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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 1101:

  A mining firm has purchased a derivative security to partially hedge itself against the losses caused by fluctuations in a base metal price. The security pays a million dollars if the metal price falls below $2 per pound. Otherwise, it pays $100,000. If the expected rate of return on the security is 21% and the security costs $400,000, what is the probability that the metal price will remain above $2 per pound?

  A. 42. 66%
  B. 61.1%
  C. 57. 33%
  D. 46. 87%
  C. 57. 33%

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  Explanation

  If p is the probability of the metal price remaining above $2/pound, then the expected total return on the derivative security is (p * 100,000 + (1-p)*1,000,000)/400,000 = (10-9p)/4. Since the expected return is given to be 21%, we get (10-9p)/4 = 1.21. Therefore, p = 57. 33%.

• Question 1102:

  A project has the following cash flows over the next 5 years: $800, $300, $400, $900 and $1,200. Assume all cash flows occur at the end of a year. The project requires an initial cash outlay of $1,750. The firm faces a marginal borrowing rate of 8%. The payback period for the project equals ________.

  A. 3. 86 year
  B. 4. 19 years
  C. 4 years
  D. 3. 28 years
  D. 3. 28 years

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  Explanation

  The payback period is defined as the expected number of years that would be required to recover the original investment. In particular, Payback period = Years before full recovery +

  (unrecovered cost at the start of payback year)/(net cash flow in the payback year) In this case, the recovery occurs in the 4th year. At the beginning of the 4th year, the unrecovered cost equals 1,750 - 800 - 300 - 400 = 250. Total cash flow

  in the 4th year equals 900. Therefore, payback period = 3 + 250/900 = 3. 28 years. Note that the discount rate does not figure in the calculation of payback period.

• Question 1103:

  While evaluating a project using net income figures, you must:

  A. subtract all non-cash net expenses.
  B. none of these answers.
  C. add back all non-cash net expenses.
  D. add back depreciation.
  C. add back all non-cash net expenses.

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  Explanation

  In capital budgeting, annual cash flows, not accounting income, are used to evaluate a project. Hence, you must add back all non-cash net expenses, defined as total non-cash expenses - total non-cash revenues. You must also ignore financing costs.

• Question 1104:

  The current earnings per share on a value-weighted index is $3. 7. If the growth rate in the index is expected to be 3%, its average payout ratio is 35% and the index value is $9.3 per share, the expected return on the index is:

  A. 16. 9%
  B. 15. 4%
  C. 17. 3%
  D. 16. 6%
  C. 17. 3%

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  Explanation

  You should remember that the Dividend Discount Model is applicable to individual stocks as well as stock indices. Indeed, that and estimation of the variables involved in the Dividend Discount Model are the thrust of Reilly and Brown, chapter

  18.

  In standard notation, Po = D1/(k-g). In this case, g = 3%. The expected dividend per share next year = $3. 7 * 35%*(1+3%) = $1.33. Therefore, 9.3 = 1.33/(k-3%). Solving for k gives k = 3% + 1.33/9.3 = 17. 3%. This is the expected return on the index.

• Question 1105:

  In investment management applications, the Internal Rate of Return is commonly referred to as which of the following?

  A. Dollar-weighted rate of return
  B. Intrinsic rate of return
  C. Time-weighted rate of return
  D. Cost-averaged rate of return
  E. None of these answers
  F. Dollar-averaged rate of return
  A. Dollar-weighted rate of return

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  Explanation

  Performance presentation is an important consideration in the field of investment management, and often involves a rather complex series of calculations. This is particularly true for portfolio's which are characterized by significant additions and withdrawals, as the cash flow measurement is periodically disrupted. In the Level I readings, two specific measurement tools are discussed: the dollar-weighted rate of return and the time-weighted rate of return. In investment management applications, the IRR equation is commonly referred to as the "dollar-weighted rate of return" because it incorporates both the timing and size of all cash flows in the determination of the return figure.

• Question 1106:

  Which of the following choices is NOT a characteristic of an efficient market?

  A. Market participants react quickly to news, and these reactions are quickly reflected in prices.
  B. A large number of participants value securities independent of other parties.
  C. Major news announcements are made on the second Friday of each month.
  D. Expected returns implicitly include a risk component.
  C. Major news announcements are made on the second Friday of each month.

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  Explanation

  One assumption of efficient markets is that the timing of a news announcement is independent of the timing of other news announcements. The other statements are examples of efficient markets.

• Question 1107:

  An analyst is attempting to value shares Kingdom Semiconductor, a large silicon distributor. Assume the following information for Kingdom shares:

  Required rate of return on equity: 16. 25% per year Free cash flow to equity multiple at t4: 32 2,500,000 shares outstanding

  Additionally, the analyst has obtained the following estimates of free cash flow to equity for Kingdom over the next four years:

  Year 1: $2,000,000 Year 2: $3,500,000 Year 3: $4,500,000 Year 4: $5,000,000

  Using this information, what is the value per share of Kingdom Semiconductor according to the Free Cash Flow to Equity Model?

  A. $44. 74
  B. $46. 29
  C. None of these answers is correct.
  D. $35. 69
  E. The answer cannot be calculated from the information provided.
  F. $39.02
  F. $39.02

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  Explanation

  When determining the value of a common stock using the free cash flow to equity model, it is necessary to determine three things:

  1. The required rate of return on equity investments.

  2. The estimated free cash flow to equity multiple at time "k."

  3. The estimated free cash flows figures for the time periods leading up to "k."

  In this example, the calculation must begin with the discounting the free cash flow to equity figures for each of the four years provided. These figures are discounted each period by the required return on equity investments, and the final answer is converted to a per-share basis. This process is illustrated below: Year 1: ($2,000,000 / 1.1625) / 2,500,000 shares outstanding = $0.69

  Year 2: [$3,500,000 / (1.1625)(1.1625)] / 2,500,000 shares outstanding = $1.04 Year 3: [$4,500,000 / (1.1625)(1.1625)(1.1625)] / 2,500,000 shares outstanding = $1.15 Year 4: [$5,000,000 / (1.1625)(1.1625)(1.1625)(1.1625)] / 2,500,000 shares outstanding = $1.10

  Now that the free cash-flow-to-equity figures have been discounted and converted to a per-share basis, the next step in the valuation process is to determine the value of the final cash flow, which is defined as:

  [(Free cash flow to equity multiple * Final free cash flow) / (1 + r)(1+r)...(1 + k)]

  In the body of this question, we were given the anticipated multiple of free cash to equity that shares of Intelligent Semiconductor will sell for at time period: specifically 32 times. Imputing this information into the terminal cash flow equation will

  yield the following:

  {[32 * ($5,000,000 / 2,500,000 shares outstanding)] / [(1.1625) (1.1625)(1.1625)(1.1625)]} = $35. 04.

  Adding the answers from step 1 to the final year cash flow will yield the following:

  Value of Intelligent Semiconductor = [$0.69 + $1.04 + $1.15 + $1.10 + $35. 04] = $39.02 per share.

• Question 1108:

  Carl Vandenberg has been asked to explain the security market line (SML), including its slope. Which of the following is equal to the slope of the SML?

  A. Beta.
  B. Alpha.
  C. Market risk premium.
  C. Market risk premium.

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  Explanation

• Question 1109:

  Patrick Manning owns stock in Lumber Providers with a return variance equal to 16%. Manning is considering the addition of Smithson Homebuilders to his portfolio. The variance of returns for Smithson Homebuilders equals 25%, and its correlation of returns with Lumber Providers equals -0.60. The covariance of returns between Lumber Providers and Smithson Homebuilders is closest to:

  A. -15. 0.
  B. -0.024
  C. -0.120
  C. -0.120

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  Explanation

• Question 1110:

  What would the offering price be if the NAV of a fund with a 7. 5% load is $10.25?

  A. 10.25
  B. 10.90
  C. 10.45
  D. 11.31
  E. 11.08
  E. 11.08

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  Explanation

  The offering (ask) price = NAV / (1.0 - percent load) $10.25 / (1 - .075) = 11.08