Chartered Insurance Institute (CII) Qualifications Investment Principles, Portfolios and Risk (R02) Syllabus

Investment Principles, Portfolios and Risk (R02) syllabus — full chapter and topic list

Expand any chapter to see its topics and sub-topics. This is the whole examinable outline for Investment Principles, Portfolios and Risk (R02) in Chartered Insurance Institute (CII) Qualifications, not a summary of it.

1. 1

   Asset Classes and Their Characteristics

   4 topics

   • Cash and fixed-interest securities
     • Deposits and money market instruments
     • Gilts and corporate bonds
     • Bond pricing, yields and duration
   • Equities
     • Ordinary and preference shares
     • Dividends and total return
     • Equity valuation measures
   • Property and alternatives
     • Direct and indirect property
     • Commodities and infrastructure
     • Hedge funds and private equity
   • Derivatives
     • Options, futures and forwards
     • Hedging vs speculation
2. 2

   Collective Investments and Products

   3 topics

   • Pooled investment vehicles
     • Unit trusts and OEICs
     • Investment trusts and gearing
     • Exchange-traded funds
   • Tax-advantaged wrappers
     • ISAs and their subscription limits
     • VCTs, EIS and SEIS
   • Life assurance investment products
     • Onshore and offshore bonds
     • Chargeable events and top-slicing
3. 3

   Portfolio Construction and Theory

   4 topics

   • Risk and return concepts
     • Standard deviation and volatility
     • Correlation and diversification
     • Systematic vs unsystematic risk
   • Investment theory and models
     • Modern portfolio theory and the efficient frontier
     • Capital asset pricing model and beta
     • Efficient market hypothesis
   • Strategic asset allocation
     • Active vs passive management
     • Rebalancing and time horizons
   • Performance measurement
     • Benchmarks and risk-adjusted returns
     • Sharpe and information ratios
4. 4

   Investment Risk and Client Suitability

   3 topics

   • Matching investments to clients
     • Risk profiling and capacity for loss
     • Investment objectives and constraints
   • Specific investment risks
     • Inflation, interest rate and currency risk
     • Liquidity, credit and shortfall risk
   • Responsible and sustainable investing
     • ESG integration
     • Ethical screening approaches

Investment Principles, Portfolios and Risk (R02) flashcards for Chartered Insurance Institute (CII) Qualifications

23 of 51 cards from the Investment Principles, Portfolios and Risk (R02) deck — real questions with worked answers.

1. What is the key difference between a 'money market' instrument and a 'capital market' instrument?

   Money market instruments are short-term debt with an original maturity of one year or less (e.g. Treasury bills, certificates of deposit, commercial paper). Capital market instruments are longer-term, comprising bonds (over one year) and equities.

2. For a conventional fixed-interest gilt, define the 'coupon', the 'redemption (par) value' and the 'running yield'.

   The coupon is the fixed annual interest, paid as a percentage of nominal value. The redemption value is the amount repaid at maturity (par, usually £100). The running (income/flat) yield is $\text{running yield} = \frac{\text{coupon}}{\text{clean price}} \times 100$.

3. How does the gross redemption yield (GRY) of a bond bought above par compare to a bond bought below par, and why?

   A bond bought above par (at a premium) has a GRY below its running yield because there is a capital loss to redemption. A bond bought below par (at a discount) has a GRY above its running yield due to a capital gain at redemption.

4. State the inverse relationship between bond prices and interest rates, and explain what 'duration' measures.

   Bond prices and market interest rates (yields) move inversely: when yields rise, prices fall and vice versa. Duration (Macaulay/modified) measures a bond's price sensitivity to interest-rate changes — the higher the duration, the greater the price volatility for a given yield change.

5. What are 'index-linked gilts' and to which index are the UK versions linked?

   Index-linked gilts have their coupon and redemption value adjusted in line with inflation, protecting real value. UK index-linked gilts are linked to the Retail Prices Index (RPI), giving inflation protection on both income and capital.

6. Define 'credit (default) risk' for fixed-interest securities and name the main credit rating agencies.

   Credit/default risk is the risk the issuer fails to pay interest or repay capital. The main agencies are Standard & Poor's, Moody's and Fitch. 'Investment grade' is BBB-/Baa3 and above; below that is 'sub-investment grade' (high-yield/junk).

7. What rights does an ordinary share confer, and where does an ordinary shareholder rank on a winding-up?

   An ordinary share confers ownership, voting rights, and the right to discretionary dividends. On a winding-up, ordinary shareholders rank last — after creditors, bondholders and preference shareholders — so they carry the highest risk but greatest upside.

8. How do preference shares differ from ordinary shares?

   Preference shares pay a fixed dividend, rank ahead of ordinary shares for dividends and on winding-up, but usually carry no voting rights. 'Cumulative' preference shares carry forward any unpaid dividends; participating ones can receive extra dividends.

9. Define the dividend yield and the price/earnings (P/E) ratio.

   Dividend yield $= \frac{\text{dividend per share}}{\text{share price}} \times 100$. The P/E ratio $= \frac{\text{share price}}{\text{earnings per share}}$, indicating how many years of current earnings the price represents — a higher P/E implies higher growth expectations.

10. State the dividend cover formula and explain what a high figure indicates.

    $\text{Dividend cover} = \frac{\text{earnings per share}}{\text{dividend per share}}$ (or net profit ÷ dividends). A high cover means dividends are well supported by earnings and more likely to be sustained or grow; a figure below 1 means dividends exceed earnings.

11. What is the Gordon Growth (dividend discount) model used to value a share with constant dividend growth?

    $$P_{0} = \frac{D_{1}}{r - g}$$ where $P_0$ is the share value, $D_1$ the expected next dividend, $r$ the required return and $g$ the constant dividend growth rate (valid only when $r > g$).

12. List the principal ways a private investor can gain exposure to commercial property, and a key drawback of direct property.

    Direct ownership, property unit trusts/OEICs, Real Estate Investment Trusts (REITs), property bonds and property shares. A key drawback of direct property is illiquidity — it cannot be sold quickly, transaction costs are high and valuation is subjective.

13. What is a REIT and what is its main tax advantage?

    A Real Estate Investment Trust is a listed company holding income-producing property. Provided it distributes at least 90% of its tax-exempt property rental profits, the rental income and gains are exempt from corporation tax within the REIT; investors are taxed on distributions instead, avoiding double taxation.

14. Name four 'alternative' asset classes and one reason they appeal within a portfolio.

    Examples: commodities, hedge funds, private equity, infrastructure, and collectibles/art. They appeal because they often have low correlation with mainstream equities and bonds, offering diversification benefits.

15. What is the essential difference between a 'future' and an 'option'?

    A future is a binding obligation for both parties to buy/sell an asset at a fixed price on a future date. An option gives the holder the right, but not the obligation, to buy (call) or sell (put) at the strike price; the writer is obligated if exercised.

16. Define a 'call option' and a 'put option' from the buyer's perspective.

    A call option gives the buyer the right to BUY the underlying asset at the strike price — bought when expecting prices to rise. A put option gives the buyer the right to SELL at the strike price — bought when expecting prices to fall or to hedge a holding.

17. How can a 'put option' be used to hedge an existing equity holding (protective put)?

    By buying a put option over shares already held, the investor locks in a minimum selling (strike) price. If the share falls below the strike, the loss on the shares is offset by the gain on the put; the cost is the premium paid.

18. What is the 'premium' on an option, and what are its two components?

    The premium is the price paid by the buyer to the writer. It comprises intrinsic value (the in-the-money amount, i.e. how favourable the strike is versus the current price) plus time value (the additional amount reflecting the chance the option moves further into the money before expiry).

19. Explain what 'gearing' (leverage) means in the context of derivatives.

    Gearing means a small initial outlay (premium or margin) controls a much larger underlying exposure, so percentage gains and losses are magnified relative to the capital committed — increasing both potential return and risk.

20. Distinguish an authorised unit trust from an OEIC in legal structure and pricing.

    A unit trust is a trust where investors buy units priced on a dual (bid/offer) basis with a spread. An OEIC (Open-Ended Investment Company) is a company issuing shares, typically single-priced. Both are open-ended and FCA-authorised.

21. What is the key structural difference between an investment trust and a unit trust/OEIC, and what does this create?

    An investment trust is a closed-ended listed company with a fixed number of shares; unit trusts/OEICs are open-ended (units created/cancelled on demand). The closed-ended structure means shares can trade at a discount or premium to net asset value (NAV).

22. Define the 'discount to NAV' on an investment trust and how it is calculated.

    It is the amount by which the share price falls below the net asset value per share: $\text{discount} = \frac{\text{NAV} - \text{share price}}{\text{NAV}} \times 100$. A negative result (price above NAV) is a premium.

23. What is 'gearing' in an investment trust and why can it not be used by an open-ended fund in the same way?

    Investment trusts can borrow to invest, magnifying gains and losses — this is gearing. Open-ended funds are generally restricted from borrowing for investment because they must redeem units on demand, so structural borrowing would create liquidity problems.

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