Question 2 Table 2 below shows five alternative ways to invest a £100,000 lump sum. Explain how each of the investments might be exposed to the three high-level risks: capital risk, income risk and liquidity risk. Discuss ho
Table 2 below shows five alternative ways to invest a £100,000 lump sum. Explain how each of the investments might be exposed to the three high-level risks: capital risk, income risk and liquidity risk. Discuss how your assessment of each investment might change if the expected inflation rate fell from 4% to 2% a year.
Table 2: Alternative ways of investing a £100,000 lump sum
Investment Key facts
Cashstream+ account Instant savings account with NewBank, a former UK building society turned into a commercial bank.
Nominal interest rate: 2% a year, variable.
From the bank’s income statement: proportion of total bank income from net interest = 23%.
Gold Star Saver account Fixed-term savings account with Queen’s Bank, one of the oldest high-street banks in the country.
Interest rate: 1.25% a year, guaranteed for four years.
From the bank’s income statement: proportion of total bank income from net interest = 65%.
Gilt: 3% Treasury 2020 Government bonds with a redemption date of 2020.
Interest rate: 3% a year, guaranteed until redemption of bond in 2020.
eSuits shares Shares in rapidly growing company eSuits, a new e-commerce outfit selling bespoke gentlemen’s suits online, also listed on the London Stock Exchange.
No dividend yet. Annual profits predicted to grow by 8% pa (might pay dividend later). Standard deviation of annualised return: 30%.
Farmhouse in France Second home and holiday-let proposition, purchase price £300,000; mortgage obtained for £250,000 over 20 years at 6% variable interest; return expected to average 25% a year.
Knowledge and understanding
• Components and organisation of the financial services industry, and the structure of debt/monetary relationships (e.g. the role of intermediaries, types of bank, role of government).
• Risk and return, and how it relates to different types of investment class (cash, bonds, stocks, property, derivatives), and composite investment product (pensions, unit trusts).
• The rudimentary mechanics of building a personal investment portfolio, including key financial and economic concepts relevant to investment planning (e.g. credit risk, systemic risk, inflation risk).
• Describe and distinguish between different types of investment class.
• Interpret financial information and data in its original form, as published in the financial press and on the internet.
• Use and interpret statistical data, including tables, charts, ratios and correlation, using appropriate software.
• Communicate ideas effectively, including in written essays and reports.
Practical and professional skills
• Demonstrate the use of relevant techniques and tools related to investment and finance, including being able to interpret relevant financial data presented in a variety of numerical and data formats.
• Before attempting Questions 1b and 1c you are recommended to first practise using the Present Value & Discount Rate segment of the Investment Tool in the activities provided in Online Unit 2. Note that marks will be given for convincing explanations of your entries in the Investment Tool, even if your answers are not precisely correct.
• For Question 1b, the relevant information for calculating the rate of return on the bonds and shares is all contained in the question, including Table 1. You can round your answers to two decimal places but you are required to use the full set of decimals when entering numbers into the Investment Tool.
• For Question 1d, you could, as part of your answer, draw on some historical examples.
• For Question 2 you should present an essay in continuous prose, structuring your answer with a short introduction and conclusion. Make sure you clearly define the three risks and consider each of them in relation to the five investment options listed. You may then reflect on how inflation can contribute to these risks, in order to reach a judgement about how the performance of each investment might be affected by a fall in inflation.
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