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2010 Level I Mock Exam: Afternoon Session

The afternoon session of the 2010 Level I Chartered Financial Analyst

Mock Examination has 120
questions. To best simulate the exam day experience, candidates are advised to allocate an average
of 1.5 minutes per question for a total of 180 minutes (3 hours) for this session of the exam.

Questions Topic Minutes
1-18 Ethical and Professional Standards 27
19-32 Quantitative Methods 21
33-44 Economics 18
45-68 Financial Statement Analysis 36
69-78 Corporate Finance 15
79-90 Equity Investments 18
91-96 Derivative Investments 9
97-108 Fixed Income Investments 18
109-114 Alternative Investments 9
115-120 Portfolio Management 9
Total: 180

Questions 1 through 18 relate to Ethical and Professional Standards.
1. The Code encourages professionals to act in a manner that will reflect credit on members and
their profession. This refers to

A. Integrity.
B. Professionalism.
C. Reasonable Care.

2. The CFA Institutes Code of Ethics specifically addresses all of the following EXCEPT:

A. Competence and independent judgment.
B. Integrity and respect.
C. Importance of contractual obligations.

3. According to CFA Institutes Code of Ethics, members must practice and encourage others to
practice in a professional and ethical manner that will:

A. Reflect credit on members and their profession.
B. Add value for clients, prospects, employers and employees.
C. Encourage talented and ethical individuals to enter the investment field and maintain the
excellent reputation of CFA Institute and its members.

4. Regarding competence, investment professionals are expected to:

A. Maintain and improve competence.
B. Maintain minimum standards.
C. Exercise independent judgment.

5. Which of the following elements of the Code encourages use of independent professional

A. Professionalism.
B. Competence.
C. Reasonable Care.

6. Liam McCoy has lunch with a wealthy client whose portfolio he manages. McCoy advises the
client to double his current position in the JKM Corporation due to an anticipated increase in
sales. In accordance with Standard (V) Investment Analysis, Recommendations and Actions,
when McCoy returns to his office he should:

A. Identify other clients for whom JKM may be a suitable investment and notify them
immediately of his recommendation.
B. Document the details of the conversation with the client with regard to his investment
C. Verify the suitability of the investment recommendation before placing the clients order.

7. Michael Malone, CFA, is an investment analyst for a large brokerage firm in New York who
covers the airlines industry. After hours in his personal time, Malone maintains an online blog on
which he expresses his personal opinions about various investment opportunities, including, but
not limited to, the airlines industry. On his blog, he posts a very negative investment opinion
about WestAir stock. Malone knows that WestAir's stock will be downgraded to a sell by his firm
next week. Malone has:

A. Violated Standard IV(A) Loyalty by divulging confidential information that is the intellectual
property of his employer.
B. Violated Standard II(A) Material Nonpublic Information by releasing material that could
negatively impact the price of the security.
C. Violated Standard VI(B) Priority of Transactions by releasing material information to the
public before releasing to the firms clients.

8. The first component of the Code of Ethics does NOT explicitly say that a CFA Institute member
will act with which of the following?

A. Solemnity.
B. Integrity.
C. Competence.

9. According to the CFA Institute Code of Ethics, CFA Institute Members and Candidates must do
all of the following EXCEPT:

A. Exercise independent judgment.
B. Act with integrity and dignity.
C. Not knowingly violate the securities acts and laws.


10. According to the CFA Institute Code of Ethics, CFA Institute members shall:

A. Act with integrity, competence, diligence, respect, and in an ethical manner when dealing with
the public, clients, prospective clients, employers, employees, colleagues in the investment
profession, and other participants in the global capital markets.
B. Maintain knowledge and comply with all applicable laws, rules and regulations.
C. Preserve the confidentiality of information communicated by clients, prospects, or employers
concerning investment matters.

11. Which of the following is NOT part of the CFA Institute Code of Ethics? Members of CFA Institute

A. Recommend investments that maximize returns for a given level of risk.
B. Use reasonable care and exercise independent professional judgment.
C. Strive to maintain and improve their competence and the competence of others in the


12. A covered person who rejects a stipulation agreement:

A. May request an appeal to a summary suspension review panel.
B. Will typically not be subject to further disciplinary procedure unless a new investigation is
C. May request an appeal to a hearing panel.

13.John Smith, an Investment Manager at a large brokerage firm, is presenting his firms
credentials to a prospective client. The client asks John which portfolios Johns firm
includes in their composites and how fee-paying portfolio and discretionary portfolios are
handled by the Firm:

A. Only portfolios that pay management fees will be included in the composite.
B. Non fee-paying portfolios may be included in the composite but special disclosure is
C. Non fee-paying portfolios may be included in the composite but prior permission from
CFA Institute is required.

14.According to the GIPS, when dealing with the statement of firm composites must be defined
according to similar investment objectives and strategies under the heading of Composite
Construction, which statement(s) is/are correct? A firm may combine the following portfolios
into a composite:

A. Two bond portfolios, both that aim for long-term performance.
B. Equity and a bond portfolio, both that aim for long-term performance.
C. Two bond portfolios, one that has a long-term strategy and the other with a short-term

15 According to GIPS, which of the following statements are incorrect when dealing with

A. Verification tests whether the firm has complied with the composite construction
requirements on a firm-wide basis.
B. Verification tests whether the firm has process and procedures in place to calculate and
to present performance results to ensure that they comply with the GIPS.
C. A verification report is issued in respect, not to the whole firm and just with respect to a
single composite.

16.Which statement is true?

A. Verification can be performed either by an independent third party or by the firm itselt.
B. Firms may claim compliance without the verification.
C. Verification can be performed on specific composites.

17.Which statement is false?

A. Although verification must be performed with respect to an entire firm, different
verification reports can be issued for different composites.
B. Firms that have been verified can add a disclosure to Composite presentations stating
that the firm has been verified.
C. By undergoing verification, a firm may improve its internal policies and procedures
with regard to all aspects of complying with the GIPS standards.

18. Viroqua DeSoto, CFA, is reading a discussion in an online forum about the construction
and purpose of composites in performance reporting. She finds these statements from

Statement 1: The purpose of composites is to let investors know how well a firm has
performed managing different types of securities or investment strategies.

Statement 2: A managed portfolio should have a performance history of at least one year
before the firm assigns it to a composite.

With respect to both statements:

A. Both are correct.
B. Both are incorrect.
C. Only one is correct.

Questions 19 through 32 relate to Quantitative Methods.

19. All of the following are bullish signals to a contrarian EXCEPT when the:

A. Chicago Board Options Exchange (CBOE) Put/Call Ratio is at 0.90.
B. Investment Advisor's Ratio is at 75%.
C. Mutual Fund Ratio is at 3%.

20. Given the following hypothesis:

The null hypothesis is H0 : = 5
The alternative is H1 : 5
The mean of a sample of 17 is 7
The population standard deviation is 2.0

What is the calculated z-statistic?

A. 4.00.
B. 8.00.
C. 4.12.

21. In a two-tailed hypothesis test, Jack Olson observes a t-statistic of -1.38 based on a sample
of 20 observations where the population mean is zero. If you choose a 5% significance level,
you should:

A. Fail to reject the null hypothesis that the population mean is not significantly different
from zero.
B. Reject the null hypothesis and conclude that the population mean is significantly
different from zero.
C. Reject the null hypothesis and conclude that the population mean is not significantly
different from zero.

22. A munitions manufacturer claims that the standard deviation of the powder packed in its
shotgun shells is 0.1% of the stated nominal amount of powder. A sport clay association has
reviewed a sample of 51 shotgun shells and found a standard deviation of 0.12%. What is
the Chi-squared value, and what are the critical values at a 95% confidence level,

A. 72; 34.764 and 67.505.
B. 70; 34.764 and 79.490.
C. 72; 32.357 and 71.420.

23. Consider the following information about a fund. The fund has been in existence for 4 years.
Over this period it has achieved a mean monthly return of 3% with a sample standard
deviation of monthly returns of 5%. It was expected to earn a 2.5% mean monthly return
over the 4-year period.
You want to test a claim that the investment disciplines of the fund result in a standard
deviation of monthly returns of less than 6%. The rejection point(s) for this hypothesis test
at the 0.05 level of significance is:

A. Accept null if X
is less than 34.764.
B. Reject alternative if X
is less than 34.764.
C. Reject null if X
is less than 34.764.

24. For a random sample of size n = 100 from a population with s = 8, the error term, E, for a
90% confidence interval is ____(to nearest 0.01).

A. 1.32
B. 0.05
C. 10

25. From the entire population of McDonalds franchises, an analyst constructs a sample of the
monthly sales volume for 50 randomly selected franchises. She calculates the mean sales
volume for those 50 franchises to be Rs. 400,000. The sampling distribution of the mean is
the probability distribution of the:

A. Mean monthly sales volume estimates from all possible samples of 50 observations
B. Mean monthly sales volume estimates from all possible samples.
C. Monthly sales volume for all McDonalds franchises

26. Find the area under normal curve up to z = 0.42. Interpret the following?

A. 66.28%; 66.28% of the observations on a standard normal random variable are smaller
than or equal to the value of 0.42.
B. 45.72%; 45.72% of the observations on a standard normal random variable are greater
than or equal to the value of 0.42.
C. 52.86%; 52.86% of the observations on a standard normal random variable are greater
than or equal to the value of 0.42.

27. Calculate the variance and standard deviation of the number of yearly earnings increases
during the next 12 years.

A. 2.73, 1.65
B. 1.45, 1.20
C. 1.82, 1.34

28. Sudhir, an analyst, is taking the view of the market outlook for next year. He expects that
among all publicly traded companies, 12% will experience a decline in earnings next year.
He has also developed a ratio to help forecast this decline. Over the years, playing with the
ratio, he came to conclusion that if the company is headed for a decline, there is a 85%
chance that this ratio will be negative. On the other hand, if the company is not headed for a
decline, there is only a 15% chance that the ratio will be negative. Now, he randomly selects
a company with a negative ratio. The updated probability that the company will experience
a decline is:

A. 43.5%
B. 38.2%
C. 36.3%

29. Mr.Raj is a portfolio manager. He has a selection screen for choosing the stocks for
investment. He finds that, out of the total stocks that successfully clear his selection screen,
10% are from IT sector. Also, the IT sector stocks with EPS greater than Rs.150 is 2% of the
total number of stocks meeting the requirement of the selection screen. Calculate the
probability of that a stock has EPS greater that Rs.150, given that, it is an IT sector stock that
has cleared Mr.Rajs criteria of selection screen.

A. 0.2
B. 0.4
C. 0.8

30. In a frequency distribution of 250 scores, the mean is reported as 78 and the median as 65.
One would expect this distribution to be:

A. Positively skewed.
B. Negatively skewed.
C. Symmetrical but not rectangular or normal.

31. What are the median and the third quintile of the following data points, respectively?

9.2%, 10.1%, 11.5%, 11.9%, 12.2%, 12.8%, 13.1%, 13.6%, 13.9%, 14.2%, 14.8%, 14.9%,

A. 13.1%; 13.6%.
B. 13.1%; 13.7%.
C. 12.8%; 13.6%.

32. Which of the following is most accurate with respect to the relationship of the money-weighted
return to the time-weighted return? If funds are contributed to a portfolio just prior to a period
of favorable performance,

A. money-weighted rate of return will tend to be elevated
B. time-weighted rate of return will tend to be elevated
C. money-weighted rate of return will tend to be depressed

Questions 33 through 44 relate to Economics

33. Monetarists believe that:

A. Shifts in aggregate demand arise from changes in expectations.
B. Monetary policy has a significant impact on aggregate demand.
C. Discretionary monetary policy should be used to stabilize the economy.

34. Which of the following is least likely a function of a central bank?

A. Issuing Currency.
B. Lending money to government agencies.
C. Keeping inflation within an acceptable range.

35. Which of the following is least accurate regarding the allocative efficiency associated with price
discrimination? Price discrimination:

A. Results in gains to the discriminating firm by selling to consumers with relatively
inelastic demand.
B. Leads to production where the sum of consumer surplus and producer surplus is
greater than it would be otherwise.
C. Leads to a decrease in allocative efficiency.

36. Which of the following statements about individuals savings behavior is most accurate?

A. Expected increases in income encourage individuals to save less.
B. Higher interest rates make individuals less willing to trade present consumption for
future consumption.
C. Individuals tend to draw down their savings when they anticipate a decline in their

37. When a large majority of a bank's depositors lose faith in it and attempt to withdraw their
deposits, the bank:

A. Will not experience difficulties because its required reserves or its excess reserves will
be adequate to meet withdrawals.
B. Will experience difficulties but will not fail.
C. Will fail unless it can obtain additional reserves or government assistance.

38. The steeper a firms marginal revenue product curve for a given resource, the:

A. Less elastic the firm's demand curve for the resource.
B. More elastic the firm's demand curve for the resource.
C. Lower the mobility of the resource.

39. Which statement is false?

A. Tax incidence does not depend on tax law.
B. If the supply is perfectly elastic, the supplier will pay the entire tax.
C. If the demand is perfectly inelastic, the buyer will pay the entire tax.

40. In the dominant firm model of oligopoly, it is least likely that one firm:

A. Is the innovation leader in product development.
B. Effectively sets the price in the market.
C. Has a significant cost advantage over its competitors.

41. Which of the following statements concerning monetary policy is most likely to be accurate?
Monetary policy changes affect the economy:

A. With a significant lag.
B. By stimulating or dampening aggregate supply.
C. As soon as they are announced.

42. A monopoly firm selling textbooks to students in a small town is currently maximizing profits
by charging a price of Rs. 50 per book. It follows that the marginal cost of textbooks:

A. Is equal to Rs. 50.
B. Is less than Rs. 50.
C. Is greater than Rs. 50.

43. Profit-sharing plans, where employees receive bonuses in proportion to the company's profits,

A. Are essentially gifts to employees and do not generate any benefit for the firm's owners.
B. Reduce the principal-agent problem but cannot eliminate shirking problems.
C. Are intended to reduce the number of employees who are residual claimants.

44. If the economy is in short-run disequilibrium below full employment, the most likely
explanation is that:

A. Money wage rates have decreased.
B. Long-run aggregate supply has decreased.
C. Aggregate demand has decreased.

Questions 45 through 68 relate to Financial Statement Analysis

45. Classifying a lease as an operating lease for a lessee, as opposed to a finance lease, will result

Current Ratio Debt/Equity Ratio Asset Turnover Ratio

A. Higher Lower Lower.
B. Lower Lower Higher.
C. Higher Lower Higher.

46. On December 31, 2004, JME Corporation had 350,000 shares of common stock outstanding. On
September 1, 2005, an additional 150,000 shares of common stock were issued. In addition,
JME had $10 million of 8% convertible bonds outstanding at December 31, 2004, which are
convertible into 200,000 shares of common stock. Net income for 2005 was $3 million.
Assuming an income tax rate of 40%, what amount should be reported as the diluted earnings
per share for 2005?

A. $5.80.
B. $5.00.
C. $6.00.

47. Ascot Corporation has 4 million shares of common stock authorized, 2.4 million shares of
common stock issued, and 1.8 million shares of common stock outstanding. How many shares
of treasury stock does Ascot own and is the treasury stock reported as an asset in Ascots
balance sheet?

Treasury shares Reported as an asset

A. 600,000 Yes.
B. 1.6 million No.
C. 600,000 No.

48. Galaxy, Inc.s balance sheet as of December 31, 2004 included the following information (in $):

12-31-03 12-31-04
Accounts Payable 300,000 500,000
Dividends Payable 200,000 300,000
Common Stock 1,000,000 1,000,000
Retained Earnings 700,000 1,000,000

Galaxys net income in 2004 was $800,000. What was Galaxys cash flow from financing
(CFF) in 2004?

A. -$300,000.
B. -$500,000.
C. -$400,000.

49. Which of the following conditions would allow a firm to classify a short-tern liability as a long-
term debt?

A. The firm has issued a long-term note with the stated purpose of extinguishing the short-
term debt when it matures. The note is cancelable if there are violations of certain
operating provisions.
B. The firm has entered into a binding agreement with a bank to refinance the short-term
debt with a long-term liability.
C. The firm has announced that it will continue to refinance the debt wit available credit
for the next 2 year.

50. In the year 2000, its second year of operation, Superior Feeds, Inc. reported income before
income tax for book purposes of $100,000. Tax depreciation was $10,000 and book
depreciation was $9,000. At the end of 1999, Superior Feeds reported a deferred tax liability of
$1,050. The statutory rate is 35% for 1999 and it is expected to remain the same in future
years. Income taxes payable reported on the December 31, 2000 balance sheet are:

A. $34,650.
B. $35,000.
C. $35,350.

51. Marcel Inc. is a large manufacturing company based in the U.S. but also operating in several
European countries. Marcel has long-lived assets currently in use that are valued on the
balance sheet at $600 million. This includes previously recognized impairment losses of $80
million. The original cost of the assets was $750 million. The fair value of the assets was
determined in a professional appraisal to be $690 million. Assuming that Marcel reports under
U.S. GAAP, the new appraisal of the assets value most likely results in:

A. No change to Marcels financial statements.
B. A $90 million gain in other comprehensive income.
C. An $80 million gain on income statement and $10 million gain in other comprehensive

52. Beginning inventory 10 units@$10 per unit.
First purchase 35 units @$11 per unit.
Second purchase 40 units @$12 per unit.
Third purchase 15 units @$13 per unit.

If 83 units are sold, what is the value of the ending inventory under a periodic inventory
system and a FIFO cost flow assumption?

A. $219.
B. $905.
C. $177.

53. Glenmark Blades and Propellers have set up special purpose entities to handle its
manufacturing. The company does not consolidate those entities. Glenmark is most likely

A. Neither the spirit of the law nor the letter of the law.
B. The spirit of the law but not the letter of the law.
C. The letter of the law but not the spirit of the law.

54. Which of the following statements about cash flow are correct or incorrect?

Statement#1: The cash effects of decreasing accounts payable turnover are unlimited.
Statement#2: The tax benefits from employee stock options can result in a significant
source of investing cash flow.

Statement#1 Statement#2

A. Correct Incorrect.
B. Incorrect Incorrect.
C. Incorrect Correct.

55. At the end of 2008, Potash Corporation reported last-in, first-out (LIFO) inventory of $20
million, cost of goods sold (COGS) of $64 million, and inventory purchases of $58 million. If the
LIFO reserve was $6 million at the end of 2007 and $16 million at the end of 2008, compute
first-in, first-out (FIFO) inventory at the end of 2008 and FIFO COGS for the year ended 2008.

FIFO Inventory LIFO Inventory

A. $26 million $54 million.
B. $36 million $74 million.
C. $36 million $54 million.

56. Par-Mac Corporation is a joint venture equally controlled by Parker Company and Macintosh
Company. Which method should Macintosh use to account for its ownership interest in Par-
Mac according to U.S. Generally Accepted Accounting Principles (U.S. GAAP), and which
method recommended for Parker under International Financial Reporting Standards (IFRS)?


A. Consolidation Method Proportionate consolidation Method.
B. Equity Method Consolidation Method.
C. Equity Method Proportionate consolidation Method.

57. Protocol, Inc.s net income for 2005 was $4,800,000. Protocol had 800,000 shares of common
stock outstanding for the entire year. The tax rate was 40 percent. The average share price in
2005 was $37.00. Protocol had 5,000 8 percent $1,000 par value convertible bonds that were
issued in 2004. Each bond is convertible into 25 shares of common stock. Protocol, Inc.s basic
and diluted earnings per share for 2005 were closest to:

Basic EPS Diluted EPS

A. $5.45 $5.19.
B. $6.00 $4.92.
C. $6.00 $5.45.

58. Firebird Company reported the following financial information at the end of 2007:

in millions
Merchandise inventory $240
Minority interest 70
Cash and equivalents 275
Accounts receivable 1,150
Accounts payable 225
Property & equipment 2,160
Accrued expenses 830
Current portion of long-term debt 120
Long-term debt 1,570
Retained earnings 4,230

Calculate Firebirds current assets and working capital.

Current assets Working capital

A. $1,665 million $490 million.
B. $1,665 million $420 million.
C. $1,735 million $490 million.

59. Which of the following best describes a ratio that measures a firms ability to acquire long-term
assets with cash flows from operations, and a performance ratio, respectively?

Acquire assets with CFO Performance ratio

A. Investing and financing ratio Cash-to-income ratio.
B. Reinvestment ratio Debt payment ratio.
C. Reinvestment ratio Cash-to-income ratio.

60. Given the following data what is the ending inventory value using the LIFO method?
Purchases Sales
50 units at $50/unit 25 units at $55/unit
60 units at $45/unit 30 units at $50/unit

A. $3,850.
B. $3,250.
C. $3,200.

61. Under IFRS, if the revaluation initially increases the assets carrying value by $2,000 and in a
subsequent period the assets carrying value is decreased by $5,000.

A. The $2,000 increase goes to the equity first. In the subsequent period the $2,000
decrease goes to the equity and the remaining $3,000 is recognized as a loss.
B. The $2,000 is recognized as a profit and the $3,000 is recognized as a loss.
C. Both $2,000 and $5,000 go the equity directly.

62. On December 31, 2002, Rosen Corp. sold a machine to Carter and simultaneously leased it back
for one year. Pertinent information at this date follows:

Sales price: $360,000.
Carrying amount: $330,000.
Present value of reasonable lease rentals ($3,000 for 12 months @12%): $34,000.
Estimated remaining useful life: 12 years.

In Rosens December 31, 2002 balance sheet, the deferred profit form the sale of this
machine should be:

A. $34,000.
B. $30,000.
C. $4,000.

63. Under what condition would a firm report marketable security as a long-term asset?

A. When funds are set aside for a specific long-term purpose such as plant expansion.
B. When the value of a firms investment in marketable securities is less than cost.
C. When a firm maintains excess trading securities.
70 units at $40/unit 45 units at $45/unit
64. Deductible temporary differences result in a deferred tax_____ when the carrying amount of a
liability is _____ than its tax base.

A. Asset, more.
B. Asset, less.
C. Liability, more.

65. On 7/1/2000, Grove Company signed a 15-year building lease that is reported in their financial
statements as a capital lease. If Grove paid all monthly lease payments when due, how should
they report the effects of this lease in the financing activities section of their 2000 statement of
cash flows?

A. An outflow equal to the 2000 principal payments only.
B. An outflow equal to the 2000 principal and interest payments on the lease.
C. The lease payments should not be reported in the financing activities section.

66. Sports Trader began operations on January 1, 1995. It has been using FIFO since then for
inventory accounting. The following stock record card for footballs was taken from the records
at the end of 2001

01/01/01 Beginning inventory 10 units, at $20 each, and total $200.
05/09/01 30 footballs purchased, at $22 each, and total $660.
08/08/01 15 footballs purchased, at $25 each, and total $375.
12/31/01 ending inventory: 25 footballs.

What is the value of the inventory at the end of year?

A. $530.
B. $640.
C. $595.

67. The Statement on Accounting Standards No. 99, Consideration of Fraud in a Financial
Statement Audit, identified nine risk factors related to attitudes and rationalizations that can
lead to fraudulent accounting. The risk factors include:

A. Management obsession with a rising stock price, high management turnover, frequent
use of materiality to justify leaving items off the books.
B. Management obsession with a rising stock price, failing to fix problems promptly,
strained relationships with auditors.
C. Commitments to third parties regarding operational results, high management
turnover, obsession with minimizing taxes.

68. Thrones Party Palace had supplies on hand at the end of their first year of operations of $200.
If Thornes has one open (unpaid) supplies invoice for $150 at year-end and they made cash
payments of $1,200 for supplies throughout the year, what amount should be recorded for
supplies expenses on their Year 1 income statement under the accrual basis?

A. $850.
B. $1,150.
C. $1,250.

Questions 69 through 78 relate to Corporate Finance

69. Agora Systems Inc. has the following capital structure and cost of new capital:

Book Value Market Value Cost of Issuing
Debt $50 million $58 million 5.3%
Preferred stock $25 million $28 million 7.2%
Common stock $200 million $525 million 8.0%
Total capital $275 million $611 million

What is Agoras weighted-average cost of capital if its marginal tax rate is 40%?

A. 6.23%.
B. 8.02%.
C. 7.50%

70. eBay.com has a revolving credit agreement with a bank. eBay.com can borrow up to $2 million
at 10% interest and is required to keep 10% compensating balance on all borrowed funds. If
the firm must also pay .4% compensating balance and borrows $1.2 million for the entire year,
what is the effective cost of borrowing?

A. 10.4%
B. 11.6%
C. 12.2%

71. Rochelle Dixon is delivering a presentation on best practices for corporate governance. Two of
her recommendations are as follows:

Statement 1: To avoid the potential for harming shareholders interests by wasting
company resources, the Board of Directors should get managements approval before it
hires outside consultants.

Statement 2: The more members a Board of Directors has, the more likely it is to represent
shareholders interests fairly.

Are Dixons statements CORRECT?

Statement 1 Statement 2

A. Incorrect Correct.
B. Correct Correct.
C. Incorrect Incorrect.
72. At the meeting Haggerty made the following statements about the companys WACC:

Statement 1: A company creates value by producing a higher return on its assets than the
cost of financing those assets. As such, the WACC is the cost of financing a firms assets and
can be viewed as the firms opportunity cost of financing its assets.

Statement 2: Since a firms WACC reflects the average risk of the projects that make up the
firm, it is not appropriate for evaluating all new projects. It should be adjusted upward for
projects with greater-than-average risk and downward for projects with less-than-average
Are Statement 1 and Statement 2, as made by Haggerty CORRECT?

Statement 1 Statement 2

A. Correct Incorrect
B. Incorrect Correct.
C. Correct Correct.

73. The NPV profile is a graphical representation of the change in net present value relative to a
change in the:

A. Discount rate.
B. Prime rate.
C. Internal rate of return.

74. Shareholders must carefully evaluate a firms proposed or existing takeover defense
mechanism. In so doing, investors should inquire whether the firm has received any formal
acquisition interest during the past:

A. Three years.
B. Two years.
C. One year.

75. A firm has a capital structure of 60% debt and 40% equity and a dividend payout ratio of 50%.
If a surplus results from first-pass pro forma financial statements based on estimated sales
growth and assuming the capital structure and dividend payout ratio are maintained, which of
the following changes in assumptions would eliminate any surplus in a single step?

A. The entire surplus will be used to pay down long-term debt.
B. No change in assumptions is necessary.
C. The entire surplus will be used to repurchase common stock.

76. The least appropriate security for investing short-term excess cash balances would be:

A. Bank certificates of deposit.
B. Preferred stock.
C. Time deposits.

77. A company has the following data associated with it:

A target capital structure of 10% preferred stock, 50% common equity and 40%
Outstanding 20-year annual pay 6% coupon bonds selling for $894.
Common stock selling for $45 per share that is expected to grow at 8% and
expected to pay a $2 dividend one year from today.
Their $100 par preferred stock currently sells for $90 and is earning 5%.
The company's tax rate is 40%.

What is the after tax cost of debt capital and after tax cost of preferred stock capital?

Debt Capital Preferred Stock Capital

A. 4.2% 6.3%
B. 4.2% 5.6%
C. 4.5% 5.6%

78. XYZ Ltd is investing Rs.30 million in new capital equipment. The present value of future after-
tax cash flows generated by the equipment is estimated to be Rs. 50 million. Currently, XYZ has
a stock price of Rs. 28.00 per share with 8 million shares outstanding. Assuming that this
project represents new information and is independent of other expectations about the
company, what should the effect of the project be on the firms stock price?

A. The stock price will increase to Rs. 30.50.
B. The stock price will increase to Rs. 34.25.
C. The stock price will remain unchanged.

Questions 79 through 90 relate to Equity Investments

79. A wind power company has a net income of Rs.425000. The numbers of outstanding shares are
1500000. The profit margin of the company is 12% and the current market price is Rs.60. The
price/sales ratio is equal to:

A. 25.42
B. 26.14
C. 26.82

80. ABC Ltd., has net income of Rs.250000 and 200000 shares outstanding. The profit margin is
9% and the current market price is Rs.45. The price/sales ratio is equal to:

A. 24.65
B. 30.50
C. 32.40

81. Last year, Sunbard had equity accounts as follows:

Common Stock (Rs.1 Par Value) Rs.50000
Retained Earnings Rs.10000
Total Shareholder's Equity Rs.60000
Projected income is Rs.40000 and Rs.0.25 dividend per share is to be paid immediately.
What will be the ending retained earnings account?

A. Rs.37500
B. Rs.50000
C. Rs.100000

82. According to the dividend valuation model the value of a stock is:

A. The future value of an expected stream of future dividends.
B. The present value of an expected stream of future dividends.
C. The sum of all future dividends.

83. A common stock pays an annual dividend per share of Rs.4.25. The risk-free rate is 6%, and the
risk premium for this stock is 3% and the stock has a beta of 1.20. If the annual dividend is
expected to grow by 7%, the value of the stock is closest to:

A. Rs.168.85
B. Rs.172.17
C. Rs.174.90

84. _________ occurs when the results of an observation is based on a sample that may seem to be
representative of the entire market.

A. Survivorship bias
B. Small sample bias
C. Selection bias

85. Which of form of EMH believes that no group of investors has monopolistic access to
information related to the price formation?

A. Weak-Form EMH
B. Semi-strong-Form EMH
C. Strong-Form EMH

86. A portfolio manager has invested in a stock at the time when the price of the stock was at its
peak. Now the price of the stock has gone down and is not picking up to reach to that level
when he purchased it. So, he invested some more money into the stock so that the price
averages out. This behavior of the portfolio manger falls in which of the following category:

A. Overconfidence bias
B. Confirmation bias
C. Escalation bias

87. Suppose a price-weighted index was constructed a month ago using 2 stocks, A and B, then
priced at Rs.8 and Rs.12, respectively. The current stock prices of the two are Rs.10 and Rs.15
respectively and stock B is about to undergo a 3-for-1 split. If the divisor is not changed in
response to the split, the value of the index immediately after the split will equal:

A. Rs.6.5
B. Rs.8.4
C. Rs.12.5

88. Assume there is a price-weighted market index composed of three stocks. The prices of the
four stocks are Rs.100, Rs.120, and Rs.35. If the price of Rs.100 stock increased by 12%, what
would be the change in the index?

A. Increase by 2.63%
B. Increase by 3.74%
C. Increase by 4.70%

89. Ram has invested in 200 shares of a company trading at Rs.120/share on a margin of 45%. The
broker charges an interest rate of 10% and the commission rate if 3% on the transactions (buy
or sell). Ram holds the share for one year during which he receives a dividend of Re.1/share. At
the end of one year, what should be the price Ram should be willing to sell the shares if he
wishes to make a return of 40%?

A. Rs.139.52/share
B. Rs.133.42/share
C. Rs.131.22/share

90. Estimate the price to sales of a firm whose sales figure is Rs.4500 and the book value of the
firm is Rs.12000. The number of outstanding shares is 1500 and the current market price per
share is Rs.25.

A. 0.0056
B. 1.075
C. 8.33

Questions 91 through 96 relate to Derivative Investments.

91. The price of a stock is $44 per share, and the October put with an exercise price of $45 is
selling for $3. The intrinsic value of the option is:

A. $1.00.
B. $2.00.
C. $0.00.

92. Consider the following four options on the same underlying instrument:

Option 1: April call, exercise price = $55.
Option 2: April call, exercise price = $60.
Option 3: July put, exercise price = $75.
Option 4: July put, exercise price = $80.

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

April Calls July Puts

A. Option 2 > Option 1 Option 3 > Option 4
B. Option 1 > Option 2 Option 3 > Option 4
C. Option 1 > Option 2 Option 4 > Option 3

93. In the option market, a covered writer would have which of the following portfolios?

A. Writer of an option.
B. Writer of a put option, and short stock.
C. Writer of a call option, and long stock.

94. Mr. Verma holds a LONG position in 20 copper futures contracts. His initial margin is IM = Rs.
23,287.50, and his maintenance margin is MM = Rs. 17,465.625. Each contract is for 25,000
pounds of copper, and his initial futures price was = Rs. 0.9315 per pound. At what price will
Mr. Verma receive a margin call (ignoring tick size restrictions)?

A. Rs. 45,992.81 per pound.
B. Rs. 0.9198 per pound.
C. Rs. 1.7326 per pound.

95. Assume that you are analyzing a plain vanilla interest rate swap with the following

Counterparty X : Counterparty Y
pay fixed rate 6% : pay floating rate LIBOR + 0.5%
receive floating rate LIBOR + 0.5% : receive fixed rate 6%
Swap tenor: 10 years
Notional principal: $1,000,000
LIBOR0: 4.75%

Swap payments are determined in advance but paid in arrears. Given this information,
which of the following best describes the first net payment for the swap?
A. $7,500 from Counterparty X to Counterparty Y.
B. $7,500 from Counterparty Y to Counterparty X.
C. $12,500 from Counterparty X to Counterparty Y.

96. ABEX Corporation common stock is selling for $50.00 per share. Both an American call option
and a European call option are available on ABEX common, and each have identical strike
prices and expiration dates. Which of the following statements concerning these two options is

A. The greater flexibility allowed in exercising the American option will normally result in
a higher market value relative to an otherwise identical European option.
B. Because the American and European options have identical terms and are written
against the same common stock, they will have identical option premiums.
C. The European option will normally have a higher option premium because of their
relative scarcity compared to American options.

Questions 97 through 108 relate to Fixed Income Investments.

97. Which of the following statement gives the logical explanation for using effective duration
rather that modified duration for a bond with embedded option?

A. Modified duration considers expected changes in cash flows.
B. Effective duration considers expected changes in cash flows.
C. Either could be used if the bond has embedded options.

98. The primary goal of calculating effective duration is to get:

A. Measure of duration that is effectively constant for the life of the bond.
B. More accurate measure of the bond's price sensitivity when embedded options exist.
C. Preliminary estimate of modified duration.

99. Par value bond ABC (Par value = Rs.1000) has a modified duration of 7. Which of the following
statements regarding the bond is TRUE?

A. If the market yield increases by 0.4% the bond's price will increase by Rs.14.
B. If the market yield increases by 0.4% the bond's price will decrease by Rs.34.
C. If the market yield increases by 0.4% the bond's price will decrease by Rs.28.

100. Mr. Ram, an investor finds that for every 2% increase in interest rates, a bonds price
decreases by 3.45% compared to a 3.70% increase in value for every 2% decline in interest
rates. If the bond is currently trading at par value, the bonds duration is closest to:

A. 1.645
B. 1.875
C. 1.228

101. Which of the following statement holds true for positive convexity?

A. The price of a fixed-coupon bond is inversely related to changes in interest rates.
B. As interest rates change, bond prices will increase at an increasing rate and decrease at
a decreasing rate.
C. The graph of a callable bond flattens out as the market value approaches the call price.

102. Which of
the following statement is true for zero volatility spread (Z-

A. It results when the cost of the call option in percent is subtracted from the option
adjusted spread.
B. It is added to each spot rate on the Treasury yield curve that will cause the present
value of the bond's cash flows to equal its market price.
C. It is added to the yield to maturity of a similar maturity Treasury bond to equal the yield
to maturity of the risky bond.

103. A portfolio manager gathers the following information about a 2-year, annual-pay bond:

i. Par value of Rs.5000
ii. Coupon of 6%
iii. 1-year spot interest rate is 3%
iv. 2-year spot interest rate is 5.5%

Using the above spot rates, the current price of the bond is closest to:
A. Rs.4280.55
B. Rs.4924.14
C. Rs.5053.17

104. Calculate the YTM of a coupon bond which pays interest Rs.120 annually has a par
value of Rs.1000, matures in 3 years, and is selling today at Rs.80 discount from par value.

A. 12.94%
B. 13.62%
C. 13.86%

Following data are the assumptions of spot rates. Solve question number 105 & 106 using the
following data:

105. Estimate the 1 year forward rate 1 year from now?

A. 6.2%
B. 7.3%
C. 8.6%

106. Estimate 6 months forward rate1.5 years from now?

A. 7.61%
B. 7.83%
C. 7.94%

107. A 10-year, Rs.1000 face value zero-coupon bond is priced to yield a return of 10%
compounded semi-annually. Mr. Parag wants to know the price of the bond, and the interest
the bond pays over its life, respectively?

A. Bond Price = Rs.376.89; Interest = Rs.623.11
B. Bond Price = Rs.305.12; Interest = Rs.689.41
C. Bond Price = Rs.618.02; Interest = Rs.312.84

108. Which of the following statements is false with respect to arbitrage-free bond prices?

A. The determination of spot rates is usually done using risk-free securities.
B. It is not possible to strip coupons from U.S. Treasuries and resell them.
C. Credit spreads are affected by time to maturity.

Questions 109 through 114 relate to Alternative Investments.

109. The portfolio manager of a large real estate investment trust (REIT) has identified an
office building as a potential investment. Based upon the following data, what is its net
operating income (NOI)?

Gross potential rental income $245,000
Estimated vacancy and collection loss
Insurance and taxes $14,000
Repairs and maintenance $16,000
Utilities $11,500
A. $190,000
B. $186350
C. $172341

110. Jimmy carter is considering a real estate investment. In the first year, the property is
expected to generate revenue of $75,000. The expense in the first year is $35,000 and the
depreciation allowance will be 3.6 percent of the $450,000 initial investment. Assuming all
cash flows occur at the end of the year and carter expects to be in a 35 percent marginal tax
bracket, the after-tax cash flow in year 1 is closest to:
A. $31670.
B. $32441.
C. $24460

111. A portfolio manager is analyzing a $2,000,000 venture capital investment. If the project
succeeds until the end of the sixth year, the net present value (NPV) of the project is
$7567,000. The project has a 29.69 percent probability of surviving to the end of the sixth year.
The expected NPV of the project is:
A. $6,667,000.
B. $840442.3
C. $2,87342.

112. Which of the following market conditions most accurately describes the conditions of a
particular commodity market for the roll yield to be positive?

A. Market is dominated by long hedgers.
B. Contango.
C. Futures prices are lower than spot prices.

113. An investor is considering the purchase of a 10-unit apartment building that is 11 years
old and in excellent condition. The asking price is $800,000. The investor plans to contribute
$150,000 in cash and finance the balance of the purchase with a $650,000 mortgage loan at
11% interest for 30 years with monthly payments. The monthly payments would be closest to:

A. $6190
B. $5,667
C. $1,915

114. Calculate the net asset value of a mutual fund company with securities valued at
$45,000,000, investment expenses payable of $7,030,000, and 25,000,000 shares outstanding
A. $1.51
B. $1.42
C. $307,200.

Questions 115 through 120 relate to Portfolio Management.

115. Standardizing the covariance of returns between two assets by the individual standard
deviations yields:

A. The correlation coefficient.
B. The variance.
C. The covariance.

116. Securities A and B have forecasted returns of 14% and 18% over the next 12 months .
During the same period the market (M) is expected to generate returns of 16%. If the risk free
rate is 6% and A = B = 1.1 use the CAPM to determine whether the securities are correctly
A. Both A and B are overvalued .
B. A is overvalued and B is undervalued.
C. B is overvalued and A is undervalued

117. Which of the following statements about portfolio management is most accurate?
A. Combining the capital market line (CML) (risk-free rate and efficient frontier) with
an investor's indifference curve map separates out the decision to invest from the
decision of what to invest in.
B. The security market line (SML) measures systematic and unsystematic risk versus
expected return; the CML measures total risk.
C. As an investor diversifies away the unsystematic portion of risk, the correlation
between his portfolio return and that of the market approaches negative one.

118. In the context of the capital market line (CML), which of the following statements is
A. Market risk can be reduced through diversification.
B. The two classes of risk are market risk and systematic risk.
C. Firm-specific risk can be reduced through diversification.

119. The risk free asset has a return of 0.05 . A risky portfolio X, has an expected return of
0.12 and a standard deviation of 0.20. For a portfolio that is 60% X and 40% risk free asset:
A. The return is 8.5%.
B. The standard deviation is 12%.
C. The standard deviation is 20%.

120. All portfolios on the capital market line are:
A. Distinct from each other.
B. Perfectly positively correlated.
C. Unrelated except that they all contain the risk-free asset.

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