CISI IAD Investment Risk and Taxation 2 — Questions and Answers
Question 1: What is the current Inheritance Tax (IHT) nil-rate band in the UK?
- £250,000
- £325,000 (Correct answer)
- £500,000
- £1,000,000
Correct answer: £325,000
The IHT nil-rate band has been frozen at £325,000 since 2009 and is expected to remain at this level until at least 2028. Estates valued above this threshold are taxed at 40% (or 36% if at least 10% of the net estate is left to charity). The residence nil-rate band provides an additional £175,000 allowance when a main residence is passed to direct descendants.
Question 2: A client has a portfolio with a beta of 1.5. If the FTSE 100 falls by 10%, what is the expected portfolio decline based on beta alone?
- 5%
- 10%
- 15% (Correct answer)
- 20%
Correct answer: 15%
Beta measures a portfolio's sensitivity to market movements relative to the benchmark. A beta of 1.5 means the portfolio is expected to move 1.5 times the market movement. If the FTSE 100 falls 10%, the expected portfolio decline is 10% × 1.5 = 15%. Similarly, if the market rises 10%, the portfolio would be expected to gain 15%. Higher beta portfolios carry more systematic risk but also higher potential returns.
Question 3: What is the annual allowance for pension contributions that receive tax relief for most individuals in 2025/26?
- £40,000
- £50,000
- £60,000 (Correct answer)
- £80,000
Correct answer: £60,000
The pension annual allowance was increased from £40,000 to £60,000 from 6 April 2023. This is the maximum combined employer and employee contributions that receive tax relief in a tax year. Individuals can carry forward unused allowance from the previous three tax years. High earners may have a tapered annual allowance reducing to a minimum of £10,000.
Question 4: Which risk measurement statistic indicates the degree to which a portfolio's returns deviate from its mean return?
- Beta
- Alpha
- Standard deviation (Correct answer)
- Sharpe ratio
Correct answer: Standard deviation
Standard deviation measures the dispersion of returns around the mean (average) return. A higher standard deviation indicates greater volatility and therefore higher risk. It captures both upside and downside deviation. In a normal distribution, approximately 68% of returns fall within one standard deviation of the mean, and 95% within two standard deviations.
Question 5: For UK tax purposes, how are offshore funds that do not have 'reporting fund' status taxed on disposal?
- Gains are taxed as capital gains at CGT rates
- Gains are taxed as income at the investor's marginal income tax rate (Correct answer)
- Gains are completely tax-exempt
- Gains are taxed at a flat rate of 15%
Correct answer: Gains are taxed as income at the investor's marginal income tax rate
Offshore funds without reporting fund status are classified as 'non-reporting funds'. On disposal, any gains are treated as income (not capital gains) and taxed at the investor's marginal income tax rate, which could be up to 45% for additional-rate taxpayers. This is significantly higher than CGT rates and removes access to the CGT annual exempt amount. This punitive treatment incentivises funds to elect for reporting status.
Question 6: What does the Sharpe ratio measure?
- The absolute return of a portfolio
- The risk-adjusted return of a portfolio relative to the risk-free rate (Correct answer)
- The correlation between two assets
- The tax efficiency of an investment
Correct answer: The risk-adjusted return of a portfolio relative to the risk-free rate
The Sharpe ratio, developed by William Sharpe, measures risk-adjusted return by calculating the excess return (portfolio return minus the risk-free rate) per unit of total risk (standard deviation). A higher Sharpe ratio indicates better risk-adjusted performance. For example, a ratio of 1.0 means the portfolio earned 1 unit of excess return per unit of risk. It allows comparison of investments with different risk profiles.
CISI IAD Investment Risk and Taxation 2
What is the current Inheritance Tax (IHT) nil-rate band in the UK?