CFAI - Mock 1

Question 1

Question
Which of the following best represents the potential for misaligned interests between shareholders and board directors when director tenures are excessively long?

Entrenchment
Empire building
Excessive risk taking

Answer 1

Entrenchment

Entrenchment
When the overall level of board director or manager compensation, or tenure, is excessive, the result may lead to the avoidance of risk motivated by a vested interest in keeping one’s position. In such a scenario, directors may avoid speaking out against management in the interest of shareholders or other stakeholders.

Empire building
When director and management compensation are high and tied to the size of the business, it can also lead to “growth for growth’s sake” in which managers are motivated to pursue acquisitions and expansion that might not increase shareholder value.

Excessive risk taking
A compensation package relying too heavily on stock grants and options can motivate risk-taking behavior by management, since option holders participate only in upside share price moves. Similarly, too little or no use of stock grants and options awarded to managers can lead to the opposite result. However, managers and directors without a meaningful equity stake in the company are typically more risk averse in their corporate decision making so they can better protect their long-term engagement by the company. This misalignment may be at odds with the company’s value creation objective or with shareholder’s desire for higher-risk, higher-reward endeavors.

Question 2

Value chain analysis most likely involves identifying the:

firm’s pricing strategy.
firm’s break-even points.
specific activities carried out by the firm. *

Answer 2

“[v]alue chain analysis provides a link between the firm’s value proposition for customers and its profitability

The “how” aspect of a business model is also referred to as a firm’s value chain:

the systems and processes within a firm that create value for its customers.

Question 3

Value proposition analysis

Answer 3

A firm’s value proposition refers to the product or service attributes valued by a firm’s target customer that lead those customers to prefer a firm’s offering over those of its competitors, given relative pricing.

(Who + What + Where + How Much)

Question 4

Business Model Features for Analysis

Answer 4

Value Proposition
- Target Customers
- Product offering
- Channel strategy
- Pricing strategy

Value Chain
- Value add and cost per activity
- Competitive advantage
- Business Activities

Profitability
- Margins
- Break-even points
- Unit economics (the direct revenue & cost associated per unit of a specific business model)

Question 5

A post-audit of a capital investment most likely:

identifies sunk costs.
determines compliance with regulatory standards.
reviews the assumptions in the investment decision. *

Answer 5

Post-auditing capital projects and monitoring an investment’s realized revenues, expenses, and cash flows against expectations are important for several reasons. First, these steps help review assumptions that underlie the capital allocation process. Systematic errors, such as overly optimistic forecasts, become apparent. Second, they might help improve business operations. If sales or costs are out of line, the monitoring and post-auditing processes will focus management’s attention on bringing performance closer to expectations, if at all possible. Finally, monitoring and post-auditing recent capital investments could produce concrete ideas for future investments.

Question 6

To finance working capital, which of the following sources provides the most financial flexibility to companies?

Long-term debt
Commercial paper
Uncommitted lines of credit

Answer 6

A is correct because longer term-securities “are generally more costly to the firm, but they can provide the firm with increased financial flexibility.”

B is incorrect because commercial paper is a short-term external source of financing that often requires companies to have a back-up line of credit and constantly reissue. In addition, it is only available as a source of financing to large, well-rated companies.

C is incorrect because an uncommitted line of credit is “the least reliable form of bank borrowing” and the bank “reserves the right to refuse to honor any request for use of the line” of credit.

Question 7

Question 9
find the optimal strategy to fund the needed cost

Question 8

Question 12
Unlever

Question 9

Resistance

(“opqRStuv”)

Support

Answer 9

Moving average can be used to determine the resistance or support

Question 10

data curation

Answer 10

“[d]ata curation refers to the process of ensuring data quality and accuracy through a data cleaning exercise. This process consists of reviewing all data to detect and uncover data errors—bad or inaccurate data—and making adjustments for missing data when appropriate.”

“Data capture refers to how the data are collected and transformed into a format that can be used by the analytical process.” “Data curation refers to the process of ensuring data quality and accuracy through a data cleaning exercise.”

“Data storage refers to how the data will be recorded, archived, and accessed and the underlying database design.” “Data curation refers to the process of ensuring data quality and accuracy through a data cleaning exercise.”

Question 11

The first decision when constructing a security market index is most likely:

identifying the target market.
identifying the investment universe.
determining the constituent securities.

Answer 11

A is correct because “the first decision in index construction is identifying the target market, market segment, or asset class that the index is intended to represent.”

Question 12

An investment-grade bond index is typically further subdivided by:

maturity only.
credit rating only.
both maturity and credit rating.

Answer 12

C is correct because “[i]nvestment-grade indexes are typically further subdivided by maturity (i.e., short, intermediate, or long) and by credit rating (e.g., AAA, BBB, etc.).”

Question 13

All else being equal, non-cumulative preference shares most likely:

offer dividends that are less than common shares.
have a claim on net assets upon liquidation of the company.*
receive any past unpaid dividends prior to dividends being paid to common shareholders.

Answer 13

B is correct because preference shares rank above common shares with respect to the distribution of the company’s net assets upon liquidation.

Question 14

All else being equal, non-cumulative preference shares most likely:

A. offer dividends that are less than common shares.
B. have a claim on net assets upon liquidation of the company.
C. receive any past unpaid dividends prior to dividends being paid to common shareholders.

Answer 14

B is correct because preference shares rank above common shares with respect to the distribution of the company’s net assets upon liquidation.

A is incorrect because the dividends on preference shares are generally higher than the dividends on common shares.

C is incorrect because the requirement to pay past unpaid dividends applies specifically to cumulative preference shares, not preference shares in general.

Question 15

Which of the following is least likely a primary reason a company would raise capital through the issuance of equity securities? To:

finance the purchase of long-lived assets
maximize the wealth of shareholders
directly satisfy stock compensation plans

Answer 15

C is correct. In general, a company will utilize share buybacks to satisfy stock compensation plans.

Question 16

Which of the following characteristics best describes two companies in the same peer group? The companies:

have the same customers.
have similar drivers of demand.
are in the same product life-cycle stage.

Answer 16

B is correct because a company’s peer group “should consist of companies with similar business activities whose economic activity depends on similar drivers of demand and similar factors related to cost structure and access to financial capital.”

A is incorrect because if two companies have the same customers this fact does not necessarily imply that the two companies have similar drivers of demand. For example, a machine tool company that supplies tools to a manufacturer would not likely be in the same peer group as a janitorial service that supplies such services to the manufacturer.

C is incorrect because if the two companies are in the same product life-cycle stage this fact does not imply they have the same drivers of demand. For example, a biotech company and a computer software company, each with products in the growth stage, are not likely to have similar drivers of demand.

Question 17

All else being equal, firms in an industry with commodity products most likely have more pricing power when:

market share is unstable.
capacity is limited and expansion lead times are long.
barriers to entry are high and substitutes are readily available.

Answer 17

B is correct because both factors, limited capacity and long lead times, provide industry participants pricing power. Tight, or limited, capacity gives participants more pricing power as demand for the product or service exceeds supply. Generally, if new capacity is physical it will take longer for new capacity to come on line to meet an increase in demand, resulting in a longer period of tight conditions. Long lead times justifies the case for tight supply conditions with resulting pricing power.

Question 18

All else being equal, firms in an industry with commodity products most likely have more pricing power when:

market share is unstable.
capacity is limited and expansion lead times are long.
barriers to entry are high and substitutes are readily available.

Answer 18

B is correct because both factors, limited capacity and long lead times, provide industry participants pricing power. Tight, or limited, capacity gives participants more pricing power as demand for the product or service exceeds supply. Generally, if new capacity is physical it will take longer for new capacity to come on line to meet an increase in demand, resulting in a longer period of tight conditions. Long lead times justifies the case for tight supply conditions with resulting pricing power.

Question 19

Stock Dividend is not a cash dividend

A stock dividend:

is relevant for valuation of a company.
involves an increase in the number of shares outstanding.*
alters the shareholders’ proportional ownership in the company.

Answer 19

a stock dividend involves the issuance of more shares in proportion to the number of shares already held by each shareholder. In other words, a stock dividend increases the number of shares a shareholder holds, but it doesn’t change the total value of their investment in the company.

B is correct because a stock dividend “is a type of dividend in which a company distributes additional shares of its common stock (typically, 2%–10% of the shares then outstanding) to shareholders instead of cash.” This results in an increase in the number of shares outstanding.