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

• Question 161:

  The first thing one does using the top-down, three step approach to stock valuation is

  A. analyze specific company performance. One undertakes such analysis to find the best performing companies in a particular industry. After finding industry favorites, one would then examine which

  industries look promising.

  B. analyze the general economic influences affecting a national or regional economy. Such analysis includes research on fiscal policy, monetary policy (with its multiplier effect), inflation, and other events such as wars or political upheavals.

  C. analyze the general economic influences affecting a national or regional economy. There is a particular focus on inflation because of the important multiplier effect that inflation has on the rest of the economy, particularly aggregate demand.

  D. analyze the general economic influences affecting a national or regional economy. There is a particular focus on government monetary policy because of the important multiplier effect that monetary policy has on the rest of the economy.

  E. analyze the general economic influences affecting a national or regional economy. Such analysis includes research on fiscal policy (with its multiplier effect), monetary policy, inflation, and other events such as wars or political upheavals.

  Correct Answer: E

  The first step in the top-down, three-step approach to valuation is analysis of alternative economies and securities markets in order to decide how to allocate investment among different countries and securities. That includes analysis of fiscal and monetary policies, inflation, and other events such as wars and political upheavals that might affect these decisions.

  Exam T

• Question 162:

  Estimates of earnings per share for a market series will consider which of the following factors?

  A. Sources for an estimate GNP

  B. Operating profit margin for the series

  C. All of these answers

  D. Depreciation and interest expense per share

  Correct Answer: C

  To estimate expected earnings per share considering an outlook for the aggregate economy and for the corporate sector, it is necessary to estimate GNP and sales per share, the operating profit margin, depreciation, interest expense and the corporate tax rate per share for the next year.

• Question 163:

  A stock paid a $5 per share dividend this year. The company's dividends are expected to grow at 5% per year, forever. What is the value of the stock if the appropriate discount rate is 8% per year?

  A. $17.50

  B. $167.12

  C. $175.00

  D. Not able to compute with the above data.

  Correct Answer: C

  Value = $5.25/(0.08-0.05) = $175.00

• Question 164:

  Recent ________ is the biggest external factor that affects the growth rate of the depreciation expense series.

  A. interest

  B. change in current levels

  C. taxes

  D. capital expenditures

  Correct Answer: D

  One way to understand this is: depreciation is most acute with new assets; if one has recently invested in new assets (i.e. capital expenditures), one would expect depreciation expense to increase. But know well that capital expenditure may not be only new asset purchase.

• Question 165:

  Alice Treehorn, a portfolio manager for a private investment firm, uses a specific methodology for identifying investment opportunities. Specifically, Ms. Treehorn begins with an examination of macroeconomic cycles and the overall global investment environment. After promising areas have been identified, Ms. Treehorn then progresses in her analysis to an examination of governmental and regulatory influences in each geographical region, as well as the prospect for specific industries in each region. Finally, the analysis concludes with an examination of specific securities.

  Which of the following best characterizes the investment approach taken by Alice Treehorn?

  A. Security valuation approach

  B. Top down approach

  C. Root analysis

  D. Macroeconomic cycle approach

  E. Bottom up approach

  F. None of these answers is correct.

  Correct Answer: B

  The approach detailed in this example is best characterized as the "top down" approach. Securities industry professionals commonly use the top down approach to identify investment opportunities, and this method has a strong following in both the academic and professional arenas. The process involved in the top down approach begins with an examination of the macroeconomic environment, then progresses to governmental, security market analysis and industry analysis, and finally to an examination of specific securities. The top down approach is contrasted by the bottom up approach, which begins with an examination of specific companies and their securities.

• Question 166:

  A high-growth firm is expected to have a dividend growth of 10% for the next 2 years. It is then expected to stabilize at 4%. The firm has just paid a dividend of $2 and investors require a rate of return of 14%. The market price of the firm's stock is:

  A. $17.98

  B. $21.26

  C. $19.68

  D. $23.46

  Correct Answer: B

  Since the dividends do not grow at a constant rate, you cannot directly apply the Dividend Discount Model valuation formula. However, note that 2 years from now, looking into the future, you will see a constant growth rate of 4% and the dividend 3 years from now will be $2 * 1.1^2 * 1.04 = $2.517. Therefore, the stock price 2 years from now, using the required rate of return of 14%, will equal P = 2.517/(14% - 4%) = $25.17. Thus, the current stock price equals 1.1/1.14 + (1.1/1.14)^2 + 25.17/1.14^2 = $21.26.

  Note that you must be very careful about the time line. In the Dividend Discount Model valuation formula, the price at time t uses the dividend paid at time (t+1). That's the reason we had to use the dividend paid in year 3 to calculate the price at the end of year 2.

• Question 167:

  Which of the following is/are true about a firm's stock?

  I. A decrease in the beta of a stock will raise its price.

  II. An increase in the variance of a stock will raise its price.

  III. An increase in the market's expected return will raise its price.

  IV.

  An increase in the risk aversion of investors will raise its price.

  A.

  III only

  B.

  IV only

  C.

  II only

  D.

  II and III

  E.

  I and III

  F.

  I only

  Correct Answer: F

  A decrease in the beta of a stock decreases its expected return, causing its price to rise. On the other hand, an increase in the market's expected return or an increase in risk aversion raises the expected return on the stock, decreasing its price. Finally, an increase in the variance of the stock does not necessarily change its expected return. Only if the systematic component of the stock's variance changes will the expected return change, causing a price change.

• Question 168:

  The value of a preferred stock is the stated ________ divided by the required rate of return on the preferred stock.

  A. monthly portfolio return

  B. monthly value estimate

  C. annual dividend

  D. daily dividend

  Correct Answer: C

  The value of preferred stock is the stated annual dividend divided by the required rate of return on preferred stock.

• Question 169:

  Two firms, A and B, have identical operations set up (except for their relative sizes). A has a debt-to-equity ratio of 0.4 while B has it at 0.3. A's profit margin is 1.2 times that of B but its sales force is not as effective as that of B. Hence, A's asset turnover is 0.9, compared to B's ratio of 1.15. A pays out 45% of its earnings as dividends while B pays out only 20%. Given this, the ratio of A's growth rate to B's growth rate must be:

  A. 1.23

  B. 0.70

  C. 1.44

  D. 0.88

  Correct Answer: B

  Use g = ROE * retention ratio and

  ROE = profit margin * asset turnover * financial leverage.

  Financial leverage = assets/equity = 1 + debt/equity.

  The ratio of A's growth rate to B's growth rate equals 1.2*(0.9/1.15)*[(1+0.4)/(1+0.3)]*[(1-0.45)/(1-0.20)] =

  0.70

• Question 170:

  An investor purchases 500 shares of Microscam common stock for $58.74 per share at t0. At t1, dividends of $1.20 per share are received on the 500 shares owned and the investor purchases an additional 340 shares at $60.12 per share, At t2, dividends of $1.20 are received on the 840 shares owned and he purchases another 60 shares for $55.14 per share. At t3, the investor sells 500 shares of Microscam for $61.25 per share and the other 400 shares for $62 per share. No dividend are received at t3. Assuming no taxes or commissions, what is the dollar-weighted rate of return for this investment?

  A. The answer cannot be calculated from the information provided.

  B. None of these answers is correct.

  C. 6.03%

  D. 4.55%

  E. 2.94%

  F. 5.23%

  Correct Answer: E

  Remember that the dollar-weighted rate of return uses the IRR equation in the determination of the

  answer. Further, the dollar-weighted rate of return is another name for the IRR equation, and this

  nomenclature is commonly used within the field of investment management. In the determination of the

  dollar-weighted rate of return calculation, the first step should be to identify the cash flows for each period.

  This process is illustrated as follows:

  t0: {-[500 shares purchased * $58.74 per share] = ($29,370.00)

  t1: {-[340 shares purchased * $60.12 per share] + [$1.20 per share dividend * 500 shares] = ($19,840.80)

  t2: {-[60 shares purchased * $55.14 per share] + [$1.20 per share dividend * 840 shares]} = ($2,300.40) t3:

  {[500 shares sold * $61.25 per share] + [400 shares sold * $62 per share] = $55,425.00

  Now that the cash flows have been determined, incorporating this information into your calculator's cash

  flow worksheet and solving for IRR will yield a dollar-weighted rate of return of 2.94% for this investment.