Securities: Problem Areas

The ratio EV/EBIT represents:

A Total market capitalisation including cash over operating revenue

B Total market capitalisation excluding cash over gross revenue

C The cost of purchasing the company over gross revenue

D The cost of purchasing the company over operating revenue

The correct answer is: D - The cost of purchasing the company over operating revenue

Explanation:

A firm’s EV is calculated as its market capitalisation plus all of its outstanding debt, minority interests and preferred shares, minus all of the cash and cash equivalents. A simplified and intuitive way to understand EV is to consider it as the cost of purchasing an entire business. Operating revenue = Gross revenue - Cost of Goods Sold, Labour, and other day-to-day expenses. N.B. 'Operating revenue' and 'operating income' are also known as Earnings Before Interest and Tax (or EBIT for short). 

Which of the following would be MOST associated with rollover risk?

A Commercial paper

B Spot FX contracts

C Unit trusts

D Rights issues

The correct answer is: A - Commercial paper

Explanation:

Commercial paper is a rolling form of debt, with new issues generally funding the retirement of old issues, the main risk is that the issuer will not be able to issue new commercial paper. This is called rollover risk.

Which of the below is likely to invest more in money market instruments?

A Bank

B Life assurance company

C Pension fund

D Hedge funds

The correct answer is: A - Bank

Explanation: In accordance with the CISI book, banks and insurance companies are more likely to need this level of liquidity to invest in short term products like money market instruments.

Which of the following types of corporate debt would most likely have the lowest coupon?

A UK treasury bonds

B Contingent convertible bonds

C Guaranteed bonds

D Mezzanine bonds

The correct answer is: C - Guaranteed bonds

Explanation:

Treasury bonds would have the lowest coupon but as the question asks about corporate debt the answer has to be a guaranteed bond, as the treasury is a government bond. A guaranteed bond is likely to be issued with a lower coupon due the credit enhancement of the guarantee from a third party.

Which of the following would not be found on the statement of financial position under intangible non-current assets?

A Goodwill

B Capitalised development costs

C Work in progress

D Patents

The correct answer is: C - Work in progress

Explanation: Work in progress will be shown as a current asset.

When a trade settles DvP where does the seller get their confidence in the settlement of the trade from?

A That both sides of the trade are settling concurrently

B That the settlement systems allow almost instantaneous settlement

C That the seller holds onto the assets until the cash payment is received

D That novation takes away all the settlement risk

The correct answer is: A - That both sides of the trade are settling concurrently

Explanation: DvP is delivery versus payment, where both sides of the trade settle concurrently.

The providers of which of the following services would be considered a participant in the wholesale market?

A Investment services

B Derivatives trading

C Financial planning

D Retail banking

The correct answer is: B - Derivatives trading

Explanation: Derivatives trading is associated with the wholesale market - as would other trading services. The other services would be associated with the retail markets.

Where the lender of stock wishes to cast their vote on a special resolution, which of the following statements is TRUE?

A The lender is never permitted to vote once the stock has been lent

B The lender always retains legal ownership and can vote accordingly

C As the security has been lent to another prima facie rules would apply

D The lender should recall the stock in good time

The correct answer is: D - The lender should recall the stock in good time

Explanation:

If the lender wants to exercise its right to vote, it should recall the stock in good time so that a proxy voting form can be completed and returned to the registrar by the required deadline.
Technically, the consequences arising from any corporate action by the issuer of a security, such as a capitalisation matter or rights issue, when that security has been lent to another would, prima facie, be to the benefit/cost of the borrower.
Under the terms of the security agreement it is customary that these costs/benefits flow back to the lender, and the exact manner in which this is implemented should be reflected in the securities lending agreement.

When can an investor sell a share in an OEIC?

A When they find a willing buyer on the open market

B When the fund has enough money to repurchase shares

C Any time outside 3 business days from purchase

D Any period specified by the OEIC prospectus

The correct answer is: D - Any period specified by the OEIC prospectus

Explanation: The holder of a share in an OEIC can sell back the share to the company in any period specified in the prospectus.

Which of the following is considered as a sell side-to-sell side electronic trading platform for bonds?

A MTS Cash

B Bloomberg bond trader

C BondVision

D TradeWeb

The correct answer is: A - MTS Cash

Explanation: Dealer-to-dealer trading can occur via an electronic market, known as an electronic trading platform, such as Message Transfer System (MTS Cash) or Brokertec.

In which market can companies use an offer for subscription as a method to float their share to raise capital?

A Dark pools

B Secondary

C Primary

D OTC market

The correct answer is: C - Primary

Explanation: An offer for subscription is a primary market activity

An authorised unit trust is essentially a unit trust that is allowed to be marketed to the investing public, and must be constituted by a trust deed made between:

A The sponsor company and the trustee

B The fund manager and the authorised corporate director

C The fund manager and the trustee

D The government and the trustee

The correct answer is: C - The fund manager and the trustee

Explanation: An authorised unit trust (AUT) is essentially a unit trust that is allowed to be marketed to the investing
public, and must be constituted by a trust deed made between the fund manager and the trustee.

A Global custodian finds itself in financial difficulty. What should it do to protect its client's assets?

A Continue as before segregating its clients' assets in internal accounts

B Ask client how to proceed with their assets and follow their instructions to move assets in accordance with the claimants' wishes

C Seek permission to legally segregate client assets depending on the outcome of the financial difficulties

D Use the clients' assets to provide a capital buffer against the firm's financial difficulties

The correct answer is: A - Continue as before segregating its clients' assets in internal accounts

Explanation:

If the custodian has properly segregated the assets, they are protected from the financial difficulties of the custodian. This is a fundamental obligation of custodians.

Which of the following could result in a 'rebate' in a stock lending situation?

A It is securities driven

B The term is relatively short

C Insufficient liquidity

D Cash is used as collateral

The correct answer is: D - Cash is used as collateral

Explanation: If the agreed form of collateral is cash, then the fee may be quoted as a rebate, meaning that the lender will earn all of the interest that accrues on the cash collateral, and will rebate an agreed rate of interest to the borrower.

A company wishes to exchange GBP for USD in three months' time. The current spot rate is 1.4500/05USD, and the company is quoted a 20/18 forward adjustment.
What would be the outright bid on the forward contract?

A 1.4520

B 1.4480

C 1.4523

D 1.4487

The correct answer is: B - 1.4480

Explanation:

The forward adjustment is a premium, therefore we subtract from spot. The bid is the price at which the bank will buy our GBP and is the first number in the spread.
1.4500 - 0.0020 = 1.4480

Which of the following cash flows would not be listed under operating cash flows in a company's cash flow statement?

A Receipts from customers on goods sold

B Payments to suppliers for stock purchased

C Profits realised on disposal of an asset

D Tax paid to HMRC

The correct answer is: C - Profits realised on disposal of an asset

Explanation: Profits are not a cash flow and would not be shown on the cash flow statement. The proceeds on disposal of an asset would be considered a cash flow and would typically be shown in investing cash flows.

Which one of the following would not increase the issued share capital?

A A capitalisation issue

B A call on partly paid shares

C Exercise of warrants

D A rights issue

The correct answer is: B - A call on partly paid shares

Explanation: A company may not demand all the value of some shares at issue, these shares are then referred to as being partly paid. At some later date, the company will call on the shareholders to pay the remaining nominal value and make the shares fully paid. This does not increase the number of shares issued.

Participants in a dark pool are MOST LIKELY to have chosen this type of execution venue because of:

A Lack of pre-trade transparency

B Ability to execute trades at efficient prices

C Ability to hide the dealer's identity

D Lower costs

The correct answer is: B - Ability to execute trades at efficient prices

Explanation:

Dark pools offer institutions a facility to deal large blocks of shares anonymously, typically using algorithm driven trading. The size of these orders would make it very difficult to achieve efficient pricing on more traditional venues but the dark pool allows them to do so. Although anonymity is an advantage, this is also available on many other systems, including exchanges.

If the price of the investment falls in a year only to rise again in the next, the fund manager will not become eligible to receive an additional fee, until the previous maximum fund price is surpassed. This would be the best description of which of the following?

A Plimsoll line

B High water mark

C Performance fees

D Hurdle rate

The correct answer is: B - High water mark

Explanation:

A high water mark which is usually associated with UCIS funds and especially hedge funds. It means that if the price of the investment falls in a year only to rise again in the next, the manager will not become eligible to receive an additional fee, until the previous maximum fund price is surpassed.

Who decides whether a company’s shares are admitted to both the official list and the LSE?

A LSE

B Sponsor

C OFT

D FCA

The correct answer is: D - FCA

Explanation: The Main Market in the UK is typically referred to as the Official List and the criteria for admission to the Official List are set out in the Listing Rules – a rule book is maintained by the FCA and applications are made to the FCA, formerly known as the UKLA

Which of the following best differentiates medium term notes (MTNs) from other bond issues?

A They are cheaper

B They are more expensive

C Issuers make payments in kind

D Issuers use shelf registration

The correct answer is: D - Issuers use shelf registration

Explanation: MTNs are issued on a scheduled funding basis. Shelf registration allows several issues to be authorised under one registration, allowing the company to roll out the issues over the next two years.

Why would a lead manager be LEAST likely to go through a syndication process and, instead, take responsibility for the entire process themselves?

A It is a bought deal

B It is a fixed price re-offer

C There is a back stop price

D It is a placing

The correct answer is: D - It is a placing

Explanation: A placing is where a company simply markets the issue directly to a broker, an issuing house or other financial institution, which in turn places the shares with selected clients. A bought deal is a fully underwritten issue and the lead manager would often enlist the help of a syndicate to do this this. The back-stop price is limit placed on the members of a syndicate limiting the price at which the shares can be sold. Whilst a Fixed Price Re-offer is NOT on the current syllabus, it is synonymous with syndication.

Stock borrowing and lending was created to address which of the following?

A Market risk

B Settlement risk

C Custodian charges

D Interest rate risk

The correct answer is: B - Settlement risk

Explanation:

The principal reason for borrowing securities is to cover a short position. Sellers are sometimes obliged to deliver securities that they do not hold and in such circumstances, they will have to borrow them. At the end of an agreed period they have to return the equivalent quantity of securities to the lender.

Sometimes there are periods when US Treasury cash balances are particularly low and there is a need to raise money for less than a month. At these times, the US Treasury is likely to issue which of the following?

A Treasury Bill

B Cash Management Bill

C Treasury Note

D Treasury Bond

The correct answer is: B - Cash Management Bill

Explanation:

During periods when Treasury cash balances are particularly low, the Treasury may sell cash management bills (or CMBs). These are sold at a discount and by auction just like weekly T-bills. They differ in that they are irregular in amount; term (often less than 21 days); and day of the week for auction, issuance, and maturity.

A bond rated AA moves to A-, what will be the effect on price and yield?

A Rise, fall

B Rise, rise

C Fall, fall

D Fall, rise

The correct answer is: D - Fall, rise

Explanation:

If a bond is downgraded, this will have a negative impact on price (and a positive impact on yield). The most marked impact on price will be if a bond is downgraded from investment grade to non-investment grade. The opposite is true if a bond is upgraded.

Revenue expenditure will have an initial impact on the:

A cash flow statement

B income statement

C statement of financial position

D balance sheet

The correct answer is: B - income statement

Explanation:

Revenue expenditure is money spent that immediately impacts the income statement. Examples of revenue expenditure include wages paid to staff, rent paid on property and professional fees, like audit fees.

Capital employed can be defined as:

A Total equity plus non-current liabilities

B Total assets plus non- current liabilities

C Total assets plus current liabilities

D Total equity plus current liabilities

The correct answer is: A - Total equity plus non-current liabilities

Explanation:

The amount of capital employed is the equity plus the long-term debt. This is the money that the company holds from shareholders and debt providers, and it is from this money that the management should be able to generate profits.

Why would an investor want to buy a share through a special-ex trade?

A To avoid capital gains tax.

B To reduce regulatory reporting requirements

C To receive a dividend that they would otherwise be not entitled to

D For tax planning purposes

The correct answer is: D - For tax planning purposes

Explanation: By dealing special ex the investor does not receive the dividend they are entitled to this may reduce income but not capital gains tax.

A 2 year corporate bond has a 100bp spread over the published reference interest rate. What is most likely to be the spread of the corporate bond over a 5 year Gilt?

A 0 bp

B 50 bp

C 100 bp

D 150 bp

The correct answer is: D - 150 bp

Explanation:

One would expect gilt yields to be lower than the comparable reference rate. This would mean that the spread between gilts and corporate bonds is likely to be wider than the corporate bond's spread to the published reference interest rate.

Which of the following would account for UK government debt being considered risk free?

A The Bank of England is a reputable body

B The UK is part of NATO

C The UK government can simply raise taxes

D The UK has an established Keynesian economic policy

The correct answer is: C - The UK government can simply raise taxes

Explanation:

The yield available on UK gilts is considered the risk-free rate for sterling-denominated bonds - after all, the UK government can simply raise taxes to repay its debt and that ultimately the UK controls the printing of sterling, so the UK gilts are effectively credit risk-free.

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 following securities are in issue, which of the following is most likely to benefit from this increase in income?

A Depositary receipt holder

B Equity warrant holder

C Cumulative preference shareholder

D Floating rate bond

The correct answer is: A - Depositary receipt holder

Explanation:

A depositary receipt is a certificate that represents ordinary shares in a company. The benefit of a higher dividend will be passed on to them. Warrants do not pay dividends and cumulative preference shares pay a fixed dividend. Floating rate bond are debt instruments and receive their payment irrespective of profits (unless default occurs).

Why would an underwriting firm performing an offer for sale decide to use a fixed price rather than a tender?

A To ensure that the issue is fully subscribed

B To allow investors to set the price

C To provide more efficient form of pricing

D To ensure everyone pays the same price

The correct answer is: A - To ensure that the issue is fully subscribed

Explanation:

When a fixed-price offer is made, the price is usually fixed just below that at which it is believed the issue should be fully subscribed, so as to encourage an active secondary market in the shares. A tender offer is a more efficient method of pricing, allowing investors to set the price through a bidding process. Both issues allow the investors to pay the same price.

An investor, after receiving excellent returns on her equity investments, switches to bonds. Which of the following is the most likely reason?

A To capitalise on the gains before a downturn

B To benefit from an increase in interest rates

C To avoid exposure to inflation

D To achieve long term capital gain

The correct answer is: A - To capitalise on the gains before a downturn

Explanation: If the investor expects a downturn in the markets, switching to bonds may assist in locking in most of the gain and benefitting from a more stable return on the bonds. A switch to bonds would be poor move if interest rates were expected to rise (bond prices fall). Bonds typically suffer from inflation more than equity and achieve less long-term capital gain.

Which is the best description of the Enterprise Value to EBITDA ratio?

A The securities' market capitalisation against total revenue

B The cost to buy a company against an adjusted operating profit

C The securities' market capitalisation against an adjusted operating profit

D The cost to buy a company against total revenue

The correct answer is: B - The cost to buy a company against an adjusted operating profit

Explanation:

EBITDA is essentially profit before interest and tax (i.e. operating profit), but with depreciation, and amortisation reversed and added back.
EV is a measure of a company's value and is often used as an alternative to straightforward market capitalisation. A simplified and intuitive way to understand EV is to envisage purchasing an entire business. If you settle with all the security-holders, you have essentially purchased the company at its EV.

Which of the following would explain why a company would buy shares in another company to forge a strategic link?

A To expand the company

B Shared corporate ethos

C Protect supplies

D To benefit from dividend income

The correct answer is: C - Protect supplies

Explanation:

Strategic stakes may be accumulated in order to prevent a company being taken over by a competitor and to influence the company concerned. This may be in order to protect supplies. The company may be a key supplier of raw materials to the strategic stakeholder, without which the strategic stakeholder may have difficulty obtaining the quantity and quality of raw materials it seeks.

Which of the following is the best definition of a bond 'on the run'?

A One that trades in an unpopular sector of the market

B A bond that has suffered a series of downgrades and is heading for default

C One that is popular with investors due to an unexpectedly positive forecast

D The most recently issued Treasury bond

The correct answer is: D - The most recently issued Treasury bond

Explanation:

On the run bonds refer to those that are most recently issued by the issuer. Those previously issued are often referred to as off the run bonds.

Which of the following could be described as a main benefit of a central counterparty?

A It prohibits anonymity

B Reduction of systemic risk

C Increased operational risk capital requirements

D Elimination of all counterparty risk

The correct answer is: B - Reduction of systemic risk

Explanation:

A central counterparty (CCP) provides certain benefits to market participants, in particular significantly reduced counterparty [credit] risk. Due to the CCP's guarantee, risk of default is reduced, but not eliminated, since it is theoretically possible that the CCP itself could become insolvent and default. Reducing by largely reducing counterparty risk, the CCP thereby reduces the risk of systemic collapse of the financial system.

What is the repo rate?

A The implied interest paid for borrowing securities

B The implied interest paid for borrowing gilts

C The implied interest paid for borrowing money

D The implied interest paid for lending stock

The correct answer is: C - The implied interest paid for borrowing money

Explanation:

A repo is an alternative way to borrow money. As.repos settle T+0 they are a means of raising quick cash.

Which of the following would be considered as passive bond strategy?

A Anomaly swapping

B Duration Immunisation

C Riding the yield curve

D Inter-market switch

The correct answer is: B - Duration Immunisation

Explanation:

Duration-based immunisation involves constructing a bond portfolio with the same initial value as the present value of the liability it is designed to meet and the same duration as this liability. A portfolio that contains bonds that are closely aligned in this way is known as a bullet portfolio. Alternatively, a barbell strategy can be adopted. If a bullet portfolio holds bonds with durations as close as possible to ten years to match a liability with ten-year duration, a barbell strategy may be to hold bonds with a durations of five and 15 years. Barbell portfolios necessarily require more frequent rebalancing than bullet portfolios.

'Over the counter' (OTC) markets in recent times seem to be converging with exchange traded markets, which of the following is the most likely explanation?

A Greater demand for OTC products

B Electronic trading

C Regulatory changes

D Straight through processing

The correct answer is: C - Regulatory changes

Explanation:

This is not specifically mentioned in the manual, so perhaps a trial question, however regulatory requirements in the OTC market are bringing them very much in line with exchange traded markets.

In an order driven platform what is the order of priority for 'on the book'?

A Price followed by time

B Time followed by price

C Price followed by quantity followed by time

D Price followed by time followed by quantity

The correct answer is: A - Price followed by time

Explanation: Price followed by time. The quantity or size of the order is not used to determine place on the book.

Consider two companies, one big and the other small. Which of the following would be most likely with regards to P/E ratio and dividend yield?

A The larger company would have a higher P/E ratio and lower dividend yield

B The smaller company would have a higher P/E ratio and lower dividend yield

C The P/E ratio and dividend yield would be the same for both companies

D The company with the highest P/E ratio and lowest dividend yield would be considered a value company

The correct answer is: B - The smaller company would have a higher P/E ratio and lower dividend yield

Explanation: This is a very unusal question and would make more sense if the companies were quoted as established and start-up. However the examiner does test how the ratios indicate growth and therefore we have to assume that this is the purpose of this question. So high P/E ratio low dividend yield may indicate high growth and smaller companies are supposed to develop into larger companies

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

The correct answer is: C - In the primary market

Explanation:

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. Other investors, such as individuals using a retail broker, trade ETF shares via a secondary market such as the NYSE/Arca exchange in the US, or the LSE in the UK.

At what percentage of share ownership would an investor be forced to make a mandatory bid?

A 10%

B 20%

C 30%

D 50%

The correct answer is: C - 30%

Explanation: If a predator acquires influence 30% or more of voting rights of a company, it must make an offer for all the remaining shares of the company.

Eurobonds, as bearer documents, typically need to be kept safe. They would normally be:

A immunised and held in Euroclear or Clearstream

B immobilised in the investor's personal filing cabinets

C held in the investor’s name with the issuer holding these details

D held in depositaries

The correct answer is: D - held in depositaries

Explanation:

As bearer documents, it is important that eurobonds are kept safe, and this is often achieved by holding the bonds in depositaries, particularly those maintained by Euroclear and Clearstream. When the bonds are deposited in these organisations they are described as being immobilised. Immobilisation does not mean that the bonds cannot be transferred in secondary market transactions, it simply means that the bonds are safely held within a reputable depositary and a buyer is likely to retain the bonds in their immobilised form.

Which of the following corporate actions would never be made available to an American depositary receipt holder?

A The right to vote in the annual general meeting

B The right to participate in the company's profit

C The right buy new shares in proportion to existing shares

D The right to receive the new shares during a scrip issue

The correct answer is: C - The right buy new shares in proportion to existing shares

Explanation:

An ADR holder can only receive the nil paid price as result of a rights issue. If they wish to participate in the rights issue to buy the new shares they would have to sell the ADRs and buy the new shares.

Who are usually the direct issuers of Commercial Paper?

A SME

B The Government

C The Treasury

D Financial companies

The correct answer is: D - Financial companies

Explanation: Financial companies are direct issuers of commercial paper.

An investor bought a convertible preference share. She suddenly starts receiving a variable dividend on the share. Why might this be?

A She has utilised the inherent option of the preference share

B The company has defaulted on the payment of a preference share dividend

C The share price on the market fell below the trigger level on the share

D Ordinary shareholders receive higher dividends than preference shareholders

The correct answer is: A - She has utilised the inherent option of the preference share

Explanation: With a convertible preference share, the preference shareholder has the right, but not the obligation, to convert the preference shares into a predetermined number of ordinary shares. If the investor uses this option, she will start to receive a variable dividend.

Debt with a high interest cover will subsequently affect:

A The ability to meet liabilities should they fall due

B Market valuation

C Securitisation

D Growth prospects

The correct answer is: B - Market valuation

Explanation:

Interest cover is used to determine how easily a company can pay interest on its outstanding debt. Similar to dividend cover a ratio of lower than 1 means that the company is not generating sufficient revenues to satisfy its interest expense, therefore a measure of risk. The greater the risk, the higher the yield the cheaper the price and visa versa.

A manufacturing company incurs the following expenditure in connection with a machine:

Acquisition cost 20,500

Operator’s salary 15,000

Annual service costs 500

What is the maximum expenditure that may be capitalised on the company’s Statement of Financial Position?

A 20,500

B 21,000

C 35,500

D 36,000

The correct answer is: A - 20,500

Explanation: Only the acquisition cost can be capitalised

What are the rules for stripping UK exchequer bonds?

A Any gilt can be stripped and only by the DMO, Bank of England and HM Treasury

B Only designated gilts can be stripped and only by the DMO, Bank of England and authorised participants

C Any gilt can be stripped and only by the GEMMs, Bank of England and HM Treasury

D Only designated gilts can be stripped and only by the DMO, Bank of England and GEMMs

The correct answer is: D - Only designated gilts can be stripped and only by the DMO, Bank of England and GEMMs

Explanation:

In the UK, only those gilts that have been designated by the DMO as strippable are eligible for the STRIPS market, not all gilts. Those gilts that are stripped have separate registered entries for each of the individual cash flows that enable different owners to hold each individual strip, and facilitate the trading of the individual STRIPS. It is only gilt-edged market makers (GEMMs), the BoE or the HM Treasury (via the DMO) that are able to strip gilts.

Why might an investor be more interested in using net debt to equity ratio instead of total debt to equity?

A To see if the company holds substantial cash and short term investments

B To determine if the company has been running for less than 3 years

C The company has an interest cover less than 5

D To assess why the total debt to gearing ratio appears very low

A - To see if the company holds substantial cash and short term investments

Explanation: Gearing ratios tend to look at the total debt compared to equity. Sometimes this ratio may be less useful because, as well as holding substantial amounts of debt, the company also holds substantial cash and short-term investments that could be used to repay the debt. So the company is not as risky as it might have seemed.

A bond with a 2-10 year maturity is created from securitised public sector loans and mortgages, where the investor has recourse against the issuer should default occur. The assets backing the bond remain on the issuer's consolidated statement of financial position (balance sheet). This would BEST describe which of the following bonds?

A Medium term note

B Asset backed security

C Covered bond

D Guaranteed bond

The correct answer is: C - Covered bond

Explanation:

In instances when no SPV is created, the asset-backed bonds are simply referred to as 'covered bonds', referring to the pool of assets that provide the 'cover' to the bondholder. So, with covered bonds, the assets are retained on the statement of financial position of the issuing entity, such as a bank, rather than transferred to an SPV.

The analysis of risk and return is best done in which of the following way?

A Backward-looking analysis of historic returns and forward-looking forecasts

B Correlations of returns and capital asset pricing model

C Alpha and beta

D Political risks and interest rate sensitivities

The correct answer is: A - Backward-looking analysis of historic returns and forward-looking forecasts

Explanation:

In order to assess the risk and expected returns from particular opportunities, an investor needs to conduct an analysis of the forecasts for the economy and the forecasts for particular companies and/or sectors and undertake a risk analysis of the possible outcomes, and their likelihood, which could adversely affect these forecasts. This can be summarised as both forward- and backward-looking:
Forward-looking forecasts and probabilities assess the likelihood of each possible state of the world occurring and estimate the returns and values arising given that particular outcome.
Backward-looking analyses tend to study historically observed returns and associated frequencies on the assumption that this past data will be representative of the future.

The price of shares in Firm A change relative to those in Firm B. What risk would this represent?

A Market Risk

B Systematic Risk

C Specific Risk

D Non-systemic Risk

The correct answer is: C - Specific Risk

Explanation: Specific risk relates directly to the price movement of a single share.

Which of the following would be the most likely response in bond and equity prices when interest rates rise, or are expected to rise?

A Bond prices will go up and equity prices will go down

B Bond prices will go down and equity prices will go down

C Bond prices will go down and equity prices will go up

D Bond prices will go up and equity prices will go up

The correct answer is: B - Bond prices will go down and equity prices will go down

Explanation:

When interest rates rise, or are expected to rise, securities prices tend to fall. Bonds fall in price to bring about a more competitive yield, and equity prices fall to remain competitive with bonds and because companies may now face increased costs on their borrowing, reducing profits. Consumers are also likely to reduce expenditure because of increased costs on their borrowing (such as mortgages) which will adversely impact company sales.

The non-displayed or hidden nature of the buy and sell orders that reside in a crossing platform is best observed in which of the following?

A MTF

B Systematic internaliser

C Retail service provider

D Dark pool

The correct answer is: D - Dark pool

Explanation:

Dark pools refer to the non-displayed or hidden nature of the buy and sell orders that reside in a crossing platform. The term dark liquidity can also be applied to all forms of non-displayed liquidity such as the order blotters of buy-side dealing desks.

A systematic internaliser is, in broad terms, an investment firm making markets outside a regulated market or an MTF. The firm executes orders from its clients against its own book or against orders from other clients.

A multi-lateral trading facility is, in a nutshell, a system that brings together multiple parties (e.g. retail investors or other investment firms) that are interested in buying and selling financial instruments and enables them to do so.

A retail service provider is a type of market maker that provides connectivity services to other LSE member firms that serve the private client; they enable the private client broker to quote firm prices to the investor for ten-day settlement in small trade sizes, and to place orders on an 'invest or raise' basis.

A bond's dirty price is the same as its clean price. Which of the following would help explain this situation?

A The credit rating of the bond

B The settlement date is the same as the coupon date

C The trade is ex-interest

D The yield of the bond is zero

The correct answer is: B - The settlement date is the same as the coupon date

Explanation:

If the settlement date is the same the coupon paid date, this would mean that there is no accrued interest.

Where a cum-dividend equity trade fails to settle on contractual settlement what will happen?

A The client buying will make a claim on the client who is selling

B The broker of the client buying will make a claim on the client selling

C The broker of the client buying will make a claim on the broker of the client selling

D The Client buying will make a claim on the broker of the client selling

The correct answer is: C - The broker of the client buying will make a claim on the broker of the client selling

Explanation: A claim will arise between the brokers on behalf of their clients.

Which of the following would be considered an advantage, for the nominee, of individual registration within designated nominee accounts?

A There are fewer additional costs for the custodian

B It helps with aspects of auditing and good control mechanisms, where identical trades are executed for different clients

C Where a company offers extra incentives these can always be received by the beneficiary

D It will not give rise to additional transactional costs imposed by the custodian for pooled accounts

The correct answer is: B - It helps with aspects of auditing and good control mechanisms, where identical trades are executed for different clients

Explanation: Designation or individual registration can help some aspects of auditing and it affords a good control mechanism where identical trades may have been executed for different clients (for example on the same date, for the same number of shares and for the same settlement consideration).

Which of the following statements would be least likely in relation to a pension fund?

A A measure of return especially useful for pension funds is the gross redemption yield

B Pension funds can invest in high risk portfolios

C Liability driven pension funds will use dedicated portfolios

D Pension funds will have significant holdings in money market instruments

The correct answer is: D - Pension funds will have significant holdings in money market instruments

Explanation:

The gross remption yield is more appropriate for long-term investors than the flat yield. In particular, because it ignores the impact of any taxation, it is especially useful for non-tax-paying long-term investors such as pension funds and charities. Pension funds have a relatively long investment horizon, they can take risks and have tended to invest heavily in equities. Defined benefit pensions have a known liability and therefore will use decicated portfolios, for example STRIPS or duration matching to meet their liabilities. The proportion of money market instrument would not be significant.

Why would a company choose to do a rights issue?

A To significantly reduce the share price

B To fund a takeover

C To avoid using an underwriter

D To ensure there is no dilution of shareholders’ interests

The correct answer is: B - To fund a takeover

Explanation:

The rationale for a rights issue is usually to fund expansion, perhaps to take over a rival or to diversify into a new business area.

An investor owns 10,000 shares of XYZ plc, which has just announced a 1 for 4 rights offering. The current price of XYZ shares is £1.45 but the subscription price in the offering is £1.20.
The investor would like to take up as many of the rights as possible without using any new cash, so she decides to finance her purchase of shares entirely through the sale of some of her rights.
What is the maximum number of new shares that she can buy in this way?

A 357

B 714

C 1786

D 2143

The correct answer is: A - 357

Explanation:

This question is asking us to calculate the 'maximum subscription at nil cost'...
First we calculate the TERP (share price after the issue)
4 shares @ £1.45 = £5.80 1 share @ £1.20 = £1.20 Total 5 shares @ £7.00, so TERP = £1.40
No. of rights to be sold = no. of rights x subscription price/ TERP = 2,500 x £1.20/£1.40 = 2143 So number of remaining rights = 2,500 - 2143 = 357

For what main reason would an investment manager make use of a bond swapping?

A To reduce the impact of taxation

B To comply with regulatory requirements

C To take advantage of inefficient markets

D To re-balance their portfolio

The correct answer is: C - To take advantage of inefficient markets

Explanation:

Bond switching, or bond swapping, is used by those portfolio managers who believe they can outperform a buy-and-hold passive policy, by actively exchanging bonds perceived to be overpriced for those perceived to be under priced.

If the Dow Jones divisor is 0.2 and the sum of share prices in the index increases by $2m, what would be the impact on the sum of prices used to calculate the index?

A An increase of $10m

B An increase of $0.4m

C A decrease of $0.4m

D A decrease of $10m

The correct answer is: A - An increase of $10m

Explanation:

The sum of the prices of all 30 DJIA stocks is divided by the Dow divisor. If the sum of prices increases by $2m, then the sum of prices used to calculate the index is increased by $2m / 0.2 = $10m

The Dow Divisor is used to maintain the historical continuity of the index, since there have been numerous stock splits, spinoffs and changes among the Dow constituents since the index was first introduced in 1896. The Divisor is continually adjusted to account for these changes, since the value of the Dow would be distorted otherwise. The fact that the Divisor is now well below one means that the divisor actually functions as a multiplier!

What was the primary reason for the introduction of the Continuous Settlement Bank system?

A To ensure certainty of payments

B To facilitate payment versus payment

C To mitigate default risk

D To allow for 24 hour settlement in the foreign exchange markets

The correct answer is: C - To mitigate default risk

ExplanationThe two parties to an FX transaction will buy and sell the respective currencies exchanged and the payments made will occur simultaneously. Unless such simultaneity in payments is ensured, there is a possibility of settlement risk which is a type of default risk. The first two answers are benefits of CLS not a reason.

Which one of the following statements about hybrid trading systems used by exchanges is true?

A They are used for trading the largest companies on the LSE

B NASDAQ in the USA is a hybrid trading system

C It describes where exchanges allow brokers to deal with company directors

D They feature both order-driven and quote-driven systems

The correct answer is: D - They feature both order-driven and quote-driven systems

Explanation:

Some trading systems combine features of both order-driven and quote-driven systems – these are referred to as hybrid systems and include the LSE’s Stock Exchange Electronic Trading Service – quotes and crosses (SETSqx).

Order-driven systems are very common in the equity markets – the NYSE, the TSE and trading in the shares of the largest companies on the LSE are all examples of order-driven equity markets.

NASDAQ is an example of a quote-driven system.

Any company traded on an exchange must, according to company legislation do which of the following?

A Produce interim financial statements

B Hold annual general meetings

C Make all information available to directors available to shareholders

D Make sure shareholder rights are upheld in merger situations

The correct answer is: B - Hold annual general meetings

Explanation:

Company legislation details the requirements for companies generally, such as the requirement to prepare annual accounts, to have accounts audited and for Annual General Meetings. Of particular significance to the LSE are the Companies Act requirements to enable a company to be a plc, since one of the requirements for a company to be listed and traded on the exchange is that the company is a plc.

Which types of bonds are most commonly purchased following a carry trade in the foreign exchange markets?

A Bonds with high yields

B Bonds with low yields

C Bonds with short periods to redemption

D Bonds with long periods to redemption

The correct answer is: A - Bonds with high yields

Explanation”

The carry trade in FX involves the borrowing of funds in a currency where the rate of interest is relatively low and then the purchase of securities, often government bonds, which have a relatively high yield

A bond's annual income is based on which of the following?

A Price of the bond

B Capital value of the bond

C Interest rates

D Inflation rates

The correct answer is: B - Capital value of the bond

Explanation:

A bond's income (coupon) is expressed as a percentage of the nominal value which represents the capital value of the bond.

The role of a gilt inter-dealer broker is to:

A ensure market makers remain anonymous

B provide bid/offer pricing during the mandatory quote period

C trade as principal with GEMMs

D help the Debt Management Office gain successful issuance

The correct answer is: A - ensure market makers remain anonymous

Explanation:

Gilt IDBs arrange deals between gilt-edged market makers anonymously. They are not allowed to take principal positions, and the identity of the market makers using the service remains anonymous at all times. The IDB will act as agent, but settle the transaction as if it were the principal. The IDB is only allowed to act as a broker between GEMMs, and has to be a separate company and not a division of a broker-dealer.

Who decides whether a company is appropriate to apply for a quotation on the junior market of an exchange?

A Listing agent

B Broker

C Listing authority

D Company secretary

The correct answer is: A - Listing agent

Explanation:

The listing agent/nominated adviser (NOMAD) is responsible, amongst other duties, for warranting to the Exchange that a particular company is appropriate for the UK's junior market.

[4002938] Calculate the present value of a two year principal strip from a 2% Treasury using yields of 8% pa.

A £85.73

B £87.58

C £89.30

D £92.59

The correct answer is: A - £85.73

Explanation: As the bond is stripped there are no coupons to discount, therefore it is only for the principal that we need to find the present value. £100 ÷ 1.08^2 = £85.73.

Eurozone investor buys a US T-bond denominated in Euros. For which reason will they need to sacrifice the risk free return commonly associated with government debt?

A It is the only way to avoid currency risk

B It is the only way to avoid inflation risk

C Euros can only be printed in the Eurozone

D Only Eurozone bonds are default risk free

The correct answer is: C - Euros can only be printed in the Eurozone

Explanation:

Although the US government issues risk-free bonds, this is only when they are denominated in their domestic currency. This condition eliminates default risk as, if all things fail, the US government can always print more dollars to pay off a dollar debt. If the debt is in Euros, however, this method of meeting obligations is not possible. 

Company X increases its holdings in company Y and yet does NOT trigger disclosure under the Takeover Code, which of the following would BEST explain this?

A Holdings in Y increases from 30.1% by just 2%

B A formal offer for Y from X is under consideration

C X is a major supplier of Y

D An offer is made and it is all in cash

The correct answer is: C - X is a major supplier of Y

Explanation: All the other three choices require disclosure. There is no indication that X has breached the 3% disclosure ceiling from the content of the question.

A company is in the process of issuing its shares and there is an origination team working on their behalf. Who would assess the best method for bringing the company to the market?

A Legal Advisor

B Reporting Accountant

C Corporate Broker

D Sponsor

The correct answer is: D - Sponsor

Explanation:

The role of the sponsor includes assessing the company's suitability for listing, the best method of bringing the company to the market, and co-ordinating the production of the prospectus.

Why would an investment trust not be allowed to be an exchange-traded fund?

A An investment trust is closed-ended

B An investment trust is open-ended

C An investment trust can be leveraged

D An investment trust is listed on an exchange

The correct answer is: A - An investment trust is closed-ended

Explanation:

An investment trust is a closed-ended vehicle, whereas exchange-traded funds (ETF) are open-ended. This would prohibit the investment trust becoming an ETF. It is true that investment trusts are listed and can be leveraged, but so can ETFs, so this would not be prohibitive in itself.

How would a trader normally gain dark liquidity?

A Partially hidden orders

B Private transactions

C Multilateral trading facilities

D Market makers

The correct answer is: C - Multilateral trading facilities

Explanation

The obvious answer is dark pools. Dark pools are a form of MTF (or alternative trading system (ATS) in the US).

Which of the following offers a guaranteed yield?

A Linkers

B Equity

C Guaranteed bonds

D UK gilts

The correct answer is: D - UK gilts

Explanation: This is the best answer as gilts where the risk of default is low, investors can be virtually certain of the yield that their investment will deliver, as long as they hold their bonds to maturity.

Which of the below would NOT appear on a company's financial statements?

A The nominal value of equity and preference share capital the company has in issue

B Cash the company generated over the accounting period

C Summary of the trading activities of the company over the year

D Disclosures in relation to contingent liabilities

The correct answer is: D - Disclosures in relation to contingent liabilities

Explanation:

The choices A B and C appear within a statement of financial position, cash flow statement and income statement respectively. There may be other information that needs to be disclosed in the notes but would not appear in the financial statements itself.

Which of the following would BEST describe the point when a pension fund interest in shares of another company might no longer be considered to be in the free float?

A 3%

B 5%

C Greater than 5%

D Shares held by the pension fund will always be considered in the free float

The correct answer is: B - 5%

Explanation:

The free-float or a public float is usually defined as being all shares held by investors. Shares held by owners owning 5% of all shares (those could be institutional investors (such as pension funds), strategic shareholders, founders, executives, and other insiders' holdings);

An authorised participant has purchased creation units in an exchange-traded fund. This will enable that authorised participant to:

A Market the fund to institutional investors only

B Act as a custodian for real investors

C Act as a market maker for the fund shares

D Restrict the supply of the fund shares

The correct answer is: C - Act as a market maker for the fund shares

Explanation:

Authorised participants may wish to invest in the ETF shares long-term, but usually act as market makers on the open market, using their ability to exchange creation units with their underlying securities to provide liquidity of the ETF shares and help ensure that their intra-day market price approximates to the NAV of the underlying assets.

The diluted EPS figure is:

A An actual calculation based on assumptions about the present impact of convertibles and warrants which will take place, and its importance to any potential investor

B A theoretical calculation based on assumptions about the future, which will not actually take place, and its importance to the reader of the accounts and any potential investor

C An actual calculation based on assumptions about present events limited to this year, due to the exercise of any convertible securities and it shows the importance to the reader of the accounts

D A theoretical calculation based on assumptions about future events, which may or may not actually take place, and its importance to the reader of the accounts and any potential investor

The correct answer is: D - A theoretical calculation based on assumptions about future events, which may or may not actually take place, and its importance to the reader of the accounts and any potential investor

Explanation:

The diluted EPS figure is a theoretical calculation based on assumptions about the future (which may or may not actually take place) and it is considered of such importance to the reader of the accounts and a potential investor that its calculation and disclosure is required by IAS 33 – earnings per share (FRS 22 in the UK). IAS 33 requires the disclosure of both basic and diluted EPS on the face of the statement of profit and loss, both for net profit or loss for the period and profit or loss for continuing operations.

A shareholder increases its proportion of shares in a company from 28.6% to 30.9%, what are they obliged to do?

A To take more active role in corporate governance

B To inform the markets

C To tell the exchange

D Make an offer under takeover laws

The correct answer is: D - Make an offer under takeover laws

Explanation:

Once a shareholder crosses the 30% threshold they are then in a takeover situation.

Which of the following bond issuances would ensure the bonds purchased were at the highest price at which they could ALL be sold?

A Auction

B Schedule programme

C Reverse inquiry

D Tender

The correct answer is: D - Tender

Explanation:

The tender offer is the lowest successful price and everyone will pay this price. As this price applies to all the bonds purchased this is the highest price that will be paid for ALL the bonds issued.

In the offering of a bond issue, which of the following would NOT be a responsibility of the listing agent?

A Pitching

B Servicing

C Communicating with the listing authorities

D Co-ordinating activities of others involved in the offering

The correct answer is: B - Servicing

Explanation:

These are all responsibilities of the listing agent with the exception of 'servicing', which is the ongoing payment of the bond's interest. This will be the responsibility of the issuing company!

What are the responsibilities of a market maker outside of the exchange's open hours?

A To provide two-way prices to the market and exchange

B A market maker has no responsibilities during this time

C To report all trades within three minutes

D To enter trade reports of trades that took place outside the mandatory quote period (MQP)

The correct answer is: B - A market maker has no responsibilities during this time

Explanation:

From 5.15 pm until 7.15 am, no trade reports can be submitted and the market is not open therefore no prices are entered. As a result the market maker has no responsibility during this time.

A 1-year zero coupon bond has a redemption value of 100. If its yield is 6%, what is its price?

A 94.00

B 94.34

C 99.40

D 106.00

The correct answer is: B - 94.34

Explanation:

As this is a zero coupon bond, the price is the present value of the £100nv, discounted used the yield.
£100 / 1.06 = £94.34

Which of the following describes how corporate bonds being traded, along with their prices, can be discovered?

A Dealers give prices within separate pools of liquidity

B Agents seek prices within dark pools of liquidity

C Agents can observe prices on organised trading facilities

D Dealers give prices within multi-lateral trading facilities

The correct answer is: A - Dealers give prices within separate pools of liquidity

Explanation:

Dealing in corporate bonds tends to be away from the major exchanges in what is commonly described as a decentralised dealer market. The dealers provide liquidity by being willing to buy or sell the bonds. There are numerous systems that dealers use to display their willingness to deal, with each system being described as a separate pool of liquidity.

The yen spot rate is 105.5. What is the three-month forward rate if interest rates in USA are at 2% pa, and 0.5% pa in Japan?

A 104.90

B 105.90

C 105.11

D 106.11

The correct answer is: C - 105.11

Explanation:

The three-month forward rate would be calculated as follows.
F/S = (1+r(var)) / (1+r(base))
Remember to treat the rate as an annualised rate unless specifically told otherwise, so we would need to de-annualise this rate.
F / 105.5 = (1 + 0.005 x 3/12) / (1 + 0.02 x 3/12)
F = 0.99627 x 105.5
F = 105.11

Who sets the rules for members of an exchange governing their trading practices?

A The regulator

B The exchange

C The listing authority

D The central bank

The correct answer is: B - The exchange

Explanation: The exchange sets the rules for its member firms.

A company when bringing securities to the primary market are not required to fulfil publishing requirements in which of the following situation?

A Offer for sale

B Offer for subscription

C Selective marketing

D Rights issue

The correct answer is: C - Selective marketing

Explanation:

When doing a financial promotion a prospectus is not required if you are selling to professional clients, this is most commonly known as 'placing' it is a selective marketing technique.

What is the key benefit of purchasing shares in an investment trust compared to a comparable unit trust?

A Lower stamp duty reserve tax costs

B Improved liquidity

C Potential to invest at a discount to the net asset value

D Clarity of a single price to buy and sell

The correct answer is: C - Potential to invest at a discount to the net asset value

Explanation:

Investment trusts’ prices are dependent on supply and demand, the price of the shares can be lower than the NAV per share. This means investors can buy investment trust shares at a discount, while the income produced by the portfolio is based on the market value of the underlying investments. The income yield is, therefore, enhanced.

Under which of the following would companies that trade on the junior market be required to provide half yearly reports?

A The exchange

B Companies Act

C Listing Rules

D IFRS

The correct answer is: A - The exchange

Explanation:

An AIM company must prepare a half-yearly report in respect of the six month period from the end of the financial period for which financial information has been disclosed in its admission document and at least every subsequent six months thereafter (apart from the final period of six months preceding its accounting reference date for its annual audited accounts). All such reports must be notified without delay and in any event not later than three months after the end of the relevant period.

Which of the following would be a result of an increase in the equity risk premium on a share?

A The return on the share falls

B The price of the share falls

C The risk-free rate rises

D Stock market indices rise

The correct answer is: B - The price of the share falls

Explanation:

The equity risk premium is the additional return above the risk-free rate that equity holders require for taking the risk of equity. The risk premium increasing - all other things being equal - would result in the share prices falling.

How do Electronic Communication Networks (ECNs) benefit clients of trading firms?

A Lower transaction costs for trading

B Price visibility on all major exchanges

C Centralised physical location for trading

D Faster access to all major exchanges

The correct answer is: A - Lower transaction costs for trading

Explanation:

Electronic Communication Networks are not to be confused with the generic description of an electronic crossing network which is simply an order driven system. Electronic Communication Networks are also known as ‘dark pools’. A function they allow firms to offer lower trading costs for their clients. As the answer to this question cannot be found in the manual we have to assume that this question is being trialled for another examination.

Organisation X is acting as a dealer on a stock exchange. As a consequence, they are most likely to be operating as:

A A hedge fund

B An investment bank

C A gilt market maker

D A custodian

The correct answer is: C - A gilt market maker

Explanation:

The term dealer is used when a financial institution is trading in principal with its clients, typically the institution is also known as a market maker, even though also known as an investment bank the answer given would be the better description.

Acting as a dealer is often described as dealing as principal, because the dealer is taking a principal position by either buying or selling the securities. The dealer on an exchange can be referred to as acting as a market maker.

How would an investor determine the issuance price in an offer for subscription?

A By auction

B By tender

C By the prospectus

D By book building

The correct answer is: C - By the prospectus

Explanation:

An offer for subscription involves the company sending a prospectus (including the share price) and an application form to potential investors.

The behaviour rules for broker/dealer firms trading on an exchange would be overseen by:

A The central bank

B The exchange

C The regulator

D The listing authority

The correct answer is: B - The exchange

Explanation:

Listing and disclosure rules are set and overseen by the United Kingdom Listing Authority (UKLA). However, day to day behaviour rules regarding trading etc. are overseen by the exchange.

When stock is lent through a stock borrowing and lending intermediary which is not true of the lender?

A Will receive a fee

B Have the ability to sell the shares before settlement

C Be able to vote on an important resolution

D Will receive dividend income

The correct answer is: B - Have the ability to sell the shares before settlement

Explanation: This is a tricky question as much of it relies on interpretation. The lender will receive a fee and they will receive dividend income in the form of a manufactured dividend. They are not able to sell the shares. Voting is possible if the shares are recalled in a timely manner.