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CFA Level I 4 th Mock Exam December, 2016 Revision 1

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CFA Level I Mock Exam 4 – Solutions (AM)

FinQuiz.com – 4 th Mock Exam 2016 (AM Session)

Questions

Topic

Minutes

1-18

Ethical and Professional Standards

27

19-32

Quantitative Methods

21

33-44

Economics

18

45-68

Financial Reporting and Analysis

36

69-76

Corporate Finance

12

77-88

Equity Investments

18

89-94

Derivative Investments

9

95-106

Fixed Income Investments

18

107-112

Alternative Investments

9

113-120

Portfolio Management

12

Total

180

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CFA Level I Mock Exam 4 – Solutions (AM)

Questions 1 through 18 relate to Ethical and Professional Standards

1. Frank Liew is a research analyst who is working with a team of analysts to produce a report on a large, multinational firm. Each member performs an independent analysis of the firm based on comprehensive data about the firm’s financials and its competitor strategies. However, after developing his recommendation, Liew discovers that the consensus opinion differs significantly. The report is published with Liew’s name included in the list of analysts.

By opting not to dissociate from the report, Liew has most likely:

A. not violated any Standards.

B. violated Standard V(A) ‘Diligence and reasonable basis’.

C. violated Standard V(A) ‘Diligence and reasonable basis and Standard II(B) ‘Market Manipulation’.

Correct Answer: A

Reference:

CFA Level I, Volume 1, Study Session 1, Reading 2

Since the consensus opinion has a reasonable and adequate basis and is independent and objective, Liew need not decline to be identified with the report.

2. To be compliant with the GIPS standards, a firm’s total assets must be the aggregate of the:

A. market value of all discretionary fee and non-fee paying accounts.

B. fair value of all discretionary and non-discretionary fee-paying accounts.

C. fair value of all discretionary and non-discretionary accounts including both fee paying and non-fee paying portfolios.

Correct Answer: C

Reference:

CFA Level I, Volume 1, Study Session 1, Reading 2

Total firm assets must be the aggregate fair value of all discretionary and non- discretionary assets managed by the firm. This includes both fee-paying and non- fee paying portfolios.

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CFA Level I Mock Exam 4 – Solutions (AM)

3. Rafael Stuart is a research analyst at Grand Investment Associates (GIA), a U.S. based financial advisory firm that targets private wealth clients. Stuart, along with a group of research analysts at GIA, is preparing a report on Tetragonal Corporation (TETCO), a large-cap technology firm. Based on a comprehensive analysis of the firm’s pro forma financial statements, Stuart reached the conclusion that TETCO’s next quarter’s EPS would be at least 5% lower than consensus. Stuart’s research team, however, disagrees, and publishes the report including a ‘buy’ recommendation.

To be in compliance with CFA Institute Standards of Professional Conduct, Stuart should most likely:

A. remove his name from the report before it is published.

B. report the disagreement to supervisory authorities and ask for corrective action.

C. remove his name from the report and report the disagreement to supervisory authorities.

Correct Answer: A

Reference:

CFA Level I, Volume 1, Study Session 1, Reading 2

Rafael should remove his name from the written report since he disagrees with the report’s conclusions. Reporting to supervisory authorities may not be necessary since it is not evident that the rest of the research team is engaging in any illegal conduct.

4. If local laws are in conflict with the GIPS standards, a GIPS compliant firm should comply with:

A. the law that is more stringent.

B. GIPS standards and disclose the conflict in the compliant presentation.

C. the local laws and make full disclosure of the conflict in the complaint presentation.

Correct Answer: C

Reference:

CFA Level I, Volume 1, Study Session 1, Reading 2

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CFA Level I Mock Exam 4 – Solutions (AM)

In cases in which laws and/or regulations conflict with the GIPS standards, firms are required to comply with the laws and regulations and make full disclosure of the conflict in the compliant presentation.

5. Jim Chao works for an investment management firm that is developing marketing material to promote its business and attract prospective clients. The firm utilizes the past 15-years return to a composite that includes only the firm’s successful client accounts that have generated an average return of at least 10% during the time period. Chao does not prepare the marketing material, but is required to use to it during preliminary meetings with prospective clients.

With regards the use of the marketing material, to be in compliance with Standard I-A of the CFA Institute Standards of Professional Conduct, Chao should most likely:

A. use the marketing material when soliciting business for the firm.

B. use the marketing material, and disclose the calculation methodology to the clients.

C. not use the marketing material, and bring the situation to the attention of the supervisor.

Correct Answer: C

Reference:

CFA Level I, Volume 1, Study Session 1, Reading 2

The firm is only using the surviving accounts’ returns in the composite, which will inflate the performance figure. Disclosing it to clients does not absolve the firm from inappropriately representing firm performance (many clients may not fully understand the implications of the calculation methodology). Hence, Chao should not use the marketing material and bring the situation to the attention of the supervisor.

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CFA Level I Mock Exam 4 – Solutions (AM)

6. In the absence of regulatory guidance, CFA Institute recommends that firms should maintain records for at least:

A. 5-years.

B. 7-years.

C. 10-years.

Correct Answer: B

Reference:

CFA Level I, Volume 1, Study Session 1, Reading 2

CFA Institute recommends maintaining records for at least seven years.

7. Edward Li is an analyst at an equity management firm in the U.S. During a meeting with one of his clients, Vincent Yan, Li discovered that Yan has a surplus of $30,000 to invest in a diversified mutual fund. A few days later, Li attended a conference of reputable financial analysts and portfolio managers. There he met Wilbert Ho, the manager of one of the area’s best performing mutual funds. In an attempt to help his client, Li told Ho to contact Yan, one of his clients who had $30,000 cash, and offer him performance details of his mutual fund.

By revealing information about his client, Li has most likely:

A. violated Standard III (E)—Preservation of Confidentiality.

B. not violated Standard III (E)—Preservation of Confidentiality because the information was not confidential.

C. not violated Standard III (E)—Preservation of Confidentiality because Li’s intent was to help his client as is stipulated by his duty of loyalty to the client.

Correct Answer: A

Reference:

CFA Level I, Volume 1, Study Session 1, Reading 2

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CFA Level I Mock Exam 4 – Solutions (AM)

Even though his intentions were good, Li has violated Standard lll (E) by revealing confidential information about his client.

8. J&J Investment Advisors (J&J) is an investment firm that is in the process of being a GIPS compliant firm. As such, J&J has calculated the portfolio performance of its largest institutional client in accordance with the GIPS standards. During a meeting with the client, J&J refers to the calculation methodology as being consistent with GIPS standards.

In making this statement, J&J is in:

A. violation of the GIPS standards, because such statements are strictly prohibited.

B. violation of the GIPS standards, because such statements can only be made in a firm’s prospectus and marketing material.

C. compliance with the GIPS standards, because J&J is in the process of being GIPS compliant and as such, has prepared the performance data in accordance with the standards.

Correct Answer: A

Reference:

CFA Level I, Volume 1, Study Session 1, Reading 2

Such statements are strictly prohibited, unless the firm is GIPS-compliant already and it reports the performance of an individual client’s portfolio to that client.

9. To be fully compliant with the required and recommended procedures of Standard II(A) ‘Material nonpublic information’, a firm should:

A. create a restricted list and a watch list in combination.

B. broadly distribute a restricted list when in possession of material nonpublic information.

C. Restrict all trading within the firm when in possession of material nonpublic information.

Correct Answer: A

Reference:

CFA Level I, Volume 1, Study Session 1, Reading 2

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CFA Level I Mock Exam 4 – Solutions (AM)

The broad distribution of a restricted list often triggers the sort of trading the list was developed to avoid. Therefore, a watch list shown to only the few people responsible for compliance should be used to monitor transactions in specified securities. Restricting all trading is also counterproductive.

10. Elaine Sen manages a trust fund worth $50,000. The trust documents transfer effective control of the funds to Sen and prohibit investing in non-U.S. stocks and bonds. Sam Kim, a 15 year old girl, is the primary beneficiary of the fund. Just recently, Kim approached Sen to discuss her educational expenses, stating that an additional cash flow of $20,000 would be needed each year for her to complete high school. Owing to the heightened need of cash, Sen deems it appropriate to invest in high-yield emerging market stocks to increase the fund returns. Consequently, she invests only 5% of the fund in such stocks.

Sen has most likely violated:

A. no Standards.

B. Standard III(C) ‘Suitability’.

C. Standard III(A) ‘Loyalty, Prudence and Care’.

Correct Answer: C

Reference:

CFA Level I, Volume 1, Study Session 1, Reading 2

Sen has custody of the client assets so her level of responsibility is heightened. Sen is obligated to manage the funds in accordance with the terms of the governing documents of the trust. In this case, the trust documents clearly prohibit investing in non-U.S. stocks and bonds. Hence, by investing in high-yield emerging market stocks, Sen has violated Standard III-A loyalty, prudence, and care.

11. The CFA Institute Standards of Professional Conduct require that a client’s investment policy statement should be reviewed at least:

A. annually.

B. quarterly.

C. semiannually.

Correct Answer: A

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CFA Level I Mock Exam 4 – Solutions (AM)

Reference:

CFA Level I, Volume 1, Study Session 1, Reading 2

The IPS should be reviewed at least annually.

12. Alex Lama has just been hired as a research analyst by Exo-Tech Limited (ETL) to produce a research report on their company. Lama has been provided with all factual information about the firm that he plans to use to perform a thorough and unbiased analysis of the firm. ETL has granted Lama 500 stock options in return for writing the report.

As an independent analyst, has Lama most likely violated best practice with regards to Standard l-B ‘Independence and Objectivity’ of the CFA Institute Standards of Professional Conduct?

A. No.

B. Yes, because her compensation arrangement is not what best practice recommends.

C. Yes, because she did not disclose the nature of the compensation to investors.

Correct Answer: B

Reference:

CFA Level I, Volume 1, Study Session 1, Reading 2

Best practice is for independent analysts to negotiate only a flat fee for their work that is not linked to their conclusions or recommendations. A stock option will increase in value if Lama issues a positive report. Hence, the compensation arrangement does not follow best practice.

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CFA Level I Mock Exam 4 – Solutions (AM)

13. Jessica Wright is a marketing specialist at Capital Managers (CAPM) an asset management firm in Houston, Texas. Wright has been asked to develop promotional material for CAPM’s Emerging Market Equities Fund created by the firm around ten years ago. Due to a typographical error, the material prepared by Wright states that the fund includes Russian securities when in fact, it does not. Wright presents the material to upper management, who approve it for distribution to clients. After several days, Wright identifies the mistake and corrects it immediately.

With regards to Standard I(C)-Misrepresentation, Wright has most likely:

A. violated the Standard since she allowed the erroneous material to be distributed and did not prepare the material with caution.

B. not violated the Standard since she corrected it immediately after identifying it.

C. not violated the Standard as long as she informs those who have received the erroneous information about the error.

Correct Answer: C

Reference:

CFA Level I, Volume 1, Study Session 1, Reading 2

Because Wright unknowingly make this mistake she did not violate Standard I(C)- Misrepresentation. However, if she does not inform those who have received the material about the mistake and does not cease distribution until the mistake is rectified, she would be violating the Standard.

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CFA Level I Mock Exam 4 – Solutions (AM)

14. Casey Hart is a fixed-income analyst at Golden Gust Investments (GGIN), an asset management firm in Indianapolis, USA. Hart is planning to leave the firm to start her own advisory business with an old friend and an entrepreneur. To ensure that she does not engage in any unethical or controversial practices, Hart refrains from soliciting clients while employed at GGIN. In addition, she does not take documents or other confidential information from the firm. Hart plans to copy and take with her only her own recommended list of securities and her personal marketing presentations containing her performance record.

With regards to Standard IV—Duties to Employers, Hart has most likely:

A. violated her duty of loyalty to the firm.

B. not violated her duty of loyalty since she plans to take only personal information with her.

C. not violated her duty of loyalty since her work and experience gained at GGIN is her property and not the firm’s.

Correct Answer: A

Reference:

CFA Level I, Volume 1, Study Session 1, Reading 2

Hart has violated her duty of loyalty to the firm. She made the recommendations and prepared the presentations using GGIN’s resources while being employed at the firm. Hence, such documents are the property of GGIN and Hart will be in violation of her duty of loyalty to the firm if she plans to take them with her without permission.

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CFA Level I Mock Exam 4 – Solutions (AM)

15. Adam Blank directs all trades of one of his clients through a broker specified by the client. Doing so does not help Blank achieve best execution and best price. Blank discloses this fact to the client but continues trading through the same broker.

Blank will least likely be in violation of Standard III(A)-Loyalty, Prudence, and Care if he:

A. continues to trade through the broker.

B. finds and selects a broker that offers the best ‘price’.

C. seeks best execution by selecting a different broker and informs the client about his selection.

Correct Answer: A

Reference:

CFA Level I, Volume 1, Study Session 1, Reading 2

Since the client specifically instructed Blank to trade through a particular broker, Blank is obligated to do so. However, Blank should disclose to the client that the broker does not help him in achieving best execution.

16. West & Graham Associates (W&G) is a financial advisory firm that allows its employees to reissue previously released reports by its own employees without attributing to those prior W&G analysts.

The firm is most likely in violation of:

A. no standards.

B. Standard I(C)-Misrepresentation.

C. Standard I(B)-Independence & Objectivity and Standard l(C)- Misrepresentation.

Correct Answer: B

Reference:

CFA Level I, Volume 1, Study Session 1, Reading 2

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CFA Level I Mock Exam 4 – Solutions (AM)

Standard l(C)-Misrepresentation, does not allow a member or candidate to reissue a previously released report solely under his or her name (even if his independent and objective research supports it).

17. The duty to clients imposed by Standard III(B)—Fair Dealing is most likely:

A. more critical when changing recommendations than when making initial recommendations.

B. more critical when making initial recommendations than when changing recommendations.

C. equally critical when making initial recommendations as well as when changing recommendations.

Correct Answer: A

Reference:

CFA Level I, Volume 1, Study Session 1, Reading 2

The duty to clients imposed by Standard III(B)-Fair Dealing may be more critical when changing recommendations. The member or candidate must make sure that the change is communicated in a fair manner especially to those who have been affected by the earlier advice.

18. Money-Etched Investments (MEIN) is a firm that attained considerable popularity last year owing to high returns on its equity funds. The firm earned at least a 20% return on its funds with the highest return being 28%. While developing advertising material for the company, the firm’s CEO, Jeremy Chinn, asked to include the following statement in the brochure:

“Investors in MEIN’s equity funds can expect the value of their investments to grow by at least 20% over a year, and hopefully, even more.”

Is MEIN’s advertising material most likely in compliance with the CFA Institute Standards of Professional Conduct?

A. Yes.

B. No, because it violates Standard III(D) ‘Performance Presentation’.

C. No, because it violates Standard III(D) ‘Performance Presentation’ and Standard I(C) ‘Misrepresentation’.

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CFA Level I Mock Exam 4 – Solutions (AM)

Correct Answer: C

Reference:

CFA Level I, Volume 1, Study Session 1, Reading 2

MEIN has misrepresented performance information, since the 20%-28% return was only in a single year and is not representative of what investors could earn every year. It is not apparent from the information provided that the firm can earn such high returns for the years to come. Hence, the brochure is in violation of the Standards.

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CFA Level I Mock Exam 4 – Solutions (AM)

Questions 19 through 32 relate to Quantitative Methods

19. According to the central limit theorem, which of the following is most accurate?

A. The variance of the distribution of the sample will decrease as the sample size increases.

B. The mean of the distribution of the sample will almost be equal to the mean of the population from which the sample is drawn.

C. The variance of the distribution of the sample will be equal to the variance of the population dividend by (n-1).

Correct Answer: A

Reference:

CFA Level I, Volume 1, Study Session 3, Reading 10

The variance of the distribution of the sample mean equals the variance of the population divided by sample size. Hence, as sample size increases, the variance decreases.

20. A financial statistician made the following comments while addressing a group of interns about the various statistical techniques used in equity analysis.

Statement 1: “Sample variance calculated with a divisor of ‘n’ is a biased estimator of the population variance.”

Statement 2: “An estimator is more efficient and unbiased the larger the sample size.”

He is most accurate with respect to:

A. Statement 1 only.

B. Statement 2 only.

C. Neither statement 1 nor statement 2.

Correct Answer: A

Reference:

CFA Level I, Volume 1, Study Session 3, Reading 10

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CFA Level I Mock Exam 4 – Solutions (AM)

Statement 1 is correct.

Statement 2 is incorrect, Un-biasedness and efficiency are properties of an estimator’s sampling distribution that hold for any size sample.

21. Which of the following is least likely a property of binomial distribution?

A. A binomial distribution has fixed number of trials.

B. The trials in a binomial distribution are independent.

C. Each trial in a binomial distribution has only one outcome.

Correct Answer: C

Reference:

CFA Level I, Volume 1, Study Session 3, Reading 9

A

distribution that involves binary outcome is referred to as binomial distribution.

It

has following properties.

i. A binomial distribution has fixed number of trials.

ii. Each trial in a binomial distribution has two possible outcomes.

iii. Probability of success is denoted as P (success) = p and probability of failure is denoted as P (failure) = 1-p.

iv. The trials are independent.

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CFA Level I Mock Exam 4 – Solutions (AM)

22. An equity analyst is using the P/E ratio to rank the component firms of a broad- based equity market index. The exhibit below is an excerpt from the information that the analyst gathered about the 35 companies included in the index.

Exhibit P/E Data provided in ascending order.

No.

Company

P/E ratio

1

A

0.55

2

B

0.67

3

C

1.10

4

D

1.47

5

E

2.89

The estimate for the 10 th percentile for the P/E ratio is closest to:

A. 1.322.

B. 1.360.

C. 1.391.

Correct Answer: A

Reference:

CFA Level I, Volume 1, Study Session 2, Reading 7

n =35, L 10 = (35+1)(10/100) = 3.6

The estimate of the 10 th percentile is:

1.10 +(3.6-3)(1.47-1.10) = 1.322

23. For a random sample of 200 small-cap U.S. stocks, the average dividend yield is 1.56% and the sample has a standard deviation of 0.40.

The 99% confidence interval for the population mean of all small-cap U.S. stocks based on the standard normal distribution will be closest to:

A. 1.487% to 1.633%.

B. 1.504% to 1.615%.

C. 1.513% to 1.606%.

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CFA Level I Mock Exam 4 – Solutions (AM)

Correct Answer: A

Reference:

CFA Level I, Volume 1, Study Session 3, Reading 10

Here, z 0.005 = 2.58

The confidence interval will be:

1.56-2.58(0.40/200) to 1.56+2.58(0.40/200)

1.487% to 1.633%

24. A stated annual interest rate is the:

A. quoted interest rate that does not account for compounding within the year.

B. amount by which a unit of currency will grow in a year with interest on interest included.

C. quoted interest rate per period that equals the periodic rate divided by the number of compounding periods per year.

Correct Answer: A

Reference:

CFA Level I, Volume 1, Study Session 2, Reading 5

A stated annual interest rate is the quoted interest rate that does not account for compounding within the year.

An effective annual rate is the amount by which a unit of currency will grow in a year with interest on interest included.

A periodic rate is the quoted interest rate per period and it equals the stated annual interest rate divided by the number of compounding periods per year.

25. The Chebyshev’s inequality will most likely hold for:

A. continuous data that is normally distributed.

B. discrete data regardless of the shape of the distribution.

C. continuous and discrete data regardless of the shape of the distribution.

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CFA Level I Mock Exam 4 – Solutions (AM)

Correct Answer: C

Reference:

CFA Level I, Volume 1, Study Session 2, Reading 7

The inequality holds for samples and populations and for discrete and continuous data regardless of the shape of the distribution.

26. Ronald Gibson is a statistical expert that works for an equity management firm. Gibson believes that the normal distribution describes most common stock returns, at least in the long-run. Under this assumption, Gibson is estimating the probability that an emerging market equity portfolio’s return would exceed 22%. The portfolio mean return is 14% and the standard deviation of returns is 26% per year. Gibson is using the following excerpt from the table of normal probabilities to help him with his calculation.

x or z

0

0.01

0.02

0.20

0.5793

0.5823

0.5871

0.30

0.6179

0.6217

0.6255

0.40

0.6554

0.6591

0.6628

Gibson’s estimated probability should be closest to:

A. 37.83%.

B. 38.21%.

C. 39.88%.

Correct Answer: A

Reference:

CFA Level I, Volume 1, Study Session 3, Reading 9

z = 22-14/26 = 0.307692

Rounding off N(0.31) = 0.6217 (from the table), Thus 1-0.6217 = 0.3783 or

37.83%.

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CFA Level I Mock Exam 4 – Solutions (AM)

27.

A

portfolio manager is concerned about the occurrence of any structural changes

in

the returns data series that he has gathered for non-U.S. stocks.

The manager’s concern is most likely related to the:

A. look-ahead bias.

B. time-period bias.

C. sample selection bias.

Correct Answer: B

Reference:

CFA Level I, Volume 1, Study Session 3, Reading 10

A long time series has the potential for a structural change occurring during the

time frame that would result in two different return distributions. This relates to time-period bias.

28. Edward Burger is meeting with his portfolio manager for the regular, annual performance review of his portfolio. The portfolio manager has recommended Burger to cash out of a few investments that he considers are not adding value to his overall wealth. Burger is presented with the following information about these investments.

Investment

Recent Annual Sharpe Ratio

A

-0.23

B

-1.56

C

-2.01

Given that Burger wants to cash out of only one investment for the time being, he selects Investment C.

Burger’s decision regarding investment C is most likely:

A. appropriate.

B. inappropriate, because a shorter evaluation period should be used.

C. inappropriate, because a different evaluation metric should be used.

Correct Answer: C

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CFA Level I Mock Exam 4 – Solutions (AM)

Reference:

CFA Level I, Volume 1, Study Session 2, Reading 7

In a comparison of portfolios with negative Sharpe ratios, we cannot generally interpret the larger Sharpe ratio to mean better risk-adjusted performance. Hence, either the evaluation period needs to be increased so that one or more of the Sharpe ratios become positive, or a different performance evaluation metric should be used.

29. Peter Brook has shortlisted three investments to add to his $10,000 equity portfolio. Brook needs to pay the first installment on his house in a year’s time and needs the portfolio to generate enough cash to be able to do so. The table below reveals certain performance measures for the portfolio after adding each of the three investments.

Investment

Sharpe

Target Semi-

Ratio

Deviation

A

2.3

17%

B

4.6

23%

C

3.5

11%

Which of the above investments should Brook most likely invest in?

A. Investment A.

B. Investment B.

C. Investment C.

Correct Answer: C

Reference:

CFA Level I, Volume 1, Study Session 3, Reading 7

Investment C is most appropriate. This is because it has a positive, relatively high Sharpe ratio and the lowest target semi-deviation. Since Brook needs to cover the cash outflow with his portfolio’s returns, a target return needs to be specified. The portfolio with the lowest target semi-deviation will have the least risk of falling short of Brook’s cash flow needs (target return).

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CFA Level I Mock Exam 4 – Solutions (AM)

30. Jeanette King, a portfolio manager, is constructing the investment policy statement of one of her firm’s new clients. Currently, the client has most of his money invested in risk-free T-bills or investment grade corporate bonds. He is considerably averse to volatility in his portfolio’s returns. King is considering the following investments for the client.

Company

Kurtosis

Skewness

A

3

0

B

4.5

-0.5693

C

2.1

0.7955

Which of the above investments will be most suitable for King’s client?

A. Company A.

B. Company B.

C. Company C.

Correct Answer: C

Reference:

CFA Level I, Volume 1, Study Session 2, Reading 7

Since the client is highly risk-averse as is apparent from his current asset allocation and his averseness to portfolio volatility, a positively skewed distribution with thinner tails (less extreme values) would be most appropriate. This is given by Company C, which has a platykurtic, positively skewed distribution of returns.

31. In candlestick charts, doji is a pattern where the stock opened:

A. and closed at the same price.

B. at its low and closed near its high.

C. at its high and dropped significantly to close near its low.

Correct Answer: A

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CFA Level I Mock Exam 4 – Solutions (AM)

Reference:

CFA Level I, Volume 1, Study Session 3, Reading 12

In candlestick chart, when stock’s high price is same as low price and opening and closing price is same, it creates a cross pattern and is referred to as ‘doji’ (used in Japanese terminology).

32. Bob Harper, a hedge fund manager, lists all the major hedge funds operating in the industry and categorizes them into different styles. He then assigns a number to each investment style.

Which of the following measures of central tendency would be most appropriate for the data Harper is analyzing?

A. Mean.

B. Mode.

C. Median.

Correct Answer: B

Reference:

CFA Level I, Volume 1, Study Session 2, Reading 7

The data that Harper has gathered is nominal data. The mode is the only measure of central tendency that can be used with nominal data.

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CFA Level I Mock Exam 4 – Solutions (AM)

Questions 33 through 44 relate to Economics

33. If the aggregate demand of an economy increases more than increase in the aggregate supply, an investor should most likely reduce investments in:

A. cyclical companies.

B. fixed-income securities.

C. commodity-oriented equities.

Correct Answer: B

Reference:

CFA Level I, Volume 2, Study Session 5, Reading 17

The question describes the emergence of an inflationary gap. In such a scenario, fixed-income securities would decline in value as interest rates rise, so exposure to them should be decreased.

34. When a firm’s TR = TC and MR > MC, the firm:

A. is at maximum profit level.

B. is operating at upper breakeven point.

C. should increase quantity to generate profits.

Correct Answer: C

Reference:

CFA Level I, Volume 2, Study Session 4, Reading 15

When TR = TC and MR > MC, the firm is operating at lower breakeven point. The firm should increase quantity to enter profit territory.

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CFA Level I Mock Exam 4 – Solutions (AM)

35. An economist is attempting to display, graphically, the income constraint of a private wealth client with regards to two of his highly consumed products: Petrol and electricity.

The slope of the income constraint equals the amount of petrol consumption that the client would have to give up if he were to consume more electricity.

If the price of petrol were to rise, the slope of the income constraint would most likely:

A. increase.

B. decrease.

C. remain unchanged.

Correct Answer: B

Reference:

CFA Level I, Volume 2, Study Session 4, Reading 14

An increase in the price of petrol will pivot the budget constraint downward (as petrol plots on the vertical axis). Hence, the budget constraint would become less steep meaning that the slope will decrease.

36. As a firm increases the quantity of its product produced, the distance between its ATC and AVC curve:

A. starts increasing.

B. starts decreasing.

C. remains constant.

Correct Answer: B

Reference:

CFA Level I, Volume 2, Study Session 4, Reading 15

The distance equals the AFC. As quantity produced increases, the average fixed cost starts decreasing because it spreads over a greater number of units.

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CFA Level I Mock Exam 4 – Solutions (AM)

37. Which of the following will least likely shift an economy’s short-run average supply leftward but will have no effect on the long-run average supply?

A. A decrease in input prices.

B. An increase in human capital.

C. A decrease in the expectation of future prices.

Correct Answer: B

Reference:

CFA Level I, Volume 2, Study Session 5, Reading 17

An increase in human capital will shift the SRAS rightward, and it will also shift the LRAS rightward.

38. Alex Gerald is examining his budget constraint given his current income and expenditures. Gerald has a total budget of $125 per week to spend on milk or juices. The price of milk is $3.5/litre and the price of juice is 2.5/litre.

If the quantity of milk is measured on the horizontal axis of the budget constraint, the slope of the budget constraint would be closest to:

A. -0.71.

B. -0.95.

C. -1.40.

Correct Answer: C

Reference:

CFA Level I, Volume 2, Study Session 4, Reading 14

Slope: -3.5/2.5 = -1.4

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CFA Level I Mock Exam 4 – Solutions (AM)

39. Diseconomies of scale lead to higher average total:

A. cost.

B. profit.

C. revenue.

Correct Answer: A

Reference:

CFA Level I, Volume 2, Study Session 4, Reading 15

Diseconomies of scale lead to higher average total cost.

40. A consumer buys both ice cream and cake each week for dessert. The price of ice cream is $1.25 per scoop and the price of cake is $1.55 per piece. The consumer’s marginal rate of substitution, MRS IC , equals 0.66.

To maximize utility, the consumer should most likely:

A. not change her consumption.

B. increase her consumption of cake and decrease her consumption of ice- cream.

C. decrease her consumption of ice-cream and increase her consumption of cake.

Correct Answer: B

Reference:

CFA Level I, Volume 2, Study Session 4, Reading 14

MRS IC = 1.25/1.55 = 0.806. Since the consumer’s MRS is smaller, he should spend a little more on cake and a little less on ice cream.

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CFA Level I Mock Exam 4 – Solutions (AM)

41. Rosy Diaz is a research analyst that follows the Russian automobile industry. As part of the industry’s competitive analysis, Diaz determined that at a range of output levels, size does not give a firm a competitive edge. However, over and above those levels, the larger the business, the greater its potential investment value.

Given the structure of the Russian automobile industry, the industry’s:

A. long-run supply curve has either a zero slope or a decreasing slope.

B. short-run supply curve is downward sloping over a particular range of output.

C. long-run supply curve is U-shaped, with the slope decreasing over a range of output.

Correct Answer: A

Reference:

CFA Level I, Volume 2, Study Session 4, Reading 15

For a range of output levels, size does not matter, so the slope of the long-run supply curve is zero or constant. For levels above that, size matters, so the LRATC curve decreases as output increases (meaning that slope decreases).

42. Which of the following asset categories price will most likely exhibit substantial price increases when the economy is in boom phase?

A. Riskiest assets.

B. Government Bonds.

C. Shares of exporting companies.

Correct Answer: A

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CFA Level I Mock Exam 4 – Solutions (AM)

Reference:

CFA Level I, Volume 2, Study Session 5, Reading 18

Option A is correct. During the boom phase, the riskiest assets will often have substantial price increases.

Option B is incorrect as safe assets such as government bonds that are normally highly priced during recessions may have lower prices and thus higher yields during the boom phase.

Option C is incorrect as investors may try to buy shares of exporting companies, as a result of restrictive economic policy or during slowdowns within the country.

43. Helen Oswald, a portfolio manager, is assessing the effect of a recent increase in one of her client’s salary on her consumption patterns. Oswald had constructed a production opportunity frontier with spending on designer dress shirts on the vertical axis and t-shirts on the horizontal axis.

Given the change in circumstances, the client’s production opportunity frontier would most likely:

A. shift upward, and the optimal indifference curve would shift rightward.

B. shift upward, and the optimal indifference curve would remain unchanged.

C. remain unchanged, and the optimal indifference curve would shift leftward.

Correct Answer: B

Reference:

CFA Level I, Volume 2, Study Session 4, Reading 14

The optimal indifference curve would shift leftward. The new point of tangency of the indifference curve and the POF would indicate a rise in the consumption of designer shirts and a fall in the consumption of t-shirts. This is because as income rises, consumption of normal goods increase (dress shirts) and of inferior goods decreases.

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CFA Level I Mock Exam 4 – Solutions (AM)

44. During his research Ross Katz, an economist, reviews the GDP data for the European economy for the year ended 2005. The following exhibit is an excerpt from the table provided by the Department of Finance in Europe.

Exhibit:

GDP Release for the European economy (in millions of euros)

Consumer spending

550,000

Government spending

190,678

Government gross fixed investment

30,000

Business gross fixed investment

145,300

Exports

320,666

Imports

312,865

Change in inventories

15,500

Statistical discrepancy

500

Interest income

77,500

Using the expenditure approach, nominal GDP for the European economy is closest to:

A. 939,779 billion.

B. 1,001,779 billion.

C. 1,1017,279 billion.

Correct Answer: A

Reference:

CFA Level I, Volume 2, Study Session 5, Reading 17

Nominal GDP = 550,000+145,300+15,500+190,678+30,000+320,666- 312,865+500 = 939,779 billion.

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CFA Level I Mock Exam 4 – Solutions (AM)

Questions 45 through 68 relate to Financial Reporting and Analysis

45. Which of the following statements is least likely correct regarding gross profit margin?

Gross profit margin:

A. is inversely related to the competition in the industry.

B. provides a liquidity measure that is independent of the financing of the firm’s assets.

C. reflects the percentage of revenue available to pay operating and other expenses and to generate profit.

Correct Answer: B

Reference:

CFA Level I, Volume 3, Study Session 8, Reading 28

Options A and C are correct however option B is incorrect. Gross profit margin is not a liquidity measure but a performance/profitability measure.

46. Which of the following would least likely affect a firm’s cash flow from financing activities?

A. A firm’s employee exercising stock options.

B. A firm increasing its dividend payout ratio effective immediately.

C. An increase in the market interest rates on debt similar to a firm’s outstanding loans.

Correct Answer: C

Reference:

CFA Level I, Volume 3, Study Session 8, Reading 27

Increase in market interest rates would decrease the fair value of the firm’s debt. But fair value is not reported in financial statements, and hence, will not affect a firm’s CFF (it is not a cash inflow).

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CFA Level I Mock Exam 4 – Solutions (AM)

47. If a firm’s leverage ratio increases, its return on equity will:

A. increase.

B. decrease.

C. either increase or decrease.

Correct Answer: C

Reference:

CFA Level I, Volume 3, Study Session 8, Reading 28

ROE will only increase if borrowing costs exceed the marginal rate earned on investing in the business.

48. Holding everything else constant, assuming a firm does not sell on credit at all, which of the following ratios for the firm would most likely be equivalent?

A. Cash ratio and quick ratio.

B. Current ratio and cash ratio.

C. Current ratio and quick ratio.

Correct Answer: A

Reference:

CFA Level I, Volume 3, Study Session 8, Reading 26

The firm has no accounts receivables, so the cash ratio and the quick ratio would be equal.

49. Under U.S. GAAP, which of the following items will most likely be reported as extraordinary in the income statement?

A. Restructuring charges.

B. Losses from a major legal case.

C. A significant gain on the sale of a rare piece of machinery.

Correct Answer: B

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CFA Level I Mock Exam 4 – Solutions (AM)

Reference:

CFA Level I, Volume 3, Study Session 8, Reading 25

Under U.S. GAAP, only those items that are unusual and infrequent can be recognized as extraordinary. Only Option B fits this criteria.

50. Sasha Audrey, a financial analyst, is preparing a report on Vault Managers (VMA), a financial management firm in Chicago, USA. Audrey has accumulated information about the firm to estimate key financial ratios. The following exhibit displays this information.

Exhibit: Selective Financial Information of Vault Managers (in thousands of US dollars)

 

December 31, 2011

Revenues

$405,000

Cost of services

$85,200

Interest

$135,500

Selling, general, and administrative expenses

75,000

Depreciation

45,500

Tax Rate

35%

VMA’s operating profit margin is closest to:

A. 10.24%.

B. 15.75%.

C. 49.21%.

Correct Answer: C

Reference:

CFA Level I, Volume 3, Study Session 8, Reading 25

Operating profit: 405,000-85,200-75,000-45,500= 63,800/405,000 = 15.75%

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CFA Level I Mock Exam 4 – Solutions (AM)

51. All Star Products (ASP) reported net income of $2,750,000 for the year ended December 31, 2010. During the same year the company had an average of 1,050,000 shares of common stock outstanding. In addition to common stock, ASP also had 50,000 of convertible preferred stock, with each convertible into ten shares of the firm’s common stock. The firm pays a preferred dividend of $15/share and a common dividend of $20.

ASP’s diluted EPS is closest to:

A. $1.77.

B. $1.29.

C. $1.90.

Correct Answer: A

Reference:

CFA Level I, Volume 3, Study Session 8, Reading 25

Diluted EPS:

$2,750,000/1,050,000+500,000 (additional shares if converted) = $1.77

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CFA Level I Mock Exam 4 – Solutions (AM)

52. An analyst is attempting to derive the operating cash flow from a company’s reported net income. The following information has been collected by the analyst for the purposes of computation:

 

Year Ended

   
 

31/12/2015

   

Income statement item

     

Net income

450,000

   

Depreciation

38,000

   

Gain from disposal of long-lived asset

3,250

   
 

31/12/2014

31/12/2015

Change

Balance Sheet Item

     

Accounts receivable

42,000

63,000

+

21,000

Inventory

18,500

10,000

- 8,500

Accounts payable

29,500

51,330

+

21,830

Deferred income tax liability

55,550

40,000

- 15,550

The company’s operating cash flow is closest to:

A. 478,530.

B. 488,000.

C. 494,080.

Correct Answer: A

Reference:

CFA Level I, Volume 3, Study Session 8, Reading 27, LOS f

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CFA Level I Mock Exam 4 – Solutions (AM)

The company’s operating cash flow is calculated as follows:

Net income

450,000

Add: Depreciation

38,000

Subtract: Gain on disposal of long-lived asset

(

3,250)

Subtract: Increase in accounts receivable

(

21,000)

Add: Decrease in inventory

8,500

Add: Increase in accounts payable

21,830

Subtract: Decrease in deferred income tax liability

(

15,550)

Operating cash flow

478,530

53. An analyst has been asked to perform a comparative analysis of the financial statements of Pin Enterprises (PIEN) for the most recent years. She initiated the analysis with the firm’s profitability ratios and compiled the following data.

 

2010

2011

Leverage

1.80

2.50

Total asset turnover

2.0

2.3

Tax burden

0.50

0.70

Interest burden

0.60

0.90

EBIT Margin

5.13%

7.29%

Which of the following least describes one of the conclusions given her compiled data?

A. The major contributor to the increase in the firm’s return on assets was the rise in net profit margin.

B. The firm’s return on equity increased by 20.87% in 2011, mostly because of an increase in leverage.

C. The firm’s interest costs decreased more than the decrease in its tax costs during the 2010-2011 financial period.

Correct Answer: B

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CFA Level I Mock Exam 4 – Solutions (AM)

Reference:

CFA Level I, Volume 3, Study Session 8, Reading 28

Interest costs decreased by 0.30 whereas tax costs decreased by 0.20.

Return on assets:

2010: 0.0513(0.60)(0.50)(2) = 3.078% 2011: 0.0729(0.90)(0.70)2.3) = 10.56%

ROE:

2010: 3.078%(1.80)= 5.54% 2011: 10.56%(2.50) = 26.41%

Although ROE increased by 20.87%, most of the increase was because of an increase in ROA.

Net profit margin contributed the most to the increase in ROA.

54. An overview of specific business lines and the segmentation of income are most likely found in the:

A. statement of operations.

B. supplementary schedule.

C. management commentary .

Correct Answer: B

Reference:

CFA Level I, Volume 3, Study Session 7, Reading 22

Supplementary schedules provide additional information and details regarding assets and liabilities of a company e.g. information regarding natural resources, overview of specific business lines, or the segmentation of business or other line items.

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CFA Level I Mock Exam 4 – Solutions (AM)

55. A portfolio manager is assessing the following information as part of a comprehensive analysis of a firm’s financial health and investment attractiveness using cash flow ratios.

Cash flow from operating activities

$89,250

Interest paid

$45,000

Taxes paid

$22,000

Lease payments

$15,500

Dividends paid

$12,000

If the firm follows US GAAP, the interest coverage ratio is closest to:

A. 2.47.

B. 2.62.

C. 3.47.

Correct Answer: C

Reference:

CFA Level I, Volume 3, Study Session 8, Reading 27

89,250+45,000+22,000/45,000 = 3.47

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CFA Level I Mock Exam 4 – Solutions (AM)

56. A portfolio manager has accumulated the following data to carry out a comparative analysis of firms within the U.S automobile industry.

Exhibit SOP Auto Manufacturers Financial Information

Net Income

$25,000,000

Weighted average common shares

150,000,000

Beginning of year stock options outstanding

75,000

Exercise price of stock options

$45

Market price of company’s stock

$65

Stock option price

$11.55

Using the treasury stock method, the diluted EPS for SOP Auto Manufacturers is closest to:

A. $0.167.

B. $0.159.

C. $1.220.

Correct Answer: A

Reference:

CFA Level I, Volume 3, Study Session 8, Reading 25

75,000 (45) = $3,375,000 (if options exercised)

3,375,000/65 = 51,923 shares could be repurchased

Incremental shares issued is 75,000-51,923 = 23,077

Diluted EPS: 25,000,000/ (150,000,000+23,077) = $0.167

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CFA Level I Mock Exam 4 – Solutions (AM)

57.

A

company engages in the dealing and trading of financial assets that are highly

liquid. Such purchase and sale is not part of the company’s primary business activity.

In

the cash flow statement the above activities would appear as:

 

A. Investing activities.

B. Operating activities.

C. Financing activities.

 

Correct Answer: B

Reference:

CFA Level I, Volume 3, Study Session 8, Reading 27

Operating activities include cash receipts and payments related to dealing securities or trading securities, even if they are not part of the company’s primary business activity.

58.

If

a firm’s price to book value ratio is one, the equity investors in the firm will

most likely earn:

A. a normal profit only.

B. excess profits since the ratio is positive.

C. zero profits as return would not exceed risk.

Correct Answer: A

Reference:

CFA Level I, Volume 3, Study Session 8, Reading 28

A P/BV ratio of 1 means that a company’s expected future returns are exactly

equal to the returns required by the market. Hence, investors would earn a normal

profit only.

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CFA Level I Mock Exam 4 – Solutions (AM)

59. The head of a firm’s sales and marketing department is attempting to determine the appropriate method of reporting revenue under a long-term contractual sale. Due to the nature of the counterparty involved, the outcome of the contract cannot be measured reliably and a 30% loss on the contract is expected.

Given the above information, under U.S. GAAP, the:

A. percentage of completion method will be used to recognize the loss immediately.

B. completed contract method will be used but the loss will be recognized immediately.

C. loss will be recognized upon completion when revenue is recognized, unlike IFRS, which will require the loss to be recognized immediately.

Correct Answer: B

Reference:

CFA Level I, Volume 3, Study Session 8, Reading 25

Under U.S. GAAP, the completed contract method is used when the outcome cannot be measured reliably. However, even under this method, if a loss is expected on a contract, it is reported immediately.

60. When the income tax expense in the income statement is greater than current income tax liability, the difference will most likely increase a firm’s:

A. taxable income.

B. deferred tax assets.

C. deferred tax liabilities.

Correct Answer: C

Reference:

CFA Level I, Volume 3, Study Session 9, Reading 31

When the income tax expense in the income statement is greater than current income tax liability, the difference will increase a firm’s deferred tax liabilities.

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CFA Level I Mock Exam 4 – Solutions (AM)

61. If a firm purchases services on credit, in effect borrowing from the provider, it would most likely appear on the cash flow statement as an:

A. operating activity.

B. investing activity.

C. financing activity.

Correct Answer: A

Reference:

CFA Level I, Volume 3, Study Session 8, Reading 27

Indirect borrowing using accounts payable is not considered a financing activity—such borrowing is classified as an operating activity.

62. For a particular firm, holding everything constant and assuming rising prices, the inventory turnover will be lowest under the:

A. FIFO method of inventory accounting.

B. LIFO method of inventory accounting.

C. average method of inventory accounting.

Correct Answer: A

Reference:

CFA Level I, Volume 3, Study Session 8, Reading 28

FIFO will result in the highest inventory values and lowest cost of sales values. Thus it will result in the lowest inventory turnover.

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CFA Level I Mock Exam 4 – Solutions (AM)

63. Superior Tech Limited (S-Tech) has a contract to develop a marketing campaign for a newly established firm. The agreed upon sales price is $15 million and S- Tech estimates that it would take 4 years to get the job done. Total costs are

estimated to be $9 million. Details about the expenditures incurred in years 1 and

2 are given below:

At the end of year 1, S-Tech spends $4 million.

At the end of year 2, the company spends an additional $3.5 million.

Under the percentage-of-completion method, how much revenue will S-Tech recognize in year 2?

A. $5,833,333.

B. $6,666,667.

C. $12,500,000.

Correct Answer: A

Reference:

CFA Level I, Volume 3, Study Session 8, Reading 25

In year 1: 4/9 = 44.44% of the costs have been spend so 44.44%(15) = $6,666,666.67 of revenue will be recognized.

In year 2: total cost spent will equal 7.5/9 = 83.33% so total revenue recognized:

0.8333(15) = $12,500,000. Since it has already recognized $6,666,666.67, in year

2 it will recognize 12,500,000-6,666,666.67 = $5,833,333

64. Compared to U.S. GAAP, under IFRS interest received or paid can be reported either as an:

A. investing activity or operating activity.

B. financing activity or investing activity.

C. operating, investing or financing activity.

Correct Answer: C

Reference:

CFA Level I, Volume 3, Study Session 8, Reading 27

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CFA Level I Mock Exam 4 – Solutions (AM)

Under IFRS, interest paid can be reported either as an operating activity or a financing activity. Interest received can be reported as an operating activity or an investing activity.

65. For an issuing company, interest expense reported for the bonds in its financial statements is based on the:

A. coupon rate.

B. effective interest rate.

C. market rate of interest.

Correct Answer: B

Reference:

CFA Level I, Volume 3, Study Session 9, Reading 32

For an issuing company interest expense reported for the bonds in the financial statements is based on effective interest rates i.e. the market rate at the time of issuance.

66. The following data relates to a manufacturing concern’s financial performance and efficiency.

Beginning inventory 2012

$70,000

Ending inventory 2012

$50,000

Cost of goods sold 2012

$180,000

Cost of goods sold 1 st quarter 2013

$45,000

Average inventory 1 st quarter 2013

$66,000

Relative to 2012, the firm’s inventory turnover ratio in 2013:

A. improved.

B. deteriorated.

C. remained unchanged.

Correct Answer: B

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CFA Level I Mock Exam 4 – Solutions (AM)

Reference:

CFA Level I, Volume 3, Study Session 8, Reading 28

Inventory turnover 2012: 180,000/( !" , """ $ %" , """ ) = 3

&

Inventory turnover 2013: 45,000/66,000 = 0.682 Since this is quarterly, we must annualize by multiplying by 4: 4 (0.682) = 2.73 Hence, the ratio deteriorated.

67. Relative to expensing, which of the following least describes the effect of capitalizing borrowing costs on a firm’s reported financials?

A. Leverage would appear higher for the firm.

B. Operating income would be lower in the future.

C. Operating cash flow would be higher but investing cash flow would be lower.

Correct Answer: A

Reference:

CFA Level I, Volume 3, Study Session 8, Reading 30

If a firm capitalizes, assets would appear higher (because the capitalized amount is added to assets) but debt would remain the same, so leverage would appear lower.

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CFA Level I Mock Exam 4 – Solutions (AM)

68. Wicker Textiles (WTEX) is a well-established firm in central Minneapolis, Minnesota. WTEX has increased inventory to meet the seasonal demand of its products. Some information about WTEX’s inventory value is given below:

The cost of the inventory is $60,000.

The estimated selling price less costs of completion and costs to make the sale equals $80,000.

The market value of the inventory is $55,000.

A normal profit margin equals 15%.

Under U.S. GAAP, the inventory value on WTEX’s financial statements should be closest to:

A. $55,000.

B. $60,000.

C. $80,000.

Correct Answer: B

Reference:

CFA Level I, Volume 3, Study Session 8, Reading 26

Under U.S. GAAP, inventory is reported at lower of cost or market. Market value is current market value but with upper and lower limits: it cannot exceed NRV and cannot be lower than NRV less a normal profit margin. Therefore, the lower limit is $80,000-(15% of 80,000) = $68,000 Hence, $68,000 is the lower limit for market value. Hence lower of cost or market is: $60,000.

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CFA Level I Mock Exam 4 – Solutions (AM)

Questions 69 through 76 relate to Corporate Finance

69. Which of the following about financial leverage and unit sales is most accurate?

The farther unit sales are from the break-even points for high leverage companies, the:

A. magnifying effect becomes unpredictable.

B. lower the magnifying effect of this leverage.

C. greater the magnifying effect of this leverage.

Correct Answer: C

Reference:

CFA Level I, Volume 4, Study Session 11, Reading 37

The farther unit sales are from the breakeven point for high-leverage companies, the greater the magnifying effect of leverage.

70. Ryan Myers, a financial analyst, has been appointed the task of developing a valuation estimate for Colors Fashion Label (CFL), a private, U.S. based firm operating in the fashion industry of the country. Myers gathered the following information to aid his analysis:

The long-term yield on U.S. government bonds is 3.5%.

The historical equity risk premium in the U.S. is 5.6%.

A comparable firm has a beta of 1.35, a debt-to-equity ratio of 1.20, and a tax rate of 40%.

CFL’s tax rate is 33%.

CFL’s Debt/Equity ratio is 0.75.

Given the aforementioned information, Myers estimate of CFL’s cost of equity should be closest to:

A. 7.896%.

B. 9.874%.

C. 10.105%.

Correct Answer: C

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CFA Level I Mock Exam 4 – Solutions (AM)

Reference:

CFA Level I, Volume 4, Study Session 11, Reading 36

1.35/(1+[(1-0.4)(1.20)] = 0.785 Levered beta for private company: 0.785[1+(1-0.33)(0.75)] = 1.179 Cost of equity: 3.5+ 1.179(5.6) = 10.105%

71. Breakeven point analysis will be least important for a company with a high ratio of:

A. debt to total assets and low business cycle sensitivity.

B. intangible assets to total assets and high operating income.

C. tangible assets to total assets and low business cycle sensitivity.

Correct Answer: C

Reference:

CFA Level I, Volume 4, Study Session 11, Reading 37

Breakeven analysis of firms with low business cycle sensitivity and low operating and financial leverage, and lower intangibles is relatively less important.

72. Xerox Technologies (XETECH) is a well-established firm in the gaming industry of the United States. Just recently, XETECH upgraded its gaming device and increased its price to $250. The production of this device cost the firm $65/unit in variable costs. The total fixed operating costs equaled $10,000,000.

If the firm changes its output from 200,000 units to 220,000 units, operating income will change by:

A. 1.37%

B. 10.00%.

C. 13.70%.

Correct Answer: C

Reference:

CFA Level I, Volume 4, Study Session 11, Reading 37

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CFA Level I Mock Exam 4 – Solutions (AM)

DOL@200,000 units = 200,000(250-65)/200,000(250-65)-10,000,000 = 1.37037 Units sold have changed by 10% so operating income will change by 1.37037 (10%) = 13.7037%

73. Major drags on liquidity for a firm most likely includes:

A. obsolete inventory.

B. reduced credit limits.

C. making payments early.

Correct Answer: A

Reference:

CFA Level I, Volume 4, Study Session 11, Reading 39

Major drags on liquidity include:

Uncollected receivables

Tight credit

Obsolete inventory

Major pulls on liquidity include:

Making payments early

Reduced credit limits

Limits on short-term lines of credit

Low liquidity positions

74. Which of the following can be least managed or controlled by a firm’s management?

A. Sales risk.

B. Financial risk.

C. Operating risk.

Correct Answer: A

Reference:

CFA Level I, Volume 4, Study Session 11, Reading 37

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CFA Level I Mock Exam 4 – Solutions (AM)

Management has more opportunity to manage and control operating risk than sales risk. DFL is also most often the choice of upper management. Hence, sales risk is least likely to be controlled by a firm’s management.

75. In the face of bankruptcy, the companies least likely to emerge as ongoing concerns are the ones with high degree of:

A. financial leverage.

B. operating leverage.

C. financial leverage and a low degree of operating leverage.

Correct Answer: B

Reference:

CFA Level I, Volume 4, Study Session 11, Reading 37

Companies with high operating leverage have less flexibility in making changes, and bankruptcy protection does little to help reduce operating costs. However, companies with high financial leverage can use bankruptcy laws and protection to change their capital structure and emerge as ongoing concerns.

76. Which of the following is least likely correct regarding staggered boards?

A. Staggered board facilitates better continuity of board expertise.

B. Management uses staggered board as an anti-takeover instrument.

C. A staggered board provides more flexibility to nominate new board members to meet changes in the marketplace.

Correct Answer: C

Reference:

CFA Level I, Volume 4, Study Session 11, Reading 40

On a staggered basis, only a portion of board members is re-elected every year. A staggered board can be used by management as an anti-takeover instrument. However staggered board facilitates better continuity of board expertise. An annually elected board may provide more flexibility to nominate new board members to meet changes in the marketplace, if needed, than a staggered board.

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CFA Level I Mock Exam 4 – Solutions (AM)

Questions 77 through 88 relate to Equity

77. A fixed-income analyst is considering investing in a pooled investment vehicle. His friend recommends a closed-ended mutual fund, an open –ended mutual fund and an exchange-traded fund. The analyst expects to hold the investment for a year or so and has determined that all options are trading at a discount.

The largest discount will most likely be for the:

A. ETF.

B. Open-ended mutual fund.

C. Close-ended mutual fund.

Correct Answer: C

Reference:

CFA Level I, Volume 5, Study Session 13, Reading 46

ETF’s trade very close to their underlying NAV. Open-ended mutual funds also have market prices close to the underlying NAV. Close ended funds, however, most often trade at discounts or premiums to NAV.

78. A price-weighted index has an initial value of 45. The prices of the constituent securities before a stock split on security B are given in Exhibit 1.

Exhibit 1 Before a 2 for 1 Split in Security B

Security

Price ($)

A

65.12

B

84.00

C

8.50

D

11.99

To ensure that the value of the index does not change after the split, the new divisor will be closest to:

A. 1.329.

B. 2.836.

C. 3.769.

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CFA Level I Mock Exam 4 – Solutions (AM)

Correct Answer: B

Reference:

CFA Level I, Volume 5, Study Session 13, Reading 46

Sum after the split: 65.12+42(after split)+8.50+11.99 = 127.61 127.61/45 = 2.835778

79. According to statistical approaches, companies are grouped based on their:

A. principal business activities.

B. relative sensitivities to the business cycle.

C. historical correlations of securities’ returns.

Correct Answer: C

Reference:

CFA Level I, Volume 5, Study Session 14, Reading 50

According to statistical approaches companies are grouped into industries based on historical correlations of their securities’ returns.

80. Cary Lee just received a performance-based bonus from her employer and desires to invest that in real estate. Her current portfolio is invested in stocks and bonds only.

If Lee wants to achieve maximum diversification, she should most likely invest in:

A. Direct real estate.

B. Real estate investment trusts (REITs).

C. Shares of companies that own and operate real estate.

Correct Answer: A

Reference:

CFA Level I, Volume 5, Study Session 13, Reading 46

Relative to the other options, direct real estate has the smallest correlation with the returns to stocks and bonds. REITs and shares in companies that own real estate have returns that are similar to the returns of the overall stock market.

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CFA Level I Mock Exam 4 – Solutions (AM)

81. Anthony Francisco just received $10,000 as inheritance from his uncle who passed away last month. Consequently, Francisco advises his portfolio manager to increase his portfolio’s allocation to domestic stocks from 15% to 25%. The manager determines that the most appropriate holding period for Francisco is ten years. He thus invests in non-dividend paying stocks that would yield the required return over ten years.

Given the information above, Francisco is most likely an:

A. Investor.

B. Speculator.

C. Information-motivated trader.

Correct Answer: A

Reference:

CFA Level I, Volume 5, Study Session 13, Reading 46

Francisco is an investor. He is trying to generate wealth by investing extra income in attractive securities. There is no indication of the use of superior information by Francisco to profit from price changes.

82. In most financial models, the assumption is that the investors are:

A. risk averse.

B. loss averse.

C. risk takers.

Correct Answer: A

Reference:

CFA Level I, Volume 5, Study Session 13, Reading 48

Rationally investors should be risk averse therefore in most financial models, the assumption is that the investors are risk averse.

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CFA Level I Mock Exam 4 – Solutions (AM)

83. A firm has just paid a dividend of $2.5 per share. The required rate of return is 15% per year and dividends are expected to grow at a constant rate of 9.4%. If an analyst uses Gordon Growth model to calculate the firm’s intrinsic value, how much does the dividend growth assumption add to the intrinsic value estimate?

A. $22.24

B. $32.17

C. $48.84

Correct Answer: B

Reference:

CFA Level I, Volume 5, Study Session 14, Reading 51

Firm’s intrinsic value using Gordon Growth Model (GGM):

V o = ' ( ) $ * = & . % ( ) $
V o = ' ( ) $ * = & . % ( ) $ 0 . 1% )
+ , *
)%% , 0 . 1%

= $48.84

$32.17 is the amount that the dividend growth assumption added to the intrinsic value estimate, as calculated below:

$ .

$48.84 – . = $32.17

84. Bobby Anderson, a portfolio manager, is considering investing in commodities to diversify the risks held in his personal portfolio. Since he has had minimal prior exposure to the commodities market and does not have the facilities to hold most commodities, he is trying to determine the most appropriate way to invest in the sector.

Which of the following markets will be most suitable for Anderson to achieve his diversification objective?

A. The spot market.

B. The futures market.

C. The forwards market.

Correct Answer: B

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CFA Level I Mock Exam 4 – Solutions (AM)

Reference:

CFA Level I, Volume 5, Study Session 13, Reading 46

The futures market would provide greatest liquidity in addition to minimal credit risk. Also, Anderson does not have the facilities to hold most commodities, so the spot market is not suitable.

85. Matt Elaine has developed software that enables him to determine the correlation between economic variables and stock returns. Elaine believes that abnormal returns could be generated using his investing approach.

Which of the following characteristics of the financial system would least likely aid Elaine in achieving his objective?

A. Market liquidity.

B. Low cost trading.

C. Transparent financial and economic disclosures.

Correct Answer: C

Reference:

CFA Level I, Volume 5, Study Session 13, Reading 46

Elaine is trying to use superior information to generate abnormal returns. Transparent financial and economic disclosures do not necessarily help informed trades profit because they are competing with each other. The most profitable are those that have unique insights into future values.

86. For which of the following indices is rebalancing a major concern?

A. Equal-weighted indices.

B. Equal-weighted and market-capitalization weighted indices.

C. Equal-weighted, market-capitalization weighted and price-weighted indices.

Correct Answer: A

Reference:

CFA Level I, Volume 5, Study Session 13, Reading 47

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CFA Level I Mock Exam 4 – Solutions (AM)

Price-weighted indices are not rebalanced. For market-cap indices, rebalancing is less of a concern because the indices largely rebalance themselves. Hence, rebalancing is most important for equal-weighted indices.

87. Which of the following is not a time series anomaly?

A. Momentum

B. Holiday effect

C. Earnings surprise

Correct Answer: C

Reference:

CFA Level I, Volume 5, Study Session 13, Reading 48

Both options A and B are time series anomalies while option C is not a time series anomaly.

88. The price of a large-cap index at the beginning of the period is $1,250 while the dividends paid to investors amounts to $400. If the total return on the index is 15.00%, the price of the index at the end of the period is equal to:

A. $1,037.50.

B. $1,062.50.

C. $1,437.50.

Correct Answer: A

Reference:

CFA Level 1, Volume 5, Study Session 13, Reading 47, LOS b

Total return = (P t – P t-1 + D t )/P t-1 P t = (0.15 × $1,250.00) – $400.00 + $1,250.00 = $1,037.50

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CFA Level I Mock Exam 4 – Solutions (AM)

Questions 89 through 94 relate to Derivatives

89. Which of the following least represents the rationale of a traditional insurance product?

A. Credit-linked note.

B. Credit default swap.

C. Credit spread option.

Correct Answer: C

Reference:

CFA Level I, Volume 6, Study Session 17, Reading 58

The buyer of a credit-linked note effectively insures the credit risk of the

underlying reference security. A CDS also captures many of the essential features

of insurance. A credit spread option behaves more like a call option.

90. Off-market forward is a forward transaction that:

A. starts with a non-zero value.

B. is used to offset the current forward transaction.

C. is not entered into within normal business timings.

Correct Answer: A

Reference:

CFA Level I, Volume 6, Study Session 17, Reading 58

A forward transaction that starts with a nonzero value is called an off-market

forward.

91. Compared to underlying spot markets, derivatives markets offer which of the following operational advantages?

A. Lower transaction costs.

B. Greater liquidity and easy short selling opportunities.

C. Lower transaction costs, greater liquidity, and easy short selling opportunities.

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CFA Level I Mock Exam 4 – Solutions (AM)

Correct Answer: C

Reference:

CFA Level I, Volume 6, Study Session 17, Reading 58

Derivatives markets provide greater liquidity as smaller amount of capital is required to trade derivatives.

Transaction costs of derivatives are typically low compared to the value of underlying.

With derivatives it is nearly as easy to take short position as to take a long position. In case of underlying, its almost always much more difficult to go short than to go long.

92. Steve Hammond is the CEO of a U.S. based company in the oil exploration business. Hammond is concerned with falling oil prices in the near future. Specifically, he wants to hedge the risk of the company’s oil production of a million liters expected in 234 days from now. He wants to ensure near perfect hedging with minimal investment.

The most appropriate way to hedge the company’s exposure is to use:

A. Futures.

B. Options.

C. Forwards.

Correct Answer: C

Reference:

CFA Level I, Volume 6, Study Session 17, Reading 58

Hammond wants to hedge the risk of the company’s oil production 234 days from now. The time-horizon does not coincide with the standardized time horizons of futures contracts. Also, since he wants near perfect hedging, a customized contract that considers all his concerns would be most appropriate. This can be achieved using a forward contract. Options require a premium to be paid and Hammond wants minimal upfront investment.

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CFA Level I Mock Exam 4 – Solutions (AM)

93. With regards to equivalence, a swap is closest to a series of:

A. futures expiring at a set of dates coinciding with the swap payment dates.

B. forwards expiring at a set of dates coinciding with the swap payment dates.

C. options expiring at a set of dates with the options’ exercise prices equal to the price inherent in the swap.

Correct Answer: B

Reference:

CFA Level I, Volume 6, Study Session 17, Reading 58

A swap is closest to a series of forwards expiring at a set of dates coinciding with the swap payment dates.

94. The higher the exercise price of a call option, the greater the:

A. price of an option.

B. premium received by the seller of the call.

C. leverage for a fixed dollar investment by option buyer.

Correct Answer: C

Reference:

CFA Level I, Volume 6, Study Session 17, Reading 60

The higher the exercise price of a call option, the lower the price of the option and the lower the premium received by the seller of the call. Lower option premiums allow option buyers to purchase more option contracts in a given dollar investment. Higher number of option contracts generate higher returns in rising prices scenario thus higher leverage.

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CFA Level I Mock Exam 4 – Solutions (AM)

Questions 95 through 106 relate to Fixed Income

95. Which of the following statements about the fixed-income market is least accurate?

A. Since, globally, the fixed-income market is not as popular as the equity market, equity securities are far more diverse than debt securities.

B. Institutional investors dominate the fixed-income markets because of informational barriers to entry and invest directly in such securities.

C. Index weighting in the fixed-income market is based on price or value, and is rarely ever equally-weighted.

Correct Answer: A

Reference:

CFA Level I, Volume 5, Study Session 15, Reading 53

Fixed-income securities are far more diverse than equity securities. The other two options are correct.

96. A fixed-income analyst is analyzing the following bonds’ performance given future market conditions.

 

Exhibit 1

 

Coupon Rate

Maturity

Bond A

5.5%

4

years

Bond B

6.5%

3

years

Bond C

5.0%

3

years

Which of the above bonds will have lowest interest rate risk?

A. Bond A.

B. Bond B.

C. Bond C.

Correct Answer: B

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CFA Level I Mock Exam 4 – Solutions (AM)

Reference:

CFA Level I, Volume 5, Study Session 15, Reading 54

The bond with the highest coupon rate and lowest maturity will have the lowest interest rate risk. This is Bond B.

97. An analyst is trying to estimate the implied forward rates as inputs to his bond valuation process. For this purpose, she gathers the data provided in the following exhibit.

Exhibit:

Zero Coupon Government Bonds

Maturity

Price

Yield to Maturity

2 year

98.77

3.556%

3 year

96.87

3.786%

4

year

93.11

3.980%

*The yields to maturity are stated on a semiannual bond basis

The ‘2y1y’ implied forward rate would be closest to:

A. 4.25%.

B. 4.56%.

C. 4.16%.

Correct Answer: A

Reference:

CFA Level I, Volume 5, Study Session 15, Reading 54

(1+0.03556/2) 4 × (1+x) 2 = (1+ 0.03786/2) 6

x = 0.021234 × 2 = 4.24678%

98. For bonds with the same time-to-maturity and yield-to-maturity, Macaulay duration is the lowest for a:

A. zero coupon bond.

B. low coupon bond trading at a discount.

C. high coupon bond trading at a premium.

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CFA Level I Mock Exam 4 – Solutions (AM)

Correct Answer: C

Reference:

CFA Level I, Volume 5, Study Session 16, Reading 56

For the same time to maturity and yield to maturity, the Macaulay duration for a zero coupon bond tends to be higher than for a low coupon bond trading at a discount.

Similarly a low-coupon bond trading at a discount has a higher duration than a high coupon bond trading at a premium.

99. A portfolio manager is confused about whether to invest in a bond issue with a serial maturity structure, or one with a term maturity structure, given everything else is similar.

Which of the following, if introduced, will make the manager largely indifferent between the two structures?

A. High credit quality.

B. Moderate liquidity needs.

C. A sinking fund provision.

Correct Answer: C

Reference:

CFA Level I, Volume 5, Study Session 15, Reading 53

The sinking fund arrangement on a term maturity structure accomplishes the same goal as the serial maturity structure—both resulted in a portion of the bond issue being paid off each year.

100. For a fully amortized bond, the annual payment, which includes both the coupon payment and the principal repayment:

A. remains constant.

B. decreases at constant rate.

C. decreases at decreasing rate.

Correct Answer: A

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CFA Level I Mock Exam 4 – Solutions (AM)

Reference:

CFA Level I, Volume 5, Study Session 15, Reading 52

For a fully amortized bond, the annual payment, which includes both the coupon payment and the principal repayment, is constant.

101. A 7% annual coupon bond is trading at a price of 105.67 and has three years to maturity. A 5.5% annual payment, 3-year T-note is trading at a price of 107.89. A 5-year 7% annual coupon T-note is trading at a price of 109.77.

Given the above information, the G-spread will be closest to:

A. 0.16%.

B. 1.32%.

C. 2.19%.

Correct Answer: C

Reference:

CFA Level I, Volume 5, Study Session 15, Reading 54

Yield on the corporate bond: 4.92% (using financial calculator)

Yield on the T-note with same maturity: 2.725%

G-Spread: 4.92%-2.725% = 2.195%

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CFA Level I Mock Exam 4 – Solutions (AM)

102. A dealer believes that the bonds issued by Super-Tee Enterprises (SUTEE) are considerably overvalued and wants to benefit from the mispricing. For achieving this objective, the dealer borrows 100 par value bonds of SUTEE from an institutional investor and lends cash in return. The bonds have a stated coupon rate of 7.5%.

The above transaction will best be known as a:

A. repurchase agreement, and the coupon will belong to the seller of the security.

B. reverse repurchase agreement, and the coupon will belong to the borrower of the security.

C. reverse repurchase agreement, and the coupon will belong to the borrower of cash.

Correct Answer: C

Reference:

CFA Level I, Volume 5, Study Session 15, Reading 53

From the dealer’s perspective, this is a reverse repurchase transaction (borrowing securities and lending cash). The coupon will belong to the owner, that is, the borrower of cash or the lender of the securities.

103. Tony Sam has invested in a floating rate bond based on Libor. Due to changing market conditions, Sam is particularly concerned with his investment value deviating from par value.

Sam’s concern is most likely:

A. justified.

B. exaggerated, since floating rate securities have little market risk.

C. exaggerated, since floating rate securities have little interest rate risk.

Correct Answer: A

Reference:

CFA Level I, Volume 5, Study Session 15, Reading 52

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CFA Level I Mock Exam 4 – Solutions (AM)

Floating rate securities have little interest rate risk. However, they are subject to credit risk, and changing market conditions can result in a significant downgrade

of such securities. As a result, they may deviate considerably from par value.

104. An analyst is attempting to determine the value of a four-year, 8% annual coupon- paying bond with a par value of 100. The exhibit below summarizes the sequence

of spot rates which will be used to value the issue.

Time-to-Maturity

Spot Rate (%)

1 year

1.25

2 years

1.80

3 years

2.45

4 years

3.00

The yield-to-maturity of the bond is equal to:

A. 2.90%.

B. 3.00%.

C. 3.08%.

Correct Answer: A

Reference:

CFA Level 1, Volume 5, Study Session 15, Reading 54, LOS h

The price of the bond will need to be determined prior to calculating the bond’s yield-to-maturity.

Price of the bond =

8

8

8

108

1.0125

+

(

1.018

)

2

+