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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 1521:

  Wilma Green has been following the stock price movements of Bakery Supply International (BSI) and Hull Petrochemical Company (HPC). Green is convinced that the price of BSI stock is going to dramatically increase from its current price of $53. 60 and that the price of HPC stock is going to dramatically decrease from its current price of $9.80. She has decided to use options to take advantage of the situation and has thus gathered the following data on three-month put and call options for the two stocks: If after three months, the price of BSI stock is $54. 60 and the price of HPC stock is $8.13, which of the following strategies would have yielded Green the greatest profits?

  

  A. Short BSI put with a $45. 00 strike; Short HPC call with a S7. 50 strike.
  B. Long BSI put with a $45. 00 strike; Long HPC call with a $7. 50 strike.
  C. Short BSI call with a $55. 00 strike; Long HPC put with a $10.00 strike.
  C. Short BSI call with a $55. 00 strike; Long HPC put with a $10.00 strike.

  ---

  Explanation

• Question 1522:

  Which of the following measures of dispersion are based on deviations from the mean?

  A. None of these answers
  B. Standard deviation
  C. Mean deviation
  D. All of these answers
  E. Variance
  D. All of these answers

  ---

  Explanation

  The formulas for all three measures are based on the deviation of the mean. Note: variance is the standard deviation squared.

• Question 1523:

  A discrete probability distribution is the same as:

  A. a collection of all possible outcomes of an experiment.
  B. an absolute frequency distribution.
  C. a relative frequency distribution.
  D. none of these answers.
  C. a relative frequency distribution.

  ---

  Explanation

  The relative probability distribution of a set shows the relative frequency in each category in which the observation set is subdivided i.e. it shows the percentage of the observation set lying in each class. This also represents the probability distribution of the observation set.

• Question 1524:

  If the government moves the entire tax schedule upward by 5%, the primary effect on the economy will be through:

  A. all of these answers.
  B. the demand side, wherein disposable income and private demand goes down.
  C. a decrease in the budget deficit due to increase in tax revenues.
  D. the supply side, wherein the relative attractiveness of productive activity goes down in relation to leisure and tax avoidance activities.
  B. the demand side, wherein disposable income and private demand goes down.

  ---

  Explanation

  It is important to realize that "the supply side answer" is not entirely accurate. The supply side effects become important when the marginal tax rates are skewed in such a way that additional productiveactivity is discouraged due to higher taxes. When the entire tax schedule moves, the effect through the demand side is much bigger.

• Question 1525:

  Two portfolio managers at an investment management firm are discussing option strategies for their clients' portfolios. The first manager is considering a covered call strategy on Consolidated Steel Inc. (CSI). The manager states that the strategy is attractive since it will increase the expected returns from the anticipated appreciation in CSI, while reducing the downside risk. The second manager is considering a protective put strategy on Millwood Lumber Company (MLC). The manager states that the protective put strategy will allow his investors to retain an infinite profit potential while limiting potential losses to an amount equal to the initial stock price minus the put premium. Determine whether the comments made by the first and second manager are correct.

  A. Only the first manager is incorrect.
  B. Only the second manager is incorrect.
  C. Both the first manager and the second manager are incorrect.
  C. Both the first manager and the second manager are incorrect.

  ---

  Explanation

• Question 1526:

  Assuming all other factors remain unchanged, which one of the following would reduce the market P/E ratio?

  A. The market ROE is expected to increase.
  B. The dividend payout ratio increases.
  C. The dividend growth rate increases.
  D. The required rate of return increases.
  D. The required rate of return increases.

  ---

  Explanation

  P/E = (dividend payout ratio) / (k - g) k = real rate + inflation = risk premium g = (ROE) (retention rate)

  a.

  ROE up, g up, P/E up; Payout up, P/E up;

  c.

  g up, k-g down, P/E up; k up, P/E down

• Question 1527:

  An increase in which of the following, holding everything else equal, will cause a decrease in the theoretical growth rate of common stock dividends according to the Growth Rate of Dividends Model?

  I. Return on equity

  II. Tax rate

  III. Dividend payout ratio

  IV.

  Annual dividend

  V.

  Discount rate

  VI. Beta coefficient

  VII.

  Retention rate

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

  ---

  Explanation

  III The equation used to determine the theoretical growth rate of common stock dividends is as follows: {Annual growth rate = [ROE * (1 - dividend payout ratio)]} As you can see, of the choices listed, only an increase in the dividend payout ratio will cause a decrease in the theoretical growth rate of common stock dividends. Remember that the retention rate is equal to (1 - dividend payout ratio). Additionally, neither the discount rate nor the tax rate is explicitly factored into the dividend growth rate equation.

• Question 1528:

  The P/E earnings multiplier can be set equal to

  A. the required rate of return minus the dividend growth rate, divided by the expected dividend payout ratio.
  B. next year's dividend divided by the spread between the required rate of return and the dividend growth rate.
  C. the spread between the required rate of return and the dividend growth rate, divided by next year's dividend.
  D. the expected dividend payout ratio, divided by the required rate of return minus the dividend growth rate.
  D. the expected dividend payout ratio, divided by the required rate of return minus the dividend growth rate.

  ---

  Explanation

  The earnings multiplier, which is the basis for a method of valuing stocks, is also known as the price / earnings (P/E) ratio. The infinite period Dividend Discount Model claims that the current price of a common stock is equal to D1 / (k - g), where D1 is next period's (most often next year's) dividend, k is the required rate of return, and g is the growth rate of dividends. If we divide both sides of the infinite period Dividend Discount Model equation by expected earnings during the next 12 months, we get P/E = (D1/E) / (k - g).

• Question 1529:

  Anabella Marconi is a junior industry analyst with Trackstar Blue, an investment advisory service firm. She has been assigned to follow 3 different firms in the telecommunication industry and reports directly to the senior manager, Constantine Naples. Constantine manages 9 other analysts and has to frequently visit Trackstar's other offices around the country. Recently, Anabella received a "friendly tip" from her friend, Socorro Shue, who works for Quicktel Com, one of the firms that Anabella is following. Socorro informed Anabella about an ultra-fast broadband channel that was about to be released by Quicktel. The channel had the potential to catapult Quicktel from the minor league to competing with national telecom giants. Anabella quickly prepared a memo for Constantine advising him of her change in the recommendation on Quicktel from hold to buy. Constantine briefly discussed the reasons with her and asked her to circulate the memo amongst the portfolio managers. Shortly thereafter, he left for San Francisco for a 10-day business trip. Anabella conferred with the portfolio managers, who then bought a substantial stake in Quicktel in the open market.

  I. Anabella has not violated any AIMR code but Constantine has violated Standard III (E) - Responsibilities of Supervisors.

  II. Anabella has violated Standard III (B) - Duty to Employer.

  III. Anabella has violated Standard IV (B.3) - Fair Dealing.

  IV.

  Anabella has violated Standard V (A) - Prohibition against Use of Non-Public Information.

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

  ---

  Explanation

  By using a "friendly tip" from an insider in her recommendation, Anabella has violated Standard V (A) - Prohibition against Use of Non-Public Information. Note that due to this, she is also in violation of Standard I - Fundamental Responsibilities and Standard II (B) - Professional Misconduct (In general, any violation of the laws of a regulatory or governmental body will automatically trigger an infringement of these two laws). However, since she does not handle any client accounts, she is not in a position to violate Standard IV (B.3) - Fair Dealing. The portfolio managers of Trackstar violate Standard IV (B.3) if they give preferential treatment to some of their clients while using the investment recommendation. Constantine, in spreading himself too thin to be able to effectively manage his subordinates and not checking to see if Anabella was violating any securities laws (insider trading in this case) is in violation of Standard III (E) Responsibilities of Supervisors. In fact, he can be held criminally accountable for not curbing insider trading in his group through sheer negligence.

• Question 1530:

  A firm is considering undertaking a project requiring $7 million of new capital. The managers of the firm consider the prospects of the project having a 36% rate of return extremely likely, with a small probability that the project will not recover anything invested. The firm's current debt ratio is 70% and market analysts have estimated that the tax benefits from an increase in the debt level will be far smaller than the increase in bankruptcy costs. The Signaling Theory implies that the firm will try to raise _______ capital. The Trade-off Theory implies that the firm will try to raise _______ capital.

  A. equity; equity
  B. equity; debt
  C. debt; debt
  D. debt; equity
  D. debt; equity

  ---

  Explanation

  Since additional debt does not create more benefits from tax shield than the losses anticipated due to increased bankruptcy costs, the Trade-off theory implies that the firm will try to raise equity capital for the project. On the other hand, since the prospects of the project are extremely favorable, Signaling Theory says that the firm would rather raise the capital through debt so that the profits from the project are shared on an equity basis only with the current shareholders.