Which of the following statements is (are) true with respect to the valuation process of a security?

I. One of the differences between the top-down approach and the bottom-up approach is that with the former, the firm forecast is actually an input item.
II. Qualitative factors such as manager's integrity cannot be built into the valuation models like quantitative factors can.
III. Holding everything else constant, the firm with a higher quality of earnings, would likely have a lower required rate of return.
IV. A top-down approach is much more effective than a bottom-up approach in valuing securities.

Correct Answer: III and IV

I is incorrect because the firm forecast is an input item in a bottom-up analysis whereas with a top-down assessment, a forecast for the firm is an output item, meaning that the firm forecast is made after estimates are inputted for the economy and the industry.

II is incorrect because with Modern Portfolio Theory, security risk is taken into account when pricing that particular security. Hence management integrity will very much affect that risk factor and thus the valuation of that security.

III is correct because holding everything else constant, the firm with a higher quality of earnings will have less risk associated with those reported figures; thus the firm would likely have a lower required rate of return.