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.&&&&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:&III is acceptable as long the limits are clear and fully disclosed.&I breaches the code of ethics of the company.;II compromises Holb’s independence as a board member.;IV 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.&&&&Class@SS01.2&&&&&1&N&0&N.N.N.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. &&&&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.&&&&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.&&&&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. &&&&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.&&&&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.&&&&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?&III The separation of voting rights from economic rights may reduce investors’ enthusiasm for the shares.&I As a state-owned enterprise, TeleNorth can only appoint a classified board.;II Proxy voting is only permitted at the discretion of golden sharesholders. i.e. the government.;IV 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.&&&&Class@SS01.0&&&&&1&N&0&N.N.N.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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&Class@SS01.0&&&&&1&N&0&N.N.N.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.&&&&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.&&&&Class@SS01.2&&&&&1&N&0&N.N.N.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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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?&II Invest in the Treasury Bills until the new investment policy and objectives are established.&I Revert to the client for a decision and do nothing until the client’s direction is received. ;III Split the investment between the corporate bond and the Treasury Bills to diversify the risk.;IV 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.&&&&Class@SS01.0&&&&&1&N&0&N.N.N.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.&&&&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.&&&&Class@SS01.2&&&&&1&N&0&N.N.N.N 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.&&&&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.&&&&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-fThe 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&&& 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&&&&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@SS02.2&&&&&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. &&&&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.&&&&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. &&&&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. &&&&Class@SS02.1&&&&&1&N&0&N.N.N.N 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.&&&&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.&&&&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.&&&&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. &;;&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.&&&&Class@SS02.1&&&&&1&N&0&N.N.N.N 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. &&&&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. &&&&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.&&&&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.&&&&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. \Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 4, pp. 192-194. &&&&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. &&&&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.&&&&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.&&&&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.&&&&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.&&&&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. &&&&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.&&&&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.&&&&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.&&&&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.&&&&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. &&&&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.&&&&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.&&&&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.&&&&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. \Reference: DeFusco, McLeavey, Pinto, Runkle, Quantitative Methods for Investment Analysis, 2nd Edition, Chapter 6, p 287.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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?
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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.
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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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 $/Ł = 2.7500 – 2.7532, the bid-ask percent spread is closest to:&0.1162%.&0.1164%.;0.3200%.;11.6400%.;&LOS: Reading 27-bThe bid – ask spread = (2.7532 – 2.7500)/2.7532 x 100 = 0.1162%Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 1, pp. 7-10.&&&&Class@SS06.1&&&&&1&N&0&N.N.N.N 2006JV.230&mcs&0&N&A customer requests a quote from a bank for the exchange rate between two currencies and he finds that the spread quoted is larger than the spread he was quoted on a previous US$/Ł transaction. This is most likely to be because:&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.&&&&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 Ł are as follows:

HK$/Ł = 12.30
Yen/Ł = 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$/Ł x Ł/Yen = 12.30/170 = 0.07235Reference: Solnik and McLeavey, International Investments, 5th Edition, Ch. 1, pp. 7-10.&&&&Class@SS06.0&&&&&1&N&0&N.N.N.N 2006JV.232&mcs&0&N&Pounds sterling is quoted at US$/Ł = 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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.\Reference: White, Sondhi, Fried, The Analysis and Use of Financial Statements, 3rd Edition, Ch.3, pp. 78-82.&&&&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 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.\Cash flow from operating activities was:&$46 million.&$36 million.;$39 million.;$49 million.;&LOS: Reading 33-a\
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.&&&&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:
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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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\\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.&&&&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.&&&&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.&&&&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.&&&&Class@SS08.0&&&&&1&N&0&N.N.N.N 2006JV.285&mcs&0&N&ABC Corporation provides you with the following information:\\Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 325-326.&&&&Class@SS08.1&&&&&1&N&0&N.N.N.N 2006JV.286&mcs&0&N&ABC Corporation provides you with the following information:
\Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 326-327.&&&&Class@SS08.2&&&&&1&N&0&N.N.N.N 2006JV.287&mcs&0&N&ABC Corporation provides you with the following information:
\Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 330-331.&&&&Class@SS08.0&&&&&1&N&0&N.N.N.N 2006JV.288&mcs&0&N&ABC Corporation provides you with the following information:
\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.&&&&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\\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.&&&&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.&&&&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.&&&&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.&&&&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:
\Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 323-324.&&&&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:
\Reference: Reilly, Brown, Investment Analysis and Portfolio Management, 7th Edition, Ch. 10, pp. 324-325.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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\
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.\
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. 260-262.&&&&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.&&&&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.&&&&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.&&&&Class@SS09.0&&&&&1&N&0&N.N.N.N 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.&&&&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.&&&&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.&&&&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.&&&&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 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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&Class@SS09.0&&&&&1&N&0&N.N.N.N 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. 9, pp. 292-296.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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. 357-358.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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:\\Reference: Brigham and Houston, Fundamentals of Financial Management, 8th Edition, Ch. 13, pp. 534-535.&&&&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. 9, pp. 362-363.&&&&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. 360-362.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&Class@SS12.2&&&&&1&N&0&N.N.N.N 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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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:
\.Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 5, pp. 151-157.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&Class@SS12.2&&&&&1&N&0&N.N.N.N 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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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: International Investments, Solnik and McLeavey, 5th Edition, Ch. 6, pp. 265-266.&&&&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.&&&&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.&&&&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.&&&&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\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.&&&&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.&&&&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.&&&&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.&&&&Class@SS14.1&&&&&1&N&0&N.N.N.N 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. 6, pp. 189-193.&&&&Class@SS15.0&&&&&1&N&0&N.N.N.N 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\\or 9.8% annual yieldReference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 5, p. 137.&&&&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\\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.&&&&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.&&&&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. 6, pp. 166-167.&&&&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. 190-194.&&&&Class@SS15.2&&&&&1&N&0&N.N.N.N 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.&&&&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.&&&&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.&&&&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. 178-182.&&&&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. 7, pp. 239-244.&&&&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. 5, pp. 138-139.&&&&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.&&&&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: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 4, pp. 180-184.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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\\Reference: Analysis of Derivatives for the CFA(r) Program, Chance, (AIMR, 2003), Chapter 7, pp. 419-421.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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. &&&&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. &&&&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. &&&&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.&&&&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.&&&&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.&&&&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 &&&&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.&&&&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. &&&&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.&&&&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.&&&&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.&&&&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 Ł8,000 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. 375-377. &&&&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&&&&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 Ł500,000. 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. &&&&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.&&&&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.\\Reference: International Investments, 5th edition, Solnik and McLeavey, Chapter 8, pp. 405-406.&&&&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. &&&&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.&&&&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. &&&&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. &&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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. &&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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. 217-218.&&&&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.&&&&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 8, pp. 247-251.&&&&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.&&&&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 8, pp. 247-250.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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\\Reference: Investment Analysis and Portfolio Management, Reilly and Brown, 7th Edition, Chapter 8, p. 241.&&&&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.&&&&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.&&&&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\
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.&&&&Class@SS02.0&&&&&1&N&0&N.N.N.N 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.&&&&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 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.&&&&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.&&&&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 \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.&&&&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.&&&&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.&&&&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.&&&&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. &&&&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. &&&&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.&&&&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.&&&&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. &&&&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: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition, Ch. 10, pp. 324-327. &&&&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. &&&&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. &&&&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. &&&&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. &&&&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. &&&&Class@SS09.2&&&&&1&N&0&N.N.N.N 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. &&&&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. &&&&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\\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. &&&&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 \\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.&&&&Class@SS15.0&&&&&1&N&0&N.N.N.N 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\\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.&&&&Class@SS15.2&&&&&1&N&0&N.N.N.N 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\\Reference: Fabozzi, Fixed Income Analysis for the Chartered Financial Analyst(r) Program, 2nd edition, Ch. 4, pp. 108-109.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 5, pp. 257-260.&&&&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.&&&&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 \ 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.&&&&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:\\Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 1, pp. 9-10.&&&&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.&&&&Class@SS02.2&&&&&1&N&0&N.N.N.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.&&&&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\\Reference: DeFusco, McLeavey, Pinto and Runkle, Quantitative Methods for Investment Analysis, 2nd edition, Ch. 6, pp. 297-302.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&Class@SS06.2&&&&&1&N&0&N.N.N.N 2006JV.888&mcs&0&N&If a bank in the U.K. quoted the US dollar exchange rate as Ł1 = 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 (Ł1). It is also in American terms because it is the dollar price of one pound sterling (Ł).Reference: Solnik and McLeavey, International Investments, 5th edition, Ch. 1, pp. 4-5.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&Class@SS07.2&&&&&1&N&0&N.N.N.N 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. &&&&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. &&&&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. &&&&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. &&&&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. &&&&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.&&&&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. &&&&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. &&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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. &&&&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: Chance, Analysis of Derivatives for the CFA(r) Program, (AIMR, 2003), Chapter 2, pp. 33-36.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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. &&&&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.&&&&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.&&&&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.&&&&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. &&&&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. &&&&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. &&&&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.&&&&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. 5, pp. 143-144&&&&Class@SS15.1&&&&&1&N&0&N.N.N.N 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: Reilly and Brown, Investment Analysis and Portfolio Management, 7th edition Ch. 7, pp. 217-218.&&&&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.&&&&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. &&&&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. &&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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.&&&&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. &&&&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.&&&&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.&&&&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.&&&&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.&&&&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.;&\