Financial Markets, Instruments and Investment Vehicles
This domain checks whether you can describe what is being traded, how it is priced and how it settles - and whether you can spot when a client's stated objective is mismatched with the instrument chosen.
Instruments
- Equities carry residual ownership, votes and discretionary dividends. Preference shares rank ahead for dividends but usually carry no vote.
- Bonds pay a fixed coupon; price and yield move inversely. A gilt is UK government debt; a corporate bond adds credit spread. Duration measures sensitivity to yield changes.
- Collective schemes. An OEIC or unit trust is open-ended: units are created and cancelled and priced at net asset value. An investment trust is closed-ended and listed, so it can trade at a premium or discount to NAV and may gear.
- Derivatives - futures, options, swaps - transfer or reshape risk rather than ownership. UK equity settlement runs through CREST.
Worked example
A client holds a bond with modified duration of 6.0. Yields rise 50 basis points. Estimate the price move and explain it. Reasoning: percentage price change ≈ −modified duration × change in yield = −6.0 × 0.005 = −3.0%, roughly £3,000 on a £100,000 holding, before convexity. Duration is a first-order approximation: it overstates the fall for small yield rises and understates the gain when yields fall, so an exact figure needs revaluation.
Traps that cost marks
- Confusing coupon with yield: a bond bought above par yields less than its coupon.
- Assuming an investment trust is priced at NAV. It trades at whatever the market pays.
- Believing every derivative position caps loss at the premium - that holds for bought options, not for futures or written options.