RFC Investment Analysis & Selection 2 — Questions and Answers
Question 1: Which ratio measures a stock's price relative to its book value per share?
- Price-to-Earnings (P/E)
- Price-to-Book (P/B) (Correct answer)
- Price-to-Sales (P/S)
- Enterprise Value/EBITDA
Correct answer: Price-to-Book (P/B)
The Price-to-Book ratio compares a company's market capitalization to its net book value (assets minus liabilities).
Question 2: A bond with a coupon rate of 5% is trading at a premium. What does this imply about current market interest rates?
- They are above 5%
- They are below 5% (Correct answer)
- They equal 5%
- They are unrelated to the coupon rate
Correct answer: They are below 5%
A bond trades at a premium when its coupon rate exceeds current market rates, making it more attractive than newly issued bonds.
Question 3: In the context of the Capital Asset Pricing Model (CAPM), which component represents the reward for bearing systematic risk?
- Risk-free rate
- Market risk premium (Correct answer)
- Beta coefficient
- Alpha
Correct answer: Market risk premium
The market risk premium (expected market return minus the risk-free rate) compensates investors for taking on market-wide systematic risk.
Question 4: Which investment style focuses on companies whose stock prices appear below their intrinsic value?
- Growth investing
- Momentum investing
- Value investing (Correct answer)
- Index investing
Correct answer: Value investing
Value investing targets undervalued securities trading below their estimated intrinsic value, popularized by Benjamin Graham and Warren Buffett.
Question 5: The Sharpe ratio is BEST described as:
- Total return divided by beta
- Excess return per unit of total risk (Correct answer)
- Alpha divided by tracking error
- Dividend yield minus inflation rate
Correct answer: Excess return per unit of total risk
The Sharpe ratio measures excess return (above the risk-free rate) per unit of total (standard deviation) risk, rewarding efficient risk-taking.
Question 6: Which of the following is an example of unsystematic risk that can be reduced through diversification?
- Inflation risk
- Interest rate risk
- Key-person risk at a specific company (Correct answer)
- Recession risk
Correct answer: Key-person risk at a specific company
Unsystematic (company-specific) risk such as dependence on one executive can be diversified away, unlike market-wide systematic risks.
Question 7: Duration is MOST useful for measuring a bond's sensitivity to changes in:
- Credit quality
- Interest rates (Correct answer)
- Inflation expectations
- Currency exchange rates
Correct answer: Interest rates
Duration measures the weighted average time to receive a bond's cash flows and approximates the percentage price change for a 1% shift in interest rates.
RFC Investment Analysis & Selection 2
Which ratio measures a stock's price relative to its book value per share?