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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 2511:

  An economic researcher publishes evidence that the consensus inflation estimation for the following year has no correlation with the actual inflation level the year before. The estimation error is often very large, but does not display a pattern. Which of the following theories would this evidence support?

  A. rational ignorance
  B. mean reversion
  C. heteroskedasticity
  D. monetarist theory
  E. rational expectations hypothesis
  F. adaptive expectations hypothesis
  E. rational expectations hypothesis

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  Explanation

  Under the rational expectations hypothesis, individuals will form inflation expectations based on all relevant information available. Therefore a comparison of expected and realized inflation would show a random estimation error and no correlation with past estimates. The adaptive expectations hypothesis suggests that individuals will base their views of the future on their recent experience. Under this theory, estimations would show a pattern in the error. Expected inflation would tend to be too high following a period of high inflation, and then too low follow a period of limited inflation.

• Question 2512:

  The ERISA fiduciary needs to be as prudent as

  A. the average investment advisor.
  B. the average person.
  C. the average expert.
  D. none of these answers.
  C. the average expert.

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  Explanation

  Under ERISA, the fiduciary is held to a higher standard than the Prudent Man Rule. The ERISA fiduciary needs to be as prudent as the average expert, not simply as prudent as the average person. Like all fiduciaries, however, the ERISA fiduciary must act solely in the best interest of the plan participants and beneficiaries and use all available care, skill, prudence and diligence.

• Question 2513:

  In the absence of bankruptcy and agency costs and signaling actions, tax deductibility of interest payments implies that the optimal debt ratio should be:

  A. none of these answers
  B. 50%
  C. 100%
  D. zero
  C. 100%

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  Explanation

  If there are no costs to increased debt, such as bankruptcy costs, and no signaling effects in a firm's decisions about the capital structure, then a firm would try to maximize the benefits of the debt shield i.e. the deductibility of interest payments. This implies a debt ratio of 100%.

• Question 2514:

  Which of the following statements about asset valuation is FALSE?

  A. The price to book value ratio can be used to value firms with negative cash flows.
  B. Economic value added (EVA? measures the economic profit generated per dollar of invested capital.
  C. When estimating the profit margin of a company, the higher the export/import level, the higher the competition.
  D. The purpose of top-down stock analysis is to determine the best company within the best performing industry.
  B. Economic value added (EVA? measures the economic profit generated per dollar of invested capital.

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  Explanation

  EVA measures management's ability to add value to the firm. One of the problems with the EVA calculation is that it is not measured relative to the capital invested in the firm. As a workaround, the ratio of EVA to capital is used, and it is this

  ratio that measures the economic profit generated per dollar of invested capital.

  The other statements are true. Use Porter's five forces to determine the level of competition within an industry and to determine the company's strategy for dealing with that competition. Do not forget about the impact of foreign competitors!

• Question 2515:

  A stock has the following returns over 4 years: +5%, -6%, +8%, +3%. The annual arithmetic and geometric rates of return over the 4 years are:

  A. 5%; 5. 57%
  B. 2. 5%; 9.79%
  C. 10%; 9.79%
  D. 2. 5%; 2. 36%
  D. 2. 5%; 2. 36%

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  Explanation

  The mean equals (5% + (-6%) + 8% + 3%)/4 = 2. 5%

  The geometric mean equals (1.05 * 0.94 * 1.08 * 1.03)^(1/4) = 2. 36%

  Note that the geometric mean is less than the mean.

• Question 2516:

  Analytics Software Incorporated currently pays 20% of its earnings in dividends and the Company has a steady growth rate of 25% per year. Assuming a 27. 5% per year required rate of return, what is the appropriate earnings multiplier for Analytics Software?

  A. The answer cannot be determined from the information provided.
  B. 16
  C. 18
  D. 22
  E. 8
  F. 9
  E. 8

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  Explanation

  To determine the earnings multiplier (i.e. the price-to-earnings ratio) for an individual company, use the following formula:

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

  Where: P/E = the earnings multiplier, d1 / e1 = the dividend payout ratio at t1, k = the required rate of return, and g = the anticipated future growth rate.

  In this example, all of the necessary information has been provided, and the calculation of the earnings multiplier is as follows:

  P/E = [0.20 / (0.275 - 0.25)] = 8

  This multiplier is likely low for a software firm growing at 25% annually. An analyst examining shares of Analytics Software would likely take this disparity into account in his or her analysis. Perhaps the use of the Infinite Period DDM to

  determine an earnings multiplier for this company is unrealistic. Perhaps valuing this company in accordance to anticipated free cash flows would provide a more realistic measure of value.

• Question 2517:

  According to the AIMR-PPS, ________ are defined to include all discretionary and nondiscretionary assets.

  A. individually managed assets
  B. individual investor's assets
  C. total firm assets
  D. global assets
  C. total firm assets

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  Explanation

  Total firm assets are defined to include all discretionary and nondiscretionary assets. Total firm assets don't 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 2518:

  An economy which is experiencing substantial inflation and slow economic growth is said to be in:

  A. a contraction.
  B. a stagflation.
  C. a hyperinflation.
  D. a recession.
  B. a stagflation.

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  Explanation

  High and variable inflation rates have severe negative impact on an economy. At times, the economy spirals into a cycle of extremely slow growth and very high inflation. This stagnant state battered by rising prices is called "stagflation."

• Question 2519:

  What annual interest rate, compounded annually, is equivalent to 9% per year, compounded quarterly?

  A. 9%
  B. 9.25%
  C. 9.01%
  D. 9.30%
  E. 8.95%
  D. 9.30%

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  Explanation

  Questions of this type are illustrating the concept of an Effective Interest Rate, which is a rate compounded annually that has the same effect as a rate compounded more often than one time a year. As such, a depositor or a creditor is indifferent between them, since they have the same effect. To solve this question, make any deposit and see how much is in the account after one year. The ratio of the ending FV to the beginning PV will indicate the annual rate earned. On the BAII Plus, press 4 N, 9 divide 4 = I/Y, 100 PV, 0 PMT, CPT FV. On the HP12C, press 4 n, 9 ENTER 4 divide i, 100 PV, 0 PMT, FV. The number displayed will be 109.30. In other words, after one year, $100 has become $109.30. An interest rate of 9.30%, compounded annually, would cause a $100 deposit to become $109.30 in one year. Choosing an initial deposit of $100 helps a great deal in these situations. Make sure the BAII Plus has the value of P/Y set to 1.

• Question 2520:

  The following data have been extracted from the financial statements of a firm for two years, 1993 and 1994:

  1993 1994 Assets 10,895 12,444 Sales 8,465 9,275 Inventory 3,126 3,549 COGS 7,120 7,387 The average inventory processing period for 1994 equals ________.

  A. 164. 9 days
  B. 223. 6 days
  C. 114. 7 days
  D. 198.2 days
  A. 164. 9 days

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  Explanation

  This can be estimated using either net sales (as is the case with receivables) or the cost-of-goods- sold. COGS is preferable since it does not include the profit margins involved in net sales.

  Therefore, two relevant ratios are:

  a.

  Inventory turnover ratio = COGS/average inventory.

  b.

  Average inventory processing period = 365/inventory turnover.

  Typically, average inventory for a given year is taken to be the average of the ending values of the inventory for this year and the last year. For 1994, the average inventory equals (3549+3126)/2 = 3,338. Inventory turnover ratio = 7,387/3,338 = 2. 21. Average inventory processing period = 365/2. 21 = 164. 9 days.