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Free Test Prep CFA-Level-I Exam Questions (page: 98)

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Which of the following statements about asset valuation is FALSE?

  1. The price to book value ratio can be used to value firms with negative cash flows.
  2. Economic value added (EVA®) measures the economic profit generated per dollar of invested capital.
  3. When estimating the profit margin of a company, the higher the export/import level, the higher the competition.
  4. The purpose of top-down stock analysis is to determine the best company within the best performing industry.

Answer(s): B

Explanation:

EVA measures management's ability to add value to the firm. One of the problems with the EVA calculation is that it is not measured relative to the capital invested in the firm. As a workaround, the ratio of EVA to capital is used, and it is this ratio that measures the economic profit generated per dollar of invested capital.
The other statements are true. Use Porter's five forces to determine the level of competition within an industry and to determine the company's strategy for dealing with that competition. Do not forget about the impact of foreign competitors!



Myra Addison, Luz Bazo, and Erik Jenss, three equity traders, are having a quick lunch around the corner from the exchange. Bazo's cell phone beeps, letting him know that he has a text message. He reads the message, then quietly tells Addison and Jenss that Badger Distributors, Inc. has just won exclusive rights to supply all major league baseball parks with uniforms for hot dog/soda vendors. Bazo stands up, gathers his unfinished lunch, and announces, "I'm going back to the exchange to trade." Jenss calmly eats his sandwich and says, "There's plenty of time to trade." Addison shakes her head and mutters, "It's too late already." Based on their reactions to the news on Badger Distributors, which statement best identifies the trading view of these three traders?

  1. Addison uses fundamental analysis, Bazo is a technician, and Jenss supports the efficient market hypothesis.
  2. Addison and Jenss both use fundamental analysis and Bazo is a technician.
  3. Addison and Jenss both use fundamental analysis and Bazo supports the efficient market hypothesis.
  4. Addison supports the efficient market hypothesis, Bazo uses fundamental analysis, and Jenss is a technician.

Answer(s): D

Explanation:

One major difference between technicians, fundamental analysis traders, and those who support the efficient market hypothesis is the speed at which they believe the market reflects new information, The order, from slowest to fastest, is: technical analysis (Jenss), fundamental analysis (Bazo), and efficient market hypothesis (Addison).



If a bond sells at a discount:

  1. its YTM will exceed its horizon yield.
  2. its current yield is greater than its YTM.
  3. its coupon rate is greater than its current yield.
  4. its coupon rate is less than the market rate of interest.

Answer(s): D

Explanation:

When a bond sells at a discount, the market rate goes above the coupon rate and the bond's price falls below par. The current yield is the coupon rate / price, so as price falls below 1000 the current yield rises above the coupon rate. The YTM considers the current yield plus the capital gain associated with the discount.



Which of the following statements about contrary-opinion and smart money technicians is INCORRECT?

  1. When margin balances in brokerages accounts increase, contrary-opinion technicians are bearish.
  2. The investment advisory ratio is at 0.65. Contrary-opinion technicians are bullish.
  3. The OTC volume is less than 87% of the NYSE volume. Investors are bearish.
  4. A narrowing of the T-bill - Eurodollar futures spread is a signal for a smart-money technician to buy.

Answer(s): A

Explanation:

Although an increase in margin (debit) balances in brokerages accounts means investors are bullish, it is not an indicator used by contrary-opinion technicians. This would be a bullish sign to smart-money technicians.
The other statements are correct. When the investment advisory ratio (bearish opinions/total opinions) is equal to or greater than 0.60, it means that investors are bearish, and contrary-opinion technicians are bullish.
Investors are considered bullish if the OTC volume is greater than 112% of the NYSE volume.
Summary of the indicators for contrary-opinion and smart money technicians:
Contrary-opinion technicians (trade the opposite of the mass of general investor):
Smart-money technicians (follow the professional investors):



Weak form efficiency states that excess risk adjusted returns cannot be obtained by using:

  1. insider information
  2. technical analysis
  3. fundamental analysis
  4. portfolio theory

Answer(s): B

Explanation:

Weak form - you can't make excess returns using technical analysis. Semi-Strong form - you can't make excess returns using fundamental analysis, which is the use of public information. Strong Form - you can't make excess returns using non-public information.



Which of the following statements is false?

  1. The price to book value ratio is seldom greater than one for industrial firms. This is caused by the fact that due to accounting rules book value will exceed market value in most firms.
  2. Since cash flows are more stable than earnings the price to cash flow ratio should be used in conjunction with the P/E ratio.
  3. Economic value added (EVA) is a present value technique used to measure management's ability over time to add value to the firm through their investment decisions.
  4. Market Value Added equals the market value of the firm's capital minus the adjusted book value of the firm's capital.

Answer(s): A



Jefferson Blake invests only in bonds and other fixed-income securities. Blake believes there is a good opportunity to purchase an undervalued 4% annual pay corporate bond with three years left until maturity and a par value of $1,000. Blake observes that 1-year, 2-year, and 3-year Treasury strip rates are currently 4.0%, 4.5%, and 4.75%, respectively. What is the maximum price Blake should be willing to pay for the bond?

  1. $1,069.58.
  2. $979.93.
  3. $958.36.

Answer(s): B



Mark Waiters' risk aversion is relatively high compared to other individual investors. Waiters is interested in generating some income on his equity portfolio. Walters decides to establish a covered call position on CGF stock and simultaneously establish a protective put position on HSD stock. After establishing the covered call

and protective put positions, which of the following would least likely describe Walters' portfolio, relative to the positions before adding the options?

  1. The HSD position will have a higher break even price and less downside risk.
  2. The CGF position will have a lower break even price and more upside potential.
  3. The HSD position will have lower upside potential and less downside risk.

Answer(s): B



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