CFA Institute CFA Institute Certifications CFA-LEVEL-1 Questions & Answers
Question 631:
Technicians believe that a high confidence index is
A. a bullish sign.
B. indicative of an approaching trough.
C. an unimportant sign.
D. indicative of an approaching peak.
E. a bearish sign.
Correct Answer: A
The confidence index measures the yield spread between high-grade bonds and a large cross section of bonds. Some technical analysts believe that during periods of high confidence, investors are more willing to invest in lower-quality bonds, thereby pushing down their yields, and increasing the confidence index. A high index value is thus viewed as a bullish sign.
Question 632:
Consider the following annual growth forecasts for a common stock:
Growth in years 1-2 = 30% Growth in years 3-4 = 20% Growth after year 4 = 15%
Assuming that the last dividend was $0.80 per share, and the required rate of return is 17.5% per year, what is the value of this common stock?
A. $50.87
B. $43.59
C. $58.12
D. $47.05
E. None of these answers is correct.
F. $61.78
Correct Answer: A
To determine the value of a common stock experiencing temporary supernormal growth, use the following equation:
Where: V = the value of common stock at t0, d0 = the dividend at t0, d1 = the dividend at t1, dn = the dividend at tn, gs = the supernormal rate of growth, gn = the normal rate of growth, n = the time period "n", and k = the required rate of return.
In this example, there is a transitional growth period of two years, during which the growth rate of Composite Software is expected to grow at 25% annually. This period will follow the two-year supernormal growth period, and would be denoted as g subset t. The calculation of the value of this common stock is illustrated as follows:
Which of the following is the correct order of the steps (from first to last) of the top-down, three-step approach to valuation?
A. Analysis of the economy and security markets, analysis of alternative industries, and analysis of individual firms and stocks
B. Analysis of alternative countries and regions, analysis of the economy and security markets, and analysis of individual firms and stocks.
C. Analysis of the economy and security markets, analysis of alternative countries, and analysis of individual firms and stocks
D. Analysis of alternative industries, analysis of the economy and security markets, and analysis of individual firms and stocks
Correct Answer: A
Analysis of alternative countries and regions is considered part of analysis of the economy and security markets. The steps follow a top-down approach, with the most general category (the economy) followed by more specific areas (industries and then individual firms).
Question 634:
You have invested in a stock that has a dividend growth rate of 4%. It is expected to pay a dividend of $4 per share next year. You expect to sell the stock after 3 years, for a capital gain of about $6 per share. If your required rate of return is 8%, what price would you be ready to pay for the stock?
A. $75.04
B. $18.98
C. $14.18
D. $15.47
Correct Answer: A
Be careful about the fact that $6 represents the capital gain on the stock, not the selling price. If you buy the stock for a price, P, then the problem has in effect told you that the cash flows from the stock are expected to be: $4 next year, $4 * 1.04 = $4.16 in year 2 and (P + $6 + $4 * 1.04^2) = $(P + 10.33) in year
3. The present value of these cash flows at a discount rate of 8% per year is equal to P and this equals
P = 4/1.08 + 4.16/1.08^2 + (P + 10.33)/1.08^3 = P/1.08^3 + 15.47. Solving for P gives P = 15.47/(1 1/1.08^3) = $75.04
Question 635:
Composite Software, Inc. is anticipated to experience temporary supernormal growth of 40% per year for the next two years. After this supernormal growth period has passed, the growth rate of Composite Software is anticipated to experience a two-year transition phase of 25% per year growth. Following this transition phase, the growth rate of Composite Software is expected to stabilize at 15% annually. The Company currently pays a dividend of $0.10 per share, and the required rate of return is 18% per year. What is the value of Composite Software common stock?
A. $6.62
B. $23.83
C. $14.15
D. $6.03
E. None of these answers is correct.
Correct Answer: A
To determine the value of a common stock experiencing temporary supernormal growth, use the following equation:
+ k)^n}} Where: V = the value of common stock at t0, d0 = the dividend at t0, d1 = the dividend at t1, dn = the dividend at tn, gs = the supernormal rate of growth, gn = the normal rate of growth, n = the time period "n", and k = the required rate of return.
In this example, there is a transitional growth period of two years, during which the growth rate of Composite Software is expected to grow at 25% annually. This period will follow the two-year supernormal growth period, and would be denoted as g subset t. The calculation of the value of this common stock is illustrated as follows:
When estimating change in sales for a market series, change in sales is regressed against change in ________.
A. Earnings
B. Nominal GNP
C. None of these answers
D. Revenues
Correct Answer: B
Regressing change in sales with change in GNP basically to find a relationship between GNP and sales, so that GNP growth rate can be used to estimate future sales changes.
Question 637:
Milton Manufacturing has an outstanding issue of preferred stock that pays a $1.15 annual dividend. This dividend is not assumed to change in the future, and similar investments are currently warranting a13.75% per year return. What is the value of Milton Manufacturing's preferred stock? Further, does this value represent a perpetuity or a finite series of cash flows?
A. $33.33; finite series of cash flows
B. $10.99; perpetuity
C. $8.36; perpetuity
D. $10.99; finite series of cash flows
E. $8.36; finite series of cash flows
Correct Answer: C
Preferred stock is commonly valued as a perpetuity using 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 an annual figure, so all of the necessary information has been given. The calculation of the value of this preferred stock is found as follows:
{P0 = [$1.15 / 0.1375] = $8.36.
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 638:
Which of the following are beliefs espoused by technical analysts?
A. Popularity of trading rules will eventually eliminate the value of the technique.
B. No one can consistently get new information and process it correctly and quickly.
C. All of these answers.
D. Fundamental analysts can only achieve superior returns if they obtain information before other investors.
Correct Answer: C
Under the heading 'advantages of technical analysis': there is a discussion on how technical analysis relies more on tracking market movement than assimilating intrinsic market data, which is advantageous perhaps because there is too much data accumulating too fast too be any help in proficient forecasting. But technicians also recognize that new market tracking techniques have short shelf lives.
Question 639:
Name the first step in estimating the expected value of an industry.
A. Estimate the expected payout ratio for the industry.
B. Estimate the earnings per share for the industry.
C. Estimate the sales per share for the industry.
D. Estimate the expected industry P/E ratio.
E. Estimate the expected growth in dividends for the industry.
Correct Answer: B
The second step of the two-step process is to estimate the expected industry P/E ratio. Multiplying the expected earnings per share by the expected earnings multiplier gives the expected ending value for the industry.
Question 640:
Assume the following information about a stock market series:
Observed beginning value: 1677 Anticipated ending value: 1890 Expected dividends during the period: $16.36 Required rate of return: 19.50%
Using this information, what is the expected rate of return for this index? (Assume a one-year holding period.)
A. 10.40%
B. 14.79%
C. None of these answers is correct.
D. 12.14%
E. 11.73%
Correct Answer: C
The anticipated rate of return for this stock market series is found as 13.68%. Thus, none of these answers is correct.
To calculate the expected rate of return for a stock market series, the following information must be known: The beginning value for the series, the anticipated ending value for the series, and the amount of any dividends and/or distributions during the period. Once this information has been determined, the expected return on a stock market index can be found by employing the following equation: {E(R) = [(EV - BV + Div) / BV]}. Where E(R) = the expected return on the stock market series, EV = the anticipated ending value for the series, BV = the observed beginning value for the series, and Div = the amount of any dividends paid during the period.
In this example, all of the necessary information has been provided and the calculation of the expected return on this stock market series is found as follows: {E(R) = [$1890 - $1677 + $16.36] / 1677} = 13.68%.
This is significantly less than the required rate of return. Assuming that both the ending value and dividend
figure is accurate, investment in this stock market series is likely not warranted.
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