CISI IoI Equities and Bonds — Questions and Answers
Question 1: What is the key difference between ordinary shares and preference shares?
- Ordinary shares pay a fixed dividend while preference shares pay a variable dividend
- Preference shares typically receive a fixed dividend and have priority over ordinary shares in a liquidation (Correct answer)
- Ordinary shares have no voting rights while preference shares always carry votes
- Preference shares can only be issued by government entities
Correct answer: Preference shares typically receive a fixed dividend and have priority over ordinary shares in a liquidation
Preference shares typically pay a fixed dividend and have priority over ordinary shares for dividend payments and capital return in a liquidation. However, preference shareholders usually have limited or no voting rights, while ordinary shareholders carry votes.
Question 2: A UK government bond (gilt) with a coupon of 4% and a nominal value of GBP 100 is trading at GBP 110. What is its current yield?
- 4.00%
- 3.64% (Correct answer)
- 4.40%
- 10.00%
Correct answer: 3.64%
Current yield = (Annual coupon / Market price) x 100. The annual coupon is 4% of GBP 100 = GBP 4. Current yield = (4 / 110) x 100 = 3.64%. When a bond trades above par (at a premium), the current yield is lower than the coupon rate.
Question 3: What happens to the price of an existing fixed-rate bond when market interest rates rise?
- The bond price rises
- The bond price falls (Correct answer)
- The bond price remains unchanged
- The bond is automatically redeemed at par
Correct answer: The bond price falls
Bond prices and interest rates have an inverse relationship. When market interest rates rise, existing bonds with lower fixed coupons become less attractive, causing their prices to fall. Conversely, when rates fall, existing bond prices rise.
Question 4: What is a 'rights issue' in relation to equity shares?
- The right of shareholders to attend the company AGM
- An offer of new shares to existing shareholders in proportion to their current holdings (Correct answer)
- The right to convert preference shares into ordinary shares
- A compulsory buyback of shares by the issuing company
Correct answer: An offer of new shares to existing shareholders in proportion to their current holdings
A rights issue is when a company offers existing shareholders the right to purchase additional new shares, usually at a discount to the current market price, in proportion to their existing holdings. This allows companies to raise additional capital while giving existing shareholders the opportunity to maintain their proportional ownership.
Question 5: Which of the following is a characteristic of a zero-coupon bond?
- It pays interest monthly at a variable rate
- It is issued at a discount to par and redeemed at par, with no periodic interest payments (Correct answer)
- It can only be issued by the UK government
- It pays double the coupon of a standard bond at maturity
Correct answer: It is issued at a discount to par and redeemed at par, with no periodic interest payments
A zero-coupon bond makes no periodic interest (coupon) payments. Instead, it is issued at a discount to its face (par) value and redeemed at par on maturity. The investor's return is the difference between the purchase price and the redemption value.
Question 6: What does the 'ex-dividend' date signify for a shareholder?
- The date by which shares must be purchased to qualify for the next dividend
- The date after which a buyer of the shares will NOT receive the upcoming dividend (Correct answer)
- The date on which the dividend is paid into shareholders' accounts
- The date the board of directors declares the dividend amount
Correct answer: The date after which a buyer of the shares will NOT receive the upcoming dividend
The ex-dividend date is the date on or after which a buyer of shares will not receive the next declared dividend. To receive the dividend, an investor must have purchased the shares before the ex-dividend date. On the ex-dividend date, the share price typically drops by approximately the dividend amount.
CISI IoI Equities and Bonds
What is the key difference between ordinary shares and preference shares?