IMC Investment Environment 2 — Questions and Answers
Question 1: What is the role of the Financial Services Compensation Scheme (FSCS) in the UK?
- To regulate financial services firms
- To compensate eligible investors if an authorised firm fails (Correct answer)
- To set interest rates for the banking sector
- To approve new financial products before they are marketed
Correct answer: To compensate eligible investors if an authorised firm fails
The FSCS is the UK's statutory deposit insurance and investors' compensation scheme. It protects eligible customers of authorised financial services firms that are unable to pay claims against them, providing compensation up to specified limits (e.g., £85,000 for deposits).
Question 2: Which of the following is a characteristic of an exchange-traded fund (ETF)?
- It can only be traded at the end-of-day NAV price
- It trades on a stock exchange throughout the day like ordinary shares (Correct answer)
- It is always actively managed
- It cannot track a bond index
Correct answer: It trades on a stock exchange throughout the day like ordinary shares
ETFs are investment funds that trade on stock exchanges during market hours, just like ordinary shares. They can be bought and sold at prevailing market prices throughout the day, unlike traditional open-ended funds which are priced once daily at NAV.
Question 3: In the context of UK fund structures, what distinguishes an Investment Trust from an OEIC?
- Investment Trusts are open-ended; OEICs are closed-ended
- Investment Trusts are closed-ended companies listed on a stock exchange; OEICs are open-ended (Correct answer)
- Investment Trusts cannot invest in equities
- OEICs are only available to institutional investors
Correct answer: Investment Trusts are closed-ended companies listed on a stock exchange; OEICs are open-ended
An Investment Trust is a closed-ended company listed on a stock exchange with a fixed number of shares. Its share price can trade at a premium or discount to NAV. An OEIC (Open-Ended Investment Company) creates and redeems shares on demand at NAV, so its size fluctuates with investor flows.
Question 4: What is the primary purpose of a Central Counterparty (CCP) in financial markets?
- To provide investment advice to retail clients
- To interpose itself between buyer and seller, guaranteeing trade settlement (Correct answer)
- To set the official exchange rate for currencies
- To conduct monetary policy on behalf of the government
Correct answer: To interpose itself between buyer and seller, guaranteeing trade settlement
A CCP stands between the two original counterparties to a trade, becoming the buyer to every seller and the seller to every buyer. This process, called novation, significantly reduces counterparty risk and is a key part of post-trade market infrastructure.
Question 5: Which of the following best describes 'dark pool' trading?
- Illegal trading of securities outside regulated exchanges
- Private trading venues where orders are not displayed to the public before execution (Correct answer)
- Trading that occurs exclusively at night outside market hours
- A pool of distressed securities with limited liquidity
Correct answer: Private trading venues where orders are not displayed to the public before execution
Dark pools are alternative trading systems that allow institutional investors to trade large blocks of shares without displaying their orders to the wider market. This helps minimise market impact and price movements that might occur if large orders were visible on public exchanges.
Question 6: What is the key difference between the 'bid' price and the 'offer' price quoted by a market maker?
- The bid is the price at which the market maker sells; the offer is the price at which it buys
- The bid is the price at which the market maker buys; the offer is the price at which it sells (Correct answer)
- The bid is the opening price; the offer is the closing price
- There is no difference; both terms mean the same
Correct answer: The bid is the price at which the market maker buys; the offer is the price at which it sells
The bid price is what the market maker is willing to pay to buy a security from a seller, and the offer (or ask) price is what the market maker charges to sell a security to a buyer. The difference between them is the bid-offer spread, which represents the market maker's profit margin.
IMC Investment Environment 2
What is the role of the Financial Services Compensation Scheme (FSCS) in the UK?