CFA Practice Question

There are 89 practice questions for this study session.

CFA Practice Question

Company A and B are identical, except that Company A has a larger accrual component in its earnings. Which company will have a quicker mean reversion?

A. A
B. B
C. Mean reversion will occur at a similar speed for both companies.
Correct Answer: A

Accruals are strongly mean reverting, while earnings and cash flows are more slowly mean reverting.

User Contributed Comments 2

User Comment
connor15 if accrual are low, this means that you have high confidence in the accounting calculation of the Net income.

if you are confident with your Net Income and they are very high, they are more likely to stay high than if you have high accrual (less confidence in you Net Income calculation) and they are very high.

example : LIFO liquidation will give you high Net income with High accrual (less confidence), Since NI are anormaly high because of LIFO liquidation, they will mean revert much faster to the normal level than if those net income was very high because of new sales (which give you lower accruals)
charliedba High accruals are low quality earnings and not sustainable then they will mean revert faster while low accuals are higher quality and are not forced to mean revert as fast.
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