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

• Question 101:

  Using the infinite period Dividend Discount Model, what is the value of a stock with the following

  characteristics?

  Current dividend $6

  Long term dividend growth rate 8%

  Required rate of return 12%

  A. $96.00

  B. $75.00

  C. $14.25

  D. $48.00

  E. $162.00

  F. $72.00

  Correct Answer: E

  The infinite period DDM indicates that:

  Value = (Dividend for period 1)/k-g where k is the required rate of return and g is the growth rate. In this case, Value = ($6 x 1.08)/(.12-.08) = $6.48/.04 = $162.

• Question 102:

  Consider the following annual growth forecasts for a common stock:

  Growth in years 1-3 = 25% Growth after year 3 = 15%

  Assuming that the last dividend was $2.25 per share, and the required rate of return is 20% per year, what is the value of this common stock?

  A. $63.78

  B. $58.23

  C. $71.92

  D. $65.82

  E. None of these answers is correct.

  F. $72.10

  Correct Answer: D

  To determine the value of a common stock experiencing temporary supernormal growth, use the following equation:

  {V = {[d0 * (1 + gs)^1] / k} + {[d1 * (1 + gs)^2} + ... {dn * (1 + gs)^n} + {[dn * (1 + gs)^n * (1 + gn] / (k - g)}/ (1

  + k)^n}}

  Where: V = the value of common stock at t0, d0 = the dividend at t0, d1 = the dividend at t1, dn = the dividend at tn, gs = the supernormal rate of growth, gn = the normal rate of growth, n = the time period "n", and k = the required rate of return.

  In this example, there is a supernormal growth period of three years, during which the growth rate of this common stock is expected to grow at 25% annually. After this period of supernormal growth, the growth rate is anticipated to settle to a "normal" rate of 15%, and this rate is expected to remain stable indefinitely. The calculation of the value of this common stock is illustrated as follows:

  {V = {[$2.25 * (1.25)^1] / (1.20)} + {[$2.25 * (1.25)^2] / (1.20)^2} + {[$2.25 * (1.25)^3] / (1.20)^3}{{[$2.25 * (1.25)^3 * (1.15)^1]/ (0.20 - 0.15)}/ (1.20)^3}

  which can be deduced to the following:

  {V = [$2.34375 + $2.441406 + $2.543132 + $58.492025] = $65.82}

• Question 103:

  If a stock price that was previously in a rising trend channel suddenly enters a flat trend channel,

  A. most technical analysts would sell the stock on the presumption that it will next enter a declining trend channel. A declining trend channel is a general pattern of price decline, while a flat trend channel is a pattern of unpredictable price fluctuation.

  B. some technical analysts would sell the stock in case it will enter a declining trend channel. Most analysts will keep the stock and see what occurs. A flat trend channel is a pattern of price stability.

  C. most technical analysts would buy the stock on the presumption that it will soon re-enter the rising trend channel. A rising trend channel is a general pattern of price increase, while a flat trend channel is a pattern of unpredictable price fluctuation.

  D. all technical analysts would sell the stock on the belief that it will almost certainly enter a declining trend channel. A declining trend channel is a general pattern of price decline, while a flat trend channel is a pattern of price stability.

  Correct Answer: B

  A declining trend channel is a general pattern of price decline. A rising trend channel is a general pattern of price increase, while a flat trend channel is a pattern of price stability. Most technical analysts would keep a stock that has changed from being in a rising trend channel to a flat trend channel because of the possibility of it re-entering the rising trend channel. If the stock price breaks out on the downside, then the analysts would take that as a sign of an incipient declining trend channel, and sell the stock.

• Question 104:

  If the overall price trend of the market has been down, the moving-average line would generally lie ________ current prices.

  A. can't be determined without further information

  B. below

  C. on

  D. above

  Correct Answer: D

  Moving averages lag current trends because data used to calculate moving averages is from recent past.

• Question 105:

  Assume the following information about a stock market series:

  Observed beginning series value: 1677 Anticipated ending series value: 1890 Expected dividends during the period: $16.36 Required rate of return: 19.50% per year

  What is the expected annual rate of return for this index? (Assume a one-year holding period.)

  A. 12.14%

  B. 14.79%

  C. 10.40%

  D. None of these answers is correct.

  E. 11.73%

  Correct Answer: D

  The anticipated rate of return for this stock market series is found as 13.68%. Thus, none of these answers

  is correct.

  To calculate the expected rate of return for a stock market series, the following information must be known:

  The beginning value for the series

  The anticipated ending value for the series, and

  The amount of any dividends and/or distributions during the period

  Once this information has been determined, the expected return on a stock market index can be found by

  employing the following equation:

  E(R) = [(EV - BV + Div) / BV]

  Where: E(R) = the expected return on the stock market series, EV = the anticipated ending value for the

  series, BV = the observed beginning value for the series, and Div = the amount of any dividends paid

  during the period.

  In this example, all of the necessary information has been provided and the calculation of the expected

  return on this stock market series is found as follows:

  E(R) = [$1890 - $1677 + $16.36] / 1677 = 13.68%

  This is significantly less than the required rate of return. Assuming that both the ending value and dividend

  figure is accurate, investment in this stock market series is likely not warranted.

• Question 106:

  Technical analysis

  A. does not conflict with the efficient market hypothesis. Technical analysis claims that the market moves in trends that can be predicted before they occur. The key to profiting from technical analysis involves a consistent ability to use past and present market data to predict future trends.

  B. does not conflict with the efficient market hypothesis. Technical analysts believe that information is disseminated slowly, first to the professionals, and later to the great bulk of investors. This causes stock prices to move in trends.

  C. conflicts with the efficient market hypothesis. Technical analysis claims that the market moves in trends that can be predicted before they occur. These trends are caused by the fact that information is disseminated relatively quickly.

  D. conflicts with the efficient market hypothesis. Technical analysts believe that information is disseminated relatively slowly, first to the professionals, and later to the great bulk of investors. In contrast, advocates of the efficient market hypothesis believe that information is spreads very quickly and is reflected in stock prices soon after it is available.

  Correct Answer: D

  Technical analysts believe that information is disseminated relatively slowly, causing the market to move in trends. They key to profiting from technical analysis lies in finding existing trends and exploiting them. The efficient market hypothesis holds that past market data (which is used to find trends) is already reflected in current prices, making effective technical analysis impossible.

• Question 107:

  An analyst with Smith, Kleen and Beetchnutty is trying to determine the earnings multiple of a stock market series composed of firms in the basic materials business. In her research, the analyst has gathered the following information:

  D1: $1.10 EPS: $4.30

  k: 13.75% per year

  g: 10.50% per year

  Using this information, what is the earnings multiplier of this stock market series? Further, is this multiple realistic for firms in the basic materials business?

  A. None of these answers is correct.

  B. 7.88, no

  C. 33.84, no

  D. 7.88, yes

  E. 10.54, no

  F. 10.54, yes

  Correct Answer: D

  To determine the earnings multiplier, or "P/E ratio," of a stock market series, use the following equation: P/ E = [(D1 / E1) / (k-g)

  Where: D1 = the annual per-share dividend at t1, E1 = the EPS figure at t1, k = the required rate of return on common stock, and g = the expected growth rate of dividends. In this example, all of the necessary information has been provided, and putting it into the equation above will yield the following:

  P/E of a stock market series = [($1.10*1.105 / ($4.30*1.105)) / (0.1375 - 0.105)] = 7.88

  This is a rather low multiple, appropriate for slow growth industries. The fact that the index under examination is a compilation of firms in the basic materials business substantiates this low multiple because firms in this line of business are not expected to grow very rapidly. Further, firms in the basic materials business are also likely to have a relatively high dividend payout ratio, as evidenced in this example.

• Question 108:

  An analyst would buy when this ratio approaches 13 percent and sell when it approaches 7 percent. This relates to:

  A. Odd-Lot, Short-Sales Theory

  B. Mutual Fund Cash Positions

  C. Block Uptick-Downtick Ratio

  D. Margin Debt

  Correct Answer: B

  Mutual funds tend to keep a portion of the investment portfolio in cash, specifically in the region of 13 to 7 percent, buying and selling cash positions to keep the cash portion in this band.

• Question 109:

  If the earnings per share on the SandP 500 index increases by 16% and the earnings multiplier decreases by 9%, the index will experience a change of:

  A. +16%

  B. -9%

  C. +26.44%

  D. +5.56%

  Correct Answer: D

  The index value = earnings multiplier * earnings per share. Therefore, the change in index value equals

  1.16 * 0.91 - 1 = 5.56%

• Question 110:

  A portfolio manager who uses the "top down" approach to investment evaluation would most likely begin her examination with which of the following?

  A. An examination of alternative industries.

  B. None of these answers is correct.

  C. An examination of governmental and regulatory influences.

  D. An analysis of the macroeconomic environment.

  E. More than one of these answers is correct.

  F. An analysis of specific securities.

  Correct Answer: D

  The top down approach typically begins with an examination of the macroeconomic environment, then progresses to an examination of alternative economies and securities markets, then to an analysis of specific industries, and finally to the examination of specific securities. The objective of the top down approach is to first decide how to allocate investment funds among various economies and styles of securities (bonds, equities, cash, etc.), then to decide which economies and industries will prosper in the current environment. The objective of the last stage of the top down approach (i.e. the examination of individual securities and companies) is to determine which companies within the selected industries offer superior investment prospects (i.e. identify investments that are undervalued).