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

• Question 251:

  If 80% of investment advisory services have bullish attitudes on the stock market, technicians may view this as

  A. a bearish sign.

  B. a bullish sign.

  C. inconsequential.

  D. indicative of an unpredictable, volatile market.

  Correct Answer: A

  Many technicians feel that investment advisory services tend to be trend followers, so that by the time most services are bullish, the bull market is nearing its peak and will soon be followed by a new bear market. For this reason, such a sign would be viewed as bearish.

• Question 252:

  Changes in the unit labor cost are caused by changes in

  A. hours worked and worker productivity.

  B. wages per hour and worker productivity.

  C. hours worked.

  D. wages per hour, hours worked, and worker productivity.

  E. worker productivity.

  Correct Answer: B

  Finkel and Tuttle found that the capacity utilization rate, unit labor costs, rate of inflation, and foreign competition were the four major variables that affected the aggregate profit margin. Per-unit labor cost is a function of the percentage change in hourly wages minus the percentage change in productivity during some period of time.

• Question 253:

  When an analyst would like to estimate the earnings-per-share for a stock market series, her analysis would likely begin with which of the following activities?

  A. Analyzing competitive pressures within the series

  B. Formulating a composite of depreciation and amortization figures for the series

  C. Estimating the profit margin of the series

  D. Estimating the tax rate for the series

  E. Estimating the sales-per-share of the series

  Correct Answer: E

  When an analyst is trying to determine the EPS for a stock market series, the following series of 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.

• Question 254:

  Marlene Gooseberry, an institutional money manager with Middle Road Brokerage, has been examining a stock market series and has determined the following information: The dividend payout ratio has been estimated at: 31% The required rate of return is 16% per year The anticipated future growth rate of dividends is 13.75% per year The anticipated future growth rate of earnings is 14.25% per year The corporate tax rate is 35%

  What is the earnings multiplier for this stock market series? Choose the best answer.

  A. None of these answers is correct.

  B. 7.75

  C. 13.78

  D. 17.71

  E. 8.96

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

  Correct Answer: C

  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, and the calculation of the earnings multiplier is shown as follows:

  P/E = [0.31 / 0.16 - 0.1375] = 13.78

  Notice that it was the anticipated growth rate of dividends, not the anticipated growth rate of earnings, which was used in determining the earnings multiplier. Additionally, note that the tax rate was notexplicitly factored in to the equation, as the earnings figure used in the dividend payout ratio is already an after-tax figure.

• Question 255:

  A portfolio manager is in the process of forecasting an earnings multiplier for the specialty software industry. In his analysis, this portfolio manager examines the historical payout ratio, required rate of return, and growth forecasts for the software industry, and then compares these figures to those of the overall market. Which of the following best characterizes this method of forecasting an industry earnings multiple?

  A. Microsimulation

  B. Microanalysis

  C. Monte Carlo simulation

  D. Macroanalysis

  E. Macrosimulation

  F. Porter Method

  Correct Answer: B

  The method profiled in this example is "microanalysis," which is one of two methods for estimating the earnings multiplier of an industry. Microanalysis involves examining the variables underlying the earnings multiplier - the required rate of return, the growth forecast, and the dividend payout ratio. In microanalysis, these variables are examined for the industry and then compared with the values of these variables for the entire market.

  The microanalysis method is contrasted by the macroanalysis method, which involves examining the historical relationship between the earnings multiplier of an industry with that of the overall market. Macroanalysis forecasts often use a time series.

  The "Porter Method" is used to examine the level of competition within an industry, and "Monte Carlo simulation" is a method of measuring stand-alone risk. "Microsimulation," and "macrosimulation" are largely fictitious terms.

• Question 256:

  The assumptions underlying technical and fundamental analysis differ in many respects. Which of the following is an important difference between technical analysis and fundamental analysis? Choose the best answer.

  A. None of these answers is correct.

  B. All of these choices are important differences between technical analysis and fundamental analysis.

  C. Technical analysis assumes that securities "price in" information immediately, whereas fundamental analysts assume that securities markets "price in" information gradually.

  D. Technical analysis assumes that the Weak Form of the Efficient Market Hypothesis is correct, whereas fundamental analysis assumes that it is incorrect.

  E. Technical analysis is not reliant on financial statements whereas fundamental analysis is heavily reliant on financial statements.

  Correct Answer: E

  Of all the differences between technical analysis and fundamental analysis, perhaps the most important is the fact that technical analysis assumes that securities markets are not weak form efficient, whereas fundamental analysis assumes that the Weak Form of the EMH is correct. Technical analysts assume that securities markets will "price-in" relevant information gradually, and that securities prices follow observable trends and patterns. Fundamental analysts, on the other hand, generally assume that past price information cannot be used to predict movements in securities prices.

• Question 257:

  A diffusion index is equal to

  A. the daily total of advancing stocks plus one-half the number of unchanged stocks, divided by the total number of stocks traded.

  B. the daily total of advancing stocks divided by the number of declining stocks.

  C. the daily total of advancing stocks plus one-half the number of unchanged stocks, divided by the number of declining stocks.

  D. the daily total of advancing stocks divided by the total number of stocks traded.

  Correct Answer: A

  The diffusion index is an alternative specification of advance-decline series, and is used as an indicator of the direction of the market. If the index reaches up to levels of 56 to 60, the market is considered overbought. If it comes down to levels of 40 to 44, the market is considered over oversold.

• Question 258:

  Which of the following correctly illustrates the infinite period dividend discount model?

  A. V = D0(1 + g) / (k - g)

  B. None of these answers is correct.

  C. (1 + g) = D0 * k / D1

  D. (1 + k)(1 +g) / V = P0/(k-g)

  E. V = {[D0 / (1 + r)] + [D1 / (1 + r)(1 + r)] ...+ [Dn / (k-g)]}

  F. V = D1/k

  Correct Answer: A

  The traditional equation for the infinite period dividend discount model is as follows: Value of common

  stock = D1 / (k - g)

  Where: D1 = the dividend at t1, k = the required rate of return, and g = the assumed growth rate of

  dividends.

  Remember that the dividend at t1, which is characterized as "D1" is calculated by multiplying the dividend

  at t0 by (1 + growth rate of dividends). This equation will produce logical results regardless of whether

  growth or contraction of dividends is expected in the future.

• Question 259:

  What is the value of a stock that paid a $10 per share dividend this year, and is expected to pay a dividend 20% higher 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 10% per year?

  A. Not able to compute with the above data.

  B. $45.49

  C. $50.16

  D. $47.27

  Correct Answer: D

  Value = $52/1.10=$47.27

• Question 260:

  The price/cash flow ratio is used to supplement the P/E ratio in company analysis because:

  I. A firm's cash flow is typically subject to less accounting manipulation than reported earnings,

  II. Cash flow has become an important measure of performance, value and financial strength because numerous academic studies have shown that various cash flow measures can be used to predict both success and future problems

  III. Under theoretically ideal conditions, the market value of a firm should reflect its book value

  IV.

  Cash flow data have become more accessible

  V.

  It is easier to compute

  A.

  II, III IV

  B.

  II, IV, V

  C.

  All of these answers

  D.

  I, II, III

  E.

  I, II, IV

  Correct Answer: E

  Developing benchmark values for these ratios is important because, similar to P/Es and P/BV ratios, they are relative measures of value.