Hi, First exam paper attempt, and a few questions, which I am hopeful you are able to help with. Q1 o could a possible deviation be the size of issues of the bonds invested in and therefore the marketability of the assets invested in. This would impact the volatility of prices in volatile markets. o Would a possible deviation be the sustainability of the assets and therefore the impact of transition risk on prices and price volatility. o Could we mention that the outperformance measure is not clear, i.e. it does not indicate if outperformance is required on a monthly/yearly basis. Q5 o Solutions state: As both UK index-linked gilts and US Treasury Inflation-Protected Securities have T +1 settlement cycles, it is possible (but unlikely) that there would be significant out of market exposure o Is this something that we would be expected to know, I do not remember seeing this detail in the course. o What is meant by out of market exposure? o Could currency risk be a possible problem of the switch or a cost associated with hedging currency risk? Q7 o Where in the notes will I find information on the key principles underlying the financial services legislative framework? o I find the principal aims in Ch 8 o The principles underlying the legislative framework for investment management and securities industry are in Ch 9 & 10, is it these that are being referred to? Q8 o Why will credit rating agencies care about EPS growth and quality of profitability? Surely they would just care about interest cover, and the stability of PBIT. o Why will both focus on cashflow generation vs book profitability? I understand why they would both care about cashflow generation but why vs book profitability? Many thanks, Rachael
Hi I have tried to add a few comments below. For questions about that alternative ideas would have scored marks, you would need to refer to the IFoA as they set and mark the exam. My thoughts are as follows: could a possible deviation be the size of issues of the bonds invested in and therefore the marketability of the assets invested in. This would impact the volatility of prices in volatile markets. o Would a possible deviation be the sustainability of the assets and therefore the impact of transition risk on prices and price volatility. o Could we mention that the outperformance measure is not clear, i.e. it does not indicate if outperformance is required on a monthly/yearly basis. The solutions focuses on the clients aims which revolve around duration and "other restrictions" which are not specified. In that you dont know whether the other restrictions could include sustainability or marketability, my feeling is that it would be better to go down the route in the solutions here. Namely focus on the difference in duration primarily, and the key incentives set in the performance targets. o Solutions state: As both UK index-linked gilts and US Treasury Inflation-Protected Securities have T +1 settlement cycles, it is possible (but unlikely) that there would be significant out of market exposure o Is this something that we would be expected to know, I do not remember seeing this detail in the course. No - this was something that was covered (to a small extent) in ST5, but not in SP5. o What is meant by out of market exposure? When conducting a switch, a trader has to sell what he/she has, and then when the cash is available, buy the things he/she wants to hold. If there is a time delay, the trader can be in cash for a period - it may be as little as a few hours. But if the market moves suddenly that can lead to a large loss which is "out of market" exposure. o Could currency risk be a possible problem of the switch or a cost associated with hedging currency risk? Currency risk would be where the portfolio ends up with a different currency exposure. But there is nothing in the question that suggests that this may be a major issue, particularly where swaps are used, as the swaps can be put in place very quickly and designed to gain whatever currency exposure is required. Where in the notes will I find information on the key principles underlying the financial services legislative framework? o I find the principal aims in Ch 8 These are the same aims. o The principles underlying the legislative framework for investment management and securities industry are in Ch 9 & 10, is it these that are being referred to? Yes - the examiner takes the principles that start in Chapter 9 section 1.1 and then applies these to the specific situation described in the question. o Why will credit rating agencies care about EPS growth and quality of profitability? Surely they would just care about interest cover, and the stability of PBIT. Well, they certainly would care MORE about security issues such as income and asset cover. But since some bonds have 10 or 15 year life, you might also be interested in the subjective aspects of determining how the company is going to progress and succeed over time (in a similar way to an equity fundamental analyst). But as you say, security would be first priority. I think the examiner just tried to cover as many ideas as he/she could , which might be relevant. o Why will both focus on cashflow generation vs book profitability? I understand why they would both care about cashflow generation but why vs book profitability? I think "book profitability" here refers to the published profits in their shareholder accounts. Anyone investing in a company (shares or bonds) would consider the published profits, and the history of those profits. But would have an eye on the fact that they can be a bit subjective (term of depreciation, what is written off and what is not ...) So looking at the cashflow would also be useful, and comparing it to the profitability. But I think this is just saying that the published profits would be useful for both equity and bond analysts.
