id&qtp&qim&qil&qtx&qca&qia&qrm&qnxt&qprv&qalb&subj&wght&pts&flr&ded&layout&qfixed&qptsbyans&flags 2006JV.001&mcs&0&N&Which of the following is classified as a firm under GIPS?&An investment firm, subsidiary, or division held out to clients or potential clients as a distinct business unit.&All the assets that are managed in one or more base currencies fall under the definition of a firm.;An entity registered with the appropriate national regulatory authority overseeing its investment management activities.;Any division of an investment bank that is providing advisory services to clients on securities listed in the local capital markets.;&LOS: Reading 4-kFirms must be an investment firm, subsidiary, or division held out to clients or potential clients as a distinct business unit, under the latest edition of GIPS.Reference: Global Investment Performance Standards, (CFA Institute, 2005), p. 114.&&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.002&mcs&0&N&Alexandra Holb, CFA, is an independent board member of Avenell Gastronomy, a publicly listed gourmet restaurant chain. As a board member she is invited to dine at no charge, accompanied by a guest of her choice, in any of the restaurants, once a month.Holb loves fine dining and never misses the opportunity to visit an Avenell restaurant to take advantage of the arrangement. This practice:&is acceptable as long the limits are clear and fully disclosed.&breaches the code of ethics of the company.;compromises Holb’s independence as a board member.;is in violation of the Code and Standards, Conflicts of Interest.;&LOS: Reading 5-iIf it is part of a transparent compensation scheme, it is still within the boundaries of corporate ethics. So Choice I is incorrect. The board needs further evidence of the lack of independence for Choice B to be correct.Choice IV is not relevant because Holb’s position is not directly linked with the trading of Avenell’s securities.Choice III is the best answer because the frequency of visits and the number of guests are limited so the expenses to the company are reasonably contained and not expected to materially erode the value of the company’s shares. Reference: The Corporate Governance of Listed Companies: A Manual for Investors, (CFA Institute, 2005), pp. 25-26.&&&a&Class@SS01.2&&&&&1:v&&&N. 2006JV.003&mcs&0&N&Which of the following is least likely an example of market manipulation according to the Code and Standards?&Taking advantage of market inefficiencies to make profits on arbitrage strategies. &Agreeing to issue stock in an IPO to market participants if they agree to generate turnover in the stock subsequent to listing.;Circulating negative rumors on a stock in order to push down the stock price and allow a fund to cover a short position in the stock. ;Purchasing leading stocks in an index just prior to the expiry date of futures contracts on the index in order to make a profit on a long position in the futures contract.;&LOS: Reading 2-bMarket manipulation is artificially creating stock market prices. Arbitrage strategies are not a form of manipulation but take advantage of pricing inefficiencies existing in the market, and are a legitimate practice.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 49-52. &&&a&Class@SS01.0&&&&&1&N&0&N.N.N.N 2006JV.004&mcs&0&N&Which of the following parties do the Global Investment Performance Standards mainly apply to?&Investment management firms, and prospective and current clients of investment management firms only.&CFA Institute members only.;CFA Institute members and investment management firms only.;CFA Institute members, investment management firms, and prospective and current clients of investment management firms.;&LOS: Reading 4-bThe main parties affected by GIPS are prospective and current clients of investment management firms and the firm itself.Reference: Global Investment Performance Standards, (CFA Institute, 2005), p. 108.&&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.005&mcs&0&N&Which of the following statements is least likely to be in compliance regarding verification with the Global Investment Performance Standards?&Verification has been a requirement since I January 2000.&Verification must be performed by an independent third party.;Verification checks whether the calculation procedures meet GIPS requirements.;Verification checks whether the composite construction meets GIPS requirements.;&LOS: Reading 4-dVerification is recommended but not required.Reference: Global Investment Performance Standards, (CFA Institute, 2005), p. 115.&&&a&Class@SS01.2&&&&&1&N&0&N.N.N.N 2006JV.006&mcs&0&N&Elizabeth Salami and Albert Toffee have both passed Level II of the CFA Exam Program. Salami advertises a resume stating that she is a candidate for the CFA designation and has passed Level II of the CFA Program. Toffee circulates a resume stating that he is a CFA candidate who has passed Level II and expects to obtain his CFA charter in 2006, the following year. Both have enrolled to take Level III in 2006. Which of the following statements is TRUE?&Only Toffee has violated the Code and Standards.&Only Salami has violated the Code and Standards.;Both Salami and Toffee have violated the Code and Standards.;Neither Salami nor Toffee have violated the Code and Standards.;&LOS: Reading 2-bStandard VII(B) indicates that candidates should not cite the expected date of the exam completion and award of the charter. If Salami had not enrolled for the Level III examination, she would have also violated the Code and Standards by claiming to be a (current) candidate.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 135-137. &&&a&Class@SS01.0&&&&&1&N&0&N.N.N.N 2006JV.007&mcs&0&N&According to the Standards of Professional Conduct, when writing material for circulation to the public:&Members may not copy or use charts or graphs without stating the sources and members may not orally, for example in a group meeting, without acknowledgment, use excerpts from articles or reports prepared by others.&Members may copy or use charts or graphs without stating the sources and members may orally, for example in a group meeting, without acknowledgment, use excerpts from articles or reports prepared by others.;Members may copy or use charts or graphs without stating the sources but members may not orally, for example in a group meeting, without acknowledgment, use excerpts from articles or reports prepared by others.;Members may not copy or use charts or graphs without stating the sources but members may orally, for example in a group meeting, without acknowledgment, use excerpts from articles or reports prepared by others.;&LOS: Reading 2-aStandard I(C) prohibits plagiarism, whether it is a written or oral form of communication of another’s work. Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 25-28.&&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.008&mcs&0&N&Jason Vasco, CFA, is the director for a major Talia-owned investment management firm branch in Rasen. Talia is known as the world’s centre of investment management with securities laws stricter than the CFA Institute Code and Standards, and Vasco is governed by Talia’s laws. In Rasen, an emerging market, the local securities laws and regulations are lenient. They are very vague in the definition of insider trading and have no provision regulating soft-dollars. Which of the following is TRUE?&Vasco must comply with Talia’s law. &Vasco only has to comply to Rasen’s law and therefore can take the fullest advantage of soft-dollar arrangements.;As a CFA Institute member, Vasco must only comply with the Code and Standards regarding insider trading and soft-dollar arrangements.;Vasco should not worry about Rasen’s law, it is an early stage emerging market and the law enforcement will be lax, if any at all.;&LOS: Reading 2-aStandard I (A) stipulates that in foreign jurisdictions members must comply with the stricter of the applicable laws and the Code of Standards. Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 7-13.&&&a&Class@SS01.2&&&&&1&N&0&N.N.N.N 2006JV.009&mcs&0&N&TeleNorth is a publicly-listed telecommunications company which is a privatized partially state-owned entity in the Republic of Norcorrea. The Norcorrean government holds ‘golden shares’ that carry super-voting rights. Which one of the statements is most appropriate from a corporate governance point of view?&The separation of voting rights from economic rights may reduce investors’ enthusiasm for the shares.&As a state-owned enterprise, TeleNorth can only appoint a classified board.;Proxy voting is only permitted at the discretion of golden sharesholders. i.e. the government.;Ordinary shareowners without the super-voting rights automatically lose the right to take legal action for fraudulent charges against the company. ;&LOS: Reading 5-pChoice I is incorrect from a corporate governance view because a company is free to choose any type of board as long as it satisfactorily protects the long-term interests of the shareowners. Choice II and IV are in violation of shareowner rights. Choice III is the correct one.Reference: The Corporate Governance of Listed Companies: A Manual for Investors, (CFA Institute, 2005), pp. 37-38.&&&a&Class@SS01.0&&&&&1:v&&&N. 2006JV.010&mcs&0&N&Matt Owusu, CFA, has just sold the company he founded, Ashburton Pet Foods, to the public. He has been asked to serve on the board of Ashburton Pet Foods for the next 10 years. Owusu’s long-term participation on the board is least likely to do which of the following?&Lead to a significant price decline in Ashburton’s shares when he retires.&Impair Owusu’s willingness to act in the best interests of shareowners.;Make it difficult for Owusu to undo any mistakes he made in the company.;Lead to Owusu developing an accommodating relationship with management.;&LOS: Reading 5-fThe departure of a long-term bard member might signify a rejuvenation of the company and may generate enthusiasm in the market.Reference: The Corporate Governance of Listed Companies: A Manual for Investors, (CFA Institute, 2005), pp. 12-13.&&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.011&mcs&0&N&Catherine Cleves, CFA, heads the Asian research department in Hong Kong of a New York-based brokerage firm. The firm employs many analysts spread about in different countries in Asia, some of whom are members of CFA Institute. If Cleves delegates some supervisory duties in the different offices in Asia, which of the following statements best describes her responsibilities under the Code and Standards?&Cleves retains supervisory responsibility for all subordinates despite her delegation of some duties.&Cleves' supervisory responsibilities only apply to those subordinates who are subject to the Code and Standards.;The Code and Standards prevent Cleves from delegating supervisory duties to subordinates in a developing or emerging market.;Cleves no longer has supervisory responsibility for those duties delegated to her subordinates who are not CFA Institute members and working from an office in an emerging market.;&LOS: Reading 2-aStandard IV(C) Responsibilities of Supervisors states that supervisory responsibility remains with the supervisor although the actual supervision can be delegated. Members who are supervisors can rely on reasonable procedures to detect and prevent violations to applicable statutes, regulations and provisions of the Code and Standards. Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 93-98.&&&a&Class@SS01.2&&&&&1&N&0&N.N.N.N 2006JV.012&mcs&0&N&Wimpy Greenback, CFA, is the research analyst responsible for following Brown Appliances Company. This analysis suggests the stock should be rated a "sell" because the market outlook for the firm's new products is bleak compared with that of the closest competition. Greenback lives on the same street as the CFO of Brown Appliances. During a recent neighborhood gathering, Greenback’s wife overheard the wife of the Chief Financial Officer of Brown Appliances complaining that her husband had been working late due to a hostile takeover threat from a foreign appliances group. This fact has not yet been made public by Brown Appliances. Upon returning to his office, Greenback released a strong "buy" recommendation to the public based on this new information. Greenback:&violated the Code and Standards because he did not have a reasonable and adequate basis for his recommendation.&was in full compliance with the Code and Standards.;did not violate the Code and Standards because he used mosaic theory to arrive at his recommendation.;violated the Code and Standards by failing to distinguish between facts and opinions in his recommendation.;&LOS: Reading 2-bStandard V(A) Diligence and Reasonable Basis, states that members must have a reasonable and adequate basis for a recommendation. Greenback should have reinvestigated the company’s situation and not only relied on unofficial information. This may well be a misappropriation of material nonpublic information as stated in Standard V(A) Prohibition against Use of Material Nonpublic Information, if a tender offer to Brown Appliances follows.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 99-103.&&&a&Class@SS01.0&&&&&1&N&0&N.N.N.N 2006JV.013&mcs&0&N&Toby Green, CFA, works in an equity brokerage department at Mulberry Securities. Green has reviewed a report from the firm’s research department that suggests Crown Appliances is rated a "buy" because the sales figures for the firm's new products have been better than those of the closest competition. Green lives on the same street as the CFO of Crown Appliances. While waiting for the train to work, Green accidentally overheard the Chief Financial Officer of Crown Appliances report to his colleague on a mobile phone about an announcement in the morning newspaper that a competitor has just launched a website for appliance distribution over the internet. Upon returning to his office, Green tipped his father to sell his holding based on this new information, but he still recommends a buy to all Mulberry’s clients. Green:&was in full compliance with the Code and Standards. &violated the Code and Standards by failing to maintain fair dealing.;violated the Code and Standards because he gave a recommendation based on material non-public information.;violated the Code and Standards because he failed to maintain priority of transactions for his firm’s clients.;&LOS: Reading 2-bGreen did not violate Standard II (A) Material Nonpublic Information because the announcement appears in the morning newspaper. His buy recommendation is consistent with that of his firm’s research department and no violation of priority of transactions occurs here.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 37-47.&&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.014&mcs&0&N&The fixed-income corporate finance department of Golden Saxon Brothers, an investment banking firm, has decided to compete for the advisory and underwriting bond offering of Kia Telcom, a ‘hot’ telecommunications company. The firm's equity brokerage unit is about to publish a "sell" recommendation on Kia Telcom due to an unexpected announcement of cost overruns. The head of fixed-income investment banking has asked the head of the equity brokerage unit to change the recommendation from "sell" to "buy" before distributing the research report to clients. According to the Code and Standards, the best course of action for the equity brokerage unit is to:&place Kia Telcom on a restricted list and publish only factual information about the company.&immediately re-rate the stock to a "buy" since the firm’s overall interest supersedes that of the client.;assign a more senior analyst to decide if the stock deserves a higher rating for the sake of objectivity since less senior analysts may err in judgment.;increase the rating by no more than one increment (in this case, to a "hold" recommendation) since little harm is done by being a bit more positive, while the firm’s overall interest is served.;&LOS: Reading 2-aIn this case, any action to accommodate the interest of the investment banking department that may compromise the independence and objectivity of the brokerage research efforts can violate Standard I(B) and the Code of Ethics.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 15-20.&&&a&Class@SS01.2&&&&&1&N&0&N.N.N.N 2006JV.015&mcs&0&N&Bud Clayton, CFA, manages the discretionary account of the Lewin Jones Corporation employees’ profit-sharing plan. Diane Lewin, the company president, recently asked Clayton to vote on behalf of the shares in the firm’s profit-sharing plan in favor of the company-nominated slate of directors and against the slate of directors sponsored by a corporate-raider stockholder group. Clayton does not want to lose Lewin Jones as a client, because the account generates more than 20 percent of his firm’s revenues. Clayton investigates the proxy-fight issue and realizes that the corporate raider’s slate of directors would probably be better for the long-run performance of the firm than that recommended by the management. However Clayton fears that the new board, which he hardly knows, will shift the business to a competing investment firm as often happens in corporate takeovers. According to the Code and Standards, Clayton should:&vote in favor of the corporate raider’s recommendation since it is in the best interest of the participants and beneficiaries of the employees’ profit sharing plan.&vote in the manner requested by Lewin due to her importance as a major client.;vote against the corporate raider’s recommendation as corporate raiding is unethical.;abstain from voting since this sort of proxy-fight is counterproductive and threatens the fabric of corporate culture.;&LOS: Reading 2-aThis is a test case on the execution of a fiduciary duty by investment managers as stated in Standard III (A) Loyalty, Prudence, and Care. Clayton’s main obligation is to maintain the interest of his client namely the Lewin Jones employees’ profit-sharing plan.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 53-56.&&&a&Class@SS01.0&&&&&1&N&0&N.N.N.N 2006JV.016&mcs&0&N&Victoria Anderson, CFA, works for Pluto Capital, a newly established investment counseling firm. The founding partners of Pluto Capital came from Vulcan Investments which was recently taken over by a large financial services group. Jonathan Beecham, a prospective client of the firm, is meeting with Anderson for the first time. Beecham has been a client of Vulcan Investments for years, but is now considering switching his account to Pluto Capital because he has been disappointed by Vulcan’s underperformance following the takeover. At the beginning of their meeting, Anderson sympathized with his situation, then immediately explains to Beecham that she has discovered a highly undervalued stock that offers large potential gains. Anderson then promises Beecham that she can buy the stock for his account at the current price if he switches the account within 48 hours. Anderson's actions violated the Code and Standards. Which of the following statements best describes the action Anderson should have taken? Anderson should have:&determined Beecham's investment needs, objectives, and tolerance for risk before making any investment recommendation.&elaborated on the technical features of Pluto’s standard valuation method used to identify the undervaluation.;avoided the meeting with Beecham in the first place because the founding partners of Pluto came from Vulcan.;given Beecham a longer time period to take advantage of the offer price when switching his account to Pluto.;&LOS: Reading 2-bPrior to recommending any investments, Anderson should determine Beecham's investment needs, objectives, and tolerance for risk before making any investment recommendation as stated in Standard III(C) Suitability.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 69-71.&&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.017&mcs&0&N&Which one of the following requirements is least likely to help to ensure the establishment of an information barrier (firewall)?&Limit the number of major institutional clients who regularly receive ‘special investment tips’ prior to information being made public.&Monitor carefully the personal trading activities of firm personnel.;Limit the number of people in the firm who have access to material nonpublic information;Place securities on a restricted list when the firm has access to material nonpublic information.;&LOS: Reading 2-aFirewalls are intended to block the dissemination of material nonpublic information. Providing ‘special investment tips’ prior to information being made public is a conscious effort of dissemination, albeit to a limited number of clients, therefore is in violation of Standard II(A) Material Nonpublic Information.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 37-43.&&&a&Class@SS01.2&&&&&1&N&0&N.N.N.N 2006JV.018&mcs&0&N&Which one of the following is least likely to be a required part of the verification process for a firm claiming compliance with GIPS?&Checking that fees charged to client accounts are in line with market practice.&Ensuring that the firm’s calculation of performance is in compliance with GIPS.;Checking that composites have been set up in line with client objectives or the strategy followed.;Checking that required disclosures have been made in the performance presentation.;&LOS: Reading 4-dThere is no requirement to check the fairness of fees being charged to clients in terms of comparing to market standards.Reference: Global Investment Performance Standards, (CFA Institute, 2005), pp. 99-100.&&&a&Class@SS01.0&&&&&1&N&0&N.N.N.N 2006JV.019&mcs&0&N&Bernard Bardots, CFA, is a research analyst who has accumulated and analyzed several pieces of nonpublic information through his contacts with publishing firms. Although none of the information is material, Bardots correctly deduced that the earnings of one of the firms under his coverage would unexpectedly decline significantly in the coming year. According to the Code and Standards, Bardots:&is allowed to use the information to make investment recommendations and decisions.&should report the sources of the material nonpublic information to the CFA Institute.;is not allowed to make investment recommendations or actions based on this information.;should urge the publishing firm to make public dissemination of the information immediately.;&LOS: Reading 2-aThis is an example of an application of mosaic theory. It is legitimate to employ an educated deduction over pieces of ‘material’ nonpublic information and to arrive at an investment recommendation, as long as the data was not misappropriated – (Standard V(A) Diligence and Reasonable Basis).Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 105-107.&&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.020&mcs&0&N&Which of the following is not a concept covered by the CFA Institute Code of Ethics?&Remuneration levels of investment professionals.&Competence.;Integrity and diligence.;Independent judgment.;&LOS: Reading 1Remuneration of investment professionals is not explicitly covered in the Code of Ethics. Disclosure of compensation is stipulated in Standard IV(B) Additional Compensation Arrangements and in Standard VI(C) Referral Fees. Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), p. 1.&&&a&Class@SS01.2&&&&&1&N&0&N.N.N.N 2006JV.021&mcs&0&N&Martha Birch, CFA, is a financial analyst at Granders Securities Corporation. Granders has information firewalls between different departments in compliance with recommendations made in the Code and Standards. Birch is preparing a purchase recommendation on B and D Corporation. Which of the following situations would NOT present a conflict of interest for Birch and, therefore, needs NOT be disclosed?&Granders, through its investment advisory arm, holds for its clients’ accounts a substantial holding of common stock in B and D Corporation.&Birch’s brother is a member of the board of directors of B and D.;Birch has been a member of the board of directors of B and D until three months ago.;Birch was formerly married to the Chief Financial Officer of B and D and has recently received a significant stock holding as part of her divorce settlement.;&LOS: Reading 2-bGrander does not present a potential conflict of interest as stated in Standard VI(A), Disclosure of Conflicts, as the appropriate firewall between an investment advisory arm and the brokerage operation would be established pursuant to the Code and Standards.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 113-116.&&&a&Class@SS01.0&&&&&1&N&0&N.N.N.N 2006JV.022&mcs&0&N&Ken Janzen, CFA, is an economist at a large bank and he has never made direct investment decisions. Jenzen is the latest winner of a well-publicized portfolio management competition in a national newspaper. On the recommendation of his friends, he is launching an investment fund. In the prospectus he tells the prospective clients, "The fund has no long-term track record as yet, but the investment manager has shown considerable skills in managing hypothetical portfolios. In a competition the manager has demonstrated a portfolio total return above 26 percent per year annualized, and that is more than 12 percent above the benchmark for the same period." He managed to raise a significant amount of money from retail investors who are interested in investing in the fund. Has Janzen violated the Code and Standards?&No, because the statement is a true and accurate description of Janzen's track record.&Yes, because the statement misrepresents Janzen's track record.;Yes, because he cannot quote performance for a hypothetical portfolio. ;Yes, because the statement about return ignores the risk preferences of his clients.;&LOS: Reading 2-bAlthough Janzen’s experience in managing investments is only based on his winning a hypothetical portfolio management competition, he does not misrepresent his capabilities and experience as described in Standard III(D) Performance Presentation. Whether it is appropriate for an investor to subscribe to his investment fund is a different matter. The role of the Code and Standards is to guide self-regulation of CFA Institute members, not to certify the merit of an investment.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 131-134.&&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.023&mcs&0&N&Compliance with GIPS can be claimed:&only on a firm-wide basis.&on a composite by composite basis.;on an asset class by asset class basis.;on an investment manager by investment manager basis.;&LOS: Reading 4-kCompliance can only be claimed if all the firm’s fee paying and discretionary accounts are include in composites and all composites are GIPS compliant.Reference: Global Investment Performance Standards, (CFA Institute, 2005), p. 113-115.&&&a&Class@SS01.2&&&&&1&N&0&N.N.N.N 2006JV.024&mcs&0&N&Material public information, as a matter of course in business, circulates within an investment banking department. If the investment bank has an equity brokerage division, it may create considerable value by using the information in advising the brokerage clients. In order to conform to the Code and Standards, which of the following are the best policies for the brokerage firm to follow?

I. Establish a firewall (information barrier) between the investment banking department and the brokerage operation.

II. Minimize the impact by allowing the information to benefit only a limited list of the largest brokerage clients, carefully selected by the head of brokerage operation.

III. Prohibit buy and sell recommendations on the stocks of the investment banking clients until the transactions with the clients are officially completed and the material information becomes public.

IV. Prohibit purchase recommendations because of the unfair advantage that the information may create, but allow the sale of current holdings until transactions with the investment banking clients are officially completed and the material information becomes public.&I and III only.&I and II only.;I and IV only.;II and IV only.;&LOS: Reading 2-aThe procedures in applying Standard II(A) are aimed to eliminate the possibility of dissemination of material non-public information. The most common ways are to establish a firewall and to create a restricted list of securities if a firm has access to material non-public information. Minimizing the dissemination as in Statement II is not sufficient since there will still be parties who can unfairly benefit from the information.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 40-43.&&&a&Class@SS01.0&&&&&1:v&&&N. 2006JV.025&mcs&0&N&Marco Maggio, CFA, is scheduled to visit the corporate headquarters of Venus Industries. Maggio expects to use the information obtained there to complete his research report on Venus stock. The location of Venus Industries is within a 15-minute drive of a prestigious golf course. On arrival at the Venus premises, Marco Maggio learns that Venus is offering Maggio an extension of his stay that weekend and invites him for a day of golf with all expenses paid. Venus Industries also offers to pay for all the expenses for the trip, including the cost of meals, hotel room, and air transportation back to Venus Industries. The total cost for the weekend is about $2,000. Which of the following actions would be the best course for Maggio to take under the Code and Standards?&Pay for all travel expenses, including costs of meals and incidental items and politely reject the golf outing offer.&Reject the golf outing offer but accept the reimbursement of the travel expenses since they are legitimate business-related expenses.;Accept both the expenses-paid trip and the golf outing as more information can often be extracted from the company in a more leisurely environment.;Accept the expenses-paid trip and disclose the value of the trip in the report, but it is at Maggio’s discretion to take the golf outing offer without disclosing it as it occurs outside working hours.;&LOS: Reading 2-bMaggio will violate Standard I(B) Independence and Objectivity because accepting any significant gift may impede his independence and objectivity.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 15-19.&&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.026&mcs&0&N&Patricia Rice, an independent member of the board of Ashburton Pet Foods, proposes an amendment to the company’s articles of association. She proposes that the board can independently, without first seeking management’s approval, hire external consultants when it sees fit. She also requests that an appropriate budget is allocated for this purpose.Which statement is most appropriate?&The proposal conforms to modern corporate governance practices specifically when the required expertise relates to financial matters and/or reputational concerns.&The proposal is unjustified because it would undermine the authority of the management.;The only way to counter such a proposal is to improve the compensation package of the members of the board.;The proposal only makes sense if management approval is sought first and the required expertise relates to auditing matters.;&LOS: Reading 5-fIt is a perfectly valid proposal within modern corporate governance practices.Reference: The Corporate Governance of Listed Companies: A Manual for Investors, (CFA Institute, 2005), pp. 14-15.&&&a&Class@SS01.2&&&&&1:v&&&N. 2006JV.027&mcs&0&N&Global Advisors runs advisory and discretionary accounts for clients domiciled in a number of different countries. Some of the client portfolios invest in single markets and some invest on a regional or global basis. Global Advisors has established a composite for their discretionary portfolios where the portfolio’s strategy is to achieve capital growth through investment in global equity markets. The composite:&on the basis of the information given, is compliant with GIPS.&is not compliant with GIPS because it should also include advisory accounts.;is not compliant with GIPS because composites should be based on investment in a single country.;is not compliant with GIPS because it should not state an investment objective in the composite description.;&LOS: Reading 4-cComposites should only include discretionary, and not advisory, accounts. They group together accounts based on strategy and style and are not restricted to a single market. There is no information in the question to suggest that it is not GIPS compliant.Reference: Global Investment Performance Standards, (CFA Institute, 2005), pp. 99 and 113.&&&a&Class@SS01.0&&&&&1&N&0&N.N.N.N 2006JV.028&mcs&0&N&Fiona Griffiths, CFA, is an equity sales manager at a London-based Tiger Securities branch in an emerging market. Initial public offerings are often oversubscribed making it difficult to ensure a fair allocation. Griffiths understands the local environment so she is able to influence the allocation process so that she can personally subscribe to the maximum she can afford and then allocate the rest to her clients. Her clients never complain because they have almost always profited from investing in the emerging market over the last couple of years. Which of the following describes Griffiths’ situation?&Griffiths violates the Code and Standards due to the priority she gives to transactions.&Griffiths violates the Code and Standards since she does not maintain client confidentiality.;Griffiths violates the Code and Standards since she lacks independence and objectivity.;Griffiths is in compliance with the Code and Standards since her clients are satisfied.;&LOS: Reading 2-bGriffiths is in violation of Standard VI(B) Priority of Transactions, since she puts her personal investment ahead of her clients, regardless of whether the clients are pleased with her services. Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 121-124.&&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.029&mcs&0&N&Tamara Deneuve, CFA, is an investment manager in charge of Asian equity portfolios. Together with her colleagues, she has developed a new proprietary valuation model for emerging markets in Asia. Back testing using 12-month earnings data, the valuation model produces favorable results particularly when applied to certain industries, but not to others. Deneuve has decided to implement the new model to those industries but use the usual model for the others. According to the Code and Standards:&Deneuve must inform her clients prior to implementing the model.&Deneuve has the sole right to any proprietary model she has developed.;Deneuve should not implement the model since it can only be applied to certain industries.;Deneuve may implement the new model without informing her private clients since they would be unlikely to understand the model.;&LOS: Reading 2-aThe application of a new valuation model may constitute a significant change to the investment process. Her clients must be informed in advance and given sufficient time to evaluate and decide whether such changes have a significant impact to their situation. This falls under Standard V(B) Communication with Clients and Prospective Clients.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 105-109.&&&a&Class@SS01.2&&&&&1&N&0&N.N.N.N 2006JV.030&mcs&0&N&Martha Pierpont, CFA, works for the securities custody department of North Pole Trust Bank. She makes a reciprocal referral fee arrangement with Robert Underhill, CFA, an adviser at BestAdvice.com. She does not disclose the referral arrangement but Underhill does so by inserting one clause in BestAdvice.com’s investment advisory agreement that includes "… from time to time referral fees may be arranged with a number of selected securities custodians." Clients of BestAdvice regularly use North Pole’s services and pay referral fees. Which of the following is CORRECT?&Neither Pierpont nor Underhill comply with the Code and Standards.&Only Pierpont complies with the Code and Standards.;Only Underhill complies with the Code and Standards.;Both Pierpont and Underhill comply with the Code and Standards.;&LOS: Reading 2-bThe best choice is "Neither Pierpont nor Underhill comply with the Code and Standards" since any referral fee arrangement that a client ultimately pays must be disclosed in terms of the nature of the consideration or the benefit together with the estimated monetary value, by both the payer and recipient of the fee. See Standard VI (C) Referral Fees.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 127-129.&&&a&Class@SS01.0&&&&&1&N&0&N.N.N.N 2006JV.031&mcs&0&N&Sigfried Freud, CFA, is a private-client investment manager at Super Echo investment firm based in Vienna, Austria. One of his clients in Monaco offers him bonus compensation beyond that provided by his firm if the portfolio performance exceeds the agreed benchmark. To make it more attractive to Freud, his client will send the bonus compensation to a tax-free account in a tax haven. Freud:&may accept the additional compensation subject to the approval of his employer as required by Standard IV(B) Additional Compensation Arrangements.&should report the situation to the compliance officer of the CFA Institute according to Standard I(B) Independence and Objectivity.;should turn down the additional compensation offer because it violates Standard IV(B) Additional Compensation Arrangements.;is free to accept the additional compensation in the tax-free account, as long as the account is not under the jurisdiction of either Monaco or Austria, it will therefore also be outside the jurisdiction of the Code and Standards.;&LOS: Reading 2-aStandard IV(B) Additional Compensation Arrangements does not prohibit the acceptance of additional compensation as long as approval from the employer is obtained. The tax-free account is a separate issue and will have to be viewed in light of tax rules and regulations. Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 91-92.&&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.032&mcs&0&N&Patricia Lualua, CFA, is a portfolio manager of Raven Asset Management. Recently she won a mandate from the Flemish Widows pension fund trustees to manage the investments of the fund. One of the Flemish Widows trustees privately mentions that Lualua should direct her trades to Churner Securities, which is owned by a relative of one of the trustees. Lualua, for fear of losing the account, directs 50% of the trades to Churner Securities. She is pleased to find that Churner’s quality of execution is good and the emerging market research quality is excellent. Although Flemish Widows does not invest in emerging markets, Lualua finds the research useful for the other funds she manages. Lualua decides not to inform anyone regarding the situation. According to the Code and Standards:&Lualua should disclose this arrangement to Flemish Widows.&Lualua should stop trading with Churner Securities.;Lualua may continue trading with Churners Securities.;Lualua should disclose this arrangement to the CFA Institute.;&LOS: Reading 2-bUnder most securities laws this situation is acceptable but under Standard III(A), Loyalty, Prudence and Care, Lualua’s trading relationship does not put her client’s interest first.Lualua should disclose the arrangement to the Board of Trustees of Flemish Widows and let the Board give the direction.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 53-56.&&&a&Class@SS01.2&&&&&1&N&0&N.N.N.N 2006JV.033&mcs&0&N&Which of the following statements regarding the requirements of the eight main provisions of the GIPS requirements is least accurate?&GIPS recommend disclosures about performance presentation and calculation methodology. Disclosures are always recommended, but not required.&The calculation methodology must be uniform firm-wide and across all composites.;The composite return is an asset-weighted return of the performance of all the portfolios comprising the composite.;Firms must present performance results incorporating the following elements: input data, calculation methodology, composite construction, disclosures and presentation and reporting.;&LOS: Reading 4-eDisclosures, in some cases, are required. In other cases it is up to the firm to decide if additional disclosures would enhance the understanding of the performance data provided.Reference: Global Investment Performance Standards, (CFA Institute, 2005), pp. 112-114.&&&a&Class@SS01.0&&&&&1&N&0&N.N.N.N 2006JV.034&mcs&0&N&Albert Wonghi, CFA, is a fund manager with Prospect Asset Management. At a lunch time party, hosted by a brokerage firm to whom he directs 50 percent of his transactions, Wonghi has too much to drink and behaves embarrassingly. Other fund managers attend the party. Wonghi’s personal behavior at the party may violate Standard I(D) because:&Wonghi’s behavior reflects poorly on him and the investment industry.&Wonghi breaks the local laws regarding behavior in public.;Wonghi should not drink any alcohol during business hours. ;Wonghi offends the brokerage firm who is forced to tolerate his behavior.;&LOS: Reading 2-bWith reference to Standard I(D) Professionalism, Wonghi’s excessive drinking will inhibit his ability to work in the afternoon and reflects badly on the profession. Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 33-35.&&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.035&mcs&0&N&Joseph Morgon, CFA, is a research analyst covering the Bourgogne Vineyard Corporation. Morgon’s parents bought $50 worth of Bourgogne Vineyard Corporation shares for his two-year old son on his birthday. Under Standard VI(A), Disclosure of Conflicts, Morgon:&does not need to disclose the fact that his son owns the shares of Bourgogne Vineyard Corporation.&must file a report with the SEC.;must sell the shares immediately.;must disclose the ownership of the shares by a member of his immediate family.;&LOS: Reading 2-bThe share ownership is not material and will not reasonably affect Morgon’s ability to make unbiased and objective recommendation according to Standard VI(A) Disclosure of Conflicts.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 113-119.&&&a&Class@SS01.2&&&&&1&N&0&N.N.N.N 2006JV.036&mcs&0&N&Carlina Paparazzi, a fund manager with Abbotswood Advisors, has just been given the authority to manage a newly acquired client which has a retirement benefit plan, when she realises that a US Government Bond belonging to the account matures the next day. The bond comprises 5% of the total assets. Abbotswood Advisors is still in the midst of a discussion with the client regarding the formulation of a new investment policy and portfolio objectives. Looking at what the current market has to offer, there are a number of attractive opportunities. One opportunity that stands out is a corporate bond of a major oil company that went out of favor due to an environmental accident that occurred the week before. She has followed the oil company for a number of years and knows that its fundamentals are sound. The outlook of an improved credit rating in the next six months is not yet reflected in the current price. Her supervisor asks Paparazzi to invest the proceeds in the corporate bond. Paparazzi prefers however to invest them in 3-month Treasury Bills, albeit with a much lower yield, until the new investment policy and objectives are formulated. What is the best course of action for Paparazzi?&Invest in the Treasury Bills until the new investment policy and objectives are established.&Revert to the client for a decision and do nothing until the client’s direction is received. ;Split the investment between the corporate bond and the Treasury Bills to diversify the risk.;Follow her supervisor’s direction as the corporate bond opportunity will benefit the overall performance of the fund.;&LOS: Reading 2-bRegardless of whether it is the best investment decision, choices III or IV will violate Standard III(C), Suitability, because the overall investment policy and objectives are not yet established. Choice I is not correct because the client pays a fee to hire expertise in investment decision making. So the best choice is II, where the client’s interest is protected, as a Treasury Bill is a cash equivalent and is risk-free, as are the maturing Treasury Bonds.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 69-74.&&&a&Class@SS01.0&&&&&1:v&&&N. 2006JV.037&mcs&0&N&Joseph Luny, CFA, is a bank analyst with London Fog Securities. On a recent trip to see a bank that he covers, he was presented with a rosy outlook for the bank’s earnings in the next two years which is above the consensus expectations. When probed further about the assumptions, the CFO inadvertently mentioned that serious discussions are taking place for a tender offer of a smaller well-managed bank that Luny also covers. This information has not been made public. Luny feels very lucky to receive this unexpected tip and rushes back to his office to revise his projections and advise his major clients to buy the smaller bank’s stock. What should have Luny done instead?&Luny should refrain from taking any action on the smaller bank’s stock until the bank has made the tender offer information public.&Luny should request his supervisor’s approval.;Luny is entitled to take advantage of the information as he did not misappropriate it.;Luny should encourage the bank to disclose the tender offer information to the public but is free to take advantage of the information in the meantime.;&LOS: Reading 2-bThe required action is to refrain from taking any action under Standard II(A) Material Nonpublic Information. Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 37-43.&&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.038&mcs&0&N&Charles Chaplane, who is not a member of the CFA Institute, is a senior partner of a small brokerage firm, Blue Moon Securities, which recently participated in a large stock offering. The offering company has been given an unfavorable recommendation by his research department in the past two quarters due to lacklustre performance. Chaplane immediately calls his junior analyst John Blumenberg, CFA, and instructs him to upgrade his recommendation. Blumenberg comes up with a more favorable recommendation within a short period of time. Which of the following Standards does Blumenberg violate?

I Standard I(B) because he failed to maintain independence and objectivity.

II Standard

III(D) because he failed to make a fair statement of investment performance.

III Standard V(A) because he failed to exercise due diligence and thoroughness in making an investment recommendation.&I and III only. &I and II only.;II and III only.;Blumenberg has violate all 3 standards;&LOS: Reading 2-bThe best answer is I and III only, because Standard III(D) deals with performance presentation, and there is no evidence to suggest that this is relevant to the question.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 15-19 and 99-103.&&&a&Class@SS01.2&&&&&1:v&&& 2006JV.039&mcs&0&N&Marianne Warner, CFA, is a portfolio manager at Creative Investment Management and in charge of managing several discretionary portfolios. Her husband holds 25 percent of the shares of Gurita Corporation, a computer services company. In line with the high sector growth, Gurita Corporation went public earlier in the year. The share price skyrocketed and the value of her husband’s holding went up from $1 million prior to the public offering to $8 million at the current market price. Warner believes that the current market price is too high and immediately advises her husband to sell half of his shares. She also recommends he put the proceeds into one of the discretionary portfolios she is currently managing. Which one is the BEST answer?&Warner does not violate the Code and Standards.&Warner violates the Code and Standards for failing to disclose the conflicts of interest.;Warner violates the Code and Standards for possessing material non-public information.;Warner violates the Code and Standards for failing to disclose additional compensation arrangements.;&LOS: Reading 2-bDisclose the conflicts of interest would apply if the advice was given when one or more of the portfolios contain Gurita shares. There is no mention of material nonpublic information or additional compensation so Warner has not violated any of the Standards.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 15-19.&&&a&Class@SS01.0&&&&&1&N&0&N.N.N.N 2006JV.040&mcs&0&N&Muhammad Taqdir, CFA, is an investment manager whose clients are high-net worth individuals. Taqdir is a member of a local charity organization that supports children with asthma. During a meeting at the charity, Taqdir recommends that the organization sends a letter to Xara Corporation requesting they make a donation to the charity. Taqdir knows of Xara Corporation’s involvement in this cause from previous discussions with a colleague in the office. The chief executive and owner of Xara Corporation is a client of the firm. The charity, citing Taqdir’s recommendation, sent the letter and received a substantial donation. According to the CFA Institute Code and Standards:&Taqdir should not have disclosed the identity of the chief executive without his prior approval.&Taqdir has done his best since the organisation received a substantial donation.;Taqdir should have informed the chief executive of Xara that he is going to receive a letter from the organization.;Taqdir should have requested the approval of his colleague before disclosing the name of the chief executive of Xara.;&LOS: Reading 2-bRegardless of the fact that that the organization finally received the substantial donation, Tariq has violated the preservation of confidentiality under Standard III(E), Preservation of Confidentiality, in disclosing the name of the chief executive and owner of Xara without prior knowledge of both the chief executive and his colleague.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 79-81.&&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.041&mcs&0&N&The number of cars sold per month over the last three years by ABC Car Distributor is as follows:



You have been asked to build a frequency distribution using 6 classes and you select the first class to be ‘10 up to 20’:

What is the class frequency and relative class frequency of the second class?
class frequency / relative class frequency& 7 -- 0.194& 7 -- 0.278; 10 -- 0.194; 10 -- 0.278;&LOS: Reading 8-f The second class is for sales from 20 up to 30 cars per month, there are 7 observations in this range which is the class frequency. The relative frequency is the percentage of observations in each class – for the second class this is 7 + 36 = 19.4%Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 3, pp. 91-99.
&&&a&Class@SS02.2&&&&&1:v&&&N. 2006JV.042&mcs&0&N&A person invests $10,000 at the end of each year for the next ten years, if the investment earns 6% interest annually, the value of the investment at the end of ten years will be closest to:&131800&134350;139708;149708;&cm&&&a&Class@SS02.0&&&&&1&N&0&N.N.N.N 2006JV.043&mcs&0&N&A team of four people is to be selected from a group of nine students. How many ways can they be selected?&126&24;2880;3024;&LOS: Reading 9-v Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 4, pp. 217-218. &&&a&Class@SS02.1&&&&&1&N&0&N.N.N.N 2006JV.044&mcs&0&N&The forecast rate of return from an investment has the following probability distribution:

Rate of Return | Probability
15% 0.250
20% 0.500
24% 0.125
26% 0.125


The standard deviation of the rate of return is closest to:&0.0357.&0.0013.;0.0250.;0.1580.;&LOS: Reading 9-p Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 4, pp. 194-196. &&&a&Class@SS02.2&&&&&1:v&&& 2006JV.045&mcs&0&N&Two investment managers have their performance analyzed. The first, A, achieves an average (arithmetic mean) performance of 20% with a standard deviation of 2%. The second, B, an average performance of 12%, with a standard deviation of 1.5%. Which of the following statements is CORRECT?&The coefficient of variation of A’s returns is lower than that of B.&The coefficient of variation of A’s returns is equal to that of B.;The coefficient of variation of A’s returns is higher than that of B.;The coefficients of variation of the returns cannot be calculated using the above information.;&LOS: Reading 8-m Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 3, pp. 139-140. &&&a&Class@SS02.0&&&&&1&N&0&N.N.N.N 2006JV.046&mcs&0&N&The following income streams will be paid from an investment: End year 1 $15,000 End year 2 $25,000 End year 3 $10,000At the end of year 3 the investment will have no remaining value. If the discount rate is 8% the present value of the investment is closest to:&43260&38580;39692;46721;&LOS: Reading 6-e Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 1, pp. 25-26. &&&a&Class@SS02.1&&&&&1&N&0&N.N.N.N 2006JV.047&mcs&0&N&A series of data is normally distributed, has a mean of 50 and standard deviation of 4. Approximately 95% of the readings will fall between:&42 to 58.&46 to 54.;38 to 62.;34 to 66.;&LOS: Reading 8-nFor a normal distribution 95% of the observations will fall between the mean plus or minus 2 standard deviations, i.e. between 50 ± 8.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 3, pp. 144-146.&&&a&Class@SS02.2&&&&&1&N&0&N.N.N.N 2006JV.048&mcs&0&N&If an investment costs $15 and will make a single payment of $25 in four years’ time the annual interest rate that will be earned on the investment is closest to:&13.6%.&8.8%.;16.7%.;27.2%.;&LOS: Reading 6-e Or use a financial calculator.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 1, pp. 26-29. &&&a&Class@SS02.0&&&&&1&N&0&N.N.N.N 2006JV.049&mcs&0&N&Equal numbers of red, white, green and blue folders are manufactured but one in ten of the folders is faulty. The probability that a folder is faulty is equal for each of the colors. What is the probability that if you select one folder that it will be green or faulty?&32.5%.&31.5%.;35.5%.;37.5%.;&LOS: Reading 9-hThe Rule of Addition for events, A and B, that are not mutually exclusive, is: P(A or B) = P(A) + P(B) - P(A and B)So the probability that a folder will be green or faulty is: P(green) + P(faulty) - P(green and faulty) = 0. 25 + 0.10 - 0.025 = 0.325 or 32.5%Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 4, pp. 187-188.&&&a&Class@SS02.1&&&&&1&N&0&N.N.N.N 2006JV.050&mcs&0&N&A portfolio increases in value from $10 million to $12 million over the first year. New cash of $2 million is then invested in the fund and the fund increases in value to $15 million at the end of the second year. The money-weighted and time-weighted rates of return are closest to (respectively):&12.8%, 13.4%.&12.8%, 27.1%.;13.4%, 22.5%.;14.0%, 22.5%.;&LOS: Reading 7-d Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition,Ch. 2, pp. 65-72. &&&a&Class@SS02.2&&&&&1&N&0&N.N.N.N 2006JV.051&mcs&0&N&An investor wants to buy an annuity that will pay out $10,000 a year at the end of each of the next 15 years. He can earn an interest rate of 8% on the annuity. The purchase price of the annuity is closest to:&85595&102037;138889;150000;&LOS: Reading 6-e Or use a financial calculator.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 1, pp. 19-23. &&&a&Class@SS02.0&&&&&1&N&0&N.N.N.N 2006JV.052&mcs&0&N&It is estimated that a stock has the following probabilities of return:
Return | Probability
15% 0.2
20% 0.4
30% 0.4


What is the expected return?&23.0%.&20.0%.;21.7%.;25.0%.;&LOS: Reading 9-mUse the formula for expected value, Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 4, pp. 194-195. &&&a&Class@SS02.1&&&&&1:v&&& 2006JV.053&mcs&0&N&If a distribution has positive excess kurtosis it means:&the distribution has fatter tails than a normal distribution.&the distribution is not symmetric.;the distribution is positively skewed.;the mean of the distribution is greater than zero.;&LOS: Reading 8-oPositive excess kurtosis means the distribution will be more peaked and have fatter tails than a normal distribution.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 3, pp. 149-153.&&&a&Class@SS02.2&&&&&1&N&0&N.N.N.N 2006JV.054&mcs&0&N&Which of the following statements about variance is FALSE? Variance is:&in the same units as the original data.&always a positive number.;the square of the standard deviation.;the arithmetic mean of the squared deviations from the mean.;&LOS: Reading 8-jThe standard deviation, not the variance, is in the same units as the original data, since the deviations are squared and then square rooted.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 3, pp. 129-135.&&&a&Class@SS02.0&&&&&1&N&0&N.N.N.N 2006JV.055&mcs&0&N&The Sharpe ratio calculates: &the excess return earned per unit of risk taken.&the excess risk taken in a portfolio.;the standard deviation relative to the return earned.;the dispersion relative to the mean of a distribution.;&LOS: Reading 8-mThe Sharpe ratio measures the excess return over the risk-free rate in units of risk (standard deviation) taken. It is a common measure used to evaluate the performance of fund managers.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 3, pp. 141-144.&&&a&Class@SS02.1&&&&&1&N&0&N.N.N.N 2006JV.056&mcs&0&N&A portfolio’s performance over 5 years is +14%, -2%, + 10%, +14%, +8%. The portfolio’s arithmetic mean return and median were:

Arithmetic Median Mean &8.8% 10.0%&8.6% 10.0%;8.8% 14.0%;8.6% 14.0%;&LOS: Reading 8-h The median is the middle value of the ordered display -2%, +8%, + 10%, +14%, +14%Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 3, pp. 103-110. &&&a&Class@SS02.2&&&&&1&N&0&N.N.N.N 2006JV.057&mcs&0&N&Which of the following statement(s) is most correct about a frequency distribution histogram?&The individual observations cannot be identified.&Neighboring points on the graph are connected by a straight line.;The frequency of a class is shown by the width of the corresponding bar.;A distribution takeing into account the correlation between the different variables.;&LOS: Reading 8-gII refers to a frequency polygon and the frequency of a class is shown by the height. Frequency distribution The organization of data to show how often certain values or ranges of values occur.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 3, pp. 99-103.&&&a&Class@SS02.0&&&&&1:v&&&N. 2006JV.058&mcs&0&N&Identify the most likely positively skewed distribution.&
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;
;
;&LOS: Reading 8-nA positively skewed distribution will have one or more observations that are very large. This will lead to the average (mean) being ‘pulled’ to the right. The median (the middle reading) will be higher than the mode (the most frequently occurring observation).Skewed distribution Probability distribution in which an unequal number of observations lie below (negative skew) or above (positive skew) the mean. Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 3, pp. 144-147.&&&a&Class@SS02.1&&&&&1:v&&& 2006JV.059&mcs&0&N&The money market yield of a 90-day Treasury bill offering a bank discount yield of 4% is closest to?&4.04%.&3.00%.;4.00%.;16.99%.;&LOS: Reading 7-e Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 2, pp. 72-75. &&&a&Class@SS02.2&&&&&1&N&0&N.N.N.N 2006JV.060&mcs&0&N&The value of $1,000 invested today, at an interest rate of 12% per year compounded quarterly, in 2 years’ time is closest to?&$1,266.77.&$1,240.00.;$1,254.40.;$1,259.48.;&LOS: Reading 6-c Or use a financial calculator.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 1, pp. 9-10.&&&a&Class@SS02.0&&&&&1&N&0&N.N.N.N 2006JV.061&mcs&0&N&The mean absolute deviation of the data 1, 5, 7, 8, 14 is:&3.2.&0.0.;4.2.;18.0.;&LOS: Reading 8-hThe mean is: (1 + 5 + 7 + 8 + 14)/ 5 = 7The absolute mean deviation is: Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 3, pp. 127-129. &&&a&Class@SS02.1&&&&&1&N&0&N.N.N.N 2006JV.062&mcs&0&N&A manager is offered two investments projects X and Y with net cash flows, in $ million, from each investment as shown below. The cost of X is $2 million and the cost of Y is $10 million. The cost of capital for X is 10% and for Y is 8%. Which should be accepted for investment? End of Year X Y 1 1.1 3.0 2 1.8 9.0&Both projects should be accepted.&X should be accepted and Y rejected.;Y should be accepted and X rejected.;Both projects should be rejected.;&LOS: Reading 7-a Both investments have positive NPVs so they should both be accepted.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 2, pp. 58-60. &&&a&Class@SS02.2&&&&&1&N&0&N.N.N.N 2006JV.063&mcs&0&N&The probability of passing an eye test for people over 70 years old is 80% and failing is 20%, for people under 70 years old the rates are 95% and 5% respectively. 15% of the people tested are over 70 years old. A report is found of someone failing the test, what is the probability that they are over 70 years old?&41.40%.&3.00%.;20.00%.;95.75%.;&LOS: Reading 9-r Note that this is the joint probability that they are over 70 and fail, divided by the total probability of failure.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 4, pp. 211-215. &&&a&Class@SS02.0&&&&&1&N&0&N.N.N.N 2006JV.064&mcs&0&N&Identify the correct statement(s) regarding a data distribution.&A mean of a population is an example of a parameter.&A parameter is a characteristic of a sample.;A statistic is a characteristic of a population.;Both A parameter is a characteristic of a sample and A statistic is a characteristic of a population are correct.;&LOS: Reading 8-bA parameter is a characteristic of a population and a statistic is a characteristic of a sample.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 3, pp. 88-91.&&&a&Class@SS02.1&&&&&1&N&0&N.N.N.N 2006JV.065&mcs&0&N&An investment is attractive if:&The IRR is higher than the cost of capital.&The net internal rate of return (IRR) is positive.;The cost of capital is less than the hurdle rate. ;The IRR provides a positive net present value (NPV).;&LOS: Reading 7-bThe IRR needs to be above the hurdle rate, which is the cost of capital, for it to be attractive.The NPV needs to be positive. The IRR is the discount rate that makes the NPV equal to zero.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 2, pp. 60-63.&&&a&Class@SS02.2&&&&&1&N&0&N.N.N.N 2006JV.066&mcs&0&N&The following data is provided on the returns from a universe of mutual funds over the previous year. Which of the following statements is supported by the data?

&One quarter of funds achieved returns that were less than or equal to 8%.&The average fund return in the first quartile was 8%.;The average fund return was between 9.5% and 9.8%.;Three quarters of funds achieved returns less than or equal to 15.5%.;&LOS: Reading 8-iThe first quartile is 8% which means that 25% of funds had returns of 8% or below, the 2nd quartile is 9.5% which means that 50% of funds had return of 9.5% and below and so on. We cannot conclude from the data the average returns for funds.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 3, pp. 120-126. &&&a&Class@SS02.0&&&&&1&N&0&N.N.N.N 2006JV.067&mcs&0&N&An analyst estimates that there is a 75% probability that the stock market will rise in the next quarter. In the case that the market rises, ABC Corp. shares will have a 90% probability of also rising, in the case that the market is flat or declines he estimates that ABC Corp. shares have a 60% probability of declining. The probability of ABC Corp. shares rising is closest to:&77.5%.&65.0%.;75.0%.;82.5%.;&LOS: Reading 9-kApply the total probability rule where A is the case that ABC Corp. shares rise and S1 is that the market rises and S2 is that the market falls.\\Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 4, pp. 192-194. &&&a&Class@SS02.1&&&&&1&N&0&N.N.N.N 2006JV.068&mcs&0&N&A stock market series is trading at 700 and is estimated to rise to 800 in one year’s time. If the dividend payment on the stock market series over this period is 25 then the expected holding period return is closest to:&17.85%.&3.33%.;14.28%.;15.63%.;&LOS: Reading 8-eE(R) = (EV - BV + Div)/BV = 125/700 = 17.85%Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 3, pp. 91-92.&&&a&Class@SS02.2&&&&&1&N&0&N.N.N.N 2006JV.069&mcs&0&N&Which of the following statements is/are TRUE regarding a money-weighted rate of return for a portfolio?

I It is the internal rate of return.
II It is the average of the periodic rates of return.
III It is always lower than the time-weighted rate of return.&I only.&II only. ;I and III only.;II and III only.;&LOS: Reading 7-dII refers to the time-weighted rate of return, III will not be true if there have been cash flows into the portfolio before superior performance.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Ch. 2, pp. 65-72.&&&a&Class@SS02.0&&&&&1&N&0&N.N.N.N 2006JV.070&mcs&0&N&Conditional probability refers to:&the probability of a particular event occurring given that another event has already occurred.&the probability that an event will happen more than once. ;the probability that two or more events will occur concurrently.;the probability that one of two mutually exclusive events will occur.;&LOS: Reading 9-fConditional probability is the probability of an event occurring given another event has already occurred. It is ‘conditional’ on the other event.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 4, pp. 184-185.&&&a&Class@SS02.1&&&&&1&N&0&N.N.N.N 2006JV.071&mcs&0&N&A perpetuity has a price of $1,500 and interest rates are 5% then the payments made per year are closest to:&$75.00.&$30.00.;$33.33.;$50.00.;&LOS: Reading 6-d Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 1, pp. 23-25. &&&a&Class@SS02.2&&&&&1&N&0&N.N.N.N 2006JV.072&mcs&0&N&If a credit card company charges interest at a rate of 15% compounded monthly, then the effective annual rate of interest is closest to:&16.08%.&10.03%.;14.04%.;15.86%.;&LOS: Reading 6-b Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 1, pp. 12-13. &&&a&Class@SS02.0&&&&&1&N&0&N.N.N.N 2006JV.073&mcs&0&N&The probability of a customer in a restaurant ordering potatoes is 40%, the probability of them ordering rice is 60% and the probability of them ordering both is 10%. What is the probability of a customer, chosen at random, ordering neither potatoes nor rice?&0.10.&0.00.;0.14.;0.24.;&LOS: Reading 9-hUse the general rule of addition to calculate the probability that a customer orders either potatoes or rice:P(A or B) = P(A) + P(B) - P(A and B = 0.4 + 0.6 - 0.1 = 0.9 The probability of a customer ordering neither is 1 - 0.9 = 0.1Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 4, pp. 187-188.&&&a&Class@SS02.1&&&&&1&N&0&N.N.N.N 2006JV.074&mcs&0&N&Which of the following statements is TRUE with respect to the holding period return of an investment?&The return includes cash paid to the investor over the period.&The return cannot be negative.;The return is an annual percentage yield.;A return of 0 indicates that the investment has become worthless.;&LOS: Reading 8-eThe holding period return is given by the equation below, it is the capital gain (or loss) plus income as a percentage of initial value. R = (EV - BV + Div)/BVReference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 3, pp. 91-92.&&&a&Class@SS02.2&&&&&1&N&0&N.N.N.N 2006JV.075&mcs&0&N&A portfolio of investments is initially worth $100 million. At the end of the first period the value rises to $120 million and then falls to $90 million at the end of the second period. If there are no cash flows the geometric mean rate of return is closest to: &-5.1%.&-2.5%.;-3.3%.;-10.0%.;&LOS: Reading 8-hThe geometric mean (GM) is given by: Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 3, pp. 115-119. &&&a&Class@SS02.0&&&&&1&N&0&N.N.N.N 2006JV.076&mcs&0&N&Semivariance is a useful measure of risk for a fund when which of the following statements concerning the distribution of returns is CORRECT?&The distribution is skewed.&The distribution is normal.;The distribution is bell shaped.;The mean of the distribution is zero.;&LOS: Reading 8-kSemivariance will not give any additional information over variance if the distribution is normal, since for every return below the mean there will be a corresponding return above the mean. However with skewed distributions semivariance provides information on the risk of returns occurring below the mean.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 3, pp. 135-136.&&&a&Class@SS02.1&&&&&1&N&0&N.N.N.N 2006JV.077&mcs&0&N&Which is the lowest yield on a 90-day Treasury bill?&Holding period yield.&Bank discount yield.;Money market yield.;Effective annual yield.;&LOS: Reading 7-fThe holding period yield is not an annualized figure, so for 90-day paper it will be the lowest yield. The highest will be the effective annual yield, followed by the money market yield, followed by the bank discount yield. This is a result of the compounding in the effective annual yield calculation, and the money market yield being based on the purchase price, whereas the bank discount yield is based on the maturity value. Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 2, pp. 72-77.&&&a&Class@SS02.2&&&&&1&N&0&N.N.N.N 2006JV.078&mcs&0&N&If P(A|B) = P(A) then the events A and B are:&independent.&exhaustive.;mutually exclusive.;equally likely to occur.;&LOS: Reading 9-iTwo events are independent if the occurrence of one event does not affect the probability of the other event occurring.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 4, p. 189.&&&a&Class@SS02.0&&&&&1&N&0&N.N.N.N 2006JV.079&mcs&0&N&A shop which sells matches knows that 14 out of 20 boxes of matches will contain 100 matches exactly, the remainder will contain more than 100 matches. The probability of a customer picking up a box of matches that contains more than 100 matches, and then picking up a second box containing more than 100 matches is closest to:&0.08.&0.06.;0.09.;0.12.;&LOS: Reading 9-gUse the general rule of Singleplication, which says that:P(A and B) = P(A) P(B/A) = 6/20 5/19 = 0.08 Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 4, pp. 185-186.&&&a&Class@SS02.1&&&&&1&N&0&N.N.N.N 2006JV.080&mcs&0&N&An investor puts $50,000 into a mutual fund at the end of each quarter and his purchase prices are $20, $25, $28, $23. The average price that he pays per share is closest to:&$23.64.&$23.12.;$24.00.;24.5;&LOS: Reading 8-hThe harmonic mean is the average price on a per share basis. Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 3, pp. 119-120. &&&a&Class@SS02.2&&&&&1&N&0&N.N.N.N 2006JV.081&mcs&0&N&An analyst is collecting data on mutual fund performance. He estimates that the standard deviation of funds’ returns is 4% and returns are independent across funds. To achieve a standard error of sample mean of 0.5% how many funds does he need to include in his sample?&64&8;32;128;&LOS: Reading 11-e Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 6, pp. 292-293. &&&a&Class@SS03.0&&&&&1&N&0&N.N.N.N 2006JV.082&mcs&0&N&Which of the following statements is FALSE?&Type I error is accepting the null hypothesis when it is false.&The null hypothesis should always contain the equal sign. ;The level of significance is the probability of rejecting the null hypothesis when it is true.;The null hypothesis is not rejected if sample data fails to produce evidence that it is false.;&LOS: Reading 12-cA Type I error is rejecting the null hypothesis when it is true.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 7, p. 329-330.&&&a&Class@SS03.1&&&&&1&N&0&N.N.N.N 2006JV.083&mcs&0&N&A binomial distribution model is created to analyze the performance of a fund relative to an index over 36 trial periods. In each period there is a 60% probability of success which is defined as the fund matching or outperforming the index, in each period the performance is assumed to be independent. The mean of the binomial random variable is closest to:&21.6&0.6;8.64;14.4;&LOS: Reading 10-hThe mean is np where n is the number of trials, 36, and p is the probability of success, 0.60, so the mean is 36 x 0.60 = 21.6 Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 5, pp. 243-246.&&&a&Class@SS03.2&&&&&1&N&0&N.N.N.N 2006JV.084&mcs&0&N&An analyst does a test of a sample of 100 observations to determine whether the mean of a normally distributed population is less than or equal to zero. The z-value is calculated to be 1.95. At the 1% significance level which of the following should the analyst conclude:&do not reject the null hypothesis that the sample mean is less than or equal to zero and reject the alternative hypothesis. &the z-value is not meaningful since insufficient observations have been made.;reject the null hypothesis and accept the alternative hypothesis that the mean is significantly higher than zero.;reject the null hypothesis and accept the alternative hypothesis that the mean is significantly lower than zero.;&LOS: Reading 12-gThe critical z-value for a one tailed test is 2.33, the z-value is below this so do not reject the null hypothesis. Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 7, pp. 335-342.&&&a&Class@SS03.0&&&&&1&N&0&N.N.N.N 2006JV.085&mcs&0&N&An analyst runs a linear regression on the annual performance of value stocks against the annual performance of the SandP Index. The regression has an intercept of 2% and the slope of the regression line of 0.9. The correlation coefficient is 0.8. If the SandP is forecast to rise by 12% what is the expected performance of value stocks over the same period?&0.128&0.096;0.108;0.116;&LOS: Reading 13-jThe expected performance is given by The information on the correlation coefficient is not relevant.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 8, pp. 395-401.&&&a&Class@SS03.1&&&&&1&N&0&N.N.N.N 2006JV.086&mcs&0&N&The sample correlations between monthly returns of 3 funds are given below:

Fund A | Fund B | Fund C
Fund A 1.0000
Fund B 0.4872 1.0000
Fund C0.9821 0.65411.0000


They are based on monthly observations in the past year. The critical values of t-statistics for the corresponding degrees of freedom are 3.169 at the 1% significance level, 2.228 at the 5% significance level and 1.812 for at the 10% significance level. At the 95% confidence level, which of the following statements is TRUE?&The correlation between Fund A and Fund B is not significant.&There is not enough data to perform hypothesis testing. ;The correlation between Fund A and Fund C is not significant. ;The correlation between Fund B and Fund C is not significant. ;&LOS: Reading 13-cOne year monthly observations give a sample size of 12, apply a t-test where: This is a two-tailed test so the critical t-value for the 95% confidence level is 2.228. The t-value for funds A and B is less than this so the correlation is not significantly more than zero.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 8, pp. 392-395. &&&a&Class@SS03.2&&&&&1:v&&& 2006JV.087&mcs&0&N&A sample of 100 observations is taken from a normal population, the sample mean is 50 and the population standard deviation is 6. The 99% confidence interval for the population mean is closest to:&48.45 up to 51.46.&48.82 up to 51.18.;49.34 up to 50.63.;49.52 up to 50.48.;&LOS: Reading 11-k Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 6, pp. 297-300. &&&a&Class@SS03.0&&&&&1&N&0&N.N.N.N 2006JV.088&mcs&0&N&When we are using a hypothesis test to test the variance of a single normally distributed population we should use the:&chi-square test.&t-test.;z-test.;F-test.;&LOS: Reading 12-jThe chi-square test is used to test the variance of a single normally distributed population. Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 7, pp. 351-352.&&&a&Class@SS03.1&&&&&1&N&0&N.N.N.N 2006JV.089&mcs&0&N&The coefficient of determination:&is the proportion of the total variation of the dependent variable that is explained by the variation in the independent variable.&is the reciprocal of the coefficient of correlation.;is the square root of the coefficient of correlation.;is negative if the variables tend to move in opposite directions.;&LOS: Reading 13-eThe coefficient of determination tells us how well the independent variable explains the dependent variable’s movements. It is the square of the coefficient of correlation (for a linear regression) or the ratio between explained variation and total variation.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 8, pp. 403-405.&&&a&Class@SS03.2&&&&&1&N&0&N.N.N.N 2006JV.090&mcs&0&N&In regression analysis if the standard error of estimate is 0:&all observed values lie on the regression line.&the regression line is horizontal. ;there are Singleple possible regression lines.;the regression line intercepts the Y axis at 0. ;&LOS: Reading 13-eThe standard error of estimate is the dispersion of the observed values around the regression line.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 8, pp. 401-403.&&&a&Class@SS03.0&&&&&1&N&0&N.N.N.N 2006JV.091&mcs&0&N&A coin has a 50% chance of landing head up and a 50% chance of landing tail up. What is the probability, if a coin is thrown four times, of it landing head up once or not at all? &31.25%.&25.00%.;37.50%.;40.00%.;&LOS: Reading 10-hApply the binomial probability distribution formula where we are solving for p(0) and p(1).Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 5, pp. 236-246. &&&a&Class@SS03.1&&&&&1&N&0&N.N.N.N 2006JV.092&mcs&0&N&The population is defined as the 1,500 employees of a company and the wages of the employees range from $10.00 per hour to $25.00 per hour with a mean of $14.00 per hour. A sample of 100 employees is taken and the mean wage of the sample is $12.50. The sampling error is closest to:&- $1.50.&+ $1.50.;- 10.7%.;+10.7%.;&LOS: Reading 11-a\\Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 6, p 287.&&&a&Class@SS03.2&&&&&1&N&0&N.N.N.N 2006JV.093&mcs&0&N&Which of the following statements concerning a Singlevariate distribution is FALSE?&A Singlevariate distribution describes the outcomes for a single random variable under different scenarios.&The distribution describes the probability of different outcomes for a group of random variables.;A Singlevariate distribution takes into account the correlation between the different variables. ;If the random variables are normally distributed it is usually assumed the Singlevariate distribution is normally distributed.;&LOS: Reading 10-lIf it is a single random variable it is a univariate distribution.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 5, p. 251.&&&a&Class@SS03.0&&&&&1&N&0&N.N.N.N 2006JV.094&mcs&0&N&Which of the following is NOT an assumption underlying linear regression analysis with a single independent variable?&The error term is correlated across observations.&The error term is normally distributed.;The independent variable is not random.;The expected value of the error term is zero.;&LOS: Reading 13-dThe error term must be uncorrelated across observations. Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 8, pp. 398-399.&&&a&Class@SS03.1&&&&&1&N&0&N.N.N.N 2006JV.095&mcs&0&N&In hypothesis testing a test statistic is:&a value which will decide whether to accept or reject the null hypothesis.&the level of significance of the test.;always positive and indicates the power of the test. ;the probability of correctly rejecting the null hypothesis.;&LOS: Reading 12-cA test statistic is calculated based on a sample and will be used to decide whether to accept or reject the null hypothesis, t and z-statistics are commonly used test statistics.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 7, pp. 327-328.&&&a&Class@SS03.2&&&&&1&N&0&N.N.N.N 2006JV.096&mcs&0&N&If the mean of a normal distribution is 0 and the standard deviation is 20, the probability of an observation lying between -40 and 20 is closest to: &81.8%.&13.6%.;40.9%.;95.4%.;&LOS: Reading 10-oFirst, calculate the z-value of -40: z = (X – u)/? = -40/20 = -2.0Therefore the area between 0 and -4 is 47.7 since 95.4% of observations lie within two standard deviations of the mean. The z value of 20 is 1. Therefore the area between 0 and 20 is 34.1, since 68.26% of observations lie within one standard deviation of the mean. So the probability that a reading lies between -44 and 20 is 47.7% + 34.1% = 81.8%.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 5, pp. 255-257.&&&a&Class@SS03.0&&&&&1&N&0&N.N.N.N 2006JV.097&mcs&0&N&The slope of a regression line:&is the same sign as the correlation coefficient.&is the square root of the correlation coefficient.;is the value of the dependent variable when the independent variable is zero.;indicates the amount of change in the independent variable for a unit of change in the dependent variable.;&LOS: Reading 13-dThe slope of a regression line indicates the amount of change in the dependent variable for a unit of change in the independent variable. An upward slope indicates that an increase in the independent variable leads to an increase in the dependent variable, i.e. they are positively correlated. A downward slope means that an increase in the independent variable tends to leads to a decrease in the dependent variable, i.e. they are negatively correlated.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 8, pp. 395-397.&&&a&Class@SS03.1&&&&&1&N&0&N.N.N.N 2006JV.098&mcs&0&N&Identify the least likely statistics that measure how well a regression analysis would explains the dependent variable.&correlation coefficient.&F-statistic.;coefficient of determination.;standard error of estimate (SEE).;&LOS: Reading 13-bThe correlation coefficient measures the extent of linear association of two variables but not necessarily the dependence of one on the other(s). Dependent variable Term used in regression analysis to represent the element or condition that is dependent on values of one or more other independent variables. Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 8, pp. 377-379.&&&a&Class@SS03.2&&&&&1&N&0&N.N.N.N 2006JV.099&mcs&0&N&An analyst has extensively tested past stock data to identify a stock valuation model. He has looked at numerous variables and has arrived at a model, using six different variables, which he believes successfully identifies undervalued stocks. His analysis is likely to exhibit: &data-mining bias.&look-ahead bias.;survivorship bias.;data-snooping bias.;&LOS: Reading 11-mData-mining baises occur when an analyst searches through data to identify patterns or significant variables. It can be detected by doing out-of-sample tests which will often show the variable is not significant.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 6, p. 306.&&&a&Class@SS03.0&&&&&1&N&0&N.N.N.N 2006JV.100&mcs&0&N&Which of the following statements regarding the level of significance in hypothesis testing is CORRECT?&It is the probability of rejecting the null hypothesis when it is true.&It is the probability of accepting the null hypothesis when it is false.;It is the probability of rejecting the alternate hypothesis when it is true.;It is the probability of the test result being relevant to the decision rule. ;&LOS: Reading 12-cThe level of significance is alpha or the probability of making a Type I error. This refers to the probability of rejecting the null hypothesis when it is true.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 7, pp. 329-330.&&&a&Class@SS03.1&&&&&1&N&0&N.N.N.N 2006JV.101&mcs&0&N&A normal distribution has a mean of 25 and a standard deviation of 5. What is the standardized normal random variable representing an observation of 15?&-2.00.&1.67.;2.00.;3.00.;&LOS: Reading 10-o Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 5, pp. 255-256.&&&a&Class@SS03.2&&&&&1&N&0&N.N.N.N 2006JV.102&mcs&0&N&Moderate positive correlation between two variables would be indicated by the coefficient of correlation between the two variables equaling: &0.5.&0.0.;0.1.;0.9.;&LOS: Reading 13-bThe coefficient of correlation lies between -1 and +1. 0 means there is no linear correlation, 0.1 indicates very weak correlation and 0.9 very strong correlation. 0.5 is the best answer.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 8, pp. 377-381.&&&a&Class@SS03.0&&&&&1&N&0&N.N.N.N 2006JV.103&mcs&0&N&A confidence interval is:&a range of values in which the population parameter falls with a specified probability.&the size of the sample taken as a percentage of the population size.;the probability that a population parameter will lie within a certain range.;the probability that the point estimate as an estimate of the population parameter. ;&LOS: Reading 11-fA confidence interval is simply an interval or range where we expect to find, with a specified probability, the population parameter.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 6, p. 297.&&&a&Class@SS03.1&&&&&1&N&0&N.N.N.N 2006JV.104&mcs&0&N&The t-statistic for the coefficient of correlation is used to:&test the significance of the coefficient of correlation.&estimate the coefficient of correlation.;calculate the coefficient of determination.;decide whether the coefficient of correlation is positive or negative. ;&LOS: Reading 13-cThe t-test is used to test the significance of the coefficient of correlation; the null hypothesis is set that the correlation is equal to zero.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 8, pp. 392-395.&&&a&Class@SS03.2&&&&&1&N&0&N.N.N.N 2006JV.105&mcs&0&N&If two series appear to be closely associated but no direct relationship exists, this characteristic is called&spurious correlation.&outliers.;randomness.;non-linear association.;&LOS: Reading 13-bSpurious correlation can arise when two variables look to be related but in fact are both related to a third variable. Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 8, pp. 368-370.&&&a&Class@SS03.0&&&&&1&N&0&N.N.N.N 2006JV.106&mcs&0&N&To calculate a test statistic in an analysis of variance (ANOVA) procedure we need to know all of the following, EXCEPT: &the correlation coefficient.&the sum of squared errors (SSE).;the regression sum of squares (RSS).;the total number of parameters to be estimated.;&LOS: Reading 13-iThe correlation coefficient is not required. We also need to know the number of observations.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 8, pp. 413-415.&&&a&Class@SS03.1&&&&&1&N&0&N.N.N.N 2006JV.107&mcs&0&N&A manager is testing to see whether a higher number of widgets being manufactured per hour are faulty. Previously 5 widgets per hour were faulty. He takes a sample of 50 hours production and the mean number found faulty is 5.5, with a standard deviation of 1.25. Using the z-test he can conclude that:&at both the 1% and 5% significance levels there is evidence that a higher number of widgets are faulty. &at both the 1% and 5% significance levels there is no evidence that a higher number of widgets are faulty. ;at the 1% significance level, but not at the 5% significance level, there is evidence that a higher number of widgets are faulty. ;at the 5% significance level, but not at the 1% significance level, there is evidence that a higher number of widgets are faulty. ;&LOS: Reading 12-gSet the null hypothesis as being that the mean is less than or equal to 5.0. This is more than 2.33 (the critical value for the 1% significance level, for a one-tailed test) and more than 1.65 (the critical value for the 5% significance level). So reject the null hypothesis at both the 1% level and the 5% level. Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 7, pp. 339-342.&&&a&Class@SS03.2&&&&&1&N&0&N.N.N.N 2006JV.108&mcs&0&N&A Type II error in hypothesis testing is: ¬ rejecting the null hypothesis when it is false.&using an incorrect test statistic. ;using an incorrect decision rule.;rejecting the null hypothesis when it is true.;&LOS: Reading 12-cA Type II error is when the null hypothesis is false but we do not reject it, possibly because we have selected a small significance level to reduce the occurrence of Type I errors. Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 7, pp. 329-330.&&&a&Class@SS03.0&&&&&1&N&0&N.N.N.N 2006JV.109&mcs&0&N&An investment manager is managing a diversified portfolio of international equities and the performance benchmark is the MSCI World index. Shortfall risk for the portfolio refers to:&the risk that the value of the portfolio falls below a critical level.&the standard deviation of returns.;the standard deviation of returns relatives to the MSCI World Index.;the absolute deviation of returns relatives to the MSCI World Index.;&LOS: Reading 10-pShortfall risk is the risk that the value of a portfolio falls below a certain level. It can be reduced by minimizing the probability that the return falls below a certain minimum level.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 5, pp. 257- 260.&&&a&Class@SS03.1&&&&&1&N&0&N.N.N.N 2006JV.110&mcs&0&N&The standard error of the sample mean is:&the standard deviation of the sampling distribution of sample mean.&the average standard deviation of each sample.;the standard deviation of the sample minus the standard deviation of the population.;the standard deviation of the sample divided by the standard deviation of the population.;&LOS: Reading 11-eThe standard deviation of a sample mean is the standard error. The central limit theorem says that this is equal to the population standard deviation divided by the square root of the sample size.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 6, p. 292.&&&a&Class@SS03.2&&&&&1&N&0&N.N.N.N 2006JV.111&mcs&0&N&If a very large sample size is used it will lead to: I A smaller standard error of the sample means. II A larger dispersion in the distribution of the sample means. III The sampling distribution of the sample mean being a normal distribution.&I and III only.&I only.;II and III only.;All 3 options.;&LOS: Reading 11-eA large sample size will lead to a smaller standard error of the sample mean since the standard error is equal to the population standard deviation divided by the square root of the sample size. The central limit theorem says that the sampling distribution of the sample mean is a normal distribution if the sample size is large (greater than thirty).However a large sample size will lead to sample means being close to the population mean and therefore less disperse. Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 6, pp. 292-293.&&&a&Class@SS03.0&&&&&1&N&0&N.N.N.N 2006JV.112&mcs&0&N&If the standard error of estimate in regression analysis is zero it means that:&the predicted values and the observed values for the dependent variable are identical.&there is zero correlation between the two variables.;the predicted values for the dependent variable and the independent variable are identical.;the sum of the differences between the predicted values and the observed values for the dependent variable is zero.;&LOS: Reading 13-eIf the standard error is zero it means that the difference between the dependent variable’s actual and predicted values are zero. All observations lie exactly on the fitted regression line.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 8, pp. 401-403.&&&a&Class@SS03.1&&&&&1&N&0&N.N.N.N 2006JV.113&mcs&0&N&An analyst is selecting a sample from the orders received from a firm’s customers. The orders are time stamped and he decides to include in the sample every 5th order received by the firm. This is an example of:&systematic random sampling.&cluster sampling.;simple random sampling.;stratified random sampling. ;&LOS: Reading 11-bSystematic random sampling is when we select every kth member of a population, often used when we cannot number or label the members of a population.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 6, pp. 286-287.&&&a&Class@SS03.2&&&&&1&N&0&N.N.N.N 2006JV.114&mcs&0&N&In regression analysis if we need to calculate the value of the dependent variable Y for a specific value of the independent variable X then it would involve calculating the: &prediction interval.&normal interval.;regression interval.;significance interval.;&LOS: Reading 13-jThe prediction interval is used to calculate Y for a specific X.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 8, pp. 416-418.&&&a&Class@SS03.0&&&&&1&N&0&N.N.N.N 2006JV.115&mcs&0&N&A hypothesis is:&a statement about a population parameter.&a statement about a sample statistic.;a statement about a sample parameter.;a statement about a population statistic.;&LOS: Reading 12-aA hypothesis is a statement about a population parameter. We use data from a sample to test whether we should accept or reject the hypothesis.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 7, p. 325.&&&a&Class@SS03.1&&&&&1&N&0&N.N.N.N 2006JV.116&mcs&0&N&A company is analyzing the days that employees take off as sick leave each year and is concerned that the number of days that employees are taking off has risen above the past average number of 4.0 days. It is assumed that the population is approximately normally distributed. A sample of 20 employees is taken and the mean number of days taken is 4.5 with a standard deviation of 1.5 days. If the rejection point for a one-tailed test with 19 degrees of freedom is 1.729 at the 5% significance level we can conclude that:&the mean number of days is still 4 days or less at the 5% significance level.&using the t-statistic is not valid for a small sample.;the mean number of days is more than 4 days at the 5% significance level.;we should use the z-test, not the t-test, if the population is approximately normally distributed.;&LOS: Reading 12-l Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 7, pp. 336-339.&&&a&Class@SS03.2&&&&&1&N&0&N.N.N.N 2006JV.117&mcs&0&N&In hypothesis testing the probability of rejecting the null hypothesis when it is true is the:&level of significance.&test statistic.;decision rule.;alternate hypothesis.;&LOS: Reading 12-gThe level of significance is the probability of a Type I error, of rejecting the null hypothesis when it is true.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 7, pp. 329-330.&&&a&Class@SS03.0&&&&&1&N&0&N.N.N.N 2006JV.118&mcs&0&N&If X’s variation has no impact on Y’s variation then the correlation coefficient between X and Y is:&0&-1;1;cannot be calculated. ;&LOS: Reading 13-bIf the movement of one variable has no impact on the movement of another there is no linear relation and the correlation is zero.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 8, pp. 376-381.&&&a&Class@SS03.1&&&&&1&N&0&N.N.N.N 2006JV.119&mcs&0&N&Given a linear regression of a stock’s returns (R) on a stock market’s returns (RM) as follows: A hypothesis test is conducted to see whether a stock’s performance differs from that of the market’s. Which of the following is TRUE? &? is significantly different to 0 and ß is significantly different to the market beta.&? is not significantly different to 0 and ß is significantly different to the market beta.;? is significantly different to 0 and ß is not significantly different to the market beta. ;? is not significantly different to 0 and ß is not significantly different to the market beta. ;&LOS: Reading 13-g Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 8, pp. 405-412. &&&a&Class@SS03.2&&&&&1&N&0&N.N.N.N 2006JV.120&mcs&0&N&The Central Limit Theorem states that if the sampling distribution of the sample mean is calculated using samples of equal size from a population that is not normal, then:&I. it is approximately a normal distribution.&II. the standard error tends to one as the size of the samples increases. ;III. the mean of the distribution will be smaller than the population mean.;IV. the dispersion of the distribution is more than the dispersion of the population.;&LOS: Reading 11-fI. is correct, the distribution will be approximately normal although the underlying population may not be normally distributed.II. is not correct, the standard error tends to zero as the sample size increases.III. is not correct, the mean of the distribution will be the same as the population mean.IV. is not correct, the dispersion is less than that of the population, or equal if n = 1.Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 6, pp. 292-293.&&&a&Class@SS03.0&&&&&1&N&0&N.N.N.N 2006JV.121&mcs&0&N&Under the Keynesian model, when there are signs that the economy is in an inflationary economic boom, the government should consider:&raising personal tax rates.&increasing defense spending.;borrowing to finance a larger budget deficit.;doing nothing and waiting for increasing resource costs and high interest rates to stabilize the economy. ;&LOS: Reading 15-cThe Keynesian model suggests that the government should adopt a restrictive fiscal policy which would involve increasing taxes and/or reducing government expenditure.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.12, pp. 269-271.&&&a&Class@SS04.1&&&&&1&N&0&N.N.N.N 2006JV.122&mcs&0&N&The supply of money in the U.S. is dependent on:&the Federal Reserve’s monetary policy.&fiscal policy.;interest rates.;the net foreign investment into the country.;&LOS: Reading 17-aThe role of a central bank, which is the Fed in the U.S., is to control money supply, through setting the reserve requirement, the discount rate and using open market operations. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.14, pp. 321-325.&&&a&Class@SS04.2&&&&&1&N&0&N.N.N.N 2006JV.123&mcs&0&N&When unemployment is higher than the natural rate of unemployment in an economy it is likely that:&inflationary pressures are weak.&the economy is growing rapidly. ;workers are demanding higher wages.;the government has just relaxed regulations on protection for employees. ;&LOS: Reading 14-bWhen unemployment is higher than the natural rate, this is due to cyclical unemployment. This is caused by cyclical factors leading to low aggregate demand for labor. This will tend to reduce inflationary pressures so "inflationary pressures are weak" is correct. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.8, pp. 186-192.&&&a&Class@SS04.0&&&&&1&N&0&N.N.N.N 2006JV.124&mcs&0&N&Which of the following is an example of a non-activist policy?&Adjust monetary policy to ensure that price indices rise within a certain range each year.&Expand annual money supply at the same rate as the annual output.;Focus on adjusting monetary policy and run a passive fiscal policy.;Focus on adjusting fiscal policy and run a passive monetary policy.;&LOS: Reading 18-dNon-activist monetary policy involves either targeting a stable growth rate in the money supply or a stable price level.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.15, pp. 360-362.&&&a&Class@SS04.1&&&&&1&N&0&N.N.N.N 2006JV.125&mcs&0&N&A country’s nominal GDP was $5 billion in 2000 and $3.5 billion in 1990. The GDP deflator was 125 in 2000 and 105 in 1990. The real GDP growth over the period was closest to:&20.0%. &19.0%.;42.9%.;70.1%.;&LOS: Reading 4-Introductory ReadingsFirst of all calculate the GDP in 2000 using 1990 prices:= $5.0(105/125) billion = $4.2 billionThen compare this with the GDP in 1990:Real increase = (4.2/3.5) -1 = 0.20 or 20%Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.7, pp. 165-168.&&&a&Class@SS04.2&&&&&1&N&0&N.N.N.N 2006JV.126&mcs&0&N&Which of the following statements is FALSE regarding the expenditure Singleplier?&When the marginal propensity to consume falls the Singleplier rises. &The Singleplier is central to Keynesian economics.;If there are few idle resources the effect of the Singleplier will be reduced. ;The Singleplier explains why small changes in government spending can lead to large changes in output.;&LOS: Reading 4-Introductory ReadingsA is false since:M = 1/(1 - MPC)Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.11, pp. 258-260.&&&a&Class@SS04.0&&&&&1&N&0&N.N.N.N 2006JV.127&mcs&0&N&New classical economists believe that if the government increases borrowing to reduce taxes then:&households will maintain the same level of consumption.&real interest rates will rise.;households will maintain the same savings rate.;households will increase their level of expenditure.;&LOS: Reading 15-cA is not the case since real interest rates will be unaffected since households save more and total consumption is unchanged.B is not the case since households will save more to pay for future tax increases.C is the Keynesian view. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.12, pp. 273-276.&&&a&Class@SS04.1&&&&&1&N&0&N.N.N.N 2006JV.128&mcs&0&N&The crowding-out effect refers to&financing high budget deficits pushes up interest rates, which will reduce private spending.&using barriers to entry to deter new entrants to an industry.;financing high budget deficits reduces interest rates, which will increase private spending.;exporting to a market at artificially low prices to deter local production in the overseas market.;&LOS: Reading 15-cThe crowding-out effect refers to when a government tries to stimulate an economy and borrowing to finance a budget deficit. This will increase interest rates, which will reduce companies and individuals expenditure, particularly on investment, which will reduce the effectiveness of the government’s policy.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.12, pp. 271-273.&&&a&Class@SS04.2&&&&&1&N&0&N.N.N.N 2006JV.129&mcs&0&N&Which of the following is NOT an automatic stabilizer?&net exports.&corporate profit tax.;unemployment benefit.;progressive income tax.;&LOS: Reading 15-dAutomatic stabilizers stimulate demand during a recession and restrain demand during a boom without the government needing to change fiscal policy through legislation.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.12, pp. 277-278.&&&a&Class@SS04.0&&&&&1&N&0&N.N.N.N 2006JV.130&mcs&0&N&Raising personal income tax rates to very high levels will:&encourage businesses to relocate overseas.&increase government tax revenue.;encourage foreign workers to move to the country. ;encourage people to work harder to maintain their net income.;&LOS: Reading 15-cIncreasing personal tax rates will make it difficult for companies to attract the best workers without increasing their gross salaries, so companies will have an incentive to move operations overseas where tax rates are less onerous.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.12, pp. 280-283.&&&a&Class@SS04.1&&&&&1&N&0&N.N.N.N 2006JV.131&mcs&0&N&Supply-side economists believe that:&an increase in marginal tax rates will lead to a decrease in aggregate supply.&an increase in marginal tax rates will not affect aggregate supply.;an increase in marginal tax rates will lead to an increase in aggregate supply.;an increase in marginal tax rates will lead to either an increase or decrease in aggregate supply depending on whether there is excess capacity in the economy. ;&LOS: Reading 15-cThey believe that high tax rates discourage work effort and reduce efficiency.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.12, pp. 280-283.&&&a&Class@SS04.2&&&&&1&N&0&N.N.N.N 2006JV.132&mcs&0&N&Which of the following would tend to increase the budget deficit during a recession?&an automatic stabilizer.&the crowding-out effect.;a fall in the exchange rate.;an increase in progressive taxation.;&LOS: Reading 15-dAn automatic stabilizer reduces taxes and increases government spending e.g. unemployment benefit, progressive tax rates.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.12, pp. 277-278.&&&a&Class@SS04.0&&&&&1&N&0&N.N.N.N 2006JV.133&mcs&0&N&Which economic model supports the following statement "an expansionary fiscal policy will have little or no impact on aggregate demand because government borrowing will push up interest rates and reduce private investment"?&Crowding-out model. &Keynesian model.;Supply-side model.;New-classical model.;&LOS: Reading 15-cThe crowding-out effect refers to an expansionary fiscal policy being ineffective since the private sector will be ‘crowded-out’ due to higher interest rates. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.12, pp. 272-273.&&&a&Class@SS04.1&&&&&1&N&0&N.N.N.N 2006JV.134&mcs&0&N&High marginal tax rates will:&discourage work effort since the after-tax remuneration has fallen.&have no noticeable effect on work effort. ;increase hours worked as workers try to maintain the same after-tax income. ;encourage workers to work more efficiently to maintain the same after-tax income.;&LOS: Reading 15-cHigh marginal tax rates discourage work effort and reduce efficiency, e.g. as the pay-off from work declines people drop out of the work force, productive individuals move overseas, and people are encouraged to do non-productive but tax free activities.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.12, pp. 279-283.&&&a&Class@SS04.2&&&&&1&N&0&N.N.N.N 2006JV.135&mcs&0&N&The required reserve ratio is reduced as part of the government's monetary policy and the new ratio is 15% giving a bank $1 billion of excess reserves. In the long term this will lead to an expansion in the money supply of: &$ 6.67 billion.&$ 0.15 billion.;$ 0.87 billion.;$15.00 billion.;&LOS: Reading 16-aThe money supply will expand by the excess reserves Singleplied by the reciprocal of the required reserve ratio, this is:$1 billion x 1/ 0.15 = $6.67 billion.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.13, pp. 304-305.&&&a&Class@SS04.0&&&&&1&N&0&N.N.N.N 2006JV.136&mcs&0&N&The major role of a central bank is to: &maintain a favorable monetary environment.&implement fiscal policy.;issue government securities.;monitor the safety of banking institutions. ;&LOS: Reading 16-bCentral banks are responsible for implementing monetary policy and thereby providing a favorable economic climate.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.13, p. 301.&&&a&Class@SS04.1&&&&&1&N&0&N.N.N.N 2006JV.137&mcs&0&N&There has just been a decline in real GDP announced for the previous quarter. A newspaper journalist states, ‘… the economy is now in recession’. Is the journalist CORRECT?&We need more information on the prior quarter’s change in real GDP rate to answer the question.&No, the economy is in a depression.;Yes, a decline in real GDP indicates a recession. ;No, this is a cyclical downturn and not a recession.;&LOS: Reading 14-aTo establish whether it is a recession we need to know if there have been two consecutive quarters of decline in real GDP.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.8, pp. 181-183.&&&a&Class@SS04.2&&&&&1&N&0&N.N.N.N 2006JV.138&mcs&0&N&Which of the following is a problem in the calculation of unemployment?&Unpaid household work is not considered to be employment.&Part-time workers are counted as being unemployed.;Unemployed workers are not included in the labor force. ;A person seeking employment is not included in the labor force.;&LOS: Reading 14-bStatements A, B D are not correct – part-time workers are counted as being employed, unemployed workers and a person seeking employment are included in the labor force. However housework is not considered to be employment.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.8, pp. 183-186.&&&a&Class@SS04.0&&&&&1&N&0&N.N.N.N 2006JV.139&mcs&0&N&In the U.S. the fractional reserve banking system refers to:&banks are permitted to hold reserves of less than 100% of their deposits.&banks must hold reserves equal to 100% of their deposits.;banks must hold reserves equal to 100% of their loans.;banks are permitted to hold reserves of less than 100% of their loans.;&LOS: Reading 16-aA fractional reserve banking system means that banks only need to keep a fraction of their deposits as cash and other reserves. The rest are available to lend to customers.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.13, pp. 297-298.&&&a&Class@SS04.1&&&&&1&N&0&N.N.N.N 2006JV.140&mcs&0&N&Which of the following statements is TRUE?&The actual deposit expansion Singleplier will be reduced if individuals hold currency rather than depositing it in a bank.&The potential deposit expansion Singleplier is 1 minus the required reserve ratio.;The actual deposit expansion Singleplier will be increased if individuals hold currency rather than depositing it in a bank.;The actual deposit expansion Singleplier is the Singleple by which an increase in reserves will decrease the money supply.;&LOS: Reading 16-aThe potential deposit expansion Singleplier is the inverse of the required reserve ratio. If individuals hold currency rather than depositing in a bank, it will reduce the potential funds available for lending and therefore reduce the expansion Singleplier.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.13, pp. 299-301.&&&a&Class@SS04.2&&&&&1&N&0&N.N.N.N 2006JV.141&mcs&0&N&When the Fed purchases US securities this will tend to: I Reduce the monetary base. II Reduce the money supply. III Increase the money supply. IV Increase the monetary base.&III and IV only.&I and III only.;II and IV only.;II and III only.;&LOS: Reading 16-cWhen the Fed purchases securities it adds to currency in circulation or deposits with banks thereby increasing the monetary base. This will lead to an increase in the money supply by a Singleple decided by the actual deposit expansion Singleplier. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.13, pp. 301-303.&&&a&Class@SS04.0&&&&&1&N&0&N.N.N.N 2006JV.142&mcs&0&N&The discount rate is:&the interest rate paid by banks borrowing funds from the Federal Reserve.&the interest rate paid to banks depositing funds with the Federal Reserve.;the minimum interest rate that customers borrowing funds pay to commercial banks. ;the minimum interest rate paid to customers depositing funds with commercial banks.;&LOS: Reading 16-bWhen banks borrow from the Federal Reserve, usually to fund a temporary shortage of reserves, the interest rate they pay is the discount rate.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.13, p. 307.&&&a&Class@SS04.1&&&&&1&N&0&N.N.N.N 2006JV.143&mcs&0&N&An unanticipated increase in money supply in the short term will lead to:&an expansion in real output.&an increase in real interest rates.;little or no change in real economic activity.;a reduction in the profit margins of corporations.;&LOS: Reading 17-dAn unanticipated increase in money supply will reduce real interest rates and make it easier to borrow, thus increasing demand pushing up product price ahead of costs. This will improve corporate profitability and corporations will expand output.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.14, pp. 325-329.&&&a&Class@SS04.2&&&&&1&N&0&N.N.N.N 2006JV.144&mcs&0&N&A long period of rapid money supply growth will: I Increase inflation. II Expand real output. III Reduce unemployment. IV Increase nominal interest rates.&I and IV only.&II and III only.;IV only.;II only.;&LOS: Reading 17-dThe first impact of rapid money supply growth will be to reduce real interest rates and stimulate aggregate demand. However over time buyers and providers of resources will adjust prices upwards so real wages and profit margins will be unchanged, leaving real output unchanged. The only long-term effect will be higher prices and higher nominal interest rates (since inflation is higher).Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.14, pp. 329-333.&&&a&Class@SS04.0&&&&&1&N&0&N.N.N.N 2006JV.145&mcs&0&N&The quantity theory of money says that:&if the quantity of money is increased, velocity of money is constant and real output is independent of monetary factors, so prices increase.&if the quantity of money is increased then output and prices will also both increase.;if the quantity of money is increased then output will increase but prices will stay unchanged.;if the quantity of money is increased then the velocity of money will decrease, therefore output and prices are unchanged. ;&LOS: Reading 17-cThe quantity theory of money says that GDP can be expressed as (price x output) or (money stock x velocity). The theory says output and velocity are unaffected by changes in the quantity of money so an increase in the supply of money will cause a proportionate increase in the price level. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.14, pp. 329-330.&&&a&Class@SS04.1&&&&&1&N&0&N.N.N.N 2006JV.146&mcs&0&N&The velocity of money is:&the average number of times that a dollar is used to purchase a final product or service during the year.&the real GDP divided by the size of the money stock.;the Singleple by which an increase in reserves will increase the money supply.;the increase in money supply divided by the value of bank deposits held by the Federal Reserve.;&LOS: Reading 17-cThe velocity of money is the nominal GDP divided by the money stock. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.14 pp. 329-330.&&&a&Class@SS04.2&&&&&1&N&0&N.N.N.N 2006JV.147&mcs&0&N&Under adaptive expectations forecasters will exhibit systematic error, for example:&when the rate of inflation is decelerating the future rate of inflation will be overestimated.&when the economy moves towards recession the rate of inflation will be underestimated. ;when the rate of inflation is decelerating the future rate of inflation will be underestimated.;when the economy moves towards recession the rate of inflation will be expected to decline below that of the preceding period. ;&LOS: Reading 18-cUnder adaptive expectations forecasters will expect inflation during recent periods to be repeated. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.15, p. 356.&&&a&Class@SS04.0&&&&&1&N&0&N.N.N.N 2006JV.148&mcs&0&N&If the inflation rate is overestimated by decision-makers then the short-term effect will be to:&increase the unemployment rate above its natural rate. &reduce the unemployment rate below its natural rate.;will have no impact on employment and the unemployment rate. ;the rate of unemployment will stay at the economy's natural rate of unemployment. ;&LOS: Reading 18-cEmployers will find that the real cost of labor is higher than they anticipated and will tend to employ fewer workers. Unemployed workers will also extend their search time as they see the wages available in real terms (when overestimating inflation) are not as good as they expect. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Application 3, pp. 358-359.&&&a&Class@SS04.1&&&&&1&N&0&N.N.N.N 2006JV.149&mcs&0&N&Under the rational expectations hypothesis, decision makers, when forecasting future economic trends:&take into account all available information relevant to the economy.&focus on anticipating government fiscal policy.;focus on anticipating government monetary policy.;expect economic data over recent periods to continue.;&LOS: Reading 18-cThe rational expectations hypothesis says that decision makers, rather than expecting the future to be the same as the past, will make adjustments to their forecasts to reflect changes in economic policy.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.15, pp. 356-357.&&&a&Class@SS04.2&&&&&1&N&0&N.N.N.N 2006JV.150&mcs&0&N&An analyst states that, ‘The index of leading economic indicators has been declining over the last six months and the policy makers should consider moving to a more expansionary policy to avoid a recession’. Is the analyst’s statement CORRECT? &Yes, leading indicators have been successful at forecasting a number of economic slowdowns in the past.&No, the policy makers should wait for coincident indicators to slow before adopting an expansionary policy.;No, the government should adopt a restrictive policy due to timing differences between policy change and impact of the policy.;No, the economy is already in recession if the leading indicators are declining so it is too late to adopt an expansionary policy.;&LOS: Reading 18-aAlthough not perfect indicators, the leading indicators are a signal of economic activity in the future and so the analyst is correct. It would be reasonable to expect policy makers to try to stimulate demand through an expansionary policy.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.15, pp. 349-354.&&&a&Class@SS04.0&&&&&1&N&0&N.N.N.N 2006JV.151&mcs&0&N&Which of the following statements concerning price indices is FALSE?&the GDP deflator is a narrower price index than the CPI. &the GDP deflator is designed to measure the change in price of goods included in GDP.;the CPI and the GDP deflator have moved very closely together in the U.S. despite their different methods of construction. ;the CPI will tend to over estimate inflation since it is a fixed basket and does not take account of consumers moving to better value goods.;&LOS: Reading 4-Introductory ReadingsThe GDP deflator is a broader price index than the CPI since it reflects all goods included in GDP.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.7, p. 165. &&&a&Class@SS04.1&&&&&1&N&0&N.N.N.N 2006JV.152&mcs&0&N&Full employment is:&the level of unemployment after allowing for frictional and structural conditions in the labor markets.&when unemployment is zero.;the level of unemployment after allowing for cyclical conditions in the labor markets.;the level of unemployment after allowing for cyclical and frictional conditions in the labor markets.;&LOS: Reading 14-cFull employment is after allowing for the normal/natural rate of unemployment caused by frictional and structural factors.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.8, pp. 186-190.&&&a&Class@SS04.2&&&&&1&N&0&N.N.N.N 2006JV.153&mcs&0&N&A fall in resource prices due to a long-term increase in the supply of resources will:&shift the SRAS curve to the right and the LRAS curve to the right.&shift the SRAS (short-run aggregate supply) curve to the left and leave the LRAS (long-run aggregate supply) curve unchanged.;shift the SRAS curve to the left and the LRAS curve to the left.;shift the SRAS curve to the right and leave the LRAS curve unchanged.;&LOS: Reading 4-Introductory ReadingsA fall in resource prices will cut production costs and move the SRAS to the right. Since this is the result of a long-term increase in supply this will also shift the LRAS to the right.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.10, pp. 234-237.&&&a&Class@SS04.0&&&&&1&N&0&N.N.N.N 2006JV.154&mcs&0&N&When the government adopts a counter cyclical fiscal policy in response to a threat of recession the government might:&increase infrastructure spending.&increase business tax rates.;reduce its outstanding debt.;reduce the size of the budget deficit (or increase the surplus).;&LOS: Reading 15-cA countercyclical policy attempts to move the economy in the opposite direction to the business cycle and therefore ahead of a recession the policy would be aimed at stimulating demand.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.12, pp. 268-271.&&&a&Class@SS04.1&&&&&1&N&0&N.N.N.N 2006JV.155&mcs&0&N&The demand for money is:&the amount of money that people wish to hold in cash and highly liquid assets.&the amount of money drawn out of cash and savings account over one year. ;a measure of consumers’ willingness to increase productivity for additional remuneration.;the interest rate level that will attract individuals to place a greater proportion of their wealth on deposit with banks. ;&LOS: Reading 17-aThe demand for money is simply the amount of money that people wish to hold in cash and highly liquid assets.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.14, pp. 321-323.&&&a&Class@SS04.2&&&&&1&N&0&N.N.N.N 2006JV.156&mcs&0&N&Which of the following is a likely effect of unanticipated high and variable inflation? &I. A reduction of investment by businesses. II. A distortion in relative price levels generating misleading information.III. Decision-makers spend more time forecasting the impact of inflation and less time in productive activities. &I. Decision-makers spend more time forecasting the impact of inflation and less time in productive activities. ;I. A distortion in relative price levels generating misleading information.II. Decision-makers spend more time forecasting the impact of inflation and less time in productive activities. ;I. A reduction of investment by businesses. II. Decision-makers spend more time forecasting the impact of inflation and less time in productive activities. ;&LOS: Reading 14-dUnanticipated high and variable inflation will lead to all of the given detrimental effects on the economy. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.8, pp. 194-196.&&&a&Class@SS04.0&&&&&1&N&0&N.N.N.N 2006JV.157&mcs&0&N&In a country there is large foreign investment and the foreign workers are well paid. Also the number of the country’s citizens who are working abroad is small. In this case:&GDP will be higher than GNP.&GDP and GNP will be equal.;GDP will be lower than GNP.;Net domestic product will be higher than GDP.;&LOS: Reading 4-Introductory Readings GNP = GDP + income of citizens earned abroad - income earned by foreigners domestically. Net domestic product will always be lower than GDP since it is GDP minus depreciation of capital goods used in the economy.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.7, p. 163.&&&a&Class@SS04.1&&&&&1&N&0&N.N.N.N 2006JV.158&mcs&0&N&Under rational expectations a move by government to adopt a more expansionary monetary policy in response to the threat of an economic slowdown will:&be ineffective in increasing output since decision-makers will adjust their expectations to reflect the policy.&have no effect on the economy.;be ineffective since it will be too early to adjust policy.;tend to stabilize the economy as output responds to the change in policy.;&LOS: Reading 18-cThe change in monetary policy would be anticipated under rational expectations and therefore decision-makers will quickly adjust their policy, so the only impact will be a rise in prices.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.15, pp. 356-357.&&&a&Class@SS04.2&&&&&1&N&0&N.N.N.N 2006JV.159&mcs&0&N&In the case that households increase their holdings of currency and reduce the balances in their checking accounts by an equal amount, and the Federal Reserve does not take any offsetting action, the impact on the money supply will be:&to reduce the amount that can be loaned by banks, which will tend to reduce the money supply. &to reduce banks’ required reserves, which will increase money supply. ;to increase money supply since the currency is available for immediate use. .;there will be no impact on money supply, since the increased holdings in currency will offset the reduction in checking accounts.;&LOS: Reading 16-aChecking accounts and currency are included in money supply. If the balances in checking accounts are reduced then it will not directly affect the money supply but it will reduce the amount of reserves that the banks need to keep and also reduce the amount that they can loan, which will reduce the money supply.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.13, pp. 293-295.&&&a&Class@SS04.0&&&&&1&N&0&N.N.N.N 2006JV.160&mcs&0&N&According to the quantity theory of money if the GDP of a country is $50 billion and the velocity of M1 money supply is 8, then M1 money supply: &is $6.25 billion.&is $160.00 billion.;is $400.00 billion.;cannot be calculated from the information given.;&LOS: Reading 17-cUse MV = GDP, so M1 = $50 billion/8 = $6.25 billion. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch.14, pp. 329-330.&&&a&Class@SS04.1&&&&&1&N&0&N.N.N.N 2006JV.161&mcs&0&N&The law of diminishing marginal utility implies that: &as the consumption of a product increases the marginal utility of consuming an additional unit will decline, although total utility will increase at a reduced rate.&as the consumption of a product increases the marginal utility of consuming an additional unit will decline, and total utility will start to decline.;as a company’s investment expenditure increases the marginal utility of an additional unit of investment expenditure will decline, and total utility will start to decline.;as a company’s investment expenditure increases the marginal utility of an additional unit of investment expenditure will decline, and total utility will increase at a reduced rate.;&LOS: Reading 19-aThe law of diminishing marginal utility means that as consumers continue to buy a product the additional benefit from that product will start to decline. However there will still be some benefit from each additional unit so the total utility will increase, although it will increase at a slower rate. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 19, pp. 450-452.&&&a&Class@SS05.2&&&&&1&N&0&N.N.N.N 2006JV.162&mcs&0&N&Income effect refers to:&the part of a change in amount of a product consumed that is the result of the consumer’s real income being altered by a change in the price of the product.&the impact on the CPI of an increase in real wage growth.;the part of a change in growth of consumer spending that is the result of the consumer’s real income being altered by a change in CPI growth.;the part of a change in amount of a product consumed that is the result of the consumer’s real income being altered by a change in the rate of CPI growth.;&LOS: Reading 19-bAs the price of a good falls a consumer’s real income will increase allowing them to buy more goods including the product whose price has declined. This is referred to as the income effect.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 19, pp. 453-454.&&&a&Class@SS05.0&&&&&1&N&0&N.N.N.N 2006JV.163&mcs&0&N&A profit-maximizing firm can employ skilled and unskilled labor and the average wages are $30 and $10 an hour respectively. If the output of the skilled workers is 40 units per day and the unskilled workers is 12 units per day, the firm will: &employ only skilled workers since their wages relative to output are lower. &employ only unskilled workers since their hourly wages are much lower. ;employ a combination of skilled and unskilled workers to increase productivity.;employ a combination of skilled and unskilled workers to lower the average cost per unit.;&LOS: Reading 24-dThe firm will employ skilled workers since:MP/P for skilled workers = 40/30 = 1.33Whereas MP/P for unskilled workers =12/10 = 1.2Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 24, pp. 582-583.&&&a&Class@SS05.1&&&&&1&N&0&N.N.N.N 2006JV.164&mcs&0&N&The supply of a resource with low resource mobility is generally: &inelastic in the short run but more elastic in the long run.&elastic in both the short and long run. ;equally inelastic in the short and long run. ;elastic in the short run and inelastic in the long run.;&LOS: Reading 24-eLow resource mobility will make the supply relatively inelastic in the short run since the resource cannot be easily transferred to another use. Generally long-run elasticity is more elastic than short-run elasticity, as suppliers have time to adjust to the change in prices.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 24, pp. 584-587.&&&a&Class@SS05.2&&&&&1&N&0&N.N.N.N 2006JV.165&mcs&0&N&Which of the following will lead to a change in the quantity demanded of a product?&a change in price of the product.&a change in consumer incomes. ;a change in consumer preferences.;a change in distribution of consumer incomes.;&LOS: Reading 19-aPrice is the only factor that will lead to a change in the quantity demanded. The other factors will lead to a shift in the entire demand curve.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 19, pp. 450-454.&&&a&Class@SS05.0&&&&&1&N&0&N.N.N.N 2006JV.166&mcs&0&N&Advertising to promote a certain brand name:&can be beneficial to consumers since once a brand name has value the owners of the brand name will be careful to protect the reputation of their product.&does not affect product pricing since consumers are under no obligation to buy goods that are heavily advertised. ;does not affect product pricing since producers must bear the cost of advertising and cannot pass the cost on to consumers. ;is never of benefit to consumers since the cost of advertising will mean that consumers are overpaying for the product. ;&LOS: Reading 19-cAdvertising can provide consumers with information about the product so it does have some benefit to consumers, but the cost of advertising will eventually be passed on to consumers through higher prices. It is true, however, that consumers are under no obligation to pay higher prices since they have the option to buy a cheaper product that is not heavily advertised. Consumers will benefit in that a firm that has spent heavily to establish a brand name will be anxious to maintain the value of the brand name and therefore provide an attractive product to the consumer. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 19, pp. 457-458.&&&a&Class@SS05.1&&&&&1&N&0&N.N.N.N 2006JV.167&mcs&0&N&If the price elasticity of demand for a product is elastic it means that:&a percent increase in prices leads to a larger percent reduction in the amount purchased.&total expenditure on the product will remain constant as the price changes.;price and total expenditures on the product will move in the same direction.;a percent increase in prices leads to a smaller percent reduction in the amount purchased.;&LOS: Reading 19-cThe amount purchased will be highly sensitive to price changes; this will mean that the price and total expenditures on the product will move in opposite directions.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 19, pp. 458-467.&&&a&Class@SS05.2&&&&&1&N&0&N.N.N.N 2006JV.168&mcs&0&N&The most important determinant of price elasticity of demand for a product is usually:&II. the availability of substitute products.&I. the consumer surplus for the product.;III. the proportion of consumer incomes spent on the product.;IV. the advertising expenditure relative to sales of the product.;&LOS: Reading 19-cIII. will only be true if the expenditure on the product is a large percentage of total spending; the availability of substitutes is usually the most important factor.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 19, p. 462.&&&a&Class@SS05.0&&&&&1&N&0&N.N.N.N 2006JV.169&mcs&0&N&Demand for products is usually: &more elastic in the long run than short run.&more elastic in the short run than long run.;the elasticity will increase more rapidly in the long run.;the elasticity will decrease more rapidly in the long run.;&LOS: Reading 19-dDemand will be more elastic in the long run since consumers will have had more time to adjust to a price change.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 19, pp. 463-464.&&&a&Class@SS05.1&&&&&1&N&0&N.N.N.N 2006JV.170&mcs&0&N&Luxury goods usually have a: &high income elasticity.&low income elasticity.;negative income elasticity.;abnormal income elasticity.;&LOS: Reading 19-dLuxury goods usually have a high (greater than one) income elasticity which means that as incomes rise, the demand for these goods rises at an even faster rate. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 19, pp. 467-468.&&&a&Class@SS05.2&&&&&1&N&0&N.N.N.N 2006JV.171&mcs&0&N&Consumption-opportunity constraints:&separate consumption bundles that are attainable from those that are not attainable.&are an example of budget constraints.;should never intersect indifference curves.;separate preferred bundles of goods from less preferred bundles of goods.;&LOS: Reading 19-eConsumption-opportunity constraints often refer to a budget constraint and define what is affordable or attainable.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 19, pp. 470-473.&&&a&Class@SS05.0&&&&&1&N&0&N.N.N.N 2006JV.172&mcs&0&N&Which of the following statements regarding consumer indifference curves is FALSE?&The point at which two indifference curves cross represents a preferred combination of goods for that individual.&Indifference curves are always convex. ;Points on the indifference curve represent combinations of goods that are preferred by an individual. ;The indifference curve is useful since it illustrates how an individual with a fixed budget will choose between different goods.;&LOS: Reading 19-eIndifference curves do not cross; if they did cross it would contradict the assumption that a consumer prefers to have more goods than fewer goods.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 19, pp. 470-473.&&&a&Class@SS05.1&&&&&1&N&0&N.N.N.N 2006JV.173&mcs&0&N&Which one of the following is NOT one of the three main business structures in the U.S.?&joint venture.&partnership.;corporation.;proprietorship.;&LOS: Reading 20-aA joint venture is not one of the three business structures in the U.S. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 20, pp. 479-480.&&&a&Class@SS05.2&&&&&1&N&0&N.N.N.N 2006JV.174&mcs&0&N&Accounting profits:&are generally higher than economic profits.&are generally similar to economic profits.;take into consideration implicit costs only.;take into consideration explicit and implicit costs.;&LOS: Reading 20-bAccounting profits do not take into consideration the implicit cost components (i.e. the opportunity cost of the resources used). Economic profits consider both explicit and implicit costs, therefore accounting profits are generally higher than economic profits. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 20, pp. 483-484.&&&a&Class@SS05.0&&&&&1&N&0&N.N.N.N 2006JV.175&mcs&0&N&In the short run, as a company increases production levels towards operating at full capacity:&marginal costs will generally rise and average total costs will also rise.&marginal costs will generally fall but average total costs will rise.;marginal costs will generally rise but average total costs will fall. ;marginal costs will generally fall and average total costs will fall.;&LOS: Reading 20-cMarginal costs are the change in total costs to produce an additional unit of output. As a firm approaches operating at full capacity, marginal costs will rise and average total costs will therefore also rise.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 20, pp. 485-493.&&&a&Class@SS05.1&&&&&1&N&0&N.N.N.N 2006JV.176&mcs&0&N&If a company is unable to expand the size of its production facilities it means that:&as more and more units of a variable resource are used output will eventually increase at a decreasing rate and marginal costs will exceed average total costs.&as more and more units of a variable resource are used output will eventually decrease and marginal costs will increase towards average total costs.;as more and more units of a variable resource are used output will eventually increase at a decreasing rate and marginal costs will be equal to average total costs.;as more and more units of a variable resource are used output will eventually increase at a decreasing rate and average fixed costs will increase as a percentage of total costs.;&LOS: Reading 20-dThe law of diminishing returns states that as more and more units of a variable resource are allocated to production they will eventually increase output at a decreasing rate. Mathematically, as the marginal costs increase, they will become higher than the average total cost, thereby increasing the average total cost.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 20, pp. 487-490.&&&a&Class@SS05.2&&&&&1&N&0&N.N.N.N 2006JV.177&mcs&0&N&Which of the following statements regarding the relationship between costs of larger firms relative to costs of smaller firms is FALSE?&Long-run average total unit costs will always be lower for large firms due to economies of scale.&Constant returns to scale can exist in an industry for different sizes of firm.;Firms that are smaller than the minimum efficient size have higher average total unit costs. ;Economies of scale refer to reductions in a firm’s unit cost due to use of large factories with large volumes of output. ;&LOS: Reading 20-fLarge firms are not always more efficient. For example, it is often harder to motivate the work force in a large firm and communication between employer and employees becomes harder. Bureaucracy also is more likely to reduce productivity.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 20, p. 492-493.&&&a&Class@SS05.0&&&&&1&N&0&N.N.N.N 2006JV.178&mcs&0&N&Which of the following statements is FALSE about a market which is characterized by firms that are price takers?&Firms have a downward sloping demand curve for their products.&It is a purely competitive market.;The products of each firm are identical.;There are a large number of small firms in the market.;&LOS: Reading 21-aIn a price-taker market there are a large number of firms producing small amounts of an identical product. Therefore if they increase the price of their product their sales will be zero. Firms with a downward sloping demand curve are price searchers.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 20, pp. 505.&&&a&Class@SS05.1&&&&&1&N&0&N.N.N.N 2006JV.179&mcs&0&N&In the short run a price-taker will expand production until:&marginal revenue is equal to marginal cost.&marginal revenue is equal to fixed cost.;marginal revenue is equal to average total cost.;marginal revenue is equal to marginal cost minus fixed cost.;&LOS: Reading 21-aA firm will keep adding to production until the extra units produced add less to revenue than to costs.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 20, pp. 505-508.&&&a&Class@SS05.2&&&&&1&N&0&N.N.N.N 2006JV.180&mcs&0&N&In a price-taker market in the long run:&firms will earn zero economic profits.&the minimum average total cost for the firms will be lower than the market price.;the minimum average total cost for the firms will be higher than the market price.;firms will earn sufficient economic profit to attract new firms to enter the business. ;&LOS: Reading 21-gIn a price-taker market if economic profits are available it will attract new competition which will force market prices down. However, if market prices fall so firms are making economic losses, then firms will drop out of the business allowing prices to rise. In either case economic profits will tend to zero in the long run.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 20, pp. 519-520.&&&a&Class@SS05.0&&&&&1&N&0&N.N.N.N 2006JV.181&mcs&0&N&In an increasing-cost industry: &the long-run market supply curve slopes upwards to the right.&the long-run market supply curve is horizontal.;the long-run market supply curve slopes downwards to the right.;the long-run market supply curve cannot be determined without more information.;&LOS: Reading 21-fIn an increasing-cost industry the cost of production increases as output expands, usually since resource prices increase. Therefore market output will only increase as higher prices push the supply curve upwards to the right.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 20, pp. 516-517.&&&a&Class@SS05.1&&&&&1&N&0&N.N.N.N 2006JV.182&mcs&0&N&Competitive price-searcher markets have: &low entry barriers and downward-sloping demand curves.&low entry barriers and upward-sloping demand curves.;high entry barriers and upward-sloping demand curves.;high entry barriers and downward-sloping demand curves.;&LOS: Reading 22-aPrice searchers produce differentiated goods. Therefore as their prices increase they will gradually lose customers, but not all their customers as in the case of price-taker markets, therefore demand curves are downward sloping. Competitive price-searcher markets, as opposed to monopolies or oligopolies, have low entry barriers.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 22, p. 526.&&&a&Class@SS05.2&&&&&1&N&0&N.N.N.N 2006JV.183&mcs&0&N&A firm which is operating in a competitive price-searcher market will make:&either economic profits or losses in the short run and zero economic profit in the long run.&economic profits in the short and long run. ;zero economic profit in the short run but economic profits in the long run.;either economic profits or losses in the short run and economic profits in the long run.;&LOS: Reading 22-bSince price-searcher markets have low barriers to entry, if a firm is making economic profits new competitors will enter the market which will drive prices down. Similarly if firms are making economic losses it will lead to firms dropping out of the market and prices increasing until economic losses are eliminated. In both cases firms will make zero economic profit in the long run.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 22, pp. 527-529.&&&a&Class@SS05.0&&&&&1&N&0&N.N.N.N 2006JV.184&mcs&0&N&Profit maximizing firms will expand production until marginal revenue equals marginal cost in:&price-taker and price-searcher markets.&price-taker markets only.;price-searcher markets only.;neither price-taker nor price-searcher markets.;&LOS: Reading 21-a and 22-bIn both markets a firm can increase profit by expanding production if the marginal revenue is greater than the marginal cost.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 21, p. 506 and Ch. 22, p. 528. &&&a&Class@SS05.1&&&&&1&N&0&N.N.N.N 2006JV.185&mcs&0&N&Demand for a resource is a derived demand which results in:&the elasticity of demand for a product being related to the elasticity of demand of the product the resource is used to manufacture.&demand curves being highly elastic.;demand curves being downward sloping.;the elasticity of demand for a resource depending on the substitute products available.;&LOS: Reading 24-aDerived demand means that the demand is a result of the demand for the final product that it is used to produce. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 24, pp. 575-576.&&&a&Class@SS05.2&&&&&1&N&0&N.N.N.N 2006JV.186&mcs&0&N&The following are all examples of factors that create entry barriers to an industry EXCEPT:&an inelastic demand curve.&patent laws.;economies of scale.;regulations that limit access to an industry.;&LOS: Reading 23-aThe four important factors are economies of scale, government licensing, patents and control over essential resources. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 23, pp. 546-547.&&&a&Class@SS05.0&&&&&1&N&0&N.N.N.N 2006JV.187&mcs&0&N&An oligopoly is characterized by:&a competitive market between a few large producers who are protected by high entry barriers.&a large number of producers who are protected by high entry barriers.;a few large producers who are not competitive since they are protected by high entry barriers. ;a small number of producers who carry our interdependent policies, there are no significant entry barriers to the market.;&LOS: Reading 23-bAn oligopoly is characterized by:1.High entry barriers. 2.Economies of scale. 3.A small number of firms.4.Interdependence between the producers.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 23, pp. 551-552.&&&a&Class@SS05.1&&&&&1&N&0&N.N.N.N 2006JV.188&mcs&0&N&Oligopolies are different to competitive price-searcher markets because: &there are high barriers to entry in an oligopoly but not in a price-searcher market.&oligopolists are price takers.;oligopolists are not competitive whereas price searchers are competitive.;oligopolists produce identical products whereas in price-searcher markets the products are differentiated;&LOS: Reading 23-bProducts can be either identical or differentiated in an oligopoly. Oligopolists are price searchers and are often highly competitive.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 23, pp. 551-552.&&&a&Class@SS05.2&&&&&1&N&0&N.N.N.N 2006JV.189&mcs&0&N&Which of the following statements is TRUE regarding the behavior of monopolists?&monopolists will expand output until marginal revenue equals marginal cost.&monopolists do not need to advertise since they are not facing competition. ;monopolists can always make an economic profit since other firms cannot easily enter their markets.;monopolists do not have any competition so they will charge the maximum possible price for their products.;&LOS: Reading 23-cAs is the case with other price searchers, monopolists will expand output until marginal revenue equals marginal cost. Monopolists still have a downward sloping demand curve and will need to attract demand (through advertising etc.) in order to make sales at a certain price level. Their concern is to achieve maximum profit rather than maximum price. Monopolists can lose money, as can any firm, if costs exceed revenue.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 23, pp. 548-550.&&&a&Class@SS05.0&&&&&1&N&0&N.N.N.N 2006JV.190&mcs&0&N&Which of the following would NOT be a sensible regulatory step to consider in order to increase resource allocation of a monopoly? ®ulating that the monopoly firm must reduce prices to the marginal cost.&abolishing licensing requirements that limit entry to the industry.;breaking up the monopoly into smaller companies, if it is not a natural monopoly.;reducing barriers and quotas that are acting as a barrier to foreign firms competing in the industry.;&LOS: Reading 23-fRegulating that a monopoly must price their product at the marginal cost would lead to the monopoly making losses, it would be better to use the average total cost. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 23, pp. 559-567.&&&a&Class@SS05.1&&&&&1&N&0&N.N.N.N 2006JV.191&mcs&0&N&Government owned monopolies: &are less efficient than ones owned by stockholders partly because voters are generally less well informed and less critical of performance than stockholders.&are more efficient than ones owned by stockholders partly because they have access to government subsidies for their business.;are more efficient than ones owned by stockholders partly because managers can focus on managing the firm rather than reporting to stockholders.;are more efficient than ones owned by stockholders partly because the managers do not have to spend time fighting take-over bids from other companies.;&LOS: Reading 23-fGovernment owned companies are generally less efficient than ones owned by stockholders due to voters being less critical of performance and because managers get less reward for efficiency.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 23, pp. 559-567.&&&a&Class@SS05.2&&&&&1&N&0&N.N.N.N 2006JV.192&mcs&0&N&A monopolist is all of the following EXCEPT:&one of a small number of producers of the good they produce.&a price searcher.;a producer of a good for which there are no attractive substitutes.;a producer in an industry where there are high barriers to entry for other firms looking to enter the business.;&LOS: Reading 23-bA monopolist is the only producer of a product in the market.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 23, pp. 547-548.&&&a&Class@SS05.0&&&&&1&N&0&N.N.N.N 2006JV.193&mcs&0&N&Which of the following make collusion difficult to implement:

I In the U.S. antitrust laws make collusion agreements illegal.
II Low entry barriers attract participants if collusion is producing large profits in an industry.
III Firms are tempted to ‘cut’ prices from the agreed level or improve the quality of their products.
IV As the number of firms involved increases then agreement on pricing and/or production levels is difficult.&All 4 options make collusion difficult to implement.&I, II, and III only.;I, II, and IV only.;I, III, and IV only.;&LOS: Reading 23-dAll of the factors given make collusion difficult to implement.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 23, pp. 555-557.&&&a&Class@SS05.1&&&&&1&N&0&N.N.N.N 2006JV.194&mcs&0&N&The role of entrepreneurs is best described by:&entrepreneurs will make business judgments when there are no proven models that can be applied to make a business evaluation. &entrepreneurs provide capital to new businesses. ;entrepreneurs take advantage of opportunities to earn long run economic profits in price-searcher markets. ;entrepreneurship cannot be fitted into economic models therefore entrepreneurs do not have a role in decision making. ;&LOS: Reading 22-cEntrepreneurs make decisions when there is uncertainty, discovery and business judgment involved and their decisions cannot be fitted into economic models.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 22, pp. 532-533.&&&a&Class@SS05.2&&&&&1&N&0&N.N.N.N 2006JV.195&mcs&0&N&Which of the following statements regarding monopolistic competition and pure monopoly is FALSE?&They are both protected by high entry barriers. &They are both price-searcher markets.;Both markets have downward sloping demand curves.;Both will expand production if marginal revenues are higher than marginal costs.;&LOS: Reading 22-aMonopolistic competition refers to a competitive price-searcher market which is characterized by low entry barriers. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 22, p. 525.&&&a&Class@SS05.0&&&&&1&N&0&N.N.N.N 2006JV.196&mcs&0&N&The supply curve for products is: &more elastic in the long run as firms have time to increase or reduce production capacity levels.&equally elastic in the short and long run.;less elastic in the long run as firms have time to benefit from economies of scale.;less elastic in the long run as firms reach the point that they can no longer expand capacity.;&LOS: Reading 21-gIt takes time for firms to expand or cut capacity so the response to price changes in the short run is small. Over the long run, as firms adjust their capacity, supply will change more rapidly as prices change. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 21, p. 516.&&&a&Class@SS05.1&&&&&1&N&0&N.N.N.N 2006JV.197&mcs&0&N&Which of the following statement(s) is/are TRUE regarding purely competitive markets?

I They are price-taker markets.
II They are markets with no entry barriers.
III They are competitive price-searcher markets.
IV They are markets where there are a large number of small firms.&I, II and IV only.&I and II only.;II and III only.;All 4 options are TRUE regarding purely competitive markets.;&LOS: Reading 21-aPurely competitive markets have no entry barriers and a large number of firms with a small market share and identical products. These are price-taker markets.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 21, p. 503.&&&a&Class@SS05.2&&&&&1&N&0&N.N.N.N 2006JV.198&mcs&0&N&In a price-taker market if prices fall below a firm’s average total cost:&the firm could temporarily shutdown their operations to reduce losses.&the firm should increase prices to marginal cost to reach break-even.;the firm should increase prices to average total cost to reach break-even.;the firm could temporarily shutdown their operations to eliminate losses.;&LOS: Reading 21-cShutting down the operations temporarily will eliminate variable costs and losses will be limited to fixed costs. If the owners expect a rise in prices in the future this would be probably preferable to going out of business. Increasing prices is not an option since the firm is a price taker, if they increase prices sales would go to zero.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 21, pp. 510-511.&&&a&Class@SS05.0&&&&&1&N&0&N.N.N.N 2006JV.199&mcs&0&N&When firms are price takers the short-run market supply curve is:&slopes upwards to the right.&horizontal.;slopes downwards to the right.;whether it slopes upwards or downwards to the right, or is horizontal, will depend on the industry.;&LOS: Reading 21-dFirms will increase supply if the price rises so the supply curve slopes upwards to the right. (Note – the long-run supply curve will not necessarily slope upwards to the right).Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 21, p. 512.&&&a&Class@SS05.1&&&&&1&N&0&N.N.N.N 2006JV.200&mcs&0&N&A railway company provides low fares to travelers prepared to start their journey after 10:00 am. This is an example of:&price discrimination.&collusion.;profiteering.;rent seeking.;&LOS: Reading 22-dPrice discrimination is when a seller charges different customers different prices for the same product or service.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 22, pp. 539-542.&&&a&Class@SS05.2&&&&&1&N&0&N.N.N.N 2006JV.201&mcs&0&N&International trade will only be beneficial for each of a group of nations if:&the relative costs of producing goods is different in the various nations.&no nation has an absolute advantage in the production of all goods.;one nation has an absolute advantage in the production of all goods.;one of the nations is able to produce goods more cheaply than the others.;&LOS: Reading 26-aThe only requirement for trade to be beneficial is that the nations have different relative costs in producing goods. If one nation produces a good relatively cheaply compared with other goods, it will be advantageous to export that good and import goods where the relative cost of production is higher. This will apply in turn to each of the nations, so trade will be for mutual advantage. Whether one nation has an absolute advantage in production is not critical.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 17, pp. 400-403.&&&a&Class@SS06.0&&&&&1&N&0&N.N.N.N 2006JV.202&mcs&0&N&The information below shows the daily output of workers in countries X and Y and the trade off in switching production from wine to cheese. It is assumed that other production costs are constant in each country and transportation costs are low. &both countries would gain if X traded cheese for Y’s wine. &both countries would gain if X traded wine for Y’s cheese.;only Y can gain since it is more efficient at producing both wine and cheese than X.;neither country will gain from trade since Y is more efficient at producing both wine and cheese than X. ;&LOS: Reading 26-aTo make an extra 2 units of wine X has to give up 3 units of cheese whereas to make an extra 4 units of wine Y has to give up only 4 units of cheese (or 1 to 1.5 and 1 to 1 respectively). So Y has a comparative advantage in producing wine. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 17, pp. 400-403.&&&a&Class@SS06.1&&&&&1&N&0&N.N.N.N 2006JV.203&mcs&0&N&The Law of Comparative Advantage implies that:&I. Countries should focus on producing goods where they have low opportunity costs.&I and III only.I. Countries should focus on producing goods where they have low opportunity costs.II. Countries should put up trade barriers to protect the industries where they have a high opportunity cost.;I. Countries with an absolute advantage in the production of a good should export that good.II. Countries should put up trade barriers to protect the industries where they have a high opportunity cost.;I. Countries should focus on producing goods where they have low opportunity costs.II. Countries with an absolute advantage in the production of a good should export that good.III. Countries should put up trade barriers to protect the industries where they have a high opportunity cost.;&LOS: Reading 26-aThe law of comparative advantage says that trading partners can benefit if each specializes in the production of goods for which it has low production costs and trades those for goods where it has high opportunity costs. A country may have an absolute advantage in the production of many goods but they should only export a specific good if the relative cost of production of that good is low, therefore II is not necessarily true.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 17, pp. 400-403.&&&a&Class@SS06.2&&&&&1&N&0&N.N.N.N 2006JV.204&mcs&0&N&The following data has been provided regarding the output per worker in Japan and the U.S.:

It is assumed that other production costs are constant in each country and transportation costs are low. Which of the following statement(s) is/are TRUE?

I Japan has an absolute advantage in the production of both radios and televisions.
II Both countries will gain if Japan focuses on the production of radios and the U.S. on the production of televisions.
III Both countries will gain if the U.S. focuses on the production of radios and Japan on the production of televisions.
IV Only Japan can gain from trade between the two countries because it is a lower cost producer of radios and televisions.&I. Japan has an absolute advantage in the production of both radios and televisions.II. Both countries will gain if the U.S. focuses on the production of radios and Japan on the production of televisions. &I. Both countries will gain if Japan focuses on the production of radios and the U.S. on the production of televisions. ;I. Japan has an absolute advantage in the production of both radios and televisions.II. Both countries will gain if Japan focuses on the production of radios and the U.S. on the production of televisions. ;I. Japan has an absolute advantage in the production of both radios and televisions.II. Both countries will gain if Japan focuses on the production of radios and the U.S. on the production of televisions. III. Only Japan can gain from trade between the two countries because it is a lower cost producer of radios and televisions.;&LOS: Reading 26-aAlthough Japan has the absolute advantage in the production of both products (i.e. it can produce both products more cheaply in terms of man hours) the U.S. has comparative advantage in the production of radios. If the U.S. switched its workers to producing radios and Japan switched its workers to producing televisions there will be an expansion in total output and both countries would gain.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 17, pp. 400-405.&&&a&Class@SS06.0&&&&&1&N&0&N.N.N.N 2006JV.205&mcs&0&N&An open economy will:&benefit both producers and consumers.&benefit consumers rather than producers. ;benefit producers rather than consumers.;benefit neither consumers nor producers.;&LOS: Reading 26-bAn open economy with no trade barriers will result in lower prices for products that are being imported (which will benefit consumers) and higher prices for products that are being exported (which will benefit producers). Trade will lead to a country focusing on producing the products that they manufacture most efficiently ending in an expansion in both output and consumption. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 17, pp. 404-405.&&&a&Class@SS06.1&&&&&1&N&0&N.N.N.N 2006JV.206&mcs&0&N&The imposition of tariffs on a product will:&benefit domestic producers of the product and the government.&benefit domestic and overseas producers of the product.;benefit overseas producers and consumers of the product.;benefit domestic producers and consumers of the product.;&LOS: Reading 26-dDomestic producers will be able to expand output if they can sell at a higher price (world price plus the tariff) leading to higher profits. The government will collect extra revenue from the tariff being paid on imports. The loser is the consumer who pays a higher price for the product. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 17, pp. 407-409.&&&a&Class@SS06.2&&&&&1&N&0&N.N.N.N 2006JV.207&mcs&0&N&The imposition of quotas on a product will:&benefit domestic and overseas producers of the product.&benefit overseas producers and consumers of the product.;benefit domestic producers and consumers of the product.;benefit domestic producers of the product and the government.;&LOS: Reading 26-dDomestic producers will be able to expand output if they can sell at a higher price (world price plus the tariff) leading to higher profits. Overseas producers who have a quota will be able to sell an amount of the product at an artificially high price. The loser is the consumer who pays a higher price for the product. The government does not collect additional revenue as in the case of tariffs.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 17, pp. 409-411.&&&a&Class@SS06.0&&&&&1&N&0&N.N.N.N 2006JV.208&mcs&0&N&Fixing the exchange rate of a nation’s currency at an artificially high rate will:&lead to low imports and low exports.&lead to low imports and high exports.;lead to high imports and low exports.;lead to high imports and high exports.;&LOS: Reading 26-cForeigners will find goods produced in the nation very expensive if the currency is over priced and they will buy elsewhere. If exports are low it is difficult for domestic consumers to have access to foreign currency so they will not be able to pay for imports. This will lead to the country having a small international trade sector.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 17, p. 410.&&&a&Class@SS06.1&&&&&1&N&0&N.N.N.N 2006JV.209&mcs&0&N&The dumping of goods by a foreign producer:&is beneficial to consumers and harmful to domestic producers who cannot compete with the new low prices.&is triggered by import subsidies paid by the foreign government. ;is harmful to the economy due to the law of comparative advantage.;is harmful to domestic producers and consumers since once the domestic producers are driven out of business the foreign supplier is free to increase prices substantially. ;&LOS: Reading 26-cDumping is often triggered by export subsidies paid by the foreign government. The law of comparative advantage implies that an economy will benefit when consumers are able to purchase imported goods more cheaply, since it means they can shift production to other goods where they have a comparative advantage. Dumping will reduce prices to the consumers and even if local producers are pushed out of business it is unlikely that the foreign producer will be able to monopolize the market, since there may be other foreign competitors and local producers can re-enter the market. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 17, pp. 411-412.&&&a&Class@SS06.2&&&&&1&N&0&N.N.N.N 2006JV.210&mcs&0&N&Empirical evidence indicates that:&high trade restrictions in a country severely reduce GDP growth rates.&high trade restrictions in a country have a smaller than expected impact on GDP growth rates.;high trade restrictions in a country have no impact on GDP growth rates but lead to high inflation.;high trade restrictions in a country have no impact on GDP growth rates but lead to high unemployment.;&LOS: Reading 26-cStudies have been done on the link between economic growth and trade openness. The data for some 91 countries was collected for the period 1980 to 1999. The twelve most open economies had GDP per capita which was almost eight times as large as that in the twelve least open economies. There is a strong relationship between trade openness and per capita GDP and economic growth.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 17, pp. 415-417.&&&a&Class@SS06.0&&&&&1&N&0&N.N.N.N 2006JV.211&mcs&0&N&Free trade between a country with high wages and one with low wages will probably: &lead to short-run unemployment in certain sectors in the country with high wages.&lead to a fall in real wages in the country that started with high wages.;lead to long-run unemployment in certain sectors in the country with high wages.;lead to an increase in output in the country with low wages and a decrease in output in the country with high wages.;&LOS: Reading 26-bIn the high wage country production would shift from the industries which were relatively uncompetitive to industries where the country had a comparative advantage (although productivity must be taken into account). This would lead to short-run unemployment in some areas. However the reallocation of resources in both countries to activities where they have a comparative advantage would lead to an increase in output for both countries and higher real wages.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 17, pp. 401-405.&&&a&Class@SS06.1&&&&&1&N&0&N.N.N.N 2006JV.212&mcs&0&N&Trade barriers are often used, despite the economic arguments that they damage the economy, for all of the following reasons EXCEPT:&they increase employment and keep wages artificially high.&domestic producers often have strong political influence.;consumers generally lose most if trade barriers are used but they often misunderstand the impact of the barriers.;once trade barriers are in place to protect a new industry it will be difficult to move the barriers when the industry has become established.;&LOS: Reading 26-eTrade barriers will harm the consumer but consumers often misunderstand the impact of trade barriers and in any case are not well organized to protest efficiently, whereas special interest groups representing producers and their workers have more political influence. If trade barriers are put in place to protect an industry it is often politically unacceptable to remove them later. Trade barriers will keep workers in inefficient industries rather than relocating them to industries that are efficient, therefore total output cannot grow as fast as if trade barriers were abolished and this will also lead to slower real wage growth. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 17, pp. 411-415.&&&a&Class@SS06.2&&&&&1&N&0&N.N.N.N 2006JV.213&mcs&0&N&If consumers in France were persuaded to buy only locally produced goods, would France’s economy improve?&No – the value of goods produced would decline if French consumers buy products that are relatively inefficiently produced domestically.&Yes – it is cheaper for France than imposing trade restrictions.;Yes – improved corporate profitability could be used to increase wages.;Yes – French industry would be protected and unemployment would be reduced.;&LOS: Reading 26-bThe production of goods where the country (in this case France) has high opportunity costs would continue. It is better if these goods are imported and the country focuses on producing goods where there is a low opportunity cost. The value of total output is critical to a nation’s well-being rather than short run changes in employment.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th Edition, Ch. 17, pp. 401-405.&&&a&Class@SS06.0&&&&&1&N&0&N.N.N.N 2006JV.214&mcs&0&N&If the indirect quote for the dollar in London moved from $1.10 to $0.80 then:&the dollar appreciated and Americans will find British goods cheaper.&the dollar depreciated and Americans will find British goods cheaper.;the dollar appreciated and Americans will find British goods more expensive.;the dollar depreciated and Americans will find British goods more expensive.;&LOS: Reading 27-aThe dollar-pound exchange rate moved from 1.10 to 0.80 means that initially it cost $1.10 to buy one pound and subsequently only cost $0.80 to buy one pound, so the dollar appreciated relative to the pound. This means it will be cheaper for Americans to buy British goods.Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 1, pp. 4-5.&&&a&Class@SS06.1&&&&&1&N&0&N.N.N.N 2006JV.215&mcs&0&N&If U.S. incomes increase at a higher rate than income growth in other countries this will tend to:&lead to a depreciation in the U.S. dollar relative to the other countries.¬ have any overall impact on exchange rates.;lead to an appreciation in the U.S. dollar relative to the other countries.;only have an impact on exchange rates if inflation rates in the U.S. are lower than in other countries.;&LOS: Reading 28-dIf incomes are growing faster in the U.S. then demand for imports will also rise faster than in other countries which will lead to higher demand for foreign currencies. This will lead to depreciation of the U.S. dollar.Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 2, p. 40.&&&a&Class@SS06.2&&&&&1&N&0&N.N.N.N 2006JV.216&mcs&0&N&Which of the following is most likely to be the cause of the appreciation in a currency under a system of flexible exchange rates?&III An unanticipated move to a more restrictive monetary policy.&I Low real interest rates relative to its trading partners.;II A high rate of inflation relative to its trading partners.;IV An increase in domestic incomes relative to domestic incomes of its trading partners.;&LOS: Reading 28-dI will lead to investment money seeking high real returns overseas which will tend to lead to depreciation in the currency. II will lead to goods produced domestically being expensive which will tend to lead to depreciation in the currency to bring the prices back in line with those of the trading partners. III is correct: A restrictive monetary policy will tend to increase real interest rates attracting investment, leading to an appreciation of the currency.IV will lead to an increase in demand for imports which will tend to lead to depreciation in the currency.Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 2, pp. 40-44.&&&a&Class@SS06.0&&&&&1&N&0&N.N.N.N 2006JV.217&mcs&0&N&Under a fixed exchange system if a country devalues its currency this is likely to:&reduce imports and increase exports.&increase overseas investment.;increase the trade deficit, or decrease the surplus.;lead to a decline in the merchandise trade balance.;&LOS: Reading 28-fLocally produced goods will be cheaper than before which will increase exports and reduce imports. This will lead to an increase in the merchandise trade surplus. Overseas investment will become more expensive and will therefore be expected to decrease. Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 2, pp. 42-43.&&&a&Class@SS06.1&&&&&1&N&0&N.N.N.N 2006JV.218&mcs&0&N&The balance of payments is:&made up of the current account, financial account and official reserve account.&the inflow into the country in terms of net investments and loans made to a country.;the difference between the value of merchandise exports and merchandise imports for a country.;the difference between the value of merchandise and service exports and merchandise and service imports for a country, plus current income from investments and gifts.;&LOS: Reading 28-bB describes the capital account.C is the balance of merchandise trade and is just one component of the balance of payments. D is a list of the items that go into the current account statement.A is the correct answer.Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 2, pp. 34-35.&&&a&Class@SS06.2&&&&&1&N&0&N.N.N.N 2006JV.219&mcs&0&N&Which of the following statements concerning the composition of the balance of payments is TRUE?

I If there is a current account surplus there must be a financial account deficit.
II The term ‘balance of payments’ is misleading since aggregate balance of payments accounts do not usually balance.
III If the merchandise trade account is in surplus it means that the citizens of a country are selling more goods to foreigners than they are buying from foreigners.&III only.&I and II only.;II and III only.;All 3 statements concerning the composition of the balance of payments are TRUE;&LOS: Reading 28-bI is not always true since the official reserve account balance plus the financial account deficit must equal the current account surplus. II is not correct, the accounts must always balance.Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 2, pp. 34-35.&&&a&Class@SS06.0&&&&&1&N&0&N.N.N.N 2006JV.220&mcs&0&N&An unanticipated shift to a more expansionary fiscal policy is most likely to:&lead to appreciation of the currency in the short run followed by a depreciation in the currency.&lead to depreciation of the currency in both the short run and the long run.;lead to appreciation of the currency in both the short run and the long run.;lead to depreciation of the currency in the short run followed by an appreciation in the currency.;&LOS: Reading 28-eAn expansionary fiscal policy will require funding by the government so it will put upwards pressure on interest rates which will push up the exchange rate. On the other hand demand will increase, as will inflation, which will encourage imports and this will push down the exchange rate. It is generally believed that the first effect will be for the currency to appreciate since investment will respond very quickly to interest rate moves whereas demand will take longer to be impacted by a change in fiscal policy. Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 2, pp. 40-41.&&&a&Class@SS06.1&&&&&1&N&0&N.N.N.N 2006JV.221&mcs&0&N&An unanticipated shift towards a more expansionary monetary policy under a flexible exchange rate system would be expected to lead to: &a capital outflow.&a rise in real interest rates.;an appreciation in the exchange rate.;a decrease in a current account surplus (or increase in deficit).;&LOS: Reading 28-eAn expansion in money supply will stimulate demand, push up inflation rates and reduce real interest rates. This will encourage capital outflow to countries with higher real interest rates. This will lead to depreciation in the currency. Greater demand will lead to higher imports which will reduce the current account surplus but the capital outflow is more immediate. Capital outflow will lead to a deficit on the capital account and under a flexible exchange rate system this will lead to a surplus on the current account. Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 2, pp. 40-41.&&&a&Class@SS06.2&&&&&1&N&0&N.N.N.N 2006JV.222&mcs&0&N&A restrictive monetary policy combined with an expansionary fiscal policy is likely to lead to:&high real interest rates and a current account deficit.&low real interest rates and a current account deficit.;low real interest rates and a current account surplus.;high real interest rates and a current account surplus.;&LOS: Reading 28-eThe expansionary fiscal policy will push up real interest rates as government borrowing increases, as will the restrictive monetary policy as it will reduce inflation. High real interest rates will lead to a capital inflow which will be the driving factor in creating a capital account surplus and current account deficit. Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 2, pp. 40-41.&&&a&Class@SS06.0&&&&&1&N&0&N.N.N.N 2006JV.223&mcs&0&N&A country with a large current account deficit:&depends on overseas investors to finance the deficit, unless it spends its reserves.&is showing signs of a stagnant economy.;is also probably running a large financial account deficit.;will face a crisis in the short-term as consumers cannot pay the cost of imports.;&LOS: Reading 28-cA current account deficit is often a sign of rapid economic growth as imports exceed exports. Investment from foreigners is needed to provide the foreign exchange to finance the current account deficit.Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 2, pp. 36-38.&&&a&Class@SS06.1&&&&&1&N&0&N.N.N.N 2006JV.224&mcs&0&N&A current account deficit can indicate that:&the country is attracting large inflows of foreign capital. &the nation is producing more goods and services for foreigners than it is buying from them.;domestic investors have insufficient opportunities to invest domestically and are investing overseas.;since a current account deficit is not sustainable long term the country will need to take measures to encourage depreciation of its currency.;&LOS: Reading 28-cA current account deficit indicates that a nation is buying more goods and services from foreigners than it is selling to them, but a current account deficit can persist in the long term. It indicates that the capital account is in surplus and therefore the country is attracting foreign capital. Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 2, pp. 35-38.&&&a&Class@SS06.2&&&&&1&N&0&N.N.N.N 2006JV.225&mcs&0&N&If a country decides to fix its exchange rate to that of another currency whilst still maintaining convertibility of the currency it means that the country:&cannot follow an independent monetary policy. &will expect a rise in the inflation rate.;cannot follow an independent fiscal policy. ;must fix the currency at above the market rate.;&LOS: Reading 28-fIf the currency is fixed above the market rate then it will be difficult for citizens to find a counterparty from which to buy foreign exchange (unless the government can provide this function which will be difficult in the long run), this will lead to a fall in trade. Fixing the currency will generally be used as a measure to control inflation.The country can follow an independent fiscal policy but their monetary policy will reflect the monetary policy of the country that they have fixed their currency to. Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 2, pp. 42-43.&&&a&Class@SS06.0&&&&&1&N&0&N.N.N.N 2006JV.226&mcs&0&N&Which of the following would NOT explain deviation from interest rate parity?&A rising interest rate environment. &Capital controls.;Transaction costs.;Taxes on interest payments to foreigners.;&LOS: Reading 27-gC would not affect interest rate parity, as long as funds can be deposited to capture the higher interest rates, the theory should hold.Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 1, pp. 16-21.&&&a&Class@SS06.1&&&&&1&N&0&N.N.N.N 2006JV.227&mcs&0&N&If the relative purchasing power of two currencies is maintained it means that the country with the highest:&inflation rate will see its currency depreciate against the other currency. &real interest rates will see its currency depreciate against the other currency. ;growth in exports will see its currency depreciate against the other currency. ;nominal interest rates will see its currency depreciate against the other currency.;&LOS: Reading 28-gPurchasing power parity refers to differences in inflation rates. Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 1, pp. 44-48.&&&a&Class@SS06.2&&&&&1&N&0&N.N.N.N 2006JV.228&mcs&0&N&A Swiss resident asks for a quotation for buying U.S. dollars and is quoted SFR/$ = 1.5030 for delivery the following day. This is an example of:&a direct quotation in the spot market.&an indirect quotation in the spot market.;a direct quotation in the forward market.;an indirect quotation in the forward market.;&LOS: Reading 27-aIn the spot market transactions are for immediate delivery – immediate means within two working days. Direct quotations gives the price in the home currency of a certain quantity of the foreign currency. Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 1, pp. 4-5.&&&a&Class@SS06.0&&&&&1&N&0&N.N.N.N 2006JV.229&mcs&0&N&The Singapore dollar is quoted against the pound at Sing $/£ = 2.7500 – 2.7532, the bid-ask percent spread is closest to:&0.1162%.&0.1164%.;0.3200%.;11.6400%.;&LOS: Reading 27-bThe bid – ask spread = (2.7532 – 2.7500)/2.7532 x 100 = 0.1162%Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 1, pp. 7-10.&&&a&Class@SS06.1&&&&&1&N&0&N.N.N.N 2006JV.230&mcs&0&N&uh oh&II the currencies are not widely traded.&I it is a larger size of transaction.;III the bank is temporarily short of one of the currencies.;IV it is a spot transaction, the previous transaction was a forward transaction.;&LOS: Reading 27-bI – larger transactions will usually have smaller spreads particularly if they are on the interbank market. II – is the most likely since the spread represents the liquidity in the market so currencies that are not widely traded will have wider spreads. III – if a bank is short of one of the currencies they are likely to adjust the price spread up or down but this will not necessarily affect the size of the spread. IV – forward transactions tend to have larger spreads due to greater volatility in the forward markets. Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 1, pp. 7-10.&&&a&Class@SS06.2&&&&&1&N&0&N.N.N.N 2006JV.231&mcs&0&N&The foreign exchange quotes for the Hong Kong dollar and Japanese Yen against £ are as follows:

HK$/£ = 12.30
Yen/£ = 170

The cross rate for HK$/Yen is closest to: & 0.0724.& 0.0478.;13.8211.;20.9100.;&LOS: Reading 27-cThe cross rate is given byHK$/Yen = HK$/£ x £/Yen = 12.30/170 = 0.07235Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 1, pp. 7-10.&&&a&Class@SS06.0&&&&&1&N&0&N.N.N.N 2006JV.232&mcs&0&N&Pounds sterling is quoted at US$/£ = 1.6114-1.6152 and the Singapore dollar is quoted at US$/Sing $ = 0.5795-0.5830. What is the direct quote for pounds sterling in Singapore? &S$ 2.7640 – 2.7872.&S$ 0.9338 – 0.9417.;S$ 0.9394 – 0.9360.;S$ 2.7704 – 2.7807.;&LOS: Reading 27-c Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 1, pp. 7-10.&&&a&Class@SS06.1&&&&&1&N&0&N.N.N.N 2006JV.233&mcs&0&N&A high risk-free interest rate in a country relative to other countries will lead to:&the direct exchange rate increasing and there being a forward discount.&the direct exchange rate decreasing and there being a forward discount.;the direct exchange rate increasing and there being a forward premium.;the direct exchange rate decreasing and there being a forward premium. ;&LOS: Reading 27-gA high risk-free interest rate in a country relative to other countries is compensation for the expected weakness in the currency. This means the indirect exchange rate is expected to decrease and the direct exchange rate will increase as a larger amount of local currency will be needed to buy a unit of foreign currency. There will be a forward discount to reflect the higher interest rate and expected depreciation of the currency.Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 1, p. 19.&&&a&Class@SS06.1&&&&&1&N&0&N.N.N.N 2006JV.234&mcs&0&N&A manufacturer in Germany (with a euro cost base) sells machinery to a customer in the U.S. and will receive in one month’s time the payment of US$1,000,000. He is concerned that the dollar is going to depreciate against the euro in the short term. Which of the following strategies should he consider to reduce his foreign currency risk?&Go short of the dollar against the euro in the forward market.&Buy dollars and sell euros in the spot market.;Go long of the dollar against the euro in the forward market. ;Borrow euros, exchange these into dollars and place on dollar deposit. ;&LOS: Reading 27-dHe would consider entering into a one month forward contract to sell US$1,000,000 and buy euro at the forward rate. He will then offset the loss he makes, in euro terms, on the payment if the US$ depreciates, with a profit on the forward contract. Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 1, pp. 14-15.&&&a&Class@SS06.2&&&&&1&N&0&N.N.N.N 2006JV.235&mcs&0&N&If the spot rate for US$/Japanese yen is 0.009345 and the 90-day forward US$/Japanese yen rate is 0.009460. The Japanese yen is selling at a forward annualized premium, or discount, of:&4.92% premium&4.86% discount.;1.23% premium.;4.86% premium.;&LOS: Reading 27-f Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 1, pp. 16-21.&&&a&Class@SS06.0&&&&&1&N&0&N.N.N.N 2006JV.236&mcs&0&N&Spot exchange transactions:&are usually settled within 48 hours.&must settle in the same business day.;are contracted today although settlement can be up to one year later.;are contracted today although settlement can be up to one month later.;&LOS: Reading 27-dSpot transactions are for immediate settlement which in practice means within 48 hours.Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 1, p. 14.&&&a&Class@SS06.1&&&&&1&N&0&N.N.N.N 2006JV.237&mcs&0&N&Interest rate parity theory says that: &the interest differential between two currencies should approximately be equal to the forward differential. &the interest differential between two currencies should approximately be equal to the expected interest rate differential. ;the interest differential between long and short rates should approximately be equal to the change in expected inflation rates. ;the interest differential between long and short rates should approximately be equal to the expected appreciation in the currency. ;&LOS: Reading 27-gInterest rate parity says that the interest differential between two currencies should approximately be equal to the forward differential. If not there would be an opportunity to arbitrage by doing a spot transaction from the first currency to the second, placing the funds on deposit and at the same time doing a forward transaction to convert the second currency back to the first. This would yield a higher return than placing the money on deposit in the first currency.Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 1, pp. 16-21.&&&a&Class@SS06.2&&&&&1&N&0&N.N.N.N 2006JV.238&mcs&0&N&One year interest rates are 6% in the US and are 2% in Japan, and the spot rate is Yen/US$ = 110. If there is interest rate parity, the one year Yen/US$ forward rate is closest to: &105.85.&101.74.;114.31.;118.93;&LOS: Reading 27-g Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 1, pp. 16-21.&&&a&Class@SS06.0&&&&&1&N&0&N.N.N.N 2006JV.239&mcs&0&N&The spot €/$ rate is 2.05 and the 90 day forward rate is 2.08, 90 day interest rates in U.S. dollars are 6% per annum and in euro are 4% per annum. Which of the following strategies will produce the highest return for an investor with US$1,000,000?&place US$1,000,000 on deposit for 90 days.&convert US$1,000,000 into € at the spot rate, place on 90 day a euro deposit, and sell €2,070,500 forward into US$. ;convert US$1,000,000 into euro at the spot rate, place on 90 day a euro deposit, and sell €2,050, 000 forward into US$. ;the returns from placing the money on 1. deposit in US$ and 2. exchanging it for € and placing it on deposit in euro will be identical.;&LOS: Reading 27-gPlacing US$1,000,000 on deposit for 90 days at 6% gives US$1,015,000.Alternatively convert US$1,000,000 to euro at the spot rate to give €2,050,000. This will earn interest over 90 days at 4% and the final value will be €2,070,500. If €2,070,500 had been sold forward this would have given $995,432 which is less than placing it on US$ deposit. Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 1, pp. 16-21.&&&a&Class@SS06.1&&&&&1&N&0&N.N.N.N 2006JV.240&mcs&0&N&Covered interest arbitrage will be possible if:&covered interest differentials are greater than transaction costs.&the interest rate parity theory holds.;covered interest differentials are zero.;covered interest differentials are greater than zero.;&LOS: Reading 27-gWhen covered interest differentials are zero the interest rate parity theory holds and there are no arbitrage opportunities. Arbitrage opportunities will occur if transaction costs are less than covered interest differentials leaving room for a risk free profit.Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 1, pp. 16-21.&&&a&Class@SS06.2&&&&&1&N&0&N.N.N.N 2006JV.241&mcs&0&N&A company that is going through a rapid growth phase:&often has negative operating cash flows as inventories and receivables increase.&often has positive operating cash flows as cash collections increase.;often has negative financing cash flows as it no longer require external financing.;often has negative operating cash flows since it has heavy capital expenditure commitments.;&LOS: Reading 33-b The major impact of heavy capital expenditure would be on investing cash flows, although the interest cost would affect operating cash flows. The major impact on operating cash flows is that as the business expands the money tied up in working capital rises. This is because inventory levels expand as sales increase and the receivables from clients are also likely to increase.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.3, pp. 91-92.&&&a&Class@SS07.2&&&&&1&N&0&N.N.N.N 2006JV.242&mcs&0&N&Which of the following will lead to the largest increase in cash flow from operations?&A decrease in accounts receivable and a decrease in inventories.&An increase in accounts receivable and a decrease in inventories.;A decrease in accounts receivable and an increase in inventories.;An increase in accounts receivable and an increase in inventories.;&LOS: Reading 33-b A decrease in accounts receivable means that the amount owing from customers has declined and a decrease in inventories means that additional inventory has been sol.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.3, pp. 78-79.&&&a&Class@SS07.0&&&&&1&N&0&N.N.N.N 2006JV.243&mcs&0&N&Free cash flow is:&cash flow from operations plus cash flow from investments.&cash available after making all the required cash outlays.;cash flow from operations plus cash flow from investments.;cash available after making all the required and discretionary cash outlays.;&LOS: Reading 33-e Free cash flow is cash flow that is available for discretionary spending after making all the required cash outlays.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.3, pp. 87-88.&&&a&Class@SS07.1&&&&&1&N&0&N.N.N.N 2006JV.244&mcs&0&N&A firm decides to use the completed contract method as opposed to the percentage-of-completion method to account for a major construction project that they are working on. Until the contract is completed this will have the following impact on its financial statements:&reduce construction in progress.&increase revenues.;reduce cash flows.;increase stockholders' equity.;&LOS: Reading 31-c Under the completed contract method the firm recognizes revenues and expenses only at the end of the contract and construction in progress will be lower since it will not include recognized income. The percentage-of-completion method recognizes revenues, costs and income in proportion to the percentage of work completed, which increases stockholders' equity. Cash flow under both methods will be the same.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.2, pp. 40-43.&&&a&Class@SS07.2&&&&&1&N&0&N.N.N.N 2006JV.245&mcs&0&N&A company uses IAS GAAP for their cash flow classification for interest and dividend payments and receipts. Which of the following statements is CORRECT?&The company's cash flow from financing may be lower than if the company had used U.S. GAAP.&Total cash flows will be lower than if the company had used U.S. GAAP.;The company's cash flow from investing may be lower than if the company had used U.S. GAAP.;Cash flow from operations will always be the same whether the company uses IAS GAAP or U.S. GAAP.;&LOS: Reading 33-fInterest and dividends paid may have been classified as cash flow from financing (CFF), thereby reducing CFF.Interest and dividends received could have been classified as cash flow from investing.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.3, p. 98.&&&a&Class@SS07.0&&&&&1&N&0&N.N.N.N 2006JV.246&mcs&0&N&The balance sheet is useful because:&III. it provides information to creditors on assets that are available as collateral for debt.&I. it reports all of the assets and liabilities of a firm.;II. it provides a report of the market value of the assets and liabilities of a firm.;IV. it is less influenced by the choice of accounting policies than the income statement or statement of cash flows.;&LOS: Reading 31-fI. is not correct since, for example, brand names and customer lists, if internally generated, will not be included.II. is not correct since, for example, assets may be priced at cost or adjusted for depreciation and the value does not reflect market value.IV. is not correct since the statement of cash flows is generally least affected by the choice of accounting policies.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.3, pp. 61-65.&&&a&Class@SS07.1&&&&&1&N&0&N.N.N.N 2006JV.247&mcs&0&N&The completed contract method is being used to recognize revenues for a ten year project and, at the end of the first year, the costs for the remaining nine years are reassessed and are found to be higher than in the original estimate. The impact on first year reported income will be:&the income will be the same regardless of whether the cost estimate has been changed or not.&the income will be lower than if the cost estimate had not been changed.;the income will be higher than if the cost estimate had not been changed.;more information is needed to decide whether the income will be lower or higher than if the cost estimate had not been changed. ;&LOS: Reading 31-cUnder the completed contract method income is only recognized at the end of the contract, so in either case the income is zero in the first year.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.2, pp. 40-44.&&&a&Class@SS07.2&&&&&1&N&0&N.N.N.N 2006JV.248&mcs&0&N&North Company uses U.S. GAAP and provides the following financial statements.- Total dividends of $15,000 were paid.- Old machinery was sold; the machinery had already been fully depreciated.The cash flow from operations is:&880000&580000;830000;910000;&LOS: Reading 33-a\\Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.3, pp. 78-82.&&&a&Class@SS07.0&&&&&1&N&0&N.N.N.N 2006JV.249&mcs&0&N&North Company uses U.S. GAAP and provides the following financial statements.


Total dividends of $15,000 were paid.- Old machinery was sold; the machinery had already been fully depreciated.The cash flow from investments for North Company is:&30000&-85000;-70000;130000;&LOS: Reading 33-aInvesting cash flows: Sale of old machine 30 Net from investment 30The cash flow from operations in 2005 is: $880,000.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.3, pp. 78-82.&&&a&Class@SS07.1&&&&&1&N&0&N.N.N.N 2006JV.250&mcs&0&N&North Company uses U.S. GAAP and provides the following financial statements.

Total dividends of $15,000 were paid.- Old machinery was sold; the machinery had already been fully depreciated.The cash flow from financing for North Company is:&-115000&-170000;-100000;-15000;&LOS: Reading 33-aFinancing cash flows: Bank note (100) Dividends paid (15) Net from financing (115)The cash flow from operations in 2005 is: $880,000.\\Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.3, pp. 78-82.&&&a&Class@SS07.2&&&&&1&N&0&N.N.N.N 2006JV.251&mcs&0&N&Which of the following condition(s) need(s) to be satisfied for revenue to be recognized in a firm's accounts?&I. The provision of services or goods is substantially complete.&I. Receipt of payment.;I. Receipt of payment.II. Delivery of services or goods.;I. Receipt of payment.II. Delivery of services or goods.III. The provision of services or goods is substantially complete.;&LOS: Reading 31-bReceipt of payment is not a condition, assurance of receiving the payment is a condition. As long as the provision of the service or good is substantially complete delivery is not necessary.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.2, p. 39.&&&a&Class@SS07.0&&&&&1&N&0&N.N.N.N 2006JV.252&mcs&0&N&If a firm's accounts receivable increase and accounts payable decrease then:&it will have a negative impact on operating cash flow as customers owe a larger amount of money to the firm and the firm owes less money to suppliers than in the previous accounting period.&it will have a positive impact on operating cash flow as customers owe a larger amount of money to the firm and the firm owes less money to suppliers than in the previous accounting period.;it will have a positive impact on operating cash flow as customers owe a smaller amount of money to the firm and the firm owes more money to suppliers than in the previous accounting period.;it will have a negative impact on operating cash flow as customers owe a smaller amount of money to the firm and the firm owes more money to suppliers than in the previous accounting period. ;&LOS: Reading 33-bWhen receivables increase it indicates that sales have been higher than cash collections, so more money is owed by customers. A decline in payables means that the firm has paid more in cash to suppliers than the value of goods received so it owes less money to suppliers. Both of these factors will lead to a smaller operating cash flow.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.3, pp. 78-81.&&&a&Class@SS07.1&&&&&1&N&0&N.N.N.N 2006JV.253&mcs&0&N&When the management of a company uses its discretion on timing and classification of income items to report additional losses in a bad year for the company this is referred to as:&Big Bath accounting.&fraud.;income smoothing.;classifactory smoothing.;&LOS: Reading 31-e'Big Bath' accounting refers to the practice of taking all the bad news at once so that the future profit outlook will be more attractive. Income smoothing and classifactory smoothing would have the opposite effect, the management would increase the earnings in a bad year.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.2, pp. 59-60.&&&a&Class@SS07.2&&&&&1&N&0&N.N.N.N 2006JV.254&mcs&0&N&I.W.S. Inc uses U.S. GAAP and supplied the following financial data:
Cash flow from operating activities was:&$46 million.&$36 million.;$39 million.;$49 million.;&LOS: Reading 33-a\\Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.3, pp. 78-82.&&&a&Class@SS07.0&&&&&1&N&0&N.N.N.N 2006JV.255&mcs&0&N&I.W.S. Inc uses U.S. GAAP and supplied the following financial data:

I.W.S. Inc.'s cash flow from investing was:&- $9 million.&- $19 million.;- $12 million.; $6 million.;&LOS: Reading 33-aCash flow from investing activities Purchase of land (15) Sale of equipment __6_ (9)Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.3, pp. 78-82.&&&a&Class@SS07.1&&&&&1&N&0&N.N.N.N 2006JV.256&mcs&0&N&I.W.S. Inc uses U.S. GAAP and supplied the following financial data:
I.W.S. Inc.'s cash flow from financing was:&- $20 million.&- $35 million.;- $23 million.;- $12 million.;&LOS: Reading 33-aCash flow from financing activities Retirement of common stock (12) Dividend payment __(8)__ (20)Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.3, pp. 78-82.&&&a&Class@SS07.2&&&&&1&N&0&N.N.N.N 2006JV.257&mcs&0&N&I.W.S. Inc uses U.S. GAAP and supplied the following financial data:
The total cash flow is $ 17 million.If the cash in I.W.S. Inc.'s balance sheet at the end of the previous year was $25 million what will be the new cash balance? &$ 42 million.&$ 5 million.;$ 61 million.;$ 71 million.;&LOS: Reading 33-aThe total cash flow is $ 17 million so the new cash balance is $ 42 million.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.3, pp. 78-82.&&&a&Class@SS07.0&&&&&1&N&0&N.N.N.N 2006JV.258&mcs&0&N&The indirect method of reporting cash flows calculates operating cash flow by which of the following methods?&Start with net income for the period, adjust for all non cash expenses/revenues, adjust for non-operating items included in net income and then adjust for changes in the balance of operating asset and liability accounts.&Start with cash collections for the period and deduct cash outflows incurred in collecting this cash.;Start with net income for the period and adjust for all non cash expenses/revenues and adjust for non-operating items included in net income.;Start with cash collections for the period and deduct cash outflows incurred in collecting this cash, and then adjust for changes in the balance of operating asset and liability accounts.;&LOS: Reading 33-bThe indirect method starts at the net income figure and makes adjustments whereas the direct method works through the cash items staring with cash collections.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.3, p. 82.&&&a&Class@SS07.1&&&&&1&N&0&N.N.N.N 2006JV.259&mcs&0&N&Which of the following choices would be included in the Statement of Stockholders' Equity?&Retained earnings and Additional paid in capital above the par value of common stock.&Capital leases and Retained earnings.;Redeemable preferred stock only.;Capital leases, Retained earnings, and Redeemable preferred stock.;&LOS: Reading 31-fThe statement of stockholders' equity does not include redeemable preferred stock, it is reported after liabilities but above the equity section.Capital leases are reported in the liabilities section of the balance sheet.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.2, pp. 65-66.&&&a&Class@SS07.2&&&&&1&N&0&N.N.N.N 2006JV.260&mcs&0&N&The basis of accounting that allocates cash flows to time periods which are different to when they occur is called:&accrual basis.&cash basis.;matching basis.;non-matching basis.;&LOS: Reading 31-aUnder the cash basis a firm recognizes revenues when they are received and expenses when they are paid. Under the accrual basis it recognizes revenue when it provides substantially all of the services that it expects to perform and under the matching principle expenses are recognized in the same period as the related revenues.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.2, pp. 31-34.&&&a&Class@SS07.0&&&&&1&N&0&N.N.N.N 2006JV.261&mcs&0&N&Bishop Steel Manufacturing reported little change in net income whereas the operating cash flows rose sharply. This might be explained by:&IV. the company used inventory to meet their customers' orders and minimized raw material purchases. &I. the company extended the payment period for customers.;II. the company raised cash through the issue of long term bonds.;III. the company sold land that was not being used for a substantial some of money.;&LOS: Reading 33-bI. is not correct since this would increase receivables and reduce operating cash flow.II. is not correct since the issue of bonds would be classified as a financing cash flow.III. is not correct since the sale of land would be classified as an investment cash flow.IV. is correct since this would raise cash from the sale of inventory.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.3, pp. 75-79.&&&a&Class@SS07.1&&&&&1&N&0&N.N.N.N 2006JV.262&mcs&0&N&Which of the following is the least important project being undertaken by the FASB in moving towards international convergence. Accounting methods used for: &acquisitions using the pooling-method.&I n-process RandD.;revenue recognition.;stock compensation.;&LOS: Reading 34-aI Purchase method accounting must now be used for acquisitions and amendments are being considered for these accounting methods.Reference: Patricia A. Mc Connell, Future FASB Changes and the Analytical Challenges of GAAP, (AIMR 2004), pp. 18-20.&&&a&Class@SS07.2&&&&&1&N&0&N.N.N.N 2006JV.263&mcs&0&N&A golf club sells five-year membership packages and, despite collecting the full non-refundable payment at the start of the five years, it recognizes the revenues over the five years period. This accounting treatment is:&incorrect , the asset–liability method of revenue recognition must be used.&the firm has issued preferred shares.;acceptable, as long as all the estimated costs are recognized at the start of the five years.;incorrect, the firm must recognize the change in net assets reflecting the payment in the first year.;&LOS: Reading 34-bCurrent guidelines are in conflict so it is acceptable to use either the net asset (asset – liability) method or to recognize revenue when the earnings process is completed. Related costs should be recognized in the same accounting period as when the revenue is recognized.Reference: Patricia A. Mc Connell, Future FASB Changes and the Analytical Challenges of GAAP, (AIMR 2004), pp. 23-24.&&&a&Class@SS07.0&&&&&1&N&0&N.N.N.N 2006JV.264&mcs&0&N&Jones Construction takes on a new project which they anticipate will take two years to complete. They agree a total contract price of $4,000,000 and their expected costs are $3,000,000. In the first year they incur costs of $1,800,000 (and total expected costs remain unchanged from the original estimate) and receive payments of $2,000,000. If they are using the percentage-of-completion method to recognize revenue then (i) the income recorded in the first year and (ii) change in liabilities in the first year from this project will be:&(i) $600,000 (ii) no change&(i) $200,000 (ii) no change;(i) $600,000 (ii) increase of $400,000;(i) $600,000 (ii) increase of $2,000,000;&LOS: Reading 31-c\\Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.2, pp. 40-44.&&&a&Class@SS07.1&&&&&1&N&0&N.N.N.N 2006JV.265&mcs&0&N&If a company decides to change from a policy of leasing plant and equipment through operating leases to purchasing its own plant and equipment this will:&increase operating cash flows.&increase investing cash flows.;decrease operating cash flows.;have no impact on operating cash flows.;&LOS: Reading 33-aLease rentals are classified as an operating cash flow and the purchase of equipment is classified as an investing cash flow. The decision to switch from leasing to purchasing plant and equipment will increase operating cash flows but decrease investing cash flows.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.3, pp. 94-96.&&&a&Class@SS07.2&&&&&1&N&0&N.N.N.N 2006JV.266&mcs&0&N&An auditor to a company is responsible for the following:&Examining a company's internal control systems and Confirming that the assets and liabilities are correctly stated.&Preparing the financial statements only.;Examining a company's internal control systems only.;Confirming that the assets and liabilities are correctly stated only.;&LOS: Reading 29-eIt is the company's responsibility to prepare the financial statements but the auditor must ensure that they conform with generally accepted accounting principles.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.1, pp. 24-26 (Preliminary Reading).&&&a&Class@SS07.0&&&&&1&N&0&N.N.N.N 2006JV.267&mcs&0&N&A company reports a negative free cash flow to equity shareholders. This could be explained by:&The company has finished a major replacement project of their machinery.&The company has raised funds by issuing new debt.;Interest rates have fallen reducing their cost of debt.;the company has increased dividends payments to equity shareholders.;&LOS: Reading 33-eFree cash flow to equity is the cash generated by the company available for discretionary spending; this is often measured as operating cash flow less capital expenditure, so heavy expenditure on new machinery would reduce free cash flow. Increasing dividends or raising funds by issuing debt would not affect free cash flow; they are part of cash flow from financing. A reduction in the cost of debt would increase free cash to equity shareholders.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.3, pp. 87-90.&&&a&Class@SS07.1&&&&&1&N&0&N.N.N.N 2006JV.268&mcs&0&N&The Management Discussion and Analysis in a stockholder report should include all of the following EXCEPT:&the background of the directors.&the business outlook.;discussion of cash flow trends.;results of operations and sales trends.;&LOS: Reading 29-dPublicly traded securities are required to provide Management Discussion and Analysis. Information about the directors would be included in a stockholder report but not in the Management Discussion and Analysis.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.1, pp. 23-24.&&&a&Class@SS07.2&&&&&1&N&0&N.N.N.N 2006JV.269&mcs&0&N&If a firm makes a provision for a write down of assets that are going to be sold as part of a restructuring of its operations this would normally be classified as:&an unusual or infrequent item.&an extraordinary item.;a loss from discontinued operations.;a profit from discontinued operations.;&LOS: Reading 31-eRestructuring costs are usually classed as nonrecurring items. Extraordinary items must be both unusual in nature and infrequent in occurrence (as well as being material).Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.2, pp. 58-61.&&&a&Class@SS07.0&&&&&1&N&0&N.N.N.N 2006JV.270&mcs&0&N&A U.S. consultancy company discovers that a transaction that took place last year was incorrectly recorded and in fact a client paid an additional $10,000 of fees over that recorded as a bonus based on the benefits he received from the consultancy provided in that period. The company should:&increase the income received in the current year's accounts.&adjust the reported income in the previous year's accounts.;adjust the retained earnings in the previous year's balance sheet.;recognize the $10,000 as an extraordinary profit in the current year.;&LOS: Reading 31-eAdjustments to prior years' accounts through adjustment to the retained earnings is only to be used for accounting errors. The adjustment should be reported in the current year's income statement. Although it is a non recurring item it is not an extraordinary item.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.3, p. 56.&&&a&Class@SS07.1&&&&&1&N&0&N.N.N.N 2006JV.271&mcs&0&N&When a firm records an allowance for uncollectible receivables as a deduction against the receivables account this is:&a contra account.&an adjunct account.;an extraordinary item.;a non-recurring item.;&LOS: Reading 31-fAn account which reduces the value of an asset, to a new estimate of its net realizable value, is a contra account.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.2, p. 63.&&&a&Class@SS07.2&&&&&1&N&0&N.N.N.N 2006JV.272&mcs&0&N&Under U.S. accounting standards a brand name:&is only reported in the balance sheet when purchased from another party.&is never reported in the balance sheet.;is always reported in the balance sheet.;is only reported in the balance sheet when it is internally created.;&LOS: Reading 31-fIn the U.S. if a brand name is internally created it is not included in the balance sheet. This is not always the case in other countries.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.2, p. 64.&&&a&Class@SS07.0&&&&&1&N&0&N.N.N.N 2006JV.273&mcs&0&N&Income that is independent of a firm's capital structure is:&operating income.&net income.;pre-tax income.;comprehensive income.;&LOS: Reading 31-aOperating income is revenues less costs of goods sold, SGA, and research and development. Therefore it is prior to interest costs which reflect the cost of debt financing.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.2, pp. 35-36.&&&a&Class@SS07.1&&&&&1&N&0&N.N.N.N 2006JV.274&mcs&0&N&If the interest payable decreased over an accounting period, under U.S GAAP, it will:&decrease operating cash flow. &increase financing cash flow.;increase operating cash flow.;decrease financing cash flow.;&LOS: Reading 33-fInterest expense is included in operating cash flows and if interest payable decreased it means that the cash paid out in interest was more than the interest expense accrued during the period.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.3, pp. 76.&&&a&Class@SS07.2&&&&&1&N&0&N.N.N.N 2006JV.275&mcs&0&N&If a company declares a total dividend of $6 million and increases dividend payables by $4 million in an accounting period, under U.S GAAP, it will:&decrease the financing cash flow by $2 million.&increase the investing cash flow by $4 million.;decrease the investing cash flow by $6 million.;decrease the investing cash flow by $2 million.;&LOS: Reading 33-fPayment of dividends is included in financing cash flows. The dividends paid out are $6million less $4 million which equals $2 million.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.3, pp. 81-82.&&&a&Class@SS07.0&&&&&1&N&0&N.N.N.N 2006JV.276&mcs&0&N&The costs of long-lived assets are usually allocated:&over a period that is chosen by the firm.&over 5 years.;at the time of disposal.;when the impairment of the assets takes place.;&LOS: Reading 30-a Usually the management has discretion over the period, or useful life, that assets are depreciated.Reference: Needles and Powers, Financial Accounting, 8th Edition, Ch.10, pp. 450-453.&&&a&Class@SS07.1&&&&&1&N&0&N.N.N.N 2006JV.277&mcs&0&N&Using different revenue and expense recognition methods:&will have no impact on the reported operating cash flow.&will have no impact on the reported income statement.;will have no impact on the assets and liabilities reported in the balance sheet.;will lead to different income, assets and liabilities, and operating cash flow being reported.;&LOS: Reading 32-aThe income statement and balance sheet will be different depending on which revenue recognition method is used. The advantage of looking at cash flow is that the cash flow is the same regardless of the method used (assuming tax treatment is the same).Reference: Needles and Powers, Financial Accounting, 8th Edition, Ch.14, pp. 613-616.&&&a&Class@SS07.2&&&&&1&N&0&N.N.N.N 2006JV.278&mcs&0&N&When costs and collection terms of a project are uncertain which of the following would be the most appropriate method to recognize revenue?&Cost recovery method.&Average cost method.;Completed contract method.;Percentage-of-completion method.;&LOS: Reading 31-bUnder the cost recovery methods all cash receipts must be counted as recovery of costs and when this is completed can additional cash receipts be counted as profits. This only allows profit to be recognized when all the costs have been paid and the uncertainty removed.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.2, pp. 44-45.&&&a&Class@SS07.0&&&&&1&N&0&N.N.N.N 2006JV.279&mcs&0&N&Minority interest appears in the balance sheet as:&a liability.&an asset.;stockholders' equity.;it appears in the income statement and not in the balance sheet.;&LOS: Reading 31-fMinority interest refers to equity held by other investors in a subsidiary that is consolidated in the accounts.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.2, pp. 62.&&&a&Class@SS07.1&&&&&1&N&0&N.N.N.N 2006JV.280&mcs&0&N&If a company decides to dispose of a clearly defined part of its business it will report as separate items in the income statement (under U.S. GAAP):&(1) the net profit or loss of the business segment prior to the measurement date and (2) the gain or loss it made from the sale of the business segment adjusted for the net income or loss made between the measurement date and disposal date. &(1) the net profit or loss of the business segment prior to the disposal date and (2) the gain or loss it made from the sale of the business segment.;(1) the gross profit or loss of the business segment prior to the disposal date as a separate item on the income statement and (2) the gain or loss it made from the sale of the business segment.;(1) the gross profit or loss of the business segment prior to the measurement date and (2) the gain or loss it made from the sale of the business segment adjusted for the net income or loss made between the measurement date and disposal date.;&LOS: Reading 31-dLosses and profits are always shown net of taxes and are initially measured up to the measurement date (the date when the firm formally commits to dispose of the business). After the measurement date they are netted off against gains or losses made on disposal. Losses are recognized in the same year as the measurement date, gains are recognized when they are actually realized, but in this case we are told that they occur in the same year.Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.2 pp. 54-55.&&&a&Class@SS07.2&&&&&1&N&0&N.N.N.N 2006JV.281&mcs&0&N&Which of the following ratios would be useful in evaluating a company's internal liquidity?&Quick ratio.&Equity turnover.;Debt/equity ratio.;Interest coverage.;&LOS: Reading 35-b\\The ratio measures the current assets that can be quickly liquidated to meet current liabilities.Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 323-326.&&&a&Class@SS08.0&&&&&1&N&0&N.N.N.N 2006JV.282&mcs&0&N&A U.S. firm must reflect the effects of conversion of an outstanding convertible on earnings per share:&only if the conversion leads to dilution of earnings per share.&in all cases.;only if the management decides to do so.;only if the combined effect of conversion of all common stock equivalents outstanding leads to dilution of earnings per share.;&LOS: Reading 36-dFirms must recognize the potential effects of conversion on earnings per share and each outstanding common stock equivalent must be considered separately to see if it is dilutive or antidilutive.Reference: Kieso, Weygandt, Warfield, Dilutive Securities and Earnings per Share, Intermediate Accounting, 11th Edition, Ch. 16, pp. 798-799.&&&a&Class@SS08.1&&&&&1&N&0&N.N.N.N 2006JV.283&mcs&0&N&A 'common-size' income statement:&calculates all entries as a percentage of sales.&calculates all entries as a percentage of net income.;is an income statement that has been restated to use the same accounting principles.;is an income statement that complies with generally accepted accounting principles.as those used by the company which it is being evaluated against. ;&LOS: Reading 35-aCommon-size statements normalize balance sheets and income statements and are used to analyze trends within a company and also to compare different sized companies.Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 320-323.&&&a&Class@SS08.2&&&&&1&N&0&N.N.N.N 2006JV.284&mcs&0&N&If company A's operating leverage is higher the company B's then:&A's operating profits are more sensitive than B's to a change in sales.&A's operating profits are more sensitive than B's to a change in COGS.;A has a lower percentage of fixed operating costs to variable costs than B.;A's operating profits are more sensitive than B's to a change in interest expense.;&LOS: Reading 35-bHigh leverage means that a high percentage of costs are fixed and that operating profits are highly sensitive to a change in sales.Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 338-340.&&&a&Class@SS08.0&&&&&1&N&0&N.N.N.N 2006JV.285&mcs&0&N&ABC Corporation provides you with the following information:\\Inventory turnover is closest to:&1.07.&0.47.;0.93.;2.14.;&LOS: Reading 35-b\\Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 325-326.&&&a&Class@SS08.1&&&&&1&N&0&N.N.N.N 2006JV.286&mcs&0&N&ABC Corporation provides you with the following information:

The payables turnover ratio of ABC Corporation is closest to:&2.5.&0.2.;0.4.;5.0.;&LOS: Reading 35-b\\Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 326-327.&&&a&Class@SS08.2&&&&&1&N&0&N.N.N.N 2006JV.287&mcs&0&N&ABC Corporation provides you with the following information:

The return on total capital of ABC Corporation is closest to:&16.1%.&10.7%.;14.0%.;20.9%.;&LOS: Reading 35-b\\Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 330-331.&&&a&Class@SS08.0&&&&&1&N&0&N.N.N.N 2006JV.288&mcs&0&N&ABC Corporation provides you with the following information:

The total asset turnover of ABC Corporation is closest to:&0.54.&0.71.;1.40.;1.87.;&LOS: Reading 35-btotal asset turnover = net sales/average total net assets\\NB. You need to use total net assets and not total net fixed assets.Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, p. 327.&&&a&Class@SS08.1&&&&&1&N&0&N.N.N.N 2006JV.289&mcs&0&N&On January 1st 2005 a company had 15,000,000 of common stock and $3,000,000 of 8% preferred stock outstanding. On October 1st the company issued and sold 5,000,000 new shares of common stock. The company did not have any common stock equivalents outstanding. If net income for the year was $23,000,000, the company's basic earnings per share in 2005 were closest to:&$1.40.&$1.14.;$1.42.;$1.52.;&LOS: Reading 36-a\\Reference: Kieso, Weygandt, Warfield, Dilutive Securities and Earnings per Share, Intermediate Accounting, 11th Edition, Ch. 16, pp. 789-791.&&&a&Class@SS08.2&&&&&1&N&0&N.N.N.N 2006JV.290&mcs&0&N&If a firm has an interest coverage ratio of 3, the company will just be able to pay its interest costs from current earnings if earnings before interest and tax decline by:& 66.67%.& 20.00%.; 33.33%.;300.00%.;&LOS: Reading 35-b\\If the interest cover falls to 1, EBIT will fall to a third of its original value i.e. decline by 66.67%.Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 343-344.&&&a&Class@SS08.0&&&&&1&N&0&N.N.N.N 2006JV.291&mcs&0&N&When a company increases the dividend pay out ratio:&the sustainable potential growth rate of the company will fall.&the sustainable potential growth rate of the company will rise.;the sustainable potential growth rate of the company will not be affected.;the sustainable potential growth rate will rise or fall depending on the ROE relative to the cost of capital.;&LOS: Reading 35-bSustainable potential growth rate = retention rate x ROEIf the dividend pay out ratio increases the retention rate will fall, reducing the future growth rate.Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 348-350.&&&a&Class@SS08.1&&&&&1&N&0&N.N.N.N 2006JV.292&mcs&0&N&If a manufacturing company has a very low total asset turnover compared to its competitors this could be explained by:&II. the company has too much capital invested in assets for the size of its revenue.&I. the company is using older, and in many cases fully depreciated, machinery.;III. the company uses operating leases rather than outright purchase for its machinery.;IV. the company is not making sufficient investment in its business to support future growth.;&LOS: Reading 35-ctotal asset turnover = net sales/average total net assetsI. is not correct since using old machinery would reduce total net assets and increase the asset turnover.III. is not correct since it would imply that the asset value was potentially lower than its competitors.IV. is not correct since this would again imply that too few assets are being used.Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, p. 327.&&&a&Class@SS08.2&&&&&1&N&0&N.N.N.N 2006JV.293&mcs&0&N&Which of the following is an example of complex capital structure?&The company has issued options to employees.&The company has preferred shares outstanding.;The company has performed a stock split in the current accounting period.;The company has performed a rights issue in the current accounting period.;&LOS: Reading 36-aA complex capital structure means that dilutive securities such as options, warrants or convertibles are outstanding.Reference: Kieso, Weygandt, Warfield, Dilutive Securities and Earnings per Share, Intermediate Accounting, 11th Edition, Ch. 16, pp. 793-794.&&&a&Class@SS08.0&&&&&1&N&0&N.N.N.N 2006JV.294&mcs&0&N&South Inc.'s breakdown of current assets and liabilities is as follows:

The quick ratio is closest to:&1.13.&0.07.;1.55.;1.82.;&LOS: Reading 35-b\\Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 323-324.&&&a&Class@SS08.1&&&&&1&N&0&N.N.N.N 2006JV.295&mcs&0&N&South Inc.'s breakdown of current assets and liabilities is as follows:

South Inc.'s net annual sales for the same period were $6,825,000 and receivables were unchanged from the previous year. What is the average receivables collection period?&34.8 days.&10.5 days.;34.3 days.;38.3 days.;&LOS: Reading 35-b\\Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 324-325.&&&a&Class@SS08.2&&&&&1&N&0&N.N.N.N 2006JV.296&mcs&0&N&A company has 60,000 shares outstanding on January 1st and issues a 50% stock dividend on June 30th. The weighted average number of shares outstanding over the years ending December 31st is:&90000&60000;75000;120000;&LOS: Reading 36-c30,000 additional shares will be issued. Since the shares are given to existing shareholders and no cash is paid the shares outstanding are adjusted for the complete year.Reference: Kieso, Weygandt, Warfield, Dilutive Securities and Earnings per Share, Intermediate Accounting, 11th Edition, Ch. 16, pp. 790-791.&&&a&Class@SS08.0&&&&&1&N&0&N.N.N.N 2006JV.297&mcs&0&N&Which of the following statements concerning managers and their companies' financial statements is accurate?&When managers distort a company's financial position they usually end up paying harsh penalties.&Private companies have more flexibility to use accounting tricks to boost profits.;Managers some times resort to manipulating their companies' accounts since their remuneration is linked to company earnings.;Managers of companies that face intense competition are some times usually more tempted to manipulate the financial statements.;&LOS: Reading 37-cManagers who distort accounts are rarely penalized, partly since GAAP allows flexibility in choice of accounting policy. Even when they are fined or prosecuted the penalties are relatively small.Reference: Financial Shenanigans, 2nd edition, Howard Schilit (McGraw-Hill, 2002) "Searching for Shenanigans" Ch. 3, pp. 32-33.&&&a&Class@SS08.1&&&&&1&N&0&N.N.N.N 2006JV.298&mcs&0&N&The cash conversion cycle is:&receivables collection period plus inventory processing period minus payables payment period.&net sales divided by cash plus marketable securities.;cost of goods sold divided by cash plus marketable securities.;payables payment period plus inventory processing period minus receivables collection period.;&LOS: Reading 35-bThe cash conversion cycle is the number of days that cash is tied up in inventory and then waiting for payment by customers less the time that the company has before they must pay suppliers.Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 326-327.&&&a&Class@SS08.2&&&&&1&N&0&N.N.N.N 2006JV.299&mcs&0&N&The gross profit margin of a company has increased steadily, this could be explained by:&a decline in raw material costs as a percentage of sales.&a foreign exchange gain.;a decline in interest expense as a percentage of sales.;a decline in sales, general and administrative expense as a percentage of sales.;&LOS: Reading 35-cGross profit is sales minus cost of goods sold and therefore would not be affected by the other answers.Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, p. 329.&&&a&Class@SS08.0&&&&&1&N&0&N.N.N.N 2006JV.300&mcs&0&N&The following financial information is given for a company:

Net profit margin = 4%
Operating profit margin = 16%
Equity turnover = 3.2
Total asset turnover = 2.5

The return on equity is closest to:&0.128&0.1;0.512;there is insufficient information given to calculate the return on equity.;&LOS: Reading 35-creturn on equity = net profit margin x equity turnover = 0.04 x 3.2 = 12.8%Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 334-337.&&&a&Class@SS08.1&&&&&1&N&0&N.N.N.N 2006JV.301&mcs&0&N&Which of the following is not an indicator of the market liquidity of a stock?&Total asset turnover.&The bid-ask spread.;The number of investors holding the stock.;The total market value of outstanding securities.;&LOS: Reading 35-bTotal asset turnover is a measure of the operating performance of a company and not related to liquidity in the market.Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 346-347.&&&a&Class@SS08.2&&&&&1&N&0&N.N.N.N 2006JV.302&mcs&0&N&The treasury stock method for calculating diluted earnings per share assumes that:&any options and warrants outstanding are exercised at the beginning of the period and the proceeds used to purchase common stock for the firm's treasury.&any dilutive securities held by the firm's treasury can be excluded from the diluted earnings per share calculation.;any dilutive securities held by the firm's treasury must be included in the diluted earnings per share calculation.;any convertible bonds outstanding are converted at the beginning of the period and the interest savings are added to the firm's interest income.;&LOS: Reading 36-dThe treasury stock method is a way of calculating earnings per share using the hypothetical assumption that any options are exercised at the beginning of the period (or date of issue if later) and the company uses the proceeds to repurchase their own stock.Reference: Kieso, Weygandt, Warfield, Dilutive Securities and Earnings per Share, Intermediate Accounting, 11th Edition, Ch. 16, pp. 796-798.&&&a&Class@SS08.0&&&&&1&N&0&N.N.N.N 2006JV.303&mcs&0&N&A company has 2,000,000 common shares outstanding throughout the last year. Total dividends of $1,000,000 were paid to common stockholders and dividends of $400,000 were paid to preferred stockholders. Net income was $6,000,000 and the tax rate was 40%. The company also had 100,000 options on common stock outstanding throughout the period; the exercise price is $20.00. The average share price over the year was $27.00 and the end year price was $35.00. The diluted earnings per share was closest to:&$2.76.&$2.74.;$2.80.;$2.96.;&LOS: Reading 36-d\\Reference: Kieso, Weygandt, Warfield, Dilutive Securities and Earnings per Share, Intermediate Accounting, 11th Edition, Ch. 16, pp. 796-798.&&&a&Class@SS08.1&&&&&1&N&0&N.N.N.N 2006JV.304&mcs&0&N&East Corporation provides the following financial information:

The cash flow coverage ratio is closest to:&11.9 times.& 7.3 times.; 9.1 times.;14.5 times.;&LOS: Reading 35-bThe text says to use traditional methods to calculate cash flow i.e. net income + depreciation + deferred tax increase.\\Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 344-345.&&&a&Class@SS08.2&&&&&1&N&0&N.N.N.N 2006JV.305&mcs&0&N&Four firms use different accounting methods to arrive at reported earnings. On the basis of the information given, which of the firms would you regard as reporting the lowest quality earnings?&Firm C - uses FIFO, amortizes goodwill over 40 years, and capitalizes start-up and computer software costs.&Firm A - uses LIFO, rapidly amortizes goodwill, and uses straight-line depreciation methods.;Firm B - uses FIFO, uses accelerated depreciation methods, and expenses start-up and computer software costs.;Firm D - uses LIFO, capitalizes start-up and computer software costs, and uses accelerated depreciation methods. ;&LOS: Reading 37-bUse of FIFO rather than LIFO, straight-line depreciation methods, capitalization of expenses, and goodwill being amortized over long periods would all indicate low earnings quality.Reference: Financial Shenanigans, 2nd edition, Howard Schilit (McGraw-Hill, 2002) "Searching for Shenanigans" Ch. 3, p. 53.&&&a&Class@SS08.0&&&&&1&N&0&N.N.N.N 2006JV.306&mcs&0&N&In the U.S. a proxy statement is an important source of information to an analyst since:&it is sent to shareholders and may contain information on management compensation that is not included in the financial statements.&it is part of the annual report to shareholders and gives information on related company transactions.;it is submitted to the SEC on a quarterly basis and provides a summary balance sheet and statement of cash flows for the company.;the audit committee repots on its findings in the proxy statement and it provides information on the accounting policies of the company.;&LOS: Reading 38-dA proxy statement may contain additional information not included in the financial statements.Reference: Financial Shenanigans, 2nd edition, Howard Schilit (McGraw-Hill, 2002) "Searching for Shenanigans" Ch. 3, p. 48.&&&a&Class@SS08.1&&&&&1&N&0&N.N.N.N 2006JV.307&mcs&0&N&A company had 500,000 common shares and $2,500,000 of a 7% convertible bond issue outstanding throughout the last accounting period. The convertible bond is convertible into 6 shares per $1,000. If the company's net income was $5,500,000 and the tax rate was 30% the diluted earnings per share was closest to.&$10.92.&$10.68.;$11.00.;$11.25.;&LOS: Reading 36-d\\Reference: Kieso, Weygandt, Warfield, Dilutive Securities and Earnings per Share, Intermediate Accounting, 11th Edition, Ch. 16, pp. 794-796.&&&a&Class@SS08.2&&&&&1&N&0&N.N.N.N 2006JV.308&mcs&0&N&When a company switches from debt to equity financing this will:&I. reduce its equity turnover.&II. increase its debt equity ratio.;III. reduce its fixed asset turnover.;IV. increase its financial leverage multiplier.;&LOS: Reading 35-bII. is not correct since its debt equity ratio will decrease.III. is not correct since the fixed asset turnover will be unchanged.IV. is not correct since its financial leverage ratio, which is total assets/equity, will decrease.Its equity turnover (sales/equity) will decrease, so I. is correct.Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 341-342.&&&a&Class@SS08.0&&&&&1&N&0&N.N.N.N 2006JV.309&mcs&0&N&All of the following ratios are used to measure operating performance EXCEPT:&receivables turnover.&return on total equity.;operating profit margin.;net fixed asset turnover.;&LOS: Reading 35-bReceivables turnover is a measure of internal liquidity.Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 327-334.&&&a&Class@SS08.1&&&&&1&N&0&N.N.N.N 2006JV.310&mcs&0&N&All of the following ratios are used to measure financial risk EXCEPT:&working capital/sales. &debt/equity ratio.;interest coverage.;cash flow coverage.;&LOS: Reading 35-bWorking capital/sales is a measure of internal liquidity.Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 340-346.&&&a&Class@SS08.2&&&&&1&N&0&N.N.N.N 2006JV.311&mcs&0&N&If the cash flow/long-term debt ratio has risen for a firm this could be explained by:&IV. the firm has switched from using long-term debt to using more short-term borrowing to finance its activities.&I. the book value of debt has not changed but the market value of long-term debt has decreased.;II. the book value of debt has not changed but the market value of long-term debt has increased.;III. the firm has switched from using short-term borrowing to using more long-term debt to finance its activities.;&LOS: Reading 35-bI. and II. are not correct since the book value of long-term debt is used in the calculation.III. would lead to a fall in the cash flow/long-term debt ratio.Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 345-346.&&&a&Class@SS08.0&&&&&1&N&0&N.N.N.N 2006JV.312&mcs&0&N&If a firm's cash ratio is below the industry average but the current ratio is above the industry average this might be explained by:&the firm has a high level of receivables compared with the rest of the industry.&the firm doesn't hold any current assets.;the firm prefers to hold marketable securities rather than cash.;the firm has low inventory levels compared with the rest of the industry.;&LOS: Reading 35-cThe current ratio includes all current assets in the numerator and the cash ratio only includes cash and marketable securities. This could indicate high levels of inventory, receivables and/or other current assets.Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, p. 324.&&&a&Class@SS08.1&&&&&1&N&0&N.N.N.N 2006JV.313&mcs&0&N&A firm reports the following financial information:

Operating profit margin = 30%
Tax retention rate = 80%
Financial leverage multiplier = 3.5
Interest expense rate = 0.2

Under the DuPont system the return on equity is closest to:&there is insufficient information to calculate the return on equity.& 1.4%.;16.8%.;26.3%.;&LOS: Reading 35-cThe total asset turnover is needed to calculate the return on equity.Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 334-337.&&&a&Class@SS08.2&&&&&1&N&0&N.N.N.N 2006JV.314&mcs&0&N&A company is deciding which accounting policies to adopt and actions to take with the objective of boosting current period net income. Which of the following is NOT likely to be done?&Moving from using a straight-line depreciation method to using an accelerated depreciation method for the purchase of new assets.&Moving to capitalizing operating expenses.;Delaying writing down impaired assets to a future date.;Selling machinery that has been fully depreciated in the balance sheet.;&LOS: Reading 37-aCapitalizing expenses will spread the costs of current and future years thereby increasing current year earnings.Delaying impairment will delay taking losses, artificially boosting current year income.Selling assets that have been fully depreciated will create a gain.An accelerated depreciation method rather than a straight-line method would increase the depreciation charge in the first year, reducing income so is not likely to be adopted.Reference: Financial Shenanigans, 2nd edition, Howard Schilit (McGraw-Hill, 2002)"Seek and Ye Shall Find" Ch. 2, pp. 24-25.&&&a&Class@SS08.0&&&&&1&N&0&N.N.N.N 2006JV.315&mcs&0&N&Footnotes to the financial statements are an important source of information to analystssince they provide information on all of the following EXCEPT?&Changes in management compensation.&Details of contingent liabilities.;Details of changes in accounting policies.;Long-term commitments to purchase raw materials.;&LOS: Reading 38-dFootnotes provide information on the financial condition of the company including accounting policies, related-party transactions and contingencies.Reference: Financial Shenanigans, 2nd edition, Howard Schilit (McGraw-Hill, 2002) "Searching for Shenanigans" Ch. 3, p. 52.&&&a&Class@SS08.1&&&&&1&N&0&N.N.N.N 2006JV.316&mcs&0&N&The gross profit margin of a company has declined relative to its competitors. This could be explained by:&the company has switched to using LIFO accounting rather than FIFO accounting in an inflationary environment.&the company's credit quality has declined pushing up the interest rate on short-term debt.;the company has recognized losses on plant and equipment that has become obsolete.;the company has increased its marketing efforts and hired additional marketing executives.;&LOS: Reading 35-cGross profit margin is (revenue - COGS)/revenue.Interest expense, losses on sale of plant and equipment and marketing expense are not part of COGS. LIFO accounting would increase the cost of inventory sold thereby reducing the gross margin.Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, p. 329.&&&a&Class@SS08.2&&&&&1&N&0&N.N.N.N 2006JV.317&mcs&0&N&A company has a low fixed asset base relative to its sector average. It is generally the case that&investors will tolerate a higher debt/equity relative to other companies in the sector.&its sales variability is higher than that of other companies in the sector.;the company's financial risk is lower than that of other companies in the sector.;operating profits will be relatively volatile compared to other companies in the sector. ;&LOS: Reading 35-cA low fixed asset base generally leads to lower operating risk, i.e. operating profits are less sensitivity to changes in sales revenue. Investors will usually accept greater financial risk of operating risk is lower. One of the measures of financial risk is the debt/equity ratio.Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 338-341.&&&a&Class@SS08.0&&&&&1&N&0&N.N.N.N 2006JV.318&mcs&0&N&The return on total capital of a company has increased, this could be explained by:&the company has sold unprofitable businesses units and used the proceeds to reduce debt.&the company has become less risky and therefore a higher return on total capital is required.;the company's operating profit has been deteriorating as competitive pressure increases.;the company has increased borrowing to expand its operating capacity but this has not yet been reflected in a rise in earnings.;&LOS: Reading 35-cThe total capital will have been reduced by the repayment of debt thereby increasing the return on total capital.Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 330-331.&&&a&Class@SS08.1&&&&&1&N&0&N.N.N.N 2006JV.319&mcs&0&N&A major competitor of a company has the same net profit margin and total asset turnover as the company. The competitor's return on equity is higher, this is explained by the competitor having:&higher financial leverage.&a lower tax rate.;lower interest costs as a percentage of sales.;lower interest costs as a percentage of operating profit.;&LOS: Reading 35-cReturn on equity = profit margin x total asset turnover x financial leverageReference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 334-338.&&&a&Class@SS08.2&&&&&1&N&0&N.N.N.N 2006JV.320&mcs&0&N&If a firm has a net profit margin of 6%, earnings per share of $1.20, a dividend pay out ratio of 30% and return on equity of 15%, the sustainable potential growth rate is closest to:&10.5%.& 4.2%.; 4.5%.; 9.0%.;&LOS: Reading 35-bThe sustainable growth rate = earnings retention rate x ROE = 0.70 x 0.15 = 10.5%Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 348-349.&&&a&Class@SS08.0&&&&&1&N&0&N.N.N.N 2006JV.321&mcs&0&N&If a firm decides to capitalize rather than expense the cost of assets this will mean:&the return on assets will be less volatile and in the long term the return on assets will be lower.&the return on assets will be more volatile and in the long term the return on assets will be lower.;the return on assets will be less volatile and in the long term the return on assets will be higher.;the return on assets will be more volatile and in the long term the return on assets will be higher.;&LOS: Reading 40-aCapitalization will lead to higher reported assets that will increase the denominator of return on assets. Earnings will be less volatile than if assets were expensed, expensing would lead to large fluctuations in earnings.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 7, pp. 229-233.&&&a&Class@SS09.1&&&&&1&N&0&N.N.N.N 2006JV.322&mcs&0&N&If prices of a product are falling the use of LIFO rather than FIFO will lead to:&higher working capital and higher net income.&lower working capital and lower net income.;lower working capital and higher net income.;higher working capital and lower net income.;&LOS: Reading 39-bCOGS will be lower under LIFO in a period of falling prices leading to higher net income and higher tax payments. Working capital will be higher since the higher inventory value will outweigh the lower cash balance due to higher tax payments.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 6, pp. 198-199.&&&a&Class@SS09.2&&&&&1&N&0&N.N.N.N 2006JV.323&mcs&0&N&Which of the following statements is FALSE regarding accelerated depreciation methods?&Accelerated depreciation methods depreciate an asset in proportion to its actual use.&Accelerated depreciation compensates for the rising repair costs as an asset ages.;Accelerated depreciation methods are often used to reduce the tax burden immediately after an asset is purchased.;Accelerated depreciation methods are appropriate if the benefits from using an asset are highest when it is relatively new.;&LOS: Reading 41-aThe Answer:"Accelerated depreciation methods depreciate an asset in proportion to its actual use."is not correct since the units of production method depreciates assets in proportion to their use, and thus becomes a variable cost. Accelerated depreciation reduces the value of an asset by the largest amount in the early years regardless of when it is getting the most use.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 8, pp. 260-262.&&&a&Class@SS09.0&&&&&1&N&0&N.N.N.N 2006JV.324&mcs&0&N&Impairment of an asset must be recognized in a firm's accounts when:&III. the carrying value of the asset is higher than the expected future cash flows from the use of the asset plus its disposal value.&I. there has been a decrease in the market value of the asset.;II. there has been an increase in the replacement cost of the asset.;IV. the carrying value of the asset is higher than the present value of expected future cash flows from the use of the asset plus its discounted disposal value.;&LOS: Reading 41-cI. does not automatically lead to a write down if the value of the asset can be recovered through future cash flows.II. is not correct; replacement cost does not impact on the value of an asset in the balance sheet.IV. is not correct; this is one of the calculations that can be done to work out the size of the loss on an impaired asset.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 8, pp. 275-276.&&&a&Class@SS09.1&&&&&1&N&0&N.N.N.N 2006JV.325&mcs&0&N&Long-lived assets refer to:&resources that are used to provide services to the company and are not bought with the intention of resale.&tangible fixed assets including plant and machinery.;assets that are held by the company for more than one year.;assets that are held by the company for more than five years.;&LOS: Reading 40-aLong-lived assets are used by the productive or administrative sides of a company to support the company's business but are not bought for resale, these include tangible and intangible assets. It does not include items such as inventory, although inventory could also be held long term.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 7, p. 228.&&&a&Class@SS09.2&&&&&1&N&0&N.N.N.N 2006JV.326&mcs&0&N&Which inventory accounting method usually gives a valuation of inventory that is closest to its economic value:&FIFO.&LIFO.;average cost method.;lower of cost or market.;&LOS: Reading 39-aSince FIFO leaves the most recently purchased goods in inventory the valuation will usually be the closest to current values.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 6, pp. 195-196.&&&a&Class@SS09.0&&&&&1&N&0&N.N.N.N 2006JV.327&mcs&0&N&U.S. GAAP requires that inventories are:&stated at lower of cost or market.&stated at cost.;stated at replacement value.;stated either at cost or market value, but the company must be consistent in which method they use. ;&LOS: Reading 39-dInventories must be stated at lower of cost or market value. Market value is defined as replacement cost.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 6, p. 220.&&&a&Class@SS09.1&&&&&1&N&0&N.N.N.N 2006JV.328&mcs&0&N&Which of the following statements concerning patents in the U.S. is CORRECT?&III. The acquisition costs of buying patents must be capitalized.&I. Patents have a legal life of 50 years.;II. The value of a patent is constant throughout its life.;IV. Legal costs associated with developing patents internally must be expensed, other costs are capitalized.;&LOS: Reading 40-aI. is not correct since patents have a legal life of 17 years; copyrights have a legal life of 50 years beyond the creator's life time.II. is not correct since patents can often become worthless if competition enters the market or the product becomes out of date.IV. is not correct since costs for internally generated patents should be expensed except for the legal costs which can be capitalized.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 7, p. 239.&&&a&Class@SS09.2&&&&&1&N&0&N.N.N.N 2006JV.329&mcs&0&N&The cost of land and subsequent development of an oil well is $3 million, and it is estimated to contain 500,000 barrels of oil, and have a life of 5 years. If, in the first year 60,000 barrels are extracted, then the depletion expense is:&360000&240000;480000;600000;&LOS: Reading 41-aThe rate of depletion is $6/bbl so if 60,000 barrels are extracted the depletion expense is $360,000.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 8, p. 262.&&&a&Class@SS09.0&&&&&1&N&0&N.N.N.N 2006JV.330&mcs&0&N&A company buys a piece of machinery for $50,000 and it estimates the life of the machine to be four years after which it will have a salvage value of $10,000. Using the double-declining-balance method of depreciation what will be the depreciation charge in the third year?&2500&5000;6250;12500;&LOS: Reading 41-aDepreciation expense will be:Year 1 ½ x ($50,000 ) = $25,000Year 2 ½ x ($50,000 - $25,000) = $12,500Year 3 ½ x ($50,000 - $37,500) = $6,250 but this is reduced to $2,500 since the machinery has already reached its salvage value.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 8, pp. 260-262.&&&a&Class@SS09.1&&&&&1&N&0&N.N.N.N 2006JV.331&mcs&0&N&If a firm decides to capitalize rather than expense the cost of assets this will lead to:&higher cash flow from operations.&lower cash flow from operations.;no impact on cash flow from operations.;higher or lower cash flow from operations depending on the level of expenditure on assets.;&LOS: Reading 40-aCash flow from operations will be higher since the cost will be recorded in the cash flow from investments.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 7, p. 237.&&&a&Class@SS09.2&&&&&1&N&0&N.N.N.N 2006JV.332&mcs&0&N&Which of the following costs related to the acquisition of a long-lived asset must be capitalized in the U.S.?&I. Installation costs.II. Freight and delivery costs.&I. Installation costs.;I. Installation costs.II. Research and development costs.;I. Installation costs.II. Freight and delivery costs.III. Research and development costs.;&LOS: Reading 40-aResearch and development costs in the U.S. should be treated as an expense when they occur.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 7, pp. 236-237.&&&a&Class@SS09.0&&&&&1&N&0&N.N.N.N 2006JV.333&mcs&0&N&When calculating financial ratios based on financial statements it is usually better to use:&LIFO for income statement related ratios and FIFO for balance sheet related ratios.&FIFO in all cases.;LIFO in all cases.;FIFO for income statement related ratios and LIFO for balance sheet related ratios.;&LOS: Reading 39-bLIFO usually gives a fairer value of COGS, since LIFO costs are closer to replacement costs, so LIFO will generally be used for income statement analysis. FIFO, however, gives a fairer valuation of inventories, giving a value that is closer to market value, so will generally be used for balance sheet analysis.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 6, pp. 206-211.&&&a&Class@SS09.1&&&&&1&N&0&N.N.N.N 2006JV.334&mcs&0&N&A company uses accelerated depreciation methods for financial reporting, rather than a straight-line depreciation method. At the beginning of an asset's life this will:&have no impact on cash flow.&decrease investing cash flow.;increase cash flow from operations.;decrease cash flow from operations.;&LOS: Reading 41-aSince deprecation is not a cash item it will not impact on cash flow.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 8, p. 265.&&&a&Class@SS09.2&&&&&1&N&0&N.N.N.N 2006JV.335&mcs&0&N&Manufacturers Corporation provides the following data:

Machinery and Equipment 2005
Gross Investment $345 million
Accumulated Depreciation $165 million
Depreciation Expense $ 26 million (straight-line method)


The average age of the machinery is closest to:& 6.3 years.& 2.1 years.; 6.9 years.;13.3 years.;&LOS: Reading 41-b\\Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 8, pp. 272-275.&&&a&Class@SS09.0&&&&&1:v&&& 2006JV.336&mcs&0&N&The average age of Manufacturers Corporation's machinery is lower than other companies in the same industry. Which of the following is the least likely to explain this?&the company has just made major write downs of impaired assets.&the company uses a shorter depreciation life for machinery than its competitors.;the company has just finished a major capital expenditure program to replace machinery.;the company has just acquired another manufacturing company and is making use of its machinery, at the time of acquisition the depreciation on this machinery was set at zero.;&LOS: Reading 41-cImpairment of assets would lead to lower current depreciation charges, this will lead to a higher average asset life.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 8, pp. 272-275.&&&a&Class@SS09.1&&&&&1&N&0&N.N.N.N 2006JV.337&mcs&0&N&A company decides to use the sum-of-years'-digits depreciation method to depreciate a piece of machinery that they are purchasing for $35,000. They estimate that the machinery has a depreciable life of 6 years and a salvage value of $8,000. The net book value of the machinery at the end of the third year is closest to:&15714&10370;19286;21500;&LOS: Reading 41-aoriginal cost minus salvage value = $27,000sum-of-years' digits = 21\\Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 8, pp. 260-262.&&&a&Class@SS09.2&&&&&1&N&0&N.N.N.N 2006JV.338&mcs&0&N&All of the following are examples of intangible assets EXCEPT:&LIFO reserve.&patents.;licenses.;copyrights.;&LOS: Reading 40-aIntangible assets are revenue-producing assets that are identifiable but non-monetary resources. LIFO reserve is an adjustment in the measurement of the value of inventories.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 7, pp. 235-236.&&&a&Class@SS09.0&&&&&1&N&0&N.N.N.N 2006JV.339&mcs&0&N&In a period of rising prices and stable inventory quantities, cash flows will be:&higher under LIFO than FIFO.&lower under LIFO than FIFO.;the same whether LIFO or FIFO is used.;higher or lower under LIFO than FIFO depending on inventory turnover.;&LOS: Reading 39-bCOGS will be higher under LIFO leading to lower pretax income and lower tax being paid. This will lead to higher cash flows.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 6, pp. 198-199.&&&a&Class@SS09.2&&&&&1&N&0&N.N.N.N 2006JV.340&mcs&0&N&A company is a producer of coffee and provides the following financial data:

$ million20042005
Inventories (year end)185205
COGS1,5601,750


The company uses FIFO for inventory accounting. Assuming that the major constituent of inventory is coffee, and coffee prices rose by 30% over the period, the COGS under LIFO in 2004 is approximately:&$1805.5 million.&$1770.0 million.;$1811.5 million.;$1935.0 million.;&LOS: Reading 39-bCOGS under LIFO= COGS under FIFO + (Beginning Inventory under FIFO x r)where r is the inflation rate for the goods being produced.= 1750 + (185 x 0.30)= 1805.5Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 6, pp. 202-203.&&&a&Class@SS09.0&&&&&1:v&&& 2006JV.341&mcs&0&N&A company constructs a new factory and finances the factory partly from borrowings and partly using retained earnings. In line with U.S. accounting rules, during the construction period the firm should:&only capitalize the interest costs associated with the borrowing.&expense the interest costs associated with the borrowing.;capitalize the interest costs associated with the borrowing and the cost of the equity used.;expense or capitalize the costs associated with financing the factory depending on the company's internal policy.;&LOS: Reading 40-aAlthough somewhat inconsistent, only interest costs are capitalized.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 7, pp. 233-235.&&&a&Class@SS09.1&&&&&1&N&0&N.N.N.N 2006JV.342&mcs&0&N&Pens are purchased by a company at $10.00 each, and then sold at $12.50; both prices are constant over the year. The inventory at the beginning of the year was 7,000 pens, 50,000 pens were purchased during the year and the ending inventory was 15,000 pens. The cost of goods sold was:&420000&525000;580000;725000;&LOS: Reading 39-aEnding Inventory = Beginning Inventory + Purchases - COGS15,000 x $10 = (7,000 x $10) + (50,000 x $10) - COGSCOGS = $420,000Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 6, pp. 193-194.&&&a&Class@SS09.2&&&&&1&N&0&N.N.N.N 2006JV.343&mcs&0&N&Internationally the treatment of research and development costs is:&both research and development costs are normally expensed.&both research and development costs are normally capitalized.;research costs are capitalized and development costs are normally expensed.;research costs are expensed and development costs are normally capitalized.;&LOS: Reading 40-aAlthough some countries do permit development costs to be capitalized, the usual treatment is for both research and development costs to be expensed in the year that they occur.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 7, p. 237.&&&a&Class@SS09.1&&&&&1&N&0&N.N.N.N 2006JV.344&mcs&0&N&In a high inflation environment if a firm uses straight-line depreciation methods this will tend to contribute to:&reported earnings being higher than economic earnings and there being a disincentive to make new investments.&reported earnings being lower than economic earnings and there being an incentive to make new investments.;reported earnings being higher than economic earnings and there being an incentive to make new investments.;reported earnings being lower than economic earnings and there being a disincentive to make new investments.;&LOS: Reading 41-aIn a high inflation environment the replacement cost of the asset increases so depreciation, which is based on historic cost, will be insufficient to pay for a replacement asset. In this case reported income is higher than economic earnings of the company and the taxes paid by the company are too high. If the company makes new investments the depreciation expense will increase sharply.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 8, pp. 266-268.&&&a&Class@SS09.2&&&&&1&N&0&N.N.N.N 2006JV.345&mcs&0&N&Top Radios Inc. provided the following data regarding its radio purchases and sales over last year.

The reported value of inventory using LIFO and FIFO respectively at 31st December was:

LIFO FIFO&$364,000 $386,500&$364,000 $375,600;$375,600 $386,500;$386,500 $364,000;&LOS: Reading 39-aLIFO: ending inventory 1,200 radios, 1,000 @ $300 and 200 @ $320 = $364,000FIFO: ending inventory 1,200 radios, 500 @ $325 and 700 @ $320 = $386,500Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 6, pp. 194-195.&&&a&Class@SS09.0&&&&&1&N&0&N.N.N.N 2006JV.346&mcs&0&N&Top Radios Inc. provided the following data regarding its radio purchases and sales over last year.

The reported value of inventory using LIFO and FIFO respectively at 31st December is as follows.Top Radios Inc. provided the following

LIFO: ending inventory = $364,000
FIFO: ending inventory = $386,500

The Cost of Goods Sold for Top Radios Inc. was:&higher under LIFO than using the weighted average cost method.&higher under FIFO than using LIFO.;higher under FIFO than using the weighted average cost method.;higher using the weighted average cost method than under LIFO.;&LOS: Reading 39-aLIFO: COGS 1300 radios, 500 @ $ 325 and 800 @ $320 = $418,500FIFO: COGS 1300 radios, 1,000 @ $300 and 300 @ $320 = $396,000Weighted Average: cost of goods available was $782,500/2,500 = $313COGS = 1,300 radios @ $313 = $ 406,900Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 6, pp. 194-195.&&&a&Class@SS09.1&&&&&1&N&0&N.N.N.N 2006JV.347&mcs&0&N&A company decides to use the straight-line depreciation method to depreciate a fixed asset that they are purchasing for $50,000 and they estimate that the asset has a depreciable life of 10 years and a salvage value of $5,000. The net book value of the asset at the end of the second year will be:&41000&35000;36000;40000;&LOS: Reading 41-aOriginal cost - salvage value = $50,000 - $5,000 = $45,000Straight-line method means depreciation expense each year will = $45,000/10 = $4,500Therefore accumulated depreciation after the second year = $9,000Net book value = $50,000 - $9,000 = $41,000Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 8, pp. 259-260.&&&a&Class@SS09.2&&&&&1&N&0&N.N.N.N 2006JV.348&mcs&0&N&If a company makes write downs due to impairments of long-lived assets this will:&decrease deferred tax liabilities and increase the debt to equity ratio.&increase deferred tax liabilities and increase the debt to equity ratio.;increase deferred tax liabilities and decrease the debt to equity ratio.;decrease deferred tax liabilities and decrease the debt to equity ratio.;&LOS: Reading 41-cImpairment losses are not recognized for tax purposes until the asset is disposed of and therefore deferred tax will be reduced. Impairment write-downs will lead to reduction in asset values and equity values and therefore an increase in the debt to equity ratio.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 8, p. 277.&&&a&Class@SS09.0&&&&&1&N&0&N.N.N.N 2006JV.349&mcs&0&N&A vehicle is purchased for $50,000 and has an assumed life of 100,000 miles when it will have a salvage value of $20,000. If it is driven for 5,000 miles in a year and the depreciation method used is units-of-production then the depreciation expense for the year will be:&1500&1000;2500;10000;&LOS: Reading 41-aThe cost per mile is the purchase cost minus the salvage value divided by the assumed life, this is $0.30 per mile. If the vehicle is used for 5,000 miles in a year the depreciation expense for that year will be $1,500.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 8, pp. 262-264.&&&a&Class@SS09.1&&&&&1&N&0&N.N.N.N 2006JV.350&mcs&0&N&In an environment of rising prices using LIFO to calculate a firm's current ratio will:&be less relevant than using FIFO and lead to a lower current ratio.&be less relevant than using FIFO and lead to a higher current ratio.;be more relevant than using FIFO and lead to a lower current ratio.;be more relevant than using FIFO and lead to a higher current ratio.;&LOS: Reading 39-bInventories under LIFO are calculated using old costs so are often meaningless as a measure of current value. Current assets under LIFO will be lower and therefore the current ratio will be lower than under FIFO.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 6, pp. 208-209.&&&a&Class@SS09.2&&&&&1&N&0&N.N.N.N 2006JV.351&mcs&0&N&The following financial data is provided by Sportswear Corporation:

$ million (using LIFO)20042005
Inventory105125
Current Assets 300350
LIFO reserve4555
Current Liabilities110 160
COGS14501700

The current ratios using FIFO are closest to: 2004 2005&3.14 2.53&1.36 1.13;2.32 1.84;2.73 2.19;&LOS: Reading 39-bAdjust current assets by adding the LIFO reserve to get current assets under FIFO of 345 in 2004 and 405 in 2005.Current ratio is current assets /current liabilities = 345/110 and 405/160 respectively which equal 3.14 and 2.53 respectively.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 6, pp. 208-209.&&&a&Class@SS09.0&&&&&1:v&&& 2006JV.352&mcs&0&N&The following financial data is provided by Sportswear Corporation:

$ million (using LIFO)20042005
Inventory105125
Current Assets 300350
LIFO reserve4555
Current Liabilities110 160
COGS14501700

The inventory turnover in 2004 using the current cost method for Sportswear Corporation is closest to:&10.3.& 9.4.;10.6.;15.5.;&LOS: Reading 39-bUsing LIFO for COGS in the numerator and the FIFO inventory balance in the denominator:\\Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 6, pp. 209-210.&&&a&Class@SS09.1&&&&&1:v&&& 2006JV.353&mcs&0&N&A company with a large LIFO reserve has:&been using LIFO to calculate inventory balances and has understated the value of inventory compared with the current market value.&been using LIFO to calculate inventory balances and has overstated the value of inventory compared with the current market value.;been using FIFO to calculate inventory balances and has overstated the value of inventory compared with the current market value.;been using FIFO to calculate inventory balances and has understated the value of inventory compared with the current market value.;&LOS: Reading 39-bThe LIFO reserve is the inventory calculated using FIFO minus the inventory calculated using LIFO and is used since accounting using LIFO usually leads to an understatement of the inventory balance compared with current values.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 6, pp. 200-201.&&&a&Class@SS09.2&&&&&1&N&0&N.N.N.N 2006JV.354&mcs&0&N&A mining company is required by regulation to restore land to its original state when mining has finished. Under SFAS 143 the company is required to:&IV. calculate the present value of restoring the land to its original state at the end of each year and recognize the difference as accretion expense.&I. calculate the undiscounted cost of restoring the land to its original state and depreciate this cost over the life of the mine.;II. calculate the present value of restoring the land to its original state and deduct this from the carrying value of the assets.;III. calculate the present value of restoring the land to its original state and recognize this as an expense in the first year of operation of the mine.;&LOS: Reading 41-dI. is not correct, the cost should be discounted.II. is not correct, present value should be added to the asset value.III. is not correct, the cost should be added to the asset value and be depreciated over the useful life of the mine.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 8, p. 280.&&&a&Class@SS09.0&&&&&1&N&0&N.N.N.N 2006JV.355&mcs&0&N&A company has just bought a machine and wants to maximize the depreciation expense in the first year. They would consider:&using an accelerated depreciation method.&understating the cost.;overestimating the useful life of the machine.;overestimating the salvage value of the machine.;&LOS: Reading 41-aOverestimating the salvage value or life of the machine would reduce the depreciation charges.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 8, pp. 259-268.&&&a&Class@SS09.1&&&&&1&N&0&N.N.N.N 2006JV.356&mcs&0&N&A U.S. company reviews the value of its fixed assets and finds that an asset that had been written down due to impairment in the previous accounting period now has a carrying value less than the future cash flows anticipated from the asset. The company should:¬ do anything, an increase in the value of assets cannot be recognized until they are sold. &revise the value of the asset and record the gain as 'other income'.;revise the value of the asset and record the gain as an unusual item.;revise the value of the asset and record the gain as an extraordinary income.;&LOS: Reading 41-cAn increase in the value of an asset cannot be recognized until sale and also previous impairments cannot be restored.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 8, pp. 276-278.&&&a&Class@SS09.2&&&&&1&N&0&N.N.N.N 2006JV.357&mcs&0&N&A franchisee who buys the rights to use a name, a product and management expertise of another company should:&capitalize the cost of purchasing these rights.&expense the costs of purchasing these rights.;capitalize the cost of purchasing the rights to use a name and expense the cost of the right to use a product and management expertise.;capitalize the cost of purchasing the rights to use a name and a product and expense the cost of the right to use management expertise.;&LOS: Reading 40-aAll the costs of purchase should be capitalized.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 7, pp. 239-240.&&&a&Class@SS09.0&&&&&1&N&0&N.N.N.N 2006JV.358&mcs&0&N&If a company decided to change the estimated life of an asset that is already owned by the company it must:&II. not make any retroactive adjustment.&I. restate prior years' accounts.;III. disclose it as a change in accounting principle.;IV. calculate the cumulative effect of the change and report net of taxes.;&LOS: Reading 41-aI. , III. and IV. are not correct since changing an estimate of life of an asset is not a change in accounting principle.Since this is only a change in accounting estimate there is no need to make retroactive adjustments, only current and future depreciation expense will be affected.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 8, pp. 268-270.&&&a&Class@SS09.1&&&&&1&N&0&N.N.N.N 2006JV.359&mcs&0&N&If the Cost of Goods Sold under LIFO is $20 million, the increase in LIFO reserve over the same period is $5 million, and the closing inventory under LIFO is $80 million, then the Cost of Goods Sold under FIFO is:&$15 million.&$25 million.;$75 million.;$85 million.;&LOS: Reading 39-bCOGS under FIFO = COGS under LIFO - change in LIFO reserve.COGS under FIFO = $20 million - $5 million = $15 millionReference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 6, pp. 200-201.&&&a&Class@SS09.2&&&&&1&N&0&N.N.N.N 2006JV.360&mcs&0&N&Most companies internationally use which accounting method for depreciating assets?&Straight-line depreciation methods.&Units-of-production methods.;Declining-balance depreciation methods.;Sum-of-years'-digits depreciation methods. ;&LOS: Reading 41-aStraight-line deprecation methods are usually used.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 8, pp. 258-260.&&&a&Class@SS09.0&&&&&1&N&0&N.N.N.N 2006JV.361&mcs&0&N&If a company issues a zero coupon bond:&an analyst should reduce cash flow from operations to reflect the portion of discount amortization that represents interest expense.&an analyst should reduce cash flow from investing to reflect the portion of discount amortization that represents interest expense.;an analyst should increase cash flow from investing to reflect the portion of discount amortization that represents interest expense.;an analyst should increase cash flow from operations to reflect the portion of discount amortization that represents interest expense.;&LOS: Reading 43-aCash flow from operations is overstated since the full repayment of maturity value is treated as a financing cash flow whereas it is representing interest repayments, which should be classified as operating cash flow.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 10, pp. 329-332.&&&a&Class@SS10.1&&&&&1&N&0&N.N.N.N 2006JV.362&mcs&0&N&The following information is given regarding a company's activities:

* Tax rate is 30%.
* The only expense is depreciation.
* A new machine is purchased at a cost of $10,000.
* Annual revenues of $40,000 are generated from the new machine.
* The company, in its financial reports, depreciates the machine by using the straight-line method over four years and the salvage value is estimated to be $2,000.
* For tax purposes the machine is depreciated using the straight-line method over two years with the same salvage value.

The deferred tax expense in year 2 will be:&600&1200;10800;11400;&LOS: Reading 42-eTax reporting - straight-line depreciation over two years\\Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 9, pp. 292-296.&&&a&Class@SS10.2&&&&&1&N&0&N.N.N.N 2006JV.363&mcs&0&N&The following information is given regarding a company's activities:

* Tax rate is 30%.
* The only expense is depreciation.
* A new machine is purchased at a cost of $10,000.
* Annual revenues of $40,000 are generated from the new machine.
* The company, in its financial reports, depreciates the machine by using the straight-line method over 4 years and the salvage value is estimated to be $2,000.
* For tax purposes the machine is depreciated using the straight-line method over two years with the same salvage value.
* The deferred tax expense in year 2 is $600.

The change in deferred tax liability in year 2 will be:&an increase of $600.&a decrease of $600.;a decrease of $1,200.;an increase of $1,200.;&LOS: Reading 42-eThe deferred tax liability is the difference between the book value of assets on the financial statements and the book value used in tax reporting, which is 30% x $4,000 = $1,200, this is an increase of $600 over the first year.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 9, pp. 292-296.&&&a&Class@SS10.0&&&&&1&N&0&N.N.N.N 2006JV.364&mcs&0&N&A company enters into a 2-year lease agreement to lease a photocopier; the photocopier has a fair value of $25,000. The agreement specifies that:

* The economic life of the photocopier is estimated to be three years.
* The lessee will pay lease payments that have a present value of $24,000.
* The lessee has no rights to purchase the photocopier at the end of the lease period.

The lease should be classified by the lessee as:&a capital lease since the present value of the lease payments is more than 90% of the fair value of the photocopier.&an operating lease because not all of the conditions for it to be a capital lease have been met.;a capital lease since the lessee term is greater than 50% of the economic life of the photocopier.;an operating lease since the lessee has no right to buy the photocopier at the end of the lease period.;&LOS: Reading 44-aA lease meeting any of the following conditions must be treated as a capital lease. 1. terms for transfer or purchase of ownership 2. lease term equal to or more than 75% of the economic life 3. present value of lease payments equal to or more than 90% of the fair value.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 11, pp. 365-368.&&&a&Class@SS10.1&&&&&1&N&0&N.N.N.N 2006JV.365&mcs&0&N&If a company uses straight-line methods to depreciate assets, then classifying a lease as an operating lease rather than a capital lease will lead to:&higher net income at the beginning of the lease period and then lower net income.&lower net income throughout the lease period.;higher net income throughout the lease period.;lower net income at the beginning of the lease period and then higher net income.;&LOS: Reading 44-bTotal expense over the life of the lease will be the same but under the capital lease total lease expense will be higher in the early years (since the interest cost is higher).Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 11, pp. 368-370.&&&a&Class@SS10.2&&&&&1&N&0&N.N.N.N 2006JV.366&mcs&0&N&The effective interest rate of a bond is:&the market rate at the time of issue.&the coupon rate of the bond.;the market rate throughout the life of the bond.;the rate that an investor earns on the bond when the bond is purchased in the secondary market. ;&LOS: Reading 43-aThe market rate at the time of issue of the bond gives the cost to the issuer over the life of the bond, it is the cost to the issuer that is important not the rate available at a later date in the secondary market.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 10, p. 327.&&&a&Class@SS10.0&&&&&1&N&0&N.N.N.N 2006JV.367&mcs&0&N&Income tax expense is:&III. expense resulting from current period pretax income.&I. income tax actually paid.;II. taxes payable less deferred income tax expense.;IV. tax return liability based on current period taxable income.;&LOS: Reading 42-aI. is not correct since this will include payments for previous years.II. is not correct since income tax expense is taxes payable plus deferred income tax expense.IV. is the taxes payable.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 9, p. 292.&&&a&Class@SS10.1&&&&&1&N&0&N.N.N.N 2006JV.368&mcs&0&N&A company decides to reduce the valuation allowance on a deferred tax asset resulting from tax loss carryforwards. This will:&increase net profit margins.&increase asset turnover.;increase financial leverage;reduce stockholders' equity;&LOS: Reading 42-bReducing the valuation allowance will increase income from continuing operations and increase the value of assets and stockholders' equity, thereby reducing leverage and asset turnover.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 9, pp. 299-300.&&&a&Class@SS10.2&&&&&1&N&0&N.N.N.N 2006JV.369&mcs&0&N&A company enters into an agreement to lease equipment (treated as a capital lease) over two years and will pay lease payments of $50,000 at the end of each year. If the discount rate used is 8% the closing liability at the end of the first year is closest to?&46296&44582;50000;58000;&LOS: Reading 44-bAt the beginning of the lease period the liability will be the present value of the lease payments, which is $89,163. The first lease payment is divided between interest (8% x $89,163 = $7,133) and principal repayment. Therefore the liability is reduced by $42,867 to $46,296.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 11, pp. 368-369.&&&a&Class@SS10.0&&&&&1&N&0&N.N.N.N 2006JV.370&mcs&0&N&The reported effective tax rate is:&income tax expense divided by pretax income.&always equal to the statutory tax rate.;taxes payable divided by pretax income.;equal to the statutory tax rate over long time periods.;&LOS: Reading 42-dStatutory tax rates will differ from the effective tax rate for a number of reasons e.g. permanent differences between financial and taxable income, overseas operations being taxed at different rates.Taxes payable divided by pretax income is the current tax expense.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 9, pp. 306-308.&&&a&Class@SS10.1&&&&&1&N&0&N.N.N.N 2006JV.371&mcs&0&N&Market rates are 5.0% per annum and a 6.0% semi annual coupon bond is issued at $1,100 with a face value of $1,000. If an investor buys 1,000 bonds at issue and receives a coupon payment after six months how much of this coupon payment will be recorded as principal repayment by the issuer?&2500&5000;5500;30000;&LOS: Reading 43-aThe coupon paid will be 3.0% multiplied by $1,000,000, which is $30,000. The interest the investor earns is 2.5% multiplied by $1,100,000, which is $27,500, so the remainder is principal repayment of $2,500.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 10, pp. 325-328.&&&a&Class@SS10.2&&&&&1&N&0&N.N.N.N 2006JV.372&mcs&0&N&Differences between the treatment of tax in tax reports and tax in financial statements can create all of the following EXCEPT:&deferred tax paid.&deferred tax assets.;deferred tax liabilities.;deferred income tax expense. ;&LOS: Reading 42-aTax paid is the actual cash flow of tax paid so is not deferred.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 9, p. 293.&&&a&Class@SS10.0&&&&&1&N&0&N.N.N.N 2006JV.373&mcs&0&N&If deferred taxes are very unlikely to be actually paid an analyst should consider them to be:&stockholders' equity.&short-term liabilities.;long-term liabilities.;extraordinary profits.;&LOS: Reading 42-cIf the deferred taxes had not been recorded, then net income and therefore retained earnings would be higher.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 9, pp. 308-309.&&&a&Class@SS10.1&&&&&1&N&0&N.N.N.N 2006JV.374&mcs&0&N&If a company actively uses operating leases, which of the following statements is least likely?&Total cash flow is understated.&Off-balance-sheet financing is significant.;Return on assets should be adjusted down to give a clearer view of the company's efficiency.;Minimum lease payments for the next five years must be disclosed in the company's accounts.;&LOS: Reading 44-bTotal cash flow is not understated but cash flow from operations is lower than if the lease were capitalized.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 11, pp. 368-371.&&&a&Class@SS10.2&&&&&1&N&0&N.N.N.N 2006JV.375&mcs&0&N&A firm decides to recognize an estimate of bad debts in the period when sales are made but on a tax basis they cannot be recognized until a customer's account becomes uncollectible. This will give rise to:&a deferred tax asset.&a deferred tax liability.;neither a deferred tax asset nor a deferred tax liability.;it will depend on whether sales are increasing or decreasing whether it is a deferred tax asset or a deferred tax liability.;&LOS: Reading 42-aThe firm's internal accounts will show a lower book value for accounts receivable than that shown on a tax basis. A deferred tax asset will account for the difference. Whether the deferred tax asset gets larger or smaller over different periods will depend on whether sales are increasing or decreasing.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 9, pp. 292-298.&&&a&Class@SS10.0&&&&&1&N&0&N.N.N.N 2006JV.376&mcs&0&N&A firm sells its product on account and allows customers to pay in installments over future time periods. In the financial reports it recognizes revenue at the time of sale but on a tax basis it recognizes revenues when it receives the cash. This will give rise to:&a deferred tax liability.&a deferred tax asset.;neither a deferred tax asset nor a deferred tax liability.;it will depend on whether sales are increasing or decreasing whether it is a deferred tax asset or a deferred tax liability.;&LOS: Reading 42-aThe firm's internal accounts will show a higher book value, due to accounts receivable, than that shown on a tax basis. A deferred tax liability will account for the difference. Whether the deferred tax liability gets larger or smaller over different periods will depend on whether sales are increasing or decreasing.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 9, pp. 292-298.&&&a&Class@SS10.1&&&&&1&N&0&N.N.N.N 2006JV.377&mcs&0&N&A company includes amortization of goodwill in its financial statements whereas amortization of goodwill is not recognized as an expense for tax purposes. This leads to the reporting of:&no deferred tax item.&a deferred tax asset.;a deferred tax liability.;prepaid tax on the income statement but no deferred tax asset on the balance sheet..;&LOS: Reading 42-dPermanent differences in tax treatment do not give rise to deferred tax items since they will not reverse in the future.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 9, p. 308.&&&a&Class@SS10.2&&&&&1&N&0&N.N.N.N 2006JV.378&mcs&0&N&If a company makes an operating loss then:&the company can obtain a refund on tax paid in prior years and can carry tax losses forward to future periods.&the company cannot obtain a refund on tax paid in prior years or carry tax losses forward to future periods.;the company can obtain a refund on tax paid in prior years but cannot carry tax losses forward to future periods.;the company cannot obtain a refund on tax paid in prior years but can carry tax losses forward to future periods. ;&LOS: Reading 42-aIf there has been insufficient tax paid prior to getting a full refund of the loss then tax loss carryforward is permitted.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 9, p. 292.&&&a&Class@SS10.0&&&&&1&N&0&N.N.N.N 2006JV.379&mcs&0&N&When market rates are above the coupon rate when the bond is issued, the liability on the issuer's balance sheet:&will increase with each coupon payment.&will decrease with each coupon payment.;will always be equal to the proceeds of the issue.;will always be equal to the maturity value of the issue.;&LOS: Reading 43-aThe liability will initially be equal to the proceeds of the bond issuance, which will be less than face value. Interest expense will be higher than cash interest paid so the liability will rise until it reaches face value at maturity.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 10, p. 325-328.&&&a&Class@SS10.1&&&&&1&N&0&N.N.N.N 2006JV.380&mcs&0&N&The interest expense related to a bond issue in any period is:&the effective interest rate multiplied by the balance sheet liability.&the coupon payments made over the period.;the effective interest rate multiplied by the size of issue proceeds.;the market rate at the time of a coupon payment multiplied by the maturity value of the issue.;&LOS: Reading 43-aThe interest expense is based on the market interest rate at the time of issue, which is the same as the effective interest rate. This is multiplied by the balance sheet liability, which for a bond issued at a premium or discount, will not be the same as the par value or issue proceeds.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 10, p. 325-328.&&&a&Class@SS10.2&&&&&1&N&0&N.N.N.N 2006JV.381&mcs&0&N&When market interest rates decline a company that has fixed-rate debt outstanding will:&lose in economic terms.&gain in economic terms.;the debt on the balance sheet is automatically adjusted to current market value so the economic loss will be reflected as an accounting loss.;the debt on the balance sheet is automatically adjusted to current market value so the economic gain will be reflected as an accounting gain.;&LOS: Reading 43-bThe debt on the balance sheet reflects the market rate at issuance and therefore if market interest rates decline the market value of the debt will increase which lead to an economic loss.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 10, pp. 342-343.&&&a&Class@SS10.0&&&&&1&N&0&N.N.N.N 2006JV.382&mcs&0&N&Tax rates are increased at the beginning of a company's financial year. In the company's financial statements the tax rate increase will lead to:&a reduction in the value of deferred tax assets.&a restatement of prior years' accounts.;an increase in the value of deferred tax liabilities.;an extraordinary gain which is stated net of tax on the income statement.;&LOS: Reading 42-fThe lower tax rate reduces the value of the tax benefit when the deferred tax asset is realized.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 9, pp. 296-298.&&&a&Class@SS10.1&&&&&1&N&0&N.N.N.N 2006JV.383&mcs&0&N&A company enters into a lease agreement to make lease payments of $20,000 at the end of each year for the next three years. It is treated as a capital lease and the discount rate used is 10%. If the asset is depreciated using the straight-line method, the lease expense in the first year will be closest to?&21553&16579;20000;22579;&LOS: Reading 44-bThe present value of the lease is $49,737. Therefore the depreciation expense will be $16,579 per annum. The interest expense in the first year will be 10% of $49,737 and this must be added to the depreciation expense to arrive at the total expense.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 11, pp. 368-370.&&&a&Class@SS10.2&&&&&1&N&0&N.N.N.N 2006JV.384&mcs&0&N&A company needs to recognize deferred tax liabilities when:&future taxable income is expected to be greater than pretax income and there is an expected future cash outflow to pay taxes.&future taxable income is expected to be less than pretax income and there is an expected future cash outflow to pay taxes.;future taxable income is expected to be less than pretax income and there is an expected future cash inflow/credit from tax payments.;future taxable income is expected to be greater than pretax income and there is an expected future cash inflow/credit from tax payments. ;&LOS: Reading 42-aIf future taxable income is expected to be greater than pretax income this implies that under tax reporting income will be greater that under financial reporting, therefore there will be a future tax liability.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 9, pp. 292-298.&&&a&Class@SS10.0&&&&&1&N&0&N.N.N.N 2006JV.385&mcs&0&N&A company manufactures a machine and agrees to lease the machine under a sales-type capital lease agreement. The company will record the gross investment in the machine as:&the sum of the minimum lease payments plus the residual value of the machine.&the sum of the minimum lease payments.;the sum of the present values of the minimum lease payments.;the sum of the present values of the minimum lease payments plus the present value of the residual value of the machine. ;&LOS: Reading 44-eNet investment looks at the present value of the payments, the difference between the gross investment and net investment is the interest component of the revenue represented by unearned income.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 11, pp. 387-390.&&&a&Class@SS10.1&&&&&1&N&0&N.N.N.N 2006JV.386&mcs&0&N&Lessees, when they are expanding companies, generally prefer to classify leases as operating rather than capital leases since it leads to all of the following EXCEPT:&I. higher reported assets.&II. higher return on equity.;III. lower reported leverage.;IV. later recognition of the lease expense. ;&LOS: Reading 44-bI. is not correct, with an operating lease both reported assets and liabilities will be lower.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 11, pp. 368-371.&&&a&Class@SS10.2&&&&&1&N&0&N.N.N.N 2006JV.387&mcs&0&N&If a firm has a 10-year bond outstanding, the debt will be classified as:&either a short-term liability or a long-term liability depending on the period to maturity.&a long-term liability with a value equal to the issue proceeds.;a long-term liability with a value equal to the payments on the bond still outstanding.;a long-term liability with a value equal to the face value of each bond multiplied by the number of bonds outstanding.;&LOS: Reading 43-aThe bond will be classified as a long-term liability until it reaches one year before redemption then it will become the current portion of the long-term debt and be a short-term liability. The value of the liability is the present value of future payments, using a discount rate that is the market interest rate at the time of issue.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 10, pp. 325-329.&&&a&Class@SS10.0&&&&&1&N&0&N.N.N.N 2006JV.388&mcs&0&N&When a bond issuer makes a coupon payment for a bond that was issued at a premium it will be reported as a:&cash flow from operations.&cash flow from investing.;cash flow from financing.;partly as a cash flow from operations and partly as a cash flow from financing.;&LOS: Reading 43-aThe coupon payment will be counted as a cash flow from operations although it can be argued that the interest component should be seen as a cash flow from operations and the reduction in principal as cash flow from financing.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 10, pp. 328-329.&&&a&Class@SS10.1&&&&&1&N&0&N.N.N.N 2006JV.389&mcs&0&N&In a direct financing lease the sale value reported at the beginning of the lease on the lessor's financial statements is:&zero, there is no sale value reported.&the sum of the lease payments.;the present value of lease payments.;the present value of lease payments plus the present value of the residual value.;&LOS: Reading 44-eWith a direct financing lease only financing or interest income is reported. There is no 'manufacturing' profit and no sale is recorded.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 11, pp. 390-391.&&&a&Class@SS10.2&&&&&1&N&0&N.N.N.N 2006JV.390&mcs&0&N&If a company uses straight-line methods to depreciate assets, then classifying a lease as an operating lease rather than a capital lease will lead to:&lower operating income throughout the lease period.&higher operating income throughout the lease period.;higher operating income at the beginning of the lease period and then lower operating income.;lower operating income at the beginning of the lease period and then higher operating income.;&LOS: Reading 44-aUsing an operating lease will lead to higher operating costs since the lease payment will always be higher than the depreciation cost (since the interest cost will appear after the operating income level).Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 11, pp. 368-367.&&&a&Class@SS10.0&&&&&1&N&0&N.N.N.N 2006JV.391&mcs&0&N&Which of the following is NOT an example of off-balance-sheet financing?&convertible bonds.&operating leases.;take-or-pay contracts.;related finance companies which are equity accounted.;&LOS: Reading 44-dConvertible bonds are classified as debt on the balance sheet.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 11, pp. 376-381.&&&a&Class@SS10.1&&&&&1&N&0&N.N.N.N 2006JV.392&mcs&0&N&Lessors usually prefer to classify leases as capital rather than operating leases because:&II. they can report larger sales revenue immediately.&I. they can report a larger net cash flow immediately.;III. they will report constant income over the lease term.;IV. over the term of the lease the total net income will be higher.;&LOS: Reading 44-bI. is not correct since operating cash flow is positive but investing cash low is negative by the same amount.II. is not correct, under an operating lease when the asset is depreciated using straight-line depreciation the income would be constant.III. is not correct since the total net income would be the same whichever method is used.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 11, pp. 386-387.&&&a&Class@SS10.2&&&&&1&N&0&N.N.N.N 2006JV.393&mcs&0&N&Analysts should adjust a firm's deferred tax liability by:&analyzing each component of the liability separately.&considering it as permanent capital.;discounting the deferred tax payments back to present value.;ignoring deferred tax since deferred tax is often not actually paid.;&LOS: Reading 42-cAnalysts should look at each component in turn and decide which items will be reversed and which will actually be paid.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 9, pp. 299-305.&&&a&Class@SS10.0&&&&&1&N&0&N.N.N.N 2006JV.394&mcs&0&N&A manufacturer sells products on an installment basis and recognizes the profit from a sale immediately. However for tax purposes a portion of the profit cannot be recognized until the following year. These will lead to:&A deferred tax liability due to a temporary difference between tax and financial statement reporting.&A deferred tax asset due to a temporary difference between tax and financial statement reporting.;A deferred tax asset due to a permanent difference between tax and financial statement reporting.;A deferred tax liability due to a permanent difference between tax and financial statement reporting.;&LOS: Reading 42-eThe income tax expense will be greater than taxes payable since profit is recognized earlier in the financial statements than in the tax reports. This will create a deferred tax liability on the balance sheet. The difference in accounting will reverse in the second year so it is a temporary difference.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 9, pp. 291-299.&&&a&Class@SS10.1&&&&&1&N&0&N.N.N.N 2006JV.395&mcs&0&N&A company sells receivables to a third party and enters this transaction as a sale and reduces accounts receivable. An analyst should generally adjust the balance sheet as follows:&increase receivables and increase the current liabilities to reflect the receivables sold but not collected.&increase receivables and increase stockholders' equity to reflect the receivables sold but not collected.;increase receivables and reduce cash and cash equivalents to reflect the receivables sold but not collected.;reduce receivables and reduce the current liabilities to reflect the fact that the receivables no longer belong to the company.;&LOS: Reading 44-dSince the sale of receivables is the same as borrowing using the receivables as collateral, the financial statements should be adjusted to reflect this. Therefore add back the receivables and increase current liabilities to reflect payment due to third party.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 11, pp. 378-381.&&&a&Class@SS10.2&&&&&1&N&0&N.N.N.N 2006JV.396&mcs&0&N&Which of the following is an example of a take-or-pay contract?&A firm agrees to buy a certain amount of oil from an oil producer at the market price each year for the next five years.&A firm has the option to buy a certain amount of oil from an oil producer at the market price each year for the next five years.;An oil producer has the option to sell a certain amount of oil to another firm at a fixed price each year for the next five years.;An oil producer has the option to sell a certain amount of oil to another firm at the market price each year for the next five years.;&LOS: Reading 44-dA take-or-pay contract is a firm commitment, not an option, at either a fixed or market price, and can provide security of supply of a raw material for the buyer and security of income for the seller. These are an example of off-balance-sheet financing since future commitments are not treated as debt.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 11, pp. 376-377.&&&a&Class@SS10.0&&&&&1&N&0&N.N.N.N 2006JV.397&mcs&0&N&An analyst notices that a company’s deferred tax liability has declined, this is most likely to be explained by:&IV. The company has written down asset values due to impairment.&I. The company has made a profit.;II. A new tax law has increased tax rates.;III. It is a growing company with rising capital expenditure.;&LOS: Reading 42-aI. would not reduce deferred tax liabilitiesII. is not correct since this would increase deferred tax liabilitiesIII. is not correct since this would to lead to increasing deferred tax liabilities if accelerated tax depreciation methods are used for tax reporting.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 9, pp. 292-298.&&&a&Class@SS10.1&&&&&1&N&0&N.N.N.N 2006JV.398&mcs&0&N&The financial ratios for a company, which uses operating leases compared to a company that uses capital leases, will be as follows:&higher interest cover and higher return on assets.&lower interest cover and lower return on assets.;lower interest cover and higher return on assets.;higher interest cover and lower return on assets.;&LOS: Reading 44-bInterest cover will be higher as interest payments will be lower.Return on assets will be higher since assets will be lower.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 11, pp. 539-540.&&&a&Class@SS10.2&&&&&1&N&0&N.N.N.N 2006JV.399&mcs&0&N&Which of the following statements is TRUE regarding cash flow impact for a lessee of a capital lease?&Total cash outflow each year is the same as the lease payment.&All of the rental payments are treated as cash flow from operations.;The rental payments are partly allocated as cash flow from operations and partly as cash flow from investing.;The present value of the lease payments is classified as an investing cash outflow at the beginning of the lease.;&LOS: Reading 44-bThere is no cash outflow at the beginning of the lease, other than lease payments, since the asset is not purchased.The rental payments are partly allocated to cash flow from operations and partly to cash flow from financing (interest).Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 11, pp. 370-371.&&&a&Class@SS10.0&&&&&1&N&0&N.N.N.N 2006JV.400&mcs&0&N&The following are all examples of permanent differences between financial and tax reporting in the U.S., EXCEPT:&depreciation.&tax credits.;amortization of goodwill.;interest on tax-exempt bonds.;&LOS: Reading 42-dDifferent methods of depreciation will only provide a temporary difference between the pretax income and taxable income.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch. 9, p. 299-305.&&&a&Class@SS10.1&&&&&1&N&0&N.N.N.N 2006JV.401&mcs&0&N&Which of the following cash flows should not be included in capital budgeting cash flow analysis?&Sunk costs.&Externalities.;Cannibalization.;Opportunity costs.;&LOS: Reading 48-aSunk costs should not be included since they will not affect future cash flows or impact on incremental cash flows.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 11, pp. 426-428.&&&a&Class@SS11.2&&&&&1&N&0&N.N.N.N 2006JV.402&mcs&0&N&If a company decides to use high financial leverage to support its operations then:&it will raise both the cost of debt and the cost of equity.&it will leave both the cost of debt and equity unchanged.;it will raise the cost of equity and the cost of debt will be unchanged.;it will raise the cost of debt and the cost of equity will be unchanged.;&LOS: Reading 50-dAs the financial leverage increases then the risk to both debt holders and equity investors will increase. This will mean that the interest rate that the company needs to pay on its debt will rise and the required rate of return of equity investors will also increase.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 13, pp. 504-508.&&&a&Class@SS11.0&&&&&1&N&0&N.N.N.N 2006JV.403&mcs&0&N&Which of the following is least likely to be a type of project risk?&Business Risk.&Market Risk.;Corporate Risk.;Standalone Risk.;&LOS: Reading 49-aBusiness risk usually refers to a firm’s risk rather than a project’s risk. Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 12, pp. 460-461.&&&a&Class@SS11.1&&&&&1&N&0&N.N.N.N 2006JV.404&mcs&0&N&ABC Corp. has a 6% ten-year bond outstanding, which is trading at a yield to maturity of 8%. The company's marginal tax rate is 40%. The component cost of debt for ABC Corp. is closest to:&4.8%.&3.6%.;6.0%.;8.0%.;&LOS: Reading 46-bThe cost of debt is the interest rate less tax savings which is\\Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 9, pp. 354-355.&&&a&Class@SS11.2&&&&&1&N&0&N.N.N.N 2006JV.405&mcs&0&N&ABC Corp. has just issued preferred stock that pays a dividend of $5 per annum. The stock was sold at $100 per share with flotation costs of 3%. The company's marginal tax rate is 40%. The cost of preferred stock for ABC Corp is closest to:&5.15%.&3.00%.;3.09%.;5.00%.;&LOS: Reading 46-bThe cost of preferred stock is the dividend divided by the price received after flotation costs.This is $5/$97 = 5.15%Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 9, pp. 355-356.&&&a&Class@SS11.0&&&&&1&N&0&N.N.N.N 2006JV.406&mcs&0&N&The beta of ABC's common stock is 1.1, the dividend paid is $3.50, and the stock price is $82.00. The expected market return is 12% and the risk free rate is 6%. The cost of retained earnings is closest to:&12.6%.& 4.3%.; 6.6%.;13.2%.;&LOS: Reading 46-bUsing CAPM to calculate the cost of equity gives:\\Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 9, pp. 357-358.&&&a&Class@SS11.1&&&&&1&N&0&N.N.N.N 2006JV.407&mcs&0&N&Under the residual dividend model, which of the following factors would lead to an increase in the total dividends paid out by a firm?&I. The firm's earnings increase.&II. Investors prefer to see a higher dividend payout ratio.;III. The firm is seeing a larger number of attractive investment opportunities.;IV. An increase in the proportion of equity financing in the target capital structure.;&LOS: Reading 51-eThe residual dividend discount model has four stages 1. decide the capital budget 2. decide how much equity is needed using target capital structure 3. use as much of the retained earnings as necessary to meet these requirements 4. distribute any remaining earnings as dividends.III. and IV. would tend to reduce the earnings that are available for distribution as dividends.II. is not correct since investors' preferences are not a component of the residual dividend model.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 14, pp. 551-556.&&&a&Class@SS11.2&&&&&1&N&0&N.N.N.N 2006JV.408&mcs&0&N&When calculating cash flows for capital budgeting cash flow analysis, which of the following statements is most accurate?&Interest payments should not be included since the cost of capital includes the cost of debt.&Gross interest payments should be included since the cost of capital includes the cost of debt.;Interest payments reflecting long-term debt should be included since the cost of capital includes the cost of debt.;Interest payments net of tax should be included since the cost of capital includes the after-tax cost of debt.;&LOS: Reading 48-aThe weighted cost of capital includes the cost of debt so the cash flow available for bond and equity holders should be used i.e. before interest payments.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 11, pp. 425-426.&&&a&Class@SS11.0&&&&&1&N&0&N.N.N.N 2006JV.409&mcs&0&N&When two projects are mutually exclusive then:&it is better to use the net present value method to evaluate the projects since it is based on the assumption that the projects' cash flows are reinvested at the cost of capital.&it is better to use the net present value method to evaluate the projects since it is easier to calculate.;it is better to use the internal rate of return method to evaluate the projects since it is widely accepted in industry.;it is better to use the internal rate of return method to evaluate the projects since it is based on the assumption that the projects' cash flows are reinvested at the cost of capital. ;&LOS: Reading 47-cIf a company is evaluating mutually exclusive projects the crossover rate is critical in deciding which project to pursue. The cost of capital should be used since this better reflects the reinvestment options available to the company. The cost of capital is used in the NPV method.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 10, pp. 399-403.&&&a&Class@SS11.1&&&&&1&N&0&N.N.N.N 2006JV.410&mcs&0&N&If a low percentage of a firm's costs are fixed costs then:&the firm has low operating leverage.&the firm has low financial leverage.;the firm has high financial leverage.;the firm has high operating leverage.;&LOS: Reading 50-bOperating leverage refers to the percentage of costs that are fixed as opposed to variable and financial leverage refers to the percentage of a firm's capital structure that is financed by debt.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 13, pp. 496-498.&&&a&Class@SS11.2&&&&&1&N&0&N.N.N.N 2006JV.411&mcs&0&N&Which of the following is most accurate with respect to dividend payment procedures?&The ex-dividend date is before the holder-of-record date.&The ex-dividend date is after the holder-of-record date.;The ex-dividend date is the same as the holder-of-record date.;The ex-dividend date is either before or after the holder-of-record date, depending on the firm's policy.;&LOS: Reading 51-fThe ex-dividend date is the date that a holder of the stock is no longer entitled to the dividend, in the US this is two days before the holder-of-record date. On the holder-of-record date whoever is a registered stockholder will receive the dividend.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 14, pp. 558-559.&&&a&Class@SS11.0&&&&&1&N&0&N.N.N.N 2006JV.412&mcs&0&N&A $1,000,000 project has the following cash flows, $500,000 at the end of the first year, $400,000 at the end of the second year and $300,000 at the end of each year thereafter. If the cost of capital is 10%, the discounted payback period is closest to:&2.95 years.&2.00 years.;2.33 years.;3.00 years.;&LOS: Reading 47-aThe discounted payback period is the number of years that it will take for the costs of the project to be recovered based on cash flows discounted at the cost of capital.The discounted values of the cash flows in the first three years are $454,545.50, $330,578.50 and $225,394.40 respectively. Payback will occur $214,876.00/$225,394.40 into the third year, i.e. 95% of the way through the year.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 10, pp. 393-395.&&&a&Class@SS11.1&&&&&1&N&0&N.N.N.N 2006JV.413&mcs&0&N&Southeast Inc.'s existing operations have a beta of 0.9 and its cost of capital is 14%. The risk free rate is 6%. It is considering investing in a new project that has a beta of 1.4, the company's assets would then be split between 75% in the original business and 25% in the new project. The company will remain debt free. If the new project does not alter the valuation of the company the new cost of capital for the company is closest to:&15.1%.&14.9%.;16.2%.;18.5%.;&LOS: Reading 49-cThe market return is given by applying CAPM to the original business:\\This is the same as the cost of capital.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 12, pp. 466-468.&&&a&Class@SS11.2&&&&&1&N&0&N.N.N.N 2006JV.414&mcs&0&N&Signaling theory suggests that if a company announces a new stock offering:&the managers are negative on the company's prospects and wish to bring in new shareholders to spread the losses or poor returns.&the managers are positive on the company's prospects and see this as a good opportunity to sell new shares since the cost of equity will be relatively low.;the managers are positive on the company's prospects and see this as a good opportunity to sell new shares since the public will be keen to subscribe given the good prospects.;the managers are positive on the company's prospects and see this as a good opportunity to sell new shares since stock prices tend to outperform after a new share offering is announced. ;&LOS: Reading 51-jThe theory that managers announce new share offerings when they are concerned about the prospects for the company is supported by empirical evidence that share prices tend to under perform after a share offering is announced.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 13, pp. 518-519.&&&a&Class@SS11.0&&&&&1&N&0&N.N.N.N 2006JV.415&mcs&0&N&Evaluation of a project is least likely to involve which of the following steps?&discounting the cash flows back at the risk-free rate.&estimating the cash flows from the project.;estimating the risk associated with the cash flows.;comparing the cost of the project to the present value of the cash flows.;&LOS: Reading 47-aThe cash flows should be discounted back at the cost of capital (which takes into account the risk of the project).Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 10, p. 391.&&&a&Class@SS11.1&&&&&1&N&0&N.N.N.N 2006JV.416&mcs&0&N&Which theory argues that investors prefer that a firm retains earnings rather than paying them out as dividends?&Tax preference theory.&Bird-in-the-hand theory.;Dividend irrelevance theory.;Dividend optimization theory.;&LOS: Reading 51-bThe tax preference theory argues that investors prefer to receive returns in the form of capital gains, which are subject to less tax than dividends. If investors need cash they can always liquidate part of their holding.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 14, pp. 542-544.&&&a&Class@SS11.2&&&&&1&N&0&N.N.N.N 2006JV.417&mcs&0&N&Empirical evidence shows that:&generally investors prefer a stable dividend payout ratio.&generally investors prefer a low dividend payout ratio.;generally investors prefer a high dividend payout ratio.;individual investors are largely indifferent to the dividend payout ratio.;&LOS: Reading 51-bDifferent individual investors have different preferences regarding the payout ratio but a common requirement is that the payout ratio should be consistent and predictable.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 14, p. 546.&&&a&Class@SS11.0&&&&&1&N&0&N.N.N.N 2006JV.418&mcs&0&N&Multiple internal rates of return (IRRs) for a project will occur if:&the project requires additional capital expenditure during its life.&the internal rate of return is a multiple of the hurdle rate.;the cash flows decline each year of the life of the project.;projects that are mutually exclusive provide different rates of return.;&LOS: Reading 47-cA nonnormal project is one which requires cash outflows during or at the end of the life of the project. In this case multiple IRRs will occur.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 10, pp. 403-405.&&&a&Class@SS11.1&&&&&1&N&0&N.N.N.N 2006JV.419&mcs&0&N&A company is evaluating whether to replace a piece of old machinery. The book value of the piece of machinery is zero, but the resale value is $10,000. The company is a tax payer with a 40% marginal rate. If they decide to go ahead with replacing the piece of machinery the sale of the old machine will:&decrease the initial investment outlay by $6,000.&increase the initial investment outlay by $6,000.;increase the initial investment outlay by $10,000.;decrease the initial investment outlay by $10,000.;&LOS: Reading 48-cThe initial outlay for the new piece of machinery will be offset by the $10,000 revenue from the sale of the old machinery. However this will be seen as taxable income so a $4,000 tax liability will be incurred which is recorded as a cash outflow.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 11, pp. 433-437.&&&a&Class@SS11.2&&&&&1&N&0&N.N.N.N 2006JV.420&mcs&0&N&Which of the following methods is the least appropriate to calculate the cost of retained earnings?&Efficient frontier.&Risk premium approach.;Dividend valuation model.;Capital Asset Pricing Model.;&LOS: Reading 46-bThe efficient frontier provides the optimal mix of securities from a risk-return point of view and is dependent on the input of expected return data for the securities.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 9, pp. 356-360.&&&a&Class@SS11.0&&&&&1&N&0&N.N.N.N 2006JV.421&mcs&0&N&The provision of executive stock options to employees is an example of:&a mechanism to prevent agency problems between stockholders and managers.&an agency problem between stockholders and creditors.;an agency problem between stockholders and managers.;a mechanism to prevent agency problems between stockholders and creditors.;&LOS: Reading 45-aAgency problems arise between stockholders and managers when the managers' main objective is not to increase stockholders' wealth. Providing stock options means that managers will only benefit when the stock price rises above a specified level.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 1, p. 20.&&&a&Class@SS11.1&&&&&1&N&0&N.N.N.N 2006JV.422&mcs&0&N&A company is considering replacing an old machine. The machine was purchased seven years ago for $100,000 and is depreciated using the straight-line method over ten years. The salvage value is zero. It could sell the machine today at its book value of $30,000. The company is considering buying a new machine for $50,000 that it would depreciate over three years using the straight-line method (assume that this is acceptable for tax purposes), this machine would also have zero salvage value. There would be an increase in working capital of $5,000 required if they switch to the new machine but annual operating costs would decrease by $12,000. The company is profitable and the marginal tax rate is 40%. The cost of capital is 10%. Which of the following describes the best course of action for the company?&The net present value of future cash flows if the machine is replaced is $28,295 - this is more than the investment outlay so the old machine should be replaced.&The net present value of future cash flows if the machine is replaced is $24,538 - this is less than the investment outlay so the old machine should be retained.;The net present value of future cash flows if the machine is replaced is $24,538 - this is more than the investment outlay so the old machine should be replaced.;The net present value of future cash flows if the machine is replaced is $28,295 - this is less than the investment outlay so the old machine should be retained.;&LOS: Reading 48-cCash outflow initially would be $50,000 -$ 30,000 + $5,000 = $25,000For each of the next three years the company would have after tax cost savings of $7,200, plus tax savings on increased depreciation of $2,667[40% x ($16,667 - $10,000)]. This is tricky, the only change to operating items in this example are the cost savings and reduction in taxes payable (due to increased depreciation).At the end of the third year the increase in working capital would be a cash inflow.The net present values of the cash flows for the next three years are $8,970, $8,155, and $11,170 respectively. These total $28,295, which is more than the investment outlay, making it attractive to replace the old machine.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 11, pp. 433-437.&&&a&Class@SS11.2&&&&&1&N&0&N.N.N.N 2006JV.423&mcs&0&N&Which of the following is a method for calculating the beta of a project?&Pure play method.&Project analysis.;Scenario analysis.;Plotting the securities market line.;&LOS: Reading 49-cThe two ways of measuring beta that are covered in the text are the pure play method and the accounting method (regression analysis). The pure play method involves comparing the betas of companies in the same line of business as the project.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 12, p. 470.&&&a&Class@SS11.0&&&&&1&N&0&N.N.N.N 2006JV.424&mcs&0&N&A company uses no debt financing and is analyzing a new project. If the expected rate of return on a project lies above the Securities Market Line it would indicate that the project should be:&accepted because the return from the project more than compensates for the market risk taken.&rejected because the return from the project does not compensate for the market risk taken.;rejected because the return from the project does not compensate for the corporate risk taken.;accepted because the return from the project more than compensates for the corporate risk taken.;&LOS: Reading 49-cThe SML measures expected return against market risk (beta). If a project is above the SML it means that the expected return is higher than required to compensate for the beta of the project.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 12, pp. 469-470.&&&a&Class@SS11.1&&&&&1&N&0&N.N.N.N 2006JV.425&mcs&0&N&Penmakers Inc. is producing 500,000 pens per annum and the pens are sold at $10 each. Fixed costs are $1 million, not including interest payments of $1.5 million. Variable costs are $3 per pen.The degree of operating leverage of Penmakers Inc. is closest to:&1.4 times.&1.5 times.;2.3 times.;3.0 times.;&LOS: Reading 50-bThe degree of operating leverage = (percentage change in EBIT)/(percentage change in sales)\\Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 13, pp. 534-535.&&&a&Class@SS11.2&&&&&1&N&0&N.N.N.N 2006JV.426&mcs&0&N&Penmakers Inc. is producing 500,000 pens per annum and the pens are sold at $10 each. Fixed costs are $1 million, not including interest payments of $1.5 million. Variable costs are $3 per pen.The degree of financial leverage of Penmakers Inc. is closest to:&2.5 times.&0.3 times.;0.4 times.;3.5 times.;&LOS: Reading 50-dThe degree of financial leverage (DFL) = (percentage change in EPS)/(percentage change in EBIT)\\Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 13, pp. 536-537.&&&a&Class@SS11.0&&&&&1&N&0&N.N.N.N 2006JV.427&mcs&0&N&Penmakers Inc. is producing 500,000 pens per annum and the pens are sold at $10 each. Fixed costs are $1 million, not including interest payments of $1.5 million. Variable costs are $3 per pen.The degree of total leverage of Penmakers Inc. is closest to:&3.5 times.&0.6 times.;1.2 times.;1.8 times.;&LOS: Reading 46-c\\Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 9, pp. 362-363.&&&a&Class@SS11.2&&&&&1&N&0&N.N.N.N 2006JV.428&mcs&0&N&South Corporation's target capital structure is 50% debt, 10% preferred stock and 40% common equity. If the before-tax costs of debt, preferred stock and common equity are 10%, 11% and 14% respectively and the marginal tax rate is 40% the weighted average cost of capital is closest to: & 9.7%.& 9.3%.;10.3%.;11.3%.;&LOS: Reading 46-c\\Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 9, pp. 362-363. &&&a&Class@SS11.-1&&&&&1&N&0&N.N.N.N 2006JV.429&mcs&0&N&Financial risk refers to:&the risk to shareholders that results from a company using debt financing.&the business risk resulting from variability in sales and costs.;the risk borne by holders of a company's bonds that the company goes into liquidation.;the risk borne by holders of a company's bonds that interest rates rise and the company can no longer service its debt.;&LOS: Reading 50-dFinancial risk is an additional risk to operating or business risk. It is the risk borne by the shareholders that results form a company using financial leverage.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 11, pp. 499-503.&&&a&Class@SS11.0&&&&&1&N&0&N.N.N.N 2006JV.430&mcs&0&N&Modigliani and Miller are famous for their theory that:&a firm's capital structure is irrelevant.&project risk can be best estimated by calculating stand-alone risk.;stock repurchases are more attractive for investors than dividend payments.;market risk is the only risk that stock market investors should be compensated for taking.;&LOS: Reading 50-hModigliani and Miller are famous for their work on capital structure theory.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 13, pp. 514-516.&&&a&Class@SS11.1&&&&&1&N&0&N.N.N.N 2006JV.431&mcs&0&N&All of the following are reasons why a firm would carry out a stock repurchase program EXCEPT:&the firm wants to increase the proportion of equity in its capital structure.&it believes that the shares are undervalued.;cash is available for distribution to stockholders.;there is a large block of stock overhanging the market.;&LOS: Reading 51-gRepurchasing equity will reduce the proportion of equity in the capital structure.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 14, pp. 568-572.&&&a&Class@SS11.2&&&&&1&N&0&N.N.N.N 2006JV.432&mcs&0&N&A proposed project is expected to increase shareholders' wealth if:&the hurdle rate is lower than the internal rate of return of the project.&the hurdle rate is lower than the cost of capital for the project.;the hurdle rate is higher than the cost of capital for the project.;the hurdle rate is higher than the internal rate of return of the project.;&LOS: Reading 47-aThe hurdle rate is the cost of capital. This must be less than the internal rate of return.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 10, pp. 397-398.&&&a&Class@SS11.0&&&&&1&N&0&N.N.N.N 2006JV.433&mcs&0&N&The clientele effect refers to:&a company has investors who are attracted by its dividend payout policy.&a company with high financial leverage will tend to attract speculators as investors.;a blue chip company will tend to have low total leverage since this is in line with investor expectations.;a blue chip company will tend to have low financial leverage since this is in line with investor expectations. ;&LOS: Reading 51-fThe clientele effect refers to dividend payout levels and argues that individual investors, who have different dividend payout preferences, will tend to purchase shares in those companies that have a dividend policy in line with their requirements.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 14, pp. 547-548.&&&a&Class@SS11.1&&&&&1&N&0&N.N.N.N 2006JV.434&mcs&0&N&A company is offered two projects with the net cash flows, in $ million, from each project as shown below. The cost of project A is $2 million and the cost of project B is $10 million. The cost of capital for project A is 10% and for project B is 12%. Which of the projects should be accepted for inclusion in the capital budget?

End of YearProject AProject B
11.12.0
20.84.0
3 0.47.0
&Both projects should be rejected.&Both projects should be accepted.;Projects A should be accepted and B rejected.;Projects B should be accepted and A rejected.;&LOS: Reading 47-aThe present value of the cash flows for project A, discounted at 10%, is $1.96 million (1.00 + 0.66 + 0.30) which is less than the cost, therefore the project should be rejected.The present value of the cash flows for project B, discounted at 12%, is $9.96 million (1.79 + 3.19 + 4.98) which is less than the cost, therefore the project should be rejected.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 10, pp. 395-397.&&&a&Class@SS11.2&&&&&1:v&&& 2006JV.435&mcs&0&N&A project's stand-alone risk can be measured using:&sensitivity analysis.&credit analysis.;corporate analysis.;the securities market line.;&LOS: Reading 49-aStand-alone risk, which is the variability of a project's returns, is measured using sensitivity analysis or scenario analysis.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 12, pp. 461-466.&&&a&Class@SS11.0&&&&&1&N&0&N.N.N.N 2006JV.436&mcs&0&N&North Company has a common stock price of $75.00. The reported earnings per share were $4.80 and dividends per share were $1.60. The return on equity is 8%. The company is considering raising funds through a new equity issue. If issuing costs are 4% the cost of new equity is closest to:&7.67%.&5.33%.;7.46%.;7.55%.;&LOS: Reading 46-bThe growth rate is the earnings retention rate multiplied by the ROE, this is 5.33%.Next year's dividends will be $1.60 x 1.0533 = $1.685\\Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 9, pp. 360-362.&&&a&Class@SS11.1&&&&&1&N&0&N.N.N.N 2006JV.437&mcs&0&N&Why does a firm's policy on capital structure involve balancing risk and return?&Debt is usually cheaper than equity since interest is tax deductible, but debt financing increases the risk to stockholders.&Equity is usually cheaper than debt since issuing costs are lower, but equity financing increases the risk to stockholders.;Equity is usually cheaper than debt since dividend yields are lower than interest rates, but dividend payouts are more uncertain.;Debt is usually cheaper than equity since payments to bond holders are for a finite period, but debt financing increases the risk to stockholders.;&LOS: Reading 50-h The major factor that reduces the cost of debt is that the interest payments are tax deductible whereas dividend payments are paid out of net income. High levels of debt increase the risks to the stockholders since holders of debt have priority of payment over stockholders.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 13, pp. 492-493.&&&a&Class@SS11.2&&&&&1&N&0&N.N.N.N 2006JV.438&mcs&0&N&The optimal capital structure for a company will:&Maximize the company's share price and Give the lowest weighted cost of capital.&Give the highest operating profit and Maximize the company's share price.;Give the highest earnings per share and Maximize the company's share price.;Give the highest operating profit and Give the lowest weighted cost of capital.;&LOS: Reading 46-cMaximizing EBIT and EPS will not give the optimal capital structure since this will probably lead to a high level of debt rather than equity financing. This will increase the variability of profits and increase the cost of debt and equity.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 9, p. 362.&&&a&Class@SS11.0&&&&&1&N&0&N.N.N.N 2006JV.439&mcs&0&N&Stock repurchases are becoming more popular in the US because:&II. Stockholders do not have to choose whether they receive cash or not.&I. Taxes on capital gains are generally higher than taxes on income.;III. They can be used to increase the weighting of equity in the capital structure of the company.;IV. One-off distributions can be made to stockholders without affecting the long-term stability of dividend payout ratios.;&LOS: Reading 51-gI. is not correct; stockholders can choose whether to receive cashII. is not correct because taxes on capital gains are generally lower than taxes on dividends.III. is not correct, stock repurchase will reduce the weighting of equity in the capital structure of the companyReference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 14, pp. 570-572.&&&a&Class@SS11.1&&&&&1&N&0&N.N.N.N 2006JV.440&mcs&0&N&Which of the following factors affect a firm's weighted average cost of capital?&IV. The capital structure policy.&I. Tax rates.;II. Interest rates.;III. The dividend payout ratio.;&LOS: Reading 46-dI. A change in tax rates will alter the after-tax cost of debt.II. A change in interest rates will affect the cost of debt and, if CAPM or the risk premium approach is used, an increase in the cost of equity.III. A high dividend payout ratio will lead to lower retained earnings being available, it will also affect the growth rate of the company and the cost of equity.IV. The capital structure policy will determine the weights used to calculate the WACC.Stock splits are essentially an administrative process to increase the number of shares outstanding and reduce the share price. It will not directly affect the cost of capital.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 9, pp. 370-372.&&&a&Class@SS11.2&&&&&1&N&0&N.N.N.N 2006JV.441&mcs&0&N&If a market is internally efficient it means that:&I. transaction costs are minimal.&II. stock prices reflect all security price information.;III. stock prices reflect all information from public and private sources.;IV. investors direct money to the companies that can make the best use of the funds.;&LOS: Reading 52-aII. and III. refer to the weak and strong forms of the efficient market hypothesis respectively.IV. refers to allocative efficiency.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, pp. 106-107.&&&a&Class@SS12.2&&&&&1&N&0&N.N.N.N 2006JV.442&mcs&0&N&In the primary market Treasury bonds are sold by: &by Federal Reserve auction.&by private placement.;by a negotiated agreement with an investment bank.;on a best efforts basis by a consortium of investment banks.;&LOS: Reading 52-bTreasury bonds (and notes and bills) are all sold through Federal Reserve auctions.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, pp. 108-109.&&&a&Class@SS12.0&&&&&1&N&0&N.N.N.N 2006JV.443&mcs&0&N&An underwriter of a bond issue, if it is a negotiated bid, will do all of the following EXCEPT:&return the unsold portion of bonds to the issuer.&origination.;distribute the bonds to investors.;acquire the bonds from the issuer.;&LOS: Reading 52-bIn a negotiated bid, the underwriter will take on the risk of selling the bonds at a price equal to, or higher than, the price paid to the issuer. Any unsold bonds will remain on the underwriter's book.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, pp. 108-109.&&&a&Class@SS12.1&&&&&1&N&0&N.N.N.N 2006JV.444&mcs&0&N&In a continuous dealer market:&II. there are always dealers available when the market is open who are willing to make a market in a stock.&I. the market is open for 24 hours a day with market makers providing liquidity.;III. there is sufficient liquidity to assume that dealers who are submitting bid and ask prices will be able to deal.;IV. all the bids and asks for a stock are continuously monitored to arrive at a price at which transactions are done. ;&LOS: Reading 52-dI. A continuous market only needs to be liquid during its opening hours, it is not necessary for trading to be open for 24 hours.III. is a continuous auction market.IV. is similar to a call market where at a specified time all the bids and asks for a stock are monitored to arrive at a price at which transactions are done.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, pp. 113-115.&&&a&Class@SS12.2&&&&&1&N&0&N.N.N.N 2006JV.445&mcs&0&N&Which of the following statements regarding NASDAQ are TRUE?I. Dealers are obligated to execute transactions at the prices shown on the NASDAQ system.II. A broker can access the bid and ask quotes for a stock from various dealers on the NASDAQ system.III. Dealers are free to make markets on as many or as few OTC stocks as they wish on the NASDAQ system.&I. A broker can access the bid and ask quotes for a stock from various dealers on the NASDAQ system.II. Dealers are free to make markets on as many or as few OTC stocks as they wish on the NASDAQ system.&I. Dealers are obligated to execute transactions at the prices shown on the NASDAQ system.II. A broker can access the bid and ask quotes for a stock from various dealers on the NASDAQ system.;I. Dealers are obligated to execute transactions at the prices shown on the NASDAQ system.II. Dealers are free to make markets on as many or as few OTC stocks as they wish on the NASDAQ system.;I. Dealers are obligated to execute transactions at the prices shown on the NASDAQ system.II. A broker can access the bid and ask quotes for a stock from various dealers on the NASDAQ system.III. Dealers are free to make markets on as many or as few OTC stocks as they wish on the NASDAQ system.;&LOS: Reading 52-dA broker will call a dealer who is showing the most attractive prices on the screen and verify the price, at that point the trade could be executed.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, pp. 120-123.&&&a&Class@SS12.0&&&&&1&N&0&N.N.N.N 2006JV.446&mcs&0&N&The third market refers to:&IV. over-the-counter trading of shares which are listed on an exchange.&I. a regional exchange.;II. a continuous auction market.;III. direct trading between two institutions.;&LOS: Reading 52-dI. the third market refers to trading outside an exchange.II. the third market refers to the location of the trading rather than the trading systemIII. direct trading without the use of a broker is the fourth market.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, p. 124.&&&a&Class@SS12.1&&&&&1&N&0&N.N.N.N 2006JV.447&mcs&0&N&An order to sell shares in ABC at $100 when the current price is $95 is an example of a:&limit order.&floor order.;market order.;stop loss order.;&LOS: Reading 52-dA limit order specifies the buy or sell price.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, pp. 125-126.&&&a&Class@SS12.2&&&&&1&N&0&N.N.N.N 2006JV.448&mcs&0&N&If an investor buys a stock that is trading at $150 on margin and the percent margin is 25% then the leverage factor is:& 4.00.& 0.25.; 6.00.;37.50.;&LOS: Reading 52-fThe leverage factor is 1/(percent margin) which 1/ 0.25 = 4Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, pp. 127-130.&&&a&Class@SS12.0&&&&&1&N&0&N.N.N.N 2006JV.449&mcs&0&N&In the U.S. a person who quotes bid and ask prices for a stock is called a:&specialist.&floor broker.;registered trader.;commission broker.;&LOS: Reading 52-dA specialist makes markets in stocks.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, pp. 130-132.&&&a&Class@SS12.1&&&&&1&N&0&N.N.N.N 2006JV.450&mcs&0&N&An institution would use the fourth market:&to avoid paying brokerage fees.&to buy ADRs.;for odd lot shares.;for small transactions.;&LOS: Reading 52-dThe fourth market refers to direct trading of securities between investors without using a broker, institutions with large orders would often use the fourth market.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, p. 124.&&&a&Class@SS12.2&&&&&1&N&0&N.N.N.N 2006JV.451&mcs&0&N&The growing institutionalization of the U.S. securities markets is illustrated by:&a rise in the number of block trades.&reduced volatility as markets become more efficient.;rapid growth in the number of small research firms supplying research to institutions.;fixed commission rates by brokerage firms ensuring that their income does not decline.;&LOS: Reading 52-gWhen an investment bank positions a trade it means that the portion of the transaction that is not placed with precommitted investors is taken on by the bank, usually with the intention of later selling it on to other institutional investors.Four major effects of institutionalization are identified:1.Negotiated commission rates2.Influence of block trades3.Impact on volatility, this has not been reduced4.Development of National Market SystemThere fore "a rise in the number of block trades" is the correct answer.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, p. 135.&&&a&Class@SS12.0&&&&&1&N&0&N.N.N.N 2006JV.452&mcs&0&N&An investor buys 1,000 shares priced at $100 on margin and the initial margin required is 40%. If the maintenance margin is 30% the investor will have to pay the first margin call if the share price falls below:&$85.71.&$70.00.;$90.00.;$99.99.;&LOS: Reading 52-fThe initial margin requirement of 40% allows the investor to borrow 60%, or $60,000 of the $100,000 cost of the shares. If the price of the shares moves to P the value of the equity is 1,000P - $60,000. This must equal 30% of 1,000P. This gives:1,000P - $60,000 = 300P or P = $85.71Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, pp. 127-130.&&&a&Class@SS12.1&&&&&1&N&0&N.N.N.N 2006JV.453&mcs&0&N&Specialists are expected to:&buy and sell against the market when a stock is moving clearly in one direction.&attempt to stop stock prices rising and falling.;sell stock from their own inventory when the market for a stock is declining.;widen the bid-ask spread for a stock when there is excessive volatility in the stock price movement.;&LOS: Reading 52-dThe obligation of a market maker is to ensure a fair and orderly market for shares by providing reasonable liquidity. This would involve narrowing the spread for an illiquid stock, buying stock for their own inventory if the stock price is declining and visa versa if the stock price is rising i.e. buying and selling against the market when shares are moving in one direction. Although this may dampen stock price moves there is not the expectation that specialists will try to stop stock prices moving.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, pp. 130-131.&&&a&Class@SS12.2&&&&&1&N&0&N.N.N.N 2006JV.454&mcs&0&N&The Dow Jones Industrial Average:&is a price-weighted index and has a downward bias since when there is a stock split of a constituent security the security weighting in the index will be reduced.&is a price-weighted index and automatically adjusts for a stock split by leaving the security weighting unchanged.;is a value-weighted index and automatically adjusts for a stock split by leaving the security weighting unchanged.;is a value-weighted index and has a downward bias since when there is a stock split of a constituent security the security weighting in the index will be reduced.;&LOS: Reading 53-aThe Dow Jones industrial Average is the price-weighted average of the 30 constituent stocks. It is computed by taking the sum of the prices of the stocks and dividing by a divisor that adjusts to take account of stock splits, so the index value is not altered by a stock split. However when a company does a stock split leading to a fall in the price, the weighting of the stock in the index will thereafter be smaller. Since more successful companies have, on average, rising share prices which lead to them having more stock splits this leads to their weighting being repeatedly reduced creating a downward bias in the index.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 5, pp. 151-153.&&&a&Class@SS12.0&&&&&1&N&0&N.N.N.N 2006JV.455&mcs&0&N&Value Line indexes are:&unweighted indexes where the geometric mean of the holding period returns are calculated.&unweighted indexes where the arithmetic mean of the holding period returns are calculated.;price-weighted indexes where the arithmetic mean of the holding period returns are calculated.;price-weighted indexes where the geometric mean of the holding period returns are calculated.;&LOS: Reading 53-aValue Line uses a geometric average of holding period returns to compute an unweighted index. Each stock therefore has an equal weight in the index and note that the geometric mean calculation gives it a downward bias compared to an arithmetic mean being used.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 5, pp. 155-157.&&&a&Class@SS12.1&&&&&1&N&0&N.N.N.N 2006JV.456&mcs&0&N&There are three shares, A, B and C in a price-weighted index and the following information is given:

Share Price Number of Shares Outstanding
A $50 100,000
B $100 40,000
C $75 10,000


If the share price of A doubles and the share prices of B and C remain unchanged then the index will rise by:&22.22%.&33.33%.;44.44%.;51.28%.;&LOS: Reading 53-aAssume that the initial index is the sum of the prices = $50 + $100 + $75 =$225If A doubles the index = $100 + $100 + $75 =$275, an increase of 22.22%.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 5, pp. 151-157.&&&a&Class@SS12.2&&&&&1:v&&& 2006JV.457&mcs&0&N&The geometric mean of the holding period returns of the constituents of an index are used, rather than the arithmetic mean, to compute an index level. If an investor replicates the index by holding the shares in the same weighting as they are represented in the index :&he will see the value of the shares increase by more than the index in a rising market.&he will see the value of the shares move exactly in line with the index.;he will see the value of the shares increase by less than the index in a rising market.;whether the value of the shares increases by more or less than the index will depend on whether it is a price-weighted or unweighted index.;&LOS: Reading 53-aIn all types of index the geometric mean will be less than the arithmetic mean (unless each share moves by an identical amount in each time period) in a rising market.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 5, p. 158.&&&a&Class@SS12.0&&&&&1&N&0&N.N.N.N 2006JV.458&mcs&0&N&In Japan, if the share price of a company with a small market capitalization, that is in both the Nikkei Dow Jones Index and the TOPIX index, rises sharply then:&there is insufficient information to determine which index will rise the most.&the TOPIX is likely to rise by more than the Nikkei-Dow Jones Average index since the Nikkei is a price-weighted index.;the TOPIX is likely to rise by more than the Nikkei-Dow Jones Average index since the Nikkei is a market-weighted index.;the Nikkei-Dow Jones Average index is likely to rise by more than the TOPIX index since the Nikkei is a price-weighted index. ;&LOS: Reading 53-aUnless we know the Yen price relative to the market capitalization of the company's stock we cannot calculate which index will rise the most. The Nikkei is a price-weighted index and the TOPIX is a market-weighted index.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 5, pp. 151-155.&&&a&Class@SS12.1&&&&&1&N&0&N.N.N.N 2006JV.459&mcs&0&N&The computation of bond market indexes is more complex than stock market indexes for all of the following reasons EXCEPT:&investors receive a higher percentage of their return from coupon income from bonds than they receive from dividends with equities.&difficulties in establishing prices for bonds.;the universe of bonds is much wider than the stock universe.;the universe of bonds is constantly changing due to the volume of new issues and bonds reaching maturity.;&LOS: Reading 53-bAll of the first three points are true plus there is also the issue of the change in volatility of bond indexes as durations are constantly changing. The Correct Answer is not a factor that would make the computation of the index more complex, either the index would include reinvestment of income or it would not.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 5, p. 163.&&&a&Class@SS12.2&&&&&1&N&0&N.N.N.N 2006JV.460&mcs&0&N&Security market indexes are used:&Computing total risk of portfolios.&Constructing index funds.;Benchmarks, to measure the performance of portfolios.;Predicting future stock market movements by technical analysts.;&LOS: Reading 53-aIndex performance is used to compute systematic or market risk of portfolios.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 5, p. 150.&&&a&Class@SS12.0&&&&&1&N&0&N.N.N.N 2006JV.461&mcs&0&N&Two indexes contain exactly the same stocks, one is a value-weighted index which increased by 12% whereas the other is an unweighted index which increased by 5% over the same period. This is explained by:&large capitalization stocks outperformed small capitalization stocks.&there were a large number of stock splits over the period.;there were a small number of stock splits over the period.;small capitalization stocks outperformed large capitalization stocks.;&LOS: Reading 53-aStock splits will not affect either index since in the market-value-weighted index when there is a stock split the number of shares outstanding will increase but the share price will fall by a corresponding amount. An unweighted index will be computed on an equal amount of money invested in each stock regardless of price or market value.In a value-weighted index companies with a larger market capitalization will have a higher weighting.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 5, pp. 151-155.&&&a&Class@SS12.1&&&&&1&N&0&N.N.N.N 2006JV.462&mcs&0&N&There are two stocks ABC and XYZ included in an unweighted index and the following data is provided:

If the index is computed using geometric averages the increase in the index over 2003 is closest to:&12.25%.&8.33%.;11.25%.;12.50%.;&LOS: Reading 53-aAn unweighted index is computed on the basis that an equal dollar amount is invested in each of stocks ABC and XYZ. ABC rose by 20% and XYZ by 5% so the index performance is given by \\.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 5, pp. 151-157.&&&a&Class@SS12.2&&&&&1&N&0&N.N.N.N 2006JV.463&mcs&0&N&If the performance of the Merrill Lynch-Wilshire Capital Markets Index was substantially higher than the Merrill Lynch Investment-Grade Bond Index over the same period this is most likely to be explained by:&the U.S. stock market performed better than the U.S. bond market.&U.S. Treasury bonds performed better than U.S. corporate bonds.;U.S. mortgage bonds performed better than U.S. corporate bonds.;international stock markets performed on average better than the U.S. stock market.;&LOS: Reading 53-bThe Merrill Lynch-Wilshire Capital Markets Index is a combination of US fixed income instruments and U.S. equities, therefore the out performance of this index against the Merrill Lynch bond index is likely to be because equity markets provided superior returns to bonds.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 5, pp. 167.&&&a&Class@SS12.0&&&&&1&N&0&N.N.N.N 2006JV.464&mcs&0&N&The analysis of the performance of professional money managers:&supports the strong-form of the Efficient Market Hypothesis.&does not support the weak-form of the Efficient Market Hypothesis.;does not support the strong-form of the Efficient Market Hypothesis.;does not support the semistrong-form of the Efficient Market Hypothesis.;&LOS: Reading 54-aThe majority of money managers cannot outperform a buy-and-hold strategy which supports the findings of the strong-form of the Efficient Market Hypothesis.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 6, pp. 195-196.&&&a&Class@SS12.1&&&&&1&N&0&N.N.N.N 2006JV.465&mcs&0&N&When a new issue of bonds is sold by an institution to raise funds this will be done in the:&primary market.&third market.;fourth market.;secondary market.;&LOS: Reading 52-cThe secondary market is where trading takes place in issues that have already been sold to the public. The third market is where trading takes place in the over the counter market of a listed security and the fourth market is where trading takes place directly between two investors without a broker acting as intermediary.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, pp. 108-111.&&&a&Class@SS12.2&&&&&1&N&0&N.N.N.N 2006JV.466&mcs&0&N&If the Wilshire 5000 value-weighted series increased by 12% whereas the Wilshire 5000 unweighted series increased by 5% over the same period this would be explained by:&large capitalization stocks outperformed small capitalization stocks.&there were a large number of stock splits over the period.;there were a small number of stock splits over the period.;small capitalization stocks outperformed large capitalization stocks.;&LOS: Reading 53-aStock splits will not affect either index since in the market-value weighted index when there is a stock split the number of shares outstanding will increase but the share price will fall by a corresponding amount. An unweighted index will be computed on an equal amount of money invested in each stock regardless of price or market value.In a value-weighted index companies with a larger market capitalization will have a higher weighting.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 5, pp. 151-157.&&&a&Class@SS12.0&&&&&1&N&0&N.N.N.N 2006JV.467&mcs&0&N&Which of the following statements regarding the Dow Jones Industrial Average (DJIA) is least accurate?&The DJIA is an unweighted index and therefore each of the 30 stocks carries an equal weight.&The daily performance of the index is similar to other New York Stock Exchange indexes.;The long-term performance of the index is not comparable to other New York Stock Exchange indexes.;Since the DJIA only includes 30 stocks it will only represent the performance of the larger, mature companies listed on the New York Stock Exchange.;&LOS: Reading 53-aThe DJIA is a price-weighted index and it is the arithmetic average of the prices of the shares in the index i.e. a high-priced share will have a larger influence on the index than a low priced share. The other NYSE indexes are value-weighted. Although on a daily basis the difference in moves between the indexes is small, over the long term the indexes are not comparable.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 5, pp. 151-153.&&&a&Class@SS12.1&&&&&1&N&0&N.N.N.N 2006JV.468&mcs&0&N&A bond market index is most likely to be constructed as:&an unweighted total return index.&an unweighted capital-only index.;a price-weighted capital-only index.;a market–weighted total return index.;&LOS: Reading 53-bA bond market index is usually constructed based on the market value of the issues and the capital gain plus income are included The correlation with high-yield bonds is low (around 0.5) as default risk is a determining factor in the performance of high-yield bonds. The correlation with non-US bonds is low but this will increase the benefits of diversification in reducing portfolio risk.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 5, pp. 163-166.&&&a&Class@SS12.2&&&&&1&N&0&N.N.N.N 2006JV.469&mcs&0&N&The Efficient Market Hypothesis and the tests done to prove the Hypothesis imply portfolio managers should do all of the following, EXCEPT:&use technical analysis.&minimize total transaction costs.;focus on analyzing neglected companies.;use analysts who have the ability to estimate economic variables that have an impact on security prices.;&LOS: Reading 54-cThe weak-form of the Efficient Market Hypothesis implies that technical analysis based on past trading data does not have any value.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 6, pp. 198.&&&a&Class@SS12.0&&&&&1&N&0&N.N.N.N 2006JV.470&mcs&0&N&Which of the following supports the semi-strong-form of the Efficient Market Hypothesis?&The performance of stocks that have announced a change in accounting methods.&The January effect.;The neglected firm effect.;The performance of stocks with a low price/book value ratio.;&LOS: Reading 54-cThe January effect, the neglected firm effect and the out-performance of low price/book value stocks are all anomalies of the semi-strong-form of the EMH. The performance of stocks that have announced a change in accounting methods supports the semi-strong-form of the EMH. Studies find that analysts look at the true value of companies rather than the effects of a change in the way financial performance is reported.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 6, pp. 181-193.&&&a&Class@SS12.1&&&&&1&N&0&N.N.N.N 2006JV.471&mcs&0&N&A corporation looking to raise funds may decide to do a private placement because:&it will reduce issuing costs.&it will avoid using an investment bank.;it will provide greater liquidity in the secondary market.;the issue can be sold at a higher price than if it was sold in a public offering. ;&LOS: Reading 52-bA private placement will have lower issue costs, mainly since the requirement for lengthy registration documentation is reduced. However the pricing will be lower than for a public offer since the purchasers will need to be compensated for the lack of liquidity in the secondary market.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, p. 108.&&&a&Class@SS12.2&&&&&1&N&0&N.N.N.N 2006JV.472&mcs&0&N&When a stock in the Dow Jones Industrial Average has a stock split this will lead to:&the divisor decreasing.&the divisor increasing.;there being no change in the divisor.;the divisor increasing if the stock is a high-priced stock and falling if it is a low-priced stock.;&LOS: Reading 53-aWhen there is a stock split the stock price will fall, there is no immediate impact on the index so the divisor must also decrease.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 5, pp. 151-153.&&&a&Class@SS12.0&&&&&1&N&0&N.N.N.N 2006JV.473&mcs&0&N&A short seller of a stock will:&I. Deposit collateral when he borrows stock.&I. Sell the stock when the price is falling.;I. Sell the stock when the price is falling.II. Benefit from the price fall when a stock goes ex-dividend.;I. Deposit collateral when he borrows stock.II. Sell the stock when the price is falling.III. Benefit from the price fall when a stock goes ex-dividend.;&LOS: Reading 52-eAnswer "Sell the stock when the price is falling." is not correct since he must sell on an uptick trade. Answer "Benefit from the price fall when a stock goes ex-dividend." is not correct since he must pay the dividends to the lender of the stock.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, pp. 126.&&&a&Class@SS12.1&&&&&1&N&0&N.N.N.N 2006JV.474&mcs&0&N&The US over-the-counter market refers to:&trading in shares that may or may not be listed on an exchange.&trading in shares that are not listed on an exchange.;trading in shares that are quoted on the NASDAQ National Market System.;trading in shares that are not quoted on either the NASDAQ National Market System or an exchange. ;&LOS: Reading 52-dThe OTC market includes the trading of all shares that are not listed on an exchange and also includes the third market, which is trading listed shares outside an exchange. This includes shares traded on the NASDAQ National Market System (NMS), on the NASDAQ system outside NMS and outside NASDAQ.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, pp. 120-124.&&&a&Class@SS12.2&&&&&1&N&0&N.N.N.N 2006JV.475&mcs&0&N&An investor calls a broker on the first day of the month to find out the price of ABC Inc.'s shares and is quoted $103 bid - 1031/2 ask. The shares are very liquid. The share price then moves to $98 - 981/2 before rising to $115 -1153/4 at the end of the month. If the investor had (i) placed a market order to buy the shares on the first day and then sold them on the last day (ii) a limit order to buy at $100 and sell at the end of the month, his profit before transaction costs would be closest to:&(i) 11.11% (ii) 15.00%.&(i) 11.11% (ii) 15.75%.;(i) 12.39% (ii) 15.00%.;(i) 12.39% (ii) 15.75%.;&LOS: Reading 52-d (i) If it is a market order he will pay the ask price to buy the shares i.e. $103 1/2 and he will sell at the bid price of $115 making a profit of 11.11%. (ii) A limit order to buy at $100 will be executed and he will sell at $115 giving a profit of 15%.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, pp. 125-127.&&&a&Class@SS12.0&&&&&1&N&0&N.N.N.N 2006JV.476&mcs&0&N&An informationally efficient market is one where:&security prices adjust rapidly to the arrival of new information and therefore security prices reflect all information about the security. &information is available on a timely basis to all investors.;investors allocate their funds to the companies that can make the best use of them.;security prices adjust slowly to the arrival of new information giving investors time to take advantage of positive news.;&LOS: Reading 54-aReference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 6, p. 177.&&&a&Class@SS12.1&&&&&1&N&0&N.N.N.N 2006JV.477&mcs&0&N&Buying on margin means that:&III. if an investor has bought shares on margin and the share price rises he will have made a more attractive return on his investment than if he had fully paid for the shares.&I. if the margin requirement is 60%, the investor may borrow 60% of the cost of buying shares, allowing him to leverage his transaction.;II. the returns from buying on margin will only be higher than paying in full for shares when the share price moves significantly up or down.;IV. if an investor has bought shares on margin he will be required to keep a maintenance margin with the broker, if the share price falls he will immediately receive a margin call. ;&LOS: Reading 52-fI. is not true since if the margin requirement is 60% the investor can only borrow 40%.II. is not true since if the share moves down the losses will be higher if the investor has bought on margin.III. is true due to the leverage effect.IV. is not true since if the maintenance margin is lower than the initial margin the investor will only receive a margin call after the shares have fallen to a level where the proportion of equity to the total value of stock is below the maintenance margin.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, pp. 127-128.&&&a&Class@SS12.2&&&&&1&N&0&N.N.N.N 2006JV.478&mcs&0&N&A call market refers to:&a market where it is attempted to match all the bids and asks at a specified time.&a market where trades are done by open outcry.;a market which specializes in providing derivatives trading.;a market where all the trading is done by computer rather than on a trading floor.;&LOS: Reading 52-dIn a call market all the bids and asks for a stock are collated and a stock price that will best match buyers and sellers is decided.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, pp. 113-114.&&&a&Class@SS12.0&&&&&1&N&0&N.N.N.N 2006JV.479&mcs&0&N&Which of the following is NOT usually a member of a U.S. securities exchange?&An underwriter.&A specialist.;A floor broker.;A registered trader.;&LOS: Reading 52-dThe four major categories of membership are1. specialist2. commission broker3. floor broker4. registered trader.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, p. 125.&&&a&Class@SS12.1&&&&&1&N&0&N.N.N.N 2006JV.480&mcs&0&N&The quotations for the price of Brown and Co. are given by 3 dealers as shown below:

bidask
dealer 117 3/418 1/4
dealer 217 1/218
dealer 317 5/818

If dealer 3 has excess inventory of Brown and Co. stock, changing his quote to which of the following would be the most effective in reducing his inventory? &17 1/4 - 17 3/4.&17 5/8 - 18.;17 5/8 - 18 1/4.;17 1/4 - 18 1/4.;&LOS: Reading 52-dMoving the ask price lower than the other dealers will mean the dealer is able to sell stock, and moving the bid price lower will mean he is unlikely to have to buy stock, until the other dealers move their prices.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 4, p. 122.&&&a&Class@SS12.2&&&&&1:v&&& 2006JV.481&mcs&0&N&The required rate of return of an investor buying an asset is least likely to depend on:&the growth rate of the asset's earnings.&the expected rate of inflation.;the risk premium of the asset.;the real risk-free rate of the economy.;&LOS: Reading 55-eThe required rate of return depends on three factors, the real risk-free rate, the expected inflation rate and a risk premium.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 11, pp. 393-395.&&&a&Class@SS13.0&&&&&1&N&0&N.N.N.N 2006JV.482&mcs&0&N&Which of the following would be seen as a buy signal by a contrary opinion technical analyst?&The bearish sentiment index for investment advisory opinions is high.&Low mutual fund cash balances.;OTC volume is high relative to volume on the NYSE.;A low put/call ratio on the Chicago Board Options Exchange.;&LOS: Reading 60-cContrarians believe that investment advisors are trend followers so the number of bears is greatest near the bottom of the market.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 16, pp. 630-634.&&&a&Class@SS13.1&&&&&1&N&0&N.N.N.N 2006JV.483&mcs&0&N&When economies move from being industrially based to service based this could be most appropriately described as:&structural economic change.&a business cycle.;value chain competition.;cyclical economic change.;&LOS: Reading 57A structural economic change is when an economy goes through a major change in the way it functions. A move from an industry-based to a service-based economy is an example of this. Business or economic cycles are shorter term ups and down in economic activity..Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 14, pp. 493-495.&&&a&Class@SS13.2&&&&&1&N&0&N.N.N.N 2006JV.484&mcs&0&N&Which of the following is most likely to lead to estimated earnings per share for a stock market series being lower than in the previous period?&Capacity utilization rates are increasing.&Tax rates are declining.;Unit labor costs are rising.;Nominal gross domestic product (GDP) is rising.;&LOS: Reading 56-aHigher unit labor costs will depress operating margins.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 13, pp. 452-464.&&&a&Class@SS13.0&&&&&1&N&0&N.N.N.N 2006JV.485&mcs&0&N&The major difference between portfolio managers who follow the top-down rather than the bottom-up approach to stock valuation is:&IV. they place emphasis on the market and industry outlook in determining stocks' performance. &I. they are stock pickers.;II. they focus on selecting stocks that will outperform the market regardless of the market outlook.;III. they focus on selecting stocks that will outperform the market regardless of the industry outlook.;&LOS: Reading 55-aI., II. and III. refer to bottom-up portfolio managers.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 11, pp. 369-370.&&&a&Class@SS13.1&&&&&1&N&0&N.N.N.N 2006JV.486&mcs&0&N&Estimating the earnings per share for a stock market series involves estimating all of the following EXCEPT:&the aggregate market earnings multiplier.&corporate tax rates.;operating profit margins.;gross domestic product for the economy.;&LOS: Reading 56-aThe aggregate market earnings multiplier multiplied by the earnings per share estimate, will give the expected future level of the stock market series.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 13, pp. 369-370.&&&a&Class@SS13.2&&&&&1&N&0&N.N.N.N 2006JV.487&mcs&0&N&The current stock market level is 320, the estimated earnings per share for the index is $24, the dividend payout ratio is 35%, and the estimated P/E ratio in one year's time is 15. The expected rate of return from the index over the next year is closest to:&15.1%.&12.5%.;20.0%.;25.3%.;&LOS: Reading 56-bThe end year index level is estimated to be 24 x 15 =360The dividend is 24 x 0.35 = 8.4The return is (360 -320 +8.4)/320 = 15.1%Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 13, pp. 472-473.&&&a&Class@SS13.0&&&&&1&N&0&N.N.N.N 2006JV.488&mcs&0&N&8. If the real risk-free rate of return is 2% and the expected inflation rate is 5%, then the nominal risk-free rate is closest to:&7.1%.&1.0%.;2.5%.;2.9%.;&LOS: Reading 55-eNominal RFR = (1 + real RFR)(1 + expected inflation) - 1 = 1.02 x 1.05 - 1 = 7.1%Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 11, pp. 393-395.&&&a&Class@SS13.1&&&&&1&N&0&N.N.N.N 2006JV.489&mcs&0&N&A company maintains a stable dividend payout ratio of 30% and the rate of return on existing equity is 15%. If new projects available to the company earn a return of only 12%, and the company does not raise any outside capital, then the earnings growth rate will be:&8.4%.&3.6%.;4.5%.;10.5%.;&LOS: Reading 55-fgrowth rate = retention rate x return on equity (for new investment)= 0.7 x 12% = 8.4%Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 11, pp. 399-401.&&&a&Class@SS13.2&&&&&1&N&0&N.N.N.N 2006JV.490&mcs&0&N&If investors' required rate of return from a stock increases then the P/E of the stock will generally:&decrease.&increase.;remain unchanged.;either increase or decrease depending on whether investors required rate of return from the market has changed.;&LOS: Reading 55-d\\Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 11, pp. 388-391.&&&a&Class@SS13.0&&&&&1&N&0&N.N.N.N 2006JV.491&mcs&0&N&A company has a dividend payout ratio of 40%, dividends are expected to grow by 5% per annum and the required rate of return is 12%. The price/earnings ratio is closest to:&5.71.&5.93.;8.33.;8.57.;&LOS: Reading 55-dP/E = D/[E(k - g)] = 0.4/(0.12 - 0.05) = 5.71Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 11, pp. 388-391.&&&a&Class@SS13.1&&&&&1&N&0&N.N.N.N 2006JV.492&mcs&0&N&The mature growth stage of an industry's life cycle is usually characterized by:&IV. sales are growing at above the rate of growth of the economy but profit margins are no longer rising since competitors are entering the industry.&I. sales are growing rapidly and profit growth is high.;II. sales are growing rapidly and there is little competition leading to high profit margins.;III. sales are growing at the same rate as the economy and the industry is subject to heavy competition.;&LOS: Reading 58-cI. and II. are rapid accelerating growth, III. is market maturity.Reference: International Investments, Solnik and McLeavey, 5th Edition, Ch. 6, pp. 264-265.&&&a&Class@SS13.2&&&&&1&N&0&N.N.N.N 2006JV.493&mcs&0&N&When a technical analyst notes that a stock has risen to a price range where she expects to see major sellers of the stock enter the market:&the stock has reached a resistance level.&the stock has broken its trend line.;the stock has reached a support level.;the stock has broken through its moving average line from below.;&LOS: Reading 60-cA resistance level is when technical analysts would expect to see an increase in supply of stock (which has been overhanging the market) lead to selling pressure and price reversal.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 16, pp. 638-639.&&&a&Class@SS13.0&&&&&1&N&0&N.N.N.N 2006JV.494&mcs&0&N&A preferred stock has a par value of $100, is trading at $90 and pays a 6% annual dividend. Assume that there is no risk that the company will default on dividend payments. If an investor's required rate of return is 6.5% the preferred stock looks:&attractive.&expensive.;fairly valued.;the value cannot be determined from the information given.;&LOS: Reading 55-cThe value of the preferred stock, since it pays dividends in perpetuity, is $6/0.065= $92.30. Therefore, at a price of $90, the stock looks attractive.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 11, pp. 376-377.&&&a&Class@SS13.1&&&&&1&N&0&N.N.N.N 2006JV.495&mcs&0&N&Price/book value is an important valuation measure because:&IV. stocks with low price/book values have shown higher risk-adjusted returns than the market returns. &I. if the price/book value is above one then the stock is expensive.;II. book value is a good indicator of a company's break-up value.;III. the price/book value is not impacted by growth expectations for the company.;&LOS: Reading 61-bI. is not correct, the P/BV of most industrial companies will be greater than 1.II. book value, which is based on historic cost is often less than the break-up value.III. is not correct since growth companies tend to have higher P/BV ratios.P/BV is one of the few valuation measures that is a good indicator of risk-adjusted performance.Reference: "Introduction to Price Multiples," John D. Stowe, Thomas R. Robinson, Jerald E. Pinto, and Dennis W. McLeavey (AIMR, 2003), pp. 7-14.&&&a&Class@SS13.2&&&&&1&N&0&N.N.N.N 2006JV.496&mcs&0&N&Which of the following would be expected to lead to a high risk premium for a market?&A volatile exchange rate.&A highly liquid market.;A stable political environment.;Low levels of financial leverage.;&LOS: Reading 55-eA volatile exchange rate would increase the exchange rate risk, one of the five components of risk that affects the risk premium.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 11, pp. 398-399.&&&a&Class@SS13.0&&&&&1&N&0&N.N.N.N 2006JV.497&mcs&0&N&An investor forecasts that the economy is going to peak within the next year. His most likely strategy would be to purchase:&bonds.&stocks.;property.;commodities.;&LOS: Reading 58-aAt the end of an economic boom stocks, property and commodities will have performed well and will be peaking. Interest rates will be high reflecting strong demand for borrowing and therefore bonds offer the best potential performance. As demand for borrowing slows interest rates will fall providing attractive returns for bonds.Reference: International Investments, Solnik and McLeavey, 5th Edition, Ch. 6, p. 258.&&&a&Class@SS13.1&&&&&1&N&0&N.N.N.N 2006JV.498&mcs&0&N&It is assumed that a company's dividends will grow at a constant growth rate of 4%, and the current dividend is $2.50 per share. If an investor's required rate of return is 9% then using the dividend discount model, the value of the company is closest to:&$52.00.&$27.77.;$28.89.;$50.00.;&LOS: Reading 55-c\\Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 11, pp. 382-384.&&&a&Class@SS13.2&&&&&1&N&0&N.N.N.N 2006JV.499&mcs&0&N&In an industry the largest two firms have a market share of 20% each and six firms have a market share of 10% each. The five firm concentration ratio and Herfindahl index are:Concentration ratio Herfindahl index& 70.0% 0.14& 62.5% 0.11; 70.0% 0.11; 62.5% 0.14;&LOS: Reading 58-d\\Reference: International Investments, Solnik and McLeavey, 5th Edition, Ch. 6, pp. 265-266.&&&a&Class@SS13.0&&&&&1&N&0&N.N.N.N 2006JV.500&mcs&0&N&When a contrary opinion technical analyst sees a build-up of credit balances in brokerage accounts they would see this as:&a bullish signal for the market, since there are funds available to buy stocks in the market.&an indicator that is only relevant to a fundamental analyst.;a bearish signal for the market, since investors are negative on the market prospects.;a bearish signal for the market, since it indicates a lack of funds available to buy stocks in the market.;&LOS: Reading 60-cHigh credit balances imply that inventors are planning to invest the money in the short term so it is a bullish signal for the market.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 16, pp. 630-634.&&&a&Class@SS13.1&&&&&1&N&0&N.N.N.N 2006JV.501&mcs&0&N&Which of the following is the least appropriate assumption of the dividend discount model?&Dividends are always greater than zero.&It is possible to estimate investors’ required rate of return.;The value of a company is the present value of future dividend payments.;The investors’ required rate of return is higher than the long-term dividend growth rate.;&LOS: Reading 55-cI. is not correct since dividends can be zero for a period of time, but at some stage dividends must be paid if the firm is to have any value.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 11, pp. 379-384.&&&a&Class@SS13.2&&&&&1&N&0&N.N.N.N 2006JV.502&mcs&0&N&Which of the following is least likely to be an assumption of technical analysis?&The Efficient Market Hypothesis holds.&The prices of securities move in long-term trends.;Market values are determined by demand and supply.;Changes in trends are the effect of shifts in supply and demand.;&LOS: Reading 60-aThe weak form of the Efficient Market Hypothesis says that all past price and trading information is reflected in current stock prices, so technical analysis does not improve returns.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 16, pp. 626-627.&&&a&Class@SS13.0&&&&&1&N&0&N.N.N.N 2006JV.503&mcs&0&N&If a stock has a high P/E ratio relative to the market P/E, this is least likely to be explained by:&I. The return on equity is higher for the stock than the market average.II. The expected growth rate of dividends is higher than the average in the &I. The investors' required rate of return is higher for this stock than the market.;I. The expected growth rate of dividends is higher than the average in the ;I. The return on equity is higher for the stock than the market average.II. The investors' required rate of return is higher for this stock than the market.III. The expected growth rate of dividends is higher than the average in the ;&LOS: Reading 55-d\\Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 11, pp. 388-391.&&&a&Class@SS13.1&&&&&1&N&0&N.N.N.N 2006JV.504&mcs&0&N&Which group of people believes that the adjustment of stock prices to new information takes the longest period of time?&Technical analysts.&Fundamental analysts.;Active portfolio managers.;Supporters of the efficient market hypothesis.;&LOS: Reading 60-aTechnical analysts believe that it takes a period of time for a new trend to establish itself.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 16, pp. 626-628.&&&a&Class@SS13.2&&&&&1&N&0&N.N.N.N 2006JV.505&mcs&0&N&A high risk premium for investing in a country's stock market might be a result of:&the political situation is unstable.&business risk is relatively low.;the stock market is very liquid.;companies use a low level of financial leverage. ;&LOS: Reading 55-eAn illiquid market would increase the risk of investing in the market and the result would be a higher risk premium.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 11, pp. 398-399.&&&a&Class@SS13.0&&&&&1&N&0&N.N.N.N 2006JV.506&mcs&0&N&In technical analysis the breadth of the stock market might be measured by:&the advance-decline ratio.&the confidence index.;the moving-averages.;credit balances versus debit balances in brokerage accounts. ;&LOS: Reading 60-cThe breadth of the market looks at the number of issues that have increased versus the number that have declined; this information can be seen in the advance-decline ratio. It provides additional information to the market index which is often dominated by a small number of large stocks which can move the market in one direction even when the majority of issues are moving in the opposite direction.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 16, pp. 635-636.&&&a&Class@SS13.1&&&&&1&N&0&N.N.N.N 2006JV.507&mcs&0&N&An analyst forecasts that a company will pay a dividend of $2.30 next year, $2.60 in the following year and dividends will grow at 5% thereafter. If an investor's required rate of return is 12%, the value of the company is closest to:&$35.21.&$33.73.;$38.48.;$42.04.;&LOS: Reading 55-cDiscount back the first two years' dividends at 12% to get $2.05 and $2.07.Thereafter apply the DDM to give value of shares at the end of the second year as2.73/(0.12 - 0.05) = $39, which discounts back to $31.09.The value of the company = $2.05 + $2.07 + $31.09 = $35.21Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 11, pp. 379-384.&&&a&Class@SS13.2&&&&&1&N&0&N.N.N.N 2006JV.508&mcs&0&N&Price/cash flow is considered a useful valuation method for all of the following reasons EXCEPT:&it is consistently calculated by analysts.&cash flow is a good indicator of financial strength of a company.;cash flow is less subject to distortion due to accounting methods than earnings.;examining the trends in relative price/cash flow ratios provides information on how the market is valuing a stock.;&LOS: Reading 61-aAnalysts use different definitions of cash flow, although free cash flow is probably the most appropriate.Reference: "Introduction to Price Multiples," John D. Stowe, Thomas R. Robinson, Jerald E. Pinto, and Dennis W. McLeavey (AIMR, 2003), pp. 17-18.&&&a&Class@SS13.0&&&&&1&N&0&N.N.N.N 2006JV.509&mcs&0&N&Technical analysts are least likely to believe that they have the following advantages over fundamental analysts:&their decisions will not be affected by changes in investor sentiment.&they do not need to use financial statements.;they can select the right timing for buying and selling securities.;they have longer to make a decision following the release of new information. ;&LOS: Reading 60-bChanges in sentiment will affect supply and demand for stocks that, in technical analysis, are the determinants of stock price moves. A fundamental analyst, if depending on the financial statements, may not take into account sentiment changes.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 16, pp. 627-628.&&&a&Class@SS13.1&&&&&1&N&0&N.N.N.N 2006JV.510&mcs&0&N&An analyst calculates the price to sales ratio for a company and finds it is significantly less than the market average, this could be explained by:&II. the company has a low profit margin relative to the average for the market.&I. sales per share are higher than for the average company.;III. the company has exhibited rapid sales growth relative to the market average.;IV. sales growth has been consistent and the risk of sales growth faltering is small.;&LOS: Reading 61-bP/S is the same as P/E multiplied by the profit margin, so a low profit margin could explain a low P/S ratio. Answers I., III. and IV. would push up the P/S ratio.Reference: "Introduction to Price Multiples," John D. Stowe, Thomas R. Robinson, Jerald E. Pinto, and Dennis W. McLeavey (AIMR, 2003), pp. 14-17.&&&a&Class@SS13.2&&&&&1&N&0&N.N.N.N 2006JV.511&mcs&0&N&If an investor's required rate of return is 12% and a company's stock price is $45.00, the next dividend is estimated to be $3.60 and the growth rate of dividends is a constant 4.5%, then the stock is:&undervalued.&overvalued.;fairly valued.;information is needed on the dividend payout ratio to answer the question. ;&LOS: Reading 55-cThe stock price using the DDM should be 3.6/(0.12 - 0.045) = $48, if the price is $45 the stock is undervalued.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 11, pp. 282-283.&&&a&Class@SS13.0&&&&&1&N&0&N.N.N.N 2006JV.512&mcs&0&N&Which of the following would be a positive factor for producers' profitability?&weak supplier power.&low entry barriers.;strong buyer power.;availability of substitutes.;&LOS: Reading 58-eWeak supplier power means that the suppliers to the industry are in a weak negotiating position and unable to squeeze the producers' profits, this is a positive factor for the producers' profitability.Low entry barriers will increase competition, reducing profit margins. Strong buyer power means the buyers can demand low prices reducing profitability. Availability of substitutes restrains producers who wish to raise prices.Reference: International Investments, Solnik and McLeavey, 5th Edition, Ch. 6, pp. 269-272.&&&a&Class@SS13.1&&&&&1&N&0&N.N.N.N 2006JV.513&mcs&0&N&Which of the following factors is least likely to directly determine the level of competition in an industry?&unit labor costs.&entry barriers.;bargaining power of buyers.;availability of substitute products.;&LOS: Reading 58-eUnit labor costs impact the profitability of an industry, and although they indirectly affect how attractive a business is for participants they are not a direct factor determining competition.Reference: International Investments, Solnik and McLeavey, 5th Edition, Ch. 6, pp. 269-272.&&&a&Class@SS13.2&&&&&1&N&0&N.N.N.N 2006JV.514&mcs&0&N&If mutual fund cash positions rise to 13% of the net asset value of the funds then a contrary-opinion technical analyst would see this as a:&buy signal since it indicates that the majority of investors are bearish.&sell signal since it indicates that the majority of investors are bearish.;sell signal since it means that they are receiving large cash flows into the funds.;sell signal since it means that they are raising cash to meet redemptions from the fund. ;&LOS: Reading 60-cA contrarian would take the opposite view to the majority of investors and high cash balances indicate that mutual fund managers, who are an indicator of institutional investors, are bearish. Also high cash balances indicate future buying power of the funds.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 16, pp. 630-634.&&&a&Class@SS13.0&&&&&1&N&0&N.N.N.N 2006JV.515&mcs&0&N&A support level in technical analysis is:&a price at which an increase in demand for a stock will reverse a declining trend.&a price at which an increase in supply of stock will reverse a rising trend.;a price at which an increase in supply of stock will reverse a declining trend.;a price at which an increase in demand for a stock will reverse a rising trend.;&LOS: Reading 60-cA support level occurs when buyers come into the market and support the price of a stock. Often this happens when the price has previously risen then fallen back due to profit taking. At this point buyers, who perhaps missed earlier opportunities to buy, come back to the market leading to a surge in demand and the price increasing.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 16, pp. 638-639.&&&a&Class@SS13.1&&&&&1&N&0&N.N.N.N 2006JV.516&mcs&0&N&Estimating a company multiplier using macroanalysis involves:&examining the relationship between the company multiplier and the market multiplier.&examining the relationship between the company multiplier and the economy.;examining the relationship between the historic multiplier for the company and company performance.;examining the specific variables that influence the multiplier, including the dividend payout ratio and required rates of return.;&LOS: Reading 59-bMicroanalysis is Answer "examining the specific variables that influence the multiplier, including the dividend payout ratio and required rates of return".Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 15, p. 569.&&&a&Class@SS13.2&&&&&1&N&0&N.N.N.N 2006JV.517&mcs&0&N&A company whose earnings are very sensitive to the business cycle is a&cyclical company.&growth stock.;cyclical stock.;growth company.;&LOS: Reading 59-aA cyclical company is one whose sales and earnings are very sensitive to the business cycle such as auto or steel companies. A cyclical stock is defined differently; it is one which has a high beta so it has changes in rates of return which are larger than the changes in rates of return of the market.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 15, pp. 542-543.&&&a&Class@SS13.0&&&&&1&N&0&N.N.N.N 2006JV.518&mcs&0&N&Value chain analysis in return expectations analysis is important because it studies:&how goods are transformed from raw materials through to the finished good and profits are shared between firms along the chain.&co-opetition risks.;competition between rival firms in an industry.;the government's ability to raise value added taxes.;&LOS: Reading 58-bValue chain analysis in return expectations analysis looks at how returns are split between the participants in a value chain. Co-opetition risks refers to risks, not returns, in the value chain and competition between rival firms is not referring to firms in the same value chain.Reference: International Investments, Solnik and McLeavey, 5th Edition, Ch. 6, pp. 263-264.&&&a&Class@SS13.1&&&&&1&N&0&N.N.N.N 2006JV.519&mcs&0&N&An analyst is valuing a company where he suspects that the management has been manipulating the accounts by capitalizing expenses that should have been treated as operating expenses. Which would be an appropriate approach to take to valuing the company?&Use price to cash flow as the main relative measure using free cash flows in the calculation.&Use normalized earnings rather than current earnings in the price to earnings calculation.;Focus on price to book value since book value will not have been affected by any manipulation of the accounts.;Not attempt to value the company if there are concerns about the quality of the reported accounts.;&LOS: Reading 61-aNormalized earnings will look at earnings over a business cycle so will not resolve the issue of earnings manipulation, book value will also reflect a decision to capitalize rather than expense earnings. Cash flow will reflect the actual cash going in and out of the company so will be less subject to manipulation.The Correct Answer is possible but analysts may not have the choice to ignore companies where they suspect that the accounts have been manipulated. They will need to attempt to value them by adjusting the accounts and/or using cash flow methods.Reference: "Introduction to Price Multiples," John D. Stowe, Thomas R. Robinson, Jerald E. Pinto, and Dennis W. McLeavey (AIMR, 2003), pp. 17-19.&&&a&Class@SS13.2&&&&&1&N&0&N.N.N.N 2006JV.520&mcs&0&N&Which of the following would contribute to a company's earnings multiplier being higher than the market multiplier?&IV. High earnings growth rates for the company relative to the market.&I. The company has a high beta.;II. The risk of the company's earnings is higher than the market.;III. Low return on equity for the company relative to the market.;&LOS: Reading 59-bI. a high beta would lead to a high required rate of return and therefore a lower multiplier.II. higher risk means a higher required rate of return, and therefore a lower multiplier.III. implies low growth rates which would lead to a lower multiplier.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 15, pp. 569-575.&&&a&Class@SS13.0&&&&&1&N&0&N.N.N.N 2006JV.521&mcs&0&N&A floating-rate note has the coupon formula below:
Six-month LIBOR × L + 130 basis points, and L varies between 0.6 and 0.9 inclusive depending upon the following schedule of 6-month LIBOR

If 6-month LIBOR is higher than 8.0%, then L = 0.6
If 6-month LIBOR is higher than 7.0% and no higher than 8.0%, then L = 0.7
If 6-month LIBOR is higher than 6.0% but no higher than 7.0%, then L = 0.8
If 6-month LIBOR is no higher than 6.0%, then L = 0.9

This floating rate note is called:&a deleveraged floater.&an inverse floater.;a dual index floater.;an extendible reset bond.;&LOS: Reading 62-bA deleveraged floater has a coupon formula where the coupon rate is computed as a fraction of the reference rate plus a quoted margin.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 1, pp. 7-10.&&&a&Class@SS14.1&&&&&1&N&0&N.N.N.N 2006JV.522&mcs&0&N&A floating-rate note has the coupon formula below:

Six-month LIBOR × L + 130 basis points, and L varies between 0.6 and 0.9 inclusive depending upon the following schedule of 6-month LIBOR
If 6-month LIBOR is higher than 8.0%, then L = 0.6
If 6-month LIBOR is higher than 7.0% and no higher than 8.0%, then L = 0.7
If 6-month LIBOR is higher than 6.0% but no higher than 7.0%, then L = 0.8
If 6-month LIBOR is no higher than 6.0%, then L = 0.9

When 6-month LIBOR is exactly 8.0% what is the coupon rate?&6.9%.&6.1%.;8.0%.;9.3%.;&LOS: Reading 62-bWhen 6-month LIBOR is exactly 8.0%, then L= 0.7. ThereforeCoupon rate = (8.0% x 0.7) + 1.30% = 6.9%Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 1, pp. 7-10.&&&a&Class@SS14.2&&&&&1&N&0&N.N.N.N 2006JV.523&mcs&0&N&Which of the following statements is least accurate regarding the term to maturity of a bond?&The term to maturity is always fixed.&The yield offered on a bond depends on the term to maturity.;The price fluctuation (price volatility) depends on, among other factors, the term to maturity.;It tells the investor the number of years before the principal is paid in full and the period over which interest payments can be expected. ;&LOS: Reading 62-aThere may be provisions in the indenture that allow the issuer or the bondholder to alter the term to maturity.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 1, pp. 5-6.&&&a&Class@SS14.0&&&&&1&N&0&N.N.N.N 2006JV.524&mcs&0&N&A floating-rate note has the following coupon formula:
Six-month Treasury bill rate + 60 basis points with a cap of 7% and a floor of 6.5%
The 6-month Treasury bill rates are as follows:

6-month Treasury bill rate
First reset date6.5%
Second reset date5.8%
Third reset date 6.3%
Fourth reset date6.1%

What would be the coupon rates at the first and the second reset dates, respectively?&7.0% 6.5%&6.5% 5.8%;6.5% 6.5%;7.6% 7.1%;&LOS: Reading 62-bThe coupon rate at the first reset date is 6.5% + 0.6% = 7.1% which is higher than the cap rate. Therefore it takes on the cap rate, which is 7.0%.The coupon rate at the second reset date is 5.8% + 0.6% = 6.4% which is lower than the floor rate. Therefore it takes on the floor rate, which is 6.5%.The cap and floor apply to the computed coupon rates, not to the reference rates.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 1, pp. 7-10.&&&a&Class@SS14.1&&&&&1:v&&& 2006JV.525&mcs&0&N&A bond is priced at 90, if yields decline by 25 basis points the price rises to 94.8 and if yields rise by 25 basis points the price falls to 84.9. What is the duration closest to:&22.0.& 9.9.;11.0.;44.0.;&LOS: Reading 63-f\\Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 4, pp. 30-31.&&&a&Class@SS14.2&&&&&1&N&0&N.N.N.N 2006JV.526&mcs&0&N&Which of the following tools is least likely to be used to manage the level of interest rates in an economy?&Corporate tax rates.&The discount rate.;Open market operations.;Bank reserve requirements.;&LOS: Reading 65-aAdjusting corporate tax rates is a tool that is used as part of fiscal, not monetary, policy.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 4, pp. 96-97.&&&a&Class@SS14.0&&&&&1&N&0&N.N.N.N 2006JV.527&mcs&0&N&Which of the following is least likely to be used as a type of external credit enhancement?&sequential disbursement.&letters of credit.;bond insurance.;corporate guarantee.;&LOS: Reading 64-gSequential disbursement rules are techniques for internal credit enhancement that are commonly used in structured securities such as collateralized mortgage obligations (CMOs).Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 3, p. 74-75.&&&a&Class@SS14.1&&&&&1&N&0&N.N.N.N 2006JV.528&mcs&0&N&The role of credit rating agencies is:&IV. to report on the likelihood of a company defaulting.&I. to perform valuations of companies.;II. to forecast the direction of interest rates.;III. to extend a credit guarantee to bond issues.;&LOS: Reading 63-iI. is the role of investment bankers or accounting firms, II. is the role of economists, and III. is the role of a bank or a credit insurance company.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 2, pp. 38-40.&&&a&Class@SS14.2&&&&&1&N&0&N.N.N.N 2006JV.529&mcs&0&N&Which of the following factors is least likely to affect the yield spread of a bond?&The behavior of any embedded options.&The coupon rate of the bond.;The expected liquidity of the issue.;The type of issuer (government, corporate, agency).;&LOS: Reading 65-cCoupon rates generally do not affect the yield spread as the price of the bond will adjust according to investors' required returns.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 4, pp. 104-106.&&&a&Class@SS14.0&&&&&1&N&0&N.N.N.N 2006JV.530&mcs&0&N&Which of the following will be least important in explaining a bond price’s volatility?&Its par value.&Its coupon.;Its term to maturity.;The direction of the yield change.;&LOS: Reading 63-cA bond's par value determines the pricing of a bond but its interest rate sensitivity mainly depends on its coupon, its term to maturity, market level of yields and the direction of the yield change.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 2, pp. 34-39.&&&a&Class@SS14.1&&&&&1&N&0&N.N.N.N 2006JV.531&mcs&0&N&The most recently auctioned Treasury bond is called a:&on-the-run issue.&fallen angel.;flower bond.;benchmark bond.;&LOS: Reading 64-bThe most recently auction Treasury bonds are called the on-the-run issues.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 3, p. 56.&&&a&Class@SS14.2&&&&&1&N&0&N.N.N.N 2006JV.532&mcs&0&N&Which one of the following descriptions relates to yield curve risk?&The risk that investors face when yields of bonds with different maturities do not move in parallel.&The risk that investors face when purchasing power weakens.;The risk that investors face when a crossover yield is reached for a callable bond.;The risk that investors face when reinvestment rates are lower than the yield to maturity.;&LOS: Reading 63-fYield curve risk exists when the bonds in the portfolio have different exposures to how the yield curve shifts. Yield curves usually do not shift in parallel.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 2, pp. 32-35.&&&a&Class@SS14.0&&&&&1&N&0&N.N.N.N 2006JV.533&mcs&0&N&Which one is the least likely to be a characteristic of a revenue-type of municipal bond?&It is guaranteed by the federal government.&It is exempt from federal tax for certain investors.;The source of repayment is from revenue-generating projects.;It generally provides a higher return than an equivalent Treasury bond.;&LOS: Reading 64-eMunicipal bonds are not guaranteed by the federal government.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 3, pp. 68-71.&&&a&Class@SS14.1&&&&&1&N&0&N.N.N.N 2006JV.534&mcs&0&N&The following are all characteristics of a Collateralized Mortgage Obligation (CMO), EXCEPT:&The structure is a pass-through instead of a pay-through.&Most CMOs are overcollateralized.;The credit quality of most tranches is equivalent to the collateral.;The bonds are serviced with the cash flows from the pool of mortgages or MBSs.;&LOS: Reading 64-cThe main difference between a MBS and a CMO is that the former is a pass-through structure and the latter is a pay-through.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 3, pp. 66-68.&&&a&Class@SS14.2&&&&&1&N&0&N.N.N.N 2006JV.535&mcs&0&N&Which of the following is the least likely characteristic of a pass-through Government National Mortgage Association (Ginnie Mae) mortgage-backed security?&The average life is the same as the maturity.&Prepayment rates are a major factor in determining the duration.;The outgoing cash flows follow the pattern of the incoming cash flows.;Each monthly payment to investors consists of interest and principal components.;&LOS: Reading 64-cThe monthly payments of a MBS consist of principal and interest components. They are not certain, primarily because prepayment events may modify the statistical characteristics of the pool. The maturity of the pool follows the longest maturity of a loan, but the average life is generally less than the maturity due in part to prepayment events. In pass-through securities, the outgoing pattern of cash flows reflects the incoming cash flows.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 3, pp. 64-66.&&&a&Class@SS14.0&&&&&1&N&0&N.N.N.N 2006JV.536&mcs&0&N&Which of the following is the least common characteristic of a Eurobond?&It is issued in registered form.&It is denominated in U.S. dollars.;It is underwritten by an international syndicate.;It is issued and traded outside the jurisdiction of any single country.;&LOS: Reading 64-aSince the issuer's aim is to reach the widest possible investor base and to provide flexibility for transfer of ownership among international investors, Eurobonds are generally issued in bearer (unregistered) form.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 3, pp. 54-55.&&&a&Class@SS14.1&&&&&1&N&0&N.N.N.N 2006JV.537&mcs&0&N&The Korean subsidiary of a Canadian corporation is planning to issue a U.S. Dollar denominated bond. To be classified as a Yankee bond, the most appropriate set of conditions is:&The issuer does not have to be domiciled in the U.S., the investor can be of any citizenship and the bond must be registered in the U.S.&The issuer must be domiciled in the U.S., the investor must be a U.S. citizen or body and the bond must be registered in the U.S.;The issuer must be domiciled in the U.S., the investor must be a U.S. citizen or body and the bond can be registered outside the U.S.;The issuer does not have to be domiciled in the U.S., the investor can be of any citizenship and the bond can be registered outside the U.S.;&LOS: Reading 64-aNeither the investors nor the issuers need to be domiciled in the U.S. for a Yankee bond issue. However the bond issue must be registered with the U.S. financial authority (the SEC) to be classified as a foreign bond in the U.S. (Yankee bond).Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 3, p. 54-55.&&&a&Class@SS14.2&&&&&1&N&0&N.N.N.N 2006JV.538&mcs&0&N&The commitments of a corporate bond issuer and the rights of investors who buy it are set forth in a contract that is called the:&indenture.&prospectus.;credit rating sheet.;underwriting agreement.;&LOS: Reading 62-aThe legal agreement that lists the obligations of the issuer to the bondholder including payment schedules, call provisions and sinking funds is called an indenture.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 1, p. 5.&&&a&Class@SS14.0&&&&&1&N&0&N.N.N.N 2006JV.539&mcs&0&N&If a country's economy is entering a recession then one would expect that the yield spread between government bonds and corporate bonds that are rated single A to:&be wider than normal, since the risk of the A-rated bonds defaulting is higher.&be wider than normal, since the risk of the A-rated bonds defaulting is lower.;be unaffected, since the risk of the A-rated bonds are unaffected by recession.;be tighter than normal, since the yield of the government bonds defaulting is higher.;&LOS: Reading 65-cIf an economy is entering recession then the risk of default of the corporate bonds will increase and therefore the extra return required for holding these bonds should be higher than normal.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 4, pp. 105-106.&&&a&Class@SS14.1&&&&&1&N&0&N.N.N.N 2006JV.540&mcs&0&N&An increase in yield volatility means that:&prices of callable bonds will tend to fall as the value of the embedded call option increases.&prices of callable bonds will tend to rise as the value of the embedded call option increases.;prices of callable bonds will tend to rise as the value of the embedded call option decreases.;prices of callable bonds will tend to fall as the value of the embedded call option decreases.;&LOS: Reading 63-dPrice of callable bond = Price of option-free bond - Price of embedded call optionThe value of the embedded option goes up when yield volatility increases. So if the price of the embedded call option increases, then the price of callable bond will decrease if the price of the option-free bond remains the same.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 2, p. 42-43.&&&a&Class@SS14.2&&&&&1&N&0&N.N.N.N 2006JV.541&mcs&0&N&Commercial paper:&is issued by both financial and nonfinancial companies.&pays interest on a semi-annual basis.;is actively traded in the secondary market.;is sold by Treasury auction on a weekly basis.;&LOS: Reading 64-iCommercial paper is a short-term unsecured promissory note, which is usually zero-coupon. It is issued by both financial companies (usually direct paper) and non-financial companies, and not normally traded in the secondary market.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 3, pp. 78-69.&&&a&Class@SS14.0&&&&&1&N&0&N.N.N.N 2006JV.542&mcs&0&N&Which of the following types of bonds will generally have the highest reinvestment risk?&High-coupon callable bonds.&Zero-coupon bonds.;Low-coupon Treasury bonds.;Bonds with an embedded put option.;&LOS: Reading 63-hReinvestment risk will be highest with callable bonds with a high coupon rate. When a callable bond is called, it generally means that the interest rates are low. So the investor will have cash in hand which he or she will have to invest in a low interest rate environment.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 2, pp. 36-37.&&&a&Class@SS14.1&&&&&1&N&0&N.N.N.N 2006JV.543&mcs&0&N&A repurchase agreement is an example of:&a collateralized borrowing arrangement.&an embedded option.;an exchangeable bond.;a margin buying arrangement.;&LOS: Reading 62-dA repurchase agreement is the sale of a security with a commitment by the seller to buy the same security back. The repurchase price will reflect the implied interest rate, i.e. repo rate or the borrowing rate of the collateralized loan.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 1, pp. 17-18.&&&a&Class@SS14.2&&&&&1&N&0&N.N.N.N 2006JV.544&mcs&0&N&A variable-rate security where the coupon rate moves in the opposite direction to a reference rate is:&an inverse floater.&a range note.;a ratchet bond.;a deleveraged floater.;&LOS: Reading 62-bAn inverse floater is a floating-rate security whose coupon formula moves the coupon rate in the opposite direction to the reference rate.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 1, pp. 7-10.&&&a&Class@SS14.0&&&&&1&N&0&N.N.N.N 2006JV.545&mcs&0&N&A bond will trade at a premium if:&market interest rates are lower than the coupon rate.&it is a zero coupon bond.;it is a bond that pays a coupon.;market interest rates are higher than the coupon rate.;&LOS: Reading 63-bWhen market interest rates are below the coupon rate the bondholders will demand a lower rate than the coupon rate so the bond price will be set higher than its par value.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 2, pp. 26-27.&&&a&Class@SS14.1&&&&&1&N&0&N.N.N.N 2006JV.546&mcs&0&N&The most appropriate definition of duration is: &IV. a measure of a bond’s sensitivity to changes in yield.&I. the slope of the yield curve.;II. the time to maturity of a bond.;III. the average time to cash flows.;&LOS: Reading 63-fI is not correct, duration is the slope of the price-yield curve. II is only true for a zero-coupon bond. III. would be correct if it is the weighted average time to cash flows, weighted by the amounts of the cash flows.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 2, pp. 30-32.&&&a&Class@SS14.2&&&&&1&N&0&N.N.N.N 2006JV.547&mcs&0&N&A bond investor wishes to minimize interest rate risk. Which of the following bonds would be most likely to be the suitable investment?&A 10% coupon bond that matures in 3 years' time.&A 5% coupon bond that matures in 5 years' time.;A 3% coupon bond that matures in 20 years' time.;A zero-coupon bond that matures in 15 years' time.;&LOS: Reading 63-cShort-dated, high coupon bonds tend to be less interest-rate sensitive.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 2, pp. 28-29.&&&a&Class@SS14.0&&&&&1&N&0&N.N.N.N 2006JV.548&mcs&0&N&Downgrade risk refers to the risk that:&the credit rating of a bond is reduced.&interest rates rise.;the liquidity of a bond declines.;the currency that the bond is issued in depreciates.;&LOS: Reading 63-iThe assignment of an inferior credit rating is referred to as downgrading.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 2, pp. 38-40.&&&a&Class@SS14.1&&&&&1&N&0&N.N.N.N 2006JV.549&mcs&0&N&The clean price of a bond is:&the agreed bond price without accrued interest.&the accrued interest component of the bond price.;the agreed bond price plus the accrued interest due to the seller of the bond.;the agreed bond price for the bond less the accrued interest due to the buyer of the bond.;&LOS: Reading 62-bThe clean price of a bond is the quoted price of a bond where the accrued interest in excluded.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 1, pp. 10-11.&&&a&Class@SS14.2&&&&&1&N&0&N.N.N.N 2006JV.550&mcs&0&N&The least likely example of embedded options that might be granted to the issuer of a bond is:&a floor on a floater.&the right to call the issue.;an accelerated sinking fund provision.;the right to prepay an amount above the scheduled principal repayment. ;&LOS: Reading 62-bA floor on a floater is a benefit to the holder of the bond if interest rates fall, not to the issuer.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 1, p. 16-17.&&&a&Class@SS14.0&&&&&1&N&0&N.N.N.N 2006JV.551&mcs&0&N&The least likely example of embedded options that might be granted to bondholders is:&a cap on a floater&a floor on a floater;conversion privileges;the right to put the issue;&LOS: Reading 62-bA cap on a floater is a benefit to the issuer if interest rates rise, not to the bondholders.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 1, pp. 22-23.&&&a&Class@SS14.1&&&&&1&N&0&N.N.N.N 2006JV.552&mcs&0&N&Which of the following is an example of a negative covenant?&The issuer cannot secure any of its assets to a new debt issue without giving equal treatment to the existing debt holders.&The issuer must submit periodic statements to the bond trustee.;Mortgage holders are not permitted to prepay mortgages ahead of the scheduled date.;A floating rate security has a minimum coupon rate that must be paid if the reference rate declines below a certain level.;&LOS: Reading 62-aA negative covenant is generally given to protect unsecured debt holders from the assets of the issuing company being given as collateral in a subsequent debt issue.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 3, pp. 5.&&&a&Class@SS14.2&&&&&1&N&0&N.N.N.N 2006JV.553&mcs&0&N&When the issuer of a bond agrees to retire a certain proportion of a bond issue each year this is an example of:&a sinking fund provision.&a callable bond.;a refundable bond.;a prepayment option.;&LOS: Reading 62-cA sinking fund provision allows the issuer of a bond to retire a certain proportion of a bond issue each year.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 1, pp. 14-15.&&&a&Class@SS14.0&&&&&1&N&0&N.N.N.N 2006JV.554&mcs&0&N&An investor pays tax at a marginal rate of 40% and holds a tax-exempt issue that has a yield of 6%. The taxable-equivalent yield is:&10.0%.& 2.4%.; 3.6%.;15.0%.;&LOS: Reading 65-ftaxable-equivalent yield = tax-exempt yield/(1 - marginal tax rate)= 0.06/0.6 = 0.1 or 10%Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 4, pp. 108-109.&&&a&Class@SS14.1&&&&&1&N&0&N.N.N.N 2006JV.555&mcs&0&N&Which of the following statements is the least accurate regarding callable bonds? &IV. A callable bond will generally be issued at a lower coupon rate than a non-callable bond with the same terms.&I. The issuer’s obligation of paying interest ends at the call date.;II. The issuer has the right to retire the issue prior to the maturity date.;III. A callable bond is more likely to be called after interest rates have fallen.;&LOS: Reading 62-cIV. is the least accurate, a callable bond will normally be offered at a higher coupon rate to compensate the investor for the possibility that the bond might be called in prior to maturity.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 1, pp. 11-14.&&&a&Class@SS14.2&&&&&1&N&0&N.N.N.N 2006JV.556&mcs&0&N&Liquidity risk in bond markets can be measured by:&the bid-ask spread.&recovery rates.;price volatility.;the slope of the yield curve.;&LOS: Reading 63-jThe bid-ask spread quoted by dealers reflects the liquidity of an issue.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 2, pp. 40-42.&&&a&Class@SS14.0&&&&&1&N&0&N.N.N.N 2006JV.557&mcs&0&N&Which one of the following is the least appropriate example of a securitized bond?&Mortgage bond.&Mortgage-backed security.;Collateralized Mortgage Obligation.;Credit Card Receivables Asset-Backed security.;&LOS: Reading 64-cMortgage bonds are corporate bonds secured by mortgages to the company's assets. They are not structured with securitisation techniques, such as the use of bankruptcy-remote special purpose vehicles.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 3, pp. 73-74.&&&a&Class@SS14.1&&&&&1&N&0&N.N.N.N 2006JV.558&mcs&0&N&The difference in yield between bonds issued by industrial companies and bonds issued by technology companies is an example of a:&intermarket sector spread.&credit spread.;quality spread.;intramarket sector spread.;&LOS: Reading 65-cThe credit or quality spread is the difference in yield between Treasury securities and non-Treasury securities. The intramarket sector spread is the difference in yield between two bonds with the same maturity, in the same sector in a market.Industrial companies are in a distinct sector to information technology companies.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 4, p. 104.&&&a&Class@SS14.2&&&&&1&N&0&N.N.N.N 2006JV.559&mcs&0&N&If the credit spread of a bond has widened it means that:&the bond price has declined relative to that of an equivalent Treasury bond issue. &it is a low-grade bond.;it is a high-grade bond.;the bond price has risen relative to that of an equivalent Treasury bond issue.;&LOS: Reading 63-iThe credit spread is the difference between the yield on the bond and the yield on a Treasury bond. If the spread has widened it means that the yield demanded by an investor in the bond has increased, so the price has fallen, relative to a Treasury bond.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 2, p. 37-40.&&&a&Class@SS14.0&&&&&1&N&0&N.N.N.N 2006JV.560&mcs&0&N&Medium-term notes (MTNs) differ from corporate bonds since:&MTNs are offered to investors on a continuous basis by the issuer or its agent.&MTNs have a maximum maturity of 5 years.;MTNs have a maximum maturity of 10 years.;MTNs are not rated by any of the major credit rating organizations.;&LOS: Reading 64-hThe unique feature of a MTN is that they are offered to investors on a continuous basis by the issuer or its agent.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 3, pp. 76-77. &&&a&Class@SS14.1&&&&&1&N&0&N.N.N.N 2006JV.561&mcs&0&N&The arbitrage-free value of a Treasury bond is&the value of a bond calculated as the present value of each cash flow discounted at the corresponding Treasury spot rate.&the price of an on-the-run Treasury bond with the same maturity.;the price of an off-the-run Treasury bond with the same maturity.;the value of a bond calculated as the present value of each cash flow discounted back at the average yield to maturity of Treasury bonds with the same maturity.;&LOS: Reading 66-cThe arbitrage-free value of a Treasury bond is the value of a bond calculated as the present value of each cash flow discounted at the corresponding Treasury spot rate rather than at the yield to maturity.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program,2nd edition, Ch. 5, pp. 142-144.&&&a&Class@SS15.2&&&&&1&N&0&N.N.N.N 2006JV.562&mcs&0&N&The following data has been provided

Years to maturitySpot rate
18.75%
26.25%
35.00%

The one-year forward rate two years from now is closest to:&2.54%.&0.00%.;5.63%.;6.25%.;&LOS: Reading 67-gThis is a negatively sloping spot-yield curve, so it is to be expected that the forward rate is lower. We cannot apply the formulas given in the text exactly since we are asked to compute a one-year forward rate, but the principal behind the calculation is the same.\\Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 6, pp. 189-193.&&&a&Class@SS15.0&&&&&1:v&&& 2006JV.563&mcs&0&N&A 6 percent coupon bond pays interest semiannually, has duration of 10, sells for $800, and is priced at a yield to maturity (YTM) of 8 percent. If the YTM increases to 9 percent, the expected decrease in price is:&80&10;64;72;&LOS: Reading 68-d\\Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 7, pp. 230-231.&&&a&Class@SS15.1&&&&&1&N&0&N.N.N.N 2006JV.564&mcs&0&N&For a given large change in yields, if the amount of price gain is less than the price loss then the cause can be attributed to:&negative convexity.&illiquidity.;positive convexity.;arbitrage opportunity.;&LOS: Reading 68-cNegative convexity will make the price gain smaller.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 7, pp. 240-241.&&&a&Class@SS15.2&&&&&1&N&0&N.N.N.N 2006JV.565&mcs&0&N&A zero-coupon bond with 2 years remaining to maturity is currently trading at $82.65. If the par value is $100, the yield to maturity is closest to?& 9.8%.& 8.7%.; 9.0%.;0.11;&LOS: Reading 66-dLet x be the semiannual yield we are looking for, then\\or 9.8% annual yieldReference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 5, p. 137.&&&a&Class@SS15.0&&&&&1&N&0&N.N.N.N 2006JV.566&mcs&0&N&A bond without any embedded options has a remaining life of three years, carries an 8% coupon rate payable annually, and has a yield to maturity of 7%. If the one- and three-year spot rates are 8.0% and 7.0%, respectively, then the two-year spot rate is closest to:& 6.5%.& 6.0%.; 7.5%.;13.5%.;&LOS: Reading 67-eThe following relationship must hold, where z is the two-year spot rate\\Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 6, pp. 143-144.&&&a&Class@SS15.1&&&&&1&N&0&N.N.N.N 2006JV.567&mcs&0&N&Modified duration is&shorter than Macaulay duration for any given bond.&any positive or negative number.;shorter or longer than the time to maturity of a bond.;a useful measure of duration for mortgage-backed securities.;&LOS: Reading 68-eModified duration is based on Macaulay duration which is the weighted-average time until an investor receives payments from a bond, so it cannot be a negative number, and it is shorter than or equal to the time to maturity. It is not used for bonds such as mortgage-backed securities where there are uncertain cash flows.The link between Modified duration and Macaulay duration is given below:\\We can see that Modified duration is shorter than Macaulay duration since the yield is positive.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 7, pp. 235-238.&&&a&Class@SS15.2&&&&&1&N&0&N.N.N.N 2006JV.568&mcs&0&N&The yield-to-maturity calculation assumes that coupon payments can be reinvested at:&the yield to maturity.&a zero yield.;the coupon rate.;the current yield.;&LOS: Reading 67-bThe yield to maturity will only be realized if the following assumptions hold:1. The bond is held to maturity2. The coupon payments can be reinvested at a yield equivalent to the yield to maturity.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 6, pp. 165-170.&&&a&Class@SS15.0&&&&&1&N&0&N.N.N.N 2006JV.569&mcs&0&N&A bond with a coupon of 11.5% and 10 years remaining maturity has an effective duration of 6.2 and convexity of 5.5. The bond is quoted at $1253/4. If the yield to maturity rises by 125 basis points the bond price will be closest to:&$116.12.&$ 97.50.;$115.89.;$135.61.;&LOS: Reading 68-f\\Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 7, pp. 239-240.&&&a&Class@SS15.1&&&&&1&N&0&N.N.N.N 2006JV.570&mcs&0&N&If the bond-equivalent yield on a U.S. bond is 5%, the yield on an annual-pay basis is closest to:&5.06%.&4.94%.;5.00%.;5.51%.;&LOS: Reading 67-d\\Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 6, pp. 166-167.&&&a&Class@SS15.2&&&&&1&N&0&N.N.N.N 2006JV.571&mcs&0&N&An investor purchases a ten-year bond at par of $100 on June 3, 2001, which has an annual coupon of 10%. The reinvestment rate at the first coupon date is 9% and at the second coupon date is 8%. The investor expects 12.5% annualized total return for the three years ending on June 1, 2004. To reach the investment goal, the bond should be sold on June 1, 2004 at a price closest to.&110&100;127;138;&LOS: Reading 67-cThe future value of the investment on June 1, 2004,\\Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 6, pp. 167-170.&&&a&Class@SS15.0&&&&&1&N&0&N.N.N.N 2006JV.572&mcs&0&N&To determine whether a bond is undervalued or overvalued, which of the following information is least likely to be required?&The convexity measure.&The current market price.;The appropriate spot rates.;The bond’s future cash flows.;&LOS: Reading 66-dGiven a bond's cash flows, appropriate spot rates or yield to maturity, the 'theoretical' price or arbitrage-free value can be calculated. Comparing it to the current market price, we can determine if a bond is undervalued or overvalued.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 5, pp. 142-146&&&a&Class@SS15.1&&&&&1&N&0&N.N.N.N 2006JV.573&mcs&0&N&The following data has been gathered

Maturity (years) Spot rates
1.0 7.6%
1.5 7.8%
2.0 8.2%
2.58.4%
3.0 9.0%

What is the six-month forward rate 2 years from now closest to?&9.2%.&4.4%.;8.3%.;8.4%.;&LOS: Reading 67-g\\Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 6, pp. 190-194.&&&a&Class@SS15.2&&&&&1:v&&& 2006JV.574&mcs&0&N&The yield to worst for a callable bond is:&the lowest of the yield to maturity and yields to call calculated using all possible call dates.&the yield to maturity.;the yield assuming the bond is called at the lowest possible call price.;the yield assuming that the bond is called at the first possible call date.;&LOS: Reading 67-bThe yield to worst for a callable bond is the lowest yield that an investor could receive so it is the lowest of the yield to maturity and all possible yields to call.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 6, p. 173-174.&&&a&Class@SS15.0&&&&&1&N&0&N.N.N.N 2006JV.575&mcs&0&N&Which of the following statements regarding reinvestment risk is least accurate?&Long-dated zero coupon bonds have significant reinvestment risk.&I The higher the coupon rate the higher the reinvestment risk.;For a coupon bond the longer the term to maturity the larger the reinvestment risk.;A bond selling at a premium will have a higher reinvestment risk than a bond selling at a discount.;&LOS: Reading 67-cThe higher the coupon rate the more difficult to obtain a comparable high reinvestment yield.The longer the term to maturity the more uncertainty there is regarding reinvestment opportunities.A bond selling at a premium means that the reinvestment income will have to compensate for the capital loss due to the premium.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 6, p. 193.&&&a&Class@SS15.1&&&&&1&N&0&N.N.N.N 2006JV.576&mcs&0&N&A bond with 5 years remaining term to maturity and a 10% coupon payable annually is trading at $95. The current yield is closest to:&10.5%.& 9.5%.;10.0%.;11.5%.;&LOS: Reading 67-bThe current yield is then 10/95 = 10.52%Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 6, p. 165.&&&a&Class@SS15.2&&&&&1&N&0&N.N.N.N 2006JV.577&mcs&0&N&The following data is collected:

Years to maturity Spot rate
1 5.75%
2 6.25%
3 7.00%

Based on the above data, the one-year implied forward rate two years from now is closest to:&8.5%.&6.2%.;6.6%.;7.0%.;&LOS: Reading 67-g\\Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 6, pp. 196-198.&&&a&Class@SS15.0&&&&&1:v&&& 2006JV.578&mcs&0&N&An option-free bond has a remaining life of three years and carries an 8% annual coupon rate payable annually and has a yield to maturity of 9%. If the one- and two-year spot rates are 6.0% and 6.5%, respectively, then the three-year spot rate is closest to:& 9.2%.& 7.0%.; 8.1%.;14.5%.;&LOS: Reading 67-eThe following relationship must hold, where the three-year spot rate is z,\\Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 6, pp. 178-182.&&&a&Class@SS15.1&&&&&1&N&0&N.N.N.N 2006JV.579&mcs&0&N&An investor who requires a return of 10% will value an 8-year maturity zero-coupon bond with a redemption value of $10,000 at a price closest to:&4580&2000;9000;21436;&LOS: Reading 66-dUsing a semi-annual discount rate to arrive at bond-equivalent-yield pricing,\\Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 5, pp. 137.&&&a&Class@SS15.2&&&&&1&N&0&N.N.N.N 2006JV.580&mcs&0&N&Which of the following statements is least accurate when referring to the characteristics of effective duration?&Effective duration can only be calculated for bonds where the cash flows are certain.&Effective duration can be a negative value.;Effective duration can be greater than maturity.;Effective duration is useful for estimating price changes of bonds with embedded options.;&LOS: Reading 68-dEffective duration is calculated by empirical observation and a pricing model taking into account changes in cash flows due to yield changes. It can take on a negative value and be greater than maturity, particularly for unconventional securities such as MBS derivatives such as IOs and POs.Effective duration is the most common tool for estimating price changes of bonds with embedded options or uncertain cash flows.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 7, pp. 235-236.&&&a&Class@SS15.0&&&&&1&N&0&N.N.N.N 2006JV.581&mcs&0&N&For a given basis point change in interest rates the percentage price increase of a bond is less than the price decrease, this indicates that the bond has:&negative convexity.&low duration.;high duration.;positive convexity.;&LOS: Reading 68-cNegative convexity, or price compression, occurs when the percentage price increase of a bond is less than the price decrease for a given yield change.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 7, p. 224-227.&&&a&Class@SS15.1&&&&&1&N&0&N.N.N.N 2006JV.582&mcs&0&N&Bootstrapping is used to:&calculate theoretical spot rates.&calculate the value of an embedded option.;calculate forward rates from a series of spot rates.;calculate the spread between the yield on a corporate bond and a Treasury bond using the spot rate curve. ;&LOS: Reading 67-eBootstrapping is used to calculate theoretical default-free spot rates from on-the-run Treasury bonds.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 6, p. 178-182.&&&a&Class@SS15.2&&&&&1&N&0&N.N.N.N 2006JV.583&mcs&0&N&The presence of a put option in a bond would make its price/yield relationship&less convex at higher yields.&more convex at higher yields.;more convex at lower yields.;less convex at lower yields.;&LOS: Reading 68-cAt lower yields the behavior of the putable bond is basically the same as an option-free bond because investors will be unlikely to exercise the put option.At higher yields, the price will gravitate toward the put price, slowing down the rate of change of the price. So the relationship is becoming less convex.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 7, p. 227-228.&&&a&Class@SS15.0&&&&&1&N&0&N.N.N.N 2006JV.584&mcs&0&N&A non-callable bond has convexity of 94 and the price of the bond is $120, if interest rates move from 8% to 10% then the price change due to convexity will be closest to:&+ $4.51.&- $1.88.;+ $1.88.;+ $2.25.;&LOS: Reading 68-fConvexity adjustment\\Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 7, pp. 239-244.&&&a&Class@SS15.1&&&&&1&N&0&N.N.N.N 2006JV.585&mcs&0&N&The duration of two bonds in a portfolio are 5 and 10 and the bonds are equally weighted in the portfolio. The portfolio duration is:& 7.5.& 5.0.;10.0.;impossible to calculate from the information provided.;&LOS: Reading 68-eThe portfolio duration is the weighted average of the durations of the bonds in the portfolio.\\Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 7, pp. 238-239.&&&a&Class@SS15.2&&&&&1&N&0&N.N.N.N 2006JV.586&mcs&0&N&26. The current yield of a bond is:&lower than the yield to maturity, if the bond is trading at a discount to maturity value.&always lower than the yield to maturity, if there are no embedded options.;always higher than the yield to maturity, if there are no embedded options.;higher than the yield to maturity, if the bond is trading at a discount to maturity value.;&LOS: Reading 67-bThe current yield is the annual coupon divided by the market price of the bond. It does not include the capital gain or loss on the bond so if the bond is at a discount the current yield will be lower than the yield to maturity and vice versa.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 6, pp. 165.&&&a&Class@SS15.0&&&&&1&N&0&N.N.N.N 2006JV.587&mcs&0&N&The measure of spread that an investor would realize over the entire Treasury spot rate curve if the bond is held to maturity is called&zero volatility spread&nominal spread;intramarket spread;option-adjusted spread;&LOS: Reading 67-fThe measure of spread that an investor would realize over the entire Treasury spot rate curve if the bond is held to maturity is called zero volatility spread, or Z-spread or static spread. Nominal spread is a spread at one point on the Treasury yield curve, not over the entire Treasury spot rate curve.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 6, pp. 184-186.&&&a&Class@SS15.1&&&&&1&N&0&N.N.N.N 2006JV.588&mcs&0&N&There are two non-callable bonds with equal duration and one has higher positive convexity than the other. If interest rates rise which bond is expected to fall the least?&The one with higher convexity.&The one with lower convexity.;They will fall by equal amounts.;It will depend on whether interest rates are at a relatively high or relatively low level.;&LOS: Reading 68-cConvexity reduces the size of the fall in the bond price that is estimated using duration.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 7, pp. 221-224.&&&a&Class@SS15.2&&&&&1&N&0&N.N.N.N 2006JV.589&mcs&0&N&The price value of a basis point is:&the absolute change in price of a bond if there is a one basis point change inyield.&the percentage change in price of a bond if there is a one basis point change in yield.;the absolute change in dollar duration of a bond if there is a one hundred basis point change in yield.;the percentage change in dollar duration of a bond if there is a one hundred basis point change in yield.;&LOS: Reading 68-hThe price value of a basis point is the absolute change in price of a bond if there is a one basis point change in yield. It is a special case of dollar duration.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 7, pp. 242-243.&&&a&Class@SS15.0&&&&&1&N&0&N.N.N.N 2006JV.590&mcs&0&N&The Z-spread is:&the spread earned on a bond over the Treasury spot rate curve if it is held to maturity.&the option-adjusted spread if a bond has embedded options.;the adjustment to the option-adjusted spread as volatility changes.;the spread between spot and forward rates over the life of a bond.;&LOS: Reading 67-fThe Z-spread, also called zero volatility or static spread, is the spread that must be added to the Treasury spot rate to give a discount rate which will make the discounted cash flows from a bond equal to its price.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 6, pp. 184-186.&&&a&Class@SS15.1&&&&&1&N&0&N.N.N.N 2006JV.591&mcs&0&N&If the duration of a bond portfolio is 5 and the average yield of bonds in the portfolio rises by 100 basis points then:&we do not have sufficient information to calculate the impact on the market value of the portfolio.&the market value of the portfolio will fall, but by less than 5%.;the market value of the portfolio will fall by approximately 5%.;the market value of the portfolio will rise by approximately 5%.;&LOS: Reading 68-eThe yield of each bond in the portfolio must rise by 100 basis points, namely there should a parallel shift in the yield curve, for the portfolio duration to be an indicator of the price move of the total portfolio. We need to know information on whether there was a parallel shift in the yield curve.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, 2nd edition, Ch. 7, pp. 238-239.&&&a&Class@SS15.2&&&&&1&N&0&N.N.N.N 2006JV.592&mcs&0&N&The Macaulay duration of a bond is:&always positive and less than, or equal to, the term to maturity of a bond.&either negative or positive.;always zero, or greater than zero.;always positive and more than, or equal to, the term to maturity of a bond.;&LOS: Reading 68-eThe unit of Macaulay duration is years. It is a measure of average time to cash flow receipts. Mathematically it means that Macaulay duration will always be positive and less than, or equal to, the term to maturity of a bond. Other measures of duration such as effective duration, can take any number either positive of negative because it better measures the interest rate sensitivity of bonds. Mortgage-backed securities can have negative effective durations. A bond with complex embedded options can have an effective duration that is longer then the life of the bond.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 7, pp. 236-238.&&&a&Class@SS15.0&&&&&1&N&0&N.N.N.N 2006JV.593&mcs&0&N&The Macaulay duration of a semiannual bond with a 12% coupon is 6.0 and the yield to maturity is 8%. The modified duration is closest to:&5.77.&5.66.;6.24.;6.36.;&LOS: Reading 68-eSemiannual bonds mean k = 2Modified duration = Macaulay duration/[(1 + yield/k)]= 6.0/(1.04)= 5.77Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, h. 7, p. 236.&&&a&Class@SS15.1&&&&&1&N&0&N.N.N.N 2006JV.594&mcs&0&N&If the semiannual yield to maturity of a bond is 5%, the bond-equivalent yield is closest to:&10.0%.& 5.1%.;10.3%.;10.6%.;&LOS: Reading 67-dThe bond equivalent yield is simply double the semiannual yield.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 6, p. 174.&&&a&Class@SS15.2&&&&&1&N&0&N.N.N.N 2006JV.595&mcs&0&N&The total dollar return from a bond is:&the coupon income plus the reinvestment income plus the capital gain/loss on the bond.&the current yield multiplied by the price of the bond.;the yield to maturity multiplied by the price of the bond.;the coupon income plus the value of the quoted margin plus the capital gain/loss on the bond.;&LOS: Reading 67-aThe total dollar return is the coupon income plus the reinvestment income plus the capital gain/loss on the bond. Yield to maturity is inaccurate since it assumes that coupons can be reinvested at the rate equivalent to the yield to maturity.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 5, pp. 167-170.&&&a&Class@SS15.0&&&&&1&N&0&N.N.N.N 2006JV.596&mcs&0&N&An 8% bond makes semiannual coupon payments, there are two further coupons to be paid and the bond matures at $100 in 273 days (there are 182 days in a coupon period). If the yield to maturity is 6% then the full price of the bond is closest to:&$103.42.&$ 96.12.;$ 98.27.;$101.91.;&LOS: Reading 66-d\\Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 5, pp. 138-139.&&&a&Class@SS15.1&&&&&1&N&0&N.N.N.N 2006JV.597&mcs&0&N&The appropriate duration measure to use for a high coupon callable bond is:&effective duration.&modified duration.;Macaulay duration.;duration cannot be used for bonds with embedded options.;&LOS: Reading 68-eIn a callable bond, the cash flows might change as interest rates change. The most appropriate duration measure is effective duration.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 7, pp. 236-238.&&&a&Class@SS15.2&&&&&1&N&0&N.N.N.N 2006JV.598&mcs&0&N&If the yield to maturity on an annual-pay bond is 12% its bond-equivalent yield is closest to:&11.66%.&12.00%.;12.36%.;12.72%.;&LOS: Reading 67-d\\Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 6, pp. 166-167.&&&a&Class@SS15.0&&&&&1&N&0&N.N.N.N 2006JV.599&mcs&0&N&A non-callable bond has:&positive convexity throughout the yield range.&negative convexity throughout the yield range.;positive convexity at low yields and negative convexity at high yields.;negative convexity at low yields and positive convexity at high yields.;&LOS: Reading 68-cThe presence of embedded options, such as a call option in a bond, would make the convexity negative in certain yield ranges. Non-callable bonds have positive convexity throughout the yield range.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 7, pp. 224-228.&&&a&Class@SS15.1&&&&&1&N&0&N.N.N.N 2006JV.600&mcs&0&N&When a dealer purchases a package of Treasury strips to create a synthetic Treasury bond, the procedure is called,&reconstitution&hedging;stripping.;bootstrapping;&LOS: Reading 66-dWhen a dealer purchases a package of Treasury strips to create a synthetic Treasury bond, the procedure is called reconstitution.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 5, p. 144-147.&&&a&Class@SS15.2&&&&&1&N&0&N.N.N.N 2006JV.601&mcs&0&N&A party to a swap agreement wishes to terminate the agreement prior to the expiry of the swap, they might consider:&I. entering into an offsetting swap agreement.&II. selling the swap at its market value through the swaps exchange.;III. offsetting a long position with a short position in the futures market.;IV. instructing their counterparty to terminate the swap with immediate effect so no further payments are necessary.;&LOS: Reading 73-aI. is not correct since swaps are dealt over-the-counter.III. is not correct, long and short are terms applied to futures positions.IV. is not correct, the counterparty must agree to terminate the agreement, unless such a clause in the contract, and if such an agreement was made the market value of the swap would change hands.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 5, p. 272.&&&a&Class@SS16.0&&&&&1&N&0&N.N.N.N 2006JV.602&mcs&0&N&A put option on a stock has an exercise price of $25.00, the stock is trading at $22.00 and the price of the put option is $3.50. The option is:&$3.00 in-the-money.&$0.50 out-of-the-money.;$3.00 out-of-the-money.;$6.50 out-of-the-money.;&LOS: Reading 72-bThe put option is in-the-money since the exercise price is above the stock price, and the difference between the two prices is $3.Reference: Analysis of Derivatives for the CFA(r)Program, Chance, (AIMR, 2003), Chapter 4, p. 164.&&&a&Class@SS16.1&&&&&1&N&0&N.N.N.N 2006JV.603&mcs&0&N&The clearinghouse of a futures exchange:&acts as counterparty to each transaction on the exchange.&acts as market maker in futures contracts traded on the exchange.;stabilizes futures prices by buying futures when the market is weak and selling futures when the market is strong.;stabilizes futures prices by selling futures when the market is weak and buying futures when the market is strong.;&LOS: Reading 71-cThe clearinghouse does not intentionally take positions in futures or act as market maker.Reference: Analysis of Derivatives for the CFA(r)Program, Chance, (AIMR, 2003), Chapter 3, p. 85.&&&a&Class@SS16.2&&&&&1&N&0&N.N.N.N 2006JV.604&mcs&0&N&When an institution does a swap transaction the counterparty to the transaction is the:&party who is the end user of the transaction.&SEC.;exchange.;clearinghouse.;&LOS: Reading 69-bSwaps differ from exchange-traded futures and options where the counterparty risk is the risk that the exchange or clearing house defaults (not likely to happen). The parties to a swap take on the risk of counterparty default.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 1, pp. 2-6.&&&a&Class@SS16.0&&&&&1&N&0&N.N.N.N 2006JV.605&mcs&0&N&Which of the following statements is CORRECT regarding forward and futures contracts?&A futures contract is a type of forward contract but futures contracts have highly standardized contract terms.&A forward contract refers to a futures contract traded outside the U.S.;A forward contract is another term for, and is identical to, a futures contract.;A forward contract is a type of futures contract but forward contracts are tradedon an organized exchange.;&LOS: Reading 71-aA forward contract is the general term applied to an agreement that leads to an exchange of assets at a later time. A futures contract has specific contract terms, is traded on a recognized exchange with the contract guaranteed by a clearinghouse.Reference: Analysis of Derivatives for the CFA(r)Program, Chance, (AIMR, 2003), Chapter 3, pp. 83-85.&&&a&Class@SS16.1&&&&&1&N&0&N.N.N.N 2006JV.606&mcs&0&N&The lower bound for an American call option compared to a European call with the same underlying, exercise date and time to maturity is&always equal to the lower bound for the European call.&equal to or less than the lower bound for the European call.;equal to or more than the lower bound for the European call.;either more or less than the lower bound for the European call depending on whether they are in-the-money or out-of-the-money. ;&LOS: Reading 72-iThe lower bound for a European call is either zero or the underlying price minus the present value of the exercise price, which ever is greater. Since an American call option is worth the same or more than a European call the lower bound is the same.Reference: Analysis of Derivatives for the CFA(r)Program, Chance, (AIMR, 2003), Chapter 4, pp. 180-184.&&&a&Class@SS16.2&&&&&1&N&0&N.N.N.N 2006JV.607&mcs&0&N&The value of a call option on a stock at expiration is:&the greater of (i) zero and (ii) the stock price minus the exercise price.&the greater of (i) zero and (ii) the exercise price minus the stock price.;the smaller of (i) zero and (ii) the stock price minus the exercise price.;the smaller of (i) zero and (ii) the exercise price minus the stock price.;&LOS: Reading 72-hAt expiration the holder of the call option can either exercise the option or let it lapse. If the stock price has ended higher than the exercise price then the investor will exercise the option since he can sell the stock in the market at a higher price. If the stock price has fallen below the exercise price he will let the option lapse worthless.Reference: Analysis of Derivatives for the CFA(r)Program, Chance, (AIMR, 2003), Chapter 4, pp. 176-178.&&&a&Class@SS16.0&&&&&1&N&0&N.N.N.N 2006JV.608&mcs&0&N&If an investor wants to protect his stock portfolio against losses he could:&buy puts on the stock market index.&sell calls on the stock market index.;sell puts on the stock market index.;buy calls on the stock market index.;&LOS: Reading 74-bIf he buys put options and the market falls he will make a profit on the put options. This will offset his loss on the stock portfolio.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 7, pp. 426-429.&&&a&Class@SS16.1&&&&&1&N&0&N.N.N.N 2006JV.609&mcs&0&N&In the case that a stock price falls below the exercise price at the expiration of a call option, then:&the profit made by the writer of the option is the same as the loss made by the buyer.&the profit made by the writer of the option is larger than the loss made by the buyer.;the loss made by the writer of the option is larger than the profit made by the buyer.;we need more information to know whether the writer or the buyer of the option would make a profit. ;&LOS: Reading 74-aOptions are a zero-sum gain, the profit (loss) made by the writer of the option will equal the loss (profit) made by the buyer.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 7, pp. 415-417.&&&a&Class@SS16.2&&&&&1&N&0&N.N.N.N 2006JV.610&mcs&0&N&If a trader has opened a position by buying a call option, he can close the position by&selling a call.&selling a put.;buying a put.;buying a call.;&LOS: Reading 72-aThe 'opposite' of buying a call is simply selling the same call option.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 4, pp. 161-166.&&&a&Class@SS16.0&&&&&1&N&0&N.N.N.N 2006JV.611&mcs&0&N&Which of the following combination of factors will tend to lead to the highest price of a put option:&a high strike price and a long time to expiry.&a low strike price and a long time to expiry.;a low strike price and a short time to expiry.;a high strike price and a short time to expiry.;&LOS: Reading 72-kThe profit on a put option will be determined by the difference between the stock price and the strike price, the higher the strike price the higher the potential profit. A longer time to expiry gives the holder a longer period in which to sell the shares at the exercise price so it will be worth more.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 4, pp. 186-187.&&&a&Class@SS16.1&&&&&1&N&0&N.N.N.N 2006JV.612&mcs&0&N&Which of the following statements is most accurate concerning two options that have the same terms except that one is an American option and one is a European option?&The American option can be exercised at any point before expiry and is worth at least as much as the European option.&The European option can be exercised at any point before expiry and is worth at least as much as the American option.;The American option can be exercised at any point before expiry and is worth less than, or the same as, the European option.;The European option can be exercised at any point before expiry and is worth less than, or the same as, the American option. ;&LOS: Reading 72-bSince an American option can be exercised at any time up to expiry, whereas a European option can only be exercised at expiry, an American option gives the holder more flexibility and therefore must be worth more (or the same).Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 4, p. 162.&&&a&Class@SS16.2&&&&&1&N&0&N.N.N.N 2006JV.613&mcs&0&N&There is a European put option expiring in 60 days, the exercise price is 110 and the underlying is trading at 100. The risk-free rate is 6%, the lower bound on the option value is closest to& 8.95.& 0.00.; 3.77.;10.00.;&LOS: Reading 72-hThe lower bound is given by\\Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 4, pp. 180-184.&&&a&Class@SS16.0&&&&&1&N&0&N.N.N.N 2006JV.614&mcs&0&N&An investor holds an asset with a current price of 120; a put option is purchased with an exercise price of 105. If the breakeven point for the hedged position is an asset price of 135 at expiration, then the value of the put option at the time of purchase must have been:&15&5;20;30;&LOS: Reading 74-bBreakeven is whenCost of put option = change in value of asset + value of put option = 15 + 0Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 7, pp. 426-429.&&&a&Class@SS16.1&&&&&1&N&0&N.N.N.N 2006JV.615&mcs&0&N&The swap markets:&offer an effective way of hedging.&are highly regulated.;are mainly used by individuals.;developed in the last five years.;&LOS: Reading 73-aThe swap markets are mainly used by institutions, are virtually unregulated and have been active for a long period. They can be used for hedging e.g. interest rate swaps are used to hedge interest rate risk.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 5, p. 271.&&&a&Class@SS16.2&&&&&1&N&0&N.N.N.N 2006JV.616&mcs&0&N&An investor deposits an initial margin of $40,000 for a futures trade and the following day makes a $15,000 loss on the trade. If the maintenance requirement is $30,000 then he must deposit a variation margin of:&15000&5000;10000;there is no requirement to pay a variation margin.;&LOS: Reading 71-eThe variation margin must be paid if the investor's margin balance falls below the maintenance requirement and must bring the margin balance back to the initial level. In this case the balance has fallen to $25,000 so he must make up the difference of $15,000 in variation margin.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 10, pp. 86-91.&&&a&Class@SS16.0&&&&&1&N&0&N.N.N.N 2006JV.617&mcs&0&N&A series of cash settled forward contracts is:&a swap.&an option.;a futures option.;a futures contract.;&LOS: Reading 69-bA swap is an agreement between two parties to exchange a series of cash flows in the future. It is dealt OTC so is effectively a series of cash settled forward contracts.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 1, p. 5.&&&a&Class@SS16.1&&&&&1&N&0&N.N.N.N 2006JV.618&mcs&0&N&An investor holds 1,000 shares of ABC Corp. and the current stock price is $45. He buys 1,000 put options with an exercise price of $46 at a premium of $6 each. If the stock price falls to $35 at the expiration date then the value of his insured portfolio is:&40000&5000;46000;51000;&LOS: Reading 74-bThe value of the portfolio will be $35,000 - $6,000 (option premium) + $11,000 (profit on exercising option) = $40,000 i.e. the minimum value is the exercise price less the premium.Reference: Analysis of Derivatives for the CFA(r)Program, Chance, (AIMR, 2003), Chapter 7, pp. 426-429.&&&a&Class@SS16.2&&&&&1&N&0&N.N.N.N 2006JV.619&mcs&0&N&The least appropriate way to close a futures position is by:&exercise.&offset.;delivery.;exchange-for-physicals.;&LOS: Reading 71-hExercise is a term used for options.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 3, pp. 84-86.&&&a&Class@SS16.0&&&&&1&N&0&N.N.N.N 2006JV.620&mcs&0&N&Daily settlement in the futures market refers to:&IV. gains and losses are added or deducted from the margin position held with a broker on a daily basis.&I. a futures contract that expires on a specific day.;II. closing prices which are reported daily by the exchange.;III. when a trader enters into a futures contract he has one day to deposit the initial margin.;&LOS: Reading 71-fI. is not correct since futures contracts are often only available which expire at three monthly intervals. III. is not correct since the initial margin must be deposited before the trade is done.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 3, p. 85.&&&a&Class@SS16.1&&&&&1&N&0&N.N.N.N 2006JV.621&mcs&0&N&An investor purchases a call option with an exercise price below the stock price and sells a call option with an exercise price above the stock price. Both options have the same expiration date. Which of the following statements is most appropriate regarding the profit/loss the investor makes?&III. If the stock price rises sharply the investor will make a profit.&I. The investor has the risk of making an unlimited loss.;II. The investor has the potential to make unlimited gains.;IV. The premium paid on buying the option will be equal to the premium received from selling the option.;&LOS: Reading 74-aI. and II. are not correct since if the stock price falls neither option will be exercised so the loss is the difference in premium between the calls. If the stock price rises then the loss on the short call will be more than made up by the profit on the long call.IV. is not correct since the option with the lower exercise price will be more expensive.If the stock price rises then the investor will make a profit since the profit on the long call will be more than the loss on the short call (due to the lower exercise price).Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 7, pp. 425-418.&&&a&Class@SS16.2&&&&&1&N&0&N.N.N.N 2006JV.622&mcs&0&N&A trader writes a put option on a stock which has a current price of $50, the option price is $5 and the exercise price is $52. At expiration the stock closes at $54, the intrinsic value of the option at expiration is:&0&2;4;5;&LOS: Reading 72-bThe intrinsic value of a put option is the greater of zero or the (exercise price - strike price). The exercise price is less than the strike price so the intrinsic value is zero.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 4, p. 178.&&&a&Class@SS16.0&&&&&1&N&0&N.N.N.N 2006JV.623&mcs&0&N&European options are available on an underlying security that is priced at $30, the exercise price is $25 and the options expire in six months. The risk free rate is 10% and the call option is priced at $7 and the put option at $2.&It is more attractive to purchase a synthetic put option than a put option.&Put-call parity holds.;A synthetic put option is not attractively priced.;It is more attractive to purchase a synthetic call option than a call option.;&LOS: Reading 72-l\\This is less than the price of the put option so it is more attractive to purchase a synthetic put. The call option is effectively under priced.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 4, pp. 187-192.&&&a&Class@SS16.1&&&&&1&N&0&N.N.N.N 2006JV.624&mcs&0&N&Party A enters into a fixed-for-fixed currency swap with Party B. Party A holds US$ 10 million and switches them into Party B's Pounds Sterling (£). The swap is done at the current exchange rate of $1.60 = £1. Interest rates in the U.S. are 7% and in the U.K. are 6%. Annual interest payments are made. The final payment of the swap from Party A to Party B will be:&£6.625 million.&$0.7 million.;$10.7 million.;£0.375 million.;&LOS: Reading 73-bThe final payment will consist of the return of principal of £6.25 million ($10 million equivalent) plus the final interest payment of 0.375 million (6% of £6.25 million).Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 5, pp. 274-278.&&&a&Class@SS16.2&&&&&1&N&0&N.N.N.N 2006JV.625&mcs&0&N&The profit (or loss) on a short position in a call option on a stock at expiration is:&the option premium minus the greater of (i) zero and (ii) the stock price minus the exercise price.&the option premium plus the greater of (i) zero and (ii) the exercise price minus the stock price.;the option premium plus the greater of (i) zero and (ii) the stock price minus the exercise price.;the option premium minus the greater of (i) zero and (ii) the exercise price minus the stock price.;&LOS: Reading 74-aAt expiration the holder will either exercise the option or let it lapse. If the stock price has ended higher than the exercise price then the holder will exercise the option and the seller of the option will make a loss of the exercise price minus the stock price, offset by the premium that he received. If the stock price has fallen below the exercise price the option will lapse and the seller of the option will make a profit of the premium that he collected.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 7, pp. 415-417.&&&a&Class@SS16.0&&&&&1&N&0&N.N.N.N 2006JV.626&mcs&0&N&A U.S. company A can borrow dollars at a lower interest rate in the U.S. than a Japanese company B can borrow dollars in the U.S., conversely the Japanese company can borrow Yen at a lower interest rate than the U.S. company can borrow Yen in Japan. If company A needs to borrow in Yen and company B needs to borrow in dollars both companies would reduce their borrowing costs by:&borrowing in their local markets and company A enters into a currency swap and swaps the dollars for Yen with company B.&borrowing in their local markets and company A enters into a currency swap and swaps the Yen for dollars with company B.;company A borrows in Japan and company B borrows in the US, and company A enters into a currency swap and swaps the dollars for Yen with company B.;company A borrows in Japan and company B borrows in the US, and company A enters into a currency swap and swaps the Yen for dollars with company B. ;&LOS: Reading 73-bSince each company can borrow more cheaply in its local market they should do this and then swap the currencies to meet their borrowing requirements.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 5, pp. 274-278.&&&a&Class@SS16.1&&&&&1&N&0&N.N.N.N 2006JV.627&mcs&0&N&If a seller of a call option deposits the underlying shares with his broker this is:&a covered call.&speculation.;a naked call.;a covered put.;&LOS: Reading 74-bA covered call means that the broker has the shares available for delivery if the buyer of the call option decides to exercise his option.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 7, pp. 422-423.&&&a&Class@SS16.2&&&&&1&N&0&N.N.N.N 2006JV.628&mcs&0&N&The value of a stock is $20 and a trader writes a call option with a value of $3 and an exercise price of $22. The stock price at expiration that will be the trader's breakeven point is:&25&17;19;23;&LOS: Reading 74-a\\Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 7, pp. 419-421.&&&a&Class@SS16.0&&&&&1&N&0&N.N.N.N 2006JV.629&mcs&0&N&The least likely benefit for an investor if a market includes financial derivatives is:®ulatory protection.&price discovery.;trading efficiency.;instruments available for risk management.;&LOS: Reading 69-ePrice discovery, ability to hedge risk and market efficiency including low transaction costs are all benefits of derivatives. Although exchange-traded derivatives provide some regulatory protection OTC derivatives often offer little regulatory protection.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 1, pp. 13-15.&&&a&Class@SS16.1&&&&&1&N&0&N.N.N.N 2006JV.630&mcs&0&N&A firm enters into a plain vanilla interest rate swap agreement to pay a fixed rate of 8%, the counterparty agrees to pay one year LIBOR. Annual payments will be made in arrears. The swap covers a five year period and is based on a notional principal of $100 million. The one year LIBOR rate at the time of agreement is 8.25%. At the end of one year it is 9%, and at the end of the second year it is 9.5%. The net payment that the pay-fixed firm receives/pays at the end of the second year is:&receives $1 million.&pays $1 million.;pays $1.5 million.;receives $1.5 million.;&LOS: Reading 73-cThe payment received is $100 million x (9% - 8%) = $1 million.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 5, pp. 278-281.&&&a&Class@SS16.2&&&&&1&N&0&N.N.N.N 2006JV.631&mcs&0&N&A trader writes a European call option on a stock, the stock's current price is $24, the option price is $4 and the exercise price is $23. At the expiration of the option the stock price is $30. The profit/loss of the option writer is a:&loss of $3.&loss of $4.;profit of $3.;profit of $4.;&LOS: Reading 74-bThe writer has received the premium of $4 but the loss when the option is exercised is $30 minus $23 giving an overall loss of $3.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 7, pp. 422-426.&&&a&Class@SS16.0&&&&&1&N&0&N.N.N.N 2006JV.632&mcs&0&N&The notional principal in a plain vanilla interest rate swap is:&never paid.&paid at the time that the swap agreement is made.;paid in equal parts when each swap payment is made.;paid at the time that the swap agreement is signed and returned when the final swap payment is made.;&LOS: Reading 73-cThe notional principal is the amount on which the interest payments are calculated and does not change hands in an interest rate swap.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 5, pp. 278-281.&&&a&Class@SS16.1&&&&&1&N&0&N.N.N.N 2006JV.633&mcs&0&N&The value of a put option at expiry is:&maximum of (i) zero and (ii) exercise price minus stock price.&maximum of (i) zero and (ii) stock price minus exercise price.;maximum of (i) zero and (ii) stock price minus exercise price, minus the option premium.;maximum of (i) zero and (ii) exercise price minus stock price, minus the option premium.;&LOS: Reading 72-eThe holder of a put option will exercise the option if the exercise price is above the stock price, in that case he could theoretically buy the stock in the market and sell it a higher price. If the stock price is higher than the exercise price he will let the option lapse worthless. The option premium should only be taken into account if the profit/loss on the option is being calculated.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 4, pp. 176-179.&&&a&Class@SS16.2&&&&&1&N&0&N.N.N.N 2006JV.634&mcs&0&N&A company has borrowed to finance its operations using floating-rate debt but it is now concerned that short-term interest rates are going to rise sharply. The company should consider:&entering into a plain vanilla interest rate swap agreement where they take the pay-fixed side of the transaction.&entering into a currency swap agreement where they take the pay-fixed side of the transaction.;entering into a currency rate swap agreement where they take the receive-fixed side ofthe transaction.;entering into a plain vanilla interest rate swap agreement where they take the receive-fixed side of the transaction.;&LOS: Reading 73-cIn a plain vanilla interest rate swap if the company pays a fixed rate of interest and receives a floating rate of interest, the floating rate interest payment will, if the agreement is correctly structured, offset the interest rate risk of its debt payments.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 5, pp. 278-281.&&&a&Class@SS16.0&&&&&1&N&0&N.N.N.N 2006JV.635&mcs&0&N&When a trader writes a covered call this will often be with the objective of:&increasing income.&insuring his portfolio value.;reducing the volatility of his return.;increasing his gain if the stock price rises above the exercise price plus the premium. ;&LOS: Reading 74-bWriting a covered call means that the trader will increase his income by the option premium. If the stock price rises above the exercise price his shares will be called and he will lose the capital gain he would have made if he had not written the option.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 7, p. 422-426.&&&a&Class@SS16.1&&&&&1&N&0&N.N.N.N 2006JV.636&mcs&0&N&An investor believes that the SandP Index is going to decline sharply over the next two years. Which of the following strategies would be consistent with this view?&Enter into a two-year equity swap to receive a fixed payment and pay an equity payment based on the performance of the SandP index.&Buy call options on the SandP Index.;Write put options on the SandP Index.;Take a long position in futures on the SandP Index.;&LOS: Reading 73-dIf the SandP Index falls the investor will receive both the fixed payment and an equity payment so this would be a viable strategy.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 5, pp. 281-5.&&&a&Class@SS16.2&&&&&1&N&0&N.N.N.N 2006JV.637&mcs&0&N&An investor deposits an initial margin of $20,000 for a futures trade and the next day makes a $2,000 loss on the trade. The next day he makes a further loss of $2,000. If the maintenance requirement is $15,000 then he must deposit a variation margin of:&there is no requirement to pay a variation margin.&1000;4000;5000;&LOS: Reading 71-eThe variation margin only needs to be paid if the investor's equity has fallen below the maintenance requirement, this is not the case since the equity is still $16,000 ($20,000 - $2,000 - $2,000).Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 3, pp. 86-92.&&&a&Class@SS16.0&&&&&1&N&0&N.N.N.N 2006JV.638&mcs&0&N&A trader sells both a call and a put option on a stock with the same exercise price and the same expiration, he will make a profit on the transaction:&if the stock price remains within a narrow range of the exercise price.&if the stock price rises sharply or falls sharply.;only if the stock price falls sharply below the exercise price.;only if the stock price rises sharply above the exercise price.;&LOS: Reading 74-aThis is a straddle (not explicitly covered in the readings) but the candidate can work out that if the stock price moves up sharply the call option would be exercised, or if it moves down sharply the put option would be exercised. If the move is significant the loss made on either option would be greater than the premium income received.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 7, pp. 413-422.&&&a&Class@SS16.1&&&&&1&N&0&N.N.N.N 2006JV.639&mcs&0&N&If put options are used to insure a portfolio which of the following statements is most accurate?&The probability of the insured portfolio achieving high positive gains is less than the uninsured portfolio.&The insured portfolio will only report substantial losses in a small number of cases.;In the majority of cases the insured portfolio will outperform an equivalent uninsured portfolio.;There is a higher probability that the insured portfolio will achieve any given positive return than the uninsured portfolio. ;&LOS: Reading 74-bCorrectly insuring a portfolio using put options should eliminate the possibility of a large loss since the portfolio value will not fall below the exercise price less the premium. But if the return from the assets is positive the uninsured portfolio will outperform the insured portfolio because of the cost of the premium.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 7, pp. 426-429.&&&a&Class@SS16.2&&&&&1&N&0&N.N.N.N 2006JV.640&mcs&0&N&An option on a futures is best described as:&an option where the underlying asset is a futures contract.&a futures contract where the holder agrees to buy a pre-specified option at a future date.;a futures contract where the holder has an option at the delivery date to extend the contract.;a futures contract where the holder has the option to buy a pre-specified asset at an agreed price at a future date. ;&LOS: Reading 72-cAn option on a futures is simply an option where the underlying asset is a futures contract. The option holder has the right to enter into a futures contract (call option for a long poison, put for a short position) at a fixed price.Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 4, p. 173.&&&a&Class@SS16.0&&&&&1&N&0&N.N.N.N 2006JV.641&mcs&0&N&Which of the following statements best describes the real estate markets?&The real estate markets are inefficient since there is no central market place and information is not circulated quickly between investors.&The real estate markets are inefficient since prices are dependent on many differentfactors.;The real estate markets are efficient since most real estate is heavily promoted priorto sale.;The real estate markets are efficient since most real estate is sold after the price has been negotiated.;&LOS: Reading 75-gThe real estate markets are regarded as informationally inefficient, this provides opportunities for investors who can identify mispriced properties.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 386-387. &&&a&Class@SS17.1&&&&&1&N&0&N.N.N.N 2006JV.642&mcs&0&N&Which of the following is the least appropriate method of valuing real estate?&balance sheet approach.&cost approach.;income approach.;discounted cash flow approach.;&LOS: Reading 75-iThe methods that are covered in the text are the cost approach, sales comparison approach, income approach and the discounted after-tax cash flow approach.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 388-392. &&&a&Class@SS17.2&&&&&1&N&0&N.N.N.N 2006JV.643&mcs&0&N&The market cap rate that is used to value a property:&reflects the rate of return required by investors in a comparable property.&is the estimated market value of the property.;is the appreciation in market value over the previous one-year period.;is the operating expense incurred in owning and managing the property.;&LOS: Reading 75-kThe market cap rate is related to the rate that is used to discount the net operating cash flows from the property to arrive at the present value.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 391-392. &&&a&Class@SS17.0&&&&&1&N&0&N.N.N.N 2006JV.644&mcs&0&N&Exchange Traded Funds (ETFs) have 'in kind' redemption, this means that&an authorized participant can redeem shares and receive a portfolio of shares that was used to track the index. &investors are encouraged to redeem for cash by the offer of a cash incentive.;an ETF can redeem shares in its underlying portfolio by giving two days' notice.;an investor will receive the cash equivalent to the net asset value of the shares they hold when they redeem them.;&LOS: Reading 75-eWhen an authorized participant or market maker redeems shares he receives a basket of the underlying securities rather than cash.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp.378-382.&&&a&Class@SS17.1&&&&&1&N&0&N.N.N.N 2006JV.645&mcs&0&N&An investor in an Exchange Traded Fund (ETF) is exposed to tracking error risk, this is the risk that:&the fund does not closely replicate the performance of the index that it is following.&the bid-ask spread for shares in the ETF widens.;the ETF fails to make dividend payments to investors.;the currency the fund is denominated in does not track the U.S. dollar.;&LOS: Reading 75-fTracking error is a measure of the deviation between ETF returns and the index returns.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 384-385.&&&a&Class@SS17.2&&&&&1&N&0&N.N.N.N 2006JV.646&mcs&0&N&Hedge funds:&use leverage to increase the return from arbitrage strategies.&hedge out all market and currency risks.;avoid counterparty risk by only dealing in exchange-traded derivatives.;are generally prohibited from using leverage, although they can use derivatives and take short positions.;&LOS: Reading 75-rHedge funds (despite their name) have the flexibility to borrow to increase their returns, this is a strategy often used by arbitrage funds.Campbell R. Harvey, Defination:Hedge fund "An investment vehicle that somewhat resembles a mutual fund, but with a number of important differences. If the fund is "off-shore", the fund does not have to adhere to any SEC regulations (and can only sell to non-U.S. investors or investment vehicles). These funds employ a number of different strategies that are not usually found in mutual funds. The term "hedge" can actually be misleading. The traditional hedge fund is actually hedged. For example, a fund employing a long-short strategy would try to select the best securities for purchase and the worst for short sale. The combination of longs and short provides a natural hedge to market-wide shocks. However, much more common are funds that are not hedged. There are funds that are long-biased and short-biased. There are funds that undertake high frequency futures strategies, sometimes called managed futures. There are funds that take long-term macroeconomic bets, sometimes called global macro. There are funds that try to capitalize on merger and acquisitions. Another distinguishing feature of hedge funds is the way that managers are rewarded. There are two fees: fixed and variable. The fixed fee is a percentage of asset under management. The variable or performance fee is a percentage of the profit of the fund. There are also funds of funds which invest in a portfolio of hedge funds. Another important difference with hedge funds is that the minimum required investment is usually quite large and, as a result, minimizes the participation of retail investors." Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 416-417.&&&a&Class@SS17.0&&&&&1&N&0&N.N.N.N 2006JV.647&mcs&0&N&An equity real estate investment trust (REIT):&has shares which are traded on a stock market.&is an open-end investment company.;is only available to institutional investors.;makes mortgage loans to real estate investors. ;&LOS: Reading 75-gA REIT is a closed-end investment company that is usually listed on a stock market making it available to retail and institutional investors.Keep in mind that Answer "makes mortgage loans to real estate investors" is a description of a mortgage REIT.Campbell R. Harvey, Defination:Real Estate Investment Trust "REITs invest in real estate or loans secured by real estate and issue shares in such investments. A REIT is similar to a closed-end mutual fund." Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, p. 388 &&&a&Class@SS17.1&&&&&1&N&0&N.N.N.N 2006JV.648&mcs&0&N&The Sharpe ratio for hedge fund indexes is&are generally higher than those for equity and bond indexes.&often understated due to survivorship bias.;a suitable measure of risk-adjusted return since returns are not always symmetrically distributed.;biased since the standard deviation of hedge funds returns is higher than those of equities, pushing down the Sharpe ratios of hedge funds.;&LOS: Reading 75-sSurvivorship bias means that returns are overstated and risk understated, and hence Sharpe ratios are overstated.If a hedge fund invests in options or other derivatives standard deviation, and hence the Sharpe ratio, may underestimate the risk of big losses.The standard deviation of hedge funds returns is lower than those of equities.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 417-422.&&&a&Class@SS17.2&&&&&1&N&0&N.N.N.N 2006JV.649&mcs&0&N&A property was purchased one year ago for $175,000. If the annual net operating income is $24,000 and the market capitalization rate is 12% then, using the income approach, the value of the property is:&200000&196000;220000;288000;&LOS: Reading 75-kMarket value = net operating income/market capitalization rate = $24,000/0.12 = $200,000Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, p. 391. &&&a&Class@SS17.0&&&&&1&N&0&N.N.N.N 2006JV.650&mcs&0&N&The discounted after-tax cash flow approach to real estate valuation is often considered more relevant than the market value approach for all of the following reasons EXCEPT:&it is not influenced by the tax status of the investor.&it looks at the individual requirements of the investor.;it uses forecasts for factors affecting real estate values.;it takes into account the leverage used to purchase real estate.;&LOS: Reading 75-lThe discounted cash flow approach takes into account the cash flows after tax for the investor.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, p. 393.&&&a&Class@SS17.1&&&&&1&N&0&N.N.N.N 2006JV.651&mcs&0&N&The least appropriate reason why after-tax cash flows rather than net operating income are used in the discounted cash flow approach to real estate valuation is:&investors usually pay federal taxes.&property taxes are payable in many locations.;different investors have different costs of borrowing.;many investors use outside finance for real estate purchases.;&LOS: Reading 75-jProperty taxes would be deducted in the calculations of both net operating income and after-tax cash flows.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 391-394.&&&a&Class@SS17.2&&&&&1&N&0&N.N.N.N 2006JV.652&mcs&0&N&Real estate appraisal refers to:&the process of establishing the current market value of a property.&investigating the location of the property.;checking the quality of construction of a property.;examining the legal documentation concerning a property.;&LOS: Reading 75-iReal estate appraisal establishes the value of a property which might include investigating the location, checking the quality of construction and legal documentation.Campbell R. Harvey, Defination:An estimate of the value of property using various methods. Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 388-389.&&&a&Class@SS17.0&&&&&1&N&0&N.N.N.N 2006JV.653&mcs&0&N&An investor calculates that the net operating income from a property will be $40,000 for each of the next two years. Depreciation expense will be £8,000 per year and her marginal tax rate is 40%. She will pay for the property with cash rather than using a mortgage. At the end of two years she believes that she will be able to sell the property for $200,000 net of tax. If the investor's required rate of return is 15%, the value of the property to the investor is closest to:&195448&182443;216257;271758;&LOS: Reading 75-lThe net income each year is ($40,000 - $8,000)0.60 = $19,200 so the after-tax cash flow is $27,200 in the first year. In the second year we need to add the expected sale proceeds of $200,000.The cash flows discount back to give a present value of\\Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 393-396.&&&a&Class@SS17.1&&&&&1&N&0&N.N.N.N 2006JV.654&mcs&0&N&Which of the following factors is the least likely to affect net operating income for a property?&Mortgage interest costs.&Rental income.;Property management costs.;Repair and maintenance costs.;&LOS: Reading 75-jNet operating income is before tax and interest costs.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 391-2. &&&a&Class@SS17.2&&&&&1&N&0&N.N.N.N 2006JV.655&mcs&0&N&A hedge fund currently has assets of $500 million and the fee structure is a fixed fee of 1% of the portfolio value at the beginning of the year plus a 20% incentive fee. The incentive fee is applied to the annual gross return in excess of the previous high water mark or maximum value since inception. The maximum value was two years ago when the value was $520 million. If the return over the next year is 10% the fee earned by the manager is:&$11 million.&$6 million.;$10 million.;$15 million.;&LOS: Reading 75-pFixed fee = 1% x $500 million = $5 millionThe new value of the fund is $550 million, which is $30 million above the high watermark so the incentive fee is 20% x $30 million = $6 millionTotal fee = $5 million + $6 million = $11 millionReference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 410-411. &&&a&Class@SS17.0&&&&&1&N&0&N.N.N.N 2006JV.656&mcs&0&N&Market capitalization rates used to calculate the value of real estate:&reflect recent selling prices.&are low for high-risk properties.;on average are the Treasury bill rate.;are the same for all types of property.;&LOS: Reading 75-kCapitalization rates reflect the investors' required rate of return and are equal to net operating income/market value.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, p. 391. &&&a&Class@SS17.1&&&&&1&N&0&N.N.N.N 2006JV.657&mcs&0&N&Which of the following is the least accurate characteristic of the real estate market? &supply and demand are in balance.&infrequent transactions.;each property is unique.;there is no central market place.;&LOS: Reading 75-hIt takes time for supply to adjust to changes in demand.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 386-387.&&&a&Class@SS17.2&&&&&1&N&0&N.N.N.N 2006JV.658&mcs&0&N&Start-up financing from a venture capital company is for:&IV. product development and initial marketing of a product before it is sold commercially.&I. capital for expansion of a business.;II. market research of a new product idea.;III. starting commercial production and sales.;&LOS: Reading 75-mI. is second or third-stage financingII. is seed financing.III. is first-stage financing.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 400-401.&&&a&Class@SS17.0&&&&&1&N&0&N.N.N.N 2006JV.659&mcs&0&N&Shares in a closed-end investment company usually trade at:&a discount or premium to the net asset value of the shares.&the net asset value of the shares.;the net asset value less the liabilities of the fund.;the net asset value of the shares plus the front-end load for a purchase at the net asset value of the shares less the back-end load for a sale.;&LOS: Reading 75-aHistorically closed-end funds have generally traded at a discount, the price is set by supply and demand for the shares. Open-end funds trade at NAV, plus or minus sales and redemption charges.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 374.&&&a&Class@SS17.1&&&&&1&N&0&N.N.N.N 2006JV.660&mcs&0&N&A hedge fund charges a 0.5% base management fee plus 20% of any return above the risk-free rate. The gross return on the fund is 30% and the risk-free rate is 5%. The net return for an investor is&0.245& 5.5%.;0.195;23.5%.;&LOS: Reading 75-pThe fee = 0.5% + 20%(30% - 5%) = 5.5%Net return = 30% - 5.5% = 24.5%Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 410-411. &&&a&Class@SS17.2&&&&&1&N&0&N.N.N.N 2006JV.661&mcs&0&N&An investment company is least likely to:&offer investment advisory services to investors.&sell its shares to several investors.;appoint an investment manager to manage its assets.;have its assets invested in securities that are referred to as a fund.;&LOS: Reading 75-aAn investment company is the name for a company that receives cash from a number of investors, uses this money to invest in securities and is often managed by a professional fund manager. It is not the same as an investment management or advisory company.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 373. &&&a&Class@SS17.0&&&&&1&N&0&N.N.N.N 2006JV.662&mcs&0&N&If a fund is to invest in illiquid assets there will be advantages in establishing it as a closed-end fund since:&investors cannot draw money out of the fund if they wish to sell their shares.&the fund itself will be more liquid.;the managers can charge a higher front-end load.;the annual investment management fees will be higher.;&LOS: Reading 75-aIf the fund is structured as an open-end fund and at some point is faced with heavy redemptions the managers could have difficulty selling the assets to pay for the redemptions.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, p. 374. &&&a&Class@SS17.1&&&&&1&N&0&N.N.N.N 2006JV.663&mcs&0&N&Which of the following is the fee that is least likely to be charged by an investment company?&premium to net asset value.&redemption fees.;deferred sales load.;annual management fees.;&LOS: Reading 75-cThe premium to net asset value refers to a closed-end fund which is trading in the market at a premium above its net asset value; this premium goes to the seller of the mutual fund.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 374-376.&&&a&Class@SS17.2&&&&&1&N&0&N.N.N.N 2006JV.664&mcs&0&N&An investor invests in an open-end mutual fund. The investment return of the fund is 10% each year (gross of any expenses) and the fund expenses are shown in the table below. The investor decided to sell the fund after two years, the investor's net return is closest to: Sales charge 2% Redemption fee 3% for the first three years Annual expense 1.25%&12.2%.& 3.3%.;13.8%.;19.1%.;&LOS: Reading 75-cFor each $1 invested only $0.98 is invested in the fund due to the 2% sales charge. After adjusting for the annual expenses and redemption fee $1 will be worth \\Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 375-377. &&&a&Class@SS17.0&&&&&1&N&0&N.N.N.N 2006JV.665&mcs&0&N&The target beta of a market-neutral hedge fund is:&0&-1;1;more than 1.;&LOS: Reading 75-pThe objective of a market-neutral fund is to have no net market exposure, so the beta would be zero.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 411-412&&&a&Class@SS17.1&&&&&1&N&0&N.N.N.N 2006JV.666&mcs&0&N&The market value of the assets held in an open-end no-load fund is $12,000,000 and the liabilities are £500,000. There are one million shares outstanding. The price an investor would pay for shares is:&$11.50.&$12.00.;likely to be at a discount to the net asset value of $12.00.;likely to be at a premium to the net asset value of $11.50.;&LOS: Reading 75-bThe net asset value is ($12,000,000 - $500,000)/1,000,000 = $11.50. An open-end fund trades at the net asset value per share, plus or minus front-end load or redemption fees.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, p. 374. &&&a&Class@SS17.2&&&&&1&N&0&N.N.N.N 2006JV.667&mcs&0&N&Investment companies can invest:&in a wide variety of listed and unlisted securities.&only in liquid assets.;only in money market instruments.;only in listed common stocks and bonds.;&LOS: Reading 75-dInvestment companies invest in anything from liquid U.S. stocks and bonds to illiquid emerging market securities.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 374.&&&a&Class@SS17.0&&&&&1&N&0&N.N.N.N 2006JV.668&mcs&0&N&A venture capital project has four years to run when it is estimated to make a payout of $5 million, the probability of failure in the next four years is given below, each probability is conditional on the project surviving the previous year.\\If an investor's required return is 15% the maximum she would be willing to pay for the project is closest to:&$1.02 million.&$1.56 million.;$2.11 million.;$3.29 million.;&LOS: Reading 75-o\\Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 405-406.&&&a&Class@SS17.1&&&&&1&N&0&N.N.N.N 2006JV.669&mcs&0&N&In the U.S. global funds refer to funds that:&invest in both the U.S. and internationally.&only invest outside the U.S.;are only marketed outside the U.S.;are marketed in both the U.S. and internationally.;&LOS: Reading 75-d'Global funds' refer to funds that are investing in both the U.S. and international markets.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, p. 374. &&&a&Class@SS17.2&&&&&1&N&0&N.N.N.N 2006JV.670&mcs&0&N&The role of venture capital investors is least likely to include:&making a market in the shares of their investments that have gone public.&assisting companies to go public.;providing financing to small privately held companies.;assisting the companies that they invest in with strategic planning.;&LOS: Reading 75-nThe role of venture capitalists is not just to provide finance but to also work with the management team to develop and expand the business. This would usually include assisting with a company going public as venture capitalists have experience dealing with underwriters and other financial institutions. They would not normally be specialists or market makers.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 401-403.&&&a&Class@SS17.0&&&&&1&N&0&N.N.N.N 2006JV.671&mcs&0&N&Capital provided to a company that is close to going public is:&mezzanine financing.&first-stage financing.;second-stage financing.;third-stage financing.;&LOS: Reading 75-mMezzanine or bridge financing is given to companies who are planning to go public in the near term.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 400-401. &&&a&Class@SS17.1&&&&&1&N&0&N.N.N.N 2006JV.672&mcs&0&N&Which of the following statements is the least appropriate characteristic of venture capital investing?&Entrepreneurs have strong management skills which increase the probability of companies being successful.&Investors need to make a long-term commitment.;Illiquidity is a feature of venture capital investment.;Investors expect to achieve higher investment returns than they receive from investing in publicly listed securities.;&LOS: Reading 75-nEntrepreneurs often have weak management skills so the venture capitalist can help in providing direction and strategic guidance to the company.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 401-403. &&&a&Class@SS17.2&&&&&1&N&0&N.N.N.N 2006JV.673&mcs&0&N&A hedge fund manager specializes in taking long positions in companies that are being bid for and taking short positions in the acquiring company. He is likely to be managing a hedge fund that is:&an event-driven fund.&a futures fund.;a long/short fund.;a market-neutral fund.;&LOS: Reading 75-p(an event-driven fund.) is the best answer since the long and short positions are being taken as a result of specific events, in this case mergers and acquisitions.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp.410-414.&&&a&Class@SS17.0&&&&&1&N&0&N.N.N.N 2006JV.674&mcs&0&N&One of the reasons that the shares in closely held companies usually trade at a discount to publicly traded securities is:&the shares are less liquid.&they have high market betas.;investors often hold a majority stake.;investors often have a greater influence on the company's management. ;&LOS: Reading 75-uClosely held companies shares are often not publicly traded and lack marketability, so investors are compensated with a liquidity discount.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 424-425.&&&a&Class@SS17.1&&&&&1&N&0&N.N.N.N 2006JV.675&mcs&0&N&The advantages of investing in a fund of hedge funds for an investor include:&diversification reducing the volatility of returns.&lower fees.;superior returns.;greater transparency.;&LOS: Reading 75-qA fund of hedge funds will invest across a number of different hedge funds which often follow different strategies so the volatility of the fund of funds' returns is reduced below the volatility of the individual hedge funds' returns.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 414-415.&&&a&Class@SS17.2&&&&&1&N&0&N.N.N.N 2006JV.676&mcs&0&N&Which of the following is the least accurate description of commodity investment?&it has low volatility of returns.&it offers inflation protection.;it produces attractive returns in periods of economic growth.;the returns have low correlations with bond and equity returns.;&LOS: Reading 75-xHistorically commodities have exhibited higher volatility than equities.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 426-430.&&&a&Class@SS17.0&&&&&1&N&0&N.N.N.N 2006JV.677&mcs&0&N&Investors in hedge funds are least likely to be motivated by which of the following?&Consistent returns across the different categories of hedge funds.&The low volatility of returns from hedge funds compared to equity returns.;Higher average returns provided by hedge funds compared to other investments.;The potential to use hedge funds to diversify portfolios that hold other asset classes.;&LOS: Reading 75-pDifferent types of hedge funds (e.g. fixed-income arbitrage versus global macro) have quite different performance records.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 417-421.&&&a&Class@SS17.1&&&&&1&N&0&N.N.N.N 2006JV.678&mcs&0&N&Which of the following statements regarding trade sales of venture capital investments is the most accurate?&Trade sales are one of the most common methods of venture capital investors divesting their holdings.&A trade sale is the first step in the public offering process.;Trade sales are an unattractive exit strategy for most venture capitalists.;Trade sales means that a venture capital investment is sold to another company operating in the same industry. ;&LOS: Reading 75-mTrade sales refer to a venture capital investment being sold to or merged with another company.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 403-404. &&&a&Class@SS17.2&&&&&1&N&0&N.N.N.N 2006JV.679&mcs&0&N&Early-stage venture capital investments are least likely to be:&invested in companies that are looking to expand their commercial production.&illiquid.;invested in relatively new companies.;invested in companies that will require further financing.;&LOS: Reading 75-mEarly-stage financing is used to help companies move into operations and occurs before commercial production has started.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 400-401.&&&a&Class@SS17.0&&&&&1&N&0&N.N.N.N 2006JV.680&mcs&0&N&The prices of hedge funds are often smoothed because:&they invest in over-the-counter instruments whose prices are based on estimates. &they use arbitrage strategies.;the managers are risk averse.;they are actively dealing in derivative exchanges.;&LOS: Reading 75-sOver the counter instruments do not have market prices so the estimated values are often less volatile than exchange-traded instruments.Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 422-423.&&&a&Class@SS17.2&&&&&1&N&0&N.N.N.N 2006JV.681&mcs&0&N&Capital Market Theory: Basic ConceptsThe Capital Asset Pricing Model says that an investor should:&adjust the beta of a portfolio to take advantage of anticipated market moves.&calculate the unsystematic risk of an asset.;calculate the variance of a multiple asset portfolio.;select different optimal portfolios on the efficient frontier to match the risk tolerance of each client.;&LOS: Reading 79-eCAPM states that the expected return of an asset or portfolio is a function of its market risk or beta risk.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 8, pp. 247-251.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.682&mcs&0&N&Which of the following is least likely to be a component of the required rate of return of an investment?&The consensus forecast return.&The real risk-free rate.;The risk of the investment.;The expected inflation rate.;&LOS: Reading 76-aThe required rate of return from an investment is the real risk-free rate, plus an inflation premium that reflects the expected rate of inflation, plus a risk premium.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 1, pp. 16-22.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.683&mcs&0&N&There are two stocks, A and B, in a portfolio and 70% of the portfolio is invested in stock A and 20% in B, the remaining 10% is invested in cash equivalents. The expected return on stock A is 15% and stock B is 12%, cash returns are 5%. The beta of stock A is 1.3 and the beta of stock B is 0.9. The expected return of the portfolio is closest to:&13.4%.&12.9%.;15.8%.;32.0%.;&LOS: Reading 78-cThe expected return using CAPM is:(0.7x15%)+(0.2x12%)+(0.1x5% = 13.4%Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 7, p. 212.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.684&mcs&0&N&If the slope of the Security Market Line becomes steeper this is explained by:&the market risk premium has increased.&the market risk premium has fallen.;investors have raised their inflation rate expectations.;investors have lowered their inflation rate expectations;&LOS: Reading 76-dChanges in inflation expectations would lead to parallel shifts in the SML whereas a change in the market premium indicates that the return investors expect for taking risk has changed. If the market risk premium increases then for any level of risk investors will expect a higher level of return than they did previously.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 1, pp. 24-25.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.685&mcs&0&N&Which of the following would explain why the return from a company's share is highly volatile when it has a low level of systematic risk?&III. The share has a high level of fundamental risk which is not linked to the overall economy.&I. The standard deviation of the returns is lower than the market average.;II. The share price is heavily influenced by movements in the market index.;IV. The company is a conglomerate whose financial and business risk is very similar to the average company in the market index.;&LOS: Reading 76-cI. would lead to low volatility. II. and IV. would lead to average or high systematic risk.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 1, pp. 22-23.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.686&mcs&0&N&It is least accurate to say that combining two assets in a portfolio will:&always reduce the risk of the portfolio to less than the risk of either asset.&diversify some of the risk if the assets are not perfectly correlated.;provide a return that is the weighted average of the individual returns.;be more effective in reducing risk when the assets have a negative, rather than a positive, correlation.;&LOS: Reading 78-fThe risk will not be reduced to less than either asset unless the correlation is low or negative e.g. if the correlation is 1 then the risk is the weighted average of the risk of the two assets.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 7, pp. 219-228.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.687&mcs&0&N&A U.S. investor is a taxpayer with a long investment time horizon. His objective is to maintain the purchasing power of his portfolio. Based on historic data which of the following is likely to represent the most appropriate investment policy:&common stocks should make up the largest portion of his portfolio.&the portfolio should only be invested in long-term bonds and municipal bonds.;long-term government bonds should make up the largest portion of his portfolio.;the portfolio should be equally divided between stocks, bonds and Treasury bills.;&LOS: Reading 77-cCommon stocks are the only asset that has produced returns that are significantly higher than inflation. An argument can be made for holding a portion of the portfolio in long-term bonds since they are less volatile than stocks, but Treasury bills are not attractive for long-term investment since they lose value in real terms.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 2, pp. 54-59.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.688&mcs&0&N&The following data is provided on the expected return of an asset under different scenarios.Probability Return 0.20 12% 0.60 15% 0.20 18%The standard deviation of the returns is closest to:&1.9%.&1.2%.;2.3%.;3.6%.;&LOS: Reading 78-cThe expected return is 15%.\\Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 7, pp. 213-218.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.689&mcs&0&N&The Security Market Line (SML) relates the expected return on an asset to its:&beta.&variance.;standard deviation.;market capitalization.;&LOS: Reading 79-eThe Security Market Line (SML) plots the required return from an asset to its systematic or beta risk.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 8, pp. 250-252.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.690&mcs&0&N&Which of the following statements is most accurate regarding Markowitz’s efficient frontier?&It contains the portfolios that have the maximum rate of return for any given level of standard deviation of returns.&It contains the portfolios that have the maximum rate of return for any given level of beta risk.;It contains the portfolios that have the minimum rate of return for any given level of beta risk.;It contains the portfolios that have the minimum rate of return for any given level of standard deviation of returns.;&LOS: Reading 78-gThe efficient frontier plots portfolio returns against total risk as represented by standard deviation. It represents the portfolios that offer the highest return for any given level of risk.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 7, pp. 228-229.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.691&mcs&0&N&The Capital Market Line:&is an efficient frontier.&is used to estimate the beta of a stock.;is used to compute the covariance between two assets.;reflects the trade off between expected return and beta risk in a market.;&LOS: Reading 79-cThe CML connects the risk-free asset with the market portfolio. It therefore is a set of portfolios offering the highest return for any given level of risk (standard deviation).Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 8, pp. 241-244.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.692&mcs&0&N&Studies show that an 18 stock portfolio investing in the U.S. stock market can diversify away approximately:&90% of the unsystematic risk.&60% of the systematic risk.;90% of the systematic risk.;60% of the unsystematic risk.;&LOS: Reading 79-dSystematic risk cannot be diversified away but unsystematic risk can be largely eliminated with a relatively small number of stocks.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 8, pp. 244-245&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.693&mcs&0&N&If the standard deviations of returns of two assets are 3.2% and 4.5%, and the covariance between the assets is 6.8, then the correlation coefficient between the returns is closest to:&0.47.&0.03.;0.22.;2.10.;&LOS: LOS: Reading 78-e\\Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 7, pp. 217-218.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.694&mcs&0&N&Analysis of portfolio performance shows that:&the most important decision is to select the normal long-term asset allocation correctly.&individual security selection is the largest contributor to performance.;there is no consistent pattern as to whether asset allocation or stock selection is the major contributor to performance.;the decision to move the short-term asset allocation away from the long-term asset allocation policy is the major contributor to performance.;&LOS: Reading 77-d85% to 95% of the investment returns come from the selection of the long-term asset allocation of the portfolio.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 2, pp. 52-55.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.695&mcs&0&N&The returns of two assets X and Y have perfect negative correlation. When the two assets are combined in a portfolio, which of the following statements is the most accurate?&62.5%.&25.0%.;37.5%.;50.0%.;&LOS: Reading 78-fThe returns of the portfolio will only be zero in a few cases e.g. the returns of the assets are perfectly inversely related and they are equally weighted, so 25.0% is not correct. The risk/return tradeoffs will be optimal on the upper part of the efficient frontier representing all possible combinations of the assets so 50.0% is not correct. Risk will be diversified away and can be completely eliminated if the weightings are calculated based on the relative standard deviations of the two assets, so 62.5% is correct\\Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 7, pp. 219-227.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.696&mcs&0&N&If the market risk premium is 4%, the risk free rate is 6%, and a stock has a beta of 1.1 and standard deviation of 3%, then the expected return from the stock is:&10.4%.&11.0%.;15.0%.;18.0%.;&LOS: Reading 79-eUsing CAPM, the return\\Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 8, pp. 247-251.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.697&mcs&0&N&Investors are generally risk-averse means that&for a given level of return investors prefer a lower risk investment.&investors prefer not to take on any risk.;there is an inverse relationship between return and risk.;investors are willing to take on risk in the short-term but avoid risk in the long-term.;&LOS: Reading 78-aRisk aversion simply means that investors wish to be compensated for taking on risk and therefore for a given level of return they prefer a lower risk investment.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 7, p. 210.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.698&mcs&0&N&If the correlation coefficient between the returns of two assets is 0.8 and the variance of the returns of the two assets is 0.0018 and 0.0026, the covariance of the returns is closest to:&17.30.& 0.04.; 4.60.;17.09.;&LOS: Reading 78-eImportant: Remember to take the square root of the variance to get standard deviation.\\Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 7, pp. 217-218.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.699&mcs&0&N&Which of the following is the least appropriate example of an investment constraint that will have an impact on an investor’s policy statement? &Capital appreciation requirements.&Time horizon.;Regulatory factors.;Liquidity requirements.;&LOS: Reading 77-cCapital appreciation is an objective rather than a constraint.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 2, pp. 46-52.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.700&mcs&0&N&Which of the following would be a factor that would have a direct impact on an investor’s risk tolerance?&I. his total net worth.&II. a high rate of income tax.;III. a preference for ethical investments.;IV. access to inside information in his job as an investment banker.;&LOS: LOS: Reading 77-bII., III. and IV. are all constraints on the way a portfolio of investments would be managed but do not directly affect the risk tolerance of the investor.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 2, pp. 42-44.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.701&mcs&0&N&Wh Which of the following is least likely to be an assumption of capital market theory?&Investors are averse to buying and selling securities.&All investors have the same time horizon when they invest.;There are no transaction costs in buying and selling securities.;Investors want to invest in portfolios that lie on the efficient frontier.;&LOS: Reading 79-aIt is not assumed that investors are averse to buying and selling securities. It is assumed they will do the transactions required to invest at a point on the efficient frontier.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 8, p. 239.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.702&mcs&0&N&The slope of an efficient frontier decreases steadily as an investor moves up the frontier because:&as an investor continues to take on more risk the incremental return diminishes.&the portfolios become increasingly efficient as you move up the frontier.;the portfolio representing the top of the frontier is the asset with the lowest risk.;an investor has to be rewarded for taking on additional risk by being given rapidly increasingly higher returns.;&LOS: Reading 78-gAdding equal increments of additional risk (horizontal axis) leads to smaller incremental returns (vertical axis).Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 7, p. 229.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.703&mcs&0&N&The fundamental risks of an asset:&are the sources of the standard deviation of returns.&are the same as systematic risk.;reflect the risk of inefficient valuation of the stock.;are the risks involved in using fundamental analysis to value the asset.;&LOS: Reading 76-cFundamental risks are simply the sources of volatility or standard deviation of returns. They include business risk, financial risk, liquidity risk, exchange rate risk and country risk.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 1, pp. 19-22.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.704&mcs&0&N&An investment manager forecasts that the stock market is going to decline. A client has specified that she wishes to remain invested in the market rather than holding cash. The investment manager is most likely to hold stocks with:&betas of less than 1, he expects them to decline by less than the market.&any beta, the beta is irrelevant to the expected return.;betas of more than 1, they are expected to perform better than the market.;betas of 1, they have no market exposure so will not decline with the market.;&LOS: Reading 79-eA beta of less than 1 means the stocks are defensive and will decline by less than the market. This can be seen from CAPM,\\Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 8, pp. 247-250.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.705&mcs&0&N&A point on the Capital Market Line represents a portfolio that has a higher expected return than the market portfolio. This portfolio:&is leveraged.&cannot exist.;includes a risk-free asset.;is invested in a different mix of equities to that in the market portfolio.;&LOS: Reading 79-cThe portfolio represents an investor who has borrowed at the risk-free rate and invested all the funds in the market portfolio.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 8, pp. 242-244.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.706&mcs&0&N&Which of the following is least likely to be part of the portfolio management process?&Advertising the manager's performance record.&Constructing the portfolio.;Evaluating investment performance.;Constructing a client policy statement;&LOS: Reading 79-aThe portfolio management process consists of four steps, construct the policy statement, forecast future economic and market trends, construct the portfolio and the continual monitoring and evaluation of performance.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 2, pp. 38-39.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.707&mcs&0&N&In capital market theory, systematic risk is:&market risk.&total risk.;unique risk.;diversifiable risk.;&LOS: Reading 79-d"unique risk" and "diversifiable risk" refer to unsystematic risk and "total risk" includes systematic and unsystematic risk.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 8, pp. 244-246.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.708&mcs&0&N&An individual who is working and in her late twenties is likely to be:&in the accumulation phase of her investment life cycle and investing in relatively high-risk assets.&in the spending phase of her investment life cycle and investing in low-risk assets.;in the consolidation phase of her investment life cycle and investing in moderate-risk assets.;in the consolidation phase of her investment life cycle and investing in relatively high-risk assets.;&LOS: Reading 77-bIn the accumulation phase individuals are accumulating assets to meet current requirements as well as longer-term goals. Although their asset base may be relatively small they have a long time horizon and future earning ability so they can invest in relatively high-risk assets.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 2, pp. 36-39.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.709&mcs&0&N&An investor policy statement is important because:&it clarifies the investors' objectives.&it provides the investor with the portfolio manager's market outlook.;it provides details on the stocks that will be purchased for the portfolio.;it means that the investor takes responsibility for investment performance.;&LOS: Reading 77-bA policy statement helps the investor specify realistic goals and in setting the goals become more aware of the risks of investing. It is a valuable way of communicating with the portfolio manager. It also helps set the benchmark against which performance can be measured.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 2, pp. 40-42.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.710&mcs&0&N&The optimal portfolio for an investor is represented by:&the point where the investor utility curve is tangent to the efficient frontier.&the point where the investor utility curves intersect each other.;the point where the security market line is tangent to the efficient frontier.;the point where the investor utility curve is tangent to the security market line.;&LOS: Reading 78-hThe utility curves represent the trade-off between risk and return, the optimal portfolio will be where the highest utility curve touches the efficient frontier.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 7, p. 230.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.711&mcs&0&N&The asset allocation of investors between equities and fixed income in the major international capital markets is:&quite different, since investors are making decisions in different economic and social environments.&very similar, since investors are using the same optimization models.;very similar, since asset allocation is the most important step in portfolio construction in all major markets.;very similar, since long term equity and fixed income returns have been consistent across different markets.;&LOS: Reading 77-dThe different social and economic environments, in addition to political and tax issues, have led to different weightings in equities and fixed income in portfolios in different countries. Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Ch. 2, pp. 59-61.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.712&mcs&0&N&The beta of an asset:&III. is 1 if the asset is the market portfolio.&I. lies between -1 and 1.;II. is a measure of unsystematic risk.;IV. is the covariance of the asset with the market.;&LOS: Reading 79-eI. is not correct since beta does not lie in any fixed range.II. is not correct, it is a measure of systematic risk.III. is not correct because beta is the covariance divided by the variance of the market.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 8, pp. 248-249.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.713&mcs&0&N&The Security Market Line represents:&the expected returns from stocks relative to their systematic risk.&the systematic risk of stocks relative to their total risk.;the unsystematic risk of stocks relative to their total risk.;the set of stocks offering the highest returns on a systematic risk-adjusted basis.;&LOS: Reading 76-dThe Security Market Line (SML) plots required or expected return from stocks against their systematic or beta risk.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 1, p. 23.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.714&mcs&0&N&The stock analyst in your firm recommends that you buy shares in Mayfair Corp., the current share price is $26 and she forecasts that a year from now the share price will have risen to $30, there is no dividend payment expected. You note that the beta of the stock is 0.8, the expected market return over the next year is 15% and the risk-free rate is 5%. On the basis of the analyst's forecast, Mayfair Corp.'s stock is:&undervalued.&overvalued.;correctly valued.;the question needs to provide the market risk premium to be able to decide whether the stock is fairly valued.;&LOS: Reading 79-fUsing CAPM the estimated return is\\The analyst is forecasting a return of 15.4% so the stock looks undervalued.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 8, pp. 250-255.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.715&mcs&0&N&Which component of the required rate of return will lead to differences between the required rates of return of two shares in an equity market?&the risk premium.&the real risk-free rate.;the nominal risk-free rate.;the expected inflation rate.;&LOS: Reading 76-aThe risk premium will create the difference; an investor will require a higher rate of return from a share if there is a greater risk or uncertainty in the return being achieved.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 1, pp. 16-23.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.716&mcs&0&N&The characteristic line is used to estimate:&the beta of a stock.&the risk free rate.;the risk aversion of an investor.;the standard deviation of a portfolio.;&LOS: Reading 79-gThe characteristic line is the regression line of best fit through a scatter diagram of points representing a stock's return against the market return; the slope gives the stock beta.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 8, p. 241.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.717&mcs&0&N&A portfolio is 70% invested in an index fund and 30% in a risk free asset. The index fund has a variance of returns of 0.0027, the variance for the total portfolio is closest to:&0.0013.&0.0019.;0.0027.;0.0039.;&LOS: Reading 79-bThe variance and standard deviation of the risk free asset are zero. Therefore the variance of the portfolio is\\Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 8, p. 241.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.718&mcs&0&N&In capital market theory the Market Portfolio can be least accurately described as:&I. the portfolio where systematic risk has been completely diversified away.&II. it is the point where the Capital Market Line touches the efficient frontier.;III. the portfolio which contains all risky assets in proportion to their market value.;IV. the point where the tangent from the risk-free rate touches the efficient frontier. ;&LOS: Reading 78-cI. is not correct, it is the unsystematic risk that can be diversified away.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 8, pp. 243-245.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.719&mcs&0&N&If an investor has steep utility curves it indicates that:&the investor is risk averse.&the investor is risk tolerant.;the investor has a long time horizon.;the investor has a short time horizon.;&LOS: Reading 78-hA steep utility curve shows that the investor needs to be compensated for taking a small amount of additional risk by receiving a significantly higher return, indicating he is risk averse.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 7, pp. 229-230.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.720&mcs&0&N&If the real risk-free rate (RRFR) is 5% and the expected rate of inflation is 3%, then the nominal risk-free rate (NRFR) is closest to:& 8.2%.& 1.7%.; 1.9%.;15.0%.;&LOS: Reading 76-b\\Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 1, pp. 16-19.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.721&mcs&0&N&Which of the following statements is least accurate with respect to the Global Investment Performance Standards regarding composites?&Composite performance calculation must equally-weight the performance of the portfolios in the composite.&Firm composites must be defined to include portfolios with similar investment objectives/strategies.;All actual fee-paying discretionary portfolios must be included in at least one composite.;Firms must provide a performance presentation on any composite if it is requested by a prospective client.;&LOS: Reading 4-cComposites should be asset-weighted, not equally-weighted, returns of the constituent portfolios.Reference: Global Investment Performance Standards, (CFA Institute, 2005), p. 113.&&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.722&mcs&0&N&ABC Investment Managers decides to calculate and present performance in compliance with GIPS standards. Which of the following is most accurate? &ABC Investment Managers must present five years’ historic data (or data from inception of the firm or composites if their existence is less than five years) which is compliant with GIPS.&ABC Investment Managers must wait five years before they can claim GIPS compliance and in the meantime build up five years of compliant data. ;ABC Investment Managers may present non-compliant data for the last five years as long as they disclose it is non-compliant, and all future data is compliant with GIPS.;ABC Investment Managers must present ten years’ historic data (or data from inception of the firm or composites if their existence is less than ten years) but prior to I January 2000 they may include non-compliant data as long as they disclose it is non-compliant.;&LOS: Reading 4-iFive years of compliant data must be presented (and non-compliant data can only be presented prior to 1 January 2000). After that ABC must build up to ten years' data.Reference: Global Investment Performance Standards, (CFA Institute, 2005), p. 110.&&&a&Class@SS01.0&&&&&1&N&0&N.N.N.N 2006JV.723&mcs&0&N&Which one of the following is least likely to be considered good corporate governance of a listed company? &All shareowners have the same right to participate in the governance of the company, with founding shareowners normally given the right to veto certain resolutions.&The board members’ actions and decisions represent the best interests of shareowners. ;Appropriate controls and procedures are in place covering management’s activities in running the day-to-day operations of the company.;The board and its committees are structured to act independently from management and other parties that might influence the management.;&LOS: Reading 5-iIn a listed company, all shareowners should have equal rights to participate in the governance of the company. Differentiating between economic and voting rights should be avoided.Reference: The Corporate Governance of Listed Companies: A Manual for Investors, (CFA Institute, 2005), pp. 7-8.&&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.724&mcs&0&N&Valery de Picarde, CFA, is the director of a major Karamba-owned investment management firm branch in Indopulo. Karamba is known as the world's centre of investment management with securities laws stricter than the CFA Institute Code and Standards. In Indopulo, an emerging market, the local securities laws and regulations are embryonic. They are very vague regarding the definition of insider trading and have no provision regulating soft-dollars. De Picarde's client is a citizen of Karamba but residing in and doing business in Indopulo. The client chooses the jurisdiction of the laws of Indopulo for his business dealings with de Picarde.Which is the most appropriate action for de Picarde to follow when dealing with this client?&As an CFA Institute member, de Picarde must comply with the CFA Institute Code and Standards regarding insider trading and soft-dollars as they are stricter than the laws of Indopulo, regardless of the client's choice.&De Picarde should follow the laws of Karamba since they are stricter that the laws of Indopulo.;De Picarde should respect the client's choice, not worry about the laws of Karamba and take full advantage of soft-dollars arrangements as well as insider trading opportunities.;De Picarde does not need to comply with the laws of Karamba since the client is not resident there, and can therefore take full advantage of soft-dollars arrangements but not insider trading opportunities.;&LOS: Reading 2-aThe rule of thumb of Standard I (A) of the Code and Standards is that in principle, members must comply with the stricter of the applicable laws (in this case Karamba's laws) and the Code of Standards.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 7-11. &&&a&Class@SS01.2&&&&&1:v&&&N. 2006JV.725&mcs&0&N&James Richards, CFA, who is a quantitative analyst at Chelsea Investments, a money management firm, has recently been working on a quantitative risk management model for convertible arbitrage strategy. Richards recently attended an CFA Institute conference where he learned that High Fidelity, a competing investment advisory firm, is also developing a similar model but approaching it from a different angle. He did not agree with the main assumptions of the High Fidelity model although he admitted that its new angle of analysis is innovative. Upon returning to his office, Richards adopted High Fidelity's quantitative techniques but kept the original assumptions from his model. The results are promising and Jane Seamore, the CEO of Chelsea Investments, is pleased with Richards' research. She appears in public seminars to present the new methodology and to win client mandates. Which of the following complies with the CFA Institute Code and Standards?&Richards or Seamore must credit High Fidelity for having developed the model.&Seamore must credit Richards every time she appears in public seminars.;Richards may sue Seamore for using his research methodology and results.;Richards should not have misappropriated the quantitative techniques from High Fidelity.;&LOS: Reading 2-aStandard I(C) Misrepresentation says Richards or Seamore must acknowledge the original source of the quantitative techniques although Richards can take credit for the final results. Richards is employed by Chelsea Investments, therefore the intellectual property of research work generally belongs to the employer unless specified differently.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 25-32. &&&a&Class@SS01.0&&&&&1:v&&&N. 2006JV.726&mcs&0&N&Catherine Vieira, CFA, has been recently recruited to head the Asian research department in Hong Kong of a Paris-based brokerage firm. The firm employs many analysts spread across different countries in Asia, some of whom are members of CFA Institute and subject to CFA Institute's Code of Ethics and Standards of Professional Conduct. Vieira thinks that the firm's compliance procedures need to be upgraded to adequately deal with current global requirements. Which is the best course of action for Vieira according to the CFA Institute’s Standards of Practice Handbook?&Vieira should seek to improve the compliance procedures before she accepts supervisory responsibility.&Vieira should not delegate supervisory duties until the compliance procedures are upgraded.;Vieira may accept supervisory responsibility and can only delegate it to her subordinates who are CFA Institute members. ;Vieira may immediately accept supervisory responsibility after notifying her employer she is not happy with the compliance procedures.;&LOS: Reading 2-aIf the compliance procedures are inadequate she should not accept responsibility until reasonable procedures are in place. Standard IV(C) states that supervisory responsibility remains with the supervisor although the actual supervision duties can be delegated. Members can rely on reasonable procedures to detect and prevent violations to applicable statutes, regulations and provisions of the Code and Standards.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 93-98. &&&a&Class@SS01.1&&&&&1:v&&&N. 2006JV.727&mcs&0&N&Which of the following actions is least likely to support an information barrier (fire wall)?&IV. Limit the number of major institutional clients who regularly receive 'special investment tips' prior to the information being made public.&I. Monitor carefully the personal trading activities of firm personnel.;II. Limit the number of people in the firm who have access to material nonpublic information.;III. Place securities on a restricted list when the firm has access to material nonpublic information.;&LOS: Reading 2-aFire walls are intended to block the dissemination of material nonpublic information. Choice IV is still dissemination and therefore in violation of Standard II(A).Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 40-47.&&&a&Class@SS01.2&&&&&1&N&0&N.N.N.N 2006JV.728&mcs&0&N&William Johnson, CFA, is a stock analyst covering the oil sector. Through his contacts in the oil industry he has accumulated and analyzed several pieces of nonpublic information. Although none of the information is 'material', Johnson reached the conclusion that one of the companies he covers has discovered a potentially new oil field and future earnings will probably exceed expectations. According to the CFA Institute Code and Standards, Johnson:&is allowed to use the information to make investment recommendations and decisions.&should report the source of the nonpublic information to CFA Institute.;should urge the oil company to make the information public immediately.;is not allowed to make investment recommendations or take actions based on this information.;&LOS: Reading 2-aThe information is nonmaterial so Johnson does not violate the Code and Standards, his action is permissible under the 'mosaic' theory.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 37-47. &&&a&Class@SS01.0&&&&&1&N&0&N.N.N.N 2006JV.729&mcs&0&N&To enable a board to act in the best long-term interests of shareowners, it is least appropriate it possesses:&political affiliation.&resources.;independence.;experience and expertise.;&LOS: Reading 5-dThe major factors that enable a board to act in the best long-term interests of shareowners are independence, experience and expertise, and the resources to support the independent work. Political affiliation may work in the short term but is likely to be detrimental in the long term.Reference: The Corporate Governance of Listed Companies: A Manual for Investors, (CFA Institute, 2005), pp. 11-12.&&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.730&mcs&0&N&Which of the following concepts does the CFA Institute Code of Ethics not include?&Verification of investment performance.&Competence.;Integrity and diligence.;Independent judgment.;&LOS: Reading 1Verification of investment performance is not covered in the CFA Institute Code of Ethics. It is only recommended when a firm claims compliance with Global Investment Performance Standards.Reference: Global Investment Performance Standards, (CFA Institute, 2005), pp. 7-10.&&&a&Class@SS01.2&&&&&1&N&0&N.N.N.N 2006JV.731&mcs&0&N&John Jameson, CFA, includes the following in his resume, "I passed each of the CFA exams at the first attempt and this success shows my superior analytical skills". Jameson is&violates CFA Institute Code and Standards since he should not link the CFA exams to claiming superior analytical skills.&in compliance with the CFA Institute Code and Standards. ;violates the CFA Institute Code and Standards since in stating he passed each exam at the first attempt.;violates CFA Institute Code and Standards since he should not refer to the CFA exams except to state that he is a CFA charterholder.;&LOS: Reading 2-aJameson is free to say he passed each exam at the first attempt (if it is true) but he should not use this to "over-promise" his individual competency.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 131-133. &&&a&Class@SS01.0&&&&&1&N&0&N.N.N.N 2006JV.732&mcs&0&N&Alan Duff, CFA, is a stock analyst with Grit and Sand securities broker. He has been concerned about the recent financial situation of Liverpool Corporation and is about to write a report with a 'sell' recommendation. While working on his report, his wife, who happens to be looking for a new job, is called by her employment agency informing her that Liverpool Corporation is interested in meeting her for a job interview. She is excited by the prospect of working for Liverpool Corporation and Duff thinks he can improve his wife's employment prospects by writing a more positive recommendation about the company. The following week he issues a 'buy' recommendation and revises the revenue, profit and cash flow projections using some of the nonpublic information which Mrs. Duff obtained in the interview process and based on an optimistic economic scenario. Which of the following CFA Institute Standards is Duff least likely to violate?&Loyalty.&Independence and Objectivity.;Diligence and Reasonable Basis.;Material Nonpublic Information.;&LOS: Reading 2-aDuff has compromised his independence and objectivity in making the buy recommendation; using optimistic economic scenarios as a basis for the recommendation does not suggest diligence and a reasonable basis. He has also made use of the nonpublic information provided by his wife. Loyalty is the best answer.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 15-24 and 37-47. &&&a&Class@SS01.1&&&&&1:v&&&N. 2006JV.733&mcs&0&N&Lee Min Chu is a senior partner of a small brokerage firm, Golden Sun Securities, which recently participated in a large convertible bond offering. The offering company has been given a poor recommendation by the research department in the past two quarters partly due to increasing competition. Anticipating a low level of interest from Golden Sun's clients, Lee immediately calls his senior analyst, Jane Kwok, CFA, and instructs her to be more optimistic with her recommendation because Golden Sun must offload its substantial participation in the offering. Kwok is promised an increase in bonus for this recommendation upgrade. Kwok comes up with a more favorable recommendation within a short period of time, by revising some of the assumptions she made earlier. Which of the following statements is most accurate?&Kwok violates the CFA Institute Code and Standards because she did not maintain her independence and objectivity.&Kwok is in compliance with the CFA Institute Code and Standards.;Kwok violates the CFA Institute Code and Standards because she failed to make a fair statement of investment performance.;Kwok violates the CFA Institute Code and Standards because she used material nonpublic information about the convertible bond offering.;&LOS: Reading 2-bKwok does not maintain her independence when she is persuaded by Lee to change her recommendation.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 15-24 and 99-103. &&&a&Class@SS01.2&&&&&1:v&&&N. 2006JV.734&mcs&0&N&Fiona Bergkamp, CFA, is an equity sales manager at London-based Arsenal Securities branch located in an emerging market in South East Asia. Initial public offerings are often oversubscribed making it difficult to ensure receiving a fair allocation. Bergkamp understands the local environment so she is able to influence the allocation process so that she can personally subscribe to the maximum she can afford and then allocate the rest to her clients. Her clients never complain because they have almost always profited from investing in the emerging market. Which of the following best describes Bergkamp's action?&Bergkamp is violating Standard IV (B.4) Priority of Transactions.&Bergkamp is violating Standard IV (B.5) Preservation of Confidentiality.;Bergkamp is violating Standard V (B) Communication with Clients and Prospective Clients.;Bergkamp is complying with the CFA Institute Code and Standards.;&LOS: Reading 2-aBergkamp is in violation as Standard VI (B) since she should put her clients' interests ahead of her own. Ideally she should not apply for IPOs for her personal account.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 121-126. &&&a&Class@SS01.0&&&&&1:v&&&N. 2006JV.735&mcs&0&N&The Code and Standards specifies that when investment transactions are concerned:&members must always put their clients' and employer's interests before their own interests.&members' families who are clients must be treated separately from other clients.;members should not invest in securities owned by clients to avoid conflicts of interest.;transactions must be done, wherever practical, for members', clients' and employer's accounts at the same time, or trades allocated on a pro-rata basis.;&LOS: Reading 2-aClients' and employer's interests must always come first. However family members who are also clients should be given the same treatment as other clients. Members are permitted to make investments in securities held by clients (although IPOs and private equity investment can create conflicts).Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 61-68. &&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.736&mcs&0&N&Peter Amir is managing a small cap German equity fund and he has decided to sell the holding in Mercury Trading. The low liquidity of Mercury Trading's shares means that selling the fund's shares is likely to drive down the share price. He decides to sell his personal position ahead of the sale of the fund's shares. Amir is least likely to have violated the following CFA Institute Standards:&Standard II(B) Market Manipulation.&Standard III(B) Fair Dealing.;Standard III(A) Loyalty, Prudence, and Care. ;Standard II(A) Material Nonpublic Information.;&LOS: Reading 2-aClients should come first and the fund's transaction should be executed first so Standard III(B) Fair Dealing and Standard III(A), Loyalty, Prudence, and Care have been violated.Also Amir dealt on material nonpublic information for his own account since he knew the fund's sale order would move the share price, so Standard II(A), Material Nonpublic Information has been violated. Standard II(B), Market Manipulation has not been violated, the intention of the sale orders was not to manipulate market prices.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 49-55. &&&a&Class@SS01.2&&&&&1&N&0&N.N.N.N 2006JV.737&mcs&0&N&Joseph Marlot is a research analyst covering ABC Foods Corporation. His wife has a sizeable holding in ABC Foods shares. Merlot:&must disclose the ownership of the shares by a member of his immediate family.&must file a report with the SEC.;must sell the shares immediately.;does not need to disclose the fact since it is his wife, not Marlot himself, who owns the shares in ABC Foods.;&LOS: Reading 2-aThe share ownership could reasonably be expected to affect Marlot's ability to make unbiased and objective recommendations and therefore it should be disclosed.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 113-119. &&&a&Class@SS01.0&&&&&1&N&0&N.N.N.N 2006JV.738&mcs&0&N&Jeremy Horton, CFA, works in a small investment firm which specializes in managing portfolios investing in the European equity markets. For discretionary clients who require exposure to non-European markets Horton relies on an independent investment firm to research and make recommendations on which stocks to buy and sell. Which of the following is the most accurate?&Horton has not violated any of the CFA Institute Standards as long as he makes reasonable efforts to check the investment firm's research is objective and sound.&Horton has violated the CFA Institute Standards; he is plagiarizing the investment firm's research by using it for his own clients' accounts.;Horton has violated the CFA Institute Standards by not doing his own research and investigation into investments in the non-European markets ;Horton has violated the CFA Institute Standards; he can only use third-party research for advisory accounts where the client has an opportunity to reject the advice.;&LOS: Reading 2-aUsing a third party's research is only plagiarism if he repeats their research or recommendations without attributing it to the other firm. Horton is free to use third-party research if he has a reasonable basis for assuming the research is sound.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 99-103. &&&a&Class@SS01.2&&&&&1:v&&&N. 2006JV.739&mcs&0&N&We are given the following data on a frequency distribution.

Interval Frequency
0 up to 10 5
10 up to 20 8
20 up to 30 10
30 up to 40 3

Which of the following statements is FALSE?&The intervals will not include outlying observations.&An observation can only fall into one interval.;The relative frequency of the first class is 0.19. ;The cumulative relative frequency of the second class is 0.50.;&LOS: Reading 8-fAll observations will be included in one of the intervals.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 3, pp. 91-99.&&&a&Class@SS02.0&&&&&1:v&&& 2006JV.740&mcs&0&N&The ages of members of two football teams were analyzed. The first had an average (mean) age of 20 years with a standard deviation of 3 years. The second had an average age of 24 years with a standard deviation of 4 years. Which of the following is the most accurate?&The coefficient of variation of the first team is lower indicating that there is less variation in ages of the members.&The coefficient of variation of the first team is higher indicating that there is more variation in ages of the members.;The coefficient of variation of the first team is higher indicating that there is less variation in ages of the members.;The coefficient of variation of the first team is lower indicating that there is more variation in ages of the members.;&LOS: Reading 8-mThe coefficient of variation is:standard deviation/mean x 100 (in percentage terms) For the first team this is (3/20) x 100 = 15%For the second team this is (4/24) x 100 = 16.67%Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 3, pp. 139-140.&&&a&Class@SS02.1&&&&&1&N&0&N.N.N.N 2006JV.741&mcs&0&N&The forecast revenues from an oil well are:

end year 1 $5 million
end year 2 $8 million
end year 3 $9 million
end year 4 $3 million

Using a discount rate of 10% the present value of the oil well is closest to:&$19.97 million.&$18.15 million.;$21.96 million.;$29.24 million.;&LOS: Reading 6-e\Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 1, pp. 25-26.&&&a&Class@SS02.2&&&&&1:v&&& 2006JV.742&mcs&0&N&Which of the following statements is most accurate?&The level of significance is the probability of rejecting the null hypothesis when it is true. &The alternate hypothesis is the hypothesis being tested.;A Type II error is rejecting the null hypothesis when it is true.;The alternate hypothesis should always contain the equals sign. ;&LOS: Reading 12-bThe null hypothesis is the hypothesis being tested. A Type I error is rejecting the null hypothesis when it is true. The null hypothesis should always contain the equals sign.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 7, pp. 326-327.&&&a&Class@SS03.0&&&&&1&N&0&N.N.N.N 2006JV.743&mcs&0&N&An investor invests $5,000 at the beginning of each year for the next six years, if the investment earns 8% interest annually, the value of the investment at the end of six years will be closest to:&39616&32400;34560;38681;&LOS: Reading 6-eThis is an annuity type question.Future value of annuity due:\\Or use a financial calculator.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 1, pp. 13-21.&&&a&Class@SS02.1&&&&&1&N&0&N.N.N.N 2006JV.744&mcs&0&N&An analyst runs a linear regression on the annual rise in London house prices and the rise in the FTSE 100 index over the same year. The regression has an intercept of -3% and a slope of the regression line of 1.3. If the FTSE 100 index is forecast to rise by 15% this year what is this year's expected performance of London house prices?&16.5%.&11.1%.;15.6%.;22.5%.;&LOS: Reading 13-dThe expected performance is given by Y = a + b X = -3% + (1.3 x 15%) = 16.5%Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 8, pp. 395-398.&&&a&Class@SS03.2&&&&&1&N&0&N.N.N.N 2006JV.745&mcs&0&N&Which of the following statements about sample standard deviation is least accurate? Sample standard deviation is:&the arithmetic mean of the squared deviations from the mean.&always zero or a positive number.;in the same units as the original data.;an estimate of the population standard deviation.;&LOS: Reading 8-jCampbell R. Harvey's Finance GlossaryStandard Deviation The square root of the variance. A measure of dispersion of a set of data from its mean.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 3, pp. 129-135.&&&a&Class@SS02.0&&&&&1&N&0&N.N.N.N 2006JV.746&mcs&0&N&If a distribution is normal:&approximately 68% of the observations will lie between the mean plus or minus one standard deviation.&approximately 99.7% of the observations will lie between the mean plus or minus one standard deviation.;approximately 99.7% of the observations will lie between the mean plus or minus two standard deviations.;approximately 68% of the observations will lie between the mean plus or minus two standard deviations.;&LOS: Reading 8-n68% will lie between the mean plus or minus one standard deviation, 95% will lie between the mean plus or minus two standard deviations, 99.7% will lie between the mean plus or minus three standard deviations.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 3, pp. 144-145.&&&a&Class@SS02.1&&&&&1&N&0&N.N.N.N 2006JV.747&mcs&0&N&A normal distribution has a mean of 7 and a variance of 3, the z-value of an observation of 8 is closest to:&0.58.&0.33.;1.73.;3.00.;&LOS: Reading 10-o\\ this is the number of standard deviations of an observation above or below the mean.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 5, pp. 250-257.&&&a&Class@SS03.2&&&&&1&N&0&N.N.N.N 2006JV.748&mcs&0&N&Interest is compounded quarterly and $1 million is invested today and will be worth $1.2 million in one year's time. The annual interest rate is closest to:&18.64%.&17.82%. ;20.00%.;21.91%.;&LOS: Reading 6-cIf the annual rate is r, the quarterly rate is (r/4), and the number of periods is 4. \\Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 1, pp. 9-10.&&&a&Class@SS02.0&&&&&1&N&0&N.N.N.N 2006JV.749&mcs&0&N&A company is a clock manufacturer and the manager wishes to check that the average number of clocks produced has not fallen significantly below the mean of 100 clocks per day. The distribution is normal and the standard deviation is 5 clocks per day. If the manager looks at a sample of 100 days' production and finds that the mean production volume is 98, he should conclude that:&there is evidence that the production levels have declined at the .01 significance level.&the sample is not sufficiently large to arrive at a conclusion.;there is insufficient information provided to arrive at a conclusion.;there is no evidence that the production levels have not declined at the .01 significance level.;&LOS: Reading 12-gdefine H0 : the mean production is greater than or equal to 100 clocks per day.H1 : the mean production is less than 100 clocks per day This is a one-tailed test so the critical value of z at the .01 significance level is 2.33. If the computed z value lies outside these ranges reject the null hypothesis and accept the alternative. In this case z falls outside the range at the .01 significance level. Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 7, pp. 339-342.&&&a&Class@SS03.1&&&&&1&N&0&N.N.N.N 2006JV.750&mcs&0&N&The population is defined as high schools in a city; the number of students in a school is between 200 and 1,000 with a mean of 700 students. A sample of five schools is taken and the mean number of students in the sample is 750. The sampling error is:&50&-50;-10;10;&LOS: Reading 11-a\\Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 6, pp. 287.&&&a&Class@SS03.2&&&&&1&N&0&N.N.N.N 2006JV.751&mcs&0&N&The forecast rate of return for a portfolio has the following probability distribution:

Rate of ReturnProbability
-10.0% 0.10
0.0% 0.25
+10.5%0.50
+25.0% 0.15

The variance of the rate of return is closest to:&0.0095.&0.0760.;0.0974.;0.2760.;&LOS: Reading 9-m Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 4, pp. 194-96.&&&a&Class@SS02.0&&&&&1:v&&& 2006JV.752&mcs&0&N&There is a 30% chance of it raining on any given day and the chance of whether it rains or not is assumed to be the same each day, and independent of the previous day's weather. The probability, over four days, of it raining on exactly one day is closest to? &41.2%.&10.3%.;25.0%.;30.0%.;&LOS: Reading 10-hApply the Binomial Probability Distribution where we are solving for P(1).\\Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 5, pp. 236-242.&&&a&Class@SS03.1&&&&&1&N&0&N.N.N.N 2006JV.753&mcs&0&N&A Treasury bill has 170 days to maturity and is selling at $97,000 with a face value of $100,000. The bank discount yield is closest to:&6.35%.&1.14%.;1.42%.;2.05%.;&LOS: Reading 9-gThe yield on a bank discount basis is given by \\Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 2, pp. 72-74.&&&a&Class@SS02.2&&&&&1&N&0&N.N.N.N 2006JV.754&mcs&0&N&The following data is given on the number of people holding driving licenses:

Holding driving license Not Holding driving license
Age 60 and under 38 24
Age over 6010 12

What is the probability of randomly selecting a person over 60 who holds a driving license?&11.9%.&22.6%.;37.5%.;71.6%.;&LOS: Reading 9-gThe Rule of Multiplication for events, A and B, that are not mutually exclusive, is:P(A and B) = P(A)P(B|A) = (22/84) x (10/22) = 11.9%Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 4, pp. 185-186.&&&a&Class@SS02.0&&&&&1:v&&& 2006JV.755&mcs&0&N&The standard deviation of a population is 25 and the size of a sample taken from the population is 40. The standard error of the sample mean is closest to:&3.956.&0.125.;0.253.;0.625.;&LOS: Reading 11-e\\Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 6, pp. 291-295.&&&a&Class@SS03.1&&&&&1&N&0&N.N.N.N 2006JV.756&mcs&0&N&Large samples are taken from a normal population, the sample mean is 25 and the sample standard deviation is 5. The 95% confidence interval for the population mean is closest to:&between 15.2 and 34.8.&between 12.1 and 37.9.;between 20.0 and 30.0.;between 15.0 and 40.0.;&LOS: Reading 11-fThe 95% confidence interval is given by sample mean plus or minus 1.96 standard deviations. \\Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 6, pp. 297-303.&&&a&Class@SS03.2&&&&&1&N&0&N.N.N.N 2006JV.757&mcs&0&N&Which of the following is an automatic stabilizer in terms of stimulating demand in a recession?&Progressive income tax.&Increase in national defense spending.;Reduction in corporate profit tax rates.;Increase in government infrastructure spending.;&LOS: Reading 15-dAutomatic stabilizers stimulate demand during a recession and restrain demand during a inflationary boom without the government needing to change fiscal policy using legislation.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 12, pp. 277-278.&&&a&Class@SS04.0&&&&&1&N&0&N.N.N.N 2006JV.758&mcs&0&N&New classical economists believe that:&a reduction in marginal tax rates will not affect aggregate demand.&a reduction in marginal tax rates will lead to a decrease in aggregate demand.;a reduction in marginal tax rates will lead to an increase in aggregate demand.;a reduction in marginal tax rates will lead to either an increase or decrease in aggregate supply depending on whether the economy is in recession or not. ;&LOS: Reading 15-cNew classical economists believe that a reduction in tax rates will have little effect on demand since participants will increase their saving in anticipation of higher tax rates in the future.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 12, pp. 273-275.&&&a&Class@SS04.1&&&&&1&N&0&N.N.N.N 2006JV.759&mcs&0&N&If the price elasticity of demand for a product is relatively inelastic it means that:&price and total expenditures on the product will move in the same direction.&an increase in price does not lead to a reduction in the amount purchased.;total expenditure on the product will remain constant as the price changes.;a percent increase in price leads to a larger percent reduction in the amount purchased.;&LOS: Reading 19-cIf sales are inelastic the percent change in sales is less than the percent change in price so the price change will have a greater impact on total expenditures than the quantity change. This means that the price and total expenditures on the product will move in the same direction.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 19, pp. 464-467.&&&a&Class@SS05.2&&&&&1&N&0&N.N.N.N 2006JV.760&mcs&0&N&Economic profits:&take into account the opportunity costs of all resources used by a company.&take into consideration explicit costs only.;take into consideration implicit costs only.;are generally more than accounting profits.;&LOS: Reading 20-cAccounting profits do not take into consideration the implicit cost components (i.e. the opportunity cost of the resources used) whereas economic profits consider both explicit and implicit costs, therefore accounting profits are generally higher than economic profits.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 20, pp. 482-484.&&&a&Class@SS05.0&&&&&1&N&0&N.N.N.N 2006JV.761&mcs&0&N&The required reserve ratio has been reduced from 15% to 12% as part of the government's monetary policy. The potential deposit expansion multiplier is closest to:&8.33.&3.00.;12.00.;33.33.;&LOS: Reading 16-a The potential deposit expansion multiplier is 1/required reserve ratio which is 1/ 0.12 = 8.33.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 13, pp. 304-305.&&&a&Class@SS04.1&&&&&1&N&0&N.N.N.N 2006JV.762&mcs&0&N&A long period of rapid money supply growth will:&increase nominal interest rates and leave real interest rates unchanged.&have no impact on the economy.;expand real output and increase inflation.;expand real output and reduce unemployment.;&LOS: Reading 17-dThe first impact of rapid money supply growth will be to reduce real interest rates and stimulate aggregate demand. However over time buyers and providers of resources will adjust prices upwards so real wages and profit margins will be unchanged, leaving real output unchanged. The only long-term effect will be higher prices and higher nominal interest rates (since inflation is higher). Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 14, pp. 329-333.&&&a&Class@SS04.2&&&&&1&N&0&N.N.N.N 2006JV.763&mcs&0&N&In competitive price-searcher markets: &firms have downward-sloping demand curves.&there is little competition.;there are high entry barriers.;there is the potential for participants to make long-term economic profits.;&LOS: Reading 22-aCompetitive price-searcher markets are competitive with low entry barriers which means in the long-term firms will earn normal (zero economic) profits. Firms will have downward-sloping demand curves.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 22, pp. 526-529.&&&a&Class@SS05.0&&&&&1&N&0&N.N.N.N 2006JV.764&mcs&0&N&An oligopoly is all of the following EXCEPT:&a market where there is a single producer of a good for which there are no attractive substitutes.&a price-searcher market.;a market where there are high barriers to entry.;a market where there are often substantial economies of scale.;&LOS: Reading 23-bThis Answer Refers to a monopoly: A market where there is a single producer of a good for which there are no attractive substitutes.Oligopoly A Market characterized by a small number of producers who often act together to control the supply of a particular good and its market price. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 23, pp. 551-552.&&&a&Class@SS05.1&&&&&1&N&0&N.N.N.N 2006JV.765&mcs&0&N&Which of the following is least likely to be a factor that creates entry barriers to an industry?&oligopolies.&patents.;government licensing.;regulations that limit access to an industry.;&LOS: Reading 23-aThe four important factors are economies of scale, government licensing, patents and control over essential resources.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 23, pp. 546-547.&&&a&Class@SS05.2&&&&&1&N&0&N.N.N.N 2006JV.766&mcs&0&N&When firms are price takers the market supply curve will:&slope upwards to the right in the short run, and the direction of the slope in the long run will depend on the industry.&slope upwards to the right in the short run, and be horizontal in the long run.;slope downwards to the right in the short run, and be horizontal in the long run.;slope downwards to the right in the short run, and the direction of the slope in the long run will depend on the industry.;&LOS: Reading 21-fFirms will increase supply if the price rises so the supply curve slopes upwards to the right. The long run supply curve will slope upwards to the right in increasing-cost industries, downwards to the right in decreasing-cost industries, and be horizontal in constant-cost industries.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 21, pp. 512-519.&&&a&Class@SS05.0&&&&&1&N&0&N.N.N.N 2006JV.767&mcs&0&N&One year interest rates in the US are 6% and in Switzerland are 4% and the spot rate is SFR/US$ = 1.71. If interest rate parity holds then the SFR/US$ forward rate is closest to:&1.68.&1.55.;1.74.;1.89. ;&LOS: Reading 27-g\\This means that if you hold US$, earning a higher rate of interest, you will get less SFR in a forward transaction compared with a spot transaction.Reference: Solnik and McLeavey, International Investments, 5th edition, Ch. 1, pp. 16-21.&&&a&Class@SS06.1&&&&&1&N&0&N.N.N.N 2006JV.768&mcs&0&N&An unanticipated shift to a more restrictive monetary policy under a flexible exchange rate system would be least likely to lead to: &an increase in the current account surplus (or decrease in the deficit). &a capital inflow.;a rise in real interest rates.;an appreciation in the exchange rate.;&LOS: Reading 28-dA contraction in money supply will reduce demand, dampen inflation and increase real interest rates. This will encourage capital inflow which will lead to an appreciation in the currency. Lower demand will decrease imports which will lead to a higher current account surplus but the capital inflow will take place more quickly. The capital inflow leads to a rise in the capital account and therefore a decline in the current account. Reference: Solnik and McLeavey, International Investments, 5th edition, Ch. 2, pp. 38-41.&&&a&Class@SS06.2&&&&&1&N&0&N.N.N.N 2006JV.769&mcs&0&N&Which of the following statements is CORRECT with respect to tariffs and import quotas on a product?&Both quotas and tariffs benefit domestic producers of the product.&The government benefits from both tariffs and quotas.;Tariffs do not affect consumers but quotas mean that consumers will be paying too high a price for the product.;Quotas do not affect consumers but tariffs mean that consumers will be paying too high a price for the product.;&LOS: Reading 26-cDomestic producers, in both cases, will be able to expand output and sell at a higher price. In the case of tariffs the government will gain extra revenue from the tariff, in the case of quotas the overseas producers will be able to sell a small amount of the product at a high price. In both cases the consumer will pay a higher price for the product.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 17, pp. 408-410.&&&a&Class@SS06.0&&&&&1&N&0&N.N.N.N 2006JV.770&mcs&0&N&Real GDP (gross domestic product) growth has been averaging 3.0% per annum over the last three years, but interest rates have been rising steadily. A supporter of the adaptive-expectations hypothesis believes that: &GDP will grow by 3% next year since the best indicator of the future is recent data. &forecasts of future economic data are never accurate.;interest rate rises mean that GDP growth is likely to be less than 3% next year.;the consensus of economic decision makers' forecasts will be the best indicator of future GDP growth.;&LOS: Reading 18-cUnder adaptive expectations forecasters will expect GDP growth during recent periods to be repeated. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 15, pp. 356-358.&&&a&Class@SS04.1&&&&&1&N&0&N.N.N.N 2006JV.771&mcs&0&N&A deferred tax liability should be: &treated as an addition to stockholders' equity if the temporary differences giving rise to the liability are unlikely to reverse.&treated as an addition to stockholders' equity if the temporary differences giving rise to the liability are likely to reverse.;treated as a deduction from stockholders' equity if the temporary differences giving rise to the liability are likely to reverse.;treated as a deduction from stockholders' equity if the temporary differences giving rise to the liability are unlikely to reverse.;&LOS: Reading 42-aIf a deferred tax liability is unlikely to be paid the associated tax expense, from an analyst's viewpoint, should not have been deducted as an expense. This would have increased net income and stockholders' equity.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 9, pp. 304-306. &&&a&Class@SS10.2&&&&&1&N&0&N.N.N.N 2006JV.772&mcs&0&N&Minimum liabilities for an underfunded pension plan appear in the balance sheet, using U.S. GAAP, as:&stockholders' equity.&an asset.;a liability.;an item between liabilities and stockholders' equity.;&LOS: Reading 31-fLiabilities related to an underfunded pension plan are now recorded in stockholders' equity.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 2, p. 66. &&&a&Class@SS07.0&&&&&1&N&0&N.N.N.N 2006JV.773&mcs&0&N&If a company declares and pays a dividend of $10 million, and pays interest of $25 million it will, under U.S. GAAP, &decrease the financing cash flow by $10 million and decrease the operating cash flow by $25 million.&decrease the financing cash flow by $35 million.;decrease the investing cash flow by $10 million and decrease the financing cash flow by $25 million.;decrease the financing cash flow by $10 million and decrease the investing cash flow by $25 million.;&LOS: Reading 33-fPayment of dividends is included in financing cash flow. Interest payments are an operating cash flow.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 3, pp. 78-79.&&&a&Class@SS07.1&&&&&1&N&0&N.N.N.N 2006JV.774&mcs&0&N&A provision for environmental remediation would normally be classed under U.S. GAAP as: &an unusual or infrequent item.&an operating expense.;an extraordinary item.;an adjunct account item.;&LOS: Reading 31-cA provision for environmental remediation is usually classed as a nonrecurring item. Extraordinary items must be both unusual in nature and infrequent in occurrence (as well as being material). Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 2, pp. 52-56.&&&a&Class@SS07.2&&&&&1&N&0&N.N.N.N 2006JV.775&mcs&0&N&A firm is using the percentage-of-completion method rather than the completed contract method to account for a major construction project that they are working on. Until the contract is completed this will have the following impact on its financial statements:&increase stockholders' equity.&increase liabilities.;reduce total assets.;increase cash flows.;&LOS: Reading 31-cThe percentage-of-completion method recognizes revenues and costs in proportion to the percentage of work completed, income is higher throughout the project and liabilities will be lower as income is a larger offsetting item. Cash flow under both methods will be the same.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 2, pp. 40-44. &&&a&Class@SS07.0&&&&&1&N&0&N.N.N.N 2006JV.776&mcs&0&N&Walton Publishing Inc., uses U.S. GAAP and has announced the following financial data:

$ million
Cash payment for salaries 30
Rent expense 6
Purchase of equipment 10
Repurchase of common stock 12
Cash collection from customers 85
Cash payment to suppliers 40
Depreciation expense 10
Sale of land 6

Cash flows from operating and investing activities are:&$9 million from operating, ($4 million) from investing.&$19 million from operating, ($4 million) from investing.;$15 million from operating, ($16 million) from investing. ;$19 million from operating, ($10 million) from investing.;&LOS: Reading 33-a\\Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 3, pp. 75-82. &&&a&Class@SS07.1&&&&&1:v&&& 2006JV.777&mcs&0&N&If a company makes write downs due to impairments of long-lived assets this will:&decrease deferred tax liabilities and increase the total asset turnover.&increase deferred tax liabilities and increase the total asset turnover.;increase deferred tax liabilities and decrease the total asset turnover.;decrease deferred tax liabilities and decrease the total asset turnover.;&LOS: Reading 41-cImpairment losses are not recognized for tax purposes until the asset is disposed of and therefore deferred tax will be reduced. Impairment write downs will lead to reduction in asset values and therefore an increase in the total asset turnover.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 8, pp. 277-278. &&&a&Class@SS09.2&&&&&1&N&0&N.N.N.N 2006JV.778&mcs&0&N&A company enters into a 6-year lease agreement to lease a machine; the machine has a fair value of $100,000. The agreement specifies that: 1. The economic life of the machine is estimated to be ten years. 2. The lessee will pay lease payments that have a present value of $80,000. 3. The lessee has no rights to purchase or receive the machine at the end of the lease period.The lease should be classified by the lessee as: &an operating lease since none of the requirements for it to be treated as a capital lease have been met.&a capital lease since the lease term is greater than 50% of the economic life of the machine.;a capital lease since the lessee will benefit from the use of the machine for more than 5 years. ;a capital lease since the present value of the lease payments is more than 75% of the fair value of the machine.;&LOS: Reading 44-aA lease meeting any of the following conditions must be treated as a capital lease.1. Terms for transfer or purchase of ownership.2. Lease term equal to or more than 75% of the economic life.3. Present value of lease payments equal to or more than 90% of the fair value. Since none of these are met it should be treated as an operating lease.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 11, p. 367.&&&a&Class@SS10.0&&&&&1&N&0&N.N.N.N 2006JV.779&mcs&0&N&A company enters into a lease agreement to make lease payments of $5,000 at the end of each year for the next three years. It is treated as a capital lease and the discount rate used is 8%. The asset is depreciated using the straight-line method. The principal repayment in the first year will be closest to?&3969&1031;3800;5325;&LOS: Reading 44-b The present value of the lease is $12,885. The interest expense in the first year will be 8% of $12,885 which is $1,031. Deduct this from the lease payment of $5,000 to arrive at the principal repayment of $3,969.Depreciation is only included if calculating the total expense. Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 11, pp. 368-371.&&&a&Class@SS10.1&&&&&1&N&0&N.N.N.N 2006JV.780&mcs&0&N&The following financial information is given for a company:

Net profit margin= 6%
Operating profit margin = 15%
Financial leverage multiplier = 1.6
Total asset turnover = 2.5
Tax retention rate = 0.65

The return on equity is closest to: &24.0%.&2.3%.;39.0%.;there is insufficient information given to calculate the return on equity.;&LOS: Reading 35-creturn on equity = net profit margin x total asset turnover x financial leverage= 0.06 x 2.5 x 1.6 = 24.0%Campbell R. Harvey'sFinance GlossaryReturn on equity Indicator of profitability. Determined by dividing net income for the past 12 months by common_stock stockholder equity (adjusted for stock_split). Result is shown as a percentage. Investors use ROE as a measure of how a company is using its money. ROE may be decomposed into return on assets (ROA) multiplied by financial leverage (total assets /total equity). Net profit margin Net income divided by sales ; the amount of each sales dollar left over after all expenses have been paid. Total asset turnover The ratio of net sales to total assets. Financial leverage Use of debt to increase the expected return on equity. Financial leverage is measured by the ratio of debt to debt plus equity. Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 10, pp. 334-337.&&&a&Class@SS08.2&&&&&1&N&0&N.N.N.N 2006JV.781&mcs&0&N&Which of the following is NOT an example of financial shenanigans which would inflate current period net income? &writing off merger costs as special charges.&extending the amortization period for goodwill.;capitalizing rather then expensing marketing costs.;moving to percentage of completion method to account for products that have not been delivered to the client.;&LOS: Reading 37-aWriting off merger costs as special charges would not increase current period income.Reference: Howard Schilit (McGraw-Hill, 2002), Financial Shenanigans, "Searching for Shenanigans", 2nd edition, Ch. 2, pp. 24-27 &&&a&Class@SS08.0&&&&&1&N&0&N.N.N.N 2006JV.782&mcs&0&N&Which of the following is an example of off-balance-sheet financing?&take-or-pay contracts.&capital leases.;zero coupon bonds.;consolidated finance companies.;&LOS: Reading 44-dOnly take-or-pay contracts are an example of off-balance-sheet financing. A take-or-pay contract is off-balance-sheet financing when a firm enters into a long-term commitment through the contract but does not record any resulting liabilities on the balance sheet.Campbell R. Harvey'sFinance GlossaryOff-balance-sheet financing Financing that is not shown as a liability on a company's balance sheet. Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 11, pp. 376-383.&&&a&Class@SS10.1&&&&&1&N&0&N.N.N.N 2006JV.783&mcs&0&N&Islington Inc.'s breakdown of current assets and liabilities is as follows:

The quick ratio is closest to: &1.07.&0.17.;1.25.;1.67.;&LOS: Reading 35-bQuick ratio = (cash + marketable securities + receivables)/ current liabilities = 445/415 = 1.07Campbell R. Harvey'sFinance GlossaryQuick ratio Indicator of a company's financial strength (or weakness). Calculated by taking current assets less inventories, divided by current liabilities. This ratio provides information regarding the firm's liquidity and ability to meet its obligations. Also called the Acid test ratio. Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 10, pp. 323-324. &&&a&Class@SS08.2&&&&&1&N&0&N.N.N.N 2006JV.784&mcs&0&N&Islington Inc.'s cash ratio is closest to (use data in question 63): &0.17.&0.06.;0.71.;1.07.;&LOS: Reading 35-bCash ratio = (cash + marketable securities)/ current liabilities = 70/415 = 0.17Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 10, p. 324. &&&a&Class@SS08.0&&&&&1&N&0&N.N.N.N 2006JV.785&mcs&0&N&A company builds new operating facilities and pays for the construction with new borrowings. Under U.S. accounting rules the firm should: &capitalize the interest costs of the new borrowing.&expense the interest costs associated with the borrowing.;expense or capitalize the costs associated with the new borrowing depending on the company's internal policy.;capitalize the costs associated with the borrowing using an interest rate that is the company's average cost of debt.;&LOS: Reading 40-aWhen specific borrowing can be identified to pay for the building work then the interest costs of that borrowing should be capitalized. (If no specific borrowing use the average interest cost of debt).Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 7, pp. 233-235. &&&a&Class@SS09.1&&&&&1&N&0&N.N.N.N 2006JV.786&mcs&0&N&A company buys a piece of machinery for $100,000 and it estimates the life of the machine to be four years after which it will have a salvage value of $10,000. Using the double-declining-balance method of depreciation what will be the depreciation charge in the fourth year?&2500&5625;6250;18000;&LOS: Reading 41-aDepreciation expense will be:Year 1 1/2 x ($100,000) = $50,000Year 2 1/2 x ($100,000) - $50,000) = $25,000Year 3 1/2 x ($100,000) - $75,000) = $12,500Year 4 1/2 x ($100,000) - $87,500) = $6,250 but this is reduced to $2,500 since at this point the value of the machinery has reached its salvage value.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 8, pp. 260-262. &&&a&Class@SS09.2&&&&&1&N&0&N.N.N.N 2006JV.787&mcs&0&N&A company's net annual sales for a period were $15 million and receivables at the beginning of the year were $1.2 million and at the end of the year were $1.5 million. The average receivables collection period was closest to:&32.85 days.&11.11 days.;32.40 days.;36.50 days.;&LOS: Reading 35-b\\Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 10, pp. 324-327. &&&a&Class@SS08.0&&&&&1&N&0&N.N.N.N 2006JV.788&mcs&0&N&Deferred income tax expense is:&III. an accrual of income tax expense expected to be paid in future years.&I. taxes payable less income tax expense.;II. a tax return liability resulting from current period taxable income.;IV. a balance sheet amount representing expected future cash outflows to pay income tax.;&LOS: Reading 42-aI. is not correct, deferred income tax expense is income tax expense less taxes payable.II. is the deferred tax liability.IV. is the taxes payable.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 9, p. 292. &&&a&Class@SS10.1&&&&&1&N&0&N.N.N.N 2006JV.789&mcs&0&N&If a firm has earnings per share of $2.20, a dividend pay out ratio of 30%, return on capital of 12% and return on equity of 10%, the sustainable potential growth rate is: &7.0%.&3.0%.;8.4%.;15.4%.;&LOS: Reading 35-bThe sustainable growth rate = earnings retention rate x ROE = 0.70 x 0.10 = 7.0%Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 10, pp. 348-350. &&&a&Class@SS08.2&&&&&1&N&0&N.N.N.N 2006JV.790&mcs&0&N&The bird-in-the-hand theory with respect to dividend policy states that:&investors prefer to receive dividends since a payment in the near term is less risky than the possibility of a capital gain in the future.&a company should retain dividends to increase its growth rate.;investors prefer the certainty of a lower tax rate on capital gains than the higher tax rate on income.;a company should retain earnings since it will help avoid having to raise capital externally for expansion.;&LOS: Reading 51-bThe bird-in-the-hand theory says that investors prefer to receive money today rather than uncertain payments in the future.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th edition, Ch. 14, pp. 542-544. &&&a&Class@SS11.0&&&&&1&N&0&N.N.N.N 2006JV.791&mcs&0&N&When calculating cash flows for capital budgeting analysis:&opportunity costs should be included.&sunk costs should be included.;gross interest payments should be included since the cost of capital includes the cost of debt.;interest payments net of tax should be included since the cost of capital includes the after-tax cost of debt.;&LOS: Reading 48-a Sunk costs should not be included since they are not an incremental cash flow. The weighted cost of capital includes the cost of debt so the cash flow available for bond and equity holders should be used i.e. before interest payments.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th edition, Ch. 11, pp. 425-427. &&&a&Class@SS11.1&&&&&1&N&0&N.N.N.N 2006JV.792&mcs&0&N&Computer Retailers Inc. provided the following data regarding its scanner purchases and sales over the year.

1st January Beginning inventory of 120 scanners at cost of $70 each.
1st MarchPurchase of 500 scanners at cost of $65 each.
1st SeptemberPurchase of 200 scanners at cost of $60 each.
31st DecemberEnding inventory of 200 scanners.

Which of the following statements is CORRECT regarding the use of LIFO or FIFO to account for inventories over the year? &The COGS is lower under LIFO than FIFO.&The net income is lower under LIFO than FIFO.;The ending inventory under LIFO is $13,600 which is lower than under FIFO.;The ending inventory under LIFO is $12,000, which is higher than under FIFO.;&LOS: Reading 39-aUnder LIFO the ending inventory 200 scanners, 120 @ $70 and 80 @ $65 = $13,600. This is higher than under FIFO ($12,000). Since the prices of scanners are falling the COGS will be lower under LIFO and net income will be higher. Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 6, pp. 193-195. &&&a&Class@SS09.2&&&&&1:v&&& 2006JV.793&mcs&0&N&Which of the following statements is most accurate regarding the straight-line depreciation method?&III. It is the most frequently used method of depreciating assets in the U.S. &I. It depreciates assets in proportion to their use.;II. It compensates for the rising repair costs as an asset ages.;IV. It is often used to reduce the tax burden immediately after an asset is purchased.;&LOS: Reading 41-aI. refers to the units of production method. II. and IV. refer to accelerated depreciation methods. Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 8, pp. 259-260. &&&a&Class@SS09.0&&&&&1&N&0&N.N.N.N 2006JV.794&mcs&0&N&In a sales-type lease the sales revenue reported at the beginning of the lease on the lessor's financial statements is:&the present value of the lease payments. &the sum of the lease payments.;there is no sales revenue reported.;the present value of the lease payments plus the present value of the residual value.;&LOS: Reading 44-eThe sales revenue reported at the beginning of the lease on the lessor's financial statements isthe present value of payments they will receive from the lease agreement.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 11, pp. 387-390. &&&a&Class@SS10.1&&&&&1&N&0&N.N.N.N 2006JV.795&mcs&0&N&Burwood Company has a common stock price of $30.00. The current reported earnings per share are $2.00 and dividends per share are $0.80. The return on equity is 12%. The company is considering raising funds through an equity issue, if issuing costs are 3% the cost of new equity will be closest to:&10.15%.&2.95%.;9.87%.;10.06%.;&LOS: Reading 46-bThe growth rate is the earnings retention rate multiplied by the ROE, this is 7.2%.Next year's dividends will be $0.80 x 1.072 = $0.858\\Reference: Brigham and Houston, Fundamentals of Financial Management, 8th edition, Ch. 9, pp. 360-362. &&&a&Class@SS11.2&&&&&1&N&0&N.N.N.N 2006JV.796&mcs&0&N&The managers of a company are reviewing a project that will cost $12 million. The cash flows from the project will be $5 million at the end of the first year and $10 million at the end of the second year. Thereafter the company may not have similar projects available to invest in. The cost of capital is 10%. The managers should&accept the project since the net present value is positive.&reject the project since the net present value is negative.;accept the project since the internal rate of return is above the cost of capital. ;reject the project since the internal rate of return is below the cost of capital.;&LOS: Reading 47-aIn this example we cannot apply the IRR method since the question indicates that cash flows will not be able to be reinvested in similar projects with the same IRR. The NPV method gives \\or use a financial calculator.This is positive so the project should be accepted.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th edition, Ch. 10, pp. 405-407. &&&a&Class@SS11.0&&&&&1&N&0&N.N.N.N 2006JV.797&mcs&0&N&A company had 500,000 common shares and $3,000,000 of a 6% convertible bond issue which was outstanding throughout the last accounting period. The convertible bond is convertible into 20 shares per $1,000. If the company's net income was $5,000,000 and the tax rate was 30%, the diluted earnings per share were closest to:&$9.15.&$8.93.;$10.00.;$10.25.;&LOS: Reading 36-dDiluted earnings per share \\If no dilution earnings per share would be $10.00Reference: Kieso, Weygandt, Warfield, Dilutive Securities and Earnings per Share, Intermediate Accounting, 11th edition, Ch. 16, pp. 794-796.&&&a&Class@SS08.2&&&&&1&N&0&N.N.N.N 2006JV.798&mcs&0&N&If a company has a very high net fixed asset turnover compared to its competitors this could be explained by:&I. the company is using older, and in many cases fully depreciated, machinery. &II. the company has too much capital invested in assets for the size of its revenue.;III. the company has bought a large amount of new machinery to support future growth.;IV. the company uses capital leases rather than operating leases for all of its machinery. ;&LOS: Reading 35-ctotal fixed asset turnover = net sales / average net fixed assets II. and III. are not correct since they would imply that too many assets are being used.IV. is not correct since it would imply that the asset value was potentially higher than its competitors.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 10, pp. 327-328. &&&a&Class@SS08.1&&&&&1&N&0&N.N.N.N 2006JV.799&mcs&0&N&When a bond issuer makes a coupon payment for a bond that was issued at a discount it will:&overstate cash flow from operations and understate financing cash flows.&understate cash flow from operations and overstate financing cash flows.;overstate cash flow from operations and understate investing cash flows.;understate cash flow from operations and overstate investing cash flows.;&LOS: Reading 43-aThe coupon payment will be counted as a cash flow from operations although it can be argued that the interest component should be seen as a larger cash outflow from operations and the increase in principal as a financing cash flow inflow.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 10, pp. 328-329. &&&a&Class@SS10.0&&&&&1&N&0&N.N.N.N 2006JV.800&mcs&0&N&As a company increases its financial leverage:&expected earnings per share will initially increase and then, when the debt levels have reached a certain level, expected earnings per share will start to decline.&expected earnings per share will increase since debt is cheaper than equity.;expected earnings per share will decrease as the company's risk has increased.;expected earnings per share will be the same regardless of whether debt or equity financing is used.;&LOS: Reading 50-dAs the financial leverage increases then the risk to both debt holders and equity investors will increase. This will mean that the interest rate that the company needs to pay on its debt will rise and the required rate of return of equity investors will also increase. Initially increasing the financial leverage will increase the expected earnings per share but at some point the cost of capital will increase so that earnings per share start to decline.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th edition, Ch. 13, pp. 504-508. &&&a&Class@SS11.2&&&&&1&N&0&N.N.N.N 2006JV.801&mcs&0&N&Which of the following statements is most accurate regarding the earnings number used in the price to earnings measure?&Normalized earnings will be lower than current earnings for a company that is at the peak of its business cycle.&Earnings are one of the most stable accounting numbers over time.;Earnings are less subject to manipulation than other financial accounting numbers.;It is important to use an earnings number that includes both recurring and nonrecurring earnings.;&LOS: Reading 61-aCumulative numbers such as book values tend to be the most stable. Cash flows are generally regarded as least subject to manipulation.Nonrecurring earnings should not be included since they do not reflect the underlying earnings of the company. Reference: John D. Stowe, Thomas R. Robinson, Jerald E. Pinto, and Dennis W. McLeavey (AIMR, 2003), "Introduction to Price Multiples," pp. 7-14. &&&a&Class@SS13.0&&&&&1&N&0&N.N.N.N 2006JV.802&mcs&0&N&An index is constructed using the unweighted geometric mean of the holding period returns of the constituents of the index. This means that:&an investor with equal dollar amounts invested in each stock in the index will outperform the index in a rising market. &price movements of a stock with a high price will be more important than movements of a stock with a low price.;an investor with equal dollar amounts invested in each stock in the index will see the value of the shares move exactly in line with the index.;price movements of a stock with a large market capitalization will be more important than movements of a stock with a small market capitalization.;&LOS: Reading 53-aThe geometric mean will be less than the arithmetic mean (or equal if each share moves by an identical amount in each time period) in a rising market.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 5, pp. 155-156. &&&a&Class@SS12.2&&&&&1&N&0&N.N.N.N 2006JV.803&mcs&0&N&Which of the following is least likely to be traded on the U.S. over-the-counter market?&Shares being traded on the fourth market.&Shares which are listed on an exchange.;Shares which are not listed on an exchange.;Shares that are quoted on the NASDAQ National Market System.;&LOS: Reading 52-dThe OTC market includes the trading of all shares that are not listed on an exchange and also includes the third market, which is trading of listed shares outside an exchange. It includes shares traded on the NASDAQ National Market System (NMS), on the NASDAQ system outside NMS and outside NASDAQ. The fourth market is trading directly between two institutions or investors without using a broker or dealer, so B is the correct answer.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 4, pp. 120-124.&&&a&Class@SS12.0&&&&&1&N&0&N.N.N.N 2006JV.804&mcs&0&N&On a U.S. exchange, specialists are: &IV. members who buy and sell shares on their own account as well as acting as broker to other members.&I. employees of a stock exchange who act as brokers to other members.;II. employees of a member firm who buy and sell shares for the firm's clients.;III. employees of a stock exchange who are responsible for stabilizing stock prices. ;&LOS: Reading 52-dII. refers to commission brokers.I. and III. are not correct since they are members rather than employees of a stock exchange.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 4, pp. 131-132. &&&a&Class@SS12.1&&&&&1&N&0&N.N.N.N 2006JV.805&mcs&0&N&The implication of liquidity preference theory is that:&the yield curve tends to be upward sloping reflecting investors' preference for shorter-term maturities.&an on-the-run issue tends to have a lower yield than an off-the-run bond issue. ;the yield curve tends to be downward sloping when investors expect the inflation rate to decline.;the yield curve tends to be upward sloping when pension funds actively increase the duration of their portfolios.;&LOS: Reading 65-bThe liquidity preference theory asserts that investors require compensation for holding long-term bonds. Therefore the yields for longer-term bonds should be progressively higher as their maturities lengthen. "Liquidity" here refers to interest rate risk, the more the interest rate risk, the less the liquidity. Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst® Program, 2nd edition, Ch. 4, pp. 100-102.&&&a&Class@SS14.2&&&&&1&N&0&N.N.N.N 2006JV.806&mcs&0&N&A call option on a stock has a strike price of $30.00, the stock is trading at $34.00 and the price of the call option is $5.00. The option is:&$4.00 in-the-money.&$1.00 out-of-the-money. ;$4.00 out-of-the-money. ;$9.00 out-of-the-money.;&LOS: Reading 72-bThe call option is in-the-money since the strike price is below the stock price, and the difference between the two prices is $4.Reference: Chance, Analysis of Derivatives for the CFA(r) Program, (AIMR, 2003), Ch. 5, pp. 164.&&&a&Class@SS16.0&&&&&1&N&0&N.N.N.N 2006JV.807&mcs&0&N&Which of the following combination of factors will tend to lead to the highest price of a call option?&A low strike price, high volatility and a long time to expiry.&A low strike price, low volatility and low interest rates.;A high strike price, low volatility and a short time to expiry.;A low strike price, high interest rates and a short time to expiry.;&LOS: Reading 72-k, o and pThe profit on a call option will be determined by the difference between the stock price and the strike price, the lower the strike price the higher the potential profit. A longer time to expiry gives the holder a longer period in which the shares can move above the strike price so the option will be worth more. High volatility and high interest rates also increase the value of call options.Reference: Chance, Analysis of Derivatives for the CFA(r) Program, (AIMR, 2003), Ch. 7, pp. 418-425.&&&a&Class@SS16.1&&&&&1&N&0&N.N.N.N 2006JV.808&mcs&0&N&A palm oil plantation owner wishes to protect himself against a fall in the price of palm oil. To do this he could:&I. sell forward contracts for palm oil.&II. buy forward contracts for palm oil. ;III. sell call options giving the right to buy palm oil.;IV. buy call options giving the right to buy palm oil.;&LOS: Reading 70-aII. is not correct since buying more palm oil will increase the loss if the palm oil price falls.III. is correct to the extent that if the price falls he will keep the premiums, but the returns will not be dependant on the size of the fall in the palm oil price.IV. is not correct, he is concerned about a price fall and a call option will only have value if the price rises.Reference: Chance, Analysis of Derivatives for the CFA(r) Program, (AIMR, 2003), Ch. 2, p. 32.&&&a&Class@SS16.1&&&&&1&N&0&N.N.N.N 2006JV.809&mcs&0&N&A firm enters into a plain vanilla interest rate swap agreement to receive a fixed rate of 6%, and pay 1 year LIBOR. Semi-annual payments will be made in arrears. The swap covers a ten year period and is based on a notional principal of $100 million. The 1 year LIBOR rate at the time of agreement is 6.5%, at the end of six months is 7%, and at the end of the first year is 7.5%. The net payment that the firm receiving the floating-rate payments receives/pays at the end of the first year is closest to: &pays $0.50 million.&pays $0.75 million.;receives $0.75 million.;receives $0.50 million.;&LOS: Reading 73-cThe payment is $100 million x (7% - 6%)(180/360) = $0.5 million.If a 365 day year had been used, the closest answer remains $0.5 million.Reference: Chance, Analysis of Derivatives for the CFA(r) Program, (AIMR, 2003), Ch. 5, pp. 278-285.&&&a&Class@SS16.2&&&&&1&N&0&N.N.N.N 2006JV.810&mcs&0&N&An investor deposits an initial margin of $100,000 for a futures trade and the first day he loses $5,000 on the trade, the next day he loses a further $20,000. If the maintenance margin is $80,000 then:&he will receive a margin call on the second day to pay a variation margin of $25,000.&there is no requirement on either day to pay a variation margin.;he will receive a margin call on the second day to pay a variation margin of $5,000.;he will receive margin calls on the first day to pay a variation margin of $5,000 and on the second day to pay a variation margin of $20,000.;&LOS: Reading 71-eA variation margin must be paid if the investor's equity falls to below the maintenance margin requirement and he must bring the equity in his account back to the initial level. In this case the equity falls to below $80,000 on the second day so he must make up the difference of $25,000 in variation margin.Reference: Chance, Analysis of Derivatives for the CFA(r) Program, (AIMR, 2003), Ch. 4, pp. 86-90.&&&a&Class@SS16.0&&&&&1&N&0&N.N.N.N 2006JV.811&mcs&0&N&A trader writes a European put option on a stock, the stock's current price is $75, the option premium is $6 and the exercise price is $74. At the expiration of the option the stock price is $65. The profit/loss of the option writer is: &loss of $3.&loss of $9.;profit of $3.;profit of $9.;&LOS: Reading 72-eThe writer has received the premium of $6, but the loss when the option is exercised is $9 ($74 minus $65) giving an overall loss of $3.Reference: Chance, Analysis of Derivatives for the CFA(r) Program, (AIMR, 2003), Ch. 4, pp. 176-178.&&&a&Class@SS16.1&&&&&1&N&0&N.N.N.N 2006JV.812&mcs&0&N&The clearinghouse of a futures exchange is least likely to do which of the following? &acts as market maker in futures contracts traded on the exchange.&accepts margin deposits from members.;acts as counterparty to each transaction on the exchange.;makes margin calls to members holding futures positions.;&LOS: Reading 69-bThe clearinghouse does not intentionally take positions in futures or act as market maker. Reference: Chance, Analysis of Derivatives for the CFA(r) Program, (AIMR, 2003), Ch. 1, pp. 4-5.&&&a&Class@SS16.2&&&&&1&N&0&N.N.N.N 2006JV.813&mcs&0&N&A company has a dividend retention ratio of 60%, dividends are expected to grow by 3% per annum and the investors' required rate of return is 8%. The price earnings ratio is: &8.0.&5.0.;12.0.;12.5.;&LOS: Reading 55-cP/E = D/[E(k - g)] = 0.4/(0.08 - 0.03) = 8.0Reference: Chance, Analysis of Derivatives for the CFA(r) Program, (AIMR, 2003), Ch. 11, pp. 388-391.&&&a&Class@SS13.0&&&&&1&N&0&N.N.N.N 2006JV.814&mcs&0&N&The Herfindahl index measures: &industry concentration. &profitability of an industry.;market share of the industry leader. ;number of companies in an industry.;&LOS: Reading 58-dThe Herfindahl index measures the industry concentration, it is the sum of the squares of the market shares of all the firms in the industry. Reference: International Investments, Solnik and McLeavey, 5th edition, Ch. 6, pp. 265-266.&&&a&Class@SS13.1&&&&&1&N&0&N.N.N.N 2006JV.815&mcs&0&N&Which stage of the industry life cycle is characterized by the following? 'Sales growth is not accelerating but is higher than the growth rate of the economy; profitability is stabilizing as competitors enter the industry'.&Mature growth. &Decline.;Market maturity.;Rapid accelerating growth.;&LOS: Reading 58-cMature growth is the third stage in the industry life cycle. Sales growth rates are slowing but are still higher than GDP growth and competition has intensified putting pressure on margins. Reference: International Investments, Solnik and McLeavey, 5th edition, Ch. 6, pp. 264-265.&&&a&Class@SS13.2&&&&&1&N&0&N.N.N.N 2006JV.816&mcs&0&N&An analyst forecasts that a company will pay a dividend of $3.50 for the next three years and dividends will grow at 4% thereafter. If investors' required rate of return is 8%, the value of the company is closest to: &$81.26.&$64.19.;$66.40.;$67.88.;&LOS: Reading 55-cDiscount back the first three years dividends at 8% to get $3.24, $3.00 and $2.78.Thereafter apply the DDM to give value of the shares at the end of the third year as 3.50(1.04)/(0.08 - 0.04) = $91 which discounts back to $72.24.The value of the company = $3.24 + $3.00 + $2.78 + $72.24 = $81.26Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 11, pp. 382-384.&&&a&Class@SS13.0&&&&&1&N&0&N.N.N.N 2006JV.817&mcs&0&N&The price paid to purchase shares in an open-end investment company is best described as:&the net asset value of the shares plus the sales charge.&a discount to the net asset value of the shares.;a premium to the net asset value of the shares.;the net asset value of the shares less the sales charge.;&LOS: Reading 75-aAn open-end fund trades at the net asset value per share, plus buyers pay a front-end load or sales charge on purchases and/or a redemption fee on sale. A closed-end fund trades at a discount or premium to net asset value.Reference: Solnik and McLeavey, International Investments, 5th edition Ch. 8, pp. 374-377.&&&a&Class@SS17.1&&&&&1&N&0&N.N.N.N 2006JV.818&mcs&0&N&A Mortgage Real Estate Investment Trust (REIT) is least likely to be characterized by which of the following?&it is illiquid since there is no organized market for the REIT shares.&it is a comparable investment to a bond.;the property portfolio is managed by professionals. ;it holds a diversified portfolio of real estate investments.;&LOS: Reading 75-gREITs are closed end investment companies that are traded on stock exchanges.Mortgage REIT An REIT that invests in loans secured_debt by real estate which deriveincome from mortgage interest and fees. Real Estate Investment Trust REITs invest in real estate or loans secured by real estate and issue shares in such investments. A REIT is similar to a closed-end mutual fund. Reference: Solnik and McLeavey, International Investments, 5th edition, Ch. 8, p. 388.&&&a&Class@SS17.2&&&&&1&N&0&N.N.N.N 2006JV.819&mcs&0&N&The annual net operating income from a property is $75,000 and the owner makes mortgage payments of $23,000 per annum. If the value of the property is estimated to be $900,000 then the market capitalization rate is closest to:&8.33%.&5.78%.;12.00%.;17.31%.;&LOS: Reading 75-k\\The mortgage payments are not deducted from the operating income.Reference: Solnik and McLeavey, International Investments, 5th edition Ch. 8, pp. 391-392.&&&a&Class@SS17.0&&&&&1&N&0&N.N.N.N 2006JV.820&mcs&0&N&As yields increase the rate of decline in the price of a bond starts to slow it is likely that the bond&contains an embedded put option.&carries a bank guarantee.;carries a sovereign guarantee.;contains an embedded call option.;&LOS: Reading 68-cAs rates rise, the price of bonds decline but the price decline of bonds with embedded put options will be less than that of option-free bonds. Investors will be looking to exercise their put options so the price will stabilize close to the put price.Guarantees do not affect the price behavior of bonds in this manner.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 7, pp. 227-228.&&&a&Class@SS15.1&&&&&1&N&0&N.N.N.N 2006JV.821&mcs&0&N&As interest rates decline to below the coupon rate on a bond with an embedded call option, the bond is likely to exhibit:&negative convexity.&negative duration.;positive convexity. ;price decompression.;&LOS: Reading 68-cAs yields decline the rate of price appreciation slows for a callable bond as the risk of the bond being called increases, this leads to negative convexity.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 7, pp. 224-227.&&&a&Class@SS15.2&&&&&1&N&0&N.N.N.N 2006JV.822&mcs&0&N&The following data has been gathered:

Years to maturitySpot rate (BEY)
18.54%
1.57.82%
27.50%
2.56.85%
36.07%
3.55.78%
45.56%

The 6-month forward rate two and half years from now is closest to:&2.22%.&0%.;3.13%.;6.25%.;&LOS: Reading 67-gThis is a negatively sloping spot-yield curve, so it is to be expected that the forward rate would be lower.\\The 6-month forward rate 2.5 years from now = 2 x 1.11% = 2.22%Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst® Program, 2nd edition, Ch. 6, pp. 190-193.&&&a&Class@SS15.0&&&&&1:v&&& 2006JV.823&mcs&0&N&A straight bond without any call features has a remaining life of three years, has a 12% coupon rate payable annually, and has a yield to maturity of 10.5%. If the one- and three-year spot rates are 8.0% and 10.7%, respectively, then the two-year spot rate is closest to:&9.4%.&9.0%.;10.5%.;10.7%.;&LOS: Reading 67-eThe following relationship must hold:Price using yield-to-maturity calculation = price of bond using spot rates\\Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 6, pp. 178-183.&&&a&Class@SS15.1&&&&&1&N&0&N.N.N.N 2006JV.824&mcs&0&N&The following data has been gathered:

6-month spot rate 8.54%
6-month forward rate 6 months from now 7.25%
6-month forward rate 1 year from now 6.95%

The 1.5-year spot rate is closest to:&7.58%.&3.79%.;6.95%.;8.54%.;&LOS: Reading 67-e\\The 1.5 year spot rate is therefore closest to: 2 x 3.79% = 7.58%Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 6, pp. 193-194.&&&a&Class@SS15.2&&&&&1:v&&& 2006JV.825&mcs&0&N&A bond is traded at par and yields 9.5% to maturity. The term to maturity is 20 years, the modified duration is 8.8 and the convexity is 62. If the yield to maturity rises by 150 basis points the bond price will be closest to:&88.2.&85.4.;86.8.;114.6.;&LOS: Reading 68-d\\Trading at par, the price of the bond is 100.The combined effect of both duration and convexity: 100 - 13.20 + 1.395 = 88.195Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 7, pp. 228-231 and 239-240.&&&a&Class@SS15.0&&&&&1&N&0&N.N.N.N 2006JV.826&mcs&0&N&Which of the following factors is least likely to affect the yield spread of a bond?&the principal amount of the bond.&the expected liquidity of the issue.;the government's monetary policy.;the issuer's industry (cyclical or non-cyclical).;&LOS: Reading 65-eUnless there is a change in the ability of the issuer to redeem the bonds at maturity, the principal amount does not affect the yield spread. Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 4, pp. 105-104.&&&a&Class@SS14.1&&&&&1&N&0&N.N.N.N 2006JV.827&mcs&0&N&If an investor's marginal tax rate is 30% and a tax-exempt bond yield is 8% then the tax-equivalent yield for the investor is closest to:&11.4%.&5.6%. ;8.0%.;26.7%.;&LOS: Reading 65-f\\Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 4, pp. 108-109.&&&a&Class@SS14.2&&&&&1&N&0&N.N.N.N 2006JV.828&mcs&0&N&If a bond is non-refundable it means that:&the bond cannot be redeemed prior to maturity using the proceeds of new debt issued at a lower yield.&the bond cannot be redeemed prior to its maturity date.;the bond cannot be exchanged with another bond of similar credit rating.;the bond cannot be redeemed prior to maturity unless the issuer can issue new debt at a lower yield.;&LOS: Reading 62-cA refunding protection clause prevents redemption from certain sources, and in particular from the proceeds of other debt issues sold at a lower funding cost.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 1, pp. 11-14.&&&a&Class@SS14.0&&&&&1&N&0&N.N.N.N 2006JV.829&mcs&0&N&The investor policy statement: &outlines an investor's objectives and constraints.&is only relevant to individual investors.;specifies the minimum return that is guaranteed to the investor.;outlines the investment manager's philosophy and decision-making process.;&LOS: Reading 77-aA policy statement helps the investor specify realistic goals and in setting the goals become more aware of the risks of investing. It is a valuable way of communicating with the portfolio manager. It also helps set the benchmark against which performance can be measured.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 2, pp. 40-42.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.830&mcs&0&N&Which of the following factors would be most likely to push up the nominal risk-free rate?&A rapidly growing economy.&A fall in the cost of funds.;An increase in the supply of capital.;A fall in the expected level of inflation.;&LOS: Reading 76-bA rapidly growing economy will increase demand for capital and provide opportunities for investors to earn a high rate of return, which will push up required rates of return by the suppliers of capital.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 1, pp. 16-19.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.831&mcs&0&N&Which of the following is the least appropriate assumption of capital market theory?&Investors are influenced by both rational and irrational factors.&Investors have the same time horizon. ;Investors can borrow at the risk-free rate of return. ;Investors wish to maximize the risk/return utility of their investments. ;&LOS: Reading 79-aCapital market theory assumes investors are rational and select portfolios on the efficient frontier. Behavioral finance and technical analysis have moved on from traditional capital market theory and say that investors are influenced by rational and irrational factors. Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 8, pp. 238-240.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.832&mcs&0&N&Which of the following statements is the most accurate?&IV. A stock with a beta that is higher than the market is expected to provide a return that is higher than the market, when the market return is above the risk free rate. &I. The beta of the market is 0.;II. Beta is a measure of unsystematic risk.;III. Betas are always greater than or equal to 1.;&LOS: Reading 79-eI. is not correct; the beta of the market is 1. II. is not correct; beta is a measure of market risk. III. is not correct, betas can be negative. Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 8, pp. 246-250.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.833&mcs&0&N&An investor has stated that his objective is to build a sizeable investment portfolio to meet his retirement needs in ten years' time. He is looking to invest primarily in shares and he expects returns to be generated by capital gains and reinvestment of the dividends paid into the portfolio. His return objective is best described in terms of:¤t income.&total return.;capital appreciation.;capital preservation.;&LOS: Reading 77-cIn the consolidation phase individuals are typically in the second part of their working life, have few debts and earnings exceed expenses. They still have a long time horizon (20 years plus) and can take on moderate risk. Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 2, pp. 37-38.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.834&mcs&0&N&When adding an asset to a multi-asset portfolio, in order to estimate the standard deviation of the combined portfolio it is most important to consider:&the covariance between the asset's returns and the returns of the other assets in the portfolio.&the standard deviation of the asset's returns.;the average standard deviation of the assets' returns in the portfolio. ;the unsystematic risk of each asset and how it will be diversified away in the combined portfolio.;&LOS: Reading 78-fThe components of the formula for portfolio standard deviation are the weighted average (where weights are squared) and the weighted covariances between each pair of assets in the portfolio. Once the number of assets in the portfolio starts to rise the number of covariance terms is significantly larger than the variance terms.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 7, pp. 219-220.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.835&mcs&0&N&The optimal portfolio for an investor is best described as:&IV. the point where his/her highest utility curve is tangent to the efficient frontier.&I. The market portfolio.;II. the point where the securities market line is tangent to the efficient frontier.;III. the point on the efficient frontier that has the highest return per unit of risk.;&LOS: Reading 78-hAnswers I. and II. describe the market portfolio which will only be optimal for investors who can tolerate exactly the risk of the market portfolio. Answer III. may be a portfolio that is too risky for the investor.The utility curves represent the trade off between risk and return; the optimal portfolio will be where the highest utility curve touches the efficient frontier.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 7, pp. 229-230.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.836&mcs&0&N&In capital markets theory unsystematic risk is:&unique risk.&total risk.;market risk.;undiversifiable risk.;&LOS: Reading 79-dTotal Risk includes systematic and unsystematic risk Market Risk. and Undiversifiable Risk. refer to systematic risk. Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 8, pp. 243-247.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.837&mcs&0&N&A U.S. investor is considering international diversification. Which of the following statements best describes his position?&Higher returns can be achieved for the same level of risk as investing solely in the U.S. market.&Higher returns may compensate for the additional risk of purchasing overseas securities. ;Markets which have a higher correlation with U.S. market returns will generally generate higher returns.;Investing in markets with low correlations to the U.S. market return will be most effective in increasing returns.;&LOS: Reading 78-gA U.S. investor, by investing in markets which provide returns which have a low correlation with the U.S. market returns, can usually achieve higher returns for the same level of risk. Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 7, pp. 219-224.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.838&mcs&0&N&The stock analyst in your firm has completed his forecasts for Kensington Corp. and Paddington Inc. The current share prices are $85 and $56 respectively, and he forecasts that a year from now the share prices will have risen to $102 and $60 respectively, each stock will make a dividend payment of $2 at the end of the year. The betas of the stock are 1.5 and 0.9, the expected market return over the next year is 15% and the risk free rate is 6%. On the basis of the analyst's forecast: &Kensington Corp. is undervalued and Paddington Inc. is overvalued.&Kensington Corp. and Paddington Inc. are both overvalued.;Kensington Corp. and Paddington Inc. are both undervalued.;Kensington Corp. is overvalued and Paddington Inc. is undervalued.;&LOS: Reading 79-fUsing CAPM the estimated return for Kensington Corp. is: 6% + 1.5 (15% - 6%) = 19.5%. The analyst is forecasting a return of 22.4% (from capital gain plus dividend) so the stock looks undervalued. The estimated return for Paddington Inc. is: 6% + 0.9 (15% - 6%) = 14.1%. The analyst is forecasting a return of 10.7% so the stock looks overvalued.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 8, pp. 247-252.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.839&mcs&0&N&If the standard deviations of the returns of two assets are 1.5% and 6.0%, and the covariance between the two assets is 5.2, then the correlation coefficient between the returns is closest to:&0.58.&0.06.;0.47.;1.73.;&LOS: Reading 78-e\\Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 7, pp. 217-218.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.840&mcs&0&N&Which of the following is least likely to be considered a limitation of the Capital Asset Pricing Model? &It is complicated to apply.&Estimates of betas are not always accurate.;Estimates of betas are not always accurate.;It assumes portfolios are sufficiently well diversified to eliminate unsystematic risk.;&LOS: Reading 79-eOne of the advantages of CAPM is that it is an easy model to apply.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 8, pp. 247-252.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.841&mcs&0&N&Which of the following is the most appropriate statement regarding acceptable behavior of candidates in the CFA Program according to the CFA Institute Standards of Professional Conduct?& I. Candidates do not need to comply with the Code and Standards until they are awarded the CFA charter.& II. Candidates can only claim partial CFA designation if they have passed one or more levels of the examinations.;III. Candidates must have both successfully registered for the CFA Program and enrolled for one of the CFA examinations.; IV. Candidates cannot claim to have passed Level I or Level II of the CFA examinations until they have completed the CFA program and been awarded the CFA charter.;&LOS: Reading 2-aThe CFA Institute Standards of Professional Conduct apply to both members and candidates so I is not correct. Partial designation is not permitted, so II is not correct. Candidates are allowed to state that they have passed one or more levels of the examinations so IV is not correct. III is a correct statement.
Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 135-141. &&&a&Class@SS01.1&&&&&1:v&&&N. 2006JV.842&mcs&0&N&Karren Black, CFA, is a portfolio manager. She has just taken over a sizeable portfolio of securities that a client has transferred from another portfolio manager. The portfolio has a large holding in a small company, Micro Engineering, which is an illiquid stock. After doing research into the prospects of Micro Engineering, Black decides to sell the holding in the company. Her sell orders push down the price of the stock. Black:&has violated Standard II(B), Market Manipulation, since she should have made every effort to spread the sale orders across a number of brokers to reduce the price impact of the trades.&has not violated Standard II(B), Market Manipulation.;has violated Standard II(B), Market Manipulation, since she distorted the share price of Micro Engineering. ;has violated Standard II(B), Market Manipulation, since she disrupted the smooth trading of the Exchange. ;&LOS: Reading 2-aBlack had no intention to mislead the market so she did not violate Standard II(B), so the correct answer is A.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 49-52. &&&a&Class@SS01.2&&&&&1&N&0&N.N.N.N 2006JV.843&mcs&0&N&Isabella Maserati, CFA, an analyst, is writing a report on the Bermuda Railtrack Corporation (BRC). She is a friend of the wife of the Chief Executive Officer (CEO) of BRC and when chatting about the report she is writing the CEO's wife says that her husband said BRC is intending to cut the dividend paid to shareholders in BRC. An announcement will be made the following week and it is expected to be badly received by investors. Maserati quickly finishes her report with a 'sell' recommendation based on the anticipated dividend cut. Based on the CFA Institute Standards of Practice Handbook:&Maserati should not use the information from the CEO's wife because it is material and non-public information.&Maserati may write the sell recommendation since the information was not given to her directly by the CEO of BRC.;Maserati should immediately disseminate the information to institutional clients and individual investors on a fair basis.;The information that BRC is likely to cut the dividend is unconfirmed therefore Maserati is free to use the information to support her sell recommendation but not should not mention in the report that the dividend will be cut.;&LOS: Reading 2-aMaserati should be aware that the information is material and nonpublic, and therefore not write the report which may cause others to act on the information.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 37-47. &&&a&Class@SS01.0&&&&&1:v&&&N. 2006JV.844&mcs&0&N&Robert Shoemaker, CFA, is an analyst in the brokerage arm of an investment bank. He follows the automotive industry. He changes his recommendation on Bayer Motors to a 'sell' after looking at the unofficial computer-generated model on the Internet of the new 2-door sports model to be launched next year. He states that the new model is unattractive and concludes therefore sales growth will slow down. Identify the most correct statement.&Shoemaker's approach reflects lack of distinction between facts and opinions.&Shoemaker's approach is an example of mosaic theory.;Shoemaker's approach violates the insider trading rules.;Shoemaker's approach reflects the misappropriation theory.;&LOS: Reading 2-aAccording to Standard IV (A.2) - Research Reports, Shoemaker should only make a recommendation based on substantiated facts. His opinion that the new model is unattractive is solely his own and not necessarily that of the purchasing public. Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 105-107. &&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.845&mcs&0&N&The corporate finance department of an investment bank recently obtained a mandate to underwrite a bond offering from Endiron Limited. The director of the corporate finance department issues a circular requesting that all research reports about Endiron should carry a favorable recommendation. Capucine van Nistelroyen, CFA, the equity analyst covering Endiron is about to write a 'sell' recommendation as the result of Endiron's current production capacity constraints. According to the CFA Institute Standards of Practice Handbook:&the investment banking company should put Endiron on a restricted list, and only disseminate factual information.&Van Nisterlroyen has professional and commercial duties to her employer and therefore should change the recommendation to a 'buy'.;Van Nistelroyen, as an equity analyst, is free to write the research report without any pressure since it is a bond issue not an equity issue.;Van Nistelroyen should incorporate the estimated benefits of the planned bond issue into her research report for Endiron in order to justify a buy recommendation.;&LOS: Reading 2-aA fire wall should be used to separate the corporate finance and research departments and this would include putting the stocks where the corporate finance department is doing an issue on a restricted listReference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 40-43. &&&a&Class@SS01.2&&&&&1&N&0&N.N.N.N 2006JV.846&mcs&0&N&Which of the following parties is least likely to be affected by the Global Investment Performance Standards?&Regulatory authorities.&Investment management firms.;Current clients of investment firms.;Prospective clients of investment firms.;&LOS: Reading 4-bGIPS applies to investment management firms and clients or prospective clients. It is not a regulatory requirement.Reference: Global Investment Performance Standards, (CFA Institute, 2005), pp. 107-110.&&&a&Class@SS01.0&&&&&1&N&0&N.N.N.N 2006JV.847&mcs&0&N&The CFA Institute Code of Ethics specifically addresses all of the following except:&supervisory responsibilities.&competence.;integrity of the investment profession.;upholding rules governing capital markets.;&LOS: Reading 1Supervisory responsibilities are addressed in the Standards of Professional Conduct, not the Code of Ethics.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), p. 1. &&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.848&mcs&0&N&Edward Winsore, CFA, based in California, manages the pension fund of a privately owned company, Brandsohn. The proprietor, Christina Brandsohn, is pleased with the consistent outperformance over the benchmark. She offers Winsore, as a token of gratitude, two tickets to a Broadway show and a weekend in New York, all expenses paid. The cost of accommodation, travel and tickets is in excess of $1,000. According to the CFA Institute Standards of Practice Handbook, Winsore should:&report the offer to his supervisor but he is free to accept the offer.&reject the offer.;pay for his travel but accept the offer of accommodation and tickets.;report the situation to the CFA Institute since this is a case of bribery.;&LOS: Reading 2-aWinsore will be in compliance with Standard I(B) if he discloses the gift to his supervisor.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 15-19. &&&a&Class@SS01.2&&&&&1&N&0&N.N.N.N 2006JV.849&mcs&0&N&Pauline Krakowsky, CFA, is the marketing director of the high net-worth division of Up In Smoke Investment Advisory Firm. In order to impress the retired chairman and co-founder of the publicly listed Lee Kok Soy Property Development, she requests that the research department of the affiliated brokerage arm of Up In Smoke write a favorable recommendation for the listed company. Krakowsky hopes to win discretionary investment management business from Lee Kok Soy. Krakowsky's request: &is in violation of the AIMR Standards.&is compliant with the AIMR Standards if performed only once.;is a legitimate business practice and not inconsistent with the AIMR Standards.;is not in violation of the AIMR Standards if the listed company operates in a country with less strict standards.;&LOS: Reading 2-aThe request is in violation of Standard I(B) as the research department is being asked to compromise the independence and objectivity of an investment recommendation.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 15-19. &&&a&Class@SS01.0&&&&&1&N&0&N.N.N.N 2006JV.850&mcs&0&N&The research department of a brokerage firm has just completed an updated report on Vroom Automobile Suppliers. The report recommends a 'sell' and is to be published and disseminated the next morning. According to the AIMR Standards of Practice Handbook, Armand Guigiaro, CFA, an institutional broker at the firm:&must wait until the official publication and dissemination of the information before contacting his clients.&must make reasonable efforts to achieve immediate public dissemination of the information.;may immediately inform his largest clients of the recommendation prior to the official publication time.;may only use the information for the benefit of his individual clients and immediate family members before institutional clients are informed.;&LOS: Reading 2-aThe best choice is C according to Standard III(B), Fair Dealing.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 61-63. &&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.851&mcs&0&N&Which of the following is considered a disadvantage of holding annual board elections compared to less frequent elections? An annually elected board may&I. Not be effective as an anti-takeover device.&II. Sustain better continuity of board expertise.;III. Not receive specialized advice on technical decisions that could affect shareowner value. ;IV. Not be able to adequately spread the work load among its members to operate effectively.;&LOS: Reading 5-hAn annually elected board, as opposed to a classified one (staggered multiple-year terms), has the disadvantage (1) it may not serve as an anti-takeover device, and (2) it may not provide continuity of board expertise.Choice II. is a false statement.Choice III. relates more to the board's ability to hire outside consultants rather to its election frequency.Choice IV. is usually a result of the size of the board rather than the frequency of its election.Reference: The Corporate Governance of Listed Companies: A Manual for Investors, (CFA Institute, 2005), pp. 15-16.&&&a&Class@SS01.2&&&&&1&N&0&N.N.N.N 2006JV.852&mcs&0&N&Which of the following statements is most accurate regarding verification of compliance with the Global Investment Performance Standards (GIPS®)?&Verification must be done on a firmwide basis not just for specific composites.&Verification by a third party is required if a firm claims that they are GIPS compliant.;Verifiers are not expected to understand the methods by which valuations and performance numbers are calculated.;Verification must be performed by the firm's compliance team, not by people involved directly in making investment decisions.;&LOS: Reading 4-dVerification is strongly recommended but is not mandatory. If verification is done it must be performed by a third party. Verifiers must understand the methods and policies used to record performance calculation for performance purposes.Reference: Global Investment Performance Standards, (CFA Institute, 2005), p. 115.&&&a&Class@SS01.0&&&&&1&N&0&N.N.N.N 2006JV.853&mcs&0&N&Investors should analyze the amounts paid to key executives for managing the company's affairs, principally because&a flawed compensation program may encourage executives to make decisions that generate additional compensation to them through short-term share price gains.&they determine the income tax position of the company.;a high level of compensation to executives would demoralize employees.;periodic incentive programs for key executives are not universally acceptable and almost always inflate expenses without necessarily producing tangible benefits to the company.;&LOS: Reading 5-mThe main concern is that an inappropriate compensation package might encourage managers to focus on short-term share price performance rather than the long-term growth of the company.Reference: The Corporate Governance of Listed Companies: A Manual for Investors, (CFA Institute, 2005), pp. 26-27.&&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.854&mcs&0&N&George Gekko, CFA, an investment manager with C. B. Asset Management, is a former classmate of a lawyer who is working to assist Fortune Cookies Manufacturing in negotiations with the labor union to delay a pay rise. He is informed in confidence that the negotiation appears to be progressing in favor of the labor union who is demanding a 25% immediate rise in pay. It can be inferred that the company will incur substantial additional labor costs for the current year. According to the CFA Institute Code and Standards, Gekko:&must not use the nonpublic information to trade or cause others to trade.&may use the nonpublic information only for his personal accounts.;may use the nonpublic information only after gaining approval from the management.;must announce the information publicly in order to achieve immediate public dissemination of the information.;&LOS: Reading 2-aThe most appropriate answer according to Standard II(A) is:George Gekko, CFA, must not use the nonpublic information to trade or cause others to trade.Reference: Standards of Practice Handbook, 9th edition (CFA Institute, 2005), pp. 37-40. &&&a&Class@SS01.2&&&&&1&N&0&N.N.N.N 2006JV.855&mcs&0&N&Which of the following is most accurate with respect to the construction of composites? &IV. If portfolios have similar objectives and strategies and are investing in the same asset classes they would generally be included in the same composite. &I. All model portfolios must be included in at least one composite. ;II. Performance of each portfolio in a composite is equally weighted.;III. Terminated portfolios must be excluded from past performance records. ;&LOS: Reading 4-cGIPS only specifies that all fee paying discretionary portfolios should be included in a composite so I. and II. are not correct. Terminated portfolios should be included until the last measurement period that they are under management. Composites are a group of portfolios that have the same strategy or objective, so IV. is correct.Reference: Global Investment Performance Standards, (CFA Institute, 2005), p. 113.&&&a&Class@SS01.0&&&&&1&N&0&N.N.N.N 2006JV.856&mcs&0&N&Under the Global Investment Performance Standards which of the following could be classified as a firm?&A subsidiary of an investment management company which is a distinct business unit.&A legal firm that gives advice on investment of trust accounts.;An accountancy firm that specializes in auditing investment firms.;A pension fund operating under the Employee Retirement Income Security Act (ERISA).;&LOS: Reading 4-iThe accountancy firm, legal firm and pension fund are not classed as firms under GIPS. A firm must be an investment firm, subsidiary or division thereof which is presented to clients as a distinct business unit.Reference: Global Investment Performance Standards, (CFA Institute, 2005), p. 114.&&&a&Class@SS01.1&&&&&1&N&0&N.N.N.N 2006JV.857&mcs&0&N&Which of the following practices of board committees is the least supportive of shareowner protection?&Members of the committee regularly attended meetings during the past year.&The company seeks shareowners' approval to issue newly registered shares to fulfil its share-based remuneration obligations.;Senior executives from other companies that have cross-directorship links with the company are members of the committee.;The company has provided detailed information to shareowners in public documents relating to the compensation paid during the past year to the company's five highest-paid executives and its board members.;&LOS: Reading 5-jCross-directorship with other companies may pose a potential conflict of interests.Reference: The Corporate Governance of Listed Companies: A Manual for Investors, (CFA Institute, 2005), pp. 26-27.&&&a&Class@SS01.2&&&&&1&N&0&N.N.N.N 2006JV.858&mcs&0&N&Which of the following is not included in the objectives of the Global Investment Performance Standards?&Control the level of investment management fees charged to clients.&foster the notion of self-regulation.;ensure accuracy and consistency in the presentation of performance.;promote fair, global competition among all firms in the investment industry.;&LOS: Reading 4-aIt is recommended that fees should be disclosed, but the standards do not limit the amount that clients can be charged.Reference: Global Investment Performance Standards, (CFA Institute, 2005), pp. 108-109.&&&a&Class@SS02.0&&&&&1&N&0&N.N.N.N 2006JV.859&mcs&0&N&There is a 20% probability that a stock will experience a decline in earnings, a 30% probability that it will not pay a dividend, and a 15% probability that it will both report a decline in earnings and not pay a dividend. What is the probability that the stock will either report a decline in earnings or not pay a dividend?&35%.& 5%.;50%.;65%.;&LOS: Reading 9-hApply the Addition Rule. P(A or B) = P(A) + P(B) - P(AB) = 0.2 + 0.3 - 0.15 = 0.35Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 4, pp. 187-189.&&&a&Class@SS02.1&&&&&1&N&0&N.N.N.N 2006JV.860&mcs&0&N&The returns from a portfolio are normally distributed with a mean of 16% and a standard deviation of 8%. The probability of a negative return occurring is closest to: &2.5%.&0.5%.;5.0%.;16.0%.;&LOS: Reading 10-kApproximately 95% of returns are expected to occur between the mean plus or minus two standard deviations. Therefore 2.5% of returns will be negative. Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 5, pp. 250-253.&&&a&Class@SS03.2&&&&&1&N&0&N.N.N.N 2006JV.861&mcs&0&N&If two events are independent:&the occurrence of one event does not effect the probability of the other event occurring. &they are mutually exclusive.;the joint probability of the two events is 0.;the joint probability of the two events is 1.;&LOS: Reading 9-iIndependent is when one event occurring has no impact on the probability of the other event occurring.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 4, p. 189.&&&a&Class@SS02.0&&&&&1&N&0&N.N.N.N 2006JV.862&mcs&0&N&A client has asked an investment manager to achieve a minimum return of 3% on his portfolio. Which of the following four funds would be the best alternative using a safety-first approach?&Expected return is 12%, standard deviation of returns is 8%. &Expected return is 5%, standard deviation of returns is 2%. ;Expected return is 8%, standard deviation of returns is 6%. ;Expected return is 15%, standard deviation of returns is 15%. ;&LOS: Reading 10-p\\Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 5, pp. 257-260.&&&a&Class@SS03.1&&&&&1&N&0&N.N.N.N 2006JV.863&mcs&0&N&Which of the following statements is least accurate with respect to a Monte Carlo simulation?&It uses computer models to find solutions to complex problems.&It does not assume returns are normally distributed.;It generates a large number of random samples from probability distributions.;It uses samples taken from historic data to calculate probabilities of certain events occurring.;&LOS: Reading 10-sUsing historic data to estimate future probabilities is historic simulation.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 5, pp. 266-269.&&&a&Class@SS03.2&&&&&1&N&0&N.N.N.N 2006JV.864&mcs&0&N&Time-weighted rates of return give&the compound growth rate of $1 invested in the portfolio at the beginning of the measurement period.&the internal rate of return of the portfolio.;the arithmetic average of the returns for each subperiod, each period weighted equally.;the geometric average of the returns for each subperiod, each period weighted by the size of the fund.;&LOS: Reading 7-dTime-weighted rates of return are the geometric average of returns for each subperiod, each period weighted equally. This gives the compound growth rate of $1 invested at the beginning of the period in the portfolio. For example, for a one year period if the quarterly time-weighted return is 5%, $1 invested over 1 year, at the end of the year, would be worth \\Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 2, pp. 66-72.&&&a&Class@SS02.0&&&&&1&N&0&N.N.N.N 2006JV.865&mcs&0&N&An analyst is collecting data on the performance of hedge funds. He does not include funds that are no longer operating. His analysis is likely to exhibit: &survivorship bias.&look-ahead bias.;data-mining bias.;data-snooping bias.;&LOS: Reading 11-mFunds which have closed (often due to bad performance and/or high risk) will not be included in the data so the data will tend to provide a distorted view of past performance of the funds.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 6, pp. 308-309.&&&a&Class@SS03.1&&&&&1&N&0&N.N.N.N 2006JV.866&mcs&0&N&A company is producing chocolate bars with a mean weight of 250 grams and a standard deviation of 16 grams. The manager takes a sample of 50 bars and finds that the mean weight of this sample is 255 grams. At the 0.01 and the 0.05 significance level is there evidence that the weight of a chocolate bar changed?&There is no evidence that the weight of the chocolate bar has changed at the 0.01 significance level but there is evidence that it has changed at the 0.05 significance level.&There is evidence that the weight of the chocolate bar has changed at both the 0.01 significance level and the 0.05 significance level.;There is no evidence that the weight of the chocolate bar has changed at either the 0.01 significance level or the 0.05 significance level.;There is evidence that the weight of the chocolate bar has changed at the 0.01 significance level but there is no evidence it has changed at the 0.05 significance level.;&LOS: Reading 12-g This is a two tailed test so the critical values of z at the 0.01 significance level are ± 2.58, and at the 0.05 significance level are ± 1.96. If the computed z value lies outside these ranges reject the null hypothesis and accept the alternative. In this case z falls outside the range at the 0.05 significance level but inside the range at the 0.01 significance level. Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 7, pp. 339-342.&&&a&Class@SS03.2&&&&&1&N&0&N.N.N.N 2006JV.867&mcs&0&N&An investor puts $5,000 a year into a savings account, at the beginning of each year, for the next 6 years earning 12% compounding annually. How much will be in the account at the end of the 6 years?&45445&40575;42148;59214;&LOS: Reading 6-eThe future value of the payments is calculated using the annuity formula:\\Note that this is an equivalent to an annuity due since the first payment is at the beginning of the year.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 1, pp. 13-23.&&&a&Class@SS02.0&&&&&1&N&0&N.N.N.N 2006JV.868&mcs&0&N&$5,000 is placed on deposit today and earns 4% interest, compounding semiannually. The value at the end of ten years is closest to:&7430&7000;7401;7445;&LOS: Reading 6-c\\Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 1, pp. 9-10.&&&a&Class@SS02.1&&&&&1&N&0&N.N.N.N 2006JV.869&mcs&0&N&An analyst is looking at the returns from two funds and calculates that Fund A has an average return of 10% per annum with a standard deviation of returns of 12%. Fund B has an average return of 14% per annum with a standard deviation of returns of 20%. The average risk-free rate was 5% per annum.Which of the following statements is most accurate?&The returns from Fund B are both absolutely and relatively more disperse than Fund A's. &Fund A's returns are relatively less disperse than B's and Fund A has a more attractive Sharpe ratio. ;The coefficient of variation of Fund A's returns is higher than Fund B's, although the Sharpe ratio is lower. ;Fund B has a higher Sharpe ratio than Fund A, which means that the return on a risk-adjusted basis is not as attractive as Fund A's.;&LOS: Reading 8-mThe coefficient of variation of A is 12%/10% = 1.2, B = 20%/14% = 1.4 so B's returns are both absolutely and relatively more disperse than A.The Sharpe ratio of A is (10% - 5%)/12% = 0.42, of B is (14% - 5%)/20% = 0.45, B has a better risk-adjusted performance. Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 3, pp. 139-144.&&&a&Class@SS02.2&&&&&1:v&&&N. 2006JV.870&mcs&0&N&Which of the following distributions exhibits kurtosis?&A distribution that is approximately normal but is more peaked with fat tails.&A lognormal distribution.;The distribution of returns from a call option.;A negatively or positively skewed distribution.;&LOS: Reading 8-oKurtosis refers to when a distribution has a larger/smaller percentage of small deviations from the mean and a higher/lower percentage of large deviations, compared to a normal distribution. A distribution that is more peaked with fat tails exhibits leptokurtosis.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 3, pp. 149-153.&&&a&Class@SS02.0&&&&&1&N&0&N.N.N.N 2006JV.871&mcs&0&N&A preference share pays an annual dividend of $5 and has a perpetual life. If an investor requires a return of 8% per annum how much would he pay for the share?&$62.50.&$120.00.;$125.00.;$160.00.;&LOS: Reading 6-gUsing the perpetuity formula\\PV = dividend/required rate of return = $5/0.08 = $62.50Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 1, pp. 23-25.&&&a&Class@SS02.1&&&&&1&N&0&N.N.N.N 2006JV.872&mcs&0&N&If all the points in a scatter plot lie on a straight line with a positive slope then the correlation coefficient between the variables is:&1&0;-1;cannot be determined without knowing the slope of the straight line.;&LOS: Reading 13-bAs long as the line is upward sloping then the correlation is one, since the movement in one variable by a unit would always lead to a movement in the other variable by a fixed positive multiple of one unit.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 8, pp. 376-378.&&&a&Class@SS03.2&&&&&1&N&0&N.N.N.N 2006JV.873&mcs&0&N&A linear regression shows that the correlation coefficient between two variables is 0.6 and the standard error is 4%. The percentage of the dependent variable's move that can be explained by the independent variable is: &36%.& 4%.;16%.;60%.;&LOS: Reading 13-eThe coefficient of determination is the square of the correlation coefficient in a linear regression.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 8, pp. 403-405.&&&a&Class@SS03.0&&&&&1&N&0&N.N.N.N 2006JV.874&mcs&0&N&When testing a hypothesis concerning the relative values of the variances of two normally distributed populations the appropriate test statistic is:&F-statistic.&t-test statistic. ;z-test statistic. ;chi-square statistic.;&LOS: Reading 12-kThe F-test is used to test the variances of two populations assuming that they are normally distributed.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 7, pp. 353-356.&&&a&Class@SS03.1&&&&&1&N&0&N.N.N.N 2006JV.875&mcs&0&N&When selecting a sample every nth item of the population is selected. This is an example of: &systematic sampling.&random sampling.;structured sampling.;stratified random sampling.;&LOS: Reading 11-bSystematic sampling is when every nth item of the population is selected.Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 6, pp. 286-287.&&&a&Class@SS03.2&&&&&1&N&0&N.N.N.N 2006JV.876&mcs&0&N&An analyst is looking at data on the salaries paid by companies in the manufacturing sector. A sample of 500 employees is selected and the sample mean salary is $55,000 and the sample standard deviation is $8,000. The 95% confidence interval for the population mean is closest to:&$54,299 up to $55,701.&$54,076 up to $55,923.;$54,642 up to $55,358.;$54,969 up to $55,031.;&LOS: Reading 11-f\\Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 6, pp. 297-302.&&&a&Class@SS03.0&&&&&1&N&0&N.N.N.N 2006JV.877&mcs&0&N&In a country the nominal GDP was $250 billion, inflation was 5% and the M1 money supply was $60 billion. The velocity of M1 money was closest to:&4.17.&3.97.;24.00.;25.43.;&LOS: Reading 17-cThe velocity of money is the nominal GDP divided by the money supply, or $250 billion divided by $60 billion which is $4.17.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 14, pp. 329-330.&&&a&Class@SS04.1&&&&&1&N&0&N.N.N.N 2006JV.878&mcs&0&N&Which of the following economists believe that changes in marginal tax rates are very important in determining aggregate supply?&Supply-side economists.&Classical economists. ;Ricardian economists.;Keynesian economists.;&LOS: Reading 15-cSupply-side economists believe that changes in the tax rate affect aggregate supply due to their impact on relative rewards from productive activity versus leisure and tax avoidance. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 12, pp. 279-280.&&&a&Class@SS04.2&&&&&1&N&0&N.N.N.N 2006JV.879&mcs&0&N&The long-term effects of a move to a more restrictive monetary policy are: &a decrease in nominal interest rates and a lower inflation rate.&a decrease in real output and a lower inflation rate.;a decrease in both the nominal and real interest rates. ;an increase in real interest rates and a decrease in real output.;&LOS: Reading 17-dThe long-term effects are on prices and nominal interest rates, not on output.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 14, pp. 330-334.&&&a&Class@SS04.0&&&&&1&N&0&N.N.N.N 2006JV.880&mcs&0&N&Under adaptive expectations decision makers:&use recent observations to make forecasts about future events. &use all available data to make forecasts about future events.;change their forecasts based on anticipated government policy. ;change their forecasts based on anticipated consumer spending and corporate investment. ;&LOS: Reading 18-cThe adaptive expectations hypothesis says that decision makers believe the recent past is the best indicator of the future.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 15, p. 356.&&&a&Class@SS04.1&&&&&1&N&0&N.N.N.N 2006JV.881&mcs&0&N&Under Keynesian economics when the economy is expanding rapidly the appropriate government action might be to:&raise personal income taxes.&increase interest rates.;increase public spending.;decrease the money supply.;&LOS: Reading 15-cRaising personal income taxes would reduce consumption and slow the economy. Increasing public spending would increase aggregate demand, which would stimulate rather than slow the economy. Changing interest rates or money supply was not part of the Keynesian policy to adjust levels of economic activity.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 12, pp. 269-271.&&&a&Class@SS04.2&&&&&1&N&0&N.N.N.N 2006JV.882&mcs&0&N&Which of the following indicates that a firm benefits from economies of scale?&IV. Marginal costs are lower than average total costs.&I. Average fixed costs are declining.;II. The average total cost curve is rising slowly. ;III. Marginal costs are higher than variable costs.;&LOS: Reading 20-fI. is not correct, average fixed costs will decline for any company.II. is not correct, for a company with economies of scale the average total cost curve is declining and III. is not correct, since this does not mean that average total costs are falling.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 20, pp. 492-495.&&&a&Class@SS05.0&&&&&1&N&0&N.N.N.N 2006JV.883&mcs&0&N&Which of the following statements is most accurate with respect to tariffs and quotas?&The imposition of a tariff usually allows domestic producers to increase prices. &Quotas, but nor tariffs, benefit the consumer.;The purpose of an import quota is to provide additional revenue for the government.;Tariffs on a product discourage the production of the product if the producer does not have a competitive advantage.;&LOS: Reading 26-dA tariff is simply a tax on imports from foreign countries; this increases the price of foreign goods and allows domestic producers in turn to increase their prices.Neither quotas nor tariffs benefit consumers; they pay the cost of both trade barriers. Tariffs, not quotas, provide additional income to the government and tariffs can protect producers who not have a competitive advantage. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 17, pp. 407-410.&&&a&Class@SS06.1&&&&&1&N&0&N.N.N.N 2006JV.884&mcs&0&N&Which of the following will cause an appreciation in a country's currency?&There is an increase in its real interest rates relative to its trading partners.&Imports rise relative to exports.;Domestic inflation is higher than its trading partners' inflation.;Its income grows rapidly relative to its trading partners' income.;&LOS: Reading 28-dAn increase in real interest rates will attract inward investment leading to an appreciation of the currency.High imports (requiring purchase of a foreign currency), high inflation (due to purchasing power parity) and strong economic growth (leading to import growth) will all lead to currency depreciation. Reference: Solnik and McLeavey, International Investments, 5th edition, Ch. 2, pp. 38-40.&&&a&Class@SS06.2&&&&&1&N&0&N.N.N.N 2006JV.885&mcs&0&N&If the price of a product falls by 10% and demand rises by 20% the price elasticity of demand is:&-2 and elastic.&-2 and inelastic.;-0.5 and elastic.;-0.5 and inelastic.;&LOS: Reading 19-dPrice elasticity is (% change in quantity/% change in price) = 20%/-10% = -2. If the demand changes by more than the price then demand is elastic. Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 19, pp. 463-464.&&&a&Class@SS05.0&&&&&1&N&0&N.N.N.N 2006JV.886&mcs&0&N&The opportunity cost of capital for a company is: &the rate of return that investors could earn by investing in a similar company.&the total costs of the company divided by its capital.;the implicit costs of the company divided by its capital. ;the economic profit generated by the company divided by its capital.;&LOS: Reading 20-cThe opportunity cost of capital is the rate of return that investors need to earn for them to continue to invest in the company rather than investing elsewhere.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 20, pp. 482-483.&&&a&Class@SS05.1&&&&&1&N&0&N.N.N.N 2006JV.887&mcs&0&N&The following data is provided on the output per worker in two countries, assume other production costs are the same and transportation costs are low.

Output per worker per day
Pens Paper
Country A 100 500
Country B 250 1000

Which of the following statements is most accurate?&Both countries gain if Country A specializes in the production of paper and Country B in the production of pens.&Both countries gain if Country A specializes in the production of pens and Country B in the production of paper.;Since Country B has an absolute advantage in the production of both pens and paper it cannot benefit form trading either pens or paper with Country A.;Since Country B has an absolute advantage in the production of both pens and paper only Country B can benefit from trading pens or paper with Country A.;&LOS: Reading 26-aIf Country A moves two workers from pens to paper they can increase paper production by 1,000 at the cost of 200 pens. If Country B moves one worker from paper to pens they can increase pen production by 250 at the cost of 1,000 units of paper. This will increase the aggregate output.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 17, pp. 400-401.&&&a&Class@SS06.2&&&&&1:v&&& 2006JV.888&mcs&0&N&If a bank in the U.K. quoted the US dollar exchange rate as £1 = US$1.45 this would be an example of:&an indirect quotation in American terms.&a direct quotation in European terms.;a direct quotation in American terms.;an indirect quotation in European terms.;&LOS: Reading 27-aThis is an indirect quotation since it is the amount of foreign currency (US$1.45) required to buy one unit of domestic currency (£1). It is also in American terms because it is the dollar price of one pound sterling (£).Reference: Solnik and McLeavey, International Investments, 5th edition, Ch. 1, pp. 4-5.&&&a&Class@SS06.0&&&&&1&N&0&N.N.N.N 2006JV.889&mcs&0&N&In a price-taker market demand is: &perfectly elastic.&unitary elastic.;perfectly inelastic.;relatively inelastic.;&LOS: Reading 21-aThe demand curve is horizontal, so perfectly elastic.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 21, pp. 505-506.&&&a&Class@SS05.1&&&&&1&N&0&N.N.N.N 2006JV.890&mcs&0&N&Which of the following companies will expand output until marginal revenue equals marginal cost?&Oligopolist.&Price taker.;Monopolist.;Price searcher.;&LOS: Reading 21-aPrice takers, monopolists and price searchers will all maximize profits by expanding output until marginal revenue equals marginal cost. An oligopolist does not necessarily do so, it may be part of a cartel in order to restrict output and fix prices.Reference: Gwartney, Stroup, Sobel and Macpherson, Economics: Private and Public Choice, 10th edition, Ch. 21, pp. 506-508.&&&a&Class@SS05.2&&&&&1&N&0&N.N.N.N 2006JV.891&mcs&0&N&If a lease is classified as an operating lease rather than as a capital lease this will lead to the lessee reporting:&higher financing cash flows.&higher total cash flows.;higher investing cash flows.;higher operating cash flows.;&LOS: Reading 44-bThe total lease payment will be recorded as an operating cash outflow. With a capital lease it will be recorded as partly operating and partly financing cash outflow.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 11, pp. 370-371.&&&a&Class@SS10.0&&&&&1&N&0&N.N.N.N 2006JV.892&mcs&0&N&Which of the following is/are least likely to be treated as a nonrecurring item (s)?&The impact of a revision of the costs of a project which is being accounted for using the percentage-of-completion method. &Losses from the early retirement of debt.;Asset write-downs as part of a restructuring of operations.;The cumulative impact on prior years' earnings of a change in accounting method. ;&LOS: Reading 31-cRevision of the costs of a project which is being accounted for using the percentage-of-completion method would be recognized in income from continuing operations, not as a nonrecurring item.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 2, p. 42.&&&a&Class@SS07.1&&&&&1&N&0&N.N.N.N 2006JV.893&mcs&0&N&The following information is provided regarding a company's operations in the last fiscal year.

The company does not pay tax and uses
U.S. GAAP Cash collected from customers		 $500,000
Cash paid for new plant and equipment $200,000
Cash paid to suppliers $150,000
Cash paid for salaries $120,000
Cash paid for rent $60,000
Depreciation expense $30,000
Cash paid for interest costs $80,000
Cash dividends paid $20,000
Cash raised from bond issue $400,000

The net cash flow from operations was:&90000&70000;150000;170000;&LOS: Reading 33-bCash flow from operations = cash flow from customers - cash paid to suppliers - rent - salaries - cash paid for interest = $500,000 - $150,000 - $120,000 - $60,000 - $80,000 = $90,000Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 3, pp. 78-81.&&&a&Class@SS07.2&&&&&1:v&&& 2006JV.894&mcs&0&N&The cash flow from financing, using the data for the company provided in the previous question, was: &380000&($500,000).;($420,000). ;300000;&LOS: Reading 33-bCash flow from financing = cash raised from bond issue - cash dividends paid = $400,000 - $20,000 = $380,000 Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 3, pp. 78-81. &&&a&Class@SS07.0&&&&&1&N&0&N.N.N.N 2006JV.895&mcs&0&N&An analyst should use calculations based on LIFO, rather than FIFO, for which of the following ratios?&Current ratio.&Gross profit margin.;Debt-to-equity ratio.;Return on total capital.;&LOS: Reading 39-bUse LIFO for income-related ratios, and FIFO for balance-sheet ratios.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 6, pp. 206-207. &&&a&Class@SS09.1&&&&&1&N&0&N.N.N.N 2006JV.896&mcs&0&N&A company has 100,000 call options outstanding with an exercise price of $40 per share. The average share price over the last accounting period was $55 and at the end of the period was $60. When calculating diluted earnings per share, using the treasury stock method, the number of potential shares created by the option is closest to: &27273&33433;66567;72727;&LOS: Reading 36-dThe number of shares issued on exercise is 100,000.This would raise $4,000,000 in cash which would buy back 72,727 shares giving net new shares of 27,273.Reference: Kieso, Weygandt, Warfield, Dilutive Securities and Earnings per Share, Intermediate Accounting, 11th edition, Ch. 16, pp. 796-798. &&&a&Class@SS08.2&&&&&1&N&0&N.N.N.N 2006JV.897&mcs&0&N&A company (1) increases its accounts receivable and (2) increases its inventory levels. The impact will be to increase or decrease, respectively, its operating cash flows: &(1) decrease (2) decrease.&(1) increase (2) increase.;(1) increase (2) decrease.;(1) decrease (2) increase.;&LOS: Reading 33-bThe company will have more money owing from customers and more money tied up in inventories. Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 3, pp. 74-77. &&&a&Class@SS07.0&&&&&1&N&0&N.N.N.N 2006JV.898&mcs&0&N&Related revenues and expenses should be recognized in the same time period under the: &matching principle.&accrual concept.;distribution concept.;economic earnings principle.;&LOS: Reading 31-bThe matching principle says that related revenues and expenses should be recognized in the same time period. Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 2, pp. 32-33. &&&a&Class@SS07.1&&&&&1&N&0&N.N.N.N 2006JV.899&mcs&0&N&A company purchases additional inventory using cash, this will lead to the current ratio:&remaining unchanged.&falling.;increasing. ;it depends if the current ratio was more or less than 1 whether it increases or falls.;&LOS: Reading 35-bThe cash and inventory are both in the numerator of the current ratio.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 10, p. 323.&&&a&Class@SS08.2&&&&&1&N&0&N.N.N.N 2006JV.900&mcs&0&N&A company has sales of $300,000, gross profit of $120,000 and operating profit of $50,000. If the average total assets are $170,000, average inventory is $25,000, then inventory turnover is:&7.2 times.&4.8 times.;10.0 times.;15.0 times.;&LOS: Reading 35-bInventory turnover is: COGS/Average inventory = (300 - 120)/25 = 7.2 timesReference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 10, pp. 325-326. &&&a&Class@SS08.0&&&&&1&N&0&N.N.N.N 2006JV.901&mcs&0&N&Using the data provided in question 60, the total asset turnover is closest to:&1.76 times.&0.29 times.;0.57 times.;3.40 times.;&LOS: Reading 35-bTotal asset turnover: = sales/average total net assets = 300/170 = 1.76 timesReference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 10, p. 327. &&&a&Class@SS08.1&&&&&1&N&0&N.N.N.N 2006JV.902&mcs&0&N&Which of the following would tend to increase a firm's long-term growth rate?&Increasing its profit margin.&Reducing its asset turnover.;Reducing its financial leverage.;Increasing the dividend payout ratio.;&LOS: Reading 35-cThe growth rate is earnings retention rate x ROE.ROE is asset turnover x profit margin x financial leverage.Therefore increasing the profit margin is the only choice which increases, rather than decreases, the growth rate.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 10, pp. 348-350.&&&a&Class@SS08.2&&&&&1&N&0&N.N.N.N 2006JV.903&mcs&0&N&The following information is provided by a company:

Net profit margin= 5%
EBIT/Sales= 12%
Total asset turnover= 2 times
Financial leverage= 1.5 times
Tax rate = 30%

The return on equity is closest to:&15.0%.&3.6%.;10.5%.;36.0%.;&LOS: Reading 35-cROE: = net profit margin x total asset turnover x financial leverage = 5% x 2 x 1.5 = 15%.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 10, pp. 348-350.&&&a&Class@SS08.0&&&&&1&N&0&N.N.N.N 2006JV.904&mcs&0&N&A company provides 5-year warranties on its products and recognizes a fixed percentage of sales as a warranty expense in its financial statements. For tax purposes a warranty expense can only be recognized when it is an actual expenditure and this usually occurs towards the end of the 5-year period. This will give rise to a:&deferred tax asset.&deferred tax liability.;tax loss carryforward.;deferred income tax expense.;&LOS: Reading 42-aTaxable income will be higher than pretax income leading to prepayment of tax and therefore a deferred tax asset.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 9, p. 295.&&&a&Class@SS10.1&&&&&1&N&0&N.N.N.N 2006JV.905&mcs&0&N&If the market interest rate is lower than the coupon rate of a bond when it is issued: &each coupon payment will be more than the interest expense and will therefore reduce the closing premium on the issuer's balance sheet.&each coupon payment will be more than the interest expense and will therefore reduce the discount on the issuer's balance sheet.;each coupon payment will be less than the interest expense and will therefore increase the discount on the issuer's balance sheet.;each coupon payment will be less than the interest expense and will therefore reduce the closing premium on the issuer's balance sheet.;&LOS: Reading 43-aThe interest expense is based on the market rate at the time of issue (the effective rate), multiplied by the balance sheet liability. Although the bond will be issued at a premium the interest expense is less than the coupon payment and the balance will reduce the premium.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 10, pp. 325-328.&&&a&Class@SS10.2&&&&&1&N&0&N.N.N.N 2006JV.906&mcs&0&N&A company enters into a four-year capital lease agreement for a piece of machinery that has a fair value of $50,000 and no salvage value at the end of four years. The lease payments are $15,000 per year and the discount rate is 10%. The machine will be depreciated using the straight line method. The total lease expense in the first year will be closest to: &16642&16887;17255;17500;&LOS: Reading 44-bInterest expense = 10% x $47,548 (the PV of the lease payments) = $4,755Depreciation expense = $47,548/4 = $11,887Total expense = $16,642Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 11, pp. 368-371.&&&a&Class@SS10.0&&&&&1&N&0&N.N.N.N 2006JV.907&mcs&0&N&Using the data in Question 66, the total lease expense over the four years will be closest to:&60000&47554;50000;69024;&LOS: Reading 44-bThe total expense will equal the total lease payments over the life of the lease.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 11, pp. 368-371.&&&a&Class@SS10.1&&&&&1&N&0&N.N.N.N 2006JV.908&mcs&0&N&Treating a lease as an operating lease rather than a capital lease will lead to the following financial ratios being lower for the lessee company:&Return on assets.&Current ratio.;Interest cover.;Debt to equity ratio.;&LOS: Reading 44-bWith an operating lease the lease does not impact on the balance sheet, lowering short and long-term debt levels. Interest expense is lower, increasing interest cover and return on assets is higher since assets are lower.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 11, pp. 369-371.&&&a&Class@SS10.2&&&&&1&N&0&N.N.N.N 2006JV.909&mcs&0&N&LIFO reserve is important because:&it is used to adjust inventory calculated using LIFO, which is usually much lower than the current cost of inventory.&it is used by analysts to calculate the tax rate using LIFO.;it is used to convert balance sheet items calculated using FIFO to LIFO numbers.;it is used to adjust COGS under LIFO, which is usually much lower than COGS under FIFO.;&LOS: Reading 39-cLIFO reserve is used to adjust inventories calculated under LIFO to inventories calculated under FIFO (nearer current cost).Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 6, pp. 201-202.&&&a&Class@SS09.0&&&&&1&N&0&N.N.N.N 2006JV.910&mcs&0&N&A company has bonds outstanding which have a coupon rate of 8% and are trading on a yield to maturity of 12%. The company's marginal tax rate is 30%. The cost of debt is closest to:& 8.4%.& 5.6%.; 8.0%.;12.0%.;&LOS: Reading 46-bCost of debt = 12%(1 - 0.3) = 8.4%Reference: Brigham and Houston, Fundamentals of Financial Management, 8th edition, Ch. 9, pp. 354-355. &&&a&Class@SS11.1&&&&&1&N&0&N.N.N.N 2006JV.911&mcs&0&N&A project is being considered which will cost $30 million and generate cash flows of $6 million at the end of the first year, $15 million at the end of the second year, and a final cash flow of $12 million at the end of the third year. The cost of capital is 12%. The net present value of the project is closest to:&($4,143,586).&($6,511,253).;($535,715).;3000000;&LOS: Reading 47-a\\Reference: Brigham and Houston, Fundamentals of Financial Management, 8th edition, Ch. 11, pp. 395-396. &&&a&Class@SS11.2&&&&&1&N&0&N.N.N.N 2006JV.912&mcs&0&N&The following information is provided on a company's purchases and sales of a product.
Beginning inventory was 50 units at a cost of $10, ending inventory 70 units.

PurchasesSales
First quarter30 units @ $1020 units @ $12
Second quarter30 units @ $1230 units @ $15
Third quarter40 units @ $1440 units @ $17
Fourth quarter50 units @ $1540 units @ $18

Under FIFO the company's gross profit from this product for the year will be:&650&240;320;1440;&LOS: Reading 39-aTotal sales = $2,090COGS will be for first 130 units purchased = (80 x $10) + (30 x $12) + (20 x $14) = $1,440 Gross profit = $650 Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 6, pp. 193-195. &&&a&Class@SS09.0&&&&&1:v&&& 2006JV.913&mcs&0&N&Using the data in question 72, the inventory value at the end of the period using LIFO is:&700&740;1030;1770;&LOS: Reading 39-aThe inventory at the end of the period will be the first items recorded, the starting inventory plus 20 units @ $10. Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 6, pp. 193-195. &&&a&Class@SS09.1&&&&&1&N&0&N.N.N.N 2006JV.914&mcs&0&N&Firms that capitalize rather then expense costs will have:&higher cash flow from operations.&more volatile earnings.;initially lower profitability. ;higher debt-to-equity ratios.;&LOS: Reading 40-aNet cash flow will be the same but will be allocated to cash flow from investing if expenses are capitalized.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 7, pp. 229-233. &&&a&Class@SS09.2&&&&&1&N&0&N.N.N.N 2006JV.915&mcs&0&N&When evaluating a 10-year project the hurdle rate is the: &company's cost of capital.&project's internal rate of return.;market interest rate for 10 year bonds. ;market interest rate for 10 year bonds plus a risk premium. ;&LOS: Reading 47-bThe hurdle rate is the company's cost of capital, if the IRR is higher than the hurdle rate the project should increase stockholders' wealth, if less it will reduce stockholders' wealth.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th edition, Ch. 10, pp. 360-362. &&&a&Class@SS11.0&&&&&1&N&0&N.N.N.N 2006JV.916&mcs&0&N&The optimal capital structure of a company will:&maximize the share price.&minimize the cost of equity.;maximize the earnings per share.;maximize the weighted-average cost of capital.;&LOS: Reading 50-gBy definition the optimal capital structure of a company maximizes the share price.Reference: Brigham and Houston, Fundamentals of Financial Management, 8th edition, Ch. 13, pp. 503-514.&&&a&Class@SS11.1&&&&&1&N&0&N.N.N.N 2006JV.917&mcs&0&N&Which of the following is usually capitalized rather than expensed under U.S. GAAP?&Cost of acquiring a brand name.&Research costs.;Advertising costs.;Software development costs.;&LOS: Reading 40-aResearch, software development, and advertising costs are normally expensed. This is more conservative since the benefit from research and development and advertising expenditure is usually uncertain.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 7, pp. 235-240.&&&a&Class@SS09.2&&&&&1&N&0&N.N.N.N 2006JV.918&mcs&0&N&A company buys a piece of machinery for $50,000 which has a useful life of 6 years and estimated salvage value of $4,000. Based on the straight-line method the depreciation expense in the second year will be closest to: &7667&8333;15333;16667;&LOS: Reading 41-aDepreciation each year = ($50,000 - $4,000)/6 = $7,667Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 8, pp. 259-260. &&&a&Class@SS09.0&&&&&1&N&0&N.N.N.N 2006JV.919&mcs&0&N&Using the data in the question 78, the depreciation expense in the second year using the sum-of-years'-digits method will be closest to: &10952&11111;11904;14286;&LOS: Reading 41-aSYD = 21 Depreciation in the second year = ($50,000 - $4,000) x 5/21 = $10,952Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 8, pp. 260-262. &&&a&Class@SS09.1&&&&&1&N&0&N.N.N.N 2006JV.920&mcs&0&N&If interest rates rise after a company has issued debt then:&the higher interest rate will not be reflected in either the income statement or balance sheet of the company.&the higher interest rate will lead to a higher interest expense on the income statement. ;the market value of the debt increases which must be reflected as an unrealized loss in the balance sheet;the market value of the debt declines which can be reflected in the balance sheet as a gain on investments.;&LOS: Reading 43-bIf interest rates rise after a company has issued debt then there is an economic impact but it is not reflected in the financial statements of the company. The effective interest rate is used throughout the life of the debt.Reference: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd edition, Ch. 10, pp. 342-343. &&&a&Class@SS10.2&&&&&1&N&0&N.N.N.N 2006JV.921&mcs&0&N&A short sale may only be done on an uptick trade means that: &the price of the short sale cannot be lower than the last traded price.&the trader will mark up the last traded price by $1 for the short sale transaction. ;the trader will mark up the last traded price by $0.25 for the short sale transaction. ;the price of the short sale must be higher than the price paid for the underlying stock.;&LOS: Reading 52-eIn order for short selling not to exacerbate a fall in stock price, short sales are only permitted when the price is higher than or equal to the previous traded price. In the case it is equal, the previous price must have been higher.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 4, p. 126.&&&a&Class@SS12.0&&&&&1&N&0&N.N.N.N 2006JV.922&mcs&0&N&An investor buys 1,000 shares at a price of $60. The initial margin is 40% and the maintenance margin is 30%. At what share price does the investor receive a margin call? &$51.43.&$18.00.;$27.69.;$54.00.;&LOS: Reading 52-fThe initial margin is 40% x $60,000 = $24,000 and he borrows $36,000.His equity is 1,000P - $36,000 and the margin call is when this equals 30% x 1000P or P = $51.43Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 4, pp. 129-130.&&&a&Class@SS12.1&&&&&1&N&0&N.N.N.N 2006JV.923&mcs&0&N&Stock splits tend to have a long-term downward bias on: &price-weighed indexes.&unweighted indexes.;value weighted indexes.;equal-weighted indexes.;&LOS: Reading 53-aStock splits have a downward bias on price-weighted indexes since more successful companies generally do more stock splits which lead to reductions in their weightings in an index. A stock split will not alter a company's weighting in an unweighted, value-weighted or equal-weighted index.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 5, pp. 152-153.&&&a&Class@SS12.2&&&&&1&N&0&N.N.N.N 2006JV.924&mcs&0&N&Which of the following statements about exchange traded funds (ETFs) is most accurate?&They have an open-ended structure.&Purchasers pay a front-end load.;In-cash redemptions are encouraged.;They almost always trade at a discount to NAV.;&LOS: Reading 75-eETFs are traded through market makers and have in-kind redemption and creation which means they trade close to NAV.Reference: Solnik and McLeavey, International Investments, 5th edition, Ch. 8, pp. 377-385.&&&a&Class@SS17.2&&&&&1&N&0&N.N.N.N 2006JV.925&mcs&0&N&If there are two shares, X and Y, making up a security market index and the following information is given:

X: share price $50.20,000 shares outstanding.
Y: share price $25.100,000 shares outstanding.

Which of the following is CORRECT?&If it is a price-weighted index, the index will rise more if X's share price rises by 10% than if Y's share price rises by 10%.&If it is a price-weighted index, the index will rise more if X's share price rises by $10 than if Y's share price rises by $10.;If it is a value-weighted index, the index will rise more if X's share price rises by $10 than if Y's share price rises by $10.;If it is a value-weighted index, the index will rise more if X's share price rises by 10% than if Y's share price rises by 10%.;&LOS: Reading 53-aPrice-weighted index:X's share price rising by $10 has the same effect as Y's share price rising by $10X's share price rising by 10% means the index rises by (55 + 25)/(50 + 25) - 1 = 6.67%Y's share price rising by 10% means the index rises by (50 + 27.5)/(50 + 25) - 1 = 3.33%Value-weighted index:X's share price rising by $10 means the index rises by (1.2 + 2.5)/(1+ 2.5) - 1 = 5.71%Y's share price rising by $10 means the index rises by (1 + 3.5)/(1+ 2.5) - 1 = 28.57%X's share price rising by 10% means the index rises by (1.1+ 2.5)/(1 + 2.5) - 1 = 2.85 %Y's share price rising by 10% means the index rises by (1 + 2.75)/(1 + 2.5) - 1 = 7.14%Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 5, pp. 151-162. &&&a&Class@SS12.1&&&&&1:v&&& 2006JV.926&mcs&0&N&An investor takes a long position in a forward rate agreement (FRA) which expires in 30 days and the underlying is 90-day LIBOR, the rate agreed is 5.0% on a notional principal of $10 million. At expiration the rate is 4.5%, the payment will be closest to? &12361&12500;24450;25000;&LOS: Reading 70-g\\Reference: Chance, Analysis of Derivatives for the CFA(r) Program, (AIMR, 2003), Chapter 2, pp. 33-36.&&&a&Class@SS16.2&&&&&1&N&0&N.N.N.N 2006JV.927&mcs&0&N&Mezzanine financing refers to:&financing just prior to a company going public.&financing for a management buyout.;the first round of financing after a company goes public.;financing for a major expansion of commercial operations.;&LOS: Reading 75-mMezzanine or bridge financing refers to the last financing ahead of a company going public.Reference: Solnik and McLeavey, International Investments, 5th edition, Ch. 8, p. 401.&&&a&Class@SS17.0&&&&&1&N&0&N.N.N.N 2006JV.928&mcs&0&N&A bond has a yield of 7.50% and the on-the-run Treasury yield is 6.55%. The yield spread and yield ratio are: Relative Yield Spread Yield Ratio&14.50% 1.145&14.50% 0.873;12.67% 0.873;12.67% 1.145;&LOS: Reading 65-bThe market practice is to measure the spread and ratio against Treasuries.Relative yield spread: = (Yield on Bond A - Yield on Treasury)/Yield on Treasury = (7.5% - 6.55%)/6.55% = 14.50%Yield Ratio: = Yield on Bond A/Yield on Treasury = 1.145Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 4, pp. 103-104.&&&a&Class@SS14.1&&&&&1&N&0&N.N.N.N 2006JV.929&mcs&0&N&If a put option is in-the-money it means that: &the stock price is below the exercise price.&the stock price is above the exercise price.;the stock price is below the exercise price, by more than the option premium.;the stock price is above the exercise price, by more than the option premium.;&LOS: Reading 72-bIn-the-money means that there is a profit if the option were to be exercised immediately; this does not take into account the cost of the option.Reference: Chance, Analysis of Derivatives for the CFA® Program, (AIMR, 2003), Ch. 4, p. 164.&&&a&Class@SS16.2&&&&&1&N&0&N.N.N.N 2006JV.930&mcs&0&N&An investor might write a covered call for which of the following reasons?&To increase income.&To protect the portfolio against losses.;To benefit from a fall in the stock price.;To increase exposure to a rise in the stock price.;&LOS: Reading 74-bAn investor would collect the premium from writing a call. If the option was exercised he would have to sell his stock to the option holder. If an investor believes that volatility will be low, writing a call option (and/or put options) is one strategy to generate income.Reference: Chance, Analysis of Derivatives for the CFA® Program, (AIMR, 2003), Ch. 7, pp. 422-426.&&&a&Class@SS16.0&&&&&1&N&0&N.N.N.N 2006JV.931&mcs&0&N&An investor purchases a put option for $5 with an exercise price of $80. The current price of the underlying asset is $72. The breakeven point at expiry is an asset price of: &75&67;85;88;&LOS: Reading 74-aThe value of the put at expiry must satisfy X - S = $5 for the value of the put to equal the option premium.Reference: Chance, Analysis of Derivatives for the CFA® Program, (AIMR, 2003), Ch. 7, pp. 419-422.&&&a&Class@SS16.1&&&&&1&N&0&N.N.N.N 2006JV.932&mcs&0&N&In a currency swap agreement Party A has US dollars which they wish to swap for Party B's euros and principals are swapped. At the end of the agreement Party A will pay Party B:&The principal plus the final interest payment, both in euros.&The principal plus the final interest payment, both in US dollars. ;The principal in US dollars and the final interest payment in euros.;Only the interest payment in euros, the notional principal does not change hands.;&LOS: Reading 73-bParty A will return to Party B the principal in euros plus the interest payment on the euros.Reference: Chance, Analysis of Derivatives for the CFA® Program, (AIMR, 2003), Ch. 5, pp. 274-275.&&&a&Class@SS16.2&&&&&1&N&0&N.N.N.N 2006JV.933&mcs&0&N&Which of the following statements is least accurate?&The interest rate risks of on-the-run and off-the-run issues with the same maturity are identical.&The yields of on-the-run issues are generally lower.;The liquidity of off-the-run issues is generally lower.;The financing rates (repo rates) of on-the-run issues are generally lower.;&LOS: Reading 65-eIdentical maturities does not mean identical coupon rates hence the durations may differ.This means that this answer is the least accurate. The interest rate risks of on-the-run and off-the-run issues with the same maturity are identical. Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 4, pp. 108. &&&a&Class@SS14.0&&&&&1&N&0&N.N.N.N 2006JV.934&mcs&0&N& Which of the following statements about futures contracts is most accurate?&II. The profit or loss on a position is calculated daily by the clearinghouse.&I. The tenor of a futures contract can be several years.;III. The maximum loss for the purchaser of a futures contract is the premium paid.;IV. There is no margin payment required when a futures contract is purchased outside an exchange.;&LOS: Reading 71-aTenor is a term used to describe the life of a swap contract, whereas a futures contract has a single expiration date so I. is not correct.III. is false; the purchaser of a futures contract has potentially an unlimited loss. There is no premium paid. IV. is false; futures are traded on an exchange in standardized terms. Reference: Chance, Analysis of Derivatives for the CFA(r) Program, (AIMR, 2003), Chapter 5, pp. 4-5.&&&a&Class@SS16.1&&&&&1&N&0&N.N.N.N 2006JV.935&mcs&0&N&A European option:&can only be exercised at expiry.&is an option traded on an European exchange. ;is traded over the counter rather than through an exchange.;is generally worth more than an equivalent American option.;&LOS: Reading 72-bA European option can only be exercised at expiry whereas an American option can be exercised at any time before and including expiry.Reference: Chance, Analysis of Derivatives for the CFA® Program, (AIMR, 2003), Ch. 4, pp. 161-162.&&&a&Class@SS16.2&&&&&1&N&0&N.N.N.N 2006JV.936&mcs&0&N&Which stage of the industry life cycle is characterized by the following? 'Sales growth matches the growth rate of the economy, profitability is low due to competition and cost control is an important factor'.&Market maturity.&Decline.;Mature growth. ;Rapid accelerating growth.;&LOS: Reading 58-cMarket maturity is the fourth stage of the industry life cycle. Returns on equity have declined due to competition so companies are earning closer to a normal rate of return.Reference: International Investments, Solnik and McLeavey, 5th edition, Ch. 6, pp. 264-265.&&&a&Class@SS13.0&&&&&1&N&0&N.N.N.N 2006JV.937&mcs&0&N&An analyst forecasts the economy is about to begin a recovery. A reasonable recommendation would be that investors: &sell commodities.&sell property.;purchase bonds.;purchase stocks.;&LOS: Reading 58-aAs the economy recovers the best performing assets will be stocks, commodities and property. Bonds will tend to under perform as interest rates rise.Reference: International Investments, Solnik and McLeavey, 5th edition, Ch. 6, pp. 258-259. &&&a&Class@SS13.1&&&&&1&N&0&N.N.N.N 2006JV.938&mcs&0&N&Which of the following statements is most accurate regarding the adjustment of stock prices to new information?&Technical analysts believe that prices adjust more slowly to new information than do fundamental analysts.&Fundamental analysts believe that prices adjust immediately to new information.;Supporters of the efficient market hypothesis believe that prices adjust slowly to new information.;Technical analysts believe that prices adjust more quickly to new information than do supporters of the efficient market hypothesis.;&LOS: Reading 60-aTechnical analysts believe that it takes a period of time for a new trend to establish itself.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 16, pp. 626-627. &&&a&Class@SS13.2&&&&&1&N&0&N.N.N.N 2006JV.939&mcs&0&N&If the price/book value of a company is higher than the market and industry average, this could be explained by: &it is a new company with has a small capital base but it is expected to grow rapidly. &the company has just purchased new machinery. ;the company has significant off-balance sheet liabilities.;the market value of the company's assets is significantly less than the book value.;&LOS: Reading 61-bThe purchase of new machinery would not immediately change the book value. Off-balance-sheet liabilities would reduce the price/book value that investors are willing to pay. If it is a new company with good growth prospects investors may be willing to pay a high multiple of the current book value of assets.Reference: John D. Stowe, Thomas R. Robinson, Jerald E. Pinto, and Dennis W. McLeavey (AIMR, 2003), "Introduction to Price Multiples," pp. 8-14. &&&a&Class@SS13.0&&&&&1&N&0&N.N.N.N 2006JV.940&mcs&0&N&Calendar studies:&do not support the semistrong-form of the Efficient Market Hypothesis.&support the weak-form of the Efficient Market Hypothesis.;support the semistrong-form of the Efficient Market Hypothesis.;do not support the weak-form of the Efficient Market Hypothesis.;&LOS: Reading 54-bAn example of anomalies discovered by calendar studies is the January anomaly which shows that certain U.S. stocks tend to under perform in November and December and outperform in January. This indicates that markets are not semistrong-form efficient.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 7, pp. 184-185.&&&a&Class@SS12.1&&&&&1&N&0&N.N.N.N 2006JV.941&mcs&0&N&The price movements of a 10.5%, 20-year option free bond are given in the following table.

Yield % Bond Price
6.75 140.8288
7.00 137.3714
7.25 134.0390
7.50 130.8265
7.75 127.7287

The duration of the bond when the yield is 7.25% is closest to:& 9.77.&13.24.;17.75.;20.00.;&LOS: Reading 68-e\\ Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 7, pp. 229.&&&a&Class@SS15.2&&&&&1:v&&& 2006JV.942&mcs&0&N&A bond has no embedded options; this means that when yields rise by 100 basis points the fall in price of the bond is:&less than the rise in price when rates fall by 100 basis points.&the same as the rise in price when rates fall by 100 basis points.;more than the rise in price when rates fall by 100 basis points.;more or less than the rise in price when rates fall by 100 basis points, depending on the convexity of the bond.;&LOS: Reading 68-fIf there are no embedded options the bond will have positive convexity, this means that the gain is greater than the loss for a given change in ratesReference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst® Program, 2nd edition, Ch. 7, pp 240-242.&&&a&Class@SS15.0&&&&&1&N&0&N.N.N.N 2006JV.943&mcs&0&N&The following theoretical spot rates are given:

PeriodYearSpot rate (%)BEY
10.53.0000
21.03.3000
31.53.5053

An 8% semi-annual coupon bond, with $100 par value, has 3 remaining coupon payments. The price of the bond is closest to: &$106.53.&$100.00.;$103.51.;$119.85.;&LOS: Reading 66-dThis is valuing a bond using spot rates. The given spot rates are on a bond equivalent basis, so\\Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 5, pp. 143-144&&&a&Class@SS15.1&&&&&1:v&&& 2006JV.944&mcs&0&N&From the information given in the question above, the 6-month forward rate one year from now is closest to:&3.9165%.&3.3000%.;3.4027%.;3.5053%.;&LOS: Reading 67-gThe given spot rates are quoted on a bond equivalent basis, so\\Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 6, pp. 190-193&&&a&Class@SS15.2&&&&&1&N&0&N.N.N.N 2006JV.945&mcs&0&N&A rate duration is defined as:&The sensitivity of the change in the bond price with respect to a particular spot rate.&The sensitivity of the change in the bond price with respect to a package of forward rates.;The sensitivity of the change in the price of an international bond with respect to a particular exchange rate.;The sensitivity of the change in the bond price with respect to a particular nonparallel shifts in the yield curve.;&LOS: Reading 63-fThe rate duration is calculated assuming that the other yields remain constant, so it is relative to a particular spot rate.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst® Program, 2nd edition, Ch. 2, pp. 35.&&&a&Class@SS14.0&&&&&1&N&0&N.N.N.N 2006JV.946&mcs&0&N&Which of the following is the least appropriate example of credit enhancement to a debt issue?&An early redemption option.&A letter of credit.;A third-party (but related) guarantee.;A third-party (but unrelated) guarantee.;&LOS: Reading 64-jEarly redemption is not a credit enhancement.Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst® Program, 2nd edition, Ch. 3, pp 73-75.&&&a&Class@SS14.1&&&&&1&N&0&N.N.N.N 2006JV.947&mcs&0&N&Which of the following is a characteristic of hedge funds?&They target absolute returns.&They charge lower than average management fees. ;They use hedging to eliminate market-related risks. ;They do not borrow but use derivatives to enhance returns.;&LOS: Reading 75-pCharacteristics of hedge funds are that they target absolute returns, have a flexible strategy in terms of using derivatives etc. and charge performance-based fees.Reference: Solnik and McLeavey, International Investments, 5th edition, Ch. 8, p. 401.&&&a&Class@SS17.1&&&&&1&N&0&N.N.N.N 2006JV.948&mcs&0&N&Investing in commodities:&provides an inflation hedge.&provides a low volatility of returns.;is a defensive policy in times of low economic activity.;provides returns that are highly correlated to equity markets. ;&LOS: Reading 75-xCommodities tend to perform well in times of high inflation and are often purchased as an inflation hedge.Reference: Solnik and McLeavey, International Investments, 5th edition, Ch. 8, pp. 426-430.&&&a&Class@SS17.0&&&&&1&N&0&N.N.N.N 2006JV.949&mcs&0&N&The required rate of return from a risky investment is best described as: &the nominal risk-free rate plus a risk premium. &the real risk-free rate plus a risk premium.;the real risk-free rate plus the expected inflation rate.;the nominal risk-free rate less the expected inflation rate, plus a risk premium.;&LOS: Reading 76-aThe required return is simply the nominal risk-free rate (which is approximately the real risk-free rate plus expected inflation) plus a risk premium. Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 1, pp. 16-23.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.950&mcs&0&N&An investment manager is concerned that the stock market is going to decline, which of the following would be the most appropriate strategy for an equity portfolio?&Ensure that the beta of the portfolio is less than one.&Ensure that the beta of the portfolio is more than one.;Ensure that the standard deviation of the portfolio is less than the market standard deviation.;Ensure that the standard deviation of the portfolio is more than the market standard deviation.;&LOS: Reading 79-eThe manager will wish to reduce the sensitivity of his portfolio to the market, which is the systematic risk or beta of the portfolio. The market beta is one so if he reduces the beta below one he would expect his portfolio to fall by less then the market in a declining market. Reducing the standard deviation of the portfolio will reduce its volatility but not necessarily the beta of the portfolio.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 8, pp. 247-252. &&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.951&mcs&0&N&Which of the following is least likely to be a step in the investment process?&Submitting regulatory reports to the appropriate authority. &Asset allocation.;Monitoring the portfolio.;Evaluating portfolio performance.;&LOS: Reading 77-aSubmitting regulatory reports is not part of the investment decision-making process.The portfolio management process consists of four steps, 1. construct the policy statement, 2. forecast future economic and market trends, 3. construct the portfolio 4. the continual monitoring and evaluation of performance.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 2, pp. 38-39.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.952&mcs&0&N&Which of the following shows that investors are generally risk averse?&Low grade bonds offer a higher yield to maturity.&Investors purchase lottery tickets.;Investors often put most of their money into property. ;Many investors prefer to only invest in their domestic market.;&LOS: Reading 78-aAnswers: Investors often put most of their money into property. Many investors prefer to only invest in their domestic market.Are examples of investors not diversifying their risk, so are not examples of risk aversion. Purchasing lottery tickets is not an example of risk aversion.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 7, pp. 210-211.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.953&mcs&0&N&Systematic risk &is measured by beta.&is zero for the market.;is the standard deviation of a stock's return.;can be largely diversified away if more than 20 stocks are held in a portfolio.;&LOS: Reading 79-dSystematic risk is the market risk that is measured by beta. It cannot be diversified away by buying more and more stocks in a market.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 8, p. 245.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.954&mcs&0&N&If a stock lies above the security market line (SML) this would indicate that the stock: &is underpriced.&is overpriced.;has a higher expected return than the market.;has a lower expected return than the market.;&LOS: Reading 79-fThe stock is underpriced because the expected rate of return is higher then the required rate of return to compensate for its beta risk.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 8, pp. 247-251.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.955&mcs&0&N&Which of the following statements describe a factor that would be included as a constraint in an individual investor's policy statement?&A high marginal income tax rate.&A requirement for capital appreciation.;A requirement for capital preservation.;A need to receive income from their investments.;&LOS: Reading 77-cRisk and return items would be part of the objectives, rather than constraints.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 2, pp. 46-52.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.956&mcs&0&N&If the nominal risk-free rate is 12% and the expected inflation rate is 3%, then the real risk-free rate is closest to:&8.7%.&4.0%. ;9.0%.;15.4%.;&LOS: Reading 76-b(1.12/1.03) - 1 = 8.7%Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 1, pp. 17-19.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.957&mcs&0&N&Which of the following factors would cause a change in slope of the security market line (SML)?&II. An increase in the market risk premium.&I. A higher rate of growth in the economy.;III. An increase in the nominal risk-free rate.;IV. A change in the expected rate of inflation.;&LOS: Reading 76-dI., III., and IV. would cause a parallel shift in the SML. Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 1, pp. 23-27.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.958&mcs&0&N&Investments along the Capital Market Line (CML) are:&combinations of the risk-free asset and the market portfolio. &less risky than the market portfolio. ;not optimal since they lie below the efficient frontier. ;optimal since the systematic risk has been diversified away.;&LOS: Reading 79-cThe CML is the tangent from the point representing the risk-free asset to the efficient frontier. Points along the tangent will represent combinations of the risk-free asset and the market portfolio. They can be more or less risky than the market portfolio according to whether the portfolio has borrowing or not. Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 8, pp. 240-242.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.959&mcs&0&N&A U.S. based investment manager is concerned that the volatility of an international equity fund he is managing is too high. Which of the following would be an appropriate course of action?&Consider investing in markets which have a low correlation with the existing assets in the portfolio.&Increase the weighting in high beta stocks.;Sell the international holdings and only hold U.S. stocks.;Sell small capitalization stocks and concentrate the portfolio in a small number of big market capitalization stocks. ;&LOS: Reading 78-gIn order to reduce volatility which is the standard deviation of returns the manager can include assets which have a low correlation with the existing assets in the portfolio. Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 7, pp. 228-229.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.960&mcs&0&N&A stock has a beta of 0.6, the expected market risk premium is 8% and the risk-free rate is 4%. The expected return from the stock is: & 8.8%.& 2.4%.;0.064;11.2%.;&R = 4% + 0.6(8%) = 8.8%Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 8, pp. 247-251. &&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.961&mcs&0&N&Mezzanine financing refers to:&financing just prior to a company going public.&financing for a management buyout.;the first round of financing after a company goes public.;financing for a major expansion of commercial operations.;&Mezzanine or bridge financing refers to the last financing ahead of a company going public.Reference: Solnik and McLeavey, International Investments, 5th edition, Ch. 8, p. 401.&&&a&Class@SS17.1&&&&&1&N&0&N.N.N.N 2006JV.962&mcs&0&N&Which of the following is a characteristic of hedge funds?&They target absolute returns.&They charge lower than average management fees. ;They use hedging to eliminate market-related risks. ;They do not borrow but use derivatives to enhance returns.;&Characteristics of hedge fund are that they target absolute returns, have a flexible strategy in terms of using derivatives etc. and charge performance-based fees.Reference: Solnik and McLeavey, International Investments, 5th edition, Ch. 8, p. 401.&&&a&Class@SS17.2&&&&&1&N&0&N.N.N.N 2006JV.963&mcs&0&N&Investing in commodities:&provides an inflation hedge.&provides a low volatility of returns.;is a defensive policy in times of low economic activity.;provides returns that are highly correlated to equity markets. ;&Commodities tend to perform well in times of high inflation and are often purchased as an inflation hedge.Reference: Solnik and McLeavey, International Investments, 5th edition, Ch. 8, pp. 426-430.&&&a&Class@SS17.0&&&&&1&N&0&N.N.N.N 2006JV.964&mcs&0&N&Investments along the Capital Market Line (CML) are:&combinations of the risk-free asset and the market portfolio. &less risky than the market portfolio. ;not optimal since they lie below the efficient frontier. ;optimal since the systematic risk has been diversified away.;&The CML is the tangent from the point representing the risk-free asset to the efficient frontier. Points along the tangent will represent combinations of the risk-free asset and the market portfolio.They can be more or less risky than the market portfolio according to whether the portfolio has borrowing or not. Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 8, pp. 240-242.&&&a&Class@SS17.2&&&&&1&N&0&N.N.N.N 2006JV.965&mcs&0&N&An investor is considering buying an apartment and is provided with the following information.

Gross rental income$50,000
Depreciation$ 8,000
Maintenance$ 5,000
Insurance$ 1,000
Property tax$ 3,000

Vacancy and collection costs are estimated to be 10% and the investor's marginal tax rate is 30%. The net operating income (NOI) is:&36000&14000;$19.600.;28000;&NOI = rental - vacancy cost - maintenance - insurance - property tax = $50,000 - $5,000 - $5,000 - $1,000 -$ 3,000 = $36,000Note that we do not deduct depreciation or the income tax in this calculation.Reference: "Alternative Investments," International Investments, 5th edition, Bruno Solnik and Dennis McLeavey, 2004, Ch. 8, pp. 391-396.&&&a&Class@SS17.1&&&&&1:v&&& 2006JV.966&mcs&0&N&Which of the following statements concerning exchange traded funds (ETFs) is least accurate?&ETFs are usually closed-end.&ETFs can be listed on an exchange.;ETFs can be traded throughout the day.;ETFs generally trade at close to their net asset value (NAV).;&They are usually open-end funds.Reference: "Alternative Investments," International Investments, 5th edition, Bruno Solnik and Dennis McLeavey, 2004, Ch. 8, pp. 377-386. &&&a&Class@SS17.1&&&&&1&N&0&N.N.N.N 2006JV.967&mcs&0&N&The investor policy statement: &outlines an investor's objectives and constraints.&is only relevant to individual investors.;specifies the minimum return that is guaranteed to the investor.;outlines the investment manager's philosophy and decision-making process.;&A policy statement helps the investor specify realistic goals and in setting the goals become more aware of the risks of investing. It is a valuable way of communicating with the portfolio manager. It also helps set the benchmark against which performance can be measured.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 2, pp. 40-42.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.968&mcs&0&N&Which of the following factors would be likely to push up the nominal risk-free rate? &A rapidly growing economy.&A fall in the cost of funds.;An increase in the supply of capital.;A fall in the expected level of inflation.;&A rapidly growing economy will increase demand for capital and provide opportunities for investors to earn a high rate of return, which will push up required rates of return by the suppliers of capital.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 1, pp. 16-19.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.969&mcs&0&N&Which of the following is least likely an assumption of capital market theory?&Investors are influenced by both rational and irrational factors.&Investors have the same time horizon. ;Investors can borrow at the risk-free rate of return. ;Investors wish to maximize the risk/return utility of their investments. ;&Capital market theory assumes investors are rational and select portfolios on the efficient frontier. Behavioral finance and technical analysis have moved on from traditional capital market theory and say that investors are influenced by rational and irrational factors. Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 8, pp. 238-240.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.970&mcs&0&N&Which of the following statements is most correct?&IV. A stock with a beta that is higher than the market is expected to provide a return that is higher than the market, when the market return is above the risk free rate. &I. The beta of the market is 0.;II. Beta is a measure of unsystematic risk.;III. Betas are always greater than or equal to 1.;&I. is not correct; the beta of the market is 1. II. is not correct; beta is a measure of market risk. III. is not correct, betas can be negative. Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 8, pp. 246-250.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.971&mcs&0&N&Investors in the consolidation phase of their life cycle will generally:&have a long time horizon and are looking to hold moderate risk investments. &have small net worth so they are looking for low risk investments.;have reached the end of their working life and the focus is on preservation of capital. ;earn less than they are spending so they will adopt a very conservative investment policy. ;&In the consolidation phase individuals are typically in the second part of their working life, have few debts and earnings exceed expenses. They still have a long time horizon (20 years plus) and can take on moderate risk. Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 2, pp. 37-38.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.972&mcs&0&N&A portfolio has 70% invested in asset A and 30% in asset B, the assets have standard deviations of 3% and 5% respectively. The correlation between the two assets is 0.8. The standard deviation of the combined portfolio is closest to:&3.42%.&2.51%.;11.70%.;19.10%.;&\\Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 8, p. 241.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.973&mcs&0&N&The optimal portfolio for an investor is represented by:&The point where his/her highest utility curve is tangent to the efficient frontier.AND The point on the efficient frontier that represents the best risk-return trade-off for the investor.&The market portfolio.AND The point on the efficient frontier that represents the best risk-return trade-off for the investor.;The point where the securities market line is tangent to the efficient frontier.AND The point where his/her highest utility curve is tangent to the efficient frontier.;The market portfolio.AND The point where his/her highest utility curve is tangent to the efficient frontier.;&The utility curves represent the trade off between risk and return; the optimal portfolio will be where the highest utility curve touches the efficient frontier.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 7, pp. 229-230.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.974&mcs&0&N&In capital markets theory unsystematic risk is:&II. unique risk.&I. total risk.;III. market risk.;IV. undiversifiable risk.;&I. includes systematic and unsystematic risk and III. and IV. refer to systematic risk. Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 8, pp. 243-247.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.975&mcs&0&N&A U.S. investor is considering international diversification. Which of the following statements is most correct?&Higher returns can be achieved for the same level of risk as investing solely in the U.S. market.&Higher returns may compensate for the additional risk of purchasing overseas securities. ;Markets which have a higher correlation with U.S. market returns will generally generate higher returns.;Investing in markets with low correlations to the U.S. market return will be most effective in increasing returns.;&A U.S. investor, by investing in markets which provide returns which have a low correlation with the U.S. market returns, can usually achieve higher returns for the same level of risk. Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 7, pp. 219-224.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.976&mcs&0&N&The stock analyst in your firm has completed his forecasts for Kensington Corp. and Paddington Inc. The current share prices are $85 and $56 respectively, and he forecasts that a year from now the share prices will have risen to $102 and $60 respectively, each stock will make a dividend payment of $2 at the end of the year. The betas of the stock are 1.5 and 0.9, the expected market return over the next year is 15% and the risk free rate is 6%. On the basis of the analyst's forecast: &Kensington Corp. is undervalued and Paddington Inc. is overvalued.&Kensington Corp. and Paddington Inc. are both overvalued.;Kensington Corp. and Paddington Inc. are both undervalued.;Kensington Corp. is overvalued and Paddington Inc. is undervalued.;&Using CAPM the estimated return for Kensington Corp. is 6% + 1.5 (15% - 6%) = 19.5%. The analyst is forecasting a return of 22.4% (from capital gain plus dividend) so the stock looks undervalued.The estimated return for Paddington Inc. is 6% + 0.9 (15% - 6%) = 14.1%. The analyst is forecasting a return of 10.7% so the stock looks overvalued.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 8, pp. 247-252.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.977&mcs&0&N&If the standard deviations of the returns of two assets are 1.5% and 6.0%, and the covariance between the two assets is 5.2, then the correlation coefficient between the returns is closest to:&0.58.&0.06.;0.47.;1.73.;&\\Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 7, pp. 217-218.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.978&mcs&0&N&Which of the following is least likely a limitation of the Capital Asset Pricing Model? &Empirically there is no evidence that betas are linked to stock returns.&It considers only systematic risk.;Estimates of betas are not always accurate.;It assumes portfolios are sufficiently well diversified to eliminate unsystematic risk.;&There is some evidence that stock returns are linked to their beta.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th Edition Ch. 8, pp. 247-252.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.979&mcs&0&N&An individual in the spending phase of his life cycle will generally: &balance fixed income and equity investment with the aim of preserving the real value of the investments.&invest primarily in equities since they can afford to take on greater levels of risk.;only invest in fixed income securities in order to generate a steady stream of income.;focus on transferring his investments to trusts to minimize estate and inheritance taxes.;&The spending phase usually begins at retirement and investment policy becomes more conservative as the investor needs to protect the real value of the capital. However he still needs to invest a portion of the portfolio in equities to provide inflation protection.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 2, pp. 37-38. &&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.980&mcs&0&N&An investment manager is concerned that the stock market is going to decline, which of the following would be the most appropriate strategy for an equity portfolio?&Ensure that the beta of the portfolio is less than one.&Ensure that the beta of the portfolio is more than one.;Ensure that the standard deviation of the portfolio is less than the market standard deviation.;Ensure that the standard deviation of the portfolio is more than the market standard deviation.;&The manager will wish to reduce the sensitivity of his portfolio to the market, which is the systematic risk or beta of the portfolio. The market beta is one so if he reduces the beta below one he would expect his portfolio to fall by less then the market in a declining market. Reducing the standard deviation of the portfolio will reduce its volatility but not necessarily the beta of the portfolio.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 8, pp. 247-252. &&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.981&mcs&0&N&Which of the following are steps in the investment process?&I. Asset allocation.II. Monitoring the portfolio.III. Evaluating portfolio performance.IV. Formulating the client policy statement.&I. Asset allocation.II. Formulating the client policy statement.;I. Monitoring the portfolio.II. Evaluating portfolio performance.III. Formulating the client policy statement.;I. Asset allocation.II. Monitoring the portfolio.III. Formulating the client policy statement.;&The portfolio management process consists of four steps, I. construct the policy statement, II. forecast future economic and market trends, III. construct the portfolio and continual monitoring and IV. evaluation of performance.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 2, pp. 38-39.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.982&mcs&0&N&Which of the following shows that investors are generally risk averse?&II. Low grade bonds offer a higher yield to maturity.&I. Investors purchase lottery tickets.;III. Investors often put most of their money into property. ;IV. Many investors prefer to only invest in their domestic market.;&III. and IV. are examples of investors not diversifying their risk, so are not examples of risk aversion. Purchasing lottery tickets is not an example of risk aversion.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 7, pp. 210-211.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.983&mcs&0&N&Systematic risk &is measured by beta.&is zero for the market.;is the standard deviation of a stock's return.;can be largely diversified away if more than 20 stocks are held in a portfolio.;&Systematic risk is the market risk that is measured by beta. It cannot be diversified away by buying more and more stocks in a market.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 8, p. 245.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.984&mcs&0&N&If a stock lies above the security market line (SML) this would indicate that the stock: &is underpriced.&is overpriced.;has a higher expected return than the market.;has a lower expected return than the market.;&The stock is underpriced because the expected rate of return is higher then the required rate of return to compensate for its beta risk.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 8, pp. 247-251.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.985&mcs&0&N&Which of the following statements describe a factor that would be included as a constraint in an individual investor's policy statement?&A high marginal income tax rate.&A requirement for capital appreciation.;A requirement for capital preservation.;A need to receive income from their investments.;&Risk and return items would be part of the objectives, rather than constraints.Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 2, pp. 46-52.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.986&mcs&0&N&If the nominal risk-free rate is 12% and the expected inflation rate is 3%, then the real risk-free rate is closest to:& 8.7%.& 4.0%. ; 9.0%.;15.4%.;&(1.12/1.03) - 1 = 8.7%Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 1, pp. 17-19.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.987&mcs&0&N&Which of the following factors would cause a change in slope of the security market line (SML)?&An increase in the market risk premium.&A higher rate of growth in the economy.;An increase in the nominal risk-free rate.;A change in the expected rate of inflation.;&The incorrect answers would cause a parallel shift in the SML. Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 1, pp. 23-27.&&&a&Class@SS18.0&&&&&1&N&0&N.N.N.N 2006JV.988&mcs&0&N&A U.S. based investment manager is concerned that the volatility of an international equity fund he is managing is too high. Which of the following would be an appropriate course of action?&Consider investing in markets which have a low correlation with the existing assets in the portfolio.&Increase the weighting in high beta stocks.;Sell the international holdings and only hold U.S. stocks.;Sell small capitalization stocks and concentrate the portfolio in a small number of big market capitalization stocks. ;&In order to reduce volatility which is the standard deviation of returns the manager can include assets which have a low correlation with the existing assets in the portfolio. Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 7, pp. 228-229.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.989&mcs&0&N&A stock has a beta of 0.6, the expected market risk premium is 8% and the risk-free rate is 4%. The expected return from the stock is: & 8.8%.& 2.4%.;0.064;11.2%.;&R = 4% + 0.6(8%) = 8.8% Reference: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 8, pp. 247-251. &&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.990&mcs&0&N&A U.S. based investment manager is concerned that the volatility of an international equity fund he is managing is too high. Which of the following would be an appropriate course of action?&Consider investing in markets which have a low correlation with the existing assets in the portfolio.&Increase the weighting in high beta stocks.;Sell the international holdings and only hold U.S. stocks.;Sell small capitalization stocks and concentrate the portfolio in a small number of big market capitalization stocks. ;&It is possible to derive a portfolio that has lower risk than each of the single asset. The reduction of the portfolio risk is a result of less correlated assets.Reference: Investment Analysis and Portfolio Management, 7th edition, Frank K. Reilly and Keith C. Brown, Ch. 7, pp. 222-224.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.991&mcs&0&N&The capital market line gives the relationship between returns and:&standard deviation.&beta.;duration.;variance.;&The capital market line is the defined to be the relationship between portfolio returns and portfolio risks. Portfolio risks are measured by the standard deviation of the portfolio returns.Reference: Investment Analysis and Portfolio Management, 7th edition, Frank K. Reilly and Keith C. Brown, Ch. 8, pp. 242-243.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.992&mcs&0&N&An individual in the spending phase of his life cycle will generally: &balance fixed income and equity investment with the aim of preserving the real value of the investments.&invest primarily in equities since they can afford to take on greater levels of risk.;only invest in fixed income securities in order to generate a steady stream of income.;focus on transferring his investments to trusts to minimize estate and inheritance taxes.;&The spending phase usually begins at retirement and investment policy becomes more conservative as the investor needs to protect the real value of the capital. However he still needs to invest a portion of the portfolio in equities to provide inflation protection.Reference: Investment Analysis and Portfolio Management, 7th edition, Frank K. Reilly and Keith C. Brown, Ch. 2, pp. 37-38.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.993&mcs&0&N&A portfolio is invested equally between two assets, the assets have standard deviations of 4% and 8%, and the correlation between the two assets is 0.3. The standard deviation of the combined portfolio is closest to:& 4.98%.& 6.00%.; 6.64%.;24.80%.;&LOS: Reading 76-c\\Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 7, pp. 219-227.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.994&mcs&0&N&A portfolio is invested equally between two assets, the assets have standard deviations of 4% and 8%, and the correlation between the two assets is 0.3. The standard deviation of the combined portfolio is closest to:& 4.98%.& 6.00%.; 6.64%.;24.80%.;&LOS: Reading 76-c\\Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 7, pp. 219-227.&&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N 2006JV.995&mcs&0&N&Two assets have zero correlation. If a portfolio is invested with 30% in the first asset that has a variance of 12, and 70% in the second asset that has a variance of 8, the variance of the combined portfolio is closest to:&5.0.&2.2.;6.7.;9.2.;&\\Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 7, pp. 219-227.&&&a&Class@SS18.1&&&&&1&N&0&N.N.N.N 2006JV.996&mcs&0&N&A bond market index is most likely to be constructed as:&The U.S. Government bond indexes are highly correlated with U.S. high-yield bond indexes, since there is no exchange rate effect.&The U.S. Government bond indexes are highly correlated with U.S. investment-grade corporate bond indexes since interest rate moves are the dominant factor in the pricing of all investment grade bonds.;The U.S. Government bond indexes are weakly correlated with many non-U.S. government bond indexes which suggests than international diversification of bond portfolios has little potential to reduce portfolio risk.;U.S. Government has issued bonds where the dividends are linked to U.S. Treasury bill yields.;&The correlation with high-yield bonds is low (around 0.5) as default risk is a determining factor in the performance of high-yield bonds. The correlation with non-US bonds is low but this will increase the benefits of diversification in reducing portfolio risk.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 5, pp. 163-166. &&&a&Class@SS18.2&&&&&1&N&0&N.N.N.N