Module I Flashcards

Building societies and banks carry out a crucial economic purpose by

Answer: Using short-term deposits to fund long-term loans

Building societies and banks perform a crucial function of financial intermediation by taking short-term deposits from savers. They then pool this capital to provide longer-term loans, such as mortgages, to borrowers. This process transforms short-term liabilities into long-term assets, facilitating economic activity and investment within the economy.

Which organization determines base rates in the United Kingdom?

Answer: The Bank of England

The Bank of England is the central bank of the United Kingdom and is solely responsible for setting the official bank rate, commonly known as the base rate. This rate influences interest rates across the entire economy, impacting borrowing and saving costs for individuals and businesses. Its primary objective is to maintain price stability and support the government's economic policy.

On a bank account, a taxpayer would always earn a real rate of return when the

Answer: Interest after tax is less than inflation

The real rate of return is the nominal interest rate adjusted for inflation and taxes, indicating the actual change in purchasing power. When the interest earned after tax is less than the inflation rate, the real rate of return becomes negative. In this situation, while a nominal return is received, the purchasing power of the investment has diminished, meaning the taxpayer has a real rate of return, albeit a negative one.

A portion of the cash in an investment portfolio would be held in reserve to supply

Answer: A readily accessible source of money

A portion of an investment portfolio is typically held in cash or highly liquid assets to provide liquidity. This reserve serves as a readily accessible source of money for unexpected expenses, short-term needs, or to take advantage of new investment opportunities without having to sell long-term assets at an inopportune time. It acts as an emergency fund and a strategic buffer within the portfolio.

Gilt: what is it?

Answer: An investment in the form of a loan to the Government

A Gilt, or Gilt-edged security, is a bond issued by the UK government. Essentially, when an investor buys a Gilt, they are lending money to the government for a specified period in exchange for regular interest payments and the return of the principal at maturity. Gilts are considered very low-risk investments due to the UK government's strong creditworthiness.

Of the four primary asset classes, which one has the highest level of risk yet may yield the largest returns in the medium to long run?

Answer: Equities

Among the primary asset classes, equities (stocks) generally carry the highest level of risk due to their volatility and direct exposure to company performance. However, this higher risk is typically associated with the potential for the largest returns over the medium to long term, as investors can benefit from capital appreciation and dividends as companies grow and increase their value.

What is the primary motivation behind stock investing?

Answer: There is a potential for long-term growth

The primary motivation for investing in stocks (equities) is the potential for long-term capital growth. While stocks can be volatile in the short term, over extended periods, they have historically outperformed other asset classes. Investors aim to benefit from the appreciation in share price as companies grow and increase their value, alongside potential dividend income.

Which asset class provides the most liquidity?

Answer: Blue chip equities

Blue chip equities represent shares in large, stable companies that are actively traded on major stock exchanges. Their high trading volume and deep markets allow for quick and efficient conversion into cash, even for substantial amounts, often making them more readily liquid than other investment assets like corporate bonds or property. While deposits are also liquid, blue-chip equities offer immediate market access for significant capital within the investment market.

When an individual wants to invest in commercial real estate, they often do it through

Answer: Collective funds

Investing directly in commercial real estate requires significant capital and can be illiquid. Collective funds, such as Real Estate Investment Trusts (REITs) or property funds, allow individuals to pool money with others. This provides a more accessible and diversified way to gain exposure to commercial property without the burden of direct ownership and management.

Which type of tax is totally free from equity kept under an ISA?

Answer: Income Tax and Capital Gains Tax

Individual Savings Accounts (ISAs) are tax-efficient wrappers for savings and investments in the UK. Any income generated from investments held within an ISA, such as interest or dividends, is exempt from Income Tax. Furthermore, any profits made from selling investments within an ISA are free from Capital Gains Tax, making them highly attractive for long-term growth.

Which mortgage interest rate option, although temporarily, shields borrowers from rising rates?

Answer: Capped rate

A capped rate mortgage offers an interest rate that can vary but will not exceed a predetermined upper limit (the cap) for a set period. This provides borrowers with protection against significant increases in interest rates, as their payments will not rise above the cap. While offering security, it also allows them to benefit if market rates fall below the cap.