FinQuiz Level1Mock2013Version2JunePMSolutions

CFA Level I Mock Exam 2 Solutions (PM)
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CFA Level I 2nd Mock Exam
June, 2013
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FinQuiz.com 2nd Mock Exam 2013 (PM 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
69-78
Corporate Finance
15
79-90
Equity Investments
18
91-96
Derivative Investments
97-110
Fixed Income Investments
21
111-114
Alternative Investments
115-120
Portfolio Management
Total
180
Questions 1 through 18 relate to Ethical and Professional Standards

1.
Davis Young, a CFA Level II candidate, always consults with the compliance
department and outside legal counsel whenever he is in doubt regarding
disclosure of confidential information of clients. Davis Young can:
A. consult both compliance department and the outside legal counsel.
B. consult the compliance department and cannot consult the outside legal
counsel due to confidentiality of the information.
C. consult the outside legal department and cannot consult the compliance
department.
Correct Answer: A
Reference:
CFA Level I, Volume 1, Study Session 1, Reading 2, Page 24.
One of the recommended procedures for compliance with Standard I (A),
Knowledge of Law, is that, when in doubt, members and candidates should seek
the advice of compliance personnel or legal counsel concerning legal
requirements.
2.
McMillan appeared in CFA Level 1 exam. Two days later, he discussed the
difficulty of the exam with his colleague, particularly the formula tested in area of
Financial Reporting and Analysis. His colleague is neither a candidate of any
CFA level nor has any plans in future to appear in CFA examination. Has
McMillan violated any Code and Standards?
A. Yes, he has violated Standard VII-(A) Conduct as member/candidate in
CFA program
B. No, because his colleague is neither a candidate nor has any plans to
appear in the exam
C. No, because discussing exam afterwards is not a violation
Correct Answer: A
Reference:
According to the Standard VII (A), providing confidential program or exam
information to candidates or the public is a violation.
3.
In an attempt to comply with the CFA Institutes Code and Standards, GreenTech
Inc. has established several policies, which are to be followed by each employee
of the firm. Three of these policies are highlighted below:
I.
II.
III.
All clients participating in a block trade must be charged with the same
execution price and commission. The execution price and commission
may vary based on the block traded.
In absence of local laws, all firm records must be retained for a minimum
of five years in electronic form. Backup of firm records is not required.
Analysts are permitted to use model or actual results in performance
presentation to clients. No disclosures are mandated.
Which of the firms policies least likely comply with the Code and Standards?
A. I and III
B. II and III
C. III only
Correct Answer: B
Reference:
CFA Level I, Volume 1, Study Session 1, Reading 2, Page 72, 81-82 & 117.
Policy I:
The Standards encourage members to formulate policies, which

give all clients accounts participating in a block trade the same
execution price, and charge the same commission (Standard III (B)
Fair Dealing). Policy I complies with this recommendation.
Policy II:
In the absence of local regulation pertaining to record retention, the

CFA Institute encourages members and candidates to retain
records for a minimum of seven years (Standard V(C) Record
Retention). Thus, GreenTech Inc.s second policy violates the
Code and Standards with respect to the period of record retention.
Policy III:
The CFA Institute Code and Standards require members and

candidates to disclose the presence of model or simulated results in
a performance presentation. By not mandating disclosure, the
firms policy is in violation of Standard III (D) Performance
Presentation.
4.
When members and candidates are in an advisory relationship with clients, they
must:
A. judge the suitability of investments in the context of clients total
portfolio.
B. maintain a list of all clients and securities & investments they hold.
C. encourage their firms to develop policies and procedures to test clients
suitability.
Correct Answer: A
Reference:
CFA Level I, Volume 1, Study Session 1, Reading 2, Page 75-78.
The Standards of Professional Conduct require members and candidates to make
investment decisions and recommendations in light of the clients risk and return
objectives. Furthermore when managing portfolios to a particular investment
mandate or style, members and candidates are required to make investment
decisions or recommendations which comply with the given mandate or style
(Standard III (C) Suitability).
Option A is the requirement of this standard and both options B & C are
recommended procedures.
5.
Which of the following situations most likely constitutes a violation of the

Standard I (D) Misconduct?
A. Employee A is currently experiencing a bankruptcy crisis, which has
forced him to sell his personal property and equity investments
B. Employee B was caught cheating during an examination fifteen years ago
while attending a local college
C. Employee C works in an insurance industry and has promised attractive
equity investment returns despite the equity markets experiencing a
cyclical low
Correct Answer: C
Reference:
Members and candidates who comply with Standard I (D) must not engage in any
professional conduct involving dishonesty, fraud, or deceit, or commit any act that
reflects adversely on their professional reputation, integrity, or competence.
Neither bankruptcy crisis nor cheating in a college exam fifteen years ago
constitutes a violation of the Standard.
However, in the case of Employee C, promising unrealistically high equity returns
reflects dishonesty on the part of the employee and is a violation of this Standard.
6.
When using secondary or third-party research as a source of information for

research reports, Standard V (A), Diligence and Reasonable Basis, least likely
requires members and candidates to:
A. review assumptions used and independence and objectivity of the
recommendations.
B. determine the extent of analysis performed.
C. base analysts compensation on the quality of research used.
Correct Answer: C
Reference:
When using secondary or third-party research, Standard V (A), Diligence and
Reasonable Basis, requires members and candidates to:
review the assumptions used;

determine the extent of the analysis;
identify the timeliness of research reports; and
evaluate the independence and objectivity of the recommendations.
7.
Under Standard VII (A), Conduct as Members or Candidates in the CFA Program,
members:
A. violate the Standard if they cheat on the CFA exam.
B. are permitted to state that they were charter-holders for the periods during
which they paid their dues and signed the Professional Conduct Statement
(PCS).
C. are not permitted to make the statement: The CFA Program is a rigorous
program, which is comparable to investment banking programs offered by
other institutes. However relative to other programs, the failure rates of
candidates participating in the CFA Program examinations are quite high.
Correct Answer: A
Reference:
Standard VII (A), Conduct as Members or Candidates in the CFA Program,
requires members and candidates to avoid engaging in any conduct that
compromises the reputation or the integrity, validity, or security of the CFA
examination.
Actions such as cheating on the CFA exam or any other exam constitute a
violation of this Standard.
Although members may only use the CFA charter holder designation as long as
they sign the PCS and pay their dues annually and may state the periods for which
they were charter holders in the past in the event of a failure to fulfill these annual
requirements, such guidelines are governed by Standard VII (B) Reference to
CFA Institute, the CFA Designation, and the CFA Program.
Under Standard VII (A), members and candidates are not prohibited from
expressing their opinions on the CFA Institute or exam program.
8.
Which of the following statements best characterizes GIPS objectives?

A. When a firm advocates itself as GIPS-compliant, then it is mandated to
comply with both required and recommended provisions
B. It is mandated for a firm to comply with both required and recommended
provisions, regardless of its compliance with GIPS
C. A firm is only mandated to comply with the required provisions if the firm
is advocating itself as GIPS-compliant
Correct Answer: C
Reference:
If a firm is advocating itself as GIPS-compliant, then the firm must comply with
the required provisions of GIPS, and it is encouraged to comply with the
recommended provisions.
9.
Which of the following is least likely a section of GIPS standards?

A. Input data
B. Composite calculation
C. Private equity
Correct Answer: B
Reference:
Following are the sections of GIPS standards:
0.
1.
2.
3.
4.
5.
6.
7.
Fundamentals of compliance
Input data
Calculation methodology
Composite construction
Disclosure
Presentation and reporting
Real estate
Private equity
10. George works for a small money market firm. He always allocates clients
partially filled orders equally among them. Thus each customer gets same number
of shares. Has he violated any standards?
A. No
B. Yes, he has violated Fair Dealing
C. Yes, ha has violated Suitability
Correct Answer: B
Reference:
CFA Level I, Volume 1, Study Session 1, Reading 2, Page 70 & 72.
Standard III (B), Fair Dealing, requires members and candidates to deal fairly and
objectively with all clients, and prohibits a preferred treatment given to any client.
Orders for the clients must be executed on a systematic basis that is fair to all
clients. When the full amount of the block order is not executed, members and
candidates should allocate partially executed orders among the participating client
accounts pro rata on the basis of order size. So, Joseph is in violation of Fair
Dealing.
11. Tom Ashley was working in the research department of Miller Inc. where he
signed a non-compete agreement. He left the firm, copied all the material he
prepared during his job, and started working with a competitor of Miller Inc. Has
he violated loyalty with employer?
A. Yes, by copying the material
B. Yes, by applying his knowledge at the competitive firm
C. Yes, both by copying the material and applying his knowledge at the
competitive firm
Correct Answer: C
Reference:
Except with the consent of their employer, departing employees may not take
employers property, which includes books, records, reports, and other materials,
and may not interfere with their employers business opportunities. Taking any
employer records, even those prepared by the member or candidate, violates
Standard IV (A).
Members and candidates are free to use public information about their former
firm after departing without violating Standard IV (A), absent a specific
agreement not to do so.
Since Tom has signed a non-compete agreement with his former client, he has
violated the Standard IV (A), Loyalty, not only by copying the material, but also
by applying his knowledge and serving the new competitive firm.
12. Which of the following Standards require investment advisors to consider clients
needs and circumstances when making investment recommendations?
A. Standards III (D)-Performance Presentations
B. Standard III (A)-Fair Dealing
C. Standard III (C)-Suitability
Correct Answer: A
Reference:
CFA Level I, Volume 1, Study Session 1, Reading 2, Page 61-65 & 75-76.
Both Standards III (A), Loyalty to Clients, and III (C), Suitability, require
investment advisors to consider clients individual needs and circumstances when
determining the appropriateness/suitability of an investment to the clients
portfolio.
13. In the event of an above-average portfolio performance, Irving Zimmermans
largest client has promised him a trip to Central Europe. Client promised him to
fund accommodation, flight fare, and tourist activities.
In context of the trip offered by his client, Zimmerman should most likely:
A. decline the offer.
B. disclose the offer to his compliance officer in writing.
C. make an oral disclosure to his compliance officer.
Correct Answer: B
Reference:
The CFA Institute Standards of Professional Conduct permit members and
candidates to accept gifts, benefits, or any form of consideration, from clients as
long as the reward does not lead to the member or candidate favoring the client,
providing the reward, over others. Standards also require proper disclosure to be
provided to the members supervisor to comply with Standard I (B) Independence
and Objectivity. Zimmerman may accept the offer if written disclosure is
provided to his supervisor.
14. Which of the following scenarios, highlighted in Exhibit 1, if left undisclosed,

most likely constitute a violation of Code and Standards?
Exhibit 1
Firm Scenarios
Scenario
Details
Irvin Bishop is serving Asset Inc. as head of
investment management. Bishop has been offered
to serve as an investment committee head at
Wiseon Securities. His new job requires Bishop
attend committee meetings twice a week.
Stevenson Brokerage establishes an arrangement
with Allen Associates, which involves purchasing
research from Allen Associates in exchange for
Stevenson Brokerage referring client-accounts
whose value exceeds $0.5 million to Allen
Associates.
While providing investment advice to one of her
high-net-worth clients, Delilah Francis uncovers
that 20% of clients portfolio funds were used for
drug trafficking.
A. A, B, and C
B. A and B only
C. B and C only
Correct Answer: A
Reference:
CFA Level I, Volume 1, Study Session 1, Reading 2, Page 84-85, 118-121 & 130.
Scenario A:
Standard VI (A), Disclosure of Conflicts, requires members and candidates to
disclose all actual and potential conflicts of interest that may impair their
independence or objectivity or interfere in their respective duties to current
clients, prospective clients, or to their employers.
Bishop is required to provide adequate disclosure to his employer regarding the
potential job offer. Serving as the investment committee head at Wiseon
Securities may conflict with his portfolio management responsibilities at Asset
Inc., and requires disclosure accordingly.
Scenario B:
Standard IV (C), Referral Fees, requires members and candidates to disclose to
their employers, clients, and prospective clients, as appropriate, any compensation
and consideration or benefit received by, or paid to, others for the
recommendation of products and services.
A failure to disclose the existence of the referral arrangement by either of the two
firms in question will constitute a violation of the Code and Standards.
Scenario C:
Standard III (E), Preservation of Confidentiality, requires members and
candidates to keep all information about a client confidential unless the
information pertains to illegal activities on part of the client, disclosure is
mandated by law, or client permits disclosure. A failure to disclose the use of a
proportion of portfolio funds for drug trafficking (illegal activities) to the
supervisor, at a minimum, will violate this Standard.
15. The CFA Institute Code and Standards least likely require compliance procedures
to:
A. assign duties among supervisors.
B. ensure that the designated compliance officer is equipped with the
appropriate resources to implement the compliance program on a firmwide scale.
C. maintain restricted, watch, and rumor lists.
Correct Answer: C
Reference:
Compliance procedures should, amongst other features:
describe the hierarchy of supervision and assign duties among supervisors;

designate a compliance officer whose authority and responsibility are clearly
defined, and who has the necessary resources and authority to implement the
firms compliance procedures.
10
16. Which of the following situations least likely constitutes a violation of CFA
Institute Code and Standards?
A. Senior Researcher obtained information concerning a potential merger
deal pertaining to an issuer company covered by him, which is yet to be
publically released. The researcher disclosed this information to his
supervisor and compliance department
B. Mark Greer recently passed Level II exam of the CFA Program and does
not intend to appear for the Level III examination for at least three years.
Greer identifies himself as an active candidate of the CFA Program
C. Portfolio Manager allocates oversubscribed IPO shares to suitable nonfamily client accounts prior to family client accounts to avoid the
appearance of a conflict
Correct Answer: A
Reference:
CFA Level I, Volume 1, Study Session 1, Reading 2, Page 47-51, 125-126 & 139140.
Standard II (A), Material Non-Public Information, prohibits members and
candidates from trading on, or causing others to trade on, material non-public
information that could affect the value of the security. Managers should make
reasonable efforts to make material non-public information public by encouraging
the issuer company to publically disclose the information. In the event public
disclosure is not possible, the member or candidate should make disclosures to its
supervisor and compliance department, and not take investment action based on
the information. Thus, the handling of information on the potential merger deal by
the Portfolio Manager complies with this Standard.
According to Standard VII (B), Reference to the CFA Institute, the CFA
Designation, and the CFA Program, a person is a candidate if:
the persons application for registration in the CFA Program has been
accepted by the CFA Institute and the person is enrolled to sit for a specific
examination; or
the registered person has sat for a specific exam and the exam results have not
yet been received.
Individual is no longer considered an active candidate who decline to sit for an

examination or does not meet the above requirements, By not sitting/being
11
enrolled for the Level III exam for at least three years, Greer has violated this
Standard by referring to himself as an active candidate.
Standard VI (B), Priority of Transactions, requires members and candidates to
place transactions of clients and employer in priority to transactions in which the
member or candidate is the beneficial owner. Alongside this requirement, family
accounts, which are client accounts should be treated like any other client
accounts, and should not be treated unfairly. By allocating the oversubscribed
IPOs to non-family client accounts prior to an allocation to family accounts,
Portfolio Manager has violated this Standard.
17. A member or candidate fails to fulfill his/her duty of loyalty, prudence, and care
to existing and prospective clients if (s)he:
A. discloses its proxy voting policies to existing and prospective clients.
B. uses client brokerage to purchase research relevant to securities held in the
member/candidates portfolio.
C. directs trade to a particular broker, as requested by clients, which provides
average execution while disclosing the fact that such arrangements may
not result in the best transaction price or execution for the client directing
the trade.
Correct Answer: B
Reference:
Standard III (A), Loyalty, Prudence, and Care, requires members to have a duty of
loyalty with clients, and exercise independent and prudent judgment. Members
and candidates fulfill this responsibility if they (amongst other responsibilities):
disclose the proxy voting policies;

use client brokerage to benefit the client and not to fulfill personal or nonclient related purposes;
disclose to clients wishing to direct trades to a particular broker that such an
arrangement may not provide the best price and execution. Nevertheless,
members and candidates have the responsibility to seek out the best price and
execution.
12
18. According to the Global Investment Performance Standards (GIPS),

noncompliant data can be presented for any tenure if the data belongs to a period
most likely before:
A. January 1, 2000.
B. January 1, 2005.
C. January 1, 2006.
Correct Answer: A
Reference:
The noncompliant data can be presented for any tenure if the data belongs to a
period before January 1, 2000.
13
Questions 19 through 32 relate to Quantitative Methods

19. The trimmed mean is most likely computed by:
A. reducing the arithmetic mean by a small percentage.
B. excluding a stated small percentage of lowest and highest values and then
recalculating the arithmetic mean of remaining values.
C. excluding values in sample close to the arithmetic mean and then
recalculating the arithmetic mean of the remaining values.
Correct Answer: B
Reference:
Trimmed mean is computed by excluding a stated small percentage of lowest and
highest values, and then recalculating the arithmetic mean of the remaining
values.
20. Interquartile range is a difference between:
A. third and first quartiles of a dataset.
B. any two quartiles of a dataset.
C. first and last quartiles of a dataset.
Correct Answer: A
Reference:
Interquartile range (IQR) focuses on middle rather than the extreme quartiles. IQR
is a difference between third and first quartiles of a dataset: IQR = Q3 Q1.
IQR represents length of the interval containing the middle 50% of the data with a
larger interquartile range indicating greater dispersion, all else equal.
14
21. Which of the following is least likely correct regarding variance and covariance?
A. Variance of a random variable with itself is its Covariance
B. Correlation is a number between 1 & +1 for two random variables
C. A correlation of zero indicates an absence of any linear relationship
between two variables
Correct Answer: A
Reference:
Covariance of a random variable with itself is its Variance

Correlation is a number between 1 & +1 for two random variables
A correlation of zero indicates an absence of any linear relationship between
two variables
22. A project should only be accepted if net present value of its future cash flows is:
A. zero or greater than zero and required rate of return is greater than IRR.
B. greater than zero, irrespective of IRR value.
C. greater than zero and the IRR is higher than the required rate of return.
Correct Answer: C
Reference:
A company should only accept projects that add value for its shareholders. A
project will have positive NPV only when the IRR is higher than the investors
required rate of return. Option B is not theoretically possible.
23. The mean return of a portfolio is 0.87% and std. deviation of monthly returns is
3.45% for 54 monthly observations. According to Chebyshevs inequality, end
points of the interval that must contain at least 75% of monthly returns are closest
to:
A. 2.58 +4.32.
B. 4.89 +6.63.
C. 6.03 +7.77.
15
Correct Answer: C
Reference:
According to Chebyshevs inequality, at least 75% of the observations must lie
within two standard deviations from the mean.
0.87% 2 3.45% = 6.03 + 7.77
24. If quoted annual interest rate on a security is 10%, effective annual rate assuming
semiannual compounding will be closest to:
A. 5.00%.
B. 10.00%.
C. 10.25%.
Correct Answer: C
Reference:
EAR = (1 + i/m)m 1
where
m = number of compounding periods
i = annual interest rate
0.10 !
EAR = 1 +
1
2
EAR = (1 + 0.05)21
EAR = 1.1025 1
EAR = 10.25%.
25. The measure used to describe a characteristic of a population is most likely known
as:
A. sample statistic.
B. inferential statistic.
C. parameter.
16
Correct Answer: C
Reference:
A measure used to describe a characteristic of a population is known as
parameter. Some of the most commonly used parameters are mean returns and
their standard deviations.
Sample statistic is similar to parameter, but it is used to describe a characteristic
of a sample dataset.
26. The term free float adjusted means that the weights of companies in index most
likely reflect value of shares:
A. actually available for investment.
B. that are restricted to be traded.
C. that are trading ex-dividend.
Correct Answer: A
Reference:
The term free float adjusted means that the weights of companies in the index
reflect the value of the shares actually available for investment.
27. Which one of the following is most suitable mean in the cost averaging
investment strategy?
A. Geometric mean
B. Arithmetic mean
C. Harmonic mean
Correct Answer: C
Reference:
Cost averaging is an investment strategy involving periodic investments of fixed
amount of money. Harmonic mean is appropriate when averaging ratios and these
ratios are repeatedly applied to a fixed quantity to yield a variable number of
17
units. In cost averaging, the ratios to be averaged are prices per share at the date
of the purchase, and then apply those prices to a constant amount of money to
yield a variable number of shares.
28. The conditional probability of an event may be:
A. equal to or less than the unconditional probability.
B. greater or less than the unconditional probability, but never equal.
C. greater than, equal to, or less than the unconditional probability.
Correct Answer: C
Reference:
The conditional probability of an event may be greater than, equal to, or less than
the unconditional probability, depending on the facts. For example, the
probability that the stock earns a return above the risk-free rate, given that the
stock earns a negative return, is 0.
29. When the mean or variance of a time series is not constant through time, the time
series is:
A. covariance stationary.
B. non-stationary.
C. stationary-in-time.
Correct Answer: B
Reference:
When the mean or variance of a time series is not constant through time, the time
series is said to be non-stationary.
18
30. Which of the following is not a property of Central limit theorem for
distribution of sample mean, as long as sample size is large?
A. Distribution of sample mean will be approximately normal
B. Distribution mean will be equal to population mean from which samples
are drawn
C. Variance of distribution of sample mean will be equal to variance of
population mean
Correct Answer: C
Reference:
According to central limit theorem the distribution of sample mean has following
properties, as long as sample mean is large.
Distribution of sample mean will be approximately normal

Distribution mean will be equal to population mean from which samples are
drawn
Variance of distribution of sample mean will be equal to variance of
population mean.
31. Descriptive statistics are used to:

A. explain important characteristics of large datasets.
B. summarize important characteristics of large datasets.
C. make forecasts, estimates, or judgments about a large set of data on the
basis of statistical characteristics of a smaller dataset.
Correct Answer: B
Reference:
Descriptive statistics are used to summarize the important characteristics of large
datasets.
19
32. If Project A and Project B are mutually exclusive and Project A has a higher NPV
than Project B, we should most likely:
A. reject Project A if its IRR is lower than the Project Bs IRR.
B. accept Project A even if its IRR is lower than the Project Bs IRR.
C. accept Project A only if its IRR is higher than the Project Bs IRR.
Correct Answer: B
Reference:
When two projects are mutually exclusive and the NPV and IRR are in conflict,
the decision to accept one project should be based on both projects net present
values. The project with the higher net present value should be accepted even if it
has a lower IRR as compared to the other project.
20
Questions 33 through 44 relate to Economics

33. Which of the following least accurately describes an unemployed person?
A. A person who is available to work and has actively searched for work in
the last four weeks
B. A person who is available to work and has been laid off from a job and is
waiting to be recalled
C. A person who is available to work and will start a new job in the next 90
days
Correct Answer: C
Reference:
A person who is not working is considered to be an unemployed person if he is
available to work and:
1. has actively searched for work in the last four weeks, or
2. has been laid off from a job and is waiting to be recalled, or
3. will start a new job in the next 30 days.
34. Which of the following is least likely a component of aggregate demand?
A. Consumption
B. Investment
C. Savings
Correct Answer: C
Reference:
The components of aggregate demand are:
1.
2.
3.
4.
Consumption.
Investment.
Government spending.
Net exports (Exports Imports).
21
35. Which of the following is least likely a type of inflation?

A. Cost-push inflation
B. Demand-pull inflation
C. Cost-pull inflation
Correct Answer: C
Reference:
CFA Level I, Volume 2, Study Session 5, Reading 18, Page 314-315
The two types of inflation are:
1. Cost-push inflation:
Inflation due to a decrease in aggregate supply caused by an increase in the
real price of an important factor of production.
2. Demand-pull inflation:
Inflation due to an increase in the aggregate demand caused by an increase in
the money supply, increased government spending, increased consumption,
etc.
36. Which of the following statements is most accurate assuming marginal product to
be at its maximum level?
A. Marginal cost is at its maximum level, average product is increasing, and
average variable cost is increasing
B. Marginal cost is at its minimum level, average product is decreasing, and
average variable cost is decreasing
C. Marginal cost is at its minimum level, average product is increasing, and
average variable cost is decreasing
Correct Answer: C
Reference:
When the marginal product is at its maximum level, marginal cost is at its
minimum level, average product is increasing, and average variable cost is
decreasing.
22
37. The marginal cost curve intersects the average variable cost curve and the average
total cost curve at their:
A. minimum points.
B. minimum and maximum points, respectively.
C. maximum and minimum points, respectively.
Correct Answer: A
Reference:
The marginal cost curve intersects the average variable cost curve and the average
total cost curve at their minimum points.
38. Which of the following is least likely to be a condition for price discrimination to
work?
A. Sellers must face a downward-sloping demand curve
B. Sellers must have at least one identifiable group of customers in addition
to the existing identified group
C. Sellers must be able to prevent the customers paying the higher price from
reselling the product to the customers paying the lower price
Correct Answer: C
Reference:
For price discrimination to work, sellers must:
face a downward-sloping demand curve;

have at least one identifiable group of customers in addition to the existing
identified group;
be able to prevent the customers paying the lower price from reselling the
product to the customers paying the higher price.
23
39. Which of the following most accurately characterizes oligopoly?

A. Small number of sellers, independence among competitors, significant
barriers to entry, and similar products
B. Small number of sellers, independence among competitors, significant
barriers to entry, and differentiated products
C. Small number of sellers, independence among competitors, significant
barriers to entry, and similar or differentiated products
Correct Answer: C
Reference:
An oligopoly is characterized by the following:
1.
2.
3.
4.
Small number of sellers.

Independence among competitors.
Significant barriers to entry.
Similar or differentiated products.
40. Cyclical unemployment is most likely expected to increase when the real GDP:
A. falls below potential GDP.
B. rises above potential GDP.
C. equals potential GDP.
Correct Answer: A
Reference:
Cyclical unemployment increases when real GDP falls below potential GDP. On
the contrary, when the real GDP rises towards and beyond the potential GDP,
cyclical unemployment decreases.
24
41. Money supply multiplied by average number of times per year each dollar is used
to buy goods and services equals:
A. real GDP.
B. nominal GDP.
C. velocity.
Correct Answer: B
Reference:
According to the equation of exchange,
MV = PY
where
M = Money supply
V = Velocity
P = Price
Y = Real output
Velocity is the average number of times per year each dollar is used to buy goods
and services.
Multiplying money supply with the velocity is the left-hand side of the equation
of exchange and it equals the nominal GDP.
42. During an inflationary environment, fiscal policy can be used to smooth the
economic cycle by:
A. increasing taxes and/or reducing government spending.
B. increasing taxes and/or increasing government spending.
C. decreasing taxes and/or increasing government spending.
Correct Answer: A
Reference:
During an inflationary environment, the government can use the fiscal policy to
tame inflation by increasing taxes and/or reducing government spending.
25
43. If total cost of producing 8 additional units increases to $40 from an initial value
of $30, marginal cost of producing the additional units is closest to:
A. $1.25.
B. $3.75.
C. $5.00.
Correct Answer: A
Reference:
Marginal cost =
Marginal cost =
!"#$%& !" !"!#$ !"#$

!"#$%& !" !"!"# !"#$%&'$
$"#!$"#
!
= $1.25.
44. Marginal product of capital is an increase in output from using one additional unit
of capital holding:
A. revenue constant.
B. quantity of labor constant.
C. impact of macroeconomic variables constant.
Correct Answer: B
Reference:
Marginal product of capital is an increase in output from using one additional unit
of capital, holding quantity of labor constant.
26
Questions 45 through 68 relate to Financial Statement Analysis

45. Cassandra Martin, CFA, an analyst at C&B Securities makes the following
statements regarding Installment sales method:
Installment sales method can be used when:
i.
ii.
iii.
seller retains risks and rewards of property

buyer lacks ability to complete the transaction
date of title transfer varies from the date of vested interest
Under IFRS which of the above mentioned facts are most likely correct?
A. i only
B. ii and iii
C. i, ii and iii
Correct Answer: C
Reference:
All three facts made by Martin regarding installment sales methods are correct.
The installment sales method can be used when the seller retains the risks and
rewards of the property.
The installment sales method can be used if the buyer lacks the ability to complete
the transaction.
It can be used if the date of title transfer varies from the date of vested interest.
46. Smiley Foods Company purchased a food-processing machine costing $49,000.
Expected salvage value of machine is $4,000, and its expected useful life is five
years. Using double-declining balance method, depreciation expense for year 3 is
closest to:
A. $7,060.
B. $9,000.
C. $19,600.
27
Correct Answer: A
Reference:
Year 1:
($49,000)(2/5) = $19,600
Year 2:
($49,000 $19,600)(2/5) = $11,760
Year 3:
($49,000 $19,600 $11,760)(2/5) = $7,056
47. Which of the following statements is most likely correct?
A. Working capital and leverage ratios are lower for assets purchased under
capital lease
B. Asset turnover, total liabilities, and operating income are higher for assets
purchased under capital lease
C. Current ratio and cash flow from financing activities are higher for assets
purchased under operating lease
Correct Answer: C
Reference:
CFA Level I, Volume 3, Study Session 9, Reading 32, Page 506, 509 & 520.
Working capital and asset turnover ratios are lower for assets purchased under the
finance lease; however, leverage, total liabilities, and operating income are higher
for these assets.
Current ratio and cash flow from financing activities are higher for assets
purchased under the operating lease.
28
48. Neon Light Inc, has the following production and cost data:
Production
Normal capacity
Actual production
90,000 units
63,000 units
Cost
Raw material
Conversion cost
Carriage inward
Fixed overhead
Warehouse cost
Abnormal waste
$160,000
$500,000
$160,000
$1,000,000
$170,000
$150,000
Capitalized per-unit cost and total cost charged to the income statement is closest
to:
A. $24.13 and $620,000, respectively.
B. $28.89 and $320,000, respectively.
C. $31.59 and $150,000, respectively.
Correct Answer: A
Reference:
Capitalized cost per unit
Raw material
$160,000
Conversion cost
$500,000
Carriage inward
$160,000
Fixed overhead
$700,000
Total capitalized cost $1,520,000
Actual production
63,000 units
Per unit cost
$24.13
($1,000,000 63,000/90,000)
Charged to the Income Statement

Fixed overhead
$300,000
Warehouse cost
$170,000
Abnormal waste
$150,000
Total
$620,000
29
49. Which of the following ratios will be least affected by inventory cost flow
assumption adopted by a company?
A. Asset turnover ratio
B. Quick ratio
C. Debt-to-equity ratio
Correct Answer: B
Reference:
Quick ratio = (Current assets Inventory)/ Current liabilities
As inventory is eliminated from numerator in quick ratio, it is not affected by any
cost flow assumption adopted.
50. Bright Enterprises (BE) has a history of providing its top executives with
competitive compensation packages and stock option plans. BE is a large
company with high capital requirements that are met through issuing common
stock, bonds, preferred stock and convertible bonds.
Given the information about Bright Enterprises, the companys basic earnings per
share will most likely be:
A. greater than its diluted EPS.
B. less than its diluted EPS.
C. equal to its diluted EPS.
Correct Answer: A
Reference:
Diluted EPS is calculated using diluted sharesnumber of shares that would be
outstanding if potentially dilutive claims on common shares were exercised by
their holders. Since BE has issued stock options to its upper management and has
also issued convertible bonds, its dilutive shares will be greater than current
number of shares outstanding. This will result in diluted EPS to be lower than the
basic EPS.
30
51. Amigo Inc. purchased intangible assets and reported them on balance sheet at
their cost less accumulated amortization. This treatment is most appropriate
under:
A. IFRS only.
B. U.S. GAAP only.
C. Both IFRS and U.S. GAAP.
Correct Answer: C
Reference:
Under both IFRS and U.S. GAAP, intangible assets purchased are reported on
balance sheet at their cost less accumulated amortization. However, upward
revaluations of intangible assets are not permitted under U.S. GAAP.
52. Which of the following relationship is most likely correct?
Deferred Tax Liability
A. Income tax expense > Taxes Payable
B. Income tax expense < Taxes Payable
C. Income tax expense > Taxes Payable
Deferred Tax Asset

Income tax expense = Taxes Payable
Income tax expense > Taxes Payable
Income tax expense < Taxes Payable
Correct Answer: C
Reference:
Deferred tax liability arises when the income tax expense is greater than taxes
payable.
Deferred tax asset arises when the taxes payable are greater than income tax
expense.
31
53. Which of the following is most likely correct regarding treatment of bond issuance
costs?
A. Under IFRS, issuance costs are included in measurement of liability,
whereas under U.S. GAAP, issuance costs are capitalized as an asset
B. Under U.S. GAAP, issuance costs are included in measurement of
liability, whereas under IFRS, issuance costs are capitalized as an asset
C. Under both U.S. GAAP and IFRS, issuance costs are capitalized as an
asset
Correct Answer: A
Reference:
Under IFRS, issuance costs are included in measurement of liability, and
increases effective interest rate.
Under U.S. GAAP, issuance costs are capitalized as an asset, and are allocated
over the term of the bond.
54. A lease is treated as a finance lease under U.S. GAAP if:
A. lease contains an option to purchase the asset cheaply.
B. lease term is 90% or more of the useful life of leased asset.
C. present value of lease payments is 70% or more of the fair value of leased
asset.
Correct Answer: A
Reference:
CFA Level I, Volume 3, Study Session 9, Reading 32, Page 506
A lease is treated as a finance lease under U.S. GAAP if at least one of the
following criteria is satisfied:
Ownership of the leased asset is transferred to the lessee at the end of the lease
term.
The lease contains an option to purchase the asset cheaply (a bargain purchase
option).
The lease term is 75% or more of the useful life of the leased asset.
32
The present value of the lease payments is 90% or more of the fair value of
the leased asset.
55. The amount at which an asset could be exchanged is most likely known as:
A. realizable value.
B. fair value.
C. current cost.
Correct Answer: B
Reference:
Fair value is the amount at which an asset could be exchanged, or a liability
settled, between knowledgeable, willing parties in an arms length transaction.
56. How reversal of valuation allowance will affect net income under US GAAP?
A. Reversal will decrease deferred tax asset and increase deferred tax expense
resulting in a decrease in net income
B. Reversal will increase deferred tax asset and decrease deferred tax expense
resulting in an increase in net income
C. Reversal will not affect net income, as it is not allowed under U.S. GAAP
Correct Answer: B
Reference:
The reversal will increase deferred tax asset and decrease deferred tax expense,
resulting in an increase in reported net income under U.S. GAAP.
57. Which of the following method is most likely to be used if cost and revenue
associated with a project cannot be estimated reliably, under U.S. GAAP?
A. Installment sales method
B. Percentage-of-completion method
C. Completed-contract method
33
Correct Answer: C
Reference:
Percentage-of-completion method can be used only if the cost and revenue of a
project can be estimated reliably. Installment sales method is used when a firm
finances a sale and cash-flows are expected to be received or a longer period of
time.
58. Which of the following is most likely included in other comprehensive income?
A. Realized gains and losses of an available-for-sale security and foreign
currency translation gains and losses
B. Unrealized gains and losses of an available for sale security and foreign
currency translation gains and losses
C. Dividends received, unrealized gains and losses of an available for sale
security, and foreign currency translation gains and losses
Correct Answer: B
Reference:
Some of the items comprising other comprehensive income are:
Foreign currency translation gains and losses

Unrealized gains and losses on available for sale securities.
Dividends received and realized gains and losses of available for sale securities
are recognized in net income.
59. Which of the following statements is most accurate?
A. Gains and losses from sale of business segment are treated as an
extraordinary item under U.S. GAAP
B. Extraordinary items are presented on an after-tax basis in income
statement under IFRS
C. Restructuring cost is reported in income statement on a before-tax basis
under both IFRS and U.S. GAAP
34
Correct Answer: C
Reference:
Extraordinary items are transactions that are both unusual and infrequent in
occurrence and are allowed under U.S. GAAP only.
Gains and losses from the sale of a business segment is an example of an unusual
or infrequent item.
Extraordinary items are presented on an after-tax basis in the income statement
under U.S. GAAP.
Restructuring cost is an example of an unusual or infrequent item, and is reported
on a before-tax basis in income from continuing operations.
60. Joe Frank, CFA, made the following statements at a local seminar:
Statement 1: Debt covenants are restrictions mandated by the issuer on
bondholders to protect issuers position.
Statement 2: The analysis of debt covenants plays a vital role for valuing
equity of a firm.
Frank is most likely correct with respect to:
A. Statement 1 only.
B. Statement 2 only.
C. both statements.
Correct Answer: B
Reference:
Statement 1 is incorrect.
Debt covenants are restrictions mandated by the bondholders on the issuer to
protect the bondholders position.
The analysis of the debt convents is important for valuing a firms equity.
35
61. In an inflationary environment, which of the following inventory cost flow

assumptions is most appropriate for a customized automobile company under
IFRS?
A. FIFO method
B. LIFO method
C. Specific-identification method
Correct Answer: C
Reference:
When inventory items are separately identifiable and are not interchangeable, the
specific-identification method is the most appropriate cost flow method.
62. Brook Russell, CFA, made the following statements at a meeting:
Statement 1: LIFO method provides the economic reality of ending inventory
regardless of the inflationary or deflationary price trends.
Statement 2: Weighted-average cost method provides the economic reality of
cost of goods sold regardless of the inflationary or deflationary
price trends.
Statement 3: FIFO method provides the economic reality of both ending
inventory and cost of goods sold regardless of the inflationary or
deflationary price trends.
Russell is most likely correct regarding:
A. statements 1 and 2 only.
B. statements 1 and 3 only.
C. none of the above statements.
36
Correct Answer: C
Reference:
CFA Level I, Volume 3, Study Session 9, Reading 29, Page 375-377 & 381.
For the ending inventory valuation, FIFO method provides the economic reality,
whereas the LIFO method provides the economic reality for the cost of goods
sold.
63. Irene Castillo made the following comments in a discussion with her colleagues:
Statement 1: Operating income reflects a companys underlying performance
after taking the effects of financial leverage into account.
Statement 2: If there is some limitation or exception to accounting standards
while preparing financial statements, the auditor will either issue a
qualified audit opinion or an adverse audit opinion.
Castillo is most accurate with respect to:
C. neither Statement 1 nor Statement 2.
Correct Answer: C
Reference:
Statement 1 is incorrect. Operating income is often referred to as earnings before
interest and taxes, and reflects the companys underlying performance
independent of the use of financial leverage (since it is before interest).
Statement 2 is incorrect. A qualified opinion is one in which there is some
limitation or exception to accounting standards. Exceptions are described in the
audit report with additional explanatory paragraphs. On the other hand, an adverse
audit opinion occurs, when financial statements materially depart from accounting
standards and are not fairly represented, (a qualified and adverse opinion are not
the same thing). If a company gets an adverse opinion, this means its financial
statements cannot be relied upon.
37
64. Rachel McGrath, CFA, made the following statements at a seminar about the
formation of common-size cash flow statement:
Statement 1: Common-size cash flow statement can be formed by expressing
each cash flow item as a percentage of revenue or asset.
Statement 2: Common-size cash flow statement can also be formed by
expressing each cash inflow as a percentage of total cash inflows,
and each cash outflow as a percentage of total cash outflows.
McGrath is least likely correct with respect to:
C. both of the statements.
Correct Answer: A
Reference:
Statement 1 is incorrect, because there are two ways to convert a cash flow
statement into a common-size format, which are as follows:
i.
ii.
By expressing each cash flow item as a percentage of revenue, and not an

asset.
By expressing each cash inflow as a percentage of total cash inflows and
each cash outflow as a percentage of total cash outflows.
65. Which one of the following is least likely correct?

A. Impairment results in a deferred tax asset
B. Restructuring results in a deferred tax asset
C. Impairment results in a deferred tax asset, but restructuring results in a
deferred tax liability
38
Correct Answer: C
Reference:
Impairment and restructuring both result in a deferred tax asset.
In the case of impairment, the asset is written off from the income statement
immediately; however, the tax deduction is not permitted until the asset is sold or
disposed off.
Restructuring costs are recorded for reporting purposes when restructuring is
announced, but not deducted for tax purposes until actually paid.
66. The ability to meet short-term obligations is most likely referred as:
A. solvency.
B. liquidity.
C. profitability.
Correct Answer: B
Reference:
Ability to meet short-term obligations is generally referred to as liquidity, whereas
the ability to meet long-term obligations is generally referred to as solvency.
67. Under which type of lease, does the lessor record gross profit in her financial
statements?
A. Direct financing lease
B. Sales-type lease
C. Both direct financing and sales-type lease
39
Correct Answer: B
Reference:
Under a sales-type lease, the lessor records the gross profit in her financial
statements when, being a financer, she also acts as a manufacturer and treats it as
a normal sales transaction.
Under the direct financing lease, the lessor recognizes no gross profit.
68. Net profit margin and return on assets of a firm are 10% and 12%, respectively. If
firms financial leverage ratio is 1.6 and dividend payout ratio is 45%, its
sustainable growth rate will be closest to:
A. 6.6%.
B. 8.6%.
C. 10.6%.
Correct Answer: C
Reference:
Using DuPont system,
Return on equity = [net income/sales] [sales/assets] [assets/equity]
Return on assets = [net income/sales] [sales/assets]
Therefore,
Return on equity = 12% 1.6 = 19.2%
g = ROE Retention rate
g = 19.2% (1 0.45) = 10.56%.
40
Questions 69 through 78 relate to Corporate Finance

69. The appropriate treatment of the floatation costs incurred while undertaking a new
project is that the floatation cost should be:
A. reflected in the projects cost of capital by increasing the overall WACC.
B. calculated in dollar terms and should be adjusted in the initial outlay of the
project.
C. should be adjusted both in the initial outlay and the cost of capital using
appropriate legal guidelines.
Correct Answer: B
Reference:
Floatation costs should be calculated in dollar terms and should be adjusted in
initial outlay of the project.
Floatation costs are costs incurred at the initiation of a project in terms of
investment banks fee, etc. If reflected in WACC, the floatation costs will impact
all the cash flows by increasing the WACC. The appropriate method, therefore, is
to calculate the dollar floatation costs and add it to the initial outlay to calculate
the one-time impact of the floatation costs on the projects NPV.
70. Which of the following is the most reliable source of short-term funding through
banks?
A. Uncommitted line of credit
B. Committed line of credit
C. Revolving line of credit
Correct Answer: C
Reference:
The least reliable source of short-term funding is the uncommitted line of credit,
as the banks may refuse to lend if circumstances change.
41
Committed line of credit is a more reliable source of short-term funding, as the

banks cannot refuse to lend the committed amount. Committed lines are, however,
for time periods up to one year.
Revolving line of credit is the most reliable source of short-term funding, since
these can be verified and listed on the firms financial statements in the footnotes
as one of the sources of liquidity.
71. Provisions that are designed and implemented in order to avert any acquisitions
are best known as:
A. takeover defenses.
B. hostile defenses.
C. acquisition defenses.
Correct Answer: A
Reference:
The provisions that are designed and implemented in order to avert any
acquisitions are known as takeover defenses.
72. If a companys annual purchases are $100 million and accounts payables are $25
million, the number of days of payables will be closest to:
A. 4 days.
B. 75 days.
C. 91 days.
Correct Answer: C
Reference:
Number of days of payables =
Number of days of payables =
!""#$%&' !"#"$%&
!"#$%&# !"!! ! !"#$%&'('
$"#,!!!,!!!
= 91.25
$"##,!!!,!!!
!"#
days.
42
73. The number of years a projects discounted cash flows take to cover its initial cost
is most likely known as:
A. payback period.
B. return period.
C. discounted payback period.
Correct Answer: C
Reference:
The number of years a projects cash flows take to cover its initial cost is known
as the payback period. However, if discounted cash flows are used to calculate the
payback period, it is known as discounted payback period.
74. Which of the following statements regarding beta estimation process of a
comparable companys equity is least likely correct?
A. Beta estimate is sensitive to the length of time and frequency of data used
for calculation.
B. Betas for small-capitalization firms should be adjusted downwards to
reflect true risk that is ignored by otherwise simple estimation process.
C. Betas have the tendency to revert to their mean, i.e., 1 and the estimates
should be readjusted if necessary to reflect this characteristic.
Correct Answer: B
Reference:
Betas for small-capitalization firms should be adjusted upwards to reflect the true
risk inherent in the small-capitalization firms that is ignored by the otherwise
simple estimation process.
43
75. The data in Exhibit 1 relates to Coach Inc.

Exhibit 1
Receivables
Inventory
Payables
Cost of goods sold
Purchases
Sales
September 2009
(in thousands)
$600,000
$550,000
$800,000
$1,800,000
$2,400,000
$5,400,000
September 2010
(in thousands)
$400,000
$300,000
$550,000
$1,500,000
$2,200,000
$4,000,000
Assuming a 365-day year, the operating cycle of Coach Inc. in 2010 is equal to:
A. 18 days, and the cash conversion cycle is equal to 149 days.
B. 110 days, and the cash conversion cycle is equal to 18 days.
C. 149 days, and the cash conversion cycle is equal to 37 days.
Correct Answer: C
Reference:
Average receivables = ($400,000+ $600,000)/2 = $500,000
Average days of receivables = $500,000/$4,000,000 365 = 46 days
Average inventory = ($300,000 + $550,000)/2 = $425,000
Average days of inventory = $425,000/$1,500,000 365 = 103 days
Average payables = ($550,000+$800,000)/2 = $675,000
Average days of payables = $675,000/$2,200,000 365 = 112 days
Operating cycle = average days of inventory + average days of receivables
= 46 + 103 = 149 days
Cash conversion cycle =
=
=
average days of inventory + average days of

receivables average days of payables
103 + 46 112
37 days.
44
76. Which of the following statements is most consistent with the best practices of
corporate governance?
A. Board of directors should perform their duties with due consultation with
management
B. Firm should act lawfully and ethically in dealing with stakeholders
C. Firm should act lawfully and ethically in dealing with shareholders
Correct Answer: C
Reference:
CFA Level I, Volume 4, Study Session 11, Reading 41, Page 188 & 201-202.
The firm should act lawfully and ethically in dealing with shareholders. In
addition, the board of directors should work independently from the management.
77. An analyst is analyzing the WACC for Alpha Inc. Alpha Inc. is a pure equity
company and has never issued any debt to raise capital. He has gathered
additional information related to the Alpha Inc. given in Exhibit 1.
Exhibit 1
Preferred dividend
Price of preferred stock
Price of common stock
WACC
Preferred stock in capital structure
$6
$50
$36
15%
25%
The cost contribution of funding an average-risk project with common stock for
Alpha Inc. is closest to:
A. 16%.
B. 15%.
C. 12%.
45
Correct Answer: A
Reference:
CFA Level I, Volume 4, Study Session 11, Reading 37, Page 36-37 & 44-46.
Since there is no debt issued by Alpha Inc., the WACC will be calculated as:
WACCAlpha = (wp)(kp) + (we)(ke)
where
wp = weight of preferred stock in capital structure
we = weight of common stock in capital structure
kp = cost of preferred stock
ke = cost of common stock
15% = 25%
!! =
$"
$"#
+ 1 25% k !
15% [25%
1 25%
15% [3%]
!! =
75%
12%
!! =
75%
!! = 16%
$"
$"#
78. Which of the following statements is least accurate?

A. A project with no IRR does not have an NPV
B. A project with multiple IRR can be a profitable project
C. A project can have no IRR and still be profitable
Correct Answer: A
Reference:
A project with no IRR does not mean that it would not have a net present value. In
fact, a project with no IRR has a net present value, which can be greater than zero,
making it a profitable venture.
46
Questions 79 through 90 relate to Equity Investments

79. If an investor over-estimates the value of a project in which its true value is less
than its cost, the most likely effect would be that:
A. a wealth diminishing project may be undertaken.
B. a wealth enhancing project may be undertaken.
C. no project may be undertaken.
Correct Answer: A
Reference:
If an investor over-estimates the value of a project in which its true value is less
than its cost, he may undertake a wealth-diminishing project.
80. A firm is experiencing an increase in demand of its product and is growing
rapidly on a long-term basis. Recently the firm has experienced above-average
fluctuation in their revenues and profits over the course of a business cycle. It is
most likely a:
A. cyclical firm.
B. noncyclical firm.
C. growth cyclical firm.
Correct Answer: C
Reference:
The label growth cyclical is sometimes used to describe companies that are
growing rapidly on a long-term basis but they still experience above-average
fluctuation in their revenues and profits over the course of a business cycle.
47
81. Harsh Motors, Inc. recently paid a $3.00 dividend, which is expected to grow at a
rate of 4%. The risk-free rate is 4%, and economy is expected to grow at a rate of
5%. If market risk premium is expected to be 6% and Harshs stock beta is 1.3,
the intrinsic value of the stock is closest to:
A. $41.
B. $46.
C. $120.
Correct Answer: A
Reference:
The intrinsic value of a stock using the Gordon growth model is calculated as:
!!
!! =
!!
where
P0 = Current price
D1 = Dividend in year 1 [D0 (1 + g)]
k = Required rate of return
g = Sustainable growth rate
D1 = 3 1.04 = $3.12
ke = 4 + 1.3(6) = 11.8%
P0 = 3.12/(0.118 0.04) = $40.
82. Christopher Bent is analyzing an industry that requires heavy investments for
entry and has a number of competitors. Customers switching costs and loyalty
are both low. Industry participants typically face high exit costs. Financing is
readily available to players in the sector at subsidized rates. Based on this
information, Bent can most likely conclude that in the industry:
A. threat of entry is low and intensity of rivalry is high.
B. threat of entry is high and intensity of rivalry is low.
C. threat of entry and intensity of rivalry are both high.
48
Correct Answer: C
Reference:
Although entry in the industry requires a lot of heavy investments, but financing
is available at cheap rates that may lower the entry barriers, therefore threat of
new entry is high.
Since industry participants face high costs of exiting the industry and there are
many competitors, therefore the intensity of rivalry is also high.
83. An industry has seen phenomenal growth in the past few years but recently its
growth has slowed down and profitability of major players in the industry has
declined as a result of intense competition for market share. The industry is most
likely in:
A. embryonic stage.
B. shakeout stage.
C. mature stage.
Correct Answer: B
Reference:
The industry displays characteristics of shakeout stage in the industry life cycle.
Slowing growth, intense competition, and declining profitability usually
characterize the Shakeout Stage. During the shakeout stage, demand approaches
market saturation levels because few new customers are left to enter the market.
Competition is intense as growth becomes increasingly dependent on market
share.
84. A corporation using a dividend reinvestment plan (DRP) will most likely:
A. purchase shares in open market.
B. restrict investments to existing shareholders.
C. issue shares at a discount to current market price.
49
Correct Answer: C
Reference:
C is correct. DRPs sometimes allow existing shareholders and other investors to
purchase shares at a discount to current market price.
A is incorrect. DRPs require corporations to issue new shares rather than purchase
them on the open market.
B is incorrect. DRPs allow existing shareholders to reinvest their dividends in
newly issued shares of the corporation. However, other investors may choose to
invest in these plans.
85. If holder of a contract can only exercise contract at maturity, the contract is
known as:
A. American-style contract.
B. European-style contract.
C. Maturity contract.
Correct Answer: B
Reference:
In European-style contract holder can only exercise the contract at maturity.
86. Adrian Gere requires organic seeds for the upcoming sowing season two months
from now. Gere entered into an OTC contract that required him to receive a fixed
amount of seeds in 2 months time and pay a fixed price, agreed upon today. The
agreement is most likely classified as a:
A. swap contract.
B. forward contract.
C. futures contract.
50
Correct Answer: B
Reference:
The OTC agreement to buy seeds in the future at a price agreed upon today is a
forward contract.
87. Price-to-earnings ratio will increase with an increase in:
A. required rate of return.
B. growth rate.
C. difference between the required rate of return and the growth rate.
Correct Answer: B
Reference:
Price-to-earning ratio is calculated as:
!! !! !!
=
!! ! !
where
P0 = Current price
E1 = Expected earnings in year 1
D1 = Dividend in year 1
k = Required rate of return
g = Sustainable growth rate
As it can be seen from the equation, price-to-earnings ratio will increase with
a/an:
1.
2.
3.
4.
increase in the growth rate.

increase in dividend payout ratio.
decrease in the required rate of return.
decrease in the difference between the required rate of return and the
growth rate.
51
88. Janet Berg is a junior equity analyst serving a sell-side research firm. She is
preparing a research report that aims to highlight factors impeding market
efficiency. She identifies the following factors:
Factor 1: Type of market participants
Factor 2: Foreign trading restrictions
Factor 3: Short selling restrictions
Which of the identified factors will least likely impede market efficiency?
A. 1
B. 2
C. 3
Correct Answer: A
Reference:
CFA Level I, Volume 5, Study Session 13, Reading 47, Page 120 & 122
Factor 1 will least likely impede market efficiency. The greater the number of
investors following the major financial markets, the higher the possibility that
markets are efficient.
Factor 2 will impede market efficiency. Foreign trading restrictions will decrease
the number of market participants and therefore impede market efficiency.
Factor 3 will impede market efficiency. Restrictions on short selling will limit
arbitrage trading which in turn will impede market efficiency.
89. Which of the following is least likely expected from a well-functioning securities
market?
A. Timely and accurate information on the price and volume of future
transactions
B. Internal efficiency
C. Informational efficiency
52
Correct Answer: A
Reference:
Following are the functions of a well-functioning securities market:
1. Timely and accurate information on the price and volume of past
transactions and on current supply and demand conditions.
2. Liquidity.
3. Internal efficiency.
4. Informational efficiency.
90. Which of the following statement is incorrect?
A. Higher the book-to-market-value ratio, higher the risk-adjusted return if
the firm is a small sized firm
B. Lower the price-to-earnings ratio, higher the returns associated with these
stocks relative to the market
C. Calendar studies incorporate the January anomaly
Correct Answer: A
Reference:
The risk-adjusted return for a firm with higher book-to-market-value ratio will be
high regardless of the firms size.
Calendar studies incorporate the January anomaly and the weekend effect.
Research has shown that firms with lower price-to-earnings ratios have higher
returns associated with them relative to the market.
53
Questions 91 through 96 relate to Derivative Investments

91. An interest rate increase most likely results in:
A. an increase in stock price.
B. a decrease in price of call option on a stock.
C. a decrease in price of put option on a stock.
Correct Answer: C
Reference:
The put-call parity relationship is expressed as:
c + X / (1 + RF)T = S + p
where
c = Call option
X = Zero-coupon Bond
RF = Risk-free rate
S = Underlying stock
p = Put option
Keeping the value of an underlying security constant, an interest rate increase will
result in:
increased price of the stock call option

decreased price of the stock put option
92. Second Federal Bank enters into a $500,000 quarterly pay, plain vanilla swap as
8% fixed-rate payer. Counter party agrees to pay 90-day LIBOR plus a 2%
margin. Current LIBOR rate is 3.0%. 90-day LIBOR rates are provided in Exhibit
1 below.
sExhibit 1
Term
90 days from now
180 days from now
270 days from now
360 days from now
LIBOR Rates (%)

5.5
6.0
6.5
7.0
54
In 270 days, the Second Federal Bank will most likely:

A. make no payment.
B. make a payment of $3,750.
C. receive a payment of $625.
Correct Answer: A
Reference:
The payment 270 days from now will depend on 180 days LIBOR and the fixed
rate (8%).
Fixed-rate payer pays = 0.08
!"
!"#
0.06 + 0.02
!"
!"#
$500,000
= $0
93. Which of the following statements is most accurate with respect to forward
contracts?
A. A forward contract is a unilateral contract that obligates long to buy the
underlying at a specific price on a specified date from the short
B. Terminating a forward position prior to its expiration by taking an
offsetting forward contract with the same features as of the initial contract
with any party removes all of the associated risks
C. A short in a T-bills forward contract will bear losses if interest rates fall
Correct Answer: C
Reference:
A forward contract is a bilateral contract that obligates the long to buy an asset at
a specified price on a specified date from the seller.
Terminating the forward position prior to expiration by taking an offsetting
position into a similar forward contract with any third-party will still have some
credit risk. However, the credit risk will be completely eliminated if the offsetting
transaction is made with the original counterparty.
55
As the interest rate decreases, the discount interest on T-bill decreases, resulting
in an increase in the price of the T-bill. The long value will, therefore, be positive,
and the short will bear losses.
94. Which of the following is least likely correct regarding swap agreements?
A. Notional principal of interest rate swap agreements can change
B. Swap agreements are not subject to any direct or indirect regulations
C. Payment in an equity swap is not known until the end of settlement period
Correct Answer: B
Reference:
CFA Level I, Volume 6, Study Session 14, Reading 60, Page 9& Reading 64, Page
131.
The notional principal of interest rate swaps can change under some
circumstances.
The swap agreements are not subject to any direct regulations; however, they are
subject to indirect regulatory oversight, as the companies using them could be
regulated by the Securities and Exchange Commission (SEC) or banking
authorities.
The payment in an equity swap is not known until the end of the settlement
period, as the return on the stock is known on the settlement date.
95. Which of the following is least likely a method of terminating a swap agreement?
A. Offsetting a contract
B. Entering into a long position in an option
C. Exchange for physicals
Correct Answer: C
Reference:
The four methods used for the termination of swap agreements are as follows:
Offsetting the contract

Mutual termination
56
Resale
Swaption
Exchange for physicals is an off-the-floor way of settling a futures contract or an

option contract, whereby both long and short negotiate the settlement of the
contract.
96. Which of the following is most likely to be a call options intrinsic value?
A. Amount by which the option is in-the-money
B. Option premium
C. Long position in the put option, long position in the stock, and short
position in the bond
Correct Answer: A
Reference:
An options intrinsic value is the amount by which the option is in-the-money.
The time value of option is also called the speculative value of the option, and is
the amount by which the option premium exceeds the intrinsic value.
Option C is the value of the call options premium according to the put-call parity
relationship.
57
Questions 97 through 110 relate to Fixed Income Investments

97. Which of the following statements is most accurate regarding duration?
A. Duration of a zero-coupon bond is equal to its maturity
B. Duration underestimates percentage price increases and decreases for an
option-free bond
C. Macaulay duration is not appropriate for estimating the price sensitivity of
bonds with embedded options
Correct Answer: C
Reference:
CFA Level I, Volume 5, Study Session 16, Reading 58, Page 571 & 577-579
The duration of a zero-coupon bond is approximately equal to its maturity.
Duration underestimates the percentage price increase, in case of a decline in
yield, and overestimates the percentage price decrease, in the case of an increase
in yield, for option-free bonds. In short, duration underestimates what the new
price will be.
The Macaulay duration measure is not appropriate for estimating the price
sensitivity of bonds with embedded options. The effective duration should be used
to measure the duration of the bonds with embedded options.
98. Which of the following statements is most likely correct:
A. A U.S. Treasury note with exactly six years to maturity can be broken into
thirteen Treasury STRIPS.
B. Mortgage pass-through securities eliminate the overall prepayment risk of
a mortgage pool.
C. An advantage of external credit enhancements is that they are not subject
to credit risk of 3rd party guarantors.
58
Correct Answer: A
Reference:
CFA Level I, Volume 5, Study Session 15, Reading 54, Page 360-361, 368-369 &
387-388.
Each of the twelve coupons would be a Treasury STRIP, and the principal would
be the thirteenth STRIP.
The mortgage pass-through securities redistribute the prepayment risk due to
trenching, but do not reduce or eliminate the overall prepayment risk of the pool.
A disadvantage of external credit enhancement is that they are subject to credit
risk of 3rd party guarantors.
99. Which of the following statements regarding the relationship between interest
rates and bond prices is most likely correct?
A. A decrease in interest rates will cause price of a callable bond and an
otherwise comparable option-free bond to increase, but at different rates
B. A decrease in interest rates will cause an identical increase in prices of a
callable bond and an otherwise comparable option-free bond
C. An increase in interest rates will cause an identical decrease in price of a
callable bond and an otherwise comparable putable bond
Correct Answer: A
Reference:
At lower yields, value of an option-free bond will increase at a faster rate as
compared to a comparable callable bond because of the presence of embedded
call option.
100. Arbitrage-free value is calculated by discounting each future cash flow of a bond
most likely by:
A. spot rates.
B. forward rates.
C. spot rates or forward rates.
59
Correct Answer: C
Reference:
CFA Level I, Volume 5, Study Session 16, Reading 56, Page 462-464 & Reading
57, Page 520.
Arbitrage-free value is calculated by discounting each future cash flow of a bond
by spot rates or forward rates. Since spot rates can also be derived using the
forward rates, an investor can use the forward rates to calculate the arbitrage-free
value of the bond.
101. During a contractionary economy, credit spreads:
A. widen, and demand of high quality issues puts an upward pressure on
prices of low-yield issues.
B. widen, and demand of high quality issues puts an upward pressure on
prices of high-yield issues.
C. tighten, and less demand of high quality issues puts an upward pressure on
prices of high-yield issues.
Correct Answer: A
Reference:
During a contractionary economy, the credit spreads widen, and investors seek
high-quality issues due to their relatively lower credit risk. Such a shift causes an
upward pressure on the prices of low-yield issues, which have higher credit
ratings and lower credit risk.
102. Consider a callable bond with an active call protection. If current yields are
favorable for issuer to call the bond, the yield of this particular issue will be most
likely known as:
A. yield to maturity.
B. yield to refunding.
C. yield to worst.
60
Correct Answer: B
Reference:
For a callable bond with an active call protection, if the current yields are
favorable for the issuer to call the bond, the yield of this particular issue will be
known as yield to refunding.
103. Which of the following is least accurate with respect to special purpose vehicles
(SPVs)? Special purpose vehicle:
A. is a separate legal entity.
B. is also known as bankruptcy remote entity.
C. can never have a rating higher than that of the originating company.
Correct Answer: C
Reference:
Special purpose vehicle is a separate legal entity to which a company can transfer
its financial assets. These assets are protected from claims against the company
and the SPV can receive a rating better than the company. Because of the
protection from bankruptcy, they are often called bankruptcy remote entities.
104. Jim Jackson, CFA, is a junior analyst at Marco Polo Investments, Inc. During a
discussion on the bonds, Jackson made the following statements:
Statement 1: Due to negative convexity, price of an option-free bond increases
more when yields fall than it decreases when yields rise.
Statement 2: Value of a put option decreases at higher yields and increases at
lower yields.
Jackson is least accurate with respect to:
C. both of the statements.
61
Correct Answer: C
Reference:
Due to positive convexity, the price of an option-free bond increases more when
the yields fall than it decreases when the yields rise.
Higher yield results in low bond prices. The holder of a put option on a bond has
the right to sell the bond at a higher strike price, which increases the value of the
put option.
105. Arista Herman works as a fixed-income analyst at Daikon Investments. She
makes the following statements at a meeting with the junior analysts:
Statement 1: Credit card receivables are type of collateral for asset-backed
securities.
Statement 2: Prepayments of a mortgage pool increase with an increase in the
interest rates.
Herman is most likely correct with respect to:
C. both statements 1 and 2.
Correct Answer: A
Reference:
CFA Level I, Volume 5, Study Session 15, Reading 53, Page 331 & Reading 54,
Page 386.
Prepayments of a mortgage pool increase with a decrease in interest rates, because
consumers can refinance their mortgage loans at the prevailing lower interest
rates.
Credit card receivables are type of collateral for the asset-backed securities.
62
106. Which of the following statement regarding term structure theories is least likely
correct:
A. An inverted yield curve cannot be explained by all the term structure
theories.
B. In liquidity preference theory, liquidity is measured in terms of duration.
C. Pure expectation theory assumes that investors are indifferent to interest
rate risk and other risk factors related to investing in bonds with different
maturities.
Correct Answer: A
Reference:
An inverted yield curve can occur with any of the three term structure theories.
In the liquidity preference theory, liquidity is measured in terms of interest rate
risk. The greater the interest rate risk, the lower the liquidity premium. Since the
interest rate risk (duration) increases with maturity, a longer maturity asserts a
higher yield premium.
The shortcoming of Pure expectation theory is that it assumes that investors are
indifferent to interest rate risk & other risk factors related to investing in bonds
with different maturities.
107. The difference between the value of a callable bond and an otherwise comparable
option-free bond at a particular yield is most likely known as:
A. call options premium.
B. call options value.
C. call options intrinsic value.
Correct Answer: B
Reference:
A difference between value of a callable bond and an otherwise comparable
option-free bond at a particular yield is known as call options value.
63
Call option premium is the price paid to buy the call option, and the intrinsic
value of the money is the amount by which an option is in-the-money.
108. If yield ratio is 1.049 and absolute yield spread is 17 basis points, the relative
yield measure is closest to:
A. 3.20%.
B. 4.90%.
C. 5.07%.
Correct Answer: B
Reference:
Relative yield = Yield ratio 1
Relative yield = 1.049 1
Relative yield = 0.049 = 4.9%.
109. The convention to quote the yields of zero-coupon Treasury bonds is:
A. BEY, which is an annual-pay YTM.
B. BEY, which is a semiannual-pay YTM.
C. EAY, which is an annual-pay YTM.
Correct Answer: B
Reference:
The bond-equivalent yield (BEY) = 2 semiannual-pay YTM.
110. For a coupon-paying bond, when the current interest rates are lower than its
coupon rate, the reinvestment risk faced by the issuer will most likely be:
A. high.
B. low.
C. zero.
64
Correct Answer: C
Reference:
Reinvestment risk is always faced by the bondholder rather than the issuer of the
bond.
65
Questions 111 through 114 relate to Alternative Investments

111. An analyst is appraising the value of an apartment complex. He begins with
projecting future cash flows expected from the property over a ten year period and
discounting these cash flows at an appropriate discount rate. Included in these
cash flows is the discounted value of the propertys resale value at the termination
of the project.
Which type of cash flows is included in the project appraisal and which appraisal
technique has been used by the analyst to determine the resale value?
A.
B.
C.
Type of Cash Flows:

free cash flows
operating cash flows
operating cash flows
Appraisal Technique:
income approach
comparable sales approach
direct capitalization approach
Correct Answer: C
Reference:
The analyst is using discounted cash flow approach to estimate the value of the
property. The type of cash flows used in this technique is annual operating cash
flows. The analyst will estimate the resale value using the direct capitalization
approach, which is an income approach.
112. Which of the following equity hedge fund strategy uses fundamental analysis to
identify under- and over-valued equity securities?
A. Market neutral
B. Fundamental growth
C. Quantitative directional
Correct Answer: A
Reference:
A is correct. Market neutral strategies use technical and/or fundamental analysis
to identify under- and over-valued equity securities.
66
B is incorrect. Fundamental growth strategies use fundamental analysis to identify

companies expected to exhibit high growth and capital appreciation.
C is incorrect. Quantitative directional strategies use technical analysis to identify
companies that are under- and over-valued.
113. Which of the following advantage is most likely offered by fund-of-funds over
typical hedge funds?
A. Higher liquidity
B. No lockup period
C. Opportunity to earn higher net returns
Correct Answer: A
Reference:
CFA, Level I, Volume 6, Study Session 18, Reading 66, Page 188
A is correct. By offering favorable negotiated redemption terms (shorter lockup
periods and/or notice period), fund-of-funds investors can withdraw their funds
sooner than investing in the underlying hedge funds.
B is incorrect. Fund-of-funds offer shorter lockup periods as opposed to no lockup
period.
C is incorrect. Fund-of-funds are associated with a multi-layered fee structure
which will further dilute the returns to investors. Thus, in contrast to conventional
hedge funds, investors will experience lower net-of-fee returns.
114. Which of the following statement is least likely correct?
A. Collateral yield on a commodity investment can be either positive or
negative
B. Roll yield is positive for commodity markets in backwardation
C. Commodity prices are uncorrelated with the security prices
67
Correct Answer: A
Reference:
CFA Level I, Volume 6, Study Session 18, Reading 67, Page 234-236 & 238-239
Collateral yield on a commodity investment is the yield on the T-bills, which can
never be negative.
In backwardation, a long can enter into a forward contract to buy the underlying
commodity at a forward price below the current spot price. The long will receive
a payment from the short (hedger) at the time of the contract expiration, and this
amount is referred to as the roll yield, which reflects the convergence of the spot
price at expiration with the initial forward price.
The commodities, when added to an equity portfolio, help reduce the overall risk
of the portfolio due to their low correlation with the stock prices.
68
Questions 115 through 120 relate to Portfolio Management

115. Which of the following is most likely included in Execution Step:
A. asset allocation.
B. performance measurement.
C. preparation of IPS.
Correct Answer: A
Reference:
The Execution Step
Asset allocation
Security analysis
Portfolio construction
116. Which of the following is least likely an investment constraint?
A. Portfolio risk
B. Regulatory factors
C. Investment time horizon
Correct Answer: A
Reference:
Risk is an investment objective and not a constraint on the portfolio.
The following are investment constraints:
Liquidity
Investment time horizon
Tax concerns
Legal and regulatory factors
Unique needs and preferences
69
117. Stephen Mullen, CFA, is calculating the variance of a portfolio comprising of

three securities. Covariance matrix for the securities is shown in Exhibit 1.
Exhibit 1
Covariance Matrix
A
B
C
A
0.0036
0.0016
0.0025
B
0.0016
0.0049
0.0031
C
0.0025
0.0031
0.0144
If weights of securities A, B, and C are 20%, 30%, and 50%, respectively, the
variance of the portfolio is closest to:
A. 0.0058.
B. 0.0278.
C. 0.0762.
Correct Answer: A
Reference:
!! = w!! !! + w!! !! + w!! !! + 2w! w! Cov!,! + 2w! w! Cov!,! + 2w! w! Cov!,!
!!! = 0.2! 0.0036 + 0.3! 0.0049 + 0.5! 0.0144 + 20.20.30.0016
+ 20.20.50.0025 + 20.30.50.0031
!!! = 0.0058.
70
118. Craig Hudson made the following statements during a board meeting.
Statement 1: Life insurance companies have shorter time horizons than non-life
insurance companies as a result of different expectations of when
payments will be required under policies.
Statement 2: If a defined benefit pension plan has been closed to new
members, it will have a very short time horizon and high liquidity
needs.
Hudson is most likely correct with respect to:
C. both Statement 1 and Statement 2.
Correct Answer: B
Reference:
Hudson is incorrect in stating first statement. Life insurance companies have
longer time horizons than non-life insurance companies as a result of different
expectations of when payments will be required under policies.
Hudson is correct with second statement. If a defined benefit pension plan has
been closed to new members, it will have a finite time horizon. Even a plan closed
to new members may still have a time horizon of 70 or 80 years. For example, a
plan member aged 25 may not retire for another 40 years and may live 20 odd
years in retirement. Therefore, even a pension plan closed to new members could
be considered as long-term investor.
119. Which one of the following statements least likely describes beta?
A. Beta is a measure of systematic risk only
B. Beta is a function of covariance of asset returns and variance of market
portfolio
C. Beta is a slope of the security market line
71
Correct Answer: C
Reference:
Beta is not the slope of the security market line. The slope of the SML is the
market risk premium,
(Rm Rf).
Beta only measures the systematic risk.
Beta can also be stated as a function of covariance of asset returns and the
variance of market portfolio:
i=
!"#$%&$'()!,!
!"#!
120. An analyst gathered data shown in Exhibit 1.

Exhibit 1
Expected return of Stock A
Risk-free rate
Covariance between Stock A and Market M
Market Ms covariance with itself
Variance of Stock A
6%
3%
0.0049
0.0064
0.0121
Correlation co-efficient between Stock (A) and Market (M) is closest to:
A. 0.34.
B. 0.56.
C. 0.73.
Correct Answer: B
Reference:
!,! =
!"#!,!
!! !!
0.0049
0.08 0.11
!,! = 0.56.
!,! =
72

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Ethical and Professional Standards

Financial Reporting and Analysis

Fixed Income Investments

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Questions 1 through 18 relate to Ethical and Professional Standards

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The Standards encourage members to formulate policies, which

In the absence of local regulation pertaining to record retention, the

The CFA Institute Code and Standards require members and

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Which of the following situations most likely constitutes a violation of the

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When using secondary or third-party research as a source of information for

review the assumptions used;

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Which of the following statements best characterizes GIPS objectives?

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Which of the following is least likely a section of GIPS standards?

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14. Which of the following scenarios, highlighted in Exhibit 1, if left undisclosed,

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describe the hierarchy of supervision and assign duties among supervisors;

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Individual is no longer considered an active candidate who decline to sit for an

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disclose the proxy voting policies;

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18. According to the Global Investment Performance Standards (GIPS),

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Questions 19 through 32 relate to Quantitative Methods

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Covariance of a random variable with itself is its Variance

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Distribution of sample mean will be approximately normal

31. Descriptive statistics are used to:

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