Exam incorrect questions
Q. Maria Martinez is a research analyst and a Level II CFA candidate. Recently, friends of Martinez organized a party for her thirtieth birthday. At the party, Martinez received an inexpensive gift from a friend who is the CEO of a publicly listed company Martinez recommends to clients. Martinez also received gifts from some of the firm's best clients. Aware of her employer's policy requiring her to report all gifts received within one week of receipt, Martinez declares the gifts she received from the firm's clients two days after the party. Does Martinez most likely violate the CFA Institute Standards of Professional Conduct? Yes. No, because her CEO friend's gift was inexpensive. No, because the gifts do not impact her research independence and objectivity.
A is correct because Standard I(D)-Misconduct states that members and candidates must not engage in any professional conduct involving dishonesty, fraud, or deceit or commit any act that reflects adversely on their professional reputation, integrity, or competence. By only reporting the gifts she received from clients but not the inexpensive gift from her CEO friend, she does not conform to her employer's gift policy of reporting all gifts. Her non-compliance with employer policies reflects adversely on her professional reputation and honesty.
Q. Which of the following is least likely a requirement of the GIPS standards? Firms are required to: have their performance records verified by an independent third party. include all discretionary, fee-paying portfolios in at least one composite. present a minimum of five years of annual investment performance compliant with GIPS standards.
A is correct because it is a recommendation but not a requirement that firms obtain independent third-party verification to claim GIPS compliance. Firms are required to include all discretionary, fee-paying portfolios in at least one composite. They must also present a minimum of five years of annual investment performance compliant with GIPS standards.
Q. Anna Saar, CFA, is the head of compliance for Tranne Advisory Services, a regional financial services group including asset management, investment banking, and stock brokerage entities. Reviewing a draft client investment management agreement for the asset management unit, she is concerned that the relationships between the firm's various business units are not properly disclosed. To prevent violating CFA Institute Standard VI(A)-Disclosure of Conflicts, which of the following should least likely be addressed in the investment management agreement? The group subsidizes staff loans for share purchases. Management fees are frequently loss leaders for brokerage. Asset managers are likely to support corporate finance deals.
A is correct because the group subsidizing staff loans for the purchase of shares is not a conflict of interest for clients because it is a funding mechanism and does not interfere with objectivity when rendering investment advice or taking investment action. However, asset managers subsidizing their asset management fees and supporting the investment banking corporate finance deals should be disclosed per Standard VI(A)-Conflicts of Interest and Standard VI(B)-Priority of Transactions, respectively.
income Statement Millions ($) Revenues 9.8 Variable operating costs 7.2 Fixed operating costs 1.5 Operating income 1.1 Interest 0.6 Taxable income 0.5 Tax 0.2 Net income 0.3 Q. The degree of operating leverage (DOL) is closest to: 2.4. 1.1. 1.7.
A is correct. DOL = Revenues−Variable operating costsRevenues−Variable operating costs−Fixed operating costs = 9.8−7.29.8−7.2−1.5 = 2.36
Q. A company's non-callable, non-convertible preferred stock that pays an annual dividend of $3.75 is currently selling at its par value of $50 per share. If the required rate of return increases by 75 bps, the preferred stock's new price is closest to: $45.45. $49.50. $55.56.
A is correct. Investors' current required return = $3.75/$50 = 7.50% New required return = 7.50% + 0.75% = 8.25% New market price = $3.75/0.0825 = $45.45
Q. The following information is available about a company: Next year's sales revenue $180 million Next year's net profit margin 15% Dividend payout ratio 60% Dividend growth rate expected during Years 2 and 3 25% Dividend growth rate expected after Year 3 5% Investors' required rate of return 12% Number of outstanding shares 8.1 million The current value per share of the company's common stock according to the two-stage dividend discount model is closest to: $39.36. $49.20. $52.86.
A is correct. Net profit margin = Net earnings/Sales Net earnings = Net profit margin × Sales Dividends per share (Dn) = (Net earnings × Payout ratio)/Number of outstanding shares Therefore, D1 = ($180 million×0.15×0.60)8.1 million=$2.00 D2 = $2.00(1 + 0.25) = $2.50 D3 = $2.00(1 + 0.25)2 = $3.13 D4 = $2.00(1 + 0.25)2(1 + 0.05) = $3.28 V3 = $3.28(0.12−0.05)=$46.86 V0 = $2.00(1+0.12)+$2.50(1+0.12)2+$3.13(1+0.12)3+$46.86(1+0.12)3=$39.36
Q. Given the function Qdx=5.7−1.3Px+0.03I−0.03Py where Qdx = the quantity demanded of good X Px = the price per unit of good X I = consumers' income Py = the price per unit of good Y the most likely cause of a shift in the demand curve is a change in: Py. Qdx. Px.
A is correct. A shift in the demand curve results from a change in any variable other than the good's own price, Px. Given the demand function, a change in either Py or I would result in a shift in the demand curve. A change in quantity demanded, which refers to a movement along the demand curve, arises when the good's own price changes.
Q. Which of the following groups is most likely responsible for maintaining oversight and responsibility for the Professional Conduct Program (PCP)? CFA Institute Board of Governors Disciplinary Review Committee Professional Conduct Division
A is correct. All CFA Institute members and candidates enrolled in the CFA Program are required to comply with the Code and Standards. The CFA Institute Board of Governors maintains oversight and responsibility for the Professional Conduct Program (PCP).
Q. Inherent risks in an investment are most appropriately evaluated in which step of the financial statement analysis framework? Develop and communicate conclusions/recommendations Articulate the purpose and context of analysis Process data
A is correct. Discussion and presentation of inherent risks in an investment is appropriate in the develop and communicate conclusions/recommendations step. B and C are incorrect because risks are evaluated and presented after data are collected and processed.
Q. A sample of 240 managed portfolios has a mean annual return of 0.11 and a standard deviation of returns of 0.23. The standard error of the sample mean is closest to: 0.01485. 0.00096. 0.00710.
A is correct. For a sample, the standard error of the mean is sX⎯⎯⎯=s/n⎯⎯√ (where s is the sample standard deviation and n is the sample size), which here is: 0.23240√/=0.01485.
Q. For a given economy and a given period of time, GDP measures the: aggregate income earned by all households, all companies, and the government. total income earned by all of the country's citizens, firms, and the government. total market value produced of resalable and final goods and services. The most appropriate description of what is measured by GDP is given by: I only. I and II. I and III.
A is correct. Gross domestic product (GDP) can be defined in terms of either output or income: it is the market value of all final goods and services produced within the economy in a given period of time (output definition) or, equivalently, it is the aggregate income earned by all households, all companies, and the government within the economy in a given period of time (income definition).
Q. Consider a $100 par value bond with a 7% coupon paid annually and 5 years to maturity. At a discount rate of 6.5%, the value of the bond today is $102.08. One day later, the discount rate increases to 7.5%. Assuming the discount rate remains at 7.5% over the remaining life of the bond, what is most likely to occur to the price of the bond between today and maturity? The price: decreases then increases. increases then decreases. decreases then remains unchanged.
A is correct. If the discount rate increases to 7.5% from 6.5%, the price of a bond decreases. At a discount rate of 7.5%, the bond sells at a discount to face value. As a discount bond approaches maturity, it will increase in price over time until it reaches par at maturity.
Q. A bond has a duration of 4.50 and convexity of 39.20. If interest rates increase by 0.5%, the percentage change in the bond's price will be closest to: −2.20%. −2.15%. −2.25%.
A is correct. Incorporating both duration and convexity, the percentage change in a bond's price = ( −Duration × Dy) + (0.5 × C × (Dy)2) = (−4.50 × 0.005) + (0.5 × 39.20 × 0.0052) = −0.0220 or −2.20%.
Q. Which of the following is most likely a private real estate investment vehicle? Real estate limited partnership Real estate investment trust Collateralized mortgage obligation
A is correct. Real estate limited partnerships are a form of private real estate investment.
Q. The dollar discount on a US Treasury bill with 91 days until maturity is $2,100. The face value of the bill is $100,000. The bank discount yield of the bill is closest to: 8.31%. 8.40%. 8.58%.
A is correct. Solve for bank discount yield, rBD, using: rBD = (D/F)×(360t) rBD = (2,100100,000)×(36091) = 0.083077~8.31%.
Q. Assume a company has the following portfolio of marketable securities, which were acquired at the end of last year: Category Original Cost (in €) at the End of Last Year Fair Market Value (in €) at the End of the Current Year Held for trading 12,000,000 12,500,000 Available for sale 17,000,000 16,000,000 If the company reports under IFRS compared with US GAAP, its net income in the current year will most likely be: the same. €500,000 higher. €500,000 lower
A is correct. Whether securities are classified as held for trading or available for sale, they are measured at their fair value on the balance sheet. All gains/losses on held-for-trading securities are reported on the income statements, whereas the unrealized gains/losses on available-for-sale securities are reported in equity. This treatment is the same for both IFRS and US GAAP reporting.
Q. The following information is provided about a stock market index m and security i: Statistic Value Covariance between market return and security return [Cov(Ri,Rm)] 0.01104 Correlation coefficient between market return and security return (ρi,m) 0.3 Standard deviation of market return (σm) 0.16 The beta of security i,βi, is closest to: 0.43. 0.23. 1.88.
A is correct. βi = Cov(Ri,Rm)/σm2 = 0.01104/(0.16)2 = 0.43
Q. Which of the following infrastructure investments would most likely be easiest to value? master limited partnership holding greenfield investments. master limited partnership holding brownfield investments. private equity fund holding brownfield investments.
B is correct because A master limited partnership (MLP) is publicly traded, whereas a private equity fund is not. Therefore the MLP will have market pricing information to help with valuation. A brownfield investment is an existing asset that likely has operational and financial history to aid in valuation; a greenfield investment is in new construction.
Ken Kawasaki, CFA, shares a building with a number of other professionals who are also involved in the investment management business. Kawasaki makes arrangements with several of these professionals, including accountants and lawyers, to refer clients to each other. An informal score is kept on the expectation the referrals will equal out over time, eliminating the need for any cash payments. Kawasaki never mentions this arrangement to clients or prospective clients. Does Kawasaki's agreement with the other building occupants most likely violate any CFA Institute Standards of Professional Conduct? No. Yes, related to referral fees. Yes, related to communication with clients.
B is correct because Standard VI(C) requires disclosure of any compensation, consideration, or benefit received from or paid to others for the recommendation of products or services. Even without cash changing hands the arrangement provides for a quid pro quo referral of clients and should be disclosed.
Kelly Amadon, CFA, an investment advisor, has two clients: Ryan Randolf, 65 years old, and Keiko Kitagawa, 45 years old. Both clients earn the same amount in salary. Randolf, however, has a large amount of assets, while Kitagawa has few assets outside her investment portfolio. Randolf is single and willing to invest a portion of his assets very aggressively; Kitagawa wants to achieve a steady rate of return with low volatility so she can pay for her child's current college expenses. Amadon recommends investing 20 percent of both clients' portfolios in the stock of very low yielding small-cap companies. Amadon least likely violated the CFA Institute Code of Ethics and Standards of Professional Conduct with regards to his investment recommendations for: both clients' portfolio. only Randolf's portfolio. only Kitagawa's portfolio.
B is correct because in Randolf's case, the investment may be appropriate given this client's financial circumstances and aggressive investment position. This investment would not be suitable for Kitagawa with a need for a steady rate of return and her low risk profile.
Q. A company using the last-in, first-out (LIFO) inventory method reports a year-end LIFO reserve of $85,000, which is $20,000 lower than the prior year. If the company had used first-in, first-out (FIFO) instead of LIFO in that year, its financial statements would most likely have reported: a higher cost of goods sold (COGS) but a lower inventory balance. both a higher cost of goods sold (COGS) and a higher inventory balance. a lower cost of goods sold (COGS) but a higher inventory balance.
B is correct. FIFO COGS = LIFO COGS − Change in LIFO reserve The negative change in the LIFO reserve would increase the COGS under FIFO compared with LIFO. FIFO inventory = LIFO inventory + LIFO reserve The LIFO reserve has a positive balance so that FIFO inventory would be higher than LIFO inventory.
Q. An investor gathers the following information about a company: Current dividend per share $3 Historical annual dividend growth rate 4% Expected annual dividend growth rate for the next three years 8% Expected stock value per share at the end of Year 3 $33 If the investors' required rate of return is 15%, the current estimate of the intrinsic value per share is closest to: $28.36. $29.65. $29.08.
B is correct. V0 = 3×1.081+0.15+3×(1.08)2(1+0.15)2+[3×(1.08)3]+33(1+0.15)3 = 2.82+2.65+2.48+21.70 = $29.65 A is incorrect because it uses t
Q. A portfolio with equal parts invested in a risk-free asset and a risky portfolio will most likely lie on: the efficient frontier. a capital allocation line. the security market line.
B is correct. A capital allocation line shows possible combinations of a risky portfolio and the risk-free asset.
Q. A major benefit of employing a risk budgeting process is that it most likely: allows the organization to determine its enterprise risk tolerance. forces risk tradeoffs across the organization. eliminates the need for hedging within the organization.
B is correct. Adding a risk budgeting process causes the organization to consider how its total risk tolerance will be allocated across its subsidiaries. Either the total current risks the subsidiaries are engaging in will exceed the risk tolerance and subsidiaries will have to compete for risk by demonstrating highest returns per unit of risk or the total current risks will be less than the risk tolerance and a search will be underway for the subsidiaries that can best utilize the remaining risk budget. The risk tolerance is determined and then sets the risk budget, rather than being determined by it. Hedging can be a part of risk budgeting if hedging produces the superior risk adjusted returns.
Q. Relative to traditional investments, alternative investments are best characterized as having: higher correlations with other asset classes. unique legal and tax considerations. greater liquidity.
B is correct. Alternative investments are more likely characterized as having unique legal and tax considerations because of the broad range and complexity of the investments.
Q. The return on a commodity index is likely to be different from returns on the underlying commodities because: data are subject to survivorship bias. indices are constructed using futures contracts. assets are not marked to market.
B is correct. Because commodity indices are constructed using commodity futures and not the underlying commodities, there can be differences between commodity index returns and the returns of the underlying commodities.
The effective annual yield (EAY) for an investment is 8.0%. Its bond equivalent yield is closest to: 8.00%. 7.85%. 8.16%.
B is correct. EAY = (1 + YTM)365/t − 1 Semiannual yield to maturity, YTM = (1 + 0.08)0.5 − 1 = 0.03923 = 3.923% Bond equivalent yield = 2 × YTM = 2 × 3.923% = 7.85%
Sales 2,200 2,500 Variable operating costs (% of sales) 28% 30% Fixed operating costs 1,400 1,400 Tax rate 25% 25% Dividends paid 55 60 Interest bearing debt at 5% 500 500 The forecasted net income (in $ thousands) for next year is closest to: 169. 244. 202.
B is correct. Forecasted net income (in $ thousands) is calculated as follows: Sales 2,500 Given Variable costs −750 30% of sales Fixed costs −1,400 Given Interest expense −25 0.05 × Average debt of $500 Earnings before taxes (EBT) 325 Taxes −81.25 25% of EBT Net income 243.75 Rounded to $244
Q. Which of the following factors will most likely drive the repo margin lower? Lower quality of the collateral Shorter supply of the collateral Lower credit quality of the counterparty
B is correct. If the collateral is in short supply or if there is a high demand for it, repo margins are lower. Repo margin is the difference between the market value of the security used as collateral and the value of the loan.
Q. For portfolio managers of passive funds, market indexes are least useful as: proxies to measure systematic risk. benchmarks for portfolio performance attribution. tools to develop exchange-traded funds for non-accessible markets.
B is correct. Market indexes are used as benchmarks for actively managed portfolios, which is not relevant to passively managed funds.
Q. Which of the following statements concerning the use of industry analysis is most accurate? Industry analysis is most useful for: sector allocations in passive equity portfolios. portfolio performance attribution. evaluating market efficiency.
B is correct. Portfolio performance attribution, which addresses the sources of a portfolio's returns, usually in relation to the portfolio's benchmark, includes industry or sector selection. Industry classification schemes play a role in such performance attribution.
Q. Which action is most likely considered a secondary source of liquidity? Increasing the efficiency of cash flow management Renegotiating current debt contracts to lower interest payments Increasing the availability of bank lines of credit
B is correct. Renegotiating debt contracts is a secondary source of liquidity because it may affect the company's operating and/or financial positions.
A price range in which selling is sufficient to stop the rise in price is best described as: change in polarity. resistance. support.
B is correct. Resistance is defined as a price range in which selling activity is sufficient to stop the rise in price.
Q. An example of risk transfer combined with self-insurance is most likely: a bond portfolio hedged with an interest rate option. an insurance policy with a deductible. a bank that establishes a loan loss reserve fund.
B is correct. Risk transfer is accomplished through an insurance policy. A deductible in an insurance policy means the insured is bearing some of the risk of loss and thereby (partially) self-insuring. Hedging with derivatives accomplishes risk shifting, not risk transfer. A bank loan loss reserve is a form of self-insurance combined with diversification, but it does not include risk transfer.
Q. An equally weighted portfolio is composed of four stocks. An analyst knows the mean and variance for each of the four stocks. In order to estimate the portfolio mean and variance, the analyst will require the stocks': skewness. pairwise correlations. kurtosis.
B is correct. Specification of the mean and variance for a portfolio of four stocks requires estimates of the mean returns and variances for each of the four stocks and the pairwise correlations between each of the four stocks.
Q. In the context of venture capital financing, seed-stage financing most likely supports: initial commercial production and sales. product development and/or marketing efforts. transformation of an idea into a business plan.
B is correct. Support of product development and/or marketing efforts takes place during seed-stage financing. A is incorrect because support of initial commercial production and sales takes place during early stage financing.C is incorrect because support in the transformation of an idea into a business plan takes place during angel investing.
Q. A portfolio manager decides to temporarily invest more of a portfolio in equities than the investment policy statement prescribes because he expects equities will generate a higher return than other asset classes. This decision is most likely an example of: rebalancing. tactical asset allocation. strategic asset allocation.
B is correct. Tactical asset allocation is the decision to deliberately deviate from the policy exposures to systematic risk factors with the intent to add value based on forecasts of the near-term returns of those asset classes.
Q. A project has the following cash flows: Year 0 Year 1 Year 2 Year 3 Year 4 −$1,000 $100 $100 $100 $1,100 The internal rate of return (IRR) for the project is closest to: 9.1%. 10.0%. 8.8%.
B is correct. The IRR is the discount rate when the net present value (NPV) = 0. The NPV is zero when discounting at 10%: ($100/10%) × [1 − 1/(1 +10%)3] + $1,100/(1 +10%)4 − $1,000.00 = $0. Consequently, 10% is the IRR. Using a financial calculator and recognizing that it is a bond: PV = 1,000, FV = −1,000, PMT = −100, N = 4, and solve for i, which will equal 10%.
In accrual accounting, if an adjusting entry results in the reduction of an asset and the recording of an expense, the originating entry recorded was most likely a(n): deferred revenue. prepaid expense. accrued expense.
B is correct. The adjusting entry to record the expiry of a prepaid expense is the reduction of an asset (the prepaid) and the recognition of the expense.
Q. The least accurate statement about measures of dispersion for a distribution is that the: range provides no information about the shape of the data distribution. arithmetic average of the deviations around the mean will be equal to one. mean absolute deviation will be either less than or equal to the standard deviation.
B is correct. The arithmetic sum of the deviations around the mean will always equal zero, not one.
Q. In a hypothetical economy, consumption is 70% of pre-tax income, and the average tax rate is 25% of total income. If planned government expenditures are expected to increase by $1.25 billion, the increase in total income and spending, in billions, is closest to: $2.6. $4.2. $1.3.
B is correct. The fiscal multiplier is 11−c(1−T) where c = marginal propensity to consume = consumption/disposable income T = the tax rate Assuming pre-tax income of $100 Disposable income: $100 × (1 − 0.25) = $75 Marginal propensity to consume: $70/$75 = 0.933 The fiscal multiplier: 1/[1 − 0.933(1 − 0.25)] = 3.33 With government expenditure of $1.25 billion, total incomes and spending will rise by $1.25 billion × 3.33 = $4.2 billion
Based on his superior return history, Vijay Gupta, CFA, is interviewed by the First Faithful Church to manage the church's voluntary retirement plan's equity portfolio. Each church staff member chooses whether to opt in or out of the retirement plan according to his or her own investment objectives. The plan trustees tell Gupta that stocks of companies involved in the sale of alcohol, tobacco, gambling, or firearms are not acceptable investments given the objectives and constraints of the portfolio. Gupta tells the trustees he cannot reasonably execute his strategy with these restrictions and that all his other accounts hold shares of companies involved in these businesses because he believes they have the highest alpha. By agreeing to manage the account according to the trustees' wishes, does Gupta violate the CFA Institute Standards of Professional Conduct? No. Yes, because the manager was hired based upon his previous investment strategy. Yes, because the restrictions provided by the Trustees are not in the best interest of the members.
No
Q. The following information is available for a company ($): December 31, 2011: Total assets 100,000 Net income for the year 4,000 Dividends paid 0 Assets are equally financed with debt and equity 50% of the equity comes from contributed capital December 31, 2012: Total assets 92,000 Net income (loss) for the year (3,000) No new debt or equity issued or repurchased In 2012, the company most likely: paid a dividend of $1,000. did not pay a dividend because it incurred a loss. paid a dividend of $5,000.
C is correct. 2011 ($) 2012 ($) Total assets (given) 100,000 92,000 Total debt (50% in 2011, no change in 2012) 50,000 50,000 Total equity (Total assets − Total debt) 50,000 42,000 Equity Components Contributed capital (50% of equity in 2011, no change in 2012) 25,000 25,000 Retained earnings (solved for): Total equity − Contributed capital 25,000 17,000 Retained earnings = Opening RE + Net income − Dividends 2012 Retained earnings = 17,000 = 25,000 − 3,000 − Dividends Dividends = 5,000 A is incorrect because it assumes that the funding
. An analyst is comparing the solvency of a company over the past two years using the information below: 2013 ¥ millions Total debt 2,300 Total shareholders' equity 17,000 Total assets 20,000 Net income 375 Interest payments 200 Taxes paid 125 Ratios in 2012 Debt to capital 12.7% Interest coverage 2.9 The best conclusion the analyst can make about 2013 is that compared with 2012, the company's solvency has: been inconclusive because the ratios give conflicting results. deteriorated because both ratios have weakened. improved because both ratios have strengthened.
C is correct. 2012 2013 Calculations (¥ millions) 2013 Debt to capital 12.7% 2,300/(2,300 + 17,000) = 11.9% 11.9% Interest coverage 2.9 (375 + 200 + 125)/200 = 3.5 3.5 times Both ratios have improved from 2012 to 2013, thus the company is more solvent in 2013.
Q. The following financial statement data are available for a company: Metric $ thousands Operating income 3,390 Net income 2,210 Operating assets 3,850 Change in cash and cash equivalents 1,010 Change in cash from operating activities 1,750 Free cash flow to the firm 2,240 The company's cash-to-income ratio is closest to: 0.79. 0.66. 0.52.
C is correct. Cash to income = Cash flow from operating activities (CFO)/Operating income = (1,750/3,390) = 0.52 B is incorrect because the ca
Q. On 1 January 2011, a company that prepares its financial statements according to International Financial Reporting Standards (IFRS) issued bonds with the following features: Face value: £20,000,000 Term: Five years Coupon rate: 6% paid annually on 31 December Market rate at issue: 4% The company carries all its bonds at cost. In December 2013, the market rate on similar bonds had increased to 5%, and the company decided to buy back (retire) the bonds after the coupon payment on 31 December. As a result, the gain on retirement reported on the 2013 income statement income is closest to: £340,410. £371,882. £382,556.
C is correct. Gain = Book value of debt − Market value = £20,754,438 − £20,371,882 = £382,556 Both at time of retirement, calculations below. The market value of debt at retirement can be determined by discounting the future cash flows at the current market rate (5%) by using a financial calculator: Face value (FV) = £20,000,000; i = 5%; PMT = £1,200,000; N = 2; Compute present value (PV) = £20,371,882. The book value after the third interest payment (two payments remaining) can be found by using either a financial calculator and the market rate at the time of issue (4%) or an amortization table (shown next). FV = £20,000,000; i = 4%; PMT = £1,200,000; N = 2; Compute PV = £20,754,438. The bond's initial value (required for amortization) can be found by using a financial calculator: FV = 20,000,000; i = 4%; PMT = 1,200,000; N = 5; Compute PV = 21,780,729. Principal Value Beginning of year (£) Interest Expense 4% Coupon 6% Premium Amortization (£) 2011 21,780,729 871,229 1,200,000 328,771 2012 21,451,958 858,078 1,200,000 341,922 2013 21,110,036 844,401 1,200,000 355,599 Book value at end of 2013 20,754,438 A is incorrect because it uses the straight-line method of amortiz
Q. An investor buys a stock on margin. Assume that the interest on the loan and the dividend are both paid at the end of the holding period. The data related to the transaction are as follows: Number of shares 500 Purchase price per share $28 Leverage ratio 3.33 Commission $0.05/share Position holding period Six months Sale price per share $30 Call money rate 5% per year Dividend $0.40/share The investor's total return on this investment over the margin holding period is closest to: 15.6%. 16.7%. 21.4%.
C is correct. Initial investment [($28 × 500) × (1/3.33)] + ($0.05 × 500) $4,229 − Purchase commission $0.05 × 500 − 25 + Trading gain ($30 − $28) × 500 1,000 − Margin interest paid $9,800 × 0.05 × 6 months − 245 + Dividends received $0.40 × 500 200 − Sales commission paid $0.05 × 500 − 25 = Remaining equity $5,134 Return on investment ($5,134 − $4,229)/$4,229
Q. An asset management firm generated the following annual returns in their US large-cap equity portfolio: Year Net Return (%) 2008 −34.8 2009 32.2 2010 11.1 2011 −1.4 The 2012 return needed to achieve a trailing five-year geometric mean annualized return of 5% when calculated at the end of 2012 is closest to: 27.6%. 17.9%. 35.2%.
C is correct. R⎯⎯⎯G=0.05=(1−0.348)(1+0.322)(1+0.111)(1−0.014)(1+R2012)⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯√5−1 Holding period total return (cumulative) factor calculation through 2011: (1 − 0.348) × (1 + 0.322) × (1 + 0.111) × (1 − 0.014) = 0.652 × 1.322 × 1.111 × 0.986 = 0.9442 Compound total return (cumulative) factor at 5% per year of 5% for five years: 1.055 = 1.2763 Return needed in 2012 to achieve a compound annualized return of 5%: 1.2763/0.9442 = 1.3517 = 35.2% Check: 0.944 × 1.352 = 1.276(1/5) = 1.050 = 5% annualized
Q. A company that wants to determine its cost of equity gathers the following information: Rate of return on 3-month Treasury bills 3.0% Rate of return on 10-year Treasury bonds 3.5% Market risk premium 6.0% The company's equity beta 1.6 Dividend growth rate 8.0% Corporate tax rate 35% Using the capital asset pricing model (CAPM) approach, the cost of equity (%) for the company is closest to: 12.6%. 7.5%. 13.1%.
C is correct. CAPM: Cost of equity = Risk-free rate + Beta × Market risk premium = 3.5% + 1.6 × (6.0%) = 13.1% The 10-year risk-free rate is appropriate based on the long-term duration of the cash flows from the project.
Q. The effective annualized cost (%) of a banker's acceptance that has an all-inclusive annual rate of 5.25% for a one-month loan of $2,000,000 is closest to: 5.54%. 5.38%. 5.27%.
C is correct. Calculate the effective annualized cost: InterestNet proceeds×12 = 2,000,000×0.0525×1/122,000,000×(1−0.0525×1/12)×12 = 0.0527 = 5.27%
Q. Which of the following companies would most likely be considered to have the lowest financial reporting quality, other things equal? A company that provides high quality, decision-useful information under GAAP but delays its reports. A company that reports significant profits due to a favorable exchange rate movement. A company that reports the results from two different segments as a combined entity.
C is correct. Combining the results from two segments is an example of biased reporting, which falls in the middle of the quality spectrum. It is difficult to interpret the profitability of each segment when their results are combined. A is incorrect because the company's reports are high quality, but the delay in reporting impairs their usefulness somewhat. The reporting is still better than biased reporting. B is incorrect because this is an example of decision-useful information about a result that may not be sustainable. Reporting is not of the highest quality, but is better than biased reporting.
Q. Net revenue most likely refers to revenue minus: revenues attributable to non-controlling interests. estimates of warranty expense. volume discounts and estimated returns.
C is correct. Net revenue means that the revenue number is reported after adjustments for cash or volume discounts or for estimated returns.
Q. The most likely impact of adding commodities to a portfolio of equities and bonds is to: increase risk. provide higher current income. reduce exposure to inflation.
C is correct. Over the long term, commodity prices are closely related to inflation, so including commodities in a portfolio of equities and bonds will reduce its exposure to inflation.
Q. According to put-call-forward parity, the difference between the price of a put and the price of a call is most likely equal to the difference between: forward price and spot price discounted at the risk-free rate. spot price and exercise price discounted at the risk-free rate. exercise price and forward price discounted at the risk-free rate.
C is correct. Put-call-forward parity can be written as: p0 − c0 = [X − F0(T)]/(1 + r)T This means that the difference between the price of a put and the price of a call is equal to the difference between exercise price and forward price discounted at the risk-free rate. A and B are incorrect because neither put-call parity nor put-call-forward parity support this interpretation.
The method used by a high-end custom-built motorcycle manufacturer to value its inventory results in the matching of the physical flow of the particular items sold, and the items remaining in inventory, to their actual cost. Which of the following inventory valuation methods is the manufacturer most likely using? FIFO Weighted average cost Specific identification
C is correct. Specific identification is the inventory method that results in the matching of the physical flow of the particular items sold and would be most suitable for high-end custom-built motorcycles that are not ordinarily considered interchangeable. A and B are incorrect because although accepted by IFRS, this method is more suitable for interchangeable inventory.
Q. Which of the following are most likely a kind of supranational bonds? Bonds issued by the: Federal Farm Agency of the United States. Government of Malaysia. European Investment Bank.
C is correct. Supranational bonds are bonds issued by such supranational agencies as the European Investment Bank and the International Monetary Fund.
Q. Which of the following most likely results in an increase of owners' equity? Share repurchase Cash dividend New equity issuance
C is correct. The basic components of owners' equity are paid-in capital and retained earnings. In the paid-in capital account, an example of an increase in owners' equity is a new equity issuance. Cash dividends reduce retained earnings and owners' equity. Share repurchases reduce paid-in capital and owners' equity.
The most likely initial (short-run) effect of demand-pull inflation is an increase in: finished good prices. employee wages. commodity prices.
C is correct. The effect of demand-pull inflation is an increase in the aggregate demand, which, in turn, leads to an increase (initially) in commodity prices. A and B are incorrect because commodity prices tend to increase initially.
Q. Business risk most likely incorporates operating risk and: financial risk. sales risk. interest rate risk.
B is correct. Business risk is the combination of sales risk and operating risk.
Q. After noting positive changes in the aggregate index of coincident economic indicators, an increase in the ratio of consumer installment debt to income would most likely help confirm that an expansion is: forthcoming. underway. ending.
B is correct. The ratio of consumer installment debt to income is a lagging indicator. An increase in it, by itself, would be evidence that an upturn is already underway. This would confirm the implication of positive changes in coincident indicators that an expansion is in place.
Q. Which of the following pairs of risks are most closely related? Model risk and tail risk Liquidity risk and operational risk Credit risk and solvency risk
A is correct. Model risk is the risk of using the wrong model to analyze an investment or the risk of using the right model for the analysis but using it incorrectly. Tail risk, although it involves unlikely but substantial losses, typically results from using inappropriate modeling assumptions such as assuming that returns are normally distributed. Credit risk involves the risk of a borrower not repaying you, whereas solvency risk is the risk of you running out of the money needed to pay your obligations. Liquidity risk is the risk that the future transaction price for an investment will be different than expected, whereas operational risk includes a wide range of potential problems occurring within an organization's personnel and systems.
Q. The real estate index most likely to suffer from sample selection bias is a(n): repeat sales index. REIT index. appraisal index.
A is correct. Only properties that sell in each period and are included in the index and vary over time which may not be representative of the whole market.B is incorrect because the REIT index is based on a set of publicly traded REITs and thus does not suffer from sample selection bias.
Q. Other factors held constant, the reduction of a company's average accounts payable because of suppliers offering less trade credit will most likely: not affect the operating cycle. reduce the operating cycle. increase the operating cycle.
A is correct. Payables are not part of the operating cycle calculation, which includes receivables and inventory. B and C are incorrect because as per above, payables are not part of the operating cycle calculation.
Q. When can a party, nonmember or firm, most likely claim compliance with the CFA Institute Code of Ethics and Standards of Professional Conduct? Once they have: ensured that their code and ethics meets the principles of the Code and Standards. notified the CFA Institute of their claim. verified their claim of compliance with the CFA Institute.
A is correct. The Code and Standards apply to individual members of CFA Institute and candidates in the CFA Program. CFA Institute does encourage firms to adopt the Code and Standards, however, as part of their code of ethics. Those who claim compliance should fully understand the requirements of each of the principles of the Code and Standard.
In order to achieve compliance with GIPS Standards, it is recommended that firms: adopt the broadest, most meaningful definition of the firm. provide existing clients a compliant presentation applicable to their portfolio, at a minimum of a bi-annual basis. define the firm by including all geographical offices operating under the same firm name.
A is correct. The Fundamentals of Compliance recommend that firms should adopt the broadest, most meaningful definition of the firm.
Q. Eldora Ltd. recently issued deferred-coupon bonds for which no coupon payments will be paid in the first two years of the bond's life. Regular annual coupon payments at a rate of 9% will then be made until the bonds mature at the end of six years. The spot rates for various maturities are given in the following table. Time to Maturity Spot Rate 1 year 8.0% 2 years 7.5% 3 years 7.0% 4 years 6.5% 5 years 6.0% 6 years 5.5% On the basis of these spot rates, the price of the bond today is closest to: 100.12. 108.20. 116.24.
A is correct. The bond price is computed as P0 = 9/(1.070)3 + 9/(1.065)4 + 9/(1.060)5 + (9 + 100)/(1.055)6 = 100.12
Q. Which of the following is most likely considered an example of matrix pricing when determining the cost of debt? Debt-rating approach only. Yield-to-maturity approach only. Both the yield-to-maturity and the debt-rating approaches.
A is correct. The debt-rating approach is an example of matrix pricing. B and C are incorrect because the yield-to-maturity approach is not an example of matrix pricing.
Q. Compared with its market-value-weighted counterpart, a fundamental-weighted index is least likely to have a: momentum effect. contrarian effect. value tilt.
A is correct. The momentum effect is a characteristic of a market-capitalization-weighted index, not a fundamental index.
Q. Based on good corporate governance practices, it is most appropriate for a company's compensation committee to: develop director remuneration policies. recommend remuneration for the external auditors. include some external directors.
A is correct. Under good corporate governance practices the compensation committee develops remuneration policies for directors as well as key executives. The audit committee, not the compensation committee, would be involved in the remuneration of the external auditors.
Which of the following is not included in the nine major provisions of the Global Investment Performance Standards (GIPS)? Input Data, Calculation Methodology, and Real Estate Fundamentals of Compliance, Composite Construction, and Disclosure Calculation Methodology, Composite Construction, and Alternative Assets
C is correct because Alternative Assets is not among the nine major provisions or sections of the Global Investment Performance Standards, which include: Fundamentals of Compliance, Input Data, Calculation Methodology, Composite Construction, Disclosure, Presentation and Reporting, Real Estate, Private Equity, and Wrap Fee/Separately Managed Account (SMA) Portfolios.
Information about a company's historical performance for the last two years and additional information are summarized in the following table. ($ thousands) 2013 2012 Sales 5,500.0 5,350.0 Cost of goods sold −2,200.0 −2,140.0 Operating expenses −2,350.0 −2,350.0 Gain on sale of short-term investments 0 140.0 Tax expense −237.5 −325.0 Income (loss) from discontinued operations (net of tax) −312.5 112.5 Net income 400.0 787.5 Industry sales are expected to increase 5%, and the company expects to maintain its current market share and gross profit margin. Operating expenses are not expected to change with the increase in sales. The company sold off its portfolio of marketable securities in 2012 and used the funds to purchase operating assets. In 2012, the company announced its intention to sell off a division, and that sale was completed in 2013. The results from the division and the gain or loss incurred on the sale are classified as discontinued operations. The projected net income (in thousands) for 2014 is closest to: $745. $836. $635.
B is correct. The loss (gain) from discontinued operations and the gain on the sale of the portfolio investments should not be included in the forecast because they are not recurring items. First, the recurring operating margin before tax should be forecasted, noting that the operating costs are fixed costs, and then the tax rate from 2013 should be used to determine net income. ($ thousands) 2014 forecast 2013 2012 Sales (increase 5%) $5,775 $5,500.0 100% $5,350.0 100% Cost of goods sold (40% each year) 2,310 2,200.0 40% 2,140.0 40% Operating expenses (fixed cost) 2,350 2,350.0 2,350.0 Recurring operating income 1,115 950.0 860 Tax expense (25% × operating income) 279 237.5 237.5950=25% Net income $836 A is incorrect because it adjusts for the discontinued operations before calculating
Q. Under IFRS, the costs incurred in the issuance of bonds are most likely: expensed when incurred. included in the measurement of the bond liability. deferred as an asset and amortized on a straight-line basis.
B is correct. Under IFRS, debt issuance costs are included in the measurement of the bond liability.
Q. All else being equal, which of the following depreciation methods is most likely to result in higher operating margins in the later years of an asset's useful life? Straight line Declining balance Units of production
B is correct. Under the declining balance approach, depreciation is calculated as a fixed percentage of the asset's carrying amount, year after year. As the undepreciated value decreases, so does the reported depreciation expense. The effect is most pronounced in the later years of the asset's life when the undepreciated cost is much lower and hence the expense is lower (and operating margins higher).
Q. In a low interest rate environment, the effective duration of a callable bond relative to a comparable non-callable bond, will most likely be: higher. lower. the same.
B is correct. When interest rates are low, the callable bond's price will not increase as much because the presence of the call option will limit the price increase. Because the bond is likely to be called when interest rates are falling, the embedded call option will reduce the effective duration of the bond.
Q. A developing country that maintains a fixed value for its currency relative to the US dollar is experiencing a decline in its economic activity, and its inflation rate falls below the level of inflation in the United States. The most likely result of the developing country's actions to maintain the fixed exchange rate target is that its: foreign exchange reserves will decrease. short-term interest rates will fall. money supply will contract.
B is correct. With a decline in economic activity and domestic inflation, the currency of the developing country would start to rise against the dollar. To protect the exchange rate target, the developing country's monetary authority will purchase foreign exchange reserves and sell its own currency. This will increase the domestic money supply, decrease short-term interest rates, and increase foreign exchange reserves.
Q. David Bravoria, CFA, is an independent financial advisor for a high-net-worth client with whom he had not had contact in more than two years. During a recent brief telephone conversation, the client states that he wants to increase his risk exposure. Bravoria subsequently recommends and invests in several high-risk venture capital funds on behalf of the client. Bravoria continues, as he has done in the past, to send to his client monthly, detailed, itemized investment statements. Did Bravoria most likely violate any CFA Standards? No. Yes, with regard to investment statements. Yes, with regard to purchasing venture capital funds.
C is correct because Bravoria violated Standard III(A)-Loyalty, Prudence, and Care as he had not updated his client's profile in more than two years and thus should not have made further investments, particularly in high-risk investments, until such time as he updated the client's risk and return objectives, financial constraints, and financial position. Bravoria provided his client with investment statements more frequently than that which is required, i.e., quarterly, so was not in violation of regular account information.
Q. Jean-Luc Schlumberger, CFA, is an independent research analyst providing equity research on companies listed on exchanges in emerging markets. He often incorporates statistical data he obtains from the web sites of the World Bank and the central banks of various countries into the body of his research reports. While not indicated within the reports, whenever his clients ask where he gets his information he informs them the information is in the public domain but he doesn't keep his own records. When the clients ask for the specific web site addresses he provides the information. Which Standard has Schlumberger least likely violated? Record Retention Misrepresentation Performance Presentation
C is correct because Standard III(D)-Performance Presentation pertains to investment performance information, and there is no indication any violation has occurred.
Q. Monique Gretta, CFA, is a research analyst at East West Investment Bank. Previously, Gretta worked at a mutual fund management company and has a long-standing client relationship with the managers of the funds and their institutional investors. Gretta often provides fund managers, who work for Gretta's former employer, with draft copies of her research before disseminating the information to all of the bank's clients. This practice has helped Gretta avoid several errors in her reports, and she believes it is beneficial to the bank's clients, even though they are not aware of this practice. Regarding her research, Gretta least likely violated the CFA Institute Code of Ethics and Standards of Professional Conduct because: her report is a draft. this practice benefits all clients. the long-standing client relationships are not disclosed.
C is correct because the analyst does not violate any of the Standards of Professional Conduct by having long-standing client relationships and generally is not required to disclose such relationships. However, the analyst is not treating all clients fairly as required by Standard III(B)-Fair Dealing when disseminating investment recommendations; disclosure of the relationship with long-standing clients is not the issue. The analyst has advantaged some clients over others by providing advance information, and all clients do not have a fair opportunity to act on the information within the draft report. Members and candidates may differentiate their services to clients, but different levels of service must not disadvantage or negatively affect clients.
Q. A company has announced that it is going to distribute a group of long-lived assets to its owners in a spin-off. The most appropriate way to account for the assets until the distribution occurs is to classify them as: held for sale with no depreciation taken. held for use until disposal with no deprecation taken. held for use until disposal with depreciation continuing to be taken.
C is correct. Long-lived assets that will be disposed of other than by sale, such as in a spin-off, an exchange for other assets, or abandonment, are classified as held for use until disposal and continue to be depreciated until that time.
Q. An e-commerce company sells hotel room nights on its website under agreement from a large number of major hotel chains. The hotel chains grant the company flexibility for the rooms they supply to the company's website and for the prices charged. These major chains bear the responsibility for providing all services once a customer books a room from the website. During the current year, the company received $5 million in payments from the sale of hotel rooms. The cost of these rooms was $4.5 million, which does not include $250,000 in direct selling costs. Under US GAAP, the e-commerce company's cost of sales is closest to: $4,750,000. $4,500,000. $250,000.
C is correct. Cost of sales is reported on the same basis as revenue. To report revenue under gross reporting, the e-commerce company must meet four criteria: Criteria Met/Not Met The e-commerce company must: be the primary obligor under the contract. Not met bear the inventory risk and credit risk. Not met be able to choose its supplier. Met also have reasonable latitude to establish pricing. Met The first criterion is not met. The major hotel chains have the obligation of fulfilling the room contract once it is entered into. The second criterion is not met either because the e-commerce company did not incur costs for vacant rooms. The major chains bear the inventory risk. Because all criteria are not met, the e-commerce company must use net reporting for which revenue is $500,000 and cost of sales is $250,000.
Q. In the current year, a company increased its deferred tax asset by $500,000. During the year, the company most likely: became entitled to a $500,000 tax refund. had permanent differences between accounting profit and taxable income. reported a lower accounting profit than taxable income.
C is correct. Deferred tax assets represent taxes that have been paid (because of the higher taxable income) but have not yet been recognized on the income statement (because of the lower accounting profit).
Q. A swap that involves the exchange of a fixed payment for a floating payment can be interpreted as a series of forward contracts with different expiration dates. These implied forward contracts will most likely have: different prices due to differences in the price of the underlying at expiration. identical prices. different prices due to differences in the cost of carry.
C is correct. Due to differences in the cost of carry, implied forward contracts will have different prices. The differences in the cost of carry stem from the timing differences of the payments. A is incorrect because differences in price are due to differences in the cost of carry. The price of the underlying at expiration is irrelevant for the price. It determines the value of the swap.
Q. If the stated annual interest rate is 9% and the frequency of compounding is daily, the effective annual rate (EAR) is closest to: 9.00%. 9.86%. 9.42%.
C is correct. EAR = (1 + periodic interest rate)m − 1 = [1 + (0.09/365)]365 − 1 = 0.094162, rounded to 9.42%.
Q. A portfolio manager estimates the probabilities of the following events for a mutual fund: Event A: the fund will earn a return of 5%. Event B: the fund will earn a return below 5%. The least appropriate description of the events is that they are: dependent. mutually exclusive. exaustive
C is correct. Events are exhaustive when they cover all possible outcomes. Mutually exclusive means that only one event can occur at a time. Two events are dependent if the occurrence of one event does affect the probability of occurrence of the other event. In this situation, Event A and B are both mutually exclusive (because they cannot occur at the same time) and dependent (because if one event occurs, the probability of the other becomes zero). However, the two events are not exhaustive because they do not cover the event that the fund will earn a return above 5%.
Q. Which of the following statements is the most appropriate treatment of flotation costs for capital budgeting purposes? Flotation costs should be: expensed in the current period. incorporated into the estimated cost of capital. deducted as one of the project's initial-period cash flows.
C is correct. Flotation costs are an additional cost of the project and should be incorporated as an adjustment to the initial-period cash flows in the valuation computation.
Q. Which of the following statements best describes a feature of an American option? Early exercise of an American: put option is optimal only if the underlying is dividend paying. call option is never optimal if the underlying is dividend paying. put option that is deep in the money may be optimal.
C is correct. For a deep-in-the-money put option, early exercise may be optimal because the additional upside is limited.
Q. Given two mutually exclusive projects with normal cash flows, the point at which their net present value profiles intersect the horizontal axis is most likely the projects': weighted average cost of capital. crossover rate. internal rate of return.
C is correct. For a project with normal cash flows, the NPV profile intersects the horizontal axis at the point where the discount rate equals the IRR. The crossover rate is the discount rate at which the NPVs of the projects are equal. Although it is possible that the crossover rate is equal to each project's IRR, it is not a likely event. It is also possible that the IRR is equal to the WACC, but that scenario is not the most likely one.
Q. An investment in 10,000 common shares of a company for one year earned a 15.5% return. The investor received a $2,500 dividend just prior to the sale of the shares at $24 per share. The price that the investor paid for each share one year earlier was closest to: $20.80. $20.50. $21.00.
C is correct. Holding period return, HPR = (P1 − P0 + D1)/P0 where P0 = initial investment P1 = price received at the end of holding period D1 = dividend paid by the investment at the end of holding period = $2,500/10,000 shares = $0.25/shares 0.155 = (24 − P0 + 0.25)/P0, and solving for P0 P0 = $20.99 ~ $21.00
During a period of rising inventory costs, a company decides to change its inventory method from FIFO to the weighted average cost method. Under the weighted average method, which of the following financial metrics will most likely be higher than under FIFO? Current ratio Number of days in inventory Debt-to-equity ratio
C is correct. If all else is held constant, in a period of rising costs the ending inventory will be lower under the weighted average cost method and the cost of goods sold will be higher (compared to FIFO), resulting in lower net income and retained earnings. There will be no impact on the debt level, current or long-term. Therefore, the debt-to-equity ratio (Total debt/Total shareholders' equity) will increase because of the decrease in retained earnings (and lower shareholders' equity).
Investor A and Investor B invest in a fund for two years: Year 1 Year 2 Fund Return Positive Negative Portfolio Money-Weighted Rate of Return Investor A 7.5% Investor B 8.2% Given the information in the table, which of the following is least likely to be an explanation for the difference between the two money-weighted rates of return? Investor A increased the investment in the fund at the end of year 1 whereas investor B did not make any additions or withdrawals. Investor B decreased the investment in the fund at the end of year 1 whereas investor A did not make any additions or withdrawals. The investors invested different amounts at inception and afterward did not make any additions or withdrawals.
C is correct. The money-weighted rate of return (MWR) is sensitive to the additions and withdrawals of funds in a portfolio over the course of an investment. If, at inception, investors A and B invest amounts of different size in the same fund but then neither add nor withdraw any cash for two years, they will obtain exactly the same MWR. In contrast, if investor A increases the investment in the fund at the end of year 1 and investor B does not make any additions or withdrawals, then Investor A will have a lower MWR than investor B because in year 2 the fund underperformed with respect to year 1. By the same token, if investor B decreases the investment at the end of year 1 and investor A does not make any additions or withdrawals, then investor B will have a higher MWR than investor A because she decreased the investment before an underperforming year. A is incorrect. If investor A increases the investment in the fund at the end of year 1 and investor B does not make any additions or withdrawals, then the former will have a lower MWR than the latter because in year 2 the fund underperformed with respect to year 1
Q. Which of the following is least likely to be a type of embedded option in a bond issue granted to bondholders? The right to: put the issue. convert the issue. call the issue.
C is correct. The right to call an issue is a type of embedded option granted to issuers, not bondholders. The other two rights are embedded options granted to bondholders. A and B are incorrect because this is a type of embedded option granted to bondholders.
Q. All, else held equal, the value of a European call option is best characterized as having a: negative relationship with the price of the underlying. negative relationship with the volatility of the underlying. positive relationship with the time to expiration.
C is correct. The value of a European call option is directly related to the time to expiration. That is, all else held equal, the value of a European call option is higher the longer the time to expiration.
Q. Using the following US Treasury forward rates, the value of a 2.5-year $100 par value Treasury bond with a 5% coupon rate is closest to: Period Years Forward Rate 1 0.5 1.20% 2 1 1.80% 3 1.5 2.30% 4 2 2.70% 5 2.5 3.00% $104.87. $101.52. $106.83.
C is correct. The value of the bond is 2.5(1+0.012/2)+2.5(1+0.012/2)×(1+0.18/2)+2.5(1+0.012/2)×(1+0.018/2)×(1+0.023/2)+2.5(1+0.012/2)×(1+0.018/2)×(1+0.023/2)×(1+0.027/2)+2.5(1+0.012/2)×(1+0.018/2)×(1+0.023/2)×(1+0.027/2)×(1+0.030/2)=$106.83 A is incorrect because it treats the forward rates as spot rates.
Q. Using a two-tailed test of the hypothesis that the population mean is zero, the calculated test statistic is 2.51. The sample has 23 observations. The population is normally distributed with an unknown variance. Degrees of freedom p = 0.10 p = 0.05 p = 0.025 p = 0.01 p = 0.005 21 1.323 1.721 2.080 2.518 2.831 22 1.321 1.717 2.074 2.508 2.819 23 1.319 1.714 2.069 2.500 2.807 24 1.318 1.711 2.064 2.492 2.797 An analyst will most likely reject the null hypothesis at significance levels of: 0.10 only. 0.10, 0.05, and 0.01. 0.10 and 0.05.
C is correct. This is a two-tailed hypothesis testing because it concerns whether the population mean is zero. H0: μ = 0 versus Ha: μ ≠ 0 With degrees of freedom (df) = n − 1 = 23 − 1 = 22, the rejection points are as follows: Significance level Rejection points for t-test 0.10 t < −1.717 and t > 1.717 0.05 t < −2.074 and t > 2.074 0.01 t < −2.819 and t > 2.819 Because the calculated test statistic is 2.51, the null hypothesis is thus rejected at the 0.05 and 0.10 levels of significance but not at 0.01. A is incorrect. As explained in choice C.