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A matter of principles

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Passing the J06 Investment Principles, Markets and Environment unit requires candidates to have a strong understanding of the more technical issues surrounding investments.

A single question may contain a number of different sections as many of the topics are related and inter-connected. In practice, this means that the candidate has to study the whole syllabus. Although some areas are tested to a greater depth than others, do not be tempted to skip parts of the syllabus in the hope that they will not be tested as they will often form part of a question dealing with another area.

Make sure you are familiar with the characteristics of the main asset classes such as equities, fixed income securities, cash and commercial property as well as alternative investments, their risks and the way in which returns are generated.

Candidates should show they understand how to assess an investment’s performance, including the use of various ratios and formulas.

They will also need to show they can assess a client’s attitude to risk and construct an appropriate portfolio of investments for that client’s circumstances.

Below are the areas of the current syllabus that tend to present the more frequent problems to candidates:

1.4 The roles of governments, central banks and financial regulators in investment markets – fiscal policy and public finances, monetary policies
and interest rates

Increasingly, governments and central banks play a critical role in the management of financial markets. A good practical knowledge and wider
reading of this subject is likely to be extremely beneficial to the candidate as questions are often set around what is happening in the real world.

2.1 Measuring investment returns

2.2 The principles of investment risk – volatility of returns

2.3 Covariance and correlation – positive correlation, negative correlation and no correlation, risk reduction through investment diversification
J06 requires candidates to understand real-life portfolio construction, including how investment returns can be measured. This part of the syllabus often includes calculations and it is an area where well prepared candidates can score highly.

In particular, candidates should under stand, and have a detailed knowledge of, the process through which calculation questions are answered. In an exam, show how you got to the answer using a step-by-step process to ensure higher marks.

Capital Asset Pricing Model (CAPM) – the concept, the limitations of CAPM, application of CAPM, alternative models, for example, the Arbitrage Pricing Model.
The Capital Asset Pricing Model (CAPM) section should be studied in detail. This exam will always include calculations and CAPM is commonly tested. Well-prepared candidates, who show their workings, can score extremely well.

Risk and return objectives
This is a fundamental part of the core syllabus. It requires candidates to be able to apply not only knowledge acquired from text books but also wider experience. Often, questions in the exam will ask the candidate to identify risk associated with specific investments, identifying whether they would be appropriate or not to the investor. This requires an understanding of the investment, how it generates returns, the level of risk associated with those returns and whether they would be appropriate to an individual.

3.4 Tax – the impact on long- term investment performance
Tax is a vital component in client investment management. It is essential that candidates understand how different investments are taxed and the implications of that taxation to the investor. This area is generally poorly answered despite being fundamental part of giving advice in the real world.

Types of risk – currency risk, event risk, etc
There are many different types of risk, which vary with the underlying investment. Risk is a fundamental part of investing and so this part of the course syllabus is regularly tested in one form or another. It is an area where candidates should be competent and, again, wider reading is likely to benefit candidates. This section is core to the whole syllabus as it deals with various types of investments and the risks and potential
returns from such investments.

The candidate’s ability to apply the knowledge they have taken from textbooks to real-world examples is a key consideration for the examiner

4. Understanding the risks and returns of cash, debt investments, equities and property
Candidates can expect to be asked about all areas of this topic and in a variety of ways. Reading a wide range of literature will help candidates gain an understanding of all the points. Practical questions are often set in which candidates must apply that knowledge to a real life situation, showing a broad knowledge of the issues will attract more marks.

Derivatives – characteristics of futures, forwards, options, and swaps. Use of contracts for difference and spread betting
An increasingly common part of investment management and so is regularly tested in the exam. As there are many different types of derivatives, knowledge of the basic types and their purposes should be understood by candidates.

Passive investment funds – comparison with active investment, rationale and efficient market hypothesis, the main criteria in passive funds selection, ETFs
This area is often tested by asking candidates to make a comparison between different passive investment techniques. Examiners have noticed that candidates often have only a basic knowledge of the different passive investment management techniques, so this is an area where further effort is likely to reap rewards.

Active investment management styles – top down, bottom up, value, growth and income investment styles
Again, this is a section that is relevant to “real world” advice and will often be tested using questions based on real situations. Candidates will benefit from a broad understanding of general investment outlooks and by reading media and literature on the subject.

7.1 Financial calculations – time value of money, compoundinterest, present value

7.2 Risk measures, risk adjusted returns, alpha, beta, Sharpe, information ratio
If a candidate has a thorough understanding of ratio and formula calculations, they are likely to get full marks. It is important to remember to show the examiner step-by-step workings and information for any calculations made.

7.6 Past performance – investment classes, fund managers, whether a guide to future performance
The analysis of past performance and the comparison of existing investments are areas commonly tested in the J06 examination. Candidates have to use formula and ratio calculations and apply the results of those calculations in the scenario.

As a final note, keep in mind that the candidate’s ability to apply the knowledge they have taken from textbooks to realworld examples is a key consideration for the examiner.

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