IMC Asset Classes 4

Question 1

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

Accepted Answer

The risk that the bond issuer will default on interest or principal payments

Answer

Credit risk (default risk) is the risk that the bond issuer will be unable to make scheduled interest payments or repay principal at maturity. Higher credit risk bonds (high yield/junk bonds) offer higher yields to compensate investors.

Question 2

What is the 'equity risk premium' (ERP)?

Accepted Answer

The additional return investors expect from equities over the risk-free rate, as compensation for higher risk

Answer

The equity risk premium is the excess return that investing in the stock market is expected to provide over a risk-free rate (such as gilts). It compensates investors for accepting the additional volatility and risk of equities versus 'safe' government bonds.

Question 3

What is a 'real return' on an investment?

Accepted Answer

The return adjusted for inflation

Answer

Real return is the nominal (stated) return adjusted for inflation. If an investment returns 6% nominally but inflation is 3%, the real return is approximately 3%. Real returns reflect the actual increase in purchasing power.

Question 4

What is 'currency risk' in international investing?

Accepted Answer

The risk that exchange rate movements will reduce returns when investing in foreign assets

Answer

Currency risk arises when investing in assets denominated in foreign currencies. If sterling strengthens against the investment's currency, the sterling value of returns falls even if the underlying investment performs well.

Question 5

What is a 'real asset'?

Accepted Answer

A tangible physical asset such as property, infrastructure, or commodities that typically provides a hedge against inflation

Answer

Real assets are tangible physical assets with intrinsic value — including real estate, infrastructure, commodities, and timberland. They often provide inflation-linked returns, as their values and income streams tend to rise with inflation.

IMC Practice Test

IMC Practice Test

IMC Asset Classes 4