AnsCFA Level I Mock Exam A - February 2022

CFA Level I Mock Exam A - February 2022
Morning Session
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Q1. The CFA Institute Code of Ethics and Standards of Professional Conduct are most
likely designed to foster and reinforce a culture of:
A. responsibility and professionalism.
B. regulatory compliance.
C. service to the firm.
Solution
A is correct. The CFA Institute Code of Ethics and Standards of Professional Conduct are
designed to foster and reinforce a culture of responsibility and professionalism. The Code and
Standards apply to all members and candidates regardless of title, position, occupation,
geographic location, or specific situation, and they apply to all professional activities of
investment professionals.
B is incorrect. The CFA Institute Code of Ethics and the Standards of Professional Conduct
are not designed to foster and reinforce a culture of regulatory compliance.
C is incorrect. The CFA Institute Code of Ethics and the Standards of Professional Conduct
are not designed to foster and reinforce a culture of service to the firm.
Ethics and Trust in the Investment Profession Learning Outcome

b. Describe the role of a code of ethics in defining a profession
Q2. Examples of the beneficial features of using an ethical decision-making framework least
likely includes analyzing:
A. the best course of action when alternatives are available.
B. the decision maker’s perspective of contemplated actions.
C. a broader picture from a long-term point of view.
Solution
B is correct. An ethical decision-making framework helps a decision maker see the situation
from multiple perspectives, not just from her personal perspective, and pay attention to
aspects of the situation that may be less evident if a short-term, self-focused perspective is
applied.
A is incorrect because an ethical decision making framework helps a decision-maker see the
best course of action when alternatives are available.
C is incorrect because an ethical decision making framework helps a decision-maker see a

situation from multiple perspectives and pay attention to aspects of the situation that may be
less evident if a short-term, not a long -term, self-focused perspective is applied.
Ethics and Trust in the Investment Profession Learning Outcome

f. Identify challenges to ethical behavior
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Q3. Disclosure of confidential CFA exam information will most likely be detected by the
Professional Conduct staff through:
A. monitoring online and social media.
B. analysis of Proctor Reports.
C. annual Professional Conduct Statements.
Solution
A is correct. Professional Conduct inquiries come from a number of sources including the
monitoring of online and social media to detect disclosure of confidential exam information.
B is incorrect. Candidate conduct is monitored by exam proctors who complete reports on
candidates suspected to have violated testing rules during the exam and at the exam center.
C is incorrect. Members and candidates must self-disclose on the annual Professional

Conduct Statement all matters that question their professional conduct, such as involvement
in civil litigation or a criminal investigation or being the subject of a written complaint.
Disclosure of confidential exam information will not be found on the annual statement.
Code of Ethics and Standards of Professional Conduct Learning

Outcome
a. Describe the structure of the CFA Institute Professional Conduct Program and the process
for the enforcement of the Code and Standards
Q4. Which CFA Institute Standard of Professional Conduct most likely includes a sub-section
entitled “Communication with Clients and Prospective Clients”?
A. Investment Analysis, Recommendations, and Actions
B. Conflicts of Interest
C. Duties to Clients
Solution
A is correct. Standard V–Investment Analysis, Recommendations, and Actions includes the
sub-section Communication with Clients and Prospective Clients. The other sub-sections
within Standard V include Diligence and Reasonable Basis and Record Retention.
B is incorrect because Standard V–Investment Analysis, Recommendations, and Actions
includes the sub-section Communication with Clients and Prospective Clients.
C is incorrect because Standard V–Investment Analysis, Recommendations, and Actions

includes the sub-section Communication with Clients and Prospective Clients.
Code of Ethics and Standards of Professional Conduct Learning

Outcome
b. Identify the six components of the Code of Ethics and the seven Standards of Professional
Conduct
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Chan Liu, CFA, is the new research manager at the Pacific MicroCap Fund. Liu observed the
following activities after she published a research report on a thinly traded micro cap stock
that included a “buy” recommendation:
 Pacific traders purchased the stock for Pacific’s proprietary account and then purchased
the same stock for all client accounts; and
 Pacific marketing department employees disseminated positive, but false, information
about this stock in widely read Internet forums.
Q5. Liu notes the stock’s price increased more than 50% within a period of two days and was
then sold for Pacific’s account. Which of the following steps is most appropriate for Liu to
take to avoid violating the CFA Institute Code of Ethics and Standards of Professional
Conduct?
A. Report the observed activities to her employer.

B. Remove her name from the micro cap stock research report.
C. Publicly refute the false information posted on Internet forums.
Solution
A is correct because certain staff at Liu’s employer appear to be engaged in front-running, a
violation of Standard VI(B)–Priority of Transactions, and market manipulation, a violation of
Standard II(B)–Market Manipulation. If Liu observes these violations without taking steps to
notify her employer, she will be in violation of Standard I(A)–Knowledge of the Law. Liu
should know that the conduct observed is likely a violation of applicable laws, rules, and
regulations and is a violation of the CFA Institute Code and Standards. Her first step,
therefore, should be to attempt to stop the behavior by bringing it to the attention of the
employer through a supervisor or the firm’s compliance department. Inaction may be
construed as participation or assistance in the illegal or unethical conduct.
B is incorrect because the firm the member is employed by appears to be engaged in a classic
pump and dump stock fraud and market manipulation scheme. Removing her name from the
firm’s investment recommendation would not alleviate the member from her more immediate
responsibilities under Standard I(A)–Knowledge of the Law because the firm and the member
must not knowingly participate or assist in and must dissociate from any violations of such
laws, rules, or regulations. Now that the member knows of the violations, she must dissociate
from them. Inaction may be construed as participation or assistance in the illegal or unethical
conduct.
C is incorrect because the firm the member is employed by appears to be engaged in a classic
pump and dump stock fraud and market manipulation scheme and the member must not
knowingly participate or assist in and must dissociate from any violations of such laws, rules,
or regulations as required by Standard I(A)–Knowledge of the Law. Inaction may be
construed as participation or assistance in the illegal or unethical conduct.
Guidance for Standards I–VII Learning Outcome

c. Recommend practices and procedures designed to prevent violations of the Code of Ethics
and Standards of Professional Conduct
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Q6. Ri Lin, CFA, is a Portfolio Manager with Dynasty Investment Management. Lin is
performing research on Titan Mining for potential inclusion in his fund. Management at Titan
is interested in having a well-known fund manager such as Lin as a shareholder. Titan pays
for Lin to fly to a company retreat in Tokyo, where a brief introductory meeting is followed
by attending a sporting event and then dinner at one of the city’s top restaurants. Lin
participates after disclosing the activities to Dynasty’s compliance department. Which
standard did Lin’s actions most likely violate?
A. Disclosures of Conflicts
B. Independence and Objectivity
C. Diligence and Reasonable Basis
Solution
B is correct because Lin is placing himself in a situation where his objectivity or appearance
of objectivity may be compromised, which is a violation of Standard I(B). It would have been
more advisable for Lin to decline having Titan pay for this trip.
A is incorrect because Lin does disclose the activities to Dynasty’s compliance department. If
Lin recommends the security, he may also want to disclose that he went on this company
sponsored trip at that time.
C is incorrect because participating in this trip done not prevent Lin from performing the
required analysis to make an informed investment decision.

b. Identify conduct that conforms to the Code and Standards and conduct that violates the
Code and Standards
Q7. Jean-Luc Schlumberger, CFA, is an independent research analyst providing equity

research on companies listed on exchanges in emerging markets. He often incorporates
statistical data he obtains from the web sites of the World Bank and the central banks of
various countries into the body of his research reports. While not indicated within the reports,
whenever his clients ask where he gets his information he informs them the information is in
the public domain but he doesn’t keep his own records. When the clients ask for the specific
web site addresses he provides the information. Which Standard has Schlumberger least
likely violated?
A. Record Retention
B. Misrepresentation
C. Performance Presentation
Solution
C is correct because Standard III(D)–Performance Presentation pertains to investment
performance information, and there is no indication any violation has occurred.
A is incorrect because under Standard V(C)–Record Retention, Members and Candidates
must develop and maintain appropriate records to support their investment analyses,
recommendations, actions, and other investment-related communications with clients and
prospective clients.
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B is incorrect because Schlumberger has plagiarized the information he obtained from the
websites of the World Bank and the various central banks by not quoting the sources within
his research reports. This is a violation of Standard I(C)–Misrepresentation.
Guidance for Standards I–VII Learning Outcomes

a. Demonstrate the application of the Code of Ethics and Standards of Professional Conduct
to situations involving issues of professional integrity
b. Identify conduct that conforms to the Code and Standards and conduct that violates the Code
and Standards
Q8. Maria Martinez is a research analyst and a Level II CFA candidate. Recently, friends of
Martinez organized a party for her thirtieth birthday. At the party, Martinez received an
inexpensive gift from a friend who is the CEO of a publicly listed company Martinez
recommends to clients. Martinez also received gifts from some of the firm’s best clients.
Aware of her employer’s policy requiring her to report all gifts received within one week of
receipt, Martinez declares the gifts she received from the firm’s clients two days after the
party. Does Martinez most likely violate the CFA Institute Standards of Professional
Conduct?
A. Yes.
B. No, because her CEO friend’s gift was inexpensive.
C. No, because the gifts do not impact her research independence and objectivity.
Solution
A is correct because Standard I(D)–Misconduct states that members and candidates must not
engage in any professional conduct involving dishonesty, fraud, or deceit or commit any act
that reflects adversely on their professional reputation, integrity, or competence. By only
reporting the gifts she received from clients but not the inexpensive gift from her CEO friend,
she does not conform to her employer’s gift policy of reporting all gifts. Her non-compliance
with employer policies reflects adversely on her professional reputation and honesty.
B is incorrect because the company policy is to report all gifts, not just those from clients.
C is incorrect because while she would likely maintain her appearance of being independent
and objective by accepting an inexpensive gift from a CEO of a publicly listed company, she
does not comply with her employer’s policy of disclosing all gifts, regardless of value.

Code and Standards
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Q9. Tonya Tucker, CFA, is a financial analyst at Bowron Consolidated. Bowron has
numerous subsidiaries and is actively involved in mergers and acquisitions to expand its
businesses. Tucker analyzes a number of companies, including Hanchin Corporation. When
Tucker speaks with the CEO of Bowron, she indicates that many of the companies she has
looked at would be attractive acquisition targets for Bowron. After her discussion with the
CEO, Tucker purchases 100,000 shares of Hanchin Corporation at $200 per share. Bowron
does not have any pre-clearance procedures, so the next time she meets with the CEO, Tucker
mentions she owns shares of Hanchin. The CEO thanks her for this information but does not
ask for any details. Two weeks later, Tucker sees a company-wide email from the CEO
announcing Bowron’s acquisition of Hanchin for $250 a share. With regards to her purchase
of Hanchin stock, Tucker least likely violated the CFA Institute Standards of Professional
Conduct concerning:
A. Loyalty.
B. Priority of Transactions.
C. Material Nonpublic Information.
Solution
C is correct because there is no indication the analyst had access to material nonpublic
information and was in violation of Standard II(A)–Material Nonpublic Information.
Specifically, Tucker did not have information concerning any decision by Bowron to acquire
Hanchin stock since she is not a part of the decision-making team at Bowron, which
determines the companies it plans to take over. The analyst had indicated numerous
companies were viable options for takeover, and she did not single out any one company in
particular.
A is incorrect because even though the company does not have a stock pre-clearance
procedure, trading the stock of a company the analyst recommended as an acquisition
candidate is an act which violates Standard IV(A)–Loyalty, as she did not give her employer
the opportunity to take advantage of her skill/recommendation prior to buying the shares for
her own portfolio.
B is incorrect because there has been a violation of Standard VI(B)–Priority of Transactions,

which requires that investment transactions for clients and employers must have priority over
investment transactions in which a Member or Candidate is the beneficial owner despite the
fact that there are no stock pre-clearance procedures at Bowron.

Code and Standards
Q10. Lewis McChord, CFA, a research analyst at an investment bank, covers the auto
industry. McChord recently read a report on an auto manufacturing company written by
Pierce Brown. Brown’s report provided extensive coverage of the company’s newly launched
products indicating that sales volume, not yet publicly available, would raise future profits.
Intrigued by the report, McChord called a senior executive at the company whom she has
known personally for years. The officer gave her specific details on new vehicle sales,
indicating that profits would double in the current quarter. McChord added this data to
Brown’s report and then circulated it within her firm as her own report. McChord least
likely violated which of the following CFA Institute Standards of Professional Conduct?
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A. Misrepresentation
B. Preservation of Confidentiality
C. Material Nonpublic Information
Solution
B is correct because Standard III(E)–Preservation of Confidentiality has not been violated.
The analyst has a personal relationship with the officer of the auto company, and he is not a
current, former, or prospective client, so there is no obligation for the analyst to maintain
client confidentiality. However, the analyst did violate Standard I(C)–Misrepresentation
when she represented another analyst’s work as her own. In addition, the analyst also violated
Standard II(A)–Material Nonpublic Information by including data that were material and
nonpublic in her research report on sales figures.
A is incorrect because Standard I(C)–Misrepresentation was violated by the analyst when she
represented another analysts research report as her own.
C is incorrect because Standard II(A)–Material Nonpublic Information was violated when the
analyst included data that were material and nonpublic in the research report on sales figures.

b. Demonstrate the application of the Code of Ethics and Standards of Professional Conduct
Q11. Dimitri Kuznetsov, CFA, is a portfolio manager and holds shares of Barnikoff Limited
and Matric Ventures in all client portfolios. Both companies have upcoming annual general
meetings scheduled for the same day. The management of Barnikoff proposes to change its
financial year-end from September to December, while Matric Ventures proposes to enter
into a high-risk venture. The proxy voting policy clause in all client investment management
agreements managed by Kuznetsov states, “When voting proxies provides a cost benefit to
the client, the manager must vote a proxy.” With regard to the proxy votes for Matric and
Barnikoff, Kuznetsov would least likely violate CFA Institute Standard III(A)–Loyalty,
Prudence, and Care if he votes:
A. with management.
B. only the Matric proxy.
C. only the Barnikoff proxy.
Solution
B is correct because Standard III(A)–Loyalty, Prudence, and Care states that it is a member
or candidate’s duty to vote proxies on behalf of clients in an informed and responsible
manner. However, if a cost–benefit analysis shows voting all proxies may not benefit the
client, voting all proxies may not be necessary. The member or candidate is responsible for
informing all clients if this is the policy of the fund manager. The member or candidate must
take steps to disclose this proxy voting policy to clients. Voting the Barnikoff proxy does not
appear to offer a benefit because the issue is not of a critical nature, but voting the proxy for
Matric involves a material issue and is a benefit that should be voted on.
A is incorrect because Standard III(A)–Loyalty, Prudence, and Care states that it is a member
or candidate’s duty to vote proxies on behalf of clients in an informed and responsible
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manner. A manager must not blindly vote with management without first considering the
impact of the issue at hand and its benefit to the client.
C is incorrect because while Standard III(A)–Loyalty, Prudence, and Care states that it is a
member or candidate’s duty to vote proxies on behalf of clients in an informed and
responsible manner, if a cost–benefit analysis shows voting all proxies may not benefit the
client, voting all proxies may not be necessary.

Code and Standards
Q12. Kam Bergeron, CFA, is an equity portfolio manager who often takes time off in the
afternoon to play golf with important clients. Today, Bergeron is on the golf course when his
game is interrupted by a phone call from his office. The call is from Bergeron’s assistant,
who notifies him of a steep and accelerating market decline. Bergeron, eager to get back to
his golf game, tells his assistant to raise cash by selling 15% of all clients’ holdings. Bergeron
instructs his assistant to first sell the most liquid stocks in each client’s portfolio and then do
the same for his personal account. Bergeron is least likely to be in violation of which of the
CFA Institute Standards of Professional Conduct?
A. Suitability
B. Priority of transactions
C. Diligence and reasonable basis
Solution
B is correct, as the manager gives instructions to sell his personal holdings after those of his
clients so there is no indication that a violation of Standard VI(B)–Priority of Transactions
occurred.
A is incorrect, as it is not clear selling a fixed percentage of all liquid stocks would be an
investment action consistent with the stated objectives and constraints of each client’s
portfolio.
C is incorrect as the decision by the manager to conduct an across the board sale of liquid
stocks does not appear to have a reasonable and adequate basis nor to be supported by
appropriate research and investigation. This action appears to be motivated by the manager's
interest in getting back to his golf game rather than any investment rationale.

Code and Standards
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Q13. Abe Seneca, CFA, supervises a team of analysts who create index funds for institutional
investors. When Seneca makes sales demonstrations without his colleagues to potential
clients simulating the fund’s performance, the scenarios he prepares show outcomes based on
assumptions reflecting upside bias and positive risk assessments. Gail Tremblay, CFA, an
analyst in Seneca’s group, observes that the actual performance of these index funds is less
than indicated in the scenario outcomes shown in the sales meetings. Seneca least
likely violated which of the following CFA Institute Standards of Professional Conduct?
A. Loyalty
B. Performance Presentation
C. Responsibilities of Supervisors
Solution
C is correct because Standard IV(C)–Responsibilities of Supervisors has not been violated as
Seneca is not responsible for the supervision of any employees when he makes sales
demonstrations to clients because he prepared the material himself. Seneca violated Standard
IV(A)–Loyalty by misleading potential investors on the performance they might achieve with
the index funds, thereby causing reputational risk to his employer. Seneca has also violated
Standard III(D)–Performance Presentation because the sales demonstrations he conducts do
not provide a fair and accurate representation of performance clients are likely to experience.
A is incorrect because Seneca understates risks and only includes positive assumptions in his
sales presentations in order to achieve higher simulated performance. This is a violation of
Standard IV(A)–Loyalty because he is causing reputational risk to his employer by
misleading potential investors on the performance they might achieve with the index funds.
Standard IV(A) requires members and candidates to protect the interests of their firm by
refraining from any conduct that would injure the firm.
B is incorrect because Seneca has violated Standard III(D)–Performance Presentation because

the sales demonstrations he conducts do not provide a fair and accurate representation of
performance clients are likely to experience.

a. Demonstrate the application of the Code of Ethics and Standards of Professional Conduct
Q14. Teresa Staal, CFA, is an investment officer in a bank trust department. She manages
money for celebrities and public figures, including an influential local politician. She receives
a request from the politician’s political party headquarters to disclose his stock holdings. The
request indicates that local law requires the disclosure. What steps should Staal most
likely take to ensure she does not violate any CFA Institute Standards of Professional
Conduct?
A. Provide the information and inform her client.
B. Send the requested documents and inform her supervisor.
C. Check with her firm’s compliance department to determine her legal responsibilities.
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Solution
C is correct. In order to avoid violating Standard III(E) Staal should determine if applicable
securities regulations require disclosing the records before she provides the confidential
information concerning her client’s investments.
A is incorrect as providing the requested information would violate the confidentiality of the
client’s records.
B is incorrect as providing the requested information would violate the confidentiality of the
client’s records.

c. Recommend practices and procedures designed to prevent violations of the Code of Ethics
and Standards of Professional Conduct
Q15. Preeta Singh, a CFA candidate, is an asset manager employed by a fund management
company managing very large segregated pension funds. In her spare time outside of working
hours, Singh likes to provide management consulting services to small companies to help
grow their businesses, focusing on strategic planning. Singh is paid for the consulting
services and has also provided her employer information about these outside activities. Does
Singh most likely violate the CFA Code of Ethics with regard to Duties to Employers?
A. No.
B. Yes, with regard to Loyalty.
C. Yes, with regard to Additional Compensation Arrangements.
Solution
A is correct because Singh does not violate any Standard relating to Duties to Employers.
She conducts unrelated non-competitive services to clients outside of business hours and thus
does not deprive her employer of the advantage of her skills and abilities, nor is there any
indication that she divulges confidential information or otherwise causes harm to her
employer. She also does not need to divulge information relating to her additional
compensation or to seek permission, as her management consulting services do not create a
conflict of interest with her employer’s interest.
B is incorrect because Singh conducts unrelated non-competitive services to clients outside of
business hours and thus does not deprive her employer of the advantage of her skills and
abilities, nor is there any indication that she divulges confidential information or otherwise
causes harm to her employer.
C is incorrect because she does not need to divulge information relating to her additional
compensation or to seek permission, as her management consulting services do not create a
conflict of interest with her employer’s interest.

Code and Standards
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Q16. Kim Klausner, CFA, monitors several hundred employees as head of compliance for a
large investment advisory firm. Klausner has always ensured that his company’s compliance
program met or exceeded those of its competitors. Klausner, who is going on a long vacation,
has delegated his supervisory responsibilities to Sue Chang. Klausner informs Chang that her
responsibilities include detecting and preventing violations of any capital market rules and
regulations, and the CFA Institute Code and Standards. Klausner least likely violated the
CFA Institute Standards of Professional Conduct by failing to instruct Chang to also
consider:
A. firm policies.
B. legal restrictions.
C. industry standards.
Solution
C is correct because the requirement under Standard IV(C)–Responsibilities of Supervisors
does not include any reference to industry standards. Standard IV(C) requires supervisors to
instruct those subordinate to whom supervision is delegated about detection methods to
prevent violations of laws, rules, regulations, firm policies, and the CFA Institute Code and
Standards.
A is incorrect because the requirement under Standard IV(C)–Responsibilities of Supervisors
includes detection of any violation of firm policies.
B is incorrect because a supervisor’s responsibilities under Standard IV(C)–Responsibilities

of Supervisors include instructing those subordinates to whom supervision is delegated about
methods to prevent and detect violations of laws, rules, regulations, firm policies, and the
Code and Standards. Laws would also include legal restrictions.

Code and Standards
Q17. Meshack Bradovic, CFA, was recently hired as a credit analyst at a credit rating agency
whose major clients include publicly listed companies on the local stock exchange. One of
the clients is currently preparing to issue a new bond to finance a major factory project.
Analysts are speculating that without the new factory the company will not survive the
onslaught of competition from increasing imports; therefore, the company is counting on an
upgraded credit rating to enhance the subscription level of the issue. Bradovic’s research
suggests that the creditworthiness of the company has severely deteriorated over the last year
due to negative operating cash flows. Without conducting extensive research, Bradovic’s
boss puts pressure on him to upgrade the credit rating to an investment grade rating. Bradovic
reports this to the firm’s compliance department where he is encouraged to follow his boss’s
advice. What course of action is most appropriate for Bradovic to prevent any violation of the
CFA Institute Code or Standards?
A. Quit his position with the firm
B. Upgrade the rating but note his objections in writing
C. Disassociate with the credit rating report, the bond issue and the client
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Solution
A is correct as the boss’ insistence that the credit rating be given an investment grade rating
irrespective of the analysis undertaken indicates a systemic disregard for due diligence,
reasonable basis, and true representation. This shows a total disregard for the Standards, in
particular Standard V(A)–Diligence and Reasonable Basis. Bradovic’s best course of action
consequently is to resign as the company’s current practice of giving false credit ratings is
likely to continue.
B is incorrect because by upgrading the credit report he would be participating in a
misrepresentation, even with a note of objection. This would violate the Code and Standards
C is incorrect because by disassociating with this particular credit report, bond issue, and
client he can remove himself from a situation that would likely cause a misrepresentation to
the true creditworthiness of the bond issue. However, due to the systemic nature of the
violations as his boss always insists on an investment grade rating, it is evident that the
company does not intend to act in an ethical manner. As the practice of giving false credit
ratings is likely to continue, the analyst should quit the company.

c. Recommend practices and procedures designed to prevent violations of the Code of Ethics and
Standards of Professional Conduct
Q18. Priscilla Moab, CFA, is the director of marketing at Red Lantern Investments. Red’s
investment approach uses technical and fundamental analysis as well as portfolio
construction to minimize risk. Moab plans to market an online investment newsletter to retail
clients. Moab decides to let prospective clients have access to Red’s buy and sell
recommendation list by posting this information on a social media site. The posting also
provides information on Red’s basic investment process and logic. To avoid violating the
CFA Institute Code of Ethics and Standards of Professional Conduct, Moab should most
likely:
A. describe the investment approach in detail.
B. update investment process changes annually.
C. indicate that additional information and analysis are available.
Solution
C is correct because if recommendations are contained in capsule form (such as a
recommended stock list), members and candidates should notify clients that additional
information and analysis are available from the producer of the report as required by Standard
V(B)–Communication with Clients and Prospective Clients. In this case, a clear statement on
the website that more information is available upon request would be required.
A is incorrect because Moab’s plans for the social media recommendations do not violate
Standard V(B)–Communication with Clients and Prospective Clients, so it does not need to
describe the investment system in detail. The recommendation outlines the basic process and
logic of Red’s investment approach and is sufficient enough for clients to understand its
limitations or inherent risks.
B is incorrect because according to Standard V(B)–Communication with Clients and

Prospective Clients, the member or candidate must keep clients and other interested parties
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informed on an ongoing basis about changes to the investment process, and an annual update
may not be sufficient.

Q19. Gregor Pavlov, CFA, is a fund manager working for the general partner of a new
private equity fund. Pavlov includes in the fund marketing material his performance history
from his previous employer. He received permission from his former employer to take his
historical recommendations and the supporting research reports he used to make those
recommendations. Did Pavlov most likely violate the CFA Institute Standards?
A. No
B. Yes, with regard to Loyalty
C. Yes, with regard to Record Retention
Solution
C is correct because even though Pavlov had his former employer’s permission to take his
performance record and supporting research reports with him, he does not have the
underlying performance data to support those historical recommendations and is therefore
most likely in violation of Standard V(C)–Record Retention. Pavlov had the permission of his
employer to take his historical performance record and research reports with him when he left
the firm so he is not in violation of Standard IV(A)–Loyalty.
A is incorrect because even though Pavlov had his former employer’s permission to take his
performance record and research reports with him, he does not have the underlying
performance data to support those historical return calculations and therefore is most likely in
violation of Standard V(C)–Record Retention.
B is incorrect because Pavlov had the permission of his employer to take his historical
performance record and research reports with him when he left the firm so he is not in
violation of Standard IV(A)–Loyalty.

b. Identify conduct that conforms to the Code and Standards and conduct that violates the Code and
Standards
Q20. Oliver Rae, CFA, is an individual investment adviser specializing in commercial real
estate. Rae recently packaged a real estate limited partnership (RELP), which he sold in a
private placement to his existing advisory clients. Prior to the private placement the
partnership had purchased four properties in which Rae held a 5% minority interest.
According to the CFA Institute Code of Ethics and Standards of Professional Conduct, Rae
should:
A. manage the partnership separately from his advisory business.

B. disclose conflicts related to the real estate he sold to the partnership.
C. return all profits earned from his minority interest to the limited partners.
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Solution
B is correct because according to Standard VI(A)–Disclosure of Conflicts, members and
candidates must make full and fair disclosure of all matters that could reasonably be expected
to impair their independence and objectivity or interfere with respective duties to clients.
A is incorrect because there is no requirement that these businesses be separated, only that
full and fair disclosure be made of all matters that could reasonably be expected to impair
their independence and objectivity or interfere with respective duties to clients.
C is incorrect because there is no requirement that profits earned be returned to the limited
partners, only that full and fair disclosure be made of all matters that could reasonably be
expected to impair their independence and objectivity or interfere with respective duties to
clients.

Q21. Colleen O’Neil, CFA, manages a private investment fund with a balanced global
investment mandate. Her clients insist that her personal investment portfolio replicate the
investments within their portfolio to ensure them that she is willing to put her money at risk.
By undertaking which of the following simultaneous investment actions for her own portfolio
would O’Neil most likely be in violation of Standard VI(B)–Priority of Transactions?
A. Sale of a listed US blue chip value stock.
B. Participation in a popular frontier market IPO.
C. Purchase of a UK government bond in the primary market.
Solution
B is correct because Standard VI(B)–Priority of Transactions dictates that members and
candidates give their clients and employer priority when making personal investment
transactions. Even when clients allow or insist the manager invest alongside them, the
manager’s transactions must never adversely affect the interests of the clients. A popular or
“hot” IPO in a frontier market is likely to be oversubscribed. In such cases, Standard VI(B)
dictates that the manager should not participate in this event to better ensure that clients
would have a higher probability of getting their full subscription allotment, even though
clients have allowed or dictated she do so.
A is incorrect because the clients are unlikely be harmed by the manager also selling a US
blue chip value stock in a stable market as the liquidity of the stock is likely to be large
enough that a simultaneous sale would not negatively impact on the price of the share.
C is incorrect because the volume of UK government bonds offered through a primary market
is likely to be large and at a fixed price based on the auction outcome. O’Neil’s bid would,
however, need to be the same as her clients’ bids.

b. Identify conduct that conforms to the Code and Standards and conduct that violates the Code and
Standards
Page 15 of 113
Q22. Hezi Cohen, a CFA candidate, is a heavy user of social networking sites on the Internet.
His favorite site only allows a limited number of characters for each entry so he has learned
to abbreviate everything, including CFA trademarks. Cohen also enjoys professional
networking sites and contributes regularly to blogs that discuss the broad topical areas
covered within the CFA Program. In addition, he posts to these blogs pieces he has written in
his area of expertise: retirement planning. By claiming to be an expert on retirement planning,
he believes his stature within the investment community increases and he can gain more
clients. Which internet activity can Cohen most likely continue to be in compliance with the
CFA Standards of Professional Conduct?
A. Use of abbreviations.
B. Claiming retirement planning expertise.
C. Blogging about broad topical areas within the CFA Program.
Solution
B is correct because the Standards do not prevent a person from claiming to be an expert in
their area of specialty as long it is not a misrepresentation and/or an exaggeration of their skill
and expertise.
A is incorrect because according to Standard VII, CFA Institute trademarks are not allowed
to be abbreviated.
C is incorrect because Standard VII–Responsibilities as a CFA Institute Member or CFA

Candidate restricts the disclosing of all aspects of the CFA exam, including broad topical
areas. These are considered confidential and thus should not be discussed over the Internet.

Q23. For firms to claim compliance with the GIPS® standards, they most likely must:
A. take responsibility for their claim of compliance and maintaining that compliance.
B. hire an independent third party to test a sample of their composites.
C. provide assurance that the firm’s policies and procedures have been implemented on a
firm-wide basis.
Solution
A is correct. Firms claiming compliance with the GIPS standards are responsible for their
claim of compliance and for maintaining that compliance — that is, firms self-regulate their
claim of compliance.
B is incorrect. Verification is recommended, not required, and is performed to test the process
with respect to an entire firm, not on specific composites or a sample of composites.
C is incorrect. Verification, not the firm, provides the assurance as to whether the firm’s
policies and procedures related to composite and pooled fund maintenance, as well as the
calculation, presentation, and distribution of performance, have been designed in compliance
with the GIPS standards and have been implemented on a firm-wide basis.
Page 16 of 113
Introduction to the Global Investment Performance Standards

(GIPS) Learning Outcome
b. Describe the key concepts of the GIPS standards for firms
Q24. Regarding composite construction in the GIPS® standards, the statement that is most
likely accurate is that firms may:
A. include nondiscretionary portfolios in a composite.
B. include non-fee-paying, discretionary portfolios in a composite.
C. exclude portfolios from composites based solely on legal structure differences.
Solution
B is correct. Standard 3.A.4 states that non-fee-paying, discretionary portfolios may be
included in a composite.
A is incorrect. Standard 3.A.2 prohibits firms from including nondiscretionary portfolios in a
composite.
C is incorrect. Standard 3.A.5 prohibits firms from excluding portfolios from composites
based solely on legal structure differences
Introduction to the Global Investment Performance Standards

(GIPS) Learning Outcome
d. Describe the fundamentals of compliance, including the recommendations of the GIPS Standards
with respect to the definition of the firm and the firm’s definition of discretion
Q25. Elana Paralova, a Level I CFA candidate working at an asset management firm, wants
to make a good impression on a prospective client. She tells the prospect: "Getting the CFA
Charter will show I am serious about protecting the interests of my clients and it will boost
my reputation. Once I get the Charter, I also hope to make more money by getting
promoted!" Her colleague, Jacob Klemmer, CFA, tells Paralova: "Study all subjects for each
exam, you never know what will be included. The three exams will be the most difficult
exams you will ever take. Any promotion and pay raise will reflect your enhanced skills."
Did either Paralova or Klemmer violate the Standards?
A. No.
B. Only Paralova violates the Standards.
C. Only Klemmer violates the Standards.
Solution
A is correct because neither Paralova or Klemmer violated CFA Standards through their
statements. Paralova did not violate Standard VII(B) Reference to CFA Institute, the CFA
Designation, and the CFA Program when she made her comments about what getting the
Charter will reflect and the hope for a pay raise. The Standard states, "When referring to CFA
Institute, CFA Institute membership, the CFA designation, or candidacy in the CFA Program,
Members and Candidates must not misrepresent or exaggerate the meaning or implications of
membership in CFA Institute, holding the CFA designation, or candidacy in the CFA
program." Klemmer did not violate Standard VII (B) Reference to CFA Institute, the CFA
Page 17 of 113
Designation, and the CFA Program when he expressed his opinion that Paralova's potential
pay raise will reflect her enhanced skills. Klemmer also complied with Standard VII(A)
Responsibilities as a CFA Institute Member or CFA Candidate, Conduct as Participants in
CFA Institute Programs when stating an opinion about the difficulty of the exam without
revealing any specific details or the need to study all subjects. The Standard states that
candidates “must not engage in any conduct that compromises . . . the integrity, validity, or
security of CFA Institute programs."
B is incorrect as Paralova did not violate Standard VII (B) Reference to CFA Institute, the
CFA Designation, and the CFA Program when she made her comments about what getting
the Charter will reflect and the hope for a pay raise. The Standard states, "When referring to
CFA Institute, CFA Institute membership, the CFA designation, or candidacy in the CFA
Program, Members and Candidates must not misrepresent or exaggerate the meaning or
implications of membership in CFA Institute, holding the CFA designation, or candidacy in
the CFA program."
C is incorrect as Klemmer did not violate Standard VII (B) Reference to CFA Institute, the
CFA Designation, and the CFA Program when he expressed his opinion that Paralova's
potential pay raise will reflect her enhanced skills. Klemmer also complied with Standard
VII(A): Responsibilities as a CFA Institute Member or CFA Candidate, Conduct as
Participants in CFA Institute Programs when stating an opinion about the difficulty of the
exam without revealing any specific details or the need to study all subjects. The
Standard states that candidates “must not engage in any conduct that compromises . . . the
integrity, validity, or security of CFA Institute programs."
Ethics Application Learning Outcome

b. Explain how the practices, policies, and conduct do or do not violate the CFA Institute Code of
Ethics and Standards of Professional Conduct
Q26. Jayson Kite, CFA, a senior analyst, is preparing a research report on a shipping
company. Kite concludes that the stock of a company is a good investment and decides to put
a "buy" recommendation on the stock. According to the recommended procedures for
compliance, Kite should communicate the recommendation:
A. within the firm first and then to customers.

B. to customers first and then within the firm.
C. simultaneously within the firm and to customers.
Solution
C is correct because according to the recommended procedures for compliance with
Standard III (B), Fair Dealing, “A common practice to assure fair dealing is to communicate
recommendations simultaneously within the firm and to customers. Members and candidates
should encourage firms to develop guidelines that prohibit personnel who have prior
knowledge of an investment recommendation from discussing or taking any action on the
pending recommendation.” Members and candidates should encourage firms to develop
guidelines that prohibit personnel who have prior knowledge of an investment
recommendation from discussing or taking any action on the pending recommendation."
Page 18 of 113
A is incorrect because according to the recommended procedures for compliance with

recommendations simultaneously within the firm and to customers.”
B is incorrect because according to the recommended procedures for compliance with

recommendations simultaneously within the firm and to customers.”

a. Evaluate practices, policies, and conduct relative to the CFA Institute Code of Ethics and Standards
of Professional Conduct
Q27. Ekta Prakash, CFA, works as an investment advisor for TXM Investments (TXM).
Prakash advises a client to transfer $150,000 from a tax-deferred investment account to
TXM's multi-cap fund. Prakash discloses to her client that withdrawals from the tax-deferred
account will attract a penalty of $15,000 but assures the client that the cost can be recovered
through better investment returns from TXM's fund. Prakash has violated the Standard(s)
relating to:
A. only misrepresentation.
B. only loyalty, prudence, and care.
C. both misrepresentation and loyalty, prudence, and care.
Solution
C is correct because Standard I(C), Misrepresentation, ".. prohibits members and candidates
from making any statements that promise or guarantee a specific rate of return on volatile
investments. Because the equity-based investment is inherently volatile, and the future return
is unpredictable, [Prakash's] promises about future returns making up for the penalty of
withdrawing the funds violates Standard I(C). Trust is the foundation of the investment
profession. Investment professionals who make false or misleading statements not only harm
investors but also reduce the level of investor confidence in the investment profession and
threaten the integrity of the capital markets." Therefore, Prakash has violated Standard I(C).
Further, according to Standard III(A), Loyalty, Prudence, and Care "[p]rudence requires
caution and discretion. The exercise of prudence by investment professionals requires that
they act with the care, skill, and diligence that a reasonable person acting in a like capacity
and familiar with such matters would use. ... Acting with care requires members and
candidates to act in a prudent and judicious manner in avoiding harm to clients." Prakash
causes harm to her client by recommending that the client transfer money from a tax-deferred
account to TXM's large-cap fund, a process that will cost the client $15,000 in penalties.
Therefore, Prakash also violated Standard III(C).
A is incorrect because Standard I(C), Misrepresentation, ".. prohibits members and candidates
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threaten the integrity of the capital markets." Therefore, Prakash has violated Standard I(C).
Further, according to Standard III(A), Loyalty, Prudence, and Care "[p]rudence requires
and familiar with such matters would use. ... Acting with care requires members and
B is incorrect because Standard III(A), Loyalty, Prudence, and Care "[p]rudence requires
and familiar with such matters would use. ...Acting with care requires members and
Further, according to Standard I(C), Misrepresentation, ".. prohibits members and candidates
threaten the integrity of the capital markets." Therefore, Prakash has also violated Standard
I(C).

b. Explain how the practices, policies, and conduct do or do not violate the CFA Institute Code of
Ethics and Standards of Professional Conduct
Q28. Once an investor chooses a particular course of action, the value forgone from
alternative actions is best described as a(n):
A. sunk cost.
B. required return.
C. opportunity cost.
Solution
C is correct. An opportunity cost is the value that investors forgo by choosing a particular
course of action.
A is incorrect. A sunk cost is one that has already been incurred and therefore cannot be
changed
Page 20 of 113
B is incorrect. The required return is the minimum rate of return an investor must receive in
order to accept the investment.
The Time Value of Money Learning Outcome

a. Interpret interest rates as required rates of return, discount rates, or opportunity costs
Q29. If the stated annual interest rate is 9% and the frequency of compounding is daily, the
effective annual rate (EAR) is closest to:
A. 9.00%.
B. 9.86%.
C. 9.42%.
Solution
C is correct. EAR = (1 + periodic interest rate)m − 1 = [1 + (0.09/365)]365 − 1 = 0.094162,
rounded to 9.42%.
A is incorrect because it treats the stated rate and the EAR as equivalents.
B is incorrect; it is calculated using (9/365) × 4 = 0.09863.
The Time Value of Money Learning Outcome

c. Calculate and interpret the effective annual rate, given the stated annual interest rate and the
frequency of compounding
A borrower is considering three competing mortgage loan offers from her bank. The amount
borrowed on the mortgage is $100,000 with monthly compounding.
Stated Annual Interest Rate at Year in Which Rate

Mortgage Type Initiation of the Loan First Adjusts
30-year fixed rate 5.000% N/A
20-year fixed rate 4.385% N/A
30-year adjustable-rate 3.750% 3

mortgage (ARM)
Q30. The rate on the ARM resets at the end of Year 3. Assuming the ARM is permanently
reset at 5.500% (i.e., the remaining balance on the loan is assumed to be repaid with a
5.500% stated annual interest), which of the three loans will have the smallest monthly
payment after the rate reset at the end of Year 3?
A. 30-year fixed-rate loan
B. 20-year fixed-rate loan
C. 30-year ARM
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Solution
A is correct. The timeline for the 30-year fixed rate is as follows:
where X is the monthly payment for all 360 months.

The timeline for the 20-year fixed rate is as follows:
where Y is the monthly payment for all 240 months.

The timeline for the 30-year ARM is as follows:
where Z is the monthly payment for the first 36 months (three years) and K is the monthly
payment for months 37 to 360 (payment after Year 3).
The loan payments are calculated using a financial calculator.
Loan Payment
Initial Payment after Three
Loan Calculation of Monthly Payments ($) Years ($)
30-year X is found as follows: 536.82 536.82

fixed N = 12 × 30 = 360, I/Y = (5/12) = 0.41667,
PV = 100,000, FV = 0, calculate PMT =
536.82.
20-year Y is found as follows: 626.46 626.46

fixed N = 12 × 20 = 240, I/Y = (4.385/12) =
0.36542, PV = 100,000, FV = 0, calculate
PMT = 626.46.
30-year Z is found as follows: 463.12 (this 559.16 (this

ARM N = 12 × 30 = 360, I/Y = (3.75/12) = corresponds corresponds to K)
0.31250, PV = 100,000, FV = 0, calculate to Z)
PMT = 463.12.
K is found in two steps:
First, the balance at end of Year 3 is
Page 22 of 113
Loan Payment
Initial Payment after Three
Loan Calculation of Monthly Payments ($) Years ($)
found: N = 12 × 27 = 324, I/Y = (3.75/12) =

0.31250, FV = 0, PMT = 463.12, calculate
PV = 94,271.43.
Then, K is calculated as follows: N =
324, I/Y = (5.5/12) = 0.45833, PV =
94,271.43, FV = 0, calculate PMT = 559.16.
After Year 3, the 30-year fixed-rate loan has the lowest payment: 536.82 < 559.16 < 626.46.
Note: Numbers may differ slightly from those given above because of rounding.
B is incorrect; 536.82 < 559.16 < 626.46.
C is incorrect; 536.82 < 559.16 < 626.46.
The Time Value of Money Learning Outcomes

d. Calculate the solution for time value of money problems with different frequencies of
compounding
e. Calculate and interpret the future value (FV) and present value (PV) of a single sum of money, an
ordinary annuity, an annuity due, a perpetuity (PV only), and a series of unequal cash flows
f. Demonstrate the use of a time line in modeling and solving time value of money problems
Q31. The following 10 observations are a sample drawn from a normal population: 25, 20,
18, −5, 35, 21, −11, 8, 20, and 9. The mean of the sample is closest to:
A. 17.20.
B. 14.00.
C. 15.56.
Solution
B is correct. The sum of the 10 numbers is 140. Dividing by 10 gives the mean of 14.
A is incorrect and is calculated by adding the absolute values of the ten numbers (i.e., −11 is
valued as 11 and −5 is valued as 5).
C is incorrect and is calculated by dividing 140 by 9 (i.e., by n − 1 rather than n).
Organizing, Visualizing, and Describing Data Learning Outcome

g. Calculate and interpret measures of central tendency
Page 23 of 113
Q32. Which of the following most accurately describes a distribution that is more peaked
than normal?
A. Leptokurtic
B. Mesokurtic
C. Platykurtic
Solution
A is correct. A distribution that is more peaked than normal is called leptokurtic.
B is incorrect. A distribution that is neither more peaked nor less peaked than normal is called
mesokurtic.
C is incorrect. A distribution that is less peaked than normal is called platykurtic.
Organizing, Visualizing, and Describing Data Learning Outcome

m. Interpret kurtosis
Q33. A tree diagram is most likely used when dealing with investment problems that involve
outcomes that are:
A. independent at each node.
B. mutually exclusive.
C. unconditional at each node.
Solution
B is correct. The following figure depicts an example of a tree diagram:
A tree diagram is a diagram with branches emanating from nodes representing either
mutually exclusive outcomes or mutually exclusive decisions. Mutually exclusive outcomes
are dependent (the occurrence of one outcome does affect the probability of occurrence of the
other outcome). In addition, outcomes at each node are conditional (the probability of an
outcome is conditioned on another outcome).
A is incorrect. Two outcomes are independent if the occurrence of one outcome does not
affect the probability of occurrence of the other outcome. At each node of a tree diagram, the
Page 24 of 113
two outcomes that follow are dependent because the probability on the outcome on one
branch is related to the probability of the outcome on the other branch.
C is incorrect. Outcomes are unconditional when the probability of an outcome is not

conditioned on another outcome. In a tree diagram, outcomes at each node are conditional
(the probability of an outcome is conditioned on another outcome).
Probability Concepts Learning Outcomes

b. Identify the two defining properties of probability, including mutually exclusive and exhaustive
events, and compare and contrast empircal, subjective, and a priori probabilities
j. Interpret a probability tree and demonstrate its application to investment problems
An analyst develops a set of criteria for evaluating distressed credits. Companies that do not
receive a passing score are classed as likely to go bankrupt within the next year. The analyst
concludes the following:
 Forty percent of the companies tested will go bankrupt within a year: P(non-survivor) =
0.40.
 Fifty-five percent of companies tested will pass: P(pass test) = 0.55.
 There is an eighty-five percent probability that a company will pass the test given that it
survives a year: P(pass test | survivor) = 0.85.
Q34. Using the total probability rule, the probability that a company passed the test given that
it goes bankrupt can be determined. The P(pass test | non-survivor) is closest to:
A. 0.22.
B. 0.35.
C. 0.10.
Solution
C is correct. The total probability rule explains the unconditional probability of an event in
terms of probabilities conditional on mutually exclusive and exhaustive scenarios,
where: P(A) = P(A | S)P(S) + P(A | SC)P(SC).
Given that P(non-survivor) = 0.40, then P(survivor) = 1 − P(non-survivor) = 1 − 0.40 = 0.60.
Accordingly,
P(pass test) = P(pass test | survivor)P(survivor) + P(pass test | non-survivor)P(non-survivor)
0.55 = 0.85(0.60) + P(pass test | non-survivor)(0.40)
Thus, P(pass test | non-survivor) = [0.55 − 0.85(0.60)]/0.40 = 0.10.
A is incorrect because the total probability rule is a weighted average probability of all
possible scenarios. This answer incorrectly applies the multiplication rule, which holds that
the joint probability of two independent (not conditional) events equals the product of the two
individual probabilities for non-survivors and passing the test: (0.40)(0.55) = 0.22, which
does not account for all mutually exclusive and exhaustive scenarios as required by the total
probability rule.
B is incorrect because 0.35 is the result if the probability of P(non-survivor) = 0.60. The
question states that the probability of P(non-survivor) is 0.40, not 0.60. It is calculated as
[0.55 − 0.85(0.40)]/0.60 = 0.35.
Probability Concepts Learning Outcome

g. Calculate and interpret an unconditional probability using the total probability rule
Page 25 of 113
Q35. Assuming no short selling, a diversification benefit is most likely to occur when the
correlations among the securities contained in the portfolio are:
A. greater than +1.
B. equal to +1.
C. less than +1.
Solution
C is correct. As long as security returns are not perfectly positively correlated,
diversification benefits are possible.
A is incorrect; correlation cannot be greater than positive one.
B is incorrect; if correlations equal 1, no diversification benefit occurs.
Probability Concepts Learning Outcome

k. Calculate and interpret the expected value, variance, standard deviation, covariances and
correlations of portfolio returns
Q36. A company has an unsecured line of credit and needs to maintain its EBIT-to-interest
coverage ratio greater than 2.0. Its EBIT is estimated to be between $36 million and $48
million, with all values equally likely. If the forecasted interest charge for the year is $20
million, the probability that EBIT/interest will be more than 2.0 is closest to:
A. 61.5%.
B. 33.3%.
C. 66.7%.
Solution
C is correct. The EBIT-to-interest ratio is equal to 2.0 when the EBIT is $40 million. Given
that the values between $36 million and $48 million are equally likely, the probability of the
ratio being equal to or less than 2.0 is 33.3% (= [$40 million − $36 million]/[$48 million −
$36 million]). Consequently, the probability of the ratio being greater than 2.0 is 66.7% (i.e.,
1 − Probability of the ratio being equal to or less than 2.0).
A is incorrect. This treats the distribution as discrete with increments in $1M.
EBIT Int EBIT/INT
36 20 1.8
37 20 1.85
38 20 1.9
39 20 1.95
Page 26 of 113
EBIT Int EBIT/INT
40 20 2
41 20 2.05
42 20 2.1
43 20 2.15
44 20 2.2
45 20 2.25
46 20 2.3
47 20 2.35
48 20 2.4
Cell Count 13 8 0.615 Prob >2.0
B is incorrect. This is the probability of the ratio being equal to or less than 2.0.
Common Probability Distributions Learning Outcome

d. Describe the properties of the continuous uniform distribution, and calculate and interpret
probabilities given a continuous uniform distribution
An analyst develops the following capital market projections.
Stocks Bonds
Mean Return 10% 2%
Standard Deviation 15% 5%
Page 27 of 113
Q37. Assuming the returns of the asset classes are described by normal distributions, which
of the following statements is correct?
A. On average 99% of stock returns will fall within ± 30% from the mean.
B. Bonds have a higher probability of a negative return than do stocks.
C. The probability of a bond return ≤ 3% is determined using a Z-score of 0.25.
Solution
B is correct. A negative return is any return that is less than zero. The chance of a negative
return falls in the area to the left of 0% under a standard normal curve. By standardizing the
returns and standard deviations of the two assets, the likelihood of either asset experiencing a
negative return may be determined: Z-score (standardized value) = (X − μ)/σ
Z-score for a bond return of 0% = (0 − 2)/5 = −0.40.
Z-score for a stock return of 0% = (0 − 10)/15 = −0.67.
For bonds, a 0% return falls 0.40 standard deviations below the mean return of 2%. In
contrast, for stocks, a 0% return falls 0.67 standard deviations below the mean return of 10%.
0.40 of a standard deviation is less than 0.67 of a standard deviation. Negative returns
therefore occupy more of the left tail of the bond distribution than the stock distribution.
Thus, bonds are more likely than stocks to experience a negative return.
A is incorrect because on average 95% of returns will fall in the interval μ ± 2σ (which is
30%).
C is incorrect because the Z-score for a 3% bond return is calculated as Z = (X − μ)/σ = (3 −

2)/5 = 0.20.
Common Probability Distributions Learning Outcomes

i. Expain how to standardize a random variable
j. Calculate and interpret probabilities using the standard normal distribution
Q38. An analyst studying the Sharpe ratios of mutual funds globally uses only the data from
the standard internal database, which covers 12 mutual funds. This sampling method
is best described as:
A. cluster sampling.
B. judgmental sampling.
C. convenience sampling.
Solution
C is correct because "[I]n this method [convenience sampling], an element is selected from
the population based on whether or not it is accessible to a researcher or on how easy it is for
a researcher to access the element. Because the samples are selected conveniently, they are
not necessarily representative of the entire population, and hence the level of the sampling
accuracy could be limited." By choosing to use all the data from an internal database, the
analyst is using convenience sampling.
A is incorrect because cluster sampling "requires the division or classification of
the population into subpopulation groups, called clusters. In this method, the population is
divided into clusters, each of which is essentially a mini-representation of the entire
Page 28 of 113
populations. Then certain clusters are chosen as a whole using simple random
sampling." However, in this situation, the analyst uses all the data from the database, without
dividing them into clusters, which best describes convenience sampling, not cluster sampling.
B is incorrect because "[t]his sampling process [judgmental sampling] involves selectively

handpicking elements from the population based on a researcher’s knowledge and
professional judgment. ... In circumstances where there is a time constraint, however, or
when the specialty of researchers is critical to select a more representative sample than by
using other probability or non-probability sampling methods, judgmental sampling allows
researchers to go directly to the target population of interest." However, in this situation, the
analyst uses all the data from the database, without selecting elements based on her
knowledge, which best describes convenience sampling, not judgmental sampling.
Sampling and Estimation Learning Outcome

c. Compare and contrast simple random, stratified random, cluster, convenience, and judgmental
sampling
Q39. All else held constant, the width of a confidence interval for a population mean is most
likely to be smaller if the sample size is:
A. larger and the degree of confidence is lower.
B. larger and the degree of confidence is higher.
C. smaller and the degree of confidence is lower.
Solution
A is correct. As the degree of confidence is increased, the confidence interval becomes
wider. A larger sample size decreases the width of a confidence interval.
B is incorrect. As the degree of confidence is increased, the confidence interval becomes
C is incorrect. As the degree of confidence is increased, the confidence interval becomes


h. Calculate and interpret a confidence interval for a population mean, given a normal distribution
with 1) a known population variance, 2) an unknown population variance, or 3) an unknown
population variance and a large sample size
Q40. Which of the following statements about bootstrap resampling is most accurate? The
bootstrap resampling process requires:
A. drawing random samples with replacement.
B. an analytic formula to perform statistical inference.
C. the number of repetitions to be equal to the sample size.
Solution
A is correct because "[i]n bootstrap, we repeatedly draw samples from the original sample,
and each resample is of the same size as the original sample. Note that each item drawn is
Page 29 of 113
replaced for the next draw (i.e., the identical element is put back into the group so that it can
be drawn more than once)." "Unlike bootstrap, which repeatedly draws samples with
replacement, jackknife samples are selected by taking the original observed data sample and
leaving out one observation at a time from the set (and not replacing it)."
B is incorrect because "[b]ootstrap, one of the most popular resampling methods, uses
computer simulation for statistical inference without using an analytical formula such as a z-
statistic or t-statistic." Moreover, "[c]ompared with conventional statistical methods,
bootstrap does not rely on an analytical formula to estimate the distribution of the estimators.
It is a simple but powerful method for any complicated estimators and particularly useful
when no analytical formula is available."
C is incorrect because this is a property of jackknife resampling technique, not bootstrap.
"For a sample of size n, jackknife usually requires n repetitions, whereas with bootstrap, we
are left to determine how many repetitions are appropriate."

i. Describe the use of resampling (bootstrap, jackknife) to estimate the sampling distribution of a
statistic
Q41. When testing a hypothesis, the power of a test is best described as the:
A. same as the level of significance of the test.
B. probability of rejecting a true null hypothesis.
C. probability of correctly rejecting the null hypothesis.
Solution
C is correct. The power of a test is the probability of correctly rejecting the null
hypothesis—that is, the probability of rejecting the null when it is false.
A is incorrect because this is the definition of Type I error.
B is incorrect because this is in fact a Type I error.
Hypothesis Testing Learning Outcome

c. Explain a test statistic, Type I and Type II errors, a significance level, and how significance levels
are used in hypothesis testing, and the power of a test
Q42. A parametric test is most likely preferred to a non-parametric test when:

A. the data are given in ratio or ordinal scale.
B. defined sets of assumptions are given.
C. the population is heavily skewed.
Solution
B is correct. A parametric test is more appropriate than a non-parametric one when an
analyst is concerned with parameters whose validity depends on a definite set of
assumptions—for example, assumptions about the distribution of the population producing
the sample.
A is incorrect. A nonparametric test is suitable for this case.
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C is incorrect. A nonparametric test is also suitable for this.
Hypothesis Testing Learning Outcome

k. Compare and contrast parametric and nonparametric tests, and describe situations where each is the
more appropriate type of test
Q43. An analyst runs a simple linear regression to test whether the variation in the demand
for corn explains the variation in the supply of wheat. In this model, the demand for corn is
a(n):
A. indicator variable.
B. explained variable.
C. independent variable.
Solution
C is correct because the variation in the demand for corn is being used to explain the
variation in the supply of wheat. "We refer to the variable whose variation is being used to
explain the variation of the dependent variable as the independent variable, or the
explanatory variable; it is typically denoted by X."
A is incorrect because demand for corn is not limited to values of 0 or 1. "Suppose we want
to examine whether a company’s quarterly earnings announcements influence its monthly
stock returns. In this case, we could use an indicator variable, or dummy variable, that takes
on only the values 0 or 1 as the independent variable."
B is incorrect because variation in the demand for corn is being used to explain the variation
in the supply of wheat. Therefore the variation in the supply of wheat is the dependent
variable, or explained variable. "We refer to the variable whose variation is being explained
as the dependent variable, or the explained variable; it is typically denoted by Y."
Introduction to Linear Regression Learning Outcome

a. Describe a simple linear regression model and the roles of the dependent and independent variables
in the model
Q44. With respect to a simple linear regression, the F-distributed test statistic
is most appropriate to use when testing if:
A. the intercept is significantly different from zero.
B. the independent and dependent variables are significantly positively correlated.
C. there is a significant linear relationship between the dependent and independent variables.
Solution
C is correct because "[i]n regression analysis, we can use an F-distributed test statistic to test
whether the slopes in a regression are equal to zero, with the slopes designated as bi, against
the alternative hypothesis that at least one slope is not equal to zero:
H0: b1 = b2 = b3 =. . . = bk = 0.
Ha: At least one bk is not equal to zero.
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For simple linear regression, these hypotheses simplify to H0: b1 = 0.Ha: b1 ≠0." If we fail
to reject the null hypothesis that the slope is 0, it implies that there is a linear relationship
between the dependent and independent variables.
A is incorrect because a t-statistic tests if the intercept is statistically different from zero. "We
can test whether the intercept is different from the hypothesized value,B0, by comparing the
estimated intercept (^b0 ) with the hypothesized intercept and then dividing the difference by
the standard error of the intercept..."
B is incorrect because a t-statistic tests if there is a positive correlation between the dependent
and independent variables, that is, whether the slope coefficient of the linear
regression is greater than zero. "We can use the F-statistic to test for the significance of the
slope coefficient (that is, whether it is significantly different from zero), but we also may
want to perform other hypothesis tests for the slope coefficient—for example, testing whether
the population slope is different from a specific value or whether the slope is positive. We
can use a t-distributed test statistic to test such hypotheses about a regression coefficient."

d. Calculate and interpret the coefficient of determination and the F-statistic in a simple linear
regression
Q45. An indicator variable used in a simple linear regression is best described as a variable
taking a value:
A. of either 0 or 1.
B. between 0 and 1.
C. in the range -1 to 1.
Solution
A is correct because for some regression analyses, "we could use an indicator variable, or
dummy variable, that takes on only the values 0 or 1 as the independent variable."
B is incorrect because it describes the range of a coefficient of determination, not an indicator
variable. "[A]n indicator variable, or dummy variable ... takes on only the values 0 or 1 as
the independent variable."
C is incorrect because it is the range of a correlation coefficient, not an indicator variable.
"[A]n indicator variable, or dummy variable ... takes on only the values 0 or 1 as the
independent variable."

f. Formulate a null and an alternative hypothesis about a population value of a regression coefficient,
and determine whether the null hypothesis is rejected at a given level of significance
Q46. The price of a good falls from $15 to $13. Given this decline in price, the quantity
demanded of the good rises from 100 units to 120 units. The own-price elasticity of demand
for the good is closest to:
A. –0.67.
B. –1.50.
C. –1.25.
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Q47. Which of the following is most likely to be a characteristic of a Giffen good? Its:
A. substitution effect is negative.
B. demand curve slopes downward.
C. income effect is negative.
Solution
C is correct. A Giffen good is an inferior good. All inferior goods have a negative income
effect (less is purchased as income rises). While the substitution effect is always positive for
all goods, for a Giffen good the income effect is so strong and so negative that it overpowers
the substitution effect; the result is that as its price declines, less of it is purchased. This
results in a positively sloped individual demand curve.
A is incorrect. A substitution effect is always positive for all goods.
B is incorrect. For a Giffen good, the consumer actually buys less of the good when its price
falls, resulting in a positively sloped demand curve (upward sloping).
Topics in Demand and Supply Analysis Learning Outcomes

c. Contrast normal goods with inferior goods
b. Compare substitution and income effects
Q48. Which of the following factors is most likely to lead to economies of scale?
A. Supply constraints
B. Duplication of product lines
C. Specialization by workers
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Solution
C is correct. Specialization by workers can increase their proficiency, leading to lower
average costs when the firm is large enough to allow specialization.
A is incorrect. Supply constraints lead to higher resource prices, creating diseconomies.
B is incorrect. Duplication of product lines is a diseconomy.
Topics in Demand and Supply Analysis Learning Outcome

f. Describe how economies of scale and diseconomies of scale affect costs
Q49. The demand curve of a perfectly competitive firm is:
A. vertical.
B. horizontal.
C. downward sloping.
Solution
B is correct because "the demand curve that each perfectly competitive firm faces is a
horizontal line at the equilibrium price, even though the demand curve for the whole market
is downward sloping."
A is incorrect because "the demand curve that each perfectly competitive firm faces is a
C is incorrect because "the demand curve that each perfectly competitive firm faces is a
The Firm and Market Structures Learning Outcome

b. Explain relationships between price, marginal revenue, marginal cost, economic profit, and the
elasticity of demand under each market structure
Q50. A power generation company is a monopoly that has very high barriers to entry. The
quantity demand (QD) for its product is QD = 800 – 0.25 × P (where P is price). The slope of
the marginal revenue curve is closest to:
A. –0.25.
B. –8.00.
C. –4.00.
Solution
B is correct. Solve for P from the quantity demanded:
Q = 800 – 0.25P
P = 3,200 – 4Q
TR = P × Q = 3,200Q – 4Q2
MR = ΔTR/ΔQ = 3,200 – 8Q
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Therefore, the slope of the curve is –8.
A is incorrect because it is the slope of the quantity demanded.
C is incorrect because it is the slope of the demand curve (–1/0.25) when P is a function of Q.
The Firm and Market Structures Learning Outcome

d. Describe and determine the optimal price and output for firms under each market structure
For a given economy and a given period of time, GDP measures the:
I.aggregate income earned by all households, all companies, and the government.
II.total income earned by all of the country’s citizens, firms, and the government.
III.total market value produced of resalable and final goods and services.
Q51. The most appropriate description of what is measured by GDP is given by:
A. I only.
B. I and II.
C. I and III.
Solution
A is correct. Gross domestic product (GDP) can be defined in terms of either output or
income:
 it is the market value of all final goods and services produced within the economy in a
given period of time (output definition) or, equivalently,
 it is the aggregate income earned by all households, all companies, and the government
within the economy in a given period of time (income definition).
B is incorrect. GDP is the total income earned by all households and not country citizens.
C is incorrect. GDP includes the final goods and not the resalable (intermediate) goods.
Aggregate Output, Prices, and Economic Growth Learning

Outcome
a. Calculate and explain gross domestic product (GDP) using expenditure and income approaches
Q52. An increase in both aggregate demand and supply occurs, with aggregate supply
increasing more than aggregate demand. The most likely result is a decrease in the:
A. real GDP.
B. participation rate.
C. price level.
Solution
C is correct. If both aggregate demand (AD) and aggregate supply (AS) increase, real GDP
will increase, but the impact on inflation is not clear unless we know the magnitude of the
changes because an increase in AD will increase the price level, but an increase in AS will
decrease the price level. If AD increases more than AS, the price level will increase. If AS
increases more than AD, as depicted in the graph, the price level will decline.
Page 35 of 113
B is incorrect. An increase in both aggregate demand (AD) and aggregate supply (AS) will
increase the participation rate as discouraged workers reenter the labor force.
A is incorrect. An increase in both aggregate demand and supply raises real GDP.
Aggregate Output, Prices, and Economic Growth Learning

Outcome
l. Analyze the effect of combined changes in aggregate supply and demand on the economy
Q53. Credit cycles:
A. can amplify business cycles.

B. are defined as fluctuations in real GDP.
C. tend to be shorter than business cycles.
Solution
A is correct because "[i]t is recognized that in a world with financial frictions, business
cycles can be amplified, with deeper recessions and more extensive expansions because of
changes in access to external financing. In line with this, it is found that the duration and
magnitude of recessions and recoveries are often shaped by linkages between business and
credit cycles."
B is incorrect because "[c]redit cycles describe the changing availability—and pricing—of
credit. They describe growth in private sector credit (availability and usage of loans), which
is essential for business investments and household purchases of real estate. They are
therefore connected to real economic activity captured by business cycles that describe
fluctuations in real GDP."
Page 36 of 113
C is incorrect because although "financial variables tend to co-vary closely with each other
and can often help explain the size of an economic expansion or contraction, [but] they are
not always synchronized with the traditional business cycle. Credit cycles tend to be longer,
deeper, and sharper than business cycles."
Understanding Business Cycles Learning Outcome

b. Describe credit cycles
Q54. The Austrian economic school of thought argues that:
A. business cycles arise primarily due to market failures.

B. policy makers should strongly intervene in the economy.
C. excessive credit growth during boom times results in subsequent recessions.
Solution
C is correct because "Austrian economists argue that low interest rates and excessive credit
growth during boom times result in over-investment in projects with low returns, causing
failure and a move into recession."
A is incorrect because "the Austrian school sees business cycles arising from government
(and central bank) policies as the cause of overinvestment and subsequent failure."
B is incorrect because as "the Austrian school sees business cycles arising from government
(and central bank) policies as the cause of overinvestment and subsequent failure, they
suggest that policy makers should rarely intervene in the economy."

d. Describe theories of the business cycle
Q55. According to the monetarist school of economic thought, business cycles may occur
because of:
A. exogenous shocks only.
B. government intervention only.
C. both exogenous shocks and government intervention.
Solution
C is correct because "[a]ccording to the monetarist school, business cycles may occur both
because of exogenous shocks and because of government intervention."
A is incorrect because "[a]ccording to the monetarist school, business cycles may occur both
B is incorrect because "[a]ccording to the monetarist school, business cycles may occur both

d. Describe theories of the business cycle
Page 37 of 113
Q56. In a fractional reserve banking system, the reserve requirement is:
A. equal to the money multiplier.

B. directly correlated with potential money creation.
C. the portion of deposits that must be held in cash.
Solution
C is correct because "[t]he process of money creation...depends on the amount of money that
banks keep in reserve to meet the withdrawals of its customers. This practice of lending
customers’ money to others on the assumption that not all customers will want all of their
money back at any one time is known as fractional reserve banking." "[B]ankers in an
economy come to the view that they need to retain [hold in cash] only 10 percent of any
money deposited with them. This is known as the reserve requirement."
A is incorrect because "[t]he amount of money that the banking system creates through the
practice of fractional reserve banking is a function of 1 divided by the reserve requirement, a
quantity known as the money multiplier."
B is incorrect because an increase in the reserve requirement will reduce the money
multiplier, and therefore reduce potential money creation.
"The total amount of money ‘created’ from this one deposit of €100 can be calculated as:
New deposit/Reserve requirement = €100/0.10 = €1,000." This formula shows that if the
reserve requirement is increased, money creation will decrease.
Monetary and Fiscal Policy Learning Outcome

c. Explain the money creation process
Q57. A central bank most likely:

A. lends money to banks facing serious shortages.
B. is one of many supplier's of a country's currency.
C. does not manage a country's foreign currency reserves.
Solution
A is correct because the central bank acts "as a lender of last resort to banks. Because the
central bank effectively has the capacity to print money, it is in the position to be able to
supply the funds to banks that are facing a damaging shortage."
B is incorrect because "[g]enerally, a central bank is the monopoly supplier of the currency."
C is incorrect because "[m]ost central banks will … be responsible for managing their
country’s foreign currency reserves."

f. Describe roles and objectives of central banks
Page 38 of 113
Q58. The neutral policy rate for an economy is the real trend rate of growth and the:
A. short-term growth rate that gives rise to no inflation.

B. long-term growth rate that gives rise to stable inflation.
C. short-term growth rate that gives rise to stable inflation.
Solution
B is correct because "the neutral policy rate for any economy comprises two
components: Real trend rate of growth of the underlying economy, and… [t]he real trend rate
of growth of an economy … that is achievable in the long run that gives rise to stable
inflation." The formula is " Neutral rate = Trend growth + Inflation target."
A is incorrect because it is the long-term growth rate that gives rise to stable inflation. No
inflation is in fact stable inflation (zero), but this does not best describe the equation. The
formula is " Neutral rate = Trend growth + Inflation target."
C is incorrect because it is the long-term growth rate, not short-term, that gives rise to stable
inflation. The formula is " Neutral rate = Trend growth + Inflation target."

m. Determine whether a monetary policy is expansionary or contractionary
Q59. Which of the following statements is most accurate? For a country to gain from trade,
it must have:
A. economies of scale or lower labor costs.
B. an absolute advantage.
C. a comparative advantage.
Solution
C is correct. A comparative advantage arises if one entity can produce an item at a lower
opportunity cost than another. An absolute advantage in producing a good (or service) arises
if one entity can produce that good at a lower cost or use fewer resources in its production
than its trading partner. Even if a country does not have an absolute advantage in producing
any of its goods, it can still gain from trade by exporting the goods in which it has a
comparative advantage. The country with the lower opportunity cost (with the comparative
advantage) should specialize and produce its low opportunity cost item, and the other country
should produce the high opportunity cost item, trading the goods between each other to make
both better off.
A is incorrect. Economies of scale or lower labor costs will likely result in a lower cost of
production, but only a comparative advantage is necessary to benefit from trade.
B is incorrect. An absolute advantage in producing a good (or service) arises if one country is
able to produce that good at a lower cost or use fewer resources in its production than its
trading partner. It is the lower opportunity cost that one country has that is the reason that one
country should specialize in order to gain from trade.
International Trade and Capital Flows Learning Outcome

c. Contrast comparative advantage and absolute advantage
Page 39 of 113
During the last month, a food company located in the United States had the following transactions:
(US$
Transaction Amount millions)
Bought raw material from Indonesia 50.0
Sold food products to France 65.0
Received royalty fees from its branch in the United Kingdom 0.5
Donated to a charitable institution in Africa 0.1
Borrowed from a bank in Singapore 2.0
Paid legal fees to its German legal consultant company 1.2
Received interest coupon from its investment in Eurobonds issued in 0.8

Luxembourg
Q60. These transactions will most likely increase the US current account by:
A. $15.0 million.
B. $14.5 million.
C. $17.0 million.
Solution
A is correct. Note that the borrowing from a bank in Singapore is not a current account
transaction.
Current Account (US$
Transaction millions)
Bought raw material from Indonesia –50.0
Sold food products to France 65
Received royalty fees from its branch in the United Kingdom 0.5
Donated to charitable institution in Africa –0.1
Borrowed from a bank in Singapore Omit
Paid legal fees to its German legal consultant company –1.2
Page 40 of 113
Current Account (US$

Transaction millions)
Received interest coupon from its investment in Eurobonds issued 0.8

in Luxembourg
Total 15
B is incorrect because the royalty fee is not included.
C is incorrect because the bank loan is included.
International Trade and Capital Flows Learning Outcome

h. Describe the balance of payments accounts including their components
A New Zealand traveler returned from Singapore with SGD7,500 (Singapore dollars). A foreign
exchange dealer provided the traveler with the following quotes:
Ratio Spot Rates
USD/SGD 1.2600
NZD/USD 0.7670
USD: US dollar; NZD: New Zealand dollar
Q61. The amount of New Zealand dollars (NZD) that the traveler would receive for his
Singapore dollars is closest to:
A. NZD7,248.
B. NZD4,565.
C. NZD7,761.
Solution
A is correct. The NZD/SGD cross-rate is NZD/USD × USD/SGD = 0.7670 × 1.2600 =
0.9664. The traveler will receive: NZD0.9664 per SGD; NZD0.9664 × SGD7,500 =
NZD7,248.
B is incorrect. It calculates NZD/SGD incorrectly by inverting USD/SGD (0.7670 × 1/1.26 =
0.6087) and multiplying by 7,500 = 4,565 NZD.
This is equivalent to incorrectly first converting to USD (1/1.26 × 7,500 SGD) to give 5,952
USD and then converting to NZD ($5,952 × 0.7670 NZD/$ = 4,565 NZD).
C is incorrect. It calculates the cross rate correctly, but divides it into 7,500: 7,500/0.9664 =
7,761.
Currency Exchange Rates Learning Outcome

d. Calculate and interpret currency cross-rates
Page 41 of 113
An investor examines the following rate quotes for the Brazilian real (BRL) and the
Australian dollar (AUD) and shorts BRL500,000.
 Spot rate BRL/AUD: 2.1128

 BRL 1-year interest rate: 4.1%
 Forward rate BRL/AUD: 2.1388
 AUD 1-year interest rate: 3.1%
Q62. The risk-free arbitrage profit that is available is closest to:
A. –BRL6,327.
B. BRL1,344.
C. BRL6,405.
The arbitrage profit is the right side of the equation minus the left side.
Left Side of Equation: BRL500,000 × (1 + 0.041) = BRL520,500

Right Side of Equation
Step Transaction Explanation
1 BRL500,000 × (1/2.1128AUD/BRL) = AUD236,653 Convert domestic to foreign
2 AUD236,653 × (1.031) = AUD243,989 Invest foreign at foreign rate
3 AUD243,989 × 2.1388 = BRL521,844 Convert foreign to domestic
Arbitrage profit = BRL521,844 – BRL520,500= BRL1,344

A is incorrect. The right side of the equation uses inverted exchange rates in Steps One and
Three and 4.1% in Step Two.
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 Step One: BRL500,000 × (2.1128AUD/BRL) = AUD1,056,400

 Step Two: AUD1,056,400 × (1.041) = AUD1,099,712
 Step Three: AUD1,099,712 × (1/2.1388) = BRL514,173Arbitrage profit = BRL514,173
(right side above) – BRL520,500 (left side above) = –6,327
C is incorrect. The right side of the equation uses 4.1% and thus 1.041 incorrectly in Step
Two.
 Step One: BRL500,000 × (1/2.1128AUD/BRL) = AUD236,653

 Step Two: AUD236,653 × (1.041) = AUD246,355
 Step Three: AUD246,355 × 2.1388 = BRL526,905Arbitrage profit = BRL526,905 (right
side above) – BRL520,500 (left side above) = 6,405
Currency Exchange Rates Learning Outcomes

f. Explain the arbitrage relationship between spot rates, forward rates, and interest rates
h. Calculate and interpret the forward rate consistent with the spot rate and the interest rate in each
currency
Q63. In the classification of currency regimes, a currency board system (CBS) most
likely differs from a fixed-rate parity system in that:
A. a CBS can peg to a basket of currencies but a fixed-rate system cannot.
B. the monetary authority within a CBS does not act as a traditional lender of last resort.
C. a CBS has a discretionary target level of foreign exchange reserves.
Solution
B is correct. In a CBS, the monetary authority has an obligation to maintain 100% foreign
currency reserves against the monetary base. It therefore cannot lend to troubled financial
institutions. As long as the country under a fixed parity regime maintains its exchange peg,
the central bank can serve as a lender of last resort.
A is incorrect. It is the fixed-rate system that can use a basket of currencies for the peg.
C is incorrect. In a fixed parity system the monetary authority has a discretionary target level
of reserves, but in a CBS it does not because there is a commitment to exchange domestic
currency for a specified foreign currency at a fixed exchange rate.
Currency Exchange Rates Learning Outcome

i. Describe exchange rate regimes
Q64. The financial statement that would be most useful to an analyst in understanding the
changes that have occurred in a company’s retained earnings over a year is the statement of:
A. comprehensive income.
B. financial position.
C. changes in equity.
Solution
C is correct. The statement of changes in equity reports the changes in the components of
shareholders’ equity over the year, which would include the retained earnings account.
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A is incorrect. The net income determined in the calculation of comprehensive income is a

component of the change in retained earnings, but there are other changes that may also have
occurred (the payment of dividends, for example) that are not included on the statement of
comprehensive income.
B is incorrect. Although the year-end balances of retained earnings may be reported on the
statement of financial position (depending on if the company breaks out the components of
shareholders’ equity), it would not detail the changes over the year.
Introduction to Financial Statement Analysis Learning Outcome

b. Describe the roles of the statement of financial position, statement of comprehensive income,
statement of changes in equity, and statement of cash flows in evaluating a company’s performance
and financial position
Q65. During the process data phase of financial statement analysis, an analyst will most
likely develop a:
A. statement of purpose.
B. common-size balance sheet.
C. statement of cash flows.
Solution
B is correct. During the process data phase, an analyst will produce a variety of reports and
documents based on the information collected. These may include common-size statements,
ratios and graphs, forecasts, adjusted statements, and analytical results.
A is incorrect. The statement of purpose is prepared during the articulation phase.
C is incorrect. The statement of cash flows is a source of information for the analyst.
Introduction to Financial Statement Analysis Learning Outcome

f. Describe the steps in the financial statement analysis framework
Q66. According to the International Financial Reporting Standards framework, which of the
following qualities of financial information is least likely cited as one of the two fundamental
characteristics that make financial information useful?
A. Faithful representation
B. Accrual accounting
C. Relevance
Solution
B is correct. The two fundamental characteristics that contribute to the usefulness of
financial information in decision making are relevance and faithful representation. Accrual
accounting is not a qualitative characteristic; it is an underlying assumption.
A is incorrect. Faithful representation is one of the six qualitative characteristics that
contribute to the usefulness of financial information in decision making under the IFRS
framework.
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C is incorrect. Comparability is one of the six qualitative characteristics that contribute to the
usefulness of financial information in decision making under the IFRS framework.
Financial Reporting Standards Learning Outcome

c. Describe the International Accounting Standards Board’s conceptual framework, including the
objective and qualitative characteristics of financial statements, required reporting elements, and
constraints and assumptions in preparing financial statements
Q67. In applying the principles of expense recognition, companies should:
A. record any estimates of uncollectible amounts as a direct reduction of revenues.

B. exclude costs of intangible assets with indefinite useful lives.
C. recognize credit losses on customer receivables when defaults occur.
Solution
B is correct. The two main types of long-lived assets whose costs are not allocated over time
are land and those intangible assets with indefinite useful lives.
A is incorrect because a company records an estimate of uncollectible amounts as an expense
on the income statement, not as a direct reduction of revenues.
C is incorrect because, under the matching principle, at the time revenue is recognized on a
sale, a company is required to record an estimate of how much of the revenue will ultimately
be uncollectible.
Understanding Income Statements Learning Outcome

d. Describe general principles of expense recognition, specific expense recognition applications, and
implications of expense recognition choices for financial analysis
The following data are available on a company:
Metric ($ millions)
Total assets 145
Total revenues 282
Total expenses 241
Research and development expenses 12

Q68. Under a common-size analysis, the value used for research and development expenses
is closest to:
A. 4.2%.
B. 8.3%.
C. 5.0%.
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Solution
A is correct. The appropriate base for a common-size income statement is revenue. As such,
the value used for research and development expenses is $12 million/$282 million × 100 =
4.25%.
B is incorrect because it uses total assets as a base: 12/145 × 100 = 8.28%. This is appropriate
for common-size balance sheets.
C is incorrect because it uses total expenses as a base: 12/241 × 100 = 4.97%.

i. Formulate income statements to common-size income statements
Q69. An analyst notes that a company’s most recent financial statements show £65 million in
net income, £7 million in dividends paid to common shareholders, and £5 million of other net
expense items excluded from the net income calculation. The company’s comprehensive
income is:
A. £60 million.
B. £65 million.
C. £53 million.
Solution
A is correct. Given that comprehensive income includes net income and both other revenue
and expense items that are excluded from the net income calculation (other comprehensive
income), then the company's comprehensive income is:
£65 million – £5 million = £60 million.
C is incorrect because £53 million results from incorrectly subtracting £7 million in common
stock dividends from comprehensive income:
£65 million – £5 million – £7 million = £53 million

B is incorrect because £5 million of other net expense items excluded from the net income
calculation is other comprehensive income and it should be subtracted from net income when
calculating the company’s comprehensive income.

k. Describe, calculate, and interpret comprehensive income
Q70. Which of the following best describes a use of the balance sheet? A company’s balance
sheet:
A. provides detail on its overall financial position at the end of a period.
B. includes detail on its cash receipts and payments made during a period.
C. specifies how much revenue it generated during a period.
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Solution
A is correct. The balance sheet enables an analyst to evaluate a company’s liquidity,
solvency, and overall financial position. It discloses what an entity owns, what it owes, and
what the owners’ claims are at a specific point in time.
B is incorrect. The cash flow statement provides information about a company’s cash receipts
and payments during a period. The balance sheet reports a total amount for cash and cash
equivalents at a specific point in time, but it does not provide the underlying detail on the
receipts and payments made during the period.
C is incorrect. The income statement communicates how much revenue a company generates
during a period and what costs it incurred in connection with that revenue. The balance sheet
reports earnings, but it does not provide detail to communicate how much revenue a company
generated during a period.
Understanding Balance Sheets Learning Outcome

b. Describe uses and limitations of the balance sheet in financial analysis
Q71. Deferred tax liabilities result when:
A. taxable income in a period is less than reported financial statement income before taxes.
B. items of expense are included in financial statement income in earlier periods than those
for which taxable income is reported.
C. straight-line depreciation methods are used for tax purposes and accelerated methods are
employed for financial statement purposes.
Solution
A is correct. Deferred tax liabilities result when, for a given period, taxable income and the
associated income tax payable are less than the reported financial statement income before
taxes and the associated income tax expense.
B is incorrect because if items of expense are included in financial statement income in
earlier periods than those for which taxable income is reported, then the financial statement
income and associated reported income tax expense will be less than taxable income and
actual income tax payable. A deferred tax liability occurs only in the opposite case, when
taxable income and income tax payable are smaller. Deferred tax liabilities result from timing
differences between financial statement income and taxable income when taxable income is
lower than financial statement income, not higher.
C is incorrect because straight-line depreciation methods result in lower depreciation expense

than accelerated methods. This approach would produce higher taxable income than financial
statement income, with no resulting deferred tax liability.

e. Describe different types of assets and liabilities and the measurement bases of each
Page 47 of 113
Metric
Working capital $60 million
Non-current assets $235 million
Equity $170 million
Current ratio 1.75

Q72. The company’s financial leverage is closest to:
A. 1.7.
B. 2.2.
C. 1.2.
Solution
B is correct. First determine current assets, where CA = Current assets, CL = Current
liabilities, WC = Working capital, and CR = Current ratio.
CR = CA/CL = 1.75
CL = CA/1.75
WC = CA – CL
60 = CA – CA/1.75
60 = 0.75/1.75 × CA
CA = 140
Then solve for total assets and determine financial leverage:
Metric
Current assets $140 million
Non-current assets + $235 million
Total assets $375 million
Equity $170 million
Financial leverage = Total assets/Equity 2.2

A is incorrect. Instead of calculating total assets, the sum of non-current assets and working
capital was used:
Page 48 of 113
Metric (all $ amounts in millions)
Working capital 60
Non-current assets + 235
Incorrect total assets 295
Equity 170
Financial leverage = Total assets/Equity 1.7

C is incorrect. Instead of calculating financial leverage, total liabilities to equity was
calculated:
Metric (all $ amounts in millions)
Total assets per calculation above 375
Less: Equity –170
Total liabilities 205
Incorrect Financial leverage calculation (Total liabilities/Equity) 1.2

h. Calculate and interpret liquidity and solvency ratios
Q73. If a company issues shares in exchange for a capital asset, the transaction is most
likely reported as:
A. supplementary information to the cash flow statement.
B. a financing inflow and an investing outflow in the cash flow statement.
C. an investing inflow and outflow in the cash flow statement.
Solution
A is correct. Significant non-cash investing and financing transactions, such as purchasing a
capital asset by issuing shares, are required to be disclosed, either in a separate note or a
supplementary schedule to the cash flow statement.
B is incorrect. Because no cash is involved in the transaction, non-cash investing and
financing activities are not incorporated as inflows and outflows on the cash flow statement.
C is incorrect. Because no cash is involved in the transaction, non-cash investing and

financing activities are not incorporated as inflows and outflows on the cash flow statement.
Understanding Cash Flow Statements Learning Outcome

b. Describe how non-cash investing and financing activities are reported
Page 49 of 113
Q74. Which of the following is the most likely reason for an analyst to choose the direct
method rather than the indirect method for analyzing a firm’s operating cash flows?
A. To understand the relationship between net income and operating cash flows
B. To identify operating cash flows by source and by use
C. To avoid making adjustments for non-cash items
Solution
B is correct. The direct method cash flow statement presents specific operating cash flows by
source and use.
A is incorrect because the indirect method starts with net income and presents clearly the
relationship between net income and operating cash flows.
C is incorrect because the indirect method cash flow statement adjusts for non-cash items, not
the direct method

d. Compare and contrast the direct and indirect methods of presenting cash from operating activities
and describe arguments in favor of each method
The following financial statement data are available for a company:
Metric £ thousands
Net income 500
Depreciation 150
Cash flow from operations 600
Free cash flow to the firm 300
Beginning total assets 4,000
Ending total assets 6,000
Ending cash balance 50
Book value 3,000

Q75. The company’s cash return on assets ratio is closest to:
A. 12%.
B. 10%.
C. 13%.
Page 50 of 113

i. Calculate and interpret free cash flow to the firm, free cash flow to equity, and performance and
coverage cash flow ratios
Q76. All else being equal, a decrease in which of the following financial metrics would most
likely result in a lower return on equity (ROE)?
A. The tax rate
B. Leverage
C. Days of sales outstanding
Solution
B is correct. Leverage is a component of the return on equity equation under the DuPont
Analysis. If leverage decreases, so will return on equity.
ROE = Tax burden × Interest burden × Earnings before interest and taxes margin × Total
asset turnover × Leverage
A is incorrect. The tax burden is one of the components of ROE in the 5-factor model:
Tax burden = Net income/EBT = (EBT – Tax)/EBT = 1 – Tax/EBT = 1 – Effective tax rate
A lower tax rate means the company keeps more of its pre-tax profits (and has a higher tax
burden). A lower tax rate increases net income and increases ROE: an increase in any of the 5
components increases ROE.
Page 51 of 113
C is incorrect. Days of sales outstanding is a component of the asset turnover measure. All
else equal, if days of sales outstanding decreased, total asset turnover would increase. If asset
turnover increases, so will return on equity.
Financial Analysis Techniques Learning Outcome

d. Demonstrate the application of DuPont analysis of return on equity and calculate and interpret
effects of changes in its components
Metric $ thousands
Interest expense and payments 1,000
Income tax expense 1,100
Net income 3,400
Lease payments 500

Q77. The company’s fixed charge coverage ratio is closest to:
A. 3.67.
B. 4.00.
C. 2.27.
Solution
B is correct. First, earnings before interest and taxes (EBIT) must be calculated, then the
fixed charge coverage ratio.
EBIT = Net income + Interest expense + Income tax expense
= 3,400 + 1,000 + 1,100 = 5,500
Fixed charge coverage ratio = (EBIT + Lease payments)/(Interest payments + Lease

payments)
= (5,500 + 500)/(1,000 + 500)
= 6,000/1,500
= 4.00
A is incorrect. It omits lease payments in the numerator.
Numerator: EBIT = 5,500

Denominator: Interest payments + Lease payments = 1,000 + 500 = 1,500
Incorrect fixed charge coverage ratio = 5,500/1,500 = 3.67
Page 52 of 113
C is incorrect. It forgot to use EBIT; this is net income/fixed charges.
Numerator: Net income = 3,400

Denominator: Interest payments + Lease payments = 1,000 + 500 = 1,500
Incorrect fixed charge coverage ratio = 3,400/1,500 = 2.27
Financial Analysis Techniques Learning Outcome

b. Identify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios
Non-Current (Long-Term) Liabilities Learning Outcome

k. Calculate and interpret leverage and coverage ratios
A firm that prepares its financial statements according to US GAAP and uses a periodic inventory
system had the following transactions during the year:
Date Activity Tons (thousands) $ per Ton
Beginning inventory 1 600
February Purchase 5 650
May Sale 2 700
August Purchase 3 680
November Sale 4 750

Q78. The cost of sales (in thousands) is closest to:
A. $5,890 using weighted average.
B. $4,080 using LIFO.
C. $3,850 using FIFO.
Solution
C is correct. Under FIFO, the oldest units are sold first, thus for the six units sold FIFO, cost
of sales is $3,850, as follows: 1 unit at $600 + 5 units at 650 = $3,850.
A is incorrect. It is the cost of goods available for sale not the cost of goods sold: 1 unit at
$600 + 5 units at 650 + 3 units at 680 = $5,890.
B is incorrect. It used the $680 most recent cost for all 6,000 units sold: 6 × $680 = $4,080.
Inventories Learning Outcome

c. Calculate and compare cost of sales, gross profit, and ending inventory using different inventory
valuation methods and using perpetual and periodic inventory systems
Page 53 of 113
An analyst gathers the following information about a company:
($ thousands) 2014 2013
Sales 2,125 2,003
End-of-year inventories (LIFO) 312 280
LIFO reserve 82 64
Net profit margin 4.9% 4.0%
Corporate tax rate for current and all prior years: 30%
Q79. If first-in, first-out (FIFO) instead of last-in, first-out (LIFO) is used, the net income (in
$ thousands) for 2014 will be higher by an amount closest to:
A. 18.0.
B. 57.4.
C. 12.6.
Solution
C is correct.
Net income (LIFO) = Net profit margin × Sales
= 0.049 × 2,125
= 104.1
Change in LIFO reserve = LIFO reserve 2014 – LIFO reserve 2013
= 82 – 64
= 18
Net income (FIFO) = LIFO net income + Change in LIFO reserve × (1 – Tax rate)
= 104.1 + 18 × (1 – 0.30)
= 116.7
Increase in net income = 116.7 – 104.1
= 12.6
More simply, the difference is the change in the LIFO reserve, after tax.
18 × (1 – 0.3) = 12.6
Page 54 of 113
A is incorrect. It ignores taxes on change in LIFO reserve.
= 0.049 × 2,125
= 104.1
Change in LIFO reserve = LIFO reserve 2014 – LIFO reserve 2013
= 82 – 64
= 18
Net income (FIFO) = Net income (LIFO) + change in LIFO reserve
= 104.1 + 18
= 122.1

= 18
Or more simply, 18: the change in LIFO reserve
B is incorrect. It applies the increase on the entire LIFO reserve (after tax).
= 0.049 × 2,125
= 104.1
Net income (FIFO) = Net income (LIFO) + LIFO reserve × (1 – Tax rate)
= 104.1 + 82 × (1 – 0.30)
= 161.5
= 57.4
Or more simply, 82 × (1 – 0.30): LIFO reserve after tax
Inventories Learning Outcomes

f. Demonstrate the conversion of a company’s reported financial statements from LIFO to FIFO for
purposes of comparison
e. Explain LIFO reserve and LIFO liquidation and their effects on financial statements and ratios
Page 55 of 113
Q80. Because of a problem with the production process, a manufacturer produced a batch of
defective finished goods with a total cost of $18,000. The sales value of this batch in its
current condition is $6,000. With $3,000 of additional processing, however, the batch could
be sold for $11,000. The value of the unsold inventory, on the balance sheet of a company
using International Financial Reporting Standards (IFRS), is closest to:
A. $9,000.
B. $8,000.
C. $11,000.
Solution
B is correct. Under IFRS, inventory is carried at the lower of cost and net realizable value
(NRV). The company would logically choose to sell the batch at its highest realizable value.
Cost Given $18,000
NRV
Estimated selling price $11,000
Less: Costs to sell $0
Less: Costs to prepare inventory for sale $3,000 $8,000
Lower of cost or NRV $8,000

A is incorrect. It is the current condition of the inventory plus the costs for additional
processing: 6000 + 3,000 = 9,000.
C is incorrect. This choice assumes that the company would sell the inventory without further
processing for $11,000. This is not a reasonable choice because the benefits of further
processing outweigh the costs.
Inventories Learning Outcome

h. Describe implications of valuing inventory at net realisable value for financial statements and ratios
The following information is available for an asset purchased at the start of its first year of
operations (Year 1):
 Purchase price: $1.8 million

 Estimated useful life: 5 years
 Estimated residual value: $500,000
Q81. If the company uses the double declining balance method of depreciation, the
depreciation expense in Year 3 will be closest to:
A. $187,200.
B. $259,200.
C. $148,000.
Page 56 of 113
Solution
C is correct. Under the double declining balance approach, the depreciation rate applied to
the carrying amount is double the depreciation rate for the straight-line method. Because the
rate for the straight-line method is 20% (1/5), the double declining rate is 40%. Depreciation
expense is recorded until the net book value (NBV) reaches the residual value.
Year 1 Year 2 Year 3
Opening NBV $1,800,000 $1,080,000 $648,000
Depreciation expense 720,000 432,000 148,000

(40% of opening NBV)
Ending NBV 1,080,000 648,000 500,000

A is incorrect. This is the double declining approach, but with the residual value incorrectly
deducted from the depreciation base:
Opening carrying value 1,300,000* 780,000 468,000
Depreciation expense (40% of opening NBV) 520,000 312,000 187,200
Ending carrying value 780,000 468,000 512,000

* incorrectly calculated net of the residual value
B is incorrect. This is the full double declining depreciation expense that would have been
recorded if the residual value had been below $388,800:
Opening net book value (NBV) $1,800,000 $1,080,000 $648,000
Depreciation expense (40% of opening NBV) 720,000 432,000 259,200
Ending net book value 1,080,000 648,000 388,800
Long-Lived Assets Learning Outcome

e. Describe how the choice of depreciation method and assumptions concerning useful life and
residual value affect depreciation expense, financial statements, and ratios
Page 57 of 113
The following information is available for a company that prepares its financial statements in
accordance with US GAAP:
 It has production facilities with a net book value of $28.4 million.
 Recently, several other companies have entered the market, and the company now
estimates that it will be able to generate cash flows of only $3 million per year for the
next seven years with its facilities.
 The firm has a cost of capital of 10%.
Q82. Reflecting these recent events related to its production facilities, the company’s
financial statements will most likely report (in millions) a:
A. $13.8 impairment loss on the income statement.
B. $7.4 reduction in the balance sheet carrying amount.
C. $13.8 reduction in operating cash flows.
Solution
A is correct. The company will report an impairment loss of $13.8 million on its income
statement. Under US GAAP, the facilities fail the recoverability test: the net book value
cannot be recovered from undiscounted cash flows (7 years × $3 = $21 < $28.4). Therefore,
the asset is impaired and should be written down to its fair value.
Fair Value is the present value (PV) of future benefits: (N = 7; i = 10; PMT = 3); PV = 14.6
Impairment Loss is Carrying value – Fair value = 28.4 – 14.6 = 13.8 to be reported on the
income statement.
B is incorrect. It was determined with no discounting of future benefits, resulting in an

incorrect impairment charge: 28.4 – 3 × 7 = 7.4.
C is incorrect. This is a non-cash item and does not affect cash from operations.

i. Explain the impairment of property, plant, and equipment and intangible assets
A technology company, reporting under US GAAP, has three classes of intangible assets. The
table below shows information on each of the three classes:
Accumulated Impairment Losses and Amortization (Currency in USD)
(in thousands) Goodwill Licenses Computer Software
31 December 2019 65,321 8,243 5,257
Exchange movements 7,324 821 334
Amortization charge for year — 1,244 2,102
Net additions (disposals) — (25) —
Impairment charge for the year ? ? ?
31 December 2020 73,194 10,856 8,214
Page 58 of 113
Q83. Based on the data provided, the intangible asset that has the largest absolute impairment
charge for the period ended 31 December 31 2020, is:
A. computer software.
B. licenses.
C. goodwill.
Solution
B is correct. Licenses will have the largest dollar impairment charge on the income statement
due to the size of the implied impairment charge, which is calculated as: Accumulated
impairment losses and amortization as of 31 December 2019 – (Accumulated impairment
losses and amortization as of 31 December 2019 + Exchange movements + Amortization
charge for year + Net Additions (Disposals)). In this case the largest impairment loss that will
be reported is due to licenses. Impairment charge due to licenses = 10,856 – (8,243 + 821 +
1,244 – 25) = 573.
A is incorrect because the amount of the impairment charge due to computer software is less
than that of licenses. The computer software impairment charge for 20X2 in dollars = 8,214 –
(5,257 + 334 + 2,102) = 521.
C is incorrect because the amount of the impairment charge due to goodwill is less than that
of licenses. The goodwill impairment charge for 20X2 in dollars = 73,194 – (65,321 + 7,324)
= 549.

m. Analyze and interpret financial statement disclosures regarding property, plant, and equipment and
intangible assets
Q84. If a company has a deferred tax asset reported on its statement of financial position and
the tax authorities reduce the tax rate, which of the following statements is most accurate
concerning the effect of the change? The existing deferred tax asset will:
A. not be affected.
B. increase in value.
C. decrease in value.
Solution
C is correct. A decrease in the tax rate will result in a decrease in the previously reported
amounts of deferred tax assets. That is, the value of the future tax assets, based on the new
lower rate, is reduced for offsetting future tax payments.
A is incorrect. The change would affect not only the current year’s reported income tax
expense but also any amounts previously established on the balance sheet.
B is incorrect. The value of the future benefits decreases, not increases.
Income Taxes Learning Outcomes

d. Calculate income tax expense, income taxes payable, deferred tax assets, and deferred tax
liabilities, and calculate and interpret the adjustment to the financial statements related to a change in
the income tax rate
e. Evaluate the effect of tax rate changes on a company’s financial statements and ratios
h. Explain recognition and measurement of current and deferred tax items
Page 59 of 113
Q85. A company that provides cruise ship vacations uses term loans to finance the
acquisition of new cruise ships. Which of the following is most likely a negative covenant for
the loans? The company must:
A. ensure the ships are insured.
B. seek lender approval to pay dividends.
C. maintain a minimum level of working capital.
Solution
B is correct. Negative covenants require that a borrower not take certain actions. The
requirement to seek the lender’s approval before paying dividends is an example of a
negative covenant. The other two are affirmative covenants.
A is incorrect. This is an affirmative covenant. The bank would want to ensure that the ships,
or collateral for the loan, are adequately insured.
C is incorrect. This is an affirmative covenant. Maintaining a minimum level of working

capital is often a covenant to ensure the company has adequate levels of liquidity to make the
interest payments.

d. Describe the role of debt covenants in protecting creditors
Q86. Which of the following statements best describes the effect of finance leases on
financial statements?
A. A lessee reports the interest portion of the lease payment as operating cash flow under
IFRS and financing cash flow under US GAAP.
B. The lessor reports a profit on the sale of the leased asset on the income statement in the
case of a sales-type lease.
C. Balance sheet effects differ based on whether the lease is a direct financing lease or a
sales-type lease.
Solution
B is correct. A lessor reports a profit on the sale of the asset on the income statement when
the present value of the lease payments exceeds the carrying amount of the leased asset
(sales-type lease).
A is incorrect because the interest portion of the lease payment is either an operating or
financing cash outflow under IFRS, and is an operating cash outflow under US GAAP.
C is incorrect because the impact on a lessor’s balance sheet is the same for both a direct-
financing and a sales-type lease.

h. Explain the financial reporting of leases from a lessor’s perspective
Page 60 of 113
Q87. Accounting choices within GAAP that decrease reported performance in the current
period and may increase performance in later periods are most likely examples of:
A. aggressive accounting.
B. conservative accounting.
C. earnings that are not sustainable.
Solution
B is correct. Conservative accounting choices decrease the company’s reported performance
and financial position in the current period and may increase its reported performance and
financial position in later periods.
A is incorrect because aggressive accounting choices have the opposite effect of increasing
the company’s reported performance and financial position in the current period and may
decrease its reported performance and financial position in later periods
C is incorrect because conservative accounting such as decreasing current reported

performance and increasing later reported performance does not typically create a
sustainability issue.
Financial Reporting Quality Learning Outcome

c. Explain the difference between conservative and aggressive accounting
Q88. An analyst would most likely conduct additional analysis when faced with which of the
following financial presentations?
A. A non-GAAP financial measure that excludes an expense that is likely to recur
B. Reporting a non-GAAP financial measure in an SEC filing
C. A change from LIFO inventory accounting to FIFO
Solution
A is correct. The exclusion of recurring items from non-GAAP financial measures is strictly
prohibited by the SEC and should raise concerns that additional analysis is needed.
B is incorrect. If a company uses non-GAAP measures in its SEC filings, it must display the
comparable GAAP measure with equal prominence and provide a reconciliation between the
two.
C is incorrect. LIFO reporting provides sufficient information in the Notes to convert from
LIFO to FIFO so a formal change should not alter an analyst’s opinion about the company.
Financial Reporting Quality Learning Outcome

g. Describe presentation choices, including non-GAAP measures, that could be used to influence an
analyst’s opinion
Page 61 of 113
Q89. A financial analyst determines that a company appears to be in the process of

accumulating a “war chest.” It is most likely that she will conclude that it will be used for:
A. recapitalization.
B. strategic acquisitions.
C. share buybacks.
Solution
B is correct. The term “war chest” refers to large cash balances that a company accumulates,
normally used to finance strategic acquisitions.
A is incorrect. Recapitalization involves restructuring a company’s equity capital, often as a
response to financial distress. At this point, the company is usually very short of cash, not
flush with cash.
C is incorrect. Companies that buy back large blocks of shares are often looking for a way to
distribute excess cash accumulations, rather than actively trying to accumulate it. The term
“war chests” is associated with a more purposeful accumulation.
Applications of Financial Statement Analysis Learning Outcome

a. Evaluate a company’s past financial performance and explain how a company’s strategy is reflected
in past financial performance
Q90. For which of the following companies would forecasting future operating profits based
on historical performance be most appropriate?
 A domestic industrial security company that has served a stable portfolio of clients for
many years
 A domestic mining company whose extraction costs are quite stable even though the
underlying commodities are volatile in price
 An international personal care products company that manufactures and sells in many
countries, with relatively stable local demand and stable local costs at its manufacturing
sites
A. The mining company
B. The personal care products company
C. The industrial security company
Solution
C is correct. As a domestic company, the industrial security company is the most appropriate
to forecast using historical performance. It likely has stable earnings from its stable client list
and is unaffected by non-domestic markets, currency changes, or changing prices. For the
mining company, the volatility of commodity prices could make its future performance differ
from past performance. For the international personal care company, the additional risks
associated with foreign markets and currencies could be significant.
A is incorrect. The volatility of commodity prices could make its future performance differ
from past performance. As such, historical operating profits may not be indicative of future
operating profits.
Page 62 of 113
B is incorrect. The additional risks associated with foreign markets and currencies could be
significant. As such, historical operating profits may not be indicative of future operating
profits.
Applications of Financial Statement Analysis Learning Outcome

b. Demonstrate how to forecast a companys future net income and cash flow
Page 63 of 113
Afternoon Session
Page 64 of 113
Q1. According to good corporate governance practices, which of the following committees
is most likely to have members from executive management?
A. Remuneration
B. Audit
C. Environmental health and safety
Solution
C is correct. In good corporate governance practices the audit and
remuneration/compensation committees should be composed entirely of independent board
members. Other committees such as environmental health and safety may have members
from executive management.
A is incorrect. The remuneration/compensation committee should be composed entirely of
independent board members.
B is incorrect. The audit committee should be composed entirely of independent board

members.
Introduction to Corporate Governance and Other ESG

Considerations Learning Outcome
f. Describe functions and responsibilities of a company’s board of directors and its committees
Q2. Which of the following features is most likely to be found in a well-structured executive
compensation plan?
A. Links to factors that drive overall corporate performance
B. Reasonably consistent total compensation from year to year
C. Higher total remuneration relative to peer companies with comparable performance
Solution
A is correct. Plans that link compensation to the factors that drive overall corporate
performance are well structured because they create alignment between shareholder and
executive objectives.
B is incorrect. Plans that exhibit little variation in results from year to year may be failing to
distinguish strong from weak performance.
C is incorrect. Compensation plans should result in comparable remuneration for comparable

companies with comparable performance.
Introduction to Corporate Governance and Other ESG

Considerations Learning Outcome
i. Describe factors relevant to the analysis of corporate governance and stakeholder management
Page 65 of 113
The following table shows the incremental after-tax cash flows (in $ millions) for three independent
investments:
Year 0 1 2 3 4 5
Investment 1 −80 0 0 60 60
Investment 2 −125 35 60 80 −20
Investment 3 −100 11 11 11 11 11 into perpetuity

Q3. The opportunity cost of capital (r) is 12%. A company is most likely to undertake which
investment(s)?
A. Investments 1 and 2
B. Investment 1 only
C. Investments 2 and 3
At the opportunity cost of capital of 12 percent, investment 1 is the only investment with
positive NPV.
A is incorrect. As per table, investment 2 has a negative NPV and should be rejected.
C is incorrect. As per table, both investments 2 and 3 have negative NPVs and should be
rejected.
Uses of Capital Learning Outcome

b. Demonstrate the use of net present value (NPV) and internal rate of return (IRR) in allocating
capital and describe the advantages and disadvantages of each method
Page 66 of 113
Q4. The acceptance of which of the following capital budgeting projects is most likely to
expose a company to the highest level of uncertainty?
A. Replacement of worn out equipment
B. Expansion projects
C. Newly launched product or services
Solution
C is correct. Investments related to new products or services expose the company to even
more uncertainties than expansion projects. These decisions are more complex and will
involve more people in the decision-making process.
A is incorrect. Replacement of worn out equipment is simply an improvement to the existing
project with recurring revenues.
B is incorrect. Investments related to new products or services expose the company to even
more uncertainties than expansion projects. These decisions are more complex and will
involve more people in the decision-making process

a. Describe the capital allocation process and basic principles of capital allocation
Q5. An option to abandon a capital investment at a future date if the NPV of the project is
less than expected is a type of:
A. sizing option.
B. timing option.
C. flexibility option.
Solution
A is correct because an abandonment option is a type of sizing option. "Sizing options. If
after investing the company can abandon the investment if the financial results are
disappointing, it has an abandonment option. At some future date, if the cash flow from
abandoning an investment exceeds the present value of the cash flows from continuing the
investment, the company should exercise the abandonment option."
B is incorrect because an abandonment option is a type of sizing option, not timing option.
"Timing options. Instead of investing now, the company can delay investing. Delaying an
investment and basing the decision on hopefully improved information that you might have
in, say, a year could help improve the NPV of the projects selected."
C is incorrect because an abandonment option is a type of sizing option, not flexibility option.
"Flexibility options. Once an investment is made, operational flexibilities besides
abandonment or expansion may be available... Management may be able to exercise a price-
setting option. By increasing prices, the company could benefit from the excess demand,
which it cannot do by increasing production. There are also production-flexibility options,
which offer the operational flexibility to alter production when demand varies from what is
forecast."

d. Describe types of real options relevant to capital investment
Page 67 of 113
Q6. Which of the following is categorized as an external source of funding for a company?
A. Assigning accounts receivable

B. Liquidating marketable securities
C. Extending the accounts payable period
Solution
A is correct. This is a source of external financing for a company. "Secured ('asset-based')
loans are loans in which the lender requires the company to provide collateral in the form of
an asset, such as a fixed asset that the company owns or high-quality receivables and
inventory...For example, a company can use its accounts receivable to generate cash flow
through the assignment of accounts receivable, which is the use of these receivables as
collateral for a loan."
B is incorrect because "[c]ompanies can generate internal financing and liquidity from
shorter-term operating activities in several ways. These include...converting liquid assets such
as receivables, inventories, and marketable securities to cash."
C is incorrect because "[c]ompanies can generate internal financing and liquidity from
shorter-term operating activities in several ways. These include...extending a company’s
payables period."
Sources of Capital Learning Outcome

a. Describe types of financing methods and considerations in their selection
An analyst gathers the following information (in € millions) about three companies:
Company 1 Company 2 Company 3
Cash and short-term securities 50 60 90
Accounts receivable 30 70 40
Inventory 40 20 60
Current liabilities 60 90 100
Q7. The company with the highest quick ratio is:
A. Company 1.
B. Company 2.
C. Company 3.
Page 68 of 113
Solution
B is correct because the quick ratio = (cash + short term securities + A/R)/Current Liabilities
Company 1 quick ratio = (50 + 30)/60 = 1.333
A is incorrect because Company 1 has the highest current ratio not quick ratio:
Current ratio = (cash + short term securities + A/R + Inventories)/Current Liabilities
Company 1 current ratio = (50 + 30 +40)/60 = 2.000
Company 2 current ratio = (60 + 70 + 20)/90 = 1.667
Company 3 current ratio = (90 + 40 + 60)/100 = 1.900
C is incorrect because Company 3 has the highest cash ratio, not quick ratio:
Cash ratio = (cash + short term securities)/Current Liabilities
Company 1 cash ratio = 50/60 = 0.8333

b. Compare a companys liquidity position with that of peer companies
Q8. Passive borrowing strategies most likely:

A. diversify the types of borrowing.
B. expose borrowers to rollover risk.
C. seek to increase the number of lenders.
Solution
B is correct because "[p]assive strategies are characterized by steady, often routine rollovers
of borrowings for the same amount of funds each time, without much comparison
shopping...[On the other hand,] [a]ctive strategies are usually more flexible and reflect
planning, reliable forecasting, and comparison pricing. With active strategies, borrowers are
more in control and do not fall into the rollover “trap” that is possible with passive
strategies."
A is incorrect because "[p]assive strategies usually involve minimal activity, with one source
or type of borrowing and with little (if any) planning... Passive strategies are characterized by
steady, often routine rollovers of borrowings for the same amount of funds each time, without
much comparison shopping."
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C is incorrect because "[p]assive strategies usually involve minimal activity, with one source
or type of borrowing and with little (if any) planning... Passive strategies are characterized by
steady, often routine rollovers of borrowings for the same amount of funds each time, without
much comparison shopping. Passive strategies might also arise when borrowing is restricted,
such as when borrowers are limited to one or two lenders by agreement (e.g., in a secured
loan arrangement)."

d. Evaluate choices of short-term funding
Q9. A firm’s estimated costs of debt, preferred stock, and common stock are 12%, 17%, and
20%, respectively. Assuming equal funding from each source and a marginal tax rate of 40%,
the weighted average cost of capital (WAAC) is closest to:
A. 13.9%.
B. 14.7%.
C. 16.3%.
Solution
B is correct. WACC = wdrd(1 – t) + wprp + were = [0.12 × (1 – 0.40) + 0.17 + 0.20]/3 =
14.73%.
A is incorrect because tax effect is miscalculated: [0.12 × 0.40 + 0.17 + 0.20]/3 = 13.93%.
C is incorrect because tax effect is ignored: [0.12 + 0.17 + 0.20]/3 = 16.33%.
Cost of Capital-Foundation Topics Learning Outcomes

a. Calculate and interpret the weighted average cost of capital (WACC) of a company
b. Describe how taxes affect the cost of capital from different capital sources
Q10. A company’s asset beta is 1.2 based on a debt-to-equity ratio (D/E) of 50%. If the
company’s tax rate increases, the associated equity beta will most likely:
A. increase.
B. decrease.
C. remain unchanged.
Solution
B is correct.
βequity=βasset×[1+(1− tax rate)×D/E]
If the tax rate increases, then the bracketed term (1 – tax rate) decreases, making the equity
beta decrease because the asset beta is unchanged.
A is incorrect because the equity beta decreases.
C is incorrect because the equity beta decreases.
Cost of Capital-Foundation Topics Learning Outcome

f. Explain and demonstrate beta estimation for public companies, thinly traded public companies, and
nonpublic companies
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A company issues a noncallable, nonconvertible perpetual preferred stock with the following
terms:
Par value $25.00
Issue price $24.75
Annual dividend $1.30
Corporate tax rate 10%
Q11. The cost of preferred stock is closest to:

A. 4.73%.
B. 5.20%.
C. 5.25%.
Solution
C is correct because the cost of preferred stock is: rP = DP/PP
Where Pp = the current preferred stock price per share
DP = the preferred stock dividend per share
rP = the cost of preferred stock
rP = 1.30/24.75 = 0.052525 ≈ 5.25%.
A is incorrect because the tax rate is used in the calculation. "Unlike interest on debt, the
dividend on preferred stock is not tax-deductible by the company; therefore, there is no
adjustment to the cost for taxes."
rP ≠ 1.30(1 – t)/24.75 = 1.17/24.75 = 0.047273 ≈ 4.73%.

B is incorrect because par value is used instead of market value.
rP ≠ 1.30/25.00 = 0.052000 ≈ 5.20%.
Cost of Capital-Foundation Topics Learning Outcome

d. Calculate and interpret the cost of noncallable, nonconvertible preferred stock
Q12. All else being equal, in which life cycle stage is a company most likely able to maintain
the highest leverage?
A. Start-up
B. Growth
C. Mature
Solution
C is correct because a mature company "becomes able to support low-cost debt, often on an
unsecured basis. From the company’s perspective, debt financing is likely to be more
attractive than higher-cost equity financing. In practice, large, mature public companies
commonly employ significant leverage, although many seek to maintain an investment-grade
rating in order to preserve maximum financial flexibility."
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A is incorrect because "[a]t this early stage, debt capital is typically not available or available
but very expensive. Most lenders require stable and positive cash flow to service debt and/or
collateral to secure it. An early-stage company often has neither, making it a high-risk
prospect to lenders.”
B is incorrect because while debt is used at this stage it is less than that of the mature
stage. "Many growth companies use debt conservatively in order to preserve operational and
financial flexibility and minimize the risk of financial distress. Equity remains the
predominant source of capital."
Capital Structure Learning Outcome

a. Describe how a companys capital structure may change over its life cycle
Q13. For an analyst estimating a company's target capital structure, which of the following
methods is most appropriate?
A. Apply the company’s current capital structure at book value weights
B. Use the average capital structure of a diversified group of companies
C. Infer the target capital structure by analyzing management statements on capital structure
policy
Solution
C is correct because an analyst can "[e]xamine trends in the company’s capital structure or
statements by management regarding capital structure policy to infer the target capital
structure."
A is incorrect because book value is used instead of market value. "Assume the company’s
current capital structure, at market value weights for the components, represents the
company’s target capital structure."
B is incorrect because an analyst can "[u]se averages of comparable companies’ capital

structures [not a diversified group] as the target capital structure."

c. Describe the use of target capital structure in estimating WACC, and calculate and interpret target
capital structure weights
Q14. Company management in which of the following industries is most likely to have the
highest information asymmetry?
A. Utility
B. Retail
C. Software
Solution
C is correct because "[a]symmetric information (an unequal distribution of information)
arises from the fact that managers have more information about a company’s performance
and prospects (including future investment opportunities) than do outsiders, such as owners
and creditors. Whereas all companies have a certain level of asymmetric information,
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companies with comparatively high asymmetry in information include those with complex
products. These include high-tech companies...Providers of both debt and equity capital
demand higher returns from companies with higher asymmetry in information because there
is greater potential for conflicts of interest."
A is incorrect because "[a]symmetric information (an unequal distribution of information)
products. These include high-tech companies."
B is incorrect because "[a]symmetric information (an unequal distribution of information)

products. These include high-tech companies."

d. Explain factors affecting capital structure decisions
Q15. A small manufacturer sources raw material from a number of large companies. If this
manufacturer decides to increase long-term financial leverage, which of the following
stakeholders is most negatively impacted?
A. Preferred shareholders
B. Suppliers of raw materials
C. Short-term, senior secured debt holders
Solution
A is correct because "preferred shareholders are vulnerable to decisions that increase
financial leverage and risk over the long term...Preferred shareholders might be concerned
that the new policy [increased long-term leverage] could gradually erode the company's
capacity to pay preferred dividends."
B is incorrect because since the suppliers of raw materials to the manufacturer are numerous
and large, they are unlikely to be concerned that a small client like the manufacturer referred
to here is planning to increase leverage. If the manufacturer experiences financial difficulties,
the impact on these suppliers would be small because the proportion of their sales that would
be impacted would also be small.
C is incorrect because "senior secured debt holders might be unconcerned [about an increase
in long-term leverage], particularly for debt maturing relatively soon, since there is minimal
default risk."

e. Describe competing stakeholder interests in capital structure decisions
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Q16. The unit contribution margin for a product is $20. A firm’s fixed costs of production up
to 300,000 units is $500,000. The degree of operating leverage (DOL) is most likely the
lowest at which of the following production levels (in units):
A. 300,000.
B. 200,000.
C. 100,000.
Solution
Q17. All else being equal, if a highly profitable company reduces financial leverage, it
is most likely that the company's ROE level:
A. decreases and ROE variability increases.
B. increases and ROE variability decreases.
C. decreases and ROE variability decreases.
Solution
C is correct because "[u]sing financial leverage generally increases the variability of return
on equity (net income divided by shareholders’ equity). In addition, its use by a profitable
company may increase the level of return on equity." The smaller the proportion of debt in
the financing mix of a business, the less earnings will be magnified upward in improving
economic times which translates into lower ROE levels for various levels of expected
operating earning, and consequently, a lower ROE variability.
A is incorrect because the smaller the proportion of debt in the financing mix of a business,
the less earnings will be magnified upward in improving economic times which translates
into lower ROE levels for various levels of expected operating earning, and consequently, a
lower ROE variability, not a higher one.
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B is incorrect because the smaller the proportion of debt in the financing mix of a business,
the less earnings will be magnified upward in improving economic times which translates
into lower ROE levels for various levels of expected operating earning, not higher.
Measures of Leverage Learning Outcome

c. Analyze the effect of financial leverage on a companys net income and return on equity
An analyst gathers the following information about a manufacturing company and its
products:
Number of units produced and sold 1,000,000
Contribution margin $10,000,000
Fixed operating costs $200,000
Fixed financial costs $100,000
18Q. The break-even number of units is:
A. 10,000.
B. 20,000.
C. 30,000.
Solution
C is correct because "QBE = (F + C)/(P – V)" where F = fixed operating costs; C = fixed
financial costs; P = price per unit; and V = variable cost per unit. Also, "[t]he per unit
contribution margin is the amount that each unit sold contributes to covering fixed costs—
that is, the difference between the price per unit and the variable cost per unit. That difference
multiplied by the quantity sold is the contribution margin..." Hence the contribution margin is
equal to Q(P – V). Here Q = 1,000,000 and Q(P – V) = 10,000,000; so (P – V) = $10. Hence
the breakeven number of units = (F + C)/(P – V) = ($200,000 + $100,000)/$10 = 30,000
A is incorrect because the numerator of the expression for the break-even number of units is
incorrectly calculated as F – C rather than F + C. Break-even number of units <> (F – C)
/ (P + V) = ($200,000 – $100,000)/$10 = 10,000
B is incorrect because this is the operating break-even number of units:"QOBE = F/(P – V)..."
Here Q = 1,000,000 and Q(P – V) = 10,000,000; so (P – V) = $10. Hence the operating
breakeven number of units = $200,000/$10 = 20,000
Measures of Leverage Learning Outcome

d. Calculate the breakeven quantity of sales and determine the companys net income at various sales
levels
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Q19. Which of the following is most likely a characteristic of real assets?

A. Substantial management costs
B. High liquidity
C. Homogeneity
Solution
A is correct. Real assets are characterized by illiquidity, not high liquidity. The heterogeneity
of real assets, their illiquidity, and the substantial costs of managing them are all factors that
complicate the valuation of real assets.
B is incorrect. Real assets are characterized by illiquidity, not high liquidity.
C is incorrect. Real assets are characterized by heterogeneity, not homogeneity.
Market Organization and Structure Learning Outcome

c. Describe the major types of securities, currencies, contracts, commodities, and real assets that trade
in organized markets, including their distinguishing characteristics and major subtypes
An investor buys a stock on margin and holds the position for one year.
Shares purchased 700
Purchase price $22/share
Call money rate 4%
Dividend $0.60/share
Leverage ratio 1.6
Total return on the investment 12%

Q20. Assuming that the interest on the loan and the dividend are both paid at the end of the
year, the price at which the investor sold the stock is closest to:
A. $23.05.
B. $23.98.
C. $23.38.
Solution
C is correct.
Total purchase value = Purchase price × Shares purchased $22 × 700 $15,400
Minus initial equity = Total purchase value/Leverage ratio $15,400/1.6 9,625
Amount borrowed = Total purchase value – Initial equity $15,400 – $9,625 $5,775
Margin interest paid = Call money rate × Amount borrowed 4% × $5,775 $231
Dividend income = Dividend per share × Shares purchased $0.60 × 700 $420
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Total return on the initial equity 12% × $9,625 $1,155
Gain from price appreciation = Total return – Dividend + Margin $1,155 – $420 + $966
interest $231
Price at which investor sold the stock = Gain from price ($966/700) + $22 $23.38
appreciation per share + Purchase price
A is incorrect because it ignores the margin interest.
Gain from price appreciation = Total return – Dividend $1,155 – $420 $735
Price at which investor sold the stock = Gain from price appreciation ($735/700) + $23.05
per share + Purchase price $22
B is incorrect because it ignores the dividend amount.
Gain from price appreciation = Total return + Margin interest $1,155 + $231 $1,386
Price at which investor sold the stock = Gain from price ($1,386/700) + $23.98
appreciation per share + Purchase price $22

f. Calculate and interpret the leverage ratio, the rate of return on a margin transaction, and the security
price at which the investor would receive a margin call
Q21. If the current share price is $60, a trader who wants to purchase the share at $58 or less
will most likely place a:
A. limit order.
B. market order.
C. stop-buy order.
Solution
A is correct because "[a] limit order conveys almost the same instruction [as market order]:
Obtain the best price immediately available, but in no event accept a price higher than a
specified limit price when buying or accept a price lower than a specified limit price when
selling."
B is incorrect because "[a] market order instructs the broker or exchange to obtain the best
price immediately available when filling the order." The trader might purchase it at more than
$58 by using market order.
C is incorrect because a stop-buy order is to buy at a price specified above the market price.
"Because stop-sell orders become valid when prices are falling and stop-buy orders become
valid when prices are rising."

h. Compare market orders with limit orders
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A market index has the following information:

Quarterly Price Returns Dividend Income Value of
Period (%) (%) Index
At the beginning of the 1,000.00

year (Base)
Quarter 1 3.0% 1.5%
Quarter 2 2.0% —
Quarter 3 –5.0% —
Q22. By the end of Quarter 3, which of the following statements is most accurate?
A. The value of the price return index is 998.1.
B. The value of the total return index is below 1,000.
C. The price return is 1.26%.
Solution
A is correct. The value of the price return index is 998.1. The value calculations for the price
return index and the total return index are based on the geometrical link of the respective
series of index returns as follows:
Value of price return index, VPRIT = VPRI0 (1 + PRI1)(1 + PRI2) … (1 + PRIT)
Value of total return index, VTRIT = VTRI0 (1 + TRI1)(1 + TRI2) … (1 + TRIT)
Quarterly Cumulative Value of Cumulative Value of
Price Dividend Price Return Index at Total Return Index at
Returns Income Quarter End Quarter End
Quarter (%) (%) (ending value) (ending value)
1 3.0% 1.5% 1,000(1.03) = 1,030.00 1,000(1.045) = 1,045.00
2 2.0% — 1,000(1.03)(1.02) = 1,000(1.045)(1.02) =

1,050.60 1,065.90
3 –5.0% — 1,000(1.03)(1.02)(0.95) 1,000(1.045)(1.02)(0.95) =

= 998.07 1,012.61
B is incorrect because the value of the total return index at the end of Q3 is 1,012.61 which is
above 1,000 (as per calculation above).
C is incorrect because by the end of Q3, the total return is 1.26% whereas the price return is
(0.2%) (as per calculation above).
Security Market Indexes Learning Outcome

b. Calculate and interpret the value, price return, and total return of an index
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A market index contains the following two securities:
Shares in Start-of-Period End-of-Period Dividend per Share

Stock Index Price ($) Price ($) ($)
A 600 40 37 2.00
B 500 50 52 1.50
Q23. The total return on an equal-weighted basis is closest to:
A. –1.75%.
B. 2.78%.
C. 2.25%.
Solution
C is correct.
Start-of- End-of- Price Total
Shares in Period Period Dividend per Return Return
Index Price ($) Price ($) Share ($) (%) (%)
= (3)/(2) – = [(3) +
Stock (1) (2) (3) (4) 1 (4)]/(2) – 1
A 600 40 37 2 –7.50% –2.50%
B 500 50 52 1.5 4.00% 7.00%
Total return = [(–2.5 + 7)/2] 2.25%

A is incorrect. It is the price return on an equal-weighted basis.
Shares in Start of Period End of Period Dividend per Price

Index Price ($) Price ($) Share ($) Return (%)
Stock (1) (2) (3) (4) = (3)/(2) – 1
A 600 40 37 2 –7.50%
B 500 50 52 1.5 4.00%
Total return =[(–7.5 + 4)/2] –1.75%

B is incorrect. It is the total return on price-weighted basis.
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Start of End of Start of Price-

Shares Period Period Dividend Total Period Weighted
in Price Price per Share Return Weight Total
index ($) ($) ($) (%) (%) Return (%)
(5) =
[(3) +
(4)]/(2)
Stock (1) (2) (3) (4) –1 (6) (5) × (6)
A 600 40 37 2 –2.50% 44% –1.11%
B 500 50 52 1.5 7.00% 56% 3.89%
Total return =[(–1.11 + 3.89)/2] 2.78%
Security Market Indexes Learning Outcomes

d. Compare the different weighting methods used in index construction
e. Calculate and analyze the value and return of an index given its weighting method
Q24. Which of the following statements regarding indexes for alternative investments
is most accurate?
A. Commodity index returns are based on changes in the prices of the underlying
commodities.
B. Commodity indexes consist of a market-weighted basket of one or more specific
commodities.
C. Hedge funds determine whether their results will be included in an index.
Solution
C is correct. Hedge fund companies are not required to report their performance to any party
other than their investors. As a result, rather than index providers determining the
constituents, the constituents determine the index.
A is incorrect. Commodity indexes are based upon futures contracts, not prices of the
underlying commodities themselves.
B is incorrect. Commodity indexes consist of futures contracts. There is no market weighting

mechanism.
Security Market Indexes Learning Outcome

j. Describe indexes representing alternative investments
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Q25. In a highly efficient market, unexpected positive news on a stock is announced to the
public. After this announcement, the difference between the market value and the intrinsic
value of the stock will most likely:
A. remain zero.
B. decrease.
C. increase.
Solution
A is correct. In a highly efficient market, (1) market value reflects new information quickly
and rationally, and (2) an asset’s market value equals its intrinsic value. Therefore, after the
announcement, the difference between a stock’s market value and its intrinsic value will
remain equal to zero because both market and intrinsic values adjust to reflect the unexpected
news by the same amount and at the same time.
B is incorrect. In a highly efficient market, (1) market value reflects new information quickly
and rationally, and (2) an asset’s market value equals its intrinsic value. In an inefficient
market, (1) the market value of a stock adjusts slowly to an unexpected news, and (2) there
are probably discrepancies between market value and intrinsic value. Therefore, only in an
inefficient market could the difference between market and intrinsic values decrease after the
announcement of an unexpected positive news.
C is incorrect. In a highly efficient market, (1) market value reflects new information quickly
and rationally, and (2) an asset’s market value equals its intrinsic value. In an inefficient
market, (1) the market value of a stock adjusts slowly to an unexpected news, and (2) there
are probably discrepancies between market value and intrinsic value. Therefore, only in an
inefficient market could the difference between market and intrinsic values increase after the
announcement of an unexpected positive news.
Market Efficiency Learning Outcomes

b. Contrast market value and intrinsic value
a. Describe market efficiency and related concepts, including their importance to investment
practitioners
Q26. If a test rejects the hypothesis that market prices reflect private information but does not
reject the hypothesis that they reflect past market data and public information, then the form
of market efficiency is best described as:
A. weak.
B. strong.
C. semi-strong.
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Solution
C is correct. The forms of market efficiency are as follows:
Market Prices Reflect:
Forms of Market Past Market Public Private

Efficiency Data Information Information
Weak ✓
Semi-strong ✓ ✓
Strong ✓ ✓ ✓
If a test rejects the hypothesis that market prices reflect private information but does not
reject the hypothesis that they reflect past market data and public information, then there is
evidence that the form of market efficiency is semi-strong (because only past market data and
public information are reflected in market prices).
A is incorrect. Markets are weak-form efficient when market prices reflect past market data
only.
B is incorrect. Markets are strong-form efficient when market prices reflect past market data,
public information, and private information.
Market Efficiency Learning Outcome

d. Contrast weak-form, semi-strong-form, and strong-form market efficiency
Q27. An overreaction in the financial markets causes a security’s price to experience a

significant loss during a short period. If this overreaction is caused by investors that sell
because other investors are selling, the behavior is best described as:
A. herding.
B. overconfidence.
C. loss aversion.
Solution
A is correct. Herding occurs when investors trade on the same side of the market in the same
securities, or when investors ignore their own private information and/or analysis and act as
other investors do. Herding behavior has been advanced as a possible explanation of under-
reaction and over-reaction in financial markets.
B is incorrect. If investors are overconfident, they overestimate their own ability to process
and interpret information about a security.
C is incorrect. Loss aversion refers to the tendency of people to dislike losses more than they
like comparable gains. This results in a strong preference for avoiding losses as opposed to
achieving gains.
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Market Efficiency Learning Outcome

g. Describe behavioral finance and its potential relevance to understanding market anomalies
Q28. The advantages to an investor owning convertible preference shares of a company most
likely include:
A. less price volatility than the underlying common shares.
B. an opportunity to receive additional dividends if the company’s profits exceed a pre-
specified level.
C. preference dividends that are fixed contractual obligations of the company.
Solution
A is correct. Convertible preference shares tend to exhibit less price volatility than the
underlying common shares because the dividend payments are known and more stable.
B is incorrect. An opportunity to receive additional dividend if the company’s profits exceed
a pre-specified level is the benefit that accrues to the holders of participating preferred shares,
not convertible preference shareholders.
C is incorrect. Preference dividends are fixed but, unlike interest payment on debt, they are
not contractual obligations of the company.
Overview of Equity Securities Learning Outcomes

b. Describe differences in voting rights and other ownership characteristics among different equity
classes
e. Compare the risk and return characteristics of different types of equity securities
Q29. Compared with public equity markets, which of the following statements
is most accurate about private equity markets? Operating in the private market:
A. offers stronger incentives to improve corporate governance.
B. allows more opportunities to raise capital.
C. allows management to better adopt a long-term focus.
Solution
C is correct. The management of a public firm is under pressures to meet shorter-term
demands, such as meeting quarterly sales and earnings projections from analysts. Private
owners are thus better able to focus on longer-term value creation opportunities.
A is incorrect. By operating under public scrutiny, companies are incentivized to be more
open in terms of corporate governance and executive compensation to ensure that they are
acting for the benefit of shareholders.
B is incorrect because public equity markets are much larger than private ones.
Overview of Equity Securities Learning Outcome

c. Compare and contrast public and private equity securities
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Q30. The voting rights of an unsponsored depository receipt (DR) belong to the:
A. depository bank.
B. direct owners of the foreign common shares.
C. foreign company whose shares are held by the depository.
Solution
A is correct. In the case of unsponsored DRs, the depository bank, not the investors in the
DR, retains the voting rights.
B is incorrect because investors in sponsored DRs have the same rights as the direct owners
of the common shares.
C is incorrect because the foreign firm does not maintain voting rights with DRs.
Overview of Equity Securities Learning Outcome

d. Describe methods for investing in non-domestic equity securities
Q31. Which of the following statements is most accurate about recessions?

A. If severe, the demand for products of defensive companies will eventually be adversely
affected.
B. Consumers are more likely to defer purchases of products of defensive companies than of
cyclical companies.
C. Non-cyclical companies tend to underperform cyclical companies.
Solution
A is correct. The impact of severe recessions usually reaches all parts of the economy and
affects cyclical and defensive companies.
B is incorrect. Consumers do not tend to defer purchases from defensive companies during a
recession.
C is incorrect. Cyclical companies underperform non-cyclical companies during economic

recessions.
Introduction to Industry and Company Analysis Learning Outcome

c. Explain the factors that affect the sensitivity of a company to the business cycle and the uses and
limitations of industry and company descriptors such as “growth,” “defensive,” and “cyclical”
Q32. When constructing a list of peer companies to be used in equity valuation, which of the
following would least likely improve the group? Companies in the same peer group should
ideally:
A. be exposed to similar stages in the business cycle.
B. have similar valuations.
C. have the effects of finance subsidiaries minimized.
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Solution
B is correct. Companies in the same peer group can have different valuations depending on
structure and competitiveness.
A is incorrect. Valuations may be of limited value when comparing companies that are
exposed to different stages of the business cycle.
C is incorrect. To make a meaningful comparison of companies, analysts should make

adjustments to the financial statements to lessen the impact that the finance subsidiaries have
on the various financial metrics being compared.

e. Explain how a company’s industry classification can be used to identify a potential “peer group” for
equity valuation
Q33. An industry characterized by rising volumes, improving profitability, falling prices, and
relatively low competition among companies is most likely in which of the following life-
cycle stages?
A. Growth
B. Mature
C. Embryonic
Solution
A is correct. An industry in growth stage is characterized by rising volumes, improving
profitability, falling prices, and relatively low competition among companies.
B is incorrect. In the mature stage there will be little or no growth and relatively stable
demand for products.
C is incorrect. In the embryonic stage there will be slowing growth and high prices.

i. Describe industry life cycle models, classify an industry as to life cycle stage, and describe
limitations of the life-cycle concept in forecasting industry performance
Q34. A corporate manager pursuing a low-cost strategy will most likely:

A. engage in offering products of unique quality or type.
B. have strong market research teams for product development and marketing.
C. invest in productivity-improving capital equipment.
Solution
C is correct. A corporate manager pursuing a cost leadership strategy must be able to invest
in productivity-improving capital equipment for achieving cost controls and being able to
offer products and services at lower prices than the competition.
A is incorrect. Offering products that are unique either in quality, type, or means of
distribution is suitable for differentiation strategies.
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B is incorrect. Having strong market research teams for product development and marketing
is suitable for differentiation strategies.

l. Describe the elements that should be covered in a thorough company analysis
Q35. Which of the following dates in the dividend chronology can fall on a weekend? The
A. payment date.
B. record date.
C. ex-date.
Solution
A is correct. The payment date can occur on a weekend or holiday unlike other pertinent
dates, such as the ex-date and record date, which occur only on business days.
B is incorrect. See the above explanation.
C is incorrect. See the above explanation.
Equity Valuation: Concepts and Basic Tools Learning Outcome

d. Describe dividend payment chronology
Q36. The Gordon growth model is most appropriate for valuing the common stock of a
dividend paying company that is:
A. mature and relatively insensitive to economic fluctuations.
B. young and just entering the growth phase.
C. experiencing growth that is higher than the sustainable growth rate.
Solution
A is correct. The Gordon growth model is most appropriate for valuing common stock of a
dividend paying company that is mature and relatively insensitive to the business cycle or
economic fluctuations.
B is incorrect. A three-stage dividend discount model would be most appropriate for a fairly
young company that is just entering the growth phase.
C is incorrect. A two-stage dividend discount model would be appropriate for a company that
is experiencing a higher than the sustainable growth rate.

h. Identify characteristics of companies for which the constant growth or a multistage dividend
discount model is appropriate
Page 86 of 113
An analyst gathered the following information about a company:
Current earnings per share $6.00
Current dividend per share $2.40
Current market price per share $35
Required rate of return on the stock 15.0%
Expected growth rate of earnings and dividends 8.0%

Q37. Which of the following statements best describes the company’s price-to-earnings ratio
(P/E)? Compared to the company’s trailing P/E ratio, the justified forward P/E ratio based on
the Gordon growth dividend discount model is:
A. the same.
B. higher.
C. lower.
Equity Valuation: Concepts and Basic Tools Learning Outcomes

i. Explain the rationale for using price multiples to value equity, how the price to earnings multiple
relates to fundamentals, and the use of multiples based on comparables
j. Calculate and interpret the following multiples: price to earnings, price to an estimate of operating
cash flow, price to sales, and price to book value
Q38. Which of the following best describes an advantage of the EV/EBITDA multiple for
valuing equity? An advantage is that:
A. the multiple must be positive.
B. it does not require the market value of debt.
C. EBITDA is a proxy for operating cash flow.
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Solution
C is correct. An advantage of EBITDA is that it is a proxy for operating cashflow because it
excludes depreciation and amortization.
A is incorrect. The multiple can be negative if EBITDA is negative.
B is incorrect. The market value of debt is needed in valuing the equity since it should be
deducted from the enterprise value and may be difficult to obtain.

m. Explain advantages and disadvantages of each category of valuation model
Q39. Which of the following most likely has the highest priority claim in the event of default?
A. Unsecured debt
B. Subordinated debt
C. Secured debt
Solution
C is correct. Secured debt is backed by assets or financial guarantees pledged to ensure
repayment in the event of default. Therefore, secured debt has a priority claim over unsecured
debt and subordinated debt.
A is incorrect because unsecured debt is paid after secured debt in the event of default.
B is incorrect because subordinated debt is a form of unsecured debt and it is paid after
secured debt in the event of default.
Fixed-Income Securities: Defining Elements Learning Outcome

b. Describe content of a bond indenture
Q40. Which one of the following is least likely to be an example of a Eurobond?

A. A Japanese company issuing euro-denominated bonds to investors domiciled in the United
Kingdom
B. A UK-based company issuing Japanese yen-denominated bonds to investors domiciled in
Japan
C. An Australian company issuing US$-denominated bonds to investors domiciled in Japan
Solution
B is correct. It is an example of a foreign bond, that is, a bond issued by a foreign company
in the domestic market of the country in whose currency the bond is denominated.
A is incorrect because this is an example of a euro-denominated Eurobond.
C is incorrect because this is an example of a Eurodollar bond.

d. Describe how legal, regulatory, and tax considerations affect the issuance and trading of fixed-
income securities
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Q41. A bond portfolio manager is considering three bonds—A, B, and C—for his portfolio.
Bond A allows the issuer to call the bond before the stated maturity, Bond B allows the
investor to put the bond back to the issuer before the stated maturity, and Bond C contains no
embedded options. The bonds are otherwise identical. The manager tells his assistant, “Bond
A and Bond B should have larger nominal yield spreads to a US Treasury than Bond C to
compensate for their embedded options.” Is the manager most likely correct?
A. No, Bond A’s nominal yield spread should be less than Bond C’s
B. No, Bond B’s nominal yield spread should be less than Bond C’s
C. Yes
Solution
B is correct. Bond B’s embedded put option benefits the investor, and the yield spread will
therefore be less than the yield spread of Bond C, which does not contain this option or
benefit.
A is incorrect because Bond A’s embedded call option benefits the issuer, not the investor,
therefore investors will demand a higher yield spread than on Bond C in compensation.
C is incorrect because Bond B should have a smaller yield spread.

f. Describe contingency provisions affecting the timing and/or nature of cash flows of fixed-income
securities and whether such provisions benefit the borrower or the lender.
Q42. Which of the following is most likely an indicator of liquidity in the secondary market
for bonds?
A. Bid-to-cover ratio
B. Bid–offer spread
C. Settlement period
Solution
B is correct. The bid–offer spread reflects the prices at which secondary market dealers will
buy from a customer (bid) and sell to a customer (offer). It is an indicator of liquidity because
a tighter bid–offer spread represents a more liquid market than a market with a wider bid–
offer spread.
A is incorrect because the bid-to-cover ratio represents the activity in a primary bond market
auction.
C is incorrect because the settlement period represents the market’s conventions for
settlement for different types of bonds (e.g., government bonds or corporate bonds.)
Fixed-Income Markets: Issuance, Trading, and Funding Learning

Outcome
d. Describe secondary markets for bonds
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Q43. Which of the following embedded options most likely provides a right to the issuer?
A. Conversion provision
B. Put feature
C. Call feature
Solution
C is correct. The right to call the issue is beneficial to the issuer when interest rates fall.
A is incorrect because the conversion provision grants the bondholder the right to convert the
bond for a specified number of shares of common stock. Such a feature allows the
bondholder to take advantage of favorable movements in the price of the issuer’s common
stock.
B is incorrect because the right to put the issue is an option granted to the bondholder to sell
the bond back to the issuer at a predetermined price on specified dates before maturity.

Outcome
g. Describe types of debt issued by corporations
Q44. Zet Bank has entered into a contract with Louly Corporation in which Zet agrees to buy
a 2.5% US Treasury bond maturing in 10 years and promises to sell it back next month at an
agreed-on price. From Zet Bank’s perspective, this contract is best described as a:
A. repo.
B. collateralized loan.
C. reverse repo.
Solution
C is correct. A reverse repo (repurchase agreement) is collateralized cash lending by
purchasing an underlying security now and selling it back in the future.
A is incorrect because it is the contract known for Louly Corporate as a collateralized
borrowing, i.e., repo.
B is incorrect because collateralized short-term borrowing involves selling the security and
subsequently repurchasing the collateral posted.

Outcome
j. Describe repurchase agreements (repos) and the risks associated with them
Q45. Consider a five-year option-free bond that is priced at a discount to par value.
Assuming the discount rate does not change, one year from now the value of the bond
will most likely:
A. stay the same.
B. decrease.
C. increase.
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Solution
C is correct. The bond is priced below its par value but will be worth exactly par value at
maturity. Over time, assuming a stable discount rate, the value of the bond must rise so that it
is equal to par at maturity. That is, the price is “pulled to par.”
A is incorrect because the bond’s value must rise over time to be equal to its par value.
B is incorrect because the bond’s value must rise over time to be equal to its par value.
Introduction to Fixed-Income Valuation Learning Outcome

b. Identify the relationships among a bond’s price, coupon rate, maturity, and market discount rate
(yield-to-maturity)
Q46. A credit analyst is least likely to use matrix pricing to estimate the required yield and
price of a(n):
A. newly underwritten bond.
B. actively traded speculative grade bond.
C. inactively traded investment grade bond.
Solution
B is correct. Matrix pricing is most suited to pricing inactively traded bonds and newly
underwritten bonds. A credit analyst is least likely to use matrix pricing to price an actively
traded bond.
A is incorrect because matrix pricing is most suited to pricing newly underwritten bonds.
C is incorrect because matrix pricing is most suited to pricing inactively traded bonds.

e. Describe matrix pricing
Q47. Which of the following statements is most likely correct regarding the spot and forward
curves. The spot curve:
A. can be calculated from the forward curve, and the forward curve can be calculated from
the spot curve.
B. can be calculated from the forward curve, but the forward curve cannot be calculated from
the spot curve.
C. cannot be calculated from the forward curve, but the forward curve can be calculated
from the spot curve.
Solution
A is correct. The forward and spot curves are interconnected to each other. The spot curve
can be calculated from the forward curve, and the forward curve can be calculated from the
spot curve. Either curve can be used to value fixed-rate bonds.
B is incorrect because the spot curve can be calculated from the forward curve, and the
forward curve can be calculated from the spot curve.
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C is incorrect because the spot curve can be calculated from the forward curve, and the
forward curve can be calculated from the spot curve.

i. Define and compare the spot curve, yield curve on coupon bonds, par curve, and forward curve
Q48. Which of the following is least likely a component of yield spread?

A. Taxation
B. Expected inflation rate
C. Credit risk
Solution
B is correct. Building blocks of the yield curve are spread (risk premium) and a benchmark
(risk-free rate of return). Expected inflation rate and expected real rate are components of the
risk-free rate of return (i.e., the benchmark).
A is incorrect because taxation is part of the yield spread providing the investor with
compensation for the tax impact of holding a specific bond.
C is incorrect because credit risk is part of the yield spread providing the investor with
compensation for the credit risks of holding a specific bond.

k. Compare, calculate, and interpret yield spread measures
Q49. The absolute priority rule is most likely violated in a:

A. bankruptcy liquidation.
B. special purpose entity securitization.
C. bankruptcy reorganization.
Solution
C is correct. When a company is reorganized, the strict absolute priority has not always been
upheld by the courts.
A is incorrect because in liquidations, the absolute priority rule generally holds.
B is incorrect because in the case of a SPV securitization, the courts (in most jurisdictions)
have no discretion to change absolute priority because the bankruptcy of a company does not
affect the SPV. The SPV is considered bankruptcy remote.
Introduction to Asset-Backed Securities Learning Outcome

c. Describe securitization, including the parties involved in the process and the roles they play
Q50. Residential mortgage-backed securities issued in the US by government-sponsored

enterprises are guaranteed by:
A. the full faith and credit of the government.
B. the government-sponsored enterprise.
C. external credit enhancements.
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Solution
B is correct. For residential mortgage-backed securities (RMBS) issued by a GSE
(government-sponsored enterprise), such as Fannie Mae and Freddie Mac, credit risk is
reduced by the guarantee of the GSE itself.
A is incorrect because RMBS issued by a federally related institution, such as Ginnie Mae,
are guaranteed by the full faith and credit of the government with respect to timely payment
of principal and interest.
C is incorrect because RMBS issued by private entities are not guaranteed by a federal
agency or GSE and use credit enhancements to reduce risk.

e. Describe types and characteristics of residential mortgage-backed securities, including mortgage
pass-through securities and collateralized mortgage obligations, and explain the cash flows and risks
for each type
Q51. Which scenario is most likely to result in a competitive return to a CDO equity holder?
A. The collateral earns a higher yield than the bond classes.
B. The senior bond class experiences early principal repayment.
C. The debt funding costs are higher than the CDO return.
Solution
A is correct. The benefit of the return on collateral in excess of what is paid out to the bond
classes accrues to the equity holders and to the CDO manager.
B is incorrect because when the senior bond class experiences early principal repayment the
CDO manager isn’t meeting pre-specified tests requiring the prepayment of low cost senior
debt, deleveraging the CDO and making it harder for the subordinated tranche to earn a
competitive return.
C is incorrect because if debt funding costs are higher than the CDO return, no return will
accrue to the subordinated tranche.

h. Describe types and characteristics of non-mortgage asset-backed securities, including the cash
flows and risks of each type
Q52. Consider bonds that have the same yield to maturity and maturity. The bond with the
greatest reinvestment risk is most likely the one selling at:
A. a premium.
B. par.
C. a discount.
Solution
A is correct. Yield to maturity is based on the assumption that a bond is held to maturity,
does not default, and has its coupon payments reinvested at the yield to maturity. The bond
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selling at a premium has the highest coupon rate and is expected to earn the most
reinvestment income from reinvesting those coupon payments at the yield to maturity. If the
reinvestment rate falls, this bond will suffer the greatest loss.
B is incorrect because the bond selling at par has a lower coupon rate than the bond selling at
a premium.
C is incorrect because the bond selling at a discount has a lower coupon rate than the bond
selling at a premium.
Understanding Fixed-Income Risk and Return Learning Outcome

a. Calculate and interpret the sources of return from investing in a fixed-rate bond
Q53. In a rising interest rate environment, the effective duration of a putable bond relative to
an otherwise identical non-putable bond, will most likely be:
A. higher.
B. lower.
C. the same.
Solution
B is correct. When interest rates are rising, the put option becomes more valuable to the
investor. The ability to sell the bond at par value limits the price depreciation as rates rise. So,
the presence of an embedded put option reduces the sensitivity of the bond price to changes
in interest rates, resulting in a lower effective duration.
A is incorrect because in a rising interest rate environment the effective duration of a putable
bond will be lower, not higher, than the effective duration of a comparable non-putable bond.
C is incorrect because in a rising interest rate environment the effective duration of a putable
bond will be lower than the effective duration of a comparable non-putable bond.

e. Explain how a bond’s maturity, coupon, and yield level affect its interest rate risk
Q54. For a non-callable bond with an approximate annual modified duration of 15.213 and an
approximate annual convexity of 350.32, if the bond’s yield increases by 100 basis points, the
estimated percentage decline in the price of the bond is closest to:
A. 0.15%.
B. 8.21%.
C. 13.46%.
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i. Calculate the percentage price change of a bond for a specified change in yield, given the bond’s
approximate duration and convexity
Q55. The real rate duration for an option-free, fixed-rate bond is equivalent to the bond’s:
A. inflation duration and liquidity duration.

B. credit duration and not its inflation duration.
C. inflation duration and not its liquidity duration.
Solution
A is correct. For an option-free, fixed-rate bond, the “inflation duration,” the “real rate
duration,” and the “liquidity duration” are all the same number.
B is incorrect because the real rate duration is equivalent to both the bond’s “credit duration”
and its “inflation duration.”
C is incorrect because the real rate duration is equivalent to both the bond’s “inflation
duration” and its “liquidity duration.”

l. Explain how changes in credit spread and liquidity affect yield-to-maturity of a bond and how
duration and convexity can be used to estimate the price effect of the changes
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Q56. As credit quality for a non-investment-grade bond deteriorates, analysis would most
likely increasingly focus on:
A. spread risk.
B. the recovery rate.
C. default probability.
Solution
B is correct. As an issuer’s default risk rises, investors will focus more on what the recovery
rate might be in the event of default.
A is incorrect. Most investors in investment-grade debt focus more on spread risk than
default risk (spread risk being defined as the effect on prices and returns from changes in
spreads).
C is incorrect. Because default probability is low for most high-quality debt issuers, bond
investors tend to focus primarily on assessing this probability and devote less effort to
assessing the potential loss severity arising from default. However, as an issuer’s default risk
rises, investors will focus more on what the recovery rate might be in the event of default.
Fundamentals of Credit Analysis Learning Outcome

b. Describe default probability and loss severity as components of credit risk
Q57. For two equally rated speculative grade bonds, what factor is least likely to account for
differences in their valuation?
A. Severity of loss
B. Probability of default
C. Perceived creditworthiness of the companies
Solution
B is correct. In the case of speculative grade bonds, two bonds with the same credit ratings
will tend to have the same probabilities of default. They may still trade at very different
valuations because for such bonds the market typically begins focusing on the severity of loss
in the event of default, which can be quite different for similarly rated bonds.
A is incorrect because for speculative grade bonds with similar credit ratings the valuations
may be quite different if the severity of loss associated with the two bonds is very different
from each other.
C is incorrect because if there is a perceived difference in credit quality there is a difference

in valuation.

d. Compare and contrast corporate issuer credit ratings and issue credit ratings and describe the rating
agency practice of "notching"
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A credit analyst observes the following information for Alpha Co. at fiscal years ending 20X1 and
20X2.
Excerpt from the Consolidated Income Statement of Alpha Co. for the Fiscal Years
Ending 31 December 20X1 and 20X2 (in millions)
20X1 20X2
Gross profit $550.0 $505.0
Operating expenses 450.0 370.0
Operating profit 100.0 135.0
Interest expense 30.0 35.0
Income before taxes 70.0 100.0
Income taxes (at 30%) 21.0 30.0
Net income 49.0 70.0
Additional information
Depreciation and amortization 25.0 35.0

Q58. Based on this information, over this period Alpha’s interest coverage ratio has:
A. improved.
B. remained unchanged.
C. deteriorated.
Solution
A is correct. The company’s interest coverage ratio can be computed as EBITDA/Interest
expense. That is:
20X1 20X2
EBITDA 125.0 170.0
Interest expense 30.0 38.0
EBITDA/Interest expense 4.17 4.47

EBITDA = Operating profit + Depreciation and amortization
The company’s EBITDA interest coverage ratio has improved over this period. If EBIT is
used to calculate the coverage ratios, the same conclusion is reached: for 20X1 the ratio is
3.33, and for 20X2 it is 3.86.
B is incorrect because the EBITDA interest coverage ratio has improved over this period.
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C is incorrect because the EBITDA interest coverage ratio has improved over this period.

g. Calculate and interpret financial ratios used in credit analysis
Q59. Which of the following is least likely to be an example of a derivative?

A. An exchange-traded fund
B. A contract to sell Alphabet Inc.’s shares at a fixed price
C. A contract to buy Australian dollars at a predetermined exchange rate
Solution
A is correct. Although an exchange-traded fund derives its value from the underlying assets
it holds, it does not transform the performance of those assets and so is not a derivative.
B is incorrect. A contract to sell Alphabet Inc.’s shares transforms the performance of the
underlying shares of Alphabet Inc and is an example of an option derivative.
C is incorrect. A contract to buy Australian dollars transforms the performance of the

underlying currency and is an example of a currency derivative.
Derivative Markets and Instruments Learning Outcome

a. Define a derivative and distinguish between exchange-traded and over-the-counter derivatives
Q60. For a call option, if the underlying asset’s value is less than the option’s exercise price,
the option is said to be:
A. at the money.
B. out of the money.
C. in the money.
Solution
B is correct. If the underlying asset’s value is less than the option’s exercise price, the call
option is not worth exercising and is said to be out of the money.
A is incorrect. For an at-the-money call option, the value of the underlying asset is equal to
the option’s exercise price, and the option buyer would be indifferent between exercising or
not exercising the option.
C is incorrect. For an in-the-money call option, the value of the underlying asset is greater
than the option’s exercise price, and the option is worth exercising.

c. Define forward contracts, futures contracts, options (calls and puts), swaps, and credit derivatives
and compare their basic characteristics
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Q61. In an efficient market, it is more likely that fundamental value will be reflected in the:
A. underlying spot market before the derivative market.
B. derivatives market and the underlying spot market at the same time.
C. derivatives market before the underlying spot market.
Solution
C is correct. In an efficient market, the derivatives market is more likely to reflect
fundamental value, even if only for a short period, before the underlying spot market because
derivatives contracts require less capital, have lower transaction costs, and are easier to sell
short.
A is incorrect. In an efficient market, the derivatives market (not the underlying spot market)
is more likely to reflect fundamental value because derivatives contracts require less capital,
have lower transaction costs, and are easier to sell short.
B is incorrect. In an efficient market, the derivatives market is more likely to reflect

fundamental value before the underlying spot market because derivatives contracts require
less capital, have lower transaction costs, and are easier to sell short.

e. Describe purposes of, and controversies related to, derivative markets
Q62. Which of the following attributes is least likely to be a requirement for the existence of
riskless arbitrage? The underlying security:
A. can be sold short.
B. is a financial asset.
C. is relatively liquid.
Solution
B is correct. For riskless arbitrage to exist, the underlying security that can be arbitraged may
be either a financial or a non-financial security.
A is incorrect. For riskless arbitrage to exist, the underlying security must be able to be short
sold.
C is incorrect. For riskless arbitrage to exist, the underlying security must be relatively liquid
so it is easy to buy and sell at a low cost.

f. Explain arbitrage and the role it plays in determining prices and promoting market efficiency
Q63. Over time, a forward contract most likely has variable:

A. value and constant price.
B. price and constant value.
C. value and variable price.
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Solution
A is correct. The price of a forward contract remains constant throughout its life. It is set as
part of the contract specifications. The value varies with changes in the price of the
underlying.
B is incorrect. The price is constant, but value varies with changes in the price of the
underlying.
C is incorrect. The price is constant, but value varies with changes in the price of the
underlying.
Basics of Derivative Pricing and Valuation Learning Outcome

b. Explain the difference between value and price of forward and futures contracts
Q64. Which of the following statements best describes changes in the value of a long forward
position during its life?
A. As the time to maturity goes down, the value of the position goes up.
B. As the price of the underlying goes up, the value of the position goes up.
C. As interest rates go down, the value of the position goes up.
Solution
B is correct. Given the formula for the value of a forward contract:Vt(T) = St – F0(T)(1 + r)–(T–
t)
it follows that the value of the contract goes up as the price of the underlying goes up.
A is incorrect. As the time to maturity goes down, the value of the contract goes down.
C is incorrect. As interest rates go down, the value of the contract goes down.

d. Explain how the value and price of a forward contract are determined at expiration, during the life
of the contract, and at initiation
Q65. Forward rate agreements are most likely used to hedge an exposure in the:
A. foreign exchange market.
B. money market.
C. equity market.
Solution
B is correct. Forward rate agreements are used to hedge interest rate exposure present in the
money market.
A is incorrect. Forward rate agreements are used to hedge interest rate exposure and not
foreign exchange exposure.
C is incorrect. Forward rate agreements are used to hedge interest rate exposure and not
equity exposure.

f. Define a forward rate agreement and describe its uses
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Q66. A swap that involves the exchange of a fixed payment for a floating payment can be
interpreted as a series of forward contracts with different expiration dates. These implied
forward contracts will most likely have:
A. different prices due to differences in the price of the underlying at expiration.
B. identical prices.
C. different prices due to differences in the cost of carry.
Solution
C is correct. Due to differences in the cost of carry, implied forward contracts will have
different prices. The differences in the cost of carry stem from the timing differences of the
payments.
A is incorrect. Differences in price are due to differences in the cost of carry. The price of the
underlying at expiration is irrelevant for the price. It determines the value of the swap.
B is incorrect. The prices will be different due to differences in the cost of carry.

h. Explain how swap contracts are similar to but different from a series of forward contracts
Q67. The price of an interest rate swap that involves the exchange of a fixed payment for a
floating payment is most likely:
A. equal to its value at expiration.
B. set at initiation and constant over time.
C. affected by changes in the floating payment.
Solution
B is correct. Swaps have both a price and a value. Price in the context of a swap is a
reference to the fixed-rate payment on the swap, which is constant over time. The value of a
swap is zero at initiation but can change over the life of the swap as market interest rates
change.
A is incorrect. Price and value are not normally equal at expiration.
C is incorrect. The price in the context of a swap is a reference to the fixed-rate payment on
the swap, which is constant over time and does not change in reaction to interest rate changes.

i. Explain the difference between value and price of swaps
Q68. According to put–call parity, for European options, a long call on an asset is equal to:
A. long put + long asset + long risk-free bond.

B. long put + long asset + short risk-free bond.
C. short put + short asset + long risk-free bond.
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Q69. For a stock that pays no dividends, the value of an American call option is most likely:
A. the same as the value of a European call option with otherwise identical features.
B. greater than the value of a European call option with otherwise identical features.
C. less than the value of a European call option with otherwise identical features.
Solution
A is correct. American call prices can differ from European call prices only if the underlying
stock is dividend paying. In the absence of such cash payments, European and American call
options have the same value.
B is incorrect. In the absence of cash payments such as dividends, the value of European and
American call options is identical.
C is incorrect. In the absence of cash payments such as dividends, the value of European and
American call options is identical.

o. Explain under which circumstances the values of European and American options differ
Q70. Categories of alternative investments would least likely be described by which of the
following?
A. Fine wine and other tangibles
B. Schools and other long-lived real assets
C. Cash and other liquid investments
Solution
C is correct. Cash and other short-term liquid investments would not generally be considered
alternative investments. Alternative investments fall outside of the definition of long-only
publicly traded investments in stocks, bonds, and cash (often referred to as traditional
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investments). In other words, these investments are alternatives to long-only positions in

stocks, bonds, and cash.
A is incorrect because the category “collectibles” would include tangible assets such as fine
wine, art, antique furniture, and automobiles.
B is incorrect because the category “infrastructure” would include capital intensive, long-
lived, real assets, such as roads, dams, and schools.
Introduction to Alternative Investments Learning Outcome

a. Describe types and categories of alternative investments
Q71. Do management fees most likely get paid to the manager of a hedge fund, regardless of
the fund’s performance?
A. No, only when the fund’s net asset value exceeds the previous high-water mark
B. No, only when the fund’s gross return is positive
C. Yes
Solution
C is correct. Regardless of performance, the management fee is always paid to the fund
manager.
B is incorrect because the gross return can be at any level and the manager is still paid the
management fee.
A is incorrect because the management fee is paid regardless of the value of the assets in the
fund.

c. Describe investment and compensation structures commonly used in alternative investments
Q72. High-water marks are typically used when calculating the incentive fee on hedge funds.
They are most likely used by clients to:
A. avoid prime brokerage fees.
B. avoid paying twice for the same performance.
C. claw back the management fees.
Solution
B is correct. High-water marks help clients avoid paying twice for the same performance.
When a hedge fund’s value drops, the manager will not receive an incentive fee until the
value of the fund returns to its previous level.
A is incorrect because high-water marks are not linked to prime brokerage fees.
C is incorrect because management fees are paid irrespective of returns.

d. Explain investment characteristics of hedge funds
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Q73. A private equity firm sells a portfolio company to a buyer that is active in the same
industry as the portfolio company. This transaction is best described as a(n):
A. trade sale.
B. secondary sale.
C. initial public offering.
Solution
A is correct. A trade sale is the sale of a portfolio company to a strategic buyer, such as a
company that is active in the same industry.
B is incorrect. A secondary sale is a sale to another private equity firm.
C is incorrect. An initial public offering involves the sale of shares to public investors.

e. Explain investment characteristics of private capital
Q74. With respect to alternative investments, which of the following investment methods
would most likely subject the investor to adverse selection bias where the fund manager
makes less attractive investment opportunities available to the investor?
A. Co-investing
B. Fund investing
C. Direct investing
Solution
A is correct. "Co-investors have reduced control over the investment selection process
(compared with direct investing) and may be subject to adverse selection bias, where the fund
manager makes less attractive investment opportunities available to the co-investor while
allocating its own capital to more appealing deals." Furthermore, in comparison to other
alternative investment approaches, co-investing is most likely to be subject to adverse
selection bias.
B is incorrect because in comparison to other alternative investment approaches, co-investing
is most likely to be subject to adverse selection bias.
C is incorrect because in comparison to other alternative investment approaches, co-investing

is most likely to be subject to adverse selection bias.

b. Describe characteristics of direct investment, co-investment, and fund investment methods for
alternative investments
Q75. Commodity futures prices are most likely in backwardation when:

A. interest rates are high.
B. storage costs are high.
C. the convenience yield is high.
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Solution
C is correct. In backwardation, futures prices are lower than spot prices, that is, the
commodity forward curve is downward sloping. This scenario occurs when the convenience
yield is high. Futures price ≈ Spot price (1 + r) + Storage costs – Convenience yield.
A is incorrect. Futures price ≈ Spot price (1 + r) + Storage costs – Convenience yield. Thus,
high interest rates contribute to an upward sloping commodity forward curve.
B is incorrect. Futures price ≈ Spot price (1 + r) + Storage costs – Convenience yield. Thus,
high storage costs contribute to an upward sloping commodity forward curve.

f. Explain investment characteristics of natural resources
Q76. An investor seeking an indirect debt investment in real estate will:
A. purchase a mortgage-backed security.

B. purchase a commercial property.
C. originate a residential mortgage.
Solution
A is correct. Mortgage-backed securities are pools of loans that are securitized and offered to
the financial markets providing indirect debt investment opportunities in residential property.
C is incorrect because originators (generally financial institutions) of residential mortgages
are making a direct debt investment in the home.
B is incorrect because commercial property is considered an appropriate direct investment—

equity (i.e., ownership) and debt (i.e. lender)—for institutional or high-net-worth investors
with long time horizons and limited liquidity needs.

g. Explain investment characteristics of real estate
Q77. Which of the following infrastructure investments would most likely be easiest to value?
A:
A. master limited partnership holding greenfield investments.
B. master limited partnership holding brownfield investments.
C. private equity fund holding brownfield investments.
Solution
B is correct. A master limited partnership (MLP) is publicly traded, whereas a private equity
fund is not. Therefore the MLP will have market pricing information to help with valuation.
A brownfield investment is an existing asset that likely has operational and financial history
to aid in valuation; a greenfield investment is in new construction.
A is incorrect because greenfield investments have no operational or financial history to aid
in valuation, whereas brownfield investments do.
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C is incorrect because master limited partnerships are publicly traded, with market pricing
data available for valuation purposes, whereas private equity funds are not.

h. Explain investment characteristics of infrastructure
Q78. Which of the following uses downside deviation of returns?
A. Sortino ratio
B. Capital loss ratio
C. Maximum drawdown
Solution
A is correct. A "quantitative measure of performance is return relative to downside
volatility—the Sortino ratio." "[T]he denominator for the Sortino ratio is downside deviation
of returns—a semi-deviation measure of volatility only during periods of loss for an
alternative investment."
B is incorrect because "capital loss ratio [is] defined as the percentage of capital in deals that
have been realized below cost, net of any recovered proceeds, divided by total invested
capital."
C is incorrect because "[a] maximum drawdown (MDD) is the maximum observed loss from
a peak to a trough of a portfolio, before a new peak is attained."

i. Describe issues in performance appraisal of alternative investments
Q79. An investor allocates $10 million at the beginning of the year to a hedge fund charging
a management fee of 2% and an incentive fee of 20% with a 6% (hard) hurdle rate. At year-
end the value of the investment is $11.8 million. The incentive fee is calculated net of the
management fee and the management fee is based on the year-end value. The net-of-fees
return the investor earned is closest to:
A. 13.71%.
B. 13.24%.
C. 13.93%.
Solution
A is correct. The net-of-fees return to the investor at year-end is closest to 13.71%.
Portfolio gain = Year-end value – Beginning value = $11.8 million – $10 million = $1.8
million
Hurdle amount = Beginning value × Hurdle % = $10 million × 6% = $600,000
Management fee = Year-end value × Management fee % = $11.8 million × 2% =

$236,000
Incentive fee = (Portfolio gain – Hurdle amount – Management fee) × Incentive fee %
= ($1.8 million – $600,000 – $236,000) × 20% = $192,800

Page 106 of 113
Total fees = Management fee + Incentive fee = $236,000 + $192,800 = $428,800
Net-of-fees return = (Portfolio gain – Total fees)/Beginning value
= ($1.8 million – $428,800)/$10 million = 13.71%
B is incorrect because 13.24% results from calculating the incentive fee independently from
the management fee as opposed to net of the management fee:
million
Hurdle amount = Beginning value × Hurdle % = $10 million × 6% = $600,000

$236,000
Incentive fee = (Portfolio gain – Hurdle amount) × Incentive fee %
= ($1.8 million – $600,000) × 20% = $240,000
= ($1.8 million – $476,000)/$10 million = 13.24%
C is incorrect because 13.93% results from calculating the hurdle amount based on the end-
of-period value instead of the beginning-of-period value:
million
Hurdle amount = Ending value × Hurdle % = $11.8 million × 6% = $708,000

$236,000
Incentive fee = (Portfolio gain – Hurdle amount – Management fee) × Incentive fee %
= ($1.8 million – $708,000 – 236,000) × 20% = $171,200
= ($1.8 million – $407,200)/$10 million = 13.93%

j. Calculate and interpret returns of alternative investments on both before-fee and after-fee bases
Page 107 of 113

Q80. Which of the following types of mutual funds most likely places the highest pressure on
the portfolio manager to manage liquidity?
A. A no-load open-end fund
B. A load closed-end fund
C. A no-load closed-end fund
Solution
A is correct. A no-load open-end fund accepts new investment money and issues additional
shares at a value equal to the net asset value of the fund at the time of investment. This
structure makes it easy to grow in size but creates pressure on the portfolio manager to
manage the cash inflows and outflows. Redemptions may create the need to liquidate assets
that the portfolio manager might not want to sell at the time or to hold cash to meet
redemptions. As a no-load fund, it charges no fee for investing in the fund or for redemption.
B is incorrect because a load closed-end fund disallows new investment money into the fund
and in addition to the annual fee, a percentage fee is charged to invest in the fund and/or for
redemption from the fund. Therefore, needs for liquidity for the portfolio managers are low.
C is incorrect because a no-load closed-end fund disallows new investment money into the
fund and charges no fee for investing in the fund or for redemption. Therefore, there are no
particular needs for liquidity for the portfolio managers.
Portfolio Management: An Overview Learning Outcome

f. Describe mutual funds and compare them with other pooled investment products
Q81. The time-weighted rate of return:
A. results in a lower return when compared with the money-weighted rate of return.
B. is affected by the amount and timing of cash flows to and from a portfolio.
C. calculates multi-period cash flows mirroring a portfolio’s compound growth rate.
Solution
C is correct. Time-weighted rate of return reflects the compound rate of growth of one unit
of currency invested over a stated measurement period, and it removes the effects of timing
and amount of withdrawals and additions to the portfolio.
A is incorrect. Time-weighted rate of return can be the same, higher, or lower than money-
weighted rate of return.
B is incorrect because this is in fact the explanation for money-weighted return.
Portfolio Risk and Return: Part I Learning Outcome

b. Calculate and compare the money-weighted and time-weighted rates of return of a portfolio and
evaluate the performance of portfolios based on these measures
Page 108 of 113

Q82. An investment portfolio consists of equal weights in two government bonds of different
nations. What correlation level will most likely result in the lowest portfolio standard
deviation?
A. 0.5
B. –0.2
C. 0.0
Solution
B is correct. A correlation of –0.2 because the lower the correlation, the lower the portfolio
risk (standard deviation), all else being equal.
A is incorrect because a 50% correlation portfolio will reduce the risks but not as much as the
negative correlated portfolio.
C is incorrect because a 0% correlation portfolio will reduce the risks but not as much as the
negative correlated portfolio.
Portfolio Risk and Return: Part I Learning Outcome

g. Describe the effect on a portfolio’s risk of investing in assets that are less than perfectly correlated
Q83. An investor whose portfolio lies to the right of the market portfolio on the capital
market line (CML) has most likely:
A. borrowed funds at the risk-free rate and invested all available funds in the market
portfolio.
B. invested all available funds in the risk-free asset.
C. loaned some funds at the risk-free rate and invested the remaining funds in the market
portfolio.
Solution
A is correct. A portfolio lying to the right of the market portfolio on the CML is formed by
borrowing funds at the risk-free rate and investing all available funds in the market portfolio.
B is incorrect because this portfolio will lie to the left of the market portfolio and on the
intercept of the capital market line.
C is incorrect because this portfolio will lie to the left (not right) of the market portfolio and
in between the risk-free asset and the market portfolio.
Portfolio Risk and Return: Part II Learning Outcome

b. Explain the capital allocation line (CAL) and the capital market line (CML)
Q84. A stock has a correlation of 0.45 with the market and a standard deviation of returns of
12.35%. If the market has a standard deviation of returns of 8.25%, then the beta of the stock
is closest to:
A. 0.30.
B. 0.67.
C. 1.50.
Page 109 of 113

Q85. The strategic asset allocation and portfolio rebalancing policy are most likely addressed
in which section of an investment policy statement?
A. Appendices
B. Investment objectives
C. Procedures
Solution
A is correct. Information related to strategic asset allocation and portfolio rebalancing policy
would be placed in the appendices of an investment policy statement.
B is incorrect because this section contains information on the client’s objectives when
investing.
C is incorrect because this section contains information on the steps to take to keep the
investment policy statement current and the procedures to follow to respond to various
contingencies.
Basics of Portfolio Planning and Construction Learning Outcome

b. Describe the major components of an IPS
Q86. When presented with new information, if an analyst asks themselves the question "how
much does this information change my forecast?" then which of the following biases is the
analyst most likely trying to overcome?
A. Hindsight bias
B. Self-control bias
C. Conservatism bias
Page 110 of 113

Solution
C is correct because "[c]onservatism bias is a belief perseverance bias in which people
maintain their prior views or forecasts by inadequately incorporating new, conflicting
information." In order to overcome such a bias, "[w]hen new information is presented, the
FMP [financial market participant] should ask such questions ... as, 'How does this
information change my forecast?' or 'What effect does this information have on my
forecast?'"
A is incorrect because "[h]indsight bias refers to believing past events as having been
predictable and reasonable to expect." "Once understood, hindsight bias should be
recognizable. FMPs [financial market participants] should ask such questions as, 'Am I re-
writing history or being honest with myself about the mistakes I made?'"
B is incorrect because "[s]elf-control bias is a bias in which people fail to act in pursuit of
their long-term, overarching goals in favor of short-term satisfaction." In order to overcome
such a bias, people "should ensure that a proper investment plan is in place and should have a
personal budget."
The Behavior Biases of Individuals Learning Outcome
b. Discuss commonly recognized behavioral biases and their implications for financial decision
making
Q87. Two risk managers are discussing how an organization’s risk tolerance should be
determined. The first manager says, “The risk tolerance must reflect the losses or shortfalls
that will cause the organization to fail to meet critical objectives.” The second manager
responds, “The risk tolerance must reflect the external forces that bring uncertainty to the
organization.” Which of them is most likely correct?
A. The second risk manager
B. The first risk manager
C. Both risk managers
Solution
C is correct. The risk tolerance of an organization should reflect both an “inside” view and
an “outside” view. The inside view asks what level of loss will leave the organization unable
to meet critical objectives. The outside view asks what sources of uncertainty or risk the
organization faces.
A is incorrect because both an “inside” and “outside” view must be reflected.
B is incorrect because both an “inside” and “outside” view must be reflected.
Introduction to Risk Management Learning Outcome

d. Explain how risk tolerance affects risk management
Q88. A risk metric that measures how different an actual investment outcome could be from
what the investor expects is most likely a:
A. vega.
B. duration.
C. standard deviation.
Page 111 of 113

Solution
C is correct. Standard deviation is a measure of dispersion in a probability distribution and is
used to describe the range of outcomes (minimum and maximum, centered on the expected
outcome) that can occur with a particular probability. In contrast, duration measures the
sensitivity of a security or portfolio to a change in market interest rates, and vega measures
the sensitivity of a security (either a derivative or a security with derivative-like
characteristics) to a change in the price volatility of the underlying asset.
A is incorrect because vega measures the sensitivity of a security (either a derivative or a
security with derivative-like characteristics) to a change in the price volatility of the
underlying asset.
B is incorrect because duration measures the sensitivity of a security or portfolio to a change

in market interest rates.
Introduction to Risk Management Learning Outcome

g. Describe methods for measuring and modifying risk exposures and factors to consider in choosing
among the methods
Q89. A stock is declining in price and reaches a price range wherein buying activity is
sufficient to stop the decline. This range is best described as the:
A. change in polarity point.
B. resistance level.
C. support level.
Solution
C is correct. The support level is defined to be a low price range in which buying activity is
sufficient to stop the decline in price.
A is incorrect. The question does not ask about the breach of a support level.
B is incorrect. Resistance is the opposite of support (price range in which selling is sufficient
to stop the rise in price).
Technical Analysis Learning Outcome

c. Compare principles of technical analysis and fundamental analysis
Q90. The advantage of distributed ledger technology (DLT) systems that will most likely lead
to their successful adoption by the investment industry is that:
A. they can help uncover fraudulent activity.
B. they are efficient and require only minimal amounts of storage capacity.
C. trade cancellations must be made by placing an equal and offsetting trade.
Solution
A is correct. An advantage of DLT systems is that they can help uncover fraudulent activity
and reduce compliance costs.
B is incorrect. DLT systems require substantial storage resources as they increase in scale.
Page 112 of 113

C is incorrect. It is a disadvantage of a DLT system. Immutability of transactions means

accidental or “canceled” trades can be undone only by submitting an equal and offsetting
trade.
Fintech in Investment Management Learning Outcome

d. Describe financial applications of distributed ledger technology
Page 113 of 113

AnsCFA Level I Mock Exam A - February 2022

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CFA Level I Mock Exam A - February 2022

Ethics and Trust in the Investment Profession Learning Outcome

C is incorrect because an ethical decision making framework helps a decision-maker see a

Ethics and Trust in the Investment Profession Learning Outcome

C is incorrect. Members and candidates must self-disclose on the annual Professional

Code of Ethics and Standards of Professional Conduct Learning

C is incorrect because Standard V–Investment Analysis, Recommendations, and Actions

Code of Ethics and Standards of Professional Conduct Learning

A. Report the observed activities to her employer.

Guidance for Standards I–VII Learning Outcome

Guidance for Standards I–VII Learning Outcome

Q7. Jean-Luc Schlumberger, CFA, is an independent research analyst providing equity

Guidance for Standards I–VII Learning Outcomes

Guidance for Standards I–VII Learning Outcome

B is incorrect because there has been a violation of Standard VI(B)–Priority of Transactions,

Guidance for Standards I–VII Learning Outcome

Guidance for Standards I–VII Learning Outcome

Guidance for Standards I–VII Learning Outcome

Guidance for Standards I–VII Learning Outcome

B is incorrect because Seneca has violated Standard III(D)–Performance Presentation because

Guidance for Standards I–VII Learning Outcome

Guidance for Standards I–VII Learning Outcome

Guidance for Standards I–VII Learning Outcome

B is incorrect because a supervisor’s responsibilities under Standard IV(C)–Responsibilities

Guidance for Standards I–VII Learning Outcome

Guidance for Standards I–VII Learning Outcome

B is incorrect because according to Standard V(B)–Communication with Clients and

Guidance for Standards I–VII Learning Outcome

Guidance for Standards I–VII Learning Outcome

A. manage the partnership separately from his advisory business.

Guidance for Standards I–VII Learning Outcome

Guidance for Standards I–VII Learning Outcome

C is incorrect because Standard VII–Responsibilities as a CFA Institute Member or CFA

Guidance for Standards I–VII Learning Outcome

Introduction to the Global Investment Performance Standards

Introduction to the Global Investment Performance Standards

Ethics Application Learning Outcome

A. within the firm first and then to customers.

A is incorrect because according to the recommended procedures for compliance with

B is incorrect because according to the recommended procedures for compliance with

Ethics Application Learning Outcome

Ethics Application Learning Outcome

The Time Value of Money Learning Outcome

B is incorrect; it is calculated using (9/365) × 4 = 0.09863.

The Time Value of Money Learning Outcome

Stated Annual Interest Rate at Year in Which Rate

30-year fixed rate 5.000% N/A

20-year fixed rate 4.385% N/A

30-year adjustable-rate 3.750% 3

where X is the monthly payment for all 360 months.

where Y is the monthly payment for all 240 months.

30-year X is found as follows: 536.82 536.82

20-year Y is found as follows: 626.46 626.46

30-year Z is found as follows: 463.12 (this 559.16 (this

found: N = 12 × 27 = 324, I/Y = (3.75/12) =

B is incorrect; 536.82 < 559.16 < 626.46.

C is incorrect; 536.82 < 559.16 < 626.46.

The Time Value of Money Learning Outcomes

C is incorrect and is calculated by dividing 140 by 9 (i.e., by n − 1 rather than n).

Organizing, Visualizing, and Describing Data Learning Outcome

C is incorrect. A distribution that is less peaked than normal is called platykurtic.

Organizing, Visualizing, and Describing Data Learning Outcome

C is incorrect. Outcomes are unconditional when the probability of an outcome is not