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CFA® Exam Review

Top Questions You Must Master for the Level I CFA® Exam
Preparing for the Level I exam is tough, but you can make life easier with an effective
study plan. If you have yet to get a plan, Wiley’s adaptive Ditigal Exam Planner in our
Platinum, Gold, Silver and Self-Study review courses will help you create a personalized
plan down to the day, provide a dashboard to keep on track and track your progress every
step of the way.
But first, here are some questions to test your knowledge of typical, fundamental topics
that are likely to appear on the actual exam.

Mastering time value of money (TVM) problems the investment): 52 x 1.5 = 78.
at Level I is a must; be familiar with your financial This question requires you to know your TVM
calculator and how to easily attack questions with calculator functions and how to capture the
different frequencies of compounding. necessary information in the question and ignore
TIP: Underlining key pieces of information keeps you what you do not need.
focused on what’s necessary to answer the question. TIP: Set the “P/Y” setting on your calculator to “1” so
1. An investor has $100,000 held in a two-year the “I/Y” represents the interest rate per compounding
bank CD earning four percent with weekly period and “N” is the number of compounding
compounding. The terms impose a 10 percent periods. Remember before starting a new TVM
penalty for early withdrawal. How much will problem – clear the TVM worksheet and reset to
the investor receive if he redeems the CD after default values: [2ND][QUIT] [2ND][CLR TVM]
18 months?
A. $95,563 CFA® Exam
B. $97,502
C. $106,181

Answer Rationale Guide QUIT





Recognize this is a basic TVM question.


Access Time-Saving

(A) is the correct answer. To solve with a financial

% 2
INV ( )

calculator: Tips and Settings

LN 7 8 9
STO 4 5 6
-100,000 [PV]; 4/52 = 0.07692 [I/Y]; 52 × 1.5 = 78 [N]; for your BA II Plus
RCL 1 2 3

[CPT][FV] = 106,181. Apply the 10 percent penalty for

CE|C 0 .

early withdrawal, and the investor should receive Calculator

$106,181 × 0.90 = $95,563.
“PV” is a cash outlay, therefore use the negative
sign. Identify the interest rate and the compounding
– you will need to adjust your inputs accordingly.
4% compounded weekly = 4/52 and notice the
question asks “how much the investor receives”;
therefore, the number of compounding periods
must reflect 18 months (not the two-year term of
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CFA® Exam Review

Level I candidates must understand the concepts [↓][CPT] Calculates NPV

of net present value (NPV) and internal rate of NPV = -197,612
return (IRR). These concepts cross topics and
For IRR: [IRR][CPT] Calculates IRR for same NPV
levels so building a strong foundation now, will calculation
pay off in the long run. IRR = 7.93% or approximately 8%

Remember the NPV / IRR rules: TIP: Should this project be accepted? No, remember
NPV rule: the NPV rule, only accept positive NPV projects.
+NPV projects ↑ shareholder wealth → accept; 3. A firm must choose between two mutually
-NPV projects ↓ shareholder wealth → reject exclusive projects. The firm’s opportunity cost
of capital is 9.5 percent. After performing both
For mutually exclusive projects
NPV and IRR analyses, the data shown in the
→ accept the highest +NPV
table below was collected.
IRR = the discount where NPV = 0
Project NPV IRR
IRR rule:
A $36,500 11.2%
IRR > r → accept; IRR < r → reject
B $15,700 12.3%
For mutually exclusive projects, if NPV and IRR
rules conflict → use NPV rule. Which project should be undertaken?

2. Company X has committed to investing A. Project A because it has the highest NPV.
$2,000,000 in a project with expected cash B. Project B because it has the highest IRR.
flows of $500,000 at the end of every year for C. Both projects because their NPVs are
the next 5 years. The appropriate discount positive.
rate is 12%. The NPV and IRR of the project are
closest to: Answer Rationale
NPV IRR (A) is the correct answer. Go back to the NPV and
IRR rules.
A. (197,612) 7%
When projects are mutually exclusive (only one may
B. (197,612) 8% be undertaken), the best choice is to accept the one
C. (142,612) 8% with the highest net present value (NPV) because it
Answer Rationale represents the actual value added by the project.

(B) is the correct answer. Again, take advantage of

your financial calculator. Free CFA® Video Lesson
For NPV:
Net Present Value &
[CF] Enters the Cash Flow function
Clears the CF memory
Internal Rate of Return
[2,000,000][+ ǀ-] CF0 value – use the negative sign
[ENTER] because this is an outflow
[↓][500,000] C01 value – this is an inflow
[↓][5] [ENTER] F01 value – the frequency of the CF, it is
received 5 times
[NPV][12] [ENTER] I value – the interest rate

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CFA® Exam Review

Concepts that repeat throughout the curriculum (Ending value+dividends−beginning value)(100)

and across levels are definite “must knows”! HPR=
beginning value
Return concepts fall into this category, in Holding Year 1 beginning (100)($60) = $6,000
particular: Holding period yield (HPY), money- Period 1 value (t = 0)
weighted and time-weighted rates of return Year 1 dividends (100)($5) = $500
(MWRR and TWRR), bank discount yield (BDY), received (t = 1)
effective annual yield (EAY), money market yield Year 1 ending (100)($70) = $7,000
(MMY) and bond equivalent yield (BEY). You will value (t = 1)
need to know how to calculate and interpret (7,000 + 500 − 6,000)(100)
HPR1 = = 25%
these. Here again, your financial calculator is your 6,000
best friend. Holding Year 2 beginning (150)($70) = $10,500
Period 2 value (t = 1)
MWRR is simply the IRR; it accounts for timing Year 2 dividends 0= 0
and the amount of cash flows coming in and received (t = 2)
going out. TWRR measures the compounded Year 2 ending (150)($75) = $11,250
rate of growth over a stated period of time. value (t = 2)
(11,250 − 10,500)(100)
Note the differences; as opposed to MWRR, HPR2 =
= 7.14%
TWRR averages holding period returns over time
and is not affected by the timing of cash inflows
or outflows. Calculate MWRR:
TWRR is the standard in the investment Step 1: Determine timing and nature of cash flows
management industry. Step 2: Calculate IRR

4. An investor purchased 100 shares of Company t = 0 Purchase of first 100 shares (100)($60) = - $6,000
X at $60/share. A year later she bought 50 more t = 1 Year 1 dividends received (100)($5) = + $500
shares of the company at a price of $70/share. Purchase of next 50 shares (50)($70) = -$3,500
She also received a $5/share dividend at the end Net cash flow at t = 1 -$3,000
of Year 1. At the end of Year 2 she sold all her
t = 2 Year 2 dividends received 0
shares for $75/share. No dividends were paid for
Year 2. Her money-weighted (MWRR) and time- Proceeds from sale of shares (150)($75) = $11,250
weighted (TWRR) rates of return are closest to: Net cash flow at t= 2 $11,250
MWRR TWRR [CF] Enters the Cash Flow function
[2ND][CEǀC] Clears the CF memory
A. 14.19% 14.23%
[6,000][+ ǀ-] CF0 value – use the negative sign because
B. 13.73% 14.23% this is an outflow
C. 14.19% 15.72%
[↓][3,000][+ ǀ-] C01 value – this is a NET out flow.
Answer Rationale [ENTER] $500 inflow from dividends and $3,500
outflow for new share purchase.
(C) is the correct answer. Know your financial [↓][↓][11,250] C02 value – this is an inflow
calculator keystrokes! [ENTER] (proceeds from the sale)
Calculate TWRR: [IRR][CPT] Calculates IRR
IRR = 14.19%
Step 1: Break down the cash flows into 2 holding
periods TIP: Know the steps and, if needed, create a visual
Step 2: Calculate HPR for each period timeline of the cash flows.
Step 3: Calculate the compounded annual rate

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CFA® Exam Review

The MMY is HPY annualized over a 360-day

The following return concept questions are period assuming simple interest. The EAY is the
more easily tackled if you calculate HPY first. HPY annualized over a 365-day year assuming
Know the relationships between the returns. compound interest.
HPY is the actual annualized return to the
investor over a specific holding period; EAY
is the HPY annualized on a 365-day year with MMY MMY = HPYx (360t( = 1.01% x 360
= 4.04%

compounding; and MMY is the HPY annualized

365 365
on a 360-day year without compounding. The EAY EAY = (1+HPY) t – 1 = (1 + 0.0101) 90 – 1 = 0.0416 = 4.16%
bond equivalent yield (BEY) is the semiannual
rate times 2. TIP: EAY can be converted back to HPY using the
following formula:
5. A T-bill with the face value of $100,000 and
t 90
90 days until maturity is selling for $99,000.
HPY = (1 + EAY) 365 – 1 = (1 + 0.0416) 365 – 1 = 0.0101 = 1.01%
Its BDY, MMY, and EAY are closest to:
BDY MMY EAY To calculate BEY, use the EAY and determine the semi-
annual rate; then multiple by 2. BEY is calculated as:
A. 4% 4.4% 4.16%
B. 4.5% 4.04% 4.4% BEY = [(1+EAY)0.5 − 1](2) = [(1+0.0416)0.5 − 1](2) = 0.04117 = 4.12%

C. 4% 4.04% 4.16% Financial Reporting and Analysis (FRA) is loaded

Answer Rationale: with ratios – you need to be able to calculate and
interpret: Activity, liquidity, solvency, profitability,
(C) is the correct answer.
and valuation ratios. In the following questions,
The Bank Discount Yield (BDY) is calculated as we look at some examples of these ratio categories
follows, where: as well as the DuPont analysis of return of equity
rBD = the annualized yield on a bank discount basis; (ROE). Ratio analysis is a definite “must know”!
D = the dollar discount (face value - purchase price)
F = the face value of the bill A quick summary of ratio analysis categories:
t = number of days remaining until maturity Activity ratios - measure how productive a
company uses its assets and how efficiently it
x 360 = (100,000−99,000)
F t 100,000 x 360
90 = 4.00%
preforms everyday operations.

To calculate the Money Market Yield (MMY) and Liquidity ratios – measure a company’s ability to
the Effective Annual Yield (EAY), first calculate the meet its short-term cash requirements.
Holding Period Yield (HPY) where: Solvency ratios – measure a company’s ability to
P0 = initial price of the investment; meet its long-term debt obligations.

P1 = price received from the instrument at Profitability ratios - measure a company’s ability
maturity/sale to generate an adequate return on invested
D1 = interest or dividend received from the investment
Valuation ratios - measure the quantity of an
(P1 − P0 − D1) (P1 − D1)
− −1
asset or flow (cash/earnings) associated with
P0 P0
HPY (100,000)
ownership of a specific claim (e.g., common
HPY = − 1 = 1.01% stock).

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CFA® Exam Review

6. ABC Corporation presents the following 7. A company’s balance sheet indicates that it has
condensed balance sheet: sufficient cash and short-term investments.
Its payables turnover ratio, however, remains
20X8 ($’000) 20X9 ($’000)
low. This most likely suggests that:
Current Assets 26,600 31,600
A. The company has a liquidity crisis.
Long-term Assets 259,900 332,900 B. The company’s suppliers offer it lenient
Total Assets 286,500 364,500 credit terms.
LIABILITIES C. The company has excellent receivables
Current Liabilities 8,500 12,300 collection.
Long-term Debt 72,000 134,700 Answer Rationale:
(B) is the correct answer.
Common Stock 100,000 100,000
10% Preferred Stock 75,000 75,000 Purchases
Payables Turnover Ratio =
Average Trade Payables
Retained Earnings 31,000 42,500
Total Shareholder’s Equity The denominator in the payables turnover ratio
286,500 364,500
and Liabilities is average trade payables; if trade payables are
high or increase, the ratio will be lower. The most
ABC Corporation’s liquidity position (as
likely explanation for a company with sufficient
measured by the current ratio) and solvency
liquid assets to have low payables turnover is that
position (as measured by its debt-to-assets
management is taking advantage of lenient credit
ratio) over 2009 has most likely:
and collection terms offered by suppliers.
Liquidity Solvency
TIP: If the preceding question required a calculation,
A. Improved Remained the same the amount for purchases may not be explicitly
B. Worsened Weakened stated on the income statement. It may need to be
determined from footnotes or calculated using the
C. Remained the same Weakened
following formula:
Answer Rationale:
Purchases = Ending Inventory + COGS - Opening Inventory
(B) is the correct answer.
Liquidity as measured by the current ratio: TIP: Make sure you can interpret ratios not only
directionally (increase / decrease) but that you
Current Assets 31,600
Current Ratio2009 = = = 2.569 understand the logical reasons why they could occur
Current Liabilities 12,300
and the impact ratios have on each other; these are
Current Assets 26,600 popular exam items!
Current Ratio2008 = = = 3.129
Current Liabilities 8,500

Solvency as measured by the debt-to-assets ratio:

Total Debt 134,700
Debt-to-Assets2009 = = = 0.37
Total Assets 364,500
Total Debt 72,000
Debt-to-Assets2008 = = = 0.25
Total Assets 286,500

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CFA® Exam Review

preceding question presents the data in descending

The DuPont analysis decomposes ROE into time order; take that into consideration when
multiple components to facilitate a meaningful answering the question.
evaluation of a company’s performance, and
to direct management to areas that need The DuPont analysis also decomposes ROE into
improvement. five components to illustrate the effects of taxes
Net Income and interest.
Average Total Equity
The five-way decomposition is: Tax Burden x
The three-way decomposition is: Net Profit Interest Burden x EBIT Margin x Asset Turnover
Margin x Asset Turnover Ratio x Financial Ratio x Financial Leverage Ratio.
Leverage Ratio. Net Income EBT EBIT Revenue Average Total Assets
ROE = x x x x
Net Income Revenue Average Total Assets EBT EBIT Revenue Avg. Total Assets Avg. Shareholders’ Equity
ROE = x x
Revenue Average Total Assets Average Shareholders’ Equity

9. A decomposition of ROE for two companies

8. An analyst has compiled the following data for is as follows:
a company:
Company A
20X3 20X2 20X1 FY13 FY12
Net profit margin 2.7% 2.8% 2.6% ROE 15.1% 25.7%
Total asset turnover 3.5 3.6 3.3 Tax burden 0.80 0.70
Financial leverage 1.18 1.17 1.14 Interest burden 0.75 0.90
Based only on the information above, which EBIT margin 7.0% 12.0%
of the following is the most appropriate Asset turnover 1.2 1.7
conclusion for the 20X1 to 20X3 period? Leverage 3.0 2.0
A. ROA and ROE have increased.
Company B
B. ROA and ROE have decreased.
FY13 FY12
C. ROA has decreased, but ROE has increased.
ROE 22.2% 25.7%
Answer Rationale Tax burden 0.70 0.70
(A) is the correct answer. Use the three-way DuPont Interest burden 0.90 0.90
EBIT margin 11.0% 12.0%
ROA is calculated by multiplying the net profit Asset turnover 1.6 1.7
margin by the total asset turnover. The resulting
Leverage 2.0 2.0
ROAs for 20X1 and 20X3 are 8.58 [(0.026)(3.3)] and
9.45 [(0.027)(3.5)] percent, respectively. This shows
that ROA increased during the period. ROE is equal An analyst is most likely to conclude that
to the ROA multiplied by the financial leverage. Company A’s lower ROE in FY13 (compared to
Given that both the ROA and the financial leverage Company B’s ROE) could be due to:
have risen, the ROE must have increased between A. the purchase of new equipment that is
20X1 and 20X3. being financed with debt.
TIP: When you are moving quickly through the exam, B. a shift in strategy by Company A to become
pay careful attention to details such as the order of more labor intensive and less capital
the information presented. Note: The table in the intensive.

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CFA® Exam Review

C. a higher tax rate, lower EBIT margin, and These items will combine to best explain the much
less efficient asset use, but these were larger decline in Company A’s ROE relative to the
somewhat offset by Company A’s increased decline in Company B’s ROE.
TIP: Do not be confused by the term “burden”.
Answer Rationale A higher ratio does not mean more tax or interest;
(A) is the correct answer. Use the five-way DuPont it means just the opposite. A higher tax and interest
decomposition. burden is actually better for the company.
If Company A purchased new equipment using debt, One of many important ratios to learn is the
it would likely cause several possible outcomes. Sharpe Ratio, which measures excess return per
1. Depreciation expense will increase. This is a unit of risk.
possible reason for the lower EBIT margin. 10. Portfolio A has a mean return of 11% and a
2. Interest paid will increase. This outcome can be standard deviation of 3%. Portfolio B has a
observed in the interest burden factor. Interest as mean return of 17% and a standard deviation
a percentage of EBIT rose from 10 percent to 25 of 6%. The risk-free rate of interest is 3%. The
percent and this resulted in the interest burden respective Sharpe ratios of the two portfolios
factor declining from 0.90 to 0.75. are closest to:
3. The effective tax rate will likely decrease Portfolio A Portfolio B
due to the lower profits caused by the first two A. 2.33 2.67
items. The tax burden factor rose from 0.70
(30 percent tax rate) to 0.80 (20 percent tax rate). B. 2.67 2.33

4. Asset turnover, which is revenue divided by C. 2.33 2.83

average total assets, will fall as new assets are Answer Rationale
added. This has definitely occurred with Company
(B) is the correct answer.
A’s asset turnover declining from 1.7 to 1.2,
while Company B’s asset turnover only declined Rp – rf
Sharpe Ratio =
modestly to 1.6 from 1.7.
5. If debt was used to add fixed assets, then equity is Sharpe ratio for Portfolio A = (11 - 3) / 3 = 2.67
not being used to fund the additions. As a result of
adding equipment, assets rise (increasing average Sharpe ratio for Portfolio B = (17 - 3) / 6 = 2.33
assets), debt rises, and equity is unchanged.
Hence, the leverage (average assets / average
equity) will rise; as was seen for Company A.

Good luck and stay on track.

Remember, good preparation is essential to success.

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