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Level I of CFA Program
2nd Mock Exam
June 2020
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 Level I of CFA Program Mock Exam 2 – Questions (AM)

FinQuiz.com – 2nd Mock Exam 2020 (AM Session)

Questions Topic Minutes

1-18 Ethical and Professional Standards 27
19-30 Quantitative Methods 18
31-42 Economics 18
43-60 Financial Reporting and Analysis 27
61-72 Corporate Finance 18
73-86 Equity Investments 21
87-100 Fixed Income Investments 21
101-106 Derivative Investments 9
107-112 Alternative Investments 9
113-120 Portfolio Management 12
Total 180

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

Questions 1 through 18 relate to Ethical and Professional Standards

1. Lance Theodore is a portfolio manager at Trescott Alliance. Theodore always

ensures he maintains regular communication with his clients. For the current
quarter Theodore has utilized $10 million of client funds to purchase high-risk,
illiquid, but high return emerging equities. The purchase was made for the
accounts of risk-averse clients who do not have an imminent or foreseeable need
for portfolio funds. During a conversation with a fellow manager, Theodore
stated, ‘I am presently studying the characteristics of emerging market equities as
this is my first time in dealing with the asset class.’ Theodore posts information
about the recent equity purchase on Trescott Alliance’s website without
mentioning which client accounts the purchase was made for and identifies
himself as Trescott’s ‘emerging market specialist’.

Theodore is in violation of the CFA Institute Standards of Professional Conduct

because:

A. he has misrepresented information on the firm’s website.

B. the investment is unsuitable given his client’s risk tolerance.
C. he does not have sufficient experience in dealing with emerging market
equities.

2. Howard Chance is an equity analyst at Lockwood & Jill, a research firm. He is

building a return forecasting model which will predict the returns of stocks in
volatile equity markets. Chance has created his model using methodology
developed by his subordinate, Sasha Walters. Walters derives her methodology
using historical stock returns in the requisite emerging markets. Historical returns
are simulated, and future economic and political factors are incorporated to build
a forecasting equation. In the company’s newsletter, Walters identifies Chance as
one of the model’s designers and specifies that historical equity returns were used
to build the model.

Which of the following CFA Institute Standards of Professional Conduct have

been violated?

A. Performance presentation
B. Independence and objectivity
C. Diligence and reasonable basis

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

3. According to the Standards of Professional Conduct, a responsible supervisor:

A. may delegate their supervisory duties to their subordinates to distribute

their work load.
B. should deal with any employee regulatory violation by reporting it up the
chain of command.
C. does not bear the responsibility of enforcing policies related to non-
investment-related activities.

4. On January 1, 2013 Rictor Associates opened a new branch in Argentina. In the

past, the firm has always operated from its US headquarters. Mark Watson has
been assigned as the chief investment officer of the new branch. Watson requests
Mary Jacob, the U.S. chief investment officer, to shift ten client accounts to the
Argentinean division whereby all trades will be directed to a local broker which
charges a low commission fee and has a historical record of achieving above-
average portfolio returns. Jacob transfers the accounts without informing firm
clients but implies that clients should expect Rictor to generate its best account
performance in the coming months. Six months later, the accounts generate
substantial portfolio losses due to a nationwide economic crisis.

Which individual is least likely in violation of the CFA Institute Standards of

Professional Conduct?

A. Jacob; because she has made an implicit performance guarantee.

B. Jacob; because she has transferred accounts without informing clients.
C. Watson; because the brokerage arrangement did not deliver the expected
performance.

5. A fund manager has fulfilled his duty of loyalty, prudence and care with respect
to client accounts if he:

A. seeks client approval prior to making investment decisions.

B. has considered individual investor risk and return requirements when
managing funds to a stated mandate.
C. directs trades to a broker with a suboptimal performance record following
a client’s written statement instructing him not to seek best execution.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

6. An investment manager uses nonmaterial nonpublic information combined with

material public information as the basis for recommendations and decisions.

Is this practice considered a violation of the CFA Institute Standards of

Professional Conduct?

A. No.
B. Yes, if obtained from an analyst conference call.
C. Yes, if the information is obtained through contacts with corporate
insiders.

7. CFA Institute Standards of Professional Conduct require members and candidates

to maintain their independence and objectivity by:

A. disclosing the receipt of any gift which compromises their independence.

B. placing the protection of market integrity prior to that of employer’s
interests.
C. disclosing potential conflicts of interest when undertaking issuer paid
research.

8. A firm possessing material nonpublic information should most likely consider:

A. prohibiting proprietary activity.

B. prohibiting employees from engaging in personal trades.
C. placing securities on a restricted list and distributing the list to firm
employees.

9. Joyce Richards operates from the South African branch of a portfolio

management firm headquartered in Brazil. Along with managing domestic (South
African) client accounts, Richards manages the accounts of offshore Brazilian
clients. Local Brazilian laws permit investment managers to undertake portfolio
trades twenty minutes after disseminating an investment recommendation. On the
contrary South African laws prohibit investment managers from undertaking
personal trades on stocks for which an investment recommendation is made
regardless of when the trade is conducted.

In order to comply with the CFA Institute Standards of Professional Conduct,

with respect to undertaking personal trades for which an investment
recommendation is made, Richards is required to:

A. avoid undertaking personal trades.

B. wait for a minimum of twenty minutes after making recommendations.
C. wait for a maximum of twenty minutes after making recommendations.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

10. Lisa Middleton, CFA, the chief operating officer of a publicly listed
pharmaceutical company and the key team members of Agatha Investments, an
asset management firm met in an informal dinner meeting. In the meeting,
Middleton described how her company donated $2 billion to create a foundation
‘Springs Cancer Center’. She briefly discloses the company’s quarterly earnings
which will be released the next morning. No team member of Agatha Investments
covers pharmaceutical stocks. Did Middleton most likely violate the CFA Institute
Standards of Professional Conduct?

A. Yes.
B. No. because no team member of Agatha Investments covers
pharmaceutical stocks.
C. No, because no one can act on the company’s earnings related information
as the market is currently closed.

11. Anne Miguel is AM Associates’ equity fund manager, a European portfolio

management firm. She manages the accounts of 25 high net worth clients with
significant allocations to Latin American and domestic equities. This year several
of her clients have requested for an allocation to North American equities.
Lacking expertise in the requested securities, she contacts her uncle Dan Harrison,
a leading North American equity specialist and delegates the responsibility of
managing the new securities to Harrison. In a recent report on client account
performance, Miguel solely discloses the overall portfolio performance providing
a breakdown of all constituent security returns.

Miguel is most likely in violation of the CFA Institute Standards of Professional

Conduct concerning:

A. Fair Dealing
B. Conflicts of interest
C. Diligence and reasonable basis

12. Which of the following statements least likely depicts why trust is extremely
important in the investment industry?

A. Laws and ethical principles often contradict with each other.

B. Investment professionals have specialized knowledge and better access to
information.
C. It is difficult to judge the quality of investment products and services due
to their unique nature.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

13. The senior compliance officer at Trinity Associates is developing a compliance

policy for his firm, which aims to strengthen the firm’s adherence to the CFA
Institute’s Standards of Professional Conduct. Of particular interest to the officer
are the standards concerning transaction priority and client communication. The
officer includes a brief description of both standards in the firm’s manual.

Priority of Transactions: Ensuring client account transactions are given priority is

essential and should supersede transactions undertaken for beneficial and fee-
paying family member accounts.

Communication with Clients and Prospects: When communicating with clients

and prospects, members and candidates should ensure that any limitation of
statistically developed projections are identified. Failing to do so may result in
violation.

With respect to his descriptions of the two standards, the officer is most likely:

A. correct.
B. incorrect regarding his description of priority of transactions.
C. incorrect regarding his description of communication with clients and
prospects.

14. To address the conflicts of interests created by personal investing, recommended

procedures for compliance most likely include:

A. public disclosure of personal holdings.

B. total trading ban for a large portfolio management firm.
C. making a disclosure to the client stating, “investment personnel are subject
to personal trading policies.”

15. Which of the following record retention practices are in compliance with the CFA
Institute Standards of Professional Conduct?

A. A firm maintains only electronic copies of records.

B. Given that no regulatory requirements exist, records are kept for a period
of five years.
C. Departing employees use historical recommendations prepared at their
former employer ensuring they recall any information used in the analysis
solely from memory.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

16. A research analyst is writing a report on an automobile manufacturer. Based on

his own analysis he has devised a buy recommendation for the manufacturer.
When reviewing the research analyst’s report, his supervisor requests a revision of
the recommendation to ‘sell’. The supervisor’s request is based on a conversation
he overheard between two company executives in the cafeteria of the
manufacturer’s premises. The executives discussed the company’s unannounced
decision to shut down a key division in the wake of substantial losses.

The analyst’s best course of action is to:

A. revise the recommendation.

B. request for a different assignment.
C. issue the report using his recommendation but disclose the difference in
opinion.

17. A member or candidate violates the duty of loyalty to clients if (s) he:

A. does not vote all proxies.

B. relieves his duty to seek best execution for his clients.
C. fulfills the obligations outlined explicitly or implicitly to the clients’
agreements to the best of his abilities.

18. In addition to the standard relating to the preservation of client confidentiality,

which of the following standards require the firm to adopt policies which ensure
members and candidates preserve client confidentiality?

A. Suitability
B. Fair Dealing
C. Loyalty, prudence and care

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

Questions 19 to 30 relate to Quantitative Methods

19. North Western Associates manages the portfolios of several private wealth
clients. Martina Gayle is one of the firm’s clients with a $600,000 investment
portfolio. Gayle would like to liquidate $25,000 from her portfolio to fund her
daughter’s college education. She has expressly stated that any funds withdrawn
should be generated from portfolio returns and the initial capital should not be
utilized. Her portfolio manager has short-listed three portfolio alternatives for
Gayle (exhibit).

Exhibit: Portfolio Alternatives for Gayle (In Percent)

A B C
Expected return 3.5 5.2 7.4
Standard Deviation 4.4 6.8 22.0

Based on the Gayle’s preferences and the information provided in the

Exhibit, the most suitable portfolio is:

A. A.
B. B.
C. C.

20. Marshall Hick is an equity analyst following the stock of Dover Inc. If Dover
earns an EPS of ≥ $45.50, its share price is forecasted to rise by 4% or more. The
probability of earning an EPS of ≥ $45.50 is 0.55. The probability of earning EPS
of ≥ $45.50 and share price rising by 4% or more is 0.45.

Using the above information, the probability that the share price rises by 4% or
more given an EPS of ≥ $45.50 is earned is closest to:

A. 25%.
B. 60%.
C. 82%.

21. The maturity premium most likely:

A. is insensitive to changes in market interest rates.

B. compensates investors for the risk of loss relative to an investment’s fair
value if the investment needs to be converted to cash quickly.
C. compensates investors for the increased sensitivity of the market value of
debt to a change in market interest rates as maturity is extended.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

22. Martin Edgar, a research analyst from the pharmaceutical industry, is performing
statistical analysis in an attempt to determine the effectiveness of chamomile tea
on patients suffering from anxiety. To perform his analysis, he has collected data
on patients in the U.S. who have successfully used the tea to overcome anxiety.
Using this data, he aims to derive a conclusion for such patients on a global scale,
adjusting his analysis for each country’s local and environmental factors.

For the purposes of his analysis, Edgar is most likely using:

A. differential statistics.
B. descriptive statistics.
C. statistical interference.

23. A positively skewed distribution is characterized by:

A. an equal median and mean.

B. a mode greater than the mean.
C. a median greater than the mode.

24. Lukas Turner is an equity analyst conducting research on Norwegian small-cap

stocks. He has collected average stock return data over the past nine years sorted
in ascending order. Turner will categorize the stocks in one of five calculated
return intervals. The average return data is as follows:

- 10.5%, -7.4%, - 6.3%, 3.7%, 5.1%, 7.3%, 8.9%, 12.4%, and 13.0%

Which of the following statements most accurately illustrates a calculated return

interval and the associated absolute frequency?

Absolute
Return Interval: Frequency:
A. - 10.5% ≤ observation ≤ - 6.3% 3
B. - 10.5% ≤ observation ≤ - 5.8% 3
C. - 5.5% ≤ observation ≤ - 0.5% 0

25. A binomial random variable:

A. has one of two possible outcomes.

B. is defined by a probability density function.
C. is completely described by three parameters.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

26. An investor is expected to receive four annual payments of $300,000 from his
deceased father’s estate. The first payment will be made today while the second,
third and fourth payments will be made one, two, and three years from now,
respectively. The investor requires a return of 12% on his investments.

The current value of the estate payments is equal to:

A. $300,000.
B. $720,549.
C. $1,020,549.

27. Carla Mathews is a portfolio manager at Horizon Associates, a wealth

management firm. She is managing the portfolio of Janet Wilson. The expected
return and standard deviation of the Wilson’s portfolio is summarized in the
exhibit. The threshold return is 1.5%.

Exhibit:
Portfolio Expected Return and Standard Deviation (%)
Wilson’s
Portfolio
Expected Return 8.9
Expected Standard Deviation 7.3

The probability that the Wilson’s portfolio return will be less than 1.5% is closest
to:

A. 0.1562
B. 0.8438
C. 1.000

28. Alexis Morgan, CFA, is a stock analyst at Walsh Associates, an asset

management firm. She is forecasting the performance of a technology stock held
in several client portfolios based on historical data. The underlying probability of
an increase in price is 0.65.

Based on the data collected and using a Bernoulli trial, the probability that the
stock price will rise in three out of next four quarters is closest to:

A. 3.1%.
B. 25.0%.
C. 38.4%.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

29. An increasingly negative correlation between two assets least likely indicates:

A. greater diversification benefits.

B. higher cost of not diversifying.
C. an increasingly strong negative linear relationship.

30. The exhibit below illustrates the annual stock returns of a global index comprising
ten markets.

Country/Stock Return
Australia 8.0%
France 8.5%
US 10.1%
China 11.8%
Great Britain 13.5%
Yugoslavia 14.4%
North Korea 15.3%
Egypt 18.1%
India 18.3%
Yemen 19.0%

The 90th percentile of stock returns is equal to:

A. 18.30%.
B. 18.37%.
C. 18.93%.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

Question 31 to 42 relate to Economics

31. Farah Ali is a British investor seeking to redeem her $1 million investment in U.S.
corporate bonds. Ali’s investment advisor has collected relevant exchange and
interest rate data in an exhibit.

Exhibit: Exchange and Interest Rate Data

Current USD/GBP spot rate 1.6715

Annualized 3-month British risk-free rate (%) 1.5000
Annualized 3-month U.S. risk-free rate (%) 2.0000

Ali’s investment advisor proposes she take advantage of the difference in risk-free
rates by investing the redemption proceeds at the U.S. risk-free rate for three
months and then convert the sum back to the GBP at the no-arbitrage forward rate
at the end of the period.

Based on the data in the exhibit, the proposed investment strategy will generate an
un-annualized domestic investment return for Ali of:

A. 0.37%.
B. 0.50%.
C. 1.50%.

32. Which of the following is the most relevant and closely watched measure of
income for household spending and saving decisions?

A. Gross mixed income

B. Household net savings
C. Household disposable income

33. According to the quantity theory of money, holding all else constant, an increase
in:

A. the demand for real money is an increasing function of real income.

B. the demand for real money is an increasing function of interest rate.
C. real income must be accompanied by a decrease in real interest rate.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

34. A large country seeking to improve national welfare by imposing trading

restrictions should opt for a (n):

A. VER
B. Import quota
C. Export subsidy

35. Risa is a developing country situated in Southeast Asia. Labor statistics for the
years 2012 and 2013 are summarized in the exhibit below by Lisa Mascot, an
economic analyst. Mascot aims to estimate the sustainable growth rate of Risa
over the time period under analysis.

Exhibit
Labor Statistics Concerning Risa
2012 2013
Long-term labor productivity growth rate (%) 1.5 2.4
Aggregate hours worked (in millions) 7,500 8,100
Long-term growth rate of labor force (%) 5.3 4.9

The percentage change in Risa’s rate of sustainable economic growth between

2012 and 2013 is closest to:

A. 7.35%.
B. 7.40%.
C. 15.94%.

36. The Brazilian monetary authorities are pursuing a stimulative monetary policy in
which the targeted money supply growth is 5%. At the same time, fiscal
authorities in the country intend to increase spending by 2%. In this scenario,
which of the following asset classes should an investor avoid?

A. commodities.
B. cyclical stocks.
C. fixed-income securities.

37. Which of the following costs can least likely be classified as being fixed in
nature?

A. Sunk costs
B. Inventory costs
C. Real estate lease payments

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

38. The exhibit below illustrates the cost structure of a company at various levels of
output:
Exhibit
Total Fixed Total Variable
Quantity Costs (TFC) Costs (TVC)
0 500 0
100 500 50
150 500 80
200 500 140
250 500 200
300 500 280

The decision to increase output quantity from 200 to 250 units will result in the
marginal cost being equal to:

A. 1.20.
B. 2.80.
C. 160.00

39. When markets are in perfect competition economic profits are:

A. zero in the short and long run.

B. generated if price is greater than average total costs in the short run.
C. generated in the long run only if price is at the minimum efficient scale
point on the long run average total cost curve.

40. An oligopoly is characterized by:

A. high barriers to entry.

B. participating firms having no pricing power.
C. firms placing less importance to non-price competition.

41. Changes in the price level will least likely impact:

A. long-run aggregate supply.

B. short-run aggregate supply.
C. short-run aggregate demand.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

42. The government of a particular country has required companies to increase

worker safety in the electric component industry. This will increase the costs of
production, which will be passed on to consumers in the form of higher selling
prices. If there is no change in consumer income, the increase in selling prices
will most likely cause:

A. movement along the demand curve.

B. cause the demand curve to shift upwards and to the right.
C. cause the demand curve to shift downwards and to the left.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

Questions 43 to 60 relate to Financial Reporting and Analysis

43. Miller Processing Inc. is a book publisher operating in the U.S. In the most recent
financial year, one of Miller’s production plants was completely destroyed by a
factory fire. Miller complies with U.S. GAAP.

Miller Processing Inc. will account for the loss as:

A. an extraordinary item.
B. a discontinued operation.
C. part of its continuing operations.

44. Recordia is a music production company operating in the U.S. The company
intends to sell one of its operating divisions generating substantial losses for the
company over the previous two years. The division is to be sold to another record
producing company, which is paying a high price for the division, $15 million,
due to its strategic fit. The carrying value of the division prior to sale is $12
million. The applicable tax rate is 30%. Recordia complies with U.S. GAAP.

In its income statement, Recordia will record a transaction gain of:

A. $3.0 million as part of operating profit.

B. $2.1 million as part of discontinued operations.
C. $2.1 million as a separate component below discontinued operations.

45. Ascillio Tech has a weighted average of 500,000 shares of common stock
outstanding in 2013. Ascillio has $300,000 of 5% convertible bonds convertible
into 4,000 shares. The company has reported net income of $750,000 while the
applicable tax rate is 30%.

Ascillio’s diluted EPS is closest to:

A. 1.05.
B. 1.47.
C. 1.50.

46. Which inventory accounting method will report the highest number of days of
inventory on hand assuming rising inventory costs and stable quantities?

A. FIFO
B. LIFO
C. Weighted average cost

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

47. Assuming declining inventory costs, in contrast to the FIFO method of inventory
accounting, LIFO will produce a lower:

A. quick ratio.
B. gross profit margin.
C. debt-to-equity ratio.

48. Under IFRS, disclosures required for property, plant and equipment least likely
include:

A. useful lives.
B. residual values.
C. measurement bases.

49. At the beginning of the current year, a company issues $450,000 worth of zero-
coupon bonds. Which of the following statements is most likely correct with
respect to how the issue is accounted for? The:

A. issue will be sold at a premium to par.

B. effective rate of the issue exceeds the coupon rate.
C. issue’s interest expense is less than the interest payment.

50. A company purchased an item of machinery at the beginning of the fiscal year
2014. Details concerning the machinery at the end of the year are summarized as
follows:

Carrying amount $1,050,000

Undiscounted expected future cash flows $920,500
Present value of expected future cash flows $910,000
Fair value if sold $980,000
Costs to sell $50,000

Under US GAAP, the impairment loss measured with respect to the machinery at
the end of the fiscal year 2014 is:

A. $20,000.
B. $70,000.
C. $120,000.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

51. The exhibit below highlights liquidity ratios for three competing manufacturing
concerns (Alpha, Beta and Gamma) for the financial year 2013.

Alpha Beta Gamma

Cash ratio 2.0 1.8 2.2
Defensive interval ratio 38 45 29
Quick ratio 1.9 1.9 1.5
Current ratio 1.0 0.5 0.7

Based on the information provided in the exhibit, which company is in the

strongest position to continue to pay its expenses solely from its existing liquid
assets?

A. Alpha
B. Beta
C. Gamma

52. In a situation where a company’s inventory becomes illiquid and experiences a

decline in inventory turnover ratio, the quick ratio should most likely:

A. rise.
B. decline.
C. remain unchanged.

53. Throck is a manufacturer of home appliances. The company prepares and presents
its financial statements in accordance with IFRS. The exhibit illustrates the
classification of selective items in its cash flow statement.

Item Cash Flow Statement

Classification
Dividends paid Operating
Dividends received Investing
Interest paid Financing
Interest received Operating

Which of the following adjustments is least likely required when deriving free
cash flows to the firm (FCFF) from cash flow from operations (CFO)? Add:

A. dividends paid.
B. interest received.
C. dividends received.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

54. Which of the following will not be a component of a cash flow statement prepared
using the indirect method?

A. Cash paid to suppliers.

B. Amortization of bond discount.
C. Gain from the sale of a long-term asset.

55. An analyst has collected the following financial information for a company for the
fiscal years 2014 and 2015.

2015 2014
Return-on-equity (ROE) 17.9% 15.5%
Net profit margin 10.8% 9.5%
Total asset turnover 1.5 1.2

Which of the following statements is most likely correct with respect to the
financial data collected? Between 2014 and 2015 the analyst will observe a (n):

A. decline in financial leverage.

B. decrease in return-on-assets.
C. increase in financial leverage.

56. The exhibit below summarizes selective financial measures calculated by an

analyst for the fiscal years 2014 and 2015:

2015 2014
Days of inventory on hand 75 days 65 days
Defensive interval ratio 70 65
Debt-to-total capital 85 60

Based on the data presented, the company has experienced an improvement in:

A. liquidity.
B. solvency.
C. efficiency.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

57. A company began its operations in 2015 by purchasing 2,000 inventory units at a
total cost of €28,000. In anticipation of an increase in demand the company
purchased an additional 750 units at a price of €16 each. The company sold 900
units in 2015 at a price of €25 per unit.

The cost of sales reported by the company under the LIFO method in the fiscal
year 2015 is closest to:

A. €12,600.
B. €14,100.
C. €14,400.

58. Which of the following reasons are most likely attributable to a decline in the
return-on-equity ratio?

A. A lower value of tax burden.

B. A decrease in borrowing costs.
C. The repurchase of common stock.

59. A discussion of the critical accounting policies that require subjective judgment
and that have a significant impact on reported financial results can be found in
the:

A. supplementary schedules.
B. management commentary.
C. financial statement of position.

60. An analyst collects the data shown in exhibit below of a steel manufacturing firm.

2013 2012
ROE 15.7% 13.2%
Tax rate 35% 40%
EBT/EBIT 95.7% 95.7%
EBT margin 7.4% 6.9%
EBIT margin 8.9% 7.7%
Financial leverage 1.3 0.8

Between 2012 and 2013, the efficiency of the manufacturer has most likely:

A. improved.
B. deteriorated.
C. remained unchanged.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

Questions 69 to relate to 76 Corporate Finance

61. Which of the following stakeholder groups is most likely concerned that a
company abides with applicable laws?

A. Customers
B. Government
C. Shareholders

62. The exhibit below shows the cash flow pattern for a project undertaken by Cecilio
Manufacturers:

Exhibit: Cash Flow Pattern

Year 0 1 2 3 4
Cash flow in 10 5 - 20 - 4 12
(in thousands)

The project will most likely have:

A. zero IRRs
B. one IRR
C. two IRRs

63. White Traders and Jones Corp are two companies operating in the furniture
making industry. Compared to Jones Corp, a greater proportion of White Traders’
operating costs are fixed. Both companies report an equivalent amount of debt in
their capital structure. Based on the facts presented, which of the following
statements is most likely correct?

A. White Traders will report a more variable return on equity.

B. The sensitivity of White Traders’ operating income to change in unit sales
is higher.
C. The sensitivity of Jones Corp’s net income to changes in operating income
is higher.

64. A 80-day, $1,000, US Treasury bill is being sold for $985. The bond equivalent
yield for this instrument is equal to:

A. 6.75%.
B. 6.85%.
C. 6.95%.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

65. A company has recently undertaken a three-year project with annual cash flows of
$30,000 and a cash inflow of $60,000 in the terminal year. The initial investment
is $100,000 and the required rate of return is 15%.

The NPV method makes certain assumptions regarding the reinvestment rate and
opportunity cost of funds. Based on the data provided, which of the following
statements is most likely correct?

A. The reinvestment rate is equal to 8.4%.

B. The opportunity cost of funds is equal to 8.4%.
C. The reinvestment rate and opportunity cost of funds are both equal to
15%.

66. Miguel Palmer is evaluating two projects, A and B. The cash flows, investment
outlays, IRRs, and NPVs for both projects are given below.

Cash Flows
Year 0 1 2 3 4 NPV IRR (%)
Project A -200 85 85 85 120 93.34 28.97
Project B -190 0 0 0 420 96.87 21.93

The discount rate at which both projects will have the same NPV is closest to:

A. 10.97%.
B. 25.45%.
C. 28.97%.

67. Which of the following components is least likely considered in capital budgeting
decisions?

A. Financing costs
B. Opportunity costs
C. Before-tax cash flows

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

68. A company has decided to shorten its operating cycle by 50 days. The reduction
will be achieved by shortening the existing number of days of inventory on hand
while keeping the number of days of receivables constant. The exhibit below
presents selective financial data currently being reported by the company:

Number of days of 222 days

inventory
Number of days of 85 days
receivables
Cost of sales $525,000

Assuming that the cost of sales remains constant, the reduction in inventory
balance required for shortening the length of the operating cycle is closest to:

A. $71,918.
B. $247,397.
C. $319,315.

69. A company has recently undertaken a project. When plotting its NPV profile, the
project manager identified that the profile intersects the vertical axis at an NPV of
$40 million.

The discount rate at this intersection is most likely identified as the:

A. IRR.
B. crossover rate.
C. rate at which the required rate of return is zero.

70. Which of the following statements is most likely correct regarding the impact of
taxes on the cost of capital?

A. Interest costs serve to reduce a company’s cost of debt.

B. Cost of equity may require adjustments for taxes if preferred stock is part
of the capital structure.
C. The weighted average cost of capital reflects a required rate of return after
adjusting all its components for taxation.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

71. Skylark Manufacturers is situated in a developing country where equity markets

have been always highly volatile with unstable equity market returns. In addition,
political turmoil has often mandated temporary halts in market trading. As a
consequence, the Skylark stock has rarely generated stable performance. Carl
Jung, a potential investor is attempting to determine Skylark’s cost of equity and
the most appropriate method to derive this estimate.

Which of the following statements most accurately characterizes a consequence of

the chosen method to estimate Skylark’s cost of equity?

A. The dividend discount model approach will generate the most stable
equity risk premium estimate.
B. The arithmetic mean estimate for equity risk premium generated by the
historical approach will exceed the geometric mean estimate.
C. The CAPM approach will adequately factor sources of priced risk such as
macro-economic and company-specific factors affecting the Skylark stock.

72. Ester Miguel is using data concerning a publically traded comparable to

determine the asset beta for a privately traded company. The beta of the publically
traded stock is 1.8 while debt-to-equity ratios and marginal tax rates are 0.4 and
30%, respectively. The privately traded corporation has a D/E ratio of 0.7 and a
marginal tax rate of 25%.

Using the pure play method, the beta used to estimate the cost of capital for a
project undertaken by the private entity having an identical risk and financing
structure as its company is closest to:

A. 1.41.
B. 2.10.
C. 2.14.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

Questions 73 to 86 relate to Equity Investments

73. Which of the following issues are faced when using a market-capitalization-
weighted index?

A. Large-cap securities are underrepresented.

B. Stock splits cause arbitrary changes in the weights of all securities.
C. Investing in a market-capitalization index is similar to a momentum
investment strategy.

74. A limitation of the cyclical/noncyclical classification is that:

A. business cycle sensitivity is a continuous spectrum rather than an

“either/or” issue.
B. the method relies on historical data and there is no guarantee that the past
will repeat itself into the future.
C. different regions of the world may pass through business cycle stages all at
the same time complicating comparisons.

75. The exhibit below summarizes selective price and dividends data for the three
stocks comprising a market capitalization technology index between the years
2014 and 2015:

Total
Price ($) – Price ($) – Shares Dividends
31/12/2014 31/12/2015 Outstanding ($)
Alpha 100 150 50,000 200,000
Sigma 80 60 120,000 120,000
Tech-X 250 410 300,000 100,000

The total return of the index is closest to:

A. 53.68%.
B. 54.15%.
C. 94.38%.

76. Which of the following statements is most likely correct with respect to weak-
form efficient markets?

A. Technical analysis cannot be used as a tool to earn abnormal returns.

B. Security prices reflect all publicly known and available information.
C. Passive portfolio management should outperform active portfolio
management.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

77. A market is said to be efficient if:

A. superior risk-adjusted returns are achievable on a consistent basis.

B. passive investment strategies are preferred to active investment strategies.
C. a majority of traders are able to earn profits with little risk as asset prices
adjust to reflect information.

78. Which of the following dividend models will be most suitable for valuing a
company which is currently in the transition phase?

A. Gordon-growth
B. Two-stage dividend discount model
C. Three-stage dividend discount model

79. An investor has recently purchased a share, which does not currently pay
dividends. The first dividend is expected to be received six years from the date of
purchase and will amount to $5. Thereafter, dividends will grow at a rate of 2.5%
into perpetuity. The required rate of return is 10%.

The current estimated intrinsic value of the share is closest to:

A. $41.39.
B. $57.86.
C. $68.33.

80. During periodic rebalancing, portfolio weights of a fund benchmarked to a

market-capitalization-weighted index will most likely:

A. have a value-tilt.
B. favor a contrarian strategy.
C. favor a momentum strategy.

81. At the end of the current fiscal year, a company paid a dividend per share of
$8.00. For the next three years, the dividends are expected to grow at a rate of 6%
per annum. From the fourth year onwards, the growth rate is expected to become
stable at 2% per annum into the indefinite future. The required return on equity is
10%.

The intrinsic value of the company’s stock is:

A. $28.94.
B. $105.27.
C. $113.57.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

82 To construct a float-adjusted market capitalization weighted index, possible

adjustments include removing shares:

A. of small-cap stocks.
B. held by corporations.
C. held by foreign investors.

83. An analyst has selected the asset-based valuation method for valuing a company.
Which of the following reasons most likely justifies the selected method? The
company:

A. reports unstable earnings.

B. is close to being liquidated.
C. has a high proportion of intangible assets.

84. An analyst is comparing the valuation of three manufacturing concerns on the

basis of the P/S and P/CF ratios. The ratios reported by the three companies are
presented in an exhibit:

Manufacturer A Manufacturer B Manufacturer C

P/S 0.68 0.15 0.30
P/CF 8.57 4.90 6.22

Which manufacturer’s stock is most likely to be overvalued?

A. A
B. B
C. C

85. An investor purchased 300 shares on margin by paying a price of $30 per share.
The investor decides to sell the shares two months later at a price of $35 per
share. The monthly interest paid during the period is 2% per month. The investor
earns a dividend income of $5 per share. The leverage ratio is 4.0 and the
purchase and sales commission paid by the investor amounts to $6 each.

The total return on the investment is:

A. – 44.8%
B. + 120.5%.
C. + 126.5%.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

86. For the year ended December 31, 2013 a company reported return-on-equity
(ROE) of 15% using average book values. In the same year the company
generated net income of $10.25 million. Total shareholder’s equity reported in the
company’s balance sheet at the beginning of the year amounted to $85.65 million.
The company has 1,000,000 equity shares outstanding in the year 2013.

The book value of equity per share for the year 2013 is closest to:

A. $51.02.
B. $85.65.
C. $222.32.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

Questions 87 to 100 relate to Fixed Income

87. Contingent convertible bonds:

A. force bondholders to take losses.

B. increase the bank’s likelihood of default.
C. offer lower yields than otherwise similar bonds.

88. An investor has purchased a 4-year, 5% annual coupon-payment bond. The

sequence of spot rates over the bond’s term to maturity is illustrated in the exhibit
below.

Exhibit:
Spot Rate Sequence over the Bond’s Term to Maturity
Time-to-maturity Spot rate (%)
1 year 2.3
2 year 3.1
3 year 4.6
4 year 5.2

The price of the bond (per 100 of par value) is closest to:

A. $99.69.
B. $100.00.
C. $114.33.

89. A 12% semi-annual coupon paying bond has three-year maturity. Based on the
spot rate sequence at the time of bond issuance, the bond is priced at 105.80 (per
100 of par value).

Relative to bond’s coupon rate, the yield-to-maturity of the bond issue is most
likely:

A. equal.
B. lower.
C. higher.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

90. An investor has purchased a 7-year, 10% annual coupon payment bond issued at
90.20 per 100 of par value and holds it till maturity. All coupon payments will be
reinvested at a rate of 8%.

The interest-on-interest gain from compounding the reinvested coupons is closest

to:

A. $19.23.
B. $20.00.
C. $36.37.

91. The investor’s realized horizon yield matches the yield-to-maturity if:

A. the bond is sold at a price to generate capital gains.

B. the bond is sold at a price on the constant-yield price trajectory.
C. coupon payments are reinvested at a rate higher than the original yield-to-
maturity.

92. The manager of defined benefit pension plan would like to measure the sensitivity
of its retirement obligations to market interest rate changes. The discount rate of
the plan is currently 8.2%. The company has hired an analyst who has compiled
estimates of pension plan liabilities based on assumed interest rate changes.

Exhibit
Present Value of Liabilities & Interest Rate Assumptions
Interest Rate Present Value of
Assumption Liabilities
7.95% $102.8 million
8.20% $90.5 million
8.45% $86.4 million

The effective duration of the plan’s liabilities is closest to:

A. 0.36.
B. 23.93.
C. 36.24.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

93. Rica Corp is a rice manufacturer operating in Mexico. Maria Salas is the
company’s chief financial analyst. Salas is attempting to calculate and interpret
key fundamental measures by examining selective information from the
company’s financial statements over the previous two financial years. She has
compiled the necessary data in an exhibit.

Exhibit
Rica Corp’s Key Financial Information
Mexican Pesos (In Millions) 2013 2012
Gross profit 35.8 25.6
Operating profit 28.9 20.1
Interest expense 5.6 3.1

Based on the information compiled by Salas, she will most likely conclude that
between 2012 and 2013 Rica Corp’s:

A. credit risk has increased.

B. ability to pay dividends has improved.
C. ability to cover interest payments has deteriorated.

94. An industry analyst is evaluating financial information concerning three

competitors in the steel manufacturing industry. He aims to determine which
company has the highest credit quality based on the information collected.

Exhibit
Financial Information Concerning Three Competitors in the Steel
Manufacturing Industry

Company Company Company Industry

A B C Average
Free cash flow from
operations/debt (%) 165.2 90.5 135.8 150.6
EBITDA interest coverage
ratio (x) 40.8 55.0 43.8 45.1
Total debt ($ millions) 543.0 330.1 400.5 340.8

Which company will receive the highest credit rating?

A. Company A
B. Company B
C. Company C

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

95. A five-year bullet bond has a principal amount and coupon rate of $1,000 and 4%,
respectively. The market interest rate is assumed to be constant at 4% over the
bond’s term to maturity. The bond will be issued and redeemed at par.

The principal payment due in Year 2 of the bond issue is closest to:

A. $0.
B. $40.
C. $200.

96. Which of the following covenants will protect unsecured creditors’ claims in the
event of default?

A. Limitations on lien
B. Restricted payments
C. Change of control put

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

97. An investor holds an American call option which is three months from expiry.
The underlying is a dividend-paying stock. Dividends are expected to be paid one
month from today. Which of the following statements is most likely correct
regarding the American call option?

A. The option is worth less relative to an otherwise identical European call

option.
B. There is a strong motivation for the option holder to exercise the option
prior to expiration.
C. The loss from a decline in price of the underlying works to the
disadvantage of the option holder should the option be exercised early.

98. The stock of Ridge Enterprises recently closed at $65 per share. An investor is
contemplating the purchase of 100 shares of the Ridge stock today. To protect his
position from a potential decline in price, the investor executes a covered call
strategy by selling a three-month call with a strike price of $70 and a premium per
share of $2. One call option covers 100 shares. If the underlying price is $68 at
option expiration and the investor sells his holding at this price, the profit on the
position will equal to:

A. $300.
B. $500.
C. $700.

99. The single auction process:

A. will result in winning bidders paying the same price.

B. will increase the cost of funds in the form of a higher coupon rate.
C. is a secondary market mechanism used to issue U.S. Treasury bonds to the
public.

100. Which of the following is most likely a non-sovereign bond? Bond issued by:

A. New York city.

B. Postal Service sponsored by Spanish Government.
C. a private banking and financial service company in Germany.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

Questions 101 to 106 relate to Derivatives

101. A criticism of using derivatives includes:

A. increased market volatility.

B. lower market liquidity relative to underlying spot market.
C. slower correction of price deviation from fundamental values.

102. A put option on a stock with a market price of $16.60 is selling for $4.37 and has
an exercise rate of $15.50. A protective put strategy constructed using this put
option and the stock will have a maximum loss closest to:

A. $3.27.
B. $4.37
C. $5.47.

103. A call option with exercise price of $120 is selling for $13. If the price of the
underlying at expiration is $111, the profit for the seller is closest to:

A. $0.00.
B. $9.00.
C. $13.00.

104. At the expiration of a call option:

A. time value is zero.

B. intrinsic value is zero.
C. option price equals to the difference between time and intrinsic value.

105. Which of the following statements is least likely correct regarding forwards,
futures and swaps?

A. Swaps can be priced as an implicit series of off-market forward contracts.

B. Costs and benefits of holding the underlying affect the forward price by
lowering and raising it, respectively.
C. Futures prices can differ from forward prices because of the effects of
interest rates on the interim cash flows from the daily settlement.

106. An American option can be worth more than an otherwise equivalent European
option if:

A. it has time value.

B. there are no cash flows on the underlying.
C. it is a callable and there are cash flows on the underlying.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

Questions 107 to relate to 112 Alternative Investments

107. Alternative investments are characterized by:

A. moderate degree of liquidity.

B. high degree of manager specialization.
C. low correlation with traditional investments

108. Which of the following is least likely a characteristic common to hedge funds?

A. Exclusive membership
B. High degree of leverage
C. Passive investment vehicles

109. Development capital, a categorization of private equity,:

A. entails investing or providing financing to private companies with high

growth potentials.
B. entails buying the debt of mature companies in financial difficulties.
C. refers to minority equity investments in more mature companies that are
looking for capital to expand or restructure operations, enter new markets
or finance major operations.

110. Which of the following statements is least likely correct regarding timberland and
farmland?

A. Only timberland provide flexibility in harvesting.

B. Both timberland and farmland have three primary return drivers.
C. There is little flexibility in harvesting in both timberland and farmland.

111. A hedge fund is solely invested in emerging market fixed-income securities. The
component securities lack an established trading platform. Which of the following
will most likely be used to value the underlying positions of the fund for the
purposes of calculating net asset value?

A. Average quotes
B. Average quotes adjusted for liquidity
C. Bid prices for longs and ask prices for shorts

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

112. LifeHouse Funds of Funds invests $350 million in Cape Hedge Fund. LifeHouse
FOF charges a 2% management fee based on assets under management at year
end and a 12% investment fee based on returns in excess of a 5% hurdle rate.
Management and incentive fees are calculated independently. At the end of the
year, the investment in Cape is valued at $450 million. The annual return to an
investor in the LifeHouse FOF, net of fees, is equal to:

A. 22.57%.
B. 23.17%.
C. 23.41%.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

Questions 113 to 120 relate to Portfolio Management

113. Data visualization for non-traditional unstructured data can be achieved using all
of the following except:

A. Tag cloud
B. Mind map
C. Text analytics

114. Is it beneficial to add new asset to the portfolio, if the Sharpe ratio of the new
asset is greater than the Sharpe ratio of the current portfolio?

A. No.
B. Yes.
C. Not always.

115. T.S. Associates is a portfolio management firm managing the investment

portfolios of high net worth clients. The chief investment officer is evaluating the
performances of three junior portfolio managers – Robert Smith, Dana Port, and
Jeremy East. Information concerning the results achieved by the managers is
given below:

Manager Return (%) s (%) b

Smith 12 11 0.8
Port 14 15 1.4
East 9 7 1.1
Market portfolio 8 7
Risk-free rate 2

Based on the information presented in the exhibit, the M2 measure is highest for:

A. Smith.
B. Port.
C. East.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

116. An investor who is willing to take additional risk and is using the capital market
line to make investment decisions will most likely:

A. lend a portion of his wealth at the risk-free rate.

B. select portfolios lying above the capital market line.
C. undertake a leveraged position in the market portfolio.

117. Lance Gayle is an asset advisor at Walsh & Homer, a portfolio management firm
in Dallas, Texas. He is evaluating three alternative asset classes for one of his
client’s portfolios. Gayle’s main objective is to select an asset class, which will
maximize his client’s risk-adjusted portfolio returns. Expected return and risk data
concerning the three alternatives is summarized in an exhibit. The risk-free rate of
return is equal to 0.8%.

Exhibit:
Data Concerning Expected Return and
Standard Deviation for Potential Asset Classes
Expected Annual Expected Annual
Asset Class Return (%) Standard Deviation (%)
Commodities 9.1 12.4
Emerging market equities 11.8 15.6
Long-term corporate bonds 7.2 8.9

Which of the proposed asset classes will meet Gayle’s objective?

A. Commodities
B. Emerging market equities
C. Long-term corporate bonds

118. Which of the following is least likely achieved with risk budgeting?

A. Specification of acceptable risk based on risk appetite.

B. Portfolio allocation based on investment risk characteristics.
C. Evaluation of investment choices against a risk-adjusted market return.

119. Which of the following is a valid assumption of the capital asset pricing model
(CAPM)?

A. Investors are risk-neutral.

B. Investors cannot influence trade prices.
C. All investors hold a combination of the risk-free asset and market
portfolio.

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 Level I of CFA Program Mock Exam 2 – Questions (AM)

120. Bella Harris, CFA, is a portfolio manager employing a utility formula of

µ = E (r ) - 0.5 As 2 to select asset classes for her clients’ investment portfolios.
Presently Harris is selecting suitable asset classes for two clients – Graham Lake,
a risk neutral investor, and Caroline Davis, a risk-loving investor. She has
compiled annual expected return and risk data in the exhibit below:

Exhibit
Expected Return and Standard Deviation Data of Potential Asset Classes
Asset Class Expected Return E(r)* Standard Deviation*
1 14% 18%
2 16 22
3 20 25
4 25 31
*Expected Return and Standard Deviation represent annual figures.

The most appropriate asset class for the two clients, respectively, is:

Lake Davis
A. 1 4.
B. 2 3.
C. 4 4.

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