CISI IAD Advanced Investment Analysis 2 — Questions and Answers
Question 1: What is 'technical analysis' in investment management?
- The analysis of a company's technology investments as a valuation factor
- The study of historical price and volume data to identify patterns and predict future price movements (Correct answer)
- The analysis of interest rate cycles to time bond purchases
- The analysis of a company's research and development spending
Correct answer: The study of historical price and volume data to identify patterns and predict future price movements
Technical analysis uses charts of historical price and trading volume data to identify patterns, trends, and signals that analysts believe can predict future price movements. It contrasts with fundamental analysis, which focuses on intrinsic value.
Question 2: What is the 'enterprise value' (EV) of a company?
- The value of a company's brand and intellectual property
- The total value of a company, including equity market capitalisation plus net debt (or minus net cash), representing the theoretical takeover price (Correct answer)
- The net asset value of a company's tangible assets
- The discounted value of a company's projected free cash flows
Correct answer: The total value of a company, including equity market capitalisation plus net debt (or minus net cash), representing the theoretical takeover price
Enterprise value = market capitalisation + debt - cash. It represents the total value of the business regardless of its capital structure, making it useful for comparing companies with different debt levels. It is often used in the EV/EBITDA valuation multiple.
Question 3: What does the 'price-to-book' (P/B) ratio measure?
- The ratio of a company's share price to its net profit per share
- The ratio of a company's market capitalisation to the book value (net assets) of its equity — indicating how much investors are willing to pay over the net asset value (Correct answer)
- The ratio of a company's revenue to its share price
- The ratio of a company's share price to its operating cash flow per share
Correct answer: The ratio of a company's market capitalisation to the book value (net assets) of its equity — indicating how much investors are willing to pay over the net asset value
The P/B ratio compares the market's valuation (share price) to the accounting book value of equity (assets minus liabilities per share). A P/B below 1 may indicate an undervalued company; a high P/B implies investors expect high future returns on equity.
Question 4: What is a 'free cash flow' (FCF) yield?
- The dividend yield of a company that has no debt
- Free cash flow (operating cash flow minus capex) divided by the market capitalisation, expressed as a percentage (Correct answer)
- The yield on a company's corporate bonds relative to gilts
- The difference between a company's earnings yield and its dividend yield
Correct answer: Free cash flow (operating cash flow minus capex) divided by the market capitalisation, expressed as a percentage
FCF yield = free cash flow / market capitalisation. Free cash flow is the cash generated after capital expenditure — it is the cash available to return to shareholders via dividends or buybacks. A high FCF yield may indicate an undervalued company generating strong cash returns.
Question 5: What is 'quantitative easing' (QE) and how does it affect financial markets?
- A policy of reducing money supply to control inflation
- A central bank policy of purchasing financial assets (typically government bonds) to inject liquidity into the financial system, typically depressing bond yields and supporting asset prices (Correct answer)
- A government policy of increasing quantitative limits on bank lending
- A policy of fixing exchange rates at a predetermined level
Correct answer: A central bank policy of purchasing financial assets (typically government bonds) to inject liquidity into the financial system, typically depressing bond yields and supporting asset prices
QE involves the central bank (e.g., Bank of England) creating money electronically to buy assets — primarily government bonds. This pushes up bond prices (depressing yields) and encourages investors to move into higher-risk assets, supporting equity and property prices.
Question 6: What is the 'Efficient Market Hypothesis' (EMH) and its three forms?
- A hypothesis that markets are always correctly valued; three forms: bull, bear, and neutral markets
- A hypothesis that asset prices fully reflect all available information; three forms: weak (historical prices), semi-strong (all public information), and strong (all information including insider) (Correct answer)
- A hypothesis that efficient managers always outperform; three forms: alpha, beta, and gamma
- A hypothesis about market regulation; three forms: conduct, prudential, and systemic
Correct answer: A hypothesis that asset prices fully reflect all available information; three forms: weak (historical prices), semi-strong (all public information), and strong (all information including insider)
EMH states that markets are informationally efficient — prices reflect available information. Weak form: prices reflect all historical price data. Semi-strong: prices reflect all publicly available information. Strong: prices reflect all information including private/insider information.
CISI IAD Advanced Investment Analysis 2
What is 'technical analysis' in investment management?