CFA Final Set

The full price of a bond: A) includes accrued interest. B) includes commissions and taxes. C) is also known as the "clean" price.

Answer A. The full price is clean price plus accrued interest. For Further Reference: Study Session 15, LOS 53.d SchweserNotes: Book 5, p.46 CFA Program Curriculum: Vol.5 p.401

Which of the following items is least likely to contain details about various accruals, adjustments, balances, and management assumptions? A) Income statement. B) Supplementary schedules. C) Discussion and analysis by management.

Answer A. The income statement reports the amounts for each of the major line items within the general categories of revenues and expenses. The various accruals, adjustments, and management assumptions are implicit in the reported amounts but are not specifically explained in the income statement. Much of the detail contained in various accruals, adjustments, and management assumptions that go into the financial statements can be found in the footnotes to the statements and Management's Discussion and Analysis. Supplementary schedules contain additional information, including a more detailed breakdown of certain large account balances. For Further Reference: Study Session 7, LOS 22.c SchweserNotes: Book 3, p.12 CFA Program Curriculum: Vol.3 p.24

Martin Gomez holds 100 shares of each of the stocks in a price-weighted index and reinvests cash dividends in additional shares. Assuming there are no stock splits, stock dividends, or changes in the makeup of the index, how will Gomez's portfolio return compare with the price return of the index if the low-priced index stocks outperform the high-priced index stocks? A) Gomez's portfolio return will be higher. B) The price return of the index will be higher . C) Gomez's portfolio return will be equal to the price return of the index.

Answer A. The price return on the index does not include cash dividends. Since the reinvested dividends will add to the number of shares of those stocks that pay dividends, Gomez's portfolio return (total return) will be higher than the price return on the index. The relative performance of high-priced and low-priced stocks does not affect this result. For Further Reference: Study Session 13, LOS 46.b SchweserNotes: Book 4, p.228 CFA Program Curriculum: Vol.5 p.79

Martin Dean, CFA, is a portfolio manager who is writing an investment policy statement (IPS) for Albert Francis, a new client. The least likely reason why Dean should prepare an IPS is to: A) set the target asset allocation for Francis's portfolio. B) comply with the Code and Standards with regard to suitability. C) specify a benchmark against which to measure Dean's performance.

Answer A. An IPS requires an investor to consider and articulate his objectives and constraints. It also provides an objective standard by which the portfolio's performance will be judged by specifying a benchmark portfolio. Guidance for Standard III(C) Suitability requires members to prepare IPS when beginning advisory relationships with clients. Asset allocation is determined after strategy is developed and capital market conditions are assessed. For Further Reference: Study Session 12, LOS 41.d SchweserNotes: Book 4, p.127 CFA Program Curriculum: Vol.4 p.250

Ed Verdi has a long position in a European put option on a stock. At expiration, the stock price is greater than the exercise price. The value of the put option to Verdi on its expiration date is: A) zero. B) positive. C) negative.

Answer A. At expiration, the value to the holder (long position) of a put option on a stock is the greater of zero or the exercise price minus the stock price. If the stock price is greater than the exercise price, the value of a put option to the holder is zero and the holder will allow the option to expire unexercised.

Clement Company has revalued an intangible asset with an indefinite life upward by 25 million. In its financial statements, Clement will most likely: A) disclose how it determined the fair value of the intangible asset. B) report lower net income in subsequent periods because of increased amortization expense on the asset. C) report higher assets, net income, and shareholders' equity in the most recent period than it would have reported under the cost model.

Answer A. For firms that revalue assets upward, IFRS requires disclosure of the date the asset was revalued, how management determined its fair value, the asset's carrying value using the historical cost model, and (for intangible assets) whether the asset's useful life is finite or indefinite. Although assets and shareholders' equity will increase as a result of the revaluation, net income will not increase. The increase in the value of the asset is reported as a revaluation surplus in shareholders' equity. Amortization expense will not increase because indefinite-lived intangible assets are not amortized. For Further Reference: Study Session 9, LOS 30.e, g, j SchweserNotes: Book 3, p.216, 218, 221 CFA Program Curriculum: Vol.3 p.444, 445, 453

Three years ago, the U.S. dollar/euro exchange rate was 1.32 USD/EUR. Over the last three years, the price level in the United States has increased by 18%, and the price level in the eurozone has increased by 12%. If the current exchange rate is 1.40 USD/EUR, the real exchange rate over the period has: A) increased, and eurozone goods are now more expensive to U.S. consumers. B) decreased, and eurozone goods are now more expensive to U.S. consumers. C) increased, and U.S. goods are now more expensive to eurozone consumers.

Answer A. For the base period, three years ago, the real exchange rate is the same as the nominal exchange rate, 1.32 USD/EUR. The real exchange rate over the period has changed from 1.32 to 1.40 × (112 / 118) = 1.3288. This increase in the real USD/EUR exchange rate indicates that the base currency (EUR) has appreciated in real terms, so that eurozone goods are now more expensive in real terms to U.S. consumers. Study Session 6, LOS 21.a SchweserNotes: Book 2, p.231 CFA Program Curriculum: Vol.2 p.487

As a result of a recent acquisition, Lombard, Inc. has placed the following items on their balance sheet as of the beginning of their fiscal year: Goodwill $30 million Patent $10 million Expires in 10 years. Trademark $15 million Expires in 15 years, renewable at minimal cost. If Lombard amortizes intangible assets using the straight line method, the amortization expense on these assets for the fiscal year will be: A) $1 million. B) $2 million. C) $3 million.

Answer A. Goodwill has an indefinite life and is not amortized. A trademark or other intangible asset that has an expiration date but is renewable at minimal cost is treated as having an indefinite life and is not amortized. The patent has a finite life and its cost will be amortized at the rate of $1 million each year over ten years under the straight-line method. For Further Reference: Study Session 9, LOS 30.f SchweserNotes: Book 3, p.217 CFA Program Curriculum: Vol.3 p.444

Greg Hoffman, CFA, has been hired by Hill Manufacturing, Inc. (HMI) to write a research report on their company. Hoffman writes a report on HMI with a "buy" recommendation and posts the report for purchase on his website but does not include the information that HMI paid for the research. According to the Standards that govern independence and objectivity and disclosure of conflicts, Hoffman has violated: A) both of these Standards. B) neither of these Standards. C) only one of these Standards.

Answer A. Hoffman has violated both Standard I(B) Independence and Objectivity, which specifically addresses the requirement of disclosure of the nature of any compensation from the subject company, and Standard VI(A) Disclosure of Conflicts, which, more generally, requires disclosure of any potential conflict of interest in research reports and investment recommendations.

Compared to its net asset value (NAV) calculated in accordance with accounting standards, a hedge fund's trading NAV: A) will be lower because of adjustments for illiquid positions. B) is likely to be higher because of upward bias in model-based security values. C) may be higher or lower, reflecting gains or losses on securities designated for short-term trading.

Answer A. If a fund calculates a trading NAV, it will adjust market prices downward for securities in which it holds positions that are large relative to trading volume or total value outstanding and thus are less liquid. For Further Reference: Study Session 18, LOS 60.e SchweserNotes: Book 5, p.215 CFA Program Curriculum: Vol.6 p.159

Yvette Michaels, CFA, an analyst for Torborg Investments, inadvertently overhears a conversation between two executives of Collective Healthcare in which they mention an upcoming tender offer for Network, a stock she covers. Michaels has followed both companies extensively and feels their consolidation would be very beneficial for both companies. She tells her supervisor, a senior analyst, about the proposed tender offer. Michaels' actions are: A) in violation of the Standards. B) not in violation of the Standards because she told only her supervisor. C) not in violation of the Standards because she has not traded shares of Network or changed her report on the company.

Answer A. Michaels has violated Standard II(A) Material Nonpublic Information. Members who possess material nonpublic information are prohibited from acting or causing others to act on that information. She may not share the information with anyone except designated supervisory or compliance employees within her firm. Disclosing to her supervisor, who is not identified as a designated supervisor of compliance issues, is not permitted.

Ron Egan, CFA, classifies firms in the transportation industry in peer groups that include airlines and bus operators. Egan learns that one of the airlines, Acme, derives half its revenue from its Acme Bus Lines subsidiary. Egan adds Acme to his peer group for bus operators while continuing to include Acme in his peer group for airlines. Is Egan's treatment of Acme appropriate? A) Yes. B) No, because each company should be included in only one peer group. C) No, because the bus operations are not the company' s principal business activity.

Answer A. Peer groups should include comparable companies with similar business activities. An analyst can appropriately include a company in multiple peer groups if the company's business activities are comparable to firms in more than one peer group.

To benefit from price discrimination, a monopolist least likely needs to have: A) a higher-quality product at a premium price and a lower-quality alternative. B) a way to prevent reselling between types of consumers. C) two identifiable groups of consumers with different price elasticities of demand for the product.

Answer A. Price discrimination involves a single product, not two alternatives. As long as the company faces a downward-sloping demand curve, can identify at least two groups of customers with different price elasticities of demand, and can prevent reselling between groups, the company can profit from price discrimination. For Further Reference: Study Session 4, LOS 16.b, d SchweserNotes: Book 2, p.96 CFA Program Curriculum: Vol.2 p.156

An economy is in full-employment equilibrium. If the government unexpectedly decreases the tax rate, in the short run the economy is most likely to experience: A) an increase in employment. B) a decrease in the price level. C) no change in employment and an increase in the price level.

Answer A. Short-run equilibrium may occur above full employment, for example as a result of an increase in aggregate demand caused by a decrease in taxes. Both employment and the price level increase in the short run. Above-full employment causes upward pressure on wages that will reduce short-run aggregate supply until, in the long run, output returns to its full-employment level with a still-higher equilibrium price level. For Further Reference: Study Session 5, LOS 17.k SchweserNotes: Book 2, p.140 CFA Program Curriculum: Vol.2 p.253

To comply with the Code and Standards, analysts who send research recommendations to clients must: A) keep records of all the data and analysis that went into creating the report. B) send recommendations only to those clients for whom the investments are suitable. C) not send recommendations without including the underlying analysis and basic investment characteristics.

Answer A. Standard V(C) Record Retention requires members to maintain records of the data and analysis they use to develop their research recommendations. Recommendations may be brief, in capsule form, or simply a list of buy/sell recommendations. A list of recommendations may be sent without regard to suitability, including both safe income stocks and aggressive growth stocks, for example.

According to the Code and Standards, members and candidates who are involved in distributing an initial public offering (IPO) of equity shares and wish to participate in the IPO: A) may participate unless the IPO is oversubscribed. B) may not participate because this creates a conflict of interest. C) must obtain pre-clearance from a supervisor before participating.

Answer A. Standard VI(B) Priority of Transactions recommends, but does not require, that a member or candidate obtain pre-clearance from his or her supervisor before participating in an equity IPO. Guidance for Standard III(B) Fair Dealing states that members and candidates distributing IPO shares must distribute shares in an oversubscribed IPO to clients and may not withhold shares for themselves.

When the Rivers Company filed its corporate tax returns for the first quarter of the current year, it owed a total of $6.7 million in corporate taxes. Rivers paid $4.4 million of the tax bill, but still owes $2.3 million. It also received $478,000 in the second quarter as a down payment towards $942,000 in custom-built products to be delivered in the third quarter. Its financial accounts for the second quarter most likely show the $2.3 million and the $478,000 as: $2.3 million $478,000 A) Income tax payable ---- Unearned revenue B) Income tax payable ---- Accrued revenue C) Deferred tax liability ---- Accrued revenue

Answer A. The $478,000 is unearned revenue, a liability. The $2.3 million owed to the government but not yet paid is income tax payable, also a liability. Deferred tax accounts arise from temporary differences between tax reporting and financial reporting. For Further Reference: Study Session 7, LOS 23.a, d SchweserNotes: Book 3, p.19, 22 CFA Program Curriculum: Vol.3 p.42, 69

Timely Taxis, Ltd. has signed a long-term lease for 20 underground parking spots at $150 each per month for its fleet of taxis. The firm currently has 18 taxis in operation and is performing an NPV analysis on the purchase of a 19th taxi. The cost of parking for the 19th taxi is best described as a(n): A) sunk cost. B) opportunity cost. C) incremental cost.

Answer A. The 19th space is neither an incremental cost, nor an opportunity cost or a type of cannibalization. It is a sunk cost since the firm has already committed to parking for 20 taxis. The cost of the 19th parking space is not directly relevant to the capital budgeting decision. For Further Reference: Study Session 11, LOS 35.b SchweserNotes: Book 4, p.12 CFA Program Curriculum: Vol.4 p.8

Greg Goldman, research analyst in the fixed-income area of an investment bank, needs to determine the average duration of a sample of twenty 15-year fixed-coupon investment grade bonds. Goldman first categorizes the bonds by risk class and then randomly selects bonds from each class. After combining the bonds selected (bond ratings and other information taken as of March 31 of the current year), he calculates a sample mean duration of 10.5 years. Assuming that the actual population mean duration is 9.7 years, which of the following statements about Goldman's sampling process and sample is least accurate? A) Goldman is using time-series data. B) The sample mean is a random variable. C) The sampling error is 0.8 years.

Answer A. The data are cross-sectional, which means that it is a sample of observations taken at a single point in time. Time-series data are observations taken at specific and equally spaced points in time (for example, the monthly returns on a specific stock for the period January 1 through December 31 of a given year). The sampling error is the difference between a sample statistic (here, the mean) and the corresponding population parameter, or 10.5 - 9.7 = 0.8. The sample statistic (here, the mean) is itself a random variable and has its own probability distribution. For Further Reference: Study Session 3, LOS 10.d SchweserNotes: Book 1, p.289 CFA Program Curriculum: Vol.1 p.569

From a high of $180, a stock price decreases to a low of $100 and then begins increasing. A technical analyst states that she expects resistance levels to emerge at $140, $150, and $153.33. This analyst is most likely forecasting these resistance levels based on: A) Fibonacci numbers. B) an inverse head and shoulders pattern. C) moving average convergence/divergence lines.

Answer A. The forecast resistance levels are one-half, five-eighths, and two-thirds of the price decrease from $180 to $100. All of these are Fibonacci ratios. Projecting from the breakout of an inverse head and shoulders pattern would more likely suggest a single price target or range than three different specific targets. Moving average convergence/divergence lines are unlikely to be used for price targeting because they are not on the same scale as prices. For Further Reference: Study Session 3, LOS 12.d, e, g SchweserNotes: Book 1, p.355, 357, 362 CFA Program Curriculum: Vol.1 p.676, 687, 705

Yamaska Mining issued a 5-year, $50 million face, 6% semiannual bond when market interest rates were 7%. The market yield of the bonds was 8% at the beginning of the next year. Using the effective interest rate method, what is the initial balance sheet liability, and what is the interest expense that the company should report for the first half of the second year of the bond's life (the third semiannual period)? Initial liability --- Interest expense, first half of year 2 A) $47,920,849 ---- $1,689,853 B) $47,920,849 ---- $1,750,000 C) $50,000,000 ----$1,500,000

Answer A. This is a discount bond since the market interest rate at issuance exceeds the coupon rate. The initial liability is equal to the proceeds received when the bond was issued. We can find this amount from the following calculation: FV = 50,000,000; N = 10; I = 3.5; PMT = 1,500,000; CPT → PV = $47,920,848.67. Change N to 8 and calculate PV to get liability value at the beginning of the second year of the bond's life, 48,281,511. Interest expense for the next semiannual period is 48,281,511(0.035) = $1,689,853. The subsequent change in the market rate has no effect on the amortization of the discount. For Further Reference: Study Session 9, LOS 32.a, b SchweserNotes: Book 3, p.258, 259 CFA Program Curriculum: Vol.3 p.512, 516

A 3-year, 6% coupon, semiannual-pay note has a yield to maturity of 5.5%. If an investor holds this note to maturity and earns a 4.5% return on reinvested coupon income, his realized yield on the note is closest to: A) 5.46%. B) 5.57%. C) 5.68%.

Answer A. This question does not require calculations. Because the return on reinvested coupon interest is less than the note's yield to maturity, the investor's realized yield on the note must be less than the YTM. Only Choice A can be correct. For Further Reference: Study Session 16, LOS 55.a SchweserNotes: Book 5, p.103 CFA Program Curriculum: Vol.5 p.512

Under U.S. GAAP, land owned by the firm is most likely to be reported on the balance sheet at: A) historical cost. B) fair market value minus selling costs. C) historical cost less accumulated depreciation.

Answer A. Unless impairment has been recognized, land is reported at historical cost and is not subject to depreciation. Increases in value are not reflected in balance sheet values under U.S. GAAP.

For a bond currently priced at $1,018 with an effective duration of 7.48, if the market yield moved down 75 basis points, the new price would be approximately: A) $961. B) $1,075. C) $1,094.

Answer B. %Δprice ≈ -7.48(-0.0075) = 0.0561 $1,018(1 + 0.0561) = $1,075.11

While motivation and opportunity both can lead to low quality of financial reporting, a third important contributing factor is: A) poor financial controls. B) rationalization of the actions. C) pressure to meet earnings expectations.

Answer B. A mindset that allows rationalization is the third important condition underlying low-quality financial reporting. Poor financial controls are an example of opportunity and pressure to meet earnings expectations is a possible motivation. For Further Reference: Study Session 10, LOS 33.e SchweserNotes: Book 3, p.294 CFA Program Curriculum: Vol.3 p.584

When comparing portfolios that plot on the security market line (SML) to those that plot on the capital market line (CML), a financial analyst would most accurately state that portfolios that lie on the SML: A) have only systematic risk, while portfolios on the CML have both systematic and unsystematic risk. B) are not necessarily well diversified, while portfolios on the CML are well diversified. C) are not necessarily priced at their equilibrium values, while portfolios on the CML are priced at their equilibrium values.

Answer B. Although the risk measure on the capital market line diagram is total risk, all portfolios that lie on the CML are well diversified and have only systematic risk. This is because portfolios on the CML are all constructed from the risk-free asset and the (well-diversified) market portfolio. Any portfolio, including single securities, will plot along the SML in equilibrium. Their unsystematic risk can be significant, but it is not measured on the SML diagram because unsystematic risk is not related to expected return. Both the CML and the SML reflect relations that hold when prices are in equilibrium. For Further Reference: Study Session 12, LOS 43.f SchweserNotes: Book 4, p.169 CFA Program Curriculum: Vol.4 p.363

Compared to an index of 100 U.S. exchange-traded stocks, an index of 100 U.S. government and corporate bonds will most likely: A) reflect equally timely price data. B) be more difficult to build and maintain. C) have less turnover among the securities in the index.

Answer B. Bond indexes are more difficult to build and maintain than stock indexes for several reasons. Bonds in an index have to be replaced as they mature, so turnover is likely to be greater in a bond index than in a stock index. Many bonds lack the continuous trade data that exists for exchange-traded equities. Study Session 13, LOS 46.i SchweserNotes: Book 4, p.237 CFA Program Curriculum: Vol.5 p.98

Which of the following statements about covariance and the correlation coefficient is least accurate? A) Covariance is a measure of how the returns of two assets tend to move together over time. B) The correlation coefficient is computed by dividing the covariance of returns on two assets by the individual variances of returns for the two assets. C) The covariance of returns between two assets is equal to the correlation between the returns of the two assets, multiplied by the product of their standard deviations of returns.

Answer B. Dividing the covariance between returns of two assets by the individual standard deviations of returns of the two assets yields the correlation coefficient. For Further Reference: Study Session 2, LOS 8.k SchweserNotes: Book 1, p.219 CFA Program Curriculum: Vol.1 p.481

Which of the following events is most likely to increase short-run aggregate supply (shift the curve to the right)? A) Inflation that results in an increase in goods prices. B) High unemployment puts downward pressure on money wages. C) An increase in government spending intended to increase real output.

Answer B. Falling money wages would cause businesses to increase (profit-maximizing) output levels at each price level for final goods and services. Changes in the price level of goods and services are represented by a movement along a short-run aggregate supply curve, not a shift in the curve. A rise in resource prices will decrease aggregate supply. An increase in government spending will shift the aggregate demand curve but not the aggregate supply curve. For Further Reference: Study Session 5, LOS 17.h SchweserNotes: Book 2, p.136 CFA Program Curriculum: Vol.2 p.240

If firms Acme and Butler have the same amount of sales and equal quick ratios, but Acme's receivables turnover is higher, it is most likely that: A) Butler has better liquidity than Acme. B) Butler has a lower cash ratio than Acme. C) Acme's average days of receivables is higher than Butler's.

Answer B. Given that they have the same amount of sales and Acme's receivables turnover (sales/average accounts receivable) is higher, Acme must have lower average accounts receivable than Butler. Given that they have equal quick ratios, subtracting accounts receivable from the numerators of the quick ratios of both firms will produce a cash ratio for Butler that is lower than the cash ratio for Acme. For Further Reference: Study Session 11, LOS 39.b SchweserNotes: Book 4, p.89 CFA Program Curriculum: Vol.4 p.145

Evelyn Stram, CFA, places a good-till-cancelled limit buy order at 86 for a stock. Stram's order specifies: A) clearing and validity instructions. B) validity and execution instructions. C) execution and clearing instructions.

Answer B. Good-till-cancelled is a validity instruction, which indicates when an order may be filled. Execution instructions include limit orders and market orders, as well as instructions regarding trade size and visibility. A clearing instruction indicates how to arrange final settlement of the trade. For Further Reference: Study Session 13, LOS 45.g SchweserNotes: Book 4, p.211 CFA Program Curriculum: Vol.5 p.44

A public offering of bonds issued over a period of time is most accurately described as a: A) serial structure. B) shelf registration. C) waterfall structure.

Answer B. In a shelf registration, an entire issue is registered with securities regulators but the bonds are sold to the public over a period of time as the issuer needs to raise funds. In a serial bond issue, bonds with multiple maturity dates are issued at the same time. A waterfall structure is issued in tranches with differing priority of claims. For Further Reference: Study Session 15, LOS 52.c, f SchweserNotes: Book 5, p.29, 32 CFA Program Curriculum: Vol.5 p.353, 367

In extending the 3-factor model of Fama and French, the additional factor suggested by Carhart that is often used is: A) GDP growth. B) price momentum. C) market-to-book value.

Answer B. In addition to the three factors of the Fama and French model, market-to-book, firm size, and excess returns on the market, Carhart added a momentum factor based on prior relative price performance. For Further Reference: Study Session 12, LOS 43.d SchweserNotes: Book 4, p.166 CFA Program Curriculum: Vol.4 p.356

The mezzanine financing portion of a leveraged buyout (LBO) is most likely to: A) represent committed capital. B) be convertible to equity or include warrants. C) have seniority over other bonds issued to finance the LBO.

Answer B. In the context of an LBO, mezzanine financing refers to debt that carries warrants or equity conversion features. This debt is typically subordinated to other bonds that are issued to finance the LBO. Committed capital is the investment of limited partners in a private equity fund and does not include debt that the fund issues to finance a particular LBO. For Further Reference: Study Session 18, LOS 60.d SchweserNotes: Book 5, p.215 CFA Program Curriculum: Vol.6 p.159

In the short run, the average product of labor: A) is increasing when the total product of labor is increasing. B) is at a maximum where it intersects the marginal product of labor curve. C) is upward-sloping if the firm is experiencing diminishing marginal returns to labor.

Answer B. In the short run, the average product of labor curve is first increasing and then decreasing as diminishing marginal returns to that factor take effect. In the short run, the marginal product of labor is first increasing and then decreasing when diminishing marginal returns take effect. The marginal product of labor curve will be above the average product of labor curve initially, and, at some point, will intersect the average product curve at its maximum. When the total product of labor begins to increase at a decreasing rate, the average product of labor will be decreasing. For Further Reference: Study Session 4, LOS 15.j SchweserNotes: Book 2, p.82 CFA Program Curriculum: Vol.2 p.134

A hedge fund uses derivative positions to take a long position in the Japanese yen and a short position in the euro. The classification of this hedge fund is most likely a(n): A) event-driven fund. B) macro strategy fund. C) quantitative directional fund.

Answer B. Macro strategy funds invest based on expected shifts of global economies, primarily in currency and interest rate derivatives. Quantitative directional funds take long and short positions in equities based on technical analysis. Event-driven funds seek to profit from investment strategies based on specific corporate events and one-time transactions. For Further Reference: Study Session 18, LOS 60.d SchweserNotes: Book 5, p.215 CFA Program Curriculum: Vol.6 p.159

From the lessee's perspective, compared to an operating lease, a finance lease results in: A) higher asset turnover. B) a higher debt-to-equity ratio. C) lower operating cash flow.

Answer B. Operating leases are not recognized as liabilities and therefore the debt-to-equity ratio will be lower than a similar finance lease. Capitalizing a lease will increase the asset base and decrease asset turnover. Lease capitalization decreases the operating cash outflow and therefore increases operating cash flows (all else equal). For Further Reference: Study Session 9, LOS 32.g SchweserNotes: Book 3, p.267 CFA Program Curriculum: Vol.3 p.531

Which of the following is most likely presented on a common-size balance sheet or common-size income statement? A) Total asset turnover. B) Operating profit margin. C) Return on common equity.

Answer B. Operating profit margin can be read directly from a common-size income statement. Asset turnover and return on equity mix balance sheet and income statement items. For Further Reference: Study Session 8, LOS 25.i, j SchweserNotes: Book 3, p.72, 74 CFA Program Curriculum: Vol.3 p.193, 196 Study Session 8, LOS 28.b SchweserNotes: Book 3, p.148 CFA Program Curriculum: Vol.3 p.338

Which of the following is one of the nine major sections of the GIPS standards? A) Verification. B) Private equity. C) Sub-advisers.

Answer B. Private equity is one of the nine major sections of the GIPS standards; the others are not. For Further Reference: Study Session 1, LOS 4.d SchweserNotes: Book 1, p.89 CFA Program Curriculum: Vol.1 p.205

A firm pays accrued wages with cash. Assuming a current ratio greater than one and a quick ratio that is less than one, what will be the impact on the current ratio and the quick ratio? A) Both ratios will remain the same. B) The current ratio will increase and the quick ratio will decrease. C) The current ratio will decrease and the quick ratio will increase.

Answer B. Reducing the numerator and denominator by the same amount will increase a ratio that is greater than one and decrease a ratio that is less than one. For Further Reference: Study Session 8, LOS 28.b SchweserNotes: Book 3, p.148 CFA Program Curriculum: Vol.3 p.338

A debt covenant designates one of a holding company' s subsidiaries as restricted. Which of the following credit-related considerations does this covenant address? A) Credit migration risk. B) Structural subordination. C) Payments to equity holders.

Answer B. Restricted subsidiaries are those whose cash flows and assets are designated to service the debt of their holding company. Classifying a subsidiary as restricted alleviates structural subordination by making holding company debt rank pari passu with the subsidiary's debt. For Further Reference: Study Session 16, LOS 56.j SchweserNotes: Book 5, p.147 CFA Program Curriculum: Vol.5 p.618

Over time, compared to traditional stock and bond investments, the commodities asset class has exhibited: A) lower returns and lower price volatility B) lower returns and higher price volatility. C) higher returns and lower price volatility.

Answer B. Returns on commodities over time have been lower than returns on global stocks or bonds, and price volatility has been higher.

A permanent difference between pretax and taxable income is least likely to arise when a firm: A) receives tax-exempt interest. B) uses the installment sales method for financial reporting. C) pays premiums on life insurance of key employees.

Answer B. The installment sales method of revenue recognition does not result in permanent differences between pretax and taxable income. Premium payments on life insurance of key employees is an expense on the financial statements, but is not deducted on tax returns. Tax exempt interest is recognized as revenue on the financial statements. These items result in permanent differences between pretax income and taxable income. For Further Reference: Study Session 9, LOS 31.f SchweserNotes: Book 3, p.239 CFA Program Curriculum: Vol.3 p.484

The type of equity security that gives its owners the right to vote the shares of, and receive dividends from, a foreign company is best described as a: A) global depository receipt. B) sponsored depository receipt. C) fully-owned depository receipt.

Answer B. The owner of a sponsored DR share has the same voting rights and receives the same dividends as the owner of a common share of the firm. With an unsponsored DR, the depository bank retains the voting rights. A global depository receipt may be sponsored or unsponsored. For Further Reference: Study Session 14, LOS 48.d SchweserNotes: Book 4, p.263 CFA Program Curriculum: Vol.5 p.163

The time value of an option is most accurately described as: A) increasing as the option approaches its expiration date. B) equal to the entire premium for an out-of-the-money option. C) the amount by which the intrinsic value exceeds the option premium.

Answer B. The price (or premium) of an option is its intrinsic value plus its time value. An out-of-the-money option has an intrinsic value of zero, so its entire premium consists of time value. Time value is zero at an option's expiration date. Time value is the amount by which an option's premium exceeds its intrinsic value. For Further Reference: Study Session 17, LOS 58.j, k SchweserNotes: Book 5, p.184, 186 CFA Program Curriculum: Vol.6 p.86, 87

The put-call-forward parity relationship is similar to the standard put-call parity relationship with a forward price substituted for: A) the risk-free bond. B) the underlying asset. C) either the call or put option.

Answer B. The put-call-forward parity relationship is the same as the standard put-call parity relationship, with the present value of the forward price substituted for the underlying asset. For Further Reference: Study Session 17, LOS 58.l, m SchweserNotes: Book 5, p.187, 189 CFA Program Curriculum: Vol.6 p.94, 98

Consider a market where quantity supplied = 1,500 - 3 × price, and quantity demanded = 2,000 - 5 × price. With respect to equilibrium price and quantity, there is: A) no market equilibrium. B) a stable market equilibrium. C) an unstable market equilibrium.

Answer B. There is a market equilibrium at a price of 250, where QS = 750 and QD = 750. Although the supply curve is downward sloping, the equilibrium is stable because the supply curve intersects the demand curve from above-the slope of the supply curve (−1/3) is steeper than the slope of the demand curve (−1/5). For Further Reference: Study Session 4, LOS 13.f SchweserNotes: Book 2, p.16 CFA Program Curriculum: Vol.2 p.25

Granite, Inc. owns a machine with a carrying value of $3.0 million and a salvage value of $2.0 million. The present value of the machine's future cash flows is $1.7 million. The asset is permanently impaired. Granite should: A) immediately write down the machine to its salvage value. B) immediately write down the machine to its recoverable amount. C) write down the machine to its recoverable amount as soon as it is depreciated down to salvage value.

Answer B. Under IFRS, when an asset is permanently impaired, it must be written down to its recoverable amount (greater of value in use or fair value less selling costs) in the period in which the impairment is recognized.

Which of the following statements about the indirect method of calculating cash flow from operations is least accurate? A) Depreciation is added back to net income because it is an expense not requiring cash. B) No adjustment is needed to account for changes in accounts receivable because no cash is involved. C) No adjustment is needed for the payment of taxes because the tax payment is already in net income.

Answer B. Using the indirect method requires adjusting for change in working capital accounts such as accounts receivable, inventory, and accounts payable.

An unexpected increase in businesses' inventory-to-sales ratios is most likely to occur as an economy: A) reaches a trough. B) enters a contraction phase. C) approaches the peak of an expansion.

Answer C. At the end or peak of an expansion, economic activity begins to slow, sales are less than planned, and excess inventory accumulates, increasing inventory-to-sales ratios. To reduce inventory-to-sales ratios to desired levels, firms decrease production, which is one of the causes of a contraction. For Further Reference: Study Session 5, LOS 18.b SchweserNotes: Book 2, p.158 CFA Program Curriculum: Vol.2 p.294

A firm uses the first-in first-out (FIFO) cost flow assumption. Compared to gross profit with a periodic inventory system, the firm's gross profit with a perpetual inventory system would be: A) lower. B) higher. C) the same.

Answer C. For a firm using FIFO, gross profit is the same whether the firm uses a periodic or perpetual inventory system. For a firm using LIFO or average cost, gross profit can be different depending on the choice of inventory system. For Further Reference: Study Session 9, LOS 29.d SchweserNotes: Book 3, p.188 CFA Program Curriculum: Vol.3 p.400

Which of the following statements about return distributions is most accurate? A) With positive skewness, the median is greater than the mean. B) If skewness is positive, the average magnitude of positive deviations from the mean is smaller than the average magnitude of negative deviations from the mean. C) If a return distribution has positive excess kurtosis and the analyst uses statistical models that do not account for the fatter tails, the analyst will underestimate the likelihood of extreme outcomes.

Answer C. If a return distribution has positive excess kurtosis, statistical models that do not account for the fatter tails will underestimate the likelihood of very bad or very good outcomes. A distribution with positive skewness will have a mean greater than the median and larger average positive deviations than average negative deviations.

The odds for an event occurring are calculated by dividing: A) one by the probability that the event occurs. B) the probability that the event does not occur by the probability that an event occurs. C) the probability that the event occurs by the probability that the event does not occur.

Answer C. If p is the probability that an event occurs, then the odds for the event occurring are expressed as p / (1 − p), or the probability that the event occurs divided by the probability that the event does not occur. The odds against the event are expressed as the reciprocal of the odds for the event.

Consider a collateralized mortgage obligation (CMO) structure with one planned amortization class (PAC) class and one support tranche outstanding. If the prepayment speed is higher than the upper collar on the PAC, the: A) life of the PAC tranche will increase. B) PAC tranche has no risk of prepayments. C) life of the support tranche will decrease.

Answer C. If the prepayment speed is higher than the PAC collar, the support tranche receives more prepayments. The life of the support tranche will shorten. The PAC tranche could receive higher prepayments if the support tranche principal is fully repaid (i.e., a broken PAC). In this case, the support tranche is still outstanding, which means that hasn't happened yet. For Further Reference: Study Session 15, LOS 54.e SchweserNotes: Book 5, p.87 CFA Program Curriculum: Vol.5 p.478

Assuming stable inventory quantities, in a period of: A) rising prices, LIFO results in higher ending inventory and FIFO results in higher gross profit. B) falling prices, LIFO results in higher gross profit and FIFO results in lower cost of goods sold. C) rising prices, LIFO results in higher cost of goods sold and FIFO results in higher working capital.

Answer C. In a period of rising prices, LIFO results in higher COGS, lower inventory balances, and lower gross profit, as compared to FIFO. In a falling price environment, these effects are the opposite. Working capital (current assets minus current liabilities) is higher under FIFO in a rising price environment because inventories are higher. For Further Reference: Study Session 9, LOS 31.i SchweserNotes: Book 3, p.245 CFA Program Curriculum: Vol.3 p.493

Over-the-counter derivatives are: A) standardized and backed by a clearinghouse. B) not standardized but are backed by a clearinghouse. C) neither standardized nor backed by a clearinghouse.

Answer C. Over-the-counter derivatives are customized private contracts between counterparties. For Further Reference: Study Session 17, LOS 57.a SchweserNotes: Book 5, p.165 CFA Program Curriculum: Vol.6 p.6

The type of technical analysis chart most likely to be useful for intermarket analysis is a: A) candlestick chart. B) point and figure chart. C) relative strength chart.

Answer C. Relative strength charts display the price of an asset relative to the price of another asset or benchmark over time. This type of chart is useful for demonstrating whether one asset class or market has outperformed or underperformed another. Candlestick charts and point-and-figure charts are generally used to display price patterns for a single asset or market over time. For Further Reference: Study Session 3, LOS 12.b, h SchweserNotes: Book 1, p.351, 363 CFA Program Curriculum: Vol.1 p.664, 708

Amy Brooks, a CFA Level III candidate, has been given supervisory responsibilities. In carrying out her responsibilities, Brooks has discovered that the firm's compliance system is inadequate. She informed her supervisor, who is not supportive of Brooks's efforts to correct the situation. According to CFA Institute Standards of Professional Conduct, Brooks: A) has satisfied her obligation under the Code and Standards by informing her manager of the situation. B) must dissociate herself from the firm if the firm is not in compliance with the CFA Institute Standards. C) should decline in writing to accept supervisory responsibilities until an adequate compliance system is adopted.

Answer C. Standard IV(C) Responsibilities of Supervisors indicates that a member should decline supervisory responsibility in writing until the firm adopts reasonable compliance procedures. Otherwise, Brooks cannot adequately exercise her responsibility.

Which of the following equity securities is most likely to have a beta greater than one? A) Utility stock. B) Health care stock. C) Homebuilder stock.

Answer C. Stocks of cyclical firms, such as homebuilders, tend to have high systematic risk (i.e., high beta). Stocks of noncyclical firms, such as utility or health care companies, tend to respond less to changes in systematic risk factors (i.e., they have low betas). For Further Reference: Study Session 12, LOS 43.c, e SchweserNotes: Book 4, p.164, 167 CFA Program Curriculum: Vol.4 p.354, 359

The Fisher effect describes the relationship among: A) savings, investment, the fiscal balance, and the trade balance. B) credit expansion, investor expectations, and the business cycle. C) nominal interest rates, real interest rates, and expected inflation.

Answer C. The Fisher effect states that a nominal interest rate is the sum of a real interest rate and the expected inflation rate. For Further Reference: Study Session 5, LOS 19.e SchweserNotes: Book 2, p.184 CFA Program Curriculum: Vol.2 p.358

According to the IASB Conceptual Framework for Financial Reporting, what are the two fundamental qualitative characteristics of financial statements that make them useful to their users? A) Timeliness and comparability. B) Verifiability and understandability. C) Relevance and faithful representation.

Answer C. The IASB Conceptual Framework for Financial Reporting describes the two fundamental qualitative characteristics of financial statements as relevance and faithful representation. The Conceptual Framework lists timeliness, comparability, verifiability, and understandability as characteristics that enhance relevance and faithful representation. For Further Reference: Study Session 7, LOS 24.d SchweserNotes: Book 3, p.36 CFA Program Curriculum: Vol.3 p.116

An investor is considering the purchase of Security X, which matures in ten years and has a par value of $1,000. During the first five years, X has a 6% coupon with quarterly payments. During the remaining five years, X has an 8% coupon with quarterly payments. The face value is paid at maturity. A second 10-year security, Security Z, has a 6% semiannual coupon and is selling at par. Assuming that X has the same bond equivalent yield as Z, the price of Security X is closest to: A) $943. B) $1,036. C) $1,067.

Answer C. The bond equivalent yield rate on the par bond (Z) is 6% or a 3% semiannual rate. The equivalent quarterly rate, 1.031/2 - 1 = 0.014889. Security X makes 20 quarterly payments of $15 and 20 quarterly payments of $20. We need to use the cash flow function as follows: CF0 = 0; CF1 = 15; F1 = 20; CF2 = 20; F2 = 19; CF3 = 1,020; F3 = 1; I = 1.4889; CPT → NPV = $1,067.27. Note that CF3 contains the final quarterly payment of $20 along with the $1,000 face value payment. For Further Reference: Study Session 15, LOS 53.f SchweserNotes: Book 5, p.50 CFA Program Curriculum: Vol.5 p.407

Daker Industries reports assets of £140 million and liabilities of £85 million. Daker decides to repurchase 5% of its 11 million outstanding shares through a tender offer at £5 per share when the market price is £4.75. If the tender offer is fully subscribed, the most likely effect on the book value of Daker's shares will be to: A) increase the book value of Daker shares by 5%. B) decrease the book value of Daker shares by 5%. C) have no effect on the book value of Daker shares.

Answer C. The book value of Daker shares is (£140 million − £85 million) / 11 million = £5 per share. Repurchasing its shares at a price equal to book value will not change the book value of Daker shares. For Further Reference: Study Session 11, LOS 38.e SchweserNotes: Book 4, p.81 CFA Program Curriculum: Vol.4 p.129

A firm's optimal capital budget can be found by moving along its investment opportunity schedule until: A) it exhausts its capital budget. B) average project return is equal to average cost of capital. C) the next project's return is less than the marginal cost of capital.

Answer C. The firm would not want to exhaust its capital budget on "bad" projects, (i.e., projects with IRR < cost of capital [NPV < 0]). They should continue to invest as long as the project's return is greater than the marginal cost of capital of the firm. When the project's IRR = cost of capital, the NPV = 0. This project will only make the firm larger; it will add nothing to the stock price. The investment opportunity schedule plots expected project returns from highest to lowest IRR. For Further Reference: Study Session 11, LOS 36.d SchweserNotes: Book 4, p.37 CFA Program Curriculum: Vol.4 p.40

Which of the following statements about the appropriate revenue recognition method to use under U.S. GAAP is most accurate? Use the: A) percentage-of-completion method if the firm cannot reliably estimate the outcome of the project. B) completed contract method if ultimate payment is reasonably assured and revenue and costs can be reliably estimated. C) installment method if collectability of payments for a sale cannot be reasonably estimated.

Answer C. The installment method should be used when future cash collection cannot be reasonably estimated. For long-term projects, a firm should use percentage of completion when payment is reasonably assured and the firm can reliably estimate the project's outcome, and completed contract when the firm cannot estimate the outcome reliably. For Further Reference: Study Session 8, LOS 25.b SchweserNotes: Book 3, p.49 CFA Program Curriculum: Vol.3 p.155

If Stock X has a standard deviation of returns of 18.9% and Stock Y has a standard deviation of returns equal to 14.73% and returns on the stocks are perfectly positively correlated, the standard deviation of an equally weighted portfolio of the two is: A) 10.25%. B) 14.67%. C) 16.82%.

Answer C. The standard deviation of two stocks that are perfectly positively correlated is the weighted average of the standard deviations: 0.5(18.9) + 0.5(14.73) = 16.82%. This relationship is true only when the correlation is one.

Which is the correct test statistic for a test of the null hypothesis that a population variance is equal to a chosen value? A) F-statistic. B) t-statistic. C) Chi-square statistic.

Answer C. This is a test of the value of a single variance and is based on a test statistic with a performed via the chi-square distribution. For Further Reference: Study Session 3, LOS 11.j SchweserNotes: Book 1, p.332 CFA Program Curriculum: Vol.1 p.632

An analyst gathers the following data about a company: The company had 1 million shares of common stock outstanding for the entire year. The company's beginning stock price was $50, its ending price was $70, and its average price was $60. The company had 100,000 warrants outstanding for the entire year. Each warrant allows the holder to buy one share of common stock at $50 per share. How many shares of common stock should the company use in computing its diluted earnings per share? A) 1,100,000. B) 1,083,333. C) 1,016,667.

Answer C. Use the Treasury stock method: Step 1: Determine the number of common shares created if the warrants are exercised = 100,000. Step 2: Calculate the cash inflow if the warrants are exercised: (100,000)($50 per share) = $5,000,000. Step 3: Calculate the number of shares that can be purchased with these funds using the average market price ($60 per share): 5,000,000 / 60 = 83,333 shares. Step 4: Calculate the net increase in common shares outstanding from the exercise of the warrants: 100,000 − 83,333 = 16,667. Step 5: Add the net increase in common shares from the exercise of the warrants to the number of common shares outstanding for the entire year: 1,000,000 + 16,667 = 1,016,667. For Further Reference: Study Session 8, LOS 25.g SchweserNotes: Book 3, p.63 CFA Program Curriculum: Vol.3 p.184

An analyst gathered the following data about a company: Collections from customers are $5,000. Depreciation is $800. Cash expenses (including taxes) are $2,000. Tax rate = 30%. Net cash increased by $1,000. If inventory increases over the period by $800, cash flow from operations equals: A) $1,600. B) $2,400. C) $3,000.

Answer C. Use the direct method. Collections from customers $5,000 Cash expenses − $2,000 Cash flow from operations $3,000 Cash expenses are given. If you had been given COGS, you would need to adjust that for inventory changes to get cash expenses for inputs. Depreciation is a non-cash change. Changes in depreciation are used with the indirect method. Net change in cash will reflect CFI and CFF, not just CFO. For Further Reference: Study Session 8, LOS 27.f SchweserNotes: Book 3, p.115 CFA Program Curriculum: Vol.3 p.282

Compared to a firm that appropriately expenses recurring maintenance costs, a firm that capitalizes these costs will have greater cash flow from: A) financing activities. B) investing activities. C) operating activities.

Answer C. When a firm capitalizes costs, it classifies the cash outflow as CFI rather than CFO. The result is higher CFO compared to expensing the same costs. For Further Reference: Study Session 9, LOS 30.a SchweserNotes: Book 3, p.204 CFA Program Curriculum: Vol.3 p.426 Study Session 10, LOS 33.h SchweserNotes: Book 3, p.296 CFA Program Curriculum: Vol.3 p.596

Michael Robe, CFA, is a junior analyst for a large financial institution and has been preparing an analysis of United Mines, a coal mining company located in the United States. As part of his research, he examines the company's proxy voting and rules and practices. Which of the following policies would be considered the most restrictive to shareholders? A) Shareholders of United Mines are allowed to cast confidential votes but must be present to do so. B) Corporate policy prohibits the use of share blocking prior to United Mines' annual meetings. C) United Mines requires shareowner attendance to vote but coordinates the timing of its annual meeting to be held on the same day as other companies in the region.

Answer C. When companies that require shareholder attendance to vote hold their meetings on the same day but in different locations, it prevents shareholders from attending all the meetings and therefore exercising their full voting rights.

The change in the intrinsic value of a firm's common stock resulting from an increase in ROE most likely: A) increases the stock's intrinsic value. B) decreases the stock's intrinsic value. C) depends on the reason for the increase in ROE.

Answer C. While an increase in a firm's ROE due to a sharp increase in earnings will, if unexpected, lead to an increase in the intrinsic value of its shares, an increase in a firm's ROE due to the repurchase of stock with debt will not necessarily increase the intrinsic value of the firm's shares, as any increase in ROE may be offset by an increase in the risk inherent in the firm's shares. For Further Reference: Study Session 14, LOS 48.h SchweserNotes: Book 4, p.266 CFA Program Curriculum: Vol.5 p.176

The yield spreads between corporate bonds and government bonds are most likely to decrease if: A) liquidity decreases in the market for the corporate bonds. B) a credit rating downgrade on the corporate bonds becomes more likely. C) investors increase their estimates of the recovery rate on the corporate bonds.

Answer C. Yield spreads reflect the credit quality of bond issuers and the liquidity of the market for their bonds. Narrowing (decreasing) yield spreads reflect improving credit quality or more liquidity. Widening (increasing) yield spreads reflect deteriorating credit quality or less liquidity. Increased estimates of the recovery rate in the event of default represent an improvement in investors' assessment of the issuer's credit quality and are likely to narrow yield spreads on the issuer's bonds. For Further Reference: Study Session 16, LOS 56.a SchweserNotes: Book 5, p.133 CFA Program Curriculum: Vol.5 p.572