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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 891:

  Collete Minogue holds stock in Bracken Entertainment. Although many of her associates still believe that Bracken will be a high-performing stock, Minogue has lost faith and wants to conduct a covered call transaction. Current market

  conditions are as follows:

  In assessing whether she should conduct the covered call strategy, Minogue sketches out the following graph. Although her sketch is correct, she cannot remember all the labels.

  

  Which of the following statements about the graph and the covered call strategy is INCORRECT?

  A. If Minogue goes ahead with the covered call, she will limit her gain to $11. B. The distance between points C and D is $5.
  C. The call writer will have unlimited upside potential.
  D. Line Y represents the covered call's profit line.
  C. The call writer will have unlimited upside potential.

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  Explanation

  The call buyer has unlimited upside potential. If the stock price exceeds $39, the buyer will exercise the option and will realize all gains (once the cost of the premium is recovered). The other statements are true. Minogue is the call writer (a covered call consists of the stock and a short call). Her gain is limited to $11 (the call premium of $5 plus the gain on the stock as long as the market price is less than the strike price, or $39 - $33). The distance between points C and D represents the call premium, or $5. Line Y represents the covered call profit line and Line X represents the stock profit line.

• Question 892:

  The CBOE put/call ratio

  A. is used by contrary-opinion technical analysts. They view a ratio of 1.00 or greater to be a bearish sign. The value of the ratio has historically been in the 0.25 to 0.75 range, but has now moved considerably higher.
  B. is used by technical analysts who try to follow the "smart money." They view a ratio of .90 or greater to be a bearish sign. The value of the ratio has historically been in the 0.30 to 0.85 range, but has now moved considerably higher.
  C. is used by contrary-opinion technical analysts. They view a ratio of 0.70 or less to be a bearish sign. The value of the ratio has historically been in the 0.35 to 0.80 range, but has now moved considerably higher.
  D. is used by technical analysts who try to follow the "smart money." They view a ratio of 0.60 or less to be a bullish sign. The value of the ratio has historically been in the 0.40 to 0.90 range, but has now moved considerably lower.
  C. is used by contrary-opinion technical analysts. They view a ratio of 0.70 or less to be a bearish sign. The value of the ratio has historically been in the 0.35 to 0.80 range, but has now moved considerably higher.

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  Explanation

  The Chicago Board Options Exchange (CBOE) put/call ratio is used by contrary-opinion technical analysts. A higher ratio of puts to calls indicates a bearish market sentiment, while a lower ratio indicates the opposite. Contrary-opinion analysts believe that the sentiment is wrong, and assume ahigher ratio value is bullish while a low value is bearish. Currently, ratio values of 0.70 or less are viewed bearishly, while ratio values of 0.90 or greater are viewed bullishly.

• Question 893:

  A stock has the following returns over 3 years: -5%, +15%, -4%. The annual geometric rate of return over the three years is ________.

  A. 9.36%
  B. 1.60%
  C. 7. 42%
  D. 0.15%
  E. -2. 21%
  F. 4. 64%
  G. 3. 31%
  H. -1.34%
  B. 1.60%

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  Explanation

  The annual geometric rate of return equals [(1-5%)(1+15%)(1-4%)]^(1/3) - 1 = (0.95 * 1.15 * .96)^0.33 - 1 = 0.016 = 1.60%

• Question 894:

  A financial analyst with Mally, Feasance and Company is examining shares of Microscam International. Assume the following information:

  Retention Rate: 72%

  EPS: $2. 16

  Growth Rate: 21%

  Discount Rate: 14. 50%

  Tax Rate: 35%

  Using this information, what is the ROE for Microscam International?

  A. 5. 88%
  B. 15. 12%
  C. 56. 88%
  D. 33. 40%
  E. The answer cannot be calculated from the information provided.
  F. 29.17%
  F. 29.17%

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  Explanation

  To determine the ROE for Intelligent, the equation used to determine the dividend growth rate must be manipulated. The dividend growth rate equation to be used is originally structured as follows: {g = ROE(1 - Dividend Payout Ratio)}. The

  original equation must be rearranged using algebra, and will yield the following: {ROE = g / Retention Rate of Dividends}. Imputing the given information into this equation will yield the following:

  {ROE = 0.21 / 0.72}.

  Solving for ROE will yield a figure of 29.17%.

  As you can see, neither the discount rate nor the tax rate is incorporated into the equation. Additionally, remember that (1 - Dividend Payout Ratio) is the same thing as the Retention Rate of Dividends.

• Question 895:

  Which of the following statements about portfolio management is FALSE?

  A. Interest and dividends are typically taxed at a higher rate than capital gains.
  B. Deferred tax investments may be appropriate for investors with tax concerns.
  C. Mutual funds face two basic constraints: time horizon and liquidity concerns.
  D. The purpose of the investment policy includes imposing discipline on the client.
  C. Mutual funds face two basic constraints: time horizon and liquidity concerns.

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  Explanation

  The two constraints faced by mutual funds are: laws created to protect the investors and investment choices as defined in the prospectus. The other statements are true. Interest and dividends are typically taxed at a higher rate than capital gains. Deferred tax investments such as 401(k) plans allow the investor to delay paying taxes until a later date and are an important tool for an invest with current tax concerns. The investment policy imposes discipline on both the client and portfolio manager.

• Question 896:

  Which of the following firms would likely have the lowest dividend payout ratio? Further, the capital structure of this firm would likely be weighted more heavily with debt or equity? Choose the best answer.

  A. A large computer manufacturer; debt
  B. A nationwide grocery chain; debt
  C. A specialty retailer; equity
  D. A healthcare company specializing in home care; debt
  E. A fledgling biotechnology company; equity
  E. A fledgling biotechnology company; equity

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  Explanation

  Of the firms listed, the biotechnology company would be expected to have the lowest dividend payout ratio. The nascent biotechnology industry is characterized by a high degree of investment in research and development, along with a high

  growth rate and high level of uncertainty. All of these factors are conducive to a high retention rate, i.e. a low dividend payout ratio.

  Further, firms within industries associated with high growth rates and high levels of uncertainty are likely to be financed primarily with equity. This is reasoned by several factors, some of which include the following:

  Firms in new industries typically have a balance sheet weighted heavily toward intangible assets, which can neither be easily liquidated nor pledged as collateral for a loan.

  Firms in new industries are characterized by a high degree of research and development expenses.

  Equity provides firms with a higher degree of agility than debt financing.

  The cash flows of firms in developing industries are characterized by a high degree of uncertainty.

• Question 897:

  If a firm's net income after dividends is greater than zero, then

  I. its equity increases.

  II. its retained earnings increase.

  III. its liabilities decrease.

  IV.

  its stock price increases.

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

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  Explanation

  The income not paid out as dividends becomes part of retained earnings, which is a component of equity. A firm's market value is not determined solely by its current book value but expected future earnings. If the current period's income falls short of expectations, then the stock price will fall even if nothing else changes simply because the unrealized part of the income was factored into the original price. A further complication arises if the market interprets the fall in income as an unfavorable signal about future earnings. Thus, while book value of the stock increases, the market value could increase or decrease.

• Question 898:

  Which of the following usually occurs at the beginning of an economic recovery (after a recession)?

  A. Profit margin decreases.
  B. Productivity decreases.
  C. Unit labor costs increase slowly or decrease.
  D. Unit labor costs increase greatly.
  C. Unit labor costs increase slowly or decrease.

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  Explanation

  At the beginning of an economic recovery, capacity utilization increases from its low recession level. Workers do not yet ask for much higher wages, and productivity increases, leading to a decrease or only a slow increase in unit labor costs. Profit margin increases as a result of these trends.

• Question 899:

  Which of the following statements is most correct?

  A. All of these statements are true.
  B. As a firm's debt ratio approaches 100 percent, the after-tax cost of debt, k(d)(1 - T) (after-tax component cost of debt, where T is the firm's marginal tax rate), will be at its lowest level.
  C. All of these statements are false.
  D. An increase in the corporate tax rate would lower the weighted average cost of capital for an average firm, other things held constant.
  E. Depreciation-generated funds have a cost equal to the firm's lowest WACC (Weighted Average Cost of Capital), and hence they have no impact on the MCC (Marginal Cost of Capital) schedule.
  D. An increase in the corporate tax rate would lower the weighted average cost of capital for an average firm, other things held constant.

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  Explanation

  Increasing the corporate tax rate would lower the after-tax component cost of debt, thereby lowering the WACC, with all other things held constant.

• Question 900:

  An increase in debit balances would be a bullish sign. This relates to:

  A. Block Uptick-Downtick Ratio
  B. Mutual Fund Cash Positions
  C. Relative Trend
  D. Odd-Lot, Short-Sales Theory
  E. Dow Theory
  F. Short Sales by Specialists
  G. Margin Debt
  H. Diffusion Index
  G. Margin Debt

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  Explanation

  Debit balances in brokerage accounts represent borrowing by knowledgeable investors from their brokers. Such borrowing is called margin debt. In such cases, an increase in debit balances would be a bullish sign.