MS MS in Finance 2 — Questions and Answers
Question 1: What is 'diversification' in portfolio management?
- Spreading investments across assets to reduce unsystematic risk (Correct answer)
- Investing all capital in the highest-returning asset class
- Rebalancing a portfolio to maintain target allocations
- Converting domestic investments into foreign currency assets
Correct answer: Spreading investments across assets to reduce unsystematic risk
Diversification reduces portfolio risk by combining assets whose returns are not perfectly correlated, so losses in one position may be offset by gains in another.
Question 2: What does the Efficient Market Hypothesis (EMH) claim?
- Asset prices fully reflect all available information at any given time (Correct answer)
- Markets always reward fundamental analysis over technical analysis
- No investor can achieve positive returns in a bear market
- Government intervention always disrupts optimal market pricing
Correct answer: Asset prices fully reflect all available information at any given time
EMH holds that financial markets are informationally efficient — prices instantly incorporate all available information, making it impossible to consistently earn excess returns through analysis.
Question 3: Which ratio measures how much profit a company generates relative to shareholder equity?
- Return on Equity (ROE) (Correct answer)
- Price-to-Earnings ratio
- Debt-to-Equity ratio
- Current ratio
Correct answer: Return on Equity (ROE)
Return on Equity (ROE = Net Income / Shareholders' Equity) measures how efficiently management uses shareholder capital to generate profits.
Question 4: In bond pricing, what is the relationship between bond prices and interest rates?
- They move in opposite directions (inverse relationship) (Correct answer)
- They move in the same direction
- Bond prices are unaffected by interest rate changes
- The relationship depends on the bond's credit rating
Correct answer: They move in opposite directions (inverse relationship)
Bond prices and interest rates have an inverse relationship: when rates rise, existing bond prices fall because new bonds offer higher coupons, making old bonds less attractive.
Question 5: What is 'working capital' in corporate finance?
- Current assets minus current liabilities (Correct answer)
- Total assets minus total liabilities
- Long-term debt minus short-term debt
- Operating cash flow minus capital expenditures
Correct answer: Current assets minus current liabilities
Working capital (current assets − current liabilities) measures a company's short-term liquidity and its ability to meet near-term obligations with available liquid assets.
Question 6: Which valuation method estimates a company's value based on the present value of its projected future free cash flows?
- Discounted Cash Flow (DCF) analysis (Correct answer)
- Comparable company analysis
- Precedent transaction analysis
- Book value method
Correct answer: Discounted Cash Flow (DCF) analysis
DCF valuation discounts a company's projected future free cash flows back to the present using a required rate of return (discount rate), estimating intrinsic value.
MS MS in Finance 2
What is 'diversification' in portfolio management?