CFA Level 1 - Quantitative Methods Session 3 - Reading 12

CFA Level 1 - Quantitative Methods Session 3 - Reading 12 (Notes, Practice Questions, Sample Questions) 1. One of the underlying assumptions of technical analysis is that supply and demand is driven by: A)rational behavior during calm markets and irrational behavior during volatilemarkets.B)rational behavior only. C)both rational and irrational behavior. {Explanation: Successful technicalanalysis assumes both rational and irrational behavior during all marketconditions} 2. One of the assumptions of technical analysis is: A)all analysts have all current information.B)the market is efficient. C)supply and demand are driven by rational and irrational behavior.{Explanation: The market is driven by rational and irrational behavior} 3. A technical analyst believes stock prices are primarily driven by: A)specialist trading. B)market supply and demand forces. {Explanation: Other assumptions oftechnical analysis include:Supply and demand is driven by both rational and irrational behavior,security prices move in trends that persist for long periods of time, andwhile the cause for changes in supply and demand are difficult to

determine, the actual shifts in supply and demand can be observed inmarket price behavior} C)the random walk hypothesis. 4. Which of the following is least likely an underlying assumption of technical analysis? A)Prices are determined by supply and demand. B)Markets are efficient and all known information is reflected in prices.{Explanation: For technical analysis to succeed, markets must have someinefficiency in order for trends to develop} C)Supply and demand for a stock is driven by rational and irrational behavior. 5. The advantages of using technical analysis include: A)the incorporation of psychological reasons behind price changes.{Explanation: Technical analysis avoids having to use fundamental dataand adjusting for accounting problems, incorporates psychological as wellas economic reasons behind price changes, and tells WHEN to buy; notWHY investors are buying. Drawbacks include subjective interpretation ofcharts and graphs} B)ease in interpreting reasons behind stock price trends.C)complete objectivity. 6. When a relative strength ratio (stock price over market price) is increasing, the stock is: A)tracking the index.B)underperforming the index. C)outperforming the index. {Explanation: Relative strength: When pricesof an individual stock or industry change, it is difficult to tell if the changeis stock specific or caused by market movements. If two variables arechanging at the same rate, the ratio created by dividing one of the variablesby the other will remain constant. This is called the relative strength ratio.

Relative Strength = Stock Price / Market PriceIf the ratio increases over time the stock is out-performing the market (a +trend)If the ratio declines over time the stock is under-performing the market (a– trend)} 7. Closing prices for a commodity were 21.4 on Monday, 22.2 on Tuesday, 21.8 on Wednesday, 22.4 on Thursday, and 23.2 on Friday. The five-day standarddeviation is 0.7 and the 30-day standard deviation is 1.0. On Friday, five-dayBollinger bands using two standard deviations are closest to: A)24.6 and 21.8. B)23.6 and 20.8. {Explanation: Bollinger bands are drawn a chosen numberof standard deviations above and below a moving average, where themoving average and the standard deviation are calculated using the samenumber of periods. The 5-day moving average is (21.4 + 22.2 + 21.8 + 22.4 +23.2) / 5 = 22.2. Using two 5-day standard deviations, the upper band onFriday is 22.2 + 2(0.7) = 23.6 and the lower band is 22.2 − 2(0.7) = 20.8} C)24.2 and 20.2. 8. A technical analyst who identifies a decennial pattern and a Kondratieff wave most likely: A)believes market prices move in cycles. {Explanation: The decennialpattern and the Kondratieff wave are cycles of ten and 54 years,respectively. A technical analyst would be most likely to use these cycles tointerpret long-term charts of monthly or annual data. Presidential electionsin the United States are a possible explanation for a four-year cycle} B)is analyzing a daily or intraday price chart.C)associates these phenomena with U.S. presidential elections. 9. An Elliott wave theorist who forecasts prices based on Fibonacci ratios is most likely to predict that a corrective wave will be:

A)four-ninths the size of the impulse wave.B)six-elevenths the size of the impulse wave. C)five-eighths the size of the impulse wave. {Explanation: The sequence ofFibonacci numbers is 0, 1, 1, 2, 3, 5, 8, 13... . Five-eighths is a Fibonacciratio} 10. When technical analysts say a stock has good "relative strength," they mean the: A)recent trading volume in the stock has exceeded the normal trading volume.B)stock has performed well compared to other stocks in the same risk categoryas measured by beta. C)ratio of the price of the stock to a market index has trended upward.{Explanation: This is the definition of relative strength. When the ratio ofthe stock price to the market price increases over time, the stock isout-performing the market} 11. The most appropriate tool to use for intermarket analysis of two different asset classes is a: A)stochastic oscillator.B)moving average convergence/divergence chart. C)relative strength chart. {Explanation: Relative strength charts are usefulfor intermarket analysis because they illustrate the performance of oneasset, sector, or index relative to another. Momentum indicators, such asstochastic oscillators and MACD oscillators, are generally used to analyzeindividual markets}