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					                              Sample Exam 5
                             Morning Session
    Questions I through 18 relate to Ethical and Professional
Standard and are allocated 27 minutes.
    1. Paul, CFA, heads the research department of a large brokerage
firm. Paul has supervisory responsibility over 25 analysts. If Paul
delegates some supervisory duties, which statement best describes his
responsibilities based on the Standards of Professional Conduct?
    A. Paul is not responsible for those duties he has delegated to
his subordinates.
    B. Paul's supervisory responsibilities only apply to analysts
with the CFA designation.
    C. Paul retains supervisory responsibility for all subordinates
despite his delegation of some duties.
    2. Alen Bishop earned the fight to use the CFA designation in
September 1968. Alen recently retired from the investment management
profession. As he is retired, Alen no longer attends CFA Institute
society meetings and has stopped paying his CFA Institute dues.
According to the Standards of Practice Handbook, how should Alen
refer to his affiliation with the CFA Program?
    A. Alen Bishop, CFA.
    B. Aien Bishop, CFA (retired).
    C. "I was awarded the CFA charter in 1968."
    3. According to the Standards of Practice Handbook, which of the
following statements about fair dealing is least accurate? The
Standard relating to fair dealing:
    A. states that members should treat all clients equally.
    B. pertains to both investment recommendations and investment
actions.
    C. imposes a duty with respect to both clients and prospective
clients.
    4. Doroth Kelly, a investment advisor, enrolled to take the Level
m CFA examination in 2004; however, he did not take the exam. When
her employer asked her about her status in the CFA program, Kelly
advised her employer that she was confident that she passed Level Ⅲ
and would become the CFA charter holder soon. Did Kelly violate the
CFA Institute's Standards of Professional Conduct relating to
professional misconduct and duty to employer, respectively?
    Professional misconduct duty to employer
    A. No No
    B. No Yes
    C. Yes No
    5. The Standards of Practice Handbook is least likely to require
a member of member's firm to disclose which of the following to
clients and prospective clients?
    A. Underwriting relationships.
    B. Market-making activities.
    C. Obligation to abide by CFA Institute Code of Ethics and
Standards of Professional Conduct.
    6. Heidi Krueger, CFA, has discretionary authority over the
accounts of Johnson, for whom she manages a portfolio of energy
stocks, and Osaki, for whom she manages a diversified portfolio of
domestic and international stocks. Krueger always seeks the best
price and execution and has disclosed to all of her clients the
process she follows to make use of soft dollars and apply them for
the benefit of her clients. In the year 2004, Krueger applied soft
dollars generated from the Johnson and Osaki accounts to purchase a
report on the economic impact of world events, to purchase an
analysis of the domestic steel industry, and to purchase a new
conference table for her office. Krueger was in compliance with the
Code and Standards in the year 2004:
    A. only if she had not used soft dollars to pay for the
conference table.
    B. only if she had not used soft dollars to pay for the
conference table and had not used soft dollars from the trading of
Johnson's account to pay for the report on the domestic steel
industry.
    C. because she disclosed her use of soft dollars and applied them
for the direct and indirect benefit of her clients.
    7. Whenever an investment management firm presents investment
performance is compliance with the Global Investment Performance
Standards (GIPS), it must start how it defines itself as a firm.
Under GIPS, a firm may define itself for the purpose of claiming GIPS
compliance using any of the following options EXCEPT when:
    A. an entity is registered with the appropriate national
regulatory authority overseeing the entity's investment management
activities.
    B. all assets are managed to one or more base currencies.
    C. the subsidiary or division of a company claims GIPS compliance
when the parent company is GIPS compliant.
    8. Bill Kimm, CFA owns an asset management firm with offices
downtown. To minimize rent expenses, each year Bill ships the
previous year's research records to a nearby warehouse. There, the
reports are digitized and stored in both electronic and hard-copy
forms. After five years, all paper copies are destroyed and only
electronic copies are retained. Are Bill's record-retention
procedures in compliance with the CFA Institute Standards of Practice?
    A. Yes.
    B. No, because he did not retain the copies in his offices.
    C. No, because he failed to retain the original documents.
    9. Sean Dahib, CFA, is in charge of the compliance program at his
investment firm. According to the Standards of Practice Handbook, as
a supervisor, Sean should least likely perform which of the following
activities?
    A. Respond promptly to all violations.
    B. Disseminate the contents of the program to all personnel.
    C. Periodically update the procedures to ensure that the measures
are adequate under the law.
    10. Karen Wilson, CFA, supervises eight junior analysts at
Spartan Financial Services. Karen suspects that one of the analysts
is violating Spartan's personal investing policy. According to the
Standards of Practice Handbook, Karen's most appropriate initial
action is to.
    A. Initiate an investigation.
    B. Notify her supervisor of the analyst's suspected misconduct.
    C. Require the analyst to liquidate and close all personal
accounts.
    11. Fred Funk, CFA, agreed in writing with his former employer
not to solicit former clients for a period of one year after his
termination. After he left his former employer, he consulted with a
lawyer about whether the agreement was legally enforceable. The
lawyer advised Fred that it was doubtful that the agreement could be
enforced, so Fred sent a marketing brochure about his new firm to his
former clients. According to the Standards of Practice Handbook,
which of the following Statements is most accurate with respect to
Fred's conduct?
    A. The standards do not apply to Fred's conduct.
    B. The Standards requires Fred to comply with the agreement with
his former employer.
    C. Because Fred relied upon the opinion of legal counsel, he did
not violate the Standards.
    12. Scott LaRue is a portfolio manager for Washington Advisors.
Washington has developed a proprietary model that has been thoroughly
researched and is known throughout the industry as the Washington
model. The model is purely quantitative and screens stocks into buy,
hold, and sell categories. The basic philosophy of the model is
thoroughly explained to clients. The director of research frequently
alters the model based on rigorous research-an aspect that is well
explained to clients, although the specific alterations are not
continually disclosed. Portfolio managers then make specific sector
and security holding decisions, purchasing only securities that are
indicated as "buys" by the model. LaRue has conducted some research
on his own and feels the model would be improved by adding some
factors. Based on his research, he applied his own version of the
model, which is occasionally in conflict with the Washington model.
LaRue discloses his model to his own clients but not to his
supervisor. LaRue is:
    A. violating the Standards by not considering the appropriateness
of the recommendations to clients.
    B. violating the Standards by not being objective.
    C. violating the Standards by not having a reasonable and
adequate basis for his investment recommendation.
    13. William Wong, CFA, is an equity analyst with Hayswick
Securities. Based on his fundamental analysis, Wong concludes that
the stock of a company he follows, Nolvec Inc., is substantially
undervalued and will experience a large price increase. He delays
revising his recommendation on the stock from "bold" to "buy" to
allow his professional conduct that relate to:
    A. Duty to clients. B. Reasonable basis. C. Duty to his employer.
    14. Win Jang is his firm' s research director, and as one of his
regular duties distributes a monthly "Top 10 Buys and Sells" list
drawn from companies listed in Hong Kong. One month, Jang reads an
academic research paper detailing a screening algorithm (based on
companies earnings, depreciation, interest expense, and current stock
price) that was used to generate abnormal profits in the German stock
market. Jang applies the algorithm, without making any changes, to
Hong Kong stocks, and uses the results to form the month's buy and
sell list. Jang has
    A. properly relied on another party's research.
    B. failed to have a reasonable basis for his investment
recommendations, due to' differences in the German and Hong Kong
markets.
    C. failed to have a reasonable basis for his investment
recommendations, due to the reliance on a quantitative model.
    15. According to the Standards of Practice Handbook, members must
make a reasonable inquiry into a client's financial situation, and
must do all of the following EXCEPT:
    A. consider the suitability of investment recommendations for the
client.
    B. distinguish between fact and opinion when making
recommendations.
    C. update information on the client' s situation at least semi-
annually.
    16. According to the Global Investment Performance Standards
(GIPS)
    A. composites must include new portfolios as soon as they come
under management.
    B. Firms may not set minimum asset levels for portfolios to be
included in a composite.
    C. Composites must be defined according to similar investment
objectives and/or strategies.
    17. Judy Albert and Bob Tye, who recently started their own
investment advisory business, plan to take the Level m CFA
examination next year. Albert's business card reads, "Judy Albert,
CFA Candidate." Tye has not put anything about the CFA on his
business card. However, the firm's promotional materials describe the
CFA requirements and indicate that Tye participates in the CFA
program and has completed Levels I and Ⅱ. According to CFA Institute
Standards of Professional Conduct:
    A. Tye has violated the Standards, but Albert has not.
    B. Albert has violated the Standards but Tye has not.
    C. Both Albert and Tye have violated the Standards.
    18. Victor Marginn, CFA, is a highly regarded portfolio manager
for Atlantic Advisors(AA), a midsized mutual fund firm. He has
watched the hedge fund boom and on numerous occasions pushed his firm
to create such a fund. Senior management has refused to commit
resources to the area. Frustrated by the inaction, and attracted by
the higher fees associated with hedge funds, Victor and several other
employees organize a hedge fund in the non-work hours. Victor is
careful to work on the fund only on her own time. Because AA
management thinks that hedge funds are a fad, he does not inform his
supervisor about the hedge fund. According to the Standards of
Practice Handbook, Victor least likely violated the Standard relating
to:
    A. loyalty. B. disclosure of conflicts. C. priority of
transactions.
    Questions 19 through 32 relate to Quantitative Methods and are
allocated 21 minutes.
    19. An individual borrows $200000 to buy a house with a 30-year
mortgage requiring payments to be made at the end of each month. The
interest rate is 8 percent, compounded monthly. What is the monthly
mortgage payment?
    A. $ 1480.46. B. $ 1467.53. C. $ 2142. 39.
    20. A recent ad for a Roth IRA includes the statement that if a
person invests $ 500 at the beginning of each month for 35 years,
they could have $1000000 for retirement. Assuming monthly compounding,
what annual interest rate is implied in this statement?
    A. 6. 988%. B. 7.411%. C. 7.625%.
    21. Which of the following statements about dependent and
independent events is TRUE?
    A. Two events are independent if the occurrence of one is related
to the probability of occurrence of the other.
    B. The multiplication rule for probabilities applies only to two
independent events.
    C. None of the above.
    22. Given that the variance is 289 for a random sample of 500
stocks. Find out the standard error of the sample mean is closest to:
    A.0.67. B. 0.76. C. 0.99.
    23. For a binomial random variable B(n=12, p=0.5), find out the
mean and variance.
    Mean Variance
    A. 6 3
    B. 7 3.5
    C. 8 4
    24. Jo Su believes that there should be a negative relation
between returns and systematic risk. She intends to collect data on
returns and systematic risk to test this theory. What is the
appropriate alternative hypothesis?
    A. Ha:ρ<0. B. Ha:ρ>0. C. Ha:ρ=0.
    25. The minimum proportion of observations falling within 2
standard deviations of the mean is closest to:
    A. 95%. B. 75%. C. 68%.
    26. A distribution with a mean of 15 and a range of 2 to 25 would
be:
    A. normally distributed.
    B. positively skewed to the right.
    C. cannot be determine.
    27. Which of the following statement about the following
frequency distribution is FALSE?
       Return
                      Frequency
    Interval
     0% to 5%            20
    >5% to 10%           10
    >10% to 15%          20
    >15% to 20%          30

   A. The cumulative absolute frequency of the third interval is 50.
   B. The cumulative absolute frequency of the fourth interval is 30.
   C. The return internals are mutually exclusive.
    28. There is a bond portfolio return of 10% and estimates a
standard deviation of annual returns of 4%. Assuming normality
assumptions for returns, which of the following statement is FALSE?
    A. The 90 percent confidence interval will be from 3.10 percent
to 17.8 percent.
    B. The 95 percent confidence interval will be from 2.16 percent
to 17.84 percent.
    C. The 99 percent confidence interval will be from -0.32 percent
to 20. 32 percent.
    29. If a $45000 car loan is financed at 12 percent over 4 years,
what is the monthly car payment?
    A. $1565. B. $985. C. $1185.
    30. The effective annual yield for an investment is 10 percent.
What is the yield for this investment on a bond-equivalent basis?
    A. 10.00%. B. 9.76%. C. 9.96%.
    31. A stock priced at $ 20 has an 80 percent probability of
moving up and a 20 percent probability of moving down. If it moves up,
it increases by a factor of 1.05. If it moves down, it decreases by a
factor of 1/1.05. What is the expected stock price after two
successive periods?
    A. $ 20.05. B. $ 22.05. C. $ 21.24.
    32. The number of ships in the harbor is an example of what kind
of variable?
    A. Discrete. B. Indiscrete. C. Continuous.
    Questions 33 through 44 relate to Economies and are allocated 18
minutes.
    33. Which of the following is NOT a barrier to entry.?
    A. Government licensing and legal barriers.
    B. Few sellers.
    C. Resource control.
    34. Which of the following situations is least likely to lead to
high barriers to entry and monopoly supply?
    A. Natural resources are spread among many firms.
    B. Governmental licensing and regulations are present.
    C. Economies of scale are present.
    35. With respect to discretionary changes in fiscal policy, the
time period, between the recognition of the change and the time the
policy change is enacted is best described as the
    A. impact lag. B. recognition lag. C. administrative period.
    36. Which one of the following is NOT a characteristic of
monopolistic competition?
    A. Differentiated products. B. Elastic demand curves. C. A single
seller.
    37. If the price elasticity of demand for a good is 4.0, then a
10 percent increase in price would result in a:
    A. 4% decrease in the quantity demanded.
    B. 10% decrease in the quantity demanded.
    C. 40% decrease in the quantity demanded.
    38. If the number of widgets demanded changes from 51 to 49 when
the price changes from $4 to $ 6, the price elasticity of demand is:
    A. -0.10. B. -2.00. C. -1.00.
    39. An increase in interest rates can be expected to:
    A. decrease investment and increase net exports.
    B. increase government spending and decrease investment.
    C. decrease investment and decrease consumption.
    40. Compared to the short-run supply curve, the long-run supply
curve is:
    A. flatter.
    B. steeper sloping downward to the right.
    C. steeper sloping upward to the right.
    41. A technology that all of the firms in a perfectly competitive
industry are using in their production process has been banned by new
legislation. What will most likely be the effect if these firms stop
using this technology?
    A. The quantity that the industry will supply at a given price
will be reduced.
    B. Firms will adopt a different technology that reduces their
costs of production.
    C. The number of firms in the industry will increase market price.
    42. Thomas Moller is an economist for Econometrics Associates.
Moller's supervisor asks him to propose how to reduce the fiscal
imbalance. Moller contends that the fiscal imbalance can be reduced
by raising income taxes. Moller's colleague, Melissa Stephens,
contends that the fiscal imbalance can be reduced by cutting
government promised benefits.
    Regarding the statements by Moller and Stephens:
    Moller Stephens
    A. Correct Incorrect
    B. Incorrect Correct
    C. Correct Correct
    43. The increase in total revenue from selling the additional
output of one more unit of an input is called the input's:
    A. factor of production.
    B. marginal revenue.
    C. marginal revenue product.
    44. At low wage rates, will an increase in the wage rate most
liken result in:
    The substitution effect? An increase in the supply of labor?
    A. Yes No
    B. Yes Yes
    C. No No
    Questions 45 through 78 relate to Financial Statement Analysis
and Corporate Finance and are allocated 51 minutes.
    45. Which of the following statements regarding footnotes to the
financial statements is FALSE?
    A. Footnotes provide information about assumptions and estimates
used by management.
    B. Footnotes may disclose what types of accounting methods are
being used.
    C. Some supplementary schedules are audited whereas footnotes are
not audited.
    46. Which of the following statements about the calculation of
earnings per share (EPS) is least accurate.?
    A. Other than for stock dividends and stock splits, shares issued
enter into the computation from the date of issuance.
    B. Shares issued after a stock split must be adjusted for the
split.
    C. Stock sold or issued in a purchase of assets is included from
the date of issuance.
    47. A company has 1000000 warrants outstanding at the beginning
of the year, each convertible into one share of stock with an
exercise price of $ 50. No new warrants were issued during the year.
The average stock price during the period was $60, and the year-end
stock price was $45. What adjustment for these warrants should be
made, under the treasury stock method, to the number of shares used
to calculate basic and diluted earnings per share (EPS)?
    Basic EPS Diluted EPS
    A. 0 166667
    B. 166667 200000
    C. 166667 166667
    48. Which one of the following is a change in an accounting
principle?
    A. A change from FIFO to LIFO.
    B. Recording a prior period adjustment.
    C. A change in the estimated service life of machinery.
    49. Which of the following statements about the component costs
of capital is least likely correct? The:
    A. cost of common equity is (expected dividend/stock price) plus
expected dividend growth.
    B. cost of common equity is the required rate of return on common
stock.
    C. cost of preferred stock is the preferred dividend divided by
the preferred' s par value.
    50. Assuming a project is in process, which of the following best
describes a difference between the percentage-of-completion method
versus the completed contract method for revenue recognition? The:
    A. completed contract method generates higher cash flows.
    B. percentage-of-completion method results in higher earnings
volatility.
    C. percentage-of-completion method generally results in higher
total assets.
    51. On January 1,2007, Sneed Corporation purchased machinery
costing $ 8 million with a salvage value of $1 million. For the year
ended 2007, Sneed recognized depreciation expense of $ 3.2 million
from the machinery using the double-declining-balance method. Should
the depreciation expense be reported as an operating component in the
income statement, and what is the estimated useful life of the
machinery?
    Operating expense Useful life
    A. No 5 years
    B. Yes 4 years
    C. Yes 5 years
    52. A company uses cash to pay off a short-term notes payable. If
the company's current ratio before the transaction is 2.0 times and
the quick ratio was 1.0 times, how would this transaction affect the
company's current, quick and debt ratios?
    Current ratio Quick ratio Debt-to-equity ratio
    A. Increase Increase Decrease
    B. Decrease Decrease Increase
    C. Increase Remain unchanged Decrease
    53. A increase in inventory over a period of time would be
considered:
    A. use of cash. B. adjusting entry. C. non-cash flow item.
    54. Which of the following is included in non-cash adjustments to
net income in the statement of cash flows?
    A. Prepaid items. B. Credit sales. C. Credit purchases.
    55. Financial information for Jefferson Corp. for the year ended
December 31st, was as follows:
                                 $ 30000
    Sales
                                  00
    Purchases                    1800000
    Inventory at Beginning        500000
    Inventory at Ending           800000
    Accounts Receivable at
                                  300000
Beginning
    Accounts Receivable at
                                 200000
Ending
    Other Operating Expenses
                                 400000
Paid

    Based upon this data and using the direct method, what was
Jefferson Corp.'s cash flow from operations (CFO) for the year ended
December 31st?
    A. $ 900000. B. $ 800000. C. $ 1100000.
    56. Determine the cash flow from financing given the following
table.
    Item                        Amount
    Cash payment of
                                  $30
dividends
    Sale of equipment             $10
    Net income                    $25
    Purchase of land              $15
    Increase in accounts
                                  $20
payable
    Sate of preferred
                                  $25
stock
    Increase in deferred
                                   $5
taxes
    Profit on sale of
                                  $15
equipment

    A. $15. B. -$15. C. -$5.
    57. AlcoBanc owns a piece of property that is under consideration
for a new bank branch. Which of the following is least likely a
relevant incremental cash flow in analyzing a capital budgeting
project? The:
    A. interest costs of a loan for the property purchase.
    B. business gained at other branches due to new customers at the
proposed site.
    C. loss of customers at alternative branches due to conducting
business at the proposed site.
    58. Which of the following accounting practices is most likely to
decrease reported earnings in the current period?
    A. Using the straight-line method of depreciating instead of an
accelerated method.
    B. Capitalizing advertising expenses rather than expensing them
in the current period.
    C. Using LIFO inventory cost methods during a period of rising
prices.
    59. An analyst notes the following about a company: Beginning
inventory was reported as $ 5000. Costs of goods sold was reported as
$ 8000. Ending inventory was $ 7000 (the analyst has physically
verified this amount). Which of the following statements about this
situation is most likely correct?
    A. Purchases must have been $ 8000.
    B. If the analyst discovered that beginning inventory was
understated by $ 2000 then earnings before taxes must have been
overstated by $ 2000.
    C. If the analyst discovered that beginning inventory was
overstated by $1000 then COGS must have been understated by $1000.
    60. Which of the following statements regarding firms that
capitalize versus expense costs is least accurate?
    A. Cash flow from financing is the same whether costs are
capitalized or expensed.
    B. Firms that capitalize costs initially have lower profitability
ratios compared to expensing firms.
    C. Costs of acquiring a trademark by purchasing it are
capitalized.
    61. A dance club purchased new sound equipment for $ 25352. It
will work for 5 years and has no salvage value. Their tax rate is 41
percent, and their annual revenues are constant at $14384. For
financial reporting, the straight-line depreciation method is used,
but for tax purposes depreciation is accelerated to 35 percent in
years 1 and 2 and 30 percent in Year 3. For purposes of this exercise
ignore all expenses other than depreciation. Assume that the tax rate
changes for years 4 and 5 from 41 percent to 31 percent. What will be
the deferred tax liability as of the end of year three?
    A. $3144. B. $2948. C. $1443.
    62. A company is considering the purchase of a copier that costs
$ 5000. Assume a cost of capital of 10 percent and the following cash
flow schedule:
    Year 1: $ 3000
    Year 2: $ 2000
    Year 3: $ 2000
    Determine the project's payback period and discounted payback
period.
    Payback Period Discounted Payback Period
    A. 2.0 years 1.6 years
    B. 2.4 years 2.4 years
    C. 2.0 years 2. 4 years
    63. Kruger Associates uses an accrual basis for financial
reporting purposes and cash basis for tax purposes. Cash collections
from customers are $ 476000, and accrued revenue is only $ 376000.
Assume expenses at 50 percent in both cases (i.e.$ 238000 on cash
basis and $188000 on accrual basis), and a tax rate of 34 percent.
What is the deferred tax asset or liability? A deferred tax:
    A. asset of $17000. B. asset of $ 48960. C. liability of $ 48960.
    64. A firm is most likely to structure a lease as an operating
lease rather than a capital lease, when it:
    A. has a high debt-to-equity ratio.
    B. is very profitable.
    C. does not have debt covenants.
    65. A firm has just signed an 8-year lease on a new machine.
    Fair value of the machine is $100000.
    Lease payments are $18000 per year, payable at the end of the
year.
    The machine has an estimated salvage value of $ 5000 at the end
of the lease term.
    The machine has a 10-year useful life.
    The firm's incremental borrowing cost is 8 percent.
    This lease should be classified as:
    A. operating. B. conventional. C. capital.
    66. If a firm uses the weighted average cost of capital (WACC) to
discount cash flows of higher than average risk projects, which one
of the following will most likely occur?
    A. Project NPVs will be understated.
    B. The overall risk of the firm' s investments will rise over
time.
    C. The WACC of the firm should fall over time.
    67. Eatan Inc. has a take-or-pay contract with SeaTac Inc. for
$1000000 per year for five years.
    Eatan also recently sold receivables of $ 500000. The present
value (PV) of Eatan's take-or-pay contract is $ 4000000 and the buyer
of the receivables has recourse to Eatan. Once an analyst has
adjusted Eatan's debt to equity ratio, earnings before interest and
taxes (EBIT), and assets for these two off-balance-sheet financing
arrangements, the changes are best described by:
    Debt-to-equity EBIT Assets
    A. Increase Decrease Increase by $ 4000000
    B. Increase Increase Increase by $ 4500000
    C. Decrease Decrease Increase by $ 5000000
    68. A company issues $10 million in 8% annual,5 -year bonds, when
the market rate is 8.25%.
    The initial balance sheet liability and liability one year from
the date of issue are closest to:
    Initial liability Liability one year later
    A. $ 9900837 $ 9884018
    B. $ 9900837 $ 9917656
    C. $ 10000000 $ 9975000
    69. Which of the following ratios would NOT measure liquidity?
    A. Quick Ratio.
    B. ROA.
    C. Cash Ratio.
    70. An analyst has gathered the following information about a
company:
                Balance Sheet
    Assets
    Cash                           100
    Accounts Receivable            750
    Marketable Securities          300
    Inventory                      850
    Property, Plant &
                                   900
Equip
    Accumulated
                                 (150)
Depreciation
    Total Assets                  2750

          Liabilities and Equity
    Accounts Payable                300
    Short-Term Debt                 130
    Long-Term Debt                  700
    Common Stock                   1000
    Retained Earnings               620
    Total Liab. and
                                   2750
Stockholder' s equity

             Income Statement
   Sales                        1500
   COGS                         1100
   Gross Profit                  400
   SG&A                          150
   Operating Profit              250
   Interest Expense               25
   Taxes                          75
   Net Income                    150
   Determine the current ratio and the cash ratio.
   Current Ratio     Cash Ratio
   A. 2.67              1.07
   B. 3.95              2.14
   C. 4.65              0.93
    71. If the inventory turnover ratio is 7, what is the average
number of days the inventory is in stock?
    A. 36 days.                       B. 52 days.
    C. 25 days.
    72. Over the past two years, a firm reported higher operating
cash flow as a result of securitizing its accounts receivable and
from increasing income tax benefits from employee stock options. The
tax benefits are solely the result of higher tax rates. Should an
analyst conclude that these two sources of operating cash flow are
sustainable?
    A. Both sources are sustainable.
    B. Neither source is sustainable.
    C. Only one of these sources is sustainable.
    73. An investor has obtained the following information about
Worldwide Industries, Inc.
     Net profit margin                       8.7%
     Total asset turnover               2.4 times
     Dividendpayout ratio                     35%
     Tax rate                                 35%
     Total sales                       $120 million
     Totalequity               40% of total assets
     Based on this information, Worldwide's ROE is closest to:
     A. 52.2%.                    B. 14.5%.                    C.
20.0%.
    74. Restless. corn has an 8% rate of interest on newly issued
bonds. The firm has a return on equity of 13.33% and a dividend
payout ratio of 40% ; the last dividend paid was $ 1.50, and the
firm's shares sell for $ 26. The stock's beta is 1.7, the expected
return on the market portfolio is 11%, and the risk-free rate of
interest is 6%. If the appropriate risk premium relative to the bond
yield is 5% for a dot-corn, estimate Restless. corn's cost of equity
capital using the bond yield plus risk premium (BY+RP), the dividend
discount model (DDM) and the capital asset pricing model (CAPM),
respectively. The firm is in a 35% marginal tax bracket.
    BY+RP DDM CAPM
    A. 10.2% 14.2% 24.7%
    B. 10.2% 11.4% 13.5%
    C. 13.0% 14.2% 14.5%
    75. Break points in a firm's marginal cost of capital schedule
are best interpreted as representing the:
    A. maximum amounts of debt, preferred stock, and common stock the
firm can issue.
    B. amounts of capital expenditure at which the company's weighted
average cost of capital increases.
    C. amounts of new securities a firm would need to issue to take
advantage of flotation cost discounts.
    76. Two projects being considered by a firm are mutually
exclusive and have the following projected cash flows:
                  Project A    Project B
       Year
                Cash Flow    Cash flow
         0          -$4.0          ?

        1           $3.0         $1.7

        2           $5.0         $3.2

        3           $2.0         $5.8

    The crossover rate of the two projects' NPV profiles is 9%. What
is the initial cash flow for Project B?
    A. -$4.22. B. -$4.51. C. +$4.51.
    77. Which of the following is least likely an important
requirement of good corporate governance?
    A. Members of the board should serve staggered, multiple-year
terms.
    B. A board should be composed of at least a majority of
independent board members.
    C. Board members should have appropriate experience and expertise
relevant to the company's business.
    78. Which of the following statements about the internal rate of
return (IRR) and net present value (NPV) is least accurate?
    A. The NPV method assumes that cash flows will be reinvested at
the cost of capital, while the IRR method assumes that they are
reinvested at the IRR.
    B. The IRR is the discount rate that equates the present value of
the cash inflows with the present value of the outflows.
    C. For mutually exclusive projects, if the NPV rankings and the
IRR rankings give conflicting signals, you should select the project
with the higher IRR.
    Questions 79 through 114 relate to Asset Valuation and are
allocated 54 minutes.
    79. All of the following are characteristics of a well
functioning securities market EXCEPT:
    A. Internal information efficiency which can lead to variable
transaction costs.
    B. It would provide liquidity (marketability, price continuity,
and depth).
    C. It would provide internal and external efficiency.
    80. In a perfectly efficient market, portfolio managers should do
all of the following EXCEPT:
    A. rebalance their portfolio when changes are necessary.
    B. diversify to eliminate systematic risk.
    C. quantify their risk and return needs within the bounds of the
client's liquidity, income, time horizon, legal, and regulatory
constraints.
    81. For a European call option X(strike price)=25 and a European
call option X=30 on the same stock with the same time to expiration,
it is true that, when the 30 call is at or in the money, the
strongest statement we can make is:
    A. the value of the 25 call is greater than or equal to the value
of the 30 call.
    B. the 30 call is worth at least as much as the 25 call.
    C. the value of the 25 call is greater than the value of the 30
call.
    82. Studies from which form(s) of the efficient market hypothesis
(EMH) provide evidence that security prices adjust so quickly to a
public announcement that it is not possible for investors to realize
significant abnormal returns after a public announcement has been
made?
    A. semistrong-form of the EMH.
    B. weak-form of the EMH.
    C. strong-form Of the EMH.
    83. An investor entered into a margin purchase transaction. He
purchased on margin 100 shares of stock priced at $ 60 per share. The
investor borrowed the maximum amount allowed by the initial margin
requirement of 50 percent, and the maintenance margin is 30 percent.
Under the requirement of margin purchase, the lowest price per share
at which the stock could sell before the investor would receive a
margin call is closest to:
    A. $30. B. $40. C. $43.
    84. A security market with price continuity is most accurately
characterized as a market in which:
    A. assets can be bought or sold quickly.
    B. an asset's price reflects all available information about the
asset.
    C. prices do not change much from one transaction to the next in
the absence of new information.
    85. Which of the following statement about indexes is true?
    A. The Nikkei-Dow Jones average is a price-weighted index of
stocks from the first tier of the Tokyo Stock Exchange.
    B. New York Stock Exchange Index is a price weighted index.
    C. The Value Line Composite Average is a price weighted index.
    86. A price-weighted series is composed of the following three
stocks:
                  Number of shares
     stock                               price
                   outstanding
       A              1000000            $ 10
       B              5000000            $ 20
       C              6000000            $ 60

    If stock C completes a two-for-one stock split, the value of the
index after the split will be closest to:
    A. 20. B. 30. C. 97.
    87. Which of the following statements concerning efficient
markets and anomalies is the least likely to be correct?
    A. Processing information has a cost and takes time, so some
market participants may be rewarded for performing fundamental
analysis if they act quickly.
    B. Strategy risk refers to the fact that the model used to adjust
for risk may not be correctly specified.
    C. The arbitrage required to exploit an anomaly may not be
riskless because there is no guarantee that the price will return to
fair value.
    88. An analyst gathered the following information about a
company's common stock.




    If markets are in equilibrium, the expected constant dividend
growth rate is closest to:
    A. 3.0%. B. 8.33%. C. 11.5%.
    89. Agamex. Inc, an established feedlot-supply company, has a
beta of 1.25, and a payout ratio of 70%. The risk-less rate is 4% and
the expected return on the market is9%. What is the appropriate
leading price-earnings ratio to be used in the valuation of this
company if an analyst expects a long-term dividend growth rate of 4%?
    A.4.80. B.6.22. C. 11.20.
    90. An analyst gathered the following information about a company:
   The value of a share of the company' s common stock is closest to:

    91. If a company can convince its suppliers to offer better terms
on their products leading to a higher profit margin, the return on
equity (ROE) will most likely:
    A. decrease and the stock price will increase.
    B. decrease and the stock price will decline.
    C. increase and the stock price will increase
    92. Which of the following statements regarding zero-coupon bonds
is TRUE?
    A. An investor who holds a zero-coupon bond until maturity will
receive a return equal to the bond's effective annual yield.
    B. An investor who holds a zero-coupon bond until maturity will
receive an annuity of coupon payments plus recovery of principal at
maturity.
    C. An investor who holds a zero-coupon bond until maturity will
receive an annuity of coupon payments.
    93. Which of the following statements regarding Treasury bond
futures is FALSE?
    A. Upon delivery, the long pays the short the futures price
divided by the conversion factor for the bond the short chooses to
deliver.
    B. The contract size is $100000 and they are a deliverable
contract.
    C. They are quoted in percent and 32nds of a percent of face
value.
    94. Assume a bond's quoted price is 105.22 and the accrued
interest is $3.54. The bond has a par value of $100. What is the
bond's clean price?
    A. $100.00. B. $103.54. C. $105.22.
    95. An investor is long in a 3×9 forward rate agreement based on
LIBOR. The investor will gain if expected:
    A. 180 -day LIBOR 90 days from flow increases.
    B. 180 -day LIBOR 90 days from now decreases.
    C. 90 -day LIBOR 180 days from now increases.
    96. Which of the following embedded options most likely benefits
the bondholder?
    A. Interest rate cap on a floating-rate bond.
    B. Accelerated sinking fund provision.
    C. Put provision at par on a bond that is trading at a premium.
    97. Tina Donaldson, CFA candidate, is studying yield volatility
and the value of putable bonds. She has the following information: a
putable bond with a put option value calculated at 0.75 (prices are
quoted as a percent of par) and a straight bond similar in all other
aspects priced at 99.0. Donaldson also wants to determine how the
bond's value will change if yield volatility decreases. Which of the
following choices is closest to what Donaldson calculates as the
value for the putable bond and correctly describes the bond's price
behavior as yield volatility decreases?
    A. 99.75, price increases. B. 99.75, price decreases. C. 98.25,
price decreases.
    98. Which of the following statements is TRUE for both callable
and putable bonds?
    A. The value of the bond is equal to the value of a similar
straight bond plus the value of the option.
    B. When yield volatility increases, the value of the option
increases.
    C. The options both benefit the bond issuer.
    99. Which of the following is NOT an example of event risk?
    A. An interim South American government imposes restrictions on
the outflow of capital.
    B. The U. S. Food and Drug Administration (FDA) determines that a
biotech company's flagship product is harmful to consumers and cannot
be marketed.
    C. A corporation calls a large bond issue.
    100. Which of the following statements is FALSE? All else equal,
a floating-rate bond with: A. coupon reset dates every 3 months will
have more price fluctuation than a bond with reset dates every 6
months.
    B. a fixed-margin rate in the coupon formula will experience
greater price fluctuation than a bond with an adjustable margin rate.
    C. an interest rate cap will have more price fluctuation than a
bond with no interest rate cap.
    101. Which of the following statements about the relationship
between the value of a callable bond, the value of an option-free
bond, and the value of the embedded call option is TRUE?
    A. Value of a callable bond=present value of the interest
payments +present value of the principal at maturity.
    B. Value of a callable bond=value of an option-free bond + value
of an embedded call option.
    C. Value of a callable bond=value of an option-free bond-value of
an embedded call option.
    102. Which of the following is a difference between an on-the-run
and an off-the-run issue? An on- the-run issue:
    A. is the most recently issued security of that type.
    B. tends to sell at a lower price.
    C. has a shorter maturity than an off-the-run issue.
    103. A mortgage-backed security has the following characteristics:
    It was created by pooling a collection of more than a thousand
mortgages
    Not all investors face the same prepayment risk
    Investors receive three distinct kinds of cash flows
    Freddie Mac issued the security
    This security is a(n):
    A. collateralized mortgage obligation.
    B. stripped mortgage-security.
    C. mortgage passthrough security.
    104. Consider three corporate bonds that are identical in all
respects except as noted:
    Bond F has $100 million face value outstanding. On average, 200
bonds trade per day.
    Bond G has $ 300 million face value outstanding. On average, 200
bonds trade per day.
    Bond H has $100 million face value outstanding. On average, 500
bonds trade per day.
    Will the yield spreads to Treasuries of Bond G and Bond H be
higher or lower than the yield spread to Treasuries of Bond F?
    Bond G Bond H
    A. Higher Higher
    B. Higher Lower
    C. Lower Lower
    105. James Waiters, CFA, is an active fixed income portfolio
manager. He manages a portfolio of fixed income securities worth
$ 7500000 for an institutional client. Waiters expects a widening
yield spread between intermediate and long term securities. He would
like to capitalize on his expectations and considers several
transactions in a number of different securities. On 01/31/ 2005,
Walters expects the yield of the 2-Year Treasury Note to decrease by
10 basis points and the yield of the 30-Year Treasury Bond to
increase by 11 basis points. The characteristics of these two fixed
income securities are shown in Table 1. Prices are quoted as a
percentage of par value.
                           Table 1
                  Security Characteristics
                                 2 -Year      30 -Year
                               T-Note        T-Bond
    Maturity                    01/31/07      11/15/34
    Bid-Ask Spread (basis
                                   5.0          5.0
points)
    Coupon                        5.375%       6.125%
    Bid Price                    99.7236      104.6086
    Ask Price                    99.7736      104.6586
    Yield to Maturity              5.51%       5. 80%
    Price Value of a Basis
                                186.6484     1461.1733
Point

    He also has the three year term structure of interest rates. This
is shown in Table 2.
                      Table 2
         Term Structure of Interest Rates
           Year                 Spot Rate
           0.50                   5.5227%
           1.00                   5.5537%
           1.50                   5.5444%
           2.00                   5.5205%
           2.50                   5.5114%
           3.00                   5.5156%

    Walters thinks of several different trading strategies that would
allow him to take advantage of his expectations. He would like to
evaluate each strategy to determine which offers the best risk-return
trade off.
    Compute the yield spread between the T-Note and T-Bond given the
information in Table 1.
    A. 0.29%. B. 0.34%. C. 0.75%.
    106. James McDonald and Veasna Lu were discussing different ways
of valuing a Treasury security.
    During their discussion Lu made the following statements:
    Statement 1: It is inappropriate to discount the cash flows of a
Treasury security by a single discount rate because that is
implicitly assuming that the yield curve is flat. Therefore, each
individual cash flow should be discounted by its corresponding spot
rate.
    Statement 2: The spot rates used for different time periods that
produce a value equal to the market price of a Treasury bond are
called forward rates or future expected spot rates.
    Are the statements made by Lu regarding bond spot rates correct?
    Statement 1 Statement 2
    A. Correct Correct
    B. Incorrect Incorrect
    C. Correct Incorrect
    107. An investor would most likely expect commodities to have
correlations with traditional stock or bond investments and inflation,
respectively, that are:
    Correlation with inflation Correlation with traditional stock or
bond investments
    A. positive positive
    B. positive negative
    C. negative positive
    108. A three-year bond with a 10 percent annual coupon has cash
flows of $100 at Year 1, $100 at Year 2, and pays the final coupon
and the principal for a cash flow of $1100 at year 3. The spot rate
for Year 1 is 5 percent, the spot rate for year 2 is 6 percent, and
the spot rate for Year 3 is 6.5 percent. What is the arbitrage-free
value of the bond?
    A. $975.84. B. $1094. 87. C. $962.38.
    109. Consider a 1-year quarterly-pay $1000000 equity swap based
on 90-day London Inter-bank Offered Rate (LIBOR) and an index return.
Current LIBOR is 3.0 percent and the index is at 840. Below are the
index level and LIBOR at each of the four settlement dates on the
swap.
                   Q1     Q2     Q3    Q4
                   3.     3.     3.    3.
      LIBOR
                2%     0%     4%    9%
                   88     85     89    90
      Index
                 1      0    2.5     0

    At the second settlement date, the equity-return payer in the
swap will:
    A. receive $43187. B. pay $43187. C. receive $21187.
    110. Faye Sagler takes a long position in 12 August yttrium
futures contracts at a contract price of $ 3.50 per unit. Each
contract is for 1000 units of yttrium. The required initial margin is
$ 400 per contract and the maintenance margin is $ 300 per contract.
August yttrium futures decline to $ 3.42, $ 3.38, and $ 3.31 on the
next three trading days. On the first day that Sagler will be
required to deposit additional cash into her futures account, the
required deposit is closest to:
    A. $ 240. B. $ 960. C. $ 1440.
    111. An investor owns a share of stock worth $ 75 and buys a put
option for a premium of $ 2 with a strike price of $ 65. What are the
risk and return characteristics of the portfolio? The:
    A. portfolio has unlimited downside risk, but the upside
potential is limited to $ 65.
    B. portfolio's downside risk is a price of $73, but there is no
maximum to the upside potential.
    C. portfolio's downside risk is a price of $ 63, but there is no
maximum to the upside potential.
    112. A manufacturing company would seek mezzanine financing in
which of the following scenarios?
    A. A company preparing for an initial public offering.
    B. A company ready for a major marketing campaign.
    C. A company already producing and selling a product, seeking an
initial expansion of operations.
    113. You need to estimate the market value of an income producing
property located in your town.
    Through research you have found that the property should have net
operating income of $ 900000, taxes of $135000, a capitalization rate
of 14 percent, and an inflation rate of 3 percent. What is the
estimated property value using above information?
    A. $ 8281756. B. $ 6428571. C. $ 5464387.
    114. Hedge funds are generally not required to publicly disclose
their performance, however, some managers choose to make performance
information available to the public. This information is then
included in hedge fund indexes and some conclusions about the
performance of hedge funds can be drawn. Which of the following
statements regarding hedge fund performance is least accurate?
    A. In recent years, the Sharpe ratio for hedge funds has been
comparable to that of fixed income investments.
    B. The reported volatility of hedge fund returns may be higher
than the actual volatility of returns.
    C. When measured by standard deviation, hedge funds are less
risky than traditional equity investments.
    Questions 115 through 120 relate to Portfolio Management and are
allocated 9 minutes.
    115. Which of the following is NOT considered a constraint when
preparing an investment policy statement?
    A. Liquidity needs. B. Time horizon. C. Risk tolerance.
    116. Which of the following have studies shown has the greatest
impact on the return of a portfolio?
    A. Security selection. B. Target asset allocation. C. Market
timing.
    117. Which of the following statements about return objectives is
FALSE?
    A. To achieve the capital appreciation objective, the nominal
rate of return must exceed the rate of inflation.
    B. The total return objective is riskier than the current income
objective and less risky than the capital appreciation objective.
    C. To achieve the capital preservation objective, the nominal
rate of return must exceed the inflation rate.
    118. An investor's portfolio currently consists of 100% of stocks
that have a mean return of 16.5% and an expected variance of 0. 0324.
The investor plans to diversify slightly by replacing 20% of her
portfolio with U. S. Treasury bills that earn 4.75%. Assuming the
investor diversifies, what are the expected return and expected
standard deviation of the portfolio?
    ERP σP
    A. 14.15% 14. 40%
    B. 10.63% 2.59%
    C. 10.63% 14.40%
    119. As an investor continues to move downward on the efficient
frontier, which of the following best describes the change in the:
    slope of the efficient frontier? incremental return per unit of
incremental risk?
    A. Increases Increases
    B. Increases Decreases
    C. Decreases Increasea
    120. Consider two investors, Will Smythe and Katherine Banning,
who desire to invest 100 percent of their available funds in the
optimal risky portfolio. Smythe invests his money in a portfolio with
an expected return of 14 percent and a standard deviation of 10
percent. Banning invests her funds in a portfolio with an expected
return of 19 percent and a standard deviation of 12 percent. Which of
the two investors has invested their funds in the optimal portfolio?
    A. Smythe, since his portfolio has minimized total risk.
    B. Banning, since the expected return per unit of risk is higher
for her investment.
    C. Both, since the optimal portfolio depends on an investor's
individual utility function.
                             Afternoon Session
    Questions 1 through 18 relate to Ethical and Professional
Standard and are allocated 27 minutes.
    1. When Wes Smith first joined Advisors, Inc., he was excited
that all the analysts at the firm had the CFA designation. In letters
to prospective clients he states that this ensures that Advisors can
provide better service than their competitors. With respect to Code
of Standards, this is:
    A. not a violation.
    B. a violation because he cannot guarantee better service.
    C. a violation for both mentioning the CFA designation and saying
the firm can guarantee better service.
    2. An analyst who is an CFA Institute member receives an
invitation from a business associate's firm to spend the weekend in a
high-quality resort, in order to abide by the Standards, the analyst
should (may):
    A. write a memo to his supervisor notifying the supervisor of the
trip.
    B. do all of the actions listed here.
    C. accept if it is a client whose portfolio he manages.
    3. A money manger works for a full-service brokerage firm. After
meeting with a new client and gathering all relevant information, the
money manager says that she thinks her firm can perform all the
financial services the new client needs. With respect to Standard Ⅰ
(C) , Misrepresentation, this:
    A. may not be a violation if the representation was made orally.
    B. is a violation because she should have gathered the relevant
information before the prospect became a client.
    C. may not be a violation if the manager's opinion is based upon
the factual information gathered.
    4. A CFA Institute member is a U. S. citizen living and working
in a foreign country. That country has no laws against insider
trading. Based on this information, the CFA Institute member may:
    A. not trade using insider information based upon the CFA
Institute Standards.
    B. not trade using insider information based upon the rules of
the SEC.
    C. trade using insider information as long as it is not with a
client with laws against insider trading.
    5. Which of the following statements regarding allocating trades
is TRUE.9 It is permissible under the Standards to allocate trades:
    A. on a pro-rata basis over all suitable accounts.
    B. based upon compensation arrangements.
    C. based upon client relationships with the firm.
    6. Frank Adwood, CFA, is the chief compliance officer for Nills
Investment Limited. Frank institutes a new policy requiring the pro
rata distribution of new security issues to all discretionary
accounts for which the new issues are appropriate. The policy does
not provide for the distribution of new issues to non-discretionary
accounts, but this is disclosed to all existing and potential clients.
Did Frank most likely violate any CFA Institute Standards of
Professional Conduct?
    A. No.
    B. Yes, because the distribution policy fails to treat all
discretionary accounts equally.
    C. Yes, because disclosure of inequitable allocation methods does
not fulfill the duty for fail and equitable trade allocation
procedures.
    7. When Peter Jiang, CFA, joined Brown Investing, Brown began
using a quantitative stock selection model that Peter had developed
on his own personal time prior to his employment with Brown. One year
later when Peter left the firm, he found the original copy of the
model that he had developed in a file at his home and presented it to
his new employer, who immediately began using the model. According to
the Standards of Practice Handbook, did Peter violate any CFA
Institute Standards of professional Conduct?
    A. No.
    B. Yes, because he failed to act in Brown's best interest.
    C. Yes, because he misappropriated property that now belonged to
Brown.
    8. Neil Barton, CFA, and Nancy Roberts, CFA, began a joint
research report on Stamp Corporation. Nancy spent several days
visiting Stamp's corporate headquarters and meeting with all company
officers. Prior to the completion of the report, Nancy was reassigned
to another project. Nell utilized his and Nancy's research to write
the report. According to the CFA Institute Standards of practice
Handbook, did Nell violate any CFA Institute Standards of
Professional Conduct?
    A. No.
    B. Yes, with respect to misrepresentation.
    C. Yes, with respect to independence and objectivity.
    9. Harry, the Hotshot, salesman got a tip from his brother about
Kansas Power Tools(KPT). He sees that his company's research
department has a sell rating on KPT, and says, "I know better." He
reads the annual report, taking notes and marking it "BUY-takeover
target (Analyst's rating is sell)." If the recommends the stock to
his clients, Harry:
    A. has violated the code because the analyst has a sell rating.
    B. has violated the code because he has not done sufficient
research, including meeting management and comparing the company to
others in its industry.
    C. is not in violation of the code.
    10. Nick Bennett, CFA, is a trader at a stock exchange. Another
trader approached Bennett on the floor of the exchange and verbally
harassed him about a poorly executed trade. Bennett pushed the trader
and knocked him to the ground. Which of the following best describes
Bennett's conduct? Bennett:
    A. did not violate either the CFA Institute Code of Ethics or any
Standards of Professional Conduct.
    B. violated the CFA Institute Code of Ethics, but did not violate
any Standards of Professional Conduct.
    C. violated the CFA Institute Code of Ethics and the Standards of
Professional Conduct that relates to Professional Misconduct.
    11. Joe Turner, CFA attended a family barbecue over the weekend
hosted by his wealthy uncle.
    While mingling during this event he overheard a discussion
between three senior executives of Lowry Company, which included
details of their upcoming IPO. The next day Joe mentioned this
information to his brother Bob, who passed along the details of the
IPO to his stockbroker, John Williams. At market opening John
purchased a sizable amount of Lowry Company stock. Based on the above,
which of the following statements is true?
    A. Given that the IPO information was discussed publicly at the
barbecue either Joe, bob, or John could have acted on this
information without violating the Prohibition Against Use of Material
Nonpublic Information Standard.
    B. John violated the Prohibition Against Use of Material
Nonpublic InformationStandard by trading on nonpublic information
related to an upcoming IPO.
    C. Joe did not violate the Code and Standard by passing on
insider information related to an IPO to his brother.
    12. With respect to the Global Investment Performance Standards
(GIPS), which of the following is one of the eight major sections
that reflect the elements involved in presenting performance
information ?
    A. Real Estate.
    B. Derivatives.
    C. Legal and Ethical Considerations.
    13. Seth Wong and Roger Pan are enrolled to take the Level I CFA
examination. Wong and Pan jointly purchased study materials from a
well-know CFA review program. Wong made a photocopy of the
copyrighted materials and gave the copied materials to Pan. Wong
studied from the original materials. Did Wong and Pan, respectively,
violate the CFA Institute Code of Ethics or Standards of Professional
Conduct?
    Pan Wong
    A. NO NO
    B. NO YES
    C. YES YES
    14. Under the Prudent Man Rule, trustees are least likely to set
the proper balance of proprieties between:
    A. principle protection and current income.
    B. the interests of sponsors and the interests of beneficiaries.
    C. expected income every year and probable safety of principle.
    15. Bill Valley has been working for Advisors, Inc. for several
years, and he just joined CFA Institute. Valley's sister just
received a large bonus in the form of stock options in Zephyr Inc,
Valley's sister knows nothing about financial assets and offers
Valley a week at her holiday home each year in exchange for Valley
monitoring Zephyr and the value of her stock options. In order to
comply with the Code and Standards, Valley needs to inform Advisors
of:
    A. the compensation in the form of the use of the holiday home
only.
    B. the fact his sister owns the options on Zephyr stock only.
    C. both the use of the holiday home and his sister's options.
    16. A money manager and member of CFA Institute is meeting with a
prospect. She gives the client a list of stocks and says, "These are
the winners I picked this past year for my clients. Their double-
digit returns indicate the type of returns I can earn for you." The
list includes stocks the manager had picked for her clients, and each
stock has listed with it an accurately measured return that exceeds
10 percent. Is this a violation of Standard Ⅲ (D), Performance
Presentation?
    A. Yes, because the manager cannot reveal historical returns of
recent stock picks.
    B. No, because the manager had the historical information in
writing.
    C. Yes, unless the positions listed constitute a complete
presentation (i. e. there were no stocks omitted that did not perform
in the double digits).
    17. Alen Bishop earned the fight to use the CFA designation in
September 1968. Alen recently retired from the investment management
profession. As he is retired, Alen no longer attends CFA Institute
society meetings and has stopped paying his CFA Institute dues.
According to the Standards of Practice Handbook, how should Alen
refer to his affiliation with the CFA Program?
    A. Alen Bishop, CFA.
    B. Aien Bishop, CFA (retired).
    C. I was awarded the CFA charter in 1968.
    18. A stated objective of the CFA Institute's Global Investment
Performance Standards(GIPS) is to:
    A. encourage investment companies to develop the Code of Ethics
internally.
    B. to foster the notion of industry self-regulation on a global
basis.
    C. foster superior investment performance among investment
companies.
    Questions 19 through 32 relate to Quantitative Methods and are
allocated 21 minutes.
    19. There is a 50 percent chance that the Fed will cut interest
rates tomorrow. On any given day, there is a 67 percent chance the
DJIA will increase. On days the Fed cuts interest rates, the
probability the DJIA will go up is 90 percent. What is the
probability that tomorrow the Fed will cut interest rates or the DJIA
will go up?
    A. 1.00. B. 0.72. C. 0.33.
    20. A very large company has twice as many male employees
relative to female employees. If a random sample of four employees is
selected, what is the probability that all four employees selected
are female?
    A. 0.0625. B. 0.0123. C. 0.3333.
    21. An analyst wants to determine whether the monthly returns on
two stocks over the last year were the same or not. What test should
she use if she is willing to assume that the returns are normally
distributed?
    A. A paired comparisons test because the samples are not
independent.
    B. A difference in means test with pooled variances from the two
samples.
    C. An F-test with the greater mean in the numerator.
    22. An investor buys one share of stock for $100. At the end of
year one she buys three more shares at $ 89 per share. At the end of
year two she sells all four shares for $ 98 each. The stock paid a
dividend of $1.00 per share at the end of year one and year two. What
is the investor's time-weighted rate of return?
    A. 6.35%. B. -2.0%. C. 0.06%.
    23. Which statement best describes the properties of Student's t-
distribution?
    A. The t-distribution is symmetrical, defined by two parameters
and is less peaked than the normal distribution.
    B. The t-distribution is symmetrical, defined by a single
parameter and is less peaked than the normal distribution.
    C. The t-distribution is skewed, defined by a single parameter
and is more peaked than the normal distribution.
    24. Which of the following is NOT an advantage of technical
analysis?
    A. It does not depend on the analysis of market trading data,
such as security prices and trading volume.
    B. It is relatively easy to implement.
    C. It tells the analyst when to buy, but not necessarily why
investors are buying.
    25. Justin Banks just won the lottery and is trying to decide
between the annual cash flow payment option or the lump sum option.
He can earn 8 percent at the bank and the annual cash flow option is
$100000/year, beginning today for 15 years. What is the annual cash
flow option worth to Banks today?
    A. $ 924423.70. B. $ 855947.87. C. $1500000.00.
    26. In order to test if Stock A is more volatile than Stock B,
prices of both stocks are observed to construct the sample variance
of the two stocks. The appropriate test statistics to carry out the
test is the:
    A. F test. B. t test. C. Z test.
    27. If the null hypothesis is H0:ρ≤0, what is the appropriate
alternative hypothesis?
    A. Hα:ρ<0. B. Hα:ρ=0. C. Hα:ρ>0.
    28. If given the standard deviations of the returns of two assets
and the correlation between the two assets, which of the following
would an analyst NOT necessarily be able to derive from these? The:
    A. covariance between the returns.
    B. expected returns.
    C. variance of each return.
    29. In order to test whether the mean IQ of employees in an
organization is greater than 100, a sample of 30 employees is taken
and the sample value of the computed test statistic, tn-1=3.4. The
null and alternative hypotheses are:
    A. H0:μ=100; Ha:μ≠100.
    B. H0:μ≤100; Ha:μ>100.
    C. H0:μ=100; Ha:X≠100.
    30. The estimated annual after-tax cash flows of a proposed
investment are shown below:
    Year 1: $10000
    Year 2: $15000
    Year 3: $18000
    After-tax cash flow from sale of investment at the end of year 3
is $120000
    The initial cost of the investment is $100000, and the required
rate of return is 12 percent. The net present value (NPV) of the
project is closest to:
    A. $63000. B. $66301. C. $19113.
    31. Jack Smith, CFA, is analyzing independent investment projects
X and Y. Smith has calculated the net present value (NPV) and
internal rate of return (IRR) for each project:
    Project X: NPV=$250; IRR=15%
    Project Y: NPV=$5000; IRR=8%
    Smith should make which of the following recommendations
concerning the two projects?
    Project X Project Y
    A. Accept Accept
    B. Accept Reject
    C. Reject Accept
    32. ff an investor bought a stock for $ 32 and sold it one year
later for $ 37.50 after receiving $ 2 in dividends, what was the
holding period return on this investment?
    A. 6.25%. B. 17.19%. C. 23.44%.
    Questions 33 through 44 relate to Economics and are allocated 18
minutes.
    33. Which of the following statements regarding the money supply
and determination of short-term interest rates is least accurate?
    A. An increase in real GDP will shift the real money demand curve
to the right.
    B. On balance, financial innovation has decreased the demand for
money.
    C. An increase in the real money supply from an initial
equilibrium situation will cause house-holds and businesses to sell
interest-bearing securities.
    34. If the money supply increases and the price level declines,
according to the quantity theory of money, velocity:
    A. declined and output rise, or velocity rise and output remained
constant.
    B. remained constant and the growth rate in output fell more than
enough to compensate for the decline in prices.
    C. declined and output rise; or velocity remained constant and
the growth rate in output rose more than enough to compensate for the
decline in prices.
    35. In a recent discussion on the quantity theory of money, three
junior economists, Fred Sauvage, Linda McIntyre and Jason Richards,
were discussing the long-run changes in economic variables that would
result from an increase in the money supply. They stated the
following: Sauvage: According to the quantity theory of money, in the
long run only the price level would change if the central bank
increased the money supply. McIntyre: According to the quantity
theory of money, an increase in the money supply would bring about a
long-run decline in unemployment. Richards: According to the quantity
theory of money, in the long run only the velocity of money would
change as a result of an increased money supply. Are the statements
made by Sauvage, McIntyre and Richards correct?
    Sauvage McIntyre Richards
    A. Incorrect Correct Correct
    B. Correct Incorrect Incorrect
    C. Correct Incorrect Correct
    36. Which of the following is least likely to be considered a
drawback of utilitarianism?
    A. Wealth transfer from the rich to the poor is expensive.
    B. High income earners will work more.
    C. Cost of tax administration associated with wealth transfers.
    37. Which of the following economic schools of thought suggests
that the greatest good occurs to the greatest number of people when
wealth is transferred from the rich to the poor?
    A. Symmetry. B. Utilitarianism. C. Utopianism.
    38. David Landau, CFA, was discussing the biases associated with
the Consumer Price Index (CPI). He was also discussing the effect of
these biases on determining the inflation rate of an economy. Which
of the following is least likely a source of bias in CPI data and
does the CPI generally understate or overstate the true rate of
inflation?
    Not a source of bias CPI bias direction
    A. Outlet substitution Overstate
    B. Quality changes Understate
    C. Consumer preferences Overstate
    39. Unemployment due to the time it takes for qualified workers
to be matched with existing job openings describes:
    A. structural unemployment. B. frictional unemployment. C.
cyclical unemployment.
    40. A discussion of the economic functions of money and banking
produced the following statements:
    Statement 1: Direct exchange of commodities is less efficient
than money exchange because of the search costs involved in finding
an individual with whom to trade.
    Statement 2: The cost of funds for borrowers is lower in an
economy that features depository institutions than it would be in an
economy that lacked them.
    Are these statements correct?
    Statement 1 Statement 2
    A. Correct Correct
    B. Correct Incorrect
    C. Incorrect Correct
    41. On January 5, the U. S. Federal Reserve (the Fed) bought
$10000000 of U. S. Treasury securities in the open market. At the
time, the reserve requirement was 25 percent, and all banks had zero
excess reserves. What is the potential impact of the Fed' s purchase
on the U. S. money supply?
    A. $ 25000000 decrease.
    B. $ 40000000 increase.
    C. $ 10000000 increase.
    42. Which of the following factors would least likely result in
demand-pull inflation? An increase in:
    A. exports. B. the wage rate. C. the quantity of money.
    43. During the 1920s in Germany and during the 1980s in Brazil
and Israel, inflation reached hyperinflationary levels. People
received their wages and spent them immediately. Companies received
revenues from their sales and immediately paid them out as wages and
dividends. This behavior best reflects which one of the following
adverse effects of inflation for an economy?
    A. Tax distortion.
    B. Gains by employers at the expense of employees.
    C. Increased transactions costs.
    44. If the price elasticity of demand is-1.5 and you increase the
price of the product 2 percent, the quantity demanded will (closest
to):
    A. decrease 0.75%. B. decrease 1.5%. C. decrease 3%.
     Questions 45 through 78 relate to Financial Statement Analysis
and Corporate Finance and are allocated 51 minutes.
    45. Which description of the objective of financial statements is
most accurate? The objective of financial statements is:
    A. to provide securities analysts with objective data about a
firm's financial prospects.
    B. to provide a wide range of users with information about a
firm's financial prospects.
    C. to provide economic decision makers with useful information
about a firm's financial performance and changes in financial
position.
    46. An analyst gathered the following data about a company:
    The company had 1 million shares of common stock outstanding for
the entire year.
    The company's beginning stock price was $ 50, its ending price
was $ 70, and its average price is $ 60.
    The company has 100000 warrants outstanding for the entire year.
    Each warrant allowed the holder to buy one share of common stock
at $ 50 per share.
    How many shares of common stock should the company use in
computing its diluted earnings per share?
    A. 1100000. B. 1016667. C. 1083333.
    47. In accrual accounting, the matching principle states that:
    A. expenses incurred to generate revenue are recognized in the
same time period as the revenue.
    B. an entity should recognize revenues only when received and
expenses only when they are paid.
    C. transactions and events producing cash flows are allocated
only to time periods in which the cash flows occur.
    48. As a general rule, revenue is normally recognized when
    A. it is measurable.
    B. it is measurable and received.
    C. the earnings process is complete and cash receipt is assured.
    49. Competitive threats to the profitability or financial
stability of a firm are best categorized as an accounting fraud risk
factor related to:
    A. opportunities.
    B. incentives and pressures.
    C. attitudes and rationalizations.
    50. Do the following characteristics have to be met in order to
classify a liability as current on the balance sheet?
    Characteristic 1: Settlement is expected within one year or
operating cycle, whichever is less.
    Characteristic 2: Settlement will require the use of cash within
one year or operating cycle, whichever is greater.
    Characteristic 1 Characteristic 2
    A. No Yes
    B. No No
    C. Yes No
    51. Books Forever Inc. uses notes payable to buy inventory.
Assuming an initial current ratio that is greater than 1 and an
initial quick (or acid test) ratio that is less than 1, what is the
effect of this transaction on the current ratio, the quick ratio, and
net income?
    Current ratio Quick ratio Net income
    A. Decrease Decrease No impact
    B. Increase Increase No impact
    C. Decrease Increase Increase
    52. When preparing a statement of cash flows under the indirect
method, the adjustment to net income for an increase in wages payable
(WP) and a decrease in the deferred tax liability (DTL) on the
balance sheet compared to the prior reporting period is:
    Increase in WP Decrease in DTL
    A. Negative No adjustment
    B. Positive Negative
    C. Positive No adjustment
    Use the follow table to answer question 53 to 55.
        Purchases               Sales
      20 units at $50       15 units at $60
      35 units at $40       35 units at $45
      85 units at $30       85 units at $35
    53. Inventory value at the end of the period using the average
cost method is:
    A. $1540. B. $177. C. $2100.
    54. Inventory value at the end of the period using FIFO is:
    A. $1200. B. $175. C. $150.
    55. Inventory value at the end of the period using LIFO is:
    A. $250. B. $1200. C. $2100.
    56. ABC Investments has purchased a new computer system for $1.4
million and decided to depreciate it over a 4-year period on a sum-
of-years' digits (SYD) method. ABC estimates that the salvage value
will be $ 200000 at the end of the four years. What will be the
depreciation expense for the third year?
    A. $ 300000. B. $ 240000. C. $186000.
    57. The audit committee of a company's Board of Directors is most
likely to act in the interests of shareholders when:
    A. a company officer other than the CEO controls the audit budget.
    B. a reliable communication "firewall" is in place between the
committee and the company's internal auditors.
    C. the committee has authority to prevent the company from
engaging in non-audit business relationships with its external
auditors.
    58. The firm's target capital structure is consistent with which
of the following?
    A. Minimum WACC.
    B. Minimum cost of equity (KS).
    C. Maximum EPS.
    59. Rasmus Company purchased equipment for $96000. The estimated
useful life is three years, and it is expected to have a salvage
value of $ 24000 at the end of its useful life. The depreciation in
the third year was $12000. What method of depreciation did Rasmus
most likely use?
    A. Sum-of-years digits.
    B. Straight Line.
    C. Double-declining balance.
    60. A company using straight-line depreciation reports gross
investment in fixed assets of $100, accumulated depreciation of $ 50,
and annual depreciation expense of $10. What is the average age and
the average depreciable life of the fixed assets?
    Average age Average depreciable life
    A. 5 years 10 years
    B. 5 years 5 years
    C. 10 years 5 years
    61. Which of the following statements about the financial
implications of capitalization versus expensing is least accurate?
    A. Capitalizing will result in smoother reported income than
expensing, and expensing will result in higher leverage ratios than
capitalizing.
    B. Capitalization will result in lower leverage ratios than
expensing, but expensing will result in higher later year
profitability ratios than capitalization.
    C. Cash flow from operations is not affected by the capitalizing
versus expensing decision, but the investing and financing cash flows
depend on the method the firm chooses.
    62. Which of the following statements about the capitalization of
interest costs is least accurate?
    A. The argument for interest capitalization is that the cost of
the self-constructed asset should be identical to the cost of the
asset purchased alter completion.
    B. Interest capitalization will distort the classification of
cash flows. The capitalized interest will be reported as cash outflow
from operations rather than cash outflow from investing.
    C. If a firm capitalizes interest, its interest coverage ratio
(EBIT/I) will be misrepresented. The analyst should adjust the
interest coverage ratio downward to make it comparable with firms
that do not self-construct assets.
    63. A company has an asset with the following characteristics:
    Net book value of $ 500000 (original cost of $ 1300000 less
accumulated depreciation of $ 800000). Undiscounted expected future
cash flows of $ 470000 present value of expected future cash flows of
$ 380000. Which of the following statements about the accounting
treatment of this asset is least accurate?
    A. The asset is deemed to be "impaired," because the present
value of expected future cash flows is less than the carrying value.
    B. The future impact of an impairment recognition is to increase
net income, asset turnover ratios, and leverage ratios.
    C. If an impairment is recognized, the company will report a
$120000 write-off in income from continuing operations.
    64. An analyst gathered the following data about a depreciating
asset:
    The company acquired the asset for $ 8000.
    The asset has a 4-year Useful life and no salvage value.
    The asset WILL generate $ 5000 a year.
    The company's tax rate is 40%.
    For tax purposes, the asset can be depreciated (straight line)
over two years.
    For financial accounting purposes the asset is depreciated
(straight line) over four years.
    Assuming a constant tax rate, what is the deferred tax liability
at the end of the second year?
    A. $1600. B. $ 400. C. $ 800.
    65. Which of the following statements about the accounting
treatment of a zero-coupon bond is least accurate?
    A. Each year the imputed interest on a zero-coupon bond is
amortized to expense, causing cash flow from operations to decrease.
    B. Over time the interest expense on the zero-coupon bond will
increase as the discount is amortized to interest expense, and the
bond liability increases.
    C. If the zero-coupon bond is redeemed prior to maturity, any
amount over or under the bond's book value should be listed as again
or loss on the income statement.
    66. 5-year noncancellable lease signed on 31 December 2006
requires annual payments of $ 47963.24, beginning on 31 December 2006.
The present value of the lease payments discounted at the appropriate
interest rate of 10% is $ 200000. Assuming zero residual value and
that the first lease payment is made on 31 Decemeber 2006, the
reported lease expense for the year ended 31 December 2007 is:
    A. $ 60000. B. $ 70000. C. $ 55204.
    67. Which of the following statements about a capital lease is
FALSE?
    A. As compared to an operating lease, a capital lease will report
higher operating cash flows and lower financing cash flows.
    B. When a capital lease is initiated, the present value of the
leased assets is treated as an investing cash flow.
    C. Total cash flows are not affected by the accounting treatment
of the lease.
    68. In analyzing disclosures related to the financing liabilities
of a company, which of the following disclosures would be least
helpful to the analyst?
    A. The interest expense for the period as provided on the income
statement or in a footnote.
    B. The present value of the future bond payments discounted at
the coupon rate of the bonds.
    C. Fillings with the Securities and Exchange Commission (SEC)
that disclose all outstanding securities and their features.
    69. Over time, the reported amount of the annual interest expense
on a long-term bond issued at a discount will:
    A. remain constant. B. increase. C. decrease.
    70. The following table contains ratios for 2005 and 2006 for
Benrttd Company:
    2005 2006
    EBIT margin (EBIT/revenue) 0.15 0.10
    Asset turnover (revenue/assets) 1.00 1.50
    Leverage ratio (assets/equity) 2.00 2.50
    Tax burden (net income/EBT) 0.70 0.70
    Interest burden (EBT/EBIT) 0.95 0.95
    Which of the following statements about Benrud Company's return
on equity (ROE) is most accurate? ROE:
    A. decreased, because the company's profit margin fell.
    B. increased, due to the increase in turnover and leverage.
    C. increased, because the company' s asset turnover increased.
    71. According to International Financial Reporting Standards, how
do cash dividends received from trading securities and available-for-
sale securities affect net income?
    Trading securities Available-for-sale securities
    A. Increase Increase
    B. Increase No effect
    C. No effect Increase
    72. Garner Corporation is investing $ 30 million in new capital
equipment. The present value of future after-tax cash flows generated
by the equipment is estimated to be $ 50 million. Currently, Garner
has a stock price of $ 28.00 per share with 8 million shares
outstanding. Assuming that this project represents new information
and is independent of other expectations about the company, what
should the effect of the project be on the firm's stock price?
    A. The stock price will remain unchanged.
    B. The stock price will increase to $ 30.50.
    C. The stock price will increase to $ 31.75.
    73. Which of the following statements about capital budgeting is
TRUE?
    A. Since capital budgeting is based on cash flows rather than net
accounting income, changes in noncash balance sheet accounts such as
inventory are not relevant to the analysis.
    B. If an investment project would make use of property that the
firm currently owns, the project should not be charged with the
opportunity cost (rental income) of the property.
    C. Any cash flow that can be classified as incremental is
relevant in a capital budgeting project analysis.
    74. The underlying cause of ranking conflicts between the net
present value (NPV) and internal rate of return (IRR) methods is the
underlying assumption related to the:
    A. initial cost. B. reinvestment rate. C. cash flow timing.
    75. VTR, Inc. has sales of $ 4993548 with a cost of goods sold
equal to 65 percent of sales. Accounts receivable turnover is 12,
inventory is $ 856700, and fixed assets are $13000095. What is VTR
inventory turnover?
    A. 2.89. B. 4.66. C. 3.79.
    76. Assume that a company has equal amounts of debt, common stock,
and preferred stock. An increase in the corporate tax rate of a firm
will cause its weighted average cost of capital (WACC) to:
    A. rise. B. remain the same. C. fall.
    77. Ravencroft Supplies is estimating its weighted average cost
of capital (WACC). Ravencroft's optimal capital structure includes 10
percent preferred stock, 30 percent debt, and 60 percent equity. They
can sell additional bonds at a rate of 8 percent. The cost of issuing
new preferred stock is 12 percent. The firm can issue new shares of
common stock at a cost of 14.5 percent. The firm's marginal tax rate
is 35 percent. Ravencroft's WACC is closest to:
    A. 12.3%. B. 13.3%. C. 11.5%.
    78. At a recent Haggerty Semiconductors Board of Directors
meeting, Merle Haggerty was asked to discuss the topic of the
company's weighted average cost of capital (WACC). At the meeting
Haggerty made the following statements about the company's WACC:
    Statement 1: A company creates value by producing a higher return
on its assets than the cost of financing those assets. As such, the
WACC is the cost of financing a firm's assets and can he viewed as
the firm's opportunity cost of financing its assets.
    Statement 2: Since a firm' s WACC reflects the average risk of
the projects that make up the firm, it is not appropriate for
evaluating all new projects. It should be adjusted upward for
projects with greater-than-average risk and downward for projects
with less-than-average risk.
    Are Statement 1 and Statement 2, as made by Haggerty correct?
    Statement 1 Statement 2
    A. Incorrect Incorrect
    B. Correct Incorrect
    C. Correct Correct
    Questions 79 through 114 relate to Asset Valuation and are
allocated 54 minutes.
    79. Which of the following statements concerning security
valuation is FALSE?
    A. The best way to value a company with high and unsustainable
growth that exceeds the required return is to use the temporary
supernormal growth (multistage) model.
    B. The best way to value a company with no current dividend but
who is expected to pay dividends in three years is to use the
temporary supernormal growth (multistage) model.
    C. A firm with a $1.50 dividend last year, a dividend payout
ratio of 40% , a return on equity of 12%, and a 15% required return
is worth $18.24.
    80. An analyst just received the following information for
Mythical Interactions, Inc. A senior equity trader in her group wants
to know if he should purchase a large block of the stock.
    Earnings retention rate at 65%
    Required rate of return, ken, of 11%
    Return on equity (ROE) of 13%, expected to remain constant
    Estimated Sales per share of $175
    Estimated EBIDTA profit margin of 22%
    Estimated Depreciation per share of $ 20
    Estimated Interest Expense per share of $12
    Corporate Tax Rate of 40%
    Current market price is $ 45.50 per share
    Based on the assumptions above, which of the following
recommendations is CORRECT? The analyst should advise the trader to:
    A. not purchase the stock. It is overvalued by approximately
$10.20.
    B. not purchase the stock. It is overvalued by approximately
$8.00.
    C. purchase the stock. It is undervalued by approximately $8.00.
    81. Which of the following statements regarding growth companies
and growth stocks is TRUE? A growth:
    A. company has management that has the ability to consistently
select projects that earn higher returns than required by their risk.
    B. company will not earn below normal returns.
    C. company will earn above normal returns given its risk.
    82. For an analyst evaluating the common stock of a financial
institution that reported a small loss for the year just ended, the
price multiple that is least likely to be meaningful is:
    A. price to cash flow.
    B. leading price to earnings.
    C. trailing price to earnings.
    83. Which of the following is a disadvantage of using the price-
to-book value (PBV) ratio?
    A. Book values are affected by accounting standards, which may
vary across firms and countries.
    B. Firms with negative earnings cannot be evaluated with the PBV
ratios.
    C. Book value may not mean much for manufacturing firms with
significant fixed costs.
    84. Which of the following statements about primary and secondary
markets is FALSE?
    A. The proceeds from a sale in the secondary market go to the
issuing unit, not the current owner of the security.
    B. The primary market benefits from the liquidity provided by the
secondary market.
    C. A secondary market is a market in which existing securities
are traded among investors.
    85. The trading of exchange registered securities over the
counter by non-exchange member firms is called:
    A. the third market. B. the fourth market. C. block trading.
    86. What is the expected rate of return on a stock that has a
beta of 1.4 if the market risk premium is 9 percent and the risk-free
rate is 4 percent?
    A. 16.6%. B. 11.0%. C. 13.0%.
    87. If you buy 100 shares of a $ 50 stock on margin when the
initial margin requirement is 40 percent, how much money must you
borrow from your broker?
    A. $ 2000. B. $ 4000. C. $ 3000.
    88. A firm has a profit margin of 10 percent, an asset turnover
of 1.2, an equity multiplier of 1.3, and an earnings retention ratio
of 0.5. What is the firm's internal growth rate?
    A. 4.5%. B. 7.8%. C. 6.7%.
    89. The conclusion that technical analysis adds no value:
    A. supports the weak form of the EMH.
    B. is not supported by fact.
    C. contradicts the strong form of the EMH.
    90. Given the following information, compute the price/cash flow
ratio for EAV Technology.
    Net income per share=$ 6
    Price per share=$ 100
    Depreciation per share=$ 2
    Interest expense per share=$ 4
    Marginal tax rate=25 %
    A. 10.0X. B. 12.5X. C. 8.3X.
    91. What is the yield to maturity (YTM) of a 20-year, U.S. zero-
coupon bond selling for $ 300?
    A. 3.06%. B. 5.90%. C. 6.11%.
    92. An investor gathers the following information about three U.
S. Treasury annual coupon bonds:
                 Bond 1      Bond 2     /Bond 3
    Maturity     2-year      1-year     2-year
      Price      $10000     $ 374.62     $9560
     Coupon        4%          0%          0%
       Par
                 $10000       $400      $10400
   Value

    Given the above information, how can the investor generate an
arbitrage profit?
    A. Purchase bond 1 while selling bonds 2 and 3.
    B. No arbitrage profit exists.
    C. Purchase bonds 2 and 3 while selling bond 1.
    93. A corporate bond with the following data is issued:
    $1000 par value.
    8.0 percent coupon payments.
    5 years to maturity with semiannual coupon payments.
    Market interest rates are 10 percent.
    What is the total interest expense?
    A. 923. B. 545. C. 477.
    94. Ly is a Treasury Manager with Deeter Holdings, a large
consumer products holding company.
    The Assistant Treasurer has asked Ly to calculate the current
yield (CY) and the Yield-to-first
    Call (YTC) on a bond the company holds that has the following
characteristics:
    7 years to maturity
    $ 1000 face value
    7.0% semi-annual coupon
    Priced to yield 9.0 percent
    Callable at $1060 in two years
    If Ly calculates correctly, the CY and YTC are approximately:
    CY YTC
    A. 7.80% 15.72%
    B. 7.78% 15.72%
    C. 7.80% 15.82%
    95. All else being equal, which of the following bond
characteristics will lead to lower levels of coupon reinvestment risk?
    A. Longer maturities and higher coupon levels.
    B. Shorter maturities and lower coupon levels.
    C. Shorter maturities and higher coupon levels.
    96. One of the most commonly used yield spread measures is the
nominal spread. Which of the following is NOT a limitation of nominal
spread? The nominal spread assumes:
    A. an upward sloping yield curve.
    B. all cash flows can be discounted at the same rate.
    C. all cash payments will be received in a prompt and timely
manner.
    97. The following information is available for two bonds:
    Bond X is callable and has an option-adjusted spread (OAS) of
55bp. Similar bonds have a Z-spread of 68bp and a nominal spread of
60bp.
    Bond Y is putable and has an OAS of 100bp. Similar bonds have a
Z-spread of 78bp and a nominal spread of 66bp.
    The embedded option cost for Bond:
    A. X is 5bp. B. X is 8bp. C. X is 13bp.
    98. Which of the following statements regarding forward rates is
FALSE?
    A. Forward rates do not account for the market's tolerance for
risk.
    B. Forward rates may be estimated from spot rates.
    C. Forward rates contain information regarding market
participants' collective expectations regarding future interest rates.
    99. An investor gathered the following information on two U. S.
corporate bonds:
    Bond J is callable with maturity of 5 years
    Bond J has a par value of $10000
    Bond M is option-free with a maturity of 5 years
    Bond M has a par value of $1000
    For each bond, which duration calculation should be applied?
    Bond J Bond M
    A. Effective Duration Effective Duration only
    B. Modified Duration Modified Duration or Effective Duration
    C. Effective Duration Modified Duration or Effective Duration
    100. An investor gathered the following information about an
option-free U. S. corporate bond:
    Par Value of $10 million
    Convexity of 45
    Duration of 7
    If interest rates increase 2 percent (200 basis points), the
bond's percentage price change is closest to:
    A. -14.0%.
    B. -15.8%.
    C. -12.2%.
    101. Which of the following statements about exchange-traded
derivatives is FALSE?
    A. They are liquid and provide price information.
    B. They are standardized contracts.
    C. They carry significant default risk.
    102. The CFO of Magma Corporation expects interest rates
especially LIBOR to increase. She would like to place the company in
a position to profit from the expected interest rate increase. Which
of the following interest rate swap arrangements would allow Magma to
profit from an increase in LIBOR?
    A. a swap in which Magma pays a fixed rate and receives a
floating rate tied to LIBOR.
    B. a swap in which Magma pays a floating rate tied to LIBOR and
receives a fixed rate.
    C. a swap in which Magma pays a fixed rate and receives a fixed
rate.
    103. Party A has entered a currency forward contract to purchase
10 million at an exchange rate of $ 0.98 per . At settlement, the
exchange rate is $ 0.97 per euro. Party A will:
    A. make a payment of $100000.
    B. receive a payment of $100000.
    C. make a payment of 103090.
    104. Which of the following statements about options is most
accurate?
    A. An open call position can be closed before expiration by
buying put options on the underlying stocks.
    B. For call options, the lower the strike price relative to the
stock's underlying price, the more the call option is worth.
    C. A put writer who deposits shares of the underlying stock has
written a covered put.
    105. Which combination of interest rate options most likely has
the same pattern of payoffs as the short position in a forward rate
agreement?
    Interest rate call option Interest rate put option
    A. Long Long
    B. Long Short
    C. Short Long
    106. An investor notices that one Australian dollar is selling
for $0. 67 in U. S. dollars. A put option with an exercise price of
$0.75 is selling for $0.14. An investor takes a long position in a
protective put. What is the value of the position at expiration and
what is the profit if the price of one Australian dollar at
expiration is $ 0.70?
    Value at expiratory Protective put profit
    A. $ 0.75 -$ 0.06
    B. $ 0.75 $ 0.08
    C. $ 0.61 $ 0.08
    107. One real estate investment has the following characteristics:
    Annual rental income       $18000000
    Annua operating
                                $1200000
expenses
    Available mortgage
                                    6%
rate
    Financing percentage           90%
    Required rate of retum         15%
    Estimated holdng
                                 5 years
period
    Investor's tax rate            25%

    Based on the income approach, the value of the investment is
closest to:
    A. $ 4000000.
    B. $ 5320000.
    C. $ 7322000.
    108. Compared to investing in a single hedge fund, an individual
investing in a fund of funds is least likely to obtain:
    A. Lower fees.
    B. A higher lever of expertise in finding good-quality hedge
funds.
    C. Better access to successful hedge funds.
    109. A closed-end fund:
    A. is traded in the primary market but not the secondary market.
    B. has its price determined by supply and demand, regardless of
its net asset value (NAV).
    C. has its price determined by the net asset value (NAV).
    110. The following table shows a mutual fund comprised of four
stocks, each stock's number of shares, and the price per share.
      Stock       Shares      Price
        A          6200        $10
        B          6000        $34
        C          3900         $8
        D          2600        $52

      Assuming no liabilities, the net asset value (NAV) of this fund
is:
    A. $26.00. B. $23.12. C. $17.30.
    111. A hedge fund that takes perfectly offsetting long and short
positions is best described as a(n):
    A. market-neutral fund. B. long/short fund. C. event-driven fund.
    112. A commodities investor establishes a $10 million
collateralized futures position. If the futures are worth $10. 5
million three months later, and treasuries have an annualized return
4.75 percent during the period, the total gain on the position is:
    A. $ 500000. B. $ 475000. C. $ 618750.
    113. All of the following are examples of commodity-linked
equities EXCEPT:
    A. a gold mining company.
    B. a supermarket operating company.
    C. an oil and gas exploration company.
    114. Investing in distressed securities is most similar to
investing in which of the following asset classes?
    A. Hedge funds. B. Commodities. C. Venture capital.
    Questions 115 through 120 relate to Portfolio Management and are
allocated 9 minutes.
    115. Given the following correlation matrix, a risk-averse
investor would least prefer which of the following two-stock
portfolios (all else the same)?
     Stock        A        B        C     D
       A         +1
       B        -0.2      +1
       C        +0.6     -0.1      +1
                                          +
       D        +0.8     -0.3    +0.5
                                        0
    A. A and C. B. C and D. C. B and C.
    116. Without the introduction of a risk-free asset or a zero-beta
portfolio, the optimal portfolio on the efficient frontier for each
investor is represented by:
    A. the point where the investor's highest indifference curve is
tangent to the efficient frontier.
    B. any point where an indifference curve intersects the efficient
frontier.
    C. the point where the capital market line touches the frontier.
    117. Which of the following statements regarding portfolio theory
is least likely correct?
    A. The covariance between the returns on a security and those of
the overall market, divided by the variance of the market returns, is
a measure of the security's systematic risk.
    B. All securities and portfolios plot on the SML when their
prices are in equilibrium.
    C. A security that lies on the CML must be priced at its
equilibrium level.
    118. ff the number of stocks in the portfolio increases, what is
the effect on systematic and unsystematic risk?
    Systematic Risk Unsystematic Risk
    A. Decreases Decreases
    B. Remains constant Increases
    C. Remains constant Decreases
    119. Which of the following portfolios could NOT lie on the
efficient frontier?
                       Expected           Standard
      Portfolio
                      Return           Deviation
           A               6                  3
           B              10                  3
           C              18                  7
           D              18                  9
    A. Portfolios A and B. B. Portfolios A and D. C. Portfolios B and
C.
    120. An analyst gathers the following information about four
stocks.
                      St       St     Sto     St
                 ock A ock B ck C ock D
      Estimated       8.       12     18.     22
     return        0%      .0%      0%     .5%
                      0.       1.             1.
         Beta                         1.2
                    6        0              8
    The analyst estimates that the risk-flee rate is 5%, and the
return on the market portfolio is 12%. Based on the above inputs and
the capital asset pricing model (CAPM) , which of the following
statements about the valuation of the four stocks is most accurate?
    Stock A Stock B Stock C Stock D
    A. Undervalued Overvalued Properly valued Undervalued
    B. Undervalued Properly valued Overvalued Overvalued
    C. Overvalued Properly valued Undervalued Undervalued
                                  Sample Exam 5
                                (Morning Session)
    1. C.
    Standard Ⅲ (E) Responsibilities of Supervisors. Paul may
delegate supervisory duties, but such delegation does not relieve him
of his supervisory responsibility.
    2. C.
    If a charterholder fails to pay dues for any year, the right to
use the CFA designation is suspended. However; stating he was awarded
the CFA charter in t968 is a matter of fact.
    3. A.
    The Standard relating to fair dealing states that all clients
cannot be treated equally because it is impossible to reach everyone
simultaneously and each client has unique needs and objectives.
    4. C.
    Members shall not engage in any professional conduct involving
dishonesty, fraud, deceit, or misrepresentation or commit any act
that reflects adversely on their honesty, trustworthiness, or
professional competence.
    Duty to employer: Members shall not undertake any independent
practice that could, result in compensation or other benefit in
competition with their employer unless they obtain written consent
from both their employer and the persons or entities for whom they
undertake independent practice.
    5. C.
    The Standards do not require members to disclose to clients and
prospective clients their obligation to abide by the Code and
Standards.
    6. A.
    Standard Ⅳ (B) requires members to act for the benefit of their
clients and to place their clients interests above their own. Soft
dollars may be used for client benefit if the practice is disclosed.
It is not required that each element of research purchased benefit
each client involved, however, the manager should seek to assure that
over time, clients benefit from the use of research purchased with
client brokerage. Using soft dollars for the purchase of office
furniture does not directly benefit any client and is violation.
    7. C.
    The subsidiary or division of a company claims GIPS compliance
when the parent company is GIPS compliant. In order for an investment
firm to claim GIPS compliance, GIPS must be applied on a firm-wide
basis. If the parent company is GIPS compliant, this does not
automatically mean the divisions or subsidiaries are compliant. A
division or. subsidiary of a company would also have to comply with
GIPS to be able to claim compliance. If an investment firm,
subsidiary, or division is held out to clients or potential Clients
as a distinct business unit it can claim GIPS compliance even if the
parent company is not compliant.
    8. A.
    According to Standard Ⅴ(C) Investment Analysis, Recommendations,
and Action Record Retention, members must maintain appropriate
records in either electronic or hard copy form for a minimum of seven
years. The Standards do not require on-site storage.
    9. B.
    According to Standard Ⅳ (C) Duties to Employers:
Responsibilities of Supervisors, members must make reasonable efforts
to detect and prevent violations of applicable laws, rules,
regulations, and the Code and Standards. Supervisors must disseminate
the contents of the program to appropriate personnel. It is
unnecessary to disseminate the contents of the program to all
employees.
    10. A.
    Once a supervisor learns that an employee has violated or may
have violated the Code and Standards, the supervisor must promptly
initiate an investigation to ascertain the extent of the wrongdoing.
    11.B.
    A member's duty of loyalty to his employer prohibits him from
violating any applicable non-compete agreement.
    12. C.
    Violating the Standards by not having a reasonable and adequate
basis for his investment recommendation. The ad hoe model is not part
of the formal research process and does not formulate an adequate
basis for a recommendation.
    13. B.
    There is nothing to suggest that Wong does not have a reasonable
basis for his conclusion related to Nolvec. However, by delaying the
revision of his recommendation so that his brother can buy shares at
a lower price, he has Violated the CFA Institute Standards relating
to duty to client, duty to employer, and priority of transactions.
    14. B.
    Jang has failed to account for international differences in
accounting standards, and has no basis to believe that the results
based on one set of accounting ~ standards will hold for another set.
    15. C.
    Updates must be made at least annually.
    16. C.
    Composites must be defined according to similar investment
objectives and/or strategies. In addition, composites must inclucde
new portfolios on a timely and consistent basis after the portfolio
comes under management. Firms may set minimum asset levels for
inclusion in a portfolio, but changes to a composite-specific minimum
asset level are not permitted retroactively. Terminated portfolios
must be included in the historical returns of appropriate composites.
    17. B.
    On letterheads and business cards and in directory listings, only
the mark CFA or the words Chartered Financial Analyst should appear
after the charterholder's name.
    18. C.
    By establishing a hedge fund separate form AA, Victor violated
several Standards. The hedge fund may conflict with her employer's
interests and must be disclosed according to Standards Ⅵ (A)
Disclosure of Conflicts. The hedge fund also provides additional
compensation and must be disclosed according to Standards Ⅳ (B)
Additional Compensation Arrangements. Finally, according to Standard
Ⅳ (A) Loyalty, members must act for the benefit of their employer,
not deprive their employer of the advantage of their skills and
abilities, or otherwise cause harm to their Employer. In setting up
the new fund, Victor was not acting for the benefit of her employer.
He should have informed AA that she wanted to organize a hedge fund
and come to same mutual agreement on how this would occur.
    19. B.
    With PV=200000, N=30×12=360, I/Y=8/12, CPT PMT=$1467.53.
    20. B.
    Solve for an annuity due with a future value of $1000000, a
number of periods equal to (35×12)=420, payments=-500, and present
value=0.Solve for i:i=0.61761×12=7.411% stated annually. Don't
forget to set your calculator for payments at the beginning of the
periods. If you don't, you'll get 7.437%.
    21.C.
    Choice A should be "two events are dependent if the occurrence of
one is related to the probability of occurrence of the other".
    Choice B should be" the multiplication rule for independent
events generalizes to more than two events".
    22. B.
    The standard error of the sample mean is s/n1/2=2891/2/5001/2=0.76
    23. A.
    A binomial random variable has an expected value or mean equal to
np and variance equal to np (1-p). Mean=12×0.5=6; variance
12×0.5×(1-0.5)=3.
    24. A.
    The alternative hypothesis is determined by the theory or the
belief. The researcher specifies the null as the hypothesis that she
wishes to reject (in favor of the alternative). The theory in this
case is that the correlation is negative.
    25. B.
    According to Chebyshev's inequality, the proportion of the
observations within 2, which is k, standard deviations of the mean is
at least 1-(1/k)2=1-(1/22)=0.75 or 75%.
    26. C.
    The distance to the left from the mean to the beginning of the
range is 13. The distance to the right from the mean to the end of
the range is 10. Therefore, the distribution is skewed to the left,
which means that it is negatively skewed.
    27. B.
    The cumulative absolute frequency of the fourth interval is 80.
Which is the sum of the absolute frequencies from the first to the
fourth intervals.
    28. A.
    The 90 percent confidence interval is 10%±1.645(4%) or from
3.42% to 16.58%.
    29. C.
    N=4×12=48; I/Y=12/12=1; PV=-45000; FV=0; CPT→PMT=1185.02.
    30. B.
    First, the annual yield must be converted to a semiannual yield.
The result is then doubled to obtain the bond-equivalent yield.
    Semiannual yield=1.10.5-1=0.0488088.
    The bond-equivalent yield=2×0.0488088=0.097618.
    31. C.
    If the stock moves up twice, it will be worth
$ 20×1.05×1.05=$ 22.05. The probability of this occurring is
0.80×0.80=0.64. If the stock moves down twice, it will be worth
$20×(1/ 1.05)×(1/1.05)=$18.14. The probability of this occurring is
0.20×0.20=0.04. If the stock moves up once and down once, it will be
worth $ 20×1.05×(1/1.05)=$ 20.00. This can occur if either the
stock goes up then down or down then up. The probability of this
occurring is 0.80×0.20+0.20×0.80=0.32. Multiplying the potential
stock prices by the probability of them occurring provides the
expected stock price: $ 22.05×0.64+$ 18.14×0.04+$20.00×0.32=$21.24.
    32. A.
    A discrete variable is one that is represented by finite units.
    33. B.
    Few sellers are a characteristic, not a barrier, of a price-
searcher market where there are high barriers to entry. Other
barriers are patents or exclusive rights of production.
    34. A.
    All cases except wide distribution of a natural resource
facilitate a monopoly. If natural resource ownership is concentrated
in one firm a monopoly would result.
    35. C.
    The three types of time lags that make the timing of
discretionary policy difficult are: Recognition lag: The time period
between an actual change in economic conditions and the recognition
of the change by policy makers. Administrative lag: The time period
between the recognition of the change and the time the policy change
is enacted. Impact lag: The time period between implementation of the
policy change and the impact of the change.
    36. C.
    All are characteristics of monopolistic competition except
"single seller." There are many sellers or producers who face demand
curves that slope downward to the right and are elastic; they sell
differentiated products that permit firms to attract customers
without reducing price; and there are low barriers to entry.
    37. C.
    Price elasticity of demand=(% change in Q demanded/% change in
price). Given the price elasticity of demand and the percentage
change in price, we can solve for the percentage change in Q demanded.
    38. A.
    Price elasticity of demand is calculated by dividing the percent
change in quantity demanded by the percent change in price, using the
average value of the variable in the computations. The percent change
in quantity demanded is (51-49)/[(51+49)/21=0.04. The percent change
in price is (4-6)/[(4+6)/2]=-0.40. The price elasticity of demand is
0.04/(-0.4)=-0.10.
    39. C.
    An increase in interest rates can be expected to decrease
business investment and decrease consumption. The impact on
government spending and net exports is not clear-cut.
    40. A.
    The long-run supply curve is more elastic and flatter than the
short-run supply curve. In the long run, firms in an industry can
adjust their production methods and scale.
    41.A.
    If all the firms in a competitive industry have adopted a
technology for production, it is presumably the technology that
minimizes their production costs. If that technology is outlawed,
firms will have to revert to the second-best technology, which will
increase their costs of production. This is represented by a shift to
the left in the industry supply curve. At each price level, the
quantity supplied will be less than before. Just as a technological
improvement will cause firms that adopt it early to earn economic
profits that attract new entrants to the industry, prohibition of the
cost-minimizing technology will cause economic losses and typically
force some firms to exit the industry. Under perfect competition,
profit is always maximized at the level of output where marginal cost
equals the market price. The state of technology is one factor that
determines the level of output at which this occurs.
    42. C.
    The fiscal imbalance, defined as the difference in present values
between the government's promised benefits and revenues, can be
reduced by increasing taxes, cutting promised benefits, or cutting
other government spending. Both Moller and Stephens are correct.
    43. C.
    The marginal revenue product of an input is the addition to total
revenue gained by selling the additional output from employing one
more unit of that input.
    44. B.
    At low wage rates, an increase in the wage rate will induce a
worker to work longer hours, leading to the substitution effect and
an increase in the quantity of labor supplied.
    45. C.
    Some supplementary schedules are not audited whereas footnotes
are audited. The financial statements and footnotes in the annual
report and the SEC 10 -k filings are all audited. The other
statements are true.
    46. B.
    Shares issued post-split need not be adjusted for the split as
they are "new" shares.
    47. A.
    Because basic EPS does not adjust for warrants, the adjustment is
0.
    Diluted EPS uses average price. Since AP>EX,


    48. A.
    A change from FIFO to LIFO is a change in accounting principle.
    49. C.
    The cost of preferred stock is calculated as the preferred
dividend divided by the market price, not the par value.
    50. C.
    Both methods generate the same cash flows, while the percentage-
of-completion method has higher total assets and lower income
volatility.
    51. C.
    Depreciation expense is reported as an operating component in the
income statement. Given the first year depreciation expense of $ 3.2
million, and the original cost of $ 8 million, the declining balance
percentage is 40% ($ 3.2 million depreciation expense/$ 8 million
cost). The double declining balance percentage is equal to 2/useful
life = 40%. Thus, the useful life is 5 years (2/0.40).
    52. C.
   A simple numerical example can help. Assume CA=2 and CL=1. Then

note              and             Debt is decreased, but equity is
unchanged, so D/E is decreased.
    53. A.
    When inventory and accounts receivable increase, this is a use of
cash (cash outflow); when assets decrease, this is a source (cash
inflow). When accounts payable increase, this is a source of cash
(cash inflow); when liabilities decrease, this is a use (cash outflow)
    54. A.
    Credit sales and interest expense are already reflected in net
income. Credit purchases will be reflected in working capital changes
under cash flows from operations. Only prepaid items are shown as
adjustments to net income in the statement of cash flows.
    55. A.
    Cost of goods sold was (beginning inventory plus purchases less
ending inventory=$ 500000+$1800000-$ 800000=) $1500000. Cash flow
from operations under the direct method is calculated by: Cash
collections: $ 3100000 (net sales plus decrease in accounts
receivable=$ 3000000+($ 300000-$ 200000))
    Less direct cash inputs: $ 1800000 (cost of goods sold plus
increase in inventory=$ 1500000+$ 300000)
    Less other cash outflows of $ 400000
    CFO=($ 3100000-1800000-400000)=$ 900000
    56. C.
    CFF=25(Sale of Stock)-30(Div Paid)=-$ 5.
    57. A.
    Financing costs should not be included in incremental cash flows.
They are reflected in the weighted average cost of capital (WACC).
New business at other branches is a positive externality, lost
business at other branches is a negative externality
(cannibalization), and the $150000 to sell the property is an
opportunity cost.
    58. C.
    LIFO will result in lower net income than FIFO in the current
period, during a period of rising prices. All the other choices will
tend to increase current period earnings.
    59. B.
    Choice A: Purchases must be $10000. Choice B: There is no way of
knowing which method the firm uses from the information given. Choice
C: If inventory is overstated, then COGS must also be overstated.
    60. B.
    In the early years, firms that expense costs will have lower
profitability ratios such as return on assets (ROA) and return on
equity (ROE). In later years as growth subsides, expensing firms will
have lower asset and equity balances and hence higher profitability
measures such as ROA and ROE. Marketing costs that are not directly
related to sales are expensed when incurred but marketing costs
directly related to sales are capitalized. Cash flow from financing
is not affected by the expensing or capitalizing decision only cash
flow from operations and cash flow from investing. Brands and
trademarks if acquired in arm's-length transactions may be
capitalized.
    61.A
    Deferred tax liability at the end of year three, after the change
in tax rate will be $3144 ($1178.93 +$1178.93+$786.16).
    Deferred Tax liability for year 1=$1178.93=[($9314-$5511)×0.31].
    Deferred Tax liability for year 2=$1178.93=[($9314-$5511)×0.31].
    Deferred Tax liability for year 3=$786.16=[($9314-$6778)×0.31].
    62. C.
    Regarding the regular payback period, after 1 year, the amount to
recover is $ 2000 ($ 5000-$ 3000). After the second year, the amount
is fully recovered.
    The discounted payback period is found by first calculating the
present values of each future cash flow. These present values of
future cash flows are then used to determine the payback time period.
    3000/(1+0.10)1=2727
    2000/(1+0.10)2=1653
    2000/(1+0.10)3=1503.
    Then:
    5000-(2727+1653)=620
    620/1503=0.4.
    So, 2+0.4=2.4.
    63. A.
    Since taxable income ($ 238000) exceeds pretax income ($188000),
Kruger will have a deferred tax asset of $17000 [($238000-
$188000)×0.34].
    64. A.
    A firm with a high debt-to-equity ratio is more likely to use an
operating lease instead of a capital lease. Use of an operating lease
avoids the recognition of debt on the lessee's balance sheet and will
not increase the debt-to-equity ratio.
    65. C.
    The useful life of the machine is 10 years and the lease is for 8
years. Because the lease period is more than 75% (8/10=80% ) of its
useful life, it must be classified as a capital lease.
    66. B.
    Risky projects will seem relatively more attractive than they
actually are, causing them to be undertaken a disproportionately high
percentage of the times they are considered.
    67. B.
    For take or pay contracts, an analyst should add the present
value of the obligation ($4000000) to both assets and long-term
liabilities, which will increase the D/E ratio. Sales of receivables
with recourse should be accounted for as a collateralized borrowing,
which includes increasing current liabilities on the balance sheet
and increasing EBIT by the amount of the loss taken to account for
the implicit interest when the receivables were "sold" at a discount
from their (face) balance sheet amount. Assets are further increased
by putting the receivables ($500000) back on the balance sheet.
    68. B.
    PMT=800000; FV=10000000; N=5; I/Y=8.25; CPT→PV=$ 9900837
    Interest expense=9900836.51×0.0825=$ 816819.01
    Year-end adjustment=816819.01-800000=$16819.01
    Year-end debt=$ 9900836.51+$16819.01=$ 9917655.52
    Note: Since this is a discount bond, we know the value will
increase each year, so we really didn't have to do any calculations
to answer this question.
    69. B.
    ROA=(EBIT/average total assets) which measures management's
ability and efficiency in using the firm's assets to generate
operating profits. Other ratios that measure liquidity (if a company
can pay its current bills) besides the quick, cash, and current
ratios are the: receivables turnover, inventory turnover, and
payables turnover ratios.
    70. C.
    Current ratio=[100(cash)+750(accounts receivable)+300(marketable
securities)+850 (inventory)]/1300 (AP)+130(short term
debt)]=2000/430=4.65.
    Cash ratio=[100(cash)+300(marketable
securities)1/[300(AP)+130(short term debt)]=400/430=0.93.
    71. B.
    Average Inventory Processing Period=365/inventory
turnover=365/7=52 days.
    72. B.
    Accelerating operating cash flow by securitizing receivables is
not sustainable because the firm only has a limited amount of
accounts receivable. An increase in tax benefits as a result higher
of tax rates is not sustainable. Tax rates could also decrease in the
future.
    73. A.
    Since equity is 40% of assets, the leverage ratio is 1/0.40=2.5.
Using the traditional DuPont formula, ROE=8.7%×2.4×2.5=52.2%.
    74. C.
    bond yield+risk premium=8%+5%=13%

                             where growth rate=13.33×(1-0.4)‰=8‰
    CAPM=0.06+1.7×(0.11-0.06)=14.5%
    75. B.
    Break points in the marginal cost of capital structure occur at
the levels where the cost of one of the components of the company's
capital structure increases, increasing its weighted average cost of
capital.
    76. A.
    The crossover rate is the rate at which the NPV for two projects
is the same. That is, it is the rate at which the two NPV profiles
cross. At a discount rate of 9%, the NPV of Project A is:
    CF0=-4; CF1=3; CF2=5; CF3=2; 1=9%; CPT→NPV=$4.51. Now perform
the same calculations except that we need to set the unknown
CF0=0.The remaining entries are:
    CF1=1.7; CF2=3.2; CF3=5.8; I=9%; CPT→NPV=$8.73. Since by
definition the crossover rate produces the same NPV for both projects,
we know that both projects should have an NPV=$4.51. Since the NPV of
Project B (with CF0=0) is $8.73, the unknown cash flow must be a
large enough negative amount to reduce the NPV for Project B from
$ 8.73 to $4.51. Thus the unknown initial cash flow for Project B is
determined as $4.51=$8.73+CF0, or CF0=-$4.22.
    77. A.
    There are benefits to both an annually elected board and a board
with staggered multiple-year terms so neither can be considered a
"requirement." An annually elected board provides flexibility to
nominate new board members in response to changes in the marketplace.
Staggered boards may provide better continuity of board expertise and
leadership.
    78. C.
    The NPV method is always preferred over the IRR, because the NPV
method assumes cash flows are reinvested at the cost of capital.
Conversely, the IRR assumes cash flows can be reinvested at the IRR.
The IRR is not an actual market rate.
    79. A.
    Internal efficiency is a characteristic of a well-functioning
securities market. However, this should lead to the lowest possible
transaction cost not higher costs.
    80. B.
    Portfolio mangers cannot eliminate systematic risk (i. e. market
risk) through the use of diversification. Portfolio managers should
try to eliminate unsystematic portfolio risk.
    81. C.
    The strongest true statement is that the value of the 25 call is
greater than the value of the 30 call. If the 30 call is at or in the
money at expiration, the minimum difference in prices is $ 5. Prior
to expiration, the difference will likely be something less, since
the 25 call has $ 5 more intrinsic value but will likely have less
time value.
    82. A.
    Event study results provide strong evidence in support of the
semistrong-form of the EMH. However, time series and cross-sectional
tests provide mixed evidence of semi-strong form efficiency.
    83. C.


    84. C.
    A well-functioning securities market should possess price
continuity; prices should not change much from one transaction to the
next unless substantial new information affecting a security's value
becomes available.
    85. A.
    The Value Line Composite Average is a equal-weighted index.
    86. B.
    The value is the same both before and after the split. The
divisor is adjusted to make the value constant. Before the split:
10+20+60=90/3=30. After the split: 10+20+30=60/X=30.
    New divisor=2.
    87. B.
    Strategy risk refers to the fact that anomalous behavior
identified in historical data may not persist into the future, or, at
least, during the timeframe within which the strategy is executed.
Incorrectly specifying the risk-adjustment mechanism is a modeling
issue.
    88. B.
    Since markets are in equilibrium, g=r-D1/P0=15%-2/30=8.33%.
    89. C.
    P/E=Payout ratio/(k-g)=0.7/(10.25%-4%)=11.20.
    90. C.
    D1=D0×(1+20%)=3×1.2=3.6,
D2=3.6×1.2=4.32,D3=4.32×1.2=5.184,D4=5.184×(1+9%)=5.65,
    CAPM: K=6%+1.2×(11%-6%)=12%,
    P3=D4/(K-g)=5.65/(12%-9%)=188.352,
    3.6/(1+12%)+4.32/(1+12%)2+(5.184+188.352)/(1+12%)3=144.
    91. C.
    Better supplier terms lead to increased profitability. Better
profit margins lead to an increase in ROE. This leads to an increase
in the dividend growth rate. The difference between the cost of
equity and the dividend growth rate will decline, causing the stock
price to increase.
    92. A.
    Because zero-coupon bonds have no coupons (all of the bond's
return comes from price appreciation), investors have no uncertainty
about the rate at which coupons will be invested. An investor who
holds a zero-coupon bond until maturity will receive a return equal
to the bond's effective annual yield.
    93. A.
    The delivery price for Treasury bonds under the contract is
multiplied by the conversion factor for the bond the short chooses to
deliver.
    94. C.
    The clean price is the bond price without the accrued interest so
it is equal to the quoted price.
    95. A.
    A 3×9 FRA is a 3-month contract with 6-month (180-day) LIBOR as
the reference rate.
    The long position will gain if 180-day LIBOR 90 days from now is
above the contract rate (the expected future rate at contract
initiation).
    96. C.
    A put provision is an option that is exercisable by, and
therefore potentially of benefit to, the bondholder. Even though the
put is out of the money, it still has value to the bondholder.
Interest rate caps, accelerated sinking fund provisions, and
prepayment options all potentially benefit the issuer of the bond.
    97. B.
    To calculate the putable bond value, use the following formula:
    Value of putable bond=Value of straight bond+Put option value
    Value of putable bond=99.0+0.75=99.75.
    Remember: The put option is added to the bond value because the
put option is of value to the bondholder, not the issuer.
    As yield volatility decreases, the value of the embedded option
decreases. The formula above shows that for a putable bond, a
decrease in the option value results in a decreased bond value.
    98. B.
    To calculate the value of a putable bond, it is correct to add
the option value to the value of a similar straight bond. However, to
calculate the callable bond value, subtract the option value from
that of a similar straight bond. As a result, when yield volatility
increases (thus increasing the option value), the value of a callable
bond decreases and the value of a putable bond increases. A call
option does benefit the issuer, but a put option benefits the holder.
    99. C.
    A corporation calling a large bond issue is an example of call
risk.
    100. A.
    The more frequent the reset dates, the less the time lag that
causes volatility. The greater the gap between reset dates, the
greater the amount of price fluctuation. Over the life of a bond, the
required market margin is not constant. A fixed-margin coupon exposes
the bond to more price fluctuations than an adjustable margin (as is
the case with an extendible reset bond).
    Cap risk refers to when market interest rates rise to the point
that the coupon on a floating-rate security hits the cap and the bond
begins to behave like a fixed coupon bond, which has more price
fluctuations.
    101. C.
    Because the bondholder has given something of value to the issue
of a callable bond, the value of the embedded call option should be
subtracted from the value of the straight bond.
    102. A.
    An on-the-run issue is the most recently auctioned Treasury issue.
An off-the-run issue older issues, when more current issues are
brought to market.
    103. A.
    While most mortgage-backed securities pay three types of cash
flows, only mortgage pass-throughs and collateralized mortgage
obligations (CMOs) are formed by pooling mortgages. Only CMOs divide
investors into tranches with different cash flows and risk profiles.
    104. C.
    Liquidity is attractive to investors, so they will pay a higher
price (demand a lower yield) for a more liquid bond than for an
identical bond that is less liquid. Bond G is more liquid than Bond F
because of its greater size. Bond H is more liquid than Bond F
because it trades in greater volume. Therefore both Bond G and Bond H
will tend to have lower yield spreads to Treasuries than Bond F.
    105. A.
    The yield spread is computed as follows: Yield Spread=Yield to
MaturityT-Bond-Yield to MaturityT-Note So we have: Yield Spread=5.80%-
5.51%=29 bp(basis points)
    106. C.
     Statement 2 is incorrect because the spot rates used for
different time periods that produce a value equal to the market price
of a Treasury bond are called arbitrage-free Treasury spot rates.
Statement 1 is correct.
     107. B.
     A primary motivation for an investment in commodities, commodity
derivatives, commodity-linked bonds, and commodity-linked equity are
the diversification benefits provided clue to the negative return
correlation with other asset and the positive correlation with
inflation.
     108. B.
     Spot interest rates can be used to price coupon bonds by taking
each individual cash flow and discounting it at the appropriate spot
rate for that year's payment. To find the arbitrage-free value:
     Bond
value=$ 100/1.05+$ 100/1.062+$1100/1.0653=$ 95.24+$89.00+$ 910.63=$109
4.87.
     109. A.
     The equity-return payer will receive the floating rate from the
end of the previous period, 3.2% , plus the negative return on the
index over the second quarter. [0.032/4-(850/881-
1)]×1000000=$43187.29.
     110. C.
     The initial margin is $ 400×12=$4800 and the maintenance margin
level will be $ 300×12= $3600. Each $0.01 change in the price of
yttrium changes the value of the account by $0.01 ×1000×12=$120.
     D     Pr      Daily    Gain/Lo
                                             Balance
  ay    ice     Change       ss
           $3                            $4800 (initial
     0
        .50                                margin)
           $3
     1            -$0.08     -$ 960           $3840
        .42
           $3
     2            -$0.04     -$ 480           $3360
        .38
           $3
     3            -$0.07     -$ 840           $2520
        .31

    At the end of Day 2, the account balance has fallen below the
maintenance margin level of $ 3600, so Sagler must deposit enough
cash to bring the balance back to the initial margin level of $ 4800.
The deposit is $ 4800-$ 3360=$1440.
    111. C.
    The investor is using a portfolio insurance ( long stock+long put)
strategy. The maximum loss is limited to the strike price of the put
option less the premium paid for the option. The maximum gain for the
strategy is unlimited, as the stock could rise by an infinite amount
and the investor will allow the put option to expire.
     112. A.
     The capital provided to prepare for an initial public offering is
at the mezzanine stage. A company ready for a major marketing
campaign or a physical plant expansion is seeking third-stage
financing. An initial expansion of operations describes second-stage
financing.
     113. B.
     NOI/(MKT CAP)=MV
     900000/0.014=6428571
     114. B.
     Many assets that are included in a hedge fund portfolio are not
actively traded. Managers utilize estimates to report the market
value and performance of their hedge funds. Using estimates rather
than actual market transactions may result in smoothed pricing,
thereby reducing reported volatility.
     115. C.
     The constraints are: liquidity needs, time horizon, taxes, legal
and regulatory factors, and unique needs and preferences. Risk
tolerance is included in the investment objectives of the policy
statement, not in the constraints.
     116. B.
     Several studies support the idea that approximately 90 percent of
a portfolio's returns can he explained by its target asset
allocations.
     117. C.
     To achieve the capital preservation objective, the nominal rate
of return must equal the inflation rate. The total return objective
is often thought to be riskier than the income objective, but less
risky than the capital appreciation objective.
     118. A.
     Since Treasury bills (T-bills) are considered risk-free, we know
that the standard deviation of this asset and the correlation between
T-bills and the other stocks is 0. Thus, we can calculate the
portfolio expected return and standard deviation.
     ERP=(WT-bills×ERT-bills)+(WStocks×ERStocks)=0.20×0.0475+(1.00-
0.20)×0.165=14.15%.
     When combining a risk-free asset and a risky asset (or portfolio
                                  2    2   2    2             1/2
or risky assets), σ1,2=(w1 σ1 +w2 σ2 +2w1w2σ1σ2ρ1,2) reduces to:
σ1,2=[(WStocks)(σStocks)]1/2=0.80×0.03241/2=14.40%. (Remember to convert
variance to standard deviation).
     119. A.
    A portfolio is efficient if it (1) maximizes return for a given
risk level, or (2) minimizes risk for a given return target. The
efficient frontier represents the set of portfolios that will give
you the highest return at each level of risk (or, alternatively, the
lowest risk for each level of return).




    120. C.
    By definition, the optimal portfolio is the point of tangency
between the efficient frontier and the utility function of a
particular investor. Since every investor has his or her own set of
utility curves (based on their attitudes toward risk and return),
every investor could have a different optimal portfolio.
                        Solutions to Sample Exam 5
                           (Afternoon Session)
    1. B.
    A violation because he cannot guarantee better service. According
to Standard Ⅶ, the analyst cannot make guarantee better service.
Smith can mention the fact that all analysts have the designation,
but he is limited in what he can say with respect to this fact. He
could say, for example, that this means the analysts all had to take
and pass three rigorous exams. Members must not make promotional
promises or guarantees tied to the CFA designation.
    2. B.
    Do all of the actions listed here. The analyst must do all of
these actions to comply with the Standards. According to code
Standard, the analyst must refuse the invitation, if it from a firm
the analyst covers for his employer. The analyst can accept the
invitation if it is from a client and the analyst gets approval from
his supervisor according to code of Standard. According to Standard,
the analyst must disclose in writing all monetary compensation and
benefits they receive for their services.
    3. C.
    There is no violation if the opinion is based upon the factual
information gathered and the firm's actual capabilities. This is true
whether or not the representation was written, oral, or electronic.
None of the other choices are correct.
    4. A.
    CFA Institute Standard Ⅱ (A) prohibits trading using insider
information. A member may not trade using such information regardless
of the rules of the country where he/she lives.
    5. A.
    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 or client relationships. Any method is not
necessarily suitable, and disclosure does not absolve the member from
ensuring that the allocation is necessarily fair.
    6. C.
    When making investments in new offerings or secondary financings,
members should ensure the pro rata distribution of the issues to all
customers for whom the investment is appropriate, not withstanding
that the member may have discretionary power over certain accounts
and not over others. Additionally, disclosure of inequitable
allocation methods does not relieve a member from this obligation.
    7. A.
    Although departing employees may not take employer property when
departing, the model Peter presented to his new employer was not
Brown's property. It was created by Peter prior to his employment
with Brown. The model was not created for Brown in the course of his
employment, but was adopted by Brown.
    8. A.
    Members are in compliance with CFA Institute's Standards ff they
rely on the research of another party who exercised diligence and
thoroughness.
    9. C.
    Answer C is correct. Analysis of the basic characteristics of the
investment is sufficient basis, for a recommendation. Thus, Answers A
and B are wrong. He must keep written records that indicate the
quality rating and basis for recommendation. He has complied with
this regulation.
    10. B.
    Members should act with integrity, dignity, and in an ethical and
professional manner; any individual behavior that reflects adversely
on the entire profession should be avoided.
    11. B.
    Answer A is wrong since the information discussed at the barbecue
does not constitute public dissemination of this material nonpublic
information. Answer C is an incorrect response as Joe should not have
passed the information related to the upcoming IPO onto his brother.
    12. A.
    Fundamentals of Compliance: These are issues for firms to
consider when claiming GIPS compliance. Definition of the firm is
part of this. Input Data: Input data should be consistent in order to
establish full, fair, and comparable investment performance
presentations. Calculation Methodology: Certain methodologies are
required for portfolio and composite return calculations. Uniformity
in methods is required. Composite Construction: Creation of
meaningful, asset-weighted composites is important to achieve a fair
presentation. Disclosures: Certain information must be disclosed
about the presentation and the policies adopted by the firm.
Presentation and Reporting: Investment performance must be presented
according to GIPS requirements, and when appropriate, other firm-
specific information should be included. Real Estate: These
provisions apply to all real estate investments (land, buildings,
etc.) regardless of the level of control the firm has over management
of the investment. Private Equity: These must be valued according to
the GIPS Private Equity Valuation Principles, unless it is an open-
end or evergreen fund (which must follow regular GIPS).
    13. C.
    Photocopying copyrighted material is a violation of law.
Candidates and members must comply with laws and must not knowingly
participate or assist in a violation of laws.
    14. B.
    Trustees must act for their clients and should always place
beneficiaries' interest before their own and sponsors.
    15. C.
    According to Standard Ⅳ (A), Loyalty to Employer, Valley must
inform Advisors of his outside consultation even if it is not for
monetary compensation. According to Standard Ⅵ (A), Disclosure of
Conflicts, Valley must also disclose possible conflicts of interest,
and his sister's position qualifies.
    16. C. Standard Ⅲ(D) requires fair representations concerning
past and potential future performance. Unless the list of the
"winners" includes all the positions that the firm held, the manager
is misrepresenting past performance. The following statement is
questionable: "Their double-digit returns indicate the type of
returns I can earn for you," but the action of submitting a partial
list is clearly a violation. The manager should have information on
past performance in writing. Whether the person is a client or
prospect is not important in this instance.
    17. C.
    If a charter holder fails to pay dues for any year, the right to
use the CFA designation is suspended. However, stating he was awarded
the CFA charter in 1968 is a matter of fact.
    18. B.
    GIPS Objectives: To obtain worldwide acceptance of a standard for
performance and presentation. To ensure accurate and consistent
investment performance data for reporting, record keeping, marketing,
and presentation. To promote fair, global competition among
investment firms for all markets without creating barriers to entry
for new firms. To foster the notion of industry self-regulation on a
global basis.
    19. B.
    This requires the addition formula. From the information: P(cut
interest rates)=0.50 and P (DJIA increase)=0.67, P(DJIA increase |
cut interest rates)=0.90. The joint probability is 0.50×0.90=0.45.
Thus P (cut interest rates or DJIA increase)=0.50+0.67-0.45=0.72.
    20. B.
    Since there are twice as many male employees to female employees,
p (male)=2/3 and p (female)=1/3. Therefore, the probability of 4
"successes"=0.3334=0.0123.
    21. A.
    A paired comparisons test must be used. The difference in means
test requires that the samples he independent. Portfolio theory
teaches us that returns on two stocks over the same time period are
unlikely to be independent since both have some systematic risk. The
F-test is used for testing a difference in variances, among other
things.
    22. C.
    The holding period return in year one is ($ 89.00-
$100.00+$1.00)/$100.00=-10.00%.
    The holding period return in year two is ($98.00-
$89.00+$1.00)/$89=11.24%.
    The time-weighted return is {[1+(-0.1000)]×(1+0.1124)}1/2-1=0.06%.
    23. B.
    The t-distribution is symmetrical like the normal distribution
but unlike the normal distribution is defined by a single parameter
known as the degrees of freedom and is less peaked than the normal
distribution.
    24. A.
    Technical analysis depends almost entirely on the analysis of
data derived from stock market trading activity, including security
prices and trading volume. It does not depend on accounting
information.
    25. A.
    First put your calculator in the BGN.
    N=15; I/Y=8; PMT=100000; CFF PV=924423.70.
    Alternatively, do not set your calculator to BGN, simply multiply
the ordinary annuity (end of the period payments) answer by 1+I/Y.
You get the annuity due answer and you don't run the risk of
forgetting to reset your calculator back to the end of the period
setting. OR N=14; I/Y=8; PMT=100000; CPT
PV=824423.70+100000=924423.70.
    26. A.
    The F test is used to test the differences of variance between
two samples.
    27. C.
    The alternative hypothesis must include the possible outcomes the
null does not.
    28. B.
    The correlations and standard deviations cannot give a measure of
central tendency, such as the expected value.
    29. B.
    The null hypothesis is that the theoretical mean is not
significantly different from zero. The alternative hypothesis is that
the theoretical mean is greater than zero.
    30. C.
    10000/1.12=8929
    15000/1.122=11958
    138000/1.123=98226
    NPV=8929+11958+98226-100000=$19113
    Alternatively: CF0=-100000, CF1=10000, CF2=15000, CF3=138000,
I=12, CPT NPV=$19112.
    31. A.
    The projects are independent, meaning that either one or both
projects may be chosen. Both projects have positive NPVs, therefore
both projects add to shareholder wealth and both projects should be
accepted.
    32. C.
    HPR=[D+End Price-Beg Price]/Beg Price
    HPR=[2+37.50-32]/32=0.2344
    33. C.
    From an initial equilibrium, an increase in real money balances
will leave households and businesses with more money than they wish
to hold, so they will purchase interest-bearing securities, driving
their prices up and yields down until a new equilibrium short-term
rate is established.
    34. C.
    MV=PY. M goes up and P goes down. So, V must go down, Y must go
up; or if V is constant, Y increases more than P decreases.
    35. B.
    The quantity theory of money states that an increase in the money
supply will cause a proportional increase in prices in the long run.
The original proponents of the quantity theory felt that velocity and
output were determined by institutional factors other than the money
supply and were thus nearly constant. Therefore, if the money supply
increases while velocity and quantities are fixed, prices must rise.
    36. B.
    The biggest problem with the utilitarian concept is that the
wealth transfer from high income earners to low income earners is
brought about by taxing the high income earners. This will cause the
high income earners to work less.
    37. B.
    Utilitarianism refers to the idea that the greatest good occurs
to the greatest number of people when wealth is transferred from the
rich to the poor in order to make everyone's wealth equal.
    38. C.
    The four sources of bias associated with CPI data are: new goods,
quality changes, commodity substitution, and outlet substitution. As
a result, in 1996 a Congressional Advisory Commission concluded that
the CPI tends to overstate the true rate of inflation by 1.1% per
year.
    39. B.
    Structural unemployment is due to structural changes in the
economy that eliminate some jobs while generating job openings for
which unemployed workers are not qualified. Cyclical unemployment
results from short-term deviations from "full employment."
    40. A.
    Both statements are correct. Using money as a medium of exchange
allows transactions to take place between any two individuals who
have something of value to trade, whereas direct exchange of
commodities requires each individual to find another who has the
commodity he wants and is willing to accept the commodity he has.
Acting as financial intermediaries is one of the economic functions
of depository institutions. They reduce the cost of borrowing
compared to what it would be if every borrower had to search for
savers with funds available to lend.
    41. B.
    Buying securities by the Fed increases the money supply because
they are injecting money into the banking system. The money supply
can potentially increase by 1/0.25×$ 10000000=$ 40000000.
    42. B.
    Demand-pull inflation can result from any factor that increases
aggregate demand, including increases in the money supply, increases
in exports, and increases in government purchases. Increases in the
money wage rate or the prices of other productive inputs would result
in cost-push inflation as aggregate supply decreases.
    43. C.
    Money holders' rush to spend cash immediately reflects an
increase in transactions costs as money becomes less effective as a
store of value.
    44. C.
    If the price elasticity of demand is -1.5, and you increase the
price of the product 2% , the quantity demanded will decrease
approximately 3%. When the price elasticity is negative, it means
that price and demand move in opposite directions. Given a price
decrease, demand will increase and vice versa. The absolute value,
1.5, indicates that demand will move one-and-a-half times as much as
price.
    45. C.
    The objective of financial statements is to provide economic
decision makers with useful information about a firm's financial
performance and changes in financial position. Assessing its
prospects is the responsibility of analysts. Financial statements
fall under the purview of the FASB in the US, not the IASB. The SEC
does not set the objectives of financial statements, it is a
regulatory authority.
    46. B.
    Use the Treasury stock method:
    Step 1: Determine the number of common shares created if the
warrants are exercised=100000.
    Step 2: Calculate the cash inflow if the warrants are exercised:
100000×$50 per share=$ 5000000.
    Step 3: Calculate the number of shares that can be purchased with
these funds using the average market price ($ 60 per share):
5000000/60=83333 shares.
    Step 4: Calculate the net increase in common shares outstanding
from the exercise of the warrants: 100000-83333=16667.
    Step 5: Add the net increase in common shares from the exercise
of the warrants to the number of common shares outstanding for the
entire year: 1000000+16667=1016667.
    47. A.
    The matching principle holds that expenses should be accounted
for in the same performance measurement period as the revenue they
generate.
    48. C.
    The firm must have provided virtually all of the goods or
services for which it is to be paid, and the expected cost of
providing the service must be measurable. The company must also be
able to reasonably estimate the probability of payment.
    49. B.
    Risk factors related to incentives and pressures include threats
to the firm's financial stability or profitability from economic,
industry, or firm-specific operating conditions.
    50. B.
    A current liability is expected to be settled within one year or
operating cycle, whichever is greater. It is not necessary to settle
a current liability with cash. There are a number of ways to settle a
current liability. For example, unearned revenue is a liability that
is settled by providing goods or services.
    51. A.
    As an example, start with CA=2, CL=1 and Inv=1.2. We begin with a
current ratio of 2 and a quick ratio of 0.8. If the firm increases
notes payable by 1 to buy inventory of 1, both the numerator and
denominator increase by 1, resulting in 3/2=1.5 (new current ratio)
and [(3-2.2)/2]=0.4(new quick ratio). This transaction does not
impact net income, so the result is a decrease in the current and
quick ratios and no effect on net income.
    52. B.
    Both are liability accounts so the adjustment for an increase is
to increase net income and the adjustment for a decrease is to
decrease net income, both by the appropriate amounts.
    53. B.
    Average Cost=Cost of Goods Available/Total Units Available
    Average Cost=$ 4950/140=$ 35.36
    EOP Inventory Value=$ 35.36×5=$176.79
    54. C.
    (Units purchased minus units sold) times cost=EOP value
    (140-135)×$30=$150
    55. A.
    5×$50=$250
    56. B.
    The SYD method depreciation=($1400000-$ 200000)×(number of years
remaining/sum of years). For third year, =$1200000×(2/10)=$ 240000.
    57. C.
    The audit committee is responsible for evaluating the financial
information that the company provides to shareholders. This committee
should be able to approve or reject the company's proposed non-audit
engagements with its external auditing firm. The audit committee, not
management, should control the audit budget, and there should be no
restrictions on communication between the committee and the company's
internal auditors.
    58. A.
    Risk the firm can take on should be maximized to the point where
it results in a higher share price; all components of the WACC should
be considered, and the goal is to maximize the stock price, not EPS.
Minimum WACC is the only correct answer.
    59. A.
    $ 96000-24000=$ 72000. Sum-of-years digits=3+2+1=6. The third
year depreciation will be $72000×(1/6)=$12000. SL depreciation would
be $24000/year. DDB would be $64000 in year 1, $8000 in year 2, and
$0 in year 3.
    60. A.




    61. C.
    Cash flows from operations, financing and investing are affected
by the capitalization/expensing choice. Total cash flows are the same,
but expensing results in lower early-year and higher later-year
profitability ratios, lower operating cash flow, and greater
investing cash flow compared to capitalizing expenses.
    62. B.
    Capitalized interest will be charged to CFI rather than CFO. In
an analytical sense, CFO will be overstated and CFI will be
understated.
    63. A.
    The asset is impaired because the carrying value is more than the
undiscounted expected future cash flows. Discounted expected future
cash flows are used to measure the amount of impairment, here 500000-
380000=120000. The other statements are true.
    The impairment will be reported as an unusual or infrequent item
in income from continuing operations. Writing down an asset decreases
future depreciation expense and thus increases future income and
leverage ratios. Assets are reduced, increasing future turnover
ratios. The indicators of impairment given are correct.
    64. A.




    annual difference=$ 2000, or($ 2000×0.4)=$ 800 deferred tax per
year
    Deferred tax:
    Year 1: $1200-$400=$800
    Year 2: $1200-$400=800
    Balance=$1600
                   Tax      Tax       Tax      Tax
              Year 1   Year 2    Year 1   Year 2
     Revenue     $5000    $5000     %5000    $5000
    Deprecia
                  4000     4000      2000     2000
    tion
      EBT       1000      1000      3000     3000
   Tax(0.4)      400       400      1200     1200
      EAT       $600      $600     $1800    $1800

    65. A.
    An increase in cash flow from financing (CFF) is recorded for the
amount received when the bond is issued. There is no annual periodic
charge to CFO because no cash is paid out. When the bond matures, the
full par value is deducted from CFF. So with a discount (or zero
coupon) bond, the annual CFO will be overstated because the interest
was not deducted.
    66. C.
    The first payment is made at lease inception, so the lease
liability balance as of 31 December 2006 is $200000-
$47963.24=$152036.76. (Think of this payment at inception as a down
payment, with the lease financing the remaining balance.)
    Interest expense for 2007=$152036.76×10%=$15204
    Depreciation expense=$200000/5=$40000
    Lease Expense for 2007=$15204+40000=$55204
    67. B.
    The present value of the leased assets is booked to fixed assets,
but the present value is not an investing cash flow because no cash
moved through the company. The transaction is reported as a note to
the statement of cash flows.
    68. B.
    When analyzing disclosures related to financing liabilities,
analysts would review the balance sheet and find the present value of
the promised future liability payments. These payments would then be
discounted at the rate in effect at issuance (i.e. the yield to
maturity) , not the coupon rate of the bonds.
    69. B.
    A portion of the discount must be amortized to the interest
expense each year. The amortized amount is debited to interest
expense and credited to debt. So debt goes up. The interest expense
is debt times the effective interest rate. Thus, interest expense
will increase over time.
    70. B


    ROE 2005=0.70×0.95×0.15×1.00×2.00=0.1995 or 19.95%
    ROE 2006=0.70×0.95×0.10×1.50×2.50=0.2494 or 24.94%
    The profit margin decreased, but asset turnover and leverage
increased. Therefore, the company's ROE increased.
    71. A.
    Dividends received from trading securities and available-for-sale
securities are recognized in the income statement. The difference in
trading and available-for-sale classifications relates to the
treatment of any unrealized gains and losses.
    72. B.
    In theory, a positive NPV project should provide an increase in
the value of a firm's shares.
    NPV of new capital equipment=$ 50 million-$ 30 million=$ 20
million
    Value of company prior to equipment
purchase=8000000×$ 28.00=$ 224000000
    Value of company after new equipment project=$ 224 million+$ 20
million=$ 244 million
    Price per share after new equipment project=$ 244 million/8
million=$ 30.50
    Note that in reality, changes in stock prices result from changes
in expectations more than changes in NPV.
    73. C.
    The other statements are false. Changes in working capital are
relevant cash flows. If an investment project makes use of property
that could be used elsewhere or leased, the project under analysis
should be charged with the opportunity cost.
    74. B.
    The IRR method assumes all future cash flows can be reinvested at
the IRR. This may not be feasible because the IRR is not based on
market rates. The NPV method uses the weighted average cost of
capital (WACC) as the appropriate discount rate.
    75. C.


    76. C.
    Recall the WACC equation:
    WACC=[wdx kdx (1-t)]+(wps, x kps)+(wcex ks)
    The increase in the corporate tax rate will result in a lower
cost of debt, resulting in a lower WACC for the company.
    77. C.
    0.10×12%+0.30×8%×(1-0.35)+0.6×14.5%=11.46%.
    78. C.
    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.
    79. C.
    A firm with a $1.50 dividend last year, a dividend payout ratio
of 40% , a return on new investment of 12%, and a 15% required return
is worth $20.64. The growth rate is (1-0.40)× 0.12=7.2%. The
expected dividend is then $ 1.50×1.072=$ 1.61. The value is then
(1.61)/(0.15-0.072):$20.64.
    80. C.
    To determine whether the trader should purchase the stock, we
need to determine if the stock is overvalued or undervalued. Given
the information in this problem, we will use the price/earnings (P/E)
ratio and the earnings per share (EPS) to calculate an estimated
value.
    The P/E ratio=Dividend Payout Ratio/(k-g),
    Dividend payout=1-retention=1-0.35=0.65
    g=retention rate×ROE=0.65×0.13=0.0845
    P/E=0.35/(0.11-0.0845)=13.725
    EPS=[(Per share Sales Estimate)×(EBITDA %)-D(per share)-I(per
share)]×(1-t)=[($0.175×0.22)-$20-$12]×(1-0.40)=$3.90
    Value of stock=EPS×P/E=13.725×$ 3.90=approximately $ 53.50
    Conclusion: The trader should purchase a block of the stock. It
is undervalued by the difference between the market price and the
estimated value, $ 53.50 -$ 45.50, or approximately $ 8.00.
    81. A.
    Growth companies may or may not be growth stocks. If the market
has identified the company as a growth company and bid up the price,
the stock may have below normal returns. The stock price may be more
(typically) or less than intrinsic value.
    82. C.
    The trailing P/E would be negative.
    83. A.
    The disadvantages of using PBV ratios are: Book values are
affected by accounting standards, which may vary across firms and
countries; Book value may not mean much for service firms without
significant fixed costs ; Book value of equity can be made negative
by a series of negative earnings, which limits the usefulness of the
variable.
    84. A.
    Proceeds in a primary market go to the issuing firm less
flotation costs if any. Proceeds in the secondary market go directly
to the current owner or seller of the securities.
    85. A.
    The third market is the portion of the Over the Counter (OTC)
market in which non-member investment firms can make markets in and
trade registered securities without going through the exchanges. The
fourth market describes the direct exchange of securities between
investors without using the services of a broker. Block trades are
large trades often made by institutions.
    86. A.
    Using the security market line (SML) equation: 4%+1.4×9%=16.6%.
    87. C.
    An initial margin requirement of 40% would mean that the investor
must put up 40% of the funds and brokerage firm may lend the 60%
balance. Therefore, for this example (100 shares ×($ 50)=$ 5000
total cost. $ 5000×0.60=$ 3000.
    88. B.
    ROE=(EAT/Sales)(Sales/Total Assets)(Total Assets)
    ROE=0.1×1.2×1.3=0.156
    g=(retention ratio)(ROE)=0.5×0.156=0.078 or 7.8%
    89. A.
    Simple trading rule, autocorrelation and runs tests generally
find evidence suggesting that technical analysis based on historical
information does not generate significant excess returns.
    90. B.
    Cash Flow = NI/share+Depr/share=$ 6+$ 2=$ 8
    Price/cash flow=$100/$ 8.0X=12.5X
    91. C.
    N=40, PV=300, FV=1000, CPTI=3.055×2=6.11.
    92. C.
    By purchasing bonds 2 and 3 and selling bond 1, the investor
could obtain a arbitrage profit of $65.38 (10000-374.62-9560). This
action will result in positive income today in return for no future
obligation—an arbitrage opportunity. Notice that in year 1, the
principal payment from bond 2 will cover the bond 1 coupon obligation.
In year 2, the coupon payment and principal obligation for bond 1
will be covered by the principal payment from bond 3.
    93. C.
    Total interest expense is the difference between the amount paid
by the issuer and the amount received from the bondholder.
    Present value of the bond is computed as follows: FV=1000,
PMT=(1000×0.08)/2=40, I/Y=5, N=10, CPTPV=-923.
    [($40 coupon payments)×(10 periods)+$1000 par value]-$923
present value of the bond=477
    94. C.
    To calculate the CY and YTC, we first need to calculate the
present value of the bond: FV=1000, N=14=7×2, PMT=35=(1000×0.07)/2,
I/Y=4.5(9/2), CPT PV=-897.77
    (negative sign because we entered the FV and payment as positive
numbers).
    Then, CY=(Face value×Coupon)/PV of
bond=(1000×0.07)/897.77=7.80%.
    And finally, YTC calculation: FV=1060 (price at first call),
N=4(2×2), PMT=35(same as above), PV=-897.77 (negative sign because
we entered the FV and payment as positive numbers), CPT I/Y=7.91
(semi-annual rate, need to multiply by 2)=15.82%.
    95. B.
    Other things being equal, the amount of reinvestment risk
embedded in a bond will decrease with lower coupons because there
will be a lesser dollar amount to reinvest and with shorter
maturities because the reinvestment period is shorter.
    96. A.
    The nominal spread is simply the yield to maturity on a bond
minus the yield to maturity on a Treasury security of a similar
maturity. Because the nominal yield is based on the yield to maturity,
it suffers the same shortcomings as yield to maturity. The yield
measures assume that all cash flows can be discounted at the same
rate (i. e. assumes a flat yield curve). They also assume that all
coupon payments will be received in a prompt and timely fashion, and
reinvested to maturity, at a rate of return that is equal to the
appropriate solving rate (i. e. the bond's YTM or its BEY).
    97. C.
    Option cost ( Bond X)=Z-spread-OAS=68bp-55bp=13bp
    Option cost (Bond Y)=Z-spread-OAS=78 bp-100bp=-22bp
    98. A.
    Spot interest rates are the result of market participant's
tolerance for risk and their collective view regarding the future
path of interest rates. If we assume that these results are purely a
function of expectations, we can use spot rates to estimate the
market's consensus on forward interest rates.
    99. C.
    The duration computation remains the same. The only difference
between modified and effective duration is that effective duration is
used for bonds with embedded options. Modified duration assumes that
all the cash flows on the bond will not change, while effective
duration considers expected cash flow changes that may occur with
embedded options.
    100. C.
    Recall that the percentage change in prices=Duration
effect+Convexity effect=[-duration× (change in
yields)]+[convexity×(change in yields)2]=(-7)×0.02+45×0.022=-
0.122=-12.2%. Remember that you must use the decimal representation
of the change in interest rates when computing the duration and
convexity adjustments.
    101. C.
    Exchange-traded derivatives have relatively low default risk
because the clearing house stands between the counter parties
involved in most contracts.
    102. A.
    The swap described in A will obligate Magma to pay a fixed
interest rate unaffected by LIBOR. It will also reward Magma with an
interest receipt that increases as LIBOR increases. If LIBOR
increases as expected, Magma will receive a larger interest inflow,
but its interest outflow will be unaffected.
    103. A.
    ($0.98-$0.97)×10 million=$100000 loss. Therefore, a payment must
be made.
    104. B.
    An open call position can be closed before expiration by selling
call options on the underlying stocks. A call writer who deposits
shares of the underlying stock has written a covered call.
    105. C.
    A short position in an FRA will have a positive payoff when the
reference rate is less than the contract rate, and a negative payoff
when the reference rate is greater than the contract rate, at
expiration. A short interest rate call will have a negative payoff
when the reference rate is greater than the strike rate, and a long
put will have a positive payoff when the reference rate is less than
the strike rate.
    106. A.
    VT=ST-4-Max (0, X-ST)
    VT=$0.70+Max (0, 0.75-0.70)=$0.75
    =VT-V0=0.75-(S0+p0)=0.75-(0.67+0.14)=-$0.06
    107. A.
    Using the income approach: ($1800000-$1200000)/0.15=$ 4000000.
    108. A.
    The fee charged by a fund of funds is in addition to that changed
by each hedge fund, so the fees would most likely increase.
    109. B.
    Closed-end investment companies are initiated through a stock
offering to raise funds. The investment company does not issue or
redeem shares after the initial offering. Shares of a closed-end
investment company are traded in public markets and are priced by
supply and demand. The share price of a closed-end fund is not
directly linked to the fund's net asset value (NAV). The NAV is the
prevailing market value of all the shares and assets owned by the
fund. Many closed-end funds sell at a discount of 5 to 20 percent
from their NAV.
    110. B.
    NAV=(Total Market Value of assets-liabilities)/Total Number of
Shares Outstanding)=
(6200×10+6000×34+5900×8+2600×52)/18700=432400/18700=23.12
    111. A.
    Market-neutral funds take long and short positions but attempt to
offset them to hedge against market moves. Long/short funds take both
long and short positions but do not try to offset them. Event-driven
funds focus on unique market opportunities, not offsetting positions.
    112. C.
    The total return on the position equals the gain on the futures
position plus the return on the Treasury bills:
$ 500000+$10000000×4.75%×90/360=$ 618750.
    113. B.
    The stocks of a gold mining company, an oil and gas exploration
company, and a timber company are highly correlated with commodities
prices, because their values are closely linked to the price of the
commodities they produce. A supermarket chain will be more
diversified, and many other factors will contribute to the value of
the company.
    114. C.
    Investing in distressed securities is similar to venture capital
investing because both strategies seek an equity position in a
company that is eventually successful. Both are illiquid investments
with long time horizons.
    115. A.
    A risk-averse investor prefers less risk to more risk. The lower
the correlation, the greater the risk reduction. Thus, a risk-averse
investor would most prefer the portfolio with the lowest correlation
coefficient and least prefer the one with the highest. Of the choices
given, A and C's correlation coefficient of +0.6 is the highest.
    116. A.
    In the absence of a riskless asset, the optimal portfolio for an
investor is the point of tangency between the efficient frontier and
the highest possible indifference curve for the investor.
    117. C.
    Points on the CML do not represent individual securities, but
rather portfolios that contain a well diversified portfolio (the
tangency portfolio) combined with either lending or borrowing at the
risk-free rate.
    118. C.
    When you increase the number of the stocks in a portfolio, the
unsystematic risk fails and the systematic risk remains constant. The
total risk falls toward the level of market risk(systematic risk).
    119. B.
    Portfolio A does not lie on the efficient frontier because it has
a lower return than Portfolio B but has greater risk. Portfolio D
does not lie on the efficient frontier because it has higher risk
than Portfolio C but has the same return.
    120. C.
    According to the SML equation, the following expected (required)
rates of return for these four stocks are :
    RA=0.05+0.6×(0.12-0.05)=0.092 or 9.2%
    RB=0.05+1.0×(0.12-0.05)=0.120 or 12.0%
    RC=0.05+1.2×(0.12-0.05)=0.134 or 13.4%
    RD=0.05+1.8×(0.12-0.05)=0.176 or 17.6%
                                       Estmated
                                     Return
    S      Estimated    Required                    Evaluatio
 tock     Return       Return                          n
                                      -Required
                                     Return
                                                    Overvalue
    A         8.0%         9.2%          -1.2%
                                                       d
                                                     Propenly
    B        12.0%        12.0%           0.0%
                                                   valued
                                                    Undervalu
    C        18.0%        13.4%           4.6%
                                                      ed
                                                    Undervalu
    D        22.5%        17.4%           4.9%
                                                      ed
    If the estimated return is greater than (less than) the required
return, the stock is undervalued (overvalued) , but if the two
returns are approximately equal then the stock is properly valued.

				
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