Gypsy

Which of the following is least likely to be a rationale for investing in small cap stocks?

A) The higher betas for small cap stocks indicate that their future returns should be higher.

B) Smaller firms are more likely to be underpriced than larger cap stocks with greater coverage.

C) Higher returns are more likely when starting from a smaller stock price base.

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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.

Gypsy

Which of the following is most accurate regarding growth stocks? Growth stocks are likely to:

A) outperform during an economic contraction and outperform during an economic expansion.

B) outperform during an economic contraction and underperform during an economic expansion.

C) underperform during an economic contraction and outperform during an economic expansion.

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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.

Gypsy

Which of the following statements about value and growth investors is least accurate?

A) Value investors focus on the numerator of the P/E ratio while growth investors focus on the denominator.

B) Growth investors seek industries where low expected earnings growth will drive the stock price down.

C) Growth investors may do better during an economic contraction than during an expansion.

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Growth investors search for firms and industries where high expected earnings growth will drive the stock price up even higher.

Gypsy

The risk for growth investors is that the expected earnings growth does not occur. How will this low growth affect the price-multiple and stock prices, respectively?

A) Decrease; decrease.

B) Increase; decrease.

C) Decrease; increase.

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Growth investors search for firms or industries where high expected earnings growth will drive the stock price up. If the actual earnings are lower than expected, the stock price will decrease due to a lower growth rate and the price multiple will decrease and as a result.

Gypsy

Which of the following is a justification of a value investing strategy?

A) Current depressed earnings will rise in the future as they revert to the mean.

B) The value of stock is volatile so a cheaply priced stock will see an increase in value in the future.

C) The investor can add value using proper analysis of the risky firm.

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There are two justifications for a value investing strategy. The first is that although a firm’s earnings are depressed now, the earnings will rise in the future as they revert to the mean. One of the risks of this strategy however is that there is a good reason why the stock is priced so cheaply. Some stocks will take a long time to increase in value. The investor needs to consider this before investing. The second justification for value investors is that growth investors expose themselves to the risk that earnings and price multiples will contract for high-priced growth stocks.

Gypsy

Which of the following is least likely to be an advantage of returns-based style analysis?

A) The use of different models provides similar results.

B) Low cost.

C) It will detect style changes quickly.

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Returns-based style analysis may detect style changes slowly because the regression requires historical data that may not reflect the current focus of the fund. Holdings-based style analysis will detect style changes more quickly than returns-based analysis.

Gypsy

Which of the following would least likely be a characteristic of a growth portfolio using holdings-based style analysis?

A) Low earnings volatility.

B) Low dividend yield.

C) Representation in the financial industry.

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A growth manager would have representation in the technology and health care industries. A value manager would have representation in the utility and financial industries. A growth manager would have a low dividend yield and low earnings volatility.

Gypsy

In comparing returns-based style analysis with holdings-based style analysis it is most accurate to say that:

A) holdings-based style analysis aggregates the effect of the investment process, and returns-based style analysis is more forward looking.

B) returns-based style analysis can capture changes in style more quickly, but holdings-based style analysis is more quickly executed.

C) holdings-based style analysis can capture changes in style more quickly, but returns-based style analysis is more quickly executed.

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Holdings-based style analysis captures changes more quickly because returns-based style analysis uses historical data, and holdings-based analysis is based upon current holdings in the portfolio. Holdings-based style analysis requires more time and work because it requires analyzing each position, and returns-based style analysis uses historical data in a regression. Returns-based style analysis aggregates the effect of the investment process and requires more theory in the process.

Gypsy

In comparing returns-based style analysis with holdings-based style analysis, it is most accurate to say that:

A) holdings-based style analysis is as equally data intensive as returns-based style analysis.

B) returns-based style analysis is more data intensive and holdings-based style analysis may be ineffective in characterizing current style.

C) holdings-based style analysis is more data intensive and returns-based style analysis may be ineffective in characterizing current style.

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Holdings-based style analysis is very data intensive because the characteristics of each position must be analyzed. However, it does give a better indication of the current style because the returns-based analysis is based upon historical data.

Gypsy

Harold Bowers, CFA, and Bill Hoffman, CFA, are analyzing the returns of several portfolios. Bowers is performing an analysis based upon the characteristics of the investments in each of the portfolios, and Hoffman is performing a regression analysis using historical data. Based upon this, with respect to returns-based style analysis and holdings-based style analysis, it is most likely that:

A) Bowers and Hoffman are both using variations of holdings-based style analysis.

B) Bowers is performing returns-based style analysis and Hoffman is performing holdings-based style analysis.

C) Bowers is performing holdings-based style analysis and Hoffman is performing returns-based style analysis.

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Bowers is clearly performing holdings-based style analysis. Of the two approaches, regression is used in the return’s-based style analysis by regressing historical returns on factors.