Mock Exam 2

Question 1

Rodgers, Inc., has fixed operating expenses of $2 million and will break even with sales of $5 million. For sales of $7 million, an analyst would estimate the firm’s operating income as:

a: 800000

Answer 1

Find the % of VC for total sales

OI = Rev - FC - VC
OI = 7 mi - 2mi - 0.6(7mi)
OI = 0.8mi
to find the VC, find the % of VC for total sales.
5 mi = 2 mi + VC

(Module 35.1, LOS 35.e)

Question 2

A security’s beta is best estimated by the slope of:

A)
the capital market line.
Incorrect Answer
B)
the security market line.
Incorrect Answer
C)
the security’s characteristic line.
Correct Answer

Answer 2

Beta, a measure of systematic risk, can be estimated as the slope coefficient from a regression based on the market model, Ri = α + βi (Rmkt – Rf). This regression line is the security’s characteristic line. (Module 63.1, LOS 63.e)

Question 3

Biases

Answer 3

Cognitive Errors (Believe Perseverance or Infromation-Processing Biases)

Emotional Biases

Question 4

A bank estimates the expected value of a one-month loss that exceeds ¥100 million to be ¥300 million. The ¥300 million estimate is best described as:

Answer 4

Conditional VaR is the expected value of a loss, given that the loss exceeds a minimum amount. Value at risk is the minimum loss that will occur over a period with a specified probability. (Module 66.1, LOS 66.g)

Value at Risk: Probability of having a minimum loss

Conditional VaR: what is the expected value of a loss given that the loss has exceed the minimum amount

Scenario VarR: what if scenarios of combined with conditional VaR

Question 5

Investing in a project that will help achieve a particular social or environmental objective is most accurately described as an example of:
A)
impact investing.
Correct Answer
B)
positive screening.
Incorrect Answer
C)
responsible investing.
Incorrect Answer

Answer 5

Impact investing refers to promoting a specific social or environmental goal through investment actions, which may include investing in a particular project. Positive screening refers to identifying companies with best practices regarding environmental, social, or governance for consideration when investing. Responsible investing refers to integrating social or environmental considerations in general into investment decisions. (Module 29.2, LOS 29.e)

Question 6

Investing in a project that will help achieve a particular social or environmental objective is most accurately described as an example of:

A)
impact investing.
Correct Answer
B)
positive screening.
Incorrect Answer
C)
responsible investing.

Answer 6

Impact investing refers to promoting a specific social or environmental goal through investment actions, which may include investing in a particular project. Positive screening refers to identifying companies with best practices regarding environmental, social, or governance for consideration when investing. Responsible investing (general term) refers to integrating social or environmental considerations in general into investment decisions. (Module 29.2, LOS 29.e)

Question 7

A portfolio manager who is comparing portfolios based on their total risk should most appropriately use:

A)
Jensen’s alpha.
Incorrect Answer
B)
the Sharpe ratio.
Correct Answer
C)
the Treynor measure.
Incorrect Answer

Answer 7

The Sharpe ratio measures excess return per unit of total risk. The Treynor measure and Jensen’s alpha are calculated with beta, not standard deviation, and are appropriate for analyzing portfolios based on systematic risk. (Module 63.2, LOS 63.i)

Question 8

Which of the following statements about the security market line (SML) and capital market line (CML) is most accurate?

A)
The SML involves the concept of a risk-free asset, but the CML does not.
Incorrect Answer
B)
The SML uses beta (systematic risk), but the CML uses standard deviation of returns for efficient portfolios (not market risk)
Correct Answer
C)
Both the SML and CML can be used to explain a stock’s expected return.
Incorrect Answer

Answer 8

The SML and CML both intersect the vertical axis at the risk-free rate. The SML describes the risk/return tradeoff for individual securities or portfolios, whereas the CML describes the risk/return tradeoff of various combinations of the market portfolio and a riskless asset.

(Module 63.2, LOS 63.f)

Total risk = market risk + firm’s risk
market risk is systematic risk
firm’s risk is unsystematic risk

Question 9

Diversification Ratio

Answer 9

Opposite of what it means

High diversification ratio means portfolio is not diversified.
Low diversification ratio means portfolio is highly diversified.

Question 10

Type of risks

Answer 10

Business Risk (associated with a firm’s operating income)
- Sales Risk
- Operating Risk

Financial Risk (additional risk that the common stockholders must have when increase debt financing)

Question 11

BBB vs BB

Answer 11

A change in a corporate bond rating from BBB to BB is a decrease from investment grade to speculative grade, which is likely to increase the bond issuer’s cost of debt capital significantly.

Question 12

The type of technical analysis chart most likely to be useful for intermarket analysis is a:

A)
candlestick chart.
Incorrect Answer
B)
volume chart.
Incorrect Answer
C)
relative strength chart.
correct

Answer 12

Relative strength charts display the price of an asset relative to the price of another asset or benchmark over time. This type of chart is useful for demonstrating whether one asset class or market has outperformed or underperformed another. Candlestick charts and volume charts are generally used to analyze a single asset or market over time. (Module 67.1, LOS 67.h)

Question 13

Parker, Inc. has the following securities outstanding:

100,000 shares of preferred stock that pays an annual dividend of $2.00, trading at $35.
$5,000,000 face value 6% bonds with a YTM of 6%.
1 million shares of common stock trading at $28 per share.
Parker’s cost of equity is 8% and its tax rate is 30%. The discount rate that Parker’s management should use when evaluating new capital investments is closest to:

Answer 13

Cost of preferred stock is $2 / $35 = 5.71%.
Kd = D / P

After-tax cost of debt is 6% (1 – 0.30) = 4.2%.

Cost of equity is 8% (given).

Preferred stock outstanding = $35(100,000) = $3.5 million.

Debt outstanding is $5 million (given).

Common stock outstanding is $28 million (given).

Total securities value = $3.5 + $5 + $28 = $36.5 million.

Weighted average cost of capital = (3.5 / 36.5) × 5.71% + (5 / 36.5) × 4.2% + (28 / 36.5) × 8% = 7.26%.

(Module 33.1, LOS 33.a)

Question 14

Bear Company produces gravel-hauling equipment. The company recently began producing the Mauler, a new line of equipment. Prior to beginning production of the Mauler, the company spent $10 million in research and development costs. Bear expects the Mauler line to generate positive cash flows beginning in the fourth year. However, Bear is forecasting a one-time expense in year 5 to comply with new government emission standards. The company will use an empty building it already owns to produce the Mauler. When analyzing the project cash flows for the Mauler, Bear should least appropriately include:

A)
the use of the empty building.
Incorrect Answer
B)
the research and development cost.
Correct Answer
C)
the compliance cost for emissions standards.

Answer 14

The R&D expenditure is a sunk cost that should not be considered in the project’s cash flows. The opportunity cost of the empty building in its next-best use should be considered in the project analysis. (Module 31.1, LOS 31.b)

Question 15

Rolly Parker has managed the retirement account funds for Misto Inc. for the last two years. Contributions and withdrawals from the account are decided by Misto’s CFO. The account history is as follows, with account values calculated before same-date deposits and withdrawals:

Jan 1, 20X1 Beginning portfolio value $10 million
Jul 1, 20X1 Account value $11.2 million
Jul 1, 20X1 Deposit of cash $1.2 million
Jan 1, 20X2 Account value $12.5 million
Jan 1, 20X2 Withdrawal of cash $0.6 million
Dec 31, 20X2 Account value $15 million
The appropriate annual return to use in evaluating the manager’s performance is closest to:

Answer 15

Since the portfolio manager is not directing the flow of cash into and out of the account, the time-weighted annual rate of return is the appropriate performance measure. Calculate the 2-year holding period return +1, then take the square root and subtract 1 to get the annual time-weighted rate of return: [(11.2 / 10)(12.5 / 12.4)(15 / 11.9)]1/2 − 1 = 19.29%.

(Module 62.1, LOS 62.a)

Question 16

Other things equal, for a profitable company, issuing debt to repurchase outstanding stock will most likely:

Answer 16

Increasing financial leverage will increase interest expense and reduce net income. The share repurchase will decrease equity as well, so the effect on ROE is indeterminate. (Module 35.1, LOS 35.c)

Question 17

Other things equal, for a profitable company, issuing debt to repurchase outstanding stock will most likely:

A)
decrease net income and ROE.
Incorrect Answer
B)
increase net income but not necessarily ROE.
Incorrect Answer
C)
decrease net income with an indeterminate effect on ROE.
Correct Answer

Answer 17

When company issue debt, they incur new fixed cost in form of interest payments. This will lower the NI

ROE = NI / Equity
buying back outstanding shares will decrease firm’s equity.

Question 18

Dividend payment steps:

Answer 18

1. Declaration date
2. Ex-dividend date
3. Record date
4. Payment date

Question 19

Compared to corporate bonds, secondary market trading in government bonds is most likely to feature:

A)
brokered markets.
Incorrect Answer
B)
earlier trade settlement.
Correct Answer
C)
narrower bid-ask spreads.
Incorrect Answer

Answer 19

Government bond trades typically settle in one day (T + 1) while corporate bond trades typically settle in two or three days (T+ 2 or T + 3). Government and corporate bonds trade primarily in dealer markets. Bid-ask spreads depend on an issue’s liquidity and may be wider for an illiquid government issue than for a liquid corporate issue. (Module 43.1, LOS 43.d)

Question 20

A company is most likely to earn economic profits if it is operating in an industry characterized by:

A)
high industry concentration, high barriers to entry, and low industry capacity.

Answer 20

High industry concentration refers to an industry that has a small number of firms, which often leads to less price competition, higher pricing power, and higher return on invested capital. High barriers to entry refer to industries where it is costly for new competitors to enter the industry, which allows companies already in the industry to maintain high profitability and prices. Low industry capacity refers to a situation where demand is greater than supply at current prices, which allows companies to maintain high prices and profits. (Module 40.2, LOS 40.h)

Question 21

Among the types of factors that influence industry growth and profitability, the one that is most likely to affect consumer discretionary goods producers more than consumer staples producers is:

A)
social factors.
Incorrect Answer
B)
demographic factors.
Incorrect Answer
C)
macroeconomic factors.
Correct Answer

Answer 21

Consumer discretionary goods purchases are very sensitive to economic cycles, while consumer staples are a non-cyclical industry. (Module 40.2, LOS 40.j)

Question 22

A 10%, 10-year bond is sold to yield 8%. One year passes, and the yield remains unchanged at 8%. Holding all other factors constant, the bond’s price during this period will have:

A)
increased.
Incorrect Answer
B)
decreased.
Correct Answer
C)
remained constant.
Incorrect Answer

Answer 22

Don’t need to calculate the solve this problem.

Coupon > YTM

The bond is sold at a premium. As time passes, the bond’s price will move toward par. Thus, the price will fall.

N = 10; FV = 1,000; PMT = 100; I = 8; CPT → PV = $1,134

N = 9; FV = 1,000; PMT = 100; I = 8; CPT → PV = $1,125

(Module 44.1, LOS 44.b)

Question 23

If an interest rate swap is replicated with a series of forward rate agreements (FRAs), at initiation, each FRA must have a forward rate equal to the swap’s:

A)
fixed rate, and must have a value of zero.
Incorrect Answer
B)
floating rate, and must have a value of zero.
Incorrect Answer
C)
fixed rate, but may have a non-zero value.
Correct Answer

Answer 23

Each FRA would have a forward rate equal to the fixed rate in the interest rate swap but would not necessarily have a value of zero at initiation, although the sum of the values of the replicating FRAs would be zero. (Module 54.1, LOS 54.a)

Each FRA will not likely to be 0, but the sum of the FRA will be 0.

Question 24

Asset-backed securities with a lockout period are most likely to be backed by:

Answer 24

Asset-backed securities backed by credit card receivables have a lockout period, during which principal repayments are reinvested in additional receivables.

(Module 45.2, LOS 45.h)

Question 25

An investor has long exposure to the risk of the asset underlying an option when taking:

A)
a short position in a put option.
Correct Answer
B)
a short position in a call option.
Incorrect Answer
C)
a long position in a put option.
Incorrect Answer

Answer 25

looking for the combination that would benefit from a increase of asset value

By taking a short position in a put option, the investor has long exposure to the risk in the underlying asset. Because the value of a put option decreases when the price of the underlying asset increases, the value of a short position in a put increases when the price of the underlying increases. Both a short position in a call option and a long position in a put option increase in value when the price of the underlying asset decreases; that is, these option positions have short exposure to the risk of the underlying asset. (Module 36.2, LOS 36.e)

Question 26

Porter, Inc., sells 200,000 newly issued shares to two institutions without registering the shares with its country’s securities regulators. This transaction is best described as being:

A)
illegal.
Incorrect Answer
B)
in the primary market.
Correct Answer
C)
in the secondary market.

Answer 26

Sales of newly issued securities take place in the primary market. Registration of shares sold in private placements of securities is not required. The secondary market refers to the markets in which previously issued securities are traded. (Module 36.3, LOS 36.i)

Question 27

Commodities differ from other alternative investments in that:

A)
returns are due only to price changes. (commodities don’t offer any cash flows)
Correct Answer
B)
specialized funds are available as an investment vehicle.
Incorrect Answer
C)
they have a low correlation of returns with traditional investments.
Incorrect Answer

Answer 27

Unlike alternative asset classes that produce income streams, commodities only generate returns from price changes. Most alternative investments have low return correlations with traditional investments. Specialized investment vehicles are available for many categories of alternative investments. (Module 60.2, LOS 60.e)

Question 28

Question 142
Beachballs, Inc., expects abnormally high earnings for the next three years due to the forecast of unusually hot summers. After the 3-year period, their growth will level off to its normal rate of 6%. Dividends and earnings are expected to grow at 20% for years 1 and 2 and 15% in year 3. The last dividend paid was $1.00. If an investor requires a 10% return on Beachballs, the price she is willing to pay for the stock is closest to:

Answer 28

36.5

1. Calculate the dividend of each year using the growth rate
2. Calculate the price
3. use the calculator to find the NPV

Question 29

An asset-based valuation model would most likely provide a reliable estimate of market value for:

A)
a pure-play online news site.
Incorrect Answer
B)
a multinational freight distribution firm.
Incorrect Answer
C)
a privately held metal fabrication company.
Correct Answer

Answer 29

Compared to the other answer choices, a privately held metal fabrication company will likely have a larger proportion of physical assets relative to intangible assets, and market values for its physical assets should be relatively easier to obtain.

Asset based model:
Equity value = Market value of asset - Market value of liabilities

Question 30

Recapitalization

Answer 30

Recapitalization is when the company issues debt to fund a dividend distribution to equity holders (the fund). It is not an exit, in that the fund still controls the company, but often is an intermediate step toward an exit. (Module 60.1, LOS 60.a)

one of the exit strategy for private equities

Question 31

With a soft lockup period of two years, investors in a hedge fund are:
A)
able to get redemptions during the first two years, but only if they pay additional fees.

Answer 31

A soft lockup period describes a provision that allows redemptions during the lockup period, but with significant additional fees for such redemptions. (Module 60.3, LOS 60.f)

A notice period (typically between 30 and 90 days) is the amount of time a fund has to fulfill a redemption request made after the lockup period has passed.

Question 32

Capital Market efficiency

Answer 32

Weak: TA doesnt work
Semi Strong: TA, FA doesnt work
Strong: TA, FA, and insider info doesnt work

Question 33

The required rate of return used in the dividend discount model is least likely to be affected by a change in:

A)
the expected rate of inflation.
Incorrect Answer
B)
the real risk-free rate of return.
Incorrect Answer
C)
the growth rate of earnings and dividends.
Correct Answer

Answer 33

Capital asset pricing model (CAPM): ki = Rf + βi[E(Rmkt) − Rf]

The expected growth rate in dividends is an input into the dividend discount model, but the real risk-free rate, the expected inflation rate, and the risk premium are the components of the required rate of return. (Module 41.2, LOS 41.e)

Question 34

An analyst needs to estimate the value of an illiquid 7% BB+ rated bond that has eight years to maturity. Using matrix pricing, the analyst should most appropriately base an estimate for this bond on yields of:

A)
on-the-run eight-year government bonds.
Incorrect Answer
B)
more frequently traded bonds rated BB+.
Correct Answer
C)
other BB+ rated bonds with similar liquidity to this bond.
Incorrect Answer

Answer 34

Matrix pricing for untraded or infrequently traded bonds should be based on yields of more frequently traded bonds with similar credit ratings. (Module 44.2, LOS 44.e)

Question 35

Investment Grade

Answer 35

BBB- or higher (BBB,A,AA,AAA)
Baa3 or better until Moodie rating

Question 36

Commercial mortgage-backed securities (CMBS) loans typically have greater call protection than agency MBS loans because:

A)
commercial mortgages may have yield maintenance charges.
Correct Answer
B)
smaller-sized mortgages typically are not refinanced if interest rates fall.
Incorrect Answer
C)
CMBS typically receive higher credit ratings from credit agencies than residential MBS.
Incorrect Answer

Answer 36

Any type of call protection structured into the loan itself (in this case, yield maintenance charges) increases the overall call protection of the CMBS. Agency MBS do not provide call protection at the individual loan level. (Module 45.2, LOS 45.g)

Question 37

A forward contract on an underlying with no holding costs or benefits specifies a forward price of 100 and settles in one year. The value of this contract at initiation is most likely to be:

A)
equal to the present value of 100 discounted at the risk-free rate.
Incorrect Answer
B)
less than the present value of 100 discounted at the risk-free rate.
Correct Answer
C)
greater than the present value of 100 discounted at the risk-free rate.
Incorrect Answer

Answer 37

The value of a forward contract at initiation is typically zero. (Module 52.1, LOS 52.a)

Question 38

Which of the following firms’ earnings are likely to exhibit the greatest degree of sensitivity to the business cycle?

A)
Furniture producer with high fixed costs as a proportion of total costs.
Correct Answer
B)
Entertainment producer with high variable costs as a proportion of total costs.
Incorrect Answer
C)
Food and beverage producer with high fixed costs as a proportion of total costs.

Answer 38

Consumers buy fewer durable goods, such as furniture, during recessions and buy more during expansions. As a result, producers of these goods tend to have cyclical demand, revenues, and earnings. Operating leverage (high fixed costs as a proportion of total costs) also contributes to cyclicality of earnings. (Module 40.1, LOS 40.c)

B)
Entertainment producer (is cyclical) with high variable costs as a proportion of total costs (non-cyclical).
Incorrect Answer

Question 39

or a domestic investor purchasing bonds in a foreign market and currency:

A)
appreciation of both the asset and the foreign currency benefits the domestic investor.
Correct Answer
B)
depreciation of both the asset and the foreign currency benefits the domestic investor.
Incorrect Answer
C)
appreciation of the asset and depreciation of the foreign currency benefit the domestic investor.
Incorrect Answer

Answer 39

When the foreign currency appreciates, each foreign currency-denominated cash flow buys more domestic currency units—increasing the domestic currency return from the investment. The appreciation of the foreign asset benefits the investor as well. (Module 42.1, LOS 42.d)

“If you buy something, no matter what asset you want it to appreciate.”

Question 40

The type of share voting most likely to result in significant minority shareholders having an approximately proportional representation on the board of directors is:

A)
statutory voting. (more beneficial to majority voters)
Incorrect Answer
B)
weighted voting.
Incorrect Answer
C)
cumulative voting. (more beneficial to minorities voters)
Correct Answer

Answer 40

Under cumulative voting, shareholders receive one vote per share for each board position election but can vote them for any board candidate or spread them over multiple candidates. This allows, for example, a holder of 20% of the shares to elect one of five board members. Under statutory voting, a minority shareholder could not elect any board members based only on their share voting rights. (Module 39.1, LOS 39.b)

Question 41

Which of the following is least likely a benefit of fund of funds (FOF) investing?

A)
FOFs may permit access to otherwise unavailable hedge funds.
Incorrect Answer
B)
FOFs allow investors to diversify the risks of holding a single hedge fund.
Incorrect Answer
C)
FoF investing has lower fees compared to investing in a typical hedge fund.
Correct Answer

Answer 41

The fee may actually be substantial since, in addition to paying the manager of the FOF, a fee must be paid to each hedge fund within the FOF. (Module 60.3, LOS 60.f)

Question 42

Question 169
Jefferson Blake believes there is a good opportunity to purchase an option-free 4% annual pay bond with three years left until maturity, a zero-volatility spread of 40 basis points, and a par value of $1,000. Blake observes that 1-year, 2-year, and 3-year government bond spot rates are currently 4.0%, 4.5%, and 4.75%, respectively. The maximum price Blake should be willing to pay for the bond is closest to:

Answer 42

be careful with the spread of 40 bps
spot rate for year 1 is 4.4%, year 2 is 4.9%, and year 3 is 5.15%

Question 43

Over the most recent period, Ladden Materials has seen slow growth, increased competition, and declining profitability in its industry. The phase of the industry life cycle for Ladden’s industry is most likely:

A)
mature.
Incorrect Answer
B)
decline.
Incorrect Answer
C)
shakeout.
Correct Answer

Answer 43

The shakeout phase of the industry life cycle is characterized by slowing growth, intense competition, and declining profitability. The mature phase is characterized by industry consolidation and little or no growth. In the decline phase of the industry lifecycle, growth is negative and excess capacity results. (Module 40.2, LOS 40.i)

Question 44

question 174 to learn about duration

Question 45

Derivatives pricing is based on the assumption that:

A)
no arbitrage occurs.
Incorrect Answer
B)
the law of one price holds.
Correct Answer
C)
long and short investors are net risk-neutral.
Incorrect Answer

Answer 45

Derivatives pricing is based on no-arbitrage pricing and replication, and therefore assumes the law of one price holds (i.e., two assets or portfolios with the same future payoffs must have the same price). Derivatives pricing does not assume long and short investors are net risk-neutral; rather, it determines no-arbitrage derivative prices using risk-neutral pricing. (Module 51.1, LOS 51.a)

Question 46

Client Referral rule

Answer 46

The member must inform clients about any benefit given or received for the recommendation of services provided by the member.

Question 47

Russell Finley, CFA, is a managing director at Wilson Brothers and is responsible for the supervision of all trading and sales operations. Finley receives information indicating that a sales assistant made personal trades on a restricted security. According to the Standard regarding responsibilities of supervisors, the least appropriate action for Finley to take is to:

A)
begin an investigation to determine the extent of the wrongdoing.
Incorrect Answer
B)
restrict and increase the monitoring of the employee’s activities at the firm.
Incorrect Answer
C)
speak directly to the employee and attain assurance that the violation will not be repeated.
Correct Answer

Answer 47

Standard IV(C) Responsibilities of Supervisors explicitly states that speaking to the employee to determine the extent of the violations and receiving assurances that it will not be repeated is not enough.

Finley must take positive steps to ensure that the violation will not be repeated, including promptly launching an investigation and limiting the employee’s activities and/or increasing supervision of the employee until the results of the investigation are known. (Module 71.6, LOS 71.b)

Question 48

Charlotte Stein, a CFA candidate, received a copy of a stock selection model designed by a Wall Street analyst friend, who told her she was free to use it. After reviewing the program and making some adjustments, Stein shows the new model to her supervisor. Her supervisor says she did a great job and tells Stein to incorporate the new model in her next industry review. Stein has:

A)
violated the Standard concerning misrepresentation.
Correct Answer

Answer 48

Stein violated Standard I(C) Misrepresentation by presenting material developed by another to her supervisor without disclosing that the work was not her own. (Module 71.2, LOS 71.b)

Even though she got the recourse for free, she still have the disclose the source.

Question 49

Justin Matthews, CFA, is chief financial officer of a bank and serves on the bank’s investment committee. The majority of the committee has voted to invest in medium-term euro debt. Matthews feels very strongly that this is a poor strategy and that trends in both the exchange rate and in euro interest rates over the next year will result in large losses on the position. According to the Code and Standards, Matthews should most appropriately:

A)
document his difference of opinion with the committee.
Correct Answer

Answer 49

Standard V(A) Diligence and Reasonable Basis states that if a consensus opinion has a reasonable basis, a member or candidate who disagrees with it does not have to dissociate from it but should document the difference of opinion. (Module 71.7, LOS 71.b)

Question 50

Howard Klein, CFA, supervises a group of research analysts, none of whom is a CFA charterholder or CFA candidate. He has attempted on several occasions to get his firm to adopt a compliance system to ensure that applicable laws and regulations are followed. The firm’s principals, however, have never adopted his recommendations. According to CFA Institute Standards of Professional Conduct, Klein at this point:

A)
should decline in writing to accept supervisory responsibility until his firm adopts reasonable compliance procedures.
Correct Answer
B)
needs to take no action because the employees are not CFA charterholders or CFA candidates.
Incorrect Answer
C)
must resign from the company and document in writing his reasons for doing so.
Incorrect Answer

Answer 50

Under Standard IV(C) Responsibilities of Supervisors, if Klein clearly cannot discharge supervisory responsibilities because of an inadequate compliance system, he should decline in writing to accept the supervisory responsibility until the firm adopts reasonable procedures to allow him to adequately exercise such responsibility. (Module 71.6, LOS 71.b)

Question 51

Lisa Crocker, CFA, manages several pension accounts and directs most of her trades to Zeta Brokers, which provides excellent trade execution as well as equities research. Regional Brokers, which also has excellent trading services, has offered to execute trades for Crocker at half the commission rate she pays Zeta, but Regional does not supply equities research. If Crocker declines to switch her business from Zeta to Regional, has she violated any CFA Institute Standards of Professional Conduct?

A)
Yes, because she has not obtained explicit permission from her clients to use Zeta.
Incorrect Answer
B)
No, if the higher commissions are justified by the value of the research services she receives.
Correct Answer
C)
Yes, because the Standard concerning loyalty, prudence, and care states that she must minimize trading costs for her accounts.
Incorrect Answer

Answer 51

According to Standard III(A) Loyalty, Prudence, and Care, Crocker may pay higher fees without violating her fiduciary duty as long as the research benefits the firm’s clients and the commission paid is reasonable in relation to the research and execution of services received. ( Module 71.4, LOS 71.b)

Question 52

Katrina Anderson, CFA, left her job as an account manager at RTJ Capital Management and joined Parnell Associates. Anderson did not sign a noncompete agreement at RTJ and took no RTJ property with her when she left. According to CFA Institute Standards of Professional Conduct, Anderson:

A)
must not harm RTJ by soliciting her previous clients.
Incorrect Answer
B)
is free to contact her previous clients at RTJ after her employment there ends.
Correct Answer
C)
must seek permission from RTJ before contacting her previous clients there.
Incorrect Answer

Answer 52

Standard IV(A) Loyalty does not prohibit former employees from contacting clients of their previous firm so long as the contact information does not come from the records of the previous employer or violate a noncompete agreement. (Module 71.6, LOS 71.b)

Question 53

Scott Houser, CFA, is a widely known equity analyst whose recommendations often influence share prices. Houser changes his recommendation to “Sell” on Drywall Company and distributes this recommendation only to his clients, many of whom act on the recommendation before it becomes known to the public. Has Houser violated the Code and Standards? (Module 71.3, LOS 71.b)

A)
No.
Correct Answer
B)
Yes, he has violated the Standard concerning communications with clients.
Incorrect Answer
C)
Yes, he has violated the Standard concerning material nonpublic information.
Incorrect Answer

Answer 53

Houser has not violated the Code and Standards. Guidance for Standard II(A) Material Nonpublic Information states that an analyst does not need to make his recommendations public just because investors would want to know about them, and is free to issue recommendations only to his clients. The guideline about what makes information material (i.e., investors would want to have the information before making an investment decision) applies to nonpublic information from the issuer of a security. An analyst covering the security, however, is not an insider with the issuing firm. (Module 71.3, LOS 71.b)

There is fair dealing (didn’t discriminate any client)
Analyst doesn’t have to have the research public.

Question 54

Christopher Kim, CFA, is a banker with Batts Brothers, an investment banking firm. Kim follows the energy industry and has frequent contact with industry executives. Kim is contacted by the CEO of a large oil and gas corporation who wants Batts Brothers to underwrite a secondary offering of the company’s stock. The CEO offers Kim the opportunity to fly on his private jet to his ranch in Texas for an exotic game hunting expedition if Kim’s firm can complete the underwriting within 90 days. According to CFA Institute Standards of Conduct, Kim:

A)
may accept the offer as long as he discloses the offer to Batts Brothers.
Incorrect Answer
B)
may not accept the offer because it is considered lavish entertainment.
Incorrect Answer
C)
must obtain written consent from Batts Brothers before accepting the offer.
Correct Answer

Answer 54

According to Standard IV(B) Additional Compensation Arrangements, members and candidates must obtain written permission from their employer before accepting an offer of compensation (for the performance of work done for their employer) in addition to what they receive from their employer and that is contingent on future performance. (Module 71.6, LOS 71.b)

Has to be written consent

Question 55

Paul White, CFA, works as an analyst at an investment banking firm that also manages equity-only accounts for clients. White has agreed independently to manage a portfolio of fixed-income securities for an endowment fund for a small fee but has not informed his employer. Additionally, White’s supervisor has asked him to work this weekend on a proposal for a large IPO that must be delivered on Monday morning, but White declines as he would prefer to spend the weekend with his family. Which of White’s actions violate the Standard concerning loyalty?

A)
Both of these actions.
Incorrect Answer
B)
Neither of these actions.
Incorrect Answer
C)
Only one of these actions.
Correct Answer

Answer 55

The Standards do not require that members put their employment ahead of their personal lives; these are issues between White and his employer.
However, Standard IV(A) Loyalty states that a member who engages in independent practice must notify his employer. (Module 71.6, LOS 71.b)

Question 56

Which of the following is least likely one of the eight major topics of the Global Investment Performance Standards (GIPS) for firms?

A)
Composite and Pooled Fund Maintenance.
Incorrect Answer
B)
Fundamentals of Compliance.
Incorrect Answer
C)
Conflicts with Local Laws and Regulations.
Correct Answer

Answer 56

The eight major sections of the GIPS standards for firms are:

Fundamentals of Compliance
Input Data and Calculation Methodology
Composite and Pooled Fund Maintenance
Composite Time-Weighted Return Report
Composite Money-Weighted Return Report
Pooled Fund Time-Weighted Return Report
Pooled Fund Money-Weighted Return Report
GIPS Advertising Guidelines
(Module 72.1, LOS 72.b)

Question 57

Gabe Klement, CFA, an analyst for HB Investments, is responsible for the valuation model for an IPO. Without his knowledge, others at HB adjusted the inputs to the model to increase the estimated value of the shares, and the offering is oversubscribed. Complying with local securities laws, Klement purchases shares of the IPO for his personal account and allocates the remaining shares to client accounts on a pro rata basis. With regard to the Standard on knowledge of the law, the analyst:

A)
did not violate the Standard.
Incorrect Answer
B)
violated the Standard by purchasing the shares of the IPO but not by allowing the IPO valuation to be published.
Correct Answer
C)
violated the Standard by allowing the IPO valuation to be published and by purchasing the shares of the IPO.
Incorrect Answer

Answer 57

Standard I(A) Knowledge of the Law requires candidates and members comply with all applicable rules and regulations, including the CFA Institute Standards of Practice. Further, Standard I(A) requires that members and candidates must not knowingly participate in violations of applicable laws and Standards. Even though local law permits purchasing shares for personal accounts before purchasing IPO shares for client accounts, Standard VI(B) Priority of Transactions does not. The analyst knowingly violated the Code and Standards and, thus, violated Standard I(A). Since the analyst was unaware of the deceit in the valuation of the IPO stock [a violation of Standard I(D) Misconduct], his participation in publishing the IPO valuation did not constitute a violation. (Module 71.8, LOS 71.b)

Question 58

Green Investments utilizes the CFA Institute Standards of Professional Conduct as their standards for ethical practice. For purposes of compliance, which of the following is least likely a violation of Green Investments’ policies?

A)
One of Green Investments’ marketing brochures states that several of the firm’s portfolio managers passed all three levels of the CFA exam on their first attempts.
Correct Answer
B)
At a meeting with potential clients, Green’s chief investment officer states that he is among a group of the most qualified investment professionals because he holds the CFA charter. (exaggerated)
Incorrect Answer
C)
In interviewing a prospective employee, a portfolio manager at the firm says that the position could be financially rewarding because CFA charterholders are known to achieve superior performance results. (exaggerated)
Incorrect Answer

Answer 58

Double negative

The chief financial officer and the portfolio manager are in violation of Standard VII(B) Reference to CFA Institute, the CFA Designation, and the CFA Program because they have improperly referenced the CFA designation or exaggerated its meaning (e.g., “group of the most qualified”). The marketing brochure is only stating factual information regarding the portfolio managers’ success at passing the CFA exams on their first attempts. (Module 71.9, LOS 71.b)

Question 59

Charmaine Townsend, CFA, has been managing equity portfolios for clients using a model that identifies growth companies selling at reasonable multiples. With economic growth slowing for the foreseeable future, she has decided to change to a securities selection model that emphasizes dividend income and low valuation. To comply with the Code and Standards, Townsend should most appropriately:

A)
promptly notify her clients of the change.
Correct Answer
B)
get written permission from her clients prior to the change.
Incorrect Answer
C)
get written acknowledgment of the change from her clients within a reasonable period of time after the change is made.
Incorrect Answer

Answer 59

There is no need of getting written communication

Standard V(B) Communication with Clients and Prospective Clients requires prompt disclosure of any change that might significantly affect the manager’s investment processes. The disclosure need not be in writing. (Module 71.7, LOS 71.b)

Question 60

With respect to the Standard on material nonpublic information, materiality is least likely to be affected by:

A)
the source of the information.
Incorrect Answer
B)
liquidity of the subject security.
Correct Answer
C)
ambiguity about the price effect of the information.
Incorrect Answer

Answer 60

According to Standard II(A) Material Nonpublic Information, how specific the information is, how different it is from public information, and its nature are key factors in determining whether a particular piece of information fits the definition of material. An additional factor is reliability, which is often a function of the source of the information.

While the liquidity of a security may be a factor in determining the materiality of advance knowledge of a large buy or sell order, in most cases, it would not be a factor in determining materiality. (Module 71.3, LOS 71.b)

Question 61

Alberto Cosini is the top-rated, sell-side analyst in the biotechnology industry. His recommendations significantly affect prices of industry stocks regularly. Yesterday Cosini changed his rating on Biopharm from “hold” to “buy,” and Cosini’s firm emailed the change to its clients although no public disclosure has yet been made. If Peter Allen, CFA, who heard about Cosini’s rating change for Biopharm from his brother, purchases Biopharm in his personal account, Allen will most likely:

A)
not violate the Standards.
Correct Answer
B)
violate the Standard concerning diligence and reasonable basis.
Incorrect Answer
C)
violate the Standard concerning material nonpublic information.
Incorrect Answer

Answer 61

There is no requirement that a firm publicly release ratings changes by its analysts. Individuals outside the firm acting on this information after it is released to clients are not in violation of the Standard concerning nonpublic information. Purchases in a member’s personal account are not subject to the requirements of the Standard concerning diligence and reasonable basis, so there is no violation indicated here. (Module 71.7, LOS 71.b)

The asset was purchased after the information has been distributed to the clients.

Question 62

Judy Dudley, CFA, is an analyst and plans to visit a company that she is analyzing in order to prepare a research report. The Standard related to independence and objectivity:

A)
requires Dudley to pay for her own transportation costs and not to accept any gifts or compensation for writing the report, but allows her to accept accommodations and meals that are not lavish.
Incorrect Answer
B)
requires Dudley not to accept any compensation for writing a research report, but allows her to accept company paid transportation, lodging, and meals.
Incorrect Answer
C)
allows Dudley to accept transportation, lodging, expenses, and compensation for writing a research report, but requires that she disclose such an arrangement in her report.
Correct Answer

Answer 62

Standard I(B) Independence and Objectivity allows investor-paid research but requires that members and candidates limit the type of compensation they accept for writing a research report so that it is not dependent on the conclusions of the research report. Best practice is for analysts to only accept a flat fee for such company-paid research reports. Such research should also include complete disclosure of the nature of the compensation received for writing such a report so that investors will not be misled as to the relationship between the analyst and the company.

Important: Paying for one’s own transportation and lodging when the analyst is not employed by the subject firm is a recommended procedure for complying with Standard I(B), but it is not a requirement. (Module 71.1, LOS 71.b)

Question 63

Campbell Hill, CFA, has recently accepted the position of Chief Compliance Officer at an investment management firm. Hill distributes a memo stating that effective immediately (1) material supporting all company research reports will be kept in the company database in electronic form for 10 years, and hard copies of the same material will be maintained for one year only, and (2) hard copy records of all trade confirmations sent to clients must be kept on file for five years, the period mandated by local regulations. With respect to record retention:

A)
neither of Hill’s policies violates the Standards.
Correct Answer
B)
Hill’s policies regarding both research reports and trade confirmations violate the Standards.
Incorrect Answer
C)
Hill’s policy regarding research reports does not violate the Standards, but the policy regarding trade confirmations does.
Incorrect Answer

Answer 63

In the absence of regulatory requirements, Standard V(C) Record Retention recommends maintaining records supporting investment recommendations and actions and records of investment-related communications with clients for at least seven years.

Important: Here, there is regulatory guidance, and 7 years is a recommendation, not a requirement, in any case. Records can be maintained in electronic or hard copy format. (Module 71.7, LOS 71.b)

Question 64

Paul James, CFA, a retail stock broker, notices that one client in particular, Chet Young, Ph.D., is especially adept at picking stocks. James decides to replicate Young’s trades in his own account after he enters them. By doing so, James:

A)
is not in violation of any Standards.
Correct Answer
B)
is in violation of the Standard on priority of transactions because he is front running the client’s account.
Incorrect Answer
C)
is in violation of the Standard on misconduct because he has misappropriated confidential client information.
Incorrect Answer

Answer 64

James is not in violation of the Standards. To comply with Standard VI(B) Priority of Transactions, members and candidates must give transactions for clients and employers priority over their personal transactions. In this instance, James did not adversely affect the client’s interest because the client’s trades were executed before James copied them. He has not acted fraudulently or deceitfully and, thus, has not violated Standard I(D) Misconduct. (Module 71.8, LOS 71.b)

Question 65

Marie Marshall, CFA, charges clients a management fee and commissions on securities transactions. Marshall receives an annual bonus based on the overall success of the firm and a quarterly bonus based on the trading volume in her clients’ accounts. If Marshall does not tell clients about her compensation package, she is violating the Standard concerning:

A)
disclosure of conflicts.
Correct Answer
B)
communication with clients.
Incorrect Answer
C)
additional compensation arrangements.
Incorrect Answer

Answer 65

Marshall has an obligation to disclose that she receives special compensation based on the amount of client trading volume. Standard VI(A) Disclosure of Conflicts requires members to disclose to clients and prospects all matters that could potentially impair the member’s ability to make investment decisions that are (and to give investment advice that is) objective and unbiased. The Standard on communications with clients addresses issues that involve clearly communicating investment recommendations and analysis. The Standard on additional compensation arrangements is concerned with accepting benefits that may create a conflict between a member’s interests and her employer’s interests. (Module 73.1, LOS 73.b)

Question 66

Lunar Wealth, a subsidiary of Galaxy Financial, has prepared GIPS- compliant performance data and asks Galaxy’s president about his interest in presenting GIPS-compliant performance data, but he does not believe it is a priority. Lunar may:

A)
claim partial compliance with GIPS if Lunar’s performance presentations are in compliance.
Incorrect Answer
B)
not claim compliance with GIPS because compliance must be made on a company-wide basis.
Incorrect Answer
C)
claim compliance with GIPS as long as Lunar is presented to the public as a distinct business entity.
Correct

Answer 66

Lunar may claim compliance as long as it has met the reporting requirements necessary and is held out to clients (advertised) as a distinct business entity. Lunar may only claim compliance with GIPS if it complies fully and on a firmwide basis.

(Module 72.1, LOS 72.d)

Question 67

Fred Reilly, CFA, is an investment advisor. Roger Harrison, a long-term client of Reilly, decides to move his accounts to a new firm. In his review of Harrison’s account history, Reilly discovers some transfers of funds from the account of Harrison’s company that Reilly suspects were illegal. Which of the following actions is most appropriate for Reilly to take under the Standards?

A)
Discuss his suspicions with outside counsel.
Correct Answer
B)
Inform Harrison’s company of the suspected illegal activities because Harrison is no longer a client.
Incorrect Answer
C)
Do nothing because he must maintain the confidentiality of client information even after the client has left the firm. (should do something due to legal requirements)
Incorrect Answer

Answer 67

Of the choices given, seeking the advice of outside counsel about what actions Reilly may be required to take is the most appropriate. Under Standard III(E) Preservation of Confidentiality, members and candidates should maintain the confidentiality of information received in the course of their professional service relating to both current and former clients. In the case of illegal activity, however, Reilly may have a legal obligation to report the activity or, on the other hand, may have a legal obligation to maintain the client’s confidentiality even if he suspects illegal activity. (Module 73.1, LOS 73.b)

Question 68

Ronald Rice, CFA, is the investment manager for a trust established for Selma Ross’s mother. Ross selected Rice after interviewing several potential managers. From time to time, Ross calls Rice and asks him to purchase or sell shares in specific firms. Rice routinely complies with these requests without determining suitability for the trust. By doing so, Rice has most likely:

A)
violated the Standard concerning loyalty, prudence, and care.
Correct Answer
B)
violated the Standard concerning independence and objectivity.
Incorrect Answer
C)
not violated the Code and Standards because he has followed the client’s request.
Incorrect Answer

Answer 68

In the case of trusts or endowments, the member must be aware that his fiduciary responsibility is not necessarily to the client (who hired him) but to the beneficiaries of the investment account.

By routinely executing trades directed by Ross without making a determination that the securities transactions are consistent with the investment goals and constraints of Ross’s mother, the account beneficiary, Ross has violated Standard III(A) Loyalty, Prudence, and Care.

Ross has likely also violated other Standards (e.g., Standard III(C) Suitability and Standard V(A) Diligence and Reasonable Basis). Standard I(B) Independence and Objectivity deals primarily with conflicts resulting from gifts, compensation, or benefits that may compromise the member’s independence and objectivity. (Module 73.1, LOS 73.b)

Question 69

Depreciation of a country’s currency will be more effective in reducing its trade deficit if its:

A)
imports do not have good substitutes.
Incorrect Answer
B)
exports are primarily luxury goods.
Correct Answer
C)
exports represent a small portion of foreign consumer expenditures.
Incorrect Answer

Answer 69

What would make the demand more elastic?

Under the elasticities approach, a currency depreciation will lead to a greater reduction in a trade deficit when export demand and/or import demand are more elastic. The demand for luxury goods is relatively elastic, while the demand for goods without good substitutes or for goods that represent only a small portion of consumer expenditures is relatively inelastic. (Module 15.3, LOS 15.j)

Question 70

Question 32
Normal Corp. has a current ratio above 1 and a quick ratio less than 1. Which of the following actions will increase the current ratio and decrease the quick ratio? Normal Corp.:

A)
buys fixed assets on credit. (long term lived asset will increase but it will not affect the CA)
Incorrect Answer
B)
uses cash to purchase inventory. (CA will offset each other)
Incorrect Answer
C)
pays off accounts payable from cash.
Correct Answer

Answer 70

Paying off accounts payable from cash lowers current assets and current liabilities by the same amount. Because the current ratio started off above 1, the current ratio will increase. Because the quick ratio started off less than 1, it will decrease further. The other choices are incorrect. Buying fixed assets on credit decreases both ratios because the denominator increases, with no change to the numerator. Using cash to purchase inventory would result in no change in the current ratio but would decrease the quick ratio by decreasing the numerator. (Module 21.2, LOS 21.b)

Question 71

An analyst constructs a histogram and frequency polygon of monthly returns for aggressive equity funds over a 20-year period. Which of the following statements about these displays is most accurate?

A)
The height of each bar in a frequency polygon represents the absolute frequency for each return interval.
Incorrect Answer
B)
Both a histogram and a frequency polygon provide a graphical display of data found in a frequency distribution.
Correct Answer
C)
To construct a histogram, the analyst would plot the midpoint of the return intervals on the x-axis and the absolute frequency for that interval on the y-axis, connecting neighboring points with a straight line.

Answer 71

The height of each bar in a histogram represents the absolute frequency for each return interval. To construct a frequency polygon, the analyst would plot the midpoint of the return intervals on the x-axis and the absolute frequency for that interval on the y-axis.

(Module 2.2, LOS 2.e)

Question 72

A firm has undertaken a contract with an estimated total cost of $200 million at a price of $220 million. At the end of the first reporting period, the firm has devoted resources of $70 million to the project. The customer has been billed for $80 million and made payments of $60 million. As a result of these transactions, the firm should report revenue from this project of:

Answer 72

Estimated: Revenue - Cost = 220-200=20mi
Year 1 revenue = 70/200 * 220 = 77mi

Question 73

A low inventory turnover ratio in a period of declining revenue growth is most likely an indication that a firm may have:

A)
obsolete inventory.
Correct Answer
B)
too little inventory. (usually will see declining growth and high turnover)
Incorrect Answer
C)
efficient inventory management. (usually will see high growth and high Turnover)
Incorrect Answer

Answer 73

Low inventory turnover and declining revenue growth may be signs that a firm has obsolete or slow-moving inventory. High turnover and low revenue growth may indicate too little inventory, while high turnover and high revenue growth may indicate efficient inventory management. (Module 22.5, LOS 22.l)

Question 74

An analyst has data on institutional salespeople at an investment banking firm showing how they ranked in total monthly commissions, from first to eighth. To determine whether a high rank in one month indicates a high probability of achieving a high rank in subsequent months, the analyst should use a:

A)
t-test.
Incorrect Answer
B)
nonparametric test. (for ranking)
Correct Answer
C)
mean differences test. (for paired comparison)
Incorrect Answer

Answer 74

A Spearman rank correlation test is appropriate in this scenario. This is a nonparametric test.(Module 6.4, LOS 6.l)

Question 75

Question 38
Selected items from the financial statements of three plumbing fixture manufacturers appear in the following table. All three firms use straight-line depreciation for financial reporting.

Robbco Sammco Teddco
PP&E at historical cost $10,000,000 $12,000,000 $18,000,000
Accumulated depreciation 6,000,000 8,000,000 9,000,000
Net PP&E 4,000,000 4,000,000 9,000,000
Depreciation expense (latest period) 800,000 1,000,000 1,500,000

Based only on these data, which firm is most likely to require significant capital expenditures sooner than the others?

Answer 75

Average life - Remaining useful life

Sammco has PP&E with the highest average age and lowest remaining useful life, and therefore appears more likely to need new equipment in the near future than the other firms.

Average age

Robbco: $6,000,000 / $800,000 = 7.5 years

Sammco: $8,000,000 / $1,000,000 = 8.0 years

Teddco: $9,000,000 / $1,500,000 = 6.0 years

Remaining useful life

Robbco: $4,000,000 / $800,000 = 5 years

Sammco: $4,000,000 / $1,000,000 = 4 years

Teddco: $9,000,000 / $1,500,000 = 6 years

(Module 23.4, LOS 23.m)

Question 76

Question 39

For an operating lease, the value of the right-to-use asset and the lease liability on the lessee’s balance sheet will be equal in each reporting period over the term of the lease under:

A)
IFRS, but not U.S. GAAP.
Incorrect Answer
B)
U.S. GAAP, but not IFRS.
Correct Answer
C)
both IFRS and U.S. GAAP.
Incorrect Answer

Answer 76

For operating leases under U.S. GAAP, the principal reduction in the lease liability and the amortization of the right-to-use asset are equal each period so that the values of the lease liability and right-to-use asset will be equal over the term of the lease. This is not the case under IFRS. (Module 25.4, LOS 25.g)

Question 77

Which of the following statements about the central limit theorem is least accurate?

A)
The central limit theorem has limited usefulness for skewed distributions.
Correct Answer
B)
The mean of the population and the mean of all possible sample means are equal.
Incorrect Answer
C)
When the sample size is large, the sampling distribution of the sample means is approximately normal.
Incorrect Answer

Answer 77

The central limit theorem holds for any distribution as long as the sample size is large (i.e., n > 30). (Module 5.1, LOS 5.d)

Question 78

When comparing two firms, an analyst should most appropriately adjust the financial statements when they include significant:

A)
acquisition goodwill, if one of the firms reports under IFRS and the other under U.S. GAAP.
Incorrect Answer
B)
property, plant, and equipment, if one of the firms uses accelerated depreciation and the other uses straight-line depreciation.
Correct Answer
C)
unrealized losses from securities held for trading, if one of the firms uses fair value reporting for securities investments and the other does not.
Incorrect Answer

Answer 78

Depreciation methods are an example of a difference that may require an analyst to adjust financial statements to make them comparable. Acquisition goodwill is treated the same way under IFRS and U.S. GAAP: it is not amortized but is tested for impairment at least annually. Securities held for trading are reported at fair value with unrealized gains and losses reported on the income statement. (Module 27.2, LOS 27.e)

Question 79

Question 46
A U.S. GAAP reporting company holds a number of marketable securities as investments. For the most recent period, the company reports that the market value of its securities held for trading decreased by $2 million and the market value of its securities available for sale increased in value by $3 million. Together, these changes in value will:

A)
reduce net income and shareholders’ equity by $2 million.
Incorrect Answer
B)
increase shareholders’ equity by $1 million and have no effect on net income.
Incorrect Answer
C)
reduce net income by $2 million and increase shareholders’ equity by ＄1 million.
Correct Answer

Answer 79

Unrealized gains and losses on securities held for trading are included in net income. Unrealized gains and losses on securities available for sale are not reported in net income but are included in comprehensive income. Net income will show a $2 million loss from the securities held for trading. Shareholders’ equity will reflect this loss as well as the $3 million unrealized gain from securities available for sale, for a net increase of $1 million. (Module 18.5, LOS 18.l)

Both of them will increase Equity
For held to maturity, unrealized gain or loss would go to I/S -> will decrease by 2mi
For available for sale, unrealized gain or loss would go to OCI -> will increase by 3mi

Question 80

Maritza, Inc., is involved in an exchange of debt for equity. In which of the following sections of the cash flow statement would Maritza record this transaction?

A)
Investing activities section.
Incorrect Answer
B)
Financing activities section.
Incorrect Answer
C)
Footnotes to the cash flow statement.
Correct Answer

Answer 80

This transaction results in a reduction of debt and an increase in equity. However, since no cash is involved, it is not reported as a financing activity in the cash flow statement, but will be disclosed in the notes to the cash flow statement. (Module 20.1, LOS 20.b)

Question 81

Question 48
Which of the following distributions is most likely symmetric if its degrees of freedom are less than five?

A)
F-distribution.
Incorrect Answer
B)
Chi-square distribution.
Incorrect Answer
C)
Student’s t-distribution.
Correct Answer

Answer 81

Student’s t-distribution is symmetric regardless of its degrees of freedom. The chi-square and F-distributions are asymmetric but approach the shape of a normal distribution as their degrees of freedom become large. (Module 4.3, LOS 4.o)

Question 82

Which of the following statements about hypothesis testing involving a z-statistic is least accurate?

A)
The p-value is the smallest significance level at which the null hypothesis can be rejected.
Incorrect Answer
B)
A z-test is theoretically acceptable in place of a t-test for tests concerning a mean when sample size is small.
Correct Answer
C)
If the confidence level is set at 95%, the probability of rejecting the null hypothesis when in fact it is true is 5%.

Answer 82

The t-test must be used when the sample size is small, the population is normal, and the population variance is unknown. If the population is non-normal and the variance is unknown, there is no valid test statistic when the sample is small. (Module 6.2, LOS 6.g)

Question 83

Question 50
Which of the following statements on the economic implications of trade restrictions is most accurate?

A)
Quota rents are the amounts received by the domestic government when it charges for import licenses.
Incorrect Answer
B)
In the importing country, import quotas, tariffs, and voluntary export restraints all decrease producer surplus.
Incorrect Answer
C)
In the case of a quota, if the domestic government collects the full value of the import licenses, the result is the same as that of a tariff.
Correct Answer

Answer 83

If the domestic government collects the full value of the import license, a quota can have the same economic result as a tariff. Quota rents are the gains to those foreign exporters who receive import licenses under a quota if the domestic government does not charge for the import licenses. With respect to the importing country, import quotas, tariffs, and voluntary export restraints all decrease consumer surplus and increase producer surplus. (Module 14.2, LOS 14.e)

Question 84

Rowlin Corporation, which reports under IFRS, wrote down its inventory of electronic parts last period from its original cost of €28,000 to net realizable value of €25,000. This period, inventory at net realizable value has increased to €30,000. Rowlin should revalue this inventory to:

A)
€28,000, and report a gain of €3,000 on the income statement.
Correct Answer
B)
€30,000, and report a gain of €3,000 on the income statement.
Incorrect Answer
C)
€30,000, and report a gain of €5,000 on the income statement.
Incorrect Answer

Answer 84

Under IFRS, inventory values are revalued upward only to the extent they were previously written down. In this case, that is from €25,000 back up to the original value of €28,000. The increase is reported as gain for the period. (Module 22.4, LOS 22.g)

In IFRS, always get the lowest of the costs and NRV
- write down goes to I/S as an expense
- If it reverse, it would get the lowest of the cost, so 25000 in B/S and increase of 3000 in I/S (US GAAP doesnt allow reversal)

Under IFRS, inventory is reported on the balance sheet at the lower of cost or net realizable value. Net realizable value (NRV) is equal to the expected sales price less the estimated selling costs and completion costs. If net realizable value is less than the balance sheet value of inventory, the inventory is “written down” to net realizable value and the loss is recognized in the income statement. If there is a subsequent recovery in value, the inventory can be “written up” and the gain is recognized in the income statement by reducing COGS by the amount of the recovery. Because inventory is valued at the lower of cost or net realizable value, inventory cannot be written up by more than it was previously written down.

The write-down, or subsequent write-up, of inventory is usually accomplished through the use of a valuation allowance account.

Question 85

Question 52
Demand for gasoline (in hundreds of liters) at a particular station, as a function of the price of gasoline and the price of bus travel, is QD = 300 – 14 Pgas + 2 Pbus. If the price of gasoline per liter (Pgas) is 1.50 euros, and the price of a standardized unit of bus travel (Pbus) is 12 euros, the cross price elasticity of gasoline demand with respect to the price of bus travel is closest to:

Answer 85

To calculate the cross price elasticity of the quantity demanded of gasoline with respect to the price of bus travel, we must first calculate the quantity of gas demanded:

300 − 14(1.5) + 2(12) = 303

The cross elasticity is:

Question 86

An investment has a mean return of 15% and a standard deviation of returns equal to 10%. If the distribution of returns is approximately normal, which of the following statements is least accurate? The probability of obtaining a return:

A)
less than 5% is about 16%.
Incorrect Answer
B)
greater than 35% is about 2.5%.
Incorrect Answer
C)
between 5% and 25% is about 95%.
Correct Answer

Answer 86

About 68% of all observations fall within ±1 standard deviation of the mean. Thus, about 68% of the values fall between 5 and 25.

(Module 4.2, LOS 4.h)

Question 87

An investment has a mean return of 15% and a standard deviation of returns equal to 10%. If the distribution of returns is approximately normal, which of the following statements is least accurate? The probability of obtaining a return:

A)
less than 5% is about 16%.
Incorrect Answer
B)
greater than 35% is about 2.5%.
Incorrect Answer
C)
between 5% and 25% is about 95%.
Correct Answer

Answer 87

About 68% of all observations fall within ±1 standard deviation of the mean. Thus, about 68% of the values fall between 5 and 25.

(Module 4.2, LOS 4.h)

Z = (X - u) / s

“have to test for all the answer choices”

Question 88

In the context of geopolitical risk, thematic risks are most accurately described as having low:

A)
impact.
Incorrect Answer
B)
velocity.
Correct Answer
C)
likelihood.
Incorrect Answer

Answer 88

Thematic risks are known factors that have long-term (i.e., low-velocity) effects. (Module 13.1, LOS 13.d)

Types of risks:
- Event risk: know when the event will occur, but doesn’t know the impact (elections)
- Exogenous risk: not predicted that it would happen (war)
- Thematic risk: expected factors that have impact for a long-period (climate change, immigration)

Each risk can be analyzed based on:
- Probability
- Impact
- Velocity (how quickly to have the impact)

Question 89

Which of the following statements regarding an audit and a standard auditor’s opinion is most accurate?

A)
The objective of an audit is to enable the auditor to provide an opinion on the numerical accuracy of the financial statements.
Incorrect Answer
B)
To provide an independent review of a company’s financial statements, an external auditor is appointed by the company’s management.
Incorrect Answer
C)
The absence of an explanatory paragraph in the audit report relating to the going concern assumption suggests that there are no serious problems that require a close examination of that assumption by the analyst.
Correct Answer

Answer 89

A specific explanatory paragraph that makes reference to (questions) the going concern assumption may be a signal of serious problems and call for close examination by the analyst. Therefore, in the absence of such a paragraph, there is no need for a close examination of the going concern assumption by the analyst.

The objective of an audit is to enable the auditor to provide an opinion on the fairness and reliability of the financial statements. This is not the same as numerical accuracy. The auditor generally only provides reasonable assurance that there are no material errors in the financial statements, not an opinion about their numerical accuracy. An external auditor is appointed by the audit committee of the company’s board of directors, not by its management. (Module 29.1, LOS 29.c)

Question 90

Question 57
Two growing firms are identical except that Alfred Company capitalizes costs for some long-lived assets that Canute Company expenses. Alfred is most likely to show higher:

A)
net income than Canute.
Correct Answer
B)
working capital than Canute. (Long lived asset are not current asset)
Incorrect Answer
C)
investing cash flow than Canute. (higher means cash inflow, which is not true: capitalizing cost will produce cash outflow) - Capitalizing is CFI and expensing is CFO
Incorrect Answer

Answer 90

For growing firms, capitalizing results in higher net income compared to expensing. A capitalizing company classifies the costs of the capitalized assets as CFI outflows, while a company that expenses these costs classifies them as CFO outflows. Thus, Alfred’s CFO will be higher and his CFI will be lower than Canute’s. Working capital is unaffected by the decision to capitalize or expense because the decision does not affect current assets or current liabilities. (Module 23.1, LOS 23.c)

Question 91

Answer 58
The probability that a fund manager will produce returns in excess of the returns on the S&P 500 index in any one year is 45%. The probability that the manager will produce returns in excess of the returns on the S&P 500 index in 4 or 5 of the next five years is closest to:

Answer 91

have to calculate for 4 and 5
Prob(4) + Prob(5)

Question 92

Time-series analysis of a firm’s common-size balance sheets reveals the following data:

20X3 20X4 20X5
Current assets 20% 22% 25%
Inventory 8% 9% 11%
Short-term debt 10% 11% 12%
Long-term debt 24% 21% 18%

Based only on the data provided, an analyst can conclude that the firm’s:

A)
debt ratio is decreasing.
Correct Answer
B)
quick ratio is decreasing.
Incorrect Answer
C)
inventory/sales ratio is increasing.
Incorrect Answer

Answer 92

Common size balance sheet is based on the total asset. For this reason, you cannot calculate the quick ratio and inventory/sales ratio based on the given information.

Question 93

An advantage of the Herfindahl-Hirschman Index (HHI) over the N-firm concentration ratio as a summary measure of the market structure of an industry is that the HHI is more sensitive to:

A)
mergers.
Correct Answer
B)
barriers to entry.
Incorrect Answer
C)
elasticity of demand.
Incorrect Answer

Answer 93

The HHI is more sensitive to the effects of mergers compared to the N-firm concentration ratio. Neither measure accounts for elasticity of demand or barriers to entry. (Module 9.4, LOS 9.g)

The HHI is calculated as the sum of the squares of the market shares of the largest firms in the market.

Question 94

Reasons why the unemployment rate is a lagging indicator of the business cycle least likely include:

A)
discouraged workers who begin seeking work.
Incorrect Answer
B)
action lag in the implementation of unemployment insurance.
Correct Answer
C)
high costs to employers of frequently hiring or firing employees.
Incorrect Answer

Answer 94

Unemployment insurance is an example of an automatic stabilizer that is not subject to the action lag of discretionary fiscal policy tools. “ there wont be action lag”

One reason why the unemployment rate is a lagging indicator is the fact that employers are slow to lay off employees early in recessions and slow to add employees early in expansions, because frequent hiring and firing has high costs. Another reason is that early in expansions, more discouraged workers (who are not counted as unemployed because they are out of the labor force) may begin seeking work (thereby re-entering the labor force) than the number of new jobs that are available, which increases the unemployment rate. (Module 12.3, LOS 12.q)

Question 95

Question 66
For which of the following investments in securities is a firm most likely to report unrealized gains or losses on its income statement?

A)
Preferred stock, which the firm classifies as available-for-sale.
Incorrect Answer
B)
Five-year bonds, which the firm purchased in a private placement.
Incorrect Answer
C)
Listed call options, which the firm intends to exercise at expiration.
Correct Answer

Answer 95

Options are derivatives (trading), which are reported at fair value on the balance sheet with unrealized gains and losses recognized on the income statement.

Available-for-sale securities are marked to market on the balance sheet, but unrealized gains and losses are reported in owners’ equity as other comprehensive income.

Bonds (held to maturity) purchased in a private placement cannot be resold to the public and therefore are likely to be classified as held-to-maturity, in which case the firm does not recognize unrealized gains or losses. (Module 19.6, LOS 19.e)
- Since they are held as amortized cost (not fair value), there is no unrealized gain or loss to record.

Question 96

Financial instruments are measured at historical cost, amortized cost, or fair value

Answer 96

Financial instruments are measured at historical cost, amortized cost, or fair value.

Financial assets measured at fair value, also known as mark-to-market accounting, include trading securities, available-for-sale securities, and derivatives.

Question 97

Accrual accounting
Going concern

Answer 97

Accrual accounting means that financial statements should reflect transactions at the time they actually occur, not necessarily when cash is paid. Going concern assumes the company will continue to exist for the foreseeable future.

Question 98

Consider two currencies, the WSC and the BDR. The spot WSC/BDR exchange rate is 2.875, the 180-day riskless WSC rate is 1.5%, and the 180-day riskless BDR rate is 3.0%. The 180-day forward exchange rate that will prevent arbitrage profits is closest to:

Answer 98

Be careful: interest rate is always presented as annual rate.

Arbitrage-free forward = 2.875 WSC/BDR × [(1 + 0.015 / 2) / (1 + 0.03 / 2)] = 2.8538 WSC/BDR.

(Module 15.2, LOS 15.h)

Question 99

Which of the following statements about probability concepts is most accurate?

A)
Subjective probability is a probability that is based on personal judgment.
Correct Answer
B)
A conditional probability is the probability that two or more events happen concurrently.
Incorrect Answer
C)
An empirical probability is one based on logical analysis rather than on observation or personal judgment.
Incorrect Answer

Answer 99

Subjective probability is based on personal judgment.

A joint probability is a probability that two or more events happen concurrently.

An a priori probability is one based on logical analysis rather than on observation or personal judgment.

An empirical probability is calculated using historical data (based on observations).

A conditional probability is the probability of one event happening on the condition that another event is certain to occur. (Module 3.1, LOS 3.d)

Question 100

Which of the following sources of information should an analyst consider the least reliable?

A)
Form 10-Q.
Incorrect Answer
B)
Proxy statement.
Incorrect Answer
C)
Corporate press release.
Correct Answer

Answer 100

Corporate press releases are written by management and are often viewed as public relations or sales materials because of the great possibility of inherent management bias in such documents. Often, little or none of the material is independently reviewed by outside auditors. Such documents are not mandated by the securities regulators.

Form 10-Q (quarterly financial statements) and proxy statements are mandatory SEC filings in the United States, which inherently increases their reliability given the penalties that can be imposed by the SEC if any serious irregularities are subsequently found. (Module 16.2, LOS 16.e)

Question 101

Question 73

Question 102

Elasticity of Supply Curve

Answer 102

The very short run aggregate supply curve is perfectly elastic because firms can adjust output by increasing or decreasing labor hours and capacity use without affecting input prices. (change in output will not change the prices)

The short-run aggregate supply curve is upward sloping.

The long-run aggregate supply curve is perfectly inelastic and represents potential GDP, the full-employment output level of an economy. (it is not influenced by aggregate demand)

(Module 10.2, LOS 10.g)

Question 103

Question 76
A hypothesis test of whether an independent variable explains a significant amount of the variation in the dependent variable is most appropriately constructed using a hypothesized value of a regression line’s:

A)
intercept.
Incorrect Answer
B)
error term.
Incorrect Answer
C)
slope coefficient.
Correct Answer

Answer 103

A test of whether an independent variable explains a significant amount of the variation in the dependent variable uses the null hypothesis that the slope coefficient is equal to zero. Rejecting the null hypothesis indicates the slope coefficient is statistically significant. (Module 7.2, LOS 7.f)

The coefficient of determination (R2) is defined as the percentage of the total variation in the dependent variable explained by the independent variable. For example, an R2 of 0.63 indicates that the variation of the independent variable explains 63% of the variation in the dependent variable.

R2 = SSR/SST

Question 104

A company takes a $10 million impairment charge on a depreciable asset in 20X3. The most likely effect will be to:

A)
increase reported net income in 20X4.
Correct Answer
B)
decrease net income and taxes payable in 20X3.
Incorrect Answer
C)
increase return on equity and operating cash flow in 20X4.
Incorrect Answer

Answer 104

Important
Impairment has no impact on the tax payable. Consequently, the cash flow won’t change.

The impairment writedown in 20X3 will reduce depreciation expense in 20X4, which will increase 20X4 EBIT and net income.

Operating cash flow and taxes payable are not affected because an impairment cannot be deducted from income for tax reporting purposes until the asset is sold or otherwise disposed of. (Module 23.3, LOS 23.j)

Question 105

The country of Colfax can produce 15 units of rice or 10 units of plastic per day of labor. The country of Birklund can produce 18 units of rice or 12 units of plastic per day of labor. With regard to potential benefits of trading rice and plastic between Colfax and Birklund:

A)
there are no potential gains from trade.
Correct Answer

Answer 105

In this case, there are no clear potential benefits from trade because the countries’ opportunity costs of production are equal. Colfax’s opportunity cost of rice = 10 / 15 = 0.67 units of plastic, and Birklund’s opportunity cost of rice = 12 / 18 = 0.67 units of plastic. Colfax’s opportunity cost of plastic = 15 / 10 = 1.5 units of rice, and Birklund’s opportunity cost of plastic = 18 / 12 = 1.5 units of rice. (Module 14.1, LOS 14.c)

Question 106

Trading blocks

Answer 106

Free Trade Areas
All barriers to import and export of goods and services among member countries are removed.

Customs Union
All barriers to import and export of goods and services among member countries are removed.
All countries adopt a common set of trade restrictions with non-members.

Common Market
All barriers to import and export of goods and services among the countries are removed.
All countries adopt a common set of trade restrictions with non-members.
All barriers to the movement of labor and capital goods among member countries are removed.

Economic Union
All barriers to import and export of goods and services among the countries are removed.
All countries adopt a common set of trade restrictions with non-members.
All barriers to the movement of labor and capital goods among member countries are removed.
Member countries establish common institutions and economic policy for the union.

Monetary Union
All barriers to import and export of goods and services among the countries are removed.
All countries adopt a common set of trade restrictions with non-members.
All barriers to the movement of labor and capital goods among member countries are removed.
Member countries establish common institutions and economic policy for the union.
Member countries adopt a single currency.

e.g., The North American Free Trade Agreement (NAFTA) is an example of a free trade area, the European Union (EU) is an example of an economic union, and the euro zone is an example of a monetary union.

Question 107

Xanos Corporation faced a 50% marginal tax rate last year and showed the following financial and tax reporting information:

Deferred tax asset of 1,000.
Deferred tax liability of 5,000.
Based only on this information and the news that the tax rate will decline to 40%, Xanos Corporation’s deferred tax:

A)
asset will be reduced by 400 and deferred tax liability will be reduced by 2,000.
Incorrect Answer
B)
liability will be reduced by 1,000 and income tax expense will be reduced by 800.
Correct Answer
C)
asset will be reduced by 200 and income tax expense will be reduced by 1,000.
Incorrect Answer

Answer 107

There is a 20% reduction in the tax rate [(40% − 50%) / 50% = –0.2]. Hence, the deferred tax asset will be 800 = 1,000(1 − 0.2), the deferred tax liability will be 4,000 = 5,000(1 − 0.2), and the income tax expense will fall by the net amount of the decline in the asset and liability balances (1,000 – 200 = 800). (Module 24.3, LOS 24.e)

Question 108

The standard normal distribution has a mean of 0 and a standard deviation of 1. (Module 4.2, LOS 4.f)
However, normal distribution alone doesn’t necessarily have mean of zero and standard deviation of one.

Question 109

The ratio of operating cash flow to net income is most likely to indicate low quality of earnings when it is:

A)
less than one.
Correct Answer
B)
highly variable.
Incorrect Answer
C)
increasing over time.
Incorrect Answer

Answer 109

Operating cash flow that is less than net income (ratio less than one) or declining over time may indicate low-quality earnings from aggressive accounting or accounting irregularities. A ratio of operating cash flow to net income that is highly variable, but consistently greater than one, is not necessarily indicative of low-quality earnings. (Module 26.3, LOS 26.i)