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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 481:

  Preferred stock is

  A. like a perpetuity. The holder of the stock receives a promise from the issuer to pay a stated dividend, usually each quarter, for an infinite period. Because of tax advantages, the yields on preferred stocks tend to be lower than those on bonds.
  B. like an annuity. The holder of the stock receives a promise from the issuer to pay a stated dividend, usually once a year, for a long but finite period of time (usually 100 years). Because the dividend payments on preferred stocks are not as certain as coupon payments on bonds, preferred stocks tend to have higher required rates of return than most bonds.
  C. like an annuity. The holder receives a promise from the issuer to pay a stated dividend, usually semiannually, for an infinite period of time. Because the dividend payments on preferred stocks are not as certain as coupon payments on bonds, preferred stocks tend to have higher required rates of return than most bonds.
  D. like a perpetuity. The holder of the stock receives a promise from the issuer to pay a stated dividend, usually semiannually, for a long but finite period of time (usually 100 years). Because of tax advantages, the yields on preferred stocks tend to be lower than those on bonds.
  A. like a perpetuity. The holder of the stock receives a promise from the issuer to pay a stated dividend, usually each quarter, for an infinite period. Because of tax advantages, the yields on preferred stocks tend to be lower than those on bonds.

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  Explanation

  Payments of dividends for preferred stocks are only made after the firm meets its bond interest payments. One would expect the required rates of return on preferred stocks to be higher than those onbonds for this reason, but because of tax advantages, the preferred stock yields are actually lower than those on even the highest-grade corporate bonds. 80% of intercompany preferred dividends are tax-exempt, thereby increasing demand for preferred stocks and decreasing yields.

• Question 482:

  Which of the following statements is most correct?

  A. None of these answers.
  B. All else equal, an increase in a company's stock price will increase the marginal cost of retained earnings.
  C. All of these answers.
  D. All else equal, an increase in a company's stock price will increase the marginal cost of issuing new common equity.
  E. If a company's tax rate increases, but the yield to maturity of its noncallable bonds remains the same, the company's marginal cost of debt capital will fall.
  E. If a company's tax rate increases, but the yield to maturity of its noncallable bonds remains the same, the company's marginal cost of debt capital will fall.

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  Explanation

  The debt cost used to calculate a firm's WACC is k(d)(1 - T).

  If k(d) remains constant but T increases, then the term (1 - T) decreases and the value of the entire equation, k(d)(1 - T), decreases.

  k(d)(1 - T) = after-tax component cost of debt, where T is the firm's marginal tax rate.

• Question 483:

  Returns on the market and Company Y's stock during the last 3 years are shown below: Year Market Company Y 1995 -24% -22% 1996 10 13 1997 22 36 The risk-free rate is 5 percent, and the required return on the market is 11 percent. You are considering a low-risk project whose market beta is 0.5 less than the company's overall corporate beta. You finance only with equity, all of which comes from retained earnings. The project has a cost of $500 million, and it is expected to provide cash flows of $100 million per year at the end of Years 1 through 5 and then $50 million per year at the end of Years 6 through 10. What is the project's NPV (in millions of dollars)?

  A. $7. 10
  B. $12. 10
  C. $9.26
  D. $15. 75
  E. $10.42
  E. $10.42

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  Explanation

  Step 1 Run a regression to find the corporate beta. Market returns are the X-input values, while Y's returns are the Y-input values. Beta is 1.2102. Step 2 Find the project's estimated beta by subtracting 0.5 from the corporate beta. The project

  beta is thus 1.2102 - 0.5 = 0.7102. Step 3 Find the company's cost of equity, which is its WACC because it uses no debt: k(s) = WACC = 5% + (11% - 5%)0.7102 = 9.26%.

  Step 4 Now find the project's NPV (inputs are in millions):

  CF(0) = -500

  CF(1-5) = 100

  CF(6-10) = 50

  I = 9.26%

  Solve for NPV = $10.42 million.

• Question 484:

  An economic researcher estimates the following regression between the annual income, I, of a family and the amount it spends on consumption goods, C:

  C = 2,000 + 0.65 I + error term

  If the R-square of the regression is just 0.3, estimate the amount that a family with an income of 50,000 will spend on consumption.

  A. 34,500
  B. none of these answers
  C. 32,500
  D. 2,000
  A. 34,500

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  Explanation

  With the given regression, the amount that a family with an income of 50,000 will spend on consumption equals 2,000 + 0.65*50,000 = 34,500.

• Question 485:

  The significance level in hypothesis testing refers to the probability that we will:

  A. Reject the alternative when it is true.
  B. Reject the null when it is true.
  C. Accept the alternative when it is true.
  D. Fail to reject the null when it is false.
  B. Reject the null when it is true.

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  Explanation

  Note that the significance level is the same as the probability of making a Type I error. A Type I error refers to the event that we will reject the null when, in fact, it is true. Clearly, lower significance levels are better, all else equal.

• Question 486:

  Michelieu tells a prospective client, "I may not have a long-term track record yet, but I'm sure that you'll be very pleased with my recommendations and service. In the three years that I've been in the business, my equity-oriented clients have averaged a total return of more than 26 percent a year." The statement is true, but Michelieu only has a few clients and one of his clients took a large position in a penny stock (against Michelieu's advice) and realized a huge gain. This large return caused the average of all of Michelieu's clients to exceed 26 percent a year. Without this one investment, the average gain would have been 8 percent a year. Has Michelieu violated the Standards?

  A. Yes, because the statement misrepresents Michelieu's track record.
  B. Yes, because the statement about return ignores the risk preferences of his clients.
  C. No, because the statement is a true and accurate description of Michelieu's track record.
  D. No, because Michelieu is not promising that he can earn a 26 percent return in the future.
  A. Yes, because the statement misrepresents Michelieu's track record.

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  Explanation

  Standard IV (B.6), Prohibition against Misrepresentation. Although Micheliu's statement regarding the total return of his client's accounts on average may be technically true, it is misleading because the majority of the gain resulted from one client's large position taken against Micheliu's advice. He has not taken steps to present a fair, accurate and complete presentation of performance. Even though he is not guaranteeing future results, his words are still a misrepresentation of performance. Not disclosing the risk preferences of clients does not make a statement misleading and is not a violation of the Standards in this context.

• Question 487:

  Which of the following figures is not expressly incorporated into the Degree of Operating Leverage, as based on the "unit sales" calculation.

  A. Average sales price
  B. Total variable operating costs per unit
  C. Price
  D. Common shares outstanding
  E. Total fixed operating costs
  F. Sales in units
  D. Common shares outstanding

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  Explanation

  The Degree of Operating Leverage (DOL) measures the percentage change in EBIT that results from a given change in sales. The DOL can be calculated using several methods, including one that is based on unit sales. This version of the DOL equation is as follows: {DOL = [(Sales in units(average sales price - variable cost per unit) / (sales in units(average sales price - variable cost per unit) - total fixed operating costs]}. Of the choices listed, only the number of common shares outstanding is not incorporated into the DTL equation. In fact, the number of common shares outstanding is not factored into any of the equations used to calculate DOL.

• Question 488:

  Which of the following is NOT involved in calculating the operating cash flow from net income from operations?

  A. Increase in current assets in the form of receivables.
  B. Increase in current liabilities in the form of payables.
  C. Gain from retirement of debt.
  D. None of these answers.
  C. Gain from retirement of debt.

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  Explanation

  Gain from retirement of debt is an extraordinary item under GAAP and is not a part of operating cash flow. Indeed, the gain is a non-cash item.

• Question 489:

  The consumer price index (CPI) is calculated

  A. using a fixed basket of goods and will tend to understate inflation.
  B. using a constantly changing basket of goods and will tend to understate inflation.
  C. using a constantly changing basket of goods and will tend to overstate inflation.
  D. using a fixed basket of goods and will tend to overstate inflation.
  D. using a fixed basket of goods and will tend to overstate inflation.

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  Explanation

  The consumer price index is calculated using a market basket based on the Consumer Expenditure Survey of urban consumers. There are 364 items in the market basket. The CPI compares the price of the fixed market basket in the base year with the price of the fixed market basket in the current year to determine how prices have changed over time.

• Question 490:

  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 Receivables 2,154 1,768

  The receivables turnover ratio and the average receivables collection period for 1994 equal ________.

  A. 4. 31, 84. 77 days
  B. 5. 25, 69.58 days
  C. none of these answers
  D. 4. 73, 77. 17 days
  D. 4. 73, 77. 17 days

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  Explanation

  Receivables turnover ratio = Net annual sales/average receivables Average receivables collection period = 365/receivables turnover. Typically, average receivables for a given year are taken to be the average of the ending values of the receivables for this year and the last year. For 1994, the average receivables equal (2154+1768)/2 = 1,961. Receivables turnover ratio = 9,275/1,961 = 4. 73. Average receivables collection period = 365/4. 73 = 77. 17 days.