Asset Classes

Chapter 2

27 questions

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Asset Classes
Equities

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Section Overview
Shares
• The advantages and disadvantages to issuers and investors of
- Ordinary share
- Preference shares

Other securities
• The principal characteristics of depositary receipts
• The rights, uses and differences between warrants and covered warrants

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 Further Information
2.1.1 Equity: Why Issue? Authorised share capital
Authorised share capital is the maximum amount of capital that can be
A company issues shares in order to raise capital. The investors buy a share in raised through share issue.
the company’s success.

Shareholders: Issued share capital

Issued share capital is the number of shares the company has allotted to
£60 shareholders.

Investor 1
SHARES
Nominal value
£40
The fixed legal value of a share. An accounting term.
Company
SHARES
Investor 2
Market Capitalisation
Number of shares in issue multiplied by the market price of the share.

Free float
All shares being held by investors other than:
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• Owners holding 5% or more of all shares

• Restricted stocks
• Insider holdings

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 Further Information
2.1.1-2 Ordinary and Preference Shares Ordinary shares
A and B ordinary shares
Types of Equity
• Different classes of shares created to separate ownership and control
Companies may issue more than just ordinary shares. Redeemable Shares
• Offered by a company to shareholders that may be bought back by the
Features Ordinary shares Preferred shares company at its election. Companies are permitted to issue ordinary shares
that can be redeemed, as long as conventional non-redeemable ordinary
Priority 2nd 1st shares are also in issue.
Partly Paid
Dividends Variable Fixed
• Each ordinary share has a nominal value, which represents the minimum
Voting Yes No amount that the company must receive from subscribers on the issue of the
shares. Occasionally, the company may not demand all of the nominal value
• Cumulative at issue, with the shares then referred to as being partly paid.
• A shares/B shares
• Participating
Special features • Redeemable
• Convertible
• Partly paid
• Redeemable Preference shares
Cumulative
• The right to receive that dividend is rolled over into the next period
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Participating
• Opportunity for further dividend
Redeemable
• The right for the issuer to buy back the shares
Convertible
• The right to convert into ordinary shares
Zero dividend
• Pay no income, redeemed by shareholder above the price at which
they were issued

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 Keeping on Target
2.1.1-2 Ordinary and Preference Shares A company announces an increase in the dividend that it will pay out to
shareholders in response to continued profit growth. Assuming all of the
Summary following shares are in issue, which of the following is least likely to benefit
Advantage Disadvantage from this increase?
Company Raise capital Sacrifice control A. Participating preference shareholder
Servicing varies with • Activism B. Ordinary shareholder
performance Reputation
Discretionary payments Potentially high payout C. Convertible preference shareholder
No redemption
D. Redeemable preference shareholder
Investor Return linked to performance Low ranking
Potential gain as well as income • Risk capital
Ownership rights Potential volatility caused by
unrelated factors

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Asset Classes
Equity-based Investments

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 Further Information
2.7.1 American and Global Depositary Receipts American Depository Receipts
American Depository Receipts (ADRs) are used by non-US companies in
ADRs: Features order to encourage US Dollar investors to buy an equity stake.
ADR: features
• US$ denominated and US$ dividend
SHARES ADRs
• Bearer document (American form)
• Rights issues: ADR holders receive cash
££££s $$$$s • Bonus issues: alters number of shares
BRIT plc BANK A Pre-release (grey market rules)
US dollar
investor An ADR, or issuing an ADR, secured by cash collateral rather than
UK USA deposited securities and can be issued in a pre-release format for up to
three months (US$ collateral required)
Brit plc will pay dividends in sterling to Bank A. Bank A will convert them into US
dollars and pass them on to the ADR holder.

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Answer to question on previous slide: D

All of the other shares can benefit through an increase in dividend, either
directly or indirectly.
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 Keeping on Target
2.7.1 American and Global Depositary Receipts In a depositary receipt issuance which of the following would the holder of
a depositary receipt NEVER receive?
Summary A. The right to receive a dividend payment
Advantage Disadvantage B. The right to vote
Company Raise capital internationally Lack of transparency on C. The right to subscribe to new shares in proportion to their existing
beneficial ownership share holdings
Investor Access to overseas companies FX risk added to market risk
D. The right to sell the depositary receipts in the secondary market
• Domestic currency Benefits may differ depending
• Domestic market on the terms of the DR

• Note
- ADRs are denominated in dollars can be traded anywhere in the world
- GDRs are usually denominated in dollars or euros

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 Hints
2.7.2 Warrants If the conversion figure were a negative, the warrant would be trading at a
discount.
Background
• Right to subscribe for new shares from a company at a fixed price on a future
date
• Not part of ordinary share capital of company

Issuance
• Typically issued as a sweetener with other investments (e.g. corporate debt)
• Detachable or non-detachable form

Conversion premium

Conversion premium = Warrant price + Exercise price - Current share price

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Answer to question on previous slide:

C: DR holders do not get the opportunity to take part in rights issues.

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 Hints
2.7.2 Warrants On exercise, warrants create new shares whereas options and covered
warrants are exercised into existing shares.
Covered Warrants: A comparison with Traditional Warrants
Warrants Covered warrants Options
Issued by Companies Investment banks Writer
New shares Existing shares Existing shares
Shares delivered
Potential dilution No dilution No dilution

Maturity Normally >1 year Normally < 1year Normally < 1year

Derivatives
Traded on LSE/OTC LSE
exchange
Call and put
Right to buy the Call and put options
warrants
Types underlying share available (right to
available (right to
only buy and sell)
buy and sell)
Cash and Cash and physically
Exercise/ Physically settled
physically settled settled contracts
Settlement contracts
contracts available available

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 Keeping on Target
2.7.2 Warrants With respect to the issuing company, which of the following would be
considered a benefit to issuing warrants rather ordinary shares?
Summary A. They may be able to issue shares at a higher price in the future, whilst
still generating some income today
Advantage Disadvantage
Company Raise capital On exercise B. They will be able to ensure their employees are more motivated to work
Delay sacrificing control • Dilution of ownership harder
Delay paying dividends • Issue equity below market
C. It will allow the company to recall these warrants at any time in the
Makes another security more price
attractive – Potentially well below future preventing possible dilution of ownership
Investor Exposure to a share at a fraction No votes or dividends D. They will be able to gain additional income when the warrants are
of the price Potentially worthless if the share traded in the secondary market
• Gearing/leverage price does not exceed the
exercise price

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Section Review
Shares
• The advantages and disadvantages to issuers and investors of
- Ordinary share
- Preference shares

• Other securities
• The principal characteristics of depositary receipts
• The rights, uses and differences between warrants and covered warrants

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Answer to question on previous slide: A

They may be able to issue shares at a higher price in the future, whilst still
generating some income today
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Asset Classes
Government Bonds

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Section Overview
Government Debt
• Know the principal features and characteristics of
- Conventional government debt
- Index-linked government debt
- Strip market
- Emerging and frontier markets

Corporate Debt
• The principal features and uses of
- Secured debt
- Unsecured debt
- Credit ratings
- Eurobonds

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Debt: Types and Features
Debt types: Summary
Capital

Debt Equity
(companies and (companies only)
governments)

Bank Loan Debt Securities

(companies only) (companies and
governments)

Bills Bond
maturities < 1 year maturities > 1 year

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 Further Information
2.3.1 Bonds: Features Characteristics
Name – to act as an identifier.
Features of Bonds
Coupon – generally paid semi-annually and the quoted coupon of a gilt
Coupon Name Nominal value Redemption represents the annual amount of interest paid per £100 nominal value.
Expressed as an The name given The capital payment The year when
annual at issue the holder receives the gilt is repaid Coupons are taxable (subject to income tax for individuals); however, tax
percentage of the at redemption is not normally deducted from the coupon payment. Therefore it is referred
nominal value
to as being a gross coupon.
Security Code
GBX00001144KK00 6 ½ PER CENT TREASURY STOCK 20X8
Principal and interest charged on the National Loan Fund, with recourse to the Consolidated Fund of the United Kingdom
122
Redemption – the redemption date is the specified date on which the
Repayable at par on the 7 December 20X8
Interest payable half-yearly on 7 June and 7 December capital is repaid by the DMO. Normally, redemption is at par, i.e. £100 for
each £100 nominal value held. All remaining stock must be repaid on the
HOLDING NUMBER CERTIFICATE NUMBER

555 - XZ333333 £100.00****** 555 - XZ333333

MR FREDERICK BLOGGS
24a ACACIA AVENUE ARBINGER SURREY SSY 345
redemption date.
Benchmarking – the yield available on UK gilts is considered the risk-free
rate for sterling denominated bonds – UK gilts are effectively credit risk-
free.
THIS IS TO CERTIFY THAT THE ABOVE-NAMED IS/ARE THE REGISTERED HOLDER(S) OF
-
ONE HUNDRED POUNDS 61/2 PER CENT TREASURY STOCK 20X8
17 JUNE 2018

CHIEF REGISTRAR
BANK OF ENGLAND

IMPORTANT: The Bank of England should be notified immediately of any change of address of any of the above stockholders
No transfer in whole or part of this holding represented by this certificate will be registered until this certificate has been delivered to the Bank of England
The stock is transferable in multiples of 1p

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 Further Information
2.3.1-2 Government Bonds: Features Inflation indices
RPI – Retail Prices Index: An average change in the prices of household
Government Bonds goods and services.
Categories of bond CPI – Consumer Prices Index: Based on an EU-wide formula to allow
international comparison. Used by the MPC.
Government bond
PPI – Producer Prices Index: Looks at goods and services further up the
production chain, at the wholesale level.

Index-linked Conventional

• Index-linked: Coupon and redemption linked to an inflation index

- Inflation protected
- Return during zero inflation

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 Further Information
2.3.3 Separate Trading of Registered Interest and Liability driven investors, such as pension funds, often use bonds to
Principal of Securities meet their liabilities. However, this can lead to reinvestment risk.
Reinvestment risk is where the investor may not receive a required rate
Strips Market – developed in US, UK and Japanese government bond of return when reinvesting coupon payments. This is often avoided through
cash-flow matching, or dedication.
market
Dedication is where the investor matches the maturity of cash-flows to the
• Case study: UK Gilts designated as strippable by the Debt Management Office liabilities. The simplest way to do this is use a zero-coupon bond.
• Permitted parties: As STRIPS function like zero-coupon bonds, they provide a useful tool in
- GEMMS this strategy.
- HM Treasury
- Bank of England

• A five-year strippable gilt may be stripped into 11 zero-coupon bonds

• Investors can precisely match their liabilities, removing any reinvestment risk

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2.3.4 International Government Bonds
International Government Debt
France Germany UK (Gilts) USA (T-bonds) Japan (JGBs)

Life when BTF: < 1 Bubills: 6-12mth T-bills: < 1 T-bills: < 1 Maturities 2-40
issued (yrs) OATs 2-50 Schatz: 2yrs Short < 7 T-notes: 2-10 10 – most
Bobl: 5yrs Medium 7-15 T-bonds: >10 common
Bund: 10-30yrs Long > 15
Coupons Annual Annual Semi-annual Semi-annual Semi-annual

Settlement T+2 T+2 T+1 T+1 T+1

time (T-bills: trade
date)

• Significant increase in the issuance of government bonds in emerging/frontier

markets
- E.g. Emerging – Brazil, Russia, India, China, South Africa, Indonesia, Mexico, Turkey
and Malaysia. Frontier – Bangladesh, Bahrain, Mauritius and Sri Lanka.
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Asset Classes
Corporate Bonds

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 Further Information
2.4.1 Corporate Bonds: Features Debentures
In the UK, a secured debt transaction is called a debenture, whereas in the
Corporate Bonds: Security US the term debenture generally refers to a loan agreement with no
security at all. In the US, the term asset-backed security is more
Corporate Bonds
commonly used for secured issues. In the US secured debt is commonly
known as an asset backed security (ABS).
Fixed Charge Over Assets – a fixed charge is security over a certain
Secured debt Unsecured debt specific company asset, e.g. a building or land, and is the most common
securities securities form of security for debentures. A mortgage charge is a type of fixed
charge.
Floating Charge Over Assets – a floating charge is security over a class
of assets, e.g. plant and machinery, fixtures and fittings, trade debtors.
Fixed charge Floating charge
over assets over assets
Unsecured Debt
The examiner may use the term ‘loan stock’ to describe unsecured debt
instruments.

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 Further Information
2.4.1 Secured Debt Types of Trustee
Note trustee
Asset-backed Securities/Covered Bonds
The note trustee is appointed to represent the interests of holders of
• Bonds secured by a pool of assets, e.g. property, loans issues of securities, while providing guidance to the issuer.
• Who owns the pool determines the type of bond Security trustee
- Pool owned by the originator Where bonds are secured (debentures) the security is protected by the
• Covered bond trustee for the benefit secured parties. The governing documents dictate
- Pool owned by a special purpose vehicle (SPV) the order of priority of payments among the entitled parties.
• Asset backed security Share trustee
• Underlying assets securitised The share trustee holds the shares in an issuing Special Purpose Vehicle
(SPV) in order to ensure off-balance-sheet treatment for the originator of
Secured debt (debentures)/asset-backed securities the transaction. Sometimes these SPVs are domiciled in offshore
Trust deed jurisdictions.
Successor trustee
• Empowers the trustee alone to act on behalf of debenture holders
- Ensures organised action and parity of treatment through a single entity This role played by a trustee is provided for banks which need to resign
because of conflicts of interest (especially in connection with defaulted or
bankrupt issues) or when work requirements exceed the bank’s capacity.
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 Hints
2.4.2 Unsecured Debt Unsecured corporate debt has a typical life of 7-30 years.

Unsecured Debt
• Convertible bonds
- Converts into stock of the issuer

• Exchangeable bonds
- Converts into stock of another, usually subsidiary of the issuer

• Guaranteed bonds Keeping on Target

- Credit enhancement based on the credit rating of a third party
A controlling shareholder knows that the company needs to raise capital
• Floating rate notes (FRNs) but is not prepared to accept any dilution of ownership. Which of the
- Coupon floats in line with market interest rates following would be most suitable for the company to issue?
- Trade near par
A. Convertible bonds
- Capital protection
B. Preference shares
• Payment in kind notes (PIK)
- Generally subordinated debt C. Ordinary shares
- Zero coupon bonds that are issued at a substantial discount to their face value D. Zero coupon bonds

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 Further Information
2.6.1 Eurobonds Listing eurobonds – a London listing of a eurobond consists of admission
to be listed by the FCA which acts as the UK’s Listing Authority, and
Types of Eurobonds admission to trading on a recognised investment exchange such as the
London Stock Exchange.
• Definition
- International bonds
- Bearer documents Eurobond variants
- Issued in a eurocurrency
Straight or plain vanilla – fixed coupon eurobonds or bullet bonds
- Any currency other than the currency of the market on which it is issued
normally pay the coupons once a year.
Dealing and settlement
Zero Coupon Bonds (ZCBs) – no coupon. Issued at a discount and
• Typically OTC but some exchange-traded
redeemed at par value.
• Regulated by International Capital Markets Association (ICMA)
- Trades reported and matched through TRAX Floating rate eurobonds (FRN/VRN) – bonds where the coupon rate
- Settlement: T+2 (if settled through Euroclear/Clearstream) varies. The rate is adjusted in line with published market interest rates.
• Gross annual coupon The published interest rates that are normally used are a reference rate
• Day-count convention for accrued interest e.g. SONIA
- 30/360
Immobilisation Stepped bonds – Coupon increases over the life of the bond.
• As bearer documents, eurobonds are often held in depositaries (immobilised)
- Euroclear/Clearstream

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Keeping on Target
Which of the following would be the best description of a eurobond?
A. A French company issuing euro denominated bond issued in Frankfurt
B. The Debt Management Office issuing a dollar denominated bond in the
UK
C. The Bank of England issuing a dollar denominated bond in the UK
D. A European company issuing a Australian dollar bond in Australia

Answer to question on previous slide: D

Zero coupon bonds

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 Further Information
9.1.11 Debt Seniority Impact of security
The impact of security is significant when a company becomes insolvent
Impact of Security or is wound up.
1. Liquidator
All classes of debt rank more highly than equity (i.e. debt is paid back
2. Fixed charge holders before equity). However, not all types of debt are equal – some are senior
(take priority), whilst others are subordinate.

CREDITORS
3. Preferential creditors (e.g. employees)

4. Floating charge holders

5. Unsecured creditors (e.g. trade creditors and the

Government)
6. Subordinated loan stock
Further Information
Mezzanine debt
7. Preference shareholders (nominal value only except The mezzanine level of debt will rank below other forms of debt but above

OWNERS
participating shares) the equity in a liquidation. An example is a payment-in-kind note
Guaranteed bonds and Convertible bonds
8. Ordinary shareholders These will rank alongside other unsecured bonds.

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Answer to question on previous slide: C

There are two possible answers to this question. The Debt Management
Office issuing a dollar denominated bond in the UK is more commonly
known as a sovereign bond. Which means the Bank of England issuing a
dollar denominated bond in the UK is the best answer.

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 Further Information
2.4.3 Credit Ratings The CISI Workbook also mentions Regional Credit Rating Agencies and
names:
Overall Risk of Bonds • Japan Credit Rating Agency
Standard & Poor’s Moody’s Fitch
• Global Credit Rating (for Africa)

AAA Aaa AAA

AA Aa AA
Investment grade
A A A
BBB Baa BBB Keeping on Target
BB Ba BB The credit rating of a particular corporate bond has changed from BBB- to
B B B BB+, what is the likely effect on the bond?
Speculative grade
CCC Caa CCC A. Increase in price, increase in yield
CC Ca B. Decrease in price, decrease in yield
C C. Increase in price, decrease in yield
Bond in default D C D D. Decrease in price, increase in yield

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Debt: Types and Features
Summary

Advantage Disadvantage
Company Raise capital Obligation to pay regardless of
No sacrifice of control performance
Known obligations Redemptions
Paid from pre-tax profit Default can lead to significant
Cheaper to finance repercussions
Investor Known payments Lower return
Priority in payment Not all debt is default risk free
Some debt is default risk free

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Answer to question on previous slide: D

Decrease in price, increase in yield. The change describes a downgrade.
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Section Review
Government Debt
• Know the principal features and characteristics of
- Conventional government debt
- Index-linked government debt
- Strip market
- Emerging and frontier markets

Corporate Debt
• The principal features and uses of
- Secured debt
- Unsecured debt
- Credit ratings
- Eurobonds

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Asset Classes
Bond Yields

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Section Overview
Debt Instruments
• Uses and limitations of yields calculations
• Calculate
- Interest income
- Conversion premiums
- Flat yield
- Accrued interest
- Spreads
- Present value of a bond

• The role of the yield curve and the relevance of negative interest rates

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 Hints
2.2.2 Yields The examiner can also use the following terms for the flat yield:
• Interest yield
Flat Yield
• Running yield
• Uses:
• Simple yield
- Income-seeking non-taxpayers
- Irredeemable bonds

Flat yield =
Gross annual coupon
x 100 % Keeping on Target
Market price
A gilt is priced at £9.00 above its nominal value. If the coupon is 3 1/2%,
what is the flat-yield?
A. 3.21%
B. 3.35%
C. 3.5%
D. 3.85%

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Hints
It is useful to notice a relationship between prices and yields:
• If price > par value then coupon > yield
• If price < par value then coupon < yield
• If price = par value the coupon = yield

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 Keeping on Target
2.2.2 Yields Which one of the following is the best approximation of the gross
redemption yield of an 8% two-year government bond with a current price
Gross Redemption Yield (GRY) of £103?
• Considers annual return due to income and gain through to redemption
• AKA Yield to maturity (YTM) A. 6.3%
B. 7.8%
Example:
C. 9.2%
An investor purchases an eight-year 7% coupon bond at a market price of £95.00 D. 10.7%
(per £100 nominal). The gross redemption yield is calculated as follows:
£7
Flat yield (coupon income) x 100% = 7.4%
£95
+ +
(£5 Profit / 8 years)
Profit / Loss at redemption x 100% = 0 .7%
£95
Gross redemption yield 8.1% Hints
Net redemption yield The coupon received from most bonds is generally taxable, but any gain
• Considers the impact of tax on the YTM made on redemption (or subsequent sale) is not taxable. This makes
bonds with a low coupon attractive to higher rate taxpayers, as the price
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may be lower than par, resulting in a part of the return coming in the form
of a tax-free capital gain.

Answer to the question on the previous slide = A

FY = £3.50 / 109 = 3.21%

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Asset Classes
Bond Pricing

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Answer to the question on the previous slide = A

As the bond is trading above par, the GRY will be less than the coupon
rate. A is the only possible answer.
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 Hints
2.2.6 The Present Value of a Bond A company's debt is valued by calculating the payoffs that debt holders
can expect to receive, taking into account the risk of default.
Discounting
• A bond is a series of future cashflows
• Discounting these cash flows at a required rate allows us to price the bond at a
present value of those cashflows

Example:
Keeping on Target
The value of a two-year 6.5% coupon bond using 4.5% interest rates:
The present value of the following bond with a 4% annual coupon with two
£coupon £coupon + £red val years to maturity and a prevailing discount rate of 2.75% is:
Value of bond = +
(1 + r ) (1 + r ) n

A. £98.51
£6.50 £106.50
= + B. £100
(1 0.045) (1 + 0.045)
+ 2

C. £102.40
= £103.74 D. £104.28

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 Further Information
2.2.3 Accrued Interest The ex-coupon period for a UK gilt is typically 7 business days.
Bearer bonds generally do not have ex-coupon periods.
Clean vs. Dirty Prices

Ex coupon period
Price Cum coupon period Cum coupon period
Dirty price
Hints
Clean price • Dirty price > clean price in the cum-coupon period
• Dirty price < clean price in the ex-coupon period
• Dirty price = clean price on the coupon paid date
Time

6 months Coupon paid date

Ex coupon date

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Answer to the question on the previous slide = C

The present value of the first year’s cash flow
£4 / 1.0275 = £3.89.
The present value of the second year’s cash flow
£104 / (1.02752) = £98.51.
The price of the bond is the sum of the present values.
£3.89 + £98.51 = £102.40
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 Hints
2.2.3 Accrued Interest Accrued interest
𝐴𝑐𝑐𝑟𝑢𝑒𝑑 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 = 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 × (𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑑𝑎𝑦𝑠 𝑓𝑟𝑜𝑚 𝑙𝑎𝑠𝑡 𝑝𝑎𝑦𝑚𝑒𝑛𝑡) /
Clean vs. Dirty Prices (𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑑𝑎𝑦𝑠 𝑖𝑛 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 𝑝𝑒𝑟𝑖𝑜𝑑)
Example:

You buy £10,000 nominal of an 8% bond for settlement on 6 July for a clean
price of £105. If the coupon payment date is 1 April, calculate the dirty price
payable on settlement using an actual/365 day-count convention.
A. £10,690 Keeping on Target
A 3% Gilt is quoted at £98.00, there has been 66 days after its last half-
B. £10,700
yearly coupon payment, how much would it cost to buy the bond?
C. £10,710 A. £98.00
D. £10,720 B. £98.54
C. £99.08
D. £100.00

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 Keeping on Target
2.2.4 Pricing Benchmark A bond is trading at a 1.5% premium to its benchmark bond. The rate for
three-month referenced rate is 3.97% and the yield on benchmark bond is
Spreads and Benchmarks 3.5%. What is the spread of the bond to the referenced rate?
• Difference between the yield on one investment and the yield on another
- Measured in basis points (0.01%) A. 500bp
Examples of spreads B. 197bp
C. 150bp
• Spread to government securities
- Default spreads
D. 103bp

• Spread to published reference rates

• Spread to swap rates

Further Information
Benchmark Interest rates
LIBOR was the published reference rate and in most cases is now
replaced by many for other interest rate benchmarks. The most prevalent
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SONIA – Sterling Overnight Index Average: Published by the Bank of
England and based on the actual overnight rates banks borrow money.
SOFR – Secured Overnight Financing Rate: Published by the Federal
Reserve and based on actual overnight Treasury repo market.

Answer to the question on the previous slide = B

Accrued interest = 66days / 365 days x £3.00 = £0.54
Dirty price = £98.00 + £0.54 = £98.54
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 Asset Classes
Other Bond Valuation Considerations

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Answer to the questions on the previous slide = D

As the bond is trading at a premium of 1.5% over the benchmark of 3.5%,
its yield must be 5% (3.5% + 1.5%).
As the reference rate is 3.97%, the difference to the bond yield is 5% -
3.97% = 1.03% or 103bp.
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 Hints
2.2.3 Interest and Conversion Premium The conversion ratio – the number of shares that each £100 of nominal
value of the bonds can convert into.
Simple Interest
Calculate simple interest income on corporate debt: Conversion ratio = Nominal value
• Corporate bond paying 6% coupon maturing in 20 years Conversion price of shares
• Market price is £108 per £100 nominal
• Investor buys bonds at a market price of £4,320

Convertible Loan Stock

Calculate the conversion premium:

Keeping on Target
A company has issued convertible loan stock which can convert into 80
• Convertible trading at £125 per £100NV ordinary shares per £100 nominal. The convertible is trading at £160 and
• Conversion terms £100NV = 50 shares the ordinary shares at 180p per share. What is the conversion premium
as a percentage?
• Current share price £2.30

Knowledge | Skills | Conduct

A. 10%
B. 11.1%
C. 20%
D. 22.2%

56
2.2.2 Yields
Factors affecting Bond Prices
• Interest rates When interest rates rise bond prices fall:

INTER
EST R
ATES
BOND
PRIC
ES

When interest rates fall bond prices rise:

ES
PRIC
BOND
ATES
EST R
INTER

• Time to redemption
Pull to redemption

PRICE

£100
(nominal value)

TIME
0
Redemption date

Knowledge | Skills | Conduct

Answer to the question on the previous slide = B

Effective price of share via convertible debt (£160 / 80 shares) = £2.
Actual share price £1.80.
Conversion premium is 20p (£2.00 - £1.80), or expressed as a percentage
of share price, (£0.20 / £1.80) 11.1%.
57
 Keeping on Target
2.2.2 Yields Modified duration shows the expected change in a bond's price, given a
specified change in interest rates. Which of the following is most likely?
Overall Risk of Bonds A. The lower the modified duration, the more the price of that instrument
• Modified duration will move
- Measure of volatility B. The higher the modified duration, the more the price of that instrument
• Approximate percentage change in a bond’s price for a 1% change in interest rates will move
- Bonds with higher modified duration will be more volatile C. The higher the modified duration, the less the price of that instrument
will move
Long-dated low coupon D. The higher the modified duration, the less of an effect the interest
bond is most volatile change will have on the bond's price.

Knowledge | Skills | Conduct

58
 Further Information
2.2.5 Yield Curves Inflation and the yield curve
• Yield curves show the nominal yield
Yield curves: Background
• Real yield curves show inflation-adjusted yields and can be observed by
• The yields currently available to investors across different time horizons looking at the yield curve for index-linked instrument
• The difference between the nominal yield curve and the real yield curve
Normal/upward Inverted
reveals an expectation of inflation

Yield
Yield

Keeping on Target
Which of the following would determine the shape of a normal yield curve?
Maturity Maturity A. Credit rating
Liquidity preference Expectation of falling rates B. Liquidity
C. Risk free rate
D. Maturity
Knowledge | Skills | Conduct

Hints
Negative Yields
Where investors are paying to lend money. Occurring in some government
bond markets, where the uncertainty of the economic climate in general
creates an increased desire to put money somewhere safe – even if you
have to pay for it.

Answer to the question on the previous slide = B

59
Section Review
Debt Instruments
• Uses and limitations of yields calculations
• Calculate
- Interest income
- Conversion premiums
- Flat yield
- Accrued interest
- Spreads
- Present value of a bond

• The role of the yield curve and the relevance of negative interest rates

Knowledge | Skills | Conduct

Answer to the question on the previous slide = B

The shape of a normal yield curve captures the fact that investors have a
liquidity preference: they prefer more rather than less liquidity. Because of
this, they are willing to accept a lower yield on more liquid, short-dated
government bonds, and demand a higher yield on less liquid, longer-dated
government bonds.
60
Asset Classes
Money Markets

Knowledge | Skills | Conduct

61
Section Overview
Cash Assets Foreign Exchange
• Uses, advantages and disadvantages • Principal features and uses of spot,
of cash forward and cross trades
• Features and characteristics of • Factors that affect FX rates
Treasury bills • Calculate forward settlement prices
• Features and uses of commercial using
paper - Pip adjustments
• Purpose and characteristics of the - Interest rate parity
repo market • Characteristics of crypto currencies

Knowledge | Skills | Conduct

62
 Further Information
2.5.1. Cash Deposits Cash deposit accounts
Interest returns on cash can be affected by the size and term of the
Cash Deposit deposit:
• Liquidity and rates of interest
• Larger deposits and longer terms attract higher rates of interest
- Why hold cash?
• Liquidity – instant access, fast access e.g. short-notice
• Emergency funds, planned spending, security Depositing cash overseas
• No volatility – safe Additional risk including
• Generates income as a rate of interest
• FX risk
- Fixed or variable
• Withholding tax
- Risks
• Potential default of the deposit taker • Exchange controls restricting repatriation
- Financial Services Compensation Scheme
• Inflation and tax reducing returns
- Real returns after tax can be negative
• Interest rates changes affecting returns

Knowledge | Skills | Conduct

63
 Further Information
2.5.2 Treasury Bills Issuance process
Minimum Treasury bill issues in the UK are known as ‘tenders’, held by the DMO at
Government Bills denomination UK the end of the week (usually a Friday).
Treasury bills T-Bill : £25,000 These tenders are open to bids from eligible bidders which include all of
• Short-term unsecured debt the major banks.
DMO
- 1 month to 12 months The bids are tendered competitively – the highest prices bid win and if
successful participants pay the price they bid.
• Zero-coupon 1. Treasury issues a 90-day T-
4. Investor redeems T-bill and
receives the full face value. The
Bill with a face value of difference between this and the
- Issued at discount redeemed £100,000 £98,500 originally paid is the
investor’s return.
at par

• Benchmark risk-free rate

2. Investor pays £98,500 for the

bill (after deducting a £1,500
3. Investor holds the Keeping on Target
T-bill for the entire 90-
discount, which is approx 3
months’ interest at
day period An investor is concerned that there could be another financial crisis and is
6% pa) looking to use a 'flight to safety' approach using UK government T-bills.
Which of the following is the correct observation about the period leading
up to the crisis?
Knowledge | Skills | Conduct

A. The redemption value is likely to increase due to the UK government

trying to control money supply
B. The yields achievable on the T-bills are likely to fall and possibly
become negative
C. Corporates are likely to be crowded out as the government issues more
T-bills to satisfy demand
D. The central bank will need to manage the FX rate to ensure the
currency does depreciate dramatically

64
 Further Information
2.5.3 Commercial Paper Commercial paper
Typically unsecured but in some countries, like the US, can be asset
Commercial Paper backed (ABCP). The paper is backed by the company’s physical assets
• Features such as trade receivables.
- Discount security by companies Commercial paper issued is up to 270 days in the US, whereas it could be
- Unsecured, short term debt up to 1 year in the UK..
• Up to 1 year (typically 3 months)
Commercial paper programme
• CP programme An on-going programme where the issuer advertises the rates at which it
- Usually a rolling programme, is willing to issue paper for various terms. Buyers can purchase the paper
not all at once whenever they have funds to invest.
• Issuance Programmes may be promoted by dealers, in which case the paper is
- Direct paper
called dealer paper.
• Buy and hold investor Larger issuers, especially finance companies, have the market presence
- Dealer paper to issue their paper directly to investors. Their paper is called direct
• Promotion of programmes
paper.

Knowledge | Skills | Conduct

Hints
Rollover risk
Where a company uses a new issue of CPs to pay off the existing CPs, it
rolls over the debt. The risk associated with being unable to issue enough
CPs to cover the existing issue is called rollover risk.

Answer to the question on the previous slide = B

During a financial crisis, many institutions want to replace all their other
money market holdings with the shortest-duration T-bills. This can have
the perverse consequence, on extreme occasions, of making such
instruments, which are priced on a discount basis, yield a negative return
or at a rate which is far below that which would normally be expected. The
desire to move into such short-term paper during moments of crisis is
referred to as a flight to safety.
65
 Further Information
2.5.4 Repo Market Terms of a repo
An open repo is where there is no fixed time for repurchase.
Repo Market
Maturity dates in excess of overnight are called term repos.
There are two components to a repo:
Repos may be used as a method of borrowing funds (using gilts as
1. The sale: GILT
collateral) and reverse repos to cover a short position taken on by a
Tripartite
market maker in the course of its market making activities.
repos also
available
£900

2. The repurchase:
GILT
Keeping on Target
Which of the following is the best definition of the repo rate?
£1,000

A. It is the difference between the amount of cash paid over at the start of
• The difference between the sale and repurchase price (£1,000 - £900 = £100)
the agreement and the amount paid over at the end expressed as a
is the ‘repo rate’. It is, in effect, the interest paid for borrowing money. percentage

Knowledge | Skills | Conduct

B. It is the amount of cash paid over at the end of the agreement
expressed as a fee
C. It is the difference between the amount of collateral handed over at the
start of the agreement and the amount paid over at the end expressed
as a percentage
D. It is an interest rate set by the central bank as a benchmark for all
borrowing opportunities

66
Asset Classes
Foreign Exchange Market

Knowledge | Skills | Conduct

Answer to the question on the previous slide = A

The repo involves the movement of an amount of cash paid over by a
participant at the start of the repo, which will be less than the amount paid
over at the end of the repo period. The difference between the two
amounts, expressed as a percentage, is the effective interest rate on the
repo transaction. It is usually referred to as the 'repo rate'.
67
 Further Information
2.8.1 Introduction to Foreign Exchange 1.8.3 Factors affecting foreign exchange rates
Supply and demand for sterling (GBP)
FX: Background
Demand
• OTC market
• Exporting goods: overseas markets need sterling to pay for UK goods
• Major international banks • Foreign investment: overseas investors want to invest capital into the UK
• Spot market and forward market • Speculation
Supply
• Importing goods: converting sterling into an overseas currency will
FX: Exchange rate quotation increase supply of sterling
• Base currency • Investing overseas: UK residents want to invest capital into overseas
GBP 1 = USD 1.3900 assets
• Counter/quote currency
USD 1 = HKD 7.7560 • Speculation
Impact
Cross rates • More demand for the currency increases its value
- Can reduce exports and foreign investment
• Any foreign currency rate which does not involve the US dollar
• More supply of a currency will diminish its value
Knowledge | Skills | Conduct - Can reduce imports as overseas goods look expensive
Currency rate management by the central bank
Other factors
Release of key economic data (or forward guidance) by central banks and
governments can have a significant effect on the FX market. For example,
when the US Labor Department issues its monthly employment data, (the
Non-Farms Payroll (NFP) report), on the first Friday of each month at
8:30 Eastern time.

68
 Keeping on Target
2.8.2 FX Spot Markets A company wishes to exchange $250,000 into GBP at a spot rate of
1.4505/15USD. How much will the company receive?
FX Spot Markets: Introduction
• Standard settlement T+2

FX: Two-way prices

GBP against USD

spot rate please

GBP against USD for

spot is 1.5010 / 1.5015

Knowledge | Skills | Conduct

69
 Further Information
2.8.2 Forward FX Rates Carry trade
A carry trade in FX involves the borrowing of funds in a currency where the
Forward Rate Pip Adjustment rate of interest is relatively low and then purchasing securities, often
• Generally government bonds, which have relatively high yields.
- Pips are either added to or subtracted from the spot rate:

Spot GBP = USD 1.5110

Forward adjustment +40
Outright forward rate GBP 1 = USD 1.5150
Keeping on Target
The current spot price is £1 : $1.4785 - $1.4815. If the forward adjustment
Spot GBP= USD 1.5110 is expressed as a premium 0.90 cents – 0.87 cents, at the 3 month
forward rate how many dollars will £1 buy?
Forward adjustment -28
Outright forward rate GBP 1 = USD 1.5082
A. $1.4695
- Forward rates can expressed as a two way pip adjustment to the spot’s bid and offer B. $1.4728
C. $1.4875
D. $1.4902
Knowledge | Skills | Conduct

Answer to the question on the previous slide

Buying or selling base? Buying, therefore offer rate.
$250,000 / 1.4515 = 172,235.18 GBP
70
 Keeping on Target
2.8.2 Forward FX Rates Interest rate parity: summary
Where:
Interest Rate Parity (IRP)
Arbitrage-free method of pricing FX forwards

• F = the forward rate

• S = the spot rate
• r variable r base = the interest rates for each currency variable and base

The spot rate is currently 1EUR : 0.8900GBP. An investor wishes to take

out a six-month forward and wants an idea of what rate to expect. He
notes that the interest rates in the UK are higher, at 4% pa, than they are
in the Eurozone, which are 2% pa. Using interest rate parity, what six-
month forward rate would he get?
A. 0.8988 GBP
B. 0.8813 GBP
Knowledge | Skills | Conduct
C. 0.9075 GBP
D. 0.8729 GBP

Purchasing power parity

It works in a similar way, using similar concepts except it uses inflation
rather than interest rates

Answer to the question on the previous slide = A

This shows an alternative method used in the exam. The 0.90 is
deducted from the quoted spot bid rate to arrive at the forward rate as
we are looking to sell GBP and buy USD, therefore £1 will buy fewer
dollars in three months’ time. As it is quoted in cents, unlike the spot
rate, which is quoted in dollars, 0.90 cents are 0.0090 dollars. So,
$1.4785 - $0.0090 = $1.4695
71
Asset Classes
Cryptocurrency

Knowledge | Skills | Conduct

Answer to the question on the previous slide = A

Remember to deannualise the rates:
Base: EUR = 2% pa / 2 = 1% over the six-month period
Variable: UK = 4% pa / 2 = 2% over the six-month period
Calculation
Forward = 1.02/1.01 x 0.89 = 0.8988
72
 Home Study
2.8.3. Cryptocurrencies This section is marked HOME STUDY. You will need to review specific
videos on the online portal for this section.
Features
• Money outside the control of governments and central banks You can find the video for this on your online study portal:
- Encryption technology used to control supply and record transfers and ownership
Asset Classes > Other Asset Classes > Chapter 2 -Cryptocurrency
- Example include Bitcoin, Litecoin, Dogecoin and Ethereum

Investment
• Investors need a digital wallet
• Methods of acquiring cryptocurrency Hints
- Buy it with fiat money
- Earn it through browsing and posting The problem of scalability
- Crypto mining Crypto mining is energy intensive and the cost of mining can often exceed
• Risks the currency earned.
- Volatility
- Decentralised and not reserve-backed
- Largely unregulated
- Operational risk and hacking

Knowledge | Skills | Conduct

73
 Home Study
7.8 Distributed Ledger Technology This section is marked HOME STUDY. You will need to review specific
videos on the online portal for this section.
Distributed Ledger
• A centralised ledger of transactions with a decentralised network of computers You can find the video for this on your online study portal:
all holding copies of exactly the same ledger, commonly associated with Asset Classes > Other Asset Classes > Chapter 2 -Cryptocurrency
cryptocurrencies
• Advantages:
- Produces a trustworthy and reliable record
- Prevents a single point of failure as numerous nodes are used
- Very difficult to hack, because of the use of multiple nodes.
- Removes the costs and delays caused by the need to maintain and update a single
central database.

Knowledge | Skills | Conduct

74
Section Review
Cash Assets Foreign Exchange
• Uses, advantages and disadvantages • Principal features and uses of spot,
of cash forward and cross trades
• Features and characteristics of • Factors that affect FX rates
Treasury bills • Calculate forward settlement prices
• Features and uses of commercial using
paper - Pip adjustments
• Purpose and characteristics of the - Interest rate parity
repo market • Characteristics of crypto currencies

Knowledge | Skills | Conduct

75
 Asset Classes
Open-ended and Closed-ended Funds

Knowledge | Skills | Conduct

76
Section Overview
Collective Investments Property (HOME STUDY)
• Regulated vs Unregulated CIS • Understand the risk and rewards of
• Open-ended vs closed ended funds property investment
• Exchange-traded funds vs trading - Direct investment
direct with the management - Real estate investment trusts
- Open-ended investment companies
• Trust-based funds vs companies vs
private equity

Structured Products (HOME STUDY)

• The key features and components
• The pay-out structures and risks

Knowledge | Skills | Conduct

77
Collective Investments
Introduction
• A collective investment is an arrangement that enables a number of investors to
'pool' their assets and have these professionally managed by an independent
manager
• Differing objectives:
- Income, capital growth, combination of the two
• Advantages of collective investments
- Many investors are not able to:
• Allocate the time to manage their own portfolios
• Have the expertise to construct, monitor and adjust their portfolios
• Benefit from economies of scale
• Diversify as easily as with pooled investments
• Disadvantages of collective investments
- Costs - Initial charge + Ongoing fund management costs
- Risk returns are not guaranteed
- Lack of control – investor loses their choice of individual investments

Knowledge | Skills | Conduct

78
 Further Information
3. Fund Regulations Risks of UCIS
Unregulated schemes are deemed to be at greater risk than regulated
Regulated and Unregulated Collective Investment funds due to the increased flexibility afforded over the investment portfolio.
This can include:
Collective investment schemes in the UK
• Less liquidity in the assets which can lead to lock-in periods for
investors.
Regulated Unregulated (UCIS)
(e.g. hedge funds) • Larger more concentrated positions creating less diversified portfolios.
Recognised Authorised • Can be highly geared with greater use of debt and derivatives.
Overseas funds Domestic Funds
• Little supervision of the fund in respect of regular reporting to the
e.g. UCITS regulator creating a greater risk of fraud and conflicts of interest.
Restrictions on investment powers fall • Most unregulated schemes are actively managed and this can lead to
higher charges. Performance fees can greatly increase the cost to the
Restrictions on marketing increases investor
• Generally based offshore adding currency and geopolitical risk to the
investment

Knowledge | Skills | Conduct

79
Summary
Unit trust OEIC Inv. trust

Legal structure Trust Company Company

Open or closed Open-ended Open-ended Closed-ended

Holdings Units Shares Shares

Independent
Supervision Trustee Depositary
auditors
Authorised
Managed Fund manager Fund manager
corporate director
Investment rules Defined rules Defined rules Flexibility
Limited ability to Limited ability to Can borrow –
Borrowing powers
borrow borrow leverage/gearing
Price system Bid – offer (dual) Single Bid – offer (dual)

Value NAV NAV Market sentiment

Knowledge | Skills | Conduct

80
 Further Information
2.9.2 Open-Ended and Closed-Ended Trust vs Company
• The key difference between the legal structure of Unit Trust and Open-
Open-Ended Funds Ended Investment Company (OEIC)
• Pricing of units/shares - Unit holders are the beneficiaries of the portfolio of assets
- Units/shares are not transferable Trustee/Depositary
- Shareholders are the beneficiaries of the company
• No secondary market £
• Trades performed with the Unit Trust Manager • Shares/units can be:
management Authorised
Corporate Director - Income/distribution
- The portfolio is valued once every £ (ACD)
business day - the valuation point Open-ended - Accumulation
Fund
- Price based on net asset value
Units/
Shares Private equity
(NAV) per unit/share £
• Typically set up as a partnership
• Single pricing Portfolio
• Two-way pricing - Invest in specialist investment and growth companies
• Costs - Seek to influence the investee companies
- Initial charges - High levels of debt is common
- Ongoing management charges - Typically illiquid
- Exit charges – typically for a limited period only

Knowledge | Skills | Conduct

Hints
One of the major disadvantages of collective investment schemes is a lack
of transparency in pricing. The true value of a unit is assessed only once a
day.
If the manager prices on a forward basis, the investor does not know the
cost of the unit until the purchase is made at the next valuation point.

81
 Further Information
2.9.2 Investment Trusts Open-ended vs. closed-ended
Closed-ended vehicles can:
Investment Trust Companies (ITCs)
• Invest in unquoted private companies as well as quoted companies
Features
• Provide venture capital to new companies or companies requiring new
• A company not a trust funds for expansion
• Shares trade on a secondary market • Borrow money to help them achieve their objectives
- Ordinary shares Cash – primary offer only
ITC Fund
- Preference shares (Closed-ended)
Shares – primary offer only

• Closed-ended
• Can use gearing
Further Information
ITCs: Buying and selling shares Portfolio
Venture Capital Trusts
• Prices dictated by supply and demand
These are closed-ended vehicles which invest in relatively new/start-up
• Can trade at a premium or discount to net asset value (NAV) companies. VCTs are structured like investment trusts and traded on the
London Stock Exchange.

Knowledge | Skills | Conduct

82
 Hints
2.9.2 Exchange-traded Funds When tracking an index, the providers of ETFs can use either physical or
synthetic replication to ensure their ETFs mimic their designated indices
Exchange-traded Products as accurately as possible.
• Incorporated as an ICVC, but tradable on the secondary markets Physical – where the ETF provider owns the constituents of the index
being tracked. Can lead to higher charges.
• Characteristics:
Synthetic – ETF provider receives the total return on an index through a
- Open-ended
derivative (e.g. a swap). Increases counterparty risk.
• Trades at NAV
- Traded on the secondary markets
• Real-time pricing
- Tracker or index funds
• Diversified and low costs Keeping on Target 1
- ‘Short’ shares can give an inverse performance to the index An investor takes a long position in an leveraged inverse index tracker
- Leveraged shares can give accelerated performance fund. Which of the following best describes the likely performance?
• Only authorised participants can participate in the primary market
- Buying or selling shares ‘in kind’ with baskets of the underlying securities A. If the index rises the investor will gain at the same rate
• An adaptation of ETFs is exchange-traded commodities (ETCs) B. If the index rises the investor will gain at an accelerated rate

Knowledge | Skills | Conduct

C. If the index falls the investor will gain at the same rate
D. If the index falls the investor will gain at an accelerated rate

Keeping on Target 2
Where can authorised participants buy exchange traded funds (ETFs)
directly from a fund manager?

A. In the secondary market

B. In the open market without restrictions
C. In the primary market
D. Through creation units via a retail broker

83
 Home Study
This sections is marked HOME STUDY. You will need to review specific
videos on the online portal for this section.

You can find the video for this on you online study portal:
Asset Classes Collective Investments > Video > Chapter 4 – Structured Products
Structured Products Collective Investments > Video > Chapter 4 – Property

Knowledge | Skills | Conduct

Answer to previous Keeping on Target 1 question = D

The investor buys (goes long) a share in a leveraged fund. The fund’s
gearing increases the rate at which profits or losses are made. The fund is
an inverse fund (sometimes called a short fund) and gives returns opposite
to the index: i.e. if the index rises, the share value falls, and vice versa.

Answer to previous Keeping on Target 2 question = C

Only authorised participants (typically large institutional investors) actually
buy or sell shares of an ETF directly from/to the fund manager, and then
only in creation units – large blocks of tens of thousands of ETF shares –
which are usually exchanged in kind with baskets of the underlying
securities, this would be known as the primary market.
84
 Home Study
2.10.1. Structured Products
Features of Structured Products
• Combining two or more individual financial instruments
- Typically a bond and a derivative

• Tailored to offer specific risk reward profiles that traditional assets may not
offer, for example:
- They may offer growth with low risk or high risk income
- They run for a defined term e.g. 18 month to 7 years
- Defined risk and return

• Two broad categories

- Structured deposit – returns on deposit linked to the performance of another asset
- Structured investment

Knowledge | Skills | Conduct

85
 Home Study
2.10.3. Pay-out Structures
Structured Investments – three broad types
Further Information
• Capital protected product
Other pay-out structures
- For example, a zero coupon bond combined with a long option position.
• The discount on the zero coupon bond funds the purchase of the option • Callable – the product can mature early
• The option could be linked to any asset • Range accruals payoff – the longer the referenced asset remains within
• No income from the underlying asset a set range the higher the payout
• Capital at risk product • Averaging levels – based on an average price of the underlying asset
- AKA accelerated tracker • Lookback – the holder can choose the most advantageous price over the
- Gives leveraged participation but sacrifices capital protection life of the product on which to base the payout
• Buffer zone product • Cash or nothing payoff – using binary options with a fixed cash payout,
but only if a set condition is reached
- Offers participation in the return on an asset
- Negative returns protected to a predetermined level, e.g. 20% • Quantity adjusting (Quantos) – to gain exposure to foreign assets but
eliminate the FX risk
- Full exposure to loss if predetermined level is breached

Knowledge | Skills | Conduct

86
 Further Information
2.10.4. Risks Call risk
• Some products have auto-call features (or kick-out triggers) that
Advantages and Risk of Structured Products terminate the product early. This could prevent further profit or prevent
recovery from loss.
Advantage Disadvantage
Structure Flexible risk return Credit risk on the bond
products • Principle protected Counterparty risk on the
• Return enhanced derivative
Reduced volatility Provider risk on the product itself
Offshore Inflation risk
Often needs to be held to
maturity
Charges can be high
Call risk

Knowledge | Skills | Conduct

87
 Home Study
This sections is marked HOME STUDY. You will need to review specific
videos on the online portal for this section.

You can find the video for this on you online study portal:
Asset Classes Collective Investments > Video > Chapter 4 – Property
Property

Knowledge | Skills | Conduct

88
 Further Information
2.7.3 Property Differences between residential and commercial property investment

Methods of Property Investment Residential Commercial

property property
Advantage Disadvantage
Direct Low volatility Illiquidity
Income and gain Transaction and maintenance Large initial outlay
Real asset costs Second homes,
restricts investment
Cyclical values and depreciation Direct investment holiday homes, buy-
to institutional
Real estate Real-time pricing on an Can behave like a share in the to-let
investors
investment trust exchange short-term
Liquidity of a share Investor taxed as property
Tax transparent vehicle income Typically short
Eligible for ISAs, pensions, etc. Tenancies Long-term contracts
renewable leases
Open ended Reflect the NAV of the property Management costs can erode
property funds portfolio returns Landlord
Investors trade direct with the Can be subject to moratoria Repairs Tenant responsible
responsible
management company –
liquidity
Rent linked to house Rent linked to
Returns
prices income potential

Knowledge | Skills | Conduct

89
Section Review
Collective Investments Property (Home study)
• Regulated vs Unregulated CIS • Understand the risk and rewards of
• Open-ended vs closed ended funds property investment
• Exchange-traded funds vs trading - Direct investment
direct with the management - Real estate investment trusts
- Open-ended investment companies
• Trust-based funds vs companies vs
private equity

Structured Products (HOME STUDY)

• The key features and components
• The pay-out structures and risks

Knowledge | Skills | Conduct

90