SESSION 1

Question 1: A profession is most accurately described as an occupational group that requires its members to:

A. abide by a code of ethical conduct.

B. have specialized expert knowledge.
C. put client interests first.

Explanation

B is correct. A profession is an occupational group (e.g., doctors or lawyers) that has requirements of specialized
expert knowledge, and often a focus on ethical behavior and service to the larger community or society. While many
professions require their members to put clients first or encourage them to serve the wider community, these are not
defining characteristics of a profession.

Question 2: Maria Valdes, CFA, is an analyst for Venture Investments in the country of Newamerica, which has
laws prohibiting the acceptance of any gift from a vendor if the gift exceeds US $250. Valdes has evidence that her
Venture Investments colleague, Ernesto Martinez, CFA, has been receiving gifts from vendors in excess of US $250.
Valdes is obligated to:

A. disassociate herself from the activity, and urge Venture to persuade Martinez to cease the activity.
B. disassociate herself from the activity, urge Venture to persuade Martinez to cease the activity, and inform CFA
Institute and regulatory authorities of the violation.
C. disassociate herself from the activity, urge Venture to persuade Martinez to cease the activity, and inform CFA
Institute of the violation.

Explanation

A is correct. Standard I(A), Knowledge of the Law requires members who have knowledge of colleagues engaging
in illegal activities to disassociate from the activity and urge their firms to persuade the individual to cease such
activity. Reporting to regulatory authorities may be prudent in certain circumstances, but is not required. Reporting
to CFA Institute is not required.

Question 3: Lynn Black, CFA, is an analyst with the underwriter for an upcoming issue of Mtex Software debentures.
Black learns from an employee in Mtex's programming department that there is a serious problem with Mtex's newest
software program and that many customers have canceled their orders with Mtex. There is no mention of these
problems in the prospectus for the debentures, which has been circulated. According to the CFA Institute Standards
of Professional Conduct, Black's best course of action is to:

A. notify potential investors of the omission on a fair and equitable basis.

B. take no action because this is material nonpublic information.
C. inform her supervisor of her discovery.

Explanation

C is correct. Black is in possession of material nonpublic information, and her most appropriate course of action is
to inform her supervisor (or the firm's compliance officer) of what she has learned. Underwriters and investment
bankers routinely possess material nonpublic information about their client firms, and it is acceptable to share this
information within the department when doing so is necessary to carry out an issuance of the client firm's securities.
If Black's firm determines that the information affects the value of the debentures, they must revise and recirculate
the prospectus. Failing to do so may violate Standard I(C) Misrepresentation. Not informing her employer may be
detrimental to her firm's interests and reputation if proceeding with the new issue without disclosure would violate
regulations or laws. Black may not, however, share the material nonpublic information with prospective buyers, or
with anyone in her firm outside the underwriting department.

Question 4: Ned Brenan manages two dozen pension accounts, one of which earned over 25% during the past two
years. Brenan tells prospective clients that based on past experience they can expect a 25% return on their funds.
Which of the following statements is CORRECT?

A. Brenan has not violated Standard of Professional Conduct III(D), Performance Presentation, but Brenan has
violated Standard I(C), Misrepresentation.
B. Brenan has violated both Standard of Professional Conduct III(D), Performance Presentation, and Standard I(C),
Misrepresentation.
C. Brenan has violated Standard of Professional Conduct III(D), Performance Presentation, but Brenan has not
violated Standard I(C), Misrepresentation.

Explanation

B is correct. Brenan violated Standard of Professional Conduct III(D) by using only one portfolio's results to create
a false impression of all the portfolios, and Brenan violated Standard of Professional Conduct I(C) by creating the
impression that a certain return was assured (he should have used the words "might" or "could" instead of "can").

Question 5: Nicole Wise, CFA, is an analyst at Chicago Securities. She attends a meeting with management of one
of the companies that she covers. During the meeting, management expresses great optimism about the company's
recent acquisition of a new business. Wise is excited about these prospects and issues a research report that states that
the company is about to achieve significant success with the new acquisition. Wise has:

A. not violated CFA Institute Standards of Professional Conduct because she had reasonable reason to believe that
the statements in her report were true.
B. violated CFA Institute Standards of Professional Conduct because she did not check the accuracy of the
statements that management made.
C. violated CFA Institute Standards of Professional Conduct because she misrepresented the optimism by turning it
to certainty.

Explanation

C is correct. Standard V(B), Communication with Clients and Prospective Clients. Members must distinguish
between fact and opinion in the presentation of a research report or investment recommendation. Wise violated the
standard because she misrepresented management's enthusiasm by turning it into certainty.

Question 6: During 2004 Nancy Arnold received an undergraduate business degree with a management major and
completed all requirements for the CFA designation imposed by CFA Institute. She is applying for employment at
several brokerage firms. Her resume states, "I was awarded the CFA degree in 2004 by CFA Institute." Her resume
also states that she graduated "with honors" and majored in finance. Her grade point average was 3.48 but "with
honors" requires a 3.50 grade point average.

Which of the following statements about Standard VII(B), Reference to CFA Institute, the CFA Designation, and the
CFA Program, and Standard I(C), Misrepresentation, is CORRECT? Arnold:

A. did not violate either Standard VII(B) or Standard I(C).

B. violated Standard I(C) but she did not violate Standard VII(B).
C. violated both Standard VII(B) and Standard I(C).

Explanation
C is correct. Arnold violated Standard VII(B). The CFA designation should not be referred to as a degree. Arnold
also violated Standard I(C) because her claim that she graduated "with honors" is not true.

Question 7: McGregor Investment Management promotes itself as a fixed-income investment management firm. The
vast majority of the discretionary portfolios it manages are fixedincome portfolios. McGregor does, however, manage
a few portfolios utilizing a growth equity investment strategy, but the firm has no intention of ever promoting this
strategy. Under the Global Investment Performance Standards (GIPS), must these portfolios be included in a
composite?

A. Yes, because the portfolios are discretionary.

B. No, because the firm does not normally manage portfolios to a growth equity strategy and does not promote it to
potential clients.
C. Yes, because the portfolios are managed to a widely recognized investment strategy.

Explanation

A is correct. GIPS require all discretionary portfolios to be included in a composite. Thus, McGregor must include
the growth equity portfolios in a composite.

Question 8: Which of the following best describes elements of a framework for ethical decision making?

A. Identify relevant facts; consider influences and alternatives; decide and act; reflect on outcomes.
B. Relevance; faithful representation; transparency; comprehensiveness; consistency.
C. State the objective; gather, process, and interpret the data; report the conclusions; update the analysis.

Explanation

A is correct. The framework for ethical decision making presented in the Level I CFA curriculum includes these
elements:

 Identify relevant facts, stakeholders, ethical principles, and conflicts of interest.

 Consider alternative actions, situational influences, and whether to seek additional guidance.
 Decide and act.
 Reflect on whether the outcome was as expected, and why or why not.

Question 9: Kevin Blank, CFA, is a representative for Campbell Advisors. A prospective client inquires about
investing in Mexican bonds. Blank assures the client that Campbell can help him with Mexican fixed income
investing. In fact, Blank had heard that his colleague, Jon Woller, might have had experience in Mexican bonds. The
following day Blank learns that Woller had no such experience. Blank does not correct his earlier statement, and the
prospective client invests with Campbell. Blank has:

A. not violated the Code and Standards because Blank did not intentionally mislead the prospect.
B. only violated the Code and Standards when he learned that his statement was incorrect and did not contact the
prospect to explain his error.
C. violated the Code and Standards, both when he misrepresented the qualifications of his firm and later, when he
learned the truth and failed to contact the prospective client and correct his earlier statement.

Explanation

C is correct. Standard I(C) Misrepresentation prohibits members from making statements, orally or in writing, that
misrepresent the services that they or their firms are capable of providing. Even though Blank's statement was not
deliberately false, he did not know whether it was true or not, and this made the statement misleading. Once it was
evident that the statement was false, Blank had a duty to contact the prospect and correct the misrepresentation, but
did not do so.

Question 10: The following information involves two research analysts at a brokerage firm.

 Erik Bagenot, CFA, is preparing a research report on Global Enterprises, Inc. In preparing the report, he uses
materials from many sources. For example, he uses factual information published by Standard & Poor's
Corporation without acknowledging the source. He also uses excerpts from a research report prepared by
another analyst. Bagenot makes only a slight change in wording for these excerpts, but acknowledges the
source.
 Sally Wain, who is currently enrolled in the CFA program, is preparing a research report on Manson
Telecommunications. She attends a conference in which several investment experts provide their views about
the future prospects of this company. Wain cites several quotations from these investment experts in her
report without specific reference.

According to CFA Institute Standards of Professional Conduct involving prohibition against plagiarism, which of
the following statements is CORRECT?

A. Wain violated the Standards, but Bagenot did not.

B. Both Bagenot and Wain violated the Standards.
C. Bagenot violated the Standards, but Wain did not.

Explanation

A is correct. Bagenot complied with Standard I(C), which permits publishing factual information from Standard &
Poor's without acknowledgment and using excerpts with acknowledgment. Wain committed plagiarism because she
failed to give specific references for the quotations that she used.

Question 11: Mark Williamson is "bearish" on ABC Manufacturing Company. Williamson is so convinced that ABC
is overpriced, two weeks ago, he shorted 100,000 shares. Today, Williamson is "surfing" several popular investment
bulletin boards on the internet and posting false derogatory comments about company management. According to
Standard II(B), Market Manipulation, Williamson has engaged in:

A. both transaction-based manipulation and information-based manipulation.

B. transaction-based manipulation, but not information-based manipulation.
C. information-based manipulation, but not transaction-based manipulation.

Explanation

C is correct. Williamson is in violation of Standard II(B), Market Manipulation, by engaging in information-based

manipulation. Information-based manipulation includes, but is not limited to, spreading false rumors about a firm in
order to induce others to trade.

Question 12: Sharon West is a CFA charterholder and trust officer for REO Trust Company. Soon after beginning
work for REO, West finds that REO has been conducting all its securities transactions through her brother who is a
registered representative. West's brother charges REO commissions that are equal to the lowest available from another
broker. West's brother tells her that if she continues doing business with him, he will give her a substantial discount
on all personal transactions she conducts through him. West:

A. must inform her employer of the arrangement because it provides her with additional compensation.
B. must inform her employer of the arrangement because she is doing business with a member of her immediate
family.
C. does not need to inform her employer of the arrangement because the commissions her brother charges the firm
are the lowest possible.

Explanation

A is correct. Members are required to disclose to their employer in writing all monetary compensation or other benefit
they receive in addition to the employer's compensation. The discounting of West's commissions is a benefit that must
be disclosed.

Question 13: Jack Stevens is employed by a company to provide investment advice to participants in the firm's 401(k)
plan. One of the investment options is a stable value fund run by the company. Stevens' research indicates that the
fund is far riskier and less liquid than the typical stable value fund and has a fundamental asset value lower than the
book value of the assets. He tells Jessica Cox, the head of employee benefits, about his research, and indicates that he
will advise new employees to not invest in the fund and will advise employees who already own the fund to reduce
their holdings in the fund. Cox points out that the fund is not in any current danger because there are very few
redemptions requested of the fund. Cox also states that a sell recommendation may become a self fulfilling prophecy,
causing investors to redeem their shares and forcing the fund to liquidate, which in turn will cause the remaining
investors to receive less than their promised value. Stevens agrees with this assessment and feels his fiduciary duty is
to all employees. Stevens should:

A. continue to recommend that new investors do not invest in the fund and existing investors reduce their holdings.
B. continue to recommend that new investors do not invest in the fund, but not advise existing investors to reduce
their holdings.
C. tell investors he cannot give advice on the fund because of a conflict of interest.

Explanation

A is correct. The employees to whom Stevens owes fiduciary duty are the ones who are seeking his advice, even if
acting on that advice hurts other employees who might eventually become clients.

Question 14: Albert Long, CFA, manages portfolios of high net worth individuals for HKB Corp. Alice Thurmont,
one of his close friends, heads a local charity for homeless children that depends on donations to operate. Because
donations have declined during the past year, the charity is experiencing financial difficulty. Thurmont asks Long to
give her a partial list of his clients so that she can contact them to make tax-deductible donations. Because Long
knows that the charity provides much benefit to the community, he provides Thurmont with the requested list.

Betty Short, CFA, also works for HKB Corp. She receives a letter from CFA Institute's Professional Conduct Program
(PCP) requesting that she provide information about one of HKB's clients who is being investigated. Short complies
with the request despite the confidential nature of the information requested by the PCP.

Based on Standard III(E), Preservation of Confidentiality, which of the following statements about Long and Short's
actions is CORRECT?

A. Both Long and Short violated Standard III(E).

B. Long violated Standard III(E) but Short did not violate Standard III(E).
C. Short violated Standard III(E) but Long did not violate Standard III(E).

Explanation

B is correct. Long violated Standard III(E) because he did not preserve the confidentiality of information
communicated by clients. Short did not violate Standard III(E) because this standard does not prevent members from
cooperating with an investigation by CFA Institute's Professional Conduct Program. Thus, Short can forward
confidential information to the PCP.

Question 15: Brendan Duval works as a research analyst for Toby Securities. Duval recommends changing a
recommendation from "sell" to "buy" on Dalton Company. His firm, which manages several mutual funds, may be
interested in buying Dalton's stock. He also manages the retirement account that his parents established with Toby.
Duval wants to buy shares of Dalton's stock because it is an appropriate investment for his parent's retirement account
and obtains approval from his employer to do so. Duval is also thinking about personally investing in Dalton stock.
According to CFA Institute Standards of Professional Conduct, which of the following best describes the priority of
transactions? Duval should give:

A. Toby's clients and his parent's account equal priority, followed by his employer, and then his personal account.
B. priority of transactions to Toby's clients, followed by his employer, then his parent's retirement account, and
finally his personal account.
C. priority to Toby's clients and his employer concurrently, followed by his parent's retirement account, and finally
his personal account.

Explanation

A is correct. According Standard VI(B) Priority of Transactions, Duval should give transactions for clients and
employers priority over his personal transactions. Because his parent's retirement account represents a client account
at Toby, Duval should treat this account just like any other firm account. His parent's retirement account should
neither be given special treatment nor disadvantaged because of an existing family relationship with Duval. If Duval
treats his parent's retirement account differently from other accounts at Toby, he would breach his fiduciary duty to
his parents.

Question 16: Lance Tuipulotu, CFA, manages investments for 400 individuals and families and often finds his
resources stretched. When his largest investors petition him to include a 5% to 7% allocation of non-investment-grade
bonds in their portfolios, he decides he needs additional help to meet the request. He considers various independent
advisors to use as submanagers, but determines that the most qualified advisors would be too expensive. Reasoning
that a lower-cost provider would enable him to pass the savings along to his clients, he chooses that provider to invest
the new bond allocation. Tuipulotu has violated:

A. Standard III(C) Suitability by failing to consider the appropriateness of the noninvestment-grade bonds.
B. Standard V(A) Diligence and Reasonable Basis by letting fee structure determine the selection of the
submanager.
C. Both Standard III(C) Suitability and Standard V(A) Diligence and Reasonable Basis.

Explanation

C is correct. Both Standard III(C) Suitability and Standard V(A) Diligence and Reasonable Basis were violated.
Tuipulotu must perform a full IPS review to determine the appropriateness of the new portfolio allocations.
Submanagers should not be selected by cost structure alone, as the quality and appropriateness of the submanager is
Tuipulotu's responsibility.

Question 17: According to the CFA Institute Code of Ethics, CFA Institute members shall:

A. preserve the confidentiality of information communicated by clients, prospects, or employers concerning

investment matters.
B. act with integrity, competence, diligence, respect, and in an ethical manner when dealing with the public, clients,
prospective clients, employers, employees, colleagues in the investment profession, and other participants in the
global capital markets.
C. maintain knowledge and comply with all applicable laws, rules and regulations.

Explanation

B is correct. Acting with integrity, competence, diligence, respect, and in an ethical manner when dealing with the
public, clients, prospective clients, employers, employees, colleagues in the investment profession, and other
participants in the global capital markets is one of the six components of the Code of Ethics, whereas the other
statements are part of the Standards of Professional Conduct.

Question 18: In order to comply with the CFA Institute Standards, an analyst should:

A. use only his own research in making investment recommendations, because anything else would violate Standard
I(B), Independence and Objectivity.
B. use outside research only after verifying its accuracy.
C. use only his company's research when making investment recommendations and use outside research for reports
and analysis on stocks.

Explanation

B is correct. Standard I(B), Independence and Objectivity: the analyst is allowed to use outside research only after
an insightful review. There are no restrictions regarding the exclusive use of outside information or in-house
information.

Question 19: Ken Howell, CFA, plans to issue a buy recommendation for Glazer Oil, Inc., based on his analysis and
forecasts. Howell suspects that the company will soon announce merger plans with a Japanese oil company. To
investigate, Howell attempts to call three executives at Glazer. Different secretaries inform Howell that the executives
are "attending a conference overseas" or "traveling in Japan." Howell is able to confirm that all three are in the same
city in Japan where the potential merger partner is headquartered. Howell feels confident that the merger will go
forward. According to CFA Institute Standards of Professional Conduct, Howell may issue a buy recommendation
on the oil company:

A. immediately.
B. only after allowing the companies a reasonable time to disclose their merger plans.
C. only after encouraging the companies’ managements to publicly disclose their merger plans.

Explanation

A is correct. Howell is using publicly available financial reports as well as non-material nonpublic information
regarding the travel plans of the company's executive officers that led him to suspect that the company is planning a
merger with a Japanese oil company. Thus, Howell formed his conclusion using the mosaic theory and did not
violate Standard II(A) Material Nonpublic Information.

Question 20: Karen Jackson is a portfolio manager. Jackson is friendly with David James, president of Acme Medical,
a rapidly growing biotech company. James has provided Jackson with recommendations in the biotech industry, which
she buys for her own portfolio before buying them for her clients. For three years, Jackson has also served on Acme
Medical's board of directors. She has received options and fees as compensation.

Recently, the board of Acme Medical decided to raise capital by voting to issue shares to the public. This was
attractive to board members (including Jackson) who wanted to exercise their stock options and sell their shares to
get cash. When the demand for initial public offerings (IPO) diminished, just before Acme Medical's public offering,
James asked Jackson to commit to a large purchase of the offering for her portfolios. Jackson had previously
determined that Acme Medical was a questionable investment but agreed to reconsider at James' request. Her
reevaluation confirmed the stock to be overpriced, but she nevertheless decided to purchase Acme Medical for her
clients' portfolios.

Did Jackson violate Standard III(C) Suitability concerning portfolio recommendations and actions?

A. Yes, because she did not consider the appropriateness and suitability of investment recommendations or actions
for each portfolio or client.
B. No.
C. Yes, because she did not deal fairly with all clients.

Explanation

A is correct. Jackson violated Standard III(C) Suitability because she did not consider her clients' financial situation,
investment experience, and investment objectives.

Question 21: Steven Wade, CFA, writes an investment newsletter focusing on high-tech companies, which he
distributes by e-mail to paid subscribers. Wade does not gather any information about his clients' needs and
circumstances. Wade has developed several complex valuation models that serve as the basis for his
recommendations. Each month, his newsletter contains a list of "buy" and "sell" recommendations. He states that his
recommendations are suitable for all types of portfolios and clients. Because of their proprietary nature, Wade does
not disclose, except in general terms, the nature of his valuation models. He conducted numerous statistical tests of
these models and they appear to have worked well in the past. In his newsletter, Wade claims that subscribers who
follow his recommendations can expect to earn superior returns because of the past success of his models.

Wade violated all of the following CFA Institute Standards of Professional Conduct EXCEPT:

A. Standard I(C), Misrepresentation.

B. Standard III(B), Fair Dealing.
C. Standard V(B), Communication with Clients and Prospective Clients.

Explanation

B is correct. Wade did not violate Standard III(B), Fair Dealing, because this situation does not indicate that he
failed to deal fairly and objectively with all clients when disseminating his newsletter containing investment
recommendations.

Wade violated Standard V(B), Communication with Clients and Prospective Clients, because he failed to include all
relevant factors behind his recommendations. Without providing the basis for his recommendations, clients cannot
evaluate the limitations or the risks inherent in his recommendations.

Wade violated Standard I(C), Misrepresentation, because his claims about gaining superior expected returns are
misleading to potential investors.

Question 22: Mary White, CFA, sits on the board of directors of XYZ Manufacturing, Inc. She discovers that
management has knowingly participated in an activity she knows is illegal. According to the CFA Institute Standards
of Professional Conduct, White is least likely to be required to:

A. disassociate herself from the activity.

B. report the violation to the CFA Institute Professional Conduct Program.
C. seek legal advice to determine what actions should be taken.

Explanation
B is correct. Members are encouraged -- but not required -- to report violations of others. Standard I(A), Knowledge
of the Law. Prohibition against knowingly practicing or assisting in violation of laws, rules, and regulations. If White
knows that someone has engaged in a possible illegal activity, she should: (1) report the finding to the appropriate
supervisory person at her firm, (2) if the situation is not remedied, disassociate herself from the situation, and (3) seek
legal advice to see what other actions, such as notifying the proper regulatory agency, should be taken.

Question 23: Fernando Abrea, CFA was an analyst for Pacific Investments. In October he left Pacific and joined
Global Securities as manager of a local office. Abrea's change of employment came about in the following manner:

 In April, Abrea contacted Global about a possible position he saw advertised in a financial publication and
had exploratory meetings with Global.
 In July, Abrea submitted a strategic plan to Global and signed an agreement to join Global. He then contracted
for office space on behalf of Global.
 On October 15, Abrea's resignation from Pacific became effective. He did not take any client lists from
Pacific.
 On October 16, Abrea mailed a letter that explained his new undertaking with Global to prospective clients,
including his former clients at Pacific.

With respect to Standard IV(A) Loyalty, Abrea:

A. violated the Standard by contacting his former clients at Pacific.

B. did not violate the Standard.
C. violated the Standard by contracting for office space on behalf of Global.

Explanation

B is correct. According to Standard IV(A) Loyalty, preparations to leave employment are not prohibited. Even though
Abrea engaged in significant preparatory activities prior to beginning his new venture, none of these actions suggest
Abrea did not continue to act in Pacific's interests while he was employed by Pacific. Abrea may contact his former
clients on behalf of Global after his employment by Pacific has officially ended, as long as he did not misappropriate
their contact information from Pacific.

Question 24: Fred Dean, CFA, has just taken a job as trader for LPC. One of his first assignments is to execute the
purchase of a block of East Street Industries. While working with East Street on an assignment for his previous
employer, he learned that East Street's sales have weakened and will likely be significantly below the LPC analyst's
estimate, but no public announcement of this has been made. Which of the following actions would be the most
appropriate for Dean to take according to the Standards?

A. Contact East Street’s management and urge them to make the information public and make the trade if they
refuse.
B. Post the information about the drop in sales on an internet bulletin board to achieve public dissemination and
inform his supervisor of the posting.
C. Request that the firm place East Street’s stock on a restricted list and decline to make any trades of the
company’s stock.

Explanation

A is correct. Standard II(A) Material Nonpublic Information requires that members and candidates who possess
material nonpublic information not act or cause others to act on the information. Refusing the trade would violate this
Standard because it would be acting or causing others to act on the nonpublic information. Dean should seek to have
East Street make the information public. If East Street does not do so, Dean must act as he would have acted if he did
not possess the information. Refusing to make the trade he was instructed to make would be "acting" on the
information in this case. The obligation here is to the integrity of financial markets.

Question 25: The following information pertains to the Galaxy Trust, a trust established by Stephen P. House and
managed by Gamma Investment LLC:

 At the time the trust was established House provided $5 million in cash to fund the trust, but Gamma was
aware that 93% of his personal assets were in the form of Oracle stock.
 Gamma has been asked to view his funds and the trust as a single entity for planning purposes, since House's
will stipulates that all of his estate will pass to the trust upon his death.
 The investment policy statement, developed in September 1996, stipulates that the trust should maintain a
short position in Oracle stock and use the proceeds to diversify the trust more adequately.
 House was able to sell all of his Oracle shares back to the corporation in January 1999 for cash.
 The policy statement redrawn in September 1999 continues to stipulate that the trust hold a short position in
Oracle stock.
 House has given the portfolio manager in charge of the trust an all expenses paid vacation package anywhere
in the world each year at Christmas. The portfolio manager has reported this fact in writing to his immediate
supervisor at Gamma.

Which of the following is most correct? The investment manager is:

A. in violation of the Code and Standards by not properly updating the investment policy statement in light of the
change in the circumstances and is in violation with regard to the acceptance of the gift from House.
B. in violation of the Code and Standards by not properly updating the investment policy statement in light of the
change in the circumstances but is not in violation with regard to the acceptance of the gift from House.
C. not in violation of the Code and Standards for not properly updating the investment policy statement in light of the
change in the circumstances and is not in violation with regard to the acceptance of the gift from House.

Explanation

B is correct. The investment manager is in violation of the Standard requiring him to make a reasonable inquiry into
the client's financial situation and update the investment policy statement since such a dramatic change in the client's
circumstances would undoubtedly alter the investment policy statement and would probably eliminate the need to
hold a short position in Oracle. The investment manager is not in violation of the Standard concerning additional
compensation, since the gift has been reported to his supervisor and has come from a client. If there was a failure to
report such a gift, if the firm had a rule in place against the acceptance of gifts from clients, or if the gift had come
from a non-client, there would be a violation of the standard.

Question 26: Calvin Moore, CFA, has been transferred from the brokerage house of the Browning Company to the
portfolio management department. In portfolio management, Moore learns that clients are grouped into three divisions
according to portfolio value, divided as follows:

 Group 1 up to $10,000
 Group 2 from $10,001 to $100,000
 Group 3 more than $100,000

When recommendations are announced or trades are initiated, a particular sequence is followed in communicating to
these groups. At the next monthly meeting, Moore suggests that the sequencing practice is a breach of CFA Institute
Standards. One of Moore's coworkers replies that the grouping approach helps the company in applying the Standard
regarding portfolio recommendations. He further suggests that because Browning's overall performance is more
strongly affected by actions taken on the high value portfolios, that these portfolios should take priority over the small
value portfolios. What should Moore do? Moore should:

A. prepare a written report to the CEO describing the problem.

B. do nothing since there is no breach with the Standards.
C. disassociate himself from the problem and seek legal advice.

Explanation

C is correct. Taking a special approach in disseminating information in relation to initiating trades is a breach of
Standard III(B), Fair Dealing. Given the fact that Moore works in the department and has already unsuccessfully tried
to prevent the practice from continuing, he needs to disassociate himself and seek legal advice.

Question 27: The following scenarios refer to two analysts who are employed at Global Securities, a large brokerage
firm.

 Paula Linstrom, CFA, is instructed by her supervisor to write a research report on Delta Enterprises. Delta's
stock is widely held by institutional and individual investors. Although Linstrom does not own any of Delta's
stocks, she believes that one of her friends may own 10 shares of Delta. The stock currently sells for $25 per
share. Linstrom does not believe that informing her employer about her friend's possible ownership of Delta
shares is necessary.
 Hershel Wadel, a member of CFA Institute, is asked by his supervisor to write a research report on Gamma
Company. Wadel's wife inherited 500 shares of Gamma Company from her father when he died five years
ago. Gamma stock currently sells for $35 per share. Wadel does not believe that informing his employer about
his wife's ownership of Gamma shares is necessary.

According to CFA Institute Standards of Professional Conduct, which the following statements about Linstrom and
Wadel's conduct is most accurate?

A. Both of these analysts must disclose a potential conflict of interest.

B. Only one of these analysts must disclose a potential conflict of interest.
C. Neither of these analysts must disclose a potential conflict of interest.

Explanation

B is correct. The possibility that Linstrom's friend may own shares of Delta's stock does not create a conflict of
interest for Linstrom, who has no beneficial interest in these shares. On the other hand, Wadel has a beneficial interest
in his wife's ownership of Gamma shares. Standard VI(A) Disclosure of Conflicts requires that Wadel disclose this
information so that his employer can make the proper determination.

Question 28: The following scenarios involve two analysts at Dupree Asset Management, a small New York-based
company with about $150 million in assets under management. Dupree restricts personal trading of stocks analyzed,
corporate directorships, trustee positions, and other special relationships that could reasonably be considered a conflict
of interest with their responsibilities to their employer.

 Ray Bolt, CFA, is a senior investment analyst. Bolt was recently elected to the board of trustees of his alma
mater, Midwest University, and was appointed as the chairman of the University's endowment committee.
Midwest has more than $2 billion in its endowment. Bolt must travel from New York to Chicago eight times
a year to attend meetings of the board of trustees and endowment committee. Bolt did not inform Dupree of
his involvement with Midwest University.
  Wanda Delvecco, a candidate in the CFA Program, is a junior investment analyst. She recently wrote a
research report on Aveco Communications and recommended the stock for Dupree's "buy" list. Delvecco
bought 200 shares of Aveco stock for her personal account 12 months before she wrote her research report.
Over the past 12 months, the stock's price has been in the $20-42 price range. Delvecco has not informed
Dupree of her ownership of Aveco stock.

According to CFA Institute Standards of Professional Conduct, which the following statements about Bolt and
Delvecco's actions is CORRECT?

A. Both Bolt and Delvecco violated the Standards.

B. Neither Bolt nor Delvecco violated the Standards.
C. Delvecco violated the Standards, but Bolt did not.

Explanation

A is correct. Standard VI(A), Disclosure of Conflicts, requires that Bolt inform Dupree of his involvement with
Midwest University given that Bolt's new role can be expected to be time consuming and possibly affect his
responsibilities at Dupree. Delvecco is required to disclose her ownership of Aveco stock before conducting the
research report because such ownership could bias her objectivity in making a recommendation. She should have
discussed owning the stock with her supervisor before beginning to write the research report on Aveco.

Question 29: The step in the financial statement analysis framework of "processing the data" is least likely to include
which activity?

A. Preparing exhibits such as graphs.

B. Acquiring the company’s financial statements.
C. Making appropriate adjustments to the financial statements.

Explanation

B is correct. The financial statement analysis framework consists of six steps. Step 2: "Gather data" includes acquiring
the company's financial statements and other relevant data on its industry and the economy. Step 3. "Process the data"
includes activities such as making any appropriate adjustments to the financial statements and preparing exhibits such
as graphs and common-size balance sheets.

Question 30: Under perfect competition, if the price of a firm's product is below its average total cost, in the short
run the firm should:

A. increase the product price to at least cover its average total cost.
B. shut down, but operate in the long run if it is covering its variable costs.
C. operate if it is covering its variable costs.

Explanation

C is correct. If the firm is covering its average variable costs and some of its fixed costs it will minimize its losses
by continuing to operate in the short run. If the price remains below average total cost in the long run, the firm should
shut down. Under perfect competition, firms have no pricing power and must take the market price.

Question 31: Nikki Ali and Donald Ankard borrowed $15,000 to help finance their wedding and reception. The
annual payment loan carries a term of seven years and an 11% interest rate. Respectively, the amount of the first
payment that is interest and the amount of the second payment that is principal are approximately:
A. $1,468; $1,702.
B. $1,650; $1,468.
C. $1,650; $1,702.

Explanation

C is correct.

Step 1: Calculate the annual payment.

Using a financial calculator (remember to clear your registers): PV = 15,000; FV = 0; I/Y = 11; N = 7; PMT
= $3,183

Step 2: Calculate the portion of the first payment that is interest.

Interest1 = Principal × Interest rate = (15,000 × 0.11) = 1,650

Step 3: Calculate the portion of the second payment that is principal.

Principal1 = Payment – Interest1 = 3,183 – 1,650 = 1,533 (interest calculation is from Step 2)

Interest2 = Principal remaining × Interest rate = [(15,000 – 1.533) × 0.11] = 1,481

Principal2 = Payment – Interest1 = 3,183 – 1,481 = 1,702.

Question 32: Which of the following is least likely to be considered a reason why regulation of monopolies is not
effective?

A. Regulation shifts industry demand and increases prices.

B. Regulation reduces the incentive for firms to reduce costs.
C. Regulators do not know the firm’s cost structure.

Explanation

A is correct. Regulation is not associated with a shift in industry demand.

Question 33: Pinto Corporation is an automobile manufacturer located in North America. Pinto owns a 5
percent interest in one of its suppliers, Continental Supply Company. Each year, Pinto receives a cash dividend from
Continental. Pinto's engine supplier, National Supply Company, recently increased prices on goods sold to all
customers due to higher labor costs. Should Pinto report the dividends received from Continental and the price
increase from National as an operating or nonoperating component on its year-end income statement?

A. Only one is operating.

B. Both are operating.
C. Both are nonoperating.

Explanation

A is correct. Since Pinto is a nonfinancial firm, dividends received would be considered a nonoperating component.
An increase in cost of goods sold would be considered a part of normal operations.

Question 34: For a long-term lease, the amount recorded initially by the lessee as a liability is:

A. the total of the lease payments.

B. the fair value of the leased asset.
C. the present value of the lease payments.

Explanation

C is correct. With a finance lease, both an asset and liability are reported on the lessee's balance sheet, equal to the
present value of the promised lease payments.

Question 35: One of the major limitations of Monte Carlo simulation is that it:

A. cannot provide the insight that analytic methods can.

B. does not lend itself to performing “what if” scenarios.
C. requires that variables be modeled using the normal distribution.

Explanation

A is correct. The major limitations of Monte Carlo simulation are that it is fairly complex and will provide answers
that are no better than the assumptions used and that it cannot provide the insights that analytic methods can. Monte
Carlo simulation is useful for performing "what if" scenarios. One of the first steps in Monte Carlo simulation is to
specify the probably distribution along with the distribution parameters. The distribution specified does not have to
be normal.

Question 36: If a firm's management wants to use its discretion over accounting choices to increase operating income
in the next period, they are most likely to:

A. increase the assumed residual values of plant and equipment.

B. decrease the assumed useful lives of plant and equipment.
C. write up plant and equipment from depreciated cost to its fair market value.

Explanation

A is correct. Increasing residual values of plant and equipment would decrease depreciation expense and increase
operating income. Decreasing the useful lives of plant and equipment would increase depreciation expense by
depreciating these assets over a shorter period. Under IFRS, the firm cannot recognize revaluation above depreciated
cost on the income statement unless it reverses a previously recognized loss. Increasing the book value of plant and
equipment would also increase depreciation expense in subsequent periods.

Question 37: A collector of antique automobiles buys one for $180,000 in 20X1 and sells it for $200,000 in 20X3.
That buyer then sells the automobile for $215,000 in 20X5. Do these sales increase gross domestic product in 20X3
and 20X5?

A. No.
B. Yes, by $20,000 in 20X3 and $15,000 in 20X5.
C. Yes, by $200,000 in 20X3 and $215,000 in 20X5.

Explanation

A is correct. These transactions do not increase GDP for either of these years because the antique automobile was
not produced during the periods. GDP includes expenditures on goods and services that were produced during a
period.

Question 38: Which of the following statements about accounting procedures and their impact on the statement of
cash flows is least valid? All else equal:
A. A company that finances through common stock issues may have the same cash flow from financing (CFF) as a
firm that issues debt.
B. A nonprofitable company that uses LIFO to account for inventory will have higher total cash flow than a
nonprofitable company that uses FIFO during a period of rising prices.
C. Cash flow from financing (CFF) is higher over the life of a bond if a firm issues the bond at a premium,
compared to issuing the bond at par.

Explanation

B is correct. Because of the impact of income taxes, a profitable company that accounts for inventory using LIFO
will have higher total cash flow than a profitable company that uses FIFO. The company that uses LIFO will have
higher cost of goods sold, resulting in lower net income and thus lower taxes.

Question 39: An analyst gathers the following data about the mean monthly returns of three securities:

Security Mean Monthly Return Standard Deviation

X 0.9 0.7
Y 1.2 4.7
Z 1.5 5.2
Which security has the highest level of relative risk as measured by the coefficient of variation?

A. Z.
B. Y.
C. X.

Explanation

B is correct. The coefficient of variation, CV = standard deviation / arithmetic mean, is a common measure of relative
dispersion (risk). CVX = 0.7 / 0.9 = 0.78; CVY = 4.7 / 1.2 = 3.92; and CVZ = 5.2 / 1.5 = 3.47. Because a higher CV
means higher relative risk, Security Y has the highest relative risk.

Question 40: Which one of the following statements best describes the components of the required interest rate on a
security?

A. The real risk-free rate, the default risk premium, a liquidity premium and a premium to reflect the risk associated
with the maturity of the security.
B. The nominal risk-free rate, the expected inflation rate, the default risk premium, a liquidity premium and a
premium to reflect the risk associated with the maturity of the security.
C. The real risk-free rate, the expected inflation rate, the default risk premium, a liquidity premium and a premium
to reflect the risk associated with the maturity of the security.

Explanation

C is correct. The required interest rate on a security is made up of the nominal rate which is in turn made up of the
real risk-free rate plus the expected inflation rate. It should also contain a liquidity premium as well as a premium
related to the maturity of the security.

Question 41: When the sources of economic growth are stated as a production function, which factor is treated as a
multiplier?
A. Size of the labor force.
B. Amount of capital available.
C. Productivity.

Explanation

C is correct. Economic output can be stated as a production function of the form Y = A × ƒ(L, K), where Y is
economic output, L is the size of the labor force, K is the amount of capital available, and A is total factor
productivity.

Question 42: Which of the following is least likely a qualitative characteristic accounting information must possess
in order to provide useful information to an analyst, according to the IASB Conceptual Framework?

A. Faithful representation.
B. Conservatism.
C. Relevance.

Explanation

B is correct. Qualitative characteristics that accounting information must possess according to the IASB Conceptual
Framework are relevance and faithful representation, which are enhanced by the characteristics of timeliness,
verifiability, understandability, and comparability. While conservatism in accounting has traditionally been viewed
as a desirable characteristic, it is not one of the qualitative characteristics specified in the IASB Conceptual
Framework.

Question 43: Which of the following is least likely to be disclosed in the financial statements of a bond issuer?

A. Collateral pledged as security in the event of default.

B. The amount of debt that matures in each of the next five years.
C. The market rate of interest on the balance sheet date.

Explanation

C is correct. The market rate on the balance sheet date is not typically disclosed. The amount of principal scheduled
to be repaid over the next five years and collateral pledged (if any) are generally included in the footnotes to the
financial statements.

Question 44: The average amount of snow that falls during January in Frostbite Falls is normally distributed with a
mean of 35 inches and a standard deviation of 5 inches. The probability that the snowfall amount in January of next
year will be between 40 inches and 26.75 inches is closest to:

A. 68%.
B. 79%.
C. 87%.

Explanation

B is correct. To calculate this answer, we will use the properties of the standard normal distribution. First, we will
calculate the Z-value for the upper and lower points and then we will determine the approximate probability covering
that range. Note: This question is an example of why it is important to memorize the general properties of the normal
distribution.

Z = (observation – population mean) / standard deviation

  Z26.75 = (26.75 – 35) / 5 = -1.65. (1.65 standard deviations to the left of the mean)
 Z40 = (40 – 35) / 5 = 1.0 (1 standard deviation to the right of the mean)

Using the general approximations of the normal distribution:

 68% of the observations fall within ± one standard deviation of the mean. So, 34% of the area falls between
0 and +1 standard deviation from the mean.
 90% of the observations fall within ± 1.65 standard deviations of the mean. So, 45% of the area falls between
0 and +1.65 standard deviations from the mean.

Here, we have 34% to the right of the mean and 45% to the left of the mean, for a total of 79%.

Question 45: Which of the following statements regarding the monetary policy transmission mechanism is most
accurate?

A. Central banks can control short-term interest rates directly, but long-term interest rates are beyond their control.
B. Central banks can control long-term interest rates directly because decisions by consumers and businesses are
based on these rates.
C. Central banks can control short-term interest rates by increasing the money supply to increase interest rates or by
decreasing the money supply to decrease interest rates.

Explanation

A is correct. Central banks can control short-term interest rates directly. However, the decisions of consumers and
businesses are based on long-term interest rates, which are beyond the control of central banks. Increasing the money
supply will decrease interest rates and decreasing the money supply will increase interest rates.

Question 46: Arlington, Inc. uses the first in, first out (FIFO) inventory cost flow assumption and a periodic inventory
system. Beginning inventory and purchases of refrigerated containers for Arlington were as follows:

Units Unit Cost Total Cost

Beginning Inventory 20 $10,000 $200,000
Purchases, April 10 12,000 120,000
Purchases, July 10 12,500 125,000
Purchases, October 20 15,000 300,000
In November, Arlington sold 35 refrigerated containers to Johnson Company. What is the cost of goods sold assigned
to the 35 sold containers?

A. $434,583.
B. $485,000.
C. $382,500.

Explanation

C is correct. Under FIFO, cost of goods sold is the value of the first units purchased. The 35 units sold consist of the
20 units in beginning inventory, the 10 units purchased in April, and 5 of the units purchased in July. COGS =
$200,000 + $120,000 + (5 × $12,500) = $382,500. Using FIFO, ending inventory and COGS are not affected by the
choice of a periodic or perpetual inventory system.

Question 47: Which of the following statements about kurtosis is least accurate? Kurtosis:
A. describes the degree to which a distribution is not symmetric about its mean.
B. is used to reflect the probability of extreme outcomes for a return distribution.
C. measures the peakedness of a distribution reflecting a greater or lesser concentration of returns around the mean.

Explanation

A is correct. The degree to which a distribution is not symmetric about its mean is measured by skewness. Excess
kurtosis which is measured relative to a normal distribution, indicates the peakedness of a distribution, and also
reflects the probability of extreme outcomes.

Question 48: The mean and standard deviation of returns for three portfolios are listed below in percentage terms.

 Portfolio X: Mean 5%, standard deviation 3%.

 Portfolio Y: Mean 14%, standard deviation 20%.
 Portfolio Z: Mean 19%, standard deviation 28%.

Using Roy's safety-first criteria and a threshold of 4%, select the optimal portfolio.

A. Portfolio X.
B. Portfolio Y.
C. Portfolio Z.

Explanation

C is correct. Portfolio Z has the largest value for the SFRatio: (19 – 4) / 28 = 0.5357.

For Portfolio X, the SFRatio is (5 – 4) / 3 = 0.3333.

For Portfolio Y, the SFRatio is (14 – 4) / 20 = 0.5000.

Question 49: Which form of regional trading agreement is least likely to allow free movement of labor?

A. Customs union.
B. Economic union.
C. Common market.

Explanation

A is correct. Economic unions and common markets remove all barriers to the movement of labor and capital
among their members. Customs unions do not have this feature.

Question 50: For a firm to use the revaluation model for balance sheet reporting of long-lived assets:

A. the firm must report under U.S. GAAP.

B. an active market must exist for the assets.
C. the firm must choose which assets of each type to revalue, and which to report at cost.

Explanation

B is correct. Under IFRS, a firm may use the revaluation model for long-lived assets that have an active market
which can be used to determine the fair value of the assets. The firm must use the same model for all assets of a
similar type. U.S. GAAP reporting firms must use the cost model for long-lived assets.

Question 51: Which of the following statements best justifies analyst scrutiny of valuation allowances?
A. If differences in taxable and pretax incomes are never expected to reverse, a company’s equity may be
understated.
B. Changes in valuation allowances can be used to manage reported net income.
C. Increases in valuation allowances may be a signal that management expects earnings to improve in the future.

Explanation

B is correct. A valuation allowance is a contra account (offset) against deferred tax assets that reflects the likelihood
that the deferred tax assets will never be realized. Changes in the valuation allowance have a direct impact on reported
income. Because management has discretion with regard to the amount and timing of a valuation allowance, changes
in the valuation allowance give management significant opportunity to manage earnings.

Question 52: Which one of the following is most likely to experience loss of wealth from an increase in the
inflation rate?

A. A commercial bank that has a large quantity of fixed-rate mortgages in its loan portfolio.
B. An individual investor who financed the purchase of a home with a 30-year fixed rate mortgage.
C. An individual investor who recently purchased a substantial amount of variable rate bonds.

Explanation

A is correct. If an economy experiences inflation, the losers are those who hold long-term contracts in which they
are to receive fixed payments. A bank that has a large quantity of fixed-rate mortgages in its loan portfolio (i.e., they
are investments for the bank) is receiving fixedrate payments. Both remaining choices are investors who are either
making fixed rate payments (the homeowner) or receiving floating-rate payments (the investor in variable rate bonds).

Question 53: A technology that all of the firms in a perfectly competitive industry are using in their production
process has been banned by new legislation. What will most likely be the effect if these firms stop using this
technology?

A. Profit will no longer be maximized at the level of output where marginal cost is equal to the market price.
B. The quantity that the industry will supply at a given price will be reduced.
C. Firms will adopt a different technology that reduces their costs of production.

Explanation

B is correct. If all the firms in a competitive industry have adopted a technology for production, it is presumably the
technology that minimizes their production costs. If that technology is outlawed, firms will have to revert to the
second-best technology, which will increase their costs of production. This is represented by a shift to the left in the
industry supply curve. At each price level, the quantity supplied will be less than before.

Just as a technological improvement will cause firms that adopt it early to earn economic profits that attract new
entrants to the industry, prohibition of the cost-minimizing technology will cause economic losses and typically force
some firms to exit the industry. Under perfect competition, profit is always maximized at the level of output where
marginal cost equals the market price. The state of technology is one factor that determines the level of output at
which this occurs.

Question 54: Which of the following is the best method to avoid data snooping bias when testing a profitable trading
strategy?

A. Use a sample free of survivorship bias.

B. Test the strategy on a different data set than the one used to develop the rules.
C. Increase the sample size to at least 30 observations per year.
Explanation

B is correct. Data snooping bias occurs when the analyst repeatedly "drills" the dataset until something statistically
significant is found.

The best way to avoid data snooping is to test a potentially profitable trading rule on a data set different than the one
you used to develop the rule (out-of-sample data). Neither a larger sample size nor a data set free of survivorship bias
will prevent data snooping.

Question 55: Which of the following statements is most accurate regarding monetarists? Monetarists believe that:

A. fiscal policy is the most powerful of all government tools used to affect prices and output.
B. discretionary monetary policy is the best way to moderate fluctuations in prices and output.
C. steady, predictable money growth is the best monetary policy.

Explanation

C is correct. Monetarists believe that the Fed's tools are powerful and should not be used to moderate fluctuations in
prices and outputs. Thus, steady, predictable growth is the best monetary policy. They believe in the power of the
money supply, not fiscal policy, to affect prices and outputs.

Question 56: Which of the following statements about inventory presentation and disclosures is most accurate?

A. An analyst must determine which inventory cost method was used by examining the firm’s current and historical
inventory values.
B. Changing from FIFO to LIFO is a change in accounting principle that must be applied retrospectively.
C. IFRS permits reversals of inventory writedowns but the firm must disclose the circumstances of the reversal in
its financial statements.

Explanation

C is correct. IFRS requires a firm that reverses an inventory writedown to discuss the circumstances that led to the
reversal. Both IFRS and U.S. GAAP require firms to disclose the inventory cost flow method they use. While a change
to LIFO from another inventory cost method is a change in accounting principle, under U.S. GAAP this change is not
applied retrospectively. The carrying value of inventory is considered to be the first LIFO layer.

Question 57: An analyst makes the following two statements:

Statement #1 – From a lender's perspective, higher volatility of a borrower's profit margins is undesirable for floating-
rate debt but not for fixed-rate debt.

Statement #2 – Product and geographic diversification should lower a borrower's credit risk.

With respect to these statements:

A. both are correct.

B. both are incorrect.
C. only one is correct.

Explanation

C is correct. Margin stability is desirable from the lender's perspective for both floating-rate and fixedrate debt.
Higher volatility will increase credit risk. Product and geographic diversification should lower credit risk as the
borrower is less sensitive to adverse events and conditions.
Question 58: Which of the following is an analyst least likely to rely on as objective information to include in a
company analysis?

A. Corporate press releases.

B. Government agency statistical data on the economy and the company’s industry.
C. Proxy statements.

Explanation

A is correct. Corporate reports and press releases are written by management and are often viewed as public relations
or sales materials. An analyst should review information on the economy and the company's industry and compare
the company to its competitors. This information can be acquired from sources such as trade journals, statistical
reporting services, and government agencies. Securities and Exchange Commission (SEC) filings include Form 8-K,
which a company must file to report events such as acquisitions and disposals of major assets or changes in its
management or corporate governance and proxy statements, which are a good source of information about the election
of (and qualifications of) board members, compensation, management qualifications, and the issuance of stock
options.

Question 59: Michael Philizaire decides to calculate the geometric average of the appreciation/deprecation of his
home over the last five years. Using comparable sales and market data he obtains from a local real estate appraiser,
Philizaire calculates the year-toyear percentage change in the value of his home as follows: 20, 15, 0, –5, –5. The
geometric return is closest to:

A. 4.49%.
B. 0.00%.
C. 11.60%.

Explanation

A is correct. The geometric return is calculated as follows:

[(1 + 0.20) × (1 + 0.15) × (1 + 0.0) (1 – 0.05) (1 – 0.05)]1/5 – 1,

or [1.20 × 1.15 × 1.0 × 0.95 × 0.95]0.2 – 1 = 0.449, or 4.49%.

Question 60: Shawn Choate wants to choose a variable of study that has the most desirable statistical
properties. The statistic he is presently considering has the following characteristics:

 The expected value of the sample mean is equal to the population mean.
 The variance of the sampling distribution is smaller than that for other estimators of the parameter.
 As the sample size increases, the standard error of the sample mean increases and the sampling distribution
is centered more closely on the mean.

Choate's estimator is:

A. unbiased and consistent.

B. unbiased and efficient.
C. efficient and consistent.

Explanation

B is correct. The estimator is unbiased because the expected value of the sample mean is equal to the population
mean. The estimator is efficient because the variance of the sampling distribution is smaller than that for other
estimators of the parameter. The estimator is not consistent. To be consistent, as the sample size increases, the standard
error of the sample mean must decrease.

Question 61: With respect to utility theory, the income effect for a decrease in the price of a good:

A. may increase or decrease consumption of the good.

B. will decrease consumption of the good.
C. will increase consumption of the good.

Explanation

A is correct. The income effect for a decrease in price may be positive (for a normal good) or negative (for an
inferior good). Therefore, the income effect from a price decrease may be to increase or decrease consumption of a
good.

Question 62: Galaxy Corporation manufactures custom motorcycles. Galaxy finances the motorcycles over 36
months for customers who make a minimum down payment of 10%. Historically, Galaxy has experienced bad debt
losses equal to 1% of sales. Galaxy also provides a 24 month unlimited warranty on all new motorcycles. In the past,
warranty expense has averaged 3% of sales. Ignoring taxes, how does the recognition of bad debt expense and
warranty expense at the time of sale affect Galaxy's liabilities?

A. Bad debt expense: No effect and Warranty expense: No effect.

B. Bad debt expense: No effect and Warranty expense: Increase.
C. Bad debt expense: Increase and Warranty expense: No effect.

Explanation

B is correct. The recognition of bad debt expense has no effect on liabilities, current revenues are reduced by the
expected amount of uncollectable accounts. Bad debt expense reduces net income and reduces assets. The recognition
of expected warranty expense decreases net income (following the matching principle), and since it is not currently
paid (doesn't reduce assets) it creates or increases a liability at the time of sale.

Question 63: If Stock X has a standard deviation of returns of 18.9% and Stock Y has a standard deviation of returns
equal to 14.73% and returns on the stocks are perfectly positively correlated, the standard deviation of an equally
weighted portfolio of the two is:

A. 10.25%.
B. 14.67%.
C. 16.82%.

Explanation

C is correct. The standard deviation of two stocks that are perfectly positively correlated is the weighted average of
the standard deviations: 0.5(18.9) + 0.5(14.73) = 16.82%. This relationship is true only when the correlation is one.

Question 64: Consider the following analysis of variance (ANOVA) table:

Source Sum of squares Degrees of freedom Mean sum of squares

Regression 556 1 556

Error 679 50 13.5

 Total 1,235 51

The R2 for this regression is closest to:

A. 0.82.
B. 0.45.
C. 0.55.

Explanation

B is correct. R2 = regression sum of squares / total sum of squares = 556 / 1,235 = 0.45.

Question 65: Consider the following statements.

Statement #1: Par value is a nominal dollar value assigned to shares of stock in a corporation's charter.

Statement #2: The par value of common stock represents the amount the corporation received when the stock was
issued.

With respect to these statements:

A. both statements are correct.

B. only statement #1 is correct.
C. only statement #2 is correct.

Explanation

B is correct. The par value of common stock is the stated or nominal value assigned to the stock. Par value has no
relationship to market value. The amount the corporation receives from the issuance of common stock is equal to the
par value plus the additional paid-in-capital (proceeds in excess of par).

Question 66: Which of the following statements about achieving proper timing in fiscal policy is least accurate?

A. Improvements in quantitative methods have made the occurrence of recessions or expansions quite predictable.
B. Policy errors are inevitable due to unpredictable events.
C. There is usually a time lag between when a change in policy is needed and when the need is recognized by
policy makers.

Explanation

A is correct. One problem in achieving proper timing in fiscal policy is the inability to accurately predict a
recession or expansion.

Question 67: A firm engages in a new type of financial transaction that has a material effect on its earnings. An
analyst should most likely be suspicious of the new transaction if:

A. management has not explained its business purpose.

B. no accounting standard exists that applies to the transaction.
C. the transaction is not governed by existing regulations.

Explanation

A is correct. New types of transactions may emerge that are not covered by existing accounting standards or
regulations. Analysts should obtain information from a firm's management about the economic substance of such
transactions to ensure that they serve a business purpose and have not been created primarily to manipulate the firm's
financial statements.

Question 68: Where in the financial statements should a firm recognize the unrealized gains and losses on cash flow
hedging derivatives and the unrealized gains and losses on available-for-sale securities?

A. Cash flow hedging derivatives: Net income and Available-for-sale securities: Other comprehensive income.
B. Cash flow hedging derivatives: Other comprehensive income and Available-for-sale securities: Other
comprehensive income.
C. Cash flow hedging derivatives: Other comprehensive income and Available-for-sale securities: Net income.

Explanation

B is correct. Unrealized gains and losses from cash flow hedging derivatives and unrealized gains and losses from
available-for-sale securities are not recognized in the income statement; rather, they are both recognized as a
component of stockholders' equity as a part of other comprehensive income.

Question 69:

Cumulative Z-Table

z 0.05 0.06 0.07 0.08 0.09

2.4 0.9929 0.9931 0.9932 0.9934 0.9936

2.5 0.9946 0.9948 0.9949 0.9951 0.9952

2.6 0.9960 0.9961 0.9962 0.9963 0.9964

2.7 0.9970 0.9971 0.9972 0.9973 0.9974

The average return on the Russell 2000 index for 121 monthly observations was 1.5%. The population standard
deviation is assumed to be 8.0%. What is a 99% confidence interval for the mean monthly return on the Russell 2000
index?

A. 0.1% to 2.9%.
B. -0.4% to 3.4%.
C. -6.5% to 9.5%.

Explanation

B is correct. Because we know the population standard deviation, we use the z-statistic. The z-statistic reliability
factor for a 99% confidence interval is 2.575. The confidence interval is 1.5% ± 2.575[(8.0%)/√121] or 1.5% ± 1.9%.

Question 70: Xanadu attempts to decrease its inflation rate by implementing contractionary monetary policy.
Which of the following is most likely to be the long-run effect on Xanadu's trade balance as a result of the monetary
policy change?

A. Remain the same.

B. Improve.
C. Worsen.

Explanation
C is correct. Contractionary monetary policy likely will cause higher domestic interest rates and attract foreign
capital. As foreign capital flows in, the currency will appreciate relative to other currencies. The higher cost of its
currency will result in higher cost exports that become less attractive to other countries. Xanadu's trade balance will
most likely worsen.

Question 71: In order to test if Stock A is more volatile than Stock B, prices of both stocks are observed to construct
the sample variance of the two stocks. The appropriate test statistics to carry out the test is the:

A. F test.
B. t test.
C. Chi-square test.

Explanation

A is correct. The F test is used to test the differences of variance between two samples.

Question 72: An analyst has gathered the following information about a firm:

 Quick ratio of 0.25.

 Cash ratio of 0.20.
 $2 million in marketable securities.
 $10 million in cash.

What is their receivables balance?

A. 3 million.
B. 5 million.
C. 2 million.

Explanation

A is correct. Cash ratio = (cash + marketable securities) / current liabilities

0.20 = ($10,000,000 + $2,000,000) / current liabilities

current liabilities = $12,000,000 / 0.2 = $60,000,000

Quick ratio = [cash + marketable securities + receivables] / $60,000,000

0.25 = [$10,000,000 + $2,000,000 + receivables] / $60,000,000

($60,000,000)(0.25) = $12,000,000 + receivables

$15,000,000 = $12,000,000 + receivables

$15,000,000 – $12,000,000 = receivables

$3,000,000 = receivables

Question 73: Blocher Company is evaluating the following methods of accounting for depreciation of long-lived
assets and inventory:

 Depreciation: straight-line; double-declining balance (DDB)

 Inventory: first in, first out (FIFO); last in, first out (LIFO)
Assuming a deflationary environment (prices are falling), which of the following combinations will result in the
highest net income in year 1?

A. DDB; FIFO.
B. Straight-line; FIFO.
C. Straight-line; LIFO.

Explanation

C is correct. For year 1, straight-line depreciation will be lower than DDB. During deflationary periods, LIFO will
result in lower cost of goods sold and hence higher income.

Question 74: Use the following t-table for this question:

Probability in Right Tail

d.f. 5.0% 2.5% 1.0%

196 1.653 1.972 2.346

197 1.653 1.972 2.345

198 1.653 1.972 2.345

199 1.653 1.972 2.345

200 1.653 1.972 2.345

201 1.652 1.972 2.345

202 1.652 1.972 2.345

A sample of 200 monthly observations is used for a simple linear regression of returns versus leverage. The resulting
equation is:

returns = 0.04 + 0.894(Leverage) + ε

If the standard error of the estimated slope variable is 0.06, a test of the hypothesis that the slope coefficient is greater
than or equal to 1.0 with a significance of 5% should:

A. be rejected the test statistic of –1.77 is greater than the critical value.
B. be rejected because the test statistic of –1.77 is less than the critical value.
C. not be rejected because the test statistic of –1.58 is not less than the critical value.

Explanation

B is correct. The test statistic is (0.894 – 1.0) / 0.06 = –1.77. The critical value with 200 – 2 = 198 degrees of
freedom for 5% significance is –1.653. Because the test statistic of –1.77 is less than the lower critical value, we
reject the hypothesis that b1 is greater than or equal to 1.0.

Question 75: Which of the following reasons is least likely a valid limitation of ratio analysis?

A. Calculation of ratios involves a large degree of subjectivity.

B. Determining the target or comparison value for a ratio is difficult.
C. It is difficult to find comparable industry ratios.
Explanation

A is correct. There is not a great deal of subjectivity involved in calculating ratios. The mechanical formulas for the
calculations are fairly standard and objective for the activity, liquidity, solvency, and profitability ratios, for instance.
On the other hand, determining the target or comparison value for a ratio is difficult as it requires some range of
acceptable values and that introduces an element of subjectivity. Conclusions cannot be made from viewing one set
of ratios as all ratios must be viewed relative to one another in order to make meaningful conclusions. It can be
difficult to find comparable industry ratios, especially when analyzing companies that operate in multiple industries.

Question 76: Assume that the market for paper supplies and the market for toothpicks have the following
characteristics:

The Market for Paper Supplies is comprised of:

 A large number of independent sellers

 Differentiated products
 Low barriers to entry/exit

The Market for Toothpicks is comprised of:

 A large number of independent sellers

 Homogeneous products
 No barriers to entry/exit

The Papyrus Company operates in the market for paper supplies and Wudden Floss operates in the toothpick market.
The sales managers for both companies want to know how a change in price will affect the quantity sold.

Which of the following choices best completes the following sentence? If both firms increase prices, the quantity sold
by Papyrus Company will:

A. increase, and the quantity sold by Wudden Floss will decrease.

B. decrease, and Wudden Floss will sell nothing.
C. decrease, and so will the quantity sold by Wudden Floss.

Explanation

B is correct. Papyrus Company is an example of a price searcher engaged in monopolistic competition (low barriers
to entry). Thus, the company faces a downward sloping demand curve and highly elastic demand. An increase in price
will result in fewer units sold. Wudden Floss is an example of a price taker operating in a purely competitive market.
Thus, the firm faces a horizontal demand curve and perfectly elastic demand. An increase in price will result in no
units sold. In a purely competitive market, the firm must take the market price.

Question 77: Selected information from Indigo Corp.'s financial activities in the year 20X9 included the following:

 Net income is $5,600,000.

 The tax rate is 40%.
 500,000 shares of common stock were outstanding on January 1.
 The average market price per share was $82 in 20X9.
 6,000 5% coupon $1,000 par value convertible bonds, which are convertible at a ratio of 20 shares for each
bond, were outstanding the entire year.
 200,000 shares of common stock were issued on July 1.
  100,000 shares of common stock were purchased by the company as treasury stock on October 1.

Indigo Corp.'s diluted earnings per share for 20X9 are closest to:

A. $8.32.
B. $8.49.
C. $9.74.

Explanation

A is correct. Indigo's weighted average common shares = [(500,000 × 12) + (200,000 × 6) – (100,000 × 3)] / 12 =
575,000. Basic EPS = $5,600,000 / 575,000 = $9.74.

For diluted EPS, assume the bonds were converted on January 1, and that interest payments were not made on the
bonds. Increasing net income by the amount of bond interest net of tax = $5,600,000 + [6,000 × $1,000 × 0.05 × (1 -
0.40)] = $5,780,000. Diluted EPS = $5,780,000 / (575,000 + 120,000) = $8.32.

Question 78: Which approach to analysis of trade deficits indicates that in the absence of excess capacity in the
economy, currency devaluation provides only a temporary improvement in a country's trade deficit, and that long
term improvement requires either a smaller fiscal deficit or a larger excess of domestic savings over domestic
investment?

A. Elasticities approach.
B. Absorption approach.
C. Real wealth approach.

Explanation

B is correct. The absorption approach to analyzing how to improve a trade deficit suggests that in the absence of
excess capacity in the economy, currency devaluation provides only a temporary improvement in a country's trade
deficit that will reverse after the decrease in real domestic wealth from the currency depreciation is restored. It also
concludes that a long-term improvement in the trade deficit requires either an improvement in the fiscal deficit or an
increase in the excess of domestic savings over domestic investment.

Question 79:

Level of Significance for One-Tailed Test

df 0.100 0.050 0.025 0.01 0.005 0.0005
Level of Significance for Two-Tailed Test
df 0.20 0.10 0.05 0.02 0.01 0.001
10 1.372 1.812 2.228 2.764 3.169 4.587
11 1.363 1.796 2.201 2.718 3.106 4.437
12 1.356 1.782 2.179 2.681 3.055 4.318
22 1.321 1.717 2.074 2.508 2.819 3.792
23 1.319 1.714 2.069 2.500 2.807 3.768
24 1.318 1.711 2.064 2.492 2.797 3.745
Roy Fisher, CFA, wants to determine whether there is a significant difference, at the 5% significance level, between
the mean monthly return on Stock GHI and the mean monthly return on Stock JKL. Fisher assumes the variances of
the two stocks' returns are equal. Using the last 12 months of returns on each stock, Fisher calculates a t-statistic of
2.0 for a test of equality of means. Based on this result, Fisher's test:
A. fails to reject the null hypothesis.
B. rejects the null hypothesis, and Fisher can conclude that the means are equal.
C. rejects the null hypothesis, and Fisher can conclude that the means are not equal.

Explanation

A is correct. The null hypothesis for a test of equality of means is H0: μ1 - μ2 = 0. Assuming the variances are equal,
degrees of freedom for this test are (n1 + n2 - 2) = 12 + 12 - 2 = 22. From the table of critical values for Student's t-
distribution, the critical value for a twotailed test at the 5% significance level for df = 22 is 2.074. Because the
calculated t-statistic of 2.0 is less than the critical value, this test fails to reject the null hypothesis that the means are
equal.

Question 80: Given the following data regarding two firms under different scenarios, determine the amount of any
deferred tax liability or asset.

Firm 1:

Tax Reporting Financial Reporting

Revenue $500,000 Revenue $500,000
Depreciation $100,000 Depreciation $50,000
Taxable income $400,000 Pretax income $450,000
Taxes payable $160,000 Tax expense $180,000
Net income $240,000 Net income $270,000

Firm 2:
Tax Reporting Financial Reporting
Revenue $500,000 Revenue $500,000
Warranty expense $0 Warranty expense $10,000
Taxable income $500,000 Pretax income $490,000
Taxes payable $200,000 Tax expense $196,000
Net income $300,000 Net income $294,000

A. Firm 1: $30,000 Asset and Firm 2: $6,000 Asset.

B. Firm 1: $20,000 Liability and Firm 2: $4,000 Asset.
C. Firm 1: $20,000 Asset and Firm 2: $6,000 Liability.

Explanation

B is correct. A deferred tax liability and asset is created when an income or expense item is treated differently on
financial statements than it is on the company's tax returns.

A deferred tax liability is when that difference results in greater tax expense on the financial statements than taxes
payable on the tax return.

The deferred tax liability for firm 1 = $180,000 tax expense - $160,000 taxes payable = $20,000
A deferred tax asset is when that difference results in lower taxes payable on the financial statements than on the tax
return.

The deferred tax asset for firm 2 = $200,000 taxes payable - $196,000 tax expense = $4,000.

Question 81: Mammoth, Inc. reports under U.S. GAAP. Mammoth has begun a long-term project to develop
inventory control software for external sale. On its financial statements, Mammoth should:

A. capitalize all costs of this project.

B. expense all costs of this project in the periods incurred.
C. expense all costs of this project until technological feasibility has been established.

Explanation

C is correct. Under IFRS and U.S. GAAP, costs of developing software are expensed until technological feasibility
is established, and capitalized after technological feasibility has been established.

Question 82: Steve Walker, CFA, is attending an economics lecture, during which the lecturer makes the following
two statements about consumer price inflation:

Statement 1: High-definition televisions are considerably more expensive than traditional models. This means
consumers are spending more money per television unit, which represents a form of inflation.

Statement 2: Employment contracts with automatic increases based on the Consumer Price Index fail to increase
wages as much as the increase in the cost of living because of biases in the price index.

Should Walker agree or disagree with these statements?

A. Statement 1: Disagree and Statement 2: Disagree.

B. Statement 1: Disagree and Statement 2: Agree.
C. Statement 1: Agree and Statement 2: Agree.

Explanation

A is correct. Walker should disagree with both statements. Price changes resulting from increases in the quality of
goods, do not represent inflation. However, the Consumer Price Index is affected by biases from product quality, as
well as new goods and substitution, causing it to overstate the rate of inflation. As a result, increases in wages that are
based on CPI will more than compensate for actual increases in the cost of living.

Question 83: Duster Company reported the following financial information at the end of 2007:

in millions
Unearned revenue $240
Common stock at par 30
Capital in excess of par 440
Accounts payable 1,150
Treasury stock 2,000
Retained earnings 5,160
Accrued expenses 830
Accumulated other comprehensive loss 210
 Long-term debt 1,570
Calculate Duster's liabilities and stockholders' equity as of December 31, 2007.

A. Liabilities: $3,550 million and Stockholders’ equity: $7,840 million.

B. Liabilities: $3,790 million and Stockholders’ equity: $3,420 million.
C. Liabilities: $3,790 million and Stockholders’ equity: $7,420 million.

Explanation

B is correct. Liabilities are equal to $3,790 million ($240 million unearned revenue + $1,570 long-term debt + $1,150
accounts payable + $830 accrued expenses). Stockholders' equity is equal to $3,420 million ($30 common stock at
par + $440 capital in excess of par – $2,000 treasury stock + $5,160 retained earnings – $210 accumulated other
comprehensive loss).

Question 84: Juniper Corp. has the following transactions in 20X5.

 Juniper's equipment with a book value of $55,000 was sold for $85,000 cash.
 A parcel of land was purchased for $100,000 worth of Juniper common stock
 ABC company paid Juniper preferred dividends of $40,000.
 Juniper declared and paid a $100,000 cash dividend.

Under U.S. GAAP, what is cash flow from financing (CFF) for Juniper for 20X5?

A. –$100,000.
B. –$115,000.
C. –$60,000.

Explanation

A is correct. The only item involving cash flow from financing (CFF) was the payment of a cash dividend by Juniper.
The sale of equipment affects cash flow from investing (CFI), the purchase of land has no effect on cash, and the
preferred dividends received are cash flow from operations under U.S. GAAP.

The other statements are accurate:

 A company that issues common stock is not required to pay dividends (which would reduce cash flow from
financing). Thus, it may have the same CFF as a firm that issues debt since interest paid on debt is a
component of CFO.
 When a company issues bonds at a premium, the proceeds raised at issuance (CFF inflow) are greater than
the par value repaid at maturity (CFF outflow). For bonds issued at par, the CFF inflow at issuance is equal
to the CFF outflow at maturity.

Question 85: An economist estimates a 60% probability that the economy will expand next year. The technology
sector has a 70% probability of outperforming the market if the economy expands and a 10% probability of
outperforming the market if the economy does not expand. Given the new information that the technology sector will
not outperform the market, the probability that the economy will not expand is closest to:

A. 33%.
B. 67%.
C. 54%.

Explanation
B is correct. Using the new information we can use Bayes' formula to update the probability.

P(economy does not expand | tech does not outperform) = P(economy does not expand and tech does not outperform)
/ P(tech does not outperform).

P(economy does not expand and tech does not outperform) = P(tech does not outperform | economy does not expand)
× P(economy does not expand) = 0.90 × 0.40 = 0.36.

P(economy does expand and tech does not outperform) = P(tech does not outperform | economy does expand) ×
P(economy does expand) = 0.30 × 0.60 = 0.18.

P(economy does not expand) = 1.00 – P(economy does expand) = 1.00 – 0.60 = 0.40.

P(tech does not outperform | economy does not expand) = 1.00 – P(tech does outperform | economy does not expand)
= 1.00 – 0.10 = 0.90.

P(tech does not outperform) = P(tech does not outperform and economy does not expand) + P(tech does not
outperform and economy does expand) = 0.36 + 0.18 = 0.54.

P(economy does not expand | tech does not outperform) = P(economy does not expand and tech does not outperform)
/ P(tech does not outperform) = 0.36 / 0.54 = 0.67.

Question 86: Consider the following:

Argument #1: The indirect method presents a firm's operating cash receipts and payments and is thus more consistent
with the objectives of the cash flow statement.

Argument #2: The indirect method provides more information than the direct method and is more useful to analysts
in estimating future operating cash flows.

Which of these arguments support the use of the indirect method for presenting cash flow from operating activities in
the cash flow statement?

A. Argument #1 only.
B. Argument #2 only.
C. Neither argument.

Explanation

C is correct. It is the direct method, not the indirect method, that presents operating cash receipts and payments and
is thus more consistent with the objectives of the cash flow statement. The direct method provides more information
than the indirect method and is preferred by analysts who are estimating future cash flows.

Question 87: Comparative income statements for E Company and G Company for the year ended December 31 show
the following (in $ millions):

E Company G Company

Sales 70 90

Cost of Goods Sold (30) (40)

Gross Profit 40 50
 Sales and Administration (5) (15)

Depreciation (5) (10)

Operating Profit 30 25

Interest Expense (20) (5)

Earnings Before Taxes 10 20

Income Taxes (4) (8)

Earnings after Taxes 6 12

The financial risk of E Company, as measured by the interest coverage ratio, is:

A. higher than G Company's because its interest coverage ratio is less than G Company's, but at least one-third of G
Company's.
B. higher than G Company's because its interest coverage ratio is less than onethird of G Company's.
C. lower than G Company's because its interest coverage ratio is at least three times G Company's.

Explanation

B is correct. E Company's interest coverage ratio (EBIT / interest expense) is (30 / 20) = 1.5.

G Company's interest coverage ratio is (25 / 5) = 5.0. Higher interest coverage means greater ability to cover required
interest and lease payments. Note that 1.5 / 5.0 = 0.30, which means the interest coverage for E Company is less than
1/3 that of G Company.

Question 88: David Forsythe and Linda Novak are discussing the advantages and disadvantages of import
restrictions. They state the following:

Forsythe: One of the groups that benefits from import restrictions is often the government that imposes them.

Novak: Import restrictions impose costs on specific groups, such as the country's import industries, but these
costs are more than offset by the benefits to other groups and to the economy as a whole.

With respect to these statements:

A. both are correct.

B. only one is correct.
C. both are incorrect.

Explanation

B is correct. Forsythe is correct. A primary reason why trade restrictions remain widespread is the revenue that
governments receive from tariffs. Novak is incorrect. Trade restrictions benefit specific groups, such as workers in
the protected industries, but those benefits are most often less than the costs imposed on consumers and other
industries as a whole.

Question 89: The spot rate for Chinese yuan per Canadian dollar is 6.4440. If the Canadian interest rate is 2.50%
and the Chinese interest rate is 3.00%, the 3-month no-arbitrage forward rate is closest to:
A. 6.436 CNY/CAD.
B. 6.452 CNY/CAD.
C. 6.475 CNY/CAD.

Explanation

B is correct. The calculation is as follows:

Question 90: Falcon Financial Group is considering the purchase of Company A or Company B based on a low price-
to-book investment strategy that also considers differences in solvency. Selected financial data for both firms, as of
December 31, 20X7, follows:

in millions, except per-share data Company A Company B

Current assets $3,000 $5,500
Fixed assets $5,700 $5,500
Total debt $2,700 $3,500
Common equity $6,000 $7,500
Outstanding shares 500 750
Market price per share $26.00 $22.50
The firms' financial statement footnotes contain the following:

 Company A values its inventory using the first in, first out (FIFO) method.
 Company B's inventory is based on the last in, first out (LIFO) method. Had Company B used FIFO, its
inventory would have been $700 million higher.
 Company A leases its manufacturing plant. The remaining operating lease payments total $1,600 million.
Discounted at 10%, the present value of the remaining payments is $1,000 million.
 Company B owns its manufacturing plant.

To make the firms financials ratios comparable, calculate the adjusted price-to-book ratios for Company A and
Company B.

A. $2.17 and $2.06.

B. $1.63 and $2.06.
C. $2.17 and $2.81.
Explanation
A is correct. Company A should be adjusted for the operating lease liability and the related assets; however, adding
the present value of the lease payments to both assets and liabilities does not change equity (book value). Thus,
Company A's adjusted P/B ratio is 2.17 = [$26 price / ($6,000 million equity / 500 million shares)]. Company B's
inventory should be adjusted back to FIFO by adding the LIFO reserve to both assets and equity. Thus, Company B's
P/B ratio is 2.06 = $22.50 / [($7,500 million equity + $700 million LIFO reserve) / 750 million shares].