Answer bequity valuation concepts and basic tools john

A.Confidentiality of proceedings
B.Fair process to the member and candidate
C.Public disclosure of disciplinary sanctions

Answer = C

Answer = B

“Introduction to the Global Investment Performance Standards (GIPS®),” CFA Institute 2012 Modular Level I, Vol. 1, p. 173
Study Session 1-3-b
Explain the construction and purpose of composites in performance reporting.

A.makes full disclosure to both companies.

B.receives written permission from the local company. C.signs confidentiality agreements with both companies.

A.Yes
B.No, because the client’s objectives were met
C.No, because the investment time frame does not match the investment horizon

Answer = B

5. Vishal Chandarana, an unemployed research analyst, recently registered for the CFA Level I exam. After two months of intense interviewing, he accepts a job with a stock brokerage company in a different region of the country. Chandarana posts on a social media blog how being a CFA candidate really helped him get a job. He also notes how relieved he was when his new employer didn’t ask him about being fired from his former employer. Which CFA Institute Code of Ethics or Standards of Professional Conduct did Chandarana least likely violate?

A.Misconduct
B.Loyalty to Employers
C.Reference to the CFA Program

6. Kam Bergeron, CFA, is an equity portfolio manager who often takes time off in the afternoon to play golf with important clients. Today, Bergeron is on the golf course when his game is interrupted by a phone call from his office. The call is from Bergeron's assistant, who notifies him of a steep and accelerating market decline. Bergeron, eager to get back to his golf game, tells his assistant to raise cash by selling 15% of all clients’ holdings. Bergeron instructs his assistant to first sell the most liquid stocks in each client’s portfolio and then do the same for his personal account. Bergeron is least likely to be in violation of which of the CFA Institute Standards of Professional Conduct?

A.Suitability
B.Priority of transactions
C.Diligence and reasonable basis

7. Ileana Inkster, CFA, was recently offered a senior management position within the trust department at a regional bank. The department is new, but the bank has plans to expand it significantly over the next few months. Inkster has been told she will be expected to help grow the client base of the trust department. She is informed the trust department plans to conduct educational seminars and pursue the attendees as new clients. Inkster notices recent seminar advertisements prepared by the bank’s marketing department do not mention investment products will be for sale at the seminar. The ads indicate attendees can “learn how to immediately add $100,000 to their net worth.” What should Inkster most likely do to avoid violating any CFA Institute Standards of Professional Conduct?

A.Decline to accept the new position
B.Accept the position and revise the marketing material
C.Accept the position and inform senior management of inadequate compliance procedures

8. Molly Burnett, CFA, is a portfolio manager for a fund that only invests in environmentally friendly companies. A multinational utility company recently acquired one of the fund’s best performing investments, a wind power company. The wind power company’s shareholders received utility company shares as part of the merger agreement. The utility has one of the worst environmental records in the industry, but its shares have been one of the top performers over the past 12 months. Because the utility pays a high dividend every three months, Burnett holds the utility shares until the remaining two dividends are paid for the year then sells the shares. Burnett most likely violated the CFA Institute Standard of Professional Conduct concerning:

A.suitability.

A is correct because the utility is not a suitable investment for a fund that only invests in companies with good environmental records. Continuing to hold this investment, therefore, was a violation of Standard III (C) Suitability.

9. Pia Nilsson is a sole proprietor investment advisor. The economic recession has reduced the number of clients she advises and caused revenues to decline. As a result, Nilsson has not paid her CFA Institute membership dues for the past two years. When a national financial publication recently interviewed Nilsson, she indicated that up until two years ago she had been a CFA charterholder and a CFA Institute member in good standing. In addition, she stated the completion of the CFA Program enhanced her portfolio management skills and enabled her to achieve superior returns on behalf of her clients. Which of Nilsson's following actions most likely violated the CFA Institute Standards of Professional Conduct?

B is correct because it is a violation of Standard VII (B) Responsibilities as a CFA Institute Member or CFA Candidate to claim the CFA charter helped her to achieve superior returns.

10. Which of the following distinct entities can least likely claim compliance with the Global Investment Performance Standards (GIPS)?

11. For periods beginning on or after 1 January 2011, the aggregate fair value of total firm assets most likely includes all:

A.fee-paying discretionary accounts.

C is correct because for periods beginning on or after 1 January 2011, total firm assets must include the aggregate fair value of all discretionary and non-discretionary assets managed by the firm. This includes both fee-paying and non-fee-paying portfolios (0.A.13).

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currently registered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting access by anyone other than currently registered CFA candidates and copying, posting to any website, e-mailing, distributing, and/or reprinting the mock exam for any purpose.

“Global Investment Performance Standards (GIPS),” CFA Institute
2012 Modular Level I, Vol. 1, p. 180
Study Session 2-4-c
Explain how the GIPS standards are implemented in countries with existing standards for performance reporting, and describe the appropriate response when the GIPS standards and local regulations conflict.

B is correct because where local laws and regulations regarding calculation and presentation conflict with GIPS standards, firms must abide by the local laws and regulations. They are still allowed to claim GIPS compliance but must disclose areas where the local requirements conflict with those of the GIPS standards.

B is correct because GIPS standards (0.A.9) state “firms must make every reasonable effort to provide a compliant presentation to all prospective clients. As long as a prospective client has received a compliant presentation within the previous 12 months, the firm has met this requirement. It is a GIPS recommendation, not a requirement, that all clients receive a compliant presentation on an annual basis (0.B.4).

A is correct because Simone violated Standard II (A) Material Nonpublic Information by giving institutional fund managers access to material nonpublic information prior to public
dissemination (i.e., the press release). By releasing earnings results to a select group of institutional fund managers prior to a public press release, Simone allows the institutional fund managers a time advantage over other investors not invited to the investor briefing.

15. Beth Kozniak, a CFA candidate, is an independent licensed real estate broker and a well-known property investor. She is currently brokering the sale of a commercial property on behalf of a client in financial distress. If the client’s building is not sold within 30 days, he will lose the building to the bank. A year earlier, another client of Kozniak’s had expressed interest in purchasing this same property. However, she is unable to contact this client, nor has she discovered any other potential buyers. Given her distressed client’s limited time frame, Kozniak purchases the property herself and foregoes any sales commission. Six months later, she sells the property for a nice profit to the client who had earlier expressed interest in the property. Does Kozniak most likely violate the CFA Institute Standards of Professional Conduct?

A is correct because Kozniak does not appear to have violated any CFA Institute Standards of Professional Conduct. Because she is known in the market for investing and brokering property and both parties have worked with Kozniak in the past, both parties would know of her interests. In addition, in both cases she acts for her own account as a primary investor, not as a broker. She buys the property for her own portfolio and then sells the property from her own portfolio. Therefore, Kozniak did not violate Standard VI (A) Disclosure of Conflicts. When she purchased the property for her portfolio, she saved her client from losing the building to the bank and did not charge a sales commission. Because the sale of the property to her other client did not take place until six months after her purchase and she was unable to contact the client who had earlier expressed interest prior to her purchase, she cannot be accused of violating any loyalty, prudence, or care to either client (Standard III (A) Loyalty, Prudence, and Care).

C is correct because Charmaine should have reported the cheating allegation when making her annual Professional Conduct Statement. Even though she successfully defended herself against the charges and the charges were dropped, she has a responsibility to report the written complaint involving her integrity. The Code of Ethics requires CFA charterholders to practice and encourage others to practice in a professional and ethical manner that will reflect credit on themselves and the profession.

C.during established time periods.

Answer = A

Answer = C

“Guidance for Standards I–VII,” CFA Institute
2012 Modular Level I, Vol. 1, pp. 99, 123–125, 136
Study Session 1-2-c
Recommend practices and procedures designed to prevent violations of the Code of Ethics and Standards of Professional Conduct.

19. If the stated annual interest rate is 20% and the frequency of compounding is monthly, the effective annual rate (EAR) is closest to:

A.20%.
B.21%.
C.22%.

A.Mode
B.Mean
C.Median

Answer = B

21.	A project offers the following incremental after-tax cash flows:

Answer = C

“Discounted Cash Flow Applications,” Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto, and David E. Runkle
2012 Modular Level I, Vol. 1, pp. 314–317
“Capital Budgeting,” John Stowe and Jacques R. Gagne
2012 Modular Level I, Vol. 4, pp. 11–13
Study Session 2-6-a, 11-36-d
Calculate and interpret the net present value (NPV) and the internal rate of return (IRR) of an investment.

Rate	NPV
2.4%	€1,065.28
4.4%	€355.75
5.5%	–€10.20
5.5% is closest to 0 and is thus closest to the IRR of the project.

“Statistical Concepts and Market Returns,” Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto, and David E. Runkle
2012 Modular Level I, Vol. 1, pp. 370–373
Study Session 2-7-e
Calculate and interpret measures of central tendency, including the population mean, sample mean, arithmetic mean, weighted average or mean (including a portfolio return viewed as a weighted mean), geometric mean, harmonic mean, median, and mode.

A is correct. The geometric mean return is calculated as
[(1 + 0.10) × (1 – 0.02) × (1 + 0.18) × (1 – 0.12)]0 25 – 1 = 0.0286 ~ 2.9%.

10	20	–8	2	–9	5	0	–8	2	3

C.10.8.

Answer = A

The sample standard deviation is
s = [ ∑𝑖=1(𝑋𝑖− 𝑋�) 2 ÷ (𝑛 − 1)] 0 5.

In this problem, 𝑋 = (10 + 20 – 8 + 2 – 9 + 5 + 0 – 8 + 3 + 21) ÷ 10 = 3.6.

A.sample.

B.statistic.

Define a parameter, a sample statistic, and a frequency distribution.

A is correct. A sample is a subset of a population.

Answer = C

“Sampling and Estimation,” Richard A. Defusco, Dennis W. McLeavey, Jerald E. Pinto, and David E. Runkle
2012 Modular Level I, Vol. 1, pp. 553–556
Study Session 3-10-d
Distinguish between time-series and cross-sectional data.

“The Time Value of Money,” Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto, and David E. Runkle
2012 Modular Level I, Vol. 1, pp. 274–278
Study Session 2-5-d, e
Solve time value of money problems for different frequencies of compounding.

1) Find the PV of an ordinary annuity of 59 periods (60,462.62) and add 1,200 (the time zero first payment) to that value.

2) Find the PV of a 60-period ordinary annuity and multiply that value by one plus the monthly periodic interest rate (1.0054166667).

Answer = A

“Hypothesis Testing,” Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto, and David E.

Paired Observation	Sample A Value	Sample B Value
1	25	18
2	12	9
3	–5	–8
4	6	3
5	–8	1

Runkle
2012 Modular Level I, Vol. 1, pp. 612–616
Study Session 3-11-h
Identify the appropriate test statistic and interpret the results for a hypothesis test concerning the mean difference of two normally distributed populations.

C is correct. First, calculate the mean difference:

Then, calculate the t-statistic:

𝑡 = 𝑑 − µ𝑑0𝑠𝑑

	An investor deposits £2,000 into an account that pays continuously compounded interest of 6%

(nominal annual rate). The value of the account at the end of four years is closest to:

Calculate and interpret the future value (FV) and present value (PV) of a single sum of money, an ordinary annuity, an annuity due, a perpetuity (PV only), and a series of unequal cash flows.

Distinguish between discretely and continuously compounded rates of return, and calculate and interpret a continuously compounded rate of return, given a specific holding period return.

C.negative skewness.

A.Increase in the sample size
B.Use of point estimates rather than confidence intervals
C.Use of the t-distribution rather than the normal distribution to establish confidence intervals

Answer = B

–41	–18	–17	–9	–8
–6	–5	3	3	3
5	5	7	7	11
12	20	21	21	61

Pinto, and David E. Runkle
2012 Modular Level I, Vol. 1, p. 362
Study Session 2-7-e
Calculate and interpret measures of central tendency, including the population mean, sample mean, arithmetic mean, weighted average or mean (including a portfolio return viewed as a weighted mean), geometric mean, harmonic mean, median, and mode.

B is correct. “The median is the value of the middle item of a set of items. . . . In an even-numbered sample, we define the median as the mean of the values of items occupying the n/2 and (n +2)/2 positions” (p. 362). The n/2 item is the 10th item, and the (n +2)/2 item is the 11th item. The value of the 10th item is 3; the value of the 11th item is 5. The mean of 3 and 5 is 4.

Answer = C

“Demand and Supply Analysis: Introduction,” Richard V. Eastin and Gary L. Arbogast
2012 Modular Level I, Vol. 2, pp. 48–49
Study Session 4-13-m
Calculate and interpret price, income, and cross-price elasticities of demand, including factors that affect each measure.

Calculate and interpret total, marginal, and average product of labor.

Describe the phenomenon of diminishing marginal returns and calculate and interpret the profit-maximizing utilization level of an input.

B.decreases.

C.is eliminated.

C is correct. In the first degree price discrimination, the entire consumer surplus is captured by the producer: The consumer surplus falls to zero.

36. Which of the following actions on the part of a central bank is most consistentwith increasing the quantity of money?

C is correct. When a central bank purchases securities, bank reserves increase. The banks thus have excess reserves and are able to increase their lending, increasing the money supply.

37. If a government increases its spending on domestically produced goods by an amount that is financed by the same increase in taxes, the aggregate demand will most likely:

“Monetary and Fiscal Policy,” Andrew Clare and Stephen Thomas
2012 Modular Level I, Vol. 2, pp. 410–411
Study Session 5-19-l, n, o
Describe the tools of fiscal policy, including their advantages and disadvantages. Explain the implementation of fiscal policy and the difficulties of implementation. Determine whether a fiscal policy is expansionary or contractionary.

Ratio	Spot Rates
USD/SGD	1.2600
NZD/USD	0.7670
USD: U.S. Dollar

Answer = B

“Currency Exchange Rates,” William A. Barker, Paul D. McNelis, and Jerry Nickelsburg 2012 Modular Level I, Vol. 2, pp. 521–525
Study Session 6-21-e
Calculate and interpret currency cross-rates.

Consumption function	C = 2,500 + 0.80 × (Y – T)


Tax function	T = –250 + 0.30 × Y

“Aggregate Output, Prices, and Economic Growth,” Paul R. Kutasovic and Richard G. Fritz 2012 Modular Level I, Vol. 2, pp. 232–240
Study Session 5-17-f
Explain the IS and LM curves and how they combine to generate the aggregate demand curve.

C is correct.

Answer = A

“Demand and Supply Analysis: The Firm,” Gary L. Arbogast and Richard V. Eastin 2012 Modular Level I, Vol. 2, pp. 101–105
Study Session 4-15-a
Calculate, interpret, and compare accounting profit, economic profit, normal profit, and economic rent.

C.Although domestic producers will receive a net benefit, the policy will give rise to inefficiencies that cause a deadweight loss to the national welfare.

Answer = C

A.It must have a comparative advantage in the production of the imported good.

B.The deadweight loss must be smaller than the benefit of its improving terms of trade. C.It must auction the import licenses for a fee to offset the decline in the consumer surplus.

A.increasing its net foreign liabilities.

B.restricting foreign direct investment.

A is correct. A current account deficit must be offset by a capital account surplus. Only by borrowing money from foreigners can a country have a current account deficit and consume more output than it produces (p. 475). An increase in net foreign liabilities is the result of borrowing from foreigners.

Answer = C

“Currency Exchange Rates,” William A. Barker, Paul D. McNelis, and Jerry Nickelsburg 2012 Modular Level I, Vol. 2, pp. 539–540
Study Session 6-21-i
Describe exchange rate regimes.

C.must state that he prepared the financial statements according to generally accepted accounting principles.

Answer = B

A.prepaid expense.
B.accrued expense.
C.deferred revenue.

Answer = A

	¥
Net income reported	42,000
Dividends paid	7,000
	3,000
	6,000

Answer = A

“Understanding Balance Sheets,” Elaine Henry and Thomas R. Robinson
2012 Modular Level I, Vol. 3, pp. 241–244, 247–250
Study Session 8-26-e, f, g
Describe different types of assets and liabilities and the measurement bases of each. Describe the components of shareholders’ equity.

48.

(US$ thousands)

2011 2010


	25,000
	13,000	8,500

Total current assets

Answer = A

“Understanding Cash Flow Statements,” Elaine Henry, Thomas R. Robinson, Jan Hendrik van Greuning, and Michael A. Broihahn
2012 Modular Level I, Vol. 3, pp. 291–292
Study Session 8-27-e, f
Describe how the cash flow statement is linked to the income statement and the balance sheet. Describe the steps in the preparation of direct and indirect cash flow statements, including how cash flows can be computed using income statement and balance sheet data.

	Company (£)	Common Size Industry Data (% of sales)
	76,000	28.0
Pretax profit	66,400	19.6
	44,500	13.1
Sales	400,000	100.0
Total assets	524,488	140.0
Total equity	296,488	74.0

ROE	15.0%	17.7%

“Financial Analysis Techniques,” Elaine Henry, Thomas R. Robinson, and Jan Hendrik van Greuning
2012 Modular Level I, Vol. 3, pp. 374–379
Study Session 8-28-c, d,
“Financial Statement Analysis,” Pamela Peterson Drake
2012 Modular Level I, Vol. 4, pp. 213–215
Study Session 11-41
Describe the relationships among ratios and evaluate a company using ratio analysis.

50.	Which of the following is least likely to be a general feature underlying the preparation of

Robinson
2012 Modular Level I, Vol. 3, pp. 128–129
“Understanding Income Statements,” Elaine Henry and Thomas R. Robinson 2012 Modular Level I, Vol. 3, p. 171
Study Session 7-24-e, 8-25-d
Describe general requirements for financial statements under IFRS.

Describe the general principles of expense recognition, specific expense recognition applications, and the implications of expense recognition choices for financial analysis.

Answer = A

(all figures in $ thousands)	2011	2010
Deferred tax assets	200	160
	(450)	(360)
	(250)	(200)

	4,000	3,800
	1,200	1,140
Current income tax expense	1,000	900

The company’s 2011 income tax expense (in thousands) is closest to:

B is correct. Income tax expense reported on the income statement = Income tax payable + Net changes in the deferred tax assets and deferred tax liabilities. The change in the net deferred tax liability is a $50 increase (indicating that the income tax expense is $50 in excess of the income

“Inventories,” Michael A. Broihahn
2012 Modular Level I, Vol. 3, p. 411
Study Session 9-29-b
Describe different inventory valuation methods (cost formulas).

C is correct. Specific identification best matches the physical flow of the inventory items because it tracks the actual units that are sold.

Answer = C

“Long-Lived Assets,” Elaine Henry and Elizabeth A. Gordon
2012 Modular Level I, Vol. 3, pp. 467, 480
Study Session 9-30-i
Explain the derecognition of property, plant and equipment, and intangible assets.

Note 17: Retirement benefit obligations
Amounts recognized in the income statement for the year

	2011	2010
	$ 692	$ 588
	80	65
	(50)	(45)
Past service costs recognized in the year	6	12
Total income statement charge	$ 728	$ 620

Compare the presentation and disclosure of defined contribution and defined benefit pension plans.

C is correct. The pension expense would be the sum of the expense for the defined contribution plan and the defined benefit plan (retirement benefit obligation): 1,525 + 728 = 2,253.

Answer = B

Note 8 to the 2011 financial statements contains the following information about the company’s future beginning of year lease commitments:

Note 8: Operating leases

“Non-Current (Long-Term) Liabilities,” Elizabeth A. Gordon and Elaine Henry
2012 Modular Level I, Vol. 3, p. 574
“Financial Statement Analysis: Applications,” Thomas R. Robinson, Jan Hendrik van Greuning, Elaine Henry, and Michael A. Broihahn
2012 Modular Level I, Vol. 3, pp. 652–658
Study Session 9-32-l, 10-35-e
Calculate and interpret leverage and coverage ratios.

58. The financial statement that would be most helpful to an analyst in understanding the changes that have occurred in a company’s retained earnings over a year is the statement of:

A.changes in equity.

A is correct. The statement of changes in equity reports the changes in the components of shareholders’ equity over the year, which would include the retained earnings account.

59. Under the IASB Conceptual Framework, one of the qualitative characteristics of useful financial information is that different knowledgeable users would agree that the information is a faithful representation of the economic events that it is intended to represent. This characteristic is best described as:

“Financial Reporting Standards,” Elaine Henry, Jan Hendrik van Greuning, and Thomas R.

Robinson
2012 Modular Level I, Vol. 3, p. 123
Study Session 7-24-d
Describe the International Accounting Standards Board’s Conceptual Framework, including the objective and qualitative characteristics of financial statements, required reporting elements, and constraints and assumptions in preparing financial statements.

Answer = A

“Understanding Cash Flow Statements,” Elaine Henry, Thomas R. Robinson, Jan Hendrik van Greuning, and Michael A. Broihahn
2012 Modular Level I, Vol. 3, pp. 273–276
Study Session 8-27-a, c
Compare cash flows from operating, investing, and financing activities, and classify cash flow items as relating to one of those three categories given a description of the items.

The company’s cash conversion cycle (in days) is closest to:

A.38.2.
B.45.2.
C.76.4.

Cash conversion cycle = DOH + DSO – Days of payables
	Formula	Calculation	Days
			41.7
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦	315,000 36,000 = 8.75
			34.7
𝐴𝑐𝑐𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒	421,000 40,000 = 10.53
Number of days of payables:			–38.2
	315,000 33,000 = 9.55
* When purchases are not available (as in this case), the COGS can be used to estimate payables turnover (p. 356).
			38.2

Operating Profit Margin	17.5%
Net Profit Margin	11.7%

	10.4%
	1.46
Debt to Equity	0.46

The company’s return on equity (ROE) is closest to:

B is correct. Using DuPont analysis, there are two ways to calculate ROE from the information provided:

should be satisfied in order to report revenue on the income statement?

A.Payment has been received.

B is correct. The IFRS conditions that should be met include that the costs incurred can be reliably measured, and it is likely that the economic benefits will flow to the entity, not the actual receipt of any payment, and that the significant risks and rewards of ownership have been transferred, which is normally when the goods have been delivered, but not always.

	Year 1	Year 2	Year 3
	$1.2	$6.0	$1.6
Amounts billed and payments received	$2.4	$5.6	$2.6

A.$3.5.
B.$5.6.
C.$7.2.

Answer = C

65. A company recently purchased a warehouse property and related equipment (shelving, forklifts, etc.) for €50 million, which were valued by an appraiser as follows: Land €10 million, building €35 million, and equipment €5 million. The company incurred the following additional costs in getting the warehouse ready to use:

“Long-Lived Assets,” Elaine Henry and Elizabeth A. Gordon
2012 Modular Level I, Vol. 3, pp. 444–446
Study Session 9-30-a
Distinguish between costs that are capitalized and costs that are expensed in the period in which they are incurred.

B is correct. The capitalized cost of the building would include the other costs that are directly attributable to the building and are involved in extending its life or getting it ready to use:

The company did not elect to carry the bonds at fair value. In December 2011 the market rate on similar bonds had increased to 5% and the company decided to buy back (retire) the bonds after the coupon payment on December 31. As a result, the gain on retirement reported on the 2011 statement of income is closest to:

A.£340,410.
B.£371,882.
C.£382,556.

Gain =		both at time of retirement, calculations
Gain =	20,754,438 – 20,371,882 = 382,556

The bond’s initial value (required for amortization) can be found using a financial calculator:
FV = 20,000,000; i = 4%; PMT = 1,200,000; N = 5; Compute PV = 21,780,729.

67. Providing information about the performance of a company, its financial position, and changes in financial position that is useful to a wide range of users is most accurately described as the role of:

A.financial reporting.

Describe the objective of audits of financial statements, the types of audit reports, and the importance of effective internal controls.

A is correct. The role of financial reporting is to provide information about the performance of a company, its financial position, and changes in financial position that is useful to a wide range of users in making economic decisions.

“Non-Current (Long-Term) Liabilities,” Elizabeth A. Gordon and Elaine Henry 2012 Modular Level I, Vol. 3, pp. 551–552
Study Session 9-32-f
Explain the motivations for leasing assets instead of purchasing them.

Answer = B

“Capital Budgeting,” John D. Stowe and Jacques R. Gagne
2012 Modular Level I, Vol. 4, p. 8
Study Session 11-36-b
Describe the basic principles of capital budgeting, including cash flow estimation.

“Cost of Capital,” Yves Courtois, Gene C. Lai, and Pamela Peterson Drake 2012 Modular Level I, Vol. 4, pp. 60–61
Study Session 11-37-i
Calculate and interpret the beta and cost of capital for a project.

A is correct. Note: 60% debt financing is equivalent to a D/E ratio of 1.50 = 0.60/(1 – 0.60). βAsset = βEQ× [1÷ (1+ [1 – t] D/E) )] = 1.4 ÷ (1 + (1 – 0.35) × 1.5) = 0.7089.

“Financial Statement Analysis,” Pamela Peterson Drake
2012 Modular Level I, Vol. 4, pp. 217–225
Study Session 11-41
The candidate should be able to demonstrate the use of pro forma income and balance sheet statements.

C is correct.

With a discount rate of 8%, the discounted payback period (in years) is closest to:

A.2.8.
B.3.0.
C.3.2.

Year	Cash Flow	PV (Cash Flow) @ 8% CFn ÷ (1.08)n
0		–75,000	75,000
1	21,600	20,000	55,000
2		20,000	35,000
3	37,791	30,000	5,000
4	40,814	30,000
Therefore, the discounted payback is 3.2 years.
* For example, the PV of Year 2’s cash flow is $23,328 ÷ [1.08]2.

“Measures of Leverage,” Pamela Peterson Drake, Raj Aggarwal, Cynthia Harrington, and Adam Kobor
2012 Modular Level I, Vol. 4, pp. 97–99
Study Session 11-38-b
Calculate and interpret the degree of operating leverage, the degree of financial leverage, and the degree of total leverage.

74. Based on best practices in corporate governance procedures, it is most appropriate for a company’s compensation committee to:

A.include a retired executive from the firm.

B is correct. Under appropriate corporate governance procedures, the compensation committee should link compensation with long-term objectives.

75. The following information is available for a company:

“Cost of Capital,” Yves Courtois, Gene C. Lai, and Pamela Peterson Drake
2012 Modular Level I, Vol. 4, pp. 41, 47–52
By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currently registered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting access by anyone other than currently registered CFA candidates and copying, posting to any website, e-mailing, distributing, and/or reprinting the mock exam for any purpose.

“Portfolio Risk and Return: Part II,” Vijay Singal
2012 Modular Level I, Vol. 4, p. 418
Study Session 11-37-a, b, 12-45-g
Calculate and interpret the weighted average cost of capital (WACC) of a company.

𝑊𝐴𝐶𝐶 = 𝑤𝑑𝑟𝑑(1 − 𝑡) + 𝑤𝑝𝑟𝑝 + 𝑤𝑒𝑟𝑒
𝑊𝐴𝐶𝐶 = 30% × 9.2% × (1 − 35%) + 15% × 16.5% + 55% × 18.3% = 14.33%

76. Financial risk is most likely affected by:

“Measures of Leverage,” Pamela Peterson Drake, Raj Aggarwal, Cynthia Harrington, and Adam Kobor
2012 Modular Level I, Vol. 4, p. 103
Study Session 11-38-a
Define and explain leverage, business risk, sales risk, operating risk, and financial risk, and classify a risk, given a description.

B is correct. As stated on p. 103, “By taking on fixed obligations, such as debt and long-term leases, the company increases its financial risk.”

B.decrease.

C.remain unchanged.

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = $6,000,000 ÷ 4,000,000 = $1.50
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 𝑟𝑒𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑑 = $10,000,000 ÷ $20.00 = 500,000 𝑠ℎ𝑎𝑟𝑒𝑠 𝐴𝑑𝑗𝑢𝑠𝑡𝑒𝑑 𝑛𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑛𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 − [𝑑𝑒𝑏𝑡 × "𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥" 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑑𝑒𝑏𝑡] = $6,000,000 − [$10,000,000 × 10% × (1 − 40%)] = $5,400,000
𝑁𝑒𝑤 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = $5,400,000 ÷ [4,000,000 − 500,000] = $1.54

Short way:

Answer = A

“Working Capital Management,” Edgar Norton, Jr., Kenneth L. Parkinson, and Pamela Peterson Drake
2012 Modular Level I, Vol. 4, p. 174
Study Session 11-40-e
Calculate and interpret comparable yields on various securities, compare portfolio returns against a standard benchmark, and evaluate a company’s short-term investment policy guidelines.

A.thinks that the stock is overvalued.

B.wants to limit the loss on a long position. C.wants to limit the loss on a short position.

C is correct. Investors who have entered into a short sale will incur losses if the stock begins to increase in value. A stop-buy order helps limit the loss on a short position because it becomes valid when the stock price rises above the specified stop price.

“The Corporate Governance of Listed Companies: A Manual for Investors,” Kurt Schacht, James C. Allen, and Matthew Orsagh
2012 Modular Level I, Vol. 4, pp. 263–266
“Overview of Equity Securities,” Ryan C. Fuhrmann and Asjeet S. Lamba
2012 Modular Level I, Vol. 5, p. 171
Study Session 11-42-g, 14-50-b
Evaluate, from a shareowner’s perspective, company policies related to voting rules,
shareowner-sponsored proposals, common stock classes, and takeover defenses.

Describe differences in voting rights and other ownership characteristics among different equity classes.


Company's sustainable growth rate	5%
Yield on comparable preferred stock issues	11.5%
	30%

“Equity Valuation: Concepts and Basic Tools,” John J. Nagorniak and Stephen E. Wilcox 2012 Modular Level I, Vol. 5, pp. 276–277
Study Session 14-52-d
Calculate the intrinsic value of a non-callable, non-convertible preferred stock.

Year	Earnings per share ($)	Dividends per share ($)	ROE

To estimate the stock's justified forward P/E, the investor prefers to use the compounded annual earnings growth and the average of the payout ratios over the relevant period (i.e., 2008–2011). If the investor uses 11.5% as her required rate of return, the stock's justified forward P/E is closest to:

A.10.
B.12.
C.21.

Average payout ratio = (0.60 + 0.50 + 0.70 + 0.64)/4 = 0.61.

P0/E1 = p/(r – g) = 0.61/(0.115 – 0.086) = 0.61/0.029 = 21.0.

“Equity Valuation: Concepts and Basic Tools,” John J. Nagorniak and Stephen E. Wilcox 2012 Modular Level I, Vol. 5, pp. 284–286
Study Session 14-52-e
Calculate and interpret the intrinsic value of an equity security based on the Gordon (constant) growth dividend discount model or a two-stage dividend discount model, as appropriate.

B is correct. Dividend per share (2012) = $2.50 (0.6) = $1.50.

=	1.50(1.25)		1.50(1.25)2	+	1.50(1.25)2 (1.05)	×	1
V2012=	1.12		1.122	+	(0.12−0.05)	×	1.122

“Security Market Indices,” Paul D. Kaplan and Dorothy C. Kelly 2012 Modular Level I, Vol. 5, p. 109–110
Study Session 13-48-j
Discuss indices representing alternative investments.

“Market Organization and Structure,” Larry E. Harris 2012 Modular Level I, Vol. 5, pp. 51–52
“Option Markets and Contracts,” Don M. Chance
2012 Modular Level I, Vol. 6, pp. 82–85
Study Session 13-47-g, h, 17-63-a
Compare execution, validity, and clearing instructions. Compare market orders with limit orders.

Describe call and put options.

“Market Organization and Structure,” Larry E. Harris
2012 Modular Level I, Vol. 5, pp. 43–46
Study Session 13-47-f
Calculate and interpret the leverage ratio, the rate of return on a margin transaction, and the security price at which the investor would receive a margin call.

Alternate solution:

1 − maintenance margin % = 64 × 0.6 ~~1 − 0.3~~ = $54.86

“Security Market Indices,” Paul D. Kaplan and Dorothy C. Kelly
2012 Modular Level I, Vol. 5, p. 98
Study Session 13-48-d
Compare the different weighting methods used in index construction.

C is correct. Momentum “effect” is a characteristic of a market-value-weightedindex, not a fundamentally weighted index.

“Overview of Equity Securities,” Ryan C. Fuhrmann and Asjeet S. Lamba 2012 Modular Level I, Vol. 5, pp. 182–184
Study Session 14-50-c, d
Distinguish between public and private equity securities.

Describe methods for investing in non-domestic equity securities.

Answer = A

“Introduction to Industry and Company Analysis,” Patrick W. Dorsey, Anthony M. Fiore, and Ian Rossa O’Reilly
2012 Modular Level I, Vol. 5, pp. 208, 223–233
Study Session 14-51-e, h, i
Describe the elements that need to be covered in a thorough industry analysis.

90. The Gordon growth model is most appropriate for valuing the common stock of a dividend- paying company that is:

A.young and just entering the growth phase.

C is correct. The Gordon growth model is most appropriate for valuing common stock of a dividend-paying company that is mature and relatively insensitive to the business cycle or economic fluctuations.

Questions 91 through 96 relate to Derivative Investments

B is correct because derivative markets improve market efficiency for the underlying assets by increasing market fairness and competitiveness, not by lowering transaction costs. Low transactions costs are a characteristic of derivative markets, not one of their purposes.

92. A futures trader takes a long position of 10 contracts. The initial margin requirement is $10 per contract and the maintenance margin requirement is $7 per contract. She deposits the required initial margin on the trade date. On Day 3, her margin account balance is $40. What is the variation margin on Day 4?

B is correct because on any day when the balance in the margin account falls below the maintenance margin, the trader must deposit sufficient funds to bring the balance back up to the initial margin requirement. This additional amount is called the “variation margin.” Therefore, $100 – $40 = $60 variation margin.

93. A portfolio manager enters into an equity swap with a swap dealer. The portfolio manager agrees to pay the return on the Value index and receive the return on the Growth index. The swap’s notional principal is $50 million and the payments will be made semi-annually. The levels of the equity indices are as follows:

	Level at Start of Swap	Level 6 Months Later
	5,460	5,350
	1,190	1,200

A.$587,158.

B.$1,007,326.
C.$1,427,494.

Growth index payment = ((1200/1190) – 1) × $50,000,000 = $420,168.

Net payment to portfolio manager = $420,168 – (–$1,007,326) = $1,427,494.

C.Epsilon may receive or pay JPY, depending on the exchange rate at expiration.

Answer = A

Answer = A

“Option Markets and Contracts,” Don M. Chance
2011 Modular Level I, Vol. 6, pp. 103–107
Study Session 17-63-k
Calculate and interpret the lowest prices of European and American calls and puts based on the rules for minimum values and lower bounds.

Answer = C

“Risk Management Applications of Option Strategies,” Don M. Chance
2011 Modular Level I, Vol. 6, pp. 172–175
Study Session 17-65-b
Determine the value at expiration, profit, maximum profit, maximum loss, break-even underlying price at expiration, and payoff graph of a covered call strategy and a protective put strategy, and explain the risk management application of each strategy.

A.step-up note.

B.inverse floater.

98. For a 10-year floating-rate security, if market interest rates change by 1%, the change in the value of the security will most likely be:

B is correct because the interest rate sensitivity of a floating-rate security comes primarily from the time remaining until its next coupon reset.

99. When a bank creates a collateralized loan obligation (CLO) to divest of commercial loans that it owns, the process is best described as a(n):

B is correct because a balance sheet transaction is one that removes assets from the balance sheet of the institutionand isoften motivated by the desire to reduce the institution’s risk.

100. Which of the following is closest to the value of a 10-year, 6% coupon, $100 par value bond with semi-annual payments assuming an annual discount rate of 7%?

Study Session 16-57-c
Calculate the value of a bond (coupon and zero coupon).

A is correct because a security with 19 semi-annual payments of $3 interest and a 20th payment


	3		+	3					+	3				+	3				+	3			+	3				+	3			+
			+	1.035				2		1.035 3					1.035 4					1.035 5				1.035 6					1.035 7
	+	3		+		3					+		3			+	3				+	3				+	3			+	3
	+	1.035 9		+		1.035 10					+		1.035 11			+	1.035 12				+	1.035 13				+	1.035 14				1.035 15
	+	3			+		3					+	3			+		3			+	103			20	=
101.	+	1.035 16			+		1.035 17					+	1.035 18			+		1.035 19			+	1.035			20	=
101.

Answer = B

“Introduction to the Valuation of Debt Securities,” Frank J. Fabozzi
2012 Modular Level I, Vol. 5, pp. 492–495
Study Session 16-57-d
Explain how the price of a bond changes if the discount rate changes and as the bond approaches its maturity date.

“Introduction to the Measurement of Interest Rate Risk,” Frank J. Fabozzi 2012 Modular Level I, Vol. 5, pp. 620–621

2)The borrower will not incur additional debt if its debt/capital ratio is more than 50%.

What types of covenants are these?

C is correct because to pay interest and principal is one of the most common affirmative covenants. Negative covenants set forth certain limitations and restrictions on the borrower’s activities. The more common restrictive covenants are those that impose limitations on the borrower’s ability to incur additional debt unless certain tests are satisfied, such as a debt/capital ratio.

104. An investor sells a bond at the quoted price of $98.00. In addition he receives accrued interest of $4.40. The clean price of the bond is:

C is correct because the agreed upon bond price without accrued interest is simply referred to as the price as well as the clean price.

“Risks Associated with Investing in Bonds,” Frank J. Fabozzi
2012 Modular Level I, Vol. 5, pp. 353
Study Session 15-54-b
Identify the relations among a bond’s coupon rate, the yield required by the market, and the bond’s price relative to par value (i.e., discount, premium, or equal to par).

B is correct because the bond would sell below par or at a discount if the yield required by the market rises above the coupon rate. Because the bond initially was purchased at par, the coupon rate equals the yield required by the market. Subsequently, if yields rise above the coupon, the bond’s market price would fall below par.

“Risks Associated with Investing in Bonds,” Frank J. Fabozzi
2012 Modular Level I, Vol. 5, pp. 354–355
Study Session 15-54-c
Explain how a bond’s maturity, coupon, embedded options, and yield level affect its interest rate risk.

B is correct because the lower the coupon rate, the greater the bond’s price sensitivity to changes in interest rates.

Answer = B

“Overview of Bond Sectors and Instruments,” Frank J. Fabozzi
2012 Modular Level I, Vol. 5, pp. 424–426
Study Session 15-55-i
Define an asset-backed security, describe the role of a special purpose vehicle in an asset-backed security’s transaction, state the motivation for a corporation to issue an asset-backed security, and describe the types of external credit enhancements for asset-backed securities.

“Understanding Yield Spreads,” Frank J. Fabozzi
2012 Modular Level I, Vol. 5, pp. 448–449
Study Session 15-56-a
Identify the interest rate policy tools available to a central bank.

C is correct because the U.S. Federal Reserve Bank (Fed) uses policy tools to directly influence short-term interest rates. It only indirectly influences long-term interest rates. The market, not the Fed, sets rates on 30-year bonds.

Answer = B

“Alternative Investments,” Bruno Solnik and Dennis McLeavey
2012 Modular Level I, Vol. 6, pp. 189–190
Study Session 18-66-a
Distinguish between an open-end and a closed-end fund, and explain how net asset value of a fund is calculated and the nature of fees charged by investment companies.

B is correct because using the income approach,
($2,100,000 – .03 × $2,100,000 – $1,600,000)/0.12 = $437,000/0.12 = $3,641,667.

C.Hedge fund database administrators decide which funds to include in the database to overcome self-selection bias.

Answer = C

	1	2	3	4	5
Failure Probability	0.25	0.20	0.15	0.15	0.15

Assuming the cost of capital for the project is 16%, the project’s expected net present value is closest to:

2012 Modular Level I, Vol. 6, pp. 216–218
Study Session 18-66-i
Calculate the net present value (NPV) of a venture capital project, given the project’s possible payoff and conditional failure probabilities.

B is correct because you calculate the probability of success as (1 – .25) × (1 – .20) × (1 – .15) × (1 – .15) × (1 – .15) = 0.3685. Then, calculate the NPV from success as [(22,000,000/1.165) – 5,000,000] × 0.3685 = 2,017,000. The NPV of failure is –5,000,000 × (1 – .3685) = –3,157,000. The expected NPV of the project is 2,017,000 – 3,157,000 = –1,140,000.

Answer = A

“Investing in Commodities,” Ronald G. Layard-Liesching
2012 Modular Level I, Vol. 6, pp. 262–264
Study Session 18-67-a
Explain the relationship between spot prices and expected future prices in terms of contango and backwardation.

“Alternative Investments,” Bruno Solnik and Dennis McLeavey
2012 Modular Level I, Vol. 6, pp. 232–233
Study Session 18-66-o
Describe alternative valuation methods for closely held companies, and distinguish among the bases for the discounts and premiums for these companies.

C is a correct because company control would increase the value of the closely held company or add a premium.

Answer = B

“Portfolio Management: An Overview,” Robert M. Conroy and Alistair Byrne 2012 Modular Level I, Vol. 4, pp. 289–296
Study Session 12-43-b
Describe types of investors and distinctive characteristics and needs of each.

A.2.15%.
B.3.96%.
C.7.50%.

Answer = B

	1	2	3	4
Starting balance ($)	0.00	2,000.00	5,275.00	4,206.25
New investment at the beginning of the year ($)	2,500.00	1,500.00	1,000.00	0.00
Net balance at the beginning of year ($)	2,500.00	3,500.00	6,275.00	4,206.25
	–20%	65%	–25%	10%
	–500.00	2,275.00	–1,568.75	420.63
Withdrawal by investor at the end of the year ($)	0.00	–500.00	–500.00	0.00
	2,000.00	5,275.00	4,206.25	4,626.88

CF0 = –2,500.

CF4 = 4,626.88 (balance at end of Year 4).
i = .0396.

117.	Selected information about shares of two companies is provided below:
	Standard

1 Correlation of returns between Cable Incorporated and GPTA Company

A is correct. Portfolio standard deviation =
�(0.682)(0.32) + (0.322)(0.22) + 2(0.68)(0.32)(0.65)(0.3)(0.2) = 0.2504.

Answer = C

“Portfolio Risk and Return Part II,” Vijay Singal
2012 Modular Level I, Vol. 4, pp. 410–411
Study Session 12-45-c
Explain systematic and nonsystematic risk, including why an investor should not expect to receive additional return for bearing nonsystematic risk.

Answer = B

“Portfolio Risk and Return Part II,” Vijay Singal
2012 Modular Level I, Vol. 4, pp. 415–417
Study Session 12-45-e
Calculate and interpret beta.

0.45 × 0.1235 × 0.0825
0.08252

A.Time horizon
B.Personality type
C.Expected income

Answer = B