Which of the following is not included in the nine major provisions of the Global Investment Performance Standards (GIPS)?
Input Data, Calculation Methodology, and Real Estate
Fundamentals of Compliance, Composite Construction, and Disclosure
Calculation
C is correct because Alternative Assets is not among the nine major provisions or sections of the Global Investment Performance Standards, which include: Fundamentals of Compliance, Input Data, Calculation Methodology, Composite Construction, Disclosure,
In order to achieve compliance with GIPS Standards, it is recommended that firms:
adopt the broadest, most meaningful definition of the firm.
provide existing clients a compliant presentation applicable to their portfolio, at a minimum of a bi-annual basi
A is correct. The Fundamentals of Compliance recommend that firms should adopt the broadest, most meaningful definition of the firm.
Based on his superior return history, Vijay Gupta, CFA, is interviewed by the First Faithful Church to manage the church's voluntary retirement plan's equity portfolio. Each church staff member chooses whether to opt in or out of the retirement plan accor
No
Ken Kawasaki, CFA, shares a building with a number of other professionals who are also involved in the investment management business. Kawasaki makes arrangements with several of these professionals, including accountants and lawyers, to refer clients to
B is correct because Standard VI(C) requires disclosure of any compensation, consideration, or benefit received from or paid to others for the recommendation of products or services. Even without cash changing hands the arrangement provides for a quid pro
Investor A and Investor B invest in a fund for two years:
Year 1 Year 2
Fund Return Positive Negative
Portfolio Money-Weighted Rate of Return
Investor A 7.5%
Investor B 8.2%
Given the information in the table, which of the following is least likely to be
C is correct. The money-weighted rate of return (MWR) is sensitive to the additions and withdrawals of funds in a portfolio over the course of an investment. If, at inception, investors A and B invest amounts of different size in the same fund but then ne
A price range in which selling is sufficient to stop the rise in price is best described as:
change in polarity.
resistance.
support.
B is correct. Resistance is defined as a price range in which selling activity is sufficient to stop the rise in price.
Q. A portfolio manager estimates the probabilities of the following events for a mutual fund:
Event A: the fund will earn a return of 5%.
Event B: the fund will earn a return below 5%.
The least appropriate description of the events is that they are:
depe
C is correct. Events are exhaustive when they cover all possible outcomes. Mutually exclusive means that only one event can occur at a time. Two events are dependent if the occurrence of one event does affect the probability of occurrence of the other eve
The effective annual yield (EAY) for an investment is 8.0%. Its bond equivalent yield is closest to:
8.00%.
7.85%.
8.16%.
B is correct. EAY = (1 + YTM)365/t ? 1
Semiannual yield to maturity, YTM = (1 + 0.08)0.5 ? 1 = 0.03923 = 3.923%
Bond equivalent yield = 2 � YTM = 2 � 3.923% = 7.85%
Q. An equally weighted portfolio is composed of four stocks. An analyst knows the mean and variance for each of the four stocks. In order to estimate the portfolio mean and variance, the analyst will require the stocks':
skewness.
pairwise correlations.
k
B is correct. Specification of the mean and variance for a portfolio of four stocks requires estimates of the mean returns and variances for each of the four stocks and the pairwise correlations between each of the four stocks.
Q. For a given economy and a given period of time, GDP measures the:
aggregate income earned by all households, all companies, and the government.
total income earned by all of the country's citizens, firms, and the government.
total market value produced
A is correct. Gross domestic product (GDP) can be defined in terms of either output or income:
it is the market value of all final goods and services produced within the economy in a given period of time (output definition) or, equivalently,
it is the agg
The most likely initial (short-run) effect of demand-pull inflation is an increase in:
finished good prices.
employee wages.
commodity prices.
C is correct. The effect of demand-pull inflation is an increase in the aggregate demand, which, in turn, leads to an increase (initially) in commodity prices. A and B are incorrect because commodity prices tend to increase initially.
The method used by a high-end custom-built motorcycle manufacturer to value its inventory results in the matching of the physical flow of the particular items sold, and the items remaining in inventory, to their actual cost. Which of the following invento
C is correct. Specific identification is the inventory method that results in the matching of the physical flow of the particular items sold and would be most suitable for high-end custom-built motorcycles that are not ordinarily considered interchangeabl
Q. Net revenue most likely refers to revenue minus:
revenues attributable to non-controlling interests.
estimates of warranty expense.
volume discounts and estimated returns.
C is correct. Net revenue means that the revenue number is reported after adjustments for cash or volume discounts or for estimated returns.
Q. On 1 January 2011, a company that prepares its financial statements according to International Financial Reporting Standards (IFRS) issued bonds with the following features:
Face value: �20,000,000
Term: Five years
Coupon rate: 6% paid annually on 31 D
C is correct.
Gain = Book value of debt ? Market value
= �20,754,438 ? �20,371,882
= �382,556
Both at time of retirement, calculations below.
The market value of debt at retirement can be determined by discounting the future cash flows at the current mark
Information about a company's historical performance for the last two years and additional information are summarized in the following table.
($ thousands) 2013 2012
Sales 5,500.0 5,350.0
Cost of goods sold ?2,200.0 ?2,140.0
Operating expenses ?2,350.0 ?2
B is correct. The loss (gain) from discontinued operations and the gain on the sale of the portfolio investments should not be included in the forecast because they are not recurring items. First, the recurring operating margin before tax should be foreca
Q. Which of the following companies would most likely be considered to have the lowest financial reporting quality, other things equal?
A company that provides high quality, decision-useful information under GAAP but delays its reports.
A company that rep
C is correct. Combining the results from two segments is an example of biased reporting, which falls in the middle of the quality spectrum. It is difficult to interpret the profitability of each segment when their results are combined.
A is incorrect beca
In accrual accounting, if an adjusting entry results in the reduction of an asset and the recording of an expense, the originating entry recorded was most likely a(n):
deferred revenue.
prepaid expense.
accrued expense.
B is correct. The adjusting entry to record the expiry of a prepaid expense is the reduction of an asset (the prepaid) and the recognition of the expense.
Q. Inherent risks in an investment are most appropriately evaluated in which step of the financial statement analysis framework?
Develop and communicate conclusions/recommendations
Articulate the purpose and context of analysis
Process data
A is correct. Discussion and presentation of inherent risks in an investment is appropriate in the develop and communicate conclusions/recommendations step. B and C are incorrect because risks are evaluated and presented after data are collected and proce
During a period of rising inventory costs, a company decides to change its inventory method from FIFO to the weighted average cost method. Under the weighted average method, which of the following financial metrics will most likely be higher than under FI
C is correct. If all else is held constant, in a period of rising costs the ending inventory will be lower under the weighted average cost method and the cost of goods sold will be higher (compared to FIFO), resulting in lower net income and retained earn
Q. Which action is most likely considered a secondary source of liquidity?
Increasing the efficiency of cash flow management
Renegotiating current debt contracts to lower interest payments
Increasing the availability of bank lines of credit
B is correct. Renegotiating debt contracts is a secondary source of liquidity because it may affect the company's operating and/or financial positions.
Q. Which of the following is most likely considered an example of matrix pricing when determining the cost of debt?
Debt-rating approach only.
Yield-to-maturity approach only.
Both the yield-to-maturity and the debt-rating approaches.
A is correct. The debt-rating approach is an example of matrix pricing. B and C are incorrect because the yield-to-maturity approach is not an example of matrix pricing.
income Statement Millions ($)
Revenues 9.8
Variable operating costs 7.2
Fixed operating costs 1.5
Operating income 1.1
Interest 0.6
Taxable income 0.5
Tax 0.2
Net income 0.3
Q. The degree of operating leverage (DOL) is closest to:
2.4.
1.1.
1.7.
A is correct.
DOL = Revenues?Variable operating costsRevenues?Variable operating costs?Fixed operating costs
= 9.8?7.29.8?7.2?1.5
= 2.36
Q. Other factors held constant, the reduction of a company's average accounts payable because of suppliers offering less trade credit will most likely:
not affect the operating cycle.
reduce the operating cycle.
increase the operating cycle.
A is correct. Payables are not part of the operating cycle calculation, which includes receivables and inventory. B and C are incorrect because as per above, payables are not part of the operating cycle calculation.
Q. Which of the following statements is the most appropriate treatment of flotation costs for capital budgeting purposes? Flotation costs should be:
expensed in the current period.
incorporated into the estimated cost of capital.
deducted as one of the pr
C is correct. Flotation costs are an additional cost of the project and should be incorporated as an adjustment to the initial-period cash flows in the valuation computation.
Q. Given two mutually exclusive projects with normal cash flows, the point at which their net present value profiles intersect the horizontal axis is most likely the projects':
weighted average cost of capital.
crossover rate.
internal rate of return.
C is correct. For a project with normal cash flows, the NPV profile intersects the horizontal axis at the point where the discount rate equals the IRR. The crossover rate is the discount rate at which the NPVs of the projects are equal. Although it is pos
Q. Which of the following pairs of risks are most closely related?
Model risk and tail risk
Liquidity risk and operational risk
Credit risk and solvency risk
A is correct. Model risk is the risk of using the wrong model to analyze an investment or the risk of using the right model for the analysis but using it incorrectly. Tail risk, although it involves unlikely but substantial losses, typically results from
Q. Compared with its market-value-weighted counterpart, a fundamental-weighted index is least likely to have a:
momentum effect.
contrarian effect.
value tilt.
A is correct. The momentum effect is a characteristic of a market-capitalization-weighted index, not a fundamental index.
Q. The following information is available about a company:
Next year's sales revenue $180 million
Next year's net profit margin 15%
Dividend payout ratio 60%
Dividend growth rate expected during Years 2 and 3 25%
Dividend growth rate expected after Year 3
A is correct.
Net profit margin = Net earnings/Sales
Net earnings = Net profit margin � Sales
Dividends per share (Dn) = (Net earnings � Payout ratio)/Number of outstanding shares
Therefore,
D1 = ($180 million�0.15�0.60)8.1 million=$2.00
D2 = $2.00(1 + 0.
Q. Which of the following is least likely to be a type of embedded option in a bond issue granted to bondholders? The right to:
put the issue.
convert the issue.
call the issue.
C is correct. The right to call an issue is a type of embedded option granted to issuers, not bondholders. The other two rights are embedded options granted to bondholders. A and B are incorrect because this is a type of embedded option granted to bondhol
Q. Eldora Ltd. recently issued deferred-coupon bonds for which no coupon payments will be paid in the first two years of the bond's life. Regular annual coupon payments at a rate of 9% will then be made until the bonds mature at the end of six years. The
A is correct. The bond price is computed as
P0 = 9/(1.070)3 + 9/(1.065)4 + 9/(1.060)5 + (9 + 100)/(1.055)6 = 100.12
Q. Which of the following factors will most likely drive the repo margin lower?
Lower quality of the collateral
Shorter supply of the collateral
Lower credit quality of the counterparty
B is correct. If the collateral is in short supply or if there is a high demand for it, repo margins are lower. Repo margin is the difference between the market value of the security used as collateral and the value of the loan.
Q. Which of the following statements best describes a feature of an American option? Early exercise of an American:
put option is optimal only if the underlying is dividend paying.
call option is never optimal if the underlying is dividend paying.
put opt
C is correct. For a deep-in-the-money put option, early exercise may be optimal because the additional upside is limited.
Q. All, else held equal, the value of a European call option is best characterized as having a:
negative relationship with the price of the underlying.
negative relationship with the volatility of the underlying.
positive relationship with the time to exp
C is correct. The value of a European call option is directly related to the time to expiration. That is, all else held equal, the value of a European call option is higher the longer the time to expiration.
Q. The real estate index most likely to suffer from sample selection bias is a(n):
repeat sales index.
REIT index.
appraisal index.
A is correct. Only properties that sell in each period and are included in the index and vary over time which may not be representative of the whole market.B is incorrect because the REIT index is based on a set of publicly traded REITs and thus does not
Q. Relative to traditional investments, alternative investments are best characterized as having:
higher correlations with other asset classes.
unique legal and tax considerations.
greater liquidity.
B is correct. Alternative investments are more likely characterized as having unique legal and tax considerations because of the broad range and complexity of the investments.
Q. The most likely impact of adding commodities to a portfolio of equities and bonds is to:
increase risk.
provide higher current income.
reduce exposure to inflation.
C is correct. Over the long term, commodity prices are closely related to inflation, so including commodities in a portfolio of equities and bonds will reduce its exposure to inflation.
Q. Which of the following is most likely a private real estate investment vehicle?
Real estate limited partnership
Real estate investment trust
Collateralized mortgage obligation
A is correct. Real estate limited partnerships are a form of private real estate investment.
Q. Which of the following is least likely a requirement of the GIPS standards? Firms are required to:
have their performance records verified by an independent third party.
include all discretionary, fee-paying portfolios in at least one composite.
presen
A is correct because it is a recommendation but not a requirement that firms obtain independent third-party verification to claim GIPS compliance. Firms are required to include all discretionary, fee-paying portfolios in at least one composite. They must
Q. Which of the following groups is most likely responsible for maintaining oversight and responsibility for the Professional Conduct Program (PCP)?
CFA Institute Board of Governors
Disciplinary Review Committee
Professional Conduct Division
A is correct. All CFA Institute members and candidates enrolled in the CFA Program are required to comply with the Code and Standards. The CFA Institute Board of Governors maintains oversight and responsibility for the Professional Conduct Program (PCP).
Q. When can a party, nonmember or firm, most likely claim compliance with the CFA Institute Code of Ethics and Standards of Professional Conduct? Once they have:
ensured that their code and ethics meets the principles of the Code and Standards.
notified t
A is correct. The Code and Standards apply to individual members of CFA Institute and candidates in the CFA Program. CFA Institute does encourage firms to adopt the Code and Standards, however, as part of their code of ethics. Those who claim compliance s
Q. Jean-Luc Schlumberger, CFA, is an independent research analyst providing equity research on companies listed on exchanges in emerging markets. He often incorporates statistical data he obtains from the web sites of the World Bank and the central banks
C is correct because Standard III(D)-Performance Presentation pertains to investment performance information, and there is no indication any violation has occurred.
Q. Monique Gretta, CFA, is a research analyst at East West Investment Bank. Previously, Gretta worked at a mutual fund management company and has a long-standing client relationship with the managers of the funds and their institutional investors. Gretta
C is correct because the analyst does not violate any of the Standards of Professional Conduct by having long-standing client relationships and generally is not required to disclose such relationships. However, the analyst is not treating all clients fair
Kelly Amadon, CFA, an investment advisor, has two clients: Ryan Randolf, 65 years old, and Keiko Kitagawa, 45 years old. Both clients earn the same amount in salary. Randolf, however, has a large amount of assets, while Kitagawa has few assets outside her
B is correct because in Randolf's case, the investment may be appropriate given this client's financial circumstances and aggressive investment position. This investment would not be suitable for Kitagawa with a need for a steady rate of return and her lo
Q. David Bravoria, CFA, is an independent financial advisor for a high-net-worth client with whom he had not had contact in more than two years. During a recent brief telephone conversation, the client states that he wants to increase his risk exposure. B
C is correct because Bravoria violated Standard III(A)-Loyalty, Prudence, and Care as he had not updated his client's profile in more than two years and thus should not have made further investments, particularly in high-risk investments, until such time
Q. Maria Martinez is a research analyst and a Level II CFA candidate. Recently, friends of Martinez organized a party for her thirtieth birthday. At the party, Martinez received an inexpensive gift from a friend who is the CEO of a publicly listed company
A is correct because Standard I(D)-Misconduct states that members and candidates must not engage in any professional conduct involving dishonesty, fraud, or deceit or commit any act that reflects adversely on their professional reputation, integrity, or c
Q. Anna Saar, CFA, is the head of compliance for Tranne Advisory Services, a regional financial services group including asset management, investment banking, and stock brokerage entities. Reviewing a draft client investment management agreement for the a
A is correct because the group subsidizing staff loans for the purchase of shares is not a conflict of interest for clients because it is a funding mechanism and does not interfere with objectivity when rendering investment advice or taking investment act
Q. If the stated annual interest rate is 9% and the frequency of compounding is daily, the effective annual rate (EAR) is closest to:
9.00%.
9.86%.
9.42%.
C is correct. EAR = (1 + periodic interest rate)m ? 1 = [1 + (0.09/365)]365 ? 1 = 0.094162, rounded to 9.42%.
Q. The dollar discount on a US Treasury bill with 91 days until maturity is $2,100. The face value of the bill is $100,000. The bank discount yield of the bill is closest to:
8.31%.
8.40%.
8.58%.
A is correct. Solve for bank discount yield, rBD, using:
rBD = (D/F)�(360t)
rBD = (2,100100,000)�(36091)
= 0.083077~8.31%.
Q. An investment in 10,000 common shares of a company for one year earned a 15.5% return. The investor received a $2,500 dividend just prior to the sale of the shares at $24 per share. The price that the investor paid for each share one year earlier was c
C is correct. Holding period return,
HPR = (P1 ? P0 + D1)/P0
where
P0 = initial investment
P1 = price received at the end of holding period
D1 = dividend paid by the investment at the end of holding period
= $2,500/10,000 shares = $0.25/shares
0.155 = (24
Q. A sample of 240 managed portfolios has a mean annual return of 0.11 and a standard deviation of returns of 0.23. The standard error of the sample mean is closest to:
0.01485.
0.00096.
0.00710.
A is correct. For a sample, the standard error of the mean is sX???=s/n??? (where s is the sample standard deviation and n is the sample size), which here is: 0.23240?/=0.01485.
Q. Using a two-tailed test of the hypothesis that the population mean is zero, the calculated test statistic is 2.51. The sample has 23 observations. The population is normally distributed with an unknown variance.
Degrees of freedom
p = 0.10 p = 0.05 p =
C is correct. This is a two-tailed hypothesis testing because it concerns whether the population mean is zero.
H0: ? = 0 versus Ha: ? ? 0
With degrees of freedom (df) = n ? 1 = 23 ? 1 = 22, the rejection points are as follows:
Significance level Rejection
Q. The least accurate statement about measures of dispersion for a distribution is that the:
range provides no information about the shape of the data distribution.
arithmetic average of the deviations around the mean will be equal to one.
mean absolute d
B is correct. The arithmetic sum of the deviations around the mean will always equal zero, not one.
Q. Given the function
Qdx=5.7?1.3Px+0.03I?0.03Py
where
Qdx = the quantity demanded of good X
Px = the price per unit of good X
I = consumers' income
Py = the price per unit of good Y
the most likely cause of a shift in the demand curve is a change in:
Py.
A is correct. A shift in the demand curve results from a change in any variable other than the good's own price, Px. Given the demand function, a change in either Py or I would result in a shift in the demand curve. A change in quantity demanded, which re
Q. After noting positive changes in the aggregate index of coincident economic indicators, an increase in the ratio of consumer installment debt to income would most likely help confirm that an expansion is:
forthcoming.
underway.
ending.
B is correct. The ratio of consumer installment debt to income is a lagging indicator. An increase in it, by itself, would be evidence that an upturn is already underway. This would confirm the implication of positive changes in coincident indicators that
Q. In a hypothetical economy, consumption is 70% of pre-tax income, and the average tax rate is 25% of total income. If planned government expenditures are expected to increase by $1.25 billion, the increase in total income and spending, in billions, is c
B is correct. The fiscal multiplier is 11?c(1?T)
where
c = marginal propensity to consume = consumption/disposable income
T = the tax rate
Assuming pre-tax income of $100
Disposable income: $100 � (1 ? 0.25) = $75
Marginal propensity to consume: $70/$75 =
Q. A developing country that maintains a fixed value for its currency relative to the US dollar is experiencing a decline in its economic activity, and its inflation rate falls below the level of inflation in the United States. The most likely result of t
B is correct. With a decline in economic activity and domestic inflation, the currency of the developing country would start to rise against the dollar. To protect the exchange rate target, the developing country's monetary authority will purchase foreign
Q. An e-commerce company sells hotel room nights on its website under agreement from a large number of major hotel chains. The hotel chains grant the company flexibility for the rooms they supply to the company's website and for the prices charged. These
C is correct. Cost of sales is reported on the same basis as revenue. To report revenue under gross reporting, the e-commerce company must meet four criteria:
Criteria Met/Not Met
The e-commerce company must:
be the primary obligor under the contract. Not
Q. Assume a company has the following portfolio of marketable securities, which were acquired at the end of last year:
Category Original Cost (in �) at the End of Last Year Fair Market Value (in �) at the End of the Current Year
Held for trading 12,000,00
A is correct. Whether securities are classified as held for trading or available for sale, they are measured at their fair value on the balance sheet. All gains/losses on held-for-trading securities are reported on the income statements, whereas the unrea
Q. Under IFRS, the costs incurred in the issuance of bonds are most likely:
expensed when incurred.
included in the measurement of the bond liability.
deferred as an asset and amortized on a straight-line basis.
B is correct. Under IFRS, debt issuance costs are included in the measurement of the bond liability.
Q. In the current year, a company increased its deferred tax asset by $500,000. During the year, the company most likely:
became entitled to a $500,000 tax refund.
had permanent differences between accounting profit and taxable income.
reported a lower ac
C is correct. Deferred tax assets represent taxes that have been paid (because of the higher taxable income) but have not yet been recognized on the income statement (because of the lower accounting profit).
Q. A company using the last-in, first-out (LIFO) inventory method reports a year-end LIFO reserve of $85,000, which is $20,000 lower than the prior year. If the company had used first-in, first-out (FIFO) instead of LIFO in that year, its financial statem
B is correct.
FIFO COGS = LIFO COGS ? Change in LIFO reserve The negative change in the LIFO reserve would increase the COGS under FIFO compared with LIFO.
FIFO inventory = LIFO inventory + LIFO reserve The LIFO reserve has a positive balance so that FIFO
Q. The following information is available for a company ($):
December 31, 2011:
Total assets 100,000
Net income for the year 4,000
Dividends paid 0
Assets are equally financed with debt and equity
50% of the equity comes from contributed capital
December
C is correct.
2011 ($) 2012 ($)
Total assets (given) 100,000 92,000
Total debt (50% in 2011, no change in 2012) 50,000 50,000
Total equity (Total assets ? Total debt) 50,000 42,000
Equity Components
Contributed capital (50% of equity in 2011, no change in
Q. The following financial statement data are available for a company:
Metric $ thousands
Operating income 3,390
Net income 2,210
Operating assets 3,850
Change in cash and cash equivalents 1,010
Change in cash from operating activities 1,750
Free cash flo
C is correct.
Cash to income = Cash flow from operating activities (CFO)/Operating income
= (1,750/3,390)
= 0.52
B is incorrect because the ca
. An analyst is comparing the solvency of a company over the past two years using the information below:
2013 � millions
Total debt 2,300
Total shareholders' equity 17,000
Total assets 20,000
Net income 375
Interest payments 200
Taxes paid 125
Ratios in 2
C is correct.
2012 2013 Calculations (� millions) 2013
Debt to capital 12.7% 2,300/(2,300 + 17,000) = 11.9% 11.9%
Interest coverage 2.9 (375 + 200 + 125)/200 = 3.5 3.5 times
Both ratios have improved from 2012 to 2013, thus the company is more solvent in
Sales 2,200 2,500
Variable operating costs (% of sales) 28% 30%
Fixed operating costs 1,400 1,400
Tax rate 25% 25%
Dividends paid 55 60
Interest bearing debt at 5% 500 500
The forecasted net income (in $ thousands) for next year is closest to:
169.
244.
2
B is correct. Forecasted net income (in $ thousands) is calculated as follows:
Sales 2,500 Given
Variable costs ?750 30% of sales
Fixed costs ?1,400 Given
Interest expense ?25 0.05 � Average debt of $500
Earnings before taxes (EBT) 325
Taxes ?81.25 25% of
Q. A company has announced that it is going to distribute a group of long-lived assets to its owners in a spin-off. The most appropriate way to account for the assets until the distribution occurs is to classify them as:
held for sale with no depreciation
C is correct. Long-lived assets that will be disposed of other than by sale, such as in a spin-off, an exchange for other assets, or abandonment, are classified as held for use until disposal and continue to be depreciated until that time.
Q. All else being equal, which of the following depreciation methods is most likely to result in higher operating margins in the later years of an asset's useful life?
Straight line
Declining balance
Units of production
B is correct. Under the declining balance approach, depreciation is calculated as a fixed percentage of the asset's carrying amount, year after year. As the undepreciated value decreases, so does the reported depreciation expense. The effect is most prono
Q. Which of the following most likely results in an increase of owners' equity?
Share repurchase
Cash dividend
New equity issuance
C is correct. The basic components of owners' equity are paid-in capital and retained earnings. In the paid-in capital account, an example of an increase in owners' equity is a new equity issuance. Cash dividends reduce retained earnings and owners' equit
Q. Business risk most likely incorporates operating risk and:
financial risk.
sales risk.
interest rate risk.
B is correct. Business risk is the combination of sales risk and operating risk.
Q. A company that wants to determine its cost of equity gathers the following information:
Rate of return on 3-month Treasury bills 3.0%
Rate of return on 10-year Treasury bonds 3.5%
Market risk premium 6.0%
The company's equity beta 1.6
Dividend growth r
C is correct. CAPM: Cost of equity = Risk-free rate + Beta � Market risk premium = 3.5% + 1.6 � (6.0%) = 13.1%
The 10-year risk-free rate is appropriate based on the long-term duration of the cash flows from the project.
Q. Based on good corporate governance practices, it is most appropriate for a company's compensation committee to:
develop director remuneration policies.
recommend remuneration for the external auditors.
include some external directors.
A is correct. Under good corporate governance practices the compensation committee develops remuneration policies for directors as well as key executives. The audit committee, not the compensation committee, would be involved in the remuneration of the ex
Q. The effective annualized cost (%) of a banker's acceptance that has an all-inclusive annual rate of 5.25% for a one-month loan of $2,000,000 is closest to:
5.54%.
5.38%.
5.27%.
C is correct. Calculate the effective annualized cost:
InterestNet proceeds�12 = 2,000,000�0.0525�1/122,000,000�(1?0.0525�1/12)�12
= 0.0527 = 5.27%
Q. A project has the following cash flows:
Year 0 Year 1 Year 2 Year 3 Year 4
?$1,000 $100 $100 $100 $1,100
The internal rate of return (IRR) for the project is closest to:
9.1%.
10.0%.
8.8%.
B is correct. The IRR is the discount rate when the net present value (NPV) = 0. The NPV is zero when discounting at 10%: ($100/10%) � [1 ? 1/(1 +10%)3] + $1,100/(1 +10%)4 ? $1,000.00 = $0. Consequently, 10% is the IRR. Using a financial calculator and re
Q. A portfolio manager decides to temporarily invest more of a portfolio in equities than the investment policy statement prescribes because he expects equities will generate a higher return than other asset classes. This decision is most likely an exampl
B is correct. Tactical asset allocation is the decision to deliberately deviate from the policy exposures to systematic risk factors with the intent to add value based on forecasts of the near-term returns of those asset classes.
Q. An asset management firm generated the following annual returns in their US large-cap equity portfolio:
Year Net Return (%)
2008 ?34.8
2009 32.2
2010 11.1
2011 ?1.4
The 2012 return needed to achieve a trailing five-year geometric mean annualized return
C is correct.
R???G=0.05=(1?0.348)(1+0.322)(1+0.111)(1?0.014)(1+R2012)??????????????????????????????????????????????????????????????????????????????????????????5?1
Holding period total return (cumulative) factor calculation through 2011:
(1 ? 0.348) � (1
Q. A portfolio with equal parts invested in a risk-free asset and a risky portfolio will most likely lie on:
the efficient frontier.
a capital allocation line.
the security market line.
B is correct. A capital allocation line shows possible combinations of a risky portfolio and the risk-free asset.
Q. A major benefit of employing a risk budgeting process is that it most likely:
allows the organization to determine its enterprise risk tolerance.
forces risk tradeoffs across the organization.
eliminates the need for hedging within the organization.
B is correct. Adding a risk budgeting process causes the organization to consider how its total risk tolerance will be allocated across its subsidiaries. Either the total current risks the subsidiaries are engaging in will exceed the risk tolerance and su
Q. The following information is provided about a stock market index m and security i:
Statistic Value
Covariance between market return and security return [Cov(Ri,Rm)] 0.01104
Correlation coefficient between market return and security return (?i,m) 0.3
St
A is correct. ?i = Cov(Ri,Rm)/?m2 = 0.01104/(0.16)2 = 0.43
Q. An example of risk transfer combined with self-insurance is most likely:
a bond portfolio hedged with an interest rate option.
an insurance policy with a deductible.
a bank that establishes a loan loss reserve fund.
B is correct. Risk transfer is accomplished through an insurance policy. A deductible in an insurance policy means the insured is bearing some of the risk of loss and thereby (partially) self-insuring. Hedging with derivatives accomplishes risk shifting,
Q. For portfolio managers of passive funds, market indexes are least useful as:
proxies to measure systematic risk.
benchmarks for portfolio performance attribution.
tools to develop exchange-traded funds for non-accessible markets.
B is correct. Market indexes are used as benchmarks for actively managed portfolios, which is not relevant to passively managed funds.
Q. An investor buys a stock on margin. Assume that the interest on the loan and the dividend are both paid at the end of the holding period. The data related to the transaction are as follows:
Number of shares 500
Purchase price per share $28
Leverage rat
C is correct.
Initial investment [($28 � 500) � (1/3.33)] + ($0.05 � 500) $4,229
? Purchase commission $0.05 � 500 ? 25
+ Trading gain ($30 ? $28) � 500 1,000
? Margin interest paid $9,800 � 0.05 � 6 months ? 245
+ Dividends received $0.40 � 500 200
? Sal
Q. Which of the following statements concerning the use of industry analysis is most accurate? Industry analysis is most useful for:
sector allocations in passive equity portfolios.
portfolio performance attribution.
evaluating market efficiency.
B is correct. Portfolio performance attribution, which addresses the sources of a portfolio's returns, usually in relation to the portfolio's benchmark, includes industry or sector selection. Industry classification schemes play a role in such performance
Q. An investor gathers the following information about a company:
Current dividend per share $3
Historical annual dividend growth rate 4%
Expected annual dividend growth rate for the next three years 8%
Expected stock value per share at the end of Year 3
B is correct.
V0 = 3�1.081+0.15+3�(1.08)2(1+0.15)2+[3�(1.08)3]+33(1+0.15)3
= 2.82+2.65+2.48+21.70
= $29.65
A is incorrect because it uses t
Q. A company's non-callable, non-convertible preferred stock that pays an annual dividend of $3.75 is currently selling at its par value of $50 per share. If the required rate of return increases by 75 bps, the preferred stock's new price is closest to:
$
A is correct.
Investors' current required return = $3.75/$50 = 7.50%
New required return = 7.50% + 0.75% = 8.25%
New market price = $3.75/0.0825 = $45.45
Q. In a low interest rate environment, the effective duration of a callable bond relative to a comparable non-callable bond, will most likely be:
higher.
lower.
the same.
B is correct. When interest rates are low, the callable bond's price will not increase as much because the presence of the call option will limit the price increase. Because the bond is likely to be called when interest rates are falling, the embedded cal
Q. Consider a $100 par value bond with a 7% coupon paid annually and 5 years to maturity. At a discount rate of 6.5%, the value of the bond today is $102.08. One day later, the discount rate increases to 7.5%. Assuming the discount rate remains at 7.5% ov
A is correct. If the discount rate increases to 7.5% from 6.5%, the price of a bond decreases. At a discount rate of 7.5%, the bond sells at a discount to face value. As a discount bond approaches maturity, it will increase in price over time until it rea
Q. Using the following US Treasury forward rates, the value of a 2.5-year $100 par value Treasury bond with a 5% coupon rate is closest to:
Period Years Forward Rate
1 0.5 1.20%
2 1 1.80%
3 1.5 2.30%
4 2 2.70%
5 2.5 3.00%
$104.87.
$101.52.
$106.83.
C is correct. The value of the bond is
2.5(1+0.012/2)+2.5(1+0.012/2)�(1+0.18/2)+2.5(1+0.012/2)�(1+0.018/2)�(1+0.023/2)+2.5(1+0.012/2)�(1+0.018/2)�(1+0.023/2)�(1+0.027/2)+2.5(1+0.012/2)�(1+0.018/2)�(1+0.023/2)�(1+0.027/2)�(1+0.030/2)=$106.83
A is incorrect
Q. A bond has a duration of 4.50 and convexity of 39.20. If interest rates increase by 0.5%, the percentage change in the bond's price will be closest to:
?2.20%.
?2.15%.
?2.25%.
A is correct. Incorporating both duration and convexity, the percentage change in a bond's price = ( ?Duration � Dy) + (0.5 � C � (Dy)2) = (?4.50 � 0.005) + (0.5 � 39.20 � 0.0052) = ?0.0220 or ?2.20%.
Q. Which of the following are most likely a kind of supranational bonds? Bonds issued by the:
Federal Farm Agency of the United States.
Government of Malaysia.
European Investment Bank.
C is correct. Supranational bonds are bonds issued by such supranational agencies as the European Investment Bank and the International Monetary Fund.
Q. According to put-call-forward parity, the difference between the price of a put and the price of a call is most likely equal to the difference between:
forward price and spot price discounted at the risk-free rate.
spot price and exercise price discoun
C is correct. Put-call-forward parity can be written as:
p0 ? c0 = [X ? F0(T)]/(1 + r)T
This means that the difference between the price of a put and the price of a call is equal to the difference between exercise price and forward price discounted at the
Q. A swap that involves the exchange of a fixed payment for a floating payment can be interpreted as a series of forward contracts with different expiration dates. These implied forward contracts will most likely have:
different prices due to differences
C is correct. Due to differences in the cost of carry, implied forward contracts will have different prices. The differences in the cost of carry stem from the timing differences of the payments.
A is incorrect because differences in price are due to diff
Q. In the context of venture capital financing, seed-stage financing most likely supports:
initial commercial production and sales.
product development and/or marketing efforts.
transformation of an idea into a business plan.
B is correct. Support of product development and/or marketing efforts takes place during seed-stage financing.
A is incorrect because support of initial commercial production and sales takes place during early stage financing.C is incorrect because suppor
Q. The return on a commodity index is likely to be different from returns on the underlying commodities because:
data are subject to survivorship bias.
indices are constructed using futures contracts.
assets are not marked to market.
B is correct. Because commodity indices are constructed using commodity futures and not the underlying commodities, there can be differences between commodity index returns and the returns of the underlying commodities.
Q. Which of the following infrastructure investments would most likely be easiest to value?
master limited partnership holding greenfield investments.
master limited partnership holding brownfield investments.
private equity fund holding brownfield invest
B is correct because A master limited partnership (MLP) is publicly traded, whereas a private equity fund is not. Therefore the MLP will have market pricing information to help with valuation. A brownfield investment is an existing asset that likely has o