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1. Smith, a research analyst with a brokerage firm, decides to change his recommendation for
the common stock of Green Company, Inc., from a buy to a sell. He mails this change in
investment advice to all the firms clients on Wednesday. The day after the mailing, a client
calls with a buy order for 500 shares of Green Company. In this circumstance, Smith should:
A. Accept the order.
B. Advise the customer of the change in recommendation before accepting the order.
C. Not accept the order because it is contrary to the firms recommendation.

Solution: B.
This question involves Standard III(B)Fair Dealing. Smith disseminated a change in the stock
recommendation to his clients but then received a request contrary to that recommendation
from a client who probably had not yet received the recommendation. Prior to executing the
order, Smith should take additional steps to ensure that the customer has received the change of
recommendation. Answer A is incorrect because the client placed the order prior to receiving the
recommendation and, therefore, does not have the benefit of Smiths most recent
recommendation. Answer C is also incorrect; simply because the client request is contrary to the
firms recommendation does not mean a member can override a direct request by a client. After
Smith contacts the client to ensure that the client has received the changed recommendation, if
the client still wants to place a buy order for the shares, Smith is obligated to comply with the
clients directive.

2. A bank quotes a stated annual interest rate of 4.00%. If that rate is equal to an effective
annual rate of 4.08%, then the bank is compounding interest:
A. daily.
B. quarterly.
C. semiannually.

Solution: A.
The effective annual rate (EAR) when compounded daily is 4.08%.
EAR = (1+Periodic interest rate)m-1
EAR = (1+0.04/365)365-1
EAR = (1.0408) 1 = 0.04081 4.08%.

3. If the cross-price elasticity between two goods is negative, the two goods are classified as:
A. normal.
B. substitutes.



C. complements.

Solution: C.
With complements, consumption goes up or down together. With a negative cross-price elasticity,
as the price of one good goes up, the demand for both falls.

4. Accounting policies, methods, and estimates used in preparing financial statements are
most likely found in the:
A. auditors report.
B. management commentary.
C. notes to the financial statements.

Solution: C.
The notes disclose choices in accounting policies, methods, and estimates.

5. An investment of $100 generates after-tax cash flows of $40 in Year 1, $80 in Year 2, and
$120 in Year 3. The required rate of return is 20 percent. The net present value is closest to:
A. $42.22.
B. $58.33.
C. $68.52.

Solutions: B.
CFt 40 80 120
NPV -100 $58.33
1 r
t 0 1.20 1.20 1.203

6. With respect to the portfolio management process, the rebalancing of a portfolios

composition is most likely to occur in the:
A. planning step.
B. feedback step.
C. execution step.

Solutions: B.
Portfolio monitoring and rebalancing occurs in the feedback step of the portfolio management



7. An analyst gathers the following information for an equal-weighted index comprised of

assets Able, Baker, and Charlie:
Beginning of End of Period Price
Security Total Dividends ()
Period Price () ()
Able 10.00 12.00 0.75
Baker 20.00 19.00 1.00
Charlie 30.00 30.00 2.00
The total return of the index is:
A. 5.0%.
B. 7.9%.
C. 11.4%.

Solution: C.
The total return of an index is calculated on the basis of the change in price of the underlying
securities plus the sum of income received or the sum of the weighted total returns of each
security. The total return of Able is 27.5 percent; of Baker is 0 percent; and of Charlie is 6.7
Able: (12 10 +0.75)/10 = 27.5%
Baker: (19 - 20 + 1)/20 = 0%
Charlie: (30 30 +2)/30 = 6.7%
An equal-weighted index applies the same weight (1/3) to each securitys return; therefore,
The total return = 1/3 * (27.5% + 0% + 6.7%) = 11.4%.

8. A company has issued a floating-rate note with a coupon rate equal to the three-month
Libor + 65 basis points. Interest payments are made quarterly on 31 March, 30 June, 30
September, and 31 December. On 31 March and 30 June, the three-month Libor is 1.55%
and 1.35%, respectively. The coupon rate for the interest payment made on 30 June is:
A. 2.00%.
B. 2.10%.
C. 2.20%.

Solution: C.
The coupon rate that applies to the interest payment due on 30 June is based on the
three-month Libor rate prevailing on 31 March. Thus, the coupon rate is 1.55% 0.65% 2.20%.



9. The recent price per share of Dragon Vacations, Inc. is $50 per share. Calls with exactly six
months left to expiration are available on Dragon with strikes of $45, $50, and $55. The
prices of the calls are $8.75, $6.00, and $4.00, respectively. Assume that each call contract is
for 100 shares of stock and that at initiation of the strategy the investor purchases 100
shares of Dragon at the current market price. Further assume that the investor will close out
the strategy in six months when the options expire, including the sale of any stock not
delivered against exercise of a call, whether the stock price goes up or goes down. If the
closing price of Dragon stock in six months is exactly $60, the profit to a covered call using
the $50 strike call is closest to:
A. $400.
B. $600.
C. $1,600.

Solutions: B.
Buying the stock at $50 and delivering it against the $50 strike call generates a payoff of zero.
The premium is retained by the writer. The net profit is $6.00 per share 100 shares or $600.

10. Which of the following is least likely to be considered an alternative investment?

A. Real estate
B. Commodities
C. Long-only equity funds

Solutions: C.
Long-only equity funds are typically considered traditional investments and real estate and
commodities are typically classified as alternative investments.