IMC Asset Classes 2 — Questions and Answers
Question 1: What is 'duration' in fixed income investing?
- The time until a bond matures
- A measure of a bond's price sensitivity to interest rate changes, expressed in years (Correct answer)
- The length of time a bond has been outstanding
- The period between coupon payments
Correct answer: A measure of a bond's price sensitivity to interest rate changes, expressed in years
Duration (specifically modified duration) measures how sensitive a bond's price is to a 1% change in interest rates. A bond with duration of 5 years will fall approximately 5% in price if rates rise by 1%. It incorporates both maturity and coupon payments.
Question 2: What is a 'yield curve' and what does a normal (upward sloping) yield curve indicate?
- A chart of different bonds' credit ratings; normal means most bonds are investment grade
- A chart showing yields at different maturities; upward sloping means longer maturities have higher yields (Correct answer)
- A chart of equity dividend yields; upward slope means dividends are growing
- A chart of currency values; upward slope means sterling is strengthening
Correct answer: A chart showing yields at different maturities; upward sloping means longer maturities have higher yields
A yield curve plots yields against maturity for bonds of similar credit quality. A normal upward-sloping curve means longer-dated bonds yield more than short-dated ones, compensating investors for the greater uncertainty and inflation risk over time.
Question 3: What is a 'collective investment scheme' (CIS)?
- A pension scheme for company employees
- A pooled investment vehicle where multiple investors' funds are combined and managed collectively (Correct answer)
- A government savings scheme
- A scheme for investing in commodities only
Correct answer: A pooled investment vehicle where multiple investors' funds are combined and managed collectively
A CIS pools money from multiple investors to invest collectively in a portfolio of assets. Examples include unit trusts, OEICs, and investment trusts. Pooling allows diversification and professional management for smaller investors.
Question 4: What is the primary difference between an open-ended fund (OEIC/unit trust) and a closed-ended fund (investment trust)?
- Open-ended funds invest in equities; closed-ended funds invest in bonds
- Open-ended funds create/cancel units based on demand; closed-ended funds have a fixed number of shares traded on a stock exchange (Correct answer)
- Open-ended funds are only for retail investors; closed-ended funds are only for institutions
- Open-ended funds are tax-exempt; closed-ended funds pay full tax
Correct answer: Open-ended funds create/cancel units based on demand; closed-ended funds have a fixed number of shares traded on a stock exchange
Open-ended funds (OEICs, unit trusts) expand and contract by creating or cancelling units as investors buy or sell, pricing at NAV. Closed-ended funds (investment trusts) have a fixed share capital listed on a stock exchange and can trade at a premium or discount to NAV.
Question 5: What are 'alternative investments' in portfolio management?
- Investments in foreign currencies only
- Asset classes other than traditional equities, bonds, and cash — such as hedge funds, private equity, real estate, and commodities (Correct answer)
- Investments that are only available online
- Ethical or ESG-focused investments
Correct answer: Asset classes other than traditional equities, bonds, and cash — such as hedge funds, private equity, real estate, and commodities
Alternative investments encompass asset classes beyond traditional equities, bonds, and cash. They include hedge funds, private equity, real assets (property, infrastructure, commodities), and are often used for diversification and return enhancement.
Question 6: What is a 'hedge fund' and what distinguishes it from a traditional fund?
- A fund that only invests in agricultural commodities
- A fund that uses a wide range of strategies including short selling, leverage, and derivatives to generate returns, typically only available to sophisticated investors (Correct answer)
- A fund that hedges only currency risk
- A government-guaranteed investment fund
Correct answer: A fund that uses a wide range of strategies including short selling, leverage, and derivatives to generate returns, typically only available to sophisticated investors
Hedge funds are alternative investment vehicles using sophisticated strategies including short selling, leverage, and derivatives to generate absolute returns regardless of market direction. They are typically restricted to institutional or high-net-worth investors due to their complexity and risk.
IMC Asset Classes 2
What is 'duration' in fixed income investing?