CISI IAD Securities and Markets — Questions and Answers
Question 1: What is the key difference between an ordinary share and a preference share?
- Ordinary shares pay fixed dividends while preference shares pay variable dividends
- Preference shares typically pay a fixed dividend and rank ahead of ordinary shares for dividend payments and on winding up, but usually have limited voting rights (Correct answer)
- Ordinary shares have no voting rights
- Preference shares always outperform ordinary shares
Correct answer: Preference shares typically pay a fixed dividend and rank ahead of ordinary shares for dividend payments and on winding up, but usually have limited voting rights
Preference shares rank ahead of ordinary shares for dividend payments and in a winding up of the company. They typically pay a fixed dividend (stated as a percentage of nominal value), providing more predictable income. However, they usually carry limited or no voting rights and have less potential for capital growth. Ordinary shares carry voting rights, participate in variable dividends, and have unlimited upside potential but rank last in liquidation.
Question 2: What is a 'corporate bond' and how does it differ from a UK Government gilt?
- They are identical instruments issued by different entities
- A corporate bond is a debt instrument issued by a company, typically carrying higher credit risk and yield than gilts which are issued by the UK Government (Correct answer)
- Corporate bonds are always more liquid than gilts
- Corporate bonds are equity instruments while gilts are debt instruments
Correct answer: A corporate bond is a debt instrument issued by a company, typically carrying higher credit risk and yield than gilts which are issued by the UK Government
Corporate bonds are debt securities issued by companies to raise capital. They carry credit risk (the risk the issuer defaults), which is reflected in a higher yield compared to gilts. The yield spread above gilts compensates for this additional credit risk. Credit rating agencies (Moody's, S&P, Fitch) rate corporate bonds — investment grade bonds are rated BBB-/Baa3 or above, while those below are 'high yield' or 'junk' bonds.
Question 3: What is the role of a 'market maker' on the London Stock Exchange?
- To regulate trading activity on behalf of the FCA
- To provide continuous buy and sell prices for securities, providing liquidity to the market (Correct answer)
- To clear and settle all trades
- To set the official closing price for all securities
Correct answer: To provide continuous buy and sell prices for securities, providing liquidity to the market
Market makers are firms that quote continuous bid (buy) and offer (sell) prices for securities, committing their own capital to facilitate trading. They profit from the bid-offer spread — the difference between the price at which they buy and sell. By providing two-way prices, they ensure liquidity, allowing investors to buy or sell at any time during market hours. On the LSE, this is particularly important for less liquid securities.
Question 4: What does the term 'ex-dividend date' mean for a shareholder?
- The date on which the dividend is paid into the shareholder's account
- The date after which a buyer of the shares will not be entitled to the next dividend payment (Correct answer)
- The date the company declares the dividend amount
- The date by which shareholders must reinvest their dividend
Correct answer: The date after which a buyer of the shares will not be entitled to the next dividend payment
The ex-dividend date is the cut-off date for dividend entitlement. If shares are purchased on or after the ex-dividend date, the buyer will NOT receive the upcoming dividend — it goes to the seller. The share price typically drops by approximately the dividend amount on the ex-dividend date. In the UK, settlement is T+1 (one business day after trade), which determines the record date relationship with the ex-dividend date.
Question 5: Which of the following is a characteristic of an Exchange-Traded Fund (ETF)?
- ETFs can only invest in UK equities
- ETFs trade on a stock exchange like shares, typically track an index, and can be bought and sold throughout the trading day at market prices (Correct answer)
- ETFs always outperform actively managed funds
- ETFs are only available to institutional investors
Correct answer: ETFs trade on a stock exchange like shares, typically track an index, and can be bought and sold throughout the trading day at market prices
ETFs are open-ended investment funds that trade on stock exchanges. They typically track an index (e.g., FTSE 100, S&P 500) using physical replication or synthetic methods. Unlike OEICs which are priced once daily, ETFs can be traded throughout the day at real-time market prices. They generally have lower ongoing charges than actively managed funds. ETFs can cover equities, bonds, commodities, and other asset classes across global markets.
Question 6: What is a 'rights issue' and how does it affect existing shareholders?
- A mandatory purchase of new shares at market price
- An offer to existing shareholders to purchase additional shares at a discounted price in proportion to their current holding, diluting non-participating shareholders (Correct answer)
- A share buyback programme
- A bonus issue of free shares
Correct answer: An offer to existing shareholders to purchase additional shares at a discounted price in proportion to their current holding, diluting non-participating shareholders
A rights issue allows existing shareholders to buy new shares at a discount to the current market price, in proportion to their existing holding (e.g., 1 new share for every 4 held). Shareholders who do not take up their rights can sell them in the market (nil-paid rights). If they neither exercise nor sell, their percentage ownership is diluted. Rights issues raise new equity capital for the company, often for acquisitions, debt reduction, or expansion.
CISI IAD Securities and Markets
What is the key difference between an ordinary share and a preference share?