CFA Level I Revision Class

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Ethics Quantitative techniques Economics Derivatives

Questions 1 Ethics
According to the Standards of Practice Handbook , a member who is an investment manager is most likely to breach his duty to clients by:
A. Habitually voting with management on proxies that relate to non-routine governance issues. B. Disclosing confidential client information to the CFA Institute Professional Conduct Program. C. Using client brokerage to purchase goods or services that are used in the investment decision-making process.

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Questions 1 Answer
A fi duciary who votes blindly with management on non-routine governance issues may breach their duty to clients by violating the standard that relates to loyalty, prudence, and care.

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Questions 2 Ethics
Kim Li, CFA, is a portfolio manager for an investment advisory firm. Li delegates some of her supervisory duties to Janet Marshall, CFA, after educating Marshall on methods to prevent and detect violations of the firm's compliance procedures. Despite these efforts, Li discovers that an employee reporting to Marshall may have violated the law. According to the Standards of Practice Handbook , Li's initial course of action must be to:
A. Suspend Marshall from her supervisory duties. B. Initiate an investigation to determine the extent of the wrongdoing. C. Demand that the employee involved provide assurances that the activity will not be repeated

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Questions 2 Answer
A supervisor may delegate supervisory responsibilities, but such delegation does not relieve them of their supervisory responsibility; Li must immediately begin an investigation of the matter to ascertain the extent of the wrongdoing. Relying on assurances from the employee or simply reporting the misconduct up the chain of command are not enough.

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Questions 3 Ethics
Meryl Mamet, CFA, manages an emerging markets fund which has generated annual returns of 30% for the past three years. Mamet distributes a marketing brochure which includes the following statement "My investment expertise has generated annual returns of 30% for the past three years and you can expect a similar rate of growth over the next two years." Does Mamet violate any CFA Institute Standards?
A. Yes, because the performance should be stated net of fees. B. Yes, because the returns must include terminated accounts. C. Yes, because the presentation makes assurances regarding investment Performance.

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Questions 3 Answer
Members must not knowingly make statements of assurances or guarantees regarding an investment.

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Questions 4 Ethics
Crandall Temasek, CFA, filed for personal bankruptcy two years ago after incurring large medical expenses. He was hired recently as a portfolio manager. According to the CFA Institute Standards, must Temasek disclose his bankruptcy filing to his new employer?
A. Yes, because bankruptcy represents a potential conflict of interest. B. Yes, because bankruptcy reflects poorly on his conduct and character. C. No

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Questions 4 Answer
Members who are involved in a personal bankruptcy filing are not automatically assumed to be in violation of the standards because bankruptcy may not reflect poorly on the integrity or trustworthiness of the person involved.

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Questions 5 Ethics
The Global Investment Performance Standards (GIPS) were created to:
A. Educate investors on misleading practices in performance measurement. B. Ensure fair representation and full disclosure of performance information. C. Impose CFA Institute Standards of Professional Conduct on nonmembers

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Questions 5 Answer
In the past, the investment community had great difficulty making meaningful comparisons on the basis of accurate investment performance data. The GIPS standards ensure fair representation and full disclosure of performance information.

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Questions 6 Ethics
Vera Abel, CFA, is the research director for ZigZag Investments. Abel discovers one of her top analysts trading in stocks in advance of client transactions and repeatedly warns him that this activity is not appropriate. Does Abel violate any CFA Institute Standards of Professional Conduct?
A. Yes, with respect to fair dealing. B. Yes, with respect to responsibilities of supervisors. C. Yes, with respect to diligence and reasonable basis.

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Questions 6 Answer
The Standards require that members make reasonable efforts to detect and prevent violations of applicable laws, rules, and regulations. Supervisors exercise reasonable supervision by establishing and implementing written compliance procedures and ensuring the procedures are followed through periodic review. Once a supervisor learns of a possible violation, the supervisor must promptly initiate an investigation. Warning the employee to cease the activity, as Abel has done, is not enough. Pending the outcome of the investigation, Abel may need to place limits on the employees activities to ensure the violations will not be repeated.

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Questions 7 Ethics
Eric Pantoja is enrolled as a candidate in the CFA examination program. He works as an assistant for Chehalis Investments (CI). Pantoja sees CI's purchase list and purchases several of the recommended stocks. Pantoja least likely violates the CFA Institute Standard relating to:
A. Loyalty to Employer. B. Priority of Transactions. C. Diligence and Reasonable Basis.

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Questions 7 Answer
Pantoja least likely violates the Standard relating to Diligence and Reasonable Care because he is taking investment actions on his own behalf rather than on behalf of clients. His actions violate the Standards relating to Priority of Transactions (he trades ahead of his employer and its clients), Loyalty to Employer (his actions cause harm to his employer), and Misconduct (his actions reflect adversely on his professional integrity).

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Questions 8 Ethics
According to the Standards of Practice Handbook , members are least likely required to disclose to clients their:
A. Beneficial ownership of stock. B. Firm's market-making activities. C. Responsibilities as CFA Charterholders.

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Questions 8 Answer
Members are not required to disclose their responsibilities as CFA charterholders to clients. They are, however, required to disclose all matters that could reasonably be expected to impair their independence and objectivity or interfere with respective duties to their clients, prospective clients, and employer. Service as a director, market-making activities, and beneficial ownership of stock are three examples of such matters.

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Questions 9 Ethics
Ron Dunder, CFA, is the CIO for Blind Trust (BT), an investment advisor. Dunder recently assigned one of his portfolio managers, Doug Cheetah, to manage several accounts that primarily invest in thinly traded micro-cap stocks. Dunder soon notices that Cheetah places many stock trades for these accounts on the last day of the month, toward the market's close. Dunder finds this trading activity unusual and speaks to Cheetah, who explains that the trading activity was completed at the client's request. Dunder does not investigate further. Six months later the SEC sanctions BT for manipulating micro-cap stock prices at month-end in order to boost account values. According to the Standards of Practice Handbook, did Dunder violate any CFA Institute Standards of Professional Conduct?
A. No B. Yes, because he failed to review regulations on thinly traded This files has expired at securities. 30-Jun-13 C. Yes, because he failed to reasonably supervise Cheetah with a view to detecting and preventing Cheetah's violations

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Questions 9 Answer
The CFA Institute Standard relating to responsibilities of supervisors requires members/candidates to take steps to detect and prevent violations of laws, rules, and regulations. Dunder failed in his supervisory role when he accepted Cheetah's explanation of the unusual trading activity. Dunder should have reviewed the client's goals and objectives, and records, to see if they in fact requested month-end trading. Regardless of the explanation provided by Cheetah, Dunder should have investigated further. This area is ripe for conflicts of interest because it influences the month-end values of client accounts and therefore the manager's performance and fees

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Questions 10 Ethics
According to the CFA institute standards of practice handbook, insider trading is least likely to be prevented by establishing:
A. Fire walls B. Watch lists C. Selective disclosures

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Questions 10 Answer
Selective disclosures occurs when companies discriminate in making material nonpublic information public. Selective disclosures raises insider trading concerns.

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Questions 11 Quantitative Techniques

Rachel Kelly, age 24, is planning for retirement. Kelly's annual consumption expenditures are currently $30,000. She assumes her consumption expenditures will increase with the rate of inflation, which she expects to average 3% until she retires at age 68. Given a life expectancy of 83 years and constant expenditures in retirement, the amount Kelly must accumulate by her retirement date, assuming an 8% rate of return on her retirement account, is closest to:
A. $423,000. B. $1,176,000. C. $1,552,000.

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Questions 11 Answer
Kelly expects her consumption spending (currently $30,000 annually) to increase with the rate of inflation (3%) over the next 44 years until she retires. Her annual consumption spending at the time she retires will be $110,143.57 (PV = 30,000, %I = 3, N = 44, solve for FV). To support that level of spending for 25 years of retirement, assuming an 8% return on her retirement account, she must accumulate $1,175,756 by her retirement date (PMT = 110,143.57, N = 25, %I = 8, solve for PV).

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Questions 12 Quantitative Techniques

An increase in which of the following items is most likely to result in an increase in the width of the confidence interval for the population mean?
A. Sample size B. Reliability factor C. Degrees of freedom

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Questions 12 Answer
An increase in the reliability factor increases the width of the confidence interval. Both increasing the sample size and increasing the degrees of freedom shrink the confidence interval.

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Questions 13 Quantitative Techniques

An analyst gathered the following information about a common stock portfolio:
Arithmetic mean return 14.30% Geometric mean return 12.70% Variance of returns 380 Portfolio beta 1.35 If the risk-free rate of return is 4.25%, then the coefficient of variation and the Sharpe ratio, respectively, for the portfolio are closest to: Coefficient of variation Sharpe ratio A. 1.36 0.52 This files has expired at 30-Jun-13 B. 1.36 7.44 C. 1.53 0.52

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Questions 13 Answer
Coefficient of variation= standard deviation / arithmetic mean return= 3800.5 / 14.3 = 19.49 / 14.3 = 1.36 Sharpe ratio= (mean return - risk free rate) / standard deviation of returns = (14.3 - 4.25) / 19.49 = 0.52

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Questions 14 Quantitative Techniques

An analyst determined that the sample mean and variance for a normal distribution are 42 and 9, respectively. The 99% confidence interval for this random variable is closest:
A. 18.8 to 65.2. B. 34.3 to 49.7. C. 39.0 to 45.0

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Questions 14 Answer
The 99% confidence interval for a normally distributed random variable is equal to the sample mean 2.58 x sample standard deviation. In this case, the 99% confidence interval = 42 (2.58 x 90.5) = 42 (2.58 x 3) = 42 7.74 34.3 to 49.7.

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Questions 15 Quantitative Techniques

Jorge MacDonald is shopping for a home. His budget will support a monthly payment of $1,300 on a 30-year mortgage with an annual interest rate of 7.2%. If MacDonald puts a 10% down payment on the home, the most he can pay for his new home is closest to:
A. $191,518. B. $210,840. C. $212,800

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Questions 15 Answer
MacDonalds budget will support a monthly payment of $1,300. Given a 30-year mortgage at 7.2%, the loan amount will be $191,517.76 (N = 360, %I = 0.6, PMT = 1,300, solve for PV). If MacDonald makes a 10% down payment, then the most he can pay for his new home = $191,517.76 / (1 - 0.10) = $212,797.51 $212,800.

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Questions 16 Quantitative Techniques

An analyst gathered the price-earnings ratios (P/E) for the firms in the S&P 500 and then ranked the firms from highest to lowest P/E. She then assigned the number 1 to the group with the lowest P/E ratios, the number 2 to the group with the second lowest P/E ratios, and so on. The measurement scale used by the analyst is best described as:
A. Ratio. B. Ordinal. C. Interval

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Questions 16 Answer
The analyst is using an ordinal scale which involves sorting data into categories based on some characteristic, such as the firms P/E ratios.

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Questions 17 Quantitative Techniques

The manager of a pension fund determined that during the past five years 85% of the stocks in the portfolio have paid a dividend and 40% of the stocks have announced a stock split. If 95% of the stocks have paid a dividend and/or announced a stock split, the joint probability of a stock paying a dividend and announcing a stock split is closest to:
A. 30%. B. 45%. C. 55%.

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Questions 17 Answer
The probability that at least one of two events will occur is the sum of the probabilities of the separate events less the joint probability of the two events. P(A or B) = P(A) + P(B) - P(AB) 95% = 85% + 40% - P(AB); therefore P(AB) = 30%

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Questions 18 Quantitative Techniques

An analyst determined that approximately 99 percent of the observations of daily sales for a company were within the interval from $230,000 to $480,000 and that daily sales for the company were normally distributed. The mean daily sales and standard deviation of daily sales, respectively, for the company were closest to: Mean daily sales Standard deviation of daily sales
A. $351,450 B. $351,450 C. $355,000 $41,667 $83,333 $41,667

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Questions 18 Answer
construct and interpret a confidence interval for a normally distributed random variable, and determine the probability that a normally distributed random variable lies inside a given confidence interval Given that sales are normally distributed, the mean is centered in the interval. Mean = ($230,000 + 480,000) / 2 = $355,000 An interval including 99% of the observations extends three standard deviations either side of the mean. The standard deviation of daily sales = ($355,000 - 230,000) / 3 = $41,667

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Questions 19 Quantitative Techniques

An analyst gathered the following information about a stock index. mean net income for all companies in the index $2.4 mn standard deviation of net income for all companies in the index $3.2 mn if the analyst takes a sample of 36 companies from the index, the standard error of the sample mean is closet to:
A. $66,667 B. $88,889 C. $533,333

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Questions 19 Answer
Standard error of the sample mean= 3,200,000/360.5= $533,333

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Questions 20 Economics
The Laffer curve depicts a relationship between which of the following sets of two economic variables and its proponents belong to which group of economists?
Two economic variables A. Tax rate and tax revenues B. Tax rate and tax revenues C. Inflation and unemployment proponents belong to Monetarists Supply-siders Monetarists

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Questions 20 Answer
The relationship between the tax rate and the amount of tax revenue collected is called the Laffer curve, named after Arthur B. Laffer, a supply-side economist and a member of President Reagans economic policy advisory board. They argued that tax cuts would increase tax revenues and decrease the budget deficit.

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Questions 21 Economics
In response to the influx of tourists, the demand for guest rooms in Sun-n-Sand, a resort hotel on a south pacific island, went up from 100 to 150 rooms. As a result, Sun-n-Sand management has decided to increase the tariff from $150 to $200 a night per room. The elasticity of supply of rooms in Sun-n-Surf is closest to:
A. 0.72. B. 1.40. C. 1.50.

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Questions 21 Answer
The elasticity of supply equals the percent change in quantity relative to the average quantity divided by the percent change in demand relative to the average demand: The average quantity = (100 + 150) / 2 = 125, the % change in quantity = 50 / 125 = 40; The average price = (150 + 200) / 2 = 175, the % change in price = 50 / 175 = 28.6 Elasticity of supply = 40 / 28.6 = 1.40

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Questions 22 Economics
The most accurate description of the effect of a price decrease on total revenue for goods that have an elastic and inelastic demand, respectively, are:
Elastic demand A. Total revenue declines B. Total revenue increases C. Total revenue increases Inelastic demand Total revenue increases Total revenue declines Total revenue increases

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Questions 22 Answer
When demand is elastic, a decrease in price by 1% increases the quantity sold by more than 1% and it results in an increase in total revenue. But when demand is inelastic, a decrease in price by 1% increases the quantity sold by less than 1% and it results in a decrease in total revenue.

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Questions 23 Economics
Key factors that influence the levels of structural and frictional unemployment in an economy, respectively, are:
Structural unemployment A. Changes in technology B. Changes in technology C. Unemployment compensation Frictional unemployment Changes in technology Unemployment compensation Changes in technology

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Questions 23 Answer
Structural unemployment refers to the unemployment due to changes in technology, changes in skills needed to perform jobs or changes in the location of jobs. Frictional unemployment, on the other hand, is influenced by unemployment compensation.

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Questions 24 Economics
According to the feedback rule with productivity shocks, in order to stabilize the price level the most likely action by the Fed and the resulting effect on real GDP, respectively, are:
Feds action A. Fed decreases the quantity of money B. Fed decreases the quantity of money C. Fed keeps the quantity of money constant Effect on real GDP The real GDP declines The real GDP remains constant The real GDP declines

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Questions 24 Answer
According to the feedback rule, when the price level rises the Fed decreases the quantity of money in order to reduce aggregate demand. As a result, the price level as well as the real GDP would remain constant

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Questions 25 Economics
In regulating a natural monopoly, the pricing rule most commonly adopted by a regulator, and its effect on the firm's profit, respectively, are:
Pricing rule A. Average cost pricing B. Average cost pricing C. Marginal cost pricing Effect on firms profit The firm earns normal profit The firm incurs economic loss The firm earns normal profit

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Questions 25 Answer
The marginal cost pricing rule is efficient but it leaves the natural monopoly incurring an economic loss. Therefore, regulators almost never impose marginal cost pricing rule. Instead, they adopt the average cost pricing rule, which allows the firm to cover its costs and earn a normal profit.

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Questions 26 Economics
An expansionary fiscal policy is most likely to include a(n):
A. Decrease in both interest rates and tax rates B. Increase in government expenditure and decrease in tax rates C. Increase in both government expenditures and central banks open market purchase

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Questions 26 Answer
An expansionary fiscal policy means the government increases its purchase of goods and services and / or cut taxes to increase the aggregate demand

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Questions 27 Economics
In a perfectly competitive industries, what is the most likely long run effect of a permanent decrease in demand?
A. Price decrease B. Firms incur economic losses C. The number of firms decreases

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Questions 27 Answer
In perfectly competitive industries in the long run firms will leave the industry due to economic losses. As firms leave the industry supply decreases thus increasing prices back to the equilibrium price where economic profit is zero.

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Questions 28 Derivatives
The effects on the price of a call option from an increase in volatility and an increase in interest rates are: Increase in volatility Increase in interest rates
A. Decrease B. Increase C. Increase Increase Increase Decrease

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Questions 28 Answer
When volatility increases, the price of options increase. When interest rates increase, call option prices increase.

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Questions 29 Derivatives
An investor purchases a stock at $60 and at the same time, sells a 3-month call on the stock. The short call has a strike price of $65 and a premium of $3.60. The risk-free rate is 4%. The breakeven underlying stock price at expiration is closest to:
A. $55.85. B. $56.40. C. $60.80.

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Questions 29 Answer
A covered call breakeven price equals the price paid for the stock less the premium received for the call. Breakeven = (S - c) = (60 - 3.60) = $56.40

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Questions 30 Derivatives
A company is long an interest rate swap with a current market value of $125,000. the company wants to terminate this swap before the expiration date. From a credit perspective, which of these is the least attractive ways to terminate the swap?
A. Sell the swap to third party B. Short an offsetting swap to a third party C. Agree to terminate the swap and receive its market value from the counterparty

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Questions 30 Answer
Both the initial and offsetting swap remain in effect, exposing the company to potential default risk.

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Questions 31 Derivatives
Which of these is best classified as a forward market derivative?
A. A swap agreement B. A convertible bond C. An asset backed security

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Questions 31 Answer
A swap agreement is equivalent to a series of forward agreements that are described as forward commitment derivatives

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