L 1 Mock V 42016 December Am Solutions

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CFA Level I 4th Mock Exam
December, 2016
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CFA Level I Mock Exam 4 Solutions (AM)

FinQuiz.com 4th Mock Exam 2016 (AM Session)
Questions Topic Minutes
1-18 Ethical and Professional Standards 27
19-32 Quantitative Methods 21
33-44 Economics 18
45-68 Financial Reporting and Analysis 36
69-76 Corporate Finance 12
77-88 Equity Investments 18
89-94 Derivative Investments 9
95-106 Fixed Income Investments 18
107-112 Alternative Investments 9
113-120 Portfolio Management 12
Total 180
FinQuiz.com 2016 - All rights reserved. 2


Questions 1 through 18 relate to Ethical and Professional Standards
1. Frank Liew is a research analyst who is working with a team of analysts to

produce a report on a large, multinational firm. Each member performs an
independent analysis of the firm based on comprehensive data about the firms
financials and its competitor strategies. However, after developing his
recommendation, Liew discovers that the consensus opinion differs significantly.
The report is published with Liews name included in the list of analysts.
By opting not to dissociate from the report, Liew has most likely:
A. not violated any Standards.

B. violated Standard V(A) Diligence and reasonable basis.
C. violated Standard V(A) Diligence and reasonable basis and Standard
II(B) Market Manipulation.
Correct Answer: A
Reference:
CFA Level I, Volume 1, Study Session 1, Reading 2
Since the consensus opinion has a reasonable and adequate basis and is
independent and objective, Liew need not decline to be identified with the report.
2. To be compliant with the GIPS standards, a firms total assets must be the
aggregate of the:
A. market value of all discretionary fee and non-fee paying accounts.

B. fair value of all discretionary and non-discretionary fee-paying accounts.
C. fair value of all discretionary and non-discretionary accounts including
both fee paying and non-fee paying portfolios.
Correct Answer: C
Reference:
Total firm assets must be the aggregate fair value of all discretionary and non-
discretionary assets managed by the firm. This includes both fee-paying and non-
fee paying portfolios.


3. Rafael Stuart is a research analyst at Grand Investment Associates (GIA), a U.S.

based financial advisory firm that targets private wealth clients. Stuart, along with
a group of research analysts at GIA, is preparing a report on Tetragonal
Corporation (TETCO), a large-cap technology firm. Based on a comprehensive
analysis of the firms pro forma financial statements, Stuart reached the
conclusion that TETCOs next quarters EPS would be at least 5% lower than
consensus. Stuarts research team, however, disagrees, and publishes the report
including a buy recommendation.
To be in compliance with CFA Institute Standards of Professional Conduct, Stuart

should most likely:
A. remove his name from the report before it is published.

B. report the disagreement to supervisory authorities and ask for corrective
action.
C. remove his name from the report and report the disagreement to
supervisory authorities.
Correct Answer: A
Reference:
Rafael should remove his name from the written report since he disagrees with the
reports conclusions. Reporting to supervisory authorities may not be necessary
since it is not evident that the rest of the research team is engaging in any illegal
conduct.
4. If local laws are in conflict with the GIPS standards, a GIPS compliant firm
should comply with:
A. the law that is more stringent.

B. GIPS standards and disclose the conflict in the compliant presentation.
C. the local laws and make full disclosure of the conflict in the complaint
presentation.
Correct Answer: C
Reference:


In cases in which laws and/or regulations conflict with the GIPS standards, firms
are required to comply with the laws and regulations and make full disclosure of
the conflict in the compliant presentation.
5. Jim Chao works for an investment management firm that is developing marketing
material to promote its business and attract prospective clients. The firm utilizes
the past 15-years return to a composite that includes only the firms successful
client accounts that have generated an average return of at least 10% during the
time period. Chao does not prepare the marketing material, but is required to use
to it during preliminary meetings with prospective clients.
With regards the use of the marketing material, to be in compliance with Standard
I-A of the CFA Institute Standards of Professional Conduct, Chao should most
likely:
A. use the marketing material when soliciting business for the firm.
B. use the marketing material, and disclose the calculation methodology to
the clients.
C. not use the marketing material, and bring the situation to the attention of
the supervisor.
Correct Answer: C
Reference:
The firm is only using the surviving accounts returns in the composite, which
will inflate the performance figure. Disclosing it to clients does not absolve the
firm from inappropriately representing firm performance (many clients may not
fully understand the implications of the calculation methodology). Hence, Chao
should not use the marketing material and bring the situation to the attention of
the supervisor.


6. In the absence of regulatory guidance, CFA Institute recommends that firms

should maintain records for at least:
A. 5-years.
B. 7-years.
C. 10-years.
Correct Answer: B
Reference:
CFA Institute recommends maintaining records for at least seven years.
7. Edward Li is an analyst at an equity management firm in the U.S. During a

meeting with one of his clients, Vincent Yan, Li discovered that Yan has a surplus
of $30,000 to invest in a diversified mutual fund. A few days later, Li attended a
conference of reputable financial analysts and portfolio managers. There he met
Wilbert Ho, the manager of one of the areas best performing mutual funds. In an
attempt to help his client, Li told Ho to contact Yan, one of his clients who had
$30,000 cash, and offer him performance details of his mutual fund.
By revealing information about his client, Li has most likely:
A. violated Standard III (E)Preservation of Confidentiality.

B. not violated Standard III (E)Preservation of Confidentiality because the
information was not confidential.
C. not violated Standard III (E)Preservation of Confidentiality because Lis
intent was to help his client as is stipulated by his duty of loyalty to the
client.
Correct Answer: A
Reference:


Even though his intentions were good, Li has violated Standard lll (E) by
revealing confidential information about his client.
8. J&J Investment Advisors (J&J) is an investment firm that is in the process of

being a GIPS compliant firm. As such, J&J has calculated the portfolio
performance of its largest institutional client in accordance with the GIPS
standards. During a meeting with the client, J&J refers to the calculation
methodology as being consistent with GIPS standards.
In making this statement, J&J is in:
A. violation of the GIPS standards, because such statements are strictly

prohibited.
B. violation of the GIPS standards, because such statements can only be
made in a firms prospectus and marketing material.
C. compliance with the GIPS standards, because J&J is in the process of
being GIPS compliant and as such, has prepared the performance data in
accordance with the standards.
Correct Answer: A
Reference:
Such statements are strictly prohibited, unless the firm is GIPS-compliant already
and it reports the performance of an individual clients portfolio to that client.
9. To be fully compliant with the required and recommended procedures of Standard

II(A) Material nonpublic information, a firm should:
A. create a restricted list and a watch list in combination.

B. broadly distribute a restricted list when in possession of material
nonpublic information.
C. Restrict all trading within the firm when in possession of material
nonpublic information.
Correct Answer: A
Reference:


The broad distribution of a restricted list often triggers the sort of trading the list
was developed to avoid. Therefore, a watch list shown to only the few people
responsible for compliance should be used to monitor transactions in specified
securities. Restricting all trading is also counterproductive.
10. Elaine Sen manages a trust fund worth $50,000. The trust documents transfer
effective control of the funds to Sen and prohibit investing in non-U.S. stocks and
bonds. Sam Kim, a 15 year old girl, is the primary beneficiary of the fund. Just
recently, Kim approached Sen to discuss her educational expenses, stating that an
additional cash flow of $20,000 would be needed each year for her to complete
high school. Owing to the heightened need of cash, Sen deems it appropriate to
invest in high-yield emerging market stocks to increase the fund returns.
Consequently, she invests only 5% of the fund in such stocks.
Sen has most likely violated:
A. no Standards.
B. Standard III(C) Suitability.
C. Standard III(A) Loyalty, Prudence and Care.
Correct Answer: C
Reference:
Sen has custody of the client assets so her level of responsibility is heightened.
Sen is obligated to manage the funds in accordance with the terms of the
governing documents of the trust. In this case, the trust documents clearly prohibit
investing in non-U.S. stocks and bonds. Hence, by investing in high-yield
emerging market stocks, Sen has violated Standard III-A loyalty, prudence, and
care.
11. The CFA Institute Standards of Professional Conduct require that a clients
investment policy statement should be reviewed at least:
A. annually.
B. quarterly.
C. semiannually.
Correct Answer: A


Reference:
The IPS should be reviewed at least annually.
12. Alex Lama has just been hired as a research analyst by Exo-Tech Limited (ETL)
to produce a research report on their company. Lama has been provided with all
factual information about the firm that he plans to use to perform a thorough and
unbiased analysis of the firm. ETL has granted Lama 500 stock options in return
for writing the report.
As an independent analyst, has Lama most likely violated best practice with
regards to Standard l-B Independence and Objectivity of the CFA Institute
Standards of Professional Conduct?
A. No.
B. Yes, because her compensation arrangement is not what best practice
recommends.
C. Yes, because she did not disclose the nature of the compensation to
investors.
Correct Answer: B
Reference:
Best practice is for independent analysts to negotiate only a flat fee for their work
that is not linked to their conclusions or recommendations. A stock option will
increase in value if Lama issues a positive report. Hence, the compensation
arrangement does not follow best practice.


13. Jessica Wright is a marketing specialist at Capital Managers (CAPM) an asset

management firm in Houston, Texas. Wright has been asked to develop
promotional material for CAPMs Emerging Market Equities Fund created by the
firm around ten years ago. Due to a typographical error, the material prepared by
Wright states that the fund includes Russian securities when in fact, it does not.
Wright presents the material to upper management, who approve it for
distribution to clients. After several days, Wright identifies the mistake and
corrects it immediately.
With regards to Standard I(C)-Misrepresentation, Wright has most likely:
A. violated the Standard since she allowed the erroneous material to be

distributed and did not prepare the material with caution.
B. not violated the Standard since she corrected it immediately after
identifying it.
C. not violated the Standard as long as she informs those who have received
the erroneous information about the error.
Correct Answer: C
Reference:
Because Wright unknowingly make this mistake she did not violate Standard
I(C)- Misrepresentation. However, if she does not inform those who have
received the material about the mistake and does not cease distribution until the
mistake is rectified, she would be violating the Standard.


14. Casey Hart is a fixed-income analyst at Golden Gust Investments (GGIN), an

asset management firm in Indianapolis, USA. Hart is planning to leave the firm to
start her own advisory business with an old friend and an entrepreneur. To ensure
that she does not engage in any unethical or controversial practices, Hart refrains
from soliciting clients while employed at GGIN. In addition, she does not take
documents or other confidential information from the firm. Hart plans to copy and
take with her only her own recommended list of securities and her personal
marketing presentations containing her performance record.
With regards to Standard IVDuties to Employers, Hart has most likely:
A. violated her duty of loyalty to the firm.

B. not violated her duty of loyalty since she plans to take only personal
information with her.
C. not violated her duty of loyalty since her work and experience gained at
GGIN is her property and not the firms.
Correct Answer: A
Reference:
Hart has violated her duty of loyalty to the firm. She made the recommendations
and prepared the presentations using GGINs resources while being employed at
the firm. Hence, such documents are the property of GGIN and Hart will be in
violation of her duty of loyalty to the firm if she plans to take them with her
without permission.


15. Adam Blank directs all trades of one of his clients through a broker specified by
the client. Doing so does not help Blank achieve best execution and best price.
Blank discloses this fact to the client but continues trading through the same
broker.
Blank will least likely be in violation of Standard III(A)-Loyalty, Prudence, and

Care if he:
A. continues to trade through the broker.

B. finds and selects a broker that offers the best price.
C. seeks best execution by selecting a different broker and informs the client
about his selection.
Correct Answer: A
Reference:
Since the client specifically instructed Blank to trade through a particular broker,
Blank is obligated to do so. However, Blank should disclose to the client that the
broker does not help him in achieving best execution.
16. West & Graham Associates (W&G) is a financial advisory firm that allows its
employees to reissue previously released reports by its own employees without
attributing to those prior W&G analysts.
The firm is most likely in violation of:
A. no standards.
B. Standard I(C)-Misrepresentation.
C. Standard I(B)-Independence & Objectivity and Standard l(C)-
Misrepresentation.
Correct Answer: B
Reference:


Standard l(C)-Misrepresentation, does not allow a member or candidate to reissue

a previously released report solely under his or her name (even if his independent
and objective research supports it).
17. The duty to clients imposed by Standard III(B)Fair Dealing is most likely:
A. more critical when changing recommendations than when making initial

recommendations.
B. more critical when making initial recommendations than when changing
recommendations.
C. equally critical when making initial recommendations as well as when
changing recommendations.
Correct Answer: A
Reference:
The duty to clients imposed by Standard III(B)-Fair Dealing may be more critical
when changing recommendations. The member or candidate must make sure that
the change is communicated in a fair manner especially to those who have been
affected by the earlier advice.
18. Money-Etched Investments (MEIN) is a firm that attained considerable popularity

last year owing to high returns on its equity funds. The firm earned at least a 20%
return on its funds with the highest return being 28%. While developing
advertising material for the company, the firms CEO, Jeremy Chinn, asked to
include the following statement in the brochure:
Investors in MEINs equity funds can expect the value of their investments to
grow by at least 20% over a year, and hopefully, even more.
Is MEINs advertising material most likely in compliance with the CFA Institute
Standards of Professional Conduct?
A. Yes.
B. No, because it violates Standard III(D) Performance Presentation.
C. No, because it violates Standard III(D) Performance Presentation and
Standard I(C) Misrepresentation.


Correct Answer: C
Reference:
MEIN has misrepresented performance information, since the 20%-28% return

was only in a single year and is not representative of what investors could earn
every year. It is not apparent from the information provided that the firm can earn
such high returns for the years to come. Hence, the brochure is in violation of the
Standards.


Questions 19 through 32 relate to Quantitative Methods
19. According to the central limit theorem, which of the following is most accurate?
A. The variance of the distribution of the sample will decrease as the sample
size increases.
B. The mean of the distribution of the sample will almost be equal to the
mean of the population from which the sample is drawn.
C. The variance of the distribution of the sample will be equal to the variance
of the population dividend by (n-1).
Correct Answer: A
Reference:
The variance of the distribution of the sample mean equals the variance of the
population divided by sample size. Hence, as sample size increases, the variance
decreases.
20. A financial statistician made the following comments while addressing a group of
interns about the various statistical techniques used in equity analysis.
Statement 1: Sample variance calculated with a divisor of n is a biased

estimator of the population variance.
Statement 2: An estimator is more efficient and unbiased the larger the sample
size.
He is most accurate with respect to:
A. Statement 1 only.
B. Statement 2 only.
C. Neither statement 1 nor statement 2.
Correct Answer: A
Reference:


Statement 1 is correct.
Statement 2 is incorrect, Un-biasedness and efficiency are properties of an

estimators sampling distribution that hold for any size sample.
21. Which of the following is least likely a property of binomial distribution?
A. A binomial distribution has fixed number of trials.

B. The trials in a binomial distribution are independent.
C. Each trial in a binomial distribution has only one outcome.
Correct Answer: C
Reference:
A distribution that involves binary outcome is referred to as binomial distribution.

It has following properties.
i. A binomial distribution has fixed number of trials.

ii. Each trial in a binomial distribution has two possible outcomes.
iii. Probability of success is denoted as P (success) = p and probability of
failure is denoted as P (failure) = 1-p.
iv. The trials are independent.


22. An equity analyst is using the P/E ratio to rank the component firms of a broad-
based equity market index. The exhibit below is an excerpt from the information
that the analyst gathered about the 35 companies included in the index.
Exhibit
P/E Data provided in ascending order.
No. Company P/E ratio
1 A 0.55
2 B 0.67
3 C 1.10
4 D 1.47
5 E 2.89
The estimate for the 10th percentile for the P/E ratio is closest to:
A. 1.322.
B. 1.360.
C. 1.391.
Correct Answer: A
Reference:
n =35, L10 = (35+1)(10/100) = 3.6
The estimate of the 10th percentile is:

1.10 +(3.6-3)(1.47-1.10) = 1.322
23. For a random sample of 200 small-cap U.S. stocks, the average dividend yield is
1.56% and the sample has a standard deviation of 0.40.
The 99% confidence interval for the population mean of all small-cap U.S. stocks
based on the standard normal distribution will be closest to:
A. 1.487% to 1.633%.
B. 1.504% to 1.615%.
C. 1.513% to 1.606%.


Correct Answer: A
Reference:
Here, z0.005 = 2.58
The confidence interval will be:
1.56-2.58(0.40/200) to 1.56+2.58(0.40/200)
1.487% to 1.633%
24. A stated annual interest rate is the:
A. quoted interest rate that does not account for compounding within the
year.
B. amount by which a unit of currency will grow in a year with interest on
interest included.
C. quoted interest rate per period that equals the periodic rate divided by the
number of compounding periods per year.
Correct Answer: A
Reference:
A stated annual interest rate is the quoted interest rate that does not
account for compounding within the year.
An effective annual rate is the amount by which a unit of currency will
grow in a year with interest on interest included.
A periodic rate is the quoted interest rate per period and it equals the
stated annual interest rate divided by the number of compounding periods
per year.
25. The Chebyshevs inequality will most likely hold for:
A. continuous data that is normally distributed.

B. discrete data regardless of the shape of the distribution.
C. continuous and discrete data regardless of the shape of the distribution.


Correct Answer: C
Reference:
The inequality holds for samples and populations and for discrete and continuous
data regardless of the shape of the distribution.
26. Ronald Gibson is a statistical expert that works for an equity management firm.
Gibson believes that the normal distribution describes most common stock
returns, at least in the long-run. Under this assumption, Gibson is estimating the
probability that an emerging market equity portfolios return would exceed 22%.
The portfolio mean return is 14% and the standard deviation of returns is 26% per
year. Gibson is using the following excerpt from the table of normal probabilities
to help him with his calculation.
x or z 0 0.01 0.02
0.20 0.5793 0.5823 0.5871
0.30 0.6179 0.6217 0.6255
0.40 0.6554 0.6591 0.6628
Gibsons estimated probability should be closest to:
A. 37.83%.
B. 38.21%.
C. 39.88%.
Correct Answer: A
Reference:
z = 22-14/26 = 0.307692
Rounding off N(0.31) = 0.6217 (from the table), Thus 1-0.6217 = 0.3783 or
37.83%.


27. A portfolio manager is concerned about the occurrence of any structural changes
in the returns data series that he has gathered for non-U.S. stocks.
The managers concern is most likely related to the:
A. look-ahead bias.
B. time-period bias.
C. sample selection bias.
Correct Answer: B
Reference:
A long time series has the potential for a structural change occurring during the
time frame that would result in two different return distributions. This relates to
time-period bias.
28. Edward Burger is meeting with his portfolio manager for the regular, annual
performance review of his portfolio. The portfolio manager has recommended
Burger to cash out of a few investments that he considers are not adding value to
his overall wealth. Burger is presented with the following information about these
investments.
Investment Recent Annual Sharpe Ratio

A -0.23
B -1.56
C -2.01
Given that Burger wants to cash out of only one investment for the time being, he
selects Investment C.
Burgers decision regarding investment C is most likely:
A. appropriate.
B. inappropriate, because a shorter evaluation period should be used.
C. inappropriate, because a different evaluation metric should be used.
Correct Answer: C


Reference:
In a comparison of portfolios with negative Sharpe ratios, we cannot generally

interpret the larger Sharpe ratio to mean better risk-adjusted performance. Hence,
either the evaluation period needs to be increased so that one or more of the
Sharpe ratios become positive, or a different performance evaluation metric
should be used.
29. Peter Brook has shortlisted three investments to add to his $10,000 equity
portfolio. Brook needs to pay the first installment on his house in a years time
and needs the portfolio to generate enough cash to be able to do so. The table
below reveals certain performance measures for the portfolio after adding each of
the three investments.
Sharpe Target Semi-

Investment
Ratio Deviation
A 2.3 17%
B 4.6 23%
C 3.5 11%
Which of the above investments should Brook most likely invest in?
A. Investment A.
B. Investment B.
C. Investment C.
Correct Answer: C
Reference:
Investment C is most appropriate. This is because it has a positive, relatively high

Sharpe ratio and the lowest target semi-deviation. Since Brook needs to cover the
cash outflow with his portfolios returns, a target return needs to be specified. The
portfolio with the lowest target semi-deviation will have the least risk of falling
short of Brooks cash flow needs (target return).


30. Jeanette King, a portfolio manager, is constructing the investment policy

statement of one of her firms new clients. Currently, the client has most of his
money invested in risk-free T-bills or investment grade corporate bonds. He is
considerably averse to volatility in his portfolios returns. King is considering the
following investments for the client.
Company Kurtosis Skewness
A 3 0
B 4.5 -0.5693
C 2.1 0.7955
Which of the above investments will be most suitable for Kings client?
A. Company A.
B. Company B.
C. Company C.
Correct Answer: C
Reference:
Since the client is highly risk-averse as is apparent from his current asset
allocation and his averseness to portfolio volatility, a positively skewed
distribution with thinner tails (less extreme values) would be most appropriate.
This is given by Company C, which has a platykurtic, positively skewed
distribution of returns.
31. In candlestick charts, doji is a pattern where the stock opened:
A. and closed at the same price.

B. at its low and closed near its high.
C. at its high and dropped significantly to close near its low.
Correct Answer: A


Reference:
In candlestick chart, when stocks high price is same as low price and opening
and closing price is same, it creates a cross pattern and is referred to as doji
(used in Japanese terminology).
32. Bob Harper, a hedge fund manager, lists all the major hedge funds operating in
the industry and categorizes them into different styles. He then assigns a number
to each investment style.
Which of the following measures of central tendency would be most appropriate

for the data Harper is analyzing?
A. Mean.
B. Mode.
C. Median.
Correct Answer: B
Reference:
The data that Harper has gathered is nominal data. The mode is the only measure
of central tendency that can be used with nominal data.


Questions 33 through 44 relate to Economics
33. If the aggregate demand of an economy increases more than increase in the
aggregate supply, an investor should most likely reduce investments in:
A. cyclical companies.
B. fixed-income securities.
C. commodity-oriented equities.
Correct Answer: B
Reference:
The question describes the emergence of an inflationary gap. In such a scenario,

fixed-income securities would decline in value as interest rates rise, so exposure
to them should be decreased.
34. When a firms TR = TC and MR > MC, the firm:
A. is at maximum profit level.

B. is operating at upper breakeven point.
C. should increase quantity to generate profits.
Correct Answer: C
Reference:
When TR = TC and MR > MC, the firm is operating at lower breakeven point.
The firm should increase quantity to enter profit territory.


35. An economist is attempting to display, graphically, the income constraint of a

private wealth client with regards to two of his highly consumed products: Petrol
and electricity.
The slope of the income constraint equals the amount of petrol consumption that
the client would have to give up if he were to consume more electricity.
If the price of petrol were to rise, the slope of the income constraint would most
likely:
A. increase.
B. decrease.
C. remain unchanged.
Correct Answer: B
Reference:
An increase in the price of petrol will pivot the budget constraint downward (as
petrol plots on the vertical axis). Hence, the budget constraint would become less
steep meaning that the slope will decrease.
36. As a firm increases the quantity of its product produced, the distance between its
ATC and AVC curve:
A. starts increasing.
B. starts decreasing.
C. remains constant.
Correct Answer: B
Reference:
The distance equals the AFC. As quantity produced increases, the average fixed
cost starts decreasing because it spreads over a greater number of units.


37. Which of the following will least likely shift an economys short-run average
supply leftward but will have no effect on the long-run average supply?
A. A decrease in input prices.

B. An increase in human capital.
C. A decrease in the expectation of future prices.
Correct Answer: B
Reference:
An increase in human capital will shift the SRAS rightward, and it will also shift
the LRAS rightward.
38. Alex Gerald is examining his budget constraint given his current income and
expenditures. Gerald has a total budget of $125 per week to spend on milk or
juices. The price of milk is $3.5/litre and the price of juice is 2.5/litre.
If the quantity of milk is measured on the horizontal axis of the budget constraint,
the slope of the budget constraint would be closest to:
A. -0.71.
B. -0.95.
C. -1.40.
Correct Answer: C
Reference:
Slope: -3.5/2.5 = -1.4


39. Diseconomies of scale lead to higher average total:
A. cost.
B. profit.
C. revenue.
Correct Answer: A
Reference:
Diseconomies of scale lead to higher average total cost.
40. A consumer buys both ice cream and cake each week for dessert. The price of ice
cream is $1.25 per scoop and the price of cake is $1.55 per piece. The consumers
marginal rate of substitution, MRSIC, equals 0.66.
To maximize utility, the consumer should most likely:
A. not change her consumption.

B. increase her consumption of cake and decrease her consumption of ice-
cream.
C. decrease her consumption of ice-cream and increase her consumption of
cake.
Correct Answer: B
Reference:
MRSIC = 1.25/1.55 = 0.806. Since the consumers MRS is smaller, he should

spend a little more on cake and a little less on ice cream.


41. Rosy Diaz is a research analyst that follows the Russian automobile industry. As
part of the industrys competitive analysis, Diaz determined that at a range of
output levels, size does not give a firm a competitive edge. However, over and
above those levels, the larger the business, the greater its potential investment
value.
Given the structure of the Russian automobile industry, the industrys:
A. long-run supply curve has either a zero slope or a decreasing slope.

B. short-run supply curve is downward sloping over a particular range of
output.
C. long-run supply curve is U-shaped, with the slope decreasing over a range
of output.
Correct Answer: A
Reference:
For a range of output levels, size does not matter, so the slope of the long-run
supply curve is zero or constant. For levels above that, size matters, so the
LRATC curve decreases as output increases (meaning that slope decreases).
42. Which of the following asset categories price will most likely exhibit substantial
price increases when the economy is in boom phase?
A. Riskiest assets.
B. Government Bonds.
C. Shares of exporting companies.
Correct Answer: A


Reference:
Option A is correct. During the boom phase, the riskiest assets will often have
substantial price increases.
Option B is incorrect as safe assets such as government bonds that are normally
highly priced during recessions may have lower prices and thus higher yields
during the boom phase.
Option C is incorrect as investors may try to buy shares of exporting companies,

as a result of restrictive economic policy or during slowdowns within the country.
43. Helen Oswald, a portfolio manager, is assessing the effect of a recent increase in
one of her clients salary on her consumption patterns. Oswald had constructed a
production opportunity frontier with spending on designer dress shirts on the
vertical axis and t-shirts on the horizontal axis.
Given the change in circumstances, the clients production opportunity frontier

would most likely:
A. shift upward, and the optimal indifference curve would shift rightward.
B. shift upward, and the optimal indifference curve would remain unchanged.
C. remain unchanged, and the optimal indifference curve would shift
leftward.
Correct Answer: B
Reference:
The optimal indifference curve would shift leftward. The new point of tangency
of the indifference curve and the POF would indicate a rise in the consumption of
designer shirts and a fall in the consumption of t-shirts. This is because as income
rises, consumption of normal goods increase (dress shirts) and of inferior goods
decreases.


44. During his research Ross Katz, an economist, reviews the GDP data for the
European economy for the year ended 2005. The following exhibit is an excerpt
from the table provided by the Department of Finance in Europe.
Exhibit:
GDP Release for the European economy (in millions of euros)
Consumer spending 550,000
Government spending 190,678
Government gross fixed investment 30,000
Business gross fixed investment 145,300
Exports 320,666
Imports 312,865
Change in inventories 15,500
Statistical discrepancy 500
Interest income 77,500
Using the expenditure approach, nominal GDP for the European economy is
closest to:
A. 939,779 billion.
B. 1,001,779 billion.
C. 1,1017,279 billion.
Correct Answer: A
Reference:
Nominal GDP = 550,000+145,300+15,500+190,678+30,000+320,666-

312,865+500 = 939,779 billion.


Questions 45 through 68 relate to Financial Reporting and Analysis
45. Which of the following statements is least likely correct regarding gross profit
margin?
Gross profit margin:
A. is inversely related to the competition in the industry.

B. provides a liquidity measure that is independent of the financing of the
firms assets.
C. reflects the percentage of revenue available to pay operating and other
expenses and to generate profit.
Correct Answer: B
Reference:
Options A and C are correct however option B is incorrect. Gross profit margin is
not a liquidity measure but a performance/profitability measure.
46. Which of the following would least likely affect a firms cash flow from financing
activities?
A. A firms employee exercising stock options.

B. A firm increasing its dividend payout ratio effective immediately.
C. An increase in the market interest rates on debt similar to a firms
outstanding loans.
Correct Answer: C
Reference:
Increase in market interest rates would decrease the fair value of the firms debt.
But fair value is not reported in financial statements, and hence, will not affect a
firms CFF (it is not a cash inflow).


47. If a firms leverage ratio increases, its return on equity will:
A. increase.
B. decrease.
C. either increase or decrease.
Correct Answer: C
Reference:
ROE will only increase if borrowing costs exceed the marginal rate earned on
investing in the business.
48. Holding everything else constant, assuming a firm does not sell on credit at all,
which of the following ratios for the firm would most likely be equivalent?
A. Cash ratio and quick ratio.

B. Current ratio and cash ratio.
C. Current ratio and quick ratio.
Correct Answer: A
Reference:
The firm has no accounts receivables, so the cash ratio and the quick ratio would
be equal.
49. Under U.S. GAAP, which of the following items will most likely be reported as
extraordinary in the income statement?
A. Restructuring charges.
B. Losses from a major legal case.
C. A significant gain on the sale of a rare piece of machinery.
Correct Answer: B


Reference:
Under U.S. GAAP, only those items that are unusual and infrequent can be
recognized as extraordinary. Only Option B fits this criteria.
50. Sasha Audrey, a financial analyst, is preparing a report on Vault Managers

(VMA), a financial management firm in Chicago, USA. Audrey has accumulated
information about the firm to estimate key financial ratios. The following exhibit
displays this information.
Exhibit: Selective Financial Information of Vault Managers

(in thousands of US dollars)
December 31, 2011
Revenues $405,000
Cost of services $85,200
Interest $135,500
Selling, general, and administrative
75,000
expenses
Depreciation 45,500
Tax Rate 35%
VMAs operating profit margin is closest to:
A. 10.24%.
B. 15.75%.
C. 49.21%.
Correct Answer: C
Reference:
Operating profit: 405,000-85,200-75,000-45,500= 63,800/405,000 = 15.75%


51. All Star Products (ASP) reported net income of $2,750,000 for the year ended
December 31, 2010. During the same year the company had an average of
1,050,000 shares of common stock outstanding. In addition to common stock,
ASP also had 50,000 of convertible preferred stock, with each convertible into ten
shares of the firms common stock. The firm pays a preferred dividend of
$15/share and a common dividend of $20.
ASPs diluted EPS is closest to:
A. $1.77.
B. $1.29.
C. $1.90.
Correct Answer: A
Reference:
Diluted EPS:
$2,750,000/1,050,000+500,000 (additional shares if converted) = $1.77


52. An analyst is attempting to derive the operating cash flow from a companys
reported net income. The following information has been collected by the analyst
for the purposes of computation:
Year Ended
31/12/2015
Income statement item
Net income 450,000
Depreciation 38,000
Gain from disposal of 3,250

long-lived asset
31/12/2014 31/12/2015 Change
Balance Sheet Item
Accounts receivable 42,000 63,000 + 21,000
Inventory 18,500 10,000 - 8,500
Accounts payable 29,500 51,330 + 21,830
Deferred income tax 55,550 40,000 - 15,550

liability
The companys operating cash flow is closest to:
A. 478,530.
B. 488,000.
C. 494,080.
Correct Answer: A
Reference:
CFA Level I, Volume 3, Study Session 8, Reading 27, LOS f


The companys operating cash flow is calculated as follows:
Net income 450,000
Add: Depreciation 38,000
Subtract: Gain on disposal of long-lived asset (3,250)
Subtract: Increase in accounts receivable (21,000)
Add: Decrease in inventory 8,500
Add: Increase in accounts payable 21,830
Subtract: Decrease in deferred income tax liability (15,550)
Operating cash flow 478,530
53. An analyst has been asked to perform a comparative analysis of the financial
statements of Pin Enterprises (PIEN) for the most recent years. She initiated the
analysis with the firms profitability ratios and compiled the following data.
2010 2011
Leverage 1.80 2.50
Total asset turnover 2.0 2.3
Tax burden 0.50 0.70
Interest burden 0.60 0.90
EBIT Margin 5.13% 7.29%
Which of the following least describes one of the conclusions given her compiled
data?
A. The major contributor to the increase in the firms return on assets was the
rise in net profit margin.
B. The firms return on equity increased by 20.87% in 2011, mostly because
of an increase in leverage.
C. The firms interest costs decreased more than the decrease in its tax costs
during the 2010-2011 financial period.
Correct Answer: B


Reference:
Interest costs decreased by 0.30 whereas tax costs decreased by 0.20.
Return on assets:
2010: 0.0513(0.60)(0.50)(2) = 3.078%
2011: 0.0729(0.90)(0.70)2.3) = 10.56%
ROE:
2010: 3.078%(1.80)= 5.54%
2011: 10.56%(2.50) = 26.41%
Although ROE increased by 20.87%, most of the increase was because of an

increase in ROA.
Net profit margin contributed the most to the increase in ROA.
54. An overview of specific business lines and the segmentation of income are most
likely found in the:
A. statement of operations.
B. supplementary schedule.
C. management commentary .
Correct Answer: B
Reference:
Supplementary schedules provide additional information and details regarding

assets and liabilities of a company e.g. information regarding natural resources,
overview of specific business lines, or the segmentation of business or other line
items.


55. A portfolio manager is assessing the following information as part of a

comprehensive analysis of a firms financial health and investment attractiveness
using cash flow ratios.
Cash flow from operating activities $89,250

Interest paid $45,000
Taxes paid $22,000
Lease payments $15,500
Dividends paid $12,000
If the firm follows US GAAP, the interest coverage ratio is closest to:
A. 2.47.
B. 2.62.
C. 3.47.
Correct Answer: C
Reference:
89,250+45,000+22,000/45,000 = 3.47


56. A portfolio manager has accumulated the following data to carry out a
comparative analysis of firms within the U.S automobile industry.
Exhibit
SOP Auto Manufacturers Financial Information
Net Income $25,000,000
Weighted average common shares 150,000,000
Beginning of year stock options
75,000
outstanding
Exercise price of stock options $45
Market price of companys stock $65
Stock option price $11.55
Using the treasury stock method, the diluted EPS for SOP Auto Manufacturers is
closest to:
A. $0.167.
B. $0.159.
C. $1.220.
Correct Answer: A
Reference:
75,000 (45) = $3,375,000 (if options exercised)
3,375,000/65 = 51,923 shares could be repurchased
Incremental shares issued is 75,000-51,923 = 23,077
Diluted EPS: 25,000,000/ (150,000,000+23,077) = $0.167


57. A company engages in the dealing and trading of financial assets that are highly
liquid. Such purchase and sale is not part of the companys primary business
activity.
In the cash flow statement the above activities would appear as:
A. Investing activities.
B. Operating activities.
C. Financing activities.
Correct Answer: B
Reference:
Operating activities include cash receipts and payments related to dealing

securities or trading securities, even if they are not part of the companys primary
business activity.
58. If a firms price to book value ratio is one, the equity investors in the firm will
most likely earn:
A. a normal profit only.

B. excess profits since the ratio is positive.
C. zero profits as return would not exceed risk.
Correct Answer: A
Reference:
A P/BV ratio of 1 means that a companys expected future returns are exactly
equal to the returns required by the market. Hence, investors would earn a normal
profit only.


59. The head of a firms sales and marketing department is attempting to determine
the appropriate method of reporting revenue under a long-term contractual sale.
Due to the nature of the counterparty involved, the outcome of the contract cannot
be measured reliably and a 30% loss on the contract is expected.
Given the above information, under U.S. GAAP, the:
A. percentage of completion method will be used to recognize the loss

immediately.
B. completed contract method will be used but the loss will be recognized
immediately.
C. loss will be recognized upon completion when revenue is recognized,
unlike IFRS, which will require the loss to be recognized immediately.
Correct Answer: B
Reference:
Under U.S. GAAP, the completed contract method is used when the outcome
cannot be measured reliably. However, even under this method, if a loss is
expected on a contract, it is reported immediately.
60. When the income tax expense in the income statement is greater than current
income tax liability, the difference will most likely increase a firms:
A. taxable income.
B. deferred tax assets.
C. deferred tax liabilities.
Correct Answer: C
Reference:
When the income tax expense in the income statement is greater than current
income tax liability, the difference will increase a firms deferred tax liabilities.


61. If a firm purchases services on credit, in effect borrowing from the provider, it
would most likely appear on the cash flow statement as an:
A. operating activity.
B. investing activity.
C. financing activity.
Correct Answer: A
Reference:
Indirect borrowing using accounts payable is not considered a financing

activitysuch borrowing is classified as an operating activity.
62. For a particular firm, holding everything constant and assuming rising prices, the
inventory turnover will be lowest under the:
A. FIFO method of inventory accounting.

B. LIFO method of inventory accounting.
C. average method of inventory accounting.
Correct Answer: A
Reference:
FIFO will result in the highest inventory values and lowest cost of sales values.
Thus it will result in the lowest inventory turnover.


63. Superior Tech Limited (S-Tech) has a contract to develop a marketing campaign
for a newly established firm. The agreed upon sales price is $15 million and S-
Tech estimates that it would take 4 years to get the job done. Total costs are
estimated to be $9 million. Details about the expenditures incurred in years 1 and
2 are given below:
At the end of year 1, S-Tech spends $4 million.

At the end of year 2, the company spends an additional $3.5 million.
Under the percentage-of-completion method, how much revenue will S-Tech

recognize in year 2?
A. $5,833,333.
B. $6,666,667.
C. $12,500,000.
Correct Answer: A
Reference:
In year 1: 4/9 = 44.44% of the costs have been spend so 44.44%(15) =

$6,666,666.67 of revenue will be recognized.
In year 2: total cost spent will equal 7.5/9 = 83.33% so total revenue recognized:
0.8333(15) = $12,500,000. Since it has already recognized $6,666,666.67, in year
2 it will recognize 12,500,000-6,666,666.67 = $5,833,333
64. Compared to U.S. GAAP, under IFRS interest received or paid can be reported
either as an:
A. investing activity or operating activity.

B. financing activity or investing activity.
C. operating, investing or financing activity.
Correct Answer: C
Reference:


Under IFRS, interest paid can be reported either as an operating activity or a

financing activity. Interest received can be reported as an operating activity or an
investing activity.
65. For an issuing company, interest expense reported for the bonds in its financial
statements is based on the:
A. coupon rate.
B. effective interest rate.
C. market rate of interest.
Correct Answer: B
Reference:
For an issuing company interest expense reported for the bonds in the financial
statements is based on effective interest rates i.e. the market rate at the time of
issuance.
66. The following data relates to a manufacturing concerns financial performance

and efficiency.
Beginning inventory 2012 $70,000

Ending inventory 2012 $50,000
Cost of goods sold 2012 $180,000
Cost of goods sold 1st quarter 2013 $45,000
Average inventory 1st quarter 2013 $66,000
Relative to 2012, the firms inventory turnover ratio in 2013:
A. improved.
B. deteriorated.
C. remained unchanged.
Correct Answer: B


Reference:
!","""$%","""
Inventory turnover 2012: 180,000/( )=3
&
Inventory turnover 2013: 45,000/66,000 = 0.682 Since this is quarterly, we must

annualize by multiplying by 4: 4 (0.682) = 2.73
Hence, the ratio deteriorated.
67. Relative to expensing, which of the following least describes the effect of
capitalizing borrowing costs on a firms reported financials?
A. Leverage would appear higher for the firm.

B. Operating income would be lower in the future.
C. Operating cash flow would be higher but investing cash flow would be
lower.
Correct Answer: A
Reference:
If a firm capitalizes, assets would appear higher (because the capitalized amount
is added to assets) but debt would remain the same, so leverage would appear
lower.


68. Wicker Textiles (WTEX) is a well-established firm in central Minneapolis,

Minnesota. WTEX has increased inventory to meet the seasonal demand of its
products. Some information about WTEXs inventory value is given below:
The cost of the inventory is $60,000.

The estimated selling price less costs of completion and costs to make the
sale equals $80,000.
The market value of the inventory is $55,000.
A normal profit margin equals 15%.
Under U.S. GAAP, the inventory value on WTEXs financial statements should
be closest to:
A. $55,000.
B. $60,000.
C. $80,000.
Correct Answer: B
Reference:
Under U.S. GAAP, inventory is reported at lower of cost or market. Market value
is current market value but with upper and lower limits: it cannot exceed NRV
and cannot be lower than NRV less a normal profit margin. Therefore, the lower
limit is $80,000-(15% of 80,000) = $68,000 Hence, $68,000 is the lower limit for
market value. Hence lower of cost or market is: $60,000.


Questions 69 through 76 relate to Corporate Finance
69. Which of the following about financial leverage and unit sales is most accurate?
The farther unit sales are from the break-even points for high leverage companies,
the:
A. magnifying effect becomes unpredictable.

B. lower the magnifying effect of this leverage.
C. greater the magnifying effect of this leverage.
Correct Answer: C
Reference:
The farther unit sales are from the breakeven point for high-leverage companies,
the greater the magnifying effect of leverage.
70. Ryan Myers, a financial analyst, has been appointed the task of developing a
valuation estimate for Colors Fashion Label (CFL), a private, U.S. based firm
operating in the fashion industry of the country. Myers gathered the following
information to aid his analysis:
The long-term yield on U.S. government bonds is 3.5%.

The historical equity risk premium in the U.S. is 5.6%.
A comparable firm has a beta of 1.35, a debt-to-equity ratio of 1.20,
and a tax rate of 40%.
CFLs tax rate is 33%.
CFLs Debt/Equity ratio is 0.75.
Given the aforementioned information, Myers estimate of CFLs cost of equity

should be closest to:
A. 7.896%.
B. 9.874%.
C. 10.105%.
Correct Answer: C


Reference:
1.35/(1+[(1-0.4)(1.20)] = 0.785
Levered beta for private company: 0.785[1+(1-0.33)(0.75)] = 1.179
Cost of equity: 3.5+ 1.179(5.6) = 10.105%
71. Breakeven point analysis will be least important for a company with a high ratio
of:
A. debt to total assets and low business cycle sensitivity.

B. intangible assets to total assets and high operating income.
C. tangible assets to total assets and low business cycle sensitivity.
Correct Answer: C
Reference:
Breakeven analysis of firms with low business cycle sensitivity and low operating
and financial leverage, and lower intangibles is relatively less important.
72. Xerox Technologies (XETECH) is a well-established firm in the gaming industry

of the United States. Just recently, XETECH upgraded its gaming device and
increased its price to $250. The production of this device cost the firm $65/unit in
variable costs. The total fixed operating costs equaled $10,000,000.
If the firm changes its output from 200,000 units to 220,000 units, operating
income will change by:
A. 1.37%
B. 10.00%.
C. 13.70%.
Correct Answer: C
Reference:


DOL@200,000 units = 200,000(250-65)/200,000(250-65)-10,000,000 = 1.37037

Units sold have changed by 10% so operating income will change by 1.37037
(10%) = 13.7037%
73. Major drags on liquidity for a firm most likely includes:
A. obsolete inventory.
B. reduced credit limits.
C. making payments early.
Correct Answer: A
Reference:
Major drags on liquidity include:
Uncollected receivables
Tight credit
Obsolete inventory
Major pulls on liquidity include:
Making payments early

Reduced credit limits
Limits on short-term lines of credit
Low liquidity positions
74. Which of the following can be least managed or controlled by a firms

management?
A. Sales risk.
B. Financial risk.
C. Operating risk.
Correct Answer: A
Reference:


Management has more opportunity to manage and control operating risk than
sales risk. DFL is also most often the choice of upper management. Hence, sales
risk is least likely to be controlled by a firms management.
75. In the face of bankruptcy, the companies least likely to emerge as ongoing
concerns are the ones with high degree of:
A. financial leverage.
B. operating leverage.
C. financial leverage and a low degree of operating leverage.
Correct Answer: B
Reference:
Companies with high operating leverage have less flexibility in making changes,
and bankruptcy protection does little to help reduce operating costs. However,
companies with high financial leverage can use bankruptcy laws and protection to
change their capital structure and emerge as ongoing concerns.
76. Which of the following is least likely correct regarding staggered boards?
A. Staggered board facilitates better continuity of board expertise.

B. Management uses staggered board as an anti-takeover instrument.
C. A staggered board provides more flexibility to nominate new board
members to meet changes in the marketplace.
Correct Answer: C
Reference:
On a staggered basis, only a portion of board members is re-elected every year. A

staggered board can be used by management as an anti-takeover instrument.
However staggered board facilitates better continuity of board expertise. An
annually elected board may provide more flexibility to nominate new board
members to meet changes in the marketplace, if needed, than a staggered board.


Questions 77 through 88 relate to Equity
77. A fixed-income analyst is considering investing in a pooled investment vehicle.

His friend recommends a closed-ended mutual fund, an open ended mutual fund
and an exchange-traded fund. The analyst expects to hold the investment for a
year or so and has determined that all options are trading at a discount.
The largest discount will most likely be for the:
A. ETF.
B. Open-ended mutual fund.
C. Close-ended mutual fund.
Correct Answer: C
Reference:
ETFs trade very close to their underlying NAV. Open-ended mutual funds also
have market prices close to the underlying NAV. Close ended funds, however,
most often trade at discounts or premiums to NAV.
78. A price-weighted index has an initial value of 45. The prices of the constituent
securities before a stock split on security B are given in Exhibit 1.
Exhibit 1
Before a 2 for 1 Split in Security B
Security Price ($)
A 65.12
B 84.00
C 8.50
D 11.99
To ensure that the value of the index does not change after the split, the new
divisor will be closest to:
A. 1.329.
B. 2.836.
C. 3.769.


Correct Answer: B
Reference:
Sum after the split: 65.12+42(after split)+8.50+11.99 = 127.61

127.61/45 = 2.835778
79. According to statistical approaches, companies are grouped based on their:
A. principal business activities.

B. relative sensitivities to the business cycle.
C. historical correlations of securities returns.
Correct Answer: C
Reference:
According to statistical approaches companies are grouped into industries based

on historical correlations of their securities returns.
80. Cary Lee just received a performance-based bonus from her employer and desires
to invest that in real estate. Her current portfolio is invested in stocks and bonds
only.
If Lee wants to achieve maximum diversification, she should most likely invest in:
A. Direct real estate.

B. Real estate investment trusts (REITs).
C. Shares of companies that own and operate real estate.
Correct Answer: A
Reference:
Relative to the other options, direct real estate has the smallest correlation with
the returns to stocks and bonds. REITs and shares in companies that own real
estate have returns that are similar to the returns of the overall stock market.


81. Anthony Francisco just received $10,000 as inheritance from his uncle who
passed away last month. Consequently, Francisco advises his portfolio manager to
increase his portfolios allocation to domestic stocks from 15% to 25%. The
manager determines that the most appropriate holding period for Francisco is ten
years. He thus invests in non-dividend paying stocks that would yield the required
return over ten years.
Given the information above, Francisco is most likely an:
A. Investor.
B. Speculator.
C. Information-motivated trader.
Correct Answer: A
Reference:
Francisco is an investor. He is trying to generate wealth by investing extra income

in attractive securities. There is no indication of the use of superior information by
Francisco to profit from price changes.
82. In most financial models, the assumption is that the investors are:
A. risk averse.
B. loss averse.
C. risk takers.
Correct Answer: A
Reference:
Rationally investors should be risk averse therefore in most financial models, the
assumption is that the investors are risk averse.


83. A firm has just paid a dividend of $2.5 per share. The required rate of return is
15% per year and dividends are expected to grow at a constant rate of 9.4%. If an
analyst uses Gordon Growth model to calculate the firms intrinsic value, how
much does the dividend growth assumption add to the intrinsic value estimate?
A. $22.24
B. $32.17
C. $48.84
Correct Answer: B
Reference:
Firms intrinsic value using Gordon Growth Model (GGM):
'( )$* &.% ()$0.1%)

Vo = = = $48.84
+,* )%%,0.1%
$32.17 is the amount that the dividend growth assumption added to the intrinsic
value estimate, as calculated below:
$.
$48.84 = $32.17
.
84. Bobby Anderson, a portfolio manager, is considering investing in commodities to

diversify the risks held in his personal portfolio. Since he has had minimal prior
exposure to the commodities market and does not have the facilities to hold most
commodities, he is trying to determine the most appropriate way to invest in the
sector.
Which of the following markets will be most suitable for Anderson to achieve his
diversification objective?
A. The spot market.

B. The futures market.
C. The forwards market.
Correct Answer: B


Reference:
The futures market would provide greatest liquidity in addition to minimal credit
risk. Also, Anderson does not have the facilities to hold most commodities, so the
spot market is not suitable.
85. Matt Elaine has developed software that enables him to determine the correlation
between economic variables and stock returns. Elaine believes that abnormal
returns could be generated using his investing approach.
Which of the following characteristics of the financial system would least likely
aid Elaine in achieving his objective?
A. Market liquidity.
B. Low cost trading.
C. Transparent financial and economic disclosures.
Correct Answer: C
Reference:
Elaine is trying to use superior information to generate abnormal returns.

Transparent financial and economic disclosures do not necessarily help informed
trades profit because they are competing with each other. The most profitable are
those that have unique insights into future values.
86. For which of the following indices is rebalancing a major concern?
A. Equal-weighted indices.
B. Equal-weighted and market-capitalization weighted indices.
C. Equal-weighted, market-capitalization weighted and price-weighted
indices.
Correct Answer: A
Reference:


Price-weighted indices are not rebalanced. For market-cap indices, rebalancing is

less of a concern because the indices largely rebalance themselves. Hence,
rebalancing is most important for equal-weighted indices.
87. Which of the following is not a time series anomaly?
A. Momentum
B. Holiday effect
C. Earnings surprise
Correct Answer: C
Reference:
Both options A and B are time series anomalies while option C is not a time series
anomaly.
88. The price of a large-cap index at the beginning of the period is $1,250 while the
dividends paid to investors amounts to $400. If the total return on the index is
15.00%, the price of the index at the end of the period is equal to:
A. $1,037.50.
B. $1,062.50.
C. $1,437.50.
Correct Answer: A
Reference:
CFA Level 1, Volume 5, Study Session 13, Reading 47, LOS b
Total return = (Pt Pt-1 + Dt)/Pt-1

Pt = (0.15 $1,250.00) $400.00 + $1,250.00 = $1,037.50


Questions 89 through 94 relate to Derivatives
89. Which of the following least represents the rationale of a traditional insurance
product?
A. Credit-linked note.
B. Credit default swap.
C. Credit spread option.
Correct Answer: C
Reference:
The buyer of a credit-linked note effectively insures the credit risk of the
underlying reference security. A CDS also captures many of the essential features
of insurance. A credit spread option behaves more like a call option.
90. Off-market forward is a forward transaction that:
A. starts with a non-zero value.

B. is used to offset the current forward transaction.
C. is not entered into within normal business timings.
Correct Answer: A
Reference:
A forward transaction that starts with a nonzero value is called an off-market

forward.
91. Compared to underlying spot markets, derivatives markets offer which of the
following operational advantages?
A. Lower transaction costs.

B. Greater liquidity and easy short selling opportunities.
C. Lower transaction costs, greater liquidity, and easy short selling
opportunities.


Correct Answer: C
Reference:
Derivatives markets provide greater liquidity as smaller amount of capital is

required to trade derivatives.
Transaction costs of derivatives are typically low compared to the value of

underlying.
With derivatives it is nearly as easy to take short position as to take a long

position. In case of underlying, its almost always much more difficult to go short
than to go long.
92. Steve Hammond is the CEO of a U.S. based company in the oil exploration
business. Hammond is concerned with falling oil prices in the near future.
Specifically, he wants to hedge the risk of the companys oil production of a
million liters expected in 234 days from now. He wants to ensure near perfect
hedging with minimal investment.
The most appropriate way to hedge the companys exposure is to use:
A. Futures.
B. Options.
C. Forwards.
Correct Answer: C
Reference:
Hammond wants to hedge the risk of the companys oil production 234 days from
now. The time-horizon does not coincide with the standardized time horizons of
futures contracts. Also, since he wants near perfect hedging, a customized
contract that considers all his concerns would be most appropriate. This can be
achieved using a forward contract. Options require a premium to be paid and
Hammond wants minimal upfront investment.


93. With regards to equivalence, a swap is closest to a series of:
A. futures expiring at a set of dates coinciding with the swap payment dates.
B. forwards expiring at a set of dates coinciding with the swap payment
dates.
C. options expiring at a set of dates with the options exercise prices equal to
the price inherent in the swap.
Correct Answer: B
Reference:
A swap is closest to a series of forwards expiring at a set of dates coinciding with

the swap payment dates.
94. The higher the exercise price of a call option, the greater the:
A. price of an option.
B. premium received by the seller of the call.
C. leverage for a fixed dollar investment by option buyer.
Correct Answer: C
Reference:
The higher the exercise price of a call option, the lower the price of the option and
the lower the premium received by the seller of the call. Lower option premiums
allow option buyers to purchase more option contracts in a given dollar
investment. Higher number of option contracts generate higher returns in rising
prices scenario thus higher leverage.


Questions 95 through 106 relate to Fixed Income
95. Which of the following statements about the fixed-income market is least
accurate?
A. Since, globally, the fixed-income market is not as popular as the equity

market, equity securities are far more diverse than debt securities.
B. Institutional investors dominate the fixed-income markets because of
informational barriers to entry and invest directly in such securities.
C. Index weighting in the fixed-income market is based on price or value,
and is rarely ever equally-weighted.
Correct Answer: A
Reference:
Fixed-income securities are far more diverse than equity securities. The other two
options are correct.
96. A fixed-income analyst is analyzing the following bonds performance given

future market conditions.
Exhibit 1
Coupon Rate Maturity
Bond A 5.5% 4 years
Bond B 6.5% 3 years
Bond C 5.0% 3 years
Which of the above bonds will have lowest interest rate risk?
A. Bond A.
B. Bond B.
C. Bond C.
Correct Answer: B


Reference:
The bond with the highest coupon rate and lowest maturity will have the lowest
interest rate risk. This is Bond B.
97. An analyst is trying to estimate the implied forward rates as inputs to his bond
valuation process. For this purpose, she gathers the data provided in the following
exhibit.
Exhibit:
Zero Coupon Government Bonds
Maturity Price Yield to Maturity
2 year 98.77 3.556%
3 year 96.87 3.786%
4 year 93.11 3.980%
*The yields to maturity are stated on a semiannual bond basis
The 2y1y implied forward rate would be closest to:
A. 4.25%.
B. 4.56%.
C. 4.16%.
Correct Answer: A
Reference:
(1+0.03556/2)4 (1+x)2 = (1+ 0.03786/2)6
x = 0.021234 2 = 4.24678%
98. For bonds with the same time-to-maturity and yield-to-maturity, Macaulay
duration is the lowest for a:
A. zero coupon bond.

B. low coupon bond trading at a discount.
C. high coupon bond trading at a premium.


Correct Answer: C
Reference:
For the same time to maturity and yield to maturity, the Macaulay duration for a
zero coupon bond tends to be higher than for a low coupon bond trading at a
discount.
Similarly a low-coupon bond trading at a discount has a higher duration than a

high coupon bond trading at a premium.
99. A portfolio manager is confused about whether to invest in a bond issue with a
serial maturity structure, or one with a term maturity structure, given everything
else is similar.
Which of the following, if introduced, will make the manager largely indifferent
between the two structures?
A. High credit quality.

B. Moderate liquidity needs.
C. A sinking fund provision.
Correct Answer: C
Reference:
The sinking fund arrangement on a term maturity structure accomplishes the same
goal as the serial maturity structureboth resulted in a portion of the bond issue
being paid off each year.
100. For a fully amortized bond, the annual payment, which includes both the coupon
payment and the principal repayment:
A. remains constant.
B. decreases at constant rate.
C. decreases at decreasing rate.
Correct Answer: A


Reference:
For a fully amortized bond, the annual payment, which includes both the coupon
payment and the principal repayment, is constant.
101. A 7% annual coupon bond is trading at a price of 105.67 and has three years to
maturity. A 5.5% annual payment, 3-year T-note is trading at a price of 107.89. A
5-year 7% annual coupon T-note is trading at a price of 109.77.
Given the above information, the G-spread will be closest to:
A. 0.16%.
B. 1.32%.
C. 2.19%.
Correct Answer: C
Reference:
Yield on the corporate bond: 4.92% (using financial calculator)
Yield on the T-note with same maturity: 2.725%
G-Spread: 4.92%-2.725% = 2.195%


102. A dealer believes that the bonds issued by Super-Tee Enterprises (SUTEE) are
considerably overvalued and wants to benefit from the mispricing. For achieving
this objective, the dealer borrows 100 par value bonds of SUTEE from an
institutional investor and lends cash in return. The bonds have a stated coupon
rate of 7.5%.
The above transaction will best be known as a:
A. repurchase agreement, and the coupon will belong to the seller of the
security.
B. reverse repurchase agreement, and the coupon will belong to the borrower
of the security.
C. reverse repurchase agreement, and the coupon will belong to the borrower
of cash.
Correct Answer: C
Reference:
From the dealers perspective, this is a reverse repurchase transaction (borrowing

securities and lending cash). The coupon will belong to the owner, that is, the
borrower of cash or the lender of the securities.
103. Tony Sam has invested in a floating rate bond based on Libor. Due to changing
market conditions, Sam is particularly concerned with his investment value
deviating from par value.
Sams concern is most likely:
A. justified.
B. exaggerated, since floating rate securities have little market risk.
C. exaggerated, since floating rate securities have little interest rate risk.
Correct Answer: A
Reference:


Floating rate securities have little interest rate risk. However, they are subject to
credit risk, and changing market conditions can result in a significant downgrade
of such securities. As a result, they may deviate considerably from par value.
104. An analyst is attempting to determine the value of a four-year, 8% annual coupon-

paying bond with a par value of 100. The exhibit below summarizes the sequence
of spot rates which will be used to value the issue.
Time-to-Maturity Spot Rate (%)
1 year 1.25
2 years 1.80
3 years 2.45
4 years 3.00
The yield-to-maturity of the bond is equal to:
A. 2.90%.
B. 3.00%.
C. 3.08%.
Correct Answer: A
Reference:
CFA Level 1, Volume 5, Study Session 15, Reading 54, LOS h
The price of the bond will need to be determined prior to calculating the bonds
yield-to-maturity.
8 8 8 108
Price of the bond = + + + = $119.0171
1.0125 (1.018) (1.0245) (1.03)4
2 3
Yield-to-maturity is determined with the aid of a financial calculator and the

following inputs:
N=4
PV = - 119.0171
PMT = 8
FV = 100
The yield-to-maturity (I/Y) is equal to 2.8965% 2.90%.


105. An investors fixed-income portfolio includes two 180-day money market

instruments. Exhibit 1 displays some key information about the securities.
Exhibit 1
Money Market
Quotation Basis Quoted Rate
Instrument
A Discount Rate 6.78%
B Add-on Rate 7.02%
Assuming that the credit risks of the instruments are comparable, the instrument
that offers a higher expected rate of return is:
A. A.
B. B.
C. neither, since they both offer almost equivalent returns.
Correct Answer: C
Reference:
For security A:
PV = 100 (1-180/360 0.0678) = 96.61
To get the BEY:

(365/180) (100-96.61/96.61) = 0.071154
For security B:
FV = 100 + (100 180/360 0.0702)
FV = 103.51
BEY:
(365/180) (103.51-100/100) = 0.071175
The yields are almost equivalent.


106. Sean Lee has just started work at D&L Dealers Association (DLD), a U.S. based
firm that specializes in dealing in stocks and bonds. During a meeting with one of
the firms colleagues, Lee posed the following question:
I am not sure how the lender of cash in a repurchase agreement would account
for the credit risk of the counterparty and make sure it has a margin of safety?
The best response to Lees question is that the:
A. repo rate will account for this concern.

B. repo margin will account for this concern.
C. collaterals value will account for this concern.
Correct Answer: B
Reference:
The lender of cash accounts for credit risk by lending less than the collaterals
market value. This difference is called the repo margin.


Questions 107 through 112 relate to Alternative Investments
107. Xoro Investors is a private equity firm that is nearing its exit stage for two of its
profitable investments. The fund plans to achieve the following objectives
through the use of appropriate exit strategies for the investments:
Investment A: Fast execution, no lock-up period and a higher level of

confidentiality.
Investment B: The potential for the highest price.
Which of the following describes the most appropriate exit strategies for the
investments?
A. A trade sale for investment A and an IPO for investment B.

B. A secondary sale for investment A and a trade sale for investment B.
C. A trade sale for investment A and a secondary sale for investment B.
Correct Answer: A
Reference:
A trade sale has the advantage of fast execution, higher confidentiality and no
lock-up periods. So it is suitable for investment A. An IPO has the potential for
the highest price so it is appropriate for investment B.
108. Which of the following hedge fund strategies is least likely to have a zero beta
position?
A. Market Neutral.
B. Quantitative Directional.
C. Fixed Income Convertible Arbitrage.
Correct Answer: B


Reference:
The quantitative directional strategy takes long and short positions, however, the
fund typically varies levels of net long or short exposure, depending upon the
anticipated direction of the market. The other two have a zero beta exposure.
109. XYZ hedge fund is a U.S. based fund with $200 million of initial investment
capital. The fund specifies a 2 and 20 fee structure with fees calculated using
end-of-period calculation.
If, in its first year, XYZ hedge fund earns a return of 25%, the investors net
return will be closest to:
A. 18.0%.
B. 18.4%.
C. 18.5%.
Correct Answer: A
Reference:
25%(200) = $50 million

250 million (2%) = $5 million
(250-200-5) (20%) = $9.0 million incentive fee
Total fees: $14.0 million
Return: 250-200-14/200 = 18%


110. During a seminar on the attractiveness of alternative investments, the guest

speaker made the following comment:
The hedge fund strategy that is closest to the strategy followed by a private
equity fund is the activist hedge fund.
The distinction between the two that sets them apart is that the hedge fund:
A. does not have a lock-up period.

B. operates in the public equity market only.
C. does not influence the target company as much as private equity.
Correct Answer: B
Reference:
The activist hedge fund operates in the public market only, unlike private equity.
111. Which of the following category of alternative investments most likely include
metals and crude oil?
A. Real Estate
B. Commodities
C. Other alternative investments
Correct Answer: B
Reference:
Commodities include grains, metals and crude oil.


112. Activist is an event driven strategy that focuses on the:
A. purchase of sufficient equity to influence a companys policies or

direction.
B. securities of the companies either in bankruptcy or perceived to be near to
bankruptcy.
C. opportunities in the equity of companies that are currently engaged in
restructuring activities.
Correct Answer: A
Reference:
Activist is an event driven strategy that focuses on the purchase of sufficient

equity to influence a companys policies or direction.


Questions 113 through 120 relate to Portfolio Management
113. The execution step of portfolio management process most likely includes:
A. portfolio monitoring.
B. portfolio construction.
C. performance measurement.
Correct Answer: B
Reference:
The execution step includes asset allocation, security analysis and portfolio
construction.
The feedback step includes portfolio monitoring and rebalancing and performance
measurement and reporting.
114. An equity analyst is using the market model to analyze the returns to a stock.
During the recent year, the market rose by 5% and the stock rose by 8%. The beta
for the stock is 0.66 and alpha is 0.02. Risk free rate is 0 percent. The company-
specific return to the stock during the recent year is closest to:
A. 2.7%.
B. 4.5%.
C. 4.7%.
Correct Answer: A
Reference:
Specific return: 0.08 - (0.02 + 0.66 0.05) = 2.7%


115. According to the CAL, an investor should choose the portfolio that lies at the
point where the:
A. efficient frontier is tangent to the capital allocation line.

B. investors indifference curve cuts the capital allocation line.
C. highest indifference curve is tangent to the capital allocation line.
Correct Answer: C
Reference:
An investor should choose the portfolio that lies at the point where his highest
indifference curve is tangent to the capital allocation line. This will define his
optimal portfolio.
116. A portfolio manager has constructed an investment portfolio for one of his firms
largest institutional clients. Exhibit 1 displays the composition of the portfolio.
Exhibit 1
Type Percentage Invested
Stocks 60%
Fixed Income 25%
Alternative Investments 15%
The above portfolio is least suitable for:
A. A foundation.
B. An insurance company.
C. A newly offered defined benefit pension plan.
Correct Answer: B
Reference:


An insurance companys risk tolerance is typically quite low and the time horizon
is short. Hence, a large proportion of stocks and alternative investments would not
be appropriate. Foundations have a very long time horizon, and risk tolerance is
typically high. For a newly offered DB plan, risk tolerance would be high and
time horizon would be long.
117. Which of the following statements is most likely correct regarding the
mathematically derived metrics.
A. Gamma is considered a second order risk because it reflects the risk of

changes in vega.
B. The sensitivity to changes in the volatility of the underlying is reflected in
a measure called rho.
C. Delta captures only small changes in the value of the underlying whereas
large changes are captured by gamma.
Correct Answer: C
Reference:
CFA Level I, Volume 4, Study Session 12, Reading 42, LOS-g.
Option C is correct. Delta captures only small changes in the value of the
underlying whereas large changes are captured by gamma.
Option A is incorrect. Gamma is considered a second order risk because it reflects

the risk of changes in delta.
Option B is incorrect. The sensitivity to changes in the volatility of the underlying

is reflected in a measure called vega.
118. Which of the following investments is likely to have a negative beta?
A. A risk-free asset.
B. An insurance policy.
C. An asset with returns that have insignificant sensitivity to the market
return.
Correct Answer: B


Reference:
An insurance policy has a negative beta. Option C will have a very low beta and
option A will have a zero beta.
119. Carlos Long, a financial analyst, is meeting with Tony John, one of his private
wealth clients. During the meeting John stated that he expects return of 15% from
his portfolio. Long estimated that the market portfolio has an expected return of
25% and a standard deviation of 37%. The risk-free rate is 5.0%.
If Long uses the capital allocation line as a benchmark, Johns portfolio will have
a standard deviation closest to:
A. 18.5%.
B. 27.0%.
C. 37.0%.
Correct Answer: A
Reference:
Slope: 25%-5%/37% = 0.54054
Standard deviation is calculated using the following CAL equation:

0.15 = 0.05+0.540541(SD)
SD = 18.49998% or 18.5%.
120. An investor with a risk aversion coefficient of 4 is analyzing an investment with

an expected return of 12% and a risk of 15%.
If the risk-free asset has a return of 5.0%, the investor will most likely prefer:
A. the risk-free asset.

B. the risky investment.
C. either the risk-free asset or the risky investment.
Correct Answer: B


Reference:
Utility from risky investment: 0.12-0.5(4)(0.15)2 = 0.075

To get the same utility, the risk free return must be 7.5%(because the second term
disappears). Since the risk-free return is only 5.0%, the risky investment is better.

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FinQuiz.com 4th Mock Exam 2016 (AM Session)

Questions Topic Minutes

1-18 Ethical and Professional Standards 27

19-32 Quantitative Methods 21

45-68 Financial Reporting and Analysis 36

69-76 Corporate Finance 12

77-88 Equity Investments 18

89-94 Derivative Investments 9

95-106 Fixed Income Investments 18

107-112 Alternative Investments 9

113-120 Portfolio Management 12

FinQuiz.com 2016 - All rights reserved. 2

Questions 1 through 18 relate to Ethical and Professional Standards

1. Frank Liew is a research analyst who is working with a team of analysts to

A. not violated any Standards.

A. market value of all discretionary fee and non-fee paying accounts.

FinQuiz.com 2016 - All rights reserved. 3

3. Rafael Stuart is a research analyst at Grand Investment Associates (GIA), a U.S.

To be in compliance with CFA Institute Standards of Professional Conduct, Stuart

A. remove his name from the report before it is published.

A. the law that is more stringent.

FinQuiz.com 2016 - All rights reserved. 4

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6. In the absence of regulatory guidance, CFA Institute recommends that firms

CFA Institute recommends maintaining records for at least seven years.

7. Edward Li is an analyst at an equity management firm in the U.S. During a

By revealing information about his client, Li has most likely:

A. violated Standard III (E)Preservation of Confidentiality.

FinQuiz.com 2016 - All rights reserved. 6

8. J&J Investment Advisors (J&J) is an investment firm that is in the process of

In making this statement, J&J is in:

A. violation of the GIPS standards, because such statements are strictly

9. To be fully compliant with the required and recommended procedures of Standard

A. create a restricted list and a watch list in combination.

FinQuiz.com 2016 - All rights reserved. 7

Sen has most likely violated:

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The IPS should be reviewed at least annually.

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13. Jessica Wright is a marketing specialist at Capital Managers (CAPM) an asset

With regards to Standard I(C)-Misrepresentation, Wright has most likely:

A. violated the Standard since she allowed the erroneous material to be

FinQuiz.com 2016 - All rights reserved. 10

14. Casey Hart is a fixed-income analyst at Golden Gust Investments (GGIN), an

With regards to Standard IVDuties to Employers, Hart has most likely:

A. violated her duty of loyalty to the firm.

FinQuiz.com 2016 - All rights reserved. 11

Blank will least likely be in violation of Standard III(A)-Loyalty, Prudence, and

A. continues to trade through the broker.

The firm is most likely in violation of:

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Standard l(C)-Misrepresentation, does not allow a member or candidate to reissue

A. more critical when changing recommendations than when making initial

18. Money-Etched Investments (MEIN) is a firm that attained considerable popularity

FinQuiz.com 2016 - All rights reserved. 13

MEIN has misrepresented performance information, since the 20%-28% return

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Questions 19 through 32 relate to Quantitative Methods

Statement 1: Sample variance calculated with a divisor of n is a biased

He is most accurate with respect to:

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