CFA Set 2

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

A) -$5. CFF = 25(Sale of Stock) − 30(Div Paid) = -$5

Which of the following statements regarding finance and operating leases is least accurate? A) For financial reporting of finance and operating leases, no entry is required on the lessee's balance sheet at the inception of the lease. B) Asset turnover is higher for the lessee with an operating lease than a finance lease. C) During the life of an operating lease, the rent expense equals the lease payment.

A) For financial reporting of finance and operating leases, no entry is required on the lessee's balance sheet at the inception of the lease. If the lease is an operating lease there is no entry made on the balance sheet for the lessee. For finance leases, the leased asset and liability are recognized on the balance sheet by the amount equal to the present value of the minimum lease payments using as the discount rate the lower of the lessor's implicit rate or the lessee's incremental borrowing rate.

The tendency for currency depreciation to increase a country's trade deficit in the short run is known as the: A) J-curve effect. B) absorption effect. C) Marshall-Lerner effect.

A) J-curve effect. The J-curve refers to a graph of the effect of currency depreciation on the trade balance over time. In the short run, a trade deficit may increase because current import and export contracts may be fixed in foreign currency units over the near term, and only reflect the exchange rate change over time. In the long run, currency depreciation should decrease a trade deficit.

Which of the following statements about the elements of financial statements under the FASB and IASB frameworks is least accurate? A) The IASB framework does not allow the values of assets to be adjusted upward. B) The word "probable" is used by the FASB to define assets and liabilities. C) The IASB framework lists income and expenses as the elements related to performance.

A) The IASB framework does not allow the values of assets to be adjusted upward. Differences in financial statement elements include: (1) The IASB framework lists income and expenses as the elements related to performance, while the FASB framework uses revenues, expenses, gains, losses, and comprehensive income. (2) FASB defines an asset as a future economic benefit, where IASB defines it as a resource from which a future economic benefit is expected. (3) The word "probable" is used by the FASB to define assets and liabilities. (4) The FASB framework does not allow the values of most assets to be adjusted upward.

If we fail to reject the null hypothesis when it is false, what type of error has occured? A) Type II. B) Type III. C) Type I.

A) Type II. A Type II error is defined as failing to reject the null hypothesis when it is actually false.

Discretionary fiscal policy refers to: A) active decisions regarding spending and taxing to affect economic growth. B) built-in devices that counteract the business cycle phase. C) increasing aggregate demand through lower interest rates.

A) active decisions regarding spending and taxing to affect economic growth. Discretionary fiscal policy, in contrast to automatic stabilizers, refers to active decisions by the government to affect economic growth through changes in government spending and taxation. Increasing aggregate demand through lower interest rates describes expansionary monetary policy.

A private equity provision that requires managers to return any periodic incentive fees resulting in investors receiving less than 80% of profits is a: A) clawback. B) high water mark. C) drawdown.

A) clawback. A clawback provision requires the manager to return any periodic incentive fees to investors that would result in investors receiving less than 80% of the profits generated by portfolio investments as a whole.

The main difference between the current ratio and the quick ratio is that the quick ratio excludes: A) inventory. B) cost of goods sold. C) assets.

A) inventory. Current ratio = (current assets / current liabilities) = [cash + marketable securities + receivables + inventory] / current liabilities Quick ratio = [cash + marketable securities + receivables] / current liabilities

As compared to an equivalent nonputable bond, a putable bond's yield should be: A) lower. B) higher. C) the same.

A) lower. A putable bond favors the buyer (investor). Hence, a premium will be paid for the option, which means the yield will be lower.

Which of the following is a component of the Code of Ethics? CFA Institute members shall: A) strive to maintain and improve their competence and the competence of others in the profession. B) disclose to their employer all matters that reasonably could be expected to interfere with their duty to their employer or ability to make unbiased and objective recommendations. C) make reasonable efforts to detect and prevent violations by those who are under their supervision.

A) strive to maintain and improve their competence and the competence of others in the profession. Striving to maintain and improve their competence and the competence of others in the profession is one of the components of the Code of Ethics, whereas the other statements are part of the Standards of Professional Conduct.

Which of the following financial ratios is least likely to be affected by classification of deferred taxes as a liability or equity? A) Debt-to-total assets. B) Return on assets (ROA). C) Return on equity (ROE).

B) Return on assets (ROA). The ROA will not be affected by the classification of the deferred taxes. The total assets will remain the same regardless of whether the deferred taxes are classified as a liability or equity.

Which of the following statements about counting methods is least accurate? A) The labeling formula determines the number of different ways to assign a given number of different labels to a set of objects. B) The combination formula determines the number of different ways a group of objects can be drawn in a specific order from a larger sized group of objects. C) The multiplication rule of counting is used to determine the number of different ways to choose one object from each of two or more groups.

B) The combination formula determines the number of different ways a group of objects can be drawn in a specific order from a larger sized group of objects. The permutation formula is used to find the number of possible ways to draw r objects from a set of n objects when the order in which the objects are drawn matters. The combination formula ("n choose r") is used to find the number of possible ways to draw r objects from a set of n objects when order is not important. The other statements are accurate.

The demand curves faced by monopolistic competitors is: A) not sensitive to price due to absence of close substitutes. B) elastic due to the availability of many close substitutes. C) inelastic due to the availability of many complementary goods.

B) elastic due to the availability of many close substitutes. The demand for products from monopolistic competitors is elastic due to the availability of many close substitutes. If a firm increases its product price, it will lose customers to firms selling substitute products.

For impaired long-lived assets, a firm reporting under IFRS is least likely required to disclose the: A) amounts of impairment losses and reversals by asset class. B) estimated probabilities of reversing impairment losses. C) circumstances that caused the impairment losses or reversals.

B) estimated probabilities of reversing impairment losses. Under IFRS, firms with impaired assets must disclose the amounts of impairment losses and reversals by asset class, the circumstances that caused the impairment losses or reversals, and where the losses or reversals are recognized on the income statement.

A mortgage that includes some repayment of principal in each payment, and has an outstanding principal balance at maturity, is most accurately described as a: A) rollover mortgage. B) partially amortizing mortgage. C) hybrid mortgage.

B) partially amortizing mortgage. A partially amortizing mortgage includes some amount of principal in each payment but still has an outstanding principal balance at maturity. A hybrid mortgage becomes an adjustable-rate mortgage after an initial fixed-rate period. A rollover mortgage changes from one fixed rate to another during its life.

Scott Marsh is a research analyst for a brokerage firm following the computer industry. Joe Perry is Marsh's former college roommate and is the head of technology for Mercury, a large software company. Perry informs Marsh on Tuesday that in two days the company will be making an official announcement that its release of its newest version of its software will be moved up one month, from October 1 to September 1. The announcement will be surprising to the industry and will likely be met with skepticism because the company has had trouble meeting release dates in the past. Perry assures Marsh that he is certain that they will meet the September 1 date. Marsh considers Perry to be very honest and highly competent. Marsh should: A) immediately put out a report recommending the stock, but waiting until the official announcement to state his reasons. B) wait until the public announcement is made, then release a report explaining that he believes the company will make the release date, disclosing that one of the reasons for his opinion is Perry is a friend of his. C) produce his research report in two days based solely on the official announcement, not taking into consideration the information from Perry.

B) wait until the public announcement is made, then release a report explaining that he believes the company will make the release date, disclosing that one of the reasons for his opinion is Perry is a friend of his. The research report cannot be released until the official announcement is made, otherwise he will be violating the Standard on prohibition against the use of material nonpublic information. Once it is made public, Marsh can disclose the nature of the conversation without violating that Standard because the information will now be public. However, he should disclose the relationship with Perry or he will be violating the Standard on communications with clients and prospective clients.

Allcans, an aluminum producer, needs to issue some debt to finance expansion plans, but wants to hedge its bond interest payments against fluctuations in aluminum prices. Jerrod Price, the company's investment banker, suggests a commodity index floater. This type of bond is least likely to provide which of the following advantages? A) Payment structure helps protect Allcan's credit rating. B) The bond's coupon rate is linked to the price of aluminum. C) Allows Allcans to set coupon payments based on business results.

C) Allows Allcans to set coupon payments based on business results. The coupon rate is set in the bond agreement (indenture) and cannot be changed unilaterally. Non-interest rate indexed floaters are indexed to a commodity price such as oil or aluminum. Business results could be impacted by numerous factors other than aluminum prices. Both of the other choices are true. By linking the coupon payments directly to the price of aluminum (meaning that when aluminum prices increase, the coupon rate increases and vice versa), the non-interest index floater allows Allcans to protect its credit rating during adverse circumstances.

Which component of traditional credit analysis includes evaluation of industry structure, industry fundamentals, and company fundamentals? A) Collateral. B) Covenants. C) Capacity.

C) Capacity. Analyzing a corporate borrower's capacity to repay its debt obligations is similar to the top-down process used in equity analysis. Collateral analysis is evaluating the issuer's assets. Analyzing covenants involves reviewing the terms and conditions of lending agreements.

Which of the following statements regarding the risks inherent in bonds is most accurate? A) The reinvestment rate assumption in calculating bond yields is generally not significant to the bond's yield. B) Interest rate risk is the risk that the coupon rate will be adjusted downward if market rates decline. C) Default risk deals with the likelihood that the issuer will fail to meet its obligations as specified in the indenture.

C) Default risk deals with the likelihood that the issuer will fail to meet its obligations as specified in the indenture. Reinvestment is crucial to bond yield, and interest rate risk is the risk of changes in a bondholder's return due to changes in a bond's yield.

Barracuda Corporation, a U.S. corporation, owns a subsidiary located in Germany. The German subsidiary's financial statements are maintained in euros. If the euro recently appreciated relative to the U.S. dollar, how would the unrealized translation gain affect Barracuda's retained earnings and total stockholders' equity? Retained earnings Total stockholders' equity A) No effect No effect B) Increase Increase C) No effect Increase

C) No effect Increase Unrealized foreign currency translation gains and losses are not reported in the income statement; thus, retained earnings are unaffected. However, unrealized foreign currency gains and losses are included in comprehensive income. Comprehensive income includes all changes in equity except those that result from transactions with shareholders. So, the translation gain increases stockholders' equity by increasing comprehensive income.

Consider three municipal bonds issued by the Greater Holmen Metropolitan Capital Improvement District, a local authority that carries an issuer rating of single-A from the major debt rating agencies. All three bonds have the same coupon rate and maturity date. •Series W was issued to finance the rebuilding and expansion of local schools and is backed by the District's authority to levy property tax. •Series X was issued to build a water purification plant for the region. The District charges fees to the surrounding municipalities for their use of the plant. These fees are the only source of the interest and principal payments on the bonds. •Series Y was issued to raise funds for the general use of the District in its ordinary maintenance projects and is backed by the District's authority to levy property tax. These bonds carry a third party guarantee of principal and interest payments. What is most likely the order of the market yields on these three bond issues, from highest to lowest? A) Series X, Series Y, Series W. B) Series Y, Series W, Series X. C) Series X, Series W, Series Y.

C) Series X, Series W, Series Y. Series X is a revenue bond. Because they pay interest and principal only if revenues from the project they finance are sufficient, revenue bonds are typically riskier and therefore have higher market yields than general obligation bonds. Series Y is an insured bond. Municipal bond insurance typically results in a higher rating, and therefore a lower market yield, than an equivalent bond from the same municipal issuer. So of these three bonds, Series X should have the highest market yield and Series Y the lowest.

If the price elasticity of a linear demand curve is −1 at the current price, an increase in price will lead to: A) no change in total revenue. B) an increase in total revenue. C) a decrease in total revenue.

C) a decrease in total revenue. On a linear demand curve, demand is elastic at prices above the point of unitary elasticity, so a price increase will decrease total revenue.

In a study seminar, the following comments were made: Comment 1: "In the short run, an increase in demand in a perfectly competitive industry will result in negative economic profit for some firms in the industry." Comment 2: "In the long run, a permanent increase in demand in a perfectly competitive industry will result in zero economic profit for the firms in the industry." With respect to these comments: A) both are correct. B) both are incorrect. C) only one is correct.

C) only one is correct. Comment 1 is incorrect because an increase in industry demand will increase equilibrium price and output. At the higher price, firms will earn positive economic profits in the short run because the higher price will exceed average total cost. Over the long run, however, new firms will enter the market to exploit the positive economic profits, causing prices to decline until all firms are again earning zero economic profit.

The least appropriate security for investing short-term excess cash balances would be: A) time deposits. B) bank certificates of deposit. C) preferred stock.

C) preferred stock. While adjustable-rate preferred is an appropriate security for short-term investment of excess cash balances, other preferred shares are not. Bank certificates of deposit and time deposits can be for appropriately short periods.

Which of the following best describes a firm with low operating leverage? A large change in: A) earnings before interest and taxes result in a small change in net income. B) sales result in a small change in net income. C) the number of units a firm produces and sells result in a similar change in the firm's earnings before interest and taxes.

C) the number of units a firm produces and sells result in a similar change in the firm's earnings before interest and taxes. Operating leverage is the result of a greater proportion of fixed costs compared to variable costs in a firm's capital structure and is characterized by the sensitivity in operating income (earnings before interest and taxes) to change in sales. A firm that has equal changes in sales and operating income would have low operating leverage (the least it can be is one). Note that the relationship between operating income and net income is impacted by the degree of financial leverage, and the relationship between sales and net income is impacted by the degree of total leverage.