IMC Quantitative Methods and Risk

Question 1

An investment of £10,000 earns a compound annual return of 6% over 3 years. What is its approximate value at the end of the period?

Accepted Answer

£11,910

Answer

Using compound interest: FV = PV × (1 + r)^n = £10,000 × (1.06)^3 = £10,000 × 1.191016 = £11,910.16. Compound interest earns interest on interest, which is why the result exceeds simple interest (which would give £11,800).

Question 2

What does standard deviation measure in the context of investment returns?

Accepted Answer

The dispersion or volatility of returns around the mean

Answer

Standard deviation measures the degree of variation of returns from the average (mean) return. A higher standard deviation indicates greater volatility and wider dispersion of returns. In finance, it is the most commonly used measure of total investment risk.

Question 3

What does Value at Risk (VaR) at a 95% confidence level over one day represent?

Accepted Answer

The maximum loss that is not expected to be exceeded on 95% of trading days

Answer

VaR at 95% confidence over one day estimates the loss level that should not be exceeded on 95 out of 100 trading days (or equivalently, there is a 5% probability the loss will be greater). It does not indicate the size of losses in the worst 5% of cases — that is measured by Conditional VaR (CVaR).

Question 4

If two assets have a correlation coefficient of -0.8, what does this indicate?

Accepted Answer

They tend to move in opposite directions with high consistency

Answer

A correlation of -0.8 indicates a strong negative (inverse) relationship — when one asset's returns increase, the other's tend to decrease, and vice versa. Correlation ranges from -1 (perfect inverse) to +1 (perfect positive). A value of -0.8 is strongly negative but not perfectly inverse.

Question 5

What is the time value of money principle?

Accepted Answer

A pound today is worth more than a pound in the future because of its potential earning capacity

Answer

The time value of money principle states that money available today is worth more than the same amount in the future because it can be invested to earn a return. This is the foundation of discounting (calculating present values) and compounding (calculating future values) in finance.

IMC Practice Test

IMC Practice Test

IMC Quantitative Methods and Risk