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.
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
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. |