📘 CFA Level 1 Equity Investments MCQs (Part 3: Q101–150)
101. Which of the following best describes the weak form of the Efficient Market Hypothesis (EMH)?
A) Security prices reflect all past market data.
B) Security prices reflect all public information.
C) Security prices reflect all information, public and private.
D) Security prices are random and unpredictable.
Answer: A
Explanation: The weak form of EMH asserts that current prices incorporate all past price and volume data. Technical analysis is ineffective under this form.
102. Semi-strong form market efficiency implies that:
A) Technical analysis is useful.
B) Fundamental analysis cannot consistently achieve abnormal returns.
C) Insider trading provides no advantage.
D) Historical price data is irrelevant but financial statements are not.
Answer: B
Explanation: Semi-strong form EMH holds that all public information is reflected in prices. Hence, fundamental analysis cannot consistently outperform the market.
103. Which of the following is a limitation of the price-to-earnings (P/E) ratio?
A) It ignores the impact of dividends.
B) It cannot be applied to firms with negative earnings.
C) It assumes all companies pay dividends.
D) It is unaffected by accounting choices.
Answer: B
Explanation: Firms with negative earnings produce a meaningless or negative P/E ratio, making it difficult to use for valuation.
104. According to behavioral finance, investors often exhibit “loss aversion,” which means:
A) They prefer losses to gains.
B) They weigh losses more heavily than equivalent gains.
C) They avoid risky assets entirely.
D) They follow market trends blindly.
Answer: B
Explanation: Loss aversion is the tendency to feel the pain of losses more strongly than the pleasure of equal gains, leading to irrational decision-making.
105. A company has a dividend payout ratio of 40% and a return on equity (ROE) of 12%. What is its sustainable growth rate?
A) 4.8%
B) 7.2%
C) 12%
D) 40%
Answer: B
Explanation: Sustainable growth rate = ROE × Retention ratio = 12% × (1 – 0.40) = 12% × 0.60 = 7.2%.
106. The Gordon Growth Model is most appropriate for valuing:
A) Firms with irregular dividend patterns.
B) Growth firms that pay no dividends.
C) Mature firms with stable dividend growth.
D) Start-up companies.
Answer: C
Explanation: The Gordon Growth Model assumes dividends grow at a constant rate, best applied to stable, mature firms.
107. A higher price-to-book (P/B) ratio typically indicates:
A) A firm is undervalued relative to assets.
B) Investors expect strong future profitability.
C) The firm is close to liquidation.
D) The company has negative earnings.
Answer: B
Explanation: A high P/B ratio suggests investors believe the firm will generate returns above its book value, indicating confidence in future profitability.
108. Which of the following is an advantage of using the price-to-sales (P/S) ratio?
A) It is unaffected by accounting choices.
B) It can be applied even when earnings are negative.
C) It always predicts stock performance.
D) It is not influenced by revenue recognition policies.
Answer: B
Explanation: Unlike P/E ratios, the P/S ratio can be applied when earnings are negative, making it useful for evaluating unprofitable firms.
109. An index fund that replicates the S&P 500 operates under the assumption of:
A) Inefficient markets.
B) Semi-strong form market efficiency.
C) Technical analysis superiority.
D) Insider trading inefficiency.
Answer: B
Explanation: Index funds assume prices reflect all publicly available information (semi-strong efficiency), making active management unnecessary.
110. Which of the following is most likely a violation of the CFA Institute’s Code of Ethics in equity research?
A) Recommending a stock based on public company reports.
B) Trading on material nonpublic information.
C) Relying on technical indicators.
D) Using discounted cash flow models.
Answer: B
Explanation: Trading on material nonpublic information (insider trading) violates both securities law and CFA ethical standards.
111. Which type of index is most likely weighted by market capitalization?
A) Dow Jones Industrial Average
B) S&P 500
C) Equal-weighted index
D) Price-weighted index
Answer: B
Explanation: The S&P 500 is a market-cap weighted index, meaning larger companies have a greater influence on the index performance.
112. Which of the following would most likely reduce a firm’s P/E ratio?
A) Rising earnings growth expectations
B) Decline in interest rates
C) Higher perceived risk of the firm
D) Higher dividend payout ratio
Answer: C
Explanation: Higher risk increases the discount rate applied to future earnings, lowering the P/E ratio.
113. The “top-down” approach to equity valuation begins with:
A) Firm-specific financials
B) Global economic trends
C) Industry-level analysis
D) Dividend history
Answer: B
Explanation: Top-down analysis starts from the global economy → industry → firm, capturing broad trends first.
114. The “bottom-up” approach to equity analysis is most likely to:
A) Rely on macroeconomic forecasts
B) Focus on individual company fundamentals
C) Ignore company-specific information
D) Exclude industry factors
Answer: B
Explanation: Bottom-up focuses on analyzing company-specific data such as financials, management quality, and competitive position.
115. Which valuation method is most suitable for companies with irregular cash flows?
A) Gordon Growth Model
B) Free Cash Flow to Equity (FCFE) model
C) Dividend Discount Model
D) Price-to-earnings ratio
Answer: B
Explanation: FCFE is useful for firms that may not pay dividends or have unstable dividend patterns, as it values equity using projected free cash flows.
116. An active portfolio manager consistently underperforms the market index after adjusting for risk. This most strongly supports:
A) Strong form market efficiency
B) Semi-strong form efficiency
C) Inefficient market hypothesis
D) Arbitrage Pricing Theory (APT)
Answer: B
Explanation: Underperformance of active managers relative to passive indices is consistent with semi-strong efficiency, where public information is already reflected in prices.
117. Which of the following is most likely to cause a stock to appear undervalued relative to its intrinsic value?
A) Investor overreaction
B) Efficient market adjustment
C) Accurate analyst forecasts
D) Constant dividend growth
Answer: A
Explanation: Behavioral biases, such as overreaction, can cause mispricing where stocks trade below intrinsic value, creating opportunities.
118. Which statement about Exchange-Traded Funds (ETFs) is correct?
A) They can only be traded at market close.
B) They usually have higher fees than mutual funds.
C) They are passively managed and trade like stocks.
D) They are illiquid and rarely traded.
Answer: C
Explanation: ETFs typically track an index passively, trade on exchanges like stocks, and often have lower fees compared to mutual funds.
119. Which is the main advantage of using the price-to-cash-flow (P/CF) ratio?
A) It is less affected by accounting choices than earnings.
B) It is more stable than sales.
C) It ignores working capital needs.
D) It is irrelevant for unprofitable companies.
Answer: A
Explanation: P/CF ratios are preferred because cash flow is less susceptible to manipulation than net income.
120. Which of the following is a limitation of the Dividend Discount Model (DDM)?
A) It cannot value firms that pay stable dividends.
B) It assumes dividend growth is zero.
C) It is sensitive to small changes in growth rate assumptions.
D) It applies only to private companies.
Answer: C
Explanation: The DDM is highly sensitive to small changes in estimated growth rates or required returns, making valuations unstable.
121. A portfolio manager uses momentum strategies to buy stocks that have recently increased in price. This approach contradicts:
A) Weak-form EMH
B) Semi-strong EMH
C) Strong-form EMH
D) Behavioral finance
Answer: A
Explanation: If weak-form EMH holds, past price trends (momentum) should provide no predictive power for future returns.
122. A company has an ROE of 15% and retains 70% of its earnings. What is its sustainable growth rate?
A) 4.5%
B) 10.5%
C) 15%
D) 21%
Answer: B
Explanation: Sustainable growth rate = ROE × retention ratio = 15% × 0.70 = 10.5%.
123. Which valuation model incorporates both earnings and book value?
A) Residual Income Model
B) Gordon Growth Model
C) Price-to-sales ratio
D) Free Cash Flow to Equity model
Answer: A
Explanation: The Residual Income Model adds economic profit (earnings – cost of equity) to the book value of equity.
124. In behavioral finance, “herding” refers to:
A) Independent rational decision-making
B) Investors following the crowd
C) Contrarian investing
D) Over-diversification
Answer: B
Explanation: Herding occurs when investors mimic the actions of the majority, often leading to asset bubbles.
125. A high dividend payout ratio usually signals:
A) Strong growth opportunities
B) Low reinvestment needs
C) High return on equity
D) High sustainable growth rate
Answer: B
Explanation: Firms with limited reinvestment opportunities tend to distribute more of their earnings as dividends.
126. Which of the following is NOT an assumption of the Constant Dividend Growth Model?
A) Dividends grow at a constant rate forever.
B) Growth rate is less than the required return.
C) Earnings grow faster than dividends.
D) Dividends are the only return to shareholders.
Answer: C
Explanation: The model assumes dividends and earnings grow at the same constant rate; faster growth in earnings breaks the assumption.
127. Which equity valuation approach is most appropriate for young companies with unpredictable earnings?
A) Dividend Discount Model
B) Price-to-earnings ratio
C) Free Cash Flow to Equity model
D) Gordon Growth Model
Answer: C
Explanation: Young firms may not pay dividends; using FCFE allows valuation based on future cash flows available to equity holders.
128. Which measure best captures shareholder wealth creation?
A) Net income
B) Economic Value Added (EVA)
C) Dividend payout ratio
D) Book value per share
Answer: B
Explanation: EVA measures economic profit, reflecting whether the firm generates returns above the cost of capital, directly linked to shareholder value creation.
129. An investor believes the market is not fully efficient and attempts to profit using insider information. This violates:
A) Semi-strong form EMH
B) Weak-form EMH
C) Strong-form EMH
D) Random walk theory
Answer: C
Explanation: Strong-form EMH assumes even insider information is reflected in stock prices. Using such info contradicts this assumption.
130. Which of the following is most likely to increase a firm’s intrinsic value under the Dividend Discount Model?
A) Lower dividend payout ratio
B) Higher required rate of return
C) Lower dividend growth rate
D) Higher expected dividend growth
Answer: D
Explanation: Higher expected dividend growth increases future dividend projections, thereby raising intrinsic value.
131. Which type of stock is most sensitive to changes in interest rates?
A) Growth stocks
B) Defensive stocks
C) Value stocks
D) Cyclical stocks
Answer: A
Explanation: Growth stocks are valued based on expected future earnings. Since these cash flows are further in the future, they are more sensitive to interest rate changes.
132. A company is trading below book value. This most likely indicates:
A) Strong growth potential
B) Overvaluation by the market
C) Market skepticism about asset quality
D) Efficient market hypothesis holds
Answer: C
Explanation: When stock price < book value, investors may doubt the true economic value of assets or future profitability.
133. Which index is price-weighted?
A) NASDAQ Composite
B) Russell 2000
C) Dow Jones Industrial Average (DJIA)
D) S&P 500
Answer: C
Explanation: The DJIA is a price-weighted index, giving greater weight to higher-priced stocks regardless of market capitalization.
134. In efficient markets, technical analysis is least likely to be effective under which form?
A) Weak form
B) Semi-strong form
C) Strong form
D) All forms
Answer: A
Explanation: Weak-form EMH states that past price/volume data cannot predict future prices, making technical analysis ineffective.
135. Which valuation metric is most useful for comparing firms with negative earnings?
A) Price-to-book (P/B) ratio
B) Price-to-earnings (P/E) ratio
C) Dividend yield
D) Residual income model
Answer: A
Explanation: P/B ratio remains useful even when earnings are negative, unlike P/E which becomes meaningless.
136. Which of the following is an advantage of sector rotation strategies?
A) Ignores macroeconomic cycles
B) Capitalizes on business cycle phases
C) Eliminates company-specific risk
D) Guarantees positive returns
Answer: B
Explanation: Sector rotation strategies shift investments across industries to benefit from different stages of the business cycle.
137. Which is NOT an advantage of ETFs?
A) Low expense ratios
B) Intraday trading flexibility
C) Guaranteed positive returns
D) Transparency of holdings
Answer: C
Explanation: ETFs provide low cost and flexibility, but returns are not guaranteed.
138. Which model is most appropriate for valuing a dividend-paying company with stable growth?
A) Two-stage growth model
B) Gordon Growth Model
C) FCFE model
D) Residual income model
Answer: B
Explanation: The Gordon Growth Model works well for mature firms with stable dividends and constant growth.
139. A company increases its dividend payout ratio. This will most likely:
A) Increase the firm’s sustainable growth rate
B) Reduce funds available for reinvestment
C) Increase retained earnings
D) Raise future ROE
Answer: B
Explanation: Higher dividend payout reduces retained earnings, leaving fewer funds for reinvestment.
140. Which behavioral bias refers to investors holding losing stocks too long and selling winners too early?
A) Anchoring
B) Loss aversion
C) Herding
D) Overconfidence
Answer: B
Explanation: Loss aversion leads investors to avoid realizing losses, even when it is rational to sell.
141. Which valuation model explicitly considers the cost of equity?
A) Residual Income Model
B) Gordon Growth Model
C) P/E multiple
D) Price-to-sales ratio
Answer: A
Explanation: Residual income subtracts the cost of equity from net income, making it sensitive to required returns.
142. A stock has a beta of 1.5. If the market return rises by 10%, the stock is expected to:
A) Rise by 5%
B) Rise by 10%
C) Rise by 15%
D) Rise by 20%
Answer: C
Explanation: With β = 1.5, the stock is expected to move 1.5× the market. 10% × 1.5 = 15%.
143. Which of the following would decrease a stock’s intrinsic value under DDM?
A) Higher dividend growth
B) Lower discount rate
C) Higher required rate of return
D) Higher expected dividend payout
Answer: C
Explanation: A higher required return reduces the present value of future dividends, lowering intrinsic value.
144. Which type of analysis is most focused on company-specific financials?
A) Technical analysis
B) Fundamental analysis
C) Macroeconomic analysis
D) Industry analysis
Answer: B
Explanation: Fundamental analysis evaluates financial statements, management, and business performance at the firm level.
145. An equal-weighted index requires:
A) Frequent rebalancing
B) No adjustments
C) Higher weight for large-cap firms
D) Dependence on stock prices
Answer: A
Explanation: Equal-weighted indexes need rebalancing to ensure each stock maintains equal influence.
146. A firm has a payout ratio of 40%, ROE of 12%, and retains 60%. What is its sustainable growth rate?
A) 4.8%
B) 6.8%
C) 7.2%
D) 8.0%
Answer: C
Explanation: SGR = ROE × retention ratio = 12% × 0.60 = 7.2%.
147. Which is the biggest limitation of relative valuation using multiples (P/E, P/B)?
A) Simplicity
B) Market mispricing can distort comparisons
C) Widely accepted
D) Ease of communication
Answer: B
Explanation: Relative valuation depends on peer multiples, which can be distorted if the whole sector is mispriced.
148. Which behavioral bias leads investors to overweight recent information?
A) Representativeness
B) Availability bias
C) Overconfidence
D) Herding
Answer: B
Explanation: Availability bias occurs when investors give too much weight to recent or easily recalled events.
149. Which index is most likely to include small-cap firms?
A) Dow Jones Industrial Average
B) S&P 500
C) Russell 2000
D) Nikkei 225
Answer: C
Explanation: The Russell 2000 focuses on small-cap companies in the U.S.
150. A portfolio manager who believes in semi-strong EMH would most likely:
A) Use insider trading to beat the market
B) Rely on technical analysis
C) Prefer passive investment strategies
D) Depend heavily on public information analysis
Answer: C
Explanation: Semi-strong EMH suggests that all public info is already reflected in prices, making passive strategies most rational.
- CFA Level 1 Equity Investments Part 2 (Q51–100)
- CFA Level 1 Equity Investments Part 1 (Q1–50)
- CFA Level 1 Ethics
- CFA Level 1 Quantitative Methods
- CFA Level 1 Financial Reporting & Analysis
- CFA Level 1 Economics MCQs
- CFA Level 1 Corporate Finance MCQs