Practice exam questions

key properties of the normal distribution

1) continuous symmetric probability function completely described by its mean and variance. 2) skewness = 0, meaning that the normal distribution is symmetric about its mean, mean = median = mode 3) kurtosis = 3. this is a measure of how flat the distribution is. excess kurtosis is measured relative to 3. 4) a linear combination of normal distributed random variables is also normally distributed 5) the probabilities of outcomes further above and below the mean get smaller and smaller but do not go to zero.

average age = accumulated depreciation / depreciation expense.

remaining useful life = net ppe / depreciation expense

Jane Walker has set a 7% yield as the goal for the bond portion of her portfolio. To achieve this goal, she has purchased a 7%, 15-year corporate bond at a discount price of 93.50. What amount of reinvestment income will she need to earn over this 15-year period to achieve a compound return of 7% on a semiannual basis? $574. $459. $624.

935(1.035)^30 = $2,624 Bond coupons: 30 × 35 = $1,050 Principal repayment: $1,000 2,624 − 1,000 - 1050 = $574 required reinvestment income

In the market model, beta measures the sensitivity of an asset's rate of return to the market's: rate of return. excess return. risk-adjusted return.

A

Which of the following statements regarding the terms population and sample is least accurate? A sample includes all members of a specified group. A descriptive measure of a sample is called a statistic. A sample's characteristics are attributed to the population as a whole.

A A population includes all members of a specified group. A sample is a portion, or subset of the population of interest.

Roger Smith, CFA, has been invited to join a group of analysts in touring the riverboats of River Casino Corp. For the tour, River Casino has arranged chartered flights from casino to casino since commercial flight schedules are not practical for the group's time schedule. River Casino has also arranged to pay for the analysts' lodging for the three nights of the tour. According to CFA Institute Standards of Professional Conduct, Smith: A) may accept the arrangements as they are. B) may accept the flight but is required to pay for his lodging. C) is required to pay for his flight and lodging.

A Because the itinerary required charter flights due to a lack of commercial transportation, River Casino can appropriately provide them. While Standard I(B) Independence and Objectivity recommends that members pay their own room costs, it is not required and it is not unusual for members to accept accommodations.

When the underlying asset does not pay any cash flows, the value of an American call option is: equal to the value of an otherwise identical European call option. less than the value of an otherwise identical European call option. greater than the value of an otherwise identical European call option.

A Because the right to exercise a call option early is not valuable when the underlying asset does not pay any cash flows, the value of an American call option is equal to the value of an otherwise identical European call option.

The convenience yield associated with holding the underlying asset of a derivative is most accurately described as: the nonmonetary benefits of holding the asset. the monetary and nonmonetary benefits of holding the asset. the monetary and nonmonetary benefits of holding the asset, net of its holding costs

A Convenience yield refers to the nonmonetary benefits of holding an asset, for example being in a position to sell an overvalued asset that is difficult to sell short. Convenience yield does not include monetary benefits such as interest and dividend income. The costs of holding the asset, net of the monetary and nonmonetary benefits of holding it, is referred to as the net cost of carry

Bonds that are issued by a corporation, but paid from a pool of the corporation's assets that is legally bankruptcy-remote, are best described as: covered bonds. securitized bonds. collateralized bonds.

A Covered bonds are an obligation of the corporation that issues them but their interest and principal payments are provided by a pool of assets that are legally recognized as bankruptcy-remote. They are different from securitized bonds, which are issued by a special purpose vehicle.

A bond with nine years to maturity is quoted at an interpolated spread of +150 basis points. The benchmark yield for this bond is a: swap rate. matrix rate. government bond yield.

A Interpolated spreads (I-spreads) are spreads to swap rates

According to the Standard concerning suitability, it is most likely that members and candidates in advisory relationships with clients should: A) document unsuccessful attempts to update client information. B) purchase only securities with low to medium risk for a client with moderate risk tolerance. C) decline to manage assets for clients who withhold important information about their financial circumstances and needs.

A Members and candidates who are in advisory relationships with clients should document unsuccessful attempts to update client information and circumstances. Because risk is to be evaluated in a portfolio context, there is no prohibition against the purchase of a security that is risky on a stand-alone basis, as long as the risk of the client's overall portfolio is consistent with their ability and willingness to assume investment risk. While lack of client information could make suitability a difficult question, Standard III(C) Suitability does not prohibit managing assets for clients who withhold information about their financial circumstances and needs.

Which of the following tests would generally be considered a nonparametric test? A) Whether a sample is random or not. B) Large sample test of the value of a population mean. C) Value of the variance of a normal population.

A Nonparametric tests can be used in a variety of instances where the assumptions required for parametric tests cannot be sustained. A runs test can be used to test for the randomness of a sample. Both of the other tests are parametric because they test the value of a parameter of the underlying distribution.

Portfolio duration most accurately approximates the sensitivity of the value of a bond portfolio to: parallel shifts in the yield curve. increases in the slope of the yield curve. decreases in the slope of the yield curve.

A Portfolio duration is an approximation of the price sensitivity of a portfolio to parallel shifts of the yield curve (yields for all maturities increase or decrease by equal amounts). Key rate duration may be used to estimate interest rate risk for non-parallel shifts in the yield curve.

When using the CAPM to estimate the cost of common equity for a company in a developing country, an analyst should most appropriately: add a country risk premium to the market risk premium. add the sovereign yield spread to the CAPM cost of common equity. make no adjustments because country risk is reflected in the equity's beta.

A The appropriate method for estimating the cost of equity for a firm in a developing market is to add a country risk premium (CRP) to the market risk premium, so the revised CAPM equation becomes: kce = RF + β[E(RMKT) - RF + CRP]. The CRP is the sovereign yield spread (between yields on the country's government bonds and a developed country's government bonds) adjusted for the volatility of the developing country's equity market. An alternative approach is to add the CRP (not the sovereign yield spread) to the cost of equity as calculated from the CAPM.

If flotation costs are treated correctly in calculating the net present value of a project that will begin in the current period, the flotation costs are most likely: included in the initial outlay. reflected in the discount rate used for the project. included in the cost of the capital raised.

A The correct treatment of flotation costs according to the CFA Curriculum is to include their cost in the initial cash outflow of the project. Since flotation costs are included in the initial outlay, they decrease the NPV by an amount that is unaffected by the discount rate, and the discount rate and cost of capital are not adjusted for flotation costs.

A firm that reports under IFRS is producing under a long-term contract for which it cannot measure the outcome reliably. In the first year of the contract, the firm has spent €300,000 and collected €200,000 in cash. What amounts related to this contract should the firm recognize on its income statement for the year? A) Revenue of €300,000, expenses of €300,000, and no profit. B) No revenue, expenses, or profit until the contract is completed. C) Revenue of €200,000, expenses of €300,000, and a loss of €100,000.

A Under IFRS, if the outcome of a long-term contract cannot be estimated reliably, the firm should expense costs when incurred, recognize revenue to the extent of the costs, and recognize profit only when the contract is complete. The firm does not need to recognize a loss when expenses are greater than cash collected, but would need to recognize a loss if it determined that a loss on the contract was likely.

Longboat, Inc. sold a luxury passenger boat from its inventory on December 31 for $2,000,000. It is estimated that Longboat will incur $100,000 in warranty expenses during its 5-year warranty period. Longboat's tax rate is 30%. To account for the tax implications of the warranty obligation prior to incurring warranty expenses, Longboat should: A) record a deferred tax asset of $30,000. B) record a deferred tax liability of $30,000. C) make no entry until actual warranty expenses are incurred.

A Warranty expense should be recorded when the inventory item covered by the warranty is sold. A deferred tax asset is created when warranty expenses are accrued on the financial statements but are not deductible on the tax returns until the warranty claims are paid. The full amount of the obligation, $100,000, is recorded as an expense, with a deferred tax asset of $30,000. Note that a deferred tax asset results when taxable income is more than pretax income and the difference is likely to reverse (warranty will be paid) in future years.

An investor purchases 1,000 shares of each of the stocks in the S&P 500 Index at their closing prices (ignore transactions costs). On a total return basis, if the index stocks remain the same, this portfolio will: perform exactly like the index over time. outperform the index over time. underperform the index over time.

B Total return includes dividend yield. Because dividends are not included in the performance of the index itself, the portfolio will outperform the index by the amount of the dividend yield.

Assume that one year ago, the exchange rate between the Japanese yen and the euro was 100 JPY/EUR, and the exchange rate between the Japanese yen and the U.S. dollar was 80 JPY/USD. Current exchange rates are 104.2 JPY/EUR and 76.6 JPY/USD. Which of the following statements is most accurate? A) The USD has depreciated relative to the EUR. B) The JPY has depreciated 4.2% relative to the EUR. C) The current U.S. dollar to euro exchange rate is approximately 1.25 USD/EUR.

A We can calculate the current USD/EUR cross rate as 104.2 / 76.6 = 1.3603 USD/EUR. The original USD/EUR cross rate was 100 / 80 = 1.2500 USD/EUR. Thus, the USD has depreciated relative to the EUR. While it is correct to say that the EUR has appreciated 4.2% relative to the JPY (104.2 / 100 - 1) = 4.2%, it is not correct to say that the JPY has depreciated by the same percentage. To calculate the percentage change in the JPY relative to the EUR, we need to invert the quotes. One year ago, the quote was 0.0100 EUR/JPY and now the quote is 0.0096 EUR/JPY. (0.0096 / 0.0100 - 1) = 0.0403 or 4.0% depreciation in the JPY relative to the EUR.

Which of the following items regarding the corporate income statement is most accurate? If a corporation disposes of a business segment that is separable from the company's core business activities, the results of the discontinued segment are reported as a separate line item below income from continuing operations on a pre-tax basis. Examples of extraordinary items include expropriations of property and equipment by foreign governments, losses from earthquakes and tornados, and gains from the sale of investments in subsidiaries. Unusual or infrequent items appear in the income statement of a corporation as a component of net income from continuing operations.

Explanations for incorrect answers are as follows: •The gain on the sale of a subsidiary is an unusual or infrequent item. •The results of a discontinued segment are reported below the line, net of tax (after tax). C

In general, as compared to companies with operating leases, companies with finance leases report: A) lower working capital and asset turnover. B) higher debt-to-equity ratios and return on equity in the early years. C) higher expenses in the early years and over the life of the lease.

A Working capital equals current assets minus current liabilities and is lower under a finance lease because the current portion of the finance lease increases current liabilities. Total asset turnover is lower because total assets are higher under a finance lease. Companies with finance leases report higher debt-to-equity ratios because liabilities increase and equity is unchanged at lease inception and lower in the early years of the lease. Return on equity is lower with a finance lease because the numerator, net income, is decreased proportionally more than the denominator, equity, from the greater expense of a finance lease in its early years. Over the life of the lease, the expenses are equal.

For a binomial random variable with a 40% probability of success on each trial, the expected number of successes in 12 trials is closest to: A) 4.8. B) 5.6. C) 7.2.

A a binomial random variable has an expected value of np = .4 x 12 = 4.8

Panel data

contain observations over time of the same chractertiscs for multiple entities, such as debt/equity ratios for 20 companies over the most recent 24 quarters.

An analyst using a one-period binomial model calculates a probability-weighted average of an option's values following an up-move or a down-move. According to this model, this average is most likely: A) equal to the option's value today. B) less than the option's value today. C) greater than the option's value today.

he probability-weighted average calculated by the analyst is the option's value after one period. To estimate the option's value today, this result must be discounted by one period.

A firm is said to have a top-heavy capital structure if a high percentage of its total capital is: debt. short-term debt. secured bank debt.

C

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

C A ratio that is highly variable, but consistently greater than one, is not necessarily indicative of low-quality earnings. 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.

According to the Code and Standards regarding knowledge of laws and regulations, CFA Institute members and candidates must: spend a minimum of five hours per calendar year on continuing education activities related to applicable laws and regulations. have detailed knowledge of all the laws that could potentially govern the member's activities. understand the relevant regulations for all the countries where they trade securities.

C Standard I(A)-Knowledge of the Law requires members and candidates to understand applicable laws and regulation in those countries where they trade or conduct business. Although an understanding of laws and regulations is required, members and candidates can rely on legal counsel and compliance to be subject matter experts in these areas. The Code and Standards do not require a minimum of five hours of continuing education.

Which of the following statements about the univariate, multivariate, and standard normal distributions is least accurate? A) A univariate distribution describes a single random variable. B) A multivariate distribution specifies the probabilities for a group of related random variables. C) The standard normal random variable, denoted Z, has mean equal to one and variance equal to one.

C The standard normal random variable, denoted Z, has mean equal to 0 and variance equal to 1.

Akor is a country that has chosen to use a conventional fixed peg arrangement as the country's exchange rate regime. Under this arrangement, Akor's exchange rate against the currency to which it pegs: A) is market-determined. B) will be equal to the peg rate. C) may fluctuate around the peg rate.

in a conventional fixed peg arrangement, a country pegs its currency within a margin of ±1% versus another currency or a basket that includes the currencies of its major trading or financial partners. Market-determined exchange rates are a characteristic of an independently floating exchange rate regime.

Henrietta Huerta, CFA, writes a weekly investment newsletter to market her services and obtain new asset management clients. A third party distributes the free newsletter on her behalf to those individuals on its mailing list. As a result, it is widely read by thousands of individual investors. The newsletter recommendations reflect most of Huerta's investment actions. After completing further research on East-West Coffee Roasters, Huerta decides to change her initial buy recommendation to a sell. To avoid violating the CFA Institute Standards of Professional Conduct, it would be most appropriate for Huerta to distribute the new investment recommendation to: asset management clients first. newsletter recipients and asset management clients simultaneously. newsletter recipients first.

A According to Standard III(A): Loyalty, Prudence, and Care, members and candidates must place their clients' interests before their own interests. The temptation may be to release the changed recommendation to newsletter recipients simultaneously with or even before the asset management clients to try to obtain new clients. But to avoid violating Standard III(A), Huerta must ensure any change in an investment recommendation is first distributed to her asset management clients before any newsletter recipients, who are not necessarily clients (that is, they receive the newsletter for free from a third-party distribution list).

Roberto Sanchez, CFA, and Andreas Lopez, CFA, have worked as financial analysts for OneWorld Analytics for years. While at OneWorld, Lopez created a highly complex financial valuation model, with Sanchez making small contributions to its development. Recently, Lopez left OneWorld to start his own company using a simplified model he developed prior to joining OneWorld. Over a six-month period, he improves this software, duplicating features he used at OneWorld. His upgraded program produces predictions similar to the results of the OneWorld program. At OneWorld, Sanchez continues to use the complex model he and Lopez developed and attains superior results. Whose behavior most likely conforms to the CFA Institute Standards of Professional Conduct? Both Lopez and Sanchez Sanchez but not Lopez Lopez but not Sanchez

A Both Lopez and Sanchez upheld the requirements of Standard I(C)-Misrepresentation with regard to work completed for an employer. Sanchez has the right to continue using the software primarily developed by Lopez because OneWorld Analytics, not the employee, owns the software. Lopez does not leave with the model he developed while employed by OneWorld, and therefore, he is not in violation of the Standards of Professional Conduct. Once Lopez leaves OneWorld, he develops a separate model based on a model he developed prior to joining OneWorld. The simplified model remains the intellectual property of Lopez. The duplication of features is allowable under Standard IV(A)-Loyalty in that Lopez's expertise gained at his former employer is not considered to be confidential or privileged. Therefore, both Lopez and Sanchez upheld the Standards.

Gregor Pavlov, CFA, is a fund manager working for the general partner of a new private equity fund. Pavlov includes in the fund marketing material his performance history from his previous employer. He received permission from his former employer to take his historical return figures and the supporting research reports he used to make the related investment decisions. Did Pavlov most likely violate the CFA Institute Standards of Professional Conduct? Yes, with regard to Record Retention Yes, with regard to Loyalty No

A Even though Pavlov had his former employer's permission to take his performance record and supporting research reports with him, he does not have the underlying performance data to support those historical return calculations and is, therefore, most likely in violation of Standard V(C)-Record Retention. Pavlov had the permission of his employer to take his historical performance record and research reports with him when he left the firm, so he is not in violation of Standard IV(A)-Loyalty

udy Blush is a CFA candidate and is recommending the purchase of a mutual fund that invests solely in long-term U.S. Treasury bonds (T-bonds) to one of her clients. She states that, "Since the U.S. government guarantees payment of both the bond's principal and interest, risk of loss with this investment is virtually zero." Blush's actions violated: A) the Standard on misrepresentation. B) the Standard on communication with clients and prospective clients. C) none of the CFA Institute Standards of Professional Conduct.

A Government bonds are default risk free but are subject to price risk. Thus, Blush misrepresented the expected performance of the fund and therefore violated Standard I(C) Misrepresentation.

A contract that requires one party to pay $100,000 each quarter to another company that will make a variable quarterly payment based on the market value of an equities portfolio is referred to as: A) a swap. B) an index option. C) portfolio insurance.

A In an equity swap, one party pays a fixed amount periodically in return for a payment that is calculated using a specific amount and the return on a stock or portfolio of stocks.

For 20X1, Belcher Motors reported a decrease in its deferred tax liabilities, a decrease in its deferred tax assets, and an increase in its valuation allowance. To an analyst, this would most likely suggest that the company has: A) decreased its estimate of future profitability. B) increased the estimated useful life of some capitalized assets. C) increased its estimate of the period over which unearned revenue will be recognized.

A The increase in the valuation allowance tells us that the company has decreased its estimate of its future profitability and thus its ability to realize the benefits of its deferred tax assets. A longer period for recognition of unearned revenue would not affect the temporary differences reflected in deferred tax assets. Increasing the estimate of assets' useful lives would tend to slow financial statement depreciation relative to depreciation for tax, which would increase deferred tax liability going forward, other things constant. Decreases in the carrying values of both a DTL and a DTA may reflect a decrease in the tax rate.

Robert Higgins is estimating the price-earnings (P/E) ratio that will be appropriate for an index at the end of next year. He has estimated that: Expected annual dividends will increase by 10% compared to this year. Expected earnings per share will increase by 10% compared to this year. The expected growth rate of dividends will be the same as the current estimate of 5%. The required rate of return will rise from 8% to 11%. Compared to the current P/E, the end-of-the-year P/E will be: 50% lower. B) 2% higher. C) 10% higher.

A The numerator of the formula for the P/E is the payout ratio, which is unchanged (both expected earnings and dividends increase by the same percentage). The denominator (k - g) doubles from 3% to 6%, which will decrease the P/E by half.

Meyer Company increases the promised payments for all employees in its defined benefit pension plan. Under which financial reporting standards would Meyer recognize past service costs in its income statement for the period? A) IFRS only. B) U.S. GAAP only. C) Both IFRS and U.S. GAAP.

A Under IFRS, past service costs (changes in defined benefit plan obligations that result from a change in the plan's terms) are reported as part of service costs, a component of net income. Under U.S. GAAP, past service costs are recognized in other comprehensive income and amortized over time to the income statement.

For a profitable company, issuing debt in order to retire common stock will most likely: A) increase both net income and return on equity. B) decrease both operating income and net income. C) increase both the level and variability of return on equity.

An increase in debt will increase interest expense, which will decrease net income but not operating income, which is calculated before subtracting interest expense. For a profitable firm, the decrease in net income will be offset by the decrease in equity from the repurchase of common stock, so that ROE increases. The effect of the increase in financial leverage will, however, increase the variability of ROE for a given change in operating earnings.

According to the CAPM, a rational investor would be least likely to choose as his optimal portfolio: a 100% allocation to the risk-free asset. the global minimum variance portfolio. a 130% allocation to the market portfolio.

B According to the CAPM, rational, risk-averse investors will optimally choose to hold a portfolio along the capital market line. This can range from a 100% allocation to the risk-free asset to a leveraged position in the market portfolio constructed by borrowing at the risk-free rate to invest more than 100% of the portfolio equity value in the market portfolio. The global minimum variance portfolio lies below the CML and is not an efficient portfolio under the assumptions of the CAPM.

According to the CAPM, a rational investor would be least likely to choose as his optimal portfolio: a 100% allocation to the risk-free asset. the global minimum variance portfolio. a 130% allocation to the market portfolio.

B According to the CAPM, rational, risk-averse investors will optimally choose to hold a portfolio along the capital market line. This can range from a 100% allocation to the risk-free asset to a leveraged position in the market portfolio constructed by borrowing at the risk-free rate to invest more than 100% of the portfolio equity value in the market portfolio. The global minimum variance portfolio lies below the CML and is not an efficient portfolio under the assumptions of the CAPM.

As output quantities expand in an industry with a downward-sloping long-run industry supply curve, what is the most likely long-run effect on the equilibrium selling price per unit of the industry's output? A) Increase, because of upward pressure on input prices. B) Decrease, because of lower input costs per unit of output. C) No effect, because selling price is only affected in the short run.

B An industry with a downward-sloping long-run industry supply curve is a decreasing-cost industry. In such an industry, input costs decrease as output quantities increase. In the short run, this causes firms to earn economic profits. In the long run, these economic profits attract new entrants to the industry, which reduces the equilibrium selling price of the industry's output.

Haltata Turf & Sod currently uses the first in, first out (FIFO) method to account for inventory. Due to significant tax-loss carryforwards, the company has an effective tax rate of zero. Prices are rising and inventory quantities are stable. If the company were to use last in, first out (LIFO) instead of FIFO: A) net income would be lower and cash flow would be higher. B) cash flow would remain the same and working capital would be lower. C) gross margin would be higher and stockholder's equity would be lower.

B In the absence of taxes, there is no difference in cash flow between LIFO and FIFO. In addition, using LIFO would result in lower working capital (inventory is lower). Using LIFO would result in lower net income because of a lower gross margin (cost of goods sold is higher).

f market interest rates have changed materially since a firm issued a bond, and the firm uses the effective interest rate method, how is a change in the market value of the firm's debt most likely to be reported in the firm's financial statements? A) The gain or loss in market value must be calculated and disclosed in the footnotes to the financial statements. B) Net income and equity are unaffected, but the change may be discussed in management's commentary. C) Net income is unaffected, but the change in market value is recorded in other comprehensive income.

B Material changes in the firm's cost of debt capital should be included in the Management Discussion and Analysis section of the financial statements. If the firm does not use fair value reporting of debt obligations, net income and shareholders' equity are not affected by changes in the market value of the firm's debt, and disclosing its gain or loss in market value is not required.

Samuel Parkin, a principal of Argora Advisers, is in charge of preparing the firm's performance history in accordance with GIPS. At the end of each year, he assigns each portfolio to a single composite based on its holdings over the year. He uses the mean annual total return of portfolios assigned to a composite as the composite's return. With respect to GIPS compliance: A) both of these actions comply with GIPS. B) neither of these actions comply with GIPS. C) only one of these actions complies with GIPS.

B To comply with GIPS, portfolios must be assigned to composites before the returns are known; assigning them at the end of the year is not acceptable. The composite return must be asset weighted not a simple average (equal- weighted). Asset weighting will ensure that the performance reported will be representative of (if not exactly equal to) the performance of all the accounts assigned to a single composite over the reporting period.

William Rex, CFA, has a one-man firm that manages investment portfolios. In his marketing materials, Rex presents the asset-weighted returns for accounts he has managed over the last five years and does not disclose that the first two years of his performance history were achieved at a previous firm. He also includes simulated results of a stock selection model he employs and indicates that they are from a simulation. Has Rex violated any CFA Institute Standards of Professional Conduct? A) No. B) Yes, failing to disclose that two years of his performance results were with a previous employer is a violation, but including the simulated results is acceptable. C) Yes, both by failing to disclose that two years of his performance results were with a previous employer and by including the simulated, rather than actual, performance results.

B Under Standard III(D) Performance Presentation, members and candidates must make reasonable efforts to ensure that investment performance information is fair, accurate, and complete. Rex has misled his potential clients by not disclosing that the first two years of his performance record were achieved at another firm. There is no prohibition against presenting simulated results as long as the fact that the results are simulated, rather than actual, is disclosed.

Business risk is best described as resulting from the combined effects of a firm's: A) financial risk and sales risk. B) sales risk and operating risk. C) operating risk and financial risk.

B Business risk is the combination of sales risk, which is the variability of a firm's sales, and operating risk, which is the additional variability in operating earnings (EBIT) caused by fixed operating costs.

Oligopolists have an incentive to cheat on collusive agreements in order to: A) avoid competitive practices. B) increase their individual share of the joint profit. C) restrict output and put upward pressure on price.

B Colluding restricts output and puts upward pressure on price, but cheating actually increases output and ultimately, if enough cheating occurs, puts downward pressure on the price. Colluders cheat to increase their share of the profits.

A company prepares a chart with the net present value (NPV) profiles for two mutually exclusive projects with equal lives of five years. Project Jones and Project Smith have the same initial cash outflow and total undiscounted cash inflows, but 75% of the cash inflows for Project Jones occur in years 1 and 2, while 75% of the cash inflows for Project Smith occur in years 4 and 5. Which of the following statements is most accurate regarding these projects? A) Project Smith has a higher internal rate of return than Project Jones. B) There is a range of discount rates in which the optimal decision is to reject both projects. C) There is a range of discount rates in which the company should choose Project Jones and a range in which it should choose Project Smith.

B If the total undiscounted cash flows from two projects are equal, their NPV profiles intersect the vertical axis at the same value. The NPV profile will have a steeper slope for Project Smith, which has more of its cash inflows occurring later in its life, and therefore the IRR of Project Smith (its intersection with the horizontal axis) must be less than the IRR of Project Jones. The NPV for Project Jones will be greater at any rate of discount, and Project Jones will be preferred over the entire range. However, if the discount rate applied to the cash flows is greater than the IRR of Project Jones, both projects will have negative NPVs and the company should reject both of them.

Which of the following statements about methods of calculating gross domestic product is most accurate? A) Except for a statistical discrepancy, the income and expenditure approaches to calculating GDP should result in the same value for economic output. B) Because it includes activity at all stages of production, the sum-of-value-added method results in a better estimate of GDP than the value-of-final-output method. C) Value-of-final-output is used to calculate GDP under the expenditure approach, while sum-of-value-added is used to calculate GDP under the income approach.

Because aggregate income is the same as aggregate output, measuring GDP by summing incomes or expenditures should produce the same value, except for a statistical discrepancy that results from using different data sources. The sum-of-value-added method of calculating GDP records the sum of the increases in value of goods and services at each stage of their production and distribution. The resulting total for GDP is the same as that reached by the value-of-final-output method because the sum of value added to a good at all stages of processing is equal to its selling price. Both methods calculate GDP based on expenditures

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

C 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

Thompson Products has seen its marginal tax rate increase from 28% to 34% over the last two years and believes the change is permanent. The effects of this change on Thompson's current WACC and on its financial leverage over time are most likely a(n): increase in both. decrease in both. increase in one and a decrease in the other.

C An increase in the tax rate will reduce Thompson's after-tax cost of debt (other things equal) and therefore reduce its WACC. With a relatively lower cost of debt the firm will likely change its capital structure to include more debt and less equity (i.e., to increase its financial leverage).

Which of the following statements with respect to hedge fund investing is least accurate? Hedge funds only publicly disclose performance information on a voluntary basis. Hedge funds are not typically registered with the SEC in the United States. Survivorship bias in hedge fund data causes risk to be overstated because funds that take on more risk tend to have higher returns.

C Because a hedge fund database only includes the more stable funds that have survived, the risk measure of hedge funds as an asset class is biased downward.

Which of the following statements regarding the money supply and determination of short-term interest rates is least accurate? A) On balance, growth in real GDP tends to increase the transactional demand for money. B) If the short-term interest rate is greater than the equilibrium rate, there will be excess supply of real money balances. C) An increase in the real money supply from an initial equilibrium situation will cause households and businesses to sell interestbearing securities.

C From an initial equilibrium, an increase in real money balances will leave households and businesses with more money than they wish to hold, so they will purchase interest-bearing securities, driving their prices up and yields down until a new equilibrium short-term rate is established.

Which of the following statements about the role of depreciable lives and salvage values in the computation of depreciation expenses for financial reporting is most accurate? A) The estimated useful life of the same depreciable asset should be the same regardless of which company owns the asset. B) Companies are specifically required to disclose data about estimated salvage values in the footnotes to the financial statements. C) Depreciable lives and salvage values are chosen by management and allow for the possibility of income manipulation.

C Useful lives and salvage values of long-lived assets are management estimates that may vary among companies. Companies typically do not disclose data about estimated salvage values, except when estimates are changed.

A central bank's ability to achieve its policy goals is most likely to be limited by available resources when which of the following actual rates is below its target rate? A) Interest rate. B) Inflation rate. C) Exchange rate. Explanation

C With exchange rate targeting, a central bank's ability to increase the value of the domestic currency is limited by the amount of foreign reserves the country has available to buy its own currency in the foreign exchange market. While inflation targeting and interest rate targeting have limitations (e.g., liquidity trap conditions may exist, interest rates are bounded by zero), the central bank's resources are not typically a limitation.

When a risk-free asset is combined with a portfolio of risky assets, which of the following is least accurate? A) The standard deviation of the return for the newly created portfolio is the standard deviation of the returns of the risky asset portfolio multiplied by its portfolio weight. B) The expected return for the newly created portfolio is the weighted average of the return on the risk-free asset and the expected return on the risky asset portfolio. C) The variance of the resulting portfolio is a weighted average of the returns variances of the risk-free asset and of the portfolio of risky assets.

C the risk free asset has no variance of returns This statement is not correct; the standard deviation of returns for the resulting portfolio is a weighted average of the returns standard deviation of the risk-free asset (zero) and the returns standard deviation of the risky-asset portfolio.

Senior subordinated bonds have a priority of claims over: first lien debt. secured bonds. subordinated bonds.

C First lien loans and secure bonds are senior to any unsecured debt. Senior subordinated debt is senior to subordinated debt.

Non-financial sources of risk for an organization most likely include: A) credit risk. B) liquidity risk. C) solvency risk.

C Non-financial risks are those that arise from an organization's operations and from outside sources other than financial markets. Solvency risk is classified as a non-financial risk.

According to the Code and Standards regarding knowledge of laws and regulations, CFA Institute members and candidates must: spend a minimum of five hours per calendar year on continuing education activities related to applicable laws and regulations. have detailed knowledge of all the laws that could potentially govern the member's activities. understand the relevant regulations for all the countries where they trade securities.

C Standard I(A)-Knowledge of the Law requires members and candidates to understand applicable laws and regulation in those countries where they trade or conduct business. Although an understanding of laws and regulations is required, members and candidates can rely on legal counsel and compliance to be subject matter experts in these areas. The Code and Standards do not require a minimum of five hours of continuing education.

Which of the following scenarios is inconsistent with efficient financial markets? A) An analyst's buy recommendations have returned 2% more than the broad market index, on average. B) Johnson, Inc. reports an increase of 8% in its earnings from a year earlier, and its stock price declines 5% on the news. C) Earl Baker, an investor, earns consistently superior risk-adjusted returns by buying stocks when most investment advisors are pessimistic and selling stocks when most investment advisors are optimistic.

C) If markets are efficient, investors should not earn consistently superior returns from technical trading rules such as a contrary opinion strategy. A stock price will decrease on a report of an increase in earnings if that increase is less than investors expected based on all the information previously available. An analyst's recommendations could be for stocks with more than market risk, or the analyst's industry may outperform for some period of time. Both could account for outperformance even though markets are efficient.

At the beginning of the year, Breidel Company changes its inventory accounting method (for both financial and tax reporting) from first in first out to average cost. Assuming an environment of increasing prices, how will this accounting change affect Breidel's forecasts of its net cash position? A) No effect because this accounting change does not affect cash flows. B) Less net cash in both the short-term forecast and the long-term forecast. C) No effect on the short-term forecast but greater net cash in the long-term forecast.

Changing the inventory accounting method has no immediate cash flow effects and therefore should not change a firm's short-term forecast (typically 4 to 6 weeks) of its net cash position. However, because the average cost inventory method will result in lower gross profit compared to FIFO, it will also result in decreased taxes. The firm's long-term forecast (typically 3 to 5 years) of its net cash position should reflect a decrease in cash outflows for taxes, and consequently greater net cash in future periods.

Which of the following statements about monopolists is most accurate? A) Monopolists have imperfect information about demand. B) Without government intervention, monopolists will always earn economic profits. C) A monopolist maximizes total revenue where marginal revenue equals marginal cost.

Demand curves are not observable so a monopolist must search for the profit maximizing price. Because demand information is not perfect, a monopolist is a price searcher. The other statements are false. Although a monopolist can earn positive economic profits in the long run, they are not guaranteed; if average total costs exceed price, the monopolist will experience economic losses. A monopolist maximizes profit, not revenue, where marginal revenue equals marginal cost.

In the Heckscher-Ohlin model, the source of comparative advantage is the relative amounts of labor and capital that are available in each country. Countries with more capital available relative to labor available will have a comparative advantage in producing capital-intensive goods, while countries with more labor available relative to capital will have a comparative advantage in labor-intensive goods.

Discontinued operations are not classified as unusual or infrequent items and are reported (net of taxes) after net income from continuing operations but before net income.

If the probability of event J multiplied by the probability of event K is not equal to the joint probability of events J and K, then events J and K are most likely: A) dependent events. B) independent events. C) mutually exclusive events.

Events J and K are dependent. By the multiplication rule, joint probability P(JK) = P(J|K) × P(K), or P(JK) = P(K|J) × P(J). Events are independent if P(J|K) = P(J) and P(K|J) = P(K). This implies that for independent events, P(JK) = P(J) × P(K). If this condition is not met, events J and K are dependent. If events J and K are mutually exclusive, their joint probability is zero. The information given is consistent with this but not sufficient to conclude that this is the case.

An analyst estimates a stock has a 40% probability of earning a 10% return, a 40% probability of earning a 12.5% return, and a 20% probability of earning a 30% return. The stock's standard deviation of returns based on this returns model is closest to: A) 3.74%. B) 5.75%. C) 7.58%.

Expected value = (0.4)(10%) + (0.4)(12.5%) + (0.2)(30%) = 15% Variance = (0.4)(10 − 15)2 + (0.4)(12.5 − 15)2 + (0.2)(30 − 15)2 = 57.5 Standard deviation = sqrt(57.5) = 7.58%

Gordon, Inc., reports using the LIFO cost method. In notes to its financial statements, Gordon discloses inventory of 500 units in 20X1 and 510 units in 20X2 and states a LIFO reserve of $50,000 in 20X1 and $48,000 in 20X2. These inventory disclosures most likely reflect: A) decreasing demand. B) decreasing prices. C) a LIFO liquidation.

Explanation Decreasing prices can cause the LIFO reserve to decrease even when the inventory quantity is stable or increasing. A LIFO liquidation is a decrease in the quantity of inventory. To look for an indication of decreasing demand, an analyst would compare the growth rates of inventories and sales.

If a stock's beta is equal to 1.2, its standard deviation of returns is 28%, and the standard deviation of the returns on the market portfolio is 14%, the covariance of the stock's returns with the returns on the market portfolio is closest to: A) 0.168. B) 0.024. C) 0.600.

From the fact that betai = Covi,mkt / Varmkt, we have Covi,mkt = betai × varmkt. Covi,mkt = 1.2 × 0.142^2 = 0.02352.

The initial market value of a portfolio was $100,000. One year later the portfolio was valued at $90,000 and two years later at $99,000. The geometric mean annual return excluding any dividend income is closest to: A) -0.5%. B) -0.4%. C) 0.0%.

R1 = −10/100 = −10%; R2 = +9/90 = +10% geometric mean = − 1 = −0.005 or −0.5%

A business cycle theory developed by applying utility theory and budget constraints to macroeconomic models is most closely associated with which school of economic thought? A) Austrian. B) New Classical. C) New Keynesian.

Real business cycle theory, which derives from applying utility theory and budget constraints to macroeconomic models, is associated with the New Classical school. B

Under IFRS, remeasurements related to defined benefit pension plans are initially recognized in: A) net income in the current period. B) other comprehensive income and are not amortized to income. C) other comprehensive income and amortized over time to income.

Remeasurements (actuarial gains and losses, difference between actual return and expected return on plan assets) are recognized as other comprehensive income under IFRS and are not amortized.

Abe Seneca, CFA, supervises a team of analysts who create index funds for institutional investors. When Seneca makes sales demonstrations without his colleagues to potential clients simulating the fund's performance, the scenarios he prepares show outcomes based on assumptions reflecting upside bias and positive risk assessments. Gail Tremblay, CFA, an analyst in Seneca's group, observes that the actual performance of these index funds is less than indicated in the scenario outcomes shown in the sales meetings. Seneca least likely violated which of the following CFA Institute Standards of Professional Conduct?

Standard IV(C)-Responsibilities of Supervisors has not been violated; when Seneca makes sales demonstrations to potential clients, he is not acting as a supervisor of any employee because he prepared the material himself. Seneca, however, violated Standard IV(A)-Loyalty by misleading potential investors on the performance they might achieve with the index funds, thereby causing reputational risk to his employer. Seneca has also violated Standard III(D)-Performance Presentation because the sales demonstrations he conducts do not provide a fair and accurate representation of performance clients are likely to experience.

With respect to the IS-LM model, in an LM curve the real interest rate is: A) positively related to real income, holding the real money supply constant. B) held constant, resulting in excess savings being positively related to real income. C) negatively related to real income, holding the marginal propensity to save constant

The LM curve illustrates a positive relationship between real income and the real interest rate, holding the real money supply constant. The IS curve illustrates a negative relationship between real income and the real interest rate, holding the marginal propensity to save constant.

Monthly demand for gasoline at a particular location, as a function of the price of gasoline and the price of bus travel, is given (in hundreds of gallons) as QD = 300 - 15 Pgas + 2 Pbus. The slope of the demand curve for gasoline is closest to:

The demand curve (price as a function of QD) is found by inverting the demand function: Pgas = 20 + 2/15 Pbus - 1/15QD The slope of this function (for any positive value of Pbus) is -1/15, or -0.0667.

A firm with earnings per share of $2 decides to repurchase a portion of its shares at their market price of $25. The firm's after-tax cost of debt is 6% and the firm earns a 2% after-tax yield on its excess cash. When the firm repurchases shares, its earnings per share will: A) increase if the firm funds the repurchase with debt or uses excess cash to repurchase the shares. B) decrease if the firm funds the repurchase with debt or uses excess cash to repurchase the shares. C) decrease if the firm funds the repurchase with debt, but increase if the firm uses excess cash to repurchase the shares.

The earnings yield on the firm's shares is $2 / $25 = 8%. Because both the firm's after-tax yield on excess cash and its after-tax cost of borrowing are less than the earnings yield, financing a share repurchase either with excess cash or with debt will increase earnings per share.

The amount of a company's optimal capital budget is most accurately determined by the point on the company's investment opportunity schedule: A) where the amount of new capital raised is at its minimum. B) where it intersects the company's marginal cost of capital curve. C) where the expected return on the next potential project is at its maximum

The investment opportunity schedule is a downward sloping curve of the internal rates of return (expected returns) of potential projects ranked from highest to lowest. This curve intersects the company's upward sloping marginal cost of capital curve at an amount of capital where the marginal project's IRR just equals the firm's cost of capital. The firm should accept projects with IRRs that exceed the marginal cost of capital (lie to the left of the intersection) and reject projects with IRRs less than the marginal cost of capital (lie to the right of the intersection).

Interest and dividends received are reported as income, regardless of the balance sheet classification of marketable securities.

The most useful estimates of inventory and cost of sales are those that best approximate current cost. Whether prices are increasing or decreasing, FIFO provides a better estimate of inventory values, and LIFO provides a better estimate of cost of sales. If prices are stable, there is no difference between LIFO and FIFO estimates of inventory or cost of sales.

The holder of the type of security that has a priority in liquidation less than that of bonds or promissory notes issued by the company but ahead of that of common stock is most likely to have: A) no voting rights. B) statutory voting rights. C) cumulative voting rights.

The security being described here is preferred stock (preference shares). In the event of liquidation of a firm, the claims of preferred equity shareholders are senior to the claims of common stockholders but subordinated to the claims of debt holders. Preferred shares typically have no voting rights.

The "up-move factor" in a binomial tree is best described as: A) the probability that the variable increases in any period. B) one minus the "down-move factor" for the binomial tree. C) one plus the percentage change in the variable when it increases.

The up-move factor equals one plus the percentage increase when the variable goes up, and the down-move factor is equal to one divided by the up-move factor.

If the yield curve is downward-sloping, the no-arbitrage value of a bond calculated using spot rates will be: A) equal to the market price of the bond. B) less than the market price of the bond. C) greater than the market price of the bond.

The value of a bond calculated using appropriate spot rates is its no-arbitrage value. If no arbitrage opportunities are present, this value is equal to the market price of a bond.

The notice period is the time within which a hedge fund must fulfill a request for redemption of shares. The period during which investors may not redeem shares is called a lockup period.

There are two formats for a common-size cash flow statement, expressing each type of outflow as a percentage of total cash outflows or as a percentage of total revenue for the period. Operating cash flow for the period mixes inflows and outflows and is not used to calculate percentage flows for payment made.

A technical analyst is most likely to expect an uptrend in prices to continue if: A) converging trendlines form a triangle pattern on a price chart. B) the 14-day relative strength index increases from 70 to 80. C) the uptrend line acts as a resistance level when the price approaches it.

Triangles are thought to be continuation patterns, suggesting that the trend will continue in the same direction it was going when the triangle pattern formed. An RSI above 70 is thought to indicate an overbought condition, which can be a warning sign that the current uptrend is not sustainable. An uptrend line should act as a support level in an uptrend when the price approaches the trendline from above. If an uptrend line acts as a resistance level, the price must have broken down through the trendline, which is a sign that the uptrend may be ending

Decisions that index providers must make when constructing and managing indexes include: •The target market the index will measure. •Which securities from the target market to include. •The appropriate weighting method. •How frequently to rebalance the index to its target weights. •How frequently to re-examine the selection and weighting of securities.

Under IFRS, if substantially all the rights and risks of ownership are transferred to the lessee, the lease is treated as a finance lease by both the lessee and lessor. Otherwise, the lease is an operating lease. Under U.S. GAAP, the lessee must treat a lease as a capital (finance) lease if any one of the following criteria is met: •Title to the leased asset is transferred to the lessee at the end of the lease period. •A bargain purchase option exists. •The lease period is 75% or more of the asset's economic life. •The present value of the lease payments is 90% or more of the fair value of the leased asset. Under U.S. GAAP, the lessor capitalizes the lease if any one of the finance lease criteria for lessees is met, collectability of lease payments is reasonably certain, and the lessor has substantially completed performance.

for a continuous uniform distribution, to calculate the probabilites between x1 and x2

X is uniformly distributed between 2 and 12. calculate the probablility that X will be between 4 and 8: (8-4) / (12 - 2) = 40%

marginal cost pricing

also referred to as efficient regulation, forces the monopolist to reduce price to the point where the firm's MC curve intersects the market demand curve. this increases output and reduces price, BUT CAUSES THE MONOPOLIST TO INCUR A LOSS BECAUSE PRICE IS BELOW ATC. this requires a government subsidy in order to provide the firm with a normal profit and prevent it from leaving the market entirely.

HHI or the herfindal-hirschman index

alternative measures of market concentration to the n firm concentration ratio. take the squared percents instead of just the percents.

longitudinal data

are observations over time of multiple characteristics of the same entity, such as unemployment, inflation, and GDP growth rates for a country over 10 year.

IFRS and U.S. GAAP both require discontinued operations to be reported on the income statement separately from continuing operations and net of tax. U.S. GAAP permits unusual and infrequent items to be treated as extraordinary items, but IFRS does not permit extraordinary items. Fixed assets can be revalued upward under IFRS but not under U.S. GAAP.

goodwill is only created in a purchase. it cannot be internally created

The power of a test is the probability of rejecting the null hypothesis when it is false

neutral interest rate is the growth rate of the money supply that neither increases nor decreases the economic growth rate: neutral interest rate = real trend rate of economic growth + inflation target

cost minimizing level of inputs = Marginal product / resource price per unit

profit maximizing quantity : MRP = P

multivariate distribution

specifies the probabilities associated with a group of random variables and is meaningful only when the behavior of each random variable in the group is in some way dependent upon the behavior of the others. both discrete and continuous random variables can have multivariate distributions. multivariate disitbrutions between two discrete random variables are described using joint probability tables. for continuous random variables, a multivariate normal distirbution may be used to describe them if all of the individual variables follow a normal distribution. CORRELATION IS THE FEATURE THAT DISTINGUISHES A MULTIVARIATE DISTRIBUTION FROM A UNIVARIATE NORMAL DISTRIBUTION. CORRELATION INDICATES THE STRENGTH OF THE LINEAR RELATIONSHIP BETWEEN A PAIR OF RANDOM VARIABLES. USE NCR TO DETERMINE THE # OF PAIRS.

average cost pricing

the most common form of regulation. it reduces price and increases output. it forces monopolists to reduce price to where the firm's ATC intersects the market demand curve. this increases output and decreases price, increases social welfare (allocative efficiency) and ensures the monopolist a normal profit because price = ATC`

the effective interest rate method of amortizing a discount or premium is required under IFRS.

under GAAP, the effective interest rate method is preferred, but the straight line method is allowed if the results are not materially different.

natural monopoly

when the average cost of production for a single firm is falling throughout the relevant range of consumer demand.