CFA Mock 2

Question 1

Russell Finley, CFA, is a managing director at Wilson Brothers and is responsible for the supervision of all trading and sales operations. Finley receives information indicating that a sales assistant made personal trades on a restricted security. According to the Standard regarding responsibilities of supervisors, the least appropriate action for Finley to take is to:

A)
begin an investigation to determine the extent of the wrongdoing.
B)
restrict and increase the monitoring of the employee’s activities at the firm.
C)
speak directly to the employee and attain assurance that the violation will not be repeated.

Answer 1

C)
speak directly to the employee and attain assurance that the violation will not be repeated.

Standard IV(C) Responsibilities of Supervisors explicitly states that speaking to the employee to determine the extent of the violations and receiving assurances that it will not be repeated is not enough. Finley must take positive steps to ensure that the violation will not be repeated, including promptly launching an investigation and limiting the employee’s activities and/or increasing supervision of the employee until the results of the investigation are known

Question 2

Justin Matthews, CFA, is chief financial officer of a bank and serves on the bank’s investment committee. The majority of the committee has voted to invest in medium-term euro debt. Matthews feels very strongly that this is a poor strategy and that trends in both the exchange rate and in euro interest rates over the next year will result in large losses on the position. According to the Code and Standards, Matthews should most appropriately:

A)
document his difference of opinion with the committee.
B)
express his concerns to the bank’s chief executive officer directly.
C)
dissociate from the recommendation by asking that his name not be included.

Answer 2

A)
document his difference of opinion with the committee

Standard V(A) Diligence and Reasonable Basis states that if a consensus opinion has a reasonable basis, a member or candidate who disagrees with it does not have to dissociate from it but should document the difference of opinion.

Question 3

Katrina Anderson, CFA, left her job as an account manager at RTJ Capital Management and joined Parnell Associates. Anderson did not sign a noncompete agreement at RTJ and took no RTJ property with her when she left. According to CFA Institute Standards of Professional Conduct, Anderson:

A)
must not harm RTJ by soliciting her previous clients.
B)
is free to contact her previous clients at RTJ after her employment there ends.
C)
must seek permission from RTJ before contacting her previous clients there.

Answer 3

B)
is free to contact her previous clients at RTJ after her employment there ends.

Standard IV(A) Loyalty does not prohibit former employees from contacting clients of their previous firm so long as the contact information does not come from the records of the previous employer or violate a noncompete agreement

Question 4

Christopher Kim, CFA, is a banker with Batts Brothers, an investment banking firm. Kim follows the energy industry and has frequent contact with industry executives. Kim is contacted by the CEO of a large oil and gas corporation who wants Batts Brothers to underwrite a secondary offering of the company’s stock. The CEO offers Kim the opportunity to fly on his private jet to his ranch in Texas for an exotic game hunting expedition if Kim’s firm can complete the underwriting within 90 days. According to CFA Institute Standards of Conduct, Kim:

A)
may accept the offer as long as he discloses the offer to Batts Brothers.
B)
may not accept the offer because it is considered lavish entertainment.
C)
must obtain written consent from Batts Brothers before accepting the offer.

Answer 4

C)
must obtain written consent from Batts Brothers before accepting the offer.

According to Standard IV(B) Additional Compensation Arrangements, members and candidates must obtain written permission from their employer before accepting an offer of compensation (for the performance of work done for their employer) in addition to what they receive from their employer and that is contingent on future performance

Question 5

Which of the following is least likely one of the eight major topics of the Global Investment Performance Standards (GIPS) for firms?

A)
Composite and Pooled Fund Maintenance.
B)
Fundamentals of Compliance.
C)
Conflicts with Local Laws and Regulations.

Answer 5

C)
Conflicts with Local Laws and Regulations.

The eight major sections of the GIPS standards for firms are:

Fundamentals of Compliance
Input Data and Calculation Methodology
Composite and Pooled Fund Maintenance
Composite Time-Weighted Return Report
Composite Money-Weighted Return Report
Pooled Fund Time-Weighted Return Report
Pooled Fund Money-Weighted Return Report
GIPS Advertising Guidelines

Question 6

Charmaine Townsend, CFA, has been managing equity portfolios for clients using a model that identifies growth companies selling at reasonable multiples. With economic growth slowing for the foreseeable future, she has decided to change to a securities selection model that emphasizes dividend income and low valuation. To comply with the Code and Standards, Townsend should most appropriately:

A)
promptly notify her clients of the change.
B)
get written permission from her clients prior to the change.
C)
get written acknowledgment of the change from her clients within a reasonable period of time after the change is made.

Answer 6

A)
promptly notify her clients of the change.

Standard V(B) Communication with Clients and Prospective Clients requires prompt disclosure of any change that might significantly affect the manager’s investment processes. The disclosure need not be in writing. (Module 71.7, LOS 71.b)

Question 7

Alberto Cosini is the top-rated, sell-side analyst in the biotechnology industry. His recommendations significantly affect prices of industry stocks regularly. Yesterday Cosini changed his rating on Biopharm from “hold” to “buy,” and Cosini’s firm emailed the change to its clients although no public disclosure has yet been made. If Peter Allen, CFA, who heard about Cosini’s rating change for Biopharm from his brother, purchases Biopharm in his personal account, Allen will most likely:

A)
not violate the Standards.
B)
violate the Standard concerning diligence and reasonable basis.
C)
violate the Standard concerning material nonpublic information.

Answer 7

A)
not violate the Standards.

There is no requirement that a firm publicly release ratings changes by its analysts. Individuals outside the firm acting on this information after it is released to clients are not in violation of the Standard concerning nonpublic information. Purchases in a member’s personal account are not subject to the requirements of the Standard concerning diligence and reasonable basis, so there is no violation indicated here

Question 8

Judy Dudley, CFA, is an analyst and plans to visit a company that she is analyzing in order to prepare a research report. The Standard related to independence and objectivity:

A)
requires Dudley to pay for her own transportation costs and not to accept any gifts or compensation for writing the report, but allows her to accept accommodations and meals that are not lavish.
B)
requires Dudley not to accept any compensation for writing a research report, but allows her to accept company paid transportation, lodging, and meals.
C)
allows Dudley to accept transportation, lodging, expenses, and compensation for writing a research report, but requires that she disclose such an arrangement in her report

Answer 8

C)
allows Dudley to accept transportation, lodging, expenses, and compensation for writing a research report, but requires that she disclose such an arrangement in her report.

Standard I(B) Independence and Objectivity allows investor-paid research but requires that members and candidates limit the type of compensation they accept for writing a research report so that it is not dependent on the conclusions of the research report. Best practice is for analysts to only accept a flat fee for such company-paid research reports. Such research should also include complete disclosure of the nature of the compensation received for writing such a report so that investors will not be misled as to the relationship between the analyst and the company. Paying for one’s own transportation and lodging when the analyst is not employed by the subject firm is a recommended procedure for complying with Standard I(B), but it is not a requirement.

Question 9

Campbell Hill, CFA, has recently accepted the position of Chief Compliance Officer at an investment management firm. Hill distributes a memo stating that effective immediately (1) material supporting all company research reports will be kept in the company database in electronic form for 10 years, and hard copies of the same material will be maintained for one year only, and (2) hard copy records of all trade confirmations sent to clients must be kept on file for five years, the period mandated by local regulations. With respect to record retention:

A)
neither of Hill’s policies violates the Standards.
B)
Hill’s policies regarding both research reports and trade confirmations violate the Standards.
C)
Hill’s policy regarding research reports does not violate the Standards, but the policy regarding trade confirmations does.

Answer 9

A)
neither of Hill’s policies violates the Standards.

In the absence of regulatory requirements, Standard V(C) Record Retention recommends maintaining records supporting investment recommendations and actions and records of investment-related communications with clients for at least seven years. Here, there is regulatory guidance, and seven years is a recommendation, not a requirement, in any case. Records can be maintained in electronic or hard copy format

Question 10

Dawn Shepard, CFA, is a broker for a regional brokerage firm. Her company’s research department recently changed its recommendation on the common stock of Orlando (ORL) from “buy” to “sell” and sent the change to all firm clients who own ORL. The next day, a client places a “buy” order for ORL. According to the Standards, under these circumstances, Shepard:

A)
must advise the customer of the change in recommendation before accepting the order.
B)
has complied with the fair dealing Standard and may accept the order because it is unsolicited.
C)
may accept the order only if the customer acknowledges in writing that she was notified of the change in the recommendation.

Answer 10

A)
must advise the customer of the change in recommendation before accepting the order.

Under Standard III(B) Fair Dealing, clients placing orders contrary to the firm’s changed recommendation should be advised of the change in recommendation before the firm accepts the orders.

Question 11

Nicholas Hart, CFA, is a portfolio manager for individuals. Last year, Hart’s wife was hospitalized for several months. Despite his best efforts to pay her bills, Hart was forced to declare personal bankruptcy but did not disclose this to his clients. According to the CFA Institute Standards of Professional Conduct, Hart:

A)
is not in violation of any Standard.
B)
is in violation of the Standard on communication with clients for not disclosing his bankruptcy to his clients.
C)
is in violation of the Standard on misconduct for personal conduct that reflects adversely on his professional reputation.

Answer 11

A)
is not in violation of any Standard.

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

Question 12

Marie Marshall, CFA, charges clients a management fee and commissions on securities transactions. Marshall receives an annual bonus based on the overall success of the firm and a quarterly bonus based on the trading volume in her clients’ accounts. If Marshall does not tell clients about her compensation package, she is violating the Standard concerning:

A)
disclosure of conflicts.
B)
communication with clients.
C)
additional compensation arrangements.

Answer 12

A)
disclosure of conflicts.

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

Question 13

Lunar Wealth, a subsidiary of Galaxy Financial, has prepared GIPS- compliant performance data and asks Galaxy’s president about his interest in presenting GIPS-compliant performance data, but he does not believe it is a priority. Lunar may:

A)
claim partial compliance with GIPS if Lunar’s performance presentations are in compliance.
B)
not claim compliance with GIPS because compliance must be made on a company-wide basis.
C)
claim compliance with GIPS as long as Lunar is presented to the public as a distinct business entity.

Answer 13

C)
claim compliance with GIPS as long as Lunar is presented to the public as a distinct business entity.

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

Question 14

red Reilly, CFA, is an investment advisor. Roger Harrison, a long-term client of Reilly, decides to move his accounts to a new firm. In his review of Harrison’s account history, Reilly discovers some transfers of funds from the account of Harrison’s company that Reilly suspects were illegal. Which of the following actions is most appropriate for Reilly to take under the Standards?

A)
Discuss his suspicions with outside counsel.
B)
Inform Harrison’s company of the suspected illegal activities because Harrison is no longer a client.
C)
Do nothing because he must maintain the confidentiality of client information even after the client has left the firm.

Answer 14

A)
Discuss his suspicions with outside counsel.

Of the choices given, seeking the advice of outside counsel about what actions Reilly may be required to take is the most appropriate. Under Standard III(E) Preservation of Confidentiality, members and candidates should maintain the confidentiality of information received in the course of their professional service relating to both current and former clients. In the case of illegal activity, however, Reilly may have a legal obligation to report the activity or, on the other hand, may have a legal obligation to maintain the client’s confidentiality even if he suspects illegal activity.

Question 15

Depreciation of a country’s currency will be more effective in reducing its trade deficit if its:

A)
imports do not have good substitutes.
B)
exports are primarily luxury goods.
C)
exports represent a small portion of foreign consumer expenditures.

Answer 15

B)
exports are primarily luxury goods.

Under the elasticities approach, a currency depreciation will lead to a greater reduction in a trade deficit when export demand and/or import demand are more elastic. The demand for luxury goods is relatively elastic, while the demand for goods without good substitutes or for goods that represent only a small portion of consumer expenditures is relatively inelastic

Question 16

Normal Corp. has a current ratio above 1 and a quick ratio less than 1. Which of the following actions will increase the current ratio and decrease the quick ratio? Normal Corp.:

A)
buys fixed assets on credit.
B)
uses cash to purchase inventory.
C)
pays off accounts payable from cash.

Answer 16

C)
pays off accounts payable from cash.

Paying off accounts payable from cash lowers current assets and current liabilities by the same amount. Because the current ratio started off above 1, the current ratio will increase. Because the quick ratio started off less than 1, it will decrease further. The other choices are incorrect. Buying fixed assets on credit decreases both ratios because the denominator increases, with no change to the numerator. Using cash to purchase inventory would result in no change in the current ratio but would decrease the quick ratio by decreasing the numerator

Question 17

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

A)
t-test.
B)
nonparametric test.
C)
mean differences test.

Answer 17

B)
nonparametric test.

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

Question 18

On January 2, a company acquires some state-of-the-art production equipment at a net cost of $14 million. For financial reporting purposes, the firm will depreciate the equipment over a 7-year life using straight-line depreciation and a zero salvage value; for tax reporting purposes, however, the firm will use straight-line depreciation over a 3-year life. Given a tax rate of 35%, by how much will the company’s deferred tax liability increase in the first year of the equipment’s life?

A)
$933,500.
B)
$1,064,800.
C)
$1,730,300.

Answer 18

A)
$933,500.

Straight-line depreciation: $14 million / 7 = $2.0 million

Accelerated depreciation: $14 million / 3 = $4.667 million

Difference in depreciation: $4.667 million − $2.0 million = $2.667 million
× Tax rate 0.35
Increase in deferred tax liability $933,500

Question 19

If an investment of $4,000 will grow to $6,520 in four years with monthly compounding, the effective annual interest rate will be closest to:

A)
11.2%.
B)
12.3%.
C)
13.0%.

Answer 19

C)
13.0%.

N = 4; PMT = 0; PV = –4,000; FV = 6,520; CPT → I/Y = 12.99%

Question 20

Which of the following statements about the central limit theorem is least accurate?

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

Answer 20

A)
The central limit theorem has limited usefulness for skewed distributions.

The central limit theorem holds for any distribution as long as the sample size is large (i.e., n > 30

Question 21

A U.S. GAAP reporting company holds a number of marketable securities as investments. For the most recent period, the company reports that the market value of its securities held for trading decreased by $2 million and the market value of its securities available for sale increased in value by $3 million. Together, these changes in value will:

A)
reduce net income and shareholders’ equity by $2 million.
B)
increase shareholders’ equity by $1 million and have no effect on net income.
C)
reduce net income by $2 million and increase shareholders’ equity by ＄1 million

Answer 21

C)
reduce net income by $2 million and increase shareholders’ equity by ＄1 million.

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

Question 22

Maritza, Inc., is involved in an exchange of debt for equity. In which of the following sections of the cash flow statement would Maritza record this transaction?

A)
Investing activities section.
B)
Financing activities section.
C)
Footnotes to the cash flow statement.

Answer 22

C)
Footnotes to the cash flow statement.

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

Question 23

Which of the following statements about hypothesis testing involving a z-statistic is least accurate?

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

Answer 23

B)
A z-test is theoretically acceptable in place of a t-test for tests concerning a mean when sample size is small.

The t-test must be used when the sample size is small, the population is normal, and the population variance is unknown. If the population is non-normal and the variance is unknown, there is no valid test statistic when the sample is small.

Question 24

Rowlin Corporation, which reports under IFRS, wrote down its inventory of electronic parts last period from its original cost of €28,000 to net realizable value of €25,000. This period, inventory at net realizable value has increased to €30,000. Rowlin should revalue this inventory to:

A)
€28,000, and report a gain of €3,000 on the income statement.
B)
€30,000, and report a gain of €3,000 on the income statement.
C)
€30,000, and report a gain of €5,000 on the income statement.

Answer 24

A)
€28,000, and report a gain of €3,000 on the income statement.

Under IFRS, inventory values are revalued upward only to the extent they were previously written down. In this case, that is from €25,000 back up to the original value of €28,000. The increase is reported as gain for the period.

Question 25

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

Answer 25

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

Question 26

An investment has a mean return of 15% and a standard deviation of returns equal to 10%. If the distribution of returns is approximately normal, which of the following statements is least accurate? The probability of obtaining a return: A) less than 5% is about 16%. B) greater than 35% is about 2.5%. C) between 5% and 25% is about 95%.

Answer 26

C) between 5% and 25% is about 95%. About 68% of all observations fall within ±1 standard deviation of the mean. Thus, about 68% of the values fall between 5 and 25.

Question 27

A market has the following characteristics: a large number of independent sellers, each producing a differentiated product; low barriers to entry; producers facing downward sloping demand curves; and demand that is highly elastic. This description most closely describes: A) an oligopoly. B) pure competition. C) monopolistic competition.

Answer 27

C) monopolistic competition. These conditions characterize monopolistic competition. By contrast, monopolies and oligopolies have high barriers to entry and involve either a single seller (monopoly) or a small number of interdependent sellers (oligopoly). Similar to monopolistic competition, pure competition involves a large number of independent sellers. With pure competition, products are homogeneous (not differentiated), no barriers to entry exist (not low barriers to entry), and the demand schedule is horizontal (not downward sloping) and perfectly elastic (not highly elastic).

Question 28

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

Answer 28

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

Question 29

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

Answer 29

B) 13.1%. We need to use the binomial formula to calculate the probabilities of 4 and 5 "successes" in five 5 years and then sum them. Prob(4)=5!/(5−4)!4! ×0.45'4 ×0.55'5−4=11.3% Prob(5) = 0.455 = 1.85% 11.28% + 1.85% = 13.12%

Question 30

Time-series analysis of a firm's common-size balance sheets reveals the following data: 20X3 20X4 20X5 Current assets 20% 22% 25% Inventory 8% 9% 11% Short-term debt 10% 11% 12% Long-term debt 24% 21% 18% Based only on the data provided, an analyst can conclude that the firm's: A) debt ratio is decreasing. B) quick ratio is decreasing. C) inventory/sales ratio is increasing.

Answer 30

A) debt ratio is decreasing. The debt ratio is total debt to total assets. Because common-size balance sheet data are stated as percentages of total assets, the debt ratio can be determined from the data given. 20X3: 10% + 24% = 34% 20X4: 11% + 21% = 32% 20X5: 12% + 18% = 30% The debt ratio is decreasing over the period shown. Neither the inventory/sales ratio nor the quick ratio can be determined from the data given because the data do not include sales or current liabilities

Question 31

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

Answer 31

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

Question 32

Consider a manufacturing company and a financial services company. Interest expense is most likely classified as a non-operating component of net income for: A) both of these companies. B) neither of these companies. C) only one of these companies.

Answer 32

C) only one of these companies Interest expense is shown as a non-operating component of net income for a manufacturing company but would typically be classified as an operating expense for a financial services company

Question 33

The two primary assumptions in preparing financial statements under IFRS are: A) accrual accounting and going concern. B) reasonable accuracy and accrual accounting. C) going concern and reasonable accuracy.

Answer 33

A) accrual accounting and going concern. In the IFRS framework, the two assumptions that underlie the preparation of financial statements are accrual accounting and the going concern assumption. (

Question 34

Forman, Inc., and Swoft, Inc., both operate within the same industry. Forman's stated strategy is to differentiate its premium products relative to its competitors, while Swoft is a low-cost producer. Given the companies' stated strategies, Forman most likely has: A) higher gross margins relative to Swoft. B) lower advertising expenses relative to Swoft. C) lower research and development expenses relative to Swoft.

Answer 34

A) higher gross margins relative to Swoft An analyst can use the historical trend in a firm's financial ratios as well as an industry relative comparison to assess the firm's business strategy. A firm producing premium products with a strategy of differentiation should have higher gross margins, higher advertising expenses, and higher research and development expenses relative to firms in its industry that pursue a low-cost-of-production strategy

Question 35

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

Answer 35

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

Question 36

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

Answer 36

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

Question 37

The median of a distribution is least likely equal to: A) the second quartile. B) the third quintile. C) the fifth decile.

Answer 37

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

Question 38

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

Answer 38

B) liability will be reduced by 1,000 and income tax expense will be reduced by 800. There is a 20% reduction in the tax rate [(40% − 50%) / 50% = –0.2]. Hence, the deferred tax asset will be 800 = 1,000(1 − 0.2), the deferred tax liability will be 4,000 = 5,000(1 − 0.2), and the income tax expense will fall by the net amount of the decline in the asset and liability balances (1,000 – 200 = 800).

Question 39

Alex White is examining a portfolio that contains 100 stocks that are either value or growth stocks. Of these 100 stocks, 40% are value stocks. The previous portfolio manager had selected 70% of the value stocks and 80% of the growth stocks. What is the probability of selecting a stock at random that is either a value stock or was selected by the previous portfolio manager? A) 28%. B) 76%. C) 88%.

Answer 39

C) 88%. Selected by the Previous Portfolio Manager Selected by the Current Portfolio Manager Total Value stocks 28 (28%) 12 (12%) 40 Growth stocks 48 (48%) 12 (12%) 60 Total 76 24 100 This problem involves the addition rule for probabilities, P(A or B) = P(A) + P(B) − P(AB). P(A) is the probability that a randomly selected stock is a value stock, which is given as 40%. P(B) is the probability that a stock was picked by the previous manager. That probability is (0.7)(0.4) + (0.8)(1 − 0.4) = 0.76. The previous manager selected 76% of the stocks in the portfolio. P(AB) is the probability that a randomly selected stock is a value stock picked by the previous manager. Since the previous manager picked 70% of the 40% of the stocks that are value stocks, the probability that a randomly selected stock is a value stock picked by the previous manager is 40% × 70% = 28%. From this, we have P(A or B) = 40% + 76% − 28% = 88%.

Question 40

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

Answer 40

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

Question 41

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

Answer 41

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

Question 42

A manager forecasts a bond portfolio return of 10% and estimates a standard deviation of annual returns of 4%. Assuming a normal returns distribution and that the manager is correct, there is: A) a 90% probability that the portfolio return will be between 3.2% and 17.2%. B) a 95% probability that the portfolio return will be between 2.16% and 17.84%. C) a 32% probability that the portfolio return will be between 6% and 14%.

Answer 42

B) a 95% probability that the portfolio return will be between 2.16% and 17.84%. The 95% confidence interval is 10% ± 1.96(4%) or from 2.16% to 17.84%. The 90% confidence interval is 10% ± 1.65(4%) or from 3.4% to 16.6%. The probability of a return ± 1 standard deviation from the mean, between 6% and 14%, is approximately 68%

Question 43

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

Answer 43

B) $300 million. Based on the data given, use the basic DuPont equation and solve for expected net income. ROE = (net income / revenues) × (revenues / total assets) × (total assets / total equity) 0.15 = (net income / $3 billion) × ($3 billion / $5 billion) × 2.5 net income / $3 billion = 0.1 net income = $300 million Alternatively, A/E = 2.5 and assets = $5 billion, so equity = $2 billion. net income / equity = 15%, so net income = 0.15($2 billion) = $300 million

Question 44

Rodgers, Inc., has fixed operating expenses of $2 million and will break even with sales of $5 million. For sales of $7 million, an analyst would estimate the firm's operating income as: A) $800,000. B) $1,200,000. C) $2,000,000.

Answer 44

A) $800,000. Since at breakeven sales, fixed costs + variable costs = revenue, variable costs for Rodgers at sales of $5 million must be $5 million − $2 million = $3 million, or 60% of sales. With sales of $7 million, variable costs are 0.6 × 7 million = 4.2 million. Operating income is then 7 million − 4.2 million − 2 million = $800,000. By assuming some arbitrary price for the product such as $1,000, this problem can be solved in units as well. Variable costs would be $600 per unit and operating income would be 7,000 (1,000 − 600) − 2 million = $800,000.

Question 45

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

Answer 45

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

Question 46

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

Answer 46

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

Question 47

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

Answer 47

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

Question 48

Given the following correlation matrix, a risk-averse investor would least prefer which of the following 2-stock portfolios (all else equal)? Stock W X Y Z W +1 X –0.2 +1 Y +0.6 –0.1 +1 Z +0.8 –0.3 +0.5 +1 A) W and Y. B) X and Y. C) X and Z.

Answer 48

A) W and Y. A risk-averse investor prefers less risk to more risk. The lower the correlation, the greater the risk reduction. Thus, a risk-averse investor would most prefer the portfolio with the lowest correlation coefficient and least prefer the one with the highest. Of the choices given, W and Y's correlation coefficient of +0.6 is the highest

Question 49

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

Answer 49

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

Question 50

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

Answer 50

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

Question 51

The uncertainty about a firm's expected operating income is most appropriately referred to as: A) sales risk. B) business risk. C) operating risk.

Answer 51

B) business risk. The uncertainty (risk) associated with a firm's operating income is referred to as business (as opposed to financial) risk and results from both operating risk and sales risk

Question 52

Which of the following indicators of a firm's liquidity position is least desirable? A) Low days of payables. B) High inventory turnover. C) Low quick ratio.

Answer 52

C) Low quick ratio. The quick ratio measures a firm's current assets that are readily convertible into cash, relative to its current liabilities. A higher quick ratio indicates greater liquidity

Question 53

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

Answer 53

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

Question 54

Parker, Inc. has the following securities outstanding: 100,000 shares of preferred stock that pays an annual dividend of $2.00, trading at $35. $5,000,000 face value 6% bonds with a YTM of 6%. 1 million shares of common stock trading at $28 per share. Parker's cost of equity is 8% and its tax rate is 30%. The discount rate that Parker's management should use when evaluating new capital investments is closest to: A) 7.00%. B) 7.25%. C) 7.50%.

Answer 54

B) 7.25% Cost of preferred stock is $2 / $35 = 5.71%. After-tax cost of debt is 6% (1 – 0.30) = 4.2%. Cost of equity is 8% (given). Preferred stock outstanding = $35(100,000) = $3.5 million. Debt outstanding is $5 million (given). Common stock outstanding is $28 million (given). Total securities value = $3.5 + $5 + $28 = $36.5 million. Weighted average cost of capital = (3.5 / 36.5) × 5.71% + (5 / 36.5) × 4.2% + (28 / 36.5) × 8% = 7.26%.

Question 55

Rolly Parker has managed the retirement account funds for Misto Inc. for the last two years. Contributions and withdrawals from the account are decided by Misto's CFO. The account history is as follows, with account values calculated before same-date deposits and withdrawals: Jan 1, 20X1 Beginning portfolio value $10 million Jul 1, 20X1 Account value $11.2 million Jul 1, 20X1 Deposit of cash $1.2 million Jan 1, 20X2 Account value $12.5 million Jan 1, 20X2 Withdrawal of cash $0.6 million Dec 31, 20X2 Account value $15 million The appropriate annual return to use in evaluating the manager's performance is closest to: A) 9%. B) 19%. C) 22%.

Answer 55

B) 19%. Since the portfolio manager is not directing the flow of cash into and out of the account, the time-weighted annual rate of return is the appropriate performance measure. Calculate the 2-year holding period return +1, then take the square root and subtract 1 to get the annual time-weighted rate of return: [(11.2 / 10)(12.5 / 12.4)(15 / 11.9)]1/2 − 1 = 19.29%

Question 56

With respect to a dividend payment, which of the following dates occurs first? A) The record date. B) The payment date. C) The ex-dividend date.

Answer 56

C) The ex-dividend date. The ex-dividend date occurs prior to the record date and the payment date.

Question 57

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

Answer 57

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

Question 58

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

Answer 58

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

Question 59

A 10%, 10-year bond is sold to yield 8%. One year passes, and the yield remains unchanged at 8%. Holding all other factors constant, the bond's price during this period will have: A) increased. B) decreased. C) remained constant.

Answer 59

B) decreased. The bond is sold at a premium. As time passes, the bond's price will move toward par. Thus, the price will fall. N = 10; FV = 1,000; PMT = 100; I = 8; CPT → PV = $1,134 N = 9; FV = 1,000; PMT = 100; I = 8; CPT → PV = $1,125

Question 60

The return impact of a 25 basis point widening in yield for an option-free bond is greatest if it has a duration of: A) 4 and convexity of 24. B) 5 and convexity of 32. C) 6 and convexity of 90.

Answer 60

C) 6 and convexity of 90. The impact on return will be greatest for the bond with the highest duration. For a 25 basis point (0.0025) increase in yield, the convexity adjustment is unlikely to be large enough to affect the ordering. Calculations for each answer choice are as follows: Return impact = –4(0.0025) + (1/2)(24)(0.0025)2 = –0.99% Return impact = –5(0.0025) + (1/2)(32)(0.0025)2 = –1.24% Return impact = –6(0.0025) + (1/2)(90)(0.0025)2 = –1.47%

Question 61

Which form of the efficient markets hypothesis (EMH) implies that an investor can achieve positive abnormal returns on average by using technical analysis? A) None. B) Weak form. C) Weak form or semistrong form.

Answer 61

A) None. An investor cannot achieve positive abnormal returns on average by using technical analysis if prices fully reflect all available security market (price and volume) information. The weak form of the EMH assumes prices reflect this information, and the semistrong and strong forms assume prices reflect additional (non-market) information as well.

Question 62

An analyst is considering a bond for purchase. The bond has a coupon that resets semiannually and is determined by the following formula: coupon = 12% − (3.0 × 6-month Treasury bill rate) This bond is most accurately described as: A) a step-up note. B) an inverse floater. C) an inflation protected security.

Answer 62

B) an inverse floater The bond is an inverse floater because the coupon rate will move opposite to any move in the reference rate

Question 63

Asset-backed securities with a lockout period are most likely to be backed by: A) automobile loans. B) home-equity loans. C) credit card receivables.

Answer 63

C) credit card receivables. Asset-backed securities backed by credit card receivables have a lockout period, during which principal repayments are reinvested in additional receivables.

Question 64

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

Answer 64

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

Question 65

Roger Templeton, an analyst for Bridgetown Capital Management, is studying past market data to identify risk factors that produce anomalous returns. He tests monthly data on each of 60 financial and economic variables over a 15-year period to find which ones are related to stock index returns. Templeton identifies three variables that show statistically significant relationships with equity returns at a 95% confidence level. What is the most likely reason why Bridgetown's management should be skeptical of the anomalies Templeton has identified? The results may suffer from: A) data snooping bias. B) survivorship bias. C) small sample bias.

Answer 65

A) data snooping bias. Data snooping bias results from the likelihood that some anomalies will show up by chance in a large enough number of tests. A test at the 5% significance level of the hypothesis that stock prices are not correlated with a variable will reject about 1 such hypothesis in 20 when the hypothesis is true

Question 66

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

Answer 66

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

Question 67

n calculating the present value of the fixed rate payments of an interest rate swap, an analyst should most appropriately discount the payments at each settlement date using the: A) fixed rate. B) current spot rate. C) expected forward rate.

Answer 67

B) current spot rate. The present values of both the fixed-rate payments and the expected floating-rate payments should be discounted at the spot rates for the period until the payment will be received.

Question 68

For an asset-backed security (ABS), a special purpose entity: A) sells an asset to the issuing corporation, which then proceeds to issue the ABS. B) is used to separate assets used as collateral from those of the company seeking financing through an ABS. C) acts as an intermediary that purchases an asset from the company issuing an ABS and then resells it to obtain sufficient liquid funds to provide collateral for the ABS.

Answer 68

B) is used to separate assets used as collateral from those of the company seeking financing through an ABS. A special purpose entity is a legal corporation to which the assets used as collateral in an ABS issue are sold. This transaction separates the assets backing the ABS from the other assets of the company that creates the SPE

Question 69

The following interest rate information is observed: Spot Rates 1 year 10% 2 years 11% 3 years 12% Based on this data, the 2-year forward rate one year from now is closest to: A) 12%. B) 13%. C) 14%.

Answer 69

B) 13%. ((1.12)'3/(1.10))'0.5 -1 =13.01% Note : (3x12)-(1x10)/2 = 13

Question 70

A repurchase agreement is most accurately described as: A) an embedded option held by a bondholder. B) a form of credit enhancement in a bond issue. C) a source of short-term funding for a bondholder.

Answer 70

C) a source of short-term funding for a bondholder. A repurchase agreement is a form of short-term collateralized borrowing in which a bondholder sells a security and agrees to buy it back at a higher price

Question 71

An asset-based valuation model would most likely provide a reliable estimate of market value for: A) a pure-play online news site. B) a multinational freight distribution firm. C) a privately held metal fabrication company.

Answer 71

C) a privately held metal fabrication company. Asset-based valuation involves determining market values for the subject company's assets and liabilities to calculate the equity value. Compared to the other answer choices, a privately held metal fabrication company will likely have a larger proportion of physical assets relative to intangible assets, and market values for its physical assets should be relatively easier to obtain. An online news site is likely to have a relatively small physical asset base and relatively high intangibles, making this company difficult to value using asset-based valuation. A large multinational corporation is likely to be difficult to value using an asset-based valuation model, even if the company has a large physical asset base relative to its intangibles, because it may have extensive international assets. (Module 41.3, LOS 41.m)

Question 72

A short position in a forward contract on an underlying with no holding costs or benefits may be replicated with a portfolio consisting of: A) a long call option, a long put option, and a short position in the risk-free asset. B) a long call option, a short put option, and a long position in the risk-free asset. C) a short call option, a long put option, and a short position in the risk-free asset.

Answer 72

C) a short call option, a long put option, and a short position in the risk-free asset. The put-call-forward parity relationship is: F0(T)(1 + Rf)–T + p0 = c0 + X(1 + Rf)–T. A short position in a forward contract, or –[F0(T)(1 + Rf)–T], is equivalent to –c0 + p0 – X(1 + Rf)–T

Question 73

A private equity firm that wants to receive money from a portfolio company without giving up control of the portfolio company is most likely to engage in: A) a trade sale. B) a secondary sale. C) a recapitalization.

Answer 73

C) a recapitalization. Recapitalization is when the company issues debt to fund a dividend distribution to equity holders (the fund). It is not an exit, in that the fund still controls the company, but often is an intermediate step toward an exit.

Question 74

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

Answer 74

C) The required rate of return increases, and the dividend payout ratio decreases. Increases in k reduce P/E. Increases in g or the dividend payout ratio increase P/E.

Question 75

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

Answer 75

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

Question 76

A call option on a $25 stock with an exercise price of $30 sells for a premium of $4. At expiration, the writer of the call will experience a net loss on the option if the stock price is greater than: A) $26 B) $29. C) $34.

Answer 76

C) $34. The call writer will experience a net loss on the call option if the stock's price exceeds X + C = $30 + $4 = $34

Question 77

The following data pertains to a firm's common stock: The stock will pay no dividends for two years. The dividend three years from now is expected to be $1. Dividends are expected to grow at a 7% rate from that point onward. If an investor requires a 17% return on this investment, how much will the investor be willing to pay for this stock now? A) $6.24. B) $7.31. C) $8.26.

Answer 77

B) $7.31. Time line = $0 now; $0 in year 1; $0 in year 2; $1 in year 3. 1/(0.17 - 0.07) = 10 Note that the price is always one year before the dividend date. Solve for the PV of $10 to be received in two years. FV = 10; N = 2; I = 17; CPT → PV = $7.31.

Question 78

Which of the following remains constant throughout the life of a futures contract? A) Its price, but not its value. B) Its value, but not its price. C) Neither its price nor its value.

Answer 78

C) Neither its price nor its value. Because futures contracts are marked to market daily, their price changes each day to the settlement price, at which their value to a new buyer or seller resets to zero. A futures contract's value to a holder of a long or short position changes with the price of the underlying

Question 79

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

Answer 79

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

Question 80

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

Answer 80

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

Question 81

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

Answer 81

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

Question 82

A forward contract on an underlying with no holding costs or benefits specifies a forward price of 100 and settles in one year. The value of this contract at initiation is most likely to be: A) equal to the present value of 100 discounted at the risk-free rate. B) less than the present value of 100 discounted at the risk-free rate. C) greater than the present value of 100 discounted at the risk-free rate.

Answer 82

B) less than the present value of 100 discounted at the risk-free rate. The value of a forward contract at initiation is typically zero

Question 83

For a domestic investor purchasing bonds in a foreign market and currency: A) appreciation of both the asset and the foreign currency benefits the domestic investor. B) depreciation of both the asset and the foreign currency benefits the domestic investor. C) appreciation of the asset and depreciation of the foreign currency benefit the domestic investor.

Answer 83

A) appreciation of both the asset and the foreign currency benefits the domestic investor. When the foreign currency appreciates, each foreign currency-denominated cash flow buys more domestic currency units—increasing the domestic currency return from the investment. The appreciation of the foreign asset benefits the investor as well.

Question 84

The type of share voting most likely to result in significant minority shareholders having an approximately proportional representation on the board of directors is: A) statutory voting. B) weighted voting. C) cumulative voting.

Answer 84

C) cumulative voting. Under cumulative voting, shareholders receive one vote per share for each board position election but can vote them for any board candidate or spread them over multiple candidates. This allows, for example, a holder of 20% of the shares to elect one of five board members. Under statutory voting, a minority shareholder could not elect any board members based only on their share voting rights

Question 85

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

Answer 85

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

Question 86

Over the most recent period, Ladden Materials has seen slow growth, increased competition, and declining profitability in its industry. The phase of the industry life cycle for Ladden's industry is most likely: A) mature. B) decline. C) shakeout.

Answer 86

C) shakeout. The shakeout phase of the industry life cycle is characterized by slowing growth, intense competition, and declining profitability. The mature phase is characterized by industry consolidation and little or no growth. In the decline phase of the industry lifecycle, growth is negative and excess capacity results

Question 87

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

Answer 87

A) reduce transactions costs. Key advantages of derivatives markets are providing price information, reducing transactions costs, and shifting risks among market participants. Derivatives markets are highly efficient and arbitrage opportunities rarely exist or are quickly eliminated. Increased systemic risk is one of the disadvantages of derivatives

Question 88

Reinvestment risk is least likely: A) minimized with zero-coupon bond issues. B) more problematic for those investors with longer time horizons. C) more problematic when the current coupons being reinvested are relatively small

Answer 88

C) more problematic when the current coupons being reinvested are relatively small. Reinvestment risk becomes more problematic when the current coupons being reinvested are relatively large.

Question 89

A duration gap is most accurately described as a difference between a bond's: A) Macaulay duration and effective duration. B) duration and the bondholder’s investment horizon. C) actual change in value and the change estimated using duration and convexity.

Answer 89

B) duration and the bondholder’s investment horizon. Duration gap" refers to a difference between a bond's Macaulay duration and the bondholder's investment horizon

Question 90

Derivatives pricing is based on the assumption that: A) no arbitrage occurs. B) the law of one price holds. C) long and short investors are net risk-neutral.

Answer 90

B) the law of one price holds. Derivatives pricing is based on no-arbitrage pricing and replication, and therefore assumes the law of one price holds (i.e., two assets or portfolios with the same future payoffs must have the same price). Derivatives pricing does not assume long and short investors are net risk-neutral; rather, it determines no-arbitrage derivative prices using risk-neutral pricing

Question 91

Siegel, Inc., has issued bonds maturing in 15 years but callable at any time after the first 8 years. The bonds have a coupon rate of 6%, and are currently trading at $992 per $1,000 par value. If interest rates decline over the next few years: A) the call option embedded in the bonds will increase in value, but the price of the bond will decrease. B) the price of the bond will increase, but likely by less than a comparable bond with no embedded option. C) the price of the bond will increase, primarily as a result of the increasing value of the call option.

Answer 91

B) the price of the bond will increase, but likely by less than a comparable bond with no embedded option. The value of the bond would increase due to the lower interest rates, but the increasing value of the call option would offset some portion of this increase in bond value because the bondholder is short the call option.