Certified Financial Analyst (CFA) Question
and Answers [100% Correct] 2024/2025
Latest Release
Explain the difference between intrinsic value and market value in equity valuation.
Intrinsic value refers to the perceived true worth of an asset based on fundamental analysis,
including cas...
Certified Financial Analyst (CFA) Question
and Answers [100% Correct] 2024/2025
Latest Release
Explain the difference between intrinsic value and market value in equity valuation.
Intrinsic value refers to the perceived true worth of an asset based on fundamental analysis,
including cash flows, growth prospects, and risk. Market value, on the other hand, is the price at which
the asset is currently traded in the market, which may be influenced by supply, demand, and investor
sentiment.
How does the dividend discount model (DDM) account for the time value of money?
The DDM accounts for the time value of money by discounting future dividend payments to their
present value using a discount rate, typically the required rate of return or cost of equity.
Describe the process of calculating the weighted average cost of capital (WACC) and its significance in
valuation.
WACC is calculated by taking the weighted average of the costs of equity and debt, proportionate
to their respective contributions to the total capital structure. It represents the minimum return a
company must earn to satisfy its investors and is crucial for investment appraisal and valuation.
What is the relationship between the capital asset pricing model (CAPM) and systematic risk?
CAPM quantifies the relationship between systematic risk and expected return by using the
formula: Expected Return = Risk-Free Rate + Beta × (Market Return - Risk-Free Rate). Beta measures the
asset's sensitivity to market movements, representing its systematic risk.
How does the arbitrage pricing theory (APT) differ from the CAPM in explaining asset returns?
Unlike CAPM, which uses a single factor (market risk), APT explains asset returns through multiple
macroeconomic factors, such as inflation, interest rates, and GDP growth. APT is more flexible but
requires identifying relevant risk factors.
Explain the difference between enterprise value (EV) and equity value.
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, EV represents the total value of a company’s operations, including equity, debt, and preferred
shares, minus cash and equivalents. Equity value is the value attributable to shareholders, derived by
subtracting debt and adding cash to the EV.
What is the significance of the efficient frontier in portfolio management?
The efficient frontier represents the set of optimal portfolios that offer the highest expected
return for a given level of risk. It helps investors select portfolios aligned with their risk tolerance and
return objectives.
How does a change in interest rates impact bond prices, and what is the role of duration?
Bond prices and interest rates have an inverse relationship. Duration measures a bond's
sensitivity to interest rate changes; higher duration implies greater price volatility with interest rate
fluctuations.
Describe how the Gordon growth model is used to value a stock with constant growth in dividends.
The Gordon growth model values a stock by dividing the expected dividend per share (next
period) by the difference between the required rate of return and the constant dividend growth rate: P =
D1 / (r - g).
What is the difference between variance and standard deviation in risk measurement, and which is more
practical?
Variance measures the dispersion of returns around the mean, while standard deviation is the
square root of variance, expressed in the same units as returns. Standard deviation is more practical as it
directly reflects risk in comparable terms.
How do you calculate free cash flow to equity (FCFE), and why is it important in valuation?
FCFE is calculated as Net Income + Depreciation - Capital Expenditures - Change in Working
Capital + Net Borrowing. It represents the cash flow available to equity shareholders after accounting for
all expenses and obligations, crucial for equity valuation.
What is the purpose of using Monte Carlo simulation in risk analysis?
Monte Carlo simulation assesses uncertainty by generating multiple scenarios of possible
outcomes using random inputs. It helps evaluate the potential range of returns and associated risks in
investment decision-making.
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