CFALevel1 Sample Questions

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CFA Level 1 Sample Questions
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CFA Questions from Austal Group (www.austalgroup.net) Austal Group 1. If a one-tailed Z-test uses a 5% significance level, the test will reject a a. False null hypothesis 95% of the time b. True null hypothesis 5% of the time c. True null hypothesis 95% of the time Answer: B -- True null hypothesis 5% of the time 2. The unconditional probability of an event, given conditional probabilities, is determined by using the: a. Addition rule of probability. b. Multiplication rule of probability c. Total probability rule Answer: C -- Total Probability Rule null hypothesis 5% of the time 3. A T-bill with a face value of $100,000 and 160 days until maturity is selling for $97,000. What is the bank discount yield? a. 6.96%. b. 6.75%. c. 5.18%. Answer: B -- Actual discount is 3%, annualized discount is: 0.03(360 / 160) = 6.75% 4. Which of the following statements regarding the speed at which analysts believe stock prices reflect new information is most accurate? a. Followers of the efficient market hypothesis believe prices adjust quickly to new information. b. Technicians believe that prices adjust quickly to new information. c. Both technicians and followers of the efficient market hypothesis believe prices adjust quickly to new information Answer: A -- Followers of the efficient market hypothesis believe prices adjust quickly to new information 5. When individuals are unemployed because they do not have perfect information concerning available jobs, this is: a. Structural unemployment. b. Frictional unemployment. c. Natural unemployment. Answer: B -- Frictional unemployment exists because workers and employers do not have perfect information and must expend time and resources on search activities 6. If a monetary policy is focused on combating inflation, which open market actions by the Federal Reserve will most effectively accomplish this? a. Sell Treasury securities, causing aggregate demand to increase b. Purchase Treasury securities, causing aggregate demand to decrease c. Sell Treasury securities, causing aggregate demand to decrease
CFA Questions from Austal Group (www.austalgroup.net) Austal Group Answer: C -- Sell Treasury securities, causing aggregate demand to decrease 7. When considering the impact of warrants on earnings per share, the method to calculate the number of shares added to the denominator is derived using which method? a. Treasury Stock method b. Cost recovery method. c. Weighted average method. Answer: A -- The treasury stock method assumes the hypothetical funds received by the company from the exercise of the options are used to purchase shares of the company's common stock in the market at the average market price 8. Selected information from ABC, Inc.s financial activities in the year 2009 included the following: Net income was $372,000; 100,000 shares of common stock were outstanding on January 1; The average market price per share was $18 in 2009; Dividends were paid in 2009; 2,000, 6 percent $1,000 par value convertible bonds, which are convertible at a ratio of 25 shares for each bond, were outstanding the entire year; ABC, Inc.s tax rate is 40%. ABC, Inc.s diluted earnings per share for 2009 was closest to: a. $3.72. b. $2.96. c. $3.28. Answer: B -- ABC basic EPS was ($372,000 / 100,000 =) $3.72. If the bonds were converted as of January1, interest payments would not have been made. Net income is increased by the interest paid on the bonds net of taxes ($372,000 + (($1000 2,000 0.06) (1 0.40)) =) $444,000. Diluted EPS was ($444,000 / (100,000 + (2,000 25)) =) $2.96. 9. Capitalizing interest costs related to a companys construction of assets for its own use is required by a. IFRS only. b. U.S. GAAP only. c. both IFRS and U.S. GAAP. Answer: C -- Both U.S. GAAP and IFRS require companies to capitalize the interest that accrues during a the construction of capital assets for their own use 10. Which of the following is least likely to happen after a last in, first out (LIFO) liquidation in an environment of rising prices? a. Increase gross income. b. Increase taxable income. c. Increase cost of goods sold (COGS). Answer: C In a LIFO liquidation, a firm allows inventory to decrease so that it is using lowercost materials. This will lower the COGS and increase income and profit
CFA Questions from Austal Group (www.austalgroup.net) Austal Group 11. An article in a journal suggests that a strategy of buying the seven stocks in the S&P 500 with the highest PE ratio at the end of the calendar year and holding them until last week of March of the following year produces significant trading profits. Upon further investigation, we discover that the study is based on data from 1993 to 1997, and the PE ratio is calculated using the stock price on December 31 of each year and the annual reported EPS for that year. Which of the following biases is least likely to influence the reported results? a. Look-ahead bias b. Time-period bias c. Survivorship bias Answer: C Survivorship bias is not likely to significantly influence the results of this study because the authors looked at the stocks in the S&P 500 at the beginning of the year and measured performance over the following three months. Look-ahead bias could be a problem because PE ratios are calculated and the trading strategy implemented at a time before earnings are actually reported. Finally, the study is conducted over a relatively short time period during the long bull market of the 1990s. This suggests the results may be time-specific and the result of time-period bias 12. The average salary for a sample of 61 CFA charterholders with 10 years experience is $200,000, and the sample standard deviation is $80,000. Assume the population is normally distributed. Which of the following is a 99% confidence interval for the population mean salary of CFA charterholders with 10 years of experience? a. $172,754 to $227,246 b. $172,514 to $227,486 c. $160,000 to $240,000 Answer: A If the distribution of the population is normal, but we dont know the population variance, we can use the Students t-distribution to construct a confidence interval. Because there are 61 observations, the degrees of freedom are 60. From the students t table, we can determine that the reliability factor for t/2, or t0.005, is 2.660. Then the 99% confidence interval is $200,000 2.660($80,000 / 61) or $200,000 2.660 $10,243, or $200,000 $27,246 13. Given a normally distributed population with a mean income of $40,000 and standard deviation of $7,500, what percentage of the population makes between $30,000 and $35,000? a. 15.96% b. 13.34% c. 41.67% Answer: A The z-score for $30,000 = ($30,000 $40,000) / $7,500 or 1.3333, which corresponds with 0.0918. The z-score for $35,000 = ($35,000 $40,000) / $7,500 or 0.6667, which corresponds with 0.2514. The difference is 0.1596 or 15.96% 14. Which of the following portfolios provides the best safety first ratio if the minimum acceptable return is 6%?
CFA Questions from Austal Group (www.austalgroup.net) Austal Group

Portfolio Expected Return (%) Standard Deviation (%) 1 2 3 13 9 11 5 2 3
a. 1 b. 2 c. 3 Answer: C Roys safety-first criterion requires the maximization of the SF Ratio: SF Ratio = (expected return threshold return) / standard deviation
Portfolio 1 2 3 Expected Return (%) 13 9 11 Standard Deviation (%) 5 2 3 SF Ratio 1.40 1.50 1.67
Portfolio #3 has the highest safety-first ratio at 1.67. 15. There is an 80% chance of rain on each of the next six days. What is the probability that it will rain on exactly two of those days? a. 0.01536 b. 0.24327 c. 0.15364 Answer: A 6 nCr 2 (0.8)^2 (0.2)^4 = 0.01536
16. John is a soybean farmer who harvests 125,000 bushels of soybeans annually. Johns fixed costs are $200,000 and his variable costs are $5 per bushel. Soybeans are currently priced at $5.35 per bushel. Based on his estimates, John sees soybean prices being relatively stable for the next two years, then increasing to $7.00 per bushel due to increased demand from Japan. What action should John take a. Cut his production by 50% for the next two years and then resume full production. b. Continue operating his business as usual c. Shut down for two years and then restart his business.
Answer: B Since John is selling soybeans, a common commodity, he is a price taker and therefore cannot adjust the price. He should continue operating his business as normal as he is currently covering variable costs and part of fixed costs. In two years from now, he will be able to cover both fixed and variable costs and be able to make a substantial profit.
17. If the price elasticity of demand is -1.5 and you increase the price of the product 3%, the quantity demanded will (closest to):
a. Decrease 1.5% b. Decrease 3.0% c. Decrease 4.5% Answer: C If the price elasticity of demand is -1.5, and you increase the price of the product 3%, the quantity demanded will decrease approximately 4.5%. When the price elasticity is negative, it means that price and demand move in opposite directions. Given a price decrease, demand will
CFA Questions from Austal Group (www.austalgroup.net) Austal Group increase and vice versa. The absolute value, 1.5, indicates that demand will move one-and-a-half times as much as price.
18. Which of the following relationships most accurately describes the inefficiency resulting form government imposed production quotas?
a. Marginal cost exceeds marginal benefit leading to underproduction b. Marginal benefit exceeds marginal cost leading to overproduction c. Marginal benefit exceeds marginal cost leading to underproduction Answer: C Government imposed quotas restrict production to a level below that which would occur if marginal benefit equals marginal cost. This restricted output quantity is less than the equilibrium quantity, so marginal benefit exceeds marginal cost 19. If the admission price for a rock concert is raised from $25 to $30 causing sales to drop from 60,000 to 40,000, the price elasticity of demand for tickets to the concert is: a. 2.20 b. -2.20 c. -1.67 Answer: B The percent change in quantity demanded is (40,000 60,000) / ((60,000 + 40,000) / 2) = -0.4. The percent change in price is (30 25) / ((30 + 25) / 2) = 0.1818. The price elasticity of demand is -0.40 / 0.1818 = -2.2 20. When a tax is imposed on the consumption of a good, which of the following terms refers to who bears the burden of the tax? a. The deadweight loss b. The incidence of a tax c. Consumer surplus Answer: B The incidence of a tax refers to how the burden of a tax is actually shared between buyers and sellers. The deadweight loss is the loss of the gains from trade from the lower equilibrium quantity that results from the tax. Consumer surplus is the gains from trade that consumers accrue from the existence of the market
21. Murray Company reported the following revenues and expenses for the year ended 2007: Sales revenue Wage expense Insurance expense Interest expense Depreciation expense $200,000 89,000 17,000 10,400 50,000
Following are the related balance sheet accounts: 2007 Unearned revenue Wages payable Prepaid insurance $15,600 5,400 1,200 2006 $13,200 6,600 0

Interest payable Accumulated depreciation 500 95,000 1,600 45,000
Calculate cash collections and cash expenses are
a. $202,400 & $58,100 b. $197,600 & $119,900 c. $202,400 & $119,900 Answer: C Cash collections are $202,400 ($200,000 sales + $2,400 increase in unearned
revenue). Cash expenses are $119,900 ($89,000 wages expense $1,200 decrease in wages payable $17,000 insurance expense $1,200 increase in prepaid insurance $10,400 interest expense $1,100 decrease in interest payable).
22. Assume that the exercise price of an option is $12, and the average market price of the stock is $15. Assuming 1,500 options are outstanding during the entire year, what is the number of shares to be added to the denominator of the diluted earnings per share (EPS)? a. 300 b. 1,200 c. 1,500 Answer: A 1,500 * 12 = 18,000; 18,000/15 = 1,200; 1,500 1,200 = 300
23. XYZ Corporation uses the LIFO method of accounting for inventory. For the year 2009, the following is provided: Cost of goods sold (COGS): $24,000 Beginning inventory: $6,000 Ending inventory: $7,500 The notes accompanying the financial statements indicate that the LIFO reserve at the beginning of the year was $2,250 and at the end of the year was $6,000 If XYZ had used FIFO, the COGS for 2009 would be: a. $3,750 b. $20,250 c. $29,250 Answer: B FIFO COGS = LIFO COGS change in LIFO reserve. $24,000 ($6,000 2,250) = $20,250 24. Khan Associates uses an accrual basis for financial reporting purposes and cash basis for tax purposes. Cash collections from customers are $476,000, and accrued revenue is only $376,000. Assume expenses at 50% in both cases (i.e., $238,000 on cash basis and $188,000 on accrual basis), and a tax rate of 34%. What is the deferred tax asset or liability? A deferred tax: a. Asset of $48,960.
CFA Questions from Austal Group (www.austalgroup.net) Austal Group b. Liability of $17,000. c. Asset of $17,000. Answer: C Since taxable income ($238,000) exceeds pretax income ($188,000), Khan will have a deferred tax asset of $17,000 *($238,000 $188,000)*(0.34)+ 25. Which of the following statements regarding the net present value (NPV) and internal rate of return (IRR) is least accurate? a. For independent projects, the internal rate of return IRR and the NPV methods always yield the same accept/reject decisions b. For mutually exclusive projects, you must accept the project with the highest NPV regardless of the sign of the NPV calculation c. The NPV tells how much the value of the firm will increase if you accept the project Answer: B For mutually exclusive projects, you must accept the project with the highest NPV regardless of the sign of the NPV calculation. If the NPV for two mutually exclusive projects is negative, both should be rejected 26. The expected rate of return is twice the 12% expected rate of return from the market. What is the beta if the risk-free rate is 6%? a. 2 b. 3 c. 4 Answer: B 24 = 6 + (12 6); 18 = 6; = 3 27. Which of the following statements best describes an investment that is not on the efficient frontier? a. There is a portfolio that has a lower risk for the same return. b. There is a portfolio that has a lower return for the same risk. c. The portfolio has a very high return Answer: A The efficient frontier outlines the set of portfolios that gives investors the highest return for a given level of risk or the lowest risk for a given level of return. Therefore, if a portfolio is not on the efficient frontier, there must be a portfolio that has lower risk for the same return. Equivalently, there must be a portfolio that produces a higher return for the same risk
28. An analyst gathered the following data for Stock A and Stock B: Time Period Stock A Returns Stock B Returns 1 2 3 10% 6% 8% 15% 9% 12%
What is the covariance for this portfolio?
a. 12 b. 3
CFA Questions from Austal Group (www.austalgroup.net) Austal Group c. 6 Answer: C Mean R(A) = (10 + 6 + 8) / 3 = 8, Mean R(B) = (15 + 9 + 12) / 3 = 12; Here, Cov1,2 = *(10 8)(15 12) + (6 8)(9 12) + (8 8)(12 12)+ / 2 = 6
29. An analyst is currently considering a portfolio consisting of two stocks. The first stock, Sesk Co., has an expected return of 12% and a standard deviation of 16%. The second stock, Labs, Inc., has an expected return of 18% and a standard deviation of 25%. The correlation of returns between the two securities is 0.25. If the analyst forms a portfolio with 30% in Sesk and 70% in Labs, what is the portfolio's expected return? a. 15.0% b. 16.2% c. 17.3% Answer: B ER = (0.3 12) + (0.70 18) = 3.6 + 12.6 = 16.2% 30. Assume that the value of a put option with a strike price of $100 and six months remaining to
maturity is $5. For a stock price of $110 and an interest rate of 6%, what value is closest to the corresponding call option with the same strike price and same expiration as the put option?
a. $11.99 b. $12.74 c. $17.87 Answer: C Call value = $110 + $5 $100/1.06^0.5 = $17.87
31. The following data applies to a forward rate agreement that settles in 60 days: It is based on 180-day LIBOR The notional principal amount is $15 million It calls for a forward rate of 6.5% In 30 days, 180-day LIBOR will be 6.2% In 60 days, 180-day LIBOR will be 7.0% In 180 days, 180-day LIBOR will be 7.5% The shorts cash payment at settlement is closest to a. $36,232 b. $37,500 c. The short will not have to make a payment
Answer: A Settlement payment from short = notional principal ((forward LIBOR at settlement
agreed forward rate) (180/360)) / (1 + (floating 180/360)) Payment = $15 million ((7.0% 6.5%) (180/360)) / (1 + (0.07 180/360)) = $36,231.88
32. a. b. If a one-tailed Z-test uses a 5% significance level, the test will reject a False null hypothesis 95% of the time True null hypothesis 5% of the time

c. True null hypothesis 95% of the time
Answer: B -- True null hypothesis 5% of the time 33. a. b. c. The unconditional probability of an event, given conditional probabilities, is determined by using the: Addition rule of probability. Multiplication rule of probability Total probability rule
Answer: C -- Total Probability Rule null hypothesis 5% of the time 34. A T-bill with a face value of $100,000 and 160 days until maturity is selling for $97,000. What is the bank discount yield? a. 6.96%. b. 6.75%. c. 5.18%. Answer: B -- Actual discount is 3%, annualized discount is: 0.03(360 / 160) = 6.75% 35. Which of the following statements regarding the speed at which analysts believe stock prices reflect new information is most accurate? a. Followers of the efficient market hypothesis believe prices adjust quickly to new information. b. Technicians believe that prices adjust quickly to new information. c. Both technicians and followers of the efficient market hypothesis believe prices adjust quickly to new information Answer: A -- Followers of the efficient market hypothesis believe prices adjust quickly to new information 36. When individuals are unemployed because they do not have perfect information concerning available jobs, this is: a. Structural unemployment. b. Frictional unemployment. c. Natural unemployment. Answer: B -- Frictional unemployment exists because workers and employers do not have perfect information and must expend time and resources on search activities 37. Reserve a. b. c. If a monetary policy is focused on combating inflation, which open market actions by the Federal will most effectively accomplish this? Sell Treasury securities, causing aggregate demand to increase Purchase Treasury securities, causing aggregate demand to decrease Sell Treasury securities, causing aggregate demand to decrease
Answer: C -- Sell Treasury securities, causing aggregate demand to decrease 38. When considering the impact of warrants on earnings per share, the method to calculate the number of shares added to the denominator is derived using which method? a. Treasury Stock method b. Cost recovery method. c. Weighted average method. Answer: A -- The treasury stock method assumes the hypothetical funds received by the company from the exercise of the options are used to purchase shares of the company's common stock in the market at the average market price 39. Selected information from ABC, Inc.s financial activities in the year 2009 included the following:
Net income was $372,000; 100,000 shares of common stock were outstanding on January 1; The average market price per share was $18 in 2009; Dividends were paid in 2009; 2,000, 6 percent $1,000 par value convertible

bonds, which are convertible at a ratio of 25 shares for each bond, were outstanding the entire year; ABC, Inc.s tax rate is 40%. ABC, Inc.s diluted earnings per share for 2009 was closest to: a. $3.72. b. $2.96. c. $3.28. Answer: B -- ABC basic EPS was ($372,000 / 100,000 =) $3.72. If the bonds were converted as of January1, interest payments would not have been made. Net income is increased by the interest paid on the bonds net of taxes ($372,000 + (($1000 2,000 0.06) (1 0.40)) =) $444,000. Diluted EPS was ($444,000 / (100,000 + (2,000 25)) =) $2.96. 40. a. b. c. Capitalizing interest costs related to a companys construction of assets for its own use is required by IFRS only. U.S. GAAP only. both IFRS and U.S. GAAP.
Answer: C -- Both U.S. GAAP and IFRS require companies to capitalize the interest that accrues during a the construction of capital assets for their own use 41. Which of the following is least likely to happen after a last in, first out (LIFO) liquidation in an environment of rising prices? a. Increase gross income. b. Increase taxable income. c. Increase cost of goods sold (COGS). Answer: C In a LIFO liquidation, a firm allows inventory to decrease so that it is using lower-cost materials. This will lower the COGS and increase income and profit 42. An article in a journal suggests that a strategy of buying the seven stocks in the S&P 500 with the highest PE ratio at the end of the calendar year and holding them until last week of March of the following year produces significant trading profits. Upon further investigation, we discover that the study is based on data from 1993 to 1997, and the PE ratio is calculated using the stock price on December 31 of each year and the annual reported EPS for that year. Which of the following biases is least likely to influence the reported results? a. Look-ahead bias b. Time-period bias c. Survivorship bias Answer: C Survivorship bias is not likely to significantly influence the results of this study because the authors looked at the stocks in the S&P 500 at the beginning of the year and measured performance over the following three months. Look-ahead bias could be a problem because PE ratios are calculated and the trading strategy implemented at a time before earnings are actually reported. Finally, the study is conducted over a relatively short time period during the long bull market of the 1990s. This suggests the results may be time-specific and the result of time-period bias 43. The average salary for a sample of 61 CFA charterholders with 10 years experience is $200,000, and the sample standard deviation is $80,000. Assume the population is normally distributed. Which of the following is a 99% confidence interval for the population mean salary of CFA charterholders with 10 years of experience? a. $172,754 to $227,246 b. $172,514 to $227,486 c. $160,000 to $240,000 Answer: A If the distribution of the population is normal, but we dont know the population variance, we can use the Students t-distribution to construct a confidence interval. Because there are 61 observations, the degrees of freedom are 60. From the students t table, we can determine that the reliability factor for t/2, or t0.005, is 2.660.

Then the 99% confidence interval is $200,000 2.660($80,000 / 61) or $200,000 2.660 $10,243, or $200,000 $27,246 44. $7,500, a. b. c. Given a normally distributed population with a mean income of $40,000 and standard deviation of what percentage of the population makes between $30,000 and $35,000? 15.96% 13.34% 41.67%
Answer: A The z-score for $30,000 = ($30,000 $40,000) / $7,500 or 1.3333, which corresponds with 0.0918. The z-score for $35,000 = ($35,000 $40,000) / $7,500 or 0.6667, which corresponds with 0.2514. The difference is 0.1596 or 15.96% 45. is 6%? Which of the following portfolios provides the best safety first ratio if the minimum acceptable return
Portfolio Expected Return (%) Standard Deviation (%)

1 2 3 a. b. c. 1 2 3 13 9 11 5 2 3
Answer: C Roys safety-first criterion requires the maximization of the SF Ratio: SF Ratio = (expected return threshold return) / standard deviation
Portfolio
1 2 3
Expected Return (%)

13 9 11
Standard Deviation (%)

5 2 3
SF Ratio
1.40 1.50 1.67
Portfolio #3 has the highest safety-first ratio at 1.67. 46. exactly a. b. c. There is an 80% chance of rain on each of the next six days. What is the probability that it will rain on two of those days? 0.01536 0.24327 0.15364
Answer: A 6 nCr 2 (0.8)^2 (0.2)^4 = 0.01536 47. John is a soybean farmer who harvests 125,000 bushels of soybeans annually. Johns fixed costs are $200,000 and his variable costs are $5 per bushel. Soybeans are currently priced at $5.35 per bushel. Based on his estimates, John sees soybean prices being relatively stable for the next two years, then increasing to $7.00 per bushel due to increased demand from Japan. What action should John take a. Cut his production by 50% for the next two years and then resume full production. b. Continue operating his business as usual c. Shut down for two years and then restart his business. Answer: B Since John is selling soybeans, a common commodity, he is a price taker and therefore cannot adjust the price. He should continue operating his business as normal as he is currently covering variable costs and part of fixed costs. In two years from now, he will be able to cover both fixed and variable costs and be able to make a substantial profit.

48. If the price elasticity of demand is -1.5 and you increase the price of the product 3%, the quantity demanded will (closest to): a. Decrease 1.5% b. Decrease 3.0% c. Decrease 4.5% Answer: C If the price elasticity of demand is -1.5, and you increase the price of the product 3%, the quantity demanded will decrease approximately 4.5%. When the price elasticity is negative, it means that price and demand move in opposite directions. Given a price decrease, demand will increase and vice versa. The absolute value, 1.5, indicates that demand will move one-and-a-half times as much as price. 49. Which of the following relationships most accurately describes the inefficiency resulting form government imposed production quotas? a. Marginal cost exceeds marginal benefit leading to underproduction b. Marginal benefit exceeds marginal cost leading to overproduction c. Marginal benefit exceeds marginal cost leading to underproduction Answer: C Government imposed quotas restrict production to a level below that which would occur if marginal benefit equals marginal cost. This restricted output quantity is less than the equilibrium quantity, so marginal benefit exceeds marginal cost 50. 40,000, a. b. c. If the admission price for a rock concert is raised from $25 to $30 causing sales to drop from 60,000 to the price elasticity of demand for tickets to the concert is: 2.20 -2.20 -1.67
Answer: B The percent change in quantity demanded is (40,000 60,000) / ((60,000 + 40,000) / 2) = -0.4. The percent change in price is (30 25) / ((30 + 25) / 2) = 0.1818. The price elasticity of demand is -0.40 / 0.1818 = -2.2 51. When a tax is imposed on the consumption of a good, which of the following terms refers to who bears the burden of the tax? a. The deadweight loss b. The incidence of a tax c. Consumer surplus Answer: B The incidence of a tax refers to how the burden of a tax is actually shared between buyers and sellers. The deadweight loss is the loss of the gains from trade from the lower equilibrium quantity that results from the tax. Consumer surplus is the gains from trade that consumers accrue from the existence of the market 52. Murray Company reported the following revenues and expenses for the year ended 2007: Sales revenue Wage expense Insurance expense Interest expense Depreciation expense Following are the related balance sheet accounts: 2007 Unearned revenue Wages payable Prepaid insurance $15,600 5,400 1,200 2006 $13,200 6,600 0 $200,000 89,000 17,000 10,400 50,000

Interest payable Accumulated depreciation Calculate cash collections and cash expenses are a. b. c. $202,400 & $58,100 $197,600 & $119,900 $202,400 & $119,900 500 95,000 1,600 45,000
Answer: C Cash collections are $202,400 ($200,000 sales + $2,400 increase in unearned revenue). Cash expenses are $119,900 ($89,000 wages expense $1,200 decrease in wages payable $17,000 insurance expense $1,200 increase in prepaid insurance $10,400 interest expense $1,100 decrease in interest payable). 53. Assume that the exercise price of an option is $12, and the average market price of the stock is $15. Assuming 1,500 options are outstanding during the entire year, what is the number of shares to be added to the denominator of the diluted earnings per share (EPS)? a. 300 b. 1,200 c. 1,500 Answer: A 1,500 * 12 = 18,000; 18,000/15 = 1,200; 1,500 1,200 = 300
54. XYZ Corporation uses the LIFO method of accounting for inventory. For the year 2009, the following is provided: Cost of goods sold (COGS): $24,000 Beginning inventory: $6,000 Ending inventory: $7,500 The notes accompanying the financial statements indicate that the LIFO reserve at the beginning of the year was $2,250 and at the end of the year was $6,000 If XYZ had used FIFO, the COGS for 2009 would be: a. b. c. $3,750 $20,250 $29,250
Answer: B FIFO COGS = LIFO COGS change in LIFO reserve. $24,000 ($6,000 2,250) = $20,250 55. Khan Associates uses an accrual basis for financial reporting purposes and cash basis for tax purposes. Cash collections from customers are $476,000, and accrued revenue is only $376,000. Assume expenses at 50% in both cases (i.e., $238,000 on cash basis and $188,000 on accrual basis), and a tax rate of 34%. What is the deferred tax asset or liability? A deferred tax: a. Asset of $48,960. b. Liability of $17,000. c. Asset of $17,000. Answer: C Since taxable income ($238,000) exceeds pretax income ($188,000), Khan will have a deferred tax asset of $17,000 [($238,000 $188,000)*(0.34)] 56. Which of the following statements regarding the net present value (NPV) and internal rate of return (IRR) is least accurate?

a. b. c. For independent projects, the internal rate of return IRR and the NPV methods always yield the same accept/reject decisions For mutually exclusive projects, you must accept the project with the highest NPV regardless of the sign of the NPV calculation The NPV tells how much the value of the firm will increase if you accept the project
Answer: B For mutually exclusive projects, you must accept the project with the highest NPV regardless of the sign of the NPV calculation. If the NPV for two mutually exclusive projects is negative, both should be rejected 57. The expected rate of return is twice the 12% expected rate of return from the market. What is the beta if the risk-free rate is 6%? a. 2 b. 3 c. 4 Answer: B 24 = 6 + (12 6); 18 = 6; = 3 58. a. b. c. Which of the following statements best describes an investment that is not on the efficient frontier? There is a portfolio that has a lower risk for the same return. There is a portfolio that has a lower return for the same risk. The portfolio has a very high return
Answer: A The efficient frontier outlines the set of portfolios that gives investors the highest return for a given level of risk or the lowest risk for a given level of return. Therefore, if a portfolio is not on the efficient frontier, there must be a portfolio that has lower risk for the same return. Equivalently, there must be a portfolio that produces a higher return for the same risk 59. An analyst gathered the following data for Stock A and Stock B:
Time Period
1 2 3 What is a. b. c.
Stock A Returns
10% 6% 8%
Stock B Returns
15% 9% 12%
the covariance for this portfolio? 12 3 6
Answer: C Mean R(A) = (10 + 6 + 8) / 3 = 8, Mean R(B) = (15 + 9 + 12) / 3 = 12; Here, Cov1,2 = [(10 8)(15 12) + (6 8)(9 12) + (8 8)(12 12)] / 2 = 6
60. An analyst is currently considering a portfolio consisting of two stocks. The first stock, Sesk Co., has an expected return of 12% and a standard deviation of 16%. The second stock, Labs, Inc., has an expected return of 18% and a standard deviation of 25%. The correlation of returns between the two securities is 0.25. If the analyst forms a portfolio with 30% in Sesk and 70% in Labs, what is the portfolio's expected return? a. b. c. 15.0% 16.2% 17.3%
Answer: B ER = (0.3 12) + (0.70 18) = 3.6 + 12.6 = 16.2%

61. Assume that the value of a put option with a strike price of $100 and six months remaining to maturity is $5. For a stock price of $110 and an interest rate of 6%, what value is closest to the corresponding call option with the same strike price and same expiration as the put option? a. $11.99 b. $12.74 c. $17.87 Answer: C Call value = $110 + $5 $100/1.06^0.5 = $17.87
62. The following data applies to a forward rate agreement that settles in 60 days: It is based on 180-day LIBOR The notional principal amount is $15 million It calls for a forward rate of 6.5% In 30 days, 180-day LIBOR will be 6.2% In 60 days, 180-day LIBOR will be 7.0% In 180 days, 180-day LIBOR will be 7.5% The shorts cash payment at settlement is closest to a. b. c. $36,232 $37,500 The short will not have to make a payment
Answer: A Settlement payment from short = notional principal ((forward LIBOR at settlement agreed forward rate) (180/360)) / (1 + (floating 180/360)) Payment = $15 million ((7.0% 6.5%) (180/360)) / (1 + (0.07 180/360)) = $36,231.88
63. The net income for Morgan Company was $3 million for the year ended December 31, 2008. Additional information is as follows: Depreciation on fixed assets $1,500,000 Gain from cash sales of land 200,000 Increase in accounts payable 300,000 Dividends paid on preferred stock 400,000
The net cash provided by operating activities in the statement of cash flows for the year ended December 31, 2008 is: a. b. c. $4,600,000 $4,200,000 $4,800,000
Answer: A =$3,000,000 + $1,500,000 $200,000 + $300,000 = $4,600,000
64.
The following table gives the price of a bond with face value $1000 for different interest rates: Interest Rate 5.15% 5.20% 5.10% Price 101.0898 100.8707 101.3094
The duration of the bond is: a. 4.78 b. 4.35

c. 2.17
Answer: B - Duration = (V - V+)/(V0 * 2 * dV). Change the price of the bond by changing yield by a small amount (here 1/20 of 1%) in both directions to get V and V+ 65. Corcoran Corp acquired an asset on 1 January 2004, for $500,000. For financial reporting, Corcoran will depreciate the asset using the straight-line method over a 10-year period with no salvage value. For tax purposes the asset will be depreciated straight line for five years and Corcorans effective tax rate is 30%. Corcorans deferred tax liability for 2004 will a. b. c. Decrease by $50,000 Increase by $15,000 Decrease by $15,000
Answer: B Straight-line depreciation per financial reports = 500,000 / 10 = $50,000; Tax depreciation = 500,000 / 5 = $100,000; Temporary difference = 100,000 50,000 = $50,000; Deferred tax liability will increase by $50,000 30% = $15,000 66. Which of the following statements about accounting treatments under IFRS and U.S. GAAP are most accurate regarding the periodic valuation of identifiable intangible assets and marketable securities classified as available for sale, respectively? Identifiable intangible assets U.S. GAAP permits upward revaluation U.S. GAAP permits upward revaluation IFRS permits upward revaluation Available-for-sale securities Carried at market value Carried at amortized cost Carried at market value
a. b. c.
Answer: B Under IFRS and U.S. GAAP, identifiable intangible assets are reported on the balance sheet at their cost less accumulated amortization. However, a significant difference is that U.S. GAAP does not permit upward revaluations of intangible assets. The accounting treatment for available-for-sale securities is the same under IFRS and U.S. GAAP. These securities are carried on the balance sheet at their fair market values. Unrealized gains and losses are not recognized on the income statement, but are included in other comprehensive income 67. A firm wishes to finance itself, and sells preferred stock, equity and bonds. It gets $2 million by selling preferred stock that will pay preferred dividends of $140,000 every year. It gets $10 million by selling equity that buyers expect will pay dividends of 4% and grow at 5% every year. It gets $8 million by selling 8-year 5.2% semiannual coupon of maturity value $10 million. The tax rate is 36%. What is the firm's WACC? a. b. c. 5.98% 6.93% 6.57%
Answer: B First calculate the 6 month yield on the bond using your financial calculator. Next (1+r)^2 - 1 to get the 12 month yield. Multiply by (1-tax rate) to get after tax cost of capital for debt. Cost of equity is dividend yield + growth rate. Cost of preferred stock is preferred dividends/price of preferred stock. Finally weight by market (not face) values of preferred stock, equity and debt to get WACC 68. Enron left plenty of clues to its accounting fraud, some of which would have been easier to find than others. Which strategy would have been least effective at unearthing Enrons fraud? a. Charting the historical seasonality of Enrons earnings. b. Checking the reported mark-to-market values against actual values of similar securities. c. Checking the cash flow/earnings index Answer: C: Unfortunately, the cash flow/earnings index would have made Enron look good, as its operating cash flow was higher than net income. However, the numbers lied because Enron overstated its operating cash flow. Both remaining strategies would have led to information suggesting Enrons results were bogus.

69. Two assets are perfectly positively correlated. If 30% of an investor's funds were put in the asset with a standard deviation of 0.3 and 70% were invested in an asset with a standard deviation of 0.4, what is the standard deviation of the portfolio a. b. c. 0.151 0.426 0.370
Answer: C: Unfortunately, the cash flow/earnings index would have made Enron look good, as its operating cash flow was higher than portfolio = [W1212 + W2222 + 2W1W212r1,2]1/2 given r1,2 = +1 = [W1212 + W2222 + 2W1W212]1/2 = (W11 + W22)2]1/2 = (W11 + W22) = (0.3)(0.3) + (0.7)(0.4) = 0.09 + 0.28 = 0.37 70. a. b. c. Which of the following statements about the efficient market hypothesis is least accurate? Efficient markets tests have found that professional money managers, as a group, have consistently outperformed the market. Exchange specialists derive above-average returns from private information. The use of a price weighting versus a market value weighting produces a downward bias on the index.
Answer: A: Professional money managers, as a group, have not been found to outperform the market 71. Assuming that a company's return on equity (ROE) is 12% and the required rate of return is 10%, which of the following would most likely cause the company's P/E ratio to rise? a. b. c. The inflation rate falls The firm's ROE falls The firm's dividend payout rises
Answer: A 72. a. b. c. If the Federal Reserve wishes to lower market interest rates without changing the discount rate, it can Raise the yield on Treasury securities. Increase bank reserve requirements. Buy Treasury securities.
Answer: C - Buying Treasury securities pumps money into the economy, lowering interest rates. Higher reserve requirements will restrict the money supply, causing rates to rise. The Federal Reserve has no direct control over the yield on existing Treasury securities 73. Suppose that IBM has a $1,000 par value bond outstanding with a 12% semi-annual coupon that is currently trading at 102.25 with seven years to maturity. Which of the following is closest to the yield to maturity (YTM) on the bond? a. 11.21% b. 11.91% c. 11.52% Answer: C - To find the YTM, enter PV = $1,022.50; PMT = $60; N = 14; FV = $1,000; CPT I/Y = 5.76%. Now multiply by 2 for the semi-annual coupon payments: (5.76)*(2) = 11.52% 74. An investor is considering investing in a venture capital project that will have a large payoff at exit, which is estimated to occur in four years. The investor realizes that the risk of failure is high, given the following estimated probabilities: Year 1 Failure Probability of 30%; Year 2 Failure Probability of 28%; Year 3 Failure Probability of 28%; Year 4 Failure Probability of 25%; The probability that the project will survive to the end of the fourth year is:

a. b. c. 25.00% 27.22% 27.75%
Answer: B - The probability is calculated as: (1 0.30) (1 0.28) (1 0.28) (1 0.25) = 0.2722 or 27.22% 75. The data below pertains to an office buildings next reporting period: Gross rental income = $6.5 million. Operating expense = $2.3 million. Financing expense = $900,000. Depreciation expense = $750,000. Vacancy rate = 8.5%.
The market expects a return of 12.3%. The value of the office building is closest to: a. b. c. $29.65 million $16.24 million $22.33 million
Answer: A - NOI = $6.5 million (91.5%) $2.3 million; NOI = $3.6475 million; Value = NOI / market cap rate; Value = $3.6475 million / 12.3%; Value = $29.6545 million 76. Bonds A, B and C have the same maturity and face value. They have coupons of 5.4%, 5.5% and 5.7% respectively. Prices of $105, $106, and $108. Yields of 5.44%, 5.45% and 5.43% respectively. Which is the bond with the highest re-investment risk? a. b. c. B C A
Answer: A - The bond with the highest yield has the greatest reinvestment risk. 77. A Zero-Coupon bond issue with 10 years to maturity has a face value of $1 million. The YTM is 5%. The dollar duration of the bonds is: a. b. c. 100,000.00 613,913.25 61,391.33
Answer: C The dollar duration is the approximate change in price for a 1% change in YTM. Dollar Duration = Duration * Price / 100 78. A commodities investor establishes a $20 million collateralized futures position. If the futures are worth $21 million three months later, and Treasuries have an annualized return 4.75% during the period, the total gain on the position is a. b. c. $1,950,000 $1,237,500 $1,000,000
Answer: B The total return on the position equals the gain on the futures position plus the return on the Treasury bills: $1,000,000 + ($20,000,000 4.75% (90 / 360)) = $1,237,500 79. a. b. c. A hedge fund that takes perfectly offsetting long and short positions is best described as Long/short fund. Event-driven fund. Market-neutral fund

Answer: C Market-neutral funds take long and short positions but attempt to offset them to hedge against market moves. Long/short funds take both long and short positions but do not try to offset them. Event-driven funds focus on unique market opportunities, not offsetting positions 80. Agrawal is considering the purchase of Star heights, a 300-unit apartment complex. He has hired Jackson, CFA, to advise him on the investment. Jackson has estimated the following data for Star heights next accounting period Potential rental income = $3.80 million Vacancy rate = 3.5% Insurance costs = $250,000 Financing costs = $940,000 Property taxes = $400,000 Utility expense = $120,000 Repair costs = $200,000 Depreciation = $350,000 Required return = 8% The propertys net operating income (NOI) and value should be closest to a. b. c. NOI $2.83mn and Value $33.75mn NOI $2.70mn and Value $33.75mn NOI $2.70mn and Value $21.60mn
Answer: B NOI = rental income (1 vacancy rate) insurance costs property taxes utility expense repair costs NOI = $3.80 million (96.5%) 250,000 400,000 120,000 200,000 = 2.70 million; Value of building = 2.70 million / 0.08 = 33.75 million 81. If firms and households decide to reduce their currency holdings and increase their holdings of funds in their checking accounts by an equal amount, what will be the impact on the money supply if the U.S. Federal Reserve does not undertake any offsetting actions? a. b. c. There will be no direct impact on the money supply. However, banks excess reserves will increase, which will enable them to increase their loans, thereby leading to an indirect increase in the money supply There will be no direct impact on the money supply, however, banks excess reserves will decrease, which will cause them to decrease their loans, thereby leading to an indirect decrease in the money supply There will be no direct or indirect impact on the money supply because the decrease in currency holdings will be exactly offset by the increase in the funds in the checking accounts
Answer: A If firms and households decide to reduce their currency holdings and increase their holdings of funds in their checking accounts by an equal amount, there will be no direct impact on the money supply. Nevertheless, the resulting increase in excess reserves will enable banks to increase their loans, thereby leading to an indirect increase in the money supply through the multiplier effect. Putting money in a checking account increases, not decreases, bank reserves
Elan Guides (www.proavenues.com/cfa)
Economics 1. Which of the following is most likely to affect the elasticity of demand for a good? A. The time elapsed since a price change. B. The time frame for making the supply decision. C. The availability of raw materials. Answer: A Elasticity of demand is influenced by the time elapsed since a price change. The time frame within which the supply decision is made and the ability to substitute productive resources are factors that influence elasticity of supply.
2.
A good has a price elasticity of demand of 1.2. In response to an increase in price of 30%, quantity demanded will change from 150 units to: A. 104.24 B. 195.76 C. 96 Answer: A Price elasticity of demand = % change in Qd / % change in price -1.2 = x / 30%, x = -36% -36% = [(x - 150)] / [(x + 150) /2] x = 104.24
3.
Which of the following most accurately describes efficient resource allocation in an unregulated economy? A. Consumer surplus is maximized. B. Consumer surplus equals producer surplus. C. The sum of producer and consumer surplus is maximized. Answer: C Resources are allocated efficiently when the sum of consumer and producer surplus is maximized.
4.
As the marginal benefit curve becomes more elastic, assuming that equilibrium price and quantity remain unchanged, consumer surplus: A. Increases B. Remains unchanged C. Decreases Answer: C As the marginal benefit curve becomes more elastic (becomes flatter), the area of the triangle between the y-axis, the market price and the demand curve decreases (assuming equilibrium price and quantity remain unchanged).
5.
A subsidy most likely: A. Shifts the demand curve to the right B. Leads to a dead weight loss from underproduction C. Leads to a dead weight loss from overproduction Answer: C A subsidy shifts the supply curve to the right and results in a deadweight loss due to overproduction.
6.
A tax on a good or service is least likely to: A. Increase the equilibrium quantity B. Decrease the equilibrium quantity C. Increase the equilibrium price Answer: A A tax, whether it is levied on consumer or producers, always results in a decrease in the equilibrium quantity of output.
1. Assume that a firm generates $125 million in total revenue by using $40 million in labor and materials. The value of the firms buildings fell from $2 million to $1.8 million during the period. Further, the firm forgoes $300,000 in interest and normal profit equals $140,000. The economic profit of this firm is closest to: A. $124,360,000. B. $82,760,000. C. $84,360,000. Answer: C Economic profit = total revenue - opportunity costs = total revenue - (explicit + implicit costs). In this case, the labor and material cost of $40 million is the explicit cost. Implicit costs include the $300,000 in foregone interest, economic depreciation of $200,000, and normal profit of $140,000. Therefore, total implicit costs equal $640,000 = $300,000 + $200,000 + $140,000 and economic profit is $125,000,000 - $40,000,000 - $640,000 = $84,360,000.
2. Which of the following statements most accurately describes technological and economic efficiency? a. For a given level of output, the technologically efficient method of production uses the least number of input units, while the economically efficient method entails the lowest possible cost. b. For a given level of output the technologically efficient method of production uses the least number of labor units, while the economically efficient method uses the least number of capital units.
Elan Guides (www.proavenues.com/cfa) c. A production method cannot be technologically efficient without being economically efficient at the same time. Answer: A Technological efficiency occurs when the least number of input units are used to produce a given level of output. Economic efficiency occurs when a given output is produced at the lowest possible cost. Option C is incorrect. While an economically efficient production method must also be technologically efficient, it is not necessary for a technologically efficient method to be economically efficient. 3. When marginal product (MP) is at its maximum, it is most likely that: a. Average product intersects it from above. b. Average variable cost is at its minimum. c. Marginal cost is at its minimum. Answer: C Marginal product is at its maximum when marginal cost is at its minimum.
4. Which of the following most accurately describes the relationship between marginal product (MP) and average product (AP)? As the quantity of labor increases: a. Initially MP exceeds AP, and later AP exceeds MP. b. Initially AP exceeds MP, and later MP exceeds AP. c. MP interests AP from above through its minimum point. Answer: A MP intersects the AP curve from above through its maximum point. Initially when MP is greater than AP, AP rises, and at higher levels of output when MP is less than AP, AP falls. 5. Firms in perfect competition will most likely increase their total output until: a. Marginal cost equals price. b. Marginal revenue equals average total cost. c. Total revenue equals price. Answer: A In perfect competition, since the demand curve is horizontal (perfectly elastic), price equals marginal revenue. Therefore, a firm in perfect competition will continue to expand output until MC equals MR (price).
6. Which of the following is most likely regarding the relationship between price (P), marginal cost (MC), and marginal revenue (MR) at the profit maximizing output level for a firm in perfect competition?
Elan Guides (www.proavenues.com/cfa) a. MC < MR < P b. P = MC = MR. c. P > MC = MR. Answer: B In perfect competition, profits are maximized at the output level where MC equals MR. Since demand facing each individual firm is perfectly elastic, MR equals price. 7. Which of the following most likely describes the price and output produced under perfect competition relative to a single-price monopoly? Price a. Higher b. Lower c. Same Answer: B In perfect competition, prices are lower and total output is higher than under a single- price monopoly. Output Lower Higher Same
8. Which of the following most likely describes the price and output produced under perfect competition relative to perfect price discrimination by a monopoly? Price A. Lower B. Lower C. Same Answer: A In perfect competition, prices are lower and total output is the same as in a situation where a monopoly engages in perfect price discrimination. 1. Which of the following is most likely an advantage of monopolistic competition compared to perfect competition? A. More choice B. Excess capacity C. Markup. Answer: A Output Same Higher Same
Even though monopolistic competition results in excess capacity (output < efficient scale of production) and mark-up (MB and P > MC), it offers consumers more choice than perfect competition.
Elan Guides (www.proavenues.com/cfa) 2. Which of the following oligopoly models asserts that there is a break in a firms marginal revenue curve? A. Kinked-demand model. B. Dominant firm model. C. Game theory. Answer: A
The kinked demand curve model suggests that there is a break in a firms MR curve due to the kink in the demand curve. 3. Which of the following statements is least likely regarding a factors income? A. The more inelastic the supply curve, the greater the share of economic rent in the factors income. B. The more elastic the supply curve, the greater the share of opportunity cost in the factors income. C. The more elastic the demand for a factor of production, the higher its income. Answer: C
Elasticity of demand does not have anything to do with a factors income. The higher the demand (MRP) for a factor of production, the greater its total income.
4. Which of the following statements is most likely regarding the market for natural resources? A. The supply of a renewable resource is perfectly elastic. B. The flow supply of a renewable resource is perfectly elastic at the expected price in the next period. C. The flow supply of a non-renewable resource is perfectly elastic at the present value of the price expected in the next period. Answer: C
The flow supply of a non-renewable resource, such as oil, is perfectly elastic at the present value of the price expected in the next period. The supply of a renewable resource is perfectly inelastic. 5. Which of the following statements is least likely?
Elan Guides (www.proavenues.com/cfa) A. The natural rate of unemployment is composed of frictional and cyclical unemployment. B. The natural rate of unemployment is the unemployment rate that exists at full employment output. C. There is zero cyclical unemployment at the full employment level of output. Answer: A
The natural rate of unemployment is composed of structural and frictional unemployment. There is no cyclical unemployment at full employment.
6. During an expansion: A. Real GDP exceeds potential GDP and unemployment is greater than the natural rate. B. Real GDP exceeds potential GDP and unemployment is lower than the natural rate. C. Real GDP is lower than potential GDP and unemployment is greater than the natural rate. Answer: B
Real GDP exceeds potential GDP and unemployment is lower than the natural rate during an expansion. 7. Suppose an economy is initially operating at full employment. A decrease in aggregate demand that takes the economy into a deflationary gap most likely results in: A. A decrease in output in the short run and the long run. B. An increase in output in the short run, but a decrease in output in the long run. C. A decrease in output in the short run, but no change in output in the long run. Answer: C
When the economy falls into a deflationary gap, real output falls in the short run, but eventually an increase in SRAS restores LR equilibrium at potential output. In the long run, the economy always operates at a point on its LRAS curve, or at the full employment level of output.
8. Which of the following theories least likely asserts that wages are downward sticky?
Elan Guides (www.proavenues.com/cfa) A. Keynesian. B. Classical. C. Monetarist. Answer: B
Classical economists believe that the economy is self-correcting. The self-adjusting mechanism only works if nominal wages are easy to change in the short run.
9. Which of the following most likely comprises the largest portion of the Feds liabilities? A. Federal Reserve Notes. B. Banks deposits. C. U.S. Government Securities. Answer: A
Federal Reserve notes represent the largest proportion of the Feds liabilities.
10. The U.S. Federal Reserve bought $20,000,000 worth of U.S. Treasury securities from the open market. The reserve requirement is currently 20%. The effect of the Feds purchase on the U.S. money supply if there were zero excess reserves in the banking system is closest to: A. A $20,000,000 increase B. A $100,000,000 decrease C. A $100,000,000 increase Answer: C
The money multiplier equals 1/0.2 = 5 As the Fed has bought securities, it will increase the money supply by: 5 * 20,000,000 = $100,000,000. 11. Which of the following most likely causes a shift in the short run and long run Phillips curves? A. A change in the natural rate of unemployment. B. A change in real output. C. A change in the actual inflation rate.
Elan Guides (www.proavenues.com/cfa) Answer: A
A change in the natural rate of unemployment brings about a change in both, the long run and the short run Phillips curves.
12. As an economy slips into a recession, which of the following is most likely? A. Interest rates are high and there is a decrease in price and output as the economy operates below its potential. B. Interest rates are low and there is a decrease in price and output as the economy operate below its potential. C. Interest rates are low and there is an increase in price and output as the economy operates below its potential. Answer: A
In a recessionary phase, interest rates are high and price and output fall as the economy operates below full employment. 13. If the economy is in the downward sloping region of the Laffer curve, a decrease in income taxes will most likely: A. Increase tax revenue B. Have no effect on tax revenue C. Decrease tax revenue Answer: A
In the downward sloping region of the Laffer curve, a decrease in tax rates leads to a significant rise in the number of total dollars earned in the economy, which leads to an increase in tax revenues.
14. Which of the following is least likely regarding the crowding-out effect? A. A budget deficit reduces real interest rates as the supply of loanable funds decreases. B. Budget deficits slow down the growth rate of real GDP. C. Budget deficits reduce the supply of loanable funds, which results in an increase in real interest rates.
Elan Guides (www.proavenues.com/cfa) Answer: A
Budget deficits reduce the supply of loanable funds, which increases real interest rates and leads to a decrease in investment expenditure in the economy. 15. Which of the following problems is least likely associated with changing the FFR to stabilize an economy? A. The FFR change takes a long time to have an effect on inflation. B. Many factors other than real interest rates also affect the components of aggregate demand. C. There is a strong link between long term real interest rates and the FFR. Answer: C
Empirically, there is only a weak link between long term real interest rate (which influences aggregate demand) and FFR
16. Which of the following monetary policy strategies most directly targets the growth rate in the monetary base? A. Money targeting rule B. McCallum rule C. K-percent rule. Answer: B
The monetary base instrument rule (also called the McCallum rule) targets the growth rate in the monetary base directly. Financial Reporting and Analysis 1. Information about extraordinary items, and other unusual or infrequent events is most likely found in: A. Supplementary schedules B. Financial statement footnotes C. Management Discussion & Analysis Answer: C
Information regarding extraordinary items and unusual or infrequent events is typically found in the Management Discussion & Analysis section.
2. An audit is most likely described as: A. A review of the financial statements by an internal auditor of the entity to check their accuracy. B. An independent review of an entitys financial statements. C. A review of the financial statements by a senior director of the entity with the purpose of stating an opinion on their fairness and reliability. Answer: B
An audit is an independent review of an entitys financial statements that enables the auditor to state an opinion on their fairness and reliability. 1. According to the accounting equation, a firms assets are least likely equal to: A. Liabilities + Beginning Retained Earnings Ending Retained Earnings Dividends declared B. Ending Retained Earnings + Contributed Capital + Liabilities C. Liabilities + Contributed Capital + Beginning Retained Earnings + Revenues Expenses Dividends declared Answer: A
Assets = Liabilities + Owners equity. Option A does not conform to the accounting equation.
2. To balance the accounting equation, an increase in a firms liabilities is least likely to be accompanied by: A. An increase in its assets only B. An increase in its owners equity only C. A decrease in its owners equity only Answer: B
An increase in a firms liabilities must either be accompanied by a corresponding increase in its assets, or a decrease in owners equity or both. 1. Which of the following statements regarding elements of the financial statements is least likely? The IFRS framework describes: A. Equity as being equal to capital contributed by the owner. B. Assets as the resources the entity controls from which it expects to derive future economic benefits. C. Liabilities as obligations that will result in an outflow of economic benefits in the future. Answer: A Equity includes owners contributed capital as well as ending retained earnings. It can also be described as the owners residual interest in the assets of a company after deducting all liabilities. 2. Accrual accounting states that: A. An entity should record revenue or an expense as soon as cash is received. B. An entity will continue to exist in the foreseeable future. C. An entity should record revenue or an expense when it is actually earned or incurred. Answer: C Financial statements are prepared using two underlying assumptions. According to the going concern assumption, an entity is assumed to exist for the foreseeable future. According to the accrual accounting, an entity must record revenue or an expense when it is actually earned or incurred, not necessarily when cash is paid.
1. A company incurs the following costs on a particular project: Year Costs incurred ($ 000) 2006 500 2007 700 2008 300 Total 1,500
The total revenue from the project is expected to be $2,000,000. Under the percentage-of-completion method, the projects net income in 2008 is closest to:
A. B. C.
$600,000 $100,000 $300,000
Answer: B
Elan Guides (www.proavenues.com/cfa) Profit recognized in 2008 = (300,000/1,500,000) * (2,000,000 1,500,000) = $100,000
2. ABC Corporation supplies heavy machinery to various companies. It sold one machine that cost $1,200,000 to XYZ Company for $1,500,000 and expects to receive the cash payments in installments. ABC cannot reasonably estimate the collectability of revenues. Year Expected cash to be collected ($ 000) 2006 400 2007 500 2008 600 Total 1,500
ABC Corporations profit for 2007 is closest to:
A. $ 100,000 B. $ 300,000 C. $ 240,000 Answer: A The installment method is used when the collectability of revenues cannot be reasonably estimated. The percentage of total profit recognized in each period equals the proportion of total cash received in each period.
Profit = (500/1,500) * 300 = $100 1. If a company pays cash before it recognizes the associated expense it results in a/(an): A. Unearned revenue liability B. Accounts receivable asset C. Prepaid expense asset. Answer: C
If a company receives cash before it recognizes the associated revenue it results in a prepaid expense asset.
2. An accrued expense liability is most likely recognized when:
Elan Guides (www.proavenues.com/cfa) A. An expense is recognized before cash payment. B. Cash is paid prior to expense recognition. C. Revenue is recognized prior to the receipt of cash. Answer: A An accrued expense liability is recognized when an expense is recognized prior to cash payment. 1. A company has a net income of $150, an increase in accounts receivable of $30, depreciation of $55 and a decrease in accounts payable of $25. Its operating cash flow is closest to: A. $200 B. $150 C. $95 Answer: B
Operating cash flow = 150 30 + 55 25 = $150.
2. Given the following information for a company, its CFO is closest to: Net income Decrease in interest payable Gain on sale of equipment Increase in accounts payable Decrease in inventory Increase in prepaid assets Depreciation Increase in taxes payable 1,000 85 45 90 35 105 85 125
A. B. C.
$1,100 $1,250 $1,050
Answer: A
CFO = 1,000 85 45 + 90 + 35 105 + 85 +125 = 1,100
1. Which of the following is most likely to be used to conduct trend analysis? A. Horizontal common-size financial statements. B. Vertical common-size financial statements. C. Pie charts. Answer: A Horizontal common-size financial statements are prepared to look for trends over time in evaluating a companys past performance and preparing forecasts.
2. Which of the following is least likely a limitation of ratio analysis? A. Companies may have several divisions that operate in different industries. B. Most companies around the world subscribe to the same set of accounting standards. C. There are no specified ranges within which particular ratios for companies must lie. Answer: B Despite the growing convergence between IFRS and U.S.GAAP significant differences remain across the two sets of standards, which makes comparison across firms difficult. 1. Given stable inventory quantities and falling prices, use of LIFO will least likely: A. Result in higher net income compared to FIFO B. Overstate net income C. Overstate inventory Answer: B Given stable inventory quantities and falling prices, use of LIFO will not overstate net income. Current replacement costs will be reflected in COGS, which would result in an accurate value for net income.
2. Given stable inventory quantities and falling prices, use of FIFO will most likely: A. Understate replacement costs B. Understate profits C. Understate inventory Answer: B Inventory will be appropriately valued if FIFO is used (regardless of whether prices are rising or falling). Replacement costs will be overstated in COGS and profits will be understated. 3. Which of the following ratios is least likely to be used to evaluate a companys inventory management? A. Inventory turnover
Elan Guides (www.proavenues.com/cfa) B. Quick ratio C. Number of days of inventory on hand. Answer: B The quick ratio ignores the companys inventory levels. It is used to measure a companys liquidity management; not its inventory management.
4. In a period of falling prices and stable inventory quantities, which of the following is most likely? A. LIFO COGS > FIFO COGS B. LIFO CF < FIFO CF C. LIFO EI < FIFO EI Answer: B In a period of falling prices and stable inventory quantities, use of LIFO results in lower COGS, higher NI and higher taxes. Therefore, CF under LIFO is lower.
5. In a period of rising prices and stable inventory quantities, which of the following is most likely? A. Profitability ratios are lower under FIFO B. Solvency ratios are higher under FIFO C. Activity ratios are lower under FIFO Answer: C In a period of rising prices and stable inventory quantities, use of FIFO results in lower activity ratios, lower solvency ratios and higher profitability ratios.
6. In a period of falling prices and stable inventory quantities, which of the following is least likely? A. The current ratio is higher under LIFO B. Solvency ratios are higher under LIFO C. The inventory turnover ratio is lower under LIFO Answer: B In a period of falling prices and stable inventory quantities, use of LIFO results in lower COGS, higher net income, higher equity, and therefore, lower solvency ratios.
7. Sun Corporation is a manufacturer of a single product. The following information relates to its production levels and costs for 2009: Normal production capacity = 10 million units Units produced = 7.5 million units
Elan Guides (www.proavenues.com/cfa) Cost of raw materials = $24 million Cost of conversion = $52 million Fixed production overheads = $18 million Freight-in charges = $3.4 million Storage costs of finished goods = $980,000 Abnormal wastage = $37,000 Given that there is no work-in-progress inventory at the end of the year, the companys capitalized cost per unit of inventory is closest to: A. $92.90 B. $12.52 C. $12.39 Answer: C Sun Corporations actual operating capacity = 7.5 / 10 = 75% Therefore, capitalized fixed production overheads = 0.75 * 18 = $13.5 million Total capitalized costs = 24 + 52 + 13.5 + 3.4 = $92.9 million Storage costs of finished goods are not capitalized inventory costs. Therefore, capitalized cost per unit = 92.9 / 7.5 = $12.39
8. JK Enterprises balance sheet reported inventory amounting to $32,300. The company suspects that it will only be able to sell this inventory at its reported value and will have to incur further selling expenses of $2,200. Assuming that the company follows IFRS, which of the following statements is least accurate? A. JK Enterprises should value its inventory at $32,300. B. JK Enterprises should value its inventory at $30,100. C. JK Enterprises should recognize a loss of $2,200. Answer: A Under IFRS, inventory is reported at the lower of cost or net realizable value.
Net realizable value = 32,300 2,200 = $30,100 Therefore, the company should write-down its inventory to $30,100 and recognize a loss of $2,200.
9. Blue Water Inc purchased inventory for $57,000. Due to an unfavorable economic outlook, the company decides to immediately liquidate its stock of inventory. It estimates that the stock will only sell for $52,700 and the company will have to bear further expenses of $3,500 in the process. Assuming that the company follows IFRS, the value of inventory that Blue Water should record on its balance sheet is closest to: A. $57,000 B. $52,700 C. $49,200 Answer: C Under IFRS, inventory is reported at the lower of cost or net realizable value. Net realizable value = Selling price Selling costs Net realizable value = 52,700 3,500 = $49,200 Net realizable value ($49,200) is lower than the cost of inventory ($57,000). Therefore, inventory must be written down to $49,200.
10. The following information relates to Royal Manufacturers: Cost of inventory = $54,000 Estimated selling price = $72,000 Estimated selling costs = $15,000 Replacement cost = $52,000 Normal profit margin = $7,000 Assuming that the company follows U.S. GAAP, the value of inventory that it should record on its balance sheet is closest to:
A. $54,000 B. $39,000 C. $52,000 Answer: C Under U.S. GAAP, inventory is measured at the lower of cost of market value. Market value is defined as replacement cost, where replacement cost must lie within a range of values between NRV minus normal profit margin and NRV. Net realizable value = 72,000 15,000 = $57,000 Net realizable value Normal profit margin = 57,000 7,000 = $50,000 The replacement cost of $52,000 lies within the specified range of $50,000 and $57,000. As the replacement cost of $52,000 is less than the original cost of $54,000, inventory will be reported at $52,000.
1. Which of the following statements is most likely regarding the effects of capitalization on a companys financial statements? A. Capitalization reduces the companys reported total asset turnover. B. Capitalization increases the companys reported debt-to-assets ratio. C. Capitalization decreases the companys outflows from investing activities. Answer: A
Capitalization of an expense results in an increase in non-current assets, which leads to a decrease in the total asset turnover ratio (sales/assets) and the debt-to-assets ratio (Debt/Assets). Capitalization results in a decrease in CFI or an increase in outflows from investing activities.
2. Which of the following statements is least likely regarding the effects of expensing on a companys financial statements? A. Expensing increases the companys net profit margin in future years. B. Expensing has no effect on the companys reported debt-to-assets ratio.
Elan Guides (www.proavenues.com/cfa) C. Expensing decreases the companys cash flow from investing activities. Answer: C
Expensing results in an increase in NP margin in the future as no depreciation or amortization expense is recognized in the future. Expensing has no effect on total debt and total assets, and reduces the companys cash flow from operating activities (not investing activities).
3. If construction and sale of buildings is a companys core business activity, interest expenses incurred in financing construction are most likely included as a part of the companys: A. Noncurrent assets and operating expenses. B. Current assets and COGS. C. Current assets and non-operating expenses. Answer: B
If construction and sale of building is a companys core business activity, interest expenses incurred in financing construction are included as a part of the companys inventory (current assets) and recognized as COGS in the period that buildings are sold.
4. Which of the following least likely describes the effects of capitalization of interest costs? A. The companys reported interest coverage ratio improves. B. The companys reported operating cash flow is inflated. C. The companys reported investing cash flow is inflated. Answer: C
When a company capitalizes its interest costs, it does not include the capitalized amount in interest expense on its income statement, thereby inflating reported profits and reporting an enhanced ability to meet its debt servicing obligations. The related cash outflow is classified as an outflow from investing activities instead of an outflow from operating activities so reported CFO is inflated (higher).
5. Assuming straight line depreciation, which of the following combinations of depreciation-related estimates result in the lowest annual depreciation expense? A. Longer useful life and lower salvage value. B. Longer useful life and higher salvage value. C. Shorter useful life and higher salvage value. Answer: B
Estimates of longer useful lives and higher salvage values result in lower depreciation expense.
6. Recognition of an ARO on a companys financial statements will least likely result in: A. A fall in the interest coverage ratio. B. A rise in the debt-to-equity ratio C. A rise in ROA. Answer: C
Recognition of an ARO on a companys financial statements results in a higher D/E ratio, and lower interest coverage, ROA and asset turnover ratios.
7. Which of the following is least likely regarding the effects of impairment recognition on a companys financial statements? A. The carrying value of non-current assets decreases. B. Net income falls. C. Cash flow from operating activities falls. Answer: C
Impairment recognition does not affect a companys cash flows.
Elan Guides (www.proavenues.com/cfa) Use the following information to answer Questions 8 and 9
XYZ acquired ABC in 2007 for $45,000. On the date of acquisition, the fair value of ABCs net assets was $41,500.
In 2008:
Fair value of ABCs net assets = $42,000 Fair value of the ABC = $43,000 Carrying value of ABC on XYZs financial statements= $44,000
8. Upon acquiring ABC, XYZ will recognize acquisition goodwill amounting to: A. $3,500 B. $8,000 C. Zero Answer: A
Value of goodwill recognized upon acquisition is calculated as:
Acquisition price Fair value of acquired companys net assets = $45,000 $41,500
9. In 2008, XYZ will recognize an impairment charge on goodwill relating to ABC amounting to: A. $3,000 B. $2,000 C. $2,500 Answer: C
The carrying value of ABC ($44,000) exceeds its fair value ($43,000). This means that goodwill is impaired. To calculate the impairment loss, the implied value of goodwill is deducted from its carrying value ($3,500)
Elan Guides (www.proavenues.com/cfa) Implied goodwill = Fair value of ABC - Fair value of ABCs net assets = $43,000 - $42,000 = $1,000.
Therefore, XYZ will recognize an impairment loss of $2,500 ($3,500 - $1,000).
10. The cost of which of the following assets is least likely expensed over time? A. Intangible assets with a definite useful life B. Land acquired with the intent to construct a factory on it. C. Machinery with a useful life of 5 years Answer: B Land is a non-depreciable asset. Intangible assets with a definite useful life are amortized over time. Machinery with a useful life of more than one year is depreciated over its useful life.
1. An increase in DTL most likely results in a (an): A. Decrease in income tax expense B. Increase in current assets C. Decrease in shareholders equity Answer: C
ITE = TP + Change in DTL Change in DTA An increase in DTL increases ITE and results in lower net income and retained earnings.
2. A decrease in the valuation allowance most likely results in a(an): A. Increase in total assets. B. Decrease in shareholders equity C. Increase in income tax expense. Answer: A
A decrease in the valuation allowance implies that the companys DTA (assets) are increasing. An increase in DTA reduces ITE, and increases retained earnings (equity).
3. A company reports DTA of $300m and DTL of $200m on its balance sheet for the year ended Dec 2009. Tax rates from 2010 onwards are brought down from 40% to 30%. In response to this change in tax rates, the decrease in the companys shareholders equity is closest to: A. $25m. B. $10m. C. $75m. Answer: A
The companys DTA and DTL will fall by 25% as a result of the decrease in tax rates. On a net basis, its net assets and shareholders equity will fall by ($300m - $200m) * 25% = $25m.
4. Taxable temporary differences would most likely arise when: A. The carrying amount of a liability exceeds its tax base. B. The carrying amount of an asset exceeds its tax base. C. The carrying amount of an asset is less than its tax base. Answer: B
Taxable temporary differences or deferred tax liabilities arise when the carrying amount of an asset is greater than its tax base, or when the carrying amount of a liability is less than its tax base.
5. Deductable temporary differences least likely arise when: A. The carrying amount of a liability is less than its tax base. B. The carrying amount of an asset is less than its tax base. C. The tax base of a liability is less than its carrying amount. Answer: A
Deductible temporary differences or deferred tax assets arise when the tax base of an asset exceeds its carrying value, or when the tax base of a liability is less than its carrying value. When the carrying amount of a liability is less than its tax base, a deferred tax liability arises.
Elan Guides (www.proavenues.com/cfa) Use the following information to answer Questions 6 to 10:
ABC Company uses the straight line method of depreciation on its financial statements to write off a piece of equipment that it purchased for $10,000. The asset has an estimated salvage value of zero and a useful life of 4 years. On the tax return it writes off the asset over two years with zero salvage value. The company is taxed at 30%.
6. The difference between the amount of depreciation recognized on the income statement and on the tax return will result in a: A. Permanent difference B. Deferred tax liability C. Deferred tax asset Answer: B
Higher depreciation expense is being recognized on the tax return, and this difference in expense recognition across the income statement and the tax return is expected to reverse in the future. Therefore, a deferred tax liability will be created.
7. The carrying value of the asset on the balance sheet for Year 2 is closest to: A. $7,500 B. $5,000 C. $2,500 Answer: B
The carrying value of the asset on the financial statements at the end of Year 2 is calculated as:
Historical cost of the asset Accumulated depreciation charged on the income statement = $10,000 $5,000 = $5,000
8. The tax base of the asset as of the end of Year 2 is closest to: A. $7,500 B. $5,000 C. Zero
Elan Guides (www.proavenues.com/cfa) Answer: C
The tax base of the asset at the end of Year 2 is calculated as:
Historical cost of the asset Accumulated depreciation charged on the tax return = $10,000 $10,000 = $0
9. The amount of DTL/DTA recognized on the balance sheet for Year 2 is closest to: A. $2,000 DTA B. $1,500 DTL C. $1,500 DTA Answer: B
DTL at the end of Year 2 are calculated as: (Carrying value of asset Tax base) * Tax rate = $5,000 * 0.3 = $1,500
10. The change in DTL over Year 3 is closest to: A. $750 increase B. $750 decrease C. $500 increase Answer: B
In Year 3, income tax expense exceeds taxes payable by $2,500 * 0.3 = $750. Therefore, DTL in Year 3 will fall by $750. The temporary difference starts to reverse in Year 3.
1. Which of the following statements is most likely regarding accounting for discount bonds? A. The book value of the liability decreases each year over the term of the bonds. B. Interest expense recognized exceeds the coupon payment each year over the term of the bonds. C. The excess of interest expense over the coupon payment serves to reduce the liability balance each year.
Elan Guides (www.proavenues.com/cfa) Answer: B
For bonds issued at a discount: o o Interest expense exceeds the coupon payment due to discount amortization. The book value of the liability increases each year and the shortfall of the coupon payment compared to interest expense serves to increase the liability balance each year.
2. Which of the following statements is least likely regarding accounting for premium bonds? A. The book value of the liability decreases each year over the term of the bonds. B. Interest expense recognized is greater than the coupon payment each year over the term of the bonds. C. The excess of coupon payment over interest expense serves to reduce the liability balance each year. Answer: B
For bonds issued at a premium: Interest expense is less than the coupon payment due to premium amortization. The book value of the liability falls each year, and the excess of the coupon payment over interest expense serves to reduce the liability balance each year.
3. In the analysis of financing liabilities, which of the following is most likely regarding premium bonds? A. CFO is overstated B. CFF is overstated C. CFI is overstated. Answer: B
For premium bonds CFO is understated and CFF is overstated.
4. In the analysis of financing liabilities, which of the following is least likely regarding discount bonds?
Elan Guides (www.proavenues.com/cfa) A. CFO is overstated B. CFF is understated C. CFI is overstated. Answer: C
CFO is overstated for discount bonds as only the coupon payment (not the entire amount of interest expense) is considered a cash outflow from operating activities. CFF is understated. CFI is reflected accurately for discount and premium bonds.
5. Company A issued bonds with a 10 year maturity 5 years ago when market interest rates stood at 10%. Company B issues 5 year bonds today when market interest rates stand at 5%. Given that the book value of these bond-related liabilities is identical on the two companies financial statements as of today, which of the following statements is most likely? A. Company A is better off because the economic value of its bonds is higher as interest rates have decreased. B. Company B is better off because the true value of its obligations is lower than that of Company As. C. The economic value of Company Bs liabilities is lower than the book value recognized on its balance sheet. Answer: B
Interest rates have fallen significantly since the time that Company A issued its bonds. Therefore, the actual value of Company As obligations (liabilities) is higher than reflected on its financial statements. The book value of bonds on Company Bs balance sheet is the same as their actual value as they were issued today.
6. Classification of redeemable preference shares as debt as opposed to equity most likely: A. Increases the companys leverage ratios and increases the interest coverage ratio. B. Decreases the companys leverage ratios and increases the interest coverage ratio. C. Increases the companys leverage ratios and decreases the interest coverage ratio. Answer: C
Classification of redeemable preference shares as debt as opposed to equity increases the companys leverage ratios (higher debt) and decreases the interest coverage ratio (higher interest expense).
7. When a lease is classified as an operating lease, a non-current asset is recognized and depreciated on the: A. Lessors financial statements B. Lessees financial statements C. Both the lessor and the lessees financial statements. Answer: A
When a lease is classified as an operating lease, a non-current is recognized and depreciated on the lessors financial statements. No asset is recognized on the lessees financial statements.
8. When a lease is classified as a finance lease, a long-lived asset is recognized and depreciated on the: A. Lessors financial statements. B. Lessees financial statements. C. Both the lessor and the lessees financial statements. Answer: B
When a lease is classified as a finance lease, a long-lived asset is recognized and depreciated on the lessees financial statements. The lessor removes the long-lived asset from its books and recognizes a lease receivable asset.
9. Recognition of a finance lease as opposed to an operating lease by the lessor most likely results in: A. Higher total net income over the lease term B. Higher total CFI over the lease term. C. Lower taxes in the early years of the lease term Answer: B
Elan Guides (www.proavenues.com/cfa) Recognition of a finance lease as opposed to an operating lease by the lessor results in the same total net income, higher total CFI over the lease term and higher taxes in the early years of the lease.
10. Recognition of a finance lease as opposed to an operating lease by the lessee least likely results in: A. Higher CFO B. Higher current liabilities C. Lower non-operating expenses Answer: C
Recognition of a finance lease as opposed to an operating lease by the lessee results in higher CFO, higher current liabilities, and higher non-operating expenses (interest expense)
1. If management wants to obtain concessions from vendors, it will most likely: A. Overstate assets to appear more solvent B. Understate liabilities to appear less solvent C. Overstate liabilities to appear less solvent Answer: C If management wants to obtain concessions from vendors, it will try to appear less solvent. This can be achieved by overstating liabilities.
2. Management will least likely understate assets to improve: A. Financial leverage ratios B. Return on assets C. Total asset turnover Answer: A In order to improve financial leverage ratios, management will need to overstate its assets. Understating assets will improve return on assets and total asset turnover ratios. 1. Which of the following statements is most accurate? A. When stock options are exercised, the associated tax benefit can be classified as an operating cash flow B. A company may improve its cash flow from financing activities by financing its payables C. Under U.S. GAAP, gain on sale of securitized receivables must be reported below net income
Elan Guides (www.proavenues.com/cfa) Answer: A Financing of payable improves a companys operating cash flows. U.S. GAAP provides no guidance as to where the gain on sale of securitized receivables should be reported. Some firms take the aggressive approach and report the gain on sale of securitized receivables as a part of revenues, others report the gain below the line, while some simply offset it against expenses.
2. Consider the following statements: Statement 1: When stock options are exercised and converted into common stock, the company is allowed to take a tax deduction equal to the difference between the book value and the market value of the shares. Statement 2: When evaluating the true earnings power of a company as measured by its cash flows, cash expended to buy back stock should not be included in operating cash flow. Which of the following is most likely? A. Only one statement is correct B. Both the statements are correct C. Both the statements are incorrect Answer: A When stock options are exercised and converted into common stock, the company is allowed to take a tax deduction equal to the difference between the value that shares were sold at (the strike or exercise price) and their market value. Statement 2 is correct. 1. Consider the following statements: Statement 1: Forecasting each expense item as a percentage of sales is a very objective method to calculate a firms future net income. Statement 2: Forecasting is relatively more difficult for mature companies that operate in nonvolatile markets, compared to new companies operating in volatile markets. Which of the following is most likely? A. Only one statement is correct B. Both statements are correct C. Both statements are incorrect Answer: C Forecasting each expense item as a percentage of sales is a very subjective method. Forecasting models tend to be simpler and work well for mature companies that operate in non-volatile markets.
2. Which of the following is least likely evaluated to analyze credit risk of a company? A. Character B. Commitments C. Covenants Answer: B Credit analysis involves evaluation of the 4 Cs of a company: Character Capacity Collateral Covenants
1. Realized gains and losses and interest income are both recognized on the income statement for: A. Trading and available-for-sale securities only B. Trading securities only C. Trading, held-for-sale and held-to-maturity securities. Answer: C Realized gains and losses and interest income are recognized on the income statement for all classifications of securities.
2. Which of the following most likely allows inventory write-downs and reversals of writedowns? A. IFRS only B. U.S.GAAP only C. IFRS and U.S.GAAP Answer: A Typically, U.S.GAAP does not permit reversals of inventory write-downs. Fixed Income Securities
3. Which of the following bonds accrue interest over a portion of their term, and make periodic coupon payments for the rest of their term? A. Step-up notes B. Deferred coupon bonds C. Zero coupon bonds Answer: B Deferred coupon bonds accrue interest over a portion of their term, and make periodic coupon payments for the rest of their term
4. For a floating-rate security that resets its coupon every 3 months, LIBOR-90 on July 1, 2008 is used to determine the coupon payment that will be made at: A. October 1, 2008 B. July 1, 2008 C. January 1, 2009
Answer: A LIBOR-90 on July 1, 2008 will determine the interest payments that will be made at the next reset date i.e. Oct 1, 2008. 5. A bond currently trading at $837.50 has a yield of 9.5% and duration of 7.5. The new price of bond if yields rise to 9.95% will be closest to: a. $868.91 b. $806.09 c. $845.87 Answer: B Change in yields = 9.95% 9.50% = 0.45% Approximate price change = -7.5 * 0.45% = -3.375% As yields increased by 45 basis points the price of the bond will decrease by 4.5% New price of bond = (1 - 0.0375) * $837.50 = $806.09
6. Which of the following statements is correct regarding the reinvestment risk faced by investors in amortizing securities and zero-coupon bonds: A. Amortizing securities have greater reinvestment risk than straight bonds, while zero coupon bonds have zero reinvestment risk. B. Amortizing securities have lower reinvestment risk than straight bonds, while zero coupon bonds have higher reinvestment risk than straight bonds. C. Amortizing securities have zero reinvestment risk than straight bonds, while zero coupon bonds have higher reinvestment risk than straight bonds. Answer: A Amortizing securities have greater reinvestment risk than straight bonds (as coupon and principal payments received over the term of the bonds bear the risk of being reinvested at a rate lower than the original YTM), while zero coupon bonds have zero reinvestment risk as they offer no payments over their terms. 7. Which of the following statements is incorrect? A. A structured MTN is a combination of a medium-term note and a derivative instrument. B. Structured MTNs are also known as rule busters. C. MTNs can only be issued at a fixed rate. Answer: C MTNs can be issued at a fixed or a floating rate.
8. Which of the following is not an example of external credit enhancements? A. Bond insurance B. Letters of credit C. Overcollateralization Answer: C Overcollateralization is an internal credit enhancement.
9. Which of the following statements is incorrect? A. Fixed rate Treasuries are exposed to inflation risk B. Treasury bills carry no reinvestment risk C. U.S. Treasuries are risk free instruments. Answer: C U.S. Treasures are not risk free instruments. They carry no default risk, but do have liquidity and interest rate risk. 10. Which of the following statements is correct? A. All other factors constant, a bond with a higher coupon rate has higher interest rate risk and lower reinvestment risk than a bond with a higher coupon rate. B. All other factors constant, a bond with a lower coupon rate has higher interest rate risk and lower reinvestment risk than a bond with a higher coupon rate. C. All other factors constant, a bond with a higher coupon rate has lower interest rate risk and lower reinvestment risk than a bond with a higher coupon rate. Answer: B All other factors constant, a bond with a lower coupon rate has higher interest rate risk and lower reinvestment risk than a bond with a higher coupon rate.
11. Under the biased expectations theory, if the yield curve is downward sloping, it definitely implies that: A. It is expected that short term interest rates will be higher in the future. B. It is expected that short term interest rates will remain at the same level in the future. C. It is expected that short term interest rates will be lower in the future. Answer: C If the yield curve is downward sloping despite the liquidity premium required for longer term investments, it means that short term interest rates are definitely expected to fall in the future.
12. Which of the following theories explains the tendency of the yield curve to shift while broadly maintaining its overall shape? A. Biased expectations theory B. Market segmentation theory C. Preferred habitat theory Answer: C
Elan Guides (www.proavenues.com/cfa) The preferred habitat theory states that institutional investors require a premium to invest in maturities similar to their preferred investment horizons. In addition to being able to explain any shape of the yield curve, this theory also explains the observed fact that yields for similar maturities rise and fall together, which means that the yield curve more or less maintains its overall shape when it shifts. 13. A 10% annual coupon bond with a 5 year term was issued one year ago for $950. Assuming that market yields have remained at the same level since bond issuance, which of the following is most likely the price of the bond today? A. $930 B. $965 C. $1,005 Answer: B The price of a bond converges towards par with the passage of time. The bond in question was issued at a discount. Given that yields do not change, the price of the bond one year into its term will be closer to its par value, but not above its par value.
Use the following information to answer Questions 14 and 15. 14. The YTM on a 4 year annual-pay 10% coupon bond is 8%. The bond is currently trading at $106.6243. One year, later the discount rate on this bond increases to 9%. The dollar change in the price of the bond attributable to the passage of time is closest to: A. $1.47 B. $2.62 C. $4.09 Answer: A Price of bond after 1 year (assuming no change in discount rates): N = 3; PMT = -$10; FV = -$100; I/Y = 8, CPT PV; PV = $105.15 Change in price attributable to the change in discount rates: $106.62 - $105.15 = $1.47
15. The dollar change in the price of the bond attributable to the change in interest rates is closest to: A. $1.47 B. $2.62 C. $4.09 Answer: B Price of bond after 1 year (assuming discount rates increase to 9%): N = 3; PMT = -$10; FV = -$100; I/Y = 9, CPT PV; PV = $102.53 Change in price attributable to the change in discount rates: $105.15 - $102.53 = $2.62
16. A 5-year U.S. zero coupon bond with a par value of $100 is discounted at an 8% interest rate. The current value of the bond is closest to: A. $67.56
Elan Guides (www.proavenues.com/cfa) B. $68.06 C. $100 Answer: A N = 10; FV = $100; I/Y = 4; PMT = 0; CPT PV; PV = -$67.56 17. Which of the following statements is correct regarding the current yield? A. The current yield is lower than the coupon rate when the bond is trading at a discount. B. The current yield only considers coupon income as a source of investment return. C. The current yield does consider reinvestment income as a source of investment return. Answer: B The current yield only considers coupon income as a source of investment return. It ignores capital gains and losses and reinvestment income.
18. For a bond that is trading at a premium: A. Coupon rate < Current yield < YTM B. YTM < Current yield < Coupon rate C. YTM > Coupon rate > Current yield Answer: B For a bond trading at a premium, the YTM is lower than the current yield, which itself is lower than the coupon rate. 19. A 5 year zero coupon bond is currently valued at $798. The semi-annual pay YTM on this bond is closest to: A. 4.56% B. 4.62% C. 4.80% Answer: A N = 10; FV = $1,000; PV = -$798; PMT = 0; CPT I/Y; I/Y = 2.282. Semi-annual YTM (BEY basis) = 2.282 * 2= 4.56%
20. Which of the following statements regarding reinvestment income is incorrect: A. For a given yield to maturity and coupon rate, the longer the term to maturity, the greater the reinvestment risk. B. For a coupon bond with a given YTM and term to maturity, the higher the coupon rate, the higher the reinvestment risk. C. Given the term and yield to maturity, bonds selling at a premium will have lower reinvestment risk. Answer: C Given the term and yield to maturity, bonds selling at a premium will be more dependent on reinvestment income to achieve a certain yield, and therefore suffer from greater reinvestment risk.
Elan Guides (www.proavenues.com/cfa) 21. Bond A is an annual-pay bond with a YTM of 8%. Bond B is a semi-annual-pay bond with a bond equivalent yield of 7.8%. Which of these bonds offers a higher return? A. Bond B B. Bond A C. Both bonds offer the same return. Answer: B Bond As return on a BEY basis is calculated as: 2[(1 + Annual-pay yield) ^ 0.5 1] = 7.85% Therefore, Bond A offers a higher return than Bond B (BEY = 7.8%)
22. A mortgage passthrough security has a monthly cash flow yield of 1.15%. Its bond equivalent yield is closest to: A. 2.31% B. 14.71% C. 14.2% Answer: C BEY = [(1 + monthly CFY) ^ 6 1] * 2 = 14.2% 23. Which of the following is not a yield spread measure for floating-rate securities? A. Discount margin B. Spread for life C. Z-spread Answer: C The z-spread is not a spread measure for floating-rate securities.
24. The 4 year spot rate equals 6.4%, and the 13 year spot rate is 6.25%. the 9 year forward rate after 4 years is closest to: A. 6.18% B. 6.28% C. 6.38% Answer: A (1 + 9f4)9 = (1 + 13s0)13 / (1+ 4s0)4 9f4 = 6.18% 25. A callable bond exhibits: A. Positive convexity at lower yields and negative convexity at higher yields B. Negative convexity at all yield levels C. Negative convexity at lower yields and positive convexity at higher yields. Answer: C A callable bond experiences negative convexity at lower yield levels (price compression at lower yields results in callable bond gaining less value in response to a decrease in yields of a given amount compared to how much it loses in response to an increase in yields of an identical amount). At higher
Elan Guides (www.proavenues.com/cfa) yield levels, a callable bond exhibits positive convexity (the potential upside from a decrease in yields is greater than the potential loss from an increase in yields)
26. A putable bond exhibits: A. Positive convexity at all yield levels B. Negative convexity at higher yields and positive convexity at low yields C. Positive convexity at higher yields and negative convexity at low yields. Answer: A Putable bonds exhibit positive convexity at all yields. At any point on the price-yield profile, the potential upside from a decrease in yields is greater than the potential loss from an increase in yields.
27. The greater the curvature of the price yield profile of a bond: A. The greater the duration at any given yield. B. The greater the convexity adjustment required to estimate the bonds price accurately in response to a change in yields C. The greater the yield curve risk of the bond. Answer: B The greater the curvature of the price-yield relationship, the more significant the convexity adjustment required.
28. A bond currently has an effective duration of 7.83. The percentage change in the price of the bond in response to a 82 basis point upward movement in yields is closest to: A. +6.42% B. -6.42% C. +5..85% Answer: B Percentage change in price = -7.83 * 0.82% = -6.42
29. Which of the following definitions of duration is appropriate to estimate the price of a bond with embedded options? A. Macaulay duration B. Modified duration C. Effective duration. Answer: C Only effective duration may be used to estimate the change in the price of a bond that contains an embedded option.
30. Which of the following statements is incorrect? A. In response to an increase in interest rate, the duration based price estimate for a bond underestimates the actual price of the bond.
Elan Guides (www.proavenues.com/cfa) B. In response to fall in interest rates, the duration based price estimate for a bond overestimates the change in the bonds price. C. In response to rise in interest rates, the duration based price estimate for a bond overestimates the fall in the bonds price. Answer: B In response to fall in interest rates, the duration based price estimate for a bond underestimates the change in the bonds price.

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CFA Level 1 Sample Questions

CFA Questions from Austal Group (www.austalgroup.net) Austal Group

CFA Questions from Austal Group (www.austalgroup.net) Austal Group

Calculate cash collections and cash expenses are

What is the covariance for this portfolio?

a. $11.99 b. $12.74 c. $17.87 Answer: C Call value = $110 + $5 $100/1.06^0.5 = $17.87

CFA Questions from Austal Group (www.austalgroup.net) Austal Group

CFA Questions from Austal Group (www.austalgroup.net) Austal Group

CFA Questions from Austal Group (www.austalgroup.net) Austal Group

Portfolio Expected Return (%) Standard Deviation (%)

Expected Return (%)

Standard Deviation (%)

CFA Questions from Austal Group (www.austalgroup.net) Austal Group

CFA Questions from Austal Group (www.austalgroup.net) Austal Group

CFA Questions from Austal Group (www.austalgroup.net) Austal Group

the covariance for this portfolio? 12 3 6

Answer: B ER = (0.3 12) + (0.70 18) = 3.6 + 12.6 = 16.2%

CFA Questions from Austal Group (www.austalgroup.net) Austal Group

Answer: A =$3,000,000 + $1,500,000 $200,000 + $300,000 = $4,600,000

The duration of the bond is: a. 4.78 b. 4.35

CFA Questions from Austal Group (www.austalgroup.net) Austal Group

CFA Questions from Austal Group (www.austalgroup.net) Austal Group

CFA Questions from Austal Group (www.austalgroup.net) Austal Group

CFA Questions from Austal Group (www.austalgroup.net) Austal Group

Elan Guides (www.proavenues.com/cfa)

Elan Guides (www.proavenues.com/cfa)

Elan Guides (www.proavenues.com/cfa) A. Keynesian. B. Classical. C. Monetarist. Answer: B

Elan Guides (www.proavenues.com/cfa) Answer: A

Elan Guides (www.proavenues.com/cfa) Answer: A

Elan Guides (www.proavenues.com/cfa)

Elan Guides (www.proavenues.com/cfa)

$600,000 $100,000 $300,000

ABC Corporations profit for 2007 is closest to:

2. An accrued expense liability is most likely recognized when:

Operating cash flow = 150 30 + 55 25 = $150.

$1,100 $1,250 $1,050

CFO = 1,000 85 45 + 90 + 35 105 + 85 +125 = 1,100

Elan Guides (www.proavenues.com/cfa)

Elan Guides (www.proavenues.com/cfa)

Elan Guides (www.proavenues.com/cfa)

Elan Guides (www.proavenues.com/cfa)

Impairment recognition does not affect a companys cash flows.

Value of goodwill recognized upon acquisition is calculated as:

Therefore, XYZ will recognize an impairment loss of $2,500 ($3,500 - $1,000).

Elan Guides (www.proavenues.com/cfa)

Elan Guides (www.proavenues.com/cfa) Answer: C

Elan Guides (www.proavenues.com/cfa) Answer: B

For premium bonds CFO is understated and CFF is overstated.

Elan Guides (www.proavenues.com/cfa)

Elan Guides (www.proavenues.com/cfa)

Elan Guides (www.proavenues.com/cfa)

Elan Guides (www.proavenues.com/cfa)

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