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

• Question 231:

  Technical analysts believe that

  A. prices adjust instantaneously to new information.

  B. prices adjust quickly to new information.

  C. prices adjust slowly to new information.

  D. prices never adjust to much new information.

  Correct Answer: C

  Technical analysis, in contrast to the efficient market hypothesis and fundamental analysis, holds that past price and volume data can be used to discover market trends that can predict future market behavior. In order for the market to have these trends, prices must adjust slowly to new information, rather than quickly or instantaneously. Adjustment is slow because of different sources of information or because certain investors receive information before others.

• Question 232:

  This is the ratio of the price of a stock or an industry index to the value for some stock series.

  A. Block Uptick-Downtick Ratio

  B. Relative Trend

  C. Odd-Lot, Short-Sales Theory

  D. Mutual Fund Cash Positions

  E. Short Sales by Specialists

  F. Diffusion Index

  G. Margin Debt

  H. Dow Theory

  Correct Answer: B

  The relative trend (or relative-strength ratio) is the ratio of the price of a stock or an industry index to the value for some stock market series like the DJIA or the SandP 400. If this ratio increases over time, it shows that the stock or industry is outperforming the market and a technician would expect this superior performance to continue.

• Question 233:

  Jones Rutherford, a portfolio manager with Churn Brothers Brokerage, has been examining a stock market series and is trying to determine an appropriate earnings multiplier for the series. In this analysis, Jones has amassed the following information:

  The next estimated annual dividend per share = $2.30 The estimated earnings per share next year = $4.85 The anticipated growth rate of dividends is 10% per year The anticipated growth rate of earnings is 9% per year The required rate of return is 14% per year

  Given this information, what is the appropriate earnings multiplier for this stock market series?

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

  B. None of these answers is correct.

  C. 9.48

  D. 10.51

  E. 13.14

  F. 13.04

  Correct Answer: B

  The appropriate earnings multiplier for this stock market series is found as 11.86, therefore none of these answers is correct.

  Estimating the earnings multiplier for a stock market series requires the estimation of each of the following components:

  The dividend payout ratio.

  The required rate of return on common stock in the country/region/industry/sector being analyzed.

  The expected growth rate of dividends for the stocks in the country/region/industry/sector being analyzed.

  Once values for each of these components have been determined, they are imputed into the following

  formula:

  P/E = [D/E / (k - g)]

  Where: P/E = the earnings multiplier, or Price-to-Earnings ratio, D/E = the dividend payout ratio at t1, k =

  the required rate of return, and g = the anticipated growth rate of dividends. In this example all of the necessary information has been provided. However, the dividend payout ratio must be calculated based on the anticipated dividend at t1 and the projected EPS figure for t1. The calculation of the dividend payout ratio is as follows:

  D/E = [$2.30 / $4.85] = 0.474227

  Now that the dividend payout ratio has been determined, the appropriate earnings multiplier is found as follows: P/E = [0.474227/ (0.14 - 0.10)] = 11.86 Notice that it is the anticipated growth rate of dividends, not the anticipated growth rate of earnings, which

  is used in the determination of the earnings multiplier.

• Question 234:

  According to the infinite period dividend discount model, the value of a common stock is equal to

  A. next period's dividend, divided by the required rate of return minus the growth rate of dividends.

  B. this period's dividend, divided by the growth rate of dividends.

  C. this period's dividend, divided by the required rate of return minus the growth rate of dividends.

  D. next period's earnings, divided by the required rate of return minus the growth rate of dividends.

  E. this period's earnings, divided by the required rate of return minus the growth rate of dividends.

  Correct Answer: A

  With certain assumptions, including a constant rate of dividend growth, the infinite period Dividend Discount Model can be simplified 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.

• Question 235:

  Which of the following is not involved in the estimation of the earnings per share (EPS) for a stock market series?

  A. Estimate next year's operating profit.

  B. Estimate next year's interest expense.

  C. Estimate next year's corporate tax rate.

  D. Estimate the sales per share of the series.

  E. Estimate next year's depreciation per share.

  F. Estimate next year's dividend payout ratio.

  Correct Answer: F

  While somewhat intuitively appealing, the estimation of next year's dividend payout ratio is not necessary when determining the anticipated EPS for a stock market series. The other five choices represent all the necessary steps in the estimation process.

• Question 236:

  What is the value of a stock that is expected to pay a $15 per share dividend in a year's time? The stock is expected to be selling for $40 per share at the end of the year. The appropriate discount rate is 12% per year.

  A. Not able to compute with the above data.

  B. $4.91

  C. $49.11

  D. $55.34

  Correct Answer: C

  Value = $55/1.12=$49.11

• Question 237:

  A market researcher with Churn Brothers Brokerage is attempting to estimate the earnings per share

  (EPS) for a broad market index, and has assimilated the following information:

  Sales per share: $700

  Next year's operating profit margin: 25%

  Next year's depreciation per share: $80

  Next year's interest expense: $45.50

  Next year's corporate tax rate: 35%

  Using this information, what is the EPS figure for this stock market series?

  A. $32.17

  B. $164.18

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

  D. $46.56

  E. None of these answers is correct.

  F. $112.67

  Correct Answer: A

  The estimation of EPS for a stock market series involves five steps. Specifically, to determine an estimate of EPS for a stock market series, it is necessary to:

  Estimate the sales per share Estimate next year's operating profit (EBIDT), or operating profit margin Estimate next year's depreciation per share Estimate next year's interest expense per share Estimate next year's corporate tax rate

  Once estimates for these components have been determined, they are put into the following equation:

  EPS for a stock market series = {[(Sales per share * operating profit margin) - depreciation per share interest expense per share] * (1 - corporate tax rate).

  Putting the given information into this equation will yield the following:

  EPS for a stock market series = {[($700 * 0.25) - $80 - $45.50] * (1 - 0.35)} = $32.17

  If you chose $112.67, remember that the depreciation figure is not added back to the EPS figure in the calculation of EPS for a stock market series. What we are looking at is operating earnings after tax, not a cash-based figure.

• Question 238:

  Which of the following are challenges to technical analysis?

  I. Technical analysis involves a great deal of subjective judgement.

  II. Technical analysis is heavily reliant on financial statements.

  III.

  The majority of studies have supported the Weak Form Efficient Market Hypothesis. IV. The standard rules that signal investment decisions can change over time.

  V.

  The majority of studies have concluded that securities prices do not move in trends.

  VI.

  Technical analysis assumes that supply-demand fluctuations lead to changes in securities prices.

  A.

  I, III, IV, V, VI

  B.

  I, II, IV, V,

  C.

  I, III, IV, V

  D.

  I, III, IV

  E.

  I, II, III, IV, V, VI

  Correct Answer: C

  Of the choices listed, only II and VI are not criticisms of technical analysis. While VI appears correct, it is not. In fact, both fundamental and technical analysis recognize the importance of supply and demand fluctuations. The difference is that technical analysis assumes that supply and demand are influenced by both rational and irrational factors, whereas the EMH assumes that investors are rational. Had choice VI been phrased as "technical analysis assumes that supply-demand fluctuations, which are caused in part by irrational forces, are the only determinants of shifts in securities prices," then it would be correct in this example.

• Question 239:

  Given that next period's dividend will be $2.50, the growth rate of dividends is 7%, and the risk premium on the common stock is 11%, using the infinite period Dividend Discount Model, what is the current value of the common stock?

  A. $38.52

  B. Not enough information

  C. $62.50

  D. $22.73

  E. $18.94

  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. In order to solve for the current value, the required rate of return on the common stock must be known. But only the risk premium is known, which, without the risk-free rate, cannot be used to derive the required rate of return

• Question 240:

  ________ = Retention Rate x Return on Equity

  A. risk free rate, RFR

  B. growth, g

  C. required rate, k

  D. period 1 earnings, E1

  Correct Answer: B

  By definition: growth, g = retention rate x ROE