Chartered Financial Analyst Exam: Trivia Quiz

1. For financial assets classified as available for sale, how are unrealized gains and losses reflected in shareholders' equity?

They are not recognized.

They are a component of accumulated other comprehensive income.

They flow through retained earnings.

For financial assets classified as available for sale, unrealized gains and losses are not recorded on the income statement and instead are part of other comprehensive income. Accumulated other comprehensive income is a component Of shareholders' equity.

Explanation

For financial assets classified as available for sale, unrealized gains and losses are not recorded on the income statement and instead are part of other comprehensive income. Accumulated other comprehensive income is a component Of shareholders' equity.

2. When, at the end of an accounting period, cash has not been paid with respect to an expense that has been incurred, the business should then record:

A prepaid expense, an asset.

An accrued expense, a liability.

An accrued expense, an asset

When an expense is incurred and no cash has been paid, expenses are increased and a liability
("accrued expense") is established for the same amount.

Explanation

When an expense is incurred and no cash has been paid, expenses are increased and a liability
("accrued expense") is established for the same amount.

3. Kirsten Kelso, CFA, is a research analyst at a research firm. Kelso is part of a team of analysts who focus on automobile industry. Recently, Kelso disagreed with research sell recommendations written by her team even though she felt confident the research process was properly conducted. In a webcast open to all institutional but not retail clients, Kelso states "even though my name is on the sell reports, these stocks are a buy in part because sales and share prices for the company will rise due to strong demand for their vehicles." Kelso's actions would least likelyviolate which of the following CFA Institute Standards of Professional Conduct?

Diligence and Reasonable Basis

Fair Dealing

Communication with Clients

the recommendation is based on a reasonable and adequate research process, so the analyst could follow the research team’s opinion, as required by Standard V (A) Diligence and Reasonable Basis.

Explanation

the recommendation is based on a reasonable and adequate research process, so the analyst could follow the research team’s opinion, as required by Standard V (A) Diligence and Reasonable Basis.

4. All of the following are names of Elliott cycles except:

Supercycle.

Presidential.

Grand supercycle.

This is the term for a separate cycle theory.
http://en.wikipedia.org/wiki/Grand_supercycle

Explanation

This is the term for a separate cycle theory.
http://en.wikipedia.org/wiki/Grand_supercycle

5.

A technical analyst has detected a price chart pattern with three segments. The left segment shows a decline followed by a reversal to the starting price level. The middle segment shows a more pronounced decline than in the first segment and again a reversal to near the starting price level. The third segment is roughly a mirror image ofthe first segment. This chart pattern is most accurately described as:

An inverse head and shoulders.

A head and shoulders.

A triple bottom.

The given price chart pattern exhibits three segments. The left segment demonstrates a decline followed by a reversal to the initial price level. The middle segment displays a more significant decline than the first segment, followed by another reversal to near the starting price level. The third segment is essentially a mirror image of the first segment. This pattern closely resembles an inverse head and shoulders, where the middle segment represents the head and the first and third segments represent the shoulders.

Explanation

The given price chart pattern exhibits three segments. The left segment demonstrates a decline followed by a reversal to the initial price level. The middle segment displays a more significant decline than the first segment, followed by another reversal to near the starting price level. The third segment is essentially a mirror image of the first segment. This pattern closely resembles an inverse head and shoulders, where the middle segment represents the head and the first and third segments represent the shoulders.

6. Jason Schmidt works for a hedge fund and he specializes in finding profit opportunitiesthat are the result of inefficiencies in the market for convertible bonds—bonds that canbe converted into a predetermined amount of a company's common stock. Schmidt triesto find convertibles that are priced inefficiently relative to the underlying stock. Thetrading strategy involves the simultaneous purchase of the convertible bond and theshort sale of the underlying common stock. The above process could best be describedas:

Hedging.

Securitization.

Arbitrage.

The process can best be described as arbitrage because it involves buying and selling instruments,
whose values are closely related, at different prices in different markets.

Explanation

The process can best be described as arbitrage because it involves buying and selling instruments,
whose values are closely related, at different prices in different markets.

7. Sam Snead, CFA, is the founder and portfolio manager of the Everglades Fund. In its first year the fund generated a return of 30%. Building on the fund's performance, Snead created new marketing materials that showed the fund's gross 1‐year return as well as the 3‐, and 5‐year returns which he calculated by using back‐tested performanceinformation. As the marketing material is used only for presentations to institutional clients, Snead did not mention the inclusion of back‐tested data. According to the Standards of Practice Handbook, did Snead violate any CFA Institute Standards of Professional Conduct?

Yes, because he did not disclose the use of back‐tested data.

No.

Yes, because he failed to deduct all expenses before calculating the fund’s track record.

The Standard III (D) Performance Presentation prohibits members/candidates from making any
statements that misrepresent the performance achieved by them or their firms. By failing to identify the simulated performance results, Snead violated the standard. Snead should have disclosed the fact that the returns were generated only in one year of the fund’s operation and the other performance information is back‐tested.

Explanation

The Standard III (D) Performance Presentation prohibits members/candidates from making any
statements that misrepresent the performance achieved by them or their firms. By failing to identify the simulated performance results, Snead violated the standard. Snead should have disclosed the fact that the returns were generated only in one year of the fund’s operation and the other performance information is back‐tested.

8. Assume U.S. GAAP applies unless otherwise noted. At the end of the year, a company sold equipment for $40,000 cash. The company paid $100,000 for the equipment several years ago and had accumulated depreciation of $60,000 for the equipment at the time of sale. All else equal, the equipment sale will result in the company's cash flow from:

Investing activities decreasing by $10,000.

Investing activities increasing by $40,000.

Operating activities being $40,000 more than net income.

Sale of Fixed asset will result in Cash Inflow. Depreciation is a non cash entry.

Explanation

Sale of Fixed asset will result in Cash Inflow. Depreciation is a non cash entry.

9. A country with a trade deficit will most likely:

Have an offsetting capital account surplus

Save enough to fund its investment spending.

Buy assets from foreigners to fund the imbalance.

A trade deficit must be exactly matched by an offsetting capital account surplus to fund the
deficit. A capital account surplus reflects borrowing from foreigners (an increase in domestic
liabilities) and/or selling assets to foreigners (a decrease in domestic assets). A capital account
surplus is often referred to as a "capital inflow" because the net effect is foreign investment in
the domestic economy.

Explanation

A trade deficit must be exactly matched by an offsetting capital account surplus to fund the
deficit. A capital account surplus reflects borrowing from foreigners (an increase in domestic
liabilities) and/or selling assets to foreigners (a decrease in domestic assets). A capital account
surplus is often referred to as a "capital inflow" because the net effect is foreign investment in
the domestic economy.

10. When comparing financial statements prepared under IFRS with those prepared under U.S. generally accepted accounting principles, analysts may need to make adjustments related to:

Unrealized gains and losses for trading securities.

Realized losses.

Unrealized gains and losses for available‐for‐sale securities.

IFRS makes a distinction between unrealized gains and losses on available‐for‐sale debt securities that arise due to exchange rate movements and requires these changes in value to be recognized in the income statement., whereas U.S. GAAP does not make this distinction.

Explanation

IFRS makes a distinction between unrealized gains and losses on available‐for‐sale debt securities that arise due to exchange rate movements and requires these changes in value to be recognized in the income statement., whereas U.S. GAAP does not make this distinction.

11. Freitag Company currently has assets on its balance sheet that are financed with 60% equity and 40% debt. The company can issue debt at the yield of 8% when the value of the debt doesn't exceed 1 million. If larger amounts of debt are issued by the company, the yield of the debt will be 9%.Calculate the break points for the company.

2.5 million

1 million

1.67 million

When the value of the debt exceeds 1 million, the yield of the bonds issued changed. So the
break point for the company occurs when 40% of the whole capital exceeds 1 million. Break
point = 1million/40% = 2.5million.

Explanation

When the value of the debt exceeds 1 million, the yield of the bonds issued changed. So the
break point for the company occurs when 40% of the whole capital exceeds 1 million. Break
point = 1million/40% = 2.5million.

12. Sisse Brimberg, CFA, is responsible for performance presentations at her investment firm. The presentation that Sisse uses states her firm: (1) deducts all fees and taxes; (2) uses actual and simulated performance results; (3) bases the performance on a representative individual account. Based on the above information, which of the following is the most appropriate recommendation to help Brimberg meet the CFA Institute Standards of Professional Conduct in her performance presentations? She should present performance based on:

A weighted composite for all similar portfolios.

A gross of fee basis.

Actual not simulated results.

In order to meet their obligations under Standard III (D), members should present the performance of the weighted composite of similar portfolios rather than using a single representative or all accounts, so this is the best selection of the options provided.

Explanation

In order to meet their obligations under Standard III (D), members should present the performance of the weighted composite of similar portfolios rather than using a single representative or all accounts, so this is the best selection of the options provided.

13. A large industrialized country has recently devalued its currency in an attempt to correcta persistent trade deficit. Which of the following domestic industries is most likely tobenefit from the devaluation?

Branded prescription drugs.

Restaurants and live entertainment venues.

Luxury cars.

A devaluation of the domestic currency means domestic producers are cutting the price faced by
their foreign customers. The impact on their unit sales and their revenue depends on the
elasticity of demand. Expensive luxury goods exhibit high price elasticity. Hence, luxury car
producers are likely to experience a sharp increase in sales and revenue due to the devaluation.

Explanation

A devaluation of the domestic currency means domestic producers are cutting the price faced by
their foreign customers. The impact on their unit sales and their revenue depends on the
elasticity of demand. Expensive luxury goods exhibit high price elasticity. Hence, luxury car
producers are likely to experience a sharp increase in sales and revenue due to the devaluation.

14. The following information is available for a firm.Market Risk Premium 7.0%Risk‐free Rate 2.0%Comparable Firm Return 10.4%Comparable Firm Debt‐to‐Equity Ratio 1.0Comparable Firm Tax Rate 40.0%The firm's unlevered beta is closest to:

1.05

0.75.

1.20

Find the comparable firm’s beta: (10.4% ‐ 2.0%) ÷ 7.0% = 1.20. Un‐lever the comparable firm’s beta: βLcomparable ÷ (1 + (1 – tax rate) x debt‐to‐equity ratio) = 1.20 ÷ (1 + (1 – 40%) x 1.0) =0.75.

Explanation

Find the comparable firm’s beta: (10.4% ‐ 2.0%) ÷ 7.0% = 1.20. Un‐lever the comparable firm’s beta: βLcomparable ÷ (1 + (1 – tax rate) x debt‐to‐equity ratio) = 1.20 ÷ (1 + (1 – 40%) x 1.0) =0.75.

15. An analyst gathered the following information about a portfolio comprised of three bonds:

Price ($)	Par Amount Owned	Duration
102,000	$7 million	1.89
94.356	$5 million	7.7
88.688	$3 million	11.55

Assuming there is no accrued interest, then the portfolio duration is closest to:

6.83 years

5.55 years.

5.76 years.

Compute the duration of a portfolio, given the duration of the bonds comprising the portfolio, and explain the limitations of portfolio duration Portfolio value = (1.02 x 7 mil) + (0.94356 x 5 mil) + (0.88688 x 3 mil) = 14,518,440 Weight, Bond A = 7,140,000 / 14,518,440 = 0.492 Weight, Bond B = 4,717,800 / 14,518,440 = 0.325 Weight, Bond C = 2,660,640 / 14,518,440 = 0.183 Portfolio duration = (0.492 x 1.89) + (0.325 x 7.70) + (0.183 x 11.55) = 5.55.

Explanation

Compute the duration of a portfolio, given the duration of the bonds comprising the portfolio, and explain the limitations of portfolio duration Portfolio value = (1.02 x 7 mil) + (0.94356 x 5 mil) + (0.88688 x 3 mil) = 14,518,440 Weight, Bond A = 7,140,000 / 14,518,440 = 0.492 Weight, Bond B = 4,717,800 / 14,518,440 = 0.325 Weight, Bond C = 2,660,640 / 14,518,440 = 0.183 Portfolio duration = (0.492 x 1.89) + (0.325 x 7.70) + (0.183 x 11.55) = 5.55.

16. Uses of market indices do not include serving as a:

Measure of systematic risk.

Basis for new investment products.

Benchmark for evaluating portfolio performance.

Security market indices are used as proxies for measuring market or systematic risk, not as
measures of systematic risk.

Explanation

Security market indices are used as proxies for measuring market or systematic risk, not as
measures of systematic risk.

17. An analyst made the following statement: "We should purchase Treasury notes becausethey are risk‐free. Default risk is essentially non‐existent." Is the analyst's statementcorrect with respect to: a. risk‐free? b. default risk?

A.Yes b.No

A.No b.No

A.No, b.Yes

For practical purposes, the default risk on Treasury securities considered zero; however, other
risks associated in investing in Treasury securities include interest rate risk, yield risk,
reinvestment risk, inflation risk, and event risk.

Explanation

For practical purposes, the default risk on Treasury securities considered zero; however, other
risks associated in investing in Treasury securities include interest rate risk, yield risk,
reinvestment risk, inflation risk, and event risk.

18. A real estate investment has the following characteristics:

Annual rental income	$1,800,000
Annual operating expenses	$1,200,000
Available mortgage rate	6%
Financing percentage	90%
Required rate of return	15%
Estimated holding period	5 years
Investor's tax rate	25%

Based on the income approach, the value of the investment is closest to:

$4,000,000.

$5,455,000

$8,696,000.

Calculate the net operating income (NOI) from a real estate investment, the value of a property using the sales comparison and income approaches, and the after-tax cash flows, net present value, and yield of a real estate investment Using the income approach: ($1,800,000 - $1,200,000) / 0.15 = $4,000,000

Explanation

Calculate the net operating income (NOI) from a real estate investment, the value of a property using the sales comparison and income approaches, and the after-tax cash flows, net present value, and yield of a real estate investment Using the income approach: ($1,800,000 - $1,200,000) / 0.15 = $4,000,000

19. Under U.S. GAAP, a lessor's reported revenues at lease inception will be highest if the lease is classified as a(n):

Operating lease.

Sales‐type lease.

Direct financing lease.

Sales‐type lease treats the lease as a sale of the asset, and revenue is recorded at the time of sale equal to the present value of future lease payments. Under a direct financing lease, only interest income is reported as earned. Under an operating lease, revenue from rent is reported when collected.

Explanation

Sales‐type lease treats the lease as a sale of the asset, and revenue is recorded at the time of sale equal to the present value of future lease payments. Under a direct financing lease, only interest income is reported as earned. Under an operating lease, revenue from rent is reported when collected.

20. Gardner Knight, CFA, is a product development specialist at an investment band. Knight is responsible for creating collateralized debt obligations (CDOs) consisting of residential mortgage bonds. In the marketing brochure for his most recent CDO, Knight provided a list of the mortgage bonds that the CDO was created from. The brochure also states that " an independent third party, the collateral manger, had sole authority over the selection of all mortgage bonds used as collateral in the CDO." However, Knight met with the collateral manager and helped her select the bonds for the CDO. Knight is least likely to be in violation of which CFA Institute Standards of Professional Conduct? (Mock79‐8)

Suitability

Conflicts of interest

Communications with Clients and Prospective Clients

There is no indication the investment is unsuitable for investors.However there is conflict of interest and clients should know he was also involved

Explanation

There is no indication the investment is unsuitable for investors.However there is conflict of interest and clients should know he was also involved

21. An investor purchased a European put option. The current price of the underlying stockis 30 dollars. The exercise price is 40 dollars and the put will expire in 270 days. If theput was not purchased, the investor could invest the premium in T‐bills with a discountrate of 3%. The lower bound of put value is closest to:

9 dollars

11 dollars

10 dollars

As a European option cannot be exercised before its maturity date, the lower bound of its
premium is as follows:
Xe‐rt‐S, where
X is the strike price
t is the annualized remaining time
r is the risk‐free rate for this period of time
S is the current stock price
In this question, X=40, t=270/365, r=3%, S=30, lower bound=9

Explanation

As a European option cannot be exercised before its maturity date, the lower bound of its
premium is as follows:
Xe‐rt‐S, where
X is the strike price
t is the annualized remaining time
r is the risk‐free rate for this period of time
S is the current stock price
In this question, X=40, t=270/365, r=3%, S=30, lower bound=9

22. A company has announced that it is going to distribute a group of long‐lived assets to its owners in a spin‐off. The most appropriate way to account for the assets until the distribution occurs is to classify them as:

Held for use until disposal with depreciation continuing to be taken.

Held for sale with no depreciation taken.

Held for use until disposal with no deprecation taken.

Long‐lived assets that will be disposed of other than by sales, such as a spin‐off, an exchange for other assets, or abandonment, are classified as held for use until disposal and continue to be depreciated until that time. http://financial-dictionary.thefreedictionary.com/Spin+Off

Explanation

Long‐lived assets that will be disposed of other than by sales, such as a spin‐off, an exchange for other assets, or abandonment, are classified as held for use until disposal and continue to be depreciated until that time. http://financial-dictionary.thefreedictionary.com/Spin+Off

23. If an institutional investor wants to borrow money for 30 days to finance a bond purchase, which of these is most likely to be the lowest loan rate available?

Broker loan rate

Term repo rate

Call money rate

For institutional investors the term repo rate is less than the cost of bank financing (i.e., broker
loan rate or call money rate.)

Explanation

For institutional investors the term repo rate is less than the cost of bank financing (i.e., broker
loan rate or call money rate.)

24. Assume U.S. GAAP applies unless otherwise noted. An analyst determined the following information concerning Franklin, Inc.'s stamping machine: Acquired January 1, 1998 Cost $22 million, Depreciation straight-line method Estimated useful life 12 years, Salvage value $4 million As of December 31, 2004, the stamping machine is expected to generate $1,500,000 per year for five more years and will then be sold for $1,000,000. The stamping machine is:

Not impaired because annual expected revenue exceeds annual depreciation

Impaired because expected salvage value has declined.

Impaired because its carrying value exceeds expected future cash flows.

The carrying value of the stamping machine is its cost less accumulated depreciation. Depreciation taken through 2004 was (($22,000,000 ‐ $4,000,000) / 12) x 7 = $10,500,000 so carrying value is ($22,000,000 ‐ $10,500,000 =) $11,500,000. Because the $11,500,000 carrying value is more than expected future cash flows of ((5x$1,500,000) + $1,000,000 =) $8,500,000, the stamping machine is impaired.

Explanation

The carrying value of the stamping machine is its cost less accumulated depreciation. Depreciation taken through 2004 was (($22,000,000 ‐ $4,000,000) / 12) x 7 = $10,500,000 so carrying value is ($22,000,000 ‐ $10,500,000 =) $11,500,000. Because the $11,500,000 carrying value is more than expected future cash flows of ((5x$1,500,000) + $1,000,000 =) $8,500,000, the stamping machine is impaired.

25. A company is planning a new issue of $100 par preferred stock with a 12% dividend.The preferred stock can be sold for $95 per share and the company must pay flotationcosts of 5% of the market price. Assuming a marginal tax rate of 40%, the after‐tax costof the preferred stock is closest to:

13.3%

12.6%.

8.0%.

The component cost of preferred stock is calculated as: (100 × 0.12) / ﹝95 × (0.95)﹞= 0.133 or 13.3%.
Note that preferred stock is not tax advantaged.

Explanation

The component cost of preferred stock is calculated as: (100 × 0.12) / ﹝95 × (0.95)﹞= 0.133 or 13.3%.
Note that preferred stock is not tax advantaged.

26. A company's optimal capital budget is best described as the amount of new capital required to undertake all projects with an internal rate of return greater than the:

Weighted average cost of capital

Marginal cost of capital.

Cost of new debt capital.

The optimal capital budget is the amount of new capital required to undertake all investment
projects with an IRR greater than the marginal cost of capital

Explanation

The optimal capital budget is the amount of new capital required to undertake all investment
projects with an IRR greater than the marginal cost of capital

27. Carrying inventory at a value above its historical cost would most likely be permitted if:

Financial statements were prepared using U.S. GAAP.

The change resulted from a reversal of a previous write‐down.

The inventory was held by a producer of agricultural products.

IFRS allows the inventories of producers and dealers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products to be carried at a net realizable value even if above historical cost. (U.S. GAAP treatment is similar.)

Explanation

IFRS allows the inventories of producers and dealers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products to be carried at a net realizable value even if above historical cost. (U.S. GAAP treatment is similar.)

28. An analyst compared the performance of a hedge fund index with the performance of a major stock index over the past eight years. She noted that the hedge fund index (created from a database) had a higher average return, higher standard deviation, and higher Sharpe ratio than the stock index. All the successful funds that have been in the hedge fund database continued to accept new money over the eight-year period. Are the average return and the standard deviation, respectively, for the hedge fund index most likely overstated or understated?

Average return for the hedge fund index	Standard deviation for thehedge fund index
Overstated	Overstated
Overstated	Understated
Understated	Overstated

Overstated Overstated

Understated Overstated

Overstated Understated

Survivorship bias affects both the returns and the risk (standard deviation) reported for the hedge funds. Hedge funds with low or negative returns will be excluded from the index as will funds with high volatility; those funds will not survive for eight years. If only the successful funds remain in the index, the returns are overstated and the risk is understated. Overstated returns and understated risk will tend to overstate the Sharpe ratio.

Explanation

Survivorship bias affects both the returns and the risk (standard deviation) reported for the hedge funds. Hedge funds with low or negative returns will be excluded from the index as will funds with high volatility; those funds will not survive for eight years. If only the successful funds remain in the index, the returns are overstated and the risk is understated. Overstated returns and understated risk will tend to overstate the Sharpe ratio.

29. As an investor assumes more risk and moves upward on the efficient frontier, the slope of the efficient frontier curve most likely:

Increases and expected return per unit of risk decreases.

Decreases and expected return per unit of risk increases.

Decreases and expected return per unit of risk decreases.

Describe the efficient frontier, and explain the implications for incremental returns as an investor assumes more risk The efficient frontier is curved. As an investor moves up the curve, risk increases and the slope decreases. The decreasing slope means that adding equal increments of risk provide diminishing increments of expected return.

Explanation

Describe the efficient frontier, and explain the implications for incremental returns as an investor assumes more risk The efficient frontier is curved. As an investor moves up the curve, risk increases and the slope decreases. The decreasing slope means that adding equal increments of risk provide diminishing increments of expected return.

30. A producer's supply function is given by the equationQ=‐55+26Ps+1.3Pawhere Q is the quantity of steel supplied by the market, Ps is the per unit price of steel, and Pa isthe per unit price of aluminum. If the unit price of aluminum is 10, the slope of the supply curve is closest to:

0.04.

1.30.

26.00.

The slope coefficient of Q. in the inverse supply function is 0.04.
Start with the supply equation : Q=‐55+26Ps+1.3Pa
Insert Pa=10; =‐55+26Ps+1.3Pa(10)
=‐42+26 Ps
Solve for Ps : Ps=1.6+0.04Q (the inverse supply function)

Explanation

The slope coefficient of Q. in the inverse supply function is 0.04.
Start with the supply equation : Q=‐55+26Ps+1.3Pa
Insert Pa=10; =‐55+26Ps+1.3Pa(10)
=‐42+26 Ps
Solve for Ps : Ps=1.6+0.04Q (the inverse supply function)