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CISI Financial Markets study materials
CISI Financial Markets study resources

CISI Financial Markets practice questions

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Question 1Financial Markets Environment

Which type of market involves the issuing of new securities by a company to raise capital for the first time?

  1. The secondary market
  2. The money market
  3. The derivatives market
  4. The primary market Correct answer.

Explanation

The primary market is where new securities are created and sold by issuers to investors, raising fresh capital for the issuer. The secondary market trades existing securities between investors.

Question 2Financial Markets Environment

A UK government bond is commonly known by which name?

  1. Debenture
  2. Commercial paper
  3. Gilt Correct answer.
  4. Treasury bill

Explanation

UK government bonds are called gilts, reflecting their historically gilt-edged certificates. Debentures are corporate debt, commercial paper is short-term corporate borrowing, and treasury bills are short-dated government instruments.

Question 3Financial Markets Environment

Which regulatory body is the conduct regulator for financial services firms in the United Kingdom?

  1. The Bank of England
  2. The Prudential Regulation Authority
  3. The Financial Conduct Authority Correct answer.
  4. The European Securities and Markets Authority

Explanation

The FCA is the UK's conduct regulator, responsible for protecting consumers and ensuring market integrity. The PRA focuses on prudential soundness of banks and insurers.

Question 4Financial Markets Environment

Which of the following best describes a share?

  1. A loan made to a company
  2. A contract to buy an asset in the future
  3. A short-term debt instrument issued by a government
  4. A unit of ownership in a company Correct answer.

Explanation

A share represents equity ownership in a company, giving the holder a claim on profits and residual assets. It is not a debt instrument or a derivative contract.

Question 5Financial Markets Environment

What is the main purpose of a stock exchange?

  1. To guarantee returns for investors
  2. To provide a regulated marketplace for buying and selling securities Correct answer.
  3. To issue currency on behalf of the government
  4. To set interest rates for the economy

Explanation

A stock exchange provides a regulated venue where securities can be traded, offering liquidity and price discovery. It does not set monetary policy, issue currency, or guarantee returns.

Question 6Financial Markets Environment

Which instrument is a short-term, unsecured promissory note issued by a company to raise working capital?

  1. Corporate bond
  2. Warrant
  3. Preference share
  4. Commercial paper Correct answer.

Explanation

Commercial paper is a short-term unsecured debt instrument issued by companies, typically with maturities under a year. Corporate bonds are longer-term, preference shares are equity, and warrants are option-like securities.

Question 7Financial Markets Environment

What does the term 'liquidity' refer to in a financial market?

  1. The total market value of a company's shares
  2. The interest rate paid on a bond
  3. The ease with which an asset can be bought or sold without significantly affecting its price Correct answer.
  4. The credit rating assigned to a bond issuer

Explanation

Liquidity describes how quickly and cheaply an asset can be converted into cash at or near its fair value. It is distinct from market capitalisation, coupon rates, and credit ratings.

Question 8Financial Markets Environment

Which of the following is a derivative instrument?

  1. A government bond
  2. A futures contract Correct answer.
  3. A corporate share
  4. A certificate of deposit

Explanation

A futures contract is a derivative because its value is derived from an underlying asset such as a commodity or index. Bonds, shares, and certificates of deposit are cash instruments.

Question 9Financial Markets Environment

A company wishes to raise long-term debt capital without diluting existing shareholders. Which instrument is most appropriate?

  1. Issuing a rights issue
  2. Paying a special dividend
  3. Issuing new ordinary shares
  4. Issuing a corporate bond Correct answer.

Explanation

Corporate bonds raise debt capital and create a creditor relationship without diluting ownership. Issuing shares or a rights issue both increase equity and dilute existing holders.

Question 10Financial Markets Environment

An investor buys a bond at a price below its face value and holds it to maturity. What return component does this represent?

  1. A coupon payment
  2. A dividend yield
  3. A redemption penalty
  4. A capital gain from buying at a discount Correct answer.

Explanation

Buying below face value and redeeming at par produces a capital gain, often called the discount accretion. Coupons are periodic interest payments, distinct from this price gain.

Question 11Financial Markets Environment

Which market participant typically acts as an intermediary, quoting both buy and sell prices to provide liquidity?

  1. A retail investor
  2. A pension fund
  3. A market maker Correct answer.
  4. A sovereign wealth fund

Explanation

Market makers continuously quote bid and offer prices, standing ready to trade and thereby providing liquidity. Investors and funds are typically price takers rather than liquidity providers.

Question 12Financial Markets Environment

What is the primary role of a central bank in financial markets?

  1. To provide investment advice to retail clients
  2. To implement monetary policy and maintain financial stability Correct answer.
  3. To set the coupon on corporate bonds
  4. To underwrite corporate bond issues

Explanation

Central banks implement monetary policy and safeguard financial stability, including acting as lender of last resort. They do not underwrite corporate issues or advise retail clients.

Question 13Financial Markets Environment

An investor holds a bond with a fixed coupon while market interest rates rise. What is the most likely effect on the bond's price?

  1. The price falls Correct answer.
  2. The price rises
  3. The price is unaffected
  4. The coupon is automatically increased

Explanation

Bond prices and market yields move inversely. When market interest rates rise, the fixed coupon becomes less attractive, so the bond's price falls to align its yield with prevailing rates.

Question 14Financial Markets Environment

Which of the following best describes an 'over-the-counter' (OTC) market?

  1. A market limited to government securities only
  2. A market where only retail investors may trade
  3. A decentralised market where trades are negotiated directly between parties Correct answer.
  4. A centralised exchange with a single order book

Explanation

OTC markets are decentralised, with trades negotiated bilaterally rather than through a central exchange order book. They are not restricted by asset type or investor category.

Question 15Financial Markets Environment

A company's share price is £4.00 and it has 50 million shares in issue. What is its market capitalisation?

  1. £50 million
  2. £2 billion
  3. £20 million
  4. £200 million Correct answer.

Explanation

Market capitalisation equals share price multiplied by shares in issue: £4.00 × 50 million = £200 million. This measures the total equity value of the company.

Question 16Financial Markets Environment

Which type of fund issues a fixed number of shares that trade on an exchange like a stock?

  1. A hedge fund
  2. An open-ended unit trust
  3. A closed-ended investment company Correct answer.
  4. A money market fund

Explanation

Closed-ended investment companies issue a fixed number of shares that are listed and traded on an exchange. Open-ended funds create and cancel units in response to investor demand.

Question 17Financial Markets Environment

Why do regulators require firms to 'know your customer' (KYC)?

  1. To set the firm's marketing strategy
  2. To guarantee investment returns
  3. To prevent money laundering and terrorist financing Correct answer.
  4. To determine the firm's tax liability

Explanation

KYC requirements are part of anti-money-laundering rules, helping firms verify client identity and detect suspicious activity. They do not concern returns, marketing, or tax.

Question 18Financial Markets Environment

An investor sells a security they do not own, borrowing it to do so, hoping to buy it back later at a lower price. What is this strategy called?

  1. Short selling Correct answer.
  2. Going long
  3. Hedging
  4. Arbitrage

Explanation

Short selling involves selling borrowed securities to profit from an expected price decline, then repurchasing to return them. Going long means buying an asset expecting a rise.

Question 19Financial Markets Environment

Which of the following is a key difference between equity and debt finance?

  1. Equity holders always receive fixed interest payments
  2. Equity holders have ownership rights, while debt holders are creditors Correct answer.
  3. Equity holders rank ahead of debt holders on liquidation
  4. Debt holders vote at the company's annual general meeting

Explanation

Equity represents ownership with residual claims, while debt holders are creditors entitled to contractual payments. Debt holders generally rank ahead of equity holders on liquidation.

Question 20Financial Markets Environment

A government issues a bond with a face value of £1,000 and a coupon of 4%. What annual interest will the holder receive?

  1. £400
  2. £40 Correct answer.
  3. £4
  4. £1,040

Explanation

Annual coupon interest equals the coupon rate multiplied by face value: 4% × £1,000 = £40. This is the fixed annual payment before considering price.

Question 21Financial Markets Environment

Which of the following best explains why secondary markets are important to primary markets?

  1. They eliminate the need for regulation
  2. They set the coupons on new bonds
  3. They remove all investment risk
  4. They provide liquidity that makes investors more willing to buy new issues Correct answer.

Explanation

An active secondary market lets investors sell holdings, providing liquidity and price discovery. This confidence encourages participation in primary issuance, though it does not remove risk or set coupons.

Question 22Financial Markets Environment

An investor expects interest rates to fall and wants to maximise capital gains from a fixed-coupon bond. Which bond would typically offer the greatest price sensitivity to a rate change?

  1. A long-dated bond with a low coupon Correct answer.
  2. A short-dated bond with a high coupon
  3. A short-dated bond with a low coupon
  4. A money market instrument maturing in one month

Explanation

Price sensitivity (duration) increases with longer maturity and lower coupons. A long-dated, low-coupon bond has the highest duration and therefore the greatest price response to rate changes.

Question 23Financial Markets Environment

A bond is trading at a price above its face value. Which statement is most likely true?

  1. Its yield to maturity is above its coupon rate
  2. Its coupon rate is zero
  3. Its yield to maturity is below its coupon rate Correct answer.
  4. It is in default

Explanation

When a bond trades above par, the investor pays a premium, so the yield to maturity is lower than the coupon. A yield above the coupon would correspond to trading at a discount.

Question 24Financial Markets Environment

Why might a company prefer to raise capital through a rights issue rather than a public offer of new shares?

  1. It avoids any dilution of existing shareholders
  2. It guarantees a higher issue price
  3. It removes the need for a prospectus entirely
  4. It allows existing shareholders to subscribe at a discount, protecting against dilution Correct answer.

Explanation

A rights issue offers existing holders the chance to buy new shares, usually at a discount, so they can avoid dilution by participating. It does not eliminate dilution for non-participants or guarantee pricing.

Question 25Financial Markets Environment

Two bonds have the same maturity and coupon, but one is issued by a highly rated sovereign and the other by a lower-rated corporate. What primarily explains the yield difference?

  1. A difference in the currency of issue
  2. A difference in coupon payment dates
  3. A credit risk premium demanded by investors Correct answer.
  4. A difference in the exchange on which they trade

Explanation

Lower-rated issuers must offer higher yields to compensate investors for greater default risk, creating a credit spread. Coupon dates, currency, and venue do not primarily drive this yield gap.

Question 26Financial Markets Environment

Which body in the UK is responsible for regulating the conduct of financial firms to ensure fair treatment of customers?

  1. The Bank of England (BoE)
  2. The Payment Systems Regulator (PSR)
  3. The Financial Conduct Authority (FCA) Correct answer.
  4. The Prudential Regulation Authority (PRA)

Explanation

The FCA is the conduct regulator, focused on protecting consumers and ensuring market integrity. The PRA and BoE focus on prudential regulation and financial stability, while the PSR oversees payment systems.

Question 27Financial Markets Environment

What is the primary purpose of a stock exchange's listing rules?

  1. To guarantee investors a minimum return
  2. To provide loans to listed companies
  3. To set the monetary policy for the country
  4. To ensure companies meet certain standards before their shares can be traded Correct answer.

Explanation

Listing rules are designed to ensure that companies seeking a listing meet minimum standards of disclosure, governance, and free float, thereby protecting investors and maintaining market integrity. They do not set monetary policy, guarantee returns, or provide loans.

Question 28Financial Markets Environment

Which type of market is characterised by trading of securities that are newly issued by companies to raise capital?

  1. Derivatives market
  2. Secondary market
  3. Primary market Correct answer.
  4. Money market

Explanation

The primary market is where new securities are issued and sold to investors for the first time, raising capital for the issuer. The secondary market involves trading of existing securities between investors.

Question 29Financial Markets Environment

What does the term 'spread' refer to in the context of trading?

  1. The ratio of a company's debt to equity
  2. The time taken to settle a trade
  3. The total cost of a transaction including commissions
  4. The difference between the highest bid and lowest offer price Correct answer.

Explanation

The spread is the difference between the bid (buy) and ask (sell) prices quoted by a market maker, representing a transaction cost for traders. It is not the total cost, settlement time, or a financial ratio.

Question 30Financial Markets Environment

An investor buys a share for £10 and sells it one year later for £12, receiving no dividends. What is the capital gain?

  1. £10
  2. £2 Correct answer.
  3. £12
  4. £1

Explanation

Capital gain is the profit from selling an asset for more than its purchase price. Here, £12 - £10 = £2.

Question 31Financial Markets Environment

Which of the following best describes 'systemic risk'?

  1. The risk of a change in interest rates
  2. The risk that a single company fails
  3. The risk that a borrower defaults on a loan
  4. The risk that a failure in one part of the financial system spreads to others Correct answer.

Explanation

Systemic risk is the risk that the failure of one institution or market can trigger a chain reaction, potentially causing widespread instability in the financial system. It is distinct from idiosyncratic, interest rate, or credit risk.

Question 32Financial Markets Environment

What is the main function of a clearing house in a derivatives market?

  1. To set the price of derivatives contracts
  2. To provide investment advice to traders
  3. To act as a central counterparty and guarantee settlement Correct answer.
  4. To issue the underlying securities

Explanation

A clearing house acts as an intermediary between buyers and sellers, becoming the central counterparty to each trade and guaranteeing performance, thereby reducing counterparty risk. It does not set prices, advise, or issue securities.

Question 33Financial Markets Environment

Which of the following is a characteristic of a money market instrument?

  1. Equity ownership in a company
  2. Long maturity and high credit risk
  3. Short maturity and high liquidity Correct answer.
  4. Derivative contract based on commodities

Explanation

Money market instruments are short-term, highly liquid debt securities with low credit risk, such as Treasury bills and commercial paper. They are not long-term, equity, or derivatives.

Question 34Financial Markets Environment

A company issues a bond with a face value of £1,000 and a coupon rate of 5%. If the bond is currently trading at £950, what is the current yield?

  1. 10.00%
  2. 4.75%
  3. 5.26% Correct answer.
  4. 5.00%

Explanation

Current yield is the annual coupon payment divided by the current market price. Annual coupon = 5% of £1,000 = £50; £50 / £950 ≈ 5.26%.

Question 35Financial Markets Environment

Which of the following best explains why regulators impose capital requirements on banks?

  1. To encourage banks to lend more
  2. To ensure banks have enough capital to absorb losses and protect depositors Correct answer.
  3. To prevent banks from issuing shares
  4. To maximise bank profits

Explanation

Capital requirements ensure banks maintain a sufficient buffer of capital to absorb unexpected losses, thereby protecting depositors and maintaining financial stability. They are not designed to maximise profits, encourage lending, or restrict share issuance.

Question 36Financial Markets Environment

What is the role of a market maker?

  1. To regulate trading activities
  2. To set official interest rates
  3. To advise clients on investment strategy
  4. To buy and sell securities on their own account to provide liquidity Correct answer.

Explanation

Market makers quote bid and ask prices and trade on their own account to ensure liquidity and facilitate trading. They do not typically advise clients, regulate, or set interest rates.

Question 37Financial Markets Environment

Which of the following is an example of a financial intermediary?

  1. A government issuing bonds
  2. A stock exchange matching orders
  3. A retail investor buying shares directly
  4. A commercial bank accepting deposits and making loans Correct answer.

Explanation

A financial intermediary channels funds between savers and borrowers; a commercial bank does this by taking deposits and lending. Retail investors, exchanges, and governments are not intermediaries in this sense.

Question 38Financial Markets Environment

An investor is comparing two bonds with the same maturity and coupon. Bond A is highly liquid and trades frequently; Bond B is illiquid and rarely trades. Which bond is likely to offer a higher yield and why?

  1. Bond A, because its price is more volatile
  2. Bond B, because investors demand a premium for illiquidity Correct answer.
  3. Both bonds will have the same yield because their coupons and maturities are identical
  4. Bond A, because its liquidity makes it more attractive

Explanation

Illiquid bonds typically offer higher yields to compensate investors for the difficulty of selling them quickly without a price concession. This liquidity premium means Bond B should have a higher yield than Bond A.

Question 39Financial Markets Environment

Which of the following best describes the 'yield curve'?

  1. A graph showing the relationship between bond yields and maturities Correct answer.
  2. A line showing the trade-off between risk and return for equities
  3. A graph showing a company's earnings over time
  4. A curve representing the demand for money

Explanation

The yield curve plots the yields of bonds (usually government bonds) against their maturities, illustrating the term structure of interest rates. It is not related to earnings, money demand, or equity risk-return.

Question 40Financial Markets Environment

A central bank decides to raise interest rates to combat inflation. Which of the following is the most likely immediate effect on the bond market?

  1. Bond prices rise because inflation erodes the real value of debt
  2. Bond prices fall because yields rise Correct answer.
  3. Bond prices rise because yields fall
  4. Bond prices remain unchanged because coupon payments are fixed

Explanation

Bond prices and yields are inversely related. When interest rates rise, newly issued bonds offer higher yields, making existing bonds with lower coupons less attractive, so their prices fall to bring their yields in line with the market.

Question 41Securities and Investments

A UK government bond that pays a fixed rate of interest twice a year is known as which of the following?

  1. A gilt Correct answer.
  2. A certificate of deposit
  3. A treasury bill
  4. A commercial paper

Explanation

Gilts are UK government securities, and conventional gilts pay a fixed coupon, typically semi-annually. Treasury bills are short-term discount instruments rather than coupon-paying bonds.

Question 42Securities and Investments

An investor buys a share for £4.00 and sells it one year later for £4.60, receiving no dividend. What is the holding period return?

  1. 60.0%
  2. 15.0% Correct answer.
  3. 13.0%
  4. 11.5%

Explanation

Holding period return equals the capital gain divided by the initial price: (4.60 − 4.00) / 4.00 = 0.15, or 15%. No income was received, so only the price change contributes.

Question 43Securities and Investments

Which of the following best describes the role of a market maker in an equity market?

  1. To guarantee investors against losses on their holdings
  2. To continuously quote bid and offer prices and trade at those prices Correct answer.
  3. To set the official closing price for each listed company
  4. To audit the financial statements of listed companies

Explanation

A market maker provides liquidity by quoting two-way prices at which it will buy and sell, standing ready to trade with other participants. It does not guarantee investor returns or set official prices unilaterally.

Question 44Securities and Investments

A company issues new shares to existing shareholders in proportion to their current holdings, usually at a discount. This is known as which of the following?

  1. A rights issue Correct answer.
  2. A scrip dividend
  3. A stock split
  4. A share buyback

Explanation

A rights issue offers existing shareholders the right to buy new shares pro rata to their holding, typically at a discount to the market price. It is a way for the company to raise new equity capital.

Question 45Securities and Investments

Which of the following is a key characteristic of a preference share?

  1. It is redeemable at par on a date fixed at issue in all cases
  2. It normally carries a fixed dividend paid before ordinary dividends Correct answer.
  3. It always carries voting rights superior to ordinary shares
  4. Its dividend must by law rise each year with inflation

Explanation

Preference shares typically pay a fixed dividend that ranks ahead of ordinary dividends, which is their main attraction to investors. Voting rights are usually limited and dividends are not index-linked.

Question 46Securities and Investments

A bond has a coupon of 5% and is currently trading at a price above its par value. Which statement is correct?

  1. Its yield to maturity equals 5%
  2. Its yield to maturity is below 5% Correct answer.
  3. Its yield to maturity is above 5%
  4. Its current yield is above 5%

Explanation

When a bond trades above par, the investor pays more than face value and also suffers a capital loss at redemption, so the yield to maturity falls below the coupon rate. The price premium offsets the coupon income.

Question 47Securities and Investments

An investor expects interest rates to fall sharply over the next year and wants to maximise capital gain from a fixed income holding. Which bond is most suitable?

  1. A floating rate note
  2. A long-dated bond with a low coupon Correct answer.
  3. A money market deposit
  4. A short-dated bond with a low coupon

Explanation

Bond prices move inversely with yields, and long-dated, low-coupon bonds have the greatest duration, so they gain most when rates fall. Floating rate notes and deposits do not benefit from falling rates in the same way.

Question 48Securities and Investments

Which of the following best describes a convertible bond?

  1. A bond that may be exchanged for a specified number of the issuer's shares Correct answer.
  2. A bond whose coupon converts from fixed to floating at a set date
  3. A bond that can be repaid early at the issuer's option
  4. A bond denominated in a foreign currency

Explanation

A convertible bond gives the holder the right to convert the bond into a predetermined number of ordinary shares of the issuer. This equity option makes it attractive but usually means a lower coupon than a straight bond.

Question 49Securities and Investments

A company has earnings per share of 40p and its shares trade on a price/earnings ratio of 12. What is the share price?

  1. £4.80 Correct answer.
  2. £5.20
  3. £3.00
  4. £0.30

Explanation

The price/earnings ratio equals price divided by earnings per share, so price equals 12 × 40p = 480p, or £4.80. This is a common relative valuation method for equities.

Question 50Securities and Investments

Which of the following statements about a forward contract is correct?

  1. It is a customised agreement settled at maturity between two parties Correct answer.
  2. It is traded on an exchange and marked to market daily
  3. It requires an initial margin payment to a clearing house
  4. It is standardised in size and delivery date

Explanation

Forwards are privately negotiated, over-the-counter contracts with terms tailored to the parties and settlement at maturity. Unlike futures, they are not standardised or cleared through an exchange.