Investments & Risks Easily Understood Copyright© Ruksons

Investments & Risks

Easily Understood
Published by Ruksons Ltd.

Written by

Tomi Omidiora
BA Hons, MBA, CeMAP, CeFA

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Investments & Risks Easily Understood Copyright© Ruksons

Published by Rucksons Ltd, UK

Investments & Risks Easily Understood
Adetomi Omidiora

Published In Great Britain 2009

Copyright © Ruksons 2009

The Investments & Risks Easily Understood guide is to be used in addition to the main accredited Textbook and will
never replace the detail contained there.

It was written with an intention to support the reader’s understanding of the main aspects of the text, and will serve as
an appropriate revision guide to understanding investments and the risks involved.
A thorough analysis, the detailed document could also provide clarity and understanding to an individual who needs a
basic understanding of investments and risks.

The Investments & Risks Easily Understood Book published in August 2009 provides information for the 2008/09
financial year. While the author has used all her efforts in preparing this book, there are no promises or warranties in
respect of the accuracy or completeness of the content of this book with updated changes from the appropriate
financial bodies.

All rights reserved. Contents and or cover may not be reproduced in whole or in part. No part of this publication may
be reproduced, stored in a retrieval system, or transmitted in any form or by any means ---- electronic, mechanical,
including photocopying, scanning and recording worldwide, without prior permission in writing from the author and/or
publisher.

Printed in the UK.

Created and Designed By
Rucksons Ltd
www.ruksons.com

Edition 2

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Investments & Risks Easily Understood Copyright© Ruksons

Abbreviation Table
BACS Bankers' Automated Clearing Services
BOE Bank of England
BOP Balance of Payments
BRT Basic Rate Taxpayer
CFD Contracts for difference
CGT Capital Gains Tax
CPI Consumer Price Index
CTF Child Trust Fund
EIRIS The Ethical Investment Research
EIS Enterprise Investment Schemes
FSA Financial Service Authority
FSCS Financial Services Compensation Scheme
GDP Gross Domestic Product
Gilts Gilt Edged Securities
GSA Guaranteed Sum Assured
ICVC Investment Companies with Variable Capital
ISA Individual Savings Account
LIBOR London Inter-bank Offered Rate
LRT Lower Rate Taxpayer
MPC Monetary Policy Committee
MVA Market Value Adjuster
NAE National Average Earnings Index
NAV Net Asset Value
NS&I National Savings & Investment
NTP Non-taxpayer
OEIC Open Ended Investment Company
PEP Personal Equity Plans
PIBS Permanent Interest Bearing Shares
PLC Public Limited Company
RIY Reduction in Yield
RPI Retail Price Index
RPIX Underlying Rate of Inflation
SAYE Save As You Earn Scheme
SHEP Second Hand Endowment Policy
SIPP Self Invested Pension Plan
SRI Socially Responsible Investment
TEP Traded Endowment Policy
TLP Traded Life Policy
UEITS Undertaking of Collective Investment in Transferable securities
UKSH The United Kingdom Social Investment Forum
VCT Venture Capital Trust

Contents

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Unit 3 Principles of Investment:

Investments 1
Deposits 1
Fixed Interest 1
Asset Backed 1
Vocabulary 2
Two types of Investments 2
Considerations to be made for advice purposes 2
What is Diversification? 3
Diversification by asset type 3
Diversification by Sector 5
Geographical Diversification 5
Diversification through collective Investments 5
Fund of Funds 5

Risks 6
Risk VS Reward 6
Equity Risk Premium 6
Types of Risks 7
Pound Cost Averaging 7
Time Value of Money 8
Objective Considerations for Risk Purposes 8
Risk and the Client/Subjective Considerations 9
Products and Risks 9

Gearing 10

Volatility 10
Standard Deviation 10

An Illustration/Expected Range of Returns 11

Beta Factors 11
Alpha Factors 11

Liquidity 12

Macro Economics 12

Micro Economics 12

Inflation 13
Measuring Inflation 13
Retail Price Index 13
Underlying Rate of Inflation 13
Producer Price Index 13
National Average Earnings Index 13
Consumer Price Index 13
Calculating the Percentage change of Index over a time period 14
Effects of Inflation 14
Real Rate of Return 14

Interest Rates - Controlling Inflation 15

What Influences Interest Rates 15
Who Sets Interest Rates 15

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Interest Rates and Equities 15

Interest Rates and Fixed Interest Securities 16
Simple and Compound Interest 16
Interest Table 16
Repo Rate 16

Exchange Rate 16
What Influences Exchange Rates 16
Correcting a Balance of Trade Deficit 17
Exchange Rate & Investments 17
What is National Income? 17
Economic Growth and Gross Domestic Product 17

Fiscal Policy 18
Approach to Spending 18
Approach to Borrowing 18
Approach to Taxation 18

Balance of Payments 19

Business Cycles 19
The Four Cycles 19

Credit Crunch 20

Equity Prices 20
Cycle Theory 20

The Two Types of Market 21

Socially Responsible and Ethical Investments 21

Two Methods of Investment 21
Ethically Screened Funds 21
Responsible Investment 21
The Three Bodies 22
How to Positively Engage 22
Ethical Indices 22
Is there a Price to Pay for SRI 23
Income Tax 23
Classification of Income Types 23

Investment Income Tax 24

The Tax Band 24
Interest Accounts 24
Dividends 25
Tax Reducers 25

Life Assurance Policies 27

Qualifying Policy 28
Non-Qualifying Policy 28

Tax Strategy 28

Income Tax - Order of Priority 29

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How Applicable Income is Taxed 29

Capital Gains Tax 30

Capital Gains - Entrepreneur’s Relief 31
Capital Gains - Calculation 31
Capital Gains - Exempt 32
Inheritance Tax 32
IHT - Potentially Exempt Transfers 33
Gift With Reservation Rule 33
IHT - Exemptions 33
Estate Planning 35

Stamp Duty Reserve Tax 35

Stamp Duty Land Tax 35

Corporation Tax 35
Unit Trusts/ OEICs 36
Investment Trusts 36

Taxation Children 36

Personal Pension Plans 36

The Rest of the Fund 37
Where the Plan Holder Dies while drawing an Unsecured Pension 38
Salary Sacrifice 38
Personal Pension 38
Self Invested Personal Pensions 38
Group Personal Pensions 38

Choosing Investments 39
Investment Objectives 39
Early Encashment 39
Charges and Commission 39
Risk and Accessibility 41
Tax Treatment 41

Alternative Investments 41
Gold 41
Art 42
Antiques 42

Comparing Providers 42
Financial Strength 42
Quality of Service 42
Performance 42
Fund Selection 42
Flexibility/Options 43

UNIT 3 Questions 44

Contents
Unit 4 Investment Products:

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Deposit Accounts 46
Types of Deposit based Investments 46
Bank Accounts 46
Building Society Accounts 47
E. Accounts 47
Nation Savings & Investments Accounts 48
Sharia - Complaint Investment 49
Offshore Deposits 50
Credit Unions 50
Savings Gateway 51
Uses of Deposit Based Accounts 51

Fixed Interest Securities 52

The Three Methods of Dealing in Fixed Interest Securities 52
Auction 52
Tender 52
Direct Issue 52
Types of Fixed Interest Securities 52
Gilt Edged Securities 52
Figure - Gilts 53
Local Authority Stocks 56
Permanent Interest Bearing Shares 56
Perpetual Subordinated Bonds 56
Corporate Bonds 56
Fixed Interest/National Savings and Investment Products 57
Eurobonds 59
Uses of Fixed Interest Securities 59

The Money Supply 60

Shares 60
Figure - Types of Shares 61

Two Markets 61
Main Market 61
Alternative Market 62
Share Purchase 62
Blue Chip 62
Capitalisation 62
Nominal Value 62
New Issue 62
Financial Ratios 62
Gearing 62
Earnings per share 62
Dividend Yield 62
Price Earnings Ratio 63
Dividend Cover 63
Net Asset Value 63
Share Categories 64
Indices 64
UK Indices 64
International Indices 64
What Affects the Price of a Share 64
Dealing in Shares 65

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Employee Share Schemes 65

Save as You Earn Scheme 65
Share Incentive Plans 66
Three Methods of Distribution 66
SAYE, Share Incentive Plan and ISAs 67

Enterprise Investment Schemes 67

Venture Capital Trusts 67

Derivatives 68
Futures 68
Options 68
Two Types of Options 69
Two Styles of Options 69
Explaining Options in Relation to the Underlying Asset 69
Hedging/Speculating 69
Warrants 70
Corporate Warrants 70
Covered Warrant 70
Contracts for Difference 71
Unlisted Unquoted Securities 72
Private Equity 73
Hedge Funds 73

Other Asset Backed Investments 74

Residential Property 74
Calculating the Rental Yield 74
Commercial Property 75
Taxation of Directly Held Property 75
Rules for CGT Exemption in a Main Dwelling 75
Indirect Property Investment (Property Company Shares) 75

Collective (Pooled Investment) 76

Unit Trusts 76
Open-Ended 76
Two Types of Unit Trusts 76
Pricing of Units 77
Charges 77
Other Documentation 78
Share Exchange 78
The Investment Management Association 78
Methods of Managing the Trust 78
Total Expense Ratio 79
Undertaking of Collective Investments In Transferable Securities 79
Investment Restrictions 79
Fund of Funds 80
Multi Manager Funds 80
Total Return Funds 80
Absolute Return Funds 81
Tracker Funds 81
Open Ended Investment Companies 82
Investment Trusts 83

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Split Capital Investment Trusts 84

Taxation of Unit Trusts, OEICs and Investment Trusts 84
On Capital Gains Tax 84
Advantages of Pooled Investments 84
Pooled Investment Table 85

Equity ISAs 86

Life Assurance Policies 88

Qualifying Policies 88

Endowment Policy 89
The 5 Types of Endowment 89
Non Profit Endowment 89
Full With Profits Endowment 89
Low Cost Endowments 90
Unit Linked Endowments 90
Maximum Investment Plans 91
Unitised with Profit Endowment 91
Endowment Table 91
Traded Endowment Policies 92
Traded Life Policies 93

Friendly Societies 93

Investment Bonds 94
The Two Types of Invest Bonds 94
Guaranteed Income and Growth Bonds 95
Tax Treatment - Top Slicing 95

Capital at Risk Product 97

Precipe Bond 97

Stakeholder Products 97
Deposit Accounts 97
Medium Term Investment Product 97
Stakeholder Pension 97
The Child Trust Fund 98

Offshore Investments (Tax Havens) 98

Offshore Deposits Accounts 98
Offshore Funds 98
The Two Types of Funds 99
Offshore Bonds 99
Life Annuity 99
Types of Purchase Annuities 100

Sales Documentation 101

UNIT 4 Questions 102

Answers & Tables:

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Answers UNIT 3 104

Answers UNIT 4 106

Tax Table 109

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PLEASE NOTE: THIS IS A SAMPLE FROM THE ORIGINAL

COPY. PAGES WILL BE MISSING

UNIT 3

PRINCIPLES OF INVESTMENT

Investments

The reason that people invest is to make the money grow.

Investments can be placed into three broad categories:
1) Deposits
2) Fixed Interest
3) Asset Backed

Deposits
• Deposits are usually held in Banks, Building societies and National
Savings and Investment (NS &I) accounts.
• They are safe (no risks) and easily accessible.
• They are usually regarded as emergency funds or rainy day funds.
• It is generally a good idea to have 3-6 months gross income in a
deposit account.
• Cash Individual Savings Accounts (ISAS) are also regarded as deposit
- based investments.

Fixed Interest
• These funds are used to provide a fixed level of interest, and have the
possibility of capital growth.
• Examples are Gilt Edged Securities (gilts), Local authority bonds,
Corporate bonds, Permanent Interest Bearing Shares (PIBS) and
certain NS&I bonds.
• They carry relatively low risks, particularly with gilts, as the
Government is unlikely to fail. However, some fixed interest securities
e.g corporate bonds could carry a higher risk, because the issuing
institution could fail.
• The NS&I are also relatively safe, as the capital remains secure
because it is deposit based.

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Personal Pension Plans (PPP)

• It is possible to contribute to a Pension Fund at any age.
• However, the contributions can only be crystallized at age 50 or at
Age 55 after 2010.
• The funds are invested for growth so the final benefits are not
guaranteed.
• Where the investment under performs, it is the responsibility of the
individual to provide additional funds for support if required at retirement.
• The fund grows income and CGT free, although subject to the 10% tax
on
dividend which is not reclaimable.
• Employers can also make contributions to the fund and claim it as an
expense against profits.
• Controlling directors and close relatives may be questioned.
• Contributions to the fund are tax free at an initial rate of 20%.
• HRT can claim extra 20% back from Inland Revenue.
• £3,600--------------Minimum contribution (parents can pay this for their
kids).
• £30k, £40k, £50k----Can contribute 100% of UK earnings.
• £245,000--------Maximum in a tax year.
• £1.75M--------- Maximum life time contribution (2009/10)
• Where combined contribution exceeds the annual allowance, the
individual will pay income tax at 40% on the excess.
• Excess of the fund over the life –time allowance is taxed at 55% if
taken as a lump sum, and taxed at 25% if taken out as an income.
• At age 55 (April 2010), the individual is allowed to take 25% of the fund
as a lump sum, tax free.
• The rest of the fund can be used to secure an annuity or withdrawn
directly from the fund (see figure below).

The Rest of the Fund

Purchase of Lifetime Annuity
The Rest of the fund Unsecured Pension

Must end before age 75 Income withdrawal cannot exceed

120% of the amount the pension
would have accrued from a normal
annuity

Life Annuity
Alternatively Secured Pension (ASP).
Income withdrawal. No minimum but cannot
exceed 65% to 90% of normal annuity for
over 75 year olds.

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• Pension income is taxed in the same way as earned Income (20, 40%).
• If plan holder dies before taking benefits, the fund can be paid as a
lump –sum.
• Where the fund was written in trust, the lump sum payable upon death
is free from IHT.
• If the plan holder dies after taking the pension and had a
widow’s/dependant pension, some or all of the annuity they received will
continue to be paid to the widow/dependant (50%, 66.67%, 100%,
depends on pensioner’s provision)

Where the Plan holder dies while drawing from an

Unsecured Pension

Where an unsecured pension is used the fund stays “Live”

Lump – sum 35% tax Annuity no tax but income

Income withdrawal; no tax, but
charge taxable
income withdrawn continues to be
taxable.

*Under an unsecured pension the maximum amount that can be withdrawn

cannot exceed 120% a person could have withdrawn under an annuity for
their age.

Figure - Types of Shares

Receive Dividends and have

voting rights
The missing dividend is
accumulated and paid when the
Cumulative firm can afford to do so
Ordinary
Receive fixed dividend & limited
Shares Preference Participating share of the firm’s profits

Dividends are lower than on

Warrants Convertible normal preference shares, but can
be converted into an ordinary
If there are no profits the preference share at a fixed price. and date
dividend will not be paid

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Right to buy ordinary shares at a

specific price and date. Do not
receive dividends

Methods of Managing the Trust

Active Management – The fund is managed actively with the

manager investing at his discretion (up to100% equities).
A minimum of 10% of the fund must be in UK equities.
Cautious Management – A maximum of 60% of a cautiously
managed fund can be held in equities, with at least 50%
being in Pounds or Euros.
Protected (guaranteed) Funds – The fund is guaranteed to return a
set amount to the investor. This could also be attained
through an investment strategy.

Total Expense Ratio (TER)

• Ratio that represents the percentage of the assets of the fund that are
swallowed up in annual charges e.g. management, trustee, custodian,
auditors and registration fees.
• It represents the impact of charges on fund performance.

TER = Total net operating expenses x Management fee for %

Average Total fund

• The TER is a better measure of charges than looking at the charges

individually.
• When comparing the TER of unit trusts, OEICS and investment trusts, the
TER of the investment trust is the lowest (Lipper analysis).

Yield
Calculation – Annual Dividends minus Annual Management Charge

Example – Unit trusts - Calculating the Yield

A unit trust offers a price of £1.60 per unit and forecasts earnings of 7pence per unit?
What is the Yield?
7 x 100 =
160

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*A unit trust that is geared towards capital growth has a low or zero yield.

Undertaking of Collective Investment in Transferable Securities

(UCITS)
• The European directive that enables cross border marketing of unit
trusts. The UCIT allowed investment in bonds and equities.
• The latest updated version is the UCITS 111, which came into being in
2002. It allows the fund managers to use a wider range of asset
classes, such as derivatives (futures, options, warrants, contracts for
difference), cash and deposits.
• Most funds that met the previous UCIT requirement, also meet the
UCIT 111 requirement.
• The use of derivatives is particularly pertinent where the fund manager
uses total and absolute return funds to achieve performance
(discussed below).

Investment Restrictions
1. The Unit trust is allowed to hold a maximum of 10% of the total fund
value in the shares of any single quoted firm. The trust is permitted to
hold a maximum of 4 separate shares this limit.
2. A 5% (of total fund value) limit is also set for share holdings in any
other firm.
3. This indicates that a unit trust cannot invest in less than 16 companies.
(See illustration that follows).
4. A unit trust is permitted to hold a maximum of 10% of any one class of
a firm’s voting shares.
5. Where the trust is set up as a UK gilt unit trust, it must invest in a
minimum of six different stock issues. Moreover, no stock holding must
be more than 30% of the fund.
6. The unit trust can borrow only in the short term (10% of fund assets
against definite inflows of capital). Long- term borrowing is not
permitted.

An Illustration – Unit trusts

1) Maximum of 10% holding in a maximum of 4 firms, gives 40% of their
holding (10 x 4).
2) 100% - 40% = 60% (leaves them with 60% of their holdings)
3) Maximum of 5% holdings in any other firm 60% divided by 5% = 12
firms
4) 4 firms + 12 firms = 16 firms.

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Fund of Funds

• A fund where the risk is spread, even further than a single collective
investment, which indicates increased diversification.
• A fund is Fettered, where it only invests in internal funds (offered by
host provider).
• A fund is Unfettered, where it invests in external funds.
• Typical charges will be an annual management fee of around 0.75%, in
addition to the charges that apply to each individual fund.
• The problem is each management fund has its own mandate (so there
is lack of control).

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