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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 1501:

  All of the following statements about a member's use of clients' brokerage commissions are true except

  A. client brokerage commissions may be directed to pay for the investment manager's operating expenses.
  B. client brokerage commissions should be commensurate with the value of the brokerage and research services received.
  C. client brokerage commissions may be used by the member to pay for securities research used in managing the client's portfolio.
  D. client brokerage commissions should be used by the member to ensure that fairness to the client is maintained.
  A. client brokerage commissions may be directed to pay for the investment manager's operating expenses.

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  Explanation

  This question deals with Standard IV (B.1), Fiduciary Duties and the specific topic of soft dollars. All the answers deal with the use of client brokerage commissions and the criteria for their use - (1) fairness to the client and (2) commensurate with the value of the services provided. The only statement that is not true is that client brokerage commissions may not be directed to pay the investment manager's operating expenses.

• Question 1502:

  Which of the following statements is TRUE about the profits and losses from buying a put:

  A. potential losses are limited to the initial premium the buyer pays when he buys the put.
  B. potential profits are theoretically unlimited.
  C. potential losses are theoretically unlimited.
  D. none of these choices are correct.
  A. potential losses are limited to the initial premium the buyer pays when he buys the put.

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  Explanation

• Question 1503:

  The portion of the insurance premiums that has expired during the fiscal period is classified as:

  A. an expense
  B. an asset
  C. an increase in retained earnings
  D. a liability
  A. an expense

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  Explanation

  In accordance with the matching rule, the amount of an insurance policy that has expired during the accounting period must be recorded and classified as an expense for the period.

• Question 1504:

  Which of the following statement completions is most correct? If investors prefer dividends to capital gains, then

  A. dividend policy as determined by the residual dividend policy is the only dividend policy which will maximize the price per share of common stock.
  B. k(s) will increase as dividends are reduced.
  C. k(s) will decrease as dividends are reduced.
  D. the equilibrium return, k(s), will not be affected by a change in dividend policy because tax effects will offset these preferences.
  E. k(s) will decrease as the retention rate increases.
  B. k(s) will increase as dividends are reduced.

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  Explanation

  The main conclusion of MM's irrelevance theory is that dividend policy does not affect the required rate of return on equity. Gordon-Lintner disagreed stating that k(s) decreases as the dividend payout is increased because investors are less certain of receiving the capital gains which should result from retaining earnings than they are of receiving dividends. They said that investors value expected dividends more highly than expected capital gains because the dividend yield is less risky than the growth component in the total expected return equation, k(s) = D1/Po + g. MM disagreed and theorized that k(s) is independent of dividend policy, implying that investors are indifferent between dividends and capital gains.

• Question 1505:

  Which of the following types of risk can be reduced through diversification? Choose the best answer.

  I. Stand-alone risk

  II. Unsystematic risk

  III. Systematic risk

  IV.

  Market risk

  V.

  Beta risk

  VI.

  Diversifiable risk

  A. I, III, VI
  B. I, VI
  C. II, III, V
  D. I, II, VI
  E. II, III, V, VI
  D. I, II, VI

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  Explanation

  Of the risks listed, only unsystematic and stand-alone risk are diversifiable. Unsystematic risk is also referred to as "diversifiable risk," therefore answer VI is correct. Stand-alone risk is defined as the variability of an asset's expected returns if it were the only asset of a firm and the stock of that firm is the only security in an investor's portfolio. This type of risk is definitively reduced through diversification, and is commonly referred to as "unsystematic risk." Systematic risk measures that part of an assets risk that is inherent regardless of the level of diversification, and is measured by the Beta coefficient. Systematic risk is also referred to as "market risk" and "beta risk." Corporate risk is defined as the variability of an asset's expected returns without taking into consideration the effects of shareholder diversification. This is one step away from Stand-alone Risk, which measures the risk of an asset not only without taking into consideration the effect of shareholder diversification, but of company diversification as well. Stand-alone risk assumes that the asset in question is the only asset of the firm and that the securities of the firm are the only asset in investors' portfolios. Corporate risk takes into consideration that firms will diversify their asset bases.

• Question 1506:

  At the end of the fiscal period, the account debited to show the estimated amount of uncollectible accounts is

  A. Allowance for Uncollectible Accounts
  B. None of these answers is correct.
  C. Accounts Receivable
  D. Bad Debt Expense
  E. Unearned Revenue
  D. Bad Debt Expense

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  Explanation

  The adjusting entry should recognize an expense and increase the allowance account.

• Question 1507:

  Social factors

  A. none of these answers.
  B. must be a primary consideration of investments because of the ERISA rule.
  C. may never be a primary consideration of investments.
  D. may be a primary consideration of investments, depending on the guidelines of the investment policy.
  E. must be a primary consideration of investments because of the prudence rule.
  F. must be a primary consideration of investments because of the loyalty rule.
  C. may never be a primary consideration of investments.

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  Explanation

  ERISA guidelines issued by the U.S. Department of Labor state that ERISA prudence standard requires a fiduciary to make investment decisions first on grounds of economic and investment merit. Consideration of social factors may be an incidental, but never primary, consideration of investments that are equal in economic and financial terms.

• Question 1508:

  Which of the following are factors in the optimal dividend payout ratio?

  I. Investor's preference for dividends versus capital gains

  II. The target capital structure

  III. The investment opportunities available to the firm

  IV.

  The cost and availability of external financing

  V.

  Beta Coefficient

  A. I, II, III
  B. I, III, III, V
  C. II, III, IV
  D. None of these answers
  E. I, II, III, IV
  F. I, II, III, IV, V
  E. I, II, III, IV

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  Explanation

  The optimal payout ratio of a firm represents the ideal amount of earnings that should be distributed to shareholders as dividends. This figure is comprised of four components, namely: the cost and availability of external financing, the investment opportunities available to the firm, the firm's target capital structure, and investor preferences. The Beta coefficient is not expressly incorporated into the determination of the Optimal Dividend Payout Ratio.

• Question 1509:

  Quasar, Inc., currently shows assets worth 5,000 and a debt of 1,500. During the year, it capitalized interest expense worth 300, of which 60 was amortized. Quasar's tax rate is 50%. If it had expensed the interest paid, which of the following would be true?

  A. Its operating cash flow would be lower by 150.
  B. Its tax expense would be lower by 150.
  C. Its equity would be higher by 300.
  D. Its operating cash flow would be lower by 300.
  A. Its operating cash flow would be lower by 150.

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  Explanation

  If Quasar had expensed the interest, its tax savings would have been 300*50% = 150. By capitalizing, it amortized 60, leading to a tax savings of 60*50%=30. Thus, if it had expensed the interest, the tax expense would have been lower by 150-30=120 (What would the effect on net income be? The net income would be lower by (300 - 60 - 120 = 120). When capitalizing, all the expense gets charged to investing cash flow while expensing charges the entire cash flow to operating cash flow. After tax, this results in an operating cash flow of -300*(1-0.5) = -150. Thus, expensing would have resulted in an operating cash flow lower by 150.

• Question 1510:

  The per-share value of an investment company is called ________.

  A. the net share price
  B. the net start-up cost
  C. the net asset value
  D. the net unit portfolio investment
  C. the net asset value

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  Explanation

  The per-share value of an investment company is called the Net Asset Value or NAV.