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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 1941:

  Which of the following correctly defines an element directly related to measuring the performance and status of a business entity?

  A. Gains are increases in equity from transactions and other events and circumstances that result from revenues or investments by owners.
  B. Equity is a residual interest.
  C. Investments by owners are limited to receipts of assets and satisfaction or conversion of liabilities.
  D. Revenues are inflows from peripheral or incidental transactions as well as the entity's ongoing major operations.
  E. None of these answers.
  B. Equity is a residual interest.

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  Explanation

  Equity in a business is considered a residual interest and represents the ownership (total assets minus total liabilities) in the firm.

• Question 1942:

  Which of the following statements about agency theory is TRUE?

  A. A company that pays fixed salaries with no variable compensation schemes likely has little agency conflict.
  B. An agency relationship is created when the board of directors appoints a new Chief Financial Officer.
  C. Restrictive debt covenants reduce the conflict between stockholders and managers.
  D. Encouraging managers to take on high-risk projects aligns their goals with that of bondholders.
  B. An agency relationship is created when the board of directors appoints a new Chief Financial Officer.

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  Explanation

  An agency relationship is created when decision-making authority is delegated to an agent without the agent being 100% responsible for the consequences of her decisions. Here, unless the Chief Financial Officer owns 100% of the firm, she

  has an agency relationship with the company.

  Stockholders and managers both benefit from risky projects that increase profitability and firm value. However, bondholders bear the risk of bankruptcy. Thus, encouraging managers to take on high-risk projects does not help to align their

  goals with that of creditors. A company that pays fixed salaries with no variable compensation schemes is not set up to reduce agency conflict. Without managerial compensation plans that motivate managers to act to increase stock price,

  stockholders and managers may have disparate goals.

• Question 1943:

  Which of the following statements is correct?

  A. The cost of debt used in calculating the WACC is an average of the after-tax cost of new debt and of outstanding debt.
  B. Preferred stock does not involve any adjustment for flotation cost since the dividend and price are fixed.
  C. The cost of new common equity includes an adjustment for flotation costs which is expressed as a fixed percentage of the current stock price. The flotation percentage is determined jointly by the current price of the firm's stock and its growth rate.
  D. The opportunity cost principle implies that if the firm cannot invest retained earnings and earn at least k(s) (component cost of retained earnings or internal equity), it should pay these funds to its stockholders and let them invest directly in other assets that do provide this return.
  E. Capital components are the types of capital used by firms to raise money. All capital comes from one of three types: long-term debt, preferred stock, and equity.
  D. The opportunity cost principle implies that if the firm cannot invest retained earnings and earn at least k(s) (component cost of retained earnings or internal equity), it should pay these funds to its stockholders and let them invest directly in other assets that do provide this return.

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  Explanation

  The firm's after-tax earnings belong to its stockholders. All earnings remaining after interest and preferred dividends belong to them, and these earnings serve to compensate stockholders for the use of their capital. The firm may either pay out earnings as dividends or retain them and reinvest them in the firm. If the firm retains earnings, there is an opportunity cost involved - stockholders could have received the earnings as dividends and invested the money in other investments. Thus, the firm should earn on its retained earnings at least as much as the stockholders themselves could have earned on alternative investments of comparable risk.

• Question 1944:

  Which of the following investments in debt securities would not normally be classified as long-term?

  A. Held-to-maturity securities
  B. Trading securities
  C. Available-for-sale securities
  D. All of these answers
  E. None of these answers
  B. Trading securities

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  Explanation

  Only held-to-maturity and available-for-sale securities are potential non-current investments. Trading securities are always considered to be current in nature, whereas held-to-maturity and available-for- sale securities may be classified as long-term should their maturity, or management's intent dictate.

• Question 1945:

  If we reject the null hypothesis what can we conclude subject to the alpha risk?

  A. Alternative hypothesis is false
  B. Null hypothesis is false
  C. Null hypothesis is true
  D. Both the null hypothesis and the alternative hypothesis are false
  E. Both the null hypothesis and the alternative hypothesis are true
  B. Null hypothesis is false

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  Explanation

  The alpha risk is the probability of rejecting the null when it is actually true. So if we had rejected the null, we can conclude, given what we know of the alpha, that the null is false.

• Question 1946:

  Which of the following is an assumption of technical analysis?

  A. Supply and demand is governed by both rational and irrational factors.
  B. All of these choices are assumptions of technical analysis.
  C. Changes in the market value of any good are determined solely by supply and demand fluctuations.
  D. Securities markets are weak-form inefficient.
  E. Securities prices move in identifiable trends.
  B. All of these choices are assumptions of technical analysis.

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  Explanation

  Technical analysis is primarily grounded on three major assumptions - (1.) the market value of any good is determined solely by supply and demand, (2. ) supply and demand fluctuations are caused by both rational and irrational factors, and (3. ) the prices of individual securities and securities markets move in trends, i.e. securities markets "price-in" information slowly. The third assumption of technical analysis negates any belief in the weak form efficient market hypothesis, which assumes that past performance data cannot be used to predict securities prices, and that the securities markets "price-in" information instantly. This "incongruence" with all forms of the EMH is cited as the greatest criticism of technical analysis.

• Question 1947:

  In the full cost method, oil firms:

  A. none of these answers.
  B. are required to expense all oil-drilling costs resulting in dry holes.
  C. must expense drilling costs which result in productive oil wells.
  D. can capitalize all oil-drilling costs.
  D. can capitalize all oil-drilling costs.

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  Explanation

  In extractive industries, firms are allowed to use either the full-cost method, in which all search and development costs can be capitalized, or the successful-efforts method, where all such costs are expensed unless they result in revenue-generating assets, in which case, they are capitalized.

• Question 1948:

  You have a portfolio of two assets, X and Y. X has an expected return of 15% with a variance of 900%%, and Y has an expected return of 9% with a variance of 400%%. Assume the covariance between X and Y is 225%%. For a portfolio composed of 50% X and 50% Y, find the expected return and variance.

  A. 10%, 437. 5%%.
  B. 12%, 437. 5%%.
  C. 12%, 367. 5%%.
  D. 14%, 512. 5%%.
  B. 12%, 437. 5%%.

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  Explanation

  The expected return is 0.5*15% + 0.5*9% = 7. 5% + 4. 5% = 12%. The variance will be trickier. The variance will be equal to (w_X)^2 * (sigma_X)^2 + (w_Y)^2 * (sigma_Y)^2 + 2 * w_X * w_Y * cov(X,Y) = (0.5)^2 * 900%% + (0.5)^2 * 400%% + 2 * (0.5) * (0.5) * 225%% = 437. 5%%.

• Question 1949:

  Consider the following information:

  30 day T-Bill rate (Risk free rate) 8.0%

  Common stock Beta 1.2

  Expected rate of return for the market 12. 0%

  Asset turnover ratio 3. 4x

  Calculate this firm's cost of retained earnings using the CAPM approach.

  A. 43. 52%
  B. 12. 8%
  C. 9.6%
  D. 8.0%
  E. 27. 2%
  F. 12. 0%
  B. 12. 8%

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  Explanation

  To calculate the cost of retained earnings for a firm using CAPM, one may use the following formula: Cost of retained earnings = risk free rate + [(expected rate of return on the market - risk free rate) x Beta]. In this case, the cost of retained earnings = 8.0% + [(12. 0% - 8.0%) x 1.2] = 12. 8%.

• Question 1950:

  You have invested in a long-term, fixed deposit account earning 4% per year for 20 years, compounded annually. Your friend has invested in a similar account but one that earns 4. 25% per year, compounded semi-annually. If each of you deposited $5,000, by what amount is your friend wealthier than you due to this deposit?

  A. $538
  B. $601
  C. $639
  D. $521
  C. $639

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  Explanation

  The friend's account has 5,000*(1+0425/2)^40 = 11,595 at the end of 20 years. Your account has 5,000*(1.04^20) = 10,956. The difference is $639.