Sample Level I Multiple Choice Questions

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

A. He did not disclose the use of back-tested data.

B. He failed to deduct all fees and expenses before calculating the fund’s track record.
C. The marketing materials only include the Everglades Fund’s performance and are not
a weighted composite of similar portfolios.

2. Roberto Vargas, CFA, is in charge of the compliance program at his investment firm.
According to the Standards of Practice Handbook, as a supervisor, Vargas is least likely
required to:

A. respond promptly to all violations.

B. disseminate the contents of the program to all personnel.
C. incorporate a professional conduct evaluation as part of an employee’s performance
review.

3. Regarding the definition of the firm, the GIPS Standards require all of the following
except:

A. firms must be defined as an investment firm.

B. a firm’s organization alters historical composite results.
C. total firm assets must be the aggregate of the market value of all discretionary and
nondiscretionary assets under management.

4. Under which measurement scale is data categorized, but not ranked?

A. An ordinal scale.
B. A nominal scale.
C. An interval scale.
5. The joint probability of events A and B is 32 percent with the probability of event A
being 60 percent and the probability of event B being 50 percent. Based on this
information, the conditional probability of event A given event B has occurred is closest
to:

A. 30.0%.
B. 53.3%.
C. 64.0%.

6. If a firm’s long-run average cost of production increases by 15 percent as a result of an 8 percent

increase in production the firm is most likely experiencing:

A. economies of scale.
B. diseconomies of scale.
C. constant returns to scale.

7. A company currently has a debt-to-equity ratio of 1.25. Common shareholder’s equity is

$4,000,000, consisting of 1.5 million shares outstanding with a current price of $28/share.
Part of the company’s debt currently outstanding is $1,000,000 of convertible bonds.
Each $1,000 par value bond can be converted into 50 common shares at any time during
the next three years. The coupon rate on the bonds is 6 percent with interest paid
annually. If all convertible bonds are converted, the company’s debt-capital ratio is
closest to:

A. 42.5%.
B. 44.4%.
C. 80.0%.

8. A company has just issued $5 million of mandatory redeemable preferred shares with a
par value of $100 per share and a 7 percent dividend. The issue matures in 5 years.
Which of the following statements is least likely correct? The company’s:

A. Debt/Total capital ratio will improve.

B. interest coverage ratio will deteriorate.
C. preferred shareholders will rank below debt holders should the company file for
bankruptcy.
9. The following selected information is from a company’s most recent financial statements:

(£ millions)
2008 2007
Sales 2,801 2,885
Cost of Goods Sold 1,969 2,071
Interest Expense 123 110

Cash & Marketable Securities 108 105

Accounts Receivable 318 286
Inventories 248 285

Accounts Payable 361 346

Notes Payable 50 99

The 2008 cash conversion cycle, in days, is closest to:

A. 23.
B. 26.
C. 28.

10. An analyst has calculated the following ratios for a company:

Number of days of receivables 48

Number of days of inventory 37
Number of days of payables 28

The cash conversion cycle for the company is closest to:

A. 57 days.
B. 85 days.
C. 113 days.

11. An analyst is developing net present value (NPV) profiles for two investment projects.
The only difference between the two projects is that Project 1 is expected to receive
larger cash flows early in the life of the project, while Project 2 is expected to receive
larger cash flows late in the life of the project. The slope of the NPV profile for Project 1
when compared to the slope of the NPV profile for Project 2 is most likely:

A. equal.
B. flatter.
C. steeper.
12. A company wants to determine the cost of equity to use in the calculation of its weighted
average cost of capital. The CFO has gathered the following information:

Rate of return on 3-month Treasury bills 3.0%

Rate of return on 10-year Treasury bonds 3.5%
Market equity risk premium 6.0%
The company’s estimated beta 1.6
The company’s after-tax cost of debt 8.0%
Risk premium of equity over debt 4.0%
Corporate tax rate 35%

Using the bond-yield-plus-risk-premium approach, the cost of equity for the company is
closest to:

A. 10.6%.
B. 12.0%.
C. 16.3%.

13. A company’s $100 par perpetual preferred stock has a dividend rate of 7 percent and a
required rate of return of 11 percent. The company’s earnings are expected to grow at a
constant rate of 3 percent per year. If the market price per share for the preferred stock is
$75, the preferred stock is most appropriately described as being:

A. overvalued by $11.36.
B. undervalued by $15.13.
C. undervalued by $36.36.

14. An analyst gathers the following information about two companies for the year ending 31
December 2008:

Company 1 Company 2
Dividend payout ratio 37.5% 40.0%
Return on assets 12% 10.0%
Financial leverage 1.6 2.0

Which of the following best describes the expected growth rate of Company 1? The
expected growth rate of Company 1 compared to Company 2 is:

A. lower.
B. greater.
C. the same.
15. An equity analyst working for a growth oriented mutual fund has a tendency to misvalue
the stocks of popular companies that she has previously recommended and the fund
already owns. Her behavior is most likely consistent with which of the following biases?

A. Escalation bias
B. Prospect theory
C. Confirmation bias

16. A portfolio manager is evaluating investments in mortgage securities as part of a

portfolio to fund long term liabilities. If she wants to minimize prepayment risk in her
portfolio she is most likely to invest in:

A. mortgage loans.
B. mortgage passthrough securities.
C. collateralized mortgage obligations.

17. An investor purchases a 1-month out-of-the-money American call option on a stock. A

week later, the stock price is less than the call option strike price. The time value of the
option is most likely:

A. Zero.
B. A positive amount.
C. A negative amount.

18. Compared to investors with long investment time horizons, investors with short
investment time horizons most likely require:

A. less liquidity and less emphasis on capital appreciation.

B. more liquidity and less emphasis on capital appreciation.
C. less liquidity and greater emphasis on capital appreciation.

19. A primary motivation for investment in commodities is most likely the:

A. positive correlation of commodities with unexpected inflation.

B. positive correlation of commodities with stock and bond investments.
C. positive volatility of commodities relative to stock and bond investments.
20. Which of the following statements regarding the Markowitz efficient frontier is least
likely to be correct? The optimal portfolio for:

A. an investor is the portfolio that lies on the efficient frontier and provides her with the
greatest level of utility.
B. an investor is found at the point of tangency between the efficient frontier and an
investor’s highest utility curve.
C. a more risk-averse investor will lie inside the efficient frontier but will lie outside the
efficient frontier for a less risk-averse investor.

Answers are provided beginning on the next page.