank of England delivered to the Bank of England The stock is transferable in multiples of 1p The stock is transferable in multiples of 1p The stock is transferable in multiples of 1p The stock is transferable in multiples of 1p • UK Government raises funds for the PSNCR (CGNCR + LGNCR + PCNCR) www.fitchlearning.com
2.2 UK Government Bonds Gilts: UK Government bonds • Categories of gilt Gilts Index-linked Non-index-linked • Coupon and redemption < Seven years to redemption • Shorts linked to RPI 7-15 years to redemption • Mediums • Inflation protection • Longs >15 years to redemption • Undated www.fitchlearning.com
Discount Instruments Treasury bills • Issued by the UK Government via the DMO • Zero coupon (pay no interest – buy at a discount) • Tradable - Their value fluctuates • Terms: - One month, three months, six months most popular • Minimum bid at tenders £500,000 - Bids made through Treasury Bill Primary Participants Zero coupon bonds • Pay no interest, issued at a deep discount - E.g. issued at £60 per £100 nominal • Taxed as though income is paid – no CGT on the gain www.fitchlearning.com
2.2.5 Local Authority Bonds Local authority bonds • Features - Interest is paid to investors net of basic rate tax - Usually secured by a charge over the assets of the issuing authority - May also be guaranteed by the Public Works Loans Board • Local authority fixed stocks - Not marketable - Investors must hold until the maturity date • Local authority negotiable loans (‘yearlings’) - Have a life of no longer than two years - Issued at par - Can be traded www.fitchlearning.com
2.3 Corporate Bonds Corporate bonds: security Corporate bonds Debentures Loan stock Secured debt securities Unsecured debt securities Fixed charge Floating charge Over assets Over assets www.fitchlearning.com
2.3 Corporate Bonds 2.3.1 Permanent interest bearing shares (PIBS) • Issued by building societies • Fixed interest security traded on the LSE - Interest paid gross/taxable – twice a year - No obligation to pay interest – non-cumulative - Irredeemable – no fixed term - In demutualisation PIBS convert to perpetual subordinated bonds (PSBs) • Higher risk than gilts, illiquid • PIBS holders are members of the Building Society • Not protected by the FSCS www.fitchlearning.com
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