IMC Asset Classes 1 — Questions and Answers
Question 1: Which of the following is the primary characteristic of an equity investment?
- Fixed regular income payments
- Ownership stake in a company with a claim on residual profits and assets (Correct answer)
- Guaranteed return of principal
- Priority claim over bondholders in liquidation
Correct answer: Ownership stake in a company with a claim on residual profits and assets
Equity represents ownership in a company. Shareholders have a residual claim on profits (dividends at the board's discretion) and assets after all other claimants (including bondholders) are paid. Returns are variable, not guaranteed.
Question 2: What is the key difference between ordinary shares and preference shares?
- Ordinary shares pay fixed dividends; preference shares pay variable dividends
- Preference shares have priority over ordinary shares for dividends and capital repayment, usually with a fixed dividend (Correct answer)
- Ordinary shares are only available to institutional investors
- Preference shares always carry voting rights; ordinary shares do not
Correct answer: Preference shares have priority over ordinary shares for dividends and capital repayment, usually with a fixed dividend
Preference shares rank ahead of ordinary shares for dividend payments and in a liquidation. They typically pay a fixed dividend. Ordinary shares receive residual profits and usually carry voting rights; preference shares often do not.
Question 3: What is a 'coupon' on a bond?
- The discount at which a bond trades below par
- The regular interest payment made to the bondholder (Correct answer)
- The fee paid to the bond trustee
- The bond's credit rating
Correct answer: The regular interest payment made to the bondholder
The coupon is the periodic interest payment paid by the bond issuer to the bondholder, usually expressed as a percentage of the bond's face (par) value. For example, a 5% coupon on a £1,000 bond pays £50 per year.
Question 4: What happens to a bond's price when interest rates rise?
- Bond prices rise proportionally
- Bond prices fall (Correct answer)
- Bond prices are unaffected by interest rates
- Bond prices rise then fall
Correct answer: Bond prices fall
Bond prices and interest rates have an inverse relationship. When rates rise, newly issued bonds offer higher yields, making existing bonds with lower coupons less attractive, so their prices fall to offer a competitive yield.
Question 5: Which asset class is generally considered to have the lowest risk and lowest expected return?
- Equities
- Property
- Bonds
- Cash and cash equivalents (Correct answer)
Correct answer: Cash and cash equivalents
Cash and cash equivalents (money market instruments, savings accounts) carry the lowest risk as capital is largely protected and returns are predictable, but they also offer the lowest expected long-term return due to the risk-return trade-off.
Question 6: What is a 'yield' in the context of a bond investment?
- The bond's coupon rate set at issuance
- The annual return an investor receives relative to the bond's current market price (Correct answer)
- The bond's credit rating
- The bond's maturity date
Correct answer: The annual return an investor receives relative to the bond's current market price
Yield (specifically current yield or yield to maturity) measures the return on a bond relative to its current market price. As bond prices fluctuate, the yield changes even if the coupon payment remains fixed.
IMC Asset Classes 1
Which of the following is the primary characteristic of an equity investment?