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

• Question 111:

  You are going to hold a stock for an infinite amount of time. The current dividend is $1 per share and is expected to grow at 15% a year. Your long run required return is 20%. Using the infinite period dividend discount model calculate the value of the stock.

  A. none of these answers

  B. $23.00

  C. $25.60

  D. $26.45

  Correct Answer: B

  g = .15 k = .20 Dividend = 1.15 x $1.00 = $1.15 V = 1.15/(.20 - .15) = $23.

• Question 112:

  As the covariance of a stock's return with the market portfolio increases, its price ______, all else equal.

  A. can be all of these answers

  B. is not affected

  C. decreases

  D. increases

  Correct Answer: C

  As the covariance of a stock's return with the market portfolio increases, its betaincreases. This increases its expected return in the CAPM framework, causing its price to decline.

• Question 113:

  An increase in the dividend payout ratio, a decrease in the required rate of return, and a slight increase in the growth rate would

  A. have an unpredictable affect on the earnings multiplier.

  B. increase the earnings multiplier.

  C. decrease the earnings multiplier.

  D. slightly decrease the earnings multiplier.

  Correct Answer: B

  The earnings multiplier is equal to Dp / (k - g), where Dp is the dividend payout ratio, k is the required rate of return, and g is the growth rate. The changes specified in this question would undoubtedly increase the earnings multiplier. This estimate is an example of the direction of change approach, which begins with the current earnings multiplier and estimates the direction and extent of change for the dividend payout ratio and the variables that influence the required rate of return and the growth rate of dividends and earnings.

• Question 114:

  If the 50-day moving average for the stock price crosses the 150-day moving average from below on heavy volume, technical analysts would consider this to be

  A. inconsequential.

  B. a sign of a flat trend.

  C. a bullish sign.

  D. a bearish sign.

  Correct Answer: C

  Technical analysts use moving averages of past stock prices as indicators of long-term trends. When the 50-day moving average crosses the 150-day moving average from below on heavy volume, this is viewed as a bullish sign possibly signaling a reversal in the declining price trend. In order for such a crossing to occur, the stock price must be going though a recent uptrend, which is pulling up the 50-day moving average faster than the 150-day moving average.

• Question 115:

  Common stocks that experience dividend growth than is consistently higher than their required rates of return

  A. are valued very highly using the infinite period Dividend Discount Model.

  B. cannot be valued using the infinite period Dividend Discount Model.

  C. are prime candidates for valuation using the infinite period Dividend Discount Model.

  D. tend to underperform the market.

  Correct Answer: B

  The infinite period Dividend Discount Model postulates that the current value of a common stock is equal to D1 / (k - g), where D1 is next period's dividend, k is the required rate of return, and g is the growth rate of dividends. If the growth rate of dividends exceeds the required rate of return, the value of the stock is shown to be negative, which is impossible. The infinite period Dividend Discount Model cannot be used to value such stocks.

• Question 116:

  The CBOE put/call ratio

  A. is used by contrary-opinion technical analysts. They view a ratio of 1.00 or greater to be a bearish sign. The value of the ratio has historically been in the 0.25 to 0.75 range, but has now moved considerably higher.

  B. is used by technical analysts who try to follow the "smart money." They view a ratio of .90 or greater to be a bearish sign. The value of the ratio has historically been in the 0.30 to 0.85 range, but has now moved considerably higher.

  C. is used by contrary-opinion technical analysts. They view a ratio of 0.70 or less to be a bearish sign. The value of the ratio has historically been in the 0.35 to 0.80 range, but has now moved considerably higher.

  D. is used by technical analysts who try to follow the "smart money." They view a ratio of 0.60 or less to be a bullish sign. The value of the ratio has historically been in the 0.40 to 0.90 range, but has now moved considerably lower.

  Correct Answer: C

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

• Question 117:

  A portfolio manager with Churn Brothers Brokerage is examining shares of a large industrial firm and has gathered the following information:

  Market discount rate: 13.75% per year Observed Price/Earnings ratio: 15.43

  Given this information, what is the Franchise Price/Earnings ratio for this large industrial firm?

  A. The answer cannot be calculated from the information provided

  B. 8.16

  C. 22.70

  D. 17.89

  E. 13.56

  Correct Answer: B

  The Franchise Factor method of value measurement is in many respects similar to EVA and MVA calculations. When examining a company using the franchise value approach, the observed price-toearnings ratio is broken down into its two components - (1) the "base P/E," which is based on the Company's ongoing performance, and (2) a "franchise P/E" that is based on the expected value of new and profitable business opportunities. This relationship is illustrated as follows:

  Franchise P/E = Observed P/E - Base P/E

  where the Base P/E equals the reciprocal of the market discount rate. For example, if the market discount rate is 13.75%, the base P/E would be equal to 7.27273 In this example, all the necessary information has been provided, and the calculation of the Franchise P/E is as follows:

  Franchise P/E = (15.43 - 7.27273) = 8.15727

• Question 118:

  Which of the following represents a "smart money" technical indicator?

  A. Futures traders bullish on stock index futures.

  B. Breadth of market.

  C. Short interest.

  D. Diffusion Index.

  E. None of these answers is correct.

  F. Debit balances in brokerage accounts.

  Correct Answer: F

  Of the choices listed, only "debit balances in brokerage accounts" is a smart money technical indicator. Technical analysts view investors who leverage their portfolios through margin loans as being sophisticated. So said, technical analysts see an increase in debit balances, i.e. an increase in margin borrowing, as a bullish signal. Conversely, technical analysts would view a decline in margin borrowingas a bearish sign. While this viewpoint is somewhat counter intuitive, the degree to which technical analysts use aggregate margin debit balances to track the "smart money" is high. "Breadth of market" refers to the measure of advancing versus declining issues. The Diffusion Index is a measure of market breadth and is defined as the volume of advancing issues plus one-half of the volume of unchanged issues, divided by the total number of issues traded. Short interest measures the total volume of outstanding short positions, and the sentiment of futures traders is used by contrarian technical analysts, who take a contra approach.

• Question 119:

  Given that an individual owns a common stock with a required rate of return of 15%, on which he expects to receive a dividend of $5 after one year, after which time he will immediately sell it for an expected price of $30, what is the value of the common stock to the individual?

  A. $30.94

  B. $30.43

  C. $31.09

  D. $35

  E. Not enough information

  Correct Answer: B

  According to the dividend discount model with a finite horizon, the value of a common stock to the owner is the present value of the future dividends that he will receive, and the present value of the price for which he will sell the stock. In this question, the value of the stock will be 5/1.15 + 30/1.15 = $30.43

• Question 120:

  An analyst with Smith, Kleen and Beetchnutty Securities is trying to determine the EPS for a stock market series. Which of the following steps will not be involved in his EPS estimation?

  A. Estimate next year's corporate tax rate for the series.

  B. Estimate next year's interest-expense-per-share for the series.

  C. Estimate the sales-per-share for the series.

  D. Estimate the operating profit margin for the series.

  E. All of these steps are required.

  F. Estimate next year's depreciation-per-share for the series.

  Correct Answer: E

  All of these answers are required steps in the estimation of the EPS figure for a stock market series.

  When an analyst is trying to determine the EPS for a stock market series, the following steps represent the preferred method:

  Step 1: Estimate sales-per-share for the series Step 2: Estimate the operating profit margin for the series Step 3: Estimate the depreciation-per-share for the series for the next year Step 4: Estimate the interest-expense-per-share for the next year Step 5: Estimate the corporate tax rate for the next year

  These steps will lead to an EPS figure, which can be multiplied by the appropriate earnings multiplier (i.e. the price-to-earnings ratio) to determine the ending price for the stock market series.