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  • pg 1
									                               Sample Exam 2
                              Morning Session
     Questions 1 through 18 relate to Ethical and Professional
Standard and are allocated 27 minutes.
    1. Vivian, CFA, a research analyst assigned to Double Limited,
has been recommending the stock's purchase in her quarterly report.
Vivian has recently married and just discovered her husband's trust
account owns several million dollars worth of Double Limited. The
stock makes up more than 50 percent of the trust's value but less
than 5 percent of Double Limited's outstanding shares. According to
AIMR Standards of Professional Conduct, Vivian should:
    A. take no action because the stock is not in her name.
    B. disclose her interest in the stock at the time of her next
    C. cease including Double Limited stock in her report.
    2. Which of the following violates the AIMR Standards of
Professional Conduct on the appropriate use of the Chartered
Financial Analyst and CFA mark?
    A. Timmy has past Level Ⅱ and is registered to take the Level Ⅲ
examination. In her resume she states, "I am a Level Ⅱ candidate in
the CFA Program. "
    B. Timmy has passed all three levels of the CFA Program, has
received her charter, and is a charter holder in good standing. She
writes on her business card, "Timmy Wong, Chartered Financial Analyst.
    C. Timmy has passed all three levels of the CFA Program, has
received her charter, and is a charter holder in good standing. Her
company writes in promotional literature "Timmy Wong is one of two
CFAs in the company".
    3. John, CFA, wants to undertake an independent consulting
practice while employed. He must get written permission from both his
employer and the company who is hiring the analyst's consulting
services. According to the AIMR Standards on Professional Conduct,
which of the following statements about the permission request is
most correct? This permission request to the employer should mention
    A. type of services he will perform.
    B. compensation he will receive.
    C. all of the above.
    4. As part of an AIMR investigation into the conduct of Helen,
CFA, AIMR requests records from Helen about her investment accounts.
Helen writes AIMR a letter stating that under Standard Ⅳ (B),
Preservation of Confidentiality, that she is unable to comply with
their request. Which of the following statement is TRUE?
    A. is correct in her interpretation of Standard Ⅳ (B).
    B. should not turn over the information because it will violate
federal material nonpublic information statutes and AIMR's Standard
Ⅴ (A) Prohibit against Use of Material Nonpublic information.
    C. will no be in violation of Standard Ⅳ (B) by turning over the
requested information because under the Professional Conduct Program,
the Disciplinary Review Subcommittee is considered an extension of
    5. According to the CFA Institute Standards of Practice handbook,
insider trading is the least likely to be prevented by establishing:
    A. fire walls.
    B. watch list.
    C. selective disclosure.
    6. Pamela Gee is a portfolio manager. She is planning to
establish her own money management firm. She has already informed her
employer, Branford, Inc., about her plans. In her remaining time at
Branford, she can:
    A. start the registration of her new company.
    B. solicit Branford colleagues but not Branford clients.
    C. inform her current clients about her resignation and let them
know how to reach her, in case any problems arise in the future.
    7. For years, John Berger, a CFA charterholder and CEO of a
company, relied upon a set of reasonable procedures for preventing
violations of the Standards of Practice in the firm. The company has
recently arranged to have members of CFA Institute as mid-level
supervisors throughout the firm. With this arrangement Berger has
delegated the supervision of employees with respect to the Code and
Standards to the mid-level managers. With this action Berger:
    A. is still responsible for seeing that procedures are in place
to prevent violations of the Code and Standards.
    B. is relieved of his obligation to supervise the employees under
the mid-level supervisors.
    C. has violated Standard Ⅳ (C), Responsibilities of Supervisors.
    8. Jack Salyers, CFA, is considering starting his own firm to
compete with his current employer. He takes several actions before
turning in his resignation. Which of the following actions is NOT in
violation of Standard Ⅳ (A), Loyalty to Employer?
    A. Before leaving, Jack solicits his employer's current clients.
    B. Jack told his employer that he was considering leaving and
requested that the employer write him a letter of recommendation.
    C. Jack took home client lists and investment statements.
    9. A CFA charter holder in a managerial position is in the
process of hiring new analysts. If the charter holder conducts
background checks on the job applicants with respect to their
character, the charter holder has:
    A. complied with Standard Ⅰ (D) concerning professional
    B. violated the Code of Ethics by invading the applicants'
    C. violated Standard Ⅲ (E) concerning confidentiality.
    10. Don Benjamin, CFA, is the compliance officer for a large
brokerage firm. He wants to prevent the communication of material
nonpublic information and other sensitive information from his firm's
investment banking and corporate finance departments to its sales and
research departments. The most common and widespread approach that
Benjamin can use to prevent insider trading by employees is the:
    A. Wall Street Rule. B. legal list. C. fire wall.
    11. Gordon is a CFA charter holder and the pension fund manager
for a worker's union. The union president informed him that during a
union meeting today with Zinc Limited he learned that Zinc will
announce several plant closings tomorrow. Because the worker's union
pension has a sizable position in Zinc, the union president wants
Gordon to sell the pension's holdings in Zinc today before the
announcement is made public. Gordon should:
    A. inform CFA Institute in writing of the union president's
    B. contact the Justice Department and tell them about the union
president's request.
    C. tell the union president that this action is illegal and
refuse to sell the stock until after the announcement.
    12. While working on her report, Jean Paul, CFA, learns from her
friend in the investment banking department that the company she is
analyzing can expect a tender offer very soon. Concerning this
conclusion, Paul can:
    A. trade on it, because she figured it out by herself.
    B. trade on it, because it is public information.
    C. not trade on it because it is material nonpublic information.
    13. If an analyst has a policy of making an inquiry into a
client's financial situation, investment experience, and investment
objectives regularly, this is:
    A. a violation of Standard Ⅲ (E), concerning client
    B. a violation of the disclosure requirements of Standard Ⅵ (A).
    C. congruent with Standard Ⅲ (C) , Suitability.
    14. The best way to determine the suitability of an investment is:
    A. based on portfolio performance results, presented as a
weighted average, from the biggest financial companies.
    B. with the help of the special performance presentation
    C. to consider the financial situation, investment experience,
and investment objectives of the client.
    15. A CFA charter holder who comes to work intoxicated is:
    A. in violation of Standard Ⅳ (A) concerning duties to employer.
    B. not in violation of the standards.
    C. in violation of Standard Ⅰ (D) concerning professional
    16. Joni Black, CFA, works for a portfolio management firm. Black
is a partner of the firm and is primarily responsible for managing
several large pension plans. Black has just finished a research
report in which she recommends Zeta Corporation as a "Strong Buy."
Her rating is based on solid management in a growing and expanding
industry. She just handed the report to the marketing department of
the firm for immediate dissemination. Upon returning to her desk she
notices a news flash by CNN reporting that management for Zeta
Corporation is retiring. Black wishes she did not recommend Zeta
Corporation as a "Strong Buy," but believes the corporation is still
a good investment regardless of the management. What course of action
for Black is best? Black:
    A. should revise the recommendation based on this new information.
    B. is not obligated to revise the recommendation regarding
material changes in the corporation because the information was
public and not private information.
    C. should report the new information to her immediate supervisor
so that they can determine whether or not the marketing department
should send out the report as written.
    17. An analyst is serving on the Board of Directors of a local
publicly traded company. To avoid violating the CFA Institute Code
and Standards, the analyst must disclose this to:
    A. only his employer.
    B. both his employer and his clients and prospective clients.
    C. only clients and prospective clients.
    18. Phil Trobb, CFA, is preparing a purchase recommendation on
Aneas Lumber for his research firm. All of the following are
potential conflicts of interest EXCEPT:
    A. Aneas hires Trobb as a consultant to analyze Aneas' financial
    B. Trobb's family trust has a large stake of ownership in Aneas
    C. Trobb's cousin repairs machines for Aneas.
    Questions 19 through 32 relate to Quantitative Methods and are
allocated 21 minutes.
    19. An investor will receive an annuity of $ 5000 a year for
seven years. The first payment is to be received 5 years from today.
If the annual interest rate is 11.5 percent, what is the present
value of the annuity?
    A. $13453. B. $23185. C. $15000.
    20. The financial manager at Genesis Company is looking into the
purchase of an apartment complex for $ 550000. Net after-tax cash
flows are expected to be $ 65000 for each of the next five years,
then drop to $ 50000 for four years. Genesis' required rate of return
is 9 percent on projects of this nature. After nine years, Genesis
Company expects to sell the property for after-tax proceeds of
$ 300000. What is the internal rate of return (IRR) and net present
value (NPV) on this project?
    A. 6.66% -$ 64170
    B. 7.01% -$ 53765
    C. 8.09% -$ 21535
    21. Most empirical studies of technical trading rules have found
that past stock price patterns:
    A. do not repeat, and therefore technical analysis is profitable.
    B. repeat, and therefore technical analysis is not profitable.
    C. do not repeat, and therefore technical analysis is not
    22. A well-diversified Investor most likely prefer a portfolio
    A high or low sharpe ratio Positive ornegative skewness
    A. low Positive
    B. low Negative
    C. high Positive
    23. Given the following table about employees of a company based
on whether they are smokers or nonsmokers and whether or not they
suffer from any allergies, what is the probability of being either a
nonsmoker or not suffering from allergies?
               Suffer from        Don't Suffer from
              Allergies             Allergies
                   35                    25               60
                   55                    185              240
    Total          90                    210              300

    A. 0.38. B. 0.88. C. 0.50.
    24. Compared with fundamental analysis, does technical analysis
place more emphasis on:
    a company's financial determining the effects of specific events
    accounting statements? on the value of a company's stock?
    A. No No
    B. No Yes
    C. Yes No
    25. What is the effective annual rate if the stated rate is 12
percent compounded quarterly?
    A. 12.00%. B. 12.55%. C. 3.00%.
    26. An analyst conducts a two-tailed test to determine whether
differences between the means of two populations exist: H0:μ1-μ2=0
versus H2:μ1-μ2≠0. Assume that the populations are independent,
normally distributed, and have unequal and unknown variances. The
critical value with 50 degrees of freedom is 2. 126. The computed
test statistic is t=1.753. Using a significance level of x=0.05,
which of the following statements is TRUE?
    A. Use a t-test to reject the null hypothesis and accept the
alternative hypothesis.
    B. Use a t-test to accept the null hypothesis and reject the
alternative hypothesis.
    C. Use a z-test to reject the null hypothesis and accept the
alternative hypothesis.
    27. In the mid 1980s J. J. Ellerson and the Boys was a famous
regional blues band. In the late 1980s, J. J. embarked on a solo
career and the rest of the band gradually folded. Now, the band is
Considering a reunion concert and may even reunite. K. Scotty, a die-
hard fan and CFA, feels that the following probabilities are correct:
The probability that the reunion concert will occur whether or not
the band reunites is 0.60. The probability that the band will get
back together is 0.30. The probability that the band will get back
together if the reunion concert occurs is 0.65. Which of the
following statements is TRUE?
    A. The chance of the band reuniting is not a dependent event.
    B. The given probability for a reunion concert is an a priori
    C. The reunion concert is an independent event.
    28. If the probability of both a new Wal-Mart and a new Wendy's
being built next month is 68 percent and the probability of a new
Wal-Mart being built is 85 percent, what is the probability of a new
Wendy's being built if a new Wal-Mart is built?
    A. 0.70.
    B. 0.60.
    C. 0.80.
    29. An analysis conducted a significance test to determine if the
relationship between two variables was real or the result of chance.
His null hypothesis is the that the population correlation
coefficient is equal to zero and his alternative hypothesis is that
the population correlation coefficient is different from zero. He
developed the following information:
    Value of the test statistic 2.8092
    Critical value at the 0.05 significance level 1.96
    Critical value at the 0. 01 significance level 2.58
    The analyst conducted a:
    A. one-tailed test and can reject-his null hypothesis.
    B. Two-tailed test and can reject his null hypothesis.
    C. One-tailed test and cannot reject his null hypothesis.
    30. Regardless of the shape of a distribution, according to
Chebyshev's Inequality, what is the minimum percentage of
observations that will lie within + or - two standard deviations of
the mean?
    A. 68%. B. 34%. C. 75%.
    31. George-Hack is evaluating the risk level in his portfolio of
approximately 20 U. S. stocks. He is only concerned with the
possibility of earning a rate of return on the portfolio below what
he can earn on T-bills. T-bills have been earning approximately4% on
average over the last few years. The most appropriate measure of risk
for Hack's portfolio is:
    A. variance. B. range of returns. C. semivariance.
    32. For a certain class of junk bonds, the probability of default
in a given year is 0.2. Whether one bond defaults is independent of
whether another bond defaults. For a portfolio of five of these junk
bonds, what is the probability that zero or one bond of the five
defaults in the year ahead?
    A. 0.5904. B. 0.7373. C. 0.0819.
    Questions 33 through 44 relate to Economics and are allocated 18
    33. Which of the following statements about monopolies is most
    A. A monopolist's optimal production quantity is at the point
where marginal revenue equals marginal cost.
    B. Monopolists charge the highest possible price.
    C. Monopolists always make a profit.
    34. Which one of the following statements best expresses the
central concept of counter cyclical fiscal policy?
    A. Planned deficits are experienced during economic booms, and
planned surpluses during economic recessions.
    B. The balanced budget approach is the proper criterion for
determining annual budget policy.
    C. Deficits are planned during economic recessions, and surpluses
are used to restrain inflationary booms.
    35. The economy is in recession, and counter cyclical fiscal
policy has been enacted. If the policy has been effective and the AD
curve has moved upward to the right, the result is:
    A. lower prices and more output.
    B. higher prices and more output.
    C. lower prices and lower unemployment.
    36. A market has the following characteristics: a large number of
independent sellers each producing a differentiated product, low
barriers to entry, producers face downward sloping demand curves, and
demand is highly elastic. This description most closely describes:
    A. a monopoly.
    B. an oligopoly.
    C. monopolistic competition.
    37. Suppose that rubber is the primary input in the production of
golf balls. If the price of rubber increases while all else remains
constant, then in the short-run:
    A. the marginal and average variable cost curves shift upward,
but not the average total or average fixed cost curves.
    B. the average total and average variable cost curves shift
upward, but the marginal and average fixed cost curves will shift
    C. the marginal, average variable, and average total cost curves
will shift upward, but the average fixed cost curve will not shift.
    38. Under a price ceiling, bribery is a mechanism to:
    A. allocate a good to the poorest individuals in the market.
    B. allocate a good to the richest individuals in the market.
    C. bring the total price of a good (including the bribe) higher
and closer to the equilibrium price.
    39. Alice Costain operates a convenience store in the financial
district of London. ff Costain increases the price of a Magnim ice
cream bar from 1.00 to 1.15, weekly sales decrease from 200 units to
180 units. Which of the following statements is most accurate?
    A. The price elasticity of demand is -0.66.
    B. The slope of the demand curve equals the elasticity of demand.
    C. The price increase will lead to an increase in total value of
Magnim ice cream bars.
    40. Assume that the supply of ethanol is relatively more elastic
than the demand for ethanol. Compared to an initial competitive
equilibrium in the market for ethanol, the imposition of a per-gallon
tax on producers of ethanol will most likely:
    A. decrease producer surplus by the total amount of tax collected.
    B. decrease producer surplus by less than it reduces consumer
    C. decrease the sum of consumer and producer surplus by the
amount of tax collected.
    41. Which of the following types of business firms exposes its
owners to the greatest legal liability in the U.S. and which type of
firm is most likely to face a principal-agent conflict?
    Liability Principal-agent conflict
    A. Corporation Corporation
    B. Corporation Partnership
    C. Proprietorship Corporation
    42. Which of the following events is most likely to increase
short-run aggregate supply (shift the curve to the right)?
    A. High unemployment puts downward pressure on money wages.
    B. A rise in resource prices.
    C. Inflation that results in an increase in goods prices.
    43. A firm has the following characteristics:
    Relatively small in size
    Marginal revenue is equal to the selling price
    Economic profits will not be earned for any significant period of
    The firm is best described as existing in a(n):
    A. purely competitive market.
    B. price searcher market.
    C. monopolistic market structure.
    44. Based On historical data and assuming less-than-full
employment, periods of sharp acceleration in the growth rate of the
money supply tend to be associated initially with
    A. periods of economic recession.
    B. an increase in the velocity of money.
    C. a rapid growth in gross domestic product.
     Questions 45 through 78 relate to Financial Statement Analysis
and Corporate Finance and are allocated 51 minutes.
    45. Which of the following is least likely to be considered a
role of financial statement analysis?
    A. Determining whether to invest in the company's securities.
    B. Deciding whether to extend trade credit to the company.
    C. Assessing the management skill of the company's executives.
    46. Which of the following statements about financial statements
and reporting standards is least accurate?
    A. Reporting standards focus mostly on format and presentation
and allow management wide latitude in assumptions.
    B. The objective of financial statements is to provide economic
decision makers with useful information.
    C. Financial statements could potentially take any form if
reporting standards didn't exist.
    47. Jessica Hightower, CFA, is analyzing the financial statements
for a local industrial solvent $ 40 million at the end of 2005. Over
the same time period, TYU was able to increase the number of units
sold by 7 percent. In making adjustments to the income statement to
reflect economic really, Hightower should adjust income:
    A. only if the decline was caused by tailing prices.
    B. only if the decline was caused by inventory liquidation.
    C. if the decline was caused by either falling prices or
inventory liquidation.
    48. Which of the following about a company using the percentage
of completion accounting method for long-term contracts, compared to
company that uses the completed contract method is FALSE?
    A. Actual cash flow will be greater in the first year.
    B. Equity will be higher in the first year.
    C. Earnings will be the same over the life of the contract.
    49. Barracuda Corporation, a U. S. corporation, owns a subsidiary
located in Germany. The German subsidiary's financial statements are
maintained in euros. If the euro recently appreciated relative to the
U.S. dollar, how would the unrealized translation gain affect
Barracuda's retained earnings and total stockholders' equity?
    Retained earnings Total stockholders' equity
    A. No effect No effect
    B. Increase Increase
    C. No effect Increase
    50. When considering convertible preferred stock which of the
following components of the earnings per share (EPS) equation needs
to be adjusted to calculate diluted earnings per share?
    A. The numerator.
    B. The denominator.
    C. The numerator and denominator.
    51. Michael Robe, CFA, is a junior analyst for a large financial
institution and has been preparing an analysis of United Mines, a
coal mining company located in the United States. As part of his
research, he examines the company's proxy voting and rules and
practices. Which of the following policies would be considered the
most restrictive to shareholders?
    A. United Mines allows proxy voting.
    B. Shareholders of United Mines are allowed to cast confidential
votes but must be present to do so.
    C. United Mines requires shareowner attendance to vote but
coordinates the timing of its annual meeting to hold them on the same
day as other companies in the region.
    52. Is the following statement an accurate description of the
account format and report format of presenting a balance sheet?
    "The account format presents the asset, liability, and equity
accounts in a single column while a report format presents the assets,
liabilities, and equity in multiple columns."
    Account format Report format
    A. No Yes
    B. Yes No
    C. No No
    53. John Stone, CFA, is an investment advisor specializing in the
preparation of company and industry reports for high net worth
customers at Learmon Brothers. Currently, Stone is preparing a report
on Soft Corporation, a rapidly growing software company. The
explosive growth of this company was financed primarily by an initial
public offering in which 3000000 shares were issued at a price of
$ 20 per share on June 27, 2004. Soft Corporation received additional
capital when employee stock options for 1000000 shares at a price of
$10 were exercised on January 1,2005. Stone realizes the importance
of cash flow on a company's financial health and would like to
include a projected statement of cash flows for 2005. Soft
Corporation financial statements are presented in Tables 1 and 2.
Included are the actual statements for the year ending December 31,
                              Table 1
                  Soft Corporation Balance Sheets
                         as of December 31
                           (in millions)
                                           Actual     Projected
                                         2004          2005
    Cash                                    $24.0         $26.0
    Accounts Receivable                      17.0          24.0
    Inventory                               100.0         150.0
    PP&E                                    100.0         125.0
    Accumulated depreciation               (30.0)        (35.0)
                   Total Assets           $ 211.0       $ 290.0

payable$                          91.0
    Long-term debt
    Common stock
    Retained earnings
              Total liabilities and
                                          $211.0       $290.0
                              Table 2
                 Soft Corporation Income Statement
                    for Years Ended December 31
                (in millions except per share data)
                                          Actual      Projected
                                         2004          2005
   Sales                                  $ 80.0        $198.0
   COGS                                   (38.0)        (90.0)
                   Gross profit            $42.0        $108.0

   SG&A                                   (13.0)        (30.0)
   Depreciation                            (3.0)         (5.0)
               Operating expenses        $(16.0)       $(35.0)

   Interest expense                       $(4,0)       $(5.0)
   Pretax Income                            22.0         68.0
   Income tax expense                      (7.0)       (25.0)
   Net income                              $15.0        $43.0

   EPS                                     $2.0         $4.3

    Average shares outstanding
                                           7.5          10.0
    Dividends per share                    $0.1         $0.4

    Under the indirect method, what will Stone find Soft
Corporation's projected net change in cash to be for the year ending
December 31, 2005 ?
    A. $9000000. B. $2000000. C. $7000000.
    54. Selected information from Rockway, Inc.'s U. S. GAAP
financial statements for the year ended December 31, included the
following (in $):
                                   2004          2005
    Sales                       17000000      21000000
    Cost of Goods Sold          11000000      15000000
    Interest Paid                 800000       1000000
    Current Income Taxes
                                  700000       1000000
    Accounts Receivable          3000000       2500000
    Inventory                    2400000       3000000
    Property, Plant &            2000000      16000000
    Accounts Payable                1000000        1400000
    Long-term Debt                  8000000        9000000
    Common Stock                    4000000        5000000

    Using the direct method, cash provided or used by operating
activities (CFO) in the year 2005 was:
    A. $4300000. B. $5300000. C. $6300000.
    Use the following data to answer Question 55 to 57.
    Net Income $1000
    Depreciation expense 70
    Purchase of equipment 200
    Goodwill amortization 30
    Sale of motor car 25
    Sale of common stock 100
    Decrease in accounts receivable 40
    Increase in inventory 35
    Issuance of bonds 20
    Increase in accounts payable 30
    Increase in wages payable 15
    Capital stock exchanged for equipment 10
    55. Cash flow from operating activities is.
    A. $1065. B. $1090. C. $1135.
    56. Cash flow from investing activities is:
    A. -$200. B. -$175. C. $175.
    57. Cash flow from financing activities is:
    A. $100. C. $120. C. none of the above
    58. A company's beginning inventory was overstated by $ 3000, now
ending inventory is understated by $ 2000. If purchases were properly
reported, then earnings before taxes will be.
    A. understated by $ 5000.
    B. overstated by $5000.
    C. understated by $1000.
    Use the following date to answer question 59 to 61.
                         Units                Unit Price
                          709                   $2.00
     Purchases             556                   $6.00
       Sales               959                  $13.00
                       $ 2649 per
    SGA Expenses

    59. What is the Cost of Goods Sold using the Weighted Average
    A. $3604.02. B. $2918.00. C. $4142.00.
    60. What is the Cost of Goods Sold using the FIFO Method?
    A. $2772. 10. B. $8325.00. C. $2918.00.
    61. What is the ending inventory level in dollars using the FIFO
    A. $1744.20. B. $1836.00. C. $3604. 02.
    62. Which of the following statements about capitalizing expenses
and depreciation is most accurate?
    A. The capitalization of a marketing expenditure (instead of
expensing it immediately) will result in an increase in fixed asset
turnover ratio.
    B. The sum-of-years-digits depreciation method charges the
largest amount of depreciation in the first year and then decreases
at a declining rate each subsequent year.
    C. The sum-of-years-digits depreciation method charges the
largest amount of depreciation in the first year and then decreases
by a constant amount each subsequent year.
    63. Trayfield has recently hired a new accountant, Judy Roehk.
Upon reviewing Trayfield's financial statements, Roehk has determined
that Trayfield should be utilizing the double-declining balance (DDB)
depreciation method rather than straight-line method. If Trayfield
switches to the DDB method, which of the following results would be
least likely?
    A. Estimated future income will need to be revised.
    B. A gradual change in income.
    C. Depreciation expense increases.
    64. In calculating the weighted average cost of capital (WACC),
which of the following statements is least likely correct?
    A. The cost of preferred equity capital is the preferred dividend
divided by the price of preferred shares.
    B. The cost of debt is equal to one minus the marginal tax rate
multiplied by the coupon rate on outstanding debt.
    C. The cost of common equity is equal to the rate of return
stockholders require on the firm's common stock.
    65. A tax loss carry forward is best described as the:
    A. net taxable loss that can be used to refund paid taxes from
the previous year.
    B. difference of deferred tax liabilities and deferred tax assets.
    C. net taxable loss that can be used to reduce taxable income in
the future.
    66. A firm has a capital structure of 60% debt and 40% equity and
a dividend payout ratio of 50%. If a surplus results from first-pass
pro-forma financial statements based on estimated sales growth and
assuming the capital structure and dividend payout ratio are
maintained, which of the following changes in assumptions would
eliminate any surplus in a single step?
    A. The entire surplus will be used to pay down long-term debt.
    B. The dividend payout ratio will decrease to 30%.
    C. The entire surplus will be used to repurchase common stock.
    67. Temporary differences in taxable and pretax income:
    A. will always be reversed.
    B. may result in lower current taxes payable and higher future
taxes payable.
    C. are not reported on the balance sheet.
    68. If a firm chooses a capital lease over an operating lease, it
can expect to have a:
    A. lower debt-to-equity ratio.
    B. higher debt-to-equity ratio.
    C. higher return on assets.
    69. Scooter has leased equipment for a period of 10 years with
the following provisions:
    Lease payments $ 5000 per year
    Current value of equipment $ 45000
    Estimated useful life of equipment 15 years
    Salvage value no salvage value after 15 years
    At the end of ten years, Scooter has the option to buy the
equipment for $15000. The discount rate is 10 percent. Scooter should:
    A. capitalize this lease because the present value of the lease
payments exceeds 90% of its fair market value.
    B. capitalize this lease because the lease term is less than 75%
of the economic life of the equipment.
    C. treat this lease as an operating lease.
    70. Rita Sang is a member of the XYZ Company Board of Directors.
Rita's sister, Sarah Everett, is employed by XYZ as Vice President of
Information Systems. Kevin Ritter is also a member of XYZ's Board of
Directors and serves on XYZ's internal audit committee. Kevin's son,
Cary Ritter, is an audit manager with a major accounting firm. Cary
Ritter's firm does not provide audit services to XYZ. Which of the
following statements concerning independence is TRUE?
    A. Kevin Ritter is considered an independent board member but
Sang is not considered an independent board member.
    B. Both Kevin Ritter and Sang are considered independent board
    C. Sang is considered an independent board member but Kevin
Ritter is not considered an independent board member.
    71. Assume that Q-Tell Incorporated is in the communications
industry, which has an average receivables turnover ratio of 16 times.
If the Q-Tell's receivables turnover is less than that of the
industry, Q-Tell's average receivables collection period is most
    A. 12 days. B. 25 days. C. 20 days.
    72. Comparative income statements for E Company and G Company for
the year ended December 31 show the following (in $ millions):
                               E Company         G Company
             Sales                70                 90
     Cost of Goods Sold          (30)               (40)
         Gross Profit             40                 50
           Sales and
                                  (5)               (15)
         Depreciation             (5)               (10)
      Operating Profit             30                 25
      Interest Expense           (20)                (5)
       Earnings Before
                                  10                 20
         Income Taxes             (4)               (8)
    Earnings after Taxes           6                 12

    The financial risk of E Company, as measured by the interest
coverage ratio, is:
    A. higher than G Company's because its interest coverage ratio is
less than one-third of G Company's.
    B. higher than G Company's because its interest coverage ratio is
less than G Company's, but at least one-third of G Company's.
    C. lower than G Company's because its interest coverage ratio is
more than G Company's but less than three times G Company's.
    73. Which of the following sources of credit would an analyst
most likely associate with a borrower of the lowest credit quality?
    A. Revolving line of credit. B. Uncommitted line of credit. C.
Committed line of credit.
    74. Pannonia Enterprises, Inc. (PEI) has a target capital
structure of 40% debt with 60% equity. PEI's pretax cost of debt will
remain at 9% until the firm raises more than $200000 in new debt
capital, at which point its pretax cost of debt will increase to 9.5%.
PEI's cost of equity will increase when more than $ 400000 in equity
capital is raised. Which of the following choices is closest to PEI's
break point for debt capita?
    A. $ 200000. B. $400000. C. $500000.
    75. Ashlyn Lutz makes the following statements to her supervisor,
Paul Ulring, regarding the basic principles of capital budgeting:
    Statement 1: The timing of expected cash flows is crucial for
determining the profitability of a capital budgeting project.
    Statement 2: Capital budgeting decisions should be based on the
after-tax net income produced by the capital project.
    Which of the following regarding Lutz's statements is most
    Statement 1 Statement 2
    A. Correct Correct
    B. Incorrect Correct
    C. Correct Incorrect
    76. Timely Taxis, Ltd. has signed a long-term lease for 20
underground parking spots at $150 each per month for their fleet of
taxis. The firm currently has 18 taxis in operation and is performing
an NPV analysis on the purchase of a 19th taxi. The cost of parking
for the 19th taxi is best described as a(n):
    A. sunk cost. B. opportunity cost. C. incremental cost.
    77. An analyst gathered the following data about a project:
    Costs are $ 8000 plus $ 2000 in shipping and installation.
    For the next five years the project will annually generate $5000
in sales and $ 2000 in costs, not including depreciation.
    The project is being depreciated on a straight-line basis over
five years with no salvage value.
    The company's tax rate is 40% , and the weighted average cost of
capital is 10%.
    The project's net present value (NPV) is closest to:
    A. -$144. B. $144. C. $279.
    78. In a net present value (NPV) profile, the internal rate of
return is represented as the:
    A. slope of the NPV profile.
    B. intersection of the NPV profile with the horizontal axis.
    C. intersection of the NPV profile with the vertical axis.
    Questions 79 through 114 relate to Asset Valuation and are
allocated 54 minutes.
    79. Within an informationally efficient securities market, new
information results in profit-maximizing investors making price
adjustments that are best described as:
    A. predictable but not unbiased.
    B. unbiased but not predictable.
    C. neither unbiased nor predictable.
    80. What will happen to interest rate risk for an option-free
bond if market yields decrease?
    A. Interest rate risk will increase.
    B. Interest rate risk is indeterminate because this type of risk
does not depend directly on the movement of market yields.
    C. Even if the term structure is flat, interest rate risk could
go up or down based on the level of the term structure at the time
market yields decrease.
    81. Consider two options A and B. Option A has a strike price of
$40 and is selling in the market for $ 4. Option B has a strike price
of $32 and is selling in the market for $3. The underlying assets for
the options, Stock A and Stock B, have a current market price of $ 43
and $ 29, respectively. Which of the following are most likely TRUE
about option A and option B?
    Option A Option B
    A. Expiring call In-the-money put
    B. In-the-money put Expiring call
    C. In-the-money call Expiring put
    82. An implication of the weak-form efficient market hypothesis
(EMH) is:
    A. insider information is of no value for obtaining excess
abnormal returns.
    B. that there should be no relationship between past price
changes and future price changes.
    C. that technical analysts can make excess returns on filter
rules but not runs rules.
    83. An analyst discovers a company with solid earnings but with
no prospect of growth. The company could still recommend it as a
growth stock:
    A. if the earnings remain solid.
    B. if it is a cyclical stock.
    C. if the market price of the stock is below its intrinsic value.
    84. According to the earnings multiplier model, which of the
following factors is the least important in estimating a stock's
price-to-earnings ratio? The:
    A. estimated required rate of return on the stock.
    B. historical dividend payout ratio.
    C. expected dividend payout ratio.
    85. David Farrington is an analyst at Farrington Capital
Management. He is aware that many people believe that the capital
markets are fully efficient. However, he is not convinced and would
like to disprove this claim. Which of the following statements would
support Farrington in his effort to demonstrate the limitations to
fully efficient markets?
    A. Fundamental analysts are poring over the same new information
that is disseminated to the public, so they do not provide any added
value to the efficiency of the markets.
    B. Technical analysis has been rendered useless by many academics
who have shown that analyzing market trends, past volume and trading
data will not lead to abnormal returns.
    C. Processing new information entails costs and takes at least
some time, so security prices are not always immediately affected.
    86. If Heritage Company's current dividend per share is $1.00,
its current market price is $ 25, and its growth rate is 8 percent,
what is the implied rate of return on the company's stock?
    A. 8.0%. B. 12.0%. C. 12.3%.
    87. The following information pertains to a company's stock:
    The current stock price is $ 45 per share.
    Earnings and dividends have been growing at an annual rate of 8%.
    The company's earnings per share during the past year was $ 5.
    The dividend payout ratio is 40%.
    The company pays a 7% flotation cost if it sells new shares of
    Based on the dividend discount model, the stockholders' required
rare of return is.
    A. 12.0%. B. 12.4%. C. 12.8%.
    88. Cassie's Card Co. expects highly volatile earnings for the
next four years, and then they expect earnings to level off to their
normal rare of 8 percent. Dividends and earnings are expected to grow
at 20% for years 1 and 2, -5% for year 3, and 15% in year 4. The last
dividend paid by Cassie's was $ 2.00. If Jason Giggs requires a 12
percent return on Cassie's, the price he is willing to pay for the
stock is closest to:
    A. $ 52.15. B. $ 62.44. C. $ 56.60.
    89. Which of the following is a shortcoming(s) of the constant
growth dividend discount model?
    A. Firms with temporary high-growth expectations have
characteristics that are inconsistent with model.
    B. Many rapid growth companies pay little or no dividends, and
forecasting their future plans may be futile.
    C. All these choices are correct.
    90. The required rate of return on equity used as an input to the
dividend discount model is influenced by each of the following
factors EXCEPT:
    A. the expected inflation rate.
    B. the stock's appropriate risk premium.
    C. the stock's dividend payout ratio.
    91. For all patties involved, which of the following financial
instruments is NOT an example of a forward commitment?
    A. Swap. B. Call option. C. Futures contract.
    92. Money managers and individual investors can indirectly
participate in the commodities market through all of the following
investment vehicles EXCEPT:
    A. trading commodities in small denominations.
    B. futures contracts.
    C. bonds indexed to some commodity price.
    93. One advantage to using the price/book value (P/B) ratio over
using the price/earnings (P/E) ratio is that P/B can be used when:
    A. the firm is in a slow growth phase.
    B. earnings or cash flows are negative.
    C. stock markets are volatile.
    94. Which statement regarding sinking funds is least likely
    A. If rates have declined since the bond was issued, companies
are likely to choose to retire a proportion of the debt through the
delivery of securities.
    B. Sinking fund redemptions can be accomplished by making cash
payment to the trustee who will then retire the applicable proportion
of the bonds.
    C. The right to retire a greater portion of the bond issue than
is stipulated in the indenture is called an "accelerated sinking fund
    95. Which of the following statements about bond call features is
least likely correct? Embedded call options in callable bonds:
    A. can be valued using the difference between the zero-volatility
spread and the nominal spread.
    B. expose investors to reduced capital appreciation potential.
    C. create risk because they add uncertainty to the bond's cash
flow pattern.
    96. Which of the following statements about embedded options is
least likely correct?
    A. The call option on a bond cannot trade separately from the
    B. If the market value of a putable bond falls below the par
value, the issuer will likely exercise the option.
    C. The prepayment right granted with a mortgage favors the
    97. Austin Traynor is considering buying a $1000 face value,
semi-annual coupon bond with a quoted price of 104.75 and accrued
interest since the last coupon of $ 33.50. If Traynor pays the dirty
price, how much will the seller receive at the settlement date?
    A. $1047.50. B. $1081.00. C. $1014. 00.
    98. A U. S. bank enters into a plain vanilla currency swap with a
notional principal of US $ 500 million (GBP£ 300 million). At each
settlement date, the U. S. bank pays a fixed rate of 4.5 percent on
the British pounds received and the British bank pays a variable rate
equal to LIBOR on the U. S. dollars received. Given the following
information, what payment is made to whom at the end of year 2?
    0 1 2
    LIBOR=4% LIBOR=4.5% LIBOR=5%
    The U. S. bank pays:
    A. US $9513.50 million and the British bank pays 25.00 million.
    B. £ 13.50 million and thee British bank pays US $ 25.00 million.
    C. £ 13.50 million and the British bank pays US $ 22.50 million
    99. Which of the following five year bonds has the highest
interest rate sensitivity?
    A. floating rate bond.
    B. callable 5% coupon bond.
    C. zero-coupon bond.
    100. A portfolio manager anticipates a major increase in market
interest rates. Which trading strategy would be most likely to
generate above average returns in a bond investment? Purchasing:
    A. short maturity bonds with high coupon rates.
    B. speculative grade bonds with high coupon rates.
    C. bonds that will increase the average duration of the
investment portfolio.
    101. Which of the following statements about the call feature is
    A. call feature exposes investors to additional reinvestment rate
    B. call feature lengthens the bond' s duration, increasing price
    C. cash flow pattern of callable bonds cannot be known with
    102. Compared to the underlying MBS, a collateralized mortgage
    A. allows an investor to select an exact maturity.
    B. has lower duration.
    C. may have more or less prepayment risk.
    103. An investor is considering investing in a venture capital
project that will have a large payoff at exit, which is estimated to
occur in four years. The investor realizes that the risk of failure
is high, given the following estimated probabilities:
           Year            1        2        3          4
                         0.30     0.28     0.28       0.25
    The probability that the project will survive to the end of the
fourth year is:
    A. 25.00%. B. 27.75%. C. 27.22%.
    104. A mortgage-backed security has been divided into three
classes or tranches as follows:
    Tranche Ⅰ receives net interest and all the principal payments
until it is completely paid off.
    Tranche Ⅱ receives its share of net interest and starts
receiving all the principal repayments after Tranche Ⅰ has been
completely paid off. Prior to that, it only receives interest
    Tranche Ⅲ receives monthly net interest and starts receiving all
principal repayments after
    Tranches Ⅰ and Ⅱ have been completely paid off. Prior to that,
it only receives interest payments.
    For a relatively small decline in mortgage interest rates, which
of the tranches has the least amount of prepayment risk?
    A. Tranche Ⅰ. B. Tranche Ⅱ. C. Tranche Ⅲ.
    105. Which of the following is the most appropriate strategy for
a fixed income portfolio manager under the anticipation of an
economic expansion?
    A. Purchase corporate bonds and sell treasury bonds.
    B. Sell corporate bonds and purchase treasury bonds.
    C. Enter a pay-fixed, receive-floating rate swap.
    106. As compared to an equivalent non-callable bond, a callable
bond's yield should be:
    A. lower. B. higher. C. the same.
    107. A municipal bond carries a coupon of 6% and is traded at par.
To a taxpayer in the 340/0 tax bracket, this bond provides an
equivalent taxable yield of:
    A. 9.09%. B. 8.53%. C. 6.00%.
    108. Which of the following statements about the yield curve is
    A. A nonparallel shift occurs when rates change by the same
number of basis points for all maturities.
    B. A nonparallel shift is more common than a parallel shift.
    C. The yield curve usually has a non zero slope because rates
change by approximately the same number of basis points across
    109. The following information relates to a futures market
     Initial fufures pnice on
                                            $ 100
             Day 0
    Initial margin requirement               $ 5
        Maintenance margin
                                             $ 3
    Settlement price on Day 1               $103
    Settlement price on Day 2               $ 96
    Settlement price on Day 3               $ 98

    If no funds are withdrawn and margin calls are met at the
beginning of the next day, the ending balance on Day 3 for an
investor with a short position of 10 contracts is closest to:.
    A. $50. B. $70. C. $100.
    110. James Jackson currently owns stock in PNG, Inc., valued at
$145 per share. Thinking that PNG is overbought and will decrease in
price soon, Jackson writes a call option on PNG with an exercise
price of $148 for a premium of $ 2. 40. At expiration of the option,
PNG stock is valued at $152 per share. What is the profit or loss
from Jackson's covered call strategy? Jackson:
    A. gained $ 9.40. B. gained $ 5.40. C. lost $ 4.60.
    111. When a party to a forward contract terminates the contract
prior to the original expiration date by entering into a perfectly
offsetting forward contract with a second eounterparty:
    A. the party terminating the forward contract has no default risk,
but both counterparties lace default risk.
    B. the party terminating the contract is exposed to default risk,
but has no further asset price risk.
    C. there is no future liability, but default risk remains for all
parties until the original contract settlement date.
    112. In discussing the characteristics of exchange traded funds
(ETFs) in markets where capital gains are taxed, and analyst made the
following statements:
                   Compared to investment in a mutual fund, an
               investor exposure to taxes on capital gains
               distributions lower with an ETF
     Statement     Compared to a closed-end investment fund, an
       2       ETF is more likely to trade at net asset value

    Are the analyst's statements correct?
    Statement 1 Statement 2
    A. Yes No
    B. Yes Yes
    C. No No
    113. Hedge funds that contain infrequently traded assets would
most likely exhibit a downward bias with respect to:
    A. Measured risk but not correlations with conventional equity
    B. Correlations with conventional equity investments but not
measured risk
    C. Both measured risk and correlations with conventional equity
    114. A real estate investment has the following characteristics:
    Annual rental income $ 2700000
    Annual operating expenses $1800000
    Available mortgage rate 6%
    Financing percentage 90%
    Required holding period 5 years
    Investor Tax rate 25%
    Based on the income approach, the value of the investment is
closest to:
    A. $ 4000000. B. $5455000. C. $ 6000000.
    Questions 115 through 120 relate to Portfolio Management and are
allocated 9 minutes.
    115. Qiang Li is primarily concerned with growing his portfolio
using a balance between capital gains and reinvestment of current
income. Qian Yun is primarily concerned with achieving an investment
return that is no lower than the rate of inflation. Which of the
following objectives is most appropriate for:
    Qiang Li Qian Yun
    A. Total return Current income
    B. Capital appreciation Current income
    C. Total return Capital preservation
    116. Over long periods of time, which of the three major asset
allocation decisions account for 85 to 95 percent of returns?
    A. the asset classes to consider and which securities to choose.
    B. the asset classes to consider and the policy (normal) asset
class weights.
    C. the policy (normal) asset class weights and the allowable
range on those weights.
    117. Tobias Johansen, CFA, is currently fully invested in the
market portfolio that lies on the capital market line (CML). Johansen
desires to increase the expected return from his portfolio. Johansen
is risk averse but willing to accept higher risk if he can increase
the expected return from his portfolio. According to capital market
theory, Johansen can meet his risk and return objectives best by:
    A. allocating a higher proportion of the portfolio to higher risk
    B. borrowing at the risk-free rate to invest in the risky market
    C. selling low-risk stocks short and invest the proceeds in
higher-risk Stocks.
    118. Which of the following statements about risk and return is
    A. Return objectives may be stated in absolute terms or
    B. Specifying investment objectives only in terms of return may
expose an investor to inappropriately high levels of risk.
    C. Risk and return may be considered on a mutually exclusive
    119. An analyst wants to determine whether Dover Holdings is
overvalued or undervalued, and by how much (expressed as percentage
return). The analyst gathers the following information on the stock:
    Market standard deviation=0.70
    Covariance of Dover with the market=0.85
    Dover's current stock price (P0)=$ 35.00
    The expected price in one year (P1) is $ 39.00
    Expected annual dividend=$1.50
    3-month Treasury bill yield=4.50%.
    Historical average S&P 500 return=12.0%.
    Dover Holdings stock is:
    A. undervalued by approximately 2.1%.
    B. overvalued by approximately 1.8%.
    C. undervalued by approximately 1.8%.
    120. Bill Adams wants to diversify his portfolio by adding
certain assets that he expects to lower the overall standard
deviation of his portfolio. After selecting several different asset
classes. Adams constructed an efficient frontier using various
combinations of the assets. Adams can choose a portfolio on the
efficient frontier and achieve a diversified investment assuming all
of the following assumptions are true, EXCEPT:
    A. investors believe all investments are represented by a
probability distribution of expected returns and seek diversification
based on the variability of expected returns.
    B. investors base investment decisions solely on the expected
risk of the investment.
    C. investor utility curves exhibit diminishing marginal utility
of wealth.
                             Afternoon Session
    Questions 1 through 18 relate to Ethical and Professional
Standard and are allocated 27 minutes.
    1. Hui Chen, CFA, develops marking materials for an investment
fund he founded three years ago. The materials show the 3-, 2-and 1-
year returns for the fund. He includes a footnote that sates in small
print. "Past performance does not guarantee future returns." He also
includes a separate sheet showing the most recent semiannual and
quarterly returns, which have been neither audited nor verified.
According to the Standards of Practice Handbook, has Chen violated
any Standards of Practice?
    A. No.
    B. Yes, because he included un-audited and unverified results.
    C. Yes, because he did not adhere to the global investment
performance standards.
    2. Country X requires firms to present performance information
using only realized returns, while the GIPS standards require
calculations to be based on both realized and unrealized returns. A
firm located in country X:
    A. cannot claim compliance with GIPS unless it fully meets all
GIPS requirements.
    B. should follow the country's guidelines, and is allowed to
claim compliance with GIPS as long as all other GIPS requirements are
    C. should follow the country's guidelines, and is allowed to
claim compliance with GIPS as long as disclosure is made regarding
the conflict.
    3. Which of the following statements regarding the verification
of a company's claim to be in compliance with the GIPS standards is
NOT true?
    A. An initial verification must cover a minimum period of five
    B. Verification must be performed by an independent third-party.
    C. A verifier may accept the work of a previous verifier's part
of the basis opinion.
    4. After extensive research, retired portfolio manager, Ryan Wang,
CFA, purchased 20000 shares of a small public company. He then posted
messages on several Internet bulletin boards. The messages read,
"This stock is going up once the pending patents are released. You
would be crazy to sell anything below $5 in a few months from now.
The stock is a buy at anything below $5. I just bought 50 K shares
for my personal account. I have done some close research on these
guys. " According to the Standards of Practice Handbook, Ryan most
likely violated the Standard or Standards associated with:
    A. Conflicts of Interest and Integrity of Capital Markets.
    B. Conflicts of Interest, but not Integrity of Capital Markets.
    C. Integrity of Capital Markets, but not Conflicts of Interest.
    5. Gloria Arraria, CFA, is a stock analyst at a large
multinational bank trust department. A cash tender offer was
announced by a company whose stock was held by Arraria's employer as
well as by her sister. Under the terms of the offer, the first
million shares tendered would be accepted in full at $45 a share
(which was 15% above the existing market) and the next one million
shares on a pro rate basis also at $ 45 a share. Arratia immediately
called her sister with the news but waited a few days to tender
holdings of the trust department. This situation violated Standard:
    A. Ⅰ (B)Independence and Objectivity.
    B. Ⅵ (B) Priority of Transactions.
    C. Ⅳ (A) Loyalty.
    6. Which of the following is an appropriate statement for a Level
Ⅱ CFA candidate to make?
    A. I am a Level I CFA charter holder.
    B. I will be a CFA charter holder within 2 years.
    C. I passed the Level I CFA exam last year.
    7. Robert Hopkins has earned the right to use the CFA designation
and wants to indicate this on his business card. According to CFA
Institute Standards of Professional Conduct, which of the following
is the proper use of the professional designation on his business
    A. Robert Hopkins, CFA
    B. Robert Hopkins, CFA Charter holder
    C. Robert Hopkins, C. F. A.
    8. An analyst, who is a CFA Institute member, manages a high-
grade bond mutual fund. This is his only professional responsibility.
When the analyst comes across a speculative stock investment that he
feels is a good investment for his personal portfolio, the analyst:
    A. may invest in the stock because the analyst would not purchase
the stock for the bond portfolio he manages.
    B. may not invest in the stock because of his position as a
portfolio manager.
    C. is in violation of Standard Ⅳ (A), Loyalty to Employer, by
spending time analyzing stocks when he should only analyze bonds.
    9. Ray Stone, CFA, follows the Amity Paving Company for his
employer. Which of the following scenarios is Stone least likely to
have to disclose to his employer.
    A. Stone's personal relationship with the CEO of Amity.
    B. Stone's ownership of Amity securities.
    C. The fact that Stone's son worked at Amity as a laborer during
the summer while in school.
    10. Wei Zhang, CFA, manages accounts for high net worth clients
including his own family's account. He has no beneficial ownership in
his family's account. Because Zhang is concerned about the appearance
of improper behavior in managing his family's account, when his firm
purchases a block of securities, Zhang allocates to his family's
account only those shares that remain after allocation to his other
client accounts. The fee form managing his family's account is based
on his firm's normal fee structure. According to the Standards of
Practice Handbook, Zhang's best course of action with regard to
management of his family's account would be to:
    A. continue to manage his family's account but treat it like his
other client accounts.
    B. discontinue management of his family's account and arrange for
the account to be transferred to another firm.
    C. discontinue management of his family's account and arrange for
the account to he transferred to another investment manager in his
    11. Paul Thomas, CFA, is designing a new layout for research
reports his firm writes and issues on individual stocks. In his
design, Thomas includes a stock chart on the first page of each
report. He does not reference that the charts are copied from an
unrecognizable Finance web site. Thomas has:
    A. not violated CFA Institute Standards of Professional Conduct
because these charts are widely available over the Internet.
    B. violated CFA Institute Standards of Professional Conduct
because he did not make sure that the information in these charts is
    C. violated CFA Institute Standards of Professional Conduct
because he did not state the source of the charts.
    12. Which of the following statements is least accurate regarding
being a part of Standard Ⅲ (B), Fair Dealing?
    A. At the same time notify clients for whom an investment is
suitable of a new investment recommendation.
    B. Maintain a list of clients and their holdings.
    C. Shorten the time between decision and dissemination.
    13. Paul Salyer, CFA and portfolio manager is making a
presentation to a prospective client. Paul says that as a new
portfolio manager, he made an average annual rate of return of 50
percent in the last two years at his previous firm and that based on
this, he can guarantee a 50 percent return to the client. Which of
the following statements is in accordance with the Standard Ⅲ (D),
Performance Presentation?
    A. Implying that he can guarantee a return.
    B. Imputing his past performance to future performance.
    C. Stating his past performance as long as it is fact.
    14. A copyrighted technique for measuring the downside risk of an
investment has just been revealed to the public. If an analyst adopts
the technique, he must cite the use of the technique in all research
reports in which the technique is used EXCEPT:
    A. none of these answers provide grounds for an exception.
    B. if the analyst uses reasonable care and verifies that the
technique provides superior results.
    C. if the analyst modifies the technique slightly.
    15. Luis Rodriguez, CFA, is an analyst at XYZ Investments. He
covers a company that is located in a region that is not easily
accessible. The company invites analysts for their annual analyst
meeting and pays for the transportation to the remote location.
Rodriguez is:
    A. not allowed to accept the payment for transportation because
this is considered a "perk" and may influence his independent
    B. allowed to accept the payment for transportation as long as it
does not exceed $100.
    C. allowed to accept the payment for transportation because the
trip was all business and was out of the way.
    16. A CFA charter holder is caught shoplifting and is sentenced
to nine months in prison. Is this a violation of Standard Ⅰ (D)?
    A. Yes, because the prison sentence is more than six months.
    B. No, because the prison sentence is less than one year.
    C. Yes, because the crime involved stealing.
    17. Standard Ⅳ (B) Additional Compensation Arrangement, requires
that analysts inform their employer regarding additional compensation:
    A. in writing only, within 60 days after acceptance of the
    B. in writing or orally, upon receipt of the compensation.
    C. in writing only, upon receipt of the compensation.
    18. Judy Dudley, a CFA candidate, just started her new job as an
analyst and plans to make her first visit to a company that she is
analyzing. According to CFA Institute Standards of Professional
Conduct, which of the following statements regarding special cost
arrangements and gifts is TRUE? To comply with the standard, Dudley
should accept:
    A. only one gift per year from a company.
    B. air transportation and hotel expenses on company visits only.
    C. company air transportation only if commercial transportation
is not available.
    Questions 19 through 32 relate to Quantitative Methods and are
allocated 21 minutes.
    19. If no other estimator of a given parameter has a sampling
distribution with a smaller variance, the estimator used is best
characterized as:
    A. accurate. B. consistent. C. efficient.
    20. An analyst asked an junior associate to evaluate the
performance of group of mutual funds over the last 10 years. The
associate calculated the following performance statistics.
              Ceometr     Arihmet                   Mean
    Mutu                              Standar
           ic Mean     ic Mean                 Absolute
 al Fund                          d Deviation
            Return      Return                Deviation
      A        13.5%       16.2%       20.8%       25.6%
      B         16.9       14.3%       23.4%       19.2%

    The analyst suspects that the associate has made some errors in
calculating the performance statistics. Based only on the expected
mathematical relationship, between the two measures of return and
between the two measures of dispersion calculated by the associate,
did the associate most likely make errors in calculating the
statistics associated with:
    Mutual Fund A? Mutual Fund B?
    A. No No
    B. No Yes
    C. Yes Yes
    21. An analyst is investigating the distribution of the SMG
stock's return over time. He calculated the mode of 12 percent, the
mean of 11 percent, and the median of 11.5 percent. The distribution
can be best described as:
    A. positively skewed, with a long tail on the left side.
    B. negatively skewed, with a long tail on the left side.
    C. positively skewed, with a long tail on the right side.
    22. A major brokerage house is currently selling an investment
product that offers an 8 percent rate of return, compounded monthly.
Based on this information, it follows that this investment has:
    A. a stated rate of 0.830%.
    B. an effective annual rate of 8.00%.
    C. a periodic interest rate of 0.667%.
    23. Which of the following is an example of a parameter?
    A. Population variance.
    B. Sample standard deviation.
    C. Sample mean.
    24. An investor wants to invest an one-year, single-payment
corporate bond and concludes that the probability of default for this
one-year, single-payment corporate bond is 10.0 percent, and the
investor will recover nothing if the corporate defaults due to its
bankruptcy. The current risk-free rate of return is 3.0 percent. The
minimum yield-to-maturity and minimum default risk premium,
respectively , that the investor should demand on the corporate bond
are closest to:
    Minimum yield-to-maturity Minimum default risk premium
    A. 3.33% 3.03%
    B. 3.33% 0.33%
    C. 14.44% 11.44%
    25. The effective annual yield (EAY) for a T-bill maturing in 150
days is 5.04 percent. What are the holding period yield (HPY) and
money market yield (MMY) respectively?
    A. 5.25% 2.04%
    B. 1.90% 3.80%
    C. 2.04% 4.90%
    26. An investor has a portfolio with 10 percent cash, 30 percent
bonds, and 60 percent stock. If last year's return on cash was 2.0
percent, the return on bonds was 9.5 percent, and the return on stock
was 25 percent, what was the return on the investor's portfolio?
    A. 22. 30%. B. 36.50%. C. 18.05%.
    27. An analyst is investigating one stock with high after-tax
return above the benchmark and is concerned about his perceptions of
slowdown in the macroeconomic next year. So he adjusts the historical
probability of the stock's return above the benchmark. The analyst is
best characterized as gaining a(n):
    A. a priori probability. B. objective probability. C. empirical
    28. Susan Bellows is comparing the return on equity for two
industries. She is convinced that the return on equity for the
discount retail industry (DR) is greater than that of the luxury
retail (LR) industry. What are the hypotheses for a test of her
comparison of return on equity?
    A. H0: μDR=μLRVersus Ha: μDR≠μLR
    B. H0: μDR<=μLRVersus Ha: μDR>μLR
    C. H0: μDR≠μLRVersus Ha: μDR=μLR
    29. An economist predicts that over the next year, there is a 56
percent probability that oil prices will fall slightly and a 17
percent probability that new estate tax legislation will be enacted.
According to this prediction, the probability that at least one of
these independent events will occur is closest to:
    A. 13.6%. B. 44.7%. C. 63.5%.
    30. Compared with fundamental analysis, does technical analysis
place more emphasis on:
    A company's financial Determining the effects of specific events
    accounting statements? on the value of a company's stock?
    A. No Yes
    B. No No
    C. Yes No
    31. The arithmetic mean and geometric mean returns of the
following series of stock market returns are:
           Year 1                 14 percent
           Year 2                  6 percent
           Year 3                 -5 percent
           Year 4                 20 percent

    Arithmetic Mean Geometric Mean
    A. 8.75% 8.34%
    B. 8.90% 8.62%
    C. 8.90% 8.34%
    32. A U. S. Treasury Bill with a face value of $ 100000 and 256
days until maturity is selling for $ 94300. The money market yield on
this security is closest to:
    A. 7.80%. B. 7.87%. C. 8.50%.
     Questions 33 through 44 relate to Economics and are allocated 18
    33. Technically, an individual is unemployed when he or she is
actively seeking employment or is:
    A. a retiree.
    B. in prison.
    C. waiting to return to a job from which he or she was just laid
    34. If the consumer price index is 252 this year compared with
240 last year, the rate of inflation for the year is closest to:
    A. 4.76%. B. 4.88%. C. 5.00%.
    35. Generally, if there is unanticipated inflation in the economy:
    A. lenders benefit and borrowers lose.
    B. borrowers benefit and lenders lose.
    C. both borrowers and lenders benefit.
    36. The primary difference between the McCallum rule and the
Taylor rule is that the McCallum role follows the:
    A. Keynesian feedback rule and adjusts the federal funds rate to
target the inflation rate.
    B. Monetarist feedback rule and adjusts the federal funds rate to
target the inflation rate.
    C. Monetarist feedback rule and adjusts the growth rate of the
monetary base to target the inflation rate.
    37. Compared to using a fixed-rule monetary policy, using a
feedback rule monetary policy:
    A. will stabilize aggregate demand.
    B. will reduce inflationary cycles.
    C. may make economic cycles more severe.
    38. Which of the following is most likely to be described as an
automatic fiscal policy stabilizer?
    A. Increase in government spending on defense.
    B. Cuts in government spending on interstate highways.
    C. A fixed income tax rate.
    39. If the Federal Reserve unexpectedly shifts to a more
expansionary monetary policy, which one of the following is most
likely occur in the short run?
    A. A decrease in the velocity of money.
    B. A decrease in real GDP.
    C. An increase in employment.
    40. When potential real GDP is less than actual real GDP, the
economy is most likely experiencing:
    A. recession. B. stagflation. C. inflation.
    41. Under which pair of conditions is a factor of production
least likely to earn economic rent?
    Supply curve Demand curve
    A. Upward sloping Downward sloping
    B. Perfectly elastic Downward sloping
    C. Upward sloping Perfectly elastic
    42. A reserve requirement of 20% implies a potential money
deposit expansion multiplier of:
    A. 5. B. 8. C. 10.
    43. In the long run, when the economy is at full employment, will
a decrease in the quantity of money due to restrictive monetary
policy that brings a decrease in aggregate demand likely result in:
    the price level? real GDP?
    A. No No
    B. No Yes
    C. Yes No
    44. Consumer surplus is best explained as the:
    A. amount by which the quantity of a good produced exceeds the
quantity that consumers demand.
    B. difference between the quantity of a good a consumer purchases
and the quantity the consumer is willing to purchase.
    C. difference between the value a consumer places on a good or
service and the amount the consumer has to pay to acquire it.
    Questions 45 through 78 relate to Financial Statement Analysis
and Corporate Finance and are allocated 51 minutes.
    45. Reading the footnotes to a company's financial statements and
the Management Discussion & Analysis is least likely to help an
analyst determine:
    A. how well the financial statements reflect the company's true
    B. in what ways he needs to adjust the data for his own analysis.
    C. the detailed information that underlies the company's
accounting system.
    46. A firm's financial statements reflect the following:
           Net income                $ 1700000
              EBIT                   $ 2900000
      Effective tax rate                 35%
       Interest payments              $ 285000
         Common equity               $ 3100000
          Total assets               $ 6600000
      Preferred dividends
                                     $ 1100000
     Weighted avg. shares

    Based on this information, what is the firm's basic EPS?
    A. $2.75. B. $1.15. C. $3.15.
    47. Tapley Acquisition, Inc., is considering the purchase of
Tangent Company. The acquisition would require an initial investment
of $190000, but Tapley's after-tax net cash flows would increase by
$ 30000 per year and remain at this new level forever. Assume a cost
of capital of 15 percent. Should Tapley buy Tangent?
    A. No, because k > IRR.
    B. Yes, because the NPV =$10000.
    C. Yes, because the NPV = $ 30000.
    48. When calculating earnings per share (EPS) for firms with
complex capital structures, convertible bonds are ordinarily
considered to be:
    A. antidilutive securities.
    B. potentially dilutive securities.
    C. nonlinear debt securities.
    49. Examples of potentially dilutive securities include all of
the following EXCEPT:
    A. convertible preferred stock. B. warrants. C. non-convertible
    50. A company changes from an incorrect method of accounting to
an acceptable one. Which of the following statements about this
change is most accurate?
    A. It is a prior period adjustment and can be accounted for by
restating results for all prior periods that are presented in the
current financial statements.
    B. It is an extraordinary item and is reported net of taxes below
the operating income line.
    C. If the change is voluntary, it is a change in accounting
principle and is reported below the line net of taxes.
    51. Which of the following would NOT be a good source for
information about a company's proxy voting rules?
    A. Firm's corporate governance statement.
    B. Firm's annual report.
    C. Proxy statement (U. S.).
    52. Robinson Company had 1 million shares outstanding at the
beginning of the year. On April 1, Robinson issued an additional
300000 shares. On July 1, Robinson issued 200000 more shares. What is
Robinson's weighted average number of shares outstanding for the
calculation of earnings per share?
    A. 1500000 shares.
    B. 1325000 shares.
    C. 1000000 shares.
    53. Should the notes to the financial statements include the
following disclosures?
    Disclosure 1: Revenue recognition policy when a right of return
    Disclosure 2: Concentrations of credit risk for receivables with
common characteristics that may affect their ultimate collection.
    Disclosure 1 Disclosure 2
    A. Yes No
    B. No No
    C. Yes Yes
    54. Earlier this year, Ponca Corporation purchased non-dividend
paying equity securities which it classified as trading securities.
Information related to the securities is as follows:
                                           Fair value at year
        Security              Cost
                                                - end
            X              $ 400000               $435000
            Y              $ 550000              $ 545000

    What amounts should Ponca report in its year-end income statement
and balance sheet as a result of its investment in securities X and Y?
    Income Statement Balance Sheet
    A. $ 30000 unrealized gain $ 950000
    B. No gain or loss $ 980000
    C. $ 30000 unrealized gain $ 980000
    55. Normal Corp. has a current ratio above 1 and a quick ratio is
less than 1. Which of the following actions will increase the current
ratio and decrease the quick ratio? Normal Corp.:
    A. buys fixed assets on credit.
    B. uses cash to purchase inventory.
    C. pays off accounts payable from cash.
    56. The footnotes to a firm's financial statements are least
likely to include:
    A. information on sales trends.
    B. details of the terms of firm debt.
    C. information on revenue recognition policies.
    57. An analyst gathered the following data about a company:
    Net sales $ 4000
    Dividends declared 170
    Cost of goods sold 2000
    Other cash expenses for inputs 500
    Long-term debt principal repayment 250
    Cash tax payments 200
    Purchase of new equipment 300
    Inventory increased by 100
    Accounts payable increased 300
    Depreciation expense 75
    The company's cash flow from operations is:
    A. $1200.
    B. $1500.
    C. $1405.
    58. Under U. S. GAAP, which of the following statements about
classifying cash flows is least accurate?
    A. Cash received from issuing long-term debt and stock is
considered a financing cash flow.
    B. Changes in working capital accounts are included in cash flow
from operating activities.
    C. Dividend payments made are financing cash flows, while
interest payments received are investing cash flows.
    59. Kimberwick Technologies reports the following information as
of December 31,2007. In addition, the company reported $1000 in
depreciation expense. If the change in the cash balance for the year
was $12000 using the indirect method, the cash collections and cash
flow from operations (CFO) using the direct method is closest to:
    Net sales                                50000
    Cash flow from
    Cash expenses                             4250
    Cash inputs                              17000
    Cash taxes                                7000
    Increase in
    Cash flow investing                      -5000
    Cash collections CFO
    A. $49500 $ 21250
    B. $49500 $ 22250
    C. $50000 $ 21250
    60. Determine the cash flow from investing given the following
             Item                      Amount
         Cash payment of
       Sale of equipment                $25
            Net income                  $25
        Purchase of land                $15
     Increase in accounts
       Sale of preferred
     Increase in deferred

    A. -$10. B. -$5. C. $10.
    61. Which of the following situations will most likely require a
company to record a valuation allowance on its balance sheet?
    A. To report depreciation, a firm uses the double-declining
balance method for tax purposes and the straight-line method for
financial reporting purposes.
    B. A firm with deferred tax assets expects an increase in the tax
    C. A firm is unlikely to have future taxable income that would
enable it to take advantage of deferred tax assets.
    62. The Orchard Supply Company uses LIFO inventory valuation.
Orchard Supply had a cost of goods sold of $1 million for the period.
The inventory at the beginning of the period was $ 0.5 million and
the inventory at the end of the period was $0.6. Orchard Supply's
LIFO reserve was $0.1 million at the end of the previous year and
$ 0.2 at the end of the current year. What is Orchard Supply's cost
of goods sold according to FIFO inventory valuation?
    A. $ 0.8 million. B. $1.0 million. C. $ 0.9 million.
    63. Selected information from Leeward Company's financial
statements for the year ended December 31 is as follows (in $):
                          30000                         1800
           Cash                    Accounts Payable
                         00                           000
         Accounts         34000       Deferred Tax      1200
      Receivable         00          Liability        000
                          63000                         1250
       Inventory                   Long-term Debt
                         00                          0000
    Property, Plant       15200                         2000
                                    Common Stock
       & Eq.            000                           000
                          27900       Retained          1040
      Total Assets
                        000         Earnings         0000
      LIFO Reserve        16000    Total Liab. &        2790
        Jan. 1           00          Equity          0000
      LIFO Reserve        21000
       Dee. 31           00

    Leeward uses the last in, first out (LIFO) inventory cost flow
assumption. The tax rate is 40 percent. Considering the impact of
taxes, if Leeward changed from LIFO to first in, first out (FIFO),
the total debt-to-total equity ratio will:
    A. increase from 1.25 to 1.32.
    B. decrease from 1.25 to 1.16.
    C. decrease from 1.25 to 1.20.
    64. An analyst will most likely use the average age of
depreciable assets to estimate the company's:
    A. future dividend payments.
    B. near-term financing requirements.
    C. cash flows.
    65. The traditional DuPont equation shows (ROE) equal to:
    A. net income/sales×sales/assets×assets/equity.
    B. net income/assets×sales/equity×assets/sales.
    C. assets/equity×net income/equity×equity/sales.
    66. Which of the following statements regarding the financial
statement impact of recording liabilities resulting from the
application of SFAS 143 is TRUE? In accounting periods following an
asset acquisition, liability values are:
    A. accreted in a manner similar to interest for bond amortization.
The difference here is that the interest component falls through time
instead of rising.
    B. accreted in a manner similar to interest for bond amortization.
The difference here is that the interest component rises through time
instead of falling.
    C. accreted in a manner similar to interest for bond amortization.
This accretion is recorded as a gain on the income statement.
    67. On January 2, a company acquires some state-of-the-art
production equipment at a net cost of $14 million. For financial
reporting purposes, the firm will depreciate the equipment over a 7-
year life using straight-line depreciation and a zero salvage value;
for tax reporting purposes, however, the firm will use 3-year
accelerated depreciation. Given a tax rate of 35% and a first year
accelerated depreciation factor of 0. 333, by how much will the
company' s deferred tax account increase in the first year of the
equipment's life?
    A. $931700. B. $1064800. C. $1730300.
    68. The Camden Company has just leased the following piece of
    Market value of $ 200000.
    Useful life of 5 years with no salvage value.
    Lease term is 4 years.
    Annual lease payment is $ 30000 and the lease rate is 11%.
    The company's overall borrowing rate is 9.5%.
    The firm can purchase the equipment at the end of the lease
period for $ 45000.
    What amount should be recorded on lessee's balance sheet?
    A. $93073. B. $96134. C. $127435.
    69. The Ewing Corporation has leased equipment for 10 years.
Annual payments of $100000 are required at the end of each year. This
lease is classified as a capital lease. K the appropriate discount
rate is 5 percent, what is the amount recorded as interest expense
for the second year?
    A. $32316. B. $35539. C. $38609.
    70. Given that the current ratio is 2.0 times if we use cash to
settle the short-term liability. How would this transaction affect
the current and quick ratios?
    Current Ratio Quick Ratio
    A. decrease decrease
    B. decrease remain unchanged
    C. increase remain unchanged
    71. In a common-size financial statements, which of the following
statement is TRUE?
    A. A common size balance sheet expresses all balance sheet
accounts as a percentage of total asset.
    B. Common size ratios are useful in comparing companies of
different sizes.
    C. All of the above.
    72. Which of the following sources of short-term liquidity is
considered reliable enough that it can be listed in the footnotes to
a firm's financial statements as a source of liquidity?
    A. Revolving line of credit.
    B. Blanket lien.
    C. Uncommitted line of credit.
    73. Which of the following statements regarding the internal rate
of return (IRR) is most accurate?
    The IRR:
    A. assumes that the reinvestment rate of the cash flows is the
cost of capital.
    B. ignores the time value of money.
    C. and the net present value (NPV) method lead to the same
accept/reject decision for independent projects.
    74. An analyst gathers the following data about a company:
    Target capital structure of 10% preferred stock,50% common equity,
and 40% debt.
    Outstanding 20-year, annual-pay,6% coupon bonds selling for $ 894.
    Common stock selling for $ 50 per share is expected to pay a $ 2
dividend that grows at 8%.
    The company's 5% , $100 par preferred stock currently sells for
    The company's tax rate is 40%.
    The after-tax cost of debt and the cost of common equity are
closest to:
    Cost of debt Cost of equity
    A. 4.2% 9.0%
    B. 4.2% 12.0%
    C. 5.1% 9.0%
    75. An analyst who is evaluating a firm's working capital
management would be least likely to be concerned if the firm's:
    A. trade payables turnover is lower than that of its peers.
    B. operating cycle is shorter than that of its peers.
    C. days of inventory on hand is higher than the industry average.
    76. Which of the following statements about net present value
(NPV) and internal rate of return (IRK) is FALSE?
    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 equals the present value of
the cash inflows with the present value of outflows.
    C. On mutually exclusive projects, if the NPV method and the IRR
method give conflicting signals, you should use the IRR to select the
    77. Which of the following statements best describes the effect
of an increase in the tax rate on a firm's component costs of capital
for debt, preferred stock, and common equity?
    Debt Preferred stock Common equity
    A. Decreases No effect No effect
    B. Decreases Increases Increases
    C. Increases Decreases Decreases
    78. Project C is similar in risk to a company in their same
industry that has an average leveraged beta of 1.2. If Conover uses a
pure play method to evaluate project C, what is the appropriate cost
of equity capital for the project?
    A. 12.2%. B. 10.3%. C. 11.2%.
    Questions 79 through 114 relate to Asset Valuation and are
allocated 54 minutes.
    79. An argument against using the price-to-earnings (P/E)
valuation approach is that:
    A. earnings power is the primary determinant of investment value.
    B. earnings can be negative.
    C. research shows that P/E differences are significantly related
to long-run average stock returns.
    80. When analyzing the relationship among the high-yield bond
indexes and the investment-grade indexes, it is evident that:
    A. the relationship among the high-yield bond indexes is stronger
than among the investment-grade indexes.
    B. there is a linear relationship between the high-yield bond
indexes and the investment grade indexes.
    C. the relationship among the high-yield bond indexes is weaker
than among the investment-grade indexes.
    81. An analyst gathered the following data about common stocks J,
K, and L, which together form a value-weighted index:
             31 December 2006         31 Decemer 2007
    Sto                  Shares                 Shares
             price                 price
  cck               outstanding            outstanding
      J       $40         10000     $50          10000
      K       $30          6000     $20        12000 *
      L       $50          9000     $40           9000

    * Two-for -one stock split
    The value-weighted index base index =100) at the end of 2007 is
closest to:
    A. 92.31. B. 93.64. C. 106. 80.
    82. An investor opens a margin account with an initial deposit of
$ 5000. He then purchases 200 shares of PRK stock at $46 in his
margin account, which has a margin maintenance requirement of 25
percent. Ignoring commissions and interest, the minimum price that
PRK stock can fall to before the investor receives a margin call is
closest to:
    A. $20.00. B. $28.00. C. $33.33.
    83. Which of the following statements is most accurate? A
continuous market most likely exists for a stock when:
    A. Significant new information about the company is released to
market participants.
    B. An overnight buildup of buy and sell orders for the stock
    C. Numerous dealers are willing to make a market in the stock.
    84. In securities exchange markets, a member who executes stop
loss or stop buy orders when the specified price occurs is most
likely a:
    A. floor broker. B. market maker. C. commission broker.
    85. Which of the following is a difference between primary and
secondary capital markets?
    A. Primary capital markets relate to the sale of new issues of
bonds, preferred, and common stock, while secondary capital markets
are where securities trade after their initial offering.
    B. Primary markets are where stocks trade while secondary-
markets are where bonds trade.
    C. Both primary and secondary markets relate to where stocks and
bonds trade after their initial offering.
    86. Under the Efficient Market Hypothesis (EMH), the major effort
of the portfolio manager should be to:
    A. minimize systematic risk in the portfolio.
    B. stay the course by following a strict buy and hold strategy.
    C. achieve complete diversification of the portfolio.
    87. An analyst gathered the following information about a company:
    2007 net sales $10000. 000
    2007 net profit margin 5.0%
    2008 expected sales growth - 15.0%
    2008 expected profit margin 5.4%
    2008 expected common stock shares outstanding 120000
    The company's 2002 expected earnings per share is closest to:
    A. $3.26. B. $3.72. C. $3.83.
    88. If the company pays a dividend of $ 0.75, the return on the
investment would be closest to:
    A. 22.00%. B. 39.55%. C. 53.75%.
    89. Using the following assumptions, calculate the rate of return
on a margin transaction for an investor who purchases the stock and
the stock price at which the investor who shorts the stock will
receive a margin call.
    Market Price Per Share: $ 32
    Number of Shares Purchased: 1000
    Holding Period: 1 year
    Ending Share Price: $ 34
    Initial Margin Requirement: 40%
    Maintenance margin: 25%
    Transaction and borrowing costs: $ 0
    The company pays no dividends
    What of the following choices is closest to the correct answer?
    Margin Return Margin Call Price
    A. 15.6% $17.07
    B. 6.3% $17.07
    C. 15.6% $35.80
    90. A stock's dividend growth rate is a function of each of the
following EXCEPT:
    A. profit margin. B. total asset turnover. C. P/E ratio.
    91. Which of the following statements regarding zero-coupon bonds
and spot interest rates is TRUE?
    A. A coupon bond can be viewed as a collection of zero-coupon
    B. Spot interest rates will never vary across time.
    C. Zero-coupon bonds have at least two coupon payments.
    92. An investor is considering the purchase of Security X, which
matures in ten years with a par value of $1000. During the first five
years X has a 6% coupon with quarterly payments. During the remaining
five years, X has an 8% coupon with quarterly payments. The face
value is paid at maturity. A second 10-year security, Security Z, has
a 6% semiannual coupon and is selling at par. Assuming that X has the
same bond equivalent yield as Z, what is the price of Security X?
    A. $943. B. $1009. C. $1067.
    93. Consider the following Treasury spot rates expressed as
annual bond equivalent yields:
            Maturity                   Spot Rate
            6 months
             1 gear
           1.5 years

    Two Treasury notes each with $1000 par values have two years
remaining to maturity. Allowing for rounding to the nearest dollar,
Treasury note 1 hasA. 4% semiannual coupon and is priced at $991, and
Treasury note 2 hasA. 5% semiannual coupon and is priced at $1008.
What can you conclude about the market prices of these two notes?
    Treasury note 1 Treasury note 2
    A. Correctly priced Underpriced
    B. Overpriced Underpriced
    C. Correctly priced Correctly priced
    94. A 10% , 10-year bond is sold to yield 8%. One year passes,
and interest rates remained unchanged (8%). Holding all other factors
constant, the bond's price during this period:
    A. will have increased.
    B. will have decreased.
    C. will have remained constant.
    95. Value a semi-annual, 8 percent coupon bond with a $1000 face
value if similar bonds are now yielding 10 percent? The bond has 10
years to maturity.
    A. $ 875.38. B. $ 1000.00. C. $ 1373.87.
    96. Using the following spot rates for pricing the bond, what is
the present value of a three-year security that pays a fixed annual
coupon of 6%?
    Year 1: 5.0%
    Year 2: 5.5%
    Year 3: 6.0%
    A. 100.10. B. 95.07. C. 100.00.
    97. Mueller is explaining how to derive the theoretical Treasury
spot rate curve from the prices of Treasury coupon bonds. She states
the following:
    Statement 1: To calculate a theoretical Treasury spot rate curve
from the yields on coupon bonds, we must know at least two actual
Treasury spot rates.
    Statement 2: To compute the theoretical 3-year Treasury spot rate,
first determine the spot rates for each of the bond' s coupon periods
from 0.5 to 2.5 years. Discount each coupon payment to its present
value using the theoretical spot rate for each period. The
theoretical 3-year spot rate is the discount rate on the final coupon
and principal payment that sets the sum of the present values of all
the bond's cash flows equal to its price.
    Are Mueller's two statements correct?
    Statement 1 Statement 2
    A. Incorrect Correct
    B. Correct Correct
    C. Correct Incorrect
    98. What is the semiannual-pay bond equivalent yield on an
annual-pay bond with a yield to maturity of 12.51 percent?
    A. 12.00%. B. 11.49%. C. 12.14%.
    99. An investor purchases a 4-year, 6 percent, semiannual-pay
Treasury note for $ 9485. The security has a par value of $10000. To
realize a total dollar return equal to 7.515 percent (its yield to
maturity), the investor must have which of the following reinvestment
    A. All payments must be reinvested at less than 7.515%.
    B. All payments must be reinvested at more than 7.515%.
    C. All payments must be reinvested at 7.515%.
    100. Four non-convertible bonds have the indicated yield spreads
to Treasury securities:
                                   Zero-        Option-
             Matur            volatility      adjuste
                                  spread        spread
      Bo        2      156
                                  155 bp        130 bp
 nd   W    years     bp
      Bo        3      173
                                  174 bp        199 bp
 nd   X    years     bp
      Bo        5      188
                                  189 bp        164 bp
 nd   y    years     bp
      Bo       10      202
                                  201 bp        226 bp
 nd   Z    years     bp

    Based on these spreads, it is most likely that:
    A. Bond X is callable and Bond Y is putable.
    B. Bond W is callable and Bond Z is putable.
    C. Bond Z is callable and the spot yield curve is inverted.
    101. Which of the following statements about duration of a bond
is least accurate?
    A. The duration of a zero coupon bond is approximately equal to
its maturity.
    B. The duration of a floater is equal to the time to the next
reset date.
    C. If a bond has an effective duration of 7.5 , it means that a
1% change in rates will result in a 7.5% change in price.
    102. The price value of a basis point (PVBP) for a 7-year, 10
percent semiannual pay bond with a par value of $1000 and yield of 6
percent is closest to:
    A. $ 0.28. B. $ 0.92. C. $ 0.64.
    103. For a given bond, the duration is 8 and the convexity is 50.
For a 60 basis point decrease in yield, what is the approximate
percentage price change of the bond?
    A. 2.52%. B. 4.98%. C. 4.62%.
    104. For an option-free bond, what are the effects of the
convexity adjustment on the magnitude (absolute value) of the
approximate bond price change in response to an increase in yield and
in response to a decrease in yield, respectively?
    Decrease in yield Increase in yield
    A. Increase in magnitude Decrease in magnitude
    B. Increase in magnitude Increase in magnitude
    C. Decrease in magnitude Decrease in magnitude
    105. In a plain vanilla interest rate swap:
    A. the notional principal is swapped.
    B. only the net notional principal is swapped.
    C. only the net interest payments are swapped.
    106. An options investor purchases one put option on March coffee
futures. The put has the following characteristics:
    Type of option put option
    Underlying asset 1 March coffee futures contract(37500pounds)
    Exercise price $ 0.775 per pound
    Premium $ 0.0425 per pound
    Expiration date March
    The current price (futures price) of the March coffee futures
contract is $ 0.762 per pound.
    This LONG put option is:
    A. in the money in the amount of $ 0.013 per pound.
    B. in the money in the amount of $ 0.7325 per pound.
    C. out of the money in the amount of $ 0.762 per pound.
    107. Most deliverable futures contracts are settled by:
    A. a cash payment at expiration.
    B. an offsetting trade.
    C. delivery of the asset at contract expiration.
    108. Compared to European call options on an asset with no cash
flows, an American call option:
    A. will have a lower, lower bound on its price.
    B. will have the same lower bound on its price.
    C. will have a higher, lower bound on its price.
    109. Consider a forward rate agreement (FRA) that expires in 90
days. The agreement is based on the 180-day LIBOR. The long position
agrees to borrow $ 10000000 from the short position (i. e. the
dealer). The dealer quotes this instrument at 6 percent. Today, the
90-day LIBOR is 5.5 percent. If the 180-day LIBOR in 90 days is
quoted at 5 percent, compute the amount of the cash settlement
payment made or received by the borrower at expiration. The borrower
    A. make a payment of $ 48780.
    B. make a payment of $ 48543.
    C. receive a payment of $ 48543.
    110. Which of the following statements about uncovered call
options is least accurate?
    A. The loss potential to the writer is unlimited.
    B. The most the writer can make is the premium plus the
difference between the exercise price (X) and the stock price (S).
    C. The profit potential to the holder is unlimited.
    111. With respect to closed-end investment companies, generally
    A. buy shares back from investors who want to sell.
    B. have the market price of their shares determined by supply and
    C. sell additional shares only through the secondary market.
    112. Which real estate valuation approach is most likely to
require specific information about an investor to estimate the value
of a property?
    A. Discounted after-tax cash flow approach.
    B. Income approach.
    C. Sales comparison approach.
    113. Which statement about mutual funds is most accurate?
    A. The redemption fee for a closed-end fund is the commission
charged on the sale and a portion of the bid/ask spread of the shares.
    B. Some open-end funds charge no fees.
    C. Closed-end funds trade at the net asset value.
    114. Which of the following is least likely to be a form of real
estate investment?
    A. Leveraged equity position.
    B. Outright or fee-simple ownership.
    C. Property insurance.
    Questions 115 through 120 relate to Portfolio Management and are
allocated 9 minutes.
    115. Nathan Edwards is preparing a training brochure for new
employees at her asset management firm. Edwards feels that the new
employees do not fully understand the relationships between portfolio
standard deviation and individual security weights, standard
deviations, and correlation. Edwards has prepared several statements
on the matter in the context of a two stock portfolio. Which of the
following statements is FALSE? The standard deviation of a two-stock
    A. will be the lowest when the correlation between the two stocks
equals zero.
    B. can be reduced by increasing the relative weight of the stock
with lower standard deviation.
    C. will always increase as the correlation between the two stocks
    116. An investor plans to divide her funds evenly between two
assets. Assets 1 and 2 have standard deviations of 10 percent and 30
percent, respectively. If the two assets are perfectly positively
correlated, the standard deviation of returns of the two-asset
portfolio is closest to:
    A. 10%. B. 15%. C. 20%.
    117. Mafia Lena, CFA, wants to determine the relationship between
the returns on two asset classes: bonds and preferred stock. She has
assembled two representative portfolios in order to estimate the
relationship. The all-bond portfolio has a variance of 90.2, while
the all-preferred-stock portfolio has a variance of 120.4. The
covariance between the two portfolios is equal to 62.5. Which of the
following statements accurately summarizes the relationship between
the two asset classes? If returns on bonds:
    A. rise by 10% , returns on the preferred stocks should rise by
    B. rise by 10%, returns on the preferred stocks should fall by 6%.
    C. fall by 1% , returns on the preferred stocks should fall by
6.25 %.
    118. David Hoch, a graduate student at Miami University, is
putting together a research paper on differences in asset allocations
between countries. Hoch's paper contains the following statements:
    Statement 1: Countries with higher income tax rates typically
have lower allocations to bonds.
    Statement 2: Countries with older populations typically have
lower allocations to equities.
    Statement 3: A strong government pension program may decrease the
average equity allocation of a country's citizens.
    Statement 4: Countries with an historical aversion to financial
risk typically have lower allocations to equities.
    Hoch's finance professor, Walter Denk, reads his research paper.
Which of the following conclusions would be most valid for Denk to
    A. Statement 2 reflects a common reason why average asset
allocations differ across countries, but Statement 3 does not.
    B. Statement 1 reflects a common reason why average asset
allocations differ across countries, but Statement 2 does not.
    C. Both Statements 1 and 4 reflect common reasons why average
asset allocations differ across countries.
    119. When the underlying assumption of zero transactions costs is
relaxed, the CAPM produces:
    A. a capital market line that is no longer straight.
    B. several different security market lines.
    C. a band of returns instead of a security market line.
    120. Which of the following is an assumption of capital market
theory? All investors:
    A. see the same risk/return distribution for a given stock.
    B. select portfolios that lie above the efficient frontier to
optimize the risk-return relationship.
    C. select portfolios that lie below the efficient frontier to
optimize the risk-return relationship.
                        Solutions to Sample Exam 2
                            (Morning Session)
    1. B.
    Vivian should disclose to her clients and prospects her husband's
holdings in Double Limited because this matter could be expected to
impair her ability to make unbiased and objective recommendations.
    2. C.
    Standard Ⅱ (A) Use of Professional Designation. The CFA and
Chartered Financial Analyst designations must always be used as
adjectives, never as nouns or common names. The appropriate
description would be "Roger Langley is one of two CFA charterholders
in the company. "
    3. C.
    Standard Ⅲ (B) Duty to Employer. According to this standard,
"Members who plan to engage in independent practice for compensation
should provide written statements to their employer describing the
types of service the members will render prospective independent
clients, the expected duration of the services, and the compensation
for the services."
    4. C.
    The requirements of Standard Ⅳ (B) are not intended to prevent
Lambert from cooperating with an investigation by AIMR's Professional
Conduct Program.
    5. C.
    Selective disclosure occurs when companies discriminate in making
material nonpublic information public. Selective disclosure raises
insider trading concerns.
    6. A.
    The only action that will not breach Standard Ⅳ (A) Loyalty to
Employer, is to start the registration of her new company.
    7. A.
    Berger has not violated any of the Standards. He has the right to
delegate supervisory duties. This delegation does not relieve him of
the responsibility of making sure that procedures are in place to
prevent violations of the Code and Standards.
    8. B.
    Asking for a letter of recommendation is perfectly acceptable.
Soliciting clients and taking the employer's property like client
lists, computer programs, etc, are not permissible.
    9. A.
    To avoid potential problems and comply with Standard Ⅰ (D) ,
employers are encouraged to conduct background checks on potential
    10. C.
    To comply with Standard Ⅱ (A), a fire wall provides an
information barrier that prevents communication of material nonpublic
information and other sensitive information from one department to
another within a firm.
    Standard Ⅱ (A) Material Nonpublic Information. The union
president has material nonpublic information. Gordon received
material nonpublic information in confidence. Therefore, he is not
permitted to breach that confidence by trading in securities to which
such information relates. Parker should make a reasonable effort to
achieve public dissemination of material nonpublic information
disclosed in breach of duty.
    12. C.
    According to Standard Ⅱ (A) , Material Nonpublic Information, an
analyst is prohibited from trading on information that is both
material and nonpublic.
    13. C.
    Standard Ⅲ (C) explicitly says that an analyst should make such
inquiries and update information regularly. Client confidentiality is
addressed in Standard Ⅲ (E) but that is with respect to how the
analyst treats the information once it is obtained. Standard Ⅵ (A)
addresses the information that an analyst must disclose to his/her
employer, clients and prospects.
    14. C.
    Although broad in scope, the best way to determine suitability is
to consider the financial situation, investment experience and
investment objectives of the client. All the other choices deviate
from these essential issues.
    15. C.
    Being intoxicated at work is poor personal behavior. It is a
violation of Standard Ⅰ (D), which covers professional competence
and integrity.
    16. A.
    This question is related to Standard Ⅴ(B) which states that CFA
Institute members should use reasonable judgment regarding the
inclusion or exclusion of relevant factors in research reports. The
change in management was a relevant factor and must be disclosed
before dissemination.
    17. B.
    Serving on a Board of Directors should be disclosed to both the
employer and clients and prospective clients.
    18. C.
    Standard Ⅵ (A) defines what constitutes a conflict of interest
with regard to clients, prospective clients, and employers. All of
these represent potential conflicts of interest with the exception of
the cousin working for Aneas Lumber in a job that is unrelated to the
Aneas' financing.
    19. C.
    With Pint=5000, N=7, I/Y 11.5, value (at t=4)=23185.175.
Therefore, PV (at t=0)=23185.175/(1.115) =$15000.68.
    20. B.
    IRR Keystrokes:
    CFO=-$ 550000, CF1=$ 65000, F1=5, CF2=$ 50000, F2=3; CF3=$ 350000,
    NPV Keystrokes:
    CF0=-$ 550000, CF1=$ 65000, F1=5, CF2=$ 50000, F2=3; CF3=$ 350000,
    CPT NPV, I=9.
    Note: Although the rate of return is positive, the IRR is less
than the required rate of 9%. Hence, the NPV is negative.
    21. C.
    The vast majority of studies have found that prices do not move
in trends based on statistical tests of autocorrelation and runs.
That is, past price patterns may not be repeated in the future.
Efficient market followers say that the market appears to react
quickly to the release of new information. This is a significant
challenge to technical analysis.
    22. C.
    All else equal, investors would prefer a greater probability of
large gains (positive skewness) and would prefer higher excess return
per unit of risk (hither Sharpe ratio)
    23. B.
    The probability of being a nonsmoker is 240/300=0.80. The
probability of not suffering from allergies is 210/300=0.70. The
probability of being a nonsmoker and not suffering from allergies is
185/300=0.62. Since the question asks for the probability of being
either a nonsmoker or not suffering from allergies we have to take
the probability of being a nonsmoker plus the probability of not
suffering from allergies and subtract the probability of being both:
    Alternatively: 1-P(Smoker & Allergies)=1-(35/300)=88.3%.
    24. A.
    The difference between fundamental analysis and technical
analysis is the assumption: about the speed at which information is
impounded into prices, Technicians believe the reaction is slow,
while fundamentalists believe prices adjust quickly. In addition,
efficient market hypothesis analysts feel the price adjustment
happens almost instantaneously. Fundamental analysis will place more
emphasis on a company's financial statements and the effects of
specific events on the value of a company's stock. 25. B.
    26. B.
    The appropriate test is a t-test concerning differences between
means. Because the critical value is greater than the computed t-
value, the null hypothesis cannot be rejected at the 0.05 level of
    27. C.
    Given two events, the independent event is the event where
knowledge of one event has no influence on the other. Here, we are
given that the probability of the reunion concert is not dependent
upon whether or not the band reunites. The other statements are false.
The probability of the band reuniting is a dependent event because it
is influenced by the probability of the reunion concert. The given
probability for a reunion concert is a subjective probability. An a
priori probability is calculated using formal reasoning and
inspection. For example, assume that 100 off, he stocks in the S&P
500 index decreased in price yesterday, if you select a stock at
random, the chance that the stock will have decreased in price is
100/500, or 20%. A subjective probability is less formal and involves
personal judgement. The probability that the band will get back
together if the reunion concert does not occur is a conditional
probability. A conditional probability is a probability for which
knowledge of another event is important. Here, the knowledge about
the reunion tour is important to the probability of the band
reuniting, Marginal probability is another term for unconditional
    28. C.
    29. B.
    Because the alternative hypothesis is that the correlation is
different from zero (either above or below zero), the analyst
conducted a two-tailed test. Because the test statistic is greater
than either of the critical values, the analyst can reject the null
    30. C.
    According to Chebyshev's Inequality, for any distribution, the
minimum percentage of observations that lie within k standard
deviations of the distribution mean is equal to: 1-(1/k2), with k
equal to the number of standard deviations. If k=2, then the
percentage of distributions is equal to 1-(1/4)=75%.
    Semivariance only measures returns below mean expectations.
    32. B.
    The outcome follows a binomial distribution where n=5 and p=0.2.
In this case p(0)=0.85=0.3277 and p(1)=5×0.84×0.2=0.4096, so P(X=0
or X=1)=0.3277+0.4096.
    33. A.
    All firms maximize profits where MR=MC. Because of a downward-
sloping demand curve and high barriers to entry, monopolists can
charge a price higher than MC. Like other price searchers,
monopolists take price from the demand curve (at the quantity where
    The other statements are false. A monopoly structure is
characterized by a well-defined product for which there are no good
substitutes. A monopolist will earn a profit as long as the demand
curve lies above the average total cost curve (ATC) at the optimal
quantity point. Monopolists want to maximize profits, not price.
    34. C.
    Countercyclical policy refers to the use of discretionary fiscal
policy to minimize fluctuations in AD over the business cycle. For
example, a planned budget deficit is enacted during a recession,
while a planned budget surplus is enacted it the economy is operating
above full employment (boom).
    35. B.
    When the AD curve moves upward to the right, the result is higher
prices and more output. Conversely, a shift in the AD curve downward
to the left results in lower prices and less output.
    36. C.
    These conditions characterize monopolistic competition. By
contrast, monopolies and oligopolies have high barriers to entry and
involve either a single seller (monopoly) or a small number of
interdependent sellers(oligopoly). Similar to monopolistic
competition, pure competition involves a large number of independent
sellers. With pure competition, products are homogeneous (not
differentiated), no barriers to entry exist(not low barriers to
entry), and the demand schedule is horizontal(not downward sloping)
and perfectly elastic (not highly elastic).
    37. C.
    Marginal cost (MC) is the change in total cost resulting from the
production of one additional unit. In the short run, MC will
typically decline if output is increased, reaching a minimum, and
then will increase sharply as maximum production capacity is
approached. Total variable costs are those costs that rise as output
increases. For a given level of output, the average variable cost
(AVC) is the total variable cost divided by output. In the short run,
AVC will slightly decline, to a certain point at which output will
increase by smaller and smaller amounts, causing AVC to rise. This is
the point of diminishing returns, where it will take successively
larger amounts of the variable factor to expand output by one unit.
    Total fixed cost is the sum of costs that do not vary with output.
Average fixed cost (AFC) is the total fixed cost divided by output.
AFC will be high for low rates of output, but will decline as output
increases, causing the curve to slope downward to the right. Average
total cost (ATC) is the total cost divided by the total number of
units produced. ATC will be a U-shaped curve, since AFC will be high
for small rates of output and MC will be high as the plant approached
maximum capacity.
    38. C.
    A price ceiling is an upper limit on the price a supplier can
charge. If the ceiling is below the equilibrium price, it can result
in bribes as a rationing mechanism, whereas the total price of a good
(including the bribe) is brought closer to the equilibrium price.
    39. C.
    The absolute value of price elasticity determines whether demand
is elastic or inelastic. Here, the absolute value is less than 1, and
demand is inelastic. When demand is inelastic, a price increase will
lead to an increase in total expenditure on the good. The slope of
the demand curve is not the same as the elasticity of demand.
Elasticity is measured from a specific point.
    40. B.
    Regardless of whether a tax is imposed on suppliers or consumers,
the relative burden of the tax to each depends on the relative
elasticity's of supply and demand. Since demand is relatively less
elastic than supply, the burden of the tax will be greater on
consumers than on producers. These burdens are equivalent to
decreases in producer and consumer surpluses. Total consumer and
producer surpluses will be reduced by the amount of the resulting
deadweight loss in addition to the total amount of tax collected.
    41. C.
    The owner of a proprietorship is subject to unlimited liability.
Shareholders of corporations have limited liability, only up to the
amount invested. In many corporations, the agent (management) may be
working for different objectives than those of the principal
    42. A.
    The short-run aggregate supply curve is constructed for a given
level of money wages and other resource prices. Falling money wages
would cause businesses to increase (profit maximizing ) output levels
at each price level for final goods and services. Changes in the
price level of goods and services are represented by a movement along
a short-run aggregate supply curve, not a shift in the curve. A rise
in resource prices will decrease aggregate supply. An increase in
government spending will shift the aggregate demand curve but not the
aggregate supply curve.
    43. A.
    The firm being described is a price taker firm in a purely
competitive market. These firms must sell their product at the going
market price, there are no barriers to entry, and there are a large
number of firms that produce a homogeneous product.
    44. C.
    At less-than-full employment, an expected increase in the growth
rate of the money supply will initially reduce the real rate of
interest, increasing the demand for goods and services
    45. C.
    The role of financial statement analysis is to use the
information in a company's financial statements, along with other
relevant information, to make economic decisions. Examples of such
decisions include whether to invest in the company's securities or
recommend them to other investors, or whether to extend trade or bank
credit to the company. Although the financial statements might
provide indirect evidence about the management skill of the company's
executives that is not generally considered the role of financial
statement analysis.
    46. A.
    Given the variety and complexity of possible transactions, and
the estimates and assumptions a firm must make when presenting its
performance, financial statements could potentially take any form if
reporting standards didn't exist. Reporting standards ensure that the
information is "useful to a wide range of users," including security
analysts, by making financial statements comparable to one another
and narrowing the range within which management's estimates can be
seen as reasonable. Reporting standards limit the range of
assumptions management can make.
    47. B.
    Reductions in the LIFO reserve that are caused by inventory
liquidations will require adjustments to the income statement since
the COGS will be artificially low. COGS will be understated as a
result of the lower historical cost from inventory booked in previous
periods. The lower cost inventory will most likely not be an adequate
reflection of current inventory costs.
    48. A.
    Earnings will be higher, but cash flows do not increase.
    49. C.
    Unrealized foreign currency translation gains and losses are not
reported in the income statement; thus, retained earnings are
unaffected. However, unrealized foreign currency gains and losses are
included in comprehensive income. Comprehensive income includes all
changes in equity except those that result from transactions with
shareholders. So, the translation gain increases stockholders' equity
by increasing comprehensive income.
    50. C.
    The numerator will increase because earnings available to the
common shareholder are increased by the reduction in preferred
dividends. The denominator increases because the weighted average
number of shares increases upon conversion of the preferred stock.
    When companies that require shareholder attendance to vote hold
their meetings on the same day but in different locations, it
prevents shareholders from attending all the meetings and therefore
exercising their full voting rights. Answer B is restrictive, but
answer C is more so.
    52. C.
    The account format follows the traditional ledger account, assets
on the left hand side and liabilities and equity on the fight hand
side. With a report format, the assets, liabilities, and equity are
presented in a single column.
    53. B.
    Using the easiest method of all, the difference in the cash
account at the end of 2004 and the cash balance projected for the end
of 2005 is $ 26.0 million-$ 24.0 million=$ 2.0 million. If the cash
balances were not available, the change in cash could be calculated
using the indirect method. Starting with cash flow from operations
(CFO) in $ millions projected for 2005:
                     Net Income                           43
         Add: Non cash Expenses or Losses
                    Depreciation                           5
        Add: Changes in Current Assets and
      Less: Increase in Accounts Receivable               -7
            Less: Increase in Inventory                  -50
       Plus: Increase in Accounts Payable                10
      Net Cash Flow from Operations (CFO)                 1

    Increase in Property Plant & Equipment               -25
       Net Cash Flow from Investing (CFI)                -25

           Increase in Long-Term Debt                    20
            Increase in Common Stock                     10
      Loss: Dividends Paid (10 million ×
                   $ 0.40)
       Net Cash Flow from Financing (CFF)                26

    Net Cash Flow=CFO+CFI+CFF=1-25+26=$ 2 million.
    54. A.
    Cash provided or used by operating activities under the direct
method is computed by adding cash inflows and subtracting cash inputs
and cash outflows. Operating Cash inflows for Rockway Inc. for 2005
came from sales ($ 21000000) and decrease in accounts receivable
($ 3000000- $ 2500000=$ 500000) for net cash inflows of
($ 21000000+$ 500000=) $ 21500000. Operating cash inputs were cost of
goods sold ($ 15000000), plus the increase in inventory ($ 3000000-
$ 2400000=$ 600000) less the increase in accounts payable, (which is
a source of funds) ($1000000-$1400000=-$ 400000) for net cash inputs
of ($15000000+$ 600000-$400000=) $ 15200000. Other operating cash
outflows were interest paid ($1000000) and current income taxes paid
($1000000) totaling ($ 2000000). Cash provided by operations was
($ 21500000-$ 15200000- $ 2000000=) $4300000. Changes in property,
plant and equipment, long-term debt and common stock do not affect
cash from operations.
    55. C.
    Direct method:
    Net income 1000
    Depreciation 70
    Goodwill 30
    Change in accounts receivable 25
    Change in inventory (35)
    Change in accounts payable 30
    Change in wages payable 15
    Operating cash flows 1135
    56. B.
    Purchase equipment (200)
    Sell truck 25
    Investing cash flows (175)
    57. C.
    Sale of common stock 100
    Issuance of bonds 20
    Financing cash flows 120
    58. A.
    COGS overstated by 5000 so EBT understated by 5000.
    59. A.
    Weighted average=cost of goods available/total units available.
COGS=Units sold×wt. ave.=959×3.7381=$3604.02.
    60. C.
    Ending Inventory=306×6=$1836.00.
    62. C.
    The sum-of-years digits method depreciation decreases each year
by (1/sum-of-years digits).
    For example, for a three-year property, the first-year
depreciation is 3/6, the second-year depreciation is 2/6, and the
third-year depreciation is 1/6. Each year depreciation decreases by a
constant amount-one-sixth of the depreciable cost of the asset.
Capitalizing an expenditure instead of expensing it will result in a
lower debt to equity ratio because the amount of capitalized expenses
is added to assets which also increases equity by increasing net
income and retained earnings. Also, capitalizing expenses will lower
the fixed asset turnover ratio since assets are increased and they
are also in the denominator of the fixed asset turnover ratio.
    63. B.
    If Trayfield had decided to switch depreciation methods for new
assets only, the effect on income would be relatively gradual.
However, switching all assets will have a much larger effect.
Trayfield would have needed to adjust estimates for future income
regardless of whether the DDB method was applied only to new assets
or existing assets as well. A switch to DDB will cause an increase in
depreciation expense, a decrease in net income, and a decrease in the
ROE and ROA ratios.
    64. B.
    After-tax cost of debt=bond yield-tax savings=kd-kd=kd(1-t).
    65. C.
    A tax loss carry-forward is the net taxable loss that can be used
to reduce taxable income in the future.
    66. C.
    If the entire surplus is used to repurchase common stock, total
equity would be reduced by the amount of the surplus without
affecting any of the other projected balance sheet or income
statement items. This would balance assets with liabilities and
equity without further iterations. If any of the surplus is used to
pay down long-term debt, interest expense and taxes would change,
requiring more iterations to reconcile the pro forma financial
statements. To reconcile the pro forma statements in a single step by
changing the dividend payout ratio, it would have to increase enough
so that the entire surplus would be paid as additional dividends.
    67. B.
    Temporary differences will result in current lower (higher) taxes
payable and future higher (lower) taxes payable. These differences
will be categorized as deferred tax assets and liabilities and will
be stated on the balance sheet. The temporary differences must be
reversed, but in some cases management does have discretion over the
time and amount of reversal.
    68. B.
    Leasing the asset with an operating lease avoids recognition of
the debt on the lessee's balance sheet. Having fewer assets and
liabilities on the balance sheet than would exist if the assets were
purchased increases profitability ratios (e.g., return on assets) and
decreases leverage ratios (e.g., debt-to-equity ratio). In the case
of a capital lease, the assets are reported on the balance sheet and
are depreciated.
    69. C.
                                                Qualify as a capital
    The title is transferred to the leassee
at the end of the lease period:
    A bargain purchase option exists:                    No
    The lease period is at least 75 percent
of the asset's life:
    The present value of the lease payments
is at least 90% of the fair value of the                 No

    PV=$30723<90% of $45000=$40500
    70. A.
    Sang is not considered independent since her sister holds an
executive position with XYZ. Kevin Ritter is independent since his
son's accounting firm does not provide audit services to XYZ.
    Average receivables collection period=365/receivables turnover,
which is 22.81 days for the industry (=365/16). If Q-Tell's
receivables turnover is less than 16, its average days collection
period must be greater that 22. 81 days.
    72. A.
    E Company's interest coverage ratio (EBIT/interest expense) is
    G Company's interest coverage ratio is (25/5=)5.0. Higher
interest coverage means greater ability to cover required interest
and lease payments. Note that 1.5/5.0=0.30, which means the interest
coverage for E Company is less than 1/3 that of G Company.
    73. B.
    A regular and committed line of credit refers to the same thing.
These types of credit lines and revolving lines of credit all contain
a commitment by a lender to lend up to a maximum amount, at the
borrower's option for some period of time. A firm with lower credit
quality may have an uncommitted line of credit which offers no
guarantee from the lender to provide any specific amount of funds in
the future.
    74. C.

    75. C.
    Lutz's first statement is correct. The timing of cash flows is
important for making correct capital budgeting decisions. Capital
budgeting decisions account for the time value of money. Lutz's
second statement is incorrect. Capital budgeting decisions should be
based on incremental after-tax cash flows, not net (accounting)
    76. A.
    The 19th space is neither an incremental cost, nor an opportunity
cost or a type of cannibalization. It is a sunk cost since the firm
has already committed to parking for 20 taxis. The cost of the 19th
parking space is not directly relevant to the capital budgeting
    77. A.
    Depreciable basis: $ 8000+$ 2000=$10000.
    Annual depreciation using straight-line depreciation:
$10000/5=$ 2000.
    Cash flow=(revenues-cost)(1-t)+(depreciation tax
savings)=($ 5000-$ 2000)×0.6+2000×0.4=$ 2600.
    PMT=2600; N=5; I/Y=10; PV=$9856.05.
    NPV=$9856.05 -$10000=-$143.95.
    78. B.
    The internal rate of return is the rate of discount at which the
NPV of a project is zero. On an NPV profile, this is the point where
the profile intersects the horizontal axis.
    79. B.
    In an information ally efficient securities market, price
adjustments are assumed to be rapid but not perfect; the adjustment
is unbiased, but the market may over or under adjust and investors
cannot predict which will occur.
    80. A.
    If market yields decrease, interest risk will increase since the
duration or the sensitivity of the bond to interest rate fluctuation
will increase.
    Since option A has a strike price lower than the stock price, it
could be a call option. Assuming it is a call option, option A has
the following intrinsic value: 43-40=3. Option A has a premium
greater than the intrinsic value which indicates there is time value
left and it is not about to expire. Since option B has a strike
higher than the stock price, it could be a put. Assuming it is a put
option, option B has an intrinsic value equal to 32-29=3. The
intrinsic value is equal to the premium for option B, indicating no
time value. Option B is about to expire.
    82. B.
    The implication of the weak-form EMH is that there should be no
relationship between past price changes and future price changes.
Results of runs tests and filter tests suggest that excess returns
are not possible. Tests related to insider or private information are
related to the strong-form EMH.
    83. C.
    Whether a stock is a growth stock depends only upon whether its
market price is below its intrinsic value. Quality of earnings and
type of firm are factors in estimating the intrinsic value, but the
primary issue is whether current valuation is such that the stock is
expected to grow in value in the future.
    84. B.
    D1/E1=the expected dividend payout ratio
    k=estimated required rate of return on the stock
    g=expected growth rate of dividends for the stock
    The P/E is most sensitive to movements in the denominator.
    85. C.
    If market prices are efficient there are no returns to the time
and effort spent on fundamental analysis. But if no time and effort
is spent on fundamental analysis there is no process for making
market prices efficient. To resolve this apparent onchcsion one can
look to the time lag between the release of new value-relevant
information and the adjustment of market prices to their new
efficient levels. Processing new information entails costs and takes
at least some time, which is a limitation of fully efficient markets.
    86. C.
    Formula is k=(D1/P0))+g=1.08/25+0.08=12.3%. where D1=(1×1.08). Be
careful of the word expected; since current dividend is given, one
must multiply the dividend by 1 plus the growth rate.
    87. C.

    Solve for k=12.8%. The flotation cost is irrelevant. It affects
the firm's cost of capital but not the investor's required rate of
    88. B.
    This is a supernormal or abnormal growth stock valuation problem.
First, find the dividends in the supernormal growth period. Second,
use the constant growth model to find the price in period 4. Finally,
discount all of the cash flows back to time zero. D1=2.00×1.20=2.40;
D2=2.4×1.2=2.88; D3=2.88×(1-0.05)=2.74; D4=2.74×1.15=5.15.

                      Discount each cash flow back to time zero at a

rate of 12% and
    89. C.
    The constant growth dividend discount model cannot be used to
value firms that don't pay dividends or are experiencing supernormal
growth and are very dependent on the assumed values of k and g.
    90. C.
    A stock's required rate of return is equal to the nominal risk-
free rate plus a risk premium. The nominal risk-free rate is
approximately equal the real risk-free rate plus expected inflation.
    A call option is not binding on both parties in the same sense
that the other financial instruments are. The call option gives the
holder a right but does not impose an obligation.
    92. A.
    Trading the commodities themselves is direct participation.
Investors can participate indirectly- though futures contracts,
indexed bonds or certain commodity-linked equities.
    93. B.
    When earnings are negative, P/E ratios cannot be used but P/B
ratios can be used. The firm's rate of growth and use of leverage and
the volatility of markets do not suggest advantages of using P/B
ratios rather than P/E ratios.
    94. A.
    Companies would retire through the delivery of securities if
rates have gone up, not down.
    95. A.
    The embedded option can be valued by analyzing the difference
between the zero-volatility spread and the option-adjusted spread.
    96. B.
    A put provision allows the investor to put the bond back to the
issuer if interest rates rise. Thus, a put option benefits (and may
be exercised by) the holder, not the issuer.
    97. B.
    The dirty price is equal to the agreed upon, or quoted price,
plus interest accrued from the last coupon date. Here, the quoted
price is 1000×104.75% , or 1000×1.0475=1047.50. Thus, the dirty
    98. C.
    £ 13.50 million and the British bank pays US $22. 50 million The
U. S. bank pays 4.5 percent fixed on £ 300 million, which makes for
an annual payment of £ 13.50 million. The variable rate to be used
at time period 2 is set at time period 1 (the arrears method).
Therefore, the British bank pays 4.5 percent times US $ 500 million
for a payment of US $ 22.50 million.
    99. C.
    The duration of a zero-coupon bond is equal to its time to
maturity. Its price is greatly affected by changes in interest rates
because its only cash-flow is at maturity and is discounted from the
time at maturity until the present.
    100. A.
    The price volatility of non-callable bonds is inversely related
to the level of market yields. As yields increase, bond prices fall,
and the price curve gets flatter. Bond price sensitivity is lowest
when yields are high.
    101. B.
    A call provision decreases the bond's duration because a call
provision introduces prepayment risk that should be factored in the
calculation. For the investor, one of the most significant risks of
callable (or prepayable) bonds is that they can be called/retired
prematurely. Because bonds are nearly always called for prepayment
after interest rates have decreased significantly, the investor will
find it nearly impossible to find comparable investment vehicles.
    102. C.
    CMOs redistribute prepayment risk and/or the expected repayment
term of the underlying MBS among the CMO tranches. If some tranches
have less prepayment risk, others must have more.
    103. C.
    The probability is calculated as: (1-0.30)×(1-0.28)×(1-
0.28)×(1-0.25)=0.2722 or 27.22%.
    104. C.
    Tranche Ⅲ has the least amount of prepayment risk since it
receives the prepayments last.
    105. A.
    During periods of economic expansion corporate yield spreads
generally narrow, reflecting corporate bonds decreased credit risk.
If yield spreads narrow, the price of corporate bonds increases
relative to the price of treasuries.
    106. B.
    A callable bond favors the issuer. Hence, the value of the bond
is discounted by the value of the option, which means the yield will
be higher.
    107. A.
    ETY=yield/(1-marginal tax rate)=0.06/(1-0.34)=9.09%.
    108. B.
    The definitions for parallel and nonparallel shifts are reversed.
The first part of the C statement that begins, "The yield curve
usually has a nonzero slope" is correct. However, the second part is
incorrect-the slope occurs because rates change by different basis
points across maturities.
    109. C.
    At the end of Day 1, the balance in the investor' s account would
be $ 20.
    At the beginning of Day 2, the investor would be required to
deposit $ 30.
    At the end of Day 2, the balance in the investor's account would
be $120.
    At the end of Day 3, the balance in the investor's account would
be $100.
    110. B.
    The option is in-the-money at expiration (MAX (0, S-X) ) and the
PNG stock will be called away from Jackson at $ 148 per share,
limiting Jackson's gain from owning the stock to $3 ($148-145).
However, Jackson also gains the $ 2.40 from writing the call option.
Therefore, Jackson's gain from the covered call strategy is $ 5.40
($ 3.00+$ 2.40).
    111. B.
    When a forward contract is terminated by an offsetting contract
with a second counterparty, there is no further asset price risk, but
since there are two separate contracts with different counterparties,
all parties are exposed to default risk until both contracts are
settled. Since the two contracts may have different forward prices,
the terminating party may have a future liability at settlement, but
the amount is fixed at the time the offsetting contract is initiated.
The terminating party may have locked in a future gain or loss,
depending on the difference between the forward prices of the two
offsetting contracts.
    112. B.
    An ETF does not require investors who remain in the fund to pay
capital gain taxes due to redemptions by others by others. The in-
kind redemption feature of an ETF means that the fund itself does not
have to sell stocks to make redemptions. Because market makers are
instrumental in the ETF creation and redemption processes, arbitrage
helps keep the price of an ETF more in line with its underlying value
    113. C.
    The presence of infrequently traded assets leads to smoothed
pricing that induces a significant downward bias to the measured risk
of the assets as well as the correlations of returns with
conventional equity and fixed income returns.
    114. C.
    ($ 2700000-$ 1800000 )/0.15=$ 6000000
    115. C.
    Total return is an appropriate strategy for an investor seeking
to grow his portfolio with a balance between income and capital gains.
Capital preservation is an appropriate strategy for strongly risk-
averse investors.
    116. B.
    Many studies confirm that the choice of asset class and the
policy weights for the asset lasses together explain about 85 to 95
percent of returns.
    117. B.
    Investing on margin in the market portfolio will raise both risk
and expected returns. This strategy would be mean-variance efficient.
Other strategies such as shifting a portion of total funds to higher
risk assets would achieve the higher return goal but would leave the
portfolio below the CML and thus would not be all optimal strategy.
    118. C.
    Risk and return must always be considered together when
expressing investment objectives. Return objectives may be expressed
either in absolute terms (dollar amounts) or in percentages.
    119. B.
    Calculate the one-year holding period return:
    Calculate the required return is from the CAPM:
    Determine over/under valuation:
    The required return is greater than the expected return, so the
security is overvalued. The amount=17.48%-15.71%=1.77%.
    120. B.
    Markowitz's assumptions about investor behavior state that
investors base investment decisions solely off expected return and
risk not risk alone. All of the other statements are true.
                            Solutions to Sample Exam 2
                               (Afternoon Session)
    1. A.
    The Standards require that members make reasonable efforts to
make sure that performance information is fair, accurate, and
complete. They do not require compliance with Global Investment
Performance Standards (GIPS), auditing, or verification.
    2. C.
    GIPS can not cover all the situation, and this behavior is
    3. A.
    The initial minimum period is one year.
    4. C.
    Ryan violated the Standard relating to Integrity of Capital
Markets by engaging in a practice that is likely to artificially
inflate trading volume. Ryan did not violate the Standard regarding
Conflicts of Interest because he clearly disclosed his ownership of
shares in his message.
    5. B.
    Standard Ⅵ (B)Priority of Transactions. If Arratia decides to
make a recommendation about the purchase or sale of a security, she
shall give her customers or employer adequate opportunity to act on
this recommendation before acting on her own behalf.
    6. C.
    The only appropriate statement is "I passed the Level I CFA exam
last year." It is a factual statement and does not imply a partial
designation, which does not exist. You also cannot claim when you
will become a charterholder when you have no idea how long it will
take you to complete the requirements.
    7. B.
    The CFA designation should always be capitalized and shown
without periods. The CFA designation should not be referred to as a
degree. Placing the designation "CFA" or "CFA Charterholder" after
one's name on a resume, business card, brochure, or other published
material is appropriate.
    8. A.
    The problem says the analyst "comes across" the speculative stock
investment. We do not know if the analyst neglected his duties. Since
such an investment is clearly not appropriate for a high-grade bond
fund, the analyst may invest in the stock without any restrictions
relating to the fund.
    9. C.
    Members are required to disclose to their employer all matters
that reasonably could interfere with their objectivity. Board
participation, personal friendships with corporate executives, and
personal ownership of securities could reasonably interfere with
objectivity, but it is unlikely that a child's employment in a labor
function would reasonably interfere with a parent's objectivity.
    10. A.
    Zhang should treat his family's account like any other client
    11. C.
    Standard Ⅰ (C) Misrepresentation. Members should not copy or use
material prepared by others without acknowledging and identifying the
source of such material. Using charts and graphs without stating
their source is a violation of the Standard.
    12. A.
    All of these are part of Standard Ⅲ (B) except notifying clients
at the same time. Standard Ⅲ (B) states that clients for whom the
investment is suitable should be notified at approximately the same
    13. C.
    There is no evidence that he's lying about his past performance.
He is in violation for implying that he can guarantee performance,
for using short-term performance, and for imputing the manager's past
performance to future performance.
    14. A.
    None of the answers in this question provide adequate grounds for
not citing the source of the methodology. Although "verifying" the
technique is a good idea and consistent with the Code and Standards,
the analyst still needs to cite the use of the copyrighted technique
even after modifying it slightly to avoid violation of Standard Ⅰ
(C), Misrepresentation.
    15. C.
    Standard Ⅰ (B) Independence and Objectivity. Analysts should pay
for their own travel accommodations if the location is accessible by
normal means. In this situation payment is acceptable because the
location is out of the way and the purpose of the trip is all
    16. C.
    Any act involving lying, cheating, stealing, or other dishonest
conduct that reflects adversely on the charterholder's professional
activities is a violation of Standard Ⅰ (D). Although the crime did
not relate to the investment profession, it certainly reflected
adversely on the charterholder professionally.
    17. C.
    Standard Ⅳ (B)—Disclosure must be in writing and must cover
compensation received or proposed under the outside arrangement.
    18. C.
    Standard Ⅰ (B)Independence and Objectivity. Choice A. Dudley
should limit the acceptance of gratuities and/or gifts to token items
with a $100 maximum value. Choice B. Dudley should pay for commercial
transportation and hotel charges when making company visits. Her
company will most likely reimburse her to these expenses.
    19. C.
    An unbiased estimator is efficient if no other unbiased estimator
of the same parameter has a sampling distribution with smaller
    20. C.
    Arithmetic Mean Return exceeds Geometric Mean Return, while
Standard Deviation exceeds Mean Absolute Deviation.
    21. B.
    For a symmetrical distribution, the mean, median, and mode are
equal. For a positively skewed distribution, the mode is less than
the median, which is less than the mean. The mean is affected by
outliers. In a positively skewed distribution there are large,
positive outliers which will tend to "pull" the mean upward. For a
negatively skewed distribution, the mean is less than the median,
which is less than the mode. In this case, there are large, negative
outliers which tend to "pull" the mean downward.
    22. C.
    Periodic rate=8.0/12=0.667. Stated rate is 8.0% and effective
rate is 8.30%.
    23. A.
    A parameter is any descriptive measure of a population
characteristic. The population variance describes a population while
the sample standard deviation, sample mean, and sample mode are each
descriptive measures of samples.
    24. C.
    Set X%—minimum default risk premium,10%×(-100%)+90%×(3%+X%)=3%,
    X%=11.44%, minimum yield-to-maturity=11.44%+3%=14.44%.
    25. C.
    The EAY takes the holding period yield and annualizes it based on
a 365-day year accounting for compounding. The
HPY=(1+0.0504)150/365=1.2041-1=2.04%. Using the HPY to compute the money
market yield=HPY×(360/t)=0.0204×(360/150)=0.04896=4.90%.
    26. C.
    Find the weighted mean of the returns.
    27. A.
    An empirical probability is established by analyzing past date; A
priori probability determined using a formal reasoning and inspection
process; A subjective probably is the least formal method of
developing probabilities and involves the use of personal judgment.
So a priori probability reflects the analyst's perceptions.
    28. B.
    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). Note that this is a
one-sided alternative because of the" greater than" belief.
    29. C.
    The probability that one of these events will occur: 0.56+0.17-
(0.56×0.17)=0.6348, or 63.5%.
    30. B.
    Technical analysis emphasizes on trends and charts.
    32. C.
    Money market yield: ($ 5700/$ 94300)×360/256=0.085, or 8.5%.
    33. C.
    An individual is technically unemployed when he or she is
actively seeking employment or is waiting to return to a job from
which he or she was just laid off. Not all people who are not working
are considered unemployed. Examples include household workers,
students, prisoners, and retirees.
    34. C.
    Inflation rate =[(This year's CPI-Last year's CPI)/Last year's
    35. B.
    In a period of unanticipated inflation, borrowers benefit and
lenders lose. Lenders tend to hold long-term contracts in which they
will receive a fixed dollar payment. Borrowers who are paying on a
long-term fixed rate contracts will win at the lenders expense when
there is unanticipated inflation because the borrowers will be able
to repay the loan with cheaper dollars.
    36. C.
    The McCallum rule, in the spirit of a monetarist fixed rule,
attempts to make adjustments to the monetary base while targeting the
inflation rate. On the other hand, the Taylor rule takes a Keynesian
perspective and attempts to adjust the federal funds rate while
targeting the inflation rate.
    37. C.
    Because of monetary policy lags, changes in the growth rate of
the money supply indicated by a feedback rule can actually result in
an increase in the size of economic cycles. For this reason monetary
policy based on a feedback rule will not necessarily stabilize
aggregate demand or inflation, although that is their intent. A
fixed-rule policy is based on a stable growth rate of the money
    38. C.
    Automatic fiscal stabilizers refer to changes in government
spending or taxing that occurs automatically as the business cycle
changes. One example of an automatic fiscal policy stabilizer is an
"induced tax". Induced taxes refer to the amount of taxes collected
as a percentage (i. e. income tax rate) of income. Incomes are
positively related to GDP, implying that incomes rise during an
economic boom. As incomes rise, the total amount of taxes collected
by the govern ment automatically increases. The increase in taxes
paid by corporations and individuals tend to slow the economy.
Increases in spending on defense or highways are examples of
discretionary fiscal policy (requiring government Administration
approval). The Federal Funds target rate is set by the Federal
Reserve and is not an example of fiscal policy.
    39. C.
    An unanticipated shift to a more expansionary monetary policy
will temporarily expand output and employment.
    40. A.
    The economy is in an inflationary phase if actual real GDP is
greater than potential real GDP. When actual real GDP equals
potential real GDP, the economy is said to be at full employment. The
economy is in a recessionary phase if real GDP is less than potential
    If the supply of a productive resource is perfectly elastic, it
earns no economic rent. Elasticity of demand is not directly related
to economic rent.
    42. A.
    The potential deposit expansion multiplier is the reciprocal of
the reserve ratio. If the reserve ratio is 20%, then 1/0.20=5.
    43. C.
    From an initial long-run equilibrium, an increase (decrease) in
aggregate demand will increase (decrease) prices and output in the
short ran, and the resulting increase (decrease) in money wages will
decrease (increase) short-ran aggregate supply; resulting in further
price increases (decreases) and a return to full-employment long-run
    44. C.
    Consumer surplus is the sum of the differences between what a
consumer is willing to pay for each unit of a good or service and
what that consumer actually pays for each unit.
    45. C.
    An analyst doesn't have access to the detailed information that
flows through a company's accounting system, but only sees its end
product, the financial statements. The analyst needs to understand
the various accruals, adjustments, and management assumptions that
went into the financial statements. Much of this is often explained
in the footnotes to the statements and in Management's Discussion and
Analysis, which is why it is crucial for an analyst to review these
parts of the presentation. With this information, the analyst can
better judge how well the financial statements reflect the company's
true performance, and in what ways he needs to adjust the data for
his own analysis.
    46. B.
    The firm's basic EPS=($1700000-$1100000)/523000=$1.147.
    47. B.
    This is perpetuity. PV=PMT/I=30000/0.15=200000.
    48. B.
    Dilutive securities are securities that decrease EPS if they are
exercised or converted to common stock. Stock options, warrants,
convertible debt, and convertible preferred stock are examples of
potentially dilutive securities. Note that if diluted EPS when
considering the convertible bonds is greater than basic EPS, the
convertible bonds would be antidilutive and should not be treated as
common stock in computing diluted EPS.
    49. C.
    Preferred stock and bonds are only considered to be potentially
dilutive if they are convertible. Warrants and options are always
considered to be potentially dilutive.
    50. A.
    This is the correct treatment of this change. The company must
disclose the nature of the error and its effect on net income and
restate any prior period results that are presented in the current
financial statements. The other choices are incorrect.
    51. B.
    The annual report would typically not contain this detailed
    52. B.
    Wtd. avg. shares=1000000+0.75×300000+0.5×200000=1325000 shares
    53. C.
    The financial statement footnotes should disclose the specific
accounting policies, including revenue recognition methods, used in
preparing the financial statements. The footnotes should also
disclose key estimation uncertainties that may cause material
adjustments in the carrying value of assets and liabilities. One such
disclosure is concentrations of credit risk.
    54. C.
    Trading securities are reported in the balance sheet at fair
value. At the end of the year, the fair value of the securities was
$ 980000 ($ 435000+$ 545000). The unrealized gains and losses from
trading securities are recognized in the income statement. Thus,
Ponca would recognize an unrealized gain of $ 30000 ($ 980000 fair
value-$ 950000 cost).
    55. C.
    Paying off accounts payable from cash lowers current assets and
current liabilities by the same amount. Because the current ratio
started off above 1, the current ratio will increase. Because the
quick ratio started off less than 1, it will decrease further. The
other choices are incorrect. Buying fixed assets on credit decreases
both ratios because the denominator increases, with no change to the
numerator. Using cash to purchase inventory would result in no change
in the current ratio but would decrease the quick ratio by decreasing
the numerator.
    56. A.
    A discussion of sales trends will be included in the Management
Discussion and Analysis section of the financial reports. The other
three items are required footnote disclosures.
    57. B.

   Sales                                 +$4000
    Cash received from          +$4000(since no change in
customers                                AR)
    Cost goods sold                       -2000
    Increase in inventory                  -100
    Increase in accounts
    Other cash input
    Cash paid inputs                       -2300
    Cash paid for taxes                     -200
    Cash flow from

    58. C.
    Interest and dividends received and interest paid are considered
operating activities under U. S. GAAP, but dividends paid are
considered financing activities.
    59. A.
    Cash collections=net sales-increase in receivables=$ 50000-
$ 500=$ 49500. Since cash flow from operations and total cash flow
are both the same under either the direct or indirect method, the
easiest way to calculate CFO is total cash flow-cash flow from
investing-cash flow from financing=$12000+5000+4250=$ 21250.
    60. C.
              Item                                 Amount
    Cash payment of dividends        CFF            -$30
         Sale of equipment           CFI            +$25
              Net income             CFO            +$25
          Purchase of land           CFI            -$15
       Increase in accounts
                                     CFO            +$20
     Sale of preferred stock         CFF            +$25
       Increase in deferred
                                     CFO            +$5

    CFI=Sale of Equipment (+25) Purchase of Land (-15)=$10.
    A valuation allowance is a contra account (offset) against
deferred tax assets that reflects the likelihood that the deferred
tax assets will never be realized. If a firm is unlikely to have
future taxable income, it would be unlikely to ever use its deferred
tax assets, and therefore must record a valuation allowance.
    62. C.
    FIFO COGS = LIFO COGS -change in LIFO reserve
    FIFO COGS = $1 million-$ 0.1 million=$ 0.9 million
    63. C.
    Total debt to total equity under LIFO is
($1800000+$1200000+$12500000)/($ 2000000+$10400000)=1.25. If Leeward
uses FIFO, on the asset side, Inventory will increase by the amount
of the ending LIFO reserve ($2100000). On the liabilities and equity
side, Deferred Tax Liability will increase by the ending LIFO reserve
times the tax rate ($ 2100000×0.4 )=$ 840000. Retained Earnings will
increase by the ending LIFO reserve times (1-tax rate), which is
($2100000)×(1-0.4)=$1260000. Leeward's total debt to total equity
ratio under FIFO will be
($1800000+$1200000+$ 840000+$12500000)/($ 2000000+$10400000+$1260000)
    64. B.
    Average age of depreciable assets is useful for two reasons:
    1) to assess how competitive the corporation will be going
forward (older assets are less efficient).
    2) to estimate financing required for major capital expenditures
in the near-term to replace depreciated assets.
    65. A.
    profit margin×asset turnover×financial leverage. Although net
income/assets×sales/equity× assets/sales also yields ROE, it is not
the DuPont equation.
    66. B.
    According to SFAS 143, in accounting periods following an
acquisition, liability values are accreted in a manner similar to
interest for bond amortization. The liability grows until it matches
expected cost of disposal at the end of the asset's life.
    67. A.
    Straight-line depreciation: $14 million/7=$ 2.0 million
    Accelerated depreciation: $14 million×0.333=$ 4.662 million
    Deferred tax liability ($ 4.662 million-$ 2.0
million)×0.35=$ 0.9317 million
    68. B.
    Use the lower of the company's lease rate or the borrowing rate
of 9.5% for I/Y.
    I/Y=9.5, N=4, FV=0, PMT=$30000, CPT PV=$96134.
    69. B.
    The PV of the remaining lease payments at the beginning of year 2
is $710782 (N=9, I=5%, PMT=$100000, CPT PV). Interest
expense=0.05×$ 710782=$ 35539.
    70. C.
    Current ratio = Current assets/Current liabilities
    Quick ratio=(Current assets-investing)/Current liabilities
    For Example, CA=$ 400 consisting of cash=$ 50, accounts
receivable=$150, and inventories=$ 200; and CL=$ 200.
    Before: Current ratio=$ 400/$ 200=2.0x; Quick
ratio=$ 200/$ 200=1.0x.
    Assume that the company uses $ 50 in cash to pay off $ 50 in
notes payable.
    After: Current ratio=$ 350/$150=2.3x; Quick ratio=$150/$150=1.0x.
    A common size balance sheet expresses all balance sheet accounts
as a percentage of total assets.
    72. A.
    With an uncommitted line of credit, the lender is not committed
to make loans in any amount. A revolving line of credit is typically
for a longer period and involves an agreement to lend funds in the
future up to some maximum amount. A blanket lien is a claim against
all firm assets.
    73. C.
    NPV and IRR lead to the same decision for independent projects,
not necessarily for mutually exclusive projects. IRR assumes that
cash flows are reinvested at the IRR rate. IRR does not ignore time
value of money (the payback period does), and the investor may find
multiple IRRs if there are sign changes after time zero (i. e.
negative cash flows after time zero).
    74. B.
    N=20; FV=IO00; PV=-894; PMT=60; CPT→I/Y=7%
    Cost of common equity:
    75. B.
    A shorter operating cycle will lead to a shorter cash conversion
cycle, other things equal, which is an indication of better working
capital management. While credit policies that are too strict could
also reduce the operating cycle, this is less of a concern than the
other choices. Lower trade payables turnover and higher days
inventory on hand, compared to peer company averages, will both tend
to lengthen the cash conversion cycle, an indication of poorer
working capital management.
    76. C.
    NPV should always be used if NPV and IRR decisions conflict.
    77. A.
    Because the interest paid on corporate debt is tax deductible,
the after-tax cost of debt capital is Kd(1-t). An increase in the tax
rate results in a decrease in the after-tax cost of debt capital. For
example, if the yield to maturity on a firm's debt is 9% and the tax
rate is 35%, the after-tax cost of debt capital is 0.09×(1-
0.35)=0.0585=5.85%. If the tax rate increases to 45% , the after-tax
cost of debt capital becomes 0.09×(1-0.45)=0. 0495=4.95%. Payments
to a firm's preferred or common shareholders are not tax deductible,
so changes in the tax rate do not change a firm's component costs of
capital for preferred stock or common equity.
    78. A.
    Project C is similar in risk to an industry that has an average
beta of 1.2. Therefore, we use the capital asset pricing model and
the industry average beta to calculate the cost of equity capital for
Project C: Cost of Equity Capital for Project C=0.05+1.2×(0.11-
    79. B.
    Negative earnings render the P/E ratio useless. All of the other
factors increase the usefulness of the P/E approach.
    80. C.
    When analyzing the relationship among the high-yield bond indexes
and the investment-grade indexes, it is evident that the relationship
among the high-yield bond indexes is weaker than among the
investment-grade indexes.
    In a market-value-weighted index, the total ending market value
for the securities is divided by the beginning market value for the
securities to determine the percentage of change, which in turn is
applied to the beginning index value: $1100000/$1030000=1.06796.
    82. B.
    Determine the price (P) that is equal to 25 percent: (200P-
4200)/200P=0.25, P=$ 28.00.
    83. C.
    A continuous market is one in which trades can occur at any time.
When numerous dealers are willing to buy and sell for their own
account, trades can occur at any time.
    84. B.
    The marker maker (specialist) has two major functions. They act
as brokers to match buy and sell orders, including special (stop loss
or stop buy) orders. They also act as a dealer to maintain a fair and
orderly market by providing liquidity when the normal flow of orders
is not adequate.
    85. A.
    Bonds and stocks are traded on both the primary and secondary
    86. C.
    In an efficient market, portfolio managers must create and
maintain the appropriate mix of assets
    to meet their client' s needs. The portfolio should be
diversified to eliminate unsystematic risk. The appropriate
systematic risk will depend on the clients risk tolerance and return
requirement. Over time the needs of the client and environment will
justify changes to the portfolio. The manager should also try to
minimize transaction costs and at least try to match the performance
of a benchmark.
    87. C.
    2008 EPS=[(2002 sales)(2002 Profit Margin)]/(number of Shares)
    2008 sales=(10 million)(1-0.15)=8.5 million
    2008 EPS=[(8.5 million)(0.054)]/120000=$3.83
    88. C.
    Dividends income=(0.75)×(200)=$150
    89. C.
    Part 1: Calculate Margin Return:
    Margin Return % =[((Ending Value-Loan Payoff)/Beginning Equity
Position)-1]×100 =[(([$34x1000]-
    Alternative (Check): Calculate the all cash return and multiply
by the margin leverage factor. =[(34000-
    Part 2: Calculate Margin Call Price:
    Since the investor is short (sold the stock), the formula for the
margin call price is:
    Margin Call=(original price)×(1+initial margin)/(1+maintenance
margin)=$ 32×(1+0.40)/(1+0.25)=approximately $ 35.80.
    90. C.
    Assuming past investments are stable and earnings are calculated
to allow for maintenance of past earnings power, then the firm's
expected dividend growth rate (g) can be defined as the firm's
earnings plowback or retention rate (RR) times the return on the
equity (ROE) portion of new investment. RR is equal to 1 minus the
dividend payout ratio, and ROE equals profit margin times total asset
turnover times financial leverage. This growth rate is also called
the sustainable growth rate.
    91. 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. Spot rates are
defined as interest rates used to discount a single cash flow to be
received in the future. Any bond can be viewed as the sum of the
present value of its individual cash flows where each of those cash
flows are discounted at the appropriate zero-coupon bond spot rate.
    92. C.
    The bond equivalent yield rate on the par bond (Z) is 6% or a 3%
semiannual rate. The equivalent quarterly rate, 1.031/2-1=0.014889.
Security X makes 20 quarterly payments of.$15 and 20 quarterly
payments of $ 20. We need to use the cash flow function as follows:
CF0=0; CF1=15; F1=20; CF2=20; F2=19; CF3=1020; F3=1; I=1.4889;
CPT→NPV= $1067.27. Note that CF3 contains the final quarterly
payment of $20 along with the $1000 face value payment.
    93. A.

    At $991 (rounded), T-note 1 is correctly priced. However at $1008,
T-note 2 is priced below the present value of its cash flows ($1010)
and is therefore under-priced.
    94. B.
    The bond is sold at a premium. As time passes, the bond's price
will move toward par. Thus, the price will fall.
    N=10; FV=1000; PMT=100; I/Y=8; CPT→PV=$1134
    N=9; FV=1000; PMT=IO0; I/Y=8; CPT→PV=$1125
    95. A.
    Using the financial calculator: N=10×2=20; PMT=$ 80/2=$40;
I/Y=10/2=5%; FV=$1000; CPT PV=$ 875.38.
    96. A.
    This value is computed as follows:
    Present Value= 6/1.05+6/1.0552+106/1.063=100.10
    The value 95.07 results if the coupon payment at maturity of the
bond is neglected.
    97. A.
    Statement 1 is incorrect. If we know one actual spot rate, we can
calculate the theoretical spot rate for the next longer period. With
these two spot rates we can calculate the next theoretical spot rate,
and so on up the coupon curve. Statement 2 is a correct description
of the methodology for computing a theoretical Treasury spot rate.
    98. C.
    The semiannual-pay bond equivalent yield of an annual-pay
bond=2×(1+yield to maturity on the annual-pay bond)×0.5-1]=12.14%.
    99. C.
    The reinvestment assumption that is embedded in any present
value-based yield measure implies that all coupons and principal
payments must be reinvested at the specific rate of return, in this
case, the yield to maturity. Thus, to obtain a 7.515% total dollar
return, the investor must reinvest all the coupons at a 7.515% rate
of return.
    100. B.
    Bonds W and Y are most likely callable and Bonds X and Z are most
likely putable. If the option-adjusted spread is less than the zero-
volatility spread, the embedded option has a negative value to the
bondholder (e. g. a call option) , and if the option-adjusted spread
is greater than the zero-volatility spread, the embedded option has a
positive value to the bondholder (e. g. a put option). Zero-
volatility spreads adjust for the fact that nominal spreads (between
the yields to maturity of two bonds) are theoretically correct only
when the spot yield curve is flat. All of these bonds' zero-
volatility spreads are nearly identical to their nominal spreads to
Treasuries, which suggests the spot yield curve is in fact
approximately flat.
    101. C.
    Because of convexity, it will be approximately a 7.5 percent
change in price, not an actual 7.5 percent change in price. The
readings are very explicit about this distinction.
    102. C.

        Initial price:          Price with change:
   FV=1000                    FV=1000
   PMT=50                     PMT=50
   N=14                       N=14
   I/Y=3%                     I/Y=3.005
   CPTPV=1225.92              CPTPV=1225.28

    PVBP=1225.92-1225.28=0.64. PVBP is always the absolute value.
    103. B.
    The estimated price change is-(duration)
(△y)+(convexity)×(△y)2=-8×(-0.006) +50×(-0.006)2=+0.0498 or 4.98%.
    104. A.
    Option-free bonds have positive convexity and the effect of
(positive) convexity is to increase the magnitude of the price
increase when yields fall and to decrease the magnitude of the price
decrease when yields rise.
    105. C.
    In a plain vanilla interest rate swap, interest payments are
netted. Note that notional principal is not exchanged and is only
used a basis for calculating interest payments.
    106. A.
    Since the current price is less than the exercise price, the put
option is in the money. The difference between the current price and
the exercise price is $ 0.013.
    107. B.
    Most futures positions are closed out by an offsetting trade at
some point during life of the contract.
    108. B.
    Since early exercise of an American call option on an asset with
no cash flows never generates more than the minimum value of the
European option, early exercise is never profitable and the lower
bounds on prices of both types of options are the same.
    109. A.
    At expiration, from the borrower's perspective, the payment will
be calculated as: $10000000×(0.05-0.06)(180/360)/(1+0.05×180/360)=-
$50000/1.025=-$ 48780
    Because the amount is negative, it reflects a cash outflow, or a
payment made, by the borrower.
    110. B.
    The most the writer can make is the premium. If the writer wrote
a covered out of the money call, then the writer would make the
premium plus the increase in the stock's price X - S.
    111. B.
    The market price of a closed-end investment company's shares is
determined in the secondary markets in which the shares trade.
    112. A.
    Because the after-tax cash flow approach requires specific
information about the investor's marginal tax rate. The value of the
property is thus dependent on the investor's marginal tax rate.
    113. A.
    Since closed-end funds are traded in the secondary market for a
price determined by supply and demand for shares, the spread along
with the sales commission represent the redemption fee. All funds
charge fees, although the fees vary widely from fund to fund. In
addition, some funds charge a load in addition to fees. Closed-end
fund prices are determined by the market and can trade at either a
premium or a discount to the net asset value.
    114. C.
    Property insurance is not considered a category of real estate
investment because the underlying real estate does not revert to the
insurer if the property holder allows the policy to lapse. Outright
ownership, a leveraged equity position, and aggregation vehicles such
as real estate investment trusts are all forms of real estate
    115. A.
    Diversification reduces the portfolio standard deviation below
the weighted average of their standard deviation if they are less
than perfectly positively correlated. However, the minimum standard
deviation occurs when the correlation is equal to negative one, not
    116. C.

    117. A.
    Remember to use standard deviation not variance. Square root of
90.2=9.5, square root of 120.4=10.97, so correlation equals:
62.5/(9.5×10.97)=0.60. Interpret the correlation coefficient as
follows: a 1% increase in returns on bonds will be met with a 0.6%
increase in returns on preferred stock and vice versa.
    118. C.
    Average asset allocations differ across countries for reasons
related to demographics, social factors, legal constraints, and
taxation. Each of the four statements made by Hoch are an example of
one of these factors, therefore all four of the statements reflect
common reasons why average asset allocations differ across countries.
    119. C.
    With positive transactions costs, there will be rates of return
on both sides of the SML for which the cost of trading will be
greater than the expected gains from trading. This means there is a
band of expected returns for each level of systematic risk that is
consistent with efficient pricing, once transactions costs are
    120. A.
    All investors select portfolios that lie along the efficient
frontier, based on their utility functions. All investors have the
same one-period time horizon, and have the same risk/return

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