Certified Valuation Analyst (CVA) Practice Exam

When assessing risk for a new investment, which approach is most widely accepted?

1. Using historical returns as a benchmark

2. Adopting a risk-neutral perspective

3. Utilizing future projections only

4. Applying solely market trends without historical context

The correct answer is: Using historical returns as a benchmark

Using historical returns as a benchmark is a well-established method in investment analysis because it provides a tangible foundation for assessing potential future performance. Historical returns offer insights into how an investment has behaved under various market conditions, helping analysts to gauge volatility and risk. This long-term perspective allows investors to identify patterns, understand the likelihood of different return scenarios, and make informed decisions about risk tolerance. In contrast, adopting a risk-neutral perspective focuses solely on expected outcomes without accounting for the intrinsic risks involved. This can lead to an incomplete understanding of a potential investment's performance. Utilizing future projections only eliminates the valuable lessons learned from historical data, which can overestimate or underestimate future risks. Applying solely market trends without historical context risks overlooking how similar conditions historically impacted performance, which can mislead investors about the risk involved. Therefore, employing historical returns as a benchmark remains the most accepted approach to comprehensively assess risk for new investments.