I just did this and it works fine. The only thing to bear in mind is that it takes quite a while to create the encrypted disk image. I created an 80GB encrypted image and it took around 4 hours (USB2 Hard Drive on a G5 iMac)
That isn't what they were asking for. The data would still be unencrypted if someone would load another OS at boot or if they had physical access to the hard drive.