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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 3671:

  Which of the following statements about portfolio theory is TRUE?

  A. According to Markowitz, the appropriate measures of risk include variance, semivariance, and covariance.
  B. There are no perfectly positively or perfectly negatively correlated stocks.
  C. A correlation coefficient of zero means that combining the securities eliminates risk.
  D. Risk decreases as the correlation coefficient goes from -1 to +1.
  B. There are no perfectly positively or perfectly negatively correlated stocks.

  ---

  Explanation

  Markowitz was the first to identify this. The lack of perfect positive or negative correlation gives rise to the efficient frontier shape. Covariance is a measure of movement, not of risk. A correlation coefficient of zero means that the returns are uncorrelated. A correlation coefficient of negative one means that risk can go to zero. Adding a security with a correlation coefficient of zero may reduce risk, but risk will not be eliminated. Risk increases as the correlation coefficient goes from ? to +1. Risk decreases as the correlation coefficient goes from +1 to -1.

• Question 3672:

  ________ and other hybrid securities must be treated consistently across and within composites.

  A. Portfolios
  B. Convertibles
  C. Assets
  D. Bonds
  B. Convertibles

  ---

  Explanation

  This is one of the requirements which is mandatory in order to be in compliance with the PPS.

• Question 3673:

  While studying for the Level 1 CFA examination, Leonard Hart draws the following graph of a firm's capital structure. Using his graph and the assumptions below, determine which of the following statements A through D below is FALSE.

  

  A. The value for X is $90 million.
  B. The weighted average cost of capital (WACC) of 10.00% uses retained earnings, the WACC of 12. 25% uses common stock.
  C. The firm should use this graph to adjust projects for risk.
  D. As the firm needs to raise more and more capital, the weighted average cost of capital (WACC) will remain lower than the marginal cost of capital.
  A. The value for X is $90 million.

  ---

  Explanation

  This graph represents the marginal cost of capital (MCC). BPRE= (Retained Earnings) / (Equity Fraction, we)

  Here, RE = earnings * (1 ?Payout) = $100 million (1 ?0.45) = $ 55. 0 million,

  And BPRE= $55. 0 million / 0.50 = $110 million.

  The other statements are true.

  WACC using internal equity (retained earnings):

  WACC = (wd)(kd) + (ws)(ks), where wd, wsare the weights used for debt and retained earnings.

  WACC = (0.50 * 7. 0%) + (0.50 * 13. 0%) =10.00%.

  WACC using external equity (common stock):

  WACC = (wd)(kd) + (we)(ke), where wd, weare the weights used for debt and common equity.

  WACC = (0.50 * 7. 0%) + (0.50 * 17. 5%) =12. 25%.

  Note:To save time on the exam, remember that internal equity cost is less than external equity cost (or ks< ke) due to floatation costs.

• Question 3674:

  Suppose capital gains are taxed at 32% and realized income is taxed at 38%. The tax preference theory implies that as the dividend pay-out ratio is increased, the cost of equity:

  A. increases or decreases.
  B. increases.
  C. remains unaffected.
  D. decreases.
  B. increases.

  ---

  Explanation

  Since the capital gains tax rate is lower than the realized income tax rate, investors would prefer to defer the realization of this income through the capital gains component. Hence, increasing the payout ratio will make the stock less attractive and depress the price, raising the cost of equity.

• Question 3675:

  A technical analyst with Churn Brothers brokerage is examining shares of Allcycles.com, believing that the shares are overvalued. In his analysis, this technical analyst has gathered the following information about Allcycles' common stock.

  Net worth: $15,381,000 Number of common shares outstanding: 1,200,000 Current stock price: $20.30 per share Required return: 15. 35% per year Expected growth rate: 12. 80% per year Next dividend: $0.15 per share Earnings per share: $1.65

  Using this information, what is the price-to-book ratio for Allcycles.com?

  A. The answer cannot be calculated from the information provided.
  B. 3. 57
  C. None of these answers is correct.
  D. 15. 81
  E. 12. 30
  F. 1.584
  F. 1.584

  ---

  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 exist 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 = {P0 / (Net worth / # of common shares outstanding)}

  In this example, all of the necessary information has been provided. Imputing these figures into the priceto-book value equation will yield the following:

  Price-to-book value = {$20.30 / ($15,381,000 / 1,200,000)} = 1.584.

  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 greater than one, a stock is said to be "trading at a premium to book." Frequently, investment professionals will use the term "intrinsic value" when referring to the book value. A figure of less than one for the price-to-book ratio is commonly referred to as "trading at a discount to book." Stocks trading below book value are often sought after by value investors, who believe these shares have been discounted below their liquidation value.

  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 3676:

  Suppose you are modeling GNP, and you believe that the probability that GNP will expand if interest rates fall is 70%; if interest rates stay constant, you believe that there is a 29% chance of expanding GNP; if interest rates increase, you believe that there is a 1% chance of GNP expanding. You think that the likelihood of interest rates falling is 60%; of staying the same is 30%; of increasing is 10%. What is the unconditional probability of GNP expanding?

  A. 49.8%.
  B. 50.0%.
  C. 50.8%.
  D. 50.9%.
  C. 50.8%.

  ---

  Explanation

  We use the total probability rule: P(A), the unconditional probability, = P(A|S_1)*P(S_1) + P(A|S_2) *P(S_3) + P(A|S_3) *P(S_3), where the S_i represent mutually exclusive and exhaustive events. So the likelihood of interest rates increasing is 0.70 * 0.60 + 0.29 * 0.30 + 0.01 * 0.10 = 0.42 + 0.087 + 0.001 = 0.508.

• Question 3677:

  By what factor will earnings per share will have to change for a 5% change in earnings multiplier to induce a change of 9% in the price of the stock?

  A. -12. 62%
  B. +14. 45%
  C. -3. 67%
  D. +3. 81%
  D. +3. 81%

  ---

  Explanation

  Stock price = earnings multiplier * earnings per share. Therefore, the earnings multiplier will have to increase by 1.09/1.05 - 1 = 3. 81%.

• Question 3678:

  Financial accounting data has some inherent limitations. Which of the following are limitations?

  I. not all economic events are easily quantifiable

  II. many accounting entries rely heavily on estimates

  III. historical cost can distort statements

  IV.

  inflation can distort accounting data

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

  ---

  Explanation

  All of the responses can be considered limitations of financial accounting data.

• Question 3679:

  An investor faces the following investment scenarios:

  Scenario Probability Return Bull market 60% 30% Neutral market 30% 7% Market crash 10% -25%

  The investor's expected rate of return is ________.

  A. 12. 45%
  B. 17. 6%
  C. 16. 2%
  D. 19.3%
  B. 17. 6%

  ---

  Explanation

  The expected return equals 0.6 * 30% + 0.3 * 7% + 0.1 * (-25%) = 17. 6%.

• Question 3680:

  The probability that SUV sales will decline by over 10% by June 1 if gasoline prices increase by 50% by May 1, is called:

  A. a lagged likelihood.
  B. an unconditional probability.
  C. a joint probability.
  D. a conditional probability.
  D. a conditional probability.

  ---

  Explanation

  A conditional probability takes the form of P(A|B), the probability that a an event (A) will happen, given the occurrence of another event, B. It is conditional because it is conditioned on another event, B.