Mock 7

Question 1

With respect to issuer-paid research, members are not required to:

strictly limit the type of compensation they accept from the covered company.

fully disclose the nature of compensation received from the covered company.

accept compensation related only to investment performance of the covered company.

Answer 1

accept compensation related only to investment performance of the covered company.

C is correct because according to Standard I (B), Independence and Objectivity, “independent analysts must also strictly limit the type of compensation that they accept for conducting issuer-paid research. Otherwise, the content and conclusions of the reports could reasonably be expected to be determined or affected by compensation from the sponsoring companies. Compensation that might influence the research report could be direct, such as payment based on the conclusions of the report, or indirect, such as stock warrants or other equity instruments that could increase in value on the basis of positive coverage in the report. In such instances, the independent analyst has an incentive to avoid including negative information or making negative conclusions.”

Question 2

According to the Standard relating to additional compensation arrangements, a member must not accept a benefit offered by a third party that might create a conflict of interest with his employer’s interest unless he obtains written consent:

only from his employer.

only from the third party offering the benefit.

both from his employer and from the third party offering the benefit.

Answer 2

both from his employer and from the third party offering the benefit.

C is correct because according to Standard IV (B), Additional Compensation Arrangements, “Members and Candidates must not accept gifts, benefits, compensation, or consideration that competes with or might reasonably be expected to create a conflict of interest with their employer’s interest unless they obtain written consent from all parties involved.” Therefore, the member is required to obtain consent from the employer and from the third party.

Question 3

Yun Hae, CFA, is a portfolio manager at Citadel Capital (CC). Hae’s brother maintains a fee-paying retirement account at CC. Hae has no beneficial ownership in her brother’s account. Whenever an IPO becomes available that is suitable for her clients, Hae first allocates shares to other clients before placing any remaining shares in her brother’s account. She adopts this procedure to avoid potential conflicts of interest. Hae’s actions violate the Standard(s) relating:

only to fair dealing.

only to priority of transactions.

both to fair dealing and to priority of transactions.

Answer 3

both to fair dealing and to priority of transactions.

C is correct because Standard VI(B), Priority of Transactions states that “[i]nvestment transactions for clients and employers must have priority over investment transactions in which a Member or Candidate is the beneficial owner” and “[f]amily accounts that are client accounts should be treated like any other firm account and should neither be given special treatment nor be disadvantaged because of the family relationship.” So, Hae’s actions are not consistent with this Standard. In addition, Hae’s actions are not consistent with Standard III(B), Fair Dealing which states that “[m]embers and Candidates must deal fairly and objectively with all clients when providing investment analysis, making investment recommendations, taking investment action, or engaging in other professional activities.” Further, “[i]f the investment professional’s family-member accounts are managed similarly to the accounts of other clients of the firm, however, the family-member accounts should not be excluded from buying such shares.” So, Hae’s actions are not consistent with this Standard as well.

Question 4

According to the Standard relating to fair dealing, when members disseminate investment recommendations, they are most likely required to make every effort to treat individual clients in a(n):

fair and equal manner.

fair and impartial manner.

equal and impartial manner.

Answer 4

fair and impartial manner.

B is correct because according to Standard III (B), Fair Dealing, “[m]embers and candidates must make every effort to treat all individual and institutional clients in a fair and impartial manner.” Additionally, “[t]he term ‘fairly’ implies that the member or candidate must take care not to discriminate against any clients when disseminating investment recommendations or taking investment action. Standard III(B) does not state ‘equally’ because members and candidates could not possibly reach all clients at exactly the same time..

Question 5

A 12-year old investment firm adopts the GIPS standards. To claim compliance with the GIPS standards, the firm is initially required to present GIPS-compliant performance history:

for at least five years.

for at least ten years.

since the firm’s inception date.

Answer 5

for at least five years.

A is correct because according to GIPS, “A firm is required to initially present, at a minimum, five years of annual investment performance that is compliant with the GIPS standards. If the firm or the composite has been in existence less than five years, the firm must present performance since the firm’s inception or the composite inception date.”

Question 6

A firm claiming compliance with the GIPS standards:

can claim compliance on specific composites.

is responsible for maintaining that compliance.

must have the verification of its claim of compliance performed by an independent third party.

Answer 6

is responsible for maintaining that compliance.

B is correct because according to GIPS standards, “Firms that claim compliance with the GIPS standards are responsible for their claim of compliance and for maintaining that compliance.”

Question 7

A portfolio manager gathers the following information about her fund:
Allocation of corporate bonds 20%
Allocation of bonds that are both corporate and high-yield 10%
If the portfolio manager randomly picks a corporate bond, the probability that the bond is high yield is closest to:

0.02.
0.10.
0.50.

Answer 7

0.50.

C is correct because using the definition of conditional probability P(A | B) = P(AB)/P(B), where P(AB) is the joint probability of A and B and P(B) is the probability of B, then the conditional probability that the portfolio manager randomly picks a high-yield bond, given that it is a corporate bond is equal to P(bond is high yield | corporate bond) = P(bond is high-yield and corporate bond)/P(corporate bond) = 0.1/0.2 = 0.5.

Question 8

An analyst gathers the following information about three portfolios:
Portfolio X Portfolio Y Portfolio Z
Expected annual return 10% 12% 14%
Standard deviation of returns 12% 16% 20%
If the shortfall level is 5%, which portfolio has the largest safety-first ratio?

Portfolio X
Portfolio Y
Portfolio Z

Answer 8

Portfolio Z

C is correct because the safety-first ratio is calculated as SF Ratio = (E(r) – RL)/σp, where E(r) is the expected return, RL is the shortfall level, and σp is the standard deviation. Since the shortfall level RL = 5%, the SF Ratios for the three portfolios are:
Portfolio X: (0.10 – 0.05)/0.12 = 0.417

Portfolio Y: (0.12 – 0.05)/0.16 = 0.438

Portfolio Z: (0.14 – 0.05)/0.20 = 0.450

Therefore, Portfolio Z is the best alternative according to the safety-first criterion.

Question 9

Sampling error is the difference between the observed value of a statistic and the:

mean of the sample.

quantity it is intended to estimate.

observed value of the random variable.

Answer 9

quantity it is intended to estimate.

B is correct because “[s]ampling error is the difference between the observed value of a statistic and the quantity it is intended to estimate as a result of using subsets of the population.”

Question 10

The central limit theorem is best described as stating that the sampling distribution of the sample mean will be approximately normal for large-size samples:

if the population distribution is normal.

for populations described by any probability distribution.

if the population distribution is symmetrical.

Answer 10

for populations described by any probability distribution.

B is correct. The central limit theorem holds without regard for the distribution of the underlying population.

Question 11

Two populations are normally distributed with unknown variances that are assumed to be equal. If a large independent random sample is drawn from each population, the most appropriate test statistic for testing the difference between the population means is the:

t-statistic.

z-statistic.

F-statistic.

Answer 11

t-statistic.

A is correct because, for tests concerning differences between population means, “[w]hen we can assume that the two populations are normally distributed and that the unknown population variances are equal, a t-test based on independent random samples is given by” t = [(X1 – X2) – (μ1 – µ2)]/√(sp2/n1 + sp2/n2), where (X1 – X2) is the difference between the sample means, (μ1 – µ2) is the hypothesized difference between the population means, sp2 is a pooled estimator of the common variance, and n1 and n2 are the corresponding sample sizes.

Question 12

GDP = Consumer spending on goods and services + Business gross fixed investment + Change in inventories + Government spending on goods and services + Government gross fixed investment + Exports – Imports + Statistical discrepancy

Question 13

Which of the following is most likely to cause a shift to the right in the aggregate demand curve?

Boom in the stock market

Increase in taxes

Decrease in real estate values

Answer 13

Boom in the stock market

A is correct. A boom in the stock market increases the value of financial assets and household wealth. An increase in household wealth increases consumer spending and shifts the aggregate demand curve to the right.

Question 14

With respect to the production function approach to analyzing sources of economic growth, total factor productivity best reflects the portion of growth related to:

labor.

capital.

technology.

Answer 14

technology.

C is correct because total factor productivity, representing primarily technological change, “is a scale factor that reflects the portion of growth that is not accounted for by the capital and labor inputs. The main factor affecting TFP is technological change.”

Question 15

In theory, money neutrality holds in the long run if:

the money supply is positively related to the velocity of circulation of money.

increases in the money supply do not influence output and employment.

price levels are unaffected by changes in the money supply.

Answer 15

increases in the money supply do not influence output and employment.

B is correct. The phenomenon of money neutrality states that, in the long run, an increase in the money supply will simply lead to an increase in the price level while leaving real economic variables such as output and employment unaffected.

Question 16

The objective of general purpose financial reporting is best described as:

providing information about financial performance to a wide range of users.

facilitating resource allocation decisions by current and potential investors and creditors.

reporting an entity’s economic resources and claims, and changes therein, to shareholders.

Answer 16

facilitating resource allocation decisions by current and potential investors and creditors.

B is correct. According to the Conceptual Framework for Financial Reporting 2010 within the International Financial Reporting Standards, as well as Concept Statement 8 under US GAAP, “the objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity.”

Question 17

Which of the following best describes a component of the income statement?

Amounts that a company owes its vendors for purchases of goods and services

Outflows or depletions of assets in the course of a business’s activities

Obligations from past events that are expected to result in an outflow of economic benefits

Answer 17

Outflows or depletions of assets in the course of a business’s activities

B is correct. Expenses are a component of the income statement and are defined as outflows, asset depletions, and liabilities incurred in the course of a business’s activities.

Question 18

If practical, retrospective application is required for a change in accounting:

policies only.

estimates only.

policies and estimates.

Answer 18

policies only.

A is correct because “changes in accounting policies (e.g., from one acceptable inventory costing method to another) are made for other reasons, such as providing a better reflection of the company’s performance. Changes in accounting policies are reported through retrospective application unless it is impractical to do so.” Changes in accounting estimates, however, are handled prospectively.

Question 19

An analyst gathers the following information (in ¥ billions) about a company:

Interest received 100
Repurchase of stock 200
Principal repayment of the company’s debt 300
The net cash used for financing activities (in ¥ billions) is:

300.

400.

500.

Answer 19

500.

C is correct because financing “[c]ash outflows include cash payments to repurchase stock (e.g., treasury stock) and to repay bonds and other borrowings…under IFRS, interest received may be classified either as an operating activity or as an investing activity.” Therefore, the cash outflow from financing activities is: Payment for repurchase of stock + Principal repayment of debt = ¥200 million + ¥300 million = ¥500 million.

Question 20

An analyst gathers the following information (in € millions) about a company:
Net income 125
Depreciation expense 22
Interest expensed and paid 20
Capital expenditures 50
Working capital expenditures 25
Dividends declared and paid 11
The income tax rate is 25%. Free cash flow to the firm (in € millions) is:

87.

92.

98.

Answer 20

87.

A is correct because FCFF = 125 + 22 + 20 × ( 1 – 0.25 ) – 50 – 25 = 87. FCFF is calculated as FCFF = NI + NCC + Int × ( 1 – tax rate ) – FCInv – WCInv.

Question 21

An analyst collects the following information about a company:
Net profit margin 4%
Return on average assets 8%
Return on average equity 16%
Revenue €2,500,000
The company’s:

total asset turnover is 4.

financial leverage ratio is 4.

average shareholders’ equity is €625,000.

Answer 21

average shareholders’ equity is €625,000.

C is correct because the company had net profit of €100,000 calculated as revenue × Net profit margin = €2,500,000 × 4% = €100,000. Return on equity = Net profit ÷ Average shareholders’ equity. Therefore, average shareholders’ equity = Net profit ÷ Return on Equity = €100,000 ÷ 16% = €625,000.

Question 22

All else being equal, cash dividends paid to common shareholders result in a:

lower ROA than if no dividends were paid.

higher ROE than if no dividends were paid.

lower net profit margin than if no dividends were paid.

Answer 22

higher ROE than if no dividends were paid

B is correct because ROE = Net income ÷ Average total equity. ““The basic components of owners’ equity are paid- in capital and retained earnings. Retained earnings include the cumulative amount of the company’s profits that have been retained in the company . . . For retained earnings . . . a dividend payment is the most common decrease.” Declaring and paying cash dividends to shareholders does not change net income but reduces retained earnings thus decreases total equity. As a result, ROE will increase compared to no dividends declared and paid.

Question 23

An analyst gathers the following information about a company for its fiscal year:
Net profit margin 8%
Total asset turnover 1.5
Financial leverage 1.2
EPS €0.15
Dividend per common share €0.10
The sustainable growth rate is closest to:

3.2%.

4.8%.

9.6%.

Answer 23

4.8%.

B is correct because the Sustainable growth rate = Retention rate × ROE, where Retention rate = (1 – Payout ratio), and the payout ratio is “the percentage of earnings that the company pays out as dividends to shareholders”, or (EPS – DPS) / EPS, and using the DuPont analysis ROE = Net profit margin × Total asset turnover × Leverage. The retention rate = 1 – (0.10 / 0.15) = 1 – 0.667 = 0.333. ROE = 8% × 1.5 × 1.2 = 0.1440. Substituting into the sustainable growth rate formula: 0.333 × 0.1440 = 0.0480, or 4.8%.

Question 24

The choice of a periodic or a perpetual inventory system could affect ending inventory and cost of sales under the:

FIFO inventory valuation method.

specific identification inventory valuation method.

weighted average cost inventory valuation method.

Answer 24

weighted average cost inventory valuation method

C is correct because “[c]ompanies typically record changes to inventory using either a periodic inventory system or a perpetual inventory system. … Under either system, the allocation of goods available for sale to cost of sales and ending inventory is the same if the inventory valuation method used is either specific identification or FIFO. This is not generally true for the weighted average cost method.”

Question 25

The reversal of an inventory write-down: reduces cost of sales. increases other comprehensive income. is permitted under both IFRS and US GAAP.

Answer 25

reduces cost of sales. A is correct because in each period subsequent to inventory write-down, “a new assessment of net realisable value is made. Reversal (limited to the amount of original write-down) is required for a subsequent increase in value of inventory previously written down. The reversal of any write-down of inventories is recognized as a reduction in cost of sales (reduction in the amount of inventories recognized as an expense).”

Question 26

The following information applies to a capital asset of a company: Year Ending Year 3 Year 2 Year 1 Capital asset €2,500 €2,500 €2,500 Accumulated depreciation 375 250 125 Net book value 2,125 2,250 2,375 This company uses the straight-line depreciation method for this capital asset. At the end of year 3, the expected remaining life of the capital asset, in years, is closest to: 17. 20. 6.

Answer 26

17. A is correct. Based on the annual increase in accumulated depreciation, annual depreciation expense is $125 and the asset was acquired in year 1. Total useful life of the capital asset = 2,500/125 = 20 years Remaining useful life three years later = 20 years – 3 years = 17 years Alternative calculation based on straight-line depreciation with no salvage value: NBV/Depreciation expense = 2,125/125 = 17 years

Question 27

An analyst gathers the following information (in £ thousands) about equipment owned by a company: Carrying amount prior to impairment 36 Fair value 34 Selling costs 4 Undiscounted expected future cash flows 38 Discounted expected future cash flows 32 The equipment is considered impaired under: IFRS only. US GAAP only. both IFRS and US GAAP.

Answer 27

IFRS only. A is correct because “[u]nder IAS 36, an impairment loss is measured as the excess of carrying amount over the recoverable amount of the asset. The recoverable amount of an asset is defined as ‘the higher of its fair value less costs to sell and its value in use.' Value in use is a discounted measure of expected future cash flows. Under US GAAP, assessing recoverability is separate from measuring the impairment loss. An asset's carrying amount is considered not recoverable when it exceeds the undiscounted expected future cash flows. If the asset's carrying amount is considered not recoverable, the impairment loss is measured as the difference between the asset's fair value and carrying amount.” Under IFRS, the impairment loss is the excess of the carrying amount (36) over the higher of fair value less costs to sell (34 – 4 = 30) and its value in use (32), or 4 (36 – 32). Under US GAAP, the carrying amount (36) does NOT exceed the undiscounted expected future cash flows (38) so the equipment is not considered impaired.

Question 28

If a fixed-rate bond is issued at a premium and carried at amortized historical cost, the: annual interest expense increases over the bond's lifetime. interest expense is less than the interest paid over the bond's lifetime. market interest rate at issuance is higher than the coupon rate of the bond.

Answer 28

interest expense is less than the interest paid over the bond's lifetime. B is correct because “[f]or bonds issued at a premium to face value, the carrying amount of the bonds is initially greater than the face value. As the premium is amortised, the carrying amount (amortised cost) of the bonds will decrease to the face value. The reported interest expense will be less than the coupon payment.”

Question 29

Which of the following companies would most likely be considered to have the lowest financial reporting quality, other things equal? A company that provides high quality, decision-useful information under GAAP but delays its reports. A company that reports significant profits due to a favorable exchange rate movement. A company that reports the results from two different segments as a combined entity.

Answer 29

A company that reports the results from two different segments as a combined entity. C is correct. Combining the results from two segments is an example of biased reporting, which falls in the middle of the quality spectrum. It is difficult to interpret the profitability of each segment when their results are combined.

Question 30

A corporate takeover in which shareholders are persuaded to vote for a group seeking a controlling position on the board of directors best describes a: tender offer. proxy contest. hostile takeover.

Answer 30

proxy contest. B is correct because "[i]n a proxy contest, shareholders are persuaded to vote for a group seeking a controlling position on a company's board of directors."

Question 31

A business model where a company produces goods to be marketed by others is best referred to as: affiliate marketing. value added reselling. private label manufacturing.

Answer 31

private label manufacturing. C is correct because business model variations include "[p]rivate label or 'contract' manufacturers that produce goods to be marketed by others. This is an extremely common arrangement, particularly for offshore production."

Question 32

Which of the following cash flow patterns is nonconventional? A initial cash outflow followed by five annual cash inflows An initial cash inflow followed by three annual cash outflows An initial cash outflow followed by a cash inflow in one year and a cash outflow in two years

Answer 32

An initial cash outflow followed by a cash inflow in one year and a cash outflow in two years C is correct because "[i]f cash flows change signs two or more times, the pattern is nonconventional."

Question 33

A company borrows $200 million for three years from a syndicate of banks. The company pledges receivables as collateral and the loan allows the borrower to draw down and repay amounts periodically. This short-term financing structure best describes a: revolver. regular credit line. factoring agreement.

Answer 33

revolver. A is correct because "[t]he main types of short-term bank financing include uncommitted bank lines of credit, committed bank lines of credit and revolving credit agreements, or revolvers. The latter two types can be unsecured or secured, depending on the company’s financial strength and the general credit situation, which can vary from country to country." "Revolving credit agreements... involve formal legal agreements that define the aspects of the agreement... Revolvers differ in that they are in effect for multiple years (e.g., three to five years) and can have optional medium-term loan features. In addition, they are often used for much larger amounts than a regular line, and these larger amounts are spread out among more than one bank. With revolvers, borrowers draw down and pay back amounts periodically."

Question 34

An analyst gathers the following information about a nonpublic company: Asset beta 0.80 Value of company debt $5,000,000 Value of company equity $10,000,000 Tax rate 20% The company's equity beta is closest to: 0.57 0.96 1.12

Answer 34

1.12 C is correct because the company's equity beta estimated by using an asset (unlevered) beta is: βE = βU × [(1 + (1 – t) × (D/E)] = 0.80 × [(1 + (1 – 20%) × (5,000,000/10,000,000)] = 1.12.

Question 35

Which of the following statements is most accurate? Capital structure policies for mature companies are: commonly equity-oriented. regulation-driven in certain industries. equivalent to rating agency thresholds.

Answer 35

regulation-driven in certain industries. B is correct because regulation in some industries limits the freedom companies have in determining their capital structures. "In certain industries, capital structures are evaluated by regulators and thus capital structure policies will be determined accordingly."

Question 36

If a company's variable costs increase relative to its fixed costs, the operating risk: decreases. remains the same. increases.

Answer 36

decreases. A is correct because variable costs are increasing relative to fixed costs and this makes the operating income less sensitive to changes in units sold, lowering the operating risk. "The greater the use of fixed, relative to variable, operating costs, the more sensitive operating income is to changes in units sold and, therefore, the more operating risk."

Question 37

If sales for both companies increase by the same proportion, the percentage change in operating income is: greater for Company A the same for both companies greater for Company B

Answer 37

the same for both companies B is correct because "[t]he degree of operating leverage is the ratio of the percentage change in operating income to the percentage change in units sold." "DOL = Q × (P – ​​​​​​V)/(Q × (P – V) – F) where Q is the number of units, P is the price per unit, V is the variable operating cost per unit, and F is the fixed operating cost." For Company A: DOL = 50,000 × ($​​​​​​40 – ​​​​​​$35)/(50,000 × ($40 – $35) – $125,000) = 2. For Company B: DOL = 40,000 × ($50 – $40)/(40,000 × ($50 – $40) – $200,000) = 2. Because of identical DOL, both companies can expect the same percentage change in operating income (for the same percentage change in units sold).

Question 38

An analyst gathers the following information about a company: Sales price per unit $10 Variable costs per unit $6 Number of units produced and sold 1,000 Breakeven quantity of sales 1,000 Ignoring taxes, if the number of units produced and sold increases by 20%, the company's net income will be closest to: $800 $2,00 $4,800

Answer 38

$800 A is correct because the breakeven quantity of sales is given by QBE=F+CP−V Where P = price per unit V = variable cost per unit F = fixed operating costs C = fixed financial cost At the breakeven point, revenue = $10 × 1,000 = $10,000, and variable cost = $6 × 1,000 = $6,000. Net income is zero, so F + C must equal $4,000 since $10,000 ˗ $6,000 ˗ $4,000 = 0. Alternatively, F + C can be derived by plugging into the QBE equation above to get 1,000 = (F + C) / ($10 ˗ $6); F + C = $4,000. If the number of units produced and sold increased 20% (to 1,200 units), net income would be: ($10 × 1,200) ˗ ($6 × 1,200) ˗ $4,000 = $12,000 ˗ $7,200 ˗ $4,000 = $800.

Question 39

In an equally weighted portfolio, the diversification ratio is best described as a measure of the: relative level of risk between any two individual assets. amount of risk an asset contributes to the portfolio's risk. risk reduction benefit of investing in the portfolio versus a security from the portfolio.

Answer 39

risk reduction benefit of investing in the portfolio versus a security from the portfolio. C is correct because the level of risk reduction from the portfolio approach to investing, relative to the risk of investing in a single security, can be measured by the diversification ratio. “[A] simple measure of the value of diversification is calculated as the ratio of the standard deviation of the equally weighted portfolio to the standard deviation of the randomly selected security. This ratio may be referred to as the diversification ratio. … The diversification ratio of the portfolio's standard deviation to the individual asset's standard deviation measures the risk reduction benefits of a simple portfolio construction method, equal weighting.”

Question 40

An asset management firm generated the following annual returns in their US large-cap equity portfolio: Year Net Return (%) 2008 –34.8 2009 32.2 2010 11.1 2011 –1.4 The 2012 return needed to achieve a trailing five-year geometric mean annualized return of 5% when calculated at the end of 2012 is closest to: 27.6% 17.9% 35.2%

Answer 40

35.2% RG⎯⎯⎯⎯⎯=0.05=(1−0.348)(1+0.322)(1+0.111)(1−0.014)(1+R2012)⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯√5−1 Holding period total return (cumulative) factor calculation through 2011: (1 – 0.348) × (1 + 0.322) × (1 + 0.111) × (1 – 0.014) = 0.652 × 1.322 × 1.111 × 0.986 = 0.9442 Compound total return (cumulative) factor at 5% per year of 5% for five years: 1.055 = 1.2763 Return needed in 2012 to achieve a compound annualized return of 5%: 1.2763/0.9442 = 1.3517 = 35.2% Check: 0.944 × 1.352 = 1.276(1/5) = 1.050 = 5% annualized

Question 41

An investor gathers the following information: Risk-free rate of return 4% Expected market return 12% Standard deviation of market returns 20% The expected return of a portfolio on the capital market line with a standard deviation of returns of 15% is closest to: 6% 8% 10%

Answer 41

10% C is correct because, according to capital market theory, all portfolios (p) on the capital market line (CML) have an expected return equal to E(Rp) = Rf + [(E(Rm) – Rf)/σm] × σp. Hence, for a portfolio with σp = 15%, we have E(Rp) = 4% + [(12% – 4%)/20%] × 15% = 4% + (0.4 × 15%) = 4% + 6% = 10%. Alternatively, it can be deduced from the standard deviation of the CML portfolio that it consists of 75% invested in the market portfolio and 25% invested in the risk-free asset. Specifically, σp = (1 – w1)σm, where w1 denotes the portfolio weight in the risk-free asset and (1 – w1) the portfolio weight in the market, and therefore (1 – w1) = σp/σm = 15%/20% = 0.75. The expected return on the portfolio is therefore: E(Rp) = (0.75 × 12%) + (0.25 × 4%) = 10%

Question 42

The variance of returns of a security and the market portfolio are 0.25 and 0.09, respectively. If the covariance of security returns and market returns is 0.06, the security’s beta is closest to: 0.24. 0.67. 0.40.

Answer 42

0.67. B is correct. The security's beta is: βi=Cov(Ri,Rm)σ2m=0.060.09=0.67

Question 43

A good risk management framework: is a top-down process and guidance directing risk management activities. seeks to prioritize avoidance of financial loss over defining policies and processes. is typically a process that addresses a common set of factors within different organizations.

Answer 43

is typically a process that addresses a common set of factors within different organizations. C is correct. Good risk management may not prevent losses but provides a framework that addresses common factors, such as risk governance, risk infrastructure, policies and procedures, risk monitoring, and integration, among others. A risk management framework flows logically from the definition of risk management that was previously given: It is the infrastructure, process, and analytics needed to support effective risk management in an organization. This process should fully integrate the “risk” and “return” aspects of the enterprise into decisions in support of best achieving its goals within its tolerance for risk. Risk management is not a “one-size-fits-all” solution; it is integral to the enterprise’s goals and needs. Despite customization, every risk management framework should address the common factors listed above.

Question 44

Which of the following statements is most accurate? Compared to institutional investors, retail investors tend to: have less in-depth information. require stocks with higher float and liquidity. form a larger proportion of the total investment base in developed equity markets.

Answer 44

have less in-depth information. A is correct because "[t]he basic difference between retail and institutional investors is that retail investors tend to have less in-depth information (to be more naive) and to be more momentum-centric than institutional investors. As a result, retail investors may depend upon technical analysis and momentum trading somewhat more than institutional investors.

Question 45

Which type of triangle pattern most likely exhibits a horizontal trendline connecting the high prices? Triple top Symmetrical Ascending

Answer 45

Ascending C is correct. In an ascending triangle pattern,

Question 46

An investor purchases stock at $25 per share on 55% initial margin. If the required maintenance margin is 25%, a margin call may first occur when the price falls below: $13.75. $15.00. $18.33.

Answer 46

$15.00. B is correct because the investor's initial equity is 55% of the initial stock price, or 0.55 × $25 = $13.75. Equity per share = $13.75 + (P − $25) where P is the current share price. The price below which a margin call will take place is equal to the maintenance margin: (equity / share) / (price / share) = 25% = [$13.75 + (P − $25)] / P; Solving for P: 0.75P = 11.25; P = $15.00.

Question 47

A US investor purchases an American depository receipt of a company based in Japan. If the total return of the company's stock in Japan is 3% and the Japanese yen appreciates by 3% against the US dollar, the investor's total return is closest to: 0%. 3%. 6%.

Answer 47

6%. C is correct because for investors who purchase depository receipts, "[f]oreign exchange gains arise because of the change in the exchange rate between the investor’s currency and the currency that the foreign shares are denominated in. For example, US investors who purchase the ADRs of a Japanese company will earn an additional return if the yen appreciates relative to the US dollar … if the total return for a Japanese company was 10 percent in Japan and the yen depreciated by 10 percent against the US dollar, the total return of the ADR would be (approximately) 0 percent. If the yen had instead appreciated by 10 percent against the US dollar, the total return of the ADR would be (approximately) 20 percent." Because the Japanese company returns 3% and the currency appreciates by 3% against the USD, then the total return is approximately 6%.

Question 48

Which of the following statements concerning the use of industry analysis is most accurate? Industry analysis is most useful for: sector allocations in passive equity portfolios. portfolio performance attribution. evaluating market efficiency.

Answer 48

portfolio performance attribution. B is correct. Portfolio performance attribution, which addresses the sources of a portfolio’s returns, usually in relation to the portfolio’s benchmark, includes industry or sector selection. Industry classification schemes play a role in such performance attribution.

Question 49

A characteristic that contributes to intense rivalry among competitors in an industry is most likely high: fixed costs. product differentiation. industry concentration

Answer 49

fixed costs. A is correct because "[i]ndustries that are fragmented among many small competitors, have high fixed costs, provide undifferentiated (commodity-like) products, or have high exit barriers usually experience more intense rivalry than industries without these characteristics."

Question 50

All else being equal, a cash dividend most likely has the same effect on shareholders' wealth as a: stock split. stock dividend. share repurchase.

Answer 50

share repurchase. C is correct because “[a] share repurchase is viewed as equivalent to the payment of cash dividends of equal value in terms of the effect on shareholders' wealth, all other things being equal.”

Question 51

An analyst gathers the following information about a company and its perpetual preferred stock: Growth rate in earnings 2% Annual preferred dividend €4.70 Required rate of return on preferred shares 8% The preferred stock's intrinsic value is closest to: €58.75 €78.33 €79.90

Answer 51

€58.75 A is correct because the preferred stock's intrinsic value is calculated as follows: V0 = D0 / r = €4.70 / 0.08 = €58.75 Where: V0 = intrinsic value of non-callable, non-convertible, perpetual preferred stock; D0 = preferred stock constant annual dividend; r = required rate of return on preferred shares.

Question 52

Bonds issued in which of the following markets most likely have fewer reporting, regulatory, and tax constraints? Eurobond markets Foreign bond markets Domestic bond markets

Answer 52

Eurobond markets A is correct because "[d]omestic and foreign bonds are subject to the legal, regulatory, and tax requirements that apply in that particular country. In contrast, a Eurobond is issued internationally, outside the jurisdiction of the country in whose currency the bond is denominated. The Eurobond market has traditionally been characterized by fewer reporting, regulatory, and tax constraints than domestic and foreign bond markets."

Question 53

Eurocommercial paper most likely: trades on an interest-bearing basis. has larger transaction sizes than US commercial paper. has a shorter settlement period than US commercial paper.

Answer 53

trades on an interest-bearing basis. A is correct because “USCP is typically issued on a discount basis – that is, USCP is issued at a discount to par value and pays full par value at maturity…In contrast, ECP may be issued at, and trade on, an interest-bearing or yield basis or a discount basis.”

Question 54

The bonds of Apex Corporations have a par value of $10,000 each and an annual required rate of return of 10%. The bonds make quarterly coupon payments at an annual rate of 6% and have two years remaining until maturity. The current market price of each bond is closest to: $10,749. $9,283. $9,306.

Answer 54

$9,283. B is correct. Using the quarterly coupon payment of $150 [= (0.06 × 10000)/4] over eight quarters and a quarterly required rate of return of 2.5%, we calculate the bond’s price as: P0 = 150/(1.025)1 + 150/(1.025)2 + ... + 150/(1.025)8 + 10,000/(1.025)8 = $9,282.99

Question 55

The bonds of Apex Corporations have a par value of $10,000 each and an annual required rate of return of 10%. The bonds make quarterly coupon payments at an annual rate of 6% and have two years remaining until maturity. The current market price of each bond is closest to: $10,749. $9,283. $9,306.

Answer 55

$9,283. B is correct. Using the quarterly coupon payment of $150 [= (0.06 × 10000)/4] over eight quarters and a quarterly required rate of return of 2.5%, we calculate the bond’s price as: P0 = 150/(1.025)1 + 150/(1.025)2 + ... + 150/(1.025)8 + 10,000/(1.025)8 = $9,282.99

Question 56

A benefit of the securitization of fixed-income instruments is that it: eliminates investors' exposure to credit risk. reduces liquidity risk in the financial system. increases the role of intermediaries between borrowers and investors.

Answer 56

reduces liquidity risk in the financial system. B is correct because “[s]ecuritization allows for the creation of tradable securities with better liquidity than that of the original loans on the bank’s balance sheet. In making loans and receivables tradable, securitization makes financial markets more efficient. It also improves liquidity, which reduces liquidity risk in the financial system…

Question 57

A buy-and-hold investor purchases a fixed-rate bond at issuance and holds it until maturity. With respect to interest rate risk, this investor is exposed to: market price risk only. coupon reinvestment risk only. both market price risk and coupon reinvestment risk.

Answer 57

coupon reinvestment risk only. B is correct because "[c]oupon reinvestment risk matters more when the investor has a long-term horizon relative to the time-to-maturity of the bond. For instance, a buy-and-hold investor only has coupon reinvestment risk."

Question 58

Credit analysts assessing high-quality debt issuers most likely focus: primarily on the default probability, and less on the loss severity given default. equally on the default probability and on the loss severity given default. primarily on the loss severity given default, and less on the default probability.

Answer 58

primarily on the default probability, and less on the loss severity given default. A is correct because, as "default risk (default probability) is quite low for most high-quality debt issuers, bond investors tend to focus primarily on assessing this probability and devote less effort to assessing the potential loss severity arising from default."

Question 59

Compared to trading an underlying directly, trading a derivative on the underlying most likely involves: higher transaction costs. a lower degree of leverage. a smaller amount of required of recapital.

Answer 59

a smaller amount of required of recapital. C is correct because “Derivative markets also typically have greater liquidity than the underlying spot markets, a result of the smaller amount of capital required to trade derivatives than to get the equivalent exposure directly in the underlying.” Therefore, derivatives most likely have lower capital requirements relative to trading the value of the underlying.

Question 60

If the net cost of carry is zero, the forward price of a commodity is most likely: less than the commodity's spot price compounded at the risk-free rate over the life of the contract. equal to the commodity's spot price compounded at the risk-free rate over the life of the contract. greater than the commodity's spot price compounded at the risk-free rate over the life of the contract.

Answer 60

equal to the commodity's spot price compounded at the risk-free rate over the life of the contract. B is correct because “The forward price of an asset with benefits and/or costs is the spot price compounded at the risk-free rate over the life of the contract minus the future value of those benefits and costs.” That is, F0(T) = S0(1+r)T – (γ – θ)(1+r)T, where the net cost of carry consists of the benefits, denoted as γ (dividends or interest plus convenience yield), minus the costs, denoted as θ. When net cost of carry is zero, the term (γ – θ) is zero, resulting in (γ – θ)(1+r)T being zero. Then, F0(T) = S0(1+r)T. Hence, the forward price of a commodity is equal to the commodity's spot price compounded at the risk-free rate over the life of the contract when the net cost of carry is zero.

Question 61

A swap is similar to a series of implicit forward contracts with each contract created at a price that corresponds to the: floating rate on the swap at each payment date. net cash flows on the swap at each payment date. fixed price of the swap with payments made at the same dates as the series of forward contracts.

Answer 61

fixed price of the swap with payments made at the same dates as the series of forward contracts. C is correct because each forward contract is “created at the fixed price that corresponds to the fixed price of a swap of the same maturity with payments made at the same dates as the series of forward contracts.”

Question 62

Which of the following alternative investment methods most likely has the advantage of lower level of investor involvement without the prerequisite of advanced expertise? Co-investing Fund investing Direct investing

Answer 62

Fund investing B is correct because "[t]he primary advantages of fund investing include the professional services offered by fund managers, a lower level of investor involvement (compared with the direct and co-investing methods), and access to alternative investments without the prerequisite of advanced expertise."

Question 63

Which of the following is categorized as a social infrastructure asset? Airport Correctional facility Telecommunciation tower

Answer 63

Correctional facility B is correct because "[s]ocial infrastructure assets are directed toward human activities and include such assets as educational, health care, social housing, and correctional facilities, with the focus on providing, operating, and maintaining the asset infrastructure."

Question 64

Which of the following natural resources has formed part of large institutional portfolios for decades? Farmland only Timberland only Both farmland and timberland

Answer 64

Timberland only B is correct because "[t]imberland investment involves ownership of raw land and the harvesting of its trees for lumber, thus generating an income stream and the potential for capital gain; it has formed part of large institutional portfolios for decades. Farmland as an investment is a more recent phenomenon, with only a few dedicated funds involved. With population growth, weather, and water management becoming more topical, however, investors may turn to these sustainable land assets to address such concerns in their portfolio."