NISM Series X-A Chapter 7: Introduction to Investments Practice Questions

Question 1

An analyst begins by scanning the macro-economic scenario, then identifies promising industries, and finally selects specific companies within those industries. This approach to fundamental analysis is known as:

Accepted Answer

Top-down approach.. The text explains: 'Scanning the macro-economic scenario and then identifying industries to choose from and zeroing in on companies, is the top-down approach.'

Question 2

What is the primary goal of fundamental analysis, according to the text?

Accepted Answer

To determine the intrinsic value of a stock based on underlying economic factors.. The text states, 'Fundamental analysis is the process of determining intrinsic value for the stock based on the fundamentals that drive its intrinsic value.'

Question 3

Which of the following statements about Market Risk is most accurate according to the text?

Accepted Answer

Beta is a proxy measure for market risk, which affects all listed assets and cannot be diversified away.. Section 8.3.1 states: 'Market risks arise due to the fluctuations in the prices of equity shares due to various market related dynamics. These factors affect all the listed, market-traded assets, irrespective of their business sector... Beta is a proxy measure for market risk. Market risks cannot be diversified away, though it can be hedged.'

Question 4

Compared to investments in unlisted companies, investments in listed companies are generally characterized by:

Accepted Answer

Higher liquidity and more regulation.. The text states, 'Investments in listed companies are relatively more liquid than investment in unlisted companies. Listed companies have to abide by the listing norms, making this investment space more regulated with better disclosures.'

Question 5

According to the text, what is the core belief of investors who engage in fundamental analysis regarding market price and intrinsic value?

Accepted Answer

Market price may differ from intrinsic value in the short term, but will eventually converge with it.. The text states, 'Investors who are engaged in fundamental analysis believe that intrinsic value may differ from the market price but eventually market price will merge with the intrinsic value.'

Question 6

What characterizes 'counter-cyclical' or 'defensive' businesses in relation to the overall business cycle?

Accepted Answer

They tend to perform better when the overall business cycle is in a trough.. The text defines them as: 'Some businesses may be at peak when the business cycle is in its trough... These products or businesses are called ‘counter-cyclical’ or defensive businesses. Businesses that do better in a recession are called ‘recession-proof’ businesses.'

Question 7

A risk that arises due to factors affecting the performance of businesses solely within a particular industry, and which can be diversified away by investing in different business sectors, is known as:

Accepted Answer

Sector specific risk. Section 8.3.2 states: 'Risks due to sector specific factors are not part of market risks. These risks can be diversified away by investing in different business sectors.'

Question 8

Which of the following scenarios best illustrates 'company specific risk' as described in the text?

Accepted Answer

A particular airline company facing bankruptcy due to poor management decisions, while other airlines in the same industry remain profitable.. The text defines company-specific risk as 'Risks arising due to factors that affect only the performance of a single company and other firms might not be affected by them.' The example provided is: 'Though, overall, the airline industry goes through turbulent times, time and again, certain airlines withstood the rough weather and other exited helplessly. Such corporate debacles are due to company specific factors.'

Question 9

What are the two primary benefits that investors who purchase equity shares typically look for?

Accepted Answer

Capital appreciation and dividend income.. The text states, 'Investors who purchase equity shares look for capital appreciation and dividend income.' It also clarifies there is no assurance of either

Question 10

Which of the following is a primary characteristic of equity securities from an investor's perspective?

Accepted Answer

Ownership in the company.. The text states, 'Equity securities are issued by companies providing ownership to the investor in their company.' Equity investors do not have contractual rights to interest payments, assured returns, or priority claims over debt holders

Question 11

Which type of risk, discussed in the context of equity investments, cannot be diversified away, though it can be hedged?

Accepted Answer

Market risk. The text explicitly states under 'Market risk' that 'Market risks cannot be diversified away, though it can be hedged.' Company specific risk and sector specific risk are described as risks that 'can be diversified away'. Transactional risk can be mitigated by transacting through a stock exchange

Question 12

An investor is utilizing a stock selection approach where they first analyze the overall economic scenario, then identify promising industries within that economy, and finally narrow down to specific companies within those industries. This approach is known as:

Accepted Answer

Top-down approach to fundamental analysis.. The text explains, 'Scanning the macro-economic scenario and then identifying industries to choose from and zeroing in on companies, is the top-down approach.'

Question 13

Which of the following statements accurately describes the claim of equity investors in a business?

Accepted Answer

Equity investors have a residual claim on the business's net assets.. The text states, 'Equity investors, also known as shareholders, have residual claim in the business.' It also clarifies that they are not lenders and the company is not contractually obligated to repay or make periodic payments

Question 14

Currency risk in financial markets primarily arises due to which of the following?

Accepted Answer

Uncontrollable, unpredictable, and volatile exchange rates, especially when international institutional investors are significant players.. Under 8.3.6 Currency Risk, the text states, 'Currency risk arises due to uncontrollable, unpredictable and volatile exchange rates of various pairs of currencies. When a significant proportion of players in a financial market belong to the international institutional investors groups, then that financial market is bound to be related to exchange rate movements.' Option A describes transactional risk, B describes market risk, and D describes company specific risk

Question 15

A financial analyst working for a large mutual fund generates investment recommendations that are circulated among the fund's top management and investment managers for internal consumption. This analyst is most likely engaged in what type of research, and what is a key expectation of their work?

Accepted Answer

Buy-side research; expected to be more accurate in their investment recommendations.. The text states: 'Buy-side analysts work for fund managers like those of mutual funds... These analysts generate investment recommendations for their internal consumption... Therefore, the buy-side researchers need to be more accurate and they are paid for their investment recommendations.'

Question 16

For equity investors, having a 'residual claim' on a business implies their claim is on:

Accepted Answer

The value of assets that remain after all company liabilities have been paid.. Footnote 8 in the text defines 'residual claim' as 'Claim on the company’s net assets, i.e. the value of assets after all liabilities have been paid.'

Question 17

A stock is described as having a 'high impact cost.' Based on the provided text, what does this imply about the stock?

Accepted Answer

It is less liquid, and a single large trade can move its price considerably.. The text states, 'The impact cost is the percentage price movement caused by a particular order size... Less liquid stocks are more thinly traded, and a single large trade can move their prices considerably. Such stocks have high impact costs.'

Question 18

Which of the following is NOT a characteristic of equity investments as described in the text?

Accepted Answer

The company is contractually obligated to repay the amount received from shareholders.. The text states: 'the company which issues equity securities, is not contractually obligated to repay the amount it receives from the shareholders.'

Question 19

The adage 'Don't put all your eggs in one basket' in the context of equity investments primarily refers to which risk mitigation strategy?

Accepted Answer

Diversification.. The text explicitly states this adage means 'a significant portion of risk can be reduced through diversification.'

Question 20

An investor expresses a strong desire for potentially higher returns, acknowledging that this might come with greater fluctuations and no guarantee of capital repayment or regular income. Based on the chapter's discussion of investment choices, which characteristic of equity investments directly addresses this investor's risk-return trade-off?

Accepted Answer

Equity investors have a residual claim and no contractual guarantee of repayment or regular payments, but benefit from all residual benefits.. The text states, 'Equity investors... have residual claim... not contractually obligated to repay... not contractually obligated to make periodic payments.' It also says, 'if they seek a higher returns they choose equity investment, but they may not be able to earn it without taking on the additional risk.' This combination means equity offers potential higher returns through residual benefits but without contractual guarantees, fitting the investor's profile

Question 21

Which of the following statements is TRUE regarding equity securities compared to debt securities?

Accepted Answer

Equity investors have a residual claim on the business.. As per the text, 'Equity investors, also known as shareholders, have residual claim in the business.' The other options describe features of debt securities or incorrect statements about equity

Question 22

An investor aiming to reduce risk by holding equities in many different kinds of businesses across various geographies at a single point in time is practicing which type of diversification?

Accepted Answer

Cross sectional risk diversification.. The text states, 'Cross sectional risk diversification is reducing risk by holding equities in many different kinds of businesses at a point in time and also across various geographies of the world.'

Question 23

What is the primary claim equity investors have on a business?

Accepted Answer

A residual claim on the business after all liabilities have been paid.. The text explicitly states, 'Equity investors, also known as shareholders, have residual claim in the business... i.e. the value of assets after all liabilities have been paid.'

Question 24

Which of the following risks cannot be diversified away through holding a portfolio of different stocks, but can be hedged?

Accepted Answer

Market risk. The text states, 'Market risks cannot be diversified away, though it can be hedged.' It also mentions that company-specific and sector-specific risks can be diversified away

Question 25

Compared to investments in unlisted companies, investments in listed companies generally offer which of the following advantages?

Accepted Answer

Greater liquidity and more regulated investment space with better disclosures.. The text states, 'Investments in listed companies are relatively more liquid than investment in unlisted companies. Listed companies have to abide by the listing norms, making this investment space more regulated with better disclosures.'

Question 26

Which of the following statements about Market Risk, as described in the text, is correct?

Accepted Answer

It affects all listed, market-traded assets, irrespective of their business sector.. The text defines Market risk as arising from 'fluctuations in the prices of equity shares due to various market related dynamics. These factors affect all the listed, market-traded assets, irrespective of their business sector.' It also states that 'Market risks cannot be diversified away'. Beta is a proxy for market risk, not company-specific risk

Question 27

What is a primary distinction between sell-side and buy-side analysts, according to the provided text?

Accepted Answer

Sell-side analysts are paid for providing broad guidance on multiple sectors, while buy-side analysts need to be more accurate and are paid for their specific investment recommendations for internal use.. The text states, "In essence the sell-side analysts are paid for providing useful information to be acted upon... the expectations from the sell-side research is broad guidance on multiple sectors, rather than accurate price predictions." For buy-side, it says, "Therefore, the buy-side researchers need to be more accurate and they are paid for their investment recommendations."

Question 28

For an investor seeking higher returns, which of the following investment choices is generally associated with taking on additional risk, as per the text?

Accepted Answer

Equity investments. The text states, 'However, if they seek a higher returns they choose equity investment, but they may not be able to earn it without taking on the additional risk of the equity investment.'

Question 29

An equity analyst is evaluating potential investments. They start by thoroughly analyzing the financial statements and management quality of individual companies. Based on promising company-specific factors, they then consider the industry outlook and finally the broader economic conditions that might affect these companies. This analytical approach is best described as a:

Accepted Answer

Bottom-up approach.. The text defines the bottom-up approach as 'Beginning at company-specific factors and moving up to the macro factors that impact the performance of the company'. The scenario perfectly matches this description

Question 30

Which of the following best describes the claim of equity investors on a company's assets?

Accepted Answer

They have a residual claim on the business.. According to the text, 'Equity investors, also known as shareholders, have residual claim in the business.' This means their claim is on the company’s net assets after all liabilities have been paid

Question 31

Among the following risks associated with equity investments, which one is explicitly stated as generally NOT being diversifiable away by investing in different companies or sectors?

Accepted Answer

Market risk. The text states, 'Market risks cannot be diversified away, though it can be hedged.' In contrast, it mentions that 'Sector specific risks...can be diversified away' and 'Company specific risk...can also be diversified away.' Transactional risk is mitigated by transacting through a stock exchange

Question 32

In fundamental analysis, what does the 'Top-Down approach' primarily involve?

Accepted Answer

Scanning the macro-economic scenario, then identifying industries, and finally selecting companies.. The text defines the top-down approach as 'Scanning the macro-economic scenario and then identifying industries to choose from and zeroing in on companies'

Question 33

The adage 'Don't put all your eggs in one basket' primarily relates to which concept in equity investments?

Accepted Answer

Diversification of risk. The text explicitly states, 'This is what the old adage ‘Don’t put all your eggs in one basket’ means' in the context of diversification and risk reduction

Question 34

The adage 'Don't put all your eggs in one basket' is used in the context of equity investments to explain the concept of:

Accepted Answer

Diversification. The text states, 'Conceptually, it is achieved due to the relatively less correlated behaviour of various business sectors which underlie each equity investment. This is what the old adage ‘Don’t put all your eggs in one basket’ means.' This directly refers to diversification

Question 35

Which of the following statements is TRUE regarding the characteristics of equity investors?

Accepted Answer

Equity investors have a residual claim on the business.. According to the text, 'Equity investors, also known as shareholders, have residual claim in the business.' Companies are not contractually obligated to repay equity investors or make periodic payments, unlike debt securities where investors are lenders

Question 36

Which of the following statements accurately describes a key characteristic of equity securities as an investment?

Accepted Answer

Equity investors, as owners, have a residual claim on the business and receive voting rights.. According to the text, equity investors have a residual claim in the business and get voting rights. The company is not contractually obligated to repay the amount or make periodic payments to shareholders. Equity investments are generally considered to have higher risk and seek higher returns than debt

Question 37

A financial advisor is explaining to a client that certain risks associated with equity investments cannot be diversified away, while others can. Which of the following risks, as per the text, cannot be diversified away?

Accepted Answer

Risks due to fluctuations in the prices of equity shares affecting all listed assets, irrespective of their business sector.. The text explicitly states under '8.3.1. Market risk' that "Market risks cannot be diversified away, though it can be hedged." Options A (Company specific risk) and B (Sector specific risk) are stated to be diversifiable. Option D (Transactional risk) is mitigated by transacting through a stock exchange, but the question asks about risks that *cannot* be diversified away in general

Question 38

The concept of 'time in the market' being suggested for equity investment as against 'timing the market' is most closely associated with which type of diversification?

Accepted Answer

Time series diversification. Under 8.2 Diversification, the text states, 'Reaping the benefits of time diversification requires investing in equities for a long period of time. The belief is that bad times will get cancelled out by good times. This is why “time in the market” is suggested for equity investment as against “timing the market”.'

Question 39

A financial analyst working for a mutual fund that purchases and sells securities for its own investment accounts is most likely a:

Accepted Answer

Buy-side analyst, generating recommendations for internal consumption.. The text states, 'Buy-side analysts work for fund managers like those of mutual funds... These analysts generate investment recommendations for their internal consumption viz. use by the fund managers within organization.' Sell-side analysts publish reports for external clients

Question 40

Based on the chapter text, how is liquidity risk in equity holdings primarily measured?

Accepted Answer

By the impact cost.. The text explicitly states under '8.3.5. Liquidity risk': 'Liquidity risk is measured by impact cost.'

Question 41

Which of the following statements accurately describes the fundamental difference between equity and debt securities?

Accepted Answer

Equity securities provide ownership in the company, whereas debt securities provide the rights of a lender.. According to the text, 'Equity securities are issued by companies providing ownership to the investor in their company, and Debt securities are issued by companies providing the rights of a lender to the investor.'

Question 42

An analyst begins their fundamental analysis by first scanning the overall macro-economic scenario, then identifying attractive industries, and finally selecting specific companies within those industries. This approach is known as:

Accepted Answer

Top-down approach. Section 8.5.2 states: 'Scanning the macro-economic scenario and then identifying industries to choose from and zeroing in on companies, is the top-down approach.'

Question 43

During a period of global travel restrictions, the airline and hospitality industries face significant challenges, leading to widespread decline in their stock values. However, within the same period, a specific airline company declares bankruptcy due to mismanagement and excessive debt. The decline in stock values across the entire airline and hospitality industries is an example of ________, while the bankruptcy of the specific airline is an example of ________.

Accepted Answer

Sector specific risk; Company specific risk. The text explains, 'Risks due to sector specific factors are not part of market risks... Say for instance there are restrictions on the movement of international tourists, the airline industry and hospitality industry are going to be affected.' This describes sector specific risk. For company specific risk, it states, 'Risks arising due to company specific factors... affect only the performance of a single company... Such corporate debacles are due to company specific factors.'

Question 44

Which of the following statements accurately describes the fundamental difference between equity securities and debt securities?

Accepted Answer

Equity securities provide ownership in a company, while debt securities provide the rights of a lender.. The text states: 'Equity securities are issued by companies providing ownership to the investor in their company, and Debt securities are issued by companies providing the rights of a lender to the investor.'

Question 45

An investor reduces risk by holding equities in many different kinds of businesses across various geographies at a single point in time. This strategy best exemplifies which type of diversification?

Accepted Answer

Cross sectional diversification. The text defines 'Cross sectional risk diversification' as 'reducing risk by holding equities in many different kinds of businesses at a point in time and also across various geographies of the world.'

Question 46

Which of the following best describes the 'Bottom-Up approach' to fundamental analysis?

Accepted Answer

Beginning analysis with company-specific factors and then moving up to macro factors.. The text states, "Beginning at company-specific factors and moving up to the macro factors that impact the performance of the company is called the bottom-up approach." Option A describes the top-down approach

Question 47

In the context of equity investments, what does 'cross-sectional risk diversification' primarily involve?

Accepted Answer

Reducing risk by holding equities in many different kinds of businesses and geographies at a point in time.. The text states, 'Cross sectional risk diversification is reducing risk by holding equities in many different kinds of businesses at a point in time and also across various geographies of the world.' Option A describes time diversification

Question 48

What is the primary principle behind time diversification in equity investments?

Accepted Answer

The belief that bad times in the market will eventually be offset by good times over a long period.. The text explains time diversification as 'Reaping the benefits of time diversification requires investing in equities for a long period of time. The belief is that bad times will get cancelled out by good times. This is why “time in the market” is suggested for equity investment as against “timing the market”.'

Question 49

Which of the following is a characteristic of equity investors in a company?

Accepted Answer

They have a residual claim in the business.. The text states, 'Equity investors, also known as shareholders, have residual claim in the business.' It also mentions they get voting rights and are not contractually obligated to receive periodic payments or repayment

Question 50

An analyst working for a mutual fund, generating investment recommendations for internal consumption by the fund managers within the organization, is typically performing which type of research?

Accepted Answer

Buy-side research. The text clarifies that 'Buy-side analysts work for fund managers like those of mutual funds... These analysts generate investment recommendations for their internal consumption viz. use by the fund managers within organization.' Sell-side analysts work for broking firms and publish reports externally

Ch.7: Introduction to Investments

What You Will Learn in This Chapter

Multiple Choice Questions (100)

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