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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 1881:

  Which of the following will most likely occur in the short-run if there is an unanticipated increase in aggregate demand?

  A. an increase in output and a higher price level
  B. a decrease in prices, while output remains unchanged
  C. a decrease in output and a higher price level
  D. a decrease in output and a lower price level
  E. an increase in output, while prices remain unchanged
  A. an increase in output and a higher price level

  ---

  Explanation

  In response to an unanticipated increase in aggregate demand prices will rise and output will temporarily exceed full employment capacity. In the long run, output will return to its long run potential.

• Question 1882:

  Which of the following is not a financing activity in the statement of cash flows?

  A. repurchase of common stock
  B. issuance of new debt
  C. payment of interest on debt
  D. cash dividend
  C. payment of interest on debt

  ---

  Explanation

  The payment of interest on debt is not a financing activity.

• Question 1883:

  Within the Keynesian model, if an economy operates below full employment,

  A. reducing wage rates and resource prices will quickly restore full-employment equilibrium.
  B. reducing government expenditures will direct the economy back to full- employment equilibrium.
  C. an increase in the real interest rate will soon restore full-employment equilibrium.
  D. output will tend to remain below full-employment capacity unless aggregate expenditures increase.
  E. reducing the real interest rate will soon restore full-employment equilibrium.
  D. output will tend to remain below full-employment capacity unless aggregate expenditures increase.

  ---

  Explanation

  An economy operating below its full employment level can only reach its full employment capacity by increasing aggregate expenditures. This can be achieved only by inducing consumers, investors, governments and foreigners to increase their expenditures.

• Question 1884:

  Which of the following statements about dividend policy and capital structure is FALSE?

  A. A company's growth rate equals the retention ratio multiplied by return on equity.
  B. Companies should use the residual dividend model to set the long-run target dividend payout ratio, but should not use it to set the dividend payment in any one year.
  C. If the board of directors decreases the target payout ratio, the stock price may increase or decrease.
  D. Assuming a world of taxes and bankruptcy, there is an optimal capital structure that maximizes earnings per share (EPS) and minimizes the cost of debt.
  D. Assuming a world of taxes and bankruptcy, there is an optimal capital structure that maximizes earnings per share (EPS) and minimizes the cost of debt.

  ---

  Explanation

  The optimal capital structure is the one that maximizes the stock price and minimizes the cost of capital.

  The other statements are true. "A company's growth rate equals the retention ratio multiplied by return on equity," is simply the word version of the equation g = (1 - Payout Ratio) * ROE. Know this equation for the exam! A company that uses

  the residual dividend model to set the dividend payment in any one year will not have a stable payout ratio, and investors will likely demand a higher required return to offset this uncertainty. The higher required return will result in a lower stock

  price. If the board of directors decreases the target payout ratio, the stock price may increase or decrease because there will be two opposing effects. For example, this may result in a decrease in stock price (due to lower dividend payout,

  D1), and an increase in the stock price due to increased funds available for reinvestment. Remember: g = (1 ?Payout) * ROE. The net effect partially depends on investor's preference for dividends over capital gains or vice versa.

• Question 1885:

  Which of the following is not one of the reasons why the valuation of common stock is difficult?

  A. Uncertainty of the risk-free rate of return
  B. Uncertainty of size of returns
  C. Uncertainty of the required rate of return
  D. Uncertainty of time pattern of returns
  A. Uncertainty of the risk-free rate of return

  ---

  Explanation

  The risk-free rate of return is widely known. It is simply the rate of return on risk-free U.S. government bonds.

• Question 1886:

  When compared to the percentage-of-completion method, the completed contract method

  A. reports larger total assets.
  B. reports higher net assets.
  C. reports higher cash flows.
  D. reports income earlier.
  E. uses higher estimates of selling prices.
  A. reports larger total assets.

  ---

  Explanation

  The completed contract method reports larger total assets because it accumulates inventory.

• Question 1887:

  In computing EPS, the equivalent number of shares of convertible preferred stock is added as an adjustment to the denominator (number of shares outstanding). If the preferred stock is preferred as to dividends, which amount should then be added as an adjustment to the numerator (earnings available to common shareholders)?

  A. Annual preferred dividend.
  B. Annual preferred dividend times (100% minus the income tax rate).
  C. Annual preferred dividend divided by the income tax rate.
  D. No adjustment should be made.
  E. Annual preferred dividend times the income tax rate.
  A. Annual preferred dividend.

  ---

  Explanation

  If a capital structure has convertible preferred stock with a dilutive effect on EPS, the "if-converted" method is used. This method assumes the conversion of the preferred stock occurred at the beginning of the accounting period or at issuance, if later. The annual preferred dividend is added back to earnings available to common shareholders.

• Question 1888:

  Long-term obligations that are or will become callable by the creditor because of the debtor's violation of a provision of the debt agreement at the balance sheet date should be classified as

  A. current liabilities unless the creditor has waived the right to demand repayment for more than 1 year from the balance sheet date.
  B. current liabilities unless it is reasonably possible that the violation will be corrected within the grace period.
  C. contingent liabilities until the violation is corrected.
  D. none of these answers.
  E. long-term liabilities
  A. current liabilities unless the creditor has waived the right to demand repayment for more than 1 year from the balance sheet date.

  ---

  Explanation

  Current liabilities include obligations that must be liquidated within 1 year as well as obligations that are or will be callable by the creditor within 1 year because of a violation of a debt covenant. An exception exists, however, if the creditor has waived or subsequently lost the right to demand repayment for more than 1 year from the balance sheet date.

• Question 1889:

  A stock has an expected dividend growth rate of 2. 4%. The firm has just announced a dividend of $2. 30 per share, with an ex dividend date 3 days from now. Investors expect a rate of return of 12% from the stock and the stock is trading at $26. 12. The stock is:

  A. insufficient information.
  B. overpriced.
  C. underpriced.
  D. fairly priced.
  B. overpriced.

  ---

  Explanation

  In the usual notation, the Dividend Discount Model gives Po = D1/(k-g). In this case, g = 2. 4%, D1 = Do*(1+g) = 2. 3 *1.024 = $2. 355, Po = $26. 12. Therefore, k = g + D1/Po = 2. 4% + 2. 355/26. 12 = 11.42%. Thus, the rate of return built into the price is less than that required by the investors, implying that the stock is overpriced. Another way of seeing this is to find the price that will give k = 12%. This price equals P = 2. 355/(12% - 2. 4%) = $24. 53. Since the stock is trading at a price higher than this, it is overpriced (by $1.59).

• Question 1890:

  Which of the following statements about Arbitrage Pricing Theory (APT) and the Capital Asset Pricing Model (CAPM) is FALSE?

  A. APT can equal CAPM.
  B. In both the APT and the CAPM, the risk-free rate is added to a premium for risk factor (X) and the responsiveness of the asset's returns to factor (X).
  C. If zero-investment arbitrage does not hold, the APT does not hold.
  D. APT is a multi-factored model with restrictive assumptions.
  D. APT is a multi-factored model with restrictive assumptions.

  ---

  Explanation

  Arbitrage Pricing Theory is a multifactored model with few limiting assumptions. More than one risk factor is able to influence security prices. The other statements are true. Arbitrage Pricing Theory can equal the Capital Asset Pricing Model (CAPM) if there is only one risk factor ?market risk. Zero-investment arbitrage is an assumption of the APT. More specifically, zero-investment arbitrage means that if an investor buys an overpriced security, the investor has access to the short-sale money needed to buy an underpriced security.