CISI IoI Equities and Bonds Basics 2 — Questions and Answers
Question 1: What is a 'gilt strip'?
- A gilt that has been downgraded by a credit rating agency
- A process by which the coupon payments and principal repayment of a gilt are separated and sold individually as zero-coupon bonds (Correct answer)
- A gilt traded on the AIM market
- A gilt issued at a premium to its face value
Correct answer: A process by which the coupon payments and principal repayment of a gilt are separated and sold individually as zero-coupon bonds
Gilt strips are created by separating (stripping) the individual cash flows of a conventional gilt — each coupon payment and the principal repayment — into separate zero-coupon bonds that can be traded independently.
Question 2: What is 'par value' (also called face value or nominal value) of a bond?
- The current market price of the bond
- The value at which the bond will be redeemed at maturity, typically £100 per £100 nominal (Correct answer)
- The total interest paid over the bond's life
- The average of the bond's highest and lowest prices over the past year
Correct answer: The value at which the bond will be redeemed at maturity, typically £100 per £100 nominal
The par (or face) value is the amount the issuer repays the bondholder at maturity — for UK gilts, this is £100 per £100 nominal. Bonds can trade above par (at a premium) or below par (at a discount) in the secondary market.
Question 3: What is a 'rights issue'?
- A company issuing bonus shares to existing shareholders at no cost
- An offer by a company to existing shareholders to buy additional new shares at a discount to the current market price (Correct answer)
- A process by which shareholders vote to remove directors
- A government scheme allowing employees to buy shares in their employer
Correct answer: An offer by a company to existing shareholders to buy additional new shares at a discount to the current market price
A rights issue is a way for a company to raise additional equity capital by offering existing shareholders the right to purchase new shares at a discounted price, usually in proportion to their existing holding.
Question 4: What is an 'index-linked gilt'?
- A gilt whose coupon and principal are adjusted in line with the Retail Prices Index (RPI) (Correct answer)
- A gilt whose price is linked to the FTSE 100 index
- A gilt that can only be purchased through an index tracker fund
- A gilt with a floating interest rate linked to the Bank Rate
Correct 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.
Question 5: What is 'earnings per share' (EPS)?
- The dividend paid to each shareholder
- A company's net profit divided by the number of shares in issue (Correct answer)
- The share price divided by the annual dividend
- The total revenue of a company per share outstanding
Correct answer: A company's net profit divided by the number of shares in issue
EPS is calculated by dividing a company's net profit (after tax) by the number of ordinary shares in issue. It measures the profitability attributable to each share and is a key metric used in valuing equities.
Question 6: What is the price-to-earnings (P/E) ratio and what does it indicate?
- The ratio of a company's share price to its annual earnings per share, indicating how much investors are willing to pay for each pound of earnings (Correct answer)
- The ratio of a company's debt to its equity
- The ratio of dividend paid to the share price
- The ratio of the current price to the book value per share
Correct answer: The ratio of a company's share price to its annual earnings per share, indicating how much investors are willing to pay for each pound of earnings
The P/E ratio divides the current share price by EPS. A higher P/E suggests investors expect strong future growth or are willing to pay a premium for the company's earnings. It allows comparison of relative valuations across companies.
CISI IoI Equities and Bonds Basics 2
What is a 'gilt strip'?