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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 1971:

  The peaks and valleys of the business cycle tend to be smoothed out using which inventory method?

  A. gross profit method
  B. LIFO
  C. weighted average
  D. FIFO
  B. LIFO

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  Explanation

  When prices are moving either upward or downward, the cost of goods sold (under LIFO) will show costs closer to the price level at the time the goods were sold. Therefore the LIFO method tends to show a smaller net income during inflationary times and a larger net income during deflationary times than other methods of inventory valuation.

• Question 1972:

  An increase in the required rate of return will have what effect on the earnings multipliers of common stocks? Further, what effect could be expected from an increase in the dividend payout ratio?

  A. Earnings multipliers will decrease; earnings multipliers will increase
  B. Earnings multipliers will increase; earnings multipliers will decrease
  C. Earnings multipliers will remain unchanged; earnings multipliers will increase
  D. Earnings multipliers will increase; earnings multipliers will increase
  E. Earnings multipliers will decrease; earnings multipliers will decrease
  A. Earnings multipliers will decrease; earnings multipliers will increase

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  Explanation

  A simple method of determining the appropriate earnings multiplier for a common stock can be found by manipulating the Infinite Period Dividend Discount Model such that it resembles the following:

  P/E = [(d1/e1) / (k - g)]

  Where: P/E = the earnings multiplier expressed as the Price-to-Earnings Ratio, d1/e1 = the dividend payout ratio at t1, k = the required rate of return, and g = the anticipated annual growth rate.

  As you can see, an increase in the required rate of return, holding everything else equal, will lead to a decrease in the earnings multiplier. Opposite this effect, an increase in the dividend payout ratio will lead to an increase in earnings

  multipliers.

• Question 1973:

  ________ financing is capital provided for a company that expects to go public within a year or so.

  A. Third-stage
  B. Second-stage
  C. Mezzanine
  D. First-stage
  E. Leveraged-buyout
  C. Mezzanine

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  Explanation

  There are three stages of "expansion financing":

  1. Second-stage financing. This capital is used for initial expansion of a company that has already been selling a product.

  2. Third-stage financing. Capital provided to fund major expansion.

  3. Mezzanine (bridge) financing. Capital provided for a company that expects to go public within a year or so.

• Question 1974:

  Consider the following transactional information for the investment account of an underwriting syndicate:

  1st Quarter Ending portfolio value: $50,800,000 Total amount invested: $46,100,000

  2nd Quarter Ending portfolio value: $51,100,000 Total amount invested: $50,800,000

  3rd Quarter Ending portfolio value: $51,000,000 Total amount invested: $51,100,000

  4th Quarter Ending portfolio value: $54,500,000 Total amount invested: $50,000,000

  Using this information, what is the annual time-weighted rate of return for this portfolio? Assume no taxes or transaction charges.

  A. None of these answers is correct.
  B. 20.59% per year
  C. 19.59% per year
  D. 22. 14% per year
  E. 18.55% per year
  F. The time-weighted rate of return cannot be calculated from the information provided.
  B. 20.59% per year

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  Explanation

  The time-weighted rate of return is the preferred method of return calculation in the investment management industry, primarily because this method is not sensitive to significant additions and withdrawals of funds from portfolios under examination. The calculation of the time-weighted rate of return involves three steps, which are illustrated as follows:

  Step 1:

  Price the portfolio immediately prior to any significant additions or withdrawals. Separate the portfolio into a series of subperiods based on the dates of cash inflows and outflows.

  Step 2:

  Calculate the holding period return for each subperiod.

  Step 3:

  Determine the annualized holding period return by linking or compounding the holding period return of each subperiod. If the investment is for more than one year, use the geometric mean of the annual returns as the time-weighted rate of

  return. If the investment is for less than one year, compound the subperiod returns to obtain an annualized measurement.

  To begin the process of determining the time-weighted rate of return, we would break the portfolio up into the subsequent series of cash flows. However, in this example, the cash flows are already aggregated for us and we can move on to

  the next step: determining the holding period return for each subperiod. This process is detailed as follows:

  Quarter 1 holding period return = [($50,800,000 ending value - $46,100,000 invested) / $46,100,000 invested] = 10.19523%

  Quarter 2 holding period return = [($51,100,000 ending value - $50,800,000 invested) / $50,800,000 invested] = 0.59055%

  Quarter 3 holding period return = [($51,000,000 ending value - $51,100,000 invested) / $51,100,000 invested] = (0.1957%)

  Quarter 4 holding period return = [($54,500,000 ending value - $50,000,000 invested) / $50,000,000 invested] = 9.00%

  Now that the holding period return for each subperiod has been determined, we must annualize the return measure by taking the product of all four quarterly returns. This process is illustrated below:

  [(1 + .10195) * (1 + .00591) * (1 - .00196) * (1 + .09) - 1] = .2059 or 20.59%

  When calculating the time-weighted rate of return, remember that the total amount invested is the relevant figure, not the beginning portfolio value. Notice that during the fourth quarter, the total amount invested does not equal the ending

  amount for the third quarter. This differential could be explained by numerous phenomena. Perhaps the difference is due to a cash withdrawal from the account. Maybe it was used to pay expenses or meet an outstanding margin call. What is

  important to note is the fact that this money was not invested, and should not be included in the holding period return for the fourth quarter. So said, whenever possible you should use the total amount invested rather than the beginning

  portfolio value in the calculation of the subperiod holding period return.

  If you chose 19.59%, remember that in the calculation of the time-weighted rate of return, it is the geometric mean that is used rather than the arithmetic mean.

• Question 1975:

  Which of the following is/are FALSE under GAAP?

  I. The change in cash balances in consecutive Balance sheets equals the operating cash flow of the firm over that period.

  II. The investing, financing and operating cash flows must together balance out to zero, to preserve the relationship, cash in = cash out.

  III. Dividends received from investments in the stocks of other firms are classified under investing cash flows.

  IV.

  Interest paid on debt financing is classified as operating cash flow.

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

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  Explanation

  The change in cash balances of a firm can come about due to investing and financing cash flows, in addition to operating cash flows. Therefore, (I) is false. The relationship cash in = cash out is incorrect since the difference between the two goes into changing the cash balance of the firm. Hence, the operating, investing and financing cash flows need not balance out. It is very important to remember the following points about dividends and interests:

  1. Dividends received from stock investments are considered operating cash flows.

  2. Dividends paid on equity are considered financing cash flows.

  3. Interest payments on debt are considered operating cash flows.

  4. Interest received from debt investments are considered operating cash flows.

• Question 1976:

  Marine Corp. uses the direct method to prepare its statement of cash flows. Marine's trial balance at December 31, 1996 and 1995 are as follows:

  Dec. 31, 1996 Dec. 31, 1995 Debits:

  Cash $35,000 $32,000 Accounts receivable 33,000 30,000 Inventory 31,000 47,000 Property, plant and equipment 100,000 95,000 Unamortized bond discount 4,500 5,000 Cost of goods sold 250,000 380,000 Selling expenses 141,500 172,000 General and administrative expenses 137,000 151,300 Interest expense 4,300 2,600 Income tax expense 20,400 61,200 Total debits $756,700 $976,100

  Credits: Allowance for doubtful accounts $1,300 $1,100 Accumulated depreciation 16,500 15,000 Trade accounts payable 25,000 17,500 Income taxes payable 21,000 27,100 Deferred income taxes 5,300 4,600 8% callable bonds payable 45,000 20,000 Common stock 50,000 40,000 Additional paid-in capital 9,100 7,500 Retained earnings 44,700 64,600 Sales 538,800 778,700 Total credits $756,700 $976,100

  Marine purchased $5,000 in equipment during 1996. Marine allocated one-third of its depreciation expense to selling expenses and the remainder to general and administrative expenses. What amount should Marine report in its statement of cash flows for the year ended December 31, 1996 for cash collected from customers?

  A. $535,800
  B. $601,800
  C. $536,000
  D. $541,600
  E. $541,800
  A. $535,800

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  Explanation

  To calculate cash collected from customers we do a T-account analysis of the gross accounts receivable. The beginning balance was $30,000 debit, we add the sales for 1996 (by debiting the accounts receivable) which were $538,800 and we subtract cash collections (the unknown here) by crediting accounts receivable to derive the ending balance of $33,000. Therefore, cash collections are $535,800.

• Question 1977:

  With regard to international portfolios, if net performance is indicated, managers are required to disclose the assumed ________ for the benchmark.

  A. hedge
  B. disclosure
  C. tax rate
  D. differentials
  E. currency effects
  C. tax rate

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  Explanation

  To be in compliance with the AIMR-PPS, the performance presentation for international portfolios must disclose whether composites and benchmarks are presented gross or net of withholding taxes on dividends, interest and capital gains; if net, the assumed tax rate for both the composite and the benchmark.

• Question 1978:

  Social investments:

  A. should never be used in pension fund investing.
  B. in pensions must be well thought-out, making sure that such investments are legal and do not impair the integrity of the funds in questions or the financial security of the participants or beneficiaries.
  C. none of these answers.
  D. have yet to be used as an investment in pension funds in the U.S.
  E. are proper investment vehicles for pensions, since they are a "public good."
  B. in pensions must be well thought-out, making sure that such investments are legal and do not impair the integrity of the funds in questions or the financial security of the participants or beneficiaries.

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  Explanation

  In a pension plan, the first and foremost duty of the fiduciary is to the plan participants and their beneficiaries rather than to the plan sponsor that has the power to hire and fire the investment manager. Consequently, if urged to make investments that might be of direct benefit to a sponsoring community or to the community at large, the manager must ensure that such investments are legal and do not impair the integrity of the funds in question or the financial security of the participants/beneficiaries.

• Question 1979:

  Chances are 50-50 that a newborn baby will be a girl. For families with five children, what is the probability that all the children are girls?

  A. 0.100
  B. None of these answers
  C. 0.250
  D. 0.001
  E. 0.031
  E. 0.031

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  Explanation

  This is a binomial probability. The probability of getting r successes out of n trials where the probability of success each trial is p and probability of failure each trial is q (where q = 1-p) is given by: n!(p^r)[q^(n-r)]/r!(n-r)!. Here n = 5, r = 5,p = 0.5 and q = 0.5. Therefore we have 5!(0.5^5)(0.5^0)/5!0! = 0.03125.

• Question 1980:

  What simple annual interest rate would cause a $200 deposit to earn $15 interest in one year?

  A. 5. 00%
  B. 12. 50%
  C. 10.25%
  D. 7. 5%
  E. 6. 67%
  D. 7. 5%

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  Explanation

  To solve this question, rearrange the simple interest formula I=PRT to isolate R. On the BAII Plus, press 15 divide 200 divide 1 = to see the answer. On the HP12C, press 15 ENTER 200 divide 1 divide to see the answer. Note that the final division by 1 (which is the time T in this question) is not necessary.