Finance Basics Quiz
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Questions and Answers

What is one method a company can use to raise new money?

Take out a loan from a bank

What is the principal that a company must pay back after taking a loan?

The sum initially borrowed

Which of these is a method for a company to raise funds through the capital markets? (Select all that apply)

  • Issuing shares (correct)
  • Selling real estate
  • Taking out a loan
  • Issuing bonds (correct)

    • A person who buys shares is called a shareholder.

    <p>True</p> Signup and view all the answers

    What are MTFs in the context of securities trading?

    <p>Multilateral trading facilities</p> Signup and view all the answers

    What is the fundamental goal from an investor's standpoint when buying securities?

    <p>To optimize the level of return at an acceptable level of risk</p> Signup and view all the answers

    What can investments in securities potentially deliver over cash deposits?

    <p>Higher returns</p> Signup and view all the answers

    What is diversification in investment?

    <p>Investing in a diverse range of securities and asset classes to spread risk.</p> Signup and view all the answers

    Securities are guaranteed to outperform cash investments.

    <p>False</p> Signup and view all the answers

    Which of the following is an avenue for generating returns on investment?

    <p>Both A and B</p> Signup and view all the answers

    The principle of buying and selling securities is similar to buying and selling __________.

    <p>used cars</p> Signup and view all the answers

    What is liquidity in the context of securities?

    <p>The ability to buy or sell a security without significant effect on market price.</p> Signup and view all the answers

    Match the following investment types to their features:

    <p>Ordinary Shares = Ownership and potential dividends Bonds = Interest payments at fixed intervals Bearer Securities = Ownership by physical possession Private Placings = Shares offered privately, not publicly traded</p> Signup and view all the answers

    Who invests in securities?

    <p>Individual investors, pension schemes, life insurance companies, and mutual funds.</p> Signup and view all the answers

    Investment banks cater directly to retail investors.

    <p>False</p> Signup and view all the answers

    What does 'pari passu' mean in the context of shares?

    <p>Shares have the same rights and status as ordinary shares under certain conditions</p> Signup and view all the answers

    What must a company fulfill to list its securities on a recognised investment exchange?

    <p>Conditions specified under the listing requirements.</p> Signup and view all the answers

    Foreign investors may be restricted from holding more than a specified percentage of the total issued capital in some companies.

    <p>True</p> Signup and view all the answers

    What is a characteristic of preference shares?

    <p>Preference shareholders receive fixed dividends.</p> Signup and view all the answers

    What is the term for the amount paid back to bondholders at maturity?

    <p>Principal</p> Signup and view all the answers

    Preference shares may be __________ or non-cumulative.

    <p>cumulative</p> Signup and view all the answers

    In case of liquidation, which group is paid first?

    <p>Senior secured debt</p> Signup and view all the answers

    What is the coupon payment in bond terminology?

    <p>The periodic interest payment made to bondholders.</p> Signup and view all the answers

    A preference shareholder is guaranteed a dividend every year.

    <p>False</p> Signup and view all the answers

    Sovereign risk refers to the risk that a government will fail to __________ its debt obligations.

    <p>honor</p> Signup and view all the answers

    Match the following types of bonds with their description:

    <p>Government Bonds = Debt instruments issued by stable governments Domestic Bonds = Bonds issued in the local currency of the issuing country Foreign Bonds = Bonds issued by a foreign issuer in the local market</p> Signup and view all the answers

    What is the equity risk premium?

    <p>The additional return generated on equities compared to bonds.</p> Signup and view all the answers

    What type of bonds are typically considered the most secure marketable investments?

    <p>Government bonds</p> Signup and view all the answers

    What currency are dividends paid by British Land distributed in?

    <p>US Dollars</p> Signup and view all the answers

    Holders of British Land ADRs are entitled to instruct NYC to cancel their ADR at any point.

    <p>True</p> Signup and view all the answers

    What is the typical settlement cycle for ADRs?

    <p>T+2</p> Signup and view all the answers

    ADRs trade on US stock exchanges and ___ markets.

    <p>OTC</p> Signup and view all the answers

    What must ADR holders pay when converting their ADR back to the underlying share?

    <p>Conversion fee</p> Signup and view all the answers

    Shares must be paid for in foreign currency when purchasing ordinary shares in the local market.

    <p>True</p> Signup and view all the answers

    What is a pre-release facility in the context of depositary receipts?

    <p>A process that allows trading of DRs before actual underlying shares are deposited.</p> Signup and view all the answers

    How is accrued interest calculated using the 30/360 convention?

    <p>Accrued interest is calculated based on a standardized 30-day month and a 360-day year.</p> Signup and view all the answers

    How is accrued interest calculated using the actual/365 convention?

    <p>Accrued interest is calculated based on the actual number of days in the periods and using a 365-day year.</p> Signup and view all the answers

    How much interest will the buyer pay to the seller for £200,000 8% bonds after 100 days of accrued interest?

    <p>The accrued interest is £4,000.</p> Signup and view all the answers

    How much interest will the seller pay to the buyer for £100,000 7% bonds after 175 days of accrued interest?

    <p>The accrued interest is £2,500.</p> Signup and view all the answers

    What do warrants provide to the investor?

    <p>Warrants provide the right to purchase shares or bonds at a specified price before a specified date.</p> Signup and view all the answers

    What is referred to as the premium in relation to warrants?

    <p>The premium is the amount paid by an investor to purchase a warrant.</p> Signup and view all the answers

    What characterizes a warrant being out-of-the-money?

    <p>A warrant is out-of-the-money if the underlying share price is lower than the strike price.</p> Signup and view all the answers

    What are American-style warrants?

    <p>American-style warrants can be exercised at any time on or before their expiry date.</p> Signup and view all the answers

    What defines a covered warrant?

    <p>A covered warrant is issued by a financial institution and provides the right to buy or sell an underlying asset.</p> Signup and view all the answers

    How do depositary receipts (DRs) function for foreign companies?

    <p>DRs represent shares of a foreign company and are traded in the domestic market of investors.</p> Signup and view all the answers

    What is a Yankee bond?

    <p>Issued in US dollars</p> Signup and view all the answers

    What is a Samurai bond?

    <p>Issued in Yen</p> Signup and view all the answers

    What is the main characteristic of a convertible bond?

    <p>It can be converted into shares of the issuing company</p> Signup and view all the answers

    Zero coupon bonds pay interest periodically.

    <p>False</p> Signup and view all the answers

    What is a floating-rate note (FRN)?

    <p>A bond whose coupon is linked to a floating interest rate.</p> Signup and view all the answers

    What do asset-backed securities (ABS) represent?

    <p>Securities issued against a pool of loans</p> Signup and view all the answers

    Define a Mortgage-Backed Security (MBS).

    <p>A type of asset-backed security that uses a pool of mortgage loans as collateral.</p> Signup and view all the answers

    How is the coupon payment for index-linked bonds adjusted?

    <p>Based on movement in retail prices</p> Signup and view all the answers

    Green bonds are exclusively issued by government entities.

    <p>False</p> Signup and view all the answers

    The difference between the clean price and the dirty price reflects the _____ interest.

    <p>accrued</p> Signup and view all the answers

    What is the formula for calculating accrued interest?

    <p>Accrued interest = nominal value × coupon for the period × days of accrual / days in coupon period</p> Signup and view all the answers

    What is a cum-interest transaction?

    <p>A transaction agreed upon before the coupon payment date where the seller receives interest.</p> Signup and view all the answers

    What is an ex-interest transaction?

    <p>A transaction where accrued interest is subtracted from the clean price.</p> Signup and view all the answers

    Which interest calculation method assumes 30 days in each month?

    <p>30/360</p> Signup and view all the answers

    Study Notes

    Investment Operations Certificate Overview

    • The manual corresponds to syllabus version 18.0 for examinations from 21 August 2023 to 20 August 2024.
    • Prepared by the Chartered Institute for Securities & Investment (CISI).
    • Author: Kevin Petley, Chartered FCSI; Reviewers: Stephen Lacey, Chartered MCSI; Henrietta Wu.
    • Estimated study time required: approximately 80 hours.

    Chartered Institute for Securities & Investment (CISI)

    • Leading professional body for the investment sector with a commitment to enhancing knowledge, skills, and integrity.
    • Annual candidate examinations total around 50,000 and require the use of CISI learning workbooks.
    • Candidates who are not already members receive free student membership for one year upon registration for examinations.

    Study Material Features

    • Workbook includes a full syllabus and multiple-choice questions for revision.
    • An ebook version of the workbook may include interactive elements such as video clips, adjustable text size, annotations, and links to external resources.
    • The learning material is designed for both examination preparation and ongoing professional development.

    Securities and Investment Fundamentals

    • Companies need capital for development and can raise funds through loans or capital markets.
    • Securities can be issued to raise equity financing (shares) or debt (bonds).
    • Shares sold represent ownership stakes in companies, while bonds are debt instruments issued in return for cash.

    Investor Motivations for Buying Securities

    • Risk/Return Balance: Investors seek optimal returns at acceptable risk levels; higher potential returns usually involve greater risk.
    • Superior Performance: Securities may yield higher long-term returns compared to bank deposits, but are not guaranteed to outperform.
    • Diversification: Investing across different types of securities and asset classes spreads risk and offers multiple growth and income opportunities.
    • Regulatory Oversight: Securities markets are typically well-regulated, providing investor protection against malpractice.
    • Liquidity: Many securities allow for quick buying and selling without significantly impacting market prices.
    • High Volume Trading: Securities often trade in significant volumes, which can reduce transaction costs for investors.

    Examination Preparation Notes

    • Regular updates regarding changes in industry practices, regulations, and examination details are available on the CISI website.
    • A learning map outlining the full syllabus can be found at the end of the workbook.
    • Candidates are encouraged to engage with educational resources and feedback options provided by the CISI.### Investment Costs and Returns
    • Securities trading generally incurs lower costs than other investment categories.
    • Two principal investment return sources: capital appreciation and income payments.

    Capital Appreciation

    • Defined as the increase in a security's price, allowing investors to sell for profit.
    • Example: Buying 100 shares at £0.80 and selling at £1.60 yields a capital gain of £80.
    • Share price increase is often linked to strong company profits.

    Income Payments

    • Investors can receive dividends (for equities) or fixed interest (for bonds).
    • Dividends reflect a company's profit-sharing decided during annual general meetings.
    • Bonds typically pay a fixed rate of interest known as the coupon.

    Who Invests in Securities?

    • Not limited to individual investors; encompasses pension schemes, life insurance companies, and mutual funds.
    • Pension funds invest in securities to ensure income for members upon retirement.
    • Government entities and sovereign wealth funds seek diversified portfolios for risk management.
    • Investment management companies handle funds from private investors and institutional clients.
    • Investment banks trade in securities both as principal (own investments) and agency (clients’ investments).

    Characteristics of Shares (Equities)

    Ordinary Shares

    • Ordinary shares represent ownership in a company and are known as equities.
    • Equity capital from ordinary shares does not need to be repaid and reflects ownership.
    • Shareholder rights include dividends, voting at meetings, and sharing in liquidation assets.
    • Non-voting shares offer no voting rights at AGMs or EGMs.

    Share Registration

    • Shareholder information is recorded in a company’s register.
    • The UK's register consists of a physical part and a dematerialized part via the CREST system.
    • CREST updates ownership records, ensuring public access and transparency.

    Listing of Securities

    • Listed securities are accepted for trading on recognized exchanges, ensuring a regulated marketplace.
    • Benefits include liquidity, price determination based on supply and demand, and investor protection.
    • Unlisted securities trade off-exchange or through private placements, which have fewer regulations.

    Bearer Securities

    • Ownership rests with the physical holder; legal title requires possession of the certificate.
    • Bearer securities have seen a decline due to ownership transparency initiatives.

    Transfer Restrictions

    • Restrictions may apply to transferring securities based on investor nationality or minimum holding sizes.
    • Certain securities may face transfer limitations during bankruptcy or legal situations.

    Preference Shares

    • Companies use preference shares to raise capital without affecting ordinary share ownership.
    • These shares do not grant voting rights and provide fixed dividends.
    • Preference shareholders are prioritized for dividend payments and liquidation returns.
    • Types include cumulative (unpaid dividends roll over) and non-cumulative (missed dividends are lost).
    • A company’s liquidation order involves satisfying debts from secured debt to ordinary shares last.### Preference Shares
    • Redeemable preference shares can be bought back by the company at a future date.
    • Example: A 3% cumulative preference share worth £0.40 has dividends of 3% and is redeemable in 2025.
    • Participating preference shares allow shareholders to receive additional dividends proportional to ordinary dividends declared.
    • Convertible preference shares enable shareholders to convert them into ordinary shares at a future date.

    Debt Instruments Overview

    • Debt instruments are interest-bearing securities used by borrowers to raise capital.
    • Issued by companies, governments, or agencies and sold to investors.
    • Borrowers promise to repay capital and make periodic interest payments (coupons).
    • Corporate bondholders face lower risk compared to shareholders, with returns on equities potentially higher over time (equity risk premium).

    Bond Characteristics

    • Bondholders have priority over shareholders regarding claims on the company’s assets.
    • Bonds provide predictable returns and fixed interest payments, unlike ordinary shares which depend on company performance.
    • Example: £1,000 bond with a 7% coupon provides £70 annually for five years, returning the nominal value of £1,000 at maturity.

    Company Perspective on Bond Issuance

    • Bonds allow companies to secure fixed-term financing at lower rates compared to bank loans.
    • Issuing bonds does not dilute equity ownership or share profits among bondholders.

    Coupon Payments

    • Coupons are interest payments based on the bond's nominal value, traditionally cut from physical certificates.
    • Payments can be gross (without tax withheld) or net (with tax withheld), depending on tax regulations.
    • Common coupon payment schedules include annually, semi-annually, and quarterly.

    Maturity and Redemption

    • Bonds mature at the end of the loan period when the principal amount is repaid.
    • Maturities categorized into short (0–7 years), medium (8–15 years), and long (15+ years).

    Bond Yields

    • Yield refers to the return on investment, expressed as a percentage of the bond’s price.
    • Flat yield is calculated based on the interest payment relative to the bond's market price.

    Default Risk

    • Bond prices reflect interest rates and the issuer's ability to meet payment obligations.
    • Credit ratings from agencies like Standard & Poor’s assess the likelihood of default.
    • AAA-rated bonds are the most secure, while BB-rated and below are classified as speculative.

    Types of Fixed Income Instruments

    • Government Bonds: Issued by stable governments, low default risk; includes Treasuries (US), gilts (UK), JGBs (Japan), and Bunds (Germany).
    • Domestic Bonds: Issued in the borrower's local currency, under local regulatory authority.
    • Foreign Bonds: Issued by foreign issuers in local markets (e.g., Yankee bonds in the US).
    • Eurobonds: Bonds issued outside the issuer's country while denominated in a foreign currency.
    • Convertible Bonds: Allow conversion into shares, typically offer lower interest rates but potential for capital gains.
    • Discount Securities: Issued below face value with no interest payments; gain realized at maturity.
    • Floating-Rate Notes (FRNs): Coupon payments linked to floating interest rates, adjusting with market rates.
    • Asset-Backed Securities (ABS): Securities backed by pools of loans that transfer cash flow risks to investors.
    • Mortgage-Backed Securities (MBS): Use mortgage loans as collateral; investors receive payments from underlying mortgage interest and principal.
    • Index-Linked Bonds: Coupons and principal adjusted based on inflation measures (e.g., Retail Prices Index in the UK).

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