Question 1

An analyst gathers the following data for a market-capitalization-weighted index composed of securities Smith, Jones
and Wang companies:
Beginning of End of Period Dividends per Shares
Security Period Price Price Share Outstanding
Smith 2,500 2,700 100 5,000
Jones 3,500 2,500 150 7,500
Wang 1,500 1,600 100 10,000
The price return of the index is closest to:
a) −9.33%
b) −10.23%
c) −13.90%
The price return of the index is Beginning of Period Values: Smith (2,500 × 5,000) = 12,500,000; Jones (3,500 ×
7,500) = 26,250,000; and Wang (1,500 × 10,000) = 15,000,000. The total Beginning of Period Value is (12,500,000 +
26,250,000 + 15,000,000) = 53,750,000.
The End of Period Value shows Smith (2,700 × 5,000) = 13,500,000; Jones (2,500 × 7,500) = 18,750,000, and Wang
(1,600 × 10,000) = 16,000,000. The total End of Period Value is (13,500,000 + 18,750,000 + 16,000,000) =
48,250,000.
The price return of the index is [(48,250,000 − 53,750,000)/53,750,000] = −10.23%.

Question 2
An investment in a baseball card collection is most likely classified as being a(n):
a) derivative investment.
b) traditional investment.
c) alternative investment.
A baseball card collection is unique, illiquid, and the sale would have to be negotiated. As such, it is best classified as
being an alternative investment.

Question 3
Consider the following statements:
Statement 1: The weekend effect suggests that returns over the weekends tend to be higher than returns on
weekdays.
Statement 2: The holiday effect suggests that returns on stocks in the day prior to market holidays tend to be lower
than other days.
Which of the following is most likely?
a) Only one statement is correct.
b) Both statements are incorrect.
c) Both statements are correct.
The weekend effect suggests that returns on weekends tend to be lower than returns on weekdays.
The holiday effect suggests that returns on stocks in the day prior to market holidays tend to be higher than other
days.

Question 4
After placing a “good-'til-canceled, stop 75, limit 92 buy” order, Morriah made a short sale of 250 shares of Dell. The
price of the sale was 63. Assuming the order is not canceled and will be execute, that maximum possible loss that
Morriah may sustain exclusive of transaction cost is
a) $3,000
b) $7,250
c) Unlimited
The second choice is correct. The maximum limit price is 92, at which Morriah will incur a loss. At 75, the order will be
valid. The maximum possible loss without the transaction cost is 250 × (92 – 63) = $7,250.

Question 5
Assuming that the semi-strong form of efficient market hypothesis does not fully hold, then active portfolio
management will:
a) perform as well as the market.
b) perform better than the market.
c) underperform passive investment strategies.
If semi-strong form of EMH does not fully hold, then some information is not reflected in the price. Investors who
identify and act on the information may earn abnormal returns.
Question 6
The OTC market refers to trading in shares that:
a) Are not listed on an exchange.
b) May or may not be listed on an exchange.
c) Are quoted using order-driven pricing mechanisms.
The OTC market includes the trading of all shares that are not listed on an exchange and the trading of listed shares
outside an exchange. The OTC markets are quote-driven, not order-driven markets.

Question 7
An equal-weighted equity index consists of five securities with an initial value of $10,000. The prices of these
securities at the end of 2010 and 2011 are as follows:
Securities 2010 ($) 2011 ($)
A 64 67
B 40 45
C 50 52
D 45 48
E 80 80
Calculate the price return of the index for 2011.
a) 4.66%.
b) 2.92%.
c) 5.57%.
Since the index consists of five securities, each security will be assigned a weight of 20% in the index. As the total
value of the index is 10,000, the value assigned to each security will be 2,000.
Securities 2010 ($) No. of Shares* 2011 ($) EOP Value ($)
A 64 31 67 2,094
B 40 50 45 2,250
C 50 40 52 2,080
D 45 44 48 2,133
E 80 25 80 2,000
*2,000 / BOP share price
The price return of the index for 2011 = [($2,094 + $2,250 + $2,080 + $2,133 + $2,000) / 10,000] – 1 = 5.57%

Question 8
The cost of information explains why:
a) Markets are not completely efficient.
b) There tends to be an upward bias to prices.
c) Arbitrageurs cannot exploit pricing anomalies.
The cost of information is one of the reasons why markets cannot be completely efficient; there must be some reward
for analyzing or sourcing new information to justify the cost.

Question 9
Since the hedge fund market is relatively unregulated compared to the equity and fixed-income markets, a unique
feature that has evolved for hedge fund indices is that they:
a) are frequently equal weighted.
b) are determined by the constituents of the index.
c) reflect the value of private rather than public investments.
For a hedge fund index, constituents determine the index rather than index providers determining the index because
they only voluntarily report their performance to the index provider.

Question 10
You are short 1,000 shares of a $500 stock and based on its chart, you believe the shares can possibly rise to $550,
but that there is a resistance level at that price and the shares will likely fall back and continue to fall to a price
significantly below $500. If the shares are able to break through $550 resistance level, they could possibly rise by an
additional $100 or more. To try to protect against a large loss on your position, which of the following orders should
most likely be placed?
a) Short sell order.
b) Good-till-cancelled stop sell order.
 c) Good-till-cancelled stop buy order.
You are short the shares and are worried that if they rise above $550, then the rise may continue. Your best protection
is to place a stop buy order. The order will be acted upon if the stock rises above a certain amount (say $550).

Question 11
An analyst gathers the following information for an equal-weighted index composed of assets Alpha, Beta, and
Gamma:
Investment Beginning of the Period Price ($) End of the Period Price ($) Total Dividends ($)
Alpha 10.00 12.00 0.75
Beta 20.00 21.00 1.00
Gamma 30.00 33.00 2.00
The total return of the index is:
a) 2.5%
b) 11.7%
c) 18.1%
The total return of an index is calculated on the basis of the change in price plus the income received of the
constituent securities. The total return of Alpha is 27.5% [(12 − 10 + .75)/10]; of Beta is 10% [(21 − 20 + 1)/20]; and of
Gamma is 16.7% [33 − 30 + 2)/30]. An equal weighted index applies the same weight (1/3) to each security's return;
therefore, the total return = 1/3(27.5% + 10% + 16.7%) = 18.1%.

Question 12
The process known as reconstitution of a security market index reduces:
a) portfolio turnover.
b) the need for rebalancing.
c) deviations from the target market.
Reconstitution is the process by which index providers review the constituent securities, re-apply the initial criteria for
inclusion in the index, and select which securities will be retained, removed, or added.

Question 13
Kim Watanabe is a portfolio manager for a long/short equity fund. By researching companies, she trades pairs of
stocks in the same industry and expects to profit by buying the relatively undervalued company and selling the
relatively overvalued company. This strategy is expected to have a high risk-adjusted return. Kim Watanabe is best
described as being a(n):
a) hedger.
b) pure investor.
c) information-motivated trader.
Kim Watanabe is an information-motivated trader because she is looking for higher than normal returns based on her
research.

Question 14
Because of voluntary performance reporting to index providers, the returns of hedge fund indices are most likely:
a) biased upward.
b) biased downward.
c) similar across different index providers.
Voluntary performance reporting may lead to survivorship bias, and poorer performing hedge funds will be less likely
to report their lower performance.

Question 15
Which of the following is not a classification used by MSCI Barra to group countries in its multimarket indices?
a) Level of economic development
b) Key services or products offered
c) Geographic región
The first choice is incorrect based on the CFAI curriculum.
The second choice is correct. MSCI Barra classifies countries based on level of economic growth and geographic
region.
The third choice is incorrect based on the CFAI curriculum.

Question 16
In its portfolio, a mutual fund can only hold public equities traded in secondary markets. This fund can most likely
purchase a:
 a) futures contract on a publicly traded stock.
b) preferred stock that is traded on an exchange.
c) swap contract where the fund makes a fixed payment and receives the return on an equity index.
A preferred stock is an equity instrument even though it has some characteristics that are similar to debt. Thus, the
preferred stock can be owned by the mutual fund. The futures and the swap are both derivative contracts, not equities.

Question 17
An investor calls a broker on the first day of the month to find out the price of ABC Inc.'s shares and is quoted $103
bid–103½ ask. The shares are very liquid. The share price then moves to $98–98½ before rising to $115–115¾ at the
end of the month. If the investor had (1) placed a market order to buy the shares on the first day and then sold them
on the last day, (2) a limit order to buy at $100 and sell at the end of the month, his profit before transaction costs
would be closest to:
a) (1) 11.11% (2) 15.00%.
b) (1) 11.11% (2) 15.75%.
c) (1) 12.39% (2) 15.00%.
(1) If it is a market order, he will pay the ask price to buy the shares, that is, $103½, and he will sell at the bid price of
$115 making a profit of 11.11%. (2) A limit order to buy at $100 will be executed, and he will sell at $115, giving a
profit of 15%.

Question 18
An index is comprised of the following assets:
Security Price, Beginning Price, Ending Total Dividends
Dawn 74 80 2.00
Dusk 74 82 5.00
Twilight 74 87 0.00
The price return of the index is:
a) 14.44%
b) 12.16%
c) 10.84%
The second choice is correct. Sum of beginning prices: 222
Sum of ending prices: 249
Price return = 249/222 – 1 = 12.16%

Question 19
A trader is comparing being long a forward contract at $90 and being long a call option contract with a strike price of
$90. Both contracts have the same underlying common stock. The trader should understand that both contracts:
a) generally benefit as the underlying asset rises in value.
b) involve a commitment to buy the underlying asset at $90.
c) require the payment of an initial premium in order to establish the position.
Both positions do have exposure to the underlying asset. For a forward contract, being long entails taking on both the
upside and downside risk related to the underlying. In contrast, being long a call option provides upside exposure and
limits the downside risk. Hence, both long positions do have the upside exposure.
A long forward is a commitment to buy the asset at $90. A long option means the trader does not have to exercise the
option unless the underlying asset's price is greater than $90. But, the option buyer does have to pay a premium in
order to obtain this single-sided exposure.

Question 20
A person entering into a forward contract will most likely have difficulty when trying to:
a) get back the deposit he paid at the contract's initiation.
b) changing the standardized terms in the contract.
c) close out the contract early.
Forward contracts are difficult to close out early because the original counterparty has to agree to the early close out.
There is no deposit and no standardized terms, so there is no associated difficulty with these items.

Question 21
Which of the following change in regulations is most likely to improve market efficiency?
a) Reducing margin requirements on short selling.
b) Raising margin requirements on short selling.
c) Raising margin requirements on margin purchases.
Reducing margin requirements on short selling will encourage greater short selling activity; i.e., a greater number of
investors acting on information.

Question 22
John Smith, CFA, wants to know the return of the index in a year. No changes happened in the shares outstanding
and market-capitalization is employed. He gathers the following information:
Security Beg, Price End, Price Shares
AX1 56 50 800
BY2 58 64 1,300
CZ3 31 32 500
The total return on the index over the period is:
a) 2.57%
b) 3.82%
c) 4.49%
The first choice is correct. Beginning market value = 135,700
Ending market value (50 × 800 + 64 × 1,300 + 32 × 500) = 139,200
Increase in value = 3,500
Price return = 3,500/135,700 = 2.57%

Question 23
Security market indices are used as:
a) proxies for risk-free assets.
b) proxies to measure unsytemmatic risk.
c) proxies for specific asset classes in asset allocation models.
Security market indices play a critical role as proxies for asset classes in asset allocation models, such as the CAPM.

Question 24
A security market index is defined as a single measure that consolidates information and reflects the performance of
an entire:
a) industry.
b) economy.
c) security market.
d)
Security market indices make it easier to consolidate information in one measure.

Question 25
An analyst gathered the following quotes for a security from different dealers in an equity market:
Bid Price ($) Ask Price ($)
Dealer 1 26.05 26.65
Dealer 2 25.95 26.70
Dealer 3 26.50 27.15
The market bid-ask spread is closest to:
a) $1.20
b) $0.67
c) $0.15
Best bid price = $26.50
Best ask price = $26.65
Therefore, market bid-ask spread = 26.65 – 26.50 = $0.15