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

• Question 361:

  The investment decision hypothesis maintains that the most important portfolio decision is that of

  A. all of these answers

  B. diversification

  C. financing

  D. asset allocation

  Correct Answer: D

  A good portfolio achieves the investor's desired risk/return profile through asset allocation. Typically a more diversified portfolio has lower risk.

  Exam S

• Question 362:

  The short interest ratio is

  A. the cumulative number of shares that have been sold short, divided by outstanding short interest.

  B. outstanding short interest divided by total daily volume on the exchange.

  C. total daily volume on the exchange divided by outstanding short interest.

  D. the cumulative number of shares that have been sold short by investors and not covered.

  Correct Answer: B

  Technical analysts measure short interest through the short interest ratio, which is equal to the outstanding short interest divided by the average daily volume of trading on the exchange. A higher ratio is interpreted as bullish because a larger relative short interest is indicative of high potential demand for stock from those who have sold short but have not yet covered their sales.

• Question 363:

  A current measure of speculative trading activity on the market is the ratio of

  A. LSE volume to OTC volume.

  B. OTC volume to NYSE volume.

  C. mutual fund volume to NYSE volume.

  D. TSE volume to NYSE volume.

  E. AMEX volume to NYSE volume.

  Correct Answer: B

  Technicians consider speculative activity high when the OTC volume reaches some high level (such as 112%, for example) relative to NYSE volume. Conversely, they consider speculative activity low when OTC volume reaches some low level (such as 87%, for example) relative to NYSE volume.

• Question 364:

  Which of the following is the correct formula for the breakdown of ROE?

  A. Profit Margin x Total Assets x Financial Leverage

  B. Profit Margin x Total Asset Turnover x Financial Leverage

  C. P/E x Earnings per share x Number of Shares Outstanding

  D. COGS x Total Asset Turnover x Current Liabilities

  Correct Answer: B

  By definition: ROE = Profit Margin x Total Asset Turnover x Financial Leverage

• Question 365:

  In the U.S. economy, suppose it is found that every 5% increase in GNP is associated with an 8% increase in SandP sales, with a negligible intercept term. Further, the net profit margin on SandP 500 is 8.2%. If the earnings multiplier on SandP 500 changes from 11.3 to 11.9 and the GNP declines by 2%, the change in the SandP 500 index value equals ________.

  A. -8.08%

  B. -5.29%

  C. +5.03%

  D. +1.94%

  Correct Answer: D

  The 2% decline in GNP will cause a decline of 2/5 * 8 = 3.2% SandP sales. This will cause a decline in earnings per share of 3.2%, too (NOT 8.2% * 3.2%). Since index value = earnings multiplier * earnings per share, the change in SandP 500 equals (1-0.032)*11.9/11.3 - 1 = +1.94%.

• Question 366:

  Which of the following statements is true?

  A. Short sales by specialists making up more than 50 percent of total short sales on an exchange is viewed as a bearish sign by technical analysts who try to follow the "smart money." Such an occurrence would be viewed as a long-range indicator of market performance.

  B. Short sales by specialists making up more than 50 percent of total short sales on an exchange is viewed as a sign of an approaching market peak by technical analysts who try to follow the "smart money." Such an occurrence would be viewed only as a short-range indicator of market performance.

  C. Short sales by specialists making up less than 30 percent of total short sales on an exchange is viewed as a sign of an approaching market trough by technical analysts who try to follow the "smart money." Such an occurrence would be viewed as a long-range indicator of market performance.

  D. Short sales by specialists making up less than 30 percent of total short sales on an exchange is viewed as a bullish sign by technical analysts who try to follow the "smart money." Such an occurrence would be viewed only as a short-range indicator of market performance.

  Correct Answer: D

  Specialists, who have access to the limit-order books for the stocks in their charge, are often studied by technical analysts trying to follow the "smart money." When their short sales make up over 50% of total short sales, this is viewed as bearish sign because of the implicit specialist expectation of declining share prices. When their short sales make up under 30% of total short sales, this is viewed as a bullish sign because of their implicit attempts to stay away from short sales. Specialist short sales typically make up 40% of total short sales.

• Question 367:

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

  A. Block Uptick/Downtick Ratio.

  B. Diffusion Index.

  C. More than one of these answers is correct.

  D. Breadth of market.

  E. Short sales by specialists.

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

  Correct Answer: E

  Of the choices listed, only "short sales by specialists" represents a "smart money" technical indicator. Technical analysts view a large increase in short sales by specialists as a bearish near-term indicator. Conversely, a decline in the ratio of short sales by specialists is viewed as a near-term bullish indicator. Data for short sales by NYSE specialists is published weekly in Barron's. The normal ratio of short sales by specialists has been approximately 40%, and technicians view a decline to 30% or below as a bullish sign. Conversely, technicians would view a ratio of 50% or greater as a bearish signal.

  "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 368:

  The current earnings per share on a value-weighted index is $3.7. If the growth rate in the index is expected to be 3%, its average payout ratio is 35% and the index value is $9.3 per share, the expected return on the index is:

  A. 16.9%

  B. 15.4%

  C. 17.3%

  D. 16.6%

  Correct Answer: C

  You should remember that the Dividend Discount Model is applicable to individual stocks as well as stock indices. Indeed, that and estimation of the variables involved in the Dividend Discount Model are the thrust of Reilly and Brown, chapter 18.

  In standard notation, Po = D1/(k-g). In this case, g = 3%. The expected dividend per share next year = $3.7

  * 35%*(1+3%) = $1.33. Therefore, 9.3 = 1.33/(k-3%). Solving for k gives k = 3% + 1.33/9.3 = 17.3%. This is the expected return on the index.

• Question 369:

  An decrease in the required rate of return will have what effect on the earnings multipliers of common stocks? Further, what effect could be expected from a decrease in the dividend payout ratio?

  A. An decrease in the earnings multiplier; a decrease in the earnings multiplier

  B. An decrease in the earnings multiplier; a increase in the earnings multiplier

  C. No change in the earnings multiplier, a decrease in the earnings multiplier

  D. An increase in the earnings multiplier; an increase in the earnings multiplier

  E. An increase in the earnings multiplier; a decrease in the earnings multiplier

  Correct Answer: E

  A simple method of determining the appropriate earnings multiplier for a common stock can be found by manipulating the Infinite Period Dividend Discount Model such that it resembles the following:

  P/E = [(d1/e1) / (k - g)]

  Where: P/E = the earnings multiplier expressed as the Price-to-Earnings Ratio, d1/e1 = the dividend payout ratio at t1, k = the required rate of return, and g = the anticipated annual growth rate.

  As you can see, a decrease in the required rate of return, holding everything else equal, will lead to an increase in the earnings multiplier. Opposite this effect, a decrease in the dividend payout ratio will lead to a decrease in earnings multiplier.

• Question 370:

  The empirical evidence on mutual fund performance indicates which of the following?

  I. Better performance is associated with higher expense ratios.

  II. On a net basis, mutual funds under-perform the market on average.

  III.

  On average, mutual funds do better than the buy-and-hold policy by about 65 basis points.

  A.

  II and III

  B.

  II only

  C.

  I only

  D.

  I, II and III

  E.

  I and III

  F.

  III only

  G.

  I and II

  Correct Answer: G

  Most of the studies on mutual fund performance show I and II. On average, mutual funds have been shown to be unable to outperform a buy-and-hold policy after fund expenses are accounted for.