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

• Question 491:

  Most studies

  A. weakly support technical analysis.

  B. strongly support technical analysis.

  C. have not supported technical analysis.

  D. have drawn mixed results with regard to technical analysis.

  Correct Answer: C

  The vast majority of studies have found that prices do not move in trends based on statistical tests of autocorrelation, runs, and trading rules. But many trading rules have not yet been tested.

• Question 492:

  Given that a firm will exist for two years and issue dividends of $20 per share at the end of each year, and the required rate of return on shares is 10%, what is the value of its common stock according to the Dividend Discount Model?

  A. $28.32

  B. $40.00

  C. $35.93

  D. Not enough information

  E. $34.71

  Correct Answer: E

  The dividend discount model (Dividend Discount Model) assumes that the value of a share of common stock is the present value of all future dividends. In this question, the value of a share of common stock is equal to 20/(1 +0.10) + 20 /[(1 + 0.10)^2] = $34.71.

• Question 493:

  Which of the following is not an assumption of the infinite period Dividend Discount Model?

  A. Earnings grow at a constant rate.

  B. The required rate of return is greater than the growth rate of dividends.

  C. The constant dividend growth rate will continue for an infinite period.

  D. Dividends grow at a constant rate.

  Correct Answer: A

  The infinite period dividend discount model does not concern itself with earnings. It assumes that dividends (which are the basis for its valuation of stock), rather than earnings, grow at a constant rate. But implicit in this assumption is the further assumption that earnings remain high enough to finance the constant and often growing dividend payments.

• Question 494:

  A preferred stock has a $100 par value and a dividend payout of $8 per year. What is the value of the preferred stock?

  A. not enough information to calculate it

  B. $102.61

  C. $93.24

  D. $89.65

  Correct Answer: A

  The value of a preferred stock is the stated annual dividend divided by the required rate of return on preferred stock.

  The required rate of return in this case is not given.

• Question 495:

  High payout ratios are closely correlated with which of the following attributes?

  A. The level of competition in the industry.

  B. More than one of these answers is correct.

  C. The growth rate of earnings.

  D. Maturity of the industry.

  E. All of these answers are correct.

  F. The level of regulation in an industry.

  Correct Answer: B

  All but one of these answers is correct. Specifically, the dividend payout ratio is very closely related to the maturity of the industry, the level of competition in the industry, and the growth rate in earnings. Remember that all of these factors are interrelated. As an industry becomes more mature, competition becomes maximized, margins shrink, and the growth potential of the industry declines. This will lead to a decrease in positive NPV investment opportunities in the industry, forcing firms to increase the proportion of earnings paid out to shareholders in the form of dividends. The level of regulation in an industry is not necessarily highly correlated with the dividend payout ratio of firms within the industry. For example, the financial services industry is very heavily regulated, yet firms within this sector do not pay a disproportionate amount of their earnings as dividends. However, he utility industry, also heavily regulated, pays a very high proportion of earnings as dividends.

• Question 496:

  Which is not a true statement concerning industry analysis?

  A. Industries that perform well in one time period will continue to outperform the aggregate market in subsequent time periods.

  B. Risk measures for different industries remain fairly constant over time.

  C. During any time period, the returns for different industries vary within a wide range.

  D. Company analysis is a necessary follow-up to industry analysis.

  E. During any time period, different industries' risk levels vary within wide ranges.

  Correct Answer: A

  Researchers found almost no association in individual industry performance year to year or over sequential rising or falling markets.

• Question 497:

  Assuming that the dividend payout ratio is 0.4, net income is 100, net sales are 400, and the equity is 500, what is the growth rate of earnings of the firm?

  A. 8%

  B. 12%

  C. 11.2%

  D. Not enough information

  E. 10%

  Correct Answer: B

  The growth rate of earnings of the firm is equal to the retention rate multiplied by the return on equity (ROE). The retention rate is equal to one minus the dividend payout ratio (1 - 0.4 = 0.6). ROE is equal to net income divided by equity (100/500 = 0.2). The growth rate is 0.6 x 0.2 = 0.12 = 12%.

• Question 498:

  A market researcher with Churn Brothers Brokerage is attempting to estimate the earnings per share (EPS) for a pharmaceutical index, and has gathered the following information:

  Sales per share: $200 Next year's operating profit margin: 30% Next year's depreciation per share: $18 Next year's interest expense: $13 Next year's corporate tax rate: 35%

  Using this information, what is the EPS figure for this stock market series?

  A. $17.75

  B. None of these answers is correct.

  C. $30.55

  D. $36.85

  E. $18.85

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

  Correct Answer: E

  The estimation of EPS for a stock market series involves five steps. Specifically, to determine an estimate of EPS for a stock market series, it is necessary to:

  Estimate the sales per share Estimate next year's operating profit (EBIDT), or operating profit margin Estimate next year's depreciation per share Estimate next year's interest expense per share Estimate next year's corporate tax rate

  Once estimates for these components have been determined, they are put into the following equation:

  EPS for a stock market series = {[(Sales per share * operating profit margin) - depreciation per share interest expense per share] * (1 - corporate tax rate).

  Imputing the given information into this equation will yield the following:

  EPS for a stock market series = {[($200 * 0.30) - $18 - $13] * (1 - 0.35)} = $18.85

  If you chose $36.85, remember that the depreciation figure is not added back to the EPS calculation. What we are looking at is an operating earnings after tax figure, not a cash-based figure.

• Question 499:

  Technical analysts tend to believe that

  A. successful fundamental analysis is impossible.

  B. financial statements contain all relevant information needed to price stocks.

  C. successful fundamental analysis is difficult.

  D. the majority of investors can earn above-average returns through fundamental analysis.

  Correct Answer: C

  Technical analysts tend to believe that while successful fundamental analysis is possible, it is very difficult to achieve. They contend that since most fundamental analysis is heavily dependent on financial statements, which do not contain all relevant stock pricing information, most investors cannot consistently earn above-average returns using that method.

• Question 500:

  In investment management applications, the Internal Rate of Return is commonly referred to as which of the following?

  A. Dollar-weighted rate of return

  B. Intrinsic rate of return

  C. Time-weighted rate of return

  D. Cost-averaged rate of return

  E. None of these answers

  F. Dollar-averaged rate of return

  Correct Answer: A

  Performance presentation is an important consideration in the field of investment management, and often involves a rather complex series of calculations. This is particularly true for portfolio's which are characterized by significant additions and withdrawals, as the cash flow measurement is periodically disrupted. In the Level I readings, two specific measurement tools are discussed: the dollar-weighted rate of return and the time-weighted rate of return. In investment management applications, the IRR equation is commonly referred to as the "dollar-weighted rate of return" because it incorporates both the timing and size of all cash flows in the determination of the return figure.