CFA Institute CFA Institute Certifications CFA-LEVEL-1 Questions & Answers

• Question 1521:

  Which of the following statements about asset valuation is TRUE?

  A. The bottom-up stock picking approach is: first, stock analysis, second, industry analysis, and third, economic analysis

  B. The absolute value of economic value added (EVA? is less important than the trend.

  C. Earnings are considered the variable least likely to be manipulated.

  D. A domestic steel firm and a foreign steel firm will have similar earnings per share (EPS) levels and price/earnings (P/E) ratios.

  Correct Answer: B

  Management's performance over time is most important. The other statements are false. The bottom-up stock picking approach consists of one step ?pick the stocks you believe are underpriced, regardless of the state of the economy or the industry. The choices given here for picking stocks are the steps of the top-down approach in reverse order. Sales are considered the variable least likely to be manipulated. Although the basic methodologies for international stock valuation and domestic stock valuation (dividend discount model [DDM], EPS, P/E) are the same, the analyst must be aware of and consider differences in accounting practices and factor in the impact of exchange rate movements. It is also important to consider the absolute performance of foreign firms and their relative performance against local firms.

• Question 1522:

  Which of the following statements about contrary-opinion and smart money technicians is CORRECT?

  A. If mutual funds cash holdings are more than 13% of total fund assets, smart-money technicians are bullish.

  B. When the ratio of short sales by specialists to total NYSE short sales is at 0.20, smart-money technicians are bearish.

  C. The CBOE put call ratio is 0.75. Contrary-opinion technicians are bullish.

  D. When the yield spread on high quality versus lower-quality bonds narrows, the confidence index decreases and smart-money technicians become bullish.

  Correct Answer: C

  When the CBOE put call ratio is equal to or greater than 0.50, this suggests that investors are bearish and

  thus contrary-opinion technicians are bullish. The other statements are incorrect. The mutual fund ratio is

  not an indicator for smart money technicians. When the mutual fund ratio is equal to or greater than 0.13, it

  means that investors are bearish and contrary-opinion technicians are bullish. The statement beginning,

  "When the yield spread on high quality versus lower-quality bonds narrows," is partially true. A narrowing

  yield spread is a bullish sign to smart-money technicians, but because it means that the confidence index

  has increased.

  Summary of the indicators for contrary-opinion and smart money technicians:

  Contrary-opinion technicians (trade the opposite of the mass of general investors):

  Smart-money technicians (follow the professional investors):

• Question 1523:

  Katrina Whittcomb, junior analyst, is trying to understand what variables impact the price/earnings (P/E) ratio for a stock. Specifically, she wants to determine under what circumstances the P/E ratio will increase or decrease. A senior analyst in the group, Clinton Dermont, devises the following question to help her understand the impact of changes in P/E variables. To make the question less theoretical, he provides the following assumptions: Using the information above, determine which of the following statements is most likely FALSE. All else equal, if the:

  A. dividend payout increases, the P/E ratio will increase.

  B. expected inflation rate decreases, the P/E ratio will rise above 12.5.

  C. earnings retention ratio increases, the P/E ratio will increase.

  D. risk free-rate increases, the P/E ratio will decrease.

  Correct Answer: A

  Memo:The P/E ratio = Dividend Payout Ratio / (ke?g), Impact of variables:

• Question 1524:

  Calculate the earnings per share (EPS) for the plastic bead industry using the information below. The industry's EPS is closest to:

  A. $110.

  B. $22.

  C. $54.

  D. $40.

  Correct Answer: D

  The formula for the industry EPS is:

  EPSindustry= [(Per share Sales Estimate) * (EBITDA%) ?D ?I] * (1 - t)

  = [($250 * 0.60) - $50 - $20] * (1 ?0.5) = $40.00

• Question 1525:

  Amie Minami recently graduated from the University of Rivendell School of Business and is now studying for the Level 1 CFA examination. She thought she would never have to read about Porter's Five Forces again. However, while taking an online review quiz to help her focus her studies, she sees a question on Porter. Luckily, she remembers all the points and correctly identifies that one of the choices is incorrect. Which of the following choices is FALSE?

  A. Porter details three strategies that are available to firms in a competitive environment: low-cost, differentiation, and vertical integration.

  B. Porter's five forces are the first step in identifying and evaluating a firm's specific competitive strategy.

  C. When the threat of substitution is highest, profit margins will be low, particularly for commodity-like products.

  D. Suppliers are more powerful if they are more concentrated than the firms in that industry.

  Correct Answer: A

  While vertical integration may be a strategy, Porter identified two strategies that are available to firms in a competitive environment: a low-cost strategy and a differentiation strategy. The other statements are correct.

• Question 1526:

  Kaylee Sumners, Level 1 CFA candidate, is having difficulty remembering the tests for the three forms of the efficient market hypothesis (EMH). On her first attempt to outline the information from memory, she made numerous mistakes. After reviewing the material, she tries again to summarize the information. This time, three of her four points are correct. Which of her summary points is INCORRECT?

  A. Results of trading rule tests, such as filter rules, support the semi-strong form of the EMH.

  B. The historical performance of professional money managers supports the strong-form of the EMH.

  C. Early tests of the semi-strong form used the formula:ReturnAbnormal= ReturnActual- RMarket

  D. The tests for the semi-strong form EMH give mixed results. Time-series tests such as dividend yield and default spread reject the semi-strong form EMH and event studies on stock splits and announcements of accounting changes support it.

  Correct Answer: A

  Results of trading rule tests, such as filter rules, support the weak form of the EMH. The other choices are true. Tests show that professional money managers perform no better than a random buy and hold strategy. This supports the strong form EMH contention that stock prices reflect all information- public and private. (Aside from corporate insiders and specialists, no group has monopolistic access to information that would result in superior returns.)

• Question 1527:

  Which of the following statements about short selling is FALSE?

  A. A short sale involves securities the investor does not own.

  B. According to the uptick rule, a short sale can only trade at a price higher than previous trade.

  C. A short seller loses if the price of the stock sold short falls.

  D. A short seller is required to set up a margin account.

  Correct Answer: C

  A short seller loses if stock prices rise. The other choices are true.

• Question 1528:

  Tamber Benz, CFA, recently joined Bay Area Investment Group as a personal financial planner. Today, she has a meeting with a client interested in equity index funds, with a particular interest in learning about the source and direction of biases. In preparation for this meeting, she makes some quick notes (relying on her memory). These notes are listed below. She then finds her well-worn CFA study notes and checks her memory. After reviewing her notes, which of the following choices does she determine is INCORRECT?

  A. The Dow Jones Industrial Index has a built-in downward bias.

  B. An index such as the Valueline Composite Average is constructed by purchasing an equal number of shares of each stock in the index, and will have a downward bias when geometric averaging is used to compute the return.

  C. One problem with an index such as the SandP 500 is that firms with greater market capitalization have more impact than other firms.

  D. A market value-weighted index, such as the New York Stock Exchange Index, accurately reflects the impact of price changes on wealth.

  Correct Answer: B

  Although the latter part of this statement is correct, the first part is incorrect. The Valueline Composite Average is an unweighted price indicator series, and is constructed by maintaining an equal dollar investment in each stock in the index. The return of an unweighted index is usually calculated using a geometric average. Assuming the existence of volatility, the geometric average will always be lower than the arithmetic average. The other statements are true. The Dow Jones Industrial Index is a price-weighted index and thus has a built-in downward bias because of the impact of stock splits. After a stock split, the denominator is adjusted downward to keep the index at the same level as before the split. Since high-growth companies tend to announce stock splits more frequently than low-growth companies, the larger, more successful firms lose influence on the index. The SandP 500 index is a market-value weighted index. One problem with market-value weighted indexes is that firms with greater market capitalization have more impact than other firms. If these firms also have higher returns, the firms can dominate the index.

• Question 1529:

  Indie Carson, management consultant, wants to become a portfolio manager. While researching the position, she learns that obtaining the CFA Charter is very important. She decides to take the Level 1 examination this June, and begins to study. During the reading on efficient markets, she rethinks her new career choice. If markets are efficient, what is the role of a portfolio manager? Distraught, she e-mails her mentor, LaMeda Durio. Durio wants to use the occasion to help Carson study, so she e-mails Carson the following reply (summarized in points A through D below) and asks her to identify the INCORRECT statement. Which of the following choices does Carson select as FALSE? Assuming an efficient market, portfolio managers assist clients with:

  A. minimizing transaction costs.

  B. quantifying risk tolerances and return needs.

  C. rebalancing the portfolio when necessary.

  D. diversifying globally to reduce systematic risk.

  Correct Answer: D

  This a "trick" question. Although portfolio managers can help clients diversify globally, they do so to reduce unsystematic risk. Systematic, or market risk, is undiversifiable. The other statements are true. There are three ways for a portfolio manager to minimize transaction costs: reduce taxes, reduce trading volume (turnover) and minimize liquidity costs by trading relatively liquid stocks.

• Question 1530:

  Laleh Mali conducts a stock transaction with the following characteristics:

  Which of the following statements about Mali's trade is least likely to be correct? Mali placed her order in:

  A. a continuous market.

  B. an order driven market.

  C. conjunction with a short sale.

  D. the secondary market.

  Correct Answer: D

  Seasoned issues are new issues by a firm whose shares are already traded on the exchange and are traded in the primary market. The other statements are likely true. Note that stop buy orders are often placed to protect a short sale from a rising market.