Equities and Bonds Flashcards

What is the primary risk associated with holding corporate bonds compared to UK government gilts?

Answer: Credit (default) risk

Corporate bonds carry higher credit (default) risk than UK government gilts because companies are more likely to default on their obligations than the UK government. This is why corporate bonds typically offer higher yields than gilts of similar maturity — to compensate investors for the additional risk.

What does a bond's 'duration' measure?

Answer: The bond's sensitivity to changes in interest rates

Duration measures a bond's price sensitivity to changes in interest rates. A higher duration means the bond's price will be more affected by interest rate changes. While related to maturity, duration specifically captures the weighted average time of all cash flows (coupons and principal) and is used as a risk measure.

An investor holds 1,000 ordinary shares in a company that announces a 1-for-4 rights issue at GBP 3.00 per share. How many new shares is the investor entitled to purchase?

Answer: 250 shares

In a 1-for-4 rights issue, existing shareholders are entitled to buy 1 new share for every 4 shares they currently hold. With 1,000 existing shares: 1,000 / 4 = 250 new shares at GBP 3.00 each.

What is the redemption yield on a bond?

Answer: The total return including both coupon income and any capital gain or loss if held to maturity

Redemption yield (also called yield to maturity or gross redemption yield) takes into account both the annual coupon payments and any capital gain or loss that will be realised if the bond is held to maturity and redeemed at par. It is a more complete measure of return than the simple current yield.

What type of share gives the holder the right to receive any unpaid dividends from previous years before ordinary shareholders receive theirs?

Answer: Cumulative preference shares

Cumulative preference shares carry the right to receive any dividends that were not paid in previous years (arrears) before any dividend can be paid to ordinary shareholders. If the company skips a preference dividend, it accumulates and must be paid in full before ordinary dividends resume.

Which of the following statements about index-linked gilts is correct?

Answer: Both the coupon and principal are adjusted in line with the Retail Price Index (RPI)

UK index-linked gilts have both their coupon payments and principal (redemption value) adjusted in line with the Retail Price Index (RPI). This protects investors against inflation by ensuring that both income and capital maintain their real (inflation-adjusted) value.