LOS b: Determine the importance of correlation analysis when using a multi-matrix valuation approach.

Q1. During the recent seminar on equity valuation, Chan Li made the following statement. "The validity of multi-metric valuation procedures is not affected by the signs of the correlation coefficients among the metrics used." Why is Li's statement incorrect?

A)   All of the signs for the correlation coefficients between the metrics in a multi-metric valuation procedure should be positive.

B)   Negative correlations among the metrics may generate valuation scores that indicate undervalued securities that are actually overvalued.

C)   The averaging of the metrics to derive a final score renders the correlation among the metrics irrelevant.

Q2. During a security analyst conference, Winston Longbrow stated: "A multi-metric valuation procedure is not affected by the signs on the correlation coefficients among the metrics employed." Why is Longbrow incorrect?

A)   All of the signs for the correlation coefficients between the metrics in a multi-metric valuation procedure should be positive.

B)   The averaging of the metrics to derive a final score renders the correlation among the metrics irrelevant.

C)   Negative correlations among the metrics may generate valuation scores that indicate overvalued securities that are actually undervalued.

Q3. Gerome Grant was asked to serve as a panelist at an investment seminar for a local college's finance club. During the panel session, Grant was asked whether the following comments were correct or incorrect.

Which of the following represents Grant's most appropriate response?

         Comment 1                         Comment 2                                  Comment 3

A)   Incorrect                                 Correct                                        Incorrect

B)   Incorrect                                 Incorrect                                      Incorrect

C)   Correct                                   Correct                                        Incorrect

Q4. During a recent seminar on equity valuation, Ralph Harper made the following statement. "The sign of the correlation coefficients among the metrics used in a multi-metric valuation process should all be negative." Why is Harper's statement incorrect?

A)   All of the signs for the correlation coefficients between the metrics in a multi-metric valuation procedure should be positive.

B)   The averaging of the metrics to derive a final score renders the correlation among the metrics irrelevant.

C)   Negative correlation among the valuation metrics tend to result in valuation scores that indicate undervalued securities that are actually overvalued.

LOS b: Determine the importance of correlation analysis when using a multi-matrix valuation approach. fficeffice" />

Q1. During the recent seminar on equity valuation, Chan Li made the following statement. "The validity of multi-metric valuation procedures is not affected by the signs of the correlation coefficients among the metrics used." Why is Li's statement incorrect?

A)   All of the signs for the correlation coefficients between the metrics in a multi-metric valuation procedure should be positive.

B)   Negative correlations among the metrics may generate valuation scores that indicate undervalued securities that are actually overvalued.

C)   The averaging of the metrics to derive a final score renders the correlation among the metrics irrelevant.

Correct answer is A)

It is important to have positive signs on the correlation coefficients among the metrics used in a multi-metric valuation process. This assures that all of the metrics change in the same direction in response to changes in the factors that affect relative values.

Q2. During a security analyst conference, Winston Longbrow stated: "A multi-metric valuation procedure is not affected by the signs on the correlation coefficients among the metrics employed." Why is Longbrow incorrect?

A)   All of the signs for the correlation coefficients between the metrics in a multi-metric valuation procedure should be positive.

B)   The averaging of the metrics to derive a final score renders the correlation among the metrics irrelevant.

C)   Negative correlations among the metrics may generate valuation scores that indicate overvalued securities that are actually undervalued.

Correct answer is A)

It is important to have positive signs on the correlation coefficients among the metrics used in a multi-metric valuation process. This assures that all of the metrics change in the same direction in response to changes in the factors that affect relative values.

Q3. Gerome Grant was asked to serve as a panelist at an investment seminar for a local college's finance club. During the panel session, Grant was asked whether the following comments were correct or incorrect.

Comment 1:	The Price/Earnings to Growth (PEG) ratio is a useful valuation model for all types of equities, regardless of the expected dividend growth rate.
Comment 2:	A 10-year moving average is a meaningful historic benchmark when performing equity valuation
Comment 3:	Due to the averaging process involved when using a multi-metric valuation procedure, the correlation among the metrics is irrelevant.

Which of the following represents Grant's most appropriate response?

         Comment 1                         Comment 2                                  Comment 3

A)   Incorrect                                 Correct                                        Incorrect

B)   Incorrect                                 Incorrect                                      Incorrect

C)   Correct                                   Correct                                        Incorrect

Correct answer is A)

Comment 1 is incorrect. Companies with zero expected growth have a PEG ratio that is undefined (division by zero), and companies with negative growth have a negative PEG ratio, which renders it meaningless. Therefore, PEG ratios are only useful for companies with normal or high earnings growth.

Comment 2 is correct.

Comment 3 is incorrect. When using a multi-metric valuation procedure, it is important that the correlation coefficients be positive so that the various metrics will tend to indicate the same over or under valuation signal. This will provide the analyst with a degree of confidence in the interpretation of each stock's overall average score.

Q4. During a recent seminar on equity valuation, Ralph Harper made the following statement. "The sign of the correlation coefficients among the metrics used in a multi-metric valuation process should all be negative." Why is Harper's statement incorrect?

A)   All of the signs for the correlation coefficients between the metrics in a multi-metric valuation procedure should be positive.

B)   The averaging of the metrics to derive a final score renders the correlation among the metrics irrelevant.

C)   Negative correlation among the valuation metrics tend to result in valuation scores that indicate undervalued securities that are actually overvalued.

Correct answer is A)

It is important to have positive signs on the correlation coefficients among the metrics used in a multi-metric valuation process. This assures that all of the metrics change in the same direction in response to changes in the factors that affect relative values.

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