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

• Question 381:

  Growth companies are those that can

  A. experience dividend growth that is consistently higher than their required rates of return.

  B. experience sales growth that is consistently higher than their required rates of return.

  C. earn rates of return on their investments that are consistently above their required rates of return.

  D. keep their leverage ratios low.

  Correct Answer: C

  Growth companies have the opportunities and abilities to earn rates of return on the investments they make that are consistently higher than their required rates of return. Such companies have trouble holding their high returns and growth forever, though. Almost all of them see a slowdown in growth over time.

• Question 382:

  Technicians often feel that a large proportion of investment advisory services with bearish attitudes is indicative of

  A. a flat trend channel.

  B. the approach of a peak and the onset of a bear market.

  C. the approach of a trough and the onset of a bull market.

  D. a low cash position by mutual funds.

  Correct Answer: C

  Many technicians feel that investment advisory services tend to be trend followers, so that by the time most services are bearish, the bear market is nearing a trough, which will be followed by a new bull market.

• Question 383:

  Lynn Burns, CFA, is examining the performance of Intelligent Semiconductor, and has gathered the following information:

  Market discount rate: 14.5% per year Observed Price/Earnings ratio: 26.50

  Given this information, what is the Franchise Price/Earnings ratio for Intelligent Semiconductor?

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

  B. 30.99

  C. 19.60

  D. 33.40

  E. None of these answers is correct.

  F. 23.14

  Correct Answer: C

  The Franchise Factor method of value measurement is in many respects similar to EVA and MVA calculations. When examining a company using the franchise value approach, the observed price-toearnings ratio is broken down into its two components - (1) the "base P/E," which is based on the Company's ongoing performance, and (2) a "franchise P/E" that is based on the expected value of new and profitable business opportunities. This relationship is illustrated as follows:

  Franchise P/E = Observed P/E - Base P/E

  Where the Base P/E equals the reciprocal of the market discount rate. For example, if the market discount rate is 14.5%, the base P/E would be equal to 6.89655.

  In this example, all the necessary information has been provided, and the calculation of the Franchise P/E is as follows:

  Franchise P/E = (26.5 - 6.89655) = 19.60345

• Question 384:

  Short interest is

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

  B. the cumulative number of shares that have been sold short and covered.

  C. the cumulative number of shares that have been sold short, divided by daily NYSE volume.

  D. the cumulative number of shares that have been sold short, divided by daily NYSE + OTC volume.

  Correct Answer: A

  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 that have sold short but have not yet covered.

• Question 385:

  Contrarians assume that:

  A. you should bet against "smart money."

  B. Past winners will lose in the future.

  C. the majority of investors are wrong.

  D. the market moves against the trend.

  Correct Answer: C

  According to the contrarians, most market participants make wrong investment decisions as the market approaches the peak or trough in a cycle. Hence, their basic trading rule is to determine if the general investing populace is strongly bullish or bearish and then bet against that trend (hence the name, "contrarian").

• Question 386:

  XYZ (a firm the produces consumer goods) is a stable company reporting the following financial information:

  Earnings per share $1.50 Dividends per share $0.30 Net Income $5 million Equity $50 million

  Given the above information, calculate the company's expected dividend growth rate.

  A. 80%

  B. 20%

  C. 1.6%

  D. 33%

  E. 8%

  F. 16%

  Correct Answer: E

  The expected dividend growth rate = (Retention Rate) x (Return on Equity). Retention Rate = 1 - Payout Rate. Return on Equity = NI/E. Thus in this case the expected dividend growth rate = (1 - (.3/1.5)) x ($5 million/$50 million) = (1 - .20) x (.10) = .08 or 8%.

• Question 387:

  Consider the following preferred stock:

  Price per share: $12.55 Semiannual dividend per share: $0.725 Required return: 11.50% per year

  Is the preferred stock realistically overvalued, undervalued, or correctly valued? Further, should this preferred stock be valued as a perpetuity or a finite series of cash flows? (Assume a long-term holding period).

  A. Correctly valued; perpetuity

  B. Undervalued; finite series of cash flows

  C. Correctly valued; finite series of cash flows

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

  E. Overvalued; perpetuity

  F. Undervalued; finite series of cash flows

  Correct Answer: A

  The preferred stock profiled in this example is trading very close to its theoretical value, which is found as $12.61.

  To determine the value of a preferred stock, use the following equation; {P0 = [d1 / k]}

  Where:P0 = the price of the preferred stock at time 0, d1 = the annual dividend at t = 1, and k = the

  required rate of return.

  In this example, the dividend is provided as a semiannual figure, which must be doubled to show the

  annual dividend. After this adjustment has been made, the value of the preferred stock can be found as

  follows.

  {P0 = [$1.45 / 0.115] = $12.61.

  Preferred stock is commonly valued as a perpetuity because there is no finite conclusion to the projected

  series of cash flows for a preferred stock. Unlike a bond, whose cash flows are characterized by a finite

  lifespan (i.e. the cash flows of a bond cease at maturity), the cash flows (dividends) produced by a

  preferred stock could theoretically last forever.

• Question 388:

  Which of the following statements about relative strength ratios is correct?

  A. In an increasing market, a stock price has to increase faster than the general market for its relative strength ratio to increase. Relative strength ratios, however, do not work during stagnant or declining markets.

  B. In an increasing market, a stock price has to increase faster than the general market for its relative strength ratio to increase. In a declining market, a stock price only has to increase in order for that ratio to increase.

  C. A high relative strength index that has not changed much over time would be interpreted as a bullish sign by technical analysts. A high ratio value that has started declining would be viewed with caution, however.

  D. In an increasing market, a stock price has to increase faster than the general market for its relative strength ratio to increase. In a declining market, a stock price only has to decline slower than the general market in order for that ratio to increase.

  Correct Answer: D

  Technical analysts believe that a stock or industry that is outperforming the market will continue to do so. Relative strength ratios are computed to find such trends. The ratios are equal to the price of the stock, or stocks in the industry group, relative to the value of some stock market series. If the ratio increases over time, the stock or industry has beenoutperforming the market.

• Question 389:

  If investors become more risk averse, the yield spread between corporate bonds and Treasury bonds will:

  A. widen.

  B. not necessarily be affected.

  C. narrow.

  D. not be affected, since the spread reflects a constant risk premium.

  Correct Answer: A

  As investors become more risk averse, they will demand more risk-free assets. Hence, thedemand for Treasury bonds will increase and that for the corporate bonds decrease. Thiswill increase the yields on corporate bonds and decrease those on Treasury bonds, thus widening the spread.

• Question 390:

  A company pays a dividend of $6 per share to the holders of its perpetual preferred stock. The appropriate discount rate is 6.5% per year. What is the value of the preferred stock?

  A. Not able to compute with the above data.

  B. $0.92

  C. $9.28

  D. $92.31

  Correct Answer: D

  Value = dividend/discount rate = 6/0.065= $92.31.