CFA Level 1 And FRM Part 1 – Test 06 -Answer Sheet

46.An investor buys four shares of stock for $50 per share. At the end of year one she sells two shares
for $50 per share. At the end of year two she sells the two remaining shares for $80 each. The stock paid
no dividend at the end of year one and a dividend of $5.00 per share at the end of year two. What is the
difference between the time-weighted rate of return and the money-weighted rate of return?

A) 20.52%.
B) 14.48%.
C) 9.86%.

C - 9.86%.

T = 0: Purchase of four shares = -$200.00

T = 1: Dividend from four shares = +$0.00

Sale of two shares = +$100.00

T = 2: Dividend from two shares = +$10.00

Proceeds from selling shares = +$160.00

The money-weighted return is the rate that solves the equation:

$200.00 = $100.00 / (1 + r) + $170.00 / (1 + r)2.

Cfo = -200, CF1 = 100, Cf2 = 170, CPT → IRR = 20.52%.

The holding period return in year one is ($50.00 − $50.00 + $0.00) / $50.00 = 0.00%.
The holding period return in year two is ($80.00 − $50.00 + $5.00) / $50 = 70.00%.

The time-weighted return is [(1 + 0.00)(1 + 0.70)]1/2 − 1 = 30.38%.

The difference between the two is 30.38% − 20.52% = 9.86%.

47.An investor is considering investing in Tawari Company for one year. He expects to receive $2 in
dividends over the year and feels he can sell the stock for $30 at the end of the year. To realize a return
on the investment over the year of 14%, the price the investor would pay for the stock today is closest
to:

A) $28.
B) $29.
C) $32.

A-

HPR = [Dividend + (Ending price − Beginning price)] / Beginning price

0.14 = [2 + (30 − P)] / P

1.14P = 32 so P = $28.07
48.Williams Warehousing currently has a warehouse lease that calls for five annual payments of
$120,000. The warehouse owner, who needs cash, is offering Williams a deal wherein Williams will pay
$200,000 this year and then pay only $80,000 each of the remaining 4 years. (Assume that all lease
payments are made at the beginning of the year.) Should Williams Warehousing accept the offer if its
required rate of return is 9%, and why?

A) Yes, there is a savings of $45,494 in present value terms.

B) No, there is an additional $80,000 payment in this year.
C) Yes, there is a savings of $49,589 in present value terms.

C - Yes, there is a savings of $49,589 in present value terms.

The present value of the current lease is $508,766.38, while the present value of the lease being offered
is $459,177.59; a savings of 49,589. Alternatively, the present value of the extra $40,000 at the beginning
of each of the next 4 years is $129,589 which is $49,589 more than the extra $80,000 added to the
payment today.

49.A broker calls with a proposal to buy a Treasury bill (T-bill) with 186 days to maturity. He says the
effective annual yield on the T-bill is 4.217%. What is the holding period yield if you hold the bill until
maturity?

A) 8.44%.
B) 2.02%.
C) 2.13%.

C - 2.13%.

To calculate the HPY from the EAY, the formula is: (1 + EAY)(t/365) − 1. Therefore, the HPY is:
(1.04217)(186/365) − 1 = 0.0213, or 2.13%.
50.A Treasury bill (T-bill) with a face value of $10,000 and 44 days until maturity has a holding period
yield of 1.1247%. Which of the following is closest to the effective annual yield on the T-bill?

A) 12.47%.
B) 8.76%.
C) 9.72%.

C - 9.72%.

The formula for the effective annual yield is: ((1 + HPY)365/t) − 1. Therefore, the EAY is: ((1.011247)(365/44))
− 1 = 0.0972, or 9.72%

51.A Treasury bill (T-bill) with 38 days until maturity has a bank discount yield of 3.82%. Which of the
following is closest to the money market yield on the T-bill?

A) 3.84%.
B) 3.81%.
C) 3.87%.

A-

The formula for the money market yield is: [360 × bank discount yield] / [360 − (t × bank discount yield)].
Therefore, the money market yield is: [360 × 0.0382] / [360 − (38 × 0.0382)] = (13.752) / (358.548) =
0.0384, or 3.84%.
Alternatively: Actual discount = 3.82%(38 / 360) = 0.4032%.

T-Bill price = 100 − 0.4032 = 99.5968%.

HPR = (100 / 99.5968) − 1 = 0.4048%.

MMY = 0.4048% × (360 / 38) = 3.835%.

52.Which of the following is NOT a problem with the internal rate of return (IRR)?

A) Non-normal cash flow patterns may result in multiple IRRs.

B) Sometimes the IRR exceeds the cost of capital.
C) A higher IRR does not necessarily indicate a more-profitable project.

A-

The formula for the money market yield is: [360 × bank discount yield] / [360 − (t × bank discount yield)].
Therefore, the money market yield is: [360 × 0.0382] / [360 − (38 × 0.0382)] = (13.752) / (358.548) =
0.0384, or 3.84%.

Alternatively: Actual discount = 3.82%(38 / 360) = 0.4032%.

T-Bill price = 100 − 0.4032 = 99.5968%.

HPR = (100 / 99.5968) − 1 = 0.4048%.

MMY = 0.4048% × (360 / 38) = 3.835%.

53.A T-bill with a face value of $100,000 and 140 days until maturity is selling for $98,000. What is the
bank discount yield?

A) 5.41%.
B) 5.14%.
C) 4.18%.

‘B - 5.14%.

Actual discount is 2%, annualized discount is: 0.02(360 / 140) = 5.14%

54.A Treasury bill (T-bill) with a face value of $10,000 and 137 days until maturity is selling for 98.125%
of face value. Which of the following is closest to the bank discount yield on the T-bill?

A) 4.56%.
B) 4.93%.
C) 5.06%.

‘B - 4.93%.

The formula for bank discount yield is: (D / F) × (360 / t). Actual discount is 1 − 0.98125 = 0.01875.
Annualized is: 0.01875 × (360 / 137) = 0.04927
55.The capital budgeting director of Green Manufacturing is evaluating a laser imaging project with the
following characteristics:

 Cost: $150,000
 Expected life: 3 years
 After-tax cash flows: $60,317 per year
 Salvage value: $0

If Green Manufacturing’s cost of capital is 11.5%, what is the project’s internal rate of return (IRR)?

A) 13.6%.
B) $3,875.
C) 10.0%.

C - 10.0%.

Since we are seeking the IRR, the answer has to be in terms of a rate of return, this eliminates the option
not written in a percentage.

Since they payments (cash flows) are equals, we can calculate the IRR as: N = 3; PV = 150,000; PMT =
60,317; CPT → I/Y = 9.999

56.The money-weighted return also is known as the:

A) return on invested capital.

B) internal rate of return (IRR) of a portfolio.
C) measure of the compound rate of growth of $1 over a stated measurement period.

‘B - internal rate of return (IRR) of a portfolio.

It is the IRR of a portfolio, taking into account all of the cash inflows and outflows.
57.An analyst managed a portfolio for many years and then liquidated it. Computing the internal rate of
return of the inflows and outflows of a portfolio would give the:

A) time-weighted return.
B) money-weighted return.
C) net present value.

‘B - money-weighted return.

The money-weighted return is the internal rate of return on a portfolio that equates the present value of
inflows and outflows over a period of time.

58.Financial managers should always select the project that provides the highest net present value
(NPV) whenever NPV and IRR methods conflict, because maximizing:

A) shareholder wealth is the goal of financial management.

B) the shareholders' rate of return is the goal of financial management.
C) revenues is the goal of financial management.

A-
Focusing on the maximization of earnings does not consider the differences in risk across projects, while
focusing on revenues precludes concern for the expenses incurred. Earning a higher return on a small
project provides less of a benefit than earning a slightly lower rate of return on a much larger project.

59.Miranda Cromwell, CFA, buys ₤2,000 worth of Smith & Jones PLC shares at the beginning of each
year for four years at prices of ₤100, ₤120, ₤150 and ₤130 respectively. At the end of the fourth year the
price of Smith & Jones PLC is ₤140. The shares do not pay a dividend. Cromwell calculates her average
cost per share as [(₤100 + ₤120 + ₤150 + ₤130) / 4] = ₤125. Cromwell then uses the geometric mean of
annual holding period returns to conclude that her time-weighted annual rate of return is 8.8%. Has
Cromwell correctly determined her average cost per share and time-weighted rate of return?

Time-weighted
< >> Average cost
return
A) Correct Correct
B) Correct Incorrect
C) Incorrect Correct

C - Incorrect Correct

Because Cromwell purchases shares each year for the same amount of money, she should calculate the
average cost per share using the harmonic mean. Cromwell is correct to use the geometric mean to
calculate the time-weighted rate of return. The calculation is as follows:

Annual rate of
Year Beginning price Ending price
return
1 ₤100 ₤120 20%
2 ₤120 ₤150 25%
3 ₤150 ₤130 −13.33%
4 ₤130 ₤140 7.69%

TWR = [(1.20)(1.25)(0.8667)(1.0769)]1/4 − 1 = 8.78%. Or, more simply, (140/100)1/4 − 1 = 8.78%.

60.When Annette Famigletti hears that a baseball-loving friend is coming to visit, she purchases two
premium-seating tickets for $45 per ticket for an evening game. As the date of the game approaches,
Famigletti’s friend telephones and says that his trip has been cancelled. Fortunately for Famigletti, the
tickets she holds are in high demand as there is chance that the leading Major League Baseball hitter will
break the home run record during the game. Seeing an opportunity to earn a high return, Famigletti
puts the tickets up for sale on an internet site. The auction closes at $150 per ticket. After paying a 10%
commission to the site (on the amount of the sale) and paying $8 total in shipping costs, Familgletti’s
holding period return is approximately:

A) 182%.
B) 191%.
C) 202%.

‘B - 191%.

The holding period return is calculated as: (ending price − beginning price +/- any cash flows) / beginning
price. Here, the beginning and ending prices are given. The other cash flows consist of the commission of
$30 (0.10 × 150 × 2 tickets) and the shipping cost of $8 (total for both tickets). Thus, her holding period
return is: (2 × 150 − 2 × 45 − 30 − 8) / (2 × 45) = 1.91, or approximately 191%.