FINA 4331

The six-year spot rate is 7% and the five-year spot rate is 6%. The implied one-year forward rate five years from now is closest to: A) 12.0%. B) 5.0%. C) 6.5%.

A) 12.0%. 5y1y= [(1 + S6)6 / (1 + S5)5] - 1 = [(1.07)6/(1.06)5] - 1 = [1.5 / 1.338] - 1 = 0.12

A 20 year, 8% semi-annual coupon, $1,000 par value bond is selling for $1,100. The bond is callable in 4 years at $1,080. What is the bond's yield to call? A) 6.87. B) 7.21. C) 8.13.

A) 6.87. n = 4(2) = 8; PMT = 80/2 = 40; PV = -1,100; FV = 1,080 Compute YTC = 3.435(2) = 6.87% *multiply by two since it is a semi-annual coupon and need the answer in annual terms*

A share of George Co. preferred stock is selling for $65. It pays a dividend of $4.50 per year and has a perpetual life. The rate of return it is offering its investors is closest to: A) 6.9%. B) 4.5%. C) 14.4%.

A) 6.9%. 4.5 / 65 = 0.0692, or 6.92%. (Module 2.1, LOS 2.a)

An analyst gathered the following data for the Parker Corp. for the year ended December 31, 2005: EPS2005 = $1.75 Dividends2005 = $1.40 BetaParker = 1.17 Long-term bond rate = 6.75% Rate of return S&P500 = 12.00% The firm has changed its dividend policy and now plans to pay out 60% of its earnings as dividends in the future. If the long-term growth rate in earnings and dividends is expected to be 5%, the appropriate price to earnings (P/E) ratio for Parker will be: A) 7.60. B) 7.98. C) 9.14.

A) 7.60. Required rate of return on equity will be 12.89% = 6.75% + 1.17(12.00% - 6.75). P/E Ratio = 0.60 / (0.1289 - 0.0500) = 7.60. (Module 48.3, LOS 48.k)

A stated interest rate of 9% compounded quarterly results in an effective annual rate closest to: A) 9.3%. B) 9.2%. C) 9.4%.

A) 9.3%. Quarterly rate = 0.09 / 4 = 0.0225. Effective annual rate = (1 + 0.0225)4 - 1 = 0.09308, or 9.308%. (Module 55.1, LOS 55.a)

Which of the following statements concerning security valuation is least accurate? A) A firm with a $1.50 dividend last year, a dividend payout ratio of 40%, a return on equity of 12%, and a 15% required return is worth $18.24. B) The best way to value a company with high and unsustainable growth that exceeds the required return is to use the temporary supernormal growth (multistage) model. C) The best way to value a company expecting to pay a constantly growing dividend as from the third year is to use the Gordon growth model.

A) A firm with a $1.50 dividend last year, a dividend payout ratio of 40%, a return on equity of 12%, and a 15% required return is worth $18.24. A firm with a $1.50 dividend last year, a dividend payout ratio of 40%, a return on new investment of 12%, and a 15% required return is worth $20.64. The growth rate is (1 - 0.40) × 0.12 = 7.2%. The expected dividend is then ($1.50)(1.072) = $1.61. The value is then (1.61) / (0.15 - 0.072) = $20.64.

Which of the following statements regarding fixed income indexes is most accurate? A) Because some fixed income securities are illiquid, indexes may include estimates of value. B) Compared to stock indexes, turnover is typically lower in fixed income indexes. C) It is typically easier for portfolio managers to replicate a fixed income index than an equity index.

A) Because some fixed income securities are illiquid, indexes may include estimates of value. Because some fixed income securities are illiquid, a lack of recent trade prices may result in indexes having to estimate values. Unlike stocks, bonds mature and must be replaced in fixed income indexes. As a result turnover is higher in fixed income indexes. Illiquidity, transaction costs, and high turnover make it more expensive and difficult for a portfolio manager to replicate a fixed income index than a stock index.

Which technique for estimating the standard error of the sample mean involves calculating multiple means from the same sample, each with one observation removed from the sample? A) Jackknife. B) Bootstrap. C) Sample variance.

A) Jackknife. The jackknife technique involves calculating the standard deviation of the means from samples, each of which is calculated with a different observation removed from the original sample. The bootstrap method involves drawing multiple random samples from a dataset and calculating the standard deviation of those sample means. Standard error based on the standard deviation of a single sample is estimated by dividing the sample standard deviation by the square root of the sample size. (Module 7.1, LOS 7.c)

Which of the following is least likely an advantage of using price/sales (P/S) multiple to value an equity security, as compared to using price/earnings (P/E) multiples? A) P/S multiples are more reliable than P/E multiples because sales data cannot be distorted by management. B) P/S multiples provide a meaningful framework for evaluating distressed firms when negative earnings prevent the use of P/E multiples. C) P/S multiples are not as volatile as P/E multiples and hence may be more reliable in valuation analysis.

A) P/S multiples are more reliable than P/E multiples because sales data cannot be distorted by management. Because aggressive revenue recognition practices can influence reported sales, it is not the case that sales data cannot be distorted by management. P/S multiples tend to me less volatile than P/E multiples and can be used to value the equity securities of firms with negative earnings. (Module 48.3, LOS 48.f)

The Treasury spot rate yield curve is closest to which of the following curves? A) Zero-coupon bond yield curve. B) Forward yield curve rate. C) Par bond yield curve.

A) Zero-coupon bond yield curve. The spot rate yield curve shows the appropriate rates for discounting single cash flows occurring at different times in the future. Conceptually, these rates are equivalent to yields on zero-coupon bonds. The par bond yield curve shows the YTMs at which bonds of various maturities would trade at par value. Forward rates are expected future short-term rates. (Module 57.1, LOS 57.c)

For a portfolio consisting solely of short-term U.S. government bonds: A) estimates of empirical and analytical durations should be similar. B) analytical duration would be the preferable risk measure. C) empirical duration will be significantly lower than analytical duration.

A) estimates of empirical and analytical durations should be similar. A portfolio consisting solely of short-term U.S. government bonds should closely resemble the performance of its government benchmark yield. As a result, estimates of empirical duration should be similar to the portfolio's analytical durations. (Module 61.1, LOS 61.d)

Shares in a publicly traded company that owns gold mines and mining operations are considered: A) financial assets. B) physical assets. C) real assets.

A) financial assets. Financial assets, such as shares of stock in a company, are claims against physical or real assets.

An analyst is using the Herfindahl-Hirschman Index (HHI) to evaluate industry concentration. The industry has four firms with the following market shares: 45%, 25%, 20%, and 10%. This industry's concentration will be considered: A) high. B) low. C) moderate.

A) high. The HHI of this industry is equal to the summation of the squares of each market share. HHI = (45 × 45) + (25 × 25) + (20 × 20) + (10 × 10) = 3,150. An HHI greater than 2,500 is indicative of high concentration. Low concentration is less than 1,500, and moderate concentration is between 1,500 and 2,500. (Module 46.1, LOS 46.c)

Because of dividend displacement of earnings, the net effect on firm value of increasing the dividend payout ratio is: A) indeterminate. B) to decrease firm value. C) to increase firm value.

A) indeterminate. The net effect on firm value of increasing the dividend payout ratio is ambiguous because the positive effect of larger dividends may be offset by a negative effect on the firm's sustainable growth rate. If increasing the payout ratio always increased firm value, all firms would have 100% payout ratios.

Asset-based models are most appropriate when examining firms: A) that hold primarily liquid assets. B) with the same stock prices. C) with older assets compared to those with newer assets.

A) that hold primarily liquid assets. Asset-based analysis works best for firms that hold primarily tangible short-term assets and assets with readily available market values. (Module 48.3, LOS 48.f)

Two parties agree to a forward contract to exchange 100 shares of a stock one year from now for $72 per share. Immediately after they initiate the contract, the price of the underlying stock increases to $74 per share. This share price increase represents a gain for: A) the buyer B) the seller C) neither the buyer or seller

A) the buyer If the value of the underlying is greater than the forward price, this increases the value of the forward contract, which represents a gain for the buyer and a loss for the seller. (Module 72.1, LOS 72.a)

Jequa is a Japanese company with the following selected financial information: ¥ billions Net income from continuingoperations503 Depreciation & amortization256 Capital expenditures140 Cash flow from operations361 Dividends72 Jequa's funds from operations (FFO) is closest to: A) ¥759 billion. B) ¥247 billion. C) ¥149 billion.

A) ¥759 billion FFO is defined as net income from continuing operations plus depreciation, amortization, deferred taxes, and other noncash items. FFO = ¥503 + ¥256 = ¥759 billion. (Module 64.1, LOS 64.b)

A company issues a $1 million annual coupon floating-rate note (FRN) with a quoted annual market reference rate (MRR) of 3.5% plus a quoted margin (QM) of 80 basis points. With three years remaining until maturity, the MRR is quoted at the same 3.5% with a discount margin equal to 50 basis points. The estimated value of the FRN is closest to: A) $1,008,910. B) $1,008,325. C) $1,007,740.

B) $1,008,325. The coupon payments will be based on a rate of 4.3% (3.5% + 0.80%), and the discount rate will be equal to 4.0% (3.5% + 0.5%). Using a financial calculator, N = 3, I/Y = 4.0, FV = 1,000,000, PMT = 43,000 (4.3% of 1,000,000), and the computed PV = 1,008,325. (Module 56.1, LOS 56.a)

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

B) $1,091. This is a present value problem 5 years in the future. N = 20, PMT = 100, FV = 1000, I/Y = 9 CPT PV = -1,091.29 The $900 purchase price is not relevant for this problem.

Based on the advice of his financial advisor regarding dollar cost averaging, a client invests $2,000 each month into a blue-chip stock. The stock price on the date of purchase each month over a four-month stretch was $12, $14, $11, and $9. Using the harmonic mean, the average cost per share of the stock is closest to: A) $11.75. B) $11.20. C) $11.50.

B) $11.20. Note that the arithmetic mean stock price is $11.50, and because the harmonic mean will always be less than the arithmetic mean for any dataset with unequal values, $11.75 would never be possible. (Module 1.1, LOS 1.b)

If an investor buys 100 shares of a $50 stock on margin when the initial margin requirement is 40%, how much money must she borrow from her broker? A) $2,000. B) $3,000. C) $4,000.

B) $3,000. An initial margin requirement of 40% would mean that the investor must put up 40% of the funds and brokerage firm may lend the 60% balance. Therefore, for this example (100 shares) * ($50) = $5,000 total cost. $5,000 * 0.60 = $3,000.

A bond is priced at 95.80. Using a pricing model, an analyst estimates that a 25 bp parallel upward shift in the yield curve would decrease the bond's price to 94.75, while a 25 bp parallel downward shift in the yield curve would increase its price to 96.75. The bond's effective convexity is closest to: A) 3,340. B) -167. C) 4.

B) -167. Approximate effective convexity is calculated as [ V- + V+ - 2V0 ] / [ (V0)(change in curve)2 ]. [ 96.75 + 94.75 - 2(95.80) ] / [ (95.80)(0.0025)^2 ] = -167.01. (Module 60.1, LOS 60.a)

Given the following information, compute price/sales. Book value of assets = $550,000. Total sales = $200,000. Net income = $20,000. Dividend payout ratio = 30%. Operating cash flow = $40,000. Price per share = $100. Shares outstanding = 1,000. Book value of liabilities = $500,000. A) 2.50X. B) 0.50X. C) 2.00X.

B) 0.50X. Market value of equity = ($100)(1000) = $100,000 Price / Sales = $100,000 / $200,000 = 0.5X (Module 48.3, LOS 48.k)

If a company's operating income increases from $3 million to $3.3 million and its net income increases from $1.5 million to $1.8 million, its degree of financial leverage is closest to: A) 0.5. B) 2.0. C) 1.0.

B) 2.0. The degree of financial leverage (DFL) is a measure used to evaluate the extent to which a company uses debt relative to equity in its capital structure. The DFL is calculated by taking the change in net income and dividing it by the change in operating income. Here, net income increased by 20% ($1.5 million to $1.8 million) and operating income increased by 10% ($3 million to $3.3 million); 20% / 10% = 2.0. With the other answer options, 0.5 switches the numerator and denominator, and 1.0 just takes the $0.3 million change in both rather than the percentage changes. (Module 45.2, LOS 45.e)

Whitetail Company issues 73-day commercial paper that will pay $1,004 at maturity per $1,000 face value. The bond-equivalent yield is closest to: A) 2.02%. B) 2.00%. C) 1.97%.

B) 2.00%. The add-on yield for the 73-day holding period is $1,004 / $1,000 - 1 = 0.4%. The bond-equivalent yield, which is an add-on yield based on a 365-day year, is (365 / 73) × 0.4% = 2.0%. (Module 56.1, LOS 56.b)

An investor buys 1,000 shares of a stock on margin at a price of $50 per share. The initial margin requirement is 40% and the margin lending rate is 3%. The investor's broker charges a commission of $0.01 per share on purchases and sales. The stock pays an annual dividend of $0.30 per share. One year later, the investor sells the 1,000 shares at a price of $56 per share. The investor's rate of return is closest to: A) 12%. B) 27%. C) 36%.

B) 27%. The total purchase price is 1,000 × $50 = $50,000. The investor must post initial margin of 40% × $50,000 = $20,000. The remaining $30,000 is borrowed. The commission on the purchase is 1,000 × $0.01 = $10. Thus, the initial equity investment is $20,010. In one year, the sales price is 1,000 × $56 = $56,000. Dividends received are 1,000 × $0.30 = $300. Interest paid is $30,000 × 3% = $900. The commission on the sale is 1,000 × $0.01 = $10. Thus, the ending value is $56,000 − $30,000 + $300 − $900 − $10 = $25,390. The return on the equity investment is $25,390 / $20,010 − 1 = 26.89%. (Module 41.2, LOS 41.f)

An analyst wants to estimate the yield to maturity on a non-traded 4-year, annual pay bond rated A. Among actively traded bonds with the same rating, 3-year bonds are yielding 3.2% and 6-year bonds are yielding 5.0%. Using matrix pricing the analyst should estimate a YTM for the non-traded bond that is closest to: A) 3.6%. B) 3.8%. C) 4.1%.

B) 3.8%. Interpolating: 3.2% + [(4 - 3) / (6 - 3)] × (5.0% - 3.2%) = 3.8% (Module 54.1, LOS 54.c)

When a company's return on equity (ROE) is 12% and the dividend payout ratio is 60%, what is the implied sustainable growth rate of earnings and dividends? A) 4.0%. B) 4.8%. C) 7.8%.

B) 4.8%. growth = ROE × retention ratio = ROE × (1 - payout ratio) = 12 (0.4) = 4.8%

Given that the two-year spot rate is 5.89% and the one-year forward rate one-year from now is 6.05%, assuming annual compounding what is the one year spot rate? A) 5.67%. B) 5.73%. C) 5.91%.

B) 5.73%. Spot Rate = ( 1 + Spot Rate)^2 / ( 1 + Forward Rate) ^1. - 1 = 5.73%

A bond portfolio consists of a AAA bond, a AA bond, and an A bond. The prices of the bonds are $1,050, $1,000, and $950 respectively. The durations are 8, 6, and 4 respectively. What is the duration of the portfolio? A) 6.00. B) 6.07. C) 6.67.

B) 6.07. The duration of a bond portfolio is the weighted average of the durations of the bonds in the portfolio. The weights are the value of each bond divided by the value of the portfolio: portfolio duration = 8 × (1050 / 3000) + 6 × (1000 / 3000) + 4 × (950 / 3000) = 2.8 + 2 + 1.27 = 6.07.

Annual Returns on ABC Mutual FundYr 1Yr 2Yr 3Yr 4Yr 5Yr 6Yr 7Yr 8Yr 9Yr 1011.0%12.5%8.0%9.0%13.0%7.0%15.0%2.0%-16.5%11.0% Assuming a mean of 7.2%, what is the sample standard deviation of the returns for ABC Mutual Fund for the period from Year 1 to Year 10? A) 7.8%. B) 9.1%. C) 9.8%.

B) 9.1%. Standard deviation = [∑i (xi - X)2 / (n - 1)]1/2 = (744.10 / 9) 1/2 = = 9.1%. (Module 3.1, LOS 3.b)

Which of the following is NOT a reason bond market indexes are more difficult to create than stock market indexes? A) There is a lack of continuous trade data available for bonds. B) Bond deviations tend to be relatively constant. C) The universe of bonds is much broader than that of stocks.

B) Bond deviations tend to be relatively constant. Bond prices are quite volatile as measured by the bond's duration. (Module 42.2, LOS 42.j)

Which of the following statements most accurately describes a data processing method? A) Capture focuses on how data moves from the underlying source to the analytical tool. B) Curation focuses on data quality and accuracy through data cleaning. C) Search focuses on how data will be recorded and archived.

B) Curation focuses on data quality and accuracy through data cleaning. Curation refers to ensuring the quality and accuracy of data. Capture refers to collecting and transforming data in preparation for analysis. Search refers to the ways data will be queried. (Module 11.1, LOS 11.c)

Which measure of duration should be matched to the bondholder's investment horizon so that reinvestment risk and market price risk offset each other? A) Effective duration. B) Macaulay duration. C) Modified duration.

B) Macaulay duration. Macaulay duration is the investment horizon at which reinvestment risk and market price risk approximately offset each other.

Which of the following statements regarding primary and secondary markets is least accurate? A) New issues of government securities can be sold on the primary market. B) Prevailing market prices are determined by primary market transactions and are used in pricing new issues. C) Secondary market transactions occur between two investors and do not involve the firm that originally issued the security.

B) Prevailing market prices are determined by primary market transactions and are used in pricing new issues. Prevailing market prices are determined by the transactions that take place on the secondary market. This information is used to determine the price of new issues sold on primary markets.

In forecasting revenue for the next year, an analyst is most likely going to exclude which of the following situations from his forecasted number? A) Gains on the sales of aged fixed assets that were replaced by newer assets with longer useful lives. B) Significant gains due to the remeasurement of subsidiary financial statements. C) Losses stemming from the launch of a new product that is not expected to be profitable for two years.

B) Significant gains due to the remeasurement of subsidiary financial statements. In forecasting revenue, an analyst will look to exclude nonrecurring items because they are not deemed to be sustainable going forward. Gains due to the remeasurement of subsidiary financial statements result from exchange rate changes, and those are not predictable. The sale and replacement of aged fixed assets occurs on a regular basis for companies, and new products often lose money early on. These would not be excluded because they are not considered nonrecurring. (Module 47.1, LOS 47.b)

Which of the following entities play a critical role in the ability to create a securitized bond with a higher credit rating than the corporation? A) Rating agencies. B) Special purpose entities. C) Investment banks.

B) Special purpose entities. Special purpose entities (SPEs), buy the assets from the corporation. The SPE separates the assets used as collateral from the corporation that is seeking financing. This shields the assets from other creditors. (Module 50.1, LOS 50.b)

The special purpose entity (SPE) in a securitization is: A) a subsidiary of the seller. B) an entity independent of the seller. C) a joint venture partner of the seller.

B) an entity independent of the seller. The SPE in a securitization must be a legal entity independent of the seller so that the seller's creditors do not have a claim against the securitized assets. (Module 65.1, LOS 65.b)

What happens to bond durations when coupon rates increase and maturities increase? As coupon rates increase, duration: As maturities increase, duration: A) decreases. decreases B) decreases. increases C) increases. increases

B) decreases. increases As coupon rates increase the duration on the bond will decrease because investors are receiving more cash flow sooner. As maturity increases, duration will increase because the payments are spread out over a longer period of time. (Module 59.1, LOS 59.b)

Which of the following statements about the constant growth dividend discount model (DDM) in its application to investment analysis is least accurate? The model: A) can't be applied when g > K. B) is best applied to young, rapidly growing firms. C) is inappropriate for firms with variable dividend growth

B) is best applied to young, rapidly growing firms. The model is most appropriately used when the firm is mature, with a moderate growth rate, paying a constant stream of dividends. In order for the model to produce a finite result, the company's growth rate must not exceed the required rate of return.

If interest rates decrease by 50 basis points, a 10-year, 6% coupon, option-free bond will increase in price by $36. If instead interest rates increase by 50 basis points, this bond's price will decrease by: A) $36. B) less than $36. C) more than $36.

B) less than $36. The bond described will have positive convexity. Because of convexity, the bond's price will decrease less as a result of a given increase in interest rates than it will increase as a result of an equivalent decrease in interest rates. (Module 60.1, LOS 60.a)

An analyst, who is a CFA Institute member, manages a high-grade bond mutual fund. This is his only professional responsibility. When the analyst comes across a speculative stock investment that he feels is a good investment for his personal portfolio, the analyst: A) is in violation of Standard IV(A), Loyalty to Employer, by spending time analyzing stocks when he should only analyze bonds. B) may invest in the stock because the analyst would not purchase the stock for the bond portfolio he manages. C) must notify his supervisor about the stock according to Standard VI(B), Priority of Transactions, to see if it is appropriate for the portfolio that he manages.

B) may invest in the stock because the analyst would not purchase the stock for the bond portfolio he manages. The problem says the analyst "came across" the speculative stock investment. We do not know if the analyst neglected his duties. Since such an investment is clearly not appropriate for a high-grade bond fund, the analyst may invest in the stock without any restrictions relating to the fund.

A Type I error: A) rejects a false null hypothesis. B) rejects a true null hypothesis. C) fails to reject a false null hypothesis.

B) rejects a true null hypothesis. A Type I Error is defined as rejecting the null hypothesis when it is actually true. The probability of committing a Type I error is the significance level or alpha risk. (Module 8.1, LOS 8.a)

When using a security market index to represent a market's performance, the performance of that market over a period of time is best represented by: A) the index value. B) the percent change in the index value. C) the change in the index value.

B) the percent change in the index value. Percentage changes in the value of a security market index over time represent the performance of the market, segment, or asset class from which the securities are chosen. (Module 42.1, LOS 42.a)

The estimated slope coefficient in a simple linear regression is: A) the predicted value of the dependent variable, given the actual value of the independent variable. B) the ratio of the covariance of the regression variables to the variance of the independent variable. C) the change in the independent variable, given a one-unit change in the dependent variable.

B) the ratio of the covariance of the regression variables to the variance of the independent variable. The estimated slope coefficient in a simple linear regression is CovX,Yσ2XCovX,YσX2, where Y is the dependent variable and X is the independent variable. The estimated slope coefficient is interpreted as the change in the dependent variable, given a one-unit change in the independentvariable. The predicted value of the dependent variable must consider the estimated intercept term along with the estimated slope coefficient. (Module 10.1, LOS 10.a)

A 7% callable semiannual-pay bond with a $1,000 face value has 20 years to maturity. If the yield to maturity is 8.25% and the yield to call is 9.25% the value of the bond is closest to: A) $797. B) $836. C) $879.

C) $879. The price of a bond is equal to the present value of future cash flows discounted at the yield to maturity. N = 20 × 2 = 40; I/Y = 8.25/2 = 4.125; PMT = 70/2 = 35; FV = 1,000; Compute PV = 878.56. Note that the yield to call cannot be used here to calculate the bond value, because the call date is not given. (Module 54.1, LOS 54.a)

Given a bond with a modified duration of 1.93, if required yields increase by 50 basis points, the price would be expected to decrease by: A) 0.009%. B) 1.930%. C) 0.965%.

C) 0.965%. Modified duration indicates the expected percent change in a bond's price given a 1% (100 bp) change in yield to maturity. For a 50 bp (0.5%) increase in YTM, the price of a bond with modified duration of 1.93 should decrease by approximately 0.5(1.93%) = 0.965%. (Module 61.1, LOS 61.b)

Assume that one- and two-year risk-free rates are 1.80% and 2.50%, respectively. Using the cash flow additivity principle, the one-year reinvestment rate, one year from now is closest to: A) 3.5%. B) 2.8%. C) 3.2%.

C) 3.2%. (1.025)^2 / (1.018). - 1 = 3.2%

Every six months a bond pays coupon interest equal to 3% of its par value. This bond is a: A) 3% semiannual coupon bond. B) 6% annual coupon bond. C) 6% semiannual coupon bond.

C) 6% semiannual coupon bond. The coupon rate on a bond is the percentage of its par value that it pays in interest each year. The coupon frequency states how often the bond will pay interest. A 6% semiannual coupon bond pays interest twice per year with each coupon equaling half of 6%, or 3%, of par value.

What is the yield to call on a bond that has an 8% coupon paid annually, $1,000 face value, 10 years to maturity and is first callable in 6 years? The current market price is $1,100. The call price is the face value plus 1-year's interest. A) 7.14%. B) 6.00%. C) 7.02%.

C) 7.02%. N = 6; PV = -1,100.00; PMT = 80; FV = 1,080; Compute I/Y = 7.02%. (Module 55.1, LOS 55.a)

What is the market-cap weighted index of the following three stocks assuming the beginning index value is 100 and a base value of $150,000? As of December 31CompanyStock PriceShares OutstandingX$15,000Y$202,500Z$601,000 A) 30. B) 100. C) 77.

C) 77. The market-cap weighted index = [(($1)(5,000) + ($20)(2,500) + ($60)(1,000))/$150,000](100) = ($115,000/$150,000)(100) = (0.767)(100) = 76.67 or 77 (Module 42.1, LOS 42.e)

At the end of the last 12-month period, Romano's Italian Foods had net income of $16.68 million and equity of $115 million. Romano's declared a $7.5 million dividend for the year. Using internally generated funds, Romano's can grow its equity by approximately: A) 14.5% per year. B) 10.0% per year. C) 8.0% per year.

C) 8.0% per year. g = ROE × retention rate = [16.68 / 115] × [1 − (7.5 / 16.68)] = 0.145 × (1 − 0.45) = 7.975%. This growth rate represents the rate at which a company can grow its equity using internally generated funds. (Module 48.2, LOS 48.h)

Assume that the following returns are a sample of annual returns for firms in the clothing industry. Firm 1. 15% Firm 2. 2% Firm 3. 5% Firm 4. (7%) Firm 5. 0% The sample standard deviation is closest to: A) 5.7. B) 7.2. C) 8.0.

C) 8.0. The sample variance is found by taking the sum of all squared deviations from the mean and dividing by (n - 1). [(15 - 3)2 + (2 - 3)2 + (5 - 3)2 + (-7 - 3)2 + (0 - 3)2] / (5 - 1) = 64.5 The sample standard deviation is found by taking the square root of the sample variance. √64.5 = 8.03 (Module 3.1, LOS 3.b)

Which of the following statements concerning kurtosis is most accurate? A) A distribution with kurtosis of +2 has fatter tails than a normal distribution. B) A leptokurtic distribution has excess kurtosis less than zero. C) A leptokurtic distribution has fatter tails than a normal distribution.

C) A leptokurtic distribution has fatter tails than a normal distribution. A leptokurtic distribution is more peaked than normal and has fatter tails. However, the excess kurtosis is greater than zero.

Daniel Ferramosco is concerned that a long-term bond he holds might default. He therefore buys a contract that will compensate him in the case of default. What type of contract does he hold? A) Physical derivative contract. B) Primary derivative contract. C) Financial derivative contract.

C) Financial derivative contract. Daniel holds a derivative contract that has a value determined by another financial contract; in this case, the long-term bond. (Module 41.1, LOS 41.c)

The mean and standard deviation of returns on three portfolios are listed below in percentage terms: Portfolio X: Mean 5%, standard deviation 3%. Portfolio Y: Mean 14%, standard deviation 20%. Portfolio Z: Mean 19%, standard deviation 28%. Using Roy's safety first criteria and a threshold of 3%, which of these is the optimal portfolio? A) Portfolio Z. B) Portfolio Y. C) Portfolio X.

C) Portfolio X. According to the safety-first criterion, the optimal portfolio is the one that has the largest value for the SFRatio (mean - threshold) / standard deviation. For Portfolio X, (5 - 3) / 3 = 0.67. For Portfolio Y, (14 - 3) / 20 = 0.55. For Portfolio Z, (19 - 3) / 28 = 0.57. (Module 5.1, LOS 5.c)

Which of the following is most accurate about a bond with positive convexity? A) Positive changes in yield lead to positive changes in price. B) Price increases and decreases at a faster rate than the change in yield. C) Price increases when yields drop are greater than price decreases when yields rise by the same amount.

C) Price increases when yields drop are greater than price decreases when yields rise by the same amount. A convex price/yield graph has a larger increase in price as yield decreases than the decrease in price when yields increase. (Module 60.1, LOS 60.a)

Which one of the following statements best describes the components of the required interest rate on a security? A) The real risk-free rate, the default risk premium, a liquidity premium and a premium to reflect the risk associated with the maturity of the security. B) The nominal risk-free rate, the expected inflation rate, the default risk premium, a liquidity premium and a premium to reflect the risk associated with the maturity of the security. C) The real risk-free rate, the expected inflation rate, the default risk premium, a liquidity premium and a premium to reflect the risk associated with the maturity of the security.

C) The real risk-free rate, the expected inflation rate, the default risk premium, a liquidity premium and a premium to reflect the risk associated with the maturity of the security. The required interest rate on a security is made up of the nominal rate which is in turn made up of the real risk-free rate plus the expected inflation rate. It should also contain a liquidity premium as well as a premium related to the maturity of the security. (Module 1.1, LOS 1.a)

Which of the following statements about the efficient market hypothesis (EMH) is most accurate? A) The semistrong form of the EMH states that current security prices fully reflect all public and nonpublic information, both market and nonmarket. B) The weak form of the EMH maintains that current security prices fully reflect all past information. C) The strong form of the EMH implies that no group of investors should be able to consistently achieve positive abnormal returns.

C) The strong form of the EMH implies that no group of investors should be able to consistently achieve positive abnormal returns. If the strong form of the EMH holds, no group of investors should be able to achieve positive abnormal returns consistently. The weak form addresses only past price and trading volume information, not all information. The semistrong form of the EMH does not assume that current security prices reflect nonpublic information. (Module 43.1, LOS 43.d)

To test a hypothesis that the population correlation coefficient of two variables is equal to zero, an analyst collects a sample of 24 observations and calculates a sample correlation coefficient of 0.37. Can the analyst test this hypothesis using only these two inputs? A) No, because the sample means of the two variables are also required. B) No, because the sample standard deviations of the two variables are also required. C) Yes.

C) Yes. The t-statistic for a test of the population correlation coefficient is where r is the sample correlation coefficient and n is the sample size. (Module 9.1, LOS 9.a)

An advantage of the bootstrap method of estimating the standard error of sample means, compared to estimating it based on a sample variance, is that the bootstrap method: A) only requires one sample to be taken. B) is less computationally demanding. C) can be applied to complex statistics.

C) can be applied to complex statistics. Calculating the standard error of sample means based on a single sample variance is most appropriate when the sample is unbiased and the population is approximately normally distributed. When these conditions do not hold, the bootstrap method may be more appropriate. This method is more computationally demanding in that it requires the analyst to calculate the means of multiple samples from the full dataset. (Module 7.1, LOS 7.c)

Suppose the 3-year spot rate is 12.1% and the 2-year spot rate is 11.3%. Which of the following statements concerning forward and spot rates is most accurate? The 1-year: A) forward rate one year from today is 13.7%. B) forward rate two years from today is 13.2%. C) forward rate two years from today is 13.7%.

C) forward rate two years from today is 13.7%.

Compared to a term repurchase agreement, an overnight repurchase agreement is most likely to have a: A) higher repo rate and repo margin. B) lower repo rate and higher repo margin. C) lower repo rate and repo margin.

C) lower repo rate and repo margin. Both the repo rate and the repo margin tend to be higher for longer repo terms. Therefore an overnight repo should have a lower repo rate and a lower repo margin than a term (i.e., longer than overnight) repo.

The measure of an asset's value that can most likely be determined without estimation is its: A) fundamental value. B) intrinsic value. C) market value.

C) market value. The current price of a traded asset is its market value. An asset's intrinsic or fundamental value is the price a rational investor with complete information about the asset would pay for it.

Octagon Advisors believes that the market is semi-strong efficient. The firm's portfolio managers most likely will use: A) an enhanced indexing strategy that relies on trading patterns. B) active portfolio management strategies. C) passive portfolio management strategies.

C) passive portfolio management strategies. If the market is semi-strong efficient, portfolio managers should use passive management because neither technical analysis nor fundamental analysis will generate positive abnormal returns on average over time. (Module 43.1, LOS 43.e)

The providers of the Smith 30 Stock Index remove Jones Company from the index because it has been acquired by another firm, and replace it with Johnson Company. This change in the index is best described as an example of: A) rebalancing. B) redefinition. C) reconstitution.

C) reconstitution.

Bo Rigley, CFA, is a financial analyst examining large-cap equity returns over a calendar year. His sample size is 252 trading days, and he observes a mean return of 0.07% and a standard deviation of 0.12%. With his null hypothesis that the daily portfolio return is equal to zero and a 10% level of significance, Rigley will: A) not reject the null because the test statistic is less than the critical value. B) not reject the null because the test statistic is greater than the critical value. C) reject the null because the test statistic is greater than the critical value.

C) reject the null because the test statistic is greater than the critical value. At a 10% level of significance, the critical z-values for a two-tailed test are + or -1.645, so the decision rule is to reject the null if the test statistic < -1.645 or > +1.645. With a sample size of 252 and a standard deviation of 0.12%, the standard error is equal to: (0.12%) / (square root of 252) = 0.0075593% The test statistic is equal to: 0.0007 / 0.0075593 = 9.26 Because the test statistic of 9.26 > 1.645, Rigley will reject the null that the daily equity return is equal to zero. (Module 8.2, LOS 8.b)

Extension in an agency residential mortgage-backed security is most likely to result from: A) a decrease in interest rates. B) exhaustion of a support tranche. C) slower-than-expected prepayments.

C) slower-than-expected prepayments. An agency RMBS is said to extend when prepayments of the underlying mortgages are slower than expected. A decrease in interest rates would tend to accelerate prepayments, resulting in contraction. Agency RMBS are not typically structured with tranches. Exhaustion of a support tranche is a source of extension risk for a planned amortization class of a CMO. (Module 67.1, LOS 67.a)

Bonds issued by the International Monetary Fund (IMF) are most accurately described as: A) quasi-government bonds. B) non-sovereign government bonds. C) supranational bonds.

C) supranational bonds. Supranational bonds are issued by multilateral organizations such as the IMF. Quasi-government bonds are issued by agencies established or sponsored by national government. Non-sovereign government bonds are issued by state, provincial, and local government or municipal entities. (Module 53.1, LOS 53.a)

The bonds of Grinder Corp. trade at a G-spread of 150 basis points above comparable maturity U.S. Treasury securities. The option adjusted spread (OAS) on the Grinder bonds is 75 basis points. Using this information, and assuming that the Treasury yield curve is flat: A) the zero-volatility spread is 225 basis points. B) the zero-volatility spread is 75 basis points. C) the option cost is 75 basis points.

C) the option cost is 75 basis points. The option cost is the difference between the zero volatility spread and the OAS, or 150 − 75 = 75 bp. With a flat yield curve, the G-spread and zero volatility spread will be the same. (Module 55.1, LOS 55.b)

Ethics are most accurately defined as: A) a belief about proper conduct. B) a written code of standards. C) the study of moral principles.

C) the study of moral principles.

The last dividend paid on a common stock was $2.00, the growth rate is 5% and investors require a 10% return. Using the infinite period dividend discount model, calculate the value of the stock. A) $42.00. B) $13.33. C) $40.00.

A) $42.00. 2(1.05) / (0.10 - 0.05) = $42.00 (Module 48.2, LOS 48.h)

Wendy Jones, CFA, is reviewing a current bond holding. The bond's duration is 10 and its convexity is 200. Jones believes that interest rates will decrease by 100 basis points. If Jones's forecast is accurate, the bond's price will change by approximately: A) +11.0%. B) -8.0%. C) +8.0%.

A) +11.0%. You can answer this question without calculations. A decrease in interest rates must cause the price to increase. Because duration alone will underestimate a price increase, the price must increase by more than 10%.

For two random variables, P(X = 2, Y = 10) = 0.3, P(X = 6, Y = 2.5) = 0.4, P(X = 10, Y = 0) = 0.3. Given that E(X) is 6 and E(Y) is 4, the covariance of X and Y is: A) -12.0. B) 24.0. C) 6.0

A) -12.0. The covariance is COV(XY) = ((0.3 × ((2 - 6) × (10 - 4))) + ((0.4 × ((6 - 6) × (2.5 - 4))) + (0.3 × ((10 - 6) × (0 - 4))) = -12.

A bond's duration is 4.5 and its convexity is 87.2. If interest rates rise 100 basis points, the bond's percentage price change is closest to: A) -4.06%. B) -4.50%. C) -4.94%.

A) -4.06%. Recall that the percentage change in prices = Duration effect + Convexity effect = [-duration × (change in yields)] + [(½)convexity × (change in yields)2] = (-4.5)(0.01) + (½)(87.2)(0.01)^2 = -4.06%. Remember that you must use the decimal representation of the change in interest rates when computing the duration and convexity adjustments.

A stock that pays no dividend is currently priced at €42.00. One year ago the stock was €44.23. The continuously compounded rate of return is closest to: A) -5.17%. B) +5.17%. C) -5.04%.

A) -5.17%. ln (42.0 / 44.23) = -5.17%

A coupon bond pays annual interest, has a par value of $1,000, matures in 4 years, has a coupon rate of $100, and a yield to maturity of 12%. The current yield on this bond is: A) 10.65%. B) 11.25%. C) 9.50%.

A) 10.65%. FV = 1,000; N = 4; PMT = 100; I = 12; CPT → PV = 939.25. Current yield = coupon / current price 100 / 939.25 × 100 = 10.65

The current 4-year spot rate is 4% and the current 5-year spot rate is 5.5%. What is the 1-year forward rate in four years? A) 11.72%. B) 10.14%. C) 9.58%.

A) 11.72%. ((1.0505)^5 / (1.04)^4)) -1 =0.1172 (Module 57.1, LOS 57.b)

A stock has a required return of 14% percent, a constant growth rate of 5% and a retention rate of 60%. The firm's P/E ratio should be: A) 4.44. B) 5.55. C) 6.66.

A) 4.44. P/E = (1 - RR) / (k - g) = 0.4 / (0.14 - 0.05) = 4.44

What is the standard deviation of a portfolio if you invest 30% in stock one (standard deviation of 4.6%) and 70% in stock two (standard deviation of 7.8%) if the correlation coefficient for the two stocks is 0.45? A) 6.20%. B) 0.38%. C) 6.83%.

A) 6.20%. The standard deviation of the portfolio is found by: [W12 σ12 + W22 σ22 + 2W1W2σ1σ2r1,2]0.5, or [(0.30)2(0.046)2 + (0.70)2(0.078)2 + (2)(0.30)(0.70)(0.046)(0.078)(0.45)]0.5 = 0.0620, or 6.20%. (Module 5.1, LOS 5.a)

In explaining aggregate bond indices to her client, Ashley James references the Bloomberg Barclays Aggregate Index. Which of the following characteristics described by James to her client is most accurate? A) Bonds included come from many sectors and currencies. B) Highly rated, high-yield, and unrated bond issuances are all included. C) There is no minimum size for bonds in the index.

A) Bonds included come from many sectors and currencies. An aggregate index like the Bloomberg Barclays Aggregate Index will include a broad selection of bonds from many sectors and currencies (the Bloomberg Barclays Aggregate Index has bonds across 28 currencies). There are minimum size thresholds for bonds to be included in the index, and high-yield and unrated bond issuances are excluded. (Module 51.1, LOS 51.b)

If the probability of a Type I error decreases, then the probability of: A) a Type II error increases. B) incorrectly rejecting the null increases. C) incorrectly accepting the null decreases.

A) a Type II error increases. If P(Type I error) decreases, then P(Type II error) increases. A null hypothesis is never accepted. We can only fail to reject the null. (Module 8.1, LOS 8.a)

An investor has bought a European put option and written a European call option. Other things equal, a decrease in the risk-free rate will increase the value of: A) both of these option positions. B) neither of these option positions. C) only one of these option positions.

A) both of these option positions. A decrease in the risk-free rate would decrease call option values and increase put option values. Because this investor is short calls and long puts, both positions would increase in value. (Module 75.1, LOS 75.c)

Sarah Metz buys a 10-year bond at a price below par. Three years later, she sells the bond. Her capital gain or loss is measured by comparing the price she received for the bond to its: A) carrying value. B) original price less amortized discount. C) original purchase price.

A) carrying value. Capital gains and losses on bonds purchased at a discount or premium are measured relative to carrying value (original price plus amortized discount or minus amortized premium) from the constant-yield price trajectory, not from the purchase price.

To estimate the average time Level I CFA candidates spend preparing for the exam, an employee of ABC Investments decides to randomly survey candidates who work at ABC's offices, although he is unsure how well they represent the candidate population. This is most likely an example of: A) convenience sampling. B) stratified sampling. C) judgmental sampling.

A) convenience sampling. Convenience sampling refers to sampling an element of a population based on ease of access.

Fixed income classifications by geography most likely include: A) emerging market bonds. B) municipal bonds. C) supranational bonds.

A) emerging market bonds. Classifying fixed income securities as developed market or emerging market bonds is an example of classification by geography. Supranational bonds are a classification by type of issuer. Municipal bonds are a classification by type of issuer or by taxable status.

Which of the following statements about hypothesis testing is most accurate? A Type II error is the probability of: A) failing to reject a false null hypothesis. B) rejecting a true alternative hypothesis. C) rejecting a true null hypothesis.

A) failing to reject a false null hypothesis. The Type II error is the error of failing to reject a null hypothesis that is not true. (Module 8.1, LOS 8.a)

In comparing the price volatility of putable bonds to that of option-free bonds, a putable bond will have: A) less price volatility at higher yields. B) less price volatility at low yields. C) more price volatility at higher yields.

A) less price volatility at higher yields. The only true statement is that putable bonds will have less price volatility at higher yields. At higher yields the put becomes more valuable and reduces the decline in price of the putable bond relative to the option-free bond. On the other hand, when yields are low, the put option has little or no value and the putable bond will behave much like an option-free bond. Therefore at low yields a putable bond will not have more price volatility nor will it have less price volatility than a similar option-free bond.

A stock is said to be undervalued if its market price is: A) less than its intrinsic value. B) greater than its intrinsic value. C) less than its book value.

A) less than its intrinsic value.

Computing the internal rate of return of the inflows and outflows of a portfolio would give the: A) money-weighted return. B) net present value. C) time-weighted return.

A) money-weighted return. The money-weighted return is the internal rate of return on a portfolio that equates the present value of inflows and outflows over a period of time.

A Type I error is made when the researcher: A) rejects the null hypothesis when it is actually true. B) rejects the alternative hypothesis when it is actually true. C) fails to reject the null hypothesis when it is actually false.

A) rejects the null hypothesis when it is actually true. A Type I error is defined as rejecting the null hypothesis when it is actually true. It can be thought of as a false positive. A Type II error occurs when a researching fails to reject the null hypothesis when it is false. It can be thought of as a false negative. (Module 8.1, LOS 8.a)

When there is a linear relationship between an independent variable and the relative change in the dependent variable, the most appropriate model for a simple regression is: A) the log-lin model. B) the lin-log model. C) the log-log model.

A) the log-lin model. A regression of the form ln Y = b0 + b1X is appropriate when the relative change in the dependent variable is a linear function of the independent variable. (Module 10.3, LOS 10.f)

Wortel Industries has preferred stock outstanding that paying an annual dividend of $3.75 per share. If an investor wants to earn a rate of return of 8.5%, how much should he be willing to pay for a share of Wortel preferred stock? A) $31.88. B) $44.12. C) $42.10.

B) $44.12. To calculate the price, we need to discount the future dividend stream at the investor's required return. The stream of dividends is a perpetuity (a fixed dividend each year forever). Given the PV of a perpetuity = cash flow / discount rate Then price = $3.75 / 0.085 = $44.12 (Module 2.1, LOS 2.a)

What value would an investor place on a 20-year, $1,000 face value, 10% annual coupon bond, if the investor required a 9% rate of return? A) $879. B) $920. C) $1,091.

C) $1,091. N = 20; I/Y = 9; PMT = 100 (0.10 × 1,000); FV = 1,000; CPT → PV = 1,091.

A firm pays an annual dividend of $1.15. The risk-free rate (RF) is 2.5%, and the total risk premium (RP) for the stock is 7%. What is the value of the stock, if the dividend is expected to remain constant? A) $16.03. B) $25.00. C) $12.10.

C) $12.10. If the dividend remains constant, g = 0. P = D1 / (k-g) = 1.15 / (0.095 - 0) = $12.10 (Module 48.2, LOS 48.h)

An analyst gathered the following information about a company: The stock is currently trading at $31.00 per share. Estimated growth rate for the next three years is 25%. Beginning in the year 4, the growth rate is expected to decline and stabilize at 8%. The required return for this type of company is estimated at 15%. The dividend in year 1 is estimated at $2.00. The stock is undervalued by approximately: A) $0.00. B) $15.70. C) $6.40.

C) $6.40.

Parsons Inc. is issuing an annual-pay bond that will pay no coupon for the first five years and then pay a 10% coupon for the remaining five years to maturity. The 10% coupon interest for the first five years will all be paid (without additional interest) at maturity. If the annual YTM on this bond is 10%, the price of the bond per $1,000 of face value is closest to: A) $778. B) $856. C) $814

C) $814 This bond has no cash flows for the first five years. It then has a $100 cash flow for years 6 through 10. Additionally, the accrued interest ($500) that wasn't paid in the first five years would have to be paid at the end, along with the principal. A financial calculator using the CF/NPV worksheet can handle this type of problem. The required inputs are CF0 = 0, CF1 = 0, F1 = 5, CF2 = 100, F2 = 4, CF3 = 1,600, F3 = 1, NPV, I = 10%, CPT = 813.69. Note that CF3 is made up of the principal ($1,000) plus the remaining $100 coupon plus the accrued interest ($500) that was not paid during the first five years of the bond's life. (Module 54.1, LOS 54.a)

For a hypothesis test regarding a population parameter, an analyst has determined that the probability of failing to reject a false null hypothesis is 18%, and the probability of rejecting a true null hypothesis is 5%. The power of the test is: A) 0.95. B) 0.18. C) 0.82.

C) 0.82. The power of the test is 1 - the probability of failing to reject a false null (Type II error); 1 - 0.18 = 0.82. (Module 8.2, LOS 8.b)