JUN18L1/EP04

QUANTITATIVE METHODS

Question 1
Consider the following statements regarding the properties of the Student's t-distribution.
 I: The t-distribution is defined by degrees of freedom.
 II: The t-distribution has more probability in the tails than the normal distribution.
 III: The t-distribution approaches the standard normal as the degrees of freedom decrease.
Which of the following is true?
a) I and II.
b) II and III.
c) I and III.
The Student's t-distribution is a symmetrical probability distribution. It has the following properties:
 The t-distribution is defined by a single parameter known as degrees of freedom.
 The t-distribution has more probability in the tails than the normal distribution.
 The t-distribution approaches the standard normal as the degrees of freedom increase.

Question 2
An analyst is modeling the probability distribution of the values (prices) for the Dow Jones Industrial Average (DJIA).
The analyst will most likely use a:
a) normal distribution, which has no skew.
b) lognormal distribution, which has no skew.
c) lognormal distribution, which is skewed to the right.
The lognormal distribution is widely used for modeling the probability distribution of share and other asset prices. The
lognormal distribution of values (prices) for the Dow Jones Industrial Average (DJIA) is bounded below by 0 and it is
skewed to the right (it has a long right tail).

Question 3
A positive economic performance for the succeeding year has a 90% chance of happening and a 10% chance if it's
otherwise. If it's the first, ABC Co. will have a 70% chance of obtaining an EPS of $8.00 and 30% chance of getting a
$4.00 EPS. If the economy turns out to have a negative performance for the succeeding year, then ABC Co. has an
85% chance of getting an EPS of $1.50 and 15% chance of obtaining $2.00. How much EPS is expected out of the
given situation?
a) 6.28
b) 6.12
c) 6.16
6.28 is computed by multiplying the probabilities of the economic outcome by the probability of the EPS and the EPS.
The total of all four outcomes is the expected EPS.
(0.90 × 0.70 × $8.00) + (0.90 × 0.30 × $4.00) + (0.10 × 0.85 × $1.50) + (0.10 × 0.15 × $2.00) = $5.04 + $1.08 +
$0.1275 + $0.03 = $6.28.

Question 4
Technical analysis can most likely be applied to identify:
a) Short-term trends only.
b) Long-term trends only.
c) Both short-term and long-term trends.
Technical analysis can be used to identify short-term and long-term trends.

Question 5
An investment of $3,000 is made at the beginning of each of the next 7 years. Given an interest rate of 0.67%, the
value of this investment 11 years from today is closest to:
a) $21,570
b) $22,154
c) $22,007
This cash flow stream is an annuity due.
With the calculator in END mode:
PMT = −$3,000; N = 7; I/Y = 0.67; CPT FV; FV = $21,426.85
The value of the annuity due at the end of Year 7 is:
$21,426.85 × 1.0067 = $21,570.41
The future value of the cash flow stream after another 4 years (Year 11) equals:
N = 4; I/Y = 0.67; PV = −$21,570.41; CPT FV; FV = $22,154.32
Question 6
An investor's trades in a stock over a period of 2 years are given below:
 Purchased 10 shares on July 1, 2007 for $50/share.
 Purchased another 5 shares of the same stock on July 1, 2008 for $100/share.
 Sold all shares on July 1, 2009 at $90/share.
Assuming that the stock doesn't pay any dividends, her money-weighted and time-weighted rates of return are closest
to:
Money-Weighted ROR Time-Weighted ROR
A. 23.23% 34.16%
B. 21.75% 34.16%
C. 23.23% 48.32%
a) Row A
b) Row B
c) Row C
Time weighted ROR
Holding Period 1
July 1, 2007 beginning value = (10)($50)= $500
July 1, 2008 ending value = (10)($100) = $1,000

Holding Period 2
July 1, 2008 beginning value = (15)($100)= $1500
July 1, 2009 ending value = (15)($90) = $1350

Time weighted ROR = [(1 + HPR1)(1 + HPR2)]0.5 − 1 = [(1 + 1)(1 + (−0.1)]0.5 − 1 = 0.3416 or 34.16%
The money-weighted ROR is simply the IRR of the cash flow stream. Calculator keystrokes for the BA II Plus for IRR:
[CF] Enters the cash flow function.
[2ND][CE|C] To clear the cash flow memory registers.
[500][−][ENTER] Value for CF0. Negative sign because this is an outflow.
[↓][500][+/−][ENTER] Value for C01. This is also an outflow.
[↓][↓][1,350][ENTER] Value for C02. This is an inflow.
[IRR][CPT] To calculate the IRR.
IRR = 21.75%

Question 7
An analyst gathered the following information about the required rate of return of different stocks held in a portfolio:
Interval Req. ROR Absolute Frequency
1 5% – 6% 1
2 6% – 7% 3
3 7% – 8% 4
4 8% – 9 % 2
5 9% – 10% 3
The relative frequency and cumulative relative frequency of Interval 4 are closest to:
Relative Frequency Cumulative Relative Frequency
A. 15% 23%
B. 20% 77%
C. 15% 77%
a) Row A
b) Row B
 c) Row C

or 15%

Cumulative relative frequency is the cumulative frequency of 4th interval divided by the total number of observations:

Question 8
The effective annual rate for an automobile loan that has an interest rate of 7%, compounded monthly, is closest to:
a) 7.35%
b) 7.23%
c) 8.12%
EAY = [1 + (0.07/12)]12 – 1 = 7.23%

Question 9
What will be the worth of an investment of $5,000 at an interest rate of 6% assuming continuous compounding at the
end of four years?
a) $6,200.
b) $6,312.
c) $6,356.

Question 10
An investor owns a $100,000 portfolio invested in three exchange traded funds (ETFs). He allocated $25,000 to
ETF01 with a beta of 1.20; $25,000 to ETF02 with a beta of 0.98; and $50,000 to ETF03 with a beta of 1.05. The beta
of the portfolio is closest to:
a) 1.08
b) 1.07
c) 1.06
A portfolio's beta is simply the weighted average of the betas of the assets that constitute the portfolio. The weights
applied to the respective asset betas are the dollar values invested in each divided by the total value of the portfolio. In
this problem, ETF01 has 25% of the value, ETF02 has 25%, and ETF03 has 50%. The beta of the portfolio can be
computed as: 0.25(1.20) + 0.25(0.98) + 0.50(1.05) = 1.07.

ECONOMICS

Question 11
Which of the following is least likely true?
a) A monopoly firm cannot charge a price that equals marginal cost without government subsidy.
b) Firms in an oligopoly market can charge a price that equals marginal cost through collusion.
c) Supply curve for a monopolistic firm is given by the marginal cost curve.
Marginal cost curve and average cost curve do not represent the supply curve of a monopolistic firm. They represent
the supply curve only for perfect competition. A monopoly firm cannot charge a price that equals marginal cost, as the
company will not cover its average cost. The difference between average cost and competitive price should be
compensated by government subsidy. Collusion among oligopoly firms lead to charging the price at which the profit is
maximum.

Question 12
If consumers in France were persuaded to buy only locally produced goods, would France's economy improve?
a) Yes, it is cheaper for the country than imposing trade restrictions.
b) Yes, improved corporate profitability could be used to increase wages.
c) No, the value of goods produced would decline if French consumers buy products that are relatively
inefficiently produced domestically.
The production of goods where the country has high opportunity costs would continue, whereas it is better if these
goods are imported and the country focuses on producing goods where there is a low opportunity cost. The value of
total output is critical to a nation's well-being rather than short-run changes in employment.

Question 13
A contractionary fiscal policy would least likely include:
a) payroll tax increases.
b) an increase in government spending.
c) increased budget surplus.
Expansionary fiscal policy usually includes an increase in government spending or a reduction in taxes.

Question 14
When a government issues a trade tariff versus a trade quota, what is its expectation for growth in tax revenue?
a) Goes higher
b) Stays unchanged
c) Goes lower
The main difference between tariffs and quotas is that the government earns direct revenue through tariffs, but not
with quotas.

Question 15
Consider the following statements:
Statement 1: An increase in unit labor cost (ULC) implies that inflationary pressures on the economy are easing.
Statement 2: Demand-pull inflationary pressures on the economy are generally analyzed based on capacity utilization
levels.
Which of the following is most likely?
a) Only Statement 1 is correct.
b) Only Statement 2 is correct.
c) Both statements are incorrect.
If wage rates grow at a faster rate than labor productivity, businesses’ costs per unit of output (OLC) increase.
Businesses then look to increase output prices to protect profit margins so inflationary pressures build on the
economy.
Statement 2 is correct.

Question 16
Activity in which of the following sectors is most sensitive to changes in interest rates?
a) External sector
b) Housing sector
c) Consumer sector
Since most home purchases are financed with mortgage loans, housing sector activity tends to be very sensitive to
changes in interest rates. A decrease in interest rates tends to increase home purchasing and construction.

Question 17
Bond market vigilantes are likely to trade actively in the market if:
a) the monetary authority lacks credibility.
b) bond prices have weakened in the last year.
c) real interest rates are at zero.
The bond “vigilantes” will be major players in the market, shifting interest rates one way or another if the central bank's
policy tools are insufficient in changing the direction of the bond market.

Question 18
The imposition of export subsidies on a product will, in the exporting country, increase:
a) The producer surplus.
b) The consumer surplus.
c) Government revenues.
Producers will have the incentive to shift sales from the domestic market to the export market, where they can receive
the international price plus the subsidy. This increases the producer surplus and reduces the consumer surplus. The
government will have to pay the subsidy reducing revenues.

Question 19
If price is less than average total cost but greater than average variable cost, in the short run, the firm is most likely to:
a) Shut down immediately.
 b) Continue to produce.
c) Make economic profits.
As long as price exceeds average variable cost, in the short run the firm will continue production so that total losses
are less than total fixed costs.
The firm would exit immediately if price were less than average variable cost.
The firm would make economic profits if price were greater than average total cost.

Question 20
If real interest rates are 3% and inflationary expectations are 2.5%, the nominal interest rate in public markets most
likely will be:
a) greater than 5.5%.
b) equal to 5.5%.
c) less than 5.5%.
Nominal interest rates are based on a real interest rate, an expectation of inflation, and a risk premium to compensate
for the uncertainty of future values of real growth and inflation.

FINANCIAL REPORTING & ANALYSIS

Question 21
Mike, an analyst, needs to understand the accounting policies, methods, and estimates used in the preparation of
financial statements. Among the complete set of financial statements, which portion should he refer to?
a) Statement of cash flows
b) Financial review by the management
c) Notes to financial statements
The statement of cash flows shows the liquidity and financial flexibility of the company's operations over a certain
period of time. Financial review by the management describes and explains the main features of the entity's financial
performance and financial position, including principal uncertainties. The notes disclose the choice management made
in account policies, estimates, and methods.

Question 22
Sheena Kereta, CFA, is a financial analyst specializing in the valuation of auto companies. She has spent the last
week gathering information two competing auto manufacturers in Malaysia. Each company manufactures a single low
cost model and sells it in a highly competitive market. The sales price and units sold vary due to intense competition in
the low-cost segment. Sheena has summarized the information in the table below.
Penang Langkawi
Number of units produced and sold 300,000 330,000
Standard deviation of unit sales 30,000 19,800
Sales price per unit MYR 25,000 MYR 30,000
Variable cost per unit MYR 10,000 MYR 17,000
Fixed operating cost MYR 2,500,000,000 MYR 2,000,000,000
Interest expense MYR 1,000,000,000 MYR 1,500,000,000
The operating breakeven points for Penang Autos and breakeven point for Langkawi Autos are closest to:
a) 166,667 and 269,231 units, respectively.
b) 166,667 and 233,333 units, respectively.
c) 153,846 and 269,231 units, respectively.
For Penang Autos, the operating breakeven is calculated as follows:

For Langkawi Autos, the breakeven is calculated as follows:

Question 23
An analyst believes that a company has changed its accounting policy with respect to depreciation method used.
The most likely best way to confirm this belief is to review the company's:
a) recent press releases.
 b) income statements for the past two years.
c) notes to the most recent financial statements.
The company is required to disclose changes in accounting policies and the most likelyplace to find this disclosure is
in the notes. The MD&A may also discuss the change if it is significant. A company is unlikely to discuss accounting
policies in press releases and it is extremely unusual to disclose accounting policies directly on the face of a financial
statement, such as the income statement.

Question 24
The payment of dividends to preferred shareholders falls under which element of the financial statements?
a) Expenses.
b) Equity.
c) Liabilities.
Payment of dividends falls under the element of Equity.

Question 25
Which statement would an analyst most likely use to evaluate additional financial performance aspects of a company'
a) Balance sheet.
b) Statement of cash flows.
c) Statement of changes in equity.
The statement of cash flows provides another important perspective of a company's performance for the analyst. The
classification and presentation method allow analysts to more readily assess from which activities the business
generates its cash flow. An analyst can assess whether the majority of a business' cash is generated from its main
operating activities or its investing or financing activities. The balance sheet is used by analysts to answer questions
about a company's financial position. The statement of changes in equity reports reconciliations of the components of
owners' equity.

Question 26
Which of the following is a suitable method for computing free cash flow to the firm?
a) Sum of operating cash flows and capital expenditures minus after-tax interest payments.
b) Net operating cash flows after deducting after-tax interest payments and capital expenditures.
c) Sum of operating cash flow and after tax interest payments minus capital expenditures.
Free cash flow to the firm is equal to operating cash flows plus after-tax interest expense minus capital expenditures.

Question 27
Which of the following statements is least likely true as per U.S. GAAP?
a) Disclosure in the footnotes is not required when a correction of prior-period errors is made by restating all
prior-period financial statements presented in the financial report.
b) A change in an accounting estimate affects financial statements only for current and future.
c) A change in accounting policy is applied retrospectively and justification for the change is provided in the
footnotes to the financial statements.
A correction of errors for prior period is made by restating all prior-period financial statements presented in the
financial report. Disclosure in the footnotes is also required for any correction of the prior-period errors.

Question 28
On 1 January 2010 Visionary Toys purchased advanced 3D printers for their design studio at a cost of €820,000. The
printers have an estimated useful life of four years and an estimated salvage value of €60,000. What depreciation
expense would the company report for financial reporting purposes under the double-declining balance method in year
1?
a) €190,000
b) €380,000
c) €410,000
The double-declining balance uses twice the rate of the straight-line method which in this scenario is 25% and making
the accelerated rate 5%. The 50% is applied to the original asset cost ignoring residual value (€820,000 × 50% =
€410,000).

Question 29
Which of the following statements regarding the cash flow statement is least accurate?
a) The cash flow statement provides information on the sources and use of cash.
b) Firms are required to provide a reconciliation between cash flow and income statement items.
 c) The total cash flow in a year is equal to the change in cash and cash equivalents recorded in the beginning
and end-year balance sheets.
An analyst can reconcile items on the cash flow statement against income statement and balance sheet items, but a
firm is not required to provide the reconciliation.
Question 30
Which of the following is least likely a format for the balance sheet?
a) Report format
b) Multi-step format
c) Account format
A balance sheet may either be presented in an account format or a report format. The multi-step format may be used
to prepare an income statement.

Question 31
A company’s balance sheet indicates that it has sufficient cash and short-term investments. However, its payables
turnover ratio remains low. This most likely suggests that:
a) The company has a liquidity crisis.
b) The company’s suppliers offer it lenient credit terms.
c) The company has excellent receivables collection policies.
If the company has sufficient liquid assets and still has a low payables turnover ratio, its suppliers are probably
offering lenient credit and collection terms.

Question 32
Simple Times Limited purchased 1,000 units throughout the year at an average price of $50. The account manager
has detailed records and the company has an advanced inventory management system in place tracking information
about each unit's purchase price, time in inventory, sales price, etc. At the end of the year, there are 125 units
remaining in inventory. The accounting manager identified the purchase date and price for each unit to calculate
ending inventory. The dates of the purchases span the entire year. Which inventory valuation method does this
company most likely use?
a) First in, first out (FIFO).
b) Weighted average method.
c) Specific identification method.
The specific identification method means the exact items sold and those in inventory can be identified and therefore
cost of goods sold and ending inventory are recorded based on the specific unit costs. Weighted average method
would have taken the average purchase price of the inventory multiplied by the remaining units in inventory. Under
FIFO the units remaining in ending would be calculated based on the most recent prices; the prices would not span
the entire year.

Question 33
According to IFRS, expenses include decreases in economic benefits from:
a) Decreases in liabilities, other than those related to owners’ equity.
b) Decreases in owners’ equity related to distributions made to them.
c) Incurrence of liabilities, other than those related to owners’ equity.
According to IFRS, expenses include decreases in economic benefits from an outflow or depletion of assets, or
incurrence of liabilities that result in decreases in owners’ equity, other than those relating to distributions to equity
participants.

Question 34
York Distilleries is considering which depreciation method to use for a new machine. Production is expected to be very
high initially, but will decrease over time. If York wants initially to minimize its debt-to-assets ratio, which of the
following methods would York most likely use?
a) Units-of-production method.
b) Double-declining balance method.
c) Straight-line method.
Initially, the lowest depreciation expense would result from the straight-line method, which would generate the highest
level of total assets, and thus the lowest debt-to-assets ratio.

Question 35
A company reports the following data on its fixed assets; it uses the straight-line depreciation method and the salvage
values are zero.
Gross PPE $1,050,000
Net PPE $420,000
 Depreciation expense $70,000
The remaining useful life of the PPE is expected to be:
a) 6 years.
b) 9 years.
c) 15 years.
Remaining useful life is the net PPE divided by the depreciation expense:
$420,000 / $70,000 = 6 years

Question 36
What action must be taken in order to avoid falsely relying on a company's financial ratios that were presented to
make it look healthier it actually was?
a) Review the chart of accounts for an increase in uncommonly named and out of the ordinary asset accounts
like “deferred marketing charges” or “deferred customer acquisition costs.”
b) Gather information on the industry average useful life of the assets which the company also uses and check
whether it is comparable with company estimates for the useful lives of its own assets.
c) Go over the balance sheet and notes and identify operating lease items, and then treat these as capital
lease arrangements.
The first choice is incorrect. Companies that wish to delay the recognition of its expense usually do so using these
unusual-sounding asset accounts. This activity helps detect those instances. The second choice is incorrect. This
activity is employed in order to check whether the company used reasonable estimates for the useful lives of its long-
lived assets. The third choice is correct. Operating leases can make it seem as if a company's ratios are healthier, as
these give a perception of lower leverage. By treating operating leases as capital leases, an analyst can view a more
conservative estimate of ratios that exclude off-balance sheet financing techniques.

Question 37
ABC Company reports the following amounts on its 2009 income statement and balance sheet:
Net income after tax: $25 million
Total assets: $400 million
Total liabilities: $300 million
Deferred tax assets: $35 million
Deferred tax liabilities: $45 million
A reduction in the statutory tax rate will most likely:
a) Benefit the income statement and have no effect on the balance sheet.
b) Benefit the income statement and improve the balance sheet.
c) Weaken the income statement and improve the balance sheet.
A reduction in the statutory tax rate will increase net profit after tax on the income statement. Further, it will reduce net
deferred tax liabilities and result in an increase in net assets (equity).

Question 38
The following information relates to Jaunt Products Inc. for the year ended 2012:
Cost of raw materials $ 8,000,000
Direct labor costs 11,000,000
Production overhead costs 3,000,000
Selling costs 500,000
Import taxes 800,000
Abnormal costs 150,000
Finished goods storage costs 400,000
Jaunt Products does not have any work-in-progress inventory at the year-end. What costs should be included in
inventory as per IFRS and U.S. GAAP?
IFRS U.S.GAAP
A. $23,300,000 $22,800,000
B. $22,000,000 $22,000,000
C. $22,800,000 $22,800,000
a) Row A
b) Row B
c) Row C
The costs to be included under both IFRS and U.S. GAAP are the same.
Total inventory costs = $8,000,000 + $11,000,000 + $3,000,000 + $800,000 = $22,800,000
Question 39
Which of the following statements is true?
a) The plan is overfunded if the fair value of plan assets is greater than the estimated pension obligation.
b) In a defined benefit plan, the firm promises to contribute a specific sum each period to the employee's
retirement account.
c) In a defined contribution plan, the firm contributes variable payments each period to the employee's
retirement account.
The first choice is correct. The second choice is incorrect. A defined benefit plan is a company pension plan in which
an employee's pension payments are calculated according to length of service and the salary they earned at the time
of retirement. The third choice is incorrect. A defined contribution plan is a type of retirement plan in which the
employer, employee or both make contributions on a regular basis.

Question 40
Mars Technologies uses the LIFO cost flow assumption to value inventory. For the year 2009, it reported the following
information in its financial statements:
 Revenue = $850,000
 Cost of goods sold = $370,000
 Other expenses = $120,000
 Interest expenses = $33,000
 Taxes paid = $24,000
 Beginning inventory = $1,200,000
 Ending inventory = $1,310,000
 Beginning LIFO reserve = $570,000
 Ending LIFO reserve = $720,000
 Ending retained earnings = $120,000
 Tax rate = 40%
Retained earnings if Mars Technologies used the FIFO cost flow assumption would be closest to:
a) $552,000
b) $180,000
c) $408,000
FIFO retained earnings = LIFO retained earnings + [LIFO reserve × (1 – Tax rate)]
FIFO retained earnings = 120,000 + [720,000 × (1 – 0.4)] = $552,000

Question 41
A strategy in which an investor invests in companies with P/E's above the industry median P/E is considered a:
a) value strategy.
b) growth strategy.
c) market-oriented strategy.
A growth strategy is a strategy in which the investor invests in companies with P/E's above the industry median P/E.

Question 42

Quarter Units Held/Purchased Unit Cost ($) Total Cost ($)

Opening Inventory 15 30 450
1 15 30 450
2 12 35 420
3 20 25 500
4 30 20 600
Total 92 2,420
Given that Tiara sold 10, 12, 15, and 20 units in the four quarters respectively, answer the following questions:
Ending inventory if the company uses LIFO cost flow assumption is closest to:
a) $725
b) $834
c) $1,075
Ending inventory consists of 92 – 57 = 35 units
Ending inventory value using LIFO = (15 × 30) + (15 × 30) + (5 × 35) = $1,075

Question 43
An analyst is comparing two companies' inventory figures.
DATA FOR COMPANIES ACCOUNTING FOR INVENTORY ON DIFFERENT BASES
Company A (FIFO) Company B (LIFO)
Current assets (includes inventory) $150,000 $40,000
LIFO reserve NA $10,000
Current liabilities 0$75,000 $22,500
Based solely on the data above, after the appropriate adjustment is made for inventory, the current ratio for Company
B will be:
a) higher than Company A's.
b) lower than Company A's.
c) the same as Company A's.
Higher than Company A's. After adjusting Company B's inventory to a comparable basis (i.e., to a FIFO basis),
Company B appears to be more liquid, as indicated by its current ratio of 2.22 [($40,000 + 10,000)/22,500] versus
Company A's ratio of 2.00 ($150,000/75,000).

Question 44
Aqua Domain Inc. received unearned revenue of $20,000. The revenue is taxed during the period in which it is
received. Assuming a tax rate of 25%, what is the associated deferred tax asset/liability, if any?
a) A deferred tax asset of $5,000.
b) A deferred tax liability of $5,000.
c) There is no deferred tax asset or liability.
Revenue received in advance results in a temporary difference that gives rise to a deferred tax asset of $5,000
($20,000 × 25%). Since revenue is taxed before it is earned, it will be nontaxable in future periods. The tax base is
zero, which is the carrying amount of $20,000 less revenue that is nontaxable in future periods of $20,000.

Question 45
A company received cash in Year 1 for rent revenue that will be recognized on its financial statements in Year 2.
However, authorities tax the revenue upon receipt of cash. This will most likely result in:
a) A deferred tax asset.
b) A deferred tax liability.
c) Neither a deferred tax asset nor a deferred tax liability.
The carrying value of the liability will be greater than its tax base. Therefore, a deferred tax asset will arise.

Question 46
Life Corp. incurred the following costs related to its inventory:
Purchase price: $3,500
Irrecoverable purchase taxes: $750
Additional fee for express shipping: $890
Insurance on shipment: $160
Storage costs of inventory: $320
What is the total cost that Life should capitalize to inventory?
a) $4,410
b) $5,300
c) $5,620
Additional fee for express shipping shall be expensed.

CORPORATE FINANCE

Question 47
A company invests $200,000 in a project that is expected to generate the following cash flows:
Years 1 2 3 4
Cash flows ($) 50,000 65,000 75,000 75,000
Given a discount rate of 10%, the project’s discounted payback period is closest to:
a) 3.13 years.
b) 4 years.
c) 3.9 years.
 Years 0 1 2 3 4
Cash flows ($) −200,000 50,000 65,000 75,000 75,000
Cumulative cash flows ($) −200,000 −150,000 −85,000 −10,000 65,000
Discounted cash flows ($) −200,000 45,454.55 53,719.01 56,348.61 51,226.01
Cumulative discounted cash flows ($) −200,000 −154,545.45 −100,826.44 −44,477.83 6,748.18
The discounted payback period for this investment equals 3 full years plus a fraction of the 4th year.
This fraction equals: 44,477.83 / 51,226.01 = 0.868
Therefore, discounted payback period = 3 + 0.868 = 3.868 years

Question 48
An analyst gathered the following information:
Inventory = $136,000
Cost of goods sold = $721,000
Number of days of receivables = 42 days
Number of days of payables = 33 days
The company’s operating cycle is closest to:
a) 78 days.
b) 47 days.
c) 111 days.
Number of days of inventory = 136,000 / (721,000 / 365) = 68.85 days
Operating cycle = 68.85 + 42 = 110.85 days

Question 49
In a dual-class structure, the goal is to:
a) allow more shareholders to vote on corporate issues.
b) separate voting power from ownership.
c) give management more participation in setting strategy.
The main reason to have a dual-class structure is to decouple voting power from ownership.

Question 50
A recent offering from Bell Curve Systems, Co. is a seven-year maturity preferred shares with annual dividends of
$15. The par value of the shares is $120. The shareholders require a 9% return from the shared. The market value of
Bell Curve's share is closest to:
a) $170.64
b) $123.08
c) $141.14
Since the preferred shares are redeemable, they are valued as though they are bonds.
PV of dividends = 15 × ((1 + 1.09−7)/0.09) = 75.4943
PV of par = 120/(1.097)= 65.6441
Total/Market price of preferred shares = 75.4943 + 65.6441 = 141.14.

Question 51
Penmakers Inc. is producing 500,000 pens per annum and the pens are sold at $10 each. Fixed costs are $1 million,
not including interest payments of $1.5 million. Variable costs are $3 per pen. The degree of financial leverage of
Penmakers Inc. is closest to:
a) 0.3 times.
b) 2.5 times.
c) 3.5 times.
The degree of financial leverage (DFL) = (Percentage change in net income) / (Percentage change in operating
income)

Question 52
ABC Corp. issued nonconvertible, noncallable preferred stock last year at an issue price of $100; it pays a dividend of
$5 per annum. The stock is now trading at $110. The company's marginal tax rate is 40%. The cost of preferred stock
for ABC Corp is closest to:
a) 2.7%.
b) 3.0%.
c) 4.5%.
The cost of preferred stock is the dividend divided by the price. There is no adjustment for tax, since a preferred
dividend is not a tax-deductible expense. The cost is $5 / $110 = 4.5%.

Question 53
An analyst gathered the following information regarding Alpha Associates:
Source of Capital Book Value ($ millions) Market Value ($ millions)
Common stock 37.5 52.8
Preferred stock 30 31.68
Bonds outstanding 7.5 11.52
Total capital 75 96
The company’s before-tax cost of debt and the cost of common equity are 9% and the cost of preferred equity is 11%.
Given that the company’s marginal tax rate is 30%, its weighted average cost of capital is closest to:
a) 9.66%
b) 9.48%
c) 9.34%
Percentage of equity in the capital structure = 52.8 / 96 = 55%
Percentage of debt in the capital structure = 11.52 / 96 = 12%
Percentage of preferred stock in the capital structure = 31.68 / 96 = 33%
WACC = (0.55 × 0.09) + [0.12 × 0.09 × (1 – 0.3)] + (0.33 × 0.11) = 9.336%

Question 54
Pluto Inc. issues a semiannual pay bond to finance a new project. The bond has a 20-year term, a par value of
$1,000, and offers a 7% coupon rate. Given that the bond is issued at $984.5 and that the company’s marginal tax
rate is 40%, the after-tax cost of debt is closest to:
a) 3.57%
b) 4.29%
c) 7.15%
N = 40; PV = −$984.5; FV = $1,000; PMT = $35; CPT I/Y; I/Y = 3.5734%
Before-tax cost of debt = 3.5734 × 2 = 7.1468%
After-tax cost of debt = 0.071468 × (1 – 0.4) = 4.29%

Question 55
Donald Investments has a target debt-to-equity ratio of 0.8. Given that the after-tax cost of debt is 5.6% and that the
company’s weighted average cost of capital is 10.8%, its cost of equity isclosest to:
a) 14.96%
b) 31.60%
c) 4.62%
0.108 = (1/1.8 × Cost of equity) + (0.8/1.8 × 0.056)
Cost of equity = 14.96%

Question 56
Recently Pomona Rental noticed that its receivables turnover had gone down from 15 to 12 times. This most likely is
explained by the fact that:
a) Pomona has switched to a more strict credit policy.
b) Pomona's clients are taking longer to pay on their payables due to Pomona.
c) Pomona is collecting its receivables faster.
A lower receivables turnover indicates that the company is taking longer time to collect on its receivables; i.e., clients
are delaying the payment due to Pomona.

Question 57
Stanley Wills, CFA, wants to determine the cost of debt of DB-Locke Co. The firm's debt is not publicly traded, so
Stanley uses the debt rating of a comparable bond with a maturity close to that of DB-Locke's debt. Stanley is using
the:
a) Substitution approach.
b) Evaluated pricing approach.
c) Discount pricing.
The first choice is incorrect based on Reading 36. The second choice is correct. This approach is an example of
matrix pricing or evaluation pricing. The third choice is incorrect based on Reading 36.

Question 58
Which stakeholder group is most protected by the legal attributes of their relationship with the company?
a) Shareholders
b) Creditors
c) Senior management
Creditors have the most protection, as seen in their agreements and contracts. Indentures, covenants, and other
aspects of their contracts give them a position that is most protected.

Question 59
An analyst has gathered the following information on a company and the market:
Current market price of company's common shares $10.20
Common stock dividend yield, based on most recent dividend paid 2.45 percent
Expected dividend payout rate 20 percent
Expected return on equity (ROE) 15 percent
Beta for company's common stock 1.4
Asset beta for company's industry 0.9
Expected rate of return for the market portfolio 10 percent
Risk-free rate of return 4 percent
Using the dividend discount model (DDM) approach, the cost of equity is closest to:
a) 14.0 percent.
b) 14.5 percent.
c) 14.7 percent.
To use the DDM approach, we need the growth rate and the dividend yield based on next year's dividend. Let's start
with the growth rate, which is calculated using the sustainable growth rate method:

G = (1 – D / EPS) ROE = (Retention rate) ROE = (1 − Payout rate) ROE = (1 − 0.2) 0.15 = 0.12

To find the dividend yield on next year's dividend, we can either calculate the current year's dividend, grow this
amount at our 12 percent growth rate, and then divide by the stock price or we can more simply (if you have a strong
understanding of how the numbers work) grow the current dividend yield of 2.45 percent by 12 percent. The two
approaches are shown below:

Approach 1: D0 = Current Yield × Price = 0.0245 × $10.20 = $0.25

D1 = D0 x (1+g) = $0.25 x (1+0.12) = $0.28

Yield based on next year's dividend = $0.28/$10.20 = 0.02744

Approach 2: Yield based on next year's dividend = 0.0245 × (1 + 0.12) = 0.02744

Now, we can find the cost of equity:

Re = D1 / P0 + g = 0.02744 + 0.12 = 0.14744 or approximately 14.7 percent

Question 60
An analyst is calculating the weighted average cost of capital (WACC) for STR Industries. The analyst has gathered
the following data for his calculation:
Market value of STR's equity $5.6 billion
Common shares outstanding for STR 200 million
Pre-tax cost of new debt for STR 5.5 percent
Market value of STR's debt $12.3 billion
STR's equity beta 1.2
Next year's dividend for STR's shares $1.40 per share
STR's growth rate 3.5 percent
Risk-free rate of interest 2.0 percent
Equity risk premium 4.0 percent
STR's marginal tax rate 30 percent
The company's WACC using the dividend discount model is closest to:
a) 4.8 percent.
b) 5.3 percent.
 c) 6.4 percent.
The first step is to find the cost of equity using the dividend discount model. The stock price used in the model is $28,
which is total equity of $5.6 billion divided by 200 million shares. The calculated cost of equity is:

Re = D1 / P0 + g = $1.40 / $28.00 + 0.035 = 0.085 = 8.5 percent

The WACC is then calculated using the data provided and the calculated cost of equity from above.

WACC = wdrd (1 − t) + were = ($12.3 / ($12.3 + 5.6)) (0.055) (1−0.30) + ($5.6 / ($12.3 + 5.6)) (0.085) = 5.3percent

Question 61
The current debt-to-equity ratio of Lonarde Corporation is 1.2. It has a target debt-to-equity ratio of 0.8. Its cost of
equity is 6% up to $120,000 in total equity, after which the weighted average cost of capital (WACC) will increase. The
corresponding break point in Lonarde's marginal cost of capital schedule is closest to:
a) $216,000.
b) $264,000.
c) $270,000.
Percentage of equity in the total capital structure = 1 / (1 + Debt-to-equity ratio) = 1 / (1 + 0.8) = 56%
Break point = Amount of capital at which the source's cost of capital changes / Proportion of new capital raised from
the source
= $120,000 / 0.56 = $216,000

PORTFOLIO MANAGEMENT

Question 62
If the investor is more likely to bear risk but his ability to bear such risk is low:
a) In the evaluation of assets, the low ability to bear such risk shall have higher priority.
b) The portfolio manager may follow the investor's instructions and invest in risky assets.
c) Then no problem exists.
The first choice is correct. This statement is true. The second choice is incorrect. Regardless of the investor's
instructions, the portfolio manager must use the investor's ability to bear risk to evaluate assets. The third choice is
incorrect. There exists a problem since the investor does not have the ability to bear risk which he is willing to bear.

Question 63
A portfolio consisted of only Treasury securities and AAA rated corporate bonds, but recently the portfolio manager
added a series of BBB+ rated corporate bonds to the portfolio. This action most likely enhances the utility of a:
a) Risk-averse investor.
b) Risk-neutral investor.
c) Risk-seeking investor.
Additional risk enhances the utility of a risk-seeking investor. Thus, the addition of riskier BBB+ corporate bonds
results in an increase in the utility of a risk-seeking investor.

Question 64
Which of the following statements about money weighted return is false?
a) The beginning value and additional deposits are considered inflows.
b) The ending value is not considered as an outflow.
c) The computation of the IRR is based on the portfolio's cash inflows and outflows.
The first choice is incorrect. This statement is true because the beginning value and additional deposits are
considered as inflows. The second choice is correct. The withdrawal of cash, interest, dividends and the ending value
are considered as outflows. The third choice is incorrect. This statement is true because the portfolio's cash inflows
and outflows are considered in the computation of the IRR.

Question 65
Beta is computed by:
a) Dividing the product of the covariance of an asset's return with the market returns and the standard
deviation of asset's return by the standard deviation of market's return.
b) Dividing the covariance of the asset return with the market return by the variance of market return.
c) Both equations give beta.
The first choice is incorrect. Beta can be computed by dividing the product of the correlation of an asset's return with
the market returns and the standard deviation of asset's return by the standard deviation of market's return. The
second choice is correct. This is the equation for beta. The third choice is incorrect. Only one of the choices gives the
equation of beta.

Question 66
The following information is available regarding the portfolio performance of three investment managers:
Manager Return Standard Deviation Beta
A 19% 27% 0.7
B 14% 22% 1.2
C 16% 19% 0.9
Market (M) 11% 24%
Risk-free rate 5%
Manager C’s Treynor ratio is closest to:
a) 0.2000
b) 0.1222
c) 0.5789
Treynor ratio = (RC – Rf) / β C = (0.16 – 0.05) / 0.9 = 0.1222

Question 67
Consider the following statements:
Statement 1: The portfolio should achieve returns within 5% of the returns on the S&P 500 Index.
Statement 2: The portfolio should outperform the benchmark index (the S&P 500 Index) by one percentage point
each year.
Which of the following is most accurate?
Statement 1 is a(n): Statement 2 is a(n):
A Relative return objective Absolute return objective
B Relative risk objective Relative return objective
C Absolute return objective Relative return objective
a) Row A
b) Row B
c) Row C
Specifying a standard deviation of returns relative to that of a benchmark index is a relative risk objective.
Specifying portfolio return relative to a benchmark is a relative return objective.

Question 68
If Suzanne allocated to two different asset classes, each of which had a standard deviation of 20% and a correlation of
0.9, what would her portfolio standard deviation be?
a) 20%
b) Higher than 20%
c) Lower than 20%
Anytime a correlation between two assets is less than 1, diversification benefits are achieved. In this example,
portfolio standard deviation would fall, but not by a large amount.

Question 69
Asset allocation is part of which step in the portfolio management process?
a) The planning step.
b) The feedback step.
c) The execution step.
The execution step is the second step and includes asset allocation, security analysis, and portfolio construction.

Question 70
How many stocks does an investor need to practically eliminate diversifiable risk?
a) 6-8 stocks.
b) 25-30 stocks.
c) 100-110 stocks.
An investor can effectively eliminate diversifiable risk by investing in 25-30 stocks. Adding a large number of stocks to
the portfolio will have an unnoticeable impact on the standard deviation of the portfolio.

Question 71
A portfolio that lies to the left of the market portfolio on the CML is:
a) A borrowing portfolio.
b) A lending portfolio.
c) An efficient portfolio.
A portfolio to the left of the market portfolio on the CML is less risky, as investors lend a proportion of their funds at the
risk-free rate.

Question 72
Nesrin built a portfolio out of an investments universe of 10 stocks. She is considering adding another stock. What can
she do to improve the efficiency of her portfolio?
a) Select a stock that offers an expected return higher than that of the portfolio.
b) Select a stock that has a standard deviation lower than that of the portfolio.
c) Select a stock that has a low correlation with the portfolio.
An efficient portfolio is one that offers the highest return for a given level of risk. Selecting a stock that has a low
correlation with the portfolio is very likely to lower the portfolio's standard deviation with little impact on the return.

Question 73
Which of the following statements is false?
a) The strategic asset allocation is required to create the IPS.
b) Investments considered for strategic asset allocation include both traditional and alternative investments.
c) Allocations of the included assets classes are stated in the strategic asset allocation.
The first choice is correct. The strategic asset allocation shall be developed after the creation of the IPS.

Question 74
The optimal risky portfolio is a portfolio:
a) that carries the highest Sharpe ratio among all possible portfolios made of risky assets.
b) that carries the least amount of risk. It is the global minimum variance portfolio.
c) that carries the highest expected rate of return among all portfolios on the Markowitz efficient frontier.
The optimal risky portfolio carries the most reward in return per unit of risk taken.

Question 75
Which of the following portfolios will be least preferred by a risk-averse investor?
a) Portfolio A having return on investment as 10% and risk on investment as 2%.
b) Portfolio B having return on investment as 10% and risk on investment as 4%.
c) Portfolio C having return on investment as 14% and risk on investment as 4%.
A risk-averse investor will prefer the portfolio which has lowest risk for a given rate of return. However, he will be
willing to take additional risk if he is compensated by additional return.

Question 76
A portfolio manager earned the following annual returns for a mutual fund. Compute the geometric mean return over
the three years.
Year 2010 2011 2012
Return 17% −9% 8%
a) 2.35%
b) 3.47%
c) 4.77%
Geometric mean return = [(1.17)(0.91)(1.08)]1/3 − 1 = 4.77%

EQUITY

Question 77
Increasing the cost of borrowing shares most likely:
a) Enhances market efficiency.
b) Has no impact on market efficiency.
c) Hinders market efficiency.
A higher cost of borrowing shares limits short selling, which impedes market efficiency.

Question 78
Each of the constituents of a float-adjusted market-capitalization-weighted index is weighted by its price and:
a) its trading volume.
b) the number of shares outstanding.
c) the number of its shares available to the investing public.
Float is measured as the number of shares available to the investing public.

Question 79
Which of the following rules is most likely to be included in a listing of regulations to implement in order to meet the
objectives of market regulation?
a) Requiring that all companies use the same accounting choices (depreciation methods, revenue recognition,
etc).
b) Setting the minimum amount of reserves that a pension fund must maintain to meet its promises to its
clients.
c) Requiring that a broker-dealer disclose all of the specific information it has that pertains to its information
advantage relative to a client.
Setting minimum capital and reserve requirements is something that regulators will do in order to achieve their
objectives. With respect to accounting, regulators will require common accounting standards, but will not specify what
specific choices have to be made. In addition, it is not practical to implement a rule requiring a broker-dealer disclose
the information that gives it an information advantage over a client.

Question 80
Which of the following items would not be considered a consumer discretionary good?
a) An automobile.
b) Food away from home.
c) Tobacco.
Tobacco is considered a consumer staple along with food and beverages consumed at home.

Question 81
United Oil Corporation is a blue-chip company in the petroleum industry, based in Colorado. Paleo Group Inc.
purchased various products from United Oil and transported them to client locations at a 40% margin for more than
two decades. However, over the past five years, Paleo's performance was dramatically regretful. The auditors of
Paleo had raised serious concerns during the audit for the year 2013, especially on the company's liquidity position.
By the end of the first quarter of 2014, rumors of a takeover of Paleo by United Oil were reported by the financial
media. However, many of these reports started claiming the backing of “unidentified top-level directors” of both
companies from the first week of May. On May 15, in a press conference, officials of United Oil declared that the
company will not acquire Paleo. However, United Oil will provide a substantial cash loan to Paleo on a long-term
basis.
A new legislation, which regulates the oil and petroleum industry, was passed by government during January 2014.
The act necessitated spending large amounts of money on disposal of waste oils and protection of the environment.
The act came into existence in the first week of May, and the share prices of United Oil came down by 25% in a week.
Assuming the market to be highly efficient, the market value of:
a) Paleo's shares will fall significantly during the second half of May.
b) Paleo's shares will remain relatively constant during April.
c) United Oil's shares will rise substantially in January.
An efficient market is a market in which asset market prices reflect new information quickly and rationally. If the market
is highly efficient, the market value of Paleo's share prices would have remained relatively constant during April. This
is because a highly efficient market is unlikely to aggressively respond to media reports.

Question 82
Aqua World Corporation raised $336 million through an initial public offering (IPO) of 80 million shares at $4.20 per
share. On the first day of trading, the opening and closing prices were $4.40 and $4.52, respectively. Around 7 million
shares were traded and lowest and highest prices for the day were $4.38 and $4.54, respectively. The return of the
IPO subscribers on the first day is closest to:
a) 6.2%.
b) 7.6%.
c) 8.1%.
First day return = [($4.52 − $4.20) / $4.20] × 100 = 7.6%

Question 83
After analyzing the stock of Beta Inc., Megan concludes that the stock is undervalued and its price will soon increase.
Based on her conclusions, she should least likely:
a) Purchase put options for the company’s stock.
 b) Purchase call options for the company’s stock.
c) Write put options on the company’s stock.
Megan expects the price of Beta Inc.’s stock to increase and therefore should either purchase call options for the
company’s stock or write put options on the company’s stock. Purchasing call options would give her the right to
purchase the company’s stock when its price increases. On the other hand, writing put options on the company’s
stock would give the other party the right to sell the company’s stock. The option would not be exercised if the price
rises, and Megan would be able to keep the option premium.

Question 84
Compared to a forward contract, a futures contract has:
a) less counterparty risk.
b) ability to be customized.
c) more flexibility in terms of maturity date.
(A) A futures contract settles through a clearinghouse and the clearinghouse guarantees performance. Therefore,
there is no counterparty risk. A forward contract, not a futures contract, can be customized and is more flexible in
terms of contract size and maturity date.

Question 85
Real estate investment trust indices can most likely be categorized as:
a) Multi-market indices.
b) Appraisal indices.
c) Price-weighted indices.
Real estate investment trust indices can be categorized as:
 Appraisal indices.
 Repeat sales indices.
 Real estate investment trust (REIT) indices.

Question 86
If a firm pays out 30% of its earnings as dividends, its return on equity is 12%, and its return on capital is 8%, then the
long-term dividend growth rate is closest to:
a) 3.6%.
b) 5.6%.
c) 8.4%.
Growth = Earnings retention rate × Return on equity = 0.7 × 12% = 8.4%

Question 87
In explaining the justified forward price-to-earnings (P/E) ratio, an analyst stated that the calculated forward P/E will
rise if an assumption is changed, such as assuming a (1) higher dividend growth rate than before; (2) lower payout
ratio than before; or (3) higher required rate of return than before. The analyst is correct with respect to the:
a) higher dividend growth rate, only.
b) higher dividend growth rate and lower payout ratio, only.
c) lower payout ratio and higher required rate of return, only.
A forward P/E is positively related to the payout ratio and dividend growth rate and inversely related to the required
rate of return. Thus, the calculated forward P/E increases when the growth rate rises, retention ratio increases, or the
required rate of return declines. This means the analyst is correct with respect to the higher growth.

Question 88
A trader is considering either selling XYZ's shares short, which are trading at $30.00, or writing call options on the
shares with a strike price of $30.00. The estimated option premium is $6.50 and it expires in 90 days. In comparing
the two potential positions, writing the call option will have a:
a) lower total gain if XYZ's shares drop to $0 in 90 days.
b) higher total loss if XYZ's shares rise to $40 in 90 days.
c) higher total loss if XYZ's shares are trading at $30 in 90 days.
To short stock, the trader has to borrow the share and post collateral. If the shares decline in value, they can be
bought back at a lower price in order to profit from the trade. The maximum gain is 100 percent, which occurs if the
shares drop to zero in value. If the stock rises, the shares still have to be bought back and the trader loses the
difference between the price paid to buy the shares and the price at which they were originally shorted. The downside
potential is unlimited as the shares have an unbounded upside.
In comparison, shorting a call options means that the trader has written call options on the company's shares. The
maximum profit in this case is the premium earned and this occurs if the option is not exercised (if the price of the
shares is below the strike price, the option buyer will not exercise). The maximum loss is unlimited just as it was for
being directly short the shares. The share price is unbounded and as the stock rises, the writer of the call loses.
If the shares fall to $0, the gain on the short is $30. In contrast, the gain from writing the call is limited to the option
premium of $6.50. Thus, writing the call has a lower total gain if the shares fall to $0.
At a $40 share price in 90 days, the loss from shorting the shares at $30 is $10 per share and the loss from writing the
call is $3.50 per share ($10 loss from having to deliver shares when the call buyer exercises less the premium
originally received of $6.50). With a $30 price in 90 days, shorting the stock has no gain or loss and there is a $6.50
gain (the option premium earned) for the call option writer (the option will not be exercised if the strike and market
prices are equal).

Question 89
Salam Enterprises released its quarterly financial statements on 5 July. The income statement showed a 10 percent
earnings surprise. The stock is actively traded on a leading world stock market. The stock price continued to react
through 20 July. This suggests that the market is:
a) semi-strong form inefficient.
b) irrational.
c) processing additional information as it is being released.
The stock is actively traded. The fact that the stock price continued to react does not suggest that the market is semi-
strong form efficient. The company announced an earnings surprise whose effect on the stock price stretches for
some time as more information is released.

Question 90
Cue 100 is an equity index representing all industries in a market. The stocks are selected based on a ranking system
whereby those stocks with low price-to-book ratios, low price-to-earnings ratios, and high dividend yields are rated
higher. Stocks may need to be reclassified over time based on the changing ratios. Based on the given information,
Cue 100 will most likely be classified as a:
a) Style index.
b) Multimarket index.
c) Broad market index.
Style indices include those based on size, such as small-cap versus large-cap equities, and others based on style,
such as growth versus value stocks. Index providers usually use different factors and valuation ratios, such as low
price-to-book ratios, low price-to-earnings ratios, and high dividend yields, to distinguish between value and growth
companies.

Question 91
Which is the riskiest form of equity ownership among the following share types?
a) Common.
b) Callable common.
c) Putable common.
Callable common stock carries the most risk among the group as the embedded call option allows the issuer to call
(redeem) the shares at a pre-determined price which adds a greater level of risk relative to putable common and
common shares.

Question 92
In the United States, which sort of capacity will usually take the longest to increase if there is a surge in demand?
Capacity that is dependent on:
a) Human capital.
b) Financial capital.
c) Physical capacity.
Financial and human capital can usually be moved relatively quickly, whereas physical capacity (e.g., new
manufacturing capacity) will often take longer to acquire.

Question 93
Two indices contain exactly the same stocks; one is a market-capitalization-weighted index that increased by 12%,
whereas the other is an equal-weighted index that increased by 5% over the same period. This is explained by which
of the following?
a) There were a large number of stock splits over the period.
b) There were a small number of stock splits over the period.
c) Large-capitalization stocks outperformed small-capitalization stocks.
Stock splits will not affect either index because in the market-capitalization-weighted index when there is a stock split
the number of shares outstanding will increase but the share price will fall by a corresponding amount. An equal-
weighted index will be computed on an equal amount of money invested in each stock regardless of price or market
value. In a market-capitalization-weighted index, companies with a larger market capitalization will have a higher
weighting, so the third choice is the correct answer.

Question 94
Which of the following statements regarding information-motivated traders is most accurate?
a) They trade for the short term.
b) They differ from pure investors with respect to their motives for trading.
c) They expect to obtain superior returns based on inside information.
Information-motivated traders expect to earn above-average returns on their investments based on information they
believe to be superior. They often invest in securities they believe are incorrectly priced and hope that the prices will
change quickly in their favor. These price changes may occur almost instantaneously or they may take years to occur.

Question 95
An analyst has estimated the following information for a company:
Expected earnings per share for next year = $9.00
Expected retention rate next year and >Projected dividend growth rate into the future = 4.0%
The required return on the shares = 12.5%
The fundamental forward price-to-earnings (P/E) ratio that the analyst will calculate is closest to:
a) 4.0
b) 5.3
c) 7.8
The fundamental forward P/E ratio is calculated as follows:
P0E1=D1/E1r−g=Divident payout ratior−g=1−retentionr−g=1−0.33⅓0.125−0.04=7.8

Question 96
Which of the following statements about barriers to entry is least accurate?
a) Industries with high barriers do not have strong competition among existing firms.
b) In industries with low barriers to entry, competition reduces existing firms' return on capital.
c) Telecommunications companies may be characterized by high barriers to entry and exit.
The first choice is correct. Industries with high barriers may have strong competition among strong competition among
existing firms, especially when products are undifferentiated and commodity-like or when high barriers to exit result in
overcapacity.

Question 97
In which sector would a manufacturer of personal care products be classified?
a) Health care.
b) Consumer staples.
c) Consumer discretionary.
Personal care products are commonly classified as consumer staples.

Question 98
Which of the following statements regarding dealers is least accurate?
a) They seek the best price for their customers’ orders.
b) They fill their clients’ orders by trading with them.
c) They connect buyers and sellers who arrive in the market at different points in time.
Dealers profit when their average purchase price is less than their average selling price. Therefore, they tend to sell to
their customers at high prices and buy from them at low prices.
Brokers, on the other hand, seek the best price for their customers’ orders.

Question 99
Which of the following statements is least accurate?
a) Investors in foreign shares incur foreign exchange losses when the foreign currency appreciates.
b) Companies in mature stages are more likely to pay dividends as they may not have many growth
opportunities.
c) Studies have shown that the compounding effect of reinvested dividends has significantly influenced long-
run returns on equity securities.
Investors in foreign shares incur foreign exchange losses when the foreign currency depreciates (domestic currency
appreciates).

Question 100
Which of the following is most likely to lead to a company's P/E multiple being higher than the market P/E multiple?
a) The company has a high beta.
b) The risk of the company's earnings is higher than the market.
c) High earnings growth rates for the company relative to the market.
A high beta would lead to a high required rate of return and therefore a lower P/E, so the first choice is not correct.
Higher risk means a higher required rate of return, and therefore a lower P/E multiple, so the second choice is not
correct. High growth generally leads to a high P/E, so the third choice is the correct answer.

Question 101
Common shareholders have:
a) The right to vote by proxy if they are absent during the annual shareholders meeting.
b) Preferential claim over the firm's assets in the case of liquidation.
c) The least priority in buying shares when the firm publicly issues new shares.
The first choice is correct. The second choice is incorrect. Common shareholders have a residual claim on firm assets,
while preferred shareholders have preferential claim. The third choice is incorrect. Common shareholders have pre-
emptive rights.

Question 102
In a thorough industry analysis, the equity analyst would employ:
a) the dividend discount model.
b) the methodology of life cycle stage.
c) a representative security market index.
An industry's life-cycle position often has a large impact on the competitive dynamics of the industry, making this
position an important component of the strategic analysis of an industry.

Question 103
All of the following statements about spreadsheet modeling are correct, except:
a) Analysts need not consider factors that may change over time and how these will affect the firm.
b) Spreadsheet modeling is used to analyze and forecast company fundamentals.
c) Analysts should be able to explain the assumptions used in the model.
The first choice is correct. Analysts need to consider factors that may change over time and how these will affect the
firm.

Question 104
An analyst is basing the calculation of fundamental equity value on the company's dividend-paying capacity rather
than its expected dividends. This analyst is most likely using the:
a) dividend discount model.
b) free cash flow to equity model.
c) cash flow from operations model.
The free cash flow to equity version of a present value model uses the company's dividend paying capacity.

Question 105
An analyst gathered the following information regarding Global Traders:
Current dividend per share = $3.80
Expected growth rate = 12%
Required return on equity = 8.6%
The analyst expects the price of the stock after 2 years to be $43.20. The value of the company’s stock today
is closest to:
a) $42.34
b) $44.59
c) $46.67
D1 = 3.8 (1 + 0.12) = $4.256
D2 = 4.256 (1 + 0.12) = $4.767
Value of the stock today = (4.26 / 1.086) + (4.77 / 1.0862) + (43.2 / 1.0862) = $44.59

Question 106
When a new issue of bonds is sold by an institution to raise funds, this will be done in the:
a) Primary market.
b) Secondary market.
c) OTC market.
The secondary market is where trading takes place in issues that have already been sold to the public. The primary
market is where new issues are sold to investors.

Question 107
Which of the following is best associated with aggregated fixed income index?
a) Comprises corporate and asset-backed securities only
b) Composed of Treasury securities only
c) Are represented by fixed income securities in different classifications
The first choice is incorrect.

Question 108
Based on the empirical evidence pertaining to efficient markets, which of the following is most likely to earn abnormal
returns?
a) A technical analyst.
b) A securities analyst.
c) A company insider.
Empirical evidence shows that weak form and semi-strong forms of EMH do hold. Strong form does not hold.
Company insiders can earn abnormal returns.

Question 109
A company has a low enterprise value (EV)/earnings before interest, taxes, depreciation, and amortization (EBITDA)
ratio and a high P/E ratio compared to its competitors, this might be explained by the company:
a) Paying a higher rate of interest on its debt.
b) Having higher gross margins than their competitors.
c) Having obsolete fixed assets, reducing the depreciation expense.
A high P/E ratio might be explained by a high interest rate being charged on the debt that would not be reflected in
EBITDA but would be reflected in lower earnings per share, so choice A is the correct answer. Low depreciation
expense would increase earnings per share and reduce the P/E and high gross margins would affect both the EBITDA
and earnings per share.

Question 110
How is a stock's valuation viewed when its price is higher than its intrinsic or fundamental value?
a) Overvalued
b) Fairly valued
c) Undervalued
If a stock price is higher than its intrinsic value, this implies it is overvalued relative to its fundamental valuation.

Question 111
Jayver Industries has specific demand dynamics so strong that they override the significance of broad economic or
other external factors. Jayver most likely belongs to which type of industry?
a) Value
b) Growth
c) Cyclical
The second choice is correct.

Question 112
Legacy Company expects to pay a dividend at the end of 2016. During 2015, Legacy did not pay any dividend. 2016
EPS is expected to be $8.12. The company will maintain its 65% payout ratio. Assuming a constant dividend growth
rate of 6% and a required rate of return of 13%, estimate the current value of this stock.
a) $30.23
b) $31.14
c) $32.05
The third choice is correct. The value of the stock is computed as follows:
(8.12 × 65%)/(0.13 − 0.06)/1.137 = 32.0496

Question 113
How does the fundamental weighting address the disadvantages of market-capitalization-weighted index?
a) By reducing the weight of securities that have outperformed and vice versa.
b) By adjusting the market capitalization of each constituent security for its market float.
c) By using measures of a company's size that are independent of the constituent security's price.
A fundamental-weighted index attempts to address the disadvantages of market-capitalization-weighted index by
using other measures of a company's size that are independent of the stock price such as book value, cash flow,
revenues, and earnings to determine weights of securities in the index.

Question 114
Which of the following investments is most likely to help diversify a long-only stock portfolio comprising large-cap U.S.
traded equities?
a) Warrants.
b) A S&P 500 index fund.
c) Long/short hedge fund.
A long/short hedge fund consists of one or more portfolios of equities that are managed very differently than a
traditional long-only stock portfolio. Therefore, it is likely to be less correlated to the existing portfolio than the other
two choices.

Question 115
An exchange traded fund most likely invests in:
a) Real assets.
b) Fixed-income instruments.
c) Shares of other companies.
An exchange traded fund is a pooled investment vehicle that exclusively owns shares in other companies.

Question 116
What is the correct order for the following companies in decreasing degree of proximity toward extended periods of
excess capacity and diminished pricing power?
a) Financial consulting firm, reinsurance company, and auto manufacturing plant.
b) Auto manufacturing company, financial consulting firm, and reinsurance company.
c) Reinsurance company, financial consulting firm, and auto manufacturing plant.
An auto manufacturing plant will be more reliant on physical capital. Because physical capital is often hard to
redeploy, industries reliant on physical capacity may get stuck in conditions of excess capacity and diminished pricing
power for an extended period.
Financial and human capital, in contrast, can be quickly shifted to new uses. A reinsurance company, being reliant on
financial capital, can shift the excess capital quicker than a financial consulting firm which relies more on human
capital.