Steven Scott, CFA works at a wealth management company. He has been asked to ana

Question

Steven Scott, CFA works at a wealth management company. He has been asked to analyze a company, MS Global, a provider of internet services through business cloud services and digital media. He reads through various company reports to understand its business model. After completing his preliminary analysis, he mentions that the cash flow from operations is a function of the net income the company generates. He wants to analyze the relationship between stock returns and net income by using the following linear regression model: where CFO/S and NI/S are the ratio of cash flow from operations to sales and net income to sales. After analyzing the data, Scott observes that the observations have both small and large residual values. Scott decides to remove observations and keep the remaining observations. Peter Potter, Scott's co-worker disagrees with Scott's action and made the following statement: The standard error of estimates would most likely increase. The value of R-squared would most likely decrease. Is Potter correct in his statements regarding the removal of small residual values? A Yes BNo, with regard to standard error of estimates C No. with regard to R-squared

Explanation / Answer

here as if we know that std error is directly proportional to residuals average approximately

also R2 reduces as Sum of squared error increases with respect to sum of square of total

hence option A is correct

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