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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 2061:

  Cornelius is a portfolio manager with Apex Investments, an investment advisory firm. Cornelius has, over the years, developed a special symbiotic relationship with Mike Milken, the owner of Milk 'em, Inc., a small brokerage firm. Cornelius puts subtle pressure on the trading desk at Apex to execute its trades through Milk 'em, thus generating brokerage revenue for Mike. In return, Mike recommends the services of Apex Investments to many of its clients. This arrangement is not disclosed to either the senior management at Apex nor to any of the clients. It has been observed by many at Apex Investments that the commissions charged by Milk 'em are 10-15% higher than those by other brokers. However, Cornelius has justified the higher costs by pointing to the extra revenue-flow from Milk 'em. Cornelius has:

  I. not violated any AIMR standards.

  II. violated Standard III (C) - Disclosure of Conflicts to Employer.

  III. violated Standard IV (B.8) - Disclosure of Referral Fees.

  IV.

  violated Standard IV (B.1) - Fiduciary Duties.

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

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  Explanation

  Cornelius is clearly in a situation representing a conflict of interests. His arrangement and non-disclosure of the arrangement are unfair to the current clients of Apex and potential clients recommended by Milk 'em. They represent a violation of his fiduciary duties to the clients. By not informing senior management at Apex about the arrangement, he has also violated Standard III (B) - Disclosure of Conflicts to Employer.

• Question 2062:

  A firm decides to capitalize the interest expenditure on a large, building construction project, instead of expensing it. This ________ its debt-to-equity ratio.

  A. has an ambiguous effect on
  B. leaves unaffected
  C. decreases
  D. increases
  C. decreases

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  Explanation

  Interest capitalization results in higher earnings compared to the case where it is expensed. This results in higher retained earnings and higher equity, thus reducing the debt-to-equity ratio.

• Question 2063:

  The semiannually compounded rate is 10% quoted on an annualized basis. The equivalent annually compounded rate is: A. 10.25%

  B. 10.5%

  C. 9.65%

  D. 10.1%

  Correct Answer. A
  A

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  Explanation

  To solve such problems, think about investing a dollar for a year. The final amount should be the same under both the quotations. Under annually compounded rate, r, $1 grows to 1+r in 1 year. Under semiannual compounding, it grows to (1 +0.1/2)^2 = 1.1025. Since these two should be equal, we get 1+r = 1.1025, giving r = 10.25%. Note that the annually compounded rate must be larger than the semiannually rate, ruling out 9.65 automatically.

• Question 2064:

  Purchases of marketable securities are:

  A. operating cash flows.
  B. investing cash flows.
  C. financing cash flows.
  D. either financing cash flows or investing cash flows.
  B. investing cash flows.

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  Explanation

  The purchase of investment securities is clearly an investing cash flow.

• Question 2065:

  The bonds of Grinder Corp. trade at a nominal spread of 150 basis points (bp) above comparable maturity U.S. Treasury securities. The option adjusted spread (OAS) on the Grinder Corp. bonds is 75 bp. Using this information, and assuming that the Treasury yield curve is flat, which of the following statements is most likely to be true?

  A. The zero-volatility spread should be 75 bp.
  B. The zero-volatility spread for these bonds is 225 bp.
  C. The option cost component of these bonds should be 75 bp.
  C. The option cost component of these bonds should be 75 bp.

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  Explanation

• Question 2066:

  Karissa Grossklaus recently joined an investment banking firm as a research analyst. One of the partners asks her to determine whether a certain stock, Park Street Holdings, is overvalued or undervalued, and by how much (expressed as

  percentage return). Grossklaus runs a regression and finds the following information on the stock:

  Grossklaus reports that Park Street Holdings stock is:

  A. undervalued by 1.1%.
  B. overvalued by 3. 7%.
  C. overvalued by 1.1%.
  D. undervalued by 3. 7%.
  C. overvalued by 1.1%.

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  Explanation

  To determine whether a stock is overvalued or undervalued, we need to compare the expected return (or holding period return) and the required return (from Capital Asset Pricing Model, or CAPM).

  Step 1: Calculate Expected Return (Holding period return):

  The formula for the (one-year) holding period return is:

  HPR = (D1+ S1?S0) / S0, where D = dividend and S = stock price.

  Here, HPR = (0 + 55 ?45) / 45 = 22. 2%

  Step 2: Calculate Required Return:

  The formula for the required return is from the CAPM:

  RR = Rf+ (ERM?Rf) * Beta

  Here, we are given the information we need except for Beta. Remember that Beta can be calculated with: Betastock= [covS,M] / [2M]. Here we are given the standard deviation of the market, so the calculation is: 1.30 / 0.752= 2. 31. RR = 4. 25% + (12. 5 ?4. 25%) * 2. 31 = 23. 3%.

  Step 3: Determine over/under valuation:

  The required return is greater than the expected return, so the security is overvalued. The amount = 23. 3% - 22. 2% = 1.1%.

• Question 2067:

  Which of the following is/are true about potentially dilutive securities?

  I. Options and warrants are assumed to be exercised at the beginning of the period or at the time of issuance, whichever is later.

  II. Warrants enter into the Diluted EPS calculations only if the maximum stock price during the period exceeds the exercise price.

  III.

  In Diluted EPS calculations, convertible bonds considered potentially dilutive only if their yield is less than two-thirds the average yield on Aa bonds.

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

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  Explanation

  In Diluted EPS, all potentially dilutive securities are assumed converted to common stock and appropriate adjustments made to the income number. If this process serves to increase Diluted EPS, then the anti-dilutive security is left out of the calculations.

  The conversion assumptions for options and warrants are as follows:

  1. They are assumed to be exercised at the beginning of the period or at the time of issuance, whichever is later.

  2. They enter into the Diluted EPS calculations only if the average stock price during the period exceeds the exercise price. Convertible bonds, regardless of their historical or current yield, are included in Diluted EPS calculations unless they are anti-dilutive.

• Question 2068:

  Warranty liabilities:

  A. result when a company sells a product
  B. must also result in an expense during the same period as the revenue from the sale of the product
  C. all of these answers are correct
  D. are estimated liabilities
  C. all of these answers are correct

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  Explanation

  All responses meet the definition of a warranty liability.

• Question 2069:

  According to the AIMR-PPS, total firm assets are defined to include

  A. all discretionary and nondiscretionary assets, as well as assets underlying overlay investment strategies.
  B. all discretionary and nondiscretionary assets.
  C. any asset deemed eligible by the firm.
  D. only assets underlying overlay investments strategies.
  B. all discretionary and nondiscretionary assets.

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  Explanation

  Total firm assets are defined to include all discretionary and nondiscretionary assets. Total firm assets do not refer to assets underlying overlay investment strategies, such as currency overlay, options and futures overlays, securities lending programs and asset allocation overlay strategies, unless the firm actually manages the underlying assets.

• Question 2070:

  The primary use of venture capital is

  A. to restructure a private firm's balance sheet debt.
  B. to help private firms out of possible bankruptcy proceedings.
  C. to finance production expansion.
  D. all of these answers are correct.
  E. for emerging growth business.
  E. for emerging growth business.

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  Explanation

  Venture capital is financing for privately held companies, typically in the form of equity and/or longterm debt. Venture capital becomes available when financing from banks and public debt or equity markets is either unavailable or

  inappropriate.

  Much like mutual fund managers, venture capitalists raise capital from investors in order to manage a portfolio of privately held investments.

  The primary use of venture capital is for emerging growth business.