exam learning 3

what are the three rules of short selling

1. can only be done in what is known as an "up market" where the market is appreciating, not declining. This is known as the uptick rule. 2. If a dividend is paid on the shares, the investor selling the shares short pays the dividend to the investor he borrowed the shares from. 3. An investor cannot borrow shares to sell short without providing some sort of collateral.

36. Which of the following does the U.S. central bank most often use to change the money supply? A. The discount rate. B. Open market operations. C. The required reserve ratio.

36. B Open market operations are the U.S. Federal Reserve's most often used tool for changing the money supply

37. The price of milk in a country increases from €1.00 per liter to €1.10 per liter, and the quantity supplied does not change. This suggests the elasticity of the short-run supply of milk in this country is equal to: A. infinity, and supply is perfectly elastic. B. zero, and supply is perfectly inelastic. C. infinity, and supply is perfectly inelastic.

37. B If quantity supplied does not respond to a change in price, supply is perfectly inelastic. For perfectly inelastic supply, elasticity equals zero.

38. In the short run, will an increase in the money supply increase the price level and real output? A. Both will increase in the short run. B. Neither will increase in the short run. C. Only one will increase in the short run.

38. A In the short run, an increase in the money supply will increase aggregate demand. The new

104. Which of the following statements regarding mortgage-backed securities (MBS) and collateral ized mortgage obligations (CMOs) is most accurate? A. M BS are created from CMOs. B. Creating CMOs does not reduce the overall prepayment risk of a mortgage passthrough security. C. The prepayment option of an MBS benefits the security holder.

104. B Creating a CMO can redistribute the prepayment risk among the tranches, but it does not alter the overall prepayment risk of a mortgage passthrough security. CMOs are created from MBS. The prepayment option benefits the issuer, or homeowner, not the investor

105. Which of the following statements about embedded options is least accurate? A. An investor benefits when a floating rate bond has an interest rate floor. B. The prepayment right granted with a mortgage favors the issuer/borrower. C. If the market value of a putable bond falls below the par value, the issuer will likely exercise the option.

105. C A put option may be exercised by the holder, not the issuer. The other statements are true. Interest rate floors benefit the holder by providing a lower limit (or minimum) on the interest rate the bondholder will receive. To understand why the prepayment right granted to a mortgage holder benefits the issuer, remember that the issuer here is the homeowner. The bank acts as a passthrough from the homeowner to the owner of a bond collateralized by the loan. The right to prepay if interest rates decrease is a benefit to the homeowner. If the homeowner prepays, the holder of the bond has reinvestment risk.

106. A $1,000 par, semiannual-pay bond is trading for 89.14, has a coupon rate of 8.75%, and accrued interest of $43.72. The clean price of the bond is: A. $847.69. 8. $891 .40. C. $935.12.

106. B The clean price of the bond is the quoted price, 89.14% of par value, which is $891.40.

107. An investor is considering floating-rate debt and other investments to protect against unexpected increases in inflation. Her friend suggests Treasury Inflation Protected Securities (TIPS) because the coupon rate is adjusted for inflation semiann ually. The friend also states on-the-run Treasury issues have narrower bid-ask spreads than other Treasury issues. Are the friend 's statements correct? A. Both of these statements are correct. B. Neither of these statements is correct. C. On ly one of these statements is correct.

107. C The friend is incorrect about TIPS (the coupon rate is fixed, the par value is adjusted for inflation) and is correct about the bid-ask spread for on-the-run issues (on-the-run issues are more liquid and, thus, have a narrower bid-ask spread).

108. For a domestic investor purchasi ng foreign bonds: A. appreciation of both the asset and the foreign currency benefits the domestic investor. 8. depreciation of both the asset and the foreign currency benefits the domestic investor. C. appreciation of the asset and depreciation of the foreign currency benefi t the domestic investor.

108. A When the foreign currency appreciates, each foreign currency-denominated cash flow buys more domestic currency units-increasing the domestic currency return from the investment. The appreciation of the foreign asset benefits the investor as well.

110. Which of the following statements regarding yield spreads is least accurate? The: A. option cost in percentage terms can be computed by subtracting te OAS from the zero-volatility spread. B. nominal yield spread measures the difference between the YTM on a risky bond and the YTM on a Treasury bond of similar maturity. C. zero-volatility spread is the constant spread that i.s added to each Treasury spot rate to equate the present value of a bond 's cash flows to the price of an otherwise identical option-free bond.

110. C The zero-volatility spread is the constant spread that is added to each Treasury spot rate to equate the present value of a bond's cash flows to its actual market price.

111. Which of the following statements about call options is least accurate? A. The buyer of a call option has a:n obligation to perform. B. A call option is in the money when the strike price is below the stock pnce. C. The lower the strike price relative to the stock's underlying price, the more the call option is worth.

111. A Call options represent an obligation to perform in the case of the seller. The owner of the option (buy) has the right, but not an obligation, to purchase an underlying good at a specified price for a specified time from the seller.

113. A 3-year annual-pay currency swap takes place between a New Zealand company with New Zealand dollars (NZD) and a U.S. company with U.S. dollars (USD). The New Zealand company swaps NZD for USD on which it makes end-of-period payments based on the rate in effect at the beginning of each period. The U.S. company makes fixed-rate payments in NZD. • The fixed swap rate at the initiation of the swap was 7%; at the end of the swap it was 8%. • The variable rate at the end of year 1 was 6%, at the end of year 2 was 8%, and at the end of year 3 was 7%. • At the beginning of the swap, one million USD were exchanged at a NZD/USD rate of 2. • At the end of the swap period, the exchange rate was NZD/USD 1.5. At the end of year 2, the: A. New Zealand company gives the U.S. company USD 60,000. B. U.S. company gives the New Zealand company USD 80,000. C. New Zealand company gives the U.S. company USO 80,000.

113. A In a foreign currency swap, both parties exchange full interest payments. The New Zealand company pays 6% variable on USO (USO 60,000). The U.S. company pays 7% fixed on NZD (NZD 140,000).

114. A dealer arranges an equity swap with a mutual fund. The notional principal on the swap is $50 million and quarterly payments have been scheduled. The mutual fund agrees to pay the dealer the return on the S&P 400 Midcap Index, which is currently at 1,038.4. Three months later it is 1,052.5. The dealer pays a fixed rate of 5.5% to the mutual fund, with payments made on the basis of 91 days in the period and 365 days in the year. What is the net payment and who makes it? A. Dealer pays $6,687. B. Dealer pays $1,364,546. C. Mutual fund pays $6,687.

114. A The dealer pays the fixed rate for 91 days. Dealer payment = (5.50%)(91 I 365)($50M) = $685,616.44. The fund pays the return on the Midcap Index: =(1052.5/1038.4)-1*50 The dealer is the net payer: $685,616.44 - $678,929.12 = $6,687.32

115. Which of the following statements about futures and forwards is most accurate? Futures: A. are subject to default risk, but forwards are not. B. are individualized contracts, but forwards are standardized. C. require that traders post margin in order to trade, but forwards typically require no cash transaction until the delivery date.

115. C Forwards are subject to default risk, but fotures are not. Forwards are individualized contracts, but fotures are standardized.

116. Which of the following statements about futures markets is most accurate? A. Hedgers accept market risk in exchange for expected profits. B. The futures exchange establishes the minimum price fluctuation for each contract. C. The role of the clearinghouse is to take an active position in the market to maintain a fair and orderly market by providing liquidity when the normal flow of orders is not adequate.

116. B A futures exchange sets the minimum price fluctuation, or "rick size," for the contracts that trade on that exchange. Speculators enter the futures market in pursuit of profit, accepting risk in the endeavor. Hedgers trade futures to reduce some pre-existing risk exposure. The clearinghouse takes no active position in the market but interposes itself between both parties to every transaction. Thus, the clearinghouse guarantees that traders in the future market will honor their obligations.

16. Fred Dean, CFA, has just taken a job as trader for LPC, a large insurance company. One of his first duties in his new position is to execute the purchase of a block of East Street Industries, a firm that is a major client of his previous employer. During his prior employment, Dean was informed directly by East Street's CEO that the company's sales have experienced a sudden drop and are 20% below current analyst estimates. This information has not yet been announced. In reviewing the research report supporting the purchase decision, Dean realizes that the buy decision is based on sales·forecasts that he knows are wrong. Which of the following actions would be the most appropriate for Dean to take according to CFA Institute Standards of Professional Conduct? A. Post the information about the drop in sales on an internet bulletin board to achieve public dissemination and inform his supervisor of the posting. B. Contact the CEO and urge him to make the information public and make the trade if he refuses. C. Request that the firm place East Street's stock on a restricted list and refuse to make any buy or sell trades of the company's stock.

16. B Standard II(A) Material Nonpublic Information requires that mem bers and candidates who possess material nonpublic information not act or cause others to act on the information. Putting the stock on a restricted list or refusing the trade are violations of this Standard since they involve acting or causing others to act on the nonpublic information he possesses. Dean should seek to have East Street make the information public. If East Street does not do so, Dean is not allowed to act on the information. Refusing to make the trade he was instructed to make would be "acting" on the information in this case. The obligation here is to the integrity of financial markets.

17. When members and candidates report performance data, according to the Code and Standards, it is: A. permissible to leave details out in a brief presentation. B. recommended that a minimum of five years performance history be included. C. a requirement to present composite performance rather than individual account performance.

17. A Members and candidates should consider the knowledge and sophistication of those receiving the performance information. Ifonly a brief presentation is given, members and candidates must make detailed information supporting the presentation available upon request. Individual account performance is permitted and no minim um number of years is recommended (these refer to GIPS, with which the Code and Standards do not require compliance). The primary requirement of Standard Ill(D) Performance Presentation is to not present false or misleading information.

18. Bob Sampson is employed by a mid-sized money management firm in Munich. He is the head portfolio manager for a Global Equities fund. The fund has been in existence for eight years. Beginning this year, the firm has decided to present performance information in compliance with the Global Investment Performance Standards (GIPS). To claim GIPS compliance, the firm must present at least: A. eight years of GIPS-compliant performance information. B. five years of GIPS-compliant performance information with no additional disclosure required for prior years. C. five years of GIPS-compliant performance information and may include non-compliant performance information since inception in the "Disclosures" section.

18. B GIPS require that, to claim compliance, firms must present GIPS-compliant performance information for a minim um of five years or since inception if in existence less than five years

A contrarian technical analyst is most likely to be bullish based on a: A. low put-call ratio. B. high volatility index. C. low mutual fund cash position.

21. B High levels of the VIX indicate that the outlook of investors is bearish. A contrarian interprets this as a bullish sign. Low mutual fund cash balances indicate that mutual fund managers are bullish, and, as a result, contrarians are bearish. A low put-call ratio indicates bullish investor sentiment, which a contrarian interprets as a bearish sign.

32. 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.

32. 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.

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

34. 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.

35. At the equilibrium levels of output and price in a competitive industry without taxes: A. consumer and producer surplus are equal. B. both consumer and producer surplus are maximized. C. the sum of producer and consumer surplus is maximized.

35. C At competitive equilibrium, the sum of consumer and producer surplus is at its maximum level. Neither consumer nor producer surplus is necessarily at a maximum at the equilibrium output and price. Which surplus is larger or smaller depends on the elasticities of supply and demand.

39. The law of diminishing marginal returns explains: A. the shape of the long-run average cost curve. B. the upward sloping portion of the short-run marginal cost curve. C. the upward sloping portion of the long-run marginal cost curve.

39. B The law of diminishing returns states that at some point, as more of a resource is used in a production process, holding other inputs constant, output increases at a decreasing rate. This accounts for the upward slope of the SRMC curve beyond that point. Returns to scale determine the shape of the long-run cost curves.

40. A firm in a perfectly competitive market will tend to expand its output as long as: A. its marginal revenue is positive. B. the market price is greater than the marginal cost. C. its marginal revenue is greater than the market price.

40. B Under perfect competition, each firm faces a flat demand curve. This means the price is constant and the marginal revenue line is flat. A company will contin ue to prod uce as long as MR > MC, so the competitive company will produce as long as P > MC. It will stop when MC = MR = P.

42. In utility analysis, a consumer's optimal bundle of goods lies on an indifference curve that is: A. most preferred by the consumer. 8. tangent to the consumer 's budget line. C. contained withi n the consumer 's opportunity set.

42. B Based on utility analysis, the optimum bundle of goods lies on the consumer's highest attainable indifference curve, at the point where this indifference curve is tangent to the consumer's budget line. The point of tangency is the only point at which this indifference curve intersects the consumer's opportunity set of attainable bundles. The consumer would prefer bundles that lie on higher indifference curves, but those bundles are unaffordable given the consumer's budget constraint.

50. A company that reports under U.S. GAAP and changes its inventory cost assumption from weighted average cost to last-in first-out is required to apply this change in accounting principle: A. retrospectively, and disclose the new cost flow method being used. B. prospectively, and explain the reasons for the change in the financial statement disclosures. C. retrospectively, and explain the reasons for the change in the financial statement disclosures.

50. B Under U.S. GAAP, a change to LIFO from another inventory cost method is an exception to the requirement of retrospective application of changes in an accounting principle. Instead of restating prior years' data, the firm uses the carrying value of inventory at the time of the change as the first LIFO layer. U.S. GAAP requires a company that is changing its inventory cost assumption to explain, in its financial statement disclosures, why the new method is preferable to the old method.

52. 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.

52. 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.

56. Compared to an operating lease, a capital lease will have what effects on operating income (earnings before interest and taxes) and net income in the first year? A. Both will be lower. B. Both will be higher. C. One will be lowerand one will be higher.

56. C With an operating lease, the entire lease payment (rent expense) is subtracted from operating income. With a capital lease, only depreciation is subtracted from operating income, so operating income is higher with a capital lease. Net income in the first year is lower with a capital lease because the sum of depreciation (operating expense) and interest (non-operating expense) is greater than the lease payment.

58. 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.

58. 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.

61. East Company incurs $110,000 of costs to establish technological feasibility of a new software application it hopes to sell and $90,000 of costs to develop the application. West Company incurs $110,000 of research costs related to a new product and $90,000 of development costs for the product. If East reports under U.S. GAAP and West reports under IFRS, these projects will: A. increase East's total assets more the West's total assets. B. increase West's total assets more than East's total assets. C. have the same effects on East's and West's total assets.

61. C Under U.S. GAAP, costs incurred to establish technological feasibility of software for sale are expensed, but software development costs incurred after technological feasibility has been established must be capitalized. Under IFRS, research costs are expensed as incurred and development costs are capitalized. Thus, both East and West will capitalize $90,000 of development costs.

62. A company that capitalizes costs instead of expensing them will have: A. higher income variability and higher cash flows from operations. B. lower cash flows from investing and lower income variability. C. lower cash flows from operations and higher profitability in early years.

62. B Capitalizing costs tends to smooth earnings and reduces investment cash flows. It will also increase cash flows from operatio11s and increase profitability in the early years.

Under accrual accounting, the payment of $15,000 at the end of fiscal year 20X8 for a special advertising campaign that will run for the first three months of 20X9 would affect the 20X8 financial statements by decreasing cash by $15,000 and generating a $15,000 increase in: A. advertising expense. B. a prepaid asset account. C. a prepaid liability account.

63. B When cash is paid before the expense is recognized in the income statement, a prepaid asset for this expense is increased and cash is decreased by the amount paid. A prepaid liability account would not be set up unless the expense is recorded before the cash payment is made.

66. Which of the following items would affect owners' equity and also appear on the income statement? A Dividends paid to shareholders. B. Unreal ized gains and losses on trading securities. C. Unrealized gains and losses on available-for-sale securities.

66. B Unreal ized gains and losses from trading securities are reflected in the income statement and affect owners' equity. However, unrealized gains and losses from available-for-sale securities are included in other comprehensive income. Transactions included in other com prehensive income affect equity but not net income. Dividends paid to shareholders reduce owners' equity but not net income.

Which of the following types of companies are more likely to use the payback method to evaluate capital projects? A. European companies and private companies. B. Asian companies and larger companies. C. European companies and larger companies.

72. A Surveys indicate that European companies and private companies tend to use the payback period criterion more than other types of companies.

76. Which of the following is least likely a problem associated with the internal rate of return (IRR) method of choosing investment projects? A. Using IRR to rank mutually exclusive projects assumes reinvestment of cash flows at the IRR. 8. For independent projects, the IRR and NPV can lead to different investment decisions. C. Ifthe project has an unconventional cash flow pattern, the result can be multiple IRRs.

76. B IRR and NPV LEad to the same decision when choosing independent projects but may lead to different decisions when choosing between projects.

79. In a case where a client's capacity 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.

79. 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.

86. A stock has the following data associated with it: • A required rate of return of 14%. • A return on equity of 15%. • An earnings retention rate of 40%. The stock's justified price-to-earnings ratio is closest to: A. 5.0. B. 6.7. c. 7.5.

86_ C P/E = dividend payout ratio/k -g dividend payout ratio I - 0.4 = 0.6 growth rare (g) = 0.4 x 15% = 6%

87. The required rate ofreturn used in the dividend discount model is least likely to be affected by a change in the: A. expected rate of inflation. B. real risk-free rate of return. C. growth rate of earnings and dividends.

87. C The expected growth rare in dividends is an input into the dividend discount model, bur the real risk-free rate, the expected inflation rate, and the risk premium are the components of the required rare of return

89. With regard to the implications of stock market efficiency for technical analysis and fundamental analysis, if market prices are: A. weak-form efficient, technical analysis that depends only on past trading data should be of limited or no value. B. semistrong-form efficient, fundamental analysis using the top-down approach should yield consistently superior returns. C. semistrong-form efficient, fundamental analysis using only publicly available market information should generate abnormal returns after considering risk and transaction costs.

89. A If capital markets are weak-form efficient and semistrong-form efficient, no publicly available information can be used to earn abnormal (risk-adjusted) returns.

what is short sellign

A short sale order, or a stock sold short, is an order to sell shares that a client does not own. As a result, the trader must borrow the stock from an existing client, sell the shares of the security and then buy the stock again to replace the shares he borrowed.

85. Which of the following statements about types of orders is least accurate? A. Market orders are orders to buy or sell at the best price available. B. Limit orders are orders to buy or sell at or away from the market price. C. A stop buy order is typically used to protect a short position in a security and is placed below the current market price.

A stop buy order is a conditional market order by which an investor directs the purchase of a stock if it rises to a certain price. Stop buys are placed above the current marker price. Limit orders can have marker price as the limit, used when lack of liquidity is a concern.

front runnning

Front running is the unethical practice of a broker trading an equity based on information from the analyst department before his or her clients have been given the information. Read more: Front Running Definition | Investopedia http://www.investopedia.com/terms/f/frontrunning.asp#ixzz49ZjwCH6K Follow us: Investopedia on Facebook

101. An investor has a 1-year, semiannual, 10% coupon bond which is priced at $1,025. Ifthe 6-month spot rate on a bond-equivalent basis is 8%, the 1-year theoretical spot rate as a BEY is: A. 6.4%. B. 7.3%. c. 8.0%.

Gives 6 month rate and need to calculate the 1 year. given all inputs to do so PV= 6 mo gain +1 year gain 6 mo gain= (1000*10%/2)/1.04 1 yr= (1000+50) / (1+r)^2 solve for r

high water mark

If a hedge fund has a high water mark, incentive fees are based on increases in investors' accounts above their highest previous values. As a result

11. Paul James, CFA, is a retail stock broker for a national financial services corporation. James 's client base is mainly comprised of small to medium sized individual accounts. James notices that one client in particular, Chet Young, Ph.D., is particularly adept at picking undervalued stocks. James decides to watch Young's trades and mimic them in his own account. 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.

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.

features of a bond affect the bond's interest rate in the following ways:

Maturity - The longer the maturity , the more sensitive, more cash flows will be affected over a longer period of time. Coupon Rates - Lower coupon more sensitive to interest rates. difference in the market yield and your yield will continue to widen, which will push your bond values down. Embedded Options - if i/y down value of the option becomes more valuable to the issuing company. P up as i/y down but held at the call or redemption price. This is because as rates decline it will become more likely that the issuer will call the bonds and that the holder will only receive the call price and not a true market price.

What is 'Operational Efficiency'

Operational efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally-efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation, without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.

efficient market hypothesis

The basic efficient market hypothesis of investment posits that the market cannot be beaten because it incorporates all important determinative information into current share prices. Therefore, stocks trade at the fairest value, meaning that they can't be purchased undervalued or sold overvalued. The theory determines that the only opportunity investors have to gain higher returns on their investments is through purely speculative investments that pose substantial risk.

Bond Equivalent Yield

The bond equivalent yield is simply the yield stated on a semiannual basis multiplied by 2. Thus, if you are given a semiannual yield of 3% and asked for the bond equivalent yield, the answer is 6%.

semi-strong form

The semi-strong form efficiency theory follows the belief that because all information that is public is used in the calculation of a stock's current price, investors cannot utilize either technical or fundamental analysis to gain higher returns in the market. Those who subscribe to this version of the theory believe that only information that is not readily available to the public can help investors boost their returns to a performance level above that of the general market.

strong form

The strong form version of the efficient market hypothesis states that all information - both the information available to the public and any information not publicly known - is completely accounted for in current stock prices, and there is no type of information that can give an investor an advantage on the market. Advocates for this degree of the theory suggest that investors cannot make returns on investments that exceed normal market returns, regardless of information retrieved or research conducted.

weak form

The weak form suggests that today's stock prices reflect all the data of past prices and that no form of technical analysis can be effectively utilized to aid investors in making trading decisions. allow that if fundamental analysis is used, undervalued and overvalued stocks can be determined, and investors can research companies' financial statements to increase their chances of making higher-than-market-average profits.

Mary Miller, CFA, manages the short-term cash position for Young Company. Miller can invest in one of three securities that will mature in 180 days: a Treasury bill priced at 97.5% of par, commercial paper with a bond-equivalent yield of 5.10%, and a 6-month certificate of deposit that will return 2.5% over the 180-day holding period. Miller should purchase the: A. Treasury bill. B. commercial paper. C. certificate of deposit.

To compare these short-term securities, state the return on each as a bond-equivalent yield. For the commercial paper, the BEY is given as 5.10%. The BEY for the certificate of deposit is 2.5% x 365 I 180 = 5.07%. For the Treasury bill, the BEY is [(100 - 97.5) I 97.5] x 365 I 180 = 5.20%. Miller should purchase the Treasury bill.

9. In calculating total firm assets for a GIPS-compliant performance statement, Allen Bund, CFA, finds that there is a mix of fee-paying and non-fee-paying accounts, some of which are discretionary and some of which are non-discretionary accounts. Should Bund include non discretionary accounts and non-fee-paying accounts in the calculation of total firm assets? Non-discretionary accounts A. Yes B. No C. No

Total firm assets must include all accounts whether discretionary or not and whether fee-paying or not.

91. A stock's price currently is $100. An analyst forecasts the following for the stock: • The normalized trailing price earnings (P/E) ratio will be 12x. • The stock is expected to pay a $5 dividend this coming year on projected earnings of $10 per share. If the analyst were to buy and hold the stock for the year, the projected rate of return based on these forecasts is closest to: A. 15%. B. 20%. c. 25%.

Use EPS and P/E ratios to find the price at the end of the year P = EPS x P/E = 10(12) = 120 Use the holding period equation to find return

31. An investment has an expected return of 10% with a standard deviation of 5%. If the returns are normally distributed, the chance of losing money is closest to: A. 2.5%. B. 5.0%. C. 16.0%.

Using the standard normal probability distribution, observation -mean 0 -10 z = 0-10/5= -2.0 , the chance of getting zero or less return standard deviation 5 (losing money) is 1 - 0.977.2 = 0.0228% or 2.28%. An alternative explanation: the expected return is 10%. To lose money means the return must fall below zero. Zero is about two standard deviations to the left of the mean. 50% of the time, a return will be below the mean, and 2.5% of the observations are below two standard deviations down. About 97.5% of the time, the return will be above zero. Thus, only about a 2.5% chance exists of having a value below zero. (Study Session 3, LOS 9.m)

97. Other things equal, for option-free bonds: A. a bond's value is more sensitive to yield increases than to yield decreases. B. the value of a long-term bond is more sensitive to interest rate changes than the. value of a short-term bond. C. the value of a low-coupon bond is less sensitive to interest rate changes than the value of a high-coupon bond.

b Long-term, low-coupon bonds are more sensitive than short-term and high-coupon bonds. Prices are more sensitive to rate decreases than to rate increases (duration rises as yields fall).

117. An investor can gain exposure to alternative investments by purchasing: A. convertible bonds of a high-yield issuer. B. a mortgage-backed security. C. an exchange-traded fund that tracks an emerging market index.

b By investing in a mortgage-backed security, an investor gains exposure to real estate, a category of alternative investments. Emerging markets are not classified as alternative investments. Neither convertible bonds nor high-yield bonds in general are classified as alternative investments, although some hedge funds (a class of alternative investments) invest in these assets.

95. Which of the following indexes is most likely to be rebalanced on a regular basis? A. Price-weighted index. B. Equal-weighted index. C. Market-capital ization weighted index.

b Equal-weighted indexes require regular and frequent rebalancing, because price changes of their component securities will cause component weights to drift away from their target weights. Price-weighted indexes and market-capitalization weighted indexes generally do not require regular rebalancing, because both the target weight and actual weight of each security varies with the price of that security.

112. Exchange-traded options are most likely to be available on: A. currencies. B. individual stocks. C. government bonds.

b Exchange-traded options are available on many individual stocks. Options on currencies and government bonds trade primarily over the counter.

14. Lunar Investment Management is a subsidiary of a larger company, Galaxy Financial. Lunar's CEO, Travis Howry, would like to have Lunar present GIPS-compliant performance data and has taken the steps necessary to ensure that Lunar 's performance presentation is compliant. He asks Galaxy's President, Don Wiggins, about Galaxy's interest in presenting GIPS-compliant performance data. Wiggins informs Howry that Galaxy is not interested. Lunar may: A. not claim compliance with GIPS because compliance must be made on a company-wide basis. B. claim compliance with GIPS as long as Lunar is presented to the public as a distinct business entity. C. claim partial compliance with GIPS if Lunar 's performance presentations are in compliance but disclose that Galaxy's are not and in which ways.

b Lunar can claim compliance as long as it has met the reporting requirements necessary and is held out to clients (advertised) as a distinct business entity. Claiming partial compliance is not allowed.

100. Which of the following statements about debt securities is most accurate? A. Insured bonds are bonds collateralized by an escrow of securities guaranteed by the U.S. government. B. Tax-backed municipal bonds are supported through revenues generated from projects that are funded in whole or in part with the proceeds of the original bond issue. C. A collateralized mortgage obligation is a derivative of a passthrough security with a payment structure that redistributes risk among investors in various tranches.

c Pre.funded municipal bonds are bonds collateralized by an escrow of securities guaranteed by the U.S. government. Revenue bonds are supported through revenues generated from projects that are funded with the proceeds of the original bond issue.

98. Which of the following is least likely a reason that floating rate bonds may trade at prices different from their par values? A. A time lag exists between the rate change in the market and the time when the coupon rate is reset. B. The fixed quoted margin on the floating rate security may differ from the margin required by the market. C. Resetting interest rates makes floating rate bonds more susceptible to the price risk that results from changing interest rates.

c Resetting interest rates makes the bond less, not more, susceptible to interest rate changes.

33. The crowding-out effect suggests that: A. government borrowing will lead to an increase in private savings. B. as government spending increases, so will incomes and taxes, and the higher taxes will reduce both aggregate demand and output. C. greater government deficits will drive up interest rates, thereby reducing private investment.

c The crowding-out effect refers to a reduction in private borrowing and investment as a result of higher interest rates generated by budget deficits that are financed by borrowing in the private loanable funds market.

96. Over the most recent period, Ladden Materials has seen slow growth, increased competition, and declining profitability in its industry. The phase of the industry life cycle for Ladden 's industry is most likely: A. mature. B. decline. C. shakeout.

c The shakeout phase of the industry life cycle is characterized by slowing growth, intense competition, and declining profitability. The mature phase is characterized by industry consolidation and little or no growth. In the decline phase of the industry lifecycle, growth is negative and excess capacity results.

92. Which of the following statements about short sales is least accurate? A. Proceeds from short sales cannot be withdrawn from the account. B. The short seller must pay the lender of the stock any dividends paid by the company. C. The short seller is required to replace the borrowed securities within six months of a short sale.

c There is no maximum time for which a security can be borrowed. It must be returned whenever the lender requires it to be.

90. The following data pertains to a firm's common stock: • The stock will pay no dividends for two years. • The dividend three years from now is expected to be $1. • Dividends are expected to grow at a 7% rate from that point onward. If an investor requires a 17% return on this investment, how much will the investor be willing to pay for this stock now? A. $6.24. B. $7.31. C. $8.26.

find price at year before dividend kicks in P2 uses D3. price is always one year before the dividend date. Solve for the PV of P2 to be received in two years.

99. An investor in the 28% tax bracket is considering buying one of the following securities: • A fully taxable Treasury security offering a 6.0% yield. • A municipal bond priced at par offering a 4.0% yield. The taxable-equivalent yield on the municipal bond is closest to: A. 2.9%. B. 4.3%. C. 5.6%.

taxable-equivalent yield = =--- tax exempt yield/1-marginal tax rate Notice that the higher the marginal tax rate, the higher the taxable equivalent yield would be needed in the taxable bond market.