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CFA Level 1 Sample Questions

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CFA Questions from Austal Group (www.austalgroup.net)

Austal Group

1. If a one-tailed Z-test uses a 5% significance level, the test will reject a

a. False null hypothesis 95% of the time

b. True null hypothesis 5% of the time

c. True null hypothesis 95% of the time

Answer: B -- True null hypothesis 5% of the time

2. The unconditional probability of an event, given conditional probabilities, is determined by

using the:

a. Addition rule of probability.

b. Multiplication rule of probability

c. Total probability rule

Answer: C -- Total Probability Rule null hypothesis 5% of the time

3. A T-bill with a face value of $100,000 and 160 days until maturity is selling for $97,000. What

is the bank discount yield?

a. 6.96%.

b. 6.75%.

c. 5.18%.

Answer: B -- Actual discount is 3%, annualized discount is: 0.03(360 / 160) = 6.75%

4. Which of the following statements regarding the speed at which analysts believe stock prices

reflect new information is most accurate?

a. Followers of the efficient market hypothesis believe prices adjust quickly to new

information.b. Technicians believe that prices adjust quickly to new information.

c. Both technicians and followers of the efficient market hypothesis believe prices

adjust quickly to new information

Answer: A -- Followers of the efficient market hypothesis believe prices adjust quickly to new

information

5. When individuals are unemployed because they do not have perfect information concerning

available jobs, this is:

a. Structural unemployment.

b. Frictional unemployment.

c. Natural unemployment.

Answer: B -- Frictional unemployment exists because workers and employers do not have

perfect information and must expend time and resources on search activities

6. If a monetary policy is focused on combating inflation, which open market actions by the

Federal Reserve will most effectively accomplish this?

a. Sell Treasury securities, causing aggregate demand to increase

b. Purchase Treasury securities, causing aggregate demand to decrease

c. Sell Treasury securities, causing aggregate demand to decrease


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Answer: C -- Sell Treasury securities, causing aggregate demand to decrease

7. When considering the impact of warrants on earnings per share, the method to calculate the

number of shares added to the denominator is derived using which method?

a. Treasury Stock method

b. Cost recovery method.c. Weighted average method.

Answer: A -- The treasury stock method assumes the hypothetical funds received by the

company from the exercise of the options are used to purchase shares of the company's

common stock in the market at the average market price

8. Selected information from ABC, Inc.s financial activities in the year 2009 included the

following:

Net income was $372,000; 100,000 shares of common stock were outstanding on January 1;

The average market price per share was $18 in 2009; Dividends were paid in 2009; 2,000, 6

percent $1,000 par value convertible bonds, which are convertible at a ratio of 25 shares for

each bond, were outstanding the entire year; ABC, Inc.s tax rate is 40%.

ABC, Inc.s diluted earnings per share for 2009 was closest to:

a. $3.72.

b. $2.96.

c. $3.28.

Answer: B -- ABC basic EPS was ($372,000 / 100,000 =) $3.72. If the bonds were converted as of

January1, interest payments would not have been made. Net income is increased by the interestpaid on the bonds net of taxes ($372,000 + (($1000 2,000 0.06) (1 0.40)) =) $444,000.

Diluted EPS was ($444,000 / (100,000 + (2,000 25)) =) $2.96.

9. Capitalizing interest costs related to a companys construction of assets for its own use is

required by

a. IFRS only.

b. U.S. GAAP only.

c. both IFRS and U.S. GAAP.

Answer: C -- Both U.S. GAAP and IFRS require companies to capitalize the interest that accruesduring a the construction of capital assets for their own use

10.Which of the following is least likely to happen after a last in, first out (LIFO) liquidation in an

environment of rising prices?

a. Increase gross income.

b. Increase taxable income.

c. Increase cost of goods sold (COGS).

Answer: C In a LIFO liquidation, a firm allows inventory to decrease so that it is using lower-

cost materials. This will lower the COGS and increase income and profit


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11.An article in a journal suggests that a strategy of buying the seven stocks in the S&P 500 with

the highest PE ratio at the end of the calendar year and holding them until last week of

March of the following year produces significant trading profits. Upon further investigation,

we discover that the study is based on data from 1993 to 1997, and the PE ratio is calculated

using the stock price on December 31 of each year and the annual reported EPS for that

year. Which of the following biases is least likely to influence the reported results?

a. Look-ahead bias

b. Time-period bias

c. Survivorship bias

Answer: C Survivorship bias is not likely to significantly influence the results of this study

because the authors looked at the stocks in the S&P 500 at the beginning of the year and

measured performance over the following three months. Look-ahead bias could be a problem

because PE ratios are calculated and the trading strategy implemented at a time before earnings

are actually reported. Finally, the study is conducted over a relatively short time period during

the long bull market of the 1990s. This suggests the results may be time-specific and the result

of time-period bias

12.The average salary for a sample of 61 CFA charterholders with 10 years experience is

$200,000, and the sample standard deviation is $80,000. Assume the population is normally

distributed. Which of the following is a 99% confidence interval for the population mean

salary of CFA charterholders with 10 years of experience?

a. $172,754 to $227,246

b. $172,514 to $227,486

c. $160,000 to $240,000

Answer: AIf the distribution of the population is normal, but we dont know the population

variance, we can use the Students t-distribution to construct a confidence interval. Because

there are 61 observations, the degrees of freedom are 60. From the students t table, we can

determine that the reliability factor for t/2, or t0.005, is 2.660. Then the 99% confidence

interval is $200,000 2.660($80,000 / 61) or $200,000 2.660 $10,243, or $200,000

$27,246

13.Given a normally distributed population with a mean income of $40,000 and standard

deviation of $7,500, what percentage of the population makes between $30,000 and

$35,000?

a. 15.96%

b. 13.34%

c. 41.67%

Answer: A The z-score for $30,000 = ($30,000 $40,000) / $7,500 or1.3333, which

corresponds with 0.0918. The z-score for $35,000 = ($35,000 $40,000) / $7,500 or0.6667,

which corresponds with 0.2514. The difference is 0.1596 or 15.96%

14.Which of the following portfolios provides the best safety first ratio if the minimum

acceptable return is 6%?


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increase and vice versa. The absolute value, 1.5, indicates that demand will move one-and-a-half

times as much as price.

18. Which of the following relationships most accurately describes the inefficiency resulting form

government imposed production quotas?

a. Marginal cost exceeds marginal benefit leading to underproductionb. Marginal benefit exceeds marginal cost leading to overproduction

c. Marginal benefit exceeds marginal cost leading to underproduction

Answer: C Government imposed quotas restrict production to a level below that which would

occur if marginal benefit equals marginal cost. This restricted output quantity is less than the

equilibrium quantity, so marginal benefit exceeds marginal cost

19. If the admission price for a rock concert is raised from $25 to $30 causing sales to drop from

60,000 to 40,000, the price elasticity of demand for tickets to the concert is:

a. 2.20

b. -2.20

c. -1.67

Answer: BThe percent change in quantity demanded is (40,000 60,000) / ((60,000 40,000) / 2)

= -0.4. The percent change in price is (30 25) / ((30 25) / 2) = 0.1818. The price elasticity of

demand is -0.40 / 0.1818 = -2.2

20.When a tax is imposed on the consumption of a good, which of the following terms refers to

who bears the burden of the tax?

a. The deadweight loss

b. The incidence of a taxc. Consumer surplus

Answer: B The incidence of a tax refers to how the burden of a tax is actually shared between

buyers and sellers. The deadweight loss is the loss of the gains from trade from the lower

equilibrium quantity that results from the tax. Consumer surplus is the gains from trade that

consumers accrue from the existence of the market

21. Murray Company reported the following revenues and expenses for the year ended 2007:

Sales revenue $200,000Wage expense 89,000

Insurance expense 17,000

Interest expense 10,400

Depreciation expense 50,000

Following are the related balance sheet accounts:

2007 2006

Unearned revenue $15,600 $13,200

Wages payable 5,400 6,600

Prepaid insurance 1,200 0


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Interest payable 500 1,600

Accumulated depreciation 95,000 45,000

Calculate cash collections and cash expenses are

a. $202,400 & $58,100b. $197,600 & $119,900

c. $202,400 & $119,900

Answer: CCash collections are $202,400 ($200,000 sales + $2,400 increase in unearned

revenue). Cash expenses are $119,900 ($89,000 wages expense $1,200 decrease in wages

payable $17,000 insurance expense $1,200 increase in prepaid insurance $10,400 interest

expense $1,100 decrease in interest payable).

22.Assume that the exercise price of an option is $12, and the average market price of the stock

is $15. Assuming 1,500 options are outstanding during the entire year, what is the number

of shares to be added to the denominator of the diluted earnings per share (EPS)?

a. 300

b. 1,200

c. 1,500

Answer: A 1,500 * 12 = 18,000; 18,000/15 = 1,200; 1,500 1,200 = 300

23.XYZ Corporation uses the LIFO method of accounting for inventory. For the year 2009, thefollowing is provided:

Cost of goods sold (COGS): $24,000

Beginning inventory: $6,000

Ending inventory: $7,500

The notes accompanying the financial statements indicate that the LIFO reserve at the

beginning of the year was $2,250 and at the end of the year was $6,000

If XYZ had used FIFO, the COGS for 2009 would be:

a. $3,750

b. $20,250c. $29,250

Answer: BFIFO COGS = LIFO COGS change in LIFO reserve. $24,000 ($6,000 2,250) =

$20,250

24.Khan Associates uses an accrual basis for financial reporting purposes and cash basis for tax

purposes. Cash collections from customers are $476,000, and accrued revenue is only

$376,000. Assume expenses at 50% in both cases (i.e., $238,000 on cash basis and $188,000

on accrual basis), and a tax rate of 34%. What is the deferred tax asset or liability? A

deferred tax:a. Asset of $48,960.


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b. Liability of $17,000.

c. Asset of $17,000.

Answer: C Since taxable income ($238,000) exceeds pretax income ($188,000), Khan will have

a deferred tax asset of $17,000 *($238,000 $188,000)(0.34)+

25.Which of the following statements regarding the net present value (NPV) and internal rate of

return (IRR) is least accurate?

a. For independent projects, the internal rate of return IRR and the NPV methods

always yield the same accept/reject decisions

b. For mutually exclusive projects, you must accept the project with the highest NPV

regardless of the sign of the NPV calculation

c. The NPV tells how much the value of the firm will increase if you accept the project

Answer: B For mutually exclusive projects, you must accept the project with the highest NPV

regardless of the sign of the NPV calculation. If the NPV for two mutually exclusive projects isnegative, both should be rejected

26.The expected rate of return is twice the 12% expected rate of return from the market. What

is the beta if the risk-free rate is 6%?

a. 2

b. 3

c. 4

Answer: B24 = 6 (12 6); 18 = 6; = 3

27.Which of the following statements best describes an investment that is not on the efficientfrontier?

a. There is a portfolio that has a lower risk for the same return.

b. There is a portfolio that has a lower return for the same risk.

c. The portfolio has a very high return

Answer: A The efficient frontier outlines the set of portfolios that gives investors the highest

return for a given level of risk or the lowest risk for a given level of return. Therefore, if a

portfolio is not on the efficient frontier, there must be a portfolio that has lower risk for the

same return. Equivalently, there must be a portfolio that produces a higher return for the same

risk

28. An analyst gathered the following data for Stock A and Stock B:

Time Period Stock A Returns Stock B Returns

1 10% 15%

2 6% 9%

3 8% 12%

What is the covariance for this portfolio?

a. 12

b. 3


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c. 6

Answer: C Mean R(A) = (10 + 6 + 8) / 3 = 8, Mean R(B) = (15 + 9 + 12) / 3 = 12; Here, Cov1,2 =

*(10 8)(15 12) (6 8)(9 12) (8 8)(12 12)+ / 2 = 6

29.An analyst is currently considering a portfolio consisting of two stocks. The first stock, Sesk

Co., has an expected return of 12% and a standard deviation of 16%. The second stock, Labs,

Inc., has an expected return of 18% and a standard deviation of 25%. The correlation of

returns between the two securities is 0.25.

If the analyst forms a portfolio with 30% in Sesk and 70% in Labs, what is the portfolio's

expected return?

a. 15.0%

b. 16.2%c. 17.3%

Answer: BER = (0.3 12) + (0.70 18) = 3.6 + 12.6 = 16.2%

30.Assume that the value of a put option with a strike price of $100 and six months remaining tomaturity is $5. For a stock price of $110 and an interest rate of 6%, what value is closestto

the corresponding call option with the same strike price and same expiration as the put

option?

a. $11.99

b. $12.74

c. $17.87

Answer: CCall value = $110 + $5 $100/1.06^0.5 = $17.87

31. The following data applies to a forward rate agreement that settles in 60 days: It is based on 180-day LIBOR The notional principal amount is $15 million It calls for a forward rate of 6.5% In 30 days, 180-day LIBOR will be 6.2% In 60 days, 180-day LIBOR will be 7.0% In 180 days, 180-day LIBOR will be 7.5%

The shorts cash payment at settlement is closestto

a. $36,232b. $37,500c. The short will not have to make a payment

Answer: ASettlement payment from short = notional principal ((forward LIBOR at settlement agreed forward rate) (180/360)) / (1 + (floating 180/360))Payment = $15 million ((7.0% 6.5%) (180/360)) / (1 + (0.07 180/360)) = $36,231.88

32. If a one-tailed Z-test uses a 5% significance level, the test will reject a

a. False null hypothesis 95% of the timeb. True null hypothesis 5% of the time


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c. True null hypothesis 95% of the time

Answer: B -- True null hypothesis 5% of the time

33. The unconditional probability of an event, given conditional probabilities, is determined by using the:

a. Addition rule of probability.

b. Multiplication rule of probabilityc. Total probability rule

Answer: C -- Total Probability Rule null hypothesis 5% of the time

34. A T-bill with a face value of $100,000 and 160 days until maturity is selling for $97,000. What is the

bank discount yield?

a. 6.96%.

b. 6.75%.

c. 5.18%.

Answer: B -- Actual discount is 3%, annualized discount is: 0.03(360 / 160) = 6.75%

35. Which of the following statements regarding the speed at which analysts believe stock prices reflectnew information is most accurate?

a. Followers of the efficient market hypothesis believe prices adjust quickly to new information.

b. Technicians believe that prices adjust quickly to new information.

c. Both technicians and followers of the efficient market hypothesis believe prices adjust quickly to new

information

Answer: A -- Followers of the efficient market hypothesis believe prices adjust quickly to new information

36. When individuals are unemployed because they do not have perfect information concerning available

jobs, this is:

a. Structural unemployment.

b. Frictional unemployment.

c. Natural unemployment.

Answer: B -- Frictional unemployment exists because workers and employers do not have perfect information and

must expend time and resources on search activities

37. If a monetary policy is focused on combating inflation, which open market actions by the Federal

Reserve will most effectively accomplish this?

a. Sell Treasury securities, causing aggregate demand to increase

b. Purchase Treasury securities, causing aggregate demand to decrease

c. Sell Treasury securities, causing aggregate demand to decrease

Answer: C -- Sell Treasury securities, causing aggregate demand to decrease

38. When considering the impact of warrants on earnings per share, the method to calculate the number of

shares added to the denominator is derived using which method?

a. Treasury Stock method

b. Cost recovery method.

c. Weighted average method.

Answer: A -- The treasury stock method assumes the hypothetical funds received by the company from the

exercise of the options are used to purchase shares of the company's common stock in the market at the average

market price

39. Selected information from ABC, Inc.s financial activities in the year 2009 included the following:

Net income was $372,000; 100,000 shares of common stock were outstanding on January 1; The average marketprice per share was $18 in 2009; Dividends were paid in 2009; 2,000, 6 percent $1,000 par value convertible


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bonds, which are convertible at a ratio of 25 shares for each bond, were outstanding the entire year; ABC, Inc.s

tax rate is 40%.

ABC, Inc.s diluted earnings per share for 2009 was closest to:

a. $3.72.

b. $2.96.

c. $3.28.

Answer: B -- ABC basic EPS was ($372,000 / 100,000 =) $3.72. If the bonds were converted as of January1,

interest payments would not have been made. Net income is increased by the interest paid on the bonds net of

taxes ($372,000 + (($1000 2,000 0.06) (1 0.40)) =) $444,000. Diluted EPS was ($444,000 / (100,000 +

(2,000 25)) =) $2.96.

40. Capitalizing interest costs related to a companys construction of assets for its own use is required by

a. IFRS only.

b. U.S. GAAP only.

c. both IFRS and U.S. GAAP.

Answer: C -- Both U.S. GAAP and IFRS require companies to capitalize the interest that accrues during a theconstruction of capital assets for their own use

41. Which of the following is least likely to happen after a last in, first out (LIFO) liquidation in an

environment of rising prices?

a. Increase gross income.

b. Increase taxable income.

c. Increase cost of goods sold (COGS).

Answer: C In a LIFO liquidation, a firm allows inventory to decrease so that it is using lower-cost materials. This

will lower the COGS and increase income and profit

42. An article in a journal suggests that a strategy of buying the seven stocks in the S&P 500 with the

highest PE ratio at the end of the calendar year and holding them until last week of March of the following yearproduces significant trading profits. Upon further investigation, we discover that the study is based on data from

1993 to 1997, and the PE ratio is calculated using the stock price on December 31 of each year and the annual

reported EPS for that year. Which of the following biases is least likely to influence the reported results?

a. Look-ahead bias

b. Time-period bias

c. Survivorship bias

Answer: C Survivorship bias is not likely to significantly influence the results of this study because the authors

looked at the stocks in the S&P 500 at the beginning of the year and measured performance over the following

three months. Look-ahead bias could be a problem because PE ratios are calculated and the trading strategy

implemented at a time before earnings are actually reported. Finally, the study is conducted over a relatively short

time period during the long bull market of the 1990s. This suggests the results may be time-specific and the resultof time-period bias

43. The average salary for a sample of 61 CFA charterholders with 10 years experience is $200,000, and

the sample standard deviation is $80,000. Assume the population is normally distributed. Which of the following is

a 99% confidence interval for the population mean salary of CFA charterholders with 10 years of experience?

a. $172,754 to $227,246

b. $172,514 to $227,486

c. $160,000 to $240,000

Answer: AIf the distribution of the population is normal, but we dont know the population variance, we can use

the Students t-distribution to construct a confidence interval. Because there are 61 observations, the degrees of

freedom are 60. From the students t table, we can determine that the reliability factor for t/2, or t0.005, is 2.660.


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Then the 99% confidence interval is $200,000 2.660($80,000 / 61) or $200,000 2.660 $10,243, or

$200,000 $27,246

44. Given a normally distributed population with a mean income of $40,000 and standard deviation of

$7,500, what percentage of the population makes between $30,000 and $35,000?

a. 15.96%

b. 13.34%c. 41.67%

Answer: A The z-score for $30,000 = ($30,000 $40,000) / $7,500 or1.3333, which corresponds with 0.0918.

The z-score for $35,000 = ($35,000 $40,000) / $7,500 or0.6667, which corresponds with 0.2514. The

difference is 0.1596 or 15.96%

45. Which of the following portfolios provides the best safety first ratio if the minimum acceptable return

is 6%?

rtfolio pected Return (%) andard Deviation (%)

1 13 5

2 9 2

3 11 3

a. 1

b. 2

c. 3

Answer: CRoys safety-first criterion requires the maximization of the SF Ratio: SF Ratio = (expected returnthreshold return) / standard deviation

Portfolio Expected Return (%) Standard Deviation (%) SF Ratio

1 13 5 1.40

2 9 2 1.50

3 11 3 1.67

Portfolio #3 has the highest safety-first ratio at 1.67.

46. There is an 80% chance of rain on each of the next six days. What is the probability that it will rain on

exactly two of those days?

a. 0.01536

b. 0.24327

c. 0.15364

Answer: A 6 nCr 2 (0.8)^2 (0.2)^4 = 0.01536

47. John is a soybean farmer who harvests 125,000 bushels of soybeans annually. Johns fixed costs are$200,000 and his variable costs are $5 per bushel. Soybeans are currently priced at $5.35 per bushel. Based on hisestimates, John sees soybean prices being relatively stable for the next two years, then increasing to $7.00 perbushel due to increased demand from Japan. What action should John take

a. Cut his production by 50% for the next two years and then resume full production.

b. Continue operating his business as usual

c. Shut down for two years and then restart his business.

Answer: B Since John is selling soybeans, a common commodity, he is a price taker and therefore cannot adjustthe price. He should continue operating his business as normal as he is currently covering variable costs and part of

fixed costs. In two years from now, he will be able to cover both fixed and variable costs and be able to make a

substantial profit.


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terest payable 500 1,600

cumulated depreciation 95,000 45,000

Calculate cash collections and cash expenses are

a. $202,400 & $58,100b. $197,600 & $119,900

c. $202,400 & $119,900

Answer: C Cash collections are $202,400 ($200,000 sales + $2,400 increase in unearned revenue). Cash

expenses are $119,900 ($89,000 wages expense $1,200 decrease in wages payable $17,000 insurance

expense $1,200 increase in prepaid insurance $10,400 interest expense $1,100 decrease in interest payable).

53. Assume that the exercise price of an option is $12, and the average market price of the stock is $15.

Assuming 1,500 options are outstanding during the entire year, what is the number of shares to be added to the

denominator of the diluted earnings per share (EPS)?

a. 300

b. 1,200

c. 1,500

Answer: A 1,500 * 12 = 18,000; 18,000/15 = 1,200; 1,500 1,200 = 300

54. XYZ Corporation uses the LIFO method of accounting for inventory. For the year 2009, the following is

provided:

Cost of goods sold (COGS): $24,000

Beginning inventory: $6,000

Ending inventory: $7,500

The notes accompanying the financial statements indicate that the LIFO reserve at the beginning of the year was

$2,250 and at the end of the year was $6,000

If XYZ had used FIFO, the COGS for 2009 would be:

a. $3,750

b. $20,250

c. $29,250

Answer: BFIFO COGS = LIFO COGS change in LIFO reserve. $24,000 ($6,000 2,250) = $20,250

55. Khan Associates uses an accrual basis for financial reporting purposes and cash basis for tax purposes.Cash collections from customers are $476,000, and accrued revenue is only $376,000. Assume expenses at 50% in

both cases (i.e., $238,000 on cash basis and $188,000 on accrual basis), and a tax rate of 34%. What is the

deferred tax asset or liability? A deferred tax:

a. Asset of $48,960.

b. Liability of $17,000.

c. Asset of $17,000.

Answer: C Since taxable income ($238,000) exceeds pretax income ($188,000), Khan will have a deferred tax

asset of $17,000 [($238,000 $188,000)*(0.34)]

56. Which of the following statements regarding the net present value (NPV) and internal rate of return

(IRR) is least accurate?


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a. For independent projects, the internal rate of return IRR and the NPV methods always yield the same

accept/reject decisions

b. For mutually exclusive projects, you must accept the project with the highest NPV regardless of the sign

of the NPV calculation

c. The NPV tells how much the value of the firm will increase if you accept the project

Answer: B For mutually exclusive projects, you must accept the project with the highest NPV regardless of thesign of the NPV calculation. If the NPV for two mutually exclusive projects is negative, both should be rejected

57. The expected rate of return is twice the 12% expected rate of return from the market. What is the beta

if the risk-free rate is 6%?

a. 2

b. 3

c. 4

Answer: B24 = 6 + (12 6); 18 = 6; = 3

58. Which of the following statements best describes an investment that is not on the efficient frontier?

a. There is a portfolio that has a lower risk for the same return.b. There is a portfolio that has a lower return for the same risk.

c. The portfolio has a very high return

Answer: A The efficient frontier outlines the set of portfolios that gives investors the highest return for a given

level of risk or the lowest risk for a given level of return. Therefore, if a portfolio is not on the efficient frontier,

there must be a portfolio that has lower risk for the same return. Equivalently, there must be a portfolio that

produces a higher return for the same risk

59. An analyst gathered the following data for Stock A and Stock B:

Time Period Stock A Returns Stock B Returns

1 10% 15%

2 6% 9%

3 8% 12%

What is the covariance for this portfolio?a. 12

b. 3

c. 6

Answer: CMean R(A) = (10 + 6 + 8) / 3 = 8, Mean R(B) = (15 + 9 + 12) / 3 = 12; Here, Cov1,2 = [(10 8)(15

12) + (6 8)(9 12) + (8 8)(12 12)] / 2 = 6

60. An analyst is currently considering a portfolio consisting of two stocks. The first stock, Sesk Co., has an

expected return of 12% and a standard deviation of 16%. The second stock, Labs, Inc., has an expected return of

18% and a standard deviation of 25%. The correlation of returns between the two securities is 0.25.

If the analyst forms a portfolio with 30% in Sesk and 70% in Labs, what is the portfolio's expected return?

a. 15.0%

b. 16.2%

c. 17.3%

Answer: B ER = (0.3 12) + (0.70 18) = 3.6 + 12.6 = 16.2%


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61. Assume that the value of a put option with a strike price of $100 and six months remaining to maturity

is $5. For a stock price of $110 and an interest rate of 6%, what value is closestto the corresponding call option

with the same strike price and same expiration as the put option?

a. $11.99

b. $12.74

c. $17.87

Answer: C Call value = $110 + $5 $100/1.06^0.5 = $17.87

62. The following data applies to a forward rate agreement that settles in 60 days: It is based on 180-day LIBOR The notional principal amount is $15 million It calls for a forward rate of 6.5% In 30 days, 180-day LIBOR will be 6.2% In 60 days, 180-day LIBOR will be 7.0% In 180 days, 180-day LIBOR will be 7.5%The shorts cash payment at settlement is closestto

a. $36,232b. $37,500

c. The short will not have to make a payment

Answer: A Settlement payment from short = notional principal ((forward LIBOR at settlement agreedforward rate) (180/360)) / (1 + (floating 180/360))Payment = $15 million ((7.0% 6.5%) (180/360)) / (1 + (0.07 180/360)) = $36,231.88

63. The net income for Morgan Company was $3 million for the year ended December 31, 2008. Additionalinformation is as follows:

Depreciation on fixed assets $1,500,000 Gain from cash sales of land 200,000 Increase in accounts payable 300,000 Dividends paid on preferred stock 400,000

The net cash provided by operating activities in the statement of cash flows for the year ended December 31, 2008is:

a. $4,600,000

b. $4,200,000

c. $4,800,000

Answer: A =$3,000,000 + $1,500,000 $200,000 + $300,000 = $4,600,000

64. The following table gives the price of a bond with face value $1000 for different interest rates:

Interest Rate Price

5.15% 101.0898

5.20% 100.8707

5.10% 101.3094

The duration of the bond is:

a. 4.78b. 4.35


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c. 2.17

Answer: B - Duration = (V - V+)/(V0 * 2 * dV). Change the price of the bond by changing yield by a small amount(here 1/20 of 1%) in both directions to get V and V+

65. Corcoran Corp acquired an asset on 1 January 2004, for $500,000. For financial reporting, Corcoran will

depreciate the asset using the straight-line method over a 10-year period with no salvage value. For tax purposesthe asset will be depreciated straight line for five years and Corcorans effective tax rate is 30%. Corcoransdeferred tax liability for 2004 will

a. Decrease by $50,000

b. Increase by $15,000

c. Decrease by $15,000

Answer: B Straight-line depreciation per financial reports = 500,000 / 10 = $50,000; Tax depreciation = 500,000/ 5 = $100,000; Temporary difference = 100,000 50,000 = $50,000; Deferred tax liability will increase by$50,000 30% = $15,000

66. Which of the following statements about accounting treatments under IFRS and U.S. GAAP are mostaccurate regarding the periodic valuation of identifiable intangible assets and marketable securities classified asavailable for sale, respectively?

Identifiable intangible assets Available-for-sale securities

a. U.S. GAAP permits upward revaluation Carried at market value

b. U.S. GAAP permits upward revaluation Carried at amortized cost

c. IFRS permits upward revaluation Carried at market value

Answer: B Under IFRS and U.S. GAAP, identifiable intangible assets are reported on the balance sheet at theircost less accumulated amortization. However, a significant difference is that U.S. GAAP does not permit upward

revaluations of intangible assets. The accounting treatment for available-for-sale securities is the same under IFRSand U.S. GAAP. These securities are carried on the balance sheet at their fair market values. Unrealized gains and

losses are not recognized on the income statement, but are included in other comprehensive income

67. A firm wishes to finance itself, and sells preferred stock, equity and bonds. It gets $2 million by sellingpreferred stock that will pay preferred dividends of $140,000 every year. It gets $10 million by selling equity thatbuyers expect will pay dividends of 4% and grow at 5% every year. It gets $8 million by selling 8-year 5.2%semiannual coupon of maturity value $10 million. The tax rate is 36%. What is the firm's WACC?

a. 5.98%

b. 6.93%

c. 6.57%

Answer: B First calculate the 6 month yield on the bond using your financial calculator. Next (1+r)^2 - 1 to getthe 12 month yield. Multiply by (1-tax rate) to get after tax cost of capital for debt. Cost of equity is dividend yield+ growth rate. Cost of preferred stock is preferred dividends/price of preferred stock. Finally weight by market (notface) values of preferred stock, equity and debt to get WACC

68. Enron left plenty of clues to its accounting fraud, some of which would have been easier to find thanothers. Which strategy would have been least effective at unearthing Enrons fraud?

a. Charting the historical seasonality of Enrons earnings.

b. Checking the reported mark-to-market values against actual values of similar securities.

c. Checking the cash flow/earnings index

Answer: C: Unfortunately, the cash flow/earnings index would have made Enron look good, as its operating cashflow was higher than net income. However, the numbers lied because Enron overstated its operating cash flow.

Both remaining strategies would have led to information suggesting Enrons results were bogus.


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69. Two assets are perfectly positively correlated. If 30% of an investor's funds were put in the asset with astandard deviation of 0.3 and 70% were invested in an asset with a standard deviation of 0.4, what is the standarddeviation of the portfolio

a. 0.151

b. 0.426

c. 0.370

Answer: C: Unfortunately, the cash flow/earnings index would have made Enron look good, as its operating cashflow was higher than portfolio = [W1

212 + W2

222 + 2W1W212r1,2]

1/2 given r1,2 = +1 = [W1

212 + W2

222 + 2W1W212]

1/2 = (W11 + W22)2]1/2

= (W11 + W22) = (0.3)(0.3) + (0.7)(0.4) = 0.09 + 0.28 = 0.37

70. Which of the following statements about the efficient market hypothesis is least accurate?

a. Efficient markets tests have found that professional money managers, as a group, have consistently

outperformed the market.

b. Exchange specialists derive above-average returns from private information.

c. The use of a price weighting versus a market value weighting produces a downward bias on the index.

Answer: A: Professional money managers, as a group, have not been found to outperform the market

71. Assuming that a company's return on equity (ROE) is 12% and the required rate of return is 10%,which of the following would most likely cause the company's P/E ratio to rise?

a. The inflation rate falls

b. The firm's ROE falls

c. The firm's dividend payout rises

Answer: A

72. If the Federal Reserve wishes to lower market interest rates without changing the discount rate, it can

a. Raise the yield on Treasury securities.

b. Increase bank reserve requirements.

c. Buy Treasury securities.

Answer: C - Buying Treasury securities pumps money into the economy, lowering interest rates. Higher reserverequirements will restrict the money supply, causing rates to rise. The Federal Reserve has no direct control overthe yield on existing Treasury securities

73. Suppose that IBM has a $1,000 par value bond outstanding with a 12% semi-annual coupon that iscurrently trading at 102.25 with seven years to maturity. Which of the following is closest to the yield to maturity(YTM) on the bond?

a. 11.21%

b. 11.91%

c. 11.52%

Answer: C - To find the YTM, enter PV =$1,022.50; PMT = $60; N = 14; FV = $1,000; CPT I/Y = 5.76%. Nowmultiply by 2 for the semi-annual coupon payments: (5.76)*(2) = 11.52%

74. An investor is considering investing in a venture capital project that will have a large payoff at exit,which is estimated to occur in four years. The investor realizes that the risk of failure is high, given the followingestimated probabilities:

Year 1 Failure Probability of 30%; Year 2 Failure Probability of 28%; Year 3 Failure Probability of 28%;Year 4 Failure Probability of 25%;

The probability that the project will survive to the end of the fourth year is:


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a. 25.00%

b. 27.22%

c. 27.75%

Answer: B - The probability is calculated as: (1 0.30) (1 0.28) (1 0.28) (1 0.25) = 0.2722 or27.22%

75. The data below pertains to an office buildings next reporting period: Gross rental income = $6.5 million. Operating expense = $2.3 million. Financing expense = $900,000. Depreciation expense = $750,000. Vacancy rate = 8.5%.

The market expects a return of 12.3%. The value of the office building is closest to:

a. $29.65 million

b. $16.24 million

c. $22.33 million

Answer: A - NOI = $6.5 million (91.5%) $2.3 million; NOI = $3.6475 million; Value = NOI / market cap rate;Value = $3.6475 million / 12.3%; Value = $29.6545 million

76. Bonds A, B and C have the same maturity and face value. They have coupons of 5.4%, 5.5% and 5.7%respectively. Prices of $105, $106, and $108. Yields of 5.44%, 5.45% and 5.43% respectively. Which is the bondwith the highest re-investment risk?

a. B

b. C

c. A

Answer: A - The bond with the highest yield has the greatest reinvestment risk.

77. A Zero-Coupon bond issue with 10 years to maturity has a face value of $1 million. The YTM is 5%. Thedollar duration of the bonds is:

a. 100,000.00

b. 613,913.25

c. 61,391.33

Answer: C The dollar duration is the approximate change in price for a 1% change in YTM. Dollar Duration =Duration * Price / 100

78. A commodities investor establishes a $20 million collateralized futures position. If the futures are worth

$21 million three months later, and Treasuries have an annualized return 4.75% during the period, the total gainon the position is

a. $1,950,000

b. $1,237,500

c. $1,000,000

Answer: B The total return on the position equals the gain on the futures position plus the return on the Treasurybills: $1,000,000 + ($20,000,000 4.75% (90 / 360)) = $1,237,500

79. A hedge fund that takes perfectly offsetting long and short positions is best described as

a. Long/short fund.

b. Event-driven fund.c. Market-neutral fund


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Elan Guides (www.proavenues.com/cfa)

Economics

1. Which of the following is most likely to affect the elasticity of demand for a good?

A. The time elapsed since a price change.B. The time frame for making the supply decision.C. The availability of raw materials.

Answer: A

Elasticity of demand is influenced by the time elapsed since a price change. The time framewithin which the supply decision is made and the ability to substitute productive resources arefactors that influence elasticity of supply.

2. A good has a price elasticity of demand of 1.2. In response to an increase in price of 30%,

quantity demanded will change from 150 units to:

A. 104.24B. 195.76C. 96

Answer: A

Price elasticity of demand = % change in Qd / % change in price-1.2 = x / 30%, x = -36%-36% = [(x - 150)] / [(x + 150) /2]x = 104.24

3. Which of the following most accurately describes efficient resource allocation in anunregulated economy?

A. Consumer surplus is maximized.B. Consumer surplus equals producer surplus.C. The sum of producer and consumer surplus is maximized.

Answer: C

Resources are allocated efficiently when the sum of consumer and producer surplus ismaximized.

4. As the marginal benefit curve becomes more elastic, assuming that equilibrium price andquantity remain unchanged, consumer surplus:

A. IncreasesB. Remains unchangedC. Decreases

Answer: C

As the marginal benefit curve becomes more elastic (becomes flatter), the area of the trianglebetween the y-axis, the market price and the demand curve decreases (assuming equilibriumprice and quantity remain unchanged).


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5. A subsidy most likely:

A. Shifts the demand curve to the rightB. Leads to a dead weight loss from underproductionC. Leads to a dead weight loss from overproduction

Answer: C

A subsidy shifts the supply curve to the right and results in a deadweight loss due tooverproduction.

6. A tax on a good or service is least likely to:

A. Increase the equilibrium quantityB. Decrease the equilibrium quantity

C. Increase the equilibrium price

Answer: A

A tax, whether it is levied on consumer or producers, always results in a decrease in theequilibrium quantity of output.

1. Assume that a firm generates $125 million in total revenue by using $40 million in labor andmaterials. The value of the firms buildings fell from $2 million to $1.8 million during theperiod. Further, the firm forgoes $300,000 in interest and normal profit equals $140,000. Theeconomic profit of this firm is closest to:

A. $124,360,000.B. $82,760,000.C. $84,360,000.

Answer: C

Economic profit = total revenue - opportunity costs = total revenue - (explicit + implicitcosts).

In this case, the labor and material cost of $40 million is the explicit cost. Implicit costsinclude the $300,000 in foregone interest, economic depreciation of $200,000, and normalprofit of $140,000.

Therefore, total implicit costs equal $640,000 = $300,000 + $200,000 + $140,000 andeconomic profit is $125,000,000 - $40,000,000 - $640,000 = $84,360,000.

2. Which of the following statements most accurately describes technological and economicefficiency?

a. For a given level of output, the technologically efficient method of production usesthe least number of input units, while the economically efficient method entails thelowest possible cost.

b. For a given level of output the technologically efficient method of production uses theleast number of labor units, while the economically efficient method uses the leastnumber of capital units.


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a. MC < MR < Pb. P = MC = MR.c. P > MC = MR.

Answer: B

In perfect competition, profits are maximized at the output level where MC equals MR. Sincedemand facing each individual firm is perfectly elastic, MR equals price.

7. Which of the following most likely describes the price and output produced under perfectcompetition relative to a single-price monopoly?

Price Outputa. Higher Lowerb. Lower Higherc. Same Same

Answer: B

In perfect competition, prices are lower and total output is higher than under a single- pricemonopoly.

8. Which of the following most likely describes the price and output produced under perfectcompetition relative to perfect price discrimination by a monopoly?

Price OutputA. Lower SameB. Lower Higher

C. Same Same

Answer: A

In perfect competition, prices are lower and total output is the same as in a situation where amonopoly engages in perfect price discrimination.

1. Which of the following is most likely an advantage of monopolistic competition compared toperfect competition?

A. More choice

B. Excess capacityC. Markup.

Answer: A

Even though monopolistic competition results in excess capacity (output < efficient scale ofproduction) and mark-up (MB and P > MC), it offers consumers more choice than perfectcompetition.


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2. Which of the following oligopoly models asserts that there is a break in a firms marginalrevenue curve?

A. Kinked-demand model.B. Dominant firm model.

C. Game theory.

Answer: A

The kinked demand curve model suggests that there is a break in a firms MR curve due tothe kink in the demand curve.

3. Which of the following statements is least likelyregarding a factors income?

A. The more inelastic the supply curve, the greater the share of economic rent in thefactors income.

B. The more elastic the supply curve, the greater the share of opportunity cost in thefactors income.

C. The more elastic the demand for a factor of production, the higher its income.

Answer: C

Elasticity of demand does not have anything to do with a factors income. The higher the

demand (MRP) for a factor of production, the greater its total income.

4. Which of the following statements is most likely regarding the market for natural resources?

A. The supply of a renewable resource is perfectly elastic.B. The flow supply of a renewable resource is perfectly elastic at the expected price in

the next period.C. The flow supply of a non-renewable resource is perfectly elastic at the present value

of the price expected in the next period.

Answer: C

The flow supply of a non-renewable resource, such as oil, is perfectly elastic at the presentvalue of the price expected in the next period.

The supply of a renewable resource is perfectly inelastic.

5. Which of the following statements is least likely?


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A. The natural rate of unemployment is composed of frictional and cyclicalunemployment.

B. The natural rate of unemployment is the unemployment rate that exists at fullemployment output.

C. There is zero cyclical unemployment at the full employment level of output.

Answer: A

The natural rate of unemployment is composed ofstructural and frictional unemployment.There is no cyclical unemployment at full employment.

6. During an expansion:

A. Real GDP exceeds potential GDP and unemployment is greater than the natural rate.B. Real GDP exceeds potential GDP and unemployment is lower than the natural rate.C. Real GDP is lower than potential GDP and unemployment is greater than the natural

rate.

Answer: B

Real GDP exceeds potential GDP and unemployment is lower than the natural rate during anexpansion.

7. Suppose an economy is initially operating at full employment. A decrease in aggregatedemand that takes the economy into a deflationary gap most likely results in:

A. A decrease in output in the short run and the long run.B. An increase in output in the short run, but a decrease in output in the long run.C. A decrease in output in the short run, but no change in output in the long run.

Answer: C

When the economy falls into a deflationary gap, real output falls in the short run, buteventually an increase in SRAS restores LR equilibrium at potential output. In the long run,the economy always operates at a point on its LRAS curve, or at the full employment level ofoutput.

8. Which of the following theories least likely asserts that wages are downward sticky?


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A. Keynesian.B. Classical.C. Monetarist.

Answer: B

Classical economists believe that the economy is self-correcting. The self-adjustingmechanism only works if nominal wages are easy to change in the short run.

9. Which of the following most likely comprises the largest portion of the Feds liabilities?

A. Federal Reserve Notes.B. Banks deposits.C. U.S. Government Securities.

Answer: A

Federal Reserve notes represent the largest proportion of the Feds liabilities.

10.The U.S. Federal Reserve bought $20,000,000 worth of U.S. Treasury securities from theopen market. The reserve requirement is currently 20%. The effect of the Feds purchase onthe U.S. money supply if there were zero excess reserves in the banking system is closest to:

A. A $20,000,000 increaseB. A $100,000,000 decreaseC. A $100,000,000 increase

Answer: C

The money multiplier equals 1/0.2 = 5

As the Fed has bought securities, it will increase the money supply by:

5 * 20,000,000 = $100,000,000.

11.Which of the following most likely causes a shift in the short run and long run Phillips curves?

A. A change in the natural rate of unemployment.B. A change in real output.

C. A change in the actual inflation rate.


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Answer: A

A change in the natural rate of unemployment brings about a change in both, the long run andthe short run Phillips curves.

12.As an economy slips into a recession, which of the following is most likely?

A. Interest rates are high and there is a decrease in price and output as the economyoperates below its potential.

B. Interest rates are low and there is a decrease in price and output as the economyoperate below its potential.

C. Interest rates are low and there is an increase in price and output as the economyoperates below its potential.

Answer: A

In a recessionary phase, interest rates are high and price and output fall as the economyoperates below full employment.

13. If the economy is in the downward sloping region of the Laffer curve, a decrease in incometaxes will most likely:

A. Increase tax revenueB. Have no effect on tax revenueC. Decrease tax revenue

Answer: A

In the downward sloping region of the Laffer curve, a decrease in tax rates leads to asignificant rise in the number of total dollars earned in the economy, which leads to an

increase in tax revenues.

14.Which of the following is least likely regarding the crowding-out effect?

A. A budget deficit reduces real interest rates as the supply of loanable funds decreases.B. Budget deficits slow down the growth rate of real GDP.C. Budget deficits reduce the supply of loanable funds, which results in an increase in

real interest rates.


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Information regarding extraordinary items and unusual or infrequent events is typically found inthe Management Discussion & Analysis section.

2. An audit is most likely described as:

A. A review of the financial statements by an internal auditor of the entity to check theiraccuracy.

B. An independent review of an entitys financial statements.C. A review of the financial statements by a senior director of the entity with the purpose of

stating an opinion on their fairness and reliability.

Answer: B

An audit is an independent review of an entitys financial statements that enables the auditor tostate an opinion on their fairness and reliability.

1. According to the accounting equation, a firms assets are least likely equal to:

A. Liabilities + Beginning Retained EarningsEnding Retained EarningsDividends

declaredB. Ending Retained Earnings + Contributed Capital + LiabilitiesC. Liabilities + Contributed Capital + Beginning Retained Earnings + RevenuesExpenses

Dividends declared

Answer: A

Assets = Liabilities + Owners equity.

Option A does not conform to the accounting equation.

2. To balance the accounting equation, an increase in a firms liabilities is least likely to beaccompanied by:

A. An increase in its assets onlyB. An increase in its owners equity onlyC. A decrease in its owners equity only

Answer: B


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Profit recognized in 2008 = (300,000/1,500,000) * (2,000,0001,500,000) = $100,000

2. ABC Corporation supplies heavy machinery to various companies. It sold one machine thatcost $1,200,000 to XYZ Company for $1,500,000 and expects to receive the cash payments ininstallments. ABC cannot reasonably estimate the collectability of revenues.

Year 2006 2007 2008 Total

Expected cash to becollected ($ 000)

400 500 600 1,500

ABC Corporations profit for 2007 is closestto:

A. $ 100,000B. $ 300,000C. $ 240,000

Answer: A

The installment method is used when the collectability of revenues cannot be reasonably estimated.The percentage of total profit recognized in each period equals the proportion of total cash received in

each period.

Profit = (500/1,500) * 300 = $100

1. If a company pays cash before it recognizes the associated expense it results in a/(an):

A. Unearned revenue liabilityB. Accounts receivable assetC. Prepaid expense asset.

Answer: C

If a company receives cash before it recognizes the associated revenue it results in a prepaidexpense asset.

2. An accrued expense liability is most likely recognized when:


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A. An expense is recognized before cash payment.B. Cash is paid prior to expense recognition.C. Revenue is recognized prior to the receipt of cash.

Answer: A

An accrued expense liability is recognized when an expense is recognized prior to cash payment.

1. A company has a net income of $150, an increase in accounts receivable of $30, depreciation of $55and a decrease in accounts payable of $25. Its operating cash flow is closest to:

A. $200B. $150C. $95

Answer: B

Operating cash flow = 15030 + 5525 = $150.

2. Given the following information for a company, its CFO is closest to:

Net income 1,000

Decrease in interest payable 85

Gain on sale of equipment 45

Increase in accounts payable 90

Decrease in inventory 35

Increase in prepaid assets 105

Depreciation 85

Increase in taxes payable 125

A. $1,100B. $1,250C. $1,050

Answer: A

CFO = 1,0008545 + 90 + 35105 + 85 +125 = 1,100


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1. Which of the following is most likely to be used to conduct trend analysis?

A. Horizontal common-size financial statements.B. Vertical common-size financial statements.

C. Pie charts.

Answer: A

Horizontal common-size financial statements are prepared to look for trends over time inevaluating a companys past performance and preparing forecasts.

2. Which of the following is least likely a limitation of ratio analysis?

A. Companies may have several divisions that operate in different industries.B. Most companies around the world subscribe to the same set of accounting standards.C. There are no specified ranges within which particular ratios for companies must lie.

Answer: B

Despite the growing convergence between IFRS and U.S.GAAP significant differencesremain across the two sets of standards, which makes comparison across firms difficult.

1. Given stable inventory quantities and falling prices, use of LIFO will least likely:

A. Result in higher net income compared to FIFO

B. Overstate net incomeC. Overstate inventory

Answer: B

Given stable inventory quantities and falling prices, use of LIFO will not overstate netincome. Current replacement costs will be reflected in COGS, which would result in anaccurate value for net income.

2. Given stable inventory quantities and falling prices, use of FIFO will most likely:

A. Understate replacement costsB. Understate profitsC. Understate inventory

Answer: B

Inventory will be appropriately valued if FIFO is used (regardless of whether prices are risingor falling). Replacement costs will be overstated in COGS and profits will be understated.

3. Which of the following ratios is least likelyto be used to evaluate a companys inventorymanagement?

A. Inventory turnover


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B. Quick ratioC. Number of days of inventory on hand.

Answer: B

The quick ratio ignores the companys inventory levels. It is used to measure a companysliquidity management; not its inventory management.

4. In a period of falling prices and stable inventory quantities, which of the following is mostlikely?

A. LIFO COGS > FIFO COGSB. LIFO CF < FIFO CFC. LIFO EI < FIFO EI

Answer: B

In a period of falling prices and stable inventory quantities, use of LIFO results in lowerCOGS, higher NI and higher taxes. Therefore, CF under LIFO is lower.

5. In a period of rising prices and stable inventory quantities, which of the following is mostlikely?

A. Profitability ratios are lower under FIFOB. Solvency ratios are higher under FIFOC. Activity ratios are lower under FIFO

Answer: C

In a period of rising prices and stable inventory quantities, use of FIFO results in loweractivity ratios, lower solvency ratios and higher profitability ratios.

6. In a period of falling prices and stable inventory quantities, which of the following is leastlikely?

A. The current ratio is higher under LIFOB. Solvency ratios are higher under LIFOC. The inventory turnover ratio is lower under LIFO

Answer: B

In a period of falling prices and stable inventory quantities, use of LIFO results in lowerCOGS, higher net income, higher equity, and therefore, lower solvency ratios.

7. Sun Corporation is a manufacturer of a single product. The following information relates toits production levels and costs for 2009:

Normal production capacity = 10 million units

Units produced = 7.5 million units


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Cost of raw materials = $24 million

Cost of conversion = $52 million

Fixed production overheads = $18 million

Freight-in charges = $3.4 million

Storage costs of finished goods = $980,000

Abnormal wastage = $37,000

Given that there is no work-in-progress inventory at the end of the year , the companyscapitalized cost per unit of inventory is closest to:

A. $92.90

B. $12.52

C. $12.39

Answer: C

Sun Corporations actual operating capacity = 7.5 / 10 = 75%

Therefore, capitalized fixed production overheads = 0.75 * 18 = $13.5 million

Total capitalized costs = 24 + 52 + 13.5 + 3.4 = $92.9 million

Storage costs of finished goods are not capitalized inventory costs.

Therefore, capitalized cost per unit = 92.9 / 7.5 = $12.39

8. JK Enterprises balance sheet reported inventory amounting to $32,300. The company

suspects that it will only be able to sell this inventory at its reported value and will have toincur further selling expenses of $2,200. Assuming that the company follows IFRS, which ofthe following statements is least accurate?

A. JK Enterprises should value its inventory at $32,300.

B. JK Enterprises should value its inventory at $30,100.

C. JK Enterprises should recognize a loss of $2,200.

Answer: A

Under IFRS, inventory is reported at the lower of cost or net realizable value.


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A. $54,000

B. $39,000

C. $52,000

Answer: C

Under U.S. GAAP, inventory is measured at the lower of cost of market value. Market valueis defined as replacement cost, where replacement cost must lie within a range of valuesbetween NRV minus normal profit margin and NRV.

Net realizable value = 72,00015,000 = $57,000

Net realizable valueNormal profit margin = 57,0007,000 = $50,000

The replacement cost of $52,000 lies within the specified range of $50,000 and $57,000.

As the replacement cost of $52,000 is less than the original cost of $54,000, inventory will bereported at $52,000.

1. Which of the following statements is most likely regarding the effects of capitalization on acompanys financial statements?

A. Capitalization reduces the companys reported total asset turnover.B. Capitalization increases the companys reported debt-to-assets ratio.C. Capitalization decreases the companys outflows from investing activities.

Answer: A

Capitalization of an expense results in an increase in non-current assets, which leads to adecrease in the total asset turnover ratio (sales/assets) and the debt-to-assets ratio (Debt/Assets).

Capitalization results in a decrease in CFI or an increase in outflows from investing activities.

2. Which of the following statements is least likely regarding the effects of expensing on acompanys financial statements?

A. Expensing increases the companys net profit margin in future years.B. Expensing has no effect on the companys reported debt-to-assets ratio.


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C. Expensing decreases the companys cash flow from investing activities.

Answer: C

Expensing results in an increase in NP margin in the future as no depreciation or amortizationexpense is recognized in the future.

Expensing has no effect on total debt and total assets, and reduces the companys cash flow fromoperating activities (not investing activities).

3. If construction and sale of buildings is a companys core business activity, interest expensesincurred in financing construction are most likely included as a part of the companys:

A. Noncurrent assets and operating expenses.B. Current assets and COGS.C. Current assets and non-operating expenses.

Answer: B

If construction and sale of building is a companys core business activity, interest expenses

incurred in financing construction are included as a part of the companys inventory (currentassets) and recognized as COGS in the period that buildings are sold.

4. Which of the following least likely describes the effects of capitalization of interest costs?

A. The companys reported interest coverage ratio improves.B. The companys reported operating cash flow is inflated.C. The companys reported investing cash flow is inflated.

Answer: C

When a company capitalizes its interest costs, it does not include the capitalized amount ininterest expense on its income statement, thereby inflating reported profits and reporting anenhanced ability to meet its debt servicing obligations.

The related cash outflow is classified as an outflow from investing activities instead of anoutflow from operating activities so reported CFO is inflated (higher).


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5. Assuming straight line depreciation, which of the following combinations of depreciation-relatedestimates result in the lowest annual depreciation expense?

A. Longer useful life and lower salvage value.B. Longer useful life and higher salvage value.C. Shorter useful life and higher salvage value.

Answer: B

Estimates of longer useful lives and higher salvage values result in lower depreciation expense.

6. Recognition of an ARO on a companys financial statements will least likely result in:

A. A fall in the interest coverage ratio.B. A rise in the debt-to-equity ratioC. A rise in ROA.

Answer: C

Recognition of an ARO on a companys financial statements results in a higher D/E ratio, andlower interest coverage, ROA and asset turnover ratios.

7. Which of the following is least likely regarding the effects of impairment recognition on acompanys financial statements?

A. The carrying value of non-current assets decreases.B. Net income falls.C. Cash flow from operating activities falls.

Answer: C

Impairment recognition does not affect a companys cash flows.


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Use the following information to answer Questions 8 and 9

XYZ acquired ABC in 2007 for $45,000. On the date of acquisition, the fair value of ABCs net assetswas $41,500.

In 2008:

Fair value of ABCs net assets = $42,000

Fair value of the ABC = $43,000

Carrying value of ABC on XYZs financial statements= $44,000

8. Upon acquiring ABC, XYZ will recognize acquisition goodwill amounting to:

A. $3,500B. $8,000C. Zero

Answer: A

Value of goodwill recognized upon acquisition is calculated as:

Acquisition priceFair value of acquired companys net assets = $45,000 $41,500

9. In 2008, XYZ will recognize an impairment charge on goodwill relating to ABC amounting to:

A. $3,000B. $2,000C. $2,500

Answer: C

The carrying value of ABC ($44,000) exceeds its fair value ($43,000). This means that goodwillis impaired.

To calculate the impairment loss, the implied value of goodwill is deducted from its carryingvalue ($3,500)


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Implied goodwill = Fair value of ABC - Fair value of ABCs net assets = $43,000 - $42,000 =$1,000.

Therefore, XYZ will recognize an impairment loss of $2,500 ($3,500 - $1,000).

10.The cost of which of the following assets is least likely expensed over time?

A. Intangible assets with a definite useful lifeB. Land acquired with the intent to construct a factory on it.C. Machinery with a useful life of 5 years

Answer: B

Land is a non-depreciable asset.

Intangible assets with a definite useful life are amortized over time.

Machinery with a useful life of more than one year is depreciated over its useful life.

1. An increase in DTL most likely results in a (an):

A. Decrease in income tax expenseB. Increase in current assetsC. Decrease in shareholders equity

Answer: C

ITE = TP + Change in DTLChange in DTA

An increase in DTL increases ITE and results in lower net income and retained earnings.

2. A decrease in the valuation allowance most likely results in a(an):

A. Increase in total assets.B. Decrease in shareholders equityC. Increase in income tax expense.

Answer: A

A decrease in the valuation allowance implies that the companys DTA (assets) are increasing. Anincrease in DTA reduces ITE, and increases retained earnings (equity).


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3. A company reports DTA of $300m and DTL of $200m on its balance sheet for the year endedDec 2009. Tax rates from 2010 onwards are brought down from 40% to 30%. In response to this

change in tax rates, the decrease in the companys shareholders equity is closest to:

A. $25m.B. $10m.C. $75m.

Answer: A

The companys DTA and DTL will fall by 25% as a result of the decrease in tax rates. On a netbasis, its net assets and shareholders equity will fall by ($300m - $200m) * 25% = $25m.

4. Taxable temporary differences would most likely arise when:

A. The carrying amount of a liability exceeds its tax base.B. The carrying amount of an asset exceeds its tax base.C. The carrying amount of an asset is less than its tax base.

Answer: B

Taxable temporary differences or deferred tax liabilities arise when the carrying amount of anasset is greater than its tax base, or when the carrying amount of a liability is less than its tax base.

5. Deductable temporary differences least likely arise when:

A. The carrying amount of a liability is less than its tax base.B. The carrying amount of an asset is less than its tax base.C. The tax base of a liability is less than its carrying amount.

Answer: A

Deductible temporary differences or deferred tax assets arise when the tax base of an assetexceeds its carrying value, or when the tax base of a liability is less than its carrying value. Whenthe carrying amount of a liability is less than its tax base, a deferred tax liability arises.


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Use the following information to answer Questions 6 to 10:

ABC Company uses the straight line method of depreciation on its financial statements to write off a pieceof equipment that it purchased for $10,000. The asset has an estimated salvage value of zero and a useful

life of 4 years. On the tax return it writes off the asset over two years with zero salvage value. Thecompany is taxed at 30%.

6. The difference between the amount of depreciation recognized on the income statement and onthe tax return will result in a:

A. Permanent differenceB. Deferred tax liabilityC. Deferred tax asset

Answer: B

Higher depreciation expense is being recognized on the tax return, and this difference in expenserecognition across the income statement and the tax return is expected to reverse in the future.Therefore, a deferred tax liability will be created.

7. The carrying value of the asset on the balance sheet for Year 2 is closest to:

A. $7,500B. $5,000C. $2,500

Answer: B

The carrying value of the asset on the financial statements at the end of Year 2 is calculated as:

Historical cost of the assetAccumulated depreciation charged on the income statement

= $10,000$5,000 = $5,000

8. The tax base of the asset as of the end of Year 2 is closest to:

A. $7,500B. $5,000

C. Zero


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Answer: C

The tax base of the asset at the end of Year 2 is calculated as:

Historical cost of the assetAccumulated depreciation charged on the tax return

= $10,000$10,000 = $0

9. The amount of DTL/DTA recognized on the balance sheet for Year 2 is closest to:

A. $2,000 DTAB. $1,500 DTL

C. $1,500 DTA

Answer: B

DTL at the end of Year 2 are calculated as:

(Carrying value of assetTax base) * Tax rate = $5,000 * 0.3 = $1,500

10.The change in DTL over Year 3 is closest to:

A. $750 increaseB. $750 decreaseC. $500 increase

Answer: B

In Year 3, income tax expense exceeds taxes payable by $2,500 * 0.3 = $750. Therefore, DTL inYear 3 will fall by $750. The temporary difference starts to reverse in Year 3.

1. Which of the following statements is most likely regarding accounting for discount bonds?

A. The book value of the liability decreases each year over the term of the bonds.B. Interest expense recognized exceeds the coupon payment each year over the term of the

bonds.C. The excess of interest expense over the coupon payment serves to reduce the liability

balance each year.


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Answer: B

For bonds issued at a discount:

o Interest expense exceeds the coupon payment due to discount amortization.o The book value of the liability increases each year and the shortfall of the coupon

payment compared to interest expense serves to increase the liability balance each year.

2. Which of the following statements is least likely regarding accounting for premium bonds?

A. The book value of the liability decreases each year over the term of the bonds.B. Interest expense recognized is greater than the coupon payment each year over the term of

the bonds.C. The excess of coupon payment over interest expense serves to reduce the liability balance

each year.

Answer: B

For bonds issued at a premium:

Interest expense is less than the coupon payment due to premium amortization. The book value ofthe liability falls each year, and the excess of the coupon payment over interest expense serves to

reduce the liability balance each year.

3. In the analysis of financing liabilities, which of the following is most likely regarding premiumbonds?

A. CFO is overstatedB. CFF is overstatedC. CFI is overstated.

Answer: B

For premium bonds CFO is understated and CFF is overstated.

4. In the analysis of financing liabilities, which of the following is least likely regarding discount

bonds?


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7. When a lease is classified as an operating lease, a non-current asset is recognized and depreciatedon the:

A. Lessors financial statementsB. Lessees financial statementsC. Both the lessor and the lessees financial statements.

Answer: A

When a lease is classified as an operating lease, a non-current is recognized and depreciated onthe lessors financial statements. No asset is recognized on the lessees financial statements.

8. When a lease is classified as a finance lease, a long-lived asset is recognized and depreciated onthe:

A. Lessors financial statements.B. Lessees financial statements.C. Both the lessor and the lessees financial statements.

Answer: B

When a lease is classified as a finance lease, a long-lived asset is recognized and depreciated onthe lessees financial statements. The lessor removes the long-lived asset from its books andrecognizes a lease receivable asset.

9. Recognition of a finance lease as opposed to an operating lease by the lessor most likely results in:

A. Higher total net income over the lease termB. Higher total CFI over the lease term.C. Lower taxes in the early years of the lease term

Answer: B


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Recognition of a finance lease as opposed to an operating lease by the lessor results in the sametotal net income, higher total CFI over the lease term and higher taxes in the early years of thelease.

10.Recognition of a finance lease as opposed to an operating lease by the lessee least likely results in:

A. Higher CFOB. Higher current liabilitiesC. Lower non-operating expenses

Answer: C

Recognition of a finance lease as opposed to an operating lease by the lessee results in higherCFO, higher current liabilities, and higher non-operating expenses (interest expense)

1. If management wants to obtain concessions from vendors, it will most likely:

A. Overstate assets to appear more solventB. Understate liabilities to appear less solventC. Overstate liabilities to appear less solvent

Answer: C

If management wants to obtain concessions from vendors, it will try to appear less solvent.This can be achieved by overstating liabilities.

2. Management will least likely understate assets to improve:

A. Financial leverage ratiosB. Return on assetsC. Total asset turnover

Answer: A

In order to improve financial leverage ratios, management will need to overstate its assets.Understating assets will improve return on assets and total asset turnover ratios.

1. Which of the following statements is most accurate?

A. When stock options are exercised, the associated tax benefit can be classified as anoperating cash flow

B. A company may improve its cash flow from financing activities by financing its payablesC. Under U.S. GAAP, gain on sale of securitized receivables must be reported below net

income


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Answer: A

Financing of payable improves a companys operating cash flows.

U.S. GAAP provides no guidance as to where the gain on sale of securitized receivablesshould be reported. Some firms take the aggressive approach and report the gain on sale ofsecuritized receivables as a part of revenues, others report the gain below the line, whilesome simply offset it against expenses.

2. Consider the following statements:

Statement 1: When stock options are exercised and converted into common stock, thecompany is allowed to take a tax deduction equal to the difference between the book valueand the market value of the shares.

Statement 2: When evaluating the true earnings power of a company as measured by its cash

flows, cash expended to buy back stock should not be included in operating cash flow.

Which of the following is most likely?

A. Only one statement is correctB. Both the statements are correctC. Both the statements are incorrect

Answer: A

When stock options are exercised and converted into common stock, the company is allowedto take a tax deduction equal to the difference between the value that shares were sold at (the

strike or exercise price) and their market value.

Statement 2 is correct.

1. Consider the following statements:

Statement 1: Forecasting each expense item as a percentage of sales is a very objectivemethod to calculate a firms future net income.

Statement 2: Forecasting is relatively more difficult for mature companies that operate in non-volatile markets, compared to new companies operating in volatile markets.

Which of the following is most likely?

A. Only one statement is correctB. Both statements are correctC. Both statements are incorrect

Answer: C

Forecasting each expense item as a percentage of sales is a very subjective method.

Forecasting models tend to be simpler and work well for mature companies that operate in

non-volatile markets.


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2. Which of the following is least likely evaluated to analyze credit risk of a company?

A. CharacterB. CommitmentsC. Covenants

Answer: B

Credit analysis involves evaluation of the 4 Cs of a company:

Character

Capacity

Collateral

Covenants

1. Realized gains and losses and interest income are both recognized on the income statementfor:

A. Trading and available-for-sale securities onlyB. Trading securities onlyC. Trading, held-for-sale and held-to-maturity securities.

Answer: C

Realized gains and losses and interest income are recognized on the income statement for allclassifications of securities.

2. Which of the following most likely allows inventory write-downs and reversals of write-downs?

A. IFRS onlyB. U.S.GAAP onlyC. IFRS and U.S.GAAP

Answer: A

Typically, U.S.GAAP does not permit reversals of inventory write-downs.

Fixed Income Securities

3. Which of the following bonds accrue interest over a portion of their term, and make periodiccoupon payments for the rest of their term?

A. Step-up notesB. Deferred coupon bondsC. Zero coupon bonds

Answer: B

Deferred coupon bonds accrue interest over a portion of their term, and make periodic couponpayments for the rest of their term


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4. For a floating-rate security that resets its coupon every 3 months, LIBOR-90 on July 1, 2008is used to determine the coupon payment that will be made at:

A. October 1, 2008B. July 1, 2008C. January 1, 2009

Answer: A

LIBOR-90 on July 1, 2008 will determine the interest payments that will be made at the next resetdate i.e. Oct 1, 2008.

5. A bond currently trading at $837.50 has a yield of 9.5% and duration of 7.5. The new price ofbond if yields rise to 9.95% will be closest to:

a. $868.91b. $806.09c. $845.87

Answer: BChange in yields = 9.95%9.50% = 0.45%Approximate price change = -7.5 * 0.45% = -3.375%As yields increasedby 45 basis points the price of the bond will decrease by 4.5%New price of bond = (1 - 0.0375) * $837.50 = $806.09

6. Which of the following statements is correct regarding the reinvestment risk faced byinvestors in amortizing securities and zero-coupon bonds:

A. Amortizing securities have greater reinvestment risk than straight bonds, while zero couponbonds have zero reinvestment risk.

B. Amortizing securities have lower reinvestment risk than straight bonds, while zero couponbonds have higher reinvestment risk than straight bonds.

C. Amortizing securities have zero reinvestment risk than straight bonds, while zero couponbonds have higher reinvestment risk than straight bonds.

Answer: A

Amortizing securities have greater reinvestment risk than straight bonds (as coupon and principalpayments received over the term of the bonds bear the risk of being reinvested at a rate lower than theoriginal YTM),while zero coupon bonds have zero reinvestment risk as they offer no payments overtheir terms.

7. Which of the following statements is incorrect?

A. A structured MTN is a combination of a medium-term note and a derivative instrument.B. Structured MTNs are also known as rule busters.C. MTNs can only be issued at a fixed rate.

Answer: CMTNs can be issued at a fixed or a floating rate.


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8. Which of the following is not an example of external credit enhancements?

A. Bond insuranceB. Letters of creditC. Overcollateralization

Answer: COvercollateralization is an internal credit enhancement.

9. Which of the following statements is incorrect?

A. Fixed rate Treasuries are exposed to inflation riskB. Treasury bills carry no reinvestment riskC. U.S. Treasuries are risk free instruments.

Answer: CU.S. Treasures are not risk free instruments. They carry no default risk, but do have liquidity andinterest rate risk.

10.Which of the following statements is correct?

A. All other factors constant, a bond with a higher coupon rate has higher interest rate risk andlower reinvestment risk than a bond with a higher coupon rate.

B. All other factors constant, a bond with a lower coupon rate has higher interest rate risk andlower reinvestment risk than a bond with a higher coupon rate.

C. All other factors constant, a bond with a higher coupon rate has lower interest rate risk andlower reinvestment risk than a bond with a higher coupon rate.

Answer: BAll other factors constant, a bond with a lower coupon rate has higher interest rate risk and lowerreinvestment risk than a bond with a higher coupon rate.

11.Under the biased expectations theory, if the yield curve is downward sloping, it definitelyimplies that:

A. It is expected that short term interest rates will be higher in the future.B. It is expected that short term interest rates will remain at the same level in the future.

C. It is expected that short term interest rates will be lower in the future.

Answer: CIf the yield curve is downward sloping despite the liquidity premium required for longer terminvestments, it means that short term interest rates are definitely expected to fall in the future.

12.Which of the following theories explains the tendency of the yield curve to shift whilebroadly maintaining its overall shape?

A. Biased expectations theoryB. Market segmentation theory

C. Preferred habitat theory

Answer: C


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The preferred habitat theory states that institutional investors require a premium to invest in maturitiessimilar to their preferred investment horizons. In addition to being able to explain any shape of theyield curve, this theory also explains the observed fact that yields for similar maturities rise and falltogether, which means that the yield curve more or less maintains its overall shape when it shifts.

13.A 10% annual coupon bond with a 5 year term was issued one year ago for $950. Assumingthat market yields have remained at the same level since bond issuance, which of thefollowing is most likely the price of the bond today?

A. $930B. $965C. $1,005

Answer: BThe price of a bond converges towards par with the passage of time. The bond in question was issuedat a discount. Given that yields do not change, the price of the bond one year into its term will becloser to its par value, but not abov

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