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

• Question 551:

  Which of the following represents a "contrary opinion" technical indicator? Choose the best answer.

  A. More than one of these answers are correct.

  B. The Diffusion Index

  C. T-Bill-Eurodollar Yield Spread

  D. Debit balances in brokerage accounts (margin debt)

  E. The Chicago Board Options Exchange (CBOE) Put/Call Ratio

  F. The Confidence Index

  Correct Answer: E

  Of the choices listed, only the "CBOE Put/Call Ratio" represents a contrarian technical indicator. While "debit balances in brokerage accounts (margin debt)" appears to be an appealing choice, this indicator is actually a measure of "smart money" because investors who leverage their portfolios through margin loans are viewed by technical analysts as being sophisticated.

  Technical analysts often examine the opinions of market participants, including future and options traders, for indications of the overall sentiment of securities prices and the direction of impending market movements. Believing that the majority of these market participants will be inaccurate in their forecasts, particularly near market peaks and troughs, contrary opinion technical analysts will take a contra approach.

  When the ratio of puts to calls is high, indicating a high degree of bearishness amongst options traders, contrary opinion technical analysts would look for an upward move in securities prices. Conversely, contrary opinion technical analysts would view a low put/call ratio as a bearish signal.

  The Confidence Index, a "smart money" technical indicator, is a measure of yield spreads between highgrade corporate bonds and the yields on average corporate bonds. The Diffusion Index measures the breadth of the market, and is found by taking the total volume of advancing shares plus one-half of the issues unchanged, divided by the total number of issues traded. The T-Bill-Eurodollar Yield Spread is another example of a "smart money" technical indicator.

• Question 552:

  Assuming that a preferred stock is fairly priced, is worth $23, and has annual dividends of $6, what is its required rate of return?

  A. 19%

  B. Not enough information

  C. 26%

  D. 31%

  E. 14%

  Correct Answer: C

  The value of a preferred stock is the present value of its dividends, which is equal to the annual dividend divided by the required rate of return. Rearranging this, the required rate of return is equal to the dividend divided by the stock price. In this question, the required rate of return is equal to 6/23 = 0.26 = 26%.

• Question 553:

  Given that the beginning value on a stock is $640, expected earnings are $80, the retention rate of earnings is 40%, and the required rate of return is 21%, what is the minimum expected ending value of the stock that makes it a profitable investment?

  A. $725.40

  B. $742.40

  C. Not enough information

  D. $726.40

  E. $758.40

  Correct Answer: D

  The dividend payout ratio is equal to one minus the retention rate (1 - 0.4 = 0.6). Expected dividends are equal to the dividend payout ratio multiplied by expected earnings (0.6 x 80 = $48). In order for a stock to be a good investment, its rate of return should be equal or greater than the required rate of return.The minimum ending value that would make the stock investment in this question profitable is given by the equation (P2 + D) / P1 = 1 + k, where P2 is the ending value, P1 is the beginning value, D is the expected dividend, and k is the required rate return. Rearranging this yield P2 = ((k + 1) x P1) - D. In this question, the minimum ending value is (1.21 x 640) - 48 = $726.40.

• Question 554:

  In estimating a firm's earnings multiplier, the expected growth rate is determined by the firm's:

  A. retention rate and expected return on equity

  B. estimated required rate of return and dividend payout ratio

  C. estimated return on equity (ROE)

  D. relationship to its industry and market

  Correct Answer: A

  Higher expected growth rates would indicate that a firm should have a higher multiple than its industry and the market.

• Question 555:

  An uptick occurs when

  A. the current day's closing price is higher than the previous day's closing price.

  B. the current day's opening price is higher than the previous day's opening price.

  C. the current day's closing price is higher than or equal to the previous day's closing price. * the current day's opening price is higher than or equal to the previous day's opening price.

  D. the current transaction price is higher than the last transaction price.

  Correct Answer: D

  An uptick is simply when the current transaction price is higher than the last transaction price.

• Question 556:

  Given that a stock is correctly priced at $29.34, has an expected dividend payment of $1.30 in one year, and has a required rate of return of 18%, what should its price be right after that dividend payment in one year?

  A. $35.68

  B. Not enough information

  C. $37.74

  D. $29.41

  E. $33.32

  F. $34.95

  Correct Answer: E

  In order for the stock to be correctly priced, the present value of next year's dividend plus the present value of the stock price right after the dividend must equal the current price. In this question, 29.34 = (1.3 / 1.18)

  + (next year's price / 1.18).

  Rearranging this yields next year's price = [29.34 - (1.3/1.18)] x 1.18 = $33.32.

• Question 557:

  Volume considerations are

  A. largely irrelevant to technical analysts.

  B. the primary tool of technical analysts.

  C. important to technical analysts.

  D. not had by technical analysts.

  Correct Answer: C

  Most technical trading rules consider both stock price and volume movements. The volume of trading is an important, yet not dominant, variable in technical analysis.

• Question 558:

  Given that the required rate of return on a common stock is 17%, the dividend growth rate is 13%, and the P/E ratio is 17, what is the expected dividend payout ratio?

  A. 0.43

  B. Not enough information

  C. 0.46

  D. 0.79

  E. 0.68

  Correct Answer: E

  The infinite period Dividend Discount Model claims that the current price of a common stock is equal to D1 / (k - g), where D1 is next period's (most often next year's) dividend, k is the required rate of return, and g is the growth rate of dividends. The earnings multiplier model goes a step further by dividing both sides of the infinite period Dividend Discount Model equation by expected earnings during the next 12 months, yielding P/E = (D1/E) / (k - g). Rearranging this results in D1/E = (P/E) x (k - g). In this question, the expected dividend payout ratio is equal to 17 x (0.17 - 0.13) = 0.68.

• Question 559:

  A portfolio manager with an independent money management firm has been examining a stock market series and is trying to determine an appropriate EPS figure for the series. In her research, this portfolio manager has determined the following information:

  1.

  Regressing sales for the series against Nominal GDP, the sales figure for the index has been estimated at: $19.85.

  2.

  Analyzing capacity utilization rates, foreign competition, rates of inflation and unit labor costs, the operating profit margin for the series has been determined to be 31%.

  3.

  Creating a time series based upon inputs such as levels of capital expenditures and PPandE turnover, next year's depreciation-per-share has been determined to be: $1.18.

  4.

  Creating a time series based upon levels of debt outstanding and prevailing debt yields, the interest expense for next year is determined to be: $0.61 per share.

  5.

  Coordinating his research with a legislative consultant, the corporate tax rate for this series has been estimated at: 34.77%.

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

  A. None of these answers is correct.

  B. $2.85

  C. $2.46

  D. $4.03

  E. The answer cannot be determined from the information provided. * $1.52

  Correct Answer: B

  All of the necessary information has been provided in this example. To determine the EPS for a stock market series, the following steps are necessary: Step 1: Estimate sales-per-share for the series: Step 2: Estimate operating profit margin for the series Step 3: Estimate the depreciation-per-share for next year Step 4: Estimate the interest expense-per-share for the next year Step 5: Estimate next year's corporate tax rate

  Once these five steps have been completed, the calculation of EPS for a stock market series is found by the following:

  EPS = [(Sales per share * Operating profit margin) - Depreciation-per-share - Interest Expense] * (1 Corporate Tax Rate)

  The calculation of EPS for this stock market series is shown as follows: EPS = [($19.85 * 0.31) - $1.18 $0.61] * (1 - 0.3477) = $2.85

• Question 560:

  The situation of monopsony is most closely affiliated with which of Porter's Five Forces of industry competition?

  A. Bargaining power of suppliers

  B. Rivalry among existing firms

  C. Threat of substitute products

  D. Bargaining power of buyers

  E. Threat of new entrants

  Correct Answer: D

  A monopsony exists when there is only one buyer for a product or service. This is contrasted by a monopoly, where there are many buyers and only one seller. Monopsony is most closely characterized by the bargaining power of buyers, as the sole buyer has much power in influencing prices. If there exists only one buyer for an industry or company's product, the bargaining power of suppliers will be small. This will lead to increased competition in the industry.

  While monopsony is a rare situation, it nonetheless occurs. For example, certain automobile parts are purchased only by one of the large auto manufacturers. These automobile manufacturers have tremendous pricing power from their suppliers, to many of which they are the only customer.