Financial Products and Asset Classes
This domain tests whether you can classify a product, explain its risk and return drivers, and calculate the metrics examiners favour. Questions often combine a definition with a number: a yield, a conversion premium, a discount to NAV.
Equities
- Ordinary shares carry voting rights, dividends and a residual claim. Preference shares pay a fixed dividend, rank ahead of ordinaries and are often non-voting; cumulative preference dividends roll up if unpaid.
- Core metrics: dividend yield = DPS ÷ price; P/E = price ÷ EPS; EPS = earnings ÷ shares in issue.
Fixed income
- Gilts and corporate bonds pay coupons and redeem principal. Gilts pay semi-annually. The clean price excludes accrued interest; the dirty price includes it. Redemption yield reflects coupon, capital gain or loss to maturity and reinvestment; duration measures sensitivity to yield changes.
- Convertibles combine a bond floor with an equity option.
Funds and packaged products
- OEICs and unit trusts are open-ended and priced at NAV. Investment trusts are closed-ended companies whose shares can trade at a premium or discount to NAV and may use gearing.
- ETFs trade intraday at a market price that tracks NAV via authorised participants. PRIIPs requires a key information document for packaged products.
Money market and derivatives
- Treasury bills, commercial paper and certificates of deposit are short-term instruments. Futures, options and swaps are derivatives used to hedge or take directional risk.
Worked example
A convertible bond with £1,000 nominal and a conversion price of £5.00 converts into 200 shares. The bond trades at £1,150 and the share price is £4.80, so conversion value = 200 × £4.80 = £960. Conversion premium = (£1,150 − £960) ÷ £960 = 19.8%. The investor is paying nearly 20% over parity for the equity option.
Traps that cost marks
- Confusing nominal value with market value when computing yields.
- Forgetting that gilts pay semi-annual coupons, which changes accrued interest.
- Treating an investment trust discount as a risk-free gain, or ignoring gearing.
- Assuming an ETF always trades exactly at NAV; premiums and discounts occur.