Deck Flashcards

Question

An investor buys a share of stock for $200.00 at time t = 0. At time t = 1, the investor buys an additional share for $225.00. At time t = 2 the investor sells both shares for $235.00. During both years, the stock paid a per share dividend of $5.00. What are the approximate time-weighted and money-weighted returns respectively? A) 10.8%; 9.4%. B) 7.7%; 7.7%. C) 9.0%; 15.0%.

Answer 1

A) 10.8%; 9.4%. Time-weighted return = (225 + 5 – 200) / 200 = 15%; (470 + 10 – 450) / 450 = 6.67%; [(1.15)(1.0667)]1/2 – 1 = 10.8% Money-weighted return: 200 + [225 / (1 + return)] = [5 / (1 + return)] + [480 / (1 + return)2]; money return = approximately 9.4% Note that the easiest way to solve for the money-weighted return is to set up the equation and plug in the answer choices to find the discount rate that makes outflows equal to inflows. Using the financial calculators to calculate the money-weighted return: (The following keystrokes assume that the financial memory registers are cleared of prior work.) TI Business Analyst II Plus® Enter CF0: 200, +/-, Enter, down arrow Enter CF1: 220, +/-, Enter, down arrow, down arrow Enter CF2: 480, Enter, down arrow, down arrow, Compute IRR: IRR, CPT Result: 9.39

Answer 2

A) 10.03. Calculate the new bond prices at the 50 basis point change in rates both up or down and then plug into the approximate modified duration equation: Current price: N = 50; FV = 1,000; PMT = (0.075/2) × 1,000 = 37.50; I/Y = 4.625; CPT → PV = $830.54. +50 basis pts: N = 50; FV = 1,000; PMT = (0.075/2)1,000 = 37.50; I/Y = 4.875; CPT → PV = $790.59. –50 basis pts: N = 50; FV = 1,000; PMT = (0.075/2)1,000 = 37.50; I/Y = 4.375; CPT → PV = $873.93. Approximate modified duration = (873.93 – 790.59) / (2 × 830.54 × 0.005) = 10.03

Answer 3

A) Net income. Property, Plant, & Equipment and payment of dividends are components of the statement of cash flows under both the direct and indirect methods. Net income is the first figure under the indirect method, but it is not a part of the statement of cash flows under the direct method. The correct response is net income.

Answer 4

A) Financing. Dividends paid to stockholders are considered cash outlays from financing according to U.S. GAAP.

Answer 5

A) 0.61 0.66 Betai = (si/sM) × rI, M BetaPNS = (0.18/0.22) × 0.75 = 0.6136 BetaInCharge = (0.17/0.22) × 0.85 = 0.6568

Answer 6

C) Omega has lower interest coverage than Alpha. Using the EBITDA coverage ratio (EBITDA / Interest expense), Omega's EBITDA coverage is 1.4 ($79,300 EBITDA / $58,100 interest expense) and Alpha's EBITDA coverage is 1.6 ($69,400 EBITDA / $44,000 interest expense). Using EBITDA to measure operating profit, Alpha has a lower operating profit margin than Omega. Alpha's EBITDA margin is 4.2% ($69,400 EBITDA / $1,650,000 revenue) and Omega's EBITDA margin is 5.5% ($79,300 EBITDA / $1,452,000 revenue). Using fixed asset turnover to measure the efficiency of fixed assets, Omega uses its fixed assets less efficiently than Alpha. Alpha's fixed asset turnover is 5.5 ($1,650,000 revenue / $300,000 average fixed assets) and Omega's fixed asset turnover is 4.5 ($1,452,000 revenue / $323,000 average fixed assets).

Answer 7

A) achieve complete diversification of the portfolio. In an efficient market, portfolio managers must create and maintain the appropriate mix of assets to meet their client's needs. The portfolio should be diversified to eliminate unsystematic risk. The appropriate systematic risk will depend on the clients risk tolerance and return requirement. Over time the needs of the client and environment will justify changes to the portfolio. The manager should also try to minimize transaction costs and at least try to match the performance of a benchmark.

Answer 8

B) 0.81. We calculate the probability that at least one of the options will fall below $35 using the addition rule for probabilities (A represents Alpha, O represents Omega): P(A or O) = P(A) + P(O) – P(A and O), where P(A and O) = P(A) × P(O) P(A or O) = 0.65 + 0.47 – (0.65 × 0.47) = approximately 0.81

Answer 9

B) 0.81. We calculate the probability that at least one of the options will fall below $35 using the addition rule for probabilities (A represents Alpha, O represents Omega): P(A or O) = P(A) + P(O) – P(A and O), where P(A and O) = P(A) × P(O) P(A or O) = 0.65 + 0.47 – (0.65 × 0.47) = approximately 0.81

Answer 10

B) 9. Degrees of freedom for the Chi-square distribution are the sample size minus one.

Answer 11

B) 0.78 $500 If equity equals 45% of assets, and current liabilities equals 20%, then long-term debt must be 35%. Long-Term Debt / Equity = 0.35 / 0.45 = 0.78 Working capital = CA – CL = 45% - 20% = 25% of assets WC = 2,000(0.25) = $500

Answer 12

B) Increase. A write-down of inventory to net realizable value is typically recognized under U.S. GAAP as an increase in cost of goods sold in the period of the write-down. Consider the inventory equation: ending inventory = beginning inventory + purchases – cost of goods sold A write-down to NRV decreases ending inventory, with no effect on beginning inventory or purchases. For the inventory equation to hold, cost of goods sold must increase

Answer 13

A) If the covariance is negative, the rates of return on two investments will always move in different directions relative to their means. Negative covariance means rates of return for one security will tend to be above its mean return in periods when the other is below its mean return, and vice versa. Positive covariance means that returns on both securities will tend to be above (or below) their mean returns in the same time periods. For the returns to always move in opposite directions, they would have to be perfectly negatively correlated. Negative covariance by itself does not imply anything about the strength of the negative correlation, it must be standardized by dividing by the product of the securities' standard deviations of return.

Answer 14

B) $30 million. 2008 sales are expected to be $600 million ($500 million 2007 sales × 1.2) and 20X8 net income is expected to be $30 million ($600 million 20X8 sales × 5%). 2008 non-cash operating working capital is expected to be $120 million ($600 million 20X8 sales × 20%). The change in cash is expected to be –$5 million ($30 million 20X8 net income + $60 million 20X8 depreciation – $20 million increase in non-cash operating working capital – $75 million 20X8 capital expenditures). The 20X8 ending balance of cash is expected to be $30 million ($35 million beginning cash balance – $5 million decrease in cash).

Answer 15

B) The calculated test statistic is 1.291. Here, we have a normally distributed population with an unknown variance (we are given only the sample standard deviation) and a small sample size (less than 30.) Thus, we will use the t-statistic. The test statistic = t = (3,150 – 3,000) / (450 / √ 15) = 1.291

Answer 16

C) against deferred tax assets based on the likelihood that those assets will not be realized. Valuation allowance is a reserve against deferred tax assets based on the likelihood that those assets will not be realized. Deferred tax assets reflect the difference in tax expense and taxes payable that are expected to be recovered from future operations.

Answer 17

C) a budget deficit during a recession and a budget surplus during an inflationary expansion. Automatic stabilizers such as unemployment compensation, corporate profits tax, and the progressive income tax run a deficit during a business slowdown but run a surplus during an economic expansion. Therefore, they automatically implement countercyclical fiscal policy without the delays associated with policy changes that require legislative action.

Answer 18

A) Lawrence has the greatest uncertainty about its net income. Jerome CV sales = 400,000 / 1,200,000 = 0.33 Lawrence CV sales = 700,000 / 3,500,000 = 0.20 Morris CV sales = 1,600,000 / 6,400,000 = 0.25 Uncertainty about sales is greatest for Jerome and least for Lawrence. Jerome CV net income = 80,000 / 120,000 = 0.67 Lawrence CV net income = 300,000 / 400,000 = 0.75 Morris CV net income = 400,000 / 800,000 = 0.50 Uncertainty about net income is greatest for Lawrence and least for Morris.

Answer 19

A) accounting standard-setting bodies. Accounting standard-setting bodies issue financial reporting standards but do not enforce compliance with them. Securities regulators and counterparties to private contracts are among the mechanisms that discipline financial reporting quality.

Answer 20

A) $11.77. The expected growth rate of dividends is the retention rate (RR) times the return on the equity portion of new investments (ROE), g = (RR)(ROE). The retention rate is 1 minus the payout rate. RR = 1 – 0.80 = 0.20. g = (0.20)(0.15)= 3.0%. The value of the stock will be the dividend paid next year divided by the required rate of return minus the growth rate. Next year's dividend is $0.80 × 1.03 = $0.824. So the value is 0.824 / (0.10 – 0.03) = 0.824 / 0.07 = $11.77.

Answer 21

C) liability of $21,760. Since pretax income ($195,000) exceeds the taxable income ($131,000), Blue Horizon will have a deferred tax liability of $21,760 [($195,000 − $131,000)(0.34)].

Answer 22

C) –0.5%. G = [(1.10)(0.85)(1.00)(1.05)]0.25 – 1 G = (0.98175)0.25 – 1 = 0.9954 – 1 = –0.00459 ≈ –0.5% Note: Taking a number to the 0.25 power is the same as taking the fourth root of the number.

Answer 23

B) operating income. An enterprise value multiple is typically calculated as the ratio of enterprise value to EBITDA or some other measure of operating income. Net income or pretax income are not typically used because they reflect a firm's current capital structure and non-cash charges, and because the ratio becomes meaningless when income is negative.

Answer 24

C) Lending money to government agencies. Lending money to government agencies is not typically a function of a central bank. Central bank functions include controlling the country's money supply to keep inflation within acceptable levels and promoting a sustainable rate of economic growth, as well as issuing currency and regulating banks.

Answer 25

B) systematic risk. Beta is a measure of systematic risk.

Answer 26

B) the value of a long-term bond is more sensitive to interest rate changes than the value of a short-term bond Long-term, low-coupon bonds are more sensitive than short-term and high-coupon bonds. Prices are more sensitive to rate decreases than to rate increases (duration rises as yields fall)

Answer 27

C) the asset and liability are equal. At the initiation of a lease, the lessee records an asset and a liability that are both equal to the present value of the promised lease payments.

Answer 28

B) percentage of the variation in the dependent variable explained by the variation of the independent variable. The coefficient of determination for a linear regression describes the percentage of the variation in the dependent variable explained by the variation of the independent variable.

Answer 29

A) consult counsel to determine the legality of the activity and disassociate from any illegal or unethical activity if the member has reasonable grounds to believe that the activity is illegal or unethical. According to the procedures for compliance involving Standard I(A), CFA Institute members should determine legality and disassociate from any illegal or unethical activity.

Answer 30

C) Perfect competition. Firms' demand curves are perfectly elastic (horizontal) in a market characterized as perfect competition, so that marginal revenue is equal to price and a firm maximizes profit by producing the output quantity at which marginal cost equals price. In monopoly markets or under monopolistic competition, firm demand curves are downward sloping so that marginal revenue is less than price

Answer 31

A) investor's highest utility curve is tangent to the efficient frontier. The optimal portfolio for an investor is determined as the point where the investor's highest utility curve is tangent to the efficient frontier.

Answer 32

B) 6.0. Effective duration is the percentage change in price for a 1% change in yield, which is given as 6.

Answer 33

A) P(A and B) = 0. If the two evens are mutually exclusive, the probability of both occurring is zero.

Answer 34

C) $1,163,000. Cash interest paid each year is 5% × $10,000,000 = $500,000. To calculate the effective interest rate: N = 3; PV = 8,000,000; FV = –10,000,000; PMT = –500,000; CPT I/Y = 13.55% The initial bond liability equals the proceeds raised of $8,000,000. Interest expense for 20X1 = 13.55% × $8,000,000 = $1,084,000. The bond liability amortizes (toward face value at maturity) by the difference between interest expense and cash interest paid: $1,084,000 – $500,000 = $584,000. The bond liability at the beginning of 20X2 = $8,000,000 + $584,000 = $8,584,000. Interest expense for 20X2 = 13.55% × $8,584,000 = $1,163,132.

Answer 35

C) repurchasing common shares. Debt covenants exist to protect creditors. Repurchasing common shares is a use of cash that rewards equity investors but might harm creditors by reducing the firm's solvency. Decreasing dividends or issuing new shares would increase the cash available to repay creditors.

Answer 36

B) 100% 0% Because there is a perfectly positive correlation, there is no benefit to diversification. Therefore, the investor should put all his money into Stock A (with the lowest standard deviation) to minimize the risk (standard deviation) of the portfolio.

Answer 37

) operating cash flow for the period. There are two formats for a common-size cash flow statement, expressing each type of outflow as a percentage of total cash outflows or as a percentage of total revenue for the period. Operating cash flow for the period mixes inflows and outflows and is not used to calculate percentage flows for payment made.

Answer 38

B) $31,000 $31,000 CFO is the same under both methods, the only difference is presentation. Direct method: $92,500 cash collections ($100,000 revenue – $7,500 increase in receivables) – $38,500 cash paid to suppliers (– $40,000 COGS + $2,500 decrease in inventory – $1,000 decrease in payables) – $20,000 cash operating expenses – $3,000 tax expense = $31,000. Indirect method: $32,000 net income + $5,000 depreciation expense – $7,500 increase in receivables + $2,500 decrease in inventory – $1,000 decrease in payables = $31,000. The increase in short-term notes payable is a financing activity.

Answer 39

C) increase by more than 10.03%. Because of positive convexity, (bond prices rise faster than they fall) for any given absolute change in yield, the increase in price will be more than the decrease in price for a fixed-coupon, noncallable bond. As yields increase, bond prices fall, and the price curve gets flatter, and changes in yield have a smaller effect on bond prices. As yields decrease, bond prices rise, and the price curve gets steeper, and changes in yield have a larger effect on bond prices. Here, for an absolute 150bp change, the price increase would be more than the price decrease.

Answer 40

C) depreciation of 9.2%. To correctly calculate the percentage change in AUD relative to GBP, convert the exchange rates so that AUD is the base currency: 1 / 1.4800 = 0.6757 GBP/AUD five years ago and 1 / 1.6300 = 0.6135 GBP/AUD today. The percentage change in the Australian dollar against the British pound is 0.6135 / 0.6757 − 1 = –9.2%. Note that the GBP has appreciated against the AUD by 1.6300 / 1.4800 − 1 = 10.1% over the same period.

Answer 41

A) CFs are more easily estimated than future dividends. CFs are not easier to estimate than dividends.

Answer 42

B) 18.7%. HPY = (1,020 + 30 + 30 – 910) / 910 = 0.1868 or 18.7%.

Answer 43

A) violated the Standards by her policy on mutual fund and pension fund proxies. Proxies should be taken seriously, and although it is likely that Griffith can understand some of the issues, it is likely that she is not capable of making responsible decisions on all potential proxy issues. Proxies for a pension plan should be voted in the best interests of the beneficiaries, not the plan sponsor. The sponsor's interests will not always be the same as the beneficiary's interest.

Answer 44

C) may be greater or less than the realized yield. For the realized yield to equal the YTM, coupon reinvestments must occur at that YTM. Whether reinvesting the coupons at the coupon rate will result in a realized yield higher or lower than the YTM depends on whether the bond is at a discount (coupon < YTM) or a premium (coupon > YTM

Answer 45

A) 1.25. The degree of financial leverage (DFL) is interpreted as the ratio of the percentage change in net income to the percentage change in EBIT. FCO can compare two EBIT forecasts to determine how net income is being driven by financial leverage. (43800 - 39000)/39000 / (88000-80000)/80000 = 1.23

Answer 46

A) fall, the bond's price increases at a decreasing rate Negative convexity occurs with bonds that have prepayment/call features. As interest rates fall, the borrower/issuer is more likely to repay/call the bond, which causes the bond's price to approach a maximum. As such, the bond's price increases at a decreasing rate as interest rates decrease.

Answer 47

A) 20%. On a common-size balance sheet, each line item is stated as a percentage of total assets: 2,000 / 10,000 = 20%.

Answer 48

C) Deductible expenses. Permanent tax differences such as tax credits, non-deductible expenses, and tax differences between capital gains and operating income give rise to differences in the effective and statutory tax rates.

Answer 49

C) Only Toffler has violated the Code of Standards. The Code and Standards permit an individual to state that he or she is a candidate for the CFA designation as long as the person is registered for the next CFA exam. The same individual may state the fact that he or she has passed Level I or II of the CFA program. There is no partial designation, such as CFA II.

Answer 50

C) nonoperating expenses are increasing. Nonoperating expenses are equal to the difference between operating profit and pretax profit. Based on the given profit margins, Mulroy's nonoperating expenses increased from 3% of sales in 20X1 to 9% of sales in 20X3. Because gross profit margin is increasing, cost of goods sold is decreasing as a percentage of sales. Other operating expenses and income tax expense, as a percentage of sales, were stable over the period shown.

Answer 51

A) 4.53% E(RA) = 11.65% σ2 = 0.0020506 = 0.15(0.18 – 0.1165)2 + 0.2(0.17 – 0.1165)2 + 0.25(0.11 – 0.1165)2 + 0.4(0.07 – 0.1165)2 σ = 0.0452836

Answer 52

B) Par value government bond maturing in five years. The bond with the least percentage price change will be the bond with the lowest interest rate risk. Higher coupons or shorter maturities decrease interest rate risk. The coupon paying bond with only five years to maturity will have the lowest interest rate risk.

Answer 53

A) 34 to 82. This question has a bit of a trick. To answer this question, remember that the mean is at the midpoint of the confidence interval. The correct confidence interval will have a midpoint of 58. (34 + 82) / 2 = 58.

Answer 54

C) Marginal cost equals price. When a firm operates under conditions of perfect competition, marginal revenue always equals price. Under perfect competition, price is constant (a horizontal line) so marginal revenue is constant. Therefore a firm will increase output until marginal cost equals price.

Answer 55

C) Simple. A complex capital structure contains potentially dilutive securities such as options, warrants, or convertible securities. There is no basic capital structure but there are basic earnings per share which does NOT consider the effects of any dilutive securities in the computation of EPS.

Answer 56

C) The frontier extends to the left, or northwest quadrant representing a reduction in risk while maintaining or enhancing portfolio returns. Reducing correlation between the two assets results in the efficient frontier expanding to the left and possibly slightly upward. This reflects the influence of correlation on reducing portfolio risk.

Answer 57

C) $0.261. To compute Gerrard's basic earnings per share (EPS) ((net income – preferred dividends) / weighted average common shares outstanding), the weighted average common shares outstanding must be computed. 700,000 shares were outstanding from January 1, and 200,000 shares were issued on March 1, so the weighted average is 700,000 + (200,000 × 10 / 12) = 866,667. Basic EPS was $330,000 − (2,000 × $500 × 0.08)) / 866,667 = $0.289. If the convertible preferred shares were converted to common stock, 2,000 × 200 = 400,000 additional common shares would have been issued and dividends on the preferred stock would not have been paid. Diluted EPS was $330,000 / (866,667 + 400,000) = $0.261.

Answer 58

C) 17.4. Find the weighted average return for each stock. Stock A: (0.10)(-5) + (0.30)(-2) + (0.50)(10) + (0.10)(31) = 7%. Stock B: (0.10)(4) + (0.30)(8) + (0.50)(10) + (0.10)(12) = 9%. Next, multiply the differences of the two stocks by each other, multiply by the probability of the event occurring, and sum. This is the covariance between the returns of the two stocks. [(–5 – 7) × (4 – 9)] (0.1) + [(–2 – 7) × (8 – 9)](0.3) + [(10 – 7) × (10 – 9)](0.5) + [(31 – 7) × (12 – 9)](0.1) = 6.0 + 2.7 + 1.5 + 7.2 = 17.4

Answer 59

A) $1.19 $1.18 Basic EPS 2400000 - 14000/ 2000000 = 1.19 Diluted EPS (24000000-14000) + (49500)(1-0.40) / (2000000)(45000) = 1.18

Answer 60

A) fair value hedge. Using an interest rate swap to hedge changes in the value of a balance sheet liability is considered a fair value hedge. If the interest rate swap is used to convert the floating-rate payments on a bond liability to fixed-rate payments, it would be considered a cash flow hedge.

Answer 61

B) An annual bonus, sent to the analyst by a client, which varies with the performance of the client's portfolio that the analyst manages as an employee even though no verbal or written agreement exists about the bonus. Standard IV(B) requires that members disclose to their employer in writing all benefits that they receive in addition to their regular compensation for services they perform on behalf of their employer. Since the bonus varies with the performance of the client's portfolio, there is a clear link to the services of the analyst. The analyst is not required to report the lunch since it is not linked to performance.

Answer 62

C) a priori probability. An a priori probability is based on formal reasoning rather than on historical results or subjective opinion.

Answer 63

A) borrow and invest in the market portfolio. Portfolios that lie to the right of the market portfolio on the capital market line ("up" the capital market line) are created by borrowing funds to own more than 100% of the market portfolio (M). The statement, "diversify the portfolio even more" is incorrect because the market portfolio is fully diversified.

Answer 64

B) a liability for unearned revenue. Sales revenue for which the product or service has yet to be delivered gives rise to a liability account, unearned revenue. This liability will be reduced as the product or service is actually delivered.

Answer 65

B) 3.00 The standard error of the sample mean equals the standard deviation of the population divided by the square root of the sample size σ / √n = 15 / √25 = 3. The standard error measures how much the sample mean deviates from the true population mean. The smaller the standard error, the closer the sample mean is likely to lie to the true population mean.

Answer 66

C) 35,000. Variable cost per unit is 140,000 / 40,000 = $3.50. 70000 + 80000/ 7.75 - 3.50 =35294

Answer 67

B) Operating. Under U.S. GAAP, interest paid is an operating cash flow.

Answer 68

B) $41.32. g = ROE × retention ratio = ROE × b = 15 × 0.4 = 6% Based on the growth rate we can calculate the expected price in year 3: P3 = D4 / (k – g) = 2.2 / (0.10 – 0.06) = $55 The stock value today is: P0 = PV (55) at 10% for 3 periods = $41.32

Answer 69

B) present value model. The free cash flow to equity model is one type of present value model or discounted cash flow model. It estimates a stock's value as the present value of cash available to common shareholders. The enterprise value model is an example of a multiplier model

Answer 70

C) reveal to the prospects referred by Smith that he performs services for Smith, along with the estimated value of those services. According to VI(C), Referral Fees, as a member of CFA Institute, Towers must tell his clients about the payment in kind to Smith along with an estimate of the value of those services.

Answer 71

B) MC curve. The short-run supply curve for a firm in a perfectly competitive market is equal to the firm's MC curve. A price taker will maximize profits when it produces the output level where P = MC. As price rises, its point of intersection with the MC curve indicates optimal production.

Answer 72

B) Variance = 0.03836; Standard Deviation = 19.59%. (0.40)2(0.18)2 + (0.60)2(0.24)2 + 2(0.4)(0.6)(0.18)(0.24)(0.6) = 0.03836. 0.038360.5 = 0.1959 or 19.59%.

Answer 73

B) involves a trade-off between the cost of increasing the sample size and the value of increasing the precision of the estimates. A larger sample reduces the sampling error and the standard deviation of the sample statistic around its population value. However, this does not imply that the sample should be as large as possible, or that the sampling error must be as small as can be achieved. Larger samples might contain observations that come from a different population, in which case they would not necessarily improve the estimates of the population parameters. Cost also increases with the sample size. When the cost of increasing the sample size is greater than the value of the extra precision gained, increasing the sample size is not appropriate.

Answer 74

C) lead to an increase in total expenditures for the good. When demand is relatively inelastic, consumers do not reduce their quantity demanded very much when the price increases. That is, a given percentage increase in price results in a smaller percentage reduction in quantity demanded. Thus, total expenditures on the good increase. "Fail to reduce the quantity demanded for the good" is inaccurate because that would only be true if demand was perfectly inelastic.

Answer 75

A) Adjust the corporate bond yield to actual months and years. Corporate bond yields are typically based on a 30/360 day count. When calculating spreads, corporate yields are often restated to the actual/actual basis typically used to state government bond yields.

Answer 76

C) H0: µ ≥ 0.15 versus Ha: µ < 0.15. The alternative hypothesis may be thought of as what the analyst is trying to establish with statistical evidence, in this case that µ < 0.15. The opposite of the alternative will be the null hypothesis, in this case that µ ≥ 0.15. Remember that the null hypothesis always includes the "equal to" condition: ≥, ≤, =. The alternative hypothesis can only have one of these signs: <, >, ≠.

Answer 77

B) Does not consider Considers The indirect method must add back depreciation expense because the starting point is net income. Since the direct method does not begin with net income it does not need to consider non-cash expenses such as depreciation.

Answer 78

B) client. Brokerage is an asset of the client.

Answer 79

A) $24 million. Free cash flow to the firm = net income + noncash charges + after-tax interest – fixed capital investment – working capital investment. Net income is $43.7 million. Noncash charges are $4.2 million (depreciation expense). No interest expense is shown. Fixed capital investment is $35 million purchased – $15 million sold = $20 million. Working capital investment is $1.5 million increase in accounts receivable + $2.3 million decrease in accounts payable = $3.8 million. (Both are uses of cash) FCFF = $43.7 million + $4.2 million – $20 million – $3.8 million = $24.1 million.

Answer 80

A) a deposit is required to return the account margin to the initial margin level. Once account margin (based on the daily settlement price) falls below the maintenance margin level, it must be returned to the initial margin level, regardless of subsequent price changes.

Answer 81

B) too high. The cash conversion cycle is equal to average days of receivables plus average days of inventory minus average days of payables. High cash conversion cycles relative to those of comparable firms are considered undesirable. A cash conversion cycle that is too high implies that the company has excessive investment in working capital.

Answer 82

B) increase Fred’s income tax expense by $400,000. The change in Fred's rates causes its deferred tax liability to increase [(40 − 30) / 30] × $1,200,000 = $400,000. This is reported on the income statement as an increase in current income tax expense

Answer 83

B) cumulative output and cost per unit. The industry experience curve shows cost per unit relative to cumulative output. Cost per unit typically decreases over time due to higher utilization rates for fixed capital, improvements in the efficiency of labor, and better product design and manufacturing methods.

Answer 84

B) negative covenants. Negative covenants are prohibitive in nature, such as restrictions on asset sales and additional borrowings. Affirmative or positive covenants are actions a borrower is required to take and are often administrative in nature, for example to comply with relevant laws and regulations or to insure and maintain assets

Answer 85

C) $170,000 $37,000 Investing Activities: $10,000 – $180,000 = -$170,000 cash flow from investing or $170,000 used Financing Activities: $38,000 – $75,000 = -$37,000 cash flow from financing or $37,000 used Note that the question asked for net cash used therefore this is a positive cash outflow.

Answer 86

A) inform her supervisor that she cannot work on the portfolio because of a legal agreement, but cannot tell him why. Jason must inform her supervisor of the conflict, but she cannot violate the terms of the confidentiality agreement and she cannot work on the portfolio.

Answer 87

B) 7.65%. The current yield is computed as: (Annual Cash Coupon Payment) / (Current Bond Price). The annual coupon is: ($1,000)(0.0775) = $77.50. The current yield is then: ($77.50) / ($1,012.45) = 0.0765 = 7.65%.

Answer 88

A) $966. We can calculate the price of the bond by discounting each of the annual payments by the appropriate spot rate and finding the sum of the present values. Bond price = [60 / (1.05)] + [1,060 / (1.08)2] = $966. Or, in keeping with the notion that each cash flow is a separate bond, sum the following transactions on your financial calculator: N = 1; I/Y = 5.0; PMT = 0; FV = 60; CPT → PV = 57.14 N = 2; I/Y = 8.0; PMT = 0; FV = 1,060; CPT → PV = 908.78 Price = 57.14 + 908.78 = $966.

Answer 89

A) either discrete or continuous random variables. Multivariate distributions can describe discrete or continuous random variables.

Answer 90

B) $316,448. Newberg, upon issuance of the bonds, recorded bonds payable of N = 2 × 7 = 14, PMT = $175,000, I/Y = 6/2 = 3, FV = $5,000,000, CPT PV = $5,282,402. Interest expense June 30, 2005, was $5,282,402 × (0.06 / 2) = $158,472. The coupon payment was $175,000, reducing bonds payable to $5,282,402 – ($175,000 - $158,472) = $5,265,874. Interest expense December 31, 2005, was $5,265,874 × (0.06 / 2) = $157,976. Total interest expense in 2005 was $158,472 + $157,976 = $316,448.

Answer 91

B) +11.0%. You can answer this question without calculations. A decrease in interest rates must cause the price to increase. Because duration alone will underestimate a price increase, the price must increase by more than 10%.

Answer 92

A) noncurrent items. Under IFRS, deferred tax assets and liabilities are classified as noncurrent. Under U.S. GAAP, deferred tax items may be current or noncurrent, depending on how the underlying asset or liability is classified.

Answer 93

C) tokenization. Tokenization refers to maintaining ownership records for physical assets on a distributed ledger. This might, but would not necessarily, use a blockchain, which is a subcategory of distributed ledgers. Smart contracts are computerized agreements designed to automatically carry out certain actions if defined conditions are met.

Answer 94

C) 0.50X. Market value of equity = ($100)(1000) = $100,000 Price / Sales = $100,000 / $200,000 = 0.5X

Answer 95

C) both behavioral finance and informationally efficient markets. Edwin's statement is consistent with both behavioral finance and informationally efficient markets. While behavioral biases that cause individuals to act irrationally can cause assets to be mispriced, markets can still be considered efficient if asset mispricing cannot consistently be exploited to earn positive risk-adjusted returns on average over time.

Answer 96

B) 3.75. Sales = $100,000,000 VC of 25% of sales = 25,000,000 FC of 40,000,000 + 15,000,000 = 55,000,000 DOL= [100,000,000 – 25,000,000] / [100,000,000 – 25,000,000 – 55,000,000] = 3.75

Answer 97

B) zero. The carrying value of the warranty liability is $26,000 (the same amount is recorded as a liability on the balance sheet and as an expense on the income statement). The tax base is equal to the carrying value less any amounts deductible in the future. Therefore, the tax base is $0 ($26,000 − $26,000) since the warranty expense will be deductible when the work is performed next year.

Answer 98

A) storage costs. Costs of holding an asset increase its no-arbitrage forward price. Benefits from holding the asset, such as dividends or convenience yield, decrease its no-arbitrage forward price.

Answer 99

C) $40,000. The traditional DuPont system is given as: ROE = (net profit margin)(asset turnover)(leverage ratio) Solving for the net profit margin yields: 0.12 = (net profit margin) × (2) × (1.5) 0.04 = (net profit margin) Recognizing that the net profit margin is equal to net income / revenue we can substitute that relationship into the above equation and solve for net income: 0.04 = net income / revenue = net income / $1,000,000 $40,000 = net income.

Answer 100

B) Risk tolerance. The constraints are: liquidity needs, time horizon, taxes, legal and regulatory factors, and unique needs and preferences. Risk tolerance is included in the investment objectives of the policy statement, not in the constraints

Answer 101

B) Semistrong and strong forms only. The semistrong form of EMH states that security prices rapidly adjust to reflect all publicly available information. If the analyst can use his model, which is based on publicly available information, to earn above average returns, the semistrong form of the EMH has been violated. If the semistrong form of EMH is violated, the strong form of EMH is also violated.

Answer 102

B) $3.0 million source of cash. 2007 inventory turnover was 5 (365 / 73 days in inventory). Given inventory turnover and COGS, 2007 average inventory was $20 million ($100 million COGS / 5 inventory turnover). 2008 inventory turnover is expected to be 7.3 (365 / 50 days in inventory). Given expected inventory turnover, 2008 average inventory is $17 million ($124.1 million COGS / 7.3 expected inventory turnover). To achieve 50 days of inventory on hand, average inventory must decline $3 million ($20 million 2007 average inventory – $17 million 2008 expected inventory). A decrease in inventory is a source of cash.

Answer 103

A) increase, if we assume that the growth rate remains constant. When payout ratio increases, the justified P/E multiple increases only if we assume that the growth rate will not change as a result.

Answer 104

B) 0.79 BDE/TOL. The real exchange rate is calculated as 0.75 BDE/TOL × 110/105 = 0.79 BDE/TOL

Answer 105

A) arise primarily due to differences between financial and tax accounting. Deferred tax liabilities result from temporary differences between financial accounting and tax accounting that cause income tax expense for a period to be larger than taxes due. Permanent differences do not result in deferred tax items. Whether to treat deferred tax liabilities as debt or equity depends on whether they are expected to reverse in the foreseeable future.

Answer 106

C) 16.20%. g = (RR)(ROE) = (.60)(.27) = 0.162 or 16.2%

Answer 107

C) risky assets in existence. The market portfolio, in theory, contains all risky assets in existence. It does not contain any risk-free assets.

Answer 108

C) Utilities. With a natural monopoly average costs of production will be lowest when a single large firm produces the entire output demanded such as a utility.

Answer 109

B) intrinsic value of a stock is the present value of its future dividends. The rationale for dividend discount models is that the fundamental or intrinsic value of a stock is the present value of all its future dividends. Dividend discount models can be applied to either a finite or infinite stream of dividends. There are many ways to calculate the inputs and the estimated stock values may vary significantly with small changes in the inputs.

Answer 110

A) Higher Higher Available-for-sale securities are reported on the balance sheet at fair value and any unrealized gains and losses bypass the income statement and are reported as an adjustment to equity. Thus, a decrease in fair value will result in a higher ROA ratio (lower assets). Trading securities are also reported on the balance sheet at fair value; however, the unrealized gains and losses are recognized in the income statement. Therefore, an increase in fair value will result in higher ROA. In this case, both the numerator and denominator are higher; however, since the ratio is less than one, the percentage change of the numerator is greater than the percentage change of the denominator, so the ratio will increase.

Answer 111

C) and real GDP in the current period. The GDP deflator is the percentage difference between the current period's nominal GDP and real GDP, reflecting inflation since the base period

Answer 112

B) 4. 30 = 6 + β (12 - 6) 24 = 6β β = 4

Answer 113

B) operating profit. This difference describes operating profit.

Answer 114

B) 13.00%. From the formula: ValuePreferred Stock = D / kp, we derive kp = D / ValuePreferred Stock = 11.50 / 88.46 = 0.1300, or 13.00%.

Answer 115

C) Total asset turnover. Total asset turnover should improve, as the numerator (sales) would not be affected while the denominator (total assets) would be lower. Profitability ratios and the debt-to-equity ratio would be worse due to lower profits and lower equity due to the inventory writedown.

Answer 116

C) Total asset turnover. Total asset turnover should improve, as the numerator (sales) would not be affected while the denominator (total assets) would be lower. Profitability ratios and the debt-to-equity ratio would be worse due to lower profits and lower equity due to the inventory writedown.

Answer 117

B) No effect Increase Unrealized foreign currency translation gains and losses are not reported in the income statement; thus, retained earnings are unaffected. However, unrealized foreign currency gains and losses are included in comprehensive income. Comprehensive income includes all changes in equity except those that result from transactions with shareholders. So, the translation gain increases stockholders' equity by increasing comprehensive income

Answer 118

A) capital account. The capital account includes goods and financial assets that migrants bring when they come to a country or take with them when they leave

Answer 119

B) Earnings for a period will be higher than analysts’ expectations. Management might be motivated to "manage earnings" by making conservative choices and estimates in periods when earnings are higher than expected, delaying recognition of some of these earnings to later periods. Meeting debt covenants or improving stock performance in the near term are more likely to motivate management to make aggressive accounting choices and estimates.

Answer 120

A) $3,840,000. With sales of $5.5 million and a gross margin of 0.32, COGS on a LIFO basis is $5.5 million × (1 − 0.32) = $3.74 million. To convert COGS to a FIFO basis, subtract the change in LIFO reserve during the year: $3,740,000 − ($75,000 − $175,000) = $3,840,000.

Answer 121

B) $2.01. Quad's basic EPS (net income / weighted average common shares outstanding) was $892,000 / 400,000 = $2.23. Diluted EPS is calculated under the assumption that the convertible bonds are converted into common stock, the bond interest net of tax is restored to net income, and the additional common shares are added to the denominator of the equation. Quad's diluted EPS was [$892,000 + (2,000 × $1,000 × 0.06)(1 − 0.40)] / [400,000 + (2,000 × 40)] = $2.01. Since diluted EPS is less than basic EPS, we know that the bonds are dilutive and should be considered in calculating diluted EPS.

Answer 122

B) 70,600. Operating breakeven quantity of sales = 1.2 million/(39 – 22) = 70,588 units.

Answer 123

C) Weighting methodology varies among index providers and leads to differences in index risk and returns. Weighting methodology is a major issue for commodity indexes. Several different methodologies are used, including equal weighting and global production values. Differences in weighting cause differing exposures for the indexes and lead to different risk and return profiles. Commodity indexes represent futures contracts on commodities, not the actual spot prices of commodities. Commodity index returns come from three sources: the risk-free rate of return, changes in futures prices, and the roll yield.

Answer 124

C) Allocation of fixed production overhead. Assuming normal capacity levels, allocation of fixed production overhead is a product cost that is capitalized as part of inventory. Thus, this cost will not be recognized as an expense until the inventory is sold (it becomes part of COGS for that period). Administrative overhead and selling costs are period costs that must be expensed in the period incurred.

Answer 125

violated CFA Institute Standards of Professional Conduct because she misrepresented the optimism by turning it to certainty. Standard V(B), Communication with Clients and Prospective Clients. Members must distinguish between fact and opinion in the presentation of a research report or investment recommendation. Wise violated the standard because she misrepresented management's enthusiasm by turning it into certainty

Answer 126

A) $3.80. The put option will not be exercised because it is out-of-the-money, Max(0, X − S). Therefore, Steadman keeps the full amount of the premium, $3.80.

Answer 127

C) violated the Code and Standards by not including the insider trading information in her report. Standard V(B), Communication with Clients and Prospective Clients, requires analysts to use reasonable judgment regarding the inclusion or exclusion of relevant factors in their research reports. It would not be unreasonable to exclude the temporary credit downgrade from 3 years earlier.

Answer 128

B) consisting of both sales risk and operating risk. Business risk is the combination of sales risk and operating risk. Business risk refers to the risk associated with a firm's operating income and is the result of uncertainty about a firm's revenues and the expenditures necessary to produce those revenues. Sales risk is the uncertainty about the firm's sales. Operating risk refers to the additional uncertainty about operating earnings caused by fixed operating costs. The greater the proportion of fixed costs to variable costs, the greater a firm's operating risk. (Module 35.1, LOS 35.a)

Answer 129

B) A recent quote from the Federal Reserve Chairman. Statistics provided by a recognized agency, such as Standard and Poor's, do not need to be cited. Charts, quotes, and algorithms developed by the firm would need to be cited when they are used but the individual(s) who developed the materials within the firm do not need to be cited.

Answer 130

B) may have credit policies that are too strict. The firm's average days of receivables should be close to the industry average. A significantly lower average days receivables outstanding, compared to its peers, is an indication that the firm's credit policy may be too strict and that sales are being lost to peers because of this. We cannot assume that stricter credit controls than the average for the industry are "better." We cannot conclude that credit sales are less, they may be more, but just made on stricter terms. The average days of receivables are only one component of the cash conversion cycle. (Module 32.1, LOS 32.d)

Answer 131

A) Purchased franchise right with a useful life of two years. A purchased, identifiable intangible asset with a finite life is amortized over its useful life. Costs incurred to develop an intangible asset such as a trademark are expensed when incurred. A patent that expires in the current period will not provide future benefits and therefore should not be recognized as an asset

Answer 132

A) the market return. The return on a security market index can be used as a proxy for the market return in a pricing model such as the CAPM.

Answer 133

B) Acquiring the company’s financial statements. The financial statement analysis framework consists of six steps. Step 2: "Gather data" includes acquiring the company's financial statements and other relevant data on its industry and the economy. Step 3. "Process the data" includes activities such as making any appropriate adjustments to the financial statements and preparing exhibits such as graphs and common-size balance sheets.

Answer 134

C) Yes. Hooper violated Standard I(D) because he repeatedly engaged in conduct that involves dishonest conduct. This violation occurred despite the fact that his offenses do not relate directly to his professional activities. However, Hooper's conduct reflects poorly on his professional reputation and integrity.

Answer 135

B) $2,000 $22,000 Unrealized gains and losses from trading securities are recognized in the income statement while unrealized gains and losses from available-for-sale securities bypass the income statement and are reported as other comprehensive income, a component of stockholders' equity. Cash dividends are recognized in the income statement for both trading and available-for-sale securities. Thus, Alpha will recognize only the $2,000 dividend if the shares are considered available-for-sale and will recognize $22,000 ($2,000 dividend + $20,000 unrealized gain) if the shares are considered trading securities

Answer 136

B) $36 million $54 million 2007 FIFO inventory was $36 million ($20 million LIFO inventory + $16 million reserve). 2007 FIFO COGS was $54 million ($64 million LIFO COGS – $10 million increase in LIFO reserve).

Answer 137

B) not permissible under the Code and Standards. Standard III(B) requires a member to deal fairly with all clients when taking investment actions. Since she knew at the outset that she was going to place shares in all accounts, regardless of the first letter of the surname, all accounts must participate on a pro-rata basis in each block in order to conform to the Standard. Her actions constitute a violation of the Standard concerning fair dealing.

Answer 138

A) an addition to equity. If deferred tax liabilities are expected to never reverse, they should be treated as equity for analytical purposes.

Answer 139

B) 67.7%. Margin debt = 40% × $50 = $20; Interest = $20 × 0.05 = $1. Equity % = [Value – (margin debt + interest)] / Value $80 - $21 / $80 = 73.8%

Answer 140

C) A rise in the stock risk premium. P/E = (1 - RR)/(k - g) To lower P/E: RR increases, g decreases and or k increases. Both a decline in the RF rate and a decline in the rate of inflation will reduce k. An increase in the stock's risk premium will increase k

Answer 141

B) 6.452 CNY/CAD. (1 +0.03/4) / (1 +0.025/4) = 6.452

Answer 142

B) $25,200. Deferred tax liability = $36,000 × 30% = $10,800.

Answer 143

A) assumes that the hypothetical funds received by the company from the exercise of the options are used to sell shares of the company’s common stock in the market at the average market price. The treasury stock method assumes any funds received by the company from the exercise of the options are used to purchase shares (not sell shares) of the company's common stock in the market at the average market price.

Answer 144

A) Declaration date, ex-dividend date, holder-of-record date, payment date The dividend payment chronology begins with the declaration of a dividend by the board of directors. The ex-dividend date occurs one or two business days before the holder-of-record date.

Answer 145

B) An advantage of the price/sales ratio is that it is meaningful even for distressed firms. The P/S ratio is meaningful even for distressed firms, since sales revenue is always positive. This is not the case for the P/E and P/BV ratios, which can be negative. In the P/BV ratio book value is an appropriate measure of net asset value for firms that primarily hold liquid assets. Analysts use several different definitions of cash flow (CFO, adjusted CFO, FCFE, EBITDA, etc.) to calculate P/CF ratios. When earnings are negative, the P/E ratio is meaningless.

Answer 146

C) recommending purchase of securities without a reasonable inquiry into the investment experience of the client. Standard III(A) Loyalty, Prudence, and Care requires members acting as advisors to make a reasonable inquiry into the client's investment experience, risk and return objectives, and financial constraints before making investment recommendations. Investment decisions must be made based on a total portfolio approach, rather than the quality of an individual investment in isolation. Some members are not acting as investment advisors and may only have a duty to provide best execution of client orders.

Answer 147

A) cash flow. For companies entering the growth stage, revenue and cash flow are typically increasing. Both debt financing costs and business risk tend to be somewhat reduced compared to the start-up stage.

Answer 148

A) only the bond rating and the recovery rate. Credit risk is calculated with the probability of default (estimated from the bond rating) and the estimated recovery value should the bond default. Yield volatility is combined with duration to estimate the price risk of a bond.

Answer 149

C) Sovereign. Many national governments use auctions to issue sovereign bonds. Corporate bonds are typically issued in an underwriting or private placement process while municipal bonds are typically issued in a negotiated or underwritten process.

Answer 150

A) presented as noncurrent on the balance sheet. Both IFRS and U.S. GAAP allow deferred taxes to be presented as noncurrent on the balance sheet. However, U.S. GAAP classification depends on whether the underlying asset or liability is current or noncurrent. IFRS requires deferred taxes to be presented as noncurrent and under certain circumstances allows them to be netted on the balance sheet. U.S. GAAP requires that deferred taxes be measured using an enacted tax rate, while IFRS allows measurement using an enacted or substantially enacted tax rate. U.S. GAAP does not allow fixed asset revaluation. Deferred taxes resulting from fixed or intangible asset revaluation is recognized in equity under IFRS

Answer 151

B) LIFO because it allocates current prices to cost of good sold (COGS) and provides a better measure of current income. LIFO is the most informative inventory accounting method for income statement purposes in periods of rising prices and stable or growing inventories. It allocates the most recent purchase prices to COGS, and thus provides a better measure of current income and future profitability.

Answer 152

B) lower debt-to-equity ratios. Capitalizing expenses will increase assets by the capitalized amount, compared with expensing. This will increase both assets and equity and decrease debt-to-equity ratios. If taxes are ignored, net cash flow is unaffected by whether the company expenses or capitalizes costs. If taxes are considered, net cash flow will be lower because capitalization of costs will increase both net income and taxes payable. Assuming that assets are greater than income, ROA will be higher in the period of capitalization, compared with expensing.

Answer 153

B) an operating cash flow but as non-operating income. Under U.S. GAAP, interest received is reported as an operating cash flow. For a non-financial services company, interest received is typically reported as non-operating income.

Answer 154

) Both statements are correct. A cash flow statement can be presented in common-size format by expressing each line item as a percentage of total revenue or by expressing each inflow of cash as a percentage of total cash inflows and each outflow as a percentage of total cash outflows. Expressing each line item of the cash flow statement as a percentage of revenue is useful in forecasting future cash flows since revenue usually drives the forecast.

Answer 155

B) only one of these assets. Acquired intangible assets with finite expected useful lives are amortized. Intangible assets with indefinite lives are not amortized but are tested at least annually for impairment. Renewal at a nominal cost means the trademark should be treated as an asset with an indefinite life.

Answer 156

A) Convertible bonds. A complex capital structure means a firm has securities outstanding that can be converted to common shares, and therefore have the potential to dilute a firm's earnings per share. For example, convertible bonds, convertible preferred stock, options, and warrants have the potential to dilute earnings per share upon conversion or exercise.

Answer 157

C) U.S. GAAP only. Deferred taxes must be recognized for undistributed earnings from an investment in an associate firm under U.S. GAAP. Under IFRS, no deferred taxes are reported for undistributed earnings if the investor firm controls the sharing of profits and it is probable the temporary difference will not be reversed in the future.

Answer 158

B) less than $50 million. When the coupon rate on a bond is lower than the market rate (yield to maturity), the bond will sell for a discount. If bonds are issued at a discount, the proceeds raised will be less than their face value.

Answer 159

B) Other comprehensive income Other comprehensive income Unrealized gains and losses from cash flow hedging derivatives and unrealized gains and losses from available-for-sale securities are not recognized in the income statement; rather, they are both recognized as a component of stockholders' equity as a part of other comprehensive income.

Answer 160

A) $1,800 4,500 The interest expense for three months net of tax is added to the numerator (12% × $100,000 × 3/12 × 60 %) = $1,800. The number of shares added to the denominator are 4,500. (18,000 × 3 / 12).

Answer 161

A) Decrease EPS. Dilutive securities such as convertibles and options are found in a complex capital structure and always decrease EPS. Convertibles and options may also be antidilutive, which will increase EPS hence the name antidilutive. The only way to know if a security is dilutive or antidilutive is to compare the basic EPS to diluted EPS. If the diluted EPS is higher than the basic EPS then the security is antidilutive and should not be included when determining diluted EPS.

Answer 162

C) The present value of the future bond payments discounted at the coupon rate of the bonds. When analyzing disclosures related to financing liabilities, analysts would review the balance sheet and find the present value of the promised future liability payments. These payments would then be discounted at the rate in effect at issuance (i.e., the yield to maturity), not the coupon rate of the bonds.

Answer 163

A) Reporting is not compliant with GAAP, although reported earnings are sustainable and adequate. When reporting is not compliant with GAAP, the sustainability and adequacy of reported earnings cannot be determined. The other two choices fall on the spectrum of the quality of financial reports.

Answer 164

A) higher asset levels and higher equity levels in the early years of the asset's life. The capitalized cost is recorded as an asset, which is then expensed in the form of depreciation over future years. Spreading the depreciation out over future years causes net income to increase along with retained earnings and equity in the early years of the asset's life.

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