Mock Exam 2023 #4 Second Session Corporate Finance, Equity, Fixed

Level I of the CFA® Exam
Mock Questions with Answers - Mock Exam 2023 #4 - Second

Session (Corporate Finance, Equity, Fixed Income, Derivatives,
Alternative Investments & Portfolio Management)
Offered by AnalystPrep
Last Updated: Sep 5, 2023
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Q.1 Land Solutions (LS) specializes in the manufacture of cultivators used for agricultural purposes.
T his year, LS manufactured 34,000 units at a sales price of $2,000. Variable costs per unit were
$1,050, and fixed costs totaled $12 million. LS’s revenue at its operating breakeven is closest to:
A. $7,868,000
B. $25,264,000
C. $68,000,000
T he correct answer is B.
F
Operating breakeven quantity =
P −V
$12, 000, 000
=
$2, 000 − $1, 050
= 12,632
Revenue at operating breakeven = 12, 632 × $2, 000

= $25, 264, 000
CFA Level 1, Vol ume 4, Readi ng 35 – Measure of Leverage, LOS 35e: Cal cul ate and
i nterpret the operati ng break even quanti ty of sal es.
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© 2014-2023 AnalystPrep.
Q.2 Gree is the market leader in the sporting goods manufacturing sector of China. However, the
company was recently accused of not providing minimum basic working conditions to its employees.
Due to these serious accusations, several pension funds reduced their exposures to Gree's equity.
Which of the following ESG factors have the pension funds most likely considered?
A. Social.
B. Governance.
C. Environmental.
T he correct answer is A.
Environmental, social, and governance (ESG) refers to the three central factors in measuring the
sustainability and ethical impact of an investment in a
Environmental, social, and governance (ESG) refer to the three central factors in measuring an
investment's sustainability and ethical impact in a company or business.
T he social factor includes considering human rights issues and welfare concerns in the workplace
and the impact of product development on the community.
B i s i ncorrect. Governance deals with issues such as ownership structure,
board independence and composition, and compensation.
C i s i ncorrect. Environmental factors that are generally considered material in investment analysis
include natural resource management, pollution prevention, water conservation, energy efficiency
and reduced emissions, the existence of carbon assets, and adherence to environmental safety and
regulatory standards.
CFA Level 1, Vol ume 4, Readi ng 29 – Introducti on to Corporate Governance and Other
ESG Consi derati on, LOS 29d: Descri be both the potenti al ri sk s of poor corporate
governance and stak ehol der management and the benefi ts from effecti ve corporate
governance and stak ehol der management.
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Q.3 Which of the following screening approaches seeks to identify companies which record the
highest ESG score in their industry?
A. Impact investing.
B. Positive screening.
C. Best-in-class approach.
T he correct answer is C.
Best-in-class investment means investing in frontrunners in companies meeting environmental,
social, and governance (ESG) criteria.
A i s i ncorrect. Impact investing seeks to achieve targeted social or environmental objectives along
with measurable financial returns through engagement with a company or by directly investing in
projects or companies.
B i s i ncorrect. Positive screening refers to investors selecting companies with positive
environmentally friendly products and socially responsible business practices.
CFA Level 1, Vol ume 4, Readi ng 29 – Introducti on to Corporate Governance and Other
ESG Consi derati on, LOS29e: Descri be how envi ronmental , soci al , and governance
factors may be used i n i nvestment anal ysi s.
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Q.4 T he stock of Lamadava (LMDV) sells for $45.12 on the Nasdaq exchange and is expected to pay a
dividend of $0.80 next year. Assuming a return on equity of 11.5% and a dividend payout ratio of 40%,
the cost of equity of LMDV is closest to:
A. 6.90%
B. 8.67%
C. 13.27%
To calculate the cost of equity, we need to calculate growth rate:
g = RoE × Retention rate
g = 11.5% × (1 − 0.4) = 6.9%
Now, we can calculate the return on equity:
0.80
Cost of equity = + 0.069 = 0.0867
45.12
A i s i ncorrect. It indicates the company's growth rate and not the cost of equity as required.
C i s i ncorrect. It assumes the following calculation in determining the cost of equity:
0.80
Cost of Equity = + 0.115 = 0.1327 ≈ 13.27%
45.12
CFA Level 1, Vol ume 4, Readi ng 33 – Cost of Capi tal -Foundati onal Topi cs, LOS 33e:
cal cul ate and i nterpret the cost of equi ty capi tal usi ng the capi tal asset pri ci ng model
approach and the bond yi el d pl us ri sk premi um approach.
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Q.5 Which of the following least likely distinguishes nonprofits from for-profit corporations?
A. Tax payments.
B. Profit generation.
C. Number of shareholders and dividend payments.
Both nonprofits and for-profit can generate profits. However, the profits generated in the nonprofit
are reinvested to promote the corporation's mission.
A i s i ncorrect. Most nonprofits are tax-exempted. On the other hand, for-profits are subject to a
tax authority.
C i s i ncorrect. Unlike for-profits, nonprofits lack shareholders and do not pay dividends.
CFA Level 1, Vol ume 3, Readi ng 28 – Corporate Structures and Ownershi ps, LOS 28a:
Compare busi ness structures and descri be k ey features of corporate i ssuers.
Q.6 If XXV Corp. issues a 7-year, 4% semiannual coupon bond, and the bond sells for $108, then the
company's before-tax cost of debt is closest to:
A. 1.28%
B. 1.37%
C. 2.74%
100
PV = −108;FV = 100;PMT = 0.04 × = 2; n = 2 × 7 = 14
2
Using the BA II Plus Pro calculator, we find i = 1.3682, which is the six-month yield.
T herefore, the before-tax cost of debt is 2 × 1.3682 = 2.7364%.
CFA Level 1, Vol ume 4, Readi ng 33 – Cost of Capi tal – Foundati onal Topi cs LOS 33c:
Cal cul ate and i nterpret the cost of debt capi tal usi ng the yi el d-to maturi ty approach
and the debt-rati ng approach
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Q.7 Tom Jones, CFA is trying to determine the beta of a ZXC Inc, a privately held company. He has
established that Stream PLC. is an appropriate publicly traded peer company. Stream PLC is 30%
funded by debt, has a beta of 0.8 and its tax rate is 30%. If ZXC Inc is only 40% funded by equity with
a tax rate of 25%, its beta is closest to:
A. 0.61
B. 1.31
C. 1.87
⎡ 1 ⎤ ⎡ 1 ⎤
βU = βE = 0.8 = 0.615
⎣ 1 + (1 − t) D⎦ ⎣ 1 + (0.7) 0. 3⎦
E 0. 7
T hus,
D 0.6
βE = βU [1 + (1 − t) ] = 0.615 [1 + (1 − 0.25) ] = 1.31
E 0.4
CFA Level 1, Vol ume 4, Readi ng 33 – Cost of Capi tal – Foundati onal Topi cs LOS 33f:
Expl ai n and demonstrate beta esti mati on for publ i c compani es, thi nl y traded publ i c
compani es, and nonpubl i c compani es.
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Q.8 Chicago Coffee Cups has the following projections available for the year 2018:
Selling price 8
Variable costs per unit 5
Fixed cost 75, 000
Interest expense 100, 000
What is the degree of total leverage (DT L) if Chicago Coffee Cups sells 125,000 units in 2018?
A. 1.500
B. 1.875
C. 2.813
Qty × (Price − Variables costs)

DOL =
(Qty × (Price − Variables costs) − Fixed costs)
125, 000 × (8 − 5)
=
(125, 000 × (8 − 5) − 75, 000)
= 1.25
EBIT = 125, 000 × (8 − 5) − 75, 000 = 300, 000
EBIT
DFL =
(EBIT − Int. Exp)
300, 000
=
(300, 000 − 100, 000)
= 1.5
DT L = DOL × DFL
= 1.25 × 1.5
= 1.875
CFA Level 1, Vol ume 4, Readi ng 35 – Measures of Leverage, 35b: Cal cul ate and i nterpret
the degree of operati ng l everage, the degree of fi nanci al l everage, and the degree of
total l everage.
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Q.9 Birmingham Corporation is launching a new product with a social media marketing campaign that
will cost $2,000,000. To finance the project, Birmingham's CEO gathered the following information:
Required return on equity 15%

Before-tax required return on debt 7%
Birmingham’s tax bracket 20%
If the CEO decides to issue $1,500,000 in new debt and $500,000 in common stocks, then the
marginal weighted average cost of capital (WACC) is closest to:
A. 7.20%
B. 7.95%
C. 9.05%
WACC = W d rd(1 − T ) + W ere + W p rp
WACC = (0.75)(7%)(1 − 0.2) + (0.25)(15%) + 0

= 4.2% + 3.75%
= 7.95%
In this case, we do not have any preferred shares.
CFA Level 1, Vol ume 4, Readi ng 33 – Costs of Capi tal – Foundati onal Topi cs, LOS 33a:
Cal cul ate and i nterpret the wei ghted average cost of capi tal (WACC) Of a company.
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Q.10 A project requires an initial investment of $800,000 and is supposed to generate cash flows of
$154,000 each year for 5 years. T he IRR of the project is closest to:
A. -1.26%
B. 1.26%
C. 3.36%
T he IRR is the rate that equals the P.V. of Cash flows to the project's initial cash outflow. Since the
Rate of Return (or Discount rate), which is required to calculate the P.V. of the cash flow, is not
given, the IRR will be estimated using the T VM function of the BAII Plus Pro calculator as follows;
T he IRR can be calculated as follows;
N = 5;PV = −800,000; PMT = 154,000; FV = 0; CPT => I = −1.26%
CFA Level 1, Vol ume 4, Readi ng 31 – Capi tal Investments, LOS 31c: Demonstrate the use
of net present val ue (NPV) and i nternal rate of return (IRR) i n al l ocati ng capi tal and
descri be the advantages and di sadvantages of each method.
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Q.11 T hirty days have passed since a company invested in a 150-day T reasury security with a face
value and a purchase price of $1,000.00 and 969.31, respectively. T he bond-equivalent yield of the
T reasury security is closest to:
A. 8.93%
B. 9.18%
C. 9.63%
Face value − Purchase price 365

Bond equivalent yield = ( )×
Purchase price Number of days to maturity
$1000.00 − $969.31 365
=( )×
$969.31 150 − 30
= 9.63%
CFA Level I, Vol ume 3, Readi ng 32: Work i ng Capi tal & Li qui di ty, LOS 32e: Cal cul ate
and i nterpret comparabl e yi el ds on vari ous securi ti es, compare portfol i o returns
agai nst a standard benchmark , and eval uate a company's short-term i nvestment pol i cy
gui del i nes.
Q.12 T he table below summarizes key financial results for Krayack Limited, a steel processor,
between the years 2015 and 2016.
$ Millions (where applicable) 2016 2015

Credit sales 100 150
Cost of goods sold 65 50
Accounts receivable 50 70
Inventory 40 25
Cash and marketable securities 15 10
Net operating cycle 65 days 83 days
Between 2015 and 2016, Krayack Limited’s day’s payables outstanding have most likely :
A. Increased.
B. Decreased.
C. Remained constant.
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T he day’s payables outstanding have increased.
To determine day’s payables outstanding, the formula for net operating cycle is used:
Net operating cycle = Number of days of receivables + Number of days of inventory– Number of days of payable
Number of days of payables (2016):
100 65
65 days = [50 ÷ ( )] + [40 ÷ ( )]– Number of days of payables
365 365
Number of days of payables = 342
Number of days of payables (2015):
150 50
83 days = [70 ÷ ( )] + [25 ÷ ( )]– Number of days of payables
365 365
Number of days of payables = 270
CFA Level 1, Vol ume 3, Readi ng 32 – Work i ng Capi tal , LOS 32c: Descri be pri mary and
secondary sources of l i qui di ty and factors that i nfl uence a company’s l i qui di ty
posi ti on.
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Q.13 A company’s executive is selecting a liquidity source that it can use without affecting its normal
operations. T he executive will most likely :
A. Utilize the cash in the company’s bank account.
B. Negotiate a debt contract on behalf of the firm.
C. File for bankruptcy protection and reorganization.
Primary sources of liquidity, such as cash in bank accounts, represent readily accessible resources
whose use is not likely to affect the company's normal operations.
B and C are i ncorrect. On the other hand, using secondary sources may result in a change in the
company's financial and operating position; these include negotiated debt contracts and filing for
bankruptcy protection and reorganization.
CFA Level 1, Vol ume 3, Readi ng 31 – Capi tal Investments, LOS 31b: descri be pri mary
and secondary sources of l i qui di ty and factors that i nfl uence a company’s l i qui di ty
posi ti on
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Q.14 FDM Ltd. had total sales of $920,000 last year, and 86% of these sales were on credit. If the
receivables turnover is 4, what are the average collection period (based on a 365-day year) and the
year-end receivables?
A. Average collection period: 73 days; Year-end receivables $230,000.
B. Average collection period: 91 days; Year-end receivables $197,800.
C. Average collection period: 91 days; Year-end receivables $230,000.
365
Accounts receivable (AR) in days = = 91.25 days
4
920, 000
Accounts receivable (AR) balance = 86% × = 197, 800
4
CFA Level 1, Vol ume 3, Readi ng 32 – Work i ng Capi tal & Li qui di ty, LOS 32c: Descri be
pri mary and secondary sources of l i qui di ty and factors that i nfl uence a company’s
l i qui di ty posi ti on/em>
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Q.15 Which of the following is least likely a step of the Capital Allocation process
A. Idea generation
B. Replacement project
C. Capital allocation planning
T he correct answer is B
Replacement project is not a step of the capital allocation process. Replacement project is a type of
capital project and are investment projects that maintain the existing size of the business. Other
types of capital projects are expansion projects, new products and services, regulatory, safety and
environmental projects and other projects.
A i s i ncorrect. Idea generation the first step of the capital allocation process. Idea can originate
from anywhere in an organization and is the most important step of the capital allocation process.
C i s i ncorrect. Capital allocation planning is the third step of the capital allocation process. T his
involves organization of proposals that bet fit a compan’s strategy. Scheduling and priotizing are key
considerations in this step.
CFA Level 1, Vol ume 3, Readi ng 31 – Capi tal Investments, LOS 31b: Descri be the capi tal
al l ocati on process and basi c pri nci pl es of capi tal al l ocati on.
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Q.16 Which of the following is least likely a short-term type of security in which a company can
invest to manage its cash?
A. U.S T reasury bonds.
B. Bank certificate of deposits.
C. Money market mutual funds.
U.S T reasury bonds are long-term investments and typically have a maturity of 10 years or more.
T hey are not suitable for managing short-term cash needs.
B i s i ncorrect. Bank certificates of deposit (CDs) are short-term deposits that offer a fixed interest
rate in exchange for keeping the funds in the bank for a specified period, usually ranging from a few
months to several years. CDs can be a good option for companies to manage their cash and earn a
return on their funds.
C i s i ncorrect. Money market mutual funds are investment vehicles that invest in short-term debt
securities, such as T reasury bills and commercial paper, with low credit risk. T hese funds provide a
relatively low-risk way for companies to earn a return on their cash while still having easy access to
their funds.
CFA Level 1, Vol ume 4, Readi ng 32: Work i ng Capi tal & Li qui di ty 32g: Eval uate the
choi ces of short-term fundi ng avai l abl e to a company and recommend a fi nanci ng
method
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Q.17 You have been provided the following figures for a manufacturing firm operating in France:
€’000
Credit sales 15 , 000
Cost of goods sold 12 , 000
Accounts receivable 1 , 800
Inventory – Beginning balance 1 , 650
Inventory – Ending balance 1 , 400
Accounts payable 1 , 200
T he operating cycle for this firm is closest to
A. 46days.
B. 52 days.
C. 90 days.
T he operating cycle is used to measure the length of time it takes to convert a firm's cash into
inventory and back into cash in the form of collections from inventory sales.
Operating cycle = No. of days of inventory + No. of days of receivables
(1,650+1,400)
2
No. of days of inventory = = 46.4 days
€12,000
( 365 days)
€1, 800
No. of days of receivables = = 43.8 days
€15,000
( 365 days)
Operating cycle = 46.4 days + 43.8 days ≈ 90 days
CFA Level 1, Vol ume 3, Readi ng 32 – Work i ng Capi tal , LOS 32c: Compare a company’s
l i qui di ty posi ti on wi th that of peer compani es.
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Q.18 Which of the following most appropriately measures the length of time it takes to convert a
firm's cash into inventory and back into cash in the form of collections from inventory sales?
A. Sales cycle.
B. Operating cycle.
C. Net operating cycle.
T he operating cycle is used to measure the length of time it takes to convert a firm's cash into
inventory and back into cash in the form of collections from inventory sales.
Operating cycle = number of days of receivables + number of days of inventory
A i s i ncorrect. T he sales cycle measures the average time between when an opportunity or deal is
created and closed-won.
C i s i ncorrect. T he net operating cycle measures the time from paying suppliers for materials to
collecting cash from the subsequent sale of goods produced from these supplies. It consists of the
operating cycle minus the number of days payable
CFA Level 1, Vol ume 3, Readi ng 32 – Work i ng Capi tal , 32c: Compare a company’s
l i qui di ty posi ti on wi th that of peer compani es.
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Q.19 What is the most likely benefit of a corporation issuing new securities in a private placement
instead of an initial public offering?
A. Lower cost of capital.
B. Cheaper offering costs.
C. More liquidity for investors.
Since issuers usually require less disclosure, private placements tend to have lower offering costs
than public ones.
A and C are i ncorrect. Because private placement securities are less liquid, investors demand a
higher return on their capital, resulting in lower security prices and a higher cost of capital for the
corporation.
CFA Level 1, Vol ume 4, Readi ng 36 – Mark et Organi zati on and Structure, LOS 36i :
Defi ne pri mary and secondary mark ets and expl ai n how secondary Mark ets support
pri mary mark ets.
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Q.20 Jesse Mackintosh is constructing a portfolio that will be benchmarked to a market-
capitalization-weighted equity index. He is in the process of calculating the index’s total return for
the most recent period. Mackintosh has collected the necessary data for the calculation in an exhibit.
Beginning of
Beginning of End of period Total Period
Security period market cap market cap Dividends Weight (%)
A 56 , 500 53 , 000 500 49.3
B 37 , 500 40 , 000 0 32.8
C 20 , 500 37 , 000 100 17.9
Total 114 , 500 130 , 000 100.0
T he total return on the index is closest to:
A. 6.67%
B. 14.06%
C. 22.93%
(53.0– 56.5 + 0.5) (40– 37.5) (37.0– 20.5 + 0.1)

Total return = [ ][0.493] + [ ][0.328] + [ ][0.179] = 14.06%
56.5 37.5 20.5
CFA Level I, Vol ume 4, Readi ng 38 – Mark et Effi ci ency, LOS 38b: Contrast mark et val ue
and i ntri nsi c val ue.
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Q.21 Which of the following statements accurately compares market-capitalization (cap)-weighted
with price-weighted indexes?
A. Reconstitution similarly affects market-cap and price-weighted indexes.
B. Market-cap-weighted indexes are most sensitive to the effects of reconstitution.
C. T he value of price-weighted indexes may depart from a market-cap weighted index due to
rebalancing.
When one security is removed and another is added, the index provider has to change the weights of
all other securities to maintain the index's market capitalization weighting.
A i s i ncorrect. Reconstitution creates a turnover, particularly in market-cap-weighted indexes.
C i s i ncorrect. Price-weighted indexes are not rebalanced because their price determines the
weight of each constituent security. Rebalancing is less of a concern for market-cap-weighted index
providers because they largely rebalance themselves.
CFA Level 1, Vol ume 4, Readi ng 39 – Mark et Effi ci ency, LOS 39f: Descri be mark et
anomal i es.
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Q.22 British investor is expected to receive $10 million in three months and would like to hedge
against an unfavorable movement in the U.S. dollar (USD). He purchases USD denominated put
options with a strike price of 1.55, paying a premium of 0.30. T he current GBP/USD spot exchange
rate is 1.66. T he investor will most likely exercise the put option if the spot exchange rate:
A. Rises above 1.55.
B. Declines below 1.25.
C. Declines below 1.55.
Since the investor is expected to receive USD, he is long the dollar and is concerned that the
GBP/USD may depreciate, lowering the value of his proceeds. T herefore, he has purchased a put
option which will only be exercised if the GBP/USD spot rate declines below the option strike price
(1.55).
CFA Level 1, Vol ume 4, Readi ng 37 – Securi ty Mark et Indexes, LOS 37c: Descri be the
choi ces and i ssues i n i ndex constructi on and management.
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Q.23 A major use of a market index is that it:
A. can be used for modeling unsystematic risk.
B. accurately reflects the overall attitudes of investors in a market.
C. can serve as a market proxy when measuring risk-adjusted performance.
A security market index can represent the market portfolio in CAPM, measuring and modeling
systematic risk and market returns.
A and B are i ncorrect. Market indexes can be used to gauge investor confidence or market
sentiment. However, it may not accurately measure overall investor attitude or market sentiment
because an index comprises only a sample of stocks traded in the market.
CFA Level 1, Vol ume 4, Readi ng 38 – Mark et Effi ci ency, LOS 38g: Descri be behavi oral
fi nance and i ts potenti al rel evance to understandi ng mark et anomal i es.
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Q.24 An investor is evaluating the degree of regulation in a country's financial markets. Which of the
following factors is most likely a sign of a high degree of market regulation?
A. Pension funds are required to maintain adequate reserves to ensure future liabilities can
be funded.
B. Allowing diversity in accounting standards to ensure a wide range of reporting situations

are adequately addressed.
C. Private financial companies are exempt from minimum capital requirement regulations to
promote corporate growth.
By requiring pension funds to maintain adequate reserves, regulators aim to ensure that they can
fund their liabilities.
B i s i ncorrect. In the absence of common reporting standards, investors may refuse to invest in
companies that do not report to a common reporting standard. Common reporting standards ease
comparability amongst companies.
C i s i ncorrect. Similarly, requiring financial companies to maintain minimum capital levels ensures
that companies can meet their contractual commitments when unexpected market declines or poor
decisions cause them to lose money. Secondly, they ensure that owners of financial firms have
substantial interests in the decisions they make.
CFA Level 1, Vol ume 4, Readi ng 37 – Securi ty Mark et Indexes, LOS 37g: Descri be uses of
securi ty mark et i ndexes.
24
Q.25 T he exhibit below illustrates the share price and earnings per share (EPS) for three companies
(Tecra, Cosmos, and Latle) in the technology sector for the most recent financial year (2016).
Tecra Cosmos Latle

Price per share 782.50 560.20 430.60
EPS 446.10 450.10 220.50
Using the method of comparison, which of the following companies appears to be the most likely
undervalued?
A. Latle.
B. Tetra.
C. Cosmos.
Cosmos appears to be the most undervalued based on P/E multiples.
Using the method of comparable, the P/E ratio for the three companies is as follows:
782.50
Tecra = = 1.7541
446.10
560.20
Cosmos = = 1.245
450.10
430.60
Latle = = 1.953
220.50
CFA Level 1, Vol ume 4, Readi ng 41 – Equi ty Val uati on: Concepts and Basi c Tool s, LOS
41a: Eval uate whether securi ty, gi ven i ts current mark et pri ce and a val ue esti mate, i s
overval ued, fai rl y val ued, or underval ued by the mark et.
25
Q.26 Which of the following voting mechanisms is most likely used to meet the interests of
shareholders who own a small number of shares?
A. Proxy.
B. Statutory.
C. Cumulative.
To meet the voting interests of shareholders with limited share ownership, cumulative voting is
often used. T his voting mechanism allows shareholders to direct their total voting rights to a specific
candidate, providing them with a higher level of representation on the board than would be allowed
under statutory voting.
A i s i ncorrect. Proxy voting provides shareholders with the convenience of casting their votes
without the need to attend board meetings.
B i s i ncorrect. Statutory voting allows shareholders to cast all of their votes for a single nominee
for the board of directors when the company has multiple openings on its board. In contrast, in
"regular" or "statutory" voting, shareholders may not give more than one vote per share to any
single nominee.
CFA Level I, Vol ume 4, Readi ng 40 – Introducti on to Industry and Company Anal ysi s,
LOS 40b: Compare methods by whi ch compani es can be grouped.
26
Q.27 A trader serving a securities trading firm has purchased a stock priced at $80 on margin using
40% equity. T he maintenance requirement for the position is 25%. T he trader will receive a margin
call if the stock price:
A. Falls below $20.
B. Falls below $64.
C. Rises above $80.
Initial equity is $32 per share ($80 × 40%) . Subsequent changes in equity per share are equal to the
sum of the initial equity per share plus change in share price, $32 + (P – $80) . T he margin call will
take place if equity drops below the 25% maintenance margin requirement.
T he following equation is used to determine the price below which a margin call will be received.
($32 + P – 80)
= 25%
P
P = $64
If the price drops below $64, the trader will receive a margin call.
CFA Level I, Vol ume 4, Readi ng 37 - Securi ty Mark et Indexes, LOS 37f: Descri be
rebal anci ng and reconsti tuti on of an i ndex.
27
Q.28 Donald Grant is a junior market analyst writing a report on dealers and arbitrageurs’ role in
equity markets. He discusses the role of both parties in providing liquidity to markets with his senior
editor.Statement: “While dealers typically provide liquidity to buyers and sellers in equity markets,
arbitrageurs do not; the latter are primarily concerned with exploiting any security
misevaluations.”Grant is most likely correct concerning the role of:
A. Dealers only.
B. Arbitrageurs only.
C. Both dealers and arbitrageurs.
Grant is only correct concerning the role of dealers who provide liquidity to buyers and sellers.
B and C are i ncorrect. Arbitrageurs sell to buyers in one market and buy from sellers in other
markets, thus providing and reducing liquidity at the same time.
CFA Level 1, Vol ume 4, Readi ng 37 - Securi ty Mark et Indexes, LOS 37d: Compare the
di fferent wei ghti ng methods used i n i ndex constructi on.
28
Q.29 Mark Bowie, a trader, buys stock on margin, posting 40% of the initial stock price of CAD 40 as
equity. T he price below which a margin call will occur, given that the maintenance margin
requirement for the position is 25% is closest to:
A. CAD 16
B. CAD 32
C. CAD 40
Bowie's initial equity = 0.4 × 40 = CAD 16 per share
T he margin call takes place when equity drops below the 25% maintenance margin requirement.
(1– initial margin requirement)

Share price × = price below which a margin call will occur
(1– maintenance margin requirement)
(1 − 0.40)
CAD 40 × = CAD 32
(1 − 0.25)
A i s i ncorrect. It represents the value of Bowie's initial equity per share.
C i s i ncorrect. It indicates the initial stock price.
CFA Level 1, Vol ume 4, Readi ng 36 - Mark et Organi zati on and Structure, LOS 36f:
cal cul ate and i nterpret the l everage rati o, the rate of return on a margi n transacti on,
and the securi ty pri ce at whi ch the i nvestor woul d recei ve a margi n cal l .
29
Q.30 Prime bank intends to make an IPO later this year to mobilize funds in readiness for an
ambitious expansion plan. If it opts for an underwritten offering, the risk that the general public may
not take up the entire issue at the specified price will most likely be borne by:
A. the bank.
B. an investment bank.
C. buyers of the part that will have sold successfully.
T he investment bank (underwriter) bears the risk that not all the specified number of shares will be
taken up by the public (under subscription). T he investment bank will buy any unsold securities at
the offering price.
A i s i ncorrect. T he role of the banks is to act as intermediaries during the IPO exercise by
providing services that ensure traders settle their trades and that the resulting positions are not
stolen or pledged more than once as collateral.
C i s i ncorrect. Buyers of the part that will have sold successfully do not bear the risk that the
general public may not take up the entire issue at the specified price.
CFA Level 1, Vol ume 4, Readi ng 36 – Mark et Organi zati on and Structure, LOS 36d:
Descri be types of fi nanci al i ntermedi ari es and servi ces that they provi de.
30
Q.31 Texas Corp. is a calculator manufacturing firm expected to pay a dividend of $2 next year that
will grow at 5% for two more years. If the stock is expected to sell for $30 at the end of the third
year, and the required rate of return is 11%, then the present value of the stock is closest to:
A. $25.00
B. $27.05
C. $31.00
Using the dividend discount model, the stock value will be estimated as:
2 2.1 (2.205 + 30)

Expected price = ( )+( ) +( ) = $27.05
1 2
1.11 1.11 1.113
41e: Expl ai n the rati onal e for usi ng present val ue model s to val ue equi ty and descri be
the di vi dend di scount and free-cash-fl ow-to-equi ty model s.
31
Q.32 Which of the following is most likely a commercial industry classification system that was
jointly developed by Standard and Poor's and MSCI Barra?
A. Russel Global Sectors.
B. Industry Classification Benchmark.
C. Global Industry Classification Standard.
T he Global Industry Classification Standard, as the name implies, was designed to facilitate global
comparisons of industries, and it classifies companies in both developed and developing economies.
A i s i ncorrect. T he RGS classification system uses a three-tier structure to classify companies
globally based on the products or services a company produces.
B i s i ncorrect. T he Industry Classification Benchmark (ICB), which Dow Jones and FT SE jointly
developed, uses a four-tier structure to categorize companies globally based on the source from
which a company derives most of its revenue.
CFA Level 1, Vol ume 4, Readi ng 40 – Introducti on to Industry and Company Anal ysi s,
LOS 40b: Compare methods by whi ch compani es can be grouped.
32
Q.33 Galaxy Ceramics is a ceramic and tiles manufacturing company based in Palo Alto. Some
information regarding the stock is given below.
Required rate of return 12%

Return on equity 10%
Earning per share $5
Dividend $1.50 per share
Using the data given in the table, the growth rate of Galaxy is closest to:
A. 3%
B. 6%
C. 7%
Growth rate = Retention rate × Return on equity
1.5
Dividend payout ratio = = 30%
5
Retention rate = 1 − 0.3 = 0.7
Growth rate = 0.7 × 10% = 7%
41g: Cal cul ate and i nterpret the i ntri nsi c val ue of an equi ty securi ty based on the
Gordon (constant) growth di vi dend di scount model or a two-stage di vi dend di scount
model , as appropri ate.
33
Q.34 In which of the following methods do analysts adjust book values of the firm's assets and
liabilities to their fair values?
A. Asset-based models.
B. Market multiple models.
C. Discounted cash flow models.
T he intrinsic value of common stock is estimated as the total asset value minus liabilities and
preferred stocks. It is essential to asset-based models.
B i s i ncorrect. T hey are based chiefly on share price multiples or enterprise value multiples.
C i s i ncorrect. T hey estimate the intrinsic value as the present value of the future benefits
expected from the security.
41g: Cal cul ate and i nterpret the i ntri nsi c val ue of an equi ty securi ty based on the
Gordon (constant) growth di vi dend di scount model or a two-stage di vi dend di scount
model , as appropri ate.
Q.35 Given the following information for a 2-stock index for the year 2016: Stock A
Beginning price: 10$
Ending price: 14$
Total dividend in the period: 1$
Stock B
Beginning price: 10$
Ending price: 13$
Total dividend in the period: 1$
34
T he price return of the index is closest to:
A. 30%
B. 35%
C. 40%
In the price return method of calculating the Return on an index, the income generated by the assets
in the portfolio, in interest and dividends, is ignored as follows;
(14 − 10)
Stock A = = 40%
10
(13 − 10)
Stock B = = 30%
10
(30% + 40%)
Price return of the index = = 35%
2
A i s i ncorrect. It indicates the index returns for Stock A.
C i s i ncorrect. It indicates the index returns for Stock B.
CFA Level 1, Vol ume 4, Readi ng 37 – Securi ty Mark et Indexes, LOS 37b: Cal cul ate and
i nterpret the val ue, pri ce return, and total return of an i ndex.
35
Q.36 What is the simplest method to weight an index and the one used by Charles Dow to construct
the Dow Jones Industrial Average?
A. Price-weighting.
B. Fundamental weighting.
C. Market capitalization-weighting.
In the price weighting method, the weight assigned to each constituent security is determined by
dividing its price by the sum of all the prices of the constituent securities.
B i s i ncorrect. It attempts to address the disadvantages of market-capitalization weighting by using
measures of a company's size independent of its security price to determine the weight on each
constituent security, including book value, cash flow, revenues, earnings, dividends, and the number
of employees.
C i s i ncorrect. T he weight on each constituent security is determined by dividing its market
capitalization by the total market capitalization (the sum of the market capitalization) of all the
securities in the index.
CFA Level 1, Vol ume 4, Readi ng 37 – Securi ty Mark et Indexes, LOS 37e: Cal cul ate and
anal yze the val ue and Return of an i ndex gi ven i ts wei ghti ng method.
36
Q.37 An investor can most likely achieve positive risk-adjusted returns on average by using
fundamental analysis in which of the following forms of market efficiency?
A. Weak form efficiency only.
B. Strong form efficiency only.
C. Weak and semi-strong form efficiency only.
Fundamental analysis is mostly applicable in weak-form efficient markets to achieve positive risk-
adjusted returns.
B and C are i ncorrect. Semi-strong and strong forms of efficiency imply that neither fundamental
nor technical analysis can be used to achieve superior gains.
CFA Level 1, Vol ume 4, Readi ng 38 – Mark et Effi ci ency, LOS 38c: Expl ai n factors that
affect a mark et's effi ci ency.
37
Q.38 Mark Patel and Eliza Butler are equity investors seeking to purchase a manufacturer’s share of
stock currently trading at $43. T hey place the orders with their respective brokers, who issue the
following instructions on behalf of the two individuals:Patel - “T his order should be executed at the
best price available, but by no means can a price higher than $50 be accepted.”Butler - “Any shares
received should automatically be transferred by us, the brokerage firm, to Butler’s security
account.”T he instructions issued on behalf of the clients can be respectively classified as:
A. Patel: Execution; Butler: Validity.
B. Patel: Validity; Butler: Execution.
C. Patel: Execution; Butler: Clearing.
T he instructions issued on behalf of Patel are classified as execution, which indicates how to fill an
order. T he order issued by the broker is a limit buy order (placing a limit of $50 on the purchase
price). Limit orders convey execution instructions.
T he instructions issued on behalf of Butler are classified as clearing, which indicates how to arrange
the final settlement of the trade.
CFA Level I, Vol ume 4, Readi ng 37 – Securi ty Mark et Indexes, LOS 37g: Descri be uses of
securi ty mark et i ndexes.
38
Q.39 A 5% annual coupon paying bond issue has a term to maturity of six years. T he bond’s par value
is $1,000 and is trading at a yield to maturity of 7%. T he bond is most likely trading at:
A. Par.
B. A discount to par.
C. A premium to par.
To calculate the bond's price, the present value of the bond needs to be determined.
Using the present value functions on the BAII Plus Pro calculator, the present value is determined as
follows:
FV = 1,000; PMT = 50; I/Y = 7%;N = 6;CPT =>;PV = −904.669
T he bond is trading at 90.47(904.1,000669× 100) of its par value or a discount to par.
CFA Level I, Vol ume 5, Readi ng 43 – Fi xed-Income Mark ets: Issuance, Tradi ng, and
Fundi ng, LOS 43a: Descri be cl assi fi cati ons of gl obal fi xed-i ncome mark ets.
Q.40 A one-year zero-coupon bond issue was purchased at $850. T he principal value of the bond is
$1,000. T he zero-coupon bond:
A. Will be redeemed at $850.
B. Will pay a fixed rate of interest.
C. Has an implied interest of $150.
T he zero-coupon bond has an implied interest of $150($1, 000– $850) .
Zero-coupon bonds do not make periodic coupon payments and are redeemed at par.
Fundi ng, LOS 43a: Descri be cl assi fi cati ons of gl obal fi xed-i ncome mark ets.
39
Q.41 An increase in market interest rates will most likely benefit the holder of:
A. A call option.
B. A put option.
C. Both call and put options.
An increase in market interest rates will benefit a call option holder. Let's say you are interested in
buying a stock. Instead of directly buying the stock, you could also have purchased a call option
selling for only a small percentage of the value of the stock. If you choose to buy the call option
instead of the underlying stock directly, you could use the difference between the full price of the
stock and the price of the call to earn some interest. T he higher the interest rates, the higher your
interest income would be. It makes the call option more attractive and more expensive if you already
hold the call.
B and C are i ncorrect. While a call option allows investors to profit when rates rise, put options,
on the other hand, allow investors to profit when rates fall.
Fundi ng, LOS 43f: descri be securi ti es i ssued by non-soverei gn governments, quasi -
government enti ti es, and supranati onal agenci es.
40
Q.42 T he spread measure, which accounts for future interest rate volatility, is the:
A. Z-spread.
B. G-spread.
C. Option-adjusted spread.
T he option-adjusted spread accounts for future interest rate volatility.
A i s i ncorrect. Z-spread calculates a constant yield spread over a government (or interest rate
swap) spot curve.
B i s i ncorrect. G-spread indicates the yield spread in basis points over an actual or interpolated
government bond.
CFA Level I, Vol ume 5, Study Sessi on 13, Readi ng 42 – Introducti on to Asset-Back ed
Securi ti es, LOS 42i : Descri be col l ateral i zed debt obl i gati ons, i ncl udi ng thei r cash
fl ows and ri sk s of each type.
41
Q.43 Each bond comprising the par curve:
A. is priced at par value.
B. is a zero-coupon issue.
C. has a full price equal to par value between coupon payment dates.
A par curve is a sequence of maturities such that each bond is priced at par value.
B i s i ncorrect. Bonds comprising the par curve are coupon-paying bonds.
C i s i ncorrect. T he flat price (not the full price) is assumed to equal the par value between coupon
payment dates.
CFA Level I, Vol ume 5, Study Sessi on 13, Readi ng 42 – Introducti on to Asset-Back ed
Securi ti es, LOS 42g: Descri be characteri sti cs and ri sk s of commerci al mortgage-
back ed securi ti es.
42
Q.44 A decline in the effective duration of a callable bond most likely implies that a bond’s
A. Yield-to-worst has risen.
B. Yield-to-maturity has risen.
C. Benchmark yield curve has shifted upwards.
T he effective duration of a callable bond measures interest rate risk in terms of a change in the
benchmark yield curve. T herefore, an upward shift in the benchmark yield curve could trigger a
decline in effective duration.
A i s i ncorrect. T he duration of a callable bond is not the sensitivity of a bond's price to a change in
the yield-to-worst.
B i s i ncorrect. Modified duration is a yield duration statistic measuring interest rate risk in terms
of a bond's yield-to-maturity.
CFA Level I, Vol ume 5, Study Sessi on 14, Readi ng 44 – Fundamental s of Credi t Anal ysi s,
LOS 44b: Descri be defaul t probabi l i ty and l oss severi ty as credi t ri sk components.
43
Q.45 A company has purchased a bond at $956. T he bond's par value is $1,000, and the original term
to maturity is five years. T he applicable capital gains tax rate is 25%. Based on the information
provided on the bond issue, the company will:
A. not need to pay any capital gains taxes on the maturity of the bond issue.
B. need to declare capital gains of $44 at the maturity of the bond issue only.
C. need to include $8.8 in taxable income every tax year for 5 years and declare a capital gain
of $44 at maturity.
A prorated portion of the $44($1, 000– $956) original issue discount is included in taxable income
$44
every year until maturity; this amounts to = $8.8. T he original issue discount will allow the
5
investor to increase their cost basis in the bonds so they do not face any capital gains or losses at
maturity.
Fundi ng, LOS 43d: Descri be secondary mark ets for bonds..
44
Q.46 T he interest income generated by a municipal bond issued in the United States is most likely :
A. exempt from federal income tax and from the income tax of the state in which the bonds
are issued.
B. taxed at the income tax of the state in which the bonds are issued but exempt from federal
income tax.
C. taxed at the federal income tax rate but exempt from the income tax of the state in which
the bonds are issued.
T he interest income generated by a municipal bond issued in the United States is often exempt from
federal income tax and the state's income tax in which the bonds are issued.
B and C are i ncorrect. T he interest rate is exempt from both the federal and state income tax,
respectively.
Fundi ng, LOS 43d: Descri be secondary mark ets for bonds.
45
Q.47 If a $1,000 par value, 5% coupon paying convertible bond has a conversion price of $120, then
the number of common shares per bond is closest to:
A. 8
B. 10
C. 12
Par value
Number of common shares per bond (Conversion ratio) =
Conversion price
$1, 000
Number of common shares per bond = =8
$120
Fundi ng, LOS 43f: Descri be securi ti es i ssued by non-soverei gn governments, quasi -
government enti ti es, and supranati onal agenci es.
46
Q.48 What is most likely the definition of a Special Purpose Vehicle (SPV)?
A. A type of asset-backed security that is secured by a mortgage or collection of mortgages.
B. A subsidiary company with an asset/liability structure and legal status that makes its
obligations secure even if the parent company goes bankrupt.
C. A structured financial product that pools together cash flow-generating assets and
repackages this asset pool into discrete tranches that can be sold to investors.
A Special Purpose Vehicle (SPV) is a subsidiary of a bankruptcy company remote from the main
organization. T he actions of an SPV are usually very tightly controlled, and they are only allowed to
finance, buy and sell assets.
A i s i ncorrect. It is the definition of Mortgage-backed securities.
C i s i ncorrect. It is the definition of CDOs.
CFA Level 1, Vol ume 5, Readi ng 45 – Introducti on to Asset-Back ed Securi ti es, LOS 45i :
Descri be col l ateral i zed debt obl i gati ons, i ncl udi ng thei r cash fl ows and ri sk s.
47
Q.49 J Ahsan, CFA, a credit analyst with High Return Investments, has been working on the credit
analysis of SnJ Inc. In his report, J Ahsan has written that SnJ Inc. has been using aggressive
accounting policies for the last three years. T his analysis is part of:
A. capacity.
B. character.
C. collateral.
Character involves analysis of management's strategy's soundness, track record, aggressive
accounting policies and/or tax strategies, history of fraud or misconduct, and previous treatment of
bondholders.
A i s i ncorrect. Capacity refers to management's integrity and its commitment to repay the loan.
C i s i ncorrect. Collateral assesses the quality and value of a company's assets.
CFA Level 1, Vol ume 5, Readi ng 47 – Fundamental s of Credi t Anal ysi s, LOS 47f: Expl ai n
the four Cs (Capaci ty, Col l ateral , Covenants, and Character) of tradi ti onal credi t
anal ysi s.
48
Q.50 As an investor, you must always be wary of where the bond is traded and issued, as this
provision directly affects the tax status, regulations and law. Which of the following bonds is issued
internationally, has lesser regulatory requirements, disclosure, and listing levels compared to other
bonds?
A. Eurobonds.
B. Global bonds.
C. Foreign bonds.
An important consideration for investors is where the bonds are issued and traded because it affects
the laws, regulations, and tax status that apply. Eurobonds are issued internationally, outside the
jurisdiction of any single country, and are subject to a lower level of listing, disclosure, and
regulatory requirements than domestic or foreign bonds.
B i s i ncorrect. Global bonds are issued simultaneously in the Eurobond market and at least one
domestic bond market.
C i s i ncorrect. Foreign bonds are subject to the legal, regulatory, and tax requirements in that
country.
CFA Level 1, Vol ume 5, Readi ng 42 – Fi xed-Income Securi ti es: Defi ni ng El ements, LOS
42d: Descri be how l egal , regul atory, and tax consi derati ons affect the i ssuance and
tradi ng of fi xed-i ncome securi ti es.
49
Q.51 Ying & T wang, a Chinese publicly-traded company, reported, for last quarter, equity and debt
amounting to $24 million and $34 million, respectively. If the company's stock beta is 1.4 and the
marginal tax rate is 30%, the asset beta is closest to:
A. 0.44
B. 0.65
C. 0.70
BEquity
BAssets =
(1 + (1 − Tax) × ( DE ))
1.4
=
(1 + (1 − 0.3) × ( 34 ))
24
= 0.7
CFA Level 1, Vol ume 4, Readi ng 33 – Cost of capi tal – Foundati onal Topi cs, LOS 33f:
Expl ai n and demonstrate beta esti mati on for publ i c compani es, thi nl y traded publ i c
compani es, and nonpubl i c compani es.
50
Q.52 JA Inc. reported the following on its balance sheet for the year ending 2016:Total asset:
$9,870 Total debt: $1,595 Shareholders' Equity: $4,159Total liability: $5,711 T he debt-to-capital ratio
and the debt ratio are closest to:
A. 28% & 16%, respectively.
B. 30% & 15%, respectively.
C. 26% & 18%, respectively.
Total debt
Debt to Capital =
(Total debt + Shareholders' equity)
$1, 595
=
($1, 595 + $4, 159)
= 27.72%
Total Debt
Debt ratio =
Total assets
$1, 595
=
$9,870
= 16.16%
CFA Level 1, Vol ume 5, Readi ng 47 – Fundamental s of Credi t Anal ysi s, LOS 47h:
Eval uate the credi t qual i ty of a corporate bond i ssuer and bond of that i ssuer, gi ven k ey
fi nanci al rati os of the i ssuer and the i ndustry.
51
Q.53 A financial analyst needs to assign a value to a five-year illiquid bond with an annual coupon
payment of 5.5%.In his analysis, the financial analyst highlights two corporate bonds having the same
credit quality:
1. 6-year, 5.50% annual coupon bond priced at 104.00.

2. 4-year, 6.50% annual coupon bond priced at 107.00.
Using the matrix pricing technique, the estimated price of the illiquid bond is closest to:
A. 101.37
B. 103.78
C. 104.56
YT M on 6-year bond:
5.5 5.5 5.5 5.5 5.5 45.5 105.5

104.00 = + + + + + +
(1 + r) 1 (1 + r) 2 (1 + r) 3 (1 + r) 4 (1 + r) 4 (1 + r) 5 (1 + r)6
r = 0.0472
YT M on 4-year bond:
6.5 6.5 6.5 106.5

107.00 = + + +
(1 + r) 1 (1 + r) 2 (1 + r) 3 (1 + r)4
r = 0.0455
(0.0472 + 0.0455)
Estimated Market Discount Rate = = 0.04635
2
Given YT M of 4.635%, the estimated price of illiquid bond is as follow:
5.5 5.5 5.5 5.5 105.5

+ + + + = 103.78
1 2
(1.04635) (1.04635) (1.04635) 3 1.04635) (1.04635)5
4
CFA Level 1, Vol ume 5, Readi ng 44 – Introducti on to Fi xed-Income Val uati on, LOS 44e:
Descri be matri x pri ci ng.
52
Q.54 A bond has a duration of 10.62 and a convexity of 91.46. For a 200 bps increase in yield, the
bond’s approximate percentage price change is closest to:
A. -24.90%
B. -19.41%
C. -1.62%
1
T he estimated price change = −(Duration) × (Change in yield) + ( ) × (Convexity) × (Change in yield)
2
= −10.62 × 0.02 + 0.5 × 91.46 × 0.022 = −19.41%
CFA Level 1, Vol ume 5, Readi ng 46 – Understandi ng Fi xed-Income Ri sk and Return, LOS
46h: Cal cul ate and i nterpret approxi mate convexi ty and compare approxi mate and
effecti ve convexi ty.
53
Q.55 A bond was issued on January 6th, 2015, at 97 (percentage of par), and the par value of the bond
is $1500. If the bond is callable in whole on September 7th, 2023, at $103.40, then the bond can most
likely be classified as a (n):
A. Bermudan style, callable bond.
B. American style, callable bond.
C. European style, callable bond.
T he bond will be classified as a European call as it provides an option to the issuer to call the bond
once at the specified date.
A i s i ncorrect. Bermudan style, a callable bond is when the issuer has the right to call bonds on
specified dates following the call protection period. T he dates frequently correspond to coupon
payment dates.
B i s i ncorrect. American style, callable bond, also referred to as continuously callable, is when the
issuer has the right to call a bond at any time starting on the first call date.
CFA Level 1, Vol ume 4, Readi ng 42 – Fi xed-Income Securi ti es: Defi ni ng El ements, LOS
42a: Descri be basi c features of fi xed i ncome securi ty.
54
Q.56 Which of the following statements is/are most accurate?
I. T he expected loss is equal to the default risk multiplied by the loss severity.
II. T he difference in yield between a credit-risk and credit-risk-free bond of similar maturity is
called the spread risk.
III. Bond prices are inversely related to spreads.
A. II
B. I and III.
C. I, II and III.
Both Statements I and III are accurate.
A and C are i ncorrect. T he difference in yield between a credit-risk and credit-risk-free bond of
similar maturity is called the yield spread.
CFA Level 1, Vol ume 5, Readi ng 47 – Fundamental s of Credi t Anal ysi s, LOS 47i :
Descri be macroeconomi c, mark et, and i ssuer-speci fi c factors that i nfl uence the l evel
and vol ati l i ty of yi el d spreads.
55
Q.57 With a discount rate of 3% per period, a 5-period zero-coupon bond with a par value of $1,000
has a value of:
A. $853.51
B. $860.00
C. $862.61
With a discount rate of 3% per period, a 5-period zero-coupon bond with a par value of $1,000 has a
1,000
value of = 862.61
1. 035
CFA Level 1, Vol ume 4, Readi ng 44 – Introducti on to Fi xed-Income Val uati on, LOS 44a:
Cal cul ate a bond's pri ce gi ven a mark et di scount rate.
Q.58 Which of the following statements most accurately illustrates a consequence of arbitrage?
A. Short selling becomes restrictive.
B. T he same good can sell for different prices in different markets in the future.
C. T he combined actions of traders would force the convergence of trading prices.
For arbitrage to be possible, traders should be able to sell and buy assets without any restrictions./
A and B are i ncorrect. T he principles of arbitrage are based on the law of one price. It implies
that the same good cannot sell for different prices in different markets once the forces of arbitrage
hold. It is because the combined actions of traders will push down the higher price and up the lower
prices, resulting in the convergence of trading prices.
CFA Level 1, Vol ume 5, Readi ng 48 – Deri vati ve i nstrument and deri vati ve mark et
features, LOS 48c: Expl ai n arbi trage and i ts rol e i n determi ni ng pri ces and promoti ng
mark et effi ci ency
56
Q.59 Consider a put option with a premium of $5 and a strike price of $20. T he maximum possible
loss for the writer of the put is closest to:
A. $5
B. $15
C. $20
T he maximum potential loss to the put writer is the strike price minus the premium ($20 - $5 =
$15).
A i s i ncorrect. It corresponds to the put option's premium amount.
C i s i ncorrect. It indicates the put option's strike price.
CFA Level 1, Vol ume 5, Readi ng 49 – Forward Commi tment and Conti ngent Cl ai m
Features and Instruments, LOS 49b: Determi ne the val ue at expi rati on and profi t from
a l ong or a short posi ti on i n a cal l or put opti on.
Q.60 Which of the following is least likely an exchange-traded derivative instrument?
A. Futures.
B. Options.
C. Forwards.
Options and futures are exchange-traded instruments, while forwards and swaps are traded on over-
the-counter (OT C) markets.
CFA Level 1, Vol ume 5, Readi ng 48 – Deri vati ve Instrument and Deri vati ve Mark et
Features, LOS 48b: Descri be the basi c features of deri vati ve mark ets, and contrast
over-the-counter and exchange-traded deri vati ve mark ets
57
Q.61 Downside risk is the financial risk associated with losses. Which of the following single-option
transactions most likely has the highest downside risk?
A. Buying an in-the-money put.
B. Writing an at-the-money call.
C. Buying an out-of-the-money call.
Buying a call or a put limits the r
Buying a call or a put limits the risk to the option premium paid. However, when writing a call option,
the potential risk is unlimited. T he potential profits are equal to the premium paid by the option
buyer.
T he writer of an option will realize profits if the underlying security price goes down and unlimited
losses if the security price goes.
A i s i ncorrect. Buying a put means one buys the right to sell a stock at a specific price. T he upside
potential is the difference between the share prices, while the downside is the premium you spent.
You want the price to go down a lot so you can sell it at a higher price.
C i s i ncorrect. Buying a call means buying the right to purchase the stock at a specific price. T he
upside potential is unlimited, and the downside potential is the premium that you spent. You want the
price to go up a lot so that you can buy it at a lower price.
CFA Level 1, Vol ume 5, Readi ng 49 – Forward Commi tment and Conti ngent Cl ai m
Features and Instruments, LOS 49a: Defi ne forward contracts, futures contracts,
swaps, opti ons (cal l s and puts), and credi t deri vati ves and compare thei r basi c
characteri sti cs
58
Q.62 Which of the following derivative contracts most likely expose the contract owner to default
risk?
A. Swaps.
B. Futures.
C. Options.
Forwards and swaps are made against the counterparty and expose the holders of the contracts to
default risk if the counterparty refuses to perform the commitment.
B and C are i ncorrect. In a futures and options contract, the exchange clearing-house itself acts
as the counterparty to both parties, thus eliminating most potential default risk.
CFA Level 1, Vol ume 5, Readi ng 49 – Deri vati ve Mark ets and Instruments, LOS 49a:
Defi ne forward contracts, futures contracts, swaps, opti ons (cal l s and puts), and credi t
deri vati ves and compare thei r basi c characteri sti cs
Q.63 Which of the following statements about valuation techniques is LEAST likely correct?
A. T he replacement cost approach to valuation is based on what it would cost to rebuild the
property at today's prices.
B. T he sales calculation comparison approach to valuation is based on the sales price of

properties similar to the subject property.
C. T he income approach to valuation calculates the property's value as the present value of
its future annual after-tax cash flows, ignoring financing costs.
T he income approach uses net operating income before financing and taxes.
CFA Level 1, Vol ume 5, Readi ng 60 – Pri vate Capi tal , Real Estate, Infrastructure,
Natural Resources, and Hedge Funds, LOS 60c: Expl ai n i nvestment characteri sti cs of
real estate
59
Q.64 A retail options trader bought a single call option on Avilerae Tech's stocks at the strike price
of $25 for the option premium of $3.20. If the current trading price of Avilerae Tech is $21.80, the
option is most likely :
A. In the money.
B. At the money.
C. Out of the money.
Out of the money: Option's strike price > Market price of the underlying security
Since the option strike price ($25) > the market price of the underlying ($21.80), the option is out of
the money.
Important note: T he option premium is not considered in determining the moneyness of the option.
A i s i ncorrect. In the money: Call option's strike price < Market price of the underlying security.
B i s i ncorrect. At the money: Option's strike price = Market price of the underlying security.
CFA Level 1, Vol ume 5, Readi ng 55 – Pri ci ng and Val uati on of Opti ons, LOS 55a: Expl ai n
the exerci se val ue, ti me val ue, and moneyness of an opti on.
60
Q.65 Which of the following is least likely an income-based approach to appraisal for an income-
producing property?
A. Comparable sales approach.
B. Direct capitalization approach.
C. Discounted cash flow approach.
T he sales comparison approach refers to a real estate appraisal method that compares one property
to comparables or other recently sold properties in the area with similar characteristics. T his
method accounts for the effect that individual features have on the overall property value.
B and C are i ncorrect. Direct capitalization and discounted cash flow approaches are two income-
based approaches to appraisal for an income-producing property.
CFA Level 1, Vol ume 5, Study Sessi on 16, Readi ng 60 – Pri vate Capi tal , Real Estate,
Infrastructure, Natural Resources, and Hedge Funds, LOS 60c Expl ai n i nvestment
characteri sti cs of real estate.
61
Q.66 Which of the following sources of venture capital (VC) financing can be used to support a major
marketing campaign of a company that has recently initiated commercial production and sales?
A. Seed-stage financing.
B. Later stage financing.
C. Formative stage financing.
Later stage financing is usually provided to companies who have already initiated commercial
production and need financing to support a major market campaign.
A i s i ncorrect. T he seed-stage financing supports market research and product development and is
generally the first stage at which venture capital funds invest.
C i s i ncorrect. Formative stage financing includes seed-stage and early-stage funding.
Natural Resources, and Hedge Funds, LOS 60a: Expl ai n i nvestment characteri sti cs of
pri vate equi ty.
62
Q.67 Which of the following factors most likely differentiate American call prices from European
call prices?
A. Volatility.
B. Right to exercise early.
C. Cash flows of the underlying.
American call prices can differ from European call prices only if there are cash flows on the
underlying, such as dividends or interest; these cash flows are the only reason for early exercise of a
call.
A i s i ncorrect. T he volatility of the underlying significantly affects the European call.
B i s i ncorrect. American put prices can differ from European put prices because the right to
exercise early always has value for a put because of a lower limit on the underlying value.
CFA Level 1, Vol ume 5, Readi ng 55 – Basi cs of Deri vati ve Pri ci ng and Val uati on, LOS
55c: Expl ai n under whi ch ci rcumstances the val ues of European and Ameri can opti ons
di ffer.
63
Q.68 Which of the following is least likely a characteristic of hedge funds? Hedge funds:
A. are almost always close-ended.
B. impose restrictions on redemptions.
C. are generally set up as private investment partnerships open to a limited number of

investors willing and able to make a large initial investment.
Hedge funds are almost always open-ended.
B and C are i ncorrect. T hey are characteristics of hedge funds.
CFA Level 1, Vol ume 5, Readi ng 60 -Pri vate Capi tal , Real Estate, Infrastructure,
Natural Resources, and Hedge Funds, LOS 60f: Expl ai n i nvestment characteri sti cs of
hedge funds.
64
Q.69 In which of the following private equity strategies is the current management team being
replaced and the acquiring team is involved in managing the company?
A. Venture capital.
B. Management buy-ins.
C. Management buyouts.
In the case of management buy-ins, the current management team is being replaced, and the
acquiring team is involved in managing the company.
A i s i ncorrect. Venture capitalists typically look for companies with a strong management team, a
large potential market, and a unique product or service with a strong competitive advantage.
C i s i ncorrect. Management buyouts, the current management team, is involved in the acquisition.
Natural Resources, and Hedge Funds, LOS 60a: Expl ai n i nvestment characteri sti cs of
pri vate equi ty.
65
Q.70 Which of the following statements is most likely correct regarding derivatives?
A. May have an indefinite lifespan.
B. T ransform the nature of a party's risk exposure.
C. Take their value and characteristics from the underlying.
Derivatives take their performance from an underlying asset; this suggests that they take their value
and other characteristics from the underlying asset.
A i s i ncorrect. Derivatives have a definite lifespan which is agreed upon at the time of contract
initiation.
B i s i ncorrect. Similar to insurance, derivatives transfer risk from one party to another such that
the risk itself does not change, but the party bearing it does.
CFA Level 1, Vol ume 5, Readi ng 51 - Arbi trage, Repl i cati on, and the Cost of Carry i n
Pri ci ng Deri vati ves, LOS 51a: Expl ai n how the concepts of arbi trage and repl i cati on
are used i n pri ci ng deri vati ves.
66
Q.71 T he table below illustrates details concerning otherwise identical call and put options on a U.S.
small-cap stock.
Call Put
Time to expiration (days) 120 120
Exercise price $ 85 $ 85
Option price $ 14 $9
Volatility (Annual standard deviation, %) 14 12
Type of option American American
Risk-free rate 5.50 % 5.50 %
Holding everything else constant, which of the following changes will most likely increase the value
of the option in question?
A. Decreasing the volatility of the call option.
B. Decreasing the exercise price of the put option.
C. Increasing the time to expiration of the put option.
Increasing a put option's time to expiration will benefit the holder of an American put option, as the
option can always be exercised; thus, there is no opportunity cost associated with waiting for option
exercise. T herefore, a longer-term put will be at least as expensive relative to its shorter-term
counterpart.
A i s i ncorrect. Higher (lower) volatility will increase (decrease) the value of call options.
B i s i ncorrect. T he value of an American put with a higher exercise price must be at least as great
as the value of an American put with a lower exercise price. T herefore, increasing the exercise
price will increase the value of the put option.
CFA Level 1, Vol ume 5, Readi ng 55 – Pri ci ng and Val uati on of Opti ons, LOS 55j : Expl ai n
the exerci se val ue, ti me val ue, and moneyness of an opti on.
67
Q.72 Luna Babbage is an investor who has invested $150,000 each in the hedge funds ART and EDD
at the beginning of the calendar year. Both funds have a “2 and 10” fee structure, with management
and incentive fees paid at the end of the year. T he incentive fee is calculated based on returns above
a 6% hurdle rate, net of management fees for both funds. At the end of the calendar year, the value of
ART appreciates by 10%, while that of EDD depreciates by 4%.T he incentive fee paid to the
management of ART is closest to:
A. $270
B. $600
C. $3,570
ART End of year capital: $150, 000 × 1.10 = $165, 000
ART Management fees: $165, 000 × 0.02 = $3, 300
Hurdle amount (ART & EDD): $150, 000 × 0.06 = $9, 000
Incentive fee (ART ) = ($165, 000– $150, 000– $3, 300– $9, 000) × 10% = $270
CFA Level 1, Vol ume 5, Readi ng 59 – IPerformance Cal cul ati on and Apprai sal of
Al ternati ve Investments, LOS 59b: cal cul ate and i nterpret returns of al ternati ve
i nvestments both before and after fees .
68
Q.73 When a future price is below the expected spot price for a particular commodity, the market is
most likely in:
A. Contango.
B. Backwardation.
C. Premium Buying.
Normal backwardation is the opposite of contango. Backwardation refers to a situation where the
futures price is below the expected spot price.
A i s i ncorrect. When futures prices are higher than the spot price, the commodity forward curve
is upward sloping, and the prices are referred to as being in contango.
C i s i ncorrect. Premium buying refers to the amount agreed upon between the purchaser and
seller to purchase or sell a futures option.
CFA Level 1, Vol ume 5, Readi ng 60– Pri vate Capi tal , Real Estate, Infrastructure,
Natural Resources, and Hedge Funds, LOS 60e: Expl ai n i nvestment characteri sti cs of
natural resources.
69
Q.74 European put and call options on GHG’s stock both have an exercise price of $50 that expires
in 120 days. T he underlying asset is priced at $52 and makes no cash payments during the options'
life. T he risk-free rate is 4.5%. If the put is selling for $3.80, the call’s price should be closest to:
A. $6.52
B. $6.32
C. $7.12
X
C0 = So + P −
(1 + r)t
50
= 52 + 3.80– ( 120
) = 6.52
1.045 365
CFA Level 1, Vol ume 5, Readi ng 56 – Opti on Repl i cati on Usi ng Put-Cal l Pari ty, LOS 56a:
Expl ai n put-cal l pari ty for European opti ons.
70
Q.75 A hedge fund has a beginning year value of $370 million and a 2 plus 20 fee structure with no
hurdle rate or watermark. T he fund calculates the management fees using end-of-period assets under
management and incentive fees net of management fees. If the ending value of the fund is $400
million, then the total fee of the hedge fund for the period is closest to:
A. $12.4 million.
B. $15.0 million.
C. $16.0 million.
Management fee = $400 million × 2% = $8 million
Incentive fee = ($400 million − $8 million − $370 million) × 20% = $22 million × 20% = $4.4 million
Total fees = Management fee + Incentive fee = $8 million + $4.4 million = $12.4 million
CFA Level 1, Vol ume 5, Readi ng 59 – Performance Cal cul ati on and Apprai sal of
Al ternati ve Investments, LOS 59b: Cal cul ate and i nterpret returns of al ternati ve
i nvestments both before and after fees
71
Q.76 GammaShort Hedge Fund had $50 million in capital at the beginning of 2016. Management fees
(based on assets under management using end-of-period) and incentive fees are 2% and 20%,
respectively. In 2016, GammaShort had a 14% return. T he hurdle rate is 7%, and, the incentive fee is
based on returns above the hurdle rate. Assuming that the performance fee is the calculated net of
the management fee, then the investors' net return for the year 2016 is closest to:
A. 11.45%
B. 12.22%
C. 10.78%
Management fee = 50, 000, 000 × 1.14 × 2% = 1, 140, 000
Incentive fee = (50, 000, 000 × 0.14 − 50, 000, 000 × 0.07 − 1, 140, 000) × 20% = 472, 000
Total fees = 1, 140, 000 + 472, 000 = 1, 612, 000
(50, 000, 000 × 1.14 − 1, 612, 000)

Investor return = −1
50, 000, 000
= 0.10776 ≈ 10.78%
CFA Level 1, Vol ume 5, Readi ng 59 –Performance Cal cul ati on and Apprai sal of
Al ternati ve Investments, LOS 59b: Cal cul ate and i nterpret returns of al ternati ve
i nvestments both before and after fees
72
Q.77 If the futures market for a commodity is in backwardation, the roll yield will most likely be:
A. Zero.
B. Positive.
C. Negative.
Backwardation occurs when futures prices are lower than the spot price resulting in a commodity
forward curve that is downward sloping.
Roll yield is the return corresponding to the difference between the spot price a futures contract
converges and the futures contract's dictated price. It is positive when the market is backward, i.e.,
when forward prices are lower than spot prices.
A i s i ncorrect. T he roll yield can either be positive (backwardation) or negative (contango).
C i s i ncorrect. Negative roll yield occurs when a market is in contango, which is the opposite of
backwardation. When a market is in contango, the asset's future price is above the expected future
spot price, so the investor will lose money when rolling contracts.
Natural Resources, and Hedge Funds, LOS 60e: Expl ai n i nvestment characteri sti cs of
natural resources.
73
Q.78 A company is considering a real estate investment that provides gross revenue of $250,000 and
operating expenses of $15,000. T he property costs $1,000,000, and the depreciation expense cost
on the property is 2.6% of the cost in the first year and 1.3% of the cost over the next several
years. If the marginal tax rate is 35%, and the property is purchased without using credit, the after-
tax cash flow in year 1 is closest to:
A. $69,650
B. $129,350
C. $161,850
After-tax cash flow = (Revenue − Expenses − Depreciation)(1 − t) + Depreciation
= [250, 000 − 15, 000 − (1, 000, 000 × 0.026)] × (1 − 0.35) + (1, 000, 000 × 0.026) = 161, 850
Natural Resources, and Hedge Funds, LOS 60c: Expl ai n i nvestment characteri sti cs of
real estate.
74
Q.79 One difference between a defined contribution (DC) and a defined benefit (DB) plan is that in
the case of the latter:
A. Future benefits are undefined.
B. Investment risk exposure is low.
C. Employees are required to contribute a portion of their wages each period.
Concerning D.B. plans, investment risk exposure is minimal. T he responsibility of ensuring that
assets invested are sufficient to generate the promised payments upon employee retirement falls on
the employer. However, in the case of D.C. plans, the responsibility of ensuring that enough funds
are available to meet employee retirement needs lies on the employees themselves.
A i s i ncorrect. Future benefits are predefined in the case of D.B. plans.
C i s i ncorrect. Employees will need to contribute a portion of their wages each period in the case
of D.C. plans.
CFA Level 1, Vol ume 5, Readi ng 61 – Portfol i o Management: An Overvi ew, LOS 61d:
Descri be defi ned contri buti on and defi ned benefi t pensi on pl ans.
75
Q.80 What are the most likely implications for investors using the Markowitz efficient frontier for
making investment decisions?
A. T he slope of the efficient frontier is concave.
B. Investors are rewarded with increasing increases in returns for assuming more risk.
C. Portfolios to the right of the global minimum variance portfolio are the most efficient.
T he Markowitz efficient frontier contains all the risky assets that rational, risk-averse investors will
choose. T he slope of the minimum variance frontier is concave, which implies that investors
seeking portfolios above the global minimum variance portfolio obtain decreasing returns as they
assume more risk.
B i s i ncorrect. Investors are rewarded with decreasing returns for assuming more risk.
C i s i ncorrect. Portfolios to the left of the global minimum variance portfolio (located along the
efficient frontier) are the most efficient. In other words, portfolios falling to the right of the
minimum-variance frontier give a lower return for the same level of risk, which is undesirable.
CFA Level 1, Vol ume 5, Readi ng 62 – Portfol i o Ri sk and Return: Part I, LOS 62i :
Descri be and i nterpret the mi ni mum-vari ance and effi ci ent fronti ers of ri sk y assets
and the gl obal mi ni mum-vari ance portfol i o.
76
Q.81 A portfolio consists of 30 assets, with the average correlation being 0.75 among all pairs of
assets. T he average variance of each asset is 0.0675. Assuming equal weights the risk of the
portfolio will be closest to:
A. 4.84%
B. 15.63%
C. 22.15%
Assuming equal weights, the portfolio variance can be written as:
σ̄2 (N − 1) ¯
σP2 = + Cov
N N
Where
N = number of assets.
σ̄2 = Average variance of the portfolio

¯ = average covariance between the assets.
Cov
σP2 = portfolio variance.
T hus,
0.0675 (30 − 1)
Portfolio risk = √ + × 0.75 × 0.0675
30 30
= 22.15%
CFA Level 1, Vol ume 5, Readi ng 62 – Portfol i o Ri sk and Return: Part I, LOS 62f:
Cal cul ate and i nterpret the mean, vari ance, and covari ance (or correl ati on) of asset
returns based on hi stori cal data.
77
Q.82 An investor currently owns a portfolio with an expected annual return and standard deviation of
12% and 18%, respectively. T he investor is considering adding stock to his current portfolio. T he
stock’s standard deviation is 22%, and its correlation with the current portfolio is 0.35.Considering a
5% risk-free rate, the risk-adjusted return of the stock from adding to the investor’s current
portfolio is closest to:
A. 7.99%
B. 12.15%
C. 25.67%
Risk-adjusted return is given by:
σnew P new ,p
E (R new ) = R f + × [E (R p) − R f ]
σp
Where:
E(R) = the return from the asset.
R f = the return on the risk-free asset.
σp = the standard deviation of the existing portfolio.
σnew = the standard deviation of the new stock.
ρnew, p = the correlation coefficient between new stock and existing portfolio.
T herefore,
0.22(0.35)
Risk-Adjusted Return = 0.05 + [ ] × [0.12– 0.05]
0.18
= 7.99%
CFA Level 1, Vol ume 6, Readi ng 64 – Basi cs of Portfol i o Pl anni ng and Constructi on, LOS
64f: Expl ai n the speci fi cati on of asset cl asses i n rel ati on to asset Al l ocati on.
78
Q.83 A portfolio manager forms an investment portfolio with two asset classes, 1 and 2, held in the
proportions 60% and 40%, respectively. T he expected annual returns and standard deviations of the
asset classes are summarized in the table below.
Asset Class Expected Annual Return (%) Expected Annual Standard Deviation(%)
1 13.5 15.2
2 20.8 24.0
If the portfolio standard deviation is 14.5%, the correlation between the two asset classes should be
closest to:
A. 0.20
B. 0.73
C. 1.00
0.1452 = (0.152)20.6)2 + (0.24)2 (0.4)2 + 2(0.152)(0.24)(0.6)(0.4)p1,2
p1,2 = 0.199399 or 0.20
CFA Level 1, Vol ume 5, Readi ng 63 – Portfol i o Ri sk and Return: Part II, LOS 63c:
Expl ai n systemati c and nonsystemati c ri sk , i ncl udi ng why an i nvestor shoul d not
expect to recei ve addi ti onal return for beari ng nonsystemati c ri sk .
79
Q.84 An investor has purchased shares of large-cap equity stock. T he covariance of the stock with
the market index is 0.0320, while the standard deviation of the stock and the market index is 22.5%
and 15.7%, respectively. T he return of the large-cap equity stock most likely follows a trend which:
A. Follows the general market.
B. Resembles the general market.
C. Moves opposite to the general market.
0. 0320
T he beta of the equity stock is +1.30[ ]. A positive beta indicates that the return of the equity
(0. 1572 )
stock follows the general market trend.
64e: Descri be the i nvestment constrai nts of l i qui di ty, ti me hori zon, tax concerns, l egal
and regul atory factors, and uni que ci rcumstances and thei r i mpl i cati ons for the choi ce
of portfol i o assets
80
Q.85 Shares of Fition Corp. are trading at $67 today, while analysts expect the shares's price to
reach $72 in 1 year and pay a dividend of $1.5. Given a required rate of return of 14%, Shares of
Fition Corp. are most likely:
A. Underpriced by $2.53.
B. Overpriced by $2.53.
C. Underpriced by $3.84.
$72 $1.5
Price = + = $64.47
1.14 1.14
Since the current value of the stock is $67, the stock is overpriced by $2.53.
A i s i ncorrect. T he shares are overpriced by $2.53.
C i s i ncorrect. T he shares are overpriced by $2.53 and not underpriced by $3.84.
CFA Level 1, Vol ume 5, Readi ng 63 – Portfol i o Ri sk and Return: Part II, LOS 63h:
Cal cul ate and i nterpret the expected Return of an asset usi ng the CAPM.
81
Q.86 Which of the following are most likely components of an Investment Policy Statement (IPS)?
I. Duties and responsibilities of the investment manager

II. Procedures to update the IPS
III. Investment expertise of the investment manager
A. I and II.
B. I and III.
C. I, II and III.
An IPS includes both the investment manager's duties and responsibilities and the procedures to
update the IPS.
B and C are i ncorrect. T he IPS does not stipulate the investment expertise of the investment
manager.
64b: Descri be the maj or components of an IPS.
82
Q.87 T he expected return of a portfolio is 17%, and the return on risk-free assets is 8%. T he beta of
the portfolio is 1.2, and the standard deviation of the portfolio is 5.5%. Assuming that an investor
invests 115% of his savings in this portfolio, his expected return is closest to:
A. 12.50%
B. 18.35%
C. 19.55%
Since the weight of the market portfolio is more than 100%, the investor is borrowing 15% of funds
at the risk-free rate and investing 115% in the market portfolio.
E[r] = (−15%) × (8%) + (115%) × (17%) = 18.35%
CFA Level 1, Vol ume 5, Readi ng 63 – Portfol i o Ri sk and Return: Part II, LOS 63a:
descri be the i mpl i cati ons of combi ni ng a ri sk -free asset wi th a portfol i o of ri sk y
assets
83
Q.88 Which of the following investors most likely has a portfolio perspective in his investment
strategy?
I. Investor A has been investing in the shares of Max Mart for the last 10 years. He always
earns above-market returns because he regularly evaluates the risk and return of his single
asset portfolio.
II. Investor B holds a Ph.D. in Economics. Due to his sound knowledge of different sectors of
the economy, he keeps shares from different firms from different sectors. He evaluates the
combined risks and returns of these assets in a portfolio.
III. Investor C is a new investor who recently started investing in some large-cap stocks. His
investment strategy involves evaluating the risks and returns of his portfolio shares in
isolation.
A. Investor A.
B. Investor B.
C. Investors B and C.
Investor B has a portfolio perspective as he evaluates each asset's combined risks and returns in his
portfolio.
A i s i ncorrect. Investor A invests in a single stock, so there is no portfolio perspective in his
strategy.
C i s i ncorrect. Investor C evaluates each share of his portfolio in isolation. T herefore, he does not
have a portfolio perspective.
CFA Level 1, Vol ume 5, Readi ng 61, Portfol i o Management: An Overvi ew, LOS 61a:
Descri be the portfol i o approach to i nvesti ng.
84
Q.89 As a technical analyst, you have been given the following information regarding the stock of
New Nirja Ltd:
1. T he 20-day moving average crosses the 90-day moving average from above.
2. T he T RIN ratio is 1.1.
3. T he RSI is 73.42.
T he most likely investment strategy for the given asset is to:
A. Buy the asset.
B. Hold the asset.
C. Short-sell the asset.
T he 20-day moving average crossing the 90-day moving average from above implies a death cross,
suggesting a bearish trend. T he T RIN ratio above 1 suggests more activity in declining stocks than in
advancing stocks, depicting a bearish trend. An RSI above 70 also implies a bearish trend. Since all
indicators suggest a bearish trend, an analyst should sell the asset.
A and B are i ncorrect. T he investment strategy would be to short sell the asset since all
indicators point to a bearish trend.
CFA Level 1, Vol ume 6, Readi ng 67 – Techni cal Anal ysi s, LOS 67g: Expl ai n common
techni cal i ndi cators.
85
Q.90 T wo portfolios have the following characteristics:
Portfolio Return Beta

A 8% 0.7
B 7% 1.1
Given a market return of 10% and a risk-free rate of 4%, calculate Jensen's Alpha for both portfolios
and comment on which portfolio has performed better.
A. -0.2% and -3.6% respectively - Portfolio A has performed better than B.
B. -0.2% and -10.6% respectively - Portfolio B has performed better than A.
C. 8.2% and 10.6% respectively - Portfolio B has performed better than A.
Jensen's Alpha is calculated as follows:
Jensen's Alpha = Rp − [Rf + Bp(Rm − Rf)]
Porfolio A's Jensen's Alpha = 8% − [4% + 0.7(10% − 4%)]
Porfolio B's Jensen's Alpha = 7% − [4% + 1.1(10% − 4%)]
Jensen's Alpha is -0.2% and -3.6% for A and B respectively. A higher Alpha indicates that a portfolio
has performed better.
CFA Level 1, Vol ume 5, Readi ng 63 – Portfol i o Ri sk and Return: Part II, LOS 63h:
Descri be and demonstrate appl i cati ons of the CAPM and the SML.
86

Mock Exam 2023 #4 Second Session Corporate Finance, Equity, Fixed

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Mock Exam 2023 #4 Second Session Corporate Finance, Equity, Fixed

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Level I of the CFA® Exam

Mock Questions with Answers - Mock Exam 2023 #4 - Second

Last Updated: Sep 5, 2023

prohibited. Infringers will be prosecuted in their local jurisdictions. ”

Revenue at operating breakeven = 12, 632 × $2, 000

i nterpret the operati ng break even quanti ty of sal es.

sustainability and ethical impact of an investment in a

investment's sustainability and ethical impact in a company or business.

and the impact of product development on the community.

B i s i ncorrect. Governance deals with issues such as ownership structure,

board independence and composition, and compensation.

governance and stak ehol der management.

Best-in-class investment means investing in frontrunners in companies meeting environmental,

social, and governance (ESG) criteria.

B i s i ncorrect. Positive screening refers to investors selecting companies with positive

environmentally friendly products and socially responsible business practices.

factors may be used i n i nvestment anal ysi s.

To calculate the cost of equity, we need to calculate growth rate:

g = RoE × Retention rate

g = 11.5% × (1 − 0.4) = 6.9%

Now, we can calculate the return on equity:

C i s i ncorrect. It assumes the following calculation in determining the cost of equity:

approach and the bond yi el d pl us ri sk premi um approach.

C. Number of shareholders and dividend payments.

are reinvested to promote the corporation's mission.

T herefore, the before-tax cost of debt is 2 × 1.3682 = 2.7364%.

and the debt-rati ng approach

compani es, and nonpubl i c compani es.

Qty × (Price − Variables costs)

EBIT = 125, 000 × (8 − 5) − 75, 000 = 300, 000

Required return on equity 15%

WACC = W d rd(1 − T ) + W ere + W p rp

WACC = (0.75)(7%)(1 − 0.2) + (0.25)(15%) + 0

In this case, we do not have any preferred shares.

T he IRR can be calculated as follows;

N = 5;PV = −800,000; PMT = 154,000; FV = 0; CPT => I = −1.26%

descri be the advantages and di sadvantages of each method.

Face value − Purchase price 365

gui del i nes.

$ Millions (where applicable) 2016 2015

T he day’s payables outstanding have increased.

Number of days of payables (2016):

Number of days of payables = 342

Number of days of payables (2015):

Number of days of payables = 270

A. Utilize the cash in the company’s bank account.

B. Negotiate a debt contract on behalf of the firm.

C. File for bankruptcy protection and reorganization.

whose use is not likely to affect the company's normal operations.

bankruptcy protection and reorganization.

A. Average collection period: 73 days; Year-end receivables $230,000.

B. Average collection period: 91 days; Year-end receivables $197,800.

C. Average collection period: 91 days; Year-end receivables $230,000.

l i qui di ty posi ti on/em>

C. Capital allocation planning

environmental projects and other projects.

considerations in this step.

A. U.S T reasury bonds.

B. Bank certificate of deposits.

C. Money market mutual funds.

T he operating cycle for this firm is closest to

Operating cycle = No. of days of inventory + No. of days of receivables

Operating cycle = 46.4 days + 43.8 days ≈ 90 days