GMAT Reading Comprehension - One Basic Assumption Lies at the Root of all Security Analysis

Reading Passage Question

One basic assumption lies at the root of all security analysis: required financial statements balance sheets, earnings statements, quarterly reports provide information that is meaningful but potentially misleading. The Generally Accepted Accounting Principles (GAAP) offer accountants a wide latitude, with the result that two companies with equivalent production and earnings figures can appear remarkably different based on how each firm chooses to represent itself in statements of earnings and net worth.

Many say that it is a waste of time to stumble through the labyrinth of a companys financial statements. Statistics show that a companys past earnings are not predictive of future earnings and, even if they were, an efficient market would already reflect the change in valuation by affecting the price of the companys stock. The Financial Accounting Standards Board (FASB) argues otherwise: financial statements are not intended to give an indication of value otherwise unavailable to the common stockholder, but rather to give an indication of causality. The FASB believes that if stockholders can understand the effect of corporate strategies and external events on a stock, they can more accurately watch for the recurrence of these or similar events and plan sales or purchases accordingly. Financial statements provide such information.

However long this debate continues will be determined by how useful corporations find the reports in pleasing stockholders and how well the evidence of stock market trends reflects the predictions made in the reports. Complicating this prognosis is the average corporations unwillingness to present a less than rosy picture of its financial situation alongside the many independent factors that affect market volatility.

“One basic assumption lies at the root of all security analysis.”- is a comprehension passage with answers. Candidates need a strong knowledge of English GMAT reading comprehension.

This GMAT Reading Comprehension consists of 4 comprehension questions. The GMAT Reading Comprehension questions are designed for the purpose of testing candidates’ abilities in understanding, analyzing, and applying information or concepts. Candidates can actively prepare with the help of GMAT Reading Comprehension Practice Questions.

Solution and Explanation

1. The passage is primarily concerned with

1. arguing for a reexamination of a previously-held belief
2. explaining the relative merits of two opposing positions
3. revisiting an old question concerning a company's value
4. informing the reader of two similar positions
5. questioning the basis of an accepted piece of wisdom

2. The function of the second paragraph is to

1. argue against the use of the GAAP-supported accounting methods mentioned in the first paragraph
2. present an assessment of the usefulness of the GAAP guidelines presented in the first paragraph
3. support the view described in the first paragraph
4. introduce a new point of view that disagrees with the main point presented in the first paragraph
5. indicate an alternative to the points of view presented in the first and third paragraphs

3. The passage suggests that two companies with similar GAAP-acceptable balance sheets and earnings statements

1. must be similar in product and structure
2. are useful benchmarks to predict future earnings
3. may have chosen to represent themselves in similar ways
4. can exercise many prerogatives in operating their companies
5. are required to structure themselves differently

4. The members of the FASB and their critics disagree about

1. acceptable sources of financial statements
2. the usefulness of financial statements as predictors of future earnings
3. the history of financial statements
4. the accuracy of financial statements
5. the best method of interpreting financial statements

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