CFA Level I June 2010 - Mock Exam Questions
1. Which of the following least likely violates Standard VII (B): Reference to CFA Institute, the CFA Designation and the CFA Program? A. Joe Smith, C.F.A. B. Joe Smith, CFA C. Joe Smith, Chartered Financial Analyst

Answer: C   According to Standard VII (B), an analyst must not exaggerate the meaning or implications of membership of CFA Institute, holding the CFA designation, or candidacy in the CFA Program. A member cannot use a bold or larger font for the letters CFA.

2. Which of the following is least likely a characteristic of GIPS? A. The investment management firm must define the entity that claims compliance. B. All fee-paying discretionary portfolios are required to be included in composites defined according to a similar strategy or investment objective. C. After presenting 5 years of compliant history, a firm must add annual performance each year going forward up to a maximum of 10 years.

Answer: C A firm is initially required to present at least five years of compliant history and must add annual performance each year going forward up to 10 years at a minimum.

3. A rock band plans to visit 15 cities all over the world in one year. They will visit 3 of these 15 cities in January. The number of possible combinations of venues for January is closest to: A. 455 B. 2,730 C. 45 Answer: A The order in which the three cities are visited during January is not important so we use the combinations formula.

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15

C3 

15! = 455 (15  3)!(3!)

4. Which of the following tests is most likely used when testing the variance of a single normally distributed population? A. T-test B. Chi-square test C. F-test Answer: B. The chi-square test is used to test the variance of a single normally distributed population.

5. For a two-tailed hypothesis test, the p-value is given as 0.04. At the 5% level of significance, the null hypothesis will most likely be: A. Rejected B. Not rejected C. Accepted. Answer: A.  The p-value is the lowest level of significance at which the null hypothesis can be rejected. At the 5% significance level the null hypothesis will be rejected as the significance level of the test is greater than the p-value (4%). We can only reject or fail to reject the null hypothesis in a hypothesis test. The null is never ‘accepted’.

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6. Consider the following statements: Statement 1: The MRP of labor for a firm that is a price taker remains constant at all output levels. Statement 2: The MRP of labor for a firm that is a price searcher rises as it expands output. Which of the following is most likely? A. Both statements are correct B. Both statements are incorrect C. Only Statement 1 is correct. Answer: C

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A firm that is a price-taker faces a perfectly elastic demand curve. Since the price of its output remains constant, MRP remains constant as well. A firm that is a price-searcher faces a downward-sloping demand curve for its output. Since MR is less than price, the MRP of each additional unit of labor falls as output expands.

7. The imposition of which of the following by the government is least likely to result in a deadweight loss from underproduction? A. Taxes B. Quotas C. Subsidies Answer: C   Taxes and production quotas result in deadweight losses from underproduction. Subsidies result in deadweight losses from overproduction.

8. Consider the following two statements: Statement 1: The more effectively a monopoly can price discriminate the greater the deadweight loss to society. Statement 2: Perfect competition results in an efficient allocation of resources and an efficient scale of production. Which of the following is most likely? A. Both statements are incorrect B. Only Statement 1 is correct C. Only Statement 2 is correct. Answer: C   Statement 2 is correct. The more perfectly a monopoly can price discriminate, the lower the deadweight loss to society. Under perfect price discrimination, the monopoly’s MR curve equals its demand curve, and there is no deadweight loss to society. Bear in mind however, that in this scenario the entire consumer surplus is taken up by the monopoly.

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9. An analyst obtains the following financial ratios for a company: Net profit margin Return on assets Asset turnover Financial leverage ratio 15% 20% 1.33 1.5

The return on equity for this company is closest to: A. 30% B. 40% C. 20% Answer: A ROE = NP margin * Asset TO * Financial leverage ratio 0.15 * 1.33 * 1.5 = 0.2993 = 30%

10. In the year of lease inception, recognition of a lease as an operating lease as opposed to a direct-financing lease by the lessor will most likely result in a higher: A. Net income B. Total debt C. CFO Answer: C In the year of inception, a lessor who recognizes an operating lease as opposed to a direct-financing lease will report:    Lower net income Higher CFO Lower CFI

11. Which of the following provides the best description of the income statement? A. It shows the financial performance of the firm at a certain point in time B. It shows the financial position of the firm over a period of time C. It shows the financial performance of the firm over a period of time. Answer: C

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The income statement shows the financial performance of a firm over a period of time. 12. A company sold a piece of equipment for $10,000. The historical cost of this equipment was $20,000 and accumulated depreciation on the equipment amounted to $8,000. The effect of this transaction alone is most likely that: A. CFO will exceed net income by $2,000 B. Net income will exceed CFO by $2,000 C. CFI will decrease by $10,000. Answer: A Book value of equipment = $20,000 - $8,000 = $12,000 Gain/(loss) on sale = $10,000 - $12,000 = -$2,000 Since the company makes a loss on the sale, CFO will be greater than net income.

13. All other factors remaining the same, a project’s discounted payback period will most likely: A. Be longer than the payback period, and considers cash flows after the discounted payback period has been reached. B. Be shorter than the payback period, and considers cash flows after the discounted payback period has been reached. C. Be longer than the payback period, and does not consider cash flows after the discounted payback period has been reached. Answer: C   The discounted payback period uses discounted cash flows so it is always longer than the payback period. Both the payback and discounted payback period calculations do not consider cash flows after payback has been achieved.

14. The performance of which type of market index can be replicated by investing the same dollar amount in each stock represented in the index? A. Value-weighted index B. Price-weighted index C. Unweighted index Answer: C

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The performance of an unweighted index can be replicated by investing the same dollar amount in each share represented in the index. 15. The theory that individuals invest more funds in ‘losers’ in order to ‘average down’ is explained by: A. Prospect theory B. Escalation bias C. Overconfidence bias Answer: B Escalation bias causes investors to invest more funds in investments that are currently trading at a loss.

16. In a 30-year mortgage, if a mortgage issuer pays back half of the total mortgage balance outstanding within the first year, it is known as a: A. Prepayment B. Refunding C. Curtailment Answer: C  A partial retirement of a mortgage loan is known as a curtailment. A full retirement of the loan is known as a prepayment.

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17. Do the following approaches to bond valuation account for the effects of changes in the shape of the yield curve on bond prices? Full Valuation Yes No No Duration/Convexity No Yes No

A. B. C. Answer: A

The duration/convexity approach only considers parallel changes in the yield curve.

18. Which of the following is least likely an example of a forward commitment? A. A call option B. A futures contract C. An interest-rate swap

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Answer: A An option is an example of a contingent claim. Forwards, futures and swaps are examples of forward commitments. 19. Consider the following statements: Statement 1: When an analyst compares the yield on a financial sector bond with that of an industrial sector bond, she is concerned with the intra-market spread. Statement 2: The credit spread between cyclical and non-cyclical sectors tends to widen with expectations of a worsening economy. Which of the following is most likely? A. Both statements are correct. B. Only Statement 1 is correct C. Only Statement 2 is correct Answer: C  Statement 2 is correct.  When an analyst compares the yield on a financial sector bond with that of an industrial sector bond, she is concerned with the inter-market spread.

20. Consider the following statements: Statement 1: Given that the yield curve is flat, an analyst would arrive at a correct value for an option-free bond if she used the nominal spread. Statement 2: Given that the yield curve is flat, an analyst would be incorrect in using the z-spread to value a callable bond. Which of the following is most likely? A. Both statements are correct. B. Only Statement 1 is correct C. Only Statement 2 is correct Answer: A   When the yield curve is flat, the nominal spread equals the z-spread and therefore, may be used to value bonds with no embedded options. To value a callable bond however, the analyst must use the option adjusted spread.

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21. An analyst gathered the following information regarding a stock: Current market price = $32 Expected dividend at year end = $2 Expected price at year end = $34 Beta = 0.8 Risk-free rate = 5% Equity market risk premium = 8% This stock is most likely A. Undervalued B. Overvalued C. Properly valued Answer: A Expected rate of return = 34 – 32 + 2 = 12.5% 32 Required rate of return = 0.05 + 0.8 (0.08) = 11.4% Since the expected rate of return is greater than the required rate of return, the stock is undervalued.

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