Question 1 of 90

Question
Most societies would least likely consider ethical principles to include:
1. justice.
2. duplicity.
C. diligence.
Solution

Solution
B is correct. Most societies acknowledge the ethical principles of honesty, fairness or
justice, diligence, and respect for the rights of others. Duplicity or deception would be in
violation of most ethical principles.
A is incorrect. Justice is often considered an ethical principle in most societies.

C is incorrect. Diligence is often considered an ethical principle in most societies.

Ethics and Trust in the Investment Profession Learning Outcome

1. Explain ethics

Question 2 of 90
Question
Under what circumstances could a client possibly win a lawsuit against a financial adviser
despite the financial adviser abiding by all regulatory and legal requirements?

1. The adviser benefiting more from the relationship than the client
2. The adviser not being subject to a code of ethics
C. The adviser violating his employer’s published code of ethics
Solution

Solution
C is correct. If the client could prove the firm marketed its code of ethics (i.e., putting the
interests of the client first) as a reason to hire the firm and the adviser violated the code,
the court may rule in the client’s favor.
A is incorrect because an adviser can still act in a fiduciary manner while benefiting more
than the client. This is particularly true when investment returns are unexpectedly
negative and the client pays fees to the adviser.

B is incorrect because unethical behavior is not necessarily illegal. However, if the client
could prove the firm marketed their code of ethics (i.e., putting the interests of the client
first) as a reason to hire the firm and the adviser violated the code, the court may rule in
the client’s favor.
Ethics and Trust in the Investment Profession Learning Outcome
5. Explain professionalism in investment management

Question 3 of 90
Question
Sato Kashingaki, CFA, is a financial advisor who practices in multiple jurisdictions. In his
resident country, Country A, he is not required by law to hold a financial advisor’s license
but he is required to uphold a fiduciary duty to his clients. In Country B, authorities require
him to hold a financial advisor’s license, but he is not expected to uphold a fiduciary duty to
his clients. In Country C, authorities require both a financial advisor’s license and an asset
management license in addition to upholding a fiduciary responsibility toward clients. In
which of the three countries does Kashingaki have the duty to adhere to the CFA Code and
Standards over local laws?

1. Country A.
2. Country B.
C. Country C.
Solution

Solution
B is correct because Standard I–Professionalism requires members and candidates to
comply with the more strict law, rule, or regulation in the event of conflicts of any
applicable laws, rules, and regulations (including the CFA Institute Code of Ethics and
Standards of Professional Conduct). Country B does not require a financial advisor to
uphold a fiduciary duty (as is required by Country A and C), i.e., put the client’s interest
before their own, therefore the CFA Code of Ethics and Standards of Professional Conduct
(Duty to Clients) would be applicable as it is the stricter of the two.
A is incorrect because Country A requires the upholding of fiduciary duties that creates a
higher standard than that of the Code and Standards.

C is incorrect because Country C requires two licenses and the upholding of fiduciary duties
that creates a higher standard than that of the Code and Standards. Thus Country C’s laws
are the governing law.

Code of Ethics and Standards of Professional Conduct Learning

Outcome
1. Describe the structure of the CFA Institute Professional Conduct Program and the
process for the enforcement of the Code and Standards

Question 4 of 90
Question
Lisa Blackstone, a new CFA charterholder, had to explain to the marketing department of
her firm that making any claim of superior analytical skills due to her designation
would most likely be a violation of:
1. Standard VII–Responsibilities as a CFA Institute Member or CFA Candidate.
2. Standard V–Investment Analysis, Recommendations, and Actions.
C. Standard IV–Duties to Employers.
Solution

Solution
A is correct. Making claims that the CFA designation was proof of superior analytical skills
is a violation of Standard VII(B)–References to CFA Institute, the CFA Designation, and the
CFA Program. When referring to CFA Institute, CFA Institute membership, the CFA
designation, or candidacy in the CFA Program, members and candidates must not
misrepresent or exaggerate the meaning or implication of membership in CFA Institute,
holding the CFA designation, or candidacy in the CFA Program.
B is incorrect. Making claims that the CFA designation was proof of superior analytical
skills is not a violation of Standard V–Investment Analysis, Recommendations, and Actions.

C is incorrect. Making claims that the CFA designation was proof of superior analytical
skills is not a violation of Standard IV–Duties to Employers.

Code of Ethics and Standards of Professional Conduct Learning

Outcome
3. Explain the ethical responsibilities required by the Code and Standards, including
the sub-sections of each Standard

Question 5 of 90
Question
Linda Chin, CFA, is a member of a political group advocating lower governmental
regulation in all aspects of life. She works in a country where local securities laws are
minimal and insider trading is not prohibited. Chin’s politics are reflected in her
investment strategy where she follows her country’s mandatory legal and regulatory
requirements. Which of the following actions by Chin is most consistent with the CFA
Institute Standards of Professional Conduct?
1. Follow the CFA Code and Standards.
2. Continue her current investment strategy.
C. Disclose her political advocacy to clients.
Solution

Solution
A is correct because Standard I(A)–Knowledge of the Law requires Members and
Candidates to comply with the more strict law, rules, or regulations and follow the highest
requirement, which in this case would be the CFA Institute Standards of Professional
Conduct. Standard II(A)–Material Nonpublic Information would also apply as Members and
Candidates who possess material nonpublic information that could affect the value of an
investment must not act or cause others to act on the information. Disclosure that she
meets local mandatory legal requirements, not the more strict law, rule, or regulation of the
Code and Standards, would not alleviate the member from following the Code and
Standards.
B is incorrect because Standard I(A)–Knowledge of the Law requires Members and
Candidates to not trade on material nonpublic information. Standard II(A)–Material
Nonpublic Information would also apply as Members and Candidates who possess material
nonpublic information that could affect the value of an investment must not act or cause
others to act on the information.

C is incorrect because Standard I(A)–Knowledge of the Law requires Members and

Candidates to comply with the more strict law, rule, or regulation, which in this case is the
Code and Standards and not local requirements. Disclosure of the manager’s political
advocacy is not required because it does not entail a conflict of interest and doing so would
not alleviate the member from following the Code and Standards.

Guidance for Standards I–VII Learning Outcome

3. Recommend practices and procedures designed to prevent violations of the Code
of Ethics and Standards of Professional Conduct

Question 6 of 90
Question
Andrew Smith, CFA, works for Granite, a commercial bank that also has a sizeable sell side
research division. Smith is presenting financing solutions to a potential business client,
Dynamic Materials Corp. As part of his presentation, Smith mentions that Granite will
initiate research coverage on Dynamic. Is Smith’s arrangement most likely appropriate with
regards to the CFA Standards?
1. Yes.
2. No, because Smith cannot offer to provide research coverage on a company if
they become a corporate finance client.
C. No, because Granite cannot provide research coverage on a corporate finance
client as this constitutes a violation of research independence.
Solution

Solution
A is correct because under Standard I(B) members and candidates must protect their
independence and objectivity. Agreeing to provide objective research coverage of a
company does not constitute a violation of this standard provided the analyst writing the
report is free to come up with their own independent conclusion. Smith can agree to
provide research coverage but cannot commit Granite’s research department to providing
a favorable recommendation.
B is incorrect because providing research coverage in this situation does not constitute a
violation of the Code and Standards as long as the independence of this research is not
compromised.

C is incorrect because providing research coverage in this situation does not constitute a
violation of the Code and Standards as long as the independence of this research is not
compromised.

Guidance for Standards I–VII Learning Outcome

2. Identify conduct that conforms to the Code and Standards and conduct that
violates the Code and Standards

Question 7 of 90
Question
Ricardo Torres, CFA, is a well-respected telecommunications analyst for Pegasus Advisers.
He is known for his thorough analysis, including interviews with suppliers, customers, and
competitors. Torres has a strong following, and his research reports can often materially
affect the market. As a result, Pegasus limits the distribution of his reports to Pegasus
clients. After losing market share to Pegasus for over two years, Marco Rodrigo, a CFA
candidate, reports Torres to the local securities regulator on suspicion of using insider
information to make share recommendations. What CFA Institute Standard of Professional
Conduct has Rodrigo most likely violated?
1. Misconduct
2. Material Nonpublic Information
C. Market Manipulation
Solution

Solution
A is correct. Rodrigo has likely violated Standard I(D)–Misconduct by behaving in an
unprofessional manner that reflects adversely on his professional integrity by reporting
Torres to the regulator when there is no apparent evidence Torres is using material
nonpublic information. Torres is a well-respected analyst known for his in-depth, thorough
analysis using a mosaic process. It appears Rodrigo only reported Torres to harm his
reputation in order to recapture the market share he has lost over the last two years. There
is no evidence Torres manipulated the market through his research. The research is used
for the benefit of the Pegasus clients. Although the public may consider Torres’ reports to
be material because of the fact that their release can move the market, it does not mean the
report must be made available to the public prior to the release of the report to Pegasus
clients.
B is incorrect because while the public may consider Torres reports to be material due to
the fact that their release can move the market, it does not mean the report must be made
available to the public prior to the release of the report to Pegasus clients.
C is incorrect because there is no evidence Torres manipulated the market through his
research. The research is used for the benefit of the Pegasus clients.

Guidance for Standards I–VII Learning Outcome

1. Demonstrate the application of the Code of Ethics and Standards of Professional
Conduct to situations involving issues of professional integrity

Question 8 of 90
Question
When a client asks her how she makes investment decisions, Petra Vogler, CFA, tells the
client she uses mosaic theory. According to Vogler, the theory involves analyzing public and
nonmaterial nonpublic information including the evaluation of statements made to her by
company insiders in one-on-one meetings where management discusses new earnings
projections not known to the public. Vogler also gathers general industry information from
industry experts she has contacted. Vogler most likely violates the CFA Institute Standards
of Professional Conduct because of her use of:
1. industry expert information.
2. one-on-one meeting information.
C. nonmaterial nonpublic information.
Solution

Solution
B is correct because a violation of Standard II(A)–Material Nonpublic Information is likely
to occur when using information that is selectively disclosed by corporations to a small
group of investors, analysts, or other market participants. Earnings estimates given in a
one-on-one meeting would likely be considered material and nonpublic information.
Information made available to analysts remains nonpublic until it is made available to
investors in general. Under the mosaic theory it is acceptable to use information from
industry contacts as long as the analyst uses appropriate methods to arrive at her
conclusions. Additionally, it is acceptable to use nonmaterial nonpublic information in her
analysis, and this use is not a violation of Standard II(A)–Material Nonpublic Information.
A is incorrect because under the mosaic theory it is acceptable to use information from
industry contacts as long as the analyst uses appropriate methods to arrive at her
conclusions.

C is incorrect because it is acceptable to use nonmaterial nonpublic information in her

analysis, and this use is not a violation of Standard II(A)–Material Nonpublic Information.

Guidance for Standards I–VII Learning Outcome

2. Identify conduct that conforms to the Code and Standards and conduct that
violates the Code and Standards

Question 9 of 90
Question
Richard Cardinal, CFA, is the founder of Volcano Capital Research, an investment
management firm whose sole activity is short selling. Cardinal seeks out companies whose
stocks have had large price increases. Cardinal also pays several lobbying firms to update
him immediately on any legislative or regulatory changes that may impact his target
companies. Cardinal sells short those target companies he estimates are near the peak of
their sales and earnings and that his sources identify as facing legal or regulatory
challenges. Immediately after he sells a stock, Cardinal conducts a public relations
campaign to disclose all of the negative information he has gathered on the company, even
if the information is not yet public. Which of Cardinal’s following actions is most likely to be
in violation of the CFA Institute Standards of Professional Conduct?
1. Selling stock short
2. Trading on information from lobbyists
C. Disclosing information about target companies
Solution

Solution
C is correct, as Cardinal’s actions related to the public relations campaign and class action
lawsuits are specifically intended to manipulate share prices lower and to advantage the
manager. Cardinal has made deliberate attempts to create artificial price volatility designed
to have a material impact on the price of an issuer’s stock, in violation of Standard II(B)–
Market Manipulation.
A is incorrect because selling stock short is a management strategy and does not
necessarily violate any aspect of the Code and Standards.

B is incorrect, as it appears a reasonable and diligent effort has been made as required by
Standard V(A)–Diligence and Reasonable Basis to determine the investment action is sound
and suitable for his clients. Information gathering is an integral part of investment analysis
and the methods described do not necessarily violate any aspect of the CFA Code and
Standards.

Guidance for Standards I–VII Learning Outcome

2. Identify conduct that conforms to the Code and Standards and conduct that
violates the Code and Standards

Question 10 of 90
Question
David Bravoria, CFA, is an independent financial advisor for a high-net-worth client with
whom he had not had contact in more than two years. During a recent brief telephone
conversation, the client states that he wants to increase his risk exposure. Bravoria
subsequently recommends and invests in several high-risk venture capital funds on behalf
of the client. Bravoria continues, as he has done in the past, to send to his client monthly,
detailed, itemized investment statements. Did Bravoria most likely violate any CFA
Standards?
 1. No.
2. Yes, with regard to investment statements.
C. Yes, with regard to purchasing venture capital funds.
Solution

Solution
C is correct because Bravoria violated Standard III(A)–Loyalty, Prudence, and Care as he
had not updated his client’s profile in more than two years and thus should not have made
further investments, particularly in high-risk investments, until such time as he updated
the client’s risk and return objectives, financial constraints, and financial position. Bravoria
provided his client with investment statements more frequently than that which is
required, i.e., quarterly, so was not in violation of regular account information.
A is incorrect because Bravoria violated Standard III(A)–Loyalty, Prudence, and Care.

B is incorrect because Bravoria provided his client with investment statements more
frequently than required, i.e., quarterly.

Guidance for Standards I–VII Learning Outcome

2. Identify conduct that conforms to the Code and Standards and conduct that
violates the Code and Standards

Question 11 of 90
Question
Noor Mawar, CFA, manages a trust fund with the beneficiary being an orphaned 18-year-
old student. The investment policy dictates that trust assets are expected to provide the
student with a stable low-risk source of income until she reaches the age of 30 years. Based
on information from an Internet blog, the student asks Mawar to invest in a new business
venture that she expects will provide high returns over the next five years. Mawar ignores
the request, instead securing conservative investments to provide sufficient income. Did
Mawar most likely violate the CFA Institute Code of Ethics and Standards of Professional
Conduct?
1. Yes.
2. No, because the client’s objectives were met.
C. No, because the investment time frame does not match the investment horizon.
Solution

Solution
B is correct because the client is the trust/trustees, not the beneficiary. Mawar followed
Standard III(C) –Suitability by managing the trust assets in a way that would likely result in
a stable source of income while keeping the risk profile low, thereby complying with the
investment objectives of the trust.
A is incorrect because Mawar did not violate any Standard as she managed trust assets
considering the suitability for the client, not the beneficiary.
C is incorrect because the client is the trust/trustees, not the beneficiary. Therefore the
time horizon of the investment is not relevant.

Guidance for Standards I–VII Learning Outcome

2. Identify conduct that conforms to the Code and Standards and conduct that
violates the Code and Standards

Question 12 of 90
Question
Sisse Brimberg, CFA, is responsible for performance presentations at her investment firm.
The presentation that Sisse uses states that when making performance presentations her
firm:

1. deducts all fees and taxes;

2. uses actual and simulated performance results; and
3. bases the performance on a representative individual account.
Based on the above information, which of the following is the most appropriate
recommendation to help Brimberg meet the CFA Institute Standards of Professional
Conduct in her performance presentations? She should present performance based on:
1. a gross of fee basis.
2. actual not simulated results.
C. a weighted composite for all similar discretionary portfolios.
Solution

Solution
C is correct because in order to meet their obligations under Standard III(D), members
should present the performance of the weighted composite of similar portfolios rather than
using a single representative or all accounts, so this is the best selection of the options
provided.
A is incorrect as either gross or net of fee performance may be disclosed.

B is incorrect since the use of simulated results is permitted as long as it is disclosed.

Guidance for Standards I–VII Learning Outcome

3. Recommend practices and procedures designed to prevent violations of the Code
of Ethics and Standards of Professional Conduct

Question 13 of 90
Question
Elbie Botha, CFA, an equity research analyst at an investment bank, disagrees with her
research team’s buy recommendation for a particular company’s rights issue. She
acknowledges that the recommendation is based on a well-developed process and
extensive research but feels the valuation is overpriced based on her assumptions. Despite
her contrarian view, her name is included on the research report to be distributed to all of
the investment bank’s clients. To avoid violating any CFA Institute Standards, it would
be least appropriate for Botha to undertake which of the following?
1. Leave her name on the report.
2. Insist her name is removed from the report.
C. Issue a new report based on her conclusions.
Solution

Solution
C is correct as Standard IV(A) calls for employees to be loyal to their employer by not
causing harm. If Botha released a contradictory research recommendation report to clients,
it could possibly cause confusion amongst clients and embarrassment to the firm.
A is incorrect as Botha does not need to disassociate from the research report even though
she does not agree with the conclusion made as she acknowledges the process was sound.

B is incorrect. While Botha does not need to disassociate from the research report, she
could still ask for her name to be removed from the report without violating any Standard.

Guidance for Standards I–VII Learning Outcome

2. Identify conduct that conforms to the Code and Standards and conduct that
violates the Code and Standards

Question 14 of 90
Question
Jefferson Piedmont, CFA, a portfolio manager for Park Investments, plans to manage the
portfolios of several family members in exchange for a percentage of each portfolio’s
profits. As his family members have extensive portfolios requiring substantial attention,
they have requested that Piedmont provide the services outside his employment with Park.
Piedmont notifies his employer in writing of his prospective outside employment. Two
weeks later, Piedmont begins managing the family members’ portfolios. By managing these
portfolios, which of the following CFA Institute Standards of Professional Conduct has
Piedmont violated?

1. Conflicts of Interest
2. Additional Compensation
C. Both Additional Compensation and Conflicts of Interest
Solution

Solution
C is correct because members should disclose all potential conflicts of interest, the
substantial time involved in managing family accounts, and when engaging in independent
practice for compensation should not render services until receiving written consent from
all parties [Standard IV(B), Standard VI(A)].
A is incorrect because both standards have been violated.

B is incorrect because both standards have been violated.

Guidance for Standards I–VII Learning Outcome

1. Demonstrate the application of the Code of Ethics and Standards of Professional
Conduct to situations involving issues of professional integrity

Question 15 of 90
Question
Eileen Fisher, CFA, has been a supervisory analyst at SL Advisors for the past ten years.
Recently, one of her analysts was found to be in violation of the CFA Institute Standards of
Professional Conduct. Fisher has placed limits on the analyst’s activities and is now
monitoring all of his investment activities. Although SL did not have any compliance
procedures up to this point, to avoid future violations, Fischer has put in place procedures
exceeding industry standards. Did Fisher most likely violate any CFA Institute Standards of
Professional Conduct? chưa clear
1. Yes.
2. No, because she has taken steps to ensure the violations will not be repeated by
the analyst.
C. No, because she is taking steps to implement compliance procedures that are
more than adequate.
Solution

Solution
A is correct because under standard IV(C) a member should exercise reasonable
supervision by establishing and implementing compliance procedures prior to the
possibility of any violation occurring, which has not been done in this case.
B is a correct action but does not address the standard violation. These actions are
intended to restrict activities after the violation and do not relate to investigating why or
how the violation occurred, which would be necessary to establish and implement
adequate compliance procedures.

C is a correct action but the steps were taken after the fact and procedures should have
been in place previously.

Guidance for Standards I–VII Learning Outcome

2. Identify conduct that conforms to the Code and Standards and conduct that
violates the Code and Standards

Question 16 of 90
Question
Lawrence Hall, CFA, and Nancy Bishop, CFA, began a joint research report on Stamper
Corporation. Bishop visited Stamper’s corporate headquarters for several days and met
with all company officers. Prior to the completion of the report, Bishop was reassigned to
another project. Hall utilized his and Bishop’s research to write the report but did not
include Bishop’s name on the report because he did not agree with and changed Bishop’s
conclusion included in the final report. According to the CFA Institute Standards of Practice
Handbook, did Hall most likely violate any CFA Institute Standards of Professional Conduct?
1. No.
2. Yes, with respect to misrepresentation.
C. Yes, with respect to diligence and reasonable basis.
Solution

Solution
A is correct because members are in compliance with Standard V (A)–Diligence and
Reasonable Basis if they rely on the research of another party who exercised diligence and
thoroughness. Because Bishop’s opinion did not agree with the final report, disassociating
her from the report is one way to handle this difference between the analysts.
B is incorrect because Hall did not make any misrepresentation.

C is incorrect because Hall is allowed to rely on a third party who exercised diligence and
thoroughness.

Guidance for Standards I–VII Learning Outcome

1. Demonstrate the application of the Code of Ethics and Standards of Professional
Conduct to situations involving issues of professional integrity

Question 17 of 90
Question
Colin Gifford, CFA, is finalizing a monthly newsletter to his clients, who are primarily
individual investors. Many of the clients’ accounts hold the common stock of Capricorn
Technologies. In the newsletter, Gifford writes, “Based upon the next six month’s earnings
of $1.50 per share and a 10% increase in the dividend, the price of Capricorn’s stock will be
$22 per share by the end of the year.” Regarding his stock analysis, the least appropriate
action Gifford should take to avoid violating any CFA Institute Standards of Professional
Conduct would be to:
1. separate fact from opinion.
2. include earnings estimates.
C. identify limitations of the analysis.
Solution

Solution
B is correct because while pro forma analysis may be standard industry practice, it is not
required by the Standards. Earnings estimates are opinions and must be clearly identified
as such.
A is incorrect because facts should be separated from opinion in investment analysis.

C is incorrect because known limitations should be identified.

Guidance for Standards I–VII Learning Outcome

3. Recommend practices and procedures designed to prevent violations of the Code
of Ethics and Standards of Professional Conduct

Question 18 of 90
Question
Suni Kioshi, CFA, is an analyst at Pacific Asset Management, where she covers small
capitalization companies. On her own time, Kioshi often speculates in low price thinly
traded stocks for her own account. Over the last three months, Kioshi has purchased
50,000 shares of Basic Biofuels Company giving her a 5% ownership stake. A week after
this purchase, Kioshi is asked to write a report on stocks in the biofuels industry with a
request to complete the report within two days. Kioshi wants to rate Basic as a “buy” in this
report but is uncertain how to proceed. Concerning the research report, what action should
Kioshi most likely take to prevent violating any of the CFA Institute Code of Ethics and
Standards of Professional Conduct?
1. Sell her shares.
2. Don’t recommend a buy.
C. Disclose her stock ownership.
Solution

Solution
C is correct because the manager’s ownership stake is a potential conflict of interest, which
should be disclosed as required by Standard VI(A)–Disclosure of Conflicts, but there is no
requirement to sell the shares. As long as the analyst has completed a well-informed
investment recommendation consistent with Standard (V)–Diligence and Reasonable Basis
and disclosed her ownership position, she could include the buy recommendation in her
report.
A is incorrect because the manager’s ownership stake is a potential conflict of interest,
which should be disclosed as required by Standard VI(A)–Disclosure of Conflicts, but there
is no requirement to sell the shares.

B is incorrect because as long as the analyst has completed a well-informed investment

recommendation consistent with Standard (V)–Diligence and Reasonable Basis and
disclosed her ownership position, she could include the buy recommendation in her report.

Guidance for Standards I–VII Learning Outcome

 3. Recommend practices and procedures designed to prevent violations of the Code
of Ethics and Standards of Professional Conduct

Question 19 of 90
Question
Wang Dazong, CFA, is a sole proprietor investment advisor. Dazong believes in putting his
money at risk along with his clients and trades the same securities as his clients. In order to
ensure fair treatment of all accounts, he rotates trade allocations so that each account has
an equal likelihood of receiving a fill on their orders. This allocation procedure also applies
to Dazong's own account. According to the CFA Institute Code of Ethics and Standards of
Professional Conduct, the allocation procedure used by Dazong:

1. complies with the Standards.

2. requires revision to ensure client trades take precedence.
C. should be disclosed and written approval received from clients.
Solution

Solution
B is correct because Standard VI(B)–requires client transactions to be given precedence
over transactions made on behalf of the member’s or candidate’s firm or personal
transactions. Because the advisor trades alongside his clients and allocates trades on a
rotating basis, there are times when the advisor’s trades will receive priority over his
clients in violation of the Code and Standards. A member or candidate having the same
investment positions or being co-invested with clients does not always create a conflict.
Some clients in certain investment situations require members or candidates to have
aligned interests. Personal investment positions or transactions of members or candidates
or their firms should never, however, adversely affect client investments.
A is incorrect because the trade allocation procedure does not meet the requirements of
Standard VI(B), which requires client transactions to be given precedence over
transactions made on behalf of the member's or candidate's firm or personal transactions.

C is incorrect because even though trade allocation procedures should be disclosed to

clients, in this case the procedure fails to meet the requirement of the Code and Standards,
so disclosure is not sufficient and the procedures should be revised.

Guidance for Standards I–VII Learning Outcome

3. Recommend practices and procedures designed to prevent violations of the Code
of Ethics and Standards of Professional Conduct

Question 20 of 90
Question
A large manufacturing company is seeking help finding a fund manager for its pension plan.
After a comprehensive but unsuccessful search, Brett Arun, CFA, is hired to solicit
proposals from various fund managers. The client pays Arun a lump sum fee for his
services. The search concludes with Ramport Investments being hired as the pension plan’s
manager. A year after Ramport is hired, the pension administrator sends Arun a letter
telling him how satisfied the pension trustees are with the services provided by the fund
manager. Subsequently, without the plan sponsor’s knowledge, Arun accepts a payment
from Ramport for successfully introducing it to the pension plan under an agreement Arun
entered into with Ramport when the initial contact with the fund manager was made. With
regard to the payment received, did Arun most likely violate the CFA Institute Code of
Ethics and Standards of Professional Conduct by accepting the introductory fee?
1. No.
2. Yes, because he did not disclose his acceptance of the introductory fee to the
client.
C. Yes, because he should have refused payment of the introductory fee from the
fund manager.
Solution

Solution
C is correct because Arun shouldn’t accept the introductory fee because he didn’t disclose
his arrangement with Ramport prior to Ramport’s appointment by the client. By refusing
the fee, he effectively voids the agreement with Ramport thus removing the conflict of
interest.
A is incorrect because Arun has violated Standard VI(C)–Referral Fees because he did not
disclose the fee paid by Ramport.

B is incorrect because by disclosing to the client that he accepted an introductory fee as

part of his agreement with Ramport he made before their appointment would not meet the
requirement of Standard VI(C) to disclose prior to the client making the appointment of
the firm making the introductory fee.

Guidance for Standards I–VII Learning Outcome

3. Recommend practices and procedures designed to prevent violations of the Code
of Ethics and Standards of Professional Conduct

Question 21 of 90
Question
At the conclusion of the afternoon section of the Level I CFA examination, the exam proctor
instructs all candidates to stop writing and put their pencils down immediately. Krishna
Chowdary sees other candidates in front of him continue to fill in their answer sheets.
Chowdary has two questions left to complete so he randomly fills in one of the ovals on his
answer sheet before putting his pencil down on the table. Did Chowdary’s actions most
likely violate the CFA Institute Code of Ethics and Standards of Professional Conduct?
1. Yes.
2. No, because other candidates continued writing.
C. No, because he randomly answered one question.
Solution
Solution
A is correct because by completing a question on his examination after time was called,
Chowdary violated Standard VII(A)–Conduct as Members and Candidates in the CFA
Program. By continuing to write, Chowdary took advantage of other candidates, and his
conduct compromised the validity of his exam performance.
B is incorrect because Chowdary violated Standard VII(A) by working on his examination
after time was called.

C is incorrect because Chowdary violated Standard VII(A) by working on his examination

after time was called.

Guidance for Standards I–VII Learning Outcome

2. Identify conduct that conforms to the Code and Standards and conduct that
violates the Code and Standards

Question 22 of 90
Question
Upon receiving notification that he passed his Level III CFA exam, Paulo Garcia updates his
educational background on his social media site by adding “completed the CFA course.”
Does Garcia most likely violate the CFA Institute Standards of Professional Conduct?
1. No.
2. Yes, because it could imply he has obtained the charter.
C. Yes, because he doesn’t describe the certification process.
Solution

Solution
B is correct because Standard VII(B)–Reference to CFA Institute, the CFA Designation, and
the CFA Program forbids candidates to imply that they have a partial designation or cite an
expected completion date of any level of the CFA Program. Final award of the Charter is
subject to meeting the CFA Program requirements and approval by the CFA Institute Board
of Governors. Garcia should state, “passed Level III CFA exam” or “passed all three levels of
the CFA exams”. By stating that he “passed the CFA Course” it could be taken to mean he
obtained his Charter, which is incorrect.
A is incorrect because Garcia violates Standard VII(B)–by implying he has obtained the CFA
Charter, when he has not.

C is incorrect because describing the process is not required by the Standards.

Guidance for Standards I–VII Learning Outcome

2. Identify conduct that conforms to the Code and Standards and conduct that
violates the Code and Standards

Question 23 of 90
Question
Firms that claim compliance with the GIPS® standards are most likely allowed to state that
performance is calculated in accordance with the GIPS standards when presenting a:
1. GIPS Composite Report to a prospective client.
2. segregated account return to the account owner.
C. GIPS Pooled Fund Report to a prospective investor.
Solution

Solution đọc kĩ
B is correct. Firms that claim compliance with the GIPS standards must not make
statements referring to the performance of a current client or pooled fund investor as being
“calculated in accordance with the GIPS standards,” except when reporting the
performance of a segregated account to a current client or a pooled fund to a current
investor.
A is incorrect because GIPS-compliant firms must not make statements referring to the
performance of a current client or pooled fund investor as being “calculated in accordance
with the GIPS standards,” except for when a GIPS-compliant firm reports the performance
of a segregated account to current clients or a pooled fund to current investors.

C is incorrect because GIPS-compliant firms must not make statements referring to the
performance of a current client or pooled fund investor as being “calculated in accordance
with the GIPS standards,” except for when a GIPS-compliant firm reports the performance
of a segregated account to current clients or a pooled fund to current investors.

Introduction to the Global Investment Performance Standards (GIPS)

Learning Outcome
4. Describe the fundamentals of compliance, including the recommendations of the
GIPS Standards with respect to the definition of the firm and the firm’s definition
of discretion

Question 24 of 90
Question
Which of the following is least likely a requirement of the GIPS® standards? Firms are
required to:
1. have their performance records verified by an independent third party.
2. include all discretionary, fee-paying portfolios in at least one composite.
C. present a minimum of five years of annual investment performance compliant
with GIPS standards.
Solution

Solution
A is correct. It is a recommendation but not a requirement that firms obtain independent
third-party verification to claim GIPS compliance. Firms are required to include all
discretionary, fee-paying portfolios in at least one composite. They must also present a
minimum of five years of annual investment performance compliant with GIPS standards.
B is incorrect. It is a requirement to include all discretionary, fee-paying portfolios in at
least one composite.

C is incorrect. It is a requirement to present a minimum of five years of annual investment

performance compliant with GIPS standards.

Introduction to the Global Investment Performance Standards (GIPS)

Learning Outcome
2. Describe the key concepts of the GIPS standards for firms

Question 25 of 90
Question
Milene Fontes, CFA, takes over coverage of a company because the original analyst left the
firm before finishing the research report. She adds her own thorough analysis and
publishes the report in her name only. Has Fontes violated the Standards?

1. No
2. Yes, by using the original analyst's work in the report
C. Yes, by not attributing the report to the original analyst
Solution

Solution
A is correct because according to Standard I(C) Misrepresentation, "Members and
Candidates must not knowingly make any misrepresentations relation to investment
analysis, recommendations, actions, or other professional activities." "Members or
Candidates may use research conducted or models developed by others within the same
firm without committing a violation The most common example relates to the situation in
which one (or more) of the original analysts is no longer with the firm."
B is incorrect because according to Standard I(C) Misrepresentation, "Members or
Candidates may use research conducted or models developed by others within the same
firm without committing a violation The most common example relates to the situation in
which one (or more) of the original analysts is no longer with the firm."

C is incorrect because according to Standard I(C) Misrepresentation, "Members or

Candidates may use research conducted or models developed by others within the same
firm without committing a violation The most common example relates to the situation in
which one (or more) of the original analysts is no longer with the firm." "The firm may
issue future reports without providing attribution to the prior analysts."

Ethics Application Learning Outcome

 2. Explain how the practices, policies, and conduct do or do not violate the CFA
Institute Code of Ethics and Standards of Professional Conduct

Question 26 of 90
Question
Mila Roy, CFA, heads the?research division of?an investment firm. Roy sends a
recommended stock list to all of her firm's?clients along with a notification that a?detailed
report on each stock is available on request. Roy later calls only her?premium fee-
paying?clients and discusses her recommendations. Such?additional services are?available
for all clients willing to pay premium fees?and is fully disclosed as part of the?client
agreement. Has Roy violated the Standards?

1. No
2. Yes, the Standard relating to fair dealing
C. Yes, the Standard relating to communication with clients and prospective clients
Solution

Solution
A is correct because Standard III(B), Fair Dealing,?"requires?CFA Institute members and
candidates to deal fairly and objectively with all clients when providing investment
analysis and making investment recommendations. It also requires that information about
investment recommendations be disseminated in such a manner that all clients have a fair
opportunity to act on the information." Roy?distributes the recommended stock list?to all
clients simultaneously via email, giving each an opportunity to act on the information. Also,
Roy is permitted to provide?detailed?reports to "[c]lients who pay a subscription fee for
the service as long as (1) all clients are eligible to purchase the service, (2) the different
levels of service are disclosed to clients, ..." ) Therefore, Roy has not violated Standard
III(B).
Further, according to Standard V(B), Communication with Clients and Prospective Clients,
"[i]f recommendations are contained in capsule form (such as a recommended stock list),
members and candidates should notify clients that additional information and analyses are
available from the producer of the report." Roy sends a recommended stock list to all of her
firm's?clients along with a notification that a?detailed report on each stock?is available on
request.?Therefore, Roy has also not violated Standard V(B).?

B is incorrect because Standard III(B), Fair Dealing,?"requires CFA Institute members and
candidates to deal fairly and objectively with all clients when providing investment
analysis and making investment recommendations. It also requires that information about
investment recommendations be disseminated in such a manner that all clients have a fair
opportunity to act on the information." Roy?distributes the recommended stock list?to all
clients simultaneously via email, giving each an opportunity to act on the information.
Also,?Roy is permitted to provide?detailed?reports to "[c]lients who pay a subscription fee
for the service as long as (1) all clients are eligible to purchase the service, (2) the different
levels of service are disclosed to clients ..." Therefore, Roy has?not violated Standard
III(B).?
C is incorrect because?according to Standard V(B), Communication with Clients and
Prospective Clients, "[i]f recommendations are contained in capsule form (such as a
recommended stock list), members and candidates should notify clients that additional
information and analyses are available from the producer of the report." Roy sends a
recommended stock list to all of her firm's?clients along with a notification that a?detailed
report on each stock?is available on request.?Therefore, Roy has?not violated Standard
V(B).

Ethics Application Learning Outcome

2. Explain how the practices, policies, and conduct do or do not violate the CFA
Institute Code of Ethics and Standards of Professional Conduct

Question 27 of 90
Question
Tharushi Ranasinghe, CFA, is president of a small investment firm. Most of her clients are
longtime associates or family members whose investment portfolios she has managed for
many years. Ranasinghe is?familiar with her clients’ investment profiles and?is in regular
contact with them. Ranasinghe?makes appropriate?adjustment in?her clients'?portfolios
following significant events in their lives. She rarely updates her clients'?records given her
familiarity with their?investment requirements. Ranasinghe has most likely violated the
Standard(s) relating to:

1. fair dealing only.

2. record retention only.
C. both fair dealing and record retention.
Solution

Solution
B is correct because Standard V(C), Record Retention states, “Members and Candidates
must develop and maintain appropriate records to support their investment analyses,
recommendations, actions, and other investment-related communications with clients and
prospective clients.” In this case, “[Ranasinghe] has a responsibility as [her] clients’ adviser
and as the president of [her] company to maintain appropriate records when client
circumstances change. Without necessary, relevant, and up-to-date know-your-client
information, [Ranasinghe] would have difficulty establishing and proving that [her firm]
has identified the needs and circumstances of its clients and has taken them into account in
recommending investments.” So,?Ranasinghe has violated this Standard.?
A is incorrect because Standard III(B), Fair Dealing states that, “Members and Candidates
must deal fairly and objectively with all clients when providing investment analysis,
making investment recommendations, taking investment action, or engaging in other
professional activities." There is nothing here to suggest that Ranasinghe has violated this
Standard.
C is incorrect because Standard III(B), Fair Dealing states that, “Members and Candidates
must deal fairly and objectively with all clients when providing investment analysis,
making investment recommendations, taking investment action, or engaging in other
professional activities." There is nothing here to suggest that Ranasinghe has violated this
Standard. Also,?Standard V(C), Record Retention states, “Members and Candidates must
develop and maintain appropriate records to support their investment analyses,
recommendations, actions, and other investment-related communications with clients and
prospective clients.” In this case, “[Ranasinghe] has a responsibility as [her] clients’ adviser
and as the president of [her] company to maintain appropriate records when client
circumstances change. Without necessary, relevant, and up-to-date know-your-client
information, [Ranasinghe] would have difficulty establishing and proving that [her firm]
has identified the needs and circumstances of its clients and has taken them into account in
recommending investments.” So, Ranasinghe has only violated the Standard relating to
record retention.?

Ethics Application Learning Outcome

2. Explain how the practices, policies, and conduct do or do not violate the CFA
Institute Code of Ethics and Standards of Professional Conduct

Question 28 of 90
Question
Assume the following:

• The real risk-free rate of return is 3%.

• The expected inflation premium is 5%.
• The market-determined interest rate of a security is 12%.
The sum of the default risk premium, liquidity premium, and maturity premium for the
security is closest to:
1. 10%.
2. 4%.
C. 8%.
Solution

Solution
B is correct. The market-determined interest rate is equal to the real risk-free rate of
return plus an inflation premium plus risk premiums for default risk, liquidity, and
maturity. In this case, 12 = 3 + 5 + X. Solving for X: X = 4.
A is incorrect. 10% =12% − (5% − 3%)

C is incorrect. Eight percent is the sum of the real risk-free rate and expected inflation.

The Time Value of Money Learning Outcome

 2. Explain an interest rate as the sum of a real risk-free rate and premiums that
compensate investors for bearing distinct types of risk

Question 29 of 90
Question
An investor requiring $10,000 in 10 years' time has $7,500 to invest today and has access
to the following two accounts:

Stated annual interest rate Compounding frequency

Account 1 3.0% Quarterly

Account 2 2.9% Daily

Which of the accounts will allow the investor to achieve their goal?

1. Account 1 only
2. Account 2 only
3. Both Account 1 and Account 2
Solution

Solution
C is correct because "[w]ith more than one compounding period per year, the future value
formula can be expressed as FVN = PV[1 + (rs/m)]mN where rs is the stated annual interest
rate, m is the number of compounding periods per year, and N now stands for the number
of years." Identifying N = 10 and PV = $7,500, we have for Account 1 (with m = 4): FV10 =
$7,500 × [1 + (0.03/4)]4×10 = $10,113 and for Account 2 (with m = 365): FV10 = $7,500 × [1 +
(0.029/365)]365×10 = $10,023. Hence, both accounts will have a balance above $10,000 in 10
years' time.
A is incorrect because Account 2 also allows the investor to meet their goal. "With more
than one compounding period per year, the future value formula can be expressed as FVN =
PV[1 + (rs/m)]mN where rs is the stated annual interest rate, m is the number of
compounding periods per year, and N now stands for the number of years." Hence for
Account 2, FV10 = $7,500 × [1 + (0.029/365)]365×10 = $10,023 which is greater than the
required goal.
B is incorrect because Account 1 also allows the investor to meet their goal. "With more
than one compounding period per year, the future value formula can be expressed as FVN =
PV[1 + (rs/m)]mN where rs is the stated annual interest rate, m is the number of
compounding periods per year, and N now stands for the number of years." Hence for
Account 1, FV10 = $7,500 × [1 + (0.03/4)]4×10 = $10,113 which is greater than the required
goal.

The Time Value of Money Learning Outcome

 4. Calculate the solution for time value of money problems with different
frequencies of compounding

Question 30 of 90
Question
A consultant starts a project today that will last for three years. Her compensation package
includes the following:

Year End-of-Year Payment

1 $100,000

2 $150,000

3 $200,000
If she expects to invest these amounts at an annual interest rate of 3%, compounded
annually until her retirement 10 years from now, the value at the end of 10 years
is closest to:
1. $618,994.
2. $566,466.
C. $460,590.
Solution

Solution
B is correct. First calculate the present value of the three cash flows with the following
formula:
PV = FVN(1+r)N
We obtain:

PVCash flow 1 = ($100,000/1.03) = $97,087 (rounded)

PVCash flow 2 = [$150,000/(1.03)2] = $141,389 (rounded)
PVCash flow 3 = [$200,000/(1.03)3] = $183,028 (rounded)
Then, sum the three present values:

$97,087 + $141,389 + $183,028 = $421,504

Calculate the FV of $421,504 ten years from now with the formula:

FVN = PV × (1 + r)N
FV10 = PV × (1 + r)10
FV10 = $421,504 × (1.03)10 = $566,466 (rounded)
The future value 10 years from now is $566,466.

Alternatively, calculate directly the FV of each of the cash flows to the end of 10 years:
 FV10 = $100,000 × (1.03)9 + $150,000 × (1.03)8 + $200,000 × (1.03)7
= $130,477 + $190,016 + $245,975

= $566,468 (rounded).

A is incorrect. First calculate the future values of the three cash flows at the end of year
three: $100,000 × (1.03)2 + $150,000 × 1.03 + $200,000 = $106,090 + $154,500 + $200,000
= $460,590. Then, calculate the FV of $460,590 at the end of year 13: $460,590 × (1.03)10 =
$618,994.
C is incorrect. It is the sum of the future values of the three cash flows at the end of year
three: $100,000 × (1.03)2 + $150,000 × 1.03 + $200,000 = $106,090 + $154,500 + $200,000
= $460,590.

The Time Value of Money Learning Outcome

5. Calculate and interpret the future value (FV) and present value (PV) of a single
sum of money, an ordinary annuity, an annuity due, a perpetuity (PV only), and a
series of unequal cash flows

Question 31 of 90
Question
Over a four-year period, a portfolio has returns of 10%, −2%, 18%, and −12%. The
geometric mean return across the period is closest to:
1. 3.5%.
2. 8.1%.
C. 2.9%.
Solution

Solution
C is correct. The geometric mean return is calculated as:
RG = [∏t=1T(1+Rt)]1/T−1[∏t=1T(1+Rt)]1/T−1
= [(1 + 0.10) × (1 − 0.02) × (1 + 0.18) × (1 − 0.12)]0.25 − 1
= 0.0286 ~ 2.9%

A is incorrect. It is the arithmetic average and is calculated as: (10 − 2 +18 − 12)/4 = 3.5%.

B is incorrect. It is the geometric average of the given numbers, but without adding one, i.e.,
(10 × −2 × 18 × −12)0.25 = 8.10%.

Organizing, Visualizing, and Describing Data Learning Outcome

7. Calculate and interpret measures of central tendency

Question 32 of 90
Question
The following ten observations are a sample drawn from an approximately normal
population:

Observation 1 2 3 4 5 6 7 8 9 10

Value −31 −14 3 −18 34 20 −6 9 7 −16

The sample standard deviation is closest to:
1. 17.56.
2. 19.59.
C. 18.58.
Solution

Solution
B is correct.
X⎯⎯⎯=∑i=1nXin
= (−31 − 14 + 3 − 18 + 34 + 20 − 6 + 9 + 7 − 16)/10

= −12.00/10 = −1.20

where

Xi = the value of the ith observation

n = the number of observations in the sample
The sample variance is:

s2=∑i=1n(Xi−X⎯⎯⎯)2(n−1)
The sample standard deviation is the (positive) square root of the sample variance:

Value Deviation from Mean Squared Deviation

−31 −31 − (−1.2) = −29.8 888.04

−14 −14 − (−1.2) = −12.8 163.84

3 3 − (−1.2) = 4.2 17.64

−18 −18 − (−1.2) = −16.8 282.24

34 34 − (−1.2) = 35.2 1,239.04

20 20 − (−1.2) = 21.2 449.44

−6 −6 − (−1.2) = −4.8 23.04

 Value Deviation from Mean Squared Deviation

9 9 − (−1.2) = 10.2 104.04

7 7 − (−1.2) = 8.2 67.24

−16 −16 − (−1.2) = −14.8 219.04

Sum of squared deviations 3,453.60

Divided by n − 1 (10 − 1) 3,453.60/9 = 383.73

Square root 383.73⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯√383.73 = 19.59

A is incorrect. 17.56 is the sum of the absolute value of the deviations from mean divided
by 9:

Value Absolute deviation from mean

−31 |−31 − (−1.2)| = 29.8

−14 |−14 − (−1.2)| = 12.8

3 |3 − (−1.2)| = 4.2

−18 |−18 − (−1.2)| = 16.8

34 |34 − (−1.2)| = 35.2

20 |20 − (−1.2)| = 21.2

−6 |−6 − (−1.2)| = 4.8

9 |9 − (−1.2)| = 10.2

7 |7 − (−1.2)| = 8.2

−16 |−16 − (−1.2)| = 14.8

Sum of absolute deviations 158

Divided by n − 1 (10 − 1) 158/9 = 17.56

C is incorrect and is calculated by dividing the sum of squared deviations by 10 rather than
9: 3,453.60/10 = 345.36 and 345.36⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯√345.36 = 18.58.

Organizing, Visualizing, and Describing Data Learning Outcome

10. Calculate and interpret measures of dispersion

Question 33 of 90
Question
The joint probability of returns for securities A and B are as follows:
Joint Probability Function of Security A and Security B Returns (Entries Are Joint
Probabilities)

Return on Security B = Return on Security B =

30% 20%

Return on Security A = 0.60 0

25%

Return on Security A = 0 0.40

20%
The covariance of the returns between Securities A and B is closest to:
1. 12.
2. 14.
C. 13.
Solution

Solution
A is correct. First calculate the expected returns on securities A and B with the formula:
E(X)=∑i=1nP(Xi)Xi
Expected return on security A = 0.6 × 25% + 0.4 × 20% = 15% + 8% = 23%

Expected return on security B = 0.6 × 30% + 0.4 × 20% = 18% + 8% = 26%

Then calculate the covariance of returns between securities A and B with the formula:

Cov(RA,RB) = ∑i∑jP(RA,i,RB,j)(RA,i−ERA)(RB,j−ERB)
where

RA and RB = the returns on securities A and B, respectively

P = the joint probability
ERA and ERB = the expected returns of securities A and B, respectively
i and j = the line and column of the joint probability function table above
 Cov(RA,RB)=0.6[(25−23)(30−26)]+0.4[(20−23)(20−26)]=0.6[2×4]+0.4[(−3)(−6)]=0.6×8+
0.4×18=4.8+7.2=12
B is incorrect. In the covariance calculation, it uses the joint probabilities in the wrong
positions:

Cov(RA,RB)=0.4[(25−23)(30−26)]+0.6[(20−23)(20−26)]=0.4[2×4]+0.6[(−3)(−6)]=0.4×8+
0.6×18=3.2+10.8=14
C is incorrect. In the covariance calculation, it uses a joint probability of 0.5:

Cov(RA,RB)=0.5[(25−23)(30−26)]+0.5[(20−23)(20−26)]=0.5[2×4]+0.5[(−3)(−6)]=0.5×8+
0.5×18=4+9=13

Probability Concepts Learning Outcome

12. Calculate and interpret the covariances of portfolio returns using the joint
probability function

Question 34 of 90
Question
An investor in Abco stock forecasts the probability that Abco exceeded, met, or fell short of
consensus expectations for free cash flow (FCF) during the prior quarter:

• P(FCF exceeded consensus) = 0.50

• P(FCF met consensus) = 0.35
• P(FCF fell short of consensus) = 0.15
While waiting for Abco to release last quarter’s FCF data, the investor learns that Abco will
acquire a competitor. Believing that the upcoming acquisition makes it more likely that last
quarter’s FCF will exceed the consensus, the investor generates a list of FCF events that
may have influenced the acquisition:

• P(Acquisition | FCF exceeded consensus) = 0.40

• P(Acquisition | FCF met consensus) = 0.25
• P(Acquisition | FCF fell short of consensus) = 0.35
Using Bayes’ Formula, calculate the probability that Abco is likely to exceed consensus FCF
expectations for last quarter given the acquisition. P(FCF exceeded
consensus | Acquisition) is closest to:
1. 34%.
2. 59%.
C. 27%.
Solution

Solution
B is correct. The updated probability P(FCF exceeded consensus | Acquisition) is 59%.
1. Calculate the unconditional probability that Abco will acquire the competitor
firm:P(Acquisition) = (0.50 × 0.40) + (0.35 × 0.25) + (0.15 × 0.35) = 0.34, or 34%.
 2. Calculate the updated probability that Abco exceeded consensus expectations for
FCF given that they acquire the competitor firm: P(FCF exceeded
consensus | Acquisition) = [P(Acquisition | FCF exceeded
consensus)/P(Acquisition)] × P(FCF exceeded consensus) = (0.40/0.34) × (0.50) =
0.59 or 59%.
A is incorrect because 34% is the unconditional probability that Abco acquires the
competitor firm: P(Abco acquires) = (0.50 × 0.40) + (0.35 × 0.25) + (0.15 × 0.35) = 0.34, or
34%.
C is incorrect because the updated probability was calculated in error:

[P(Acquisition | FCF exceeded consensus) × P(Acquisition)]/P(FCF exceeded consensus) =

(0.40 × 0.34)/(0.50) = 0.27 or 27%

Probability Concepts Learning Outcome

13. Calculate and interpret and updated probability using Bayes' formula

Question 35 of 90
Question
An analyst determines that 60% of all US pension funds hold hedge funds. In evaluating this
probability, a random sample of 10 US pension funds is taken. Using the binomial
probability function, the probability that exactly 6 of the 10 firms in the sample hold hedge
funds is closest to:
1. 60.0%.
2. 11.2%.
C. 25.1%.
Solution

Solution
C is correct. The number of trials is 10 (n), the number of successes is 6 (x), and the
probability of success is 0.60 (p). By using the formula:
P(X=x)=n!/(n−x)!x!px(1−p)n−x
and the values given,

P(X=6)=10!(10−6)!6!(0.6)6(0.4)4=25.08%
A is incorrect. It is the given chance of success, 60%.

B is incorrect. It uses a probability of 0.40 instead than 0.60:

10!(10−6)!6!0.46(1−0.4)10−6−11.15%

Common Probability Distributions Learning Outcome

 5. Describe the properties of a Bernoulli random variable and a binomial random
variable, and calculate and interpret probabilities given the binomial distribution
function

Question 36 of 90
Question
An investor currently has a portfolio valued at $700,000. The investor’s objective is long-
term growth, but she will need $30,000 by the end of the year to pay her son’s college
tuition and another $10,000 by year-end for her annual vacation. The investor is
considering three alternative portfolios:

Portfolio Expected Return Standard Deviation of Returns Safety-First Ratio

1 0.2290

2 0.3300

3 14% 22%
Using Roy’s safety-first criterion, which of the alternative portfolios most likely minimizes
the probability that the investor’s portfolio will have a value lower than $700,000 at year-
end?
1. Portfolio 1
2. Portfolio 3
C. Portfolio 2
Solution

Solution
B is correct. The investor requires a minimum return of ($30,000 + $10,000)/$700,000, or
5.71%. Roy’s safety-first model uses the excess portfolio’s expected return over the
minimum return and divides that excess by the standard deviation for that portfolio:
Safety-first ratio = [E(RP) − RL]/σP,
where

E(RP) = the expected return of portfolio P

RL = the minimum return required by the investor
σP = the standard deviation of returns of portfolio P
Portfolio Safety-First Ratio

1 0.2290

2 0.3300

3 (14% − 5.71%)/22% = 0.3768

The portfolio with the highest safety-first ratio minimizes the probability that the
investor’s portfolio will have a value lower than $700,000 at year end. The highest safety-
first ratio is associated with Portfolio 3: 0.3768.

A is incorrect. The investor requires a minimum return of ($30,000 + $10,000)/$700,000

or 5.71 percent. Roy’s safety-first model uses the excess portfolio’s expected return over
the minimum return and divides that excess by the standard deviation for that
portfolio:Safety-first ratio = [E(RP) − RL]/σP,where
E(RP) = is the expected return of portfolio P
RL = the minimum return required by the investor
σP = the standard deviation of returns of portfolio P
Portfolio Safety-First Ratio

1 0.2290

2 0.3300

3 (14% − 5.71%)/22% = 0.3768

The portfolio with the highest safety-first ratio minimizes the probability that the
investor’s portfolio will have a value lower than $700,000 at year end. The highest safety-
first ratio is associated with Portfolio 3: 0.3768.

C is incorrect. The investor requires a minimum return of ($30,000 + $10,000)/$700,000

or 5.71 percent. Roy’s safety-first model uses the excess portfolio’s expected return over
the minimum return and divides that excess by the standard deviation for that
portfolio:Safety-first ratio = [E(RP) − RL]/σP,where
E(RP) = is the expected return of portfolio P
RL = the minimum return required by the investor
σP = the standard deviation of returns of portfolio P
Portfolio Safety-First Ratio

1 0.2290

2 0.3300

3 (14% − 5.71%)/22% = 0.3768

The portfolio with the highest safety-first ratio minimizes the probability that the
investor’s portfolio will have a value lower than $700,000 at year end. The highest safety-
first ratio is associated with Portfolio 3: 0.3768.

Common Probability Distributions Learning Outcome

 11. Define shortfall risk, calculate the safety-first ratio, and identify an optimal
portfolio using Roy’s safety-first criterion

Question 37 of 90
Question
A mutual fund manager wants to create a fund based on a high-grade corporate bond index.
She first distinguishes between utility bonds and industrial bonds; she then, for each
segment, defines maturity intervals of less than 5 years, 5 to 10 years, and greater than 10
years. For each segment and maturity level, she classifies the bonds as callable or
noncallable. She then randomly selects bonds from each of the subpopulations she has
created. For the manager’s sample, which of the following best describes the sampling
approach?
1. Simple random
2. Systematic
C. Stratified random
Solution

Solution
C is correct. In stratified random sampling, one divides the population into subpopulations
and randomly samples from within the subpopulations.
A is incorrect. The approach described is called stratified random sampling. In stratified
random sampling, one divides the population into subpopulations and randomly samples
from within the subpopulations.

B is incorrect. The approach described is called stratified random sampling. In stratified

random sampling, one divides the population into subpopulations and randomly samples
from within the subpopulations.

Sampling and Estimation Learning Outcome

3. Compare and contrast simple random, stratified random, cluster, convenience,
and judgemental sampling

Question 38 of 90
Question
Which of the following statements about bootstrap resampling is most accurate?
1. Multiple samples are taken from the population.
2. In each resample, items are drawn without replacement.
C. The randomly drawn sample is treated as if it were the population.
Solution

Solution
C is correct because "a random sample offers a good representation of the population,
[therefore] we can simulate sampling from the population by sampling from the observed
sample. In other words, the bootstrap mimics the process by treating the randomly drawn
sample as if it were the population."
A is incorrect because "[t]he idea behind bootstrap is to mimic the process of performing
random sampling from a population. ... The difference lies in the fact that we have no
knowledge of what the population looks like, except for a sample with size n drawn from
the population." In other words, only one sample, not multiple samples, is taken from the
population. The subsequent resamples are then taken from the original sample and not
directly from the population.
B is incorrect because "[i]n bootstrap, we repeatedly draw samples from the original
sample, and each resample is of the same size as the original sample. Note that each item
drawn is replaced for the next draw (i.e., the identical element is put back into the group so
that it can be drawn more than once)." Hence items are drawn with replacement, not
without.

Sampling and Estimation Learning Outcome

9. Describe the use of resampling (bootstrap, jackknife) to estimate the sampling
distribution of a statistic

Question 39 of 90
Question
The value of a swap contract at initiation is most likely equal to:
1. zero
2. the present value of the fixed payments of the swap.
C. average price of a series of forward contracts with each forward contract
maturing at each swap payment date.
Solution

Solution
A is correct because "[f]orwards, futures, and swaps start off with values of zero...[and
swap price is] the fixed price or rate at which the underlying will be purchased at a later
date." The value of a swap is zero at contract initiation.
B is incorrect because "[t]he forward, futures, or swap price is a concept that represents
the fixed price or rate at which the underlying will be purchased at a later date." The value
of a swap includes all payments, fixed and floating - not just fixed payments.

C is incorrect because "the value and price [of a swap] are not at all comparable with each
other." The above number is a price figure and hence not at all comparable with the value
of a swap.

Basics of Derivative Pricing and Valuation Learning Outcome

9. Explain the difference between value and price of swaps

Question 40 of 90
Question
An analysis of US share prices determines that there is consistent underpricing by $0.02
with a p-value of 0.0012. Assuming an average transaction cost of $0.05, which statement
is most accurate? The underpricing result is:
1. statistically significant and indicates a possible arbitrage opportunity.
2. not economically meaningful.
C. not statistically significant.
Solution

Solution
B is correct. The underpricing result is not economically meaningful when the average
transaction cost is taken into consideration.
A is incorrect. As explained in C, the result is statistically significant. However, there is no
arbitrage opportunity in this case because the transaction cost is too high (i.e., not
economically meaningful).

C is incorrect. The result should be statistically significant as a p-value of 0.0012 is the

smallest level of significance that the null hypothesis is rejected. In this case, it is far less
than level of significance of 0.01.

Hypothesis Testing Learning Outcomes

4. Explain a decision rule and the relation between confidence intervals and
hypothesis tests, and determine whether a statistically significant result is also
economically meaningful
e. Explain and interpret the p-value as it relates to hypothesis testing

Question 41 of 90
Question
For tests concerning the differences between two normally distributed population means
with equal but unknown variances, which of the following test statistics is
the most appropriate?
1. z-test
2. approximate t-test
C. t-test
Solution

Solution
C is correct. A t-test is best used in a test of the difference between two population means
when we can assume they are normally distributed and that the unknown variances are
equal
A is incorrect because a z-test is not appropriate in the case of testing the difference
between two population means. A z-test is used in the case of a hypothesis test of the
population mean where the variance is known or in the case of an unknown variance when
the sample is large and we can rely on the central limit theorem.
B is incorrect because we use an approximate t-test in order to test the difference between
two population means that we can assume are normally distributed but the population
variances are unknown and cannot be assumed equal.

Hypothesis Testing Learning Outcome

8. Identify the appropriate test statistic and interpret the results for a hypothesis
test concerning the equality of the population means of two at least approximately
normally distributed populations, based on independent random samples with
equal assumed variances

Question 42 of 90
Question
If a paired comparison test of mean differences supports rejecting the null hypothesis, then
the:

1. independence of the samples is statistically significant.

2. standard error of the mean differences is low relative to the sample mean
difference.
C. difference in means is not statistically significant.
Solution

Solution check lại kthuc phần này

B is correct. According to the test statistic, t=d⎯⎯−μd0sd⎯⎯t=d¯−μd0sd¯, the lower the standard
error in the denominator, the higher the value of the t-statistic. The t-statistic calculation
includes the sample mean difference in the numerator. Therefore, a lower standard error
(denominator) relative to the sample mean difference (numerator) results in a higher t-
statistic value.
A is incorrect because a paired comparison test is used to test mean differences when we
believe that the samples are dependent; it is not used to test whether samples are
dependent or independent.

C is incorrect because if the null hypothesis is rejected, the evidence is statistically

significant.

Hypothesis Testing Learning Outcome

9. Identify the appropriate test statistic and interpret the results for a hypothesis
test concerning the mean difference of two normally distributed populations

Question 43 of 90
Question
In a simple linear regression model, the residual for an observation of Y is computed as:
 1. the observed value of Y divided by the expected value of Y.
2. the unexplained variation in Y divided by the explained variation in Y.
C. the difference between the observed value of Y and the estimated value of Y.
Solution

Solution
C is correct because "[t]he residual for the ith observation, ei, is how much the observed
value of Yi differs from the Yi estimated using the regression line."
A is incorrect because "[t]he residual for the ith observation, ei, is how much the observed
value of Yi differs from the Yi estimated using the regression line."
B is incorrect because "[t]he residual for the ith observation, ei, is how much the observed
value of Yi differs from the Yi estimated using the regression line."

Introduction to Linear Regression Learning Outcome

2. Describe the least squares criterion, how it is used to estimate regression
coefficients, and their interpretation

Question 44 of 90
Question
An analyst runs a simple linear regression using 35 months of data to assess a country's
short-term interest rate as a function of its inflation rate, with the following results:

Source Degrees of Freedom Sum of Squares Mean square

Regression 1 17.3009 17.3009

Error 33 20.2299 0.6130

Total 34 37.5308
The percentage of the variation in the short-term interest rate that is explained by the
inflation rate is closest to:
1. 46%.
2. 54%.
3. 61%.
Solution

Solution
A is correct because the percentage of the variation in the short-term rate that is explained
by the inflation rate is the coefficient of determination, computed as sum of squares
regression/sum of squares total:
17.3009/37.5308 = 0.461 = 46.1% ≈ 46%.
B is incorrect because it computes the coefficient of determination as sum of squares
error/sum of squares total:

20.2299/37.5308 = 0.5390 = 53.9% ≈ 54%.

C is incorrect because it incorrectly considers the coefficient of determination as equal to
the mean square error:

0.6130 = 61.30% ≈ 61%.

Introduction to Linear Regression Learning Outcome

5. Describe the use of analysis of variance (ANOVA) in regression analysis, interpret
ANOVA results, and calculate and interpret the standard error of estimate in a
simple linear regression

Question 45 of 90
Question
Which of the following statements about prediction intervals is most accurate? All else
being equal:
1. the width of the prediction interval does not depend on the standard error of the
estimate.
2. a smaller variation of the independent variable will result in a narrower
prediction interval.
C. a larger sample size in the regression estimation will result in a smaller standard
error of the forecast.
Solution

Solution
C is correct because "[w]e can see ... from the equation for the standard error of the
forecast [that] ... [t]he larger the sample size (n) in the regression estimation, the smaller
the standard error of the forecast."
A is incorrect because "[t]he better the fit of the regression model, the smaller the standard
error of the estimate (se) and, therefore, the smaller standard error of the forecast."
Moreover, "[o]nce we have this estimate of the standard error of the forecast, determining
a prediction interval around the predicted value of the dependent variable (Yˆf)(Y^f)is very
similar to estimating a confidence interval around an estimated parameter. The prediction
interval is Yˆf±tcritical for α/2sfY^f±tcritical for α/2sf." Thus, a smaller standard error of the
estimate will result in a narrower prediction interval.
B is incorrect because "the standard error of the forecast is
sf=se1+1n+(Xf−X⎯⎯⎯)2∑ni=1(Xi−X⎯⎯⎯)2⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯√sf=se1+1n+(Xf-
X¯)2∑i=1n(Xi-X¯)2
The standard error of the forecast depends on...the variation of the independent variable

[∑ni=1(Xi−X⎯⎯⎯)2]∑i=1n(Xi-X¯)2."
From the equation of the standard error of the forecast, the smaller variation of the
independent variable will increase the standard error of the forecast, and thus will result in
a wider prediction interval.

Introduction to Linear Regression Learning Outcome

7. Calculate and interpret the predicted value for the dependent variable, and a
prediction interval for it, given an estimated linear regression model and a value
for the independent variable

Question 46 of 90
Question
The monthly demand curve for playing tennis at a particular club is given by the following
equation: PTennis Match = 9 – 0.20 × QTennis Match. The club currently charges members $4.00 to play a
match but is considering adding a membership fee. If the club continues to charge the same
per play charge, the most that it will be able to charge as a membership fee is closest to:
1. $62.50.
2. $162.50.
C. $40.00.
Solution

Solution
A is correct. On rearrangement, the demand function is:
QTennis Match = 45 – 5.0 × PTennis Match
The number of matches played per month at $4.00/match = 45 – 5.0 × 4.00 = 25

The y-intercept of the demand curve occurs when Q = 0: P = 9

The x-intercept of the demand curve occurs when P = 0: Q = 45
In addition to the per play charge, the club will be able to charge the consumer surplus: the
area under the demand curve above the current price per match to a total of 25 matches:
0.5 × ($9.00 – $4.00) × 25 = $62.50.

This is illustrated in the diagram as triangle A.

C is incorrect. It is the triangle formed under the demand curve to the right of the 25
matches: 0.5 × (45 – 25) × $4 = $40 (This is triangle C).

B is incorrect. It is consumer surplus plus the rectangle below it to the 25 matches played,
i.e., 0.5 × ($9.00 – $4.00) × 25 + (4 × 25) = $162.50 (triangles A plus B).

Topics in Demand and Supply Analysis Learning Outcome

1. Calculate and interpret price, income, and cross-price elasticities of demand and
describe factors that affect each measure

Question 47 of 90
Question
With respect to the relationship between output and costs in the short run, a decline in the
marginal cost per unit most likely occurs at what level of production?
1. Low output
2. Profit-maximizing output
C. High output
Solution

Solution
A is correct. Marginal cost per unit, in the short run, decreases at low levels of output as a
result of economies from greater specialization. At higher levels of output, however, it
eventually increases because of the law of diminishing returns.
B is incorrect. Assuming a given price per unit (i.e., a flat marginal revenue curve), the
profit-maximizing output must be above the minimum point on the marginal cost curve.
That is, MC must be increasing at MR = MC.

C is incorrect. At higher levels of production, marginal cost eventually increases because of

the law of diminishing returns.
Topics in Demand and Supply Analysis Learning Outcome
4. Describe the phenomenon of diminishing marginal returns

Question 48 of 90
Question
For inferior goods:

1. the demand curve is positively sloped.

2. an increase in income causes consumers to buy less.
C. the income and substitution effects reinforce one another.
Solution

Solution
B is correct because consumers will "[b]uy less because the increase in real income
prompts the consumer to buy less of the inferior good in favor of its preferred substitutes."
C is incorrect because "if the good is inferior, the income effect and the substitution effect
work in opposite directions."

A is incorrect because "[i]n virtually every case in the real world, the law of demand holds:
A decrease in price results in an increase in quantity demanded, resulting in a negatively
sloped demand curve." In a few unusual cases, however, we may find a positively sloped
demand curve—a decrease (increase) in price may result in a decrease (increase) in the
quantity demanded. These unusual cases are called Giffen goods and Veblen goods."

Topics in Demand and Supply Analysis Learning Outcome

3. Contrast normal goods with inferior goods

Question 49 of 90
Question
A monopolist can charge each customer the highest price the customer is willing to pay
under:

1. first-degree price discrimination.

2. second-degree price discrimination.
C. third-degree price discrimination.
Solution

Solution
A is correct because "[t]his scenario is called first-degree price discrimination, where a
monopolist can charge each customer the highest price the customer is willing to pay."
B is incorrect because "[i]n second-degree price discrimination the monopolist offers a
menu of quantity-based pricing options designed to induce customers to self-select based
on how highly they value the product."
C is incorrect because "[t]hird-degree price discrimination happens when customers are
segregated by demographic or other traits."

The Firm and Market Structures Learning Outcome

6. Describe pricing strategy under each market structure

Question 50 of 90
Question
The two dominant supermarket chains in the area are attempting to increase their market
share by moving to 24-hour service instead of closing at 9 p.m. every night. The strategic
outcomes and payoff matrix that arise from their actions are depicted in the diagram (with
the shaded sections representing payoffs for Chain 2).

The most likely Nash equilibrium strategy for the two chains is for:
1. both chains to open for 24 hours.
2. only Chain 2 to open for 24 hours.
C. both chains to close at 9 p.m.
Solution

Solution
A is correct. Each company will consider the other’s reaction in selecting its strategy. Using
the following summary, it is best for both chains to provide 24-hour service.
Chain Consideration Best Decision

If it opens for 24 hours, it will see a higher payoff Open for 24

1
regardless of what Chain 2 does. hours
 Chain Consideration Best Decision

Chain 2 Chain 2
Closes at 9 p.m. Opens for 24 hours

Chain 1 earns 540 instead of Chain 1 earns 108 instead of

180 55

If it opens for 24 hours, it will see a higher payoff

regardless of what Chain 1 does.

Chain 1 Chain 1 Open for 24

2
Closes at 9 p.m. Opens for 24 hours hours

Chain 2 earns 592 instead of Chain 2 earns 140 instead of

290 75
B is incorrect because it produces the highest combined profit from all combinations but is
not relevant for any 1 chain in this market environment.

C is incorrect. As indicated in the table, both chains have an incentive to open for 24 hours
because they will do better regardless of what their competitor does.

The Firm and Market Structures Learning Outcomes

1. Describe characteristics of perfect competition, monopolistic competition,
oligopoly, and pure monopoly
4. Describe and determine the optimal price and output for firms under each market
structure
e. Explain factors affecting long-run equilibrium under each market structure

Question 51 of 90
Question
Which of the following is most likely to cause a shift to the right in the aggregate demand
curve?
1. Boom in the stock market
2. Increase in taxes
C. Decrease in real estate values
Solution

Solution
A is correct. A boom in the stock market increases the value of financial assets and
household wealth. An increase in household wealth increases consumer spending and
shifts the aggregate demand curve to the right.
B is incorrect. An increase in taxes decreases household wealth and shifts the aggregate
demand to the left.

C is incorrect. A decrease in real estate values decrease household wealth and shifts the
aggregate demand to the left.

Aggregate Output, Prices, and Economic Growth Learning Outcome

8. Explain causes of movements along and shifts in aggregate demand and supply
curves

Question 52 of 90
Question
According to the neoclassical growth model, for an economy operating below full potential,
a percentage increase in only one input in the production process leads to:

1. no change in output.
2. diminishing marginal returns.
C. the same percentage growth in total output.
Solution

Solution
B is correct because the neoclassical growth model "assumes that the production function
exhibits diminishing marginal productivity with respect to any individual input."
"Diminishing marginal productivity means that at some point the extra output obtained
from each additional unit of the input will decline. … "
A is incorrect because an increase in any input will increase output unless the economy is
operating at full potential, at which point output will not increase.

C is incorrect because the neoclassical growth model "assumes that the production function
has constant returns to scale. This means that if all the inputs in the production process are
increased by the same percentage, then output will rise by that percentage. Thus, doubling
all inputs would double output.."

Aggregate Output, Prices, and Economic Growth Learning Outcome

14. Describe the production function approach to analyzing the sources of economic
growth

Question 53 of 90
Question
In which phase of the business cycle is actual output most likely below potential output?
1. Recovery
2. Slowdown
C. Expansion
Solution

Solution
A is correct because in the recovery phase "actual output is at its lowest level relative to
potential output. Economic activity, including consumer and business spending, is below
potential but is starting to increase, closing the negative output gap."
B is incorrect because in the slowdown phase the "[p]ositive output gap starts to narrow
[but remains positive]."

C is incorrect because in the expansion phase the "[p]ositive output gap opens."

Understanding Business Cycles Learning Outcome

1. Describe the business cycle and its phases

Question 54 of 90
Question
Assuming all other factors remain unchanged, which of the following changes would most
likely cause a simultaneous increase in the participation ratio and a decrease in the
unemployment rate?
1. A decrease in the number of unemployed people
2. A decrease in the total population of working-age people
C. An increase in the number of people included in the labor force
Solution

Solution
C is correct. The participation ratio (or activity ratio) is the ratio of the number of people
in the labor force to the total population of working-age people, and the unemployment
rate is the ratio of the number of unemployed to the number of people in the labor force.
The labor force is the numerator in the participation ratio, and the denominator is the
unemployment rate. Therefore, assuming all else remains unchanged, an increase in the
number of people included in the labor force would cause the participation ratio to
increase and unemployment rate to decrease.
A is incorrect. Although a decrease in the total number of unemployed people would
decrease the unemployment rate, this would not have a direct effect on the participation
rate.

B is incorrect. Although a decrease in the total population of working age people would
increase the participation rate if the size of the labor force remained unchanged, this would
have no direct effect on the unemployment rate.

Understanding Business Cycles Learning Outcome

6. Describe types of unemployment and compare measures of unemployment
Question 55 of 90
Question
A rising inventory-sales ratio most likely indicates the economy is undergoing a:
1. recovery.
2. slowdown.
C. contraction.
Solution

Solution
B is correct because in a slowdown the inventory-sales "[r]atio increases. Signals
weakening economy."
A is incorrect because in a recovery the ratio "[b]egins to fall as sales recovery outpaces
production."

C is incorrect because in a contraction the "[r]atio begins to fall back to normal."

Understanding Business Cycles Learning Outcome

3. Describe how resource use, consumer and business activity, housing sector
activity, and external trade sector activity vary as an economy moves through the
business cycle

Question 56 of 90
Question
Which of the following acts as an automatic stabilizer for the economy?

1. A decrease in corporate tax rates

2. New public spending on hospitals
C. Government expenditure on unemployment benefits
Solution

Solution
C is correct because "as an economy slows and unemployment rises, government spending
[expenditure] on social insurance and unemployment benefits will also rise and add to
aggregate demand. This is known as an automatic stabilizer."
A is incorrect because a decrease in corporate tax rates is a discretionary fiscal policies.
"Automatic stabilizers should be distinguished from discretionary fiscal policies, such as
changes in government spending or tax rates, which are actively used to stabilize aggregate
demand."

B is incorrect because new public spending on social goods and infrastructure, such as
hospitals is an example of a [discretionary] fiscal policy. "Automatic stabilizers should be
distinguished from discretionary fiscal policies, such as changes in government spending or
tax rates, which are actively used to stabilize aggregate demand."

Monetary and Fiscal Policy Learning Outcome

15. Describe roles and objectives of fiscal policy

Question 57 of 90
Question G-T increase
Substantial government borrowing is less likely to be of concern when:
1. the private sector decreases savings to offset the debt.
2. most of the borrowing is owed internally to local citizens.
C. the private sector is crowded out to make room for the debt.
Solution

Solution
B is correct because the issue of significant debt "may be overstated because the debt is
owed internally to fellow citizens."
A is incorrect because "[d]eficits may have no net impact because the private sector may
act to offset fiscal deficits by increasing [not decreasing] saving in anticipation of future
increased taxes."

C is incorrect because "[g]overnment borrowing may divert private sector investment from
taking place (an effect known as crowding out); if there is a limited amount of savings to be
spent on investment, then larger government demands will lead to higher interest rates
and lower private sector investing."

Monetary and Fiscal Policy Learning Outcome

17. Describe the arguments about whether the size of a national debt relative to GDP
matters
monetary -> private
Question 58 of 90
fiscal -> public
Question
Assuming wages and prices are stable, which of the following policy combinations most
likely leads to an increase in the private sector's share of GDP?
1. Easy fiscal and easy monetary policy
2. Tight fiscal and easy monetary policy
C. Easy fiscal and tight monetary policy
Solution

Solution
B is correct because with [t]ight fiscal policy/easy monetary policy: If a fiscal contraction
is accompanied by expansionary monetary policy and low interest rates, then the private
sector will be stimulated and will rise as a share of GDP, while the public sector will shrink.
A is incorrect, because "[i]f both fiscal and monetary policy are easy, then the joint impact
will be highly expansionary leading to—…lower interest rates (at least if the monetary
impact is larger), and growing private and public sectors," without the private sector's
share of GDP growing.

C is incorrect, because under "Easy fiscal policy/tight monetary policy: … "[w]e have higher
output and higher interest rates, and government spending [not the private sector] will be
a larger proportion of overall national income."

Monetary and Fiscal Policy Learning Outcome

20. Explain the interaction of monetary and fiscal policy

Question 59 of 90
Question
Consider two countries, A and B. Country A, a closed country with a relative abundance of
labor, holds a comparative advantage in the production of textiles. Country B has a relative
abundance of capital. When the textile trade is opened between the two countries, Country
A will most likely experience a favorable impact on:
1. labor.
2. both capital and labor.
C. capital.
Solution

Solution
A is correct. As a country opens up to trade, the benefit accrues to the abundant factor,
which is labor in Country A.
B is incorrect. The favorable impact goes to the factor in relative abundance, which includes
labor and excludes capital in Country A.

C is incorrect. Country B has an abundance of capital, therefore the favorable benefit to

capital lies in Country B, not in Country A.

International Trade and Capital Flows Learning Outcomes

3. Contrast comparative advantage and absolute advantage
d. Compare the Ricardian and Heckscher–Ohlin models of trade and the source(s) of
comparative advantage in each model
e. Compare types of trade and capital restrictions and their economic implications

Question 60 of 90
Question
Which of the following best describes a function of the International Bank for
Reconstruction and Development?
 1. Lending foreign currencies on a temporary basis to address balance of payment
issues
2. Regulating cross-border trade relationships on a global scale
C. Providing low interest rate loans to developing countries
Solution

Solution
C is correct. Closely affiliated with The World Bank Group, the International Bank for
Reconstruction and Development (IBRD) provides low or no-interest loans and grants to
developing countries that have unfavorable credit or no access to international credit
markets.
A is incorrect. This is a function of the IMF.

B is incorrect. This is a function of the World Trade Organization.

International Trade and Capital Flows Learning Outcome

10. Describe functions and objectives of the international organizations that facilitate
trade, including the World Bank, the International Monetary Fund, and the World
Trade Organization

Question 61 of 90
Question
Assume the percentage increases in each of the following listed items:

Percentage Increase

Real domestic exchange rate (USD/EUR) 5

Eurozone price level 2

US price level 1.5

The predicted change in the nominal US spot exchange rate is closest to:
1. 4.5%.
2. –0.5%.
C. 5.5%.
Solution

Solution
A is correct. Change in the nominal exchange rate =
(1+ΔRdf/Rdf)×(1+ΔPdPd)/(1+ΔPfPf)−1=(1+5%)×(1+1.5%)/(1+2%)−1=4.5%
B is incorrect because the change in the real exchange rate is not included: [(1 + 1.5%)/(1 +
2%)] – 1 = –0.5%.
C is incorrect because the change in the price levels are inverted: (1 + 5%) × [(1 + 2%)/(1 +
1.5%)] – 1 = 5.5%.

Currency Exchange Rates Learning Outcome

1. Define an exchange rate and distinguish between nominal and real exchange rates
and spot and forward exchange rates

Question 62 of 90
Question
Assume the following:

Current spot rate for the USD/EUR 0.7500

Forward rate for the EUR/AUD 1.4300

EUR/AUD forward premium to the spot rate 400 points

USD: US dollar; EUR: Euro; AUD: Australian dollar

The USD/AUD spot rate is closest to:

1. 1.0296.
2. 1.0425.
C. 1.1154.
Solution

Solution
B is correct.
Step 1: Find the spot rate for the EUR/AUD

Spot = Forward Rate – Forward Points

= 1.4300 – (400/10,000)

= 1.3900
cách tính theo appreciate/basispoint

Step 2: Calculate current cross rate

(USD/AUD) = (EUR/AUD) × (USD/AUD)

= 0.7500 × 1.3900

= 1.0425

A is incorrect. It incorrectly subtracts forward premium from 1.

 (1 – 400/10000) × 1.43 = 1.3728
1.3728 × 0.75 = 1.0296
C is incorrect. It incorrectly adds forward premium to 1.

(1 + 400/10000) × 1.43 = 1.4872

1.4872 × 0.75 = 1.1154

Currency Exchange Rates Learning Outcomes

4. Calculate and interpret currency cross-rates
e. Calculate an outright forward quotation from forward quotations expressed on a
points basis or in percentage terms

Question 63 of 90 1 đồng base đổi được ít đồng price hơn ở fwd

Question
If the domestic currency is trading at a forward premium, then relative to the interest rate
of the domestic country, the interest rate in the foreign country is most likely:
1. lower.
2. higher.
C. the same.
Solution
phân biệt currency hay contract traded
Solution
B is correct. The currency with the higher (lower) interest rate will always trade at a
discount (premium) in the forward market. The lower interest rate in the domestic country
will be offset by the appreciation of the domestic country’s currency over the investment
horizon.
A is incorrect because the forward rate is trading at a premium and not at a discount.

C is incorrect because the forward rate does not equal the spot rate.

Currency Exchange Rates Learning Outcome

8. Calculate and interpret the forward rate consistent with the spot rate and the
interest rate in each currency

Question 64 of 90
Question
Reviewing the MD&A section of an annual report is important because:

1. future revenue projections must be disclosed.

2. accounting policies may require subjective judgment by management.
C. management commentary is typically unaudited.
Solution
Solution
B is correct. Companies should disclose in management commentary any critical
accounting policies that require management to make subjective judgements that may have
a significant impact on reported financial results. These subjective judgements should be
carefully reviewed because they may materially alter an analyst’s conclusions about the
future performance or financial position of a company
A is incorrect because companies are not required to disclose future revenue projections in
the management’s discussion and analysis section of financial statements, but should
highlight any favorable or unfavorable trends or uncertainties that may impact future
performance or financial position.

C is incorrect because although management commentary is typically unaudited, it is not a

reason why management commentary is of importance to analysts. Rather, analysts should
be aware that management commentary is unaudited and interpret accordingly.

Introduction to Financial Statement Analysis Learning Outcome

3. Describe the importance of financial statement notes and supplementary
information—including disclosures of accounting policies, methods, and
estimates—and management’s commentary

Question 65 of 90
Question
Interim reports most likely:
1. are audited.
2. are issued semi-annually or quarterly.
C. include a full set of financial statements and notes.
Solution

Solution
B is correct. Interim reports are provided semi-annually or quarterly, depending on
applicable regulatory requirements.
A is incorrect. Interim reports are not audited.

C is incorrect. Interim reports generally present the four basic financial statements and
condensed notes.

Introduction to Financial Statement Analysis Learning Outcome

5. Identify and describe information sources that analysts use in financial statement
analysis besides annual financial statements and supplementary information

Question 66 of 90
Question
Which of the following statements best describes the role of the International Organization
of Securities Commissions (IOSCO)? The IOSCO
1. is the oversight body to which the International Accounting Standards Board
(IASB) reports.
2. is responsible for regulating financial markets of member nations.
C. assists in attaining the goal of cross-border cooperation in combating violations
of securities laws.
Solution

Solution
C is correct. The IOSCO is not a regulator of financial markets. Its role is to assist in
attaining the goal of uniform regulation and enforcement of international financial
standards and in attaining the goal of cross-border cooperation in combating violations of
securities and derivative laws.
A is incorrect. The IOSCO assists in attaining the goal of uniform regulation of international
financial standards including IFRS, but the IASB does not report to it.

B is incorrect. The IOSCO is not a regulatory authority.

Financial Reporting Standards Learning Outcome

2. Describe roles and desirable attributes of financial reporting standard-setting
bodies and regulatory authorities in establishing and enforcing reporting
standards, and describe the role of the International Organization of Securities
Commissions

Question 67 of 90
Question
Company A owns 60% of Company B. Company A’s consolidated income statement most
likely includes 100% of Company A’s revenues and expenses and what portion of Company
B's?
1. 0%
2. 100%
C. 60%
Solution

Solution
B is correct. Because Company A owns more than 50% of the shares in Company B it must
present consolidated financial statements, which will include 100% of Company B’s
revenues and expenses.
A is incorrect. All subsidiaries, even those that are partially owned, are included in a
consolidated statement.
C is incorrect. All subsidiary revenues and expenses are included, even if they are not 100%
owned by the parent.

Understanding Income Statements Learning Outcome

1. Describe the components of the income statement and alternative presentation
formats of that statement

Question 68 of 90
Question
Selected year-end financial data for Smalley Enterprises follows:

Net income $200,000

Tax rate 15 percent

Weighted average number of common shares outstanding 125,000

12% bond convertible into 3,000 common shares (potentially dilutive) $60,000
Given this information, Smalley’s diluted EPS is closest to:
1. $1.61.
2. $1.60.
luôn luôn check dilutive
C. $1.51.
Solution

Solution
B is correct. First determine the basic EPS, calculated as follows:
Basic EPS=Net income−Preferred dividendsWeighted average number of shares outstanding=$200,000−$0125,000=$1
.60
Next, calculate diluted EPS using the if-converted method for the convertible debt:

Diluted EPS=Net income+After-

tax interest on convertible debt−Preferred dividendsWeighted average numberof shares outstanding+Additional common shares
that wouldhave been issued at conversion=$200,000+[$60,000×0.12×(1−0.15)]−0125,000+3,000=$206,120128,000=$1.61
The calculated diluted EPS is greater than the basic EPS. By definition, the diluted EPS is
always equal to or less than basic EPS and this means that the diluted EPS will be $1.60.

C is incorrect because it miscalculates the effect of the after-tax interest on debt in the if-
converted method used for the convertible debt to determine the diluted EPS:

Diluted EPS=Net income−After-

tax interest on convertible debt−Preferred dividendsWeighted average numberof shares outstanding+Additional common shares
that wouldhave been issued at conversion=$200,000−[$60,000×0.12×(1−0.15)]−0125,000+3,000=$193,880128,000=$1.51
The $1.51 is a result due to mistakenly subtracting the after-tax interest on the debt. It
should be added.
A is incorrect because it shows a diluted EPS greater than basic EPS.

The first step is to determine the basic EPS, which is calculated as follows:

Basic EPS=Net income−Preferred dividendsWeighted average number of shares outstanding=$200,000−$0125,000=$1

.60
Next, the if-converted method is used for the convertible debt to calculate the diluted EPS:

Diluted EPS=Net income+After-

tax interest on convertible debt−Preferred dividendsWeighted average numberof shares outstanding+Additional common shares
that wouldhave been issued at conversion=$200,000+[$60,000×0.12×(1−0.15)]−0125,000+3,000=$206,120128,000=$1.61
The higher diluted EPS of $1.61 cannot be used because by definition, the diluted EPS is
always equal to or less than basic EPS.

Understanding Income Statements Learning Outcome

8. Contrast dilutive and antidilutive securities and describe the implications of each
for the earnings per share calculation

Question 69 of 90
Question
An analyst gathers the following annual information on three companies:

Company A Company B Company C

Sales $40,000 $200,000 $450,000

Cost of sales 21,000 110,000 240,000

Selling, general and administrative 6,000 24,000 48,000

All other operating expenses 1,000 2,000 5,000

Operating income 12,000 64,000 157,000

Interest and other expense 2,000 0 14,000

Taxes 4,000 26,000 58,000

Net income $6,000 $38,000 $85,000

The company with the highest gross profit margin is:

1. Company A.
2. Company C.
C. Company B.
Solution

Solution
A is correct. The gross profit is sales minus cost of sales and the gross profit margin is
calculated as gross profit divided by sales. The calculations for the three companies are as
follows:
Company A: Gross profit = $40,000 – $21,000 = $19,000 and the gross profit margin is
47.5% ($19,000/$40,000). Of the three companies, this gross profit margin is the highest.

Company B: Gross profit = $200,000 – $110,000 = $90,000 and the gross profit margin is
45.0% ($90,000/$200,000).

Company C: Gross profit = $450,000 – $240,000 = $210,000 and the gross profit margin is
46.7% ($210,000/$450,000).

C is incorrect because Company B has the highest net profit margin (net income divided by
sales) at 19.0% ($38,000/$200,000), but it does not have the highest gross profit margin
([Sales – Cost of sales]/Sales).

B is incorrect because Company C has the highest gross profit (sales – cost of sales) at
$210,000 ($450,000 – $240,000) and operating profit margin (operating income divided by
sales) at 34.9% ($157,000/$450,000), but it does not have the highest gross profit margin
([Sales – Cost of sales]/Sales).

Understanding Income Statements Learning Outcome

10. Evaluate a company’s financial performance using common-size income
statements and financial ratios based on the income statement

Question 70 of 90
Question
Which of the following items is most likely to appear near the top of the asset section in a
liquidity-based presentation of a balance sheet?
1. Land use rights
2. Deferred revenue
C. Marketable securities
Solution

Solution
C is correct. Within a liquidity-based presentation, assets and liabilities are presented
broadly in order of liquidity. The asset section generally begins with liquid items such as
cash and marketable securities.
A is incorrect because land use rights are considered to be less liquid than marketable
securities and would be expected to appear near the bottom of the asset section.
B is incorrect because deferred revenue is a liability and would not be found within the
asset section of a balance sheet.

Understanding Balance Sheets Learning Outcome

3. Describe alternative formats of balance sheet presentation

Question 71 of 90
Question
Which of the following items is most likely to be classified as a current asset?
1. A trade payable due to be settled within one year
2. A receivable expected to be collected within one operating cycle
C. Goodwill attributable to an acquisition made in the most recent reporting period
Solution

Solution
B is correct. Current assets are assets expected to be sold, used up, or otherwise realized
in cash within one year or one operating cycle of a business, whichever is greater. A
receivable expected to be collected within one operating cycle is therefore a current asset.
A is incorrect because a trade payable is considered a current liability.

C is incorrect because goodwill is not expected to be sold or used up within one year or one
operating cycle of a business. Long-term assets such as goodwill are classified as non-
current assets.

Understanding Balance Sheets Learning Outcome

4. Contrast current and non-current assets and current and non-current liabilities

Question 72 of 90
Question
Shares which have been repurchased by a company and not canceled are best described as:
1. other reserves.
2. treasury shares.
C. minority interest.
Solution

Solution
B is correct. Treasury shares are issued shares that have been repurchased by the
company and held rather than canceled.
A is incorrect because other reserves are the part of a company’s comprehensive income
that is reflected under equity in accumulated other comprehensive income.
C is incorrect because minority interest, or non-controlling interest, is the equity interest of
minority shareholders in the subsidiary companies that have been consolidated by the
parent (controlling) company but that are not wholly owned by the parent company.

Understanding Balance Sheets Learning Outcome

6. Describe the components of shareholders’ equity

Question 73 of 90
Question
Which of the following statements is most accurate regarding cash flow statements?
1. Under IFRS, the indirect method of preparation is encouraged.
2. Under IFRS, interest paid can be reported either as an operating or as an
investing cash flow.
C. Under US GAAP, bank overdrafts should be classified as a financing cash flow.
Solution

Solution
C is correct. Under US GAAP, bank overdrafts are not considered part of cash and cash
equivalents and are classified as financing cash flows.
A is incorrect. Both direct method and indirect method are allowed under IFRS and US
GAAP, and the direct method is encouraged under both.

B is incorrect. Under IFRS, interest paid could be reported either as an operating or

financing cash flow.

Understanding Cash Flow Statements Learning Outcome

3. Contrast cash flow statements prepared under International Financial Reporting
Standards (IFRS) and US generally accepted accounting principles (US GAAP)

Question 74 of 90
Question
The following information (in millions) on a company is available:

Cost of goods sold $500

Increase in total assets $250

Increase in total liabilities $200

Change in inventory –$30

Change in accounts payable –$25

The amount of cash (in millions) that the company paid to its suppliers is closest to:
1. $505.
2. $495.
C. $445.
Solution

Solution
B is correct.
Cost of goods sold $500

Minus decrease in inventory –$30

Purchases from suppliers $470

Plus decrease in accounts payable $25

Cash paid to suppliers $495

A is incorrect. Decrease in inventory treated as an increase and decrease in AP treated as
decrease in cash flow: 500 + 30 – 25 = 505.

C is incorrect. Decrease in accounts payable treated as a reduction rather than an increase

in cash flow: 500 – 30 – 25 = 445.

Understanding Cash Flow Statements Learning Outcome

6. Describe the steps in the preparation of direct and indirect cash flow statements,
including how cash flows can be computed using income statement and balance
sheet data

Question 75 of 90
Question
An analyst gathers the following information from a company’s current financial
statements:
Cash Flow Statement for Year Ended 31 December ($ millions)

Net income 2,520

Depreciation 1,178

Change in accounts receivable (62)

Change in accounts payable 295

 Change in inventory (792) () vì đg tính CF
và là bảng indirect
Operating cash flow 3,139 -> inventory trong kì tăng
Income Statement for Year Ended 31 December ($ millions)

Revenue 26,430

Cost of goods sold 12,831

Operating expenses 9,802

Income tax expense 1,277

Net income 2,520

If the company uses the direct method to prepare its cash flow statement, the cash paid to
suppliers (in $ millions) will be closest to:
1. 12,334.
2. 13,328.
C. 12,536.
Solution

Solution
B is correct. The cash paid to suppliers is calculated as follows:
$ Millions

Cost of goods sold 12,831

Plus: Increase in inventory 792

Purchases 13,623

Less: Increase in accounts payable 295

Cash paid to suppliers 13,328

A is incorrect. This answer reverses the direction for A/P and inventory

Cost of goods sold 12,831

LESS Increase in inventory 792

 Purchases 12,039

Plus: Increase in accounts payable 295

Cash paid to suppliers 12,334

C is incorrect. This answer ignores inventory

Cost of goods sold 12,831

Plus Increase in inventory (error) 0

Purchases 12,831

Less: Increase in accounts payable (295)

Cash paid to suppliers 12,536

Understanding Cash Flow Statements Learning Outcome

7. Demonstrate the conversion of cash flows from the indirect to direct method

Question 76 of 90
Question
The following information is available about a conglomerate and one of its reportable
operating segments:

Segment A Total
($ millions) ($ millions)

Assets 300 6,000

Liabilities 100 4,000

Capital expenditures 140 550

Revenue 1,250 12,000

Expenses 1,160 11,000

Operating profit 90 1,000

The element of Segment A’s financial statement excerpts that most likely causes it to qualify
as a reportable segment is its:
 1. capital expenditures.
2. assets.
C. revenue.
Solution

Solution
C is correct. Segment A most likely qualifies as a reportable segment because its revenue
amounts to 10.4% of total revenues, which is above the 10% threshold for the revenue test.
A is incorrect. The qualifying elements are assets, revenues, and operating profit. Segments
are not qualified based on capital expenditures.

B is incorrect. Segment A’s assets amount to 5% of total assets, which falls below the 10%
threshold.

Financial Analysis Techniques Learning Outcome

6. Explain the requirements for segment reporting and calculate and interpret
segment ratios

Question 77 of 90
Question
By themselves, financial ratios are least likely to be sufficient in determining a company’s:
1. past performance.
2. creditworthiness.
C. current financial condition.
Solution

Solution
B is correct. Financial ratios alone are not sufficient to determine the creditworthiness of a
company. Other factors must also be considered, such as examining the entire operation of
the company, meeting with management, touring company facilities, and so forth.
A is incorrect because ratio analysis by itself does enable a financial analyst to evaluate past
performance.

C is incorrect because ratio analysis by itself does enable the assessment of a company’s
current financial position.

Financial Analysis Techniques Learning Outcomes

1. Describe tools and techniques used in financial analysis, including their uses and
limitations
5. Calculate and interpret ratios used in equity analysis and credit analysis

Question 78 of 90
Question
A firm incurred the following costs related to production during the past year:

$ millions

Fixed production overhead costs 3.0

Raw materials costs 6.0

Labor costs 4.0

Freight-in costs for raw materials 1.0

Warehousing costs for finished goods 2.0

The total capitalized inventory cost for the year is closest to:
1. 14.0.
2. 16.0.
C. 13.0.
Solution

Solution
A is correct.
Total Capitalized Inventory Cost $ millions

Fixed production costs 3.0

Raw materials 6.0

Labor costs 4.0

Freight-in 1.0

Total capitalized inventory cost 14.0

B is incorrect. This answer incorrectly includes warehousing costs for finished goods: $14 +
$2 = $16 million.

C is incorrect. This answer incorrectly excludes freight-in.

Inventories Learning Outcome

1. Contrast costs included in inventories and costs recognised as expenses in the
period in which they are incurred

Question 79 of 90
Question
Compared with using the FIFO (first in, first out) method to account for inventory, during a
period of rising prices, which of the following is most likely higher for a company using
LIFO (last in, first out)?
1. Current ratio
2. Gross margin
C. Inventory turnover
Solution

Solution
C is correct. During a period of rising prices, ending inventory under LIFO will be lower
than that of FIFO and cost of goods sold higher; therefore, inventory turnover (Cost of
goods sold/Average inventory) will be higher.
A is incorrect. During a period of rising prices, ending inventory under LIFO will be lower
than that of FIFO; therefore, current assets will be lower, and the current ratio will be
lower.

B is incorrect. During a period of rising prices, cost of goods sold under LIFO will be higher
than that of FIFO; therefore, gross margin will be lower.

Inventories Learning Outcomes

3. Calculate and compare cost of sales, gross profit, and ending inventory using
different inventory valuation methods and using perpetual and periodic inventory
systems
k. Calculate and compare ratios of companies, including companies that use different
inventory methods

Question 80 of 90
Question
Under US GAAP, financial statement disclosures relating to inventory are least likely to
include which of the following? Information about the:
1. reversal of any inventory write-down.
2. amount of inventories pledged as security for liabilities.
C. inventory valuation method used.
Solution

Solution
A is correct. US GAAP does not allow the reversal of inventory write-downs, therefore it
would not be a disclosure.
B is incorrect. This is a required disclosure of both IFRS and US GAAP.

C is incorrect. This is a required disclosure of both IFRS and US GAAP.

Inventories Learning Outcome
9. Describe the financial statement presentation of and disclosures relating to
inventories

Question 81 of 90
Question
A company’s debt covenant requires it to maintain an interest coverage of 2.25; the ratio is
calculated using total interest paid. The following information is taken from the company’s
2014 financial statements:

2014 $ thousands

Net sales 11,159

Cost of goods sold (COGS) 9,898

Selling and administrative expense (S&A) 872

Interest expense 122

Earnings before tax 267

Note 11: Property and Equipment (all figures in $ thousands)
Depreciation expense for 2014 is $388. This amount includes capitalized interest of $34.
Interest is allocated and capitalized to construction in progress by applying the firm’s cost of borrowing rate to qualifying
assets. Interest capitalized in 2014 is $66.
Note 13: Long-Term Debt
All bonds were issued at par.

The most appropriate statement about the company’s debt covenant restriction in 2014 is
that the firm:
1. just satisfied it.
2. failed to meet it by at least 5%.
C. exceeded it by at least 5%.
Solution

Solution
A is correct.
($ thousands)

EBIT = Sales – COGS – S&A = 11,159 – 9,898 – 872 = 389

Add back depreciation related to capitalized interest 34

Adjusted EBIT 423

 ($ thousands)

Interest expense: Income statement 122

Add capitalized interest: Notes to financial statement 66

Total interest paid 188

The interest coverage ratio requirement has been exactly achieved.

Because the bonds were issued at par, no amortization of premiums or discounts is

included in interest paid.

B is incorrect. It does not adjust EBIT for depreciation related to interest = 389/188 = 2.07:
violates threshold. This is (2.07/2.25 – 1) = 8.8% below the threshold (more than 5%
below).

C is incorrect. It is the unadjusted TIE = 389/122 = 3.19: exceeds threshold. This is

(3.19/2.25 – 1) = 41.7% above the threshold (more than 5%).

Long-Lived Assets Learning Outcome

3. Explain and evaluate how capitalising versus expensing costs in the period in
which they are incurred affects financial statements and ratios

Question 82 of 90
Question
A company acquires a product patent at the beginning of Year 1 for $5,000,000 and makes
the following assumptions about its use:

Assumptions and Production

Useful life Three years

Production capacity 800 units

Units produced in Year 1 300 units

Residual value 0
The company will experience the highest asset turnover ratio in the first year under which
of the following amortization methods?
1. Double declining balance
2. Straight line
 C. Units of production
Solution

Solution
A is correct. Using the double declining balance method will result in the highest asset
turnover ratio (Total asset turnover = Total revenue/Average total assets) for the
company. This is because its higher amortization expense in earlier periods ($3,333 in Year
1, compared with $1,667 and $1,875 for straight line and units of production, respectively)
decreases the company’s average total assets (the denominator), causing its asset turnover
ratio to be higher than under the other two methods. The following are the amortization
expense calculations under each method for Year 1:
Amortization Expense in Year
Method Calculation ($ thousands) 1 ($ thousands)

Double declining Rate is twice the straight-line

balance rate.

1/3 × 2 = 66.7%

66.7% × 5,000 = $3,335

Straight line (Cost – Residual

value)/Useful life

($5,000 × $0)/3 = $1,667

Units of Cost per unit =

production Cost/Production capacity

($5,000/800 units) = $6.25

Year 1 = 6.25 × 300 units = $1,875

B is incorrect. See table.

C is incorrect. See table.

Long-Lived Assets Learning Outcome

7. Describe how the choice of amortisation method and assumptions concerning
useful life and residual value affect amortisation expense, financial statements,
and ratios

Question 83 of 90
Question
An analyst is reviewing the property, plant, and equipment disclosure related to a
company’s warehouse. The company uses the International Financial Reporting Standards
(IFRS) revaluation model. The analyst would least likely be able to determine:
1. the carrying amount under the cost model.
2. how the fair value was obtained.
C. the original date of acquisition.
Solution

Solution
C is correct. IFRS does not require disclosure of the original date of acquisition.
A is incorrect. Under the cost model, the carrying amount must be disclosed by companies
using the revaluation model.

B is incorrect. The details of how fair value was obtained must be disclosed by companies
using the revaluation model.

Long-Lived Assets Learning Outcome

12. Describe the financial statement presentation of and disclosures relating to
property, plant, and equipment and intangible assets

Question 84 of 90
Question
Which of the following events will most likely result in a decrease in a valuation allowance
for a deferred tax asset under US GAAP? A(n):
1. decrease in interest rates
2. reduction in tax rates
C. extension in the tax loss carry-forward period
Solution

Solution
C is correct. Under US GAAP, deferred tax assets must be assessed at each balance sheet
date. If there is any doubt whether the deferral will be recovered, the carrying amount
should be reduced to the expected recoverable amount. The asset is reduced by increasing
the valuation allowance. Should circumstances change so that it is more probable that the
deferred tax benefits will be recovered, the deferred asset account will be increased (and
the valuation allowance decreased). An increase in the carry-forward period for tax losses
extends the possibility that benefits will be realized from the deferred tax asset and would
likely result in a decrease in the valuation allowance and an increase in the deferred tax
asset.
A is incorrect. Interest rate changes are not related; there is no discounting of the future
benefits from the deferred tax asset.
B is incorrect. A reduction in tax rates will permanently decrease the carrying value of the
deferred tax asset; deferred tax assets and liabilities arise only from temporary differences.

Income Taxes Learning Outcome

7. Describe the valuation allowance for deferred tax assets—when it is required and
what effect it has on financial statements

Question 85 of 90
Question
After issuance, the rate demanded by the purchaser of a bond is best described as the:
1. market rate of interest.
2. effective interest rate.
C. coupon rate.
Solution

Solution
A is correct. The market rate of interest is the rate demanded by the bond purchaser given
the risks associated with future cash payment obligations of the particular bond issue.
B is incorrect because the effective interest rate is the market rate of interest at the time of
issuance (not after issuance).

C is incorrect because the coupon rate is the interest rate promised in the contract, which is
the rate used to calculate the periodic interest payments.

Non-Current (Long-Term) Liabilities Learning Outcome

1. Determine the initial recognition, initial measurement and subsequent
measurement of bonds

Question 86 of 90
Question
Which of the following best describes a reason a company would acquire the use of
equipment through an operating lease rather than by purchase?
1. To take advantage of less costly financing
2. To obtain preferential tax treatment for the lease payments compared with
ownership
C. To increase cash from operations
Solution

Solution
A is correct. Leases can provide less costly financing. Because of the tax and economic
advantages enjoyed by lessors, they are often able and willing to offer attractive lease
terms resulting in less costly financing to the lessees.
B is incorrect. Lessors (the owners) are normally in a better position to take advantage of
tax deductions, such as depreciation and interest.

C is incorrect. Cash from operations would be lower with an operating lease compared to
purchasing the asset.

Non-Current (Long-Term) Liabilities Learning Outcome

6. Explain motivations for leasing assets instead of purchasing them

Question 87 of 90
Question
An analyst is comparing the solvency of a company over the past two years using the
information below:

2013 ¥ millions

Total debt 2,300

Total shareholders’ equity 17,000

Total assets 20,000

Net income 375

Interest payments/interest expense 200

Taxes paid 125

Ratios in 2012

Debt to capital 12.7%

Interest coverage 2.9

The best conclusion the analyst can make about 2013 is that compared with 2012, the
company’s solvency has:
1. been inconclusive because the ratios give conflicting results.
2. deteriorated because both ratios have weakened.
C. improved because both ratios have strengthened.
Solution

Solution
C is correct.
2012 2013 Calculations (¥ millions) 2013

Debt to capital 12.7% 2,300/(2,300 + 17,000) = 11.9% 11.9%

Interest coverage 2.9 (375 + 200 + 125)/200 = 3.5 3.5 times

Both ratios have improved from 2012 to 2013, thus the company is more solvent in 2013.

A is incorrect. It calculates interest coverage using net income instead of EBIT (1.875), a
deterioration, and correctly notes the debt to capital as an improvement.

B is incorrect. It calculates interest coverage using net income instead of EBIT (1.875), and
interprets the change in debt to capital as a deterioration because the value has decreased.

Non-Current (Long-Term) Liabilities Learning Outcome

10. Calculate and interpret leverage and coverage ratios

Question 88 of 90
Question
For a company reporting under IFRS, which of the following events most likely represents
low financial reporting quality? The company:
1. included gains from foreign exchange rate changes in its cost of goods sold.
2. entered a long-term lease for a customized piece of equipment and classified it
as a finance lease.
C. reported an increase in EPS as a result of the sale of a subsidiary.
Solution

Solution
A is correct. High financial reporting quality provides useful information to decision
makers. Since foreign exchange gains and losses may not recur, they should be disclosed
separately and not included in cost of goods sold.
B is incorrect. Long-term leases for customized pieces of equipment should be reported as
finance leases and conforms to IFRS, therefore this is not low quality reporting.

C is incorrect. If properly disclosed, an increase in EPS from the sale of a subsidiary does
not represent low quality financial reporting, but it may be low quality earnings.

Financial Reporting Quality Learning Outcome

1. Compare and contrast financial reporting quality and quality of reported results
(including quality of earnings, cash flow, and balance sheet items)

Question 89 of 90
Question
Which of the following conditions conducive to issuing low-quality financial reports is most
likely a result of poor internal controls?
1. Rationalization
2. Opportunity
C. Motivation
Solution

Solution
B is correct. Poor internal controls provide opportunities for errors or fraud to be
incorporated in financial reporting without being detected.
A is incorrect. Rationalization takes place after the low-quality reporting act has taken
place and is a psychological process used by individuals to justify their actions. Poor
internal controls are not a psychological process.

C is incorrect. Motivation results from personal pressures or corporate pressures to report

on a low-quality basis. Poor internal controls provide the vehicle through which low-
quality reporting can be concealed, not the motivation for it.

Financial Reporting Quality Learning Outcome

5. Describe conditions that are conducive to issuing low-quality, or even fraudulent,
financial reports

Question 90 of 90
Question
A credit analyst considers selected ratios calculated for three companies:

Company A Company B Company C

EBITDA/Average assets 8.4% 6.2% 4.3%

Debt/EBITDA 2.0 2.8 3.5

Inventory turnover 4.2 5.8 6.3

Based on the information given, which company is most likely to receive the highest credit
rating?
1. Company C
2. Company A
C. Company B
Solution

Solution
B is correct. Company A has the highest EBITDA/Average assets and the lowest
Debt/EBITDA. It is likely to receive the highest credit rating since these measures suggest it
is best able to repay debt. Inventory turnover does not measure debt paying ability.
A is incorrect. Company C is less able to repay its debt based on its lower EBITDA/Average
Assets and its higher Debt/EBITDA.

C is incorrect. Company B is less able to repay its debt based on its lower EBITDA/Average
Assets and its higher Debt/EBITDA.

Applications of Financial Statement Analysis Learning Outcome

3. Describe the role of financial statement analysis in assessing the credit quality of a
potential debt investment