LOS v: Discuss the security selection process and differentiate between top-down and bottom-up approaches to equity research.

Q1. An investment management firm is preparing to hire an independent analyst to recommend security selections for the firm’s portfolio. The firm would like to keep the manager’s compensation straightforward and predictable. Which of the following best describes the firm’s situation? The investment management firm wants to hire a:

A)   buy-side analyst and pay them performance-based fees.

B)   sell-side analyst and pay them on ad valorem basis.

C)   buy-side analyst and pay them on ad valorem basis.

Q2. Which of the following best describes the buy-side equity research approach?

A)   Investment recommendations are used to promote stocks and the research is available to the public.

B)   Investment recommendations are presented to a committee and the research is available to the public.

C)   Investment recommendations are presented to a committee and the research is not available to the public.

Q3. Jane Andrews has investigated the economic conditions in the country of Semeria and is forecasting an economic expansion. She then investigates the valuations for cyclical stocks in this country. What equity research approach is she using?

A)   A combination of top-down and bottom-up.

B)   Bottom-up.

C)   Top-down.

Q4. Which of the following would least likely be included in bottom-up equity research?

A)   Currency forecasts.

B)   Price-multiple.

C)   Dividend yield.

LOS v: Discuss the security selection process and differentiate between top-down and bottom-up approaches to equity research. fficeffice" />

Q1. An investment management firm is preparing to hire an independent analyst to recommend security selections for the firm’s portfolio. The firm would like to keep the manager’s compensation straightforward and predictable. Which of the following best describes the firm’s situation? The investment management firm wants to hire a:

A)   buy-side analyst and pay them performance-based fees.

B)   sell-side analyst and pay them on ad valorem basis.

C)   buy-side analyst and pay them on ad valorem basis.

Correct answer is B)

Sell-side analysts often work for an investment bank that uses the research to promote stocks the bank is selling. Sell-side research is also conducted by independent firms available for hire by investment managers. Ad valorem fees are straightforward and predictable. This is useful when the investor is budgeting investment fees. Performance-based fees are more complex to administer.

Q2. Which of the following best describes the buy-side equity research approach?

A)   Investment recommendations are used to promote stocks and the research is available to the public.

B)   Investment recommendations are presented to a committee and the research is available to the public.

C)   Investment recommendations are presented to a committee and the research is not available to the public.

Correct answer is C)

Buy-side equity research is used to formulate investment recommendations for an investment management firm. The analyst usually must present their investment recommendations to and have them approved by a committee. Buy-side research is not usually available to those outside the firm because this is how the firm hopes to establish their competitive advantage.

Sell-side research is often used by an investment bank to promote stocks the bank is selling. It is thus available to the public.

Q3. Jane Andrews has investigated the economic conditions in the country of Semeria and is forecasting an economic expansion. She then investigates the valuations for cyclical stocks in this country. What equity research approach is she using?

A)   A combination of top-down and bottom-up.

B)   Bottom-up.

C)   Top-down.

Correct answer is A)

Jane is using a combination of top-down and bottom-up. She starts at the country level and after finding attractive economic conditions, she then drops down to the individual stock level to find stocks that are attractive based on their valuations.

Q4. Which of the following would least likely be included in bottom-up equity research?

A)   Currency forecasts.

B)   Price-multiple.

C)   Dividend yield.

Correct answer is A)

Bottom-up equity research focuses on individual stock valuation so the firm’s dividend yield and price-multiple would likely be included. Currency valuations are at the macroeconomic level and would be less likely to be included in a bottom-up approach.

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