CFA Level 1 Practice Questions by AnalystPrep

Avaikan has not violated any standards because she sent an email to all of her clients simultaneously. After sending the email, she called her major clients directly. The CFA Institute Standard III(B): Fair Dealing does not prohibit members and candidates from providing extra services for higher fees or major clients. However, all clients must be dealt with fairly and objectively, which Avaikan did by sending an email to all of them at the same time.

A is incorrect. Standard III(B): Fair Dealing relates to members and candidates dealing fairly and objectively when providing investment analysis, making investment recommendations, taking investment action, or engaging in other professional activities. Avaikan did not violate Standard III(B): Fair Dealing of the CFA Institute Code and Standards.

B is incorrect. The recommendation was presented as an opinion and not a fact and was well documented. Standard I(C): Misrepresentation relates to members and candidates misrepresenting investment analysis, recommendations, actions, or other professional activities. Avaikan did not violate Standard I(C): Misrepresentation.

Jacobs has violated Standard II(A): Material Non-Public Information by publishing non-public information on her blog and Standards IV(A) Loyalty by sharing private company information.

B is incorrect. Standard IV(A): Loyalty relates to an employee depriving their employer of the advantage of their skills and abilities, divulging confidential information, or causing harm to their employer.

C is incorrect. Melissa Jacobs has shared an investment recommendation based on material, non-public information that could influence the stock’s price; therefore, he has violated Standard II (A). It makes little difference that she published the blog under a pseudonym. Her integrity as a CFA member or candidate must be preserved regardless of how she represents herself online.

The question requires calculating the present value of a series of equal cash flows compared to the lump sum payment.
The annuity payment qualifies as an ordinary annuity since it has equal annuity payments, with the first payment starting at time t=1.
Hence the formula is as follows; $$PV=A+A\left[\frac{1-\frac{1}{{(1+r)}^{N-1}}}{r}\right]$$

Where;
A = Annuity amount.
r = The annual interest rate per period corresponding to the frequency of annuity payments.
N = Number of annuity payments since the first payment is currently due for payment at time t=1.
Therefore;

$${{{\rm PV}_{Annuity}}_t}_{14}=$400,000+$400,000\left[\frac{1-\frac{1}{{(1+0.07)}^{14}}}{0.07}\right]=$400,000\times8.745=$3,898,187.19$$
We can also use Using the BA II Plus Pro Calculator. First, set the calculator to BGN by pressing 2ND PMT then 2ND ENTER then 2ND CPT (because the payments start today), then proceed as follows;

N= 15; I/Y= 7; PMT=400,000; FV = 0; CPT => PV = 3,898,187.19
The total annuity payment amount of $3,898,187.19 is less than the lumpsum payment of $4.5 million; hence settle for a lump sum payment.

Alternatively, consider the equation:

$$PV=A+A\left[\frac{1-\frac{1}{{(1+r)}^{N-1}}}{r}\right]$$

We can clearly solve the second part of the right-hand side of the equation using Using the BA II Plus Pro Calculator. In this case,

N= 14; I/Y= 7; PMT=400,000; FV = 0; CPT => PV = -3,498,187.19

Then we add $400,000 to the result, to arrive at the same answer:

$$ \$3,498,187.19+\$400,000=\$ 3,898,187.19$$

Note: Remember to remove the minus sign on the resulting PV before adding $400,000.

A is incorrect. The present value of the lump sum is greater than the present value of the annuity payments, as evidenced in Choice B.

C is incorrect. The present value of the lump sum is greater than the present value of the annuity payments.

India can produce both goods at a lower cost than England. India needs 160 (150) hours to produce one iPad (Personal Computer), whereas England needs 200(170) hours. Therefore, India has an absolute advantage for both iPads and PCs.

B is incorrect. England does not have an absolute advantage in iPads production or personal computers because India can produce both products at a lower cost than England.

C is incorrect. India has a comparative advantage for PCs over iPads. It takes them 1.06 times more hours \((\frac{160}{150}=1.06)\) to build a PC but 1.17 times more hours \((\frac{200}{170}=1.17)\) to build an iPad. As a result, both countries can maximize their use of resources if India specializes in building PCs and exchanges them for iPads built in England.

$$\begin{align*}\text{Net income for 2018}& = \text{Increase in retained earnings} + \text{Dividends paid}\\& = \$25 + \$40 = \$65\end{align*}$$
Depreciation of $55 is a non-cash expense and is added back to net income.

Increases in accounts receivable, $5, and in inventory, $3, are uses of cash. Thus, they ought to be subtracted from net income.

The decrease in accounts payable is also a use of cash and, therefore, a subtraction from net income.

Thus, cash flow from
operations is:
$$\$65 + \$55 – \$5 – \$3 – \$7 = \$105$$
B is incorrect. Adds the increase in accounts receivable to the net income.

C is incorrect. Adds the accounts payable to the net income.

Recall the WACC formula:
$$\text{WACC} = w_dr_d(1-t) + w_sr_s + w_pr_p$$

Where,

\(w_d\) = the target proportion of debt in the capital structure when the company raises new funds.
\(r_d\) = the before-tax marginal cost of debt.
\(t\) = the company’s marginal tax rate.
\(w_p\) = the target proportion of preferred stock in the capital structure when the company raises new funds.
\(r_p\) = the marginal cost of preferred stock.
\(w_e\) = the target proportion of common stock in the capital structure when the company raises new funds.
\(r_e\) = the marginal cost of common stock.
If the tax rate decreases the cost of debt will increase. Hence, the WACC will also increase.
Random number, say 5, to be the before-tax cost of debt, and assuming an initial tax rate of, say, 30%, then decreasing the tax rate to, say, 25%, we can understand the relationship between WACC and tax rate.
Tax rate of 30%: \(\text{After tax cost of debt} = 5\times\left(1-0.3\right)=3.5\)
Tax rate of 25%: \(\text{After tax cost of debt} = 5\times\left(1-0.25\right)=3.75\)
As seen above, the after-tax cost of debt increases with a decrease in the tax rate. An increase (decrease) in the after-tax cost of debt increases (decreases) the WACC.

B is incorrect. An increase (decrease) in the after-tax cost of debt increases (decreases) the WACC.

C is incorrect. The tax has an overall effect on WACC has its impacts on the after-tax cost of Debt.

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

B is incorrect. The unstable nature of Craig’s business creates a low ability and not a high ability to take a risk.

C is incorrect. Craig has a high willingness to take a risk, but the unstable nature of the business creates a low ability to take a risk.

Fundamental analysis analyzes the intrinsic value of a company’s stock using micro and macroeconomic factors. It comprises three parts: Industry Analysis, Economic Analysis, and Company Analysis. Fundamental analysis relies on public data, for example, a company’s historical earnings and profit margins, to predict future growth. Traders cannot earn abnormal profits by using fundamental analysis if the security prices of the markets they trade in already reflect public information.

On the other hand, Technical analysis analyzes statistical trends, such as price movements and volume, to identify trading opportunities. Technical analysts use historical (past) trading activity and a security’s price changes as valuable indicators of the security’s future price movements.

The market is weak-form efficient if a trader can earn abnormal profits using fundamentals but not technical analysis. An investor cannot earn abnormal profits by using technical analysis in all forms of market efficiency.

The table below summarizes the possibility of earning abnormal returns through various strategies and active management, assuming different types of market efficiency.
$$\begin{array}{l|c|c|c|c}{}&\textbf{Technical Analysis}&\textbf{Fundamental Analysis}&\textbf{Insider Trading}&\textbf{Active Management}\\ \hline \text{Weak}&\text{No}&\text{Yes}&\text{Yes}&\text{Yes}\\ \hline \text{Semi-strong}&\text{No}&\text{No}&\text{Yes}&\text{No}\\ \hline \text{Strong}&\text{No}&\text{No}&\text{No}&\text{No}\\ \end{array}$$

B is incorrect. Investors in the strong form of market efficiency cannot use any trading strategy to consistently earn abnormal profits because the security prices reflect all information. Investors can earn abnormal profits only by being lucky.

C is incorrect. Investors in the semi-strong form of market efficiency can earn abnormal profits only by using insider information.

The price of the bond is calculated using the general formula for calculating a bond price given the sequence of spot rates as follows;
$$PV=\frac{PMT}{{{(1+Z}_1)}^1}+\frac{PMT}{{{(1+Z}_2)}^2}+\frac{PMT+FV}{{{(1+Z}_3)}^3}$$

$$\Rightarrow \text{price}=\frac { 7 }{ { (1+0.04) }^{ 1 } } +\frac { 7 }{ { (1+0.05) }^{ 2 } } +\frac { 107 }{ { (1+0.055) }^{ 3 } } =104.20$$
Tip: In an exam situation; this calculation can be easily done as one calculation by using brackets at each step. $$\left(7/\left({1.04}^1\right)\right)+\left(7/\left({1.05}^2\right)\right)+\left(107/\left({1.055}^3\right)\right)=104.20$$

A is incorrect. It excludes the coupon payment in the last year:
$$PV=\frac{7}{{1.04}^1}+\frac{7}{{1.05}^2}+\frac{100}{{1.055}^3}=98.24$$

B is incorrect. It uses the three-year spot rate only.
$$\text{price}=\frac { 7 }{ (1+0.055)^{ 1 } } +\frac { 7 }{ (1+0.055)^{ 2 } } +\frac { 107 }{ (1+0.055)^{ 3 } } =104.05$$