CFA Institute CFA Institute Certifications CFA-LEVEL-1 Questions & Answers

• Question 601:

  At which stage in an industry life cycle would profit margins most likely be at their highest?

  A. mature growth

  B. pioneering development

  C. rapid accelerating growth

  D. deceleration of growth and decline

  E. stabilization and market maturity

  Correct Answer: C

  In this stage, there are a limited of number of firms for the product/service and demand is very high enabling the firm to experience high markups.

• Question 602:

  Closed end funds sell

  A. none of these answers.

  B. at a price equal to its NAV.

  C. at a premium over its NAV.

  D. at a discount from its NAV.

  Correct Answer: D

  Historically, the market price of a closed end fund has been 5 to 20 percent below the NAV of the fund.

• Question 603:

  The P/E ratio is not determined by

  A. the ROE.

  B. the expected dividend growth rate for the stock.

  C. the expected dividend payout ratio.

  D. the required rate of return on the stock.

  Correct Answer: A

  The infinite period Dividend Discount Model claims that the current price of a common stock is equal to D1 / (k - g), where D1 is next period's (most often next year's) dividend, k is the required rate of return, and g is the growth rate of dividends. If we divide both sides of the infinite period Dividend Discount Model equation by expected earnings during the next 12 months, we get P/E = (D1/E) / (k - g). This equation shows that the P/E ratio is determined by the expected dividend payout ratio (D1/E), k, and g. ROE does not help determine the P/E ratio.

• Question 604:

  Which of the following are assumptions of the dividend discount model?

  A. No inflation

  B. All of these answers

  C. The required rate of return is greater than the growth rate

  D. Earnings will not be negative

  Correct Answer: C

  The assumptions of the Dividend Discount Model are: (1) Dividends grow at a constant rate; (2) The constant growth rate will continue for an infinite period; (3) The required rate of return is greater than the growth rate.

• Question 605:

  If the moving average of past stock prices has been above the current price, this indicates

  A. that the stock price has been declining.

  B. that the stock price has been increasing.

  C. an approaching market peak.

  D. probable market instability.

  Correct Answer: A

  A 50-day moving average, for example, would be equal to the average stock price for the past 50 days. In order for this average to be consistently above the current price, the current price must be going through a general decline that is dragging it below the moving average, which takes longer to adjust to falling prices.

• Question 606:

  The ratio of upside-downside volume is equal to

  A. the number of downticks in the stock market divided by the number of upticks.

  B. the total volume of increasing stocks plus half the volume of unchanged stocks, divided by the total volume of decreasing stocks.

  C. the number of stocks increasing divided by the number of stocks decreasing.

  D. the total volume of increasing stocks divided by the total volume of decreasing stocks.

  Correct Answer: D

  Technical analysts may use the ratio of upside-downside volume as an indicator of short-term momentum for the market. They feel that a ratio value of 1.50 or more indicates that the market is overbought, while a ratio of 0.70 or less indicates that the market is oversold.

• Question 607:

  Which of the following does not affect the growth rate of earnings and dividends of a stock?

  A. Changes in the dividend payout ratio

  B. Changes in the return on equity (ROE)

  C. Changes in the risk premium

  D. Changes in the earnings retention rate

  Correct Answer: C

  The growth rate is equal to the retention rate multiplied by the ROE. The retention rate is itself equal to one minus the dividend payout ratio. Changes in the risk premium affect the required rate of return on a stock. Changes in all these variables are used in the direction of change approach to estimate the earnings multiplier.

• Question 608:

  Which of the following represents a "contrary opinion" technical indicator?

  A. Mutual fund cash position.

  B. Diffusion Index.

  C. T-Bill-Eurodollar Yield Spread.

  D. None of these answers is correct.

  E. Short sales by specialists.

  F. The Confidence Index.

  Correct Answer: A

  Of the choices listed, only "mutual fund cash positions" represents a contrarian technical indicator. Technical analysts often believe that the majority of market participants are incorrect in their opinions about market direction and valuation, especially during periods preceding market peaks and troughs. This style of thinking is often referred to as "contrary opinion" technical analysis.

  The mutual fund cash position is a contrary opinion technical indicator because contrarian technical analysts believe that mutual funds will be wrong in their forecasts of market direction. Technical analysts often use mutual funds as a proxy for institutional investors, and believe that the mutual fund cash position provides important insight into the sentiment of institutional investors. Specifically, these technical analysts believe that a high mutual fund cash position, which indicates that mutual funds are bearish on the market, is actually a signal of an impending upward move in stock prices. Conversely, a low mutual fund cash position is viewed as bearish by contrarian technical analysts. The intuition behind this opinion is relatively straightforward - a low mutual fund cash position indicates a low amount of buying power within mutual funds, i.e. there is less money available to support stock prices.

  Several studies have examined the cash ratio's ability to predict market cycles and have determined its usefulness is less than that implied by the technical analyst community. The Confidence Index is a measure of yield spreads between high-grade 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 ratio of short sales by specialists is used by technical analysts to track the opinions of the "smart money," and the yield spread between T-Bills and Eurodollars is used to measureinternational sentiment and confidence. The T-Bill-Eurodollar Yield Spread is another example of a "smart money" technical indicator.

• Question 609:

  Mary Short is a retail investor. During the course of the last several weeks, Ms. Short has been examining shares of Tellcorr Industries, a large telecommunications firm. In her examination, Mary has determined that Tellcorr's $1.05 per share dividend is anticipated to grow 20% annually. Assuming that Mary can sell her shares of Tellcorr for $70 per share at the end of three years, and that her required rate of return is 22% per year, what is the value of Tellcorr's common stock?

  A. $41.60

  B. $39.98

  C. None of these answers is correct.

  D. $59.23

  E. $63.44

  Correct Answer: A

  The Multiple Holding Period form of the Dividend Discount Model takes the following form: {V = {[d1 / (1 + k)] + [d2 / (1 + k)^2] + ... .[dn / (1 + k)^n] + [Pn / (1 + k)^n]}

  Where: V = the price of the common stock at t0, d1 = the annual dividend at t1 (this is found by multiplying the annual dividend at t0 by (1 + the anticipated growth rate), d2 = the annual dividend at t2 (this is found by multiplying the dividend at t1 by (1 + the anticipated growth rate), k = the required rate of return, n = period "n", and Pn = the sale price of the common stock at time "n".

  In this example, time "n" is the third year, as this is the end horizon for Mary's holding period. Had the investor in this example forecasted selling the shares at the end of the 10th year, then "n" would be the tenth year.

  Now that the formality of expressing the equation for this form of the DDM has been carried through, we can move toward a calculation of the value of this common stock. In this example, all of the necessary information has been provided, and the calculation of the value of this retail stock is as follows:

  {V = [($1.05 * 1.20) / (1 + 0.22)^] + [($1.26 * 1.20) / (1 + 0.22)^2] + [($1.512 * 1.20) / (1 + 0.22)^3] + [$70 / (1 + 0.22)^3]}

  Which can be further broken down into the following:

  {V = [$1.032787 + $1.015856 + $0.999203+ $38.549482] = $41.60}

• Question 610:

  Which of the following factors is an underlying assumption of technical analysis?

  A. Supply and demand is driven by rational and irrational behavior.

  B. The actual shifts in supply and demand cannot be observed in market behavior.

  C. Prices move randomly.

  D. Prices are not determined by supply and demand.

  Correct Answer: A

  Supply and demand is driven by rational and irrational behavior.