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

• Question 1541:

  Given the following spot and forward rates, how much should an investor pay for a 3-year, annual zero-coupon bond with a face value of $1,000? The investor should pay approximately:

  A. $720.

  B. $724.

  C. $884.

  D. $886.

  Correct Answer: B

  The yield to maturity on an N-year zero coupon bond is equivalent to the N-year spot rate.Thus, to

  determine the present value of the zero-coupon bond, we need to calculate the 3-year spot rate.

  Using the formula: (1 + Z3)3= (1 +1f0) + (1 +1f1) + (1 +1f2)

  Where Z = spot rate andnfm= The n year rate m periods from today, (1f0= the 1 year spot rate now)

  (1 + Z3)3= (1.035) * (1.115) * (1.1975)

  Z3= 1.38191/3- 1 = 0.11386, or 11.39%

  Then, the value of the zero coupon bond = 1,000 / (1.1139)3= 723.62, or approximately$724.

  or, using a financial calculator, N = 3, I/Y = 11.39, FV = 1,000, PMT = 0, Compute PV = 723.54, or

  approximately$724.

• Question 1542:

  Tony Ly is a Treasury Manager with Deeter Holdings, a large consumer products holding company. The

  Assistant Treasurer has asked Ly to calculate the current yield (CY) and the Yield-to-first Call (YTC) on a

  bond the company holds that has the following characteristics:

  If Ly calculates correctly, the CY and YTC are approximately:

  A. 7.80% and 15.82%, respectively.

  B. 7.78% and 15.72%, respectively.

  C. 3.89% and 15.72%, respectively.

  D. 7.78% and 15.82%, respectively.

  Correct Answer: A

  To calculate the CY and YTC, we first need to calculate the present value of the bond: FV =1,000, N =14=

  7*2, PMT =35=(1000*0.07)/2, I/Y =4.5(9 / 2), Compute PV = -897.77 (negative sign because we entered

  the FV and payment as positive numbers).

  Then, CY = (Face value * Coupon) / PV of bond = (1,000 * 0.07) / 897.77 =7.80%

  And finally, YTC calculation: FV =1,060(price at first call), N =4(2*2), PMT =35(same as above), PV =

  897.77 (negative sign because we entered the FV and payment as positive numbers), ComputeI/Y = 7.91 (semi-annual rate, need to multiply by 2) =15.82%

• Question 1543:

  Which of the following statements about refunding and redemption is TRUE?

  A. A sinking fund is an example of refunding.

  B. An investor concerned about premature redemption is indifferent between a noncallable bond and a nonrefundable bond.

  C. Callable bonds redeemed at a special redemption price are redeemed at par.

  D. A nonrefundable bond can be redeemed with funds from operations, from a new equity issue, or from a lower coupon issue.

  Correct Answer: C

  This statement is true. Bonds redeemed at par are redeemed at the special redemption price. When bonds are called at a premium, the issuer redeems them at a price above par, or the regular or general redemption price. The other statements are false. A sinking fund is a type of redemption, which refers to the retirement of bonds. An investor concerned about premature redemption would prefer a noncallable bond because a noncallable bond cannot be called for any reason. A nonrefundable bond can be called for any reason other than refunding. The term refunding specifically means redeeming a bond with funds raised from a new bond issued at a lower coupon rate. A nonrefundable bond can be redeemed with funds from operations or a new equity issue. Note: A bond can be both nonrefundable and callable.

• Question 1544:

  Simone Girau holds a callable bond and Chi Rigazio holds a putable bond. Which of the following statements about the two investors is TRUE?

  A. As the yield volatility increases, the value of both Girau's bond and the underlying option increases.

  B. Both investors calculate the value of the bond held by adding the value of the option to the value of a similar straight bond.

  C. Girau's bond has less potential for price appreciation.

  D. If yield volatility increases, the value of Rigazio's option will decrease.

  Correct Answer: C

  When a bond has a call provision, the potential for price appreciation is reduced, because the call caps the price of the bond near the call price. Even if interest rates fall considerably, it is unlikely that investors would pay a price that exceeds the call price. The other statements are false. To calculate the value of a putable bond, it is correct to add the option value to the value of a similar straight bond. However, to calculate the callable bond value, subtract the option value from that of a similar straight bond. As a result, when yield volatility increases (thus increasing the option value), the value of a callable bond decreases and the value of a putable bond increases. A call option does benefit the issuer, but a put option benefits the holder. Embedded options (puts and calls) increase in value when volatility increases.

• Question 1545:

  Kelly Windsor and Joe Agosti, expatriates working in Yemen, are studying for the Level 1 CFA examination. This week, they are focused on new concepts in the asset valuation material. While sitting on his balcony overlooking the desert, Agosti creates the following true/false question to test Windsor's knowledge of dollar-weighted and time-weighted returns. Which of the following statements did he make FALSE?

  A. If a client adds funds to an investment during an unfavorable market, the time-weighted return will be lower than actual.

  B. The dollar-weighted return applies the concept of internal rate of return (IRR) to investment portfolios.

  C. The time-weighted return measures the compound rate of growth of $1 over a stated time period.

  D. If the investment period is greater than one year, an analyst must use the geometric mean approach when using the time-weighted return method.

  Correct Answer: A

  The time-weighted method is preferred because it is not affected by the timing of cash flows. This statement should read, "If a client adds funds to an investment during an unfavorable market, the dollarweighted return will be lower than actual." The other statements are true.

• Question 1546:

  Which bond has the greatest price volatility? A

  A. 10% coupon bond with a 20-year life.

  B. 5% coupon bond with a 20-year life.

  C. 5% coupon bond with a 10-year life.

  D. 10% coupon bond with a 10-year life.

  Correct Answer: B

  This question is asking: given a change in yield, which of the bonds will exhibit the greatest price change? Of the four choices, the bond with the longest maturity and lowest coupon will have the greatest price volatility. All else equal, the bond with the longer term to maturity is more sensitive to changes in interest rates. Cash flows that are further into the future are discounted more than near-term cash flows. Here, this means that one of the 20-year bonds will have the highest volatility. Similar reasoning applies to the coupon rate. A lower coupon bond delivers more of its total cash flow (the bond's par value) at maturity than a higher coupon bond. All else equal, a bond with a lower coupon than another will exhibit greater price volatility. Here, this means that of the 20-year bonds, the one with the 5% coupon rate will exhibit greater price volatility than the bond with the 10% coupon.

• Question 1547:

  Using the information below, value the stock of Meerkat Publishing, Inc. using the free cash flow from equity (FCFE) valuation method.

  

  Which of the following choices is closest to the correct answer? The per share value of Meerkat Publishing is:

  A. $31.52.

  B. $45.39.

  C. $32.86.

  D. $24.06.

  Correct Answer: C

  The FCFE is calculated as follows (all amounts in million of $ except per share price): Step 1: Calculate Present Value of Each Year's FCFE Step 2: Calculate Present Value of final cash flow times FCFE multiple Step 3: Calculate per share value Add up PV of FCFE and end value and divide by number of shares outstanding = (10.67 + 11.85 + 15.45 + 339.93) / 11.5 =32.86

• Question 1548:

  Myra Addison, Luz Bazo, and Erik Jenss, three equity traders, are having a quick lunch around the corner from the exchange. Bazo's cell phone beeps, letting him know that he has a text message. He reads the message, then quietly tells Addison and Jenss that Badger Distributors, Inc. has just won exclusive rights to supply all major league baseball parks with uniforms for hot dog/soda vendors. Bazo stands up, gathers his unfinished lunch, and announces, "I'm going back to the exchange to trade." Jenss calmly eats his sandwich and says, "There's plenty of time to trade." Addison shakes her head and mutters, "It's too late already." Based on their reactions to the news on Badger Distributors, which statement best identifies the trading view of these three traders?

  A. Addison uses fundamental analysis, Bazo is a technician, and Jenss supports the efficient market hypothesis.

  B. Addison and Jenss both use fundamental analysis and Bazo is a technician.

  C. Addison and Jenss both use fundamental analysis and Bazo supports the efficient market hypothesis.

  D. Addison supports the efficient market hypothesis, Bazo uses fundamental analysis, and Jenss is a technician.

  Correct Answer: D

  One major difference between technicians, fundamental analysis traders, and those who support the

  efficient market hypothesis is the speed at which they believe the market reflects new information, The

  order, from slowest to fastest, is:

  technical analysis (Jenss), fundamental analysis (Bazo), and efficient market hypothesis (Addison).

• Question 1549:

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

  A. When margin balances in brokerages accounts increase, contrary-opinion technicians are bearish.

  B. The investment advisory ratio is at 0.65. Contrary-opinion technicians are bullish.

  C. The OTC volume is less than 87% of the NYSE volume. Investors are bearish.

  D. A narrowing of the T-bill - Eurodollar futures spread is a signal for a smart-money technician to buy.

  Correct Answer: A

  Although an increase in margin (debit) balances in brokerages accounts means investors are bullish, it is not an indicator used by contrary-opinion technicians. This would be a bullish sign to smart-money technicians. The other statements are correct. When the investment advisory ratio (bearish opinions/total opinions) is equal to or greater than 0.60, it means that investors are bearish, and contrary-opinion technicians are bullish. Investors are considered bullish if the OTC volume is greater than 112% of the NYSE volume. Summary of the indicators for contrary-opinion and smart money technicians: Contrary-opinion technicians (trade the opposite of the mass of general investor): Smart-money technicians (follow the professional investors):

• Question 1550:

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

  A. A contrary-opinion technician is bearish when the specialist short sale ratio falls below 30%.

  B. A smart-money technician buys when futures traders are bullish on stock index futures.

  C. When investor credit balances are falling, contrary-opinion technicians are bearish.

  D. A smart-money technician takes a bullish position when the yield spread on high quality versus lower-quality bonds increases from 75 basis points to 150 basis points.

  Correct Answer: C

  When investor credit balances are falling, investors are bullish, so contrary-opinion technicians are bearish. The other statements are incorrect. Although a specialist short sale ratio less than 30% indicates a bull market, this indicator is followed by smart money technicians. When the yield-differential between high quality and lower-quality bonds widens, the confidence index decreases, and smart-money technicians would be bearish. A widening yield spread is a bearish sign to smart-money technicians because it means that the confidence index has decreased. When 75% or more of futures traders are bullish on stock index futures,contrary-opinion technicians become bearish and sell. 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):