2010 - 2013 CFA Level I Sample Exams

目录

2013 Level 1 Sample Exam ................................................................................................................ 1

2013 Level 1 Sample Exam Answers ............................................................................................... 35

2012 Level 1 Sample Exam .............................................................................................................. 58

2012 Level 1 Sample Exam Answer ................................................................................................. 89

2011 Level 1 Sample Exam ............................................................................................................ 109

2011 Level 1 Sample Exam Answer ............................................................................................... 141

2010 Level 1 Sample Exam ............................................................................................................ 161

2010 Level 1 Sample Exam Answer ............................................................................................... 193

2013‐CFA Level 1 Sample Exam

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2013 Level 1 Sample Exam

SS1‐Ethical and Professional Standards

1. Alan Quanta, CFA, provides credit rating analysis of high‐yield bonds using external credit

ratings as a foundation. At the end of the last quarter, Quanta’s firm, North Investment Bank, held

a large position in the bonds of Veyron Corporation, a real estate company with all of its land

holdings in a country recently downgraded by several credit rating agencies. The downgrades

made Veyron bonds extremely difficult to sell because the bond price has dropped every day

since the downgrades. Quanta has been asked by his supervisor to contact institutional clients of

the firm to convince them that Veyron bonds are still an attractive purchase, especially at these

lower prices. Quanta does not consider the Veyron bonds a buy at this price level. According to

the CFA Institute Code of Ethics and Standards of Professional Conduct, the most appropriate

action for Quanta is to:

A. obey his supervisor’s request.

B. ignore his supervisor’s request.

C. promote the bonds with appropriate disclosures.

2. Lewis McChord, CFA, a research analyst, covers the auto industry at an investment bank.

McChord recently read a report on an auto manufacturing company written by Pierce Brown.

Brown’s report provided extensive coverage of the company’s newly launched products indicating

that sales volume, not yet publicly available, would raise future profits. Intrigued by the report,

McChord called a senior executive at the company whom she has known personally for years. The

officer gave her specific details on new vehicle sales, indicating that profits would double in the

current quarter. McChord added this data to Brown’s report and then circulated it within her firm

as her own report. McChord least likely violated which of the following CFA Institute Code of

Ethics and Standards of Professional Conduct?

A. Misrepresentation

B. Preservation of Confidentiality

C. Material Nonpublic Information

3. Jacques Lagarde, CFA, is a sell‐side analyst at Springhill Financial, a small investment bank.

Springhill is the lead manager for the equity offering of Chorale Music, a guitar maker. Lagarde is

not part of the IPO team for this offering. While finalizing a research report on Chorale, Lagarde

discovers information that makes him believe the company concealed losses in its leasing division

last quarter that would significantly reduce its earnings. Based upon this information, Lagarde


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adds the following statement to his report: “The factual data I have gathered indicate Chorale

experienced losses in the last quarter rather than profits.” Lagarde suspects Springhill’s

investment bankers are aware of the unreported losses. The prospectus for Chorale’s equity

offering has already been approved by regulators and distributed to potential investors.

According to the CFA Institute Code of Ethics and Standards of Professional Conduct, Lagarde

should least likely.

A. seek legal counsel.

B. report the issue to his supervisor.

C. keep loss data in his research report.

4. PNW Bank publishes Investment Monthly magazine, which highlights a specific stock in each

issue. Publication of the magazine invariably causes the highlighted stocks to rise significantly in

value. Rachel Coursing, CFA, manager of PNW’s marketing department, often trades in the

securities mentioned in the Investment Monthly articles prior to publication of the magazine.

Coursing has access to the recommendations prior to the magazine’s publication because the

magazine is created in her department and edited by her. PNW’s Code of Ethics restricts trading

by all of the bank’s analysts and portfolio managers and requires their trades to be pre‐cleared by

the Compliance Department. Coursing least likely violated which of the following CFA Institute

Code of Ethics and Standards of Professional Conduct?

A. Priority of Transactions

B. Diligence and Reasonable Basis


5. Abe Seneca, CFA, supervises a team of analysts who create index funds for institutional

investors. When Seneca provides sales demonstrations 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

Code of Ethics and Standards of Professional Conduct?

A. Loyalty

B. Performance Presentation

C. Responsibilities of Supervisors

6. Manuel Tacqueria, CFA, is a sole proprietor investment adviser managing accounts for a

diversified group of clients. Tacqueria obtains his investment research through a subscription


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service with Alpha Services, a large financial services organization. Tacqueria notes the research

reports are sound because they are extremely detailed and comprehensive. As a result, Tacqueria

feels comfortable relying solely upon this research when making recommendations to clients.

Tacqueria should most likely do which of the following to conform to the CFA Institute Code of

Ethics and Standards of Professional Conduct?

A. Utilize additional sources of research.

B. Add his own research to the existing reports.

C. Conduct additional due diligence on Alpha Services.

7. Priscilla Moab, CFA, is the director of marketing at Red Lantern Investments. Red’s

investment approach uses technical and fundamental analysis as well as portfolio construction to

minimize risk. Moab plans to market an online investment newsletter to retail clients. Moab

decides to let prospective clients have access to Red’s buy and sell recommendation list by

posting this information on a social media site. The posting also provides information on Red’s

basic investment process and logic. To avoid violating the CFA Institute Code of Ethics and

Standards of Professional Conduct, Moab should most likely.

A. describe the investment approach in detail.

B. update investment process changes annually.

C. indicate that additional information and analysis are available.

8. At the conclusion of the afternoon section of the Level I CFA examination, the exam proctor

instructs all candidates to stop writing and put their pencils down immediately. Krishna Chowdary

thinks he sees other candidates in front of him continue to fill in their answer sheets. Chowdary

has two questions left to complete so he randomly fills in one of the ovals on his answer sheet

before putting his pencil down on the table. Did Chowdary’s actions most likely violate the CFA

Institute Code of Ethics and Standards of Professional Conduct?

A. Yes.

B. No, because other candidates continued writing.

C. No, because he randomly answered one question.

9. A large manufacturing company is seeking help finding a fund manager for its pension plan.

After a comprehensive but unsuccessful search, Brett Arun, CFA, is hired to solicit proposals from

various fund managers. Arun is paid a lump sum fee for his services. The search concludes with

the hiring of Ramport Investments as the pension plan’s manager. A year after Ramport is hired,

the pension administrator sends Arun a letter telling him how satisfied the pension trustees are

with the services provided by the fund manager. Subsequently, without the plan sponsor’s


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knowledge, Arun receives a payment from Ramport for successfully introducing it to the pension

plan under an agreement entered into when the search was initiated. Regarding the payment

received, did Arun most likely violate the CFA Institute Code of Ethics and Standards of

Professional Conduct?

A. No.

B. Yes, because he did not disclose the payments to all parties.

C. Yes, because he should have refused payment from the fund manager.

10. Maria Martinez is a research analyst and a Level II CFA candidate. Recently, friends of

Martinez organized a party for her 30th birthday. At the party, Martinez received an inexpensive

gift from a friend who is the CEO of a publicly listed company Martinez recommends to clients.

Martinez also received gifts from some of the firm’s best clients. Aware of her employer’s policy

requiring her to report all gifts received within one week of receipt, Martinez declares the gifts

she received from the firm’s clients two days after the party. Does Martinez most likely violate the

CEA Institute Code of Ethics and Standards of Professional Conduct?

A. Yes.

B. No, because her CEO friend’s gift was inexpensive.

C. No, because the gifts do not impact her research independence and objectivity.

11. Upon receiving notification that he passed his Level III CFA exam, Paulo Garcia updates his

educational background on his social media site by adding “completed the CFA course.” Does

Garcia most likely violate the CFA Institute Code of Ethics and Standards of Professional Conduct?

A. No.

B. Yes, because it could imply he has obtained the charter.

C. Yes, because he doesn’t describe the certification process.

12. Roberto Sanchez, CFA, and Andreas Lopez, CFA, 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 One

World, Sanchez continues to use the complex model he and Lopez developed and attains

superior results. Whose behavior most likely conforms to the CFA Institute Code of Ethics and

Standards of Professional Conduct?


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A. Lopez but not Sanchez

B. Sanchez but not Lopez

C. Both Lopez and Sanchez

13. Ricardo Torres, CFA, is a well‐respected telecommunications analyst for Pegasus Advisors. He

is known for his thorough analysis, including interviews with suppliers, customers, and

competitors. Torres has a strong following, and his research reports can often materially move

the market. As a result, Pegasus limits the distribution of his reports to Pegasus clients. After

losing market share to Pegasus for over two years, Marco Rodrigo, a CFA candidate, reports Torres

to the local securities regulator on suspicion of using insider information to make share

recommendations. What CFA Institute Standard has Rodrigo most likely violated?

A. Misconduct

B. Market Manipulation


14. Alexandra Smirnov, CFA, is a pension consultant to the Springwell Pension Fund. After

reviewing Springwell’s three‐year performance presentation showing the fund’s

underperformance relative to its investment objectives and agreed benchmarks, Smirnov

recommends the fund hire new asset managers. Smirnov proposes the fund hire Newday

Managers on the basis of recent meetings she has had with the firm. Lengthy discussions at these

meetings included Newday’s investment strategy, its suitability to manage pension funds, its

ability to adhere to its stated strategy, the firm’s historical investment performance, and its

adoption of the CFA Institute Code of Ethics and Standards of Professional Conduct. Smirnov

turned down Newday’s offer of an introduction fee when recommending its services but did not

inform Springwell trustees of this offer. Which of the following CFA Institute Standards does

Smirnov most likely violate?

A. Referral Fees

B. Loyalty, Prudence, and Care

C. Diligence and Reasonable Basis

15. Dimitri Kuznetsov, CFA, is a portfolio manager and holds shares of Barnikoff Limited and

Matric Ventures in all client portfolios. Both companies have upcoming annual general meetings

scheduled for the same day. The management of Barnikoff proposes to change its financial

year‐end from September to December, while Matric Ventures proposes to enter into a high‐risk

venture. The proxy voting policy clause in all client investment management agreements

managed by Kuznetsov states, “When voting proxies provides a cost benefit to the client, the

manager must vote a proxy.” Regarding the proxy votes for Matric and Barnikoff, Kuznetsov would


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least likely violate CFA Institute Standard III (A) Loyalty, Prudence, and Care if he votes:

A. with management.

B. only the Matric proxy.

C. only the Barnikoff proxy.

16. Merchant Capital Partners, a regional investment bank, acts as a market maker for Vital Link

Health Services and other small firms listed on an over‐the‐counter exchange. For those shares

Merchant acts as market maker, it trades for its own book, as well as engaging in risk arbitrage

trading. Merchant allows staff members to trade in shares once clients and the company have

traded. Merchant recently obtained material nonpublic information regarding Vital’s planned

reverse takeover of a publicly listed competitor. In order to be in compliance with the CFA

Institute Code of Ethics and Standards of Professional Conduct, which type of trading in Vital

shares should Merchant least likely suspend?

A. Personal

B. Risk arbitrage

C. Passive proprietary

17. 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 Code of Ethics and Standards of Professional

Conduct?

A. No.

B. Yes, regarding Loyalty.

C. Yes, regarding Record Retention.

18. Anna Saar, CFA, is the head of compliance for Tranne Advisory Services, a regional financial

services group including asset management, investment banking, and stock brokerage entities.

Reviewing a draft client investment management agreement for the asset management unit, she

is concerned the relationships between the firm’s various business units are not properly

disclosed. To prevent violating CFA Institute Standard VI (A) Disclosure of Conflicts, which of the

following should least likely be addressed in the investment management agreement?

A. The group subsidizes staff loans for share purchases.

B. Management fees are frequently loss leaders for brokerage.

C. Asset managers are likely to support corporate finance deals.


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SS2/3‐Quantitative Methods

19. Monte Carlo simulation is best described as:

A. An approach to back testing data.

B. A restrictive form of scenario analysis.

C. Providing a distribution of possible solutions to complex functions.

20. Use of a nonparametric test is most appropriate when the:

A. data are given in ranks.

B. distribution is symmetric.

C. population variance is unknown.

21. An analyst applies four valuation screens to a set of potential investments. Assume the

screens are independent of one another.

Valuation Screen Probability of Passing

1 0.65

2 0.45

3 0.40

4 0.30

If there are 1,200 potential investments, the number expected to simultaneously pass all four

screens is closest to:

A. 42.

B. 97.

C. 360.

22. Consider the following information:

Point estimate of the population mean 12.5

t‐statistic( 2tα )used in calculating the 90% confidence interval 1.67

Sample size 64

Sample standard deviation 5


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The 90% confidence interval is closest to:

A. 11.46 to 13.54.

B. 11.98 to 13.02.

C. 12.36 to 12.63.

23. A variable is normally distributed with a mean of 2.00 and a variance of 16.00. Calculate the

probability of observing a value of 7.40 or less. That is, calculate P( 7.40iX ≤ ) given that X is

distributed as N(2, 16). Use this excerpt from the cumulative distribution function for the

standard normal random variable table to calculate your answer.

Cumulative Probabilities for a Standard Normal Distribution

P(Z ≤ x) = N(x) for x ≥ 0 or P(Z ≤ z) = N(z) for z ≥ 0

x or z 0 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09

0.10 0.5398 0.5438 0.5478 0.5517 0.5557 0.5596 0.5636 0.5675 0.5714 0.5753

0.20 0.5793 0.5832 0.5871 0.5910 0.5948 0.5987 0.6026 0.6064 0.6103 0.6141

0.30 0.6179 0.6217 0.6255 0.6293 0.6331 0.6368 0.6406 0.6443 0.6480 0.6517

0.40 0.6554 0.6591 0.6628 0.6664 0.6700 0.6736 0.6772 0.6808 0.6844 0.6879

…

1.10 0.8643 0.8665 0.8686 0.8708 0.8729 0.8749 0.8770 0.8790 0.8810 0.8830

1.20 0.8849 0.8869 0.8888 0.8907 0.8925 0.8944 0.8962 0.8980 0.8997 0.9015

1.30 0.9032 0.9049 0.9066 0.9082 0.9099 0.9115 0.9131 0.9147 0.9162 0.9177

1.40 0.9192 0.9207 0.9222 0.9236 0.9251 0.9265 0.9279 0.9292 0.9306 0.9319

…

1.80 0.9641 0.9649 0.9656 0.9664 0.9671 0.9678 0.9686 0.9693 0.9699 0.9706

1.90 0.9713 0.9719 0.9726 0.9732 0.9738 0.9744 0.9750 0.9756 0.9761 0.9767

2.00 0.9772 0.9778 0.9783 0.9788 0.9793 0.9798 0.9803 0.9808 0.9812 0.9817

2.10 0.9821 0.9826 0.9830 0.9834 0.9838 0.9842 0.9846 0.9850 0.9854 0.9857

The probability of observing a value of 7.40 or less is closest to:

A. 63.31%.

B. 91.15%.

C. 96.78%.

24. The following chart is best described as an example of which type of technical analysis

chart?


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A. A line chart

B. A candlestick chart

C. A point and figure chart

25. A portfolio provides the following returns over a five‐year period.

Year 1 2 3 4 5

Return 10% ‐25% 8% 5% 7%

The compound rate of return (%) of the portfolio across the five‐year period is closest to:

A. ‐9.31.

B. 0.02.

C. 1.00.

26. If the probability for an event “Z” is 14% (i.e., P(Z) = 14%), the odds for Z are closest to:

A. 7.1%.

B. 12.3%.

C. 16.3%.

27. Based on historical returns, a portfolio has a Sharpe ratio of 2.0. If the mean return to the

portfolio is 20% and the mean return to a risk‐free asset is 4%, the standard deviation of return

on the portfolio is closest to:

A. 8%.

B. 10%.


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C. 12%.

28. The following 10 observations represent a sample drawn from an approximately normal

population:

Observation 1 2 3 4 5 6 7 8 9 10

Value ‐31 ‐14 3 ‐18 34 20 ‐6 9 7 ‐16

The sample standard deviation is closest to:

A. 17.56.

B. 18.58.

C. 19.59.

29. Once an investor chooses a particular course of action, the value forgone from alternative

actions is best described as:

A. sunk cost. B. required return. C. opportunity cost.

30. Assume that a stock’s price over the next two periods is as shown below.

Time = 0 Time = 1 Time = 2

0s = 40

us =44

uus =48.4

d

s =36 ,ud dus =39.60

dds =32.40

The initial value of the stock is $40. The probability of an up move in any given period is 65%, and

the probability of a down move in any given period is 35%. Using the binomial model, the

probability that the stock’s price will be $39.60 at the end of two periods is closest to:

A. 22.75%.

B. 42.25%.

C. 45.50%.

31. Given a discount rate of 10%, the net present value (NPV) of the following investment cash


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flows is closest to:

Time 0 1 2 3 4 5 6

Cash flow (€) ‐1,500 300 600 1,000 200 500 300

A. €578.

B. €605.

C. €636.

32. Investors should most likely be attracted to return distributions that are:

A. normal.

B. positively skewed.

C. negatively skewed.

SS4/5/6‐Economics

33. The diagram to the right illustrates a market that had been in equilibrium at (PE, QE) prior to

the imposition of a price ceiling, PC The deadweight loss that arises because of this market

intervention is best described by the area defined by:

A. d + b.

B. d + e.

C. d + g.

34. The two dominant supermarket chains in the area are attempting to increase their market

share by moving to 24‐hour service instead of closing at 9 p.m. every night. The strategic


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outcomes and payoff matrix that arise from their actions are depicted in the diagram to the right

(with the shaded sections representing payoffs for Chain 2). According to a Nash equilibrium, the

best strategy is for:

A. both chains to close at 9 p.m.

B. both chains to open for 24 hours.

C. only Chain 2 to open for 24 hours.

35. Which of the following will most likely cause the short‐run aggregate supply (SRAS) curve to

shift to the right? An increase in:

A. business taxes.

B. nominal wages.

C. the supply of human capital.

36. The most recent economic data release indicates the following:

Capital spending is expanding rapidly but the growth rate of spending has begun to slow

down and

The rate of hiring has slowed but the unemployment rate continues to fall.

The economy is most likely in which of the following phases?

A. Peak

B. Contraction

C. Late expansion

37. A country’s international transactions accounts data for last year are presented below in its

domestic currency:


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Transaction Amount

Exports of goods and services 10,000

Imports of goods and services 14,216

Investment income payments made to foreigners 2,519

Investment income received from foreigners 3,409

Net change in assets owned abroad 1,548

Net change in foreign‐owned assets domestically 4,989

Unilateral current transfers received 346

Unilateral current transfers paid 1,107

Statistical discrepancy 646

The current account balance is closest to:

A. ‐4,345.

B. ‐4,216.

C. ‐4,087.

38. The following information is available for 2011:

New Zealand Canada

Jan 1 Dec 31 Jan 1 Dec 31

Price index 1,137 1,158 117.8 119.9

Nominal exchange rate: NZD/CAD 1.2844 1.2589

The change in the real exchange rate (in NZD/CAD terms) is closest to:

A. ‐2.05%.

B. ‐1.92%.

C. +1.96%.

39. Which of the following is least likely to be a characteristic of a Giffen good?

A. Its income effect is negative.

B. Its demand curve slopes upward.

C. Its substitution effect is negative.

40. A firm’s production process requires two factors, labor and capital. The following table


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illustrates the marginal productivity and cost of each factor at the current level of production.

Type of Input Marginal Product (MP) of Input Current Price of Input

Labor 120 units $4 per unit

Capital 120 units $12 per unit

If MP is the marginal product, which of the following best describes the firm’s optimal decision?

A. Simultaneously increase the use of both factors until the MP is maximized.

B. Initially increase the use of capital until its MP/unit cost equals the MP/unit cost of labor.

C. Initially increase the use of labor until its MP/unit cost equals the MP/unit cost of capital.

41. The nominal and real GDP for a country are provided below :

2010 2011

GDP at market prices ( € millions ) 3,679,098 3,818,145

Real GDP (2001 € millions ) 3,163,330 3,342,570

For 2011, the inflation rate ( % ) in the country is closest to :

A. ‐1. 8

B. 3. 8

C. 5. 7

42. The price index that best resolves the substitution bias is the:

A. Fisher index.

B. Paasche index .

C. Laspeyres index.

43. A development country that maintains a fixed value for its currency relative to the U.S. dollar

is experiencing a decline in its economic activity, and its inflation rate falls below the Ievel in the

United States. As a result of the developing country‘s actions to maintain the fixed exchange rate

target, its :

A. money supply will contract.

B. short‐term interest rates will fall.

C. foreign exchange reserves will decrease.

44. The diagram below shows the domestic demand and supply curves for a country that


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imports a commodity where PW is the commodity ' s world price and TP is its domestic price

after the imposition of a tariff .

The gain in government revenues arising from the imposition of the tariff is best described by

area(s):

A. J

B. L

C. K+M


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SS7/8/9/10‐Financial Statement Analysis

45. The following data are available on a company:

Metric Company

Stock price per share $60.75

Comprehensive income per share $4.15

Other comprehensive income (millions) $87.60

Common shares outstanding (millions) 46.506

On a net income basis, the company’s P/E ratio is closest to:

A. 10.1.

B. 14.6.

C. 26.8.


Metric ($ thousands) Company

Interest expense & payments 1,000

Income tax expense 1,100

Net income 3,400

Lease payments 500

The company’s fixed charge coverage ratio is closest to:

A. 2.27.

B. 4.00.

C. 5.50.

47. Under the IFRS Conceptual Framework for Financial Reporting, which of the following is

least likely considered a fundamental qualitative characteristic that makes financial information

useful?

A. Relevance

B. Comparability

C. Faithful representation


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48. Under IFRS, which of the following is most commonly classified as a noncurrent liability?

A. Warranties

B. Notes payable

C. Deferred tax liability

49. The following financial data are available for a company:

Metric 2011

(€ thousands)

2010

(€ thousands)

Cost of goods sold 600 400

Inventory 500 600

Accounts payable 200 400

Accounts receivable 400 900

Cash paid to suppliers (€ thousands) in 2011 is closest to:

A. 300.

B. 700.

C. 900.

50. The following financial statement data are available for a company:

Metric (€ thousands)

Net income 500

Depreciation 150

Cash flow from operations 600

Free clash flow to the firm 300

Beginning total assets 4,000

Ending total assets 6,000

Book value 3,000

The company’s cash return on assets ratio is closest to:

A. 10%.

B. 12%.

C. 13%.


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51. For which of the following inventory valuation methods is the gross profit margin least likely

to be the same under both a perpetual inventory system and a periodic inventory system?

A. FIFO

B. LIFO

C. Specific identification

52. Under U.S. GAAP, which of the following is least likely a disclosure concerning inventory?

A. The amount of inventories recognized as an expense during the period

B. The carrying amounts of inventories carried at fair value less costs to sell

C. The circumstances or events that led to the reversal of any write‐down of inventories

53. Due to significant changes in the marketplace, the demand for a company’s product has

fallen and is not expected to recover to previous levels. The following information is related to

the patent under which the product is produced:

Item Description $ (thousands)

Carrying value amount 36,000

Undiscounted expected future cash flows 38,000

Present value of expected future cash flows 32,000

Fair value if sold 34,000

Costs to sell 4,000

Which of the following statements is most accurate? The patent is impaired under:

A. IFRS only.

B. U.S. GAAP only.

C. both IFRS and U.S. GAAP.

54. The following information is available about a company for its 2011 fiscal year:

Accounting profit (earnings before taxes) $250,000

Taxable income $215,000

Tax rate 30%

Income taxes paid in 2011 $61,200

Deferred tax liability, 1 January 2011 $82,400

Deferred tax liability, 31 December 2011 $90,650

The income tax expense reported on the 2011 statement of earnings is closest to:


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A. $64,500.

B. $72,750.

C. $83,250.

55. A company that provides cruise ship vacations uses term loans to finance the acquisition of

new cruise ships. Which of the following is most likely a negative covenant for the loans? The

company must:

A. ensure that the ships are insured.

B. seek lender approval to pay dividends.

C. maintain a minimum level of working capital.

56. Activities or actions that result in inflated sales or underreported expenses will most likely

lead to a(an):

A. buildup of assets.

B. buildup of liabilities.

C. increase in cash from operations.


Metric 2011 2010

Revenue (HK$ millions) 18,980 18,490

Cost of sales (HK$ millions) 14,600 13,695

Beginning inventory (HK$ millions) 1,500 1,500

Ending inventory (HK$ millions) 2,500 1,500

Days of sales outstanding (HK$ millions) 60 70

Numbers of days of payables 70 60

The least likely explanation for the change in the cash conversion cycle is that the firm improved

on its:

A. payments to suppliers.

B. inventory management.

C. ability to collect from customers.

58. An e‐commerce company Sells hotel room nights on its Website Under agreement from a

large number of major hotel chains. The hotel chains grant the company flexibility for the rooms


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they supply to the Company's website and for the prices charged. These major chains bear the

responsibility for providing all services once a customer books a room from the website. During

2011, the company received $5 million in payments from the sale of hotel rooms. The cost of

these rooms was $4.5 million, which does not include $250,000 in direct selling costs. Under U. S.

GAAP, the company’s cost of Sales is closest to:

A. $250, 000.

B. $4,500, 000.

C. $4,750, 000.

59. The following information is available about a company with potentially dilutive securities in

its capital structure:

1. 2011 net income of $32 million.

2. Weighted average number of common shares outstanding of 4.5 million.

3. $15 million of 12% convertible bonds, convertible into 50.000 shares.

4. 200, 000 options with an exercise price of $50 per share.

5. Average market price of $80 per share during the fiscal year.

6. Tax rate of 30 %.

The company's diluted EPS 15 close, to:

A. $6.99.

B. $7.19.

C. $7.31.

60. Which of the following statements about the direct method for presenting cash from

operating activities is most appropriate? The direct method:

A. shows the impact of accruals.

B. shows the reasons for differences between net income and operating cash flows.

C. provides information on the specific sources of operating cash receipts and payments.

61. Interest payable decreased during a company’s fiscal year. Compared with the amount of

cash interest payments made, interest expense is most likely.

A. lower.

B. higher.

C. the same.

62. Unused tax losses and credits that a company expects to use in future periods will most


21

likely give rise to:

A. deferred tax assets.

B. valuation allowances.

C. deferred tax liabilities.

63. During the year, a company purchases 1,000 units of inventory at £20.20 per unit. In addition,

the following items relate to inventory acquisition and handling during the year.

Item description £(thousands)

Volume rebate received 404

Import and sales taxes 2,970

Inspection on delivery 325

Storage costs 1,250

Warehouse administrative costs 3,300

The total costs (in £ thousands) that will be included in inventory are closest to:

A. 22,766.

B. 23,091.

C. 24,341.

64. The following information is available concerning a new showroom a company built with

construction starting on 1 January 2010 and the grand opening on 2 January 2012:

Loan: Borrowed on 1 January 2010 and put to

use immediately

€30 million

Interest rate on loan 8% payable annually

Repayment terms for loan balloon payment due on 1 January 2015

Total construction costs incurred during 2010

and 2011

€38.5 million

Expected useful life of the showroom 40 years

Expected residual value of the showroom €5 million

Depreciation method Straight‐line

The depreciation expense (in € millions) for the showroom in 2012 is closest to:

A. 0.8250.


22

B. 0.9575.

C. 1.0175.

65. A company that prepares its financial statements under IFRS can most likely report which of

the following assets using the fair value model?

A. Houses built by the company for sale to customers

B. A building owned by the company and leased out to tenants

C. A building the company owns and uses to house its administrative activities

66. If a company has a deterred tax asset reported on its statement of financial position and the

tax authorities reduce the tax rate, which of the following statements is most accurate concerning

the effect of the change? The existing deferred tax asset will:

A. not be affected.

B. increase in value.

C. decrease in value.

67. A company prepares its financial statements according to U.S. (JAAI‐ and leased a piece of

equipment on 1 January 2012. Information relevant to the transaction is as follows:

1. Five annual lease payments of $25,000, with the first payment due 1 January 2012.

2. Interest rate on similar company debt is currently 8%.

3. The fair value of the equipment is $115,000.

4. Useful life of the equipment is seven years.

5. The company depreciates other equipment in the same asset class on a straight‐line basis.

The total expense related to the lease on the company’s 2012 income statement will be closest

to:

A. $22,024.

B. $25,000.

C. $28,185.

68. An increase in which of the following ratios would most likely result in an increase in

operating cash flows?

A. Quick ratio

B. Days sales in payables

C. Days sales in receivables


23

SS11‐Corporate Finance

69. When a new project reduces the cash flows of an existing project of the same firm, it is best

described as a(n):

A. sunk cost.

B. externality.

C. opportunity cost.

70. A company intends to issue new common stock with flotation costs of 3.2% per share. The

expected dividend next year is $0.32, and the dividend growth rate is expected to be 10% in

perpetuity. Assuming the shares are issued at a price of $14.69, the cost (%) of external equity for

the firm is closest to:

A. 12.18.

B. 12.25.

C. 12.48.

71. A company is considering a switch from an all‐equity capital structure to a structure with

equal amounts of equity and debt without increasing assets. This change will reduce the net

income by 30%. If the current return on equity (ROE) is 10%, the ROE (%) under the proposed

capital structure will be closest to:

A. 6.

B. 14.

C. 20.

72. According to best practices of corporate governance, which of the following committees will

most likely have members from executive management?

A. Audit

B. Nominations

C. Environmental health and safety

73. A project has the following cash flows (￡):

Year 0 Year 1 Year 2 Year 3 Year 4

‐1,525 215 345 475 1,215


24

Assuming a discount rate of 11% annually, the discounted payback period (in years) is closest to:

A. 3.4.

B. 3.9.

C. 4.0.

74. A company issues new 20‐year, $1,000 bonds with a coupon rate of 6.2% payable

semiannually at an issue price of $1,030.34. Assuming a tax rate of 28%, the firm’s annual

after‐tax cost of debt (%) is closest to:

A. 4.28.

B. 4.46.

C. 5.94.

75. A company has decided to switch to using accelerated depreciation from straight‐line

depreciation. Holding other factors constant, the degree of total leverage will most likely

A. increase.

B. decrease.

C. not change.

76. Which of the following is most likely a secondary source of liquidity?

A. Trade credit

B. Bank line of credit

C. Inventory liquidation

77. If a 90‐day, $10,000 U.S. Treasury security is selling for $9,870, the discount‐basis yield (%) is

closest to:

A. 5.20.

B. 5.27.

C. 5.34.

78. If a stock is currently selling at $30.00, after a 5% stock dividend, the new share price is

closest to:

A. $28.50.


25

B. $28.57.

C. $30.00.

SS13/14‐Equity Investments

79. A trader who owns shares of a stock currently trading at $100/share places a “GTC, stop 90,

limit 85 sell” order (GTC = Good till cancelled). Assuming the specified stop condition is satisfied

and the order becomes executed, which of the following statements is the most accurate?

A. The trader faces a maximum loss of 15.

B. The order will be executed at the exact price, either 90 or 85.

C. The order becomes a market order when the price falls below 85 and remains valid for

execution.

80. Which of the following statements is least accurate with respect to fixed‐income indices?

A. Many of the underlying securities in the index tend to be illiquid.

B. The indices are susceptible to turnover of the underlying securities.

C. Compared with equity indices, it is easier and less expensive to replicate fixed‐income

indices.

81. Which of the following statements concerning the characteristics of equity securities is most

accurate?

A. Putable common shares provide benefits to both the issuing company and investors.

B. Convertible preference shares are more volatile and riskier than the underlying common

shares.

C. Investors owning a small number of common shares would prefer statutory voting to

cumulative voting.

82. Which of the following statements concerning companies in different industry environments

is most accurate?

A. Companies in mature industries tend to focus on efficiency gains and gain market share

through superior products.

B. An industry’s experience curve declines with a decrease in the utilization of capital

equipment and spreading overhead over a fewer number of units.

C. Companies in fragmented industries would not be highly price competitive because they


26

tend to think individualistically, making coordination difficult.

83. An investor gathers the following data pertaining to a company for the fiscal year 2011.

Net income $5,000,000

Dividend payout ratio 40%

Common shareholders’ equity (1 January 2011) $45,000,000

Number of outstanding shares 6,000,000

Price per share (31 December 2011) $30.00

The company’s price‐to‐book ratio as of 31 December 2011 is closest to:

A. 3.60.

B. 3.75.

C. 3.83.

84. A company’s non‐callable, non‐convertible preferred stock paying an annual dividend of

$3.75 is currently selling at its par value of $50 per share. If the investors’ required rate of return

increases by 75 bps, the preferred stock’s new price is closest to:

A. $45.45.

B. $49.50.

C. $55.56.

85. If the following three stocks are held in a portfolio, the portfolio’s total return on an

equal‐weighted basis (%) is closest to:

Stock Number of shares

owned

Price ($) per share as of

1/1/2011

Price per share ($) as

of 1/1/2012

Dividend per share ($)

During 2011

A 500 40 37 2.00

B 320 50 52 1.50

C 800 30 34 0.00

A. 3.28.

B. 5.94.

C. 6.37.

86. An internal evaluation of the trading behavior of three fund managers of a mutual fund


27

company during the past year has revealed the following:

Manager X: She was slower than peers when reacting to changes in information.

Manager Y: He rarely realized investment losses but realized most of the investment gains.

Manager Z: She tended to overreact by disliking losses more than liking comparable gains.

From the above, which of the three managers most likely displayed a behavioral bias called

“disposition effect”?

A. Manager X

B. Manager Y

C. Manager Z

87. For a U.S. investor, which of the following statements concerning investing in depository

receipts (DRs) is least accurate?

A. Investing in DRs could provide arbitrage opportunities and entail currency risk.

B. Sponsored DRs are subject to greater reporting requirements than unsponsored DRs.

C. Investors in unsponsored DRs would have the same voting rights as the direct owners of

common shares.

88. An investor who wants to estimate the market capitalization of a company located in India

has gathered the following data:

Values in INR (millions)

Market value of debt 10.0

Market value of preferred stock 5.0

Cash & short‐term investments 4.5

EBITDA 15.0

Assuming an enterprise value multiple of 3.2, the company’s market capitalization (in INR millions)

is closest to:

A. 28.5.

B. 33.0.

C. 37.5.

89. The following data pertain to a company that can be appropriately valued using the Gordon

growth model. The dividend is expected to grow indefinitely at the current sustainable growth


28

rate.

EPS growth rate (three‐year average) 7.50%

Current dividend per share $3.00

Return on equity 15%


Investors’ required rate of return 16%

The stock’s intrinsic value is closest to:

A. $34.62.

B. $37.94.

C. $41.90.

90. Which of the following statements concerning different valuation approaches is most

accurate?

A. The justified forward P/E approach offers the advantage of incorporating fundamentals and

presenting intrinsic‐value estimations.

B. It is advantageous to use asset‐based valuation approaches rather than forward‐looking cash

flow models in the case of companies that have significant intangibles.

C. One advantage of the three‐stage dividend discount model (DDM) is that it is equally

appropriate for young companies entering the growth phase and those entering the

maturity phase.

SS17‐ Derivative Investments

91. A financial institution enters into a forward rate agreement (FRA), expiring in 30 days, to

lend $15,000,000 at the 90‐day LIBOR interest of 2%. If 90‐day LIBOR is 3% when the FRA expires

in 30 days, the payoff to the financial institution is closest to:

A. ‐$37,500.

B. ‐$37,221.

C. $12,469.

92. A U.S.‐based company wishes to borrow R$434,525,000 to fund an expansion of its

operations in Brazil. Based on an exchange rate of R$1.7381 per US$, the company borrows


29

US$250,000,000 in the United States and enters into a currency swap with a dealer. The interest

rates are 6.5% on US dollars and 10.7% on Brazilian real. Payments are made every 180 days.

Based on a 360‐day year, the periodic 180‐day payments made by the U.S. company and the

dealer, respectively, are closest to:

U.S. Company Dealer

A. Pays US$5,250,000 —

B. Pays R$23,247,088 Pays US$8,125,000

C. Receives R$434,525,000 Receives US$250,000,000

93. An interest rate cap can best be described as a combination of a series of interest rate:

A. put options.

B. call options.

C. call and put options.

94. For which of the following futures contracts is price dependent on the LIBOR interest rate

and cash settlement permitted when the contract expires?

A. Currency futures

B. Eurodollar futures

C. U.S. T‐bond futures

95. A put option with an exercise price of $530 that is expiring in five months is selling for a

price of $23. If the price of the underlying stock at expiration is $540, the profit to the seller (or

writer) of the put is closest to:

A. —$33.

B. —$13.

C. $23.

96. An investor has purchased a share of stock for $190. A call option on this stock, expiring in

seven months and with an exercise price of $200, is priced at $11.40. If the investor enters into a

covered call now, the profit on this strategy if the stock price at expiration is $215 is closest to:

A. ‐$3.60.

B. $21.40.


30

C. $28.60.

SS18‐ Alternative Investments

97. Compared with traditional investments, over longer periods, alternative investments are

least likely to have:

A. higher expected returns.

B. better diversifying power.

C. more efficiently priced assets.

98. A hedge fund strategy that most likely involves simultaneously holding short and long

positions in common stock is:

A. volatility.

B. quantitative directional.

C. distressed/restructuring.

99. A hedge fund begins the year with $120 million and earns a 25% return for the year. The

fund charges a 1.5% management fee on end‐of‐year fund value and a 15% incentive fee on the

return, net of the management fees, that is in excess of a 6% fixed hurdle rate. A fund investor’s

return for the year, net of fees, is closest to:

A. 19.66%.

B. 20.56%.

C. 21.25%.

100. Management fees for a private equity fund are most likely based on:

A. fair value of assets under management.

B. drawdowns of committed capital plus any undistributed capital gains.

C. total committed capital less capital returned from investments that are exited.

101. It is most likely easiest for a research analyst to value the holdings of a:

A. hedge fund that follows a short bias strategy.

B. REIT invested only in high‐rise office buildings.

C. private equity firm concentrating in management buy‐in LBOs.


31

102. Which of the following risk issues is most likely important for an investment in a private

equity fund that focuses on venture capital but not an investment in a REIT that holds

undeveloped land?

A. Investment liquidity

B. Mismeasurement of volatility

C. Independence of valuation estimates

SS15/16‐Fixed Income Investments

103. Which of the following would most likely represent the coupon rate for an inverse floater?

A. 5% + 1‐year LIBOR

B. 5 × 1‐year LIBOR ‐ 6%

C. 18% ‐ 2 × 1‐year LIBOR

104. A 20‐year bond indenture requires its issuer to retire 5% of the issue each year. This

requirement is best referred to as a:

A. refunding provision.

B. sinking fund provision.

C. special redemption provision.

105. Which of the following most likely increases the interest rate risk of a floating‐rate security?

A. Higher interest rate cap

B. Greater spread over the index

C. Longer time until the next coupon reset

106. A bond is currently selling for 102.31. A valuation model estimates the price will fall to

101.12 if interest rates increase by 20 bps and rise to 103.74 if interest rates decrease by 20 bps.

Using these estimates, the duration of the bond is closest to:

A. 6.31.

B. 6.40.

C. 6.48.


32

107. A central government auctions additional bonds of a previously outstanding bond issue. This

is best referred to as the:

A. tap method.

B. single price method.

C. ad hoc auction method.

108. Compared with Tranche A, Tranche B of the same CMO structure will most likely have:

A. more prepayment risk.

B. a lower principal balance.

C. a longer repayment period.

109. The argument that investors cannot learn about market expectations for future interest rate

changes from the shape of the yield curve is most closely associated with which theory of the

term structure of interest rates?

A. Pure expectations

B. Liquidity preference

C. Market segmentation

110. The yield on a five‐year U.S. corporate bond is 8.17%, and the yield on a five‐year U.S.

Treasury bond is 5.64%. An analyst calculates a yield spread measure for the corporate bond

equal to 1.45. This measure is most likely the:

A. yield ratio.

B. relative yield spread.

C. absolute yield spread.

111. How much will the value of a three‐year $100 par value coupon bond with annual payments,

a coupon rate of 9%, and a discount rate of 7% most likely change if market interest rates

immediately increase by 1%?

A. ‐3.47

B. ‐2.68

C. ‐2.40

112. Treasury spot rates on a bond‐equivalent yield (BEY) basis are provided below.


33

Maturity BEY

0.5 years 0.40%

1.0 years 0.80%

1.5 years 1.00%

2.0 years 1.10%

2.5 years 1.20%

Using these spot rates, the value of a 2.5‐year Treasury security that makes semiannual payments

based on a 2% coupon rate is closest to:

A. 99.06.

B. 101.98.

C. 106.88.

113. A bond’s duration is 7.31 and its convexity is ‐24.85. Using the duration model with convexity

adjustment, the bond’s percentage change in price if interest rates decrease 2% is closest to:

A. 13.64%.

B. 15.12%.

C. 15.60%.

114. Consider two sovereign bonds issued in different markets. Bond A will most likely have

higher interest rate risk than Bond B if Bond A has a higher:

A. yield.

B. coupon rate.

C. expected yield volatility.

SS12‐Portfolio Management

115. Which of the following is least likely true for a separately managed account (SMA) compared

to a mutual fund?

A. Assets are directly owned by the individual.

B. Transactions can be tailored to the specific tax needs of the investor.

C. The minimum investment required to open an SMA is lower than that of a mutual fund.


34

116. The 15‐month holding period return for a security is 12%. Its annualized return is closest to:

A. 9.49%.

B. 9.60%.

C. 10.03%.

117. A portfolio contains equal weights of two securities having the same standard deviation. If

the correlation between the returns of the two securities was to decrease, the portfolio risk

would most likely:

A. increase.

B. decrease.

C. remain the same.

118. If the expected return on the market portfolio is 6% and the risk‐free rate is 2%, the

expected return of a security with a beta of 1.25 is closest to:

A. 5.00%.

B. 7.00%.

C. 9.50%.

119. Which of the following is least likely an assumption of the capital asset pricing model

(CAPM)?

A. Security prices are not affected by investor trades.

B. An investor can invest as much as he or she desires in any asset.

C. Investors are different only with respect to their unique holding periods.

120. Which of the following is most likely associated with an investor’s ability to take risk rather

than the investor’s willingness to take risk?

A. The investor has a long investment time horizon.

B. Safety of principal is very important to the investor.

C. The investor believes earning excess returns on stocks is a matter of luck.


35

2013 Level 1 Sample Exam Answers

1. Correct answer: B

Quanta should refuse to promote the bonds, which he does not rate as a buy, because his opinion

of the Veyron bonds must not be affected by internal pressure or compensation. If Quanta

followed the request from his supervisor, he would be in violation of Standard I(B) Independence

and Objectivity. Quanta must refuse to promote Veyron bonds until they are an attractive

purchase based on fundamental analysis and market pricing.


Standard III (E) Preservation of Confidentiality has not been violated. The analyst has a personal

relationship with the officer of the auto company, and he is not a current, former, or prospective

client, so there is no obligation for the analyst to maintain client confidentiality. However, the

analyst did violate Standard I(C) Misrepresentation when she represented another analyst’s work

as her own. In addition, the analyst violated Standard II(A) Material Nonpublic Information by

including data in her research report on sales figures, which were material and nonpublic.

3. Correct answer: C

Lagarde would be in violation of Standard V (B) Communication with Clients and Prospective

Clients if he included the suspected loss details in his research report, because he has not

separated fact from opinion. Lagarde suspects Chorale concealed losses in its leasing division but

has not determined this as fact, despite declaring the losses as fact in his research report. In

addition, Lagarde may also be in violation of Standard VI (A) Disclosure of Conflicts because he

has not made full and fair disclosure of all matters that could reasonably be expected to impair

his independence and objectivity or interfere with respective duties to clients. As a sell‐side

research analyst working for an investment bank, Lagarde faces potential cross‐departmental

conflicts in writing a research report about a company for whom the bank is currently the lead

manager in an IPO, and Lagarde should disclose potential conflicts related to this situation.


Coursing has not violated Standard V (A) Diligence and Reasonable Basis because she is not

analyzing investments, making investment recommendations, or taking investment actions for

clients. Coursing has violated Standard VI (B) Priority of Transactions because clients of the bank

have not been given priority over investment transactions in which a member or candidate is the

beneficial owner. In addition, Coursing violated Standard II(A) Material Nonpublic Information by

trading on material nonpublic information. The Investment Monthly article written by PNW is

considered nonpublic until the magazine is widely distributed, and publication of the magazine


36

will materially impact the market price of stocks highlighted. Even though Coursing is not

required by her bank to pre‐clear her trades, she is restricted from trading by Standard II (A).


Standard IV (C) Responsibilities of Supervisors has not been violated; Seneca is not responsible

for the supervision of any employees when he makes sales demonstrations to clients because he

prepared the material himself. Seneca 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 that clients are likely to experience.


Tacqueria is in violation of Standard V (A) Diligence and Reasonable Basis because he is required

to undertake due diligence efforts on the third‐party research provider on a regular basis to

ensure that the quality of this research continues to meet his necessary standards.


If recommendations are contained in capsule form (such as a recommended stock list), members

and candidates should notify clients that additional information and analysis are available from

the producer of the report as required by Standard V (B) Communication with Clients and

Prospective Clients. In this case, a clear statement on the website that more information is

available upon request would be required.

8. Correct answer: A

By completing a question on his examination after time was called, Chowdary violated Standard

VII (A) Conduct as Members and Candidates in the CFA Program. By continuing to write,

Chowdary took advantage of other candidates and his conduct compromised the validity of his

exam performance.


Arun has violated Standard VI (C) Referral Fees because he did not disclose the fee paid by

Ramport to his employer The disclosure should have occurred prior to the search being

conducted, and at this point the question of a potential lack of objectivity in the

recommendations Arun is making remains, regardless of whether or not the payment is accepted.


Standard I(D) Misconduct states that members and candidates must not engage in any

professional conduct involving dishonesty, fraud, or deceit or commit any act that reflects


37

adversely on their professional reputation, integrity, or competence. By reporting only the gifts

she received from clients and not the inexpensive gift from her CEO friend, she does not conform

to her employer’s gift policy of reporting all gifts. Her non‐compliance with employer policies

reflects adversely on her professional reputation and honesty.


Standard VII (B) Reference to CFA Institute, the CFA Designation, and the CFA Program forbids

candidates to imply they have a partial designation or cite an expected completion date of any

level of the CFA Program. Final award of the charter is subject to meeting the CFA Program

requirements and approval by the CFA Institute Board of Governors. Garcia should state that he

“passed Level III CFA exam” or “passed all three levels of the CFA exams.” Stating that he “passed

the CFA course” could be taken to mean he obtained his charter, which is incorrect.


Both Lopez and Sanchez upheld the requirements of Standard I (C) Misrepresentation regarding

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 Analytics, and

therefore, he is not in violation of the Standards. Once Lopez leaves OneWorld, he develops a

separate model based on a model he developed prior to joining OneWorld Analytics. The

simplified model remains the intellectual property of Lopez. The duplication of features is

allowable under Standard IV (A) 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.


Rodrigo has likely violated Standard I (D) Misconduct by behaving in an unprofessional manner

that reflects adversely on his professional integrity by reporting Torres to the regulator when

there is no apparent evidence Torres is using material nonpublic information. Torres is a

well‐respected analyst known for his in‐depth, thorough analysis using a mosaic process. It

appears Rodrigo reported Torres only to harm his reputation in order to recapture the market

share he has lost over the last two years.


Smirnov violated Standard V (A) Diligence and Reasonable Basis because she recommended an

external adviser without first understanding the adviser’s compliance and internal control

procedures. She was correct in seeking to understand the proposed fund manager’s code of

ethics, quality of performance returns, and ability to adhere to its stated investment strategy, but

in order to complete her work, she also needed to perform due diligence regarding the firm’s


38

compliance and internal control procedures.


Standard III (A) Loyalty, Prudence, and Care states: it is a member’s or candidate’s duty to vote

proxies on behalf of clients in an informed and responsible manner. However, if a cost‐benefit

analysis shows voting all proxies may not benefit the client, voting all proxies may not be

necessary. The member or candidate is responsible for informing all clients if this is the policy of

the fund manager. The member or candidate must takes steps to disclose this proxy voting policy

to clients. Voting the Barnikoff proxy does not appear to offer a benefit because the issue is not

of a critical nature, while voting the proxy for Matric involves a material issue and is a benefit that

should be voted on.


According to Standard II(A) Material Nonpublic Information, if Merchant stopped market

making—a form of proprietary trading—due to being in possession of material nonpublic

information, it could tip off investors that Vital is likely to be making a major announcement in

the near future. This would be counterproductive to the goals of maintaining the confidentiality

of information and providing market liquidity. The Standard recommends market makers remain

passive when in possession of material nonpublic information.


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.


The group subsidizing staff loans for the purchase of shares is not a conflict of interest for clients

because it is a funding mechanism and does not interfere with objectivity when rendering

investment advice or taking investment action. However, share purchases by staff would still

require disclosure and reporting requirements as per Standard VI (A) Disclosure of Conflicts and

Standard VI (B) Priority of Transactions, respectively.


Monte Carlo simulation provides a distribution of possible solutions to complex functions. The

central tendency and the variance of the distribution of solutions give important clues to

decision‐makers regarding expected results and risk.


Nonparametric procedures are primarily used in three situations: when the data do not meet


39

distributional assumptions, when the data are given in ranks, or when the hypothesis being

addressed does not concern a parameter.


Because the screens are independent, the probability of passing all four simultaneously is the

product of their respective probabilities: 0.65 × 0.45 × 0.40 × 0.30 = 0.0351.

Given 1,200 potential investments, approximately 1,200 × 0.0351 = 42.12 will pass the screens.


The confidence interval is calculated as 2 ,sX tnα± where X is the mean of the sample,

2ta is the appropriate t‐statistic, s is the sample standard deviation, and n is the sample size.

In this problem, the confidence interval is 12.5 ± [1.67 × 5 / 8] = 12.5 ± 1.04 = 11.46 to 13.54.


First, standardize the value of interest, 7.40, for the given normal distribution:

Z = (X ‐ μ) / σ = (7.40 — 2.00) /4 = 1.35.

Then, use the given table of values to find the probability of a Z value being less than or equal to

1.35 standard deviations above the mean. The value is P(Z ≤ 1.35) = 0.9115.


The chart is an example of a candlestick chart.


The geometric mean return is the correct approach in calculating portfolio average returns across

a period of time. In this problem, the geometric mean return is

(1.10 × 0.75 × 1.08 × 1.05 × 1.07)1/5 – 1 = 0.02%.


Odds for Z are calculated as P(Z) / (1 — P(Z)). In this problem, 0.14 / 0.86 = 0.16279 = 16.3%.


The Sharpe ratio for a portfolio p, based on historical returns, is defined as

p Fh

p

R RS

S

− −

−=


40

where p

R−

is the mean return to the portfolio, F

R−

is the mean return to a risk‐free asset,

and p

S is the standard deviation of return on the portfolio. In this instance, 2 = (20 — 4) /

pS . Thus,

pS equals 8.


The sample mean is

( 31 14 3 18 34 20 6 9 7 16)/ 10 1.20

n

ii

x

xn

−

= = − − + − + + − + + − = −∑

The sample variance is

−

−=

−

∑ 2

2 1

( )

1

n

ix x

sn

The sample standard deviation is the (positive) square root of the sample variance.

Value Difference vs. Mean Difference Squared

‐31 ‐31‐(‐1.2) = ‐29.8 888.04

‐14 ‐14 ‐ (‐1.2) = ‐12.8 163.84

3 3 ‐ (‐1.2) = 4.2 17.64

‐18 ‐18 ‐ (‐1.2) =‐16.8 282.24

34 34 ‐ (‐1.2) = 35.2 1239.04

20 20‐(‐1.2)=21.2 449.44

‐6 ‐6‐(‐1.2)=‐4.8 23.04

9 9 ‐(‐1.2) = 10.2 104.04

7 7 ‐ (‐1.2) = 8.2 67.24

‐16 ‐16‐(‐1.2)=‐14.8 219.04

Sum of squared differences 3453.60

Divided by n — 1 (10 — 1) 383.73

Square root 19.59

29. Correct answer: C An opportunity cost is the value that investors forgo by choosing a particular course of action.


Across two periods, there are four possibilities:


41

A. an up move followed by an up move ($48.40 end value),

B. an up move followed by a down move ($39.60 end value),

C. a down move followed by an up move ($39.60 end value), and

D. a down move followed by a down move ($32.40 end value).

The probability of an up move followed by a down move is 0.65 x 0.35, which equals 0.2275.

The probability of a down move followed by an up move is 0.35 x 0.65, which also equals 0.2275.

Both of these sequences result in an end value of $39.60.

Therefore, the probability of an end value of $39.60 is 45.50%.


Enter the given cash flows into a financial calculator along with the 10% discount rate, and

compute NPV. Alternatively, separately find the present values of the given cash flows using 10%

and sum the discounted cash flows.


Investors should be attracted by a positive skew because the mean return falls above the median.


Prior to the price ceiling, the total surplus was d + e + f + g + h, consisting of consumer surplus of f

+ e and producer surplus of d + g + h. The price ceiling causes the quantity supplied to decrease

to QC and for those consumers who can find supply to gain consumer surplus of g at the expense

of producers. With the decline in supply, consumers lose consumer surplus e and producers lose

producer surplus d for a combined deadweight loss of d + e.


Each company will consider the other’s reaction in selecting its strategy. Based on the following

summary, it is best for both chains to provide 24‐hour service.

Chain Consideration Best Decision

1

If it opens for 24 hours, it will see a higher

payoff regardless of what Chain 2 does.

Open for 24 hours Chain 2

Closes at 9 p.m.

Chain 2

Open for 24 hours

Chain 1 earns 540

instead of 180.

Chain 1 earns 108

instead of 55.

2

If it opens for 24 hours, it will see a higher

payoff regardless of what Chain 1 does. Open for 24 hours.

Chain 1

Closes at 9 p.m.

Chain 1

Open for 24 hours


42

Chain 2 earns 290

instead of 75.

Chain 2 earns 592

instead of 140.


An increase in the supply of human capital will increase the resource base and cause a shift of the

SRAS to the right.


During the peak phase of the business cycle, capital spending expands rapidly but the rate of

growth of consumer and business spending slows down; in addition, during the peak, businesses

slow their rate of hiring, but the unemployment rate continues to fall.


Current account amounts with signs and grouped appropriately:

Transaction Amount Totals

Exports of goods and services in income receipts 13,409

Exports of goods and services 10,000

Investment income received from foreigners 3,409

Imports of goods and services in income payments ‐16,735

Imports of goods and services ‐14,216

Investment income payments made to foreigners ‐2,519

Net unilateral current transfers ‐761

Unilateral current transfers received 346

Unilateral current transfers paid ‐1,107

Current account balance ‐4,087


Formula New Zealand Canada

Inflation

Rate

Nominal

Exchange

Rate

Change

1.2589 1.2844 =1.99%1.2844

−


43

Real

Exchange

Rate

Change

1+ (1 )1

(1 )

SNZD CDA PCANADASNZD CDA PCANADA

PNZPNZ

⎛ ⎞Δ Δ× +⎜ ⎟

⎝ ⎠ −Δ

+-1=-2.05.×（1-0.0199）（1+0.0178）

（1+0.0185）

Approximation: ‐1.99% + 1.78% ‐ 1.85% = ‐2.06%


A Giffen good is an inferior good. All inferior goods have a negative income effect (less is

purchased as income rises). While the substitution effect is always positive for all goods, for a

Giffen good the income effect is so strong and so negative that it overpowers the substitution

effect. The result is that as its price declines, less of it is purchased: This results in a positively

sloped individual demand curve. Therefore, it is least likely that the substitution effect is

negative.


The firm should initially utilize that resource that maximizes output per monetary unit of input

cost (i.e., use the resource with the highest MP/input cost). In this case, it is labor at 120 units/$4

or 30 units/$ while for capital, it is 120 units/$12 or 10 units!/$, indicating that a dollar spent on

labor is more effective in raising output than a dollar spent on capital. However, as more labor is

used, its marginal product will fall and that of capital will rise. Therefore, the optimal output level

will be attained when the MP/input cost ratio for both factors are equal.


Inflation rate is calculated as the percentage change in the implicit GDP price deflator.

Implicit GDP price deflator= at market prices 100

Real GDP in base year pricesGDP

×

2010 2011

Implicit GDP price deflator 3.679.098 100 116.33.163.330

× = 3.818.145 100 114.23.342.570

× =

Inflation Rate = 114.2( 1) 100 1.8%116.3

− × = −


Both the Laspeyres index and the Paasche index ignore the substitution effect whereby people

may substitute higher‐priced goods or services with cheaper ones. This situation causes the


44

Laspeyres index (which uses the historical composition of a basket of goods ) to be upward biased

relative to the true inflation rate , while the Paasche index ( which uses the current composition

of the basket with cheaper options replacing more expensive ones ) is downward biased relative

to the true inflation rate . The Fisher index is a geometric mean of the Laspeyres and Paasche

indices, and it will, therefore , display less of a substitution bias than the other two .


With a decline in economic activity and domestic inflation, the currency of the developing

country would start to rise against the dollar. To protect the exchange rate target, the developing

country‘s monetary authority Will purchase foreign exchange reserves and Sell its own currency.

This action will increase the domestic money supply and decrease short‐term interest rates.


With the imposition of the tariff, domestic supply will increase from 1Q to 2Q but domestic

demand will fall from 4Q to 3Q . The net amount imported will be 3 2-Q Q . The change in

government revenues is area L, which is the rectangle 3 2) ( )T WQ Q P P− × −（ .


Comprehensive earnings = Comprehensive income per

share × Common shares outstanding.

$4.15 × 46.506 $193

Net income = Comprehensive earnings –

Other comprehensive income (OCI).

$193‐$87.60 $105.40

Net income per share (EPS) =

Net income / Common shares outstanding.

$105.40 / 46.506 $2.27

P/E = Stock Price / EPS. $60.75 / $2.27 26.76


First, EBIT must be calculated, then the fixed charge coverage ratio.

Company

EBIT = Net income + Interest expense + Income tax expense. 3,400 + 1,000 + 1,100 = 5,500

Fixed charge coverage ratio =

payments Lease paymentsInterest payments Lease EBIT

++ 5,500 500 6,000

1,000 500 1,500+ =+ =

Fixed charge coverage ratio 4.00



45

Comparability is not a fundamental qualitative characteristic but rather one of the four

characteristics that enhance the usefulness of relevant and faithfully represented financial

information.


A deferred tax liability is a noncurrent liability that results from temporary differences between a

company’s income as reported for tax purposes and income as reported for financial statement

purposes. Though temporary, deferred tax liabilities are defined as the amounts of income taxes

payable in future periods with respect to taxable temporary differences; under IFRS, they are

always classified as non‐current.


The calculation is as follows:

(€ thousands)

COGS 600

Less decrease in inventory (500 ‐ 600) ‐100

Purchases from suppliers 500

Plus decrease in A/P （200 ‐ 400） 200

Cash paid to suppliers 700


Cash return on assets = CFO / Average total assets.

6001 (6,000 4,000)2× +

= 12.0%


The periodic and perpetual systems result in the same inventory and cost‐of‐goods‐sold values

(and hence, gross profit margin) using both FIFO and specific identification valuation methods but

not necessarily using LIFO.


U.S. GAAP does not permit the reversal of prior‐year write‐downs; therefore, there are no

disclosures related to reversals.


Under IFRS, first you must determine the recoverable amount that is the higher of:

Value in use, which is the present value of the future cash flows: $32,000.

Fair value less costs to sell: $34,000 ‐ 4,000 = $30,000.


46

The recoverable amount ($32,000) is lower than the carrying value ($36,000).

Therefore, the asset is impaired and should be written down to that amount.

Under U.S. GAAP, to assess impairment the carrying value ($36,000) is compared with the

undiscounted expected future cash flows ($38,000).

In this case, the carrying value is lower, so the patent is not impaired.


Income tax expense equals income tax payable (the tax rate times the taxable income) plus the

increase in the deferred tax liabilities.

(0.30 × 215,000) + (90,650 ‐ 82,400) = 64,500 + 8,250 = 72,750.


Negative covenants require that a borrower not take certain actions. The requirement to seek the

lender’s approval before paying dividends is an example of a negative covenant. The other two

are affirmative covenants.


A is correct. Activities or actions that inflate sales and understate expenses generally lead to a

buildup in assets, such as receivables and inventory, on the balance sheet. Early revenue

recognition and delayed expense recognition would decrease cash from operations, not increase

it.


Inventory turnover and days of inventory on hand (DOH) are calculated as follows:

2011 2010

Number of days in period 365 365

Average inventory (1,500+2,500)/ 2 (1,500+1,500)/ 2

Cost of sales 14,600 13,695

/Average inventory / 2,000 / 1,500

=inventory turnover 7.30 9.13

DOH=#days in period/ Inventory turnover (365 / 7.30)=50 (365 / 9.13)=40

The cash conversion cycle, or net operating cycle, is calculated as follows:

2011 2010

DSO 60 70

Plus DHO +50 +40

Less # of days payable ‐70 ‐60


47

Cash conversion cycle 40 50

The company's cash conversion cycle improved. The reduction in days of sales outstanding

indicates the company improved its collections from customers and shortened the cash

conversion cycle. The increase in days Payable indicates that the company took longer to pay

suppliers, which also shortened the cash conversion cycle and indicates greater liquidity. The only

metric that deteriorated is days of inventory on hand, which indicates that the company tied up

more capital in inventory. Therefore, it did not benefit the cash conversion cycle.


To report cost of sales under gross reporting (and include the cost of rooms), the company must

meet four criteria:

Criteria Met / Not Met

The company must:

Be the primary obligor under the contract. Not Met

Bear the inventory risk and credit risk. Met

Be able to choose its supplier. Met

Also have reasonable latitude to establish pricing Met

The first criterion is not met. The major hotel chains have the obligation of fulfilling the room

contract once it is entered into. Because not all of these conditions are met, the company must

use net reporting, where revenue is $ 500,000 and cost of sales is $250, 000.


EPS=（Net income‐Preferred dividends) / Weighted average number of shares outstanding.

Diluted EPS must be less than basic EPS.

Basis EPS Diluted EPS

Net income (there are no preferred dividends) $32,000,000 $32,000,000

Plus After‐tax cost of interest=$15,000,000ⅹ

0.12=$1,800,000ⅹ(1‐0.30)=

+$0 +$1,260,000

Numerator (net income) $320,000,000 $33,260,000

Weighted average# shares outstanding 4,500,000 4,500,000

Plus: Convertible bonds if converted +50,000

Denominator 4,500,000 4,550,000

Basis EPS: 32,000,000/ 4.500,000 $7.11

Diluted EPS for bonds: 33,260,000/ 4,550,000 $7.31

Therefore, the bonds are antidilutive and should not be

included


48

option if Converted = 200,000 option, outstanding $50

per Share =＄10,000 ,000 that at $80 per share can be

used to repurchase 125,000 shares

($10,000,000/80.00).Results in incremental

200,000‐125,000=75,000 shares issued.

+75,000

Denominator(4,500,00+75,000) 4,575,000

Diluted EPS with options:32,000,000 / 4,575,000 $6.99

Therefore the diluted EPS of $6.99 should be used.


The direct method provides information on the specific sources of operating cash receipts and

payments. This method is in contrast to the indirect method, which reconciles net income to cash

flow and shows only the net result of these receipts and payments.


If the interest payable decreases during the year, then the interest expense on an accrual basis

will be lower than the amount of cash interest payments. The cash paid would be the full amount

of the expense plus the amounts paid to reduce the interest payable. For example:

Interest expense 100

Plus decrease in interest payable +12

Cash paid for interest 112


Deferred tax assets arise from carrying forward unused tax losses and credits but are recognized

only if there is an expectation that the company expects to use them (that there will be taxable

income in the future).


Inventory costs include all direct costs of acquisition, including import taxes and inspection but

not storage costs or warehouse administrative costs. Trade discounts, rebates, and similar items

reduce the price paid and the costs of purchase.

Cost Determination £ (thousands)

Purchase price (1,000 x £20.20) 20,200

Volume rebate (404)

Import and sales taxes 2,970

Inspection on delivery 325

Total costs to be inventoried £23,091


49


Because the asset is self‐constructed, the costs of specifically identifiable interest during the

construction period can be capitalized and included in the cost of the showroom.

€(millions)

Construction costs 38.5

Interest expense in 2010 & 2011: 0.08 x €30 x 2 years 4.8

Total capitalized cost 43.3

[Capitalized cost — Residual value] / Useful life = [43.3

— 5.0] / 40.

0 9575


Under IFRS, a building owned for the purpose of earning rentals or capital appreciation—in this

case, the one owned by the company and leased out to tenants—is an investment property and

can be reported under either the cost model or fair value model.


A decrease in the tax rate will result in a decrease in the previously reported amounts of deferred

tax assets. That is, the value of the future tax assets, based on the new lower rate, is reduced for

offsetting future tax payments.


The lease would qualify as a finance (capital) lease under U.S. GAAP because the present value of

the lease payments is more than 90% of the fair value.

Using a financial calculator for an annuity due at the beginning of the period:

PV of lease payments: PMT = 25,000, i = 8%, N = 5, BGN Compute PV.

PV = $107,803, 90% of the fair value: 0.90 x 115,000 = $103,500.

Therefore, the lease is greater than 90% and would be capitalized at $107,803. With the first

payment made immediately, the outstanding balance in 2012 = 107,803 ‐25,000 = 82,803.

Interest expense in 2012 0.08 x 82,803 6,624.24

Amortization expense for the year using the lease

term as the useful life (no indication that the lease

will be renewed beyond the initial term)

107,803 / 5 21,560.60

Total expense in 2012 28,184.84


An increase in days sales in payables would indicate a lengthening payables cycle, which indicates

that the company is not paying its payables as quickly, and would increase the cash flow from


50

operations.


A new project reducing the cash flows of an existing project is an externality called

“cannibalization.”


Using Equation 16:

1

0

( )(1 )

$0.320.1225 ( ) 0.10$14.69(1 0.032)

eDr g

P f= +

−

= +−


All Equity Half Equity and Debt

Net income Net income × [1 – 30%]

Equity = 100% × Assets. Equity = 50% × Assets.

ROE:

= Net income / Equity

= Net income / (100% × Assets)

= Net income / (Assets)

= 10%.

ROE:

= (Net income × [1 – 30%]) / Equity

= (Net income × [1 – 30%]) / (50% × Assets)

= (Net income / Assets) × ([1 – 30%] / 50%)

= 10% × 1.4 = 14%.

Alternatively, looking at the effects of the changes in sequence:

When equity decreases by half, ROE would become 10% / 0.50 = 20%.

When net income decreases by 30%, the adjusted ROE would become = 20% × (1 ‐ 0.30) =

14%.


Assuming appropriate corporate governance measures, the audit, remuneration/compensation,

and nominations committees should be composed entirely of independent board members.

Other committees may have members from executive management.


The discounted cash flows are:

Year Discounted CF Cumulative Discounted CF

0 ‐1.525.00

1 193.69 = 215 / (1.11)1 193.69

2 280.01 = 345 / (1.11)2 473.70


51

3 347.32 = 475 / (1.11)3 821.02

4 800.36 = 1,215 / (1.11)4 1,621.38

After three years, $821.02 of the $1,525 investment is recovered, leaving $703.98 left to recover

in the fourth year. Proportionately, only 0.88 (= $703.98 / $800.36) of the cash flow in the fourth

year is necessary to recover all of the investment, which makes the discounted payback equal to

3.9 years (rounded up from 3.88).


The annual after‐tax cost of debt is the after‐tax annual yield to maturity (YTM).

Find the YTM by using a financial calculator as follows:

PV = —1,030.34; FV = 1,000; N = 40 (20 x 2); PMT = 31 (0.062 x 1,000 x 0.5); Compute i.

i= 2.97 semiannually.

Annual YTM = 2.97 x 2 = 5.94.

Consequently, the associated after‐tax value = 0.0428 = 0.0594 x [1 — 0.28].


Based on Equation (6):

DTL=( )

( )Quantity Price -Variable cost

Quantity Price-Variable cost - Fixed costs -Financing costs ×

×⎡ ⎤⎣ ⎦

The change to accelerated depreciation increases the fixed costs, making DTL (degree of total

leverage) increase (i.e., the numerator does not change and the denominator decreases).


Trade credit and a bank line of credit are considered primary sources of liquidity. Liquidating

inventory is a secondary source of liquidity.


Discount‐basis yield:

Face value-Purchase price 360) ( )Face value Number of days to maturity

$10,000 $9,870 360( ) ( ) 0.0520$10,000 90

×

−= × =

=（


[ ] [ ]Old price $30.00New Price= $28.57

1+Precentage of stock dividend 1 0.05= =

+


52


The order becomes valid when the price falls to or below 90. But, the “limit 85” makes the order

invalid if the price falls below 85. Thus, the trader faces a maximum loss of 15.


Compared with equity indices, the large number of fixed‐income securities— combined with the

lack of liquidity of some securities—has made it more costly and difficult for investors to replicate

fixed‐income indices and duplicate their performance.


The put option feature facilitates raising capital because the shares are more appealing to

investors. It helps investors limit their potential losses because they can sell the shares back to

the issuing company if the market price falls below the pre‐specified put price. Therefore, putable

common shares are beneficial to both the issuing company and the investors.


Companies in mature industries are likely to be pursuing replacement demand rather than new

buyers and are probably focused on extending successful product lines rather than introducing

revolutionary new products. Therefore, they tend to focus on cost rationalization and efficiency

gains rather than on taking lots of market share. Further, companies with superior products or

services are likely to gain market share.


First, determine the end‐of‐year book value.

Increase in retained earnings = Net income × (1 ‐ Payout ratio) = $5,000,000 × (1 ‐ 0.4) =

$3,000,000.

Book value per share = (Beginning equity + Increase in retained earnings) / # of

Outstanding shares = ($45,000,000 + $3,000,000) / 6,000,000 = $8.00.

Price‐to‐book ratio = Price / Book value per share = $30.00 / $8.00 = 3.75.


Investors’ current required return = $3.75 / $50 = 7.50%.

New required return = 7.50% + 0.75% = 8.25%.

New market price = $3.75 / 0.0825 = $45.45.


Equal weighting assigns an equal weight to each constituent security at inception. Therefore, it is

the sum of the total return from each security divided by the number of securities in the


53

portfolios (see Exhibit 3).

Stock 1 0 0( ) /P P D P− + = Total Returns (%)

A (37‐40+2.00)/40= ‐2.5

B (52‐50+1.50)/50= 7.00

C (34‐30+0)/30= 13.33

Portfolio return with equal weighting:

(—2.50 + 7.00 + 13.33) / 3 =

5.94%


Disposition effect relates to the behavioral bias in which investors tend toward avoiding realizing

losses but, rather, seek to realize gains. Manager Y has displayed this bias because he rarely

realized investment losses but realized most of the investment gains.


Investors of unsponsored DRs would not have the same voting rights as the direct owners of

common shares because the depository bank retains the voting rights.


Enterprise Value (EV) = EBITDA x EV multiple = 15 x 3.2 = 48.

Market capitalization = Enterprise value — MV of debt — MV of preferred stock + Cash

& short‐term investments = 48 — 10 — 5 + 4.5 = 37.5.


V0 = D0(1 + g)/(r—g), where

Sustainable growth rate: g = b x ROE;

b = (1 — Payout ratio);

g = (1—0.45) x 15% = 8.25%;

V0 = $3(1.0825) / (0.16 ‐0.0825) = $41.90.


The justified forward P/E approach offers the advantage of incorporating fundamentals and

presenting intrinsic‐value estimations.


The financial institution is lending, that is, it is short and will, therefore, lose if the 90‐day LIBOR

rate at expiration is greater than 2%. The payoff is calculated as follows:

$15,000,000 x [((0.02 — 0.03) (90 / 360)) / ((1 + 0.0 3(90 / 360))] = $37,220.84


54


The periodic six‐month or 180‐day payments are calculated as follows:

U.S. company pays the dealer R$23,247,088 = 0.107 × (180 / 360) × R$434,525,000.

Dealer pays the U.S. company US$8,125,000 = 0.065 × (180 / 360) × US$250,000,000.


An interest rate cap is a combination of a series of interest rate call options, each with the same

exercise rate, where each call option expires on the date the floating rate loan resets.


The price of a Eurodollar futures contract is dependent on the value of LIBOR, and cash

settlement is permitted.


Profit for a seller of a put option is calculated as

π= ‐max(0,X ‐ST) + P0

Ð =‐max(0, $530‐$540) + $23 = $23.


The profit on a covered call is calculated as follows:

π= ST ‐ S0‐max(0,ST ‐X) + c0

Ð = $215 ‐$190 ‐ max(0, $215 ‐ $200) + $11.40 = $21.40.


Alternative investment strategies are more likely to employ securities that trade in less liquid

markets than securities that trade in relatively more liquid markets in which traditional, long‐only

investments trade.


Quantitative directional is an equity strategy that uses “Technical Analysis to identify over‐ and

underpriced securities, buy the underpriced ones, and short the overpriced ones.


The $120 million grows by 25% to $150 million = $120 million × (1 + 0.25). The management fee

is $2.25 million = $150 million × 0.015, leaving $147.75 million, net of the management fee, or an

increase of $27.75 million over the beginning value of $120 million. The 6% hurdle rate requires

an increase of $7.2 million = $120 million × 0.06, so the fund has earned $20.55 million = $27.75

million ‐ $7.2 million over the hurdle rate, net of the management fee. The incentive fee is 15% of

this, or $3.0825 million = $20.55 million × 0.015, leaving an increase in fund assets, net of


55

management and incentive fees, of $24.6675 million = $27.75 million‐ $3.0825 million. The

investor’s return, net of fees, is $24.6675 / $120 million = 20.56%.


Private equity management fees are based on the full amount of committed capital, whether

drawn down or not, less capital that has been returned to investors from investments that have

been exited.


A short bias strategy involves positions in traded equities and, moreover, many equities that are

liquid enough to be shorted. Valuation can be accomplished using market prices and bid‐ask

quotes. Valuation of the REIT requires subjective appraisal using a variety of techniques, none of

which reflect a market price for the property being appraised. Valuation of firms acquired in LBOs

(leveraged buyouts) requires appraisals or estimates because market pricing is no longer available

after the firm is taken private.


While the REIT’s holdings are illiquid, the REIT itself is publicly traded. From the investor’s

perspective, the REIT is a liquid investment and the private equity fund is not.


An inverse floater’s coupon rate must rise when market interest rates fall.


A requirement to retire a specified portion of a bond issue each year is a sinking fund provision.


The longer until a security’s coupon rate resets to market levels, the more its value can differ

from par.


Duration =

(Price if yields decline ‐ Price if yields rise) /

(2 × Initial price × Change in yield in decimal) = 103.74 101.122 102.31 0.002

−× ×

= 6.40


The tap method is when more bonds that are identical to a previous issue are auctioned.


56


In a CMO structure, the principal balance of the tranches is paid sequentially, so Tranche A will be

repaid first and have a shorter repayment period than Tranche B.


The market segmentation theory posits that investors will invest only in their desired maturity

and will not move to longer or shorter maturities in response to yields that are too low or too

high compared with investors’ expectations for the future. Therefore, the shape of the yield curve

will not reflect these expectations.


The yield ratio =8.17%

1.455.64%

=


The value of the bond is

1 2 3

9 9 1098.41 7.86 89.98 105.25

1.07 1.07 1.07+ + = + + =

If market interest rates increase, the discount rate will increase and the value will become

1 2 3

9 9 1098.33 7.72 86.53 102.57

1.08 1.08 1.08+ + = + + = ,a change of —2.68.


The value of the bond is

1 2 3 4 5

1 1 1 1 101

1.002 1.004 1.005 1.0055 1.006+ + + + =

0.9980 0.9920 0.9851 0.9783 98.0238 101.98= + + + + =


The duration model estimates the change in price as Ð x Δi x 100, or ‐7.31 x ‐0.02 x 100 = +

14.62%, and the convexity adjustment is C x (Δi)2 x 100, or ‐24.8 5 x (0.02)2 x 100 = ‐0.98%, and

14.62% ‐0.98% = 13.64%.


Higher expected yield volatility means greater likelihood of large interest rate changes in that

market, implying higher interest rate risk.


57


The minimum investment required to open a separately managed account is usually much higher

than the amount required to open a mutual fund.


(1 + 0.12)0.8 ‐ 1 = 9.49%.


The formula for the return standard deviation (risk) of a two‐asset portfolio is

2 2 2 21 1 2 2 1 2 1 2 1 22 ( , ).p w w w w COV R Rσ σ σ σ σ= + +

The formula for portfolio risk shows that portfolio risk decreases as the correlation decreases.


The CAPM posits the expected return of a security is E(Ri) = Rf+ iβ [E(Rm) — Rf)], where fR is

the risk‐free rate, mR is the return on the market portfolio, and /3 is the beta of the security. 2% +

1.25 x (6% — 2%) = 7.00%.


One of the assumptions of the CAPM is that investors plan for the same single holding period.


A is correct. Investment time horizon is an objective factor that measures ability to take risk.

2012 CFA Level Sample Exam

58

2012 Level 1 Sample Exam SS1‐ETHICAL AND PROFESSIONAL STANDARDS (27 MINUTES) 1. Carlos Cruz, CFA, is one of two founders of an equity hedge fund. Cruz manages the fund's assets

while the other co‐founder, Brian Burkeman, is responsible for fund sales and marketing. Cruz notices that the most recent sales material used by Burkeman indicates the value of the assets under management in the fund is listed at a higher than actual value. Burkeman justifies the discrepancy by stating that the recent market decline accounts for the difference. To avoid violating the CFA Institute Standards of Professional Conduct, Cruz should least likely take which of the following actions?

A. Correct the asset information and provide the update to prospective clients. B. Report the discrepancy to the Professional Conduct Program of CFA Institute. C. Check with the firm's legal counsel to determine what action should be taken. 2. Linda Chin, CFA, is a member of a political group advocating lower governmental regulation in all

aspects of life. She works in a country where local securities laws are minimal and insider trading is not prohibited. Chin's politics are reflected in her investment strategy, where she follows her country's mandatory legal and regulatory requirements. What steps should Chin most likely take to ensure she does not violate any CFA Institute Standards of Professional Conduct?

A. Continue current investment strategy. B. Follow the CFA Institute Code and Standards. C. Disclose to clients that she meets mandatory legal requirements. 3. Wouter Duyck, CFA, is the sole proprietor of an investment advisory firm serving a middle‐class

retail clientele. Duyck claims to be different from his competitors because he conducts his own independent research. Duyck has hundreds of clients. He fully discloses that to simplify the management of all these accounts he has created a recommended list of stocks, from which he selects investments for all of his clients. Duyck's recommended list of stocks is obtained from his primary broker, who has completed due diligence on each stock. Duyck's recommended list least likely violates which of the following CFA Institute Standards of Professional Conduct?

A. Fair Dealing. B. Misrepresentation. C. Diligence and Reasonable Basis. 4. Lisa Hajak, CFA, specialized in research on real estate companies at Cornerstone Bank (CB) for

the past twenty years. Hajak recently started her own investment research firm, Hajak Advisory (HA). One of her former clients at CB asks Hajak to update a research report she wrote on a real estate company when she was at CB. Hajak updates the report, which she had copied to her


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personal computer, without the bank’s knowledge, and replaces references to the bank with her new firm, HA. Hajak incorporates the conclusions of a real estate Study conducted by the Realtors Association that appeared in the Wall Street Journal. She references the Journal as her source in her report. She provides the revision free of charge along with a request for the bank’s client to become a client of her firm. Concerning the reissued research report, Hajak least likely violated the CFA Institute Standards of Professional Conduct because she:

A. solicited the bank’s client. B. did not obtain consent to use the bank report. C. must cite the actual source of the real estate Study. 5. Tonya Tucker, CFA, is a financial analyst at BC Corporation (BC). BC has numerous subsidiaries

and is actively involved in mergers and acquisitions. Tucker analyzes HR Corporation (HR) and tells the CEO of BC that the acquisition of HR would be a good fit for BC. After her discussion with the CEO, Tucker purchases 100,000 shares of HR at $200 per share. BC does not have any pre‐clearance procedures, so the next time she meets the CEO, Tucker mentions she is a stockowner of HR. The CEO thanks her for this information but does not ask for any details. Two weeks later, Tucker sees a company‐wide email from the CEO announcing BC’s acquisition of HR for $250 a share. Regarding her purchase of HR stock, Tucker most likely violated the CFA Institute Standards of Professional Conduct concerning:

A. Loyalty. B. Market Manipulation. C. Material Nonpublic Information.

6. When a client asks her how she makes investment decisions, Petra Vogler, CFA, tells the client

she uses the mosaic theory. According to Vogler, the theory involves analyzing public and nonmaterial nonpublic information, including evaluating statements made to her by company insiders in one‐ on‐one meetings discussing management’s new earnings projections not known to the public. She also gathers general industry information not known to the public from industry experts and other contacts. Vogler most likely violates the CFA Institute Standards of Professional Conduct because of her use of:

A. industry contact information. B. one‐on‐one meeting information. C. nonmaterial nonpublic information in her analysis. 7. Lin Liang, CFA, is an investment manager and an auto industry expert. Last month, Liang

requested securities regulators to open an investigation into accounting irregularities at Road Rubber Company (RRC) despite having no basis for the request. Shortly before he spoke to the regulators, Liang shorted RRC stock for his clients. Once the regulators opened an investigation, Liang leaked this information to multiple sources in the media. When news of the investigation became public, ‘the share price of RRC immediately dropped 30%. Liang then covered the short positions and made $5 per share for his clients. Liang least likely violated which of the CFA


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Institute Standards of Professional Conduct?

A. Misconduct. B. Market Manipulation. C. Priority of Transactions. 8. Sanjay Gupta, CFA, has been hired by the First Faithful Church to manage the pension plan’s

equity portfolio. The plan trustees tell Gupta that stocks of companies involved in the sale of alcohol, tobacco, gambling, or firearms are not acceptable investments. Gupta believes that he can reasonably execute his strategy with this restriction. Does Gupta violate the CFA Institute Standards of Professional Conduct?

A. No. B. Yes, because the restrictions provided in the guidelines are not in the best interest and

objectives of the client. C. Yes, because Gupta should construct the portfolio with these limitations since he can execute on

the strategy. 9. Jorge Lopez, CFA, is responsible for his bank’s proxy voting on behalf of the bank’s asset

management clients. Lopez recently performed a cost‐benefit analysis, showing that voting all proxies might not benefit the bank’s clients. Based on this analysis, Lopez changes the proxy voting policies and procedures without informing anyone else of the change. Lopez now votes client proxies on the side of management on all issues with the exception of major mergers where a significant impact on the stock price is expected. Lopez least likely violated the CFA Institute Standards of Professional Conduct regarding:

A. cost‐benefit analysis. B. voting with management. C. proxy voting policy disclosures. 10. Henrietta Huerta, CFA, writes a free investment newsletter widely followed by individual

investors. Huerta is not aware of who receives the newsletter but it is the primary marketing tool she uses to obtain investment management clients for those who contact her and are willing to pay management fees. For Huerta, the newsletter recommendations serve as the basis for most of her investment actions. Huerta recently completed research on East‐West Coffee Roasters (ECR) and has decided to change her initial buy recommendation on ECR to a sell. To avoid violating the CFA Institute Standards of Professional Conduct, Huerta should most likely ensure that the changed investment recommendation reaches:

A. newsletter recipients first. B. asset management clients first. C. asset management clients and newsletter recipients simultaneously. 11. Danielle Deschutes, CFA, is a portfolio manager and part of a ten‐person team managing an


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indexed stock portfolio for institutional accounts. A competing firm, South West Index Managers (SWIM), asks Deschutes to interview with them and to bring her performance history to the meeting. Deschutes informs her employer about the interview and receives written permission to bring the performance history of the stock portfolio with her. When Deschutes shows up for the interview at SWIM she discloses that the performance numbers represent the work of her team and describes the role of each member. To bolster her credibility, she also provides the names of institutional accounts and related assets constituting the portfolio. In her interview at SWIM, Deschutes least likely violated the CFA Institute Standards of Professional Conduct regarding:

A. her contribution to the portfolio’s returns. B. the stock portfolio’s performance history. C. providing details on the institutional accounts. 12. When Abdullah Younis, CFA, became a broker at a global financial services organization two

years ago, he was told he could allocate his work hours as he saw fit. At this time, Younis served on the board of three non‐public golf equipment companies and managed money for several members of his immediate family in a pooled fund. Younis was not compensated for his board service or for the investment pool management. Younis’ outstanding returns attract interest from friends and co‐workers who persuade him to include their assets in his investment pool. Younis recently retired from all board responsibilities and now spends more than 80% of his time managing the investment pool for which he charges non‐family members a management fee. Younis has never told his employer about any of these activities. To comply with the CFA Institute Standards of Professional Conduct, regarding his business activities over the past two years, Younis should least likely disclose which of the following to his employer?

A. Board activity. B. Family investment pool management. C. Non‐family member management fees. 13. Kim Klausner, CFA, manages several hundred employees as the head of research for a large

investment advisory firm. Klausner is a former securities regulatory official who, until recently, ensured that his department’s compliance program always met or exceeded those of its competitors. Klausner has delegated his supervisory responsibilities concerning compliance issues to Sue Chang. Klausner informed Chang that her responsibilities include ensuring that the firm has appropriate compliance procedures and is making reasonable efforts to detect and prevent violations of Rules, Regulations, and the Code and Standards. Klausner most likely violated the CFA Institute Standards of Professional Conduct by not telling Chang to consider

A. firm policies. B. legal restrictions. C. industry standards.

14. Sheila Schleif, CFA, is an equity analyst at an investment bank. Schleif uses a data‐driven


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computer model in making her stock recommendations. Schleif discovers the model contains a coding error. If the coding error were corrected, her most recent buy recommendation would change to a sell. Schleif corrects the coding error, issues a bank‐wide revision of her recommendation changing the buy to a sell, and then forwards the revision to all bank clients who received the initial recommendation. Concerning her actions related to the coding error, Schlief most likely violated which of the following CFA Institute Standards of Professional Conduct?

A. Fair Dealing. B. Priority of Transactions. C. Diligence and Reasonable Basis. 15. Rodney Rodrigues, CFA, is responsible for identifying managers to manage specific asset classes

for his firm. In selecting external advisers or subadvisers, Rodrigues reviews the adviser’s investment process, established code of ethics, the quality of their published return information, and their compliance and internal control procedures. In completing his review, Rodrigues most likely violated the CFA Institute Standards of Professional Conduct regarding his due diligence on:

A. adherence to strategy. B. performance measures. C. internal control procedures. 16. Jackson Barnes, CFA, provides financial planning services to his local community for a fee. Barnes

has developed a network of specialists including accountants, lawyers, and brokers who contribute their expertise to the financial planning process. Each of the specialists is an independent contractor. Each contractor bills Barnes separately for the work they perform, providing a discount based upon the number of clients Barnes has referred. What steps should Barnes most likely take to ensure he does not violate any CFA Institute Standards of Professional Conduct?

A. Check with his firm’s legal counsel to determine what action should be taken. B. Disclose to clients on their bills the consideration he receives from the specialists. C. Inform clients about his arrangement with the contractors before they agree to hire him. 17. Millicent Plain, CFA, has just finished taking Level II of the CFA examination. Upon leaving the

examination site, she meets with four other Level III candidates who also just sat for their exams. Curious about their examination experience, Plain asks the other candidates how difficult the Level III exam was and how they did on it. The candidates say the examination was very difficult but do not speak about specific questions. However, the candidates tell Plain about broad topic areas that were tested and complain about specific formulas, which they prepared for but which did not appear on the exam. The Level III candidates least likely violated the CFA Institute Standards of Professional Conduct by discussing:


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A. specific formulas. B. broad topic areas. C. difficulty of the examination. 18. On a flight to Europe, Romy Haas, CFA, strikes up a conversation with a fellow passenger, Vincent

Trujillo. When Trujillo learns Haas is in the investment profession, he asks about the CFA designation. Haas tells him the following about the CFA designation: Statement 1: Individuals who have completed the CFA Program have the right to use the CFA designation. Statement 2: Use of the designation must be accompanied by an accurate explanation of the requirements to earn and use the designation. Statement 3: Once granted the right to use the designation, an individual must also satisfy the CFA Institute membership requirements to maintain their right to use the designation. In explaining the use of the CFA designation, Haas least likely violated the Professional Conduct concerning which of the following statements?

A. Statement 1. B. Statement 2. C. Statement 3. SS2/3‐QUANTITATIVE ANALYSIS (21 MINUTES) 19. The nominal (quoted) annual interest rate on an automobile loan is 10%. The effective annual

rate of the loan is 10.47%. The frequency of compounding periods per year for the loan is closest to:

A. weekly. B. monthly. C. quarterly. 20. A U.S. Treasury bill (T‐bill) has 90 days to maturity and a bank discount yield of 3.25%. The

effective annual yield (EAY) for the T‐bill is closest to:

A. 3.29%. B. 3.32%. C. 3.36%. 21. The following ten observations are a sample drawn from an approximately normal population:

Observation 1 2 3 4 5 6 7 8 9 10

Value ‐3 ‐11 3 ‐18 18 20 ‐6 9 2 ‐16


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The sample standard deviation is closest to:

A. 11.92. B. 12.50. C. 13.18. 22. Assume that a stock’s price over the next two periods is as shown below.

Time=0 Time=1 Time=2S0=80 Su=88 Suu=96.8

Sd=72 Sud,du=79.2Sdd=64.8

The initial value of the stock is $80. The probability of an up move in any given period is 75% and the probability of a down move in any given period is 25%. Using the binomial model, the probability that the stock’s price will be $79.20 at the end of two periods is closest to: A. 18.75%. B. 37.50%. C. 56.25%. 23. In setting the confidence interval for the population mean of a normal or approximately normal

distribution and given that the sample size is small, Student’s t‐distribution is the preferred approach when the variance is:

A. known. B. negative. C. unknown. 24. A two‐tailed test of the null hypothesis that the mean of a distribution is equal to 4.00 has a

p‐value of 0.0567. Using a 5% level of significance (i.e., α=0.05), the best conclusion is to:

A. reject the null hypothesis. B. accept the null hypothesis. C. increase the level of significance to 5.67%. 25. A stock is declining in price and reaches a price range wherein buying activity is sufficient to stop

the decline. This is best described as a:

A. support level. B. resistance level. C. change in polarity points. 26. A borrower is considering three competing mortgage loan offers from her bank The amount

borrowed on the mortgage is $100,000 with monthly compounding.


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Mortgage type Nominal(stated)annual interest

rate at initiation of the loan Year in which rate first adjusts

30‐year fixed rate 5% N/A 15‐year fixed rate 4.385% N/A

30‐year 3/5 adjustable rate mortgage(ARM)

3.75% 3

The rate on the ARM resets at the end of the year 3. Assuming the ARM is reset at 5.5% (i.e. the remaining balance on the loan will now be repaid with 5.5% nominal annual interest), which of the three loans will have the smallest monthly payment after the rate reset at the end of year 3? A. 30‐year ARM. B. 15‐year fixed‐rate loan. C. 30‐year fixed‐rate loan. 27. Equity returns series are best described as, for the most part:

A. platykurtotic (less peaked than a normal distribution) B. leptokurtotic (more peaked than a normal distribution) C. mesokurtotic (identical to the normal distribution in peakedness) 28. By definition, the probability of any event E is a number between:

A. zero and positive one. B. zero and positive infinity. C. minus one and positive one 29. X and Y are independent events. The probability of X is 0.2 (P(X) = 0.2) and the probability of Y is

0.5 (P(Y) = 0.5). The joint probability of X and Y (P(X, Y)is closest to:

A. 0.1. B. 0.3. C. 0.7. 30. A variable is normally distributed with a mean of 5.00 and a variance of 4.00. Calculate the

probability of observing a value of negative 0.40 or less. That is, calculate P (X1 ≤ ‐0.40) given X is distributed as N(5, 4). Use this excerpt from the cumulative distribution function for the standard normal random variable table to calculate your answer.

Cumulative Probabilities for a Standard Normal Distribution P(Z≤X)=N(x)for x≥0 or P(Z≤z)=N(z)for z≥0 X or Z 0 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09 1.10 0.8643 0.8665 0.8686 0.8708 0.8729 0.8749 0.8770 0.8790 0.8810 0.8830


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1.20 0.8849 0.8869 0.8888 0.8907 0.8925 0.8944 0.8962 0.8980 0.8997 0.9015 1.30 0.9032 0.9049 0.9066 0.9082 0.9099 0.9115 0.9131 0.9147 0.9162 0.9177 1.40 0.9192 0.9207 0.9222 0.9236 0.9251 0.9265 0.9279 0.9292 0.9306 0.9319 … 2.50 0.9938 0.9940 0.9941 0.9943 0.9945 0.9946 0.9948 0.9949 0.9951 0.9952 2.60 0.9953 0.9955 0.9956 0.9957 0.9959 0.9960 0.9961 0.9962 0.9963 0.9964 2.70 0.9965 0.9966 0.9967 0.9968 0.9969 0.9970 0.9971 0.9972 0.9973 0.9974 2.80 0.9974 0.9975 0.9976 0.9977 0.9977 0.9978 0.9979 0.9979 0.9980 0.9981 2.90 0.9981 0.9982 0.9982 0.9983 0.9984 0.9984 0.9985 0.9985 0.9986 0.9986 3.00 0.9987 0.9987 0.9987 0.9988 0.9988 0.9989 0.9989 0.9989 0.9990 0.9990 3.10 0.9990 0.9991 0.9991 0.9991 0.9992 0.9992 0.9992 0.9992 0.9993 0.9993

The calculated value is closest to:

A. 0.35% B. 0.62%. C. 8.85%. 31. Which of the following statements of null and alternative hypotheses requires a two‐tailed test?

0 0 0

0 0 0

0 0 0

: :: :: :

a

a

a

H versusHH versusHH versusH

θ θ θ θθ θ θ θθ θ θ θ

= ≠≤ >≥ <

A. B. C.

32. Using the following data: Population 1 2 Sample size n1=5 n2=5 Sample variance S12 =4 S22=28 The sample are drawn independently and both populations are assumed to be normally distributed.

An analyst is trying to test the hypothesis that the population variances are equal（ 2 20 1 2:H S S= ）

against the alternative hypothesis that the variances are not equal（ 2 21 2:AH S S≠ ）at the 5% level of

significance. The table of the F‐Distribution is provided below. Table of the F‐Distribution Panel A: Critical values for right‐hand tail areas equal to 0.05 df1 (read across) 1 2 3 4 5 df2 (read down) 1 161 200 216 225 230 2 18.5 19.0 19.2 19.2 19.3 3 10.1 9.55 9.28 9.12 9.01 4 7.71 6.94 9.59 6.39 6.26 5 6.61 5.79 5.41 5.19 5.05


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Panel B: Critical values for right‐hand tail areas equal to 0.025 df1 (read across) 1 2 3 4 5 df2 (read down) 1 648 799 864 900 922 2 38.51 39.00 39.17 39.25 39.03 3 17.44 16.04 15.44 15.01 14.88 4 12.22 10.65 9.98 9.60 9.36 5 10.01 8.43 7.76 7.39 7.15

Which of the following statements is most appropriate? The critical value is:

A. 6.39 and reject the null. B. 7.15 and accept the null. C. 9.60 and accept the null. SS4‐ECONOMICS (18 MINUTES) 33. A college student’s monthly demand for pizza is given by the equation:

QD

pizza=11‐0.70 Ppizza+0.009I‐0.20PColaWhere QD

pizzais the number of pizzas ordered per monthPpizza is the price of a pizzaI is her monthly food budgetPCola is the price of cola per bottle

The student’s current monthly food budget is $500, the price of a pizza is $5, and the price of a bottle of cola is $1.25 / bottle. If the student’s monthly food budget were to increase to $700, the slope of her demand curve for pizza would be closest to: A. ‐2.42. B. ‐1.43. C. ‐0.70. 34. Partial information on three baskets (1, 2, and 3) containing goods A and B is given in the table

below. The marginal rate of substitution of B for A, (MRSBA), at basket 2 is also provided.

Basket Units of A Unit of B MRSBA 1 30 2 50 35 4.0 3 40 40

A consumer claims that he is indifferent between baskets 2 and 3 and his indifference curves are strictly convex. If he is also indifferent between baskets 1 and 3, the number of units of A in basket 1


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is most likely. A. equal to 60. B. less than 60. C. greater than 60. 35. Three firms operate under perfect competition, producing 900 units of the same product but

using different production technologies. Each company’s cost structure is indicated below:

Company X Y Z Total Variable Costs $2,700 $3,600 $4,500Total Fixed Costs 2,700 1,800 900Total Costs $5,400 $5,400 $5,400

Which of the following statements is most accurate? If the unit selling price is: A. $6.00, all firms should exit the market in the long run. B. $3.00, firm X should continue to operate in the short run, but firms Y and Z should shut down

production. C. $4.50, all firms should continue to operate in the short run, but exit the market in the long run if

these conditions are expected to persist. 36. The total output in units and average selling prices in a hypothetical economy producing only

two products, X and Y, is provided below:

Production X Production YYear Output(units) Selling price/unit Output(units) Selling price/unit 2010 2,800 €9 2,000 €472011 3,000 €11 1,800 €52

If the implicit price deflator for GDP in 2010 was 100, for 2011 it is closest to: A. 106.2. B. 106.8. C. 113.4.

37. In an economy, consumption is 70% of pre‐tax income and the average tax rate is 25% of total

income. If planned government expenditures are expected to increase by $1.25 billion, the increase in total incomes and spending, in billions, is closest to:

A. $1.3. B. $2.6. C. $4.2.


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38. The following diagram shows the domestic demand and supply curves for a country that imports

a commodity, where Pw is its world price and PT is its domestic price after the imposition of a tariff. The reduction in the net national welfare of this country as a result of the tariff is best described by the area(s):

A. E. B. G. C. F+H. 39. The market demand function for item X is a function of its price, household income, and the

price of item Y.

Own‐price elasticity of demand for X ‐0.8Income elasticity of demand for X 1.5Cross‐price elasticity of demand for X with respect to the price of Y 0.4

Given the above elasticity coefficients for the two items, which of the following statements is most accurate? A. X and Y are substitutes. B. Demand for X is elastic. C. Item X is an inferior good.

40. The monthly demand curve for playing tennis at a particular club is given by the following

equation: PTennis Match = 9‐ 0.20 ×Q Tennis Match .The club currently charges members $4.00 to play a match, but is considering a new flat rate monthly membership fee for unlimited play. The most fee that the club will be able to charge for this membership is closest to:

A. $40.00. B. $62.50. C. $162.50. 41. With its existing production facilities, a monopolist firm can produce up to 100 units. It faces the

E F G H

Price Domestic Supply

DomesticDemand

PT

PW

0 Q1 Q2 Q3 Q4 Quantity


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following demand and cost schedules:

Output (units) Price($/unit) Total cost($/unit) 0 3,000 600 20 2,800 10,600 40 2,600 32,600 60 2,400 66,600 80 2,200 112,600 100 2,000 170,600

The optimal output level for this producer (in units) is closest to: A. 20. B. 60. C. 100. 42. The following information has been gathered for a hypothetical economy:

Total Population 1,100 Working Age Population 975 Labor Force 750 Underemployed 120 Unemployed 95 Discouraged workers 80 Frictionally Unemployed 25 Voluntarily Unemployed 40

The unemployment rate is closest to: A. 9.7%. B. 12.6%. C. 16.0%. 43. Which of the following would be most useful as a leading indicator to signal the start of an

economic recovery?

A. An increase in aggregate real personal incomes (less transfer payments). B. A decrease in average weekly initial claims for unemployment insurance. C. The narrowing of the spread between the 10‐year Treasury yield and the federal funds rate. 44. In early 2011, the British pound (GBP) to New Zealand dollar (NZD) spot exchange rate was

2.0979. The LIBOR interest rates, quoted on a 360‐day year basis, were 1.6025% for the British pound and 3.2875% for the New Zealand dollar. The 180‐day forward points (scaled up by four decimal places) in GBP/NZD would be closest to:


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A. ‐343. B. ‐173. C. 176. SS7/8/9/10‐FINANCIAL STATEMENT ANALYSIS (47 MINUTES) 45. Information about management compensation and any potential conflicts of interest that may

exist between management and shareholders is most likely found in the:

A. proxy statement. B. notes to the financial statements. C. management discussion and analysis. 46. The following information is available about a company:

Contributed capital, beginning of the year $50,000Retained earnings, beginning of the year 225,000Sales revenues earned during the year 450,000Investment income earned during the year 5,000Expenses paid during the year 402,000Dividends paid during the year 10,000Total assets, end of the year 800,000

Total liabilities at the end of the year are closest to:

A. $472,000. B. $482,000. C. $487,000. 47. According to the International Accounting Standards Boards Conceptual Framework for Financial

Reporting, the two fundamental qualitative characteristics that make financial information useful are best described as:

A. timeliness and accrual accounting. B. understandability and verifiability. C. relevance and faithful representation. 48. The following information is available from a company’s accounting records:

€millions Revenues for the year 12,500


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Total expenses for the year 10,000 Gains from available‐for‐sale securities 1,475 Loss on foreign currency translation adjustments on a foreign subsidiary 325 Dividends paid 500

The company’s total comprehensive income (in millions) is closest to:

A. €1,150. B. €3,150. C. €3,650. 49. Based on the following information about a company, the bad debt expense (in millions) for

2011 is closest to:

￡millions 2011 2010

Accounts receivables，gross 6,620 4,840 Allowance for doubtful accounts 92 56

Write‐offs during the year 84 42

A. £36. B. £84. C. £120. 50. An analyst has gathered the following information about a company:

Cdn $ millionsCash flow from operating activities 105.9Cash flow from investing activities (11.8)Cash flow from financing activities 46.5Net change in cash for the year 140.6Interest paid(included in CFO) 22.4Taxes pa id(tax rate of 30％) 18.0

Total debt，end of year 512.8 The cash flow debt coverage ratio for the year is closest to:

A. 20.6%. B. 23.7%. C. 27.4%. 51. Which inventory method best matches the actual historical cost of the inventory sold with their

physical flow if a company is using a perpetual inventory system?

A. FIFO.


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B. LIFO. C. Specific identification 52. On 1 January, a company, which prepares its financial statements according to IFRS, arranged

financing for the construction of a new plant. The company: • borrowed NZ$5,000,000 at an interest rate of 8%, • issued NZ$5,000,000 of preferred shares with a cumulative dividend rate of 6%, and • during the first year of construction the company was able to temporarily invest NZ$2,000,000 of the loan proceeds for the first six months and earned 7% on that amount. The amount of financing costs to be capitalized (NZ$) to the cost of the plant in the first year is closest to:

A. 330,000. B. 400,000. C. 630,000. 53. Which of the following statements most accurately describes a valuation allowance for deferred

taxes? A valuation allowance is required under:

A. IFRS on revaluation of capital assets. B. U.S. GAAP if there is doubt about whether a deferred tax asset will be recovered. C. both IFRS and U.S. GAAP on tax differences arising from the translation of foreign operations. 54. A company had the following events related to $5 million of 10‐year bonds with a coupon rate of

8% payable semiannually on 30 June and 31 December: • Issued on 1 January 2005, when the market rate of interest was 6%. • Bought back in an open market transaction on 1 January 2011, when the market rate of interest was 8%. Which of the following statements best describes the effect of the bond repurchase on the financial statements for 2011? If the company uses the indirect method of calculating the cash from operations, there will be a:

A. $346,511 gain on the income statement. B. $743,873 gain on the income statement. C. $350,984 decrease in the cash from operations. 55. On a cash flow statement prepared using the indirect method, which of the following would

most likely increase the cash from investing activities?

A. Sale of a long‐term receivable. B. Sale of held‐for‐trading securities. C. Securitization of accounts receivable. 56. If a company chooses to capitalize an expenditure related to capital assets instead of expensing


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it, ignoring taxes, the company will most likely report:

A. a lower cash flow per share in that period. B. a higher earnings per share in future periods. C. the same free cash flow to the firm in that period. 57. An accounting document that records transactions in the order in which they occur is best

described as a:

A. trial balance. B. general ledger C. general journal. 58. Which of the following statements is most accurate with respect to financial reporting

requirements?

A. Regulatory authorities are typically private sector, self‐regulated organizations. B. Standard‐setting bodies have authority because they are recognized by regulatory agencies. C. The requirement to prepare financial reports in accordance with specified accounting standards

is the responsibility of standard‐setting bodies. 59. Income statements for two companies (A and B) and the common‐sized income statement for

the industry are provided below:

All$ figures in ’000s Company A Company B Industry Sales $10,500 $8,250 100.0%Cost of goods sold 6,353 5,239 62.8%Selling, general, and administrative expenses

2,625 2,021 24.8%

Interest expense 840 536 7.0%Pretax earnings 683 454 5.4%Taxes 205 145 1.7%Net earnings $478 $309 3.7%

The best conclusion an analyst can make is:

A. Company B’s interest rate is lower than the industry average. B. both companies’ tax rates are higher than the industry average. C. Company A earns a higher gross margin than both Company B and the industry. 60. Which of the following statements about balance sheets is most accurate? Under:

A. U.S. GAAP, intangibles must be valued at historical cost


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B. IFRS, a commercial real estate company should use a liquidity based presentation. C. IFRS, a classified balance sheet must present current assets before non‐current assets. 61. A company recorded the following events in 2010:

$’000sPurchase of securities for trading purposes 240Proceeds from the sale of trading securities 300Proceeds from issuance of bonds 500Purchase of 30% of shares of an affiliated company 275

On the 2010 statement of cash flows, the company’s cash flow from investing activities (in ‘000s) is closest to:

A. ‐$275. B. ‐$215. C. $285. 62. Selected information for a company is provided below.

$ millionsSales 4,800Cost of goods sold 2,880Purchases 2,940Average receivables 625Average inventory 710Average payables 145

The company’s cash conversion cycle (in days) is closest to:

A. 84. B. 120. C. 138. 63. Select information from a company that uses FIFO inventory method is provided below.

Event Units $/Units Total ($) Opening inventory 1,000 7.50 7,500Purchases 250 7.60 1,900Sales 550 12.00 6,600Purchases 300 7.70 2,310Sales 600 12.00 7,200Ending Inventory 400


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If the company uses the perpetual inventory system versus the periodic inventory system, the gross margin would most likely be:

A. lower. B. higher. C. the same. 64. A company, which prepares its financial statements according to IFRS, owns several investment

properties on which it earns income. It values the properties using the fair value model based on prevailing rental markets. A summary of the properties’ valuations is as follows: •Original cost (acquired in 2009) €50 million •Fair value valuation as at 31 December 2009 €50.5 million •Fair value valuation as at 31 December 2010 €54.5 million •Fair value valuation as at 31 December 2011 €48.0 million Which of the following best describes the impact of the revaluation on the 2011 financial statements?

A. €6.5 million charge to net income. B. €6.5 million charge to revaluation surplus. C. €4.5 million charge to revaluation surplus and €2.0 million charge to net income. 65. A company purchased equipment in 2009 for £25,000; the year‐end values for accounting

purposes and tax purposes are as follows:

2010 2009 Carrying amount for accounting purposes £20,000 £22,500 Tax base for tax purposes £16,000 £20,000 Tax rate 25% 30%

Which of the following statements best describes the effect of the change in the tax rate on the company’s 2010 financial statements? The deferred tax liability: A. increased by £250. B. decreased by £200. C. decreased by £800. 66. An analyst can most accurately identify a LIFO liquidation by observing a(n):

A. increase in gross margin. B. decrease in the LIFO reserve. C. change in inventory out of line with change in sales. 67. Selected information about a company is as follows:


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($’000) 2010 31 December 2011 Projection Sales 2,200 2,500Variable operating costs(% of sales) 28% 30% Fixed operating costs 1,400 1,400 Tax rate 25% 25% Dividends paid 55 60 Interest bearing debt at 5% 500 500

The forecasted net income (in ‘000s) for 2011 is closest to: A. $169. B. $202. C. $244. 68. An analyst has gathered the following information about a company’s capita’ assets:

Year ending 2011 2010 Property plant and equipment €2500 €2500 Accumulated depreciation 375 250 Net book value 2,125 2,250

As at the end of 2011, the expected remaining life of the assets, in years, is closest to: A. 6. B. 17. C. 20. SS11‐CORPORATE FINANCE (18 MINUTES) 69. Two mutually exclusive projects have the following cash flows (€) and internal rates of return

(IRR):

Project IRR Year 0 Year 1 Year 2 Year 3 Year 4 Project A 27.97% ‐2,450 345 849 635 3,645 Project B 28.3% ‐2,450 345 849 1,051 3,175

Assuming a discount rate of 8% annually for both projects, the firm most likely should accept:

A. both projects. B. Project A only. C. Project B only.


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70. A company’s asset beta is 1.2 based on a debt‐to‐equity ratio of 50%. If the company’s tax rate increases, the associated equity beta will most likely.

A. increase. B. decrease. C. remain unchanged. 71. A firm’s price‐to‐earnings ratio (P/E) is 12.5. The firm has decided to repurchase shares using

external funds that have an after‐tax cost of 9%. After the repurchase, the earnings per share (EPS) will most likely.

A. increase. B. decrease. C. remain unchanged.

72. Which is most likely considered a “pull” on liquidity?

A. Obsolete inventory. B. Reduction in a line of credit. C. Increased difficulty in collecting receivables. 73. Based on best practices in corporate governance procedures, independent board members most

likely.

A. meet only in the presence of management. B. have a “lead” director when the board chair is not independent. C. hire independent consultants who are pre‐approved by management. 74. Given the following information about a firm:

• debt‐to‐equity ratio of 50% • tax rate of 40% • cost of debt of 8% • cost of equity of 13%, the firm’s weighted average cost of capital (WACC) is closest to:

A. 7.5%. B. 8. 9%. C. 10.3%. 75. The unit contribution margin for a product is $20 and the firm’s fixed costs of production up to

300,000 units is $500,000. The degree of operating leverage (DOL) is most likely the lowest at which of the following production levels (in units)?

A. 100,000.


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B. 200,000. C. 300,000. 76. Which date in the chronology of a dividend payment is most likely determined by a security

exchange? The: A. declaration date. B. ex‐dividend date. C. holder‐of‐record date. 77. Which of the following share repurchase methods will most likely take the longest amount of

time to execute?

A. Dutch auction. B. fixed price tender offer. C. open market repurchase. 78. Assuming a 365‐day year and the following information for a company:

Current Year Previous Year Sales $12,000 $10,000 Cost of goods sold $6,000 $5,000 Inventory $1,200 $1,000 Accounts payable $600 $500

The firm’s days in payables for the current year is closest to:

A. 18.3. B. 35.3. C. 36.5. SS13/14‐EQUITY INVESTMENTS (18 MINUTES) 79. Which of the following statements concerning regulatory bodies is least accurate? Regulatory

bodies:

A. act to level the playing field for market participants. B. help define minimum standards of practice for agents. C. require that regulated firms maintain optimum levels of capital. 80. Which of the following statements is most accurate?

A. Investors prefer to invest in callable common shares rather than putable common shares


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B. The issuing company is obligated to buy callable common shares at a predetermined price. C. Putable common shares facilitate raising capital because of their appeal to investors over

callable common shares. 81. An investor who wants to estimate the enterprise value multiple (EV/EBITDA) of a company has

gathered the following data:

Market value of debt $10million Market capitalization $45million Cash and short‐term investments $2.5million EBITDA $15million Firm’s marginal tax rate 40%

The company’s EV/EBITDA multiple is closest to:

A. 2.5. B. 3.5. C. 5.8. 82. An investor gathers the following data to estimate the intrinsic value of a company’s stock using

the justified forward P/E approach.

Next year’s earnings per share $3.00Return on equity 12.5%Dividend payout ratio 60%Required return on shares 10%

The intrinsic value per share is closest to:

A. $36. B. $48. C. $72. 83. A company’s series B, 8% preferred stock with a par value of $50 pays quarterly dividends. Its

current market value is $35. The shares are retractable (at par) with the retraction date set for three years from today. Similarly rated preferred issues have an estimated nominal required rate of return of 12%. Analysts expect a sustainable growth rate of 4% for the company’s earnings. The intrinsic value estimate of a share of this preferred issue is closest to:

A. $33.33. B. $45.02. C. $52.00.


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84. Which of the following multiples is most useful when comparing companies with significant differences in capital structure?

A. EV/EBITDA. B. Price‐to‐book ratio. C. Price‐to‐cash flow ratio. 85. If a stock’s intrinsic value is less than its current market price, the most appropriate strategy an

active investor can adopt is to:

A. sell the stock short. B. buy the stock on margin. C. buy a call option on the stock. 86. An analyst finds that a company she is following has initiated the process of selling unproductive

land representing 5% of its total assets and using the proceeds to buy back its common shares. Holding other factors constant these actions by the company will most likely result in a:

A. higher return on equity. B. higher operating margin. C. lower sustainable growth. 87. Which of the following is the most appropriate reason for using a free‐cash‐flow‐to‐equity (FCFE)

model to value equity of a company?

A. FCFE is a measure of the firm’s dividend‐paying capacity. B. FCFE models provide more accurate valuations than the dividend discount models. C. A firm’s borrowing activities could influence dividend decisions but they would not impact FCFE. 88. The following information is available about a company:

Next year’s sales revenue $180millions Next year’s net profit margin 15% Dividend payout ratio 60% Dividend growth rate expected during Years 2 and 3 25% Dividend growth rate expected after Year 3 5% investors’ required red rate of return 12% Number of outstanding shares 8.1million

The current value per share of the company’s common stock according to the two‐stage dividend discount model is closest to:

A. $39.36.


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B. $49.20. C. $51.20.

89. A trader buys 500 shares of a stock on margin at $36 a share using an initial leverage ratio of

1.66. The maintenance margin requirement the position is 30%. The stock price at which the margin call occurs is closest to:

A. $20.57. B. $25.20. C. $30.86. 90. Which of the following inferences concerning market efficiency most accurate?

A. Fully exploitable over and under‐reactions often occur in efficient markets. B. Market pricing anomalies and behavioral biases are contrary to the existence of market

efficiency. C. If a market is semi‐strong form efficient neither technicians nor fundamental analysts can expect

to consistently earn abnormal returns. SS18‐ALTERNATIVE INVESTMENT (18 MINUTES) 91. U.S. farmers become concerned that the future supply of wheat production would exceed

demand. Their hedging activities would most likely drive which market condition?

A. Contango. B. Full carry. C. Backwardation. 92. United Capital is a hedge fund with $250 million of initial capital. United charges a 2%

management fee based on assets under management at year end, and a 20% incentive fee based on returns in excess of an 8% hurdle rate. In its first year, United appreciates 16%. Assume management fees are calculated using end‐of‐period valuation. The investor's net return assuming the performance fee is calculated net of the management fee is closest to:

A. 11.58% B. 12.54% C. 12.80% 93. Capricorn Fund of Funds invests GBP 100 million in each of Alpha Hedge Fund and ABC Hedge

Fund. Capricorn FOF has a "1 and 10" fee structure. Management fees and incentive fees are calculated independently at the end of each year. After one year, net of their respective management and incentive fees, the investment in Alpha is valued at GBP80 million and the investment in ABC is valued at GBP140 million. The annual return to an investor in Capricorn, net of fees assessed at the fund of funds level, is closest to:


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A. 7.9% B. 8.0% C. 8.1% 94. An analyst wanting to assess the downside risk of an alternative investment is least likely to use

the investment's: A. Sortino ratio. B. value at risk (VaR). C. standard deviation of returns. 95. An investor may prefer a single hedge fund to a fund of funds if he seeks:

A. due diligence expertise. B. better redemption terms. C. a less complex fee structure. 96. Angel investing capital is typically provided in which stage of financing?

A. Later‐stage. B. Formative‐stage. C. Mezzanine‐stage. SS15/16‐FIXED INCOME INVESTMENTS (9 MINUTES) 97. If a bond’s issuer is required to retire a specified portion of the issue each year, the bond most

likely:

A. is a step‐up note. B. is currently callable. C. has a sinking fund provision. 98. One reason why the duration of a portfolio of bonds does not properly reflect that portfolio’s

yield curve risk is that the duration measure:

A. assumes all yields change by the same amount B. assumes all the bonds have the same discount rate. C. ignores differences in coupon rates across the bonds. 99. Investor A’s marginal tax rate is 45%, while Investor B’s is 30%. Both investors are considering

two bonds for inclusion in a taxable portfolio. One bond is tax‐exempt with a yield of 4.50%, while the other is taxable with a yield of 6.30%. Which bond will each investor most likely choose?


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A. Both investors will choose the taxable bond. B. Both investors will choose the tax‐exempt bond. C. Investor A will choose the tax‐exempt bond and investor B will choose the taxable bond. 100. The yield on a U.S. Treasury STRIPS security is also known as the Treasury:

A. spot rate. B. yield spread. C. forward rate. 101. A 4‐year amortizing security with a par value of $5,000 and a coupon rate of 7% has an expected

cash flow of $1,476 per year, assuming no principal prepayments. Assuming a discount rate of 5%, the present value of this security is closest to:

A. $5,234. B. $5,355. C. $9,347. 102. Consider a 5‐year option‐free bond that is priced at a discount to par value. Assuming the

discount rate does not change, one year from now the value of the bond will most likely.

A. increase. B. decrease. C. stay the same. 103. The value of an 18‐year zero‐coupon bond with a maturity value of $1,000 discounted at a 12%

annual interest rate with semi‐annual compounding is closest to:

A. $122.74. B. $130.04. C. $350.34. 104. A 10% coupon bond with annual payments, maturing in 3 years, is priced at 105. The bond is

callable in one year at a call price of 104 or two years at a call price of 102. The bonds yield to worst most likely occurs when the bond is:

A. called in year 1. B. called inyear2. C. held until maturity. 105. All else being the same, the difference between the nominal spread and the Z‐spread for a

non‐Treasury security will be larger when the: A. yield curve is flatter.


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B. maturity of the security is longer. C. security has a bullet maturity rather than an amortizing structure. 106. Assume the following six‐month forward rates (presented on an annualized, bond‐equivalent

basis) were calculated from the yield curve. Notation Forward Rate

1f0 0.50%

1f1 0.70%

1f2 1.00%

1f3 1.50%

1f4 2.20%

1f5 3.00%

1f6 4.00%

The 3‐year spot rate is closest to:

A. 0.74%. B. 1.48%. C. 2.06%. 107. One advantage of the full valuation approach to measuring interest rate risk relative to the

duration/convexity approach is the full valuation approach is:

A. more accurate. B. easier to model. C. less time‐consuming. 108. An analyst uses a valuation model to estimate the value of an option‐free bond at 92.733 to

yield 11%. If the value estimate rises to 94.474 for a 60 basis point decrease in yield and falls to 91.041 for a 60 basis point increase in yield, the effective duration of the bond closest to:

A. 1.85. B. 3.09. C. 6.17. SS17‐DERIVATIVES (8 MINUTES) 109. A corporation issues 5‐year fixed‐rate bonds. Its treasurer expects interest rates to decline for all

maturities for at least the next year. She enters into a 1‐year agreement with a bank to receive quarterly fixed‐rate payments and to make payments based on floating rates benchmarked on 3‐month LIBOR. This agreement is best described as a:


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A. swap. B. futures contract. C. forward contract. 110. A portfolio manager is required to sell 31,250 shares of XYZ Inc. in two months. She is concerned

that the price of XYZ will decline during the 2‐month period, so she enters into a deliverable equity forward contract to sell 31,250 shares of XYZ in 2 months for EUR 160 per share. When the contract expires, XYZ is trading at EUR 138 per share. The portfolio manager will most likely.

A. pay EUR 687,500 to the dealer. B. receive EUR 4,312,500 from the dealer. C. receive EUR 5,000,000 from the dealer. 111. A trader takes a long position in 40 futures contracts on Day 1. The futures have a price limit of

$5 and settle at $106. On Day 2, the futures trade at $111 and the bid and offer move to $113 and $115, respectively. The futures remain at these price levels until the market closes. What marked‐to‐market value does the trader receive in his account for Day 2?

A. $200. B. $280. C. $320. 112. An investor is long an in‐the‐money American call option. Would this option most likely ever be

exercised early?

A. No. B. Yes, if its time value is high enough. C. Yes, if it pays a high enough dividend.

113. European company issues a 5‐year euro‐denominated bond with a face value of EUR 50,000,000.

The company then enters into a 5‐year currency swap with a bank to convert the EUR exposure into US$ exposure. The notional principals of the swap are EUR 50,000,000 and US$70,000,000. The European company pays a fixed rate of 5% and the bank pays a fixed rate of 4.5%. Payments are made semiannually on a basis of 30 days per month and 360 days per year. What the payment from the bank to the company at the end of year 4?

A. US$ 1,750,000. B. EUR 1,125,000. C. EUR 1,250,000. 114. An investor with $5000 to invest believes that the price of ABC Corp. stock will appreciate by $7

to $95 in two months. Two‐month at‐the‐ money puts on one share of ABC stock are trading at $1.76, while two‐month at‐the‐money calls are trading at $1.56. What action will he most likely


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take to profit from his view on ABC stock?

A. Sell 100 ABC puts. B. Buy 100 ABC calls. C. Buy 100 ABC shares. SS12‐PORTFOLIO MANAGEMENT (9 MINUTES) 115. Which of the following is least likely a part of the execution step of the portfolio management

process?

A. Security analysis. B. Portfolio construction. C. Performance measurement 116. The correlation between the historical returns of Stock A and Stock B is 0.75. If the variance of

Stock A is 0.16 and the variance of Stock B is 0.09, the covariance of returns of Stock A and Stock B is closest to:

A. 0.01. B. 0.09. C. 0.16. 117. The point of tangency between the Capital Allocation Line (CAL) and the efficient frontier of

risky assets most likely identifies the:

A. optimal risky portfolio. B. optimal investor portfolio. C. global minimum‐variance portfolio. 118. The stock of GBK Corporation has a beta of 0.65. If the risk‐free rate of return is 3% and the

expected market return is 9%, the expected return for GBK is closest to:

A. 3.9%. B. 6.9%. C. 10.8%. 119. A return‐generating model that provides an estimate of the expected return of a security based

on factors such as earnings growth and cash flow generation is best described as a: A. market factor model. B. fundamental factor model. C. macroeconomic factor model.


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120. A portfolio manager earned a rate of return of 15.5%. The beta of the portfolio is 1.2. If the

risk‐free rate of return is 2.5% and the market return is 11.8%, Jensen’s alpha for the portfolio is closest to:

A. 1.84%. B. 3.70%. C. 4.34%.


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2012 Level 1 Sample Exam Answer 1. Correct answer: B B is correct. Although a violation of Standard I (A) Knowledge of the Law is likely to occur unless the asset base information is corrected, Cruz has yet to violate any CFA Institute Standards, so he need not report a violation. If Cruz does not take action, he will be in violation of the Standards. He would need to report this violation because Standard I (A) applies as the member should know his conduct may contribute to a violation of applicable laws, rules, regulations, or the Code and Standards related to the inaccurate sales materials. 2. Correct answer: B B is correct because Standard I (A) Knowledge of the Law requires Members and Candidates to comply with the more strict law, rules, or regulations and follow the highest requirement, which in this case would be the CFA Institute Standards of Professional Conduct. 3. Correct answer: A A is correct because Standard III (B) Fair Dealing concerns the fair treatment of clients when making investment recommendations or taking investment action, but there is no indication the advisor has discriminated against any clients regarding his recommendations as he invests all clients in the same universe of stocks. 4. Correct answer A A is correct as soliciting the bank client did not violate any Standard because the manager is no longer an employee of the bank. There is no violation of Standard IV (A) Loyalty, which prohibits the solicitation of employer’s clients prior to cessation of employment. 5. Correct answer A A is correct because even though the company does not have a stock pre‐clearance procedure, trading the stock of a company the analyst recommended as an acquisition candidate is an act that violates Standard IV(A) Loyalty ,as she did not give her Employer the opportunity to take advantage of her skill/recommendation prior to buying the shares for her own portfolio. 6. Correct answer: B B is correct because a violation of Standard II(A) Material Nonpublic Information is likely to occur when using information that is selectively disclosed by corporations to a small group of investors, analysts, or other market participants. Information that is made available to analysts remains nonpublic until it is made available to investors in general. 7. Correct answer: C C is correct because the member has engaged in information‐based manipulation of RRC stock. Members and candidates must refrain from “pumping up” (or down in this case) the price of an investment by issuing misleading positive (negative) information for their or their clients’ benefit. In addition, the member would be in violation of Standard I (A) Knowledge of the Law, because he has


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not acted with professionalism and integrity. The member has not violated Standard VI (B) Priority of Transactions because this concerns client investment transactions having priority over member or candidate investment transactions and is not applicable here. 8. Correct answer: A A is correct. Standard III (A) Loyalty, Prudence, and Care and Gupta’s duty of loyalty, prudence, and care is owed to the participants and beneficiaries (members) of the pension plan. As a church plan, the restrictions are reasonable and Gupta indicates it will not impact his ability to construct the portfolio. 9. Correct answer: A A is correct because there is no violation of Standard III (A) Loyalty, Prudence, and Care by performing a cost‐benefit analysis showing that voting all proxies might not benefit the client, and concluding voting proxies may not be necessary in all instances. 10. Correct answer: B B is correct because, according to Standard III(B) Fair Dealing, members and candidates may provide more personal, specialized, or in‐depth service to clients willing to pay for premium services through higher management fees or higher levels of brokerage. Members and candidates can differentiate their services to clients, but different levels of service must not disadvantage or negatively affect clients. In addition, the different service levels should be disclosed to clients and prospective clients and be available to everyone (i.e., different service levels should not be offered selectively). The newsletter recipients are not even clients, because the newsletter is free, and the manager does not even know if the recipients of the newsletter have acted on her recommendations, nor does she know whom these recipients are, so the manager’s obligation is to first serve clients who are paying her a management fee. 11. Correct answer: B B is correct because Standard III(D) Performance Presentation does not prohibit showing past performance of funds managed at a prior firm as part of a performance track record as long as showing that record is accompanied by appropriate disclosures about where the performance took place and the person’s specific role in achieving that performance, which has been done in this case. 12. Correct answer: A A is correct because golf is a business independent of the financial industry and the board obligation would not be a conflict of interest requiring disclosure according to Standard IV (B) Additional Compensation Arrangements, which requires members and candidates to obtain permission from their employer before accepting compensation or other benefits from third parties for the services rendered to the employer or for any services that might create a conflict with their employer’s interest. 13. Correct answer: B B is correct because a supervisor’s responsibilities under Standard IV (C) Responsibilities of Supervisors include instructing those subordinates to whom supervision is delegated about methods


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to prevent and detect violations of laws, rules, regulations, and the Code and Standards. Laws would also include legal restrictions. 14. Correct answer: A A is correct as the analyst violated Standard III(B) Fair Dealing by selectively distributing the recommendation internally at the investment bank prior to communicating her recommendation to clients. This might also be a violation of Standard III(A) Loyalty, Prudence, and Care, which requires that members must act for the benefit of their clients and place their clients’ interests before their employer’s or their own interests. 15. Correct answer: A A is correct because Standard V (A) Diligence and Reasonable Basis applies to the level of review necessary in selecting an external adviser or subadviser and would include reviewing the adviser’s adherence to its stated strategy. 16. Correct answer C C is correct because the referral arrangements should be disclosed to clients “before entry into any formal agreement for services” and not after the fact. 17. Correct answer: C C is correct because discussing the level of difficulty of the examination did not violate Standard VII (A) Conduct as Members and Candidates in the CFA Program. Standard VII (A) and the Candidate Pledge was violated by candidates revealing broad topical areas and formulas tested or not tested on the exam. 18. Correct answer: C C is correct because according to Standard VII (B) Reference to CFA Institute, the CFA Designation, and the CFA Program, this is an accurate statement concerning the CFA designation. 19. Correct answer: B Use the formula for effective annual rate: EAR = (1 + Periodic interest rate)m—1 Iteratively substitute the possible frequency of compounding until the EAR is 10.47%. For weekly compounding, (1 + 0.10 / 52)52 — 1 = 0.10506 = 10.50% For monthly compounding, (1 + 0.10 / 12)12 — 1 = 0.10471 = 10.47% For quarterly compounding, (1 + 0.10 / 4)4 — 1 = 0.10381 = 10.38% Thus, the correct answer is monthly compounding. 20. Correct answer: C First calculate the initial price (P0) of the T‐bill:


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BD 0

0

D 360r = ,P =100-DF t

D 3600.0325= ,D=0.8125100 90

P =100-0.8125=99.1875

×

×

Then calculate the holding period yield (HPY) (recall that T‐bills are pure discount instruments and do not pay coupons): HPY = (Pt‐P0) ÷ P0 HPY = (100 — 99.1875) ÷ 99.1875 = 0.00819 Finally, convert the HPY into effective annual yield: EAY (1 + HPY)365/t‐1 EAY = (1 + 0.00819)365/90 ‐1 = 0.03364 = 3.36% 21. Correct answer: C The sample mean is:

/ ( 3 11 3 18 18 20 6 9 2 16) /10 2.00 /10 0.20n

ii

X X n= = − − + − + + − + + − = − = −∑

The sample variance is:

2 2( ) / 1n

ii

S X X n= − −∑

The sample standard deviation js the (positive) square root of the sample variance, Value Diff.from mean [value‐(‐0.20)] Difference Square ‐3 ‐2.8 7.84 ‐11 ‐10.8 116.64 3 3.2 10.24 ‐18 ‐17.8 316.84 18 18.2 331.24 20 20.2 408.04 ‐6 ‐5.8 33.64 9 9.2 84.64 2 2.2 4.84 ‐16 ‐15.8 249.64 Sum of Squared differences 1,563.6 Divided by n‐1 173.7333333 Square root 13.18079411

22. Correct answer: B Across two periods, there are four possibilities: an up move followed by an up move ($96.8 end value), an up move followed by a down move ($79.2 end value), a down move followed by an up move ($79.2 end value), and a down move followed by a down move ($64.8 end value).


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The probability of an up move followed by a down move is 0.75 times 0.25 equals 0.1875. The probability of a down move followed by an up move is 0.25 times 0.75 also equals 0.1875. Both of these sequences result in an end value of $79.2. Therefore, the probability of an end value of $79.2 is (0.1875 + 0.1875) = 37.5%. 23. Correct answer: C When the sample size is small, the t‐distribution is preferred if the variance is unknown. 24. Correct answer: B As the p‐value (0.0567) exceeds the stated level of significance (0.05), we cannot reject the null hypothesis. We therefore accept the null hypothesis. 25. Correct answer: A Support level is defined to be “a low‐price range in which buying activity is sufficient to stop the decline in price.” 26. Correct answer C After year 3 the 30‐year fixed‐rate loan has the lowest payment. The loan payments, summarized in the table, are calculated using a financial calculator following the table. Loan Initial Payment ($) Payment after 3 years($) 30‐year fixed 536.82 536.82 15‐year fixed 759.82 759.82 ARM 463.12 559.15

Payment on the 30‐year fixed is: N = 12×30= 360; I/Y= (5/12) = 0.41667; PV= 100,000; FV = 0; calculate PMT=536.82 Payment on the 15‐year fixed is: N = 12×15= 180: I/Y= (4.385/12) = 0.36542; PV =100,000; FV=0; calculate PMT=759.13 Calculations for the ARM Initial payment N = 12×30 = 360; I/Y = (3.75 / 12) = 0.31250; PV = 100,000; FV = 0; calculate PMT = 463.12 Balance at end of year 3: N = 12×27 = 324;I/Y = (3.75 / 12) = 0.31250; FV = 0; PMT = 463.12; calculate PV = 94,270.54 Payment after the end of year 3: N = 324; I/Y = (5.5 / 12) = 0.45833; PV = 94,270.54; FV = 0; calculate PMT = 559.15 27. Correct answer: B Most equity return series have been found to be leptokurtotic. 28. Correct answer: A The two defining properties of a probability are as follows: 1. The probability of any event E is a number between 0 and 1. 2. The sum of the probabilities of any set of mutually exclusive and exhaustive events equals 1.


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29. Correct answer: A Given that X and Y are independent, their joint probability is equal to the product of their individual probabilities. In this problem, we calculate 0.2×0.5 = 0.1 30. Correct answer A First standardize the value of interest, —0.40, for the given normal distribution: Z = (X - ) / = (- 0.40 - 5.00)/2 = -2.70.μ σ

Then use the given table of values to find the probability of a Z value being 2.70 standard deviations below the mean (i.e., when z ≤ 0). The value is 1 — P(Z ≤ +2.70). In this problem, the solution is: 1 — 0.9965 = 0.0035 = 0.35% 31. Correct answer: A

When the null and alternative hypotheses are of the form: 0 0 H : θ = θ versus ≠a 0 H : θ θ , the

correct approach is to use a two‐ tailed test. 32. Correct answer C The test statistic is the ratio of the variances, with the larger variance in the numerator. Here the test statistic is 28 ÷ 4 = 7. The degrees of freedom are 4 by 4. As it is a two‐ tailed test the correct critical value at α= 5% is 9.60. As the test statistic is less than the critical value, we cannot reject the null hypothesis. We therefore accept the null hypothesis. 33. Correct answer B Initial Price Quantity Relationship:

DPizza pizza PizzaQ =11-0.70P +0.009 $500-0.20 1.25=15.25-0.70P× ×

Resulting Demand Curve: D

Pizza PizzaP =21.79-1.43Q

Price Quantity Relationship at New Income Level DPizza Pizza PizzaQ =11-0.70P +0.009 $700-0.20 1.25=17.05-0.70P× ×



The slope of her demand curve for pizza will still be ‐1.43 even with the higher income of $700 as the income effect will result in a parallel shift of the initial demand curve to the right. 34. Correct answer: C As he is indifferent between all three baskets, all three must fall on the same indifference curve. The MRSBA at basket 2 is 4, meaning that the slope of the indifference curve at that point is ‐4, hence ΔA/ΔB = ‐4 = (A ‐ 50) / (30 ‐ 35): Solve for A = 70: greater than 60. 35. Correct answer: B Revenue Cost Relationship Short‐Run Decision Long‐Run Decision TR≥TC Stay in market Stay in market


95

TR>TVC but TR<TFC+TVC Stay in market Exit market TR<TVC Shut down production to zero Exit market Where TR=Total revenue And TC =total cost; TVC=total variable Costs; TFC=total fixed costs Hence, if the selling price is $3.00, the total revenue will be $3.00 per unit ×900 units =$2,700; only firm X’s variable costs are covered and it should continue operating, while firms Y and Z should immediately shut down production.

36. Correct answer: C Nominal GDP Real GDP 2010 2,800×9+2,000×47=119,200 119,200 2011 3,000×11+1,800×52=126,600 3,000×9+1,800×47=111,600 GDP Deflator=Nominal GDP/Real GDP×100=126,600/111,600×100=113.4

37. Correct answer: C Explain the implementation of fiscal policy and the difficulties of implementation. The fiscal multiplier is 1/[1‐c(1‐T)] where c marginal propensity to consume = consumption ÷ disposable income T the tax rate

Assuming pre‐tax income of $100Disposable income $100×(1‐0.25)=$75Marginal propensity to consume $70÷$75=0.933The fiscal multiplier 1÷[1‐0.933×(1‐0.25)]=3.33With government expenditure of $1.25 Billion, total incomes and spending will rise by $1.25 Billion×3.33=$4.2 Billion

38. Correct answer: C The loss in consumer surplus because of higher prices is represented by area E + F + G + H. This exceeds the gains from producer surplus (E) and government revenues on imports (G). Hence the net welfare effect to the country is a loss of [E + F +G+H]‐[E]‐[G]=F+H. 39. Correct answer: A The cross‐price elasticity is positive, indicating that as the price of Y increases, more of X is demanded, making X and Y substitutes. 40. Correct answer: B On rearrangement the demand function is

Tennis Match Tennis MatchQ = 45 - 5.0 P

The number of matches played per month at $4.00/match = 45 ‐ 5.0×4.00 = 25 The Y‐intercept of the demand curve occurs when Q = 0; P = 9


96

The X‐intercept of the demand curve occurs when P = 0; Q = 45 The club will be able to charge the consumer surplus: the area under the demand curve above the per match price to a total of 25 matches: 0.5×($9.00 ‐ $4.00)×25 = $62.50. This is illustrated in the diagram as triangle A.

41. Correct answer: B Output (units) Price($/unit) Total Revenues Total cost ($/unit) Profit 20 2,800 56,000 10,600 45,400 60 2,400 144,000 66,600 77,400 100 2,000 200,000 170,600 29,400

42. Correct answer B Unemployment rate = Unemployed / Labor force×100 = 95/750×100 = 12.6%. 43. Correct answer B Average weekly initial claims for unemployment insurance are a leading indicator of economic activity and a decline is an indicator of rehiring at the start of a recovery. 44. Correct answer: B GBP investment £2.0979 (1 +0.016025×180 / 360) = £2.1147 NZD investment NZ$1× (1 + 0.032875×180 / 360) = NZ$1.0164 The forward rate is determined by equating these two terminal amounts. GBP / NZD Forward Rate = £2.1147 / NZ$1.0164 = £2.0806 / NZ$ Forward points = (Forward ‐Spot) × 10,000 = (2.0806 ‐2.0979) × 10,000 = ‐173.0 45. Correct answer: A Information about management compensation and any potential conflicts of interest that may exist between management and shareholders is typically provided in the proxy statement.

C

10 8 6 4 2 0 5 10 15 20 25 30 35 40 45 50

P R I C E

A

B

P=9‐0.20×Q

QUANTITY


97

46. Correct answer. B Given Assets = Liabilities + Equity First calculate ending equity ($318,000,see calculation below) $800,000=Liabilities + $318,000 Total Liabilities = $ 482,000 Contributed capital $ 50,000Initial retained earnings 225,000Sales revenues 450,000Investment income 5,000Expenses (402,000)Net income for the year 53,000Dividends paid (10,000)Increase in retained earnings 43,000 43,000Ending owners’ equity $ 318,000

47. Correct answer: C Relevance and faithful representation are the two fundamental qualitative characteristics that make financial information useful according to the IASB Conceptual Framework. 48. Correct answer: C Total comprehensive income = Net income + other comprehensive income Net Income = revenues ‐ expenses Other comprehensive income includes gains or losses on available‐for‐sale securities and translations adjustments on foreign subsidiaries. (Revenues ‐ expenses) + gain on AFS ‐loss on FX translation (12,500 ‐ 10,000) + 1,475 ‐325 = 3,650. 49. Correct answer: C The allowance for doubtful accounts increases by the bad debt expense recognized for the year and decreases by the amounts written off during the year. Beginning balance allowance 56Plus bad debt expense ?Less write‐offs (84)Ending balance allowance 92Therefore Bad debt expense =120

50. Correct answer: A Cash flow debt coverage ratio = CFO ÷ Total debt. 105.9÷512.8 = 20.6% 51. Correct answer: C Specific identification matches the actual historical costs of the specific inventory items to their physical flow: the costs remain in inventory until the actual identifiable inventory is sold.


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52. Correct answer A The interest costs can be capitalized. Under IFRS any amounts earned by temporarily investing the funds are deducted from the capitalized amount． The costs related to the preferred shares cannot be capitalized. Capitalized costs Interest costs 0.08×5,000,000=400,000 Less interest income 0.07×2,000,000×0.5=(70,000) Total capitalized costs 330,000

53. Correct answer: B A valuation allowance is required under U.S. GAAP if there is doubt about whether a deferred tax asset will be recovered. Under IFRS the deferred tax asset is written down directly. 54. Correct answer : C The book value of the bonds on 1 January 2011 is equal to the present value of the remaining coupon payments and principal discounted at the market rate at time of issue (3% per period). Coupon = 0.08×0.5×5,000,000 = 200,000; there are 4 years remaining or 8 coupon payments. Book value = 200,000 PV Annuity (n = 8; i = 3%) + 5.000,000 PV (n = 8; i = 3%) = 1,403,938 + 3,947,046 = 5,350,984 Using a financial calculator PMT = 200,000; FV = 5,000.000; (I % = 3%; N = 8); Compute PV = 5,350,984 Because the market interest rate when the bonds are bought back（8%）is equal to the coupon rate, the company can buy back the bonds at par $5,000,000. Cost of repurchase $5000,000 Book value 5,350,984 Gain on retirement 350,984 On the cash flow statement the gain would be deducted from net income in calculating the cash from operations under the indirect method, and the cash paid to repurchase the bonds would be a cash outflow in the financing section. 55. Correct answer: A The candidate should be able to analyze and describe the following ways to manipulate the cash flow statement • stretching out payables, • financing of payables, • securitization of receivables, and • using stock buybacks to offset dilution of earnings. The sale of a long‐term receivable would increase cash from investing activities; the other two activities mentioned are operating activities.


99

56. Correct answer: C Example Capitalizing delivery cost as opposed to expensing it. FCFF CFO + interest ×(1‐t)—capital expenditures Capital expenditures If capitalized，the amount capitalized increases capital

expenditures and is recorded as a cash outflow from investing activities．

CFO The CFO will be higher by amount capitalized, i.e., the amount not expensed.

Since capital expenditures and CFO increase by the same amount, FCFF is unchanged.

57. Correct answer: C The general journal records transactions in the order in which they occur (chronological order) and is therefore sorted by date. 58. Correct answer: B Without the recognition of the standards by the regulatory authorities, such as the U.S. Securities and Exchange Commission, the private sector standard‐setting bodies, such as U.S. FASB, would have no authority. 59. Correct answer: C Common‐sized analysis of the income statements shows that Company A has a lower percentage cost of goods sold and hence a higher gross margin than the industry. Co A Co B Industry Co A Co B Sales $10,500 $8,250 100.0% 100% 100% Cost of goods sold 6,353 5,239 62.8% 60.5% 63.5% Gross margin 37.2% 39.5% 36.5% Company A earns a higher gross margin than both Company B and the industry. Pretax earnings 683 454 5.4% 6.5% 5.5% Taxes 205 145 1.7% 2.0% 1.8% Tax rate = taxes ÷ pretax earnings

32% 30% 32%

The tax rates for the companies are not higher than the industry.The interest rate is not a function of sales and cannot be analyzed on a common sized income statement .Tax rates are determined based on taxes ÷ pretax earnings, not as a percentage of sales (as shown in common sized analysis). 60. Correct answer A


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Under U.S. GAAP, intangibles must be valued at historical cost whereas under IFRS, they can be valued at cost or revaluation. 61. Correct answer: A Only the cash flows for the purchase of the shares in an affiliated company are cash from investing activities; therefore the net amount is ‐ $275,000. Cash flows from trading securities are operating activities. 62. Correct answer: B Cash conversion cycle = Days sales outstanding + Days of inventory on hand — Days of payables Accounts receivable

Days in sales(DSO) Inventory Days on hand(DHO)

Accounts payables Days in payables

Turnover SalesA/R

Cost of Goods Sold

Inventory

PurchasesPayables

4,800÷625 2,880÷170 2,940÷145 =7.68 times =4.06 times =20.3 times In days 365÷7.68 365÷4.06 365÷20.3 =48days =90days =18days Cash conversion cycle=DSO+DOH‐Days in Payables=48+90‐18=120 days

63. Correct answer: C When using the FIFO inventory method the ending inventory, the cost of goods sold and the gross margin are the same under either the perpetual or periodic methods. 64. Correct answer: A For investment properties, when using the fair value model of revaluing assets, all increases and decreases affect the net income. Here, it is 54.5 — 48.0 = 6.5. 65. Correct answer: B Evaluate the impact of tax rate changes on a company’s financial statements and ratios. Deferred tax liability=taxable temporary difference×tax rate In 2010 if the rates had not changed, and deferred tax liability would be:

0.30×4,000= £1200

But with the lower tax rate, the deferred tax liability will be: 0.25×4,000= £1000 Effect of the change in rate therefore is a decrease in the liability £(200) Alternative calculation=change in rate×taxation difference ‐5%×4,000 £(200)

66. Correct answer: B The most appropriate way to identify a LIFO liquidation is by reviewing the inventory footnotes for a decrease in the LIFO reserve. Although LIFO liquidation may result in an increase in gross margin or changes in inventory out of line with changes in sales, there are other factors could explain those changes.


101

67. Correct answer: C The candidate should be able to demonstrate the use of pro forma income and balance sheet statements. Net income is calculated as follows: Sales $2,500 GivenVariable costs (750) 30% of SalesFixed costs (1,400) GivenInterest expense (25) 0.05×500 average debt Earnings before 325 Taxes (81.25) 25% of EBTNet income $243.75 Rounded to $244

68. Correct answer: B The expected remaining useful life of a company’s overall asset base

= net PPE ÷ depreciation expense

Depreciation expense equals the change in accumulated depreciation A

375‐250=125

The expected remaining useful life 2125÷125=17years When there are no asset disposition or acquisitions as appears to be the case here, because the gross PPE does not change.

69. Correct answer: B The NPV of project A is €1,780.59

1 2 3 4

345 849 635 36451780.59 24501.08 (1.08) (1.08) (1.08)

= − + + + +

The NPV of project B is €1,765.36

2 3 4

345 849 1051 31751765.36 24501.08 1.08 1.08 1.08

= − + + + +

Because Project A has a higher NPV and the projects are mutually exclusive, only Project A should be accepted. 70. Correct answer. B Based on equation (10) with D/E referring to the debt‐to‐equity ratio:

[1 ((1 ) )]equity assetDtaxrateE

β β= × + − ×

If the tax rate increases, then the bracketed term decreases, making the equity beta decrease because the asset beta is unchanged. 71. Correct answer. B Convert the P/E to the earnings yield (E/P): 1 ÷ 12.5 = 8%. Because the after‐tax cost of the external


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funds is higher than the earnings yield i.e., 9% > 8%), the PS will decrease after the repurchase. 72. Correct answer: B A “pull” on liquidity occurs when disbursements are made too quickly (e.g., current liabilities are paid instead of being held or when credit availability is reduced or limited). A “drag’ on liquidity occurs when receipts lag (i.e., non‐cash current assets do not convert to cash quickly). Consequently, a reduction in a credit line is a “pull” on liquidity. 73. Correct answer B Under best practices in corporate governance procedures, independent board members should have a lead” director when the board chair is not independent. 74. Correct answer: C Convert D/E to the weight for debt:

1 0.503 (1 0.50)1

DEDE

= =++

The weight for equity is one minus the weight of debt: 2 113 3= −

WACC = weight of debt×cost of debt×(1 — tax rate) + weight of equity×cost of equity

1 20.08 (1 0.04) 0.13 0.1026 10.26%3 3× × − + × = =


quantity contributionmarginDOL=[quantity contributionmargin-fixedcosts]

$20 100,000DOL(100000units)= =1.3333[$20 100,000-$500,000]

$20 200000DOL(200000units)= =1.143[$20 200000-$500000]

$2DOL(300000units)=

××

××

××

0 300000 =1.091[$20 300000-$500000]

××

The DOL is lowest at the 300,000 units production level. 76. Correct answer: B The ex‐dividend date is normally determined by the security exchange on which the shares are listed. The corporation determines the holder‐of‐record date and declaration date.


103

77. Correct answer C Of the methods listed, open market repurchases take the longest time to execute. 78. Correct answer: B

Accounts payable Accounts payableThe days in payables = =Purchases 365 (Change in inventory + Cost of goods sold) 365

$600= =35.3($1200-$1000 + $6000) 365

÷ ÷

÷ 79. Correct answer C Regulators impose minimum levels of capital that apply across the board to all regulated firms, not the optimum level that is firm‐specific and determined by the firms themselves. 80. Correct answer C Putable common shares facilitate raising capital because of their appeal to investors over callable common shares. The put feature gives investors the right to sell the shares back to the issuing company when the market price is below the pre‐specified put price. 81. Correct answer: B Enterprise Value (EV) = Market capitalization + MV of debt + MV of preferred stock ‐ cash & short‐term investments EV = 45 + 10 ‐2.5 = 52.5; EV/EBITDA = 52.5 / 15 = 3.5 82. Correct answer A Dividend growth rate = (1 ‐ Payout ratio) × ROE = 0.4 ×12.5 = 5%; Justified forward P/E: P0 / E1 = p/ (r — g); Where p is the payout ratio = 0.60 / (0.10 — 0.05) = 12× intrinsic value:P0 = P/E1 × E1 = 12 × $3 = $36 83. Correct answer: B Because the current market value is well below the retraction price, retraction is likely and the preferred share will be priced on the basis of retraction feature. Quarterly dividend = ($50×0.08) /4 = $1 a share; Quarterly required return = 12% / 4 = 3%; V0= [$1/1.03 + 1/1.032 + 1/1.033 + ... + 1/1.0311 + 1/1.0312+ 50/1.0312] = $45.02 Using a financial calculator: PMT = $1, N = 12; FV = $50; I = 3%; Compute PV = $45.02 84. Correct answer A The EV/EBITDA approach is most useful when comparing companies with significant differences in capital structure. EBITDA is computed prior to payment to any of the company’s financial stakeholders and is not impacted by the amount of debt leverage.


104

85. Correct answer: A A stock whose intrinsic value is less than its current market price is overvalued. Therefore, the most appropriate strategy is to sell the stock short. Short sellers profit by selling at high prices and repurchasing at lower prices. 86. Correct answer: A Selling unproductive land and using the proceeds from the sale to buy back shares reduces the total assets. Holding sales constant, the decrease in assets would improve the asset turnover. Buying back shares increases the firm’s financial leverage. Both the increase in asset turnover and financial leverage will lead to a higher return on equity. 87. Correct answer: A ECEE is a measure of the firm’s dividend paying capacity. 88. Correct answer: A Net profit margin = Net earnings / Sales; Net earnings = Net profit margin×Sales; DPS (Net earnings×Payout ratio) / # of outstanding shares; Therefore, Next years DPS = ($180 million x 0.15 x 0.60) / 8 million = $2 V = 2/1.12 + 2(1.25)1 / 1.122 + 2(1.25)2 / 1.123 + [2(1.25)2 (1.05) / (0.12 ‐ 0.05)] / 1.123 = $1.79 + $1.99 + $2.22 + $33.36 = $39.36 89. Correct answer A Initial equity (%) in the margin transaction = 1/ Leverage ratio = 1 / 1.66 = 0.60; Initial equity per share at the time of purchase = $36×0.60 = $21.60; Price at which margin call occurs. Equity per share / Price per share = Maintenance margin % = ($21.60 + P ‐ $36) / P = 0.30; 0.7P = $14.40; P = $20.57. 90. Correct answer: C If securities markets are semi‐strong form efficient, active trading to exploit price patterns or public information is not likely to generate abnormal returns. Thus, both technical and fundamental analyses become futile exercises. 91. Correct answer C C is correct because when a commodity market is in backwardation, the futures price is below the spot price as market participants believe the spot price will be lower in the future. When spot prices are below the futures price, the market is said to be in contango. 92. Correct answer: B The net investor return is 12.54%, calculated as: End of year capital = $250 million x 1.16 = $290 million Management fee = $290 million x 2% = $5.8 million Hurdle amount = 8% of $250 million = $20 million; Incentive fee = ($290 ‐ $250 ‐ $20 ‐ $5.8) million x 20% = $2.84 million Total fees to United Capital = ($5.8 + $2.84) million = $8.64 million


105

Investor net return: ($290 ‐ $250 ‐ $8.64) / $250 = 12.54% 93. Correct answer: A A is correct because the net investor return is 7.9%, calculated as: First, note that "1 and 10" refers to a 1% management fee, and a 10% incentive fee. End of year capital = GBP140 million + GBP80 million = GBP220 million Management fee = GBP220 million x 1% = GBP2.2 million Incentive fee = (GBP220 ‐ GBP200) million x 10% = GBP2 million Total fees to Capricorn = (GBP2.2 + GBP2) million = GBP4.2 million Investor net return: (GBP220 ‐ GBP200 ‐ GBP4.2) / GBP200 = 7.9% 94. Correct answer: C Downside risk measures focus on the left side of the return distribution curve where losses occur. The standard deviation of returns assumes that returns are normally distributed. Many alternative investments do not exhibit close‐to‐normal distribution of returns, which is a crucial assumption for the validity of a standard deviation as a comprehensive risk measure. Assuming normal probability distributions when calculating these measures will lead to an underestimation of downside risk for a negatively skewed distribution. Both the Sortino ratio and the value‐at‐risk measure are both measures of downside risk. 95. Correct answer: C Hedge funds of funds have multi‐layered fee structures, while the fee structure for a single hedge fund is less complex. Funds of funds presumably have some expertise in conducting due diligence on hedge funds and may be able to negotiate more favorable redemption terms than could an individual investor in a single hedge fund. 96. Correct answer: B Formative‐stage financing occurs when the company is still in the process of being formed and encompasses several financing steps. Angel investing capital is typically raised in this early stage of financing. 97. Correct answer: C C is correct because a sinking fund provision requires retirement of a portion of the bond issue each year, rather than retirement of the entire issue at maturity. 98. Correct answer: A A is correct because duration assumes that all interest rates across the yield curve change by the same amount and therefore each bond’s yield changes by the same amount. 99. Correct answer: B B is correct because the after‐tax yield of the taxable security is lower than the yield on the tax‐exempt security for both investors. After‐tax yield= Pre‐tax yield×(1 — Marginal tax rate). For Investor A, the After‐tax yield = 6.30%×(1 — 0.45) = 3.47%. For Investor B, the After‐tax yield 6.30%×(1 —0.30)=4.41%. Both are less than 4.50% and the investor will choose the investment with the highest after‐tax yield.


106

100. Correct answer: A A is correct because a STRIPS security is a zero‐coupon bond with no default risk and therefore represents the appropriate discount rate for a cash flow certain to be received at the maturity date for the STRIPS. 101. Correct answer: A

( ) ( ) ( )2 3 41

1, 476 1, 476 1, 476 1, 476 1, 406 1,339 1, 275 1, 214 5, 2341.05 1.05 1.05 1.05

+ + + = + + + =

102. Correct answer: A A is correct because the bond is priced below its par value but will be worth exactly par value at maturity. Overtime, assuming a stable discount rate, the value of the bond must rise so that it is equal to par at maturity. 103. Correct answer: A A is correct because the value of a zero‐coupon bond is

no. of years 2

Maturity value ,where i is the(1+i) ×

18 2

$1000semi-annualdiscountrateor $122.741.06 × =

104. Correct answer: C C is correct because the yield to worst for a callable bond is the lowest of the yields to call for each possible call date and the yield to maturity. The yield to call or yield to maturity solves the following equation:

1

/ (1 )T

tt

t

P CF i=

= +∑

where i is the yield to call, or yield to maturity CF is the cash flow at date t, and T is the maturity or

call date. The yield to call if the bond is called in one year is 8.57%, because 105= 1

10 1041.0857+

The yield to call if the bond is called in two years is 8.15%, because 105= 1 2

10 10 1021.0815 1.0815

++ . The

yield to maturity of the bond is 8.06%, because 1 2 3

10 10 10 1001051.0806 1.0806 1.0806

+= + + . The yield to

worst is the lowest of these and occurs when the bond is held until maturity (i.e., it is the yield to maturity). 105. Correct answer: B B is correct because for short‐term securities, the difference between the nominal spread (which does not account for the shape of the yield curve) arid the zero‐volatility spread or Z‐spread (the spread over the entire theoretical spot rate curve) is small. This difference grows with the maturity of


107

the security and as the slope of the yield curve increases. 106. Correct answer: B

B is correct because 1/66 1 1 1 1 2 1 5[(1 ) (1 f ) (1 f )... (1 f )] -1Z Z= + × + × + × + , which is then multiplied

by 2 to convert to a bond‐equivalent basis, where the forward rates are adjusted to a semi‐annual basis and Z1=1f0. Therefore, Z6 =[1.0025×1.0035×1.0050×1.0075=0.0074×2=1.48% 107. Correct answer: A A is correct because the full valuation approach allows modeling of the response to both parallel and non‐parallel yield curve changes and will reflect cash flows that change when interest rates change, whereas the duration/convexity approach assumes parallel yield curve changes and fixed cash flows. 108. Correct answer: B

B is correct because the effective duration of a bond is 00

, ,2V VD whereV V andVV y− +

− +

−=

× ×Δare the

values of the bond when the yield falls, under the current yield, and when the yield rises, respectively, and Δy is size of the yield change.

Therefore, 94.474 91.041D= 3.09

2 92.733 0.0060−

=× ×

109. Correct answer: A A is correct because a swap is a series of forward payments. Specifically, a swap is an agreement between two parties to exchange a series of future cash flows. Given that the contract is for 1 year and the floating rate is based upon 3‐month LIBOR, at least 4 payments will be made during the year. 110. Correct answer: C C is correct because the portfolio manager entered into a contract to sell the stock to the dealer at $160 per share in 2 months time. 31,250 shares×EUR 160 = EUR 5,000,000. 111. Correct answer A A is correct because the future has a price limit of $5, therefore, it settled at the highest possible level of $111.Therefore, the marked to market value would be ($111‐$106)×40=$200 112. Correct answer: C C is correct because a cash flow such as a dividend payment is required for an early exercise. A dividend payment doesn’t guarantee early exercise, as the dividend also needs to be large enough to justify the early exercise. 113. Correct answer: B B is correct because the bank’s payments are based upon a notional principal of EUR 50,000,000 and an interest rate of 4.5%. The payment is: EUR 50,000,000×(0.045)×(180 / 360) = EUR 1,125,000.


108

114. Correct answer: B B is correct because buying a call gives the owner the right to buy the stock at the exercise price. The investor predicts that the stock will increase to $95 at the end of two months. He will be able to exercise the call, buy the stock at $88, and sell it at $95, thereby making a profit. 115. Correct answer: C C is correct Performance measurement is a part of the feedback step of the portfolio management process. 116. Correct answer: B B is correct. AB A BCov (A,B) = = 0.75 0.4 0.3 = 0.09ρ σ σ × ×

117. Correct answer: A A is correct. The optimal risky portfolio lies at the point of tangency between the capital allocation line and the efficient frontier of risk assets. 118. Correct answer B Calculate and interpret the expected return of an asset using the CAPM. B is correct. E(RGBK) = 0.03 + 0.65×(0.09 — 0.03) = 0.069 119. Correct answer B B is correct. A return generating model based on factors such as earnings growth and cash flow generation is a fundamental factor model. 120. Correct answer A A is correct. Jensen’s alpha= P f P m fR -[R + (R -R )]β

=0.155 — [0.025 + 1.2×(0.118 — 0.025)] = 0.0184

2011 CFA Level 1 Sample Exam

109

2011 Level 1 Sample Exam SS1‐ETHICAL AND PROFESSIONAL STANDARDS (27 MINUTES) 1. Carlos Cruz, CFA, is one of two founders of an equity hedge fund. Cruz manages the fund's assets

while the other co‐founder, Brian Burkeman, is responsible for fund sales and marketing. Cruz notices that the most recent sales material used by Burkeman indicates the value of the assets under management in the fund is listed at a higher than actual value. Burkeman justifies the discrepancy by stating that the recent market decline accounts for the difference. To avoid violating the CFA Institute Standards of Professional Conduct, Cruz should least likely take which of the following actions?

A. Correct the asset information and provide the update to prospective clients. B. Report the discrepancy to the Professional Conduct Program of CFA Institute. C. Check with the firm's legal counsel to determine what action should be taken. 2. Linda Chin, CFA, is a member of a political group advocating lower governmental regulation in all

aspects of life. She works in a country where local securities laws are minimal and insider trading is not prohibited. Chin's politics are reflected in her investment strategy, where she follows her country's mandatory legal and regulatory requirements. What steps should Chin most likely take to ensure she does not violate any CFA Institute Standards of Professional Conduct?

A. Continue current investment strategy. B. Follow the CFA Institute Code and Standards. C. Disclose to clients that she meets mandatory legal requirements. 3. Wouter Duyck, CFA, is the sole proprietor of an investment advisory firm serving a middle‐class

retail clientele. Duyck claims to be different from his competitors because he conducts his own independent research. Duyck has hundreds of clients. He fully discloses that to simplify the management of all these accounts he has created a recommended list of stocks, from which he selects investments for all of his clients. Duyck's recommended list of stocks is obtained from his primary broker, who has completed due diligence on each stock. Duyck's recommended list least likely violates which of the following CFA Institute Standards of Professional Conduct?

A. Fair Dealing. B. Misrepresentation. C. Diligence and Reasonable Basis. 4. Lisa Hajak, CFA, specialized in research on real estate companies at Cornerstone Bank (CB) for

the past twenty years. Hajak recently started her own investment research firm, Hajak Advisory (HA). One of her former clients at CB asks Hajak to update a research report she wrote on a real estate company when she was at CB. Hajak updates the report, which she had copied to her personal computer, without the bank’s knowledge, and replaces references to the bank with her


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new firm, HA. Hajak incorporates the conclusions of a real estate Study conducted by the Realtors Association that appeared in the Wall Street Journal. She references the Journal as her source in her report. She provides the revision free of charge along with a request for the bank’s client to become a client of her firm. Concerning the reissued research report, Hajak least likely violated the CFA Institute Standards of Professional Conduct because she:

A. solicited the bank’s client. B. did not obtain consent to use the bank report. C. must cite the actual source of the real estate Study. 5. Tonya Tucker, CFA, is a financial analyst at BC Corporation (BC). BC has numerous subsidiaries

and is actively involved in mergers and acquisitions. Tucker analyzes HR Corporation (HR) and tells the CEO of BC that the acquisition of HR would be a good fit for BC. After her discussion with the CEO, Tucker purchases 100,000 shares of HR at $200 per share. BC does not have any pre‐clearance procedures, so the next time she meets the CEO, Tucker mentions she is a stockowner of HR. The CEO thanks her for this information but does not ask for any details. Two weeks later, Tucker sees a company‐wide email from the CEO announcing BC’s acquisition of HR for $250 a share. Regarding her purchase of HR stock, Tucker most likely violated the CFA Institute Standards of Professional Conduct concerning:

A. Loyalty. B. Market Manipulation. C. Material Nonpublic Information.

6. When a client asks her how she makes investment decisions, Petra Vogler, CFA, tells the client

she uses the mosaic theory. According to Vogler, the theory involves analyzing public and nonmaterial nonpublic information, including evaluating statements made to her by company insiders in one‐ on‐one meetings discussing management’s new earnings projections not known to the public. She also gathers general industry information not known to the public from industry experts and other contacts. Vogler most likely violates the CFA Institute Standards of Professional Conduct because of her use of:

A. industry contact information. B. one‐on‐one meeting information. C. nonmaterial nonpublic information in her analysis. 7. Lin Liang, CFA, is an investment manager and an auto industry expert. Last month, Liang

requested securities regulators to open an investigation into accounting irregularities at Road Rubber Company (RRC) despite having no basis for the request. Shortly before he spoke to the regulators, Liang shorted RRC stock for his clients. Once the regulators opened an investigation, Liang leaked this information to multiple sources in the media. When news of the investigation became public, ‘the share price of RRC immediately dropped 30%. Liang then covered the short positions and made $5 per share for his clients. Liang least likely violated which of the CFA Institute Standards of Professional Conduct?


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A. Misconduct. B. Market Manipulation. C. Priority of Transactions. 8. Sanjay Gupta, CFA, has been hired by the First Faithful Church to manage the pension plan’s

equity portfolio. The plan trustees tell Gupta that stocks of companies involved in the sale of alcohol, tobacco, gambling, or firearms are not acceptable investments. Gupta believes that he can reasonably execute his strategy with this restriction. Does Gupta violate the CFA Institute Standards of Professional Conduct?

A. No. B. Yes, because the restrictions provided in the guidelines are not in the best interest and

objectives of the client. C. Yes, because Gupta should construct the portfolio with these limitations since he can execute on

the strategy. 9. Jorge Lopez, CFA, is responsible for his bank’s proxy voting on behalf of the bank’s asset

management clients. Lopez recently performed a cost‐benefit analysis, showing that voting all proxies might not benefit the bank’s clients. Based on this analysis, Lopez changes the proxy voting policies and procedures without informing anyone else of the change. Lopez now votes client proxies on the side of management on all issues with the exception of major mergers where a significant impact on the stock price is expected. Lopez least likely violated the CFA Institute Standards of Professional Conduct regarding:

A. cost‐benefit analysis. B. voting with management. C. proxy voting policy disclosures. 10. Henrietta Huerta, CFA, writes a free investment newsletter widely followed by individual

investors. Huerta is not aware of who receives the newsletter but it is the primary marketing tool she uses to obtain investment management clients for those who contact her and are willing to pay management fees. For Huerta, the newsletter recommendations serve as the basis for most of her investment actions. Huerta recently completed research on East‐West Coffee Roasters (ECR) and has decided to change her initial buy recommendation on ECR to a sell. To avoid violating the CFA Institute Standards of Professional Conduct, Huerta should most likely ensure that the changed investment recommendation reaches:

A. newsletter recipients first. B. asset management clients first. C. asset management clients and newsletter recipients simultaneously. 11. Danielle Deschutes, CFA, is a portfolio manager and part of a ten‐person team managing an

indexed stock portfolio for institutional accounts. A competing firm, South West Index Managers


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(SWIM), asks Deschutes to interview with them and to bring her performance history to the meeting. Deschutes informs her employer about the interview and receives written permission to bring the performance history of the stock portfolio with her. When Deschutes shows up for the interview at SWIM she discloses that the performance numbers represent the work of her team and describes the role of each member. To bolster her credibility, she also provides the names of institutional accounts and related assets constituting the portfolio. In her interview at SWIM, Deschutes least likely violated the CFA Institute Standards of Professional Conduct regarding:

A. her contribution to the portfolio’s returns. B. the stock portfolio’s performance history. C. providing details on the institutional accounts. 12. When Abdullah Younis, CFA, became a broker at a global financial services organization two

years ago, he was told he could allocate his work hours as he saw fit. At this time, Younis served on the board of three non‐public golf equipment companies and managed money for several members of his immediate family in a pooled fund. Younis was not compensated for his board service or for the investment pool management. Younis’ outstanding returns attract interest from friends and co‐workers who persuade him to include their assets in his investment pool. Younis recently retired from all board responsibilities and now spends more than 80% of his time managing the investment pool for which he charges non‐family members a management fee. Younis has never told his employer about any of these activities. To comply with the CFA Institute Standards of Professional Conduct, regarding his business activities over the past two years, Younis should least likely disclose which of the following to his employer?

A. Board activity. B. Family investment pool management. C. Non‐family member management fees. 13. Kim Klausner, CFA, manages several hundred employees as the head of research for a large

investment advisory firm. Klausner is a former securities regulatory official who, until recently, ensured that his department’s compliance program always met or exceeded those of its competitors. Klausner has delegated his supervisory responsibilities concerning compliance issues to Sue Chang. Klausner informed Chang that her responsibilities include ensuring that the firm has appropriate compliance procedures and is making reasonable efforts to detect and prevent violations of Rules, Regulations, and the Code and Standards. Klausner most likely violated the CFA Institute Standards of Professional Conduct by not telling Chang to consider

A. firm policies. B. legal restrictions. C. industry standards.

14. Sheila Schleif, CFA, is an equity analyst at an investment bank. Schleif uses a data‐driven

computer model in making her stock recommendations. Schleif discovers the model contains a


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coding error. If the coding error were corrected, her most recent buy recommendation would change to a sell. Schleif corrects the coding error, issues a bank‐wide revision of her recommendation changing the buy to a sell, and then forwards the revision to all bank clients who received the initial recommendation. Concerning her actions related to the coding error, Schlief most likely violated which of the following CFA Institute Standards of Professional Conduct?

A. Fair Dealing. B. Priority of Transactions. C. Diligence and Reasonable Basis. 15. Rodney Rodrigues, CFA, is responsible for identifying managers to manage specific asset classes

for his firm. In selecting external advisers or subadvisers, Rodrigues reviews the adviser’s investment process, established code of ethics, the quality of their published return information, and their compliance and internal control procedures. In completing his review, Rodrigues most likely violated the CFA Institute Standards of Professional Conduct regarding his due diligence on:

A. adherence to strategy. B. performance measures. C. internal control procedures. 16. Jackson Barnes, CFA, provides financial planning services to his local community for a fee. Barnes

has developed a network of specialists including accountants, lawyers, and brokers who contribute their expertise to the financial planning process. Each of the specialists is an independent contractor. Each contractor bills Barnes separately for the work they perform, providing a discount based upon the number of clients Barnes has referred. What steps should Barnes most likely take to ensure he does not violate any CFA Institute Standards of Professional Conduct?

A. Check with his firm’s legal counsel to determine what action should be taken. B. Disclose to clients on their bills the consideration he receives from the specialists. C. Inform clients about his arrangement with the contractors before they agree to hire him. 17. Millicent Plain, CFA, has just finished taking Level II of the CFA examination. Upon leaving the

examination site, she meets with four other Level III candidates who also just sat for their exams. Curious about their examination experience, Plain asks the other candidates how difficult the Level III exam was and how they did on it. The candidates say the examination was very difficult but do not speak about specific questions. However, the candidates tell Plain about broad topic areas that were tested and complain about specific formulas, which they prepared for but which did not appear on the exam. The Level III candidates least likely violated the CFA Institute Standards of Professional Conduct by discussing:

A. specific formulas.


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B. broad topic areas. C. difficulty of the examination. 18. On a flight to Europe, Romy Haas, CFA, strikes up a conversation with a fellow passenger, Vincent

Trujillo. When Trujillo learns Haas is in the investment profession, he asks about the CFA designation. Haas tells him the following about the CFA designation: Statement 1: Individuals who have completed the CFA Program have the right to use the CFA designation. Statement 2: Use of the designation must be accompanied by an accurate explanation of the requirements to earn and use the designation. Statement 3: Once granted the right to use the designation, an individual must also satisfy the CFA Institute membership requirements to maintain their right to use the designation. In explaining the use of the CFA designation, Haas least likely violated the Professional Conduct concerning which of the following statements?

A. Statement 1. B. Statement 2. C. Statement 3. SS2/3‐QUANTITATIVE METHODS AND ARE (21 MINUTES) 19. The nominal (quoted) annual interest rate on an automobile loan is 10%. The effective annual

rate of the loan is 10.47%. The frequency of compounding periods per year for the loan is closest to:

A. weekly. B. monthly. C. quarterly. 20. A U.S. Treasury bill (T‐bill) has 90 days to maturity and a bank discount yield of 3.25%. The

effective annual yield (EAY) for the T‐bill is closest to:

A. 3.29%. B. 3.32%. C. 3.36%. 21. The following ten observations are a sample drawn from an approximately normal population: Observation 1 2 3 4 5 6 7 8 9 10

Value ‐3 ‐11 3 ‐18 18 20 ‐6 9 2 ‐16

The sample standard deviation is closest to: A. 11.92.


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B. 12.50. C. 13.18. 22. Assume that a stock’s price over the next two periods is as shown below.

Time=0 Time=1 Time=2S0=80 Su=88 Suu=96.8

Sd=72 Sud,du=79.2Sdd=64.8

The initial value of the stock is $80. The probability of an up move in any given period is 75% and the probability of a down move in any given period is 25%. Using the binomial model, the probability that the stock’s price will be $79.20 at the end of two periods is closest to: A. 18.75%. B. 37.50%. C. 56.25%. 23. In setting the confidence interval for the population mean of a normal or approximately normal

distribution and given that the sample size is small, Student’s t‐distribution is the preferred approach when the variance is:

A. known. B. negative. C. unknown. 24. A two‐tailed test of the null hypothesis that the mean of a distribution is equal to 4.00 has a

p‐value of 0.0567. Using a 5% level of significance (i.e., α=0.05), the best conclusion is to:

A. reject the null hypothesis. B. accept the null hypothesis. C. increase the level of significance to 5.67%. 25. A stock is declining in price and reaches a price range wherein buying activity is sufficient to stop

the decline. This is best described as a:

A. support level. B. resistance level. C. change in polarity points. 26. A borrower is considering three competing mortgage loan offers from her bank The amount

borrowed on the mortgage is $100,000 with monthly compounding. Mortgage type Nominal(stated)annual interest

rate at initiation of the loan Year in which rate first adjusts


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30‐year fixed rate 5% N/A 15‐year fixed rate 4.385% N/A

30‐year 3/5 adjustable rate mortgage(ARM)

3.75% 3

The rate on the ARM resets at the end of the year 3. Assuming the ARM is reset at 5.5% (i.e. the remaining balance on the loan will now be repaid with 5.5% nominal annual interest), which of the three loans will have the smallest monthly payment after the rate reset at the end of year 3? A. 30‐year ARM. B. 15‐year fixed‐rate loan. C. 30‐year fixed‐rate loan. 27. Equity returns series are best described as, for the most part:

A. platykurtotic (less peaked than a normal distribution) B. leptokurtotic (more peaked than a normal distribution) C. mesokurtotic (identical to the normal distribution in peakedness) 28. By definition, the probability of any event E is a number between:

A. zero and positive one. B. zero and positive infinity. C. minus one and positive one 29. X and Y are independent events. The probability of X is 0.2 (P(X) = 0.2) and the probability of Y is

0.5 (P(Y) = 0.5). The joint probability of X and Y (P(X, Y)is closest to: A. 0.1. B. 0.3. C. 0.7. 30. A variable is normally distributed with a mean of 5.00 and a variance of 4.00. Calculate the

probability of observing a value of negative 0.40 or less. That is, calculate P (X1 ≤ ‐0.40) given X is distributed as N(5, 4). Use this excerpt from the cumulative distribution function for the standard normal random variable table to calculate your answer.

Cumulative Probabilities for a Standard Normal Distribution P(Z≤X)=N(x)for x≥0 or P(Z≤z)=N(z)for z≥0 X or Z 0 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09 1.10 0.8643 0.8665 0.8686 0.8708 0.8729 0.8749 0.8770 0.8790 0.8810 0.8830 1.20 0.8849 0.8869 0.8888 0.8907 0.8925 0.8944 0.8962 0.8980 0.8997 0.9015 1.30 0.9032 0.9049 0.9066 0.9082 0.9099 0.9115 0.9131 0.9147 0.9162 0.9177 1.40 0.9192 0.9207 0.9222 0.9236 0.9251 0.9265 0.9279 0.9292 0.9306 0.9319 … 2.50 0.9938 0.9940 0.9941 0.9943 0.9945 0.9946 0.9948 0.9949 0.9951 0.9952 2.60 0.9953 0.9955 0.9956 0.9957 0.9959 0.9960 0.9961 0.9962 0.9963 0.9964 2.70 0.9965 0.9966 0.9967 0.9968 0.9969 0.9970 0.9971 0.9972 0.9973 0.9974


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2.80 0.9974 0.9975 0.9976 0.9977 0.9977 0.9978 0.9979 0.9979 0.9980 0.9981 2.90 0.9981 0.9982 0.9982 0.9983 0.9984 0.9984 0.9985 0.9985 0.9986 0.9986 3.00 0.9987 0.9987 0.9987 0.9988 0.9988 0.9989 0.9989 0.9989 0.9990 0.9990 3.10 0.9990 0.9991 0.9991 0.9991 0.9992 0.9992 0.9992 0.9992 0.9993 0.9993

The calculated value is closest to:

A. 0.35% B. 0.62%. C. 8.85%. 31. Which of the following statements of null and alternative hypotheses requires a two‐tailed test?

0 0 0

0 0 0

0 0 0

: :: :: :

a

a

a

H versusHH versusHH versusH

θ θ θ θθ θ θ θθ θ θ θ

= ≠

≤ >

≥ <

A. B. C.

32. Using the following data:

Population 1 2 Sample size n1=5 n2=5 Sample variance S12 =4 S22=28 The sample are drawn independently and both populations are assumed to be normally distributed.

An analyst is trying to test the hypothesis that the population variances are equal（ 2 20 1 2:H S S= ）

against the alternative hypothesis that the variances are not equal（ 2 21 2:AH S S≠ ）at the 5% level of

significance. The table of the F‐Distribution is provided below. Table of the F‐Distribution Panel A: Critical values for right‐hand tail areas equal to 0.05 df1 (read across) 1 2 3 4 5 df2 (read down) 1 161 200 216 225 230 2 18.5 19.0 19.2 19.2 19.3 3 10.1 9.55 9.28 9.12 9.01 4 7.71 6.94 9.59 6.39 6.26 5 6.61 5.79 5.41 5.19 5.05

Panel B: Critical values for right‐hand tail areas equal to 0.025 df1 (read across) 1 2 3 4 5 df2 (read down) 1 648 799 864 900 922 2 38.51 39.00 39.17 39.25 39.03 3 17.44 16.04 15.44 15.01 14.88


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4 12.22 10.65 9.98 9.60 9.36 5 10.01 8.43 7.76 7.39 7.15

Which of the following statements is most appropriate? The critical value is:

A. 6.39 and reject the null. B. 7.15 and accept the null. C. 9.60 and accept the null. SS4/5/6‐ECONOMICS (18 MINUTES) 33. A college student’s monthly demand for pizza is given by the equation:

QD

pizza=11‐0.70 Ppizza+0.009I‐0.20PCola Where QD

pizzais the number of pizzas ordered per month Ppizza is the price of a pizza I is her monthly food budget PCola is the price of cola per bottle

The student’s current monthly food budget is $500, the price of a pizza is $5, and the price of a bottle of cola is $1.25 / bottle. If the student’s monthly food budget were to increase to $700, the slope of her demand curve for pizza would be closest to: A. ‐2.42. B. ‐1.43. C. ‐0.70. 34. Partial information on three baskets (1, 2, and 3) containing goods A and B is given in the table

below. The marginal rate of substitution of B for A, (MRSBA), at basket 2 is also provided.

Basket Units of A Unit of B MRSBA 1 30 2 50 35 4.0 3 40 40

A consumer claims that he is indifferent between baskets 2 and 3 and his indifference curves are strictly convex. If he is also indifferent between baskets 1 and 3, the number of units of A in basket 1 is most likely. A. equal to 60. B. less than 60. C. greater than 60.


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35. Three firms operate under perfect competition, producing 900 units of the same product but

using different production technologies. Each company’s cost structure is indicated below: Company X Y Z Total Variable Costs $2,700 $3,600 $4,500Total Fixed Costs 2,700 1,800 900Total Costs $5,400 $5,400 $5,400

Which of the following statements is most accurate? If the unit selling price is: A. $6.00, all firms should exit the market in the long run. B. $3.00, firm X should continue to operate in the short run, but firms Y and Z should shut down

production. C. $4.50, all firms should continue to operate in the short run, but exit the market in the long run if

these conditions are expected to persist. 36. The total output in units and average selling prices in a hypothetical economy producing only

two products, X and Y, is provided below:

Production X Production YYear Output(units) Selling price/unit Output(units) Selling price/unit 2010 2,800 €9 2,000 €472011 3,000 €11 1,800 €52

If the implicit price deflator for GDP in 2010 was 100, for 2011 it is closest to: A. 106.2. B. 106.8. C. 113.4. 37. In an economy, consumption is 70% of pre‐tax income and the average tax rate is 25% of total

income. If planned government expenditures are expected to increase by $1.25 billion, the increase in total incomes and spending, in billions, is closest to:

A. $1.3. B. $2.6. C. $4.2. 38. The following diagram shows the domestic demand and supply curves for a country that imports

a commodity, where Pw is its world price and PT is its domestic price after the imposition of a tariff. The reduction in the net national welfare of this country as a result of the tariff is best described by the area(s):


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A. E. B. G. C. F+H. 39. The market demand function for item X is a function of its price, household income, and the

price of item Y.

Own‐price elasticity of demand for X ‐0.8Income elasticity of demand for X 1.5Cross‐price elasticity of demand for X with respect to the price of Y 0.4

Given the above elasticity coefficients for the two items, which of the following statements is most accurate? A. X and Y are substitutes. B. Demand for X is elastic. C. Item X is an inferior good. 40. The monthly demand curve for playing tennis at a particular club is given by the following

equation: PTennis Match = 9‐ 0.20 ×Q Tennis Match .The club currently charges members $4.00 to play a match, but is considering a new flat rate monthly membership fee for unlimited play. The most fee that the club will be able to charge for this membership is closest to:

A. $40.00. B. $62.50. C. $162.50. 41. With its existing production facilities, a monopolist firm can produce up to 100 units. It faces the

following demand and cost schedules:

Output (units) Price($/unit) Total cost($/unit) 0 3,000 600

E F G H

Price DomesticSupply

DomesticDemand

PT

PW

0 Q1 Q2 Q3 Q4 Quantity


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20 2,800 10,600 40 2,600 32,600 60 2,400 66,600 80 2,200 112,600 100 2,000 170,600

The optimal output level for this producer (in units) is closest to: A. 20. B. 60. C. 100. 42. The following information has been gathered for a hypothetical economy:

Total Population 1,100Working Age Population 975Labor Force 750Underemployed 120Unemployed 95Discouraged workers 80Frictionally Unemployed 25Voluntarily Unemployed 40

The unemployment rate is closest to: A. 9.7%. B. 12.6%. C. 16.0%. 43. Which of the following would be most useful as a leading indicator to signal the start of an

economic recovery? A. An increase in aggregate real personal incomes (less transfer payments). B. A decrease in average weekly initial claims for unemployment insurance. C. The narrowing of the spread between the 10‐year Treasury yield and the federal funds rate. 44. In early 2011, the British pound (GBP) to New Zealand dollar (NZD) spot exchange rate was

2.0979. The LIBOR interest rates, quoted on a 360‐day year basis, were 1.6025% for the British pound and 3.2875% for the New Zealand dollar. The 180‐day forward points (scaled up by four decimal places) in GBP/NZD would be closest to:

A. ‐343. B. ‐173. C. 176.


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SS7/8/9/10‐FINANCIAL STATEMENT ANALYSIS (47 MINUTES) 45. Information about management compensation and any potential conflicts of interest that may

exist between management and shareholders is most likely found in the:

A. proxy statement. B. notes to the financial statements. C. management discussion and analysis. 46. The following information is available about a company:

Contributed capital, beginning of the year $50,000Retained earnings, beginning of the year 225,000Sales revenues earned during the year 450,000Investment income earned during the year 5,000Expenses paid during the year 402,000Dividends paid during the year 10,000Total assets, end of the year 800,000

Total liabilities at the end of the year are closest to:

A. $472,000. B. $482,000. C. $487,000. 47. According to the International Accounting Standards Boards Conceptual Framework for Financial

Reporting, the two fundamental qualitative characteristics that make financial information useful are best described as:

A. timeliness and accrual accounting. B. understandability and verifiability. C. relevance and faithful representation. 48. The following information is available from a company’s accounting records:

€millions Revenues for the year 12,500 Total expenses for the year 10,000 Gains from available‐for‐sale securities 1,475 Loss on foreign currency translation adjustments on a foreign subsidiary 325 Dividends paid 500


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The company’s total comprehensive income (in millions) is closest to:

A. €1,150. B. €3,150. C. €3,650. 49. Based on the following information about a company, the bad debt expense (in millions) for

2011 is closest to:

￡millions 2011 2010

Accounts receivables，gross 6,620 4,840 Allowance for doubtful accounts 92 56

Write‐offs during the year 84 42

A. £36. B. £84. C. £120. 50. An analyst has gathered the following information about a company:

Cdn $ millionsCash flow from operating activities 105.9Cash flow from investing activities (11.8)Cash flow from financing activities 46.5Net change in cash for the year 140.6Interest paid(included in CFO) 22.4Taxes pa id(tax rate of 30％) 18.0

Total debt，end of year 512.8 The cash flow debt coverage ratio for the year is closest to:

A. 20.6%. B. 23.7%. C. 27.4%. 51. Which inventory method best matches the actual historical cost of the inventory sold with their

physical flow if a company is using a perpetual inventory system?

A. FIFO. B. LIFO. C. Specific identification


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52. On 1 January, a company, which prepares its financial statements according to IFRS, arranged financing for the construction of a new plant. The company: • borrowed NZ$5,000,000 at an interest rate of 8%, • issued NZ$5,000,000 of preferred shares with a cumulative dividend rate of 6%, and • during the first year of construction the company was able to temporarily invest NZ$2,000,000 of the loan proceeds for the first six months and earned 7% on that amount. The amount of financing costs to be capitalized (NZ$) to the cost of the plant in the first year is closest to:

A. 330,000. B. 400,000. C. 630,000. 53. Which of the following statements most accurately describes a valuation allowance for deferred

taxes? A valuation allowance is required under:

A. IFRS on revaluation of capital assets. B. U.S. GAAP if there is doubt about whether a deferred tax asset will be recovered. C. both IFRS and U.S. GAAP on tax differences arising from the translation of foreign operations. 54. A company had the following events related to $5 million of 10‐year bonds with a coupon rate of

8% payable semiannually on 30 June and 31 December: • Issued on 1 January 2005, when the market rate of interest was 6%. • Bought back in an open market transaction on 1 January 2011, when the market rate of interest was 8%. Which of the following statements best describes the effect of the bond repurchase on the financial statements for 2011? If the company uses the indirect method of calculating the cash from operations, there will be a:

A. $346,511 gain on the income statement. B. $743,873 gain on the income statement. C. $350,984 decrease in the cash from operations. 55. On a cash flow statement prepared using the indirect method, which of the following would

most likely increase the cash from investing activities?

A. Sale of a long‐term receivable. B. Sale of held‐for‐trading securities. C. Securitization of accounts receivable. 56. If a company chooses to capitalize an expenditure related to capital assets instead of expensing

it, ignoring taxes, the company will most likely report:

A. a lower cash flow per share in that period.


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B. a higher earnings per share in future periods. C. the same free cash flow to the firm in that period. 57. An accounting document that records transactions in the order in which they occur is best

described as a:

A. trial balance. B. general ledger C. general journal. 58. Which of the following statements is most accurate with respect to financial reporting

requirements?

A. Regulatory authorities are typically private sector, self‐regulated organizations. B. Standard‐setting bodies have authority because they are recognized by regulatory agencies. C. The requirement to prepare financial reports in accordance with specified accounting standards

is the responsibility of standard‐setting bodies. 59. Income statements for two companies (A and B) and the common‐sized income statement for

the industry are provided below:

All$ figures in ’000s Company A Company B Industry Sales $10,500 $8,250 100.0%Cost of goods sold 6,353 5,239 62.8%Selling, general, and administrative expenses

2,625 2,021 24.8%

Interest expense 840 536 7.0%Pretax earnings 683 454 5.4%Taxes 205 145 1.7%Net earnings $478 $309 3.7%

The best conclusion an analyst can make is:

A. Company B’s interest rate is lower than the industry average. B. both companies’ tax rates are higher than the industry average. C. Company A earns a higher gross margin than both Company B and the industry. 60. Which of the following statements about balance sheets is most accurate? Under:

A. U.S. GAAP, intangibles must be valued at historical cost B. IFRS, a commercial real estate company should use a liquidity based presentation. C. IFRS, a classified balance sheet must present current assets before non‐current assets.


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61. A company recorded the following events in 2010:

$’000sPurchase of securities for trading purposes 240Proceeds from the sale of trading securities 300Proceeds from issuance of bonds 500Purchase of 30% of shares of an affiliated company 275

On the 2010 statement of cash flows, the company’s cash flow from investing activities (in ‘000s) is closest to:

A. ‐$275. B. ‐$215. C. $285. 62. Selected information for a company is provided below.

$ millionsSales 4,800Cost of goods sold 2,880Purchases 2,940Average receivables 625Average inventory 710Average payables 145

The company’s cash conversion cycle (in days) is closest to:

A. 84. B. 120. C. 138. 63. Select information from a company that uses FIFO inventory method is provided below.

Event Units $/Units Total ($) Opening inventory 1,000 7.50 7,500Purchases 250 7.60 1,900Sales 550 12.00 6,600Purchases 300 7.70 2,310Sales 600 12.00 7,200Ending Inventory 400

If the company uses the perpetual inventory system versus the periodic inventory system, the gross margin would most likely be:

A. lower.


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B. higher. C. the same. 64. A company, which prepares its financial statements according to IFRS, owns several investment

properties on which it earns income. It values the properties using the fair value model based on prevailing rental markets. A summary of the properties’ valuations is as follows: •Original cost (acquired in 2009) €50 million •Fair value valuation as at 31 December 2009 €50.5 million •Fair value valuation as at 31 December 2010 €54.5 million •Fair value valuation as at 31 December 2011 €48.0 million Which of the following best describes the impact of the revaluation on the 2011 financial statements?

A. €6.5 million charge to net income. B. €6.5 million charge to revaluation surplus. C. €4.5 million charge to revaluation surplus and €2.0 million charge to net income. 65. A company purchased equipment in 2009 for £25,000; the year‐end values for accounting

purposes and tax purposes are as follows:

2010 2009 Carrying amount for accounting purposes £20,000 £22,500 Tax base for tax purposes £16,000 £20,000 Tax rate 25% 30%

Which of the following statements best describes the effect of the change in the tax rate on the company’s 2010 financial statements? The deferred tax liability: A. increased by £250. B. decreased by £200. C. decreased by £800. 66. An analyst can most accurately identify a LIFO liquidation by observing a(n):

A. increase in gross margin. B. decrease in the LIFO reserve. C. change in inventory out of line with change in sales.

67. Selected information about a company is as follows:

($’000) 2010 31 December 2011 Projection Sales 2,200 2,500Variable operating costs(% of sales) 28% 30%


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Fixed operating costs 1,400 1,400Tax rate 25% 25%Dividends paid 55 60Interest bearing debt at 5% 500 500

The forecasted net income (in ‘000s) for 2011 is closest to: A. $169. B. $202. C. $244. 68. An analyst has gathered the following information about a company’s capita’ assets:

Year ending 2011 2010 Property plant and equipment €2500 €2500 Accumulated depreciation 375 250 Net book value 2,125 2,250

As at the end of 2011, the expected remaining life of the assets, in years, is closest to: A. 6. B. 17. C. 20. SS11‐CORPORATE FINANCE (18 MINUTES) 69. Two mutually exclusive projects have the following cash flows (€) and internal rates of return

(IRR):

Project IRR Year 0 Year 1 Year 2 Year 3 Year 4 Project A 27.97% ‐2,450 345 849 635 3,645 Project B 28.3% ‐2,450 345 849 1,051 3,175

Assuming a discount rate of 8% annually for both projects, the firm most likely should accept:

A. both projects. B. Project A only. C. Project B only. 70. A company’s asset beta is 1.2 based on a debt‐to‐equity ratio of 50%. If the company’s tax rate

increases, the associated equity beta will most likely.


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A. increase. B. decrease. C. remain unchanged. 71. A firm’s price‐to‐earnings ratio (P/E) is 12.5. The firm has decided to repurchase shares using

external funds that have an after‐tax cost of 9%. After the repurchase, the earnings per share (EPS) will most likely.

A. increase. B. decrease. C. remain unchanged.

72. Which is most likely considered a “pull” on liquidity?

A. Obsolete inventory. B. Reduction in a line of credit. C. Increased difficulty in collecting receivables.

73. Based on best practices in corporate governance procedures, independent board members most

likely. A. meet only in the presence of management. B. have a “lead” director when the board chair is not independent. C. hire independent consultants who are pre‐approved by management. 74. Given the following information about a firm:

• debt‐to‐equity ratio of 50% • tax rate of 40% • cost of debt of 8% • cost of equity of 13%, the firm’s weighted average cost of capital (WACC) is closest to:

A. 7.5%. B. 8. 9%. C. 10.3%. 75. The unit contribution margin for a product is $20 and the firm’s fixed costs of production up to

300,000 units is $500,000. The degree of operating leverage (DOL) is most likely the lowest at which of the following production levels (in units)?

A. 100,000. B. 200,000. C. 300,000. 76. Which date in the chronology of a dividend payment is most likely determined by a security


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exchange? The:

A. declaration date. B. ex‐dividend date. C. holder‐of‐record date. 77. Which of the following share repurchase methods will most likely take the longest amount of

time to execute?

A. Dutch auction. B. fixed price tender offer. C. open market repurchase. 78. Assuming a 365‐day year and the following information for a company:

Current Year Previous Year Sales $12,000 $10,000Cost of goods sold $6,000 $5,000Inventory $1,200 $1,000Accounts payable $600 $500

The firm’s days in payables for the current year is closest to:

A. 18.3. B. 35.3. C. 36.5. SS13/14‐EQUITY INVESTMENTS (18 MINUTES) 79. Which of the following statements concerning regulatory bodies is least accurate? Regulatory

bodies:

A. act to level the playing field for market participants. B. help define minimum standards of practice for agents. C. require that regulated firms maintain optimum levels of capital. 80. Which of the following statements is most accurate?

A. Investors prefer to invest in callable common shares rather than putable common shares B. The issuing company is obligated to buy callable common shares at a predetermined price. C. Putable common shares facilitate raising capital because of their appeal to investors over


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callable common shares. 81. An investor who wants to estimate the enterprise value multiple (EV/EBITDA) of a company has

gathered the following data:

Market value of debt $10million Market capitalization $45million Cash and short‐term investments $2.5million EBITDA $15million Firm’s marginal tax rate 40%

The company’s EV/EBITDA multiple is closest to:

A. 2.5. B. 3.5. C. 5.8. 82. An investor gathers the following data to estimate the intrinsic value of a company’s stock using

the justified forward P/E approach. Next year’s earnings per share $3.00 Return on equity 12.5% Dividend payout ratio 60% Required return on shares 10%

The intrinsic value per share is closest to:

A. $36. B. $48. C. $72. 83. A company’s series B, 8% preferred stock with a par value of $50 pays quarterly dividends. Its

current market value is $35. The shares are retractable (at par) with the retraction date set for three years from today. Similarly rated preferred issues have an estimated nominal required rate of return of 12%. Analysts expect a sustainable growth rate of 4% for the company’s earnings. The intrinsic value estimate of a share of this preferred issue is closest to:

A. $33.33. B. $45.02. C. $52.00. 84. Which of the following multiples is most useful when comparing companies with significant

differences in capital structure?


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A. EV/EBITDA. B. Price‐to‐book ratio. C. Price‐to‐cash flow ratio. 85. If a stock’s intrinsic value is less than its current market price, the most appropriate strategy an

active investor can adopt is to:

A. sell the stock short. B. buy the stock on margin. C. buy a call option on the stock.

86. An analyst finds that a company she is following has initiated the process of selling unproductive

land representing 5% of its total assets and using the proceeds to buy back its common shares. Holding other factors constant these actions by the company will most likely result in a:

A. higher return on equity. B. higher operating margin. C. lower sustainable growth. 87. Which of the following is the most appropriate reason for using a free‐cash‐flow‐to‐equity (FCFE)

model to value equity of a company?

A. FCFE is a measure of the firm’s dividend‐paying capacity. B. FCFE models provide more accurate valuations than the dividend discount models. C. A firm’s borrowing activities could influence dividend decisions but they would not impact FCFE. 88. The following information is available about a company:

Next year’s sales revenue $180millions Next year’s net profit margin 15% Dividend payout ratio 60% Dividend growth rate expected during Years 2 and 3 25% Dividend growth rate expected after Year 3 5% investors’ required red rate of return 12% Number of outstanding shares 8.1million

The current value per share of the company’s common stock according to the two‐stage dividend discount model is closest to:

A. $39.36. B. $49.20. C. $51.20.


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89. A trader buys 500 shares of a stock on margin at $36 a share using an initial leverage ratio of 1.66. The maintenance margin requirement the position is 30%. The stock price at which the margin call occurs is closest to:

A. $20.57. B. $25.20. C. $30.86. 90. Which of the following inferences concerning market efficiency most accurate?

A. Fully exploitable over and under‐reactions often occur in efficient markets. B. Market pricing anomalies and behavioral biases are contrary to the existence of market

efficiency. C. If a market is semi‐strong form efficient neither technicians nor fundamental analysts can expect

to consistently earn abnormal returns.


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SS18‐ALTERNATIVE INVESTMENT (18 MINUTES) 91. U.S. farmers become concerned that the future supply of wheat production would exceed

demand. Their hedging activities would most likely drive which market condition?

A. Contango. B. Full carry. C. Backwardation. 92. An apartment building currently being marketed has the following financial characteristics:

Annual Figures Gross potential rental income $625,000 Estimated vacancy and collection losses 3.75％ insurance and taxes $65,000 Utilities $27,000 Repairs and maintenance $62,000 Depreciation $55,000 Interest rate on proposed financing 6.5％ Average market cap rate 8.5％

The estimated value for the building being sold using the income approach is closest to: A. $5,265,400. B. $5,541,200. C. $6,400,000. 93. An investor contributes £2,500,000 to a new venture capital project that is expected to earn

£7,500,000 at the end of year 5 if it is successful. The probabilities of failure for the project are provided in the table below:

Year 1 2 3 4 5 Failure Probability 0.35 0.20 0.15 0.15 0.15

If the cost of capital for the JV is 12%, the project’s expected NPV is closest to:

A. —£560,674. B. —£1,140,964. C. £1,701,638. 94. An investor is evaluating the purchase of a mutual fund that offers three classes of shares. Fees

for each class are provided in the table below:


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Class A Class B Class C Annual fees 1.00％ 1.25％ 1.25％ Front—end load 2.75％ None None Back‐end load None 4％year 1，1％annually after 1.50％initial 5 years

Given a time horizon of three years, which class is most likely to result in the lowest fees for the investor?

A. Class A. B. Class B. C. Class C. 95. In estimating the value of inactively traded securities of a closely held corporation, which of the

following statements is least likely correct?

A. A control premium values the equity from a minority shareholder perspective. B. The cost approach assigns the original acquisition price to the company’s assets. C. Shares should reflect a marketability discount to compensate for a lack of trading in a public

market. 96. When using the historical track record of hedge funds to interpret performance, which of the

following is least likely correct?

A. Databases may have backfilling bias since only hedge fund managers with good track records agree to be included.

B. Self‐selection bias is present as index providers decide whether to include a hedge fund in a performance database.

C. Survivorship bias occurs because poorly performing hedge funds no longer appear in hedge fund databases, thus inflating the reported average performance.

SS15/16‐FIXED INCOME INVESTMENTS (9 MINUTES) 97. If a bond’s issuer is required to retire a specified portion of the issue each year, the bond most

likely:

A. is a step‐up note. B. is currently callable. C. has a sinking fund provision. 98. One reason why the duration of a portfolio of bonds does not properly reflect that portfolio’s

yield curve risk is that the duration measure:


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A. assumes all yields change by the same amount B. assumes all the bonds have the same discount rate. C. ignores differences in coupon rates across the bonds. 99. Investor A’s marginal tax rate is 45%, while Investor B’s is 30%. Both investors are considering

two bonds for inclusion in a taxable portfolio. One bond is tax‐exempt with a yield of 4.50%, while the other is taxable with a yield of 6.30%. Which bond will each investor most likely choose?

A. Both investors will choose the taxable bond. B. Both investors will choose the tax‐exempt bond. C. Investor A will choose the tax‐exempt bond and investor B will choose the taxable bond. 100. The yield on a U.S. Treasury STRIPS security is also known as the Treasury:

A. spot rate. B. yield spread. C. forward rate. 101. A 4‐year amortizing security with a par value of $5,000 and a coupon rate of 7% has an expected

cash flow of $1,476 per year, assuming no principal prepayments. Assuming a discount rate of 5%, the present value of this security is closest to:

A. $5,234. B. $5,355. C. $9,347. 102. Consider a 5‐year option‐free bond that is priced at a discount to par value. Assuming the

discount rate does not change, one year from now the value of the bond will most likely.

A. increase. B. decrease. C. stay the same. 103. The value of an 18‐year zero‐coupon bond with a maturity value of $1,000 discounted at a 12%

annual interest rate with semi‐annual compounding is closest to:

A. $122.74. B. $130.04. C. $350.34. 104. A 10% coupon bond with annual payments, maturing in 3 years, is priced at 105. The bond is

callable in one year at a call price of 104 or two years at a call price of 102. The bonds yield to


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worst most likely occurs when the bond is:

A. called in year 1. B. called inyear2. C. held until maturity. 105. All else being the same, the difference between the nominal spread and the Z‐spread for a

non‐Treasury security will be larger when the:

A. yield curve is flatter. B. maturity of the security is longer. C. security has a bullet maturity rather than an amortizing structure. 106. Assume the following six‐month forward rates (presented on an annualized, bond‐equivalent

basis) were calculated from the yield curve.

Notation Forward Rate

1f0 0.50%

1f1 0.70%

1f2 1.00%

1f3 1.50%

1f4 2.20%

1f5 3.00%

1f6 4.00%

The 3‐year spot rate is closest to:

A. 0.74%. B. 1.48%. C. 2.06%. 107. One advantage of the full valuation approach to measuring interest rate risk relative to the

duration/convexity approach is the full valuation approach is:

A. more accurate. B. easier to model. C. less time‐consuming. 108. An analyst uses a valuation model to estimate the value of an option‐free bond at 92.733 to

yield 11%. If the value estimate rises to 94.474 for a 60 basis point decrease in yield and falls to 91.041 for a 60 basis point increase in yield, the effective duration of the bond closest to:


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A. 1.85. B. 3.09. C. 6.17. SS17‐DERIVATIVES (8 MINUTES) 109. A corporation issues 5‐year fixed‐rate bonds. Its treasurer expects interest rates to decline for all

maturities for at least the next year. She enters into a 1‐year agreement with a bank to receive quarterly fixed‐rate payments and to make payments based on floating rates benchmarked on 3‐month LIBOR. This agreement is best described as a:

A. swap. B. futures contract. C. forward contract. 110. A portfolio manager is required to sell 31,250 shares of XYZ Inc. in two months. She is concerned

that the price of XYZ will decline during the 2‐month period, so she enters into a deliverable equity forward contract to sell 31,250 shares of XYZ in 2 months for EUR 160 per share. When the contract expires, XYZ is trading at EUR 138 per share. The portfolio manager will most likely.

A. pay EUR 687,500 to the dealer. B. receive EUR 4,312,500 from the dealer. C. receive EUR 5,000,000 from the dealer. 111. A trader takes a long position in 40 futures contracts on Day 1. The futures have a price limit of

$5 and settle at $106. On Day 2, the futures trade at $111 and the bid and offer move to $113 and $115, respectively. The futures remain at these price levels until the market closes. What marked‐to‐market value does the trader receive in his account for Day 2?

A. $200. B. $280. C. $320. 112. An investor is long an in‐the‐money American call option. Would this option most likely ever be

exercised early?

A. No. B. Yes, if its time value is high enough. C. Yes, if it pays a high enough dividend.

113. European company issues a 5‐year euro‐denominated bond with a face value of EUR 50,000,000.

The company then enters into a 5‐year currency swap with a bank to convert the EUR exposure into US$ exposure. The notional principals of the swap are EUR 50,000,000 and US$70,000,000.


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The European company pays a fixed rate of 5% and the bank pays a fixed rate of 4.5%. Payments are made semiannually on a basis of 30 days per month and 360 days per year. What the payment from the bank to the company at the end of year 4?

A. US$ 1,750,000. B. EUR 1,125,000. C. EUR 1,250,000. 114. An investor with $5000 to invest believes that the price of ABC Corp. stock will appreciate by $7

to $95 in two months. Two‐month at‐the‐ money puts on one share of ABC stock are trading at $1.76, while two‐month at‐the‐money calls are trading at $1.56. What action will he most likely take to profit from his view on ABC stock?

A. Sell 100 ABC puts. B. Buy 100 ABC calls. C. Buy 100 ABC shares. SS12‐ PORTFOLIO MANAGEMENT (9 MINUTES) 115. Which of the following is least likely a part of the execution step of the portfolio management

process?

A. Security analysis. B. Portfolio construction. C. Performance measurement 116. The correlation between the historical returns of Stock A and Stock B is 0.75. If the variance of

Stock A is 0.16 and the variance of Stock B is 0.09, the covariance of returns of Stock A and Stock B is closest to:

A. 0.01. B. 0.09. C. 0.16. 117. The point of tangency between the Capital Allocation Line (CAL) and the efficient frontier of

risky assets most likely identifies the:

A. optimal risky portfolio. B. optimal investor portfolio. C. global minimum‐variance portfolio. 118. The stock of GBK Corporation has a beta of 0.65. If the risk‐free rate of return is 3% and the

expected market return is 9%, the expected return for GBK is closest to:


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A. 3.9%. B. 6.9%. C. 10.8%. 119. A return‐generating model that provides an estimate of the expected return of a security based

on factors such as earnings growth and cash flow generation is best described as a: A. market factor model. B. fundamental factor model. C. macroeconomic factor model. 120. A portfolio manager earned a rate of return of 15.5%. The beta of the portfolio is 1.2. If the

risk‐free rate of return is 2.5% and the market return is 11.8%, Jensen’s alpha for the portfolio is closest to:

A. 1.84%. B. 3.70%. C. 4.34%.


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2011 Level 1 Sample Exam Answer 1. Correct answer: B B is correct. Although a violation of Standard I (A) Knowledge of the Law is likely to occur unless the asset base information is corrected, Cruz has yet to violate any CFA Institute Standards, so he need not report a violation. If Cruz does not take action, he will be in violation of the Standards. He would need to report this violation because Standard I (A) applies as the member should know his conduct may contribute to a violation of applicable laws, rules, regulations, or the Code and Standards related to the inaccurate sales materials. 2. Correct answer: B B is correct because Standard I (A) Knowledge of the Law requires Members and Candidates to comply with the more strict law, rules, or regulations and follow the highest requirement, which in this case would be the CFA Institute Standards of Professional Conduct. 3. Correct answer: A A is correct because Standard III (B) Fair Dealing concerns the fair treatment of clients when making investment recommendations or taking investment action, but there is no indication the advisor has discriminated against any clients regarding his recommendations as he invests all clients in the same universe of stocks. 4. Correct answer A A is correct as soliciting the bank client did not violate any Standard because the manager is no longer an employee of the bank. There is no violation of Standard IV (A) Loyalty, which prohibits the solicitation of employer’s clients prior to cessation of employment. 5. Correct answer A A is correct because even though the company does not have a stock pre‐clearance procedure, trading the stock of a company the analyst recommended as an acquisition candidate is an act that violates Standard IV(A) Loyalty ,as she did not give her Employer the opportunity to take advantage of her skill/recommendation prior to buying the shares for her own portfolio. 6. Correct answer: B B is correct because a violation of Standard II(A) Material Nonpublic Information is likely to occur when using information that is selectively disclosed by corporations to a small group of investors, analysts, or other market participants. Information that is made available to analysts remains nonpublic until it is made available to investors in general. 7. Correct answer: C C is correct because the member has engaged in information‐based manipulation of RRC stock. Members and candidates must refrain from “pumping up” (or down in this case) the price of an investment by issuing misleading positive (negative) information for their or their clients’ benefit. In addition, the member would be in violation of Standard I (A) Knowledge of the Law, because he has


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not acted with professionalism and integrity. The member has not violated Standard VI (B) Priority of Transactions because this concerns client investment transactions having priority over member or candidate investment transactions and is not applicable here. 8. Correct answer: A A is correct. Standard III (A) Loyalty, Prudence, and Care and Gupta’s duty of loyalty, prudence, and care is owed to the participants and beneficiaries (members) of the pension plan. As a church plan, the restrictions are reasonable and Gupta indicates it will not impact his ability to construct the portfolio. 9. Correct answer: A A is correct because there is no violation of Standard III (A) Loyalty, Prudence, and Care by performing a cost‐benefit analysis showing that voting all proxies might not benefit the client, and concluding voting proxies may not be necessary in all instances. 10. Correct answer: B B is correct because, according to Standard III(B) Fair Dealing, members and candidates may provide more personal, specialized, or in‐depth service to clients willing to pay for premium services through higher management fees or higher levels of brokerage. Members and candidates can differentiate their services to clients, but different levels of service must not disadvantage or negatively affect clients. In addition, the different service levels should be disclosed to clients and prospective clients and be available to everyone (i.e., different service levels should not be offered selectively). The newsletter recipients are not even clients, because the newsletter is free, and the manager does not even know if the recipients of the newsletter have acted on her recommendations, nor does she know whom these recipients are, so the manager’s obligation is to first serve clients who are paying her a management fee. 11. Correct answer: B B is correct because Standard III(D) Performance Presentation does not prohibit showing past performance of funds managed at a prior firm as part of a performance track record as long as showing that record is accompanied by appropriate disclosures about where the performance took place and the person’s specific role in achieving that performance, which has been done in this case. 12. Correct answer: A A is correct because golf is a business independent of the financial industry and the board obligation would not be a conflict of interest requiring disclosure according to Standard IV (B) Additional Compensation Arrangements, which requires members and candidates to obtain permission from their employer before accepting compensation or other benefits from third parties for the services rendered to the employer or for any services that might create a conflict with their employer’s interest. 13. Correct answer: B B is correct because a supervisor’s responsibilities under Standard IV (C) Responsibilities of Supervisors include instructing those subordinates to whom supervision is delegated about methods


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to prevent and detect violations of laws, rules, regulations, and the Code and Standards. Laws would also include legal restrictions. 14. Correct answer: A A is correct as the analyst violated Standard III(B) Fair Dealing by selectively distributing the recommendation internally at the investment bank prior to communicating her recommendation to clients. This might also be a violation of Standard III(A) Loyalty, Prudence, and Care, which requires that members must act for the benefit of their clients and place their clients’ interests before their employer’s or their own interests. 15. Correct answer: A A is correct because Standard V (A) Diligence and Reasonable Basis applies to the level of review necessary in selecting an external adviser or subadviser and would include reviewing the adviser’s adherence to its stated strategy. 16. Correct answer C C is correct because the referral arrangements should be disclosed to clients “before entry into any formal agreement for services” and not after the fact. 17. Correct answer: C C is correct because discussing the level of difficulty of the examination did not violate Standard VII (A) Conduct as Members and Candidates in the CFA Program. Standard VII (A) and the Candidate Pledge was violated by candidates revealing broad topical areas and formulas tested or not tested on the exam. 18. Correct answer: C C is correct because according to Standard VII (B) Reference to CFA Institute, the CFA Designation, and the CFA Program, this is an accurate statement concerning the CFA designation. 19. Correct answer: B Use the formula for effective annual rate: EAR = (1 + Periodic interest rate)m—1 Iteratively substitute the possible frequency of compounding until the EAR is 10.47%. For weekly compounding, (1 + 0.10 / 52)52 — 1 = 0.10506 = 10.50% For monthly compounding, (1 + 0.10 / 12)12 — 1 = 0.10471 = 10.47% For quarterly compounding, (1 + 0.10 / 4)4 — 1 = 0.10381 = 10.38% Thus, the correct answer is monthly compounding. 20. Correct answer: C First calculate the initial price (P0) of the T‐bill:


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BD 0

0

D 360r = ,P =100-DF t

D 3600.0325= ,D=0.8125100 90

P =100-0.8125=99.1875

×

×

Then calculate the holding period yield (HPY) (recall that T‐bills are pure discount instruments and do not pay coupons): HPY = (Pt‐P0) ÷ P0 HPY = (100 — 99.1875) ÷ 99.1875 = 0.00819 Finally, convert the HPY into effective annual yield: EAY (1 + HPY)365/t‐1 EAY = (1 + 0.00819)365/90 ‐1 = 0.03364 = 3.36% 21. Corret answer: C The sample mean is:

/ ( 3 11 3 18 18 20 6 9 2 16) /10 2.00 /10 0.20n

ii

X X n= = − − + − + + − + + − = − = −∑

The sample variance is:

2 2( ) / 1n

ii

S X X n= − −∑

The sample standard deviation js the (positive) square root of the sample variance, Value Diff.from mean [value‐(‐0.20)] Difference Square ‐3 ‐2.8 7.84 ‐11 ‐10.8 116.64 3 3.2 10.24 ‐18 ‐17.8 316.84 18 18.2 331.24 20 20.2 408.04 ‐6 ‐5.8 33.64 9 9.2 84.64 2 2.2 4.84 ‐16 ‐15.8 249.64 Sum of Squared differences 1,563.6 Divided by n‐1 173.7333333 Square root 13.18079411

22. Correct answer: B Across two periods, there are four possibilities: an up move followed by an up move ($96.8 end value), an up move followed by a down move ($79.2 end value), a down move followed by an up move ($79.2 end value), and a down move followed by a down move ($64.8 end value).


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The probability of an up move followed by a down move is 0.75 times 0.25 equals 0.1875. The probability of a down move followed by an up move is 0.25 times 0.75 also equals 0.1875. Both of these sequences result in an end value of $79.2. Therefore, the probability of an end value of $79.2 is (0.1875 + 0.1875) = 37.5%. 23. Correct answer: C When the sample size is small, the t‐distribution is preferred if the variance is unknown. 24. Correct answer: B As the p‐value (0.0567) exceeds the stated level of significance (0.05), we cannot reject the null hypothesis. We therefore accept the null hypothesis. 25. Correct answer: A Support level is defined to be “a low‐price range in which buying activity is sufficient to stop the decline in price.” 26. Correct answer C After year 3 the 30‐year fixed‐rate loan has the lowest payment. The loan payments, summarized in the table, are calculated using a financial calculator following the table. Loan Initial Payment ($) Payment after 3 years($) 30‐year fixed 536.82 536.82 15‐year fixed 759.82 759.82 ARM 463.12 559.15

Payment on the 30‐year fixed is: N = 12×30= 360; I/Y= (5/12) = 0.41667; PV= 100,000; FV = 0; calculate PMT=536.82 Payment on the 15‐year fixed is: N = 12×15= 180: I/Y= (4.385/12) = 0.36542; PV =100,000; FV=0; calculate PMT=759.13 Calculations for the ARM Initial payment N = 12×30 = 360; I/Y = (3.75 / 12) = 0.31250; PV = 100,000; FV = 0; calculate PMT = 463.12 Balance at end of year 3: N = 12×27 = 324;I/Y = (3.75 / 12) = 0.31250; FV = 0; PMT = 463.12; calculate PV = 94,270.54 Payment after the end of year 3: N = 324; I/Y = (5.5 / 12) = 0.45833; PV = 94,270.54; FV = 0; calculate PMT = 559.15 27. Correct answer: B Most equity return series have been found to be leptokurtotic. 28. Correct answer: A The two defining properties of a probability are as follows: 1. The probability of any event E is a number between 0 and 1. 2. The sum of the probabilities of any set of mutually exclusive and exhaustive events equals 1.


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29. Correct answer: A Given that X and Y are independent, their joint probability is equal to the product of their individual probabilities. In this problem, we calculate 0.2×0.5 = 0.1 30. Correct answer A First standardize the value of interest, —0.40, for the given normal distribution: Z = (X - ) / = (- 0.40 - 5.00)/2 = -2.70.μ σ

Then use the given table of values to find the probability of a Z value being 2.70 standard deviations below the mean (i.e., when z ≤ 0). The value is 1 — P(Z ≤ +2.70). In this problem, the solution is: 1 — 0.9965 = 0.0035 = 0.35% 31. Correct answer: A When the null and alternative hypotheses are of the form: 0 0 H : θ = θ versus ≠a 0 H : θ θ , the

correct approach is to use a two‐ tailed test. 32. Correct answer C The test statistic is the ratio of the variances, with the larger variance in the numerator. Here the test statistic is 28 ÷ 4 = 7. The degrees of freedom are 4 by 4. As it is a two‐ tailed test the correct critical value at α= 5% is 9.60. As the test statistic is less than the critical value, we cannot reject the null hypothesis. We therefore accept the null hypothesis. 33. Correct answer B Initial Price Quantity Relationship:

DPizza pizza PizzaQ =11-0.70P +0.009 $500-0.20 1.25=15.25-0.70P× ×



Price Quantity Relationship at New Income Level DPizza Pizza PizzaQ =11-0.70P +0.009 $700-0.20 1.25=17.05-0.70P× ×



The slope of her demand curve for pizza will still be ‐1.43 even with the higher income of $700 as the income effect will result in a parallel shift of the initial demand curve to the right. 34. Correct answer: C As he is indifferent between all three baskets, all three must fall on the same indifference curve. The MRSBA at basket 2 is 4, meaning that the slope of the indifference curve at that point is ‐4, hence ΔA/ΔB = ‐4 = (A ‐ 50) / (30 ‐ 35): Solve for A = 70: greater than 60. 35. Correct answer: B Revenue Cost Relationship Short‐Run Decision Long‐Run Decision TR≥TC Stay in market Stay in market


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TR>TVC but TR<TFC+TVC Stay in market Exit market TR<TVC Shut down production to zero Exit market Where TR=Total revenue And TC =total cost; TVC=total variable Costs; TFC=total fixed costs Hence, if the selling price is $3.00, the total revenue will be $3.00 per unit ×900 units =$2,700; only firm X’s variable costs are covered and it should continue operating, while firms Y and Z should immediately shut down production.

36. Correct answer: C Nominal GDP Real GDP 2010 2,800×9+2,000×47=119,200 119,200 2011 3,000×11+1,800×52=126,600 3,000×9+1,800×47=111,600 GDP Deflator=Nominal GDP/Real GDP×100=126,600/111,600×100=113.4

37. Correct answer: C Explain the implementation of fiscal policy and the difficulties of implementation. The fiscal multiplier is 1/[1‐c(1‐T)] where c marginal propensity to consume = consumption ÷ disposable income T the tax rate

Assuming pre‐tax income of $100Disposable income $100×(1‐0.25)=$75Marginal propensity to consume $70÷$75=0.933The fiscal multiplier 1÷[1‐0.933×(1‐0.25)]=3.33With government expenditure of $1.25 Billion, total incomes and spending will rise by $1.25 Billion×3.33=$4.2 Billion

38. Correct answer: C The loss in consumer surplus because of higher prices is represented by area E + F + G + H. This exceeds the gains from producer surplus (E) and government revenues on imports (G). Hence the net welfare effect to the country is a loss of [E + F +G+H]‐[E]‐[G]=F+H. 39. Correct answer: A The cross‐price elasticity is positive, indicating that as the price of Y increases, more of X is demanded, making X and Y substitutes. 40. Correct answer: B On rearrangement the demand function is

Tennis Match Tennis MatchQ = 45 - 5.0 P

The number of matches played per month at $4.00/match = 45 ‐ 5.0×4.00 = 25 The Y‐intercept of the demand curve occurs when Q = 0; P = 9


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The X‐intercept of the demand curve occurs when P = 0; Q = 45 The club will be able to charge the consumer surplus: the area under the demand curve above the per match price to a total of 25 matches: 0.5×($9.00 ‐ $4.00)×25 = $62.50. This is illustrated in the diagram as triangle A.

41. Correct answer: B Output (units) Price($/unit) Total Revenues Total cost ($/unit) Profit 20 2,800 56,000 10,600 45,400 60 2,400 144,000 66,600 77,400 100 2,000 200,000 170,600 29,400

42. Correct answer B Unemployment rate = Unemployed / Labor force×100 = 95/750×100 = 12.6%. 43. Correct answer B Average weekly initial claims for unemployment insurance are a leading indicator of economic activity and a decline is an indicator of rehiring at the start of a recovery. 44. Correct answer: B GBP investment £2.0979 (1 +0.016025×180 / 360) = £2.1147 NZD investment NZ$1× (1 + 0.032875×180 / 360) = NZ$1.0164 The forward rate is determined by equating these two terminal amounts. GBP / NZD Forward Rate = £2.1147 / NZ$1.0164 = £2.0806 / NZ$ Forward points = (Forward ‐Spot) × 10,000 = (2.0806 ‐2.0979) × 10,000 = ‐173.0 45. Correct answer: A Information about management compensation and any potential conflicts of interest that may exist between management and shareholders is typically provided in the proxy statement.

C

10 8 6 4 2 0 5 10 15 20 25 30 35 40 45 50

P R I C E

A

B

P=9‐0.20×Q

QUANTITY


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46. Correct answer. B Given Assets = Liabilities + Equity First calculate ending equity ($318,000,see calculation below) $800,000=Liabilities + $318,000 Total Liabilities = $ 482,000 Contributed capital $ 50,000Initial retained earnings 225,000Sales revenues 450,000Investment income 5,000Expenses (402,000)Net income for the year 53,000Dividends paid (10,000)Increase in retained earnings 43,000 43,000Ending owners’ equity $ 318,000

47. Correct answer: C Relevance and faithful representation are the two fundamental qualitative characteristics that make financial information useful according to the IASB Conceptual Framework. 48. Correct answer: C Total comprehensive income = Net income + other comprehensive income Net Income = revenues ‐ expenses Other comprehensive income includes gains or losses on available‐for‐sale securities and translations adjustments on foreign subsidiaries. (Revenues ‐ expenses) + gain on AFS ‐loss on FX translation (12,500 ‐ 10,000) + 1,475 ‐325 = 3,650. 49. Correct answer: C The allowance for doubtful accounts increases by the bad debt expense recognized for the year and decreases by the amounts written off during the year. Beginning balance allowance 56 Plus bad debt expense ? Less write‐offs (84) Ending balance allowance 92 Therefore Bad debt expense =120

50. Correct answer: A Cash flow debt coverage ratio = CFO ÷ Total debt. 105.9÷512.8 = 20.6% 51. Correct answer: C Specific identification matches the actual historical costs of the specific inventory items to their physical flow: the costs remain in inventory until the actual identifiable inventory is sold.


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52. Correct answer A The interest costs can be capitalized. Under IFRS any amounts earned by temporarily investing the funds are deducted from the capitalized amount． The costs related to the preferred shares cannot be capitalized. Capitalized costs Interest costs 0.08×5,000,000=400,000 Less interest income 0.07×2,000,000×0.5=(70,000) Total capitalized costs 330,000

53. Correct answer: B A valuation allowance is required under U.S. GAAP if there is doubt about whether a deferred tax asset will be recovered. Under IFRS the deferred tax asset is written down directly. 54. Correct answer : C The book value of the bonds on 1 January 2011 is equal to the present value of the remaining coupon payments and principal discounted at the market rate at time of issue (3% per period). Coupon = 0.08×0.5×5,000,000 = 200,000; there are 4 years remaining or 8 coupon payments. Book value = 200,000 PV Annuity (n = 8; i = 3%) + 5,000,000 PV (n = 8; i = 3%) = 1,403,938 + 3,947,046 = 5,350,984 Using a financial calculator PMT = 200,000; FV = 5,000,000; (I % = 3%; N = 8); Compute PV = 5,350,984 Because the market interest rate when the bonds are bought back（8%）is equal to the coupon rate, the company can buy back the bonds at par $5,000,000. Cost of repurchase $5,000,000 Book value 5,350,984 Gain on retirement 350,984 On the cash flow statement the gain would be deducted from net income in calculating the cash from operations under the indirect method, and the cash paid to repurchase the bonds would be a cash outflow in the financing section. 55. Correct answer: A The candidate should be able to analyze and describe the following ways to manipulate the cash flow statement • stretching out payables, • financing of payables, • securitization of receivables, and • using stock buybacks to offset dilution of earnings. The sale of a long‐term receivable would increase cash from investing activities; the other two activities mentioned are operating activities.


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56. Correct answer: C Example Capitalizing delivery cost as opposed to expensing it. FCFF CFO + interest ×(1‐t)—capital expenditures Capital expenditures If capitalized，the amount capitalized increases capital

expenditures and is recorded as a cash outflow from investing activities．

CFO The CFO will be higher by amount capitalized, i.e., the amount not expensed.

Since capital expenditures and CFO increase by the same amount, FCFF is unchanged.

57. Correct answer: C The general journal records transactions in the order in which they occur (chronological order) and is therefore sorted by date. 58. Correct answer: B Without the recognition of the standards by the regulatory authorities, such as the U.S. Securities and Exchange Commission, the private sector standard‐setting bodies, such as U.S. FASB, would have no authority. 59. Correct answer: C Common‐sized analysis of the income statements shows that Company A has a lower percentage cost of goods sold and hence a higher gross margin than the industry. Co A Co B Industry Co A Co B Sales $10,500 $8,250 100.0% 100% 100% Cost of goods sold 6,353 5,239 62.8% 60.5% 63.5% Gross margin 37.2% 39.5% 36.5% Company A earns a higher gross margin than both Company B and the industry. Pretax earnings 683 454 5.4% 6.5% 5.5% Taxes 205 145 1.7% 2.0% 1.8% Tax rate = taxes ÷ pretax earnings

32% 30% 32%

The tax rates for the companies are not higher than the industry.The interest rate is not a function of sales and cannot be analyzed on a common sized income statement .Tax rates are determined based on taxes ÷ pretax earnings, not as a percentage of sales (as shown in common sized analysis). 60. Correct answer A Under U.S. GAAP, intangibles must be valued at historical cost whereas under IFRS, they can be


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valued at cost or revaluation. 61. Correct answer: A Only the cash flows for the purchase of the shares in an affiliated company are cash from investing activities; therefore the net amount is ‐ $275,000. Cash flows from trading securities are operating activities. 62. Correct answer: B Cash conversion cycle = Days sales outstanding + Days of inventory on hand — Days of payables Accounts receivable

Days in sales(DSO) InventoryDays on hand(DHO)

Accounts payables Days in payables

Turnover SalesA/R

Cost of Goods Sold

Inventory

PurchasesPayables

4,800÷625 2,880÷170 2,940÷145 =7.68 times =4.06 times =20.3 times In days 365÷7.68 365÷4.06 365÷20.3 =48days =90days =18days Cash conversion cycle=DSO+DOH‐Days in Payables=48+90‐18=120 days

63. Correct answer: C When using the FIFO inventory method the ending inventory, the cost of goods sold and the gross margin are the same under either the perpetual or periodic methods. 64. Correct answer: A For investment properties, when using the fair value model of revaluing assets, all increases and decreases affect the net income. Here, it is 54.5 — 48.0 = 6.5. 65. Correct answer: B Evaluate the impact of tax rate changes on a company’s financial statements and ratios. Deferred tax liability=taxable temporary difference×tax rate In 2010 if the rates had not changed, and deferred tax liability would be:

0.30×4,000= £1200

But with the lower tax rate, the deferred tax liability will be: 0.25×4,000= £1000 Effect of the change in rate therefore is a decrease in the liability £(200) Alternative calculation=change in rate×taxation difference ‐5%×4,000 £(200)

66. Correct answer: B The most appropriate way to identify a LIFO liquidation is by reviewing the inventory footnotes for a decrease in the LIFO reserve. Although LIFO liquidation may result in an increase in gross margin or changes in inventory out of line with changes in sales, there are other factors could explain those changes. 67. Correct answer: C


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The candidate should be able to demonstrate the use of pro forma income and balance sheet statements. Net income is calculated as follows: Sales $2,500 Given Variable costs (750) 30% of Sales Fixed costs (1,400) Given Interest expense (25) 0.05×500 average debt Earnings before 325 Taxes (81.25) 25% of EBT Net income $243.75 Rounded to $244

68. Correct answer: B The expected remaining useful life of a company’s overall asset base

= net PPE ÷ depreciation expense

Depreciation expense equals the change in accumulated depreciation A

375‐250=125

The expected remaining useful life 2125÷125=17years When there are no asset disposition or acquisitions as appears to be the case here, because the gross PPE does not change.

69. Correct answer: B The NPV of project A is €1,780.59

1 2 3 4

345 849 635 36451780.59 24501.08 (1.08) (1.08) (1.08)

= − + + + +

The NPV of project B is €1,765.36

2 3 4

345 849 1051 31751765.36 24501.08 1.08 1.08 1.08

= − + + + +

Because Project A has a higher NPV and the projects are mutually exclusive, only Project A should be accepted. 70. Correct answer:B Based on equation (10) with D/E referring to the debt‐to‐equity ratio:

[1 ((1 ) )]equity assetDtaxrateE

β β= × + − ×

If the tax rate increases, then the bracketed term decreases, making the equity beta decrease because the asset beta is unchanged. 71. Correct answer:B Convert the P/E to the earnings yield (E/P): 1 ÷ 12.5 = 8%. Because the after‐tax cost of the external funds is higher than the earnings yield i.e., 9% > 8%), the PS will decrease after the repurchase.


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72. Correct answer: B A “pull” on liquidity occurs when disbursements are made too quickly (e.g., current liabilities are paid instead of being held or when credit availability is reduced or limited). A “drag’ on liquidity occurs when receipts lag (i.e., non‐cash current assets do not convert to cash quickly). Consequently, a reduction in a credit line is a “pull” on liquidity. 73. Correct answer B Under best practices in corporate governance procedures, independent board members should have a lead” director when the board chair is not independent. 74. Correct answer: C Convert D/E to the weight for debt:

1 0.503 (1 0.50)1

DEDE

= =++

The weight for equity is one minus the weight of debt: 2 113 3= −

WACC = weight of debt×cost of debt×(1 — tax rate) + weight of equity×cost of equity

1 20.08 (1 0.04) 0.13 0.1026 10.26%3 3× × − + × = =


quantity contributionmarginDOL=[quantity contributionmargin-fixedcosts]

$20 100,000DOL(100000units)= =1.3333[$20 100,000-$500,000]

$20 200000DOL(200000units)= =1.143[$20 200000-$500000]

$2DOL(300000units)=

××

××

××

0 300000 =1.091[$20 300000-$500000]

××

The DOL is lowest at the 300,000 units production level. 76. Correct answer: B The ex‐dividend date is normally determined by the security exchange on which the shares are listed. The corporation determines the holder‐of‐record date and declaration date. 77. Correct answer C Of the methods listed, open market repurchases take the longest time to execute.


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78. Correct answer: B Accounts payable Accounts payableThe days in payables = =Purchases 365 (Change in inventory + Cost of goods sold) 365

$600= =35.3($1200-$1000 + $6000) 365

÷ ÷

÷

79. Correct answer C Regulators impose minimum levels of capital that apply across the board to all regulated firms, not the optimum level that is firm‐specific and determined by the firms themselves. 80. Correct answer C Putable common shares facilitate raising capital because of their appeal to investors over callable common shares. The put feature gives investors the right to sell the shares back to the issuing company when the market price is below the pre‐specified put price. 81. Correct answer: B Enterprise Value (EV) = Market capitalization + MV of debt + MV of preferred stock ‐ cash & short‐term investments EV = 45 + 10 ‐2.5 = 52.5; EV/EBITDA = 52.5 / 15 = 3.5 82. Correct answer A Dividend growth rate = (1 ‐ Payout ratio) × ROE = 0.4 ×12.5 = 5%; Justified forward P/E: P0 / E1 = p/ (r — g); Where p is the payout ratio = 0.60 / (0.10 — 0.05) = 12× intrinsic value:P0 = P/E1 × E1 = 12 × $3 = $36 83. Correct answer: B Because the current market value is well below the retraction price, retraction is likely and the preferred share will be priced on the basis of retraction feature. Quarterly dividend = ($50×0.08) /4 = $1 a share; Quarterly required return = 12% / 4 = 3%; V0= [$1/1.03 + 1/1.032 + 1/1.033 + ... + 1/1.0311 + 1/1.0312+ 50/1.0312] = $45.02 Using a financial calculator: PMT = $1, N = 12; FV = $50; I = 3%; Compute PV = $45.02 84. Correct answer A The EV/EBITDA approach is most useful when comparing companies with significant differences in capital structure. EBITDA is computed prior to payment to any of the company’s financial stakeholders and is not impacted by the amount of debt leverage. 85. Correct answer: A A stock whose intrinsic value is less than its current market price is overvalued. Therefore, the most appropriate strategy is to sell the stock short. Short sellers profit by selling at high prices and repurchasing at lower prices.


156

86. Correct answer: A Selling unproductive land and using the proceeds from the sale to buy back shares reduces the total assets. Holding sales constant, the decrease in assets would improve the asset turnover. Buying back shares increases the firm’s financial leverage. Both the increase in asset turnover and financial leverage will lead to a higher return on equity. 87. Correct answer: A ECEE is a measure of the firm’s dividend paying capacity. 88. Correct answer: A Net profit margin = Net earnings / Sales; Net earnings = Net profit margin×Sales; DPS (Net earnings×Payout ratio) / # of outstanding shares; Therefore, Next years DPS = ($180 million x 0.15 x 0.60) / 8 million = $2 V = 2/1.12 + 2(1.25)1 / 1.122 + 2(1.25)2 / 1.123 + [2(1.25)2 (1.05) / (0.12 ‐ 0.05)] / 1.123 = $1.79 + $1.99 + $2.22 + $33.36 = $39.36 89. Correct answer A Initial equity (%) in the margin transaction = 1/ Leverage ratio = 1 / 1.66 = 0.60; Initial equity per share at the time of purchase = $36×0.60 = $21.60; Price at which margin call occurs. Equity per share / Price per share = Maintenance margin % = ($21.60 + P ‐ $36) / P = 0.30; 0.7P = $14.40; P = $20.57. 90. Correct answer: C If securities markets are semi‐strong form efficient, active trading to exploit price patterns or public information is not likely to generate abnormal returns. Thus, both technical and fundamental analyses become futile exercises. 91. Correct answer C C is correct because when a commodity market is in backwardation, the futures price is below the spot price as market participants believe the spot price will be lower in the future. When spot prices are below the futures price, the market is said to be in contango. 92. Correct answer: A A is correct because to arrive at the estimated value of the property, subtract operating expenses from gross income ($625,000— (3.75%×$625,000) — $65,000 — $27,000 — $62,000 = $447,563). Then divide the net operating income by the cap rate ($447,563 / 0.085) = $5,265,441).Note that neither depreciation nor financing costs are deducted as operating expenses. 93. Correct answer: B B is correct because you calculate the probability of success as (1 — 0.35)×(1 — 0.20)×(1 — 0.15)×(1 — 0.15)×(1 — 0.15) = 0.319345.


157

5

7500000 2500000 1755701 0.319345 5606741.12

- = ´ =

Subtract the NPV of failure, — 2,500,000×(1 — 0.319345 or 0.680655) = —1,701,638. The difference between the NPVs is the expected NPV of the project 560,674 — 1,701,638 = —$1,140,964. 94. Correct answer: B B is correct because it results in the lowest cost over 3 years, as the table below shows: Year 1 Year 2 Year 3 Total Class A 1.00+2.75 1.00 1.00 5.75 Class B 1.25 1.25 1.25+1.00 4.75 Class C 1.25 1.25 1.25+1.50 5.25

95. Correct answer: B B is correct because the cost approach attempts to determine what it would cost to replace the company’s assets in their present form, not original cost. 96. Correct answer: B B is correct because hedge fund managers themselves decide whether they want to be included in a database. Managers who have funds an unimpressive track record will not wish to have that information exposed 97. Correct answer: C C is correct because a sinking fund provision requires retirement of a portion of the bond issue each year, rather than retirement of the entire issue at maturity. 98. Correct answer: A. A is correct because duration assumes that all interest rates across the yield curve change by the same amount and therefore each bond’s yield changes by the same amount. 99. Correct answer: B B is correct because the after‐tax yield of the taxable security is lower than the yield on the tax‐exempt security for both investors. After‐tax yield= Pre‐tax yield×(1 — Marginal tax rate). For Investor A, the After‐tax yield = 6.30%×(1 — 0.45) = 3.47%. For Investor B, the After‐tax yield 6.30%×(1 —0.30)=4.41%. Both are less than 4.50% and the investor will choose the investment with the highest after‐tax yield. 100. Correct answer: A A is correct because a STRIPS security is a zero‐coupon bond with no default risk and therefore represents the appropriate discount rate for a cash flow certain to be received at the maturity date for the STRIPS. 101. Correct answer: A


158

( ) ( ) ( )2 3 41

1, 476 1, 476 1, 476 1, 476 1, 406 1,339 1, 275 1, 214 5, 2341.05 1.05 1.05 1.05

+ + + = + + + =

102. Correct answer: A A is correct because the bond is priced below its par value but will be worth exactly par value at maturity. Overtime, assuming a stable discount rate, the value of the bond must rise so that it is equal to par at maturity. 103. Correct answer: A A is correct because the value of a zero‐coupon bond is

no. of years 2

Maturity value ,where i is the(1+i) ×

18 2

$1000semi-annualdiscountrateor $122.741.06 × =

104. Correct answer: C C is correct because the yield to worst for a callable bond is the lowest of the yields to call for each possible call date and the yield to maturity. The yield to call or yield to maturity solves the following equation:

1/ (1 )

Tt

tt

P CF i=

= +∑

where i is the yield to call, or yield to maturity CF is the cash flow at date t, and T is the maturity or

call date. The yield to call if the bond is called in one year is 8.57%, because 105= 1

10 1041.0857+

The yield to call if the bond is called in two years is 8.15%, because 105= 1 2

10 10 1021.0815 1.0815

++ . The

yield to maturity of the bond is 8.06%, because 1 2 3

10 10 10 1001051.0806 1.0806 1.0806

+= + + . The yield to

worst is the lowest of these and occurs when the bond is held until maturity (i.e., it is the yield to maturity). 105. Correct answer: B B is correct because for short‐term securities, the difference between the nominal spread (which does not account for the shape of the yield curve) arid the zero‐volatility spread or Z‐spread (the spread over the entire theoretical spot rate curve) is small. This difference grows with the maturity of the security and as the slope of the yield curve increases. 106. Correct answer: B

B is correct because 1/66 1 1 1 1 2 1 5[(1 ) (1 f ) (1 f )... (1 f )] -1Z Z= + × + × + × + , which is then multiplied

by 2 to convert to a bond‐equivalent basis, where the forward rates are adjusted to a semi‐annual basis and Z1=1f0. Therefore, Z6 =[1.0025×1.0035×1.0050×1.0075=0.0074×2=1.48% 107. Correct answer: A


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A is correct because the full valuation approach allows modeling of the response to both parallel and non‐parallel yield curve changes and will reflect cash flows that change when interest rates change, whereas the duration/convexity approach assumes parallel yield curve changes and fixed cash flows. 108. Correct answer: B

B is correct because the effective duration of a bond is 00

, ,2V VD whereV V andVV y− +

− +

−=

× ×Δare the

values of the bond when the yield falls, under the current yield, and when the yield rises, respectively, and Δy is size of the yield change.

Therefore, 94.474 91.041D= 3.09

2 92.733 0.0060−

=× ×

109. Correct answer: A A is correct because a swap is a series of forward payments. Specifically, a swap is an agreement between two parties to exchange a series of future cash flows. Given that the contract is for 1 year and the floating rate is based upon 3‐month LIBOR, at least 4 payments will be made during the year. 110. Correct answer: C C is correct because the portfolio manager entered into a contract to sell the stock to the dealer at $160 per share in 2 months time. 31,250 shares×EUR 160 = EUR 5,000,000. 111. Correct answer A A is correct because the future has a price limit of $5, therefore, it settled at the highest possible level of $111.Therefore, the marked to market value would be ($111‐$106)×40=$200 112. Correct answer: C C is correct because a cash flow such as a dividend payment is required for an early exercise. A dividend payment doesn’t guarantee early exercise, as the dividend also needs to be large enough to justify the early exercise. 113. Correct answer: B B is correct because the bank’s payments are based upon a notional principal of EUR 50,000,000 and an interest rate of 4.5%. The payment is: EUR 50,000,000×(0.045)×(180 / 360) = EUR 1,125,000. 114.Correct answer: B B is correct because buying a call gives the owner the right to buy the stock at the exercise price. The investor predicts that the stock will increase to $95 at the end of two months. He will be able to exercise the call, buy the stock at $88, and sell it at $95, thereby making a profit. 115. Correct answer: C C is correct Performance measurement is a part of the feedback step of the portfolio management process.


160

116. Correct answer: B B is correct. AB A BCov (A,B) = = 0.75 0.4 0.3 = 0.09ρ σ σ × ×

117. Correct answer: A A is correct. The optimal risky portfolio lies at the point of tangency between the capital allocation line and the efficient frontier of risk assets. 118. Correct answer B Calculate and interpret the expected return of an asset using the CAPM. B is correct. E(RGBK) = 0.03 + 0.65×(0.09 — 0.03) = 0.069 119. Correct answer B B is correct. A return generating model based on factors such as earnings growth and cash flow generation is a fundamental factor model. 120. Correct answer A A is correct. Jensen’s alpha= P f P m fR -[R + (R -R )]β

=0.155 — [0.025 + 1.2×(0.118 — 0.025)] = 0.0184


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2010 Level 1 Sample Exam SS1‐ETHICAL AND PROFESSIONAL STANDARDS (27 MINUTES) 1. Abasi Hasina, CFA, signed an employment contract with a non‐compete clause restricting him

from working for a competitor for three years after leaving the employer, an investment bank. After one year, Hsaina quits his job for a position with an investment bank in a city across the country. The new job pays twice as much as the old one. Lawyers with whom he consulted determined the non‐compete clause was a violation of human rights and thus illegal, so he took the offer. Did Hssina most likely violate the CFA Institute Code of Ethics?

A. Yes B. No, the non‐compete clause was considered illegal. C. No, the non‐compete clause is void since the new position is geographically distant. 2. Benefits of compliance with the CFA Institute Global Investment Performance Standards(GIPS )

least likely include: A. strengthening of internal controls. B. Participation in competitive bidding. C. Elimination of in‐depth due diligence for investors. 3. Who is most likely responsible for claiming and maintaining compliance with CFA Institute

Global Investment Performance Standards (GIPS)? A. An independent third party B. The firm claiming compliance C. The risk management department 4. Mariam Musa, CFA, Head of Compliance at Dunfield Brokers, questions her colleague Omar

Kassim, a CFA Candidate and a research analyst, about his purchase of shares in a company for his own account immediately before he published a "buy" recommendation. He defends his actions by stating he has done nothing wrong because Dunfield doesn't have any personal trading policies in place. The CFA Institute Code of Ethics and Standards of Professional Conduct were most likely violated by:

A. only Musa. B. only Kassim C. both Musa and Kassim. 5. Zhao Xuan, CFA, is a sell side investment analyst. While at a software industry conference, Xuan

hears rumors that Green Run Software may have falsified its financial results. When she returns


162

to her office, Xuan conducts a thorough analysis of Green. Run. Based on her research, including discussions with some of Green Gun's customers, Xuan is convinced that Green Run's reported 50 percent increase in net income in recent quarters is completely fictitious. So far, however, Xuan is the only analyst that is suspicious about the company's reported earning. According to the CFA Institute Code of Ethics and Standards of Professional Conduct, the least appropriate action for Xuan is to:

A. report her suspicions to Green Run's management. B. do nothing, until her analysis is supported by other analysts. C. Recommend that her clients sell their Green Run shares immediately. 6. Richard Cardinal, CFA, is the founder of Volcano Capital Research(VCR), an investment

management firm whose sole activity is short selling. Cardinal seeks out companies whose stocks have had large price increases. Cardinal also pays several Washington lobbying firms to update him immediately on any legislative or regulatory changes that may impact his target companies. Cardinal sells short those target companies that he estimates are near the peak of their sales and earnings and that his Washington sources identify as facing legal or regulatory challenges. Immediately after he sells a stock, Cardinal conducts a public relations campaign to disclose all of the negative information he has gathered on the company, even if the information is not yet public, Cardinal then encourages shareholders to file widely publicized shareholder class‐action lawsuits that seek damages because the stock dropped in price. Which of Cardinal's following actions is least likely to be in violation of the CFA Institute Standards Professional Conduct?

A. Selling stock short B. Trading on information from lobbyists C. Disclosing information about target companies 7. Kirsten Kelso, CFA, is a research analyst at an independent research firm. Kelso is part of a team

of analysts who focus on the automobile industry. Recently, Kelso disagreed with two research "sell" recommendations written by her team even though she felt confident the research process was properly conducted. In discussions with several clients, Kelso states "even though my name is on the sell reports, these stocks are a buy because sales and share prices for both auto companies will rise significantly due to strong demand for their vehicles." Concerning the "sell" recommendations, which of Kelso's following actions would most likely violate the CFA Institute Standards of Professional Conduct?

A. Dissociating from the report B. Distinguishing between fact and opinion C. Sharing her personal opinion of the stocks 8. Gardner Knight, CFA, is a product development specialist at an investment band. Knight is

responsible for creating collateralized debt obligations (CDOs) consisting of residential mortgage bonds. In the marketing brochure for his most recent CDO, Knight provided a list of the


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mortgage bonds that the CDO was created from. The brochure also states that “ an independent third party, the collateral manger, had sole authority over the selection of all mortgage bonds used as collateral in the CDO.” However, Knight met with the collateral manager and helped her select the bonds for the CDO. Knight is least likely to be in violation of which CFA Institute Standards of Professional Conduct?

A. Suitability B. Conflicts of interest C. Communications with Clients and Prospective Clients 9. Monique Gretta, CFA, is a research analyst at East West Investment Band. Gretta has several

long‐standing relationships with mutual funds and institutional investors. Gretta often provides these clients with draft copies of her research before disseminating the information to all of the bank’s clients. This practice has helped Gretta avoid several errors in her reports and she believes it is beneficial to the rest of her client base. Regarding her research, Gretta least likely violated the CFA Institute Code of Ethics and Standards of Professional Conduct because:

A. her report is a draft. B. Of her conflicts of interest C. this practice benefits clients. 10. Which of the following least likely reflects the two primary principles of the CFA Institute Rules

of Procedure for Professional Conduct? A. Confidentiality of proceedings B. Fair process to the member and candidate C. Public disclosure of disciplinary sanctions 11. Fundamental Asset Managers (FAM) claims compliance with the CFA Institute Global Investment

Performance Standards (GIPS) and manages both discretionary and nondiscretionary accounts. Alma Dzuya, CFA, includes all discretionary, fee‐paying value and growth accounts when constructing a composite for FAM. Does the composite Dzuya constructed most likely meet GIPS criteria?

A. Yes. B. No, because value and growth accounts are included, C. No, because nondiscretionary accounts are not included. 12. Adira Badawi, CFA, who owns a research and consulting company, is an independent board

member of a leading cement manufacturer in a small local market. Based on Badawi's expertise in the cement industry, a foreign cement manufacturer looking to enter the local market has hired him to undertake a feasibility study. Under what circumstances can Badawi most likely undertake the assignment without violating the CFA Code of Ethics and Standards of Professional Conduct?


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A. If he makes full disclosure to both companies, B. If he receives written permission from the local company. C. If he signs confidentiality agreements with both companies, 13. Noor Mawar, CFA, manages a trust fund for an orphaned 18‐year‐old student. The trust assets

are expected to provide the beneficiary with a stable, low‐risk source of income until she reaches 30. The student asks Mawar to invest in a new business venture expected to provide a handsome income return over the next 10 to 25 years as was discussed on an Internet blog. Mawar ignores the request, instead securing conservative investments to provide sufficient income. Did Mawar most likely violate the CFA Code of Ethics and Standards of Professional Conduct?

A. Yes B. No, because the client's objectives were met. C. No, because the student's age allows for a high‐risk profile 14. Vishal Chandarana, an unemployed research analyst, recently registered for the CFA Level I exam.

After two months of intense interviewing, he accepts a job with a stock brokerage company in a different region of the country. While posting on his social networking webpage he brags about how being a CFA Candidate really helped him get a job. He adds he was so relieved his new employer didn't ask about his being fired from his former employer. Which CFA Code of Ethics or Standards of Professional Conduct did Chandarana least likely violate?

A. Integrity B. Duties to Employers C. Reference to the CFA Program 15. Kam Bergeron, CFA, is an equity portfolio manager who often takes time off in the afternoon to

play golf with important clients. Today, Bergeron is on the golf course when his game is interrupted by a phone call from his office. The call is from Bergeron's assistant, who notifies him of a steep and accelerating market decline. Bergeron, eager to get back to his clients tells his assistant to raise cash by selling 15 percent of all clients' holdings. Bergeron instructs his assistant to first sell the most liquid stocks in each client's portfolio and then do the same for his personal account. Bergeron is least likely to be in violation of which CFA Institute Standards of Professional Conduct?

A. Suitability B. Priority of transactions C. Diligence and reasonable basis 16. Ileana Inkster, CFA, was recently offered a senior management position with the trust

department of a regional bank. The department is now but the bank has plans to expand it significantly over the next few months; Inkster has been told she needs to aid that growth and


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has been asked to have her department conduct educational seminars and then pursue new business by follow‐up contacts with the attendees. Inkster notices that advertisements for upcoming seminars, prepared by the marketing department, do not mention any investment products. The ads indicate attendees can "learn how to immediately earn $100,000 to their net worth." What is the first action Inkster most likely should take to avoid violating any CFA Institute Standard a of Professional Conduct?

A. Decline to accept the new position, B. Accept the position and revise the marketing material. C. Accept the position but bring the lack of procedures to the attention of senior management. 17. Molly Burnett, CFA, is a portfolio manager that specializes in investing in environmentally

friendly companies. A multinational utility company recently acquired one of Burnett's best performing in vestments, a wind power company. The wind power company's shareholders received utility company shares as part of the merger agreement. The utility has one of the worst environmental records in the industry, but its shares have been one of the top performers over the past 12 months. Because the utility pays a high dividend every three months, Burnett holds the utility shares until the remaining two dividends are paid for the year, and then sells the shares. Burnett mot likely violated the CFA Institute Standards of Professional Conduct concerning:

A. suitability B. disclosure of conflicts. C. Independence and objectivity. 18. Pia Nilsson is a sole proprietor investment advisor. The economic recession has reduced the

number of clients that she advises and her revenues. As a result, Nilsson has not paid her CFA Institute membership dues for the past two years. When a national financial publication interviewed Nilsson recently, she indicated that she had been a CFA charterholder for many years. In addition, she stated that the completion of the CFA program contributed to her successful career, enhanced her portfolio management skill, and enabled her to achieve superior returns and performance results. Nilsson's actions concerning which of the following most likely violated the CFA Institute standards of Professional Conduct?

A. Discussion of the CFA Program B. Nonpayment of CFA Institute Membership dues C. Statement about being a CFA charterholder SS2/3‐QUANTTATIVE ANALYSIS (21 MINUTES) 19. The stated annual interest rate is 20 percent and the frequency of compounding is monthly. The

effective annual rate (EAR) is closest to:


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A. 20% B. 21% C. 22% 20. For a positively skewed unimodal distribution, which of the following measure is most accurately

described as the largest? A. Mode B. Mean C. Median 21. A project offers the following incremental after‐tax cash flows:

Year 0 1 2 3 4 5 6

Cash flow(€) ‐12,500 2,000 4,000 5,000 2,000 1,000 500

The internal rate of return of the project is closest to: A. 4.4% B. 5.5% C. 19.3% 22. Given the following data, the portfolio return is closest to:

Asset class Asset allocation (weight) (%)

Asset class return(%)

Correlation with equities class (%)

Equities 45 16 100

Mortgages 25 12 30

Cash and equivalents 30 2 10

A. 8.2% B. 10.0% C. 10.8% 23. Rank the following portfolios based on their Sharpe ratios. The risk‐free rate is 4 percent.

Portfolio Mean return on the portfolio (%)

Standard deviation of the return on the portfolio (%)

A 10 20

B 18 15


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C 6 3 Which portfolio has the highest Sharpe ratio? A. Portfolio A B. Portfolio B C. Portfolio C 24. If two events, A and B, are independent and the probability of A does not equal the probability

of B (i.e., P (A)≠ P(B)), then the probability of event A given that event B has occurred (i.e., P(A∣B)) is most accurately described as:

A. P(A) B. P(B) C. P(A I B) 25. The following sample of 20 items is selected from a population. The population variance is

unknown.

10 20 ‐8 2 ‐9

5 0 ‐8 3 21

‐11 5 3 7 11

‐5 ‐8 12 ‐6 . 6

The Standard error of the sample mean is closet to: A. 2.1. B. 2.5. C. 9.4. 26. An analyst has established the following prior probabilities regarding a company's next quarter's

earnings per share (EPS) exceeding, equaling, or being below the consensus estimate.

Prior probabilities

EPS exceed consensus 25%

EPS equal consensus 55%

EPS are less than consensus 20%

Several days before releasing its earnings statement, the company announces a cut in its dividend. Given this information, the analyst revises his opinion regarding the likelihood that the company will have EPS below the consensus estimate. He estimates the likelihoods the company will cut the dividend given that EPS exceed/meet/fall below consensus as reported below.


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Probabilities the company cuts dividends conditional on EPS exceeding/equaling/falling below consensus

P(Cut div ∣EPS exceed) 5%

P(Cut div∣EPS equal) 10%

P(Cut div∣EPS below) 85%

Based on this analysis, the updated (posterior) probability that the company's EPS are below the consensus is closest to: A. 72% B. 85% C. 100% 27. If the distribution of the population form which the samples are drawn is positively skewed, the

sampling distribution of the sample means for samples drawn from that population is most likely:

A. approximately normally distributed, B. to have a variance equal to the entire population C. to have a mean smaller than the mean of the entire population 28. A project offers the following incremental after‐tax cash flows:

Year 0 1 2 3 4

Cash flow (€) ‐12,500 2,000 4,000 5,000 2,000

The appropriate discount rate to use in evaluating the project is 8 percent. The NPV (in €) of the project is closest to: A. ‐1,780 B. ‐1,736 C. 474 29. Over a four‐year period, a portfolio has returns of 10 percent, ‐2 percent, 18 percent, and ‐12

percent. The geometric mean return across the period is closest to: A. 2.9% B. 3.5% C. 8.1% 30. Monte Carlo simulation is best described as:


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A. an approach to back testing data. B. Providing exact analytic solutions to complex functions. C. Providing a distribution of possible solutions to complex functions. 31. A subset of a population is best described as a: A. sample. B. statistic C. parameter. 32. Assume that the real risk‐free rate of return is 3 percent and that the expected inflation

premium is 5 percent. If the risk premium incorporates default risk, liquidity risk, and any maturity premium, and observed (nominal) interest rate of 12 percent implies that the risk premium is closest to:

A. 2% B. 4% C. 8% SS4/5/6‐ECONOMIC (18 MINUTES) 33. Consumer surplus is best described as being: A. always less than or equal to zero. B. always greater than or equal to zero. C. at times positive and at other times negative. 34. A local laundry and dry cleaner collects the following data on its workforce productivity. Workers

always work in teams of two. The laundry charges $3.00 to launder a shirt (revenue is $3.00 per shirt laundered).

Quantity of Labor (L) (Workers) Total Product (TP) (Shirts Laundered per Hour)

0 0

2 20

4 36

6 50

8 62

The marginal revenue product ($ per worker) for hiring the fifth and sixth workers is closest to: A. 14. B. 21 C. 42


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35. Holding the working‐age population constant, if the labor force participation rate declines while

the number of people employed remains unchanged, the unemployment rate is most likely to: A. increase B. decrease C. remain unchanged. 36. Which of the following actions on the part of a central bank is most consistent with increasing

the quantity of money? A. Selling securities on the open market B. Increasing the required reserve ratios C. Purchasing securities on the open market 37. Perfect price discrimination is best described as pricing that allows producers to increase their

economic profit while consumer surplus: A. increase B. decreases C. remains steady. 38. Which of the following multipliers is least likely to be part of fiscal policy? A. Money multiplier B. Balanced budget multiplier C. Government expenditure multiplier 39. Which of the following government interventions in market forces is most likely to cause

underproduction? A. Subsidies B. Price floors C. Production quotas 40. Demand for a good is most likely to be more elastic when: A. the good is a necessity. B. a lesser proportion of income is spent on the good. C. there has been a longer time since the price change 41. If the currency drain ratio is 1.05 and the desired reserve ratio is 0.20, the money multiplier is

closest to:


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A. 1.26 B. 1.64 C. 5.25 42. An economy in which all firms and individuals, whether suppliers or consumers, accept the

market price as their transaction price is best described as: A. an oligopoly. B. perfectly competitive C. monopolistic competition 43. Suppose that at a tax rate of 85 percent, a nation's growth rate in GDP is 2 percent and its tax

revenue is the equivalent of $100 billion. If the nation reduces its rate to 50 percent, growth rate of GDP becomes 6 percent, and tax revenue increase to $120 billon. Such a possibility is best described as an example that is consistent with the:

A. tax wedge, B. Laffer cruve C. Phillips curve 44. In the United States, monetary policy is primarily a function of the: A. Congress. B. President. C. Federal Reserve System SS7/8/9/10‐FINANCIAL STATEMENT ANALYSIS (47 MINUTES) 45. Which of the following statements is most accurate about the responsibilities of an auditor for a

publicly traded firm in the United States? The auditor: A. Assures the reader that the financial statement are free form error, fraud, or illegal acts. B. Must express an opinion about the effectiveness of the company's internal control systems. C. Must state that it has prepared the financial statements according to generally accepted

accounting principles. 46. In accrual accounting, if an adjusting entry results in the reduction of an asset and the recording

of an expense, the originating entry recorded was most likely a(n): A. prepaid expense B. accrued expense C. unearned revenue.


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47. At the beginning of the year, a company had total shareholders' equity consisting of ￥50,000 in retained earnings, contributed capital at the start was ￥200,000.

During the year, the following events occurred: ￥

1.Net income reported . 42,000

2.Dividend paid 7,000

3.Realized loss on available‐for‐sale investments 3,000

4.Foreign currency translation gain on foreign subsidiaries 8,000

5.Repurchase of company stock, to be held as Treasury stock 6,000 The total shareholders' equity at the end of the year is closest to: A. ￥268,000 B. ￥284,000 C. ￥287,000 48. A company's comparative income statements and balance sheets are presented below.

Income Statement for the year ended 31 August (U.S $ thousands)

2009 2008

Sales $100,000 $95,000

Cost of goods sold 47,000 47.500

Gross profit 53,000 47,500

Operating expenses 34,000 38,000

Interest expense 2,400 2,700

Earnings before taxes 16,600 6,800

Income taxes 33% 5,478 2,244

Net Income $ 11,122 $ 4,556

Balance Sheet as at 31 August (U.S.$ thousands)

2009 2008

Assets

Cash & investments $21,122 $25,000

Accounts receivable 25,000 13,500

Inventories 13,000 8,500

Total current assets $59,122 $47,000


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Total long‐term assets 72,000 80,000

Total Assets $131,122 5127,000

Liabilities

Accounts payable $ 15,000 $ 15,000

Other current liabilities 7,000 9 000

Total current liabilities $ 22,000 $ 24,000

Long‐term debt 35,000 40,000

Total liabilities $ 57,000 $ 64,000

Shareholders' equity

Common stock $ 58,000 $ 58,000

Retained earnings 16.122 5,000

$ 74.122 $ 63,000

Total Liabilities &Equity $ 131.122 $127,000

The cash collected from customers in 2009 is closest to: A. $88,500 B. $96,100 C. $111,500 49. Selected information for a company and the common size data for its industry are provided

below.

Company(￡) Common Size Industry Data (% of sales)

EBIT 76,000 28,0

Pretax profit 66,400 19.6

Net income 44,488 13.1

Sales 400,000 100.0

Total assets 524,488 131.0

Total equity 296,488 74.0

ROE 14.5% 17.7%

The main driver of the company's inferior ROE compared to that of the industry is most likely the result of its lower: A. EBIT margin


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B. tax burden ratio C. Interest burden ratio 50. Which of the following is least likely to be a fundamental principle in the preparation of financial

statements within the IFRS Framework? A. Matching B. Materiality C. Accrual basis 51. The following information is available about a company:

(all figures in $ thousands) 2010 2009

Deferred tax assets 200 160

Deferred tax liabilities (450) (360)

Net deferred tax liabilities (250) (200)

Earning before taxes 4,000 3,800

Income taxes at the statutory rate 1,200 1,140

Income tax payable (Current income tax expense) 1,000 900

The company's 2010 income tax expense (in thousands) is closest to: A. $1,000 B. $1,050 C. $1,250 52. Which of the following inventory valuation methods best matches the actual historical cost of

the inventory items to their physical flow? A. FIFO B. LIFO C. Specific identification 53. A company has announced that it is going to distribute a group of long‐lived assets to its owners

in a spin‐off. The most appropriate way to account for the assets until the distribution occurs is to classify them as:

A. held for sale with no depreciation taken. B. held for use until disposal with no depreciation taken. C. held for use disposal with depreciation continuing to be taken.


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54. The following information is available from a company's 2010 financial statements: Note 6: Employee costs


Wages and salaries $21,000 $18,500

Share‐based payment costs (Note 15) 600 425

Defined contribution pension plan 1,525 1,462

Retirement benefit obligations (Note 17) 728 620

Other employee costs 3,233 3,080

Total employee costs $27,086 $24,087

Note 17: Retirement benefit obligations Amounts recognized in the income statement for the year


Current service cost $692 $588

Interest cost on pension obligation 80 65

Expected return on plan assets (50) (45)

Past service costs recognized in the year 6 12

Total income statement charge $720 $620

The pension expense (thousands) reported in 2010 is closest to: A. $1,525 B. $2,217 C. $2,253 55. Given the following information about a company:

(all figures in $ millions) 2010 2009

Short‐term borrowings $2,240 $5,400

Current portion of long‐term interest‐bearing debt 2,000 1,200

Long‐term interest‐bearing debt 12,000 9,000

Total shareholders' equity 23,250 21,175

EBIT 3,850 3,800

Interest payments 855 837

Operation lease payments 800 800

What is the most appropriate conclusion an analyst can make about the solvency of the company?


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Solvency has: A. improved because the debt‐to‐equity ratio decreased. B. deteriorated because the debt‐to‐equity ratio increased. C. improved because the fixed charge coverage ratio increased. 56. Which of the following will most likely increase a company's operating cash flow? An increase in: A. Days sales payable (DSP). B. Gains on the sale of long‐term assets. C. Use of operating leases versus financing leases. 57. Which of the following is least likely to appear in a company's proxy statement? A. Compensation arrangements for management and directors B. Significant events and contingencies that may affect future operations C. Potential conflicts of interest between management, directors, and shareholders. 58. At the start of the year, a company's capital contributed by owners and retained earnings

accounts had balances of $10,000 and $6,000, respectively. During the year, the following events took place:

Net income earned $4,000

Interest paid on debt $500

Repayment of long‐term debt $1,000

Proceeds from shares issued $1,000

Dividends paid $600

The end‐of‐year owners' equity is closest to: A. $19,400 B. $19,900 C. $20,400 59. A retailer provides credit cards only to its most valued customers who pass a rigorous credit

check. A credit card customer ordered an item from the retailer in May. The item was shipped and delivered in July. The item appeared on the customer's July credit card statement and was paid in full by the due date in August. The most appropriate month in which the retailer should recognize the revenue is :

A. May B. July C. August


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60. Which of the following will most likely result in an increase in a company's sustainable growth

rate? A. Higher tax burden ratio B. Lower interest burden ratio C. Higher dividend payout ratio 61. During 2009, the following events occurred at a company. The company:

1. purchased a customer list for $100,000, which is expected to provide equal annual benefits for the next 4 years.

2. recorded $200,000 of goodwill in the acquisition of a competitor. It is estimated that the acquisition would provide substantial benefits for the company for at least the next 10 years.

3.

Repeatedly received favorable mention in the media for its response to a local natural disaster, in which it donated $300,000 in products and services to the community. The CEO of the company was heard to say that the publicity enhanced the firm's reputation substantially and would likely be worth at lease $100,000 annually over the next 5 years.

Based on these events, the amortization expense that the company should report in 2010 is closet to: A. $25,000 B. $45,000 C. $125,000 62. The following items are from a company's Cash Flow Statement.

Classification of cash flow Item Amount (￡‐000s)

Operating activities Cash received from customers 55,000

Investing activities Interest and dividends received 10,000

Financing activities Net repayment of revolving credit loan 12,000 Which of the following standards and formats did the company most likely use in the preparation of its financial statements? A. IFRS, direct format B. IFRS, indirect format C. Either IFRS or U.S. GAAP, direct format 63. The following information is available about a manufacturing company:


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$ million

Cost of ending inventory computed using FIFO 4.3

Net realizable value 4.1

Current replacement cost 3.8

Compared to U.S. GAAP, the company's gross profit ($ millions) computed under International Financial Reporting Standards (IFRS) is most likely: A. the same B. 0.3 lower C. 0.3 higher 64. For which type of long‐lived asset is it most appropriate to test for impairment at least annually A. Property, plan, and equipment B. Intangible assets with a finite fire C. Intangible assets with indefinite lives. 65. On 1 January 2010 the market rate of interest on a company's bonds is 5 percent and it issues a

bond with the following characteristics:

Face value €50 million

Coupon rate, paid annually 4%

Maturity date December 31,2019 (10 years)

Issue price 92.28

If the company uses IFRS, its interest expense (in millions) in 2010 is closest to: A. €1.846 B. €2.307 C. €2.500 66. An analyst is assessing a company's quality of earnings by looking at the cash flow earnings index

(operating cash flow divided by net income). Potential problems would most likely be indicated if the ratio were consistently:

A. equal to 1.0. B. less than 1.0. C. greater than 1.0.


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67. As a result of a change in strategy to selling differentiated products at premium prices, a

company's gross margin ratio increased by 5 percentage points (i.e., from 35 percent to 40 percent). The most likely effect on the company's operating margin ratio as a result of the changes in strategy would be an increase;

A. equal to 5% B. less than 5% C. greater than 5% 68. A retail company that leases the majority of its space has total assets of $4,500 million and total

long‐term debt of $2,125 million bearing an average interest rate of 10 percent. Note 8 to the 2010 financial statements contains the following information about the company's leases:

Note 8: Operating leases

Year Millions

2011 $140

2012 140

2013 140

2014 140

2015 140

2016 and thereafter 1,260

Total $1,960

After adjustment for the off‐balance sheet financing, the debt‐to‐total‐assets ratio for the company is closest to: A. 57% B. 62% C. 72% 69. Matrix pricing is a process in which a bond's yield‐to‐maturity is determined from bonds

currently available in the market that have similar attributes as the bond being considered. Matrix pricing is most similar to the:

A. debt‐rating approach only. B. yield‐to‐maturity approach only C. yield‐to‐maturity approach and the debt‐rating approach. SS11‐CORPORATE FINANCE (18 MINUTES)


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70. When computing the cash flows for a capital project, which of the following is least likely to be

included? A. Tax effects. B. Financing costs. C. Opportunity costs 71. A firm's estimated costs of debt, preferred stock, and common stock are 12 percent, 17 percent,

and 20 percent, respectively. Assuming equal funding from each source and a 40 percent tax rate, the weighted average cost of capital is closest to:

A. 9.80% B. 13.90% C. 14.73% 72. A project has the following annual cash flows:

Year 0 Year 1 Year 2 Year 3

‐$606,061 $2,151,515 ‐$2,542,424 $1,000,000 Which discount rate most likely provides a positive net present value? A. 15% B. 18% C. 21% 73. Based on a need to borrow $2 million for one month, which of the following alternatives has the

least expensive effective annual cost? A. A banker's acceptance with an all‐inclusive annual rate of 6.1% B. A credit line at 6.0% annually with a 0.5% annual commitment fee C. Commercial paper at 5.9% annually with a dealer's commission of $3,000 (or 0.15%) and a

backup line cost of $4,000 (or 0.20%) 74. Given the following income statement:

$ millions

Revenues 9.8

Variable Operating Costs 7.2

Fixed Operating Costs 1.5

Operating Income 1.1


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Interest 0.6

Taxable Income 0.5

tax 0.2

Net Income 0.3

The company's degree of operating leverage is closest to: A. 1.1 B. 1.7 C. 2.4 75. A stop‐buy order is most likely placed when a trader: A. this that the stock is overvalued. B. want to limit the loss on a long position C. wants to limit the loss on a short position. 76. The type of voting in board elections that is most beneficial to shareholders with a small number

of shares is best described as: A. statutory voting B. voting by proxy C. cumulative voting. 77. A company has an equity beta of 1.4 and is 60 percent funded with debt. Assuming a tax rate of

35 percent, the company's asset beta is closest to: A. 0.71 B. 0.98 C. 1.01 78. A company's taxable income is 17.1 percent of sales. Assuming taxes of 42 percent and dividend

payout of 50 percent, the net profit margin is closest to: A. 5.0% B. 7.2% C. 9.9% 79. A project has the following annual cash flows:

Year 0 Year 1 Year 2 Year 3 Year 4

‐$75,000 $21,600 $23,328 $37,791 $40,815


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With a discount rate of 8 percent, the discounted payback period (in years) is closest to: A. 2.8. B. 3.2. C. 4.0. 80. Review the following income statement:

$ million

Revenues 10,2

Variable Operating Costs 4.6

Fixed Operating Costs 2.0

Operating Income 3.6

Interest 1.2

Taxable Income 2.4

Tax 1.0

Net Income 1.4

The firm's degree of financial leverage is closest to: A. 1.5. B. 1.7. C. 2.6. SS13/14‐EQUITY INVESTMENTS (18 MINUTES) 81. An investor gathered the following data in order to estimate the value of the company's

preferred stock: Par value of preferred stock offered at a 6% dividend rate $100 Company's sustainable growth rate 5% Yield on comparable preferred stock issues 11.5%Investor's marginal tax rate 30%

The value of the company's preferred stock is closest to: A. $52.17 B. $74.53 C. $96.92


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82. An investor uses the data below and the constant growth model to evaluate a company's common stock. To estimate growth, she uses the average value of the: 1. dividend growth rate over the period 2004‐2009 and 2. sustainable growth rate for the year 2009

Year EPS DPS ROE

2009 $3.20 $1.92 12%

2008 $3.60 $1.85 17%

2007 $2.44 $1.74 13%

2006 $2.08 $1.62 15%

2005 $2.76 $1.35 11%

2004 $2.25 $1.25 ‐ 9% If her requited return is 15 percent, the stock's estimated value is closest to: A. $23.71 B. $25.31 C. $30.14 83. Which of the following is least likely to be directly reflected in the returns on a commodity

index? A. Roll yield B. Risk‐free interest rate C. Changes in the underlying commodity's price 84. The following data pertains to a margin purchase of a stock by an investor.

Stock's purchase price $50/share

Sale price $55/share

Shares purchased 500

Margin 45%

Call money rate 6%

Dividend $1.80/share

Transaction commission on purchase $0.05/share

Transaction commission on sale $0.05/share

If the stock is sold exactly one year after the purchase, the total return on the investor's investment is closest to: A. 14%


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B. 19% C. 22% 85. The index weighting that results in portfolio weights shifting away from securities that have

increased in relative value toward securities that have fallen in relative value whenever the portfolio is rebalanced is most accurately described as:

A. equal weighting B. fundamental weighting C. float‐adjusted market‐capitalization weighting. 86. According to the industry life‐cycle model, an industry in the shakeout stage is best

characterized as experiencing: A. increasing demand but falling prices. B. slowing growth and intense competition C. little or no growth and industry consolidation. 87. An investor gathers the following data. To estimate the stock's justified forward P/E, the investor

prefers to use:

the earnings growth rate rather than the dividends growth rate and the average of the payout ratios over the relevant period, in this case 2006‐2009, rather the

most recent payout ratio.

Year EPS DPS ROE

2009 $3.20 $1.92 12%

2008 $3.60 $1.80 17%

2007 $2.44 $1.71 13%

2006 $2.50 $1.60 15% The yield on 10‐year T‐notes is 3 percent and the current equity risk premium is 6.5 percent. If beta is 1.3, then the stock's justified forward P/E is closest to: A. 12. B. 16. C. 21. 88. An investor evaluating a company's common stock for investment has gathered the following

data.


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Current year's earnings per share $2.50


Dividend growth rate expected during Year 1 and 2 25%

Dividend growth rate expected after Year 2 5%

Investors' requited rate of return 12%

The value per shore of this common stock is closest to: A. $28.57 B. $31.57 C. $38.70 89. According to behavioral finance, observed overreaction in securities markets most likely occurs

due to A. loss aversion B. gambler's fallacy. C. disposition effect. 90. Companies pursuing cost leadership will most likely: A. invest in productivity‐improving capital equipment. B. Engage in defensive pricing when the competitive environment is one of high rivalry. C. Establish strong market research teams to match customer needs with product development. SS18‐ALTERNATIVE INVESTMENT (18 MINUTES) 91. A mutual fund with a 2.0 percent sales charge and 0.75 percent annual expense, earns 6.0

percent annually for 4 years. At the end of year 4, the NAV calculation most likely reflects: A. a deduction of the sales charge and annual expenses at t=0 B. the compounded return, net of expenses, after deducting the sales charge at t=0 C. the compounded return after deducting the compounded sales charge and annual expenses. 92. Which of the following statements regarding biases in hedge fund performance in hedge fund

databases is least likely correct? A. Only hedge fund managers with good track records enter the database, creating a positive bias. B. The correlations between asset class returns are artificially low when underlying assets trade

infrequently. C. Hedge fund database administrators decide which funds to include in the database to overcome

self‐selection bias.


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93. When market participants expect the spot price of a commodity to be higher to be higher in the future, the commodity market is said to be in:

A. contango. B. full carry C. backwardation. 94. An analyst is evaluating an investment in an apartment complex based on the following annual

data:

Gross rental income $2,100,000

Estimated vacancy and collection expenses 3%

Operating expenses $1,600,00

Depreciation $300,000

Current mortgage rate 5%

Financing percentage 80%

Capitalization rate 12%

Cost of equity 15%

Based on the income approach, the value of the investment is closest to: A. $1,141,667 B. $3,641,667 C. $6,242,857 95. A project that requites an initial investment of €5 million is expected to pay €22 million at the

end of 5 years if it is successful. The probabilities of failure for the project are provided below:

Year 1 2 3 4 5

Failure probability 0.25 0.20 0.15 0.15 0.15

Assuming the cost of capital for the project is 16 percent, the project's expected net present value is closest to: A. ‐€3,157,000. B. ‐€1,140,000 C. €2,017,000 96. Which of the following statements is most likely correct with respect to valuing a privately held

company?


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A. The cost approach values company assets using historical book value. B. To estimate a control premium, the base is an estimate of that company's value of equity not

reflecting control. C. Share prices should reflect a liquidity premium compensating investors for illiquidity in the

market for the shares. SS15/16‐FIXED INCOME INVESTMENTS (9 MINUTES) 97. Which of these embedded options most likely benefits a bondholder? A. The floor in a floating‐rate security B. An accelerated sinking fund provision C. The call option in a fixed‐rate security 98. Consider two bonds that are identical except for their coupon rates. The bond that will have the

highest interest rate risk most likely has the: A. lower coupon rate B. higher coupon rate C. coupon rate closest to its market yield. 99. Duration is not an accurate measure of yield‐curve risk for 2 bond portfolio because it: A. can be applied only to measure the risk of a single bond. B. Assumes that the yield for all maturities change by the same amount. C. Measures the impact of a change in the short‐term, riskless rate of interest. 100. An investor whose marginal tax rate is 33.5 percent is analyzing a tax‐exempt bond offering a

yield of 5.02 percent. The taxable equivalent yield of the bond is closest to: A. 3.46% B. 6.94% C. 7.82% 101. If the yield on a 5‐year U.S. corporate bond is 7.39 percent an the yield on a 5‐year U.S. Treasury

note is 4.26 percent, the relative yield spread of the bond is closest to: A. 3.13% B. 42.4% C. 73.5% 102. Consider a $100 par value bond, with an 8 percent coupon paid annually, maturing in 20 years. If

the bond currently sells for $96.47, the yield to maturity is closest to:


188

A. 8.29% B. 8.37% C. 8.93% 103. The table below provides a history of a fixed‐income security's coupon rate and the risk‐free rate

over a five‐year period.

Year Risk‐Free Rate Coupon Rate

1 3.00% 6.00%

2 3.50% 5.00%

3 4.25% 3.50%

4 3.70% 4.60%

5 3.25% 5.50%

The security is most likely a (n): A. step‐up note. B. inverse floater. C. deferred coupon bond. 104. For a 10‐year floating‐rate security, if market interest rates change by 1 percent, the change in

the value of the security will most likely be: A. zero B. related to the security's coupon reset frequency. C. Similar to an otherwise identical fixed‐rate security. 105. When a bank creates a collateralized loan obligation (CLO) by securitizing a portfolio of

commercial loans that it holds, the process is best described as a(n): A. arbitrage transaction B. balance sheet transaction C. capital infusion transaction. 106. What is closes to the value of a 10‐year, 6 percent coupon, $100 par value bond with semiannual

payments assuming an annual discount rate of 7 percent? A. $92.89 B. $99.07 C. $107.44 107. Consider a $100 par value bond with a 7 percent coupon paid annually and 5 years to maturity.


189

At a discount rate of 6.0 percent, the value of the bond is $104.21. One year later, the appropriate discount rate has risen to 6.5 percent and the bond's value is $101.71. What part of this change in value is most likely attributable to the passage of time?

A. $0.37 B. $0.74 C. $1.76 108. A fixed‐income security's current price is 101.45. You estimate that the price will rise to 103.28 if

interest rates decrease 0.25 percent and will fall to 100.81 if interest rates increase 0.25 percent. The security's effective duration is closest to:

A. 1.22 B. 4.87 C. 9.74 SS17‐ DERIVATIVES (8 MINUTES) 109. Derivative markets serve a number of purposes in global economic systems. Which of the

following is least likely one of these purposes? A. Reveal prices and volatility of the underlying assets B. Improve market efficiency by lowering transaction costs C. Enable companies to more easily practice risk management 110. A futures trader takes a long position of 10 contracts. The initial margin requirement is $10 per

contact and the maintenance margin requirement is $7 per contract. She deposits the required initial margin on the trade date. On Day 3, her margin account balance is $40. What is the variation margin on Day 4?

A. $30 B. $60 C. $100 111. A portfolio manager enters into an equity swap with a swap dealer. The portfolio manager pays

the return on the Value index and, in return, receives the return on the Growth index. The swap's notional principal is $50 million and the payments will be made semiannually. The levels of the equity indices are as follows:

Index Level at Start of Swap Level 6 Months Later

Value Index 5,460 5,350

Growth Index 1,190 1,200


190

The net payment due after 6 months is closest to: A. $587,158 B. $1,007,326 C. $1,427,494 112. Epsilon Inc., a U.S.‐based company, is obligated to deliver 1,000,000,000 yen to its Japanese

component supplier in 3 months. Epsilon approaches a dealer and enters into a USD/JPY currency forward contract with physical delivery to manage the foreign exchange risk associated with the cash flow. Which of these best describes the currency forward contract?

A. the dealer will deliver yen on expiration. B. Epsilon has the right but not the obligation to deliver USD. C. The amount of USD exchanged for yen is determined on expiration. 113. Which of the following options makes the following statement most accurate? The greater of

either zero or the present value of the exercise price minus the underlying price is the lower bound on the price of a(n):

A. European put B. American put C. American call 114. An investor executes a protective put strategy on ABC stock. At the time of execution, the price

of ABC is $71. A $66 strike put option on ABC with a 2‐month expiration is trading at $1.45. the protective put strategy breaks even when the price of ABC is closest to:

A. $67.45 B. $69.55 C. $72.45 SS12‐PORTFOLIO MANAGEMENT (9 MINUTES) 115. Which of the following types of institutions is most likely to have a long investment time horizon

and a high level of risk tolerance? A. A bank B. An endowment C. An insurance company 116. Selected information about shares of two companies is provided below:


191

Stock Standard Deviation Correlation of Returns Portfolio Weights

Cable Incorporated 30% 0.65 68%

GPT Company 20% 32%

Correlation of returns between Cable Incorporated and GPT Company The standard deviation of returns of a portfolio formed with these two stocks is closest to: A. 25.04% B. 26.80% C. 32.85%

117. A stock has a correlation of 0.45 with the market and a standard deviation of returns of 12.35

percent. If the market has a standard deviation of returns of 8.25 percent, then the beta of the stock is closest to:

A. 0.30 B. 0.67 C. 1.50 118. An investor's transactions in a mutual fund and the fund's returns over a four‐year period are

provided in the table below:

Year 1 2 3 4 New investment at the beginning of the year $2,500.00 $1,500.00 $1,000.00 $0.00

Investment return for the year ‐20% 65% ‐25% 10%

Withdrawal by investor at the end of the year $0.00 ‐$500.00 ‐$500.00 ‐$500.00

Based on these data, the money‐weighted return (or internal rate of return) for the investor is closest to A. 2.15% B. 3.96% C. 7.50%

119. Risk that can be attributed to factor(s) that impact a company or industry is best described as: A. market risk B. systematic risk C. unsystematic risk


192

120. Which of the following factors is least likely to impact an individual's ability to take risk? A. Time horizon B. Personality type C. Expected income


193

2010 Level 1 Sample Exam Answer 1. Correct answer: A By not adhering to the non‐compete clause that he agreed to abide by when signing the employment contract, Hasina shows a lack of professional integrity toward his employer and reflects poorly on the good reputation of members, which is required by the Code of Ethics and Standard 1(D), Professionalism (Misconduct). 2. correct answer: C Compliance with the GIPS standards does not eliminate the need for in‐depth due diligence on the part of the investor. 3. correct answer: B The firms that claim compliance with the GIPS standards are responsible for their claim of compliance and for maintaining that compliance. 4. Correct answer: C Both Musa and Kassim violated the Standards of Professional Conduct. Musa violated Standard IV(C), Duties to Employers (Responsibilities of Supervisors), by not ensuring that policies were in place to prevent violations of the Code and Standards (in this case Standard VI(B)), Conflicts of Interest (Priority of Transactions) by someone subject to her supervision. As Head of Compliance, Musa supervised Kassim. Kassim violated Srandard VI(B), Conflicts of Interest (Priority of Transactions), in that he did not give sufficient priority to Dunfied's clients before trading on his recommendation. 5. correct answer: B Analysts are in the business of formulating opinions and insights that are not obvious to the general investing public about the attractiveness of particular securities. In particular, under the mosaic theory, and analyst is free to trade based upon information developed in the course of her own research even if this information would have been material inside information had it been communicated directly to the analyst by the company. In addition, members and candidates should make reasonable efforts to achieve public dissemination of information that is material and nonpublic. This effort usually entails encouraging the issuer company to make the information public. 6. Correct answer: A It appears that a reasonable and diligent effort has been made to determine that the investment action is sound and suitable for his clients. Selling stock short is a management strategy and does not necessarily violate any aspect of the CFA Institute Code and Standards. 7. correct answer: C The analyst can express her disagreement with the team by documenting her difference of opinion, but it is inappropriate for the analyst to make selective disclosure. In addition, the analyst has not separated fact from opinion. Members and candidates must make every effort to treat all individual and institutional clients in a fair and impartial manner,


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8. Correct answer: A There is no indication the investment is unsuitable for investors. 9. Correct answer: B Even though the analyst is not treating all clients in an equitable manner, there is no indication she has breached any conflicts of interest. 10. Correct answer: C The two principles of the Rules of Procedure for Professional Conduct are confidentiality of proceedings and fair process to the member and candidate. 11. Correct answer: B A composite must include all actual, fee‐paying, discretionary portfolios managed in accordance with the same investment mandate, objective, or strategy. By including both value and growth accounts, the composite is made up of portfolios with different investment mandates or strategies. 12. Correct answer: A Making full and fair disclosure of all matters that could reasonably be expected to impair their independence and objectivity or interfere with respective duties to their clients is required by Standard VI, Conflicts of Interest, of the CFA Code of Ethics and Standard of Professional Conduct. 13. Correct answer: B The client is the trust/trustees, not the beneficiary. Mawar followed Standard 111(C), Duties to Clients (Suitability), by managing the assets in a way that would likely result in a stable source of income while keeping the risk profile low. 14. Correct answer: C There is no evidence that Chandarana violated Standard VII(B) with regard to his being a CFA Candidate. It does appear that Chandarana did not act with integrity when he hid information that could potentially harm his new employer's reputation, thus violating Standard 1(C), Professionalism (Misrepresentation), and Standard IV(A), Duty to Employers (Loyalty). 15. Correct answer: B There is no indication that a violation of this standard (Vl(B), Conflicts of Interest (Priority of Transactions)) occurred. The standard concerns transactions for clients having priority over employees' transactions and is not applicable in this case since the manager sells his personal holdings after clients' holdings. 16. Correct answer: A The prospective supervisor's first step should be to bring the inadequate compliance system to the attention of the firm's senior managers and recommend corrective action before taking the position. This may be accomplished by the supervisor taking on an interim consulting role with the bank in order to implement adequate procedures before taking on the supervisory role.


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17. Correct answer: A The utility is not a suitable investment for clients who desire investments in companies with good environmental records 18. Correct answer: A The reference to the superior management abilities ascribed to the CFA Program is improper. An appropriate reference would be to indicate "completion of the CFA Program has enhanced my portfolio management skill. 19. Correct answer: C The effective annual rate (EAR) is (1+periodic interest rate)n ‐1. In this case, the periodic interest rate is 0.02/12=0.01667 and the EAR is (1.01667)12‐1=0.21939=22%. 20. Correct answer: B For the positively skewed unimodal distribution, the mode is less than the median, which is less than the mean. 21. Correct answer: B Enter the given cash flows into a financial calculator and solve for IRR. The IRR is 5.46867%. Alternatively, find the NPV of the given cash flows using the three possible answers. The NPV using 4.41% as the discount rates is €352.35; the NPV using 5.47% is €‐0.43: the NPV using 19.33% is €‐3,499.58. The NPV using 5.47% is closest to zero, and 5.5% is ,therefore, closest to the IRR of the project. 22. Correct answer: C The portfolio return is the weighted mean return and is calculated as: (0.45x 16)+(0.25x12)+(0.30 x2)=10.80 23. Correct answer: B Define. Calculate, and interpret the coefficient of variation and the Sharpe ratio.

The Sharpe ratio is defined as:

p fp

p

R RS

S−

=

In this case, AS =(10‐4)/20=0.30

BS =(18‐4)15=0.9333

CS =(6‐4)/3=0.6667 Portfolio B has the highest Sharpe ratio. 24. Correct answer: A Two events, A and B, are independent if and only if P(Al B)=P(A) or, equivalently, P(A I B)=P(B). The wording of the question precludes P(A)=P(B); therefore, responses B and C cannot be correct.


196


nSS xx /= , 1

)( 22

−

−= ∑

nxx

S ix

In this problem, mean of x =(10+20‐8+2‐9+5+0‐8+3+21‐11+5+3+7+11‐5‐8+12‐6+6)/20=2.50

( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) ( )( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) ( )( ) ( )

2 2 2 2 2 2 2 2 2

2 2 2 2 2 2 2 2 2

2

S 10 2.5 20 2.5 + 8 2.5 2 2.5 9 2.5 5 2.5 0 2.5 8 2.5 3 2.5

21 2.5 11 2.5 5 2.5 3 2.5 7 2.5 11 2.5 5 2.5 8 2.5 1 2 2.5

6 2.5 6 2.52 ] /19 89.105 and S 9.400

= − + − − − + − + − − + − + − + − − + −

+ − + − − + − + − + − + − + − − + − − + −

+ − − ÷ − = =

The standard error of the mean is therefore 0.59.440 / 20 2.111=

26. Correct answer: A Calculate and interpret an updated probability using Bayes'formula. First, calculate the unconditional probability for a cut in dividends: P(Cut div)= P(Cut div I EPS exceed)x P(EPS exceed)+ P(Cut div I EPS equal)x P(EPS equal)‐f‐ P(Cut div I EPS blow)x P(EPS below) = (0.05x0.25)+(0.10x0.55)+(0.85x0.20)=0.2375 Then update the probability of EPS falling below the consensus as: P(EPS below I Cut div)= P(Cut div I EPS blow)/ P(Cut div) x P(EPS blow) = (0.85/0.2375)x0.20=0.71579=72% 27. Correct answer: A The central limit theorem establishes that the sampling distribution of sample means will be approximately normal; will have a mean equal to the population mean, and will have a variance equal to the population variance divided by the sample size. 28. Correct answer: A Enter the given cash flows and the given discount rate into a financial calculator and solve for NPV. The NPV is ‐1,780 (negative 1,780). 29. Correct answer: A Define, calculate, and interpret measures of central tendency, including the population mean, sample mean, arithmetic mean, weight average or mean (including a portfolio return viewed as a weighted mean), geometric mean, harmonic mean, mean, median, and mode. 30. Correct answer: C Monte Carlo simulation provides a distribution of possible solutions to complex functions. The central tendency and the variance of the distribution of solutions give important clues to decision‐makers regarding expected results and risk. 31. Correct answer: A Define a parameter, a sample statistic, and a frequency distribution, A sample is a subset of a population,


197

32. Correct answer: B The nominal rate is equal to the real risk‐free rate of return plus an inflation premium plus risk premiums (default, liquidity, maturity preference). In this case, 12=3+5+X. Solve for X. X=4. 33. Correct answer: B Consumer surplus is the value (or marginal benefit) of a good minus the price paid for it, summed over the quantity bought. As no consumer will (willingly) pay a price greater than the marginal value or benefit, consumer surplus is always positive. Abd of firce us used to coerce the consumer to buy a product, then the marginal benefit must be adjusted also so as to include the benefit of avoiding the punishment for not buying the product. 34. Correct answer: B Marginal revenue product equals the change in total revenue divided by the change quantity of labor: MRP=ATR/AL. In this problem, the marginal product of hiring the fifth and sixth workers (AL=2) is 14 shirts per hour. The change in total revenue for hiring the fifth and sixth workers is 14x$3.00 and the MRP=(14x3)/2=21 35. Correct answer: B For a given working‐age population, a decline in the labor force participation rate, often due to an increase in discouraged workers, reduces the labor force. If the number of people employed remains the same while the labor force is smaller, the number of workers defined to be unemployed must be smaller and the unemployment rate lower. 36. Correct answer: C When a central bank such as the Fed purchases securities, bank reserves increase. The banks therefore have excess reserves and are able to increase their lending, increasing the money supply. See the sequence of events given on p. 376 of the reading, 37. Correct answer: B In perfect price discrimination, all surplus is captured by the producer. Consumer surplus falls to zero. 38. Correct answer: A The balanced budget multiplier and the government expenditure multiplier are part of fiscal policy. The money multiplier is best thought of as part of monetary policy, 39. Correct answer: C Production quotas are most likely to result in underproduction. 40. Correct answer: C The longer the time that has elapsed since a price change, the more elastic is demand. 41. Correct answer: B The money multiplier is calculated as 1 plus the currency drain ratio divided by the sum of the currency drain ratio and the desired reserve ratio. In this problem, the money multiplier is


198

(1+1.05)/(1.05+0.2)=1.64 42. Correct answer: B Firms in perfect competition are price takers. A price taker is a firm that cannot influence the market price and that sets its own price at the market price. 43. Correct answer: B The Laffer curve argues that when a nation reduces its tax rate from a "too high" tax rate, economic growth will be stimulated to such a degree that tax revenue to the government will actually increase. It is difficult to define exactly how high 'too high" is. 44. Correct answer: C In the United States, the Federal Reserve System is primarily responsible for monetary policy. 45. Correct answer: B For a publicly traded firm in the United States, the auditor must express an opinion as to whether the company's internal control system is in accordance with the Public Accounting Oversight Board, under the Sarbanes‐Oxley Act. This is done either as a final paragraph in the Auditor's Report, or as a separate opinion. 46. Correct answer: A The adjusting entry to record the expiry of a prepaid expense is the reduction of an asset (the prepaid) and the recognition of the expense. 47. Correct answer: C List and explain the components of owners' equity.

Shareholders' Equity (￥) Start‐of‐year share capital 200,000Less treasury stock (6,000)Beginning retained earnings 50,000Plus net income 42,000Less dividends paid (7,000)Ending retained earnings 85,000 85,000Accumulated other comprehensive income Foreign $8,000currency translation adjustment gainEnd‐of‐year shareholders' equity 287,000The realized loss on the available‐for‐sale investments is already accounted for in net income.

48. Correct answer: A cash flows can be computed using income statement and balance sheet data. Cash collected from customers=Revenues‐increase in AR=$100‐(25‐13.5)=88.5


199


50. Correct answer: A The five fundamental principles underlying the preparation of financial statements under the IFRS Framework are fair presentation, going concern, accrual basis, consistency, and materiality. Matching is a general principle of expense recognition. 51. Correct answer: B Income tax expense reported on the income statement=income tax payable+ net changes in the deferred tax assets and deferred tax liabilities. The change in the net deferred tax liability is a $50 increase (indicating that the income tax expense is $50 in excess of the income tax payable (or current income tax expense)) and representing an increase in the expense. Therefore, the income tax expense= $1,000+50=. $1,050 52. Correct answer: C Specific identification best matches the physical flow of the inventory items because it tracks the actual units that are sold. 53. Correct answer: C Long‐lived assets that will be disposed of other than by sale (such as a spin‐off, an exchange for other assets, or abandonment) are classified as held for use until disposal and continue to be depreciated until that time. 54. Correct answer: C The pension expense would be the sum of the expense for the defined contribution plan and the defined benefit plan (retirement benefit obligation): 1,525+728=2,253 55. Correct answer: A The debt‐to‐equity ratio decreased thereby improving solvency; the fixed charge coverage ratio remained the same.

Calculation Company Industry

EBIT Margin EBIT/Sales 76,000/400,000=0.19 28.0/100=0.28

Tax Burden ratio Net Inc/EBT 44,488/66,400=0.67 13.1/19.6=0.67

Interest Burden ratio

EBT/EBIT 66,400/76,000=0.87 19.6/28.0=0.70

The company has a higher interest burden ratio bur a lower EBIT margin than the industry, and the same tax burden ratio; the lower EBIT margin relative to the

industry is the cause of the company's poor relative performance

EBI: Pretax profit (earnings before tax) Net Inc: Net Income


200

2010 2009 comments

Debt‐to‐euity (total debt/equity)

(2,240+2,000+12,000)/23,250=70%

(5,400+1,200+9,000)/21,175=74%

Ratio decreased:company has lessfinancial risk is moresolvent

Fixed charge coverageratio=(EBIT+lease PMTs)/(IntPMTs+ lease PMTs)

(3850+800)/（855+800）（3,800+800）/（837+800）=2.81

No change in FCCratio

56. Correct answer: A An increase in the days sales payable would indicate the company is stretching out its payables, which would increase the cash from operations. 57. Correct answer: B Significant events, conditions, trends, and contingencies that may affect future operations are contained in Management's Discussion and Analysis/ compensation agreements for directors and management and their potential conflicts of interest are required in the proxy statement. 58. Correct answer: C

Start‐of‐year capital contributed by owners $10,000

Additional shares issued 1,000

Initial retained earnings 6,000

Net income 4,000

Dividends paid (600)

Increase in retained earnings 3,400 3,400

Ending owners' equity $20,400

59. Correct answer: B The appropriate time to recognize revenue would be in the month of July, the risk and rewards have been transferred to the buyer (shipped and delivered), the revenue can be reliably measured, and it is probable that the economic benefits will flow to the seller (the rigorous credit check was completed). Neither the actual payment date nor the credit card statement date is relevant here. 60. Correct answer: A The higher a company's ROE and its ability to finance itself from internally generated funds (a higher retention ratio), the greater will be its sustainable growth rate. In the 5 factor ROE, any factor that increases ROE will increase sustainable growth: ROE= tax burden x interest burden x EBIT margin x asset turnover x leverage A higher tax burden ratio (Net Income/Earnings before tax) implies that the company can keep a


201

higher percentage of pretax profits: this implies a lower tax rate, and a higher ROE. The interest burden ratio is Earnings before tax/EBIT, and a lower ratio means that the company has higher borrowing casts (it gets to keep a lower pre‐tax income from a given EBIT), implying a lower ROE and sustainable growth. 61. Correct answer: A The customer list is the only identifiable intangible asset and it should be amortized on a straight‐line basis over its expected future life: $100,000/4=25,000 per year. Goodwill is an generated intangible that is not recorded on the balance sheet and is therefore not amortized, 62. Correct answer: A The direct method of cash flow statement presentation shows the specific cash inflows and outflows that result in reported cash flow from operating activities; e.g., cash from customers, cash to suppliers, etc. companies using IFRS reporting standards can decide to report interest and dividend receipts as either an investing or an operating activity, whereas under U.S. GAAP, they must report such income as an operating activity. The listed operating and investment activities indicate that the company reports under IFRS, using the direct method. 63. Correct answer: C Under IFRS, the inventory would be written down to its net realizable value ($4.1 million) whereas, under U.S. GAAP, market is defined as current replacement cost and hence would be written down to its current replacement cost ($3.8). The smaller write‐down under IFRS will reduce the amount charged to the cost of goods sold, as compared to U.S. GAAP, and result in a higher gross profit of $0.3 million. 64. Correct answer: C Intangible assets with indefinite lives need to be tested for impairment at least annually/ PP&E and intangibles with finite lives are tested only if there has been a significant change or other indication of impairment. 65. Correct answer: B IFRS recommends the effective interest method for the amortization of bond discounts/premiums. The bond is issued for 0.9228x50 million= 46.140. Interest expense=46.140x5%=2.307million 66. Correct answer: B A cash flow earnings index consistently below 1.0 could indicate potential problems in a company's quality of earnings. 67. Correct answer: B A strategy of selling differentiated products at premium prices usually requires additional advertising or research and development to support the differentiating features; therefore, the effect on operating profit is normally less than the effect on gross profit margin.


202

68. Correct answer: A The present value of the operating leases should be added to both the total debt and the total assets. To estimate the present value it is appropriate to estimate the number of years of lease payments reflected in the 2016 and thereafter figure. Based on the constant expense shown in the first 5 years, there are 9 (1,260/140) more payments for a total of 14 payments. N=14, I/Y=10, PMT=140, FV=0, CPT(PV)=1031.34 Adjusted debt to total assets=(2,125+1,031)/(4,500+1,031)=57% 69. Correct answer: A Matrix pricing (as described) is an example of the debt‐rating approach only. 70. Correct answer: B Financing costs are not included in a cash flow calculation, but are considered in the calculation of the discount rate. 71. Correct answer: C WACC= wdrd (1 ‐t)+wprp+ were =[0.12x(1‐0.40)+0.17+0.20]/3=14.73% 72. Correct answer: C

Discount Rate

NPV Calculation

15% ‐100 ( ) ( ) ( )2 3$606,061 $2,151,515 / 1.15 $2,542, 424 / 1.15 $1,000,000 / 1.15= − + − + 18% ‐42 ( ) ( ) ( )2 3$606,061 $2,151,515 / 1.18 $2,542, 424 / 1.18 $1,000,000 / 1.18− + − + 21% +15 ( ) ( ) ( )2 3$606,061 $2,151,515 / 1 21 $2,542, 424 / 1.21 $1,000,000 / 1 .21− + − +

The NPV at 21% is $15 while the other two NPVs are negative. 73. Correct answer: A BA: [(1*6.1% /12) /(1‐6.1%/12)]*12=6.1312% Credit Line: 6.5% CP: (5.9% /12+0.15% /12+0.2% /12) /(1‐5.9%/12)]*12=6.3102% 74. Correct answer: C

=LDO

( )( )

var cosvar cos cosrevenues iable operating ts

revenues iable operating ts fixed operating ts−

− −

=

59.8 57.259.8 57.2 1.5

−⎛ ⎞⎜ ⎟− −⎝ ⎠ =2.36≈2.4

75. Correct answer: C Investors who have entered into a short sale will incur losses if the stock begins to increase in value. A


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stop‐buy order helps limit the loss on a short position, as it becomes valid when the stock price rises above the specified stop price. 76. Correct answer: C Cumulative voting allows shareholders to direct their total voting rights to specific candidates, as opposed to having to allocate their voting rights evenly among all candidates. Thus, applying all of the votes to one candidate provides the opportunity for a higher level of representation on the board than would be allowed under statutory voting. 77. Correct answer: A Note: (60% debt financing is equivalent to a DIE ratio of 1.50.0.60/(1‐0.60)

( )( ) ( )( )1/ 1 1 / 1.4 / 1 1 0.35 1.5 0.7089 0.71Assets EQ t D Eβ β ⎡ ⎤= × + − = + − × = ≈⎣ ⎦ 78. Correct answer: C Net Profit Ma rgin=Net Income/Sales= Earnings Before Tax x(1‐Tax Rate)/Sales

= 0.171 x Sales x (1‐0.42)/Sales=9.92% 79. Correct answer: B

Year Cash Flow PV (Cash Flow)@ 8% Amount to Pay Back

0 ‐75,000 ‐75,000 75,000

1 21,600 20,000 55,000

2 23,328 20,000 35,000

3 37,791 30,000 5,000

4 40,814 30,000 The first three cash flows recover $70,000 (in present value terms) of the cost, making only $5,000 of the $30,000 in Year 4 necessary to completely recover the cost. Therefore, the discounted payback is 3.2 years. For example: PV of Year 2's cash flow is $23,328/ [1.08]2 80. Correct answer: A DFL=(Operating Income)/(Operating income‐ Interest Expense) Or operating income divided by pretax earnings

=

( )$2.4 $1.2$2.4+

= 1.50 81. Correct answer: A Vo=Do/r= ($100x0.06)/0.115=$52.17 82. Correct answer: B Dividend growth rate over the period 2004‐2009= 1.25x(1+g)5=1.92; g=8.96%=9% Sustainable growth


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rate for the year 2009; retention rate= (1‐Dividend payout ratio)=[1‐(1.92/3.20)]=0.40 g= bxROE; g=0.40x12%=4.8% Average of the two approaches=(9+4.8)/2=‐‐6.90% V0=D1/(r‐g)=($1.92x1.069)/(0.15‐0.069)=32.05/0.081=$25.31 83. Correct answer: C Commodity index returns reflect the risk‐free interest rate, the changes in futures prices, and the roll yield. Changes in the underlying commodity price are not directly reflected in a commodity index. 84. Correct answer: C

Proceeds on sale: $55x500 $27,500

Payoff loan: $55x500x0.55 ‐$13,750

Margin interest paid: $13,750x0.06 ‐$825

Dividend received: $1.80x500 +$900

Sales commission paid: $0.05x500 ‐$25

Remaining equity $13,800Initial investment (including commission):($50x500x0.45)+($0.05x500)

$11,275

Return on the initial investment: ($13,800‐$11,275)/$11,275

22.4%

85. Correct answer: B Fundamentally weighted indices generally will have a contrarian "effect" in that the portfolio weights will shift away from securities that have increased in relative value and toward securities that have fallen in relative value whenever the portfolio is rebalanced. 86. Correct answer: B The shakeout stage is usually characterized by slowing growth, intense competition, and declining profitability. During the shakeout stage, demand approaches market saturation levels because few new customers are left to enter the market. Competition is intense as growth becomes increasingly dependent on market share gains. 87. Correct answer: A Earnings growth rate over the period 2006‐2009=2.05x(1+g)3=3.2; g=8.6% Average payout ratio=(0.60+0.50+0.70+0.64)/4=0.61 Required rate of return on share i= Current expected risk‐free rate of return+ Betax[Market (equity) risk premium]=3%+1.3(6.5%)=11.5%

1/P E =p/(r‐g) =0.61/(0.115‐0.086)=0.61/0.029=21.0 88. Correct answer: B


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Current year's dividend per share =$2.50x0.6=$1.50 V=1.50(1.25)/1.12+1.50(1.25)2/1.122+1.50(1.25)2(1.05)/(0.12‐0.05)}/1.122 = $1.67+$1.87+ 28.03 =$31.57

89. Correct answer: A According to loss aversion related arguments in behavioral theories, investors dislike• losses more that they like comparable gains. Thus, such a behavioral bias can explain observed overreaction in markets. 90. Correct answer: A Companies pursuing cost leadership must be able to invest in productivity‐improving capital equipment in order to be low‐cost producers and maintain efficient operating systems. 91. Correct answer: B NAV calculation first deducts the sales charge at t=o and then compounds the annual return. The NAV also reflects the compounded deduction of the annual expenses. 92. Correct answer: C The hedge fund managers themselves decide whether they want to be included in a database. Managers who have funds wit an unimpressive track record will not wish to have that information exposed. 93. Correct answer: A When a commodity market is in contango. Futures prices are higher than the spot price as market participants believe the spot price will be higher in the future. When spot prices are above the futures prices, the market is said to be in backwardation, 94. Correct answer: B Using the income approach: ($2,100,000‐0.03x2,100,000‐$1,600,000)/0.12=$437,000/0.12=$3,641,666.70 The property is appraised based on cash flows and is independent of the financing decision, 95. Correct answer: B You calculate the probability of success as (1‐0.25)x(1‐0.20) x(1‐0.15) x(1‐0.15) x(1‐0.15)=0.3685 Then calculate the NPV from success: (22,000/1.165)‐5,000=5,474x0.3685=2.017 Subtracting the NPV of failure, ‐5,000x(1‐0.3685, or 0.632)=‐3,157. The difference between the NPVs is the expected NPV of the project: 2,017‐3,157=‐1,140. 96. Correct answer: B 97. Correct answer: A The floor guarantees a minimum rate that the investor will earn 98. Correct answer: A


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A lower coupon rate means that more of the bond's value comes from repayment of face value, which occurs at the end of the bond's life. 99. Correct answer: B Duration measures the change in the price of a portfolio of bonds assuming that the yield for all maturities changes by the same amount. 100. Correct answer: C The tax‐equivalent yield= tax‐exempt yield/ (1‐marginal tax rate) =5.20%(1‐0.335)=7.82% 101. Correct answer: C The relative yield spread= (bond yield‐reference yield)/reference yield = (7.39%‐4.26%)/4.26% =73.5% 102. Correct answer: B A security with a present value of 96.47, 19 interest payments of 8, and a 20th payment of principal plus interest (108) has a yield to maturity of 8.37% 103. Correct answer: B The security's coupon rate moves in the opposite direction (inversely) with the risk‐free rate. (Specifically, the coupon rate = 12.00%‐2x risk‐free rate) 104. Correct answer: B The interest rate sensitivity of a floating‐rate security comes primarily from the time remaining until its next coupon reset. 105. Correct answer: B A balance sheet transaction is one that removes assets from the balance sheet of the institution, often motivated by the desire to reduce the institution's risk 106. Correct answer: A N=20, I/Y=3.5, PMT=3, FV=100, CPT(PV)=92.89 107. Correct answer: B With 4 years remaining to maturity and a discount rate that is unchanged at 6.0 percent, the value of the bond would be $103.47 or N=4, I/Y=6, PMT=7, FV=100, CPT(PV)=103.47 104.21‐103.47=0.74 108. Correct answer: B The effective duration equals: (price if rates fall‐price if rates rise)/(2xcurrent price x change in rates) =(103.28‐100.81)/(2 x 101.45 x0.0025)=4.87.


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109. Correct answer: B Derivative markets improve market efficiency for the underlying assets by increasing market fairness and competitiveness, not by lowering transaction costs. Lower transaction cost is a characteristic of derivative markets that is required for them to exist, not a purpose for derivative markets. 110. Correct answer: B On any day when the balance in the margin account falls below the maintenance margin, the trader must deposit sufficient funds to bring the balance back up to the initial margin requirement. This additional amount is called the variation margin. Therefore, $100‐$40=$60 variation margin. 111. Correct answer: C The portfolio manager pays the Value Index return, which had a loss, and receives the Growth Index, which had a gain during the period. Therefore, the portfolio manager will receive a cash flow from the swap dealer. . Value Index payment:[(5,350/5,460)‐1} x$50,000,000=$(1,007,326) Growth Index payment: [(1,200/1,190)‐1]x$50,000,000=$420,168 Net payment to portfolio manager= $420,168‐$(1,007,326)$1,427,494 112. Correct answer: A A currency forward contract can settle in cash or with actual delivery of the foreign currencies specified in the contract. This question refers to physical delivery; therefore, Epsilon receivers 1,000,000,000 JPY from the dealer in exchange for paying USD. 113. Correct answer: A For a European put, the exercise price must be adjusted to the present value since the option can be exercised only on expiration. 114. Correct answer: C To break even, the underlying stock must be at least as high as the amount expended up front to establish the position. To establish the protective put, the investor would have spent $71+1.45=72.45 115. Correct answer: B Endowments have a long investment time horizon and a high level of risk tolerance (Exhibit 14) 116. Correct answer: A Portfolio standard deviation=0.2504

0627.065.02.03.032.068.022.032.03.068.0 2222 =×××××+×+× 117. Correct answer: B

2 2

0.45 0.1235 0.08285 0.670.08285

im i m

m

ρ σ σβσ

× ×= = =



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Year 1 2 3 4

Starting balance $0.00 $2,000.00 $5,275.00 $4,206.25

New investment at beginning of year $2,500.00 $1,500.00 $1,000.00 $0.00

Net balance at beginning of year $2,500.00 $3,500.00 $6,275.00 $4,206.25

Investment return for the year ‐20% 65% ‐25% 10%Investment gain (loss) ‐$500.00 $2,275.00 ‐$1,568.75 $420.63

Withdrawal by investor at end of year $0.00 ‐$500.00 ‐￥500.00 $0.00

Balance at end of the year $2,000.00 $5,275.00 $4,206.25 $4,626.88

The money weighted return is calculated by solving for i in the equation below:

( ) ( ) ( ) ( )1 2 3 41500 500 500 4626.882500

1 1 1 1i i i i− −

= + + ++ + + +

CF1=‐1500 CF2=‐500 CF3=1000‐500=500 CF4=4,626.88 119. Correct answer: C Risk that is due to company‐specific or industry‐specific factors is referred to as unsystematic risk. 120. Correct answer: B An individual's ability to take risk is impacted by factors such as time horizon and expected income. Personality type is most likely to impact an individual's willing.

2010 - 2013 CFA Level I Sample Exams

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Transcript of 2010 - 2013 CFA Level I Sample Exams