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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 3061:

  Firms in which of the following industries would likely have the highest earnings retention rates? Further, would firms within this industry likely be financed primarily through debt or equity?

  A. Automobile manufacturing; debt
  B. Retail banking; equity
  C. Pharmaceuticals; debt
  D. Pharmaceuticals; equity
  E. Retail banking; debt
  F. Automobile manufacturing; equity
  D. Pharmaceuticals; equity

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  Explanation

  Firms in the pharmaceutical industry would likely retain a higher proportion of their earnings than automobile manufacturers or retail banks. This is reasoned primarily by two factors. First, pharmaceutical companies have high research and development costs, and their success depends largely on the discovery of promising drugs. This requires that adequate funds be held within the firm. Secondly, growth opportunities in the pharmaceuticals industry are much more abundant than in either the automobile manufacturing or retail banking, and this is largely due to the maturity of the industry as a whole. Pharmaceutical companies typically have numerous positive NPV investment opportunities. In terms of financing, pharmaceutical firms would be expected to have a capital structure weighted more heavily toward equity than debt. As the cash flows of an industry become more certain and stable, the level of debt financing should be expected to increase. Automobile manufacturers and retail banks have very predictable cash flows, along with high degrees of leverage. Certainty of revenues and earnings is a very important consideration in the financing decision, and firms whose cash flows are both stable and easily forecasted will likely prefer a high degree of debt versus equity financing. Another important note to consider is the fact that the balance sheet of a pharmaceutical firm is more heavily weighted toward intangible assets than is a retail bank or an automobile manufacturer. Intangible assets cannot easily be pledged as collateral for a loan, neither can intangible assets be liquidated with any degree of certainty. A high proportion of intangible assets within the asset structure of a firm is conducive to a low degree of debt financing.

• Question 3062:

  Ace Consulting, a multinational corporate finance consulting firm, is analyzing the profitability of a new line of superconductors designed by Clay Industries, a large industrial firm. In their analysis, Ace Consulting has developed a detailed statistical model that generates random values for key variables, and these random numbers are incorporated into the analysis. Using this proprietary statistical software, Ace Consulting is allowed to formulate a computer-based model of the superconductor's expected cash flows and NPV, given any randomly selected value for seven essential variables. Which of the following choices best describes this technique for measuring stand-alone risk?

  A. Relational computation analysis
  B. Monte Carlo simulation
  C. Sensitivity analysis
  D. Scenario analysis
  E. Regression analysis
  F. Marco Polo simulation
  B. Monte Carlo simulation

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  Explanation

  In this example, Ace Consulting has developed a statistical model which generates random values for seven key variables. Using this information, Ace can provide Clay Industries with an expected range of NPV and IRR for any assumed variable values. This process is referred to as Monte Carlo simulation, and is so named because the first Monte Carlo models were incorporated into the mathematical analysis of Casino gambling.

• Question 3063:

  Which of the following are challenges to technical analysis?

  I. Technical analysis involves a great deal of subjective judgement.

  II. Technical analysis is heavily reliant on financial statements.

  III.

  The majority of studies have supported the Weak Form Efficient Market Hypothesis. IV. The standard rules that signal investment decisions can change over time.

  V.

  The majority of studies have concluded that securities prices do not move in trends.

  VI.

  Technical analysis assumes that supply-demand fluctuations lead to changes in securities prices.

  A. I, III, IV, V, VI
  B. I, II, IV, V,
  C. I, III, IV, V
  D. I, III, IV
  E. I, II, III, IV, V, VI
  C. I, III, IV, V

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  Explanation

  Of the choices listed, only II and VI are not criticisms of technical analysis. While VI appears correct, it is not. In fact, both fundamental and technical analysis recognize the importance of supply and demand fluctuations. The difference is that technical analysis assumes that supply and demand are influenced by both rational and irrational factors, whereas the EMH assumes that investors are rational. Had choice VI been phrased as "technical analysis assumes that supply-demand fluctuations, which are caused in part by irrational forces, are the only determinants of shifts in securities prices," then it would be correct in this example.

• Question 3064:

  What is the Net Present Value of this series of annual cash flows at an interest rate of 12% per year: Year 0: <$14,000>, Year 1: $5,000, Year 2: $4,000, Year 3: $5,000, Year 4 are used to indicate a negative number).

  B. $114. 37
  D. $51.21
  E

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  Explanation

  On the BAII Plus, press CF 2nd CLRWork 14000 +/- ENTER DownArrow 5000 ENTER DownArrow DownArrow 4000 ENTER DownArrow DownArrow 5000 ENTER DownArrow DownArrow 4000 ENTER DownArrow DownArrow 2nd Quit. Then press NPV 12 ENTER DownArrow CPT. On the HP12C, press these keys: 14000 CHS BlueShift CFo 5000 BlueShift CFj 4000 BlueShift CFj 5000 BlueShift CFj 4000 BlueShift CFj. Then press 12 i, YellowShift NPV. The "DownArrow" represents the downward-pointing arrow on the top row of the BAII Plus keyboard. Make sure the BAII Plus has the value of P/Y set to 1.

• Question 3065:

  A telecommunications analyst is attempting to value shares of Ludicrous Telecom, a multinational fiberoptics and networking company. Assume the following information for Ludicrous shares:

  Required rate of return: 14. 50% per year Free cash flow to equity multiple at t4: 30 1,000,000 shares outstanding

  Additionally, the analyst has obtained the following estimates of free cash flow to equity for Ludicros Telecom over the next four years:

  Year 1: $4,000,000 Year 2: $4,500,000 Year 3: $3,500,000 Year 4: $4,800,000

  Using this information, what is the value per share of Ludicrous Telecom according to the free cash flow to equity model?

  A. $24. 64
  B. $83. 44
  C. None of these answers is correct.
  D. $54. 60
  E. The answer cannot be calculated from the information provided.
  F. $99.34
  C. None of these answers is correct.

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  Explanation

  When determining the value of a common stock using the free cash flow to equity model, it is necessary to determine three things:

  1. The required rate of return on equity investments.

  2. The estimated free cash flow to equity multiple at time "k."

  3. The estimated free cash flows figures for the time periods leading up to "k."

  In this example, the calculation must begin with the discounting the free cash flow to equity figures for each of the four years provided. These figures are discounted each period by the required return on equity investments, and the final answer is converted to a per-share basis. This process is illustrated below:

  Year 1: ($4,000,000 / 1.145) / 1,000,000 shares outstanding = $3. 49 Year 2: [$4,500,000 / (1.145)(1.145)] / 1,000,000 shares outstanding = $3. 43 Year 3: [$3,500,000 / (1.145)(1.145)(1.145)] / 1,000,000 shares outstanding = $2. 33 Year 4: [$4,800,000 / (1.145)(1.145)(1.145)(1.145)] / 1,000,000 shares outstanding = $2. 79

  Now that the free cash-flow-to-equity figures have been discounted and converted to a per-share basis, the next step in the valuation process is to determine the value of the final cash flow, which is defined as:

  [(Free cash flow to equity multiple * Final free cash flow) / (1 + r)(1+r)...(1 + k)]

  In the body of this question, we were given the anticipated multiple of free cash to equity that shares of Intelligent Semiconductor will sell for at time period: specifically, 30 times. Imputing this information into the terminal cash flow equation will yield the following: {[30 * ($4,800,000 / 1,000,000 shares outstanding)] / [(1.145) (1.145)(1.145)(1.145)]} = $83. 78. Adding the answers from step 1 to the final year cash flow will yield the following:

  Value of Intelligent Semiconductor = [$3. 49 + $3. 43 + $2. 33 + $2. 79 + $83. 78] = $95. 82 per share. This is illustrated by none of the answers provided.

• Question 3066:

  Technical analysts would consider the fact that 90% of stocks are trading above their 200-day moving average as

  A. a sign of a market trough.
  B. a sign that the market is overbought.
  C. a bullish indicator.
  D. a sign that the market is oversold.
  B. a sign that the market is overbought.

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  Explanation

  Technical analysts may compute the moving average of a stock market series in order to determine its general trend. The 200-day moving average has been popular. When over 80% of stocks are trading above their 200-day moving average, the market is considered overbought. When less than 20% of stocks are trading above their 200-day moving average, the market is considered oversold.

• Question 3067:

  Roland Cad owns a portfolio of large capitalization stocks. He has a positive long term outlook for the stock market, but Carl is worried about the possible effects of recent changes in monetary policy. Carl would like to protect his portfolio from any sudden declines in the stock market, without selling his holdings. The most likely way for Carl to achieve his objective of limiting the downside risk of his portfolio is to:

  A. sell put options on the SandP 500.
  B. sell an SandP 500 futures contract.
  C. buy an SandP 500 forward contract.
  B. sell an SandP 500 futures contract.

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  Explanation

• Question 3068:

  A bank savings account offers a savings rate of 3. 5% per year, compounded annually. How long would it take for an investment of $710 to grow to $1,000?

  A. 9 years
  B. 8 years
  C. 11 years
  D. 10 years
  D. 10 years

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  Explanation

  If it takes n years for the growth, then 1000 = 710*(1+3. 5%)^n. Solving for n gives 9.96 years.

• Question 3069:

  A stock that you are considering for purchase has the following characteristics:

  Current dividend $2. 00

  Expected dividend in 1 year $2. 20

  Long term growth rate of dividends 10%

  Required rate of return 14%

  Using the infinite period Dividend Discount Model, what is the maximum price that you would pay for this stock?

  A. $10.00
  B. $12. 00
  C. $120.00
  D. $15. 00
  E. $55. 00
  F. $150.00
  E. $55. 00

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  Explanation

  The infinite period Dividend Discount Model indicates that:

  Value = (Dividend for period 1)/(k-g) where k is the required rate of return and g is the growth rate. In this case Value = ($2. 20)/(.16-.10) = $2. 20/.04 = $55.

• Question 3070:

  Tran Holten, a quantitative analyst with Smith, Kleen and Beetchnutty Brokerage, has just been informed of an important error in one of his recent statistical endeavors. Specifically, in one hypothesis test, Mr. Holten rejected a null hypothesis that later was proven to be true. Which of the following best describes this type of error in hypothesis testing? Further, if the confidence level of the test were increased, would the probability of this error increase, decrease, or remain unchanged?

  A. Type I error; decrease
  B. Type I error; increase
  C. Type II error; decrease
  D. Type I error; remain unchanged
  E. Type II error; remain unchanged
  F. Type II error; increase
  A. Type I error; decrease

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  Explanation

  In this example, Tran Holten has incorrectly rejected a null hypothesis. This type of error in hypothesis testing is called a Type I error. In hypothesis testing, the Type I error is given much more attention than the Type II error. In most

  hypothesis tests, the probability of a null hypothesis is equal to the significance level of the test. A significance level of 0.01, for example, indicates that a 1% chance exists that the null hypothesis will be rejected when it is indeed true. Another

  way to think of the probability of a Type I error is to observe the following relationship:

  {Probability of a Type I error = (1 - confidence level)}.

  For example, a confidence level of 95% leaves a 5% probability of a Type I error occurring. If this confidence level were to increase to say, 98%, then the probability of a Type I error would reduce to 2%. As you can see, there is a relationship

  between the confidence level of a test and the probability of a Type I error. If the confidence level of the test in this example were to increase, then the probability of a Type I error would decrease.