Knowledge | Skills | Conduct

Financial Assets and Markets

5 questions

Chapter 3

Further informationThis chapter is an introduction to financial assets and looks at cash, money market instruments, the property market and foreign exchange.

This chapter has five questions in the exam.

Answer to question on the previous slideAnswer A. The Consumer Price Index is used throughout the EU and beyond.

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Knowledge | Skills | Conduct

Investing in cash

• Advantages- Interest earned- Liquidity- Capital protection

Rates of interest

• Interest is a % of funds deposited - Higher the deposit = Higher the rate

• Fixed vs. variable interest rates

• Longer-term deposits = Higher rates

• No capital growth on cash deposits

• Disadvantages- Low rates of return- Inflation corrodes value- Investment not protected above a

certain level (£85,000)- Currency risk if held overseas

2. Cash Deposits

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Knowledge | Skills | Conduct

Instant access accounts

• Flexible but a low rate of interest

Notice accounts

• Better rate of interest but possible penalty for early withdrawal

Calculation of interest

• Gross interest = principal x gross interest rate x years deposited

• Tax rules - Basic rate tax payers – first £1000 of interest tax free 20% taxed above this- Higher rate tax payers – first £500 of interest tax free 40% taxed above this- Additional higher rate tax payers no tax free allowance taxed at 45%

2. Cash DepositsFurther informationIn April 2016 a new personal savings allowance was introduced. As a result, banks and building societies will stop automatically deducting 20% tax at source on interest paid.

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Knowledge | Skills | Conduct

Money serves three functions:

• A store of value

• A medium of exchange with which to make payments

• A unit of account with which to measure the value of any particular item that is for sale.

Cryptocurrencies are:

• Too volatile to be a good store of value

• They are not widely accepted as a means of exchange

• They are not used as a unit of account.

2. Cryptocurrencies

There are three main kinds of crypto-assets: • Exchange tokens – such as Bitcoin and other cryptocurrencies.

• Security tokens – has features similar to general investments

• Utility tokens – gives access to services and products.

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Knowledge | Skills | Conduct

Government bills

• UK Treasury bills (UK T-bills)

3. Money Markets: Instruments

D.M.O

1. DMO issues a 90 day T-bill with a face value of £100,000.

2. Investor pays £98,500 for the bill (after deducting a £1,500 discount, which is approx three months’ interest at 6% pa).

3. Investor holds the T-bill for the entire 90-day period.

4. Investor redeems T-bill and receives the full face value. The difference between this

and the £98,500 originally paid is the investor’s return:

£100,000 - £98,500 = £1,500

£1,500 x 12 = 6.1 %

£98,500 3

Further informationThe Debt Management Office (DMO) organises weekly auctions. Financial institutions are invited to tender for the Treasury Bills being offered. The auction is blind, which means participants are not told at what price they should bid nor what price any other party is bidding. The DMO sells the Treasury Bills to institutions willing to pay the highest price, which effectively is the lowest yield.

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Knowledge | Skills | Conduct

Certificates of deposit

3. Money Markets: Instruments

Bank X

£5m on deposit for three months at 6% pa

Investor Certificate of deposit£5m deposit deposited at Bank X for three months at 6% pa

Further informationA CD gives the holder a rate of interest comparable to a fixed term deposit, but with the flexibility of instant access as the holder can sell the CD in the money market before maturity.

Keeping on targetWho organises the weekly treasury bill auctions?A. The TreasuryB. The Debt Management OfficeC. The Bank of EnglandD. The Monetary Policy Committee

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Knowledge | Skills | Conduct

Commercial paper

• Short-term unsecured debt

• Usually zero-coupon

• Usually high nominal value

• A CP programme specifies a total amount that can be issued and may have an end date

3. Money Markets: Instruments

CP programmeIssue limit £150m

End date 2022

Date Issue TermMar 2018 £100m Six monthsApr 2019 £50m Three monthsOct 2019 £75m Three monthsJan 2020 £75m Three months

Further informationLarge multinationals often issue commercial paper as it may be cheaper than using a bank overdraft.

Answer to question on the previous slideAnswer B.

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Knowledge | Skills | Conduct

Money market funds

• Overview- Collective investment scheme structured like an OEIC- Invest in cash or near cash assets – low risk assets

• Two types:- Constant net asset value (income can be paid out or accumulated)- Accumulating net asset value (roll-up funds – income is not distributed)

• Objectives:- Primary objective: Preservation of capital- Other objectives: Liquidity, sector related returns (better than cash)

3. Money Markets: InstrumentsLinksA money market fund is a type of collective investment that you will see in the chapter on investment products.Example

£

£

Portfolio

Trustee

Units

£

Open EndedFund

Unit Trust Manager

Investment Manager

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Knowledge | Skills | Conduct

Features of the property market• Heterogeneous – segmented

- Commercial- Residential- Agricultural

• Decentralised • Indivisible – difficult to split up• High transaction costs • Maintenance costs• Government regulation

Property prices – influence• Supply (inelastic) and demand (demographics)• Cost of borrowing• Stamp Duty Land Tax (SDLT)

4. Property MarketFurther informationInvesting in property through, for example, the buy-to-let schemes has proved very popular in recent years. However, as the slide opposite shows there are unique characteristics which makes investing in property more problematic than investing in shares.

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Knowledge | Skills | Conduct

Direct property investment

• Investors buy property and rent out

• Sale and lease back- Buying a property and leasing it back to the seller

Indirect property investment

• Property bonds- Issued by insurance companies – coupons are linked to the underlying rental income

of property at maturity the building is sold to repay the loan value of the bond

• Property Funds- Collective investment investing in commercial property- May be redemption restrictions on investors if too many liquidations

4. Property MarketFurther informationA number of years ago HSBC sold its tower block in Canary Wharf but agreed with the purchaser that the bank would continue to occupy the building and pay rent. From the buyer’s perspective this reduces the major risk of buying property that has no tenants.

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Knowledge | Skills | Conduct

Introduction• OTC market• Major international banks• London largest centre• Quotes

- Currencies are quoted in pairs such as:• USD/JPY: E.g. USD1.00/JPY 116.15• GBP/USD: E.g. GBP 1.00/USD 1.23

- The first currency is the ‘base’ currency- The second currency is the ‘counter’ or ‘quoted’ currency

• Spot market and forward market

5. Foreign Exchange

Keeping on targetWhich of the following is not true of the FX market?A. London is the biggest market in the worldB. The dollar is the reserve currency of the worldC. Trades are settled through the London Clearing HouseD. It is dominated by large Banks

Further informationThe US Dollar is the reserve currency of the world. As a result most commodities are quoted in USD. Most currencies are quoted against each other via the dollar. This is the ‘cross rate’.

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Further informationCurrency Swaps – two parties exchange currencies OTC for a certain period and then reverse at a later date

Knowledge | Skills | Conduct

• Calculating the forward rate - The calculation is based on the difference between the two currencies respective

nominal interest rates over the term being considered- Example: 3-month forward rate GBP:USD

• GBP:USD spot rate 1:1.25• 3-month LIBOR GBP is 0.50% USD rate 1.00% (these are the annual rates so divide by 4 to

give the quarterly rate)- GBP 0.50% / 4 = 0.125% (decimalised = 0.00125)- USD 1.00% / 4 = 0.25% (decimalised = 0.0025)

• Forward rate = Spot rate x (1+ Quote currency short-term rate)• (1 + Base currency short-term rate)

• Therefore = 1.25 x (1 + 0.0025) =1.2516• (1 + 0.00125)

• Note: As interest rates in USA are higher than UK, the forward rate is higher

5. Foreign Exchange

Answer to question on the previous slideAnswer C. The FX market is over-the-counter (OTC), so there is no central exchange.

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Knowledge | Skills | Conduct

Question:

• What is the 3-month forward rate GBP:USD?- GBP:USD spot rate 1.25- 3-month LIBOR GBP is 1.00% USD rate 0.50% (Note: These are the annual rates)

5. Foreign Exchange

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