Mock Exam 2

t. A joint probability t. i

is a probability that two or more events happen concurrently.

Mike Bowers observes that during one year the return on the S&P 500 index is 20%. Recalculating the return on an equally weighted basis, Bowers estimates that the index return is 15%. The difference in the two calculations of return is best explained by: A) large capitalization stocks outperforming small capitalization stocks. B) small capitalization stocks outperforming large capitalization stocks. C) dividends on the stocks in the index.

large capitalization stocks outperforming small capitalization stocks. Explanation Because the S&P 500 index is market capitalization weighted, stocks with higher market capitalization have greater influence on the performance of the index. Because the index outperformed its equally weighted version, larger capitalization stocks performed better than smaller capitalization stocks.

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

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

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

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

An analyst gathered the following data about a company: 1,000 common shares are outstanding (no change during the year). Net income is $5,000. The company paid $500 in preferred dividends. The company paid $600 in common dividends. The average market price of their common stock is $60 for the year. The company had 100 warrants (for one share each) outstanding for the entire year, exercisable at $50. The company's diluted earnings per share is closest to: A) $4.42. B) $4.55. C) $4.83.

A) $4.42. he warrants are dilutive because their exercise price is less than the average market price. shares issued to warrant holders = 100 warrants generate cash of 100(50) = $5,000 repurchased shares=5,00060=83repurchased shares=5,00060=83 net new shares created = 100 − 83 = 17 Alternatively, 60−5060×100≈1760−5060×100≈17 diluted EPS=NI−preferred dividendsweighted average # shares+warrant adjustdiluted EPS=NI−preferred dividendsweighted average # shares+warrant adjust diluted EPS=5,000−5001,017=$4.42

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

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

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

A) The central limit theorem has limited usefulness for skewed distributions. The central limit theorem holds for any distribution as long as the sample size is large (i.e., n > 30).

bank borrows for 360 days and simultaneously lends the proceeds for 90 days. This transaction creates a synthetic forward rate agreement (FRA) closest to: A) a long position in a 90-day FRA on 270-day LIBOR. B) a long position in a 90-day FRA on 360-day LIBOR. C) a short position in a 360-day FRA on 90-day LIBOR.

A) a long position in a 90-day FRA on 270-day LIBOR. If a bank borrows for 360 days and simultaneously lends the proceeds for 90 days, it creates a synthetic long (borrower) position in a 90-day FRA on 270-day LIBOR. The bank has no net position for the first 90 days and a borrowing position at a fixed rate of interest for the subsequent 270 days.

An investor has long exposure to the risk of the asset underlying an option when taking: A) a short position in a put option. B) a short position in a call option. C) a long position in a put option.

A) a short position in a put option. By taking a short position in a put option, the investor has long exposure to the risk in the underlying asset. Because the value of a put option decreases when the price of the underlying asset increases, the value of a short position in a put increases when the price of the underlying increases. Both a short position in a call option and a long position in a put option increase in value when the price of the underlying asset decreases; that is, these option positions have short exposure to the risk of the underlying asset.

With a soft lockup period of two years, investors in a hedge fund are: A) able to get redemptions during the first two years, but only if they pay additional fees. B) able to get redemptions during the first two years, but only if investment results do not meet the target return. C) unable to get redemptions of more than a specified percentage of their fund investment during the first two years.

A) able to get redemptions during the first two years, but only if they pay additional fees. A soft lockup period describes a provision that allows redemptions during the lockup period, but with significant additional fees for such redemptions.

The credit rating agency practice of "notching" is best described as: A) assigning different ratings to different debt issues from the same issuer. B) downgrading or upgrading the rating of a debt issue or issuer by one increment. C) adding a plus or minus sign to a rating to indicate a positive or negative outlook.

A) assigning different ratings to different debt issues from the same issuer. "Notching" refers to the credit rating agency practice of assigning ratings to debt issues that differ from the issuer's credit rating. An issuer credit rating applies to a firm's senior unsecured debt. Debt issues with different seniority or covenants may be notched to a higher or lower issue credit rating.

Commercial mortgage-backed securities (CMBS) loans typically have greater call protection than agency MBS loans because: A) commercial mortgages may have yield maintenance charges. B) smaller-sized mortgages typically are not refinanced if interest rates fall. C) CMBS typically receive higher credit ratings from credit agencies than residential MBS.

A) commercial mortgages may have yield maintenance charges. Explanation Any type of call protection structured into the loan itself (in this case, yield maintenance charges) increases the overall call protection of the CMBS. Agency MBS do not provide call protection at the individual loan level.

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

A) disclosure of conflicts. Marshall has an obligation to disclose that she receives special compensation based on the amount of client trading volume. Standard VI(A) Disclosure of Conflicts requires members to disclose to clients and prospects all matters that could potentially impair the member's ability to make investment decisions that are (and to give investment advice that is) objective and unbiased. The Standard on communications with clients addresses issues that involve clearly communicating investment recommendations and analysis. The Standard on additional compensation arrangements is concerned with accepting benefits that may create a conflict between a member's interests and her employer's interests. (Module 60.1)

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

A) economies of scale are great. A natural monopoly may exist when economies of scale are great. The large economies of scale mean that a single producer results in the lowest production costs.

A company is most likely to earn economic profits if it is operating in an industry characterized by: A) high industry concentration, high barriers to entry, and low industry capacity. B) low industry concentration, low barriers to entry, and low industry capacity. C) low industry concentration, high barriers to entry, and high industry capacity.

A) high industry concentration, high barriers to entry, and low industry capacity. High industry concentration refers to an industry that has a small number of firms, which often leads to less price competition, higher pricing power, and higher return on invested capital. High barriers to entry refer to industries where it is costly for new competitors to enter the industry, which allows companies already in the industry to maintain high profitability and prices. Low industry capacity refers to a situation where demand is greater than supply at current prices, which allows companies to maintain high prices and profits.

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

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

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

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

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

A) is not in violation of any Standard. The circumstances of Hart's bankruptcy do not compromise his professional reputation. The bankruptcy did not involve fraudulent or deceitful business conduct; therefore, there is no violation of Standard I(D) Misconduct. The Standards do not require disclosing the bankruptcy to clients because it does not create any conflict of interest and is not relevant to Hart's professional activity. (Module 60.1)

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

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

Assume most hedge funds have a 2-and-20 fee structure and most funds of funds have a 1-and-10 fee structure. Over a long investment horizon, compared to net returns from investing directly in hedge funds, net returns from investing in funds of funds are most likely to be: A) lower. B) higher. C) the same.

A) lower. Explanation Investing in funds of funds is likely to result in lower returns net of fees over time compared to investing directly in hedge funds. Funds of funds receive net-of-fees returns from the funds in which they invest, and charge their own investors an additional layer of management and incentive fees.

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

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

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

A) neither of Hill's policies violates the Standards. In the absence of regulatory requirements, Standard V(C) Record Retention recommends maintaining records supporting investment recommendations and actions and records of investment-related communications with clients for at least seven years. Here, there is regulatory guidance, and seven years is a recommendation, not a requirement, in any case. Records can be maintained in electronic or hard copy format. (Module 58.7)

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

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

Derivatives markets are most likely to: A) reduce transactions costs. B) increase speculation and risk. C) provide arbitrage opportunities to investors.

A) reduce transactions costs. The key advantages of derivatives markets are providing price information, reducing transactions costs, and shifting risks among market participants. Derivatives markets are highly efficient and arbitrage opportunities rarely exist or are quickly eliminated.

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

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

An a priori probability

An a priori probability is one based on logical analysis rather than on observation or personal judgmen

An investor wants to receive $10,000 annually for ten years with the first payment five years from today. If the investor can earn a 14% annual return, the amount that she will have to invest today is closest to: A) $27,091. B) $30,884. C) $52,161.

B) $30,884. This problem involves determining the present value of an annuity followed by finding the present value of a lump sum. Enter PMT = 10,000, N = 10, and I = 14. Compute PV = 52,161.16. That is the present value of the 10-year annuity, four years from today. Next, we need to discount that back to present for four years to find the amount of the investment today. Enter FV = −52,161.16, N = 4, I = 14, PMT = 0. Compute PV = 30,883.59.

Jefferson Blake, CFA, believes there is a good opportunity to purchase an option-free 4% annual pay bond with three years left until maturity, a zero-volatility spread of 40 basis points, and a par value of $1,000. Blake observes that 1-year, 2-year, and 3-year government bond spot rates are currently 4.0%, 4.5%, and 4.75%, respectively. The maximum price Blake should be willing to pay for the bond is closest to: A) $940. B) $970. C) $980.

B) $970. Explanation To compute the value of this bond, discount each of the cash flows at a different interest rate appropriate for the timing of the cash flow. The appropriate rates are 40 bp greater than the spot rates. 40(1.0400+0.0040)+40(1.0450+0.0040)2+(40+1,000)(1.0475+0.0040)3=969.22

Demand for gasoline (in hundreds of liters) at a particular station, as a function of the price of gasoline and the price of bus travel, is QD = 300 - 14 Pgas + 2 Pbus. If the price of gasoline per liter (Pgas) is 1.50 euros, and the price of a standardized unit of bus travel (Pbus) is 12 euros, the cross price elasticity of gasoline demand with respect to the price of bus travel is closest to: A) 0.01. B) 0.08. C) 2.00. Explanation

B) 0.08. To calculate the cross price elasticity of the quantity demanded of gasoline with respect to the price of bus travel, we must first calculate the quantity of gas demanded: 300 − 14(1.5) + 2(12) = 303 The cross elasticity is: ΔQDΔPbus×PbusQD=2×(12303)=0.0792 or 0.08

Consider two currencies, the WSC and the BDR. The spot WSC/BDR exchange rate is 2.875, the 180-day riskless WSC rate is 1.5%, and the 180-day riskless BDR rate is 3.0%. The 180-day forward exchange rate that will prevent arbitrage profits is closest to: A) 2.833 WSC/BDR. B) 2.854 WSC/BDR. C) 2.918 WSC/BDR.

B) 2.854 WSC/BDR. Arbitrage-free forward = 2.875 WSC/BDR × [(1 + 0.015 / 2) / (1 + 0.03 / 2)] = 2.8538 WSC/BDR.

Which of the following is most likely to represent the management fees of a private capital fund? A) 2% of invested capital. B) 3% of committed capital. C) 1% of drawn-down capital.

B) 3% of committed capital. Explanation Private equity management fees are typically a percentage of committed capital rather than invested (drawn-down) capital.

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

B) A z-test is theoretically acceptable in place of a t-test for tests concerning a mean when sample size is small. The t-test must be used when the sample size is small, the population is normal, and the population variance is unknown. If the population is non-normal and the variance is unknown, there is no valid test statistic when the sample is small.

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

B) Both a histogram and a frequency polygon provide a graphical display of data found in a frequency distribution. Theheight of each bar in a histogram represents the absolute frequency for each return interval. To construct a frequency polygon, the analyst would plot the midpoint of the return intervals on the x-axis and the absolute frequency for that interval on the y-axis. For Further Reference:

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-capitalization weighted index.

B) Equal-weighted index. 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.

Listed debt securities owned by a company, for which the company intends to collect interest payments and sell the securities, must be carried at fair value with gains and losses reported as other comprehensive income under: A) IFRS only. B) U.S. GAAP only. C) both U.S. GAAP and IFRS.

B) U.S. GAAP only. Under IFRS, firms may make an irrevocable choice to carry any financial asset at fair value through profit and loss. Under U.S. GAAP, such debt securities are classified as "available for sale," and carried at fair value with gains and losses reported as other comprehensive income.

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

B) a conditional VaR. Conditional VaR is the expected value of a loss, given that the loss exceeds a minimum amount. Value at risk is the minimum loss that will occur over a period with a specified probability.

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

B) a recessionary gap. The manager's investment decisions are most consistent with expectations of a recessionary gap. In a recession, commodity prices and interest rates are likely to decrease. Decreasing interest rates should increase the prices of high-quality bonds. An inflationary gap would likely cause interest rates to increase, which would decrease bond prices. An inflationary gap or stagflation conditions would likely result in increasing commodity prices. For Further Reference: (Study Session 3, Module 10.3, LOS 10.i)

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

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

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

B) base the assessment of risk tolerance in the IPS on client's ability to bear risk. 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.

Compared to corporate bonds, secondary market trading in government bonds is most likely to feature: A) brokered markets. B) earlier trade settlement. C) narrower bid-ask spreads.

B) earlier trade settlement. Explanation Government bond trades typically settle in one day (T + 1) while corporate bond trades typically settle in two or three days (T+ 2 or T + 3). Government and corporate bonds trade primarily in dealer markets. Bid-ask spreads depend on an issue's liquidity and may be wider for an illiquid government issue than for a liquid corporate issue.

Porter, Inc., sells 200,000 newly issued shares to two institutions without registering the shares with its country's securities regulators. This transaction is best described as being: A) illegal. B) in the primary market. C) in the secondary market.

B) in the primary market. Sales of newly issued securities take place in the primary market. Registration of shares sold in private placements of securities is not required. The secondary market refers to the markets in which previously issued securities are traded.

An American-style call option is most likely to be more valuable than an otherwise equivalent European-style call option if: A) the call is deep in the money. B) its underlying asset is a semiannual-pay bond. C) implied volatility increases during the life of the call.

B) its underlying asset is a semiannual-pay bond. American options can be more valuable than otherwise equivalent European options only if early exercise has value to the option holder. For call options, early exercise may be valuable if the underlying asset provides cash flows. Early exercise may be valuable for put options, particularly if they are deep in the money.

Xanos Corporation faced a 50% marginal tax rate last year and showed the following financial and tax reporting information: Deferred tax asset of 1,000. Deferred tax liability of 5,000. Based only on this information and the news that the tax rate will decline to 40%, Xanos Corporation's deferred tax: A) asset will be reduced by 400 and deferred tax liability will be reduced by 2,000. B) liability will be reduced by 1,000 and income tax expense will be reduced by 800. C) asset will be reduced by 200 and income tax expense will be reduced by 1,000.

B) liability will be reduced by 1,000 and income tax expense will be reduced by 800.

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

B) liquidity of the subject security. According to Standard II(A) Material Nonpublic Information, how specific the information is, how different it is from public information, and its nature are key factors in determining whether a particular piece of information fits the definition of material. An additional factor is reliability, which is often a function of the source of the information. While the liquidity of a security may be a factor in determining the materiality of advance knowledge of a large buy or sell order, in most cases, it would not be a factor in determining materiality. (Module 58.3)

An analyst needs to estimate the value of an illiquid 7% BB+ rated bond that has eight years to maturity. Using matrix pricing, the analyst should most appropriately base an estimate for this bond on yields of: A) on-the-run eight-year government bonds. B) more frequently traded bonds rated BB+. C) other BB+ rated bonds with similar liquidity to this bond.

B) more frequently traded bonds rated BB+. B) Matrix pricing for untraded or infrequently traded bonds should be based on yields of more frequently traded bonds with similar credit ratings.

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

B) nonparametric test. A Spearman rank correlation test is appropriate in this scenario. This is a nonparametric test.

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

B) property, plant, and equipment, if one of the firms uses accelerated depreciation and the other uses straight-line depreciation. Depreciation methods are an example of a difference that may require an analyst to adjust financial statements to make them comparable. Acquisition goodwill is treated the same way under IFRS and U.S. GAAP: it is not amortized but is tested for impairment at least annually. Securities held for trading are reported at fair value with unrealized gains and losses reported on the income statement.

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

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

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

B) today the XYZ three-month interest rate is higher than the PQR three-month interest rate. Interest rate parity requires that the currency with the higher interest rate will sell at a discount in the forward market.

Al Pike, CFA, is analyzing Red Company by projecting pro forma financial statements. Pike expects Red to generate sales of $3 billion and a return on equity of 15% in the next year. Pike forecasts that Red's total assets will be $5 billion and that the company will maintain its financial leverage ratio of 2.5. Based on these forecasts, Pike should project Red's net income to be: A) $100 million. B) $300 million. C) $500 million.

Based on the data given, use the basic DuPont equation and solve for expected net income. ROE = (net income / revenues) × (revenues / total assets) × (total assets / total equity) 0.15 = (net income / $3 billion) × ($3 billion / $5 billion) × 2.5 net income / $3 billion = 0.1 net income = $300 million

a plain vanilla interest rate swap is replicated with a series of forward rate agreements (FRAs), at initiation, each FRA must have a forward rate equal to the swap's: A) fixed rate and must have a value of zero. B) floating rate and must have a value of zero. C) fixed rate but may have a non-zero value.

C) fixed rate but may have a non-zero value. Explanation Each FRA would have a forward rate equal to the fixed rate in the interest rate swap but would not necessarily have a value of zero at initiation, although the sum of the values of the replicating FRAs would be zero.

A firm has undertaken a contract with an estimated total cost of $200 million at a price of $220 million. At the end of the first reporting period, the firm has devoted resources of $70 million to the project. The customer has been billed for $80 million and made payments of $60 million. As a result of these transactions, the firm should report revenue from this project of: A) $60 million. B) $70 million. C) $77 million.

C) $77 million. Using the percentage of total costs incurred to date as an estimate of the portion of the performance obligations completed, revenue should be (70/200) × $220 million = $77 million. For Further Reference: (Study Session 6, Module 17.2, LOS 17.c) CFA® Program Curriculum, Volume 3, page 12

Which of the following is least likely a benefit of fund of funds (FOF) investing? A) FOFs may permit access to otherwise unavailable hedge funds. B) FOFs allow investors to diversify the risks of holding a single hedge fund. C) FoF investing has lower fees compared to investing in a typical hedge fund.

C) FoF investing has lower fees compared to investing in a typical hedge fund. Explanation The fee may actually be substantial since, in addition to paying the manager of the FOF, a fee must be paid to each hedge fund within the FOF.

Which of the following indicators of a firm's liquidity position is least desirable? A) Low operating cycle. B) High inventory turnover. C) High cash conversion cycle.

C) High cash conversion cycle. The cash conversion cycle measures the amount of time it takes for the firm to turn the firm's cash investments in inventory back into cash. A high cash conversion cycle implies that the company has too much invested in working capital

How does the cost of holding the underlying asset affect option values? A) Decreases both call and put values. B) Decreases call values and increases put values. C) Increases call values and decreases put values.

C) Increases call values and decreases put values. Explanation Carrying costs of holding the underlying asset increase the value of call options and decrease the value of put options.

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

C) Listed call options, which the firm intends to exercise at expiration. 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.

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

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

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

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

f all other factors remain unchanged, which of the following would most likely reduce a company's price/earnings ratio? A) The dividend payout ratio increases, and the dividend growth rate increases. B) The dividend growth rate increases, and the required rate of return decreases. C) The required rate of return increases, and the dividend payout ratio decreases.

C) The required rate of return increases, and the dividend payout ratio decreases. P/E=dividend payout ratiok−gg=ROE×retention rateP/E=dividend payout ratiok−gg=ROE×retention rate Increases in k reduce P/E. Increases in g or the dividend payout ratio increase P/E.

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

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

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

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

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

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

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

C) pays off accounts payable from cash. Paying off accounts payable from cash lowers current assets and current liabilities by the same amount. Because the current ratio started off above 1, the current ratio will increase. Because the quick ratio started off less than 1, it will decrease further. The other choices are incorrect. Buying fixed assets on credit decreases both ratios because the denominator increases, with no change to the numerator. Using cash to purchase inventory would result in no change in the current ratio but would decrease the quick ratio by decreasing the numerator. For Further Reference: (Study Session 6, Module 20.2, LOS 20.b)

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

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

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) shakeout. Explanation 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.

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

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

An analyst obtains a market quote for the two-year forward rate two years from now. To derive the next point on a theoretical annual forward rate curve, the analyst can use: A) the two-year and five-year spot rates. B) the three-year and four-year spot rates. C) the three-year and five-year spot rates.

C) the three-year and five-year spot rates. Explanation Given the two-year forward rate two years from now, the next point on an annual forward rate curve is the two-year forward rate three years from now, 3y2y. This rate can be derived from the three-year and five-year spot rates as follows: (1 + S5)5 = (1 + S3)3 (1 + 3y2y)2.

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.

Corporate press release. Explanation 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.

hich of the following firms' earnings are likely to exhibit the greatest degree of sensitivity to the business cycle? A) Furniture producer with high fixed costs as a proportion of total costs. B) Entertainment producer with high variable costs as a proportion of total costs. C) Food and beverage producer with high fixed costs as a proportion of total costs.

Furniture producer with high fixed costs as a proportion of total costs. Explanation Consumers buy fewer durable goods, such as furniture, during recessions and buy more during expansions. As a result, producers of these goods tend to have cyclical demand, revenues, and earnings. Operating leverage (high fixed costs as a proportion of total costs) also contributes to cyclicality of earnings.

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

Increase to 26 The NPV of the new equipment is $500 million - $300 million = $200 million. This NPV is added to CPM's current market value. On a per share basis, the addition is worth $200 million / 100 million shares, for a new addition to the share price of $2.00. Theoretical share price = $24.00 + $2.00 = $26.00.

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

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

A basis swap may be structured as: A) a contingent claim only. B) a forward commitment only. C) either a contingent claim or a forward commitment.

Interest rate swaps are forward commitments. A basis swap is an interest rate swap in which the parties exchange one floating-rate obligation for another. (Module 45.2)

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

LIFO. With LIFO, more recent, lower costs would be used for COGS. A reduction in COGS will increase gross profits and net income, other things equal.

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.

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. 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.

Debt Ratio

The debt ratio is total debt to total assets. Because common-size balance sheet data are stated as percentages of total assets, the debt ratio can be determined from the data given.

The median of a distribution is least likely equal to: A) the second quartile. B) the third quintile. C) the fifth decile. Explanation The median is the midpoint of a distribution, such that 50% of the observations are greater than the median and 50% are less than the median. This is equivalent to the second quartile (4 groups) and the fifth decile (10 groups). If a distribution is divided into quintiles (5 groups), 60% of the observations are less than the third quintile.

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

The probability that a fund manager will produce returns in excess of the returns on the S&P 500 index in any one year is 45%. The probability that the manager will produce returns in excess of the returns on the S&P 500 index in 4 or 5 of the next five years is closest to: A) 11.3%. B) 13.1%. C) 16.3%.

We need to use the binomial formula to calculate the probabilities of 4 and 5 "successes" in five 5 years and then sum them. Prob(4)=5!(5−4)!4!×0.454×0.555−4=11.3%Prob(4)=5!(5−4)!4!×0.454×0.555−4=11.3% Prob(5) = 0.455 = 1.85% 11.28% + 1.85% = 13.12%

n-firm concentration ratio

a measure of the market share of the largest n firms in an industry

impairment

a permanent decline in the fair value of an asset

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

c) 30 equally-weighted stocks with companies from different industries. The diversification ratio of a portfolio equals its standard deviation of returns divided by the average standard deviation of the individual securities in the portfolio. Therefore, a more diversified portfolio will have a lower diversification ratio than a less diversified portfolio. A portfolio containing the highest number of securities from different industries will be the most diversified and will have the lowest diversification ratio. A portfolio of stocks from the same industry is likely to have a higher diversification ratio (reflecting less diversification) than a portfolio of stocks from different industries.

hedonic pricing.

efers to adjusting a price index for improvements in the quality of goods.

A conditional probability is t

he probability of one event happening on the condition that another event is certain to occur.

Commodities differ from other alternative investments in that: A) returns are due only to price changes. B) specialized funds are available as an investment vehicle. C) they have a low correlation of returns with traditional investments.

returns are due only to price changes. Unlike alternative asset classes that produce income streams, commodities only generate returns from price changes. Most alternative investments have low return correlations with traditional investments. Specialized investment vehicles are available for many categories of alternative investments.

An empirical probability

s calculated using historical data.