cfa ans level 1 test 13

Question 1 -

Correct Answer is C- on a pro-rata basis over all suitable accounts.

It is permissible to allocate trades on a pro-rata basis over all suitable accounts. It is not permissible to base allocations upon compensation arrangements. Any method is not necessarily suitable, and disclosure does not absolve the member from ensuring that the allocation is necessarily fair.

This question tested from Session 1, Reading 2-III, LOS B..

Question 2 -

Correct Answer is C- a violation of the Standard concerning appropriateness and suitability of investment actions.

Given the variety of accounts under her supervision, it is not likely the shares of a speculative biotech firm would be suitable for all accounts. Placing such shares in all accounts indicates that she has failed to consider the appropriateness and suitability of the investment for each account, and this places her in violation of Standard III(C).

This question tested from Session 1, Reading 2-III, LOS C..

Question 3 -

Correct Answer is A-

Coleman's statement that Standard will cut its dividend from $2 to $1 a share is an opinion, not a fact. She should distinguish between facts and opinions in research reports.

This question tested from Session 1, Reading 2-V, LOS B..

Question 4 -

Correct Answer Is B-the clients contact information.

The Member or Candidate is not required to disclose confidential information about his independent clients.

This question tested from Session 1, Reading 2-IV, LOS A..

Question 5 -

Correct Answer is C- may be a violation despite the clients' approval.

Just because the clients know of a practice does not make it right. The analyst must put the clients first. It is a violation for the analyst to participate in a â€œhot new issueâ€• which can lower the allocation to any given client below what that client would prefer. This is tantamount to putting the analyst’s interests ahead of the clients’ interests.

This question tested from Session 1, Reading 2-VI, LOS B..

Question 6 -

Correct Answer Is B-in violation of Standard IV(C) "Responsibilities of Supervisors."

Show should review important changes to the portfolio for compliance with firm policies and procedures. The decision to work with Garnet seems arbitrary, and may not be necessary or prudent.

This question tested from Session 1, Reading 2-IV, LOS C..

Question 7 -

Correct Answer is C- a need to address issues, such as portability of investment results.

The GIPS were created to address the portability of investment results, varying time periods, and survivorship biases. Insider trading was not an issue.

This question tested from Session 1, Reading 3, LOS a.

Question 8 -

Correct Answer Is B-require managers to include all actual fee-paying and non-fee-paying discretionary portfolios in composites defined according to similar strategy and/or investment objective.

The GIPS do not require managers to include non-fee-paying accounts in composites (Standard 3.A.1).


Question 9 -

Correct Answer is C- Young violated Standard IV(A) Loyalty to Employer, because she was making preparations to start a competitive business before terminating her relationship with her employer.

Young did not violate Standard IV(A) Loyalty to Employer because such preparations are permitted provided that they do not breach Young’s duty of loyalty to her employer. Breaches that would violate Standard IV(A) include soliciting clients or taking records or files while still working for the current employer.

This question tested from Session 1, Reading 2, LOS a, b, c.

Question 10 -


According to VI(C), Referral Fees, as a member of CFA Institute, Towers must tell his clients about the payment in kind to Smith along with an estimate of the value of those services.

This question tested from Session 1, Reading 2-VI, LOS C..

Question 11 -

Correct Answer Is B-Monitoring all the phone calls made by the brokers.

Standard II(A), Material Nonpublic Information, applies in this situation. Standard II(A) suggests the use of "fire walls" to protect the firm and to conform to the Standards. A fire wall is an information barrier designed to prevent the communication of material nonpublic information between departments of a firm. Although the fire wall system should provide a means to review transactions, it is not feasible to monitor all communications into/out of departments. Placing sensitive securities/firms on "watch, "restricted," or "rumor" lists helps management target monitoring of transactions.


Question 12 -

Correct Answer is C- start the registration of her new company.

The only action that will not breach Standard IV(A) Loyalty to Employer, is to start the registration of her new company.


Question 13 -

Correct Answer Is B-Misrepresenting information on the Professional Conduct Statement.

Misrepresenting information on the Professional Conduct Statement is a direct violation of Standard VII(A) Conduct as Participants in CFA Institute Programs. The other choices are violations of Standard VII(B) Reference to CFA Institute, the CFA Designation, and the CFA Program.

This question tested from Session 1, Reading 2-VII, LOS A..

Question 14 -

Correct Answer Is B-has not violated the Code and Standards.

Standard I(B) requires members to maintain independence and objectivity. A visit by an analyst to an out-of-the-way site may be paid for by a client company host as long as the analyst can maintain objectivity. Members should encourage clients to limit the use of corporate aircraft, but exceptions can be made if transportation would not otherwise be available or would be inefficient.

This question tested from Session 1, Reading 2-I, LOS B..

Question 15 -

Correct Answer Is B-fire wall.

To comply with Standard II(A), a fire wall provides an information barrier that prevents communication of material nonpublic information and other sensitive information from one department to another within a firm.

This question tested from Session 1, Reading 2-II, LOS A..

Question 16 -

Correct Answer Is B-use reasonable care and exercise independent professional judgment.

Using reasonable care and exercising independent professional judgment is one of the components of the Code of Ethics, whereas the other statements are part of the Standards of Professional Conduct.

This question tested from Session 1, Reading 1, LOS b.

Question 17 -

Correct Answer Is B-information-based manipulation, but not transaction-based manipulation.

Williamson is in violation of Standard II(B), Market Manipulation, by engaging in information-based manipulation. Information-based manipulation includes, but is not limited to, spreading false rumors about a firm in order to induce others to trade.

This question tested from Session 1, Reading 2-II, LOS B..

Question 18 -

Correct Answer is C- Passing each exam in no more than two tries.

Passing each exam in two or fewer tries is not required to maintain active status as a member of the CFA Institute. CFA Institute imposes both of the other choices.

This question tested from Session 1, Reading 2-VII, LOS B..

Question 19 -

Correct Answer is C- At the same time notify clients for whom an investment is suitable of a new investment recommendation.

All of these are part of Standard III(B) except notifying clients at the same time. Standard III(B) states that clients for whom the investment is suitable should be notified at approximately the same time.

This question tested from Session 1, Reading 2-III, LOS B..

Question 20 -


Hurst is most likely in violation of Standard V(C) "Record Retention" because the supporting documentation is unavailable. He needs to recreate the supporting records based on information gathered through public sources or the covered company.

This question tested from Session 1, Reading 2-V, LOS C..

Question 21 -


Election of internal auditors is not a major proxy issue.


Question 22 -

Correct Answer Is B-do both of these.

Both of these are explicitly required by Standard V(A).

This question tested from Session 1, Reading 2-V, LOS A..

Question 23 -


In no case should information be disclosed to a reporter before all clients are provided with the research doing so will violate the Standard on fair dealing. However, once clients have been informed, there is no violation in releasing the information to the reporter, and in doing so Phillips might obtain information that can further help his clients.


Question 24 -

Correct Answer is C- Harrow must disclose to Dominion both his relationship with the president of Miracle and his ownership of shares in Wonder.

Standard VI(A) requires that Harrow disclose to Dominion conflicts that reasonably could be expected to interfere with his independence and objectivity. Both Harrow's relationship with the president of Miracle and his ownership of a substantial dollar amount of Wonder's shares represent a potential conflict requiring prompt disclosure to Dominion.

This question tested from Session 1, Reading 2-VI, LOS A..

Question 25 -

Correct Answer Is B-violated the Standards by not disclosing her performance bonus.

Standard VI(A) requires members to disclose all matters that could reasonably be expected to impair the member’s ability to make unbiased and objective recommendations. Compensation based on a percentage of fees generated does not create an inherent bias. If, however, a performance bonus is paid for investment results, it may unduly encourage the manager to take more risk than is proper and prudent, and so the existence of the bonus opportunity must be disclosed to the client.

This question tested from Session 1, Reading 2-VI, LOS A..

Question 26 -

Correct Answer Is B-making arrangements to go into a competitive business before terminating her relationship with Nationwide.

Standard IV(A) permits Thompson to make preparations to go into a competitive business before terminating her relationship with Nationwide provided that such preparations do not breach her duty of loyalty.


Question 27 -


According to Standard III(C), Suitability, the member manager must determine that an investment is suitable given the client’s objectives/constraints and within the context of the client’s total portfolio. In this case, the member manager must examine the new strategy to see if it is appropriate for the client, even if the client asked for the change. The member should also explain the implications of the strategy to avoid any misrepresentations that may result from omitting details.

This question tested from Session 1, Reading 2-III, LOS C..

Question 28 -


Using soft dollars for the purchase of office furniture does not benefit clients and is a violation. Purchasing research reports with soft dollars is not a violation, but the advisor should ensure that research purchased with client brokerage will benefit her clients.

This question tested from Session 1, Reading 2-III, LOS A..

Question 29 -

Correct Answer is C- fulfilled all obligations.

If the analyst had been an investment manager, it would have been inappropriate for him to make a blanket recommendation for all of his clients without considering the unique needs of each. However, the analyst is merely stating that given the qualities of the investment, it is an attractive buy. He has kept adequate records, and made fair disclosure of his rating decision.

This question tested from Session 1, Reading 2-V, LOS A..

Question 30 -


Standard III(E) requires members to preserve client confidentiality. An exception to this standard is a PCP investigation. Because PCP will also keep the clients’ information confidential, members are expected to fully cooperate with PCP investigations.

This question tested from Session 1, Reading 2-III, LOS E..

Question 31 -


Any act involving lying, cheating, stealing, or other dishonest conduct that reflects adversely on the charterholder’s professional activities is a violation of Standard I(D). Although the crime did not relate to the investment profession, it certainly reflected adversely on the charterholder professionally.

This question tested from Session 1, Reading 2-I, LOS D..

Question 32 -

Correct Answer Is B-The balance sheet.

The balance sheet represents information at a specific point in time. The income statement represents information over a period of time.


Question 33 -

Correct Answer Is B-analysts can use footnotes and Management’s Discussion and Analysis to better understand assumptions used in the financial statements.

Analysts must have a good understanding of a firm’s accounting process and must read the footnotes to the financial statement as well as Management’s Discussion and Analysis to better understand assumptions used in the financial statements. Even if the firm conforms to appropriate accounting principles, there is still room for management discretion. Because analysts do not have access to a firm ’s detailed accounting information, they must rely on what they can glean from the footnotes and Management’s Discussion and Analysis.

This question tested from Session 7, Reading 23, LOS g.

Question 34 -

Correct Answer is C- income statement.

Revenues for a reporting period are presented on a company’s income statement. They can be, but are not required to be, classified as operating and nonoperating revenues. Cash from operating activities is presented on the company’s statement of cash flows, but this is not necessarily equal to operating revenues because revenue might be recognized in a different period than cash is collected. The balance sheet displays a company’s financial position at a fixed point in time.


Question 35 -

Correct Answer is C- The footnotes disclose whether or not the company is adhering to GAAP.

Various accruals, adjustments, and management assumptions that went into the financial statements are often explained in the footnotes to the statements and in Management’s Discussion and Analysis. Because adjustments and assumptions within the financial statements are to some extent at the discretion of management, the possibility exists that management can try to manipulate or misrepresent the company’s financial performance. With this information, the analyst can better judge how well the financial statements reflect the company’s true performance, and in what ways he needs to adjust the data for his own analysis. Whether or not the company is adhering to GAAP is addressed in the auditor’s opinion, not the footnotes.


Question 36 -


Information flows through an accounting system in four steps: 1. Journal entries record every transaction, showing which accounts are changed by what amounts. A listing of all the journal entries in order by date is called the â€œgeneral journal.â€• 2. The general ledger sorts the entries in the general journal by account. 3. At the end of the accounting period, an initial trial balance is prepared that shows the balances in each account. If any adjusting entries are needed, they will be recorded and reflected in an adjusted trial balance. 4. The account balances from the adjusted trial balance are presented in the financial statements.

This question tested from Session 7, Reading 23, LOS f.

Question 37 -

Correct Answer is C-

$32,800 $129,600

Liabilities plus equity are equal to $129,600 ($16,000 accounts payable + $20,000 notes payable + $19,600 common stock + $42,000 additional paid-in capital + $32,000 retained earnings). Since assets must equal liabilities plus equity, cash must equal $32,800 ($129,600 total assets $58,000 accounts receivable $12,000 inventory $26,800 plant and equipment).

This question tested from Session 7, Reading 23, LOS e.

Question 38 -

Correct Answer is C- Transparency.

There is widespread agreement that transparency is desirable in financial reporting. Disagreements that inhibit development of a single framework often arise around issues of measurement, valuation, and standard setting.


Question 39 -

Correct Answer Is B-$1.74.

Savannah Corp.’s basic EPS ((net income preferred dividends) / weighted average number of common shares outstanding) was (($122,000 − $35,000) / $50,000 =) $1.74.


Question 40 -


1.59 0.86

Current ratio = current assets / current liabilities = 12,297 / 7,735 = 1.59 Quick ratio = (cash + receivables) / current liabilities = 2,098 + 4,570 / 7,735 = 0.86


Question 41 -

Correct Answer Is B-

4.65 0.93

Current ratio = [100(cash) + 750(accounts receivable)+ 300(marketable securities) + 850(inventory)] / [300(AP) + 130(short term debt)] = (2000 / 430) = 4.65

Cash ratio = [100(cash) + 300(marketable securities)] / [300(AP) + 130(short term debt)] = (400 / 430) = 0.93


Question 42 -


The installment sales method recognizes revenue and associated cost of goods sold only when cash is received. Gross profit (sales cost of goods sold) reflects the proportion of cash received.

The cost recovery method is similar to the installment sales method but is more conservative. Sales are recognized when cash is received, but no gross profit is recognized until all of the cost of goods sold is collected.


Question 43 -


In accounting for long-term construction contracts, the percentage-of-completion method is preferable to the completed contract method when estimates of the costs to complete and the extent of progress toward completion are reasonably dependable.


Question 44 -

Correct Answer is C- expenses are incurred.

Accrual accounting is based on the matching principle, under which revenues are recognized in the same period that the expenses are incurred to generate those revenues.

This question tested from Session 8, Reading 25, LOS d.

Question 45 -


Treatment of a change in an accounting principle is similar under U.S. GAAP and IFRS. Under both standards, a change in accounting principle is made retrospectively. The treatment of extraordinary items differs between U.S. GAAP and IFRS. Under U.S. GAAP, extraordinary items are reported net of tax below income from continuing operations. IFRS does not permit firms to treat transactions as extraordinary in the income statement.


Question 46 -


Expensing instead of capitalizing results in lower assets. Since the entire expense is recognized in the current period (whereas only a portion of the expenditure is amortized when capitalizing), net income (and therefore equity, via retained earnings) is lower with expensing than with capitalizing. Liabilities are unaffected.


Question 47 -

Correct Answer is C- an addition to equity.

If deferred tax liabilities are expected to never reverse, they should be treated as equity for analytical purposes. This situation usually arises because of growth in capital expenditures.


Question 48 -

Correct Answer Is B-net taxable loss that can be used to reduce taxable income in the future.

A tax loss carryforward is the net taxable loss that can be used to reduce taxable income in the future.


Question 49 -

Correct Answer Is B-sporadic in nature, and the analyst should try to identify the termination date and determine if taxes will be payable at that time.

As the name suggests, a tax holiday is usually a temporary exemption from having to pay taxes in some tax jurisdiction. Because of the temporary nature, the key issue for the analyst is to determine when the holiday will terminate, and how the termination will affect taxes payable in the future.

This question tested from Session 9, Reading 31, LOS i.

Question 50 -

Correct Answer Is B-Capitalizing costs creates higher cash flows from operations and lower cash flows from investing.

Although net cash flows are not affected by the choice of capitalization or expensing, the components of cash flow are affected. Because, a firm that capitalizes classifies the expenditure as investing (not operations), cash flow from operations will be higher for firms that capitalize and investing cash flows will be lower than that of an expensing firm.


Question 51 -


The inventory turnover ratio is cost of sales / average inventory. Compared to FIFO, LIFO results in higher cost of sales and lower average inventory when prices are increasing, and therefore results in a

higher inventory turnover ratio. Because cost of sales is higher with LIFO, gross profit margin is lower. The quick ratio is unaffected by the inventory cost assumption.

This question tested from Session 9, Reading 29, LOS h.

Question 52 -


For a lease to be classified as a finance (capital) lease the present value of the lease payments must be at least 90% of the fair market value of the asset.


Question 53 -

Correct Answer Is B-leverage.

Finance (capital) leases are recorded on the balance sheet, and by recording all leases as operating leases, the company can reduce its leverage. Lease accounting has no effect on inventory. "Expenses" is not the best answer as operating leases will result in higher expenses in the later years relative to the finance (capital) lease.


Question 54 -

Correct Answer is C- Goodwill and intangible assets.

Price to tangible book value is calculated by removing goodwill and intangible assets from equity. This adjustment reduces assets and equity and produces a ratio that is not affected by differences in intangible asset values that may result from how the assets were acquired.


Question 55 -

Correct Answer Is B-adding the LIFO reserve.

LIFO ending inventory can be adjusted to a FIFO basis by adding the LIFO reserve, which a firm using LIFO must disclose in the notes to its financial statements.


Question 56 -

Correct Answer Is B-only one is correct.

Margin stability is desirable from the lender’s perspective for both floating-rate and fixed-rate debt. Higher volatility will increase credit risk. Product and geographic diversification should lower credit risk as the borrower is less sensitive to adverse events and conditions.

This question tested from Session 10, Reading 35, LOS c.

Question 57 -

Correct Answer Is B-$30 million.

2008 sales are expected to be $600 million ($500 million 2007 sales × 1.2) and 20X8 net income is expected to be $30 million ($600 million 20X8 sales × 5%). 2008 non-cash operating working capital is expected to be $120 million ($600 million 20X8 sales × 20%). The change in cash is expected to be â€―$5 million ($30 million 20X8 net income + $60 million 20X8 depreciation $20 million increase in non-cash operating working capital $75 million 20X8 capital expenditures). The 20X8 ending balance of cash is expected to be $30 million ($35 million beginning cash balance $5 million decrease in cash).


Question 58 -

Correct Answer Is B-overstate earnings.

Overstating the salvage value reduces depreciation expense, which in turn increases earnings.


Question 59 -


Value stocks are considered to be those that have low prices relative to earnings (or relative to sales, cash flow, or book value). Screens that exclude firms with low earnings growth rates or high dividend payout ratios are more likely to be used to identify growth stocks.


Question 60 -


Although there is little empirical evidence to support the contention, there is nevertheless a widespread belief in financial circles that an optimal price range exists for stocks. â€œOptimalâ€• means that if the price is within this range, the price/earnings ratio, price/sales and other relevant ratios will be maximized. Hence, the value of the firm will be maximized.


Question 61 -


$5,513 $32,872

In order to determine the discount rate, we need to calculate the WACC.

After-tax cost of debt = 9.0% (1 0.40) = 5.40% Cost of equity = ($1.50 / $32.00) + 0.05 = 0.0469 + 0.05 = 0.0969, or 9.69% WACC = 0.70(9.69%) + 0.30(5.40%) = 8.40%

Since the project is financed with 70% newly issued equity, the amount of equity capital raised is 0.70 Ã— $175,000 = $122,500

Flotation costs are 4.5 percent, which equates to a dollar flotation cost of $122,500 Ã— 0.045 = $5,512.50.

This question tested from Session 11, Reading 37, LOS l.

Question 62 -

Correct Answer Is B-the interest on debt is tax deductible.

Equity and preferred stock are not adjusted for taxes because dividends are not deductible for corporate taxes. Only interest expense is deductible for corporate taxes.


Question 63 -


The number of IRRs equals the number of changes in the sign of the cash flow. In this case, from negative to positive and then back to negative. Although 38% seems appropriate, one should not automatically discount the value of 260%.

Check answers by calculation:

10,000 Ã· 1.38 - 10,000 Ã· 1.382 = 1995.38

And:

10,000 Ã· 3.6 - 10,000 Ã· 3.62 = 2006.17

Both discount rates give NPVs of approximately zero and thus, are IRRs.


Question 64 -


Pretax cost of debt: N = 20; FV = 1000; PV = −894; PMT = 60; CPT → I/Y = 7%

After-tax cost of debt: kd = (7%)(1−0.4) = 4.2%


Question 65 -

Correct Answer is C- Disgruntled stockholders are forced to sell their shares, improving management's position.

A repurchase gives stockholders a choice. They can sell or not sell. Stock repurchase is also more tax-efficient as only those shareholders that choose to sell their shares would potentially have a tax liability.


Question 66 -


The key to finding the optimal capital structure is identifying the level of debt that will maximize firm value. Earnings and earnings per share are not critical in and of themselves when assessing firm value, because they do not consider risk.


Question 67 -


The firm’s average days of receivables should be close to the industry average. A significantly lower average days receivables outstanding, compared to its peers, is an indication that the firm’s credit policy may be too strict and that sales are being lost to peers because of this. We can not assume that stricter credit controls than the average for the industry are â€œbetter.â€• We cannot conclude that credit sales are less, they may be more, but just made on stricter terms. The average days of receivables are only one component of the cash conversion cycle.


Question 68 -

Correct Answer Is B-business risk.

Business risk is the uncertainty regarding the operating income of a company. Financial risk refers to the uncertainty caused by the fixed cost associated with borrowed money.


Question 69 -

Correct Answer is C- 4.3%.

CRP = Sovereign Yield Spread(Annualized standard deviation of equity index ÷ Annualized standard deviation of sovereign bond market in terms of the developed market currency)

= (0.072 0.046)(0.40/0.24) = 0.043, or 4.3%.

This question tested from Session 11, Reading 37, LOS j.

Question 70 -

Correct Answer is C- one should accept all independent projects with positive NPVs.

Where the NPV intersects the vertical y-axis you have the value of the cash inflows less the cash outflows, assuming an absence of money having a time value (i.e., the discount rate is zero). Where the NPV intersects the horizontal x-axis you have the project’s internal rate of return. At this cost of financing, the cash inflows and cash outflows offset each other. The NPV profile is a tool that graphically plots the project’s NPV as calculated using different discount rates. Assuming an appropriate discount rate, one should accept all projects with positive net present values, if the projects are independent. If projects are mutually exclusive select the one with the higher NPV at any given level of the cost of capital.


Question 71 -


A break point refers to a level of new investment at which a component’s cost of capital changes. The formula for break point is:

As indicated, as the weight of a capital component in the capital structure increases, the break point at which a change in the component’s cost will decline. No computation is necessary, but when Hardcastle has 40% debt, the breakpoint is $600,000,000 / 0.4 = $1.5 billion. If Hardcastle’s debt increases to 50%, the breakpoint will decline to $600,000,000 / 0.5 = $1.2 billion.

This question tested from Session 11, Reading 37, LOS k.

Question 72 –

Correct Answer is C- increases default risk and increases potential return on equity.

Issuing debt introduces default risk. The interest expense associated with using debt represents a fixed cost that reduces net income. However, compared to financing entirely with equity, the lower net income is spread over a smaller base of shareholders’ equity. This financing structure increases the potential return on equity.


Question 73 -

Correct Answer Is B-earnings per share variability.

Financial leverage results in the existence of required interest payments and, hence, increased earnings per share variability. Higher debt ratios, given a fixed asset base, result in a greater earnings per share variability. Operating income is based on the products and assets of the firm and not on the firm ’s financing and, hence, has no impact on financial leverage. Greater financial leverage is likely to reduce taxes due to the tax deductibility of interest payments.


Question 74 -

Correct Answer is C- The internal rate of return and net present value methods can yield different accept/reject decisions for independent projects.

For independent projects the IRR and NPV give the same accept/reject decision. For mutually exclusive projects the IRR and NPV techniques can yield different accept/reject decisions.


Question 75 -

Correct Answer is C- an increase in financial leverage ratios.

A cash dividend will increase leverage ratios such as debt-to-equity and debt-to-assets, reflecting a decrease in the denominator. A cash dividend should decrease liquidity ratios such as the current ratio and cash ratio, due to the decrease in cash in the numerator. Unlike a cash dividend, a stock dividend or a stock split has no impact on liquidity or financial leverage ratios.


Question 76 -

Correct Answer is C- financial risk.

When a company finances its operations with fixed cost financing (debt), it takes on fixed expenses in the form of interest payments. The greater the proportion of debt in a firm’s capital structure, the greater the firm’s financial risk.

Business risk refers to the risk associated with a firm’s operating income. Operating risk refers to the additional uncertainty about operating earnings caused by fixed operating costs.


Question 77 -

Correct Answer Is B-inventories, which are not necessarily liquid.

The quick ratio is usually defined as (current assets inventory) / current liabilities. It is a more restrictive measure of liquidity than the current ratio, which equals current assets / current liabilities. The numerator of the quick ratio includes cash, receivables, and short-term marketable securities.


Question 78 -

Correct Answer Is B-stock dividend

Stock dividends are dividends paid out in new shares of stock instead of cash. Unlike stock dividends, dividend reinvestment plans are at the discretion of individual shareholders. In the case of stock repurchases, the company is buying back shares so the number of shares in the investment public’s hands is declining.


Question 79 -

Correct Answer is C- a list of permissible securities.

An investment policy statement typically begins with a statement of the purpose and objective of the investment portfolio, some general guidelines about the strategy to be employed to achieve those objectives, and the types of securities that will be used. A list of permitted securities for investment would be limited and likely too restrictive. A list of permitted security types is appropriate and can provide the necessary flexibility to increase yield within the safety and liquidity constraints appropriate for the firm.


Question 80 -

Correct Answer Is B-Super-voting rights by certain classes of shareholders impair the firm’s ability to raise capital for the future.

Firms with dual classes of common equity could encourage prospective acquirers to only deal directly with shareholders with the supermajority rights. If the firm has a significant minority ownership group, such as a founding family, use of cumulative voting to elect board members can favor specific interests at the expense of the interests of other shareholders.


Question 81 -

Correct Answer is C- For mutually exclusive projects you should use the IRR to rank and select projects.

For mutually exclusive projects you should use NPV to rank and select projects.


Question 82 -

Correct Answer is C- Same effect.

Assuming the tax treatment of the two alternatives is the same, a share repurchase has the same impact on shareholder wealth as a cash dividend payment of an equal amount. Because shares are repurchased using a company’s own cash, a share repurchase can be considered an alternative to a cash dividend as a way of distributing earnings to shareholders.


Question 83 -


Correct Correct

Each statement that Haggerty has made to the board of directors regarding the weighted average cost of capital is correct. New projects should have a return that is higher than the cost to finance those projects.


Question 84 -

Correct Answer Is B-The tradeoff between fixed and variable costs.

Operating leverage can be defined as the trade off between variable and fixed costs.


Question 85

Correct Answer Is B-Both will rise.

A higher breakeven point resulting from increased interest costs associated with debt financing increases the risk of the company. Since the risk is tied to firm financing, it is referred to as financial risk. Given the positive risk-return relationship, the expected return of the company’s common stock also rises.


Question 86


BEY = HPY Ã— (365/days)

BEY = 0.80% Ã— (365/30) = 9.73%


Question 87 -

Correct Answer Is B-captured in the project’s required rate of return.

Financing costs are reflected in a project’s required rate of return. Project specific financing costs should not be included as project cash flows. The firm's overall weighted average cost of capital, adjusted for project risk, should be used to discount expected project cash flows.


Question 88 -

Correct Answer is C- The audit committee has authority over the procedures used to audit the entire corporate group including subsidiaries and affiliates.

The independent auditor has authority over the audit procedures. The audit committee is responsible for hiring and supervising the independent auditor.


Question 89 -

Correct Answer is C- Regulatory projects.

Mandatory regulatory or environmental projects may be required by a governmental agency or insurance company and typically involve safety-related or environmental concerns. The projects typically generate little to no revenue, but they accompany other new revenue producing projects and are accepted by the company in order to continue operating.


Question 90 -

Correct Answer is C- $280,913.

The key to this problem is identifying this as a NPV problem even though the first cash flow will not occur until the following year. Next, the year of each cash flow must be property identified; specifically: CF0 =

$0; CF1 = -430,000; CF2-8 = +$200,000; CF9 = -$170,000. One simply has to discount all of the cash flows to today at a 16% rate. NPV = $280,913.


Question 91 -

Correct Answer Is B-buying and holding a broad market portfolio is the preferred investment strategy.

If financial markets are informationally efficient, active investment strategies cannot consistently achieve risk-adjusted returns superior to holding a passively managed index portfolio. In addition, a passive investment strategy has lower transactions costs than an active management strategy. Share prices should not adjust when a company announces results in line with expectations in an informationally efficient market, because the market price already reflects the expected results.


Question 92 -

Correct Answer is C- Spend more time working on security selection.

In an efficient market all stocks are properly priced and reflect all publicly available information. Therefore, individual selection of stocks is not important the only thing that is relevant is the portfolio’s beta.


Question 93 -


26 * (1 - 0.5)/(1 - 0.25) = $17.33.


Question 94 -


An efficient capital market fully reflects all of the information currently available about a given security, including risk.


Question 95 -

Correct Answer Is B-market value.

The current price of a traded asset is its market value. An asset’s intrinsic or fundamental value is the price a rational investor with complete information about the asset would pay for it.


Question 96 – Correct Answer is C- standardized terms.

Futures are forward contracts that trade on exchanges and have standardized terms, in contrast with forward contracts, which are customized instruments. A futures clearinghouse reduces counterparty risk by guaranteeing the performance of buyers and sellers. Futures contracts trade on organized exchanges and are more liquid than forward contracts.


Question 97 -

Correct Answer is C- target market.

The first decision that must be made is choosing the target market the index will represent. Only then can the index provider determine which constituent securities should be included and which weighting scheme is most appropriate to measure the target market’s returns.


Question 98 -

Correct Answer is C- The weak-form EMH suggests that fundamental analysis will not provide excess returns while the semi-strong form suggests that technical analysis cannot achieve excess returns.

The weak-form EMH suggests that technical analysis will not provide excess returns while the semi-strong form suggests that fundamental analysis cannot achieve excess returns. The weak-form EMH assumes the price of a security reflects all currently available historical information. Thus, the past price and volume of trading has no relationship with the future, hence technical analysis is not useful in achieving superior returns.

The other choices are correct. The strong-form EMH states that stock prices reflect all types of information: market, non-public market, and private. No group has monopolistic access to relevant information; thus no group can achieve excess returns. For these assumptions to hold, the strong-form assumes perfect markets information is free and available to all.


Question 99 -

Correct Answer Is B-Hedge funds.

Most hedge fund indexes are equal-weighted. Equity and fixed income indexes are predominately market capitalization weighted.


Question 100 -


Capital will flow to its most valuable uses if markets function well and investors are well informed about the risk and return characteristics of various investments. Allocation of capital to its most valuable uses does not require that all investors have complete information or that financial markets are frictionless.


Question 101 -

Correct Answer Is B-order-driven market.

In an order-driven market, buy orders and sell orders are matched up by the exchange according to order matching rules. In a quote-driven market, customers trade with dealers at bid and ask prices set by the dealers. In a brokered market, brokers organize trades among their clients.


Question 102 -


This is the definition of the strong-form EMH. Private sources include insider information, such as persons holding monopolistic access to information relevant to the formation of prices.


Question 103 -

Correct Answer is C- Low returns over a three-year period are followed by high returns over the following three years.

The overreaction effect refers to stocks with poor returns over three to five-year periods that had higher subsequent performance than stocks with high returns in the prior period. The result is attributed to overreaction in stock prices that reverses over longer periods of time. Stocks with high previous short-term returns that have high subsequent returns show a momentum effect.


Question 104 -

Correct Answer Is B-Primary capital markets relate to the sale of new issues of bonds, preferred, and common stock, while secondary capital markets are where securities trade after their initial offering.

Bonds and stocks are traded on both the primary and secondary markets.

This question tested from Session 13, Reading 46, LOS i.

Question 105 -

Correct Answer Is B-

minimum amount of equity required of the investor

a deposit must be made to bring the margin back to the maintenance margin

The initial margin requirement refers to the minimum amount of equity required of the investor.

With equities, if the margin falls below the maintenance margin, funds must be deposited to bring it back up to the maintenance margin level.


Question 106 -

Correct Answer Is B-Underweight the industry.

A cyclical industry is one that is expected to outperform during an expansion and underperform in a contraction. The industry rotation strategy for a cyclical industry is to overweight during an expansion and underweight during a contraction.


Question 107 -

Correct Answer is C- 10.000.

The price/sales ratio is (price per share)/(sales per share) = (40)/(4,000/1,000) = 10.0. Alternatively, the price/sales ratio may be thought of as the market value of the company divided by its sales, or (40 × 1,000)/4,000, or 10.0 again.


Question 108 -

Correct Answer Is B-is being liquidated.

Asset-based valuation models are appropriate for a firm that is being liquidated because when a firm ceases to operate as a going concern, its value to equity owners depends on the difference between the fair value of its assets and liabilities. Asset-based models are unlikely to be reliable for estimating the value of firms that have significant intangible assets because fair values of such assets are often difficult to determine. Such a firm may or may not have cyclical earnings.


Question 109 -


$2(1.06)/0.14 - 0.06 = $26.50.

This calculation is an example of the Gordon Growth Model also known as the constant growth model.


Question 110 -

Correct Answer is C- receive extra dividends if firm profits exceed a predetermined threshold.

Participating preference shares receive extra dividends if firm profits exceed a predetermined threshold. Convertible preference shares can be exchanged for common stock at a conversion ratio determined at issuance. Putable common shares give the shareholder the right to sell the shares back to the firm at a specific price.


Question 111 -


g = ROE × retention ratio = ROE × b = 15 × 0.4 = 6%

Based on the growth rate we can calculate the expected price in year 3:

P3 = D4 / (k − g) = 2.2 / (0.10 − 0.06) = $55

The stock value today is: P0 = PV (55) at 10% for 3 periods = $41.32


Question 112 -

Correct Answer Is B-Computech's stock is currently worth $17.46.

The dividends for years 1, 2, and 3 are expected to be ($1.62)(1.12) = $1.81; ($1.81)(1.12) = $2.03; and ($2.03)(1.12) = $2.27. At the end of year 2, the stock should sell for $2.27 / (0.15 0.04) = $20.64. The stock should sell currently for ($20.64 + $2.03) / (1.15)

2 + ($1.81) / (1.15) = $18.71.


Question 113 -

Correct Answer is C- Mature.

The mature stage exhibits little or no growth, industry consolidation, and high barriers to entry. Kidwell has noted that the industry is growing, but slowly (replacement demand and population gains). Furthermore, the firms have efficient cost structures and strong brand loyalty; both of which are high barriers to entry.

The decline stage exhibits negative growth, excess capacity, and high competition. Kidwell has observed positive, slow growth and a lack of price wars. Both of these observations are contrary to what would be expected in the decline stage.

The shakeout stage exhibits slowing growth, intense competition, and declining profitability. Kidwell has observed that growth is stable, the firms have achieved efficient cost structures, and price wars are uncommon. Hence, growth is not slowing, competition must not be intense because there are price wars (these occur when competition is intense), and profitability is likely stable given the efficient cost structures.


Question 114 -

Correct Answer is C- A stock with a dividend last year of $3.25 per share, an expected dividend growth rate of 3.5%, and a required return of 12.5% is estimated to be worth $36.11.

A stock with a dividend last year of $3.25 per share, an expected dividend growth rate of 3.5%, and a required return of 12.5% is estimated to be worth $37.33Â using the DDM where Po = D1 / (k − g). We are given Do = $3.25, g = 3.5%, and k = 12.5%. What we need to find is D1 which equals Do Ã— (1 + g) therefore D1 = $3.25 Ã— 1.035 = $3.36 thus Po = 3.36 / (0.125 − 0.035) = $37.33.

In the answer choice where the stock value is $18.70, discounting the future cash flows back to the present gives the present value of the stock. the future cash flows are the dividend in year 1 plus the dividend and value of the stock in year 2 thus the equation becomes: Vo = 2.2 / 1.15 + (2.2 + 20) / 1.15

2 =

$18.70

For the answer choice where the stock value is $31.13 use the DDM which is Po = D1 / (k − g). We are given k = 0.08, g = 0.04, and what we need to find is next year’s dividend or D1. D1 = Expected earnings Ã— payout ratio = $4.15 Ã— 0.3 = $1.245 thus Po = $1.245 / (0.08 − 0.04) = $31.13


Question 115


g = (RR)(ROE)

= (0.15)(0.40)

= 0.06 or 6%


Question 116 -


The current stock price is equal to (D1 + P1) / (1 + ke). D1 equals $6.10(1.04) = $6.34. The equity discount rate is 3% + 12% = 15%. Therefore the current stock price is ($6.34 + $60)/(1.15) = $57.70


Question 117 -


Low capacity is associated with pricing power because it increases the likelihood that supply in the short run will be less than demand at current prices. Low barriers to entry and low industry concentration (a fragmented market) typically suggest firms have little pricing power.


Question 118 -

Correct Answer is C- $90.91.

Preferred stock yield (Kp) = bond yield 0.75% = 6.25% − 0.75% = 5.5%

Value = dividend / Kp = $5 / 0.055 = $90.91.


Question 119 -

Correct Answer Is B-free cash flow to equity model.

Free cash flow to equity represents a firm’s capacity to pay future dividends. A free cash flow to equity model estimates the firm’s FCFE for future periods and values the stock as the present value of the firm’s future FCFE per share.


Question 120 -

Correct Answer Is B-P/S ratios do not express differences in cost structures across companies.

P/S ratios do not express differences in cost structures across companies. Both remaining responses are advantages of the P/S ratios, not disadvantages.

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