CISI IoI Investment Risk and Return

Question 1

What is the 'risk-return trade-off' in investing?

Accepted Answer

Investors generally expect higher potential returns from higher-risk investments to compensate for the greater uncertainty of outcome

Answer

The risk-return trade-off reflects the principle that investors require higher expected returns to compensate for taking on greater risk. There is no guarantee of higher returns with higher risk, but rational investors demand a higher expected return as compensation.

Question 2

What is 'volatility' as a measure of investment risk?

Accepted Answer

The degree to which an investment's price fluctuates over time, typically measured by standard deviation of returns

Answer

Volatility measures how much an investment's price moves up and down over time. It is commonly measured by the standard deviation of historical returns — the higher the standard deviation, the greater the volatility and the higher the risk.

Question 3

What is 'credit risk' in the context of bond investing?

Accepted Answer

The risk that the bond issuer defaults on its obligation to pay interest or repay principal

Answer

Credit risk (also called default risk) is the risk that the issuer of a bond fails to make the promised coupon payments or to repay the principal at maturity. Corporate bonds carry higher credit risk than UK gilts.

Question 4

What is 'liquidity risk'?

Accepted Answer

The risk that an investor cannot sell an investment quickly at a fair price when they need to

Answer

Liquidity risk is the risk of being unable to convert an investment into cash quickly without accepting a significant discount to its fair value. Some assets — such as property or AIM shares — have lower liquidity than FTSE 100 shares.

Question 5

What is meant by 'diversification' as a risk management strategy?

Accepted Answer

Spreading investments across different asset classes, sectors, and geographies to reduce the impact of poor performance in any single investment

Answer

Diversification reduces portfolio risk by spreading investments so that poor performance in one area is offset by better performance elsewhere. A well-diversified portfolio is less volatile than a concentrated one because not all assets move in the same way at the same time.

CISI Introduction to Investment Practice Test

CISI Introduction to Investment Practice Test

CISI IoI Investment Risk and Return