CFA Practice Question

There are 57 practice questions for this study session.

CFA Practice Question

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.

User Contributed Comments 8

User Comment
Masterkang IV is just the opinion of the CFA institute. There are many great investors out there who are proponents of the bottom-up approach, notably Warren Buffett or Peter Lynch.
AusPhD Couldn't agree more Masterkang
elbaker This is by far the stupidest question I have ever read regarding the CFA material. While I am not some botom-up Buffett follower, to suggest that the top-down is more effective than bottom-up is very presumptious of the CFA institute. I don't want to learn CFA institute opinions, I want factual material.

I am not blaming analystnotes here as it follows CFA Institute study guide.
SageofOmaha who dare to deny the sage of omaha?
giroth When a question says something like "qualitative factors cannot be built into a model" I take the question at face value, i.e., how do I literally quantify the integrity of management in my model? Answer: I don't, I adjust qualitatively in the discount rate or something.
qwsx Ans is right becz firm forcase should be made on the basis of industry so top down as here industry inouts and estimates are used for making estimates about firm performance. In bottom up company estimates are inputed to estimate industry performance which seems only totally wrong so i dnt understand y so many pple have problem with CFA institute opinion.Its totally logical and rational.
charomano Both approaches could serve what we call "a good analysis" if we a acheive our goal. But if we look broadly, we notice investors are more comfortable with the top-down approach. So let us say that it is "more conservative" "less risky" better than "more effective". CFA intends not to go further into discussion so that's why it used an"end of discussion" expression.
ashish100 Lol never seen sageofomaha before. Popped up outta no where as soon as some shit on bottom up analysis
I agree tho. CFA gonna mint even more bums who can't beat the market with that advice.
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