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

• Question 481:

  The third step of the three-step, top-down approach to valuation is to decide to allocate investment funds

  A. among the various types of securities.

  B. among individual firms, and the various securities they offer.

  C. among the various groups of firms.

  D. among individual firms.

  Correct Answer: D

  The third step of the three-step, top-down approach is the analysis (for purposes of allocating investment funds) of individual companies and stocks. The decision of types of securities to invest in is made in the first step, and the decision to focus on certain industries is made in the second step.

• Question 482:

  An investor purchases 1,000 shares of Clay Industries common stock for $40.00 per share at t0. At t1, this investor receives a $0.78 per share dividend on the 1,000 shares and purchases an additional 400 shares for $49.75 per share. At t2, he receives another $0.78 per share dividend on 1,400 shares and purchases 400 more shares for $55.90 per share. At t3, sells 1,000 of the shares for $59.50 per share and the remaining 800 shares at $60.25 per share. Assuming no commissions or taxes, what is the dollar-weighted rate of return received on this investment?

  A. 18.22%

  B. None of these answers is correct.

  C. 15.42%

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

  E. 15.07%

  F. 17.70%

  Correct Answer: B

  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 name is

  commonly used within the field of investment management. In the determination of the dollar-weighted rate

  of return calculation, the first step should be to identify the cash flows for each period. This process is

  illustrated as follows:

  t0: {-[1,000 shares purchased * $40 per share] = [$40,000.00]

  t1: {-[ 400 shares purchased * $49.75 per share] + [$0.78 per share dividend * 1,000 shares] = [$19,120]

  t2: {-[400 shares purchased * $55.90 per share] + [$0.78 per share dividend * 1,400 shares]} = [$21,268]

  t3: {[1000 shares sold * $59.50 per share] + [800 shares sold * $60.25 per share] = $107,700.00

  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 13.70% for this investment,

  which is none of the answers provided.

• Question 483:

  A confidence index value of 105 is

  A. a bullish sign.

  B. impossible.

  C. an unimportant sign.

  D. a bearish sign.

  Correct Answer: B

  The confidence index is equal to the average yield on 10 top-grade corporate bonds divided by the yield on the Dow Jones average of 40 bonds, multiplied by 100. Since the average yield on high-grade bonds will always be higher than the average yield on a large cross section of bonds, the index will always have a value under 100.

• Question 484:

  In practice, preferred stocks have

  A. higher rates of return than junk bonds.

  B. lower rates of return than corporate bonds.

  C. higher rates of return than common stock.

  D. higher rates of return than moderately rated bonds.

  Correct Answer: B

  Although one would think that preferred stocks would have higher rates of return than many bonds because their dividend payments are riskier than bond interest and principal payments, it turns out that preferred stocks have a lower rate of return than corporate bonds because of the tax advantages preferred stocks present corporations (thereby increasing their demand and decreasing their yield).

• Question 485:

  Macro techniques are based on the relationship between the economy and ________ markets.

  A. international

  B. none of these answers

  C. micro

  D. security

  Correct Answer: D

  Macro techniques are based on the strong relationship between the economy and security markets. These models base their market projections on their outlook for the aggregate economy and certain components. Micro techniques estimate future market values by applying basic valuation models to equity markets.

• Question 486:

  Two stocks, A and B, have the same price. However, stock A has a dividend growth twice that of stock B. If the recent dividend on A was half that on B, the expected return on A equals 5% and B's dividend growth rate is 2%, the expected return on B is:

  A. 1.75%

  B. 4.0%

  C. 10%

  D. 2.5%

  Correct Answer: B

  In the usual notation, Po = D1/(k-g) and D1 = Do*(1+g). Hence, Po = Do*(1+g)/(k-g).

  The dividend growth rate of A equals 2 * 2% = 4%. We have been given PoA = PoB. Therefore, DoA*(1 + 4%)/(kA - 4%) = DoB*(1 + 2%)/(kB - 2%). Also, DoA = 0.5* DoB and kA = 5%. Thence, 0.5 * 1.04/(5% 4%) = 1.02/(kB - 2%). Solving for kB gives the expected return on B equal to 3.96%

• Question 487:

  The industry growth rate is a function of the

  A. return on equity multiplied by profit margin.

  B. earnings per share multiplied by the retention rate.

  C. payout ratio multiplied by the return on total assets.

  D. required rate of return multiplied by the return on equity.

  E. retention rate multiplied by the return on equity.

  Correct Answer: E

  The growth rate is a function of the retention rate multiplied by the return on equity.

• Question 488:

  Technical analysts would consider the fact that 90% of stocks are trading above their 200-day moving average as

  A. a sign of a market trough.

  B. a sign that the market is overbought.

  C. a bullish indicator.

  D. a sign that the market is oversold.

  Correct Answer: B

  Technical analysts may compute the moving average of a stock market series in order to determine its general trend. The 200-day moving average has been popular. When over 80% of stocks are trading above their 200-day moving average, the market is considered overbought. When less than 20% of stocks are trading above their 200-day moving average, the market is considered oversold.

• Question 489:

  Which of the following best describes the first step in the Top Down Approach to security valuation?

  A. None of these answers

  B. Analysis of the growth potential of specific industries

  C. Identification of geographical growth trends

  D. Analysis of specific companies

  E. Analysis of the Macroeconomic Environment

  Correct Answer: E

  The "top down" approach to investment identification begins with an analysis of the macroeconomic environment, then moving on to an analysis of specific regions and countries. The later stages of the top-down approach involve the analysis of specific industries and end with the analysis of specific companies.

  While "identification of geographical growth trends" is an appealing choice, it does not represent the best possible answer. Had the question asked for the first step in the Bottom Up approach, then "analysis of specific companies" would have been the correct choice.

• Question 490:

  The stock of a zero growth firm has a beta of 1.3 at a time when the market premium equals 7.7% and the risk-free rate equals 5%. The firm's earnings multiplier ratio equals ________.

  A. 7.19

  B. information about earnings and dividends is missing

  C. 6.66

  D. 4.32

  Correct Answer: C

  According to the Dividend Discount Model, P/E = payout ratio/(k-g) in standard notation. A no growth firm has a retention ratio of zero and a payout ratio of 1. Further, g = 0 for no growth. Therefore, the P/Eratio of a no-growth firm is simply equal to the reciprocal of its required rate of return. the firm's CAPM required rate = 5% + 1.3 * 7.7% = 15%. The earnings multiplier is therefore equal to 1/0.15 = 6.66.