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

• Question 571:

  The estimated ________ is applied to the estimated ________ to arrive at estimated future values of a company's share.

  A. earnings multiplier, earnings per share

  B. dividend payout ratio, expected growth rate less the required rate of return

  C. dividend payout ratio, required rated of return less the expected growth rate

  Correct Answer: A

  Estimated earnings multiplier x Estimated earnings per share = Estimated future value of the share.

• Question 572:

  A market strategist for Churn Brothers Brokerage is trying to determine an EPS figure for a stock market series. In her analysis, this portfolio manager has determined the following:

  1.

  Regressing sales for the series against Nominal GDP, the sales figure for the index has been estimated at: $26.44.

  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 28%.

  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: $1.89.

  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: $0.94 per share.

  5.

  Coordinating his research with a legislative consultant, the corporate tax rate for this series has been estimated at: 36%

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

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

  B. $3.87

  C. None of these answers is correct.

  D. $3.18

  E. $4.82

  F. $2.93

  Correct Answer: F

  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 = [($26.44 * 0.28) - $1.89 - $0.94] * (1 - 0.36) = $2.93

• Question 573:

  You have a stock that you are holding for one year. It has an estimated dividend payout of $1.10 and an expected sale price of $22. Using the dividend discount model, calculate the value of the stock if your required rate of return is 14%.

  A. $23.10

  B. $20.26

  C. $22

  D. not enough information to calculate it

  Correct Answer: B

  Bring both dividend and expected sale price to present value and sum the two: V = $1.10/1.14 + $22.00/1.14 = $20.26

• Question 574:

  The short-interest ratio is equal to

  A. the outstanding short interest on an exchange divided by the daily volume of trading on the exchange. A low short-interest ratio would be interpreted by technical analysts as a bearish sign, because of the small potential demand for stocks by those who have sold short by not yet covered their sales.

  B. the outstanding short interest on an exchange divided by the daily volume of trading on the exchange. A high short-interest ratio would be interpreted by technical analysts as a bearish sign, because a large amount of short sales indicates investors' expectations of declining share prices.

  C. the outstanding short interest on an exchange divided by the market capitalization of shares on the exchange. A low short-interest ratio would be interpreted by technical analysts as a bullish sign, because a small amount of short sales indicates investors' expectations of rising share prices.

  D. the outstanding short interest on an exchange divided by the number of long positions held. A high short-interest ratio would be interpreted by technical analysts as a bullish sign, because of the large potential demand for stocks by those who have sold short but not yet covered their sales.

  Correct Answer: A

  Technical analysts interpret the short-interest ratio contrary to initial intuition. Because short sales reflect investors' expectations of declining share prices, a large amount of short sales might be taken as a bearish sign. But technical analysts prefer to focus on the potential demand for shares that short sales create. Once an investor has sold short a stock, he will eventually have to repurchase it to cover his position.

• Question 575:

  There are two popular methods for estimating the earnings multiplier for an industry or a stock market series, which of the following correctly lists these two techniques?

  A. Discounted cash flow estimation, regression analysis.

  B. The direction of change and the specific estimate approach.

  C. Microanalysis and Macroanalysis.

  D. The top-down and the bottom-up approach.

  E. Scenario Analysis, Monte Carlo Simulation.

  F. More than one of these answers is correct.

  Correct Answer: F

  More than one of these answers is correct. Specifically, the "direction of change" and the "specific estimate" are methods of forecasting the earnings multiplier of a stock market series and "microanalysis" and "macroanalysis" are used to forecast the earnings multiplier for an industry.

  When estimating the earnings multiplier for an industry, there are two common methods - the "direction of change" and the "specific estimate" approaches. The direction of change approach begins with the present earnings multiplier for a stock market series and seeks to estimate both the amount and direction of any change based upon changes in the components of the P/E ratio - the required rate of return, the anticipated growth rate of dividends, and the dividend payout ratio.

  This approach is contrasted by the specific estimate approach, which involves the estimation of a specific value for the earnings multiplier based on a series of projections for values of the components of the earnings multiplier components. When using this approach, analysts commonly confine their estimates to a series of scenarios, typically a best case, worst case, and base case scenario.

  There are two common methods for estimating the earnings multiplier for an industry - macroanalysis and microanalysis. Macroanalysis involves an examination of the relationship between the earnings multiplier for an industry and the earnings multiplier for the market. Microanalysis involves an estimation of the specific variables that influence the earnings multiplier, including the required rate of return, the estimated growth rate, and the dividend payout ratio. While the top down and bottom up method are similar to Macroanalysis and Microanalysis, respectively, they do not represent the best possible answer. Specifically, the top-down and bottom up approaches are typically used to identify investment opportunities, not for the estimation of an industry earnings multiplier.

• Question 576:

  Using the microanalysis approach to estimating a company's earnings multiplier, the multiplier is based on:

  I. the dividend payout ratio

  II. the required rate of return

  III. the company's relationship to the industry

  IV.

  the rate of growth

  V.

  the estimated earnings per share

  VI.

  the company's relationship to the market

  A.

  III, VI

  B.

  I, II, III, IV, V

  C.

  I, II, IV

  D.

  I, II, III

  E.

  II, III, IV

  Correct Answer: C

  The earnings multiplier, under the microanalysis approach, is estimated based on its three components: the dividend payout ratio, the required rate of return, and the rate of growth. Under the Macroanalysis approach, it is estimated from the relationships among the firm, its industry and the market. The estimates derived from each approach are resolved to settle on one estimate.

• Question 577:

  The risk premium

  A. causes differences in the required rate of return among alternate types of investments.

  B. causes differences in required rates of return among alternate types of investments and among investments of the same type.

  C. can be less than zero.

  D. causes differences in the required rate of return among investments of the same type.

  Correct Answer: B

  Every investment has its own risk premium, which may change over time. The required rate of return on any security is equal to the risk-free rate of return plus the risk premium on that security. Because the lowest possible required rate of return on any investment is the risk-free rate of return, the risk premium cannot be less than zero.

• Question 578:

  What is the value of a preferred stock with a par value of $150, an annual dividend equal to 15% of par value, and a required rate of return of 12%?

  A. $150.00

  B. $187.50

  C. Not enough information

  D. $123.49

  E. 230.54

  Correct Answer: B

  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. In this question, the annual dividend is equal to 150 x .15 = $22.5, and the preferred stock is worth $22.5/0.12 = $187.50

• Question 579:

  A high short interest ratio would be interpreted by technical analysts as

  A. a sign of coming market instability.

  B. irrelevant.

  C. bearish.

  D. bullish.

  E. indicative of an approaching market peak.

  Correct Answer: D

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

• Question 580:

  The ________ gives an estimate for the spread between the required rate of return and the expected growth of dividends.

  A. none of these answers

  B. dividend yield

  C. P/E ratio

  D. yield-to-maturity

  Correct Answer: B

  The dividend yield gives an estimate for the spread between the required rate of return and the expected growth of dividends.