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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 1211:

  Which of the following is/are true about the confidence index?

  I. It measures the spread between high-grade bonds and a broad cross-section of bonds.

  II. It indicates investor confidence and their appetite for risk.

  III.

  A high value of the confidence index is interpreted by technicians as a bullish indicator.

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

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  Explanation

  The Confidence index is the ratio of the average yield on 10 top grade bonds to the Dow Jones average of 40 bonds. The index measures the difference in yield spreads between high-grade bonds and a large cross-section of available bonds. An increase in this index implies that the yield spread between the bonds has narrowed. From a demand perspective, this will happen when the demand for riskier bonds rises i.e. when investors are bullish. Similarly, a fall in the index value indicates that investors are bearish.

• Question 1212:

  A firm's capital structure has a debt-to-equity ratio of 1.2. The pretax cost of debt is 6. 8% and the weighted average cost of capital of the firm equals 9.8%. The risk-free rate in the economy is 6. 2% the expected rate of return on the market is 14%. The firm must pay 35% of its gross income in taxes. The beta of the stock equals ________.

  A. 1.02
  B. 1.64
  C. 1.3
  D. 0.91
  C. 1.3

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  Explanation

  Since the debt interest is tax deductible, the after-tax cost of debt equals 6. 8%*(1-0.35) = 4. 42%. Since the D/E ratio = 1.2, (D+E)/E = 2. 2, giving E/(D+E) = 0.455. Thus, equity forms 45. 5% of the capital whiledebt forms 54. 5%. The WACC is then equal to 0.455*RE + 0.545*4. 42% = 9.8% (given). Solving gives RE = 16. 24%. If B is the beta of the stock, then using CAPM, 16. 24% = 6. 2% + B*(14% - 6. 2%), giving B = 1.29.

• Question 1213:

  The largest obstacle to development of venture capital in emerging markets is

  A. the lack of capital to develop young companies.
  B. the lack of investor interest.
  C. the lack of a strong IPO market for fast-growing and high technology firms.
  D. government interference.
  E. the lack of accurate financial information of the young companies.
  C. the lack of a strong IPO market for fast-growing and high technology firms.

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  Explanation

  The largest obstacle to development in emerging markets is the lack of a strong IPO market for fastgrowing and high technology firms. Emerging markets lack an active IPO market, which will create problems for exit strategies.

• Question 1214:

  The primary determinant of a fiduciary's powers and duties are to be found in the ________.

  A. board of director's meeting minutes
  B. governing documents (trust documents and investment management agreements)
  C. FDIC General Rules
  D. ERISA Statement of Procedures
  E. none of these answers
  F. ERISA Funding Guidelines
  B. governing documents (trust documents and investment management agreements)

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  Explanation

  Fiduciaries must manage any pool of assets in their control in accordance with the terms of the governing documents (such as trust documents and investment management agreements), which are the primary determinant of a fiduciary's powers and duties. Whenever their actions are contrary to provisions of those instruments or applicable law, fiduciaries are exposed to liability through litigation brought by parties at interest.

• Question 1215:

  Stock ABC has the following characteristics:

  Current dividend $1.00

  Expected dividend in 1 year $1.10

  Long term growth rate of dividends 10%

  Required rate of return 12%

  Using the infinite period Dividend Discount Model, what is the maximum price that you would pay for stock ABC?

  A. $10.00
  B. $120.00
  C. $55. 00
  D. $550.00
  E. $15. 00
  F. $12. 00
  C. $55. 00

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  Explanation

  The infinite period Dividend Discount Model indicates that:

  Value = (Dividend for period 1)/(k-g) where k is the required rate of return and g is the growth rate. In this case, Value = ($1.10)/(.12-.10) = $1.10/.02 = $55.

• Question 1216:

  The following are the weekly amounts of welfare payments made by the federal government to a sample of six families: $139, $136, $130, $136, $147 and $136. What is the range?

  A. $52
  B. None of these answers
  C. $14
  D. $17
  E. $0
  D. $17

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  Explanation

  Range = 147 - 130 = 17

• Question 1217:

  Which of the following statements is most correct?

  A. Sunk costs should be ignored in capital budgeting.
  B. None of these answers are correct.
  C. Externalities should be ignored in capital budgeting.
  D. All of these answers are correct.
  E. Opportunity costs should be ignored in capital budgeting.
  A. Sunk costs should be ignored in capital budgeting.

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  Explanation

  Sunk costs should be ignored. The other statements are false.

• Question 1218:

  In a recent press release, the management of Intelligent Semiconductor have announced their intention on an engaging a rather liberal debt offering, which will bring the proportion of debt within their capital structure from 35% to 50%. According to the Signaling Theory, his decision should be viewed as which of the following? Choose the best answer.

  A. The Signaling Theory would not apply to this announcement.
  B. Bullish, because it indicates superior investment prospects for the firm.
  C. Bearish, because it is indicative of a shift toward a more liberal capital structure.
  D. Bearish, because this will increase the financial risk of the firm.
  E. Bullish, because it is indicative of a shift toward a more conservative capital structure.
  F. Bearish, because it indicates poor investment prospects for the firm.
  B. Bullish, because it indicates superior investment prospects for the firm.

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  Explanation

  According to the Signaling Theory, the management of companies send implicit signals to investors by their capital budgeting decisions. Believers of this theory feel that corporate managers have access to superior information, and are allowed to exploit this information asymmetry through their capital budgeting decisions. According to the signaling theory, when investment prospects are good, companies will prefer to raise capital first by using internally generated funds, i.e. retained earnings and marketable securities investments. If this source of capital is unavailable, then companies will prefer to issue debt rather than common or preferred equity. The reasoning behind this is the fact that by raising debt, the company will not dilute the ROE figure, which is expected to be high due to favorable investment prospects. In contrast, when investment prospects are poor, the Signaling Theory states that companies will prefer to raise funds first by issuing common equity. The reasoning behind this is the fact that by issuing additional equity when investment prospects are poor, companies will be able to "spread the losses" amongst a greater pool of investors, thereby lessening the overall negative effect of the poor investment prospects. In this example, the management of Intelligent Semiconductor has announced its intention on issuing more debt. According to the Signaling Theory, this should be viewed as an indication that the firm has superior investment prospects. While the decision to issue more debt is indicative of a shift toward a more liberal capital structure, and the issuance of this debt will increase the financial risk of the firm, both of which are somewhat bearish, neither represent the best answer.

• Question 1219:

  According to the New Classical View, ________ is unaffected by deficits since people will save more money in order to pay the higher future taxes.

  A. the real interest rate
  B. the marginal tax rate
  C. price equalization
  D. the supply-side
  E. fiscal policy
  A. the real interest rate

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  Explanation

  New classical economies stress that debt financing merely affects the timing of taxes, not their magnitude. Debt financing substitutes higher future taxes for lower current taxes. As a result, households reduce their current consumption in response to additional government debt as surely as would be the case if an equivalent amount of current taxes were levied.

• Question 1220:

  Under the Residual Dividend Policy, a firm pays out:

  A. none of these answers.
  B. only net earnings left over after financing the current optimal capital budget requirements, consistent with the target capital structure.
  C. all of its earnings left over after taxes and expenses as dividends.
  D. only net earnings from new projects as dividends, using the rest to finance current capital requirements.
  B. only net earnings left over after financing the current optimal capital budget requirements, consistent with the target capital structure.

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  Explanation

  Under the Residual Dividend Policy, a firm first determines the amount of capital it requires for sufficiently profitable projects. It then uses retained earnings to supply equity capital and raises debt in the proper amount to maintain the target capital structure. If any earnings are left over after this, they are paid out as dividends. If not, the firm will not only not pay any dividends but also issues new equity for financing.