Mixed Deck — All CISI IOI Topics Flashcards

What is 'market risk' (also called systematic risk)?

Answer: The risk inherent to the entire market that cannot be eliminated through diversification, such as recessions or interest rate changes

Systematic (market) risk affects the whole market and cannot be diversified away. Examples include macroeconomic shocks, interest rate changes, and recessions. In contrast, unsystematic (specific) risk relates to individual companies and can be reduced through diversification.

What does 'gearing' or 'leverage' mean in the context of derivatives?

Answer: The ability to gain large exposure to an asset for a relatively small initial outlay

Gearing (leverage) in derivatives means that an investor can gain a large exposure to the price movements of an underlying asset by committing only a fraction of its full value (e.g., a margin deposit or option premium). This amplifies both potential gains and losses.

What is 'volatility' as a measure of investment risk?

Answer: The degree to which an investment's price fluctuates over time, typically measured by standard deviation of returns

Volatility measures how much an investment's price moves up and down over time. It is commonly measured by the standard deviation of historical returns — the higher the standard deviation, the greater the volatility and the higher the risk.

What is the maximum custodial sentence for a principal money laundering offence under the Proceeds of Crime Act 2002?

Answer: 14 years

The maximum sentence for the principal money laundering offences under POCA 2002 is 14 years' imprisonment, reflecting the severity with which the UK treats financial crime.

A fund manager who follows a 'passive' investment strategy will typically:

Answer: Aim to replicate the performance of a specific market index at low cost

Passive (index-tracking) management aims to replicate the returns of a specific benchmark index (e.g., FTSE 100) by holding the same securities in similar proportions. This approach has lower costs than active management because it requires minimal research and trading.

What is the primary purpose of using derivatives for hedging?

Answer: To reduce or offset the risk of adverse price movements in an existing position

Hedging uses derivatives to protect an existing position against adverse price movements. For example, a fund manager holding UK equities might buy put options or sell futures to protect against a market fall. The hedge reduces potential losses but may also limit potential gains.

What is an 'index-linked gilt'?

Answer: A gilt whose coupon and principal are adjusted in line with the Retail Prices Index (RPI)

Index-linked gilts are UK government bonds where both the coupon payments and the redemption value are adjusted in line with the Retail Prices Index (RPI), protecting the investor's return from the erosive effects of inflation.

Under FCA rules, what must a firm do before providing personal investment advice to a retail client?

Answer: Conduct a suitability assessment including the client's knowledge, experience, financial situation, and investment objectives

Before providing a personal recommendation, a firm must assess suitability by gathering information about the client's knowledge and experience, financial situation, and investment objectives (including risk tolerance). This ensures the advice is appropriate for the individual client's circumstances, as required by the FCA's Conduct of Business Sourcebook (COBS).

What is 'beta' as a measure of investment risk?

Answer: A measure of a security's volatility relative to the overall market. A beta of 1.0 means the security moves in line with the market; above 1.0 means more volatile; below 1.0 means less volatile

Beta measures a security's sensitivity to market movements. A beta of 1.2 means the security is expected to move 20% more than the market (up or down). Beta above 1 indicates higher market sensitivity; beta below 1 indicates lower sensitivity.

How are gains on UK government gilts treated for Capital Gains Tax purposes?

Answer: They are exempt from Capital Gains Tax

Capital gains on UK government gilts (and most qualifying corporate bonds) are exempt from CGT. This is a significant tax advantage. However, the coupon (interest) payments on gilts are subject to Income Tax, although they are paid gross (without tax deducted at source).

What is the 'coupon' on a bond?

Answer: The fixed interest payment made by the bond issuer to the bondholder, expressed as a percentage of the face value

The coupon is the annual interest payment on a bond, fixed at issuance. For example, a £1,000 bond with a 5% coupon pays £50 interest per year. Coupons are typically paid semi-annually for UK gilts and corporate bonds.

Which of the following is classified as an alternative investment?

Answer: A hedge fund using a long/short equity strategy

Hedge funds are classified as alternative investments, along with private equity, property, commodities, and infrastructure. They differ from traditional investments (equities, bonds, cash) by often using complex strategies such as long/short positions, leverage, and derivatives.

What is the Financial Ombudsman Service (FOS) limit for complaints about investment firms (as of 2024)?

Answer: £375,000

The FOS can award a maximum of £375,000 per complaint for cases referred on or after 1 April 2022. This increased from the previous £355,000 limit to give consumers greater protection when they cannot resolve disputes with investment firms directly.

Which of the following best describes the role of an investment bank in the UK financial services industry?

Answer: Advising corporations on mergers, acquisitions, and capital raising

Investment banks primarily advise corporate clients on mergers and acquisitions, underwriting securities, and raising capital through debt and equity markets. They do not accept retail deposits (commercial banks) or set interest rates (Bank of England).

What is the difference between an 'income unit' and an 'accumulation unit' in a unit trust?

Answer: Income units distribute investment income (dividends/interest) to investors as cash; accumulation units reinvest the income automatically within the fund

Income units pay out dividends and interest generated by the fund's investments as a cash distribution. Accumulation units automatically reinvest that income into the fund, increasing the value of each unit over time without a cash payment to the investor.

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 is 'concentration risk'?

Answer: The risk of having too large a proportion of a portfolio in a single investment, sector, or asset class, so that poor performance in that area has a disproportionate impact

Concentration risk arises when a portfolio is overly weighted towards a single stock, sector, geography, or asset class. Poor performance in that concentrated area will have a disproportionately large negative impact on the overall portfolio.

What is the role of a clearing house in derivatives trading?

Answer: To act as the counterparty to both buyer and seller, reducing counterparty risk

A clearing house (such as LCH in London) acts as the central counterparty (CCP) to every trade, becoming the buyer to every seller and the seller to every buyer. This eliminates bilateral counterparty risk, as both parties deal with the creditworthy clearing house rather than directly with each other.

What does the 'yield curve' show?

Answer: The relationship between bond yields and their time to maturity — typically showing how yields change as the maturity lengthens

The yield curve plots the yields (interest rates) of bonds of equal credit quality (e.g., gilts) against their maturities. A normal upward-sloping curve reflects higher yields for longer maturities. An inverted yield curve can signal an expected economic slowdown.

An investor sells (writes) a call option. What is their maximum potential loss?

Answer: Theoretically unlimited

The writer (seller) of a call option faces theoretically unlimited losses because there is no upper limit to how high the underlying asset's price can rise. If the option is exercised, the writer must sell the asset at the strike price regardless of how much higher the market price has gone.