Chartered Financial Analyst (CFA) Level 1 Practice Exam

What do valuation ratios measure?

1. The quantity of an asset or flow associated with ownership of a specified claim

2. The total debt to equity of a company

3. The profitability of a company's operations

4. The market perception of a company's growth potential

The correct answer is: The quantity of an asset or flow associated with ownership of a specified claim

Valuation ratios primarily focus on assessing the relative value of a company's stock, and they are designed to provide insights into the present and future value of a company's claims. They measure the relationship between a company's current share price and its fundamentals, such as earnings, sales, and book value. The essence of valuation ratios lies in understanding how much investors are willing to pay for each unit of these financial metrics, allowing them to gauge the company's overall attractiveness compared to its peers or the market overall. For instance, common valuation ratios include the price-to-earnings (P/E) ratio, price-to-book (P/B) ratio, and price-to-sales (P/S) ratio. In the context provided, the reference to "the quantity of an asset or flow associated with ownership of a specified claim" captures the core concept of what a valuation ratio achieves: it relates asset value or financial metric flow to ownership in a company. Thus, the correct understanding of valuation ratios encompasses their role in revealing how the market values the claims associated with ownership of the business, captured through various financial performance measures. The other choices pertain to different financial metrics or aspects of a company's performance. For instance, total debt to equity reflects the leverage and risk profile of the