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

• Question 351:

  When estimating the industry net profit margin, it is suggested that you

  A. begin with profit before interest and taxes and then estimate interest.

  B. begin with profit after taxes and deduct dividends paid.

  C. begin with the operating profit margin and then estimate depreciation expense, interest expense, and the tax rate.

  D. calculate the average earnings per share.

  Correct Answer: C

• Question 352:

  A net advance on an advance-decline series for the NYSE, coupled with a declining SandP 500 would, according to technical analysts,

  A. signal a market trough.

  B. signal a period of market unpredictability.

  C. signal a market peak.

  D. signal a temporary reprieve from the bear market.

  Correct Answer: A

  Technical analysts predict that when a market index is declining, but most stocks post price increases, the market is near its trough. Conversely, they predict that when a market index is increasing, but most stocks post price declines, the market is near its peak.

• Question 353:

  Which of the following factors account for differences among required rates of return for different countries?

  A. Different risk premiums due to different risk environments

  B. Wide variance in inflation rates

  C. All of these answers

  D. Exchange-rate volatility

  Correct Answer: C

  All of the mentioned variables affect the RFR because they affect an investment's real return.

• Question 354:

  Contrary-opinion traders expect mutual funds to have a

  A. low percentage of cash near the peak of the market.

  B. high percentage of cash near the peak of the market.

  C. high percentage of cash during a rising market trend.

  D. low percentage of cash during a rising market trend.

  Correct Answer: A

  Contrary-opinion traders believe that mutual fund managers are usually wrong in their market expectations near peaks or troughs. Mutual fund managers would thus be expected to believe the market would continue to increase when it is near a peak. The managers would have a very low position in cash in order to invest as much as possible in the rising market. When their cash positions are very low, contrary-opinion traders would see this as a sign that the market is approaching a peak and sell shares in anticipation of the upcoming bear market.

• Question 355:

  The problem with using the confidence index as an indicator of investor sentiment is that:

  A. it ignores the equity market in its calculation.

  B. it ignores the supply side of the bond market.

  C. it is difficult to calculate precisely due to incomplete bond data.

  D. it is difficult to calculate precisely due to incomplete bond data and it ignores the supply side of the bond market.

  Correct Answer: B

  The Confidence index is the ratio of the average yield on 10 top grade bonds to the Dow Jones average of 40 bonds. The index measures the difference in yield spreads between high-grade bonds and a large cross-section of available bonds. An increase in this index implies that the yield spread between the bonds has narrowed. Now, from a demand perspective, this will happen when the demand for riskier bonds rises. However, the spread could also decrease if the supply of the risky bonds decreases relative to the highgrade bonds. In that case, the change in the confidence index simply reflects the credit needs of the economy and not a change in the risk appetite of investors.

• Question 356:

  During years of temporary supernormal growth, where growth exceeds the required rate of return, the analyst must use the ________ version of the dividend discount model to value a stock.

  A. expected

  B. current

  C. interim

  D. finite

  Correct Answer: D

  During years of temporary supernormal growth, where growth exceeds the required rate of return, the analyst must use the finite version of the dividend discount model to value a stock. This is also known as the variable growth version of the dividend discount model.

• Question 357:

  Jim Williams, a financial analyst with Churn Brothers Brokerage, is attempting to value share of Intelligent Semiconductor. In his calculation, Jim calculates the following for each subperiod: [Net income + Depreciation - Capital Expenditures - Increases in Working Capital - Principal Repayments

  + New Debt Issues]. The results of this calculation will be referred to as "X."

  The second step in the process is the determination of the "multiple" of X that shares of Intelligent will trade for in three years. This figure will be referred to as "M." Finally, Jim determines the required equity rate of return for shares of Intelligent Semiconductor. This

  figure will be referred to as "r."

  These calculations are inputted into the following equation:

  Price of Intelligent Semiconductor = {[X during year 1 / (1 + r)] + [X during year 2 / (1 + r)(1 + r)] + [X in year

  3 / (1 + r)(1 + r)(1 + r)] + [M * X in year 3/ (1 + r)(1 + r)(1 + r)]}

  The results of this calculation are used as the value of Intelligent shares.

  Which of the following best characterized the valuation method employed by Jim Williams?

  A. Free cash flow to equity method

  B. Arbitrage-pricing model

  C. Supernormal growth model

  D. None of these answers

  E. Multi-period dividend discount model

  Correct Answer: A

  The method illustrated in this example is the free cash flow to equity method.

• Question 358:

  Technical analysts would feel that an upside-downside volume ratio with a value of 1.04

  A. is bearish.

  B. indicates that the market is overbought.

  C. indicates that the market is oversold.

  D. is neither particularly bullish nor bearish.

  Correct Answer: D

  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.

• Question 359:

  Calculate the dividend growth rate for a company that consistently pays out 30% of its earnings in dividends and has a Return on Equity (ROE) of 10%.

  A. 6.4%

  B. 12%

  C. 15%

  D. 10.0%

  E. 7.0%

  F. 9.6%

  Correct Answer: E

  The estimated growth rate of dividends = (Retention Rate) x (Return on Equity). In this case the estimated growth rate of dividends = (1 - Payout Ratio) x (ROE) = 70% x 10% = 7%.

• Question 360:

  Consider the following transactional information for the inventory account of an institutional bond house:

  1st Quarter Ending portfolio value: $400,500,000 Total amount invested: $396,000,000

  2nd Quarter Ending portfolio value: $401,900,000 Total amount invested: $400,500,000

  3rd Quarter Ending portfolio value: $406,500,000 Total amount invested: $400,000,000

  4th Quarter Ending portfolio value: $409,800,000 Total amount invested: $400,000,000

  Using this information, what is the annual time-weighted rate of return for this portfolio? Assume no taxes or transaction charges.

  A. None of these answers is correct.

  B. 5.91% per year

  C. The time-weighted rate of return cannot be calculated from the information provided.

  D. 5.79% per year

  E. 6.22% per year

  F. 5.09% per year

  Correct Answer: B

  The time-weighted rate of return is the preferred method of return calculation in the investment

  management industry, primarily because this method is not sensitive to significant additions and

  withdrawals of funds from portfolios under examination. The calculation of the time-weighted rate of return

  involves three steps, which are illustrated as follows:

  Step 1:

  Price the portfolio immediately prior to any significant additions or withdrawals. Separate the portfolio into a

  series of subperiods based on the dates of cash inflows and outflows.

  Step 2:

  Calculate the holding period return for each subperiod.

  Step 3:

  Determine the annualized holding period return by linking or compounding the holding period return of

  each subperiod. If the investment is for more than one year, use the geometric mean of the annual returns

  as the time-weighted rate of return. If the investment is for less than one year, compound the subperiod

  returns to obtain an annualized measurement.

  To begin the process of determining the time-weighted rate of return, we would break the portfolio up into

  the subperiod series of cash flows. However, in this example, the cash flows are already aggregated for us

  and we can move on to the next step:

  determining the holding period return for each subperiod. This process is detailed as follows:

  Quarter 1 holding period return = [($400,500,000 ending value - $396,000,000 invested) / $396,000,000

  invested] = 1.13636%

  Quarter 2 holding period return = [($401,900,000 ending value - $400,500,000 invested) / $400,500,000

  invested] = 0.34956%

  Quarter 3 holding period return = [($406,500,000 ending value - $400,000,000 invested) / $400,000,000

  invested] = 1.625%

  Quarter 4 holding period return = [($409,800,000 ending value - $400,000,000 invested) / $400,000,000

  invested] = 2.450%

  Now that the holding period return for each subperiod has been determined, we must annualize the return

  measure by taking the product of all four quarterly returns. This process is illustrated below:

  [(1 + .0136) * (1 + .0035) * (1 + .0163) * (1 + .0245) - 1] = .05905 or 5.905%

  When calculating the time-weighted rate of return, remember that the total amount invested is the relevant

  figure, not the beginning portfolio value. Notice that during the third quarter, the total amount invested does

  not equal the ending amount for the second quarter. (A similar situation exists in the fourth quarter).

  This differential could be explained by numerous phenomena. Perhaps the difference is due to a cash

  withdrawal from the account. Maybe it was used to pay expenses or meet an outstanding margin call.

  What is important to note is the fact that this money (the difference between the total amount invested and

  the ending portfolio value for the previous subperiod) was not invested, and should not be included in the

  holding period return for the fourth quarter. So said, whenever possible you should use the total amount

  invested rather than the beginning portfolio value in the calculation of the subperiod holding period return.

  If you chose 5.79%, remember that in the calculation of the time-weighted rate of return, it is the geometric

  average that is used, not the arithmetic average.