CFM Investment Analysis & Portfolio Management 4 — Questions and Answers
Question 1: A CFM candidate analyzes a company with a P/E ratio of 25x while the industry average is 15x. What does this most likely suggest?
- The stock is undervalued
- The market expects higher future growth from this company (Correct answer)
- The company has poor earnings quality
- The stock should be immediately sold
Correct answer: The market expects higher future growth from this company
A higher P/E than peers typically reflects market expectations of superior future earnings growth or lower perceived risk.
Question 2: Which of the following best describes systematic risk in portfolio management?
- Risk specific to a single company or industry
- Risk that can be eliminated through diversification
- Market-wide risk that affects all securities and cannot be diversified away (Correct answer)
- Risk arising from liquidity constraints
Correct answer: Market-wide risk that affects all securities and cannot be diversified away
Systematic risk (market risk) affects the entire market and cannot be eliminated by diversification, unlike idiosyncratic risk.
Question 3: An investor uses a top-down investment approach. Which sequence correctly describes this process?
- Stock selection → Sector analysis → Macroeconomic analysis
- Macroeconomic analysis → Sector selection → Stock selection (Correct answer)
- Fundamental analysis → Technical analysis → Portfolio construction
- Screening → Valuation → Risk assessment
Correct answer: Macroeconomic analysis → Sector selection → Stock selection
The top-down approach starts with macroeconomic analysis, then narrows to sector selection, and finally individual stock picks.
Question 4: What is convexity in bond analysis used to measure?
- The linear relationship between bond price and yield
- The curvature of the price-yield relationship, improving duration estimates for large yield changes (Correct answer)
- The credit spread of a bond relative to Treasuries
- The bond's sensitivity to inflation expectations
Correct answer: The curvature of the price-yield relationship, improving duration estimates for large yield changes
Convexity captures the non-linear (curved) relationship between bond prices and yields, improving price change estimates beyond the linear duration approximation.
Question 5: A portfolio manager employs a core-satellite strategy. What does the 'core' component typically consist of?
- High-risk, high-return speculative positions
- Passive index funds providing broad market exposure (Correct answer)
- Concentrated bets on emerging market equities
- Short-selling strategies to hedge downside
Correct answer: Passive index funds providing broad market exposure
In a core-satellite strategy, the core is typically a low-cost passive index fund providing stable broad market exposure.
Question 6: Which of the following is an example of a relative value hedge fund strategy?
- Global macro
- Long/short equity
- Fixed income arbitrage (Correct answer)
- Managed futures
Correct answer: Fixed income arbitrage
Fixed income arbitrage exploits price discrepancies between related fixed income securities, making it a relative value strategy.
Question 7: A fund manager evaluates investment ideas using the Information Ratio. What does a high Information Ratio indicate?
- The fund has a high absolute return
- The manager consistently generates excess returns relative to active risk taken (Correct answer)
- The fund has low volatility
- The fund's beta is significantly above 1.0
Correct answer: The manager consistently generates excess returns relative to active risk taken
A high Information Ratio indicates the manager generates consistent alpha (active return) per unit of tracking error (active risk).
CFM Investment Analysis & Portfolio Management 4
A CFM candidate analyzes a company with a P/E ratio of 25x while the industry average is 15x.
What does this most likely suggest?