Try 2_CFA Institute 2016_Morning Practice

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B.) Yes

Under Standard III(B)-Fair Dealing, members and candidates should disclose to clients and prospective clients how they select accounts to participate in and how they determine the amount of securities each account will buy or sell. Trade allocation procedures must be fair and equitable, and disclosure of inequitable allocation methods does not relieve the member or candidate of this obligation. All discretionary accounts should be treated in the same manner. Treating newer accounts differently would be considered inequitable regardless of whether this policy is disclosed.

Alexander Newton, CFA, is the chief compliance officer for Mills Investment Limited. Newton institutes a new policy requiring the pro rata distribution of new security issues to all established discretionary accounts for which the new issues are appropriate. The policy also provides for the exclusion of newly established discretionary accounts from the distribution until they have reached their one-month anniversary date. This policy is disclosed to all existing and potential clients. Did Newton most likely violate any CFA Institute Standards of Professional Conduct?

A.) No, because the policy has been adequately disclosed to all existing and potential clients

B.) Yes

C.) No, because the allocation policy is not inequitable under the standards

A.) English.
In the event of a discrepancy between the official GIPS standards and the local language translation, the official governing language is:

A.) English.

B.) the language of a neutral country.

C.) the language of the local country.

A.) decline to accept supervisory responsibility until her firm adopts procedures to allow her to adequately exercise such responsibility.
Madeline Smith, CFA, was recently promoted to senior portfolio manager. In her new position, Smith is required to supervise three portfolio managers. Smith asks for a copy of her firm’s written supervisory policies and procedures but is advised that no such policies are required by regulatory standards in the country where Smith works. According to the Standards of Practice Handbook, Smith’s most appropriate course of action would be to:

A.) decline to accept supervisory responsibility until her firm adopts procedures to allow her to adequately exercise such responsibility.

B.) require her firm to adopt the CFA Institute Code of Ethics and Standards of Professional Conduct.

C.) require the employees she supervises to adopt the CFA Institute Code of Ethics and Standards of Professional Conduct.

A.) Yes

Nyakenda was effectively trying to bribe the policeman so that he would not issue a speeding ticket. This action violates the Code of Ethics. Despite feeling he was wrongly accused, it is only his opinion, and may not be based on fact or upheld in a court of law. Nyakenda has a responsibility to act with integrity and in an ethical manner as required by the Code of Ethics.

Albert Nyakenda, CFA, was driving to a client’s office where he was expected to close a multi-million-dollar deal, when he was pulled over by a traffic policeman although he did not believe he had violated any traffic laws. When Nyakenda realized the policeman planned to wrongly ticket him for speeding, he offered to buy him “lunch” so that he could quickly get to his client’s office. The lunch would cost significantly more than the ticket. The alternative was to go to the police station and file a complaint of being wrongly accused that would also involve going to court the next day to present his case. Did Nyakenda most likely violate the CFA Institute Code of Ethics?

A.) Yes

B.) No, because the cost of lunch is more than the ticket

C.) No, because he was wrongly accused

A.) Yes

This answer is unclear

Under Standard I(B), members and candidates must protect their independence and objectivity. Agreeing to provide objective research coverage of a company does not constitute a violation of this standard, provided the analyst writing the report is free to come up with his own independent conclusion. Smith can agree to provide research coverage but cannot commit Granite’s research department to providing a favorable recommendation.

Andrew Smith, CFA, works for Granite, a commercial bank that also has a sizable sell-side research division. Smith is presenting financing solutions to a potential business client, Dynamic Materials Corp. As part of his presentation, Smith mentions that Granite will initiate research coverage on Dynamic. Is Smith’s arrangement most likely appropriate with regard to the Code and Standards?

A.) Yes

B.) No, because Granite cannot provide research coverage on a corporate finance client because it constitutes a violation of research independence

C.) No, because Smith cannot offer to provide research coverage on a company if it becomes a corporate finance client

A.) Yes, with regard to Fair Dealing and Material Nonpublic Information

Clients should be treated fairly and impartially according to Standard III(B). In addition, the flexible trading terms allow the hedge fund manager to enrich itself and are a violation of Standard II(A), which concerns trading on material nonpublic information. This situation is also a conflict of interest, and thus a violation of Standard VI(A)-Disclosure of Conflicts.

Charlie Mancini, CFA, is the Managing Director for Business Development at SV Financial, (SVF), a large U.S.-based mutual fund organization. Mancini has been under pressure recently to increase revenues. In order to secure business from a large hedge fund manager based in Asia, Mancini recently approved flexible terms for the fund’s client agreement. To allow for time zone differences, the agreement permits the hedge fund to trade in all of SVF’s mutual funds six hours after the close of U.S. markets, which is prohibited by U.S. regulators. Did Mancini violate any CFA Institute Standards of Professional Conduct?

A.) Yes, with regard to Fair Dealing and Material Nonpublic Information

B.) No

C.) Yes, with regard to Fair Dealing

C.) it relates to a tender offer.

Trading on the information is restricted given that it relates to a tender offer; it is clearly material, nonpublic information as stated in Standard II(A).

During an on-site company visit, Marsha Ward, CFA, accidentally overheard the chief executive officer of Stargazer, Inc. discussing the company’s tender offer to purchase Dynamica Enterprises, a retailer of Stargazer products. According to the CFA Institute Standards of Professional Conduct, Ward most likely cannot use the information because:

A.) it was overheard and might be considered unreliable.

B.) she does not have a reasonable and adequate basis for taking investment action.

C.) it relates to a tender offer.

B.) Both Additional Compensation and Conflicts of Interest

According to Standard IV(B) and Standard VI(A), members should disclose all potential conflicts of interest, should disclose the substantial time involved in managing family accounts and, when engaging in independent practice for compensation, should not render services until receiving written consent from all parties.

Jefferson Piedmont, CFA, a portfolio manager for Park Investments, plans to manage the portfolios of several family members in exchange for a percentage of each portfolio’s profits. Because his family members have extensive portfolios requiring substantial attention, they have requested that Piedmont provide the services outside of his employment with Park. Piedmont notifies his employer in writing of his prospective outside employment. Two weeks later, Piedmont begins managing the family members’ portfolios. By managing these portfolios, which of the following CFA Institute Standards of Professional Conduct has Piedmont violated?

A.) Additional Compensation

B.) Both Additional Compensation and Conflicts of Interest

C.) Conflicts of Interest

B.) 0.163.

Odds are calculated as P(Z)/[1 – P(Z)]. In this problem, 0.14/0.86 = 0.16279 ~ 0.163.

If the probability for an event Z is 14% (i.e., P(Z) = 14%), the odds for Z are closest to:

A.) 0.071.

B.) 0.163.

C.) 0.123.

A.) providing a distribution of possible solutions to complex functions.

Monte Carlo simulation provides a distribution of possible solutions to complex functions. The central tendency and the variance of the distribution of solutions give important clues to decision makers regarding expected results and risk.

Monte Carlo simulation is best described as:

A.) providing a distribution of possible solutions to complex functions.

B.) an approach to backtest data.

C.) a restrictive form of scenario analysis.

A.) 5,040.

Ia permutation sequence matters

The number of permutations that are possible when choosing 4 objects from a total of 10 objects is closest to:

A.) 5,040.

B.) 30.

C.) 210.

C.) four.

(H,H,T), (H,T,H), (T,H,H) and (H,H,H)

When flipping three coins simultaneously, the number of outcomes that contain at least two-heads is most likely:

A.) three.

B.) eight.

C.) four.

C.) Subtract the mean of X from X, and then divide that result by the standard deviation of X.

There are two steps in standardizing a random variable X: Subtract the mean of X from X, and then divide that result by the standard deviation of X. This is represented by the following formula: Z = (X – ?)/?.

Which of the following most accurately describes how to standardize a random variable X?

A.) Divide X by the difference between the standard deviation of X and the standard deviation of the standard normal distribution.

B.) Subtract the mean of X from X, and then divide that result by the standard deviation of the standard normal distribution.

C.) Subtract the mean of X from X, and then divide that result by the standard deviation of X.

B.) vertical.

When the total income of a factor of production consists solely of economic rent, it indicates that the factor has perfectly inelastic supply. For perfectly inelastic supply, the supply curve is a vertical line.

The supply curve for a particular factor of production with total income consisting solely of economic rent is most likely:

A.) perfectly elastic.

B.) vertical.

C.) horizontal.

B.) did not violate any axioms of consumer choice.

The contestant exhibited indifference between the two prizes, which is consistent with the axiom of complete preferences (which includes preferring one prize over the other or being indifferent between the two). Neither the axiom of transitivity nor non-satiation was violated.

The winning contestant on a television game show was asked to choose between two prizes that were both worth the same amount. The contestant said they were both lovely prizes, but she was unable to choose one over the other and asked the game show host to make the choice for her. Given her behavior, it is most accurate to state that the contestant:

A.) violated the axiom of non-satiation.

B.) did not violate any axioms of consumer choice.

C.) violated the axiom of transitive preferences.

C.) variable in the long run.

In the short run, a company can vary the quantity of labor, but the quantity of capital is fixed. In the long run, a firm can vary both the quantity of labor and the quantity of capital.

Regarding a company’s production function, both labor costs and capital costs are best described as:

A.) fixed in the long run.

B.) variable in the short run.

C.) variable in the long run.

A.) crowding out of private investments.

Expansionary policy increases government borrowing, which may divert private sector investment from taking place (resulting in an effect known as crowding out). A rise in capital gain tax rates is a form of contractionary fiscal policy. Rises in government spending on social insurance and benefits is a form of automatic stabilizer and not due to discretionary fiscal expansion.

An expansionary fiscal policy is most likely associated with:

A.) crowding out of private investments.

B.) an increase in government spending on social insurance and benefits.

C.) an increase in capital gains tax rates.

C.) 1.3.

Arc price elasticity of demand is calculated as: %?Q/%?P = (?Q/Qavg) / (?P/Pavg).

The price of a good falls from $15 to $13. Given this decline in price, the quantity demanded of the good rises from 100 units to 120 units. The arc price elasticity of demand for the good is closest to:

A.) 1.5.

B.) 10.0.

C.) 1.3.

A.) 33.2%.

The FIFO cost of goods sold (COGS) is determined from the LIFO COGS less the change in LIFO reserve:
Change in LIFO Reserve 2014 LIFO reserve – 2013 LIFO reserve = 36.4 – 21.8 = 14.6

FIFO COGS = LIFO COGS – Change in LIFO reserve = 203.9 – 14.6 = 189.3

FIFO gross profit Sales – FIFO COGS = 283.5 – 189.3 = 94.2
FIFO gross profit margin Gross profit/Sales= 94.2/283.5 = 33.2%

An analyst gathers the following information about a company:
($ millions) 2014 2013
Sales 283.5 234.9
Year-end inventory (LIFO inventory method) 81.4 53.7
LIFO reserve 36.4 21.8
Cost of goods sold (LIFO) 203.9 167.3

Had the company used the first-in, first-out (FIFO) inventory method instead of last-in, first-out (LIFO), the company’s 2014 gross profit margin would be closest to:

A.) 33.2%.

B.) 15.2%.

C.) 22.9%.

A.) $21,000 higher.

Change in LIFO reserve
($ thousands) 2014 LIFO reserve – 2013 LIFO reserve = $450 – $420 = $30

FIFO cost of goods sold (COGS) = LIFO COGS – Change in LIFO reserve LIFO COGS – $30

If an increase in the LIFO reserve occurs, LIFO COGS will be higher than FIFO by the amount of the increase.

With a lower COGS under FIFO, pretax income will be higher by $30,000.

With a lower COGS under FIFO, after-tax income will be higher by $30,000 × (1 – 0.30) = $21,000.

An analyst gathers the following information about a company:

LIFO reserve as of 31 December 2013 $420,000
LIFO reserve as of 31 December 2014 $450,000
Marginal tax rate 30%

If the company had used the first-in, first-out (FIFO) method instead of last-in, first-out (LIFO), its 2014 net income would most likely have been:

A.) $21,000 higher.

B.) $30,000 lower.

C.) $9,000 higher.

C.) higher debt-to-equity ratio.

With rising costs of inventory, a company using LIFO compared with FIFO will report a higher cost of sales and lower profits. This scenario will result in lower increments to retained earnings and a higher debt-to-equity ratio.

All else being equal, if the purchase price of inventory is increasing, a company that accounts for its inventory under last-in, first-out (LIFO) instead of first-in, first-out (FIFO) is most likely to have a:

A.) lower market valuation of its common equity.

B.) lower net cash flow from operating activities.

C.) higher debt-to-equity ratio.

C.) Consistency

Consistency is one of the general features underlying the preparation of financial statements based on IFRS.

Under International Financial Reporting Standards (IFRS), which of the following is most likely one of the general features underlying the preparation of financial statements?

A.) Timeliness

B.) Understandability

C.) Consistency

B.) U.S. GAAP or under IFRS.

Historically, the Securities & Exchange Commission required reconciliation for foreign private issuers that did not prepare financial statements in accordance with U.S. GAAP. However the reconciliation requirement was eliminated as of 2008 for companies that prepared their financial statements under IFRS.

The convergence of global accounting standards has advanced to a degree that the Securities & Exchange Commission in the United States now mandates that foreign private issuers who use IFRS may report under:

A.) U.S. GAAP with voluntary supplemental reporting under IFRS.

B.) U.S. GAAP or under IFRS.

C.) U.S. GAAP or under IFRS with a reconciliation to U.S. GAAP.

C.) increased by the LIFO reserve.

The analyst should add the ending balance in the LIFO reserve to the LIFO inventory to equal the ending balance for inventory on a FIFO basis: LIFO reserve = Inventory (FIFO) – Inventory (LIFO).

Greene Corporation uses the last-in, first-out (LIFO) inventory method, but most of the other companies in Greene’s industry use first-in, first-out (FIFO). To best compare Greene’s financial statements with its competitors’, an analyst would make which of the following adjustments to Greene’s ending inventory? It should be:

A.) decreased by the LIFO reserve.

B.) increased by the change in the LIFO reserve for that period.

C.) increased by the LIFO reserve.

B.) lists all account balances at a particular point in time.
Which of the following statements best describes a trial balance? A trial balance is a document or computer file that:

A.) contains all business transactions recorded in the order in which they occur.

B.) lists all account balances at a particular point in time.

C.) shows all business transactions by account.

A.) the same.

When using the FIFO inventory method, the ending inventory, the cost of goods sold, and the gross margin are the same under either the perpetual or periodic methods. The use of a perpetual or periodic system makes a difference under weighted average and LIFO.

Selected information from a company that uses the FIFO inventory method is provided:

If the company used a perpetual system versus a periodic inventory system, the gross margin would most likely be:

A.) the same.

B.) higher.

C.) lower.

B.) relevance and faithful representation.

Relevance and faithful representation are the two fundamental qualitative characteristics that make financial information useful, according to the IASB Conceptual Framework.

According to the International Accounting Standards Board’s (IASB) Conceptual Framework for Financial Reporting, the two fundamental qualitative characteristics that make financial information useful are best described as:

A.) understandability and verifiability.

B.) relevance and faithful representation.

C.) timeliness and accrual accounting.

C.) $0.8 million using the installment method.

Because of the uncertainty about collection of the remaining payments, it would not be appropriate to use the accrual method. Under the installment method, the portion of the total profit that is recognized in each period is determined by the percentage of the total sales price for which the seller has received cash. Company A will recognize 2/10 × $4 million = $0.8 million. Although the cost recovery method could have been used in this situation, the reported profit would be $0.

At the start of the current year, Company A, which reports using US GAAP, sold a piece of land to Company B for $10 million. The land cost $6 million. Company B made a $2 million down payment with the remaining balance to be paid over the next five years. Over the course of the year, it has been determined that there is significant doubt about the ability and commitment of Company B to complete all payments. In the current year, Company A would most likely report a profit related to the sale of the land of:

A.) $4 million using the accrual method.

B.) $2 million using the cost recovery method.

C.) $0.8 million using the installment method.

B.) €265 million.

US GAAP requires that both research and development costs be expensed as incurred. Cash flow from operations would be lower by the amount spent on development: €290 million – €25 million = €265 million. The amortization of previous development costs is a non-cash expense, so it does not affect cash flow.

A Europe-based telecommunications provider follows International Financial Reporting Standards (IFRS) and capitalizes new product development costs. During 2014, it spent €25 million on new product development and reported an amortization expense related to a prior year’s new product development of €10 million. The company’s cash flow from operations was €290 million.
An analyst is comparing the European company with a US-based telecommunications provider and has decided to adjust its financial statements to US GAAP. Under US GAAP, ignoring tax effects, the cash flow from operations for the European company would be closest to:

A.) €290 million.

B.) €265 million.

C.) €275 million.

A.) of minority shareholders in subsidiaries that have been consolidated.

Non-controlling interests found in the equity section represent the equity interests of minority shareholders in non-wholly-owned subsidiaries that have been consolidated.

The non-controlling or minority interests found in the equity section of the balance sheet are best described as the equity interests:

A.) of minority shareholders in subsidiaries that have been consolidated.

B.) held by the corporation in other entities which it does not control, but has significant influence.

C.) of minority shareholders of the corporation who have significant influence, but not control.

A.) expense costs until technical feasibility has been established.

Under IFRS, research and development costs are expensed until certain criteria including demonstration of technical feasibility, have been met.

A company that prepares its financial statements in accordance with International Financial Reporting Standards (IFRS) is attempting to produce lighter and longer-lasting batteries for portable electronic devices. The most appropriate accounting treatment for the related costs incurred in this project is to:

A.) expense costs until technical feasibility has been established.

B.) capitalize costs directly related to the development.

C.) expense them as incurred.

B.) Standard-setting bodies have authority because they are recognized by regulatory authorities.

Without the recognition of the standards by the regulatory authorities, such as the US SEC, the private sector standard-setting bodies, such as US Financial Accounting Standards Board, would have no authority.

Which of the following statements is most accurate with respect to the jurisdiction underlying financial reporting?

A.) The requirement to prepare financial reports in accordance with specified accounting standards is the responsibility of standard-setting bodies.

B.) Standard-setting bodies have authority because they are recognized by regulatory authorities.

C.) Regulatory authorities are typically private sector, self-regulated organizations.

C.) 4.28.

The annual after-tax cost of debt is the after tax annual yield to maturity (YTM). Find the YTM by using a financial calculator as follows:

Present value (PV) = -1,030.34; Future value (FV) = 1,000; N = 40 (20 × 2); Payment (PMT) = 31 (0.062 × 1,000 × ½); compute i.
i = 2.97 semiannually.

Annually, YTM = 2.97 × 2 = 5.94.
Therefore, the associated after-tax value = 0.0428 = 0.0594 × (1 – 0.28).

A company issues new 20-year $1,000 bonds with a coupon rate of 6.2% payable semiannually at an issue price of $1,030.34. Assuming a tax rate of 28%, the firm’s annual after-tax cost of debt (%) is closest to:

A.) 4.46.

B.) 5.94.

C.) 4.28.

C.) decrease.

Equity Beta = Asset Beta * (1+ ((1- Tax Rate)*D/E))

If the tax rate increases, then the bracketed term (1 – Tax rate) decreases, thus making the equity beta decrease because the asset beta is unchanged.

A company’s asset beta is 1.2 based on a debt-to-equity ratio (D/E) of 50%. If the company’s tax rate increases, the associated equity beta will most likely:

A.) remain unchanged.

B.) increase.

C.) decrease.

C.) 13.0%.

Wd = .5 / (1+.5) = 33.3%
We = 66.7%

WACC = WdRd * (1-t) + WeRe = 33.3% * 10% * (1-30%) + 66.7%*16% = 13.%

A company’s data are provided in the following table:
Cost of debt 10%
Cost of equity 16%
Debt-to-equity ratio (D/E) 50%
Tax rate 30%
The weighted average cost of capital (WACC) is closest to:

A.) 11.5%.

B.) 14.0%.

C.) 13.0%.

18.3%

4% + 1.3*11%

If The risk-free rate is 4%, the market premium is 11%, and Common equity has a beta of 1.3 what is the cost of equity?
A.) Renegotiating current debt contracts to lower interest payments

Secondary sources of liquidity – These are sources which when used affects company’s financial and operating positions

1.) One source would be to renegotiate debt contracts to relieve pressure from high interest payments or principal payments

2.) Another source would be to liquidate assets. However, this would depend on the extent to which assets can be diluted without significant loss

3.) Filing for bankruptcy and reorganization

Renegotiating debt contracts is a secondary source of liquidity because it may affect the company’s operating and/or financial positions.

Which action is most likely considered a secondary source of liquidity?

A.) Renegotiating current debt contracts to lower interest payments

B.) Increasing the efficiency of cash flow management

C.) Increasing the availability of bank lines of credit

C.) Financing costs

Financing costs are not included in a cash flow calculation but are considered in the calculation of the discount rate.

When computing the cash flows for a capital project, which of the following is least likely to be included?

A.) Tax effects

B.) Opportunity costs

C.) Financing costs

Use the following formula:

Re = ( D1 / [ Po * { 1 – f } ] ) + g

where
D1 = Expected dividend
Po = Current price
f = Flotation costs
g = Growth rate

A company intends to issue new common stock with floatation costs of 5.0% per share. The expected dividend next year is $0.32, and the dividend growth rate is expected to be 10% in perpetuity. Assuming the shares are issued at a price of $14.69, the cost (%) of external equity for the firm is closest to:

A.) 12.3.

B.) 12.5.

C.) 12.2.

B.) the disposition effect.

Behavioral biases in which investors tend to avoid realizing losses but, rather, seek to realize gains is the disposition effect.

The behavioral bias in which investors tend to avoid realizing losses but rather seek to realize gains is best described as:

A.) mental accounting.

B.) the disposition effect.

C.) the gambler’s fallacy.

C.) Fundamental

Fundamental weighting satisfies the fund manager’s preferences. Fundamental indices use a single measure, such as total dividends, to weight the constituent securities. Fundamentally weighted indices generally will have a contrarian effect, in that the portfolio weights will shift away from securities that have increased in relative value and toward securities that have fallen in relative value whenever the portfolio is rebalanced. All shares are included in a fundamental weighted index.

An equity fund manager is considering a market index as the benchmark for his portfolio, and he has the following preferences:

• the index should have a contrarian effect;
• shares held by controlling shareholders should be included;
• dividends should be included in the weighting of constituent securities; and
• the weights of constituent securities should not be arbitrarily determined by the index provider.

Which of the following weightings of indices best meets the fund manager’s preferences?

A.) Float-adjusted market capitalization

B.) Equal

C.) Fundamental

C.) Determining an equilibrium interest rate

One of the main functions of the financial system is to determine the equilibrium interest rate, which is the only interest rate that would exist if all securities were equally risky, had equal terms, and were equally liquid.

Which of the following is most likely one of the main functions of the financial system?

A.) Ensuring that markets are informationally efficient

B.) Ensuring that all investment projects receive sufficient funding

C.) Determining an equilibrium interest rate

B.) wants to limit the loss on a short position.

A trader who has entered into a short sale will incur losses if the stock price begins to increase. A stop-buy order helps limit the loss on a short position because it becomes valid for execution when the stock price rises above the specified stop price.

A stop-buy order is most likely placed when a trader:

A.) thinks that the stock is overvalued.

B.) wants to limit the loss on a short position.

C.) wants to limit the loss on a long position.

C.) Dealers

A broker is a trader, a dealer is a salesman

The service that dealers provide is liquidity. Liquidity is the ability to buy or sell with low transaction costs when investors want to trade. By allowing their clients to trade when they want to trade, dealers provide liquidity to them.

Which of the following financial intermediaries is most likely to provide liquidity service to its clients?

A.) Exchanges

B.) Brokers

C.) Dealers

A.) loss aversion.

According to loss aversion-related arguments in behavioral theories, investors dislike losses more than they like comparable gains. Thus, such a behavioral bias can explain observed overreaction in markets.

According to behavioral finance, observed overreaction in securities markets most likely occurs because of:

A.) loss aversion.

B.) disposition effect.

C.) gambler’s fallacy.

C.) Weak form

The observation that stocks with high above average price-to-earnings ratios have consistently underperformed those with below average price-to-earnings ratios is a cross-sectional anomaly. It is a contradiction to the semi-strong form of market efficiency and strong form market efficiency because all the information used to categorize stocks by their price-to-earnings ratios is publicly available. It is not a contradiction to weak form market efficiency.

An observation that stocks with above average price-to-earnings ratios have consistently underperformed those with below average price-to-earnings ratios least likely contradicts which form of market efficiency?

A.) Strong form

B.) Semi-strong form

C.) Weak form

B.) The divisor will be adjusted to prevent changes not related to prices of constituent securities.

An index provider will adjust the value of the divisor as necessary to avoid changes in the index value that are unrelated to changes in the prices of constituent securities.

Which of the following statements concerning a security market index is most accurate?

A.) Estimated market prices of constituent securities are not used to calculate the index value.

B.) The divisor will be adjusted to prevent changes not related to prices of constituent securities.

C.) At inception, the total return version of an index will be greater than the price version of an index.

B.) Changes in the spot prices of underlying commodities

Commodity index returns reflect the changes in future prices and the roll yield. Changes in the underlying commodity spot prices are not reflected in a commodity index.

Which of the following is least likely to be directly reflected in the returns on a commodity index?

A.) Changes in the futures prices of commodities in the index

B.) Changes in the spot prices of underlying commodities

C.) Roll yield

A.) long the put, long the asset and short the bond.

According to put-call parity, a long call is equal to long put, long asset, short bond.

Using put-call parity, a long call can best be replicated by going:

A.) long the put, long the asset and short the bond.

B.) short the put, long the asset and short the bond.

C.) long the put, short the asset and long the bond.

B.) asset.

Convenience yield represents the nonmonetary advantage of holding the asset.

Convenience yield is best described as a nonmonetary benefit of holding a(n):

A.) forward contract.

B.) asset.

C.) option contract.

A.) the market value of the underlying asset.

A protective put with forward contract is defined as a long position in (1) a bond which has the face value equal to the forward contract, (2) a forward contract and (3) a long position in a put. If the put expires out of the money, the value of the overall position is equal to the market value of the asset.

+ F0(t) (payoff of bond)

+ ST – F0(t) (payoff of forward)

+ 0 (payoff of option)

= ST (payoff of strategy)

According to put-call-forward parity, if the put in a protective put with forward contract expires out of the money, the payoff is most likely equal to:

A.) the market value of the underlying asset.

B.) the face value of a risk-free bond.

C.) zero.

A.) is less than the price of contract 2.

The forward price is the spot price compounded at the risk-free rate over the life of the contract. Since Contract 2 has the longer life, compounding will lead to a larger value.

There are two forward contracts, contract 1 and contract 2, on the same underlying. The underlying makes no cash payments, does not yield any nonfinancial benefits, and does not incur any storage costs. Contract 1 expires in one year while contract 2 expires in two years. It is most likely that the price of contract 1:

A.) is less than the price of contract 2.

B.) is equal to the price of contract 2.

C.) exceeds the price of contract 2.

A.) financial guarantor.

In the securitization process the seller of the collateral, the special purpose entity, and the servicer of the loan are the main parties. All other parties, including independent accountants, lawyers/attorneys, trustees, underwriters, rating agencies, and financial guarantors are third parties to the transaction.

In the securitization process which of the following is most likely a third party to the transaction? The:

A.) financial guarantor.

B.) special purpose entity.

C.) seller of the collateral.

B.) repackage loans into simpler structures.

ecuritization allows banks to originate (or create) loans and the process results in a reduction in the layers between borrowers and ultimate investors. The loans are repackaged into more complex, not simpler, structures.

The process of securitization is least likely to allow banks to:

A.) reduce the layers between borrowers and ultimate investors.

B.) repackage loans into simpler structures.

C.) originate loans.

A.) Letter of credit

The use of letters of credit is a type external credit enhancement used in a securitization.

Which of the following is least likely a form of internal credit enhancement used in a securitization?

A.) Letter of credit

B.) Overcollateralization

C.) Subordination

C.) 26.363.

Approximate Convexity =

[ { ( -PV ) + ( +PV ) } – 2*PVo ] / [ (Delta Yield ^2) * PVo ]

$110.481 + $108.029 – 2*$109.246 / [(.0025^2)*$109.246]

A bond is currently trading for $109.246 per $100 of par value. If the bond’s yield to maturity falls by 25 bps, the bond’s full price is expected to rise to $110.481. If the bond’s yield to maturity rises by 25 bps, the bond’s full price is expected to fall to $108.029. The bond’s approximate convexity is closest to:

A.) 400.066.

B.) 0.066.

C.) 26.363.

C.) subordinated bonds and senior bonds.

Credit tranching allows investors to choose between subordinate and senior bond classes as a means of credit enhancement. The purpose of this structure is to redistribute the credit risk associated with the collateral.

In a securitization structure, credit tranching allows investors to choose between:

A.) extension risk and contraction risk.

B.) partially amortizing loans and fully amortizing loans.

C.) subordinated bonds and senior bonds.

C.) has a lower coupon.

The lower the coupon rate, the more sensitive the bond’s price is to changes in interest rates.

Given two otherwise identical bonds, when interest rates rise, the price of Bond A declines more than the price of Bond B. Compared with Bond B, Bond A most likely:

A.) is callable.

B.) has a shorter maturity.

C.) has a lower coupon.

C.) A limited partnership that takes long and short positions in publicly traded equity.

A limited partnership that takes long and short positions in publicly traded equity is one type of hedge fund, a category of alternative assets.

Which of the following most likely belongs in an alternative asset category?

A.) Equity in an emerging market company that is traded over-the-counter.

B.) Securitized commercial real estate debt.

C.) A limited partnership that takes long and short positions in publicly traded equity.

Support of product development and/or marketing efforts takes place during seed-stage financing.

A.) product development and/or marketing efforts.

In the context of venture capital financing, seed-stage financing most likely supports:

A.) product development and/or marketing efforts.

B.) initial commercial production and sales.

C.) transformation of an idea into a business plan.

C.) Investment strategy and process.

The investment strategy and process of a hedge fund is likely to be challenging to fully assess since hedge funds often limit disclosure in order to maintain their competitive advantage and to not give away information that is considered proprietary.

Investors look at many key due diligence factors when investing in hedge funds. Which of the following factors is most likely the biggest challenge to fully assess?

A.) Track record.

B.) Size and longevity.

C.) Investment strategy and process.

B.) Securities B and C

The negative correlation of -0.5 between investment securities B and C is the lowest and thus is the most effective for portfolio diversification.

A correlation matrix of the returns for securities A, B, and C is reported below:
Security A B C
A 1
B 0.5 1
C 0 -0.5 1
Assuming that the expected return and the standard deviation of each security are the same, a portfolio consisting of an equal allocation of which two securities will be most effective for portfolio diversification?

A.) Securities A and C

B.) Securities B and C

C.) Securities A and B

C.) overvalued.

Because the estimated return on the stock is lower than the expected return using the CAPM, the stock does not compensate the investor for the level of risk and so it is most likely overvalued.

Based on the capital asset pricing model (CAPM), the expected return on FGL Corp’s shares is 12%. Using a model independent of the CAPM, an analyst has estimated the returns on the stock at 10%. Based on this information, the analyst is most likely to consider the stock to be:

A.) undervalued.

B.) correctly valued.

C.) overvalued.

B.) 17.0%.

Using the CAPM relationship of E(Ri) = Rf+ [E(Rm) – Rf]?i, we can estimate the expected return as: E(Ri) = 0.05+ (0.08)(1.5) = 17.0%.

The risk-free rate is 5% and the market risk premium is 8%. If the beta of TRL Corp. is 1.5, based on the capital asset pricing model (CAPM), the expected return of TRL’s stock is closest to:

A.) 9.5%.

B.) 17.0%.

C.) 15.5%.

A.) Appendices

Information related to strategic asset allocation and portfolio rebalancing policy would be placed in the appendices of an investment policy statement.

The strategic asset allocation and portfolio rebalancing policy are most likely addressed in which section of an investment policy statement?

A.) Appendices

B.) Procedures

C.) Investment objectives

A.) 0.67.

B = Covar / Variance Market = .06 / .09

The variance of returns of a security and the market portfolio are 0.25 and 0.09, respectively. If the covariance of security returns and market returns is 0.06, the security’s beta is closest to:

A.) 0.67.

B.) 0.24.

C.) 0.40.

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