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Schweser Printable Answers - Compre 1


Test ID#: 12

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Question 1 - #127394

Nancy Korthauer, CFA, has launched a new hedge fund called the Korthauer Tautology Fund and is actively
soliciting clients from competitor’s firms. Client presentations are necessarily brief and often take place with the
prospective client’s current investment advisor in the room. The Code and Standards require that:

member or candidate provide (on request) additional detail information which supports the abbreviated
A)
presentation.
B) a prospective client’s current investment advisor not participate in meetings.
all client presentations provide a thorough review of all elements of the investment management
C)
process. Abbreviated presentations are forbidden.

Your answer: A was correct!

See Standard III(D). When presentations are brief, additional detail which supports the abbreviated presentation
information must be provided on request. Best practice dictates that the member or candidate should make
reference to the abbreviated nature of the presentation.

This question tested from Session 1, Reading 2-III, LOS D..

Question 2 - #94981

The Securities and Exchange Commission (SEC) sanctioned Stephen Rangen, a former broker, for unsuitable
recommendations and excessive trading in several accounts. His clients were unsophisticated, inexperienced
individual investors with limited means. As such, they relied heavily on Rangen’s advice and expected him to
initiate any transactions in their respective accounts. The SEC found that Rangen’s trading methods were
contrary to his clients’ goals. For example, he used margin accounts and concentrated their equity holdings in
particular securities. Rangen claimed that his actions were justified because his clients were aware of the risks.

Part 1)
Which of the following statements best describes why Rangen’s argument, that his clients were aware of the risks,
did NOT meet the requirements of the Code and Standards? Rangen failed to:

A) deal fairly and objectively with his clients when taking investment action.
B) make recommendations that were consistent with his clients' financial needs.
disclose to his clients all matters that reasonably could be expected to impair his ability to make
C)
unbiased and objective recommendations.

Your answer: B was correct!

Rangen did not fulfill the obligation he assumed when he agreed to counsel these clients. That is, he did not make
recommendations that were consistent with their financial needs. According to Standard III(C), Suitability, Rangen
must “consider the appropriateness and suitability of investment recommendations or actions for each portfolio or
client.” This is true even if his clients wanted to speculate and were aware of the risks.

This question tested from Session 1, Reading 2, LOS a, b, c.

The Securities and Exchange Commission (SEC) sanctioned Stephen Rangen, a former broker, for unsuitable

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recommendations and excessive trading in several accounts. His clients were unsophisticated, inexperienced
individual investors with limited means. As such, they relied heavily on Rangen’s advice and expected him to
initiate any transactions in their respective accounts. The SEC found that Rangen’s trading methods were
contrary to his clients’ goals. For example, he used margin accounts and concentrated their equity holdings in
particular securities. Rangen claimed that his actions were justified because his clients were aware of the risks.

Part 2)
Rangen bought U.S. Treasury strips and over-the-counter stocks that did not produce income as sought by his
clients. Rangen claimed that his actions were justified because his firm’s research department recommended the
purchase of the Treasury strips. Also, he claimed the stocks that he bought were all in the top-rated categories of
his firm’s research division. Which of the following statements best describes why Rangen’s arguments, in which
he attempted to shift the blame to his employer, did NOT meet the requirements of the Code and Standards?

Rangen misrepresented the basic characteristics of the investments that he bought for his clients'
A)
accounts.
Rangen did not use reasonable care and judgment to achieve and maintain independence and
B)
objectivity in taking investment actions.
C) Rangen's duty was to make only recommendations that were in the best interests of his clients.

Your answer: B was incorrect. The correct answer was C) Rangen's duty was to make only recommendations that
were in the best interests of his clients.

Rangen cannot shift the blame to his employer. He had an obligation to consider not only his firm's
recommendations, but also his clients' investment objectives and financial situations. He failed to consider
relevant factors relating to his clients. Rangen violated Standard III(C) because he initiated investment actions
without properly considering whether these actions were suitable to his clients' financial situations and investment
objectives.

This question tested from Session 1, Reading 2, LOS a, b, c.

Question 3 - #94971

Which of the following is NOT a key characteristic of the Global Investment Performance Standards (GIPS)?
GIPS:

require firms to use certain calculation and presentation methods and to make certain disclosures
A)
along with the performance record.
require managers to include all actual fee-paying and non-fee-paying discretionary portfolios in
B)
composites defined according to similar strategy and/or investment objective.
do not address every aspect of performance measurement, valuation, attribution, or coverage of all
C)
assets.

Your answer: B was correct!

The GIPS do not require managers to include non-fee-paying accounts in composites (Standard 3.A.1).

This question tested from Session 1, Reading 4, LOS a.

Question 4 - #94924

Mary White, CFA, sits on the board of directors of XYZ Manufacturing, Inc. She discovers that management has
knowingly participated in an activity she knows is illegal. According to the CFA Institute Standards of Professional
Conduct, White is required to:

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A) disassociate herself from the activity.


B) both of these choices are correct.
C) seek legal advice to determine what actions should be taken.

Your answer: B was correct!

Standard I(A), Knowledge of the Law. Prohibition against knowingly practicing or assisting in violation of laws,
rules, and regulations. If White knows that someone has engaged in a possible illegal activity, she should: (1)
report the finding to the appropriate supervisory person at her firm, (2) if the situation is not remedied,
disassociate herself from the situation, and (3) seek legal advice to see what other actions, such as notifying the
proper regulatory agency, should be taken.

This question tested from Session 1, Reading 2-I, LOS A..

Question 5 - #93517

Ron Taylor, a CFA Level I candidate, trades cotton contracts for a small commodity broker. Taylor convinces a
government cotton inspector to issue a warning that the Texas cotton crop is in danger from insect infestation.
The price of cotton soars. Taylor immediately shorts cotton futures. Once the position is created, the government
inspector issues a second report reversing his original opinion and cotton prices plummet.

Cedric Sims, a CFA Level III candidate, would like to generate a tax loss on a security held in his personal
portfolio; however, he believes the security has significant upside potential. To avoid the wash sale provisions of
the income tax code, Sims sells the security and simultaneously creates a synthetic long position using
derivatives.

With regard to Standard II(B) Market Manipulation, which of the following statements concerning Taylor’s and
Sims’s conduct is CORRECT?

A) Neither Taylor nor Sims is in violation of Standard II(B).


B) Both Taylor and Sims are in violation of Standard II(B).
C) Taylor is in violation of Standard II(B), but Sims is not in violation.

Your answer: B was incorrect. The correct answer was C) Taylor is in violation of Standard II(B), but Sims is not in
violation.

Taylor is in violation of Standard II(B) Market Manipulation by creating a scheme that caused others to trade on
false information. Sims is not in violation of Standard II(B). The Standard does not prohibit transactions conducted
for tax purposes.

This question tested from Session 1, Reading 2-II, LOS B..

Question 6 - #93505

Sallie Reid, CFA, is asked by her boss, also a CFA charterholder, to use a research report of a competing firm,
change a few details, sign it and send it to a large client. He says their firm’s researchers will draw the same
conclusions but haven’t gotten to them yet. If she complies, she is doing all of the following EXCEPT:

A) obeying her boss, a CFA charterholder, but violating several of the CFA Institute Code and Standards.
B) violating CFA Institute standards dealing with plagiarism.
C) complying with CFA Institute standards because she cannot disobey her boss.

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Your answer: B was incorrect. The correct answer was C) complying with CFA Institute standards because she
cannot disobey her boss.

If Sallie complies, she is violating Standard I(C) Misrepresentation, because copying the report is plagiarism.
Sallie should attempt to disassociate from any activity that she knows is in violation of the standards.

This question tested from Session 1, Reading 2, LOS a, b, c.

Question 7 - #127409

Dave Kline, CFA, is a personal investment advisor. After a dispute with a coworker on margin policy, he formally
resigns his position by giving suitable notice. However, he does not follow his firm’s established "Transition and
Exit Policies" regarding discussion of the reason for his departure. During his final two weeks of employment,
Kline routinely discusses the margin policy dispute, stating "...anyone who would lend that much money on
securities of such low quality does not belong in this business..." Kline’s statements are in direct violation of the
firm’s "Transition and Exit Policies," but he considers it a free-speech issue. Kline is most likely:

in violation of Standard IV(A) "Loyalty" recommended procedures for failing to notify regulators of the
A)
dangerous margin policy.
B) not in violation of the Code and Standards.
in violation of Standard IV(A) "Loyalty" recommended procedures for failing to follow the employer’s
C)
policies and procedures related to termination policy.

Your answer: B was incorrect. The correct answer was C) in violation of Standard IV(A) "Loyalty" recommended
procedures for failing to follow the employer’s policies and procedures related to termination policy.

Kline is in violation of Standard IV(A) "Loyalty" recommended procedures for failing to follow the employer’s
policies and procedures related to termination policy. Members and candidates should understand and follow their
employer’s policies and operating procedures. Also, members and candidates planning to leave their current
employer must continue to act in the employer’s best interest.

This question tested from Session 1, Reading 2-IV, LOS A..

Question 8 - #94598

When providing outside services, a member should provide all of the following information to her current employer
EXCEPT:

A) the compensation she will receive.


B) the types of services to be provided.
C) a promise to remit an agreed-upon percentage of the proceeds to the current employer.

Your answer: B was incorrect. The correct answer was C) a promise to remit an agreed-upon percentage of the
proceeds to the current employer.

She should provide information about the type of services, the compensation arrangement and the expected
duration of the project.

This question tested from Session 1, Reading 2-IV, LOS A..

Question 9 - #94705

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A CFA charterholder is caught shoplifting and is sentenced to nine months in prison. Is this a violation of Standard
I(D) Misconduct?

A) Yes, because the prison sentence is more than six months.


B) No, because the crime does not relate to the investment profession.
C) Yes, because the crime involved stealing.

Your answer: B was incorrect. The correct answer was C) Yes, because the crime involved stealing.

Any act involving lying, cheating, stealing, or other dishonest conduct that reflects adversely on the
charterholder’s professional activities is a violation of Standard I(D). Although the crime did not relate to the
investment profession, it certainly reflected adversely on the charterholder professionally.

This question tested from Session 1, Reading 2-I, LOS D..

Question 10 - #94606

Luis Rodriguez, CFA, is an analyst at XYZ Investments. He covers a company that is located in a region that is
not easily accessible. The company invites analysts for their annual analyst meeting and pays for the
transportation to the remote location. Rodriguez is:

allowed to accept the payment for transportation because the trip was all business and was out of the
A)
way.
B) allowed to accept the payment for transportation as long as it does not exceed $100.
not allowed to accept the payment for transportation because this is a considered a “perk” and may
C)
influence his independent judgment.

Your answer: A was correct!

Standard I(B) Independence and Objectivity. Analysts should pay for their own travel accommodations if the
location is accessible by normal means. In this situation payment is acceptable because the location is out of the
way and the purpose of the trip is all business.

This question tested from Session 1, Reading 2-I, LOS B..

Question 11 - #94413

Amanda Brad, CFA, is a security analyst at UpTrend, Inc. During a routine visit to a beauty salon, she learns that
a major cosmetic company, Lorean, is expected to present a revolutionary formula for facial cream. Brad buys
Lorean stock for her portfolio and prepares a special report on the company. Brad also makes a call to Hillary
Lang, another security analyst at UpTrend, to inform her about the news. Lang starts trading on her clients’
portfolios. Brad’s report states that given the on-going research activity at Lorean within the last months, investors
can expect some successful new products and a sharp increase in the price of the stock. Lang’s actions:

A) violate the Standard of Objectivity and Independence.


B) violate the Standards because she trades on inside information.
C) violate the Standard of Fair Dealing.

Your answer: B was incorrect. The correct answer was C) violate the Standard of Fair Dealing.

Lang violates Standard III(B), Fair Dealing, which imposes the requirement to start trading on the clients’ portfolios
only after the information is disseminated to all clients.

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This question tested from Session 1, Reading 2, LOS a, b, c.

Question 12 - #93693

Assume a sample of beer prices is negatively skewed. Approximately what percentage of the distribution lies
within plus or minus 2.40 standard deviations of the mean?

A) 95.5%.
B) 58.3%.
C) 82.6%.

Your answer: B was incorrect. The correct answer was C) 82.6%.

Use Chebyshev’s Inequality to calculate this answer. Chebyshev’s Inequality states that for any set of
observations, the proportion of observations that lie within k standard deviations of the mean is at least 1 – 1/k2.
We can use Chebyshev’s Inequality to measure the minimum amount of dispersion whether the distribution is
normal or skewed. Here, 1 – (1 / 2.42) = 1 − 0.17361 = 0.82639, or 82.6%.

This question tested from Session 2, Reading 7, LOS h.

Question 13 - #93997

Jamie Morgan needs to accumulate $2,000 in 18 months. If she can earn 6% at the bank, compounded quarterly,
how much must she deposit today?

A) $1,829.08.
B) $1,832.61.
C) $1,840.45.

Your answer: B was incorrect. The correct answer was A) $1,829.08.

Each quarter of a year is comprised of 3 months thus N = 18 / 3 = 6; I/Y = 6 / 4 = 1.5; PMT = 0; FV = 2,000; CPT
→ PV = $1,829.08.

This question tested from Session 2, Reading 5, LOS d.

Question 14 - #93719

A supervisor is evaluating ten subordinates for their annual performance reviews. According to a new corporate
policy, for every ten employees, two must be evaluated as “exceeds expectations,” seven as “meets
expectations,” and one as “does not meet expectations.” How many different ways is it possible for the supervisor
to assign these ratings?

A) 360.
B) 10,080.
C) 5,040.

Your answer: B was incorrect. The correct answer was A) 360.

The number of different ways to assign these labels is:

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This question tested from Session 2, Reading 8, LOS o.

Question 15 - #95440

The bank discount of a $1,000,000 T-bill with 135 days until maturity that is currently selling for $979,000 is:

A) 6.1%.
B) 5.8%.
C) 5.6%.

Your answer: B was incorrect. The correct answer was C) 5.6%.

($21,000 / 1,000,000) × (360 / 135) = 5.6%.

This question tested from Session 2, Reading 6, LOS e.

Question 16 - #95610

An investor has a $15,000 portfolio consisting of $10,000 in stock A with an expected return of 20% and $5,000 in
stock B with an expected return of 10%. What is the investor’s expected return on the portfolio?

A) 12.2%.
B) 16.7%.
C) 7.9%.

Your answer: B was correct!

Find the weighted mean where the weights equal the proportion of $15,000. [(10,000 / 15,000) × 0.20] + [(5,000 /
15,000 × 0.10] = 16.7%.

This question tested from Session 2, Reading 7, LOS e.

Question 17 - #95813

Which measure of scale has a true zero point as the origin?

A) Nominal scale.
B) Ordinal scale.
C) Ratio scale.

Your answer: B was incorrect. The correct answer was C) Ratio scale.

Ratio scales are the strongest level of measurement; they quantify differences in the size of data and have a true
zero point as the origin.

This question tested from Session 2, Reading 7, LOS a.

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Question 18 - #93876

Which of the following statements about sampling errors is least accurate?

Sampling error is the difference between a sample statistic and its corresponding population
A)
parameter.
B) Sampling errors are errors due to the wrong sample being selected from the population.
C) Sampling error is the error made in estimating the population mean based on a sample mean.

Your answer: B was correct!

Sampling error is the difference between a sample statistic (the mean, variance, or standard deviation of the
sample) and its corresponding population parameter (the mean, variance, or standard deviation of the
population).

This question tested from Session 3, Reading 10, LOS b.

Question 19 - #93918

A random variable that has a countable number of possible values is called a:

A) probability distribution.
B) continuous random variable.
C) discrete random variable.

Your answer: B was incorrect. The correct answer was C) discrete random variable.

A discrete random variable is one for which the number of possible outcomes are countable, and for each
possible outcome, there is a measurable and positive probability. A continuous random variable is one for which
the number of outcomes is not countable.

This question tested from Session 3, Reading 9, LOS b.

Question 20 - #94029

If the null hypothesis is H0: ρ ≤ 0, what is the appropriate alternative hypothesis?

A) Ha: ρ ≠ 0.
B) Ha: ρ > 0.
C) Ha: ρ < 0.

Your answer: A was incorrect. The correct answer was B) Ha: ρ > 0.

The alternative hypothesis must include the possible outcomes the null does not.

This question tested from Session 3, Reading 11, LOS a.

Question 21 - #94272

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A stock portfolio's returns are normally distributed. It has had a mean annual return of 25% with a standard
deviation of 40%. The probability of a return between -41% and 91% is closest to:

A) 90%.
B) 65%.
C) 95%.

Your answer: B was incorrect. The correct answer was A) 90%.

A 90% confidence level includes the range between plus and minus 1.65 standard deviations from the mean. (91
− 25) / 40 = 1.65 and (-41 − 25) / 40 = -1.65.

This question tested from Session 3, Reading 9, LOS l.

Question 22 - #94236

A technical analyst believes stock prices are primarily driven by:

A) specialist trading.
B) market supply and demand forces.
C) the random walk hypothesis.

Your answer: B was correct!

Other assumptions of technical analysis include: Supply and demand is driven by both rational and irrational
behavior, security prices move in trends that persist for long periods of time, and while the cause for changes in
supply and demand are difficult to determine, the actual shifts in supply and demand can be observed in market
price behavior.

This question tested from Session 3, Reading 12, LOS a.

Question 23 - #93933

A sample of size n = 25 is selected from a normal population. This sample has a mean of 15 and a sample
variance of 4. What is the standard error of the sample mean?

A) 0.4.
B) 2.0.
C) 0.8.

Your answer: B was incorrect. The correct answer was A) 0.4.

The standard error of the sample mean is estimated by dividing the standard deviation of the sample by the
square root of the sample size. The standard deviation of the sample is calculated by taking the positive square
root of the sample variance 41/2 = 2. Applying the formula: sx = s / n1/2 = 2 / (25)1/2 = 2 / 5 = 0.4.

This question tested from Session 3, Reading 10, LOS f.

Question 24 - #138294

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An internal combustion engine is best described as a(n):

A) intermediate good.
B) finished good.
C) factor of production.

Your answer: B was incorrect. The correct answer was A) intermediate good.

Engines are most likely to be considered intermediate goods because they are used in the production of such
finished goods as motor vehicles. They are unlikely to be considered finished goods, even though consumers
might occasionally purchase them, because their primary use is in the production of other goods that are driven
by engines.

This question tested from Session 4, Reading 13, LOS a.

Question 25 - #140384

Which of the following statements about indifference curves is most accurate?

A) All bundles of goods on an indifference curve provide equal utility to a consumer.


B) On any indifference curve, the bundle nearest the origin is the consumer’s least preferred bundle.
C) A consumer’s optimal bundle of goods is the bundle at which the indifference curves intersect.

Your answer: B was incorrect. The correct answer was A) All bundles of goods on an indifference curve provide
equal utility to a consumer.

An indifference curve represents all the bundles of two goods that provide equal utility to a particular consumer.
Any bundle on a higher indifference curve is preferred to any bundle on a lower indifference curve. Indifference
curves cannot cross if the consumer’s preferences are transitive (i.e., logically consistent).

This question tested from Session 4, Reading 14, LOS b.

Question 26 - #147068

The demand function for a good is QD = 2000 − 125P and its supply function is QS = −400 + 75P. At a price of
$10, the market for this good exhibits:

A) an equilibrium.
B) excess supply.
C) excess demand.

Your answer: B was incorrect. The correct answer was C) excess demand.

At P = $10, QD = 2000 − 125(10) = 750 and QS = −400 + 75(10) = 350. Quantity demanded is greater than
quantity supplied at this price, so the market exhibits excess demand.

This question tested from Session 4, Reading 13, LOS d.

Question 27 - #97341

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In the short run, price searchers maximize profits by producing output where marginal revenue (MR):

A) equals marginal costs (MC) and charging a price based on the average total cost (ATC) curve.
B) is greater than marginal costs (MC) and charging a price based on the demand curve.
C) equals marginal costs (MC) and charging a price based on the demand curve.

Your answer: B was incorrect. The correct answer was C) equals marginal costs (MC) and charging a price based
on the demand curve.

Price searchers maximize profits by producing an amount of output where MR equals MC and charging a price
based on the demand curve. In the short run, profits or losses occur depending upon where the individual firm’s
ATC curve is in relationship to the demand curve. In the long run, economic profits are zero due to the low
barriers to entry. Important note for the test: regardless of whether a firm is a price taker, price searcher,
monopoly, or oligopoly, all firms will seek to maximize profits and want to produce the ouput where marginal
revenue equals marginal cost.

This question tested from Session 4, Reading 16, LOS b.

Question 28 - #97030

Which type of unemployment describes a situation where workers who have been laid off due to economic
changes and they are unable to find work due to a lack of education or the necessary skills to move into another
available job?

A) Structural.
B) Frictional.
C) Cyclical.

Your answer: B was incorrect. The correct answer was A) Structural.

Structural unemployment is due to structural changes in the economy that eliminate some jobs while generating
job openings for which unemployed workers are not qualified. Cyclical unemployment is when the economy is
operating at less than full capacity.

This question tested from Session 5, Reading 18, LOS d.

Question 29 - #97194

Which of the following is least likely a source of bias in CPI data?

A) Sample selection
B) Quality changes
C) Substitution

Your answer: B was incorrect. The correct answer was A) Sample selection

The three sources of bias associated with CPI data are: new goods, quality changes, and substitution.

This question tested from Session 5, Reading 18, LOS g.

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Question 30 - #140415

Arguments for being concerned about the size of a fiscal deficit least likely include:

A) the crowding-out effect.


B) Ricardian equivalence.
C) a reduction in long-term economic growth.

Your answer: A was incorrect. The correct answer was B) Ricardian equivalence.

If Ricardian equivalence holds, private savings will increase in anticipation of the future taxes required by a fiscal
deficit. The crowding-out effect of government borrowing on private investment and the reduction in long-term
economic growth due to higher future taxes argue in favor of being concerned about the size of a fiscal deficit.

This question tested from Session 5, Reading 19, LOS p.

Question 31 - #138320

As an economic expansion approaches its peak, the economy is most likely to show:

A) a decrease in inventory levels.


B) accelerating sales growth.
C) an increase in the inventory-to-sales ratio.

Your answer: A was incorrect. The correct answer was C) an increase in the inventory-to-sales ratio.

As the economy approaches its peak, sales growth begins to slow, unsold inventories begin to accumulate, and
the inventory-to-sales ratio increases.

This question tested from Session 5, Reading 18, LOS b.

Question 32 - #140425

The international organization whose primary role is settling disputes among trading nations is the:

A) World Bank.
B) World Trade Organization.
C) International Monetary Fund.

Your answer: B was correct!

The role of the World Trade Organization is to deal with rules of global trade and settle trade-related disputes
among nations.

This question tested from Session 6, Reading 20, LOS i.

Question 33 - #143185

An exchange rate at which two parties agree to trade a specific amount of one currency for another a year from
today is called a:

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A) forward exchange rate.


B) spot exchange rate.
C) real exchange rate.

Your answer: B was incorrect. The correct answer was A) forward exchange rate.

A forward exchange rate specifies the amount of two currencies that will be exchanged at a specific point of time
in the future. A transaction that uses the spot exchange rate is one that would occur immediately. A real exchange
rate is one that has been adjusted for the relative inflation rates in two countries, and could be referring to an
exchange rate that prevails at any given time.

This question tested from Session 6, Reading 21, LOS a.

Question 34 - #147081

Country G and Country H have currencies that trade freely and have markets for forward currency contracts. If
Country G has an interest rate greater than that of Country H, the no-arbitrage forward G/H exchange rate is:

A) equal to the G/H spot rate.


B) greater than the G/H spot rate.
C) less than the G/H spot rate.

Your answer: A was incorrect. The correct answer was B) greater than the G/H spot rate.

. If the interest rate in Country G is greater than the interest rate in Country H,

the numerator is greater than the denominator on the right side of the equation. The left side must have the same
relationship, so the forward rate must be greater than the spot rate.

This question tested from Session 6, Reading 21, LOS f.

Question 35 - #89172

Who benefits least from tariffs?

A) Foreign consumers.
B) Domestic producers.
C) Domestic consumers.

Your answer: B was incorrect. The correct answer was C)

Domestic consumers.

A tax imposed on imports is called a tariff, which benefits domestic producers and domestic governments.
Domestic consumers lose through higher prices, less choice of products, and lower quality products.

This question tested from Session 6, Reading 20, LOS e.

Question 36 - #98180

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In the financial statement analysis framework, using the data to address the objectives of the analysis and
deciding what conclusions or recommendations the information supports is best described as:

A) processing the data.


B) analyzing and interpreting the data.
C) reporting the conclusions.

Your answer: B was correct!

The financial statement analysis framework consists of six steps:

1. State the objective and context. Determine what questions the analysis is meant to answer, the form in
which it needs to be presented, and what resources and how much time are available to perform the
analysis.
2. Gather data. Acquire the company’s financial statements and other relevant data on its industry and the
economy. Ask questions of the company’s management, suppliers, and customers, and visit company
sites.
3. Process the data. Make any appropriate adjustments to the financial statements. Calculate ratios. Prepare
exhibits such as graphs and common-size balance sheets.
4. Analyze and interpret the data. Use the data to answer the questions stated in the first step. Decide what
conclusions or recommendations the information supports.
5. Report the conclusions or recommendations. Prepare a report and communicate it to its intended
audience. Be sure the report and its dissemination comply with the Code and Standards that relate to
investment analysis and recommendations.
6. Update the analysis. Repeat these steps periodically and change the conclusions or recommendations
when necessary.

This question tested from Session 7, Reading 22, LOS f.

Question 37 - #98086

Which of the following statements about financial statements and reporting standards is least accurate?

A) Financial statements could potentially take any form if reporting standards didn’t exist.
Reporting standards focus mostly on format and presentation and allow management wide latitude in
B)
assumptions.
C) The objective of financial statements is to provide economic decision makers with useful information.

Your answer: B was correct!

Given the variety and complexity of possible transactions, and the estimates and assumptions a firm must make
when presenting its performance, financial statements could potentially take any form if reporting standards didn’t
exist. Reporting standards ensure that the information is “useful to a wide range of users,” including security
analysts, by making financial statements comparable to one another and narrowing the range within which
management’s estimates can be seen as reasonable. Reporting standards limit the range of assumptions
management can make.

This question tested from Session 7, Reading 24, LOS a.

Question 38 - #98090

An analyst can find a company’s significant accounting methods and estimates in:

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A) only the footnotes.


B) both the footnotes and in the auditor’s opinion.
C) both the footnotes to the financial statements and Management’s Discussion and Analysis.

Your answer: B was incorrect. The correct answer was C) both the footnotes to the financial statements and
Management’s Discussion and Analysis.

Companies that prepare financial statements under IFRS or U.S. GAAP must disclose their accounting policies
and estimates in the footnotes and address those policies and estimates where significant judgment was required
in Management’s Discussion and Analysis. The auditor’s opinion discusses whether policies have been applied
appropriately, but does not include the estimates and policies themselves.

This question tested from Session 7, Reading 24, LOS i.

Question 39 - #95629

Which of the following items is NOT found in the financing cash flow part of the statement of cash flows?

A) Change in long-term debt.


B) Change in retained earnings.
C) Dividends paid.

Your answer: B was correct!

Changes in retained earnings are not included in the calculation of financing cash flows.

This question tested from Session 8, Reading 27, LOS a.

Question 40 - #98138

Which of the following characteristics are required for recognition of a balance sheet asset?

Characteristic #1: Future economic benefits to the firm are probable.

Characteristic #2: The asset is tangible and is obtained at a cost.

Characteristic #1 Characteristic #2

A) Yes Yes
B) Yes No
C) No No

Your answer: A was incorrect. The correct answer was B)


Yes No

An asset is recognized on the balance sheet only if it is probable that it will provide future economic benefits.
Assets can be tangible or intangible. In some cases, assets are acquired without cost, but will be reported to the
extent that they will provide future economic benefit, and thus have value.

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This question tested from Session 8, Reading 26, LOS a.

Question 41 - #97032

If a firm has a net profit margin of 0.05, an asset turnover of 1.465, and a leverage ratio of 1.66, what is the firm's
ROE?

A) 12.16%.
B) 3.18%.
C) 5.87%.

Your answer: B was incorrect. The correct answer was A) 12.16%.

One of the many ways to express ROE = net profit margin × asset turnover × leverage ratio

ROE = (0.05)(1.465)(1.66) = 0.1216

This question tested from Session 8, Reading 28, LOS d.

Question 42 - #127242

At the beginning of 20X3, Creston Company issues $10 million face amount of 6% coupon bonds when the
market rate of interest is 7%. The bonds mature in four years and pay interest annually. Assuming the effective
interest rate method, what is the bond liability Creston will report at the end of 20X3?

A) $9,661,279
B) $10,346,511
C) $9,737,568

Your answer: B was incorrect. The correct answer was C) $9,737,568

Under the effective interest rate method, the bond liability is equal to the present value of the remaining cash
flows discounted at the market rate of interest at the issue date. At the end of this year, there are 3 annual
payments of $600,000 and one payment of $10,000,000 remaining. Using your financial calculator, the present
value is $9,737,568 (N = 3, I = 7, PMT = 600,000, FV = 10,000,000, Solve for PV).

This question tested from Session 9, Reading 32, LOS b.

Question 43 - #95370

If a lease is treated as a finance lease, as compared to being treated as an operating lease, the effect on the
lessee's current ratio and the debt/equity ratio will be an:

Debt/Equity
Current Ratio
Ratio

A) Increase Increase
B) Increase Decrease
C) Decrease Increase

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Your answer: B was incorrect. The correct answer was C)


Decrease Increase

With finance leases the lessee's assets, current liabilities, and long-term liabilities will be greater than if the lease
was an operating lease. With the debt to equity ratio, the liability is in the numerator, which results in an increase
in the ratio. With the current ratio, current liabilities are increased and are in the denominator which results in a
decrease in the ratio.

This question tested from Session 9, Reading 32, LOS h.

Question 44 - #140454

If a firm pledges inventories as collateral for a loan, the firm must:

A) offset the pledged inventories against current liabilities.


B) create a contra asset account in the amount of the pledged inventories.
C) disclose the carrying value of the pledged inventories.

Your answer: B was incorrect. The correct answer was C) disclose the carrying value of the pledged inventories.

Carrying value of inventories pledged as collateral is one of the required disclosures under both IFRS and U.S.
GAAP.

This question tested from Session 9, Reading 29, LOS g.

Question 45 - #87618

Marnie Colston, CFA, suspects one of the companies she covers is committing accounting fraud. She has
uncovered evidence of pressure to increase earnings and weak internal controls. To satisfy the third point of the
fraud triangle, Colston should try to find a sign of:

A) rationalization.
B) motivation.
C) temptation.

Your answer: B was incorrect. The correct answer was A) rationalization.

The fraud triangle has three points: incentive/pressure, opportunity, and attitude/rationalization.

This question tested from Session 10, Reading 33, LOS c.

Question 46 - #87615

Which of the following sets of conditions make up the fraud triangle?

A) Pressure, greed, weakness in internal controls.


B) Opportunity, attitude, greed.
C) Incentive, opportunity, rationalization.

Your answer: B was incorrect. The correct answer was C) Incentive, opportunity, rationalization.

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The fraud triangle has three points: incentive/pressure, opportunity, and attitude/rationalization.

This question tested from Session 10, Reading 33, LOS c.

Question 47 - #87591

Which of the follow characteristics is the least compelling evidence that a company has a conservative financial-
reporting strategy?

A) Fixed assets are carried at book value.


B) Earnings growth has been steady and dependable over the last few years.
C) The LIFO method is used.

Your answer: B was correct!

Steady earnings growth can be a sign of manipulation of the numbers. It is not a sure sign, but of the choices, the
earnings growth is the only one that presents a yellow flag with regard to earnings quality. The LIFO method is
considered more conservative for the income statement than FIFO; FIFO is preferred on the balance sheet
statement – neither is exclusively more conservative. Most fixed assets are carried at book value – that fact alone
says nothing about a company’s financial reporting.

This question tested from Session 10, Reading 33, LOS a.

Question 48 - #87157

Which justification for repurchasing stock is the least valid?

A) Repurchases offer shareholders more choices than cash dividends.


B) A cash dividend increase, in response to short-term excess cash flows, may confuse investors.
C) Shareholders prefer capital gains to cash dividends.

Your answer: B was incorrect. The correct answer was C) Shareholders prefer capital gains to cash dividends.

Some shareholders prefer capital gains, while others prefer dividends. Repurchases offer shareholders the choice
of tendering or not tendering their stock, while cash dividends represent a payment they cannot refuse. Raising
dividends is often seen as a positive signal, but an increase funded by short-term cash flows may not be
sustainable, forcing the company to reduce the dividend later.

This question tested from Session 11, Reading 39, LOS c.

Question 49 - #96559

An analyst who is evaluating a firm’s working capital management would be least likely to be concerned if the
firm’s:

A) number of days of inventory is higher than that of its peers.


B) operating cycle is shorter than that of its peers.
C) total asset turnover is lower than its industry average.

Your answer: B was correct!

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A shorter operating cycle will lead to a shorter cash conversion cycle, other things equal, which is an indication of
better working capital management. Higher days inventory on hand, compared to peer company averages, will
lengthen the cash conversion cycle, an indication of poorer working capital management. Good working capital
management would tend to increase a firm’s total asset turnover since a given amount of sales can be supported
with less working capital (less current assets).

This question tested from Session 11, Reading 40, LOS c.

Question 50 - #96554

Mollette Industries uses the payback period as its primary means for ranking capital projects. Which of the
following most likely describes Mollette Industries with regard to location and management education?

Location Management education

Undergraduate degree or
A) U.S. based firm
lower
Undergraduate degree or
B) European-based firm
lower
C) European-based firm MBA degree or higher

Your answer: A was incorrect. The correct answer was B)


Undergraduate degree or
European-based firm
lower

Despite the theoretical superiority of the NPV and IRR methods for determining and ranking project profitability,
surveys of corporate managers show that a variety of methods are used. Firms that were most likely to use the
payback period method were European firms and management teams with less education.

This question tested from Session 11, Reading 36, LOS f.

Question 51 - #96773

Which of the following is used to illustrate a firm’s weighted average cost of capital (WACC) at different levels of
capital?

A) Marginal cost of capital schedule.


B) Schedule of marginal capital break points.
C) Cost of capital component schedule.

Your answer: B was incorrect. The correct answer was A) Marginal cost of capital schedule.

The marginal cost of capital schedule shows the WACC at different levels of capital investment. It is usually
upward sloping and is a function of a firm’s capital structure and its cost of capital at different levels of total capital
investment.

This question tested from Session 11, Reading 37, LOS k.

Question 52 - #97744

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Which of the following events will reduce a company's weighted average cost of capital (WACC)?

A) An increase in expected inflation.


B) A reduction in the market risk premium.
C) A reduction in the company's bond rating.

Your answer: B was correct!

An increase in either the company’s beta or the market risk premium will cause the WACC to increase using the
CAPM approach. A reduction in the market risk premium will reduce the cost of equity for WACC.

This question tested from Session 11, Reading 37, LOS a.

Question 53 - #97174

Ferryville Radar Technologies has five-year, 7.5% notes outstanding that trade at a yield to maturity of 6.8%. The
company’s marginal tax rate is 35%. Ferryville plans to issue new five-year notes to finance an expansion.
Ferryville’s cost of debt capital is closest to:

A) 4.9%.
B) 2.4%.
C) 4.4%.

Your answer: B was incorrect. The correct answer was C) 4.4%.

Ferryville’s cost of debt capital is kd(1 - t) = 6.8% × (1 - 0.35) = 4.42%. Note that the before-tax cost of debt is the
yield to maturity on the company’s outstanding notes, not their coupon rate. If the expected yield on new par debt
were known, we would use that. Since it is not, the yield to maturity on existing debt is the best approximation.

This question tested from Session 11, Reading 37, LOS f.

Question 54 - #97569

The most likely outcome of adopting a golden parachute, poison pill, or greenmail is a:

A) negative impact on the stock price and a greater possibility for a successful takeover bid.
B) reduced possibility for a successful takeover bid and a positive impact on the stock price.
C) reduced possibility for a successful takeover bid and a negative impact on the stock price.

Your answer: B was incorrect. The correct answer was C) reduced possibility for a successful takeover bid and a
negative impact on the stock price.

Adopting a golden parachute, poison pill, or greenmail are all take-over defenses used to frustrate an acquisition
attempt. The barriers created by such defenses are likely to decrease the value of the stock.

This question tested from Session 11, Reading 41, LOS g.

Question 55 - #97584

Which of the following might be an undesirable trait of a member of the board of directors?

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A) Lack of legal or regulatory problems as a result of working with other firms.


B) Service on the board for more than 10 years.
C) Experience with the technologies, products, and services the firm offers.

Your answer: B was correct!

Service on the board for more than 10 years may indicate knowledge and experience, but may result in a member
becoming too close to management.

This question tested from Session 11, Reading 41, LOS d.

Question 56 - #97516

Which of the following statements concerning Board committees is least accurate?

The nominations committee is responsible for recruiting qualified board members and preparing an
A)
executive management succession plan.
The audit committee has authority over the procedures used to audit the entire corporate group
B)
including subsidiaries and affiliates.
C) Members of the audit committee should be independent experts in accounting and finance.

Your answer: B was correct!

The independent auditor has authority over the audit procedures. The audit committee is responsible for hiring
and supervising the independent auditor.

This question tested from Session 11, Reading 41, LOS e.

Question 57 - #119458

The condition that occurs when a company disburses cash too quickly, stretching the company’s cash reserves, is
best described as a:

A) drag on liquidity.
B) liquidity premium.
C) pull on liquidity.

Your answer: B was incorrect. The correct answer was C) pull on liquidity.

When cash payments are made too quickly, the condition is known as a pull on liquidity. A drag on liquidity occurs
when cash inflows lag.

This question tested from Session 11, Reading 40, LOS a.

Question 58 - #97654

Which of the following would NOT be a good source for information about a company’s proxy voting rules?

A) Company’s articles of organization and by-laws.


B) Firm’s corporate governance statement.

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C) Firm’s annual report.

Your answer: B was incorrect. The correct answer was C) Firm’s annual report.

The annual report would typically not contain this detailed information.

This question tested from Session 11, Reading 41, LOS g.

Question 59 - #97499

Jeffery Marian, an analyst with Arlington Machinery, is estimating a country risk premium to include in his estimate
of the cost of equity for a project Arlington is starting in India. Marian has compiled the following information for his
analysis:

n Indian 10-year government bond yield = 7.20%


n 10-year U.S. Treasury bond yield = 4.60%
n Annualized standard deviation of the Bombay Sensex stock index = 40%.
n Annualized standard deviation of Indian dollar denominated 10-year government bond = 24%
n Annualized standard deviation of the S&P 500 Index = 18%.

The estimated country risk premium for India based on Marian’s research is closest to:

A) 4.3%.
B) 2.6%.
C) 5.8%.

Your answer: B was incorrect. The correct answer was A) 4.3%.

CRP = Sovereign Yield Spread(Annualized standard deviation of equity index ÷ Annualized standard deviation of
sovereign bond market in terms of the developed market currency)

= (0.072 – 0.046)(0.40/0.24) = 0.043, or 4.3%.

This question tested from Session 11, Reading 37, LOS j.

Question 60 - #94391

Which of the following statements about the efficient frontier is NOT correct?

A) The slope of the efficient frontier increases steadily as one moves up the curve.
B) The efficient frontier line bends backwards due to less than perfect correlation between assets.
A portfolio to the left of the efficient frontier is not attainable, while a portfolio to the right of the efficient
C)
frontier is inefficient.

Your answer: A was correct!

This statement should read, "The slope of the efficient frontier decreases steadily as one moves up the curve."
The other statements are true.

This question tested from Session 12, Reading 43, LOS g.

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Question 61 - #93446

Using the following correlation matrix, which two stocks would combine to make the lowest-risk portfolio?
(Assume the stocks have equal risk and returns.)

Stock A B C
A +1 -- --
B - 0.2 +1 --
C + 0.6 - 0.1 +1

A) A and B.
B) C and B.
C) A and C.

Your answer: B was incorrect. The correct answer was A) A and B.

Portfolios A and B have the lowest correlation coefficient and will thus create the lowest-risk portfolio.

The standard deviation of a portfolio = [W12σ12 + W22σ22 + 2W1W2σ1σ2r1,2]1/2

The correlation coefficient, r1,2, varies from + 1 to - 1. The smaller the correlation coefficient, the smaller σportfolio
can be. If the correlation coefficient were - 1, it would be possible to make σportfolio go to zero by picking the proper
weightings of W1 and W2.

This question tested from Session 12, Reading 43, LOS e.

Question 62 - #94032

Which one of the following portfolios cannot lie on the efficient frontier?

Portfolio Expected Return Standard Deviation


A 20% 35%
B 11% 13%
C 8% 10%
D 8% 9%

A) Portfolio D.
B) Portfolio C.
C) Portfolio A.

Your answer: B was correct!

Portfolio C cannot lie on the frontier because it has the same return as Portfolio D, but has more risk.

This question tested from Session 12, Reading 43, LOS g.

Question 63 - #93417

Luis Green is an investor who uses the security market line to determine whether securities are properly valued.

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He is evaluating the stocks of two companies, Mia Shoes and Video Systems. The stock of Mia Shoes is currently
trading at $15 per share, and the stock of Video Systems is currently trading at $18 per share. Green expects the
prices of both stocks to increase by $2 in a year. Neither company pays dividends. Mia Shoes has a beta of 0.9
and Video Systems has a beta of (-0.30). If the market return is 15% and the risk-free rate is 8%, which trading
strategy will Green employ?

Mia Shoes Video Systems

A) Buy Sell
B) Buy Buy
C) Sell Buy

Your answer: B was incorrect. The correct answer was C)


Sell Buy

The required return for Mia Shoes is 0.08 + 0.9 × (0.15-0.08) = 14.3%. The forecast return is $2/$15 = 13.3%. The
stock is overvalued and the investor should sell it. The required return for Video Systems is 0.08 - 0.3 × (0.15-
0.08) = 5.9%. The forecast return is $2/$18 = 11.1%. The stock is undervalued and the investor should buy it.

This question tested from Session 12, Reading 44, LOS h.

Question 64 - #95016

An investor calculates the following statistics on her two-stock (A and B) portfolio.

n σA = 20%
n σB = 15%
n rA,B = 0.32
n WA = 70%
n WB = 30%

The portfolio's standard deviation is closest to:

A) 0.1832.
B) 0.1600.
C) 0.0256.

Your answer: B was correct!

The formula for the standard deviation of a 2-stock portfolio is:


s = [WA2sA2 + WB2sB2 + 2WAWBsAsBrA,B]1/2
s = [(0.72 × 0.22) + (0.32 × 0.152) +( 2 × 0.7 × 0.3 × 0.2 × 0.15 × 0.32)]1/2 = [0.0196 + 0.002025 + 0.004032]1/2 =
0.02565701/2 = 0.1602, or approximately 16.0%.

This question tested from Session 12, Reading 43, LOS e.

Question 65 - #93482

The correlation coefficient between stocks A and B is 0.75. The standard deviation of stock A’s returns is 16%

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and the standard deviation of stock B’s returns is 22%. What is the covariance between stock A and B?

A) 0.0264.
B) 0.3750.
C) 0.0352.

Your answer: B was incorrect. The correct answer was A) 0.0264.

cov1,2 = 0.75 × 0.16 × 0.22 = 0.0264 = covariance between A and B.

This question tested from Session 12, Reading 43, LOS b.

Question 66 - #93367

Beta is least accurately described as:

A) a standardized measure of the total risk of a security.


B) a measure of the sensitivity of a security’s return to the market return.
C) the covariance of a security’s returns with the market return, divided by the variance of market returns.

Your answer: B was incorrect. The correct answer was A) a standardized measure of the total risk of a security.

Beta is a standardized measure of the systematic risk of a security. β = Covr,mkt / σ2mkt. Beta is multiplied by the
market risk premium in the CAPM: E(Ri) = RFR + β[E(Rmkt) – RFR].

This question tested from Session 12, Reading 44, LOS e.

Question 67 - #93472

Betsy Minor is considering the diversification benefits of a two stock portfolio. The expected return of stock A is 14
percent with a standard deviation of 18 percent and the expected return of stock B is 18 percent with a standard
deviation of 24 percent. Minor intends to invest 40 percent of her money in stock A, and 60 percent in stock B.
The correlation coefficient between the two stocks is 0.6. What is the variance and standard deviation of the two
stock portfolio?

A) Variance = 0.03836; Standard Deviation = 19.59%.


B) Variance = 0.02206; Standard Deviation = 14.85%.
C) Variance = 0.04666; Standard Deviation = 21.60%.

Your answer: B was incorrect. The correct answer was A) Variance = 0.03836; Standard Deviation = 19.59%.

(0.40)2(0.18)2 + (0.60)2(0.24)2 + 2(0.4)(0.6)(0.18)(0.24)(0.6) = 0.03836.

0.038360.5 = 0.1959 or 19.59%.

This question tested from Session 12, Reading 43, LOS e.

Question 68 - #93434

Which of the following is an assumption of capital market theory? All investors:

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A) select portfolios that lie above the efficient frontier to optimize the risk-return relationship.
B) see the same risk/return distribution for a given stock.
C) have multiple-period time horizons.

Your answer: B was correct!

All investors select portfolios that lie along the efficient frontier, based on their utility functions. All investors have
the same one-period time horizon, and have the same risk/return expectations.

This question tested from Session 12, Reading 44, LOS f.

Question 69 - #147142

Historically, which of the following asset classes has exhibited the smallest standard deviation of monthly returns?

A) Long-term corporate bonds.


B) Treasury bills.
C) Large-capitalization stocks.

Your answer: B was correct!

Based on data for securities in the United States from 1926 to 2008, Treasury bills exhibited a lower standard
deviation of monthly returns than large-cap stocks or long-term corporate bonds.

This question tested from Session 12, Reading 43, LOS c.

Question 70 - #127352

High risk tolerance, a long investment horizon, and low liquidity needs are most likely to characterize the
investment needs of a(n):

A) defined benefit pension plan.


B) insurance company.
C) bank.

Your answer: A was correct!

A defined benefit pension plan typically has a long investment time horizon, low liquidity needs, and high risk
tolerance. Insurance companies and banks typically have low risk tolerance and high liquidity needs. Banks and
property and casualty insurers typically have short investment horizons.

This question tested from Session 12, Reading 42, LOS b.

Question 71 - #96852

A stock's abnormal rate of return is defined as the:

A) rate of return during abnormal price movements.


B) expected risk-adjusted rate of return minus the market rate of return.

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C) actual rate of return less the expected risk-adjusted rate of return.

Your answer: B was incorrect. The correct answer was C) actual rate of return less the expected risk-adjusted
rate of return.

Abnormal return = Actual return – expected risk-adjusted return

This question tested from Session 12, Reading 44, LOS h.

Question 72 - #131589

Voluntary reporting of performance by hedge fund managers leads to:

A) a downward bias in hedge fund index returns.


B) an upward bias in hedge fund index returns.
C) no appreciable bias in hedge fund index returns.

Your answer: B was correct!

Empirical studies have shown that since hedge fund managers have the option to report performance results only
funds with good results will report. Since funds with poor performance do not report their results, the results of
hedge fund indexes will be biased upwards.

This question tested from Session 13, Reading 47, LOS j.

Question 73 - #147143

An analyst using the capital asset pricing model is most likely to use a security market index as a proxy for:

A) the market return.


B) beta.
C) the risk-free rate.

Your answer: B was incorrect. The correct answer was A) the market return.

The return on a security market index can be used as a proxy for the market return in a pricing model such as the
CAPM.

This question tested from Session 13, Reading 47, LOS g.

Question 74 - #97810

An order placed to protect a short position is called a:

A) stop loss sell.


B) protective call.
C) stop loss buy.

Your answer: B was incorrect. The correct answer was C) stop loss buy.

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A short position profits from declines in stock price and experiences losses as the price rises. A stop loss buy is a
limit order that is placed above the market price. When the stock price reaches the stop price, the limit order is
executed curtailing further loses.

This question tested from Session 13, Reading 46, LOS g.

Question 75 - #97352

Which of the following is least likely a service provided by an underwriter in the primary market?

A) Origination.
B) Diversification.
C) Risk Bearing.

Your answer: B was correct!

The underwriter provides the following services to the issuer:

n Origination, which involves the design, planning, and registration of the issue.
n Risk bearing, which means the underwriter guarantees the price by purchasing the securities.
n Distribution, which is the sale of the issue.

This question tested from Session 13, Reading 46, LOS i.

Question 76 - #97055

The statement, "Stock prices fully reflect all information from public and private sources," can be attributed to
which form of the efficient market hypothesis (EMH)?

A) Semistrong-form EMH.
B) Strong-form EMH.
C) Weak-form EMH.

Your answer: B was correct!

This is the definition of the strong-form EMH. Private sources include insider information, such as persons holding
monopolistic access to information relevant to the formation of prices.

This question tested from Session 13, Reading 48, LOS d.

Question 77 - #98236

Which of the following forms of the EMH assumes that no group of investors has monopolistic access to relevant
information?

A) Strong-form.
B) Weak-form.
C) Both weak and semistrong form.

Your answer: B was incorrect. The correct answer was A) Strong-form.

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According to the strong-form EMH, security prices reflect all information, which includes the privately available
(monopolistic) information.

This question tested from Session 13, Reading 48, LOS d.

Question 78 - #96232

A stock is expected to pay a dividend of $1.50 at the end of each of the next three years. At the end of three years
the stock price is expected to be $25. The equity discount rate is 16 percent. What is the current stock price?

A) $24.92.
B) $17.18.
C) $19.39.

Your answer: B was incorrect. The correct answer was C) $19.39.

The value of the stock today is the present value of the dividends and the expected stock price, discounted at the
equity discount rate:

$1.50/1.16 + $1.50/1.162 + $1.50/1.163 + $25.00/1.163 = $19.39

This question tested from Session 14, Reading 51, LOS e.

Question 79 - #96444

General, Inc., has net income of $650,000 and one million shares outstanding. The profit margin is 6 percent and
General, Inc., is selling for $30.00. The price/sales ratio is equal to:

A) 2.77.
B) 0.65.
C) 10.83.

Your answer: B was incorrect. The correct answer was A) 2.77.

6% profit margin = $650,000/x; x (sales) = $10,833,333.


Sales per share = $10.83 M/1,000,000 = $10.83 per share.
P/Sales = $30.00/$10.83 = 2.77.

This question tested from Session 14, Reading 51, LOS h.

Question 80 - #96211

If a stock sells for $50 that has an expected annual dividend of $2 and has a sustainable growth rate of 5%, what
is the market discount rate for this stock?

A) 7.5%.
B) 10.0%.
C) 9.0%.

Your answer: A was incorrect. The correct answer was C) 9.0%.

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k = [(D1 / P) + g] = [(2/50) + 0.05] = 0.09, or 9.00%.

This question tested from Session 14, Reading 51, LOS e.

Question 81 - #96403

Which of the following is least likely a reason the price to cash flow (P/CF) model has grown in popularity?

A) CFs are generally more difficult to manipulate than earnings.


B) CFs are used extensively in valuation models.
C) CFs are more easily estimated than future dividends.

Your answer: B was incorrect. The correct answer was C) CFs are more easily estimated than future dividends.

CFs are not easier to estimate than dividends.

This question tested from Session 14, Reading 51, LOS g.

Question 82 - #96248

The following data pertains to a common stock:

n It will pay no dividends for two years.


n The dividend three years from now is expected to be $1.
n Dividends are expected to grow at a 7% rate from that point onward.

If an investor requires a 17% return on this stock, what will they be willing to pay for this stock now?

A) $ 7.30.
B) $10.00.
C) $ 6.24.

Your answer: B was incorrect. The correct answer was A) $ 7.30.

time line = $0 now; $0 in yr 1; $0 in yr 2; $1 in yr 3.


P2 = D3/(k - g) = 1/(.17 - .07) = $10
Note the math. The price is always one year before the dividend date.
Solve for the PV of $10 to be received in two years.
FV = 10; n = 2; i = 17; compute PV = $7.30

This question tested from Session 14, Reading 51, LOS e.

Question 83 - #96356

A company has 8 percent preferred stock outstanding with a par value of $100. The required return on the
preferred is 5 percent. What is the value of the preferred stock?

A) $160.00.
B) $152.81.
C) $100.00.

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Your answer: B was incorrect. The correct answer was A) $160.00.

The annual dividend on the preferred is $100(.08) = $8.00. The value of the preferred is $8.00/0.05 = $160.00.

This question tested from Session 14, Reading 51, LOS d.

Question 84 - #97167

A corporation may issue asset backed securities because:

A) it wants to change the structure of its balance sheet.


B) both of the reasons are valid.
C) it wants to reduce the cost of borrowing.

Your answer: B was correct!

Both of the reasons are valid.

This question tested from Session 15, Reading 54, LOS i.

Question 85 - #97152

Which of the following statements does NOT describe a characteristic of an illiquid asset or market?

A) Large block trades that do not materially affect prices.


B) Small trading volumes.
C) Wide bid-ask spreads.

Your answer: B was incorrect. The correct answer was A) Large block trades that do not materially affect prices.

In a liquid market with large trading volumes, large block trades should not affect prices. The other choices are
characteristics of illiquid markets or assets.

This question tested from Session 15, Reading 53, LOS k.

Question 86 - #96723

Which of the following statements concerning municipal bonds is NOT correct?

A) Before-tax yields on municipal bonds are usually lower than before-tax yields on Treasury bonds.
The vast majority of municipal bonds sell at lower yields because their bond interest is exempt from
B)
federal income tax.
C) Municipal bonds have lower risk than Treasury bonds because of their lower yield.

Your answer: B was incorrect. The correct answer was C) Municipal bonds have lower risk than Treasury bonds
because of their lower yield.

Treasury bonds are considered default free and have the least amount of risk. After-tax yields are highest for
individuals in the highest tax bracket who benefit the most from the municipal bond’s tax-exempt status. Before
tax yields on municipal bonds are lower due to their tax shield.

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This question tested from Session 15, Reading 54, LOS g.

Question 87 - #97275

Assuming a flat term structure of interest rates of 5%, the duration of a zero-coupon bond with 5 years remaining
to maturity is closest to:

A) 4.35.
B) 5.00.
C) 3.76.

Your answer: B was correct!

The duration of a zero coupon bond is approximately equal to its time to maturity.

This question tested from Session 15, Reading 53, LOS f.

Question 88 - #97634

Which of the following investors faces the least inflation risk? An investor whose portfolio is concentrated in:

A) long-term treasury bonds.


B) equity securities.
C) fixed-rate certificates of deposit.

Your answer: B was correct!

Inflation risk refers to the possibility that prices of general goods and services will increase in the economy.
Empirical evidence shows that equity securities, or stocks, have the least inflation risk of the investments listed
here. Since fixed coupon bonds pay a constant coupon, increasing prices erode the buying power associated with
bond payments. Fixed-rate certificates of deposit have high inflation risk.

This question tested from Session 15, Reading 53, LOS m.

Question 89 - #98103

The interest rate paid on negotiable CDs by banks in London is referred to as:

A) the Fed Funds rate.


B) the London rate.
C) LIBOR.

Your answer: B was incorrect. The correct answer was C) LIBOR.

The interest rate paid on negotiable CDs by banks in London is referred to as LIBOR. LIBOR is determined every
day by the British Bankers Association. The Fed Funds rate is the rate paid on interbank loans within the U.S. The
London rate is a fabricated term in this context.

This question tested from Session 15, Reading 55, LOS j.

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Question 90 - #96096

Consider a bond that pays an annual coupon of 5% and that has three years remaining until maturity. Assume the
term structure of interest rates is flat at 6%. If the term structure of interest rates does not change over the next
twelve-month interval, the bond's price change (as a percentage of par) will be closest to:

A) 0.84.
B) -0.84.
C) 0.00.

Your answer: A was correct!

The bond price change is computed as follows:

Bond Price Change = New Price − Old Price = (5/1.06 + 105/1.062) − (5/1.06 + 5/1.062 + 105/1.063) = 98.17 −
97.33 = 0.84.

The value -0.84 is the correct price change but the sign is wrong. The value 0.00 is incorrect because although
the term structure of interest rates does not change the bond price increases since it is selling at a discount
relative to par.

This question tested from Session 16, Reading 56, LOS d.

Question 91 - #95925

Answering an essay question on a midterm examination, a finance student writes these two statements:

Statement 1: The value of a fixed income security is the sum of the present values of all its expected future
coupon payments.

Statement 2: The steps in the bond valuation process are to estimate the bond’s cash flows, determine the
appropriate discount rate, and calculate the present value of the expected cash flows.

With respect to the student's statements:

A) only one is correct.


B) both are correct.
C) both are incorrect.

Your answer: B was incorrect. The correct answer was A) only one is correct.

Statement 1 is incorrect. The value of a fixed income security is the sum of the present values of its expected
future coupon payments and its future principal repayment. Statement 2 is correct. The three steps in the bond
valuation process are to estimate the cash flows over the life of the security; determine the appropriate discount
rate based on the risk of the cash flows; and calculate the present value of the cash flows using the appropriate
discount rate.

This question tested from Session 16, Reading 56, LOS a.

Question 92 - #96086

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A 12-year, $1,000 face value zero-coupon bond is priced to yield a return of 7.50% compounded semi-annually.
What is the bond’s price?

A) $250.00
B) $419.85.
C) $413.32.

Your answer: B was incorrect. The correct answer was C) $413.32.

Using an equation: Pricezerocoupon = Face Value × [ 1 / ( 1 + i/n)n × 2]

Here, Pricezerocoupon = 1000 × [ 1 / (1+ 0.075/2)12 × 2] = 1000 × 0.41332 = 413.32.

Using the calculator: N = (12 × 2) = 24, I/Y = 7.50 / 2 = 3.75, FV = 1000, PMT = 0. PV = -413.32

This question tested from Session 16, Reading 56, LOS e.

Question 93 - #95971

When a bond's coupon rate is greater than its current yield, and its current yield is greater than its yield to
maturity, the bond is a:

A) discount bond.
B) premium bond.
C) par value bond.

Your answer: B was correct!

For a premium bond, coupon rate > current yield > yield to maturity.
For a par bond, coupon rate = current yield = yield to maturity.
For a discount bond, coupon rate < current yield < yield to maturity.

This question tested from Session 16, Reading 57, LOS b.

Question 94 - #96108

An investor gathers the following information about three U.S. Treasury annual coupon bonds:

Bond #1 Bond #2 Bond #3


Maturity 2-year 1-year 2-year
Price $10,000 $476.19 $9,500
Coupon 5% 0% 0%
Par Value $10,000 $500 $10,500
Misvaluation $0 $0 ?

If bond price converge to their arbitrage-free value, what should happen to the price of Bond #3?

A) Buying pressure should decrease its value.


B) Buying pressure should increase its value.

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C) Selling pressure should decrease its value.

Your answer: B was correct!

Currently, an arbitrage opportunity exists with the three bonds. An investor could purchase Bonds #2 and #3 and
sell Bond #1 for an arbitrage-free profit of $23.81 (10,000 + -476.19 + -9,500). This action will result in positive
income today in return for no future obligation – an arbitrage opportunity. Hence, buying pressure on Bond #3
should increase its value to the point where the arbitrage opportunity would cease to exist.

This question tested from Session 16, Reading 56, LOS f.

Question 95 - #147169

An indicator of decreasing credit risk for a sovereign bond is an increase in:

A) corruption.
B) debt as a percentage of GDP.
C) income per capita.

Your answer: B was incorrect. The correct answer was C) income per capita.

An increase in income per capita improves a sovereign’s ability to repay its debts by increasing tax revenue. The
other choices indicate increasing sovereign credit risk.

This question tested from Session 16, Reading 59, LOS j.

Question 96 - #95066

A currency forward contract:

A) requires a payment at settlement based on London Interbank Offered Rate.


B) can be a deliverable contract.
C) is priced using the future interest rate on a foreign currency.

Your answer: B was correct!

A currency forward contract can be a deliverable or cash-settlement contract. It is a contract to exchange fixed
amounts of two currencies at settlement and its value depends on market exchange rates at contract expiration.

This question tested from Session 17, Reading 61, LOS h.

Question 97 - #95716

A futures contract is least likely to be:

A) illiquid.
B) regulated.
C) standardized.

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Your answer: B was incorrect. The correct answer was A) illiquid.

Futures contracts are standardized and subject to governmental and exchange regulation. They are actively
traded in the secondary market.

This question tested from Session 17, Reading 62, LOS a.

Question 98 - #95014

The settlement price for a futures contract is:

A) the price of the last trade of a futures contract at the end of the trading day.
B) an average of the trade prices during the ‘closing period’.
C) the price of the asset in the future for all trades made in the same day.

Your answer: B was correct!

The margin adjustments are made based on the settlement price, which is calculated as the average trade price
over a specific closing period at the end of the trading day. The length of the closing period is set by the
exchange.

This question tested from Session 17, Reading 62, LOS c.

Question 99 - #95284

Standardization features of futures contracts do not include the:

A) delivery time.
B) delivery price of the commodity.
C) quality of the good that can be delivered.

Your answer: B was correct!

The delivery, or spot price at contract expiration, of a commodity is a variable and cannot be included in a futures
contract. Quality and delivery time are both part of the standardized terms of a futures contract.

This question tested from Session 17, Reading 62, LOS a.

Question 100 - #95379

Consider the following four options on the same underlying instrument:

Option 1: September call, exercise price = $55.


Option 2: September call, exercise price = $60.
Option 3: December put, exercise price = $75.
Option 4: December put, exercise price = $80.

What is most likely the relationship among the values of these options?

September calls December puts

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A) Option 1 > Option 2 Option 4 > Option 3


B) Option 2 > Option 1 Option 3 > Option 4
C) Option 1 > Option 2 Option 3 > Option 4

Your answer: A was correct!

For options that differ only by exercise price, a call with a lower exercise price typically has more value than a call
with a higher exercise price because the underlying instrument can be purchased at a lower price. A put with a
higher exercise price typically has more value than a put with a lower exercise price because the underlying
instrument can be sold for a higher price.

This question tested from Session 17, Reading 63, LOS l.

Question 101 - #95617

Which of the following statements is CORRECT concerning the above diagram? Counterparty:

A) B pays a fixed rate to counterparty A.


B) B will gain in the swap when interest rates increase.
C) A will gain in the swap when interest rates increase.

Your answer: B was incorrect. The correct answer was C) A will gain in the swap when interest rates increase.

From the diagram, counterparty A pays fixed to and receives variable from counterparty B. As interest rates rise,
counterparty B owes counterparty A higher variable payments.

This question tested from Session 17, Reading 64, LOS b.

Question 102 - #95288

A forward rate agreement is equivalent to:

A) a long interest rate call and a written interest rate put.


B) either an interest rate put or an interest rate call.
C) a swap.

Your answer: B was incorrect. The correct answer was A) a long interest rate call and a written interest rate put.

A long forward rate agreement is equivalent to a call (profits when interest rates go up) and a written put (losses
when interest rates go down).

This question tested from Session 17, Reading 63, LOS f.

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Question 103 - #95282

All of the following are characteristics of futures contracts EXCEPT:

A) they are liquid.


B) they trade in a dealer (over the counter) market.
C) the contract size is standardized.

Your answer: B was correct!

Futures contracts trade on organized exchanges; forward contracts are created by dealers.

This question tested from Session 17, Reading 62, LOS a.

Question 104 - #95020

Madison Bailey recently purchased a futures contract. The transaction did NOT:

A) take place through a private party.


B) use a structured contract.
C) include a guaranty by a clearinghouse.

Your answer: B was incorrect. The correct answer was A) take place through a private party.

A futures transaction is an exchange-traded contract. A forward contract occurs between private parties. The
following table illustrates the differences between forwards and futures:

Forwards Futures
Private contracts Exchange-traded contracts
Unique contracts Structured contracts
Default Risk Guaranteed by clearinghouse
No up front cash Margin Account
Low/no regulation Regulated

This question tested from Session 17, Reading 62, LOS b.

Question 105 - #95280

Which of the following statements regarding futures contracts is least accurate?

A) The exchange sets the times of trading for futures contracts.


B) Price fluctuations can be any amount.
C) The long will have gains when the futures price rises above the initial contract price.

Your answer: B was correct!

The minimum price fluctuation, called a ‘tick’, is set by the exchange. The other statements are true

This question tested from Session 17, Reading 62, LOS a.

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Question 106 - #95583

Consider a swap with a notional principal of $100 million.

Given the above diagrams, which of the following statements is CORRECT? At time period 2:

A) A pays B $2 million.
B) A pays B $7 million and B pays A $8 million.
C) B pays A $1 million.

Your answer: B was incorrect. The correct answer was C) B pays A $1 million.

The variable rate to be used at time period 2 is set at time period 1 (the arrears method). Therefore, the
appropriate variable rate is 7%, the fixed rate is 8%, and the interest payments are netted. The fixed-rate payer,
counterparty B, pays according to:

(Swap Fixed Rate – LIBORt-1)(# of days/360)(Notional Principal).

In this case, we have (0.08 - 0.07)(360/360)($100 million) = $1 million

This question tested from Session 17, Reading 64, LOS b.

Question 107 - #95697

Which of the following statements about moneyness is most accurate? When the stock price is:

A) above the strike price, a put option is in-the-money.


B) above the strike price, a put option is out-of-the-money.
C) below the strike price, a call option is in-the-money.

Your answer: B was correct!

When the stock price is above the strike price, a put option is out-of-the-money.

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When the stock price is below the strike price, a call option is out-of-the-money.

This question tested from Session 17, Reading 63, LOS c.

Question 108 - #147172

The least likely additional risk borne by including alternative investments in a portfolio of traditional investments is:

A) liquidity risk.
B) market risk.
C) counterparty risk.

Your answer: B was correct!

Market risk is already a risk traditional investments assume. Liquidity and counterparty risks are additional risks
investors in alternative investments assume.

This question tested from Session 18, Reading 66, LOS a.

Question 109 - #147198

In which of the following alternative investments is an investor most likely to require a liquidity premium?

A) Real estate investment trusts.


B) Commodity futures.
C) Private equity funds.

Your answer: B was incorrect. The correct answer was C) Private equity funds.

Private equity funds tend to have lockup periods; investors will require liquidity premiums as compensation. REITs
and commodity futures are exchange-traded instruments and much more liquid than private equity funds.

This question tested from Session 18, Reading 66, LOS g.

Question 110 - #147183

An advantage of investing in real estate is that real estate:

A) is very liquid although transactions are complex.


B) can provide a potential inflation hedge.
C) provides limited liability if directly owned.

Your answer: A was incorrect. The correct answer was B) can provide a potential inflation hedge.

Real estate can provide a potential inflation hedge because rents and real estate values tend to increase with
inflation. Real estate is not liquid. Direct real estate ownership may provide limited liability only if it is structured
appropriately as a limited partnership or other corporate structure.

This question tested from Session 18, Reading 66, LOS d.

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Question 111 - #147190

A Canadian hedge fund has a value of C$100 million at the beginning of the year. The fund charges a 2%
management fee based on assets under management at the beginning of the year and a 20% incentive fee with a
10% hard hurdle rate. Incentive fees are calculated net of management fees. The value at the end of the year
before fees is C$112 million. The net return to investors is closest to:

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

Your answer: B was incorrect. The correct answer was A) 10%.

Management Fee: C$100.0 × 2.0% = C$2.0 million


Gross value at end of year (given) = C$112.0 million
Incentive fee = [(C$112.0 − C$100.0 − C$2.0 − (C$100.0 × 10.0%)] × 20% = C$0
Total fee = C$2.0 million
Net of fee: C$112.0 − C$2.0 = C$110.0 million
Net return = (C$110.0 / C$100.0) − 1 =10.0%

This question tested from Session 18, Reading 66, LOS f.

Question 112 - #100684

Which of the following best defines a backwardated commodities market?

A) The futures price is below the current spot price.


B) The futures price is below the expected future spot price.
C) The futures price is above the current spot price.

Your answer: B was incorrect. The correct answer was A) The futures price is below the current spot price.

A backwardated commodities market occurs when the futures price is below the current spot price.

This question tested from Session 18, Reading 67, LOS a.

Question 113 - #147177

The most prevalent types of private equity funds are:

A) venture capital funds.


B) leveraged buyout funds.
C) distressed securities funds.

Your answer: B was correct!

Leveraged buyout funds comprise the majority of private equity investment funds.

This question tested from Session 18, Reading 66, LOS b.

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Question 114 - #147197

An example of a downside risk measure for due diligence is:

A) value at risk.
B) Sharpe ratio.
C) standard deviation.

Your answer: B was incorrect. The correct answer was A) value at risk.

Value at risk (VaR) is a downside risk measure that estimates the potential loss from outcomes in the left tail of
the distribution of returns.

This question tested from Session 18, Reading 66, LOS g.

Question 115 - #147186

Using private equity standard deviations and returns for portfolio optimization is problematic because:

A) backfill bias can lead to understated returns.


B) infrequent revaluations can lead to overstated standard deviations.
C) survivorship bias can lead to overstated returns.

Your answer: B was incorrect. The correct answer was C) survivorship bias can lead to overstated returns.

Private equity return data may suffer from survivorship bias and backfill bias, both of which lead to overstated
returns. Because portfolio companies are revalued infrequently, reported standard deviations of returns may be
understated.

This question tested from Session 18, Reading 66, LOS e.

Question 116 - #100692

The component of the return on a futures position that results from interest earned on U.S. Treasury bills
deposited to establish the position is called the:

A) roll yield.
B) current yield.
C) collateral yield.

Your answer: B was incorrect. The correct answer was C) collateral yield.

Collateral yield is the return earned on the collateral posted to satisfy margin requirements. In most cases, the
collateral posted will be U.S. Treasury Bills, in which case the collateral yield is the T-bill yield.

This question tested from Session 18, Reading 67, LOS b.

Question 117 - #147276

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In the valuation of a real estate investment trust (REIT), subtracting the REIT’s liabilities from the value of its real
estate assets and dividing by the number of shares outstanding provides an estimate of the REIT’s:

A) free cash flow per share.


B) net asset value.
C) adjusted funds from operations.

Your answer: B was correct!

An asset-based approach to valuing a REIT is to estimate its net asset value as the difference between the value
of the REIT’s real estate assets and its liabilities, divided by the number of shares outstanding.

This question tested from Session 18, Reading 66, LOS e.

Question 118 - #147179

A hedge fund strategy that takes positions in shares of firms undergoing restructuring or acquisition is an:

A) event driven strategy.


B) macro strategy.
C) equity hedge strategy.

Your answer: B was incorrect. The correct answer was A) event driven strategy.

Event-driven strategies include merger arbitrage, distressed/restructuring, and special situations strategies that
involve long or short positions in common equity, preferred equity, or debt of a specific corporation. Macro
strategies are based on global economic trends and events, and may involve long or short positions in equities,
fixed income, currencies, or commodities. Equity hedge strategies seek to profit from long and short positions in
publicly traded equities and derivatives with equities as their underlying assets, but are not based on events such
as restructuring or acquisition.

This question tested from Session 18, Reading 66, LOS d.

Question 119 - #122506

The active management that is required to maintain a long-only commodity index strategy is least likely to affect
the:

A) price return.
B) roll yield.
C) collateral yield.

Your answer: B was incorrect. The correct answer was A) price return.

To maintain long exposure to an index of commodity prices, the manager must periodically roll over expiring
futures contracts. The manager must also manage the short-term debt posted as collateral, replacing bills as they
mature. The manager can enhance the strategy’s roll yield and collateral yield by carrying out these transactions
in ways that minimize costs and take best advantage of market conditions. Price return on the index strategy
depends on the direction of prices of the commodities in the index.

This question tested from Session 18, Reading 67, LOS c.

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