Question #1 of 101 Question ID: 1472131

An analyst wants to model quarterly sales data using an autoregressive model. She has
found that an AR(1) model with a seasonal lag has significant slope coefficients. She also
finds that when a second and third seasonal lag are added to the model, all slope
coefficients are significant too. Based on this, the best model to use would most likely be an:

A) ARCH(1).
B) AR(1) model with no seasonal lags.
C) AR(1) model with 3 seasonal lags.

Explanation

She has found that all the slope coefficients are significant in the model xt = b0 + b1xt– 1 +
b2xt– 4 + et. She then finds that all the slope coefficients are significant in the model xt = b0
+ b1xt– 1 + b2xt– 2 + b3xt– 3 + b4xt– 4 + et. Thus, the final model should be used rather than
any other model that uses a subset of the regressors.

(Module 2.2, LOS 2.d)

Question #2 of 101 Question ID: 1472132

The model xt = b0 + b1 xt − 1 + b2 xt − 2 + b3 xt −12 + εt is an autoregressive model of type:

A) AR(2).
B) AR(1).
C) AR(12).

Explanation

The b1xt − 1 and b2xt − 2 lag terms make this an autoregressive model of order p = 2 with a
seasonal lag. The b3xt −12 term is a seasonal term which does not transform the model to
AR(12).

(Module 2.2, LOS 2.d)

Question #3 of 101 Question ID: 1472163

An AR(1) autoregressive time series model:

can be used to test for a unit root, which exists if the slope coefficient equals
A)
one.
B) cannot be used to test for a unit root.
can be used to test for a unit root, which exists if the slope coefficient is less
C)
than one.

Explanation

If you estimate the following model xt = b0 + b1 × xt-1 + et and get b1 = 1, then the process
has a unit root and is nonstationary.

(Module 2.3, LOS 2.k)

Question #4 of 101 Question ID: 1472145

Consider the estimated AR(2) model, xt = 2.5 + 3.0 xt-1 + 1.5 xt-2 + εt t=1,2,...50. Making a
prediction for values of x for 1 ≤ t ≤ 50 is referred to as:

A) an in-sample forecast.
B) an out-of-sample forecast.
C) requires more information to answer the question.

Explanation

An in-sample (a.k.a. within-sample) forecast is made within the bounds of the data used to
estimate the model. An out-of-sample forecast is for values of the independent variable
that are outside of those used to estimate the model.

(Module 2.2, LOS 2.g)

Question #5 of 101 Question ID: 1472126

The model xt = b0 + b1 xt-1 + b2 xt-2 + b3 xt-3 + b4 xt-4 + εt is:

A) an autoregressive conditional heteroskedastic model, ARCH.

B) a moving average model, MA(4).
C) an autoregressive model, AR(4).

Explanation
This is an autoregressive model (i.e., lagged dependent variable as independent variables)
of order p=4 (that is, 4 lags).

(Module 2.2, LOS 2.d)

Question #6 of 101 Question ID: 1472133

The procedure for determining the structure of an autoregressive model is:

test autocorrelations of the residuals for a simple trend model, and specify the
A)
number of significant lags.
estimate an autoregressive model (for example, an AR(1) model), calculate the
B) autocorrelations for the model's residuals, test whether the autocorrelations
are different from zero, and add an AR lag for each significant autocorrelation.
estimate an autoregressive model (e.g., an AR(1) model), calculate the
autocorrelations for the model's residuals, test whether the autocorrelations
C)
are different from zero, and revise the model if there are significant
autocorrelations.

Explanation

The procedure is iterative: continually test for autocorrelations in the residuals and stop
adding lags when the autocorrelations of the residuals are eliminated. Even if several of
the residuals exhibit autocorrelation, the lags should be added one at a time.

(Module 2.2, LOS 2.e)

Question #7 of 101 Question ID: 1472192

Which of the following is least likely a consequence of a model containing ARCH(1) errors?
The:

A) regression parameters will be incorrect.

B) variance of the errors can be predicted.
C) model's specification can be corrected by adding an additional lag variable.

Explanation
The presence of autoregressive conditional heteroskedasticity (ARCH) indicates that the
variance of the error terms is not constant. This is a violation of the regression
assumptions upon which time series models are based. The addition of another lag
variable to a model is not a means for correcting for ARCH (1) errors.

(Module 2.5, LOS 2.m)

Question #8 of 101 Question ID: 1472146

The primary concern when deciding upon a time series sample period is which of the
following factors?

A) The length of the sample time period.

B) Current underlying economic and market conditions.
C) The total number of observations.

Explanation

There will always be a tradeoff between the increase statistical reliability of a longer time
period and the increased stability of estimated regression coefficients with shorter time
periods. Therefore, the underlying economic environment should be the deciding factor
when selecting a time series sample period.

(Module 2.2, LOS 2.h)

Diem Le is analyzing the financial statements of McDowell Manufacturing. He has modeled

the time series of McDowell's gross margin over the last 16 years. The output is shown
below. Assume 5% significance level for all statistical tests.

Autoregressive Model

Gross Margin – McDowell Manufacturing

Quarterly Data: 1st Quarter 1985 to 4th Quarter 2000

Regression Statistics

R-squared 0.767

Standard error of forecast 0.049

Observations 64

Durbin-Watson 1.923 (not statistically significant)

 Coefficient Standard Error t-statistic

Constant 0.155 0.052 ?????

Lag 1 0.240 0.031 ?????

Lag 4 0.168 0.038 ?????

Autocorrelation of Residuals

Lag Autocorrelation Standard Error t-statistic

1 0.015 0.129 ?????

2 –0.101 0.129 ?????

3 –0.007 0.129 ?????

4 0.095 0.129 ?????

Partial List of Recent Observations

Quarter Observation

4th Quarter 2002 0.250

1st Quarter 2003 0.260

2nd Quarter 2003 0.220

3rd Quarter 2003 0.200

4th Quarter 2003 0.240

Abbreviated Table of the Student's t-distribution (One-Tailed Probabilities)

df p = 0.10 p = 0.05 p = 0.025 p = 0.01 p = 0.005

50 1.299 1.676 2.009 2.403 2.678

60 1.296 1.671 2.000 2.390 2.660

70 1.294 1.667 1.994 2.381 2.648

Question #9 - 12 of 101 Question ID: 1472122

Le can conclude that the model is:

A) properly specified because the Durbin-Watson statistic is not significant.

 properly specified because there is no evidence of autocorrelation in the
B)
residuals.
not properly specified because there is evidence of autocorrelation in the
C)
residuals and the Durbin-Watson statistic is not significant.

Explanation

The Durbin-Watson test is not an appropriate test statistic in an AR model, so we cannot

use it to test for autocorrelation in the residuals. However, we can test whether each of
the four lagged residuals autocorrelations is statistically significant. The t-test to
accomplish this is equal to the autocorrelation divided by the standard error with 61
degrees of freedom (64 observations less 3 coefficient estimates). The critical t-value for a
significance level of 5% is about 2.000 from the table. The appropriate t-statistics are:

Lag 1 = 0.015/0.129 = 0.116

Lag 2 = -0.101/0.129 = -0.783
Lag 3 = -0.007/0.129 = -0.054
Lag 4 = 0.095/0.129 = 0.736

None of these are statically significant, so we can conclude that there is no evidence of
autocorrelation in the residuals, and therefore the AR model is properly specified.

(Module 2.2, LOS 2.d)

Question #10 - 12 of 101 Question ID: 1472123

What is the forecast for the gross margin in the first quarter of 2004?

A) 0.246.
B) 0.250.
C) 0.256.

Explanation

The forecast for the following quarter is 0.155 + 0.240(0.240) + 0.168(0.260) = 0.256.

(Module 2.2, LOS 2.d)

Question #11 - 12 of 101 Question ID: 1472124

With respect to heteroskedasticity in the model, we can definitively say:

A) nothing.
an ARCH process exists because the autocorrelation coefficients of the residuals
B)
have different signs.
C) heteroskedasticity is not a problem because the DW statistic is not significant.

Explanation

None of the information in the problem provides information concerning

heteroskedasticity. Note that heteroskedasticity occurs when the variance of the error
terms is not constant. When heteroskedasticity is present in a time series, the residuals
appear to come from different distributions (model seems to fit better in some time
periods than others).

(Module 2.2, LOS 2.d)

Question #12 - 12 of 101 Question ID: 1543894

Supposing the time series is actually a random walk, which of the following approaches
would be appropriate prior to using an autoregressive model?

A) First differencing the time series.

B) ARCH.
C) Convert the time series by taking a natural log of the series.

Explanation

First differencing often transforms a random walk into a covariance stationary time series
which can then be fitted using autoregressive models. ARCH is a type of AR model where
the residuals exhibit conditional heteroskedasticity and is not an approach to convert a
random walk into a covariance stationary time series. Taking natural log is recommended
for a time series with an exponential growth prior to fitting a trend model.

(Module 2.2, LOS 2.d)

Question #13 of 101 Question ID: 1472092

In the time series model: yt=b0 + b1 t + εt, t=1,2,...,T, the:

A) change in the dependent variable per time period is b1.

B) disturbance terms are autocorrelated.
C) disturbance term is mean-reverting.

Explanation

The slope is the change in the dependent variable per unit of time. The intercept is the
estimate of the value of the dependent variable before the time series begins. The
disturbance term should be independent and identically distributed. There is no reason to
expect the disturbance term to be mean-reverting, and if the residuals are autocorrelated,
the research should correct for that problem.

(Module 2.1, LOS 2.a)

Question #14 of 101 Question ID: 1472185

Which of the following is a seasonally adjusted model?

A) Salest = b1 Sales t-1+ εt.

B) (Salest - Sales t-1)= b0 + b1 (Sales t-1 - Sales t-2) + b2 (Sales t-4 - Sales t-5) + εt.

C) Salest = b0 + b1 Sales t-1 + b2 Sales t-2 + εt.

Explanation

This model is a seasonal AR with first differencing.

(Module 2.4, LOS 2.l)

Question #15 of 101 Question ID: 1472111

Trend models can be useful tools in the evaluation of a time series of data. However, there
are limitations to their usage. Trend models are not appropriate when which of the following
violations of the linear regression assumptions is present?

A) Model misspecification.
B) Serial correlation.
C) Heteroskedasticity.

Explanation
One of the primary assumptions of linear regression is that the residual terms are not
correlated with each other. If serial correlation, also called autocorrelation, is present,
then trend models are not an appropriate analysis tool.

(Module 2.1, LOS 2.b)

Question #16 of 101 Question ID: 1472153

A time series that has a unit root can be transformed into a time series without a unit root
through:

A) first differencing.
B) mean reversion.
C) calculating moving average of the residuals.

Explanation

First differencing a series that has a unit root creates a time series that does not have a
unit root.

(Module 2.3, LOS 2.j)

Question #17 of 101 Question ID: 1472151

A time series x that is a random walk with a drift is best described as:

A) xt = b0 + b1 xt − 1.

B) xt = xt − 1 + εt.

C) xt = b0 + b1xt − 1 + εt.

Explanation

The best estimate of random walk for period t is the value of the series at (t − 1). If the
random walk has a drift component, this drift is added to the previous period's value of
the time series to produce the forecast.

(Module 2.3, LOS 2.i)

Question #18 of 101 Question ID: 1472136

An analyst modeled the time series of annual earnings per share in the specialty department
store industry as an AR(3) process. Upon examination of the residuals from this model, she
found that there is a significant autocorrelation for the residuals of this model. This indicates
that she needs to:

A) revise the model to include at least another lag of the dependent variable.
B) switch models to a moving average model.
C) alter the model to an ARCH model.

Explanation

She should estimate an AR(4) model, and then re-examine the autocorrelations of the
residuals.

(Module 2.2, LOS 2.e)

Question #19 of 101 Question ID: 1472137

A monthly time series of changes in maintenance expenses (ΔExp) for an equipment rental
company was fit to an AR(1) model over 100 months. The results of the regression and the
first twelve lagged residual autocorrelations are shown in the tables below. Based on the
information in these tables, does the model appear to be appropriately specified? (Assume a
5% level of significance.)

Regression Results for Maintenance Expense Changes

Model: DExpt = b0 + b1DExpt–1 + et

Coefficients Standard Error t-Statistic p-value

Intercept 1.3304 0.0089 112.2849 < 0.0001

Lag-1 0.1817 0.0061 30.0125 < 0.0001

Lagged Residual Autocorrelations for Maintenance Expense Changes

Lag Autocorrelation t-Statistic Lag Autocorrelation t-Statistic

1 −0.239 −2.39 7 −0.018 −0.18

2 −0.278 −2.78 8 −0.033 −0.33

3 −0.045 −0.45 9 0.261 2.61

4 −0.033 −0.33 10 −0.060 −0.60

5 −0.180 −1.80 11 0.212 2.12

6 −0.110 −1.10 12 0.022 0.22

A) Yes, because the intercept and the lag coefficient are significant.
B) Yes, because most of the residual autocorrelations are negative.
C) No, because several of the residual autocorrelations are significant.

Explanation

At a 5% level of significance, the critical t-value is 1.98. Since the absolute values of several
of the residual autocorrelation's t-statistics exceed 1.98, it can be concluded that
significant serial correlation exists and the model should be respecified. The next logical
step is to estimate an AR(2) model, then test the associated residuals for autocorrelation.
If no serial correlation is detected, seasonality and ARCH behavior should be tested.

(Module 2.2, LOS 2.e)

Question #20 of 101 Question ID: 1472110

Dianne Hart, CFA, is considering the purchase of an equity position in Book World, Inc, a
leading seller of books in the United States. Hart has obtained monthly sales data for the
past seven years, and has plotted the data points on a graph. Hart notices that the revenues
are growing at approximately 4.5% per year. Which of the following statements regarding
Hart's analysis of the data time series of Book World's sales is most accurate? Hart should
utilize a:

mean-reverting model to analyze the data because the time series pattern is
A)
covariance stationary.
B) linear model to analyze the data because the mean appears to be constant.
log-linear model to analyze the data because it is likely to exhibit a compound
C)
growth trend.

Explanation

A log-linear model is more appropriate when analyzing data that is growing at a compound
rate. Sales are a classic example of a type of data series that normally exhibits compound
growth.

(Module 2.1, LOS 2.b)

Question #21 of 101 Question ID: 1508645

Consider the following estimated model:

(Salest - Sales t-1) = 30 + 1.25 (Sales t-1 - Sales t-2) + 1.1 (Sales t-4 - Sales t-5) t=1,2,.. T

and Sales for the periods 1999.1 through 2000.2:

t Period Sales

T 2000.2 $2,000

T-1 2000.1 $1,800

T-2 1999.4 $1,500

T-3 1999.3 $1,400

T-4 1999.2 $1,900

T-5 1999.1 $1,700

The forecasted Sales amount for 2000.3 is closest to:

A) $2,270.00.
B) $2,625.00.
C) $1,730.00.

Explanation

Note that since we are forecasting 2000.3, the numbering of the "t" column has changed.

Change in sales = $30 + 1.25 ($2,000-1,800) + 1.1 ($1,400-1,900)

Change in sales = $30 + 250 - 550 = -$270

Sales = $2,000 – 270 = $1,730

(Module 2.5, LOS 2.n)

Question #22 of 101 Question ID: 1472205

Alexis Popov, CFA, wants to estimate how sales have grown from one quarter to the next on
average. The most direct way for Popov to estimate this would be:

A) an AR(1) model with a seasonal lag.

B) a linear trend model.
C) an AR(1) model.

Explanation

If the goal is to simply estimate the dollar change from one period to the next, the most
direct way is to estimate xt = b0 + b1 × (Trend) + et, where Trend is simply 1, 2, 3, ....T. The
model predicts a change by the value b1 from one period to the next.

(Module 2.5, LOS 2.o)

Question #23 of 101 Question ID: 1472134

The regression results from fitting an AR(1) model to the first-differences in enrollment
growth rates at a large university includes a Durbin-Watson statistic of 1.58. The number of
quarterly observations in the time series is 60. At 5% significance, the critical values for the
Durbin-Watson statistic are dl = 1.55 and du = 1.62. Which of the following is the most
accurate interpretation of the DW statistic for the model?

A) Since DW > dl, the null hypothesis of no serial correlation is rejected.

B) Since dl < DW < du, the results of the DW test are inconclusive.
C) The Durbin-Watson statistic cannot be used with AR(1) models.

Explanation

The Durbin-Watson statistic is not useful when testing for serial correlation in an
autoregressive model where one of the independent variables is a lagged value of the
dependent variable. The existence of serial correlation in an AR model is determined by
examining the autocorrelations of the residuals.

(Module 2.2, LOS 2.e)

Question #24 of 101 Question ID: 1472147

The main reason why financial and time series intrinsically exhibit some form of
nonstationarity is that:

serial correlation, a contributing factor to nonstationarity, is always present to a

A)
certain degree in most financial and time series.
most financial and time series have a natural tendency to revert toward their
B)
means.
most financial and economic relationships are dynamic and the estimated
C)
regression coefficients can vary greatly between periods.

Explanation

Because all financial and time series relationships are dynamic, regression coefficients can
vary widely from period to period. Therefore, financial and time series will always exhibit
some amount of instability or nonstationarity.

(Module 2.2, LOS 2.h)

Question #25 of 101 Question ID: 1472201

One choice a researcher can use to test for nonstationarity is to use a:

A) Breusch-Pagan test, which uses a modified t-statistic.

B) Dickey-Fuller test, which uses a modified χ2 statistic.

C) Dickey-Fuller test, which uses a modified t-statistic.

Explanation
The Dickey-Fuller test estimates the equation (xt – xt-1) = b0 + (b1 - 1) * xt-1 + et and tests if
H0: (b1 – 1) = 0. Using a modified t-test, if it is found that (b1– 1) is not significantly
different from zero, then it is concluded that b1 must be equal to 1.0 and the series has a
unit root.

(Module 2.5, LOS 2.n)

Question #26 of 101 Question ID: 1472127

Troy Dillard, CFA, has estimated the following equation using semiannual data: xt = 44 +
0.1×xt– 1 – 0.25×xt– 2 - 0.15×xt– 3 + et. Given the data in the table below, what is Dillard's best
forecast of the second half of 2007?

Time Value

2003: I 31

2003: II 31

2004: I 33

2004: II 33

2005: I 36

2005: II 35

2006: I 32

2006: II 33

A) 33.74.
B) 34.05.
C) 34.36.

Explanation
To get the answer, Dillard must first make the forecast for 2007:I

E[x2007:I]= 44 + 0.1 × xt– 1 - 0.25 × xt– 2 - 0.15 × xt– 3

E[x2007:I] = 44 + 0.1×33 - 0.25×32 - 0.15×35

E[x2007:I] = 34.05

Then, use this forecast in the equation for the first lag:

E[x2007:II] = 44 + 0.1×34.05 - 0.25×33 - 0.15×32

E[x2007:II] = 34.36

(Module 2.2, LOS 2.d)

Question #27 of 101 Question ID: 1472148

Which of the following statements regarding the instability of time-series models is most
accurate? Models estimated with:

A) shorter time series are usually more stable than those with longer time series.
a greater number of independent variables are usually more stable than those
B)
with a smaller number.
C) longer time series are usually more stable than those with shorter time series.

Explanation

Those models with a shorter time series are usually more stable because there is less
opportunity for variance in the estimated regression coefficients between the different
time periods.

(Module 2.2, LOS 2.h)

Question #28 of 101 Question ID: 1472135

The table below includes the first eight residual autocorrelations from fitting the first
differenced time series of the absenteeism rates (ABS) at a manufacturing firm with the
model ΔABSt = b0 + b1ΔABSt-1 + εt. Based on the results in the table, which of the following
statements most accurately describes the appropriateness of the specification of the model,
ΔABSt = b0 + b1ΔABSt-1 + εt?

Lagged Autocorrelations of the Residuals of the First Differences in Absenteeism

Rates

Lag Autocorrelation Standard Error t-Statistic

1 −0.0738 0.1667 −0.44271

2 −0.1047 0.1667 −0.62807

3 −0.0252 0.1667 −0.15117

4 −0.0157 0.1667 −0.09418

5 −0.1262 0.1667 −0.75705

6 0.0768 0.1667 0.46071

7 0.0038 0.1667 0.02280

8 −0.0188 0.1667 −0.11278

The Durbin-Watson statistic is needed to determine the presence of significant

A)
correlation of the residuals.
B) The low values for the t-statistics indicate that the model fits the time series.
The negative values for the autocorrelations indicate that the model does not fit
C)
the time series.

Explanation

The t-statistics are all very small, indicating that none of the autocorrelations are
significantly different than zero. Based on these results, the model appears to be
appropriately specified. The error terms, however, should still be checked for
heteroskedasticity.

(Module 2.2, LOS 2.e)

Question #29 of 101 Question ID: 1472120

Which of the following is NOT a requirement for a series to be covariance stationary? The:
A) expected value of the time series is constant over time.
B) covariance of the time series with itself (lead or lag) must be constant.
C) time series must have a positive trend.

Explanation

For a time series to be covariance stationary: 1) the series must have an expected value
that is constant and finite in all periods, 2) the series must have a variance that is constant
and finite in all periods, and 3) the covariance of the time series with itself for a fixed
number of periods in the past or future must be constant and finite in all periods.

(Module 2.2, LOS 2.c)

Question #30 of 101 Question ID: 1472187

The table below shows the autocorrelations of the lagged residuals for quarterly theater
ticket sales that were estimated using the AR(1) model: ln(salest) = b0 + b1(ln salest − 1) + et.
Assuming the critical t-statistic at 5% significance is 2.0, which of the following is the most
likely conclusion about the appropriateness of the model? The time series:

Lagged Autocorrelations of the Log of Quarterly Theater Ticket Sales

Lag Autocorrelation Standard Error t-Statistic

1 −0.0738 0.1667 −0.44271

2 −0.1047 0.1667 −0.62807

3 −0.0252 0.1667 −0.15117

4 0.5528 0.1667 3.31614

A) contains seasonality.
B) contains ARCH (1) errors.
C) would be more appropriately described with an MA(4) model.

Explanation

The time series contains seasonality as indicated by the strong and significant
autocorrelation of the lag-4 residual.

(Module 2.4, LOS 2.l)

Winston Collier, CFA, has been asked by his supervisor to develop a model for predicting the
warranty expense incurred by Premier Snowplow Manufacturing Company in servicing its
plows. Three years ago, major design changes were made on newly manufactured plows in
an effort to reduce warranty expense. Premier warrants its snowplows for 4 years or 18,000
miles, whichever comes first. Warranty expense is higher in winter months, but some of
Premier's customers defer maintenance issues that are not essential to keeping the
machines functioning to spring or summer seasons. The data that Collier will analyze is in
the following table (in $ millions):

Seasonal Lagged
Change in Lagged Change in
Warranty Change in
Quarter Warranty Warranty
Expense Warranty
Expense yt Expense yt-1
Expense yt-4

2002.1 103

2002.2 52 –51

2002.3 32 –20 –51

2002.4 68 +36 –20

2003.1 91 +23 +36

2003.2 44 –47 +23 –51

2003.3 30 –14 –47 –20

2003.4 60 +30 –14 +36

2004.1 77 +17 +30 +23

2004.2 38 –39 +17 –47

2004.3 29 –9 –39 –14

2004.4 53 +24 –9 +30

Winston submits the following results to his supervisor. The first is the estimation of a trend
model for the period 2002:1 to 2004:4. The model is below. The standard errors are in
parentheses.

(Warranty expense)t = 74.1 - 2.7* t + et

(14.37) (1.97)

R-squared = 16.2%
Winston also submits the following results for an autoregressive model on the differences in
the expense over the period 2004:to 2004:4. The model is below where "y" represents the
change in expense as defined in the table above. The standard errors are in parentheses.

yt = -0.7 - 0.07* yt-1 + 0.83* yt-4 + et

(0.643) (0.0222) (0.0186)

R-squared = 99.98%

After receiving the output, Collier's supervisor asks him to compute moving averages of the
sales data.

Question #31 - 34 of 101 Question ID: 1472158

Collier's supervisors would probably not want to use the results from the trend model for all
of the following reasons EXCEPT:

A) the model is a linear trend model and log-linear models are always superior.
B) the slope coefficient is not significant.
it does not give insights into the underlying dynamics of the movement of the
C)
dependent variable.

Explanation

Linear trend models are not always inferior to log-linear models. To determine which
specification is better would require more analysis such as a graph of the data over time.
As for the other possible answers, Collier can see that the slope coefficient is not
significant because the t-statistic is 1.37=2.7/1.97. Also, regressing a variable on a simple
time trend only describes the movement over time, and does not address the underlying
dynamics of the dependent variable.

(Module 2.3, LOS 2.k)

Question #32 - 34 of 101 Question ID: 1472159

For this question only, assume that Winston also ran an AR(1) model with the following
results:

yt = −0.9 − 0.23* yt −1 + et

R-squared = 78.3%

(0.823) (0.0222)

The mean reverting level of this model is closest to:

A) 1.16.
B) −0.73.
C) 0.77.

Explanation

The mean reverting level is X1 = bo/(1 − b1)

X1 = −0.9/[1 − (−0.23)] = −0.73

(Module 2.3, LOS 2.k)

Question #33 - 34 of 101 Question ID: 1472160

Based on the autoregressive model, expected warranty expense in the first quarter of 2005
will be closest to:

A) $51 million.
B) $60 million.
C) $65 million.

Explanation

Substituting the 1-period lagged data from 2004.4 and the 4-period lagged data from
2004.1 into the model formula, change in warranty expense is predicted to be higher than
2004.4.

11.73 = –0.7 – 0.07*24 + 0.83*17.

The expected warranty expense is (53 + 11.73) = $64.73 million.

(Module 2.3, LOS 2.k)

Question #34 - 34 of 101 Question ID: 1472161

Based on the results, is there a seasonality component in the data?

A) Yes, because the coefficient on yt–4 is large compared to its standard error.

B) Yes, because the coefficient on yt is small compared to its standard error.

No, because the slope coefficients in the autoregressive model have opposite
C)
signs.

Explanation

The coefficient on the 4th lag tests the seasonality component.

The t-statistic is equal to 0.83/0.0186 = 44.62, which is greater than the critical t-value (5%
LOS, 2-tailed, dof = 4) = 2.78

(Module 2.3, LOS 2.k)

Jason Cranwell, CFA, has hypothesized that sales of luxury cars have grown at a constant
rate over the past 15 years.

Question #35 - 38 of 101 Question ID: 1472114

After discussing the above matter with a colleague, Cranwell finally decides to use an
autoregressive model of order one i.e. AR(1) for the above data. Below is a summary of the
findings of the model:

b0 0.4563

b1 0.6874

Standard error 0.3745

R-squared 0.7548

Durbin Watson 1.23

F 12.63

Observations 180

Calculate the mean reverting level of the series.

A) 1.26.
B) 1.46.
C) 1.66.

Explanation

The formula for the mean reverting level is b0/(1-b1) = 0.4563/(1-0.6874)=1.46

(Module 2.1, LOS 2.b)

Question #36 - 38 of 101 Question ID: 1472115

Cranwell is aware that the Dickey Fuller test can be used to discover whether a model has a
unit root. He is also aware that the test would use a revised set of critical t-values. What
would it mean to Bert to reject the null of the Dickey Fuller test (Ho: g = 0) ?

A) There is no unit root.

B) There is a unit root and the model cannot be used in its current form.
C) There is a unit root but the model can be used if covariance-stationary.

Explanation
The null hypothesis of g = 0 actually means that b1 – 1 = 0 , meaning that b1 = 1. Since we
have rejected the null, we can conclude that the model has no unit root.

(Module 2.1, LOS 2.b)

Question #37 - 38 of 101 Question ID: 1472116

Cranwell would also like to test for serial correlation in his AR(1) model. To do this, Cranwell
should:

A) use the provided Durbin Watson statistic and compare it to a critical value.
B) use a t-test on the residual autocorrelations over several lags.
determine if the series has a finite and constant covariance between leading
C)
and lagged terms of itself.

Explanation

To test for serial correlation in an AR model, test for the significance of residual
autocorrelations over different lags. The goal is for all t-statistics to lack statistical
significance. The Durbin-Watson test is used with trend models; it is not appropriate for
testing for serial correlation of the error terms in an autoregressive model. Constant and
finite unconditional variance is not an indicator of serial correlation but rather is one of
the requirements of covariance stationarity.

(Module 2.1, LOS 2.b)

Question #38 - 38 of 101 Question ID: 1472117

When using the root mean squared error (RMSE) criterion to evaluate the predictive power
of the model, which of the following is the most appropriate statement?

A) Use the model with the highest RMSE calculated using the in-sample data.
B) Use the model with the lowest RMSE calculated using the out-of-sample data.
C) Use the model with the lowest RMSE calculated using the in-sample data.

Explanation
RMSE is a measure of error hence the lower the better. It should be calculated on the out-
of-sample data i.e. the data not directly used in the development of the model. This
measure thus indicates the predictive power of our model.

(Module 2.1, LOS 2.b)

Question #39 of 101 Question ID: 1472142

Frank Batchelder and Miriam Yenkin are analysts for Bishop Econometrics. Batchelder and
Yenkin are discussing the models they use to forecast changes in China's GDP and how they
can compare the forecasting accuracy of each model. Batchelder states, "The root mean
squared error (RMSE) criterion is typically used to evaluate the in-sample forecast accuracy
of autoregressive models." Yenkin replies, "If we use the RMSE criterion, the model with the
largest RMSE is the one we should judge as the most accurate."

With regard to their statements about using the RMSE criterion:

A) Batchelder is incorrect; Yenkin is incorrect.

B) Batchelder is incorrect; Yenkin is correct.
C) Batchelder is correct; Yenkin is incorrect.

Explanation

The root mean squared error (RMSE) criterion is used to compare the accuracy of
autoregressive models in forecasting out-of-sample values (not in-sample values).
Batchelder is incorrect. Out-of-sample forecast accuracy is important because the future is
always out of sample, and therefore out-of-sample performance of a model is critical for
evaluating real world performance.

Yenkin is also incorrect. The RMSE criterion takes the square root of the average squared
errors from each model. The model with the smallest RMSE is judged the most accurate.

(Module 2.2, LOS 2.g)

Albert Morris, CFA, is evaluating the results of an estimation of the number of wireless
phone minutes used on a quarterly basis within the territory of Car-tel International, Inc.
Some of the information is presented below (in billions of minutes):

Wireless Phone Minutes (WPM)t = b0 + b1 WPMt–1 + εt

ANOVA Degrees of Freedom Sum of Squares Mean Square

 Regression 1 7,212.641 7,212.641

Error 26 3,102.410 119.324

Total 27 10,315.051

Coefficients Coefficient Standard Error of the Coefficient

Intercept –8.0237 2.9023

WPMt–1 1.0926 0.0673

The variance of the residuals from one time period within the time series is not dependent
on the variance of the residuals in another time period.

Morris also models the monthly revenue of Car-tel using data over 96 monthly observations.
The model is shown below:

Sales (CAD$ millions) = b0 + b1 Salest−1 + εt

Coefficients Coefficient Standard Error of the Coefficient

Intercept 43.2 12.32

Salest−1 0.8867 0.4122

Question #40 - 43 of 101 Question ID: 1472101

The value for WPM this period is 544 billion. Using the results of the model, the forecast
Wireless Phone Minutes three periods in the future is:

A) 691.30.
B) 586.35.
C) 683.18.

Explanation

The one-period forecast is −8.023 + (1.0926 × 544) = 586.35.

The two-period forecast is then −8.023 + (1.0926 × 586.35) = 632.62.

Finally, the three-period forecast is −8.023 + (1.0926 × 632.62) = 683.18.

(Module 2.1, LOS 2.a)

Question #41 - 43 of 101 Question ID: 1472102

The WPM model was specified as a(n):

A) Moving Average (MA) Model.

B) Autoregressive (AR) Model.
C) Autoregressive (AR) Model with a seasonal lag.

Explanation

The model is specified as an AR Model, but there is no seasonal lag. No moving averages
are employed in the estimation of the model.

(Module 2.1, LOS 2.a)

Question #42 - 43 of 101 Question ID: 1472103

The mean reverting level of monthly sales is closest to:

A) 381.29 million.
B) 8.83 million.
C) 43.2 million.

Explanation
b0 43.2
MRL = = = 381.29 million
1 − b1 1 − 0.8867

(Module 2.1, LOS 2.a)

Question #43 - 43 of 101 Question ID: 1472104

Morris concludes that the current price of Car-tel stock is consistent with single stage
constant growth model (with g=3%). Based on this information, the sales model is most
likely:

Incorrectly specified and first differencing the data would be an appropriate

A)
remedy.
B) Correctly specified.
Incorrectly specified and first differencing the natural log of the data would be
C)
an appropriate remedy.

Explanation

If constant growth rate is an appropriate model for Car-tel, its dividends (as well as
earnings and revenues) will grow at a constant rate. In such a case, the time series needs
to be adjusted by taking the natural log of the time series. Taking the natural log of the
time series would lead to a series that exhibits a constant amount of growth (and still not
stationary). The final step would be to first difference the transformed series to make it
covariance stationary. First differencing would remove the trending component of a
covariance non-stationary time series but would not be appropriate for transforming an
exponentially growing time series.

(Module 2.1, LOS 2.a)

Bill Johnson, CFA, has prepared data concerning revenues from sales of winter clothing
made by Polar Corporation. This data is presented (in $ millions) in the following table:

Lagged Change Seasonal Lagged

Change In Sales
In Sales Change In Sales

Quarter Sales Y Y + (−1) Y + (−4)

2013.1 182

2013.2 74 −108

2013.3 78 4 −108

2013.4 242 164 4

2014.1 194 −48 164

2014.2 79 −115 −48 −108

2014.3 90 11 −115 4

2014.4 260 170 11 w

Question #44 - 49 of 101 Question ID: 1472165

The preceding table will be used by Johnson to forecast values using:

A) an autoregressive model with a seasonal lag.

B) a serially correlated model with a seasonal lag.
C) a log-linear trend model with a seasonal lag.

Explanation

Johnson will use the table to forecast values using an autoregressive model for periods in
succession since each successive forecast relies on the forecast for the preceding period.
The seasonal lag is introduced to account for seasonal variations in the observed data.

(Module 2.3, LOS 2.k)

Question #45 - 49 of 101 Question ID: 1472166

The value that Johnson should enter in the table in place of "w" is:

A) 164.
B) −115.
C) −48.

Explanation

The seasonal lagged change in sales shows the change in sales from the period 4 quarters
before the current period. Sales in the year 2013 quarter 4 increased $164 million over the
prior period.

(Module 2.3, LOS 2.k)

Question #46 - 49 of 101 Question ID: 1472167

Imagine that Johnson prepares a change-in-sales regression analysis model with seasonality,
which includes the following:

Coefficients

Intercept −6.032

Lag 1 0.017

Lag 4 0.983

Based on the model, expected sales in the first quarter of 2015 will be closest to:

A) 190.
B) 210.
C) 155.

Explanation

Substituting the 1-period lagged data from 2014.4 and the 4-period lagged data from
2014.1 into the model formula, change in sales is predicted to be −6.032 + (0.017 × 170) +
(0.983 × −48) = −50.326. Expected sales are 260 + (−50.326) = 209.674.

(Module 2.3, LOS 2.k)

Question #47 - 49 of 101 Question ID: 1543896

Johnson's model was most likely designed to correct for:

A) heteroskedasticity of model residuals.

B) nonstationarity in time series data.
C) cointegration in the time series.

Explanation

Johnson's model transforms raw sales data by first differencing it and then modeling
change in sales. This is most likely an adjustment to make the data stationary for use in an
AR model.

(Module 2.3, LOS 2.k)

Question #48 - 49 of 101 Question ID: 1472169

To test for covariance-stationarity in the data, Johnson would most likely use a:

A) Durbin-Watson test.
B) t-test.
C) Dickey-Fuller test.

Explanation

The Dickey-Fuller test for unit roots could be used to test whether the data is covariance
non-stationarity. The Durbin-Watson test is used for detecting serial correlation in the
residuals of trend models but cannot be used in AR models. A t-test is used to test for
residual autocorrelation in AR models.

(Module 2.3, LOS 2.k)

Question #49 - 49 of 101 Question ID: 1472170

The presence of conditional heteroskedasticity of residuals in Johnson's model is would

most likely to lead to:

invalid standard errors of regression coefficients, but statistical tests will still be
A)
valid.
B) invalid standard errors of regression coefficients and invalid statistical tests.
invalid estimates of regression coefficients, but the standard errors will still be
C)
valid.

Explanation

The presence of conditional heteroskedasticity may leads to incorrect estimates of

standard errors of regression coefficients and hence invalid tests of significance of the
coefficients.

(Module 2.3, LOS 2.k)

Question #50 of 101 Question ID: 1472191

Suppose you estimate the following model of residuals from an autoregressive model:

εt2 = 0.25 + 0.6ε2t-1 + µt, where ε = ε^

If the residual at time t is 0.9, the forecasted variance for time t+1 is:

A) 0.790.
B) 0.736.
C) 0.850.

Explanation

The variance at t = t + 1 is 0.25 + [0.60 (0.9)2] = 0.25 + 0.486 = 0.736. See also, ARCH
models.

(Module 2.5, LOS 2.m)

Question #51 of 101 Question ID: 1472149

David Brice, CFA, has tried to use an AR(1) model to predict a given exchange rate. Brice has
concluded the exchange rate follows a random walk without a drift. The current value of the
exchange rate is 2.2. Under these conditions, which of the following would be least likely?

A) The forecast for next period is 2.2.

B) The residuals of the forecasting model are autocorrelated.
C) The process is not covariance stationary.

Explanation

The one-period forecast of a random walk model without drift is E(xt+1) = E(xt + et ) = xt + 0,
so the forecast is simply xt = 2.2. For a random walk process, the variance changes with
the value of the observation. However, the error term et = xt - xt-1 is not autocorrelated.

(Module 2.3, LOS 2.i)

Housing industry analyst Elaine Smith has been assigned the task of forecasting housing
foreclosures. Specifically, Smith is asked to forecast the percentage of outstanding
mortgages that will be foreclosed upon in the coming quarter. Smith decides to employ
multiple linear regression and time series analysis.

Besides constructing a forecast for the foreclosure percentage, Smith wants to address the
following two questions:

Research Question Is the foreclosure percentage significantly affected by short-term

1: interest rates?

Research Question Is the foreclosure percentage significantly affected by government

2: intervention policies?

Smith contends that adjustable rate mortgages often are used by higher risk borrowers and
that their homes are at higher risk of foreclosure. Therefore, Smith decides to use short-
term interest rates as one of the independent variables to test Research Question 1.

To measure the effects of government intervention in Research Question 2, Smith uses a

dummy variable that equals 1 whenever the Federal government intervened with a fiscal
policy stimulus package that exceeded 2% of the annual Gross Domestic Product. Smith sets
the dummy variable equal to 1 for four quarters starting with the quarter in which the policy
is enacted and extending through the following 3 quarters. Otherwise, the dummy variable
equals zero.

Smith uses quarterly data over the past 5 years to derive her regression. Smith's regression
equation is provided in Exhibit 1:
Exhibit 1: Foreclosure Share Regression Equation

foreclosure share = b0 + b1(ΔINT) + b2(STIM) + b3(CRISIS) + ε

where:

Foreclosure = the percentage of all outstanding mortgages foreclosed upon during

share the quarter

= the quarterly change in the 1-year Treasury bill rate (e.g., ΔINT = 2 for a
ΔINT
two percentage point increase in interest rates)

STIM = 1 for quarters in which a Federal fiscal stimulus package was in place

= 1 for quarters in which the median house price is one standard

CRISIS
deviation below its 5-year moving average

The results of Smith's regression are provided in Exhibit 2:

Exhibit 2: Foreclosure Share Regression Results

Variable Coefficient t-statistic

Intercept 3.00 2.40

ΔINT 1.00 2.22

STIM -2.50 -2.10

CRISIS 4.00 2.35

The ANOVA results from Smith's regression are provided in Exhibit 3:

Exhibit 3: Foreclosure Share Regression Equation ANOVA Table

Source Degrees of Freedom Sum of Squares Mean Sum of Squares

Regression 3 15 5.0000

Error 16 5 0.3125

Total 19 20

Smith expresses the following concerns about the test statistics derived in her regression:

If my regression errors exhibit conditional heteroskedasticity, my t-

Concern 1:
statistics will be underestimated.
 If my independent variables are correlated with each other, my F-statistic
Concern 2:
will be overestimated.

Before completing her analysis, Smith runs a regression of the changes in foreclosure share
on its lagged value. The following regression results and autocorrelations were derived using
quarterly data over the past 5 years ( Exhibit 4 and Exhibit 5, respectively):

Exhibit 4. Lagged Regression Results

Δ foreclosure sharet = 0.05 + 0.25(Δ foreclosure sharet– 1)

Exhibit 5. Autocorrelation Analysis

Lag Autocorrelation t-statistic

1 0.05 0.22

2 -0.35 -1.53

3 0.25 1.09

4 0.10 0.44

Exhibit 6 provides critical values for the Student's t-Distribution

Exhibit 6: Critical Values for Student's t-Distribution

Area in Both Tails Combined

Degrees of Freedom 20% 10% 5% 1%

16 1.337 1.746 2.120 2.921

17 1.333 1.740 2.110 2.898

18 1.330 1.734 2.101 2.878

19 1.328 1.729 2.093 2.861

20 1.325 1.725 2.086 2.845

Question #52 - 57 of 101 Question ID: 1472179

The most appropriate interpretation from the foreclosure share regression equation model
is:

A) Multiple-R of the model is 0.75.

B) Multiple-R of the model is 0.87.
C) Variable STIM explains 37.5% of the variation in foreclosure share.

Explanation

R2 = RSS/SST = 15/20 = 0.75

Multiple-R = (0.75)0.50 = 0.87.

Correct interpretation of the coefficient of determination is that all the independent

variables (ΔINT, STIM, CRISIS) collectively help explain 75% of the variation in the
independent variable (Foreclosure Share).

(Module 1.2, LOS 1.d)

Question #53 - 57 of 101 Question ID: 1472180

Based on her regression results in Exhibit 2, using a 5% level of significance, Smith should
conclude that:

stimulus packages do not have significant effects on foreclosure percentages,

A)
but housing crises do have significant effects on foreclosure percentages.
both stimulus packages and housing crises have significant effects on
B)
foreclosure percentages.
stimulus packages have significant effects on foreclosure percentages, but
C)
housing crises do not have significant effects on foreclosure percentages.

Explanation

The appropriate test statistic for tests of significance on individual slope coefficient
estimates is the t-statistic, which is provided in Exhibit 2 for each regression coefficient
estimate. The reported t-statistic equals -2.10 for the STIM slope estimate and equals 2.35
for the CRISIS slope estimate. The critical t-statistic for the 5% significance level equals
2.12 (16 degrees of freedom, 5% level of significance).

Therefore, the slope estimate for STIM is not statistically significant (the reported t-
statistic, -2.10, is not large enough). In contrast, the slope estimate for CRISIS is statistically
significant (the reported t-statistic, 2.35, exceeds the 5% significance level critical value).

(Module 2.3, LOS 2.k)

Question #54 - 57 of 101 Question ID: 1508639

The standard error of estimate for Smith's regression is closest to:

A) 0.16.
B) 0.53.
C) 0.56.

Explanation

The formula for the Standard Error of the Estimate (SEE) is:

SSE 5
SEE = √ = √ = 0.56
n - k - 1 16

The SEE equals the standard deviation of the regression residuals. A low SEE implies a high
R2.

(Module 2.3, LOS 2.k)

Question #55 - 57 of 101 Question ID: 1472182

Is Smith correct or incorrect regarding Concerns 1 and 2?

A) Correct on both Concerns.

B) Only correct on one concern and incorrect on the other.
C) Incorrect on both Concerns.

Explanation

Smith's Concern 1 is incorrect. Heteroskedasticity is a violation of a regression

assumption, and refers to regression error variance that is not constant over all
observations in the regression. Conditional heteroskedasticity is a case in which the error
variance is related to the magnitudes of the independent variables (the error variance is
"conditional" on the independent variables). The consequence of conditional
heteroskedasticity is that the standard errors will be too low, which, in turn, causes the t-
statistics to be too high. Smith's Concern 2 also is not correct. Multicollinearity refers to
independent variables that are correlated with each other. Multicollinearity causes
standard errors for the regression coefficients to be too high, which, in turn, causes the t-
statistics to be too low. However, contrary to Smith's concern, multicollinearity has no
effect on the F-statistic.

(Module 2.3, LOS 2.k)

Question #56 - 57 of 101 Question ID: 1472183

The most recent change in foreclosure share was +1 percent. Smith decides to base her
analysis on the data and methods provided in Exhibit 4 and Exhibit 5, and determines that
the two-step ahead forecast for the change in foreclosure share (in percent) is 0.125, and
that the mean reverting value for the change in foreclosure share (in percent) is 0.071. Is
Smith correct?

A) Smith is correct on both the forecast and the mean reverting level.
Smith is correct on the mean-reverting level for forecast of change in
B)
foreclosure share only.
Smith is correct on the two-step ahead forecast for change in foreclosure share
C)
only.

Explanation

Forecasts are derived by substituting the appropriate value for the period t-1 lagged value.

ΔForeclosure Sharet = 0.05 + 0.25(ΔForeclosure Sharet-1)

= 0.05 + 0.25(1) = 0.30

So, the one-step ahead forecast equals 0.30%. The two-step ahead (%) forecast is derived
by substituting 0.30 into the equation.

ΔForeclosure Sharet+1 = 0.05 + 0.25(0.30) = 0.125

Therefore, the two-step ahead forecast equals 0.125%.

b0 0.05
mean reverting level = = = 0.067
(1 - b ) (1 - 0.25)
1

(Module 2.3, LOS 2.k)

Question #57 - 57 of 101 Question ID: 1472184

Assume for this question that Smith finds that the foreclosure share series has a unit root.
Under these conditions, she can most reliably regress foreclosure share against the change
in interest rates (ΔINT) if:

A) ΔINT has unit root and is cointegrated with foreclosure share.

B) ΔINT does not have unit root.
C) ΔINT has unit root and is not cointegrated with foreclosure share.

Explanation
The error terms in the regressions for choices A, B, and C will be nonstationary. Therefore,
some of the regression assumptions will be violated and the regression results are
unreliable. If, however, both series are nonstationary (which will happen if each has unit
root), but cointegrated, then the error term will be covariance stationary and the
regression results are reliable.

(Module 2.3, LOS 2.k)

Question #58 of 101 Question ID: 1472193

Suppose you estimate the following model of residuals from an autoregressive model:

εt2 = 0.4 + 0.80εt-12 + µt, where ε = ε^

If the residual at time t is 2.0, the forecasted variance for time t+1 is:

A) 2.0.
B) 3.6.
C) 3.2.

Explanation

The variance at t=t+1 is 0.4 + [0.80 (4.0)] = 0.4 + 3.2. = 3.6.

(Module 2.5, LOS 2.m)

Question #59 of 101 Question ID: 1472155

Barry Phillips, CFA, has the following time series observations from earliest to latest: (5, 6, 5,
7, 6, 6, 8, 8, 9, 11). Phillips transforms the series so that he will estimate an autoregressive
process on the following data (1, -1, 2, -1, 0, 2, 0, 1, 2). The transformation Phillips employed
is called:

A) first differencing.
B) beta drift.
C) moving average.

Explanation

Phillips obviously first differenced the data because the 1=6-5, -1=5-6, .... 1 = 9 - 8, 2 = 11 -
9.

(Module 2.3, LOS 2.j)

Question #60 of 101 Question ID: 1472154

Barry Phillips, CFA, has estimated an AR(1) relationship (xt = b0 + b1 × xt-1 + et) and got the
following result: xt+1 = 0.5 + 1.0xt + et. Phillips should:

A) not first difference the data because b0 = 0.5 < 1.

B) first difference the data because b1 = 1.

C) not first difference the data because b1 − b0 = 1.0 − 0.5 = 0.5 < 1.

Explanation

The condition b1 = 1 means that the series has a unit root and is not stationary. The
correct way to transform the data in such an instance is to first difference the data.

(Module 2.3, LOS 2.j)

Question #61 of 101 Question ID: 1472152

Given an AR(1) process represented by xt+1 = b0 + b1×xt + et, the process would not be a
random walk if:

A) the long run mean is b0 / (1-b1).

B) E(et)=0.

C) b1 = 1.

Explanation

For a random walk, the long-run mean is undefined. The slope coefficient is one, b1=1, and
that is what makes the long-run mean undefined: mean = b0/(1-b1).

(Module 2.3, LOS 2.i)

Question #62 of 101 Question ID: 1472093

David Wellington, CFA, has estimated the following log-linear trend model: LN(xt) = b0 + b1t +
εt. Using six years of quarterly observations, 2001:I to 2006:IV, Wellington gets the following
estimated equation: LN(xt) = 1.4 + 0.02t. The first out-of-sample forecast of xt for 2007:I is
closest to:

A) 1.88.
B) 4.14.
C) 6.69.

Explanation

Wellington's out-of-sample forecast of LN(xt) is 1.9 = 1.4 + 0.02 × 25, and e1.9 = 6.69. (Six
years of quarterly observations, at 4 per year, takes us up to t = 24. The first time period
after that is t = 25.)

(Module 2.1, LOS 2.a)

Question #63 of 101 Question ID: 1472140

David Brice, CFA, has used an AR(1) model to forecast the next period's interest rate to be
0.08. The AR(1) has a positive slope coefficient. If the interest rate is a mean reverting
process with an unconditional mean, a.k.a., mean reverting level, equal to 0.09, then which
of the following could be his forecast for two periods ahead?

A) 0.072.
B) 0.113.
C) 0.081.

Explanation

As Brice makes more distant forecasts, each forecast will be closer to the unconditional
mean. So, the two period forecast would be between 0.08 and 0.09, and 0.081 is the only
possible answer.

(Module 2.2, LOS 2.f)

Yolanda Seerveld is an analyst studying the growth of sales of a new restaurant chain called
Very Vegan. The increase in the public's awareness of healthful eating habits has had a very
positive effect on Very Vegan's business. Seerveld has gathered quarterly data for the
restaurant's sales for the past three years. Over the twelve periods, sales grew from $17.2
million in the first quarter to $106.3 million in the last quarter. Because Very Vegan has
experienced growth of more than 500% over the three years, the Seerveld suspects an
exponential growth model may be more appropriate than a simple linear trend model.
However, she begins by estimating the simple linear trend model:

(sales)t = α + β × (Trend)t + εt

Where the Trend is 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12.

Regression Statistics

Multiple R 0.952640

R2 0.907523

Adjusted R2 0.898275

Standard Error 8.135514

Observations 12

1st order autocorrelation coefficient of the

residuals: −0.075

ANOVA

df SS

Regression 1 6495.203

Residual 10 661.8659

Total 11 7157.069

Coefficients Standard Error

Intercept 10.0015 5.0071

Trend 6.7400 0.6803

The analyst then estimates the following model:

(natural logarithm of sales)t = α + β × (Trend)t + εt

Regression Statistics

Multiple R 0.952028

R2 0.906357

Adjusted R2 0.896992
 Standard Error 0.166686

Observations 12

1st order autocorrelation coefficient of the

residuals: −0.348

ANOVA

df SS

Regression 1 2.6892

Residual 10 0.2778

Total 11 2.9670

Coefficients Standard Error

Intercept 2.9803 0.1026

Trend 0.1371 0.0140

Seerveld compares the results based upon the output statistics and conducts two-tailed
tests at a 5% level of significance. One concern is the possible problem of autocorrelation,
and Seerveld makes an assessment based upon the first-order autocorrelation coefficient of
the residuals that is listed in each set of output. Another concern is the stationarity of the
data. Finally, the analyst composes a forecast based on each equation for the quarter
following the end of the sample.

Question #64 - 67 of 101 Question ID: 1472106

Are either of the slope coefficients statistically significant?

A) The simple trend regression is not, but the log-linear trend regression is.
B) Yes, both are significant.
C) The simple trend regression is, but not the log-linear trend regression.

Explanation

The respective t-statistics are 6.7400 / 0.6803 = 9.9074 and 0.1371 / 0.0140 = 9.7929. For
10 degrees of freedom, the critical t-value for a two-tailed test at a 5% level of significance
is 2.228, so both slope coefficients are statistically significant.

(Module 2.1, LOS 2.a)

Question #65 - 67 of 101 Question ID: 1472107

With respect to the possible problems of autocorrelation and nonstationarity, using the log-
linear transformation appears to have:

A) not improved the results for either possible problems.

B) improved the results for nonstationarity but not autocorrelation.
C) improved the results for autocorrelation but not nonstationarity.

Explanation

The fact that there is a significant trend for both equations indicates that the data is not
stationary in either case. As for autocorrelation, the analyst really cannot test it using the
Durbin-Watson test because there are fewer than 15 observations, which is the lower limit
of the DW table. Looking at the first-order autocorrelation coefficient, however, we see
that it increased (in absolute value terms) for the log-linear equation. If anything,
therefore, the problem became more severe.

(Module 2.1, LOS 2.a)

Question #66 - 67 of 101 Question ID: 1472108

Using the simple linear trend model, the forecast of sales for Very Vegan for the first out-of-
sample period is:

A) $97.6 million.
B) $113.0 million.
C) $123.0 million.

Explanation

The forecast is 10.0015 + (13 × 6.7400) = 97.62.

(Module 2.1, LOS 2.a)

Question #67 - 67 of 101 Question ID: 1472109

Using the log-linear trend model, the forecast of sales for Very Vegan for the first out-of-
sample period is:

A) $109.4 million.
B) $117.0 million.
C) $121.2 million.

Explanation

The forecast is e2.9803 + (13 × 0.1371) = 117.01.

(Module 2.1, LOS 2.a)

Question #68 of 101 Question ID: 1472186

Barry Phillips, CFA, is analyzing quarterly data. He has estimated an AR(1) relationship (xt =
b0 + b1 × xt-1 + et) and wants to test for seasonality. To do this he would want to see if which
of the following statistics is significantly different from zero?

A) Correlation(et, et-5).

B) Correlation(et, et-4).

C) Correlation(et, et-1).

Explanation

Although seasonality can make the other correlations significant, the focus should be on
correlation(et, et-4) because the 4th lag is the value that corresponds to the same season
as the predicted variable in the analysis of quarterly data.

(Module 2.4, LOS 2.l)

Question #69 of 101 Question ID: 1472118

To qualify as a covariance stationary process, which of the following does not have to be
true?

A) Covariance(xt, xt-2) = Covariance(xt, xt+2).

B) E[xt] = E[xt+1].

C) Covariance(xt, xt-1) = Covariance(xt, xt-2).

Explanation

If a series is covariance stationary then the unconditional mean is constant across periods.
The unconditional mean or expected value is the same from period to period: E[xt] =
E[xt+1]. The covariance between any two observations equal distance apart will be equal,
e.g., the t and t-2 observations with the t and t+2 observations. The one relationship that
does not have to be true is the covariance between the t and t-1 observations equaling
that of the t and t-2 observations.

(Module 2.2, LOS 2.c)

Question #70 of 101 Question ID: 1472094

Modeling the trend in a time series of a variable that grows at a constant rate with
continuous compounding is best done with:

A) simple linear regression.

B) a log-linear transformation of the time series.
C) a moving average model.

Explanation

The log-linear transformation of a series that grows at a constant rate with continuous
compounding (exponential growth) will cause the transformed series to be linear.

(Module 2.1, LOS 2.a)

Question #71 of 101 Question ID: 1472141

Suppose that the time series designated as Y is mean reverting. If Yt+1 = 0.2 + 0.6 Yt, the best
prediction of Yt+1 is:

A) 0.5.
B) 0.8.
C) 0.3.

Explanation
The prediction is Yt+1 = b0 / (1-b1) = 0.2 / (1-0.6) = 0.5

(Module 2.2, LOS 2.f)

Question #72 of 101 Question ID: 1508640

The data below yields the following AR(1) specification: xt = 0.9 – 0.55xt-1 + Et , and the
indicated fitted values and residuals.

Time xt fitted values residuals

1 1 - -

2 -1 0.35 -1.35

3 2 1.45 0.55

4 -1 -0.2 -0.8

5 0 1.45 -1.45

6 2 0.9 1.1

7 0 -0.2 0.2

8 1 0.9 0.1

9 2 0.35 1.65

The following sets of data are ordered from earliest to latest. To test for ARCH, the
researcher should regress:

A) (1, 4, 1, 0, 4, 0, 1, 4) on (1, 1, 4, 1, 0, 4, 0, 1).

(-1.35, 0.55, -0.8, -1.45, 1.1, 0.2, 0.1, 1.65) on (0.35, 1.45, -0.2, 1.45, 0.9, -0.2, 0.9,
B)
0.35).
(1.8225, 0.3025, 0.64, 2.1025, 1.21, 0.04, 0.01) on (0.3025, 0.64, 2.1025, 1.21,
C)
0.04, 0.01, 2.7225).

Explanation
The test for ARCH is based on a regression of the squared residuals on their lagged values.
The squared residuals are (1.8225, 0.3025, 0.64, 2.1025, 1.21, 0.04, 0.01, 2.7225). So,
(1.8225, 0.3025, 0.64, 2.1025, 1.21, 0.04, 0.01) is regressed on (0.3025, 0.64, 2.1025, 1.21,
0.04, 0.01, 2.7225). If coefficient a1 in:
2 2
ε̂ = a0 + a1 ε̂ + μ
t t-1 t

is statistically different from zero, the time series exhibits ARCH(1).

(Module 2.5, LOS 2.m)

Question #73 of 101 Question ID: 1508636

Consider the estimated model xt = -6.0 + 1.1 xt-1 + 0.3 xt-2 + εt that is estimated over 50

periods. The value of the time series for the 49th observation is 20 and the value of the time
series for the 50th observation is 22. What is the forecast for the 51st observation?

A) 23.
B) 24.2.
C) 30.2.

Explanation

Forecasted x51 = -6.0 + 1.1 (22) + 0.3 (20) = 24.2.

(Module 2.2, LOS 2.d)

Question #74 of 101 Question ID: 1472188

Which of the following statements regarding seasonality is least accurate?

The presence of seasonality makes it impossible to forecast using a time-series

A)
model.
A time series that is first differenced can be adjusted for seasonality by
B) incorporating the first-differenced value for the previous year's corresponding
period.
Not correcting for seasonality when, in fact, seasonality exists in the time series
C)
results in a violation of an assumption of linear regression.

Explanation
The goal of a time series model is to identify factors that can be predicted. Seasonality in a
time series refers to patterns that repeat at regular intervals. When a time series exhibits
seasonality, seasonal lags should be included in the model in order to increase its
predictive ability.

(Module 2.4, LOS 2.l)

Question #75 of 101 Question ID: 1508646

Consider the following estimated model:

(Salest - Sales t-1)= 100 - 1.5 (Sales t-1 - Sales t-2) + 1.2 (Sales t-4 - Sales t-5) t=1,2,.. T

and Sales for the periods 1999.1 through 2000.2:

t Period Sales

T 2000.2 $1,000

T-1 2000.1 $900

T-2 1999.4 $1,200

T-3 1999.3 $1,400

T-4 1999.2 $1,000

T-5 1999.1 $800

The forecasted Sales amount for 2000.3 is closest to:

A) $730.00.
B) $1,430.00.
C) $1,730.00.

Explanation

Change in sales = $100 - 1.5 ($1,000-900) + 1.2 ($1,400-1,000)

Change in sales = $100 - 150 + 480 =$430

Sales = $1,000 + 430 = $1,430

(Module 2.5, LOS 2.n)

Question #76 of 101 Question ID: 1472189

The table below shows the autocorrelations of the lagged residuals for the first differences
of the natural logarithm of quarterly motorcycle sales that were fit to the AR(1) model: (ln
salest − ln salest − 1) = b0 + b1(ln salest − 1 − ln salest − 2) + εt. The critical t-statistic at 5%
significance is 2.0, which means that there is significant autocorrelation for the lag-4
residual, indicating the presence of seasonality. Assuming the time series is covariance
stationary, which of the following models is most likely to CORRECT for this apparent
seasonality?

Lagged Autocorrelations of First Differences in the Log of Motorcycle Sales

Lag Autocorrelation Standard Error t-Statistic

1 −0.0738 0.1667 −0.44271

2 −0.1047 0.1667 −0.62807

3 −0.0252 0.1667 −0.15117

4 0.5528 0.1667 3.31614

A) (ln salest − ln salest − 4) = b0 + b1(ln salest − 1 − ln salest − 2) + εt.

B) ln salest = b0 + b1(ln salest − 1) − b2(ln salest − 4) + εt.

(ln salest − ln salest − 1) = b0 + b1(ln salest − 1 − ln salest − 2) + b2(ln salest − 4 − ln

C)
salest − 5) + εt.

Explanation

Seasonality is taken into account in an autoregressive model by adding a seasonal lag

variable that corresponds to the seasonality. In the case of a first-differenced quarterly
time series, the seasonal lag variable is the first difference for the fourth time period.
Recognizing that the model is fit to the first differences of the natural logarithm of the
time series, the seasonal adjustment variable is (ln salest − 4 − ln salest − 5).

(Module 2.4, LOS 2.l)

Question #77 of 101 Question ID: 1472138

Which of the following statements regarding a mean reverting time series is least accurate?

A) If the time-series variable is x, then xt = b0 + b1xt-1.

 If the current value of the time series is above the mean reverting level, the
B)
prediction is that the time series will decrease.
If the current value of the time series is above the mean reverting level, the
C)
prediction is that the time series will increase.

Explanation

If the current value of the time series is above the mean reverting level, the prediction is
that the time series will decrease; if the current value of the time series is below the mean
reverting level, the prediction is that the time series will increase.

(Module 2.2, LOS 2.f)

Question #78 of 101 Question ID: 1472204

Alexis Popov, CFA, is analyzing monthly data. Popov has estimated the model xt = b0 + b1 ×
xt-1 + b2 × xt-2 + et. The researcher finds that the residuals have a significant ARCH process.
The best solution to this is to:

A) re-estimate the model using only an AR(1) specification.

B) re-estimate the model using a seasonal lag.
C) re-estimate the model with generalized least squares.

Explanation

If the residuals have an ARCH process, then the correct remedy is generalized least
squares which will allow Popov to better interpret the results.

(Module 2.5, LOS 2.o)

Question #79 of 101 Question ID: 1472144

William Zox, an analyst for Opal Mountain Capital Management, uses two different models
to forecast changes in the inflation rate in the United Kingdom. Both models were
constructed using U.K. inflation data from 1988-2002. In order to compare the forecasting
accuracy of the models, Zox collected actual U.K. inflation data from 2004-2005, and
compared the actual data to what each model predicted. The first model is an AR(1) model
that was found to have an average squared error of 10.429 over the 12 month period. The
second model is an AR(2) model that was found to have an average squared error of 11.642
over the 12 month period. Zox then computed the root mean squared error for each model
to use as a basis of comparison. Based on the results of his analysis, which model should
Zox conclude is the most accurate?

A) Model 1 because it has an RMSE of 3.23.

B) Model 1 because it has an RMSE of 5.21.
C) Model 2 because it has an RMSE of 3.41.

Explanation

The root mean squared error (RMSE) criterion is used to compare the accuracy of
autoregressive models in forecasting out-of-sample values. To determine which model will
more accurately forecast future values, we calculate the square root of the mean squared
error. The model with the smallest RMSE is the preferred model. The RMSE for Model 1 is
√10.429 = 3.23, while the RMSE for Model 2 is √11.642 = 3.41. Since Model 1 has the lowest
RMSE, that is the one Zox should conclude is the most accurate.

(Module 2.2, LOS 2.g)

Question #80 of 101 Question ID: 1508637

Suppose that the following time-series model is found to have a unit root:

Salest = b0 + b1 Sales t-1+ εt

What is the specification of the model if first differences are used?

A) Salest = b0 + b1 Sales t-1 + b2 Sales t-2 + εt.

B) (Salest - Salest-1)= b0 + b1 (Sales t-1 - Sales t-2) + εt.

C) Salest = b1 Sales t-1+ εt.

Explanation

Estimation with first differences requires calculating the change in the variable from
period to period.

(Module 2.3, LOS 2.j)

Question #81 of 101 Question ID: 1472112

Rhonda Wilson, CFA, is analyzing sales data for the TUV Corp, a current equity holding in her
portfolio. She observes that sales for TUV Corp. have grown at a steadily increasing rate over
the past ten years due to the successful introduction of some new products. Wilson
anticipates that TUV will continue this pattern of success. Which of the following models is
most appropriate in her analysis of sales for TUV Corp?

A log-linear trend model, because the data series can be graphed using a
A)
straight, upward-sloping line.
A linear trend model, because the data series is equally distributed above and
B)
below the line and the mean is constant.
A log-linear trend model, because the data series exhibits a predictable,
C)
exponential growth trend.

Explanation

The log-linear trend model is the preferred method for a data series that exhibits a trend
or for which the residuals are predictable. In this example, sales grew at an exponential, or
increasing rate, rather than a steady rate.

(Module 2.1, LOS 2.b)

Vikas Rathod, an enrolled candidate for the CFA Level II examination, has decided to perform
a calendar test to examine whether there is any abnormal return associated with
investments and disinvestments made in blue-chip stocks on particular days of the week. As
a proxy for blue-chips, he has decided to use the S&P 500 index. The analysis will involve the
use of dummy variables and is based on the past 780 trading days. Here are selected
findings of his study:

RSS 0.0039

SSE 0.9534

SST 0.9573

R-squared 0.004

SEE 0.035

Jessica Jones, CFA, a friend of Rathod, overhears that he is interested in regression analysis
and warns him that whenever heteroskedasticity is present in multiple regression this could
undermine the regression results. She mentions that one easy way to spot conditional
heteroskedasticity is through a scatter plot, but she adds that there is a more formal test.
Unfortunately, she can't quite remember its name. Jessica believes that heteroskedasticity
can be rectified using White-corrected standard errors. Her son Jonathan who has also taken
part in the discussion, hears this comment and argues that White correction would typically
reduce the number of Type I errors in financial data.

Question #82 - 87 of 101 Question ID: 1508642

How many dummy variables should Rathod use?

A) Four.
B) Six.
C) Five.

Explanation

There are 5 trading days in a week, but we should use (n − 1) or 4 dummies in order to
ensure no violations of regression analysis occur.

(Module 2.5, LOS 2.m)

Question #83 - 87 of 101 Question ID: 1472196

What is most likely represented by the intercept of the regression?

A) The drift of a random walk.

B) The return on a particular trading day.
C) The intercept is not a driver of returns, only the independent variables.

Explanation

The omitted variable is represented by the intercept. So, if we have four variables to
represent Monday through Thursday, the intercept would represent returns on Friday.

(Module 2.3, LOS 2.k)

Question #84 - 87 of 101 Question ID: 1472197

What can be said of the overall explanatory power of the model at the 5% significance?

The coefficient of determination for the above regression is significantly higher

A) than the standard error of the estimate, and therefore there is value to calendar
trading.
B) There is value to calendar trading.
C) There is no value to calendar trading.

Explanation

This question calls for a computation of the F-stat. F = (0.0039/4)/(0.9534/(780−4−1) = 0.79.

The critical F is somewhere between 2.37 and 2.45 so we fail to reject the Null that all the
coefficients are equal to zero.

(Module 2.3, LOS 2.k)

Question #85 - 87 of 101 Question ID: 1508643

The test mentioned by Jessica is known as the:

A) Breusch-Pagan, which is a two-tailed test.

B) Breusch-Pagan, which is a one-tailed test.
C) Durbin-Watson, which is a two-tailed test.

Explanation

The Breusch-Pagan is used to detect conditional heteroskedasticity and it is a one-tailed

test. This is because we are only concerned about large values in the residuals coefficient
of determination.

(Module 2.3, LOS 2.k)

Question #86 - 87 of 101 Question ID: 1508644

Are Jessica and her son Jonathan, correct in terms of the method used to correct for
heteroskedasticity and the likely effects?

A) Neither is correct.
B) Both are correct.
C) One is correct.
Explanation

Jessica is correct. White-corrected standard errors are also known as robust standard
errors. Jonathan is correct because White-corrected errors are higher than the biased
errors leading to lower computed t-statistics and therefore less frequent rejection of the
Null Hypothesis (remember incorrectly rejecting a true Null is Type I error).

(Module 2.3, LOS 2.k)

Question #87 - 87 of 101 Question ID: 1472200

Assuming the a1 term of an ARCH(1) model is significant, the following can be forecast:

A) The variance of the error term.

B) A significant a1 implies that the ARCH framework cannot be used.
C) The square of the error term.

Explanation

A Model is ARCH(1) if the coefficient a1 is significant. It will allow for the estimation of the
variance of the error term.

(Module 2.3, LOS 2.k)

Question #88 of 101 Question ID: 1472150

Which of the following statements regarding time series analysis is least accurate?

If a time series is a random walk, first differencing will result in covariance

A)
stationarity.
B) We cannot use an AR(1) model on a time series that consists of a random walk.
An autoregressive model with two lags is equivalent to a moving-average model
C)
with two lags.

Explanation

An autoregression model regresses a dependent variable against one or more lagged

values of itself whereas a moving average is an average of successive observations in a
time series. A moving average model can have lagged terms but these are lagged values of
the residual.

(Module 2.3, LOS 2.i)

Question #89 of 101 Question ID: 1472143

Which of the following statements regarding an out-of-sample forecast is least accurate?

Out-of-sample forecasts are of more importance than in-sample forecasts to

A)
the analyst using an estimated time-series model.
There is more error associated with out-of-sample forecasts, as compared to in-
B)
sample forecasts.
C) Forecasting is not possible for autoregressive models with more than two lags.

Explanation

Forecasts in autoregressive models are made using the chain-rule, such that the earlier
forecasts are made first. Each later forecast depends on these earlier forecasts.

(Module 2.2, LOS 2.g)

Question #90 of 101 Question ID: 1472139

The regression results from fitting an AR(1) to a monthly time series are presented below.
What is the mean-reverting level for the model?

Model: ΔExpt = b0 + b1ΔExpt–1 + εt

Coefficients Standard Error t-Statistic p-value

Intercept 1.3304 0.0089 112.2849 < 0.0001

Lag-1 0.1817 0.0061 30.0125 < 0.0001

A) 0.6151.
B) 7.3220.
C) 1.6258.

Explanation

The mean-reverting level is b0 / (1 − b1) = 1.3304 / (1 − 0.1817) = 1.6258.

(Module 2.2, LOS 2.f)

Question #91 of 101 Question ID: 1508635

Consider the estimated model xt = −6.0 + 1.1 xt − 1 + 0.3 xt − 2 + εt that is estimated over 50

periods. The value of the time series for the 49th observation is 20 and the value of the time
series for the 50th observation is 22. What is the forecast for the 52nd observation?

A) 42.
B) 24.2.
C) 27.22.

Explanation

Using the chain-rule of forecasting,

Forecasted x51 = −6.0 + 1.1(22) + 0.3(20) = 24.2.

Forecasted x52 = −6.0 + 1.1(24.2) + 0.3(22) = 27.22.

(Module 2.2, LOS 2.d)

Question #92 of 101 Question ID: 1472206

Alexis Popov, CFA, has estimated the following specification: xt = b0 + b1 × xt-1 + et. Which of
the following would most likely lead Popov to want to change the model's specification?

A) Correlation(et, et-2) is significantly different from zero.

B) b0 < 0.

C) Correlation(et, et-1) is not significantly different from zero.

Explanation

If correlation(et, et-2) is not zero, then the model suffers from 2nd order serial correlation.
Popov may wish to try an AR(2) model. Both of the other conditions are acceptable in an
AR(1) model.

(Module 2.5, LOS 2.o)

Bert Smithers, CFA, is a sell-side analyst who has been asked to look at the luxury car sector.
He has hypothesized that sales of luxury cars have grown at a constant rate over the past 15
years.

Exhibit 1
b0 0.4563

b1 0.6874

Standard error 0.3745

R-squared 0.7548

Durbin-Watson 1.23

F 12.63

Observations 15

20X1 sales ($bn) 1.05

Question #93 - 98 of 101 Question ID: 1472172

If his assumption about a constant is correct, which of the following models is most
appropriate for modeling these data?

A) LuxCarSalest = b0 + b1LuxCarSales(t-1) + et.

B) ln(LuxCarSales) = b0 + b1(t) + et.

C) LuxCarSales = b0 + b1(t) + et.

Explanation

Whenever the rate of change is constant over time, the appropriate model is a log- linear
trend model. A is a linear trend model and C is an autoregressive model.

(Module 2.1, LOS 2.b)

Question #94 - 98 of 101 Question ID: 1472173

After discussing the above matter with a colleague, Bert finally decides to use an annual
autoregressive model of Order One [i.e., AR(1)]. Using the data in Exhibit 1, calculate the
mean reverting level of the series.

A) 1.66.
B) 1.26.
C) 1.46.

Explanation

The formula for the mean reverting level is:

b0 0.4563
= = 1.46
(1−b1 ) (1−0.6874)

(Module 2.2, LOS 2.f)

Question #95 - 98 of 101 Question ID: 1472174

Bert is aware that the Dickey Fuller test can be used to discover whether a model has a unit
root. He is also aware that the test would use a revised set of critical t-values. What would it
mean to Bert to reject the null of the Dickey Fuller test (Ho: g = 0)?

A) There is a unit root and the model cannot be used in its current form.
B) There is a unit root but the model can be used if covariance-stationary.
C) There is no unit root.

Explanation

The null hypothesis of g = 0 actually means that b1 – 1 = 0, this will be the case if b1 = 1.
Since we have rejected the null, we can conclude that the model has no unit root.

(Module 2.3, LOS 2.j)

Question #96 - 98 of 101 Question ID: 1472175

Bert would also like to test for serial correlation in his AR(1) model. How could this be done?

A) use the provided Durbin-Watson statistic and compare it to a critical value.

determine if the series has a finite and constant covariance between leading
B)
and lagged terms of itself.
C) use a t-test on the residual autocorrelations over several lags.

Explanation

To test for serial correlation in an AR model, test for the significance of residual
autocorrelations over different lags. The goal is for all t-statistics to lack statistical
significance. A is only used for trend models and C is one of the requirements of
covariance stationarity.

(Module 2.2, LOS 2.e)

Question #97 - 98 of 101 Question ID: 1472176

When using the root mean squared error (RMSE) criterion to evaluate the predictive power
of the model, which of the following is the most appropriate statement?

A) Use the model with the lowest RMSE calculated using the in-sample data.
B) Use the model with the lowest RMSE calculated using the out-of-sample data.
C) Use the model with the highest RMSE calculated using the in-sample data.

Explanation

RMSE, or root of the mean squared error, is a measure similar to the SEE from multiple
regression. The lower, the better. It should be calculated on the out-of-sample data (i.e.,
the data not directly used in the development of the model) as this will be a better test of
the relevance and predictive power of the model going forward. This measure thus
indicates the predictive power of our model.

(Module 2.2, LOS 2.g)

Question #98 - 98 of 101 Question ID: 1472177

Bert would like to use his AR(1) model to forecast future sales of luxury automobiles. What is
the annualized growth rate between today and 20X3?

A) 11%.
B) 12%.
C) 10%.

Explanation
To get the 20X2 value, plug today's value of 1.05 into the model:

0.4563 + 0.6874 × 1.05 = 1.18.

Then use the result, 1.18, to forecast 20X3 as follows:

0.4563 + 0.6874 × 1.18 = 1.27.

The annualized return between 20X1 and 20X3 is, therefore, (1.27 / 1.05)0.5 – 1 = 9.87%.

(Module 2.2, LOS 2.d)

Question #99 of 101 Question ID: 1472119

Which of the following statements regarding covariance stationarity is CORRECT?

The estimation results of an AR model involving a time series that is not

A)
covariance stationary are meaningless.
A time series that is covariance stationary may have residuals whose mean
B)
changes over time.
C) A time series may be both covariance stationary and heteroskedastic.

Explanation

Covariance stationarity requires that the expected value and the variance of the time
series be constant over time.

(Module 2.2, LOS 2.c)

Question #100 of 101 Question ID: 1472128

Troy Dillard, CFA, has estimated the following equation using quarterly data: xt = 93 - 0.5×xt–

1 + 0.1×xt– 4 + et. Given the data in the table below, what is Dillard's best estimate of the first

quarter of 2007?

Time Value

2005: I 62

2005: II 62

2005: III 66

2005: IV 66

2006: I 72

2006: II 70

2006: III 64

2006: IV 66

A) 66.60.
B) 66.40.
C) 67.20.

Explanation

To get the answer, Dillard will use the data for 2006: IV and 2006: I, xt– 1 = 66 and xt– 4 = 72
respectively:

E[x2007:I] = 93– 0.5×xt– 1 + 0.1×xt– 4

E[x2007:I] = 93– 0.5×66 + 0.1×72

E[x2007:I] = 67.20

(Module 2.2, LOS 2.d)

Question #101 of 101 Question ID: 1472162

Which of the following statements regarding unit roots in a time series is least accurate?

A) A time series that is a random walk has a unit root.

B) A time series with a unit root is not covariance stationary.
 Even if a time series has a unit root, the predictions from the estimated model
C)
are valid.

Explanation

The presence of a unit root means that the least squares regression procedure that we
have been using to estimate an AR(1) model cannot be used without transforming the data
first.

A time series with a unit root will follow a random walk process. Since a time series that
follows a random walk is not covariance stationary, modeling such a time series in an AR
model can lead to incorrect statistical conclusions, and decisions made on the basis of
these conclusions may be wrong. Unit roots are most likely to occur in time series that
trend over time or have a seasonal element.

(Module 2.3, LOS 2.k)