Mock Exam 2 (No Calculator)

Which of the following statements about the central limit theorem is least accurate? A:The central limit theorem has limited usefulness for skewed distributions. B: The mean of the population and the mean of all possible sample means are equal. C: When the sample size is large, the sampling distribution of the sample means is approximately normal.

A - The central limit theorem holds for any distribution as long as the sample size is large (i.e., n > 30). (Module 5.1, LOS 5.d)

A perfectly elastic aggregate supply curve represents: A: the productive capacity of an economy at full employment. B: the production decisions of firms only in the very short run. C: the short-run relationship between output and the price level.

B - The very short run aggregate supply curve is perfectly elastic because firms can adjust output by increasing or decreasing labor hours and capacity use without affecting input prices. The short-run aggregate supply curve is upward sloping. The long-run aggregate supply curve is perfectly inelastic and represents potential GDP, the full-employment output level of an economy. (Module 10.2, LOS 10.g)

Weights to be used in calculating a company's weighted average cost of capital are least appropriately based on: A: information from the company about its target capital structure. B: the average capital structure weights for companies of a similar size. C: the average capital structure weights for companies in the same industry.

B - The weights used to calculate WACC should be based on the firm's target capital structure. If the company does not provide information about its target capital structure, an analyst can use the company's current capital structure or the average capital structure weights for the industry. Similar size is not enough for the average weights for other companies to be relevant if those companies are not in the same industry. (Module 34.2, LOS 34.d)

In the context of geopolitical risk, thematic risks are most accurately described as having low: A: impact. B: velocity. C: likelihood.

B - Thematic risks are known factors that have long-term (i.e., low-velocity) effects. (Module 13.1, LOS 13.d)

To derive the cost of equity for a thinly traded public company, Paul Dufray is estimating an asset beta for a comparable firm. In addition to the beta of the comparable firm, Dufray will need to estimate its: A: sales risk and financial risk. B: debt-to-equity ratio and tax rate. C: operating leverage and financial leverage.

B - To calculate the asset beta, the analyst will need to estimate the firm's beta, its debt-to-equity ratio, and its tax rate. (Module 33.2, LOS 33.f)

Depreciation of a country's currency will be more effective in reducing its trade deficit if its: A: imports do not have good substitutes. B: exports are primarily luxury goods. C: exports represent a small portion of foreign consumer expenditures.

B - Under the elasticities approach, a currency depreciation will lead to a greater reduction in a trade deficit when export demand and/or import demand are more elastic. The demand for luxury goods is relatively elastic, while the demand for goods without good substitutes or for goods that represent only a small portion of consumer expenditures is relatively inelastic. (Module 15.3, LOS 15.j)

Which of the following statements about the analysis of cash flows is least accurate? A: Interest payments on debt are not a financing cash flow under U.S. GAAP. B: Both the direct and indirect methods involve adding back noncash items such as depreciation and amortization. C: When using the indirect method, an analyst should add any losses on the sales of fixed assets to net income.

B - When using the direct method of calculating operating cash flows, depreciation and amortization are not "added back" (to net income) because we don't begin with net income under the direct method. Depreciation and amortization are noncash changes and are not used under the direct method. The other statements are true. Interest payments on debt affect cash flow from operations. When using the indirect method, an analyst should add any losses on sales of fixed assets to net income since they are not operating cash flows. (Module 20.2, LOS 20.f)

From a liquidity management perspective, an increase in the number of days of payables is best described as: A: liquidity neutral. B: a pull on liquidity. C: a source of liquidity.

C - An increase in the number of days of payables suggests a company is taking longer to pay its vendors. This reduces the cash conversion cycle and represents effective working capital management, a source of liquidity for a company. A decrease in days of payables would be a pull on liquidity because the company is paying its vendors more quickly, which uses cash. (Module 32.1, LOS 32.c)

A security's beta is best estimated by the slope of: A: the capital market line. B: the security market line. C: the security's characteristic line.

C - Beta, a measure of systematic risk, can be estimated as the slope coefficient from a regression based on the market model, Ri = α + βi (Rmkt - Rf). This regression line is the security's characteristic line. (Module 63.1, LOS 63.e)

An analyst who is interested in the core inflation rate should most appropriately examine a price index: A: for wholesale goods. B: that uses hedonic pricing. C: that excludes food and energy.

C - Core inflation refers to prices excluding food and energy, which tend to exhibit higher price volatility than most other goods and services. Hedonic pricing refers to adjusting a price index for improvements in the quality of goods. (Module 11.2, LOS 11.i)

Which of the following sources of information should an analyst consider the least reliable? A: Form 10-Q. B: Proxy statement. C: Corporate press release.

C - Corporate press releases are written by management and are often viewed as public relations or sales materials because of the great possibility of inherent management bias in such documents. Often, little or none of the material is independently reviewed by outside auditors. Such documents are not mandated by the securities regulators. Form 10-Q (quarterly financial statements) and proxy statements are mandatory SEC filings in the United States, which inherently increases their reliability given the penalties that can be imposed by the SEC if any serious irregularities are subsequently found. (Module 16.2, LOS 16.e)

Unlike members of free trade areas, customs union members: A: adopt a single currency. B: remove barriers to trade with all members. C: adopt uniform trade restrictions with non-members.

C - Customs unions adopt uniform trade restrictions with non-members. Customs union members do not adopt a single currency. Both free trade areas and customs unions remove trade barriers among their members. (Module 14.2, LOS 14.f)

A natural monopoly is most likely to exist when: A: economies of scale are great. B: average total cost increases as output increases. C: a single firm owns essentially all of a productive resource.

A - A natural monopoly may exist when economies of scale are great. The large economies of scale mean that a single producer results in the lowest production costs. (Module 9.4, LOS 9.b)

Given the following correlation matrix, a risk-averse investor would least prefer which of the following 2-stock portfolios (all else equal)? W+1 X-0.2+1 Y+0.6-0.1+1 Z+0.8-0.3+0.5+1 A: W and Y. B: X and Y. C: X and Z.

A - A risk-averse investor prefers less risk to more risk. The lower the correlation, the greater the risk reduction. Thus, a risk-averse investor would most prefer the portfolio with the lowest correlation coefficient and least prefer the one with the highest. Of the choices given, W and Y's correlation coefficient of +0.6 is the highest. (Module 62.4, LOS 62.h)

Forman, Inc., and Swoft, Inc., both operate within the same industry. Forman's stated strategy is to differentiate its premium products relative to its competitors, while Swoft is a low-cost producer. Given the companies' stated strategies, Forman most likely has: A: higher gross margins relative to Swoft. B: lower advertising expenses relative to Swoft. C: lower research and development expenses relative to Swoft.

A - An analyst can use the historical trend in a firm's financial ratios as well as an industry relative comparison to assess the firm's business strategy. A firm producing premium products with a strategy of differentiation should have higher gross margins, higher advertising expenses, and higher research and development expenses relative to firms in its industry that pursue a low-cost-of-production strategy. (Module 27.1, LOS 27.a)

A company is most likely to have a high proportion of equity in its capital structure if the company exhibits: A: high operating risk. B: a low but stable growth rate of cash flows. C: assets that are primarily marketable securities.

A - Companies with a high degree of operating risk tend to have highly variable operating cash flows, making them less able to service debt compared to companies with less operating risk. Stable cash flows and high proportions of liquid assets typically enable companies to service a higher proportion of debt in their capital structures. (Module 34.1, LOS 34.a)

Two growing firms are identical except that Alfred Company capitalizes costs for some long-lived assets that Canute Company expenses. Alfred is most likely to show higher: A: net income than Canute. B: working capital than Canute. C: investing cash flow than Canute.

A - For growing firms, capitalizing results in higher net income compared to expensing. A capitalizing company classifies the costs of the capitalized assets as CFI outflows, while a company that expenses these costs classifies them as CFO outflows. Thus, Alfred's CFO will be higher and his CFI will be lower than Canute's. Working capital is unaffected by the decision to capitalize or expense because the decision does not affect current assets or current liabilities. (Module 23.1, LOS 23.c)

Scott Houser, CFA, is a widely known equity analyst whose recommendations often influence share prices. Houser changes his recommendation to "Sell" on Drywall Company and distributes this recommendation only to his clients, many of whom act on the recommendation before it becomes known to the public. Has Houser violated the Code and Standards? (Module 71.3, LOS 71.b) A: No. B: Yes, he has violated the Standard concerning communications with clients. C: Yes, he has violated the Standard concerning material nonpublic information.

A - Houser has not violated the Code and Standards. Guidance for Standard II(A) Material Nonpublic Information states that an analyst does not need to make his recommendations public just because investors would want to know about them, and is free to issue recommendations only to his clients. The guideline about what makes information material (i.e., investors would want to have the information before making an investment decision) applies to nonpublic information from the issuer of a security. An analyst covering the security, however, is not an insider with the issuing firm.(Module 71.3, LOS 71.b)

Investing in a project that will help achieve a particular social or environmental objective is most accurately described as an example of: A: impact investing. B: positive screening. C: responsible investing.

A - Impact investing refers to promoting a specific social or environmental goal through investment actions, which may include investing in a particular project. Positive screening refers to identifying companies with best practices regarding environmental, social, or governance for consideration when investing. Responsible investing refers to integrating social or environmental considerations in general into investment decisions. (Module 29.2, LOS 29.e

The two primary assumptions in preparing financial statements under IFRS are: A: accrual accounting and going concern. B: reasonable accuracy and accrual accounting. C: going concern and reasonable accuracy.

A - In the IFRS framework, the two assumptions that underlie the preparation of financial statements are accrual accounting and the going concern assumption. (Module 17.2, LOS 17.c)

An advantage of the Herfindahl-Hirschman Index (HHI) over the N-firm concentration ratio as a summary measure of the market structure of an industry is that the HHI is more sensitive to: A: mergers. B: barriers to entry. C: elasticity of demand.

A - The HHI is more sensitive to the effects of mergers compared to the N-firm concentration ratio. Neither measure accounts for elasticity of demand or barriers to entry. (Module 9.4, LOS 9.g)

Campbell Hill, CFA, has recently accepted the position of Chief Compliance Officer at an investment management firm. Hill distributes a memo stating that effective immediately (1) material supporting all company research reports will be kept in the company database in electronic form for 10 years, and hard copies of the same material will be maintained for one year only, and (2) hard copy records of all trade confirmations sent to clients must be kept on file for five years, the period mandated by local regulations. With respect to record retention: A: neither of Hill's policies violates the Standards. B: Hill's policies regarding both research reports and trade confirmations violate the Standards. C: Hill's policy regarding research reports does not violate the Standards, but the policy regarding trade confirmations does.

A - In the absence of regulatory requirements, Standard V(C) Record Retention recommends maintaining records supporting investment recommendations and actions and records of investment-related communications with clients for at least seven years. Here, there is regulatory guidance, and seven years is a recommendation, not a requirement, in any case. Records can be maintained in electronic or hard copy format. (Module 71.7, LOS 71.b)

Ronald Rice, CFA, is the investment manager for a trust established for Selma Ross's mother. Ross selected Rice after interviewing several potential managers. From time to time, Ross calls Rice and asks him to purchase or sell shares in specific firms. Rice routinely complies with these requests without determining suitability for the trust. By doing so, Rice has most likely: A: violated the Standard concerning loyalty, prudence, and care. B: violated the Standard concerning independence and objectivity. C: not violated the Code and Standards because he has followed the client's request.

A - In the case of trusts or endowments, the member must be aware that his fiduciary responsibility is not necessarily to the client (who hired him) but to the beneficiaries of the investment account. By routinely executing trades directed by Ross without making a determination that the securities transactions are consistent with the investment goals and constraints of Ross's mother, the account beneficiary, Ross has violated Standard III(A) Loyalty, Prudence, and Care. Ross has likely also violated other Standards (e.g., Standard III(C) Suitability and Standard V(A) Diligence and Reasonable Basis). Standard I(B) Independence and Objectivity deals primarily with conflicts resulting from gifts, compensation, or benefits that may compromise the member's independence and objectivity. (Module 73.1, LOS 73.b)

The country of Colfax can produce 15 units of rice or 10 units of plastic per day of labor. The country of Birklund can produce 18 units of rice or 12 units of plastic per day of labor. With regard to potential benefits of trading rice and plastic between Colfax and Birklund: A: there are no potential gains from trade. B: Colfax should produce and trade rice for Birklund's plastic. C: Birklund should produce and trade rice for Colfax's plastic.

A - In this case, there are no clear potential benefits from trade because the countries' opportunity costs of production are equal. Colfax's opportunity cost of rice = 10 / 15 = 0.67 units of plastic, and Birklund's opportunity cost of rice = 12 / 18 = 0.67 units of plastic. Colfax's opportunity cost of plastic = 15 / 10 = 1.5 units of rice, and Birklund's opportunity cost of plastic = 18 / 12 = 1.5 units of rice. (Module 14.1, LOS 14.c)

Joseph Drake, CFA, an investment advisor at Best Wealth Managers, has identified a growth stock that he believes has the potential to provide excellent returns over the next five years. He includes this stock on a "recommended list" that he sends to all of his clients. Drake includes recent earnings, his estimates of future earnings, and a note that more information is available on request. Drake has: A: not violated the Standards. B: violated the Standard on suitability. C: violated the Standard on client communications.

A - It is not a violation of the Standards to present a recommended list of securities, some of which may not be suitable for some clients. It is permitted to present investment recommendations in capsule form as long as clients are informed that more information about the securities is available on request. (Module 71.7, LOS 71.b)

Paul James, CFA, a retail stock broker, notices that one client in particular, Chet Young, Ph.D., is especially adept at picking stocks. James decides to replicate Young's trades in his own account after he enters them. By doing so, James: A: is not in violation of any Standards. B: is in violation of the Standard on priority of transactions because he is front running the client's account. C: is in violation of the Standard on misconduct because he has misappropriated confidential client information.

A - James is not in violation of the Standards. To comply with Standard VI(B) Priority of Transactions, members and candidates must give transactions for clients and employers priority over their personal transactions. In this instance, James did not adversely affect the client's interest because the client's trades were executed before James copied them. He has not acted fraudulently or deceitfully and, thus, has not violated Standard I(D) Misconduct. (Module 71.8, LOS 71.b)

A low inventory turnover ratio in a period of declining revenue growth is most likely an indication that a firm may have: A: obsolete inventory. B: too little inventory. C: efficient inventory management.

A - Low inventory turnover and declining revenue growth may be signs that a firm has obsolete or slow-moving inventory. High turnover and low revenue growth may indicate too little inventory, while high turnover and high revenue growth may indicate efficient inventory management. (Module 22.5, LOS 22.l)

Marie Marshall, CFA, charges clients a management fee and commissions on securities transactions. Marshall receives an annual bonus based on the overall success of the firm and a quarterly bonus based on the trading volume in her clients' accounts. If Marshall does not tell clients about her compensation package, she is violating the Standard concerning: A: disclosure of conflicts. B: communication with clients. C: additional compensation arrangements.

A - Marshall has an obligation to disclose that she receives special compensation based on the amount of client trading volume. Standard VI(A) Disclosure of Conflicts requires members to disclose to clients and prospects all matters that could potentially impair the member's ability to make investment decisions that are (and to give investment advice that is) objective and unbiased. The Standard on communications with clients addresses issues that involve clearly communicating investment recommendations and analysis. The Standard on additional compensation arrangements is concerned with accepting benefits that may create a conflict between a member's interests and her employer's interests. (Module 73.1, LOS 73.b)

Fred Reilly, CFA, is an investment advisor. Roger Harrison, a long-term client of Reilly, decides to move his accounts to a new firm. In his review of Harrison's account history, Reilly discovers some transfers of funds from the account of Harrison's company that Reilly suspects were illegal. Which of the following actions is most appropriate for Reilly to take under the Standards? A: Discuss his suspicions with outside counsel. B: Inform Harrison's company of the suspected illegal activities because Harrison is no longer a client. C: Do nothing because he must maintain the confidentiality of client information even after the client has left the firm.

A - Of the choices given, seeking the advice of outside counsel about what actions Reilly may be required to take is the most appropriate. Under Standard III(E) Preservation of Confidentiality, members and candidates should maintain the confidentiality of information received in the course of their professional service relating to both current and former clients. In the case of illegal activity, however, Reilly may have a legal obligation to report the activity or, on the other hand, may have a legal obligation to maintain the client's confidentiality even if he suspects illegal activity. (Module 73.1, LOS 73.b)

Which of the following is most likely an advantage of using IRR to evaluate a project, compared to using the project's net present value? An IRR: A: is a percentage return. B: can accommodate irregular cash inflows and outflows. C: is useful for ranking projects with equal initial outlays.

A - One advantage claimed for IRR is that because it is a percentage return, it is easier for non-financial managers to understand and compare to the company's cost of capital. (Module 31.2, LOS 31.c)

The ratio of operating cash flow to net income is most likely to indicate low quality of earnings when it is: A: less than one. B: highly variable. C: increasing over time.

A - Operating cash flow that is less than net income (ratio less than one) or declining over time may indicate low-quality earnings from aggressive accounting or accounting irregularities. A ratio of operating cash flow to net income that is highly variable, but consistently greater than one, is not necessarily indicative of low-quality earnings. (Module 26.3, LOS 26.i)

Kim Vance, CFA, tells a prospective client, "Over the three years I have been in the business, my equity-oriented accounts have had a mean return of more than 20% a year." The statement is accurate, but the mean return was influenced by the account of one client realizing a large gain on a position in a small-cap company he took based on his own research. Without this account, the average gain would have been 18% per year. Has Vance violated CFA Institute Standards of Professional Conduct? A: Yes, because the statement misrepresents Vance's performance. B: Yes, because returns for an equities composite must be asset- weighted. C: No, because it is accurate and Vance has not guaranteed such returns in the future.

A - Standard III(D) Performance Presentation requires that statements about performance be not only accurate but also fair and complete. While Vance's statement may be accurate in a technical sense, it is neither fair nor complete, and it seems intended to mislead prospects about Vance's past performance in managing equities accounts or selecting equity securities [and, thus, also likely violates Standard I(C) Misrepresentation]. While compliance with GIPS and its methods of composite construction and calculation are recommended, they are not required by the Standards. (Module 71.5, LOS 71.b)

Justin Matthews, CFA, is chief financial officer of a bank and serves on the bank's investment committee. The majority of the committee has voted to invest in medium-term euro debt. Matthews feels very strongly that this is a poor strategy and that trends in both the exchange rate and in euro interest rates over the next year will result in large losses on the position. According to the Code and Standards, Matthews should most appropriately: A: document his difference of opinion with the committee. B: express his concerns to the bank's chief executive officer directly. C: dissociate from the recommendation by asking that his name not be included.

A - Standard V(A) Diligence and Reasonable Basis states that if a consensus opinion has a reasonable basis, a member or candidate who disagrees with it does not have to dissociate from it but should document the difference of opinion. (Module 71.7, LOS 71.b)

Charmaine Townsend, CFA, has been managing equity portfolios for clients using a model that identifies growth companies selling at reasonable multiples. With economic growth slowing for the foreseeable future, she has decided to change to a securities selection model that emphasizes dividend income and low valuation. To comply with the Code and Standards, Townsend should most appropriately: A: promptly notify her clients of the change. B: get written permission from her clients prior to the change. C: get written acknowledgment of the change from her clients within a reasonable period of time after the change is made.

A - Standard V(B) Communication with Clients and Prospective Clients requires prompt disclosure of any change that might significantly affect the manager's investment processes. The disclosure need not be in writing. (Module 71.7, LOS 71.b)

Which of the following is most appropriately termed an emotional bias? A: Status quo bias. B: Mental accounting bias. C: Anchoring and adjustment bias.

A - Status quo bias, irrational resistance to change due to comfort with an existing situation, is a type of emotional bias. The other two choices are examples of cognitive bias. (Module 65.1, LOS 65.b)

Charlotte Stein, a CFA candidate, received a copy of a stock selection model designed by a Wall Street analyst friend, who told her she was free to use it. After reviewing the program and making some adjustments, Stein shows the new model to her supervisor. Her supervisor says she did a great job and tells Stein to incorporate the new model in her next industry review. Stein has: A: violated the Standard concerning misrepresentation. B: violated the Standard concerning conflicts of interest. C: not violated CFA Institute Standards of Professional Conduct.

A - Stein violated Standard I(C) Misrepresentation by presenting material developed by another to her supervisor without disclosing that the work was not her own. (Module 71.2, LOS 71.b)

Which of the following statements about probability concepts is most accurate? A: Subjective probability is a probability that is based on personal judgment. B: A conditional probability is the probability that two or more events happen concurrently. C: An empirical probability is one based on logical analysis rather than on observation or personal judgment.

A - Subjective probability is based on personal judgment. A joint probability is a probability that two or more events happen concurrently. An a priori probability is one based on logical analysis rather than on observation or personal judgment. An empirical probability is calculated using historical data. A conditional probability is the probability of one event happening on the condition that another event is certain to occur. (Module 3.1, LOS 3.d)

Green Investments utilizes the CFA Institute Standards of Professional Conduct as their standards for ethical practice. For purposes of compliance, which of the following is least likely a violation of Green Investments' policies? A: One of Green Investments' marketing brochures states that several of the firm's portfolio managers passed all three levels of the CFA exam on their first attempts. B: At a meeting with potential clients, Green's chief investment officer states that he is among a group of the most qualified investment professionals because he holds the CFA charter. C: In interviewing a prospective employee, a portfolio manager at the firm says that the position could be financially rewarding because CFA charterholders are known to achieve superior performance results.

A - The chief financial officer and the portfolio manager are in violation of Standard VII(B) Reference to CFA Institute, the CFA Designation, and the CFA Program because they have improperly referenced the CFA designation or exaggerated its meaning (e.g., "group of the most qualified"). The marketing brochure is only stating factual information regarding the portfolio managers' success at passing the CFA exams on their first attempts. (Module 71.9, LOS 71.b)

Nicholas Hart, CFA, is a portfolio manager for individuals. Last year, Hart's wife was hospitalized for several months. Despite his best efforts to pay her bills, Hart was forced to declare personal bankruptcy but did not disclose this to his clients. According to the CFA Institute Standards of Professional Conduct, Hart: A: is not in violation of any Standard. B: is in violation of the Standard on communication with clients for not disclosing his bankruptcy to his clients. C: is in violation of the Standard on misconduct for personal conduct that reflects adversely on his professional reputation.

A - The circumstances of Hart's bankruptcy do not compromise his professional reputation. The bankruptcy did not involve fraudulent or deceitful business conduct; therefore, there is no violation of Standard I(D) Misconduct. The Standards do not require disclosing the bankruptcy to clients because it does not create any conflict of interest and is not relevant to Hart's professional activity. (Module 73.1, LOS 73.b)

A company takes a $10 million impairment charge on a depreciable asset in 20X3. The most likely effect will be to: A: increase reported net income in 20X4. B: decrease net income and taxes payable in 20X3. C: increase return on equity and operating cash flow in 20X4.

A - The impairment writedown in 20X3 will reduce depreciation expense in 20X4, which will increase 20X4 EBIT and net income. Operating cash flow and taxes payable are not affected because an impairment cannot be deducted from income for tax reporting purposes until the asset is sold or otherwise disposed of. (Module 23.3, LOS 23.j)

Which of the following statements about the normal distribution is least accurate? The normal distribution: A: has a mean of zero and a standard deviation of one. B: is completely described by its mean and standard deviation. C: is bell-shaped, with tails extending without limit to the left and to the right.

A - The standard normal distribution has a mean of 0 and a standard deviation of 1. (Module 4.2, LOS 4.f)

Alberto Cosini is the top-rated, sell-side analyst in the biotechnology industry. His recommendations significantly affect prices of industry stocks regularly. Yesterday Cosini changed his rating on Biopharm from "hold" to "buy," and Cosini's firm emailed the change to its clients although no public disclosure has yet been made. If Peter Allen, CFA, who heard about Cosini's rating change for Biopharm from his brother, purchases Biopharm in his personal account, Allen will most likely: A: not violate the Standards. B: violate the Standard concerning diligence and reasonable basis. C: violate the Standard concerning material nonpublic information.

A - There is no requirement that a firm publicly release ratings changes by its analysts. Individuals outside the firm acting on this information after it is released to clients are not in violation of the Standard concerning nonpublic information. Purchases in a member's personal account are not subject to the requirements of the Standard concerning diligence and reasonable basis, so there is no violation indicated here. (Module 71.7, LOS 71.b)

Isabelle Burns, CFA, is an investment advisor and holds shares of Torex in her personal account because she thinks it is undervalued. According to the CFA Institute Standards of Professional Conduct, Burns may: A: recommend Torex to clients but must disclose her investment in Torex. B: not recommend Torex to clients while she has a personal investment in the stock. C: recommend Torex to clients for whom it is suitable without disclosing her investment in Torex.

A - To comply with Standard VI(A) Disclosure of Conflicts, members and candidates must make full disclosure of all matters that could impair their independence. Sell-side members and candidates should disclose to their clients any ownership in a security that they are recommending. (Module 71.8, LOS 71.b)

Rowlin Corporation, which reports under IFRS, wrote down its inventory of electronic parts last period from its original cost of €28,000 to net realizable value of €25,000. This period, inventory at net realizable value has increased to €30,000. Rowlin should revalue this inventory to: A: €28,000, and report a gain of €3,000 on the income statement. B: €30,000, and report a gain of €3,000 on the income statement. C: €30,000, and report a gain of €5,000 on the income statement.

A - Under IFRS, inventory values are revalued upward only to the extent they were previously written down. In this case, that is from €25,000 back up to the original value of €28,000. The increase is reported as gain for the period. (Module 22.4, LOS 22.g)

Dawn Shepard, CFA, is a broker for a regional brokerage firm. Her company's research department recently changed its recommendation on the common stock of Orlando (ORL) from "buy" to "sell" and sent the change to all firm clients who own ORL. The next day, a client places a "buy" order for ORL. According to the Standards, under these circumstances, Shepard: A: must advise the customer of the change in recommendation before accepting the order. B: has complied with the fair dealing Standard and may accept the order because it is unsolicited. C: may accept the order only if the customer acknowledges in writing that she was notified of the change in the recommendation.

A - Under Standard III(B) Fair Dealing, clients placing orders contrary to the firm's changed recommendation should be advised of the change in recommendation before the firm accepts the orders. ( Module 71.4, LOS 71.b)

Howard Klein, CFA, supervises a group of research analysts, none of whom is a CFA charterholder or CFA candidate. He has attempted on several occasions to get his firm to adopt a compliance system to ensure that applicable laws and regulations are followed. The firm's principals, however, have never adopted his recommendations. According to CFA Institute Standards of Professional Conduct, Klein at this point: A: should decline in writing to accept supervisory responsibility until his firm adopts reasonable compliance procedures. B: needs to take no action because the employees are not CFA charterholders or CFA candidates. C: must resign from the company and document in writing his reasons for doing so.

A - Under Standard IV(C) Responsibilities of Supervisors, if Klein clearly cannot discharge supervisory responsibilities because of an inadequate compliance system, he should decline in writing to accept the supervisory responsibility until the firm adopts reasonable procedures to allow him to adequately exercise such responsibility. (Module 71.6, LOS 71.b)

During a period of decreasing costs of manufacturing, which of the following inventory cost methods would result in the greatest reported net income? A: LIFO. B: FIFO. C: Average cost.

A - With LIFO, more recent, lower costs would be used for COGS. A reduction in COGS will increase gross profits and net income, other things equal. (Module 22.1, LOS 22.b)

Based on her forecast for the economy, a portfolio manager increases her investments in high-quality bonds and decreases her investments in commodities. The portfolio manager most likely expects the economy to experience: A: stagflation. B: a recessionary gap. C: an inflationary gap.

B - The manager's investment decisions are most consistent with expectations of a recessionary gap. In a recession, commodity prices and interest rates are likely to decrease. Decreasing interest rates should increase the prices of high-quality bonds. An inflationary gap would likely cause interest rates to increase, which would decrease bond prices. An inflationary gap or stagflation conditions would likely result in increasing commodity prices. (Module 10.3, LOS 10.i)

The median of a distribution is least likely equal to: A: the second quartile. B: the third quintile. C: the fifth decile.

B - The median is the midpoint of a distribution, such that 50% of the observations are greater than the median and 50% are less than the median. This is equivalent to the second quartile (4 groups) and the fifth decile (10 groups). If a distribution is divided into quintiles (5 groups), 60% of the observations are less than the third quintile. (Module 2.4, LOS 2.i)

An analyst has data on institutional salespeople at an investment banking firm showing how they ranked in total monthly commissions, from first to eighth. To determine whether a high rank in one month indicates a high probability of achieving a high rank in subsequent months, the analyst should use a: A: t-test. B: nonparametric test. C: mean differences test.

B - A Spearman rank correlation test is appropriate in this scenario. This is a nonparametric test.(Module 6.4, LOS 6.l)

The most appropriate method to estimate a company's cost of debt capital is to use: A: a weighted average of the coupon rates on all the company's outstanding debt. B: the yield to maturity on bonds of other companies with the same credit rating as the company's bonds. C: the average rate market rate on outstanding company bonds for a company that issues only floating-rate bonds.

B - A company may use the YTM on the bonds of other companies with the same credit rating and maturity as the company's debt when it is not publicly traded, an example of matrix pricing. Market yields to maturity should be used rather than the coupon rates. For companies that issue floating-rate debt, analysts should use the yield for a longer term that is estimated from the yield curve, rather than using current short-term rates that will likely change over the life of the bonds. (Module 33.1, LOS 33.c)

Which of the following statements regarding an audit and a standard auditor's opinion is most accurate? A: The objective of an audit is to enable the auditor to provide an opinion on the numerical accuracy of the financial statements. B: To provide an independent review of a company's financial statements, an external auditor is appointed by the company's management. C: The absence of an explanatory paragraph in the audit report relating to the going concern assumption suggests that there are no serious problems that require a close examination of that assumption by the analyst.

B - A specific explanatory paragraph that makes reference to (questions) the going concern assumption may be a signal of serious problems and call for close examination by the analyst. Therefore, in the absence of such a paragraph, there is no need for a close examination of the going concern assumption by the analyst. The objective of an audit is to enable the auditor to provide an opinion on the fairness and reliability of the financial statements. This is not the same as numerical accuracy. The auditor generally only provides reasonable assurance that there are no material errors in the financial statements, not an opinion about their numerical accuracy. An external auditor is appointed by the audit committee of the company's board of directors, not by its management. (Module 29.1, LOS 29.c)

With respect to the Standard on material nonpublic information, materiality is least likely to be affected by: A: the source of the information. B: liquidity of the subject security. C: ambiguity about the price effect of the information.

B - According to Standard II(A) Material Nonpublic Information, how specific the information is, how different it is from public information, and its nature are key factors in determining whether a particular piece of information fits the definition of material. An additional factor is reliability, which is often a function of the source of the information. While the liquidity of a security may be a factor in determining the materiality of advance knowledge of a large buy or sell order, in most cases, it would not be a factor in determining materiality. (Module 71.3, LOS 71.b)

Which of the following statements about hypothesis testing involving a z-statistic is least accurate? A: The p-value is the smallest significance level at which the null hypothesis can be rejected. B: A z-test is theoretically acceptable in place of a t-test for tests concerning a mean when sample size is small. C: If the confidence level is set at 95%, the probability of rejecting the null hypothesis when in fact it is true is 5%.

B - The t-test must be used when the sample size is small, the population is normal, and the population variance is unknown. If the population is non-normal and the variance is unknown, there is no valid test statistic when the sample is small. (Module 6.2, LOS 6.g)

Lisa Crocker, CFA, manages several pension accounts and directs most of her trades to Zeta Brokers, which provides excellent trade execution as well as equities research. Regional Brokers, which also has excellent trading services, has offered to execute trades for Crocker at half the commission rate she pays Zeta, but Regional does not supply equities research. If Crocker declines to switch her business from Zeta to Regional, has she violated any CFA Institute Standards of Professional Conduct? A: Yes, because she has not obtained explicit permission from her clients to use Zeta. B: No, if the higher commissions are justified by the value of the research services she receives. C: Yes, because the Standard concerning loyalty, prudence, and care states that she must minimize trading costs for her accounts.

B - According to Standard III(A) Loyalty, Prudence, and Care, Crocker may pay higher fees without violating her fiduciary duty as long as the research benefits the firm's clients and the commission paid is reasonable in relation to the research and execution of services received. ( Module 71.4, LOS 71.b)

Open market sales of securities by a country's central bank will most likely result in: A: decreasing short-term interest rates. B: appreciation of the domestic currency. C: an increasing growth rate of real GDP.

B - Central bank sales of securities reduce excess reserves in the banking system, causing interbank lending rates and other short-term interest rates to increase. If the monetary policy transmission mechanism operates normally, long-term interest rates should also increase, the domestic currency should appreciate, and economic growth and inflation should decrease. (Module 12.2, LOS 12.j)

A bank estimates the expected value of a one-month loss that exceeds ¥100 million to be ¥300 million. The ¥300 million estimate is best described as: A: a value at risk. B: a conditional VaR. C: a scenario-based VaR.

B - Conditional VaR is the expected value of a loss, given that the loss exceeds a minimum amount. Value at risk is the minimum loss that will occur over a period with a specified probability. (Module 66.1, LOS 66.g)

When comparing two firms, an analyst should most appropriately adjust the financial statements when they include significant: A: acquisition goodwill, if one of the firms reports under IFRS and the other under U.S. GAAP. B: property, plant, and equipment, if one of the firms uses accelerated depreciation and the other uses straight-line depreciation. C: unrealized losses from securities held for trading, if one of the firms uses fair value reporting for securities investments and the other does not.

B - Depreciation methods are an example of a difference that may require an analyst to adjust financial statements to make them comparable. Acquisition goodwill is treated the same way under IFRS and U.S. GAAP: it is not amortized but is tested for impairment at least annually. Securities held for trading are reported at fair value with unrealized gains and losses reported on the income statement. (Module 27.2, LOS 27.e)

For an operating lease, the value of the right-to-use asset and the lease liability on the lessee's balance sheet will be equal in each reporting period over the term of the lease under: A: IFRS, but not U.S. GAAP. B: U.S. GAAP, but not IFRS. C: both IFRS and U.S. GAAP.

B - For operating leases under U.S. GAAP, the principal reduction in the lease liability and the amortization of the right-to-use asset are equal each period so that the values of the lease liability and right-to-use asset will be equal over the term of the lease. This is not the case under IFRS. (Module 25.4, LOS 25.g)

Erbdin Company determines that replacing some of its manufacturing equipment with an updated model would decrease its variable cost of production by 15%. Doing so would be best characterized as: A: an expansion project. B: a going concern project. C: a business growth investment.

B - Going concern projects include those needed to maintain the business and those undertaken to reduce costs. (Module 31.1, LOS 31.a)

In a case where a client's ability to bear risk is significantly less than the client's expressed willingness to bear risk, the most appropriate action for a financial advisor is to: A: counsel the client and attempt to change his attitude towards risk. B: base the assessment of risk tolerance in the IPS on client's ability to bear risk. C: attempt to educate the client about investment risk and correct any misconceptions.

B - In a situation where the client's expressed willingness to bear investment risk is significantly greater than the client's ability to bear investment risk, the advisor's assessment of the client's risk tolerance in the IPS should reflect the client's ability to bear investment risk. (Module 64.1, LOS 64.d)

One year ago, the currency of Xyland (XYZ) was at a three-month forward premium to the currency of Piqua (PQR). Today, the XYZ is at a three-month forward discount to the PQR. Assuming the interest rate forward parity relationship holds, this change implies that: A: the XYZ has depreciated relative to the PQR. B: today the XYZ three-month interest rate is higher than the PQR three-month interest rate. C: one year ago the XYZ three-month interest rate was higher than the PQR three-month interest rate.

B - Interest rate parity requires that the currency with the higher interest rate will sell at a discount in the forward market. (Module 15.2, LOS 15.g)

Lunar Wealth, a subsidiary of Galaxy Financial, has prepared GIPS- compliant performance data and asks Galaxy's president about his interest in presenting GIPS-compliant performance data, but he does not believe it is a priority. Lunar may: A: claim partial compliance with GIPS if Lunar's performance presentations are in compliance. B: not claim compliance with GIPS because compliance must be made on a company-wide basis. C: claim compliance with GIPS as long as Lunar is presented to the public as a distinct business entity.

B - Lunar may claim compliance as long as it has met the reporting requirements necessary and is held out to clients (advertised) as a distinct business entity. Lunar may only claim compliance with GIPS if it complies fully and on a firmwide basis..

The uncertainty about a firm's expected operating income is most appropriately referred to as: A: sales risk. B: business risk. C: operating risk.

B - The uncertainty (risk) associated with a firm's operating income is referred to as business (as opposed to financial) risk and results from both operating risk and sales risk. (Module 35.1, LOS 35.a)

The public sector is most likely to increase as a proportion of economic output if fiscal policy: A: and monetary policy are both expansionary. B: is contractionary and monetary policy is expansionary. C: is expansionary and monetary policy is contractionary.

C - Reducing taxes is likely to keep the public sector size unchanged, but an increase in government spending will increase the size of the public sector. Contractionary monetary policy is likely to decrease the output of the private sector as interest rates rise. (Module 12.3, LOS 12.t)

Gabe Klement, CFA, an analyst for HB Investments, is responsible for the valuation model for an IPO. Without his knowledge, others at HB adjusted the inputs to the model to increase the estimated value of the shares, and the offering is oversubscribed. Complying with local securities laws, Klement purchases shares of the IPO for his personal account and allocates the remaining shares to client accounts on a pro rata basis. With regard to the Standard on knowledge of the law, the analyst: A: did not violate the Standard. B: violated the Standard by purchasing the shares of the IPO but not by allowing the IPO valuation to be published. C: violated the Standard by allowing the IPO valuation to be published and by purchasing the shares of the IPO.

B - Standard I(A) Knowledge of the Law requires candidates and members comply with all applicable rules and regulations, including the CFA Institute Standards of Practice. Further, Standard I(A) requires that members and candidates must not knowingly participate in violations of applicable laws and Standards. Even though local law permits purchasing shares for personal accounts before purchasing IPO shares for client accounts, Standard VI(B) Priority of Transactions does not. The analyst knowingly violated the Code and Standards and, thus, violated Standard I(A). Since the analyst was unaware of the deceit in the valuation of the IPO stock [a violation of Standard I(D) Misconduct], his participation in publishing the IPO valuation did not constitute a violation. (Module 71.8, LOS 71.b)

Katrina Anderson, CFA, left her job as an account manager at RTJ Capital Management and joined Parnell Associates. Anderson did not sign a noncompete agreement at RTJ and took no RTJ property with her when she left. According to CFA Institute Standards of Professional Conduct, Anderson: A: must not harm RTJ by soliciting her previous clients. B: is free to contact her previous clients at RTJ after her employment there ends. C: must seek permission from RTJ before contacting her previous clients there.

B - Standard IV(A) Loyalty does not prohibit former employees from contacting clients of their previous firm so long as the contact information does not come from the records of the previous employer or violate a noncompete agreement. (Module 71.6, LOS 71.b)

Courtney Johnson, CFA, manages equity accounts and recommends Reliable Management to clients who ask about fixed-income investments. Reliable, in turn, provides Johnson with equity research. Johnson has not informed her equity clients, who are always very happy with Reliable's performance, of the arrangement with Reliable. Johnson has violated: A: none of the Standards. B: the Standard concerning client referrals. C: the Standard concerning soft dollar arrangements

B - Standard VI(C) Referral Fees requires members and candidates to disclose to clients and prospects any consideration or benefit received by the member for the recommendation of any service. "Soft dollars" refers to benefits received from client brokerage. (Module 71.8, LOS 71.b)

A manager forecasts a bond portfolio return of 10% and estimates a standard deviation of annual returns of 4%. Assuming a normal returns distribution and that the manager is correct, there is: A: a 90% probability that the portfolio return will be between 3.2% and 17.2%. B: a 95% probability that the portfolio return will be between 2.16% and 17.84%. C: a 32% probability that the portfolio return will be between 6% and 14%.

B - The 95% confidence interval is 10% ± 1.96(4%) or from 2.16% to 17.84%. The 90% confidence interval is 10% ± 1.65(4%) or from 3.4% to 16.6%. The probability of a return ± 1 standard deviation from the mean, between 6% and 14%, is approximately 68%. (Module 4.2, LOS 4.h)

CPM Industries invested $300 million in new manufacturing equipment. The present value of the future after-tax cash flows from this project is $500 million. CPM has 100 million shares of outstanding common stock and currently trades for $24 per share. Assuming this project is new information and is independent of other expectations about the company, the stock price should theoretically: A: decrease to $23. B: increase to $26. C: increase to $27.

B - The NPV of the new equipment is $500 million - $300 million = $200 million. This NPV is added to CPM's current market value. On a per share basis, the addition is worth $200 million / 100 million shares, for a new addition to the share price of $2.00. Theoretical share price = $24.00 + $2.00 = $26.00. (Module 31.3, LOS 31.e)

Which of the following statements about the security market line (SML) and capital market line (CML) is most accurate? A: The SML involves the concept of a risk-free asset, but the CML does not. B: The SML uses beta, but the CML uses standard deviation as the risk measure. C: Both the SML and CML can be used to explain a stock's expected return.

B - The SML and CML both intersect the vertical axis at the risk-free rate. The SML describes the risk/return tradeoff for individual securities or portfolios, whereas the CML describes the risk/return tradeoff of various combinations of the market portfolio and a riskless asset. (Module 63.2, LOS 63.f)

A portfolio manager who is comparing portfolios based on their total risk should most appropriately use: A: Jensen's alpha. B: the Sharpe ratio. C: the Treynor measure.

B - The Sharpe ratio measures excess return per unit of total risk. The Treynor measure and Jensen's alpha are calculated with beta, not standard deviation, and are appropriate for analyzing portfolios based on systematic risk. (Module 63.2, LOS 63.i)

When computing weighted average cost of capital (WACC), what is the correct treatment of flotation costs, related to raising additional equity capital? A: Increase the discount rate to account for flotation costs. B: Adjust the initial project costs by the amount of the flotation costs. C: Flotation costs are not substantial enough to be considered in adjusting the cost of equity.

B - The correct method to account for flotation costs is to make the adjustment in the initial project cost. Adjusting the WACC is incorrect because flotation costs are a cash outflow at the initiation of the project, rather than an ongoing expense. Flotation costs can be substantial, typically 2% to 7% of the amount raised. (Module 33.2, LOS 33.g)

An analyst constructs a histogram and frequency polygon of monthly returns for aggressive equity funds over a 20-year period. Which of the following statements about these displays is most accurate? A: The height of each bar in a frequency polygon represents the absolute frequency for each return interval. B: Both a histogram and a frequency polygon provide a graphical display of data found in a frequency distribution. C: To construct a histogram, the analyst would plot the midpoint of the return intervals on the x-axis and the absolute frequency for that interval on the y-axis, connecting neighboring points with a straight line.

B - The height of each bar in a histogram represents the absolute frequency for each return interval. To construct a frequency polygon, the analyst would plot the midpoint of the return intervals on the x-axis and the absolute frequency for that interval on the y-axis. (Module 2.2, LOS 2.e)

Reasons why the unemployment rate is a lagging indicator of the business cycle least likely include: A: discouraged workers who begin seeking work. B: action lag in the implementation of unemployment insurance. C: high costs to employers of frequently hiring or firing employees.

B: Unemployment insurance is an example of an automatic stabilizer that is not subject to the action lag of discretionary fiscal policy tools. One reason why the unemployment rate is a lagging indicator is the fact that employers are slow to lay off employees early in recessions and slow to add employees early in expansions, because frequent hiring and firing has high costs. Another reason is that early in expansions, more discouraged workers (who are not counted as unemployed because they are out of the labor force) may begin seeking work (thereby re-entering the labor force) than the number of new jobs that are available, which increases the unemployment rate. (Module 12.3, LOS 12.q)

A hypothesis test of whether an independent variable explains a significant amount of the variation in the dependent variable is most appropriately constructed using a hypothesized value of a regression line's: A: intercept. B: error term. C: slope coefficient.

C - A test of whether an independent variable explains a significant amount of the variation in the dependent variable uses the null hypothesis that the slope coefficient is equal to zero. Rejecting the null hypothesis indicates the slope coefficient is statistically significant. (Module 7.2, LOS 7.f)

An investment has a mean return of 15% and a standard deviation of returns equal to 10%. If the distribution of returns is approximately normal, which of the following statements is least accurate? The probability of obtaining a return: A: less than 5% is about 16%. B: greater than 35% is about 2.5%. C: between 5% and 25% is about 95%.

C - About 68% of all observations fall within ±1 standard deviation of the mean. Thus, about 68% of the values fall between 5 and 25. (Module 4.2, LOS 4.h)

Christopher Kim, CFA, is a banker with Batts Brothers, an investment banking firm. Kim follows the energy industry and has frequent contact with industry executives. Kim is contacted by the CEO of a large oil and gas corporation who wants Batts Brothers to underwrite a secondary offering of the company's stock. The CEO offers Kim the opportunity to fly on his private jet to his ranch in Texas for an exotic game hunting expedition if Kim's firm can complete the underwriting within 90 days. According to CFA Institute Standards of Conduct, Kim: A: may accept the offer as long as he discloses the offer to Batts Brothers. B: may not accept the offer because it is considered lavish entertainment. C: must obtain written consent from Batts Brothers before accepting the offer.

C - According to Standard IV(B) Additional Compensation Arrangements, members and candidates must obtain written permission from their employer before accepting an offer of compensation (for the performance of work done for their employer) in addition to what they receive from their employer and that is contingent on future performance. (Module 71.6, LOS 71.b)

Stakeholder theory is most accurately described as the belief that corporate governance should focus on managing: A: the activities of a company in the best interests of its owners. B: employee activities in compliance with ethical standards and applicable laws. C: conflicts among different groups that have an interest in a company's activities.

C - According to stakeholder theory, the focus of corporate governance is managing conflicts among the interests of different groups that have an interest in a company's activities. Shareholder theory holds that the focus of corporate governance should be to manage the activities of a company in the best interests of its owners. (Module 29.1, LOS 29.c)

Which of the following statements about sampling and estimation is least accurate? A: Sampling error is the difference between the observed value of a statistic and the value it is intended to estimate. B: A simple random sample is a sample obtained in such a way that each element of the population has an equal probability of being selected. C: The central limit theorem states that the sample mean for a large sample size will have a distribution that is the same as the distribution of the underlying population.

C - According to the central limit theorem, the sample mean for large sample sizes will be distributed normally regardless of the distribution of the underlying population. (Module 5.1, LOS 5.d)

Brian Farley, CFA, is an investment manager with one client, a $75 million university endowment fund. A representative of the endowment fund calls Farley and places a "sell" order on a portfolio holding whose management has just reduced its earnings guidance for the coming year. Farley also owns the security and, because the new guidance is public information, places simultaneous "sell" orders for both the client account and his personal account. According to the Standards on fair dealing and priority of transactions, Farley is in violation of: A: both of these Standards. B: neither of these Standards. C: only one of these Standards.

C - Farley is in violation of Standard VI(B) Priority of Transactions. Client transactions must take precedence over members' or candidates' trades. He should have submitted his personal trade order only after trading for his client. Standard III(B) Fair Dealing requires that Farley deal fairly with all clients when recommending securities or taking investment action. Since the endowment fund is Farley's only account, he has not disadvantaged any other client.(Module 71.8, LOS 71.b)

Other things being equal, a company is most likely to issue additional debt if: A: the alternative is to rely on internally generated capital. B: doing so will only change its corporate bond rating from BBB to BB. C: it is funding an acquisition that will generate significant cash flows.

C - Funding an acquisition, especially one that is expected to generate significant cash flows, is often a reason for a company to issue additional debt. According to pecking order theory, managers prefer to finance a firm with internally generated capital than with additional debt. A change in a corporate bond rating from BBB to BB is a decrease from investment grade to speculative grade, which is likely to increase the bond issuer's cost of debt capital significantly. (Module 34.2, LOS 34.d)

Wells Investments implements a new procedure for unsolicited trade requests that an advisor believes are inconsistent with the client's IPS: If the trade will have only a minimal impact on the client's portfolio, first advise the client in what way the trade deviates from the IPS, and then request the client's approval for the trade. If the trade will have a material impact on the risk and return characteristics of the client's portfolio, discuss with the client that this trade will require a change in the IPS. Which of these statements is consistent with the standard concerning suitability? A: Both of these statements. B: Neither of these statements. C: Only one of these statements.

C - If an unsolicited trade is inconsistent with a client's IPS, a member or candidate should not execute the trade before discussing it with the client. According to Standard III(C) Suitability, if the trade will have only a minimal impact on the client's portfolio, the member or candidate should attempt to educate the client with regard to how it deviates from the IPS and then may follow her firm's policies for obtaining client approval for the trade. If the trade will have a material impact on the risk and return characteristics of the client's portfolio, the discussion should focus on changing the IPS. (Module 71.5, LOS 71.b)

Which of the following statements on the economic implications of trade restrictions is most accurate? A: Quota rents are the amounts received by the domestic government when it charges for import licenses. B: In the importing country, import quotas, tariffs, and voluntary export restraints all decrease producer surplus. C: In the case of a quota, if the domestic government collects the full value of the import licenses, the result is the same as that of a tariff.

C - If the domestic government collects the full value of the import license, a quota can have the same economic result as a tariff. Quota rents are the gains to those foreign exporters who receive import licenses under a quota if the domestic government does not charge for the import licenses. With respect to the importing country, import quotas, tariffs, and voluntary export restraints all decrease consumer surplus and increase producer surplus. (Module 14.2, LOS 14.e)

According to the crowding-out effect, the sale of government bonds used to finance excess government spending is least likely to: A: increase the real interest rate. B: reduce private investment spending. C: increase the profitability of corporate investment projects.

C - Increased government borrowing would decrease, not increase, the profitability of corporate investment projects since it will tend to increase interest rates and required rates of return in general. (Module 12.3, LOS 12.p)

Consider a manufacturing company and a financial services company. Interest expense is most likely classified as a non-operating component of net income for: A: both of these companies. B: neither of these companies. C: only one of these companies.

C - Interest expense is shown as a non-operating component of net income for a manufacturing company but would typically be classified as an operating expense for a financial services company. (Module 18.3, LOS 18.f)

For which of the following investments in securities is a firm most likely to report unrealized gains or losses on its income statement? A: Preferred stock, which the firm classifies as available-for-sale. B: Five-year bonds, which the firm purchased in a private placement. C: Listed call options, which the firm intends to exercise at expiration.

C - Options are derivatives, which are reported at fair value on the balance sheet with unrealized gains and losses recognized on the income statement. Available-for-sale securities are marked to market on the balance sheet, but unrealized gains and losses are reported in owners' equity as other comprehensive income. Bonds purchased in a private placement cannot be resold to the public and therefore are likely to be classified as held-to-maturity, in which case the firm does not recognize unrealized gains or losses. (Module 19.6, LOS 19.e)

Normal Corp. has a current ratio above 1 and a quick ratio less than 1. Which of the following actions will increase the current ratio and decrease the quick ratio? Normal Corp.: A: buys fixed assets on credit. B: uses cash to purchase inventory. C: pays off accounts payable from cash.

C - Paying off accounts payable from cash lowers current assets and current liabilities by the same amount. Because the current ratio started off above 1, the current ratio will increase. Because the quick ratio started off less than 1, it will decrease further. The other choices are incorrect. Buying fixed assets on credit decreases both ratios because the denominator increases, with no change to the numerator. Using cash to purchase inventory would result in no change in the current ratio but would decrease the quick ratio by decreasing the numerator. (Module 21.2, LOS 21.b)

Judy Dudley, CFA, is an analyst and plans to visit a company that she is analyzing in order to prepare a research report. The Standard related to independence and objectivity: A: requires Dudley to pay for her own transportation costs and not to accept any gifts or compensation for writing the report, but allows her to accept accommodations and meals that are not lavish. B: requires Dudley not to accept any compensation for writing a research report, but allows her to accept company paid transportation, lodging, and meals. C: allows Dudley to accept transportation, lodging, expenses, and compensation for writing a research report, but requires that she disclose such an arrangement in her report.

C - Standard I(B) Independence and Objectivity allows investor-paid research but requires that members and candidates limit the type of compensation they accept for writing a research report so that it is not dependent on the conclusions of the research report. Best practice is for analysts to only accept a flat fee for such company-paid research reports. Such research should also include complete disclosure of the nature of the compensation received for writing such a report so that investors will not be misled as to the relationship between the analyst and the company. Paying for one's own transportation and lodging when the analyst is not employed by the subject firm is a recommended procedure for complying with Standard I(B), but it is not a requirement. (Module 71.1, LOS 71.b)

Russell Finley, CFA, is a managing director at Wilson Brothers and is responsible for the supervision of all trading and sales operations. Finley receives information indicating that a sales assistant made personal trades on a restricted security. According to the Standard regarding responsibilities of supervisors, the least appropriate action for Finley to take is to: A: begin an investigation to determine the extent of the wrongdoing. B: restrict and increase the monitoring of the employee's activities at the firm. C: speak directly to the employee and attain assurance that the violation will not be repeated.

C - Standard IV(C) Responsibilities of Supervisors explicitly states that speaking to the employee to determine the extent of the violations and receiving assurances that it will not be repeated is not enough. Finley must take positive steps to ensure that the violation will not be repeated, including promptly launching an investigation and limiting the employee's activities and/or increasing supervision of the employee until the results of the investigation are known. (Module 71.6, LOS 71.b)

Which of the following distributions is most likely symmetric if its degrees of freedom are less than five? A: F-distribution. B: Chi-square distribution. C: Student's t-distribution.

C - Student's t-distribution is symmetric regardless of its degrees of freedom. The chi-square and F-distributions are asymmetric but approach the shape of a normal distribution as their degrees of freedom become large. (Module 4.3, LOS 4.o)

Paul White, CFA, works as an analyst at an investment banking firm that also manages equity-only accounts for clients. White has agreed independently to manage a portfolio of fixed-income securities for an endowment fund for a small fee but has not informed his employer. Additionally, White's supervisor has asked him to work this weekend on a proposal for a large IPO that must be delivered on Monday morning, but White declines as he would prefer to spend the weekend with his family. Which of White's actions violate the Standard concerning loyalty? A: Both of these actions. B: Neither of these actions. C: Only one of these actions.

C - The Standards do not require that members put their employment ahead of their personal lives; these are issues between White and his employer. However, Standard IV(A) Loyalty states that a member who engages in independent practice must notify his employer. (Module 71.6, LOS 71.b)

Which of the following statements about risk is most accurate? A: The capital market line plots expected return against market risk. B: The efficient frontier plots expected return against unsystematic risk. C: The security market line plots expected return against systematic risk.

C - The capital market line plots expected return against standard deviation of returns for efficient portfolios. The efficient frontier plots expected return against the standard deviation of return, a measure of total risk. (Module 63.2, LOS 63.f)

Which of the following portfolios will have the lowest diversification ratio? A portfolio of: A: 30 equally weighted stocks with companies from the same industry. B: 20 equally weighted stocks with companies from different industries. C: 30 equally weighted stocks with companies from different industries.

C - The diversification ratio of a portfolio equals its standard deviation of returns divided by the average standard deviation of the individual securities in the portfolio. Therefore, a more diversified portfolio will have a lower diversification ratio than a less diversified portfolio. A portfolio containing the highest number of securities from different industries will be the most diversified and will have the lowest diversification ratio. A portfolio of stocks from the same industry is likely to have a higher diversification ratio (reflecting less diversification) than a portfolio of stocks from different industries. (Module 61.1, LOS 61.a)

Which of the following is least likely one of the eight major topics of the Global Investment Performance Standards (GIPS) for firms? A: Composite and Pooled Fund Maintenance. B: Fundamentals of Compliance. C: Conflicts with Local Laws and Regulations.

C - The eight major sections of the GIPS standards for firms are: Fundamentals of Compliance Input Data and Calculation Methodology Composite and Pooled Fund Maintenance Composite Time-Weighted Return Report Composite Money-Weighted Return Report Pooled Fund Time-Weighted Return Report Pooled Fund Money-Weighted Return Report GIPS Advertising Guidelines (Module 72.1, LOS 72.b)

In choosing asset classes for establishing strategic portfolio allocation across assets, the manager would most prefer that: A: asset classes are only those with tradable liquid assets. B: the asset classes span the broadest universe of investable assets. C: correlations of asset returns within an asset class are significantly greater than correlations of asset class returns.

C - The important points in the determination of asset classes are that assets included in a class have similar performance characteristics and a relatively high correlation of returns between assets, and that returns of asset classes have relatively low correlations to realize the benefits of diversification across asset classes. Some asset classes, such as real estate and hedge funds, may be illiquid. The asset classes in the strategic allocation should be mutually exclusive and cover the universe of investable assets available to the fund manager(s) based on the client's objectives and constraints, not the broadest possible universe of asset classes. (Module 64.1, LOS 64.f)

A market has the following characteristics: a large number of independent sellers, each producing a differentiated product; low barriers to entry; producers facing downward sloping demand curves; and demand that is highly elastic. This description most closely describes: A: an oligopoly. B: pure competition. C: monopolistic competition.

C - These conditions characterize monopolistic competition. By contrast, monopolies and oligopolies have high barriers to entry and involve either a single seller (monopoly) or a small number of interdependent sellers (oligopoly). Similar to monopolistic competition, pure competition involves a large number of independent sellers. With pure competition, products are homogeneous (not differentiated), no barriers to entry exist (not low barriers to entry), and the demand schedule is horizontal (not downward sloping) and perfectly elastic (not highly elastic). (Module 9.4, LOS 9.h)

Maritza, Inc., is involved in an exchange of debt for equity. In which of the following sections of the cash flow statement would Maritza record this transaction? A: Investing activities section. B: Financing activities section. C: Footnotes to the cash flow statement.

C - This transaction results in a reduction of debt and an increase in equity. However, since no cash is involved, it is not reported as a financing activity in the cash flow statement, but will be disclosed in the notes to the cash flow statement. (Module 20.1, LOS 20.b)

A U.S. GAAP reporting company holds a number of marketable securities as investments. For the most recent period, the company reports that the market value of its securities held for trading decreased by $2 million and the market value of its securities available for sale increased in value by $3 million. Together, these changes in value will: A: reduce net income and shareholders' equity by $2 million. B: increase shareholders' equity by $1 million and have no effect on net income. C: reduce net income by $2 million and increase shareholders' equity by ＄1 million.

C - Unrealized gains and losses on securities held for trading are included in net income. Unrealized gains and losses on securities available for sale are not reported in net income but are included in comprehensive income. Net income will show a $2 million loss from the securities held for trading. Shareholders' equity will reflect this loss as well as the $3 million unrealized gain from securities available for sale, for a net increase of $1 million. (Module 18.5, LOS 18.l)

Which of the following indicators of a firm's liquidity position is least desirable? A: Low days of payables. B: High inventory turnover. C: Low quick ratio.

C: The quick ratio measures a firm's current assets that are readily convertible into cash, relative to its current liabilities. A higher quick ratio indicates greater liquidity. (Module 32.1, LOS 32.d)