Try 2_Kaplan_Test 2

B) If the PCP staff determine that a sanction against a member is warranted, the member must either accept the sanction or lose the right to use the CFA designation.

Members can accept or reject a disciplinary sanction proposed by the Professional Conduct Program staff. If the member rejects the sanction, the matter is referred to a hearing before a disciplinary review panel of CFA Institute members. The other statements are accurate.

B) neither of these Standards.

Watson’s excessive drinking is unfortunate but we have no evidence that it has affected his work, professional integrity, judgment, or reputation. His arrest for public intoxication occurred while he was away from work. If he commits an act involving fraud or dishonesty, he would violate the Standard on misconduct.

A) place their clients’ interests before their employer’s interests.

The requirement that members and candidates place their clients’ interests before their employer’s or their own is in Standard III(A) Loyalty, Prudence, and Care. The other choices are included in the CFA Institute Code of Ethics.

B) neither of these Standards.

Thompson has not violated Standard II(B) Market Manipulation by posting his firm’s projections for Ibex. A firm’s recommendation of a security may increase its price without any intent to mislead the market. The firm has disseminated the details of the offering to its clients fairly, so Thompson may call individual clients without violating the Standard III(B) Fair Dealing.

B) comply with both GIPS and the Standard regarding performance presentation.

Mendoza has not violated the Standards of Practice or GIPS. Because the presentation was introductory and brief, Mendoza was not required to give any supporting documentation, but he made it available to clients and prospective clients upon request. His claim of GIPS compliance on the information sheet is appropriate.

B) violated the Standard on nonpublic information by revising her rating on LevelTech.

Telling a selected group of analysts new information does not constitute public disclosure, and therefore acting or causing others to act on this information is a violation of Standard II(A) Material Nonpublic Information. Recommending the sale of a stock rated as a “hold” is not a violation of Standard III(B) Fair Dealing.

C) A client’s IPS must be updated at least quarterly to reflect any changes in their investment profile.

Standard III(C) Suitability requires that members and candidates update client information (the IPS) at least annually. The IPS can be updated more frequently if there are significant changes in the investment strategy or client characteristics.

A) thinner tails fatter tails

A t-distribution with sufficiently high degrees of freedom is approximately normal and a normal distribution has thinner tails compared to a t-distribution. The less the degrees of freedom, the fatter the tails.

C) one plus the percentage change in the variable when it increases.

The up-move factor equals one plus the percentage increase when the variable goes up, and the down-move factor is equal to one divided by the up-move factor.

B) MMY < BEY < EAY. No calculations are really necessary here since the MMY involves no compounding and a 360-day year, the BEY requires compounding the quarterly HPR to a semiannual rate and doubling that rate, and the EAY requires compounding for the entire year based on a 365-day year. A numerical example of these calculations based on a 90-day holding period yield of 1.3% is: the money market yield is 1.3% × 360 / 90 = 5.20%, the bond equivalent yield is 2 × [1.013182.5 / 90 - 1] = 0.0531 = 5.31%, which is two times the effective semiannual rate of return, and the effective annual yield is 1.013 365 / 90 - 1 = 0.0538 = 5.38%. Calculating the semiannual effective yield using 180 days instead of 182.5 does not change the order.

C) that portfolio value will fall below some minimum level at a future date.

Choice A is downgrade risk; choice B is default risk.

B) confidence level of the test is 95%.

Rejecting the null hypothesis when it is true is a Type I error. The probability of a Type I error is the significance level of the test and one minus the significance level is the confidence level. The power of a test is one minus the probability of a Type II error, which cannot be calculated from the information given.

B) New Classical.

Real business cycle theory, which derives from applying utility theory and budget constraints to macroeconomic models, is associated with the New Classical school.

B) 1.3253 USD/EUR.

Arbitrage-free forward rate = 1.3382 USD/EUR × (1.025 / 1.035) = 1.3253 USD/EUR.

C) Exchange rate.

With exchange rate targeting, a central bank’s ability to increase the value of the domestic currency is limited by the amount of foreign reserves the country has available to buy its own currency in the foreign exchange market. While inflation targeting and interest rate targeting have limitations (e.g., liquidity trap conditions may exist, interest rates are bounded by zero), the central bank’s resources are not typically a limitation.

C) An increase in the real money supply from an initial equilibrium situation will cause households and businesses to sell interestbearing securities.

From an initial equilibrium, an increase in real money balances will leave households and businesses with more money than they wish to hold, so they will purchase interest-bearing securities, driving their prices up and yields down until a new equilibrium short-term rate is established

A) Both increase aggregate demand.

An increase in expected future incomes will cause consumers to increase current expenditures (reduce current savings) in anticipation of the higher future incomes. An increase in the money supply will tend to decrease interest rates which will lead to increased consumer spending on durable goods and increased investment by businesses. Both effects increase aggregate demand.

C) relative amounts of labor and capital.

In the Heckscher-Ohlin model, the source of comparative advantage is the relative amounts of labor and capital that are available in each country. Countries with more capital available relative to labor available will have a comparative advantage in producing capital-intensive goods, while countries with more labor available relative to capital will have a comparative advantage in labor-intensive goods.

C) Uninsured losses from earthquakes and expropriations by foreign governments can be classified as extraordinary items under U.S. GAAP but not under IFRS.

These are examples of items that are typically treated as extraordinary under U.S. GAAP. There is no provision for accounting for an item as extraordinary under IFRS. Accounting errors are corrected with prior-period adjustments, which are made by restating results for any prior periods that are presented in the current financial statements. Discontinued operations are not classified as unusual or infrequent items and are reported (net of taxes) after net income from continuing operations but before net income.

A) decreases by approximately 3 days.

Cash conversion cycle (CCC) = days of sales outstanding + days of inventory on hand – number of days of payables. Days of sales outstanding = 365 / receivables turnover = 365 / 11 = 33.18; 365 / 12 = 30.42. This means the CCC decreases by 2.76 days.

A) Management has provided optimistic earnings guidance.

Meeting or exceeding its own earnings guidance is a possible motivation for management to issue low-quality financial reports. Inadequate board oversight and wide ranges of acceptable accounting treatments are more appropriately viewed as opportunities for issuing low-quality financial reports.

A) Include too many financial service firms Exclude too many growth firms

Screening for high dividend yield stocks will likely include a disproportionately high number of financial services firms as such firms typically have higher dividend payouts. A screen to identify firms with low P/E ratios will likely exclude growth firms from the sample as high expected earnings growth leads to high P/Es.

C) highly variable.

A ratio that is highly variable, but consistently greater than one, is not necessarily indicative of low-quality earnings. Operating cash flow that is less than net income (ratio less than one) or declining over time may indicate low quality earnings from aggressive accounting or accounting irregularities.

A) Revenue of €300,000, expenses of €300,000, and no profit.

Under IFRS, if the outcome of a long-term contract cannot be estimated reliably, the firm should expense costs when incurred, recognize revenue to the extent of the costs, and recognize profit only when the contract is complete. The firm does not need to recognize a loss when expenses are greater than cash collected, but would need to recognize a loss if it determined that a loss on the contract was likely.

C) Depreciable lives and salvage values are chosen by management and allow for the possibility of income manipulation.

Useful lives and salvage values of long-lived assets are management estimates that may vary among companies. Companies typically do not disclose data about estimated salvage values, except when estimates are changed.

A) both of these securities.

Interest and dividends received are reported as income, regardless of the balance sheet classification of marketable securities.

B) $10,556.

Straight line depreciation is (100,000 + 10,000 + 5,000 – 25,000) / 6 = 15,000 each year. Double-declining balance depreciation in the second year is: 115,000 (2/3)(1/3) = 25,556. The difference is $10,556. Remember that salvage value is not part of the declining balance calculation.

A) record a deferred tax asset of $30,000.

Warranty expense should be recorded when the inventory item covered by the warranty is sold. A deferred tax asset is created when warranty expenses are accrued on the financial statements but are not deductible on the tax returns until the warranty claims are paid. The full amount of the obligation, $100,000, is recorded as an expense, with a deferred tax asset of $30,000. Note that a deferred tax asset results when taxable income is more than pretax income and the difference is likely to reverse (warranty will be paid) in future years.

C) $9,715,850.

The initial liability is the amount received from the creditor, not the par value of the bond.

N = 8; I/Y = 11/2 = 5.5; PMT = 500,000; FV = 10,000,000; CPT → PV = $9,683,272.

The interest expense is the effective interest rate (the market rate at the time of issue) times the balance sheet liability. $9,683,272 × 0.055 = $532,580.

The value of the liability will change over time and is a function of the initial liability, the interest expense and the actual cash payments. In this case, it increases by the difference between the interest expense and the actual cash payment: $532,580 – $500,000 = $32,580 + $9,683,272 = $9,715,852. Tip: Knowing that the liability will increase is enough to select choice C without performing this last calculation. Entering N = 7 and solving for PV also produces $9,715,852.

C) horizontal common-size balance sheet.

On a horizontal common-size balance sheet, the divisor is the first-year values so they are all standardized to 1.0 by construction. Trends in the values of these items as well as the relative growth in these items are readily apparent. A vertical common-size balance sheet expresses all balance sheet accounts as a percentage of total assets and does not standardize the initial year.

C) No effect on the short-term forecast but greater net cash in the long-term forecast.

Changing the inventory accounting method has no immediate cash flow effects and therefore should not change a firm’s short-term forecast (typically 4 to 6 weeks) of its net cash position. However, because the average cost inventory method will result in lower gross profit compared to FIFO, it will also result in decreased taxes. The firm’s long-term forecast (typically 3 to 5 years) of its net cash position should reflect a decrease in cash outflows for taxes, and consequently greater net cash in future periods.

A) factoring.

Factoring refers to the sale of receivables without recourse; that is, the risk that the firm’s customers will not pay, or will not pay in a timely manner, is borne by the factor, who purchases the receivables. Thus, the amount the factor will pay per dollar of receivables is lower (higher discount or interest rate) if the credit quality of the firm’s credit customers is lower.

B) financial leverage.

The degree of financial leverage (DFL) is the percent change in earnings per share for a given percent change in operating income. The degree of operating leverage (DOL) is the percent change in operating income for a given percent change in sales. The degree of total leverage (DTL) is the percent change in earnings per share for a given percent change in sales, and is the product of DOL and DFL. Based on the information given, Smith has a higher DFL than Jones, but we cannot conclude that Smith has a higher DTL than Jones.

A) included in the initial outlay.

The correct treatment of flotation costs according to the CFA Curriculum is to include their cost in the initial cash outflow of the project. Since flotation costs are included in the initial outlay, they decrease the NPV by an amount that is unaffected by the discount rate, and the discount rate and cost of capital are not adjusted for flotation costs.

A) rate of return.

The market model is expressed as: Ri = αi + βiRm + εi. In this model, beta (βi) measures the sensitivity of the rate of return on an asset (Ri) to the market rate of return (Rm)

B) 20%.

The correlation between the returns of the two assets is:

Correl = covar / (SDa * SDb)

Therefore, the standard deviation of the portfolio returns is a weighted average of the standard deviations of returns for the two assets: 0.3 * sqrt(0.031) + 0.7 * sqrt(0.045) = 20.13%.

Since the correlation of returns is +1, there are no diversification benefits.

A) open-end funds stand ready to redeem their shares, while closed-end funds do not.

Open-end funds redeem existing shares or issue new shares in accordance with investor demand. Closed-end fund shares are fixed in number and trade on exchanges as though they were common stock.

B) the global minimum variance portfolio.

According to the CAPM, rational, risk-averse investors will optimally choose to hold a portfolio along the capital market line. This can range from a 100% allocation to the risk-free asset to a leveraged position in the market portfolio constructed by borrowing at the risk-free rate to invest more than 100% of the portfolio equity value in the market portfolio. The global minimum variance portfolio lies below the CML and is not an efficient portfolio under the assumptions of the CAPM.

C) 13.7%.

g = (1-payout ratio)*ROE = 9.6%

k = $1.50*(1.096) / $40 + 9.6% = 13.7%

or

$1.50 * 1.096% / (x – .096%) = 40

solve for x

A) 7, 150

Price-weighted index = (4+10) / 2 = 7. A price-weighted index is not affected by a split. The divisor is adjusted to account for the price change.

B) 13.

Required return = 5% + 1.1(8%) = 13.8%

Sustainable growth = 18%(1 − 0.4) = 10.8%

Po / E1 = .4 / (.138 – .108) = 13.33

C) shakeout.

The shakeout industry life-cycle stage is characterized by slowing (but still positive) growth, intense competition, and declining profitability, as demand begins to approach market saturation. In contrast, the decline industry stage is characterized by negative growth. The lack of brand loyalty among customers suggests the industry has not yet reached the mature stage.

B) $33.32.

Dividend payout = 1 − earnings retention rate = 1 − 0.4 = 0.6

RS = Rf + β(RM − Rf) = 0.06 + 1.2(0.11 − 0.06) = 0.12

g = (retention rate)(ROE) = 0.4(0.12) = 0.048

P/E = Div Payout Ratio / (k – g) = .6 / (.12 – .048) = 8.33

Price = E(P/E) = $4(8.33) = $33.32

C) Telecommunications.

Both technology and housing firms tend to be quite cyclical, that is, their profits are very sensitive to changes in overall growth. The profits of telecommunications firms, on the other hand, are less economically sensitive.

B) outperform the index over time.

Total return includes dividend yield. Because dividends are not included in the performance of the index itself, the portfolio will outperform the index by the amount of the dividend yield.

B) decrease.

Because the coupon rate is greater than its yield to maturity, the bond price is at a premium to par value. If the yield remains unchanged, the price will decrease toward par value along its constant-yield price trajectory.

C) A medium-term note (MTN) is a corporate bond with an original maturity of 2 to 10 years.

The name “medium-term note” does not imply anything about the original maturity of the security.

C) secured bank debt.

“Top-heavy” refers to a capital structure that includes a high percentage of secured bank debt. A firm with a top-heavy capital structure may be limited in its access to additional bank borrowing, which increases the likelihood of default if the firm encounters financial distress.

B) 6.8.

First calculate V− and V+, the bond’s value at 7.25% and 8.75% yields to maturity. The bond values are $1,052.70 and $950.69, respectively:

N = 20; I/Y = 7.25 / 2 = 3.625; PMT = 40; FV = 1,000; CPT PVu = −1052.70

N = 20; I/Y = 8.75 / 2 = 4.375; PMT = 40; FV = 1,000; CPT PVd = −950.69

D = Vu – Vd / (2*Vo*(Delta V)) = 1,052.7 – 950.69 / (2*1,000*.0075) = 6.8

A) swap rate.

Interpolated spreads (I-spreads) are spreads to swap rates.

A) 5.61%.

We know that: rBD = D/F * (360/t)

D = $1,000,000 − $987,845 = $12,155
F = $1,000,000
t = 78 days

Substituting we get: rBD = = 0.0561

A) covered bonds.

Covered bonds are an obligation of the corporation that issues them but their interest and principal payments are provided by a pool of assets that are legally recognized as bankruptcy-remote. They are different from securitized bonds, which are issued by a special purpose vehicle.

C) If the margin account balance falls below the maintenance margin level, the account balance must be brought back up to the maintenance level.

If the margin account balance falls below the maintenance margin level, the account must be brought back up to the initial margin amount.

C) Survivorship bias in hedge fund data causes risk to be overstated because funds that take on more risk tend to have higher returns.

Because a hedge fund database only includes the more stable funds that have survived, the risk measure of hedge funds as an asset class is biased downward.

A) real estate and commodities.

Real estate and commodities offer potential hedges against inflation because rents, property values, and commodity prices tend to increase with inflation in the long term.

B) exited an investment in a portfolio company.

In a secondary sale, a private equity firm sells one of its portfolio companies to a group of investors or another private equity firm.

B) a request for redemption of shares, within which the fund must fulfill the request.

The notice period is the time within which a hedge fund must fulfill a request for redemption of shares. The period during which investors may not redeem shares is called a lockup period.

A) keep records of all the data and analysis that went into creating the report.

Standard V(C) Record Retention requires members to maintain records of the data and analysis they use to develop their research recommendations. Recommendations may be brief, in capsule form, or simply a list of buy/sell recommendations. A list of recommendations may be sent without regard to suitability, including both safe income stocks and aggressive growth stocks, for example.

B) the plan participants and beneficiaries.

Under Standard III(A) Loyalty, Prudence, and Care, the fiduciary duty in this case is to plan participants and beneficiaries, not shareholders or plan trustees.

A) advise his client of the change in recommendation before accepting the order.

According to Standard III(B) Fair Dealing, if a client places an order that goes against the firm’s recommendation for that security, members and candidates should inform the client of the discrepancy between the order and the firm’s recommendation before accepting the order.

B) Private equity.

Private equity is one of the nine major sections of the GIPS standards; the others are not.

A) both of these Standards.

Hoffman has violated both Standard I(B) Independence and Objectivity, which specifically addresses the requirement of disclosure of the nature of any compensation from the subject company, and Standard VI(A) Disclosure of Conflicts, which, more generally, requires disclosure of any potential conflict of interest in research reports and investment recommendations.

C) may write the report if she discloses both that Waller & Madison is a market maker in CorpEast shares and that Waller sits on the CorpEast board.

To comply with Standard VI(A) Disclosure of Conflicts, both the market-making activities by the firm and the directorship held by a principal in the firm must be disclosed.

A) may trade or make recommendations based on his analysis.

According to Standard II(A) Material Nonpublic Information, Farr is free to act under the mosaic theory because nonmaterial nonpublic information does not fall within the prohibition on trading based on material nonpublic information. He should keep detailed documentation of his analysis to document that he did not advise or act based on material nonpublic information.

B) to his employer and all prospective clients referred by Jan.

Standard VI(C) Referral Fees states that members and candidates must disclose to employers and to affected prospects and clients, before entering into any formal agreement for services, any benefits received for the recommendation of services provided by the member.

A) in violation of the Standards.

Michaels has violated Standard II(A) Material Nonpublic Information. Members who possess material nonpublic information are prohibited from acting or causing others to act on that information. She may not share the information with anyone except designated supervisory or compliance employees within her firm. Disclosing to her supervisor, who is not identified as a designated supervisor of compliance issues, is not permitted.

B) The correlation coefficient is computed by dividing the covariance of returns on two assets by the individual variances of returns for the two assets.

Dividing the covariance between returns of two assets by the individual standard deviations of returns of the two assets yields the correlation coefficient.

A) Goldman is using time-series data.

The data are cross-sectional, which means that it is a sample of observations taken at a single point in time. Time-series data are observations taken at specific and equally spaced points in time (for example, the monthly returns on a specific stock for the period January 1 through December 31 of a given year). The sampling error is the difference between a sample statistic (here, the mean) and the corresponding population parameter, or 10.5 – 9.7 = 0.8. The sample statistic (here, the mean) is itself a random variable and has its own probability distribution.

C) relative strength chart.

Relative strength charts display the price of an asset relative to the price of another asset or benchmark over time. This type of chart is useful for demonstrating whether one asset class or market has outperformed or underperformed another. Candlestick charts and point-and-figure charts are generally used to display price patterns for a single asset or market over time.

C) Chi-square statistic.

This is a test of the value of a single variance and is based on a test statistic with a performed via the chi-square distribution.

A) Fibonacci numbers.

The forecast resistance levels are one-half, five-eighths, and two-thirds of the price decrease from $180 to $100. All of these are Fibonacci ratios. Projecting from the breakout of an inverse head and shoulders pattern would more likely suggest a single price target or range than three different specific targets. Moving average convergence/divergence lines are unlikely to be used for price targeting because they are not on the same scale as prices.

A) an increase in employment.

Short-run equilibrium may occur above full employment, for example as a result of an increase in aggregate demand caused by a decrease in taxes. Both employment and the price level increase in the short run. Above-full employment causes upward pressure on wages that will reduce short-run aggregate supply until, in the long run, output returns to its full-employment level with a still-higher equilibrium price level.

A) increased, and eurozone goods are now more expensive to U.S. consumers.

For the base period, three years ago, the real exchange rate is the same as the nominal exchange rate, 1.32 USD/EUR. The real exchange rate over the period has changed from 1.32 to 1.40 × (112 / 118) = 1.3288. This increase in the real USD/EUR exchange rate indicates that the base currency (EUR) has appreciated in real terms, so that eurozone goods are now more expensive in real terms to U.S. consumers.

C) nominal interest rates, real interest rates, and expected inflation.

The Fisher effect states that a nominal interest rate is the sum of a real interest rate and the expected inflation rate.

B) High unemployment puts downward pressure on money wages.

Falling money wages would cause businesses to increase (profit-maximizing) output levels at each price level for final goods and services. Changes in the price level of goods and services are represented by a movement along a short-run aggregate supply curve, not a shift in the curve. A rise in resource prices will decrease aggregate supply. An increase in government spending will shift the aggregate demand curve but not the aggregate supply curve.

C) approaches the peak of an expansion.

At the end or peak of an expansion, economic activity begins to slow, sales are less than planned, and excess inventory accumulates, increasing inventory-to-sales ratios. To reduce inventory-to-sales ratios to desired levels, firms decrease production, which is one of the causes of a contraction.

C) descending price auction.

In a descending price or Dutch auction, the government will sell bonds to the bidders who bid the lowest yields (highest prices) until all the bonds are sold. Bidder 1 receives 200 bonds at a yield of 5.25%, Bidder 2 receives 100 bonds at a yield of 5.30%, and Bidder 3 receives the remaining 200 bonds at a yield of 5.40%.

B) is at a maximum where it intersects the marginal product of labor curve.

In the short run, the average product of labor curve is first increasing and then decreasing as diminishing marginal returns to that factor take effect. In the short run, the marginal product of labor is first increasing and then decreasing when diminishing marginal returns take effect. The marginal product of labor curve will be above the average product of labor curve initially, and, at some point, will intersect the average product curve at its maximum. When the total product of labor begins to increase at a decreasing rate, the average product of labor will be decreasing.

C) installment method if collectability of payments for a sale cannot be reasonably estimated.

The installment method should be used when future cash collection cannot be reasonably estimated. For long-term projects, a firm should use percentage of completion when payment is reasonably assured and the firm can reliably estimate the project’s outcome, and completed contract when the firm cannot estimate the outcome reliably.

B) Operating profit margin.

Operating profit margin can be read directly from a common-size income statement. Asset turnover and return on equity mix balance sheet and income statement items.

C) 1,016,667.

Use the Treasury stock method:

Step 1: Determine the number of common shares created if the warrants are exercised = 100,000.
Step 2: Calculate the cash inflow if the warrants are exercised: (100,000)($50 per share) = $5,000,000.
Step 3: Calculate the number of shares that can be purchased with these funds using the average market price ($60 per share): 5,000,000 / 60 = 83,333 shares.
Step 4: Calculate the net increase in common shares outstanding from the exercise of the warrants: 100,000 − 83,333 = 16,667.
Step 5: Add the net increase in common shares from the exercise of the warrants to the number of common shares outstanding for the entire year: 1,000,000 + 16,667 = 1,016,667.

A) historical cost.

Unless impairment has been recognized, land is reported at historical cost and is not subject to depreciation. Increases in value are not reflected in balance sheet values under U.S. GAAP.

C) Relevance and faithful representation.

The IASB Conceptual Framework for Financial Reporting describes the two fundamental qualitative characteristics of financial statements as relevance and faithful representation. The Conceptual Framework lists timeliness, comparability, verifiability, and understandability as characteristics that enhance relevance and faithful representation.

B) a higher debt-to-equity ratio.

Operating leases are not recognized as liabilities and therefore the debt-to-equity ratio will be lower than a similar finance lease. Capitalizing a lease will increase the asset base and decrease asset turnover. Lease capitalization decreases the operating cash outflow and therefore increases operating cash flows (all else equal).

B) rationalization of the actions.

A mindset that allows rationalization is the third important condition underlying low-quality financial reporting. Poor financial controls are an example of opportunity and pressure to meet earnings expectations is a possible motivation.

A) liquidating inventory.

During periods of rising prices, liquidating inventory is a potential way for companies that use the LIFO inventory cost method to report higher current-period earnings, but LIFO is not permitted under IFRS. Managers attempting to influence analysts’ opinions may manipulate accounting assumptions or emphasize non-GAAP measures in their financial reports.

B) immediately write down the machine to its recoverable amount.

Under IFRS, when an asset is permanently impaired, it must be written down to its recoverable amount (greater of value in use or fair value less selling costs) in the period in which the impairment is recognized.

A) disclose how it determined the fair value of the intangible asset.

For firms that revalue assets upward, IFRS requires disclosure of the date the asset was revalued, how management determined its fair value, the asset’s carrying value using the historical cost model, and (for intangible assets) whether the asset’s useful life is finite or indefinite. Although assets and shareholders’ equity will increase as a result of the revaluation, net income will not increase. The increase in the value of the asset is reported as a revaluation surplus in shareholders’ equity. Amortization expense will not increase because indefinite-lived intangible assets are not amortized.

A) $1 million.

Goodwill has an indefinite life and is not amortized. A trademark or other intangible asset that has an expiration date but is renewable at minimal cost is treated as having an indefinite life and is not amortized. The patent has a finite life and its cost will be amortized at the rate of $1 million each year over ten years under the straight-line method.

B) selecting an external auditor for the company.

Selecting an external auditor (subject to shareholder approval) is a responsibility of the Board’s audit committee.

C) United Mines requires shareowner attendance to vote but coordinates the timing of its annual meeting to be held on the same day as other companies in the region

When companies that require shareholder attendance to vote hold their meetings on the same day but in different locations, it prevents shareholders from attending all the meetings and therefore exercising their full voting rights.

B) Butler has a lower cash ratio than Acme.

Given that they have the same amount of sales and Acme’s receivables turnover (sales/average accounts receivable) is higher, Acme must have lower average accounts receivable than Butler. Given that they have equal quick ratios, subtracting accounts receivable from the numerators of the quick ratios of both firms will produce a cash ratio for Butler that is lower than the cash ratio for Acme.

C) have no effect on the book value of Daker shares.

The book value of Daker shares is (£140 million − £85 million) / 11 million = £5 per share. Repurchasing its shares at a price equal to book value will not change the book value of Daker shares.

B) are not necessarily well diversified, while portfolios on the CML are well diversified.

Although the risk measure on the capital market line diagram is total risk, all portfolios that lie on the CML are well diversified and have only systematic risk. This is because portfolios on the CML are all constructed from the risk-free asset and the (well-diversified) market portfolio. Any portfolio, including single securities, will plot along the SML in equilibrium. Their unsystematic risk can be significant, but it is not measured on the SML diagram because unsystematic risk is not related to expected return. Both the CML and the SML reflect relations that hold when prices are in equilibrium.

A) Portfolio X.

Portfolio X has a lower expected return and a higher standard deviation than Portfolio Y. X must be inefficient.

B) price momentum.

In addition to the three factors of the Fama and French model, market-to-book, firm size, and excess returns on the market, Carhart added a momentum factor based on prior relative price performance.

B) validity and execution instructions.

Good-till-cancelled is a validity instruction, which indicates when an order may be filled. Execution instructions include limit orders and market orders, as well as instructions regarding trade size and visibility. A clearing instruction indicates how to arrange final settlement of the trade.

B) sponsored depository receipt.

The owner of a sponsored DR share has the same voting rights and receives the same dividends as the owner of a common share of the firm. With an unsponsored DR, the depository bank retains the voting rights. A global depository receipt may be sponsored or unsponsored.

B) be more difficult to build and maintain.

Bond indexes are more difficult to build and maintain than stock indexes for several reasons. Bonds in an index have to be replaced as they mature, so turnover is likely to be greater in a bond index than in a stock index. Many bonds lack the continuous trade data that exists for exchange-traded equities.

B) increasing profitability.

An industry in the growth stage is usually characterized by increasing profitability, decreasing prices, and a low degree of competition among competitors.

C) $1,067.

The bond equivalent yield rate on the par bond (Z) is 6% or a 3% semiannual rate. The equivalent quarterly rate, 1.031/2 – 1 = 0.014889. Security X makes 20 quarterly payments of $15 and 20 quarterly payments of $20. We need to use the cash flow function as follows: CF0 = 0; CF1 = 15; F1 = 20; CF2 = 20; F2 = 19; CF3 = 1,020; F3 = 1; I = 1.4889; CPT → NPV = $1,067.27. Note that CF3 contains the final quarterly payment of $20 along with the $1,000 face value payment.

C) Greater reinvestment risk.

Reinvestment risk is a disadvantage of a sinking fund provision. Some bondholders will be repaid the bond principal earlier than the maturity date. If interest rates have declined since they bought the bonds, these bondholders will only be able to reinvest the returned principal at a lower rate of return. A sinking fund provision increases the credit quality of an issue and typically does not affect a bond’s taxable status.

B) Structural subordination.

Restricted subsidiaries are those whose cash flows and assets are designated to service the debt of their holding company. Classifying a subsidiary as restricted alleviates structural subordination by making holding company debt rank pari passu with the subsidiary’s debt.

C) life of the support tranche will decrease.

If the prepayment speed is higher than the PAC collar, the support tranche receives more prepayments. The life of the support tranche will shorten. The PAC tranche could receive higher prepayments if the support tranche principal is fully repaid (i.e., a broken PAC). In this case, the support tranche is still outstanding, which means that hasn’t happened yet.

B) $1,075.

%Δprice ≈ -7.48(-0.0075) = 0.0561
$1,018(1 + 0.0561) = $1,075.11

B) shelf registration.

In a shelf registration, an entire issue is registered with securities regulators but the bonds are sold to the public over a period of time as the issuer needs to raise funds. In a serial bond issue, bonds with multiple maturity dates are issued at the same time. A waterfall structure is issued in tranches with differing priority of claims.

A) 5.46%.

This question does not require calculations. Because the return on reinvested coupon interest is less than the note’s yield to maturity, the investor’s realized yield on the note must be less than the YTM. Only Choice A can be correct.

B) the underlying asset.

The put-call-forward parity relationship is the same as the standard put-call parity relationship, with the present value of the forward price substituted for the underlying asset.

C) neither standardized nor backed by a clearinghouse.

Over-the-counter derivatives are customized private contracts between counterparties.

B) equal to the entire premium for an out-of-the-money option.

The price (or premium) of an option is its intrinsic value plus its time value. An out-of-the-money option has an intrinsic value of zero, so its entire premium consists of time value. Time value is zero at an option’s expiration date. Time value is the amount by which an option’s premium exceeds its intrinsic value.

B) lower returns and higher price volatility.

Returns on commodities over time have been lower than returns on global stocks or bonds, and price volatility has been higher.

A) will be lower because of adjustments for illiquid positions.

If a fund calculates a trading NAV, it will adjust market prices downward for securities in which it holds positions that are large relative to trading volume or total value outstanding and thus are less liquid.

B) be convertible to equity or include warrants.

In the context of an LBO, mezzanine financing refers to debt that carries warrants or equity conversion features. This debt is typically subordinated to other bonds that are issued to finance the LBO. Committed capital is the investment of limited partners in a private equity fund and does not include debt that the fund issues to finance a particular LBO.