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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 1131:

  A reserve requirement of 5 percent implies a potential money deposit multiplier of ________.

  A. 20
  B. 5
  C. 10
  D. 25
  E. 100
  A. 20

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  Explanation

  The potential money deposit multiplier is the reciprocal (inverse) of the required reserve ratio. Thus, a reserve requirement of .5 implies a potential money deposit multiplier of 1/.5 = 20.

• Question 1132:

  Which of the following is a key benefit of using the degree of leverage concept in financial analysis?

  A. It shows how a given change in leverage will affect sales.
  B. None of these statements are correct.
  C. It establishes the optimal capital structure for the firm.
  D. It allows decision-makers a relatively clear assessment of the consequences of alternative actions.
  E. All of these statements are correct.
  D. It allows decision-makers a relatively clear assessment of the consequences of alternative actions.

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  Explanation

  The degree of leverage concept is useful primarily for the insights it provides regarding the joint effects of operating and financial leverage on EPS. DOL concepts provide alternatives to decision-makers, giving a better idea of the ramifications of alternative actions.

• Question 1133:

  A major goal of the venture capital industry has been to resolve the conflicts that arise between

  A. investors and entrepreneurs.
  B. venture capitalists and investment bankers.
  C. investors and venture capitalists and between venture capitalists and entrepreneurs.
  D. venture capitalists and stockbrokers.
  C. investors and venture capitalists and between venture capitalists and entrepreneurs.

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  Explanation

  When selecting venture capitalists, investors must understand exactly how both sets relationships are to be handled and whether the incentive structure is competitive.

• Question 1134:

  A ratio that measures the average portion of each dollar of revenue that results in profit is

  A. profit margin
  B. both of these answers are correct
  C. neither of these answers is correct
  D. return on sales
  B. both of these answers are correct

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  Explanation

  Profit margin, also called return on net sales, is calculated by dividing net income by net sales. This ratio measures the average portion of each dollar of revenue that ends up as profit.

• Question 1135:

  The actual rate of unemployment could fall below the natural rate of unemployment during which of the following?

  I. An economic boom.

  II. An economic expansion, where the economy is trying to extricate itself from a recession.

  III. A war.

  IV.

  Never. The natural rate of unemployment is a lower limit on unemployment rate in a given economy, depending on its structural features.

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

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  Explanation

  If the economy is in a recession, that means the unemployment rate is quite high, far above the natural rate. Hence, II is incorrect. IV is also incorrect since the natural rate of unemployment prevails in a healthy economy operating at maximum sustainable efficiency. However, in times of high demand like economic booms or war, it is possible that the unemployment rate temporarily dips below the natural rate, causing the output to rise above the sustainable GDP.

• Question 1136:

  A product financing arrangement exists when

  A. the party who manufactures the inventory gives extended terms to certain preferred customers.
  B. a party transfers ownership of inventory to a purchaser yet retains the inventory in their own warehouse.
  C. all of the answers would be accounted for as product financing arrangements.
  D. a party bearing the risks and rewards of ownership transfers inventory to a purchaser, and in a related transaction agrees to repurchase the product at a specified price over a specified time.
  D. a party bearing the risks and rewards of ownership transfers inventory to a purchaser, and in a related transaction agrees to repurchase the product at a specified price over a specified time.

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  Explanation

  The key to product financing is that the purchaser retains very little of the risk because typically whatever does not sell, the seller agrees to buy back at a specified price.

• Question 1137:

  The dividend payout ratio

  A. varies positively with the retention rate of earnings.
  B. varies inversely with the retention rate of earnings.
  C. varies convexly with the retention rate of earnings.
  D. does not vary with the retention rate of earnings.
  B. varies inversely with the retention rate of earnings.

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  Explanation

  The dividend payout ratio is simply one minus the retention rate (what is not retained is paid out in dividends). An increase in the dividend payout ratio would increase the earnings multiplier. But this would be partially offset by the decrease in the retention rate, which would decrease the growth rate in earnings and dividends, which would, in turn, decrease the earnings multiplier.

• Question 1138:

  Joe Wellworth, an oil analyst with Smith, Kleen and Beetchnutty institutional brokerage, is trying to determine an appropriate earnings multiplier for the natural gas industry. In his research, Mr. Wellworth has examined the relationship

  between the earnings multiplier of the natural gas industry and the Price-to-Earnings ratio of the Standard and Poors 500. Using a time series analysis, Joe examines the trend in the relationship between the natural gas industry and the overall

  market and uses this information to estimate the appropriate earnings multiplier for the natural gas industry.

  Which of the following best characterizes this method of estimating the earnings multiplier of an industry? Choose the best answer.

  A. Correlation analysis
  B. Microanalysis
  C. The bottom-up approach
  D. Macroanalysis
  E. Time series analysis
  D. Macroanalysis

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  Explanation

  The answer called for in this example is macroanalysis. This method involves an examination of the relationship between the earnings multiplier of a stock market series and the earnings multiplier of the overall market. For example, an individual projecting an earnings multiplier for a software index using macroanalysis would begin by examining the relationship between the P/E ratio of the software index and the P/E ratio of a broad market index such as the Standard and Poors 500. Both historical trends and point estimates would be examined, and from this information, a projection of the earnings multiplier for the stock market series is deduced. This is precisely the process illustrated in this example.

  This is contrasted by microanalysis, which involves an examination of the components of the earnings multiplier, including the anticipated growth rate of dividends, the required rate of return, and the dividend payout ratio. Once these variables have been examined, both from the perspective of trend analysis and point estimation, a value for the earnings multiplier is deduced.

  The bottom-up approach is used in the investment selection process, and involves identifying superior investments by first examining companies, rather than beginning with an examination of macroeconomic cycles and influence. Time series analysis, while materially correct, does not represent the best possible answer.

• Question 1139:

  A firm's reliance on debt ________ as bankruptcy costs increase. The debt ratio _______ as the probability of default increases.

  A. increases; decreases.
  B. decreases; decreases.
  C. increases; increases.
  D. decreases; increases.
  B. decreases; decreases.

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  Explanation

  Expected bankruptcy costs are a deterrent to high debt levels. These costs increase if the probability of default increases or the costs associated with the bankruptcy increase. In either of these cases, a firm will reduce its reliance on debt.

• Question 1140:

  In computing skewness, which of the following is true?

  I. It uses the cubed deviation from the mean.

  II. It raises the deviation from the mean to the third power.

  III.

  The formula preserves the direction of the deviation.

  A. I and III
  B. II and III
  C. I, II, and III
  D. None of these answers is correct.
  C. I, II, and III

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  Explanation

  I and II are true and equivalent. III is true because the cube of a negative number is still a negative number: -2 * -2 * -2 = -8.