CFAI Mock 1
Bonds issued in which of the following markets most likely have fewer reporting, regulatory, and tax constraints? Eurobond markets Foreign bond markets Domestic bond markets
A is correct because "[d]omestic and foreign bonds are subject to the legal, regulatory, and tax requirements that apply in that particular country. In contrast, a Eurobond is issued internationally, outside the jurisdiction of the country in whose currency the bond is denominated. The Eurobond market has traditionally been characterized by fewer reporting, regulatory, and tax constraints than domestic and foreign bond markets."
The best measure of the percentage of the outstanding mortgage balance prepaid in a given year is the: single monthly mortality rate. weighted average life. conditional prepayment rate.
C is correct. The conditional prepayment rate (CPR) is the annualized single monthly mortality (SMM) rate and is used to describe the assumed prepayment for a pool of mortgage loans by the end of the year. A is incorrect because the SMM rate represents the percentage of the outstanding mortgage balance prepaid in the current month. B is incorrect because the weighted average life is used to assess the sensitivity of the securitized bonds to interest rate movements. It is the average time to receipt of all principal repayments (scheduled principal repayments and projected prepayments).
The price of a forward contract most likely: decreases as the price of the underlying goes up. is constant and set as part of the contract specifications. increases as market risk increases.
B is correct. The price of a forward contract remains constant throughout the life of the contract. It is set as part of the contract specifications. Can the value of the forward contract change due to change in price of underlying? If so, then how? The value of a forward will change as the price of the underlying changes but it will not impact the prices of existing forward contracts. The price of a new forward will be dependent on the price of the underlying on the day it is created.
To obtain the spot yield curve, a bond analyst would most likely use the most: recently issued and actively traded corporate bonds. recently issued and actively traded government bonds.
B is correct. To obtain the spot yield curve, a bond analyst would prefer to use the most recently issued and actively traded government bonds. Such bonds will have similar liquidity as well as fewer tax effects because they will be priced closer to par value.
Describe the Balance of Payment Accounts
BOP = Current Account + Capital Account + Financial Account Current: Goods and Services, Foreign asset income, Unilateral Transfers (Foreign aid) Capital: Migrant assets, inheritance transfers, nonproduced and nonfinancial assets (natural resources, intangible assets) Financial Account: Government and Corporate Securities, Foreign direct investments (build/ buy factories, acquire companies)
An analyst gathers the following information (in ¥ billions) about a company: Interest Received 100 Repurchase of Stock 200 Principal Repayment of Debt 300 The net cash used for financing activities (in ¥ billions) is:
Because the question is denominated in Yen, we must use IFRS accounting standards "[c]ash outflows include cash payments to repurchase stock (e.g., treasury stock) and to repay bonds and other borrowings...under IFRS, interest received may be classified either as an operating activity or as an investing activity." Therefore, the cash outflow from financing activities is: Payment for repurchase of stock + Principal repayment of debt = ¥200 million + ¥300 million = ¥500 million.
Define the bid-ask spread What does it mean when it is narrow or wide?
Bid is the highest price a buyer is willing to purchase (offer) while ask is the lowest price a person is willing to sell (accept) Typically assets with narrower bid asks spreads will have greater demand. By contrast, assets with a wide bid-ask spread may have a low volume of demand, therefore influencing wider discrepancies in its price.
A bubble line chart without any color-coding can represent a maximum of:
Bubble Line Chart Statement: [w]hen an observational unit ... has more than two features (or variables) of interest, it would be useful to show the multi-dimensional data all in one chart to gain insight from a more holistic view. How can we add an additional dimension to a two-dimensional line chart? We can replace the data points with varying-sized bubbles to represent a third dimension of the data. This version of a line chart is called a bubble line chart." Hence, if color-coding is not used, the maximum number of dimensions that can be represented is three (x-axis, y-axis, and size of bubbles).
When to use Conditional Probability vs Bayes Theorem -Write formulas for both
Conditional Probability is the probability of occurrence of a certain event, say A�, based on some other event whether B� is true or not. -It is used to compute the conditional probability and the events A�andB�are relatively simple. -It is used for relatively simple problems. Bayes Theorem includes two conditional probabilities for the events, say A� and B�. -It gives a structured formula for solving more complex problems.
The weighted average of the time to receipt of a bond's promised future payments is best measured by:
Macaulay duration is a weighted average of the time to receipt of the bond's promised payments, where the weights are the shares of the full price that correspond to each of the bond's promised future payments...Macaulay duration is measured in terms of time periods," not in terms of a percentage price change. Why not modified duration? [m]odified duration provides an estimate of the percentage price change for a bond given a change in its yield-to-maturity; ... [it] provides a linear estimate of the percentage price change."
Liquidity Pulls and Drags
Pulls are factors that accelerate the flow of liquidity out of a company Drags are factors that slow the flow of liquidity into a company Increased pull and drags decrease liquidity and reduced pulls and drags increase liquidity
Cash paid to supplier/ Purchases from suppliers formula Example Q: An analyst gathers the following information (in € millions) about a company: Cost of Sales: 800 Decrease in Inventory: 250 Increase in AP: 100 Cash paid to suppliers (in € millions) is:
Purchases from Suppliers = Cost of goods sold - Decrease in inventory (+ Increase in inventory) Cash Paid to Suppliers = Purchases + decrease in AP (- increase in AP)
Eurocommercial paper most likely:
TLDR: -may be issued at and trade on an interest-bearing basis where as USCP typically trades at a discount to par -ECP has smaller transaction sizes compared with USCP -ECP has longer settlement periods (T+2) A is correct because "USCP is typically issued on a discount basis - that is, USCP is issued at a discount to par value and pays full par value at maturity...In contrast, ECP may be issued at, and trade on, an interest-bearing or yield basis or a discount basis." B is incorrect because "[t]ypical transaction sizes in ECP are also much smaller than in USCP..." C is incorrect because USCP settles T+0 and ECP settles T+2, so ECP has a longer settlement period than USCP.
Deferred Tax Asset "Creators"
Temporary (timing) differences between "tax" and "book" (GAAP) accounting -Occurs when taxable income is higher than book income
Who is most likely responsible for claiming and maintaining compliance with the CFA Institute Global Investment Performance Standards (GIPS®)?
The firm claiming compliance An independent party is not responsible for the claim or for maintaining compliance. Independent third-party verifiers can be voluntarily hired by the firm claiming compliance to verify compliance.
The structural deficit is equal to the budget deficit:
The structural deficit is the deficit that would exist if the economy was at full employment (or full potential output). Economists often consider the structural deficit as an indicator of the fiscal policy stance. The structural deficit does not adjust for inflation and includes the impact of automatic stabilizers on the budget assuming full employment
Using the one-period binomial option pricing model, the value of an option will be affected by:
The value of an option is determined by its risk-neutral expectation discounted at the risk-free rate. In a one-period binomial model, the risk-neutral probabilities are determined only by the risk-free rate over the life of the option and the underlying asset's volatility (as measured by the up and down gross returns, Ru and Rd)." Therefore, and using the one-period binomial option pricing model, the value of an option will be affected by the volatility of the underlying.
Q54 CFAI PM (Redo this problem) Time Weighted Vs Money Weighted Return
Time Weighted: The time-weighted rate of return is calculated by computing the quarterly holding period returns and linking those returns into an annual return as follows: Money Weighted Rates of Return: Solves for rates of return using cash inflows solving for IRR
LIFO to FIFO
To convert a company's inventory balance and assets from LIFO to FIFO, the LIFO reserve is added to the ending inventory balance To convert a company's net income, COGS must be adjusted by subtracting the change in LIFO reserve during the period
Efficient Market Hypothesis
Weak Form: Security prices fully reflect all past market data Semi Strong: Prices reflect all publicly known and available information [i]f markets are semi-strong efficient, no single investor has access to information that is not already available to other market participants, ..." Therefore private information is not reflected in market prices in a semi-strong-form market. Strong: both the information available to the public and any information not publicly known—is completely accounted for in current stock prices, and there is no type of information that can give an investor an advantage on the market
Peter Chang, CFA, spreads rumors on social media about a potential acquisition of Advanced Electronics Company (AEC) after buying the stock for his personal account. Despite the rumors, AEC's stock price declines and Chang closes his position at a significant loss. Has Chang violated the Standards?
Yes, both the Standard relating to market manipulation and the Standard relating to misconduct
Describe: Panel Data Time - Series Data Cross - Sectional Data
[p]anel data are a mix of time-series and cross-sectional data that are frequently used in financial analysis and modeling. Panel data consist of observations through time on one or more variables for multiple observational units." Here, the multiple observational units are the different stocks within the industry, and 10 yearly observations for each stock are present in the dataset. "Time-series data are a sequence of observations for a single observational unit of a specific variable collected over time and at discrete and typically equally spaced intervals of time, such as daily, weekly, monthly, annually, or quarterly." "Cross-sectional data are a list of the observations of a specific variable from multiple observational units at a given point in time. The observational units can be individuals, groups, companies, trading markets, regions, etc
Economic Infrastructure vs Social Infrastructure Assets
[s]ocial infrastructure assets are directed toward human activities and include such assets as educational, health care, social housing, and correctional facilities, with the focus on providing, operating, and maintaining the asset infrastructure." Economic infrastructure assets reinforce economic activity and include three types of assets: Transportation assets: such as roads, bridges, tunnels, and airports. ICT assets: such as databases, broadcasting systems, and information transmitting assets. Utility and energy assets: that generate power and produce potable water.
What is the difference between GDP and GNP?
[t]he difference between a country's GDP and its GNP is that GDP includes, and GNP excludes, the production of goods and services by foreigners within that country."
An analyst gathers the following information about a company and its perpetual preferred stock: Growth in earnings: 2% Annual Preferred Dividend: 4.70 (Euros) Required Rate of Return on preferred shares: 8% The preferred stock's intrinsic value is closest to:
58.75 (Euros) Why did I get this wrong? One point to highlight here is that the annual preferred dividends is a fixed amount and does not consider the growth rate. I have misread the growth rate in earnings as it would also results in a growth in preferred dividends.
If a semi-annual pay bond has a yield-to-maturity of 7.5%, the yield-to-maturity based on quarterly compounding is closest to: Hint: use financial calculator for this
7.43%.
A company borrows $200 million for three years from a syndicate of banks. The company pledges receivables as collateral and the loan allows the borrower to draw down and repay amounts periodically. This short-term financing structure best describes a:
"Revolving credit agreements... involve formal legal agreements that define the aspects of the agreement... Revolvers differ in that they are in effect for multiple years (e.g., three to five years) and can have optional medium-term loan features. In addition, they are often used for much larger amounts than a regular line, and these larger amounts are spread out among more than one bank. With revolvers, borrowers draw down and pay back amounts periodically." Committed (regular) lines of credit are the form of bank line of credit that most companies refer to as regular lines of credit...These lines of credit are in effect for 364 days, less than a full year...Regular lines are unsecured and are pre-payable without any penalties." in a factoring arrangement, the company shifts the credit granting and collection process to the lender or factor." In a revolver, the borrower only uses receivables as collateral for the loan and remains responsible for the management of these accounts.
What is sampling error?
"[s]ampling error is the difference between the observed value of a statistic and the quantity it is intended to estimate as a result of using subsets of the population."
What is a hostile takeover?
"a hostile takeover is an attempt by one entity to acquire a company without the consent of the company's management." A hostile takeover does not involve a vote.
If practical, retrospective application is required for a change in accounting: policies only. estimates only. policies and estimates.
"changes in accounting policies (e.g., from one acceptable inventory costing method to another) are made for other reasons, such as providing a better reflection of the company's performance. Changes in accounting policies are reported through retrospective application unless it is impractical to do so." Changes in accounting estimates, however, are handled prospectively.
The objective of general purpose financial reporting is best described as:
"the objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity."
Steps 1-6 for Hypothesis Testing
1. state the hypothesis 2. identify the appropriate test statistic 3. specify the level of significance 4. state the decision rule 5. collet data and calculate test statistic 6. make a decision
Capital Market Line Formula
-understand which standard deviation to use in the denominator
Which of the following is most accurate? A derivative: derives its value from an underlying. transforms risk of the underlying. derives its value based on the principle that arbitrage opportunities exist in the market.
A derivative is a financial instrument that derives its performance from the performance of an underlying asset. B is incorrect: Derivatives transform performance - not risk Risk is transferred - not transformed! C is incorrect: We simply assume that no arbitrage opportunities can exist and infer the derivative price that guarantees there are no arbitrage opportunities. Therefore, a derivative does not derive its performance from the presence of arbitrage but the price of a derivative is determined with no arbitrage present.
Credit analysts assessing high-quality debt issuers most likely focus: primarily on the default probability, and less on the loss severity given default. equally on the default probability and on the loss severity given default. primarily on the loss severity given default, and less on the default probability.
A is correct default risk (default probability) is quite low for most high-quality debt issuers, which is why they tend to focus primarily on assessing this probability and devote less effort to assessing the potential loss severity arising from default
Deferred tax assets could arise when: taxable income is greater than accounting profit. the carrying amount of an asset exceeds its tax base. the carrying amount of a liability is lower than its tax base.
A is correct because "[d]eferred tax assets, which appear on the balance sheet, arise when an excess amount is paid for income taxes (taxable income higher than accounting profit) and the company expects to recover the difference during the course of future operations. B is incorrect because when the carrying amount of an asset exceeds its tax base, this results in a deferred tax liability. C is incorrect because when the carrying amount of a liability is lower than its tax base, this results in a deferred tax liability.
Which of the following is an assumption in Modigliani and Miller's capital structure framework? Investors can lend and borrow at the risk free rate Interest expense is deductible from income for tax purposes Investors have heterogeneous expectations about future corporate earnings
A is correct because "[g]iven their assumptions, Modigliani and Miller proved that changing the capital structure does not affect firm value, in part because individual investors can create any capital structure they prefer for the company by borrowing and lending in their own accounts in addition to holding shares in the company. This 'homemade' leverage argument relies on the MM assumption that investors can lend and borrow at the risk-free rate." B is incorrect because the assumption is that investors can borrow and lend at the risk free rate. "In their theoretical framework, MM assumed that all investors have homogeneous expectations about expected future corporate earnings and the riskiness of those earnings. Their assumptions, including a world of perfect capital markets—in which there are no taxes, no transaction costs, and no bankruptcy costs, and all investors have equal ("symmetric") information."
Which of the following statements is most accurate? Compared to institutional investors, retail investors tend to: have less in-depth information. require stocks with higher float and liquidity. form a larger proportion of the total investment base in developed equity markets.
A is correct because "[t]he basic difference between retail and institutional investors is that retail investors tend to have less in-depth information (to be more naive) and to be more momentum-centric than institutional investors. As a result, retail investors may depend upon technical analysis and momentum trading somewhat more than institutional investors." B is incorrect because "[i]nstitutional investors also must have enough float/liquidity in a given stock to participate in scale, so are limited in their interest in micro-cap stocks with minimal liquidity." Thus, it is institutional not retail investors, that require stocks to have higher float and liquidity. C is incorrect because "[w]ith regard to equities, in many less-liquid frontier and emerging markets, local retail investors are active traders, whereas developed markets have a higher percentage of institutional investors." Thus, institutional investors form a larger proportion of the total investment base in developed equity markets, whereas retail investors have a higher percentage in less-liquid emerging markets.
Which of the following market anomalies is best described as a cross-sectional anomaly? Size effect Momentum Initial public offerings
A is correct because "[t]wo of the most researched cross-sectional anomalies in financial markets are the size effect and the value effect. The size effect results from the observation that equities of small-cap companies tend to outperform equities of large-cap companies on a risk-adjusted basis." B is incorrect because the momentum anomaly is best described as a time-series anomaly. Momentum is a short-term price pattern where past price moves continued through time to move in the same direction. C is incorrect because the Initial Public Offering (IPO) anomaly is best described as an "other" anomaly.
The liability of a borrower most likely rises in real terms during: deflation. disinflation. hyperinflation.
A is correct because as "most debt contracts are written in fixed monetary amounts, the liability of a borrower [...] rises in real terms during deflation." Disinflation is incorrect because even after periods of disinflation, the inflation rate remains positive
A discrete random variable X has the following probability distribution: Prob: 0.2, 0.3, 0.5 Outcome: 35, 50, 80 The standard deviation of X is closest to
A: 18.73
If a company's variable costs increase relative to its fixed costs, the operating risk:
A: Decreases A is correct because variable costs are increasing relative to fixed costs and this makes the operating income less sensitive to changes in units sold, lowering the operating risk. "The greater the use of fixed, relative to variable, operating costs, the more sensitive operating income is to changes in units sold and, therefore, the more operating risk." Operating risk is risk attributed to the use of fixed cost in operation. The greater the fixed operating costs relative to variable operating costs, the greater operating risk. DOL = Contribution/EBIT. If VC are higher --> Contribution (numerator) is lower --> DOL is lower (answer A). Ex: Imagine you run an ice cream stand. You pay for rent. Your variable costs? Milk, cream, whatever flavoring and colors, etc.If I sell more ice cream, I need to buy more of these variable goods, and my fixed costs will always be the same (rent). When I sell more ice cream, I'll have more revenue coming into the door, which ultimately LOWERS RISK. If I have more variable costs, that means I'm making more sales, more money, and thus, pushing me to stay in business. My operational risk is very low, it's a proven model.
If a firm's supply curve equals its long-run marginal cost schedule, the firm most likely operates in a market structure of:
A: Perfect Competition "the monopolist does not have a well-defined supply function that determines the optimal output level and the price to charge." A monopolistic firm does not have a supply curve but will produce the quantity that maximizes profit, which is the intersection of marginal cost and marginal revenue the oligopolist does not have a well-defined supply function. That is, there is no way to determine the oligopolist's optimal levels of output and price independent of demand conditions and competitors' strategies." "[N]either the dominant firm nor the follower firms have a single functional relationship that determines the quantity supplied at various prices." Therefore, the oligopolist's supply curve is not determined solely by its marginal cost schedule.
The reversal of an inventory write-down: reduces cost of sales. increases other comprehensive income. is permitted under both IFRS and US GAAP.
A: Reduce cost of sales When you write down the cost of inventory it reduces the value of your ending inventory. I.E. COGS= Beg Inv + Purchases - Ending Inventory Lets say its, 200+100-50= 250 If inventory w/d happens i.e ending inventory decrease to for eg. 25 It will be 200+100-25 = 275 i.e increase in COGS If you reverse it, you will see a reduction in COGS
Beta formula
B= Cov(asset return, market return)/variance of market return understand which variance goes into the denominator
American vs European Waterfall
American: Deal by Deal Deal-by-deal waterfalls are more advantageous to the [general partner] because performance fees are collected on a per-deal basis, allowing the [general partner] to get paid before [limited partners] receive both their initial investment and their preferred rate of return (i.e., the hurdle rate) on the entire fund European: whole of fund n whole-of-fund waterfalls, all distributions go to the [limited partners] as deals are exited and the [general partner] does not participate in any profits until the [limited partners] receive their initial investment and the hurdle rate has been met
Annual Inflation Rate Formula using GDP Deflator
Annual Inflation Rate = ((GDP Deflator final year)/ (GDP Deflator earlier year) ^ 1/N ) -1
Which of the following statements about REITs is most accurate? Equity REITs primarily invest in mortgages. The main appeal of the REIT structure is the avoidance of corporate income taxation. The REIT structure is ideal for companies that do not intend to distribute their taxable net rental income to shareholders.
Answer is B the REIT structure avoids double (i.e., corporate level / shareholder level) taxation as their earnings have been passed along as dividend payments "Real estate investment trusts are the preferred investment vehicles for owning income-producing real estate of both private and public investors. The main appeal of the REIT structure is the elimination of double corporate taxation: Corporations pay taxes on income, and then the dividend distributions of after-tax earnings are subsequently taxed at the shareholder's personal tax rate. REITs can avoid corporate income taxation by distributing dividends equal to 90%-100% of their taxable net rental income." A is incorrect because "[m]ortgage REITs, which invest primarily in mortgages, are similar to fixed-income investments. Equity REITs, which invest primarily in commercial or residential properties and use leverage, are similar to direct equity investments in leveraged real estate."
A characteristic that contributes to intense rivalry among competitors in an industry is most likely high: fixed costs. product differentiation. industry concentration.
Answer is fixed costs Why? [i]ndustries that are fragmented among many small competitors, have high fixed costs, provide undifferentiated (commodity-like) products, or have high exit barriers usually experience more intense rivalry than industries without these characteristics." high fixed costs would encourage the firm to sell more, creating additional pressures and potential price wars to gain market share.
For corporate bonds, the components of credit risk most likely include: default risk and liquidity risk. default risk and loss severity. loss severity and liquidity risk.
B is correct because "[c]redit risk is the risk of loss resulting from the borrower (issuer of debt) failing to make full and timely payments of interest and/or principal. Credit risk has two components. The first is known as default risk, or default probability...The second component is loss severity (also known as 'loss given default')."
With respect to fintech, which of the following statements is most accurate? Big Data solves the issue of selection bias. A neural network that learns a dataset too precisely may indicate overfitting. Machine learning algorithms require assumptions on the underlying probability distribution of the data.
B is correct because "[o]verfitting occurs when the ML model learns the input and target dataset too precisely." Neural networks can be ML algorithms. "The growth in Big Data has provided ML algorithms, such as neural networks, with sufficient data to improve modeling and predictive accuracy, and greater use of ML techniques is now possible." A is incorrect because "Big Data poses several challenges when it is used in investment analysis, including the quality, volume, and appropriateness of the data. Key issues revolve around the following questions, among others: Does the dataset have selection bias, missing data, or data outliers?" C is incorrect because "[m]achine learning (ML) involves computer-based techniques that seek to extract knowledge from large amounts of data without making any assumptions on the data's underlying probability distribution."
Which of the following natural resources has formed part of large institutional portfolios for decades? Farmland only Timberland only Both farmland and timberland
B is correct because "[t]imberland investment involves ownership of raw land and the harvesting of its trees for lumber, thus generating an income stream and the potential for capital gain; it has formed part of large institutional portfolios for decades. Farmland as an investment is a more recent phenomenon, with only a few dedicated funds involved. With population growth, weather, and water management becoming more topical, however, investors may turn to these sustainable land assets to address such concerns in their portfolio."
A firm claiming compliance with the GIPS standards: can claim compliance on specific composites. is responsible for maintaining that compliance. must have the verification of its claim of compliance performed by an independent third party.
B is correct because according to GIPS standards, "Firms that claim compliance with the GIPS standards are responsible for their claim of compliance and for maintaining that compliance." C is incorrect because according to GIPS standards, "Once a firm claims compliance with the Standards, they may voluntarily hire an independent third party to perform a verification in order to increase confidence in the firm's claim of compliance." Therefore, a firm that claims compliance with the GIPS standards is not required to perform a verification of its claim of compliance by using an independent third party but may do so voluntarily.
The hedge fund strategy that typically uses options to go long or short market volatility is most likely classified as a(n): event-driven strategy. relative value strategy. fundamental value strategy.
B is correct because this is the definition of a volatility strategy which is an example of a relative value strategy. Volatility strategies "typically use options to go long or short market volatility, either in a specific asset class or across asset classes. In a volatility trading strategy, the trader is often looking for discrepancies between the implied volatility of options (which is a component of their price) and their expectations for future volatility. This is a form of relative value trading. In contrast, while event-driven strategies can also involve a focus on mispricings, these mispricings are generally related to specific corporate events (like mergers or bankruptcies), rather than to broader market conditions or statistical measures like volatility. Funds following a fundamental value strategy "take long positions in these companies and sometimes hedges the portfolio by shorting index ETFs or more growth-oriented companies deemed overvalued. Such managers also tend to be long biased and have a positive factor bias to value as well as to small- cap factors since many underappreciated value situations tend to reside in the small- cap sector."
Which of the following best describes a component of the income statement? Amounts that a company owes its vendors for purchases of goods and services Outflows or depletions of assets in the course of a business's activities Obligations from past events that are expected to result in an outflow of economic benefits
B is correct. Expenses are a component of the income statement and are defined as outflows, asset depletions, and liabilities incurred in the course of a business's activities. A is incorrect. Accounts payable is a liability, a component of the balance sheet, and is defined as amounts that a company owes its vendors for purchases of goods and services. C is incorrect. Liabilities are a component of the balance sheet and are defined as obligations from past events that on settlement are expected to result in an outflow of economic benefits.
If the company's WACC increases as a result of taking on additional debt, the company has moved beyond the
the optimal capital range.. The costs of financial distress may outweigh any tax benefits from the use of debt.
A buyer's profit from an in-the-money put option is best described as the:
value of the option at expiration minus the option premium.
An equal-weighted index most likely: (understand what an equal weighted index is) requires infrequent rebalancing. has weights arbitrarily assigned by market prices. underrepresents large cap securities versus the target market.
C is correct because "securities that constitute the largest fraction of the target market value are underrepresented, and securities that constitute a small fraction of the target market value are overrepresented." A is incorrect because "after the index is constructed and the prices of constituent securities change, the index is no longer equally weighted. Therefore, maintaining equal weights requires frequent adjustments (rebalancing) to the index." (p. 85) Also, if a candidate believes that equal weighting implies no over/underweighting they will select this choice. B is incorrect because an equally-weighted index weights each security equally regardless of market price.
A swap is similar to a series of implicit forward contracts with each contract created at a price that corresponds to the: floating rate on the swap at each payment date. net cash flows on the swap at each payment date. fixed price of the swap with payments made at the same dates as the series of forward contracts.
C is correct because each forward contract is "created at the fixed price that corresponds to the fixed price of a swap of the same maturity with payments made at the same dates as the series of forward contracts."
An analyst gathers the following information about a nonpublic company: Asset Beta: 0.80 Value of Company Debt: 5M Value of Company Equity: 10M Tax Rate: 20% The Company's Equity Beta is closest to:
C is correct because the company's equity beta estimated by using an asset (unlevered) beta is: βE = βU × [(1 + (1 - t) × (D/E)] = 0.80 × [(1 + (1 - 20%) × (5,000,000/10,000,000)] = 1.12.
#82 AM On 1 January, a company that prepares its financial statements according to International Financial Reporting Standards (IFRS) arranged financing for the construction of a new plant. The company borrowed NZ$5,000,000 at an interest rate of 8%, issued NZ$5,000,000 of preferred shares with a cumulative dividend rate of 6%, and temporarily invested NZ$2,000,000 of the loan proceeds during the first six months of construction and earned 7% on that amount. The amount of financing costs to be capitalized to the cost of the plant in the first year is closest to:
C is correct. The interest costs can be capitalized during the construction phase; however, under IFRS any amounts earned by temporarily investing the funds are deducted from the capitalized amount. The costs related to the preferred shares cannot be capitalized. Total Capitalized Costs: 330,000
Thomas Petrov, CFA, posts his investment views anonymously on social media and tags his post using "#CFAcharter." Did he violate the standards?
Petrov violates Standard VII(B) because "where individuals may anonymously express their opinions, pseudonyms or online profile names created to hide a member's identity should not be tagged with the CFA designation."
Describe Industry Concentration (High and Low) What about HHI?
Low industry concentration: In an industry would indicate greater competition among the firms in that industry High Industry Concentration: Industries that have dominant firms such as CoCa Cola maintaining 80% of market share. The Herfindahl-Herschman Index (HHI) is an alternative indicator of firm size, calculated by squaring the percentage share (stated as a whole number) of each firm in an industry, then summing these squared market shares to derive an HHI. The HHI has a fair amount of correlation to the concentration ratio and can be a better measure of market concentration.
Compared to trading an underlying directly, trading a derivative on the underlying most likely involves: higher transaction costs. a lower degree of leverage. a smaller amount of required of capital.
Derivative markets also typically have greater liquidity than the underlying spot markets, a result of the smaller amount of capital required to trade derivatives than to get the equivalent exposure directly in the underlying." Therefore, derivatives most likely have lower capital requirements relative to trading the value of the underlying.
Florence Zuelekha, CFA, is an equity portfolio manager at Grid Equity Management (GEM), a firm specializing in commodities. Zuelekha, who previously focused on alternative energy, recently attends her first commodity conference, sponsored in large part by GEM. Independent industry experts argued that commodities would increase in value and recommended that investors hold at least 10% of their portfolio assets in commodities based on consistent increases in their values over the previous two years. Without doing any additional research, Zuelekha recommends to all her clients an immediate allocation of 5% of their portfolio into commodities. Over the next few weeks, Zuelekha moves her own portfolio to a 10% commodity allocation. Which of the CFA Standards did Zuelekha most likely violate?
Florence violated the Standard of Diligience and a Reasonable Basis. Relying solely upon attendance at a one-day conference listening to industry experts to make an investment recommendation, especially when the industry experts have based their recommendations upon price data only, would not meet the requirements of the Code and Standards with regard to Diligence and a Reasonable Basis.
A normal distribution has a skewness of __ and a kurtosis of ___?
skewness: 0 Kurtosis: 3
Q 13 - CFAI PM Beta Asset (Unlevered) and Equity (levered)
Equity (levered) beta = Asset (unlevered) beta x (1+((1-T) x (D/E)))
Describe Monetary Policy Tools Expansionary vs Contractionary
Expansionary: -Buy Securities -Set lower Interest rates -decrease reserve requirements Contractionary: -sell securities -raise interest rates -increase reserve requirements
Write out the GDP formula under the following: Expenditure Approach Income Approach Value Added Approach
Expenditure: GDP = Consumer spending on goods and services + Business gross fixed investment + Change in inventories + Government spending on goods and services + Government gross fixed investment + Exports - Imports + Statistical discrepancy Income: It includes all items including transfer payments and capital consumption allowance, which are components of the income approach. GDP = Total national income + Sales taxes + Depreciation + Net foreign factor income
FCFF and FCFE Formula
FCFF = Net income + D&A + Interest Exp * (1-t) - Increase in WC - CAPEX FCFE = FCFF + Net New Debt - Interest * (1-t)
Give me the other terms to describe flat and full price
Flat price refers to a bond less accrued interest AKA quoted price, clean price Full Price refers to bond with accrued interest priced in AKA Invoiced price, dirty price
A good risk management framework: is a top-down process and guidance directing risk management activities. seeks to prioritize avoidance of financial loss over defining policies and processes. is typically a process that addresses a common set of factors within different organizations.
Good risk management may not prevent losses but provides a framework that addresses common factors, such as risk governance, risk infrastructure, policies and procedures, risk monitoring, and integration, among others. It is the infrastructure, process, and analytics needed to support effective risk management in an organization. This process should fully integrate the "risk" and "return" aspects of the enterprise into decisions in support of best achieving its goals within its tolerance for risk A is incorrect. Risk governance is the top-down process and guidance that directs risk management activities to align with and support the overall enterprise. B is incorrect. A good risk management framework prioritizes the definition of policies and procedures over avoidance of financial loss.
Yun Hae, CFA, is a portfolio manager at Citadel Capital (CC). Hae's brother maintains a fee-paying retirement account at CC. Hae has no beneficial ownership in her brother's account. Whenever an IPO becomes available that is suitable for her clients, Hae first allocates shares to other clients before placing any remaining shares in her brother's account. She adopts this procedure to avoid potential conflicts of interest. Hae's actions violate the Standard(s) relating:
Hae violated Priority of Transactions because family accounts should not be given special treatment or disadvantaged because of the family relationship She has also violated fair dealing since she limited her family's accounts ability to buy shares
Question 84: Describe Impairment under US GAAP and IFRS
IFRS: an impairment loss is measured as the excess of carrying amount over the recoverable amount of the asset. The recoverable amount of an asset is defined as 'the higher of its fair value less costs to sell and its value in use.' Value in use is a discounted measure of expected future cash flows. US GAAP: assessing recoverability is separate from measuring the impairment loss. An asset's carrying amount is considered not recoverable when it exceeds the undiscounted expected future cash flows. If the asset's carrying amount is considered not recoverable, the impairment loss is measured as the difference between the asset's fair value and carrying amount."
Describe credit enhancement in regard to bonds.
Internal enhancements are processes undertaken by the issuer to reduce its own credit risk such as overcollateralization while external enhancements consists of assurances made by entities other than the issuer. Ex: Internal: subordination of debt, pledged assets, reserved accounts External: Surety bonds, letters of credit, cash collateral accounts (cash deposited by guarantor that issuer can borrow)
A US investor purchases an American depository receipt of a company based in Japan. If the total return of the company's stock in Japan is 3% and the Japanese yen appreciates by 3% against the US dollar, the investor's total return is closest to: Explain this.
Let's say we buy 100 USD of the DRs, if we assume JPY/USD = 100, this gets 10,000 JPY into this company. Stock goes up 3% so we get 10,300 JPY. JPY appreciates by 3%, so JPY/USD = 100 / 1.03 = 97.0874.We then convert 10,300 JPY back into USD giving JPY 10,300 / 97.0874 = 106.09 ~ +6% USD I think the issue with your formula, is the 97 and 100 exchange rates aren't the multiplier you'd apply to JPY to get USD. You'd actually want the reciprocal of it, which would give your formula: Total return = (1 + 0.03 ) x [(1/97)/(1/100)] - 1= 1.03 x (100/97) - 1 = 0.06186 ~ 6% For a moment forget stock return on that particular stock. And Think of it this way, you sold USD [because you had to buy something denominated in Yen] (Shorted an Asset) and Brought Yen (Long on this asset) and the Asset you shorted (The USD) lost in value (Depreciated) [you sold it t 50 and now it trades at say 47] buy it back from the Open market, now you have to pay 47 only to get the Original Asset back. you made a gain of 3 Points here. Add that up with the Stock return.
Describe Market Anomalies
Market anomalies are exceptions to the notion of market efficiency. They may be present if a change in the price of an asset or security cannot directly be linked to current relevant information known in the market. Time Series Anomalies: -Calendar Anomalies: Jan effect, in which stocks tend to outperform in the month of January -Momentum/ Over-reaction: The momentum anomaly refers to the empirically observed tendency for rising asset prices to rise further and falling prices to keep falling. Stocks with strong past performance continue to outperform stocks with poor past performance in the next period Cross Sectional Anomalies: -Size effect: small companies tend to outperform larger companies -Value effect: value stocks, which generally are stocks with below-average price-to-earnings and market-to-book ratios, and above-average dividend yields, have consistently outperformed growth stocks. Other Anomalies: -Closed-End Fund discounts: sell at a discount to their net asset value or the price that the fund's holdings could theoretically be sold for if fully liquidated -Earnings Surprise: stock prices have a tendency to underreact to new information, allowing for a momentum strategy -Initial public offerings (IPOs): Investors can purchase a stock at its initial offering price to earn excess returns. -Prior information: some researchers have found that equity returns relate to prior information like interest rates, inflation rates, stock volatility, and dividend yields.
When analyzing a specific project a company should consider the project's cash flows from the perspective of:
Opportunity Costs, the cash flows if the project is accepted. versus what they would be if it is not. Costs that were previously incurred, such as the price paid for the land are considered sunk costs. (Costs which can't be recovered regardless of whether the project is accepted) These costs should not be considered in the analysis.
All else being equal, cash dividends paid to common shareholders result in a: lower ROA than if no dividends were paid. higher ROE than if no dividends were paid. lower net profit margin than if no dividends were paid.
ROE = Net income ÷ Average total equity. ""The basic components of owners' equity are paid- in capital and retained earnings. Retained earnings include the cumulative amount of the company's profits that have been retained in the company . . . For retained earnings . . . a dividend payment is the most common decrease." Declaring and paying cash dividends to shareholders does not change net income but reduces retained earnings thus decreases total equity. As a result, ROE will increase compared to no dividends declared and paid. Declaring and paying cash dividends decreases total assets but does not affect net income. Cash dividends are paid from net income so it would not affect it.
What is NRV for IFRS?
Sales price-cost to sell
Kush Shah, CFA, is the chief investment officer of an investment firm. Shah discovers during a routine review of the firm's trading system that the firm erroneously bought shares of IY Steel (IYS) for several clients. Shah immediately sells IY shares and realises significant profits for the clients. Later, Shah outsources a portion of the clients' portfolios to an external manager. Shah does not notify the firm's clients about the external manager because the fund's stock selection process remains unchanged. Shah has violated the Standards because he failed to notify the clients:
about the erroneous purchase of IY shares and about outsourcing a portion of the clients' portfolios to an external manager.
With respect to issuer-paid research, members are not required to:
according to Standard I (B), Independence and Objectivity, "independent analysts must also strictly limit the type of compensation that they accept for conducting issuer-paid research. Compensation that might influence the research report could be direct, such as payment based on the conclusions of the report, or indirect, such as stock warrants or other equity instruments that could increase in value on the basis of positive coverage in the report
According to the Standard relating to fair dealing, when members disseminate investment recommendations, they are most likely required to make every effort to treat individual clients in a(n): fair and equal manner. fair and impartial manner. equal and impartial manner.
according to Standard III (B), Fair Dealing, "[m]embers and candidates must make every effort to treat all individual and institutional clients in a fair and impartial manner." Additionally, "[t]he term 'fairly' implies that the member or candidate must take care not to discriminate against any clients when disseminating investment recommendations or taking investment action. Standard III(B) does not state 'equally' because members and candidates could not possibly reach all clients at exactly the same time..."
The choice of a periodic or a perpetual inventory system could affect ending inventory and cost of sales under the: FIFO inventory valuation method. specific identification inventory valuation method. weighted average cost inventory valuation method.
because "[c]ompanies typically record changes to inventory using either a periodic inventory system or a perpetual inventory system. ... Under either system, the allocation of goods available for sale to cost of sales and ending inventory is the same if the inventory valuation method used is either specific identification or FIFO. This is not generally true for the weighted average cost method."
With regard to probability concepts, an event represents:
both a single outcome and a set of outcomes. "[a]lthough we may be concerned about a single outcome, frequently our interest may be in a set of outcomes. The concept of 'event' covers both."
According to the Standard relating to additional compensation arrangements, a member must not accept a benefit offered by a third party that might create a conflict of interest with his employer's interest unless he obtains written consent:
both from his employer and from the third party offering the benefit. according to Standard IV (B), Additional Compensation Arrangements, "Members and Candidates must not accept gifts, benefits, compensation, or consideration that competes with or might reasonably be expected to create a conflict of interest with their employer's interest unless they obtain written consent from all parties involved." Therefore, the member is required to obtain consent from the employer and from the third party.
A buy-and-hold investor purchases a fixed-rate bond at issuance and holds it until maturity. With respect to interest rate risk, this investor is exposed to: Why?
coupon reinvestment risk only. Why? "[c]oupon reinvestment risk matters more when the investor has a long-term horizon relative to the time-to-maturity of the bond. For instance, a buy-and-hold investor only has coupon reinvestment risk. Market price risk matters more when the investor has a short term horizon relative to maturity. For example, an investor who sells the bond before the first coupon is received has only market price risk *Investor hold to maturity: meaning receives all coupons and principal at maturity - effectively market risk - relating to YTM change - is eliminated. Only risk investor has is the interest earnings they will receive on reinvested coupons. Buy-and-hold is equivalent as a "hold-until-maturity", at least for the CFA Curriculum, since we are talking about long term position of fixed income
A portfolio manager gathers the following information about her fund: Allocation of corporate bonds 20% Allocation of bonds that are both corporate and high-yield 10% If the portfolio manager randomly picks a corporate bond, the probability that the bond is high yield is closest to:
definition of conditional probability P(A | B) = P(AB)/P(B), where P(AB) is the joint probability of A and B and P(B) is the probability of B, then the conditional probability that the portfolio manager randomly picks a high-yield bond, given that it is a corporate bond is equal to P(bond is high yield | corporate bond) = P(bond is high-yield and corporate bond)/P(corporate bond) = 0.1/0.2 = 0.5.
If the net cost of carry is zero, the forward price of a commodity is most likely: less than the commodity's spot price compounded at the risk-free rate over the life of the contract. equal to the commodity's spot price compounded at the risk-free rate over the life of the contract. greater than the commodity's spot price compounded at the risk-free rate over the life of the contract.
equal to the commodity's spot price compounded at the risk-free rate over the life of the contract. Why? "The forward price of an asset with benefits and/or costs is the spot price compounded at the risk-free rate over the life of the contract minus the future value of those benefits and costs." That is, F0(T) = S0(1+r)T - (γ - θ)(1+r)T When net cost of carry is zero, the term (γ - θ) is zero, resulting in (γ - θ)(1+r)T being zero. Then, F0(T) = S0(1+r)T.
A 12-year old investment firm adopts the GIPS standards. To claim compliance with the GIPS standards, the firm is initially required to present GIPS-compliant performance history:
for at least five years. according to GIPS, "A firm is required to initially present, at a minimum, five years of annual investment performance that is compliant with the GIPS standards. If the firm or the composite has been in existence less than five years, the firm must present performance since the firm's inception or the composite inception date
The central limit theorem is best described as stating that the sampling distribution of the sample mean will be approximately normal for large-size samples:
for populations described by any probability distribution. The central limit theorem holds without regard for the distribution of the underlying population.
The NZD/EUR (amount of NZD per 1 EUR) spot rate is 1.5453. If the 3-month forward discount is 24 points, the 3-month forward rate is closest to:
if the forward rate is less than the spot rate, the points (forward rate minus spot rate) are negative and the base currency is said to be trading at a forward discount." To convert ... quoted forward points into a forward rate, one would divide the number of points by 10,000 (to scale down to the fourth decimal place, the last decimal place in the spot quote) and then add the result to the spot exchange rate quote Therefore, scaling down the forward points by dividing by 10,000 gives a forward discount of 24/10,000 = 0.0024. Since it is a discount, subtracting it from the spot rate results in a three-month forward rate of 1.5453 - 0.0024 = 1.54290
What causes permanent differences in DTA/ DTL?
income or expense items not allowed by tax legislation create a permanent difference that will not be reversed at some future date. Because they will not be reversed at a future date, these differences do not give rise to deferred tax. Deferred tax liabilities are created because of temporary differences that are expected to reverse in the future. All permanent differences result in a difference between the company's effective tax rate and statutory tax rate.
A member or candidate who pays a higher brokerage commission than he or she would normally pay to allow for the purchase of goods or services, without corresponding benefit to the client, violates the duty of
loyalty to the client. Using commissions or soft dollars for the good of the clients does not violate the standard
Management Buy ins vs Buy Outs
management buy-ins (MBIs), the current management team is being replaced and the acquiring team will be involved in managing the company In management buyouts (MBOs), the current management team is involved in the acquisition,
A corporate takeover in which shareholders are persuaded to vote for a group seeking a controlling position on the board of directors best describes a:
proxy contest. [i]n a proxy contest, shareholders are persuaded to vote for a group seeking a controlling position on a company's board of directors."
What is "other comprehensive income"?
revenues, expenses, gains, and losses that are included in comprehensive income but excluded from net income. This means that they are instead listed after net income on the income statement. Ex: Unrealized holding gains or unrealized holding losses on investments that are classified as available for sale Foreign currency translation gains or losses Pension plan gains or losses Gains and losses (effective portion) on derivatives instruments that are designated as, and qualify as, cash flow hedges.
In an equally weighted portfolio, the diversification ratio is best described as a measure of the:
risk reduction benefit of investing in the portfolio versus a security from the portfolio. C is correct because the level of risk reduction from the portfolio approach to investing, relative to the risk of investing in a single security, can be measured by the diversification ratio. "[A] simple measure of the value of diversification is calculated as the ratio of the standard deviation of the equally weighted portfolio to the standard deviation of the randomly selected security. This ratio may be referred to as the diversification ratio. ... The diversification ratio of the portfolio's standard deviation to the individual asset's standard deviation measures the risk reduction benefits of a simple portfolio construction method, equal weighting."
Arbitrage is best described as an opportunity to earn:
risk-free returns with no investment capital. because "[a]rbitrage is risk free and requires no capital because selling the overpriced asset produces the funds to buy the underpriced asset." Why is the answer abnormal returns by applying an absolute valuation method incorrect? It is certainly desirable but is hardly an arbitrage because it requires the assumption of risk and the investment of capital. Arbitrage also does not tell us the fundamental value
All else being equal, a cash dividend most likely has the same effect on shareholders' wealth as a: stock split. stock dividend. share repurchase.
share repurchase. Why? With Stock splits and dividends, the company does not need to pay any money and just increases the shares outstanding and maintains the same market cap. While cash dividends and Share repurchases require the company to pay money to the shareholder (dividend) and market (Share Repurchase). The effect on share holder wealth is: Stock Split: Income - no effect, Assets - no effect Stock Dividend: Income - no effect, Assets - Increase Share Repurchase: Income - increased by money received, Assets - decrease by the shares repurchased Cash Dividend: Income - money increased, Assets - decrease as share price decreases after dividends are paid
