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

• Question 301:

  Assume the following series of financial transactions:

  t0: Purchase 1500 shares of Allcycles.com for $18,555.00 t1: Purchase an additional 500 shares for $8,130.00 t2: Purchase an additional 1000 shares for $18,000.00 t3: Sell 1000 shares for $19,810 t4: Sell the remaining 2000 shares for $42,400

  Investments of this type have typically justified a 12.50% rate of return. Assuming no taxes or transaction costs, what is the dollar-weighted rate of return for this series of investments?

  A. 11.15%

  B. 14.60%

  C. 12.89%

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

  E. None of these answers is correct.

  F. 12.32%

  Correct Answer: C

  Remember that the dollar-weighted rate of return uses the IRR equation in the determination of its 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. So said, the required rate of return is not explicitly factored into the calculation of the dollar-weighted rate of return; rather what is being determined is the rate which equates the present value of the cash inflows to the present value of the cash outflows. In the determination of the dollar-weighted rate of return calculation, the first step should be to identify the cash flows for each period. In this example, the cash flows have been stated, and no preliminary calculation is necessary. The portfolio cash flows are illustrated as follows:

  t0: ($18,555.00) t1: ($8,130.00) t2: ($18,000.00) t3: $19,810.00 t4: $42,400.00

  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 12.885% for this investment

• Question 302:

  A technical analyst with Bullfighter.com, a noted investment research firm, has been examining the U.S. securities markets, and believes that the market is technically "oversold." Which of the following technical indicators would this analyst likely use to support his opinion? Choose the best answer.

  A. The CBOE Put/Call ratio is greater than 50%.

  B. The Confidence Index has decreased substantially.

  C. The ratio of short sales by specialists is at 30%.

  D. The % of issues trading below their 200 day moving average is greater than 80%.

  E. The diffusion index has increased substantially.

  F. All of these are indicative of an oversold condition.

  Correct Answer: D

  The % of issues trading below their 200-day moving average is frequently cited by technical analysts as a measure of oversold and overbought market conditions. Specifically, technical analysts see the market as "oversold" when 80% of issues are trading below their 200-day moving average, and consider a market "overbought" when 80% of issues are trading above their 200-day moving average. The "Diffusion Index" is a measure of market breadth, and is defined as [(# of advancing issues + 1/2 # of issues unchanged) / # of issues traded]. The Confidence Index is used as a measure of international sentiment, and a decline in this index is indicative of widespread investor uncertainty. The CBOE Put/Call Ratio is a contrarian technical indicator used to gauge the sentiment of investment professionals, and a ratio greater than 50% would be viewed by contrarian technical analysts as bullish.

• Question 303:

  A portfolio manager with Churn Brothers Brokerage Company is asked to provide an a registered representative with a figure for the "risk-free interest rate." The portfolio manager references the quoted rate on U.S. Treasury 10-year notes, currently at 4.75% per year, and uses this rate as the risk-free interest rate. Which of the following best describes the rate referenced by this portfolio manager? Further, what two components comprise this rate?

  A. Real interest rate; inflation premium, real inflation-free rate of return

  B. Nominal interest rate; risk premium, real inflation-free rate of return

  C. Nominal interest rate; inflation premium, real inflation-free rate of return

  D. Quoted intrinsic rate, inflation premium, real inflation-free rate of return

  E. Quoted interest rate; nominal interest rate, inflation premium

  F. None of these answers is correct.

  Correct Answer: C

  The risk-free rate as measured by the rate on U.S. Treasury securities often referred to as the "nominal," or "quoted," rate. This rate is comprised of two components, the real "inflation-free" rate of interest, and an inflation premium that is equal to the anticipated rate of inflation. The equation for the calculation of the nominal interest rate is as follows:

  Risk-free rate of return = k* + IP

  where: k* = the real inflation-free rate of return and IP = the inflation premium

  An increase in anticipated inflation will cause a change in the nominal risk-free rate equal to the change in expected inflation. For instance, if the inflation premium increases by 100 basis points, then the nominal risk-free interest rate will increase by 100 basis points. Further, if the inflation-free rate of interest experiences a change, that change will be identically mirrored in the nominal risk-free interest rate. For example, suppose the inflation-free rate of interest decreases by 50 basis points. In this situation, the result would be a 50 basis point reduction in the nominal risk-free rate of interest.

  When either the real "inflation-free" interest rate or the expected inflation rate are significantly large, the calculation of the nominal risk-free rate differs from the equation used when these factors are significantly small. Specifically, the calculation of the nominal risk-free rate of interest when theinflation-free rate of interest and/or the inflation premium are significantly high, the calculation of the nominal risk-free rate is as follows:

  Nominal RFR = (1 + Real RFR)(1 + E(I)) - 1

  Where: Real RFR = the real inflation-free rate of interest and E(I) = the anticipated inflation rate.

• Question 304:

  A portfolio manager is attempting to determine the earnings multiple for an index of technology companies, and has gathered the following information:

  D1: $0.20 EPS: $1.44

  k: 28% per year

  g: 26.5% per year

  Using the information provided, what is the price-to-earnings ratio for this technology index? Further, is this earnings multiple realistic assuming that the demand for technology is great, earnings visibility is clear, and the industry is expected to grow rapidly? To solve for P/E, manipulate the infinite period dividend discount model.

  A. 13.33, this multiple is unrealistic

  B. 9.26, this multiple is realistic

  C. 9.26, this multiple is unrealistic

  D. 480, this multiple is likely to high

  E. None of these answers is correct

  F. 13.33, this multiple is realistic

  Correct Answer: C

  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 = [($0.20 *1.265/ ($1.44*1.265)) / (0.28 - 0.265)] = 9.26

  This is a rather low multiple, appropriate only for slow growth industries or specific situations such as industries with high risk or uncertainty. The fact that the index under examination is a compilation of firms in the high tech business, where demand is expected to be great, does not logically lead to this low of an earnings multiple. The fact that earnings visibility is clear augments this. The reasoning behind this is the fact that firms in the technology sector are expected to grow very rapidly, i.e. they should merit higher earnings multiples. Think of a P/E ratio as a proxy for future earnings growth. In this situation, a multiple of less than 10 seems unrealistic.

• Question 305:

  Holding other things constant, an increase in a firm's ROE will

  A. have no effect on the firm's expected growth rate.

  B. decrease the earnings multiplier.

  C. increase the earnings multiplier.

  D. decrease the firm's expected growth rate.

  Correct Answer: C

  An increase in a firm's return on equity (ROE) will increase its expected growth rate of earnings and dividends. This, in turn, will increase the earnings multiplier.

• Question 306:

  An investor should purchase a stock if A. its estimated value is greater than its market value.

  B. the company that issued it is expected to be the industry leader.

  C. its estimated value is greater than its book value.

  D. the company that issued it is one of the best performing firms in one of the best performing industries in the economy.

  Correct Answer: A

  Book value has little relevance to purchasing decisions. A company that is expected to perform well may have a stock that is overvalued because of the very positive attention surrounding it. Instead, an investor should purchase a stock if its estimated value is greater than its market value. This implies that the market is undervaluing the stock, the investor can buy it for less than it is worth, and receive excess returns as the market eventually realizes its mistake.

• Question 307:

  A stock's P/E ratio is 6.4, with an expected return of 8% and a dividend growth rate of 4%. The firm's earnings retention ratio equals ________.

  A. 42.8%

  B. 74.4%

  C. 25.6%

  D. 31.7%

  Correct Answer: B

  In standard notation, the Dividend Discount Model gives P/E = (dividend payout ratio)/(K - g). Therefore, dividend payout ratio = 6.4*(8% - 4%) = 25.6%. The earnings retention ratio equals 1 minus the dividend payout ratio. In this case, the earnings retention ratio equals 1 - 25.6% = 74.4%.

• Question 308:

  A stock has a beta of 0.27 and the risk-free rate is 6.15%. Its dividend growth rate is 4.11% and its P/E ratio is 8.9. If the firm has a dividend payout ratio of 23%, the market risk premium equals ________.

  A. 13.65%

  B. 10.23%

  C. 2.00%

  D. 11.82%

  Correct Answer: C

  If the expected return on the stock is K, then the Dividend Discount Model gives P/E = (dividend payout ratio)/(K - g). Therefore, K = g + (div. payout ratio)/(P/E) = 0.0411 + 0.23/8.9 = 6.69%. Now, CAPM implies that the expected return on a stock equals the risk-free rate plus beta times the market premium. Hence, 6.69% = 6.15% + 0.27 * market premium, giving market premium = (6.69% 6.15%)/0.27 = 2.00%.

• Question 309:

  Assume the following information about a publicly traded specialty retailer:

  Revenue: $6,500,000 Cash flow: $1,500,000 Net worth per share: $10.87 Number of common shares outstanding: 1,000,000 Current stock price per share: $28.37

  Using this information, what are the price-to-sales, price-to-book, and price-to-cash flow ratios, respectively?

  A. 4.36, 0.38, 18.91

  B. 4.36, 2.61, 18.91

  C. None of these answers is correct.

  D. The answer cannot be completely calculated from the information provided.

  E. 0.60, 2.61, 18.91

  F. 4.36, 2.61, 42.56

  Correct Answer: B

  To calculate the price-to-sales ratio, divide the market price of a common stock by its sales-per share

  figure. The equation for the price-to-sales ratio is as follows:

  Price-to-sales ratio = [P0 / sales per share].

  Incorporating the given information into this equation will yield the following: Price-to-sales ratio = [$28.37 /

  ($6,500,000 / 1,000,000)] = 4.364 The calculation of the price-to-book ratio involves dividing the market

  price of a common stock by its net worth per share. The equation for the price-to-book ratio is as follows:

  Price-to-book ratio = [P0 / net worth per share].

  Where: net worth per share = (total assets - total liabilities) / # of common shares outstanding.

  In this example, the net worth figure has been converted to a per-share basis, and the calculation of the

  price-to-book ratio is straightforward:

  Price-to-book ratio = ($28.37 / $10.87) = 2.6099

  The calculation of the price-to-cash flow ratio involves dividing the market price of a common stock by the

  cash-flow-per-share figure. The calculation of the price-to-cash flow ratio is as follows:

  Price-to-cash flow = (P0 / cash flow per share)

  Incorporating the given information into this equation will yield the following: Price-to-cash flow = [$28.37 /

  ($1,500,000 / 1,000,000)] = 18.91

• Question 310:

  Technical analysts would feel that an upside-downside volume ratio with a value of 1.7 indicates that the market is

  A. breaching a resistance level.

  B. breaching a support level.

  C. is overbought.

  D. entering a significant market upswing.

  E. is oversold.

  Correct Answer: C

  Technical analysts may use the ratio of upside-downside volume as an indicator of short-term momentum for the market. They feel that a ratio value of 1.50 or more indicates that the market is overbought, while a ratio of 0.70 or less indicates that the market is oversold.