Mock Exam 2023 #5 Second Session Corporate Finance, Equity, Fixed

Level I of the CFA® Exam
Mock Questions with Answers - Mock Exam 2023 #5 - Second

Session (Corporate Finance, Equity, Fixed Income, Derivatives,
Alternative Investments & Portfolio Management)
Offered by AnalystPrep
Last Updated: Sep 5, 2023
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Q.1 What will most likely happen to EBIT if a firm's sales (with a degree of operating leverage (DOL)
of 2.25) increase by 10%?
A. A 2.25% increase.
B. A 22.5% increase.
C. A 22.5% decrease.
T he correct answer is B.
Degree of operating leverage (DOL) measures the sensitivity of a firm's operating income to a
change in the firm's number of units sold.
A degree of operating leverage (DOL) ratio of 2.25 suggests that a 10% increase in sales will result in
a increase in EBIT, i.e.,
Percentage change in operating income (EBIT )

Degree of leverage =
Percentage change in sales
Percentage change in operating income (EBIT )
∴ 2.25 =
10%
⇒ Percentage change is operating income = 2.25% × 10% = 22.5%
A i s i ncorrect. We have to multiply the percentage change in sales by the degree of operating
leverage to get the percentage change in operating income.
C i s i ncorrect. T he operating income will increase and not decrease. It would have decreased if
the number of units sold had decreased.
CFA Level 1, Vol ume 4, Readi ng 35 – Measures of Leverage, LOS 35b: cal cul ate and
i nterpret the degree of operati ng l everage, the degree of fi nanci al l everage, and the
degree of total l everage.
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© 2014-2023 AnalystPrep.
Q.2 Which of the following most accurately describes a situation where shareholders sell their
interests directly to a group seeking company control?
A. A tender offer.
B. A proxy fight.
C. A hostile takeover.
T he correct answer is A.
A tender offer describes a corporate takeover mechanism involving shareholders selling their
interests directly to the group seeking control.
B i s i ncorrect. In a proxy fight, shareholders are persuaded to vote for a group seeking a
controlling position on the company's board of directors.
C i s i ncorrect. In a hostile takeover, an attempt is made by one entity to acquire another company
without the consent of the company's management.
CFA Level 1, Readi ng 29 – Introducti on to Corporate Governance and other ESG
consi derati ons, LOS 29g: Descri be mark et and non-mark et factors that can affect
stak ehol der rel ati onshi ps and corporate governance
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Q.3 If Degree of Financial Leverage (DFL) is 1.0, what is the relationship between the operating
breakeven point and the breakeven point? T he operating breakeven point is:
A. equal to the breakeven point.
B. lower than the breakeven point.
C. higher than the breakeven point.
T he degree of financial leverage measures the sensitivity of the cash flows available to shareholders
to a change in operating income.
It is calculated using the formula below:
EBIT
DFL =
EBIT-Interest
A DFL of 1 implies that interest is zero.
T he breakeven and operating breakeven points are obtained using the formulas below
Fixed cost+Interest
Breakeven point =
Contribution margin
Fixed costs
Operaoting Breakeven point
Contribution margin
Since interest (the only variable present in the breakeven point formula and lacking in the operating
breakeven point formula) is zero, the breakeven point equals the operating breakeven point.
B and C are i ncorrect. When the degree of financial leverage (DFL) ratio is 1, the breakeven
point will equal the operating breakeven point.
CFA Level 1, Vol ume 4, Readi ng 35 – Measures of Leverage, LOS 35a: defi ne and expl ai n
l everage, busi ness ri sk , sal es ri sk , operati ng ri sk , and fi nanci al ri sk and cl assi fy
ri sk .
Q.4 Cinnamon Company recently issued 5-year zero-coupon bonds for a total face value of $100
4
million at the price of $74.72 million to raise 50% of its capital. T he company's cost of equity is
13%, and the firm earned before tax income of $16 million last year. Assuming that the company
distributed all of its earnings in dividends of $1.28 to its 10 million common shareholders, then
Cinnamon's weighted average cost of capital is closest to:
A. 8.90%.
B. 9.50%.
C. 12.50%.
Weighted Average Cost of Capital (WACC);
WACC = (After-tax cost of debt × Weight of debt) + (Cost of equity × Weight of equity)
Since Cinnamon issued $100 million in debt to raise 50% of its capital, the capital of the firm
(weights) consists of 50% debt and 50% equity.
T he cost of debt is not provided in the question, but since the price of zero-coupon bonds is given,
we can derive the cost of debt with the help of the financial calculator's T VM function.
Cinnamon's cost of debt is 6% (N=5; PV=-74.72; PMT =0; FV=100; CPT => I/Y = 6%).
To calculate the WACC, we need the after-tax cost of debt which is again not provided in the
question. However, the question mentions that the firm earned pre-tax income (or EBT ) of $16
million, out of which the firm distributed all its earning as a dividend of $1.28 to its 10 million
shareholders which means the total dividend (or total after-tax earnings) is $12.8 million.
Given this information we can calculate the firm's tax as
(EBT − EAT ) (16 − 12.8)

= = 0.2
EBT 16
Lastly, using the WACC formula we can calculate the cost of capital as:
(6% × (1 − 0.2)0.5) + (13% × 0.5) = 8.9%
CFA Level 1, Vol ume 4, Readi ng 33 – Cost of Capi tal - Foundati onal topi cs, LOS 33a:
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cal cul ate and i nterpret the wei ghted average cost of capi tal (WACC) of a company;
Q.5 A public company is least likely described as a:
A. company affiliated with the government.
B. company whose shares are listed on an exchange.
C. company registered with a regulatory body and, as such, is subject to greater compliance
and reporting requirements.
A private company need not have government attachment. A company can be considered public or
private based on the following factors:
Exchange l i sti ng and exchange ownershi p: T he shares of a public company are
listed and traded on an exchange. T his allows the ownership of such a company to easily be
transferred since buyers and sellers transact directly with each other in the secondary
market. On the other hand, private companies' shares are not listed on an exchange. For
this reason, there is no noticeable valuation or price transparency, making it difficult to
buy and sell shares.
Regi strati on and di scl osure requi rements: Public companies are obligated to
register with a regulatory authority. T he implication of this is that they are subject to
greater compliance and reporting requirements. Private companies, on the other hand, are
not subject to the same level of regulatory authority as public companies. However, some
pertinent rules, such as filing of tax returns and prohibitions against fraud are still
applicable.
Issuance of shares: Public companies may issue additional shares in the capital markets
to raise huge amounts of capital from investors. In contrast, private companies invite
investors to purchase their shares through a private placement memorandum (PPM also
called offering memorandum). PPM is a document that describes a business, the terms of
offering, and the risks involved in investing in the company.
CFA Level 1, Vol ume 3, Readi ng 28 – Corporate Structures and Ownershi ps, LOS 28a:
Compare busi ness structures and descri be k ey features of corporate i ssuers.
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Q.6 Best corporate management practices most appropriately suggest that:
A. all Board of Directors members should be independent.
B. at least 50% of all members on the Board of Directors should be independent.
C. at least 75% of all members on the Board of Directors should be independent.
T he correct answer is C.
According to the CFA curriculum, best practices suggest that at least 75% of the board members
should be independent.
CFA Level 1, Vol ume 3, Readi ng 29 – Introducti on to Corporate Governance and other
ESG consi derati ons, LOS 29f: descri be functi ons and responsi bi l i ti es of a company's
board of di rectors and i ts commi ttees.
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Q.7 Damascus T rading Corp. is a shoe manufacturer in Syria with a risk-free rate of 5%, a market
return of 10%, and a Beta of 1.2. T he resulting cost of (equity) capital is closest to;
A. 6%
B. 11%
C. 18%
CAPM or cost of capital of stocks of Damascus is calculated as;
CAPM = Risk − Free rate + Beta × (Market Risk − Risk − Free rate)
Er = 5% + 1.2(10% − 5%)
= 11%
A i s i ncorrect. It is the market premium multiplied by beta, not the resulting cost of capital, as
shown below.
Er = 1.2(10% − 5%) = 6%
C i s i ncorrect. 23\% results from incorrectly adding the risk-free rate to the market risk when
calculating the market risk premium, as shown below.
Er = 1.2(10% + 5%) = 18%
CFA Level 1, Vol ume 4, Readi ng 33 –Cost of Capi tal -Foundati onal Topi cs, LOS 33e:
Cal cul ate and i nterpret the cost of equi ty capi tal usi ng the capi tal asset pri ci ng model
approach and the bond yi el d pl us ri sk premi um approach.
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Q.8 T he contribution margin per unit for product A is $25, and the firm’s fixed costs of production up
to 500,000 units is $400,000. T he degree of operating leverage (DOL) at 300,000 units is closest to:
A. 0.62
B. 1.03
C. 1.06
Contributions margins
DOL =
Contribution margin-Fixed cost
300, 000
= 25 ×
25 × 300, 000 − 400, 000
= 1.056
A i s i ncorrect. 0.62 has been incorrectly obtained by using the wrong number of units in the
denominator, as shown below.
Contribution Margin $25 × 300, 000

DOL = = = 0.62
Contribution Margins-Fixed cost ($25 × 500, 000) − $400, 000
B i s i ncorrect. 1.03 is the firm's operating leverage for 500,000 and not 300,000 units, as shown
below.
Contribution Margin $25 × 500, 000

DOL = = = 1.03
Contribution Margins-Fixed cost ($25 × 500, 000) − $400, 000
CFA Level 1, Vol ume 4, Readi ng 35 – Measures of Leverage, LOS 35b: Cal cul ate and
i nterpret the degree of operati ng l everage, the degree of fi nanci al l everage, and the
degree of total l everage
Q.9 An analyst working in the corporate finance department of AlfaZone Corporation is trying to
estimate the optimal capital structure for his firm. Exhibit 1 outlines the firm’s most important
financial information critical parameters, and exhibit 2 shows the firm's debt schedule.
Exhibit 1 : Financial Information - AlphaZone
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Asset beta 0.85
Risk-free rate 2%
Market risk premium 4%
Tax rate 30%
Exhibit 2 : Debt Schedule - AlphaZone
Debt-to-equity ratio Cost of debt

0.20 2%
0.40 2.5%
0.60 4.5%
0.80 6%
If the company plans to maintain a debt-to-equity ratio of 0.80, then the firm's weighted average cost
of capital (WACC) would be closest to:
A. 5.13%
B. 5.45%
C. 5.93%
Cost of equity = Risk-free rate + Equity-beta × Market risk premium
We need to calculate the equity beta using the formula:
D
βE = βU [1 + (1 − t) ]
E
Where,
βE = Equity beta.
βU = Asset beta (Unlevered beta).
D
= Debt to equity ratio.
E
T herefore,
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D
βE = βU [1 + (1 − t) ]
E
D
= Asset Beta × (1 + [1 − 30%] × )
E
T herefore,
D
Cost of equity = Risk-free rate + Asset-beta × (1 + [1 − 30%] × ) × Market risk premium
E
D/E Cost of equity Cost of debt WACC

0.20 2% + 0.969 × 4% = 5.876% 2% 5.13%
0.40 2% + 1.088 × 4% = 6.352% 2.5% 5.04%
0.60 2% + 1.207 × 4% = 6.828% 4.5% 5.45%
0.80 2% + 1.326 × 4% = 7.304% 6% 5.93%
T he WACC at its lowest when the D/E ratio = 0.40.
A i s i ncorrect. 5.13% is the company's WACC at a debt-to-equity ratio of 0.2.
B i s i ncorrect. 5.45% is the company's WACC at a debt-to-equity ratio of 0.6.
CFA Level 1, Vol ume 4, Readi ng 34 – Capi tal Structure, LOS 34d: Descri be the use of
target capi tal structure i n esti mati ng WACC and cal cul ate and i nterpret target
capi tal structure wei ghts.
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Q.10 A manufacturer buys its raw materials from an international supplier whose credit terms are
"3/10 net 90". If the invoice is paid on the 50th day, then the cost of trade credit is closest to:
A. 25%
B. 32%
C. 13%
365
Discount Days past discount
Cost of trade credit = [1 + ] −1
1 − Discount
365
0.03 50−10
Cost of trade credit for the manufacturer = [1 + ( )] – 1 = 32.04%
0.97
CFA Level 1, Vol ume 4, Readi ng 32– Work i ng Capi tal , LOS 32d: compare a company’s
l i qui di ty posi ti on wi th that of peers
Q.11 A firm has the option to buy either Machine A or Machine B. Both machines have the same
useful lives, but Machine A is $10,000 more expensive than Machine B.
For the first 3 years, Machine A is expected to produce $45,000 in sales. T hen, its production is
expected to slow down to only $36,000 in sales for the remaining 2 years of useful life. Machine B is
expected to produce $42,000 in sales for all of its useful life.
Assuming a required rate of 10%, the company should most likely purchase:
A. Machine A.
B. Machine B
C. Either Machine A or Machine B.
T he incremental cash flows if Machine A is purchased instead of Machine B
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Incremental cash flow if
Machine A is purchased Remark
(Machine A’s Cash Flow –
Machine B’s Cash Flow)
Year 0 −$10, 000 Machine A is $10,000 more costly than Machine B
Year 1 +$3, 000 Machine A will generate $3,000 more sales than Machine B
Year 4 +$6, 000 Machine B will generate $6,000 more sales than Machine A
Year 5 +$6, 000 Machine B will generate $6,000 more sales than Machine A
3, 000 3,0002 3, 0003 6, 0004 6, 0005

NPV of Machine A− NPV of Machine B = −10, 000 + + + – –
1.1 1.1 1.1 1.1 1.1
= −$10, 363.05
T he company should purchase Machine B since it has a higher NPV than Machine A.
Steps when determining the NPV using the BA II Plus financial calculator;
CFO = -10,000, C01=3,000, C02=3,000, C03=3,000, C04 = -6,000, C05 = -6,000.
T hen press "CPT " "NPV" input "I" as 10, then press "CPT " to get the NPV as -10,363.05.
A and C are i ncorrect. T he company should not purchase Machine A as it has a lower NPV than
Machine B.
CFA Level 1, Vol ume 3, Readi ng 31 – Capi tal Investments, LOS 31c: demonstrate the use
of net present val ue (NPV) and i nternal rate of return (IRR) i n al l ocati ng capi tal and
descri be the advantages and di sadvantages of each method.
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Q.12 An analyst calculated the following ratios for companies A and B:
Company A Company B
Current Ratio 2.5 3.0
Quick Ratio 2.0 1.5
Given the above information, the statement that is most likely to explain the difference in the
liquidity position of companies A and B is:
A. Company B has a smaller proportion of inventories in its current assets compared to

Company A.
B. Company B has a larger proportion of cash and marketable securities in its current assets
compared to Company A.
C. Company B has a smaller proportion of cash and marketable securities in its current
assets compared to Company A.
Since the quick ratio excludes inventories and other illiquid current assets, a lower quick ratio for
Company B indicates that it has a smaller proportion of cash and marketable securities.
A i s i ncorrect. Based on the current ratio, we can't ascertain the proportion of inventory since
the higher current ratio of Company B could be attributed to other factors like an increase in other
items of current assets.
B i s i ncorrect. Company B has a lower proportion of cash and marketable securities in its current
assets than Company A since it has a lower quick ratio.
CFA Level 1, Vol ume 3, Readi ng 32 – Work i ng Capi tal , LOS 32c: compare a company’s
l i qui di ty posi ti on wi th that of peers
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Q.13 In an NPV profile, the point at which the profile crosses the x-axis is most accurately described
as the:
A. project’s IRR.
B. point at which the NPV is at its highest.
C. point at which the discount rate equals 0% and the NPV is the sum of the undiscounted
cash flows for the project.
T he NPV profile shows a project's NPV graphed as a function of various discount rates. T ypically,
the NPV is graphed vertically (on the y-axis), and the discount rates are graphed horizontally (on the
x-axis). At the horizontal axis, the NPV=0 and, by definition, this occurs whenever the discount rate
is equal to the IRR.
CFA Level 1, Vol ume 3, Readi ng 31 – Capi tal Investments, LOS 31c: demonstrate the use
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Q.14 A firm had total sales of $600,000 last year, and 90% of these sales are on credit. If the
receivables turnover is 5, the average collection period (based on a 365-day year) and the year-end
receivables are closest to:
A. 73 days and $100,000.
B. 73 days and $108,000
C. 81 days and $108,000.
365
Accounts Receivable Days =
Receivable turnover ratio
365
=
5
= 73 days
$600, 000
Accounts Receivable balance = 90% ×
5
= $108,000
CFA Level 1, Vol ume 3, Readi ng 32 – Work i ng Capi tal & Li qui di ty, LOS 32d: Compare a
company's l i qui di ty posi ti on wi th that of peer compani es.
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Q.15 Assuming the initial cash outlay of a commercial real estate project is $7 million, and the
project generates identical cash flows of $5 million for 3 years, then estimate the required rate of
return if the NPV of the project is $5.816 million.
A. 6.70%
B. 8.30%
C. 9.50%
Since the project has identical cash inflows, the required rate of return can be estimated using the
T VM function of the financial calculator.
NPV = PV of cash inflows-PV of cash outflows
T herefore,
PV of the project = NPV+PV of cash outflows = $5.816 + $7 = $12.816
T he required rate of return of the project obtained using the BAII Plus Financial Calculator (steps
shown below) is 8.3%.
(N=3, PV=12.816, PMT =5, FV=0, CPT =I).
CFA Level 1, Vol ume 4, Readi ng 31 –Capi tal Investments, LOS 31d: Demonstrate the use
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Q.16 Consider the following information:
Company Market Value of Debt Market of Value of Equity

A $120 $150
B $80 $90
C $150 $180
A fourth company, Company X, operates in the same industry. Using the competitor’s capital
structure, what would be Company’s X proportions of debt and equity?
A. 45.65% debt; 54.34% equity.
B. 54.34% debt; 45.65% equity.
C. 44.65% debt; 55.35% equity.
Market value of the debt $120 $80 $150

Weightdebt = = + + =
Market value of the debt +Market Value of equity
$(120 + 150) $(80 + 90) $(150 + 180)
To get the weighted average cost of debt, we have to divide by 3:
1.3695
= 0.4565
3
Market value of the equity $150 $90 $180

Weightdebt = = + + =
Market value of the debt +Market Value of equity
$(150 + 120) $(90 + 80) $ (180 + 150)
To get the weighted average cost of equity, we have to divide by 3:
1.63005
= 0.5434
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CFA Level 1, Vol ume 4, Readi ng 34 – Capi tal Structure, LOS 34d: Descri be the use of
target capi tal structure i n esti mati ng WACC and cal cul ate and i nterpret target
capi tal structure wei ghts.
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Q.17 Which of the following is least likely an assumption of Modigliani–Miller?
A. Investors have homogeneous expectations.
B. Investors lend and borrow money at a fixed rate.
C. Financing and investment decisions are independent of each other.
One of the assumptions of Modigliani-Miller is that investors can borrow and lend money at a risk-
free rate and not at a fixed rate. T he other assumptions are:
i. Homogenous expectations: Investors have similar expectations regarding future cash flows.
ii. Perfect capital markets: T here are no transaction costs, bankruptcy costs, and taxes.
Additionally, all investors have the same information.
iii. No agency costs: Managers all aim to maximize shareholder wealth.
iv. Independent decisions: Investment and financing decisions are independent of each other.
CFA Level 1, Vol ume 4, Readi ng 34 – Capi tal Structure, LOS 34c: Expl ai n the
Modi gl i ani -Mi l l er proposi ti ons regardi ng capi tal structure.
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Q.18 Mehmet Khali is a project analyst at Excel Investments. He is analyzing two independent
projects - A and Z. Both projects have positive net cash flows, but Project's A cash flow is greater
than project Z. Which project should Khali most likely accept?
A. Project Z.
B. Project A.
C. Project A and Z.
Since the projects are independent, he can accept projects A and Z since they both have positive
NPVs.
If the projects were dependent, Khali would have accepted the project with the highest NPV.
CFA Level 1, Vol ume 3, Readi ng 31– Capi tal Investments, LOS 31c: Demonstrate the use
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Q.19 Assume that a total and price return index for the same group of stocks start with the same
value. While comparing the two indices, the year-end total return index will most likely be:
I. Greater than the price index if the price index falls and lower than the price index if the
price index rises.
II. T he same as the price index if the constituent stocks do not pay dividends.
III. Greater than the price index if the constituent stock pay dividends.
A. I and II.
B. II and III.
C. I, II and III.
While calculating index value only prices of the constituent securities are considered in the price
index whereas the prices and the dividends paid are considered in the total return index. Assuming
none of the constituents pay dividends, then the total return index will be the same as the price index
at the end of the year. Otherwise, the total return index will be greater than the price index.
CFA Level 1, Vol ume 4, Readi ng 37 – Securi ty Mark et Indi ces, LOS 37b: Cal cul ate and
i nterpret an i ndex's val ue, pri ce return, and total return.
21
Q.20 T he type of equity wherein the company needs to pay a scheduled dividend that has been
missed before paying any dividend to common equity holders is most likely ;
A. Convertible preference shares.
B. Cumulative preference shares.
C. Participating preference shares.
Cumulative preference shares are preferred shares whose shareholders receive any pending
dividend payments before other classes of shareholders receive their dividends.
A i s i ncorrect. Convertible preference shares are preference shares that can be converted to
common shares at a fixed conversion ratio at a specific date or after a predetermined period.
Preference shareholders convert their shares to common shares once the market price of common
shares exceeds the conversion price to earn an immediate profit. T he preference shareholders
become common shareholders after conversion.
C i s i ncorrect. Participating preferred stock is a preferred stock that gives the holder the right to
receive dividends equal to the customarily specified rate that preferred dividends are paid to
preferred shareholders and an additional dividend based on some predetermined condition.
CFA Level 1, Vol ume 4, Readi ng 36 – Mark et Organi zati on and Structure, LOS 36c:
Descri be the maj or types of securi ti es, currenci es, contracts, commodi ti es, and real
assets that trade in organi zed mark ets, i ncl udi ng thei r di sti ngui shi ng
characteri sti cs and maj or subtypes.
22
Q.21 Calculate the present value of a stock if the stock is expected to pay dividends of $1.50 and $2
at the end of the 1st and 2nd year, respectively. At the end of the second year, the stock is expected
to sell for $25. Assuming that the required rate of return of 12%, the stock's intrinsic value is :
A. $22.86
B. $24.50
C. $26.36
We use the dividend discount model to estimate the intrinsic value of a dividend-paying company.
T he formula used to estimate intrinsic value using the dividend discount model is:
Dt Pn
Vo = ∑n(t=1) (1+r) + (1+r) n
Where:
Vo - the present value of a stock today,
Dt -- expected dividend in year t,
r -- required rate of return, and
P n -- selling price of the stock at the end of the investment horizon.
T he stock pays a dividend of $1.50 at the end of the first year. We have to account for it in our
calculation, as shown in the first part of the below equation. T he second part of the equation
represents the accumulation of year 2's dividend and stock price discounted at the required rate of
return.
1.5 (2 + 25)
( )+( ) = $22.86
1.121 1.122
CFA Level 1, Vol ume 4, Readi ng 41 – Equi ty Val uati on: Concepts and Basi c Tool s, LOS
41g: Cal cul ate and i nterpret the i ntri nsi c val ue of an equi ty securi ty based on the
Gordon (constant) growth di vi dend di scount model or a two-stage di vi dend di scount
model , as appropri ate.
23
Q.22 According to the efficient market hypothesis, consistent abnormal returns using technical
analysis most likely works in:
A. Weak form efficiency.
B. Weak and semi-strong form efficiency.
C. Neither the weak, semi-strong, or strong form.
It is impossible to consistently obtain abnormal returns using technical analysis in all forms of
market efficiency. T he table below summarizes the forms of market efficiency and whether or not it
is possible to obtain consistent abnormal returns using various trading strategies.
Technical Fundamental Insider Active

Analysis Analysis T rading Management
Weak No Yes Yes Yes
Semi-strong No No Yes Yes
Strong No No No No
CFA Level 1, Vol ume 4, Readi ng 38 – Mark et Effi ci ency, LOS 38e: Expl ai n the
i mpl i cati ons of each form of mark et effi ci ency for fundamental anal ysi s, techni cal
anal ysi s, and the choi ce between acti ve and passi ve portfol i o management.
24
Q.23 Amentha Tech has total assets of $2.2 million and liabilities of $1.2 million. If its shares
currently trade on the market for $32, and 82,000 shares are outstanding in the open market, then
Amentha’s book value is closest to:
A. $2,624,000.00
B. $1,000,000.00
C. $1,424,000.00
Book value = Total assets − Total liabilities
Book value = $2.2 million − 1.2 million = $1, 000, 000
B i s i ncorrect. $2,624,000 is Amentha's market value. Market value is a company's total value of
outstanding shares in the market, obtained by multiplying its current share price by its number of
outstanding shares, as shown below.
C i s i ncorrect. $3.4 million has been obtained by incorrectly adding the total liabilities to total
assets.
CFA Level 1,Vol ume 4, Readi ng 39 – Overvi ew of Equi ty Securi ti es, LOS 39g: contrast
the mark et val ue and book val ue of equi ty securi ti es.
Q.24 Given the following information:
Stock A Stock B Stock C

Opening price $10 $10 $10
Ending price $14 $13 $12
Dividend $1 $1 $1
Average daily traded $500, 000 $100, 150 $110, 000
volume
T he total return of this equally weighted index is closest to:
A. 30%
B. 40%
25
C. 50%
A total return index is an index that considers both dividend payments and any cash distributions like
dividends and interests paid by the stock.
VPR 1 + VPR 0 + Interest1

Total return =
VPR 0
Where,
VPR 1 =the price return index value at the end of the period.
VPR 0 =the price return index value at the beginning of the period.
Interest1 = total income from all securities in the index over the period.
14 + 1 − 10
Stock A : = 50%
10
13 + 1 − 10
Stock B : = 40%
10
12 + 1 − 10
Stock C : = 30%
10
1
T he weight of each security in an equally weighted index is obtained by using the formula where
N
N is the number of securities in that index; T his implies that an equally weighted index gives each
stock in the index the same weight. T here are three stocks in this index. For each stock to be given
the same weight, we will divide the sum of the total return of the three indices by three, as shown
below.
30 + 40 + 50
Total Return = = 40
3
A i s i ncorrect. 30% would have been the correct answer if we had been asked to calculate the
price and not the index's total return. We exclude any cash distributions like dividends and interests
paid by the stock for a price return.
C i s i ncorrect. It indicates the weighted index for Stock A.
26
CFA Level 1, Vol ume 4, Readi ng 37 – Securi ty Mark et Indi ces, LOS 37e: Cal cul ate and
anal yze the val ue and return of an i ndex gi ven i ts wei ghti ng method
Q.25 Which of the following is most likely a similarity between common and preferred shares?
A. Both have voting rights.
B. Both make fixed periodic payments.
C. Both can have put-and-call features.
Common shares and preferred shares can both have put and call features.
A and B are i ncorrect., Unlike common shares, preferred shares make fixed periodic payments
and do not have voting rights.
CFA Level 1, Vol ume 4, Readi ng 39 – Overvi ew of Equi ty Securi ti es, LOS 39b: Descri be
di fferences i n voti ng ri ghts and other ownershi p characteri sti cs among di fferent
equi ty cl asses.
27
Q.26 A trader purchases 1000 shares of HYA at the price of $30 per share using a leverage ratio of
2.0. If the maintenance margin is 25%, then the stock price at which the trader will receive a margin
call is closest to:
A. $3.75
B. $7.50
C. $20
T he equity investment can be found by dividing the total purchase price by the leverage ratio:
$30
2
= $15
T herefore, this trade involves $15 of equity and $15 of debt, and we need to find at what price a
margin call would take place.
Debt
Margin call =
1– Maintenance margin
$15 $15
= = = $20
1– 0.25 0.75
A i s i ncorrect. $3.75 has been incorrectly obtained by multiplying the equity investment by the
maintenance margin.
B i s i ncorrect. $7.50 has been incorrectly obtained by multiplying the share price by the
maintenance margin.
CFA Level 1, Vol ume 4, Readi ng 36 – Mark et Organi zati on and Structure, LOS 36f:
Cal cul ate and i nterpret the l everage rati o, the rate of return on margi n transacti on,
and the securi ty pri ce at whi ch the i nvestor woul d recei ve a margi n cal l .
Q.27 Using the Gordon growth dividend discount model and assuming that r > g > 1%, what would be
the effect of a 1% decrease in both the required rate of return and the constant growth rate on the
stock’s current valuation? Assume that there is no change to the current dividend payment (D0).
A. T he current valuation would increase.
28
B. T he current valuation would decrease.
C. T he current valuation would remain unchanged.
T he formula used to calculate an equity security's intrinsic value using the Gordon growth discount
model is
D1
Vo =
r −g
where,
V0 = ntrinsic value of the security.
D1 = Expected dividend in year 1, obtained by multiplying the current dividend by (1+g).
r = Required rate of return.
g= Growth rate.
If the same amount decreases both the required rate of return and the growth rate, the denominator
should remain unchanged. However, to obtain D1, we have to multiply the current dividend by (1 + g).
While the current dividend payment is unchanged in this instance, D1 will decrease when g is
decreased by 1%, thus making the current valuation lower than the previous.
A and C are i ncorrect. T he current valuation will decrease if both the required rate of return and
the growth rate decreases by 1%.
CFA Level 1, Vol ume 4, Readi ng 41 – Equi ty Val uati on: Concepts and Basi c Tool s, LOS
41g: cal cul ate and i nterpret the i ntri nsi c val ue of equi ty securi ty based on the Gordon
(constant) growth di vi dend di scount model or a two-stage di vi dend di scount model , as
appropri ate.
29
Q.28 Which of the following is a correct statement regarding the advantages of the asset-based
valuation models? T hey
A. take into account current or expected cash flows, earnings, or growth rates.
B. are usually the best stand-alone option for valuing firms as going concerns.
C. are particularly useful in valuing firms that are heavy in current assets and light in
intangibles.
T he advantages of asset-based models include;
T heir calculations are simple and do not need any projections.
T hey are particularly useful in valuing firms that are heavy in current assets and light in
intangibles.
T hey are useful in supplementing other valuation methods.
A and B are i ncorrect. T hey depict the disadvantages of the assets-based models.
Disadvantages of asset-based models are:
T hey are not usually the best stand-alone option for valuing firms as going concerns.
T hey do not take into account current or expected cash flows, earnings, or growth rates.
CFA Level I, Vol ume 4, Readi ng 38 - Mark et Effi ci ency, LOS 38b: contrast mark et val ue
and i ntri nsi c val ue.
30
Q.29 An investor buys 300 shares of XYZ at the market price of $200 on full margin. T he initial
margin requirement is 30%, and the maintenance margin requirement is 20%. If the shares of stocks
are later sold for $250 per share, what is the margin transaction return?
A. 25%
B. 83%
C. 125%
To get the margin transaction return, we must determine the profit (or loss) realized and divide it by
the initial equity investment.
T he initial equity investment is the amount paid by the investor to secure the margin transaction,
i.e., the initial margin requirement.
30
T he initial margin paid = × (300 × 200) = 18, 000
100
T he profit (or loss) realized from the transaction = 300 shares × (250 − 200) = 15, 000
A i s i ncorrect. 25% has been incorrectly obtained by assuming that the transaction was not a
15,000
margin transaction i.e., 60,000
× 100
C i s i ncorrect. 67% has been incorrectly obtained by using the wrong initial margin. T he initial
margin used has been calculated using the maintenance margin requirement percentage instead of the
initial margin percentage.
CFA Level 1, Vol ume 4, Readi ng 37 – Mark et Organi zati on and Structure, LOS 37f:
cal cul ate and i nterpret the l everage rati o, the rate of return on a margi n transacti on,
and the securi ty pri ce at whi ch the i nvestor woul d recei ve a margi n cal l
31
Q.30 A market index only contains these three securities:
Security Price per share Market cap ($ millions)

A $2.50 2, 000
B $26.34 234
C $10.20 1, 234
Which approach will most likely give Security A the highest weight?
A. Price-weighted.
B. Equal-weighted.
C. Market capitalization-weighted.
Price-weighted (2.50)/(2.50 + 26.34 + 10.20) 6.4%

Equal-weighted 1/3 33%
Market capitalization-weighted (2, 000)/(1,234 + 234 + 2, 000) 57.67%
CFA Level 1, Vol ume 4, Readi ng 37 – Securi ty Mark et Indi ces, LOS 37e: Cal cul ate and
anal yze the val ue and return of an i ndex gi ven i ts wei ghti ng method.
32
Q.31 Exhibit 1 shows the dividends paid by two Asian companies for the past five years:
Exhi bi t 1
Di vi dends pai d to i nvestors
Company 2014 2015 2016 2017 2018

Yukmen $2.60 $3.12 $3.74 $4.49 $5.39
ChenTao $1.85 $2.12 $2.86 $3.23 $3.88
Which company (or companies) would most likely be valued using the Gordon growth dividend
discount model?
A. Yukmen.
B. ChenTao.
C. Both Yukmen and ChenTao.
For Yuk men:
3.12 3.74 4.49 5.39

= 1.2; = 1.2; = 1.2; = 1.2
2.60 3.12 3.74 4.49
T hus, we can see that the dividend is growing by 20% each year, which is in line with the Gordon
growth model.
For ChenTao:
2.12 2.86 3.23 3.88

= 1.15; = 1.35; = 1.13; = 1.20
1.85 2.12 2.86 3.23
Here, we see that the dividend is not growing at a constant rate.
B and C are i ncorrect. Since ChenTao's dividends are not constant, we cannot use the Gordon
growth dividend discount model to value it.
CFA Level 1, Vol ume 4, Readi ng 41 – Equi ty Val uati on: Concepts and Basi c tool s, LOS
41g: cal cul ate and i nterpret the i ntri nsi c val ue of equi ty securi ty based on the Gordon
(constant) growth di vi dend di scount model or a two-stage di vi dend di scount model , as
appropri ate.
33
Q.32 In which of the following types of preference shares are shareholders most likely entitled to
receive the standard preference dividend plus a premium dividend if profits exceed a specified level?
A. Cumulative Preference shares.
B. Participating preference shares.
C. Non-cumulative preference shares.
Participating preference stock gives the holder the right to receive dividends equal to the normally
specified rate paid to preferred shareholders and an additional dividend based on some predetermined
condition.
A i s i ncorrect. Cumulative preference shares give the holders the right to receive their unpaid
dividends before any other group of shareholders' dividends are paid.
C i s i ncorrect. For non-cumulative preference shares, dividends not paid in the current or
subsequent periods are relinquished permanently.
CFA Level 1, Vol ume 4, Readi ng 39 – Overvi ew of Equi ty Securi ti es, LOS 39b: descri be
di fferences i n voti ng ri ghts and other ownershi p characteri sti cs among di fferent
equi ty cl asses.
34
Q.33 Which of the following most accurately describes the overconfidence bias
A. Market participants tend to dislike losses more than they like comparable gains.
B. Market participants tend to trade with other investors while potentially ignoring their own
private information or analysis.
C. Market participants tend to overestimate their ability to determine intrinsic values

accurately, and may not process information appropriately as a result.
Overconfidence bias is when people overestimate their ability to accurately determine intrinsic
values and may not process information appropriately, which ultimately leads to mispriced
securities.
A i s i ncorrect. It describes the loss aversion bias.
B i s i ncorrect. It describes the herding bias.
CFA Level 1, Vol ume 4, Readi ng 38 – Mark et effi ci ency, LOS 38g: descri be behavi oural
fi nance and i ts potenti al rel evance to understandi ng mark et anomal i es.
35
Q.34 You have been provided the following information regarding a market capitalization index for the
years 2017 and 2018:
Security Total shares Price on 01-01-2017 Market cap 2017 (in $) Weight Price on 01-01-2018 Market cap 2018
A 500 40 20 , 000 12.80 % 44
B 2 , 000 10 20 , 000 12.80 % 14
C 4 , 000 4 16 , 000 10.25 % 5
D 2 , 000 12.5 25 , 000 16.02 % 7
E 3 , 000 25 75 , 000 48.08 % 20
Given that the index value was 889 on January 1st, 2017, what is the index value on January 1st,
2018?
A. 820.62
B. 923.08
C. 963.08
Step 1: Fi nd the i ndex capi tal i zati on val ues
Market capitalization2017 = $20, 000 + $20, 000 + $16, 000 + $25, 000 + $75, 000 = $156, 000
Market capitalization2018 = $22, 000 + $28, 000 + $20, 000 + $14, 000 + $60, 000 = $144, 000
Step 2: Fi nd the i ndex val ue for 2018
Beginning index value = 889
144, 000
Ending index value = ( ) × 889 = 820.62
156, 000
CFA Level 1, Vol ume 4, Readi ng 37 – Securi ty Mark et Indi ces, LOS 37d: compare the
di fferent wei ghti ng methods used i n i ndex constructi on.
36
Q.35 During the year 2010, an index portfolio benchmarked to a newly formed equity index
generated a total capital gain of $125, while cumulative dividend generated by index securities
amounted to $50. T he total price of the constituent securities at the end of the period was $1,250.
T he total return of the index portfolio is closest to:
A. 12.73%
B. 14.00%
C. 15.56%
(Capital appreciation + Dividend income)

Total return =
Price of the index at the beginning of the period
($125 + $50)
Total return = = 15.56%
($1,250 − $125)
T he index appreciated by $125 from its level at the beginning of the period. Removing the capital
appreciation amount will generate the index price level at the beginning of the period.
A i s i ncorrect. It incorrectly adds the capital appreciation amount to the price at the end of the
period to determine the price at the beginning of the period.
$125 + $50
$1, 250 + $125
B i s i ncorrect. It incorrectly uses the price at the end of the period as its denominator.
$125 + $50
$1, 250
CFA Level I, Vol ume 4, Readi ng 41 – Equi ty Val uati on: Concepts and Basi c Tool s, LOS
41l : Descri be asset-based val uati on model s and thei r use i n esti mati ng equi ty val ue.
Q.36 T he exhibit below illustrates the limit orders outstanding on a market’s book following a large
37
order’s arrival.
Buyer Bid Size Limit Price (€) Offer Size Seller

Jones 9 49.9
Victor 8 50.0
Stevens 6 50.1
50.2 7 Allens
50.3 8 Cunningham
50.4 12 Whittaker
Kim Toyama submits a day order to buy 18 contracts, limit €50.3. Toyama’s average trade price is
closest to:
A. €50.20
B. €50.25
C. €50.28
Toyama’s buy order will fill at the most aggressively priced sell order, which is Allen’s order. After
completely filling Allen’s order at a price of €50.2, Toyama still has 11 contracts remaining. T he next
most aggressively priced sell order is Cunningham’s that will fill completely, leaving Toyama with 3
unfilled contracts. Toyama cannot trade using Whittaker’s order, as his limit sell price is above
Toyama’s limit buy price.
[(7 × €50.2) + (8 × €50.3)]

Toyama’s average trade price = = €50.25
(7 + 8)
A i s i ncorrect. €50.20 is the selling price of the first seven orders, not the average trade price of
the 18 orders.
C i s i ncorrect. €50.28 has been incorrectly obtained by assuming that Toyama will buy 3 of
Whittaker's orders at a price exceeding his limit price, i.e.,
7 × €50.2 + 8 × €50.3 + 3 × 50.4

= 50.28
7+8 +3
CFA Level 1, Vol ume 4, Readi ng 36 – Mark et organi zati on and structure, LOS 36h:
38
compare mark et orders wi th l i mi t orders.
Q.37 T he table below summarizes information concerning a market-capitalization-weighted index:
Stock Beginning of Dividends End of period Shares

period price per per share price per share outstanding
shares($) ($) ($)
A 120 50 140 45,570
B 200 25 250 59,650
C 180 30 160 112,740
Total 217,960
T he price return on the market-capitalization-weighted index is closest to:
A. 4.08%
B. 4.35%
C. 6.49%
(End of period value– beginning of period value)

Price return =
beginning of period value
Beginning of period value = ($120 × 45, 570) + ($200 × 59, 650) + ($180 × 112, 740) = $37, 691, 600
End of period value = ($140 × 45, 570) + ($250 × 59, 650) + ($160 × 112, 740) = $39, 330, 700
($39, 330, 700– $37, 691, 600)

Price return = = 4.35%
$37, 691, 600
CFA Level 1, Vol ume 4, Readi ng 38 – Mark et Effi ci ency, LOS 38b: contrast mark et val ue
and i ntri nsi c val ue.
39
Q.38 You have been provided the following figures regarding HighTech Industries:
Fiscal Year-End Dec. 31, 2018

Total shareholders' equity $20, 223
Net income available to common shareholders $4, 518
Stock price $18.40
Shares outstanding 4, 000
T he price-to-book ratio at the end of 2018 for HighTech Industries is closest to:
A. 1.13
B. 3.64
C. 16.28
$20,223
T he book value per share at the end of 2018 is 4,000 = $5.06 per share
$18. 4
T he price-to-book ratio at the end of 2018 is = = 3.64
$5. 06
A i s i ncorrect. It represents HighTech's EPS:
Net Income-Preferred dividends4, 518

EPS = = = 1.13
Outstanding shares 4000
C i s i ncorrect. It represents HighTech's price to earnings ratio:
Price per share 18.4

Price-to-earnings ratio = = = 16.28
Earnings per share 1.13
CFA Level I, Vol ume 4, Readi ng 41 – Equi ty val uati on: Concepts and basi c tool s, LOS
41j : Cal cul ate and i nterpret the fol l owi ng mul ti pl es: pri ce to earni ngs, pri ce to an
esti mate of operati ng cash fl ows, pri ce to sal es, and pri ce to book val ue.
40
Q.39 A Euro commercial paper is most likely ?
I. An unsecured, short-term loan.

II. Issued in the international market.
III. Issued in the corporation's domestic currency.
A. I and II.
B. II and III.
C. I, II, and III.
A Euro commercial paper is an unsecured, short-term loan issued in the international market.
B and C are i ncorrect. A Euro commercial paper is issued in the international market and can be
denominated in any currency.
CFA Level 1, Vol ume 4, Readi ng 43 – Fi xed-Income Mark ets: Issuance, Tradi ng, and
Fundi ng, LOS 43g: Descri be types of debt i ssued by corporati ons.
41
Q.40 Given the following sequence of spot rates:
S1 = 5.5%
S2 = 6.85%
T he forward rate for one period, one period from now, 1y1y, is closest to:
A. 1.28%
B. 1.35%
C. 8.22%
From the equations given:
(1 + S1 )(1 + 1y1y) = (1 + S2 )2
T hus we have:
(1 + S2 )2 1.06852
1y1y = 1− = = 0.0822 = 8.22
(1 + S1) 1.055
A i s i ncorrect. 1.28% has been incorrectly obtained by failing to square S2, as shown below.
1.0685
1y 1y = [ ] − 1 = 1.38%
1.055
B i s i ncorrect. 1.35% has been incorrectly obtained by subtracting S1 from S2, as shown below.
1y 1y = 6.85% − 5.5% = 1.35%
CFA Level 1, Vol ume 4, Readi ng 44 – Introducti on to Fi xed-Income Val uati on, LOS 44j :
defi ne forward rates and cal cul ate spot rates from forward rates, forward rates from
spot rates, and the pri ce of a bond usi ng forward rates.
42
Q.41 Synthetic collateralized debt obligations (Synthetic CDOs) are backed up by which of the
following?
A. Credit default swaps.
B. Leveraged bank loans.
C. Corporate market bonds.
A portfolio of credit default swaps backs up Synthetic CDOs.
B i s i ncorrect. CDOs backed up by leveraged bank loans are collateralized loan obligations (CLOs).
C i s i ncorrect. CDOs backed up by corporate and emerging market bonds are collateralized bond
obligations (CBOs).
CFA Level 1, Vol ume 4, Readi ng 45 – Introducti on to Asset-Back ed Securi ti es, LOS 45i :
Descri be col l ateral i zed debt obl i gati ons, i ncl udi ng thei r cash fl ows and ri sk s.
43
Q.42 When the government par curve is raised and lowered by 30 bps, the new full prices for a
callable bond are $99 and $103, respectively. If this bond currently sells for $101 on the secondary
market, its effective duration is closest to:
A. 6.6
B. 13.2
C. 9.89
Effective duration measures a bond's price sensitivity to a change in a benchmark yield curve.
P V− − P V+
EffDur =
2 × ΔCurve × P V0
Where,
PV− =Price of the bond if the yield was to decrease by the basis points.
PV+ =Price of the bond if the yield was to increase by the basis points.
PVo – Original price of the bond.
If the present value of the bond is 101, then PV0 = 101.000;PV+ = 99.000;PV- = 103.000; and
Δcurve = 0.0030(30 basis points)
P V− − P V+ 103 − 99
EffDur = = = 6.6
2 × ΔCurve × P V0 2 × 0.0030 × 101
CFA Level I, Vol ume 4, Readi ng 46 – Understandi ng Fi xed-Income Ri sk and Return, LOS
46c: expl ai n why the effecti ve durati on i s the most appropri ate measure of i nterest rate
ri sk for bonds wi th embedded opti ons.
44
Q.43 A bond was issued on January 6th, 2017, at 97 (percentage of par). T he par value was $1,500.
T he bond is callable in whole on September 7th, 2025, at $103.40. T he bond can most likely be
classified under which category?
A. American callable bond.
B. European callable bond.
C. Bermuda style callable bond.
T he bond will be classified as a European callable bond as it has only one specific call date.
A i s i ncorrect. American callable bond is also referred to as continuously callable, for which the
issuer has the right to call a bond at any time starting on the first call date.
C i s i ncorrect. T he issuer of a Bermuda-style callable bond has the right to call bonds on specified
dates following the call protection period. T hese dates frequently correspond to coupon payment
dates.
CFA Level 1, Vol ume 4, Readi ng 42 – Fi xed-Income Securi ti es: Defi ni ng El ements, LOS
42f: Descri be conti ngency provi si ons affecti ng the ti mi ng and nature of cash fl ows of
fi xed-i ncome securi ti es and i denti fy whether such provi si ons benefi t the borrower or
the l ender.
45
Q.44 Richard Grove invests in a 2-year, 4% semi-annual coupon paying bond with a par value of
1,000. T he sequence of spot rates is as follows:
T ime-to-maturity Spot Rate

0.5 year 1.0%
1.0 year 1.8%
1.5 years 2.9%
2.0 years 4.2%
2.5 years 5.6%
T he price of the bond is closest to:
A. $997.33
B. $904.10
C. $921.06
20 20 20 20 1000
Price of the bond = + + + + = 997.33
1.005 (1 + 0.009)2 (1 + 0.0145)3 (1 + 0.021)4 (1 + 0.021)4
CFA Level I, Vol ume 4, Readi ng 44 – Introducti on to Fi xed-Income Val uati on, LOS 44c:
defi ne spot rates and cal cul ate the pri ce of a bond usi ng spot rates.
46
Q.45 T he government of Ilaka, a developing country, has issued 30-year capital indexed bonds linked
to the domestic consumer price index (CPI) in local currency IA. T he bonds have a par value of IA
1,000. T he bonds make semiannual coupon payments at a rate of 6%. Over the most recent six
months, the CPI has increased by 4%. If the bonds were interest-indexed, as opposed to capital-
indexed bonds, the semiannual coupon would have been:
A. T he same.
B. Lower by $1.20.
C. Higher by $2.40.
As capital-indexed bonds, the annual coupon rate remains the same, but the principal amount will
increase to reflect inflation. Following the 4% increase in inflation, the new principal amount will be
IA1, 040(IA1, 000 × 1.04) and the semi-annual coupon payment is IA31.20(IA1, 040 × 0.03).
If the bonds are interest-indexed bonds, the principal amount will remain the same, but coupon
payments will be adjusted to reflect inflation. T he new semi-annual coupon payment would thus be
IA 31.20 (IA 1,000 × 1.04 × 0.03); i.e., the two coupon payments will be identical.
CFA Level I, Vol ume 4, Readi ng 43 – Fi xed-Income Mark ets: Issuance, Tradi ng, and
Fundi ng, LOS 43e: descri be securi ti es i ssued by soverei gn governments.
47
Q.46 Seniority ranking indicates the priority of payments in case of a winding-up. Among the
following, which one is the lowest-ranked corporate debt?
A. Subordinated.
B. Second lien loan.
C. Senior unsecured.
Here is the ranking in order of most secured to least secured:
First Lien Loan – Senior Secured
Second Lien Loan – Secured (option C)
Senior Unsecured (option A)
Senior Subordinated
Subordinated (option B)
Junior Subordinated
B i s i ncorrect. Senior lien loan is among the highest (the second-highest) ranked corporate bonds.
C i s i ncorrect. Senior unsecured debt is among the highest (the third highest) ranked corporate
bonds.
CFA Level I, Vol ume 5, Readi ng 47 – Fundamental s of Credi t Anal ysi s, LOS 47c:
descri be seni ori ty rank i ngs of corporate debt and expl ai n the potenti al vi ol ati on of the
pri ori ty of cl ai ms i n a bank ruptcy proceedi ng.
48
Q.47 T he most frequently used benchmark for floating-rate notes is the:
A. Libor.
B. I-spread.
C. G-spread.
T he most frequently used benchmark for floating-rate notes is the Libor. T he London Interbank
Offered Rate is the average of interest rates estimated by each of the leading banks in London that it
would be charged were it to borrow from other banks. T he reason for its most frequent use is its
nature (i.e., a composite interbank rate). Also, it is not a risk-free rate.
B i s i ncorrect. T he I-spread refers to the difference between a yield on a bond and the swap rate
(the interest rate applicable to the fixed leg in the floating-for-fixed interest rate swap, say, LIBOR).
I-Spread allows the comparison of bonds with differing credit and liquidity risks against an interbank
lending benchmark.
C i s i ncorrect. G-Spread refers to the yield spread in basis points over an actual or interpolated
government bond. T he spread over a government bond is the return for greater credit, liquidity, and
other risks relative to the sovereign bond.
CFA Level 1, Vol ume 4, Readi ng 43 – Fi xed-Income Mark ets: Issuance, Tradi ng, and
Fundi ng, LOS 43b: Descri be the use of i nterbank offered rates as reference rates i n
fl oati ng-rate debt.
49
Q.48 A 3.125% government bond is priced for settlement on 12th July. T he bond makes quarterly
coupon payments on June 30th and September 30th. of each year. T he accrued interests per 100 of
par value are closest to:
A. 0.10%
B. 0.41%
C. 0.68%
T he accrued interest (AI) is given by:
t
AI = × P MT
T
where
t = number of days from the last coupon payment to the settlement date
T = number of days in the coupon period
t/T = fraction of the coupon period that has gone by since the last payment
P MT = coupon payment per period
In this case, we have
t = 12 Days, T = 92 Days
T herefore,
12 0.03125
AI = × = 0.10190
92 4
Note: Government bonds use a 365 days notation.
CFA Level 1, Vol ume 4, Readi ng 44 – Introducti on to Fi xed-Income Val uati on, LOS 44d:
descri be and cal cul ate the fl at pri ce, accrued i nterest, and the ful l pri ce of a bond.
50
Q.49 A company has issued a 15-year bond with a notional principal of $350 million. T he sinking fund
provision calls for 8% of the outstanding principal amount to be retired in years 8-14, with the
outstanding balance paid off at maturity in 15 years. T he outstanding principal balance at the end of
Year 9 is closest to:
A. $294.00
B. $296.24
C. $322.00
The correct answer i s B.
T he exhibit below demonstrates the sinking fund provision schedule for the first 9 years of the bond
issue:
Year Outstanding principal at Sinking Fund Outstanding principal at

the beginning of the Year payment ($ millions) the End of the year ($
($ millions) millions)
0 350.00
1 to 7 350.00 0.00 350.00
8 350.00 28.00 322.00
9 322.00 25.67 296.24
A i s i ncorrect. It assumes that the company starts to retire the principal amount immediately, yet
it retires in years 8-14.
C i s i ncorrect. It is the resulting outstanding principal at the end of year eight.
CFA Level 1, Vol ume 5, Readi ng 46– Understandi ng fi xed i ncome ri sk and return, LOS
46l : expl ai n how changes i n credi t spread and l i qui di ty affect yi el d-to-maturi ty of a
bond and how durati on and convexi ty can be used to esti mate the pri ce effect of the
changes.
51
Q.50 An analyst is comparing two corporate bond issues, X and Y. He has compiled statistics for the
two bonds. T he analyst would like to determine which bond offers a higher yield-to-maturity when
the yields are stated on a monthly bond basis.
X Y
Annual coupon rate 5.00% 8.00%
Coupon payment frequency Quarterly Monthly
Yield-to-maturity 5.67% 6.15%
Believing that Bond Y is riskier than X, the analyst will most likely conclude that the additional
compensation offered by the former is closest to:
A. 47.0 bps.
B. 50.7 bps.
C. 51.2 bps.
0.0567 4 APR 12 12
(1 + ) = (1 + )
4 12
1
APR 12 = (1.0579 12– 1) × 12 = 0.05643
T he additional compensation for greater risk in Bond Y is 50.7 basis points (0.0615 – 0.05643) when
both are annualized for monthly compounding.
CFA Level I, Vol ume 5, Study Sessi on 14, Readi ng 45 – Introducti on to Asset-Back ed
Securi ti es, LOS 45f: defi ne prepayment ri sk and descri be the prepayment ri sk of
mortgage-back ed securi ti es.
52
Q.51 Contingent convertible bonds are most appropriately referred to as debt instruments that:
A. convert from debt to common equity automatically if a specific event occurs.
B. give their holders the right to buy the firm's common shares at a given price over a given
period.
C. give their holders the option to exchange the bond for a specific number of shares of the
issuing corporation's common stock.
Contingent convertible bonds ("CoCos") automatically convert from debt to common equity if a
specific event occurs.
B i s i ncorrect. A rights offering (rights issue) is a group of rights offered to existing shareholders
to purchase additional stock shares, known as subscription warrants, in proportion to their existing
holdings.
C i s i ncorrect. Convertible bonds let a bondholder exchange a bond for a specific number of
common shares issued by the same corporation. Exchangeable bonds allow for the exchange of bonds
to shares of a corporation other than the issuer.
CFA Level 1, Vol ume 4, Readi ng 42 – Fi xed-Income Securi ti es: Defi ni ng El ements, LOS
42f: Descri be conti ngency provi si ons affecti ng the ti mi ng and nature of cash fl ows of
fi xed-i ncome securi ti es and i denti fy whether such provi si ons benefi t the borrower or
the l ender.
53
Q.52 An analyst needs to value a 4-year, 5% annual coupon payment bond, Bond-K, which is not
actively traded. T he analyst could find some other bonds, however, with comparable credit quality.
• Bond-L: 3-year, 5.5% annual coupon payment bond at 108.
• Bond-M: 5-year, 4.5% annual coupon payment bond at 105. Which of the following is closest to
the yield to maturity of Bond-K?
A. 3.05%
B. 3.24%
C. 5.00%
T he YT M of Bond-L can be calculated using the financial calculator:
N = 3; PV = −108; PMT = 5.5; FV = 100
CPT => I/Y = 2.69%
T he YT M of Bond-M can be calculated using the financial calculator:
N = 5; PV = −105; PMT = 4.5; FV = 100
CPT => I/Y = 3.40%
T hen, we simply need to average those two values:
2.69% + 3.40%
YT MBond-K = = 3.045%
2
CFA Level 1, Vol ume 4, Readi ng 44 – Introducti on to fi xed-i ncome val uati on, LOS 44b:
i denti fy the rel ati onshi ps among a bond's pri ce, coupon rate, maturi ty, and mark et
di scount rate (yi el d-to-maturi ty) & LOS 44e: descri be matri x pri ci ng.
54
Q.53 A positive duration gap most likely exposes the investor to:
A. reinvestment risk and market price risk.
B. market price risk from increasing interest rates.
C. reinvestment risk from decreasing interest rates.
A positive duration gap (Macaulay duration greater than the investment horizon) exposes investors to
market price risk from increasing interest rates.
A and C are i ncorrect. A positive duration gap exposes investors to market price risk.
CFA Level 1, Readi ng 46 – Understandi ng Fi xed-Income Ri sk and Return, LOS 46b:
defi ne, cal cul ate, and i nterpret Macaul ay, modi fi ed, and effecti ve durati ons.
55
Q.54 ABC Corp's debt ranking is low because it doesn't have enough fixed assets to cover a
respectable portion of the debt. Which one of the four Cs of credit analysis would you most likely
associate with this statement?
A. Capacity.
B. Collateral.
C. Character.
Collateral refers to the quality and value of assets put up against a debt as protection. Good quality
assets will sufficiently cover the debt, making it rank higher. T he opposite, as is in this case, is true.
Fixed assets are often put up as collateral on a debt.
T he four Cs of credit analysis are: Capacity, Collateral, Covenants, and Character.
A i s i ncorrect. Capacity refers to a firm's ability to repay principal and interest payments to its
bondholders on time.
C i s i ncorrect. Character is simply the quality of the management (its strategy, quality of earnings,
and past treatment of bondholders).
T he other C (Covenants) refers to provisions in a bond indenture meant to protect lenders from
default by borrowers by requiring borrowers to do some things (positive/affirmative covenants) or
by forbidding them from doing some things (negative covenants).
CFA Level 1, Vol ume 5, Readi ng 47 – Fundamental s of Credi t Anal ysi s, LOS 47f: Expl ai n
the 4 C's (Capaci ty, Col l ateral , Covenants and Character)of tradi ti onal credi t
anal ysi s.
56
Q.55 Regarding fixed income, which of these statements is least likely a negative covenant?
A. Negative pledges.
B. Insure and maintain assets.
C. Restrictions on prior claims.
A requirement to 'insure and maintain assets' is a positive covenant. Positive covenants refer to
what the issuer must do. T hat may include making interest payments, returning principal at maturity,
maintaining the underlying collateral, a requirement to insure assets, and furnishing the lender with
financial statements every year (or every quarter).
Negative covenants refer to what the issuer must not do. T hey restrict one party, usually the
borrower, from carrying out certain actions. T hat may include not taking on additional debt, not
paying dividends, not making key appointments without the lender's knowledge, negative pledges, and
restrictions on prior claims.
CFA Level I, Vol ume 4, Readi ng 47– Fundamental s of Credi t Anal ysi s, LOS 47c:
Compare affi rmati ve and negati ve covenants and i denti fy exampl es of each
Q.56 A trader takes a short position in 25 future contracts where the initial margin is $1,000 per
contract, and the maintenance margin is $800 per contract. If the margin account balance is $19,000
on day 10, the variation margin is closest to:
A. $1,000
B. $5,000
C. $6,000
Futures contracts are traded in a clearinghouse and settled daily. T he daily settlement process is
known as mark-to-market, where the clearinghouse determines an average of the final futures trades
of the day and makes that price the settlement price.
57
T raders are needed to deposit an initial margin before trading futures contracts.
T he position of traders should not go below the maintenance margin requirement, which is the
minimum equity that an investor has to hold in their margin account after a purchase has been made.
If it goes below the maintenance margin requirement, a trader receives a call to deposit additional
funds.
Variation margin is the additional funds or margin required by a party to raise its equity to the initial
margin.
We will first calculate the margin account balance of one contract by dividing the account balance on
day ten by 25 (the number of contracts).
$19, 000
= $760 < 800 (T he account balance is less than the maintenance margin requirement, thereby creating a
25
T hen we will get the variation margin of one contract by subtracting the margin account balance
from the maintenance margin requirement, then multiply the result by 25 contracts to get the total
variation margin.
($1, 000 − $760) × 25 = $6, 000
A i s i ncorrect. $1000 is the initial margin requirement of one contract.
B i s i ncorrect. $5000 has been incorrectly obtained by subtracting the initial margin requirement
per contract from the total variation margin.
CFA Level 1, Vol ume 5, Readi ng 49 – Deri vati ve Mark ets and Instruments, LOS 49a:
Defi ne forward contracts, futures contracts, opti ons (cal l s and puts), swaps, and credi t
deri vati ves and compare thei r basi c characteri sti cs
58
Q.57 Doug Beckham, an AAPL’s derivative manager, purchased a USD 100 call option for the price of
USD 11 in February 2019. If Beckham predicts AAPL will be trading at USD 120 in February 2019,
the breakeven price for the option is closest to:
A. USD 109.
B. USD 111.
C. USD 131.
For options, the breakeven price is the level at which the underlying security covers the option's
premium.
T herefore, the breakeven price for this call option is the strike price plus the option premium, i.e.,
U SD 100 + USD 11 = U SD 111.
Note: T he prediction (or price of the underlying at expiration) does not affect the breakeven price
in the equation.
A i s i ncorrect. $109 has been incorrectly obtained by subtracting the call option premium from
the price of the underlying at expiration.
C i s i ncorrect. $131 has been incorrectly obtained by adding the call option premium to the price
of the underlying at expiration.
CFA Level 1, Vol ume 5, Readi ng 49 – Deri vati ve mark et and i nstruments, LOS 49b:
determi ne the val ue at expi rati on and profi t from a l ong or a short posi ti on i n a cal l or
put opti on.
59
Q.58 Blackoil T raders Inc. is an American oil-producing company that regularly sells oil futures to
reduce the risk of fluctuating oil prices. T his activity can best be described as:
A. Hedging.
B. Clearing.
C. Speculating.
Hedgers enter in future contracts to reduce the price risk of underlying assets.
B i s i ncorrect. Clearing occurs when a clearinghouse settles financial trades between the buyers
and the sellers.
C i s i ncorrect. Speculation refers to the act of conducting a financial transaction that has a
substantial risk of losing value but also holds the expectation of a significant gain or other major
value. With speculation, the risk of loss is offset by the possibility of a substantial gain.
CFA Level 1, Vol ume 5, Readi ng 49 – Deri vati ve Mark ets And Instruments, LOS 49a:
defi ne forward contracts, futures contracts, opti ons (cal l s and puts), swaps, and credi t
deri vati ves and compare thei r basi c characteri sti cs.
60
Q.59 A debt instrument whose entire face value is paid in one lump sum on the maturity date is most
likely called:
A. a bullet bond.
B. a fully amortized bond.
C. a partially amortized bond.
A bullet bond is a non-callable bond wherein the total principal amount or total value is paid as a lump
sum on the bond's maturity date.
B i s i ncorrect. A partially amortized bond is a hybrid bond with features of both bullet bonds and
fully amortized bonds. Although the borrower pays off a portion of the debt with regular monthly
payments, they also make a "balloon payment"—a large lump sum—on the loan maturity date. In
other words, only a portion of the full loan value is amortized, with a significant lump-sum payment
due at the end of the loan's term.
C i s i ncorrect. A fully amortized loan means that principal and interest payments are made
gradually over the term of the debt contract. T he borrower makes payments according to the loan's
amortization schedule.
CFA Level I, Vol ume 4, Readi ng 42 – Fi xed i ncome securi ti es: Defi ni ng el ements, LOS
42e: Descri be how cash fl ows of fi xed-i ncome securi ti es are structured.
61
Q.60 Which of the following statements regarding future contracts is least likely accurate?
A. Futures contracts are all cash-settled contracts.
B. Future contracts always trade on regulated markets.
C. T he value of a futures contract is always derived from its underlying asset.
Futures contracts are either cash-settled or physically delivered. Futures contracts that are
physically delivered require the holder to either produce the commodity or take delivery from the
exchange.
B i s i ncorrect. Statament B is correct. Futures contracts trade on regulated exchange markets
such as the Chicago Board of Exchange, the Eurex Exchange, the New York Board of T rade, etc.
C i s i ncorrect. Statement C is correct. T he price of an option or futures contract is derived from
the price of an underlying asset.
CFA Level 1, Vol ume 5, Readi ng 49 – Forward Commi tment and Conti ngent Cl ai m
Features and Instruments, LOS 49a: defi ne forward contracts, futures contracts,
opti ons (cal l s and puts), swaps, and credi t deri vati ves and compare thei r basi c
characteri sti cs.
62
Q.61 An investor purchased a 3-month call option by paying $1.08. T he exercise price of the option
is $3.32, while the underlying is priced at $4.35. T he price at which the break-even will occur is
closest to:
A. $2.24
B. $4.40
C. $5.43
T he call option is in-the-money as the underlying price is greater than the exercise price ($4.35 vs.
$3.32, respectively). T he break-even price is the exercise price plus the premium paid to purchase
the option.
Break-even price = X + C0 = $3.32 + $1.08 = $4.40
A i s i ncorrect. It has been incorrectly obtained by subtracting the premium paid from the exercise
price instead of adding.
C i s i ncorrect. It has been incorrectly obtained by adding the premium paid to the price of the
underlying.
CFA Level 1, Vol ume 5, Readi ng 49 – Forward Commi tment and Conti ngent Cl ai m
Features and Instruments, LOS 49b: determi ne the val ue at expi rati on and profi t from
a l ong or a short posi ti on i n a cal l or put opti on.
63
Q.62 T he maximum of zero and the underlying price minus the present value of the exercise price
most likely results in a minimum value for a?
A. European call.
B. European put.
C. Protective put.
T he minimum value of a European call is the maximum of zero and the underlying price minus the
present value of the exercise price:
X
Co ≥ Max (0, So − )
(1 + r)T
B i s i ncorrect. T he minimum value of a European put is the maximum of zero and the exercise
price minus the underlying price.
X
P o ≥ Max (0, − So )
(1 + r)T
C i s i ncorrect. A protective put is an options strategy in which a long position in an asset is
combined with a long position in a put.
CFA Level 1, Vol ume 5, Study Sessi on 15, Readi ng 46 – Basi cs of Deri vati ve Pri ci ng and
Val uati on, LOS 46k : Identi fy the factors that determi ne the val ue of an opti on and
expl ai n how each factor affects the val ue of an opti on.
64
Q.63 Which of the following best describes why future and forward prices differ?
A. Futures contracts settle daily, which means investors in futures contracts must hold a
margin account.
B. Since traded on an exchange, futures contracts have more liquidity, reason why it is
cheaper to invest them.
C. T he forward contract has essentially no counterparty risk since it is a private agreement

between two parties, so forward contracts are more expensive.
Futures contracts settle daily which requires the investor to have a margin account. Since futures
settle daily, any increase in value will lead to an increase in the excess margin which can then be
reinvested.
B i s i ncorrect. Forward contracts are cheaper than futures contracts.
C i s i ncorrect. Futures contracts are more expensive than forward contracts. Forward contracts
have counterparty risk since traders directly trade with each other. Futures contracts lack
counterparty risk since the clearinghouse acts as the counterparty.
CFA Level 1, Vol ume 5, Readi ng 53 – Pri ci ng and Val uati on of Futures Contracts, LOS
53b: Expl ai n why forward and futures pri ces di ffer.
65
Q.64 A synthetic long position in a risk-less bond is created by combining:
A. A long position in a put + long position in the underlying + short position in the call.
B. A long position in a call + long position in the underlying + short position in the put.
C. A short position in a put + short position in the underlying + long position in the call.
T he put-call parity explains the relationship between a call and its corresponding put option.
If two combinations of assets or a portfolio of assets have the same payoff, their acquisition cost
must be identical. T herefore, to make a risk-free profit, an investor will need to buy the cheaper
priced asset and sell the most expensive one.
As a result of the no-arbitrage principle, we can set the value at the inception of the protection call
equal to the value at the inception of the protective put as follows:
X
Co + = P o + So
(1 + r)T
Where,
Co = Call premium.
X
= Present value of the strike price.
(1+r) T
P o = Put premium.
So = Current price of the underlying.
As shown below, we can re-arrange the above equation (the put-call parity) to determine the
equivalent of a synthetic long position in a risk-less bond.
X
Synthetic risk-free bond = p0 + S0 − c 0 =
(1 + r)T
CFA Level 1, Vol ume 5, Readi ng 56 – Basi cs of deri vati ve pri ci ng and val uati on, LOS
56a: expl ai n put-cal l pari ty for European opti ons.
66
Q.65 XYZ Hedge fund charges a management fee of 2% based on assets under management at year-
end and a 20% incentive fee. T he following are the value of the investment at the end of each year
(before fee).
Initial investment GBP 125 million

End of the year 1 GBP 175 million
What are the fees earned by XYZ Hedge fund in the 3rd year if incentive fees and management fees
are computed independently? Assume management fees are calculated using end-of-period valuation,
and the fee structure includes the use of a high watermark.
A. GBP 7.5 million.
B. GBP 5.7 million.
C. GBP 8.4 million.
Management fee earned by XYZ hedge fund = 185 × 2% = GBP 3.7 million
Incentive fee = (185 − 161.5) × 20% = GBP 4.7 million
T he GBP 161.5 million represents the high water mark established at the end of year 1.
HWM = 175 − (0.02 × 175) − (0.2 × (175 − 125)) = 161.5
T herefore, the total fees earned by XYZ hedge fund in the 3rd year is GBP 8.4 million
CFA Level 1, Vol ume 5, Readi ng 59 – Performance Cal cul ati on and Apprai sal of
Al ternati ve Investments, LOS 59b: Cal cul ate and i nterpret returns of al ternati ve
i nvestments on both before-fee and after-fee bases.
67
Q.66 A real estate index that is based on changes in the price of properties that are sold for multiple
times is most likely known as a/an:
A. REITs index.
B. Appraisal index.
C. Repeat sales index.
A repeat sales index is based on changes in prices of properties that have been sold multiple times.
A i s i ncorrect. REIT indexes are constructed using the prices of publicly traded shares of Real
Estate Investment T rusts.
B i s i ncorrect. Appraisal indexes are based on estimates of value (appraisals) as inputs.
CFA Level 1, Vol ume 5, Readi ng 60 – Pri vate Capi tal , Real Estate, Infrastructure,
Natural Resources, and Hedge Funds, LOS 60g: Expl ai n i nvestment characteri sti cs of
real estate.
68
Q.67 Adding alternative investments to a diversified portfolio will most likely result in:
A. A higher return and a lower standard deviation.
B. A higher return and a higher standard deviation.
C. A lower return and no effect on standard deviation.
Alternative investments will increase the chances of higher returns and decrease the portfolio's
risk. Since risk is measured using standard deviation, the standard deviation of the portfolio will
decrease.
B and C are i ncorrect. Adding alternative investments to diversified portfolios will increase and
decrease the returns and standard deviation of the portfolios, respectively.
CFA Level 1, Vol ume 5, Readi ng 58 –Categori es, Characteri sti cs, and Compensati on
Structures of Al ternati ve Investments, LOS 58a: Descri be types and categori es of
al ternati ve i nvestments.
69
Q.68 T he sources of commodities futures return can best be described to be from:
A. Roll yield only.
B. Roll yield and collateral yield.
C. Roll yield, collateral yield, and change in spot prices.
T he three sources of commodities futures returns are roll yield, collateral yield, and change in spot
prices. Roll yield refers to the difference between a commodity's spot price and the price specified
by its futures contract.
T he collateral yield component of commodity index returns is the interest earned on the collateral
posted as a good-faith deposit for the futures contracts. T he change in spot prices is the relationship
between current supply and demand.
A and B are i ncorrect. Roll yield, collateral yield, and change in spot prices are all sources of
commodities futures return.
CFA Level 1, Vol ume 5, Study Sessi on 16, Readi ng 60 –Pri vate Capi tal , Real Estate,
Infrastructure, Natural Resources, and Hedge Funds, LOS 60e: Expl ai n i nvestment
characteri sti cs of natural resources.
70
Q.69 Which of the following are most likely benefits of a trade sale as a form of exit strategy pursued
by private equity portfolio managers?
I. An immediate cash exit for Private Equity investors.

II. Fast and simple execution.
III. A higher number of potential trade buyers.
A. I and II.
B. I and III.
C. I, II, and III.
A trade sale is one of the ways of exit from a company that involves the sale of the company or part
of it to another company that typically operates in the same business. T he benefits of a trade sale
are;
1. Immediate cash exit for the private equity investors.

2. Potential for high valuations because strategic buyers may be willing and able to pay more
than the other potential buyers.
3. Fast and simple execution.
4. Lower transactions than IPOs.
5. Lower levels of disclosure and higher confidentiality.
B and C are i ncorrect. Statement III is incorrect. One of the disadvantages of a trade sale as a
form of exit strategy is that it has a limited and not a higher number of potential trade buyers. Other
disadvantages are; possible opposition by management, lower attractiveness to employees of the
portfolio company, a limited number of potential trade buyers, and a possibly lower price than in an
IPO.
Natural Resources, and Hedge Funds, LOS 60a: Expl ai n i nvestment characteri sti cs of
pri vate equi ty.
Q.70 A European put and call options both have an exercise price of $50 that expires in 120 days.
T he long forward is priced at a forward price of $52 (also expires in 120 days) and makes no cash
71
payments during the options life. T he risk-free rate is 4.5%, and the put is selling for $3.80. T he
price of the synthetic call is closest to:
A. -$5.77
B. $5.71
C. $5.77
T he put-call forward parity equates a fiduciary call (buying a call option and a bond) and a synthetic
protective put (buying a put option and a forward contract on the underlying that expires at the same
time as the put option) of the same payoff, i.e.,
X Fo(T )
Co + = Po +
(1 + r)t (1 + r)t
Where,
Co = Call premium.
X
= Present value of the underlying's strike price.
(1+r) T
P o = Put premium.
Fo (T)
= Value of the forward contract today.
(1+r) t
Making the synthetic call the subject;
Fo X
C0 = p0 + −
(1 + r) T (1 + r)T
T herefore,
52 50
c 0 = 3.8 + 120
− 120 = 5.77
(1.045) 365 (1.045) 365
A i s i ncorrect. It uses a short pot, a short position in the forward contract, and a long position in
the bond instead of a long put, a long position in the forward contract and a short position in the bond:
72
50 52
C0 = − − 3.8 = −5.77
120 120
1.045 365 1.045 365
B i s i ncorrect. It fails to discount the forward price and the bond price to today, as shown below:
52 50
C0 = 3.8 + − = 5.71
1.045 1.045
CFA Level 1, Vol ume 5, Readi ng 56 – Opti on Repl i cati on Usi ng Put–Cal l Pari ty, LOS
56b: Expl ai n put-cal l -forward pari ty for European opti ons
Q.71 Which of these statements is least likely correct regarding an option?
A. An option’s market price equals its intrinsic value plus its time value.
B. An option’s intrinsic value equals its market price plus its time value.
C. An option is a contract that gives the buyer (the owner or holder) the right, but not the
obligation, to buy or sell an underlying asset at a later date.
T he market price of an option equals its intrinsic value plus its time value. T herefore, the intrinsic
value equals the market price minus the time value. Intrinsic value represents the extent to which
the option’s exercise price (strike price) would be better than the market price of the underlying
security. On the other hand, time value represents the benefit of having the choice of exercising or
not for a given period of time.
CFA Level 1, Vol ume 5, Readi ng 55 – Pri ci ng and Val uati on of Opti ons, LOS 55a: Expl ai n
the exerci se val ue, ti me val ue, and moneyness of an opti on
73
Q.72 European put and call options both have an exercise price of $50 that expires in 120 days. T he
underlying asset is priced at $52 and makes no cash payments during the option's life, and the risk-
free rate is 4.5%. If the put is selling for $3.80, what should be the call option's price given that no
arbitrage opportunity exists in this market?
A. 3.8
B. 4.21
C. 6.52
T he correct answer C.
We’re going to use the putt-call parity formula to find the value of the call option:
X
C0 = P 0 + S0 −
(1 + r)t
T he call’s price must be $6.52, otherwise arbitrage exists.
Where;
Co = Call premium.
X
= Present value of the strike price.
(1+r) T
P o = Put premium.
So = Current price of the underlying.
T hen we re-arrange the put-call parity to make Co the subject.
X 50
Co = P o + So − = 3.80 + 52 − 120=
6.52
T
(1 + r) (1 + 4.5%) 365
T he call's price must be $6.52; otherwise, an arbitrage opportunity exists.
CFA Level 1, Vol ume 5, Readi ng 56 – Opti on Repl i cati on Usi ng Put–Cal l Pari ty, LOS
56a: expl ai n put-cal l pari ty for European opti ons.
74
Q.73 Which of the following characteristics will most likely be considered as desirable by a private
equity company seeking a target for an LBO (leveraged buyout)?
A. Inefficient management.
B. An average ability to generate cash flows.
C. Companies perceived as being “in favor” in the general market.
When selecting candidates for an LBO, a private equity firm will prefer inefficiently managed
companies that can perform better in the future. Private equity firms expect to generate attractive
returns on equity by creating value in the companies they buy.
B i s i ncorrect. Private equity firms consider companies that generate strong and sustainable cash
flows, not average cash flows, because strong and sustainable cash flows will cover the debt the
firms are taking on.
C i s i ncorrect. Private equity firms may focus on companies that are "out of favour" in public
markets.
Natural Resources, and Hedge Funds, LOS 60a: Expl ai n i nvestment characteri sti cs of
pri vate equi ty.
75
Q.74 A hedge fund with $120 million of initial investment and a 2-20 fee structure earned a 35%
return at year-end. Assuming that management fees are based on assets under management at year-
end and incentive fee is calculated net of management fee, the total fees earned by the fund is closest
to:
A. $10.15 million.
B. $10.99 million.
C. $11.64 million.
Management Fees = $120 million × 1.35 × 2% = $3.24 million
Incentive Fees = ($162 − $120 – $3.24) million × 20% = $7.75 million
Total Fees = $3.24 million + $7.75 million = $10.99 million
A i s i ncorrect. T he management fee has been calculated using the assets under management at the
start of the year.
C i s i ncorrect. $11.64 million is the total fees if the incentive fee would have been calculated
independent of the management fee.
i nvestments on both before-fees and after-fees bases.
76
Q.75 In contrast to traditional investments, alternative investments are characterized by:
A. High absolute returns.
B. Low degree of leverage.
C. Potential tax advantage.
In contrast to traditional investments, alternative investments are characterized by;
1. potential tax disadvantages

2. high expected (absolute) returns
3. a high degree of leverage
4. inadequate historical risk and return data
5. limited manager specialization
6. higher fees usually made of incentive fees
7. less transparency and regulation, and
8. limitations on redemptions.
B i s i ncorrect. Alternative investments have a higher degree of leverage as compared to traditional
investments.
C i s i ncorrect. Alternative investments have potential tax disadvantages.
CFA Level 1, Readi ng 58 – Introducti on to Al ternati ve Investments, LOS 58a: Descri be
types and categori es of al ternati ve i nvestments.
77
Q.76 Quantum Returns is a hedge fund with $250 million as initial investment capital. A 3%
management fee based on assets under management is charged at year-end, and a 20% incentive fee is
charged on performance net of management fees. In the first year of operations, the fund earned a
return of 16%.
T he investor's effective return given this fee structure is closest to:
A. 9.32%
B. 10.02%
C. 12.52%
Management fee = $250 million × 1.16 × 3% = $8.7 million
Incentive fee = ($290 million − $250 million − $8.70 million) × 20% = $6.26 million
Total fees to Right-Lance Capital = $8.7 million + $6.26 million = $14.96 million
($290 million − $250 million − $14.96 million)

Investor's return = = 10.02%
$250 million
i nvestments on both before-fees and after-fees bases.
78
Q.77 Which of the following is least likely a valuation method for private equity portfolio companies?
A. Cost-based approach.
B. Asset-based approach.
C. Discounted cash flow method.
Private equity firms use the discounted cash flow (DCF) method, the market approach, and the asset-
based approach to value portfolio companies. Private equity firms do not use the cost-based
approach to value portfolio companies.
CFA Level 1, Vol ume 5, Readi ng 60 – Introducti on to Al ternati ve Investments, LOS 60a:
Expl ai n i nvestment characteri sti cs of pri vate equi ty.
Q.78 Which of the following is least likely a category of alternative investments?
A. Collectables.
B. Infrastructure.
C. Supranational bonds.
Supranational bonds are bonds issued by entities formed by two or more central governments to
promote economic development for the member countries. Bonds are classified as fixed income, not
as alternative investments.
A and B are i ncorrect. ET Fs, private equity funds, commodities, real estate, infrastructure, and
other investments like antiques, collectables, and fine wine are categories of alternative
investments.
CFA Level 1, Vol ume 5, Readi ng 58 –Categori es, Characteri sti cs, and Compensati on
Structures of Al ternati ve Investments, LOS 58a: Descri be types and categori es of
al ternati ve i nvestments.
79
Q.79 An investor is interested in knowing the real return his portfolio has earned over a certain
period. Assuming that the nominal return of his portfolio is 18%, the CPI is 6%, and the tax rate is
38.9%, then the real return of the portfolio is closest to:
A. -11.17%
B. 11.32%
C. 18.00%
T he real rate of return is nominal return that has been adjusted for inflation. Unlike the nominal rate
of return, the real rate gives the actual purchasing power of an amount of money over time.
(1 + Nominal rate)
Real rate of return = −1
(1 + Inflation)
1.18
=( )−1
1.06
= 11.32%
A i s i ncorrect. -10.17% has been incorrectly obtained by dividing 1+Inflation by 1+Nominal rate
instead of the other way around.
C i s i ncorrect. 18% is the nominal rate of return as given in the question.
CFA Level 1, Vol ume 5, Readi ng 62 – Portfol i o Ri sk and Return: Part I, LOS 62a:
Cal cul ate and i nterpret maj or return measures and descri be thei r appropri ate uses.
80
Q.80 Distributed ledger technology (DLT ) has the potential to accommodate “smart contracts.”
T hose smart contracts are most likely :
A. Computer programs that self-execute based on pre-specified terms and conditions agreed
to by the parties to a contract.
B. A digital currency created in January 2009 by the mysterious Satoshi Nakamoto.
C. Computer programs that follow trends and patterns of money invested by people with
expert knowledge.
DLT has the potential to accommodate “smart contracts,” which are computer programs that self-
execute on the basis of pre-specified terms and conditions agreed to by the parties to a contract.
Examples of smart contract use are the automatic execution of contingent claims for derivatives and
the instantaneous transfer of collateral in the event of default.
CFA Level 1, Vol ume 6, Readi ng 68 – Fi ntech i n Investment Management, LOS 68d:
Descri be Fi nanci al Appl i cati ons of Di stri buted Ledger Technol ogy
81
Q.81 T he table below illustrates expected annual risk and beta data concerning three textile
manufacturers (A, B, and C).
Textile Expected Annual

Manufacturer Standard Deviation (%) Beta
A 25.5 1.8
B 31.8 0.6
C 19.4 1.2
Out of the three manufacturers, the highest total risk is closest to:
A. 0.065
B. 0.101
C. 0.318
Total risk is equal to the total variance. T he manufacturer with the highest total variance is B, and
this variance is equal to 0.101, obtained by squaring the standard deviation (0.318).
A i s i ncorrect. It is manufacturer's A variance, i.e., 0.2552=0.065.
C i s i ncorrect. It depicts the expected annual standard deviation of Manufacturer B.
CFA Level 1, Vol ume 6, Readi ng 64– Basi cs of Portfol i o Pl anni ng and Constructi on, LOS
64c: descri be ri sk and return obj ecti ves and how they may be devel oped for a cl i ent.
82
Q.82 Which of the following return-generating models most likely uses macroeconomic indicators
such as GDP growth and inflation along with fundamental factors such as earnings and earnings
growth to forecast future value?
A. Market model.
B. Revenue model.
C. Multifactor model.
A multi-factor model allows for many inputs or factors in determining the security return.
Multifactor models often use macroeconomic indicators such as GDP growth and inflation and
fundamental factors such as earnings, earnings growth, etc.
A i s i ncorrect. T he market model illustrates how the forces of supply and demand interact to
determine prices and the quantity sold.
B i s i ncorrect. A revenue model is a framework for generating financial income. It identifies which
revenue source to pursue, what value to offer, how to price the value, and who pays for the value.
CFA Level 1, Vol ume 5, Readi ng 63 – Portfol i o Ri sk and Return: Part II, LOS 63d:
expl ai n return generati ng model s (i ncl udi ng the mark et model ) and thei r uses.
83
Q.83 Which of the following key factors of the risk management framework most likely involves the
quantitative assessment of potential sources of risk and the organization's risk exposure?
A. Risk infrastructure.
B. Risk Analysis and integration.
C. Risk identification and integration.
Risk identification and measurement is the key element of the risk management framework that
involves the quantitative and qualitative assessment of potential sources of risk and the
organization's risk exposure. It also involves the calculation of risk metrics under various stress
scenarios.
A i s i ncorrect. Risk infrastructure refers to the people and systems required to track risk
exposures and perform the most quantitative risk analysis to assess the organization's risk profile.
B i s i ncorrect. Risk analysis and integration involve using risk tools to rigorously sort out the
factors that are not adding value and incorporate this analysis into the management decision process
to improve outcomes.
CFA Level 1, Vol ume 6, Readi ng 66 – Introducti on to ri sk management, LOS 66b:
descri be features of a ri sk management framework .
84
Q.84 Which of the following portfolios is/are most appropriately priced?
I. A portfolio with an estimated return above the securities market line (SML).
II. A portfolio with an estimated return plotted on the SML.
III. A portfolio with an estimated return below the SML.
A. Portfolio II.
B. Portfolios I and II.
C. Portfolio II and III.
T he security market line (SML), also known as the characteristic line, is a graphical representation
of CAPM used to model the risk-return relationships of securities. It tells whether a given security’s
return is favourable enough for its level of risk.
When plotted on the Security Market Line, undervalued security appears above the SML, i.e., the
security’s expected return is greater than its risk. On the other hand, security that appears below
the SML is overvalued, i.e., the security’s expected return is lower than its risk. Security that
appears on the SML is correctly valued.
B and C are i ncorrect. As discussed above, Portfolio I (whose estimated return is above the SML)
is undervalued, and Portfolio III (whose estimated return is below the SML) is overvalued.
CFA Level 1, Vol ume 5, Readi ng 63 – Portfol i o Ri sk and Return: Part II, LOS 63f: expl ai n
the capi tal asset pri ci ng model (CAPM), i ncl udi ng i ts assumpti ons and the securi ty
mark et l i ne (SML).
Q.85 A junior fund manager at Dapper Assets Management is constructing a portfolio consisting of a
few large-cap stocks that trade on the London Stock Exchange. In a meeting with the investment
committee, the manager was asked to present the risk associated with the stock of AT T. T he returns
of the stock for the past 7 years are shown in the following table:
85
Year ATT Return
2010 17 %
2011 21 %
2012 −8 %
2013 −1 %
2014 4%
2015 19 %
2016 −7 %
Using the given data, the standard deviation of the stock is closest to:
A. 1.33%
B. 11.53%
C. 12.46%
We will first calculate the stock’s variance, then get the square root of the variance to determine its
standard deviation.
∑N
i=1 (X i − μ)
2
Variance =
N
Where
μ = Mean return (which will be calculated below).
X i = T he value of one observation.
N = Number of variables.
(0.17 + 0.21 − 0.08 − 0.01 + 0.04 + 0.19 − 0.07)

Mean return = = 0.064
7
[(0.17 − 0.064)2 + (0.21 − 0.064)2 + (−0.08 − 0.064)2 + (−0.01 − 0.064)2 + (0.04 − 0.064)2 +
Variance =
7
= 0.0133
As the variance of AT T is 0.0133, the standard deviation = √0.0133 = 0.1153
A i s i ncorrect. 1.33% is the stock’s variance and not its standard deviation. To get the standard
86
deviation, we have to get the square root of the variance.
C i s i ncorrect. 12.46% would have been the correct answer if the data provided would have been
from a sample and not from a population.
When getting the variance of data obtained from a sample, we divide by N-1 and not by N.
CFA Level 1, Vol ume 5, Readi ng 62 – Portfol i o Ri sk and Return: Part I, LOS 62d:
Cal cul ate and i nterpret the mean, vari ance, and covari ance (or correl ati on) of asset
returns based on hi stori cal data.
Q.86 Distributed ledger technology (DLT ) has the potential to accommodate "smart contracts."
T hose smart contracts are most likely :
A. Computer programs that use pre-specified rules and guidelines to trade.
B. A digital currency that was created in January 2009 by the mysterious Satoshi Nakamoto.
C. Computer programs that self-execute based on pre-specified terms and conditions agreed
to by the parties to a contract
Distributed Ledger Technology (DLT ) has the potential to accommodate "smart contracts," which
are computer programs that self-execute based on pre-specified terms and conditions agreed to by
the parties to a contract. Examples of smart contracts are the automatic execution of contingent
claims for derivatives and the instantaneous transfer of collateral in the event of default.
A i s i ncorrect. It refers to algorithmic trading, the computerized buying and selling of financial
instruments following pre-specified rules and guidelines.
B i s i ncorrect. It refers to bitcoin (a decentralized digital currency created in January 2009). It
follows the ideas set out in a whitepaper by the mysterious and pseudonymous Satoshi Nakamoto,
whose identity is still a mystery.
CFA Level 1, Vol ume 6, Readi ng 68– Fi ntech i n Investment Management, LOS 68d:
Descri be Fi nanci al Appl i cati ons of Di stri buted Ledger Technol ogy
87
Q.87 T he standard deviation of an asset's return is 10%, and the standard deviation of the market's
return is 14%. If the correlation of returns with the market index is 0.7, then the beta of the asset is
closest to:
A. 0.1
B. 0.5
C. 1.8
Standard deviation of the asset

Asset’s beta = Correlation with markets return ×
Standard deviation of market returns
10%
= 0.7 ×
14%
= 0.5
CFA Level 1, Vol ume 5, Readi ng 63 – Portfol i o Ri sk and Return: Part II, LOS 63e:
Cal cul ate and i nterpret beta.
88
Q.88 Which of the following investors most likely has a portfolio perspective in his investment
strategy?
I. Investor A has been investing in the shares of Max Mart for the last ten years. He always
earns above-market returns because he regularly evaluates the risk and return of his single
asset portfolio.
II. Investor B holds a PhD in Economics. Due to his sound knowledge of different sectors of the
economy, he keeps shares from different firms from different sectors. He evaluates the
combined risks and returns of these assets in a portfolio.
III. Investor C is a new investor who recently started investing in large-cap stocks. His
investment strategy involves evaluating the risks and returns of his portfolio shares in
isolation.
A. Investor A.
B. Investor B.
C. Investors B and C.
Investor B has a portfolio perspective as he evaluates each asset's combined risks and returns in his
portfolio.
A i s i ncorrect. Investor A invests in a single stock, so his strategy has no portfolio perspective.
C i s i ncorrect. Investor C evaluates each share of his portfolio in isolation. T herefore, he does not
have a portfolio perspective.
CFA Level 1, Vol ume 5, Readi ng 61 – Portfol i o Management: An overvi ew, LOS 61a:
descri be the portfol i o approach to i nvesti ng
89
Q.89 During a meeting with his investment manager, an investor requested the manager not to invest
his money in the Republic of Somalia. T he investors believe that the taxes that Somalia collects on
investments are used for arms manufacturing. Determine the most appropriate categorization of the
investor's request.
A. T he Investor’s request should be categorized under tax constraints.
B. T he investor’s request should be categorized under unique constraints.
C. T he investor’s request should be categorized under both tax and unique constraints.
'Unique constraints' is the most appropriate categorization of the investor's request.
A i s i ncorrect. Tax constraints deal with the individual's overall tax treatment.
C i s i ncorrect. Legal constraints deal with regulations and legal frameworks. Here, the investor
voluntarily decides not to invest in Somalia.
CFA Level 1, Vol ume 6, Readi ng 64 – Basi cs of Portfol i o Pl anni ng and Constructi on, LOS
64e: descri be the i nvestment constrai nts of l i qui di ty, ti me hori zon, tax concerns, l egal
and regul atory factors, and uni que ci rcumstances and thei r i mpl i cati ons for the choi ce
of portfol i o assets.
90
Q.90 Which of the following statements concerning risk assembling activities is most likely an
example of risk budgeting?
A. T he beta of the portfolio must not be above 0.
B. T he portfolio must not include more than 55% of equities and 45% of real estate.
C. T he portfolio must invest 50% of its funds in value stocks and 50% in fixed assets with
maturities longer than 3 years.
In risk budgeting, the risk is allocated or restricted by some risk measures like beta or VaR instead of
limiting the risk by allocating the amount of money spent.
CFA Level 1, Vol ume 6, Readi ng 66 – An Introducti on to Ri sk Management, LOS 66e:
descri be ri sk budgeti ng and i ts rol e i n ri sk governance.
91

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Level I of the CFA® Exam

Mock Questions with Answers - Mock Exam 2023 #5 - Second

Last Updated: Sep 5, 2023

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

change in the firm's number of units sold.

a increase in EBIT, i.e.,

Percentage change in operating income (EBIT )

leverage to get the percentage change in operating income.

the number of units sold had decreased.

degree of total l everage.

interests directly to the group seeking control.

controlling position on the company's board of directors.

without the consent of the company's management.

CFA Level 1, Readi ng 29 – Introducti on to Corporate Governance and other ESG

stak ehol der rel ati onshi ps and corporate governance

A. equal to the breakeven point.

B. lower than the breakeven point.

C. higher than the breakeven point.

to a change in operating income.

It is calculated using the formula below:

A DFL of 1 implies that interest is zero.

point will equal the operating breakeven point.

l everage, busi ness ri sk , sal es ri sk , operati ng ri sk , and fi nanci al ri sk and cl assi fy

Weighted Average Cost of Capital (WACC);

(weights) consists of 50% debt and 50% equity.

Given this information we can calculate the firm's tax as

(EBT − EAT ) (16 − 12.8)

(6% × (1 − 0.2)0.5) + (13% × 0.5) = 8.9%

Q.5 A public company is least likely described as a:

A. company affiliated with the government.

B. company whose shares are listed on an exchange.

private based on the following factors:

Exchange l i sti ng and exchange ownershi p: T he shares of a public company are

this reason, there is no noticeable valuation or price transparency, making it difficult to

buy and sell shares.

offering, and the risks involved in investing in the company.

A. all Board of Directors members should be independent.

B. at least 50% of all members on the Board of Directors should be independent.

C. at least 75% of all members on the Board of Directors should be independent.

board of di rectors and i ts commi ttees.

CAPM or cost of capital of stocks of Damascus is calculated as;

calculating the market risk premium, as shown below.

Er = 1.2(10% + 5%) = 18%

approach and the bond yi el d pl us ri sk premi um approach.

denominator, as shown below.

Contribution Margin $25 × 300, 000

Contribution Margin $25 × 500, 000

degree of total l everage

Exhibit 1 : Financial Information - AlphaZone

Exhibit 2 : Debt Schedule - AlphaZone

Debt-to-equity ratio Cost of debt

Cost of equity = Risk-free rate + Equity-beta × Market risk premium

We need to calculate the equity beta using the formula:

βU = Asset beta (Unlevered beta).

D/E Cost of equity Cost of debt WACC

T he WACC at its lowest when the D/E ratio = 0.40.

A i s i ncorrect. 5.13% is the company's WACC at a debt-to-equity ratio of 0.2.

B i s i ncorrect. 5.45% is the company's WACC at a debt-to-equity ratio of 0.6.

capi tal structure wei ghts.