CFA Equity Investments 2

Question 1

An analyst uses a residual income model to value a stock. Residual income is defined as:

Accepted Answer

Net income minus the equity charge (required return × book value of equity)

Answer

Residual income = Net income – (required return on equity × beginning book value of equity); it measures value created above the cost of equity.

Question 2

Which industry structure, under Porter's Five Forces, would MOST support high profitability for existing firms?

Accepted Answer

Few rivals, high barriers to entry, few substitutes

Answer

High barriers to entry, few competitors, and limited substitutes reduce competitive pressure, allowing existing firms to maintain pricing power and high margins.

Question 3

A company repurchases shares in the open market. All else equal, this will MOST likely:

Accepted Answer

Increase earnings per share (EPS)

Answer

Share buybacks reduce the share count; if net income is unchanged, EPS rises because the same earnings are divided among fewer shares.

Question 4

The price-to-book (P/B) ratio is LEAST informative when analyzing a company in which sector?

Accepted Answer

Technology or software

Answer

Technology and software firms have significant intangible assets (IP, brand, human capital) not fully captured on the balance sheet, making P/B less meaningful.

Question 5

In the two-stage dividend discount model, the second stage typically assumes:

Accepted Answer

A stable, sustainable long-run growth rate

Answer

The two-stage DDM uses a high near-term growth rate followed by a terminal stage with a stable, long-run sustainable growth rate applied in perpetuity.

CFA Practice Test

CFA Practice Test

CFA Equity Investments 2