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

• Question 791:

  The graph below combines the efficient frontier with the indifference curves for two different investors, X and Y.

  Which of the following statements about the above graph is INCORRECT?

  A. Investor X is less risk-averse than Investor Y.

  B. Investor X's return will always be less than that of Investor Y.

  C. The portfolios indicated by the points X and Y represent the optimal portfolio for each investor.

  D. The efficient frontier line represents the portfolios that provide the highest return at each risk level.

  Correct Answer: A

  Investor X has a steep indifference curve, indicating that he is risk-averse. Flatter indifference curves, such as those for Investor Y, indicate a less risk-averse investor. The other choices are true. A more risk-averse investor will likely obtain lower returns than a less risk-averse investor.

• Question 792:

  Keenan Omarik, a portfolio manager in the private banking division of GSK Bank, is trying to convince a conservative client to diversify using international bonds and equities. Currently, the client holds only U.S. investments (but is well diversified) and is reluctant to change his allocation. All of the following statements support Omarik's recommendation for international diversification EXCEPT:

  A. By replacing domestic investments with foreign investments in a portfolio, investors can reduce the portfolio risk while holding the number of investments constant.

  B. Foreign securities usually have low correlations with U.S. investments and offer more diversification opportunities than domestic investments alone.

  C. Historically, non-U.S. securities have outperformed U.S. investments on a return basis, at least in part because the non-U.S. economies have experienced higher growth rates.

  D. By diversifying both domestically and internationally, investors eliminate the risk from worldwide systematic risk factors.

  Correct Answer: D

  This statement should read, "By diversifying both domestically and internationally, investors limit risk to worldwide systematic risk factors only." (Much like domestic diversification reduces unsystematic risk from individual investments, but systematic risk still exists.) The other choices are valid arguments for international diversification.

• Question 793:

  Which of the following statements about portfolio management is TRUE?

  A. Investment constraints include liquidity, time horizon, taxes, legal and regulatory concerns, and unique characteristics such as concern for social issues.

  B. The order of the four step investment process is: analyze current financial and economic conditions, specify goals and constraints, allocate assets across asset classes, and monitor and rebalance the portfolio as needed.

  C. An investor's portfolio (in the spending and gifting phase) should contain a sizable portion of equities to preserve capital over the long term.

  D. The investment performance should be judged based on the raw portfolio return.

  Correct Answer: A

  This statement is true. The steps of the investment process are listed in the incorrect order. The order should be as follows: specify goals and constraints (write a policy statement), analyze current financial and economic conditions (develop investment strategy), allocate assets across asset classes (implement the plan), monitor and rebalance the portfolio as needed (monitor and update). In the spending and gifting phases, investor portfolios generally less in equities as investors seek lower risk securities. Performance should be judged using an objective, benchmark standard ?not the raw portfolio return.

• Question 794:

  Which of the following statements about the investment life cycle is FALSE?

  A. In general, a recent college graduate working at her first job is in the accumulation phase, has a long time horizon, and should invest in high-risk securities to earn above average nominal returns.

  B. A working couple both in the midpoint of their careers has a fairly long time horizon and is beginning to move to investments with moderate risk to provide asset protection.

  C. A retired financial planner in the spending phase is most concerned with estate planning and tax minimization.

  D. Risk capacity generally declines though the investment life cycle.

  Correct Answer: C

  The gifting state is associated with estate planning and tax minimization. The spending phase is associated with protection for assets. Although these two states usually run concurrently, the life cycle distinguishes them in that the gifting phase is concerned with giving away assets while in the spending phase, there is still some accumulation from low-risk investments. The other choices are true.

• Question 795:

  The nominal required rate is determined by the inflation premium, the risk premium, and the:

  A. nominal risk-free rate.

  B. real risk-free rate.

  C. exchange rate impact.

  D. liquidity risk.

  Correct Answer: B

  The equation for the nominal risk free rate is: RequiredReturnnominal= [(1 + Risk-FreeRatereal) * (1 + Inflation Premium) * (1 + Risk Premium)] - 1 The market risk premium is used when determining the security market line (SML) and equals the required market return minus the nominal risk-free rate. Liquidity risk is a part of total risk which is measured by the risk premium. The exchange rate is not a factor in this calculation.

• Question 796:

  Ryan Konkol, CFA, is helping Gabriel Miskowiak study for the Level 1 CFA examination. Konkol asks

  Miskowiak to calculate the market risk premium based on the following assumptions:

  Which of the following choices is closest to the correct answer?

  A. 8.0%.

  B. 4.4%.

  C. 8.5%.

  D. 5.2%.

  Correct Answer: B

  The Market Risk Premium = Expected Market Return ?Nominal Risk Free Rate. Here, we are given the

  expected market return, but need to calculate the nominal risk free rate. Then, we can determine the

  Market Risk Premium.

  Step 1: Calculate the Nominal Risk-Free Rate:

  Nominal Risk-Free Rate = [(1 + Risk FreeRatereal)*(1 + Inflation Premium)] - 1

  = [(1 + 0.04)*(1 + 0.035)] ?1 = 1.076 ?1 = 0.076 or 7.6%

  Step 1: Calculate the Risk Premium:

  Market Risk Premium = Expected Market Return ?Nominal Risk Free Rate

  = 12% - 7.6% = 4.4%

• Question 797:

  An investor believes Stock M will rise from a current price of $20 per share to a price of $26 per share over

  the next year. The following information pertains:

  Should the investor purchase the stock?

  A. No, because it is undervalued.

  B. Yes, because it is overvalued.

  C. No, because it is overvalued.

  D. Yes, because it is undervalued.

  Correct Answer: C

  Expected return of Stock M = 8 + 1.7(16 - 8) = 21.6. Estimated return of Stock M = 26 - 20/20 = 30%. Since the estimated return is greater than the expected return, the investor should purchase the stock.

• Question 798:

  A drastic decrease in the United States market would:

  A. cause an increase in the world market index.

  B. not affect the world market index.

  C. cause a decrease in the world market index.

  D. cannot predict the impact.

  Correct Answer: C

• Question 799:

  When investor inflation expectations increase, all else equal, the security market line (SML) will:

  A. shift downward in a parallel manner.

  B. rotate counterclockwise.

  C. shift upward in a parallel manner.

  D. rotate clockwise.

  Correct Answer: C

  Parallel shifts in the SML result from changing market conditions (such as an increase in expected inflation). When inflation expectations increase, investors want to be compensated for the increased risk and to insure that their purchasing power is not eroded. Thus, the SML shifts upward, increasing the expected return at each level of risk. The SML will shift downward in response to decreasing inflation expectations, decreased economic growth, and expanding capital markets. Changes in slope cause the SML to rotate. The slope of the SML will change in response to changes in attitudes of investors toward risk that affects the market risk premium. If there is an increase in the market risk premium, the SML will rotate counterclockwise about the risk free rate. If there is a decrease in the market risk premium, the SML will rotate clockwise about the risk free rate.

• Question 800:

  Using the data in the following table, calculate the national beta for Country A and Country B and

  determine which country is most likely an emerging market. Note: rx, U.S. represents the correlation

  coefficient between Country X and the U.S.

  index.

  Which of the following statements about Country A and Country B is FALSE?

  A. Country B is most likely an emerging market.

  B. The national beta for Country A is less than the beta for Country B.

  C. The national beta for Country B equals 0.82.

  D. Adding either country to a domestically-only diversified portfolio will reduce overall risk.

  Correct Answer: A

  The equation for the national beta is as follows:

  As shown above, the beta for Country A is less than the beta for Country B. Country A is most likely the emerging market because of its lower correlation with the U.S, the lower Beta, and the higher risk (standard deviation). Because of the low correlations with the U.S. market, adding either asset to a domestically-only diversified portfolio will reduce risk. The principle of diversification holds even for risky assets.