Mock Exam 2023 #1 Second Session Corporate Finance, Equity, Fixed

Level I of the CFA® Exam
Mock Questions with Answers - Mock Exam 2023 #1 - Second

Session (Corporate Finance, Equity, Fixed Income, Derivatives,
Alternative Investments & Portfolio Management)
Offered by AnalystPrep
Last Updated: Sep 5, 2023
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Q.1 Which of the following most likely distinguishes a general partner (GP) from limited partner (LP)
in a limited partnership?
A. Both general partners (GP) and limited partners (LPs) have limited liability.
B. T he growth of the business is limited to the competence and integrity of the limited
partners.
C. A general partner has unlimited liability and manages the business, while limited partners
have limited liability but can provide capital or expertise.
In a limited partnership, there is at least one general partner (GP) wi th unl i mi ted l i abi l i ty
and i s responsi bl e for managi ng the business. T he remaining partners are limited partners. As
the name suggests, they have limited liability (their losses are capped at their investment amounts in
the limited partnership).
A i s i ncorrect. Contradicts with option C.
B i s i ncorrect. Apart from the GP/LP financing capability, competence, and integrity of the GPs in
running a business are some factors that facilitate business growth in limited partnerships.
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© 2014-2023 AnalystPrep.
Q.2 Which of the following is least likely an ESG implementation method?
A. Worst-in-class.
B. Impact investing.
C. Positive screening.
T he correct answer is A.
Worst-in-class is not the name of an ESG implementation strategy. On the flip side, best-in-class
describes an ESG approach that seeks to identify the best ESG-scoring companies in each industry.
B and C are i ncorrect.Positive screening and impact screening are both examples of ESG
implementation methods.
CFA Level 1, Vol ume 4, Readi ng 29– Introducti on to Corporate Governance and other
ESG consi derati ons, LOS 29k : Descri be how envi ronmental , soci al , and governance
factors may be used i n i nvestment anal ysi s.
Q.3 Organic Foods Inc. is considering a new project in the health-based packaged foods segment. An
analyst has gathered information about a listed company named Health Farms Inc. which is
exclusively into the health-based packed foods business. T he following information is available:
Organic Foods
Inc.
Debt/Equity 1.5
Marginal Tax Rate 30 %
Debt Yield 12.50 %
Health Farms
Inc.
Debt/Equity 2.0
Marginal Tax Rate 40 %
Equity Beta 1.2
Market Data
Risk-Free rate 5%
Market Risk Premium 7%
T he weighted average cost of capital for the project is closest to:
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A. 10.40%
B. 12.90%
C. 13.20%
Step 1: Cal cul ate the Asset Beta for Heal th Farms Inc.
⎡ 1 ⎤
Asset Beta = Equity Beta ∙
⎣ (1 + (1 − tax rate) ∙ D⎦
E
1
= 1.2 × [ ] = 0.55
(1 + (1 − 40%) × 2)
Step 2: Cal cul ate the Proj ect's Equi ty Beta usi ng data of Asset Beta and Organi c Foods
Inc.
D
Equity Beta = Asset Beta × (1 + (1 − tax rate) × )
E
= 0.55 × (1 + (1 − 30%) × 1.5) = 1.13
Step 3: Proj ect Cost of Equi ty
Ke = R f + Equity Beta × Market Risk Premium

= 5% + 1.13 × 7%
= 12.9%
Step 4: Wei ghted Average Cost of Capi tal
Assume 1 unit of equity and 1.5 units of debt for D/E ratio of 1.5x. So total funding is 2.5 (1 of equity
1 1. 5
+ 1.5 of debt). Accordingly, equity weightage is and debt weightage is
2. 5 2. 5
1 1.5
= × 12.83% + × 12.50% × (1– 0.30) = 10.4%
2.5 2.5
CFA Level 1, Vol ume 4, Readi ng 33 – Cost of Capi tal -Foundati onal Topi cs, LOS 33a:
Cal cul ate and i nterpret the wei ghted average cost of capi tal (WACC) of a company.
4
Q.4 Veko Plastic is a plastics manufacturing company that has the maximum capacity to manufacture
200,000 plastic bags per year. Currently, Veko operates at 60% of its maximum capacity in order to
generate revenues of $600,000.
Revenue $600, 000

Total Variable Cost $400, 000
Fixed Operating Cost $90, 000
Fixed Financing Cost $25, 000
Without considering fixed financing costs, the operating breakeven quantity of bags Veko should
produce is closest to:
A. 30,000 bags.
B. 54,000 bags.
C. 90,000 bags.
T he correct answer is B.
T he firm only operates at 60% of its maximum capacity, and it only produces 120,000 plastic bags
(200,000 bags × 60% operating capacity).
Fixed operating cost

Breakeven quantity of bags =
Price − Variable cost
90, 000
= 600,000 400 000
120,000
− 120,,000
= 54, 000.
A i s i ncorrect. It assumes the difference between the maximum capacity and the operation
capacity as follows;
Break-even Quantity of bags = 200, 000 − (200, 000 × 60%) = 800, 000 bags
C i s i ncorrect. It equates the breakeven quantity of bags to the operating capacity of 120,000 bags.
CFA Level 1, Vol ume 4, Readi ng 35– Measures of Leverage, LOS 35e: Cal cul ate and
i nterpret the operati ng break even quanti ty of sal es..
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Q.5 Raman Enterprises and Madan Enterprises are operating in the same industry segment of locks
manufacturing. T here is an expectation of improvement in the market environment and a 20%
increase in sales for all the industry players going forward. Both companies have an identical scale of
operations with total assets deployed of $400,000 and unit sales of 100,000. T hey sell their products
at $4 per unit incurring a variable cost of $2 per unit and fixed costs of $50,000. Raman Enterprises
finances 40% of its assets from equity and 60% from debt. Madan Enterprises finances its operations
100% from equity. T he interest rate on debt for both companies is 8%. T he Degree of Total
Leverage for the two companies is closest to:
A. Raman Enterprises: 1.11; Madan Enterprises 1.33.
B. Raman Enterprises: 1.33; Madan Enterprises 1.53.
C. Raman Enterprises: 1.53; Madan Enterprises 1.33.
T he correct answer is C.
T he calculation can be summarized as follows;
Raman Enterprises Madam Enterprises

Assets 400 , 000 Assets 400 , 000
Equity 40 % Equity 100 %
Equity 160 , 000 Equity 400 , 000
Debt 240 , 000 Debt -
FC Fixed Cost 50 , 000 FC Fixed cost 50 , 000
Q Units Sold 100 , 000 Q Units Sold 100 , 000
P Selling Price 4 P Selling price 4
V Variable cost 2 V Variable cost 2
Interest rate 8% Interest rate 8%
Interest Cost (Debt * Interest Interest Cost (Debt *
1 Rate) 19 , 200 1 Interest Rate) -
1 Q*(P-V) 200 , 000 1 Q*(P-V) 200 , 000
2 Q*(P-V)-FC-I 130 , 800 2 Q*(P-V)-FC-I 150 , 000
Degree of Total Leverage Degree of Total Leverage
DTL) = 200,000/130,800 1.53 (DTL) = 200,000/150,000 1.33
A i s i ncorrect. It ignores the deduction of finance costs for Raman Enterprises.
B i s i ncorrect. T he correct position is a DT L of 1.53 for Raman Enterprises and 1.33 for Madan
Enterprises.
CFA Level 1, Vol ume 4, Readi ng 35– Measures of Leverage, LOS 35b: Cal cul ate and
i nterpret the degree of operati ng l everage, the degree of fi nanci al l everage, and the
degree of total l everage.
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Q.6 Rachel Green is discussing corporate governance best practices with her team. Following are
two of her statements regarding corporate governance.
I. To avoid wasting shareholders' resources, the board of directors should get management approval
before hiring an outside consultant.
II. A higher number of representatives on the Board of Directors is better for shareholders as the
shareholder's interest will be fairly represented.
Which of the statement(s) mentioned above is/are most likely accurate?
A. Both statements are correct.
B. Only one statement is correct.
C. Both statements are incorrect.
An independent board should have the ability to hire outside advice without the approval of the
management. Having more members does not necessarily mean better representation. T he
independence of the board members is more important. T he size of the board should be aligned with
the size and circumstances of the firm.
CFA Level 1, Vol ume 4, Readi ng 29– Introducti on to Corporate Governance and other
ESG consi derati ons, LOS 29f: Descri be functi ons and responsi bi l i ti es of a company's
board of di rectors and i ts commi ttees.
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Q.7 Carton Co. expects to produce 50,000 units of watches for the following year. T he selling price
per watch is $200, the variable cost per watch is $100, fixed costs are $3,500,000, and interests are
$750,000.
T he degree of operating and the degree of total leverage for Carton Co.is closest to:
A. DOL: 3.33; DT L: 1.12
B. DOL: 3.33; DT L: 6.67
C. DOL: 6.67; DT L: 3.33
T he calculation is as follows:
Q (P − V) 50, 000(200 − 100)

DOL = = = 3.33
Q(P − V) − F 50, 000(200 − 100) − 3, 500, 000
Q(P − V) 50, 000 (200 − 100)

DT L = = = 6.67
Q (P − V) − F − I 50, 000(200 − 100) − 3, 500, 000 − 750, 000
A i s i ncorrect. T he calculation of DT L ignores the fixed costs as follows;
Q (P − V) 50, 000 (200 − 100)

DOL = = = 1.12
Q (P − V) 50, 000 (200 − 100)
C i s i ncorrect. T he correct outcome is DOL 3.33 and DT L 6.67.
CFA Level 1, Vol ume 4, Readi ng 35– Measures of Leverage, LOS 35b: Cal cul ate and
i nterpret the degree of operati ng l everage, the degree of fi nanci al l everage, and the
degree of total l everage.
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Q.8 T he initial outlay on a new project is $100,000. It generates annual cash flows of $40,000 for the
next five years. T he firm's debt to equity ratio is 1x, and new projects are also financed in the same
proportion. T he company's weighted average cost of capital is 11.34%, and flotation costs for equity
are 5%. T he NPV of the project using the correct treatment of flotation costs is closest to:
A. 44,080
B. 46,580
C. 41,251
Period Cash flow without Revised cash flows with flotation

foatation costs costs
0 (100 , 000) (102 , 500)
1 40 , 000 40 , 000
2 40 , 000 40 , 000
3 40 , 000 40 , 000
4 40 , 000 40 , 000
5 40 , 000 40 , 000
NPV 46,580 44,080
WACC 11.34 %
D/E 1
Flotation Cost 5%
D
100,000 cost of project will be financed 50,000 from equity and 50,000 from debt (given that = 1x )
E
Flotation Costs = 5% × 50, 000

= 2, 500
Initial outlay after considering flotation costs = 100, 000 + 2, 500

= 102, 500
Compute NPV using new cash flows and WACC of 11.34%
CFA Level 1, Vol ume 4, Readi ng 33 – Cost of Capi tal – Foundati onal Topi cs, LOS 33g:
Expl ai n and demonstrate the correct treatment of fl otati on costs.
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Q.9 Following is the data of Blue-Chip Co. Target Capital Structure: Debt: 30%; Preference Shares:
15%; Equity: 55% T he price of their bonds on a fair value of $1,000 is $955. T he company is paying a
6% coupon for ten years. Equity dividends are expected to be $2.50 in the next year and will grow at
5%. T he current market price of the stock is $25. T he preferred stock with a par value of $100
pays a dividend of 7% and is currently selling at $95. If the marginal tax rate is 40%, the after-tax cost
of debt and after-tax cost of preferred stock is closest to:
A. Debt: 3.98%; Preferred Shares: 7.37%.
B. Debt: 3.98%; Preferred Shares: 4.42%.
C. Debt: 6.63%; Preferred Shares: 7.37%.
T he calculation of the Cost of Debt using the BAII Plus Pro calculator is as follows:
Cost of Debt = Calculate using N=10;PMT = 60;PV = −955;FV = 1000; CPT = 6.63%
Cost of Debt = Calculate YI using N=10;PMT = 60;PV = −955; FV = 1000; CPT I

Y
= 6.63%
Post tax cost of debt = 6.63 × (1 − 40%) = 3.98%
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Cost of Preference Dividend = = 7.37
95
T he preference dividend is not tax-deductible. Hence, the post-tax cost will be equal to pre-tax cost
= 7.37
B i s i ncorrect. It indicates the post-tax cost of preference shares of 4.42%.
C i s i ncorrect. It indicates the pre-tax cost of debt of 6.63%.
CFA Level 1, Vol ume 4, Readi ng 33– Cost of Capi tal - Foundati onal Topi cs, LOS 33a:
Cal cul ate and i nterpret the wei ghted average cost of capi tal (WACC) of a company.
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Q.10 An investor is interested in investing in a pharma Company listed on S&P 500. T he correlation
between the company and S&P 500 is 0.78, while the standard deviation of returns of the company is
18% and the standard deviation of returns of S&P is 25%. T he adjusted beta value of the Companyis
closest to:
A. 0.5616
B. 0.7077
C. 1.1757
Standard deviation of returns of the company

Beta = Correlation between the company and S&P 500 ×
Standard deviation of returns of S&P
0.18
= 0.78 × = 0.5616
0.25
T hus,
2 1 2 1
Adjusted Beta = (Unadjusted beta) + (1.0) = (0.5616) + (1.0) = 0.7077
3 3 3 3
CFA Level 1, Vol ume 4, Readi ng 33 - Cost of Capi tal -Foundati onal Topi cs, LOS 33f:
Expl ai n and demonstrate beta esti mati on for publ i c compani es, thi nl y traded publ i c
compani es, and nonpubl i c compani es.
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Q.11 Energy Beverages plans to introduce a new mineral drink named "Spark." T he company has
estimated that the new project's NPV is $5 million, but this ignores the decrease in sales of existing
energy drink named "Power" caused by a new project. It is estimated by the company that the
existing drink will lose $700,000 in after-tax cash flows during each of the next 10 years because of
the cannibalization. Energy's WACC is 8.5%. T he NPV of the new energy drink "Spark" after
considering externalities is most likely :
A. $407,056.
B. $4,592,94.
C. $5,000,000.
Calculations are in the table below:
First, we will calculate the NPV of the negative externalities due to the cannibalization of an existing
product. Enter the following input data in the calculator:
CF0 = 0; CF1-10 = -700000; I = 8.5%; and solve for NPV = $4,592,943.6
T hen, recalculate the new product’s NPV after considering externalities: +$5,000,000 - $4,592,944
= $407,056.
CFA Level 1, Vol ume 3, Readi ng 31– Capi tal i nvestments, LOS 31b: demonstrate the use
of net present val ue (NPV) and i nternal rate of return (IRR) i n al l ocati ng capi tal and
descri be the advantages and di sadvantages of each method.
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Q.12 Based on the data provided in the following table, the operating cycle of Armenia Ltd. is closest
to:
Sale $ 2, 990, 000

COGS $ 1, 940, 000
Avg. Acc. Payables $ 310, 000
Avg.Acc.Rec $ 440, 000
Avg.Inventory $ 220, 000
A. 95 days.
B. 99 days.
C. 108 days.
Operating cycle = Days of Inventory in hand+ Number of days of Receivables
365 Days
No. of days of inventory =
Inventory turnover
365 days
=
$1,940,000
( $220,000 )
= 41.39 days
365 Days
No. of days of receivables =
Sales
( )
Avg. Acc. Rec.
365 days
=
$2 990 000
, ,
( $440 )
000
,
= 53.71 days
T herefore,
Operating cycle = 41.39 + 53.71 = 95 days
CFA Level 1, Vol ume 3, Readi ng 32– Work i ng Capi tal & Li qui di ty, LOS 32d: compare a
company’s l i qui di ty posi ti on wi th that of peers
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Q.13 Mr. Roy is planning to invest $150,000 in a home décor business. T he cash inflows are as
follows:
1st year: $35,000
2nd year: $55,000
3rd year: $75,000
T he cost of capital is 7%. T he IRR of the business is:
A. 0%. Hence, Roy should not invest in the business.
B. 4.37%. Hence, Roy should not invest in the business.
C. 7%. Hence, Roy should invest in the business.
Using BA II Plus calculator.CF0 = -150,000

CF1 = 35,000
F01 = 1
CF2 = 55,000
F02 = 1
CF3 = 75,000
F03 = 1
IRR ⇒ CPT ⇒ 4.37%. Since IRR is less than the cost of capital, Roy should not invest in the business.
CFA Level 1, Vol ume 3, Study Sessi on 9, Readi ng 31- Capi tal Investments, LOS 31c.
demonstrate the use of net present val ue (NPV) and i nternal rate of return (IRR) i n
al l ocati ng capi tal and descri be the advantages and di sadvantages of each method;
Q.14 For distributed ledger technology to work, what are the most appropriate required elements?
A. Peer-to-peer network.
B. Clearly defined asset classes for exchange.
C. Blockchain to provide secure and valid achievement.
T he correct answer is A. A distributed ledger (also called a shared ledger, or referred to as

distributed ledger technology) is digital data that is consensually replicated, shared, and synchronized
across multiple sites, countries, or institutions. T he elements required for DLT to work include a
digital ledger, a peer-to-peer network, and a consensus algorithm used to confirm new entries. B i s
i ncorrect. Clearly defined asset classes for exchange are not a required element for DLT. C i s
i ncorrect. A blockchain system is a form of distributed ledger design in which information, such as
changes in ownership, is recorded sequentially within blocks that are then linked through
cryptography. But not all distributed ledgers have to employ a chain of blocks to attain consensus and
synchronization. CFA Level 1, Vol ume 6, Readi ng 68– Fi ntech i n Investment Management,
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LOS 68d: Descri be fi nanci al appl i cati ons of di stri buted l edger technol ogy.
Q.15 Below are the details of the Operating cycle and Cash Conversion cycle of Citrus Corp for the
last three years.
2013 2014 2015

Operating Cycle (days) 52 57 61
Cash Conversion Cycle (days) 31 34 36
T he trend in the operating and cash conversion cycles most likely indicates that the:
A. Payables of Citrus Corp are stretched in the last 3 years.
B. T he liquidity of Citrus Corp has improved over the last 3 years.
C. Receivable Collection of Citrus Corp has slowed down over the past 3 years.
T he difference between the operating cycle and the cash conversion is the number of days payable.
T he number of days payable has been increasing over the three year period - indicating stretched
payables.
CFA Level 1, Vol ume 3, Readi ng 32– Work i ng Capi tal , LOS 32d:compare a company’s
l i qui di ty posi ti on wi th that of peers
Q.16 A project has the following characteristics:
Initial Investment $ 75 , 000

Expected post-tax Cash Flow (each year) from year 1 to
year 5 $ 22 , 000
Target Debt/Equity Ratio: 0.5
Cost of Equity 12.5 %
Cost of Debt 11 %
Effective tax rate 40 %
T he Net Present Value (NPV) of the project is closest to:
A. $6,515.
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B. $7,239.
C. $9,365.
Cal cul ate Wei ght of Equi ty and Debt
We +Wd=1
Wd
= 0.5
We
T herefore,
W d = 0.5 × W e
0.5 × W e = 1 − W e
0.5 × W e + W e = 1
1.5 × W e = 1
W e = 1/1.5
W e = 0.67
W d = 0.33
W ACC = 0.33 × 0.11 × (1 − 0.4) + 0.67 × 0.125 = 10.55
Discount the cash flow using WACC
Year Cash flow after tax PV of Cash flow after tax

1 $22, 000 $19, 900
2 $22, 000 $18, 001
3 $22, 000 $16, 283
4 $22, 000 $14, 729
5 $22, 000 $13, 324
Total $82, 239
N P V = $82, 239 − $75, 000 = $7, 239
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CFA Level 1, Vol ume 4, Readi ng 33– Cost of Capi tal – Foundati onal Topi cs. LOS 33a:
cal cul ate and i nterpret the wei ghted average cost of capi tal (WACC) of a company.
Q.17 Lili Telecom Limited recently acquired MMQ Telematics Limited in a highly competitive bid.
T he details of Lili’s share price pre-acquisition are given in the following exhibit. Exhi bi t 1: Li l i
Tel ecom Li mi ted
Share price before acquisition $ 4.00

Outstanding shares 10 million
Lili Telecom paid $5 million to the shareholders of MMQ Telematics for the acquisition. Post-
acquisition, the share price of Lili Telecom rose by 10%. T herefore, the fair value of MMQ
Telematics is closest to:
A. $8 million.
B. $9 million.
C. $10 million.
Let the fair value of the acquisition = x
Value of Lili Telecom Limited after acquisition of MMQ Telematics = $4*10 million - 5 million + x =
$35 million + x
As the value of Lili’s shares increased by 10%, the value of Lili Telecom Limited after acquisition =
$44 million
44 million = 35 million + x
⇒ x = 9 million
CFA Level 1, Vol ume 3, Readi ng 31– Capi tal Investments, LOS 31e: Descri be expected
rel ati ons among a company’s i nvestments, company val ue, and share pri ce;
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Q.18 Which of the following is the appropriate term for the discount rate that makes the present
value of expected incremental after-tax cash inflows equivalent to the initial cash outlay?
A. Net Present Value.
B. Opportunity Cost.
C. Internal rate of Return.
T he internal rate of return (IRR) is the discount rate that makes the present value of expected
incremental after-tax cash inflows equivalent to the initial cash outlay.
A i s i ncorrect. T he net present value (NPV) is not a discount rate. It is the present value of cash
inflows minus the present value of cash outflows.
B i s i ncorrect. An opportunity cost is the loss of potential gain from other alternatives when one
alternative is chosen.
CFA Level 1, Vol ume 3, Study Sessi on 9, Readi ng 28 – Uses of Capi tal , LOS 28b:
Demonstrate the use of net present val ue (NPV) and i nternal rate of return (IRR) i n
al l ocati ng capi tal and descri be the advantages and di sadvantages of each method.
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Q.19 T he most appropriate term for excluding shares held by owners and shares unavailable for
foreign buyers while constructing a market capitalization-weighted index is:
A. free float.
B. index float.
C. market float.
T he term "free float" refers to the number of shares of a company that is available for trading by the
public and are not held by major shareholders or insiders. T his is the most appropriate term to use
when constructing a market capitalization-weighted index, as it ensures that the index is
representative of the market as a whole and not skewed by the holdings of a small number of large
shareholders.
B i s i ncorrect. T he float index shows the representation of the whole picture of simply floating
shares, which are actively traded in the stock market and have no exclusions for shares held by
owners and shares unavailable for foreign buyers.
C i s i ncorrect. Market float it refers to the number of shares of the constituent security available
to the investing public and includes shares held by owners and foreign buyers.
CFA Level 1, Vol ume 4, Readi ng 37– Securi ty Mark et Indexes, LOS 37e: Cal cul ate and
anal yze the val ue and return of an i ndex gi ven i ts wei ghti ng method.
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Q.20 An investor buys 100 shares of a stock on a margin of $146 a share using an initial leverage ratio
of 1/2. T he price at which he will receive a margin call if the position's maintenance margin
requirement is 40% is closest to:
A. $58.40.
B. $116.80.
C. $121.67.
T he calculation is determined as follows;
1
Leverage ratio = = 0.5
2
Initial equity per share = 0.5 × $146 = $73
($73 + P − $146)
= 0.40
P
$73 + P − $146 = 0.40P
$73 − $146 = −0.60P
−$73 = −0.60P
P = 121.67
CFA Level 1, Vol ume 4, Readi ng 36– Mark et Organi zati on and Structure, LOS 36f:
Cal cul ate and i nterpret the l everage rati o, the rate of return on a margi n transacti on,
and the securi ty pri ce at whi ch the i nvestor woul d recei ve a margi n cal l .
20
Q.21 Which of the following is most likely a disadvantage of market capitalization-weighting?
A. Constituent securities are held in proportion to their value in the target market.
B. Its simplicity and failure to consider other factors such as the volume of shares sold.
C. Constituent securities whose prices have risen the most (or fallen the most) have a
greater (or lower) weight in the index.
As a security's price rises relative to other securities in the index, its weight increases; and as its
price decreases in value relative to other securities in the index, its weight decreases.
A i s i ncorrect. It depicts an advantage of market capitalization- weighting.
B i s i ncorrect. It is an advantage associated with index weighting.
CFA Level 1, Vol ume 4, Readi ng 37– Securi ty Mark et Indexes, LOS 37d: Compare the
di fferent wei ghti ng methods used i n i ndex constructi on.
21
Q.22 A Company is planning to raise USD 15 million for its expansion project. T he Company’s CFO
discusses with the CEO three options that are available to the Company to raise capital. T hese
include retained earnings, debt from the bank, and issuance of equity in the market. According to the
Pecking order theory, which of the following should be the order of preference for the Company?
A. Finance the expansion project first through retained earnings, then through debt financing,
and then through the issuance of equity.
B. Finance the expansion project first through the issuance of equity, then through debt
financing, and then through retained earnings.
C. Finance the expansion project first through debt financing, then through retained earnings,
and then through the issuance of equity.
T he pecking order theory states that managers display the following preference sources of
financing: first, through the company’s retained earnings, followed by debt, and choosing equity
financing as a last option. T he retained earnings financing (internal financing) comes directly from
the company and therefore minimizes information asymmetry. In contrast, external financing, such
as debt or equity financing, where the company has to incur fees to obtain external financing,
internal financing is the cheapest and most convenient source of financing.
CFA Level 1, Vol ume 4, Study Sessi on 10, Readi ng 34 – Capi tal Structure. LOS 34a.
expl ai n factors affecti ng the capi tal structure.
22
Q.23 Texas Corp. is a calculator manufacturing firm expected to pay a dividend of $2 next year that
will grow 5% for two more years. If the stock is expected to sell for $30 at the end of the third year
and the required rate of return is 11%, then the stock's present value is closest to:
A. $23.55
B. $25.44
C. $27.05
Using the dividend discount model the stock value will be:
2 2.1 (2.205 + 30)

= + + = 27.05
1.111 1.112 1.113
B i s i ncorrect.It results from the following calculation:
2 2.1 30
+ + = $25.44
1.111 1.112 1.113
C i s i ncorrect. It results from the following calculation:
2.205 + 30
= $23.55
1.113
CFA Level 1, Vol ume 4, Readi ng 41– Equi ty Val uati on: Concepts and Basi c Tool s, LOS
41g: cal cul ate and i nterpret the i ntri nsi c val ue of equi ty securi ty based on the Gordon
(constant) growth di vi dend di scount model or a two-stage di vi dend di scount model , as
appropri ate.
23
Q.24 Sadin Nigaro is an equity analyst who is evaluating Piron Corp. T he firm is a public limited
company that manufactures lifeboats.
Total Aseets $ 575 million

Total liabilities $ 225 million
Revenue during the year $ 101 million
Number of shares outstanding 8,750,000 shares
Market capitalization $ 393.75 million
From the data given above, the difference between the per-share market value of equity and the per-
share book value of equity is closest to:
A. $5
B. $5.33
C. $5.75
Book value = Total Assets − Total liabilities.
($575, 000, 000 − $225, 000, 000)

Book value per share = = $40 per share
8, 750,000shares
Total market capitalization

Market value per share =
Number of shares outstanding.
$393, 750, 000

MV per share = = $45 per share
8, 750,000shares
Difference between the market value of equity and book value of equity = $45 − $40 = $5
CFA Level 1, Vol ume 4, Readi ng 39– Overvi ew of Equi ty Securi ti es, LOS 39g: Contrast
the mark et val ue and book val ue of equi ty securi ti es.
24
Q.25 If a market is semi-strong form efficient, the risk-adjusted returns of a passively managed
portfolio relative to an actively managed portfolio are most likely :
A. lower
B. higher
C. the same
In a semi-strong form efficient market, all publicly available information, both historical and current,
is reflected in the prices of securities, making it difficult for active managers to consistently
generate higher returns than passive managers. T herefore, on a risk-adjusted basis, the returns of a
passively managed portfolio should be higher than an actively managed portfolio.
A i s i ncorrect. In a semi-strong form efficient market, all publicly available information is reflected
in the prices of securities, making it difficult for active managers to consistently generate higher
returns than passive managers. T herefore, on a risk-adjusted basis, the returns of a passively
managed portfolio should be higher than an actively managed portfolio.
C i s i ncorrect. Even though both active and passive portfolio strategies have access to the same
information, the active managers are trying to make predictions about future market conditions and
pick stocks or bonds that they believe will perform better than the market average, while passive
managers simply track the market average. Since active managers are trying to predict future
performance, they are more likely to underperform the market than passive managers because it is
hard to consistently predict future market conditions, therefore, passive strategies are more likely
to have higher returns.
CFA Level 1, Vol ume 4, Readi ng 38– Mark et Effi ci ency, LOS 38e: Expl ai n the
i mpl i cati ons of each form of mark et effi ci ency for fundamental anal ysi s, techni cal
anal ysi s, and the choi ce between acti ve and passi ve portfol i o management.
25
Q.26 In the case of a share denominated in foreign currency, the appreciation of the foreign
currency most likely :
A. increases the returns.
B. not affect the returns.
C. decreases the returns.
If the foreign currency appreciates, the shares denominated in that currency will have higher
returns as they are affected by the change in the exchange rates. In other words, foreign
investments would have higher returns when translated back to the local currency if the foreign
currency appreciates.
We can use a practical illustration to understand this better. Assume that an equity investor based in
the United States invests in shares denominated in the Sterling Pound. Assume also that at the time of
investing, the exchange rate was I Pound Sterling = 1.06 United States Dollar. If the sterling pound
appreciates against the dollar to have an exchange rate of, say, 1 Pound Sterling = 1.36 United States
Dollars, then the returns obtained from the shares will also increase. Suppose we assume that the
investor gets a dividend of 1 Sterling Pound per share, in place of getting $1.06 per share after
converting Sterling Pounds to United States Dollar (the local currency), the investor will now be
getting a dividend of $ 1.36 per share (an increase of $0.30 per share).
B i s i ncorrect. Foreign currency appreciation and depreciation will affect shares denominated in
foreign currency.
C i s i ncorrect. Returns will decrease if the foreign currency will depreciate against the local
currency.
CFA Level 1, Vol ume 4, Readi ng 39– Overvi ew of Equi ty Securi ti es, LOS 39d: Descri be
methods for i nvesti ng i n non-domesti c equi ty securi ti es.
26
Q.27 T he segregated cash flows from securitized assets are most appropriately called:
A. dark pools.
B. tranches.
C. special purpose entities.
"T ranche" is actually a French word meaning "slice" or "portion." In the world of investing, it is used
to describe a security that can be split up into smaller pieces and subsequently sold to investors.
A i s i ncorrect. Dark pools refer to alternative trading systems that don't display their clients'
orders and are unrelated to segregated cash flows.
C i s i ncorrect. Special purpose entities protect investors in an asset pool instead of placing the
assets and liabilities in the balance sheet; hence, don't segregate cashflows from securitized assets.
CFA Level 1, Vol ume 4, Readi ng 36– Mark et Organi zati on and Structure, LOS 66c:
Descri be the maj or types of securi ti es, currenci es, contracts, commodi ti es, and real
assets that trade in organi zed mark ets, i ncl udi ng thei r di sti ngui shi ng
characteri sti cs and maj or subtypes.
27
Q.28 Muhammad Umar is a fund manager who wants to purchase 5,000 stocks of Wellington Inc. at
the current price of $92. If the initial margin required to open up a leveraged position is 35%, the
leverage ratio is closest to:
A. 2.86.
B. 3.10.
C. 4.45.
T he leverage ratio is calculated by dividing 1 by the initial margin required to execute leverage
trade.
Leverage ratio:
1
= 2.86.
0.35
28
Q.29 Open Ltd has average days of receivables of 50 days, average days inventory of 40 days, and
average days payable of 30 days. Port Ltd, operating in the same industry, has a receivables turnover
of 6 times, inventory turnover of 12 times, and payables turnover of 9 times. Given the information
above, what is the most accurate statement?
A. Port Ltd has a shorter cash conversion cycle than Open Ltd.
B. Open Ltd has a shorter cash conversion cycle than Port Ltd.
C. Cash conversion cycle for Open Ltd and Port Ltd is approximately equal.
T he cash conversion cycle is a metric that measures the amount of time it takes for a company to
convert its investments in inventory and other resources into cash from sales. It is calculated as:
Cash conversion cycle = Days of inventory + Days of receivables – Days of payables
Cash conversion cycle for both companies are as follows:
Receivables turnover 6
Inventory turnover 12
Open Ltd Port Ltd
Average Days of Receivable = 365/receivables turnover 50.0 60.8
Average Days of Inventory = 365/ inventory turnover 40.0 30.4
Average Days of Payable = 365 / payables turnover 30.0 40.6
Cash conversion cycle = Days Receivable + Days Inventory - 60.0 50.7
-Days Payable
Port Ltd's cash conversion cycle is lower
T he CCC for Open Ltd is 60 days, while the CCC for Port Ltd is 50.7 days. Port Ltd has a shorter cash
conversion cycle than Open Ltd, therefore the correct answer is A) Port Ltd has a shorter cash
conversion cycle than Open Ltd.
CFA Level 1, Vol ume 3, Study Sessi on 9, Readi ng 32 – Work i ng Capi tal &Li qui di ty, LOS
32d: compare a company’s l i qui di ty posi ti on wi th that of peers.
29
Q.30 Which of these is most likely the major focus of a portfolio manager under the efficient market
hypothesis?
A. Diversify the portfolio.
B. Follow a strict buy and hold strategy.
C. Reduce the systematic risk to the minimum.
Under the efficient market hypothesis, it is believed that all publicly available information is already
reflected in the prices of securities. T herefore, individual stock selection is not important and the
main focus of a portfolio manager is to diversify the portfolio to spread out risk. Diversifying the
portfolio allows the manager to minimize the impact of any single stock's performance on the overall
portfolio's returns.
B i s i ncorrect. Following a strict buy and hold strategy can be a good investment approach in an
efficient market, but it's not necessary to follow it strictly. A portfolio manager may consider
adjusting the portfolio as needed based on market conditions and changes in the economy.
C i s i ncorrect. he efficient market hypothesis assumes that the market is efficient and all
securities are already priced correctly, so it may not be possible to eliminate the systematic risk
entirely. However, a portfolio manager may aim to reduce the systematic risk by diversifying the
portfolio and making sure the portfolio aligns with the client's risk profile..
CFA Level 1, Vol ume 4, Readi ng 38– Mark et Effi ci ency, LOS 38d: Contrast weak -form,
semi -strong-form, and strong-form mark et effi ci ency.
30
Q.31 Efficient market portfolio managers are least likely to<:
A. limit transaction costs to the minimum.
B. devote more time working on security selection.
C. devote more time to better understand their clients’ preferences of risk.
In efficient markets, individual stock selection is not important as all stocks are already properly
priced and reflect all publicly available information. T herefore, a portfolio manager in an efficient
market is less likely to devote more time working on security selection and instead focus on
maintaining a well-diversified portfolio and minimizing transaction costs.
A i s i ncorrect. A portfolio manager's role includes crafting a well-diversified portfolio in an
efficient market, which includes minimizing transaction costs. By limiting transaction costs, the
manager aims to maximize returns for the portfolio.
C i s i ncorrect. Understanding the individual client risk profiles is an essential part of a portfolio
manager's role. Knowing the client's risk appetite and investment goals helps the manager to
construct a portfolio that aligns with the client's objectives.
CFA Level 1, Vol ume 4, Readi ng 38– Mark et Effi ci ency, LOS 38e: Expl ai n the
i mpl i cati ons of each form of mark et effi ci ency for fundamental anal ysi s, techni cal
anal ysi s, and the choi ce between acti ve and passi ve portfol i o management.
31
Q.32 Dylan Farmer is an active portfolio manager who uses an industry rotation strategy. How should
he most likely treat stocks in a cyclical industry during a contraction phase?
A. Overweight the industry.
B. Underweight the industry.
C. Maintain the target weight of the industry.
A cyclical industry is anticipated to outperform during expansion phases and underperform in
contraction phases. T herefore, the industry rotation strategy for a cyclical industry will to
overweight this industry during expansion phases and underweight it during contraction phases.
A i s i ncorrect. Overweighting the industry is applicable during the expansion phase in a cyclical
industry.
C i s i ncorrect. Maintaining the weight of the industry is not applicable during a contraction phase.
CFA Level 1, Vol ume 4, Readi ng 40– Introducti on to Industry and Company Anal ysi s,
LOS 40c: Expl ai n the factors that affect the sensi ti vi ty of a company to the busi ness
cycl e and the uses and the l i mi tati ons of i ndustry and company descri ptors such as
"growth," "defensi ve," and "cycl i cal ."
32
Q.33 T he financial details of a financial transaction are given below:
Market Price per share on June 30, 2015 $28

Number of Shares Purchased 4, 000
Ending Share Price on June 30, 2016 $30
Assuming there are no transaction and borrowing costs, the rate of return on a margin transaction
for an investor who purchased the stock on Jun 30, 2015, using an initial margin requirement of 35%
and the stock price at which the investor would have received a margin call given a 25% margin
requirement is closest to:
A. Return: 10.99%; Margin Call Price: $26.00.
B. Return: 20.41%; Margin Call Price: $24.27.
C. Return: 20.41%; Margin Call Price: $26.00.
Margi n Return
Ending value − Loan payoff

Margin Return = − 1 × 100
Beginning Equity Position
($30 × 4, 000) − ($28 × 4, 000 × 0.65)

= − 1 × 100 = 20.41
($28 × 0.35 × 4, 000)
Margi n Cal l Pri ce
1 − Initial margin
Margin Call = Original price ×
1 − Maintenance margin
(1 − 0.35)
= $28 × = $24.27
(1 − 0.25)
Q.34 A stock's limit order book is as follows:
33
Bid Size Limit Price (£) Offer Size
26.65 300
26.45 200
26.35 300
600 26.30
700 26.25
800 26.15
If an investor places a new sell limit order for 150 shares at £26.32, the limit order is most likely said
to be:
A. an iceberg order.
B. behind the market.
C. making a new market.
A limit order is said to be making a new market when it is placed between the best bid and best ask,
i.e., the highest bid and the lowest offer, and it creates a new price level. In other words, it will be
the new best bid or best ask, depending on whether it is a buy or sell order.
In the case presented in the question, an investor places a sell limit order for 150 shares at £26.32;
this order is between the best bid, which is £26.30, and the best ask, which is £26.35; it creates a
new market, by having a new offer (best ask) at £26.32 and it is not behind the market.
A i s i ncorrect. An iceberg order refers to a limit order where only a small quantity of shares is
visible to the market and the rest of the shares are hidden. T his type of order is used to conceal the
true intentions of the trader and is typically used by large institutional traders. It is not related to the
limit order being placed between the best bid and the best ask.
B i s i ncorrect. Behind the market refers to a limit order that is placed at a price that is worse than
the current best bid or best ask, meaning that the trader is willing to sell shares at a lower price than
the current highest bid, or buy shares at a higher price than the current lowest offer. In this case,
the order is not likely to be filled immediately and will wait until the market moves to the trader's
desired price level. It's not related to the limit order being placed between the best bid and the best
ask.
CFA Level 1, Vol ume 4, Readi ng 36– Mark et Organi zati on and Structure, LOS 36g:
34
Compare executi on, val i di ty, and cl eari ng i nstructi ons.
Q.35 In a semi-strong efficient market, investors should most likely consider:
A. active portfolio management strategies.
B. passive portfolio management strategies.
C. an enhanced indexing strategy that is dependent on trading patterns.
In a semi-strong efficient market, passive strategies are suitable as investors cannot make abnormal
profits by using fundamental analysis or technical analysis.
A i s i ncorrect. In a semi-strong efficient market, the implication is that active portfolio
management strategies, whether attempting to exploit price patterns or public information, are not
likely to generate abnormal returns.
C i s i ncorrect. An investment strategy in which an investor constructs a portfolio to mirror the
performance of a specified index and doesn't take into account a semi-strong efficient market.
CFA Level 1, Vol ume 4, Readi ng 38– Mark et Effi ci ency, LOS 38a: Descri be mark et
effi ci ency and rel ated concepts, i ncl udi ng thei r i mportance to i nvestment
practi ti oners.
35
Q.36 An investor short-sells a stock at $90. A few days later, the stock is now trading at $72. What is
the most appropriate action that the investor must take if he wants to hold on to his investment as
long as the price does not go back up to $80?
A. Stop order to buy at $80.
B. Stop order to sell for $80.
C. Limit order to buy at $80.
T he investor is short the stock. T hus, he wants to use a buy order to get out of the trade. With a
stop order, the investor's trade will be executed only when the security he wants to buy back
reaches a particular price (the stop price). A limit order at $80 would get filled instantaneously as the
stock price is $72. T herefore, the investor would not be able to hold on to his investment.
CFA Level 1, Vol ume 4, Readi ng 36– Mark et Organi zati on and Structure, LOS 36g:
Compare executi on, val i di ty, and cl eari ng i nstructi ons.
36
Q.37 Which of the following investors in the U.S stock market would most likely earn the highest
return in their local currency in the event of a depreciating dollar and increasing U.S equity prices?
A. A U.S. investor who reinvests dividends.
B. A non-U.S. investor who reinvests dividends.
C. A non-U.S. investor who does not reinvest dividends.
Sources of return on equity securities include price appreciation or depreciation, dividend income,
and foreign exchange gains or losses for investors outside the country. When U.S equity prices
increase, reinvesting dividends is likely to increase returns compared to not reinvesting dividends.
B i s i ncorrect. Foreign investors will experience foreign exchange losses that reduce their
returns in a depreciating currency.
C i s i ncorrect. A foreign investor who doesn't reinvest dividends may avoid foreign exchange
losses that will reduce returns.
CFA Level 1, Vol ume 4, Readi ng 39– Overvi ew of Equi ty Securi ti es, LOS 39e: Compare
the ri sk and return characteri sti cs of di fferent types of equi ty securi ti es.
37
Q.38 Which of these best describes the shape of the slope of the experience curve, which
illustrates the cumulative units of production relative to the direct cost per new unit produced?
A. Upward sloping.
B. Downward sloping.
C. Upward sloping in early years and downward sloping in later years.
T he experience curve expresses the relationship between equations for experience and efficiency
or between efficiency gains and investment in the effort. T he curve is always downward sloping due
to increases in productivity and economies of scale, especially in industries with high fixed costs.
A i s i ncorrect. An upward slope exists at the growth stage of an industry life cycle curve but not
an experience curve slope.
C i s i ncorrect. It indicates the varying stages of an industry life cycle and not specifically the
experience curve slope.
LOS 40f: Descri be the el ements that need to be covered i n a thorough i ndustry
anal ysi s.
38
Q.39 A small investor just bought 100 shares of UYA on margin. T he share price of UYA at the time
of purchase was $50, the initial margin requirement was 50%, and the maintenance margin was 30%.
Given this information, the margin call trigger price is closest to:
A. $35.71
B. $70.00
C. $79.00
(1 − Initial margin)
T rigger price = Initial purchase price ×
(1 − Maintenance margin)
$50 × (1 − 0.5)
= = $35.71
1 − 0.3
T he investor will receive a margin call when the stock price falls to $35.71.
B i s i ncorrect. It assumes the following calculation;
(1 − 0.5)
T rigger price = $50 × = $70.00
1 − 0.3
C i s i ncorrect. It assumes the following calculation:
(0.5)
T rigger price = $50 × = $83.33
0.3
39
Q.40 In the event of default, which of the following is most likely to have the lowest priority of
claims?
A. Senior Secured Debt.
B. Senior Unsecured Debt.
C. Senior Subordinated Debt.
Priority of claim is:
First Lien Loan;
Senior Secured;
Senior Unsecured;
Senior Subordinated;
Subordinated; and
Junior Subordinated.
A and B are i ncorrect. T hey are classified as higher priority claims.
CFA Level 1, Readi ng 47– Fundamental s of Credi t Anal ysi s, LOS 47c: Descri be
seni ori ty rank i ngs of corporate debt and expl ai n the potenti al vi ol ati on of the pri ori ty
of cl ai ms i n a bank ruptcy proceedi ng.
40
Q.41 If a firm enters into a repo agreement to sell a 5.75% 10-year bond with a par value of $1
million and a market value of $980,000 for $945,000 and to repurchase it 120 days later for $955,000,
then the repo margin is closest to:
A. -3.57%.
B. -2.55%.
C. 2.62%.
T he percentage difference between the market value and the amount loaned is called the repo
margin and is calculated as:
$945,000
− 1 = − 3.57%
$980, 000
B i s i ncorrect. It calculates the repo margin as follows:
$955, 000
Repo Margin = − 1 = −2.551%
$980, 000
C i s i ncorrect. It calculates the repo margin as follows:
$980, 000
Repo Margin = − 1 = 2.618%
$955, 000
CFA Level 1, Vol ume 5, Readi ng 43– Fi xed-Income Mark ets: Issuance, Tradi ng, and
Fundi ng, LOS 43j : descri be repurchase agreements (repos) and the ri sk s associ ated
wi th them.
41
Q.42 Which of the following statements is/are most accurate? I. For a lender, loans with higher loan
value (i.e., LT Vs) are less risky because the borrower has more to lose in the event of default. II.
Mortgages to borrowers of lower credit quality or that have a lower priority claim to the collateral
in the event of default are called prime loans
A. II only.
B. I and II.
C. Both I and II are incorrect.
Statement I i s i ncorrect. For a lender, loans with lower LT Vs are less risky because the
borrower has more to lose in the event of default.
Statement II i s i ncorrect. Mortgages to borrowers of lower credit quality, or that have a lower
priority claim to the collateral in the event of default, are termed subprime loans.
CFA Level 1, Vol ume 4, Readi ng 45– Introducti on To Asset-Back ed Securi ti es, LOS 45e:
Descri be types and characteri sti cs of resi denti al mortgage-back ed securi ti es,
i ncl udi ng mortgage pass-through securi ti es and col l ateral i zed mortgage obl i gati ons
expl ai n the cash fl ows and ri sk s for each type.
42
Q.43 Which of the following class of commercial papers most likely requires registration with the
SEC in the United States?
A. Securities with an original maturity in excess of 180 days.
B. Securities with original maturity in excess of 270 days.
C. Securities with original maturity in excess of 1 year.
Securities with original maturities in excess of 270 days are required to be registered with the SEC
in the United States.
A i s i ncorrect. Commercial paper is short-term funding and matures in less than 270 days; hence,
between 180 days to 270 days are not required to be registered with the SEC in the United States.
C i s i ncorrect. To avoid the time and expense associated with an SEC registration, issuers of U.S.
commercial paper rarely offer maturities longer than 270 days.
Fundi ng, LOS 43g: Descri be types of debt i ssued by corporati ons.
43
Q.44 A bond with a $1,000 par value has a conversion price of $50 and, the market price of the
common share is $75. T he conversion value is closest to :
A. $925.
B. $950.
C. $1,500.
Par value of the bond

Conversion ratio =
Conversion price
1,000
Conversion ratio = = 20
50
Conversion value is the market value of the shares that would be received upon conversion. A bond
with a conversion ratio of 20 shares, when the current market price of a common share is $75,
would have a conversion value of 20 × 75 = $1, 500.
A i s i ncorrect. It assumes the calculation of conversion value as follows:
Conversion value = Bond par value-Common share market price = $1, 000 − $75 = $925
B i s i ncorrect. It assumes the calculation of conversion value as follows:
Conversion value = Bond par value-Conversion price = $1, 000 − $50 = $950
CFA Level 1, Vol ume 4, Readi ng 42– Fi xed-Income Securi ti es: Defi ni ng El ements, LOS
42f: Descri be conti ngency provi si ons affecti ng the ti mi ng and/or nature of cash fl ows of
fi xed-i ncome securi ti es and i denti fy whether such provi si ons benefi t the borrower or
the l ender.
44
Q.45 What does an “excess of 100 PSA” prepayment model assumption developed by the Public
Securities Association (PSA) most likely indicates?
A. Prepayments are faster than the benchmark.
B. Prepayments are slower than the benchmark.
C. Prepayments are not correlated with the benchmark PSA value.
T he PSA Prepayment Model is a prepayment scale developed by the Public Securities Association
for analyzing American mortgage-backed securities. A PSA assumption over 100 PSA indicates that
the prepayment is faster than the benchmark.
B i s i ncorrect. A PSA assumption lower than 100 PSA means that prepayments are assumed to be
slower than the standard model.
C i s i ncorrect. In the United States, market participants describe prepayment rates in terms of a
prepayment pattern or benchmark over the life of a mortgage pool. T he resulting pattern is the
Public Securities Association (PSA) prepayment benchmark produced by the Securities Industry and
Financial Markets Association (SIFMA).
CFA Level 1, Vol ume 4, Readi ng 45– Introducti on to Asset-Back ed Securi ti es, LOS 45f:
Defi ne prepayment ri sk and descri be the prepayment ri sk of mortgage-back ed
securi ti es.
45
Q.46 A $1,000 par value 5% semi-annual coupon bond has a Macaulay duration of 3.59 years. Which
of the following is most accurate?
I. If yields increase by 100 basis points, then the bond’s price will drop by approximately
3.59%.
II. If the yields increase by 1%, the bond would need to be held for approximately 3.59 years
before the decrease in price would be offset by the gain in reinvested coupons.
A. I only.
B. II only.
C. Both I and II
Statement I i s i ncorrect. Macaulay duration is not a measure of bond price sensitivity to interest
rate changes. It only measures the weighted average time to receive the bond's cash flows and the
time it takes for the reinvested coupons to offset the price change.
Statement II i s correct. T he Macaulay duration measures the weighted average time to receive
the bond's cash flows; in other words, it measures the period a bond would have to be held before
the value of the reinvested coupons would offset the price change.
With 100 basis points (1%) increase in yields, the Modified duration calculates the approximate drop
in the bond's price, not the Macaulay duration. MacDur measures the period a bond would have to be
held before the value of the reinvested coupons would offset the price change.
CFA Level 1, Vol ume 5, Readi ng 46– Understandi ng Fi xed-Income Ri sk and Return, LOS
46c: Expl ai n why the effecti ve durati on i s the most appropri ate measure of i nterest
rate ri sk for bonds wi th embedded opti ons.
46
Q.47 A $1,000 par value bond with 6% annual coupons matures in 2 years. If the required rate of
return on the bond is 11%, then the current yield on the bond using simple compounding is closest
to:
A. 0.35%
B. 5.78%
C. 6.56%
First, we need to calculate the present value of the bond.
N = 2;I/Y = 11;PMT = 60; FV = 1, 000;CPT => PV = −914.37
T hen, we calculate the current yield:
Annual coupon
Current yield =
Current price
$60
=
$914.37
= 6.56%
CFA Level 1, Vol ume 4, Readi ng 42– Fi xed-Income Securi ti es: Defi ni ng El ements, LOS
42a: Descri be basi c features of a fi xed i ncome securi ty
47
Q.48 Which of the following is the most appropriate statement regarding the underutilized capacity
of an industry?
A. Underutilized capacity results in excess demand.
B. Underutilized capacity results in higher pricing power.
C. Underutilized capacity results in a lower return on capital.
Underutilized capacity occurs when a company or industry is not utilizing all of its available
resources to produce goods or services, resulting in excess capacity and lower returns on
investment.
LOS 40h: Expl ai n the effects of barri ers to entry, i ndustry concentrati on, i ndustry
capaci ty, and mark et share stabi l i ty on pri ci ng power and pri ce competi ti on.
Q.49 A bond has an annual modified duration of 5 years and a convexity of 92. Given a 350 bps
increase in yield, the approximate percentage price change of the bond is closest to:
A. -11.87%
B. -6.23%
C. 9.52%
1
T he estimated price change = −(AnnModDur) × (Change in yield) + ( )
2
× (Convexity) × (Change in yield)2
1
= −5 × 0.035 + × 92 × 0.0352
2
= −11.87%
46h: Cal cul ate and i nterpret approxi mate convexi ty and di sti ngui sh between
approxi mate and effecti ve convexi ty.
48
Q.50 A 10% annual coupon corporate bond maturing in two years is trading at of 100.75. T he two-
year, 8% annual payment government benchmark bond is trading at of 100.95. If the one-year and
two-year government spot rates are 2.4% and 3.5%, respectively, stated as effective annual rates,
then the G-spread is closest to:
A. 190 bps.
B. 200 bps.
C. 210 bps.
T he yield-to-maturity for the corporate bond is 9.57% calculated as folllows:
10 110
100.75 = +
(1 + r) (1 + r)2
Using BA II Plus PV = -100.75, PMT = 10, N=2, FV = 100, CPT = I/Y = 0.0957
T he yield-to-maturity for the government bond is 7.47% calculated as follows:
8 108
100.95 = +
(1 + r) (1 + r)2
Using BA II Plus PV = -100.95, PMT = 8, N=2, FV = 100, CPT = I/Y = 0.0747
T he G-spread is 210 bps: 0.0957– 0.0747 = 0.021
CFA Level 1, Vol ume 4, Readi ng 44– Introducti on to Fi xed-Income Val uati on, LOS 44k :
compare, cal cul ate, and i nterpret yi el d spread measures.
49
Q.51 Which of the following bonds is least likely to make periodic coupon payments
I. Pure discount bonds
II. U.S. T reasury Bills
III. Plain vanilla bonds
A. I only.
B. I and II only.
C. I, II and III.
I i s correct. Pure discount bonds, also known as zero-coupon bonds, are bonds that do not pay any
interest or coupons during their lifetime. Instead, they are sold at a discount to their face value, and
the investor receives the full face value upon maturity. T hese bonds are also known as zero-coupon
bonds because they have no coupon payments to generate interest income.
II i s correct. U.S. T reasury Bills (T-bills) are a type of debt securities issued by the U.S.
Department of the T reasury. T hey have a maturity of one year or less, and, like pure discount bonds,
they do not pay interest before maturity. Instead, they are sold at a discount of the par value to
create a positive yield to maturity. T-bills are considered to be a very safe investment because they
are backed by the full faith and credit of the U.S. government.
III i s i ncorrect. Plain vanilla bonds are the most basic or standard version of a financial instrument.
T hey typically pay periodic coupon payments, which are usually fixed and paid semi-annually. T he
face value of the bond is returned to the investor at maturity. T hese bonds are considered to be less
risky than other types of bonds, such as junk bonds or emerging market bonds.
Fundi ng, LOS 43e: Descri be securi ti es i ssued by soverei gn governments.
50
Q.52 Debt instruments that allow an investor to take possession of an asset and pay for it over time
are most likely known as:
A. collateral trust bonds.
B. equipment trust certificates.
C. mortgage-backed securities.
T he term equipment trust certificate describes a debt instrument held by a trust and secured by a
specific asset. Equipment trust certificates are typically backed by an asset that can be readily
transported and sold. Once the debt has been repaid, ownership of the asset is transferred to the
certificate's issuer.
A i s i ncorrect. Collateral trust bonds are secured by securities such as common shares, other
bonds, or other financial assets and are pledged by the issuer and typically held by the trustee.
C i s i ncorrect. Mortgage-backed securities are debt obligations that represent claims to the cash
flows from pools of mortgage loans, most commonly on residential property. T hey are purchased
from banks, mortgage companies, and other originators and then assembled into pools by a
governmental, quasi-governmental, or private entity.
CFA Level 1, Vol ume 4, Readi ng 45– Introducti on to Asset-Back ed Securi ti es, LOS 45b:
Descri be securi ti zati on, i ncl udi ng the parti es i nvol ved i n the process and the rol es
they pl ay.
51
Q.53 Which of the following statements is/are most accurate?
A. T he 'Actual/Actual' and '30/360' are commonly used to calculate corporate and

government bond days.
B. T he 'Actual/Actual' convention is commonly used to calculate days in government bonds,

and the '30/360' convention is commonly used to calculate days in corporate bonds.
C. T he 'Actual/Actual' convention is commonly used to calculate days in corporate bonds, and

the '30/360' convention is commonly used to calculate days in government bonds.
T he government calculates accrued interests on an actual basis, whereas corporate bonds assume 30
days in a month for the calculation of accrued interests.
A i s i ncorrect. 'Actual/Actual' is commonly used to calculate government bonds, not corporate
bonds.
C i s i ncorrect. T he correct position is the 'Actual/Actual' convention is commonly used to
calculate days in government bonds, and the '30/360' convention is commonly used to calculate days
in corporate bonds.
CFA Level 1, Vol ume 4, Readi ng 44– Introducti on to Fi xed-Income Val uati on, LOS 44d:
Descri be and cal cul ate the fl at pri ce, accrued i nterest, and the ful l pri ce of a bond.
52
Q.54 Securitization is a process by which financial assets are purchased by an entity that then issues
securities supported by the cash flows from those financial assets.
Which of the following are the least likely primary benefits?
A. An increase in the liquidity of the underlying financial assets.
B. An increase in credit rating from banks and other financial institutions.
C. A reduction in funding costs for firms selling the financial assets to the securitizing entity.
An increase in credit rating from banks and other financial institutions is not the primary benefit of
securitization, as securitization does not directly increase the credit rating of banks and financial
institutions. It does, however, allows banks to transfer risk to the investors of the securities.
A i s i ncorrect. Securitization allows financial assets that may be illiquid, such as mortgages, to be
converted into securities that can be bought and sold more easily on the market. T his increases the
liquidity of the assets and allows the originator of the assets, such as a bank, to free up capital and
reduce risk.
C i s i ncorrect. By selling the financial assets to the securitizing entity, firms may be able to reduce
their funding costs, as they no longer have to hold the assets on their balance sheet. T his can free up
capital and reduce the need to raise funds through expensive means such as issuing equity or debt.
CFA Level 1, Vol ume 4, Readi ng 45– Introducti on to Asset-Back ed Securi ti es, LOS 45b:
Descri be securi ti zati on, i ncl udi ng the parti es i nvol ved i n the process and the rol es
they pl ay.
53
Q.55 Consider a par bond priced at $1,110 and has a modified duration of 4.562. In response to a 0.5%
increase in YT M, the price of the bond should most likely :
A. fall by approximately 0.02281%.
B. fall by approximately 2.281%.
C. rise by approximately 0.02281%.
Approximate percentage change in bond price = −(ModDur) × YT M.
Change in bond price = −4.562 × 0.5% = −4.562 × 0.005 = −0.02281. price of the bond should most
likely fall in price by approximately 2.281%
B i s i ncorrect. It calculates the percentage change in the bond's price as follows:
Change in bond price = −4.562 × 0.5% = −4.562 × 0.5 = −2.281
C i s i ncorrect. T here is a negative percentage change and not a positive percentage change in bond
price.
46f: Cal cul ate the durati on of a portfol i o and expl ai n the l i mi tati ons of portfol i o
durati on.
54
Q.56 A repurchase agreement is most likely similar to:
A. an auction.
B. a barter transaction.
C. a collateralized loan.
A repurchase agreement is similar to a collateralized loan, i.e., it involves the sale of a security with
a simultaneous agreement by the seller to buy the security back from the purchaser at an agreed
price in the future.
A i s i ncorrect. An auction involves bidding, helping provide price discovery, and allocating
securities; hence not similar to a repurchase agreement.
B i s i ncorrect. A barter transaction refers to agents as households, corporations, and governments
"pay" for goods and services with another good or service, thus having no similarities to a
repurchase agreement.
CFA Level 1, Vol ume 4, Readi ng 43 – Fi xed-Income Mark ets: Issuance, Tradi ng, and
Fundi ng, LOS 43j : Descri be repurchase agreements (repos) and the ri sk s associ ated
wi th them.
55
Q.57 Matrix pricing is most likely used for determining the price of:
I. New bonds
II. Actively traded bonds
III. Inactive bonds
A. I only.
B. I and III only.
C. I, II and III.
Matrix pricing is used for underwriting new bonds to get an estimate of the required yield spread
over the benchmark rate. Also, when a bond is not actively traded, matrix pricing is often used to
estimate the value based on comparable securities.
A i s i ncorrect. Both new bonds and inactive bonds use matrix pricing to determine the price.
C i s i ncorrect. Matrix pricing is not used in determining the prices of actively traded bonds.
CFA Level 1, Vol ume 4, Readi ng 44 – Introducti on to Fi xed-Income Val uati on, LOS 44e:
Descri be matri x pri ci ng.
56
Q.58 A bond selling for par currently has a 9% yield. If the bond price increases to 102.5 when yields
fall ten basis points and the price falls to 96 when yields rise by ten basis points, then the bond's
effective duration is closest to:
A. 20.85
B. 31.25
C. 32.50
(P − − P + )
DE ff =
(2 × ΔCurve × P V0)
(102.5 − 96)
=
(2 × 0.001 × 100)
= 32.5
46c: Expl ai n why the effecti ve durati on i s the most appropri ate measure of i nterest
rate ri sk for bonds wi th embedded opti ons.
57
Q.59 As compared to shorter maturity bonds, similar longer maturity bonds tend to have:
I. Less credit risk.
II. Wider spreads.
A. II only.
B. I and II.
C. None of I and II
Statement I i s i ncorrect. Credit risk is the risk that the issuer of the bond will default on their
obligation to repay the bond's principal and interest. Generally, bonds with shorter maturities tend to
have less credit risk because they are closer to maturity and are less sensitive to changes in credit
quality.
Statement II i s correct. Longer maturity bonds tend to have wider spreads than shorter maturity
bonds because they are considered to be riskier. T he longer the maturity of a bond, the more time
there is for interest rates to change and for the issuer's creditworthiness to change, both of which
can impact the bond's value. T his increased risk is reflected in the bond's yield, which is typically
higher for longer-term bonds.
CFA Level 1, Vol ume 5, Readi ng 47 – Fundamental s of Credi t Anal ysi s, LOS 47i :
Descri be macroeconomi c, mark et, and i ssuer-speci fi c factors that i nfl uence the l evel
and vol ati l i ty of yi el d spreads.
58
Q.60 Which of the following derivative contracts will most likely expose the contract owner to
default risk?
I. Futures
II. Forwards
III. Options
IV. Swaps
A. II and IV.
B. I, II, and IV.
C. I, II, III, and IV.
Forwards and swap contracts are traded in over-the-counter markets. T he two parties involved trade
directly, giving rise to counterparty risk if either party defaults.
B and C are i ncorrect. Futures and Options don't trade directly in OT C markets as they are traded
on major exchanges. On major exchanges, the exchange acts as the counterparty. It is the seller for
every buyer and the buyer for every seller, thereby eliminating counterparty/default risk.
CFA Level 1, Vol ume 5, Study Sessi on 15, Readi ng 49– Forward Commi tment and
Conti ngent Cl ai m Features and Instruments, LOS 49a: Defi ne forward contracts,
futures contracts, opti ons (cal l s and puts), swaps, and credi t deri vati ves and compare
thei r basi c characteri sti cs.
59
Q.61 Which of the following is/are least likely exchange-traded derivative instruments?
I. Futures
II. Forwards
III. Options
IV. Swaps
A. I and III.
B. II and IV.
C. I, II, and IV.
Options and futures are exchange-traded instruments traded on major exchanges like the NYSE or
the CBOE. Forwards and swaps are traded on over-the-counter (OT C) markets. Over-the-counter
refers to instruments that trade via a dealer network instead of a centralized exchange.
CFA Level 1, Vol ume 5, Readi ng 49– Forward Commi tment and Conti ngent Cl ai m
Features and Instruments, LOS 49c: Defi ne forward contracts, futures contracts,
opti ons (cal l s and puts), swaps, and credi t deri vati ves and compare thei r basi c
characteri sti cs.
60
Q.62 T he Value of a European call at expiration is most likely :
A. an exercise value greater than zero or the value of the underlying minus the exercise
price.
B. an exercise value greater than zero or the exercise price minus the value of the
underlying.
C. the greater the exercise price minus the value of the underlying or the value of the
underlying minus the exercise price.
T he value of a European call at expiration is the exercise value which is the greater of zero or the
value of the underlying minus the exercise price. CT = Max(0, ST – X).
On the other hand, the value of a European put at expiration is the exercise value which is the
greater of zero or the exercise price minus the value of the underlying.
CFA Level 1, Vol ume 5, Study Sessi on 15, Readi ng 45– Deri vati ve mark et and
i nstruments, LOS 45d: Determi ne the val ue at expi rati on and profi t from a l ong or a
short posi ti on i n a cal l or put opti on.
61
Q.63 Which of the following statement(s) is/are most likely to be correct regarding derivatives?
I. Derivatives are similar to insurance in that both allow for the transfer of risk from one party to
another
II. Derivatives derive their performance from the performance of an underlying asset
III. T he writer of an options contract is referred to as the short because he/she holds a short
position
A. I and III.
B. II and III.
C. I, II, and III.
Statement I i s correct: Derivatives and insurance are similar in that they both allow risk to be
transferred from one party to another. It is usually accomplished using options
Statement II i s correct: Derivatives are financial instruments that derive their performance from
the performance of an underlying asset.
Statement III i s correct: T he writer of an options contract is referred to as the short because
they hold a short position.
CFA Level 1, Vol ume 5, Readi ng 48– Deri vati ve Instrument and Deri vati ve Mark et
Features, LOS 48b: descri be the basi c features of deri vati ve mark ets and contrast
over-the-counter and exchange-traded deri vati ve mark ets.
62
Q.64 Which of the following is the least likely characteristic(s) of exchange-traded derivatives
markets?
A. T ransparency.
B. Lower degree of regulation and oversight.
C. Standardization of contract terms and conditions.
Exchange-traded derivatives markets are typically subject to a high degree of regulation and oversight
by government and regulatory bodies. T his is to ensure that market participants are operating in a
fair and transparent manner and to protect against market manipulation, fraud, and other forms of
misconduct.
A i s i ncorrect. Exchange markets are said to have transparency, which means that complete
information on all transactions is disclosed to exchanges and regulatory bodies. Exchange-traded
derivatives are also default-free since the exchange acts as the counterparty for each transaction.
OT C-traded derivatives face default risk since the two involved parties trade directly.
C i s i ncorrect. Exchange-traded derivatives are standardized, i.e., the terms and conditions are
precisely specified by the exchange, whereas OT C derivatives are customized.
CFA Level 1, Vol ume 5, Readi ng 48– Deri vati ve Instrument and Deri vati ve Mark et
Features, LOS 48b: descri be the basi c features of deri vati ve mark ets and contrast
over-the-counter and exchange-traded deri vati ve mark ets.
63
Q.65 Which of the following is least likely a terminology used to identify venture capital investment
at different stages of a company's life?
A. Formative Stage.
B. Middle Stage.
C. Later Stage.
T he three stages used to identify venture capital investment at different stages of a company's life
are the formative stage, the later stage and the mezzanine stage financing.
CFA Level 1, Vol ume 5, Readi ng 60 – Pri vate Capi tal , Real Estate, Infrastructure,
Natural Resources, and Hedge Funds, LOS 60a: expl ai n i nvestment characteri sti cs of
pri vate equi ty.
64
Q.66 According to the put-call parity, a long position in a put option can be replicated by going:
A. Long a call option, short the underlying, and long a risk-free bond.
B. Short a call option, long the underlying, and short a risk-free bond.
C. Long a call option, short the underlying, and short a risk-free bond.
T he put-call parity is represented by the equation:
X
S0 + p0 = c 0 +
(1 + r)T
Rearranging the equation:
X
p0 = c 0 + − S0
(1 + r)T
T herefore, a long put option position can be replicated by going long a call option, long a risk-free
bond, and short the underlying.
CFA Level 1, Vol ume 5, Readi ng 56 –Opti on Repl i cati on Usi ng Put–Cal l Pari ty, LOS 56b:
expl ai n put–cal l pari ty for European opti ons.
65
Q.67 Which of the following conditions will most likely decrease the value of a call option?
A. Increase in volatility.
B. Increase in stock price.
C. Decrease in the risk-free rate.
Note that the value of a call option at any time before maturity \((tIt is easy to see that a lower risk-
free rate decreases the value of the call option. T his is because a lower risk-free rate increases the
present value of the exercise price, provided the option is in the money
A i s i ncorrect. An increase in volatility refers to the degree of fluctuation in the price of the
underlying asset. A higher volatility means that the price of the underlying asset is more likely to
move in a wider range. T his increases the likelihood that the option will be in the money, making it
more valuable. T hus, an increase in volatility will actually increase the value of a call option.
B i s i ncorrect. For a call option, it is exercisable if ST > X . As such, the value of the call option
(and long forward) appreciates when the spot pri ce of the underlying increases.
CFA Level 1, Vol ume 5, Readi ng 55 – Pri ci ng and Val uati on of Opti ons, LOS 55c: Identi fy
the factors that determi ne the val ue of an opti on and expl ai n how each factor affects the
val ue of an opti on.
66
Q.68 Which of the following is most likely to be (a) key reason(s) for investing in real estate?
I. Potential to provide an inflation hedge if rents can be adjusted quickly for inflation.
II. T he prospect that multiple-year leases with fixed rents for some property types may lessen
cash flow impact from economic shocks.
III. Potential for competitive long-term total returns-driven by both income generation and
capital appreciation.
A. I, II and III.
B. I & III only.
C. II & III only.
Investing in real estate can provide various benefits to investors, such as the potential to provide an
inflation hedge, to lessen the impact of economic shocks, and to generate long-term total returns
through both income and capital appreciation. Additionally, real estate can offer diversification
benefits due to its less-than-perfect correlation with other asset classes.
Natural Resources, and Hedge Funds, LOS 60C: expl ai n i nvestment characteri sti cs of
real estate.
67
Q.69 Strategies that use technical analysis to identify companies that are under and overvalued and to
ascertain relationships between securities are known as:
A. Fundamental value.
B. Quantitative directional.
C. Fundamental growth.
Strategies that use technical analysis to identify companies that are under and overvalued and to
ascertain relationships between securities are known as quantitative directional strategies. T his
approach uses mathematical models and statistical techniques to analyze historical data and identify
trends in securities prices and volumes to make trading decisions.
A i s i ncorrect. Fundamental value strategies use fundamental analysis to identify companies that
are undervalued. T his approach analyzes a company's financial and economic fundamentals, such as
its earnings, revenue, and assets, to determine its intrinsic value and identify potential opportunities
for investment.
C i s i ncorrect. Fundamental growth strategies use fundamental analysis to identify companies
expected to exhibit high growth and capital appreciation. T his approach analyzes a company's growth
prospects, such as revenue and earnings growth, and focuses on companies with strong potential for
long-term growth.
Natural Resources, and Hedge Funds, LOS 60f: expl ai n i nvestment characteri sti cs of
hedge funds.
68
Q.70 Which of the following is least likely a compensation structure used in alternative investments?
A. Dividends.
B. Soft-hurdle rate.
C. High watermark.
Alternative investments are typically non-traditional investments, such as private equity, hedge
funds, real estate, and venture capital, that do not have the same characteristics as traditional
investments, such as stocks or bonds.
B i s i ncorrect. Soft-hurdle rate is a compensation structure used in hedge funds and private equity
funds, where the fund manager is only eligible to earn a performance (incentive) fee if the fund's
returns exceed a certain "hurdle" rate, usually the benchmark rate of return.
C i s i ncorrect. A high watermark is a compensation structure used in alternative investments. A
high watermark is the highest value a firm has reached in its history. Managers have to recover the
decrease in funds value from the high-water mark before charging a performance fee on any new
profits earned.
CFA Level 1, Vol ume 5, Readi ng 58 – Introducti on to Al ternati ve Investments, LOS 58c:
descri be i nvestment and compensati on structures commonl y used i n al ternati ve
i nvestments
69
Q.71 Which of the following statement(s) are most likely to be correct regarding typical
contemporary hedge funds?
I. T hey have high investment restrictions and have a goal of generating high returns, either in
an absolute sense or over a specified market benchmark.
II. T hey are set up as private investment partnerships open to a limited number of investors.
III. T hey have an aggressively managed portfolio of investments across asset classes and regions
that is leveraged and/or use derivatives.
A. I and II.
B. II and III.
C. I, II, and III.
Hedge funds have a goal of generating high returns, either in an absolute sense or over a specified
market benchmark, and have few, if any, investment restrictions. T hey are set up as private
investment partnerships open to a limited number of investors and able to make large initial
investments. T hey have an aggressively managed portfolio of investments across asset classes and
regions that are leveraged and/or use derivatives.
Natural Resources, and Hedge Funds, LOS 60f: expl ai n i nvestment characteri sti cs of
natural resources.
70
Q.72 Convenience yield most likely refers to the benefit of:
I. Holding an asset for sale.

II. Being able to take advantage of volatility in the market to sell high.
III. Using the asset on demand if necessary.
A. I &III only.
B. II only.
C. All of the above.
Convenience yield refers to the benefit of holding an asset for sale and being able to take advantage
of volatility in the market (sell high) and use it on demand if necessary. For example, having barrels of
crude oil on hand if there is a sudden increase in price would give the investor the benefit of using
the crude oil or selling the barrel on the secondary market at a higher price.
Natural Resources, and Hedge Funds, LOS 60e: expl ai n i nvestment characteri sti cs of
natural resources.
71
Q.73 Stocks of Orange Corp. are trading at $60, and the strike price of 6-month put options is $40.
Given the price of the 6-months put option on Orange Corp. is $2, and the risk-free rate is 8%, the
price of the call option is closest to:?
A. $23.51
B. $29.81
C. $33.32
X
C+ = So + P
(1 + R f )t
x
Using the put-call parity, the call price of the 6-month option on Orange Corp. is C = S + p– or
(1+Rf) t
40
C = 60 + 2– = $23.51
1. 080. 5
CFA Level 1, Vol ume 5, Readi ng 56– Opti on Repl i cati on Usi ng Put–Cal l Pari ty, LOS 56a:
Expl ai n put-cal l pari ty for European opti ons.
72
Q.74 XYZ Hedge fund charges a management fee of 2% based on assets under management at year-
end and a 20% incentive fee. T he initial investment is GBP 125 million, and the fund earns a 40
percent return in its first year. What are the fees earned by XYZ Hedge fund if incentive fee is
computed based net of management fee? Assume management fees are calculated using end-of-period
valuation?
A. GBP 5.8 million.
B. GBP 13.5 million.
C. GBP 12.8 million.
Management fee earned by XYZ hedge fund = (125 × 1.40) × 2% = GBP 3.5 million
Incentive fee based on net of management fees = ((125 × 40%)– 3.5) × 20% = GBP 9.3 million
Total fees = 3.5 + 9.3 = GBP 12.8 million
CFA Level 1, Vol ume 5, Readi ng 59 – Performance Cal cul ati on and Apprai sal of
Al ternati ve Investments, LOS 59b: Cal cul ate and i nterpret returns of al ternati ve
i nvestments on both before-fee and after-fee bases.
73
Q.75 From the put-call parity, the long bond is most likely equivalent to:
A. Long asset, short put, long call.
B. Long asset, long put, short call.
C. Short asset, long put, long call.
T he relationship
X
S0 + p0 = c 0 +
(1 + rT )
is known as put-call parity where
S0 = Price of an asset at time 0,
p0 = value of a put option,
c 0 = cost of the call and

X
= Value of the bond at time 0.
(1+r) T
T he equation above can be rewritten as
X
= S0 + p0 − c 0 .
(1 + r)T
Hence,
Long bond = Long asset, long put, short call
CFA Level 1, Vol ume 5, Readi ng 56– Opti on Repl i cati on Usi ng Put–Cal l Pari ty, LOS 56a:
Expl ai n put-cal l pari ty for European opti ons.
74
Q.76 Which of the following is/are most likely to be characteristic(s) of alternative investments?
I. Low level of regulation
II. High use of leverage
III. High correlation to systematic risk
A. I & II.
B. II & III.
C. I, II & III.
Alternative investments are typically characterized by low levels of regulation and less
transparency, illiquidity, low diversification of managers and investments within the portfolio, high
use of leverage, restrictions on fund redemptions, high fees, unique legal and tax considerations, etc.
Alternative investment strategies seek a low correlation to systematic risk and are known as
absolute return strategies. T heir key objective is to attain relative independence from the
performance of underlying equity or fixed-income market benchmarks.
However, alternative investments may not necessarily have a high correlation to systematic risk, as
they often employ strategies that aim to reduce overall risk or are uncorrelated to market
performance. Alternative investments are often used as a diversification tool to reduce overall
portfolio risk.
CFA Level 1, Vol ume 5, Readi ng 58 –Categori es, Characteri sti cs, and Compensati on
Structures of Al ternati ve Investments, LOS 58a: descri be types and categori es of
al ternati ve i nvestments.
75
Q.77 Strategies that focus on the relative value between a variety of asset-backed securities and
mortgage-backed securities and seek to take advantage of mispricing across different asset-backed
securities are known as:
A. Activist.
B. Fixed income asset-backed.
C. Fixed income convertible arbitrage.
Fixed income asset-backed securities (ABS) strategies focus on the relative value between a variety
of asset-backed securities and mortgage-backed securities. T hese strategies seek to take advantage
of mispricing across different asset-backed securities. T his is done by investing in securities that are
deemed undervalued and shorting securities that are deemed overvalued. T he goal of these strategies
is to generate returns through the price appreciation of the long positions and the price depreciation
of the short positions.
A i s i ncorrect. Activist strategies refer to a type of investment strategy where an investor
purchases a significant stake in a company and actively works to influence the company's
management, usually with the goal of improving the company's performance and, therefore, the
value of the investor's shares.
C i s i ncorrect. Fixed-income convertible arbitrage strategies focus on relative value opportunities
in the convertible bond market. T hese strategies involve purchasing convertible bonds and shorting
the underlying stock. T he goal is to benefit from the price differences between the convertible bond
and the underlying stock.
CFA Level 1, Vol ume 5, Study Sessi on 16, Readi ng 60– Introducti on to Al ternati ve
Investments, LOS 60f: Expl ai n i nvestment characteri sti cs of hedge funds.
76
Q.78 Which of the following is/are least likely accurate regarding the Leveraged buyouts (LBO)?
A. In LBOs, the acquisition of a target company is funded through debt.
B. In LBOs, the acquiring company’s cash flows are used to service the debt.
C. After the buyout, the target company becomes or remains a privately owned company.
In LBOs, the target company’s cash flows are expected to be sufficient to service the debt. Both
statements A and C are correct statements.
CFA Level 1, Vol ume 5, Study Sessi on 16, Readi ng 60– Pri vate Capi tal , Real Estate,
Infrastructure, Natural Resources, and Hedge Funds, LOS 60a: expl ai n i nvestment
characteri sti cs of pri vate equi ty
Q.79 Which of the following is most likely the first-order risk measure of the change in the option
price for a change in the underlying asset's volatility?
A. Rho.
B. Vega.
C. Gamma.
Vega is the risk metric that measures the change in the derivative's price for a change in the
volatility of the underlying asset.
A i s i ncorrect. Rho measures changes in interest rates concerning derivatives.
C i s i ncorrect. Gamma is considered a second-order risk because it reflects the risk of changes in
the delta.
CFA Level 1, Vol ume 6, Readi ng 66– Introducti on to Ri sk Management: LOS 66g:
Descri be methods for measuri ng and modi fyi ng ri sk exposures and factors to consi der
i n choosi ng among the methods.
77
Q.80 Which of the following is least likely a characteristic of open-ended mutual funds?
A. An open-end structure makes it easy to grow in size but creates pressure on the portfolio
manager to manage the cash inflows and outflows.
B. New shares are created and sold at a premium or a discount to net assets values depending
on the demand for the shares in open-end funds.
C. Open-end funds accept new investment money and issue additional shares to existing or
new investors. T herefore, the number of outstanding shares changes after every new
investment.
In open-end funds, new shares are issued at the net asset value of the fund at the time of investment.
An open-end fund is a collective investment scheme that can issue and redeem shares at any time. An
investor will generally purchase shares in the fund directly from the fund itself rather than from the
existing shareholders.
It contrasts with a closed-end fund, which typically issues all the shares it will issue at the outset,
with such shares usually being tradable between investors thereafter.
CFA Level 1, Vol ume 6, Readi ng 61– Portfol i o Management: An Overvi ew, LOS 61f:
Descri be mutual funds and compare them wi th other pool ed i nvestment products.
78
Q.81 A portfolio had the following annual rates of return:
2013 5 %
2014 12 %
2015 −2 %
T he portfolio’s manager states that the return for the period is 5%. T he manager is most likely
referring to:
A. holding period return.
B. arithmetic mean return.
C. geometric mean return.
Holding period return = (1 + 0.05) × (1 + 0.12) × (1 − 0.02) − 1 = 15.25%
(5% + 12% − 2%)

Arithmetic mean return = = 5%
3
Geometric mean return = √3(1 + 0.05) (1 + 0.12) (1 − 0.02) − 1 = 4.84
CFA Level 1, Vol ume 5, Readi ng 62– Portfol i o Ri sk and Return: Part I, LOS 62a:
Cal cul ate and i nterpret maj or return measures and descri be thei r appropri ate uses.
79
Q.82 BCG Bank has a one month Value at Risk (VaR) of $400 million with the probability of 5%, and
hence it most likely refers to:
A. loss of $20 million will occur one month from now.
B. one month maximum loss of $400 million will occur 5% of the time.
C. one month minimum loss of $400 million will occur 5% of the time.
VaR measures the minimum amount of loss expected for a given period at a given probability level.
A i s i ncorrect. It does not relate to the indicative VaR of $400 million.
B i s i ncorrect. VaR does not provide the maximum loss amount since it is used as a capital
requirement measure at banks.
CFA Level 1, Vol ume 6, Readi ng 66– Introducti on to Ri sk Management, LOS 66g:
Descri be methods for measuri ng and modi fyi ng ri sk exposures and factors to consi der
i n choosi ng among the methods
80
Q.83 Which of the following are sentiment indicators?
I. Relative strength index (RSI)
II. CBOE Volatility Index
III. Short interest ratio
IV. Put/call ratio
V. Moving average convergence-divergence (MACD)
VI. Stochastic oscillator
A. I, II, and V.
B. II, III, and IV.
C. II, V, and VI.
CBOE Volatility Index, Short interest ratio, and Put/call ratio are sentiment indicators.
Relative strength indexes (RSI), Moving average convergence-divergence (MACD) and Stochastic
oscillators are momentum oscillators.
CFA Level 1, Vol ume 6, Readi ng 67 – Techni cal Anal ysi s, LOS 67g: Expl ai n common
techni cal i ndi cators;.
81
Q.84 T he line that represents the combination of the optimal risky portfolio and the risk-free asset is
most accurately known as:
A. efficient Frontier.
B. indifference curve.
C. capital allocation Line.
T he capital allocation line represents the combination of the optimal risky portfolio and the risk-free
assets.
A i s i ncorrect. T he efficient frontier refers to the set of optimal portfolios that offer the highest
expected return for a defined level of risk or the lowest risk for a given level of expected return.
Portfolios that lie below the efficient frontier are sub-optimal because they do not provide enough
return for the level of risk.
B i s i ncorrect. An indifference curve shows a combination of two goods that give a consumer
equal satisfaction and utility, making the consumer indifferent. Along the curve, the consumer has an
equal preference for the combinations of goods shown—i.e., is indifferent about any combination of
goods on the curve.
CFA Level 1, Vol ume 5, Readi ng 62– Portfol i o Ri sk and Return: Part I, LOS 62e: Expl ai n
the sel ecti on of an opti mal portfol i o, gi ven an i nvestor's uti l i ty (or ri sk aversi on) and
the capi tal al l ocati on l i ne
82
Q.85 Which of the following is/are the most likely similarity(ies) between exchange-traded funds and
closed-end funds?
I. Both types of funds are passively managed to match a particular index.
II. In both types of funds, the market price of shares and the net asset value (NAV) can differ
significantly.
III. Both types of funds can be sold and purchased on the open market.
A. III.
B. I and II.
C. I and III.
ET Fs and closed-end funds is that both types of funds can be sold and purchased on the open market
(Option A). ET Fs are passively managed to match a particular index, while closed-end funds are
actively managed.
B and C are i ncorrect. ET Fs are passively managed to match the index, while closed-end funds are
actively managed. In closed-end funds, the market price of shares and the NAV differ significantly,
whereas ET Fs are designed to keep their share price close to the NAVs.
CFA Level 1, Vol ume 5, Readi ng 61– Portfol i o Management: An Overvi ew, LOS 61f:
Descri be mutual funds and compare them wi th other pool ed i nvestment products.
83
Q.86 T he data collected from such devices as smart phones, cameras, RFID chips, is referred as:
A. generated by sensors.
B. generated by individuals.
C. generated by business processes.
Because the world has become increasingly connected, we can now obtain data from a wide range of
devices, including smartphones, cameras, microphones, radio-frequency identification (RFID)
readers, wireless sensors, and satellites that are now in use all over the world. Sensor data are
collected from such devices as smartphones, cameras, RFID chips, and satellites that are usually
connected to computers via wireless networks.
B i s i ncorrect. Data generated by individuals are often produced in text, video, photo, and audio
formats and may also be generated through such means as website clicks or time spent on a webpage
and tends to be unstructured.
C i s i ncorrect. Business process data include information flows from corporations and other public
entities. T hese data tend to be structured and include direct sales information, such as credit card
data and corporate exhaust.
CFA Level 1, Vol ume 6, Readi ng 68– Fi ntech i n Investment Management, LOS 68b:
Descri be Bi g Data, Arti fi ci al Intel l i gence, and Machi ne Learni ng.
84
Q.87 Ben Carter, CFA, is an equity analyst and is assigned to discount the net present value (NPV) of
Indo Inc., which has 40% of debt in its capital structure. T he discount rate Carter should use if the
after-tax cost of debt is 7%, the risk premium is 11%, the risk-free rate is 2%, and the Beta of Indo is
0.8 is closest to:
A. 9.40%
B. 9.28%
C. 10.80%
Cost of equity = Risk-free rate + Beta × (market risk − risk-free rate)
0.108 = 2% + 0.8 × (11%)
Discount rate = (Weight of debt × After tax cost of debt) + (Weight of equity + Cost of equity)
0.0928 = (0.4 × 0.07) + (0.6 × 0.108)
CFA Level 1, Vol ume 5, Readi ng 63– Portfol i o Ri sk and Return: Part II, LOS 63g:
Cal cul ate and i nterpret the expected return of an asset usi ng the CAPM.
85
Q.88 An analyst gathered this information about two stocks:
Variance of returns
Stock A 1.5 %
Stock B 2.0 %
What is the covariance between A and B if their correlation coefficient is 0.4?
A. 0.00012
B. 0.0069
C. 0.043
r(A. B) = 0.4 × √0.00015 × √0.0002 = 0.4 × 0.01225 × 0.01414 = 0.0069
CFA Level 1, Vol ume 5, Readi ng 62– Portfol i o Ri sk and Return: Part I, LOS 62d:
Cal cul ate and i nterpret the mean, vari ance, and covari ance (or correl ati on) of asset
returns based on hi stori cal data.
86
Q.89 Four portfolios have the following expected returns and risk:
Portfolio Expected Return Standard deviation

A 5% 12 %
B 7% 15 %
C 9 % 15 %
D 8% 16 %
A risk-neutral agent choosing from these portfolios would most likely select:
A. Portfolio A
B. Portfolio B
C. Portfolio C
A risk-neutral investor only cares about the expected return and not the risk involved. T herefore, a
risk-neutral agent choosing from these portfolios would most likely select Portfolio C as it has the
highest expected return (9%) among the given portfolios.
It's worth noting that a risk-averse investor would tend to select a portfolio with lower volatility
(Standard deviation) and a higher expected return among the options.
CFA Level 1, Vol ume 5, Readi ng 62– Portfol i o Ri sk and Return: Part I, LOS 62e: Expl ai n
ri sk aversi on and i ts i mpl i cati ons for portfol i o sel ecti on.
87
Q.90 An analyst gathered this information about two stocks:
Time period Stock A Return Stock B return

1 15 % 12 %
2 −10 % 2%
3 −2 % 15 %
4 22 % 12 %
T he covariance between A and B is closest to
A. 42.21
B. 43.21
C. 45.91
We know the covariance is given by:
∑ni=1 (Ai − Ā )(Bi − B̄)

Cov A,B =
n−1
Where
15 − 10 − 2 + 22
Ā = = 6.25
4
12 + 2 + 15 + 12
B̄ = = 10.25
4
T herefore,
(15 − 6.25) (12 − 10.25) + (−10 − 6.25) (2 − 10.25) + (−2 − 6.25) (15 − 10.25) + (22 − 6.25)
⇒ Cov A,B =
4−1
8.75 × 1.75 + 16.25 × 8.25 − 8.25 × 4.75 + 15.75 × 1.753
= = 45.91
3
CFA Level 1, Vol ume 5, Readi ng 52– Portfol i o Ri sk and Return: Part I, LOS 52d:
Cal cul ate and i nterpret the mean, vari ance, and covari ance (or correl ati on) of asset
returns based on hi stori cal data.
88

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Level I of the CFA® Exam

Mock Questions with Answers - Mock Exam 2023 #1 - Second

Last Updated: Sep 5, 2023

prohibited. Infringers will be prosecuted in their local jurisdictions. ”

the limited partnership).

A i s i ncorrect. Contradicts with option C.

factors may be used i n i nvestment anal ysi s.

T he weighted average cost of capital for the project is closest to:

Step 3: Proj ect Cost of Equi ty

Ke = R f + Equity Beta × Market Risk Premium

Step 4: Wei ghted Average Cost of Capi tal

Revenue $600, 000

(200,000 bags × 60% operating capacity).

Fixed operating cost

i nterpret the operati ng break even quanti ty of sal es..

A. Raman Enterprises: 1.11; Madan Enterprises 1.33.

B. Raman Enterprises: 1.33; Madan Enterprises 1.53.

C. Raman Enterprises: 1.53; Madan Enterprises 1.33.

T he calculation can be summarized as follows;

Raman Enterprises Madam Enterprises

A i s i ncorrect. It ignores the deduction of finance costs for Raman Enterprises.

degree of total l everage.

A. Both statements are correct.

B. Only one statement is correct.

C. Both statements are incorrect.

the size and circumstances of the firm.

board of di rectors and i ts commi ttees.

A. DOL: 3.33; DT L: 1.12

B. DOL: 3.33; DT L: 6.67

C. DOL: 6.67; DT L: 3.33

Q (P − V) 50, 000(200 − 100)

Q(P − V) 50, 000 (200 − 100)

A i s i ncorrect. T he calculation of DT L ignores the fixed costs as follows;

Q (P − V) 50, 000 (200 − 100)

C i s i ncorrect. T he correct outcome is DOL 3.33 and DT L 6.67.

degree of total l everage.

Period Cash flow without Revised cash flows with flotation

Flotation Costs = 5% × 50, 000

Initial outlay after considering flotation costs = 100, 000 + 2, 500

Compute NPV using new cash flows and WACC of 11.34%

Expl ai n and demonstrate the correct treatment of fl otati on costs.

A. Debt: 3.98%; Preferred Shares: 7.37%.

B. Debt: 3.98%; Preferred Shares: 4.42%.

C. Debt: 6.63%; Preferred Shares: 7.37%.

Cost of Debt = Calculate YI using N=10;PMT = 60;PV = −955; FV = 1000; CPT I

Post tax cost of debt = 6.63 × (1 − 40%) = 3.98%

B i s i ncorrect. It indicates the post-tax cost of preference shares of 4.42%.

C i s i ncorrect. It indicates the pre-tax cost of debt of 6.63%.

Standard deviation of returns of the company

compani es, and nonpubl i c compani es.

Calculations are in the table below:

descri be the advantages and di sadvantages of each method.

Sale $ 2, 990, 000

Operating cycle = Days of Inventory in hand+ Number of days of Receivables

Operating cycle = 41.39 + 53.71 = 95 days

company’s l i qui di ty posi ti on wi th that of peers

A. 0%. Hence, Roy should not invest in the business.

B. 4.37%. Hence, Roy should not invest in the business.

C. 7%. Hence, Roy should invest in the business.