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

• Question 331:

  What is the name of this technical indicator?

  (Number of advancing issues + 1/2 volume of issues unchanged) / total number of issues traded

  A. Confidence Index.

  B. CBOE Put/Call Ratio.

  C. None of these answers is correct.

  D. Block Uptick/Downtick Ratio.

  E. Advance/Decline Line.

  Correct Answer: C

  The technical indicator profiled in this example is the diffusion index, which is a measure of market breadth. While "Advance/Decline Line" is an esthetically appealing choice, it is nonetheless incorrect. The Advance/Decline Line is found by subtracting the volume of declining issues by the volume of advancing issues, with no regard to the volume of issues unchanged.

• Question 332:

  This relates to stock prices moving in trends, analogous to the movement of water.

  A. Mutual Fund Cash Positions

  B. Dow Theory

  C. Short Sales' by Specialists

  D. Diffusion Index

  E. Relative Trend

  F. Margin Debt

  G. Block Uptick-Downtick Ratio

  H. Odd-Lot, Short-Sales Theory

  Correct Answer: B

  Charles Dow, who published the Wall Street Journal in the late 1800s, described stock prices as moving in trends analogous to the movement of water. He postulated three types of price movements over time:

  1.

  major trends that resemble tides in the ocean.

  2.

  intermediate trends that resemble waves.

  3.

  short-run movements that resemble ripples.

• Question 333:

  The direction of change approach to estimating an earnings multiplier involves

  A. inferring the direction of change in the multiplier based on derivations of the specific estimates for its ten major components.

  B. inferring the direction of change in the multiplier based on predictions for changes in its three major components.

  C. inferring the direction of change in the multiplier based on derivations of specific estimates for its three major components.

  D. inferring the direction of change in the multiplier based on predictions for change in its ten major components.

  Correct Answer: B

  The direction of change approach 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 334:

  Which of the following best describes the relationship between the relative maturation of an industry and the retention ratio of companies within the industry? Further, what is the proposed relationship between expected growth and the relative maturity of an industry?

  A. Negative relationship; no correlation

  B. Negative relationship; negative relationship

  C. Positive relationship; negative relationship

  D. Positive relationship; positive relationship

  E. Negative relationship; positive relationship

  Correct Answer: B

  As an industry advances in maturity, growth of the overall industry will decline. As growth opportunities diminish, companies within the industry will be forced to pay out a larger proportion of their earnings as dividends; i.e. the dividend payout ratio will increase. Remember that the retention ratio is equal to (1 - the dividend payout ratio). Thus, the retention ratio of companies will likely decline as the industry advances in maturity. The relationship between the dividend payout ratio and the maturity of the industry is negative and loosely linear.

  As an industry becomes more mature, growth opportunities decline. This relationship is also loosely linear.

• Question 335:

  If the current stock price breaks through its moving average from below on heavy volume, most technical analysts would consider this a to be a

  A. bearish sign.

  B. sign of an approaching period of instability.

  C. sign of an approaching market peak.

  D. bullish sign.

  Correct Answer: D

  Technical analysts use moving averages of past stock prices as indicators of long-term trends. When the current stock price breaks through its moving average from below on heavy volume, this is viewed as a bullish sign possibly signaling a reversal in the declining price trend.

• Question 336:

  Most technical analysts believe that

  A. successful fundamental analysis is possible, and is practiced by the majority of fundamental analysts. They believe that technical analysis is simpler to implement, however, and more reliable because of its greater use of financial statements.

  B. successful fundamental analysis is very difficult. They believe that while success is possible, most fundamental analysts are unable to consistently earn above-average returns. They believe that fundamental analysts rely too heavily on financial accounting statements, which do not contain a great deal of information useful to security analysts.

  C. successful fundamental analysis is very difficult. They believe that while success is possible, most fundamental analysts are unable to consistently earn above-average returns. Technical analysis is a better investment guide because of its greater use of financial accounting statements.

  D. successful fundamental analysis is very difficult. They believe that while success is possible, most fundamental analysts are unable to consistently earn above-average returns. They believe that fundamental analysts rely too heavily on financial accounting statements, which often have incorrect information.

  Correct Answer: B

  Technical analysts tend to believe that successful fundamental analysis is contingent on obtaining new information before others, and processing it quickly and correctly. But they feel that this is very difficult, and that fundamental analysis is held back by its heavy reliance on financial accounting statements. They believe that those statements do not contain a great deal of information useful to security analysts, that different accounting standards make comparisons difficult, and that many important psychological factors and other nonquantifiable variables (such as customer goodwill) do not appear in those statements.

• Question 337:

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

  A. D1 = V * (k - g)

  B. None of these answers is correct.

  C. V = (D1 / k) + g

  D. V = D1 / (1 + r)

  E. V = D0 / (k - g)

  F. (k-g) = V * r / D1

  Correct Answer: A

  The infinite dividend discount model assumes can be used to value a common stock when dividends are expected to grow at a constant rate. The equation which characterizes 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.

  The equation illustrated in choice D is simply an algebraic rearrangement of this equation, solving for D1.

• Question 338:

  Contrary-opinion technicians would view the fact that 85% of stock index futures speculators are bullish as

  A. an unimportant sign.

  B. indicative of an approaching trough.

  C. a bullish sign.

  D. a bearish sign.

  E. indicative of a flat trend channel.

  Correct Answer: D

  The percentage of stock index futures speculators who are bullish is a measure used by contrary-opinion technical analysts. If a majority over some decision rule (70%, for example) were bullish, this would be interpreted as a bearish sign.

• Question 339:

  Which of the following represents a "smart money" technical indicator? Choose the best answer.

  A. Percentage of futures traders bullish on stock index futures.

  B. Diffusion Index.

  C. T-Bill-Eurodollar Yield Spread.

  D. More than one of these answers is correct.

  E. Breadth of market.

  F. Block Uptick/Downtick Ratio.

  Correct Answer: C

  Of the choices listed, only the "T-Bill-Eurodollar Yield Spread" represents a "smart money" technical indicator. The T-Bill-Eurodollar Yield Spread is used by technical analysts to measure investor sentiment

  (i.e. confidence) on a global scale. Specifically, during times of international crisis, there is usually a "flight to quality" personified by a bidding up on U.S. Treasury issues. This will cause a widening of the spread between U.S. T-Bills and Eurodollars, causing a decline in this ratio. Technical analysts would view a sharp increase in the spread between T-Bills and Eurodollars as indicative of an upcoming market trough, and historical evidence has tended to support this belief. "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. The "Block Uptick/ Downtick Ratio" is used to measure the near-term sentiment of institutions.

• Question 340:

  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 "overbought." 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 % of futures traders bullish on stock index futures has increased significantly.

  C. All of these choices are indicative of an "overbought" condition.

  D. The ratio of short sales by specialists is less than 50%.

  E. The diffusion index has declined significantly.

  F. The % of issues trading above their 200-day moving averages is greater than 80%.

  Correct Answer: F

  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 "overbought" when 80% of issues are trading above their 200-day moving average, and consider a market "oversold" when 80% of issues are trading under 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]. A decline in the diffusion index is indicative of an increase in declining issues relative to advancing issues. 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 technical analysts as bullish. Finally, contrarian technical analysts would view a large increase in the amount of futures traders who express bullish sentiment on stock index futures as a bearish signal.