LOS g: Explain and justify the use of equity investment style classifications and discuss the difficulties in applying style definitions consistently. fficeffice" />
Q1. Which of the following is most accurate regarding growth stocks? Growth stocks are likely to:
A) outperform during an economic contraction and underperform during an economic expansion.
B) outperform during an economic contraction and outperform during an economic expansion.
C) underperform during an economic contraction and outperform during an economic expansion.
Correct answer is A)
Growth stocks are more likely to outperform during a recession as there are few other firms with growth and a premium would be priced into growth stock valuation. During an expansion, many firms are doing well and the valuation premiums for growth stocks may decline.
Q2. Which of the following is least likely to be a rationale for investing in small cap stocks?
A) Smaller firms are more likely to be underpriced than larger cap stocks with greater coverage.
B) The higher betas for small cap stocks indicate that their future returns should be higher.
C) Higher returns are more likely when starting from a smaller stock price base.
Correct answer is B)
Although small-cap stocks may have a higher beta, this is not given as a rationale for investing in them. Both remaining responses indicate the most common rationales for investing in these stocks.
Q3. Which of the following is the primary risk of a market-oriented equity investing approach?
A) The tilt to growth is too strong.
B) The tilt to value is too strong.
C) The portfolio must outperform broad market averages or investors will switch to low cost indexing strategies.
Correct answer is C)
Market-oriented investors have portfolios that resemble a broad market average over time. The risk for a market-oriented manager is that he or she must outperform a broad market index or investors will use lower cost indexing strategies. Although a poor growth at a reasonable price (GARP) model would be a concern for this subset of market-oriented equity investing, it is not the primary risk of market-oriented equity investing.
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