R02 Capital, income, interest rate and inflation risk: free practice questions

1. Question 1 of 5

   Which of these is a type of credit risk?

   Option A: Reverse pound cost averagingOption B: Downgrade riskOption C: Shortfall riskOption D: Political risk

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   The answer is B: Downgrade risk

   The main types of credit risk are default risk, downgrade risk, credit spread risk, counterparty risk and bail-in risk. Credit risk matters most for bond investors and depositors.

   Why the other options are wrong

   A

   That's an effect of volatility on withdrawals.

   C

   Shortfall risk is about missing a target.

   D

   Political risk is a separate category.

2. Question 2 of 5

   Why does bail-in risk challenge the usual view of bank accounts?

   Option A: Withdrawals become tax-freeOption B: Interest rates on accounts become fixedOption C: Depositors' balances may be reducedOption D: Accounts are converted into gilts

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   The answer is C: Depositors' balances may be reduced

   With a bail-in, those with money in the bank may see their balance reduced, which is at odds with the idea of a bank account being 100% secure. It can also affect FSCS compensation.

   Why the other options are wrong

   A

   Bail-in has nothing to do with tax.

   B

   Bail-in doesn't fix interest rates.

   D

   That isn't how bail-in works.

3. Question 3 of 5

   Apart from borrowing, how can gearing be achieved?

   Option A: By diversifying across more and more asset classes and regionsOption B: Synthetically, using derivatives such as futures and optionsOption C: By buying index-linked giltsOption D: By holding more cash within the portfolio

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   The answer is B: Synthetically, using derivatives such as futures and options

   Gearing increases exposure to assets. It can be achieved by borrowing or synthetically using futures, options and other derivatives.

   Why the other options are wrong

   A

   Diversification reduces risk rather than gearing it.

   C

   These don't create gearing.

   D

   Holding cash reduces exposure.

4. Question 4 of 5

   Why do some very large, profitable companies pay no dividends at all?

   Option A: They prefer to reinvest profits to grow the businessOption B: Dividends can only be paid by small companiesOption C: Their shareholders aren't entitled to profitsOption D: UK company law bans dividends from large companies

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   The answer is A: They prefer to reinvest profits to grow the business

   Tradition is one factor: some companies choose not to pay dividends as a rule, preferring to reinvest profits in growth and expansion. Payouts also depend on profits, cover targets, regulation and tax.

   Why the other options are wrong

   B

   Companies of any size can pay dividends.

   C

   Shareholders own the company; the board decides payouts.

   D

   There's no such ban.

5. Question 5 of 5

   Which of these tends to push interest rates up?

   Option A: Investors moving into short-term securitiesOption B: An economy moving into recessionOption C: Quantitative tightening by the central bankOption D: Quantitative easing by the central bank

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   The answer is C: Quantitative tightening by the central bank

   QT decreases liquidity in the system, which tends to push rates up. Strong economic demand, Government borrowing and rising inflation expectations also push rates higher.

   Why the other options are wrong

   A

   That pushes short-term rates down.

   B

   Rates tend to be lower in a recession.

   D

   QE increases liquidity and tends to reduce rates.

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