2017 UAP Level I Sample Exam

1 Colin Gifford, CFA, is finalizing a monthly newsletter to his clients, who are primarily individual investors. Many of the clients’ accounts hold the common stock of Capricorn Technologies. In the newsletter, Gifford writes, “Based on the next six month's earnings of $1.50 per share and a 10% increase in the divi-dend, the price of Capricorn's stock will be $22 per share by the end of the year.” Regarding his stock analysis, the least appropriate action Gifford should take to avoid violating any CFA Institute Standards of Professional Conduct would be to:A separate fact from opinion.B include earnings estimates.C identify limitations of the analysis.

ANSWER = B

Although pro forma analysis may be standard industry practice, it is not required by the Standards of Professional Conduct. Earnings estimates are opinions and must be clearly identified as such. It is also important for investors to be able to identify limitations of analysis when making investment decisions.

CFA Level IGuidance for Standards I–VIIStandard V(B)–Communication with Clients and Prospective Clients

2 Belen Zapata, CFA, is the owner of Kawah Investments. Kawah promises inves-tors returns of up to 12% per year and claims to achieve these returns by invest-ing in non- investment- grade bonds and other fixed- income instruments. Over the next 12 months, bond market yields reach unprecedented lows and Zapata finds it impossible to achieve the returns she expected. No investments are ever made by Kawah, and clients are completely paid back all of their original invest-ment. Zapata most likely violated the CFA Institute Standards of Professional Conduct because of the:A return of capital.B investment mandate.C promised returns.

ANSWER = C

The member misrepresented the returns she could realistically achieve for her clients, violating Standard  I(C)–Misrepresentation, which prohibits members and candidates from guaranteeing clients any specific return on volatile investments.

CFA Level IGuidance for Standards I–VIIStandard I(C)–Misrepresentation

© CFA Institute 2017. All rights reserved.

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3 Which of the following distinct entities can least likely claim compliance with the Global Investment Performance Standards (GIPS)?A A multinational financial services holding companyB An investment management division of a regional commercial bankC A locally incorporated subsidiary undertaking investment management

services

ANSWER = A

The GIPS standards require that firms be defined as an investment firm, subsidiary, or division held out to clients or prospective clients as a distinct business entity. A mul-tinational financial services holding company is unlikely to be solely operating as an investment firm, and the scope of the business could also make it more difficult to claim compliance on a firmwide basis.

CFA Level IGlobal Investment Performance Standards (GIPS)GIPS Requirement 0.A.12

4 Ileana Inkster, CFA, was recently offered a senior management position within the trust department at a regional bank. The department is new, but the bank has plans to expand it significantly over the next few months. Inkster has been told she will be expected to help grow the client base of the trust depart-ment. She is informed that the trust department plans to conduct educa-tional seminars and pursue the attendees as new clients. Inkster notices that recent seminar advertisements prepared by the bank’s marketing department do not mention investment products will be for sale at the seminar. The ads indicate attendees can “learn how to immediately add $100,000 to their net worth.” What should Inkster most likely do to avoid violating any CFA Institute Standards of Professional Conduct?A Accept the position and inform senior management of inadequate compli-

ance proceduresB Accept the position and revise the marketing materialC Decline to accept the new position

ANSWER = C

The prospective supervisor's first step should be to not take the position. Accepting the position with inadequate procedures in place or improper marketing material would leave Inkster at risk of incurring a violation of Standard IV(C)–Responsibilities of Supervisors. She could agree to be hired as an interim consultant with the bank in order to implement adequate procedures before taking on any supervisory role.

CFA Level IGuidance for Standards I–VIIStandard IV(C)–Responsibilities of Supervisors

5 Eileen Fisher, CFA, has been a supervisory analyst at SL Advisers for the past 10 years. Recently, one of her analysts was found to be in violation of the CFA Institute Standards of Professional Conduct. Fisher has placed limits on the analyst's activities and is now monitoring all of his investment activities. Although SL did not have any compliance procedures up to this point, to avoid

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future violations, Fisher has put in place procedures exceeding industry stan-dards. Did Fisher most likely violate any CFA Institute Standards of Professional Conduct?A No, because she has taken steps to ensure the violations will not be repeated

by the analystB YesC No, because she is taking steps to implement compliance procedures that

are more than adequate

ANSWER = B

Under Standard IV(C)–Responsibility of Supervisors, a member should exercise reasonable supervision by establishing and implementing compliance procedures in place prior to the possibility of any violation occurring, which has not been done in this case.

CFA Level IGuidance for Standards I–VIIStandard IV(C)–Responsibilities of Supervisors

6 Zhao Xuan, CFA, is a sell- side investment analyst. While at a software industry conference, Zhao hears rumors that Green Run Software may have falsified its financial results. When she returns to her office, Zhao conducts a thorough analysis of Green Run. Based on her research, including discussions with some of Green Run's customers, Zhao is convinced that Green Run's reported 50% increase in net income during recent quarters is completely fictitious. But so far Zhao is the only analyst suspicious about Green Run's reported earnings. According to the CFA Institute Code of Ethics and Standards of Professional Conduct, the least appropriate action for Zhao is to:A report her suspicions to Green Run's management.B do nothing until other analysts support her analysis.C recommend her clients sell their Green Run shares immediately.

ANSWER = B

The analyst has conducted thorough research that indicates the company falsified its financial results, and she should request the company address this issue publicly as rec-ommended by Standard II(A)–Material Nonpublic Information. If a member or candidate determines that information is material, the member or candidate should make reason-able efforts to achieve public dissemination of the information. This effort usually entails encouraging the issuer company to make the information public. If public dissemination is not possible, the member or candidate must communicate the information only to the designated supervisory and compliance personnel within the member's or candidate's firm and must not take investment action on the basis of the information.

CFA Level IGuidance for Standards I–VIIStandard II(A)–Material Nonpublic Information

7 Monique Gretta, CFA, is a research analyst at East West Investment Bank. Previously, Gretta worked at a mutual fund management company and has a long- standing client relationship with the managers of the funds and their institutional investors. Gretta often provides fund managers, who work for Gretta’s former employer, with draft copies of her research before disseminating

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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 bank's clients, even though they are not aware of this practice. Regarding her research, Gretta least likely violated the CFA Institute Standards of Professional Conduct because:A her report is a draft.B this practice benefits all clients.C the long- standing client relationships are not disclosed.

ANSWER = C

The analyst does not violate any of the Standards of Professional Conduct by having long- standing client relationships and generally is not required to disclose such relationships. However, the analyst is not treating all clients fairly as required by Standard III(B)–Fair Dealing when disseminating investment recommendations; disclosure of the relationship with long- standing clients is not the issue. The analyst has advantaged some clients over others by providing advance information, and all clients do not have a fair opportunity to act on the information within the draft report. Members and candidates may differ-entiate their services to clients, but different levels of service must not disadvantage or negatively affect clients.

CFA Level IGuidance for Standards I–VIIStandard III(B)–Fair Dealing

8 Which of the following is not part of the nine major sections of the Global Investment Performance Standards (GIPS)?A Performance feesB Input dataC Disclosure

ANSWER = A

The nine major sections of the GIPS standards do not include performance fees. The nine sections are fundamentals of compliance, input data, calculation methodology, composite construction, disclosure, presentation and reporting, real estate, private equity, and wrap fee/separately managed account portfolios.

CFA Level IThe GIPS StandardsSection: Provisions of the Global Investment Performance Standards

9 Oliver Opdyke, CFA, works for an independent research organization that does not manage any client money. In the course of his analysis of Red Ribbon Mining, he hears rumors that the president of Red Ribbon, Richard Leisberg, has recently been diagnosed with late stage Alzheimer's disease, a fact not publicly known. The final stage of Alzheimer's is when individuals lose the ability to respond to their environment, the ability to speak, and ultimately, the ability to control movement. Leisberg is the charismatic founder of Red Ribbon, and under his leadership the company grew to become one of the largest in the industry. According to the CFA Institute Code of Ethics and Standards of Professional Conduct, the most appropriate action for Opdyke is to:

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A encourage Red Ribbon Mining management to disclose the president’s med-ical condition.

B immediately publish a sell recommendation for Red Ribbon Mining.C confirm the president’s diagnosis before publishing his research report.

ANSWER = A

Members and candidates should make reasonable efforts to achieve public dissemination of information that is material and nonpublic, as required by Standard  II(A)–Material Nonpublic Information. This effort usually entails encouraging the issuer company to make the information public. In this case, if the diagnosis is fact and not rumor, then this information is material and should be disclosed.

CFA Level IGuidance for Standards I–VIIStandard II(A)–Material Nonpublic Information

10 Gardner Knight, CFA, is a product development specialist at an investment bank. Knight is responsible for creating and marketing collateralized debt obligations (CDOs) consisting of residential mortgage bonds. In the market-ing brochure for his most recent CDO, Knight provided a list of the mortgage bonds that the CDO was created from. The brochure also states “an indepen-dent third party, the collateral manager, 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 of the following CFA Institute Standards of Professional Conduct?A SuitabilityB Conflicts of InterestC Client Communication

ANSWER = A

There is no indication the investment is unsuitable for investors and in violation of Standard III(C)–Suitability.

CFA Level IGuidance for Standards I–VIIStandard III(C)–Suitability, Standard V(B)–Communication with Clients and Prospective

Clients, Standard VI(A)–Disclosure of Conflicts

11 As a monetary policy tool, quantitative easing (QE) will most likely help revive an ailing economy in which of the following environments?A Declining bank reserves and economic activityB Liquidity trapC Deflationary trap

ANSWER = A

Quantitative easing (QE) is an “unconventional” approach to monetary policy and is operationally similar to open market purchase operations but conducted on a much larger scale. The additional reserves created by central banks in a policy of quantitative

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easing can be used to buy any assets. The idea is that this additional reserve will kick- start lending, causing broad money growth to expand, which will eventually lead to an increase in real economic activity.

CFA Level IMonetary and Fiscal Policy, Andrew Clare and Stephen ThomasSections 2.5.1, 2.5.2

12 A one- tailed hypothesis testing has a p-value for a test statistic of 3%. An ana-lyst would not reject the null hypothesis at a significance level of:A 0.01.B 0.05.C 0.10.

ANSWER = A

By the definition of p-value, 0.03 is the smallest level of significance at which the null hypothesis can be rejected. An analyst cannot reject the null hypothesis at the 0.01 significance level.

CFA Level IHypothesis Testing, Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto, and

David E. RunkleSection 2

13 If the distribution of the population from which samples of size n are drawn is positively skewed and given that the sample size, n, is large, the sampling distri-bution of the sample means is most likely to have a:A mean smaller than the mean of the entire population.B variance equal to that of the entire population.C distribution that is approximately normal.

ANSWER = C

Given a population that has a finite variance and a large sample size, 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.

CFA Level ISampling and Estimation, Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto,

and David E. RunkleSection 3.1

14 The following information applies to a sample:● The point estimate of the population mean is 12.5.● The t-statistic (tα/2) used in calculating the 90% confidence interval is 1.67.● The sample size is 64.● The sample standard deviation is 5.● The 90% confidence interval for the population mean is closest to:A 11.98 to 13.02.

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B 12.37 to 12.63.C 11.46 to 13.54.

ANSWER = C

The confidence interval for the population mean is calculated as:

X t sn

± α 2

where X is the mean of the sample (12.5), tα/2 is the appropriate t-statistic (1.67), s is the sample standard deviation (5), and n is the sample size (64). In this problem, the

confidence interval is 12.5  ± 1.67  × 5 64 = 12.5  ± 1.04375  = 11.45625 to 13.54375, rounded to 11.46 to 13.54.

CFA Level ISampling and Estimation, Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto,

and David E. RunkleSection 4.2

15 Independent samples drawn from normally distributed populations exhibit the following characteristics:

Sample Size Sample Mean Sample Standard Deviation

A 25 200 45B 18 185 60

Assuming that the variances of the underlying populations are equal, the pooled estimate of the common variance is 2,678.05. The t-test statistic appropriate to test the hypothesis that the two population means are equal is closest to:A 1.90.B 0.29.C 0.94.

ANSWER = C

The t-statistic for the given information (normally distributed populations, population variances assumed equal) is calculated as:

tX X

sn

sn

p p

=−( ) − −( )

+

1 2 1 2

2

1

2

2

0 5

µ µ.

In this case, we have:

sp2 = 2678.05.

t =−( ) − ( )

+

=200 185 0

2678 0525

2678 0518

0 93768 0 940 5. .. ..

CFA Level IHypothesis Testing, Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto, and

David E. Runkle

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Section 3.2

16 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 most appropriate approach when the variance is:A known.B large.C unknown.

ANSWER = C

When the sample size is small (and the population is normally or approximately normally distributed), the Student’s t-distribution is preferred if the variance is unknown.

CFA Level ISampling and Estimation, Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto,

and David E. RunkleSection 4.2

17 A sample of 240 managed portfolios has a mean annual return of 0.11 and a standard deviation of returns of 0.23. The standard error of the sample mean is closest to:A 0.01485.B 0.00096.C 0.00710.

ANSWER = A

For a sample, the standard error of the mean is s snX = where s is the sample standard

deviation and n is the sample size, which here is: 0 23 240. = 0.01485.CFA Level ISampling and Estimation, Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto,

and David E. RunkleSection 3.1

18 A technical analyst observes a head and shoulders pattern in a stock she has been following. She notes the following information:

Head price $83.50Shoulder price $72.00Neckline price $65.75Current price $64.00

Based on this information, her estimate of the price target is closest to:A $59.50.B $48.00.C $44.50.

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ANSWER = B

Price target = Neckline − (Head − Neckline).In this example, Price target = $65.75 − ($83.50 − $65.75) = $65.75 – $17.75 = $48.00.CFA Level ITechnical Analysis, Barry M. Sine and Robert A. StrongSection 3.3.1.3

19 The price index that best resolves the substitution bias is the:A Fisher index.B Laspeyres index.C Paasche index.

ANSWER = A

The Fisher index is a geometric mean of the Laspeyres and Paasche indexes, and it will therefore display less of a substitution bias than the other two. Both the Laspeyres index and the Paasche index ignore the substitution effect whereby people may substitute higher priced goods or services with cheaper ones. The Laspeyres index uses the his-torical composition of a basket of goods making it upward biased relative to the true inflation rate, while the Paasche index uses the current composition of the basket with cheaper options replacing more expensive ones, making it downward biased relative to the true inflation rate.

CFA Level IUnderstanding Business Cycles, Michele Gambera, Milton Ezrati, and Bolong CaoSection 4.2.2

20 Cost–push inflation is least likely to be affected by an increase in:A employee wages.B finished goods prices.C commodity prices.

ANSWER = B

Cost–push inflation arises due to increases in costs associated with production: wages and raw materials prices.

CFA Level IUnderstanding Business Cycles, Michele Gambera, Milton Ezrati, and Bolong CaoSection 4.2.4.1

21 Labor markets are best described as a type of:A capital market.B goods market.C factor market.

ANSWER = C

Factor markets are markets for the purchase and sale of factors of production. Labor markets are a type of factor market in which households offer to sell their labor services.

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CFA Level IDemand and Supply Analysis: Introduction, Richard V. Eastin and Gary L. ArbogastSection 2

22 If the scale of a single producer is small relative to the demand for an undiffer-entiated good, the market structure of the producer is best described as being:A an oligopoly.B monopolistic competition.C perfect competition.

ANSWER = C

Perfect competition involves the sale of a homogeneous product by many sellers; monopolistic competition may also involve many sellers, but its product is differentiated.

CFA Level IThe Firm and Market Structures, Richard G. Fritz and Michele GamberaSection 2.2

23 Which characteristic is a firm least likely to exhibit when it operates in a market with a downward sloping demand curve, many competitors, and zero economic profits in the long run?A No pricing powerB Low barriers to entryC Differentiated product

ANSWER = A

The characteristics of monopolistic competition include a large number of competitors, low pricing power, and the production of differentiated products (through advertising and other non- price strategies), but these still result in some pricing power. The ease of entry results in zero economic profits in the long run.

CFA Level IThe Firm and Market Structures, Richard G. Fritz and Michele GamberaSections 2.1, 2.2, 4

24 The following is an excerpt from the note to the financial statements on intangi-ble assets for a company:

Intangible Assets (€ millions)

Licenses Other Total

Cost 23,984 1,475 25,459Accumulated amortization 7,390 1,195 8,585Net book value 2016 16,594 280 16,874

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Licenses Other Total

Net book value 2015 15,200 480 15,680

As of year- end, licenses with a net book value of €2,530  million have been pledged as security against borrowings.

The percentage of intangible assets pledged as security against borrowings in 2016 is closest to:A 9.9%.B 15.3%.C 15.0%.

ANSWER = C

The percentage of intangible assets pledged as security against borrowings in 2016 is closest to 15.0% (€2,530/€16,874 = 15.0%).

CFA Level ILong- Lived Assets, Elaine Henry and Elizabeth A. GordonSection 7

25 A company acquired a customer list for $300,000 and a trademark for $5,000,000. Management expects the customer list to be useful for three years, and it expects to use the trademark for the foreseeable future. The trademark must be renewed every 10 years with the Patent and Trademark office for a nominal amount; otherwise it expires. If the company uses straight- line depre-ciation for all its intangible assets, the annual amortization expense for these two assets will be closest to:A $100,000.B $600,000.C $0.

ANSWER = A

The trademark can be renewed at a minimal cost, therefore it is considered to have an indefinite life and amortization expense is not required.

Annual amortization expense on the customer list = $300,000 ÷ 3 years = $100,000.CFA Level ILong- Lived Assets, Elaine Henry and Elizabeth A. GordonSection 3.2

26 The following information is available concerning a new showroom a company built. Construction started on 1 January 2012 and the grand opening was on 1 January 2014:

(Continued)

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Loan: Funds borrowed on 1 January 2012 and put to use immediately

€30 million

Interest rate on loan 8%, payable annuallyRepayment terms for loan Balloon payment, due on

1 January 2017Total construction costs incurred during 2012 and 2013 €38.5 millionExpected useful life of the showroom 40 yearsExpected residual value of the showroom €5 millionDepreciation method Straight line

The depreciation expense (in millions) for the showroom in 2014 is closest to:A €1.0175.B €0.9575.C €0.8375.

ANSWER = B

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 38.5Interest expense in 2012 and 2013: 0.08 × €30 × 2 years 4.8Total capitalized cost 43.3

Straight line depreciation expense:

(Capitalized cost – Residual value)/Useful life = (43.3 – 5.0)/40 0.9575

CFA Level ILong- Lived Assets, Elaine Henry and Elizabeth A. GordonSections 2.1, 3.1

27 The role of the International Organization of Securities Commissions (IOSCO) is best described as:A promoting cross- border cooperation and uniformity in securities regulation.B enforcing financial reporting requirements for entities participating in capi-

tal markets.C promoting the use of International Financial Reporting Standards and the

convergence of national accounting standards.

ANSWER = A

IOSCO provides a forum for regulators from different jurisdictions to work together toward fair, efficient, and transparent markets, promoting cross- border cooperation and uniformity in securities regulation.

CFA Level IFinancial Reporting Standards, Elaine Henry, Jan Hendrik van Greuning, and Thomas

R. RobinsonSection 3.2.1

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28 The following information for a company was taken from its financial state-ments and the accompanying notes:

Income Statement ($ thousands)

For Periods Ending 31 December 2014 2013

Net sales 11,159 8,895Cost of goods sold (COGS) 9,898 7,901

Note 5. InventoriesInventories are reported on a last- in, first- out (LIFO) basis. The LIFO reserve was $867 thousand and $547 thousand at the end of 2014 and 2013, respectively. During 2014, the company liquidated certain LIFO inventories that had been carried at lower costs in prior years, and the effect of the liquidation was to decrease COGS by $263 thousand. No LIFO liquidation occurred in 2013.

After adjusting for the LIFO liquidation in 2014, the change in gross profit mar-gin compared with 2013 is most likely:A essentially unchanged.B higher by 2.5%.C lower by 2.3%.

ANSWER = C

Gross profit margin = Sales COGSSales−

×100

Gross profit under LIFO in 2014 ($ thousands) = 11,159 – 9,898 = 1,261

This figure arose in part from the LIFO liquidation, which decreased COGS by $263,000 and hence increased gross profit.

Adjusting the gross profit downward by this amount gives adjusted gross profit ($ thousands) of 1,261 – 263 = 998.

Adjusted gross profit margin in 2014 = 99811159

100,

×

 = 8.9%

Gross profit margin in 2013 = 8 895 7 9018 895

100, ,,−

×

 = 11.2%

After adjusting for the LIFO liquidation, gross profit margin is lower by (11.2% – 8.9%) = 2.3%.

CFA Level IInventories, Michael A. BroihahnSection 4.2

29 If a company has a deferred 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.

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B increase in value.C decrease in value.

ANSWER = C

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.

CFA Level IIncome Taxes, Elbie Louw and Michael A. BroihahnSection 3.3

30 On 1 January, a company that prepares its financial statements according to International Financial Reporting Standards (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●● temporarily invested NZ$2,000,000 of the loan proceeds during the first six

months of construction and earned 7% on that amount.The amount of financing costs to be capitalized to the cost of the plant in the first year is closest to:A NZ$400,000.B NZ$630,000.C NZ$330,000.

ANSWER = C

The interest costs can be capitalized during the construction phase however 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 NZ$

Interest costs 0.08 × 5,000,000 400,000Minus interest income 0.07 × 2,000,000 × ½ year – 70,000Total capitalized costs 330,000

CFA Level ILong- Lived Assets, Elaine Henry and Elizabeth A. GordonSection 2.1

31 Information about the coupon rates on the various long- term fixed- rate debt issues of a company can most likely be found in the:A notes to the financial statements.B non- current liabilities section of the balance sheet.C Management Discussion & Analysis (MD&A).

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ANSWER = A

Information about the coupon rates on the various long- term fixed- rate debt issues can usually be found in the notes to the financial statements. The MD&A is more likely to discuss interest rate trends and/or current financing costs but not specific information on individual debt issues.

CFA Level INon- Current (Long- Term) Liabilities, Elizabeth A. Gordon and Elaine HenrySections 2.6

32 In a period of rising prices and stable inventory levels, which inventory valua-tion method will most likely result in the highest inventory turnover ratio, all else being equal?A Last- in, first- out (LIFO)B Weighted average costC First- in, first- out (FIFO)

ANSWER = A

In a period of rising prices, the most recently purchased units of inventory carry the highest cost. Under the LIFO approach, it is these high- cost units (those that are “last in”) that are transferred to the income statement (“first out”) as cost of goods sold. The lowest- cost units remain on the balance sheet as inventory. With a high cost of goods sold value (numerator) and a low inventory value (denominator), the inventory turnover ratio is highest under LIFO.

CFA Level IInventories, Michael A. BroihahnSection 3.7

33 A company has recently revalued one of its depreciable properties and esti-mates that its remaining useful life will be another 20 years. The applicable tax rate for all years is 30%, and the revaluation of the property is not recognized for tax purposes. Details related to this asset are provided in the following table:

(millions)Accounting

PurposesTax Purposes

Original Values and EstimatesAcquisition cost in 2011 £8,000 £8,000Depreciation, straight line 20 years 8 yearsAccumulated depreciation, end of 2013 £1,200 £3,000Net balance, end of 2013 £6,800 £5,000

Re- estimated Values and Estimates, Start of 2014Revaluation balance, start of 2014 £10,000 Not applicableNew estimated life 20 years

The deferred tax liability related to this asset (in millions) as at the end of 2014 is closest to:A £960.B £690.

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C £1,650.

ANSWER = B

(millions)Accounting

Purposes Tax Purposes

Revaluation surplus (£10,000 – £6,800) = £3,200

No revaluation allowed

Depreciation, straight line 20 years 5 years remainingStart of year balance after revaluation, 2013

£10,000 £5,000

Depreciation, 2013 (£10,000/20 years) = £500

£1,000

Net balance, end of 2013 £9,500 £4,000Minus revaluation surplus – £ 3,200Carrying value for purposes of deferred taxes

£6,300 £4,000

Deferred tax liability = 0.30 × (£6,300 – £4,000) = £690Only the portion of the difference between the tax base and the carrying amount

that is not the result of the revaluation is recognized as giving rise to a deferred tax lia-bility. The portion arising from the revaluation surplus is used to reduce the revaluation surplus in equity.

CFA Level IIncome Taxes, Elbie Louw and Michael A. BroihahnSections 2.2, 6.2

34 To evaluate the potential effect of an innovative and unique type of business transaction on financial statements, an analyst's best approach is to:A monitor the actions of standard setters and regulators.B gain an understanding of the transaction’s economic purpose.C consider the approach taken for “new” transactions that arose in the past.

ANSWER = B

By understanding the economic purpose of a transaction and applying the conceptual framework, an analyst may be able to evaluate the potential effect on financial state-ments, even in the absence of specific standards.

CFA Level IFinancial Reporting Standards, Elaine Henry, Jan Hendrik van Greuning, and Thomas

R. RobinsonSection 8.1

35 If a company capitalizes 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.B the same free cash flow to the firm (FCFF) in that period.C a higher earnings per share in future periods.

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ANSWER = B

The FCFF [Cash flow from operations (CFO) + Interest × (1 – t) – Capital expenditures] would be the same. CFO and capital expenditures would both increase by the same amount (ignoring taxes). Therefore, net effect on FCFF would be zero.

Example Capitalizing delivery cost as opposed to expensing it

Ignoring taxesFCFF 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 capital-ized (i.e., the amount not expensed)

Because capital expenditures and CFO increase by the same amount, ignoring taxes, FCFF is unchanged.

CFA Level IUnderstanding Cash Flow Statements, Elaine Henry, Thomas R. Robinson, Jan Hendrik

van Greuning, and Michael A. BroihahnSection 4.3Long- Lived Assets, Elaine Henry and Elizabeth A. GordonSection 2.1

36 The following information is available for a firm in a developing country:

Risk- free rate 2.0%Firm’s equity beta 1.5Equity risk premium in a developed country 3.0%Developing country risk premium 4.0%Sovereign yield spread 2.5%

The firm’s cost of equity using the CAPM approach is closest to:A 10.5%.B 12.5%.C 10.3%.

ANSWER = B

Cost of equity = Risk- free rate + Equity beta × (Equity risk premium + Country risk pre-mium) = 0.02 + 1.5 × (0.03 + 0.04) = 12.5%

CFA Level ICost of Capital, Yves Courtois, Gene C. Lai, and Pamela Peterson DrakeSection 4.2 and 3.3

37 For a 90- day US Treasury bill selling at a discount, which of the following meth-ods most likely results in the highest yield?A Discount- basis yield (DBY)

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B Money market yield (MMY)C Bond equivalent yield (BEY)

ANSWER = C

The face value is greater than the purchase price because the T- bill sells at a discount.

DBY Face value Purchase priceFace value Days to maturit

=−

×360

yy

MMY Face value Purchase pricePurchase price Days to m

=−

×360

aaturity, MMY DBY

BEY Face value Purchase pricePurchase pri

>

=−

cce Days to maturity

BEY MMY , BEY MMY DBY

×

= × > >

365

365300

CFA Level IWorking Capital Management, Edgar A. Norton, Jr., Kenneth L. Parkinson, and Pamela

Peterson DrakeSection 4.1.1

38 A mining company has received government approval for the development of a mining property and has also consulted with members of the local community near the development site throughout the project assessment process. The latter action is best described as an example of:A principal–agent conflict mitigation.B stakeholder management.C regulatory compliance.

ANSWER = B

Stakeholder theory broadens a company’s focus beyond the interests of only its share-holders to those of its customers, suppliers, employees, and others who have an interest in the company. The local community is likely a stakeholder in the company's development plans. By identifying the community and understanding its interests, the company is engaging in stakeholder management.

CFA Level ICorporate Governance and ESG: An Introduction, Assem Safieddine, Young Lee, Donna

F. Anderson, and Deborah KiddSection 4.2

39 Other factors held constant, the reduction of a company’s average accounts payable because of suppliers offering less trade credit will most likely:A not affect the operating cycle.B reduce the operating cycle.C increase the operating cycle.

19

ANSWER = A

Payables are not part of the operating cycle calculation, which includes receivables and inventory.

CFA Level IFinancial Analysis Techniques, Thomas R. Robinson, Jan Hendrik van Greuning, Elaine

Henry, and Michael A. BroihahnSection 4.3.2Working Capital Management, Edgar A. Norton, Jr., Kenneth L. Parkinson, and Pamela

Peterson DrakeSection 2.2

40 The following table shows information on three different investment strategies with equivalent systematic risk:

Annualized Data

Strategy Type of StrategyFees and Expenses Net Return

1 Passive 0% 15%2 Exploits price patterns 1% 14%3 Uses fundamental analysis 2%

The return, gross of fees and expenses, that causes Strategy 3 to be most consis-tent with the strong form of market efficiency is:A 18%.B 16%.C 17%.

ANSWER = C

For a violation of the strong form of market efficiency to occur, the strategy based on fundamental analysis must achieve a net return higher than the net return of the passive strategy, on a risk- adjusted basis. This threshold corresponds to 15% because both strategies had the same systematic risk and the passive strategy has no fees or expenses. To find the gross return on the strategy that uses fundamental analysis, the fees and expenses must be added to the net return: Gross return = Net return + Fees and expenses = 15% + 2% = 17%. Anything in excess of 17% would violate the strong form of market efficiency for the fundamental analysis strategy.

CFA Level IMarket Efficiency, W. Sean Cleary, Howard J. Atkinson, and Pamela Peterson DrakeSections 3.4 and 2.1

41 An internal evaluation of the trading behavior of three fund managers of a mutual fund company during the past year has revealed the following:

Manager X Was slower than peers when reacting to changes in informationManager Y Rarely realized investment losses but realized most of the

investment gainsManager Z Tended to overreact by disliking losses more than liking compa-

rable gains

Which of the three managers most likely displayed the disposition effect bias?

20

A Manager YB Manager XC Manager Z

ANSWER = A

The disposition effect relates to the behavioral bias in which investors tend to avoid realizing losses but, rather, seek to realize gains. Manager Y has displayed this bias.

CFA Level IMarket Efficiency, W. Sean Cleary, Howard J. Atkinson, and Pamela Peterson DrakeSection 5.3

42 A portfolio of securities representing a given security market, market segment, or asset class is best described as a:A benchmark.B security market index.C total return index.

ANSWER = B

A security market index represents a given security market, market segment, or asset class and is normally constructed as portfolios of marketable securities.

CFA Level ISecurity Market Indices, Paul D. Kaplan and Dorothy C. KellySection 2

43 Which of the following statements is most accurate in an efficient market?A Active strategies will lead to excess risk adjusted portfolio returns.B Securities market prices fully reflect their fundamental values.C Securities market prices respond over time to changes in economic

information.

ANSWER = B

In an efficient market, market participants will process available information and those with opposite views will trade among each other until securities market prices fully reflect their fundamental values. An efficient market is thus a market in which asset prices reflect all past and present information.

CFA Level IMarket Efficiency, W. Sean Cleary, Howard J. Atkinson, and Pamela Peterson DrakeSection 2.1

44 An industry characterized by rising volumes, improving profitability, falling prices, and relatively low competition among companies is most likely in which of the following life- cycle stages?A GrowthB MatureC Embryonic

21

ANSWER = A

An industry in growth stage is characterized by rising volumes, improving profitability, falling prices, and relatively low competition among companies.

CFA Level IIntroduction to Industry and Company Analysis, Patrick W. Dorsey, Anthony M. Fiore,

and Ian Rossa O’ReillySection 5.1.5

45 Unlike commercial industry classification systems, industry classification sys-tems developed by governments most likely:A are updated more frequently.B are more transparent.C include private companies.

ANSWER = C

Industry classification systems developed by governments do not distinguish between public and private companies, whereas commercial classification systems include only publicly traded organizations.

CFA Level IIntroduction to Industry and Company Analysis, Patrick W. Dorsey, Anthony M. Fiore,

and Ian Rossa O'ReillySection 4.3

46 Centro Corp. recently issued a floating- rate note (FRN) that includes a feature that prevents its coupon rate from falling below a prespecified minimum rate. This feature in an FRN is most likely referred to as a:A cap.B collar.C floor.

ANSWER = C

An FRN with a floor on the coupon rate prevents the coupon rate from falling below a prespecified minimum rate.

CFA Level IFixed- Income Securities: Defining Elements, Moorad Choudhry and Stephen E. WilcoxSection 4.2

47 In a rising interest rate environment, the effective duration of a putable bond relative to an otherwise identical non- putable bond, will most likely be:A higher.B lower.C the same.

22

ANSWER = B

When interest rates are rising, the put option becomes more valuable to the investor. The ability to sell the bond at par value limits the price depreciation as rates rise. So, the presence of an embedded put option reduces the sensitivity of the bond price to changes in interest rates, resulting in a lower effective duration.

CFA Level 1Understanding Fixed-Income Risk and Return, James F. Adams and Donald J. SmithSection 3.3

48 The Macaulay duration of a non- callable perpetual bond with a yield in perpe-tuity of 8% is closest to:A 7.4.B 8.0.C 13.5.

ANSWER = C

The Macaulay duration of a non- callable perpetual bond is:

MacDur = (1 + r)/r

So, MacDur = 1.08/0.08 = 13.5.CFA Level 1Understanding Fixed-Income Risk and Return, James F. Adams and Donald J. SmithSection 3.3

49 Which of the following statements is least accurate regarding the factors that affect the interest rate risk characteristics of an option- free bond?A The lower the coupon rate, the greater the bond's price sensitivity to

changes in interest rates.B The higher the yield, the greater the bond's price sensitivity to changes in

interest rates.C The longer the bond's maturity, the greater the bond's price sensitivity to

changes in interest rates.

ANSWER = B

Option- free bonds have positive convexity. The higher the yield to maturity, the lower the duration (and thus the lower the interest rate risk).

CFA Level IUnderstanding Fixed- Income Risk and Return, by James F. Adams and Donald J. SmithSection 3.3

50 A bond with a par value of $100 matures in 10 years with a coupon of 4.5% paid semiannually; it is priced to yield 5.83% and has a modified duration of 7.81. If the yield of the bond declines by 0.25%, the approximate percentage price change for the bond is closest to:A 3.91%.B 1.95%.

23

C 0.98%.

ANSWER = B

Approximate percentage price change = –[7.81 × (–0.0025)] = 0.01953 or 1.95%.

CFA Level IUnderstanding Fixed- Income Risk and Return, James F. Adams and Donald J. SmithSection 4.1

51 An investor is least likely exposed to reinvestment risk from owning a(n):A amortizing security.B zero- coupon bond.C callable bond.

ANSWER = B

There are no interim cash flows for a zero- coupon bond until the maturity.CFA Level IUnderstanding Fixed- Income Risk and Return, James F. Adams and Donald J. SmithSection 2

52 Which statement best describes the early exercise of non- dividend paying American options? Early exercise may be advantageous for:A both deep- in- the- money calls and deep- in- the- money puts.B deep- in- the- money calls.C deep- in- the- money puts.

ANSWER = C

Only deep- in- the- money put options may be exercised early. The price cannot fall below zero and thus the additional upside of such an option is limited.

CFA Level IBasics of Derivative Pricing and Valuation, Don M. ChanceSection 4.3

53 A corporation issues five- year fixed- rate bonds. Its treasurer expects interest rates to decline for all maturities for at least the next year. She enters into a one- year agreement with a bank to receive quarterly fixed- rate payments and to make payments based on floating rates benchmarked on three- month Libor. This agreement is best described as a:A futures contract.B forward contract.C swap.

24

ANSWER = C

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. The corporation receives fixed interest rate payments and makes variable interest rate payments. Given that the contract is for one year and the floating rate is based on three- month Libor, at least four payments will be made during the year.

CFA Level IDerivative Markets and Instruments, Don M. ChanceSection 4.1

54 Which of the following statements is least accurate concerning differences in the pricing of forwards and futures?A Differences in the pattern of cash flows of forwards and futures can explain

pricing differences.B Pricing differences can arise if futures prices and interest rates are

uncorrelated.C Interest rate volatility can explain pricing differences.

ANSWER = B

If futures prices and interest rates are uncorrelated, the prices of forwards and futures will be identical.

CFA Level IBasics of Derivative Pricing and Valuation, Don M. ChanceSection 3.2

55 When the futures price of a commodity exceeds the spot price, the commodity market is most likely in:A contango.B backwardation.C carry.

ANSWER = A

When a commodity market is in contango, futures prices are higher than spot prices. When spot prices are higher than the futures price, the market is said to be in backwardation.

CFA Level IIntroduction to Alternative Investments, Terri Duhon, George Spentzos, and Scott

D. StewartSection 6.4.1

56 Concentrated portfolio strategies are attractive because of their:A potential to generate alpha.B ability to track market indices.C low risk.

25

ANSWER = A

Concentrated portfolio strategies focus on only a few securities, strategies, or managers. This focus reduces diversification but may enable investors to achieve alpha.

CFA Level IIntroduction to Alternative Investments, Terri Duhon, George Spentzos, and Scott

D. StewartSection 2.2

57 The return measure that best allows one to compare asset returns earned over different length time periods is the:A holding period return.B annualized return.C net portfolio return.

ANSWER = B

The annualized return is an average return measure that can be calculated using return data for a period that is shorter (or longer) than one year. In many cases, it is most conve-nient to annualize all available returns in order to compare returns when the time periods during which a return is earned or computed vary. It reflects the return that would be earned over a one- year period, assuming that money can be reinvested repeatedly while earning a similar return.

CFA Level IPortfolio Risk and Return: Part I, Vijay SingalSection 2.1

58 When considering a portfolio that is optimal for one investor, a second investor with a higher risk aversion would most likely:A expect a higher variance for the portfolio.B derive a lower utility from the portfolio.C have a lower return expectation for the portfolio.

ANSWER = B

Utility has two terms: the expected return and a negative term based on the portfolio risk weighted by risk aversion. For an identical portfolio, the investor with a higher risk aversion (A) would calculate a lower utility (U).

U E r A= ( ) − 12

σ

CFA Level IPortfolio Risk and Return: Part I, Vijay SingalSection 3.2

59 The covariance of the assets in the following portfolio is closest to:

26

Asset 1 Asset 2 Asset 1 vs. Asset 2

Correlation 0.8

Portfolio weight 0.6 0.4

Variance 3.5% 1.5%

A 1.8%B 0.4%C 2.3%

ANSWER = A

The covariance is calculated from the standard deviations of the two assets and their correlation. The portfolio weights are not relevant.

cov = × ×

= × ×

= × × =

ρ σ σ

ρ12 1 2

12 1 2

0 8 3 5 1 5 1 8

var var

. . % . % . %CFA Level IPortfolio Risk and Return: Part I, Vijay SingalSection 4.1.3

60 A portfolio has the following returns:

Portfolio Returns

2006 2.4%2007 9.6%2008 –4.0%2009 5.6%2010 4.8%2011 –3.2%

The sample variance of the portfolio is closest to:A 0.23%.B 0.36%.C 0.28%.

ANSWER = C

The sample variance is calculated as the sum of squared deviations from the arithmetic mean.

27

mean = + − + + −=∑2 4 9 6 4 0 5 6 4 8 3 2

62 5. % . % . % . % . % . % . %

sample variance sum squared deviations=

−N 1

=−( ) + −( ) + − −( ) + −( ) +2 4 2 5 9 6 2 5 4 0 2 5 5 6 2 5 4 82 2 2 2. % . % . % . % . % . % . % . % . % −−( ) + − −( )∑ 2 5 3 2 2 5

5

2 2. % . % . %

= 0.28%

CFA Level IPortfolio Risk and Return: Part I, Vijay SingalSection 4.1.3