Mock Test 1 – CFA Level I

Morning Session

Topics Questions Points

Ethics and Professional Standard 1-18 27

Quantitative Analysis 19-32 21

Economics 33-44 18

Financial Reporting and Analysis 45-68 36

Corporate Finance 69-78 15

Equity Investment 79-90 18

Derivatives 91-96 9

Fixed Income 97-108 18

Alternative Investment 109-114 9

Portfolio Management 115-120 9

ETHICS QUESTIONS( 1 – 18)

1. Jason Dawson, CFA is an equity portfolio manager at Star Real Advisors, a firm specializing in real
estate investments.

Dawson recently attended his first seminar on real estate investments. In the seminar, real estate
analysts discussed the bright prospects of real estate as an alternative investment & highly
recommended it considering the consistent above-average performance of real estate as an asset
class in the past 3 years.

On being excited with his new-found knowledge, Dawson immediately recommended to all his
clients an immediate allocation of 10% of their portfolio to real estate investments. After a week, he
allocated 10% of his own portfolio to real estate investments.
 Mock Test 1 – CFA Level I

Which of the standards did Jason most likely violate?

A: Standard I (B) Independence & Objectivity.

B: Standard V (A) Diligence & Reasonable Basis.
C: Standard VI (B) Priority of Transactions.

Sol. B. Standard V (A) Diligence & Reasonable Basis.

Standard V (A) requires members to exercise diligence & thoroughness in analysing investments,
making recommendations & taking investment actions. Members must have reasonable & adequate
basis, supported by appropriate research & investigation for any investment analysis,
recommendation or action.
Dawson relied solely on the views of the analysts who themselves have based their opinion only on
the performance data of the past three years. Therefore he has violated this standard.
In this case his independence & objectivity has not been impaired by any gift, benefit or other
consideration.
He has not violated the standard of priority of transactions because he changed the allocation of his
own portfolio after a reasonable period of time.

2. Emily Lynch, CFA is preparing advertising material of her sole proprietary investment management
concern.
The material states: “I am a CFA & have cleared all the three examinations in first attempt.”
Lynch has:

A. Violated the Standard VII (B) Reference to CFA Institute, CFA Designation & the CFA Program
by improperly referencing the CFA mark & by exaggerating her examination performance.
B. Violated the Standard VII (B) Reference to CFA Institute, CFA Designation & the CFA Program
by improperly referencing the CFA mark but not by mentioning her examination
performance.
C. Has not violated the Standard VII (B) Reference to CFA Institute, CFA Designation & the CFA
Program.

Sol. B. violated the Standard VII (B) Reference to CFA Institute, CFA Designation & the CFA Program by
improperly referencing the CFA mark but not by mentioning her examination performance.

The CFA mark must always be used either after a charter holder’s name or as adjective, but not as a
noun n written or oral communication.
Lynch may state that she has cleared all the examinations in first attempt as long as it is true & is not
linked to superior performance & ability.
 Mock Test 1 – CFA Level I

3. The CFA Institute Professional Conduct Program (PCP) is investigating some investment actions of
Edwin Schneider, CFA. These actions were suspected to be unsuitable for a few clients. PCP requires
Edwin to provide data of his clients he considered suitable for an exotic derivative which was
deemed to be very risky & speculative.
Edwin will:

A. Violate the Code & Standards if he discloses the names of the clients & their investments.
B. Not violate the Code & Standards if he discloses only their investments but not their names.
C. Will not violate the Code & Standards if he discloses the names of the clients & their
investments.

Sol. C.will not violate the Code & Standards if he discloses the names of the clients & their
investments.

An exception to the Standard governing the preservation of client’s confidentiality is a PCP

investigation. Members are expected to full co-operate with PCP’s investigations because PCP will
keep the clients’ information confidential.

4. Global Investment Performance Standards (GIPS) require a minimum of:

A: 3 years of historical performance.

B: 5 years of historical performance.
C: 10 years of historical performance.

Sol. B. 5 years of historical performance.

5. The supplemental provisions within the GIPS must be applied to which of the following asset classes?

A: Real Estate & Private Equity.

B: Real Estate & Commodities.
C: Commodities & Private Equity.

Sol. A. Real Estate & Private Equity.

Sections 6 & 7 are supplemental provisions within GIPS which must be specifically applied to real
estate & private equity respectively.

6. Jonathan Graf, CFA a portfolio manager failed to intimate the broker of a trading instruction to sell a
stock from her client’s portfolio after issuing a sell recommendation. Graf was in charge of making
recommendations & taking investments actions for his client. This error resulted in a loss to the
 Mock Test 1 – CFA Level I

client who was upset with Graf. In order to make good the loss, Graf promised him over-allocation
of a new IPO which was expected to be in great demand & having bright prospects.
Graf has most likely violated the standard concerning:

A: Market Manipulation.
B: Priority of Transactions.
C: Fair Dealing.

Sol. C. Fair Dealing

The Standard concerning Fair Dealing requires members to deal fairly with ALL CLIENTS. Graf was
putting other clients at disadvantage by offering preferential service to this client.
Priority of Transactions is concerned with investment transactions for clients & employers taking
precedence over transactions in which the member is a beneficial owner.
There is no violation of Market Manipulation since the action of Graf is not going to affect the price
of the stock.

7. If any requirement of GIPS is in direct conflict with local reporting regulations, in order to be in full
compliance with GIPS, one must

A: follow the GIPS requirement & disclose the conflict.

B: follow the local reporting regulation & disclose the conflict.
C: follow the requirement which is more conservative & disclose the conflict.

Sol. B. Follow the local reporting regulation & disclose the conflict.

8. Which of the following is not a component of Code of Ethics?

A. Members must not knowingly make any misrepresentations relating to investment analysis,
recommendations, actions or other professional activities.
B. Promote the integrity of, and uphold the rules governing, capital markets.
C. Practice & encourage others to practice in a professional & ethical manner that will reflect
credit on themselves & the profession.

Sol. A. Members must not knowingly make any misrepresentations relating to investment analysis,
recommendations, actions or other professional activities.

The above statement is a Standard of Professional Conduct – I (C). The other two statements are
components of Code of Ethics.

9. Which of the following is not considered plagiarism under CFA Institute Standards?
 Mock Test 1 – CFA Level I

A. Fine-tuning an already published model & claiming it to be a new model without

acknowledging the source of the original model.
B. Using factual information from recognized financial information agency without
acknowledging the source of the information.
C. Adding a few important points to an existing report & distributing under your own name
without citing the author of the original report.

Sol. B. Using factual information from recognized financial information agency without acknowledging
the source of the information.

Factual information that is already published & is obtained from a recognized agency can be used
without acknowledgement. It is not considered plagiarism.
The other two options are considered plagiarism.

10. Standard III (E) Preservation of Confidentiality applies to information received from:

A: current & former clients only

B: current & prospective clients only.
C: former, current & prospective clients.

Sol. C. Standard III (E) Preservation of Confidentiality applies to information received from former,
current & prospective clients.

11. Ted Peters, CFA is a portfolio manager at a mutual fund. She is also a member of the Investment
Committee of the local club in which his son takes swimming lessons. He provides investment advice
to the club based on the general practices of the mutual fund. He is not paid for this advice but
receives free monthly membership of the swimming pool for his son which would have otherwise
cost $150. What should Ted do before making any recommendations to the club, in order to comply
with the CFA Institute’s Standards?

A: Obtain prior permission from his employer.

B: Disclosing his arrangement with the club to his clients.
C: Can give recommendations to the club as long as his employer’s clients have had the opportunity
of using those recommendations first.

Sol. A. Obtain prior permission from his employer.

As per Standard IV (A) Loyalty to Employer, it is the duty of Ted to inform his employer about any
type of outside consultancy irrespective of the monetary benefit involved. Only after obtaining prior
permission from his employer, can he proceed.
 Mock Test 1 – CFA Level I

12. Rupert Young has been hired by a brokerage firm to supervise the actions of the traders & report to
the higher management if he suspects of any violations.
He finds that the compliance & the internal control system at the firm is inadequate & wanting in
many areas. He develops a system which he feels is adequate but the management tells him that
the new system will be implemented after 8 months when the new calendar year commences.
Rupert should:

A: Resign from the job with immediate effect.

B: accept the management’s contention since it is justified.
C: decline in writing to accept the supervisory responsibility until an adequate system is put into
place.

Sol. C. Decline in writing to accept the supervisory responsibility until an adequate system is put into
place.

According to Standard IV (C) – Responsibilities of Supervisors, members with supervisory

responsibilities have an obligation to bring an inadequate compliance system to the attention of the
management & recommend corrective action.
A member faced with an inadequate compliance system must decline supervisory responsibility in
writing until adequate procedures are adopted by the firm.

13. Victor Carlos, CFA manages accounts for Drape Capital Advisors. Victor’s cousin is a client of the firm.
Carlos emails a recommendation to his cousin 3 days after emailing it to other clients so that the
other clients get ample time to trade on his recommendations before his cousin does.
Which of the following statement is most accurate?

A. Victor has complied with the Standards of Professional Conduct by giving priority to other
clients.
B. Victor has violated Standard of Professional Conduct by issuing recommendations to a
family account.
C. Victor has violated Standard of Fair Dealing by not treating his cousin’s account at par with
other clients.

Sol. C. Victor has violated Standard of Fair Dealingby not treating his cousin’s account at par with
other clients.

The Standard concerning Fair Dealing requires members to deal fairly with ALL CLIENTS. Victor was
putting his cousin’s account at disadvantage which was not required because cousin was also a
client of the firm.
 Mock Test 1 – CFA Level I

14. Lucy Pique, CFA is caught shoplifting a box of expensive chocolates at a mall. She is found guilty &
sentenced to 100 hours of community service.
Lucy has:

A: not violated any Standard because shoplifting is a minor offence.

B: has violated Standard I (D) Misconduct.
C: not violated any Standard because the offence is not related to her profession.

Sol. B. has violated Standard I (D) Misconduct.

Any act involving lying, cheating, stealing, or other dishonest misconduct that reflects adversely on
member’s professional activities is a violation of Standard I (D). Though the crime does not relate to
her profession, it reflects adversely on her professionally.

15. Jose Coutinho, CFA is an analyst with a large equity research firm. His immediate superior has asked
him to prepare a report on Moss Inc., an electrical appliances manufacturer. Jose’s wife’s personal
portfolio comprises of significant investment in Moss’s stock. In order to comply with the Standards
of Professional Conduct, Jose should:

A: disclose his wife’s ownership of the stock to his supervisor & if asked to write the report, disclose
the same in his report.
B: sell the shares from his wife’s portfolio before writing the report.
C: decline to write the report because he is a beneficial owner of the stock.

Sol. A. Disclose his wife’s ownership of the stock to his supervisor & asked to write the report, disclose
the same in his report.

As per Standard VI (A) - Disclosure of Conflicts, Jose is obligated to disclose the potential conflict to
his supervisor & to his clients who will rely on his report.
The Standard does not require the member to refuse writing a report or liquidate his beneficial
holdings in the covered stock before writing a report.

16. Eva Jones, CFA Level III candidate, expresses her frustration a week after the exam on an online
analyst forum. She states “CFA Institute has committed a blunder by not testing GIPS this time. I had
spent so much time grasping & memorizing the GIPS but in vain!”
Jones is most likely:

A: in violation for criticizing the CFA Institute & for disclosing confidential information about the
exam.
B: in violation for disclosing confidential information about the exam but not for criticizing the CFA
Institute.
 Mock Test 1 – CFA Level I

C: neither in violation for criticizing the CFA Institute nor for disclosing confidential information
about the exam.

Sol. B. in violation for disclosing confidential information about the exam but not for criticizing the
CFA Institute.

Standard VII (A) - Conduct as Members and Candidates in the CFA Program prohibits members and
candidates from providing confidential information about the exam.
Members and Candidates are allowed to express their opinions about the CFA Institute and CFA
Program without violation of any Standards.

17. As per Standard V (C) – Record Retention, CFA institute recommends a minimum holding-period of:

A: 5 years.
B: 7 years.
C: 8 years.

Sol. B. As per Standard V (C) – Record Retention, CFA institute recommends a minimum holding-
period of 7 years.

18. Stephen King, CFA resides in London & often refers his clients to a firm specialized in accounting &
taxation. King does not disclose any confidential information about the clients to the firm & does
not receive any monetary compensation for the referral. However, the firm often gives King tickets
of English Premiership League matches.
King:

A: need not disclose the benefits received for referring clients to the firm since it does not involve
monetary compensation.
B: must not accept the tickets under any circumstances.
C: must disclose the benefits received for referring clients to the accounting & taxation firm.

Sol. C. Must disclose the benefits received for referring clients to the accounting & taxation firm.

Standard VI (C) – Referral Fees require members to disclose to clients & prospects any benefit
received by the member for referring the clients to others. The benefit may be monetary or non-
monetary. Disclosure should be made to the clients so that they can determine any partiality of the
referral.

QUANTITATIVE METHODS
 Mock Test 1 – CFA Level I

19. An investor will receive an annuity of $15,000 for 8 years. The first payment is to be received 6 years
from today. What is the present value of the annuity if the annual interest rate is 6%?

A: $84,595
B: $69,605
C: $65,665

Sol. B. $65,605

PMT = 15,000; N = 8; I/Y = 6; FV = 0; CPT PV = 93,147

93,147 is the value at t = 5.
Therefore, PV at t = 0 is equal to 93,147/ (1.06)5
= $69,605

20. You have borrowed $50,000 on 1st January 2010 at 8% interest to be paid quarterly over 5 years. The
repayment dates are 31st March, 30th June, 30th September, 31stDecember. Calculate the amount of
the outstanding balance for the loan on 31st March 2012 assuming the installment as on that date
has been paid.

A: $24,959
B: $29,927
C: $32,338

Sol. B. $29,927

PV = -50,000; FV = 0; N =5 X 4 = 20; I/Y = 8/4 = 2;

CPT PMT = 3058

You don’t have to construct the full amortization schedule. The trick is to find the number of periods
remaining for the loan to be paid-off fully.
After the instalment on 31st March 2012, the number of remaining instalments or periods is 11. (3 of
2012 + 3 of 2013 + 3 of 2014)
N = 11; FV = 0; I/Y = 8/4 = 2; PMT = 3058;
CPT PV = -29,927

21. Mrs Dorothy Hudson will retire from her job after 4 years. Her life-long savings as on today amount
to $600,000. Assume she has no other expected pension income in future. After she retires, she
wants to support her existing lifestyle. She is considering a post-retirement plan to invest in today.
The plan offers a return of 8% annually. The plan will make 15 equal annual payments, the first one
being paid on the day Dorothy retires & the plan will cease after the last payment. What is the
annual payment Dorothy will receive in her post-retirement stage?
 Mock Test 1 – CFA Level I

A: $88,303
B: $95,367
C: $99,014

Sol. A. $88,303

Since the annuity will begin on the day Dorothy retires, i.e. after 4 years, we need the value of the
investment after 3 years.
600,000 X (1.08)3 = $755,827

Now, PV = -755,827; FV = 0; I/Y = 8; N =15;

CPT PMT = 88,303

22. An investor buys one share for $100. At the end of the year one he buys another share of the same
company for $104. At the end of year two he sells both the shares for $109 each. The share paid a
dividend of $1per share & $2 per share at the end of year one & two respectively. Calculate the
investor’s money-weighted return.

A: 6.146%
B: 5.862%
C: 4.657%

Sol. C. 6.146%

Money-weighted return is calculated using the IRR function on your financial calculator.
At t=0, CF0 = 100 (purchase of 1st share)

At t=1, CF1 = 104 – 1 = 103 (purchase of 2nd share & dividend on 1st share)

At t=2, CF2 = -(218 + 4) = -222 (sale of both the shares & dividend on them)

CPT IRR = 6.146%

23. What is the effective annual yield of a commercial paper priced at $95,000 with a maturity value of
$100,000 & 90 days remaining to maturity?

A: 23.11%
B: 21.35%
C: 22.76%
 Mock Test 1 – CFA Level I

Sol. A. 23.11%

Effective annual yield = (1 + holding-period yield)365/t – 1

Holding-period yield = (100,000 – 95,000) / 95,000 = 5.263%
EAY = (1.050263)365/90 = (1.050263)4.056 = 23.11%

24. If the stated annual interest rate is 8% & the frequency of the compounding is daily, what is the
effective annual interest rate?

A: 8.30%
B: 8.33%
C: 8.16%

Sol. B. 8.33%

Effective Annual Rate = [1 + (0.08/365) ]365 – 1 = 8.33%

25. Which type of measurement scale represents the most refined level of measurement?

A: Ordinal Scale
B: Interval Scale
C: Measurement Scale

Sol. C. Ratio scales represent the most refined level of measurement. They provide ranking & equal
differences between scale values. They also have a true zero point as the origin.

26. For values that are not equal, the geometric mean will most likely be

A: greater than arithmetic mean.

B: less than arithmetic mean.
C: equal to arithmetic mean.

Sol. B. Geometric mean is always less than or equal to arithmetic mean. The only time the two means
will be equal is when all the observations are equal.

27. The mean monthly return on T-bills is 0.30%. The mean monthly return & standard deviation for S&P
500 is 1.25% & 6% respectively.
Calculate the coefficient of variation (CV) & Sharpe-ratio of S&P 500.
 Mock Test 1 – CFA Level I

CV Sharpe Ratio
A: 4.8 0.158
B: 0.208 0.158
C: 4.8 0.24

Sol. A. CV = 4.8; Sharpe Ratio = 0.158

CV = Std.dev. / Mean = 6 / 1.25 = 4.8

Sharpe Ratio = Mean Return – Risk free rate
Standard deviation

= 1.25 – 0.3 = 0.158

6

28. Regardless of the shape of the distribution, according to Chebyshev’s Inequality, what is the
minimum percentage of observations that will lie within +/- two standard deviations of the mean?

A: 56%
B: 68%
C: 75%

Sol. C. 75%

According to Chebyshev’s Inequality, for any distribution, the minimum percentage of observations
that will lie within k standard deviations of the distribution mean = 1 – (1/k2)
If k = 2, then percentage of distribution = 1 – (1/22) = 0.75

29. Which of the following statements regarding negative skewness& excess kurtosis is least accurate?

A: The mean will be lower than the mode.

B: A negatively skewed distribution has a disproportionately large number of outliers in its lower
(left) tail.
C: A platykurtic distribution will have excess kurtosis greater than zero.

Sol. C. A platykurtic distribution will have excess kurtosis greater than zero.

A platykurtic distribution will have excess kurtosis LESS THAN than zero. The other two statements
are correct.

30. The Compensation Committee of Lucas Inc. has given a raise 25% to the best performing employee
of the company who is also the highest earning employee of the company. Which of the following
values will be affected by this raise?
 Mock Test 1 – CFA Level I

A: Mean salary of the employees in the company.

B: Median salary of the employees in the company.
C: Mean & Median salary of the employees of the company.

Sol. A. Mean salary of the employees in the company.

Mean will be affected because it is the sum of the observations divided by the number of the
observations.
Median will not be affected because it is the midpoint between the top half of values & bottom half
of values.

31. Given the following annual returns, what is the mean absolute deviation?

Year
Return

2008 8%

2009 -4%

2010 9%

2011 12%

2012 0%

A: 6%
B: 5.6%
C: 4.6%

Sol. B. 5.6%

Mean = [8 + (-4) + 9 +12 + 0] / 5 = 5%

Mean Absolute Deviation = (│8 – 5│+│– 4 – 5│+│9 – 5│+
│12 – 5│+│0 – 5│) / 5

= (3+9+4+7+5)/5 = 5.6%

32. If the probability of both a new mall & a new theatre being constructed in a city is 72% & the
probability of a new mall being constructed is 88%, what is the probability of a new theatre being
constructed if a new mall is constructed?
 Mock Test 1 – CFA Level I

A: 82%
B: 63%
C: 96%

Sol. A. 82%

P (AB) = P (A│B) X P (B)

P (B) = P (AB) / P (A|B)
= 0.72/0.88 = 82%

Economics

33. Joe & Jane are discussing the topic of elasticity of demand.
Joe states that cross elasticity is negative for substitutes while positive for complements.
Jane states that inferior goods have negative income elasticity while normal goods have positive
income elasticity.
Whether Joe & Jane are correct?

A: Joe is correct but Jane is incorrect.

B: Jane is correct but Joe in incorrect.
C: Both of them are correct.

Sol. B. Jane is correct but Joe is incorrect.

Cross elasticity is positive for substitutes but negative for complements.

34. Which of the following is not a factor that influences the elasticity of supply for a good?

A: The availability of substitutes for the inputs used to produce the good.
B: The price of the inputs used to produce the good.
C: The time that has elapsed since the price change.

Sol. B. The price of the inputs used to produce the good.

This is not a factor that influences the elasticity of supply for a good.

35. Which of the following condition will exist when the quantity of goods in the economy are produced
at a point, where marginal cost equals marginal benefit?

A: Consumer Surplus will be greater than Producer Surplus.

B: Consumer Surplus = Producer Surplus.
 Mock Test 1 – CFA Level I

C: Sum of Consumer & producer Surplus is maximized.

Sol. C. Sum of Consumer & Producer Surplus is maximized.

The point where marginal cost equals marginal benefit implies the efficient quantity of goods. It is
the quantity of production that maximizes total consumer surplus & producer surplus.

36. What will be the effect of setting the price ceiling above the equilibrium price?

A: Demand will fall.

B: Suppliers may reduce the quality of goods.
C: There will be no effect.

Sol. C. There will be no effect.

A price ceiling is the maximum price which a seller can charge. If the ceiling is set above the
equilibrium price, it will have no effect. However if it is set below the equilibrium price, it will result
in excess demand because the suppliers will now be selling at a price below the equilibrium price.
Suppliers may discriminate among the buyers, charge them extra illegally, reduce the quality of
goods produced, etc.

37. Which of the following action of the government will most likely result in increase of price paid by
the consumers for a product?

A: Imposing penalty on sale of the product.

B: Imposing penalty on purchase of the product.
C: Providing subsidy to the producers of the product.

Sol. A. Imposing penalty on the sale of the product.

Imposing penalty on purchase of the product will reduce demand & consequently reduce the
equilibrium price.
Providing subsidy to the producers of the product will increase supply & consequently reduce the
equilibrium price.
Imposing penalty on sale of good will reduce the supply & consequently increase the price.

38. Which of the following set of factors of production is most likely to be variable in the short run?

A: Raw material & Capital Equipment

B: Labour& Capital Equipment
C: Raw material &Labour
 Mock Test 1 – CFA Level I

Sol. C: Raw materials &labour are variable in the short run while plant size, technology & capital
equipment are held constant in the short run.

39. Which of the following principle implies states that the greatest good occurs to the greatest good
occurs to the greater number of people when wealth is transferred from the rich to the poor to the
point where everyone has the same wealth?

A: Fairness Principle
B: Utilitarianism Principle
C: Symmetry Principle

Sol. B. Utilitarianism.

Fairness Principle implies that individuals should get goods & services from the economy, that are
equal in value to their contribution to the economy.
Symmetry Principle implies that market allocates resources fairly if the rules of economic allocation
are fair.

40. Which of the following Cost Curves is not U-shaped?

A: Average Fixed Cost Curve

B: Average Variable Cost Curve
C: Average Total Cost Curve

Sol. A. Average Fixed Cost Curve.

AFC will continue to slope downwards & eventually flatten since fixed costs are constant & will
spread over larger number of units as output increases.
AVC slopes downward initially, but due to the law of diminishing returns, it starts sloping
upward resulting in a U-shaped curve.
Since ATC is the sum of AFC & AVC, it is U-shaped.

41. The demand for the product of a purely competitive firm is

A: Perfectly Inelastic
B: Perfectly Elastic
C: Relatively Inelastic

Sol. B. Perfectly Elastic.

 Mock Test 1 – CFA Level I

The demand for the product of a purely competitive firm is perfectly elastic because price is
determined purely by the interaction of market forces. If a seller increases the price of the product
above its market price, he will sell nothing.

42. Which of the following is least likely to be a condition for price discrimination to work under a
monopoly?

A: There should be at least two identifiable groups of customers with different tastes & preferences.
B: The seller must face a downward sloping demand curve.
C: Resale by customers must be prevented.

Sol. A.

Following are the conditions for price discrimination to work under a monopoly:
 Seller must face a downward sloping demand curve.
 There should be at least two identifiable groups of customers having different price
elasticities of demand for the product.
 Customers paying the lower price must be prevented from reselling the product to
customers willing to pay a higher price.

43. If the rate of inflation has increased beyond the acceptable range, the central bank would most
likely:

A: decrease the bank reserve requirement.

B: decrease the repo rate.
C: sell government securities.

Sol. C. Sell government securities.

Decreasing the bank reserve requirements or the repo rate would increase the money supply in
economy & further increase the inflation.
Selling the government securities would result in cash being replaced with securities in the accounts
of people. The money supply would reduce in the economy & consequently inflation will come
down gradually.

44. India & Pakistan have agreed to adhere to an arrangement that restricts the production of sugar
such that maximum economic profit will be realized by these two countries in Asia. The possible
outcomes of the arrangement are given in the table below.

Pakistan complies Pakistan defaults

 Mock Test 1 – CFA Level I

India gets Rs.1 billion. India gets Rs.300 million.

India complies
Pakistan gets Rs.1 billion.
India gets Rs.1.5 billion.
India defaults
Pakistan gets Rs.300 million.
Pakistan gets Rs.1.5 billion.
India gets Rs.500 million.
Pakistan gets Rs.500 million

Using Prisoners’ Dilemma, the most likely action taken by both the countries will be:

A: Neither country will increase its production

B: Only one country will increase its production
C: Both the countries will increase their production.

Sol. C. Both the countries will increase their production.

The solution to the Prisoners’ Dilemma is to take the best course of action given the action taken by
the other party.
Given that Pakistan complies with the agreement, India will get Rs.1 billion if it complies but Rs.1.5
billion if it does not. Hence, India will not comply & increase its production.
Given that Pakistan violates the agreement, India will get Rs.300 million if it complies but Rs.500
million if it violates too. Hence, India will not comply in this case either.
Pakistan will follow the same logic.

FINANCIAL REPORTING & ANALYSIS

45. Acquiring Plant & Machinery is a/an

A: Operating Cash Flow

B: Investing Cash Flow

C: Financing Cash Flow

Sol. B. Acquiring Plant & Machinery is an investing cash-flow.

46. Which of the following is not a characteristic of an effective financial reporting framework?

A: Accuracy

B: Transparency

C: Comprehensiveness

Sol. A. Accuracy is not a characteristic of a coherent financial reporting framework.

 Mock Test 1 – CFA Level I

Transparency, comprehensiveness & consistency are the characteristics of a coherent financial

reporting framework.

47. Information about accounting methods & estimates used by management is provided in

A: Management Discussion & Analysis

B: Supplementary Schedules

C: Footnotes

Sol. C.Footnotes

48. If the financial statements are not prepared in accordance with the generally accepted accounting
principles & are materially departing from the required accounting standards, the auditor

A: will issue an adverse opinion.

B: will issue a qualified opinion.

C: will decline to issue an opinion.

Sol. A. will issue an adverse opinion.

49. Rana Builders has secured a contract to construct a bridge in 5 years for $15million. The estimated
cost of the project is $12million. Costs incurred by Rana in the initial 2 years are:

Year Costs

2010 $3 million

2011 $2 million

Calculate the net income of Rana Builders for 2010 & 2011 under Percentage of Completion
Method.

A: 2010-$600,000; 2011-$400,000

B: 2010-$750,000; 2011-$500,000

C: Nil in both years since project is not completed.

Sol. B. 2010-$750,000; 2011-$500,000

 Mock Test 1 – CFA Level I

Under percentage-of-completion method, revenue is recognized as the work is performed. The

percentage of completion is measured by the total cost incurred to date divided by the total
expected cost of the project.

Year 2010: Revenue = 3/12 X 15 = $3.75 million

Cost = $3.00 million

Profit = $0.75 million

Year 2011: Revenue = 2/12 x 15 = $2.50 million

Cost = ($2.00 million)

Profit = $0.50 million

50. Rana Builders sold an apartment on installment basis for $500,000.The cost of constructing the
apartment is $400,000. Proceeds from the sale:

Year Proceeds

2010 $100,000

2011 $150,000

Calculate the net income of Rana Builders for 2010 & 2011 under Installment Basis.

A: 2010-$100,000; 2011-$0

B: 2010-$20,000; 2011-$30,000

C: 2010-$25,000; 2011-$37,500

Sol. B. 2010-$20,000; 2011-$30,000

Under installment method, profit is recognized as cash is collected.

Profit for the year = Cash collected during the year X Total profit

Total Revenue

Profit for Year 2010 = 100,000 X 100,000/500,000 = $20,000

Profit for Year 2011 = 150,000 X 100,000/500,000 = $30,000
 Mock Test 1 – CFA Level I

51. Cosmo Inc. acquires machinery on 1st Jan 2011 for $250,000. The useful life is 5 years & the residual
value is $5000. Calculate the depreciation expense for the year 2013 under Double Declining
Balance Method.

A: $49,000

B: $36,000

C: $32,000

Sol. B. $36,000

DDB Dep. = (2/useful life) (Cost – accumulated dep.)

Dep. for 2011 = (2/5) X (250,000) = 100,000
Dep. for 2012 = (2/5) X (250,000 – 100,000) = 60,000
Dep. for 2013 = (2/5) X (250,000 – 160,000) = 36,000

Remember that Residual Value is not taken into consideration for Double Declining Balance method

52. Which of the following will result in a higher net income?

A: Increasing the estimated useful life & residual value of the asset.

B: Decreasing the estimated useful life & residual value of the asset.

C: Increasing the estimated useful life but decreasing the residual value of the asset.

Sol. A. Increasing the estimated useful life & residual value of the asset will have the effect of reducing
the depreciation expense & consequently increasing the profit.

53. Which of the following does not constitute a discontinued operation for the purpose of reporting as
such in the current year?

A: An operation which the management has approved to discontinue but has not yet done so.

B: An operation which has been discontinued in the current year after generating losses.

C: An operation which has been discontinued last year.

Sol. C. An operation which has been discontinued last year does not constitute as a discontinued
operation in the current year for reporting as such.
 Mock Test 1 – CFA Level I

54. The net income of Mercury Inc. for the year ended 31st Dec 2010 is $45 million. It paid dividends of
$5 million & $3million to common & preferred stockholders respectively. Further information about
common stock is as follows:

Jan 1 Shares outstanding 2 million

July 1 Shares issued 500,000

Oct 1 Shares repurchased 250,000

Compute EPS for the year 2010.

A: $19.20

B: $20.36

C: $16.91

Sol. A. $19.2.

Net income available to common stockholders =

$ 45 million - $ 3 million = $ 42 million

* Dividend paid to common stockholders is not to be deducted.

No. of Weighted Average Shares =

2 + 0.5 x (6/12) – 0.25 x (3/12) = 2.1875 million shares

EPS = 42/2.1875 = $ 19.2 per share

55. Recognizing income before cash is received, results in

Asset Revenue Liability

A: Increase Increase Decrease

B: Decrease No effect Increase

C: Increase Increase No effect

Sol. C. Recognizing income before cash is received results in the increase of receivable & revenue. Thus
there is an increase in asset & revenue. The liabilities are unaffected.
 Mock Test 1 – CFA Level I

56. As per IFRS, substance over form, neutrality & prudence are specific factors that support which
qualitative characteristic of financial statements?
A: Relevance

B: Reliability

C: Understandability

Sol. B. Reliability. Specific factors that support reliability are faithful representation, substance over
form, neutrality, prudence & completeness.

57. Which of the following item is not included in other comprehensive income?

A: Adjustments for minimum pension liability.

B: Realized gains & losses from cash flow hedging derivatives.

C: Foreign currency translation gains & losses.

Sol. B. Realized gains & losses from cash flow hedging derivatives. Since they are realized, they are
recorded in the Income Statement. Unrealized gains & losses from cash flow hedging derivatives are
recorded in other comprehensive income.

58. Reliable Inc. fully acquired Unreliable Inc. for $550 million cash.
Following is the extract of Balance Sheet of Unreliable just before the acquisition:
Book Value
(Million $)
Plant & machinery 820
Current Assets 120
Goodwill 20
Liabilities 500
Shareholders’ Equity 460

The actual market value of Plant & Machinery is $900 million.

Calculate the amount of goodwill Reliable Inc. should report on its consolidated Balance Sheet.

A: $30 million

B: $10 million

C: $90 million
 Mock Test 1 – CFA Level I

Sol. A. $30 million.

In millions

Plant & Machinery $900

Current Assets $120

Liabilities ($500)

Fair value of Net Assets $520

Purchase Price $550

Less: Fair Value of Net Assets ($520)
Acquired goodwill$30

*Goodwill of $20 million reported on Balance Sheet of Unreliable Inc. is an unidentifiable asset &
hence ignored in the calculation of goodwill of Reliable Inc.

59. Treasury Stock is stock which has been

A: reacquired by the issuing company but not yet retired.

B: approved to be reacquired but not yet reacquired by the issuing company.

C: reacquired & retired by the issuing company.

Sol. A. Treasury Stock is stock which has been reacquired by the issuing company but not yet retired.

60. Under US GAAP, tax paid on gain on sale of factory building is reported as outflow under

A: Investing Activities

B: Operating Activities

C: Financing Activities

Sol. B. Operating Activities.

Under US GAAP, ALL taxes paid are reported as outflows under operating activities even if those
taxes are related to investing or financing activities.
 Mock Test 1 – CFA Level I

61. From the given information calculate the amount of cash collected from the customers & payments
made to suppliers in Year 2010.

Income Statement for the year ended 31/12/2010

Credit Sales $250,000
COGS $150,000
Salaries & Wages $30,000
Depreciation $20,000
Interest $10,000
Total Expenses ($210,000)
Net Income $40,000

Extract of Balance Sheet

On 01/01/10 On 31/12/10
Cash $40,000 $45,000
Accounts Receivable $25,000 $35,000
Accounts Payable $20,000 $29,000
Advances received from customers $10,000 $8,000
Advances paid to suppliers $7,000 $12,000
Inventory $30,000 $38,000

Cash collected Cash paid

from customers to suppliers

A: $258,000 $162,000

B: $242,000 $155,000

C: $238,000 $154,000

Sol. C. Cash collected Cash paid

from customers to suppliers

$238,000 $154,000

Cash collected from customers

Credit Sales 250,000
Less:
Increase in Accounts Receivable (10,000)
Decrease in Advances Received (2,000)
 Mock Test 1 – CFA Level I

Cash collected from customers $238,000

Cash paid to suppliers

COGS 150,000
Add:
Increase in Inventory 8,000
Increase in Advances Paid 5,000
Less:
Increase in Accounts Payable (9,000)

Cash paid to suppliers $154,000

*Cash balances are irrelevant in the given question.

62. From the given information, calculate Free Cash Flow to the Firm:

Cash collected from customers $340,000

Cash paid to suppliers $260,000
Cash Operating Expenses $25,000
Cash paid for interest $10,000
Cash paid for taxes $15,000
Machinery acquired for cash $30,000
Land sold for cash $50,000
Bonds repaid $20,000
Bonds issued $25,000
Stock issued for cash $35,000
*Tax rate is 30%

A: $57,000

B: $55,000

C: $62,000

Sol. A. $57,000

Free cash flow to the firm

= CFO + [Interest X (1 – tax rate)] – Net Capital Expenditures

CFO = 340,000 – 260,000 – 25,000 – 10,000 – 15,000

= 30,000

FCFF = 30,000 + [10,000 X 0.7] – (30,000 – 50,000)

 Mock Test 1 – CFA Level I

= 57,000

63. Following is the data about the company:

2010 2011
EBIT Margin 0.18 0.14
Asset Turnover 1.2 1.3
Leverage Multiplier 1.4 1.5
Tax Burden 0.75 0.80
Interest Burden 0.70 0.70

Which of the following is the best conclusion about the change in ROE of the company?

A: ROE has decreased drastically because of the fall in profit margin.

B: ROE has increased slightly because of the increase in asset turnover, leverage & tax burden even
though the profit margin as fallen.
C: ROE has decreased slightly because the fall in profit margin is compensated to some extent by
increase in asset turnover, leverage & tax burden.

Sol. C. ROE has decreased slightly because the fall in profit margin is compensated to some extent by
increase in asset turnover, leverage & tax burden.

ROE of 2010 = 0.18 X 1.2 X 1.4 X 0.75 x 0.70 = 15.88%

ROE of 2011 = 0.14 X 1.3 X 1.5 X 0.80 x 0.70 = 15.29%

Thus, ROE has reduced only slightly in spite of a more severe fall in profit margin. The fall in ROE has
been moderated by the increase in asset turnover, leverage & tax burden.

64. Following is the data of a company:

Sales $500,000
Gross Profit $125,000
Average Total Assets $300,000
Average Total Inventory $100,000

Calculate the company’s total asset turnover & inventory turnover.

Asset Turnover Inventory Turnover

A: 1.67 5
 Mock Test 1 – CFA Level I

B: 0.60 0.20

C: 1.67 3.75

Sol. C. Asset Turnover Inventory Turnover

1.67 3.75

Asset Turnover = Sales/Assets

= 500,000 / 300,000 = 1.67

Inventory Turnover = COGS / Average Inventory

= (500,000 – 125,000) / 100,000 = 3.75

65. Following is the company’s production & cost data:

Raw Materials consumed $625,000

Direct costs of manufacturing $415,000
Freight inward $54,000
Warehousing charges of finished goods $25,000
Abnormal waste $12,000
Freight outward $36,000
Units manufactured 4,000

Calculate the capitalized cost per unit.

A: $288.75

B: $279.50

C: $273.50

Sol. C. $273.50

Capitalized cost of inventory includes the raw material costs, conversion costs & freight- inward.
= 625,000 + 415,000 + 54,000 = 1,094,000

The storage costs, freight outward & abnormal waste are not included in the cost of inventory but
expensed in the period incurred.

Capitalized cost per unit = 1,094,000 / 4,000 = $273.50 per unit

66. From the following inventory data of a company, answer the questions (22.) & (23.)
 Mock Test 1 – CFA Level I

January 1 (opening inventory) 1500 units @ $5 per $7,500

unit
January 5 purchase 2000 units @ $6 per $12,000
unit
January 15 purchase 3500 units @ $8 per $28,000
unit
Total cost of goods available 7000 units $51,000
Units sold during January 4500 units

Which method of inventory valuation will yield the highest closing inventory value & COGS?

A: LIFO will yield highest closing inventory value while FIFO will yield highest COGS value.
B: FIFO will yield highest closing inventory value while LIFO will yield highest COGS value.
C: FIFO will yield highest closing inventory & COGS value.

Sol. B. FIFO will yield highest closing inventory value while LIFO will yield highest COGS value.

This question does not require any calculations. All we have to conclude from the given table is that
the prices have increased during the month. In inflationary environment, FIFO will yield highest
inventory value & lowest COGS value while LIFO will yield lowest inventory value & highest COGS
value. Inventory & COGS values under Weighted Average Cost method will lie somewhere in
between.

67. What will be the effect on current ratio & quick ratio if the company was to use either FIFO or LIFO
respectively?

A: Under FIFO, current ratio will be higher while quick ratio will be the same under both methods.

B: Under FIFO, current & quick ratio will be higher.

C: Under LIFO, current ratio will be higher while quick ratio will be same under both methods.

Sol. A. Under FIFO, current ratio will be higher while quick ratio will be same under both methods.

Since inventory will be higher under FIFO, current ratio will be higher. Quick ratio does not include
inventory in the calculation of quick assets & hence it will remain unaffected.

68. Which of the following statement about inventory write-up is most accurate?

A: Under US GAAP, the write-up is allowed to the extent of the original write-down.

B: Under IFRS, the write-up is allowed beyond the original write-down & profit can be recognized to
that extent.
 Mock Test 1 – CFA Level I

C: Under US GAAP, no write-up is allowed & the profit is recognized only on the sale of inventory.

Sol. C. Under US GAAP, no write-up is allowed & the profit is recognized only on the sale of inventory.

Under IFRS, the write-up is allowed to the extent of the original write-down. The carrying value
cannot exceed the original cost under IFRS.

CORPORATE FINANCE

69. (corrected)Consider the following statements:

(a)NPV & Profitability Index methods will always yield the same result assuming the size of the
projects to be equal.

(b)If IRR >Required rate, then the project will always yield a positive NPV.

(c)The project with the higher IRR should always be selected while considering two mutually
exclusive projects.

Choose the most appropriate option.

Statement (a) Statement (b) Statement (c)

A: Correct CorrectCorrect

B: Incorrect IncorrectIncorrect

C: Correct Correct Incorrect

Sol. C.

Statements (a) & (b) are correct. Statement (c) is incorrect because a project may have a higher
NPV but a lower IRR as compared to other project. In such a case the project with the higher
NPV should be selected because it will increase the firm’s value more.

70. The following data is regarding Jupiter Inc.

 It just paid a dividend of $ 2 per share.
 The share price is $ 25
 The expected constant growth rate in the foreseeable future is 4%
 YTM on its bonds in 9%
 Target Debt/Equity Ratio is 0.25
 Mock Test 1 – CFA Level I

 Marginal Tax Rate is 30%

Calculate Jupiter’s after-tax cost of capital

A: 10.82%

B: 11.12%

C: 10.86%

Sol. B.

Cost of equity is calculated using the revised Gordon’s formula

= (D1/ P0) + g = 2(1.04) + 0.04 = 12.32%
25

After-tax cost of debt = kd(1-t)

= 0.09(1-0.3) = 6.3%

Weight of debt = 0.25/1+0.25

= 0.25/1.25 = 0.2

Weight of equity = 1 - 0.2 = 0.8

After-tax WACC = 0.8(12.32) + 0.2(6.3)

= 11.12%

71. A country risk premium is required to be incorporated in the cost of equity for a project which, U.S
Company Saturn Inc. is planning to commence in a developing country called Sparta. Following
information has been gathered :
 Yield on 5-year Spartan government bond denominated in U.S $. = 9.5 %
 Yield on 5-year U.S Treasury bond = 5 %
 Annualized standard deviation of Spartan government bond denominated in U.S $ =
18%
 Annualized standard deviation of Spartan National Equity Index = 26%
 U.S Risk Free Rate = Yield on 5-year U.S Treasury bond
 Expected Return on S&P 500 = 10%
 Project Beta = 1.2

Calculate the cost of equity for Jupiter’s project in Sparta.

A: 14.74 %
 Mock Test 1 – CFA Level I

B: 18.80%

C: 24.80%

Sol. B

First we calculate the country risk premium of Sparta

= Sovereign Yield Spread X (Annualized Standard Deviation of equity index of developing

country)/(Annualized Standard Deviation of Sovereign Bond denominated in the currency of
developed country)

Sovereign Yield Spread = Difference between yields of government bonds of developing country &
developed country.

= 9.5% – 5% = 4.5%

Country risk premium = 4.5% X (26%/18%)

= 6.5%

Cost of equity = Risk Free Rate + β (Market Risk Premium +

Country Risk Premium)

= 5% + 1.2(10% - 5% + 6.5%)

= 18.8%

72. The correct treatment of floatation costs of equity is to

A: incorporate in the discount rate thereby increasing the cost of equity.

B: ignore it since it is a financing cost.

C: to adjust the initial cash outlay.

Sol. C. The correct treatment of floatation costs of equity is to adjust the initial cash outlay.

73. The sole supplier of inputs of Uranus Inc. is seeking a revision in prices. Uranus Inc. is stipulated by a
working capital loan agreement with its bank, to keep the degree of total leverage (DTL) at 4 or
below.
The company’s estimated results without considering the revised input prices are as follows:

Sales $1,000,000
 Mock Test 1 – CFA Level I

Variable Costs 70% of Sales

Fixed Costs $150,000

Interest $25,000

The maximum percentage increase in its input prices Uranus Inc. can allow without violating its
agreement with the bank, is closest to

A: 9.5%

B: 10.5%

C: 11.5%

Sol. A. 9.50%

Let the revised variable costs be ‘x’

DTL = (Sales – Variable Costs) / (Sales – Variable Costs – Fixed
Costs – Interest Costs)
Limiting DTL as 4u
4 = (1,000,000 – x) / (1,000,000 – x – 150,000 – 25,000)
Solving for x, we get x = 766,667

Existing Variable Costs = 700,000 (70% of 1,000,000)

% increase = (766,667/700,000) – 1

= 9.52 %

74. Mars Inc., a closely-held company is planning to start a project in furniture manufacturing. Pluto Inc.
is a listed company & an established player in furniture manufacturing. Following is the data on
these two companies :
Mars Pluto
D/E 1.5 1.25

Marginal Tax-Rate 30% 25%

The βequity of Pluto Inc. is 1.25. Calculate βproject required in the calculation of WACC for the project.

A: 1.32
 Mock Test 1 – CFA Level I

B: 1.42

C: 1.52

Sol. A. 1.32

First we calculate Pluto’s asset beta.

βasset = βequity ((1 / {1 + [(1 – t) (D/E)}))
= 1.25 ((1 / {1 + [0.75 X 1.25]}))
= 0.645
Then we shall calculate project equity beta using the data of Mars.
βproject= βasset (1 + [(1 – t) (D/E)]
= 0.645 (1 + [(0.7) (1.5)]
= 1.32

75. Which is the most accurate statement regarding the effect of share repurchase versus cash dividend
on the shareholder wealth, assuming equal amount of repurchase or cash dividend & same taxes in
either case?

A: Share repurchase may result in a higher shareholder wealth.

B: Share repurchase & cash dividend will have equal effect on shareholder wealth.

C: Share repurchase will always result in an increase in shareholder wealth.

Sol. B.Sharerepurchase& cash dividend will have equal effect on shareholder wealth, assuming equal
amount of repurchase or dividend & same taxes in either case.

76. Assuming everything else constant, the average days of payables of a company has increased
compared to previous year. The effect on the company’s operating cycle & cash conversion cycle is

Operating cycleCash conversion cycle

A: No effect Decrease
B: Increase Increase
C: Decrease Decrease

Sol. Operating CycleCash conversion cycle

A. No effect Decrease

Operating cycle = Days of inventory + Days of receivables

 Mock Test 1 – CFA Level I

Cash conversion cycle = (Average Days of inventory) +

(Average Days of receivables) –
(Average Days of payables)

77. A 91-day Treasury Bill currently quoted @ $97.5 has a face value of $100. What is the money-
market yield of this T-Bill?

A: 9.89%
B: 10.14%
C: 10.28%

Sol. B. 10.14%

Money-market yield = (face value – Price) x (360/days)

Price
= (2.5/97.5) x (360/91) = 10.14%

78. The most preferred form of short-term financing for a large creditworthy company would be

A: Committed Line of credit

B: Factoring the receivables
C: Commercial Paper

Sol. C. Commercial Paper

Factoring Receivables entails a higher cost of financing. Committed line of credit is a reliable
source of short-term financing but it involves paying a fee to the bank. The interest rates of
commercial paper are slightly less than the rates offered by the bank.

EQUITY INVESTMENTS

79. Which of the following index assumes that the index portfolio invests an equal dollar amount in each
stock of the index?

A: Value-weighted index
B: Price-weighted index
C: Unweighted index

Sol. C. An unweighted index places an equal weight on all the stocks of the index. It assumes that the
index portfolio invests an equal dollar amount in each stock of the index.

80. Which of the following is least likely true?

 Mock Test 1 – CFA Level I

a. A firm may employ a special purpose entity to remove risky assets from their balance
sheets
b. Alternative trading systems differ from exchanges in that the latter have no regulatory
function
c. The cash flow from securitized assets are segregated by risks, with senior tranches
having the most certain cash flow

Solution: (b) Exchanges provide venue for traders to meet and sometimes also act as brokers by
providing electronic order matching. They also regulate their members and require firms that list on the
exchanges to provide timely financial disclosures to promote shareholder democratization. The
Alternative trading systems are similar to exchanges but do not have regulatory functions.

81. An order to protect the short sale position is called

A: Stop Loss Buy Order

B: Stop Loss Sell Order
C: Covered Sale Order

Sol. A. Short position gains from fall in stock price & loses when the price rises. A stop loss buy is a limit
order placed above the current market price. When the market price reaches the stop price, the limit
order (in this case buy) is executed thereby preventing further losses.

82. You have bought a share for $50. The initial margin requirement is 60% & the maintenance margin is
40%. At what price will the margin call trigger?

A: 30
B: 33.33
C: 20

Sol. B. 33.33

50(1-0.6)/ (1-0.4) = 33.33

83. You purchase 100 shares on margin, of Poseidon Inc. for $50 per share. The initial & maintenance
margin requirements are 60% & 30% respectively. After a year, the share price rises to $56 per share
& you sell the shares.3 months ago Poseidon paid a dividend of $3per share. What is the return on
investment?

A: 18%
B: 30%
C: 60%
 Mock Test 1 – CFA Level I

Sol. B. 30%

Return on Investment = Profit/Initial Investment

Profit = final stock price + dividend – initial stock price
Initial Investment = initial stock price *maintenance margin
Here, stock quantity need not be taken into account as it is multiplied into both numerator and
denominator.

(56+3-50)/(50*60%) = 30%

84. Following are the quarterly returns of Earth Inc.

First Quarter 1.50%
Second Quarter -0.75%
Third Quarter 3.00%
Fourth Quarter 2.50%

The return for the year is closest to

A: 6.25%
B: 6.35%
C: 6.45%

Sol. B. 6.35%

[(1.015) (0.9925) (1.03) (1.025) – 1] = 6.35%

85. Which form of efficient market hypothesis states that stock prices fully reflect all information from
public & private sources?

A: Strong-form
B: Semi-strong-form
C: Weak-form

Sol. A. Strong-form

86. Peter has recently acquired shares of Dig Earth Inc., a mining company since he believes it has bright
prospects. He is excited because a preliminary report which has suggested that the company is
about to announce a new find in Amazon forests. However, the environmentalists are lobbying
strongly to oppose any further mining activity in the forest area. In the last two years, four mining
companies were forced out of these forests by the environmentalists’ lobby.
Peter is however confident that Dig Earth will find a way to subvert the environmentalists &
purchases more shares of Dig Earth.
Which bias is Peter exhibiting?
 Mock Test 1 – CFA Level I

A: Over-confidence
B: Confirmation
C: Escalation

Sol. B. Confirmation Bias.

Peter is exhibiting confirmation bias because he relies on information which supports his belief
that Dig Earth is a good prospect. He is considering the preliminary report which is positive but
ignores the information about environmentalists’ opposition that questions his decision.

87. Which of the following is not a limitation on the market’s ability to produce informationally efficient
prices?

A: Processing news is costly & time-consuming

B: Sometimes transaction costs exceed the gains to be be made on small mispricings

C: Markets do not work round the clock.

Sol. C. Markets do not work round the clock.

The other two reasons impair the ability of markets to produce informationally efficient
markets.

88. Which of the following is least likely a function of Clearinghouses?

a. Transfer cash and assets to the respective parties
b. Prevent loss due to fraud
c. Limit aggregate net order quantity, i.e., buy minus sell orders

Solution: (b) Clearinghouses provide:

 Escrow Services (transfer of cash and assets to the respective parties)

 Guarantees of contract completion
 Assurance that margin traders have adequate capital
 Limits on aggregate net order quantity

Custodians are intermediaries who improve market integrity by holding client securities and preventing
their loss due to fraud which affect the broker or investment manager.

89. Jubilant Inc.’s expected retention ratio is 40% & expected growth rate is 5%. What should be the
price-to-earnings multiple if the required return on this type of stocks is 10%?

A: 12x
B: 8x
 Mock Test 1 – CFA Level I

C: 10x

Sol. A. 12x

Expected P/E ratio = (D/E)/(k-g)

= (1-0.4)/(.10 - 0.05)= 0.6/0.05 = 12

90. Which of the following is not a disadvantage of price-to-sales ratio?

A: P/S ratio is more volatile than P/E ratio

B: P/S ratio does not capture differences in costing
C: P/S ratio is susceptible to manipulation

Sol. A. P/S ratio is more volatile than P/E ratio.

The above statement is not a disadvantage of P/S ratio. In fact, P/S ratio is less than volatile than
P/E ratio. The other two statements are disadvantages of P/S ratio.

DERIVATIVES

91. The primary criticism of derivatives is that

A: they are sometimes complex & hard to understand which makes them riskier.
B: the counterparty is unknown.
C: they are short-term in nature.

Sol. A. The primary criticism of derivatives is that they are sometimes complex & hard to understand
which makes them riskier.

92. Eurodollar deposits are

A: Deposits in large banks outside USA but denominated in US dollars.

B: Deposits in large banks in USA but denominated in Euros.
C: Deposits in large banks in Europe, denominated in Euros & issued to US investors.

Sol. A. Eurodollar deposits are deposits in large banks outside USA but denominated in US dollars.

93. Consider a 60-day forward rate agreement based on 180-day LIBOR with a notional principal of $ 10
million. The FRA specifies a forward rate of 6%. If the 180-day LIBOR 60 days from now is 7%,
calculate the payment made at settlement & by whom.

A: Long party will make a payment of $50,000.

 Mock Test 1 – CFA Level I

B: Short party will make a payment of $48,309.

C: Short party will make a payment of $50,000.

Sol. B. Short party will make a payment of $48,309.

The short party is obligated to lend to the long party at the rate of 6% even though the market
rate is 7%. Hence the short party will pay the interest difference to the long.
= (0.07 - 0.06) (180/360) X 10 million = $ 50,000.
But this interest saving to the long would not come until the end of the 180-day loan. Hence the
payment made by the short party at settlement (i.e. at the commencement of the loan) is the
present value of $ 50,000.
= 50,000/1+ [(0.07) x (180/360) ]
= $ 48,309

94. The funds that must be deposited in the account with the broker to bring it to the level of initial
margin, is called

A: Variation Margin

B: Maintenance Margin

C: Minimum Margin

Sol. B. The funds that must be deposited in the account with the broker to bring it to the level of initial
margin, is called variation margin.

Maintenance margin is the minimum balance required to be maintained in the account. If

account balance falls below this level, margin call is triggered & additional funds are required to
be deposited to restore the balance to the initial margin.

95. You have taken the long side in ten Acme Inc. futures contract. Each contract covers 50 shares of
Acme Inc. The contract price is $50 per share. Each contract requires a deposit of $150 initial margin
& has a maintenance margin of $100. Following are the price increase/decrease for the next 3 days.
Day 1 : 50 cents decrease
Day 2 : 80 cents decrease
Day 3 : $ 1 increase

What is the balance in the margin account at the end of 3rd day?

A: $2000
B: $1350
C: $1250
 Mock Test 1 – CFA Level I

Sol. A. $2000

Day Amt. deposited Gain/(Loss) Balance

0 150 x 10 = $1500
-- $1500
1 -- 0.5 X 50 X 10 =($250)
$1250
2 -- 0.8 X 50 X 10 =($400)
$850
3 * 1 X 50 X 10
$650 = $500 $2000
*1500-850=$650

96. Which of the following is a characteristic of Treasury Bond Futures Contracts?

A: They are cash-settlement contracts.

B: They have a face-value of $1000.
C: They are traded for Treasury Bonds with maturities greater than 15 years.

Sol. C. They are traded for Treasury Bonds with maturities greater than 15 years.

They are deliverable contracts & have a face value of $100,000.

FIXED INCOME QUESTIONS

97. A 20-year, 9% annual coupon bond selling for $1,098.96 offers a yield of:

A. 8%
B. 10%
C. 9%

Correct answer is A

N = 20, PMT = 90, PV = -1,098.96, FV = 1,000, CPT I/Y

98. The interbank funds market is most accurately described as:

A. Banks’ borrowing of reserves from the central bank

B. unsecured short-term loans from one bank to another
C. trading of negotiable certificates of deposit

Correct answer is B
 Mock Test 1 – CFA Level I

The interbank funds market refers to short-term unsecured loans between banks. It
does not refer to trading of negotiable certificates of deposit. Borrowing from the
central bank is said to occur in the central bank funds market.

99. The 3-year spot rate is 10%, and the 4-year spot rate is 10.5%. What is the 1-year forward rate 3
years from now?

A. 10.0%
B. 12.0%
C. 11.0%

Correct answer is B

[(1 + S4)4 / (1 + S3)3] − 1 = 12.01% = 12%

100. Harmon Moving has a 13.25% coupon semiannual coupon bond currently trading in the market at
$1,229.50. The bond has eight years remaining until maturity, but only two years until first call on
the issue at 107.50% of $1,000 par value. Which of the following is closest to the yield to first call on
the bond?

A. 5.16%
B. 9.14%
C. 4.72%

Correct answer is C

To compute yield to first call, enter: FV = $1,075; N = 2 × 2 = 4; PMT = $66.25; PV = -

1,229.50, CPT → I/Y = 2.36%, annualized as (2.36)*(2) = 4.72%

101. The type of credit risk that is defined as the possibility that a borrower will fail to pay interest or
repay principal when due is:

A. credit spread risk

B. downgrade risk
C. default risk

Correct answer is C

Default risk refers to the failure of a borrower to make timely and complete payments of
interest or principal.
 Mock Test 1 – CFA Level I

102. The price of a bond is equal to $101.76 if the term structure of interest rates is flat at 5%. The
following bond prices are given for up and down shifts of the term structure of interest rates. Using
the following information what is the effective duration of the bond?

Bond price : $98.46 if term structure of interest rates is flat at 6%

Bond price : $105.56 if term structure of interest rates is flat at 4%

A. 3.49
B. 1.56
C. 1.74

Correct answer is A

The effective duration is computed as follows:

Effective Duration= (105.56-98.46) / (2*101.76*0.01) = 3.49

103. Which measure of duration should be matched to the bondholder’s investment horizon so that
reinvestment risk and market price risk offset each other?

A. Modified duration.
B. Effective duration.
C. Macaulay duration.

Correct answer is C

Macaulay duration is the investment horizon at which reinvestment risk and market
price risk approximately offset.
104. A bond has a convexity of 51.44. What is the approximate percentage price change of the bond due
to convexity if rates rise by 150 basis points?

A. 0.71%
B. 0.26%
C. 0.58%

Correct answer is C

The convexity effect, or the percentage price change due to convexity, formula is:
convexity * (ΔYTM)2. The percentage price change due to convexity is then:
(½)*(51.44)*(0.015)2 = 0.0058.
 Mock Test 1 – CFA Level I

105. A firm with a corporate family rating (CFR) of A3/A- issues secured bonds. Covenants to these
bonds include a limitation on liens and a change of control put. If credit rating agencies notch this
issue, its credit rating is most likely to be:

A. A2/A
B. Baa1/BBB+
C. Baa2/BBB

Correct answer is A

Both the priority of claims and the covenants suggest this issue has less credit risk than
the issuer and therefore its issue credit rating may be notched upward. The issue’s
credit rating (corporate family rating) is based on its senior unsecured debt. This issue is
a secured bond, and therefore has a higher seniority ranking. A change of control put
protects lenders by requiring the borrower to buy back its debt in the event of an
acquisition. A limitation on liens limits the amount of secured debt that a borrower can
carry. Both covenants reduce the credit risk of the issue.

106. Ronald McDonald, CFA, is analyzing a client’s fixed income portfolio. As of the end of the last
quarter, the portfolio had a market value of $7,545,000 and a portfolio duration of 6.24. McDonald
is predicting that the yield for all of the securities in the portfolio will decline by 25 basis points next
quarter. If McDonald‘s prediction is accurate, the market value of the portfolio:

A. will increase by approximately $117,700

B. will increase by approximately 6.24%
C. at the end of the next quarter will be approximately $7,427,300

Correct answer is A

A portfolio’s duration can be used to estimate the approximate change in value for a
given change in yield. A critical assumption is that the yield for all bonds in the portfolio
change by the same amount, known as a parallel shift. For this portfolio the expected
change in value can be calculated as: $7,545,000 × 6.24 × 0.0025 = $117,702. The
decrease in yields will cause an increase in the value of the portfolio, not a decrease.

107. A $1,000 face, 10-year, 8.00% semi-annual coupon, option-free bond is issued at par (market rates
are thus 8.00%). Given that the bond price decreased 10.03% when market rates increased 150 basis
points (bp),if market yields decrease by 150 bp, the bond's price will:

A. decrease by more than 10.03%

 Mock Test 1 – CFA Level I

B. increase by 10.03%
C. increase by more than 10.03%

Correct answer is C

Because of positive convexity, (bond prices rise faster than they fall) for any given
absolute change in yield, the increase in price will be more than the decrease in price for
a fixed-coupon, noncallable bond. As yields increase, bond prices fall, and the price
curve gets flatter, and changes in yield have a smaller effect on bond prices. As yields
decrease, bond prices rise, and the price curve gets steeper, and changes in yield have a
larger effect on bond prices. Here, for an absolute 150bp change, the price increase
would be more than the price decrease.

108. Adjusting for convexity improves an estimated price change for a bond compared to using duration
alone because:

A. the slope of the price/yield curve is not linear

B. it measures the volatility of non-callable bonds
C. the slope of the callable bond price/yield curve is backward bending at high
interest rates

Correct answer is A

Modified duration is a good approximation of price changes for an option-free bond only for
relatively small changes in interest rates. As rate changes grow larger, the curvature of the bond
price/yield relationship becomes more prevalent, meaning that a linear estimate of price changes
will contain errors. The modified duration estimate is a linear estimate, as it assumes that the
change is the same for each basis point change in required yield. The error in the estimate is due to
the curvature of the actual price path. This is the degree of convexity. If we can generate a measure
of this convexity, we can use this to improve our estimate of bond price changes.

ALTERNATIVE INVESTMENTS

109. Which of the following most appropriately describes merger arbitrage?

a. Buy shares of the firm acquired and short the shares of acquiring firm
b. Buy shares of acquiring firm and short the shares of acquired firm
c. Buy shares of both the acquiring firm and the acquired firm

Solution: (a) The shares of the firm acquired tend to be undervalued. Also, the shares of acquiring firms
tend to attain a lower market price after the acquisition. Hence, a short position for them will be
valuable. Also, ‘seller’ knows more about the asset than the ‘buyer’ and hence, a ‘seller’ is generally a
net beneficiary of the transaction.
 Mock Test 1 – CFA Level I

110. Which of the following is most likely a characteristic of seed stage in the life of a firm?
a. The sources of investment are mostly individuals
b. The sources of investments are venture capital firms who invest mainly through
ordinary or convertible preferred shares
c. Investments are made to fund initial commercial production and sales

Solution: (b) The ‘idea’ stage of the firm’s life is a very early stage and is mainly funded by individuals
rather than venture capital funds. These investments are known as angel investments. In the seed stage,
venture capital funds make initial investments, through ordinary or convertible preferred shares. Finally,
initial commercial production and sales occur in the early stage.

111. The fees charged by a mutual fund at the time of redemption is called

A: Distribution fee
B: Front-end load
C: Back-end load

Sol. C. The fees charged by a mutual fund at the time of redemption is called back-end load.

112. The price of a unit of a closed-end fund is

A: equal to market value of assets – liabilities divided by number of units outstanding.

B: determined in the secondary market
C: equal to book value of assets – liabilities divided by the number of units outstanding.

Sol. B. The price of a unit of a closed-end fund is determined in the secondary market.

113. A stable-value fund would most likely:

A: mimic its benchmark index.

B: invest in short-term government securities.
C: invest in value stocks.

Sol. B.invest in short-term government securities.

A stable-value fund invests in short-term government securities or other securities that offer
fixed-rate of return & timely repayment of principal.
 Mock Test 1 – CFA Level I

114. Which of the following is not a primary advantage of ‘the in-kind’ redemption process of
ETFs?

A: provides more diversification.

B: reduces tax bill
C: keeps the market price of the shares of ETF close to NAV & avoids large premium or discount.

Sol. A.Provides more diversification.

The ‘in-kind’ redemption process does not affect the diversification of the ETF.

PORTFOLIO MANAGEMENT

115. A portfolio consists of Galaxy Inc. & Neptune Inc. 40% of funds are invested in Galaxy
while remaining is invested in Neptune.The correlation between them is 0.6. Standard deviation
of Galaxy & Neptune is 15% & 20% respectively.

Calculate the standard deviation of the portfolio.

A: 18.23%

B: 16.32%

C: 14.94%

Sol. B

Std. dev. of portfolio

= {(w1)2 (σ 1)2 + (w2)2 (σ 2)2 + 2 w1 w2 σ 1 σ 2 ρ} 0.5

= {(0.4)2(0.15)2 + (0.6)2(0.2)2 + 2(0.4) (0.6) (0.15) (0.2) (0.6)} 0.5

= {0.0036 + 0.0144 + 0.00864} 0.5

= {0.02664} 0.5

= 16.32%

116. Which of the following is the first step in the portfolio management process?

A: Forecasting the economic conditions

 Mock Test 1 – CFA Level I

B: Developing the investment strategy

C: Framing the policy statement

Sol. C

The first & foremost step in portfolio management process is framing the policy statement of the
portfolio which highlights the goals &constraints of the investor.

117. Which of the following portfolio will not lie on the efficient frontier?

Portfolio Expected Return Standard Deviation

A 21% 27%

B 25% 26%

C 12% 15%

D 8% 13%

E 10% 15%

F 8% 14%

A: A, C & F

B: A, E & F

C: B, D & E

Sol. B. Portfolio A, E & F will not lie on the efficient portfolio.

Portfolio A will not lie on the efficient frontier because its risk is higher than Portfolio B but has a lower
return.

Portfolio E will not lie on the efficient frontier because it has the same risk as Portfolio C but offers a
lower return.

Portfolio F will not lie on the efficient frontier because it offers the same return as Portfolio D but has a
higher risk.

118. Following is the information given on two stocks, Uranium Inc. & Plutonium Inc.

 Standard Deviation of Uranium’s Returns = 26%

 Mock Test 1 – CFA Level I

 Standard Deviation of Plutonium’s Returns = 35%

 Covariance between the two stocks = 0.091

119. You can use only these two stocks to construct a portfolio. Which of the following
portfolios will result in a minimum variance portfolio?

A: 100% in Uranium & 0% in Plutonium

B: 50% in Uranium & 50% in Plutonium

C: 75% in Uranium & 25% in Plutonium

Sol. A. 100% in Uranium

First we will calculate the correlation coefficient between the two stocks to see whether there will be
any diversification benefit.

R uranium, plutonium = Covariance uranium, plutonium / [(σ uranium) x (σ plutonium)]

= 0.091/ (0.26) x (0.35)

=1

Since the stocks are perfectly positively correlated, there are no diversification benefits. Hence we select
the stock with the lowest risk i.e. Uranium. The other two combinations will generate a risk higher than
100% Uranium portfolio.

120. An investor’s optimal portfolio lies at the point where

A: Investor’s utility curve intersects the efficient frontier

B: Investor’s highest utility curve is tangent to the efficient frontier

C: Investor’s lowest utility curve is tangent to the efficient frontier

 Mock Test 1 – CFA Level I

Sol. B. An investor’s optimal portfolio lies at the point where his highest utility curve is tangent to the
efficient frontier.