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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 881:

  The promulgation of GAAP is a responsibility that rests with:

  A. The Securities and Exchange Commission (SEC).
  B. The Committee on Accounting Procedures (CAP).
  C. None of these answers.
  D. The American Accounting Association (AAA).
  A. The Securities and Exchange Commission (SEC).

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  Explanation

  The SEC has the primary responsibility for creation of accounting standards in the US. The AAA does issue its own statements about accounting standards and these are quite influential in shaping the official framework. However, its statements are not binding on the industry unless the SEC adopts them.Currently, the SEC has relegated most of the duties of addressing needs for various accounting standards to the Financial Accounting Standards Board (FASB), though it remains the final authority in these matters.

• Question 882:

  James Clinton, a portfolio manager with Middle Road Investment Advisors, is trying to estimate the appropriate earnings multiplier for the automobile industry. In his analysis, James examines the expected growth rate of dividends for the industry, as well as the expected dividend payout ratio and required rate of return. From this information, James proceeds toward an estimation of the earnings multiplier for the series.

  Which of the following best describes this method of estimating an earnings multiplier for an industry?

  A. Microanalysis
  B. The specific estimate approach
  C. The rate of change approach
  D. Input-output analysis
  E. Macroanalysis
  F. The arbitrage pricing method
  A. Microanalysis

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  Explanation

  The answer called for in this question is "microanalysis." This method involves an examination of the components of the earnings multiplier, including the anticipated growth rate of dividends, the required rate of return, and the dividend payout ratio. Once these variables have been examined, both from the perspective of trend analysis and point estimation, a value for the earnings multiplier is deduced.

  Microanalysis is contrasted by macroanalysis, which involves an examination of the relationship between the earnings multiplier of a stock market series and the earnings multiplier of the overall market. For example, an individual projecting an earnings multiplier for a software index using macroanalysis would begin by examining the relationship between the P/E ratio of the software index and the P/E ratio of a broad market index such as the Standard and Poors 500. Both historical trends and point estimates would be examined, and from this information, a projection of the earnings multiplier for the stock market series is deduced.

  Input-output analysis is used in the examination of competitive forces within an industry. The arbitrage pricing model is a security valuation model which allows for several relevant "situation specific" variables. Finally, the "specific estimate" and "rate of change" approaches are used to estimate the earnings multiplier of a stock market series, rather than an industry.

• Question 883:

  Consider the following information:

  Borrowing Rate 10%

  Marginal Tax Rate 40%

  Preferred Stock Par Price $100

  Preferred Dividend $10

  Preferred Stock floatation cost 2. 5%

  Cost of common equity 12. 0%

  Preferred Stock issued at Par

  The Optimal Capital Structure is 40% debt, 50% common equity, and 10% preferred stock. Credit Rating BB+ What is the firm's Weighted Average Cost of Capital (WACC)?

  A. 12. 62%
  B. 7. 42%
  C. 9.0%
  D. 8.0%
  E. 2. 5%
  F. 9.42%
  F. 9.42%

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  Explanation

  The firm's Weighted Average Cost of Capital (WACC) is a weighted average of the component cost of capital. In this case 10%(borrowing rate) x (1-.4)Tax savings = 6% is the component cost of debt. $10 (preferred dividend) / 97. 5(Par minus floatation cost) = 10.25% is the component cost of preferred stock. Thus the WACC = .4(6%) + .5(12%) + .1(10.25%) = 9.42%

• Question 884:

  A bell-shaped, symmetrical frequency distribution has a mean of 10. If 16% of the observations in the distribution are negative, what is the coefficient of variation of X?

  A. 1.0
  B. 0.32
  C. 10.0
  D. 0.1
  A. 1.0

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  Explanation

  The fraction of observations which are less than zero equals 16% i.e. the fraction of observations which are less than (mean - 10) equals 16% (given). Since the distribution is symmetrical about the mean, this implies that the fraction of observations which are more than (mean + 10) also equals 16%. Thus, the fraction of the observations lying between 0 and 20 equals 1-0.16-0.16 = 0.68. For a bellshaped, symmetrical frequency distribution, 68% of the observations lie within one standard deviation of the mean. Hence, the standard deviation of the distribution equals 10. The coefficient of variation is then equal to standard deviation/mean = 10/10 = 1.

• Question 885:

  Assume the least squares equation is Y' = 10 + 20X. What does the value of 10 in the equation indicate?

  A. None of these answers
  B. For each unit increased in X, Y increases by 10
  C. Y intercept
  D. For each unit increased in Y, X increases by 10
  C. Y intercept

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  Explanation

  The regression is written as Y' = a + bX. The letter "a" is the Y intercept and b is the slope of the line. Y' is the predicted value of Y given a specific value of X. Here a=10.

• Question 886:

  The real risk-free rate of return depends most on

  A. the real growth rate of the economy.
  B. money supply.
  C. interest rates.
  D. inflation.
  A. the real growth rate of the economy.

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  Explanation

  The real risk-free rate of return does not take inflation into account (in contrast to the nominal risk-free rate). It should depend on the real growth rate of the economy because the capital invested should grow at least as fast as the economy. The rate can also be temporarily affected by tightness or ease in the capital markets.

• Question 887:

  Consider the following information:

  Borrowing Rate 10%

  Marginal Tax Rate 40%

  Preferred Stock Par Price $100

  Preferred Dividend $10

  Preferred Stock floatation cost 2. 5%

  Cost of common equity 12. 0%

  Preferred Stock issued at Par

  The Optimal Capital Structure is 45% debt, 50% common equity, and 5% preferred stock. Credit Rating BB+

  What is the firm's Weighted Average Cost of Capital (WACC)?

  A. 7. 21%
  B. 9.21%
  C. 9.0%
  D. 8.0%
  E. 2. 5%
  F. 28.00%
  B. 9.21%

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  Explanation

  The firm's Weighted Average Cost of Capital (WACC) is a weighted average of the component cost of capital. In this case 10%(borrowing rate) x (1-.4)Tax savings = 6% is the component cost of debt. $10 (preferred dividend) / 97. 5(Par minus floatation cost) = 10.25% is the component cost of preferred stock. Thus the WACC = .45(6%) + .5(12%) + .05(10.25%) = 9.21%

• Question 888:

  The confidence index is equal to the ratio of

  A. the yield on 10 top-grade corporate bonds divided by the yield on the Dow Jones average of 40 bonds, multiplied by 100.
  B. the yield on the Dow Jones average of 40 bonds divided by the average yield on 10 top-grade corporate bonds, multiplied by 100.
  C. the expected return on the SandP 500 divided by the yield on 10 top-grade corporate bonds, multiplied by 100.
  D. the yield on the Dow Jones average of 40 stocks divided by the expected return on the SandP 500.
  E. the expected return on the SandP 500 divided by the yield on the Dow Jones average of 40 stocks.
  A. the yield on 10 top-grade corporate bonds divided by the yield on the Dow Jones average of 40 bonds, multiplied by 100.

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  Explanation

  The confidence index measures the yield spread between high-grade bonds and a large cross section of bonds. Some technical analysts believe that during periods of high confidence, investors are more willing to invest in lower-quality bonds, thereby pushing down their yields, and increasing the confidence index. An increase in the index is viewed as a bullish sign.

• Question 889:

  An intern at Smith, Kleen, and Beetchnutty has recently been asked to value shares of Dynamic Impact, a multinational media conglomerate, using the Gordon Model. Dynamic Impact is a stable firm which has experienced steady growth for much of the last twenty years, and this growth rate is not anticipated to change. In his assignment, the intern has been provided with the following information:

  Expected dividend at t5: $1.45 Required rate of return on equity: 14. 25% per year Growth rate of dividends: 10.00% per year

  Using the information provided, what is the value of Dynamic Impact's common shares?

  A. $18.90
  B. None of these answers is correct.
  C. $21.12
  D. $26. 65
  E. $31.34
  F. The answer cannot be calculated from the information provided.
  B. None of these answers is correct.

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  Explanation

  Since the growth rate of dividends is not expected to change in the future, the Gordon Model can be applied. The Gordon Model is commonly referred to as the "constant growth dividend discount model." This model of common stock

  valuation is illustrated as follows:

  P0 = [D1 / (r - g)]

  Where

  P0 = the price of common stock X at time 0

  D1 = the expected dividend at t1

  r = the required rate of return on equity investments and g = the expected growth rate of dividends.

  Since we are not provided the dividend at t1, we must determine it manually be discounting the dividend at t5 by the growth rate of dividends. The determination of D1 is as follows:

  D1 = {D5 / [(1 + g)(1 + g)(1 + g)(1 + g)]}

  D1 = {$1.45 / [1 + 0.10)(1 + 0.10)(1 + 0.10)(1 + 0.10)]}

  D1 = {$1.45 / 1.1461} = $0.9904

  Now that the dividend at t1 has been determined, the given information can be put into the equation provided, leading to the following series of calculations:

  P0 = [$0.9904 / (0.1425 - 0.10)] = $23. 30

  This is illustrated by none of the answers provided.

  When using the Gordon model, remember that the required rate of return "r" must be greater than the expected growth rate "g." Otherwise, this equation will produce a nonsensical answer.

• Question 890:

  The probability that a mutual fund will generate a positive return in the next 12 months is called:

  A. a conditional probability.
  B. an unconditional probability.
  C. a joint probability.
  D. a fantasy.
  B. an unconditional probability.

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  Explanation

  An unconditional probability takes the form of P(A), the probability that an event (A) will happen. It is unconditional because it is not conditioned on any other event.