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)
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)
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)
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.
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)
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.
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 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.
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)
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.
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)
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)
An investor buys a call option that has an option premium of $5 and an exercise price of $22.50. The current market price of the stock is $25.75. At expiration, the value of the stock is $23.00. The net profit/loss of the call position is closest to: A) −$4.50. B) $4.50. C) −$5.00.
A) −$4.50. The option is in-the-money by $0.50 ($23.00 − $22.50). The investor paid $5.00 for the call option, thus the net loss is −$4.50 ($0.50 − $5.00).
Mosaks, Inc., has a put option with an exercise price of $105. If Mosaks stock price is $115 at expiration, the value of the put option is: A) $0. B) $10. C) $105.
A) $0. The put has a value of $0 because it will not be exercised. Put value is Max(0, X − S).
Al Steadman receives a premium of $3.80 for writing a put option with an exercise price of $64. If the stock price at expiration is $84, Steadman's profit or loss from the options position is: A) $3.80. B) $16.20. C) $23.80.
A) $3.80. The put option will not be exercised because it is out-of-the-money, Max(0, X − S). Therefore, Steadman keeps the full amount of the premium, $3.80. (Module 69.2, LOS 69.b)
An annuity will pay eight annual payments of $100, with the first payment to be received one year from now. If the interest rate is 12% per year, what is the present value of this annuity? A) $496.76. B) $1,229.97. C) $556.38.
A) $496.76.
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%
John purchased 60% of the stocks in a portfolio, while Andrew purchased the other 40%. Half of John's stock-picks are considered good, while a fourth of Andrew's are considered to be good. If a randomly chosen stock is a good one, what is the probability John selected it? A) 0.75. B) 0.30. C) 0.40.
A) 0.75. Using the information of the stock being good, the probability is updated to a conditional probability: P(John | good) = P(good and John) /P(good). P(good and John) = P(good | John) × P(John) = 0.5 × 0.6 = 0.3. P(good and Andrew) = 0.25 × 0.40 = 0.10. P(good) = P(good and John) + P (good and Andrew) = 0.40. P(John | good) = P(good and John) / P(good) = 0.3 / 0.4 = 0.75. (Module 4.1, LOS 4.c)
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
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 of the following is most similar to a short position in the underlying asset? A) Buying a put. B) Writing a put. C) Buying a call.
A) Buying a put. Buying a put is most similar to a short position in the underlying asset because the put increases in value if the underlying asset value decreases. The writer of a put and the holder of a call have a long exposure to the underlying asset because their positions increase in value if the underlying asset value increases. (Module 41.2, LOS 41.e)
Which of the following is typically equal to zero at the initiation of an interest rate swap contract? A) Its value. B) Its price. C) neither its value or price
A) Its value. As with other derivatives, the price of an interest rate swap (the fixed rate specified in the contract) is typically set such that the value of the swap is zero at initiation. (Module 74.1, LOS 74.b)
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)
Which of the following statements about options is most accurate? A) The holder of a put option has the right to sell to the writer of the option. B) The holder of a call option has the obligation to sell to the option writer if the stock's price rises above the strike price. C) The writer of a put option has the obligation to sell the asset to the holder of the put option.
A) The holder of a put option has the right to sell to the writer of the option. The holder of a put option has the right to sell to the writer of the option. The writer of the put option has the obligation to buy, and the holder of the call option has the right, but not the obligation to buy. (Module 69.1, LOS 69.a)
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 futures contract, the adjustment for the change in settlement price from one day to the next will result in: A) a change in contract price but no change in contract value. B) changes in both the contract price and contract value. C) no change in contract price but a change in contract value.
A) a change in contract price but no change in contract value The mark to market adjustment to futures contracts resets the price of the futures contract to the new settlement price, which returns the value of the contract to zero each day. (Module 73.1, LOS 73.a)
If the margin balance in a futures account with a long position goes below the maintenance margin amount: A) a deposit is required to return the account margin to the initial margin level. B) a margin deposit equal to the maintenance margin is required within two business days. C) a deposit is required which will bring the account to the maintenance margin level.
A) a deposit is required to return the account margin to the initial margin level. Once account margin (based on the daily settlement price) falls below the maintenance margin level, it must be returned to the initial margin level, regardless of subsequent price changes.
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.
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)
A corporation that employs hedge accounting and uses derivatives to reduce the volatility of the value of its inventory is most likely using a: A) fair value hedge. B) cash flow hedge. C) net investment hedge.
A) fair value hedge. Using derivatives to hedge the changes in value of inventory is considered a fair value hedge. (Module 70.1, LOS 70.b)
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.
For exchange-traded derivatives, the role of the central clearinghouse is to: A) guarantee that all obligations by traders will be honored. B) maintain private insurance that can be used to provide funds if a trader defaults. C) stabilize the market price fluctuations of the underlying commodity.
A) guarantee that all obligations by traders will be honored. The central clearinghouse does not originate trades, it acts as the opposite party to all trades. In other words, it is the buyer to every seller and the seller to every buyer. This action guarantees that all obligations under the terms of the contract will be fulfilled. (Module 68.1, LOS 68.b)
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.
An investor will exercise a European put option on a stock at its expiration date if the stock price is: A) less than the exercise price. B) equal to the exercise price. C) greater than the exercise price.
A) less than the exercise price. A put option gives its owner the right to sell the underlying good at a specified exercise price for a specified time period. When the stock's price is less than the exercise price a put option has value and is said to be in-the-money. (Module 75.1, LOS 75.a)
Other things equal, the no-arbitrage forward price of an asset will be higher if the asset has: A) storage costs. B) dividend payments. C) convenience yield.
A) storage costs. Costs of holding an asset increase its no-arbitrage forward price. Benefits from holding the asset, such as dividends or convenience yield, decrease its no-arbitrage forward price.
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)
For a European style put option: A) time value is equal to its market price minus its exercise value. B) intrinsic value is equal to its market price plus its exercise value. C) exercise value is equal to the underlying stock price minus its ex
A) time value is equal to its market price minus its exercise value. The time value of an option (either a put or a call) is equal to its market price minus its exercise value. A put's exercise value is the maximum of zero or its exercise price minus the stock price. Intrinsic value is another term for exercise value. (Module 75.1, LOS 75.a)
For a series of forward contracts to replicate a swap contract, the forward contracts must have: A) values at swap initiation that sum to zero. B) values at swap expiration that sum to zero. C) values at swap initiation that are equal to zero
A) values at swap initiation that sum to zero. When replicating a swap with a series of forward contracts, each forward contract is likely to have a non-zero value at initiation, but they can replicate a swap with a value of zero at initiation if the values of the forward contracts sum to zero at swap initiation. (Module 74.1, LOS 74.a)
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)
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)
What is the value of a stock that paid a $0.25 dividend last year, if dividends are expected to grow at a rate of 6% forever? Assume that the risk-free rate is 5%, the expected return on the market is 10%, and the stock's beta is 0.5. A) $3.53. B) $17.67. C) $16.67.
B) $17.67. The discount rate is ke = 0.05 + 0.5(0.10 - 0.05) = 0.075. Use the infinite period dividend discount model to value the stock. The stock value = D1 / (ke - g) (0.25 × 1.06) / (0.075 - 0.06) = $17.67. (Module 48.2, LOS 48.h)
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.
Consider a call option with an exercise price of $32. If the stock price at expiration is $41, the value of the call option is: A) $0. B) $9. C) $41
B) $9. The call has a $9 ($41 − $32) value at expiration, because the holder of the call can exercise his right to buy the stock at $32 and then sell the stock on the open market for $41. The intrinsic value of a call at expiration is Max(0, S − X).
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)
Given the following probability distribution, find the covariance of the expected returns for stocks A and B. Event. P(Ri). RA. RB Recession 0.10 -5% 4% Below Average 0.30 2% 8% Normal 0.50 10% 10% Boom 0.10 31% 12% A) 3.2. B) 17.4. C) 10.9
B) 17.4. Find the weighted average return for each stock. Stock A: (0.10)(-5) + (0.30)(-2) + (0.50)(10) + (0.10)(31) = 7%. Stock B: (0.10)(4) + (0.30)(8) + (0.50)(10) + (0.10)(12) = 9%. Next, multiply the differences of the two stocks by each other, multiply by the probability of the event occurring, and sum. This is the covariance between the returns of the two stocks. [(-5 - 7) × (4 - 9)] (0.1) + [(-2 - 7) × (8 - 9)](0.3) + [(10 - 7) × (10 - 9)](0.5) + [(31 - 7) × (12 - 9)](0.1) = 6.0 + 2.7 + 1.5 + 7.2 = 17.4 (Module 5.1, LOS 5.b)
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)
A financial intermediary buys a stock and then resells it a few days later at a higher price. Which intermediary would this most likely describe? A) Broker. B) Dealer. C) Arbitrageur.
B) Dealer. This situation best describes a dealer. A dealer buys an asset for its inventory in the hopes of reselling it later at a higher price. Brokers stand between buyers and sellers of the same security at the same location and time. Arbitrageurs trade in the same security simultaneously in different markets. (Module 41.1, LOS 41.d)
Which of the following statements regarding the distribution of returns used for asset pricing models is most accurate? A) Normal distribution returns are used for asset pricing models because they will only allow the asset price to fall to zero. B) Lognormal distribution returns are used for asset pricing models because they will not result in an asset return of less than -100%. C) Lognormal distribution returns are used because this will allow for negative returns on the assets.
B) Lognormal distribution returns are used for asset pricing models because they will not result in an asset return of less than -100%. Lognormal distribution returns are used for asset pricing models because this will not result in asset returns of less than 100% because the lowest the asset price can decrease to is zero which is the lowest value on the lognormal distribution. The normal distribution allows for asset prices less than zero which could result in a return of less than -100% which is impossible. (Module 6.1, LOS 6.a)
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 forward rate 2y3y represents the interest rate on a loan for the period from: A) Year 2 to Year 3. B) Year 2 to Year 5. C) Year 3 to Year 5.
B) Year 2 to Year 5 2y3y is the 2-year forward 3-year rate, covering a period that begins two years from now and extends for three years after that. (Module 72.1, LOS 72.b)
A financial instrument with a payoff that depends on a specified event occurring is most accurately described as: A) a default swap. B) a contingent claim. C) an option.
B) a contingent claim. Contingent claims are contracts with payoffs that depend on a specified event occurring. Options and credit default swaps are examples of contingent claims, but neither of these terms describes all contingent claims. (Module 69.2, LOS 69.c)
A synthetic European call option includes a short position in: A) the underlying asset. B) a risk-free bond. C) a European put option.
B) a risk-free bond. Explanation A synthetic European call option consists of a long position in the underlying asset, a long position in a European put option, and a short position in a risk-free bond (i.e., borrowing at the risk-free rate).
In futures markets, the primary role of the clearinghouse is to: A) prevent arbitrage and enforce federal regulations. B) act as guarantor to both sides of a futures trade. C) reduce transaction costs by making contract prices public.
B) act as guarantor to both sides of a futures trade. Acting as the counterparty for all buyers and sellers is the primary role of the clearinghouse. By providing liquidity, the clearinghouse may also help lower transaction costs indirectly. (Module 68.1, LOS 68.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)
The real risk-free rate can be thought of as: A) approximately the nominal risk-free rate plus the expected inflation rate. B) approximately the nominal risk-free rate reduced by the expected inflation rate. C) exactly the nominal risk-free rate reduced by the expected inflation rate.
B) approximately the nominal risk-free rate reduced by the expected inflation rate. The approximate relationship between nominal rates, real rates and expected inflation rates can be written as: Nominal risk-free rate = real risk-free rate + expected inflation rate. Therefore we can rewrite this equation in terms of the real risk-free rate as: Real risk-free rate = Nominal risk-free rate - expected inflation rate The exact relation is: (1 + real)(1 + expected inflation) = (1 + nominal)
Which of the following statements regarding exchange-traded derivatives is least accurate? Exchange-traded derivatives: A) are backed by a central clearinghouse. B) are illiquid. C) often trade in a physical location.
B) are illiquid. Derivatives that trade on exchanges have good liquidity in most cases. They have the other characteristics listed. (Module 68.1, LOS 68.b)
An investor holds two options on the same underlying stock, a call option with an exercise price of 25 and a put option with an exercise price of 30. If the market price of the stock is 27: A) only one of the options is in the money. B) both options are in the money. C) neither option is in the money.
B) both options are in the money. Both options are in the money. The put option is in the money because the option holder has the right to sell the stock for more than its market price. The call option is in the money because the option holder has the right to buy the stock for less than its market price. (Module 75.1, LOS 75.a)
We can use the risk-free rate to value an option with a one-period binomial model because: A) options investors are risk-neutral, on average. B) combining options with the underlying asset in a specific ratio will produce a risk-free future payment. C) combining put and call options in specific ratio can produce a risk-free future payment
B) combining options with the underlying asset in a specific ratio will produce a risk-free future payment. A portfolio of an option position and a position in the underlying asset can be constructed so that the portfolio value at option expiration is certain, the same for an up-move and for a down-move. (Module 77.1, LOS 77.a)
A net benefit from holding the underlying asset of a forward contract will: A) increase the value of the forward contract during its life. B) decrease the no-arbitrage forward price at initiation. C) decrease the value of the forward contract at expiration.
B) decrease the no-arbitrage forward price at initiation. Compared to an underlying asset with no net holding cost or benefit, a net benefit from holding the underlying asset will decrease the no-arbitrage forward price at initiation and the value of a forward contract during its life. Holding costs and benefits have no effect on the value of a forward contract at expiration.
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 kurtosis is least accurate? Kurtosis: A) is used to reflect the probability of extreme outcomes for a return distribution. B) describes the degree to which a distribution is not symmetric about its mean. C) measures the peakedness of a distribution reflecting a greater or lesser concentration of returns around the mean.
B) describes the degree to which a distribution is not symmetric about its mean. The degree to which a distribution is not symmetric about its mean is measured by skewness. Excess kurtosis which is measured relative to a normal distribution, indicates the peakedness of a distribution, and also reflects the probability of extreme outcomes. (Module 3.2, LOS 3.c)
For a forward contract on an asset that has no costs or benefits from holding it to have zero value at initiation, the arbitrage-free forward price must equal the: A) expected future spot price. B) future value of the current spot price. C) present value of the expected future spot price.
B) future value of the current spot price For an asset with no holding costs or benefits, the forward price must equal the future value of the current spot price, compounded at the risk-free rate over the term of the forward contract, for the contract to have a value of zero at initiation. Otherwise an arbitrage opportunity would exist. (Module 73.1, LOS 73.a)
Bea Moran wants to establish a long derivatives position in a commodity she will need to acquire in six months. Moran observes that the six-month forward price is 45.20 and the six-month futures price is 45.10. This difference most likely suggests that for this commodity: A) long investors should prefer futures contracts to forward contracts. B) futures prices are negatively correlated with interest rates. C) there is an arbitrage opportunity among forward, futures, and spot prices.
B) futures prices are negatively correlated with interest rates. Differences may exist between forward and futures prices for otherwise identical contracts if futures prices are correlated with interest rates. If futures prices are negatively correlated with interest rates, daily settlement of long futures contracts will require cash when interest rates are increasing and produce cash when interest rates are decreasing. As a result the futures price will be lower than the forward price. The difference in price does not provide an arbitrage opportunity or suggest that investors should prefer forward or futures contracts.
Basil, Inc., common stock has a market value of $47.50. A put available on Basil stock has a strike price of $55.00 and is selling for an option premium of $10.00. The put is: A) out-of-the-money by $2.50. B) in-the-money by $7.50. C) in-the-money by $10.00.
B) in-the-money by $7.50. The put allows a trader to sell Basil common stock for $7.50 more than the current market value ($55.00 − $47.50). The trade is normally closed out with a cash settlement, but the trader could buy 100 shares for $47.50 per share and immediately sell them to the option writer for $55.00.
A call option's intrinsic value: A) increases as the stock price increases above the strike price, while a put option's intrinsic value decreases as the stock price decreases below the strike price. B) increases as the stock price increases above the strike price, while a put option's intrinsic value increases as the stock price decreases below the strike price. C) decreases as the stock price increases above the strike price, while a put option's intrinsic value increases as the stock price decreases below the strike price.
B) increases as the stock price increases above the strike price, while a put option's intrinsic value increases as the stock price decreases below the strike price. For a call option, as the underlying stock price increases above the strike price, the option moves farther into the money, and the intrinsic value is increasing. For a put option, as the underlying stock price decreases below the strike price, the option moves farther into the money, and the intrinsic value is increasing. (Module 75.1, LOS 75.c)
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.
The price of a fixed-for-floating interest rate swap contract: A) may vary over the life of the contract. B) is established at contract initiation. C) is directly related to changes in the floating rate.
B) is established at contract initiation. The price of a swap contract is set such that the contract has a value of zero at initiation. The valueof a fixed-for-floating interest rate swap contract may vary over its life as the floating rate changes.(Module 74.1, LOS 74.b)
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)
A dataset contains six values, none of which are equal. The arithmetic mean of the data is 13.25, and the geometric mean of the data is 12.75. The harmonic mean will be: A) greater than 13.25. B) less than 12.75. C) between 12.75 and 13.25.
B) less than 12.75. For any dataset where the values are not equal, the harmonic mean will be less than the geometric mean (which, in turn, will be less than the arithmetic mean). Here, the arithmetic mean is 13.25, and the geometric mean is 12.75—so the harmonic mean must be less than 12.75. It is worth noting that all three means are equal if every value in the dataset is the same. (Module 1.1, LOS 1.b)
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.
Long forward contracts without central clearing may be preferred to equivalent futures contracts when interest rates are: A) positively correlated with the price of the underlying. B) negatively correlated with the price of the underlying. C) uncorrelated with the price of the underlying
B) negatively correlated with the price of the underlying When interest rates are negatively correlated with the price of the underlying, the mark-to-market feature of futures means that when additional margin deposits are required (lower price of the underlying), interest cost is higher. When margin can be withdrawn from the account (higher price of the underlying), the interest earned on the cash withdrawn will be lower. This makes futures less desirable than equivalent forward contracts. (Module 73.1, LOS 73.b)
For a futures contract to be more attractive than an otherwise equivalent forward contract, interest rates must be: A) uncorrelated with futures prices. B) positively correlated with futures prices. C) negatively correlated with futures prices.
B) positively correlated with futures prices. If interest rates are positively correlated with futures prices, interest earned on cash from daily settlement gains on futures contracts will be greater than the opportunity cost of interest on daily settlement losses, and a futures contract is more attractive than an otherwise equivalent forward contract that does not feature daily settlement. (Module 73.1, LOS 73.b)
If the price of a forward contract is greater than the price of an identical futures contract, the most likely explanation is that: A) the forward contract is more liquid than the futures contract. B) the futures contract requires daily settlement and the forward contract does not. C) the futures contract is more difficult to exit than the forward contract.
B) the futures contract requires daily settlement and the forward contract does not The reason there may be a difference in price between a forward contract and an identical futures contract is that a futures position has daily settlement and so makes or requires cash flows during its life. (Module 73.1, LOS 73.b)
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)
The value of a forward or futures contract is: A) specified in the contract. B) typically zero at initiation. C) equal to the spot price at expiration.
B) typically zero at initiation. The value of a forward or futures contract is typically zero at initiation, and at expiration is the difference between the spot price and the contract price. The price of a forward or futures contract is defined as the price specified in the contract at which the two parties agree to trade the underlying asset on a future date.
An investor could best replicate the position of the floating rate payer in a swap by: A) borrowing at a fixed rate and entering a series of zero-value FRAs. B) borrowing at a floating rate and buying a fixed-rate bond. C) borrowing at a floating rate and entering a series of zero-value FRAs.
B)borrowing at a floating rate and buying a fixed-rate bond. The investor in the swap will pay the reference rate and receive fixed-rate payments (on a notional principal amount). The net payments can be replicated by borrowing at a floating rate and investing the proceeds in a fixed-rate bond. The payments could also be replicated by taking a floating-rate loan (or issuing a floating-rate bond) and entering a series of FRAs, but these would not necessarily (or likely) be zero-value FRAs; zero-value FRAs would typically not all have the same fixed rate as swap payments do. (Module 74.1, LOS 74.a)
Tom Edwin, CFA, states, "Individuals exhibit biases, such as loss aversion and herding, that result in observed pricing anomalies in financial markets. However, a strategy based on exploiting these anomalies will not earn positive abnormal returns over time." With regard to the efficient markets and behavioral finance views of market pricing, Edwin's statement is most likely consistent with A) behavioral finance, but not informationally efficient markets. B) neither behavioral finance nor informationally efficient markets. C) both behavioral finance and informationally efficient markets.
C) both behavioral finance and informationally efficient markets. Edwin's statement is consistent with both behavioral finance and informationally efficient markets. While behavioral biases that cause individuals to act irrationally can cause assets to be mispriced, markets can still be considered efficient if asset mispricing cannot consistently be exploited to earn positive risk-adjusted returns on average over time.
Jimmy Casteel pays a premium of $1.60 to buy a put option with an exercise price of $145. If the stock price at expiration is $128, Casteel's profit or loss from the options position is: A) $1.60. B) $18.40. C) $15.40.
C) $15.40. The put option will be exercised and has a value of $145-$128 = $17 [Max(0, X − S)]. Therefore, Casteel receives $17 minus the $1.60 paid to buy the option. The profit is $15.40 ($17 less $1.60).
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)
An investor buys a stock on March 24 for $63.25. The stock pays quarterly dividends of $0.54 on May 1 and August 1. On September 27, the investor sells the stock for $62.80. The investor's holding period return is closest to: A) 2.5%. B) 2.0%. C) 1.0%.
C) 1.0%. (62.80+0.54+0.54) / (63.25))−1. =0.01=1% Because we are asked for the HPR, the beginning and ending dates are irrelevant. If we had been asked to annualize the return, we would need to know the length of the holding period. (Module 1.1, LOS 1.b)
A survey is taken to determine whether the average starting salaries of CFA charterholders is equal to or greater than $59,000 per year. What is the test statistic given a sample of 135 newly acquired CFA charterholders with a mean starting salary of $64,000 and a standard deviation of $5,500? A) 0.91. B) -10.56. C) 10.56.
C) 10.56. With a large sample size (135) the z-statistic is used. The z-statistic is calculated by subtracting the hypothesized parameter from the parameter that has been estimated and dividing the difference by the standard error of the sample statistic. Here, the test statistic = (sample mean - hypothesized mean) / (population standard deviation / (sample size)1/2) = (X − µ) / (σ / n1/2) = (64,000 - 59,000) / (5,500 / 1351/2) = (5,000) / (5,500 / 11.62) = 10.56. (Module 8.2, LOS 8.b)
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.
Which of the following will increase the value of a call option? A) An increase in the exercise price. B) A dividend on the underlying asset. C) An increase in volatility.
C) An increase in volatility. As volatility increases, the value of a call option increases. As volatility increases, the value of a put option increases. Increased volatility of the underlying asset increases both put values and call values. A higher exercise price or an increase in cash flows on the underlying asset decrease the value of a call option.
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)
Which of the following statements about long positions in put and call options is most accurate? Profits from a long call: A) and a long put are positively correlated with the stock price. B) are negatively correlated with the stock price and the profits from a long put are positively correlated with the stock price. C) are positively correlated with the stock price and the profits from a long put are negatively correlated with the stock price.
C) are positively correlated with the stock price and the profits from a long put are negatively correlated with the stock price. For a call, the buyer's (or the long position's) potential gain is unlimited. The call option is in-the-money when the stock price (S) exceeds the strike price (X). Thus, the buyer's profits are positively correlated with the stock price. For a put, the buyer's (or the long position's) potential gain is equal to the strike price less the premium. A put option is in-the-money when X > S. Thus, a put buyer wants a high exercise price and a low stock price. Thus, the buyer's profits are negatively correlated with the stock price.
A derivative is defined as a security that has a value: A) established outside an organized exchange. B) stated in a contract between two counterparties. C) based on another security, commodity, or index.
C) based on another security, commodity, or index. A derivative is a security the value of which is derived from the value of some other underlying asset. Some derivatives trade on organized exchanges. The price at which a transaction will (or may) take place in the future is stated in a derivatives contract. (Module 68.1, LOS 68.b)
Which of the following statements regarding call options is most accurate? The: A) call holder will exercise (at expiration) if the exercise price exceeds the stock price. B) breakeven point for the seller is the exercise price minus the option premium. C) breakeven point for the buyer is the exercise price plus the option
C) breakeven point for the buyer is the exercise price plus the option The breakeven for the buyer and the seller is the exercise price plus the premium. The call holder will exercise if the market price exceeds the exercise price. (Module 69.2, LOS 69.b)
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)
An analyst announces that an increase in the discount rate next quarter will double her earnings forecast for a firm. This is an example of a: A) use of Bayes' formula. B) joint probability. C) conditional expectation.
C) conditional expectation. This is a conditional expectation. The analyst indicates how an expected value will change given another event.
The time value of an option is most accurately described as: A) increasing as the option approaches its expiration date. B) the amount by which the intrinsic value exceeds the option premium. C) equal to the entire premium for an out-of-the-money option.
C) equal to the entire premium for an out-of-the-money option. The price (or premium) of an option is its intrinsic value plus its time value. An out-of-the-money option has an intrinsic value of zero, so its entire premium consists of time value. Time value is zero at an option's expiration date. Time value is the amount by which an option's premium exceeds its intrinsic value. (Module 75.1, LOS 75.a)
Compared to an interest rate futures contract, an otherwise equivalent forward rate agreement will: A) have greater volatility. B) have greater payments for a given decrease in interest rates. C) exhibit greater convexity.
C) exhibit greater convexity Because payments on forward rate agreements are discounted to the beginning of the loan period at the realized rate, they exhibit convexity, whereas payments on interest rate futures are linear (no convexity). (Module 73.1, LOS 73.b)
An investor who buys a government bond from a dealer's inventory is said to obtain a: A) real asset in a primary market transaction. B) financial asset in a primary market transaction. C) financial asset in a secondary market transaction.
C) financial asset in a secondary market transaction. Bonds are financial assets. Real assets are physical things such as a commodity or a factory. Buying a bond from a dealer is a secondary market transaction. A primary market transaction is an issuance of securities by an entity that is raising funds. (Module 41.1, LOS 41.b)
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%.
A futures investor receives a margin call. If the investor wishes to maintain her futures position, she must make a deposit that restores her account to the: A) maintenance margin. B) daily margin. C) initial margin.
C) initial margin. In futures trading, a margin call requires the investor to restore the account to the initial margin level or close the position
Which of the following statements regarding a forward commitment is least accurate? A forward commitment: A) can involve a stock index. B) is a contractual promise. C) is not legally binding.
C) is not legally binding. A forward commitment is a legally binding promise to perform some action in the future and can involve a stock index or portfolio. (Module 69.2, LOS 69.c)
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)
On the expiration date of a put option, if the spot price of the underlying asset is less than the exercise price, the value of the option is: A) zero. B) negative. C) positive.
C) positive. Put options are in the money (have positive value) at expiration if the spot price of the underlying asset is less than the exercise price, because the put option holder has the right to sell the asset for the higher exercise price. The value of an option cannot be negative; at expiration its value is the greater of zero or its intrinsic value. (Module 69.2, LOS 69.b)
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)
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)
At expiration, the value of a call option is the greater of zero or the: A) underlying asset price minus the exercise value. B) exercise price minus the exercise value. C) underlying asset price minus the exercise
C) underlying asset price minus the exercise The value of a call option at expiration is its exercise value, which is Max[0, S - X]. (Module 69.2, LOS 69.b)
A European call option on a stock has an exercise price of 42. On the expiration date, the stock price is 40. The value of the option at expiration is: A) positive. B) negative. C) zero.
C) zero. For a call option, the value at expiration is zero if the price of the underlying is less than or equal to the exercise price. The holder will allow the option to expire unexercised.
