CISI IAD Securities and Markets 2

Question 1

What is the difference between 'clean' and 'dirty' prices when trading bonds?

Accepted Answer

The clean price excludes accrued interest while the dirty price (settlement price) includes accrued interest

Answer

The clean price is the quoted price of a bond excluding any accrued interest since the last coupon payment. The dirty price (or full/settlement price) adds the accrued interest to the clean price and is the actual amount paid on settlement. Bonds are quoted at clean prices to allow fair comparison between bonds with different coupon dates, but settlement always occurs at the dirty price. Accrued interest = coupon × (days since last coupon / days in coupon period).

Question 2

What is 'duration' in the context of bond investment?

Accepted Answer

A measure of a bond's price sensitivity to changes in interest rates, expressed in years

Answer

Duration (specifically modified duration) measures a bond's price sensitivity to changes in interest rates. A duration of 5 years means that for a 1% rise in yields, the bond price will fall by approximately 5% (and vice versa). Longer duration bonds are more sensitive to interest rate changes. Duration considers all cash flows (coupons and principal) weighted by time. Zero-coupon bonds have a duration equal to their maturity; coupon-paying bonds have duration less than maturity.

Question 3

What is the purpose of a 'collective investment scheme' such as a unit trust or OEIC?

Accepted Answer

To pool money from multiple investors to achieve diversification, professional management, and economies of scale

Answer

Collective investment schemes pool funds from many investors into a professionally managed portfolio, providing benefits that would be difficult to achieve individually: diversification across many securities reduces unsystematic risk; professional fund management provides expertise; economies of scale reduce dealing costs per investor. In the UK, unit trusts and OEICs are the most common structures, regulated by the FCA and governed by the FCA's Collective Investment Schemes sourcebook (COLL).

Question 4

What is an 'investment trust' and how does it differ from an OEIC?

Accepted Answer

An investment trust is a closed-ended company listed on the stock exchange whose shares can trade at a premium or discount to NAV, unlike an OEIC which deals at NAV

Answer

An investment trust is a closed-ended listed company that invests in other securities. Unlike OEICs, it has a fixed number of shares which trade on the stock exchange at prices determined by supply and demand. This means shares can trade at a premium (above NAV) or discount (below NAV). Investment trusts can also use gearing (borrowing to invest), which amplifies both gains and losses. They are governed by company law and the Listing Rules, not COLL.

Question 5

What is 'best execution' under MiFID II?

Accepted Answer

The obligation on firms to take all sufficient steps to obtain the best possible result for clients when executing orders, considering price, costs, speed, likelihood of execution, and other factors

Answer

MiFID II best execution (Article 27) requires firms to take all sufficient steps to obtain the best possible result for clients, considering multiple factors: price, costs (explicit and implicit), speed, likelihood of execution and settlement, size, nature, and any other relevant consideration. For retail clients, the best possible result is generally determined by total consideration (price plus all costs). Firms must have an execution policy, monitor effectiveness, and disclose their top five execution venues annually.

CISI Investment Advice Practice Test

CISI Investment Advice Practice Test

CISI IAD Securities and Markets 2