CFA Set 7

An individual investor specifies to her investment advisor that her portfolio must produce a minimum amount of cash each period. This investment constraint is best classified as: A) liquidity. B) legal and regulatory. C) unique circumstances.

Answer A. Liquidity constraints arise from an investor's need for spendable cash.

Which of the following statements with regard to floating rate notes that have caps and floors is most accurate? A) A cap is a disadvantage to the bondholder while a floor is a disadvantage to the issuer. B) A floor is a disadvantage to both the issuer and the bondholder while a cap is an advantage to both the issuer and the bondholder. C) A cap is an advantage to the bondholder while a floor is an advantage to the issuer.

Answer A. A cap limits the upside potential of the coupon rate paid on the floating rate bond and is therefore a disadvantage to the bondholder. A floor limits the downside potential of the coupon rate and is therefore a disadvantage to the bond issuer.

The sample mean is a consistent estimator of the population mean because the: A) sample mean provides a more accurate estimate of the population mean as the sample size increases. B) expected value of the sample mean is equal to the population mean. C) sampling distribution of the sample mean has the smallest variance of any other unbiased estimators of the population mean.

Answer A. A consistent estimator provides a more accurate estimate of the parameter as the sample size increases.

Which one of the following statements about correlation is NOT correct? A) If the correlation coefficient were 0, a zero variance portfolio could be constructed. B) Potential benefits from diversification arise when correlation is less than +1. C) If the correlation coefficient were -1, a zero variance portfolio could be constructed.

Answer A. A correlation coefficient of zero means that there is no relationship between the stock's returns. The other statements are true.

Greg Stiles, CFA, CAIA, has recently liquidated most of a client's portfolio because the client is planning to buy a house. Stiles informs one of the brokers in his office who has his real estate license about the plans of his client. With respect to Standard III(E), Preservation of Confidentiality, this action: A) violates the Standard unless the client asks Stiles to tell the licensed salesman. B) is appropriate since Stiles only tells a licensed salesman. C) is appropriate since Stiles keeps the information in the firm.

Answer A. According to Standard III(E), Preservation of Confidentiality, Stiles must keep client information confidential and limit the information to those people directly related to servicing the client. Merely working in the same firm does not qualify a person for learning about the client of a fellow analyst.

Profit is maximized at the quantity of output for which marginal revenue equals marginal cost under: A) both perfect competition and imperfect competition. B) perfect competition, but not under imperfect competition. C) imperfect competition, but not under perfect competition.

Answer A. All firms, regardless of market structure, maximize profit at the output quantity for which marginal revenue equals marginal cost.

Which of the following statements about American and European options is most accurate? A) Prior to expiration, an American option may have a higher value than an equivalent European option. B) European options allow for exercise on or before the option expiration date. C) There will always be some price difference between American and European options because of exchange-rate risk.

Answer A. American and European options both give the holder the right to exercise the option at expiration. An American option also gives the holder the right of early exercise, so American options will be worth more than European options when the right to early exercise is valuable, and they will have equal value when it is not.

While trading on behalf of a pension account, an analyst receives special research reports from the brokerage firm with whom she is doing the trades. Such an activity is: A) not in itself a violation of Standard III(A), Loyalty, Prudence, and Care, nor the Code of Ethics. B) a violation of only The Code of Ethics. C) a violation of both Standard III(A), Loyalty, Prudence, and Care, and the Code of Ethics.

Answer A. An analyst can receive research from a brokerage firm with whom she is trading on behalf of a client. The analyst should inform the client of the arrangement. The analyst is more likely to violate Standard III(A) by obtaining non-research services or, worse yet, personal benefits from the brokerage firm.

The spot exchange rate for Canadian dollars (CAD) per Swiss franc (CHF) is 1.1350 CAD/CHF and the 12-month forward exchange rate is 1.1460 CAD/CHF. The forward quote is a: A) premium of 110 points and the CAD is at a forward discount to the CHF. B) premium of 11 points and the CAD is at a forward premium to the CHF. C) discount of 110 points and the CAD is at a forward discount to the CHF.

Answer A. Because the forward CAD/CHF exchange rate is higher than the spot rate, the quote is a forward premium. Forward points represent 0.0001 for an exchange rate quoted to four decimal places. Here, the forward discount is 1460 − 1350 = 110 points. The base currency, the CHF, is at a forward premium to the CAD, therefore the CAD is at a forward discount to the CHF.

Which of the following statements about probability distributions is most accurate? A) A binomial distribution counts the number of successes that occur in a fixed number of independent trials that have mutually exclusive (i.e. yes or no) outcomes. B) A discrete uniform random variable has varying probabilities for each outcome that total to one. C) A continuous uniform distribution has a lower limit but no upper limit.

Answer A. Binomial probability distributions give the result of a single outcome and are used to study discrete random variables where you want to know the probability that an exact event will happen. A continuous uniform distribution has both an upper and a lower limit. A discrete uniform random variable has equal probabilities for each outcome.

Proceeds from issuing a bond are recorded on the statement of cash flows as an inflow from: A) financing (CFF). B) investing (CFI). C) operations (CFO).

Answer A. Cash from financing (CFF) is increased by the amount of the proceeds.

Penguin Company is planning to lease a $5 million machine to produce goods for eventual sale. Penguin is able to structure the lease so as to classify it as either an operating or a finance lease. Advantages to Penguin of classifying this lease as an operating lease are least likely to include that: A) no disclosures of payments due under the lease are required. B) the lease is not reported as debt on Penguin's balance sheet, so leverage ratios are not increased. C) depreciation is not recorded.

Answer A. Cash payments due under an operating lease must be disclosed in the notes to the financial statements for each of the following five years and in aggregate. Operating leases are simpler to account for and the often adverse ratio implications of offsetting increases in assets and liabilities are avoided.

The covariance of the market's returns with the stock's returns is 0.008. The standard deviation of the market's returns is 0.1 and the standard deviation of the stock's returns is 0.2. What is the correlation coefficient between the stock and market returns? A) 0.40. B) 0.00016. C) 0.91.

Answer A. CovA,B = (rA,B)(SDA)(SDB), where r = correlation coefficient and SDx = standard deviation of stock x Then, (rA,B) = CovA,B / (SDA × SDB) = 0.008 / (0.100 × 0.200) = 0.40 Remember: The correlation coefficient must be between -1 and 1.

A $1,000 par value, 10%, semiannual, 20-year debenture bond is currently selling for $1,100. What is this bond's current yield and will the current yield be higher or lower than the yield to maturity? Current Yield Current Yield vs. YTM A) 9.1% higher B) 8.9% lower C) 8.9% higher

Answer A. Current yield = annual coupon payment/price of the bond CY = 100/1,100 = 0.0909 The current yield will be between the coupon rate and the yield to maturity. The bond is selling at a premium, so the YTM must be less than the coupon rate, and therefore the current yield is greater than the YTM. The YTM is calculated as: FV = 1,000; PV = -1,100; N = 40; PMT = 50; CPT → I = 4.46 × 2 = 8.92

When calculating the weighted average cost of capital (WACC) an adjustment is made for taxes because: A) the interest on debt is tax deductible. B) equity is risky. C) equity earns higher return than debt.

Answer A. Equity and preferred stock are not adjusted for taxes because dividends are not deductible for corporate taxes. Only interest expense is deductible for corporate taxes.

Assume a stock index consists of many firms who have recently split their stock. Which of the following weighting schemes will see a bias due to the impact of stock splits? A) Price-weighted series. B) Unweighted price series. C) Market value-weighted series.

Answer A. Firms that split their stock price will have the identical weight before and after the split in both the unweighted and the market value-weighted series. However, in the price-weighted series, large successful firms will lose weight within the index due to simply splitting their stock. This creates a downward bias in a price-weighted series. Standard and Poor's 500 Index is a market value-weighted index.

The spot exchange rate for United States dollars per United Kingdom pound (USD/GBP) is 1.5775. If 30-day interest rates are 1.5% in the United States and 2.5% in the United Kingdom, and interest rate parity holds, the 30-day forward USD/GBP exchange rate should be: A) 1.5762. B) 1.5788. C) 1.5621.

Answer A. Forward USD/GBP = spot USD/GBP × (1 + U.S. interest rate) / (1 + UK interest rate) = 1.5775 × [(1 + 0.015/12) / (1 + 0.025/12)] = 1.5762

Do gains and losses, as well as expenses appear on the income statement? A) Both appear on the income statement. B) Only expenses appear on the income statement. C) Only gains and losses appear on the income statement.

Answer A. Gains and losses result from, transactions that are not a part of the firm's normal business operations. Expenses are amounts that are incurred to generate revenue; thus, expenses result from the firm's ongoing operations. Both are included on the income statement.

Government-owned assets abroad and foreign-owned assets in the country are included in which of the balance of payments accounts? A) Financial account. B) Capital account. C) Current account.

Answer A. Government-owned assets abroad and foreign-owned assets in the country are sub-accounts of the financial account.

If an investor puts $5,724 per year, starting at the end of the first year, in an account earning 8% and ends up accumulating $500,000, how many years did it take the investor? A) 27 years. B) 26 years. C) 87 years.

Answer A. I/Y = 8; PMT = -5,724; FV = 500,000; CPT → N = 27. Remember, you must put the pmt in as a negative (cash out) and the FV in as a positive (cash in) to compute either N or I/Y.

A firm has $4 million in outstanding bonds that mature in four years, with a fixed rate of 7.5% (assume annual payments). The bonds trade at a price of $98 in the open market. The firm's marginal tax rate is 35%. Using the bond-yield plus method, what is the firm's cost of equity risk assuming an add-on of 4%? A) 12.11%. B) 11.50%. C) 13.34%.

Answer A. If the bonds are trading at $98, the required yield is 8.11%, and the market value of the issue is $3.92 million. To calculate this rate using a financial calculator (and figuring the rate assuming a $100 face value for each bond), N = 4; PMT = 7.5 = (0.075 × 100); FV = 100; PV = -98; CPT → I/Y = 8.11. By adding the equity risk factor of 4%, we compute the cost of equity as 12.11%.

Technical analysts who employ Elliott Wave Theory are most likely to use Fibonacci numbers to forecast the: A) sizes of waves. B) timing of wave direction changes. C) number of subwaves within a larger wave.

Answer A. In Elliott Wave Theory, the sizes of waves are believed to correspond to ratios of Fibonacci numbers. Technical analysts who employ this theory may use Fibonacci ratios to estimate price targets.

What is the risk measure associated with the CML? A) Standard deviation. B) Beta. C) Market risk.

Answer A. In the context of the CML, the measure of risk (x-axis) is total risk, or standard deviation. Beta (systematic risk) is used to measure risk for the security market line (SML).

In dealing with the public and others, the CFA Institute Code of Ethics indicates that CFA Institute members will act with: A) integrity, competence, and respect. B) confidence, knowledge, and high ethical standards. C) honesty, professionalism, and goodwill.

Answer A. Integrity, competence, and respect are included in the first component of the Code of Ethics.

Deloris Johnson, CFA, suspected that her intern, who was working without pay at her brokerage firm, had violated a federal securities regulation. Johnson discussed the matter with her company's legal counsel who said that the intern's conduct was illegal. According to the CFA Institute Code and Standards of Professional Conduct, Johnson can dissociate herself from this illegal activity by: A) reporting the activity to the appropriate authorities. B) telling her intern to stop such conduct. C) transferring supervision of the intern to another person.

Answer A. Johnson can dissociate herself from the illegal activity by reporting the activity to the appropriate authorities. However, the Code and Standards do not require that she report legal violations to the appropriate governmental or regulatory organizations, but such disclose is prudent in this circumstance. By transferring the intern to another supervisor this may not solve the problem of the illegal activity occurring and the company would still be held liable for it.

Prema Singh is the bookkeeper for Octabius Industries. Singh has been asked by the CFO of Octabius to review all purchases that occurred between February 1 and February 8 to investigate an error on the receiving dock. Singh will most likely look at the: A) general journal. B) initial trial balance. C) general ledger.

Answer A. Journal entries record every transaction, showing which accounts are changed by what amounts. A listing of all the journal entries in order by date is called the "general journal."

A mutual fund that invests in short-term debt securities and maintains a net asset value of $1.00 per share is best described as a: A) money market fund. B) balanced fund. C) bond mutual fund.

Answer A. Money market funds invest primarily in short-term debt securities and are managed to maintain a constant net asset value, typically one unit of currency per share. A bond mutual fund typically invests in longer-maturity securities than a money market fund. A balanced fund invests in both debt and equity securities.

Multivariate distributions can describe: A) either discrete or continuous random variables. B) continuous random variables only. C) discrete random variables only.

Answer A. Multivariate distributions can describe discrete or continuous random variables.

Compared to corporate bonds with the same credit ratings, municipal general obligation (GO) bonds typically have less credit risk because: A) default rates on GOs are typically lower for same credit ratings. B) governments can print money to repay debt. C) GOs are not affected by economic downturns.

Answer A. Municipal bonds usually have lower default rates than corporate bonds of the same credit ratings. GO bonds' creditworthiness is affected by economic downturns. Sovereigns can print money to repay debt, but municipalities cannot.

A 20-year, 9% annual coupon bond selling for $1,098.96 offers a yield of: A) 8%. B) 10%. C) 9%.

Answer A. N = 20, PMT = 90, PV = -1,098.96, FV = 1,000, CPT I/Y

The inventory turnover ratio and the number of days in inventory are least likely used to evaluate the: A) stability of a firm's inventory levels. B) effectiveness of a firm's inventory management. C) age of a firm's inventory.

Answer A. Neither metric is directly relevant in evaluating the stability of a firm's inventory levels. Determining stability would presumably require other information such as purchase and sales levels, for example. The inventory turnover ratio and the number of days in inventory can be used to evaluate the relative age of a firm's inventory as well as the effectiveness of a firm's inventory management.

The price to book value ratio (P/BV) is a helpful valuation technique when examining firms: A) that hold primarily liquid assets. B) with the same stock prices. C) with older assets compared to those with newer assets.

Answer A. P/BV analysis works best for firms that hold primarily liquid assets.

Denise Weaver is a portfolio manager who manages a mutual fund and has pension clients. When Weaver receives a proxy for stock in the mutual fund, she gives it to Susan Griffith, her administrative assistant, to complete. When the proxy is for a stock owned in a pension plan, she asks Griffith to send the proxy on to the sponsor of the pension fund. Weaver has: A) violated the Standards by her policy on mutual fund and pension fund proxies. B) violated the Standards by her policy on mutual fund proxies, but not her policy on pension fund proxies. C) not violated the Standards.

Answer A. Proxies should be taken seriously, and although it is likely that Griffith can understand some of the issues, it is likely that she is not capable of making responsible decisions on all potential proxy issues. Proxies for a pension plan should be voted in the best interests of the beneficiaries, not the plan sponsor. The sponsor's interests will not always be the same as the beneficiary's interest.

Current spot rates are as follows: 1-Year: 6.5% 2-Year: 7.0% 3-Year: 9.2% Which of the following statements is most accurate: A) For a 3-year annual pay coupon bond, the first coupon can be discounted at 6.5%, the second coupon can be discounted at 7.0%, and the third coupon plus maturity value can be discounted at 9.2% to find the bond's arbitrage-free value. B) The yield to maturity for 3-year annual pay coupon bond can be found by taking the geometric average of the 3 spot rates. C) For a 3-year annual pay coupon bond, all cash flows can be discounted at 9.2% to find the bond's arbitrage-free value.

Answer A. Spot interest rates can be used to price coupon bonds by taking each individual cash flow and discounting it at the appropriate spot rate for that year's payment. Note that the yield to maturity is the bond's internal rate of return that equates all cash flows to the bond's price. Current spot rates have nothing to do with the bond's yield to maturity.

The Konkol Company implements a new methodology for portfolio valuation that is licensed to them by ABC Statistics. Konkol complies with the CFA Institute Code and Standards by: A) discussing the new methodology with the clients, in its entirety. B) discussing the new methodology with clients only when a change in the security selection process is involved. C) not discussing the new methodology with clients because there is no need to, as it will not change their risk and yield preferences.

Answer A. Standard V(B), Communication with Clients and Prospects, requires any change in the scope, valuation methodology, or focus of the portfolio to be discussed with clients.

Nikki Ali and Donald Ankard borrowed $15,000 to help finance their wedding and reception. The annual payment loan carries a term of seven years and an 11% interest rate. Respectively, the amount of the first payment that is interest and the amount of the second payment that is principal are approximately: A) $1,650; $1,702. B) $1,650; $1,468. C) $1,468; $1,702.

Answer A. Step 1: Calculate the annual payment. Using a financial calculator (remember to clear your registers): PV = 15,000; FV = 0; I/Y = 11; N = 7; PMT = $3,183 Step 2: Calculate the portion of the first payment that is interest. Interest1 = Principal × Interest rate = (15,000 × 0.11) = 1,650 Step 3: Calculate the portion of the second payment that is principal. Principal1 = Payment − Interest1 = 3,183 − 1,650 = 1,533 (interest calculation is from Step 2) Interest2 = Principal remaining × Interest rate = [(15,000 − 1.533) × 0.11] = 1,481 Principal2 = Payment − Interest1 = 3,183 − 1,481 = 1,702

The sustainable growth rate of real GDP is most likely to be increased by: A) the discovery of untapped oil fields. B) an increase in the propensity to consume by households. C) an increase in government spending.

Answer A. Sustainable growth in real GDP is defined as the growth rate in real GDP that is sustainable over the long term. The sustainable growth rate is positively affected by increases in the supply of natural resources, the supply of physical capital, or the supply or productivity of labor. An increase in government spending does not increase an economy's sustainable growth rate.

A country's labor force is projected to decrease by 2% while its labor productivity is projected to increase by 3% per year. Based on these projections, the country's sustainable annual economic growth rate: A) depends on the proportions of labor and capital in production. B) is positive. C) is negative.

Answer B. Growth in potential GDP = growth in labor force + growth in labor productivity. In this example, -2% + 3% = 1% growth in potential GDP.

Brian Ci believes that the average return on equity in the airline industry, µ, is less than 5%. What are the appropriate null (H0) and alternative (Ha) hypotheses to test this belief? A) H0: µ ≥ 0.05 versus Ha: µ < 0.05. B) H0: µ < 0.05 versus Ha: µ > 0.05. C) H0: µ < 0.05 versus Ha: µ ≥ 0.05.

Answer A. The alternative hypothesis is determined by the theory or the belief. The researcher specifies the null as the hypothesis that he wishes to reject (in favor of the alternative). Note that this is a one-sided alternative because of the "less than" belief.

Which of the following is least likely to be useful to an analyst when estimating the cost of raising capital through the issuance of non-callable, nonconvertible preferred stock? A) The firm's corporate tax rate. B) The stated par value of the preferred issue. C) The preferred stock's dividend rate.

Answer A. The corporate tax rate is not a relevant factor when calculating the cost of preferred stock. The cost of preferred stock, kps is expressed as: kps = Dps / P where: Dps = divided per share = dividend rate × stated par value P = market price

A Treasury bill (T-bill) with a face value of $10,000 and 44 days until maturity has a holding period yield of 1.1247%. Which of the following is closest to the effective annual yield on the T-bill? A) 9.72%. B) 12.47%. C) 8.76%.

Answer A. The formula for the effective annual yield is: ((1 + HPY)^365/t) − 1. Therefore, the EAY is: ((1.011247)^(365/44)) − 1 = 0.0972, or 9.72%

The long-run aggregate supply curve is: A) inelastic because all input prices can vary. B) elastic because input prices are sticky. C) perfectly elastic because input prices are fixed.

Answer A. The long-run aggregate supply curve is perfectly inelastic because in the long run all input prices change in proportion to the price level. Therefore the price level has no effect on long-run aggregate supply, which represents the level of potential GDP.

In the foreign exchange markets, transactions by households and small institutions for tourism, cross-border investment, or speculative trading comprise the: A) retail market. B) real money market. C) sovereign wealth market.

Answer A. The retail foreign exchange market refers to transactions by households and relatively small institutions and may be for tourism, cross-border investment, or speculative trading.

When creating intervals around the mean to indicate the dispersion of outcomes, which of the following measures is the most useful? The: A) standard deviation. B) median. C) variance.

Answer A. The standard deviation is more useful than the variance because the standard deviation is in the same units as the mean. The median does not help in creating intervals around the mean.

The country of Zurkistan is experiencing both high interest rates and high inflation. The government passes laws that reduce government spending and increase taxes. It takes many months before interest rates fall and inflation is reduced. This is an example of: A) impact lag in discretionary fiscal policy. B) recognition lag in discretionary fiscal policy. C) action lag and automatic stabilizers.

Answer A. This is an example of discretionary fiscal policy involving impact lag because it takes time for the impact of the change in taxing and spending to be felt throughout the economy.

Which of the following could be the set of all possible outcomes for a random variable that follows a binomial distribution? A) (0, 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11). B) (1, 2). C) (-1, 0, 1).

Answer A. This reflects a basic property of binomial outcomes. They take on whole number values that must start at zero up to the upper limit n. The upper limit in this case is 11.

Which of the following least likely represents a primary market offering? When bonds are sold: A) from a dealer's inventory. B) in a private placement. C) on a best-efforts basis.

Answer A. When bonds are sold from a dealer's inventory, the bonds have already been sold once and the transaction takes place on the secondary market. The other transactions in the responses take place in the primary market. When bonds are sold on a best-efforts basis, the investment banker does not take ownership of the securities and agrees to sell all she can. In a private placement, the bonds are sold privately to a small number of investors.

The following data pertains to the Megatron company: Net income equals $15,000. 5,000 shares of common stock issued on January 1. 10% stock dividend issued on June 1. 1000 shares of common stock were repurchased on July 1. 1000 shares of 10%, par $100 preferred stock each convertible into 8 shares of common were outstanding the whole year. How many common shares should be used in computing the company's basic earnings per share (EPS)? A) 4,500. B) 5,000. C) 5,500.

Answer B. 1/1 5,500 shares issued (includes 10% stock dividend on 6/1) × 12 = 66,000 7/1 1,000 shares repurchased × 6 months = 6,000 66,000 − 6,000 = 60,000 shares 60,000 shares / 12 months = 5,000 average shares

The holding period yield of a T-bill that has a bank discount yield of 4.70% and a money market yield of 4.86% and matures in 240 days is closest to: A) 2.8%. B) 3.2%. C) 4.9%.

Answer B. 4.86 × (240/360) = 3.24%.

A special-purpose board committee with which of the following responsibilities would be least likely to act in the best interests of the shareholders? A) Mergers and acquisitions. B) Takeover defense. C) Corporate governance.

Answer B. A committee responsible for takeover defense would most likely be acting in the interests of the company's current management rather than in the interests of shareholders.

While working on her report, Jean Paul, CFA, learns from her friend in the investment banking department that the company she is analyzing can expect a tender offer very soon. Concerning this conclusion, Paul can: A) trade on it, because she figured it out by herself. B) not trade on it because it is material nonpublic information. C) trade on it, because it is public information.

Answer B. According to Standard II(A), Material Nonpublic Information, an analyst is prohibited from trading on information that is both material and nonpublic.

Under normal circumstances, intangible assets with indefinite lives are: A) amortized over a reasonable period and subject to impairment. B) amortized over a reasonable period but not subject to impairment. C) not amortized but subject to impairment.

Answer C. Intangible assets with indefinite lives are not amortized but are subject to impairment charges. Under such situations, there may be in impairment in the asset value where events and circumstances indicate that the firm may not be able to recover the carrying value through future use. Examples include significant declines in market value of the asset or significant deterioration in the asset's physical condition.

John Johnson, portfolio manager at Sunshine Investments, has passed all three levels of the CFA® Program and has completed his work experience requirements. He expects to receive his charter in the near future. He includes the following statement in his firm's brochure: "Johnson has passed all three levels of the exam and has completed the required work experience for the CFA Charter. He is eligible for the CFA Charter and expects to receive the charter in the near future. Over the years, he has demonstrated a superior performance and his CFA Charter will be rightfully awarded." Johnson has: A) violated CFA Institute Standards of Professional Conduct because he advertised the CFA Charter before actually obtaining it. B) violated CFA Institute Standards of Professional Conduct because he implied superior performance that would be linked to the CFA Charter. C) not violated CFA Institute Standards of Professional Conduct because he met all disclosure requirements.

Answer B. According to Standard VII(B), Reference to CFA Institute, the CFA Designation, and the CFA Program, Johnson may indicate that he has completed the requirements and is eligible for the CFA charter along with an accurate explanation of the requirements. However, he may not imply that the designation would mean superior performance capabilities.

A due diligence factor that is common to analyzing real estate investment trusts, hedge funds, and private equity is (are): A) drawdown procedures. B) variability of manager performance. C) dividend distribution requirement.

Answer B. All of these classifications of alternative investments share variability of manager performance as a due diligence factor. Drawdown procedures are primarily a due diligence factor for analyzing private equity. Dividend distribution requirement is specific to REITs.

Portfolios that plot on the security market line in equilibrium: A) must be well diversified. B) may be concentrated in only a few stocks. C) have only systematic (beta) risk.

Answer B. All portfolios plot on the SML in equilibrium according to the capital asset pricing model.

Which valuation method is most appropriate to estimate a floor value for a firm being liquidated? A) Discounted cash flow. B) Asset-based. C) Price/earnings ratio.

Answer B. An asset-based model would likely be most appropriate to estimate a floor value for a firm entering liquidation. Prior or future years' earnings and cash flow are not relevant measures for a firm that is not a going concern.

Determine the cash flow from investing given the following table: Item Amount Cash payment of dividends $30 Sale of equipment $25 Net income $25 Purchase of land $15 Increase in accounts payable $20 Sale of preferred stock $25 Increase in deferred taxes $5 A) -$5. B) $10. C) -$10.

Answer B. CFI = Sale of Equipment (+25) + Purchase of Land (-15) = $10.

Capitalized interest costs are typically reported in the cash flow statement as an outflow from: A) operating. B) investing. C) financing.

Answer B. Capitalized interest costs are reported as CFI on the statement of cash flows, as they are treated as part of the cost of the constructed capital asset.

An analyst has gathered the following information about a firm: Quick ratio of 0.25. Cash ratio of 0.20. $2 million in marketable securities. $10 million in cash. What is their receivables balance? A) 5 million. B) 3 million. C) 2 million.

Answer B. Cash ratio = (cash + marketable securities) / current liabilities 0.20 = ($10,000,000 + $2,000,000) / current liabilities current liabilities = $12,000,000 / 0.2 = $60,000,000 Quick ratio = [cash + marketable securities + receivables] / $60,000,000 0.25 = [$10,000,000 + $2,000,000 + receivables] / $60,000,000 ($60,000,000)(0.25) = $12,000,000 + receivables $15,000,000 = $12,000,000 + receivables $15,000,000 − $12,000,000 = receivables $3,000,000 = receivables

Common size income statements express all income statement items as a percentage of: A) assets. B) sales. C) net income.

Answer B. Common size income statements express all income statement items as a percentage of sales. Note that common size balance sheets express all balance sheet accounts as a percentage of total assets.

After completing a thorough industry analysis, which of the following is most likely an additional element an analyst should examine when analyzing a specific company within the industry? A) Threat of new entrants. B) Competitive strategy. C) Bargaining power of buyers.

Answer B. Company analysis involves examining a specific firm's financial condition, products and services, and competitive strategy (cost leadership or differentiation). Industry analysis should include examining competitive forces such as the threat of new entrants and the bargaining power of buyers.

Deferred tax liabilities may result from: A) pretax income greater than taxable income due to permanent differences. B) pretax income greater than taxable income due to temporary differences. C) pretax income less than taxable income due to temporary differences.

Answer B. Deferred tax liabilities result from temporary differences that cause pretax income and income tax expense (on the income statement) to be greater than taxable income and taxes due (on the firm's tax form). Temporary differences that cause pretax income to be less than taxable income are recognized as deferred tax assets. Permanent differences do not result in deferred tax items; instead they cause the effective tax rate to differ from the statutory tax rate.

When calculating earnings per share (EPS) for firms with complex capital structures, stock options are ordinarily considered to be: A) derivative securities. B) potentially dilutive securities. C) antidilutive securities.

Answer B. Dilutive securities are securities that decrease EPS if they are exercised or converted to common stock. When the exercise price is less than the average market price, stock options are considered to be dilutive, Stock options, warrants, convertible debt, and convertible preferred stock are examples of potentially dilutive securities.

The amount of money a commercial bank has available to lend is known as: A) fractional reserves. B) excess reserves. C) required reserves.

Answer B. Excess reserves are the amount of money a commercial bank has available with which to make new loans, after depositing its required reserves with the central bank.

Which of the following is least likely an example of external credit enhancement? A) Surety bond. B) Excess spread. C) Bank guarantee.

Answer B. Excess spread is an internal credit enhancement. External credit enhancements include bank guarantees, letters of credit, and surety bonds.

Which of the following is NOT an over-the-counter (OTC) derivative? A) A bond option. B) A futures contract. C) A forward contract.

Answer B. Futures contracts are exchange-traded; forwards and most bond options are OTC derivatives.

Distribution X has a mean of 10 and a standard deviation of 20. Distribution Y is identical to Distribution X in all respects except that each observation in Distribution Y is three times the value of a corresponding observation in Distribution X. The mean and standard deviation of Distribution Y are closest to: Mean Standard deviation A) 30 20 B) 30 60 C) 10 60

Answer B. If the observations in Distribution Y are three times the observations in Distribution X, the mean and standard deviation of Distribution Y are three times the mean and standard deviation of Distribution X. The standard deviation of a data set measured in feet, for example, will be 3 times the standard deviation of the data set measured in yards (since 1 yard = 3 feet).

A company says that whether it increases its dividends depends on whether its earnings increase. From this we know: A) P(dividend increase | earnings increase) is not equal to P(earnings increase). B) P(earnings increase | dividend increase) is not equal to P(earnings increase). C) P(both dividend increase and earnings increase) = P(dividend increase).

Answer B. If two events A and B are dependent, then the conditional probabilities of P(A | B) and P(B | A) will not equal their respective unconditional probabilities (of P(A) and P(B), respectively). Both remaining choices may or may not occur, e.g., P(A | B) = P(B) is possible but not necessary.

If two events are mutually exclusive, the probability that they both will occur at the same time is: A) 0.50. B) 0.00. C) Cannot be determined from the information given.

Answer B. If two events are mutually exclusive, it is not possible to occur at the same time. Therefore, the P(A∩B) = 0.

A trading system that matches buyers and sellers based on price and time precedence is most likely a(n): A) quote-driven market. B) order-driven market. C) brokered market.

Answer B. In an order-driven market, buy orders and sell orders are matched up by the exchange according to order matching rules. In a quote-driven market, customers trade with dealers at bid and ask prices set by the dealers. In a brokered market, brokers organize trades among their clients.

One way in which monopolistic competition can be distinguished from perfect competition is that in monopolistic competition: A) marginal revenue is greater than marginal cost at the quantity produced. B) price is greater than marginal cost. C) each firm faces a perfectly elastic demand curve.

Answer B. In monopolistic competition, price is greater than marginal cost (i.e., firms can realize a markup). In perfect competition, P = MC. Firms in monopolistic competition are price searchers, i.e., each firm faces a downward sloping demand curve. Regardless of the market structure, all firms produce the quantity at which marginal revenue equals marginal cost.

An analyst divides the population of U.S. stocks into 10 equally sized sub-samples based on market value of equity. Then he takes a random sample of 50 from each of the 10 sub-samples and pools the data to create a sample of 500. This is an example of: A) systematic cross-sectional sampling. B) stratified random sampling. C) simple random sampling.

Answer B. In stratified random sampling we first divide the population into subgroups, called strata, based on some classification scheme. Then we randomly select a sample from each stratum and pool the results. The size of the samples from each strata is based on the relative size of the strata relative to the population. Simple random sampling is a method of selecting a sample in such a way that each item or person in the population being studied has the same (non-zero) likelihood of being included in the sample.

If both aggregate demand and short-run aggregate supply increase, real GDP: A) will decrease. B) will increase. C) may increase or decrease.

Answer B. Increases in AD and SRAS both cause real GDP to increase. An increase in AD increases the price level, but an increase in SRAS tends to decrease the price level, so their combined effect could be an increase or a decrease in the price level.

Which of the following statements regarding margin accounts is most accurate? A) Maintenance margin refers to the amount of funds the investor can borrow. B) Margin accounts can be used to purchase securities by borrowing part of the purchase price. C) The total equity in the margin account cannot fall below the initial margin requirement.

Answer B. Margin accounts are brokerage accounts that allow investors to borrow part of the purchase price from the broker.

When comparing a barter economy with an economy that uses money as a medium of exchange we would expect increased efficiencies due to a reduction in which of the following? A) The need to specialize. B) Transaction costs. C) Nominal interest rates.

Answer B. Money functions as a medium of exchange because it is accepted as payment for goods and services. Compare this to a barter economy, where if I have goat and want an ox, I have to find someone willing to trade. Finding someone takes time and time is costly. With money, I can sell the goat and buy the ox. Thus, transaction costs are reduced. Having money as a medium of exchange would not reduce the inflation rate, interest rates, or the need to specialize in the production of those goods in which we have a comparative advantage (low opportunity cost producer).

Which of the following statements describes a limitation of Monte Carlo simulation? A) Variables are assumed to be normally distributed but may actually have non-normal distributions. B) Outcomes of a simulation can only be as accurate as the inputs to the model. C) Simulations do not consider possible input values that lie outside historical experience.

Answer B. Monte Carlo simulations can be set up with inputs that have any distribution and any desired range of possible values. However, a limitation of the technique is that its output can only be as accurate as the assumptions an analyst makes about the range and distribution of the inputs.

Which of the following industries is most likely to operate in a fragmented market? A) Confections. B) Oil services. C) Pharmaceuticals.

Answer B. Most areas of the oil services industry are characterized by many small competitors. The confections and pharmaceutical industries each have a small number of very large firms.

An investor has the choice of two investments. Investment A offers interest at 7.25% compounded quarterly. Investment B offers interest at the annual rate of 7.40%. Which investment offers the higher dollar return on an investment of $50,000 for two years, and by how much? A) Investment B offers a $36.92 greater return. B) Investment A offers a $122.18 greater return. C) Investment A offers a $53.18 greater return.

Answer C. Investment A: I = 7.25 / 4; N = 2 × 4 = 8; PV = $50,000; PMT = 0; CPT → FV = $57,726.98 Investment B: I = 7.40; N = 2; PV = $50,000; PMT = 0; CPT → FV = $57,673.80 Difference = investment A offers a $53.18 greater dollar return.

Which of the following strategies is most likely to be considered good payables management? A) Paying trade invoices on the day they arrive. B) Paying invoices on the last possible day to still get the supplier's discount for early payment. C) Taking trade discounts only if the firm's annual return on short-term investments is less than the discount percentage.

Answer B. Paying invoices on the last day to get a discount (for early payment) is often the most advantageous strategy for a firm. If the annualized percentage cost of not taking advantage of the discount is less than the firm's short-term cost of funds, it would be advantageous to pay on the due date. However, the discount percentage is not an annualized rate, so it cannot be compared directly to the firm's annual return on short-term investments. Paying prior to the discount cut-off date or prior to the due date sacrifices interest income for no advantage.

A 6-year annual interest coupon bond was purchased one year ago. The coupon rate is 10% and par value is $1,000. At the time the bond was bought, the yield to maturity (YTM) was 8%. If the bond is sold after receiving the first interest payment and the bond's yield to maturity had changed to 7%, the annual total rate of return on holding the bond for that year would have been: A) 8.00%. B) 11.95%. C) 7.00%.

Answer B. Price 1 year ago N = 6, PMT = 100, FV = 1,000, I = 8, Compute PV = 1,092 Price now N = 5, PMT = 100, FV = 1,000, I = 7, Compute PV = 1,123 % Return = (1,123.00 + 100 − 1,092.46)/1,092.46 x 100 = 11.95%

An analysis of the industry reveals that firms have been paying out 45% of their earnings in dividends, asset turnover = 1.2; asset-to-equity (A/E) = 1.1 and profit margins are 8%. What is the industry's projected growth rate? A) 4.55%. B) 5.81%. C) 4.95%.

Answer B. ROE = profit margin × asset turnover × A/E = 0.08 × 1.2 × 1.1 = 0.1056 RR = (1 - 0.45) = 0.55 g = ROE × RR = 0.1056 × 0.55 = 0.0581

Participants in foreign exchange markets that can be characterized as "real money accounts" most likely include: A) central banks. B) insurance companies. C) hedge funds.

Answer B. Real money accounts are foreign exchange buy-side investors that do not use derivatives. Many mutual funds, pension funds, and insurance companies can be classified as real money accounts. Hedge funds typically use derivatives. Central banks usually do not act as investors in foreign exchange markets but may intervene in foreign exchange markets to achieve monetary policy objectives.

Stephanie Orange, Level II CFA candidate, posts blogs for her exam study group three days after the exam to vent her frustrations over the exam. However, to avoid disclosing what was actually on the exam, she only discusses topic areas she thought would be on the exam that were not. She writes "...the topics selected were unnecessarily obscure. Important items like FCF, DDM, and Residual Income were ignored completely..." Orange is most likely: A) not in violation because the information about the actual exam contents was posted only after the conclusion of the exam. B) in violation of Standard VII(A) "the Code and Standards" for providing confidential information about the exam. C) not in violation because the information was only about what was not on the exam.

Answer B. Standard VII(A) Conduct as Participants in CFA Institute Programs prohibits members and candidates from providing confidential information about the exam - even after the conclusion of the exam. Examples include broad topical areas tested or not tested.

The Fisher effect describes a nominal interest rate as the: A) actual inflation rate less the real interest rate. B) expected inflation rate plus the real interest rate. C) expected inflation rate less the real interest rate.

Answer B. The Fisher effect states that a nominal interest rate is equal to the real interest rate plus the expected inflation rate.

Which of the following statements regarding the Sharpe ratio is most accurate? The Sharpe ratio measures: A) peakedness of a return distrubtion. B) excess return per unit of risk. C) total return per unit of risk.

Answer B. The Sharpe ratio measures excess return per unit of risk. Remember that the numerator of the Sharpe ratio is (portfolio return − risk free rate), hence the importance of excess return. Note that peakedness of a return distribution is measured by kurtosis.

A strong corporate code of ethics is vitally important. Which of the following statements concerning a firm's code of ethics is least likely accurate? A) A firm's code of ethics sets standards for ethical conduct based on basic principles of integrity, trust and honesty. B) A firm's code of ethics should require clear disclosure of any advantages given to the firm's insiders that are not also offered to shareholders. C) As part of investor review of the firm's ethical climate, investors should determine whether the firm gives the board access to relevant corporate information in a timely manner.

Answer B. The firm's code of ethics should prohibit practices that give advantages to company insiders that are not also offered to shareholders.

When a tax is imposed on the consumption of a good, which of the following terms refers to who bears the burden of the tax? A) Consumer surplus. B) The incidence of a tax. C) The deadweight loss.

Answer B. The incidence of a tax refers to how the burden of a tax is actually shared between buyers and sellers. The deadweight loss is the loss of the gains from trade from the lower equilibrium quantity that results from the tax. Consumer surplus is the gains from trade that consumers accrue from the existence of the market.

The mosaic theory is the idea that an analyst can: A) base his recommendations on nonpublic material information only for the clients of the company, but not for the general public. B) make recommendations or trade based on several pieces of public or nonpublic information, each piece by itself being nonmaterial, but when compiled the information becomes material. C) make investment recommendations on the basis of several pieces of nonpublic information as long as the aggregate information remains nonmaterial.

Answer B. The mosaic theory permits an analyst to make recommendations based upon several pieces of public or nonmaterial information, even though the complied result is both material and nonpublic.

The expected annual dividend one year from today is $2.50 for a share of stock priced at $25. What is the cost of equity if the constant long-term growth in dividends is projected to be 8%? A) 19%. B) 15%. C) 18%.

Answer C. Ks = (D1 / P0) + g = (2.5/25) + 0.08 = 0.18 or 18%.

Which of the following measures produces the same portfolio rankings as the Sharpe ratio but is stated in percentage terms? A) Treynor measure. B) Jensen's alpha. C) M-squared.

Answer C. M-squared measures the excess return of a leveraged portfolio relative to the market portfolio and produces the same portfolio rankings as Sharpe ratio.

The share price of Winnipeg Auto Unlimited is $5 per share. There are 50 million shares outstanding, and Winnipeg has a book value of $900 million. What is the book value per share (BVPS) after the share repurchase of $10 million? A) $21.24. B) $18.54. C) $14.76.

Answer B. The share buyback is $10 million / $5 per share = 2,000,000 shares. Remaining shares: 50 million − 2 million = 48 million shares. Winnipeg Auto Unlimited's current BVPS = $900 million / 50 million = $18. Book value after repurchase: $900 million − $10 million = $890 million. BVPS = $890 million / 48.0 million = $18.54. BVPS increased by $0.54. Book value per share (BVPS) increased because the share price is less than the original BVPS. If the share prices were more than the original BVPS, then the BVPS after the repurchase would have decreased.

From a population with a known standard deviation of 15, a sample of 25 observations is taken. Calculate the standard error of the sample mean. A) 1.67. B) 3.00. C) 0.60.

Answer B. The standard error of the sample mean equals the standard deviation of the population divided by the square root of the sample size: sx = s / n^1/2 = 15 / 25^1/2 = 3.

A zero coupon bond, compared to a bond issued at par, will result in higher: A) interest expense. B) cash flows from operations (CFO). C) cash flows from financing (CFF).

Answer B. The zero-coupon bond will have higher cash flows from operations, as the cash interest expense in this case is zero and no cash is paid until maturity. Candidates should remember that any bond issued at a discount will have more cash flow from operations and less cash flow from financing.

An investor buys a 25-year, 10% annual pay bond for $900 and will sell the bond in 5 years when he estimates its yield will be 9%. The price for which the investor expects to sell this bond is closest to: A) $1,122. B) $1,091. C) $964.

Answer B. This is a present value problem 5 years in the future. N = 20, PMT = 100, FV = 1000, I/Y = 9 CPT PV = -1,091.29 The $900 purchase price is not relevant for this problem.

Elise Corrs, hedge fund manager and avid downhill skier, was recently granted permission to take a 4 month sabbatical. During the sabbatical, (scheduled to start in 11 months), Corrs will ski at approximately 12 resorts located in the Austrian, Italian, and Swiss Alps. Corrs estimates that she will need $6,000 at the beginning of each month for expenses that month. (She has already financed her initial travel and equipment costs.) Her financial planner estimates that she will earn an annual rate of 8.5% during her savings period and an annual rate of return during her sabbatical of 9.5%. How much does she need to put in her savings account at the end of each month for the next 11 months to ensure the cash flow she needs over her sabbatical? Each month, Corrs should save approximately: A) $2,065. B) $2,080. C) $2,070.

Answer B. This is a two-step problem. First, we need to calculate the present value of the amount she needs over her sabbatical. (This amount will be in the form of an annuity due since she requires the payment at the beginning of the month.) Then, we will use future value formulas to determine how much she needs to save each month. Step 1: Calculate present value of amount required during the sabbatical Using a financial calculator: Set to BEGIN Mode, then N = 4; I/Y = 9.5 / 12 = 0.79167; PMT = 6,000; FV = 0; CPT → PV = -23,719. Step 2: Calculate amount to save each month Using a financial calculator: Make sure it is set to END mode, then N = 11; I/Y = 8.5 / 12.0 = 0.70833; PV = 0; FV = 23,719; CPT → PMT= -2,081, or approximately $2,080.

Using the following spot rates for pricing the bond, what is the present value of a three-year security that pays a fixed annual coupon of 6%? Year 1: 5.0% Year 2: 5.5% Year 3: 6.0% A) 95.07. B) 100.10. C) 102.46.

Answer B. This value is computed as follows: Present Value = 6/1.05 + 6/1.055^2 + 106/1.06^3 = 100.10 The value 95.07 results if the coupon payment at maturity of the bond is neglected.

Assume that a perfectly competitive firm produces 10 units of a good and sells them each for a price (P) equal to $15. If the marginal cost (MC) of the 10th unit is $15 and the average total cost (ATC) is $13, economic profit for the firm is closest to: A) $120. B) $20. C) $0.

Answer B. When MR = MC = P, economic profit equals TR - TC. In this case, TR = $150 = 10 × $15 and TC = $130 = 10 × ATC = 10 × $13. So, economic profit is $20 = $150 − $130.

An investor wants to take advantage of the 5-year spot rate, currently at a level of 4.0%. Unfortunately, the investor just invested all of his funds in a 2-year bond with a yield of 3.2%. The investor contacts his broker, who tells him that in two years he can purchase a 3-year bond and end up with the same return currently offered on the 5-year bond. What 3-year forward rate beginning two years from now will allow the investor to earn a return equivalent to the 5-year spot rate? A) 5.6%. B) 3.5%. C) 4.5%.

Answer C. (1.04^5 / 1.032^2)^1/3 - 1 = 4.5%.

The number of ships in the harbor is an example of what kind of variable? A) Continuous. B) Indiscrete. C) Discrete.

Answer C. A discrete variable is one that is represented by finite units.

If a firm uses accelerated depreciation for tax purposes and straight-line depreciation for financial reporting, which of the following results is least likely? A) Income tax expense will be greater than taxes payable. B) A temporary difference will result between tax and financial reporting. C) A permanent difference will result between tax and financial reporting.

Answer C. A permanent difference between tax and financial reporting is a difference that is expected to not reverse itself. Under normal circumstances, the effects of the different depreciation methods will reverse.

The most likely outcome of adopting a golden parachute, poison pill, or greenmail is a: A) negative impact on the stock price and a greater possibility for a successful takeover bid. B) reduced possibility for a successful takeover bid and a positive impact on the stock price. C) reduced possibility for a successful takeover bid and a negative impact on the stock price.

Answer C. Adopting a golden parachute, poison pill, or greenmail are all take-over defenses used to frustrate an acquisition attempt. The barriers created by such defenses are likely to decrease the value of the stock.

Which of the following statements regarding marginal costs (MC) and average variable costs (AVC) is most accurate? A) MC = AVC when average total cost is at its minimum. B) MC = Average total cost when AVC is at its minimum. C) MC = AVC when AVC is at its minimum.

Answer C. MC = AVC at minimum average variable cost. MC = ATC at minimum average total cost.

Which of the following is the best interpretation of the no-arbitrage principle? A) There is no way you can find an opportunity to make a profit. B) The information flow is quick in the financial market. C) There is no free money.

Answer C. An arbitrage opportunity is the chance to make a riskless profit with no investment. In essence, finding an arbitrage opportunity is like finding free money. As you recall, in arbitrage, you observe two identical assets with different prices. Your immediate response should be to buy the cheaper one and sell the expensive one short. You can then deliver the cheap one to cover your short position. Once you take the initial arbitrage position, your arbitrage profit is locked in. The no-investment statement referenced in the text refers to the assumption that when you short the expensive asset, you will be given access to the cash created by the short sale. With this cash, you now have the money to buy the cheaper asset. The no-investment assumption means that the first person to observe a market pricing error will have the financial resources to correct the pricing error instantaneously all by themselves.

The NPV profile is a graphical representation of the change in net present value relative to a change in the: A) prime rate. B) internal rate of return. C) discount rate.

Answer C. As discount rates change the net present values change. The NPV profile is a graphic illustration of how sensitive net present values are to different discount rates. By comparison, every project has a single internal rate of return and payback period because the values are determined solely by the investment's expected cash flows.

Which one of the following statements about the t-distribution is most accurate? A) Compared to the normal distribution, the t-distribution has less probability in the tails. B) The t-distribution is the only appropriate distribution to use when constructing confidence intervals based on large samples. C) The t-distribution approaches the standard normal distribution as the number of degrees of freedom becomes large.

Answer C. As the number of degrees of freedom grows, the t-distribution approaches the shape of the standard normal distribution. Compared to the normal distribution, the t-distribution has fatter tails. When choosing a distribution, three factors must be considered: sample size, whether population variance is known, and if the distribution is normal.

Financial information for Jefferson Corp. for the year ended December 31st, was as follows: Sales $3,000,000 Purchases 1,800,000 Inventory at Beginning 500,000 Inventory at Ending 800,000 Accounts Receivable at Beginning 300,000 Accounts Receivable at Ending 200,000 Accounts Payable at Beginning 100,000 Accounts Payable at Ending 100,000 Other Operating Expenses Paid 400,000 Based upon this data and using the direct method, what was Jefferson Corp.'s cash flow from operations (CFO) for the year ended December 31st? A) $1,200,000. B) $800,000. C) $900,000.

Answer C. CFO = sales $3,000,000 - change in accounts receivable ($200,000 - $300,000) - purchases $1,800,000 - other cash operating expenses $400,000 = $900,000. Note that no adjustment for inventories is necessary because purchases are given. From the inventory equation, P = COGS + EI - BI.

Cameron Ryan wants to make an offer on the condominium he is renting. He takes a sample of prices of condominiums in his development that closed in the last five months. Sample prices are as follows (amounts are in thousands of dollars): $125, $175, $150, $155 and $135. The sample standard deviation is closest to: A) 38.47. B) 370.00. C) 19.24.

Answer C. Calculations are as follows: Sample mean = (125 + 175 + 150 + 155 + 135) / 5 = 148 Sample Variance = [(125 - 148)^2 + (175 - 148)^2 + (150 - 148)^2 + (155 - 148)^2 + (135 - 148)^2] / (5 - 1) = 1,480 / 4 = 370 Sample Standard Deviation = 370^1/2 = 19.24%.

What is the coefficient of variation for a distribution with a mean of 10 and a variance of 4? A) 40%. B) 25%. C) 20%.

Answer C. Coefficient of variation, CV = standard deviation / mean. The standard deviation is the square root of the variance, or 4^½ = 2. So, CV = 2 / 10 = 20%.

An analyst can find a company's accounting policies that require significant judgement or estimates in: A) both the footnotes and in the auditor's opinion. B) only the footnotes. C) both the footnotes to the financial statements and Management's Discussion and Analysis.

Answer C. Companies that prepare financial statements under IFRS or U.S. GAAP must disclose their accounting policies and estimates in the footnotes and address those policies and estimates where significant judgment was required in Management's Discussion and Analysis. The auditor's opinion discusses whether policies have been applied appropriately, but does not include the estimates and policies themselves.

The law of comparative advantage explains why a nation will benefit from trade when it: A) exports goods for which it is a high-cost producer, while importing those for which it is a low-cost producer. B) exports more than it imports. C) exports goods for which it is a low-cost producer, while importing those for which it is a high-cost producer.

Answer C. Comparative advantage is the ability to produce a good at a lower opportunity cost than others can produce it. When trading partners specialize in producing products for which they have a comparative advantage; costs are minimized, output is greater, and both trading partners benefit.

Is an acquisition of treasury stock or a loss from the write-down of inventory under the lower-of-cost-or-market rule included in comprehensive income? Inventory write-down - Acquisition of treasury stock A) No Yes B) No No C) Yes No

Answer C. Comprehensive income includes all transactions that affect shareholders' equity except transactions with shareholders. Thus, any transaction that affects net income would also affect comprehensive income. Since the inventory write-down is included in net income, it is part of comprehensive income. The acquisition of treasury stock is a transaction with shareholders; thus, it is not a part of comprehensive income.

Which of the following statements about the median is least accurate? It is: A) equal to the 50th percentile. B) equal to the mode in a normal distribution. C) more affected by extreme values than the mean.

Answer C. Median is less influenced by outliers since the median is computed as the "middle" observation. On the other hand, all of the data including outliers are used in computing the mean. Both remaining statements are true regarding the median.

Merchandise and services, income receipts, and unilateral transfers are included in which of the balance of payments accounts? A) Financial account. B) Capital account. C) Current account.

Answer C. Merchandise and services, income receipts, and unilateral transfers are sub-accounts of the current account.

National Scooter Company and Continental Chopper Company are motorcycle manufacturing companies. National's target market includes consumers that are switching to motorcycles because of the high cost of operating automobiles and they compete on price with other manufacturers. The average age of National's customers is 24 years. Continental manufactures premium motorcycles and aftermarket accessories and competes on the basis of quality and innovative design. Continental is in the third year of a five-year project to develop a customized hybrid motorcycle. Which of the two firms would most likely report higher gross profit margin, and which firm would most likely report higher operating expense stated as a percentage of total cost? Higher gross profit margin Higher percentage operating expense A) Continental - National B) National - Continental C) Continental - Continental

Answer C. Continental likely has the highest gross profit margin percentage since it is selling a customized product and does not compete primarily based on price. Because of the research and development costs of developing a new hybrid motorcycle, Continental likely has the higher operating expense stated as a percentage of total cost.

A research paper that reports finding a profitable trading strategy without providing any discussion of an economic theory that makes predictions consistent with the empirical results is most likely evidence of: A) a sample that is not large enough. B) a non-normal population distribution. C) data mining.

Answer C. Data mining occurs when the analyst continually uses the same database to search for patterns or trading rules until he finds one that works. If you are reading research that suggests a profitable trading strategy, make sure you heed the following warning signs of data mining: Evidence that the author used many variables (most unreported) until he found ones that were significant. The lack of any economic theory that is consistent with the empirical results.

Which of the following statements about the indirect method of calculating the statement of cash flows is NOT correct? A) An adjustment is needed for the payment of deferred taxes. B) No adjustment is needed to account for extraordinary items because they are found above net income and are thus already accounted for. C) No adjustment is needed to account for changes in accounts receivable since no cash was involved.

Answer C. Extraordinary items are reported below income from continuing operations but above net income. You must adjust for changes in the working capital accounts: accounts receivable, inventory, and accounts payable.

Yeoman Partners is a private equity fund that raised $100 million in committed capital at inception with a 2% management fee and 20% incentive fee. In Year 1, Yeoman drew down $40 million and did not return any capital to investors. The fund's fees in Year 1 are: A) $800,000. B) $8,800,000. C) $2,000,000.

Answer C. Fees in Year 1 are 2% × $100 million = $2 million. Private equity funds charge a management fee on the amount of committed capital, regardless of the actual amount deployed. A private equity fund typically does not earn incentive fees until after it has returned the initial capital to investors.

Use the following information to determine the value of River Gardens' common stock: Expected dividend payout ratio is 45%. Expected dividend growth rate is 6.5%. River Gardens' required return is 12.4%. Expected earnings per share next year are $3.25. A) $27.25. B) $30.12. C) $24.80.

Answer C. First, estimate the price to earnings (P/E) ratio as: (0.45) / (0.124 - 0.065) = 7.63. Then, multiply the expected earnings by the estimated P/E ratio: ($3.25)(7.63) = $24.80.

Given the following information about a firm: Net Sales = $1,000. Cost of Goods Sold = $600. Operating Expenses = $200. Interest Expenses = $50. Tax Rate = 34%. What are the gross and operating profit margins? Gross Profit Margin Operating Profit Margin A) 20% 15% B) 40% 10% C) 40% 20%

Answer C. Gross profit margin = ($1,000 net sales − $600 COGS) / $1,000 net sales = 400 / 1,000 = 0.4 Operating profit margin = ($1,000 net sales − $600 COGS − $200 operating expenses) / $1,000 net sales = $200 / $1000 = 0.2

You borrow $15,000 to buy a car. The loan is to be paid off in monthly payments over 5 years at 12% annual interest. What is the amount of each payment? A) $546. B) $456. C) $334.

Answer C. I = 12 / 12 = 1; N = 5 × 12 = 60; PV = 15,000; CPT → PMT = 333.67.

Portsmouth Industries has stated that in the market for their medical imaging product, their strategy is to grow their market share in the premium segment by leveraging their research and development capabilities to produce machines with greater resolution for the most challenging cases of spinal degeneration. An analyst examining their financials for evidence that Portsmouth is indeed successfully pursuing this strategy would least appropriately look for: A) an increase in average unit prices. B) an increase in net revenue. C) decreasing cost of goods sold as a percentage of net sales.

Answer C. If Portsmouth is in fact growing their share of the premium market we would expect an increase in unit selling prices as more premium units are sold and an increase in net revenue as sales shift from "regular" to premium machines. COGS may or may not change as percentage of sales if the strategy is successful, but a decrease in COGS would be consistent with a strategy of being the low-cost producer of regular machines.

The demand for a product tends to be price inelastic if: A) few good complements for the product are available. B) people spend a large share of their income on the product. C) few good substitutes for the product are available.

Answer C. If a large price change results in a small change in quantity demanded, demand is inelastic. Cigarettes are an example of a good with inelastic demand.

The CFA Institute's Professional Conduct Program may learn about potential violations of the Code and Standards by members and candidates: A) only from written complaints or members and candidates self-reporting. B) only from members and candidates self-reporting. C) from sources other than written complaints or members and candidates self-reporting.

Answer C. In addition to self-reporting by members and candidates and written complaints about members and candidates, the Professional Conduct Program may learn about potential violations through public sources such as the news media, through reports from CFA exam proctors, by review of exam results and materials, or through monitoring of online and social media activity.

Which of the following would be assessed first in a top-down valuation approach? A) Industry risks. B) Industry return on equity (ROE). C) Fiscal policy.

Answer C. In the top-down valuation approach, the investor should analyze macroeconomic influences first, then industry influences, and then company influences. Fiscal policy, as part of the macroeconomic landscape, should be analyzed first.

Which one of the following structures is characterized by free entry and exit, a differentiated product, and price searcher behavior? A) Pure competition. B) Oligopoly. C) Monopolistic competition.

Answer C. Monopolistic competition is another name for competitive price-searcher markets. There are a large number of independent sellers, each produces a differentiated product, each market has a low barrier to entry, and each producer faces a downward sloping demand curve.

When a company is evaluating two mutually exclusive projects that are both profitable but have conflicting NPV and IRR project rankings, the company should: A) use a third method of evaluation such as discounted payback period. B) accept the project with the higher internal rate of return. C) accept the project with the higher net present value.

Answer C. Net present value is the preferred criterion when ranking projects because it measures the firm's expected increase in wealth from undertaking a project.

If X and Y are independent events, which of the following is most accurate? A) P(X or Y) = (P(X)) × (P(Y)). B) P(X or Y) = P(X) + P(Y). C) P(X | Y) = P(X).

Answer C. Note that events being independent means that they have no influence on each other. It does not necessarily mean that they are mutually exclusive. Accordingly, P(X or Y) = P(X) + P(Y) − P(X and Y). By the definition of independent events, P(X|Y) = P(X).

What type of ratio is revenue divided by average working capital and what type of ratio is average total assets divided by average total equity? Revenue / Average working capital - Average total assets / Average total equity A) Profitability ratio Solvency ratio B) Activity ratio Liquidity ratio C) Activity ratio Solvency ratio

Answer C. Revenue divided by average working capital, also known as the working capital turnover ratio, is an activity ratio. Average total assets divided by average total equity, also known as the financial leverage ratio, is a solvency ratio.

Portfolio A earned a return of 10.23% and had a standard deviation of returns of 6.22%. If the return over the same period on Treasury bills (T-bills) was 0.52% and the return to Treasury bonds (T-bonds) was 4.56%, what is the Sharpe ratio of the portfolio? A) 0.56. B) 0.91. C) 1.56.

Answer C. Sharpe ratio = (Rp - Rf) / σp, where (Rp - Rf) is the difference between the portfolio return and the risk free rate, and σp is the standard deviation of portfolio returns. Thus, the Sharpe ratio is: (10.23 - 0.52) / 6.22 = 1.56. Note, the T-bill rate is used for the risk free rate.

George Mote owns stock in IBM currently valued at $112 per share. Mote writes a call option on IBM with an exercise price of $120. The call option is sold for $1.80. At expiration, the price of IBM is $115. What is Mote's profit (or loss) from his covered call strategy? Mote: A) gained $3.00. B) lost $3.20. C) gained $4.80.

Answer C. Since the option is out-of-the-money at expiration (MAX (0, S - X)), the option is worthless. Also, the stock increased in value from $112 per share to $115 per share, creating a $3 gain. The $3 gain in the stock price is added to the $1.80 gain from writing the (unexercised) call option. Therefore, the total gain is $4.80 ($3 + $1.80).

An investment has a mean return of 15% and a standard deviation of returns equal to 10%. If returns are normally distributed, which of the following statements is least accurate? The probability of obtaining a return: A) greater than 35% is 0.025. B) between 5% and 25% is 0.68. C) greater than 25% is 0.32.

Answer C. Sixty-eight percent of all observations fall within +/- one standard deviation of the mean of a normal distribution. Given a mean of 15 and a standard deviation of 10, the probability of having an actual observation fall within one standard deviation, between 5 and 25, is 68%. The probability of an observation greater than 25 is half of the remaining 32%, or 16%. This is the same probability as an observation less than 5. Because 95% of all observations will fall within 20 of the mean, the probability of an actual observation being greater than 35 is half of the remaining 5%, or 2.5%.

A money manager, who is a member of CFA Institute, suggests during phone calls to his clients that, "I hope you will relay to your friends the great returns I earned for you this past year." The manager had generated above average returns in the past year. Is this a violation of Standard III(D), Performance Presentation? A) Not if it is true. B) Yes, because the intended message fails the test of completeness as required under the standard. C) Yes, because the Standard forbids members asking their clients to say anything about how well the member has done.

Answer C. Standard III(D) requires that members communicate performance in a fair, accurate, and complete fashion, and covers both written and oral communication. Asking someone to advertise only one year's performance is unlikely to be representative since this constitutes a timeframe that is too short.

Jill Marsh, CFA, works for Advisors where she manages various portfolios. Marsh's godfather is an accountant and has done Marsh's tax returns every year as a birthday gift. Marsh's godfather has recently become a client of Advisors and asked specifically for Marsh to manage his account. In order to comply Standard IV(B), Disclosure of Additional Compensation Arrangements, she needs to: A) have her godfather cease doing her taxes. B) liquidate from her personal portfolio any stocks her godfather owns and verbally tell her supervisor about the tax services. C) do neither of the actions listed here.

Answer C. Standard IV(B) requires that members disclose to their employer in writing all benefits that they receive in addition to their regular compensation for services they perform on behalf of their employer. It is not unreasonable for an individual's godfather to give them a birthday gift. Moreover, since the tax services were a regular birthday present before her godfather became a client, this implies that they are unrelated to any investment management services.

Tom will retire 20 years from today and has $34,346.74 in his retirement account. He believes he will need $40,000 at the beginning of each year for 20 years of retirement, with the first withdrawal on the day he retires. Tom assumes his investment account will return 7%. The amount he needs to deposit at the beginning of this year and each of the next 19 years is closest to: A) $7,800. B) $6,500. C) $7,300.

Answer C. Step 1: Calculate the amount needed at retirement at t = 20, with calculator in BGN mode. N = 20; FV = 0; I/Y = 7; PMT = 40,000; CPT PV = -453,423.81 Step 2: Calculate the required deposits at t = 0 to 19 to result in a time 20 value of 453,423.81. Remain in BGN mode so that the FV is indexed to one period after the final payment. PV = -34,346.74; N = 20; I/Y = 7; FV = 453,423.81; CPT PMT = -$7,306.77

Corcoran Corp acquired an asset on 1 January 2004, for $500,000. For financial reporting, Corcoran will depreciate the asset using the straight-line method over a 10-year period with no salvage value. For tax purposes the asset will be depreciated straight line for five years and Corcoran's effective tax rate is 30%. Corcoran's deferred tax liability for 2004 will: A) decrease by $15,000. B) decrease by $50,000. C) increase by $15,000.

Answer C. Straight-line depreciation per financial reports = 500,000 / 10 = $50,000 Tax depreciation = 500,000 / 5 = $100,000 Temporary difference = 100,000 − 50,000 = $50,000 Deferred tax liability will increase by $50,000 × 30% = $15,000

A traffic engineer is trying to measure the effects of carpool-only lanes on the expressway. Based on a sample of 1,000 cars at rush hour, he finds that the mean number of occupants per car is 2.5, with a standard deviation of 0.4. Assuming that the population is normally distributed, what is the confidence interval at the 5% significance level for the number of occupants per car? A) 2.288 to 2.712. B) 2.455 to 2.555. C) 2.475 to 2.525.

Answer C. The Z-score corresponding with a 5% significance level (95% confidence level) is 1.96. The confidence interval is equal to: 2.5 ± 1.96(0.4 / √1,000) = 2.475 to 2.525. (We can use Z-scores because the size of the sample is so large.)

If the null hypothesis is H0: ρ ≤ 0, what is the appropriate alternative hypothesis? A) Ha: ρ < 0. B) Ha: ρ ≠ 0. C) Ha: ρ > 0.

Answer C. The alternative hypothesis must include the possible outcomes the null does not.

The central limit theorem concerns the sampling distribution of the: A) population mean. B) sample standard deviation. C) sample mean.

Answer C. The central limit theorem tells us that for a population with a mean m and a finite variance σ^2, the sampling distribution of the sample means of all possible samples of size n will approach a normal distribution with a mean equal to μ and a variance equal to σ^2 / n as n gets large.

An analyst observes that the exchange rate for Mexican pesos is MXN/USD 8.0000, and the exchange rate for Polish zlotys is PLN/USD 6.0000. The MXN/PLN exchange rate is closest to: A) 14.0000. B) 0.7500. C) 1.3333.

Answer C. The cross rate of MXN/PLN is (MXN/USD 8) / (PLN/USD 6) = 1.3333 MXN/PLN.

The increase in total revenue from selling the additional output of one more unit of an input is called the input's: A) factor of production. B) marginal revenue. C) marginal revenue product.

Answer C. The marginal revenue product of an input is the addition to total revenue gained by selling the additional output from employing one more unit of that input.

Bond X and Bond Y have the same par value, coupon, maturity, and credit rating, but Bond X trades at a higher price than Bond Y. A possible reason for this difference is that: A) Bond X has a higher expected loss in a default. B) Bond Y has a higher expected recovery rate in a default. C) the market expects a downgrade to Bond Y's credit rating.

Answer C. The market price difference can be accounted for by a lag in the bonds' credit rating behind the market's assessment of their creditworthiness. The bond market may be expecting a downgrade of Bond Y or an upgrade of Bond X. Bond X would have a lower price than Bond Y if it had a higher expected loss. Bond Y would have a higher price than Bond X if it had a higher expected recovery rate.

The statement, "Stock prices fully reflect all information from public and private sources," can be attributed to which form of the efficient market hypothesis (EMH)? A) Semistrong-form EMH. B) Weak-form EMH. C) Strong-form EMH.

Answer C. This is the definition of the strong-form EMH. Private sources include insider information, such as persons holding monopolistic access to information relevant to the formation of prices.

If a firm is going to create three teams of four from twelve employees. Which approach is the most appropriate for determining how the twelve employees can be selected for the three teams? A) Permutation formula. B) Combination formula. C) Labeling formula.

Answer C. This problem is a labeling problem where the 12 employees will be assigned one of three labels. It requires the labeling formula. In this case there are [(12!) / (4!4!4!)] = 34,650 ways to group the employees.

An analyst is asked to calculate standard deviation using monthly returns over the last five years. These data are best described as: A) systematic sampling data. B) cross-sectional data. C) time series data.

Answer C. Time series data are taken at equally spaced intervals, such as monthly, quarterly, or annual. Cross sectional data are taken at a single point in time. An example of cross-sectional data is dividend yields on 500 stocks as of the end of a year.

Which of the following statements about risk is NOT correct? A) Unsystematic risk is diversifiable risk. B) The market portfolio consists only of systematic risk. C) Total risk = systematic risk - unsystematic risk.

Answer C. Total risk = systematic risk + unsystematic risk

Under the expenditure approach, gross domestic product is the sum of: A) wages and benefits, corporate profits, interest income, unincorporated business owners' income, rent, and indirect business taxes less subsidies. B) national income and transfer payments to households, less corporate and indirect business taxes and undistributed corporate profits. C) consumption spending, gross private domestic investment, government spending, and net exports.

Answer C. Under the expenditure approach, GDP is the sum of consumption, investment, government spending, and net exports. National income is the sum of wages and benefits, corporate profits, interest income, unincorporated business owners' income, rent, and indirect business taxes less subsidies. Personal income is the sum of national income and transfer payments to households, less corporate and indirect business taxes and undistributed corporate profits.

When a firm operates under conditions of perfect competition, marginal revenue always equals: A) total cost. B) average variable cost. C) price.

Answer C. When a firm operates under conditions of perfect competition, marginal revenue always equals price. This is because, in perfect competition, price is constant (a horizontal line) so that marginal revenue is constant.

A firm that invests the majority of a portfolio to track a benchmark index, and uses active investment strategies for the remaining portion, is said to be using: A) strategic asset allocation. B) risk budgeting. C) a core-satellite approach.

Answer C. With a core-satellite approach, a firm invests the majority of a portfolio passively and uses active strategies for the remaining portion. Strategic asset allocation refers to specifying the percentages of a portfolio's value to allocate to specific asset classes. Risk budgeting refers to allocating a portfolio's overall permitted risk among strategic asset allocation, tactical asset allocation, and security selection.

A company with a return on equity (ROE) of 27%, required return on equity (ke) of 20%, and a dividend payout ratio of 40% has an implied sustainable growth rate closest to: A) 12.00%. B) 10.80%. C) 16.20%.

Answer C. g = (RR)(ROE) = (.60)(.27) = 0.162 or 16.2%

A firm will not pay dividends until four years from now. Starting in year four dividends will be $2.20 per share, the retention ratio will be 40%, and ROE will be 15%. If k = 10%, what should be the value of the stock? A) $55.25. B) $58.89. C) $41.32.

Answer C. g = ROE × retention ratio = ROE × b = 15 × 0.4 = 6% Based on the growth rate we can calculate the expected price in year 3: P3 = D4 / (k − g) = 2.2 / (0.10 − 0.06) = $55 The stock value today is: P0 = PV (55) at 10% for 3 periods = $41.32

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