Stock Broker Portfolio Analysis & Risk Management 2 — Questions and Answers
Question 1: What is the 'price-to-earnings (P/E) ratio' and how is it used in stock valuation?
- A company's profit margin relative to sales
- A stock's current price divided by its earnings per share; used to assess whether a stock is over- or undervalued relative to peers (Correct answer)
- A bond's price relative to its coupon payment
- A company's debt relative to its earnings
Correct answer: A stock's current price divided by its earnings per share; used to assess whether a stock is over- or undervalued relative to peers
The P/E ratio compares a stock's market price to its earnings per share, providing a quick measure of how much investors are paying per dollar of earnings; higher P/E may indicate growth expectations or overvaluation.
Question 2: What is 'rebalancing' a portfolio and why is it done?
- Switching all investments to bonds when markets are volatile
- Periodically adjusting a portfolio back to its target asset allocation after market movements cause drift (Correct answer)
- Adding more money to the best-performing assets
- Selling all underperforming investments annually
Correct answer: Periodically adjusting a portfolio back to its target asset allocation after market movements cause drift
Portfolio rebalancing involves selling assets that have grown above their target allocation and buying those that have fallen below, restoring the original intended risk profile and asset mix.
Question 3: What is 'standard deviation' as a measure of investment risk?
- The average annual return over a 10-year period
- A statistical measure of how much returns deviate from their average, indicating the investment's volatility (Correct answer)
- The maximum loss an investment has experienced
- The correlation between two investments
Correct answer: A statistical measure of how much returns deviate from their average, indicating the investment's volatility
Standard deviation measures the dispersion of an investment's returns around its average (mean) return, with higher standard deviation indicating greater volatility and uncertainty in future returns.
Question 4: What is 'asset allocation' and how does it relate to an investor's risk tolerance?
- Selecting individual stocks within a sector
- Deciding how to distribute investments among asset classes (stocks, bonds, cash) based on goals, time horizon, and risk tolerance (Correct answer)
- Timing the market to buy at the lowest price
- Choosing between domestic and international stocks only
Correct answer: Deciding how to distribute investments among asset classes (stocks, bonds, cash) based on goals, time horizon, and risk tolerance
Asset allocation is the strategic distribution of investments across major asset classes; an investor's risk tolerance, time horizon, and goals determine the mix — aggressive investors hold more equities, conservative investors hold more bonds and cash.
Question 5: What is 'dollar-cost averaging' (DCA) as an investment strategy?
- Always investing at market lows using technical analysis
- Investing a fixed dollar amount at regular intervals regardless of price, buying more shares when prices are low and fewer when high (Correct answer)
- Averaging the purchase prices of multiple stocks in a sector
- Maintaining equal dollar amounts in each investment at all times
Correct answer: Investing a fixed dollar amount at regular intervals regardless of price, buying more shares when prices are low and fewer when high
Dollar-cost averaging involves investing a fixed dollar amount on a regular schedule, automatically buying more shares when prices are low and fewer when prices are high, reducing the impact of volatility.
Question 6: What is the difference between 'growth investing' and 'value investing'?
- Growth investing buys bonds; value investing buys stocks
- Growth investing targets companies expected to grow faster than average; value investing targets stocks trading below their intrinsic value (Correct answer)
- Growth investing is long-term; value investing is short-term
- Growth investors diversify; value investors concentrate in one sector
Correct answer: Growth investing targets companies expected to grow faster than average; value investing targets stocks trading below their intrinsic value
Growth investors seek companies with above-average earnings growth potential (often with high P/E ratios), while value investors seek companies whose stocks trade below their estimated intrinsic value, often indicated by low P/E or P/B ratios.
Stock Broker Portfolio Analysis & Risk Management 2
What is the 'price-to-earnings (P/E) ratio' and how is it used in stock valuation?