CPM Equity Portfolio Management 2 — Questions and Answers
Question 1: Dividend discount models (DDM) value a stock based on:
- Current book value
- The present value of all expected future dividend payments (Correct answer)
- Historical price trends
- Quarterly earnings surprises
Correct answer: The present value of all expected future dividend payments
The DDM values a stock as the present value of its expected future dividends, discounted at the required rate of return, making it appropriate for dividend-paying companies.
Question 2: Which of the following describes a long/short equity strategy?
- Buying equities and holding cash
- Simultaneously buying stocks expected to outperform and short-selling stocks expected to underperform (Correct answer)
- Investing only in small-cap stocks
- Replicating an equity index using derivatives
Correct answer: Simultaneously buying stocks expected to outperform and short-selling stocks expected to underperform
Long/short equity strategies take long positions in stocks expected to rise and short positions in stocks expected to fall, aiming to generate returns with reduced market exposure.
Question 3: The price-to-book (P/B) ratio is particularly useful for analyzing:
- Technology companies with few tangible assets
- Financial institutions where book value reflects asset quality (Correct answer)
- High-growth startup companies
- Companies with negative earnings
Correct answer: Financial institutions where book value reflects asset quality
The P/B ratio is most applicable to financial companies (banks, insurance firms) where the balance sheet closely represents actual asset values and book value is a meaningful metric.
Question 4: Which of the following events would most likely cause a large-cap growth stock's P/E ratio to compress?
- An earnings beat that exceeds expectations
- Rising interest rates that increase the discount rate applied to future earnings (Correct answer)
- A stock buyback announcement
- A dividend initiation
Correct answer: Rising interest rates that increase the discount rate applied to future earnings
P/E ratios compress when discount rates rise (often due to higher interest rates), as the present value of future earnings falls, making investors less willing to pay a high multiple.
Question 5: Which equity management style is most likely to have the lowest portfolio turnover?
- High-frequency trading
- Momentum investing
- Long-term fundamental value investing (Correct answer)
- Market timing strategies
Correct answer: Long-term fundamental value investing
Long-term fundamental value investing holds stocks until they reach intrinsic value, resulting in low portfolio turnover and lower transaction costs compared to momentum or tactical strategies.
Question 6: Sector rotation is an active equity strategy that involves:
- Holding equal weights in all sectors permanently
- Shifting portfolio weights among sectors based on where the economy is in the business cycle (Correct answer)
- Buying every stock in the index
- Eliminating international exposure
Correct answer: Shifting portfolio weights among sectors based on where the economy is in the business cycle
Sector rotation overweights sectors expected to outperform in the current or anticipated phase of the business cycle (e.g., overweighting consumer staples during recessions) and underweights others.
CPM Equity Portfolio Management 2
Dividend discount models (DDM) value a stock based on: