Investment Risk and Taxation Flashcards

What is the current Inheritance Tax (IHT) nil-rate band in the UK?

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.

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?

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.

What is the annual allowance for pension contributions that receive tax relief for most individuals in 2025/26?

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.

Which risk measurement statistic indicates the degree to which a portfolio's returns deviate from its mean return?

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.

For UK tax purposes, how are offshore funds that do not have 'reporting fund' status taxed on disposal?

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.

What does the Sharpe ratio measure?

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.