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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 2491:

  The probability that GNP will expand in the next 12 months is called:

  A. an unconditional probability.
  B. a conditional probability.
  C. a joint probability.
  D. a guess.
  A. an unconditional probability.

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  Explanation

  An unconditional probability takes the form of P(A), the probability that an event (A) will happen. It is unconditional because it is not conditioned on any other event.

• Question 2492:

  Which of the following relationships is/are correct:

  I. change in assets + change in liabilities = change in equity.

  II. change in retained earnings = net income + dividends paid.

  III. assets - liabilities = retained earnings + contributed capital.

  IV.

  assets = liabilities + revenues - expenses.

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

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  Explanation

  The basic accounting equation is Total assets = Total liabilities + Total Equity. In I and II, the "plus" should be "minus."

• Question 2493:

  A market strategist with Churn Brothers Brokerage is trying to determine the earnings multiplier of an equity index comprised of grocery stores, and has gathered the following information:

  g: 6. 00% per year

  k: 8.50% per year EPS: $3. 35 D0: $1.20

  Using this information, what is earnings multiplier for this equity index? Further, assuming that the grocery business is a mature industry, and that the economy is experiencing stable growth, is this earnings multiple realistic?

  A. None of these answers is correct.
  B. 4. 21, this multiple is too low
  C. 5. 97, this multiple is too low
  D. 130, this multiple is much too high
  E. 15. 67, this multiple is likely realistic
  F. 14. 33, this multiple is likely realistic
  F. 14. 33, this multiple is likely realistic

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  Explanation

  To determine the earnings multiplier, or "P/E ratio," of a stock market series, use the following equation: P/E = [(D1 / E1) / (k-g)

  Where: D1 = the annual per-share dividend at t1, E1 = the EPS figure at t1, k = the required rate of return on common stock, and g = the expected growth rate of dividends.

  In this example, all of the necessary information has been provided, and putting it into the equation above will yield the following:

  P/E of a stock market series = [($1.20*1.06 / ($3. 35*1.06)) / (0.085 - 0.06)] = 14. 33

  This earnings multiple is appropriate for lower growth industries, such as the grocery business, which has historically grown in the mid-to-high single digits for much of the last decade. Consider the fact that the P/E ratio is a proxy for future

  growth. Firms in the automobile, basic materials, or other mature industries, which are expected to grow slowly, are characterized by lower earnings multiples and higher dividend payout ratios. Firms in the software, networking, biotechnology, and other high-growth industries, are typically characterized by high earnings multiples and low dividend payout ratios. What is happening here is that investors are giving up current income (i.e. dividends) in the hopes of rapid earnings growth (i.e. greatly increased EPS in the future).

  A complete understanding of this relationship is absolutely crucial, and as a Level 1 candidate, I encourage you to examine this relationship further if you are not completely comfortable with the P/E ratio, its components and the relationships between them, and the implications of the earnings multiplier across different industries. Indeed, the P/E ratio is a valuable tool, one which can provide significant information about the growth prospects priced into a common stock.

• Question 2494:

  The following is true about the price earnings ratio

  A. it is the ratio between the company's current market value and its earnings per share
  B. none of these answers
  C. the ratio is calculated based on the earnings per share from the past year
  D. stocks with price earnings ratios of 25 or less are considered to be underpriced
  A. it is the ratio between the company's current market value and its earnings per share

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  Explanation

  PE ratio is calculated based on expected earnings per share and a ratio of less than 5 to 8 makes a stock appear underpriced.

• Question 2495:

  Investment companies tend to be

  A. corporations that are managed by separate investment management companies. About 20% of funds, however, are managed by the internal management, rather than by outside companies.
  B. corporations that are self-managed. About 30% of funds, however, are managed by separate investment management companies that are chosen by their board of directors based on previous management experience.
  C. corporations that are managed by separate investment management companies. The board of directors of an investment company typically choose an investment management company to manage the fund. That company is very often the owner of the investment company.
  D. corporations that are managed by separate investment management companies. The board of directors of an investment company typically choose an independent investment management company to manage the fund.
  C. corporations that are managed by separate investment management companies. The board of directors of an investment company typically choose an investment management company to manage the fund. That company is very often the owner of the investment company.

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  Explanation

  Investment management companies are corporations that are managed by investment management companies that tend to be their owners. A typical scenario would involve an investment management company forming an investment company, and the board of directors of that investment company proceeding to hire the parent investment management company to manage the new firm.

• Question 2496:

  What is the present value of $250 per year for 6 years, with the first cash flow occurring today, rather than 1 year from now? Assume interest is 7% per year, compounded annually.

  A. $1,209.48
  B. $1,500.00
  C. $1,191.63
  D. $1,275. 05
  E. $1,293. 55
  D. $1,275. 05

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  Explanation

  Recognize that this question is an annuity due situation, since the first cash flow occurs immediately or at the beginning of each period. Annuities where the first payment occurs 1 period from today (or at the end of each period) are called "ordinary" annuities. This requires placing the calculator into "Begin" mode prior to solving the question. NOTE: Be sure to place the calculator OUT OF annuity due mode after this question before going on to subsequent questions, or you will get the wrong answers! On the BAII Plus, press 2nd BGN. If the display shows END, then press 2nd SET and then 2nd Quit. This will place the BAII Plus into annuity due mode (you can tell this because the BAII Plus will display BGN in small letters). Now press 6 N, 7 I/Y, 250 PMT, 0 FV, CPT PV. Place the calculator back into End mode (for ordinary annuities) by pressing 2nd BGN and then if the calculator is displaying BGN, press 2nd SET and 2nd Quit. The BGN letters should disappear from the display. On the HP12C, press BlueShift END, which is the blue function on the front of the 8 digit key. This places the HP12C into Begin mode (the HP12C shows the word BEGIN in the display when in this mode). Then press 6 n, 7 i, 250 PMT, 0 FV, PV. To place the HP12C back into ordinary annuity mode (or END mode), press BlueShift BEG (the blue function written on the front of the 7 digit key). Note that the answer is displayed as a negative number. Make sure the BAII Plus has the value of P/Y set to 1.

• Question 2497:

  A random variable, X, has a mean of 12 and a standard deviation of 14. If another variable, Y, is defined by Y = 2X - 3, the coefficient of variation of Y is ________.

  A. 0.75
  B. 1.33
  C. 1.19
  D. 1.17
  B. 1.33

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  Explanation

  You should remember two important points:

  1. Multiplying a random variable by a constant multiplies its mean and standard deviation by the same constant.

  2. Adding a constant to a random variable increases the mean by the same constant but leaves the standard deviation unchanged.

  Using these two rules, the mean of Y equals 2 * 12 - 3 = 21. The standard deviation of Y equals 2 * 14 = 28. The coefficient of variation equals the ratio of the standard deviation to the mean. Thus, the coefficient of variation of Y equals 28 / 21 = 1.33.

• Question 2498:

  A value investor is examining shares of Clay Industries common stock for possible investor. This investor has a history of investing in companies trading below their "intrinsic value" and believes that ClayIndustries represents such a situation. In her research, this value investor has gathered the following information about Clay Industries:

  Total assets: $150,000,000 Total liabilities: $119,000,000 Number of common shares outstanding: 1,000,000 Current stock price: $26. 43 per share Required return: 17% per year Expected growth rate: 14. 5% per year Next dividend: $1.05 per share Earnings per share: $2. 85

  Using this information, what is the price-to-book ratio for Clay Industries common stock? Further, are the beliefs of this value investor justified, assuming that the book value of Clay Industries accurately illustrates the liquidation value of the firm?

  A. 1.17, no
  B. 9.27, yes
  C. The answer cannot be calculated from the information provided.
  D. 0.85, no
  E. 9.27, no
  F. 0.85, yes
  F. 0.85, yes

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  Explanation

  The book value of a common stock is found by dividing the net worth of a company by the number of outstanding shares. While there exists several different methods for calculating net worth, the most simplistic involves subtracting total

  liabilities from total assets, giving us the shareholder's equity figure. Investment professionals often see the book value as a "floor" for common stock prices, and the price-to-book ratio is quite popular in the field of investment management.

  The calculation of the price-to-book ratio involves the following equation:

  Price-to-book ratio = {Market price of common stock at t0 / [(total assets - total liabilities) / # of common shares outstanding]}

  While the # of common shares outstanding has been provided, the shareholder's equity figure must be calculated manually. The calculation of the per share shareholders equity is illustrated as follows:

  Shareholders equity = [($150,000,000 - $119,000,000) / 1,000,000] = $31. Now that the shareholders equity has been calculated and transformed into a per-share figure, the priceto-book value can be calculated as follows:

  Price-to-book value = ($26. 43 / $31) = 0.8526.

  As you can see, the required rate of return, along with the expected growth rate, is not necessary in the calculation of the price-to-book ratio.

  Any time the price-to-book ratio is less than one, a stock is said to be "trading at a discount to book."

  Frequently, investment professionals will use the term "intrinsic value" when referring to the book value, and thus stocks trading below their book value are often referred to as being priced "below their intrinsic value." Stocks trading below

  book value are often sought after by value investors, who believe that these shares have been discounted below their real value.

  A figure of more than one for the price-to-book ratio is commonly referred to as "trading at a premium to book."

  While the price-to-book value is a useful tool in the stock selection process, it possesses some important flaws. One problem with the Price-To-Book Ratio is that one of the terms - Book Value - is so easily manipulated. Valuation of inventory

  and real estate are easily adjusted on the books. Stock buy-backs and write-offs of exceptional items also deflate Book Value, making high priced stocks seem overvalued.

• Question 2499:

  If you buy an item and pay for it with 48 monthly payments of $75, beginning next month, what was the cash price today, if interest accrues at 13% per year, compounded monthly?

  A. $575. 29
  B. $44. 71
  C. $2,795. 64
  D. $2,904. 12
  E. $2,598.42
  C. $2,795. 64

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  Explanation

  The cash price would be the present value of the payments made using the specified interest rate. On the BAII Plus, press 48 N, 13 divide 12 = I/Y, 75 PMT, 0 FV, CPT PV. On the HP12C, press 48 n, 13 ENTER 12 divide i, 75 PMT, 0 FV, PV. Note that the answer will be shown as a negative number. Make sure the BAII Plus has the P/Y value set to 1.

• Question 2500:

  Why should the analyst place special emphasis in their assessment of cash balances?

  A. Cash represents the point in a firm's operating cycle where management has maximum discretion with the deployment and use of its resources.
  B. Cash is a company's most liquid asset.
  C. All of these answers.
  D. Cash is typically the only asset that is available to meet a firm's financial obligations.
  E. None of these answers.
  C. All of these answers.

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  Explanation

  All of these answers are correct because any assessment of a firm's liquidity should be focused on a firm's ability to meet its near-term liabilities. While inventory may be sold, it is subject to shrinkage through loss of value, theft, etc. and while accounts receivable a current assets, not all firms collect the full balance of what they are owed, let alone collecting it when it is due. Cash is king in the world of finance because it is cash and cash alone that is used to meet financial commitments.