Extra questions i mess up 2 weeks before exam Flashcards

Question

Based on 30 years of quarterly data, an analyst calculates a sample correlation of 0.68 between real estate returns and inflation. The analyst hypothesizes a statistically significant relationship at the 5% level of significance between these two variables in the population. All else equal, reducing the number of observations in the sample will most likely increase the: A critical value of the t-statistic. B t-statistic's degrees of freedom. C likelihood of rejecting the null hypothesis.

Answer 1

A critical value of the t-statistic. The critical value of the t-statistic. is determined by the degrees of freedom and the level of significance. For a given level of significance, reducing the number of observations will reduce the number of degrees of freedom (n - 2) , which will result in a higher critical value for the t-statistic. This will also reduce the calculated value of the t-statistic, which will reduce the likelihood of rejecting the null hypothesis that the linear relationship between the two variables is not statistically significant.

Answer 2

r real = (1 + r nominal) / (1 + r inflation) - 1

Answer 3

The test statistic for the variance of a population is the chi-square measure, which is calculated using the following formula: chi-square = ((n - 1) * sample variance) / hypothesized variance

Answer 4

C Both outliers and spurious correlation Both outliers and spurious correlation are potential problems with interpreting correlation coefficients.

Answer 5

A Algorithms are not explicitly programmed Algorithms are not explicitly programmed, which can result in outcomes that are not easily understood. Supervised learning involves explicitly labeling data as either inputs or outputs. However, it is not essential to label outputs. In unsupervised learning, relationships are identified without any prior labeling of the outputs to be linked to the inputs.

Answer 6

C non-negative. A lognormal distributed variable has a lower bound of zero. The lognormal distribution is also right skewed, which is a useful property in describing asset prices.

Answer 7

standard error of sample mean = population standard deviation / sqrt (n)

Answer 8

B stratified sampling. Stratified sampling divides the population into subpopulations (strata) based on a criteria (i.e., height in this problem). Then, simple random samples are drawn from each stratum in proportion to the size of the stratum relative to the population. Cluster sampling involves selecting only a few of the subgroups instead of all intervals. Since exactly two people are selected from each interval, this is more likely to be stratified sampling.

Answer 9

he continuously compounded return of an asset over a period is equal to the natural log of the asset’s price change during the period. In this case, ln(120/112) = 6.90%.

Answer 10

t = (r * sqrt(n - 2)) / sqrt(1 - r^2) r = correlation coefficient

Answer 11

A Mind map Unlike a tag cloud, which displays words in varying sizes according to the frequency that they are used in a textual data file, a mind map is a data visualization technique that shows how different concepts are related to each other.

Answer 12

B the probability of not making a Type II error. B is correct. The power of a hypothesis test is the probability of correctly rejecting the null when it is false. Failing to reject the null when it is false is a Type II error. Thus, the power of a hypothesis test is the probability of not committing a Type II error.

Answer 13

A judgmental sampling. A is correct. With judgmental sampling, Kinzua will use his knowledge and professional judgment as a seasoned auditor to select transactions of interest from the population. This approach will allow Kinzua to create a sample that is representative of the population and that will provide sufficient audit coverage. Judgmental sampling is useful in cases that have a time constraint or in which the specialty of researchers is critical to select a more representative sample than by using other probability or non-probability sampling methods. Judgement sampling, however, entails the risk that Kinzua is biased in his selections, leading to skewed results that are not representative of the whole population.

Answer 14

C semistructured data. HTML code is an example of semistructured data, which has attributes of both structured and unstructured data. Structured data can be organized in tables and stored in databases. By contrast, unstructured data comes from sources such as text, audio files, and pictures and typically must be cleansed with specialized applications before it can be used by investment professionals.

Answer 15

rh = e^r - 1

Answer 16

A Residual sum of squares For a linear regression with one independent variable, the F-statistic is calculated as follows: F = Mean regression sum of squares / MSE Mean regression sum of squares = RSS / 1 MSE = SSE / (N - 2) RSS = the regression sum of squares SSE = sum of squared errors

Answer 17

C training data can be learned too precisely, resulting in inaccurate predictions when used with different datasets. C is correct. Overfitting occurs when the ML model learns the input and target dataset too precisely. In this case, the model has been “over trained” on the data and is treating noise in the data as true parameters. An ML model that has been overfitted is not able to accurately predict outcomes using a different dataset and might be too complex.

Answer 18

B corporate exhaust. Retail point-of-sale scanner data are an example of corporate exhaust that is generated by business processes to provide a real-time indication of business performance.

Answer 19

B are concerned about shortfall risk. Safety-first rules are designed to address shortfall risk, which is the possibility that portfolio returns will fail to meet a specified threshold.

Answer 20

A identifying and correcting for data errors. The objective of the data curation process is to ensure high quality, accurate data. Any errors in a dataset are identified and appropriate action is taken. For example, it may be necessary to make adjustments for missing data that was unavailable or had to be removed.

Answer 21

Same thing as standard deviation, but you just find the absolute value of (X - Mean). Additionally, you don't square it and you divide by n, not n - 1

Answer 22

Negatively skewed

Answer 23

A no excess kurtosis. A mesokurtic (meso = middle) distribution has no excess kurtosis, which is any value greater than 3. If excess kurtosis is positive, the function is leptokurtic. A platykurtic distribution has negative excess kurtosis.

Answer 24

B thin-tailed compared to the normal distribution. B is correct. The distribution is thin-tailed relative to the normal distribution because the excess kurtosis is less than zero.

Answer 25

A Unlike the correlation coefficient, covariance is not bounded by –1 and 1 Answer choice A is correct. A correlation coefficient can only be between –1 and +1, but covariance is not subject to the same constraint. Answer choice C is incorrect. The correlation coefficient only measures the degree of linear association between two variables. It does not explain the amount each variable changes.

Answer 26

C may have a significant non-linear relationship. Two random variables are independent if there is no linear or non-linear relationship. By contrast, correlation coefficients only address linear relationships. Two independent variables with zero correlation may still have a significant non-linear relationship.

Answer 27

C 3 The kurtosis of the normal distribution is 3. Its excess kurtosis is zero.

Answer 28

C drawing simple random samples from each subpopulation in sizes proportional to the relative size of each subpopulation. C is correct. Stratified random sampling involves dividing a population into subpopulations based on one or more classification criteria. Then, simple random samples are drawn from each subpopulation in sizes proportional to the relative size of each subpopulation. These samples are then pooled to form a stratified random sample.

Answer 29

A judgmental sampling. A is correct. With judgmental sampling, Kinzua will use his knowledge and professional judgment as a seasoned auditor to select transactions of interest from the population. This approach will allow Kinzua to create a sample that is representative of the population and that will provide sufficient audit coverage. Judgmental sampling is useful in cases that have a time constraint or in which the specialty of researchers is critical to select a more representative sample than by using other probability or non-probability sampling methods. Judgement sampling, however, entails the risk that Kinzua is biased in his selections, leading to skewed results that are not representative of the whole population.

Answer 30

Variance 1 / variance 2

Answer 31

B A one-tailed test more strongly reflects the beliefs of the researcher than a two-tailed test. B is correct. One-tailed tests in which the alternative is “greater than” or “less than” represent the beliefs of the researcher more firmly than a “not equal to” alternative hypothesis.

Answer 32

A Critical value B is correct. The critical value in a decision rule is the rejection point for the test. It is the point with which the test statistic is compared to determine whether to reject the null hypothesis, which is part of the fourth step in hypothesis testing.

Answer 33

B is correct. There are only 12 (monthly) observations over the one year of the sample and thus the samples are small. Additionally, the funds’ returns are non-normally distributed. Therefore, the samples do not meet the distributional assumptions for a parametric test. The Mann–Whitney U test (a nonparametric test) could be used to test the differences between population means.

Answer 34

A The sample data are ranked according to magnitude. A is correct. A nonparametric test is used when the data are given in ranks.

Answer 35

B difference between the means of two at least approximately normally distributed populations with unknown but assumed equal variances. B is correct. The assumption that the variances are equal allows for the combining of both samples to obtain a pooled estimate of the common variance.

Answer 36

B is correct. A T-statistic is the most appropriate for hypothesis tests of the population mean when the variance is unknown and the sample is small but the population is normally distributed.

Answer 37

A a single variance. A is correct. A chi-square test is used for tests concerning the variance of a single normally distributed population.

Answer 38

C nonparametric test. When data is ranked, such as when it has been sorted according to an ordinal scale, the assumptions of parametric tests (ex: t-test and z-test) do not hold and a nonparametric test should be used. Parametric tests require a stronger measurement scale.

Answer 39

A. t-test Because the sample size in this example is small (less than 30) and the population variance is unknown, it is inappropriate to use a z-test. The t-test is always considered more appropriate in such circumstances.

Answer 40

B power of a test. The power of a test is the probability of rejecting the null hypothesis when it is false.

Answer 41

C paired comparisons test. A paired comparisons test is appropriate to test the mean differences of two samples believed to be dependent.

Answer 42

B power of a test. The power of a test is the probability of rejecting the null hypothesis when it is false.

Answer 43

B Type I error: No ; Type II error: Yes B is correct. Specifying a smaller significance level decreases the probability of a Type I error (rejecting a true null hypothesis) but increases the probability of a Type II error (not rejecting a false null hypothesis). As the level of significance decreases, the null hypothesis is less frequently rejected.

Answer 44

C a chi-square test. For hypotheses regarding the variance of a single normally distributed population, a chi-square test is used.

Answer 45

A Critical value B is correct. The critical value in a decision rule is the rejection point for the test. It is the point with which the test statistic is compared to determine whether to reject the null hypothesis, which is part of the fourth step in hypothesis testing.

Answer 46

A a single variance. A is correct. A chi-square test is used for tests concerning the variance of a single normally distributed population.

Answer 47

A The test has a one-sided rejection region A is correct. The test statistic comprises squared differences between the observed and expected values, so the test involves only one side, the right side. B is incorrect because the null hypothesis is that the groups are independent.

Answer 48

A An increase in short-term interest rates A is correct. Interest rates are expected to rise to protect the exchange rate target.

Answer 49

B Decrease B is correct. In the case of a direct exchange rate, the domestic currency is the price currency (the numerator) and the foreign currency is the base currency (the denominator). If the domestic currency appreciates, then fewer units of the domestic currency are required to buy 1 unit of the foreign currency and the exchange rate (domestic per foreign) declines. For example, if sterling (GBP) appreciates against the euro (EUR), then euro–sterling (GBP/EUR) might decline from 0.8650 to 0.8590.

Answer 50

A minus taxes plus transfer benefits. A country's disposable income, YD, is calculated as national income, Y, minus net taxes, which is total taxes net of transfer benefits. Mathematically, disposable income is calculated as national income minus taxes plus transfer benefits.

Answer 51

A two countries within the same industry. Intra-industry trade occurs between two countries within the same industry. For example, despite having a large domestic automobile manufacturing sector, Germany imports Japanese vehicles while Japan also imports vehicles from Germany.

Answer 52

C The fact that interest rates cannot fall significantly below zero. C is correct. Deflation poses a challenge to conventional monetary policy because once the central bank has cut nominal interest rates to zero (or slightly less than zero) to stimulate the economy, they cannot cut them further.

Answer 53

C the margin of error is too great.

Answer 54

C downward sloping.

Answer 55

Forward rate - spot rate

Answer 56

C demand curve for money is horizontal. A liquidity trap can happen when the demand for money is completely elastic. Graphically, this situation is captured by a horizontal demand curve. In such circumstances, an increase in the money supply will not reduce interest rates or increase real economic activity.

Answer 57

A observed very infrequently. Because human traders and algorithms are prepared to act quickly on any mispricings that may emerge in the FX market, triangular arbitrage opportunities are very uncommon.

Answer 58

A eventually decelerates, but with a lag. A weakening economy and activity measures that are below potential signal the beginning of the contraction phase of the business cycle. After achieving its fastest rate of growth during the slowdown phase, inflation eventually begins to decelerate during the contraction phase, but with a la

Answer 59

B policy changes are implemented very quickly. B is correct. Fiscal policy is subject to recognition, action, and impact lags.

Answer 60

B Hegemony Like multilateralism, hegemony falls on the globalization end of the nationalism-globalization axis. By contrast, autarky and bilateralism are closer to the nationalism/anti-globalization end of the spectrum.

Answer 61

C lending to countries with developing economies. he IDA operates as a not-for-profit bank, providing low-interest or no-interest loans to countries with limited access to international debt markets. It is closely affiliated with the World Bank. Resolving global economic imbalances is part of the International Monetary Fund's mandate, while the World Trade Organization seeks to facilitate the coordination of trade policies among its member states.

Answer 62

C Globalization/Non-cooperation Sanctions are a financial tool that counties use in pursuit of geopolitical objectives. This tool is located in the Globalization/Non-cooperation quadrant of the geopolitical risk assessment framework and is most consistent with a hegemonic approach.

Answer 63

B Scenario 2 The fiscal multiplier is calculated as follows: 1 / (1 - c * (1 - t)) c = marginal propensity to consume t = rate

Answer 64

C Independently floating exchange rates. C is correct. An ideal currency regime would have credibly fixed exchange rates among all currencies. This would eliminate currency-related uncertainty with respect to the prices of goods and services as well as real and financial assets.

Answer 65

C the interest rate is higher in the price currency than in the base currency. C is correct. To eliminate arbitrage opportunities, the spot exchange rate (S), the forward exchange rate (F), the interest rate in the base currency (ib), and the interest rate in the price currency (ip) must satisfy: F / S = (1 + ip) / (1 + ib) According to this formula, the base currency will trade at forward premium (F > S) if, and only if, the interest rate in the price currency is higher than the interest rate in the base currency (ip > ib).

Answer 66

C Expansion

Answer 67

B The country's excess savings are greater than its fiscal deficit The relationship between a country's trade balance and its expenditure/saving decisions is captured by the following equation: X - M = (S - I) + (T - G) If a country has a trade surplus (X > M), it must be true that the amount of excess domestic savings (S > I) is greater than the country's fiscal deficit (T < G).

Answer 68

B not maintaining equipment. B is correct. Physical capital adjustments to downturns come through aging of equipment plus lack of maintenance

Answer 69

C Perfect competition In perfectly competitive markets, sellers have no pricing power and non-price competition (e.g., advertising) is absent. Advertising is used by sellers in both oligopolies and monopolies.

Answer 70

A New entrants come in and take away customers, reducing economic profits for incumbents The long run outlook of a company in a monopolistically competitive industry is very similar to that in a purely competitive industry -- other companies see the profits, join the market, take away customers, and economic profits are reduced to zero.

Answer 71

C General Agreement on Tariffs and Trade (GATT). C is correct. The GATT was the only multilateral body governing international trade from 1948 to 1995. It operated for almost half a century as a quasi-institutionalized, provisional system of multilateral treaties and included several rounds of negotiations.

Answer 72

C export subsidies. Export subsidies are payments made by governments to domestic firms with the objective of stimulating exports. Firms have an incentive to sell their products internationally, increasing the country's share of the global market. Trading partners often response by imposing countervailing duties on subsidized exports.

Answer 73

A event risk. A is correct. Event risk evolves around set dates, such as elections or new legislation, or other date-driven milestones, such as holidays or political anniversaries. Analysts can thus look to political calendars as a predictable starting point for determining the occurrence of event risk, with time to devise a suitable response. B is incorrect because thematic risks are known risks that evolve and expand over a period of time. Climate change, pattern migration, the rise of populist forces, and the ongoing threat of terrorism fall into this category. These are more foreseeable than exogenous risks, but with their extended interval of exposure, planned responses will likely require continuing adjustments. C is incorrect because exogenous risk is sudden and unanticipated. Examples include sudden uprisings, invasions, or the aftermath of natural disasters. The timing and range of its effects thus have the greatest unknowns.

Answer 74

A Autarky Voluntary export restraints (VERs) are implemented unilaterally to advance a county's economic interest. This tool falls in the non-cooperation/nationalism quadrant of the geopolitical risk assessment framework, which is aligned with the autarky model.

Answer 75

B Expansionary B is correct. Quantitative easing is an example of an expansionary monetary policy stance. It attempts to spur aggregate demand by drastically increasing the money supply.

Answer 76

B lending foreign exchange reserves to countries that have current account imbalances. Among its other functions, the International Monetary Fund (IMF) makes temporary loans of foreign exchange reserves to assist member countries that have incurred balance of payments problems. Cross-border trade relationships are regulated by the World Trade Organization. Providing low-interest loans to countries that have limited access to international credit markets is one of the World Bank's functions.

Answer 77

B Economic union A customs union is a free trade agreement with a common external trade policy. A common market expands on a customs union by allowing free movement of the factors of production. However, an economic union involves further integration with common economic institutions designed to coordinate the economic policies of member states.

Answer 78

C Cultural program development C is correct. Cultural program development is likely lowest on a country’s hierarchy of interests. Military determination (B) is often a primary source of national security and key to a country’s national interest. Tariff harmonization (A) may improve economic activity and improve cooperation. Cultural programs are important and influential but likely lower priority compared to A and B.

Answer 79

A Financial A is correct. The free exchange of currency across borders is a financial tool.

Answer 80

B trade diversion. The replacement of low-cost imports from non-member countries with costlier imports from members of a trade agreement is known as trade diversion.

Answer 81

A the global market price of cotton will decrease below $1.40 per pound. As a large economy and the world's largest producer of cotton, Extopia has the ability to influence the commodity's price. Export subsidies will allow domestic producers to remain profitable while charging lower prices in order to increase their share of the global market. As a result, the price of cotton will fall below its current level of $1.40 per pound.

Answer 82

B is independent of political cooperation. While globalization can be facilitated and accelerated by political cooperation, it is an independent process that can be driven even without government support or harmonized rules. Non-state actors can advance the process of globalization through exchanges of products, technologies, ideas, etc.

Answer 83

C an increase in its domestic money supply. Under the classic gold standard, more formally known as the price-specie flow mechanism, trade imbalances directly impacted the flow of capital (i.e., gold). As a country's trade surplus increased, it would accumulate more gold as payment. This accumulation of gold increased the domestic money supply by the amounts prescribed by the gold standard's fixed conversion rates, putting upward pressure on domestic prices and ultimately reducing the country's exports.

Answer 84

B Multilateralism vs. autarky B is correct. Multilateralism describes countries that participate in mutually beneficial trade relationships and extensive rules harmonization. Autarky describes countries seeking political self-sufficiency with little or no external trade or finance. In the Exhibit 6 display of these behavior patterns, these choices are most widely separated on both the globalization and cooperation continuums. A is incorrect because bilateral or regional approaches describe those countries leveraging regional trade relationships and may face the world as a group. Bilateralism shares with autarky a bias against globalization. These approaches diverge, however, regarding cooperation, with autarky being more non-cooperative. C is incorrect because multilateralism describes countries that participate in mutually beneficial trade relationships and extensive rules harmonization. Hegemony represents countries exerting political or economic influence of others to control resources. Multilateralism shares with hegemony an inclination towards globalization, as shown in Exhibit 6, but diverges from hegemony regarding cooperation; hegemony is more non-cooperative.

Answer 85

B Domestic price level. B is correct. The real exchange rate (quoted in terms of domestic currency per unit of foreign currency) is given by: Real exchange rate (d/f) = S d/f * (Pf / Pd)

Answer 86

A oligopoly.

Answer 87

A average total cost curve. A is correct. A company is said to break even if its total revenue is equal to its total cost. Under conditions of perfect competition, a company will break even when market price is equal to the minimum point of the average total cost curve.

Answer 88

B companies have similar market shares. B is correct. When companies have similar market shares, competitive forces tend to outweigh the benefits of collusion.

Answer 89

B The country's excess savings are greater than its fiscal deficit

Answer 90

B horizontal. In a perfectly competitive market, demand is perfectly elastic. In such conditions, the demand curve is horizontal because the same price is paid for any quantity sold. A seller cannot obtain a higher price than the market price because goods are perfect substitutes.

Answer 91

C A country's welfare may decrease when it imposes tariffs on goods even if it is large enough to influence the global prices of those goods A country that is large enough to influence the price of a good can improve its terms of trade by imposing tariffs if exporters reduce their prices to maintain their share of the large country's market. However, even in large countries, tariffs create deadweight losses due to inefficient allocation of resources. A large country can only improve its welfare by imposing tariffs if none of its trading partners retaliate and the deadweight losses are less than the benefits from improved terms of trade.

Answer 92

C the interest rate is higher in the price currency than in the base currency.

Answer 93

A customs union. A is correct. A customs union extends a free trade area (FTA) by not only allowing free movement of goods and services among members, but also creating common trade policy against non-members. Unlike a more integrated common market, a customs union does not allow free movement of factors of production among members.

Answer 94

C the interest rate is higher in the price currency than in the base currency.

Answer 95

C Increased efficiency of domestic firms Since before World War I, governments have used capital restrictions to keep capital within the domestic economy. Implementing these measures achieves various objectives, such as higher taxation revenues, a greater ability to allocate credit within the economy, and lower government borrowing costs. However, capital restrictions also limit the inflows of foreign investment and competition that drive domestic firms to operate more efficiently.

Answer 96

C Administrative controls In the context of capital restrictions, administrative controls include measures such as requiring government approval for transactions involving certain types of assets. Price controls typically take the form of taxes on certain types of transactions or mandatory reserve requirements. Quantity controls involve limits on or requiring approvals for new or existing loans from foreign lenders.

Answer 97

C More than 12% C is correct. The appreciation of sterling against the Swiss franc is simply the inverse of the 12% depreciation of the Swiss franc against Sterling

Answer 98

B both retailers and wholesalers. In a traditional channel strategy, products are sold by manufacturers to wholesalers and then re-sold to retailers before being sold to the end-user customers. A direct sales strategy excludes both wholesalers and retailers, with manufacturers selling directly to their customers

Answer 99

A Dynamic pricing A dynamic pricing strategy is executed by charging different prices based on fluctuating demand, such as peak and off-peak rates. This strategy can be employed by many different types of companies and does not give explicit consideration to network effects. By contrast, both the freemium penetration pricing strategies are based on sacrificing revenues during an initial period in order to gain users and develop network effects

Answer 100

A Add-on pricing An add-on pricing strategy increases sales by having customers increase their orders at the time of purchase or after the product has been used. Firms risk reputational damage if they take the “captive” element of this strategy too far.

Answer 101

C A resume preparation service for online job seekers C is correct. The resume preparation service benefits from the network effects on various online job sites, but the service is not the source of those network effects. The other businesses (A and B) become more valuable to their customers as they attract users. The telephone network is very useful because most people are on it. An airfare price comparison website is valuable to airlines because it has many shoppers and valuable to shoppers because it features prices for multiple airlines and routes.

Answer 102

C DAG Inc. faces unlimited liability as the general partner, while DAG Inc.’s status as a corporation implies that its shareholders face limited liability. C is correct. DAG Inc. is the general partner of DAG LP and thus has unlimited liability in the partnership. However, as a corporation, DAG Inc.’s shareholders have limited liability for its losses and obligations. A is incorrect. DAG LP is 80% owned by DAG Inc., the general partner that manages the partnership. DAG Inc. is 30% owned by the Dee family, who holds several key managerial positions. B is incorrect. As a public company, DAG Inc. can raise new equity by issuing shares on an exchange. The dividend requirement is not a binding limit on its ability to raise capital but, rather, might be an attractive feature to prospective investors.

Answer 103

B is composed of two separate boards. A two-tier structure has a supervisory board, which contains non-executive directors, that oversees a management board, which contains executive directors. There is no requirement to have equal numbers of executive and non-executive directors.

Answer 104

C Delinquent account receivable In basic terms, for a company to be liquid, money must come in before it goes out. There are 2 potential difficulties; drags and pulls. A drag is when the money doesn't come in when expected (such as an account receivable being late or uncollectible). A pull is when the money must go out sooner than expected (such as a reduced line of credit, or early payments).

Answer 105

B Project 2 Typically, replacement decisions involve the least uncertainty. Expansion decisions are subject to more uncertainties than replacement decisions, but less uncertainty than decisions about new products or services. In this example, Project 2 is the most complex because Quantum's operations are limited to ground delivery and the company would need to make significant investments in both physical and human capital in order to expand its services to include air delivery. Project 1 is an expansion decision. The company is already operating in Europe but would be extending its reach into new regions.

Answer 106

1. Before-tax interest payment on bonds 2. After-tax interest payment on bonds 3. tax shield = difference

Answer 107

C the cost of equity increases as the use of debt in the capital structure increases. C is correct. The cost of equity rises with the use of debt in the capital structure (e.g., with increasing financial leverage).

Answer 108

B Method 2 only While both an IPO and a direct listing can be used to take a privately held company public, only an IPO will allow the company to raise new capital. In a direct listing, the company’s shares are listed on a public exchange but the transaction is not underwritten and no new capital is raised.

Answer 109

A Cash flow can be positive or negative. When the company reaches the growth stage, revenues are typically rising, but investment spending is necessary to fund the growth, and thus the cash flow is typically negative at the beginning of the growth stage. As the company goes through this stage, cash flows typically turn positive and become more predictable.

Answer 110

B provide a more temporary source of capital. Debt is a temporary source of capital with a principal repayment due at maturity. By contrast, equity is a permanent source of capital. Lenders have no voting rights and no ability to influence a company’s management in a manner similar to the board of directors that is elected to represent the interests of shareholders. Debt does have a higher priority claim to a company’s assets and cash flows, which allows bondholde

Answer 111

C Incorrect with respect to both the cost of equity and the cost of debt. The analyst’s claim is incorrect with respect to both the cost of equity and the cost of debt. According to the static trade-off theory, however much debt a firm has in its capital structure, the cost of issuing incrementally more debt will be higher due to the increased risk associated with greater financial leverage. Rather, it is the firm's weighted average cost of capital (WACC) that will decline as its debt-to-capital ratio rises to its optimal level and then increase as the firm borrows beyond this point.

Answer 112

B supply chain. B is correct. A company’s supply chain is the network or system inside and outside the company involved in producing a product or service and delivering it to an end user. A is incorrect because value chain refers to the systems and processes within a firm that create value for its customers. It is the “how” aspect of a business model.

Answer 113

A Rollover risk A conservative approach to working capital management makes greater use of longer-term sources of capital, which reduces rollover risk compared to a more aggressive approach that is more reliant on short-term debt. However, despite the lower rollover risk, the additional long-term debt and equity required by a conservative approach increase a company's cost of equity and dilute the positions of existing shareholders. Additionally, the higher inventory levels needed to execute a conservative approach increase the risk of inventory obsolescence.

Answer 114

B Leverage increases as the company is able to support more debt.

Answer 115

C the company’s debt/equity has moved beyond the optimal range. C is correct. If the company’s WACC increases as a result of taking on additional debt, the company has moved beyond the optimal capital range. The costs of financial distress may outweigh any tax benefits from the use of debt.

Answer 116

C a network business model. Crowdsourcing the voluntary, often collaborative, contributions of users to enhance a product or services is a critical element of many network business models. For example, online retailers benefit from customer product reviews.

Answer 117

A one-tier structure. A one-tier board is likely to include significant representation of both executive (internal) and non-executive (external) directors. By contrast, the supervisory board in a two-tier structure includes few, if any, executive directors.

Answer 118

B profitability. Regulatory compliance projects and going concern projects are both business maintenance capital expenditures that are undertaken with the intention of allowing a company to continue operating at its current scale. However, while going concern projects are generally expected to improve a company's profitability by replacing aging assets with newer, more efficient ones, regulatory compliance projects are initiated by outside parties (e.g., governments, insurers) and will not necessarily increase or even maintain a company's current profitability. Both types of projects have the same potential for rollover risk, which occurs when the duration of financing sources does not match a capital investment's expected useful life.

Answer 119

C managers cannot change the value of the company by changing the amount of debt. C is correct. Proposition I, or the capital structure irrelevance theorem, states that in perfect markets the level of debt versus equity in the capital structure has no effect on company value.

Answer 120

B The market value of a company is not affected by the capital structure of the company. Statement A refers to MM Proposition II without taxes: The cost of equity increases linearly with the debt-to-equity ratio. Statement C refers to MM Proposition I with taxes: The market value of a levered company is equal to the value of an unlevered company plus the value of the debt tax shield.

Answer 121

C Incorrect with respect to both the cost of equity and the cost of debt. The analyst’s claim is incorrect with respect to both the cost of equity and the cost of debt. According to the static trade-off theory, however much debt a firm has in its capital structure, the cost of issuing incrementally more debt will be higher due to the increased risk associated with greater financial leverage. Rather, it is the firm's weighted average cost of capital (WACC) that will decline as its debt-to-capital ratio rises to its optimal level and then increase as the firm borrows beyond this point.

Answer 122

A An electric utility A is correct. An electric utility has the capacity to support substantial debt, with very stable and predictable revenues and cash flows. The software company also has these attributes, but it would have been much less likely to have raised debt during its development and may have raised equity. The mining company has fixed assets, which it would have needed to finance, but the cyclical nature of its business would limit its debt capacity.

Answer 123

B Management’s stock options are worthless at the current share price. The acquisition has a high (50%) risk of failure (with zero value) but substantial (30%) upside if it works out. B is correct. Management is advocating an acquisition that is likely to be positive for the value of the company’s options but negative for equity holders, given the substantial risk. A is an example of a debt-equity conflict. C is an example of stakeholder interests that are not being considered by management.

Answer 124

B types of users. Multi-sided networks have two or more types of users. For example, payment systems must be adopted by both merchants and customers.

Answer 125

C has a contract manufacturing arrangement. Contract manufacturers produce goods that are marketed and sold by other firms that specialize in functions such as design and R&D.

Answer 126

B function. The company has included labor and material costs, depreciation, some salaries, and other direct sales related expenses as cost of goods sold. This is an example of grouping by function.

Answer 127

B geographic composition of revenue. B is correct. Classification by country is typically by the country where the issuer is incorporated, the country of the primary listing of its equity securities, the location of its headquarters, or market perception. Note that classification by the geographic composition of revenue is generally not the approach taken, though this aspect may be the foremost concern for an analyst.

Answer 128

B innovator’s dilemma. B is correct. The described mobile application represents a fundamental change in the business model of a law firm. The application is a disruptive, not sustaining, innovation, as it brings new entrants into the market but with a very different value proposition. The CEO’s decision represents the “innovator’s dilemma”: the firm can either invest in the disruptive innovation, speeding the decline of its existing business but not losing market share, or ignore the innovation and lose market share while continuing to generate strong profits in the near term.

Answer 129

C purchasing stocks that have underperformed. If an equally-weighted index is composed of four stocks, each will begin with a 25% weighting (100%/4). As a stock’s price increases, its weight in the index will increase above this baseline and vice versa. When it is time to rebalance, shares of stocks that have outperformed the index will be sold and the proceeds will be used to purchase the shares of stocks that have underperformed.

Answer 130

B management has more control over the book value of equity. There are other formulas that relate earnings to a stock's market value, but ROE is frequently used when analysts want to directly measure management's performance. Since management has relatively less control over the market value (market value is subject to market expectations, economic environment, and other factors), it is not as good a metric on management.

Answer 131

B will settle any trade presented to them by a member who is unable to do so. Clearinghouses serve financial markets by arranging for the final settlement of trades. Members of clearinghouses guarantee to settle any trades that their customers present to them. In turn, clearinghouses provide assurance that they will settle any trade presented to them by their members.

Answer 132

C the number of securities not available to the general public. A company's market float is the number of shares available to the general public. In the float-adjusted market-capitalization weighting method, the market float is considered and included in the weighting.

Answer 133

A depository share. Depository receipts are international claims on depository shares. These shares may act very similar to common stock, but they are a different type of security, designed specifically for foreign investment.

Answer 134

C disclosed regularly or based on items that are disclosed regularly. C is correct. Forecast objects should either be disclosed regularly or be directly calculable using what is disclosed regularly. Information that is not disclosed regularly (such as a third-party consultancy’s report) is suitable to inform forecasts but can be problematic for direct use, because forecasts cannot be confirmed in a timely manner. While it may be intuitive to forecast individual discrete items, such as sales and gross margin by individual product line, if gross margin is disclosed only on a consolidated basis, it will be difficult for analysts to verify their product-line gross margin estimates.

Answer 135

B denominated in US dollars. Global depository receipts are not required to be denominated in US dollars, however, the majority are. GDRs are issued outside of a company's domestic market as well as outside the United States. Also, although GDRs do not trade on US exchanges, they can be purchased by American institutional investors.

Answer 136

(Equity / share) / (Price / share) = (Initial equity needed - (Share price at the start - P)) / P

Answer 137

CCC = DOH + DSO - DPO

Answer 138

A the percentage change in net income divided by the percentage change in units sold. Degree of Total Leverage = Percentage change in net income / Percentage change in units sold

Answer 139

A Global registered shares only Global registered shares may trade simultaneously in multiple markets with prices quoted in local currencies. They provide the underlying securities for the issuers of global depository receipts. Global depository receipts trade on exchanges located outside an issuer's domestic market.

Answer 140

A capital expenditures of a company. A is correct. Management has an advantage at the firm level and tends to make more accurate forecasts for objects that are subject to management actions, such as capital expenditures. Management does not have an informational advantage over investors in forecasting macroeconomic variables, such as GDP, the business cycle, or the prices of commodities. Hutton et al. (2012) found that investors have an informational advantage over management at the macroeconomic level.

Answer 141

C secondary precedence rules. In order-driven markets, the highest priority is given to the most aggressively priced orders. For orders at the same price, order-driven market use secondary precedence rules to establish trading priority. Among orders with the same price, priority may be granted based on the time that the orders were received or whether the entire order size is displayed. While each market is free to use its own order-ranking criteria, the objective is to establish rules that increase liquidity.

Answer 142

B No, because ROIC is an after-tax measure Henry incorrectly refers to ROIC as a before-tax measure. In fact, the numerator for ROIC is net operating profit less adjusted taxes (NOPLAT), which makes it an after-tax measure. NOPAT is calculated as operating profit (EBIT) times 1 minus the tax rate, which adds the tax-adjusted amount of interest paid on debt back to net income. The denominator used in the calculation of ROIC includes all sources of capital, both debt and equity. Because of how the inputs for both the numerator and denominator are defined, ROIC is unaffected by a company's degree of financial leverage.

Answer 143

B relevant information released in January. The text mentions a couple reasons which each explain part, but not all, of the January effect: De-risking: Portfolio managers sell off their risky assets at the end of the year so their portfolio appears less risky Tax transactions: Investors selling their loser securities at the end of the year to offset capital gains increases for tax liability The text briefly discusses market news, mentioning that is not a factor at all.

Answer 144

A data mining. Data mining occurs when analysts repeatedly run tests of market data until a statistically significant relationship can be found and subsequently formulate a hypothesis for why this relationship might exist. This is the opposite order that these steps occur when following generally accepted research practices and can lead to the identification of apparent market anomalies with no compelling rationale for their existence.

Answer 145

A weak form efficient. The presence of technical analysts who trade based on patterns observed in past price and trading volume data. Any pricing anomalies based on an analysis of this information will be identified and prices will adjust to levels that are consistent with the weak form of the efficient market hypothesis. To be semi-strong form efficient, markets must reflect historical price and volume data as well as all other publicly-available information. The work of technical analysts is a necessary but insufficient condition for achieving this.

Answer 146

DOL = % Change in Operating Income / % Change in Units Sold

Answer 147

B market capitalization weighted. A market capitalization weighted index performs as if it is a portfolio of all securities issued by constituent firms. Making a float adjustment will cause the index's performance to reflect the performance of a portfolio of all outstanding shares available to the investing public. This excludes shares owned by, for example, controlling shareholders and other corporations.

Answer 148

A More objective inputs Because market values of a company's outstanding bonds are often not readily available, determining enterprise value can be difficult. Analysts may be required to make subjective estimates of this input based on the book value of a company's debt or market prices of comparable debt issues. Compared to the P/E ratio, the EV/EBITDA ratio is more flexible across capital structures because it takes into account the obligations that a company has to its debt owners and preferred shareholders. Another advantage of the EV/EBITDA ratio is that it may provide useful information for companies with negative earnings. This is because EBITDA is always greater than net income.

Answer 149

A Putable common shares Putable common shares can be sold back to their issuer at a pre-specified price. However, investors have no obligation to do so and there is no limit on the potential value of these shares.

Answer 150

the sum of the market value of its debt and equity net of the cash on its balance sheet

Answer 151

A only that the market is rational. A is correct. The efficient market hypothesis and asset-pricing models only require that the market is rational. Behavioral finance is used to explain some of the market anomalies as irrational decisions.

Answer 152

B the same sensitivity of operating income to changes in unit sales. B is correct. Grundlegend’s degree of operating leverage is the same as Basic Company’s, whereas Grundlegend’s degree of total leverage and degree of financial leverage are higher.

Answer 153

C determine the major sources and uses of cash. C is correct. Before a review of a company’s capital investments, the first step is to determine the company’s sources and uses of capital on a historical basis. A and B are incorrect, because both take place after the analyst has identified the company’s sources and uses of cash and determined what to focus on.

Answer 154

B standing limit order. In order-driven markets, standing limit orders are either buy orders with a limit price below the best offer or sell orders with a limit price above the best bid. These orders are waiting to trade until the market prices match or improve upon the specified limit price.

Answer 155

A may be partially filled. An order with immediate or cancel validity instructions, also known as a fill or kill order, will be immediately cancelled if it cannot be at least partially filled.

Answer 156

A Yes This comment is correct. COGS include the cost of raw materials used in products and the direct labor costs incurred to produce (e.g., salaries of production staff). Additionally, COGS include overhead costs attributable to production, such as the cost of maintaining facilities. The SG&A expense includes any costs incurred to sell or deliver a company's products, such as salaries and benefits paid to sales staff.

Answer 157

A may not be either informationally efficient and operationally efficient.

Answer 158

A Borrowers will have difficulty attracting lenders At an equilibrium interest rate, there would be the same number of borrowers and lenders. If the prevailing rate is too low, there would be an excess of borrowers but not enough lenders. This occurs because borrowers prefer a lower interest rate, so they owe less to the lenders. However, low-interest rates would deter lenders from loaning money to these willing borrowers.

Answer 159

C exceed the value of the price return version of the index At inception, the total return and price return versions of a security market index are both set to the same value. As constituent companies pay dividends, the total return version of the index will grow faster than the price return version.

Answer 160

B Retention ratio The book value of a company's equity increases when net income is earned and retained. All else equal, if 100% of a company's net income was paid out as dividends (a 0% retention ratio), the book value of its equity would be unchanged. F or the same amount of net income, a higher retention ratio causes the book value of equity to increase.

Answer 161

A The analyst is valuing a privately held company. A is correct. Asset-based valuations are most often used when an analyst is valuing private enterprises. Both B and C are considerations in asset-based valuations but are more likely to be reasons to avoid that valuation model rather than reasons to use it.

Answer 162

B Certificates of deposit only Both commercial banks and non-financial corporations issue commercial paper. However, only banks are able to issue certificates of deposit.

Answer 163

A an entire asset class. A broad market index attempts to broadly represent an asset class (i.e., equity). Indices covering multiple markets are referred to as multi-market indices.

Answer 164

C An investment having identical risk and return characteristics shall have same value

Answer 165

C take a short position in a corn futures contract. By taking a short futures contract, the farmer agrees to sell an amount of corn at a price fixed today. The value of that futures contract will increase (decrease) as the value of the corn crop decreases (increases), and the farmer is able to lock in the prices today and eliminate exposure to corn price fluctuations in the spot market.

Answer 166

A hybrid approach. Ahmad’s long-run revenue projection is based on nominal GDP growth, which is consistent with a top-down approach. However, he also focuses on the historical growth rate of a particular segment, which is consistent with a bottom-up approach. Therefore, it is most accurate to characterized Ahmad's method as a hybrid approach, which incorporates elements of both top-down and bottom-up analysis.

Answer 167

C operating earnings to changes in the number of units produced and sold C is correct. The degree of operating leverage is the elasticity of operating earnings with respect to the number of units produced and sold. As an elasticity, the degree of operating leverage measures the sensitivity of operating earnings to a change in the number of units produced and sold.

Answer 168

C ratio of net income to shareholders' equity. Operating income is earnings before interest and tax, whereas net income is operating income less interest and taxes. Increasing the share of debt in a company's capital structure will affect net income through higher interest costs, but operating income will be unaffected. Financial leverage has no effect on operating leverage.

Answer 169

C The company issues debt to repurchase outstanding shares of equity. C is correct. A company’s ROE will increase if it issues debt to repurchase outstanding shares of equity.

Answer 170

C The method of comparables The method of comparables is a commonly-used approach that relies on comparisons of market multiples for peer companies. The assumption underlying this approach is that similar companies should have similar price ratios, which is an extension of the law of one price

Answer 171

total assets minus total liabilities

Answer 172

C require relatively more frequent rebalancing. Value-weighted indexes are largely self-rebalancing, with adjustments needed only in the event of mergers, acquisitions, liquidations, or similar corporate events between rebalancing dates. By contrast, fundamentally weighted indexes will require more frequent rebalancing to adjust for stocks that have appreciated or depreciated in terms of relative value.

Answer 173

A the Gordon growth model. The Gordon growth model works well with stable dividends, and it requires a stable dividend growth rate to work properly.

Answer 174

1 / margin

Answer 175

percentage change in operating income = DOL * (percentage change in units sold)

Answer 176

C current assets and current liabilities. Asset-based valuation models consider the value of the company as the market value of the assets less market value of liabilities. Such models are best-suited for valuing companies that have a relatively high proportion of current assets and current liabilities as market values are relatively easy to determine for these items.

Answer 177

B Quote-driven markets Dealers are the only source of liquidity in quote-driven markets.

Answer 178

C disclosed regularly or based on items that are disclosed regularly. C is correct. Forecast objects should either be disclosed regularly or be directly calculable using what is disclosed regularly Information that is not disclosed regularly (such as a third-party consultancy’s report) is suitable to inform forecasts but can be problematic for direct use, because forecasts cannot be confirmed in a timely manner. While it may be intuitive to forecast individual discrete items, such as sales and gross margin by individual product line, if gross margin is disclosed only on a consolidated basis, it will be difficult for analysts to verify their product-line gross margin estimates.

Answer 179

C determine the major sources and uses of cash. C is correct. Before a review of a company’s capital investments, the first step is to determine the company’s sources and uses of capital on a historical basis.

Answer 180

C A company’s dividend-paying capacity should be reflected in the cash flow estimates rather than the expected dividend. The assumption underlying the use of the FCFE model is that a company’s dividend-paying capacity should be reflected in the cash flow estimates rather than expected dividends.

Answer 181

C minus market value of debt and preferred stock plus short-term investments. C is correct. Enterprise value is calculated as the market value of equity plus the market value of debt and preferred stock minus short-term investments. Therefore, the market value of equity is enterprise value minus the market value of debt and preferred stock plus short-term investments.

Answer 182

C less than the rate of return required by investors. A company's cost of equity is the minimum rate of return that investors expect to receive by purchasing its shares. If the return that investors expect is less than the return that they require, they will sell the company's stock and the share price will fall until the expected return is equal to (or greater than) the required return.

Answer 183

C proxies for specific asset classes in asset allocation models. C is correct. Security market indexes play a critical role as proxies for asset classes in asset allocation models.

Answer 184

A operationally efficient. Markets with low trading costs and high liquidity are described as being operationally efficient. Allocationally efficient markets allocate resources in such a manner as to maximize productivity. In informationally efficient markets, prices reflect all available information.

Answer 185

C management guidance to forecast fixed operating costs and analyst discretion to forecast variable operating costs. C is correct. Management has an advantage in forecasting for objects that are subject to its actions (such as capital expenditures and inventories, which affect fixed costs). The analyst is likely to have an informational advantage when it comes to forecasting economic conditions and commodity prices, which affect revenues and variable costs.

Answer 186

A the percentage change in net income divided by the percentage change in units sold.

Answer 187

B A young company entering the growth phase A three-stage dividend discount model is the most appropriate for a company that is fairly young and entering the growth phase. A two-stage dividend discount model is suitable for an older company that has moved from the growth phase to the transition phase, and a constant growth model is appropriate for a company that is in the mature phase of growth.

Answer 188

A All automated trading systems are order-driven Every automated trading system is an order-driven system. In order-driven markets, orders can be submitted by either dealers or customers. Although stocks typically trade in order-driven markets, almost all trading of currencies and fixed-income securities occurs in quote-driven markets.

Answer 189

C Emerging market companies have benefited from the stability of foreign exchange markets. C is correct. The trends in emerging markets have not led to the stability of foreign exchange markets.

Answer 190

B primary market. B is correct. This transaction is a sale in the primary market. It is a sale of shares from the issuer to the investor and funds flow to the issuer of the security from the purchaser.

Answer 191

A Yes This comment is correct. COGS include the cost of raw materials used in products and the direct labor costs incurred to produce (e.g., salaries of production staff). Additionally, COGS include overhead costs attributable to production, such as the cost of maintaining facilities. The SG&A expense includes any costs incurred to sell or deliver a company's products, such as salaries and benefits paid to sales staff.

Answer 192

A sell some Sunrise, Inc. shares. Under an equally weighted method, you are looking to keep the same amount of money invested in each security. Since your Sunrise investment has appreciated by 10%, you would sell off that 10% and redistribute that amount among other index components in order to reestablish equal money weights and minimize tracking error. Note that indexes based on equal weighting schemes require frequent rebalancing.

Answer 193

B statutory voting. B is correct. Statutory voting is the type of equity voting right that grants one vote per share owned.

Answer 194

C Defined-benefit pension plans Defined-benefit pension plans may be users of risk management instruments such as interest rate swaps, but these entities are not known as designers of these instruments. By contrast, exchanges and investment banks specialize in designing instruments that help other financial market participants manage their exposure to various risks and ensuring that they can be traded in liquid markets.

Answer 195

A validity instructions. Electronic algorithmic trading systems are designed to submit thousands of immediate or cancel orders for every order that they fill when searching for hidden liquidity in a market. Such immediate or cancel orders are termed as validity instructions.

Answer 196

C streamlining of current post-trade processes. C is correct. DLT has the potential to streamline the existing, often complex and labor-intensive post-trade processes in securities markets by providing close to real-time trade verification, reconciliation, and settlement, thereby reducing related complexity, time, and costs.

Answer 197

B Fully constructed brownfield assets with contracted revenues The correct answer is B. Brownfield assets with mitigated risks (e.g., fully constructed with contracted/regulated revenues) that are located in the most stable OECD countries have a high weighting to current yield. Greenfield assets with limited construction and demand risk have a mix of yield and capital appreciation. Greenfield projects without guarantees of demand upon completion—e.g., variable electricity prices, uncertain traffic on roads and through ports—have a high weighting to capital appreciation.

Answer 198

C Less likelihood of opposition by the portfolio company's management Relative to an initial public offering, a trade sale to a strategic buyer can be executed in less time and at a lower cost. However, because strategic buyers are often competitors within the same industry, the portfolio company's managers are more likely to oppose a private equity firm's efforts to execute such a transaction. An initial public offering is more attractive to managers because it would allow them to maintain their current roles.

Answer 199

A farmland has less flexibility in harvesting. Timberland is more flexible in harvesting, since timber can be stored easily by not harvesting, while farmland must be harvested when ripe. Commodity price changes are a primary driver of returns for investments in both timberland and farmland. Farmland is often used as a hedge against inflation.

Answer 200

B predictable cash flows. B is correct. A brownfield investment is an investment in an existing infrastructure asset, which is more likely to have a history of steady cash flows compared with that of a greenfield investment. Growth opportunities and returns are expected to be lower for brownfield investments, which are less risky than greenfield investments.

Answer 201

B a trade sale. B is correct. Private equity funds can realize an immediate cash exit in a trade sale. Using this strategy, the portfolio company is typically sold to a strategic buyer.

Answer 202

B Smart contracts The correct answer is B. Smart contracts are the building block of dApps. dApps are usually developed on the Ethereum blockchain network or other smart contract platforms that allow for peer-to-peer interaction using interoperable, transparent smart contracts that persist for the duration of the chain. These decentralized applications, or dApps, allow for transactions to take place—and to be recorded on the blockchain—without a central coordinating mechanism or centralized exchange.

Answer 203

C tax-deductible interest expenses. The correct answer is C. Direct private real estate owners can reduce their taxable income using non-cash property depreciation expenses and tax-deducible interest expenses.

Answer 204

B Though equity REIT correlations with other asset classes are typically moderate, they are highest during steep market downturns. B is correct. Real estate investments, including REITs, provide important portfolio benefits due to moderate correlation with other asset classes. However, there are periods when equity REIT correlations with other securities are high, and their correlations are highest during steep market downturns.

Answer 205

B high mean returns. The correct answer is B. Historical Bitcoin returns are characterized by high mean returns and high standard deviation. Despite the high volatility, the return distribution is positively skewed.

Answer 206

A Backwardation A is correct. Low inventories of a specific commodity create incentives for market participants to own the physical commodity rather than a derivative contract. This incentive drives up spot prices relative to forward prices and can lead to spot prices being greater than forward prices (i.e., backwardation). B is incorrect because low inventories of a commodity indicate scarcity and would be more likely to contribute to a rising price for the commodity. C is incorrect because a contango market is the opposite of a market in backwardation.

Answer 207

A risk tolerance, then risk budgeting, and then risk exposures. A is correct. In establishing a risk management system, determining risk tolerance must happen before specific risks can be accepted or reduced. Risk tolerance defines the appetite for risk. Risk budgeting determine how or where the risk is taken and quantifies the tolerable risk by specific metrics. Risk exposures can then be measured and compared against the acceptable risk.

Answer 208

B Financial risks such as market risk, liquidity risk, and credit risk comprise nearly all of the risks affecting firms Firms must consider both financial and non-financial risks. Both are usually important.

Answer 209

B greater liquidity needs than life insurance companies. B is correct. The unpredictable nature of property and casualty (P&C) claims forces P&C insurers to allocate a substantial proportion of their investments into liquid, short maturity assets. This need for liquidity also forces P&C companies to accept investments with relatively low expected returns. Liquidity is of less concern to life insurance companies given the greater predictability of life insurance payouts.

Answer 210

B Risk tolerance and return objectives The objectives section of an IPS includes two categories - risk tolerance and return objectives.

Answer 211

C The higher the risk aversion coefficient, the higher the negative impact of risk on utility The risk aversion coefficient for a risk-neutral investor is zero, not positive. The risk aversion coefficient for a risk-averse investor is positive. The risk aversion coefficient for a risk-seeking investor is negative.

Answer 212

B The primary determinant of expected return of an individual asset is the market risk premium The primary determinant of expected return of an individual asset is how well the asset correlates with the market (the asset’s beta).

Answer 213

B stock mutual funds. stock mutual funds have about the same market size as all other types of mutual funds combined.

Answer 214

A Higher yields Bond mutual funds offer diversification, as well as greater liquidity and a lower capital requirement. For less than the face value of many bonds, retail investors can access a diverse fixed-income portfolio through a bond mutual fund. This is also a relatively liquid investment compared to trading bonds in the cash market. However, there is no assurance that bond mutual funds allow investors to earn higher yields than could be achieved by holding individual bonds.

Answer 215

C Legal and regulatory factors A restriction such as the one described in this example should be included in the legal and regulatory factors section of the IPS. Liquidity constraints include expected or unanticipated needs to withdraw funds from a portfolio. The unique circumstances category is used for any relevant factors that do not fit neatly into any of the other categories of constraints.

Answer 216

B privately owned. The majority of private management firms are privately owned. Most of these firms are structured as limited liability corporations (LLCs) or limited liability partnerships (LLPs).

Answer 217

A Framing bias Processing error biases relate to an individual's inability to accurately process information rationally when making financial decisions. They include: --> Anchoring and adjustment bias --> Mental accounting bias --> Framing bias --> Availability bias Hindsight bias is a type of belief perseverance bias, while status quo bias is a type of emotional bias.

Answer 218

C establish a reserve fund to cover losses. C is correct. Risk acceptance is similar to self-insurance. An organization choosing to self-insure may set up a reserve fund to cover losses. Buying insurance is a form of risk transfer and using derivatives is a form of risk-shifting, not risk acceptance.

Answer 219

B Life insurance companies Insurance firms typically have low risk tolerance, while endowments and defined benefit pension plans have higher risk tolerance.

Answer 220

correlation between asset and market * (standard deviation of asset / standard deviation of market) or COV / variance of market

Answer 221

A The left endpoint of the efficient frontier is represented by the portfolio with the lowest risk level Each portfolio on the efficient frontier provides maximum return for a given risk level. At the leftmost endpoint of the efficient frontier is the portfolio with the lowest risk. At the rightmost endpoint is the portfolio with the highest return and highest standard deviation.

Answer 222

B Investment Guidelines. B is correct. The major components of an IPS are listed in Section 2 of the reading. Investment Guidelines are described as the section that provides information about how policy may be executed, including restrictions on the permissible use of leverage and derivatives and on specific types of assets excluded from investment, if any. Statement of Duties and Responsibilities “detail[s] the duties and responsibilities of the client, the custodian of the client’s assets, the investment managers, and so forth.” Investment Objectives is “a section explaining the client’s objectives in investing.”

Answer 223

A time-weighted return. Time-weighted return, which is unaffected by the timing and amount of cash flows, is most appropriate for measuring the performance of a manager who does not control new contributions and withdrawals. The money-weighted return measure, which is an internal rate of return, will give a skewed indication of the manager's performance depending on factors that are beyond his or her control.

Answer 224

A Exchange traded funds. A is correct. Exchange traded funds do not have capital gain distributions. If an investor sells shares of an ETF (or open-end mutual fund or closed-end mutual fund), the investor may have a capital gain or loss on the shares sold; however, the gain (or loss) from the sale is not a distribution.

Answer 225

C higher values for nonsystematic variance. C is correct. Since managers are concerned with maximizing risk-adjusted returns, securities with greater nonsystematic risk should be given less weight in the portfolio.

Answer 226

A decrease the diversification ratio. The diversification ratio of an equally-weighted portfolio is the ratio of the portfolio's standard deviation to the average standard deviation of its components. Adding a security with negatively correlated returns will reduce the diversification ratio.

Answer 227

B an asset's risk should be measured in relation to its non-diversifiable risk. According to modern portfolio theory, investors should not be rewarded for accepting risk that can be diversified away. This implies that an asset's risk should be measured in relation to its non-diversifiable risk, also known as systematic risk. Therefore, the priced risk of an asset is actually affected by holding it in a well-diversified portfolio.

Answer 228

C Confirmation C is correct. Both endowment bias and regret-aversion bias often result in indecision or inertia—a typical outcome of status quo bias, in which people prefer to not make changes even when changes are warranted.

Answer 229

B systematic risk.

Answer 230

C Risk identification and measurement Risk governance directs risk management activities to be in alignment with the overall enterprise's goals. Risk mitigation is the process of adjusting risk exposures to desired levels. Risk identification and measurement make up the main quantitative core elements of risk management.

Answer 231

A It is possible for some portfolios to reduce risk without affecting expected return By adding securities that have low correlations with existing securities, it is possible to reduce a portfolio's level of risk without affecting its expected return. If return correlations are less than perfect, an equally-weighted portfolio's standard deviation will be less than the average standard deviation of its components. Diversification does not avoid downside risk in extreme economic conditions. In a crisis, return correlations tend to increase sharply.

Answer 232

B Representativeness B is correct. Representativeness refers to the tendency to adopt a view or forecast based on individual information or a small sample, as well to use simple classifications. The halo effect is an example of representativeness, because FMPs extend an overall favorable evaluation to an investment (e.g., a “good company”) based on one or few characteristics (e.g., a “visionary CEO”).

Answer 233

B Companies with strong historical growth rates are viewed as good investments, with higher expected returns than risk characteristics merit. B is correct. This choice describes the halo effect, which does offer a behavioral explanation for the poor performance of growth stocks versus value stocks. Growth stocks are mispriced relative to their risk characteristics, because FMPs focusing on just a few properties, such as a high historical revenue growth rate, while neglecting other characteristics.

Answer 234

B align risk exposures with risk appetite. B is correct. When risk tolerance has been determined, the risk framework should be geared toward measuring, managing, and complying with the risk tolerance, or aligning risk exposure with risk tolerance. The risk tolerance decision begins by looking at what shortfalls within an organization would cause it to fail to achieve some critical goals and what are the organization’s risk drivers.

Answer 235

A Risk A is correct. Many decision makers focus on return, which is not something that is easily controlled, as opposed to risk, or exposure to risk, which may actually be managed or controlled

Answer 236

A Representativeness A is correct. Under-diversified portfolios are a consequence of both illusion of control and confirmation biases. Researchers have found that some investors prefer to invest in companies that they feel they have control over, such as the companies they work for, leading them to hold concentrated positions. Confirmation bias may lead to FMPs ignoring negative news, paying attention only to information confirming that a company is a good investment, which may result in large positions. Representativeness bias is not typically associated with under-diversified portfolios.

Answer 237

A A written IPS communicates a plan for trying to achieve investment success. A is correct. A written IPS is best seen as a communication instrument allowing clients and portfolio managers to mutually establish investment objectives and constraints.

Answer 238

A income. A is correct. Income is necessary to meet the cash flow obligation to retirees. Although defined benefit plans have a need for income, the need for liquidity typically is quite low. A retiree may need life insurance; however, a defined benefit plan does not need insurance.

Answer 239

C Anchoring and adjustment bias Belief perseverance biases relate to cognitive dissonance, the mental discomfort when an investor is given new information that conflicts with prior beliefs. Biases in this category include: --> Conservatism bias --> Confirmation bias --> Representativeness bias --> Illusion of control bias --> Hindsight bias Anchoring and adjustment bias is a type of processing error bias.

Answer 240

C Investors are compensated based on the total risk exposure of their portfolios Investors are compensated for holding assets or portfolio based on the investment’s systematic (non-diversifiable) risk. Investors do not receive any return for accepting nonsystematic (diversifiable) risk. A risk-free asset has no risk by definition. A market portfolio is an efficient portfolio in which no additional risk can be diversified away. Thus, a market portfolio does not contain any nonsystematic (diversifiable) risk.

Answer 241

C Risk identification, measurement, and monitoring C is correct. Risk infrastructure refers to the people and systems required to track risk exposures and perform most of the quantitative risk analysis to allow an assessment of the organization’s risk profile. The risk management infrastructure identifies, measures, and monitors risks (among other things).

Answer 242

B The number of outstanding shares does not change Since an open-end fund will issue additional shares, the number of outstanding shares will change accordingly.

Answer 243

A Framing bias Processing error biases relate to an individual's inability to accurately process information rationally when making financial decisions. They include: --> Anchoring and adjustment bias --> Mental accounting bias --> Framing bias --> Availability bias Hindsight bias is a type of belief perseverance bias, while status quo bias is a type of emotional bias.

Answer 244

B above Investor B's and is steeper. An indifference curve for a risk-averse investor actually runs from southwest to northeast. As risk increases (going east), the risk-averse investor expected to be compensated with greater return (going north) for the same utility.

Answer 245

B security market line. B is correct. The security market line (SML) is a graphical representation of the capital asset pricing model, with beta risk on the x-axis and expected return on the y-axis.

Answer 246

B An unexpected change in monetary policy Systematic risk is market-wide, non-diversifiable risk. Monetary policy impacts all asset classes, not just a specific company or industry. Legal action related to a price-fixing investigation could potentially have a significant impact on the companies involved, but would have minimal impact beyond that. The impact of damage to a major pipeline on companies that are not directly involved in the supply chain would be minimal. Adjustments would be made during any temporary period of disruption.

Answer 247

C highest expected return relative to the risk-free rate. C is correct. The efficient frontier does not account for the risk-free rate. The efficient frontier is the set of all attainable risky assets with the highest expected return for a given level of risk or the lowest amount of risk for a given level of return.

Answer 248

B maximizing utility while bearing a tolerable level of risk. B is correct. For individuals, risk management concerns maximizing utility while taking risk consistent with individual’s level of risk tolerance.

Answer 249

A a deferred tax asset. A is correct. Because the carrying amount is less than the tax base for this asset, this difference is a temporary difference that will result in a deferred tax asset.

Answer 250

A A single customer represents 5 percent or more of the company’s total revenue The quantitative criteria necessitating a company to disclose separate information about any operating segment are: --> The segment constitutes 10 percent or more of combined operating profit, assets, or revenue --> The combined revenue from external customers for all reportable segments is less than 75 percent of the total company revenue --> A single customer represents 10 percent or more of the company’s total revenue.

Answer 251

C The terminal year free cash flow projection should be adjusted based on the timing of the business cycle When using the DCF method to estimate a company's terminal value, analysts should adjust their estimates of terminal year free cash flows to account for the timing of the business cycle. Using an estimate for a terminal year that coincides with the peak or trough of a cycle can lead to excessively high or low valuations. Cash flow estimates should be normalized before being incorporated into long-term projections.

Answer 252

B operations section of the cash flow statement Manipulations to accounts payable to increase the reported amount of cash flow from operations (such as by delaying payments to creditors) can be detected by examining the composition of the operations section of the cash flow statement.

Answer 253

Gross profit - Opex - opex include selling, general, and administrative expenses, and depreciation.

Answer 254

B on the income statement for the period when the assessment is made. Under IFRS, inventory must be carried at the lower of cost or net realizable value. If an assessment determines that the net realizable value is below the current carrying cost, an immediate write-down is required. This is treated as an expense on the income statement. Note that IFRS does allow for the reversal of prior-year write-downs if a later assessment finds that inventories have increased in value.

Answer 255

COGS / Average trade payables

Answer 256

B Proceeds from issuance of long-term debt The direct method for reporting cash flows includes only cash receipts and cash payments. Because there is no cash receipt or payment for unrealized gains or depreciation expense, these items would not be included on a direct-format cash flow statement. The proceeds from the issuance of long-term debt is a cash receipt, so this would be included in a direct-format cash flow statement.

Answer 257

C Cash flows from investing activities Acquisition and disposals of long-term assets are treated as investing activities. Transactions related to a company's core day-to-day functions are treated as operating activities. For the company in this example, advertisement revenue and employee's salaries would be included among its operating activities. Financing activities are related to raising the capital required to fund investments and operations.

Answer 258

C gives analysts a reasonable degree of confidence that the financial statements are free of material misstatements. Auditors issue unqualified audit opinions when they believe that a company's financial statements have been prepared in accordance with applicable accounting standards. The presence of an unqualified audit opinion can give analysts reasonable, but not complete, assurance that a set of financial statements is free of material errors and unaffected by fraudulent activities. Auditors issue a disclaimer of opinion when they are unable to properly assess a company's financial statements due to a scope limitation.

Answer 259

B proxy statement. Information about management compensation is found in the proxy statement.

Answer 260

B provide a reconciliation of the non-GAAP measure and equivalent GAAP measure. B is correct. If a company uses a non-GAAP financial measure in an SEC filing, it is required to provide the most directly comparable GAAP measure with equivalent prominence in the filing. In addition, the company is required to provide a reconciliation between the non-GAAP measure and the equivalent GAAP measure. Similarly, IFRS require that any non-IFRS measures included in financial reports must be defined and their potential relevance explained. The non-IFRS measures must be reconciled with IFRS measures.

Answer 261

B recorded as a separate line item in the company's 20X6 income statement. Under both IFRS and US GAAP, revenues from a business unit that will not impact a company's balance sheet in the future should be reported as income from discontinued operations in a separate line in the income statement.

Answer 262

B Making coupon payments to bondholders Making interest payments to bondholders (paying coupons) is classified as an operating cash flow under US GAAP, but may be listed as either an operating cash flow or a financing cash flow under IFRS. The purchase of vehicles to expand operations is a fixed capital investment (such as the purchase of PP&E) that would be classified as an investing cash flow. Raising capital by, for example, issuing bonds is a financing cash flow.

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