CFA CFA Certifications CFA-LEVEL-1 Questions & Answers

• Question 21:

  The price range at which a technician would expect a substantial increase in demand for a stock is

  A. the support level.

  B. the resistance level.

  C. the peak level.

  D. the demand level.

  Correct Answer: A

  Demand level is not a real term. Technicians believe that a support level on a stock will develop after it has experienced substantial price gains. They reason that at some price range (the support level), other investors who did not buy the stock the first time it went up will now buy it after a small price reversal.

• Question 22:

  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%

  Correct Answer: E

  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 23:

  A net decline on an advance-decline series for the NYSE, coupled with a rising SandP 500 would, according to technical analysts,

  A. signal a market trough.

  B. signal a market peak.

  C. be neither particularly bullish nor bearish.

  D. be a bullish sign.

  Correct Answer: B

  Technical analysts predict that when a market index is going up, but most stocks post price declines, the market is near its peak. Conversely, they predict that when a market index is going down, but most stocks post price increases, the market is near its trough.

• Question 24:

  A high ratio of specialists' short sales to total short sales would be viewed

  A. bearishly by technical analysts.

  B. as unimportant by technical analysts.

  C. bullishly by technical analysts.

  D. as a signal of an approaching trough by technical analysts.

  Correct Answer: A

  Technical analysts trying to follow the "smart money" sometimes use the proportion of specialists' short sales to total short sales as a market indicator. If the ratio is high, specialists are seen as trying to profit from upcoming market declines. If the ratio is low, specialists are seen as trying to minimize their participation in short sales in expectation of a rising market.

• Question 25:

  George Black, CFA, is examining the financial performance of Clay Industries, a large industrial firm, and has assimilated the following information from the most recent fiscal year: Adjusted operating profit before tax: $13,900,000 Cash operating taxes: $4,350,000 Cost of capital: 15.60% per year Total capital employed: $56,500,000

  Using this information, what is the Economic Value Added for Clay Industries? Further, should the management of Clay Industries be considered to have created economic value for shareholders?

  A. ($736,000); management has not created economic value

  B. $736,000; management has not created economic value

  C. None of these answers is correct.

  D. ($736,000); management has created economic value

  E. $736,000; management has created economic value

  F. $850,000; management has created economic value

  Correct Answer: E

  Economic Value Added, a value-based measure of economic profit, is a registered trademark of Stern,

  Stewart and Company. The equation used to calculate EVA is as follows:

  EVA = {Net Operating Profits Less Adjusted Taxes - [Total Capital Employed * (Cost of Capital)]}.

  In this case, the NOPLAT figure must be calculated manually by subtracting the Cash Operating Taxes

  from the Adjusted Operating Profit before Tax (AOPBT) figure. Doing so will produce an answer of

  $9,550,000 for the Net Operating Profit less Adjusted Taxes figure. Now that the necessary information

  has been determined, the calculation of EVA is as follows:

  EVA = {$9,550,000 - ($56,500,000 * 0.156)} = $736,000

  A positive EVA calculation indicates that management has provided economic profits to shareholders, as

  evidenced by the fact that the opportunity cost of capital employed is less than the NOPLAT figure. In this

  example, the management of Intelligent Semiconductor should be considered as having succeeded in

  providing shareholder value.

  The calculation of Adjusted Operating Profit Before Taxes (AOPBT), and Cash Operating Taxes are

  important. The calculation of AOPBT is as follows:

  Operating profit (after depreciation and amortization) + Implied interest on operating leases + any increase

  in the LIFO reserve + goodwill amortization = Adjusted Operating Profit Before Taxes.

  Cash Operating Taxes, another important component of EVA, is calculated as follows:

  Cash Operating Taxes = Income Tax Expense + tax benefit from interest expenses + tax benefit from

  interest on leases + taxes on non-operating income

  Adjusted Operating Profit Before Taxes minus Cash Operating Taxes = Net Operating Profit Less Adjusted

  Taxes (NOPLAT). Subtracting the dollar cost of capital from the NOPLAT figure will yield the EVA.

• Question 26:

  Consider the following preferred stock issued by Bluebook Pharmaceuticals:

  Price per share: $12.65 Annual dividend per share: $1.30 Required rate of return: 9% per year

  Is the preferred stock realistically overvalued, undervalued, or correctly valued? Further, should this preferred stock be valued as a perpetuity or a finite series of cash flows?

  A. Undervalued; perpetuity

  B. Undervalued; finite series of cash flows

  C. Correctly valued; finite series of cash flows

  D. Correctly valued; perpetuity

  E. Overvalued; finite series of cash flows

  F. Overvalued; perpetuity

  Correct Answer: A

  The preferred stock profiled in this example is trading above its theoretical value, which is found to be

  $14.44.

  To determine the value of a preferred stock, use the following equation: {P0 = [d1 / k]}

  Where:P0 = the price of the preferred stock at time 0, d1 = the annual dividend at t = 1, and k = the

  required rate of return.

  In this example, the dividend is provided as an annual figure, so all of the necessary information has been

  given. The calculation of the value of this preferred stock is as follows:

  {P0 = [$1.30 / 0.09] = $14.44

  Preferred stock is commonly valued as a perpetuity because there is no finite conclusion to the projected

  series of cash flows for a preferred stock. Unlike a bond, whose cash flows are characterized by a finite

  lifespan (i.e. the cash flows of a bond cease at maturity), the cash flows (dividends) produced by a

  preferred stock could theoretically last forever.

• Question 27:

  Which of the following is not involved in the estimation of the earnings per share (EPS) for a stock market series?

  A. Estimation of sales per share

  B. Estimation of next year's interest expense

  C. Estimation of next year's operating profit margin

  D. Estimation of next year's corporate tax rate

  E. All of these choices are involved in the estimation of EPS for a stock market series.

  F. Estimation of next year's depreciation per share

  Correct Answer: E

  All of the choices listed are used in the estimation of EPS for a stock market series. Further, the estimation of EPS for a stock market series involves these five processes exclusively.

• Question 28:

  Which of the following represents a "contrary opinion" technical indicator? Choose the best answer.

  A. The Confidence Index

  B. More than one of these answers is correct.

  C. T-Bill-Eurodollar yield spread

  D. The Diffusion Index

  E. Debit balances in brokerage accounts

  F. OTC versus NYSE volume

  Correct Answer: F

  Of all the choices listed, only "OTC versus NYSE volume" represents a contrarian technical indicator. While "debit balances in brokerage accounts (margin debt)" appears to be an appealing choice, this indicator is actually a measure of "smart money" because investors who leverage their portfolios through margin loans are viewed by technical analysts as being sophisticated.

  The measure of OTC to NYSE volume is used by contrarian technical analysts as a measure of speculation in the U.S. securities markets. A high degree of OTC volume is viewed as a bearish signal to contrarian technical analysts, who believe this is indicative of abounding speculation. Prior to the collapse of the NASDAQ in 2000, the OTC to NYSE volume experienced a marked spike, and many contrarian technical analysts were vocal in their opinion that the degree of speculation in the securities markets was rampant. While for years the explicit level of OTC to NYSE volume was used, recently it has been decided that the proper method is to examine trends in the OTC to NYSE volume, rather than static figures.

  The Confidence Index, a "smart money" technical indicator, is a measure of yield spreads between highgrade corporate bonds and the yields on average corporate bonds. The Diffusion Index measures the breadth of the market, and is found by taking the total volume of advancing shares plus one-half of the issues unchanged, divided by the total number of issues traded. The T-Bill-Eurodollar Yield Spread is another example of a "smart money" technical indicator.

• Question 29:

  Common stocks of good companies may not be good investments because:

  I. The stocks may be overpriced compared to other stocks with similar risks.

  II. Empirically, stocks which have performed well in the past tend to produce lower-than-expected returns in the future.

  III.

  Good companies frequently happen to be large stocks which are low risk and do not provide very high rates of return.

  A.

  IV only

  B.

  I and III

  C.

  III only

  D.

  I only

  E.

  I, II and III

  F.

  II only

  G.

  I and II

  Correct Answer: D

  Even if a company is good, the market could temporarily elevate the price above that consistent with its risk. In that case, the stock is overpriced and it may not make sense to buy it, though that decision still must be based on a portfolio diversification context.

• Question 30:

  When estimating an industry's risk premium, the following should be examined for the industry and compared to the aggregate market

  A. country risk

  B. business risk

  C. all of these are correct

  D. financial risk

  E. liquidity risk

  F. the industry required rate of return

  G. exchange rate risk

  Correct Answer: C

  Alternatively, you can estimate the risk premium based on the CAPM, which implies that the risk premium is a function of the systematic risk of the asset.