CFA Level I Mock Exam B: Afternoon Session

The following information applies to a sample: The point estimate of the population mean is 12.5. The t-statistic (tα/2) used in calculating the 90% confidence interval is 1.67. The sample size is 64. The sample standard deviation is 5. The 90% confidence interval for the population mean is closest to:

12.5±1.67×(5/√64)=12.5±1.04375=11.45625

A 90-day commercial paper issue is quoted at a discount rate of 4.75% for a 360-day year. The bond equivalent yield for this instrument is closest to:

4.87% PV=FV×(1−Days/Year)×DR)

An investor performs the following transactions on the shares of a firm. At t = 0, she purchases a share for $1,000. At t = 1, she receives a dividend of $25 and then purchases three additional shares for $1,055 each. At t = 2, she receives a total dividend of $100 and then sells the four shares for $1,100 each. The money-weighted rate of return is closest to:

6.9% ?

beta

=covariance(ri,rm)/standard dev,m)

What is an European bond

A Eurobond is an international bond issued outside the jurisdiction of any one country and not denominated in the currency of the country where it is issued.

Which of the following statements describes the most appropriate treatment of cash flows in capital budgeting?

A project is evaluated using its incremental cash flows on an after-tax basis

Over the past four years, a portfolio experienced returns of −8%, 4%, 17%, and −12%. The geometric mean return of the portfolio over the four-year period is closest to:

Add one to each of the given returns, then multiply them together and take the fourth root of the resulting product. 0.92 × 1.04 × 1.17 × 0.88 = 0.985121; 0.985121 raised to the 0.25 power is 0.996259. Subtracting one and multiplying by 100 gives the correct geometric mean return: [(0.92 × 1.04 × 1.17 × 0.88)0.25 − 1] × 100 = −0.37%.

A company is considering a switch from an all-equity capital structure to a structure with equal amounts of equity and debt without increasing assets. This change will reduce the net income by 30%. If the current return on equity (ROE) is 10%, the ROE under the proposed capital structure will be closest to:

All Equity Half Equity and Debt Net income Net income × (1 − 30%) Equity = 100% × Assets Equity = 50% × Assets ROE: = Net incomeequity = Net income(100%×Assets) = Net incomeAssets = 10% ROE: = [Netincome×(1−30%)]Equity = [Net income×(1−30%)](50×Assets) = (Net incomeAssets)×[(1−30%50%)] = 10% × 1.4 = 14% Alternatively, looking at the effects of the changes in sequence: When equity decreases by half, ROE would become 10%/0.50 = 20%. When net income decreases by 30%, the adjusted ROE would become = 20% × (1 − 0.30) = 14%.

Which of the following accounting actions would increase stockholders' equity in the current period?

Capitalizing, rather than expensing, a payment The capitalization of payments is an example of how choices affect both the balance sheet and income statement. Capitalizing a payment changes the benefit from only the current period—making it an expense—to a benefit in future periods as an asset. The creation of an asset results in a comparable increase in stockholder's equity.

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

The joint probability of returns for securities A and B are as follows: Joint Probability Function of Security A and Security B Returns (Entries Are Joint Probabilities) Return on Security B = 30% Return on Security B = 20% Return on Security A = 25% 0.60 0 Return on Security A = 20% 0 0.40 The covariance of the returns between Securities A and B is closest to:

Expected return on security A = 0.6 × 25% + 0.4 × 20% = 15% + 8% = 23% Expected return on security B = 0.6 × 30% + 0.4 × 20% = 18% + 8% = 26% covariance: 0.6[(25−23)(30−26)]+0.4[(20−23)(20−26)]

Which of the following is the most appropriate reason for using a free cash flow to equity (FCFE) model to value equity of a company?

FCFE is a measure of the firm's dividend paying capacity.

A risk manager would like to calculate the coefficient of variation of a portfolio. The following table reports the annual returns of the portfolio and of the risk-free rate over the most recent five years: Year Portfolio Return Risk-Free Rate 1 4.0% 2.0% 2 −1.0% 1.5% 3 7.0% 1.0% 4 11.0% 1.0% 5 2.0% 0.5%

First calculate the sample mean return as follows: Then calculate the sample standard deviation with the following formula:

Working capital $60 million Non-current assets $235 million Equity $170 million Current ratio 1.75 The company's financial leverage is closest to:

First determine current assets, where CA = Current assets, CL = Current liabilities, WC = Working capital, and CR = Current ratio CR = CA/CL = 1.75 CL = CA/1.75 WC = CA − CL 60 = CA − CA/1.75 60 = 0.75/1.75 × CA CA = 140 Then solve for total assets and determine financial leverage: Metric Current assets $140 million Non-current assets + $235 million Total assets $375 million Equity $170 million Financial leverage = Total assets/Equity 2.2

A 20-year $1,000 fixed-rate non-callable bond with 8% annual coupons currently sells for $1,105.94. Assuming a 30% marginal tax rate and an additional risk premium for equity relative to debt of 5%, the cost of equity using the bond-yield-plus-risk-premium approach is closest to:

First, determine the yield to maturity, which is the discount rate that sets the bond price to $1,105.94 and is equal to 7%. This calculation can be done with a financial calculator: FV = −$1,000, PV = $1,105.94, N = 20, PMT = −$80, solve for i, which will equal 7%. The bond-yield-plus-risk-premium approach is calculated by adding a risk premium to the cost of debt (i.e., the yield to maturity for the debt), making the cost of equity 12.00% (= 7% +5%).

Which of the following events would most likely have a positive impact on the GDP of Switzerland and the gross national product (GNP) of France?

GDP measures the market value of all final goods and services produced by factors of production (such as labor and capital) located within a country, therefore Swiss GDP includes the accounting services provided within Switzerland. GNP measures the market value of all final goods and services produced by factors of production supplied by residents of a country, regardless of whether such production takes place within the country or outside of the country. Therefore, GNP includes the accounting services produced by a French citizen abroad.

An economist states that the probability of having the gross domestic product (GDP) of a country higher than 3% is 0.20. What are the odds against a GDP higher than 3%?

Given the probability of an event, P(E), the odds against that event are: [1−P(E)]P(E). By using the input of the problem, Odds against E = (1−0.2)0.2 = 4. This means that given the probability stated by the economist, the odds against a GDP above 3% are 4 to 1.

Previously, a manufacturer of high-quality industrial electrical generators only sold its units to customers, but it has just introduced a leasing program. The generators have expected useful lives of about 25 years, and the company anticipates that the leases will have a term of 20 years or more. The company reports under International Financial Reporting Standards. Which of the following statements about the first year of the new leasing program is most accurate?

If the lease is classified as a finance lease, it will decrease the company's liquidity position compared with when the company was only selling its generators.

The following information is available about a company for its current fiscal year: Accounting profit (earnings before taxes) $250,000 Taxable income $215,000 Tax rate 30% Income taxes paid in year $61,200 Deferred tax liability, start of year $82,400 Deferred tax liability, end of year

Income tax expense equals income tax payable (the tax rate multiplied by the taxable income) plus the increase in the deferred tax liabilities. (0.30 × $215,000) + ($90,650 − $82,400) = $64,500 + $8,250 = $72,750

On 1 January 2014, the market rate of interest on a company's bonds is 5%, and it issues a bond with the following characteristics: Face value €50 million Coupon rate, paid annually 4% Time to maturity 10 years (31 December 2023) Issue price (per €100) €92.28 If the company uses International Financial Reporting Standards (IFRS), its interest expense (in millions) in 2014 is closest to:

Interest expense = Liability value × Market rate at issuance = 0.05 × €46.140 = €2.307

To project the assets and liabilities of a pension plan using a number of different assumptions, the most appropriate method to employ is:

Monte Carlo simulation is better suited to hypothetical "what if" analysis than historical simulation. To model a pension plan's status under a number of different hypothetical assumptions affecting the assets and liabilities, Monte Carlo simulation is the most appropriate method B is incorrect because Monte Carlo simulation is not an analytical method that can provide great insights into cause and effect relationships. It is a complement to analytical methods.

FCFF

NI + NCC + Int(1 − t) − FCInv − WCInv

total comprehensive income

NI + Other comprehensive income other comprehensive income = includes gains or losses on available-for-sale (AFS) securities and translation adjustments on foreign subsidiaries.

Returns from a depository receipt are least likely affected by which of the following factors?

Number of depository receipts

A company that prepares its financial statements according to US GAAP leased a piece of equipment on 1 January 2013. Information relevant to the transaction is as follows: Five annual lease payments of $25,000, with the first payment due 1 January 2013 Interest rate on similar company debt is currently 8% The fair value of the equipment is $115,000 Useful life of the equipment is seven years The company depreciates other equipment in the same asset class on a straight-line basis The total expense related to the lease on the company's 2013 income statement will be closest to:

PV of lease payments: PMT = $25,000, i = 8%, N = 5, Mode = Begin, Compute PV. PV = $107,803, 90% of the fair value: 0.90 × $115,000 = $103,500 Therefore, the lease is greater than 90% and would be capitalized at $107,803. Present value of the lease (asset value capitalized and initial liability) $107,803 Payment 1 January 2013 −25,000 Liability value 1 January 2013 $82,803 Interest expense in 2013 0.08 × $82,803 $6,624.25 Amortization expense for the year using the lease term as the useful life (no indication that the lease will be renewed beyond the initial term) $107,8035 $21,560.63 Total expense in 2013

Investors in alternative assets who seek liquidity are most likely to invest in:

REITS

cash collected from customers

Revenues - increase in accounts receivables

cost of equity

Risk-free rate + Equity beta × (Equity risk premium + Country risk premium)

Spot Rate One-Year Forward Rate USD/EUR 1.2952 1.3001

The euro is trading at a forward premium of 49 points

An investor deposits £2,000 into an account that pays 6% per annum compounded continuously. The value of the account at the end of four years is closest to:

The future value (FV) of a given lump sum, calculated using continuous compounding, is: FV = PVerN = 2,000 × e0.06 × 4 = £2,542.49 ~ £2,542.

An investor notices that the price of an American call option is above the price of a European call option with otherwise identical features. What is the most likely reason for this difference?

The underlying will go ex-dividend.

Price before Split Price after Split Stock End of Day 1 End of Day 2 X $10 $12 Y $20 $19 Z $60 $22

The value of the price-weighted index is determined by dividing the sum of the security values by the divisor, which is typically set at inception to equal the initial number of securities in the index. In the case of a stock split, the index provider must adjust the value of the divisor by dividing the sum of the constituent prices after the split by the value of the index before the split. This adjustment results in a new divisor that keeps the index value at the same level as before the split. The new divisor will then be used to calculate the index value after the split. see QUESTION 93

An analyst has established the following prior probabilities regarding a company's next quarter's earnings per share (EPS) exceeding, equaling, or being below the consensus estimate Prior Probabilities EPS exceed consensus 25% EPS equal consensus 55% EPS are less than consensus 20% Probabilities the Company Cuts Dividends, Conditional on EPS Exceeding/Equaling/Falling below Consensus P(Cut div|EPS exceed) 5% P(Cut div|EPS equal) 10% P(Cut div|EPS below) 85%

Updated probability of event given the new information =Probability of the new information given eventUnconditional probability of the new information×Prior probability of event where Updated probability of event given the new information: P(EPS below|Cut div); Probability of the new information given event: P(Cut div|EPS below) = 85%; Unconditional probably of the new information: P(Cut div) = 23.75%; Prior probability of event: P(EPS below) = 20%. Therefore, the probability of EPS falling below the consensus is updated as: P(EPS below|Cut div) = [P(Cut div|EPS below)/P(Cut div)] × P(EPS below) = (0.85/0.2375) × 0.20 = 0.71579 ~ 72%

gordon growth model

V0=D0(1+g)/r−g=D1r−g

Consider the investment in the following table: Start of Year 1 One share purchased at $100 End of Year 1 $5.00 dividend/share paid and one additional share purchased at $125 End of Year 2 $5.00 dividend/share paid and both shares sold for $140 per share Assuming dividends are not reinvested, compared with the time-weighted return, the money-weighted return is:

Year Contribution Start-of-Year Value after Contribution End-of-Year Dividend End-of-Year Value after Dividend 1 1 × $100 1 × $100 = $100 1 × $5 = $5 $125 2 1 × $125 2 × $125 = $250 2 × $5 = $10 (2 × 140) + 10 = $290 The time-weighted rate of return (TWR) on this investment is found by taking the geometric mean of the two holding period returns (HPRs): TWR = [(1 + HPRYear 1) × (1 + HPRYear 2)]1/2 − 1 where HPRYear 1 = ($125 − $100 + $5)/$100 = 30.0% HPRYear 2 = ($280 − $250 + $10)/$250 = 16.0% TWR = [(1 + 0.30) × (1 + 0.16)]1/2 − 1 = 22.80% The money-weighted rate of return (MWR) is the internal rate of return (IRR) of the cash flows associated with the investment: 0=−100+(−125+5)(1+r1)+(280+10)(1+r2), where r = MWR. Using the cash flow (CF) function of a financial calculator: CF0 = −100, CF1 = (−125 + 5), CF2 = (280 + 10), and solving for IRR: MWR or IRR = 20.55%. The difference between the TWR and MWR of this investment = 22.80% − 20.55% = 2.25%, or 225 bps, with MWR being lower than TWR.Year Contribution Start-of-Year Value after Contribution End-of-Year Dividend End-of-Year Value after Dividend 1 1 × $100 1 × $100 = $100 1 × $5 = $5 $125 2 1 × $125 2 × $125 = $250 2 × $5 = $10 (2 × 140) + 10 = $290 The time-weighted rate of return (TWR) on this investment is found by taking the geometric mean of the two holding period returns (HPRs): TWR = [(1 + HPRYear 1) × (1 + HPRYear 2)]1/2 − 1 where HPRYear 1 = ($125 − $100 + $5)/$100 = 30.0% HPRYear 2 = ($280 − $250 + $10)/$250 = 16.0% TWR = [(1 + 0.30) × (1 + 0.16)]1/2 − 1 = 22.80% The money-weighted rate of return (MWR) is the internal rate of return (IRR) of the cash flows associated with the investment: 0=−100+(−125+5)(1+r1)+(280+10)(1+r2), where r = MWR. Using the cash flow (CF) function of a financial calculator: CF0 = −100, CF1 = (−125 + 5), CF2 = (280 + 10), and solving for IRR: MWR or IRR = 20.55%. The difference between the TWR and MWR of this investment = 22.80% − 20.55% = 2.25%, or 225 bps, with MWR being lower than TWR.Year Contribution Start-of-Year Value after Contribution End-of-Year Dividend End-of-Year Value after Dividend 1 1 × $100 1 × $100 = $100 1 × $5 = $5 $125 2 1 × $125 2 × $125 = $250 2 × $5 = $10 (2 × 140) + 10 = $290 The time-weighted rate of return (TWR) on this investment is found by taking the geometric mean of the two holding period returns (HPRs): TWR = [(1 + HPRYear 1) × (1 + HPRYear 2)]1/2 − 1 where HPRYear 1 = ($125 − $100 + $5)/$100 = 30.0% HPRYear 2 = ($280 − $250 + $10)/$250 = 16.0% TWR = [(1 + 0.30) × (1 + 0.16)]1/2 − 1 = 22.80% The money-weighted rate of return (MWR) is the internal rate of return (IRR) of the cash flows associated with the investment: 0=−100+(−125+5)(1+r1)+(280+10)(1+r2), where r = MWR. Using the cash flow (CF) function of a financial calculator: CF0 = −100, CF1 = (−125 + 5), CF2 = (280 + 10), and solving for IRR: MWR or IRR = 20.55%. The difference between the TWR and MWR of this investment = 22.80% − 20.55% = 2.25%, or 225 bps, with MWR being lower than TWR.

Risk management is most likely the process by which an organization:

adjusts its risk to a predetermined level

In a mortgage pass-through security, the pass-through rate:

adjusts the rate on the underlying pool of mortgages by a servicing fee In a mortgage pass-through security, the pass-through rate is less than the mortgage rate on the underlying pool of mortgages by an amount equal to the servicing (and other administrative) fees. A and C are incorrect because in a mortgage pass-through security, the pass-through rate is less than the mortgage rate on the underlying pool of mortgages by an amount equal to the servicing (and other administrative) fees.

Which of the following statements best describes the role of the International Organization of Securities Commissions (IOSCO)? The IOSCO

assists in attaining the goal of cross-border cooperation in combating violations of securities laws

In valuing underlying hedge fund positions, the most conservative approach is most likely one that uses:

bid prices for longs and ask prices for shorts

Which of the following most likely exhibits negative convexity?

callable bond

Samsung Electronics Co has issued a five-year bond with a par value of $1,000 and a coupon rate of 6.5%. This bond is most likely to be classified as a:

capital market security Fixed-income securities with original maturities that are longer than one year are called capital market securities. The bond mentioned in the question has a five-year maturity and therefore is a capital market security.

The most appropriate treatment for intangible assets with indefinite useful lives is to:

capitalize with no amortization

The financial statement that would be most useful to an analyst in understanding the changes that have occurred in a company's retained earnings over a year is the statement of:

changes in equity

A company extends its trade credit terms by four days to all its credit customers. These credit customers are most likely to experience a four-day:

decrease in their net operating cycle The company's customers are receiving a four-day increase in their number of days of payables, which will reduce the company's cash conversion cycle (net operating cycle) by four days.

If the exercise price of a European put option at expiration is below the price of the underlying, the value of the option is most likely:

equal to zero

An equity analyst is forecasting next year's net profit margin of a heavy equipment manufacturing firm by using the average net profit margin over the past three years. In making his profit projection, he identifies the following three items: The company reported losses from discontinued operations in each of the past three years. The most recent year's tax rate was only half of the prior two years' rate as a result of a fiscal stimulus. The company reported gains on the sale of investments in each of the past three years.

exclude the gains on the sale from investments because the company is a manufacturing firm The company is a heavy equipment manufacturer. Because gains on investments are not a core part of the company's business, they should not be viewed as an ongoing source of earnings. Discontinued operations are considered to be non-recurring items (even though they have occurred in the past three years); they are normally treated as random and unsustainable and should not be included in a short-term forecast. The change in the current tax rate is best viewed as temporary in the absence of additional information and should not be the basis of the calculation of the average tax rate.

Which of the following is least likely a component of yield spread?

expected inflation rate

Which of the following derivatives is least likely to be classified as a contingent claim?

futures contract

An accounting document that records transactions in the order in which they occur is best described as a:

general journal

A positive movement in a lagging indicator would least likely be used to:

identify an expected future economic upturn

Under IFRS, which of the following balance sheet presentation formats is most acceptable? Classifying assets and liabilities:

in liquidity order

Conservative, rather than aggressive, accounting is most likely associated with:

increased sustainability of earnings

In efficient financial markets, risk-free arbitrage opportunities:

may exist temporarily

Forward rate agreements are most likely used to hedge an exposure in the:

money market

An analyst observes that stock markets usually demonstrate return distributions concentrated to the right with a higher frequency of negative deviation from the mean. This feature is most likely known as:

negatively skewed The negatively skewed investment characteristic is usually related to the stock returns whose distribution is concentrated to the right.

Under US GAAP, interest paid is most likely included in which of the following cash flow activities?

operating only

The net present value (NPV) of an investment is equal to the sum of the expected cash flows discounted at the:

opportunity cost of capital

Q. Which of the following most likely exhibits positive convexity?

option free bond

If the scale of a single producer is small relative to the demand for an undifferentiated good, the market structure of the producer is best described as being:

perfect competition

Which of the following portfolios of risky assets is most likely the global minimum-variance portfolio? Portfolio Expected Return Standard Deviation A 5% 20% B 8% 33% C 3% 20%

portfolio B The global minimum-variance portfolio is the left-most point on the minimum-variance frontier among all portfolios of risky assets. Portfolios A and C have the same standard deviation, but Portfolio A dominates Portfolio C because of a higher return.

A good risk governance process would most likely:

provide guidance on the largest acceptable lost on the firm

Q. Which of the following most likely exhibits positive convexity?

putable bond (>option free bond)

According to the concept of money neutrality, over the long term, the money supply is *least likely* to affect:

real rate of interest (inflation and inflation expectations)

The process of securitization is least likely to allow banks to:

repackage loans into simpler structures

Based on a need to borrow $2 million for one month, which of the following alternatives has the least expensive effective annual cost?

see question 76

A project has the following cash flows ($) where the cash inflows are earned evenly throughout the year: Year 0 Year 1 Year 2 Year 3 Year 4 −1,525 215 345 475 1,215

see question 78

According to the industry life-cycle model, an industry in the shakeout stage is best characterized as experiencing:

slowing growth and intense competition

An index provider launches a new index that will include value stocks in a specific country. This index will most likely be a:

style index

Under US GAAP, which of the following is least likely a disclosure concerning inventory?

the amount of reversal of any write down of inventories

Which of the following is most likely associated with an investor's ability to take risk rather than the investor's willingness to take risk?

the investor has a long term investment horizon

A firm reports negative earnings for the year just ended. The price multiple of the firm's stock that is least likely to be meaningful is:

trailing price to earnings Negative earnings in the last year result in a negative ratio of trailing price to earnings and are not meaningful. Practitioners may use the ratio of (1) current price to cash flow or (2) leading price to earnings by replacing last year's loss with forecasted earnings.

In order to provide investors with a more comprehensive view of a firm's performance, the current GIPS standards includes new provisions related to:

various measure of risk