SIMULACRO 1 (PM) – NIVEL 1

ETHICS
Question #1
Question ID: 412256
Sanctions that CFA Institute may impose on a member or candidate under the Professional Conduct Program include:
A) returning of all profits gained through violations of the Code and Standards.
B) public censure.
C) suspension from employment in the financial services industry.
Sanctions that CFA Institute may impose include public censure, suspension from membership and use of the CFA
designation, revocation of the CFA charter, or suspension of a candidate's participation in the CFA program.
Reading 2

Question #2
The first component of the Code of Ethics does NOT explicitly say that a CFA Institute member will act in a certain
manner with respect to which of the following groups?
A) Colleagues.
B) CFA Institute members and candidates in the CFA Program.
C) Prospective clients.
Participants in the CFA Program are not specifically mentioned in the Code of Ethics. Component one mentions duties to
the public, clients, prospects, employers, employees, colleagues, and other participants in the global capital markets.
Reading 2

Question #3
Question ID: 412679
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 III(B), Fair Dealing.
B) Standard I(C), Misrepresentation.
C) Standard V(B), Communication with Clients and Prospective Clients.
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.
Reading 3

Question #4
For an employee with the CFA designation who works for a firm, which of the following is NOT necessary to meet the
requirements of the Code and Standards?
A) Deliver a copy of the Code and Standards to their employer.
B) Recommend notifying their employer of their responsibility to follow the Code and Standards.
C) It is recommended that their employer is aware of the Code and Standards.
It is no longer required but recommended that CFA members and candidates notify their employer that they are required
to follow the Code and Standards.
Reading 3

Question #5
An analyst routinely has the opportunity to offer his clients the opportunity to purchase "hot new issues." He tells his
clients that he will distribute each issue equally among those interested, with himself included in the distribution. The
clients do not object to this. With respect to Standard VI(B), Priority of Transactions, this:
A) may be a violation because it is impossible to distribute hot new issues equally.
B) cannot be a violation because the clients know of the practice and agree.
C) may be a violation despite the clients' approval.
Just because the clients know of a practice does not make it right. The analyst must put the clients first. It is a violation for
the analyst to participate in a "hot new issue" which can lower the allocation to any given client below what that client
would prefer. This is tantamount to putting the analyst's interests ahead of the clients' interests.
Reading 3

Question #6
Which of the following is least likely a violation of Standard VII(A), Conduct as Participants in CFA Institute Programs?
A) Disregarding the rules related to the administration of the CFA examination.
B) Expressing opinions in disagreement with CFA Institute advocacy positions.
C) Improperly using the CFA Designation to further professional goals.
Members and Candidates are allowed to express their opinions about the CFA Institute and CFA Program. Both of the
other choices violate Standard VII(A) Conduct as Participants in CFA Institute Programs.
Reading 3

Question #7
All of the following violate Standard I(C), Misrepresentation, EXCEPT:
A) citing quotes attributable to "investment experts" without specific references.
B) copying a proprietary computerized spreadsheet without seeking authorization from the creators.
C) presenting factual information published by recognized statistical reporting services without acknowledgment.
Standard I(C), Misrepresentation, permits using factual information from recognized financial and statistical reporting
services without acknowledgment.
Reading 3

Question #8
Timothy Hooper, CFA, is a security analyst at an investment firm. In his spare time, Hooper serves as a volunteer for City
Pride, which collects clothes for the homeless. Hooper has occasionally given some of the clothes to his friends or sold
the clothes instead of returning all of the clothing to City Pride. City Pride discovers what he has been doing and
dismisses him. Later, City Pride learns that other volunteer organizations have dismissed Hooper for similar actions. Has
Hooper violated Standard I(D) on professional misconduct in the CFA Institute Standards of Professional Conduct?
A) No, because Hooper's conduct is unrelated to his professional activities as a security analyst.
B) Yes.
C) No, because Hooper volunteers his services to City Pride.
Hooper violated Standard I(D) because he repeatedly engaged in conduct that involves dishonest conduct. This violation
occurred despite the fact that his offenses do not relate directly to his professional activities. However, Hooper's conduct
reflects poorly on his professional reputation and integrity.
Reading 3

Question #9
Concerning Standard III(B), Fair Dealing, which of the following actions is NOT a valid procedure for compliance with the
Standard?
A) Communicate investment recommendations simultaneously within the firm and to customers, where possible.
B) Limit the number of people that are involved and are privy to the fact that an investment recommendation is going to be
disseminated.
C) Communicate investment recommendations to all customers including those accounts for which the securities are not
eligible for purchase.
To ensure compliance with the Standard, members should seek to communicate investment recommendations to all
clients who have indicated an interest and also those for whom the securities are suitable. There is no need to
communicate recommendations to clients for whom the securities are deemed unsuitable.
Reading 3

Question #10
All of the following activities might constitute a violation of Standard IV(A), Loyalty to Employer, EXCEPT:
A) misuse of confidential information.
B) solicitation of the employer's clients prior to termination of employment.
C) solicitation of the employer's clients following termination of employment.
Solicitation of the employer's clients prior to termination of employment would constitute a violation of Loyalty to Employer,
but solicitation of clients following termination would not.
Reading 3

Question #11
Greg Stiles, CFA, CAIA, has recently liquidated most of a client's portfolio because the client is planning to buy a house.
Stiles informs one of the brokers in his office who has his real estate license about the plans of his client. With respect to
Standard III(E), Preservation of Confidentiality, this action:
A) violates the Standard unless the client asks Stiles to tell the licensed salesman.
B) is appropriate since Stiles only tells a licensed salesman.
C) is appropriate since Stiles keeps the information in the firm.
According to Standard III(E), Preservation of Confidentiality, Stiles must keep client information confidential and limit the
information to those people directly related to servicing the client. Merely working in the same firm does not qualify a
person for learning about the client of a fellow analyst.
Reading 3

Question #12
All of the following are required for a CFA Institute member to maintain his or her active status EXCEPT:
A) Passing each exam in no more than two tries.
B) paying membership dues to CFA Institute on an annual basis.
C) remit a completed Professional Conduct Statement on an annual basis.
Passing each exam in two or fewer tries is not required to maintain active status as a member of the CFA Institute. CFA
Institute imposes both of the other choices.
Reading 3

Question #13
Tony Calaveccio, CFA, is the manager of the TrustCo Small Cap Venture Fund in Toronto. He places trades for the fund
with River City Brokerage. River City provides Calaveccio with soft dollars to purchase research. River City also deals in
municipal bonds, some of which Calaveccio holds in his personal portfolio. He periodically uses the soft dollars to request
research reports on various small cap stocks and also on the status of the municipal bond market and issues that he
holds. These actions are:
A) in violation of his fiduciary duties regarding both the small cap research and the municipal bond research.
B) in violation of his fiduciary duties regarding the municipal bond research but not so regarding the research on the small
cap issues.
C) not in violation of the Code and Standards.
The issue at hand is the member's fiduciary responsibilities in handling "soft dollars" which are technically the property of
the client. Standard III(A), Loyalty, Prudence, and Care, delineates the member's fiduciary responsibilities with regard to
soft dollars. Since municipal bond research is clearly not relevant to the Small Cap Fund holders, he is clearly using the
soft dollars to obtain research for his personal benefit and is in violation of the Standard.
Reading 3

Question #14
Jan Hirsh, CFA, is employed as manager of a college endowment fund. The college's endowment is held by the
brokerage firm Advisors, Inc. Over the years, Hirsh has developed a solid relationship with Advisors. Because of this
relationship, Advisors has given her their Platinum level service for her personal account. Advisors ordinarily gives the
Platinum level only to clients who do a minimum of $2,500 of commission business in a year. Hirsh has never reached the
$2,500 commission level and probably will never do so. According to Standard IV(B), Additional Compensation
Arrangements, Hirsh needs to:
A) do none of the actions listed here.
B) inform her supervisor in writing about the Platinum account.
C) inform her supervisor verbally about the Platinum account.
Having the Platinum account is a benefit from her managing the endowment, which led to the relationship with Advisors.
Members should report to their employers any additional compensation or benefits they receive for their services. This
must be in writing. Doing $2,500 in business alone will not negate her obligation unless she explicitly tells Advisors that
she is willing to accept whatever penalties accompany a Platinum account when a client does less business.
Reading 3

Question #15
Scott LaRue is a portfolio manager for Washington Advisors. Washington has developed a proprietary model that has
been thoroughly researched and is known throughout the industry as the Washington model. The model is purely
quantitative and screens stocks into buy, hold, and sell categories. The basic philosophy of the model is thoroughly
explained to clients. The director of research frequently alters the model based on rigorous research-an aspect that is well
explained to clients, although the specific alterations are not continually disclosed. Portfolio managers then make specific
sector and security holding decisions, purchasing only securities that are indicated as "buys" by the model. La Rue feels
the model would be improved by adding some factors but he has not fully tested this new version of the model. LaRue
discloses his model to his own clients but not to his supervisor. LaRue is:
A) not violating the Standards.
B) violating the Standards by not considering the appropriateness of the recommendations to clients.
C) violating the Standards by not having a reasonable and adequate basis for his investment recommendation.
The ad hoc model is not part of the formal research process and does not formulate an adequate basis for a
recommendation.
Reading 3

Question #16
Janet Coleman, a CFA Institute member, is an analyst at a regional brokerage firm. She is preparing a research report on
Standard Power and Light. Due to deregulation, utility companies face increased competition. During the past year, three
of the five utility companies in her region have cut their dividends by 50%, on average, to provide more internal funds for
investment purposes. In a discussion with Standard's chief executive officer, Coleman learned that Standard expects to
have a record amount of capital expenditures during the next year. Although Standard subsequently issued a press
release about its capital expenditure plans, it did not make any public statements about a change in dividend policy.
Coleman reasons that the management of Standard will be under pressure to cut its dividends within the next year to
remain competitive. Coleman issues a research report in which she states:
"We expect Standard Power and Light will experience an initial decrease of $3 a share in its stock price when it cuts its
dividend from $2 to $1 a share by the second quarter. We expect that Standard will strengthen its competitive position by
using more internally generated funds to finance its investment opportunities. If investors buy the stock now at around $50
a share, their total return should be at least 20% on the stock."
Based on CFA Institute Standards of Professional Conduct, which of the following statements about Coleman's actions is
CORRECT?
A) Coleman violated the Standards because she failed to separate opinion from fact in her research report.
B) Coleman violated the Standards because she used material inside information.
C) Coleman did not violate the Standards.
Coleman's statement that Standard will cut its dividend from $2 to $1 a share is an opinion, not a fact. She should
distinguish between facts and opinions in research reports.
Reading 3

Question #17
Which of the following statements most accurately describes the requirements for GIPS verification?
A) A firm must select a representative set of composites for third-party GIPS verification.
B) Third-party verification is required for a firm to claim compliance with GIPS.
C) Verification of GIPS compliance is recommended, but not required.
Verification of GIPS compliance is recommended but not required. If a firm chooses verification, GIPS require the
verification to be performed by a third party and apply to the entire firm's methods and practices, rather than that of
selected composites.
Reading 3

Question #18
Assume that on January 1, 2005, a 15-year old firm with no Global Investment Performance Standards (GIPS) compliant
performance history wishes to claim compliance with the GIPS standards. Which of the following accurately reflects the
appropriate action for the firm to take?
A) Comply with GIPS for the year beginning January 1, 2004, and report nine additional years of performance history (ten
total) and disclose why the earlier years are not GIPS compliant.
B) Comply with GIPS for the year beginning January 1, 2004, and report four additional years of performance history (five
total) and disclose why the earlier years are not GIPS compliant.
C) Comply with the GIPS standards for the 5-year period January 1, 2000, through December 31, 2004, and report five
additional years of non-GIPS-compliant performance and disclosure of why the performance in the earlier years is not
GIPS compliant.
In order to claim GIPS compliance, a firm must present at least five years of annual investment performance that is
compliant with GIPS. If a firm or composite is less than five years old, the performance since the inception of the firm or
composite must be presented. A firm may link a non-GIPS-compliant performance record to their 5-year compliant history
as long as only GIPS-compliant performance is presented for periods after January 1, 2000, and the firm discloses the
periods of non-compliance with an explanation of why the presentation is not GIPS compliant (Standard 4.A.15 and
5.A.1.a).
Reading 5

QUANTITATIVE METHODS
Question #19
Given: an 11% annual rate compounded quarterly for 2 years; compute the future value of $8,000 today.
A) $8,962.
B) $9,857.
C) $9,939.
Divide the interest rate by the number of compound periods and multiply the number of years by the number of compound
periods. I = 11 / 4 = 2.75; N = (2)(4) = 8; PV = 8,000.
Reading 6

Question #20
If $10,000 is invested in a mutual fund that returns 12% per year, after 30 years the investment will be worth:
A) $300,000.
B) $10,120.
C) $299,599.
FV = 10,000(1.12)30 = 299,599
Using TI BAII Plus: N = 30; I/Y = 12; PV = -10,000; CPT → FV = 299,599.
Reading 6

Question #21
The bank discount of a $1,000,000 T-bill with 135 days until maturity that is currently selling for $979,000 is:
A) 5.8%.
B) 5.6%.
C) 6.1%.
($21,000 / 1,000,000) × (360 / 135) = 5.6%.
Reading 7

Question #22
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) 8.76%.
B) 9.72%.
C) 12.47%.
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%
Reading 7

Question #23
A Treasury bill has 90 days until its maturity and a holding period yield of 3.17%. Its effective annual yield is closest to:
A) 13.49%.
B) 13.30%.
C) 12.68%.
The effective annual yield (EAY) is equal to the annualized holding period yield (HPY) based on a 365-day year. EAY = (1
+ HPY)365/t − 1 = (1.0317) 365/90 − 1 = 13.49%.
Reading 7

Question #24
Which of the following statements about skewness and kurtosis is least accurate?
A) Positive values of kurtosis indicate a distribution that has fat tails.
B) Kurtosis is measured using deviations raised to the fourth power.
C) Values of relative skewness in excess of 0.5 in absolute value indicate large levels of skewness.
Positive values of kurtosis do not indicate a distribution that has fat tails. Positive values of excess kurtosis (kurtosis > 3)
indicate fat tails.
Reading 7

Question #25
A firm wants to select a team of five from a group of ten employees. How many ways can the firm compose the team of
five?
A) 252.
B) 120.
C) 25.
This is a labeling problem where there are only two labels: chosen and not chosen. Thus, the combination formula
applies: 10! / (5! × 5!) = 3,628,800 / (120 × 120) = 252.
With a TI calculator: 10 [2nd][nCr] 5 = 252.
Reading 9
Question #26
The following table summarizes the results of a poll taken of CEO's and analysts concerning the economic impact of a
pending piece of legislation:
Think it will have a Think it will have a
Group Total
positive impact negative impact

CEO's 40 30 70

Analysts 70 60 130

110 90 200
What is the probability that a randomly selected individual from this group will be either an analyst or someone who thinks
this legislation will have a positive impact on the economy?
A) 0.80.
B) 0.75.
C) 0.85.
There are 130 total analysts and 40 CEOs who think it will have a positive impact. (130 + 40) / 200 = 0.85.
Reading 9

Question #27
The following table summarizes the results of a poll taken of CEO's and analysts concerning the economic impact of a
pending piece of legislation:
Think it will have a Think it will have a
Group Total
positive impact negative impact

CEO's 40 30 70

Analysts 70 60 130

110 90 200
What is the probability that a randomly selected individual from this group will be an analyst that thinks that the legislation
will have a positive impact on the economy?
A) 0.45.
B) 0.30.
C) 0.35.
70 analysts / 200 individuals = 0.35.
Reading 9

Question #28
A stock portfolio has had a historical average annual return of 12% and a standard deviation of 20%. The returns are
normally distributed. The range -27.2 to 51.2% describes a:
A) 99% confidence interval.
B) 95% confidence interval.
C) 68% confidence interval.
The upper limit of the range, 51.2%, is (51.2 − 12) = 39.2 / 20 = 1.96 standard deviations above the mean of 12. The
lower limit of the range is (12 − (-27.2)) = 39.2 / 20 = 1.96 standard deviations below the mean of 12. A 95% confidence
level is defined by a range 1.96 standard deviations above and below the mean.
Reading 9

Question #29
From a population with a known standard deviation of 15, a sample of 25 observations is taken. Calculate the standard
error of the sample mean.
A) 3.00.
B) 0.60.
C) 1.67.
The standard error of the sample mean equals the standard deviation of the population divided by the square root of the
sample size: sx = s / n1/2 = 15 / 251/2 = 3.
Reading 11

Question #30
A scientist working for a pharmaceutical company tries many models using the same data before reporting the one that
shows that the given drug has no serious side effects. The scientist is guilty of:
A) look-ahead bias.
B) sample selection bias.
C) data mining.
Data mining is the process where the same data is used with different methods until the desired results are obtained.
Reading 11

Question #31
An analyst wants to determine whether the monthly returns on two stocks over the last year were the same or not. What
test should she use if she is willing to assume that the returns are normally distributed?
A) A difference in means test only if the variances of monthly returns are equal for the two stocks.
B) A difference in means test with pooled variances from the two samples.
C) A paired comparisons test because the samples are not independent.
A paired comparisons test must be used. The difference in means test requires that the samples be independent. Portfolio
theory teaches us that returns on two stocks over the same time period are unlikely to be independent since both have
some systematic risk.
Reading 12

Question #32
A test of a hypothesis that the means of two normally distributed populations are equal based on two independent random
samples:
A) is based on a Chi Square statistic.
B) is a paired-comparisons test.
C) is done with a t-statistic.
We have two formulas for test statistics for the hypothesis of equal sample means. Which one we use depends on
whether or not we assume the samples have equal variances. Either formula generates a test statistic that follows a T-
distribution.
Reading 12

Question #33
Which of the following statements about hypothesis testing is least accurate?
A) A Type II error is failing to reject a false null hypothesis.
B) If the alternative hypothesis is Ha: µ > µ0, a two-tailed test is appropriate.
C) The null hypothesis is a statement about the value of a population parameter.
The hypotheses are always stated in terms of a population parameter. Type I and Type II are the two types of errors you
can make - reject a null hypothesis that is true or fail to reject a null hypothesis that is false. The alternative may be one-
sided (in which case a > or < sign is used) or two-sided (in which case a ≠ is used).
Reading 12

ECONOMICS
Question #34
Gene Bawerk, an economics professor, is lecturing on the factors that influence the price elasticity of demand. He makes
the following assertions:
Statement 1: For most goods, demand is more elastic in the long run than the short run.
Statement 2: Demand for a good becomes more elastic when a close substitute for it becomes available on the market.
With respect to Bawerk's statements:
A) only statement 1 is correct.
B) both are correct.
C) only statement 2 is correct.
Both of these statements are accurate. Price elasticity for most goods is greater in the long run because individuals can
make long-term decisions that require different quantities of the good, such as buying more fuel efficient vehicles to use
less gasoline. Price elasticity is greater the better the available substitutes because an increase in price will lead more
buyers to switch to the substitute products.
Reading 14

Question #35
Twenty firms in a region's gravel market have identical supply functions of QS = −2,000 + 25P. The market supply curve
(inverse supply function) is:
A) QS = −40,000 + 500P
B) P = 0.002QS + 80
C) P = 0.04QS + 80
The aggregate supply function is: QS = 20(−2,000) + 20(25)P
QS = −40,000 + 500P
The market supply curve (inverse supply function) is:
500P = QS + 40,000
P = (1 / 500)QS + (40,000 / 500) P = 0.002QS + 80
Reading 14

Question #36
A firm realizes that it is producing more than the profit maximizing level of output and makes a short-run decision to
decrease its output. Which of the firm's cost measures isleast likely to decrease as a result?
A) Average fixed cost.
B) Marginal cost.
C) Average variable cost.
A short-run decrease in output will cause a firm's average fixed costs to increase because its fixed costs are spread over
a smaller number of units. In terms of cost curves, average fixed cost never slopes upward, so a decrease in output never
reduces average fixed costs. The average variable cost, average total cost, and marginal cost curves all have upward
sloping components along which a lower level of output would result in a lower cost.
Reading 14

Question #37
Price discrimination is most accurately defined by which of the following? Price discrimination is the practice of charging
different consumers different prices for:
A) the same product or service.
B) similar products that have identical per-unit production costs.
C) similar products that have different price elasticities of demand.
Price discrimination is the practice of charging different consumers different prices for the same product or service.
Examples include different prices for airline tickets based on whether a Saturday-night stay is involved and different prices
for movie tickets based on age.
Reading 15

Question #38
Which of the following statements about monopolies is most accurate?
A) Monopolists charge the highest possible price.
B) A monopolist's optimal production quantity is at the point where marginal revenue equals marginal cost.
C) A monopoly structure is characterized by a well-defined product for which there are no good complements.
All firms maximize profits where MR = MC. Because of a downward-sloping demand curve and high barriers to entry,
monopolists can charge a price higher than MC. Like other price searchers, monopolists take price from the demand
curve (at the quantity where MR=MC).
Both remaining statements are false. A monopoly structure is characterized by a well-defined product for which there are
no good substitutes. Monopolists want to maximize profits, not price.
Reading 15

Question #39
Compared to GDP calculated using the sum-of-value-added method, GDP using the value-of-final-output method will be:
A) biased downward.
B) biased upward.
C) equal to it.
GDP calculated under the two methods is the same.
Reading 16

Question #40
Average weekly initial claims for unemployment insurance are classified as a:
A) coincident indicator.
B) lagging indicator.
C) leading indicator.
Initial claims for unemployment insurance are considered a leading indicator.
Reading 17

Question #41
What are the three essential qualities an effective central bank should possess?
A) Transparency, comprehensiveness, and consistency.
B) Understandability, relevance, and reliability.
C) Independence, credibility, and transparency.
A central bank that is independent from political interference, possesses credibility, and exhibits transparency is more
likely to achieve its monetary policy objectives than a central bank that lacks these qualities. The characteristics listed in
the other answer choices relate to financial statements and financial reporting standards.
Reading 18

Question #42
An example of a contractionary fiscal policy change is a(n):
A) increase in a fiscal deficit.
B) increase in a fiscal surplus.
C) decrease in a fiscal surplus.
An increase in a fiscal surplus or a decrease in a fiscal deficit is contractionary. An increase in a fiscal deficit or a
decrease in a fiscal surplus is expansionary.
Reading 18

Question #43

Which form of regional trading agreement is least likely to allow free movement of labor?
A) Common market.
B) Customs union.
C) Economic union.
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.
Reading 19

Question #44
In 20X5, Carthage's merchandise imports exceeded the value of its merchandise exports. In this case, Carthage
would most likely have which of the following?
A) Capital account surplus.
B) Balance of trade surplus.
C) Current account surplus.
If a country is running a current account deficit, it must have an inflow of foreign capital, creating a surplus in the capital
account.
Reading 19

Question #45

Given an exchange rate of USD/CAD 0.9250 and USD/CHF 1.6250, what is the cross rate for CAD/CHF?
A) 1.7568.
B) 0.5692.
C) 1.5032.
(USD/CHF 1.6250) / (USD/CAD 0.9250) = CAD/CHF 1.7568
Reading 20

FINANCIAL REPORTING & ANALYSIS

Question #46
Which of the following is the best description of the flow of information in an accounting system?
A) General ledger, trial balance, general journal, financial statements.
B) Trial balance, general ledger, general journal, financial statements.
C) Journal entries, general ledger, trial balance, financial statements.
Information flows through an accounting system in four steps:
1. Journal entries record every transaction, showing which accounts are changed by what amounts. A listing of all the
journal entries in order by date is called the "general journal."
2. The general ledger sorts the entries in the general journal by account.
3. At the end of the accounting period, an initial trial balance is prepared that shows the balances in each account. If any
adjusting entries are needed, they will be recorded and reflected in an adjusted trial balance.
4. The account balances from the adjusted trial balance are presented in the financial statements.
Reading 22

Question #47

Converged accounting standards issued in May 2014 addressed:

A) depreciation of tangible assets.
B) revenue recognition.
C) inventory valuation.
The converged accounting standards issued by IASB and FASB in May 2014 concern revenue recognition.
Reading 24

Question #48
Robinson Company had 1 million shares outstanding at the beginning of the year. On April 1, Robinson issued an
additional 300,000 shares. On July 1, Robinson issued 200,000 more shares. What is Robinson's weighted average
number of shares outstanding for the calculation of earnings per share?
A) 1,325,000 shares.
B) 1,200,000 shares.
C) 1,500,000 shares.
Weighted average shares = 1,000,000 + (0.75) 300,000 + (0.5) 200,000 = 1,325,000 shares
Reading 24

Question #49
Which of the following is least likely reported net of tax on the income statement under U.S. GAAP?
A) Income from discontinued operations.
B) Interest expense.
C) Extraordinary items.
Interest expense would be considered an expense that is incurred from continuing operations and, therefore, is listed prior
to subtracting the income tax expense on the income statement. Income from discontinued operations and extraordinary
items are included on the income statement after the net income from continuing operations is reported and after the
income tax expense from continuing operations is reported. Therefore, these latter accounts are reported net of tax.
Reading 24

Question #50
Royster Company presents the following income statement:
Sales $12,000
Cost of goods sold $6,000
Selling and administrative expense $1,200
Interest expense $600
Pretax income $4,200
Income tax expense $1,470
Net income $2,730
Which of the following line items would appear on a common-size income statement for this period?
A) Net income 65%
B) Income tax expense 54%
C) Pretax income 35%
Common-size income statements express each line item as a percentage of sales.
Sales 100%
Cost of goods sold 50%
Selling and administrative expense 10%
Interest expense 5%
Pretax income 35%
Income tax expense 12.25%
Net income 22.75%
Reading 24
Question #51
A firm has a weighted average number of 20,000 common shares selling at an average of $10 throughout the year and
11,000, 10%, $100 par value preferred shares. If the firm earns $210,000 after taxes, what is its Basic EPS?
A) $7.50 / share.
B) $10.50 / share.
C)$5.00 / share.
(210,000 − 110,000) / 20,000 = $5 share
Reading 24

Question #52

An analyst has gathered the following information about a company:

Balance Sheet
Assets
Cash 100
Accounts Receivable 750
Marketable Securities 300
Inventory 850
Property, Plant & Equip 900
Accumulated Depreciation (150)
Total Assets 2750

Liabilities and Equity

Accounts Payable 300
Short-Term Debt 130
Long-Term Debt 700
Common Stock 1000
Retained Earnings 620
Total Liab. and Stockholder's equity 2750

Income Statement
Sales 1500
COGS 1100
Gross Profit 400
SG&A 150
Operating Profit 250
Interest Expense 25
Taxes 75
Net Income 150
What is the quick ratio?
A) 0.62.
B) 1.53.
C) 2.67.
Quick ratio = [100(cash) + 750(AR) + 300(marketable securities)] / [300(AP) + 130(short-term debt)] = (1,150 / 430) = 2.67
Reading 25

Question #53
Earlier this year, Ponca Corporation purchased non-dividend paying equity securities which it classified as trading
securities. Information related to the securities follows:
Security Cost Fair value at year-end
X $400,000 $435,000
 Y $550,000 $545,000
What amounts should Ponca report in its year-end income statement and balance sheet as a result of its investment in
securities X and Y?
Income Statement Balance Sheet
A) $30,000 unrealized gain $980,000
B) No gain or loss $980,000
C) $30,000 unrealized gain $950,000
Trading securities are reported in the balance sheet at fair value. At the end of the year, the fair value of the securities
was $980,000 ($435,000 + $545,000). The unrealized gains and losses from trading securities are recognized in the
income statement. Thus, Ponca would recognize an unrealized gain of $30,000 ($980,000 fair value - $950,000 cost).
Reading 25

Question #54

What is the impact on accounts receivable if sales exceed cash collections and what is the impact on accounts payable if
cash paid to suppliers exceeds purchases?
A) Only accounts receivable will increase.
B) Both accounts payable and accounts receivable will increase.
C) Only accounts payable will increase.
If a firm sells more than it collects, accounts receivable will increase. If a firm pays suppliers more than it purchases,
accounts payable will decrease.
Reading 26

Question #55
Financial information for Jefferson Corp. for the year ended December 31st, was as follows:
Sales $3,000,000
Purchases 1,800,000
Inventory at Beginning 500,000
Inventory at Ending 800,000
Accounts Receivable at Beginning 300,000
Accounts Receivable at Ending 200,000
Accounts Payable at Beginning 100,000
Accounts Payable at Ending 100,000
Other Operating Expenses Paid 400,000
Based upon this data and using the direct method, what was Jefferson Corp.'s cash flow from operations (CFO) for the
year ended December 31st?
A) $900,000.
B) $800,000.
C) $1,200,000.
CFO = sales $3,000,000 - change in accounts receivable ($200,000 - $300,000) - purchases $1,800,000 - other cash
operating expenses $400,000 = $900,000.
Note that no adjustment for inventories is necessary because purchases are given. From the inventory equation, P =
COGS + EI - BI.
Reading 26

Question #56
What is the net income of a firm that has a return on equity of 12%, a leverage ratio of 1.5, an asset turnover of 2, and
revenue of $1 million?
A) $36,000.
B) $40,000.
C) $360,000.
The traditional DuPont system is given as:
ROE = (net profit margin)(asset turnover)(leverage ratio)
Solving for the net profit margin yields:
0.12 = (net profit margin) × (2) × (1.5)
0.04 = (net profit margin)
Recognizing that the net profit margin is equal to net income / revenue we can substitute that relationship into the above
equation and solve for net income:
0.04 = net income / revenue = net income / $1,000,000
$40,000 = net income.
Reading 27

Question #57
Which of the following ratios is NOT part of the original DuPont system?
A) Asset turnover.
B) Debt to total capital.
C) Equity multiplier.
The debt to total capital ratio is not part of the original DuPont system. The firm's leverage is accounted for through the
equity multiplier.
Reading 27

Question #58
Using the lower of cost or market principle under U.S. GAAP, if the market value of inventory falls below its historical cost,
the minimum value at which the inventory can be reported in the financial statements is the:
A) net realizable value minus selling costs.
B) market price minus selling costs minus normal profit margin.
C) net realizable value.
When inventory is written down to market, the replacement cost of the inventory is its market value, but the "market value"
must fall between net realizable value (NRV) and NRV less normal profit margin. NRV is the market price of the inventory
less selling costs. Therefore the minimum value is the market price minus selling costs minus normal profit margin.
Reading 28

Question #59
Given the following data and assuming a periodic inventory system, what is the ending inventory value using the FIFO
method?
Purchases Sales
50 units at $50/unit 25 units at $55/unit
60 units at $45/unit 30 units at $50/unit
70 units at $40/unit 45 units at $45/unit
A) $3,200.
B) $3,600.
C) $3,250.
Purchased 50 + 60 + 70 = 180 units. Sold 25 + 30 + 45 = 100.
Ending inventory = 180 - 100 = 80 of the last units purchased.
(70 units)($40/unit) + (10 units)($45/unit) = $2,800 + $450 = $3,250.
Reading 28

Question #60
Marcel Inc. is a large manufacturing company based in the U.S. but also operating in several European countries. Marcel
has long-lived assets currently in use that are valued on the balance sheet at $600 million. This includes previously
recognized impairment losses of $80 million. The original cost of the assets was $750 million. The fair value of the assets
was determined in a professional appraisal to be $690 million. Assuming that Marcel reports under U.S. GAAP, the new
appraisal of the assets' value most likely results in:
A) an $80 million gain on income statement and $10 million gain in other comprehensive income.
B) no change to Marcel's financial statements.
C) a $90 million gain in other comprehensive income.
Under U.S. GAAP, long-lived assets are reported on the balance sheet at depreciated cost less any impairment losses
($750 million original cost less $70 million accumulated depreciation and less $80 million impairment loss, for a net
amount of $600 million). Increases are generally prohibited with the exception of assets held for sale. Since these assets
are currently in use, this exception does not apply. Therefore, Marcel may not revalue the assets upward.
Reading 29

Question #61
On January 1, 20X4, Cayman Corporation bought manufacturing equipment for $30 million. On December 31, 20X6,
Cayman determined the equipment was impaired and recognized a $5 million impairment loss in its income statement. As
of December 31, 20X7, the fair value of the equipment exceeded the book value by $7 million. Cayman may recognize a
gain in its 20X7 income statement if it reports under:
A) neither IFRS nor U.S. GAAP.
B) either IFRS or U.S. GAAP.
C) IFRS, but not U.S. GAAP.
U.S. GAAP does not permit upward valuations of plant and equipment. Under IFRS, the recovery is reported in the
income statement to the extent that the previous downward adjustment (loss) was reported in net income. Any further
increase in value is reported as revaluation surplus in shareholders' equity.
Reading 29

Question #62

A firm needs to adjust its financial statements for a change in the tax rate. Taxable income is $80,000 and pretax income
is $120,000. The current tax rate is 50%, and the new tax rate is 40%. The effect on taxes payable of adjusting the tax
rate is closest to:
A) $4,000.
B) $8,000.
C) $16,000.
"Pretax income" denotes earnings before taxes for financial reporting. "Taxable income" is earnings before taxes for
computing taxes payable, where taxes payable refers to the actual tax liability to the government. Since taxable income is
$80,000, the difference in taxes payable is ($80,000)(0.5) - ($80,000)(0.4) = $8,000.
Reading 30

Question #63
For analytical purposes, if a deferred tax liability is expected to not be reversed, it should be treated as a(n):
A) immaterial amount and ignored.
B) an addition to equity.
C) liability.
If deferred tax liabilities are expected to never reverse, they should be treated as equity for analytical purposes.
Reading 30

Question #64
The Puchalski Company reported the following:
Year 1 Year 2 Year 3 Year 4

Income before taxes $1,000 $1,000 $900 $800

Taxable income $800 $900 $900 $1,000

The differences between income before taxes and taxable income are the result of using accelerated depreciation for tax
purposes on an asset purchased in Year 1. Puchalski had no deferred tax liability prior to Year 1. If the tax rate is 40%,
what is the amount of the deferred tax liability reported at the end of Year 4?
A) $120.
B) $80.
C) $40.

Year 1 Year 2 Year 3 Year 4

Income tax expense $400 $400 $360 $320
Taxes paid $320 $360 $360 $400
Deferred tax liability $80 $120 $120 $40
Reading 30

Question #65
At the end of 20X8, Martin Inc. estimates that $26,000 of warranty repairs will be required in the future on goods already
sold. For tax purposes, warranty expense is not deductible until the work is actually performed. The firm believes that the
warranty work will be required over the next two years. The tax base of the warranty liability at the end of 20X8 is:
A) $26,000.
B) zero.
C) $13,000.
The carrying value of the warranty liability is $26,000 (the same amount is recorded as a liability on the balance sheet and
as an expense on the income statement). The tax base is equal to the carrying value less any amounts deductible in the
future. Therefore, the tax base is $0 ($26,000 − $26,000) since the warranty expense will be deductible when the work is
performed next year.
Reading 30

Question #66

Which of the following statements regarding zero-coupon bonds is most accurate?

A) Interest expense is a combination of operating and financing cash flows.
B) A company should initially record zero-coupon bonds at their discounted present value.
C) The interest expense in each period is found by applying the discount rate to the book value of debt at the end of the
period.
The liability initially recorded for a zero-coupon bond is equal to the proceeds received, which is the present value of the
principal repayment discounted at the company's normal borrowing rate. Interest expense is found by applying the
discount rate to the book value of debt at the beginning of the period, and there is no cash outflow from operations for a
zero coupon bond.
Reading 31

Question #67
When bonds are issued at a premium:
A) earnings of the firm decrease over the life of the bond as the bond premium is amortized.
B) earnings of the firm increase over the life of the bond as the bond premium is amortized.
C) coupon interest paid decreases each period as bond premium is amortized.
As bond premium is amortized, interest expense will be successively lower each period, thus increasing earnings over the
life of the bond.
Reading 31

Question #68
Assume a city issues a $5 million semiannual-pay bond to build a new arena. The bond has a coupon rate of 8% and will
mature in 10 years. When the bond is issued its yield to maturity is 9%. Interest expense in the second semiannual period
is closest to:
A) $80,000.
B) $106,550.
C) $210,830.
Step 1: Compute the proceeds raised (i.e., the present value of the bond): Since the yield is above the coupon rate the
bond will be issued at a discount.
FV = $5,000,000; N = (10 × 2) = 20; PMT = (0.08 / 2)(5 million) = $200,000; I/Y = (9 / 2) = 4.5; CPT → PV = -$4,674,802
Step 2: Compute the interest expense at the end of the first period.
= (0.045)(4,674,802) = $210,366
Step 3: Compute the interest expense at the end of the second period.
= (new balance sheet liability)(current interest rate)
= $4,674,802 + $10,366 = $4,685,168 new balance sheet liability
(0.045)(4,685,168) = $210,833
Reading 31

Question #69

Which of the following is one of circumstances that is conducive to issuing low-quality financial reports?
A) There is a large range of acceptable accounting treatments.
B) Earnings per share are highly variable from year to year.
C) Balance sheet values are likely to violate debt covenants.
A large range of acceptable accounting treatments is conducive to manager bias affecting the quality of financial
reporting. In such a circumstance, misleading estimates and accounting choices that do not flow from the economic reality
of a firm's transactions fall more into the category of mistakes rather than fraudulent reporting. Potentially violating debt
covenants is considered a motivation for low quality financial reporting. Variability of earnings could be a motivating factor
for earnings smoothing but are not necessarily conducive to low quality financial reporting.
Reading 32
CORPORATE FINANCE

Question #70
For a project with cash outflows during its life, the least preferred capital budgeting tool would be:
A) profitability index.
B) net present value.
C) internal rate of return.
The IRR encounters difficulties when cash outflows occur throughout the life of the project. These projects may have
multiple IRRs, or no IRR at all. Neither the NPV nor the PI suffer from these limitations.
Reading 35

Question #71

A financial analyst is estimating the effect on the cost of capital for a company of a decrease in the marginal tax rate. The
company is financed with debt and common equity. A decrease in the firm's marginal tax rate would:
A) decrease the cost of capital because of a lower after-tax cost of debt and equity.
B) increase the cost of capital because of a higher after-tax cost of debt.
C) increase the cost of capital because of a higher after-tax cost of debt and equity.
The cost of debt capital is affected by the marginal tax rate because interest costs are tax-deductible. A lower marginal tax
rate decreases the value to the firm of the tax deduction for interest and therefore increases the after-tax cost of debt
capital. Cost of equity capital is not affected by the marginal tax rate.
Reading 36

Question #72
Carlos Rodriquez, CFA, and Regine Davis, CFA, were recently discussing the relationships between capital structure,
capital budgets, and net present value (NPV) analysis. Which of the following comments made by these two individuals
is least accurate?
A) "For projects with more risk than the average firm project, NPV computations should be based on the marginal cost of
capital instead of the weighted average cost of capital."
B) "The optimal capital budget is determined by the intersection of a firm's marginal cost of capital curve and its
investment opportunity schedule."
C) "A break point occurs at a level of capital expenditure where one of the component costs of capital increases."
The marginal cost of capital (MCC) and the weighted average cost of capital (WACC) are the same thing. If a firm's capital
structure remains constant, the MCC (WACC) increases as additional capital is raised.
Reading 36

Question #73
Nippon Post Corporation (NPC), a Japanese software development firm, has a capital structure that is comprised of 60%
common equity and 40% debt. In order to finance several capital projects, NPC will raise USD1.6 million by issuing
common equity and debt in proportion to its current capital structure. The debt will be issued at par with a 9% coupon and
flotation costs on the equity issue will be 3.5%. NPC's common stock is currently selling for USD21.40 per share, and its
last dividend was USD1.80 and is expected to grow at 7% forever. The company's tax rate is 40%. NPC's WACC based
on the cost of new capital is closest to:
A) 13.1%.
B) 11.8%.
C) 9.6%.
kd = 0.09(1 - 0.4) = 0.054 = 5.4%
kce = [(1.80 × 1.07) / 21.40] + 0.07 = 0.16 = 16.0%
WACC = 0.6(16.0%) + 0.4(5.4%) = 11.76%
Flotation costs, treated correctly, have no effect on the cost of equity component of the WACC.
Reading 36

Question #74

As financial leverage increases, what will be the impact on the expected rate of return and financial risk?
A) Both will fall.
B) Both will rise.
C) One will rise while the other falls.
A higher breakeven point resulting from increased interest costs associated with debt financing increases the risk of the
company. Since the risk is tied to firm financing, it is referred to as financial risk. Given the positive risk-return relationship,
the expected return of the company's common stock also rises.
Reading 37

Question #75
Annah Korotkin is the sole proprietor of CoverMeUp, a business that designs and sews outdoor clothing for dogs. Each
year, she rents a booth at the regional Pet Expo and sells only blankets. Korotkin views the Expo as primarily a marketing
tool and is happy to breakeven (that is, cover her booth rental). For the last 3 years, she has sold exactly enough blankets
to cover the $750 booth rental fee. This year, she decided to make all blankets for the Expo out of high-tech
waterproof/breathable material that is more expensive to produce, but that she believes she can sell for a higher profit
margin. Information on the two types of blankets is as follows:
Per Unit Last Year's (Basic) Blanket This Year's (New) Blanket
Sales Price $25 $40
Variable Cost $20 $33
Assuming that Korotkin remains most interested in covering the booth cost (which has increased to $840), how many
more or fewer blankets (new style) does she need to sell to cover the booth cost? To cover this year's booth costs,
Korotkin needs to sell:
A) 42 more blankets than last year.
B) 42 fewer blankets than last year.
C) 30 fewer blankets than last year.
To obtain this result, we need to calculate Last Year's Breakeven Quantity, This Year's Breakeven Quantity, and calculate
the difference.
Step 1: Determine Last Year's (Basic Blanket) breakeven quantity:
QBE = (Fixed Costs) / (Sales Price per unit − Variable Cost per unit) = 750 / (25 − 20) = 150
Step 2: Determine This Year's (New Blanket) breakeven quantity:
QBE = (Fixed Costs) / (Sales Price per unit - Variable Cost per unit) = 840 / (40 − 33) = 120
Step 3: Determine Change in Units:
Q = QThis Year - QLast Year = 120 − 150 = −30. Korotkin needs to sell 30 fewer blankets.
Reading 37

Question #76
Which yield measure is the most appropriate for comparing a company's investments in short-term securities?
A) Money market yield.
B) Discount basis yield.
C) Bond equivalent yield.
When evaluating the performance of its short-term securities investments, a company should compare them on a bond
equivalent yield basis.
Reading 39

Question #77
An investment policy statement for a firm's short-term cash management function would least appropriately include:
A) information on who is allowed to invest corporate cash.
B) a list of permissible securities.
C) procedures to follow if the investment guidelines are violated.
An investment policy statement typically begins with a statement of the purpose and objective of the investment portfolio,
some general guidelines about the strategy to be employed to achieve those objectives, and the types of securities that
will be used. A list of permitted securities for investment would be limited and likely too restrictive. A list of permitted
security types is appropriate and can provide the necessary flexibility to increase yield within the safety and liquidity
constraints appropriate for the firm.
Reading 39

PORTFOLIO MANAGEMENT

Question #78
Which of the following statements best describes an investment that is not on the efficient frontier?
A) The portfolio has a very high return.
B) There is a portfolio that has a lower risk for the same return.
C) There is a portfolio that has a lower return for the same risk.
The efficient frontier outlines the set of portfolios that gives investors the highest return for a given level of risk or the
lowest risk for a given level of return. Therefore, if a portfolio is not on the efficient frontier, there must be a portfolio that
has lower risk for the same return. Equivalently, there must be a portfolio that produces a higher return for the same risk.
Reading 42

Question #79
In a two-asset portfolio, reducing the correlation between the two assets moves the efficient frontier in which direction?
A) The efficient frontier is stable unless the asset's expected volatility changes. This depends on each asset's standard
deviation.
B) The frontier extends to the left, or northwest quadrant representing a reduction in risk while maintaining or enhancing
portfolio returns.
C) The efficient frontier is stable unless return expectations change. If expectations change, the efficient frontier will
extend to the upper right with little or no change in risk.
Reducing correlation between the two assets results in the efficient frontier expanding to the left and possibly slightly
upward. This reflects the influence of correlation on reducing portfolio risk.
Reading 42

Question #80
Over the long term, the annual returns and standard deviations of returns for major asset classes have shown:
A) a positive relationship.
B) a negative relationship.
C) no clear relationship.
In most markets and for most asset classes, higher average returns have historically been associated with higher risk
(standard deviation of returns).
Reading 42

Question #81

Which of the following statements about a stock's beta is CORRECT? A beta greater than one is:
A) risky, while a beta less than one is risk-free.
B) riskier than the market, while a beta less than one is less risky than the market.
C) undervalued, while a beta less than one is overvalued.
Beta is a measure of the volatility of a stock. The overall market's beta is one. A stock with higher systematic risk than the
market will have a beta greater than one, while a stock that has a lower systematic risk will have a beta less than one.
Reading 43

Question #82
Mason Snow, CFA, is an analyst with Polari Investments. Snow's manager has instructed him to put only securities that
are undervalued on the buy list. Today, Snow is to make a recommendation on the following two stocks: Bahre (with an
expected return of 10% and a beta of 1.4) and Cubb (with an expected return of 15% and a beta of 2.0). The risk-free rate
is at 7% and the market premium is 4%.
Snow places:
A) neither security on the list.
B) only Cubb on the list.
C) only Bahre on the list.
In the context of the SML, a security is underpriced if the required return is less than the holding period (or expected)
return, is overpriced if the required return is greater the holding period (or expected) return, and is correctly priced if the
required return equals the holding period (or expected) return.

Here, the holding period (or expected) return is calculated as: (ending price - beginning price + any cash flow or
dividends) / beginning price. The required return uses the equation of the SML: risk free rate + Beta × (expected market
rate - risk free rate).
 For Bahre: ER = 10% (given), RR = 0.07 + (1.4)(0.11-0.07) = 12.6%. Stock is overpriced - do not put on buy list.
 For Cubb: ER = 15%, (given) RR = 0.07 + (2.0)(0.11-0.07) = 15%. Stock is correctly priced - do not put on buy list
(per Snow's manager).
Reading 43

Question #83
Consider the following graph of the Security Market Line (SML). The letters X, Y, and Z represent risky asset portfolios.
The SML crosses the y-axis at the point 0.07. The expected market return equals 13.0%. Note: The graph is NOT drawn
to scale.

Using the graph above and the information provided, which of the following statements is most accurate?
A) Portfolio X's required return is greater than the market expected return.
B) The expected return (or holding period return) for Portfolio Z equals 14.8%.
C) Portfolio Y is undervalued.
At first, it appears that we are not given the information needed to calculate the holding period, or expected return
(beginning price, ending price, or annual dividend). However, we are given the information required to calculate the
required return (CAPM) and since Portfolio Z is on the SML, we know that the required return (RR) equals the expected
return (ER). So, ER = RR = Rf + (ERM - Rf) × Beta = 7.0% + (13.0% − 7.0%) × 1.3 = 14.8%.
The SML plots beta (or systematic risk) versus expected return, the CML plots total risk (systematic plus unsystematic
risk) versus expected return. Portfolio Y is overvalued - any portfolio located below the SML has an RR > ER and is thus
overpriced. Since Portfolio X plots above the SML, it is undervalued and the statement should read, "Portfolio X's required
return is less than the market expected return."
Reading 43

Question #84

Which of the following should least likely be included as a constraint in an investment policy statement (IPS)?
A) How funds are spent after being withdrawn from the portfolio.
B) Any unique needs or preferences an investor may have.
C) Constraints put on investment activities by regulatory agencies.
How funds are spent after withdrawal would not be a constraint of an IPS.
Reading 44

Question #85
Which of the following statements about risk is NOT correct? Generally, greater:
A) insurance coverage allows for greater risk.
B) existing wealth allows for greater risk.
C) spending needs allows for greater risk.
Greater spending needs usually allow for lower risk because there is a definite need to ensure that the return may
adequately fund the spending needs (a "fixed" cost).
Question From: Session 12 > Reading 44

Question #86
Which of the following factors is least likely to affect an investor's risk tolerance?
A) Number of dependent family members.
B) Level of inflation in the economy.
C) Level of insurance coverage.
The level of inflation in the economy should be considered in determining the return objective. Risk tolerance is a function
of the investor's psychological makeup and the investor's personal factors such as age, family situation, existing wealth,
insurance coverage, current cash reserves and income.
Reading 44

EQUITY

Question #87
An investor purchases 100 shares at $75 per share with an initial margin of 50%. Assume there is no interest on the call
loan and no transactions fees. If the stock price rises to $112.50, the rate of return to the investor is:
A) 200%.
B) 100%.
C) 50%.
$75/share × 100 shares = $7,500.
50% margin means investor only pays half of the $7,500 in cash, or $3,750, and borrows the remaining $3,750.
Rate of return = (market value - initial investment - margin loan repayment) / initial equity
= ($11,250 - $3,750 - $3,750) / $3,750 = 100%.
Reading 45

Question #88
A market that directs capital to its most productive use is best described as:
A) operationally efficient.
B) informationally efficient.
C) allocationally efficient.
Markets are said to be allocationally efficient when capital is directed to its most productive uses. Operationally efficient
markets are those that have low trading costs. Informationally efficient markets are those in which security prices reflect
all information associated with fundamental value in a timely fashion.
Reading 45

Question #89

Which of the following is NOT a reason bond market indexes are more difficult to create than stock market indexes?
A) The universe of bonds is much broader than that of stocks.
B) There is a lack of continuous trade data available for bonds.
C) Bond deviations tend to be relatively constant.
Bond prices are quite volatile as measured by the bond's duration.
Reading 46

Question #90
The Top Banking Index contains stocks in the finance industry that represent more than 90% of the total market
capitalization for the finance industry. The index is bestdescribed as a:
A) broad market index.
B) style index.
C) sector index.
A sector index measures the returns for an industry sector such as financials. Style indexes measure the returns to
strategies that are differentiated by market capitalization and by value or growth. A broad market index typically consists
of constituent securities that represent 90% or more of the total market capitalization for a given market.
Reading 46

Question #91
In a perfectly efficient market, portfolio managers should do all of the following EXCEPT:
A) monitor their client's needs and circumstances.
B) diversify to eliminate systematic risk.
C) quantify their risk and return needs within the bounds of the client's liquidity, income, time horizon, legal, and regulatory
constraints.
Portfolio managers cannot eliminate systematic risk (i.e., market risk) thru the use of diversification. Portfolio managers
should try to eliminate unsystematic portfolio risk.
Reading 47

Question #92
Equity securities are least likely issued to finance:
A) research and development.
B) inventories.
C) equipment.
Equity securities are typically issued to finance a firm's long-lived assets, such as equipment, and long-term projects such
as research and development.
Reading 48

Question #93
Commercial industry classification systems such as the Global Industry Classification Standard (GICS) typically classify
firms according to their:
A) sensitivity to business cycles.
B) correlations of historical returns.
C) principal business activities.
Commercial providers of industry classification systems such as the GICS classify firms according to principal business
activity, such as Consumer Staples, Financial Services, or Health Care.
Reading 49

Question #94
Question ID: 415430
One advantage of price/sales (P/S) multiples over price to earnings (P/E) and price-to-book value (PBV) multiples is that:
A) Regression shows a strong relationship between stock prices and sales.
B) P/S is easier to calculate.
C) P/S can be used for distressed firms.
Unlike the PBV and P/E multiples, which can become negative and not meaningful, the price/sales multiple is meaningful
even for distressed firms (that may have negative earnings or book value).
Reading 50

Question #95
All of the following factors affects the firm's P/E ratio EXCEPT:
A) the expected interest rate on the bonds of the firm.
B) growth rates of dividends.
C) the required rate of return.
The factors that affect the P/E ratio are the same factors that affect the value of a firm in the infinite growth dividend
discount model. The expected interest rate on the bonds is not a significant factor affecting the P/E ratio.
Reading 50

Question #96
A company last paid a $1.00 dividend, the current market price of the stock is $20 per share and the dividends are
expected to grow at 5 percent forever. What is the required rate of return on the stock?
A) 10.25%.
B) 9.78%.
C) 10.00%.
D0 (1 + g) / P0 + g = k
1.00 (1.05) / 20 + 0.05 = 10.25%.
Reading 50

Question #97
If the expected dividend payout ratio of a firm is expected to rise from 50 percent to 55 percent, the cost of equity is
expected to increase from 10 percent to 11 percent, and the firm's growth rate remains at 5 percent, what will happen to
the firm's price-to-equity (P/E) ratio? It will:
A) decline.
B) increase.
C) be unchanged.
Payout increases from 50% to 55%, cost of equity increases from 10% to 11%, and dividend growth rate stays at 5%, the
P/E will change from 10 to 9.16:
P/E = (D/E) / (k - g).
P/E0 = 0.50 / (0.10 - 0.05) = 10.
P/E1 = 0.55 / (0.11 - 0.05) = 9.16.
Reading 50

Question #98
Preferred stock most likely has a:
A) fixed dividend and no maturity.
B) fixed dividend and maturity.
C) variable dividend and no maturity.
Preferred stock typically pays a fixed dividend and does not mature.
Reading 50

FIXED INCOME
Question #99
A purchase of a new bond issue by a single investor is most accurately described as a(n):
A) grey market transaction.
B) private placement.
C) underwritten offering.
In a private placement, an entire bond issue is sold to a single investor or a small group of investors, rather than being
offered to the public.
Reading 52

Question #100
Bonds issued by the International Monetary Fund (IMF) are most accurately described as:
A) non-sovereign government bonds.
B) quasi-government bonds.
C) supranational bonds.
Supranational bonds are issued by multilateral organizations such as the IMF. Quasi-government bonds are issued by
agencies created by a national government. Non-sovereign government bonds are issued by state, provincial, and local
governments or municipal entities.
Reading 52

Question #101

Consider a bond selling for $1,150. This bond has 28 years to maturity, pays a 12% annual coupon, and is callable in 8
years for $1,100. The yield to call is closest to:
A) 10.05%.
B) 10.55%.
C) 9.25%.
N = 8; PMT = 120; PV = -1,150; FV = 1,100; CPT I/Y = 10.0554.
Reading 53

Question #102
The Treasury spot rate yield curve is closest to which of the following curves?
A) Par bond yield curve.
B) Forward yield curve rate.
C) Zero-coupon bond yield curve.
The spot rate yield curve shows the appropriate rates for discounting single cash flows occuring at different times in the
future. Conceptually, these rates are equivalent to yields on zero-coupon bonds. The par bond yield curve shows the
YTMs at which bonds of various maturities would trade at par value. Forward rates are expected future short-term rates.
Reading 53

Question #103
A 20-year, 9% semi-annual coupon bond selling for $914.20 offers a yield to maturity of:
A) 10%.
B) 8%
C) 9%.
N = 40; PMT = 45; PV = -914.20; FV = 1,000; CPT → I/Y = 5%
YTM = 5% × 2 = 10%
Reading 53

Question #104
A five-year bond with a 7.75% semiannual coupon currently trades at 101.245% of a par value of $1,000. Which of the
following is closest to the current yield on the bond?
A) 7.53%.
B) 7.65%.
C) 7.75%.
The current yield is computed as: (Annual Cash Coupon Payment) / (Current Bond Price). The annual coupon is:
($1,000)(0.0775) = $77.50. The current yield is then: ($77.50) / ($1,012.45) = 0.0765 = 7.65%.
Reading 53

Question #105
A bond-equivalent yield for a money market instrument is a(n):
A) discount yield based on a 365-day year.
B) add-on yield based on a 365-day year.
C) discount yield based on a 360-day year.
A bond-equivalent yield is an add-on yield based on a 365-day year.
Reading 53

Question #106

Which of the following five year bonds has the highest interest rate sensitivity?
A) Zero-coupon bond.
B) Floating rate bond.
C) Option-free 5% coupon bond.
The Macaulay duration of a zero-coupon bond is equal to its time to maturity. Its price is greatly affected by changes in
interest rates because its only cash-flow is at maturity and is discounted from the time at maturity until the present.
Reading 55

Question #107
How does the price-yield relationship for a callable bond compare to the same relationship for an option-free bond? The
price-yield relationship is best described as exhibiting:
A) negative convexity at low yields for the callable bond and positive convexity for the option-free bond.
B) negative convexity for the callable bond and positive convexity for an option-free bond.
C) the same convexity for both bond types.
Since the issuer of a callable bond has an incentive to call the bond when interest rates are very low in order to get
cheaper financing, this puts an upper limit on the bond price for low interest rates and thus introduces negative convexity
between yields and prices.
Reading 55

Question #108
Which of the following will be the greatest for a putable bond at relatively high yields?
A) Effective duration of the bond.
B) Modified duration of the bond ignoring the option.
C) Macaulay duration of the bond ignoring the option.
Modified duration is less than Macaulay duration. The effective duration of a putable bond is less than its modified
duration ignoring the put option.
Reading 55

Question #109
An investor buys a bond that has a Macaulay duration of 3.0 and a yield to maturity of 4.5%. The investor plans to sell the
bond after three years. If the yield curve has a parallel downward shift of 100 basis points immediately after the investor
buys the bond, her annualized horizon return is most likely to be:
A) greater than 4.5%.
B) less than 4.5%.
C) approximately 4.5%.
With Macaulay duration equal to the investment horizon, market price risk and reinvestment risk approximately offset and
the annualized horizon return should be close to the yield to maturity at purchase.
Reading 55

Question #110

Compared to corporate bonds with the same credit ratings, municipal general obligation (GO) bonds typically have less
credit risk because:
A) GOs are not affected by economic downturns.
B) default rates on GOs are typically lower for same credit ratings.
C) governments can print money to repay debt.
Municipal bonds usually have lower default rates than corporate bonds of the same credit ratings. GO bonds'
creditworthiness is affected by economic downturns. Sovereigns can print money to repay debt, but municipalities cannot.
Reading 56
DERIVATIVES

Question #111
Which of the following definitions involving derivatives is least accurate?
A) A call option gives the owner the right to sell the underlying good at a specific price for a specified time period.
B) An option writer is the seller of an option.
C) An arbitrage opportunity is the chance to make a riskless profit with no investment.
A call option gives the owner the right to buy the underlying good at a specific price for a specified time period.
Reading 57

Question #112
Which of the following statements regarding plain-vanilla interest rate swaps is least accurate?
A) The time frame covered by the swap is called the tenor of the swap.
B) In a swap contract, the counterparties usually swap the notional principal.
C) The settlement dates are when the interest payments are to be made.
The notional principal is generally not swapped, as it is usually the same for both parties in the swap deal.
Reading 57

Question #113
If the price of a forward contract is greater than the price of an identical futures contract, the most likely explanation is that:
A) the futures contract requires daily settlement.
B) the forward contract is more liquid.
C) the futures contract is more difficult to exit.

The reason there may be a difference in price between a forward contract and an identical futures contract is that a
futures position has daily settlement and so makes or requires cash flows during its life.
Reading 58

Question #114
As a forward contract approaches its expiration date, its value:
A) depends on the price of the underlying asset.
B) increases to the forward contract price.
C) approaches zero.
The value of a forward contract is zero at initiation, and during its life its value depends on changes in the spot price of the
underlying asset. At expiration its value is based on the difference between the spot price of the underlying asset and the
price specified in the forward contract.
Reading 58

Question #115

Which of the following statements about the potential profits and losses from selling a call is most accurate?
A) Losses are limited to the strike price plus the premium.
B) Losses are theoretically unlimited.
C) Profits are theoretically unlimited.
The following table provides the potential payoffs from puts and calls.
Buyer/Holder Seller/Writer
Potential Gain Potential Loss Potential Gain Potential Loss
Call Unlimited Premium Premium Unlimited
Put Strike P - Premium Premium Premium Strike P - Premium
Reading 59

Question #116
An investor bought a 40 put on a stock trading at 43 for a premium of $1. What is the maximum gain on the put and the
value of the put at expiration if the stock price is $41?
Maximum Gain on Put Value of the Put at Expiration
A) $42 $2
B) $39 $0
C) $40 $2
The maximum gain on a long put is the strike price minus the premium, 40 - 1 = $39. The value at expiration is zero
because the put is out-of-the-money.
Reading 59

ALTERNATIVE INVESTMENTS

Question #117
The difference between a hedge fund's trading net asset value and its accounting net asset value is that:
A) accounting NAV tends to be lower because of model prices.
B) trading NAV tends to be lower because of illiquid assets.
C) accounting NAV tends to be higher because of estimated liabilities.
Trading NAV adjusts accounting NAV downward to account for illiquidity of a hedge fund's investments, such as positions
that are large relative to trading volume.
Reading 60

Question #118
The yield from an investment in commodities that results from a difference between the spot price and a futures price is
the:
A) collateral yield.
B) convenience yield.
C) roll yield.
Roll yield is the yield return due to a difference between the spot price and futures price, or a difference between two
futures prices with different expiration dates, and results from futures prices converging to the spot price as futures
contracts approach their expiration dates. Roll yield may be positive or negative.
Reading 60

Question #119
A private equity provision that requires managers to return any periodic incentive fees resulting in investors receiving less
than 80% of profits is a:
A) drawdown.
B) clawback.
C) high water mark.
A clawback provision requires the manager to return any periodic incentive fees to investors that would result in investors
receiving less than 80% of the profits generated by portfolio investments as a whole.
Reading 60

Question #120
The period of time within which a hedge fund must fulfill a redemption request is the:
A) notice period.
B) lockup period.
C) withdrawal period.
A notice period, typically 30 to 90 days, is the amount of time a fund has after receiving notice of a redemption request to
fulfill the redemption request. A lockup period is a minimum length of time before an investor may redeem shares or make
withdrawals.
Reading 60