Mock Exams questions I messed

Question 1

An analyst gathers the following information with respect to the machine used by a company that issues financial statements in accordance with US GAAP.

Undiscounted expected future cash flows $21,000
Present value of expected future cash flows $18,000
Fair value $19,000
Estimated selling cost $3,000

The company is currently carrying this asset at $20,000. Based on the information presented above, the company will most likely:

A
continue carrying this asset at $20,000.

B
revise the carrying value of this asset down to $16,000.

C
revise the carrying value of this asset down to $18,000.

Answer 1

A
continue carrying this asset at $20,000.

According to US GAAP, an asset’s carrying amount is considered to be recoverable if it is less than the undiscounted value of expected future cash flows.

In this example, the company would continue to carry this asset at $20,000 because this amount is less than the $21,000 value of undiscounted expected future cash flows.

Question 2

Which of the following statements is most accurate?

A
All intangible assets must be amortized over their useful life

B
An intangible asset with an indefinite useful life cannot incur an impairment charge

C
Impairment losses attributable to intangible assets are recognized on a company’s income statement

Answer 2

C
Impairment losses attributable to intangible assets are recognized on a company’s income statement

As with tangible assets, any impairment losses attributable to intangible assets are recognized on the income statement.

An intangible asset may be deemed to have an indefinite life, in which case it would not be amortized. Instead, it would be tested at least annually for impairment.

Question 3

The homoskedasticity assumption has most likely been violated if:

A
errors are correlated across observations.

B
the error term is not normally distributed.

C
the variance of the error term is the not same for all observations.

Answer 3

C
the variance of the error term is the not same for all observations.

The homoskedasticity assumption states that the variance of the error term is the same for all data points used in a linear regression model. If this is not observed, the data is said to be heteroskedastic.

Question 4

coefficient of variation formula

Answer 4

standard deviation / mean

Question 5

The regression residual for a single data point is the

Answer 5

the difference between the actual value of the dependent variable (Y) and the value predicted by the regression model

Question 6

Ralph Sheppard, CFA, is both an equity analyst covering the consumer goods sector and an avid chef in his spare time. On Tuesday evenings, with his employer’s written consent, Sheppard teaches a class at a local culinary school, for which he is compensated at the standard rate paid to all instructors. Recently, the culinary school where Sheppard teaches was chosen to test prototypes of a new line of kitchen appliances being developed by Cuisineware, a manufacturer that Sheppard has covered for over a decade in his role as an analyst. After using the prototypes for the first time, Sheppard is convinced there will be significant demand for this new line of appliances. The next morning, he makes an upward revision to his previously published price target for Cuisineware’s stock, but he does not disclose that he has tested the company’s prototypes.

Sheppard has most likely violated the CFA Standards with respect to:

A
disclosure of conflicts only.

B
diligence and reasonable basis only.

C
both disclosure of conflicts and diligence and reasonable basis.

Answer 6

B
diligence and reasonable basis only.

Sheppard has violated Standard V(A) - Diligence and Reasonable Basis, which requires members and candidates to have a “reasonable and adequate basis, supported by appropriate research and investigation, for any investment analysis, recommendation, or action.” In this example, Sheppard does not have a reasonable and adequate basis for increasing the price target for Cuisineware’s stock simply because he is familiar with the company and has tested the prototypes for its new line of appliances.

However, working at a culinary school that was chosen to test Cuisineware’s prototypes does not constitute a benefit that must be disclosed according to Standard VI(A) - Disclosure of Conflicts.

Question 7

Robert Choi, CFA, works for Challenger Asset Management, which offers its clients ten emerging market equity funds. All ten funds had negative five-year returns, although each has outperformed its benchmark. Choi approves an advertisement that includes a statement that the company’s funds have provided investors with “positive excess returns” for investors seeking exposure to these markets.

Each fund’s five-year returns are presented alongside the returns of their relevant benchmark and a website where potential clients can obtain more detailed information is listed. Has Choi most likely violated the Standards?

A
No

B
Yes, by failing to provide sufficient information

C
Yes, by misleading potential clients with the implication that returns have been positive

Answer 7

A
No

According to Standard III(D) - Performance Presentation, members and candidates must ensure that communication of performance is “fair, accurate, and complete.”

In this example, the claim of positive excess returns is accurate because, although the funds have posted negative returns, each fund has outperformed its relevant benchmark. The clients are also given a presentation of the five-year returns with the benchmark returns, eliminating any potential misinterpretation.

Question 8

To develop a better understanding of intra-industry trade, an analyst would most likely use:

A
the Ricardian model.

B
the Hecksher-Ohlin model.

C
a monopolistically competitive model.

Answer 8

C
a monopolistically competitive model.

Monopolistically competitive models have been used to explain intra-industry trade, which takes place between two countries within the same industry.

The Ricardian and Heckesher-Ohlin models focus on countries developing specialization based on absolute and comparative advantages.

Question 9

Under IFRS, a reversal of a prior-year inventory write-down is most likely recorded as:

A
non-operating income.

B
other comprehensive income.

C
a reduction in cost of goods sold.

Answer 9

C
a reduction in cost of goods sold.

Under IFRS, reversals of inventory write-downs are recognized by reducing the cost of goods sold.

Question 10

Hillary Goff, CFA, is an investment banker with Robertson & Davis, a financial services firm with multiple lines of business. When making presentations to potential new investment banking clients in a range of industries, she promises that her firm will provide full research coverage if the potential client signs on as an investment banking client. Goff does not mention that the two analysts currently employed by her firm both cover companies in various subsectors of the transportation sector. Goff most likely violated the Standards with respect to:

A
misrepresentation only.

B
independence and objectivity only.

C
both misrepresentation and independence and objectivity.

Answer 10

A
misrepresentation only.

Goff has violated Standard I(C) - Misrepresentation by giving prospective clients the impression that her firm is currently capable of providing full research coverage when it only employs two analysts who both cover the transportation sector.

Goff does not violate Standard I(B) - Independence and Objectivity by promising research coverage as such promises are consistent with this Standard as long as the subsequent research is not influenced by any commercial relationship between the companies.

Question 11

Brian Gilman, CFA, has been asked to write a research report on Kennemetal, a major copper mining firm in which Gilman’s wife owns 750 shares. Which of the following statements is most accurate? Gilman:

A
must refuse to write the report on a company in which his wife owns shares.

B
may accept the assignment, but must disclose his wife’s stock ownership in the report.

C
may accept the assignment and is not required to disclose his wife’s stock ownership in the report.

Answer 11

B
may accept the assignment, but must disclose his wife’s stock ownership in the report.

Standard VI(A) - Disclosure of Conflicts requires members and candidates to “make full and fair disclosure of all matters that could reasonably be expected to impair their independence and objectivity or interfere with respective duties to their client, prospective clients, and employer.” In this example, Gilman is not required to refuse this assignment, but he must disclose his wife’s ownership of the company’s stock if he chooses to accept it.

Question 12

Patrick Cobb, CFA, works as a portfolio manager at Paradiso Asset Management (PAM), which manages investments for large, institutional investors. PAM’s minimum account size is $20 million. Twice a week, Cobb volunteers to serve meals at a local homeless shelter, Hospitality at the Heart (HH). The chair of the HH board has asked Cobb to manage the charity’s portfolio, valued at $8 million, in return for compensation of 0.06% of assets under management annually. Domingo Rivera, another portfolio manager at PAM, overheard Cobb discussing details for this potential arrangement and accused his colleague of being disloyal to his employer and engaging in independent practice. Has Cobb most likely violated the Standards?

A
No, because HH’s account is too small for PAM

B
No, because he has not accepted the offer from HH’s board

C
Yes, because he has not received written permission from PAM

Answer 12

B
No, because he has not accepted the offer from HH’s board

According to Standard IV(A) - Loyalty, “in matters related to their employment, Members and Candidates must act for the benefit of their employer and not deprive their employer of the advantage of their skills and abilities, divulge confidential information, or otherwise cause harm to their employer.”

Cobb’s work as a portfolio manager for PAM is related to the work that he has been asked to do on behalf of HH, for which he would receive compensation. Therefore, Cobb would violate this Standard if he accepted the offer without receiving written consent from PAM after having provided a detailed description of the arrangement with HH. However, Cobb does not violate this Standard merely by having received an offer and discussing it.

Question 13

how to do the t-test?

Answer 13

1. find pooled estimator of common variance
2. do t test

Question 14

how to find the marginal propensity to save?

Answer 14

1. find fiscal multiplier
2. Find c
3. Find marginal propensity to save

Question 15

A company purchased a fire insurance policy for its office building, paying its annual premium in advance at the 6-month point of its financial year. The accounting entry required at the end of the financial year to adjust for this purchase will most likely reduce:

A
both prepaid expenses and cash.

B
cash and increase prepaid expenses.

C
prepaid expenses and increase insurance expense.

Answer 15

C
prepaid expenses and increase insurance expense.

Under the accrual accounting method, the company will decrease cash and increase prepaid expenses when it pays the premium at the 6-month point of its financial year.

After six months, the balance of the prepaid insurance asset that was created when the company paid its annual premium in advance will be reduced to half of its initial value and an expense will be recognized as each month passes and the company enjoys the benefit of having insurance coverage (even if no claims are made, value is derived from having transferred risk to the insurer).

Thus, the accounting entry required to reflect the company’s financial position at the end of the financial year will decrease prepaid expenses on the balance sheet and increase insurance expense on the income statement.

Question 16

With respect to potential changes to financial reporting standards, CFA Institute most likely:

A
refrains from taking positions in order to avoid the appearance of a conflict of interest.

B
issues position papers only if input has been solicited by the relevant accounting standards board.

C
advocates for its interests in position papers and through direct contact with representatives of the relevant accounting standards board.

Answer 16

C
advocates for its interests in position papers and through direct contact with representatives of the relevant accounting standards board.

Question 17

Marge Varney, CFA, provides retirement planning services for her clients, including Kendra Hodge and Philippe Bourque. Both Hodge and Bourque own 1,000 shares of Philatech Industries (PHI). These positions account for 2% of Hodge’s total wealth and 40% of Bourque’s. After scrutinizing the company’s latest financial reports, Varney becomes convinced that PHI will underperform over the next 5 years. She e-mails both Hodge and Bourque a copy of a detailed report that she prepared to support her recommendation that they each sell at least 20% of their PHI shares. Within 5 minutes, Bourque replies to Varney’s e-mail, authorizing her to sell 200 PHI shares from his account. A few minutes after that, Hodge replies with the same instructions. Immediately after receiving Hodge’s email, Varney submits sell orders on behalf of both clients’ accounts. Has Varney most likely violated the Standards?

A
No

B
Yes, with respect to fair dealing

C
Yes, with respect to communication with clients and prospective clients

Answer 17

C
Yes, with respect to communication with clients and prospective clients

Standard V(B) - Communication with Clients and Prospective Clients requires members and candidates to use reasonable judgment in identifying which factors are important to their recommendations and include those factors in communications with clients. This creates an obligation to consider each client’s particular circumstances when making recommendations.

In this case, Hodge and Bourque both own 1,000 shares of PHI. However, selling 200 of these shares will have a disproportionately large impact on Bourque’s portfolio. Varney violated this Standard by taking a “one-size-fits-all” approach with two clients who have very different circumstances. At a minimum, Varney should have taken additional time with Bourque to go over the significant impact that this trade would have on his portfolio.

Question 18

The most likely reason that forward currency exchange rates are considered to be poor predictors of future spot rates is:

A
systematic over-estimation.

B
systematic under-estimation.

C
the margin of error is too great.

Answer 18

C
the margin of error is too great.

Question 19

harles Telford, CFA, is a research analyst for Edgemont Investments, and one of the companies he covers is Jackson Dynamics (JDN). Knowing that many of Edgemont’s clients own JDN shares, Telford increases his projection of the company’s next quarterly earnings in order to augment their returns. Neither Telford or any members of his immediate family owns any JDN shares and his compensation is unaffected by the returns on clients’ portfolios. Has Telford most likely violated the Standards?

A
No, because he served the clients’ interests

B
Yes, with respect to market manipulation only

C
Yes, with respect to market manipulation and independence and objectivity

Answer 19

B
Yes, with respect to market manipulation only

Telford acted with the intention of artificially manipulating the price of JDN shares, which is a violation of Standard II(B) - Market Manipulation.

There is no indication that Telford violated Standard I(B) - Independence and Objectivity.

Question 20

Carol Leung, CFA, discovers that a technical error has caused her firm to issue inaccurate account statements to its clients. Upon receiving this information, Leung informs all affected clients of the error and oversees the effort to ensure that the technical error is resolved and that new, accurate account statements are issued. Leung then ensures that all electronic and paper copies of the inaccurate statements are removed from client files and destroyed. Has Leung most likely violated the Standards?

A
No

B
Yes, with respect to record retention

C
Yes, with respect to both record retention and performance presentation

Answer 20

B
Yes, with respect to record retention

Standard V(C) - Record Retention requires members and clients to develop and maintain records of investment-related communications with clients and prospective clients. In this example, Leung has violated this Standard by destroying all copies of the inaccurate statements. An action that is more consistent with this Standard would be to ensure that all copies of inaccurate statements are clearly labeled as such.

Question 21

Nathan Bradley, CFA, an independent equity analyst, accepts an offer from Whitten Manufacturing (WMN) to write a research report analyzing the company’s stock. Before undertaking any work on the report, Bradley agrees to accept a flat fee and a fixed number of WMN stock options as compensation. Neither the value of the fee or the number of options Bradley receives is linked to his report’s conclusions or recommendations. One year after the report is issued, Bradley exercises the options. Has Bradley most likely violated the Standards?

A
No

B
Yes, with respect to independence and objectivity only

C
Yes, with respect to both independence and objectivity and additional compensation arrangments

Answer 21

B
Yes, with respect to independence and objectivity only

Issuer-paid research, such as the work described in this example, is allowed by Standard I(B) - Independence and Objectivity under certain conditions. Bradley would not have violated this Standard by accepting a flat fee that was agreed in advance of him undertaking any work and was not linked to his report’s conclusions or recommendations. However, Bradley does violate this Standard by accepting a compensation package that includes options to purchase WMN shares as this type of equity-based compensation could reasonably be expected to influence his ability to remain independent and objective. Bradly will likely be biased to release a positive report as that will increase the value of his stock options of WMN.

There is no indication that Bradley has violated Standard IV(B) - Additional Compensation Arrangements, which prohibits members and candidates from accepting compensation for work that conflicts with the interest of their employer without receiving written consent from all parties involved

Question 22

Crispin Dell, CFA, has recently joined Herefordshire Securities after working for several years as an equity analyst at Vexhale Capital.

Dell covers the mining sector and believes that environmental, social, and governance (ESG) factors have a material impact on company valuations.

During his time at Vexhale, Dell relied on the firm’s subscription to an online ESG rating database. After moving to Herefordshire, Dell learned that his new firm uses an alternative ESG rating service that he had not previously used. Dell has not found any reason to question the soundness of the methodology employed by the ESG rating service used by Herefordshire, but he has a strong preference for the ESG rating database that he used for many years at Vexhale.

The research reports that he writes for Herefordshire’s clients are based on insights from both his new firm’s ESG rating service and the ESG rating database that he continues to access using his login information from his time at Vexhale. Dell has most likely violated the Standards with respect to:

A
loyalty only.

B
diligence and reasonable basis only.

C
both loyalty and diligence and reasonable basis.

Answer 22

A
loyalty only.

Standard IV(A) - Loyalty prohibits members and candidates from misappropriating an employer’s former property. In this case, Dell has violated this Standard by continuing to use his login information from his time at Vexhale after he is no longer employed by that firm.

Question 23

Which of the following statements is most accurate? Under the converged revenue recognition standards issued by IASB and FASB, companies are:

A
prohibited from recognizing revenue for services that have not been completely rendered.

B
not required to recognize revenue for services that have already been completely rendered.

C
prohibited from recognizing revenue for goods until they have been physically delivered to the customer.

Answer 23

B
not required to recognize revenue for services that have already been completely rendered.

Under the converged standards adopted by IASB and FASB in May 2014, decisions about revenue recognition depend significantly on the terms of a contract. The two key issues to consider are:

What are each party’s rights and responsibilities under the contract?

Is it likely that payment will be collected?

A contract can only exist if it is likely that the seller will be able to collect the payment. Sellers are not required to recognize revenue if there are significant doubts about collectability. Indeed, revenue recognition is prohibited under such circumstances, even if the contracted services have already been performed.

Question 24

Emily Champlain, CFA, is the CEO of an online securities exchange. In order to attract interest in new weather derivatives, Champlain issues a press release announcing an agreement that she brokered with a group of exchange members that will ensure a guaranteed minimum trading volume in these securities for the first three months that they are traded on the exchange.

With interest in weather derivatives still below expectations after this initial period, Champlain convinces the group to extend their agreement for an additional three months, but no subsequent press release is issued. Has Champlain most likely violated the Standards?

A
No

B
Yes, by brokering an agreement to provide artificial liquidity

C
Yes, by failing to notify investors that the agreement was extended

Answer 24

C
Yes, by failing to notify investors that the agreement was extended

According to Standard II(B) - Market Manipulation, member and candidates must not “artificially inflate trading volume with the intent to mislead market participants.” In this example, Champlain does not violate this Standard by brokering an agreement to ensure a minimum trading volume because this information has been disclosed to investors and there is therefore no intention to mislead.

However, Champlain does violate this Standard when she extends the term of the agreement without announcing this. She has misled investors who are under the impression that the agreement expired after the initial three-month period.

Question 25

Which of the following is most likely an indication of a bias in a company’s revenue recognition choices?

A
Revenue is recognized after goods are shipped to customers

B
Revenue has increased significantly from the previous period

C
Estimates of rebate fulfillment have a significant impact on net revenues

Answer 25

C
Estimates of rebate fulfillment have a significant impact on net revenues

Rebate programs with many estimates could significantly impact revenue. For example, company forecasts could estimate low rebate amounts to boost revenue. Therefore, this is a potential bias in revenue recognition.

Question 26

debt to equity ratio formula

Answer 26

(long term debt + short term debt) / total equity

Question 27

Ken Bush, CFA, has recently joined the fixed income department of a regional bank. After observing some activities that he believes to be illegal, Bush does not report his suspicions to his firm’s compliance department, choosing instead to immediately resign and report his suspicions to regulators. Has Bush most likely violated the Standards?

A
No

B
Yes, by resigning without reporting his suspicions to his firm’s compliance department

C
Yes, by reporting his suspicions to regulators without reporting his suspicions to his firm’s compliance department

Answer 27

A
No

Standard I(A) - Knowledge of the Law requires members and candidates to dissociate from any violation of laws, rules, regulations, or the Standards themselves.

This Standard does not require members and candidates to report their suspicions to legal or regulatory authorities (unless such action is specifically required by law and there is no evidence of such a requirement in this example). The guidance for this Standard recommends that members and candidates who have observed what they believe to be illegal or unethical activities begin by reporting these concerns by their firm’s compliance department. While Bush may have reported his suspicions to regulators and resigned his position earlier than might be required by this Standard, he has not violated it by doing so.

Question 28

ichard Golic, CFA, is a research analyst covering firms in the consumer electronics sector for G&G Investments. Golic finds that he is able to provide his clients with more insightful analysis by consulting with a network of industry experts, who he compensates. His analysis of these consultations informs the research reports that he distributes to his clients. Has Golic most likely violated the Standards?

A
No

B
Yes, with respect to independence and objectivity

C
Yes, with respect to material nonpublic information

Answer 28

A
No

Standard II(A) - Material Nonpublic Information allows members and candidates to maintain a network of experts and provide compensation for their work, provided they do not solicit, act on, or cause others to act on material nonpublic information.

Compensating industry experts for their work does not constitute a violation of Standard I(B) - Independence and Objectivity.

Question 29

Lucas Stamford, CFA, and Tamara Howarth, CFA, are money managers with a large investment firm. Both receive quarterly bonuses from their employer for each of their clients whose portfolio outperforms its benchmark. Additionally, both receive quarterly bonuses based on client reports on service quality. Howarth discloses the details of both of these bonuses to clients and prospective clients orally and in writing, whereas Stamford only discloses the details of the bonus based on outperforming a benchmark. Which of the following statements is most likely correct?

A
Howarth and Stamford have both violated the CFA Standards

B
Howarth and Stamford have both adhered to the CFA Standards

C
Howarth has adhered to the CFA Standards, but Stamford has not

Answer 29

B
Howarth and Stamford have both adhered to the CFA Standards

Standard VI(A) - Disclosure of Conflicts requires members and candidates to make “full and fair disclosure of all matters that could reasonably be expected to impair their independence and objectivity.” In this example, both Howard and Stamford have adhered to this Standard because they have disclosed the details of their bonuses based on short-term investment performance to their clients and prospective clients. Stamford does not violate this Standard by failing to disclose the details of a bonus based on client reports on service quality.

Question 30

Katrina Bradshaw passed the Level II CFA exam in 2020 and is currently registered to take the next Level III exam. Which of the following references to her participation in the CFA Program is most likely consistent with the Standards?

A
Level III CFA (Candidate)

B
CFA Level II passed (2020)

C
Passed Level II of the CFA exam

Answer 30

C
Passed Level II of the CFA exam

Standard VII(B) - Reference to CFA Institute, the CFA Designation, and the CFA Program prohibits any use of references that imply a partial CFA designation. “Passed Level II of the CFA exam” is a factual statement that is consistent with this Standard.

By contrast, “Level III CFA (Candidate)” and “CFA Level II passed (2020)” imply a partial designation.

Question 31

how to find Days of Payable?

Answer 31

1. Cash Conversion cycle formula:

CCC = DOH + DSO - DP

DSO = 365 / receivables turnover

receivables turnover = revenues / averages AR

DOH = 365 / inventory turnover

inventory turnover = COGS / average value of inventory

DP = Days of payable

Question 32

All else equal, an increase a company’s effective tax rate will most likely affect:

A
its operating margin, but not its ROIC.

B
its ROIC, but not its operating margin.

C
both its operating margin and its ROIC.

Answer 32

B
its ROIC, but not its operating margin.

Return on invested capital (ROIC) is calculated as net operating profit less adjusted taxes (NOPLAT) divided by invested capital (net operating assets). Operating margin is earnings before interest and tax (EBIT) divided by sales.

Question 33

An equity analyst would most likely use a nonparametric test rather than a parametric test when:

A
comparing the means of two populations with known variance.

B
the sample size is small and does not conform to a normal distribution.

C
the data are sufficiently robust to allow more assumptions to be made about the population.

Answer 33

B
the sample size is small and does not conform to a normal distribution.

A nonparametric test is preferable to a parametric test in cases when there is a small sample and the distribution of the population may deviate significantly from the assumption of normality. Nonparametric tests are either unconcerned with the population from which the sample is drawn or make minimal assumptions about them.

Question 34

Fred Lange, CFA, a senior portfolio manager for a major Midwest banking organization, frequently goes out to lunch with clients and consumes alcoholic beverages on most of those occasions. Lange’s coworkers are aware of his habits, but Lange’s drinking has not compromised his ability to do work, as he is regularly recognized for his professional achievements. One afternoon after returning from lunch with a client, Lange misstates his fund’s performance in a conversation with a prospective client. This misstatement is quickly corrected by Lange’s colleague, Jennifer Helton. Has Lange most likely violated the Standards?

A
No

B
Yes, with respect to misconduct

C
Yes, with respect to misrepresentation

Answer 34

A
No

It does not appear that Lange has violated Standard I(C) - Misrepresentation, as there is no evidence that he deliberately misstated his fund’s performance.

Lange has not violated Standard I(D) - Misconduct, as his actions do not appear to constitute conduct that “reflects adversely” on his “professional reputation, integrity, or competence.” Of note, although it appears that Lange regularly consumes alcohol, there is no evidence that he does so to excess or that such consumption has affected his performance at work.

Question 35

an analyst states that the equity risk premium is greater than 3.7%. Which of the following is most likely an example of a Type I error committed while testing this hypothesis?

A
Rejecting the null hypothesis when the equity risk premium is equal to 3.7%

B
Not rejecting the null hypothesis when the equity risk premium is less than 3.7%

C
Not rejecting the null hypothesis when the equity risk premium is greater than 3.7%

Answer 35

A
Rejecting the null hypothesis when the equity risk premium is equal to 3.7%

In this example, the “suspected” or “hoped for” condition is that the equity risk premium is greater than 3.7%. By convention, this is established as the alternative hypothesis. The null hypothesis is that the equity risk premium is equal to or less than 3.7%.

A Type I error occurs when the null hypothesis is rejected when it should have been accepted. In this example, the null hypothesis should only be rejected (and the alternative hypothesis accepted) if the equity risk premium is greater than 3.7%. Rejecting the null hypothesis when the equity risk premium is equal to 3.7% is a Type I error.

Not rejecting the null hypothesis when the equity risk premium is less than 3.7% would be a correct decision.

Not rejecting the null hypothesis when the equity risk premium is greater than 3.7% would be a Type II error.

Question 36

fixed chares coverage ratio:

Answer 36

(EBIT + lease payments) / (Interest + lease payments)

Question 37

ROE formula (dupont formula)

Answer 37

The DuPont formula separates return on equity (ROE) into five components as follows:

ROE = tax burden * Interest burden * EBIT margin * Total asset turnover * leverage

Question 38

A currency that cannot be converted into any other commodity is most accurately described as:

A
fiat money.

B
legal tender.

C
a promissory note.

Answer 38

A
fiat money.

Most of the world’s major currencies today are fiat money, meaning that they cannot be converted into any other commodity (e.g., gold). Fiat money is backed only by a decree from its issuing government.

Question 39

IFRS-compliant companies are least likely required to disclose which of the following for their intangible assets?

A
Fair value

B
Amortization method

C
Whether the useful lives are indefinite or finite

Answer 39

A
Fair value

Under IFRS, for intangible assets, a company must disclose whether the useful lives are indefinite or finite.

If an asset is deemed to have an indefinite life, the company must disclose the reasons for this judgment as well as the asset’s carrying value.

For intangible assets with finite useful lives, for each class of intangible asset, the company must disclose:

• Estimated useful lives
• Amortization methods
• Gross carrying amount
• Accumulated amortization at the beginning and end of the period, where amortization is included on the income statement
• A reconciliation of the carrying amount at the beginning and end of the period

Question 40

Brian Sheppard is registered to take the Level III CFA exam. In a conversation with Sheppard about his preparations, his supervisor, Rita McDowell, CFA, makes the following comment: “The Global Investment Performance Standards (GIPS) were not tested on the Level III CFA exam when I took it because they were not in the Candidate Book of Knowledge (CBOK) at that time.” Upon hearing this, Edward Holbrook, CFA, adds: “GIPS wasn’t tested on the Level III exam when I took it three years ago, but they were in the CBOK.” What is the most accurate assessment of this conversation?

A
The Standards have not been violated

B
Only Holbrook has violated the Standards

C
Both Holbrook and McDowell have violated the Standards

Answer 40

B
Only Holbrook has violated the Standards

According to the guidance related to Standard VII(A) - Conduct as Participants in CFA Institute Programs, information about topics that are either tested or not tested on a CFA exam cannot be shared. Holbrook violates this Standard by revealing that GIPS was not tested on the Level III CFA exam he took when this topic was included in the CBOK. Such disclosure violates the Candidate Pledge taken by all candidates who take a CFA exam.

McDowell does not violate this Standard by stating that GIPS was not tested on the Level III CFA exam that she took. Only material that is included in the CBOK may be tested on a CFA exam, so GIPS could not possibly have been tested that year.

Question 41

Jack Fahey, CFA, is a portfolio manager of Pacific Sunrise Investments, which does not claim compliance with the Global Investment Performance Standards (GIPS). When presenting the historical performance of his small-cap growth composite, Fahey notes that only fee-paying accounts are included, but he does not mention that both discretionary and non-discretionary accounts are included. Has Fahey most likely violated the Standards?

A
Yes, with respect to performance presentation only

B
Yes, with respect to both performance presentation and misrepresentation

C
No, because Pacific Sunrise Investments does not claim compliance with GIPS

Answer 41

B
Yes, with respect to both performance presentation and misrepresentation

According to Standard I(C) - Misrepresentation, members and candidates “must not knowingly make any misrepresentations relating to investment analysis, recommendations, actions, or other professional activities.”

Standard III(D) - Performance Presentation requires members and candidates to make reasonable efforts to present performance information in a manner that is “fair, accurate, and complete.”

In this example, Fahey violates both of these Standards by failing to note that the small-cap growth composite includes both discretionary and non-discretionary accounts, as the composite’s performance may misrepresent his abilities as a portfolio manager. The compliance status of Fahey’s firm with GIPS is irrelevant to whether he has personally violated these Standards.

Question 42

If an economy’s real trend growth rate is 1.0% and the target inflation rate is 2.0%, a central bank interest rate of 2.5% would most likely be described as:

A
neutral.

B
expansionary.

C
contractionary.

Answer 42

B
expansionary.

The basis for contractionary/expansionary interest rates is the neutral interest rate, which is the sum of the real trend rate of economic growth and the target rate of inflation. In this example, the neutral rate is 3.0% (1.0% real growth plus 2.0% target inflation).

Rates above the neutral interest rate work to slow the economy and are viewed as contractionary. Rates below the neutral interest rate are expected to grow the economy and can be seen as expansionary. The 2.5% policy rate in this example is expansionary because it is below the 3.0% neutral rate.

Question 43

Walter Simon, CFA, manages an equity fund. One of the investors in Simon’s fund is the Prince Family Trust, which is administered by its trustee, David Bollinger. The Trust’s beneficiary is Debbie Prince, who requires long-term care for a chronic illness. The Trust generates income to help pay for Debbie’s care, and any additional costs are covered by her sister and legal guardian, Ann Prince. Simon’s duty of loyalty is most likely owed to:

A
Ann Prince.

B
Debbie Prince.

C
his fund’s mandate.

Answer 43

C
his fund’s mandate.

According to Standard III(A) - Loyalty, Prudence, and Care, fund managers must remain faithful to their fund’s statement mandate rather than acting in the interests of one or more particular investors. Therefore, Simon’s duty of loyalty is owed to the fund’s mandate.

On the other hand, as a trustee, Bollinger owes his duty of loyalty to Debbie Prince, who is the ultimate beneficiary.

Question 44

IFRS-compliant companies are least likely required to disclose which of the following for their intangible assets?

A
Fair value

B
Amortization method

C
Whether the useful lives are indefinite or finite

Answer 44

A
Fair value

Under IFRS, for intangible assets, a company must disclose whether the useful lives are indefinite or finite.

If an asset is deemed to have an indefinite life, the company must disclose the reasons for this judgment as well as the asset’s carrying value.

Question 45

Jack Fahey, CFA, is a portfolio manager of Pacific Sunrise Investments, which does not claim compliance with the Global Investment Performance Standards (GIPS). When presenting the historical performance of his small-cap growth composite, Fahey notes that only fee-paying accounts are included, but he does not mention that both discretionary and non-discretionary accounts are included. Has Fahey most likely violated the Standards?

A
Yes, with respect to performance presentation only

B
Yes, with respect to both performance presentation and misrepresentation

C
No, because Pacific Sunrise Investments does not claim compliance with GIPS

Answer 45

B
Yes, with respect to both performance presentation and misrepresentation

According to Standard I(C) - Misrepresentation, members and candidates “must not knowingly make any misrepresentations relating to investment analysis, recommendations, actions, or other professional activities.”

Standard III(D) - Performance Presentation requires members and candidates to make reasonable efforts to present performance information in a manner that is “fair, accurate, and complete.”

In this example, Fahey violates both of these Standards by failing to note that the small-cap growth composite includes both discretionary and non-discretionary accounts, as the composite’s performance may misrepresent his abilities as a portfolio manager. The compliance status of Fahey’s firm with GIPS is irrelevant to whether he has personally violated these Standards.

Question 46

Compared to an otherwise identical option-free bond, a putable bond’s convexity is most likely:

A
lower.

B
the same.

C
higher.

Answer 46

C
higher.

a putable bond behaves like an equivalent option-free bond if interest rates are below its exercise rate.

However, as the interest rates increase and the put option becomes more valuable, the value of the putable bond will decrease more slowly than that of the vanilla bond.

The prices of bonds with more convexity appreciate more when interest rates fall and depreciate less when interest rates rise. All else equal, adding a put option to an option-free bond increases convexity.

Question 47

Which of the following is most accurate for a company in the growth stage?

A
Debt is typically not available or is very expensive due to the financial characteristics in this stage.

B
Companies in this stage use debt cautiously to preserve flexibility and minimize the risk of financial distress.

C
In this stage, debt financing may be more attractive than higher-cost equity financing due to tax benefits

Answer 47

B
Companies in this stage use debt cautiously to preserve flexibility and minimize the risk of financial distress.

Question 48

A make-whole call option on a bond most likely provides its issuer with the right to:

A
pay the bond off early by issuing new subordinated debt securities.

B
miss a payment, provided they make up for it, with interest, at a later date.

C
repurchase bonds based on the present value of expected future cash flows.

Answer 48

C
repurchase bonds based on the present value of expected future cash flows.

A make-whole provisions are included in a callable bond, which grant the issuer the right to repurchase it before maturity. Under a make-whole provision, the price at which the issuer can repurchase the bonds is set to the net present value of future payments.

By contrast, callable bonds without such a provision typically stipulate a pre-set price that the issuer has to pay bondholders.

Question 49

Which of the following is most likely to be correct with regard to swaps?

A
The price of a swap at initiation is zero

B
The price of a swap changes over the life of the contract

C
The value of a swap is equal to the present value of the net cash flow payments from the swap

Answer 49

C
The value of a swap is equal to the present value of the net cash flow payments from the swap.

The value of a swap is zero at the initiation, not the price.

The price of a swap contract is determined at initiation and remains fixed over the life of the contract.

The value of a swap contract is calculated by using the principle of replication which calculates the value by calculating the present value of the net cash flow payments from the swap.

Question 50

An active portfolio manager who relies exclusively on fundamental analysis to identify undervalued securities most likely:

A
subscribes to the weak-form of the efficient market hypothesis.

B
does not subscribe to any forms of the efficient market hypothesis.

C
subscribes to the semi-strong-form of the efficient market hypothesis.

Answer 50

A
subscribes to the weak-form of the efficient market hypothesis.

Both the semi-strong-form and the strong-form hypothesize that market prices reflect all publicly available information. Under these paradigms, the manager would have nothing to gain from looking at these documents.

The hypothesis that leaves room for management gain with financial reports is the weak-form, which only claims that current prices reflect all past price data but allows for the possibility of excess risk-adjusted returns for fundamental analysis.

Question 51

Under which of the following situations are the IRR and NPV approaches most likely to give you consistent results?

A
When ranking projects of different sizes

B
When there is only one project to consider

C
When ranking projects with different cash flow timings

Answer 51

B
When there is only one project to consider

In general, IRR and NPV give you the same results when you are deciding whether or not to accept a stand-alone project. They are much less likely to agree when ranking projects, particularly projects of different sizes and projects with different cash flow timings.

Question 52

Compared to a traditional 2 and 20 compensation package, an either/or fee arrangement most likely has:

A
a lower management fee rate and a higher incentive fee rate.

B
an incentive fee structure that makes hurdle rates unnecessary.

C
a higher management fee rate and a variable incentive fee rate.

Answer 52

A
a lower management fee rate and a higher incentive fee rate.

In an either/or compensation structure, managers agree that their annual compensation will be either a relatively low management fee (e.g., 1%) or a relatively high incentive fee rate (e.g., 30%) on gains above a specified hurdle rate.

Question 53

An analyst made the following statement:

“The static trade-off theory states that, as the proportion of debt in a firm’s capital structure moves above zero toward its optimal level, the firm’s marginal costs of debt and equity decrease. Once the firm borrows beyond the optimal level, both of these costs increase.”

The analyst’s comments in the statement are most likely:

A
Correct.

B
Incorrect with respect to the cost of equity only.

C
Incorrect with respect to both the cost of equity and the cost of debt.

Answer 53

C
Incorrect with respect to both the cost of equity and the cost of debt.

The analyst’s claim is incorrect with respect to both the cost of equity and the cost of debt. According to the static trade-off theory, however much debt a firm has in its capital structure, the cost of issuing incrementally more debt will be higher due to the increased risk associated with greater financial leverage.

Rather, it is the firm’s weighted average cost of capital (WACC) that will decline as its debt-to-capital ratio rises to its optimal level and then increase as the firm borrows beyond this point.

Question 54

Prosystems Development, an IT consulting firm, has been around for 20 years and is facing its first liquidity crisis. Prosystems recently purchased a building, but work has since dried up and rent is difficult to come by. The primary sources of liquidity have been utilized already, and Prosystems is looking for options. Which of the following would most accurately be classified as a secondary source of liquidity?

A
Short-term treasuries

B
Restructuring debt obligations

C
Drawing upon a revolving line of credit

Answer 54

B
Restructuring debt obligations

Liquidity, the ability to meet short-term obligations, can be broken down into primary and secondary sources. Primary sources are those which are able to be taken without affecting the normal company operations. Secondary sources will have an effect.

Secondary sources of liquidity include:

Suspending or reducing dividend payments
Reducing or delaying capital expenditures
New equity issues
Restructuring debt obligations
Liquidating assets
Filing for bankruptcy

Primary sources of liquidity include:

Cash and marketable securities on hand
Borrowings
Cash flow from the business

Question 55

Terynor ratio formula

Answer 55

(Return P - RF)/Beta P

Question 56

Portfolio Beta formula

Answer 56

Wa * Ba + Wb * Bb

Question 57

In an investment policy statement (IPS), a client’s risk objectives should most likely be stated:

A
in relative terms only.

B
in absolute terms.

C
in either absolute or relative terms.

Answer 57

C
in either absolute or relative terms.

Either absolute or relative are acceptable approaches to specifying risk objectives. If relative, they should reference a suitable benchmark, such tracking risk relative to an index.

Question 58

Which of the following statements is most accurate? Real assets:

A
are limited to tangible, physical assets.

B
include both timberland and infrastructure.

C
cannot be accessed through publicly-traded investment vehicles.

Answer 58

B
include both timberland and infrastructure.

Question 59

Which of the following comments is most likely correct?

A
Contingent claims provide linear payoffs

B
Both parties to a contingent claim are exposed to counterparty default risk

C
The long party to a contingent claim cannot lose more than the premium specified in the contract

Answer 59

C
The long party to a contingent claim cannot lose more than the premium specified in the contract

Contingent claims payoffs are not linearly related to the underlying. For example, the long party to a call option will profit if the price of the underlying is above the exercise price, but does not face symmetrical downside risk because potential losses are limited to the premium paid.

After the premium has been paid at initiation, the long party cannot be required to make any additional payments. Therefore, the short party is not exposed to any default risk.

Question 60

float-adjusted, value-weighted index will most likely exclude shares held by:

A
mutual funds.

B
pension funds.

C
other corporations.

Answer 60

C
other corporations.

float-adjusted, value-weighted index includes component securities based on the market value of their shares that are available to the investing public. Typically, shares held by controlling shareholders, governments, and other corporations are considered to be unavailable and therefore excluded. By contrast, shares owned by institutional investors such as mutual funds and pension funds would be included in a float-adjusted, value-weighted index because they are available to be traded.

Question 61

Donna Anderson, a portfolio manager with Argentia Investments, has been asked to contribute to the development of her firm’s risk budgeting policy. In an email to her supervisor, she makes the following comment: “The objective of risk budgeting is to achieve maximum returns. I recommend a firm-wide risk budget that allocates risk as measured by beta.” Anderson’s comment is most likely:

A
correct.

B
incorrect with respect to the objective of risk budgeting.

C
incorrect because beta cannot be used as a metric for risk budgeting.

Answer 61

B
incorrect with respect to the objective of risk budgeting.

Risk budgeting is the implementation of an organization’s risk tolerance decision. The optimal risk tolerance is quantified according to a specific metric or metric and allocated among the organization’s various units. Metrics that are commonly used in the risk budgeting process include standard deviation, beta, value at risk (VaR), and scenario loss.

The objective of risk budgeting is not to maximize returns, but rather to frame decisions in terms of return per unit of risk.

Question 62

Securitizers most likely structure collateralized mortgage obligations (CMOs) that include floating rate tranches with the objective of:

A
reducing extension risk.

B
attracting more investors.

C
reducing prepayment risk.

Answer 62

B
attracting more investors.

A CMO that includes floating rate tranches will appeal to a larger pool of potential investors than an otherwise equivalent CMO that offers only fixed-rate tranches.

Floating rate tranches are created by dividing a fixed rate tranche into two equal subtranches. The first subtranche pays a floating rate, such as Libor + 2.0%, and the second subtranche pays an inverse floating rate, such as 10.0% - (Libor + 2.0%). If interest rates rise, the floating rate subtranche pays more interest and the inverse floating rate subtranche pays less interest, but total interest payments are equal to the fixed rate for the tranche from which these offsetting subtranches were created.

Neither prepayment risk nor extension risk is affected because of the decision to offer floating rate tranches.

Question 63

A portfolio’s rebalancing policy is most accurately described as:

A
guidelines for adhering to an investor’s risk budget.

B
the requirement to reset asset classes to their policy weights at predetermined time intervals.

C
the rules guiding the process of restoring the portfolio’s original exposures to systematic risk factors.

Answer 63

C
the rules guiding the process of restoring the portfolio’s original exposures to systematic risk factors.

The formal definition of the rebalancing policy is the set of rules that guide the process of restoring a portfolio’s original exposures to systematic risk factors. This is may be done periodically according to a schedule or whenever asset class weights move outside of specified corridors. It is not necessary for a rebalancing policy to refer to a risk budget.

Question 64

maximum initial leverage ratio formula

Answer 64

1 / initial margin requirement

Question 65

Which of the following best describes the free cash flow hypothesis?

A
Unequal information distribution exists between management and other stakeholders.

B
Higher debt levels discipline managers by forcing them to manage the company efficiently.

C
Managers choose methods of financing according to a hierarchy that gives first preference to methods with the least potential information content.

Answer 65

B
Higher debt levels discipline managers by forcing them to manage the company efficiently.

Statement A describes asymmetric information.
Statement B describes the free cash flow hypothesis.
Statement C describes the pecking order theory.

Question 66

A bond’s current yield is most likely used to measure the return that investors expect to receive as:

A
capital gains.

B
coupon income.

C
reinvestment income.

Answer 66

B
coupon income.

Current yield is measured as the total amount of coupon payments expected from a bond over the next year divided by its current price. This measure only considers coupon income and does not account for capital gains or reinvestment income.

Question 67

n equity index designed to represent all the market capitalization of all the major large-cap stocks in the world would most accurately be described as a:

A
sector index.

B
multi-market index.

C
broad market index.

Answer 67

B
multi-market index.

To reflect the market capitalization of all worldwide large-cap stocks, we would need to use a multi-market index invested in multiple markets.

Question 68

hich of the following is most likely the biggest source of risk from holding non-negotiable certificates of deposit (CDs) rather than negotiable CDs?

A
Credit risk

B
Liquidity risk

C
Interest rate risk

Answer 68

B
Liquidity risk

in a certificate of deposit (CD) is non-negotiable, investors are not allowed to sell the certificate. They will also pay a withdrawal penalty to access the money early. Negotiable CDs allow investors to sell the certificate on the open market.

Question 69

Which of the following combinations will most likely replicate the performance of a fiduciary call position?

A
Long risk-free bond, long forward contract, long put

B
Long risk-free bond, short forward contract, long put

C
Long risk-free bond, short forward contract, short put

Answer 69

A
Long risk-free bond, long forward contract, long put

Per put-call parity, the payoffs for a fiduciary call and a protective put must be identical:

fiduciary call = protective put

long call + risk free bond = long put + asset

Put-call forward parity is based on the same equilibrium, but the long asset position is replicated with the combination of a forward contract and a risk-free bond:

long call + risk free bond = long put + long forward contract + risk free bond

Question 70

n order to value an equity security, an analyst has collected information regarding cash flows available to be distributed to shareholders, capital expenditures of the company, and working capital needs. The analyst is most likely using:

A
a multiplier model.

B
a present value model.

C
an asset-based valuation model.

Answer 70

B
a present value model.

Cash flows available to be distributed to shareholders, capital expenditures of the company and working capital needs of the company are inputs required for determining equity value using a present value model.

Question 71

Which of the following derivative contracts are most likely traded on public exchanges?

A
Swaps

B
Futures

C
Forwards

Answer 71

B
Futures

Forwards and swaps are private, over-the-counter transactions. Futures, on the other hand, are standardized and traded on an exchange.

Question 72

futures prices formula

Answer 72

spot price * (1+r) + storage costs - convenience yield

Question 73

Which of the following statements is least likely correct? The risk management committee:

A
reviews risk policies at the operational level.

B
provides a forum for the top decision-makers to discuss risk management issues.

C
plans and executes value-maximizing strategies consistent with the governance guidance.

Answer 73

C
plans and executes value-maximizing strategies consistent with the governance guidance.

The risk management committee provides the governance structure at the operational level and provides a forum for the top decision-makers to discuss risk management issues.

It does not plan and execute strategies. That is the role of management.

Question 74

duration gap formula

Answer 74

Macaulay duration - Investment horizon

Ann Mod duration * (1=RF) - Investment horizon

Question 75

A channel strategy based on disintermediating distributors and retailers is most appropriate for companies with:

A
complex products.

B
a large target market.

C
a franchise business model.

Answer 75

A
complex products.

Implementing a direct sales model that circumvents distributors and retailers requires a significant investment to develop an in-house sales team.

Companies that have enjoyed the most success with this model tend to offer complex, high-margin products. This strategy is better suited for companies with business-to-business (B2B) business models because the customer base is relatively small and can be easily reached.

Question 76

formula to find the no-arbitrage forward price for a one-year contract based on a stock with spot price of $340

Answer 76

F0(T) = S0 * (1+r)^T

Question 77

Which of the following biases will least likely result in the under-diversification of a portfolio?

A
Availability bias

B
Self-control bias

C
Overconfidence bias

Answer 77

B
Self-control bias

Both availability bias and overconfidence bias result in portfolio under-diversification.

Availability bias – Investors assume that outcomes which are easier to remember are more likely. This results in limited investment opportunity sets and in turn causes their portfolios to be under-diversified.

Overconfidence bias - Investors underestimate risks and overestimate returns. As a result, they do not sufficiently diversify their portfolios.

Self-control bias occurs when people fail to make decisions that are best for their long-term goals due to a lack of self-discipline. While it causes investors to sacrifice long-term goals in favor of short-term satisfaction, it does not directly result in portfolio under-diversification.

Question 78

The fair value of a put option can be calculated using the put-call parity formula:

Answer 78

po = co - So + X/(1+r)

Question 79

how to find the arbitrage-free forward rate for currency pairs (formula):

Answer 79

Fo(T) = So * e^((rf-rd)*t)

Question 80

Under Modigliani and Miller’s propositions with corporate taxes, a company’s cost of equity (re) is calculated as follows:

Answer 80

re = ro + (ro - rd) * (1 - t)*(D/E)

ro is the cost of equity assuming no debt in the capital structure
rd is the pre-tax cost of debt
D is the market value of the company’s debt
E is the market value of the company’s equity

Question 81

security’s excess return is most likely plotted against the market’s excess return on the:

A
capital market line.

B
security market line.

C
security characteristic line.

Answer 81

C
security characteristic line.

The security characteristic line plots the performance of a specific security (or portfolio) against that of the market portfolio. It is a plot of the excess return of a security against the excess return on the market.

Question 82

cost of trade credit formula

Answer 82

(1 + discount/(1 - discount)) ^ (365/days beyond discount period) - 1

Question 83

linear interpolation formula

Answer 83

New Value = Low Value + (High Value - Low value) * (Goal reference - Low reference)/(High reference - Low reference)

Question 84

The party to a futures contracts who has received a margin call is least likely to take which of the following actions?

A
Close out the contract without depositing additional funds

B
Deposit additional funds to bring the account balance to the initial margin

C
Deposit additional funds to bring the account balance to the maintenance margin

Answer 84

C
Deposit additional funds to bring the account balance to the maintenance margin

When a party’s account balance falls below the maintenance margin, a margin call is made. The party must deposit additional funds sufficient to bring the account’s balance back to the initial margin level, not just back to the maintenance margin. Alternatively, the party can close out (settle) the contract without having to deposit any additional funds.

Question 85

Which of the following types of markets is most likely characterized by extended periods of complete illiquidity during the trading day?

A
Call markets

B
Brokered markets

C
Continuously traded markets

Answer 85

A
Call markets

Call markets conduct periodic auctions to determine a clearing price that maximizes trading volume. Such markets can be highly liquid at the specific auction times, but they are completely illiquid at all other times.

By contrast, trading can occur whenever a continuously traded market is open. While brokered markets are used as a venue for trading illiquid assets, they are never characterized by complete illiquidity.

Question 86

Which of the following biases will least likely result in the under-diversification of a portfolio?

A
Availability bias

B
Self-control bias

C
Overconfidence bias

Answer 86

B
Self-control bias

Both availability bias and overconfidence bias result in portfolio under-diversification.

Availability bias – Investors assume that outcomes which are easier to remember are more likely. This results in limited investment opportunity sets and in turn causes their portfolios to be under-diversified.

Overconfidence bias - Investors underestimate risks and overestimate returns. As a result, they do not sufficiently diversify their portfolios.

Self-control bias occurs when people fail to make decisions that are best for their long-term goals due to a lack of self-discipline. While it causes investors to sacrifice long-term goals in favor of short-term satisfaction, it does not directly result in portfolio under-diversification.

Question 87

An analyst made the following statement:

“The static trade-off theory states that, as the proportion of debt in a firm’s capital structure moves above zero toward its optimal level, the firm’s marginal costs of debt and equity decrease. Once the firm borrows beyond the optimal level, both of these costs increase.”

The analyst’s comments in the statement are most likely:

A
Correct.

B
Incorrect with respect to the cost of equity only.

C
Incorrect with respect to both the cost of equity and the cost of debt.

Answer 87

C
Incorrect with respect to both the cost of equity and the cost of debt.

The analyst’s claim is incorrect with respect to both the cost of equity and the cost of debt. According to the static trade-off theory, however much debt a firm has in its capital structure, the cost of issuing incrementally more debt will be higher due to the increased risk associated with greater financial leverage.

Rather, it is the firm’s weighted average cost of capital (WACC) that will decline as its debt-to-capital ratio rises to its optimal level and then increase as the firm borrows beyond this point.

Question 88

Franklin Motamba, CFA, works as a sell-side equity analyst and has covered the pharmaceutical sector for over a decade. Last year, Motamba’s father passed away after suffering from cancer for several years. Motamba later accepted a volunteer position on the board of the Patient Care Foundation (PCF), which advocates for the interests of cancer patients and has a history of lobbying for the approval of new cancer drugs that pre-dates his involvement with the organization. Motamba’s employer is aware of his volunteer work and has no business relationship with PCF. Since joining PCF’s board, Motamba has disclosed this position in all research reports published under his name. Upon learning that Colprex Pharmaceuticals unexpectedly received approval to market a new cancer drug, Motamba spends several hours updating his model before changing his recommendation for Colprex from “neutral” to “buy”. Has Motamba most likely violated the Standards?

A
No

B
Yes, with respect to independence and objectivity

C
Yes, with respect to diligence and reasonable basis

Answer 88

A
No

Motamba has not violated the Standards.

According to Standard I(B) - Independence and Objectivity, members and candidates must not “offer, solicit, or accept any gift that reasonably could be expected to compromise their own or another’s independence and objectivity.” In this example, Motamba receives no consideration of any kind for serving as a volunteer. Although PCF advocates for the approval of new cancer drugs, Motamba’s role as a director does not create an incentive for him to issue reports that are less-than-objective about the prospects for the pharmaceutical firms that he covers.

Standard V(A) - Diligence and Reasonable Basis requires members and candidates to “exercise diligence, independence, and thoroughness” when analyzing investment and making recommendations. Motamba’s buy recommendation was made after Colprex received approval that had not been expected, so this new information was unlikely to be reflected in its current share price. Additionally, Motamba spent several hours analyzing the impact of this news before updating his recommendation.

Question 89

Which one of the following is least likely to require a company to disclose separate information about any operating segment?

A
A single customer represents 5 percent or more of the company’s total revenue

B
The segment constitutes 10 percent or more of combined operating profit, assets, or revenue

C
The combined revenue from external customers for all reportable segments is less than 75 percent of the total company revenue

Answer 89

A
A single customer represents 5 percent or more of the company’s total revenue

The quantitative criteria necessitating a company to disclose separate information about any operating segment are:

The segment constitutes 10 percent or more of combined operating profit, assets, or revenue

The combined revenue from external customers for all reportable segments is less than 75 percent of the total company revenue

A single customer represents 10 percent or more of the company’s total revenue.

Question 90

If the neutral interest rate is 3.0%, and the long-term expected inflation rate is 1.5% within a range of plus or minus 1.0%, the real trend growth rate of the underlying economy is closest to:

A
1.5%.

B
2.5%.

C
4.5%.

Answer 90

A
1.5%.

The neutral interest rate is the sum of the real trend growth rate and long-term expected inflation.

Question 91

The quoted 1-year MXN/USD forward rate of 19.80 is above the intrinsic value implied by the current spot rate of 19.00 and risk-free rates of 6% and 3% for Mexico and the United States, respectively. A successful arbitrage strategy for an investor who can borrow at the Mexican risk-free rate would most likely involve:

A
selling MXN in the spot market.

B
buying USD in the forward market.

C
investing at the Mexican risk-free rate.

Answer 91

A
selling MXN in the spot market.

To exploit the arbitrage opportunity presented in this example, an investor would take the following steps:

1. Borrow MXN 19.00
2. Sell MXN 19.00 in the spot market, receive USD 1.00
3. Invest USD 1.00 at the 3% US risk-free rate
4. Enter a forward contract to sell USD (buy MXN) at the 1-year MXN/USD rate of 19.80

One year later,

1. The USD 1.00 invested at the 3% US risk-free rate is worth USD 1.03
2. USD 1.03 is sold and converted to MXN 20.394 based on the 19.80 MXN/USD rate in the forward contract
3. MXN 20.14 is repaid based on having borrowed MXN 19.00 for one year at the 6% Mexican risk-free rate
4. After repaying the loan, the investor earns an arbitrage profit of MXN 0.254 per USD.

Question 92

Paul Sparfeld, CFA, is in charge of presenting performance results for his investment firm, a sole proprietorship with three employees. Which of the following performance presentation policies adopted by Sparfeld’s firm is least likely consistent with the recommendations for compliance with the Standards?

A
Applying the GIPS standards.

B
Presenting composite returns that include both actual and simulated data

C
Removing the contribution of terminated portfolios when presenting historical returns

Answer 92

C
Removing the contribution of terminated portfolios when presenting historical returns

According to the recommendations for compliance with Standard III(D) - Performance Presentation, terminated accounts should be included when calculating historical performance. The point at which accounts were terminated should be clearly indicated. Removing the contribution of such accounts misrepresents historical performance.

Question 93

Herman Boldin, a Level III candidate in the CFA Program, is having a discussion about the designation with his colleague, Georgia Redwood. Redwood states, “I used to have the letters CFA after my name on my business cards before taking them off when I stopped paying my dues and filling out Professional Conduct Statements. But I’m still a CFA charterholder because I’ve got a charter from CFA Institute that says I fulfilled all the requirements prescribed for the use of the designation.” Redwood has most likely:

A
violated the CFA Standards and made an incorrect statement about the CFA designation.

B
not violated the CFA Standards and made a correct statement about the CFA designation.

C
not violated the CFA Standards but made an incorrect statement about the CFA designation.

Answer 93

A
violated the CFA Standards and made an incorrect statement about the CFA designation.

By removing the letters CFA after her name on her business cards when she stopped paying her dues and filling out Professional Conduct Statements, Redwood has complied with Standard VII(B) - Reference to CFA Institute, the CFA Designation, and the CFA Program.

However, she has violated this Standard, which applies to both written and oral statements, by incorrectly claiming to be a “CFA charterholder” when she no longer has the right to use the CFA designation because she is no longer fulfilling the obligations of a CFA charterholder.

Question 94

If an expansionary monetary policy is combined with a contractionary fiscal policy, the most likely outcome is that:

A
the private sector will expand as a share of GDP.

B
the public sector will expand as interest rates rise.

C
aggregate output will increase due to the larger share of government spending as a share of GDP.

Answer 94

A
the private sector will expand as a share of GDP.

The combination of contractionary fiscal policy and expansionary monetary policy (i.e., low interest rates) will reduce the public sector and increase the private sector as a share of GDP.

Question 95

The modeling of relationships using labeled training data is most accurately described as:

A
data curation.

B
supervised learning.

C
unsupervised learning.

Answer 95

B
supervised learning.

Question 96

A firm in a monopolistically competitive market most likely:

A
maximizes the selling price of its goods.

B
sells fewer goods than is socially optimal.

C
sets a price at the point where its marginal cost curve intersects with the demand curve.

Answer 96

B
sells fewer goods than is socially optimal.

A monopolistically competitive firm focuses on product differentiation. The different varieties of products offered imply there would be fewer goods sold than is socially optimal as opposed to a perfectly competitive firm. In this market, companies profit through innovation and experiment instead of price competition that tries to maximize the quantities sold.

Answer choice A is incorrect because a maximized selling price will severely drive down the demand, reducing the overall profit.

Answer choice C is incorrect because the maximum profit is accomplished by setting a price at the point where the marginal cost curve intersects with the marginal revenue curve, not the demand curve. This answer choice would be accurate only for a firm in a perfectly competitive market. In that case, the marginal revenue curve represents the demand curve (both are horizontal). So, its intersection with the marginal cost curve will produce an equilibrium price.

Question 97

deferred tax liability formula

Answer 97

(carrying value - tax base) * tax rate

Question 98

William Thorpe, CFA, is a portfolio manager who serves both individual and institutional clients. Due to a heavy workload, Thorpe is struggling to keep up with his clients. One task which takes up a large amount of Thorpe’s time is proxy voting. Which of the following statements is least likely correct, as it relates to Thorpe’s responsibility regarding voting of proxies? Thorpe:

A
must vote proxies in an informed and responsible manner.

B
is required to vote proxies only when specifically instructed to do so by his clients.

C
may choose not to vote proxies based on an analysis of the net benefit such action would provide the client.

Answer 98

B
is required to vote proxies only when specifically instructed to do so by his clients.

According to Standard III(A) - Loyalty, Prudence, and Care, members and candidates “have a duty of loyalty to their clients and must act with reasonable care and exercise prudent judgment. Members and Candidates must act for the benefit of their clients and place their clients’ interests before their employer’s or their own interests.”

Proxies have economic value and Thorpe must vote them responsibly on behalf of his clients, even when he is not specifically instructed to do so. While this obligation applies to votes on non-routine matters, members and candidates are not required to vote proxies in cases when a cost-benefit analysis shows that the client would not benefit.

Question 99

Which of the following statements is most likely correct regarding currencies that trade in foreign exchange markets?

A
The currency with the higher interest rate will trade at a forward discount

B
Currencies trade in foreign exchange markets based on real exchange rates

C
An increase in a direct exchange rate quote means that the domestic currency is appreciating versus the foreign currency

Answer 99

A
The currency with the higher interest rate will trade at a forward discount

The currency with the higher interest rate will tend to trade at a forward discount.

Currencies trade in foreign exchange markets based on nominal rather than real exchange rates.

A direct exchange rate quote uses the domestic currency as the price currency and the foreign currency as the base currency. An increase in this rate means that it takes more units of the price (domestic) currency to purchase one unit of the base (foreign) currency. Therefore, the domestic currency is depreciating relative to the foreign currency if the direct exchange rate quote increases.

Question 100

Which of the following statements is most accurate? Under US GAAP, companies that use the FIFO method must measure inventories at:

A
cost.

B
the lower of cost or market value.

C
the lower of cost or net realizable value.

Answer 100

C
the lower of cost or net realizable value.

Historically, US GAAP required inventories to be measured at the lower of cost or market value. Since 15 December 2016, companies that do not use LIFO or retail inventory methods must carry inventories at the lower of cost or net realizable value. This new requirement is similar to the reporting requirements imposed by IFRS.

Question 101

interest coverage ratio formula

Answer 101

(CFO + Interest paid + taxes paid) / interest paid

Question 102

enny Schmidt, CFA, works with high net worth clients at an investment firm. Schmidt regularly issues her investment recommendations. However, these recommendations are only provided to clients for whom the recommendation is deemed suitable or clients who have shown an interest in similar investments. Schmidt offers a higher level of service to clients who are wiling to pay an addition level of fees and she chooses to discuss her recommendations in more detail with the clients who pay for this option. The fee schedule is disclosed to all clients and prospective clients. Has Schmidt most likely violated the Standards?

A
No

B
Yes, by failing to distribute her recommendations to all her clients simultaneously

C
Yes, by discussing the recommendations in greater detail with a select group of clients

Answer 102

A
No

Standard III(B) - Fair Dealing requires members and candidates to “deal fairly and objectively with all clients when providing investment analysis, making investment recommendations, taking investment action, or engaging in other professional activities.” However, dealing fairly and objectively does not require equal treatment. Members and candidates are allowed to choose which clients receive recommendations, as long as the selection criteria are fair and objective rather than designed to benefit preferred clients. Additional levels of service for higher fees are consistent with this Standard as long as the fee schedule is disclosed to all clients and prospective clients.

Question 103

Which of the following items would most likely be included in a statement of cash flows that has been prepared using the direct method?

A
Depreciation expense

B
Proceeds from issuance of long-term debt

C
Unrealized gain on available-for-sale securities

Answer 103

B
Proceeds from issuance of long-term debt

The direct method for reporting cash flows includes only cash receipts and cash payments. Because there is no cash receipt or payment for unrealized gains or depreciation expense, these items would not be included on a direct-format cash flow statement. The proceeds from the issuance of long-term debt is a cash receipt, so this would be included in a direct-format cash flow statement

Question 104

Kentaro Ino, CFA, owns a 9% shareholder position of Vandyke Motors (VDM). Local regulations require public disclosure of any ownership position over 10%. However, this requirement applies only to direct stock ownership, not derivatives-based positions. Over the next three months, Ino, an activist investor, intends to execute a hostile takeover of VDM. However, in order to avoid having to publicly disclose his position before pursuing this strategy, Ino acquires VDM call options that expire in 6 months.

Ultimately, Ino is able to exercise his call options for less than VDM’s prevailing market price as part of his successful takeover bid. Has Ino most likely violated the Standards?

A
No

B
Yes, by engaging in transaction-based manipulation

C
Yes, by engaging in information-based manipulation

Answer 104

A
No

Standard II(B) - Market Manipulation prohibits members and candidates from engaging in “practices that distort prices or artificially inflate trading volume with the intent to mislead market participants.” This Standard does not prohibit legitimate trading strategies

In this example, Ino has complied with the relevant regulation. He had no obligation to publicly declare his ownership position until after the options had been exercised. While unwelcome by managers of companies that are targeted, hostile takeovers are not inherently unethical. Ino has attempted to ensure that he does not overpay for VDM, but he has not acted to intentionally mislead market participants by distorting prices or trading volume

Question 105

cott Holly, CFA, is an equity manager who pursues a value investment style. When making investment decisions for clients, Holly relies on a proprietary quantitative model that has been developed within his firm. Recently, Holly decided to use a new version of the original model that has been adapted to forecast stock prices using different discount rates for various stages of growth. The recommendations are consistent with Holly’s value investment style that has been deemed suitable for all of his clients. Has Holly most likely violated the Standards if he does not inform his clients about the change in the model?

A
Yes

B
No, because his investment style has not changed and it is suitable for his clients

C
No, because the recommendations are based on a version of a model that is known to clients

Answer 105

A
Yes

Standard V(B) - Communication with Clients and Prospective Clients requires members and candidates to disclose changes in investment analysis to clients and prospective clients.

In this example, Holly violates this Standard by failing to disclose that his recommendations are based on a new version of a model that he had previously used.

Question 106

im Reddington, CFA, is researching Elizabeth Keene Brands (EKN), a designer clothing manufacturer. After analyzing both public and nonpublic information, including insights obtained from interviews with fashion industry experts, Reddington concludes that consumer demand for EKN’s new line will fall below expectations and he shorts the company’s stock in his personal account. Has Reddington most likely violated the Standards?

A
No

B
Yes, with respect to priority of transactions

C
Yes, with respect to material nonpublic information and priority of transactions

Answer 106

A
No

Reddington’s actions appear to be consistent with Standard II(A) - Material Nonpublic Information, which prohibits members and candidates from acting on or causing others to act on information that is both material and nonpublic. Although Reddington has based his actions in part on nonpublic information, there is no indication that any of it is material.

Additionally, there is no evidence that Reddington has violated Standard VI(B) - Priority of Transactions by taking a short position in EKN’s stock. Reddington does not appear to manage any client accounts and is free to take such action because no clients that have been disadvantaged by his personal trades.

Question 107

Under the matching principle, administrative costs are least likely to be recognized as expenses for the period when:

A
cash is paid.

B
the benefit is received.

C
the corresponding revenue is recognized.

Answer 107

C
the corresponding revenue is recognized.

Under the matching principle, expenses that can be directly tied to revenues are recognized when the revenue is recognized. For example, the cost of goods sold expense is recognized when inventory is sold.

However, expenses that cannot be easily linked to specific revenues should be recognized during the period when they are incurred or the benefit is received. For example, the salary of an inventory warehouse manager is not directly linked to the sale of any particular item that has been stored in the facility. The company should recognize this expense as it receives the benefit of the manager’s services and pays the manager’s salary.

Question 108

Which of the following statements is least accurate? A country’s domestic institutions:

A
may lack a formal structure.

B
are formed exclusively by state actors.

C
influence its international relationships.

Answer 108

B
are formed exclusively by state actors.

Institutions may be created by both governments or non-state actors. Their structure may be formal (e.g., universities) or informal (e.g., cultural practices). As a general rule, strong domestic institutions allow a country to operate with more authority and independence in its international relationships.

Question 109

Calvin Beauregard, CFA, works as an analyst with a securities dealer. For each potential investment that he is assigned to work on, Beauregard adheres to local laws by retaining electronic copies of all relevant documents for six years, at which point they are removed from the firm’s server. Documents that are produced as hard copies are scanned and saved in digital form before the original copies are securely shredded. Has Beauregard most likely violated the Standards?

A
No

B
Yes, by destroying hard copies of documents

C
Yes, by retaining records for less than seven years

Answer 109

A
No

Beauregard has not violated the Standards. According to Standard V(C) - Record Retention, members and candidates must maintain hard or soft copies of all documents that support their “investment analyses, recommendations, actions, and other investment-related communications with clients and prospective clients.” While CFA Institute recommends that records be maintained for a period of seven years, Beauregard does not violate this Standard by maintaining his records for the six-year period required by local laws.

If Beauregard did not take proper measures to ensure that hard copies of documents were shredded in a secure manner, he may be at risk of violating Standard III(E) - Preservation of Confidentiality. However, the evidence suggests that these documents were disposed of in an appropriate manner. Standard V(C) - Record Retention does not prohibit members and candidates from destroying hard copies of documents as long as electronic copies are retained.

Question 110

A sample of 20 months of normally distributed returns has a mean of 0.7% and a standard deviation of 3.5%. The population variance is unknown. To test the null hypothesis that the mean return for the population is less than 1.0%, which of the following tests is most likely appropriate?

A
A t-test only

B
A z-test only

C
Either a t-test or a z-test

Answer 110

A
A t-test only

Because the sample size in this example is small (less than 30) and the population variance is unknown, it is inappropriate to use a z-test. The t-test is always considered more appropriate in such circumstances.

Question 111

While working as an unpaid intern for Harborview Investments, Jenna Martin registers to take the Level I CFA exam. One of her projects at Harborview was the development of a financial model used to value commodity derivatives. After completing the Level I CFA exam, and while awaiting her results, Martin accepts a paid position with Dynavest Capital and receives written approval of her request to take the model that she developed during her time at Haborview to her new firm. She also takes the handwritten notes that she compiled while developing the model, without seeking approval to do so, since she was permitted to take the model itself. After formally starting with her new firm, Martin solicits the business of clients who she worked for while in her unpaid role at Harborview. Has Martin most likely violated the Standards?

A
No

B
Yes, by taking Harborview’s property to Dynavest

C
Yes, by soliciting the business of Harborview’s clients

Answer 111

B
Yes, by taking Harborview’s property to Dynavest

Martin violates Standard IV(A) - Loyalty by taking her handwritten notes, which belong to Harborview, without the firm’s consent. The fact that the firm approved her request to take the model does not eliminate the requirement for her to seek and obtain approval before taking her handwritten notes as well.

However, Martin does not violate this Standard by soliciting the business of Harborview’s clients after her relationship with that firm has ended. She is permitted to rely on her simple knowledge of her former employer’s clients and obtain their contact information through public records. There is also no indication that she is subject to a non-compete agreement.

Question 112

Thomas Easterling, CFA, is the Director of Research for Spruce Grove Capital (SGC). Easterling is careful to avoid giving even the appearance of exerting undue pressure on the analysts who work under his supervision. Although this is not official firm policy, Easterling and his analysts are aware that SGC will not distribute reports recommending the sale of shares issued by companies with which it has an investment banking relationship. Over the years that he has held his current position, Easterling has noted his opposition to this practice in conversations with SGC’s senior executives, but he has accepted that it will likely continue and believes that he can provide his analysts - mostly recent business school graduates - with training and skills that they can use after they leave SGC to work for other firms. Has Easterling most likely violated the Standards?

A
No

B
Yes, with respect to loyalty

C
Yes, with respect to independence and objectivity

Answer 112

C
Yes, with respect to independence and objectivity

According to Standard IV(A) - Loyalty, members and candidates “must act for the benefit of their employer and not deprive their employer of the advantage of their skills and abilities, divulge confidential information, or otherwise cause harm to their employer.” There is no indication that Easterling has violated this Standard in this example. At most, the scenario indicates that he works to improve the skills of the analysts he supervises while privately hoping that they will one day have the opportunity to apply these skills in a workplace environment that does not attempt to unduly influence the conclusions of their work.

In the guidance for Standard I(B) - Independence and Objectivity, we learn that managers, such as Easterling in this example, “have a responsibility to provide an environment in which analysts are neither coerced nor enticed into issuing research that does not reflect their true opinions.” Easterling has violated Standard I(B) when he continues to work for a firm that refuses to be independent and objective with its reporting standard.

Note that Easterling has likely also violated Standard I(A) - Knowledge of the Law by failing to take sufficient action to dissociate from the firm’s practice of refusing to publish reports recommending the sale of shares issued by its investment banking clients.

Question 113

hat is the most accurate assessment of the following statements?

Statement 1: A portfolio’s time-weighted rate of return is affected by cash withdrawals and additions.

Statement 2: The money-weighted return is an inappropriate measure to use when assessing the performance of a fund manager who does not control the timing and amount of cash withdrawals and additions.

A
Only Statement 1 is correct

B
Only Statement 2 is correct

C
Statement 1 and Statement 2 are both correct

Answer 113

B
Only Statement 2 is correct

Statement 2 is correct. A fund manager’s performance should only be judge on the basis of his or her decisions and actions, not on the basis of events over which he or she has no control. The money-weighted return can be skewed by the timing and amount of cash flows into and out of a fund, making it an inappropriate metric for assessing the performance of a manager who has no control over these.

Statement 1 is incorrect. The time-weighted return measure is unaffected by the timing and amount of cash flows.

Question 114

Excel Brokers has established a referral arrangement with Miller Investments according to which Excel refers clients seeking investment advice to Miller. In exchange, Miller provides Excel with access to all its investment research. Additionally, Miller’s clients who were referred by Excel pay lower commissions for trades that Excel executes on their behalf. Randall Jacoby, CFA, is an advisor with Miller. Jacoby has recently signed a client who has an account with Excel but was not referred by anyone at that firm. After completing the paperwork required to formalize the advisory relationship, Jacoby discloses the full details of the arrangement between his firm and Excel. Has Jacoby most likely violated the Standards?

A
Yes

B
No, because he is not receiving any direct compensation

C
No, because the client came to Miller without being referred

Answer 114

A
Yes

Standard VI(C) - Referral Fees requires members and candidates to “disclose to their employer, clients, and prospective clients, as appropriate, any compensation, consideration, or benefit received from or paid to others for the recommendation of products or services.”

In this example, Jacoby violates this Standard by failing to disclose the details of the arrangement between Excel and Miller before entering into a service agreement with his new client, who would have been able to more accurately assess the nature of the services and their relative costs. Although the client was not referred by anyone at Excel and Jacoby is not being directly compensated, these facts do not absolve him of his responsibilities under this Standard. This arrangement will impact the client’s account and must be disclosed.

Question 115

when to used a paired comparison test?

Answer 115

when to samples are dependent to each other

Question 116

coefficient of variation formula

Answer 116

sample standard deviation / sample mean

Question 117

Companies that issue financial statements in accordance with IFRS are least likely required to disclose:

A
the main classes of assets affected by impairment losses.

B
an itemized list of assets that have incurred impairment losses.

C
the events and circumstances responsible for the recognition of impairment losses.

Answer 117

B
an itemized list of assets that have incurred impairment losses.

According to IFRS, companies are required to disclose the amounts of impairment losses (and/or reversals of impairment losses) for each asset class. An itemized list of assets that have incurred impairment losses is not required.

Companies must also disclose the main classes of assets affected by impairment losses (and/or reversals of impairment losses) as well as the events and circumstances that lead to these losses and/or reversals of losses being recognized.

Question 118

Which of the following items from a company’s financial statement is least likely to be useful to an analyst seeking to understand the issuer’s financial position?

A
Assets

B
Equity

C
Income

Answer 118

C
Income

Question 119

Kyle Hodgson is an equity analyst covering the automotive parts sector for Frontier Capital. For his latest project, Hodgson uses a simple linear regression model to determine the sensitivity of Cranston Automotive (CRA) stock returns to the overall equity market, which is the beta measure.

Hodgson gathers 48 months of return data for CRA, the dependent variable, and a benchmark equity index, the independent variable.

Given his chosen model, Hodgson is least likely to observe the:

A
fitted parameter for beta.

B
estimated parameter for beta.

C
population parameter for beta.

Answer 119

C
population parameter for beta.

Linear regression analysis computes a line that provides the best fit for the observed values of the independent and dependent variables. However, the regression coefficients (intercept and slope) are only estimates of the population parameters, which cannot be observed.

The coefficients generated by a linear regression analysis are referred to as estimated parameters or fitted parameters.

Question 120

Which of the following is most accurately described as an association of national regulatory authorities?

A
The Securities and Exchange Commission

B
The International Accounting Standards Board

C
The International Organization of Securities Commissions

Answer 120

C
The International Organization of Securities Commissions

The International Organization of Securities Commissions (IOSCO) is composed of various financial regulators from more than 115 countries. For example, the US Securities and Exchange Commission (SEC) is one of that country’s representatives. IOSCO’s purpose is to facilitate the evolution of financial market regulation in an increasingly globalized context. These efforts help to achieve uniform application of international standards, such as IFRS and the Basel standards.

The IASB is an independent accounting standards-setting body. The standards issued by the IASB are authoritative to the extent that they are recognized and adopted by local regulators.

Question 121

returns on timberland investments are least likely affected by:

A
land price changes.

B
lumber price volatility.

C
biological growth rates.

Answer 121

B
lumber price volatility.

An advantage of timber is that it can simply be stored by not harvesting. If the price of lumber falls, production can be slowed until it recovers.

The three main return drivers for investments in timberland are biological growth, commodity price changes, and land price changes.

Question 122

global depository receipt (GDR) issued by a German auto parts manufacturer will most likely trade on equity markets in:

A
Japan.

B
the United States.

C
Germany and the United States.

Answer 122

A
Japan.

Global depository receipts do not trade on exchanges that are based in either the United States or the issuer’s home country. In this example, the German company’s GDRs will most likely trade on exchanges in Japan.

Question 123

The performance of a market capitalization weighted index is most likely to reflect which of the following investment strategies?

A
Value

B
Contrarian

C
Momentum

Answer 123

C
Momentum

Market capitalization weighting schemes are susceptible to overweighting securities that have outperformed the market. Indexes constructed according to this scheme tend to reflect a momentum investment strategy.

Question 124

An investor declines the opportunity to purchase a stock, believing that it is too risky. Upon being told that this stock offers diversification benefits that would improve the risk-return profile of his retirement portfolio, the investor chooses to purchase it. This investor is most likely exhibiting:

A
risk aversion bias.

B
conservatism bias.

C
narrow framing bias.

Answer 124

C
narrow framing bias.

Narrow framing bias is the observed tendency for investors to respond differently to the same scenario depending on how the issues are framed. In this case, the investor does not want to purchase the stock when focused on its risk in isolation, but chooses to purchase it when told of the benefits that it can offer his portfolio.

Risk aversion is the tendency of investors to want a higher expected return as compensation for increasing their risk exposure. This not a behavioral bias, but rather the mindset of a rational investor.

Conservatism bias is the tendency for investors to inadequately update their existing views after receiving new information.

Question 125

Matrix pricing is most likely to be used to value bonds when:

A
the bonds are illiquid.

B
the yield curve is inverted.

C
the bonds contain embedded options.

Answer 125

A
the bonds are illiquid.

Matrix pricing is an approach to value bonds when the market interest rate is unknown. The rate wouldn’t be known because that particular bond is not commonly traded.

Question 126

you are provided with the following details of a leveraged stock purchase:

Purchase price: £65.00
Initial margin requirement: 50%
Maintenance margin requirement: 25%
A margin call will most likely occur when the stock price drops below:

A
£26.00.

B
£43.33.

C
£48.75.

question: what is the formula to use to find when the margin call will be made

Answer 126

(equity/share / price/share) = 25%

($32.50 - ($65 - P)) / P = 25%

Question 127

An analyst who believes that short-term interest will fall and long-term interest rates will rise would most likely used which of the following measures to estimate the expected impact on a bond’s price?

A
Money duration

B
Key rate duration

C
Effective duration

Answer 127

B
Key rate duration

Lower short-term rates and higher long-term rates will make the yield curve steeper. When a change in the shape of the yield curve is expected, key rate duration is the most appropriate measure to use.

Other duration measures are based on the assumption that rates change equally for all maturities (a parallel shift).

Question 128

An entity with a mandate from a sovereign government issues bonds that are backed by collateral but not guaranteed by the government. The entity’s bonds are most accurately described as:

A
supranational bonds.

B
quasi-government bonds.

C
non-sovereign government bonds.

Answer 128

B
quasi-government bonds.

Quasi-government bonds, or agency bonds, are bonds issued by national government organizations, such as the Federal Home Loan Bank in the United States.

Supranational bonds are those issued by supranational agencies, like the International Monetary Fund, the World Bank, or the European Investment Bank.

Non-sovereign government bonds are those issued by levels of government below the national level, like provinces, regions, states, and cities.

Question 129

A restriction on the percentage of a pension plan’s assets that may be invested in securities issued by its sponsor is most accurately described as a:

A
risk budget.

B
unique circumstance.

C
self-investment limit.

Answer 129

C
self-investment limit.

Pension plans are often subject to restrictions such as a maximum percentage allocation to equities. Restrictions on holding securities issued by the plan sponsor are known as self-investment limits. Such a restriction is included among the investment policy statement’s legal and regulatory constraints.

Risk budgeting involves determining a portfolio’s acceptable level of overall risk exposure and allocating it among various sources of return.

Question 130

An investor with confirmation bias will most likely:

A
invest in assets that are highly correlated with their employer’s stock.

B
focus an excessive amount of attention on negative news about assets in their portfolio.

C
make forecasts using a very narrow range of expected returns with a low standard deviation.

Answer 130

A
invest in assets that are highly correlated with their employer’s stock.

Investors affected by confirmation bias tend to hold a disproportionately large amount of shares issued by their employer, pooling exposures to the same risk. This stems from a belief that they know the company and a conviction that its prospects are favorable.

Answer choice C describes overconfidence bias instead of confirmation bias.

Question 131

For a risk-averse investor, the utility of a given investment is most likely:

A
less than its expected return because the risk aversion coefficient has a positive value.

B
less than its expected return because the risk aversion coefficient has a negative value.

C
greater than its expected return because the risk aversion coefficient has a positive value.

Answer 131

A
less than its expected return because the risk aversion coefficient has a positive value.

According to utility theory, the value of the risk aversion coefficient is greater than zero for risk-averse investors, meaning that the utility these investors derive from a given investment is less than its expected return.

Question 132

Assuming that put-call parity holds, a short put position can most likely be replicated by:

A
selling a call, shorting the underlying asset, and lending at the risk-free rate.

B
buying a call, shorting the underlying asset, and lending at the risk-free rate.

C
buying the underlying asset, selling a call, and borrowing at the risk-free rate.

Answer 132

C
buying the underlying asset, selling a call, and borrowing at the risk-free rate.

Question 133

New Frontier Enterprises (NFE), a manufacturer of oil and gas drilling equipment, is a mature-stage company with stable, predictable profits and relatively limited growth opportunities. Nolan Dirk, an equity analyst, is forecasting the company’s expected financial statements for the coming year (20X9) by taking figures reported for 20X8 and making any adjustments deemed necessary based on macroeconomic data, industry growth expectations, and company-specific analysis.

Inflation has been positive for more than a decade and Dirk forecasts that this trend to continue, leading to increases in various items on NFE’s income statement. However, because the company uses the straight-line method, Dirk expects the company’s depreciation expend to be unchanged from the $250 million recorded for 20X8. For his pro forma statement of cash flows, Dirk forecasts VDF’s 20X9 capital expenditures to be $275 million, of which $250 million is deemed to be for maintenance and $25 million is assumed to be for expansion projects.

Is Dirk’s estimate of NFE’s 20X9 maintenance capital expenditures most likely appropriate?

A
Yes

B
No, because NFE is in the mature-stage company

C
No, because NFE is operating in an inflationary environment

Answer 133

C
No, because NFE is operating in an inflationary environment

Dirk’s $250 million estimate of maintenance capital expenditures for 20X9 is equal to the depreciation expense forecast. This is inappropriate because maintenance capital expenses should exceed the depreciation expense to account for inflation.

Question 135

A portfolio manager is analyzing an 8-year, 6.25% annual coupon corporate bond that is callable at par after 4 years. If the bond’s Z-spread is 110 basis points (bps), its option-adjusted spread is most likely:

A
less than 110 bps.

B
110 bps as well.

C
greater than 110 bps.

Answer 135

A
less than 110 bps.

The option-adjusted spread (OAS) measure indicates what the yield spread would be if a bond had no embedded options.

Mathematically, for a callable bond:

OAS = Z-spread - Option value (in basis points)

For a callable bond, the issuer can exercise its option to buy back the callable bond if interest rates fall. Since the option value is positive (from the perspective of the issuer), the OAS must be smaller than the Z-spread, which is 110 bps in this example.

Question 136

collateralized debt obligation (CDO) backed by asset-backed securities is most accurately described as a:

A
synthetic CDO.

B
structured finance CDO.

C
collateralized loan obligation.

Answer 136

B
structured finance CDO.

Structured finance CDOs are backed by asset-backed securities, residential or commercial mortgage-backed securities, or even other CDOs.

Synthetic CDOs are backed by credit default swaps, while collateralized loan obligations are backed by leveraged bank loans.

Question 137

Which of the following most accurately describes futures contracts relative to forward contracts?

A
Greater flexibility

B
Higher counterparty risk

C
Subject to daily price limits

Answer 137

C
Subject to daily price limits

Because they are customizable, forward contracts are highly flexible. By contrast, futures contracts are highly standardized with terms specified by the exchange on which a contract trades.

Some futures contracts have a provision that limits price changes. The provision establishes a band relative to the previous day’s settlement price, which all trades must occur within. These price limits help the clearinghouse manage its credit exposure, as sharply moving prices make it more difficult for the clearinghouse to collect from the parties losing money.

Question 138

Historically, which set of ESG factors has least likely been treated as negative externalities?

A
Social

B
Governance

C
Environmental

Answer 138

B
Governance

Until relatively recently, social and environmental factors have been treated as negative externalities, meaning that their associated costs were not thought to be borne by companies or their investors.

Question 139

Master limited partnerships (MLPs) that invest in infrastructure projects are most likely:

A
taxable entities.

B
publicly-traded pass-through securities.

C
owned entirely by their limited partners.

Answer 139

B
publicly-traded pass-through securities.

Infrastructure MLPs are publicly-traded securities like real estate investment trusts (REITs) that are generally free to distribute their cash flows to their limited partners.

Limited partners typically own most of the MLP, but a small share is typically held by a general partner who manages the MLP in exchange for a fee.

Regulations vary among jurisdictions, but taxes are typically applied at the investor level rather than the MLP level.

Question 140

Jensen’s Alpha formula

Answer 140

Rp - (Rf + Bp * (Rm - rf))

Question 141

Which of the following is most accurate with respect to Modigliani and Miller’s Proposition II without taxes?

A
The cost of equity increases linearly with the debt-to-equity ratio.

B
The market value of a company is not affected by the capital structure of the company.

C
The market value of a levered company is equal to the value of an unlevered company plus the value of the debt tax shied.

Answer 141

A
The cost of equity increases linearly with the debt-to-equity ratio.

Statement A refers to MM Proposition II without taxes.
Statement B refers to MM Proposition I without taxes.
Statement C refers to MM Proposition I with taxes.

Question 142

he persistence of closed-end investment fund discounts is most likely attributable to:

A
transaction costs.

B
management fees.

C
restrictions against trading closed-end funds in the secondary market.

Answer 142

A
transaction costs.

Closed-end investment fund discounts do exist, but it is often difficult for investors to exploit these differences because of the high transaction costs associated with purchasing all the shares in order to liquidate.

There is no evidence to support the claim that these discounts are attributable to management fees.

Closed-end investment funds do trade in the secondary market.

Question 143

Thomas Peschak, CEO of Thomason Furniture Company, has received four different capital investment proposals (projects) and all proposals have the potential to add value for the shareholders of the company. The firm’s surplus cash from last year’s operations is sufficient to fund only two of the four projects. Peschak is confident that the management will be able to raise any amount of funds by paying the firm’s required rate of return. The most appropriate course of action for Peschak is to invest in:

A
all four projects.

B
only the two highest NPV projects.

C
invest in the third and fourth highest NPV projects only if the financial results of the other two projects are favorable.

Answer 143

A
all four projects.

If a company can raise the funds it wants for all value-enhancing capital projects simply by paying the required rate of return, then the firm should invest in all such projects available. Therefore, Peschak should invest in all four projects and raise the additional funds required from the markets or through borrowing.

Question 144

if available, the most appropriate weight to apply to debt when calculating its issuer’s weighted average cost of capital is its share of the:

A
target capital structure.

B
current capital structure.

C
current capital structure, adjusted for trends.

Answer 144

A
target capital structure.

If known, a company’s target capital structure should be used when calculating its weighted average cost of capital.

Question 145

trailing P/E ratio formula

Answer 145

Price / trailing EPS

trailing EPS = Earnings / shares outstanding

Question 146

A real estate fund that speculates on improving market conditions is most likely:

A
a finite-life fund.

B
an open-end fund.

C
pursuing a core-plus real estate strategy.

Answer 146

A
a finite-life fund.A

Funds that pursue opportunistic real estate strategies accept the highest level of risk, including speculating on significant improvements in market conditions. These funds typically adopt a closed-end structure and have finite lives.

Question 147

Based on MM propositions with corporate taxes, how do we find the weighted average cost of capital after the issuance of debt?

Answer 147

1. find the value of an unlevered firm
2. find value of levered firm (with taxes)
3. determine the value of the firm’s equity after the change in its capital structure
4. determine the updated cost of equity for the levered firm. Note that this will be higher than the rate of return that investor’s required to hold the firm’s equity before it added debt to its capital structure
5. find the WACC

Question 148

formula to find the value of an unlevered firm Based on MM propositions with corporate taxes (assuming constant EBIT)

Answer 148

EBIT * (1 - tax rate) / cost of equity

Question 149

formula to find the value of levered firm Based on MM propositions with corporate taxes (assuming constant EBIT)

Answer 149

Value levered firm = Value Unlevered + tax rate * debt

Question 150

formula to find the value of the firm’s equity after the change in its capital structure when becoming a levered firm based on MM propositions with corporate taxes

Answer 150

E = VL - D

Question 151

formula to find cost of equity after the issuance of debt

Answer 151

re = ro + (re - rd) * (1 - t) * (D/E)

Question 152

DTC Logistics, which is incorporated in the US state of Delaware and listed on the New York Stock Exchange, has a 20-member board of directors, including 10 women and 10 men. The board’s audit committee is composed of five directors, all of whom are independent, but the only one of these directors with expertise in accounting does not chair the committee. The board’s three other independent directors serve on its compensation committee.

Is the composition of DTC’s board of directors most likely consistent with corporate governance best practices?

A
No, because of the structure of the audit committee

B
Yes, because it includes equal numbers of men and women

C
No, because it lacks a sufficient number of independent directors

Answer 152

A
No, because of the structure of the audit committee

According to current best practices for corporate governance, the majority of a board’s members should be independent. With only eight independent directors on a 20-member board (40%), DTC falls below the recommended level of representation.

Question 153

Over the past six months, the number of stocks included in a portfolio has increased from 12 to 17. The portfolio manager has made a particular effort to add only stocks that are not highly correlated with the existing portfolio. Assuming that macroeconomic conditions have been stable, it is most likely that the portfolio’s exposure to:

A
nonsystematic risk has declined.

B
systematic risk has decreased and its exposure to nonsystematic risk has increased.

C
systematic risk has decreased and its exposure to nonsystematic risk has been unaffected.

Answer 153

A
nonsystematic risk has declined.

The portfolio’s exposure to both systematic and nonsystematic risk has decreased.

Nonsystematic risk is associated with specific assets. For example, a firm’s stock may become essentially worthless in the aftermath of massive accounting fraud being exposed. However, the impact of this development on other stocks is at most peripheral. By adding new stocks to the portfolio, exposure to nonsystematic risk has been reduced. With sufficient diversification, this exposure can be effectively avoided entirely.

Exposure to systematic cannot be avoided through diversification, but can be reduced by adding assets that have a low correlation with an existing portfolio.

Question 154

investments by venture capital firms to support a company’s product development are most likely made at the:

A
seed stage.

B
early stage.

C
angel investing stage.

Answer 154

A
seed stage.

Angel investments, which are typically made by individuals, support activities such as the development of a business plan.

Venture capital firms generally do not make investments until the seed stage, during which product development occurs.

Early-stage investments typically fund the initial phase of commercial production.

Question 155

ROE formula

Answer 155

(Net Income - Preferred Share dividends) / (Average Book Value Equity)

Question 156

Which of the following best describes exchange-traded derivatives markets?

A
The transactions process provides a credit guarantee

B
The market operates at a lower degree of regulatory oversight

C
Transaction-specific is not disclosed to exchanges and regulatory bodies

Answer 156

A
The transactions process provides a credit guarantee

Exchange-traded derivatives markets are heavily regulated. Hence, its contracts are all standardized. This makes it easier for the market to provide liquidity. Exchange-traded derivatives markets have high transparency, i.e., they reveal all information on all transactions to exchanges and regulatory bodies.

Question 157

A stock that has seen its earnings yield decrease significantly over the past two months without any significant change in company performance or outlook is most likely:

A
to have a lesser impact on the performance of an equally-weighted index.

B
to have a greater impact on the performance of a fundamentally-weighted index.

C
the subject of speculation that it will be added to a popular value­-weighted index.

Answer 157

C
the subject of speculation that it will be added to a popular value­-weighted index.

Earnings yield is the ratio of past or expected earnings per share to share price. A decreasing earnings yield occurs when price increases relative to earnings.

Because there has been no change in company performance or outlook, the change in this example is most likely due to price increases caused by speculative buying, which can occur when fund managers purchase the shares that they believe will be added to the benchmark against which their performance is assessed.

Question 158

The J-Curve effect exhibited by private equity and real estate investors most likely refers to a fund’s:

A
net cash position.

B
performance fee payments.

C
degree of portfolio diversification.

Answer 158

A
net cash position.

The J-Curve effect describes the cash pattern observed in many alternative investment funds. In its early years, a typical fund exhibits negative cash flows as capital is drawn and investments are made. The negative cash flow trend during this period is exacerbated by management fees paid to general partners. This pattern bottoms out as investments begin to generate cash. Net cash flows continue to increase as a fund moves into the later stages of its life.

Question 159

A company seeking a derivative instrument that will qualify for hedge accounting treatment while offsetting the currency risk attributable to the equity of a foreign subsidiary will most likely use:

A
a currency swap.

B
currency futures contracts.

C
currency options contracts.

Answer 159

A
a currency swap.

To qualify for hedge accounting treatment, a derivative instrument must closely match the characteristics of the asset, liability, or transaction that it is meant to hedge. Companies typically use customizable over-the-counter derivatives like currency swaps rather than exchange traded derivatives such as futures and options.

Question 160

By disseminating value-relevant information, fundamental analysts most likely ensure that markets are:

A
weak form efficient.

B
strong form efficient.

C
semi-strong form efficient.

Answer 160

C
semi-strong form efficient.

Fundamental analysis is necessary in a well-functioning market because this analysis helps the market participants understand the value implications of information. It facilitates semi-strong efficient markets by disseminating value-relevant information.

Question 161

Thomas Peschak, CEO of Thomason Furniture Company, has received four different capital investment proposals (projects) and all proposals have the potential to add value for the shareholders of the company. The firm’s surplus cash from last year’s operations is sufficient to fund only two of the four projects. Peschak is confident that the management will be able to raise any amount of funds by paying the firm’s required rate of return. The most appropriate course of action for Peschak is to invest in:

A
all four projects.

B
only the two highest NPV projects.

C
invest in the third and fourth highest NPV projects only if the financial results of the other two projects are favorable.

Answer 161

A
all four projects.

If a company can raise the funds it wants for all value-enhancing capital projects simply by paying the required rate of return, then the firm should invest in all such projects available. Therefore, Peschak should invest in all four projects and raise the additional funds required from the markets or through borrowing.

Question 162

if available, the most appropriate weight to apply to debt when calculating its issuer’s weighted average cost of capital is its share of the:

A
target capital structure.

B
current capital structure.

C
current capital structure, adjusted for trends.

Answer 162

A
target capital structure.

If known, a company’s target capital structure should be used when calculating its weighted average cost of capital.

Question 163

trailing P/E ratio formula

Answer 163

Price / trailing EPS

trailing EPS = Earnings / shares outstanding

Question 164

A real estate fund that speculates on improving market conditions is most likely:

A
a finite-life fund.

B
an open-end fund.

C
pursuing a core-plus real estate strategy.

Answer 164

A
a finite-life fund.A

Funds that pursue opportunistic real estate strategies accept the highest level of risk, including speculating on significant improvements in market conditions. These funds typically adopt a closed-end structure and have finite lives.

Question 165

Based on MM propositions with corporate taxes, how do we find the weighted average cost of capital after the issuance of debt?

Answer 165

1. find the value of an unlevered firm
2. find value of levered firm (with taxes)
3. determine the value of the firm’s equity after the change in its capital structure
4. determine the updated cost of equity for the levered firm. Note that this will be higher than the rate of return that investor’s required to hold the firm’s equity before it added debt to its capital structure
5. find the WACC

Question 166

formula to find the value of an unlevered firm Based on MM propositions with corporate taxes (assuming constant EBIT)

Answer 166

EBIT * (1 - tax rate) / cost of equity

Question 167

formula to find the value of levered firm Based on MM propositions with corporate taxes (assuming constant EBIT)

Answer 167

Value levered firm = Value Unlevered + tax rate * debt

Question 168

formula to find the value of the firm’s equity after the change in its capital structure when becoming a levered firm based on MM propositions with corporate taxes

Answer 168

E = VL - D

Question 169

formula to find cost of equity after the issuance of debt

Answer 169

re = ro + (re - rd) * (1 - t) * (D/E)

Question 170

DTC Logistics, which is incorporated in the US state of Delaware and listed on the New York Stock Exchange, has a 20-member board of directors, including 10 women and 10 men. The board’s audit committee is composed of five directors, all of whom are independent, but the only one of these directors with expertise in accounting does not chair the committee. The board’s three other independent directors serve on its compensation committee.

Is the composition of DTC’s board of directors most likely consistent with corporate governance best practices?

A
No, because of the structure of the audit committee

B
Yes, because it includes equal numbers of men and women

C
No, because it lacks a sufficient number of independent directors

Answer 170

A
No, because of the structure of the audit committee

According to current best practices for corporate governance, the majority of a board’s members should be independent. With only eight independent directors on a 20-member board (40%), DTC falls below the recommended level of representation.

Question 171

Over the past six months, the number of stocks included in a portfolio has increased from 12 to 17. The portfolio manager has made a particular effort to add only stocks that are not highly correlated with the existing portfolio. Assuming that macroeconomic conditions have been stable, it is most likely that the portfolio’s exposure to:

A
nonsystematic risk has declined.

B
systematic risk has decreased and its exposure to nonsystematic risk has increased.

C
systematic risk has decreased and its exposure to nonsystematic risk has been unaffected.

Answer 171

A
nonsystematic risk has declined.

The portfolio’s exposure to both systematic and nonsystematic risk has decreased.

Nonsystematic risk is associated with specific assets. For example, a firm’s stock may become essentially worthless in the aftermath of massive accounting fraud being exposed. However, the impact of this development on other stocks is at most peripheral. By adding new stocks to the portfolio, exposure to nonsystematic risk has been reduced. With sufficient diversification, this exposure can be effectively avoided entirely.

Exposure to systematic cannot be avoided through diversification, but can be reduced by adding assets that have a low correlation with an existing portfolio.

Question 172

investments by venture capital firms to support a company’s product development are most likely made at the:

A
seed stage.

B
early stage.

C
angel investing stage.

Answer 172

A
seed stage.

Angel investments, which are typically made by individuals, support activities such as the development of a business plan.

Venture capital firms generally do not make investments until the seed stage, during which product development occurs.

Early-stage investments typically fund the initial phase of commercial production.

Question 173

ROE formula

Answer 173

(Net Income - Preferred Share dividends) / (Average Book Value Equity)

Question 174

Which of the following best describes exchange-traded derivatives markets?

A
The transactions process provides a credit guarantee

B
The market operates at a lower degree of regulatory oversight

C
Transaction-specific is not disclosed to exchanges and regulatory bodies

Answer 174

A
The transactions process provides a credit guarantee

Exchange-traded derivatives markets are heavily regulated. Hence, its contracts are all standardized. This makes it easier for the market to provide liquidity. Exchange-traded derivatives markets have high transparency, i.e., they reveal all information on all transactions to exchanges and regulatory bodies.

Question 175

A stock that has seen its earnings yield decrease significantly over the past two months without any significant change in company performance or outlook is most likely:

A
to have a lesser impact on the performance of an equally-weighted index.

B
to have a greater impact on the performance of a fundamentally-weighted index.

C
the subject of speculation that it will be added to a popular value­-weighted index.

Answer 175

C
the subject of speculation that it will be added to a popular value­-weighted index.

Earnings yield is the ratio of past or expected earnings per share to share price. A decreasing earnings yield occurs when price increases relative to earnings.

Because there has been no change in company performance or outlook, the change in this example is most likely due to price increases caused by speculative buying, which can occur when fund managers purchase the shares that they believe will be added to the benchmark against which their performance is assessed.

Question 176

The J-Curve effect exhibited by private equity and real estate investors most likely refers to a fund’s:

A
net cash position.

B
performance fee payments.

C
degree of portfolio diversification.

Answer 176

A
net cash position.

The J-Curve effect describes the cash pattern observed in many alternative investment funds. In its early years, a typical fund exhibits negative cash flows as capital is drawn and investments are made. The negative cash flow trend during this period is exacerbated by management fees paid to general partners. This pattern bottoms out as investments begin to generate cash. Net cash flows continue to increase as a fund moves into the later stages of its life.

Question 177

A company seeking a derivative instrument that will qualify for hedge accounting treatment while offsetting the currency risk attributable to the equity of a foreign subsidiary will most likely use:

A
a currency swap.

B
currency futures contracts.

C
currency options contracts.

Answer 177

A
a currency swap.

To qualify for hedge accounting treatment, a derivative instrument must closely match the characteristics of the asset, liability, or transaction that it is meant to hedge. Companies typically use customizable over-the-counter derivatives like currency swaps rather than exchange traded derivatives such as futures and options.

Question 178

By disseminating value-relevant information, fundamental analysts most likely ensure that markets are:

A
weak form efficient.

B
strong form efficient.

C
semi-strong form efficient.

Answer 178

C
semi-strong form efficient.

Fundamental analysis is necessary in a well-functioning market because this analysis helps the market participants understand the value implications of information. It facilitates semi-strong efficient markets by disseminating value-relevant information.

Question 179

Compared to endowments and foundations, non-life insurance companies most likely have higher:

A
risk tolerance.

B
income needs.

C
liquidity needs.

Answer 179

C
liquidity needs.

Non-life insurance companies have relatively high liquidity needs because assets may need to be sold on short notice in order to pay policyholders’ claims. By contrast, foundations and endowments have longer investment time horizons and more predictable cash flows and therefore have a greater ability to invest in less liquid assets.
Compared to foundations and endowments, non-life insurance companies have a lower level of risk tolerance and less of a need to generate a stable flow of income. Because of the high level of uncertainty with respect to the timing and amount of their outgoing payments, non-life insurance companies tend to hold assets that are more conservative and offer greater liquidity.

Question 180

Which of the following statements is the most accurate? An American waterfall:

A
Distributes performance fees on a per-deal basis and is more advantageous to the GP.

B
Distributes performance fees on a per-deal basis and is more advantageous to the LPs.

C
Distributes performance fees on an aggregate fund basis and is more advantageous to the GP.

Answer 180

A
Distributes performance fees on a per-deal basis and is more advantageous to the GP.

Question 181

A bond’s put provision is most likely to be exercised when:

A
interest rates increase.

B
interest rates decrease.

C
the issuer’s credit spread narrows.

Answer 181

A
interest rates increase.

A bond’s put option would be exercised if its price decreases.

This can occur if interest rates increase or if the issuer’s credit rating declines, which would be associated with a wider credit spread.

Question 182

A company reports the following values for the recently-completed financial year:

Inventory (1 January) $6,375 million
Inventory (31 December) $6,643 million
Accounts Payable (1 January) $3,177 million
Accounts Payable (31 December) $2,984 million
Cost of Goods Sold $17,976 million

How do we find the amount of cash paid by the company to suppliers during the year

Answer 182

1. Ending inventory + COGS - Beginning Inventory = Purchases from suppliers
2. Beginning AP + Purchases from suppliers - Ending AP = Cash paid to suppliers

Question 183

Last year, Tom Ennis, CFA, set up an irrevocable trust for his long-time client, Sam Bennett, to transfer his company’s shares to his son Taylor, 23, in a tax-efficient manner. The terms of the trust specify that Taylor Bennett cannot access any of the assets held in trust while his father is alive, but the assets are no longer legally part of Sam Bennett’s estate. As trustee, Ennis has sole authority to exercise proxy votes for the shares held in trust until Sam Bennett’s death. Recently, Sam Bennett asked Ennis to vote with management on an important matter to be decided at his company’s shareholder meeting next week. The next day, Taylor Bennett asks Ennis to vote the proxies against management on this matter. In order to comply with the CFA Standards, Ennis should most likely:

A
abstain from voting.

B
vote with management.

C
vote against management.

Answer 183

C
vote against management.

Standard III(A) - Loyalty, Prudence, and Care requires members and candidates to act in the best interest of their client. In this example, when exercising the proxies, Ennis’ client is Taylor Bennett because he is the ultimate beneficiary of the assets being held in trust. Because the trust is irrevocable, Sam Bennett has given up control over them. Ennis must therefore vote against management’s proposal in accordance with Taylor Bennett’s wishes.

Ennis would also be violating this Standard by abstaining from voting on an important matter, particularly after receiving instructions on how to vote from his client.

Question 184

FRS Corp. is considering issuing a $1,000 bond next month, depending on what happens to the interest rate. The probability that FRS Corp. will issue the bond, based on the change in the interest rate, is:

Situation Probability of issuing a bond
Interest rate rises 20%
Interest rate remains the same 40%
Interest rate falls 65%

There is an equally likely chance that the interest rate will rise, fall, or remain the same over the next month.

Given that FRS Corp. issues a bond next month, the probability that the interest rate stays the same is closest to:

what is the formula to find this conditional probability?

Answer 184

First, define the possible events.
A = Interest rate rises
B = Interest rate remains the same
C = Interest rate falls
X = FRS Corp. issues a bond

The probabilities given in the problem are as follows:
P(A) = 33.33%
P(B) = 33.33%
P(C) = 33.33%
P(X | A) = 20%
P(X | B) = 40%
P(X | C) = 65%

We want to find the probability that the interest rate stays the same, given that FRS Corp. issues a bond, or P(B | X) This can be done using Bayes’ Formula:

P(B | X) = P(B) * P(X | B) / P(X)

Question 185

Ashley Powell, CFA, works as a manager of an international equity fund and has a personal portfolio that includes the stocks of several Chilean companies. Powell also has a strong social media following. After reading an article about a violent clash between striking Chilean miners and local police, Powell publishes a blog post that includes her opinion that “the current level of labor unrest could cause investors to pull their capital out of the Chilean market.”

Although the mining strike covered in the article she read has attracted attention from several international media outlets, Powell is aware that the number of days lost to labor disruptions has steadily declined in Chile over the past decade and she expects this trend to continue, but she does not include this information in her blog post.

Over the subsequent month, the main Chilean equity benchmark falls 2.3%. Has Powell most likely violated the Standards?

A
No

B
Yes, with respect to misrepresentation

C
Yes, with respect to market manipulation

Answer 185

B
Yes, with respect to misrepresentation

Standard I(C) - Misrepresentation prohibits members and candidates from making “any misrepresentations relating to investment analysis, recommendations, actions, or other professional activities.” Misrepresentation includes creating a misleading impression by omitting facts and relevant inputs. In this example, Powell has violated this Standard by failing to refer to the general decline in days lost to labor disruptions in Chile over the past decade, as this omission may mislead her readers regarding the true state of affairs in that country - particularly at a time when a single incident is attracting a disproportionate share of the media’s attention.

Question 186

Andrew Clement, CFA, has been providing advisory services to individual investors for over 20 years.

Recently, Clement reached an agreement with Yarmouth Investments, under which he receives a referral fee based on the value of his clients’ investments in its various funds. Clement is familiar with Yarmouth’s funds, which have a well-deserved reputation for producing strong risk-adjusted returns and low expense ratios, as many of his existing clients hold them in their portfolios.

Since signing this agreement, Clement has established a practice of providing the full details about this referral fee when recommending Yarmouth’s funds to prospective clients for whom they are deemed a suitable investment so that they can assess the partiality of his advice. Has Clement most likely violated the Standards?

A
No

B
Yes, with respect to referral fees

C
Yes, with respect to diligence and reasonable basis

Answer 186

B
Yes, with respect to referral fees

Standard VI(C) - Referral Fees requires members and candidates to disclose the nature of any referral fee arrangement, including an estimate of the value of the compensation received, to client, prospective clients, and employers.

In this example, Clement has adhered to this Standard in his dealing with prospective clients, but failed to inform his existing clients about the referral fees that he will be receiving based on the value of their investments in Yarmouth’s funds.

Question 187

Under a Stackelberg duopoly model with a leader setting output and a follower reacting, which company most likely ends up in a superior position?

A
Leader

B
Follower

C
New entrants

Answer 187

A
Leader

With the Stacklberg approach to a duopoly (market with two suppliers), the leader has a few significant advantages. First, it can produce more than its optimal amount, forcing the follower to take a very diminished role or even exit entirely. If that approach is carried completely through, it may even be able to eliminate the competitor completely from the market.

Question 188

All else equal, the real exchange rate (quoted in domestic currency / foreign currency) will most likely decrease due to an increase in the:

A
foreign price level.

B
domestic price level.

C
nominal amount of domestic currency units that can be purchased per unit of foreign currency.

Answer 188

B
domestic price level.

All else equal, a decrease in the real exchange rate could arise from:

A decrease in the foreign price level

An increase in the domestic price level

A decrease in the nominal exchange rate

Question 189

formula to find the real exchange rate

Answer 189

Spot d/f * (Pf / Pd)

Spot d/f = the nominal exchange rate in terms of domestic currency units per unit of foreign currency

Pf represents the foreign price level

Pd represents the domestic price level

Question 190

Decisions about whether to reject null hypotheses concerning differences between the variances of two normally distributed populations are most likely based on the results of:

A
a t-test.

B
an F-test.

C
a chi-square test.

Answer 190

B
an F-test.

When testing hypotheses about differences between the variances of two normally distributed populations, an an F-test is used

Question 191

Karl Cohn, CFA, a broker at Slater Investments, works primarily with high net worth individuals. One of his clients, Claire Stafford, has adopted a very successful investment strategy and made a number of successful trades over the past year. Having observed this pattern, Cohn replicates Stafford’s trades in his personal account after carrying out the instructions in his client’s orders. Has Cohn most likely violated the Standards?

A
No

B
Yes, with respect to fair dealing

C
Yes, with respect to priority of transactions

Answer 191

A
No

Cohn has not violated Standard VI(B) - Priority of Transactions, which allows members and candidates to hold the same positions as (or be co-invested with) their clients, as long as they do not give priority to trades for their personal accounts.

Cohn has not violated Standard III(B) - Fair Dealing as he is not under any obligation to allow other clients to replicate Stafford’s trades.

Question 192

Keagan Fahey, CFA, is a research analyst for Omega Securities. Fahey is personally exposed to several of the stocks that he covers by virtue of being the sole beneficiary of a trust in which his parents have placed significant holdings of several diversified mutual funds. The terms of the trust specify that Fahey receives monthly statements that include a full listing of its assets and the current market value of each, but that he cannot exercise any control over these assets until after both of his parents have died. Fahey has not disclosed his beneficial ownership of the trust’s assets in any of his research reports. Has Fahey most likely violated the Standards?

A
Yes

B
No, because the assets are held in trust

C
No, because of the nature of the assets held in trust

Answer 192

C
No, because of the nature of the assets held in trust

Standard VI(A) - Disclosure of Conflicts requires members and candidates to “make full and fair disclosure of all matters that could reasonably be expected to impair their independence and objectivity.” For example, an individual would violate this Standard by failing to disclose a beneficial ownership position in a stock that he or she covers.

However, in this example, Fahey is not required by this Standard to disclose the positions he has obtained by virtue of being the beneficial owner of various diversified mutual funds.

The fact that the assets are held in trust does not, on its own, eliminate the need to disclose. Although Fahey cannot exercise any control over these assets until after both of his parents have died, as a sole beneficiary of the trust, he would be required to disclose his beneficial ownership if the trust held individual stocks instead of mutual funds.

Question 193

Brian Orton, CFA, runs a small investment management firm and lacks the resources to hire his own research analysts. As a cost-effective alternative, Orton obtains third-party research reports and sends full, unedited versions of selected reports to clients in envelopes displaying his firm’s logo. In each envelope, Orton includes a letter, written on his firm’s letterhead, in which he shares his comments on each of the enclosed reports. Based on his initial research and ongoing scrutiny, Orton believes that the research reports he sends to clients have an adequate basis, although he does not always agree with their conclusion. Has Orton most likely violated the Standards?

A
No

B
Yes, with respect to misrepresentation

C
Yes, with respect to diligence and reasonable basis

Answer 193

A
No

Standard I(C) - Misrepresentation prohibits members and candidates from taking credit for work that they have not done. There is no indication that Orton has claimed to be the author of the reports that he sends to his clients. He does not violate this Standard by sending these reports in envelopes displaying his firm’s logo or by including a letter with his comments on his firm’s letterhead.

Orton does not appear to have violated Standard V(A) - Diligence and Reasonable Basis as it is noted that he researched the providers before choosing them and conducts ongoing scrutiny of their work. He is not required to agree with the conclusions of all (or any) reports that he sends to his clients, as long as he believes that they have an adequate basis.

Question 194

Jessica McLachlan is a Level II candidate in the CFA Program. In addition to working at her full-time job, McLachlan studied more than 300 hours to prepare for the Level II exam. However, she was frustrated by her inability to consistently remember all the variables that are used in a formula that she believes is very likely to be tested. On exam day, McLachlan gets to the test center early and studies her review notes intently so that she can commit the elusive formula to memory before entering the testing room. After the exam has started, McLachlan worries that she may forget the elusive formula before she is required to use it, so she writes it on the desk. Has McLachlan most likely violated the Standards?

A
Yes, by writing on her desk

B
Yes, by reviewing her notes at the test center

C
No, because she waited until after the exam had started before writing down the formula

Answer 194

A
Yes, by writing on her desk

Standard VII(A) - Conduct as Participants in CFA Institute Programs requires candidates to adhere to CFA Institute’s testing policies. In this example, McLachlan has violated this Standard and these policies, which prohibit candidates from doing scratch work on their desks, even after the exam has started. Candidates may only do scratch work on the laminated sheet or erasable tablet provided by the testing center.

Question 195

A company reports the following values for the recently-completed financial year:

Accounts receivable (1 January) $100 million
Accounts receivable (31 December) $150 million
Inventory (1 January) $100 million
Inventory (31 December) $100 million
Accounts Payable (1 January) $100 million
Accounts Payable (31 December) $50 million
Net income $500 million
Depreciation expense $50 million

The company’s operating cash flow for the year is closest to:

Answer 195

This question requires the use of the indirect approach, which calculates operating cash flow by starting with net income and making the following adjustments:

Net income $500 million
Plus: Depreciation expense $50 million
Less: Increase in accounts receivable ($50 million)
Plus: Decrease in inventory $0
Less: Decrease in accounts payable ($50 million)

Equals: Operating cash flow $450 million

Question 196

Monetarists, those who subscribe to the quantity theory of money, most likely believe that:

A
the level of economic activity determines the quantity of money in circulation.

B
rising inflation can be contained by reducing the growth rate of the money supply.

C
if money neutrality holds, an increase in the money supply will increase real output.

Answer 196

B
rising inflation can be contained by reducing the growth rate of the money supply.

Monetarists believe that there is a direct causal relationship between the growth of the money supply and inflation. It follows that rising inflation can be controlled by reducing the growth rate of the money supply.

Question 197

An analyst claims that a fund has generated positive alpha. Which of the following conclusions with respect to the testing of this claim is most likely a Type II error?

A
Rejecting the null hypothesis when the true alpha is greater than zero

B
Not rejecting the null hypothesis when the true alpha is greater than zero

C
Not rejecting the alternative hypothesis when the true alpha is less than zero

Answer 197

B
Not rejecting the null hypothesis when the true alpha is greater than zero

In this example, the “suspected” or “hoped for” condition is that the fund’s true alpha is positive (greater than zero). By convention, this is established as the alternative hypothesis. The null hypothesis is that the equity risk premium is equal to or less than zero.

A Type II error occurs when the null hypothesis is accepted when it should have been rejected. In this example, the alternative hypothesis should only be accepted (and the null hypothesis rejected) if the equity risk premium is greater than zero. Accepting the null hypothesis of zero or negative alpha when the fund’s true alpha is positive is a Type II error.

Accepting the alternative hypothesis when the true alpha is less than zero would be a Type I error.

Question 198

Jeri Hosmer, CFA, has been researching Digger Energy (DGE) and has a client for whom the company’s stock is a suitable investment. She establishes her client’s position by placing a series of smaller orders over the course of a two-week period. Although her intention was to minimize the price impact associated with acquiring a relatively large number of thinly-traded shares, DGE’s stock price increased significantly over that period. Has Hosmer most likely violated the Standards?

A
No

B
Yes, with respect to market manipulation

C
Yes, with respect to loyalty, prudence, and care

Answer 198

A
No

As noted in the guidance for Standard II(B) - Market Manipulation, it is “not intended to preclude transaction undertaken on legitimate trading strategies.” The price of thinly-traded shares can be significantly affected by large trades and Hosmer does not violate this Standard by structuring the purchase as a series of smaller trades.

Although her client may have ended up paying a higher price on a volume-weighted average basis than she would have preferred, there is no evidence that Hosmer has violated Standard III(A) - Loyalty, Prudence, and Care.

Question 199

Bruce Bollinger, CFA, a portfolio manager, is meeting with a client, Rebecca Jansen, for the first time. During the course of the meeting, Bollinger describes several possible investment strategies and recommends a stock that has a low correlation with the asset classes in the partial list of assets that Jansen has provided. Has Bollinger most likely violated the Standards?

A
No

B
Yes, with respect to suitability

C
Yes, with respect to suitability and loyalty, prudence, and care

Answer 199

B
Yes, with respect to suitability

Standard III(C) - Suitability requires members and candidates who are in an advisory role to make “a reasonable inquiry into a client’s or prospective client’s investment experience, risk and return objectives, and financial constraints prior to making any investment recommendation or taking investment action.” This Standard further requires members and candidates to “determine that an investment is suitable to the client’s financial situation and consistent with the client’s written objectives, mandates, and constraints before making an investment recommendation or taking investment action.”

In this example, Bollinger has recommended a specific stock during his initial meeting with Jansen - before he could possibly have developed an investment policy statement or acquired a sufficient understanding of her objectives and constraints.

Question 200

To determine the number of days payable outstanding (DPO), what do we have to do?

Answer 200

1. Payables turnover = COGS / Average trade payables
2. Days of payable = Days in Period / Payables turnover

Question 201

igny Falco, CFA, is an investment advisor with Hollyoak Associates, where she oversees the discretionary accounts of individual investors. One of Falco’s long-time clients, Raymond Sun, has ordered her to execute an order to purchase shares of Boxtop Technologies (BXT). Upon receiving this order, Falco reviews Sun’s investment policy statement (IPS), which the two updated three months ago during their annual review meeting. Falco is concerned because the transaction that Sun has ordered would cause his portfolio’s allocation to equities to be both significantly different from its current level and inconsistent with his IPS.

In order to adhere to the Standards, Falco is least likely to:

A
work with Sun to update his IPS.

B
comply with Sun’s order to execute the trade immediately.

C
recommend that Sun convert his account status to non-discretionary.

Answer 201

B
comply with Sun’s order to execute the trade immediately.

Standard III(C) - Suitability requires members and candidates to “determine that an investment is suitable to the client’s financial situation and consistent with the client’s written objectives, mandates, and constraints before making an investment recommendation or taking investment action.”

In this example, Falco has received an order for a trade that she knows to be inconsistent with her client’s IPS. Immediately executing this order without further discussing its potential impact with her client would be the course of action that is least consistent with this Standard. As noted in the guidance for this Standard, if Sun refuses to amend his IPS and/or change his account’s status to non-discretionary, Falco should consider whether it is proper for her to continue in an advisory role with this client.

Question 202

how to find the slope coefficient in a regression model?

Answer 202

b = Cov(X, Y) / Var(X)

covariance = correlation * sX * sY

Question 203

ABC Corporation, which adheres to US GAAP, has accumulated deferred tax assets of $67 million. Based on the likelihood of realizing this deferred tax asset, the company had recorded a valuation allowance of $5.0 million but subsequently increased this amount to $6.5 million in its most recent financial statements. The impact of this revision will most likely be observed on the company’s:

A
balance sheet only.

B
balance sheet and income statement.

C
balance sheet and statement of other comprehensive income.

Answer 203

B
balance sheet and income statement.

Deferred tax assets are reduced by valuation allowances to reflect uncertainty regarding the likelihood that future earnings will be sufficient to offset the asset.

The impact of an increase in the valuation allowance will be recorded on the balance sheet and on the income statement in the form of lower operating income.

Question 204

Kathleen Davis is a financial analyst studying the durability of the MotorGo Auto Company’s highest-selling model. Specifically, she wants to test a hypothesis about the cost of maintaining these vehicles as they age.

To facilitate the analysis, Davis asks her junior assistant, Brandon Larmer, to collect data for her and run a linear regression analysis of the relationship between a vehicle’s odometer reading and its annual maintenance costs.

Larmer performs the requested regression based on data obtained by a team of engineers who tested 25 vehicles. He defines the dependent variable as Costs, or maintenance costs (in thousands of EUR) for the last calendar year for a given car, and the independent variable as Odometer, or the distance driven (in thousands of kilometers) at the end of the last completed calendar year. Exhibit 1 displays the results of the regression model.

Exhibit 1: Regression Statistics

R squared 0.9421
Standard error 2.1581
Observations 25

Larmer’s report containing his analysis of the regression results includes the following statements:

Statement 1: “The value of the coefficient of determination is 0.9421.”

Statement 2: “With 25 observations and 1 independent variable, there are 24 degrees of freedom for the t-test of the slope coefficient.”

A
Statement 1 and Statement 2 are both correct

B
Statement 1 is correct and Statement 2 is incorrect

C
]Statement 2 is correct and Statement 1 is incorrect

Answer 204

B
Statement 1 is correct and Statement 2 is incorrect

Statement 1 is correct because the coefficient of determination for a linear regression is defined as the R^2 term

However, Statement 2 is incorrect. The degrees of freedom of a linear regression equals the number of observations minus the number of parameters estimated. Larmer estimates two parameters in his regression: the intercept and the slope coefficient. Therefore, there are 23 degrees of freedom (25 – 1 – 1).

Question 205

The Public Company Accounting Oversight Board was most likely created by the:

A
Securities Act of 1933.

B
Sarbanes-Oxley Act of 2002.

C
Securities Exchange Act of 1934.

Answer 205

B
Sarbanes-Oxley Act of 2002.

The Sarbanes-Oxley Act followed a series of high-profile accounting scandals. The intent of this legislation was to protect the integrity of auditors’ opinions. To this end, the act created the Public Company Accounting Oversight Board, which oversees the work of auditors.

Question 206

Free Cash Flow to Equity formula

Answer 206

FCFE = CFO - FCInv + Net borrowing

CFO = NI + Non-Cash Charges (depreciation) = working capital investment

Net borrowing = new borrowing - debt repayments

Question 207

Karen Horobin, CFA, is an investment manager for Kettleworth Advisors. She has decided to sell 500 shares of Alphamega Construction (AMC) stock from the account of her client, Matthew Comeau. Horobin has discretionary authority over Comeau’s account and the trade is consistent with his investment policy statement, which was updated last month. Horobin asks her fellow investment manager at Kettleworth, Alim Sayed, CFA, if 500 AMC shares would be appropriate for any of his clients. After consulting his files, Sayed finds that this position would be a good fit for his client Kailey McGrath. Horobin and Sayed arrange to transfer the shares from Comeau’s account to McGrath’s at the current market price. They both document the reasons for the trade on behalf of their respective clients. Have the Standards most likely been violated?

A
No

B
Yes, with respect to fair dealing

C
Yes, with respect to preservation of confidentiality

Answer 207

A
No

There is no evidence of a violation in this case. Standard III(B) - Fair Dealing allows for assets to be moved from the account of one client to another client’s account, provided that the trade is consistent with both clients’ investment policy statements. Indeed, firms may be able to add value for their clients with such trades due to lower transaction costs.

Standard III(E) - Preservation of Confidentiality does allow for authorized sharing of confidential client information among employees within the same firm. However, there is no evidence that Horobin and Sayed have shared any information about their clients, only that they have arranged for a trade between the two accounts.

Question 208

David Antonelli, CFA, is an equity analyst covering the pharmaceutical sector for a large investment firm. While attending a conference, Antonelli overhears senior executives of one of the firms that he covers discussing the promotion of a mid-level executive. This recently promoted executive has mentioned her desire to increase the company’s revenues from generic drugs in conversations with Antonelli. Upon returning to his office, Antonelli decides to do some additional research on that company and determines that the company is going to expand its presence in the market for generic drugs. Based on this research, Antonelli changes his recommendation on the company’s stock to “strong buy” and significantly increases his earnings forecast. Has Antonelli most likely violated the Standards?

A
No

B
Yes, with respect to diligence and reasonable basis

C
Yes, with respect to material nonpublic information

Answer 208

A
No

Standard II(A) - Material Nonpublic Information prohibits members and candidates from acting on or causing others to act on information that is both material and nonpublic. In this example, Antonelli has learned about the promotion of a mid-level executive, which may be nonpublic information, but is not material on its own. He knows from previous conversations that this executive has advocated a certain strategy - information that may be nonpublic, but is also not material on its own. In short, there is no evidence that Antonelli has violated this Standard, and his process appears to be consistent with the mosaic theory.

Additionally, Antonelli has not violated Standard V(A) - Diligence and Reasonable Basis, which requires members and candidates to have a “reasonable and adequate basis, supported by appropriate research and investigation, for any investment analysis, recommendation, or action.” There is no evidence that he failed to exercise proper diligence in conducting the research supporting his updated conclusions.

Question 209

udith Bollinger, CFA, is an analyst with Hamlin Brothers, a full-service international bank. For the past six weeks, Bollinger was a key member of a team that prepared a prospectus for an initial public offering being underwritten by Hamlin Brothers. Bollinger is confident that the offer price recommended by the team, which included several members of the investment banking department, is a fair reflection of intrinsic value based on rigorous analysis and internal discussions. Shortly before the prospectus was due to be sent to clients, Bollinger discovered that the team had not been given access to data that would have affected her price recommendation. Bollinger ensures that her name is not included in the report before it is distributed to potential investors and later refers all inquiries to other team members. Has Bollinger most likely violated the Standards?

A
Yes, with respect to knowledge of the law

B
Yes, with respect to independence and objectivity

C
No, because she had her name removed from the report before it was distributed

Answer 209

A
Yes, with respect to knowledge of the law

Standard I(A) - Knowledge of the Law requires members and candidates to actively dissociate from any violation of laws, rules, or regulations of which they become aware. In this case, it is not sufficient for Bollinger to simply have her name removed from the prospectus, she must take steps to prevent the prospectus from being distributed. This requirement is established by Standard V(B) - Communications with Clients and Prospective Clients, which states that members and candidates must “use reasonable judgment in identifying which factors are important to their investment analyses, recommendations, or actions and include those factors in communications with clients and prospective clients.” At a minimum, Bollinger should have discussed this matter with her firm’s legal and/or compliance departments.

Bollinger has not violated Standard I(B) - Independence and Objectivity, which does not prohibit analysts from working with investment bankers in their firm. In this example, Bollinger appears to have maintained her independence and objectivity while reaching a consensus offer price based on the information that was available to her at the time.

Question 210

Compared to perfectly competitive markets, a benefit of monopolistic competition is least likely that:

A
firms have an incentive to innovate.

B
consumers gain access to a wider variety of products and services.

C
successful firms are able to earn a positive economic profit over the long-run.

Answer 210

C
successful firms are able to earn a positive economic profit over the long-run.

Monopolistic competition is characterized by product differentiation, which provides consumers with the variety of products and services that they seek.

Product differentiation also gives firms an incentive to innovate experiment with new products or services, which is a benefit that a perfect competition market structure does not provide.

However, because of the low barriers to entry and exit, it is not possible for firms in a monopolistically competitive market to earn a positive economic profit over the long-run.

Question 211

Miranda Lambert, CFA, has five clients who have asked her to follow a large-cap value investment style. Two years ago, Lambert created a composite based on these accounts and she regularly refers to its historical returns in her marketing materials. In recent years, the returns for the large-cap value composite have been significantly higher than those posted by Lambert’s other composites. In meetings with prospective clients for whom a large-cap investment style is appropriate, Lambert refers only to the large-cap value composite unless the prospective client asks about other investment styles. Has Lambert most likely violated the Standards?

A
No

B
Yes, in her meetings with prospective clients

C
Yes, by distributing her firm’s marketing materials

Answer 211

A
No

Question 212

Amalie Svoboda, CFA, is an analyst with Next Horizon Investments, where she has worked since graduating from business school ten years ago. In recent years, Svoboda has become increasingly frustrated with what she perceives to be a workplace culture that fails to promote high ethical standards. For example, the firm’s social media policy is limited to requiring employees to refrain from visiting social media sites for personal use during business hours. Last weekend, Svoboda used her home computer to set up a profile with a website that allows financial professionals to give anonymous reviews of their firms. Under the username frustrated_worker, Svoboda posted the following review of Next Horizon, “I feel like I have put in too much time here to leave now, but I would advise people starting out in the industry to think twice before accepting a job here.” Has Svoboda most likely violated the Standards?

A
No

B
Yes, by using a fictitious name

C
Yes, by being disloyal to her employer

Answer 212

A
No

Svoboda has not violated the CFA Standards. According to Standard IV(A) - Loyalty, members and candidates must “act for the benefit of their employer and not deprive their employer of the advantage of their skills and abilities, divulge confidential information, or otherwise cause harm to their employer.” However, in this example, Svoboda has not used her employer’s time or resources to express an opinion. There is no evidence that she has violated Next Horizon’s social media guidelines, and the CFA Standards do not prevent members and candidates from expressing personal opinions about their employer.

Question 213

Which of the following indicators would be most appropriate to use in a forecast of the US economy’s performance over the next year?

A
S&P 500 Index

B
Average bank prime lending rate

C
Commercial and industrial loans outstanding

Answer 213

A
S&P 500 Index

Leading economic indicators are most appropriate to use for economic forecasts. The S&P 500 Index is a leading indicator because stock prices, historically, tend to anticipate economic turning points.

The other indicators have less value for forecasting purposes. Changes in the average bank prime rate and commercial and industrial loans outstanding are both lagging indicators.

Question 214

Which of the following is most likely an example of an indirect tax?

A
Sales tax

B
Property tax

C
Inheritance tax

Answer 214

A
Sales tax

Indirect taxes are taxes on sales of goods and services, such as alcohol or tobacco.

Direct taxes are those based on employment income (individual income tax), investment income (capital gains tax, dividend tax), and corporate profits (corporate income tax). Property taxes and inheritance taxes on estates are also classified as direct taxes.

Question 215

Which of the following best describes cluster sampling?

A
A one-stage cluster sampling uses all observations in each sampled cluster

B
The samples in each cluster need to share similar characteristics based on certain criteria

C
Cluster sampling creates samples that are more representative of the population compared to simple random sampling

Answer 215

A
A one-stage cluster sampling uses all observations in each sampled cluster

Answer choice A is accurate. A one-stage cluster sampling selects all the members in the sampled clusters, while a two-stage cluster sampling randomly selects a subsample from each sampled cluster.

Answer choice B is not accurate. Unlike stratified random sampling, cluster sampling divides the entire sample into mini-representations of the population. Each cluster may not consist of samples with similar characteristics.

Answer choice C is not accurate. Cluster sampling is more efficient than other probability sampling methods. However, the sample from a cluster may be less representative of the entire population.

Question 216

Companies that offer defined benefit pension plans most likely meet their obligations to retired employees:

A
indirectly through a legally distinct entity.

B
directly from internally-generated cash flows.

C
directly from funds that have been contributed by current plan participants.

Answer 216

A
indirectly through a legally distinct entity.

Sponsors of defined benefit pension plans typically establish a pension fund trust that operates as a separate legal entity. Sponsors then make payments to the trust, which is responsible for managing assets on behalf of the plan’s participants and administering payments to beneficiaries.

Question 217

Which of the following actions is most likely to be taken as part of an expansionary monetary policy?

A
Lowering reserve requirements

B
Increasing social transfer payments

C
Reducing tax rates for individuals and corporations

Answer 217

A
Lowering reserve requirements

Monetary policy is enacted by central banks. Lowering reserve requirements is a prime example of an action taken by a central bank that is pursuing an expansionary monetary policy. A lower reserve requirement will increase the money multiplier effect.

Increasing social transfers and reducing taxes are examples of expansionary policies. However, these are fiscal rather than monetary policies.

Question 218

formula to calculate a currency forward rate

Answer 218

forward rate = Sport rate * (1 + foreign interest rate) / (1 + domestic interest rate)

Question 219

Vivek Patel, an analyst covering the alcoholic beverages sector, typically issues price targets based on the base case scenario output of his quantitative model. The price target in his latest report on Majestic Breweries (MJB) is based on the best case scenario. Patel enacted this change, which was not disclosed to readers, for the benefit of a client who is seeking to divest a significant number of MJB shares. Patel has most likely violated the Standards with respect to:

A
market manipulation only.

B
communication with clients and prospective clients only.

C
both market manipulation and communication with clients and prospective clients.

Answer 219

C
both market manipulation and communication with clients and prospective clients.

Standard II(B) - Market Manipulation prohibits members and candidates from engaging in “practices that distort prices or artificially inflate trading volume with the intent to mislead market participants.” Patel violates this Standard by deviating from his established practice to publish an optimistic forecast with the intention of helping the client obtain a higher sale price.

Patel also violates Standard V(B) - Communication with Clients and Prospective Clients by failing to disclose a significant change to his process of analyzing and recommending investments.

Question 220

By setting an inflation target, central banks are most likely seeking to:

A
minimize inflation.

B
maintain nominal price levels.

C
minimize the volatility of inflation.

Answer 220

C
minimize the volatility of inflation.

Central banks typically target inflation of approximately 2%, but any rate within a defined range (e.g., +/- 1%) is permissible. Maintaining nominal prices would require a 0% inflation target. This is not desirable because it would increase the risk of deflation, which would limit the central bank’s monetary policy options. By setting an inflation target with an allowable range, central banks are seeking to maintain stable prices by minimizing the volatility of inflation.

Question 221

Which of the following would most likely be included among the properties of an ideal currency regime?

A
Countries regulate capital flows

B
Currency exchange rates are floating

C
Countries pursue their own independent monetary policies

Answer 221

C
Countries pursue their own independent monetary policies

Under an ideal currency regime, each country would be able to set independent monetary policy. The appropriate policy should be consistent with a country’s domestic objectives.

Question 222

Thomas Nolte, CFA, works for an investment firm and has a large roster of clients who are personally loyal to him based on years of dedicated service. Nolte has made plans to start his own investment firm, which will directly compete with his employer. He expects most of his clients will follow him. Before giving notice of his departure, and without notifying his employer, he submits the appropriate regulatory papers required to start his own firm. Has Nolte most likely violated the Standards?

A
No

B
Yes, by failing to notify his employer that he has submitted regulatory papers

C
Yes, by making plans to compete with his employer before giving notice of his departure

Answer 222

A
No

Standard IV(A) Loyalty states that “in matters related to their employment, Members and Candidates must act for the benefit of their employer and not deprive their employer of the advantage of their skills and abilities, divulge confidential information, or otherwise cause harm to their employer.”

In this example, Nolte is not actively soliciting clients. Instead, he is just making preparations to set up his own shop. There is no violation of this Standard as long as the activity does not distract him excessively from his current position and is done on his own time.

Question 223

Which of the following statements is most accurate? A correlation coefficient of zero allows us to conclude that two random variables:

A
have no linear or non-linear relationship.

B
are necessarily independent of each other.

C
may have a significant non-linear relationship.

Answer 223

C
may have a significant non-linear relationship.

Two random variables are independent if there is no linear or non-linear relationship. By contrast, correlation coefficients only address linear relationships.

Two independent variables with zero correlation may still have a significant non-linear relationship.

Question 224

Which of the following is most likely to be listed as an advantage of machine learning?

A
Outcomes are transparent

B
The need to rely on human judgment is eliminated

C
Analysis of unstructured data can help predict market trends

Answer 224

C
Analysis of unstructured data can help predict market trends

Unstructured data can complement structured data to help analysts predict market trends. For example, satellite images of retail parking lots can be used as an indication of consumer spending.

Machine learning techniques are not fully transparent and can lead to outcomes that are not easily understood.

Despite advances in machine learning, human judgment remains essential to the process of screening datasets for potential biases or spurious data.

Question 225

payables turnover formula

Answer 225

COGS / average trade payables

Question 226

rom an bondholder’s perspective, interest payments on debt are most likely:

A
discretionary and tax-deductible.

B
non-discretionary and tax-deductible.

C
non-discretionary and not tax-deductible.

Answer 226

C
non-discretionary and not tax-deductible.

Unlike discretionary distributions to shareholders, payments to bondholders are contractual obligations.

Although interest payments on debt are tax deductible for the issuer, they represent taxable income from a bondholder’s perspective.

Question 227

discount rate on banker’s acceptance note formula

Answer 227

DR = Return * (days per year / days remaining)

Question 228

Rebekah Woodham, a hedge fund manager, values the assets in the hedge fund using a mark-to-model valuation. The valuation performed by Woodham most likely:

A
overstates the return volatility.

B
uses observable transaction prices.

C
produces returns that are smoothed or overstated.

Answer 228

C
produces returns that are smoothed or overstated.

Assets that can only be modeled on a “mark-to-model” basis are so illiquid that no reliable market values are available. The model does not reflect a true liquidation value since estimates, rather than observable transaction prices, are used. As a result, returns may be smoothed or overstated and the return volatility may be understated.

Question 229

Common stock is most accurately described as a claim on a company’s:

A
assets.

B
net assets.

C
unsecured assets.

Answer 229

B
net assets.

A company’s assets are financed with either debt (liabilities) or equity. This can be formally expressed as the accounting formula: Assets = Liabilities + Equity. So, while both equity holders and debtholders have claims to a company’s assets, the claims of debtholders rank above those of equity holders.

More specifically, equity ownership in the form of common stock represents a residual claim to the value of all assets above and beyond the priority claims of debtholders. Therefore, it is most accurate to say that common stock represents a claim on a company’s net assets.

Question 230

A bond is issued with an interest rate of 6% and semi-annual interest payments. The bond has a maturity of 30 years. Assume that the market rate after 10 years is 7.2%. The bond would most likely be redeemed early if it were a(n):

A
step-up bond.

B
putable bond.

C
callable bond.

Answer 230

B
putable bond.

A putable bond allows the bondholder to sell the bond back to the issuer at a pre-determined price on specified dates. This protects the bondholder if interest rates rise after the issue date, depressing the bond’s price. Thus, when interest rates rise after issue (in this case, from 6% to 7.2%), a putable bond would most likely be redeemed early, as the cash could be reinvested in bonds that offer higher yields.

A callable bond gives the issuer the right to redeem all or part of the bond before the specified maturity date. Thus, issuers are protected against a decline in interest rates, as they are able to refinance debt at the lower interest rate.

Question 231

Returns on commodity investments most likely include:

A
price appreciation only.

B
both price appreciation and income.

C
both price appreciation and the real risk-free rate.

Answer 231

A
price appreciation only.

Returns on commodity investments are based on changes in price alone and do not include an income stream such as interest, dividends, or rent.

Question 232

n investor creates two positions - a protective put and a fiduciary call. All options are European-style and have the same strike price and time to expiry. Assuming that put-call forward parity holds and the call option expires in-the-money, the payoff of a protective put is most likely:

A
less than the payoff of a fiduciary call.

B
equal to the payoff of a fiduciary call.

C
greater than the payoff of a fiduciary call.

Answer 232

B
equal to the payoff of a fiduciary call.

According to put-call forward parity, the payoff of the protective put (long put, long asset) with a long forward contract is the same as the payoff of a fiduciary call (long call, long risk-free bond).

Question 233

A portfolio manager is evaluating investment opportunities in a country with an emerging economy and inefficient securities markets. The most appropriate investment strategy for this country is:

A
buy and hold.

B
active investment.

C
passive investment.

Answer 233

B
active investment.

Inefficient markets provide arbitrage opportunities. Active managers could generate positive alpha by exploiting the arbitrage opportunities in the inefficient market.

Question 234

Trade-off theory seeks to balance the value-enhancing effects of debt on a firm’s capital structure (i.e., debt tax shield) with the value-reducing effects (i.e., financial distress, agency costs).

Accounting for the value-reducing effects, the value of the levered firm becomes:

Answer 234

VL = VU + PV(Interest tax shield) - PV(Financial distress costs) - PV(Agency costs of debt)

Question 235

In over-the-counter derivatives markets, the market making function is most likely provided by:

A
banks.

B
a clearinghouse.

C
a central counterparty.

Answer 235

A
banks.

Question 236

Holders of which of the following categories of debt most likely have the highest priority claim to a borrower’s assets?

A
Second lien debt

B
Senior unsecured debt

C
Senior subordinated debt

Answer 236

A
Second lien debt

In order, the general rankings are as follows:

1. First lien loan - Senior secured
2. Second lien loan - Secured
3. Senior unsecured
4. Senior subordinated
5. Subordinated
6. Junior Subordinated

Question 237

Assuming it is trading at its par value, an option-free bond’s duration is most likely:

A
positively related to both its coupon rate and time-to-maturity.

B
inversely related to its coupon rate and positively related to its time-to-maturity.

C
inversely related to its coupon rate and positively related to its yield-to-maturity.

Answer 237

B
inversely related to its coupon rate and positively related to its time-to-maturity.

Question 238

Which of the following statements about the credit risk exposure of parties to a repurchase agreement is most likely correct?

A
Only the lender is exposed to credit risk

B
Both the borrower and the lender are exposed to credit risk

C
The lender’s exposure to credit risk is eliminated when the borrower posts collateral

Answer 238

B
Both the borrower and the lender are exposed to credit risk

Both parties to a repurchase agreement are exposed to credit risk, even if the borrower posts collateral because the market value of this collateral can decline over the term of the agreement.

The borrower may not be able to produce the funds required to repurchase the collateral. Alternatively, the lender may not be able to replace collateral that has increased in value.

Question 239

Which of the following is least likely to be included among the effects of securitization on financial markets?

A
An increased role of intermediaries

B
Additional funds available for lending

C
Greater liquidity for the underlying loans

Answer 239

A
An increased role of intermediaries

Securitization lessens the role of intermediaries. It removes the wall between ultimate investors and originating borrowers.

Securitization allows for the creation of the tradable securities with better liquidity than the original loans on the bank’s balance sheet. This has the additional effect of allowing banks to increase the supply of funds available for lending.

Question 240

Which of the following pricing models is most accurately classified as a type of price discrimination?

A
Auctions

B
Fractionalization

C
Penetration pricing

Answer 240

A
Auctions

Auctions are a type of price discrimination because different customers are changed different prices for the same served based on the willingness to pay.

Fractionalization is an alternative to full ownership that involves dividing an asset into smaller units.

Question 241

A relative value hedge fund strategy is most likely executed by:

A
selling the stock of an acquiring company when the acquisition is announced.

B
buying convertible debt securities and simultaneously selling the same issuer’s common stock.

C
buying the stock of a company that is expected to show high growth and taking an offsetting short position in a peer company that is expected to underperform.

Answer 241

B
buying convertible debt securities and simultaneously selling the same issuer’s common stock.

Relative value strategies aim to profit from a pricing discrepancy between related securities.

Buying convertible debt securities and simultaneously selling the same issuer’s common stock establishes a position that seeks to exploit perceived mispricing between a convertible bond and its component parts. This is an example of convertible bond arbitrage, which is a relative value strategy.

Event-driven strategies seek to profit from specific events. Selling the stock of an acquiring company is an example of merger arbitrage, which is an event-driven strategy.

Taking offsetting long and short positions is consistent with a market neutral strategy, which falls into the category of equity hedge strategies.

Question 242

Which of the following statements is most accurate? For two interest rate futures contracts to have the same basis point value:

A
it is only necessary that they have the same notional value.

B
they must have the same notional value and their market reference rates must be at the same level.

C
they must have the same notional value and their market reference rates must have the same periodicity.

Answer 242

C
they must have the same notional value and their market reference rates must have the same periodicity.

The basis point value (BPV) of an interest rate futures contract is calculated as follows:

Notional Principal * 0.0001 * Period

In the above formula, the term for Period refers to the portion of the year covered by the term of the MRR. For example, the Period value for a six-month MRR is 0.5.

Two interest rate futures contracts with the same notional and reference rates with the same periodicity will have the same basis point value.

Question 243

nvestors are most likely to use both fixed-income and equity indices based on:

A
credit quality.

B
economic sector.

C
market capitalization.

Answer 243

B
economic sector.

There are sector indices for both equities and fixed-income securities.

Choice A is incorrect because credit quality is a characteristic used only in the construction of fixed-income indices.

Choice C is incorrect because market capitalization is a characteristic used only in the construction of equity indices.

Question 244

Compared to participants in defined contribution pension plans, employees who participate in a defined benefit pension plan most likely:

A
have greater income needs.

B
accept less investment risk.

C
have more ability of develop an optimal asset allocation.

Answer 244

B
accept less investment risk.

Participants in defined contribution (DC) pension plans are entirely responsible for choosing their optimal asset allocation and accept all investment risk. By contrast, participants in defined benefit (DB) pension plans have no ability to determine the allocation of plan assets and accept no investment risk because their promised benefits are defined.

It is not possible to make any conclusions about the income needs of DB plan members relative to those of DC plan members as each individual participant in either type of plan will have his or her own individual income needs.

Question 245

A 5-year, 5% annual coupon bond is callable after each year. Which of the bond’s yield measures is most likely lowest?

A
Yield-to-worst

B
Yield-to-maturity

C
Yield-to-first-call

Answer 245

A
Yield-to-worst

Depending on the fist call date and the exercise price, yield-to-first-call may be a bond’s lowest yield measure, in which case, this would also be the bond’s yield-to-worst.

Alternatively, yield-to-maturity may be a bond’s lowest yield measure, in which case, this would also be the bond’s yield-to-worst.

However, a callable bond’s yield-to-worst measure (the lowest yield for all option possibilities) is always at least as low as any of its other yield measures.

Question 246

From the perspective of an equity issuer, the advantage of issuing shares as part of a shelf registration is most likely:

A
lower disclosure requirements.

B
minimizing the potential for negative price impact.

C
the opportunity to sell directly in the primary market.

Answer 246

B
minimizing the potential for negative price impact.

The structure of shelf registration allows issuers to sell securities in increments over time, rather than selling all securities in an issue at one time. This ability to control the amount and timing of sales allows the issuer to minimize the potential for negative price impact associated with a large increase in supply.

Making securities available as part of a shelf registration does not reduce the issuer’s disclosure requirements. Also, all transactions resulting from a shelf registration take place in the secondary market, not the primary market.

Question 247

Which of the following is least likely to be included among the elements of a value at risk measure?

A
A probability

B
A time period

C
An estimated maximum loss stated in units of currency

Answer 247

C
An estimated maximum loss stated in units of currency

A value at risk (VaR) measure includes three elements: a probability, a time period, and a minimum possible loss stated in units of currency.

For example, a bank may have a 5% monthly VaR of EUR 500 million, which means that there is a 5% chance of suffering a loss greater than EUR 500 million in a given month. Alternatively, over a period of 20 months, losses of at least EUR 500 million can be expected in one of those months.

Question 248

Which of the following statements is most accurate? Eurobonds are typically:

A
underwritten by a domestic financial institution.

B
unsecured bonds issued outside any country’s jurisdiction.

C
subject to less regulation than domestic bonds because they are secured.

Answer 248

B
unsecured bonds issued outside any country’s jurisdiction.

Eurobonds are usually unsecured. They are subject to lower regulatory requirements than domestic bonds because Eurobonds are issued internationally (i.e., beyond the jurisdiction of any single country).

Traditionally, most Eurobonds were bearer bonds, meaning that the trustee does not maintain a central record of ownership. However, more recently, they are more likely to be registered bonds. All Eurobonds are underwritten by an international syndicate of financial institutions.

Question 249

Which of the following statements is most likely correct?

A
Options payoffs are non-linearly related to the payoffs of the underlying

B
Options and swap payoffs are linearly related to the payoffs of the underlying

C
Options and forwards payoffs are linearly related to the payoffs of the underlying

Answer 249

A
Options payoffs are non-linearly related to the payoffs of the underlying

Options are referred to as contingent claims which provide payoffs that are non-linearly related to the underlying.

A swap is a series of forward commitments, which provides payoffs that are linearly related to the underlying.

Question 250

formula for a money market instrument with an add-on rate

Answer 250

PV = FV / (1 + Days/Year * AOR)

Question 251

If the borrowing rate is lower than the risk-free rate for a leveraged portfolio, the slope of the capital market line (CML) to the right of the market portfolio would most likely be:

A
less than the slope to the left of the market portfolio.

B
equal to the slope of the left of the market portfolio.

C
greater than the slope to the left of the market portfolio.

Answer 251

C
greater than the slope to the left of the market portfolio.

Since there is a difference between the borrowing rate and the risk-free rate, the capital market line will have a kink in it at the market portfolio location in a leveraged portfolio. The slope of the line is equal to:

Slope = (ERm - RF) / standard deviation m

When the borrowing rate differs from the risk-free rate, the equation above is the slope to the left of the market portfolio. The slope to the right of the market portfolio is:

Slope = (ERm - Rb) / standard deviation m

If the value for the borrowing rate is less than the risk-free rate, then the slope will be larger for all points to the right of the market portfolio location.

Question 252

Based on put-call parity, a combination of a short put, a long call and a long bond will most likely create a synthetic:

A
asset.

B
protective put.

C
fiduciary call.

Answer 252

A
asset.

By put-call parity:

So + po = co + X/(1+r)^T

Rearrange the equation to:

So = -po + co + X/(1+r)^T

Thus, the combination of a short put, a long call and a long position with a bond can create a synthetic long asset.

Question 253

Which of the following is most likely a source of funds available to sovereign borrowers and inaccessible by non-sovereign issuers?

A
Taxing citizens

B
Monetary policy

C
Dedicated cash flows from infrastructure projects

Answer 253

B
Monetary policy

Non-sovereign (provincial, regional, state) governments can raise funds to service their debt obligations by, for example, taxing citizens who fall under their jurisdiction or by accessing a stream of cash flows from a project that was financed with debt.

However, the authority to print new money by implementing an expansionary monetary policy is limited to sovereign governments.

Question 254

Which of the following company’s is most accurately classified as a value added reseller?

A
ABC Corp. earns royalties from operators that have paid for the right to sell the products that it has developed

B
KLM Corp. provides installation and maintenance services for the large excavating machinery that it manufactures

C
XYZ Corp. designs and markets personal electronic devices that are manufactured by third-party firms in countries with low labor costs

Answer 254

B
KLM Corp. provides installation and maintenance services for the large excavating machinery that it manufactures

A value added reselling model is typically used by firms that provide services such as installation and after-sales maintenance for their relatively complex products.

A company that earns royalties from operators with the exclusive right to sell its products is a franchisor.

Outsourcing the production of internally-developed products is part of a contract manufacturing business model.

Question 255

A corporate bond’s yield spread is most likely to reflect:

A
default risk and interest rate risk.

B
market liquidity risk and interest rate risk.

C
credit migration risk and market liquidity risk.

Answer 255

C
credit migration risk and market liquidity risk.

A bond’s yield spread relative to a risk-free reference rate is primarily influenced by the bond’s credit migration risk and market liquidity risk.

Question 256

A company that has issued its common shares directly on exchanges in multiple countries has most likely issued:

A
global registered shares.

B
global depository receipts.

C
a basket of listed depository receipts.

Answer 256

A
global registered shares.

Global registered shares are common shares that are issued directly by companies and traded on exchanges in multiple countries.

By contrast, global depository receipts are issued by depository banks, not the issuers themselves. The issuer deposits its shares in a bank, which then issues receipts that represent these shares and can be traded on exchanges outside the issuer’s domestic market without being subject to foreign ownership or capital flow restrictions.

Question 257

Which of the following statements regarding indifference curves is least accurate?

A
Compared to a risk-averse investor, a risk-seeking investor’s indifference curve is more upward-sloping

B
For two indifference curves, the indifference curve that lies further to the northwest has a higher level of utility

C
The slope of the indifference curve represents the additional return required by the investor to assume an additional unit of risk

Answer 257

A
Compared to a risk-averse investor, a risk-seeking investor’s indifference curve is more upward-sloping

At a given risk level, the indifference curve for a more risk-seeking investor would be less steep than that of a less risk-seeking investor. This is because a more risk-seeking investor does not require as much additional return to assume more risk.

Question 258

Participants in dividend reinvestment plans most likely receive the opportunity to acquire:

A
shares on the open market.

B
newly issued shares at a discount.

C
newly issued shares in a private placement.

Answer 258

B
newly issued shares at a discount.

Corporate issuers offer dividend reinvestment plans (also known as DRPs or DRIPs) to give existing shareholders the opportunity to purchase newly issued shares at a discount. Such plans encourage investors to increase their holding period.

Investors do not need to participate in a DRIP in order to acquire shares in the open market.

Question 259

The widespread adoption of permissionless networks in the investment industry has most likely been limited due to the:

A
immutability of transaction records.

B
lack of trust between counterparties.

C
inability of participants to perform all network functions

Answer 259

A
immutability of transaction records.

Permissionless networks record transactions on a blockchain. These records are immutable, meaning that they cannot be changed once they have been adopted by a consensus among network participants. This feature is an advantage because records cannot be manipulated as long as there is a diverse group of network participants. However, it is also a challenge to the adoption of permissionless networks because trades that are later cancelled cannot be removed and can only be offset by creating a fictional offsetting trade.