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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 2171:

  You believe the stock of Microsquish reflects a 90% chance of a dismissal of its contractual liability suit. If the suit is dismissed, you expect the stock of Microsquish and its partner, AWOL, to rise. If the suit is not dismissed, both will fall in price. However, you think that AWOL's stock only reflects a 60% chance of dismissal of this suit. What strategy would be optimal?

  A. Sell both short
  B. Buy Microsquish
  C. Sell AWOL
  D. Buy AWOL
  D. Buy AWOL

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  Explanation

  This is an example of the investment consequences of inconsistent probabilities. If the true probability of a lawsuit dismissal is only 60%, then AWOL's stock is fairly valued, and Microsquish is overvalued. If the true probability is 90%, then Microsquish is fairly valued, and AWOL is undervalued. Your can thus construct a profitable risk-free strategy. You should buy AWOL, because at worst, the stock will be fairly valued. At best, it is undervalued. You could also simultaneously short Microsquish, because at best, it is fairly valued; there is a chance that it is overvalued. Note that this example ignores all other factors other than the lawsuit.

• Question 2172:

  The following data are taken from the Ultimate Omega's financial statements ending Dec 31, 1985:

  Increase in inventories 220 Stock's repurchased 135 Provision for warranty expenses 15 Depreciation 90 Interest paid 35 Outstanding bonds retired 225 After-tax gain on bond retirement 25 Net Income 430 Tax rate 40%

  What was Ultimate Omega's operating cash flow in 1985?

  A. 240
  B. 225
  C. 305
  D. 290
  D. 290

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  Explanation

  In this case, OCF = 430 - 220 + 15 + 90 - 25 = 290. Note a few important things: Warranty provision is a non-cash expense and must be added back to net income. Gain on bond retirement is an extraordinary item and is part of financing cash flow. Hence, it must be subtracted from net income to obtain income from continuing operations. Stock repurchase and bond retirement are financing cash flows. Note that tax rate is not relevant in the indirect method since it has already been factored in the net income figure.

• Question 2173:

  When a composite of international portfolios is created, firms should separate portfolios that are allowed to use currency ________ from portfolios that may not use ________, unless the use of currency ________ is considered immaterial. (Same answer for all three spaces)

  A. selection
  B. hedging
  C. exchanges
  D. swaps
  E. strategy
  B. hedging

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  Explanation

  If a firm makes significant use of currency hedging when allowed, it should separate portfolios that do not allow such hedging into a different composite and use a different benchmark for the highly hedged and unhedged composites. Similarly, portfolios with materially different risk exposures do not belong in the same composite.

• Question 2174:

  Information is ________ if its disclosure would be likely to have an impact on the price of a security or if reasonable investors would want to know the information before making an investment decision.

  A. inside information
  B. none of these answers
  C. breached
  D. secured
  E. material
  F. tipable
  E. material

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  Explanation

  According to Standard V (A), information is "material" if it would significantly alter the total mix of information currently available regarding a security.

• Question 2175:

  While calculating the weights of various components of the capital structure, one must use:

  A. minimum of book or market values.
  B. book values.
  C. liquidation values.
  D. market values.
  D. market values.

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  Explanation

  WACC calculations are based on current market values, not historical cost.

• Question 2176:

  When using transactional analysis, the following changes in the balance sheet account and the corresponding cash flow description would be correct except, A. long-term debt; increase or decrease in debt

  B. rent payable; cash paid for inputs

  C. accounts payable; cash paid for inputs

  D. short-term debt; increase or decrease in debt

  E. retained earnings; dividends paid

  Correct Answer. B
  B

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  Explanation

  The cash flow of rent payable would be cash expenses.

• Question 2177:

  A firm's financial statements reveal the following data: interest coverage ratio 3. 6X interest expense rate 7. 2% depreciation 678 total assets 10,946 total asset turnover 1.46

  The firm's operating margin equals ________.

  A. 13. 84%
  B. 23. 18%
  C. 21.99%
  D. 25. 93%
  C. 21.99%

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  Explanation

  Interest Coverage = EBIT/interest expense Operating Profit Margin = EBDIT/Net sales Interest expense rate = interest expense/total assets Total Asset turnover = sales/total assets Therefore, interest expense = 7. 2%*10,946 = 788 and EBIT = 3. 6*788 = 2,837. So EBDIT = EBIT + depreciation = 2,837 + 678 = 3,515. Also, net sales = 1.46*10,946 = 15,981. This gives Operating Profit Margin = 3,515/15,981 = 21.99%.

• Question 2178:

  Economic Value Added (EVA) equals

  A. Operating profits after adjusted taxes less the cost of total capital.
  B. Operating profits minus the cost of borrowed capital.
  C. Net income minus the cost of equity capital.
  D. Gross profits minus the cost of capital, including equity capital.
  A. Operating profits after adjusted taxes less the cost of total capital.

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  Explanation

  The EVA measures the net value added by the firm's operations to the firm once operating costs are taken into account. It should be remembered that the EVA is designed to evaluate the value added by the operating activities over and above that required by the equity holders.

• Question 2179:

  Given the following points: (-2, 0), (-1,0), (1, 1) and (2, 3)

  If the regression equation is Y' = 2 - .4X, what is the value of Y when X = -3?

  A. None of these answers
  B. 3. 2
  C. -10.0
  D. 0.8
  E. 14. 0
  B. 3. 2

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  Explanation

  Y' = 2 - 0.4*(-3) = 2 + 1.2 = 3. 2

• Question 2180:

  Suppose capital gains are taxed at 28% and realized income is taxed at 40%. The tax preference theory implies that as the dividend pay-out ratio is increased, the stock price:

  A. increases or decreases.
  B. decreases.
  C. increases.
  D. remains unaffected.
  B. decreases.

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  Explanation

  Since the capital gains tax rate is lower than the realized income tax rate, investors would prefer to defer the realization of this income through the capital gains component. Hence, increasing the payout ratio will make the stock less attractive and depress the price.