Mock Exam 1 - Revision

Question 1

Arguments against being concerned about the size of a fiscal deficit include:

A)
higher future taxes.
Incorrect Answer
B)
Ricardian equivalence.
Correct Answer
C)
the crowding-out effect.

Answer 1

Ricardian equivalence suggests that it does not matter whether a government finances its spending with debt or a tax increase because the effect on the total level of demand in the economy is the same.

Arguments for being concerned about the size of the fiscal deficit include the crowding-out effect of government borrowing taking the place of private sector borrowing and the negative effects on work incentives and entrepreneurship from higher future taxes.

Question 2

Which of the following is least likely a source of bias in CPI data?

A)
Quality changes.
Incorrect Answer
B)
Sample selection.
Correct Answer
C)
Substitution.

Answer 2

The three sources of bias associated with CPI data are: new goods, quality changes, and substitution.
“NQS”

Question 3

Which of the following statements is CORRECT? Income tax expense:

A)
is the amount of taxes due to the government.
Incorrect Answer
B)
includes taxes payable and deferred income tax expense.
Correct Answer
C)
is the reported net of deferred tax assets and liabilities.

Answer 3

Income tax expense = tax payable +DTL - DTA + valuation allowance

Income tax expense is defined as expense resulting from current period pretax income. It includes taxes payable and deferred income tax expense. Taxes payable are the amount of taxes due the government.

Question 4

With regard to the goal of neutrality in financial reporting, accounting standards related to research costs and litigation losses should be viewed as:

A)
promoting neutral financial reporting.
Incorrect Answer
B)
biased toward conservative financial reporting.
Correct Answer
C)
biased toward aggressive financial reporting.

Answer 4

Some accounting principles, such as IFRS and U.S. GAAP standards for expensing research costs and recognizing probable litigation losses, reflect conservatism rather than neutrality, in that they require earlier recognition of probable losses and later recognition of probable gains.

(Module 26.1, LOS 26.c)

Ideally, financial statements should be neutral or unbiased in order to offer the most value to analysts. In general, we describe the choices made within GAAP with respect to reported earnings as conservative accounting if they tend to decrease the company’s reported earnings and financial position (on the balance sheet) for the current period. We describe choices that increase reported earnings or improve the financial position for the current period as aggressive accounting.

Question 5

Corcoran Corp acquired an asset on 1 January 2004, for $500,000. For financial reporting, Corcoran will depreciate the asset using the straight-line method over a 10-year period with no salvage value. For tax purposes the asset will be depreciated straight line for five years and Corcoran’s effective tax rate is 30%. Corcoran’s deferred tax liability for 2004 will:

Answer 5

understand if it will become DTA or DTL
it is DTL because 30K will in expense in IS and 15 will become tax payable in the BS. Then, there will need a tax liability.

Question 6

Assume that the exercise price of an option is $5, and the average market price of the stock is $8. Assuming 816 options are outstanding during the entire year, what is the number of shares to be added to the denominator of the diluted EPS?

Answer 6

(816)(5) = $4,080. $4,080 / $8 = 510 shares. 816 − 510 = 306 new shares or [(8 − 5) / 8]816 = 306.

(Module 18.4, LOS 18.h)

Question 7

permanent different on tax rate

Answer 7

It doesnt create DTA or DTL but it will make the efffective tax rate to differ from the statutory tax rate

Question 8

Which of the following statements regarding deferred taxes is NOT correct?

A)
If deferred taxes are not expected to reverse in the future then they should be classified as equity.
Incorrect Answer
B)
Only those components of deferred tax liabilities that are likely to reverse should be considered a liability.
Incorrect Answer
C)
If deferred tax liabilities are not included in equity, debt-to-equity ratio will be reduced.

Answer 8

When deferred tax liabilities are included in equity, it will reduce the debt-to-equity ratio (by increasing the denominator), in some cases considerably.

(Module 24.2, LOS 24.b)

Question 9

A firm has one actively traded bond issue outstanding, with a 6% coupon and a yield to maturity of 5%. When estimating the firm’s weighted average cost of capital (WACC), the appropriate after-tax cost of debt capital is:

Answer 9

Yield to maturity is an appropriate estimate of a firm’s before-tax cost of capital. Its after-tax cost of capital may be estimated as YTM × (1 – tax rate) and will be less than the before-tax cost of capital, as long as the firm faces a positive tax rate. (Module 33.1, LOS 33.c)

Question 10

An example of macro risk that companies may face is:

A)
ESG risk.
Incorrect Answer
B)
exchange-rate risk.
Correct Answer
C)
capital investment risk.

Answer 10

Macro risks include economic factors such as exchange-rate changes. ESG risk and capital investment risk are examples of firm-specific risks.

Question 11

Which of the following is least likely to be useful to an analyst who is estimating the pretax cost of a firm’s fixed-rate debt?
A)
The coupon rate on the firm’s existing debt.
Correct Answer
B)
The yield to maturity of the firm’s existing debt.
Incorrect Answer
C)
Seniority and any special covenants of the firm’s anticipated debt.

Answer 11

asking about the debt cost. Kd.

Question 12

A firm is least likely to reduce its capital needs by adopting which of the following business models?

A)
Asset-light.
Incorrect Answer
B)
Pay-in-advance.
Incorrect Answer
C)
Bundling.
correct

Answer 12

Bundling is a pricing strategy for multiple products. Firms that rent or lease major assets (an asset-light model) or receive cash before providing goods or services (a pay-in-advance model) tend to have less need for capital than firms that own fixed assets or do not collect cash in advance.

(Module 30.1, LOS 30.b)

Question 13

Which of the following statements about securities exchanges is most accurate?

A)
Call markets are markets in which the stock is only traded at specific times.
Correct Answer
B)
Continuous markets are markets where trades occur 24 hours per day.
Incorrect Answer
C)
Setting a negotiated price to clear the market is a method used to set the closing price in major continuous markets.

Answer 13

Continuous markets are markets where trades occur at any time the market is open (i.e., they do not need to be open 24 hours per day). Setting one negotiated price is a method used in major continuous markets to set the opening price.

Question 14

An investor buys 200 shares of ABC at the market price of $100 on full margin. The initial margin requirement is 40% and the maintenance margin requirement is 25%.

If the shares of stock later sold for $200 per share, what is the rate of return on the margin transaction?
A)
100%.
Incorrect Answer
B)
250%.
Correct Answer
C)
400%.

Answer 14

Leverage Factor = 1 / Initial Margin % = 1 / 0.40 = 2.50

Question 15

The factors that must be considered when estimating the credit risk of a bond include:

Answer 15

bond rating and recovery rate (% of bond value investor would receive if issuer defaults)

Question 16

funds from operations (FFO)

Answer 16

FFO is defined as net income from continuing operations plus depreciation, amortization, deferred taxes, and other noncash items.

Question 17

2 and 20: 2-% management fee and 20% incentive fee
hurdle rate: minimum return to achieve before managers earn incentive fees
- hard: fee is % of return above hurdle
-soft: fee is % of full return, but only if above hurdle (the whole profit amount)
soft hurdle rate is always be bigger than hard hurdle rate

High water mark: the reference point would never fall, it can maintain or go up (when the hedge fund margin increase); this happens due to the fact that there must be a recovery of losses before any incentives fees are given; the incentive will always be calculated based on the gain above high water mark

Question 18

A hedge fund has a 2-and-20 fee structure with a soft hurdle rate of 5% and a high water mark. Incentive fees are calculated net of management fees. The fund’s gross return is 15% in Year 1, −10% in Year 2, and 30% in Year 3. Incentive fees for Year 3 will be:

Answer 18

Because the fund lost value in Year 2 and has a high water mark, incentive fees for Year 3 will be 20% of only the portion of the Year 3 gain that exceeds the previous highest value. (Module 59.1, LOS 59.b)

Incentives are calculated based on the high water mark

Question 19

Jem Capital is a hedge fund with $150 million of initial investment capital. The fund charges a 2% management fee based on assets under management at the end of the year and a 20% incentive fee. Incentive fees and management fees are calculated independently. In the first year, Jem Capital has a 25% return. What is an investor’s after-fee return for the year?

Answer 19

Gross value end of year: $150 million × 1.25 = $187.5 million

Management fee: $187.5 million × 2% = $3.75 million (‘calculated at the end of the year)
Incentive fee: ($187.5 million – $150 million) × 20% = $7.5 million (don’t take into account the management fee)

Total fees to Jem Capital: $11.25 million

Investor’s after-fee return: [(187.5 – 11.25) / 150] – 1 = 17.5%.

(Module 59.1, LOS 59.b)

Question 20

Carr Funds is a hedge fund with $125 million of assets under management at the end of the prior year. The fund has a “1 and 10” fee structure. Incentive fees are calculated on gains net of management fees at the end of the year. In the current year, Carr Funds had a 5% gross return. An investor’s after-fee return for the year is closest to:

Answer 20

Gross value end of year: $125 million × 1.05 = $131.25 million

Management fee: $131.25 million × 1% = $1.3125 million

Incentive fee: ($131.25 – $125 – $1.3125) × 10% = $493,750

Total fees to Carr Funds = $1.3125 million + $493,750 = $1,806,250

The after-fee return: [($131.25 – $1.80625) / 125] – 1 = 3.56%.

(Module 59.1, LOS 59.b)

Question 21

The formative stage of venture capital investing when capital is furnished for market research and product development is best characterized as the:

Answer 21

Formative stage:
1. The angel investing or pre-seed stage is when investment funds are used for business plans and assessing market potential
2. In the seed stage of venture capital investing, capital is furnished for product development, marketing, and market research.
3. The early stage or start up stage refers to investments made to fund initial commercial production and sales.

Question 22

A portfolio manager who adds commodities to a portfolio of traditional investments is most likely seeking to:

A)
increase expected returns only.
Incorrect Answer
B)
decrease portfolio variance only.
Correct Answer
C)
both increase expected returns and decrease portfolio variance.

Answer 22

Unlike most alternative investments, expected returns on commodities are typically less than expected returns on traditional investments. However, because their returns typically have a low correlation with returns on traditional investments, adding commodities to a portfolio of traditional investments can decrease portfolio variance.

Question 23

The period of time within which a hedge fund must fulfill a redemption request is the:

Answer 23

A notice period, typically 30 to 90 days, is the amount of time a fund has after receiving notice of a redemption request to fulfill the redemption request. A lockup period is a minimum length of time before an investor may redeem shares or make withdrawals.

Question 24

Which private capital fund waterfall structure involves distributing profits as each investment is sold and subsequently shared according to the partnership agreement?

Answer 24

With a deal-by-deal waterfall, profits are distributed as each fund investment is sold and subsequently shared according to the partnership agreement. With a whole-of-fund waterfall (or European waterfall), the limited partners receive all distributions until they have received 100% of their initial investment plus the hurdle rate.

Question 25

To exit an investment in a portfolio company through a trade sale, a private equity firm sells:

Answer 25

A trade sale involves selling a portfolio company to a competitor or another strategic buyer. An IPO involves selling all or some shares of a portfolio company to the public. A secondary sale involves selling a portfolio company to another private equity firm or a group of investors. (Module 60.1, LOS 60.a)

Question 26

A private equity provision that requires managers to return any periodic incentive fees resulting in investors receiving less than 80% of profits is a:

Answer 26

A clawback provision requires the manager to return any periodic incentive fees to investors that would result in investors receiving less than 80% of the profits generated by portfolio investments as a whole.