R02 Direct compared with indirect investment: free practice questions

1. Question 1 of 5

   According to research cited on portfolio diversification, roughly how many stocks deliver most of the risk reduction available?

   Option A: About 20Option B: About 200Option C: About 1,000Option D: About 5

   Show answer

   The answer is A: About 20

   One study found single-stock risk of about 49% fell to about 20% with 20 stocks, against market risk of about 19%. Adding more stocks beyond 20 gave little extra reduction.

   Why the other options are wrong

   B

   Most of the reduction comes much earlier.

   C

   Going from 20 to 1,000 stocks reduces risk by less than 1%.

   D

   Risk is still well above market risk with so few.

2. Question 2 of 5

   Which of the following are advantages of direct investment in shares compared with collective funds? 1. Specific stocks can easily be excluded, for ethical reasons say 2. Costs are more transparent 3. Managers can be changed by transferring stocks, not selling them 4. There's no VAT on management fees

   Option A: 1 and 2 onlyOption B: 1, 2 and 3 onlyOption C: 1, 2, 3 and 4Option D: 2, 3 and 4 only

   Show answer

   The answer is B: 1, 2 and 3 only

   Direct portfolios can be tailored, exclude specific stocks, show costs transparently and transfer between managers without selling. But VAT is charged on management fees, and smaller portfolios cost more.

   Why the other options are wrong

   A

   Changing managers without selling is also an advantage.

   C

   VAT is charged on direct portfolio management fees.

   D

   VAT is charged on direct management fees.

3. Question 3 of 5

   What is a drawback of a small directly invested share portfolio?

   Option A: It can't be transferred between managersOption B: Higher volatility, as one or two stocks can dominateOption C: No exposure to individual companiesOption D: Stocks can't be excluded from it for ethical reasons

   Show answer

   The answer is B: Higher volatility, as one or two stocks can dominate

   Fewer holdings mean higher volatility and more variable results, and small portfolios may cost more. Direct holdings also need more manager involvement and may trigger CGT on switches.

   Why the other options are wrong

   A

   Stocks can be transferred.

   C

   Direct holdings are exposure to individual companies.

   D

   Exclusions are easier with direct holdings.

4. Question 4 of 5

   Which tax advantage do unit trusts and OEICs have over a directly held share portfolio?

   Option A: No tax is charged on gains realised within the fundOption B: All their income is free of income tax for investorsOption C: Stamp duty is charged at a lower rateOption D: Investors pay no CGT when selling units

   Show answer

   The answer is A: No tax is charged on gains realised within the fund

   Gains realised inside unit trusts and OEICs aren't taxed, so managers can switch holdings without a tax charge. There's also no VAT on fund charges and no stamp duty on units.

   Why the other options are wrong

   B

   Distributions are taxable.

   C

   There's no stamp duty on buying units at all.

   D

   CGT can apply when investors sell units.

5. Question 5 of 5

   Which is a disadvantage of collective investments compared with direct holdings?

   Option A: Gains within them are always taxedOption B: They give no spread of risk for those investing small sumsOption C: They can't give investors exposure to overseas marketsOption D: Investors have no direct involvement in stock selection

   Show answer

   The answer is D: Investors have no direct involvement in stock selection

   Collective investors have no direct involvement, charges vary, portfolio changes can be costly through spreads and dealing charges, and changing managers may cost more.

   Why the other options are wrong

   A

   Internal gains aren't taxed.

   B

   A spread of risk is a key advantage.

   C

   They give easy access to overseas markets.

R0 Exam Prep is an independent revision tool. It is not produced, endorsed by or affiliated with the Chartered Insurance Institute (CII). Questions and explanations are original. Use it alongside the official study text. About R0 Exam Prep