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CFA Level I Practice Questions

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Free CFA Level 1 Practice Questions

Question 1

Ethical and Professional Standards

George Mendes is considering an employment offer made by DR Associates, an investment bank. Should Mendes accept the offer, he will be responsible for supervising twenty portfolio managers. Mendes’ only concern is that employees’ personal trades are not being adequately monitored and many of these transactions involve front-running clients’ trades.

To comply with the CFA Institute Standards of Professional Conduct, Mendes should most likely:

A) accept the offer and dismiss employees involved in front-running.

B) accept the offer and implement adequate compliance procedures.

C) decline the offer in writing until the firm adopts reasonable procedures to allow the exercise of his supervisory responsibilities.

The correct answer is: B)

Although the front-running client trades constitutes a violation of the CFA Institute Standards of Professional Conduct, this does not mean that Mendes cannot discharge his supervisory responsibilities. His best course of action would be to accept the position offered and implement adequate compliance procedures.

Option C is incorrect. Since Mendes will be able to discharge his supervisory responsibilities despite front-running by employees, declining supervisory responsibilities in writing is not a recommended course of action.

Option A is incorrect. Dismissal is the course of action which is inconsistent with the CFA Institute Standards of Professional Conduct. Once a supervisor learns that an employee has violated the Code and Standards, the supervisor should promptly initiate an assessment to determine the extent of the wrongdoing.

Question 2

Ethical and Professional Standards

An investment management firm has been in existence for eight years. To enhance the quality of reported performance, the firm’s senior compliance officer decides to make the firm’s presented performance compliant with the GIPS standards.

To comply with the GIPS standards, the firm is required to initially present a GIPS-compliant performance track record of:

A) one year.

B) five years.

C) eight years.

The correct answer is: B)

To comply with the GIPS standards, the firm is initially required to present a GIPS-compliant performance track record of five years and present an additional year of performance each year going forward, building up to a minimum of 10 years of GIPS-compliant performance.

Question 3

Quantitative Methods

You are presented with 2 investment opportunities and must choose the one with the greater present value: A lump-sum of $2 million or an annuity with 25 payments of $250,000 a year with the first payment starting today. The interest rate is 9% per year compounded annually.
Which one will you choose?

A) The annuity

B) The lump-sum

C) There’s no difference between the two options

The correct answer is: A)

The first option’s present value (PV) is $2,000,000.

The second option is an annuity due with 25 payments, which means an immediate $250,000 at time t=0 plus an ordinary annuity of $250,000 per year for 24 years. The present value of the second option is: PV = $250,000+A*((1-1/(1+r)N)/r) = $2,676,652.90, where A=250,000, N=24, r=9%=0.09.

Question 4

Economics

Two hypothetical currencies – ABC and XYZ – are trading at a spot rate of 1.60 ABC/XYZ . If the interest rate in ABC and XYZ’s countries are 7% and 5%, respectively, the arbitrage-free forward rate ABC/YXZ is closest to:

A) 1.5410.

B) 1.7113.

C) 1.6304.

The correct answer is: C)

The arbitrage-free forward exchange rate can be calculated as the spot rate (ABC/XYZ) * (ABC interest rate / XYZ interest rate).
The arbitrage-free forward rate for ABC/XYZ is (1.60 * 1.07/1.05) = 1.6304.

Question 5

Financial Reporting and Analysis

Galactic Hyper is a chain of hypermarkets which sells most of its products for cash, which is why its days of sales outstanding are as low as 22 days. Assuming that the firm’s average receivables are $234,000, and the cost of goods sold (COGS) for the 1-year period is $1,245,000, the annual sales of Galactic are closest to:

A) $3,882,000.

B) $1,410,400.

C) $4,880,200.

The correct answer is: A)

Since Days sales outstanding = 365 / Receivables Turnover = 365 / (Annual sales / Avg. acc. rec.),
we can rearrange the formula as:
Annual sales = [(365 / Days sales outstanding ) * Average acc. rec.]
Annual sales = 365/22 * $234,000 = $3,882,000

Question 6

Corporate Finance

Birmingham Corporation is launching a new product with a social media marketing campaign that will cost $2,000,000. To finance the project, Birmingham’s CEO gathered the following information:

Required return on equity: 15%
Before-tax required return on debt: 7%
Birmingham’s tax bracket: 20%

If the CEO decides to issue $1,500,00 in new debt and $500,000 in common stocks, then the marginal weighted average cost of capital (WACC) is closest to:

A) 7.20%.

B) 7.95%.

C) 9.05%.

The correct answer is: B)

To solve this question, we need to use the WACC formula:
WACC = wdrd*(1-T) + wsrs + wprp
WACC = (0.75)(7%)(1-0.2) + (0.25)(15%) = 4.2% + 3.75% = 7.95%

Question 7

Portfolio Management

Bruce Craig is in the business of trading steel in Chicago, which he inherited from his father one month ago. His financial adviser notes the following aspects of his situation:

– He is 24 years old;
– His investment horizon is 10-20 years;
– His primary objective for investing is aggressive growth;
– His business returns are not stable as he is not being able to take prudent business decisions.

Given the aforementioned information, which of the following statements is correct?

A) Craig has a low ability to take risk, but a high willingness to take risk.

B) Craig has a high ability to take risk, but a low willingness to take risk.

C) Craig has a high ability to take risk, but a high willingness to take risk.

The correct answer is: A)

As Craig’s business returns are not stable, he has a low ability to take risk. However, his age factor, time horizon and investment goal suggest a high willingness to take risk.

Question 8

Equity Investments

Which of the following statements regarding market efficiency is least likely accurate?

A) In an efficient market, prices of stocks will slowly adjust to new information.

B) An efficient capital market reflects all of the information about its securities, including risk.

C) There are three forms of market efficiency: weak, semi-strong and strong.

The correct answer is: A)

In an efficient market, prices of stocks will adjust INSTANTANEOUSLY to new information. Therefore, option A is the least likely option, as stated in the question.

Question 9

Fixed Income

A 3-year bond offers a 7% coupon rate with interests paid annually. Assuming the following sequence of spot rates, the price of the bond is closest to:

Time to Maturity Spot Rate (%)
1 4
2 5
3 5.5

 

A) 102.48

B) 106.74

C) 104.24

The correct answer is: C)

PBond = 7/(1+0.04)1 + 7/(1+0.05)2 + 107/(1+0.055)3
PBond = 104.24

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