Deck Flashcards
Which of the following provisions would least likely be included in the bond covenants? The borrower must:
A)
maintain insurance on the collateral that secures the bond.
B)
not increase dividends to common shareholders while the bonds are outstanding.
C)
maintain a debt-to-equity ratio of no less than 2:1.
C)
maintain a debt-to-equity ratio of no less than 2:1.
A lender wants to prohibit the borrower from becoming more leveraged. This can be done by requiring a leverage ratio that is no more than a specified amount. Reducing leverage would be beneficial to the lender by lowering risk
According to the CAPM, a rational investor would be least likely to choose as his optimal portfolio:
A)
the global minimum variance portfolio.
B)
a 130% allocation to the market portfolio.
C)
a 100% allocation to the risk-free asset.
A)
the global minimum variance portfolio.
According to the CAPM, rational, risk-averse investors will optimally choose to hold a portfolio along the capital market line. This can range from a 100% allocation to the risk-free asset to a leveraged position in the market portfolio constructed by borrowing at the risk-free rate to invest more than 100% of the portfolio equity value in the market portfolio. The global minimum variance portfolio lies below the CML and is not an efficient portfolio under the assumptions of the CAPM.
Martin Tripp, CFA, is vice-president of the equity department at Walker Financial, a large money management firm. Of the twenty analysts in his department for whom he has supervisory responsibility, eight are subject to CFA Institute Standards of Professional Conduct. Tripp believes that he cannot personally evaluate the conduct of the twenty analysts on a continuing basis. Therefore, he plans to delegate some of his supervisory duties to Sarah Green, who is subject to the Standards, and some to Bob Brown, who is not subject to the Standards. According to CFA Institute Standards of Professional Conduct, which of the following statements about Tripp’s ability to delegate supervisory duties is most accurate?
A)
Tripp may delegate some or all of his supervisory duties to Brown, even though Brown is not subject to the Standards.
B)
Tripp may delegate some or all of his supervisory duties only to Green because she is subject to the Standards.
C)
Tripp may not delegate any of his supervisory duties to either Green or Brown
A)
Tripp may delegate some or all of his supervisory duties to Brown, even though Brown is not subject to the Standards.
Standard IV(C) Responsibilities of Supervisors permits Tripp to delegate supervisory duties to Green, Brown, or both, but such delegation does not relieve Tripp of his supervisory responsibility.
Regarding the use of financial ratios in the analysis of a firm’s financial statements, it is most accurate to say that:
A)
a range of target values for a ratio may be more appropriate than a single target value.
B)
variations in accounting treatments have little effect on financial ratios.
C)
many financial ratios are useful in isolation.
A)
a range of target values for a ratio may be more appropriate than a single target value.
A range of target values for a financial ratio may be more appropriate that a single numerical target. Financial ratios are not useful when viewed in isolation and are only valid when compared to historical figures or peers. Comparing ratios among firms can be complicated by variations in accounting treatments used at each firm.
Which of the following items for a financial services company is least likely to be considered an operating item on the income statement?
A)
Financing expenses.
B)
Income tax expense.
C)
Interest income.
B)
Income tax expense.
For a financial services company, interest income, interest expense, and financing expenses are likely considered operating activities. For both financial and nonfinancial companies, income tax expense is a non-operating item that is reported within “income from continuing operations” as opposed to “operating profit” as with the other answer choices. Therefore, of the three choices, income tax expense is least likely to be considered an operating item
A survey is taken to determine whether the average starting salaries of CFA charterholders is equal to or greater than $58,500 per year. What is the test statistic given a sample of 175 CFA charterholders with a mean starting salary of $67,000 and a standard deviation of $5,200?
A)
1.63.
B)
–1.63.
C)
21.62.
C)
21.62.
With a large sample size (175) the z-statistic is used. The z-statistic is calculated by subtracting the hypothesized parameter from the parameter that has been estimated and dividing the difference by the standard error of the sample statistic. Here, the test statistic = (sample mean – hypothesized mean) / (population standard deviation / (sample size)1/2 = (X − µ) / (σ / n1/2) = (67,000 – 58,500) / (5,200 / 1751/2) = (8,500) / (5,200 / 13.22) = 21.62.
A stock is expected to pay a dividend of $1.50 at the end of each of the next three years. At the end of three years the stock price is expected to be $25. The equity discount rate is 16 percent. What is the current stock price?
A)
$24.92.
B)
$19.39.
C)
$17.18.
B)
$19.39.
The value of the stock today is the present value of the dividends and the expected stock price, discounted at the equity discount rate:
$1.50/1.16 + $1.50/1.162 + $1.50/1.163 + $25.00/1.163 = $19.39
Tom Gisard has signed up with the U.S. Peace Corps for a two-year term that begins in 18 months. Gisard has calculated that he will need $1,500 at the beginning of each month for living expenses. The annual rate of return during his time in the Peace Corps is estimated at 7.25%. He will save an equal amount at the end of each month for the next 18 months in an account that returns 6.25%, compounded monthly. Each month, Gisard should save approximately:
A)
$1,748.
B)
$1,786.
C)
$1,707.
B)
$1,786.
This is a two-step problem. First, calculate the present value of the amount Gisard needs during the Peace Corps assignment at the end of Month 18. (This amount will be in the form of an annuity due because he requires the payment at the beginning of the month.) Then, determine how much he needs to save each month (ordinary annuity).
Step 1: In BGN mode: N = 24 (months); I/Y = 7.25 / 12; PMT = 1,500; FV = 0; CPT PV = 33,620.
Step 2: In END mode: N = 18 (months); I/Y = 6.25 / 12.0; PV = 0; FV = 33,620; CPT PMT = –1,786.45.
(Module 1.2, LOS 1.c)
A $1,000 par, semiannual-pay bond is trading for 89.14, has a coupon rate of 8.75%, and accrued interest of $43.72. The flat price of the bond is:
A)
$847.69.
B)
$891.40.
C)
$935.12.
B)
$891.40.
The flat price of the bond is the quoted price, 89.14% of par value, which is $891.40.
For a non-dividend paying firm, an increase in net income must increase:
A)
book value of equity.
B)
both book value and market value of equity.
C)
market value of equity.
A)
book value of equity.
Book value of equity is the company’s assets minus its liabilities. For a non-dividend paying firm, positive net income will increase the book value of equity. An increase in book value of equity may or may not increase the market value of equity. An increase in net income that does not meet investors’ prior expectations may decrease the market value of equity
The Treasury spot rate yield curve is closest to which of the following curves?
A)
Forward yield curve rate.
B)
Zero-coupon bond yield curve.
C)
Par bond yield curve.
B)
Zero-coupon bond yield curve.
The spot rate yield curve shows the appropriate rates for discounting single cash flows occurring at different times in the future. Conceptually, these rates are equivalent to yields on zero-coupon bonds. The par bond yield curve shows the YTMs at which bonds of various maturities would trade at par value. Forward rates are expected future short-term rates
A company issues $50 million face value of bonds with a 4.0% coupon rate, when the market interest rate on the bonds is 4.5%. Proceeds raised from these bonds will be:
A)
less than $50 million.
B)
greater than $50 million.
C)
equal to $50 million.
A)
less than $50 million.
When the coupon rate on a bond is lower than the market rate (yield to maturity), the bond will sell for a discount. If bonds are issued at a discount, the proceeds raised will be less than their face value.
An investor purchases a 5-year, A-rated, 7.95% coupon, semiannual-pay corporate bond at a yield to maturity of 8.20%. The bond is callable at 102 in three years. The bond’s yield to call is closest to:
A)
8.3%.
B)
8.9%.
C)
8.6%.
B)
8.9%.
First determine the price paid for the bond:>
N = 5 × 2 = 10; I/Y = 8.20 / 2 = 4.10; PMT = 7.95 / 2 = 3.975; FV = 100; CPT PV = –98.99
Then use this value and the call price and date to determine the yield to call:
N = 3 × 2 = 6; PMT = 7.95 / 2 = 3.975; PV = –98.99; FV = 102; CPT I/Y = 4.4686 × 2 = 8.937%
Student’s t-Distribution
Level of Significance for One-Tailed Test
df 0.100 0.050 0.025 0.01 0.005 0.0005
Level of Significance for Two-Tailed Test
df 0.20 0.10 0.05 0.02 0.01 0.001
30 1.310 1.697 2.042 2.457 2.750 3.646
40 1.303 1.684 2.021 2.423 2.704 3.551
60 1.296 1.671 2.000 2.390 2.660 3.460
120 1.289 1.658 1.980 2.358 2.617 3.373
Based on Student’s t-distribution, the 95% confidence interval for the population mean based on a sample of 40 interest rates with a sample mean of 4% and a sample standard deviation of 15% is closest to:
A)
-0.794% to 8.794%.
B)
-0.851% to 8.851%.
C)
1.261% to 6.739%.
A)
-0.794% to 8.794%.
The standard error for the mean = s/(n)0.5 = 15%/(40)0.5 = 2.372%. The critical value from the t-table should be based on 40 – 1 = 39 df. Since the standard tables do not provide the critical value for 39 df the closest available value is for 40 df. This leaves us with an approximate confidence interval. Based on 95% confidence and df = 40, the critical t-value is 2.021. Therefore the 95% confidence interval is approximately: 4% ± 2.021(2.372) or 4% ± 4.794% or -0.794% to 8.794%
f the AUD/CAD spot exchange rate is 0.9875 and 60-day forward points are −25, the 60-day AUD/CAD forward rate is closest to:
A)
1.0125.
B)
0.9900.
C)
0.9850.
C)
0.9850.
For an exchange rate quoted to four decimal places, forward points are expressed in units of 0.0001. The 60-day forward rate is 0.9875 + 0.0001(−25) = 0.9850.
For a callable bond, the option-adjusted spread (OAS):
A)
is less than the zero-volatility spread.
B)
is greater than the zero-volatility spread.
C)
can be greater than or equal to the zero-volatility spread.
A)
is less than the zero-volatility spread.
For a callable bond, the OAS is less than the zero-volatility spread because of the extra yield required to compensate the bondholder for the call option
Peter Wallace wants to deposit $10,000 in a bank certificate of deposit (CD). Wallace is considering the following banks:
Bank A offers 5.85% annual interest compounded annually.
Bank B offers 5.75% annual interest rate compounded monthly.
Bank C offers 5.70% annual interest compounded daily.
Which bank offers the highest effective interest rate and how much?
A)
Bank A, 5.85%.
B)
Bank B, 5.90%.
C)
Bank C, 5.87%.
B)
Bank B, 5.90%.
Effective interest rates:
Bank A = 5.85 (already annual compounding)
Bank B, nominal = 5.75; C/Y = 12; effective = 5.90
Bank C, nominal = 5.70, C/Y = 365; effective = 5.87
Hence Bank B has the highest effective interest rate.
An investor buys a 20-year, 10% semi-annual bond for $900. She wants to sell the bond in 6 years when she estimates yields will be 10%. What is the estimate of the future price?
A)
$946.
B)
$1,000.
C)
$1,079.
B)
$1,000.
Since yields are projected to be 10% and the coupon rate is 10%, we know that the bond will sell at par value.
Sterling Company is a start-up technology firm that has been experiencing super-normal growth over the past two years. Selected common-size financial information follows:
2007 Actual % of Sales 2008 Forecast % of Sales
Sales 100% 100%
Cost of goods sold 60% 55%
Selling and administration expenses 25% 20%
Depreciation expense 10% 10%
Net income 5% 15%
Non-cash operating working capitala 20% 25%
a Non-cash operating working capital = Receivables + Inventory – Payables
For the year ended 2007, Sterling reported sales of $20 million. Sterling expects that sales will increase 50% in 2008. Ignoring income taxes, what is Sterling’s forecast operating cash flow for the year ended 2008, and is this forecast likely to be as reliable as a forecast for a large, well diversified, firm operating in mature industries?
Operating cash flow Reliable forecast
A)
$4.0 million No
B)
$4.5 million No
C)
$4.0 million Yes
A)
$4.0 million No
2008 sales are expected to be $30 million ($20 million 2007 sales × 1.5) and 2008 net income is expected to be $4.5 million ($30 million 2008 sales × 15%). 2007 non-cash operating working capital was $4 million ($20 million 2007 sales × 20%) and 2008 non-cash operating working capital is expected to be $7.5 million ($30 million 2008 sales × 25%). 2008 operating cash flow is expected to be $4 million ($4.5 million 2008 net income + $3 million 2008 depreciation – $3.5 million increase in non-cash operating working capital). Forecasts for small firms, start-ups, or firms operating in volatile industries may be less reliable than a forecast for a large, well diversified, firm operating in mature industries.
Compute the standard deviation of a two-stock portfolio if stock A (40% weight) has a variance of 0.0015, stock B (60% weight) has a variance of 0.0021, and the correlation coefficient for the two stocks is –0.35?
A)
0.07%.
B)
1.39%.
C)
2.64%.
C)
2.64%.
The standard deviation of the portfolio is found by:
[W12σ12 + W22σ2 2+ 2W1W2σ1σ2ρ1,2]0.5
= [(0.40)2(0.0015) + (0.60)2 (0.0021) + (2)(0.40)(0.60)(0.0387)(0.0458)(–0.35)]0.5
= 0.0264, or 2.64%.
An analyst gathered the following data for Stock A and Stock B:
Time Period Stock A Returns Stock B Returns
1 10% 15%
2 6% 9%
3 8% 12%
What is the covariance for this portfolio?
A)
12.
B)
6.
C)
3.
B)
6.
The formula for the covariance for historical data is:
cov1,2 = {Σ[(Rstock A − Mean RA)(Rstock B − Mean RB)]} / (n − 1)
Mean RA = (10 + 6 + 8) / 3 = 8, Mean RB = (15 + 9 + 12) / 3 = 12
Here, cov1,2 = [(10 − 8)(15 − 12) + (6 − 8)(9 − 12) + (8 − 8)(12 − 12)] / 2 = 6
Which of the following statements best describes the investment assumption used to calculate an equal weighted price indicator series?
A)
A proportionate market value investment is made for each stock in the index.
B)
An equal dollar investment is made in each stock in the index.
C)
An equal number of shares of each stock are used in the index.
B)
An equal dollar investment is made in each stock in the index.
An equal weighted price indicator series assumes that an equal dollar investment is made in each stock in the index. All stocks carry equal weight regardless of their price or market value.
There is a 50% probability that the Fed will cut interest rates tomorrow. On any given day, there is a 67% probability the DJIA will increase. On days the Fed cuts interest rates, the probability the DJIA will go up is 90%. What is the probability that tomorrow the Fed will cut interest rates or the DJIA will go up?
A)
0.33.
B)
0.72.
C)
0.95.
B)
0.72.
This requires the addition formula. From the information: P(cut interest rates) = 0.50 and P(DJIA increase) = 0.67, P(DJIA increase | cut interest rates) = 0.90. The joint probability is 0.50 × 0.90 = 0.45. Thus P (cut interest rates or DJIA increase) = 0.50 + 0.67 – 0.45 = 0.72.
Which of the following is an assumption of the Capital Asset Pricing Model (CAPM)?
A)
There are no margin transactions or short sales.
B)
No investor is large enough to influence market prices.
C)
Investors with shorter time horizons exhibit greater risk aversion.
B)
No investor is large enough to influence market prices.
The CAPM assumes all investors are price takers and no single investor can influence prices. The CAPM also assumes markets are free of impediments to trading and that all investors are risk averse and have the same one-period time horizon.
An investor buys a share of stock for $200.00 at time t = 0. At time t = 1, the investor buys an additional share for $225.00. At time t = 2 the investor sells both shares for $235.00. During both years, the stock paid a per share dividend of $5.00. What are the approximate time-weighted and money-weighted returns respectively?
A)
10.8%; 9.4%.
B)
7.7%; 7.7%.
C)
9.0%; 15.0%.
A)
10.8%; 9.4%.
Time-weighted return = (225 + 5 – 200) / 200 = 15%; (470 + 10 – 450) / 450 = 6.67%; [(1.15)(1.0667)]1/2 – 1 = 10.8%
Money-weighted return: 200 + [225 / (1 + return)] = [5 / (1 + return)] + [480 / (1 + return)2]; money return = approximately 9.4%
Note that the easiest way to solve for the money-weighted return is to set up the equation and plug in the answer choices to find the discount rate that makes outflows equal to inflows.
Using the financial calculators to calculate the money-weighted return: (The following keystrokes assume that the financial memory registers are cleared of prior work.)
TI Business Analyst II Plus®
Enter CF0: 200, +/-, Enter, down arrow
Enter CF1: 220, +/-, Enter, down arrow, down arrow
Enter CF2: 480, Enter, down arrow, down arrow,
Compute IRR: IRR, CPT
Result: 9.39
Consider a 25-year, $1,000 par semiannual-pay bond with a 7.5% coupon and a 9.25% YTM. Based on a yield change of 50 basis points, the approximate modified duration of the bond is closest to:
A)
10.03.
B)
12.50.
C)
8.73.
A)
10.03.
Calculate the new bond prices at the 50 basis point change in rates both up or down and then plug into the approximate modified duration equation:
Current price: N = 50; FV = 1,000; PMT = (0.075/2) × 1,000 = 37.50; I/Y = 4.625; CPT → PV = $830.54.
+50 basis pts: N = 50; FV = 1,000; PMT = (0.075/2)1,000 = 37.50; I/Y = 4.875; CPT → PV = $790.59.
–50 basis pts: N = 50; FV = 1,000; PMT = (0.075/2)1,000 = 37.50; I/Y = 4.375; CPT → PV = $873.93.
Approximate modified duration = (873.93 – 790.59) / (2 × 830.54 × 0.005) = 10.03
An analyst contemplates using the indirect method to create the projected statement of cash flows. She decides to research the differences between the direct and indirect methods. Which of the following is least likely a component of the statement of cash flows under the direct method?
A)
Net income.
B)
Payment of dividends.
C)
Investment in Property, Plant, & Equipment.
A)
Net income.
Property, Plant, & Equipment and payment of dividends are components of the statement of cash flows under both the direct and indirect methods. Net income is the first figure under the indirect method, but it is not a part of the statement of cash flows under the direct method. The correct response is net income.
When a U.S. company pays dividends to its stockholders, which type of cash flow does this represent?
A)
Financing.
B)
Investing.
C)
Operating.
A)
Financing.
Dividends paid to stockholders are considered cash outlays from financing according to U.S. GAAP.
An analyst has developed the following data for two companies, PNS Manufacturing (PNS) and InCharge Travel (InCharge). PNS has an expected return of 15% and a standard deviation of 18%. InCharge has an expected return of 11% and a standard deviation of 17%. PNS’s correlation with the market is 75%, while InCharge’s correlation with the market is 85%. If the market standard deviation is 22%, which of the following are the betas for PNS and InCharge?
Beta of PNS Beta of InCharge
A)
0.61 0.66
B)
0.66 0.61
C)
0.92 1.10
A)
0.61 0.66
Betai = (si/sM) × rI, M
BetaPNS = (0.18/0.22) × 0.75 = 0.6136
BetaInCharge = (0.17/0.22) × 0.85 = 0.6568
Selected financial information gathered from Alpha Company and Omega Corporation follows:
Alpha Omega
Revenue $1,650,000 $1,452,000
Earnings before interest, taxes, depreciation, and amortization
69,400 79,300
Quick assets 216,700 211,300
Average fixed assets 300,000 323,000
Current liabilities 361,000 404,400
Interest expense 44,000 58,100
Which of the following statements is most accurate?
A)
Alpha has a higher operating profit margin than Omega.
B)
Omega uses its fixed assets more efficiently than Alpha.
C)
Omega has lower interest coverage than Alpha.
C)
Omega has lower interest coverage than Alpha.
Using the EBITDA coverage ratio (EBITDA / Interest expense), Omega’s EBITDA coverage is 1.4 ($79,300 EBITDA / $58,100 interest expense) and Alpha’s EBITDA coverage is 1.6 ($69,400 EBITDA / $44,000 interest expense). Using EBITDA to measure operating profit, Alpha has a lower operating profit margin than Omega. Alpha’s EBITDA margin is 4.2% ($69,400 EBITDA / $1,650,000 revenue) and Omega’s EBITDA margin is 5.5% ($79,300 EBITDA / $1,452,000 revenue). Using fixed asset turnover to measure the efficiency of fixed assets, Omega uses its fixed assets less efficiently than Alpha. Alpha’s fixed asset turnover is 5.5 ($1,650,000 revenue / $300,000 average fixed assets) and Omega’s fixed asset turnover is 4.5 ($1,452,000 revenue / $323,000 average fixed assets).
Under the efficient market hypothesis (EMH), the major effort of the portfolio manager should be to:
A)
achieve complete diversification of the portfolio.
B)
follow a strict buy and hold strategy.
C)
minimize systematic risk in the portfolio.
A)
achieve complete diversification of the portfolio.
In an efficient market, portfolio managers must create and maintain the appropriate mix of assets to meet their client’s needs. The portfolio should be diversified to eliminate unsystematic risk. The appropriate systematic risk will depend on the clients risk tolerance and return requirement. Over time the needs of the client and environment will justify changes to the portfolio. The manager should also try to minimize transaction costs and at least try to match the performance of a benchmark.
The probabilities that the prices of shares of Alpha Publishing and Omega Software will fall below $35 in the next six months are 65% and 47%. If these probabilities are independent, the probability that the shares of at least one of the companies will fall below $35 in the next six months is:
A)
0.31.
B)
0.81.
C)
1.00.
B)
0.81.
We calculate the probability that at least one of the options will fall below $35 using the addition rule for probabilities (A represents Alpha, O represents Omega):
P(A or O) = P(A) + P(O) – P(A and O), where P(A and O) = P(A) × P(O)
P(A or O) = 0.65 + 0.47 – (0.65 × 0.47) = approximately 0.81
The probabilities that the prices of shares of Alpha Publishing and Omega Software will fall below $35 in the next six months are 65% and 47%. If these probabilities are independent, the probability that the shares of at least one of the companies will fall below $35 in the next six months is:
A)
0.31.
B)
0.81.
C)
1.00.
B)
0.81.
We calculate the probability that at least one of the options will fall below $35 using the addition rule for probabilities (A represents Alpha, O represents Omega):
P(A or O) = P(A) + P(O) – P(A and O), where P(A and O) = P(A) × P(O)
P(A or O) = 0.65 + 0.47 – (0.65 × 0.47) = approximately 0.81
or a Chi-square distribution with a sample size of 10 the degrees of freedom are:
A)
8.
B)
9.
C)
10.
B)
9.
Degrees of freedom for the Chi-square distribution are the sample size minus one.
Adams Co.’s common sized balance sheet shows that:
Current Liabilities = 20%
Equity = 45%
Current Assets = 45%
Total Assets = $2,000
What are Adams’ long-term debt to equity ratio and working capital?
Debt to Equity Working Capital
A)
0.78 $250
B)
0.78 $500
C)
1.22 $500
B)
0.78 $500
If equity equals 45% of assets, and current liabilities equals 20%, then long-term debt must be 35%.
Long-Term Debt / Equity = 0.35 / 0.45 = 0.78
Working capital = CA – CL = 45% - 20% = 25% of assets
WC = 2,000(0.25) = $500
A U.S. GAAP firm writes down inventory to net realizable value. In the period of the writedown, what is the most likely effect on cost of goods sold?
A)
Decrease.
B)
Increase.
C)
No effect.
B)
Increase.
A write-down of inventory to net realizable value is typically recognized under U.S. GAAP as an increase in cost of goods sold in the period of the write-down. Consider the inventory equation:
ending inventory = beginning inventory + purchases – cost of goods sold
A write-down to NRV decreases ending inventory, with no effect on beginning inventory or purchases. For the inventory equation to hold, cost of goods sold must increase
Which of the following statements regarding the covariance of rates of return is least accurate?
A)
If the covariance is negative, the rates of return on two investments will always move in different directions relative to their means.
B)
Covariance is positive if two variables tend to both be above their mean values in the same time periods.
C)
Covariance is not a very useful measure of the strength of the relationship between rates of return.
A)
If the covariance is negative, the rates of return on two investments will always move in different directions relative to their means.
Negative covariance means rates of return for one security will tend to be above its mean return in periods when the other is below its mean return, and vice versa. Positive covariance means that returns on both securities will tend to be above (or below) their mean returns in the same time periods. For the returns to always move in opposite directions, they would have to be perfectly negatively correlated. Negative covariance by itself does not imply anything about the strength of the negative correlation, it must be standardized by dividing by the product of the securities’ standard deviations of return.
Baetica Company reported the following selected financial statement data for the year ended December 31, 20X7:
in millions % of Sales
For the year ended December 31, 20X7: $500 100%
Sales
Cost of goods sold (300) 60%
Selling and administration expenses (125) 25%
Depreciation (50) 10%
Net income $25 5%
As of December 31, 20X7:
Non-cash operating working capitala $100 20%
Cash balance $35 N/A
aNon-cash operating working capital = Receivables + Inventory – Payables
Baetica expects that sales will increase 20% in 20X8. In addition, Baetica expects to make fixed capital expenditures of $75 million in 20X8. Ignoring taxes, calculate Baetica’s expected cash balance, as of December 31, 2008, assuming all of the common-size percentages remain constant.
A)
$80 million.
B)
$30 million.
C)
$40 million.
B)
$30 million.
2008 sales are expected to be $600 million ($500 million 2007 sales × 1.2) and 20X8 net income is expected to be $30 million ($600 million 20X8 sales × 5%). 2008 non-cash operating working capital is expected to be $120 million ($600 million 20X8 sales × 20%). The change in cash is expected to be –$5 million ($30 million 20X8 net income + $60 million 20X8 depreciation – $20 million increase in non-cash operating working capital – $75 million 20X8 capital expenditures). The 20X8 ending balance of cash is expected to be $30 million ($35 million beginning cash balance – $5 million decrease in cash).
Brandee Shoffield is the public relations manager for Night Train Express, a local sports team. Shoffield is trying to sell advertising spots and wants to know if she can say with 90% confidence that average home game attendance is greater than 3,000. Attendance is approximately normally distributed. A sample of the attendance at 15 home games results in a mean of 3,150 and a standard deviation of 450. Which of the following statements is most accurate?
A)
With an unknown population variance and a small sample size, no statistic is available to test Shoffield’s hypothesis.
B)
The calculated test statistic is 1.291.
C)
Shoffield should use a two-tailed Z-test.
B)
The calculated test statistic is 1.291.
Here, we have a normally distributed population with an unknown variance (we are given only the sample standard deviation) and a small sample size (less than 30.) Thus, we will use the t-statistic.
The test statistic = t = (3,150 – 3,000) / (450 / √ 15) = 1.291
Which of the following best describes valuation allowance? Valuation allowance is a reserve:
A)
created when deferred tax assets are greater than deferred tax liabilities.
B)
against deferred tax liabilities based on the likelihood that those liabilities will be paid.
C)
against deferred tax assets based on the likelihood that those assets will not be realized.
C)
against deferred tax assets based on the likelihood that those assets will not be realized.
Valuation allowance is a reserve against deferred tax assets based on the likelihood that those assets will not be realized. Deferred tax assets reflect the difference in tax expense and taxes payable that are expected to be recovered from future operations.
Which of the following statements best explains how automatic stabilizers work? Even without a change in fiscal policy, automatic stabilizers tend to promote:
A)
a budget surplus during a recession and a budget deficit during an inflationary expansion.
B)
a budget deficit during a recession but do not promote a budget surplus during an inflationary expansion.
C)
a budget deficit during a recession and a budget surplus during an inflationary expansion.
C)
a budget deficit during a recession and a budget surplus during an inflationary expansion.
Automatic stabilizers such as unemployment compensation, corporate profits tax, and the progressive income tax run a deficit during a business slowdown but run a surplus during an economic expansion. Therefore, they automatically implement countercyclical fiscal policy without the delays associated with policy changes that require legislative action.
An analyst calculates the following data for three firms in an industry over the most recent 40 quarters:
Sales Net income
Mean Std Dev Mean Std Dev
Jerome 1,200,000 400,000 120,000 80,000
Lawrence 3,500,000 700,000 400,000 300,000
Morris 6,400,000 1,600,000 800,000 400,000
Based only on these data, the analyst should conclude that, relative to the other two firms:
A)
Lawrence has the greatest uncertainty about its net income.
B)
Morris has the greatest uncertainty about its sales.
C)
Jerome has the least uncertainty about its net income.
A)
Lawrence has the greatest uncertainty about its net income.
Jerome CV sales = 400,000 / 1,200,000 = 0.33
Lawrence CV sales = 700,000 / 3,500,000 = 0.20
Morris CV sales = 1,600,000 / 6,400,000 = 0.25
Uncertainty about sales is greatest for Jerome and least for Lawrence.
Jerome CV net income = 80,000 / 120,000 = 0.67
Lawrence CV net income = 300,000 / 400,000 = 0.75
Morris CV net income = 400,000 / 800,000 = 0.50
Uncertainty about net income is greatest for Lawrence and least for Morris.
Mechanisms that enforce discipline over financial reporting quality least likely include:
A)
accounting standard-setting bodies.
B)
counterparties to private contracts.
C)
government securities regulators.
A)
accounting standard-setting bodies.
Accounting standard-setting bodies issue financial reporting standards but do not enforce compliance with them. Securities regulators and counterparties to private contracts are among the mechanisms that discipline financial reporting quality.
A firm has a return on equity (ROE) of 15% and a dividend payout rate of 80%. If last year’s dividend was $0.80 and the required return on equity is 10%, the stock price today is closest to:
A)
$11.77.
B)
$9.96.
C)
$10.87.
A)
$11.77.
The expected growth rate of dividends is the retention rate (RR) times the return on the equity portion of new investments (ROE), g = (RR)(ROE). The retention rate is 1 minus the payout rate.
RR = 1 – 0.80 = 0.20.
g = (0.20)(0.15)= 3.0%.
The value of the stock will be the dividend paid next year divided by the required rate of return minus the growth rate. Next year’s dividend is $0.80 × 1.03 = $0.824. So the value is 0.824 / (0.10 – 0.03) = 0.824 / 0.07 = $11.77.
his year, Blue Horizon has recorded $390,000 in revenue for financial reporting purposes, but, on a cash basis, revenue was only $262,000. Assume expenses at 50% in both cases (i.e., $195,000 on accrual basis and $131,000 on cash basis), and a tax rate of 34%. What is the deferred tax liability or asset? A deferred tax:
A)
liability of $16,320.
B)
asset of $21,760.
C)
liability of $21,760.
C)
liability of $21,760.
Since pretax income ($195,000) exceeds the taxable income ($131,000), Blue Horizon will have a deferred tax liability of $21,760 [($195,000 − $131,000)(0.34)].
An analyst observes the following four annual returns: R1 = +10%, R2 = –15%, R3 = 0%, and R4 = +5%. The average compound annual rate over the four years is closest to:
A)
0.0%.
B)
–5.0%.
C)
–0.5%.
C)
–0.5%.
G = [(1.10)(0.85)(1.00)(1.05)]0.25 – 1
G = (0.98175)0.25 – 1 = 0.9954 – 1 = –0.00459 ≈ –0.5%
Note: Taking a number to the 0.25 power is the same as taking the fourth root of the number.
An enterprise value multiple is typically calculated as the ratio of enterprise value to a measure of:
A)
net income.
B)
operating income.
C)
pretax income.
B)
operating income.
An enterprise value multiple is typically calculated as the ratio of enterprise value to EBITDA or some other measure of operating income. Net income or pretax income are not typically used because they reflect a firm’s current capital structure and non-cash charges, and because the ratio becomes meaningless when income is negative.
Which of the following is least likely a function or objective of a central bank?
A)
Issuing currency.
B)
Keeping inflation within an acceptable range.
C)
Lending money to government agencies.
C)
Lending money to government agencies.
Lending money to government agencies is not typically a function of a central bank. Central bank functions include controlling the country’s money supply to keep inflation within acceptable levels and promoting a sustainable rate of economic growth, as well as issuing currency and regulating banks.
Beta is a measure of:
A)
company-specific risk.
B)
systematic risk.
C)
total risk.
B)
systematic risk.
Beta is a measure of systematic risk.
Other things equal, for option-free bonds:
A)
a bond’s value is more sensitive to yield increases than to yield decreases.
B)
the value of a long-term bond is more sensitive to interest rate changes than the value of a short-term bond.
C)
the value of a low-coupon bond is less sensitive to interest rate changes than the value of a high-coupon bond.
B)
the value of a long-term bond is more sensitive to interest rate changes than the value of a short-term bond
Long-term, low-coupon bonds are more sensitive than short-term and high-coupon bonds. Prices are more sensitive to rate decreases than to rate increases (duration rises as yields fall)
When a lessee recognizes a balance sheet asset and liability for a new lease:
A)
the liability is typically greater than the asset.
B)
the asset is typically greater than the liability.
C)
the asset and liability are equal.
C)
the asset and liability are equal.
At the initiation of a lease, the lessee records an asset and a liability that are both equal to the present value of the promised lease payments.
The coefficient of determination for a linear regression is best described as the:
A)
percentage of the variation in the independent variable explained by the variation of the dependent variable.
B)
percentage of the variation in the dependent variable explained by the variation of the independent variable
C)
covariance of the independent and dependent variables.
B)
percentage of the variation in the dependent variable explained by the variation of the independent variable.
The coefficient of determination for a linear regression describes the percentage of the variation in the dependent variable explained by the variation of the independent variable.
If an analyst suspects a client or a colleague of planning or engaging in ongoing illegal activities, which of the statements about the actions that the analyst should take is most correct? According to the CFA Institute Standards of Professional Conduct, the analyst should:
A)
consult counsel to determine the legality of the activity and disassociate from any illegal or unethical activity if the member has reasonable grounds to believe that the activity is illegal or unethical.
B)
consult counsel to determine the legality of the activity.
C)
disassociate from any illegal or unethical activity if the member has reasonable grounds to believe that the activity is illegal or unethical.
A)
consult counsel to determine the legality of the activity and disassociate from any illegal or unethical activity if the member has reasonable grounds to believe that the activity is illegal or unethical.
According to the procedures for compliance involving Standard I(A), CFA Institute members should determine legality and disassociate from any illegal or unethical activity.
Under which market structure is the profit maximizing strategy to produce the quantity of output for which the price is equal to marginal cost?
A)
Monopolistic competition.
B)
Monopoly.
C)
Perfect competition.
C)
Perfect competition.
Firms’ demand curves are perfectly elastic (horizontal) in a market characterized as perfect competition, so that marginal revenue is equal to price and a firm maximizes profit by producing the output quantity at which marginal cost equals price. In monopoly markets or under monopolistic competition, firm demand curves are downward sloping so that marginal revenue is less than price
According to Markowitz, an investor’s optimal portfolio is determined where the:
A)
investor’s highest utility curve is tangent to the efficient frontier.
B)
investor’s utility curve meets the efficient frontier.
C)
investor’s lowest utility curve is tangent to the efficient frontier.
A)
investor’s highest utility curve is tangent to the efficient frontier.
The optimal portfolio for an investor is determined as the point where the investor’s highest utility curve is tangent to the efficient frontier.
A bond’s yield to maturity decreases from 8% to 7% and its price increases by 6%, from $675.00 to $715.50. The bond’s effective duration is closest to:
A)
5.0.
B)
6.0.
C)
7.0.
B)
6.0.
Effective duration is the percentage change in price for a 1% change in yield, which is given as 6.
Let A and B be two mutually exclusive events with P(A) = 0.40 and P(B) = 0.20. Therefore:
A)
P(A and B) = 0.
B)
P(A and B) = 0.08.
C)
P(B|A) = 0.20.
A)
P(A and B) = 0.
If the two evens are mutually exclusive, the probability of both occurring is zero.
A company issues $10,000,000 face value of 5% annual coupon, 3-year bonds on January 1, 20X1, raising $8,000,000 in cash proceeds. Using the effective interest method, and ignoring issuance costs, interest expense for the year ending December 31, 20X2 is closest to:
A)
$1,084,000.
B)
$500,000.
C)
$1,163,000.
C)
$1,163,000.
Cash interest paid each year is 5% × $10,000,000 = $500,000. To calculate the effective interest rate: N = 3; PV = 8,000,000; FV = –10,000,000; PMT = –500,000; CPT I/Y = 13.55%
The initial bond liability equals the proceeds raised of $8,000,000. Interest expense for 20X1 = 13.55% × $8,000,000 = $1,084,000. The bond liability amortizes (toward face value at maturity) by the difference between interest expense and cash interest paid: $1,084,000 – $500,000 = $584,000.
The bond liability at the beginning of 20X2 = $8,000,000 + $584,000 = $8,584,000. Interest expense for 20X2 = 13.55% × $8,584,000 = $1,163,132.
A debt covenant is most likely to restrict a firm from:
A)
decreasing its common dividends.
B)
issuing new common shares.
C)
repurchasing common shares.
C)
repurchasing common shares.
Debt covenants exist to protect creditors. Repurchasing common shares is a use of cash that rewards equity investors but might harm creditors by reducing the firm’s solvency. Decreasing dividends or issuing new shares would increase the cash available to repay creditors.
Stock A has a standard deviation of 4.1% and Stock B has a standard deviation of 5.8%. If the stocks are perfectly positively correlated, which portfolio weights minimize the portfolio’s standard deviation?
Stock A Stock B
A)
0% 100%
B)
100% 0%
C)
63% 37%
B)
100% 0%
Because there is a perfectly positive correlation, there is no benefit to diversification. Therefore, the investor should put all his money into Stock A (with the lowest standard deviation) to minimize the risk (standard deviation) of the portfolio.
A common-size cash flow statement is least likely to provide payments to employees as a percentage of:
A)
total cash outflows for the period.
B)
operating cash flow for the period.
C)
revenues for the period.
)
operating cash flow for the period.
There are two formats for a common-size cash flow statement, expressing each type of outflow as a percentage of total cash outflows or as a percentage of total revenue for the period. Operating cash flow for the period mixes inflows and outflows and is not used to calculate percentage flows for payment made.
Cash flow from operations (CFO) calculated using the indirect method is: net income (100) + depreciation (50) – increase in accounts receivable (10) + decrease in inventory (20) + increase in accounts payable (50) = $210
For the year ended December 31, 2007, Challenger Company reported the following financial information:
Revenue $100,000
Cost of goods sold (40,000)
Cash operating expenses (20,000)
Depreciation expense (5,000)
Tax expense (3,000)
Net income $32,000
Increase in accounts receivable $7,500
Decrease in inventory $2,500
Increase in short-term notes payable $3,000
Decrease in accounts payable $1,000
Calculate cash flow from operating activities using the direct method and the indirect method.
Direct method Indirect method
A)
$31,000 $34,000
B)
$31,000 $31,000
C)
$34,000 $34,000
B)
$31,000 $31,000
CFO is the same under both methods, the only difference is presentation. Direct method: $92,500 cash collections ($100,000 revenue – $7,500 increase in receivables) – $38,500 cash paid to suppliers (– $40,000 COGS + $2,500 decrease in inventory – $1,000 decrease in payables) – $20,000 cash operating expenses – $3,000 tax expense = $31,000. Indirect method: $32,000 net income + $5,000 depreciation expense – $7,500 increase in receivables + $2,500 decrease in inventory – $1,000 decrease in payables = $31,000. The increase in short-term notes payable is a financing activity.
A $1,000 face, 10-year, 8.00% semi-annual coupon, option-free bond is issued at par (market rates are thus 8.00%). Given that the bond price decreased 10.03% when market rates increased 150 basis points (bp),if market yields decrease by 150 bp, the bond’s price will:
A)
decrease by more than 10.03%.
B)
increase by 10.03%.
C)
increase by more than 10.03%.
C)
increase by more than 10.03%.
Because of positive convexity, (bond prices rise faster than they fall) for any given absolute change in yield, the increase in price will be more than the decrease in price for a fixed-coupon, noncallable bond. As yields increase, bond prices fall, and the price curve gets flatter, and changes in yield have a smaller effect on bond prices. As yields decrease, bond prices rise, and the price curve gets steeper, and changes in yield have a larger effect on bond prices. Here, for an absolute 150bp change, the price increase would be more than the price decrease.
The exchange rate for Australian dollars per British pound (AUD/GBP) was 1.4800 five years ago and is 1.6300 today. The percent change in the Australian dollar relative to the British pound is closest to:
A)
appreciation of 10.1%.
B)
depreciation of 10.1%.
C)
depreciation of 9.2%.
C)
depreciation of 9.2%.
To correctly calculate the percentage change in AUD relative to GBP, convert the exchange rates so that AUD is the base currency: 1 / 1.4800 = 0.6757 GBP/AUD five years ago and 1 / 1.6300 = 0.6135 GBP/AUD today. The percentage change in the Australian dollar against the British pound is 0.6135 / 0.6757 − 1 = –9.2%.
Note that the GBP has appreciated against the AUD by 1.6300 / 1.4800 − 1 = 10.1% over the same period.
Which of the following is least likely a reason the price to cash flow (P/CF) model has grown in popularity?
A)
CFs are more easily estimated than future dividends.
B)
CFs are generally more difficult to manipulate than earnings.
C)
CFs are used extensively in valuation models.
A)
CFs are more easily estimated than future dividends.
CFs are not easier to estimate than dividends.
A bond was purchased exactly one year ago for $910 and was sold today for $1,020. During the year, the bond made two semi-annual coupon payments of $30. What is the holding period return?
A)
12.1%.
B)
18.7%.
C)
6.0%.
B)
18.7%.
HPY = (1,020 + 30 + 30 – 910) / 910 = 0.1868 or 18.7%.
Denise Weaver is a portfolio manager who manages a mutual fund and has pension clients. When Weaver receives a proxy for stock in the mutual fund, she gives it to Susan Griffith, her administrative assistant, to complete. When the proxy is for a stock owned in a pension plan, she asks Griffith to send the proxy on to the sponsor of the pension fund. Weaver has:
A)
violated the Standards by her policy on mutual fund and pension fund proxies.
B)
not violated the Standards.
C)
violated the Standards by her policy on mutual fund proxies, but not her policy on pension fund proxies.
A)
violated the Standards by her policy on mutual fund and pension fund proxies.
Proxies should be taken seriously, and although it is likely that Griffith can understand some of the issues, it is likely that she is not capable of making responsible decisions on all potential proxy issues. Proxies for a pension plan should be voted in the best interests of the beneficiaries, not the plan sponsor. The sponsor’s interests will not always be the same as the beneficiary’s interest.
If the coupon payments are reinvested at the coupon rate during the life of a bond, then the yield to maturity:
A)
is greater than the realized yield.
B)
is less than the realized yield.
C)
may be greater or less than the realized yield.
C)
may be greater or less than the realized yield.
For the realized yield to equal the YTM, coupon reinvestments must occur at that YTM. Whether reinvesting the coupons at the coupon rate will result in a realized yield higher or lower than the YTM depends on whether the bond is at a discount (coupon < YTM) or a premium (coupon > YTM
FCO, Inc. (FCO) is comparing EBIT forecasts to help determine the impact its capital structure has on net income.
Expected EBIT EBIT + 10%
EBIT $80,000 $88,000
Interest expense 15,000 15,000
EBT 65,000 73,000
Taxes 26,000 29,200
Net income 39,000 43,800
Liabilities 200,000
Shareholder equity 250,000
Return on equity 15.60%
FCO’s degree of financial leverage is closest to:
A)
1.25.
B)
0.80.
C)
0.60.
A)
1.25.
The degree of financial leverage (DFL) is interpreted as the ratio of the percentage change in net income to the percentage change in EBIT. FCO can compare two EBIT forecasts to determine how net income is being driven by financial leverage.
(43800 - 39000)/39000 / (88000-80000)/80000 = 1.23
Which of the following statements best describes the concept of negative convexity in bond prices? As interest rates:
A)
fall, the bond’s price increases at a decreasing rate.
B)
fall, the bond’s price increases at an increasing rate.
C)
rise, the bond’s price decreases at a decreasing rate.
A)
fall, the bond’s price increases at a decreasing rate
Negative convexity occurs with bonds that have prepayment/call features. As interest rates fall, the borrower/issuer is more likely to repay/call the bond, which causes the bond’s price to approach a maximum. As such, the bond’s price increases at a decreasing rate as interest rates decrease.
Selected balance sheet data for Parker Company are as follows:
Current assets 3,000
Long-lived assets 7,000
Total assets 10,000
Current liabilities 2,000
Long-term liabilities 4,000
Total liabilities 6,000
Shareholders’ equity 4,000
On a common-size balance sheet, Parker’s current liabilities would be stated as:
A)
20%.
B)
33%.
C)
67%.
A)
20%.
On a common-size balance sheet, each line item is stated as a percentage of total assets: 2,000 / 10,000 = 20%.
Which of the following factors is least likely to cause a difference between a firm’s effective tax rate and statutory rate?
A)
Tax credits.
B)
Non-deductible expenses.
C)
Deductible expenses.
C)
Deductible expenses.
Permanent tax differences such as tax credits, non-deductible expenses, and tax differences between capital gains and operating income give rise to differences in the effective and statutory tax rates.
Nichole Zeller and Randy Toffler have both passed Level II of the CFA Exam Program and have registered for Level III. Zeller circulates a resume stating that she is a candidate for the CFA designation and has passed Level II of the CFA program. Toffler circulates a resume stating that he is a CFA II. Which of the following statements is CORRECT?
A)
Both Zeller and Toffler have violated the Code of Standards.
B)
Only Zeller has violated the Code of Standards.
C)
Only Toffler has violated the Code of Standards.
C)
Only Toffler has violated the Code of Standards.
The Code and Standards permit an individual to state that he or she is a candidate for the CFA designation as long as the person is registered for the next CFA exam. The same individual may state the fact that he or she has passed Level I or II of the CFA program. There is no partial designation, such as CFA II.
Selected financial ratios from Mulroy Company’s common-size income statements are as follows:
20X1 20X2 20X3
Gross profit margin 22% 24% 26%
Operating profit margin 18% 20% 22%
Pretax margin 15% 14% 13%
Net profit margin 11% 10% 9%
Relative to sales, it is most likely that Mulroy’s:
A)
income tax expense is increasing.
B)
operating expenses are increasing.
C)
nonoperating expenses are increasing.
C)
nonoperating expenses are increasing.
Nonoperating expenses are equal to the difference between operating profit and pretax profit. Based on the given profit margins, Mulroy’s nonoperating expenses increased from 3% of sales in 20X1 to 9% of sales in 20X3. Because gross profit margin is increasing, cost of goods sold is decreasing as a percentage of sales. Other operating expenses and income tax expense, as a percentage of sales, were stable over the period shown.
ully Advisers, Inc., has determined four possible economic scenarios and has projected the portfolio returns for two portfolios for their client under each scenario. Tully’s economist has estimated the probability of each scenario, as shown in the table below. Given this information, what is the standard deviation of returns on portfolio A?
Scenario Probability Return on Portfolio A Return on Portfolio B
A 15% 18% 19%
B 20% 17% 18%
C 25% 11% 10%
D 40% 7% 9%
A)
4.53%.
B)
1.140%.
C)
5.992%.
A)
4.53%
E(RA) = 11.65%
σ2 = 0.0020506 = 0.15(0.18 – 0.1165)2 + 0.2(0.17 – 0.1165)2 + 0.25(0.11 – 0.1165)2 + 0.4(0.07 – 0.1165)2
σ = 0.0452836
