Mock 1

Question 1

Which of the following statements about the CFA Institute’s Professional Conduct Program (PCP) is least accurate?

A)
Possible sanctions include condemnation by a member’s peers or suspension of a candidate’s participation in the CFA Program.
B)
If the PCP staff determine that a sanction against a member is warranted, the member must either accept the sanction or lose the right to use the CFA designation.
C)
Members who cooperate with a PCP inquiry by providing confidential client information to PCP staff are not in violation of Standard III(E) Preservation of Confidentiality.

Answer 1

B
Members can accept or reject a disciplinary sanction proposed by the Professional Conduct Program staff. If the member rejects the sanction, the matter is referred to a hearing before a disciplinary review panel of CFA Institute members. The other statements are accurate. ( Module 70.1, LOS 70.a)

Question 2

Robert Miguel, CFA, is a portfolio manager. On Saturday, one of his clients invited Miguel and his wife to be his guests at his luxury suite for a major league baseball playoff game, which they did. Miguel told his supervisor on Monday that they had attended the game with the client and that the suite was luxurious. Miguel has:

A)
not violated the Standards.
B)
violated the Standards because disclosure must be in writing.
C)
violated the Standards because he must disclose the gift prior to accepting.

Answer 2

A
In this case, Miguel has not violated the standards. For a gift from a client in appreciation of past service or performance, informing his supervisor verbally is sufficient. Standard I(B) Independence and Objectivity requires disclosure prior to accepting the gift “when possible,” but in cases such as this when there is short notice, notification afterward is permitted.

Question 3

At his golf club on Saturday morning, Paul Corwin, CFA, sees Frank Roberts, a friend and institutional client of his, who tells him that he is planning to sell his house on the 7th fairway. While golfing that day, Corwin tells Robert Lowe, a realtor, that Roberts is planning to sell his house and may need a realtor. He also tells Lowe that he manages an equities account for Roberts. If Corwin has not received permission from Roberts, he has violated the Standard on preservation of confidentiality:

A)
both by disclosing Roberts’ plan to sell his home and that he is a client.
B)
by disclosing Roberts’ plan to sell his home but not by mentioning that he was a client.
C)
by disclosing that Roberts is a client of his but not by mentioning Roberts’ plan to sell his home.

Answer 3

C)
by disclosing that Roberts is a client of his but not by mentioning Roberts’ plan to sell his home.

Corwin violated Standard III(E) Preservation of Confidentiality by revealing his business relationship with Roberts without permission. Because the information that Roberts’ plans to sell his home is not received as part of his professional relationship with Roberts, it is not covered by the Standard.

Question 4

Doug Watson, CFA, serves in a sales position at Sommerset Brokerage, a registered investment adviser. Watson frequently drinks excessively. On one occasion, Watson was cited by local police for misdemeanor public intoxication. According to the Standard on knowledge of the law and the Standard on misconduct, Watson is in violation of:

A)
both of these Standards.
B)
neither of these Standards.
C)
only one of these Standards.

Answer 4

B)
neither of these Standards.

Watson’s excessive drinking is unfortunate, but we have no evidence that it has affected his work, professional integrity, judgment, or reputation. If he commits an act involving fraud or dishonesty, he would violate the Standard on misconduct.

Question 5

Which of the following is least likely included in the CFA Institute Code of Ethics? Members of CFA Institute must:

A)
place their clients’ interests before their employer’s interests.
B)
strive to maintain and improve the competence of others in the profession.
C)
use reasonable care and exercise independent professional judgment.

Answer 5

A)
place their clients’ interests before their employer’s interests.

The requirement that members and candidates place their clients’ interests before their employer’s or their own is in Standard III(A) Loyalty, Prudence, and Care. The other choices are included in the CFA Institute Code of Ethics.

Question 6

Dudley Thompson is a bond salesman for a small broker/dealer in London. His firm is the lead underwriter on a new junk bond issue for Ibex Corporation, and Thompson has sent details of the offering to clients. Thompson calls only his accounts over £1,000,000 for whom he thinks the issue is suitable. Thompson also posts his firm’s optimistic projections for Ibex’s performance in several Internet chat rooms. According to the Standards concerning market manipulation and fair dealing, Thompson is in violation of:

A)
both of these Standards.
B)
neither of these Standards.
C)
only one of these Standards.

Answer 6

B)
neither of these Standards.

Thompson has not violated Standard II(B) Market Manipulation by posting his firm’s projections for Ibex. A firm’s recommendation of a security may increase its price without any intent to mislead the market. The firm has disseminated the details of the offering to its clients fairly, so Thompson may call individual clients without violating the Standard III(B) Fair Dealing.

Question 7

Angie Franklin, CFA, who covers technology stocks, joins a conference call for analysts presented by Cynthia Lucas, chief technology officer for LevelTech. Lucas tells the analysts that overseas shipments of the company’s important new product are going to be delayed due to manufacturing defects, which is new information to the analysts. After the meeting Franklin changes her rating on LevelTech from “buy” to “hold” and sends a note to accounts recommending the sale of LevelTech. Franklin:

A)
did not violate the Standards.
B)
violated the Standard on nonpublic information by revising her rating on LevelTech.
C)
violated the Standard on fair dealing by rating the stock a “hold” but recommending sale of the shares to her accounts.

Answer 7

B)
violated the Standard on nonpublic information by revising her rating on LevelTech.

Telling a selected group of analysts new information does not constitute public disclosure, and therefore acting or causing others to act on this information is a violation of Standard II(A) Material Nonpublic Information. Recommending the sale of a stock rated as a “hold” is not a violation of Standard III(B) Fair Dealing.

Question 8

According to the recommended procedures for complying with the Standard on suitability, which of the following statements regarding an investment policy statement (IPS) is least accurate?

A)
An IPS should describe the roles and responsibilities of both the adviser and the client.
B)
A member or candidate is not responsible for financial information withheld by the client
C)
A client’s IPS must be updated at least quarterly to reflect any changes in their investment profile

Answer 8

C)
A client’s IPS must be updated at least quarterly to reflect any changes in their investment profile.

Standard III(C) Suitability requires that members and candidates update client information (the IPS) at least annually. The IPS can be updated more frequently if there are significant changes in the investment strategy or client characteristics.

Question 9

Which of the following statements made in a marketing brochure is a violation of the Standards?

A)
“Roger Langley, Chartered Financial Analyst, has been a portfolio manager for ten years and passed all three levels of the CFA examinations on his first attempts.”
B)
“Jennifer York has passed the Level II exam and will earn the right to use the CFA designation after completing the Level III exam this June.”
C)
“Paul Yeng, CFA, has retired from the firm after 25 years of service. Much of the firm’s past success can be attributed to Yeng’s efforts as an analyst and portfolio manager.”

Answer 9

B)
“Jennifer York has passed the Level II exam and will earn the right to use the CFA designation after completing the Level III exam this June.

According to Standard VII(B) Reference to the CFA Institute, the CFA Designation, and CFA Program, citing an expected date for completing a level of the CFA Program is a misuse of the CFA designation. (Module 71.9, LOS 71.b)

Question 10

According to the Code and Standards, members and candidates who are involved in distributing an initial public offering (IPO) of equity shares and wish to participate in the IPO:

A)
may participate unless the IPO is oversubscribed.
B)
may not participate because this creates a conflict of interest.
C)
must obtain pre-clearance from a supervisor before participating.

Answer 10

A)
may participate unless the IPO is oversubscribed.

Standard VI(B) Priority of Transactions recommends, but does not require, that a member or candidate obtain pre-clearance from his or her supervisor before participating in an equity IPO. Guidance for Standard III(B) Fair Dealing states that members and candidates distributing IPO shares must distribute shares in an oversubscribed IPO to clients and may not withhold shares for themselves. (Module 71.8, LOS 71.b)

Question 11

Linda Bryant, CFA, is an employee of Roomkin Investment House, which underwrites equity and debt offerings. She has been approached by SimthCo to consult on a private debt placement. According to CFA Institute Standards of Professional Conduct, before Bryant agrees to accept this job, she is required to:

A)
obtain written consent from Roomkin after submitting details of the arrangement.
B)
talk to her immediate supervisor and get her approval to take this consulting job.
C)
inform SimthCo in writing that she will accept the job and provide details of the arrangement to Roomkin in writing.

Answer 11

A)
obtain written consent from Roomkin after submitting details of the arrangement.

To comply with Standard IV(B) Additional Compensation Arrangements, Bryant must obtain written consent from her employer before undertaking the independent consulting project. Bryant must also provide a description of the types of services being provided, the length of time the arrangement will last, and the compensation she expects to receive for her services. (Module 71.6, LOS 71.b)

Question 12

To comply with the Code and Standards, analysts who send research recommendations to clients must:

A)
keep records of all the data and analysis that went into creating the report.
B)
send recommendations only to those clients for whom the investments are suitable.
C)
not send recommendations without including the underlying analysis and basic investment characteristics.

Answer 12

A)
keep records of all the data and analysis that went into creating the report.

Standard V(C) Record Retention requires members to maintain records of the data and analysis they use to develop their research recommendations. Recommendations may be brief, in capsule form, or simply a list of buy/sell recommendations. A list of recommendations may be sent without regard to suitability, including both safe income stocks and aggressive growth stocks, for example. (Module 71.7, LOS 71.b)

Question 13

Excluding the results of terminated accounts when calculating historical performance is recommended by:

A)
both GIPS and the Standard concerning performance presentation.
B)
GIPS, but not by the Standard concerning performance presentation.
C)
neither GIPS nor the Standard concerning performance presentation.

Answer 13

C)
neither GIPS nor the Standard concerning performance presentation.

Standard III(D) Performance Presentation recommends that terminated accounts be included in historical performance calculations.

Question 14

Ken Toma, CFA, has just completed an extensive analysis and concluded that the demand for vacation rentals in Hawaii will far exceed the supply for the foreseeable future. Toma writes a research report stating, “Based on the fact that the demand for Hawaiian beach vacations will exceed the supply of rooms for the foreseeable future, I recommend the purchase of shares of The Hawaiian REIT, a diversified portfolio of Hawaiian beachfront resorts.” If Toma presents this report to his clients, he will most likely violate the CFA Institute Standards by:

A)
not distinguishing between fact and opinion.
B)
not considering the suitability of the investment for his clients.
C)
failing to have a reasonable and adequate basis for his recommendation.

Answer 14

A)
not distinguishing between fact and opinion.

Standard V(B) Communication with Clients and Prospective Clients requires that Toma separate opinion from fact. Toma’s statement that excess demand will persist into the foreseeable future is an opinion, not a fact. Toma has established a reasonable basis for his recommendation through his analysis. Suitability does not become an issue until a client chooses to act on Toma’s recommendation. (Module 71.7, LOS 71.b)

Question 15

Which of the following is one of the eight major sections of the GIPS standards for firms?

A)
Independent Third-Party Verification.
B)
Input Data and Calculation Methodology.
C)
Guidelines for Attributing Performance to Sub-Advisers.

Answer 15

B)
Input Data and Calculation Methodology.

Input Data and Calculation Methodology is one of the eight major sections of the GIPS standards for firms; the others are not. (Module 72.1, LOS 72.b)

Question 16

Shan Ang, CFA, is a portfolio manager at Huang Investments. Lian Jan, an old friend of Ang’s, is an executive recruiter in the same city. Jan proposes that she will refer any high-level executives that she places locally to Ang, in exchange for one round of golf at Ang’s country club for each new client. According to the Standard concerning referral fees, Ang would be required to disclose this referral arrangement:

A)
only to all prospective clients referred by Jan.
B)
to his employer and all prospective clients referred by Jan.
C)
to all prospective clients, current clients, and his employer.

Answer 16

B)
to his employer and all prospective clients referred by Jan.

Standard VI(C) Referral Fees states that members and candidates must disclose to employers and to affected prospects and clients, before entering into any formal agreement for services, any benefits received for the recommendation of services provided by the member. (Module 71.8, LOS 71.b)

Question 17

Yvette Michaels, CFA, an analyst for Torborg Investments, inadvertently overhears a conversation between two executives of Collective Healthcare in which they mention an upcoming tender offer for Network, a stock she covers. Michaels has followed both companies extensively and feels their consolidation would be very beneficial for both companies. She tells her supervisor, a senior analyst, about the proposed tender offer. Michaels’ actions are:

A)
in violation of the Standards.
B)
not in violation of the Standards because she told only her supervisor.
C)
not in violation of the Standards because she has not traded shares of Network or changed her report on the company.

Answer 17

A)
in violation of the Standards.

Michaels has violated Standard II(A) Material Nonpublic Information. Members who possess material nonpublic information are prohibited from acting or causing others to act on that information. She may not share the information with anyone except designated supervisory or compliance employees within her firm. Disclosing to her supervisor, who is not identified as a designated supervisor of compliance issues, is not permitted. (Module 71.3, LOS 71.b)

Question 18

Kimberwick Technologies reported the following information for the year ending December 31.

Data
Net sales 50,000
Cash expenses 3,250
Cash inputs 17,000
Cash taxes 7,000
Increase in receivables 500
Depreciation expense 1,000
Cash flow from investing -5,000
Cash flow from financing -4,250

If the cash balance increased $13,000 over the year, cash flow from operations (CFO) is closest to:

A)
$21,250.
B)
$21,750.
C)
$22,250.

Answer 18

C)
$22,250.

The easiest way to calculate CFO here is total cash flow – cash flow from investing – cash flow from financing = $13,000 + 5,000 + 4,250 = $22,250. Alternatively, CFO = $50,000 − 3,250 − 17,000 − 7,000 − 500 = $22,250. (Module 20.2, LOS 20.f)

Question 19

A business cycle theory developed by applying utility theory and budget constraints to macroeconomic models is most closely associated with which school of economic thought?

A)
Austrian.
B)
New Classical.
C)
New Keynesian.

Answer 19

B)
New Classical

Real business cycle theory, which derives from applying utility theory and budget constraints to macroeconomic models, is associated with the New Classical school. (Module 11.1, LOS 11.d)

Question 20

Which of the following is most likely a motivation for a company’s management to issue low-quality financial reports?

A)
Management has provided optimistic earnings guidance.
B)
Oversight provided by the board of directors is weak or inadequate.
C)
Accounting principles permit a wide range of acceptable treatments and estimates.

Answer 20

A)
Management has provided optimistic earnings guidance.

Meeting or exceeding its own earnings guidance is a possible motivation for management to issue low-quality financial reports. Inadequate board oversight and wide ranges of acceptable accounting treatments are more appropriately viewed as opportunities for issuing low-quality financial reports. (Module 26.1, LOS 26.e)

Question 21

The initial market value of a portfolio was $100,000. One year later the portfolio was valued at $90,000 and two years later at $99,000. The geometric mean annual return excluding any dividend income is closest to:

A)
−0.5%.
B)
−0.4%.
C)
0.0%.

Answer 21

A) -0.5%

R1 = −10/100 = −10%; R2 = +9/90 = +10%

geometric mean= √(0.9)(1.1)−1= −0.005 or −0.5%

Question 22

Consider the following foreign exchange and interest rate information:

Spot rate: 1.3382 USD/EUR.
One year riskless USD rate = 2.5%.
One year riskless EUR rate = 3.5%.
The one-year arbitrage-free forward exchange rate is closest to:

A)
1.2391 USD/EUR.
B)
1.3253 USD/EUR.
C)
1.3513 USD/EUR.

Answer 22

B)
1.3253 USD/EUR

Arbitrage-free forward rate = 1.3382 USD/EUR × (1.025 / 1.035) = 1.3253 USD/EUR. (Module 15.2, LOS 15.h)

Question 23

Other things equal, a country is most likely to have a current account deficit if it also has:

A)
a low savings rate
B)
a government budget surplus.
C)
a low rate of domestic investment.

Answer 23

A)
a low savings rate.

As shown by the fundamental macro relationship (X – M) = (S – I) – (G – T), a current account deficit (X < M) is associated with a low savings rate, a high rate of domestic investment, or low government savings (i.e., a budget deficit). (Module 14.2, LOS 14.i)

Question 24

Haltata Turf & Sod currently uses the first in, first out (FIFO) method to account for inventory. Due to significant tax-loss carryforwards, the company has an effective tax rate of zero. Prices are rising and inventory quantities are stable. If the company were to use last in, first out (LIFO) instead of FIFO:

A)
net income would be lower and cash flow would be higher.
B)
cash flow would remain the same and working capital would be lower.
C)
gross margin would be higher and stockholder’s equity would be lower.

Answer 24

B)
cash flow would remain the same and working capital would be lower.

In the absence of taxes, there is no difference in cash flow between LIFO and FIFO. In addition, using LIFO would result in lower working capital (inventory is lower). Using LIFO would result in lower net income because of a lower gross margin (cost of goods sold is higher). (Module 22.5, LOS 22.l)

Question 25

The probability that an acquisition has been executed well is 48%. If it is executed well, the probability of EPS greater than $3.20 is 55%. If the acquisition has not been executed well, the probability of EPS less than or equal to $3.20 is 65%. The unconditional probability of EPS greater than $3.20 is closest to: A) 45% B) 48%. C) 55%

Answer 25

A) 45% The unconditional probability, Prob(EPS>$3.20), is equal to Prob(executed well) × Prob(EPS > $3.20)|executed well) + Prob(not executed well) × Prob(EPS > $3.20|not executed well) = 0.48 × 0.55 + (1 – 0.48)(1 – 0.65) = 0.446.

Question 26

A simple linear regression model produces the following outputs: Total sum of squares 9,575.81 Mean regression sum of squares 7,115.74 Mean squared error 1,663.46 The F-statistic for this regression is closest to: A) 1.3. B) 4.3. C) 5.8.

Answer 26

B) 4.3. The F-statistic is the ratio of the mean regression sum of squares (MSR) to the mean squared error (MSE). 7,115.74 / 1,663.46 = 4.278. (Module 7.2, LOS 7.d)

Question 27

Which of the following statements about monopolists is most accurate? A) Monopolists have imperfect information about the demand curve for their product. B) Without government intervention, monopolists will always earn economic profits. C) A monopolist maximizes total revenue where marginal revenue equals marginal cost.

Answer 27

A) Monopolists have imperfect information about the demand curve for their product. Demand curves are not observable so a monopolist must search for the profit maximizing price. Because demand information is not perfect, a monopolist is a price searcher. The other statements are false. Although a monopolist can earn positive economic profits in the long run, they are not guaranteed; if average total costs exceed price, the monopolist will experience economic losses. A monopolist maximizes profit, not revenue, where marginal revenue equals marginal cost. (Module 9.4, LOS 9.f)

Question 28

A company's investments in marketable securities include a 3-year tax-exempt bond measured at amortized cost and a 5-year government note measured at fair value through other comprehensive income. On its income statement, the company should report the coupon interest received from: A) both of these securities. B) neither of these securities. C) only one of these securities.

Answer 28

A) both of these securities. Interest and dividends received are reported as income, regardless of the balance sheet classification of marketable securities. (Module 19.6, LOS 19.e)

Question 29

A central bank's ability to achieve its policy goals is most likely to be limited by available resources when which of the following actual rates is below its target rate? A) Interest rate B) Inflation rate. C) Exchange rate.

Answer 29

C) Exchange rate. With exchange rate targeting, a central bank's ability to increase the value of the domestic currency is limited by the amount of foreign reserves the country has available to buy its own currency in the foreign exchange market. While inflation targeting and interest rate targeting have limitations (e.g., liquidity trap conditions may exist, interest rates are bounded by zero), the central bank's resources are not typically a limitation. (Module 12.2, LOS 12.n)

Question 30

Acme Corp. purchased a new stamping machine for $100,000, paid $10,000 for shipping, and paid $5,000 to have it installed in their plant. Based on an estimated salvage value of $25,000 and an economic life of six years, the difference between straight-line depreciation and double-declining balance depreciation in the second year of the asset's life is closest to: A) $7,220. B) $10,556. C) $16,666.

Answer 30

B) $10,556. Straight line depreciation is (100,000 + 10,000 + 5,000 − 25,000) / 6 = 15,000 each year. Double-declining balance depreciation in the second year is: 115,000 (2/3)(1/3) = 25,556. The difference is $10,556. Remember that salvage value is not part of the declining balance calculation. (Module 18.3, LOS 18.d)

Question 31

From the point of view of a financial analyst, when evaluating companies that use different inventory cost assumptions, in a period of: A) stable prices, LIFO inventory is preferred to FIFO inventory. B) decreasing prices, FIFO inventory is preferred to LIFO inventory. C) increasing prices, FIFO cost of sales is preferred to LIFO cost of sales.

Answer 31

B) decreasing prices, FIFO inventory is preferred to LIFO inventory. The most useful estimates of inventory and cost of sales are those that best approximate current cost. Whether prices are increasing or decreasing, FIFO provides a better estimate of inventory values, and LIFO provides a better estimate of cost of sales. If prices are stable, there is no difference between LIFO and FIFO estimates of inventory or cost of sales.

Question 32

An analyst estimates a stock has a 40% probability of earning a 10% return, a 40% probability of earning a 12.5% return, and a 20% probability of earning a 30% return. The stock's standard deviation of returns based on this returns model is closest to: A) 3.74%. B) 5.75%. C) 7.58%.

Answer 32

C) 7.58%. Expected value = (0.4)(10%) + (0.4)(12.5%) + (0.2)(30%) = 15% Variance = (0.4)(10 − 15)2 + (0.4)(12.5 − 15)2 + (0.2)(30 − 15)2 = 57.5 Standard deviation =√57.5 = 7.58%

Question 33

Shortfall risk is best described as the probability: A) of a credit rating downgrade due to possible earnings shortfalls. B) of failing to make a contractually promised payment. C) that portfolio value will fall below some minimum level at a future date.

Answer 33

C) that portfolio value will fall below some minimum level at a future date. Choice A is downgrade risk; Choice B is default risk.

Question 34

Longboat, Inc., sold a luxury passenger boat from its inventory on December 31 for $2,000,000. It is estimated that Longboat will incur $100,000 in warranty expenses during its 5-year warranty period. Longboat's tax rate is 30%. To account for the tax implications of the warranty obligation prior to incurring warranty expenses, Longboat should: A) record a deferred tax asset of $30,000. B) record a deferred tax liability of $30,000. C) make no entry until actual warranty expenses are incurred.

Answer 34

A) record a deferred tax asset of $30,000. Warranty expense should be recorded when the inventory item covered by the warranty is sold. A deferred tax asset is created when warranty expenses are accrued on the financial statements but are not deductible on the tax returns until the warranty claims are paid. The full amount of the obligation, $100,000, is recorded as an expense, with a deferred tax asset of $30,000. Note that a deferred tax asset results when taxable income is more than pretax income and the difference is likely to reverse (warranty will be paid) in future years. (Module 24.2, LOS 24.c)

Question 35

The presentation format of balance sheet data that standardizes the first-year values to 1.0 and presents subsequent years' amounts relative to 1.0 is: A) an indexed balance sheet. B) a vertical common-size balance sheet. C) a horizontal common-size balance sheet.

Answer 35

C) a horizontal common-size balance sheet. On a horizontal common-size balance sheet, the divisor is the first-year values so they are all standardized to 1.0 by construction. Trends in the values of these items as well as the relative growth in these items are readily apparent. A vertical common-size balance sheet expresses all balance sheet accounts as a percentage of total assets and does not standardize the initial year.

Question 36

Which of the following statements regarding the money supply and determination of short-term interest rates is least accurate? A) On balance, growth in real GDP tends to increase the transactional demand for money. B) If the short-term interest rate is greater than the equilibrium rate, there will be excess supply of real money balances. C) An increase in the real money supply from an initial equilibrium situation will cause households and businesses to sell interest- bearing securities.

Answer 36

C) An increase in the real money supply from an initial equilibrium situation will cause households and businesses to sell interest- bearing securities. From an initial equilibrium, an increase in real money balances will leave households and businesses with more money than they wish to hold, so they will purchase interest-bearing securities, driving their prices up and yields down until a new equilibrium short-term rate is established. (Module 12.1, LOS 12.d)

Question 37

The bootstrap method of estimating the standard error of sample means involves drawing repeated samples from a data set, each with: A) outliers removed. B) the same sample size. C) one observation removed.

Answer 37

B) the same sample size. The bootstrap method involves drawing repeated samples of size n from the same data set and calculating the standard deviation of the resulting sample means. The jackknife method involves calculating multiple means from the same sample, each with one observation removed, and calculating the standard deviation of those means. (Module 5.2, LOS 5.i)

Question 38

n analyst writes the following about two nations: East Dumerde has a state-dominated domestic economy and conducts little foreign trade. West Dumerde uses its large economy and geophysical resource endowment to discourage other nations from criticizing its human rights record. In this analyst's opinion, the geopolitics of both East Dumerde and West Dumerde are most accurately described as: A) hegemony. B) nationalism. C) non-cooperation.

Answer 38

C) non-cooperation. In this analyst's opinion, East Dumerde is best described as practicing autarky (nationalism and non-cooperation) and West Dumerde is best described as practicing hegemony (globalization and non-cooperation). (Module 13.1, L

Question 39

An analyst gathered the following data about a company: Collections from customers are $5,000. Depreciation is $800. Cash expenses (including taxes) are $2,000. Tax rate = 30%. Net cash increased by $1,000. If inventory increases over the period by $800, cash flow from operations equals: A) $1,600. B) $2,400. C) $3,000.

Answer 39

C) $3,000. Use the direct method. Collections from customers $5,000 Cash expenses –$2,000 Cash flow from operations $3,000 Cash expenses are given. If you had been given COGS, you would need to adjust that for inventory changes to get cash expenses for inputs. Depreciation is a non-cash change. Changes in depreciation are used with the indirect method. Net change in cash will reflect CFI and CFF, not just CFO. (Module 20.2, LOS 20.f)

Question 40

Automatic stabilizers are government programs that require no legislation and tend to: A) automatically increase spending at the same growth rate as real GDP. B) reduce interest rates, thus stimulating aggregate demand. C) change the government budget deficit in an opposite direction to economic growth.

Answer 40

C) change the government budget deficit in an opposite direction to economic growth Automatic stabilizers are built-in features that tend to automatically promote a budget deficit during a recession and a budget surplus during an inflationary boom, without a change in policy. (Module 12.3, LOS 12.o)

Question 41

An economy is in full-employment equilibrium. If the government unexpectedly decreases the tax rate, the economy is most likely to experience: A) an increase in employment in the short run. B) a decrease in the price level in the short run. C) no change in employment in the short run.

Answer 41

A) an increase in employment in the short run. Short-run equilibrium may occur above full employment, for example as a result of an increase in aggregate demand caused by a decrease in taxes. Both employment and the price level increase in the short run. Above-full employment causes upward pressure on wages that will reduce short-run aggregate supply until, in the long run, output returns to its full-employment level with a still-higher equilibrium price level. (Module 10.3, LOS 10.k)

Question 42

Pat Bannerman is analyzing economic indicators to form an opinion on whether an economic contraction has ended. Which of the following turning points should Bannerman most appropriately interpret as a coincident indicator suggesting economic growth is entering the early stage of a new expansion? A) Real personal income has begun increasing. B) The unemployment rate has begun decreasing. C) Building permits for new houses have begun increasing.

Answer 42

A) Real personal income has begun increasing. Real personal income is a coincident indicator with turning points that tend to coincide with business cycle turning points. The unemployment rate is a lagging indicator, here suggesting an expansion has been underway for some time. Building permits are a leading indicator because builders may seek permits in anticipation of an economic expansion that has not begun yet. (Module 11.2, LOS 11.e)

Question 43

Three years ago, the U.S. dollar/euro exchange rate was 1.32 USD/EUR. Over the last three years, the price level in the United States has increased by 18%, and the price level in the eurozone has increased by 12%. If the current exchange rate is 1.40 USD/EUR, the real exchange rate over the period has: A) increased, and eurozone goods are now more expensive to U.S. consumers. B) decreased, and eurozone goods are now more expensive to U.S. consumers. C) increased, and U.S. goods are now more expensive to eurozone consumers.

Answer 43

A) increased, and eurozone goods are now more expensive to U.S. consumers For the base period, three years ago, the real exchange rate is the same as the nominal exchange rate, 1.32 USD/EUR. The real exchange rate over the period has changed from 1.32 to 1.40 × (112 / 118) = 1.3288. This increase in the real USD/EUR exchange rate indicates that the base currency (EUR) has appreciated in real terms, so that eurozone goods are now more expensive in real terms to U.S. consumers. (Module 15.1, LOS 15.a)

Question 44

As a result of a recent acquisition, Lombard, Inc., has placed the following items on their balance sheet as of the beginning of their fiscal year: Goodwill $30 million Patent $10 million Expires in 10 years. Trademark $15 million Expires in 15 years, renewable at minimal cost. If Lombard amortizes intangible assets using the straight line method, the amortization expense on these assets for the fiscal year will be: A) $1 million. B) $2 million. C) $3 million.

Answer 44

A) $1 million. Goodwill has an indefinite life and is not amortized. A trademark or other intangible asset that has an expiration date but is renewable at minimal cost is treated as having an indefinite life and is not amortized. The patent has a finite life and its cost will be amortized at the rate of $1 million each year over ten years under the straight-line method. (Module 23.2, LOS 23.g)

Question 45

An investment with an initial cost of $30,000 is sold for $60,000 after two years. The annual return on a continuously compounded basis is closest to: A) 35%. B) 38%. C) 40%.

Answer 45

A) 35%. The two-year holding period return is +100%. The effective annual rate is (1 + 1.00)1/2 – 1 = 41.42%. The equivalent annual rate of interest on a continuously compound basis is ln(1.4142) = 34.66%. Alternatively, we can calculate the two-year continuously compounded rate as ln(2) = 69.31% and divide by two to get 34.66%. (Module 4.3, LOS 4.m)

Question 46

A firm uses the first-in first-out (FIFO) cost flow assumption. Compared to gross profit with a periodic inventory system, the firm's gross profit with a perpetual inventory system would be: A) lower. B) higher. C) the same.

Answer 46

C) the same. For a firm using FIFO, gross profit is the same whether the firm uses a periodic or perpetual inventory system. For a firm using LIFO or average cost, gross profit can be different depending on the choice of inventory system. (Module 22.2, LOS 22.c)

Question 47

A permanent difference between pretax and taxable income is least likely to arise when a firm: A) receives tax-exempt interest. B) uses the installment sales method for financial reporting. C) pays premiums on life insurance of key employees.

Answer 47

B) uses the installment sales method for financial reporting. The installment sales method of revenue recognition does not result in permanent differences between pretax and taxable income. Premium payments on life insurance of key employees is an expense on the financial statements, but is not deducted on tax returns. Tax exempt interest is recognized as revenue on the financial statements. These items result in permanent differences between pretax income and taxable income. (Module 24.4, LOS 24.f)

Question 48

Clement Company has revalued an intangible asset with an indefinite life upward by €25 million. In its financial statements, Clement will most likely: A) disclose how it determined the fair value of the intangible asset. B) report lower net income in subsequent periods because of increased amortization expense on the asset. C) report higher assets, net income, and shareholders’ equity in the most recent period than it would have reported under the cost model.

Answer 48

A) disclose how it determined the fair value of the intangible asset. For firms that revalue assets upward, IFRS requires disclosure of the date the asset was revalued, how management determined its fair value, the asset's carrying value using the historical cost model, and (for intangible assets) whether the asset's useful life is finite or indefinite. Although assets and shareholders' equity will increase as a result of the revaluation, net income will not increase. The increase in the value of the asset is reported as a revaluation surplus in shareholders' equity. Amortization expense will not increase because indefinite-lived intangible assets are not amortized. (Module 23.4, LOS 23.l)

Question 49

An investment manager wants to select three analysts from a group of six analysts to receive first-, second-, and third-place awards for outstanding performance. In how many ways can the investment manager make the three awards? A) 20 ways. B) 54 ways. C) 120 ways.

Answer 49

C) 120 ways. When order of selection matters, as it does here, use the permutation formula: nPr=n!(n−r)! nPr = 6! / (6 – 3)! = (6 × 5 × 4 × 3 × 2 × 1) / (3 × 2 × 1) = (6 × 5 × 4) = 120

Question 50

A researcher has data on the 20 largest firms in each state and samples the data by choosing 20 states at random and then selecting 10 firms at random from each of the samples. Her sampling method is referred to as: A) cluster sampling B) convenience sampling. C) stratified random sampling.

Answer 50

A) cluster sampling. The procedure described is an example of two-stage cluster sampling. With stratified random sampling, all subsets of the data (all states) would be included, and random samples would be selected from each. Convenience sampling is based on the low cost or easy availability of the data used.

Question 51

In a period of rising prices, management of a company that reports under IFRS is least likely to attempt to influence analysts' opinions of its financial results by: A) liquidating inventory. B) increasing the useful lives of assets. C) emphasizing earnings that exclude nonrecurring costs.

Answer 51

A) liquidating inventory. During periods of rising prices, liquidating inventory is a potential way for companies that use the LIFO inventory cost method to report higher current-period earnings, but LIFO is not permitted under IFRS. Managers attempting to influence analysts' opinions may manipulate accounting assumptions or emphasize non-GAAP measures in their financial reports. (Module 26.3, LOS 26.i)

Question 52

Which is the correct test statistic for a test of the null hypothesis that a population variance is equal to a chosen value? A) F-statistic. B) t-statistic. C) Chi-square statistic.

Answer 52

C) Chi-square statistic. This is a test of the value of a single variance and is based on a test statistic with a performed via the chi-square distribution. (Module 6.4, LOS 6.j)

Question 53

Yamaska Mining issued a 5-year, $50 million face, 6% semiannual bond when market interest rates were 7%. The market yield of the bonds was 8% at the beginning of the next year. Using the effective interest rate method, what is the initial balance sheet liability, and what is the interest expense that the company should report for the first half of the second year of the bond's life (the third semiannual period)? Initial liability Interest expense, first half of year 2 A) $47,920,849 $1,689,853 B) $47,920,849 $1,750,000 C) $50,000,000 $1,500,000

Answer 53

A) $47,920,849 $1,689,853 This is a discount bond since the market interest rate at issuance exceeds the coupon rate. The initial liability is equal to the proceeds received when the bond was issued. We can find this amount from the following calculation: FV = 50,000,000; N = 10; I = 3.5; PMT = 1,500,000; CPT → PV = $47,920,848.67. Change N to 8 and calculate PV to get liability value at the beginning of the second year of the bond's life, 48,281,511. Interest expense for the next semiannual period is 48,281,511(0.035) = $1,689,853. The subsequent change in the market rate has no effect on the amortization of the discount. (Module 25.2, LOS 25.b)

Question 54

A financial firm employs machine learning to model its risk exposures. The machine identifies a number of risk relationships in the input data, but the firm's management believes some of these relationships are spurious. If so, it is most likely that the model: A) exhibits overfitting. B) treats true parameters as noise. C) is not complex enough to describe the data.

Answer 54

A) exhibits overfitting. Spurious relationships and patterns are likely to result from overfitting, which describes a model that is too complex and treats noise as true parameters. (Module 68.1, LOS 68.c)

Question 55

Under Modigliani and Miller's assumptions and with no taxes, the value of a firm is: A) unaffected by its capital structure. B) maximized with an all-debt capital structure. C) maximized with an all-equity capital structure.

Answer 55

A) unaffected by its capital structure. Under Modigliani and Miller's assumptions, in the absence of taxes a firm's capital structure does not affect its value. If taxes exist while the rest of their assumptions hold, Modigliani and Miller conclude a firm would finance itself entirely with debt to maximize its value.

Question 56

The type of short-term financing for which the financing cost is most closely tied to the creditworthiness of a firm's customers is: A) factoring. B) issuing commercial paper. C) an uncommitted line of credit.

Answer 56

A) factoring. Factoring refers to the sale of receivables without recourse; that is, the risk that the firm's customers will not pay, or will not pay in a timely manner, is borne by the factor, who purchases the receivables. Thus, the amount the factor will pay per dollar of receivables is lower (higher discount or interest rate) if the credit quality of the firm's credit customers is lower. The cost of issuing commercial paper or borrowing on a line of credit is more closely tied to the creditworthiness of the borrowing firm itself. (Module 32.1, LOS 32.a)

Question 57

Smith Company's earnings per share are more sensitive to changes in operating income than are those of Jones Company. This implies that Smith Company has a higher degree of: A) total leverage. B) financial leverage. C) operating leverage.

Answer 57

B) financial leverage. The degree of financial leverage (DFL) is the percent change in earnings per share for a given percent change in operating income. The degree of operating leverage (DOL) is the percent change in operating income for a given percent change in sales. The degree of total leverage (DTL) is the percent change in earnings per share for a given percent change in sales, and is the product of DOL and DFL. Based on the information given, Smith has a higher DFL than Jones, but we cannot conclude that Smith has a higher DTL than Jones. (Module 35.1, LOS 35.b)

Question 58

A portfolio is invested 30% in Asset X with the remainder invested in Asset Y. Asset X has an expected return of 6% and variance of returns of 0.031, while Asset Y has an expected return of 7% and variance of returns of 0.045. The covariance between the returns of the two assets is 0.03735. The standard deviation of returns for the portfolio is closest to: A) 18%. B) 20% C) 22%.

Answer 58

B) 20%. The correlation between the returns of the two assets is: CovAB/σXσY = 0.03735/√0.031×√0.045= 1 Therefore, the standard deviation of the portfolio returns is a weighted average of the standard deviations of returns for the two assets: 0.3√0.031 + 0.7√0.045 = 20.13% Since the correlation of returns is +1, there are no diversification benefits

Question 59

The risk-free rate is 5% and the expected market risk premium is 10%. A portfolio manager is projecting a return of 20% on a portfolio with a beta of 1.5. After adjusting for its systematic risk, this portfolio is expected to: A) equal the market’s performance B) outperform the market. C) underperform the market.

Answer 59

A) equal the market’s performance. Based on the CAPM, the portfolio should earn: E(R) = 0.05 + 1.5(0.10) = 20%. On a risk-adjusted basis, this portfolio lies on the security market line (SML) and thus is earning a risk-adjusted rate of return equivalent to that of the market portfolio.

Question 60

Which of the following investments is least likely to be evaluated using traditional capital allocation analysis? Investing: A) $100 million for the research and development of new paint products. B) $200 million in equipment to reduce carbon output rather than pay daily fines. C) $75 million to expand production and sales into a neighboring country.

Answer 60

A) $100 million for the research and development of new paint products. Some research and development projects may involve such a high degree of risk that they are very difficult to evaluate using traditional capital budgeting methods. Replacement projects and mandatory environmental projects can typically be evaluated with the usual capital budgeting techniques.

Question 61

A manager states that the objectives of a firm's risk management process should be to: - Identify the firm's risk tolerance. - Identify and measure risks faced by the organization. - Minimize or eliminate these risks. Which of these objectives is least appropriate in a risk management process? A) Identifying risk tolerance. B) Identifying and measuring risks. C) Minimizing or eliminating risks.

Answer 61

C) Minimizing or eliminating risks. Not all risks should be minimized or eliminated. A firm might choose to increase its exposure to some identified risks if it can profit from its ability to manage them.

Question 62

A company is most likely to be viewed as having poor liquidity, compared to its industry, if it has a: A) low current ratio. B) low days of payables C) high debt-to-equity ratio.

Answer 62

A) low current ratio. The current ratio, CA/CL, is a primary measure of liquidity. The debt-to-equity ratio is primarily a measure of a company's solvency and financial risk, not liquidity. Low days of payables indicate the company pays it suppliers sooner than other firms, not necessarily that is has poor liquidity.

Question 63

Which of the following project analysis decisions most likely represents a common capital allocation pitfall? A) Comparing mutually exclusive projects based on their net present values. B) Incorporating competitors’ likely responses to the launch of a new product. C) Including a standard allocation of administrative overhead in the initial cost

Answer 63

C) Including a standard allocation of administrative overhead in the initial cost Only incremental overhead costs related to a project should be included in the analysis. Comparing mutually exclusive projects based on NPV is appropriate, as is incorporating competitors' expected economic responses into the project analysis.

Question 64

Analysts typically consider a company's interest coverage ratio to be a warning about its ability to repay debt if the ratio is: A) less than two. B) greater than three. C) increasing over time.

Answer 64

A) less than two. Many analysts consider it a warning sign about a company's ability to repay debt if its interest coverage ratio is less than two.

Question 65

Timely Taxis, Ltd. has signed a long-term lease for 20 underground parking spots at $150 each per month for its fleet of taxis. The firm currently has 18 taxis in operation and is performing an NPV analysis on the purchase of a 19th taxi. The cost of parking for the 19th taxi is best described as: A) a sunk cost. B) an opportunity cost. C) an incremental cost.

Answer 65

A) a sunk cost. The 19th space is neither an incremental cost, nor an opportunity cost or a type of cannibalization. It is a sunk cost since the firm has already committed to parking for 20 taxis. The cost of the 19th parking space is not directly relevant to the capital allocation decision.

Question 66

Which of the following types of institutions is most likely to have the lowest risk tolerance? A) Commercial bank. B) College endowment. C) Mutual fund company.

Answer 66

A) Commercial bank. Banks typically need to maintain excess reserves in order to meet regulatory requirements. As a result, a bank must invest in assets that are more conservative than those invested by other types of financial institutions. An endowment will usually have significant long-term spending requirements in addition to its current expenses. Thus, a college endowment should accept higher risk in order to attain the returns indicated by its mandate. A mutual fund company may invest in many types of securities depending on the type of funds being managed. Investments may range from conservative money market funds to more aggressive derivatives. Therefore, a mutual fund company's level of risk tolerance may be greater than or less than those of a bank or endowment

Question 67

Wreathfield, Inc., is choosing between two mutually exclusive projects. The cash flows for the two projects are below. The firm has a cost of capital of 12%, and the risk of the projects is equivalent to the average risk of the firm. 0 1 2 3 4 5 6 Project J: –12,000 4,000 5,000 6,000 Project K: –20,000 3,000 3,000 3,000 5,000 8,000 8,000 Wreathfield should accept: A) Project J. B) Project K. C) Neither project J nor project K.

Answer 67

C) Neither project J nor project K The firm should reject both projects.

Question 68

Consider three firms of approximately equal size: - Brinde is a retailer that owns its shops and sells primarily on credit. - Enbird is a regional airline that leases its aircraft and service facilities. - Ribden is a magazine publisher that takes advance payments for subscriptions. Based only on this information, which of these firms is likely to have the greatest capital needs? A) Brinde. B) Enbird. C) Ribden.

Answer 68

A) Brinde. Other things equal, a firm that owns its assets and extends credit to customers will have a greater need for capital compared to firms that operate using an asset-light model (Enbird) or a pay-in-advance model (Ribden).

Question 69

Appeal, Inc. has sold only one bond issue, $10 million face value of 20-year debt that pays annual interest at a rate of 6%, at a YTM of 6.5%. Appeal's management is evaluating a project that would require the issuance of another $10 million face value of debt. If the new bond has a 7.0% coupon and can be sold with a YTM of 7.5%, the pre-tax cost of debt that Appeal's management should use in evaluating the project is: A) 6.5%. B) 7.0%. C) 7.5%.

Answer 69

C) 7.5%. The appropriate pre-tax cost of debt is the required yield on newly issued debt to be issued.

Question 70

An analyst gathered the following data about three stocks: Stock Beta Estimated Return A 1.5 18.1% B 1.1 15.7% C 0.6 12.5% If the risk-free rate is 8%, and the market risk premium is 7%, the analyst is least likely to recommend buying: A) Stock A. B) Stock B. C) Stock C.

Answer 70

A) Stock A. Stock A: kA = 8% + 1.5(7%) = 18.5%. Because the estimated return of 18.1% is less than the required return of 18.5%, Stock A is overvalued. Stock B: kB = 8% + 1.1(7%) = 15.7%. Because the estimated return of 15.7% equals the required return of 15.7%, Stock B is properly valued. Stock C: kC = 8% + 0.6(7%) = 12.2%. Because the estimated return of 12.5% is greater than the required return of 12.2%, Stock C is undervalued.

Question 71

An analyst gathered the following data about three stocks: Stock Beta Estimated Return A 1.5 18.1% B 1.1 15.7% C 0.6 12.5% If the risk-free rate is 8%, and the market risk premium is 7%, the analyst is least likely to recommend buying: A) Stock A. B) Stock B. C) Stock C.

Answer 71

A) Stock A. Stock A: kA = 8% + 1.5(7%) = 18.5%. Because the estimated return of 18.1% is less than the required return of 18.5%, Stock A is overvalued. Stock B: kB = 8% + 1.1(7%) = 15.7%. Because the estimated return of 15.7% equals the required return of 15.7%, Stock B is properly valued. Stock C: kC = 8% + 0.6(7%) = 12.2%. Because the estimated return of 12.5% is greater than the required return of 12.2%, Stock C is undervalued.

Question 72

Which of the following equity securities is most likely to have a beta greater than one? A) Utility stock. B) Health care stock. C) Homebuilder stock.

Answer 72

C) Homebuilder stock. Stocks of cyclical firms, such as homebuilders, tend to have high systematic risk (i.e., high beta). Stocks of noncyclical firms, such as utility or health care companies, tend to respond less to changes in systematic risk factors (i.e., they have low betas).

Question 73

A firm that uses the public markets for all of its financing has the following securities outstanding: Book value Market value Equity securities $35 million $70 million Debt securities $25 million $30 million If an analyst assumes these data reflect the firm's target capital structure, he should estimate that its target weight of debt financing is closest to: A) 26%. B) 30%. C) 43%.

Answer 73

B) 30%. An analyst should use market values, not book values, to estimate the weights of debt and equity in a firm's target capital structure. Here, the weight of debt based on market values is 30 / (30 + 70) = 30%

Question 74

If the availability of a physical commodity over the period of a forward contract has value to users of the commodity, the commodity is said to provide: A) storage yield. B) economic yield. C) convenience yield

Answer 74

C) convenience yield. Convenience yield is the value of a physical commodity being available for use over the period of a forward contract.

Question 75

An analyst determines that a company has a return on equity of 16% and pays 40% of its earnings in dividends. If the firm recently paid a $1.50 dividend and the stock is selling for $40, what is the required rate of return on the stock if it is priced according to the dividend discount model? A) 9.6%. B) 10.2%. C) 13.7%.

Answer 75

C) 13.7%. g = (1 − payout)(ROE) = (1 − 0.40)(16%) = 9.6% k = $1.50(1.096)/$40 + 0.096= 13.7%

Question 76

A 7.5% coupon, semiannual-pay, five-year bond has a yield to maturity of 6.80%. Over the next year, if the bond's yield to maturity remains unchanged, its price will: A) increase B) decrease. C) remain unchanged.

Answer 76

B) decrease. Because the coupon rate is greater than its yield to maturity, the bond price is at a premium to par value. If the yield remains unchanged, the price will decrease toward par value along its constant-yield price trajectory

Question 77

A securities market exhibits operational efficiency if it offers: A) low transaction costs B) prices that respond rapidly to new information. C) rates of return that are proportional to risk on average.

Answer 77

A) low transaction costs. Operational efficiency refers to low transactions costs in a securities market. Informational efficiency means prices change rapidly to reflect new information without predictable bias and rates of return are, on average, proportional to risk.

Question 78

Other things equal, the value of a long position in a forward contract priced at F(0)T will most likely be higher during its life at time t if the: A) risk-free rate is higher. B) costs of holding the underlying are lower. C) benefits of holding the underlying are higher.

Answer 78

A) risk-free rate is higher. During its life value of a forward contract is: [St + PVt (costs of holding) – PVt (benefits of holding)] – F(0)T × (1 + Rf)–(T – t). A higher risk-free rate will increase the value of a long forward position during its life. Lower costs or higher benefits from holding the underlying will decrease the value of a long forward position

Question 79

An investor buys a stock for $50. The initial margin requirement is 50%, and the maintenance margin requirement is 25%. The price below which the investor would receive a margin call would be: A) $25.00. B) $33.33. C) $37.50.

Answer 79

B) $33.33. The following formula indicates the stock price that will trigger a margin call: long =(original price)(1−initial margin %)/ 1−maintenance margin =($50)(1−0.50)/1−0.25=$33.33 An intuitive way to solve minimum margin problems for equity accounts is based on the fact that while the margin amount changes with stock price changes after purchase, the loan amount does not. Stock price is $50, loan is $25, when the margin is 25% the loan must be 75% (of share price). $25 / 0.75 = $33.33.

Question 80

Pat McCoy is analyzing a technology firm that has experienced annual earnings growth of 12%. McCoy does not expect the firm to begin paying dividends on its common shares in the foreseeable future. To estimate the value of this firm's common shares, McCoy should most appropriately use: A) a two-stage DDM. B) a free cash flow model. C) a Gordon growth model.

Answer 80

B) a free cash flow model. Free cash flow-based valuation techniques are appropriate for valuing shares of a firm that does not pay dividends. The Gordon growth model and two-stage dividend discount model are appropriate for valuing shares of dividend-paying firms.

Question 81

Portfolio duration most accurately approximates the sensitivity of the value of a bond portfolio to: A) parallel shifts in the yield curve. B) increases in the slope of the yield curve. C) decreases in the slope of the yield curve.

Answer 81

A) parallel shifts in the yield curve Portfolio duration is an approximation of the price sensitivity of a portfolio to parallel shifts of the yield curve (yields for all maturities increase or decrease by equal amounts). Key rate duration may be used to estimate interest rate risk for non-parallel shifts in the yield curve.

Question 82

A university endowment commits $80 million to Lawson Private Capital Fund. Lawson charges a 1% management fee per year and incentive fees of 20% on all gains, and has an American-style waterfall structure with no clawback. Lawson draws down the endowment's capital to invest in the following portfolio companies: Portfolio company Investment Cash received on exit Adams $20 million in Year 1 $30 million in Year 3 Borland $25 million in Year 2 $45 million in Year 4 Chambers $30 million in Year 3 $20 million in Year 5 At the end of Year 5, the investor's total gain after fees is closest to: A) $10 million. B) $12 million. C) $14 million.

Answer 82

A) $10 million. The increase in value over the five years is (30 + 45 + 20) – (20 + 25 + 30) = $20 million. Management fees are a percentage of committed capital: 1% × $80 million × 5 years = $4 million. With an American-style waterfall structure, incentive fees are calculated on a deal-by-deal basis. Lawson would receive 20% of ($30 million – $20 million) = $2 million on the Adams investment and 20% of ($45 million – $25 million) = $4 million on the Borland investment, and no incentive fees on the Chambers investment, for a total of $6 million. Total fees over the five years are $4 million + $6 million = $10 million, and the investor's gain after fees is $20 million – $10 million = $10 million

Question 83

A firm is said to have a top-heavy capital structure if a high percentage of its total capital is: A) debt. B) short-term debt. C) secured bank debt.

Answer 83

C) secured bank debt. "Top-heavy" refers to a capital structure that includes a high percentage of secured bank debt. A firm with a top-heavy capital structure may be limited in its access to additional bank borrowing, which increases the likelihood of default if the firm encounters financial distress.

Question 84

An 8%, semiannual pay, option-free corporate bond that is selling at par has ten years to maturity. What is the approximate modified duration of the bond based on a 75 basis point change (up or down) in rates? A) 5.6. B) 6.8. C) 7.2.

Answer 84

B) 6.8 First calculate V− and V+, the bond's value at 7.25% and 8.75% yields to maturity. The bond values are $1,052.70 and $950.69, respectively: N = 20; I/Y = 7.25 / 2 = 3.625; PMT = 40; FV = 1,000; CPT PV = −1,052.70 N = 20; I/Y = 8.75 / 2 = 4.375; PMT = 40; FV = 1,000; CPT PV = −950.69 D =V− − V+/2V0(Δy) =1,052.70−950.69/2(1,000)(0.0075)=6.8.

Question 85

During the life of an option, the amount by which its price is greater than its exercise value is most accurately described as its: A) time value. B) moneyness. C) intrinsic value.

Answer 85

A) time value. Before expiration, an option can have a price greater than its exercise or intrinsic value. This amount by which an option's price is greater than its exercise value is referred to as its time value

Question 86

A bond with nine years to maturity is quoted at an interpolated spread of +150 basis points. The benchmark yield for this bond is: A) a swap rate. B) a matrix rate. C) a government bond yield.

Answer 86

A) a swap rate Interpolated spreads (I-spreads) are spreads to swap rates.

Question 87

An investor purchases 1,000 shares of each of the stocks in a price-weighted index at their closing prices (ignore transactions costs). On a total return basis, if the index stocks remain the same, this portfolio will most likely: A) perform exactly like the index over time. B) outperform the index over time. C) underperform the index over time.

Answer 87

B) outperform the index over time. Total return includes dividend yield. Because dividends are not included in the performance of the index itself, the portfolio will outperform the index by the amount of the dividend yield.

Question 88

Among valuation models, the difficulty of estimating a required rate of return is most likely to be a disadvantage of using: A) a Gordon growth model. B) an asset-based valuation model. C) an enterprise value multiplier model.

Answer 88

A) a Gordon growth model. One of the disadvantages of present value models such as the Gordon growth model is that the required rate of return on equity must be estimated. Neither an enterprise value multiplier model nor an asset valuation model requires an explicit estimate of the required rate of return.

Question 89

Consider two option-free, 5% annual-pay bonds from the same issuer and with the same seniority. One of the bonds has a modified duration of 3.5 and approximate convexity of 15. The other has a modified duration of 8.5 and approximate convexity of 75. Can the lower-duration bond have more price volatility than the higher-duration bond? A) No, because it also exhibits lower convexity. B) Yes, because shifts in the yield curve may be non-parallel. C) No, because its price will respond relatively less in response to changes in yield.

Answer 89

B) Yes, because shifts in the yield curve may be non-parallel. Duration-based estimates of bond value changes assume the yield curve shifts in a parallel manner. If instead short-term interest rates are more volatile than long-term interest rates, it is possible for a bond with lower duration to have more price volatility than a bond with higher duration.

Question 90

Which of the following portfolios has the same future cash flows as a put option? A) Long call option, long risk-free bond, short underlying asset. B) Long call option, short risk-free bond, long underlying asset. C) Short call option, long risk-free bond, long underlying asset.

Answer 90

A) Long call option, long risk-free bond, short underlying asset. Using the put-call parity relationship, a synthetic put option can be created by combining a long call option with the same exercise price and expiration date, a short position in the underlying asset, and a long position in a risk-free bond that pays the exercise price on the expiration date.

Question 91

Compared to a recourse mortgage loan, a nonrecourse mortgage loan: A) is likely to have a higher interest rate. B) is less likely to be purchased by a government agency. C) is issued with less strict standards for a borrower’s credit history.

Answer 91

A) is likely to have a higher interest rate. In the event of a default, a borrower with a nonrecourse loan is not liable for the loan amount, the property is simply returned to the lender. With a nonrecourse loan, the lender has more risk in the event of default so interest rates will be higher. Even without recourse, the creditworthiness of a borrower is a primary concern to originators of residential mortgage loans. (Module 45.1, LOS 45.d)

Question 92

A 10-year note issued by Gaullic Finance will be paid from a bankruptcy-remote pool of Gaullic's balance sheet assets. These notes are best described as: A) covered bonds. B) securitized bonds. C) asset-backed bonds.

Answer 92

A) covered bonds. Covered bonds are an obligation of the corporation that issues them, but their interest and principal payments are provided by a pool of assets that are legally recognized as bankruptcy remote. They are different from securitized bonds (i.e., asset-backed securities), which are issued by a special purpose entity to which the underlying assets are sold.

Question 93

Returns calculated from which type of real estate index are most likely to have the lowest standard deviation? A) REIT index. B) Appraisal index. C) Repeat sales index.

Answer 93

B) Appraisal index. Valuations based on appraisals tend to smooth returns compared to using market-based valuations. As a result, returns based on an appraisal index are likely to have a lower standard deviation than returns based on a repeat sales index or a REIT index.

Question 94

An analyst gathered the following data about a company: The historical earnings retention rate of 40% is projected to continue into the future. The sustainable ROE is 12%. The stock's beta is 1.2. The nominal risk-free rate is 6%. The expected market return is 11%. If the analyst believes next year's earnings will be $4 per share, what value should be placed on this stock? A) $22.24. B) $33.32. C) $45.45.

Answer 94

B) $33.32. Dividend payout = 1 − earnings retention rate = 1 − 0.4 = 0.6 RS = Rf + β(RM − Rf) = 0.06 + 1.2(0.11 − 0.06) = 0.12 g = (retention rate)(ROE) = 0.4(0.12) = 0.048 P/E=dividend payout ratio/k−g =0.6/0.12−0.048= 8.33 Price = E(P/E) = $4(8.33) = $33.32

Question 95

The type of equity depository receipt that gives its owners the right to vote and receive dividends from a company's shares is best described as: A) a global depository receipt. B) a sponsored depository receipt. C) a fully-owned depository receipt.

Answer 95

B) a sponsored depository receipt. The owner of a sponsored DR share has the same voting rights and receives the same dividends as the owner of a common share of the firm. With an unsponsored DR, the depository bank retains the voting rights. A global depository receipt may be sponsored or unsponsored

Question 96

Consider the following Treasury spot rates expressed as bond equivalent yields: Maturity Spot Rate 6 months 3.0% 1 year 3.5% 1.5 years 4.0% 2 years 4.5% If a Treasury note with two years remaining to maturity has a 5% semiannual coupon and is priced at $1,008, the note is: A) overpriced. B) underpriced. C) correctly priced.

Answer 96

B) underpriced. The market value of the Treasury note is the present value of the remaining coupons plus the present value of the principal, discounted at the semiannual rates available from dividing each annual spot rate in the table by two. value of T-note =$25/(1.015) + $25/(1.0175)2 + $25/(1.02)3 + $1,025/(1.0225)4 =$1,010.05 At $1,008, the T-note is priced below the present value of its cash flows ($1,010) and is therefore underpriced.

Question 97

Ron Egan classifies firms in the transportation industry in peer groups that include airlines and bus operators. Egan learns that one of the airlines, Acme, derives half its revenue from its Acme Bus Lines subsidiary. Egan adds Acme to his peer group for bus operators while continuing to include Acme in his peer group for airlines. Is Egan's treatment of Acme appropriate? A) Yes. B) No, because each company should be included in only one peer group. C) No, because the bus operations are not the company’s principal business activity.

Answer 97

A) Yes. Peer groups should include comparable companies with similar business activities. An analyst can appropriately include a company in multiple peer groups if the company's business activities are comparable to firms in more than one peer group.

Question 98

Which of the following is a disadvantage to bondholders if a bond has a sinking fund provision? A) Lower credit quality. B) Unfavorable tax status. C) Greater reinvestment risk.

Answer 98

C) Greater reinvestment risk. Reinvestment risk is a disadvantage of a sinking fund provision. Some bondholders will be repaid the bond principal earlier than the maturity date. If interest rates have declined since they bought the bonds, these bondholders will only be able to reinvest the returned principal at a lower rate of return. A sinking fund provision increases the credit quality of an issue and typically does not affect a bond's taxable status.

Question 99

The change in the intrinsic value of a firm's common stock resulting from an increase in ROE most likely: A) increases the stock’s intrinsic value. B) decreases the stock’s intrinsic value. C) depends on the reason for the increase in ROE.

Answer 99

C) depends on the reason for the increase in ROE While an increase in a firm's ROE due to a sharp increase in earnings will, if unexpected, lead to an increase in the intrinsic value of its shares, an increase in a firm's ROE due to the repurchase of stock with debt will not necessarily increase the intrinsic value of the firm's shares, as any increase in ROE may be offset by an increase in the risk inherent in the firm's shares.

Question 99

The change in the intrinsic value of a firm's common stock resulting from an increase in ROE most likely: A) increases the stock’s intrinsic value. B) decreases the stock’s intrinsic value. C) depends on the reason for the increase in ROE.

Answer 99

C) depends on the reason for the increase in ROE While an increase in a firm's ROE due to a sharp increase in earnings will, if unexpected, lead to an increase in the intrinsic value of its shares, an increase in a firm's ROE due to the repurchase of stock with debt will not necessarily increase the intrinsic value of the firm's shares, as any increase in ROE may be offset by an increase in the risk inherent in the firm's shares.

Question 100

For a bond currently priced at $1,018 with an effective duration of 7.48, if the market yield moved down 75 basis points, the new price would be approximately: A) $961. B) $1,075. C) $1,094.

Answer 100

B) $1,075. %Δprice ≈ –7.48(–0.0075) = 0.0561 $1,018(1 + 0.0561) = $1,075.11

Question 101

A public offering of bonds issued over a period of time is most accurately described as: A) a serial structure. B) a shelf registration. C) a waterfall structure.

Answer 101

B) a shelf registration. In a shelf registration, an entire issue is registered with securities regulators but the bonds are sold to the public over a period of time as the issuer needs to raise funds. In a serial bond issue, bonds with multiple maturity dates are issued at the same time. A waterfall structure is issued in tranches with differing priority of claims

Question 102

ompared to an index of 100 U.S. exchange-traded stocks, an index of 100 U.S. government and corporate bonds will most likely: A) reflect equally timely price data. B) be more difficult to build and maintain. C) have less turnover among the securities in the index.

Answer 102

B) be more difficult to build and maintain. Bond indexes are more difficult to build and maintain than stock indexes for several reasons. Bonds in an index have to be replaced as they mature, so turnover is likely to be greater in a bond index than in a stock index. Many bonds lack the continuous trade data that exists for exchange-traded equities

Question 103

The minimum data required to calculate the implied forward rate for three years beginning three years from now is: A) the 3-year and 6-year spot rates. B) the 4-year, 5-year, and 6-year spot rates. C) spot rates at 1-year intervals for the 6-year period.

Answer 103

A) the 3-year and 6-year spot rates. If we want the 3-year forward rate in three years, the appropriate formula is: see book S6 = 6-year spot rate and S3 = 3-year spot rate.

Question 104

An industry in the growth phase of the industry life cycle is most likely to experience: A) increasing prices. B) increasing profitability. C) intense competition among competitors.

Answer 104

B) increasing profitability. An industry in the growth stage is usually characterized by increasing profitability, decreasing prices, and a low degree of competition among competitors.

Question 105

Which of the following provisions is least likely to benefit the limited partners in a private equity fund? A) High hurdle rate. B) Catch-up clause. C) Whole-of-fund waterfall structure.

Answer 105

B) Catch-up clause. Catch-up clauses benefit the general partners, allowing them to collect all gains after the hurdle rate is met until they have collected their specified incentive percentage of the initial gains. A high hurdle rate benefits the limited partners because they do not pay incentive fees until the hurdle rate is met. A whole-of-fund waterfall structure is more favorable to limited partners than a deal-by-deal waterfall structure.

Question 106

Consider an investor who has sold a cash-settled call option at $39 on 100 shares of General Industry at a price of $5. If the share price is $41 at expiration, the investor will have a: A) loss of $300. B) profit of $300. C) payoff of $300.

Answer 106

B) profit of $300. The investor will receive $500 from the sale of the call and must pay 100 × (39 – 41) = –$200 at expiration for a profit of $300.

Question 107

Acquire Corp. has a business model based on making accretive acquisitions each year. The company has historically been successful in implementing its strategy. Earnings per share have grown each of the last five years at a 15% compounded rate. Acquire's two primary business segments are engineering construction and mining. During the past year, Acquire purchased a services company with large net operating losses. The purchase price was one-half the company's current market value. The most appropriate technique to value Acquire is based on its: A) price-to-book value ratio. B) forward price-to-earnings ratio. C) trailing price-to-sales ratio.

Answer 107

B) forward price-to-earnings ratio. The new acquisition has likely changed the nature of Acquire's business so that historical information is not as relevant to the investment decision-making process. The most appropriate earnings multiple for analyzing Acquire is the forward price-to-earnings ratio.

Question 108

A 60-day forward rate agreement (FRA) on a 60-day market reference rate has a fixed rate of 6%. If, at the initiation of the contract, the market reference rate is 5%, the payment in 60 days: A) is unknown. B) will be received by the long position. C) will be received by the short position.

Answer 108

A) is unknown. The payment on an FRA is unknown until the settlement date of the forward, when the future 60-day market reference rate is known.

Question 109

3-year, 6% coupon, semiannual-pay note has a yield to maturity of 5.5%. If an investor holds this note to maturity and earns a 4.5% return on reinvested coupon income, his realized yield on the note is closest to: A) 5.46%. B) 5.57%. C) 5.68%.

Answer 109

A) 5.46% This question does not require calculations. Because the return on reinvested coupon interest is less than the note's yield to maturity, the investor's realized yield on the note must be less than the YTM. Only Choice A can be correct.

Question 110

Public-private partnerships are most likely to be a vehicle for investing in: A) tangible collectibles. B) distressed securities. C) greenfield infrastructure.

Answer 110

C) greenfield infrastructure. Public-private partnerships are a vehicle for investing in infrastructure.

Question 111

Liquidity is generally supplied by dealers in: A) a brokered market. B) an order-driven market. C) a quote-driven market.

Answer 111

C) a quote-driven market. Liquidity is generally supplied by dealers in a quote-driven market, by other traders in an order-driven market, and by brokers (who arrange the trades) and traders in a brokered market.