CFA Institute CFA-LEVEL-1 Online Practice Questions and Exam Preparation

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 1001:

  Which of the following is/are true about held-to-maturity securities?

  I. They are mostly non-current assets.

  II. They are reported at fair market value.

  III.

  Income on these securities is included in operating income.

  A. II only
  B. II and III
  C. I and III
  D. I, II and III
  C. I and III

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  Explanation

  Marketable securities classified as "Held-to-maturity" are financial securities purchased with the intent (and ability) to hold until maturity. They are therefore categorized as non-current assets in all periods except the one in which they are about to mature. They are reported on the balance sheet at theamortized historical cost and income on the securities, including amortization of premium or discount, is part of the operating income.

• Question 1002:

  Which of the following choices correctly describes an investment in which the cash flows from an existing project must be considered along with the expected cash flows of a proposed project?

  A. Expansion project
  B. Retrenchment project
  C. Replacement project
  D. Non-normal project
  E. Marginal project
  C. Replacement project

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  Explanation

  In an analysis of a replacement project, the cash flows associated with the existing project must be examined along with the expected cash flows from a new project. Expansion project is defined as one for which the firm in question does not have an existing proxy, or a project which will expand the operations of the Company into a new market or functional niche. Expansion projects are for the expansion of revenues. "Marginal project" and "retrenchment project," are fictitious terms.

• Question 1003:

  Fiduciaries are obligated to vote proxies:

  A. none of these answers.
  B. on an "as needed" basis, depending on the issue at hand.
  C. only when there is a nonroutine governance issue.
  D. only when there is a change in firm capitalization.
  E. in an informed and responsible manner.
  F. only when management requests the fiduciary to vote, in writing.
  E. in an informed and responsible manner.

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  Explanation

  As part of a fiduciary's duty of loyalty, they are obligated to vote proxies in an informed and responsible manner. A fiduciary who fails to vote, casts a vote without considering the impact of the question or votes blindly with management on nongovernance issues may violate this duty of loyalty.

• Question 1004:

  Countries A and B have the same monetary base and reserve requirement. People in A tend to hold more currency than people in B. The money supply will be:

  A. higher in B
  B. same in the two countries.
  C. insufficient information.
  D. higher in A
  A. higher in B

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  Explanation

  When people hold currency instead of bank deposits, the money goes out of circulation temporarily and the full impact of the deposit expansion multiplier is not felt. The higher this tendency to hold currency, the lower will be the money supply, even though the monetary base has not been affected.

• Question 1005:

  Empire Builders is in need of capital to finance its current expansion plans. For this, it has decided not to raise dividends for the next 4 years, maintaining them constant at $2 per share. Analysts expect the growth rate after that to be about 3% per year. If the investors expect a 9% rate of return on the stock, the market price of Empire Builders is ________.

  A. $34. 33
  B. $27. 61
  C. $30.80
  D. $32. 23
  C. $30.80

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  Explanation

  Since the dividends do not grow at a constant rate, you cannot directly apply the Dividend Discount Model valuation formula. However, note that 4 years from now, looking into the future, you will see a constant growth rate of 3% and the dividend 5 years from now will be $2 * 1.03 = $2. 06. Therefore, the stock price 4 years from now, using the required rate of return of 9%, will equal P = 2. 06/(9% - 3%) = $34. 33. Thus, the current stock price equals $2*(1/1.09 + 1/1.09^2 + 1/1.09^3 + 1/1.09^4) + 34. 33/1.09^4 = $30.80.

  Note that you must be very careful about the time line. In the Dividend Discount Model valuation formula, the price at time t uses the dividend paid at time (t+1). That's the reason we had to use the dividend paid in year 5 to calculate the price at the end of year 4.

• Question 1006:

  Consider the following preferred stock:

  Price per share: $12. 55 Semiannual dividend per share: $0.725 Required return: 11.50% per year

  Is the preferred stock realistically overvalued, undervalued, or correctly valued? Further, should this preferred stock be valued as a perpetuity or a finite series of cash flows? (Assume a long-term holding period).

  A. Correctly valued; perpetuity
  B. Undervalued; finite series of cash flows
  C. Correctly valued; finite series of cash flows
  D. The answer cannot completely be determined from the information provided.
  E. Overvalued; perpetuity
  F. Undervalued; finite series of cash flows
  A. Correctly valued; perpetuity

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  Explanation

  The preferred stock profiled in this example is trading very close to its theoretical value, which is found as $12. 61. To determine the value of a preferred stock, use the following equation; {P0 = [d1 / k]}

  Where:P0 = the price of the preferred stock at time 0, d1 = the annual dividend at t = 1, and k = the required rate of return.

  In this example, the dividend is provided as a semiannual figure, which must be doubled to show the annual dividend. After this adjustment has been made, the value of the preferred stock can be found as follows.

  {P0 = [$1.45 / 0.115] = $12. 61. Preferred stock is commonly valued as a perpetuity because there is no finite conclusion to the projected series of cash flows for a preferred stock. Unlike a bond, whose cash flows are characterized by a finite lifespan (i.e. the cash flows of a

  bond cease at maturity), the cash flows (dividends) produced by a preferred stock could theoretically last forever.

• Question 1007:

  Trading securities are carried on the books at ________.

  A. current market value
  B. acquisition cost or current market value
  C. acquisition cost
  D. lower-of-cost-or-market
  A. current market value

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  Explanation

  Marketable securities are classified into various categories, one of which is "Trading securities." As the name implies, these financial securities are purchased with the intent to sell in the near future. They are therefore categorized as current assets and reported at the fair market value on the date of the balance sheet

• Question 1008:

  After getting her degree in marketing and working for 5 years for a large department store, Sally started her own specialty shop in a regional mall. Sally's current lease calls for payments of $1,000 at the end of each month for the next 60 months. Now the landlord offers Sally a new 5-year lease which calls for zero rent for 6 months, then rental payments of $1,050 at the end of each month for the next 54 months. Sally's cost of capital is 11 percent. By what absolute dollar amount would accepting the new lease change Sally's theoretical net worth?

  A. $4,681.76
  B. $3,803. 06
  C. $4,299.87
  D. $3,243. 24
  E. $2,810.09
  B. $3,803. 06

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  Explanation

  CF(0) = 0 CF(1-6) = 0 CF(7-60) = 1,050 I = 11/12 = 0.9167 Solve for NPV = -$42,189.97. Therefore, the PV of payments under the proposed lease would be less than the PV of payments under the old lease by $45,993. 03 - $42,189.97 = $3,803. 06. Sally should accept the new lease because it would raise her theoretical net worth by $3,803. 06.

• Question 1009:

  Which of the following equations correctly illustrates the calculation of the cost of equity using the Discounted Cash Flow approach?

  A. (Retention rate)*(ROE)
  B. Last annual dividend/(1 + required rate of return)
  C. Next annual dividend/current stock price
  D. (1-tax rate)
  E. (Next annual dividend/current stock price) + expected growth rate
  F. (Last annual dividend/[expected return - required return])
  G. expected growth rate
  H. Risk-free rate of return + beta(expected return on the market - risk-free rate of return)
  E. (Next annual dividend/current stock price) + expected growth rate

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  Explanation

  The Dividend-Yield-plus-Growth-Rate approach calls for the following components: next annual dividend, current stock price, and expected growth rate. This approach, also known as the Discounted Cash Flow (DCF) method, is a flexible and very adept tool in the hands of the financial analyst, and is it is imperative that the CFA candidate fully understand both the applications and the methodology of this approach. The fourth choice illustrates the Capital Asset Pricing Model, while the fifth represents an approach for calculating sustainable growth rate. The remaining answers are somewhat fictitious.

• Question 1010:

  Capitol City Transfer Company is considering building a new terminal in Salt Lake City. If the company goes ahead with the project, it must spend $1 million immediately (at t = 0) and another $1 million at the end of Year 1 (t = 1). It will then receive net cash flows of $0.5 million at the end of Years 2 - 5, and it expects to sell the property and net $1 million at the end of Year 6. All cash inflows and outflows are after taxes. The company's cost of capital is 12 percent, and it uses the modified IRR criterion for capital budgeting decisions. What is the project's modified IRR?

  A. 11.5%
  B. 11.9%
  C. 11.4%
  D. 12. 0%
  E. 11.7%
  E. 11.7%

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  Explanation

  Time line: (In millions)

  k = 12%

  MIRR = ?

  0123456 Yrs

  -1-1.5. 5. 5. 51.0

  Tabular/Numerical solution:

  PV(Outflows) = -$1,000,000 - ($1,000,000/1.12) = $1,892,857.

  TV(Inflows) = $500,000(FVIFA(12%,4))(FVIF(12%,1)) + $1,000,000

  = $500,000(4. 7793)(1.12) + $1,000,000 = $3,676. 408.

  $1,892,857 = $3,676,408/(PVIF(MIrr,6)0

  PVIF(MIrr,6) = 1.94225 (Take 6th root of both sides)

  1 + MIRR = 1.11699

  MIRR = 11.699%.