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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 2281:

  Which of the following describes an investment company?

  A. provides complete investment advice to clients for a fee
  B. tracks the market price performance of a sample of U.S. mutual funds
  C. invests in a pool of funds belonging to many individuals in a portfolio of investments
  D. all of these answers are correct
  E. market value of all its assets divided by shares outstanding
  C. invests in a pool of funds belonging to many individuals in a portfolio of investments

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  Explanation

  For example, an investment company sells 20 million shares to individuals at $10 per share for a total of $200 million. The manager then invests this money in securities (according to fund objectives). Each investor owns a percentage of the investment company's total portfolio.

• Question 2282:

  A firm's capital structure consists of 25% debt with a pre-tax cost of 7% and an after-tax cost of 4. 9%. Common equity makes up 45% of the structure and the rest is made up of preferred equity. Thepreferred stock has a coupon of 8% and is currently trading at 84% of its par value. The required rate of return on the common stock is 16. 2%. The firm's WACC is ________.

  A. 11.5%
  B. 10.92%
  C. 11.37%
  D. 11.90%
  C. 11.37%

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  Explanation

  To get the WACC in this case, you need to have information on the cost of preferred stock. This is not necessarily equal to the coupon rate on the preferred equity. Rather, it is the discount rate, R, that equates the present value of the perpetual payments on the preferred equity to its current price. The price of a perpetuity that pays C per year, at a discount rate of R, equals C/R. In this problem, since the preferred stock is at 84% and pays 8% coupon, we have 84% = 8%/ R, giving R = 9.52%. Now, the interest payments on debt are tax-deductible but those on preferred equity are not. Hence, no tax adjustment is necessary for preferred stock but you must use after-tax cost of debt in WACC calculations. With this in mind, WACC = 0.25*4. 9% + 0.45*16. 2% + 0.3*9.52% = 11.37%.

• Question 2283:

  Uncertainty may cause banks to hold larger excess reserves. Other things constant, this will

  A. tend to reduce the money supply during a period of inflation and increase it during a recession.
  B. tend to reduce the money supply.
  C. tend to increase the money supply.
  D. have no effect on the money supply.
  B. tend to reduce the money supply.

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  Explanation

  The money supply is reduced when banks hold larger excess reserves through the work of the deposit expansion multiplier. Since banks extend fewer loans when they hold larger excess reserves, the money supply falls.

• Question 2284:

  Clay Industries, a large industrial firm, has just released a new process system allowing mining companies to automate much of their copper extraction procedures. While the sales of this process system are expected to be hugely successful, analysts predict that sales of Clay Industries existing products will decline as a result, as customers substitute the new process system for much of the Clay Industries' older drilling components and non-automated process systems. Which of the following terms most correctly describes the problem faced by Clay Industries?

  A. Externality problem
  B. Diminishing returns problem
  C. Cannibalization
  D. Opportunity cost problem
  E. Incremental sales deterioration
  C. Cannibalization

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  Explanation

  When a new product or service takes sales away from existing products or services, this is often referred to as cannibalization (or erosion). While firms naturally do not wish to cannibalize existing products, often if they do not, other firms will begin to erode their market share. The cannibalization problem is frequently considered in the analysis of new releases of products and services.

• Question 2285:

  When investors are pessimistic about the market, the confidence index should have

  A. a value over 100.
  B. a low value.
  C. a high value.
  D. a value over 85.
  B. a low value.

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  Explanation

  The confidence index measures the yield spread between high-grade bonds and a large cross section of bonds. Technical analysts believe that during periods of low confidence, investors are less willing to invest in lower-quality bonds, thereby pushing up their yields, and decreasing the confidence index. A low index value is thus viewed as a bearish sign.

• Question 2286:

  ________ measures, which relate to the total variability of actual returns (i.e. beta), indicate the risk of having returns different from that particular benchmark or index.

  A. Index
  B. Absolute
  C. Volatility
  D. Risk
  C. Volatility

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  Explanation

  It is very important not to confuse risk with volatility. The type of risk that volatility measures represent are only one of many risks.

• Question 2287:

  Jones Rutherford, a portfolio manager with Churn Brothers Brokerage, has been examining a stock market series and is trying to determine the anticipated rate of return for the series. In his analysis, Jones has amassed the following information:

  Anticipated ending value: 1475 Expected dividends during the period: $35 Observed beginning value: 1310 Required rate of return: 19%

  Using this information, what is the anticipated rate of return for this stock market series? (Assume a oneyear holding period).

  A. None of these answers is correct.
  B. 13. 56%
  C. 9.92%
  D. 8.81%
  E. 15. 27%
  E. 15. 27%

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  Explanation

  To calculate the expected rate of return for a stock market series, the following information must be known:

  The beginning value for the series, the anticipated ending value for the series, and the amount of any dividends and/or distributions during the period. Once this information has been determined, the expected return on a stock market index can be found by employing the following equation: {E(R) = [(EV - BV + Div) / BV]}. Where: E(R) = the expected return on the stock market series, EV = the anticipated ending value for the series, BV = the observed beginning value for the series, and Div = the amount of any dividends paid during the period. In this example, all of the necessary information has been provided and the calculation of the expected return on this stock market series is found as follows: {E(R) = [$1475 - $1310 + $35] / $1310} = 15. 27%. This is less than the required rate of return. Assuming that the figures for the ending value and the expected dividends are accurate, then investment in this stock market series is not likely warranted.

• Question 2288:

  The "family of funds" approach of investment companies ________.

  A. promotes flexibility for the investor
  B. improves the net risk-return exposure
  C. all of these answers
  D. discourages investors from switching from one fund to the other
  E. consistently outperforms the market
  A. promotes flexibility for the investor

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  Explanation

  The "family of funds" approach of investment companies promotes flexibility and increases the total capital managed by the investment firm. It allows investors to switch among funds as economic or personal conditions change.

• Question 2289:

  Which of the following equations correctly illustrates the calculation of the cost of perpetual preferred equity?

  A. None of these examples
  B. Net offering price/(required rate of return) + expected growth
  C. Offering price/(expected rate of return- required rate of return) + expected growth
  D. Annual dividend/(offering price + flotation costs)
  E. (Annual dividend/current preferred stock price) + expected growth rate
  F. Annual dividend/(offering price - flotation costs)
  F. Annual dividend/(offering price - flotation costs)

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  Explanation

  The cost of perpetual preferred equity can be found by dividing the annual dividend by the net offering price, or gross offering price less flotation costs. Of the six answers listed, only #2 represents a recognized financial equation; the rest are largely fictitious.

• Question 2290:

  Within the simple Keynesian model, when an economy operates below its long-run, full-employment output constraint, an increase in aggregate demand will lead to an increase in

  A. real income.
  B. unemployment.
  C. prices.
  D. employment, output and prices, but real income will remain constant.
  E. interest rates and money income, but employment and real income will remain constant.
  A. real income.

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  Explanation

  Keynes considered aggregate supply to be accommodative of aggregate demand. Thus, an increase in aggregate demand will stimulate aggregate output. The equivalence between output and income also suggests that real income will rise. Below the full employment capacity of the economy, increases in aggregate supply have little effect on the price level. This is the result of the Keynesian assumption that at less than full employment output levels, prices and wages are fixed since they are inflexible in a downward direction.