2018年CFA一级官方mock（中册）

3 2018 Level I Mock Exam (B) AM C 15 years of GIPS-compliant performance. 6 In the event of a discrepancy between the official GIPS standards and the local language translation, the official governing language is: A English. B the language of the local country. C the language of a neutral country. 7 Disclosure of confidential CFA exam information will most likely be detected by the Professional Conduct staff through: A monitoring online and social media. B analysis of Proctor Reports. C annual Professional Conduct Statements. 8 When making performance presentations to prospective clients, a GIPS compli- ant firm should least likely do which of the following? A Selectively report its top fund performance B Include the fund performance of former clients C Report performance history for all market cycles under review 9 A central bank fines a commercial bank it supervises for not following statutory regulations regarding non-performing loan provisions on three large loans as a result of the bank’s loan provisioning policy. Louis Marie Buffet, CFA, sits on the Board of Directors of the commercial bank as a non-executive director, representing minority shareholders. He also chairs the internal audit committee of the bank that determines the loan provisioning policy of the bank. Mercy Gatabaki, CFA, is the bank’s external auditor and follows international auditing standards whereby she tests the loan portfolio by randomly selecting loans to check for compliance in all aspects of central bank regulations. Which charter- holder is most likely in violation of the Code and Standard? A Both. B Buffet. C Gatabaki. 10 Diana Fairbanks, CFA, is married to an auditor who is employed at a large accounting firm. When her husband mentions that a computer firm he audits will receive a qualified opinion she thinks nothing of it. Later that week when she reviews a new client account she notices that there are substantial holdings of this computer firm. When she does a thorough internet search for news on the company, she does not find anything about its most recent audit or any other adverse information. Which of the following actions concerning the computer stock should Fairbanks most likely take to avoid violating the CFA Institute Standards of Professional Conduct? A Take no investment action. B Complete a thorough and diligent analysis of the company and then sell the stock. C Sell the stock immediately as she has a reasonable basis for taking this investment action. 11 Sherry Buckner, CFA, manages equity accounts for government entities whose portfolios are classified as being conservative and risk averse. Since the objec- tive of her clients is to maximize returns with the lowest possible risk, Buckner considers adding to their holdings a new, thinly traded, leveraged derivative product that she believes has the potential for high returns. To make her invest- ment decision, Buckner relies upon comprehensive research from an investment

6 2018 Level I Mock Exam (B) AM 19 An individual wants to be able to spend €80,000 per year for an anticipated 25 years in retirement. To fund this retirement account, he will make annual deposits of €6,608 at the end of each of his working years. He can earn 6% com- pounded annually on all investments. The minimum number of deposits that are needed to reach his retirement goal is closest to: A 51. B 40. C 28. 20 A company has an unsecured line of credit and needs to maintain its EBIT- to-interest coverage ratio greater than 2.0. Its EBIT is estimated to be between $36 million and $48 million, with all values equally likely. If the forecasted interest charge for the year is $20 million, the probability that EBIT/interest will be more than 2.0 is closest to: A 61.5%. B 33.3%. C 66.7%. 21 A small-cap growth fund’s monthly returns for the past 36 months have been consistently outperforming its benchmark. An analyst is determining whether the standard deviation of monthly returns is greater than 6%. Which of the following best describes the hypothesis to be tested? A H 0 : σ 2 ≤ 0.36% B H a : σ 2 > 6% C H 0 : σ 2 ≥ 0.36% 22 The variance of returns of Asset A is 625. The variance of returns of Asset B is 1,225. The covariance of returns between Asset A and Asset B is 600. The cor- relation of returns between Asset A and Asset B is closest to: A 0.29. B 0.69. C 0.47. 23 The central limit theorem is best described as stating that the sampling distribu- tion of the sample mean will be approximately normal for large-size samples: A if the population distribution is normal. B for populations described by any probability distribution. C if the population distribution is symmetrical. 24 Technical analysts most likely study trends and patterns in security prices to forecast a company’s: A future price trends. B earnings potential. C intrinsic value. 25 Given a large random sample, which of the following types of data are least appropriately analyzed with nonparametric tests? A Signed data (e.g., number of positives and negatives) B Ranked data (e.g., 1st, 3rd) C Numerical values (e.g., 28.43, 79.11)

9 2018 Level I Mock Exam (B) AM C commodity prices. 40 The following information is available for 2011: New Zealand Canada Jan 1 Dec 31 Jan 1 Dec 31 Price index 1,137 1,158 117.8 119.9 Nominal exchange rate: NZD/CAD 1.2844 1.2589 The change in the real exchange rate (in NZD/CAD terms) is closest to: A –2.05%. B –1.92%. C +1.96%. 41 Assume that the central bank reduces the reserve requirement. The most likely effect will be: A a decrease in the money supply. B a decrease in new deposits. C an increase in the money multiplier. 42 Assuming its trading partner does not retaliate, which of the following condi- tions must hold in order for a large country to increase its national welfare by imposing a tariff? A The deadweight loss must be smaller than the benefit of its improving terms of trade. B It must auction the import licenses for a fee to offset the decline in the con- sumer surplus. C It must have a comparative advantage in the production of the imported good. 43 A dealer report includes the following exchange rate details: Spot Rate Expected Change over Next Year USD/EUR 1.30 1.75% CAD/USD 0.95 –0.25% CHF/EUR 1.22 0.75% The expected CAD/CHF cross rate in one year is closest to : A 1.04. B 0.98. C 1.02. 44 Higher than expected inflation will most likely lead to an increase in: A the real wealth of borrowers. B investment. C the information content of market prices for economic agents. 45 The structural deficit is equal to the budget deficit: A adjusted for inflation. B that would exist at full employment. C excluding the impact of automatic stabilizers.

12 2018 Level I Mock Exam (B) AM 54 The year-end balances in a company’s last-in, first-out (LIFO) reserve are $56.8 million as reported in the company’s financial statements for both 2013 and 2014. For 2014, the measure that will most likely be the same regardless of whether the company uses the LIFO or the first-in, first-out (FIFO) inventory method is the: A gross profit margin. B amount of working capital. C inventory turnover. 55 The following selected fixed asset information is available for a company: 2016 ($US millions) Cost: Total property, plant, and equipment (PP&E) 30,815 Accumulated depreciation 16,465 Net PP&E 14,350 Average net PP&E 12,200 Net sales 21,670 Net income 2,705 The company’s fixed asset turnover ratio is closest to: A 1.78. B 8.01. C 1.51. 56 Which of the following ratios is most likely to be used as a measure of operating performance? A Cash ratio B Working capital turnover ratio C Defensive interval ratio 57 The following information is available about a company ($ millions): Year Ended 31 December 2012 2011 Sales 322.8 320.1 Net income 27.2 26.8 Cash flow from operations 15.3 38.1 During 2012, the company most likely experienced a significant decrease in: A inventory, anticipating lower demand for its products in 2013. B the proportion of sales made on a cash basis. C the proportion of interest-bearing debt relative to trade accounts payable. 58 Selected information from a company’s recent income statement and balance sheets is presented in the following table. Selected Financial Information as of 31 December (C$ thousands) 2013 2012 Sales 2,240,000 Cost of goods sold (COGS) 1,320,000

15 2018 Level I Mock Exam (B) AM A supplementary information about accounting policies, methods, and estimates. B an auditor’s opinion as to the fair presentation of the financial statements. C a discussion of significant trends, events, and uncertainties that affect the operating results. 67 A US company that complies with US GAAP would like to exclude some items in determining non-GAAP financial measures, other than EBIT and EBITDA. Which of the following items may be excluded? A For performance measures, items tagged as infrequent that occurred within the past two years B Impairment charges for long-lived assets C For liquidity measures, litigation costs requiring cash settlement 68 Which of the following conditions is most likely associated with decreased earn- ings quality? Compared with the prior year, the reporting entity’s earnings: A decreased slightly in response to the introduction of conservative account- ing policies. B were similar in magnitude but included a large gain on the sale of a manu- facturing plant. C increased slightly because of a reduction in bad debt expense based on more-current experiences. 69 An analyst is comparing the financial leverage of two companies, A and B, from the same industry. ● Both companies can borrow at a rate of 4%. ● The two companies are virtually identical except that Company A leases essentially all of its premises; Company B owns all of its premises. ● Company A recorded €15,280 (thousand) of lease expenses in 2015, the cur- rent year, ending 31 December. The following excerpt is from the notes to its 2015 financial statements: Note on Leasing Activities: Non-Cancellable Operating Lease Rentals Are Payable on 1 January as Follows: € thousands 2016 15,280 2017 15,280 2018 15,280 To facilitate a fair comparison with Company B, the analyst will most likely adjust (in € thousands) for the operating leases by increasing Company A’s: A earnings before tax by €15,280. B liabilities by €45,840. C liabilities by €44,100. 70 The following information is available for a firm:

18 2018 Level I Mock Exam (B) AM A sequentially smaller increases in expected return. B consistent increases in expected return. C sequentially larger increases in expected return. 84 Information about a portfolio that consists of two assets is provided below: Asset Portfolio Weight Standard Deviation A 25% 12% B 75% 16% If the correlation coefficient between the two assets is 0.75, the standard devia- tion of the portfolio is closest to: A 15.00%. B 12.37%. C 14.39%. 85 In general, which of the following institutions will most likely have a high need for liquidity and a short investment time horizon? A Banks B Defined-benefit pension plans C Endowments 86 If the expected return on the market portfolio is 6% and the risk-free rate is 2%, the expected return of a security with a beta of 1.25 is closest to: A 7.00%. B 5.00%. C 9.50%. 87 If the following three stocks are held in a portfolio, the portfolio’s total return on an equal-weighted basis is closest to: Stock Number of Shares Owned Beginning of Period Price per Share ($) End of Period Price per Share ($) Dividend per Share during the Period ($) A 500 40 37 2.00 B 320 50 52 1.50 C 800 30 34 0.00 A 3.28%. B 5.94%. C 6.37%. 88 If the number of financial analysts who follow or analyze a company increases substantially, then the market for this company’s shares will most likely become: A more attractive for active investors. B overvalued. C more efficient. 89 A corporate manager pursuing a low-cost strategy will most likely : A engage in offering products of unique quality or type. B have strong market research teams for product development and marketing. C invest in productivity-improving capital equipment.

21 2018 Level I Mock Exam (B) AM B lower. C the same. 105 Which of the following is least likely to be a negative covenant associated with a coupon-paying corporate bond issue? A A requirement to pay withholding taxes to foreign governments in a timely manner B A prohibition from investing in long-term projects in emerging market countries C A requirement to hedge at least 50% of the firm’s revenues generated from foreign sales 106 The bonds of Apex Corporations have a par value of $10,000 each and an annual required rate of return of 10%. The bonds make quarterly coupon pay- ments at an annual rate of 6% and have two years remaining until maturity. The current market price of each bond is closest to: A $10,749. B $9,283. C $9,306. 107 Which type of fixed-income security is most likely to have coupon payments that reset periodically? A Callable bonds B Floating-rate notes C Convertible bonds 108 The semiannual bond equivalent yield spot rates for US Treasury yields are provided below. Period Years Spot Rate 1 0.5 1.20% 2 1.0 2.10% 3 1.5 2.80% 4 2.0 3.30% On a semiannual bond equivalent yield (BEY) basis, the six-month forward rate one year from now is closest to : A 4.21%. B 3.64%. C 2.10%. 109 Treasury spot rates on a semiannual bond equivalent yield basis are provided below. Maturity Semiannual Bond Equivalent Yield 0.5 years 0.40% 1.0 years 0.80% 1.5 years 1.00% 2.0 years 1.10% 2.5 years 1.20% Using these spot rates, the value of a 2.5-year Treasury security that makes semiannual payments based on a 2% coupon rate is closest to :

22 2018 Level I Mock Exam (B) AM A 101.98. B 106.88. C 99.06. 110 A bond’s duration is 7.31, and its convexity is –24.85. Using the duration model with convexity adjustment, the bond’s percentage change in price if interest rates decrease 2% is closest to : A 15.12%. B 15.60%. C 14.12%. 111 For a forward contract with a value of zero, a situation where the spot price is above the forward price is best explained by high: A interest rates. B storage costs. C convenience yield. 112 According to put–call–forward parity, if the put in a protective put with for- ward contract expires out of the money, the payoff is most likely equal to: A the market value of the underlying asset. B zero. C the face value of a risk-free bond. 113 A derivative can best be described as a financial instrument that: A duplicates the underlying asset’s performance. B transforms the underlying asset’s performance. C passes through the underlying asset’s returns. 114 In a credit default swap, the party that receives a series of cash payments in return for promising to pay compensation for credit losses resulting from a third party’s default is most likely the: A clearinghouse. B seller of the swap. C buyer of the swap. 115 A swap that involves the exchange of a fixed payment for a floating payment is most likely equivalent to a series of: A off-market forward contracts. B forward contracts that all have an initial positive value. C forward contracts that all have an initial value equal to the fixed payment. 116 Which of the following most likely belongs in an alternative asset category? A A limited partnership that takes long and short positions in publicly traded equity. B Equity in an emerging market company that is traded over-the-counter. C Securitized commercial real estate debt. 117 High Plains Capital is a hedge fund with a portfolio valued at $475,000,000 at the beginning of the year. One year later, the value of assets under management is $541,500,000. The hedge fund charges a 1.5% management fee based on the end-of-year portfolio value as well as a 10% incentive fee. If the incentive fee and management fee are calculated independently, the effective return for a hedge fund investor is closest to: A 12.29%.

23 2018 Level I Mock Exam (B) AM B 10.89%. C 11.06%. 118 Collectibles are least likely to provide: A long-term capital appreciation. B portfolio diversification. C current income. 119 Which of the following hedge fund strategies emphasizes a top- down approach? A Macro B Equity hedge C Event-driven 120 A hedge fund with $225 million of initial capital charges a management fee of 1% and an incentive fee of 10%. The management fee is based on assets under management at year-end, and the incentive fee is calculated independently from the management fee. Assuming the fund earns a 15% return at year-end, total fees earned by the hedge fund during the year are closest to: A $5.96 million. B $5.70 million. C $5.63 million.

2018 Level I Mock Exam (B) AM T he morning session of the 2018 Level I Chartered Financial Analyst ® Mock Examination has 120 questions. To best simulate the exam day experience, candidates are advised to allocate an average of one and a half minutes per question for a total of 180 minutes (3 hours) for this session of the exam. Questions Topic Minutes 1–18 Ethical and Professional Standards 27 19–33 Quant 22.5 34–45 Econ 18 46–69 Financial Reporting and Analysis 36 70–78 Corporate Finance 13.5 79–86 Portfolio Management 12 87–98 Equity 18 99–110 Fixed Income 18 111–115 Derivatives 7.5 116–120 Alternative Investments 7.5 Total: 180 By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currently registered CFA candidates. Candidates may view and print the exam for personal exam prepara- tion only. The following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose © 2017 CFA Institute. All rights reserved.

2 2018 Level I Mock Exam (B) AM 2018 LEVEL I MOCK EXAM (B) AM 1 Justin Blake, CFA, a retired portfolio manager, owns 20,000 shares of a small public company that he would like to sell because he is worried about the com- pany’s prospects. He posts messages on several internet bulletin boards. The messages read, “This stock is going up once the pending patents are released, so now is the time to buy. The stock is a buy at anything below $3. I have done some close research on these guys.” According to the Standards of Practice Handbook , Blake most likely violated the Standard or Standards associated with: A Integrity of Capital Markets and Conflicts of Interest. B Integrity of Capital Markets, but not Conflicts of Interest. C Neither Integrity of Capital Markets nor Conflicts of Interest. B is correct because Blake violated the Integrity of Capital Markets by engaging in a practice that is likely to artificially inflate trading volume [Standard II(B)]. A is incorrect because the Conflicts of Interests [Standard VI(A)] requires disclosure of conflicts to clients, prospective clients, and employers, which is not the case in this example. C is incorrect because Blake violated the Integrity of Capital Markets Standard. Guidance for Standards I–VII LOS a Standard II(B)–Market Manipulation, Standard VI(A)–Disclosure of Conflicts 2 According to the CFA Institute Code of Ethics and Standards of Professional Conduct, trading on material nonpublic information is least likely to be pre- vented by establishing: A firewalls. B selective disclosure. C personal trading limitations. B is correct as selective disclosure occurs when companies discriminate in making material nonpublic information public. Corporations that disclose information on a limited basis create the potential for insider-trading violations. Standard II(A). A is incorrect as an information barrier commonly referred to as a “firewall” is a widely used approach to preventing the communication of material nonpublic information within firms. C is incorrect as limitations on personal trading by employees is one of the recom- mended procedures for compliance to prevent employees from trading on material nonpublic information. Guidance for Standards I–VII LOS c Standard II(A)–Material Nonpublic Information

3 2018 Level I Mock Exam (B) AM 3 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? A Conflicts of Interest B Additional Compensation C Both Additional Compensation and Conflicts of Interest C is correct because members should disclose all potential conflicts of interest, the sub- stantial 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 LOS a Standard IV(B)–Additional Compensation Arrangements, Standard VI(A)–Disclosure of Conflicts 4 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? A Yes. B No, because the client’s objectives were met. C No, because the investment time frame does not match the investment horizon. 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.

4 2018 Level I Mock Exam (B) AM 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 LOS b Standard III(C)–Suitability 5 After a firm presents a minimum required number of years of GIPS-compliant performance, the firm must present an additional year of performance each year, building up to a minimum of: A 10 years of GIPS-compliant performance. B 5 years of GIPS-compliant performance. C 15 years of GIPS-compliant performance. A is correct. After a firm presents a minimum of five years of GIPS-compliant performance, the firm must present an additional year of performance each year, building up to a minimum of 10 years of GIPS-compliant performance. B is incorrect. The initial period is five years of GIPS-compliant performance, building up to a minimum of 10 years of GIPS-compliant performance. C is incorrect. An additional year of performance each year is added building up to a minimum of 10 years of GIPS-compliant performance. The GIPS Standards LOS b 6 In the event of a discrepancy between the official GIPS standards and the local language translation, the official governing language is: A English. B the language of the local country. C the language of a neutral country. A is correct. Although the GIPS standards may be translated into many languages, if a dis- crepancy arises, the English version of the GIPS standards is the official governing version. B is incorrect. The English version of the GIPS standards is the official governing version, not the language of the local country. C is incorrect. The English version of the GIPS standards is the official governing version, not the language of a neutral third country. The GIPS Standards LOS c 7 Disclosure of confidential CFA exam information will most likely be detected by the Professional Conduct staff through: A monitoring online and social media. B analysis of Proctor Reports. C annual Professional Conduct Statements.

5 2018 Level I Mock Exam (B) AM A is correct. Professional Conduct inquiries come from a number of sources including the monitoring of online and social media to detect disclosure of confidential exam information. B is incorrect. Candidate conduct is monitored by exam proctors who complete reports on candidates suspected to have violated testing rules during the exam and at the exam center. C is incorrect. Members and candidates must self-disclose on the annual Professional Conduct Statement all matters that question their professional conduct, such as involve - ment in civil litigation or a criminal investigation or being the subject of a written complaint. Disclosure of confidential exam information will not be found on the annual statement. Code of Ethics and Standards of Professional Conduct LOS a 8 When making performance presentations to prospective clients, a GIPS compli- ant firm should least likely do which of the following? A Selectively report its top fund performance B Include the fund performance of former clients C Report performance history for all market cycles under review A is correct. When a firm complies with GIPS standards it cannot selectively choose its top fund performances while excluding weaker performing funds. It must include all fee-paying discretionary funds managed to a similar investment mandate, objective, or strategy. B is incorrect because GIPS standards require the performance of former clients to be included to avoid survivorship bias. C is incorrect because GIPS standards require the fund performance to reflect results across all market cycles for the periods under review. Fund managers are not allowed to select a time period during which the mandate produced superior results while leaving out other time period that underperformed (varying time periods). Introduction to the Global Investment Performance Standards (GIPS) LOS a Section I 9 A central bank fines a commercial bank it supervises for not following statutory regulations regarding non-performing loan provisions on three large loans as a result of the bank’s loan provisioning policy. Louis Marie Buffet, CFA, sits on the Board of Directors of the commercial bank as a non-executive director, representing minority shareholders. He also chairs the internal audit committee of the bank that determines the loan provisioning policy of the bank. Mercy Gatabaki, CFA, is the bank’s external auditor and follows international auditing standards whereby she tests the loan portfolio by randomly selecting loans to check for compliance in all aspects of central bank regulations. Which charter- holder is most likely in violation of the Code and Standard? A Both. B Buffet. C Gatabaki.

6 2018 Level I Mock Exam (B) AM B is correct because Buffet sat on the audit committee that determined the bank’s provi- sioning policies that were contrary to the statutory regulations of the central bank. As a result, he most likely violated Standard I–Professionalism by not abiding with regulations of a regulatory body. Gatabaki did not violate Standard I–Professionalism as it is not apparent she knowingly facilitated the incorrect provisioning policy, A is incorrect because only Buffet is most likely to have violated Standard  I– Professionalism by not following central bank regulations. C is incorrect because Gatabaki most likely did not violate Standard I–Professionalism as it is not apparent she knowingly facilitated the incorrect provisioning policy or followed it. Gatabaki randomly selects loans for her audit and given the relatively small number of loans in violation, it is likely she did not come across the files which were treated in a manner by the bank that was contrary to the central bank regulations. Guidance for Standards I–VII LOS a Standard I(A)–Knowledge of the Law 10 Diana Fairbanks, CFA, is married to an auditor who is employed at a large accounting firm. When her husband mentions that a computer firm he audits will receive a qualified opinion she thinks nothing of it. Later that week when she reviews a new client account she notices that there are substantial holdings of this computer firm. When she does a thorough internet search for news on the company, she does not find anything about its most recent audit or any other adverse information. Which of the following actions concerning the computer stock should Fairbanks most likely take to avoid violating the CFA Institute Standards of Professional Conduct? A Take no investment action. B Complete a thorough and diligent analysis of the company and then sell the stock. C Sell the stock immediately as she has a reasonable basis for taking this investment action. A is correct as the information concerning the qualified opinion is nonpublic and if it is material she would be in violation of Standard II(A) if she took investment action based on the information. She should also make reasonable efforts to achieve public dissem- ination of the information. B is incorrect because she should make reasonable efforts to achieve public dissem- ination of the information prior to selling the stock. C is incorrect because she should make reasonable efforts to achieve public dissem- ination of the information prior to selling the stock. Guidance for Standards I–VII LOS c Standard II(A)–Material Nonpublic Information 11 Sherry Buckner, CFA, manages equity accounts for government entities whose portfolios are classified as being conservative and risk averse. Since the objec- tive of her clients is to maximize returns with the lowest possible risk, Buckner considers adding to their holdings a new, thinly traded, leveraged derivative

7 2018 Level I Mock Exam (B) AM product that she believes has the potential for high returns. To make her invest- ment decision, Buckner relies upon comprehensive research from an invest- ment bank with a solid reputation for top quality research. After her review of that research, Buckner positions her accounts so each has a 10% allocation to the derivative product. Did Buckner most likely violate any CFA Institute Standards of Professional Conduct by purchasing the derivative product for her clients? A No. B Yes, related to Suitability. C Yes, related to Loyalty, Prudence, and Care. B is correct as Buckner is in violation of Standard III(C) since she did not consider issues such as the limited liquidity or any potential leverage of this new product when she invested a substantial percentage of her clients’ portfolios in these instruments. A is incorrect because Buckner violated the suitability Standard. C is incorrect because Buckner relied upon comprehensive research from the invest- ment bank. Guidance for Standards I–VII LOS b Standard III(C)–Suitability 12 Which of the following is least likely part of the CFA Institute Standards of Professional Conduct, Standard V(B)–Communication with Clients and Prospective Clients? Members and candidates must: A make reasonable efforts to ensure that when communicating investment performance information it is fair, accurate, and complete. B disclose to clients and prospective clients significant limitations and risks associated with the investment process. C distinguish between fact and opinion in the presentation of investment anal- ysis and recommendations. A is correct. The statement, “When communicating investment performance informa- tion, Members and Candidates must make reasonable efforts to ensure that it is fair, accurate, and complete.” can be found in The CFA Institute Standards of Professional Conduct, Standard III–Duties to Clients (D) Performance Presentation. It is not part of Standard  V–Investment Analysis, Recommendations, and Actions (B) Communication with Clients and Prospective Clients. B is incorrect. The statement, “Members and Candidates must disclose to clients and prospective clients significant limitations and risks associated with the investment pro- cess” can be found in The CFA Institute Standards of Professional Conduct, Standard V– Investment Analysis, Recommendations, and Actions (B) Communication with Clients and Prospective Clients.

8 2018 Level I Mock Exam (B) AM C is incorrect. The statement, “Members and Candidates must distinguish between fact and opinion in the presentation of investment analysis and recommendations” can be found in The CFA Institute Standards of Professional Conduct, Standard V–Investment Analysis, Recommendations, and Actions (B) Communication with Clients and Prospective Clients. Code of Ethics and Standards of Professional Conduct LOS b 13 Jack Steyn, CFA, recently became the head of the trading desk at a large investment management firm that specializes in domestic equities. While reviewing the firm’s trading operations he notices that clients give discretion to the manager to select brokers on the basis of their overall services to the management firm. Despite the client directive, Steyn would most likely violate Standard III(A)–Loyalty, Prudence, and Care if he pays soft commissions for which of the following services from the brokers? A Equity research reports B Investment conference attendance C Database services for offshore investments C is correct because Standard III(A)–Loyalty, Prudence, and Care stipulates that the client owns the brokerage. Therefore, members and candidates are required to only use client brokerage to the benefit of the clients (soft commissions policy). As the firm specializes in domestic equity, an offshore investment database service would not benefit clients. A is incorrect because it is likely that equity research reports would benefit all clients. B is incorrect because it is likely that attendance at an investment conference could lead to ideas and subsequent investment actions that would benefit all clients. Guidance for Standards I–VII LOS b 14 Henrietta Huerta, CFA, writes a weekly investment newsletter to market her services and obtain new asset management clients. A third party distributes the free newsletter on her behalf to those individuals on its mailing list. As a result, it is widely read by thousands of individual investors. The newsletter recom- mendations reflect most of Huerta’s investment actions. After completing fur- ther research on East-West Coffee Roasters, Huerta decides to change her initial buy recommendation to a sell. To avoid violating the CFA Institute Standards of Professional Conduct it would be most appropriate for Huerta to distribute the new investment recommendation to: A newsletter recipients first. B asset management clients first. C newsletter recipients and asset management clients simultaneously. B is correct because according to Standard III(A)–Loyalty, Prudence, and Care, members and candidates must place their clients’ interests first before their own interests. The temptation may be to release the changed recommendation to newsletter recipients

9 2018 Level I Mock Exam (B) AM simultaneously with or even before the asset management clients to try to obtain new clients. However, to avoid violating Standard III(A)–Loyalty, Prudence, and Care, Huerta must ensure that any change in an investment recommendation is first distributed to her asset management clients before any newsletter recipients, who are not necessarily clients (that is, they receive the newsletter for free from a third party distribution list). A is incorrect because according to Standard  III(A)–Loyalty, Prudence, and Care members and candidates when making investment recommendations (or changing investment recommendations) must give priority to clients; i.e., asset management clients rather than to non-clients; i.e., newspaper recipients who receive the newsletter for free from a third party distribution list. C is incorrect because according to Standard  III(A)–Loyalty, Prudence, and Care, members and candidates when making investment recommendations (or changing investment recommendations) must give priority to clients, i.e., asset management clients rather than to non-clients, i.e., newspaper recipients who receive the newsletter for free from a third party distribution list. Guidance for Standards I–VII LOS c 15 Wouter Duyck, CFA, is the sole proprietor of an investment advisory firm serving several hundred middle class retail clients. Duyck claims to be different from his competitors because he conducts research himself. He discloses that to simplify the management of all these accounts he has created a recommended list of stocks, from which he selects investments for all of his clients based on their suitability. Duyck’s recommended list of stocks is obtained from his pri- mary broker, who has completed due diligence on each stock. Duyck’s recom- mended list least likely violates which of the following CFA Institute Standards of Professional Conduct? A Fair Dealing. B Misrepresentation. C Diligence and Reasonable Basis. A is correct because Standard III(B)–Fair Dealing concerns the fair treatment of clients when making investment recommendations or taking investment action, but there is no indication that the advisor has discriminated against any clients with regard to his recommendations as he invests all clients in the same universe of stocks. The advisor has violated Standard I(C)–Misrepresentation with his research, which is not independently created and instead relies upon information provided by his broker. This is contrary to the advisor telling clients he does his own independent investment research. In addition, the advisor has violated Standard V(A)–Diligence and Reasonable Basis, as he has not made reasonable and diligent efforts to determine if the third party’s research is sound. B is incorrect, as the advisor has violated Standard I(C)–Misrepresentation with his research, which is not independently created and instead relies upon information pro- vided by his broker.

10 2018 Level I Mock Exam (B) AM C is incorrect, as the advisor has violated Standard V(A)–Diligence and Reasonable Basis as he does not have a reasonable basis for making his investment recommendations and relies solely on his broker’s research to create his list of stock investments. This is directly contrary to telling clients that he does his own independent investment research. Guidance for Standards I–VII LOS b Standard  I(C)–Misrepresentation, Standard  III(B)–Fair Dealing, Standard  V(A)–Diligence and Reasonable Basis 16 Heidi Halvorson, CFA, is the Chief Investment Officer for Tukwila Investors, an asset management firm specializing in fixed-income investments. Tukwila is in danger of losing one of its largest clients, Quinault Jewelers, which accounts for nearly one third of its revenues. Quinault recently told Halverson that Tukwila would be fired unless the performance of Quinault’s portfolio improves sig- nificantly. Shortly after this conversation, Halvorson purchases two corporate bonds she believes are suitable for any of her clients based upon third party research from a reliable and diligent source. Immediately after the purchase, one bond increases significantly in price while the other bond declines sig- nificantly. At the end of the day, Halvorson allocates the profitable bond trade to Quinault and the other bond to two of her largest institutional accounts. Halvorson most likely violated the CFA Institute Standards of Professional with regards to: A client suitability. B trade allocations. C third party research. B is correct because the investment officer failed to deal fairly for her clients by allocating profitable trades to a favored client at the expense of others, a violation of Standard III(B)– Fair Dealing. The standard requires members and candidates to treat all clients fairly when taking investment action. Tukwila should have a systematic approach to allocating trades, such as pro rata, before or at the time of trade execution or as soon as possible after trades are executed. A is incorrect because the analyst believes the bonds are suitable for any of her clients and has not violated Standard III(C)–Suitability. C is incorrect because the analyst does have a reasonable or adequate basis for her investment decision, because it is based upon reliable third party research, and has not violated Standard V(A)–Diligence and Reasonable Basis. Guidance for Standards I–VII LOS b Standard III(B)–Fair Dealing, Standard III(C)–Suitability, Standard V(A)–Diligence and Reasonable Basis 17 Alan Quanta, CFA, provides credit rating analysis of high-yield bonds using external credit ratings as a foundation. At the end of the last quarter, Quanta’s firm, North Investment Bank, held a large position in the bonds of Veyron Corporation, a real estate company with all of its land holdings in a country recently downgraded by several credit rating agencies. The downgrades made Veyron bonds extremely difficult to sell because the bond price has dropped every day since the downgrades. Quanta has been asked by his supervisor to contact the firm’s institutional clients to convince them Veyron bonds are still

11 2018 Level I Mock Exam (B) AM an attractive purchase, especially at these lower prices. Quanta does not con- sider the Veyron bonds a buy at this price level. According to the CFA Institute Code of Ethics and Standards of Professional Conduct, the most appropriate action for Quanta is to: A obey his supervisor’s request. B ignore his supervisor’s request. C promote the bonds with appropriate disclosures. B is correct because Quanta must refuse to promote Veyron bonds until they are an attractive purchase based on fundamental analysis and market pricing. If Quanta followed the request from his supervisor, he would be in violation of Standard I(B)–Independence and Objectivity, as he does not rate Veyron bonds as a buy. His opinion of the Veyron bonds must not be affected by internal pressure or compensation. A is incorrect because Quanta should refuse to follow his supervisor’s request and promote the bonds as his opinion of the Veyron bonds must not be affected by internal pressure or compensation. C is incorrect because Quanta should refuse to promote the bonds as his opinion of the Veyron bonds must not be affected by internal pressure or compensation. Guidance for Standards I–VII LOS b Standard I(B)–Independence and Objectivity 18 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 receives 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? A No. B Yes, because he did not disclose the referral fee to the client. C Yes, because he should have refused payment from the fund manager. C is correct because Arun has violated Standard VI(C)–Referral Fees because he did not disclose the referral fee arrangement with Ramport to his client prior to Ramport being appointed as the client’s fund manager. This disclosure is necessary for the client to be able to determine Arun’s level of independence and objectivity in recommending Ramport to the fund. If Arun had made proper disclosure, he would be able to accept the payment without violating any Standards. A is incorrect because Arun has violated Standard VI(C)–Referral Fees because he did not disclose the fee paid by Ramport.

12 2018 Level I Mock Exam (B) AM B is incorrect because Arun violated Standard VI(C)–Referral Fees when he accepted the fee paid by Ramport. Disclosure after the fact would not cure the acceptance of the fee because disclosure should have occurred prior to the search being conducted. Withholding this information raises the question of a potential lack of objectivity in the recommendations Arun is making. There are also questions concerning the legality of having firms pay so that they may be entered in the money manager search. Guidance for Standards I–VII LOS c Standard VI(C)–Referral Fees 19 An individual wants to be able to spend €80,000 per year for an anticipated 25 years in retirement. To fund this retirement account, he will make annual deposits of €6,608 at the end of each of his working years. He can earn 6% com- pounded annually on all investments. The minimum number of deposits that are needed to reach his retirement goal is closest to: A 51. B 40. C 28. B is correct. The following figure represents the timeline for the problem: 0 1 (€6,608) ... ... R (€6,608) R + 1 (€80,000) ... ... R + 25 (€80,000) Using a financial calculator, the funds needed at retirement ( R on the timeline) are calculated: N = 25; I / Y = 6%; PMT = €80,000; Future value (FV) = €0; Mode = End. The calculated present value (PV) is €1,022,668. PV = - + ( )               = - ( )         A r r N 1 1 1 80 000 1 1 1 06 0 06 25 , . .       = 1 022 688 , , Then, €1,022,668 is used as the FV (at R on the timeline) for the accumulation phase annuity as per: I / Y = 6%; PV = €0; PMT = –€6,608; FV = €1,022,668; Mode = End. The computed N is 40. Alternatively, 40 could be calculated with the formula: FV = + ( ) -         A r r N 1 1 and solving for N , 1 022 668 6 608 1 0 06 1 0 06 , , , . . = + ( ) -         N

13 2018 Level I Mock Exam (B) AM A is incorrect. 80,000 is multiplied by 25 years (2,000,000) and the result is used as the FV of the 6,608 annuity at 6% and PV = 0. The result is N = 50.67. C is incorrect. 80,000 is multiplied by 25 years and then discounted at 6% for 25 years (465,997). The result is used as the PV of the 6,608 annuity at 6% as follows: I / Y = 6%; PMT = 6,608; PV =465,997; FV = 0; Calculate N : N = –28.40 and the minus sign is ignored. The Time Value of Money LOS e, f Sections 4.1, 6.1 20 A company has an unsecured line of credit and needs to maintain its EBIT- to-interest coverage ratio greater than 2.0. Its EBIT is estimated to be between $36 million and $48 million, with all values equally likely. If the forecasted interest charge for the year is $20 million, the probability that EBIT/interest will be more than 2.0 is closest to: A 61.5%. B 33.3%. C 66.7%. C is correct. The EBIT-to-interest ratio is equal to 2.0 when the EBIT is $40 million. Given that the values between $36 million and $48 million are equally likely, the probability of the ratio being equal to or less than 2.0 is 33.3% (= [$40 million – $36 million]/[$48 million – $36 million]). Consequently, the probability of the ratio being greater than 2.0 is 66.7% (i.e., 1 – Probability of the ratio being equal to or less than 2.0). A is incorrect. This treats the distribution as discrete with increments in $1M. EBIT Int EBIT/INT 36 20 1.8 37 20 1.85 38 20 1.9 39 20 1.95 40 20 2 41 20 2.05 42 20 2.1 43 20 2.15 44 20 2.2 45 20 2.25 46 20 2.3 47 20 2.35 48 20 2.4 Cell Count 13 8 0.615 Prob >2.0 B is incorrect. This is the probability of the ratio being equal to or less than 2.0. Common Probability Distributions LOS h Section 3.1

14 2018 Level I Mock Exam (B) AM 21 A small-cap growth fund’s monthly returns for the past 36 months have been consistently outperforming its benchmark. An analyst is determining whether the standard deviation of monthly returns is greater than 6%. Which of the following best describes the hypothesis to be tested? A H 0 : σ 2 ≤ 0.36% B H a : σ 2 > 6% C H 0 : σ 2 ≥ 0.36% A is correct. This is a one-tailed hypothesis testing with a “greater than” alternative hypothesis. A squared standard deviation is being used to obtain a test of variance. The hypotheses are H 0 : σ 2 ≤ 0.36% versus H a : σ 2 > 0.36%. B is incorrect as explained in choice A. C is incorrect as explained in choice A Hypothesis Testing LOS b Section 2 22 The variance of returns of Asset A is 625. The variance of returns of Asset B is 1,225. The covariance of returns between Asset A and Asset B is 600. The cor- relation of returns between Asset A and Asset B is closest to: A 0.29. B 0.69. C 0.47. B is correct. Correlation of returns between asset i and j , ρ( R i , R j ), is defined as: ρ( R i , R j ) = Cov( R i , R j )/σ( R i )σ( R j ) where R i and R j = the returns of assets i and j Cov( R i , R j ) = the covariance of returns between assets i and j σ( R i ) and σ( R j ) = the standard deviations of returns of assets i and j In this problem, the correlation is 600 625 1 225 × ( ) , = 0.6857 ~ 0.69. A is incorrect. The mistake is an incorrect order of operations as in 600 625 1 255 ( ) × , = 840, then the square root of 840 is taken: 840 = 28.98. The result is divided by 100: 28.98/100 = 0.2898 ~ 0.29. C is incorrect. It is calculated as follows: 600 2 /(625 × 1,225) = 0.47. Probability Concepts LOS k Section 3 23 The central limit theorem is best described as stating that the sampling distribu- tion of the sample mean will be approximately normal for large-size samples: A if the population distribution is normal.

15 2018 Level I Mock Exam (B) AM B for populations described by any probability distribution. C if the population distribution is symmetrical. B is correct. The central limit theorem holds without regard for the distribution of the underlying population. A is incorrect because the central limit theorem holds without regard for the distri- bution of the underlying population. C is incorrect because the central limit theorem holds without regard for the distri- bution of the underlying population. Sampling and Estimation Section 3.1 LOS e 24 Technical analysts most likely study trends and patterns in security prices to forecast a company’s: A future price trends. B earnings potential. C intrinsic value. A is correct. Technical analysts believe that market trends and patterns tend to repeat, so they rely on recognizing past patterns in an attempt to project future security price patterns. B is incorrect. Forecasting a company’s earnings potential would fall under funda- mental analysis, not technical analysis. C is incorrect. Forecasting a company’s intrinsic value would fall under fundamental analysis, not technical analysis. Technical Analysis LOS a Sections 2.1, 2.2 25 Given a large random sample, which of the following types of data are least appropriately analyzed with nonparametric tests? A Signed data (e.g., number of positives and negatives) B Ranked data (e.g., 1st, 3rd) C Numerical values (e.g., 28.43, 79.11) C is correct. Nonparametric tests are primarily concerned with ranks, signs, or groups, and they are used when numerical parameters are not known or do not meet assumptions about distributions. Even if the underlying distribution is unknown, parametric tests can be used on numerical data if the sample is large. A is incorrect because nonparametric tests can be used on grouped or counted data.

16 2018 Level I Mock Exam (B) AM B is incorrect because nonparametric tests can be used on ranked data. Hypothesis Testing LOS k Section 5 26 A group of fund analysts have to select the first, second, and third best fund manager of the year for 2012 based on their subjective judgment. If 10 fund managers are candidates for the three awards, the number of ways in which each analyst can make his ranking is closest to: A 30. B 720. C 120. B is correct. This problem is a counting one in which order does matter. For this reason, use the permutation formula n P r = n n r ! ! - ( ) , where n = the total number of fund managers; in the problem, n = 10. r = the number of fund managers that will receive the awards (first, second, and third); in the problem, r = 3. 10 P 3 = 10 10 3 10 7 3 628 800 5 040 ! ! ! ! , , , - ( ) = = = 720 There are 720 ways that each analyst can rank 3 fund managers out of 10, when order does matter. A is incorrect. It uses the following calculation: 3 × 10 = 30. C is incorrect. It uses the combination formula as follows: n C r = n r n n r r       = - ( ) = - ( ) = = ! ! ! ! ! ! ! ! ! , , , 10 10 3 3 10 7 3 3 628 800 30 240 = 120 Probability Concepts LOS o Section 4.2 27 The bond-equivalent yield for a semi-annual pay bond is most likely : A equal to the effective annual yield. B equal to double the semi-annual yield to maturity. C more than the effective annual yield. B is correct. The bond equivalent yield for a semi-annual pay bond is equal to double the semi-annual yield to maturity and is lower than the effective annual yield. A is incorrect. The bond equivalent yield for a semi-annual pay bond is equal to double the semi-annual yield to maturity and is lower than the effective annual yield.

17 2018 Level I Mock Exam (B) AM C is incorrect. The bond equivalent yield for a semi-annual pay bond is equal to double the semi-annual yield to maturity and is lower than the effective annual yield. Discounted Cash Flow Applications LOS e, f Section 4 28 An analyst gathers the following information about the performance of a port- folio ($ millions): Quarter Value at Beginning of Quarter (Prior to Inflow or Outflow) Cash Inflow (Outflow) at Beginning of Quarter Value at End of Quarter 1 2.0 0.2 2.4 2 2.4 0.4 2.6 3 2.6 (0.2) 3.2 4 3.2 1.0 4.1 The portfolio’s annual time-weighted rate of return is closest to: A 8%. B 32%. C 27%. B is correct. The time-weighted rate of return is calculated by computing the quar- terly holding period returns and linking those returns into an annual return as follows: Quarter Value ($ millions) at Beginning of Quarter (Considering Inflows and Outflows) Value ($ millions) at End of Quarter Holding Period Return 1 2.0 + 0.2 = 2.2 2.4 (2.4 – 2.2)/2.2 = 9.09% 2 2.4 + 0.4 = 2.8 2.6 (2.6 – 2.8)/2.8 = –7.14% 3 2.6 – 0.2 = 2.4 3.2 (3.2 – 2.4)/2.4 = 33.33% 4 3.2 + 1.0 = 4.2 4.1 (4.1 – 4.2)/4.2 = –2.38% The time-weighted return (TWR) is found as follows: TWR = (1 + 9.09%) × (1 – 7.14%) × (1 + 33.33%) × (1 – 2.38%) – 1 = 32% (rounded) A is incorrect. It uses the following formula: 1 9 09 1 7 14 1 33 33 1 2 38 1 4 + ( ) × - ( ) × + ( ) × - ( ) -     . % . % . % . % = 8% (rounded) C is incorrect. It is the money-weighted rate of return (MWR). Solve for r in the fol- lowing formula: 2 0 2 0 4 1 1 1 0 2 1 4 1 1 1 3 2 4 + ( ) + + ( ) + + ( ) = + ( ) + + ( ) . . . . r r r r

18 2018 Level I Mock Exam (B) AM To solve, use the cash flow (CF) function of a financial calculator and enter: CF0 = –2 – 0.2= –2.2, CF1 = –0.4, CF2 = 0.2, CF3 = –1, and CF4 = 4.1. Compute the quarterly IRR and obtain 6.09%. By annualizing we obtain: (1 + 0.0609) 4 – 1 = 27% (rounded). Discounted Cash Flow Applications LOS c, d Sections 3, 3.2 29 The joint probability of events A and B is 32%, with the probability of event A being 60% and the probability of event B being 50%. On the basis of this information, the conditional probability of event A given that event B occurs is closest to : A 53.3%. B 30.0%. C 64.0%. C is correct. The conditional probability of A given that B has occurred is equal to the joint probability of A and B divided by the probability of B . In this case: P ( A | B ) = P ( AB )/ P ( B ) = 32.0%/50.0% = 64.0% B is incorrect because it equals P ( A ) × P ( B ) = 60.0% × 50.0% = 30.0% A is incorrect because it is P ( B | A ) = P ( AB )/ P ( A ) = 32.0%/60.0% = 53.3% Probability Concepts LOS f Section 2 30 If the stated annual interest rate is 20% and the frequency of compounding is monthly, the effective annual rate (EAR) is closest to: A 20%. B 21%. C 22%. C is correct. EAR = (1 + periodic interest rate) m – 1 = (1 + 0.20/12) 12 – 1 = 0.21939%, rounded to 22%. A is incorrect. It is simply the given stated annual rate. B is incorrect. It uses semiannual compounding as follows: (1 + 0.20/2) 2 – 1 = 21%. The Time Value of Money LOS c Section 3.3 31 The following 10 observations are a sample drawn from a normal population: 25, 20, 18, –5, 35, 21, –11, 8, 20, and 9. The mean of the sample is closest to: A 17.20. B 14.00.

19 2018 Level I Mock Exam (B) AM C 15.56. B is correct. The sum of the 10 numbers is 140. Dividing by 10 gives the mean of 14. A is incorrect and is calculated by adding the absolute values of the ten numbers (i.e., –11 is valued as 11 and –5 is valued as 5). C is incorrect and is calculated by dividing 140 by 9 (i.e., by n – 1 rather than n ). Statistical Concepts and Market Returns LOS e Section 5.1.2 32 A subset of a population is best described as a: A statistic. B sample. C conditional distribution. B is correct. A sample is a subset of a population. A is incorrect. A statistic is a quantity computed from or used to describe a sample of data. C is incorrect. A conditional distribution is a misnomer, but it sounds like the distri- bution of some value conditional upon some event. Statistical Concepts and Market Returns LOS a Section 2.2 33 If the price of a stock goes from $15.00 to $16.20 in one year, the continuously compounded rate of return is closest to: A 7.70%. B 8.33%. C 8.00%. A is correct. The continuously compounded rate of return is calculated with the following formula: r 0, T = ln( S T / S 0 ) where r 0, T = r 0,1 = and is the continuously compounded rate of return from time 0 to time T (1 year) S 0 = 15.00 and is the price of the stock at time 0 S T = 16.20 and is the price of the stock at time T (1 year) The continuously compounded rate of return is: r 0,1 = ln(16.20/15.00) = 7.70%. Alternatively, the end of period price, 16.20 can be found from 15.00 × e 0.077×1 .

20 2018 Level I Mock Exam (B) AM B is incorrect. It is calculated as: exp(Holding period return) – 1= exp[(16.20/15.00) – 1] – 1 = exp(8.00%) – 1 = 8.33%. C is incorrect. It is the holding period return: (16.20/15.00) – 1 = 8.00%. Common Probability Distributions LOS o Section 3.4 34 The price of a good falls from $15 to $13. Given this decline in price, the quan- tity demanded of the good rises from 100 units to 120 units. The own-price elasticity of demand for the good is closest to: A –0.67. B –1.50. C –1.25. B is correct. The own-price elasticity of demand E p d x ( ) is calculated as: E Q P p d x d x x = = - - = - % % . Δ Δ 120 100 100 13 15 15 1 50 where % ∅ Q x d = the change in quantity (in %) % ∅ P x = the change in price (in %) A is incorrect. It uses %Δ P /%Δ Q , calculated as [(13 – 15)/15]/[(120 – 100)/100] = –0.67. C is incorrect. It uses correct formula, but bases %Δ Q on new level of demand, calcu- lated as [(120 – 100)/120]/[(13 – 15)/15] = –1.25. Topics in Demand and Supply Analysis LOS a Section 2.2 35 Three firms operate under perfect competition, producing 900 units of the same product but using different production technologies. Each company’s cost structure is indicated in the table: Company X Y Z Total Variable Costs $2,700 $3,600 $4,500 Total Fixed Costs 2,700 1,800 900 Total Costs $5,400 $5,400 $5,400 Which of the following statements is most accurate? If the unit selling price is: A $6.00, all firms should exit the market in the long run. B $4.50, all firms should continue to operate in the short run, but exit the market in the long run if these conditions are expected to persist. C 3.00, Firm X should continue to operate in the short run, but Firms Y and Z should shut down production.

21 2018 Level I Mock Exam (B) AM C is correct. Revenue–Cost Relationship Short-Run Decision Long-Term Decision TR ≥ TC Stay in market Stay in market TR > TVC but TR < TFC + TVC Stay in market Exit market TR < TVC Shut down production Exit market TR = Total Revenue; TC = Total Costs; TVC = Total Variable Costs; TFC = Total Fixed Costs Hence, if the selling price is $3.00, total revenue for all firms will be $3.00/unit × 900 units = $2,700. Only Firm X’s variable costs are covered and it should continue operating, while Firms Y and Z should immediately shut down production. A is incorrect. If total revenue equals or exceeds total costs, the firms should remain in the market both in the long and short run: each firm is just earning an economic profit, which includes its opportunity cost. B is incorrect. At $4.50, total revenue is $4.50 × 900 = $4,050. Only Firms X and Y cover their variable costs; Firm Z should shut down. It is true, however, that if conditions persist, all should shut down in the long run as they won’t be covering their total costs. Topics in Demand and Supply Analysis LOS e Section 3.2.7 36 In a country with a high level of income, as domestic income rises, it is most likely that an increase will occur in: A the fiscal balance. B private saving and investment. C the trade balance. B is correct. In a country with a high level of income, as domestic income rises, private saving and investment will increase. A is incorrect. The fiscal balance is given by G – T. An increase in domestic income leads to an increase in net taxes. Government’s fiscal balance will decrease (smaller deficit or larger surplus). C is incorrect. The trade balance is given by X – M. An increase in domestic income leads to an increase in imports and lower net exports. The trade balance will decrease. Aggregate Output, Prices, and Economic Growth LOS e Section 3.1.1 37 In order to reduce a trade deficit, the government of a country experiencing full employment moves to depreciate its currency. As a result, if the country’s domestic spending declines relative to income, the most likely mechanism that causes this to occur is the: A income effect.

22 2018 Level I Mock Exam (B) AM B wealth effect. C substitution effect. B is correct. At full employment, a weaker currency reduces the purchasing power of all domestic currency denominated assets (including the present value of current and future income). Households respond by reducing general expenditures and increasing savings. This response is the wealth effect and reflects the proportion of one’s income that is saved (or spent). A is incorrect. The income effect arises when the price of a good changes: with currency depreciation, foreign goods are more expensive, so real purchasing power (income) is reduced. C is incorrect. The substitution effect refers to the changes in the composition of spending across different product areas. With currency depreciation, less foreign goods relative to domestic goods are purchased. Currency Exchange Rates LOS j Sections 5.2 Aggregate Output, Prices, and Economic Growth LOS h Section 3.3.1 38 Which characteristic is a firm least likely to exhibit when it operates in a market with a downward sloping demand curve, many competitors, and zero economic profits in the long run? A No pricing power B Low barriers to entry C Differentiated product A is correct. The characteristics of monopolistic competition include a large number of competitors, low pricing power, and the production of differentiated products (through advertising and other non-price strategies), but these still result in some pricing power. The ease of entry results in zero economic profits in the long run. B is incorrect. Low barriers to entry are a characteristic of monopolistic competition. C is incorrect. Product differentiation is a characteristic of monopolistic competition. The Firm and Market Structures LOS a, b Sections 2.1, 2.2, 4 39 Cost–push inflation is least likely to be affected by an increase in: A employee wages. B finished goods prices. C commodity prices.

23 2018 Level I Mock Exam (B) AM B is correct. Cost–push inflation arises due to increases in costs associated with produc- tion: wages and raw materials prices. A is incorrect. Cost–push inflation arises due to increases in costs associated with production. Wages are the single biggest cost to businesses. C is incorrect. Cost–push inflation arises due to increases in costs associated with production. Commodities are an input to production, so they are major source of cost– push inflation. Understanding Business Cycles LOS h Section 4.2.4.1 40 The following information is available for 2011: New Zealand Canada Jan 1 Dec 31 Jan 1 Dec 31 Price index 1,137 1,158 117.8 119.9 Nominal exchange rate: NZD/CAD 1.2844 1.2589 The change in the real exchange rate (in NZD/CAD terms) is closest to: A –2.05%. B –1.92%. C +1.96%. A is correct. Formula New Zealand Canada Inflation rate (I 1 – I 0 )/I 0 (1,158 – 1,137)/1,137 = 1.85% (119.9 – 117.8)/117.8 = 1.78% Nominal Exchange Rate Change (S 1 – S 0 )/S 0 (1.2589 – 1.2844)/1.2844 = –1.99% Real Exchange Rate Change 1 1 1 +         × +       + Δ Δ Δ S S P P P P NZD CAD NZD CAD Canada Canada NZ NZ       - 1 1 0 0199 1 0 0178 1 0 0185 1 2 05 - ( ) × + ( ) + ( ) - = - . . . . Approximation: –1.99% + 1.78% – 1.85% = –2.06% B is incorrect. It uses the correct change in nominal exchange rate, but inverts the inflation rate ratio: (1 – 0.0199) × (1.0185)/(1.0178) – 1 = –1.92% or –1.99% +1.85% – 1.78%. C is incorrect. It uses the appreciation of the Canadian dollar but the correct ratio of inflation rate changes; CAD/NZD: (0.7943 – 0.7786)/0.7786 = +2.02% or [1/(1 – 0.0199)] – 1 = 2.03%. Giving (1 + 0.0203) ×1.0178/1.0185 – 1= +1.96% or (+2.03 +1.78% – 1.85% = +1.96%). Understanding Business Cycles LOS g Sections 4.2.2 and 4.2.3 Currency Exchange Rates (continued)

24 2018 Level I Mock Exam (B) AM LOS a, c Section 2 41 Assume that the central bank reduces the reserve requirement. The most likely effect will be: A a decrease in the money supply. B a decrease in new deposits. C an increase in the money multiplier. C is correct. Reducing the reserve requirement will increase the money supply, money multiplier, and new deposits. A is incorrect because the money supply will increase. B is incorrect because new deposits will increase. Monetary and Fiscal Policy LOS c Section 2.1.2 42 Assuming its trading partner does not retaliate, which of the following condi- tions must hold in order for a large country to increase its national welfare by imposing a tariff? A The deadweight loss must be smaller than the benefit of its improving terms of trade. B It must auction the import licenses for a fee to offset the decline in the con- sumer surplus. C It must have a comparative advantage in the production of the imported good. A is correct. The large country is able to cause the foreign exporter to reduce price in order to retain market share. In the large country, domestic producers gain from higher volume and the government gains from collecting the tariff. The sum of these two gains must exceed the deadweight loss to domestic consumers to achieve a national welfare gain. The change in terms of trade causes income redistribution from the foreign exporter to the domestic producer. B is incorrect. An import license relates to a quota, not a tariff. C is incorrect. If the large country had a comparative advantage, it would be exporting more than importing. This is not relevant to whether there is a net domestic gain from the tariff. The tariff hurts domestic consumers. Unless the gain from the tariff exceeds the loss to consumers, national welfare will decrease. International Trade and Capital Flows LOS e Section 3.1 43 A dealer report includes the following exchange rate details:

25 2018 Level I Mock Exam (B) AM Spot Rate Expected Change over Next Year USD/EUR 1.30 1.75% CAD/USD 0.95 –0.25% CHF/EUR 1.22 0.75% The expected CAD/CHF cross rate in one year is closest to : A 1.04. B 0.98. C 1.02. C is correct. Spot Rate Expected Appreciation Expected Spot Rate in One Year USD/EUR 1.30 1.75% 1.323 CAD/USD 0.95 –0.25% 0.948 CHF/EUR 1.22 0.75% 1.229 CAD/CHF = (USD/EUR) × [(CAD/USD)/ (CHF/EUR)] = 1.020 A is incorrect because the cross rates are calculated incorrectly: CAD/CHF = S CHF CAD expected appreciation of the 3 exchange rates × + ( ) ∑ 1      = 1.012 × [1 + (1.75% – 0.25% + 0.75%)]  = 1.012 × (1 + 2.25%)  = 1.035 B is incorrect. It calculates the Swiss Franc (CHF) relative to the Canadian dollar (CAD): (CHF/EUR)/[(USD/EUR)/(CAD/USD)] = 1.229/(1.323/0.948) = 0.881. Currency Exchange Rates LOS d Section 3.2 44 Higher than expected inflation will most likely lead to an increase in: A the real wealth of borrowers. B investment. C the information content of market prices for economic agents. A is correct. Unexpected inflation that is higher than anticipated will likely result in bor- rowers benefiting at the expense of creditors as the real value of their borrowing declines. B is incorrect because higher than expected inflation will likely result in greater inflation uncertainty. Lenders will ask for a premium to compensate for this uncertainty, which leads to higher borrowing costs and thereby will discourage investment.

26 2018 Level I Mock Exam (B) AM C is incorrect because one of the potentially destabilizing effects of unexpected inflation is that it can reduce the information content of market prices. Monetary and Fiscal Policy LOS g Section 2.3.1 45 The structural deficit is equal to the budget deficit: A adjusted for inflation. B that would exist at full employment. C excluding the impact of automatic stabilizers. B is correct. The structural deficit is the deficit that would exist if the economy was at full employment (or full potential output). Economists often consider the structural deficit as an indicator of the fiscal policy stance. A is incorrect because the structural deficit makes no adjustment for inflation. C is incorrect because the structural deficit includes (rather than excludes) the impact of automatic stabilizers on the budget assuming full employment. Monetary and Fiscal Policy LOS s Section 3.3.1 46 All else being equal, if the purchase price of inventory is increasing, a company that accounts for its inventory under last-in, first-out (LIFO) instead of first-in, first-out (FIFO) is most likely to have a: A higher debt-to-equity ratio. B lower net cash flow from operating activities. C lower market valuation of its common equity. A is correct. With rising costs of inventory, a company using LIFO compared with FIFO will report a higher cost of sales and lower profits. This scenario will result in lower increments to retained earnings and a higher debt-to-equity ratio. B is incorrect. A company using LIFO will report lower taxes paid and a higher net cash flow from operating activities. C is incorrect. The higher cash flows under LIFO due to lower income taxes paid will increase its market value relative to an identical company that uses FIFO. Inventories LOS l, d Sections 3.7, 4 47 Which of the following best describes common equity? A The initial investment by common shareholders in the company B The resources owned or controlled by a company C The residual interest in a company’s assets after deducting its liabilities

27 2018 Level I Mock Exam (B) AM C is correct. Common equity is a component of the balance sheet and represents the owners’ residual interest in the company’s assets after deducting its liabilities. A is incorrect. Common equity includes the initial investment by the shareholders and the retained earnings; this definition is incomplete. B is incorrect. Assets are a component of the balance sheet and represent resources controlled by an enterprise as a result of past events and from which future economic benefits to the enterprise are expected to flow. Understanding Balance Sheets LOS a Section 2 48 The cumulative amount of earnings recognized on a company’s income state- ments that have not been distributed as dividends to the company’s owners is best described as: A retained earnings. B accumulated other comprehensive income. C dividends payable. A is correct. Retained earnings, a component of equity, is defined as the cumulative amount of earnings recognized on the company’s income statements that have not been distributed as dividends to the company’s owners. B is incorrect. Other comprehensive income is also a component of equity, but it is defined as items of comprehensive income not reported on the income statement. C is incorrect. Dividends payable represent dividends that have been declared but not yet paid. Not all earnings not yet paid out would be accrued as a liability: only those that have been declared as dividends. Understanding Balance Sheets LOS f Section 6.1 49 Income statements for two companies (A and B) and the common-size income statement for the industry are provided in the following table: ($ thousands) Company A Company B Industry Sales $10,500 $8,250 100.0% Cost of goods sold 6,353 5,239 62.8% Selling, general, and administra- tive expenses 2,625 2,021 24.8% Interest expense 840 536 7.0% Pretax earnings 683 454 5.4% Taxes 205 145 1.7% Net earnings $478 $309 3.7% The best conclusion an analyst can make is that: A Company A earns a higher gross margin than both Company B and the industry.

28 2018 Level I Mock Exam (B) AM B both companies’ tax rates are higher than the industry average. C Company B’s interest rate is lower than the industry average. A is correct. Common-sized analysis of the income statements shows that Company A has a lower percentage cost of goods sold and thus a higher gross margin than the industry and Company B. Company A Company B Industry Company A Company B Sales $10,500 $8,250 100.0% 100% 100% Cost of goods sold 6,353 5,239 62.8% 60.5% 63.5% Gross margin 37.2% 39.5% 36.5% Company A earns a higher gross margin than both Company B and the industry. Company A Company B Industry Company A Company B Pretax earnings $683 $454 5.4% 6.5% 5.5% Taxes 205 145 1.7% 2.0% 1.8% Tax rate = Taxes/ Pretax earnings 32% 30% 32% The tax rates for the companies are not higher than the industry. The tax rates for the companies are not higher than the industry. The interest rate is not a function of sales and cannot be analyzed on a common-size income statement. Tax rates are determined based on Taxes/Pretax earnings, not as a percentage of sales (as shown in common-size analysis). B is incorrect. Tax rate varies with the pretax income, and as shown in the table neither companies’ tax rate is above the industry average. C is incorrect. Although Company B’s interest rate as a percentage of sales is lower than the industry average, interest cost does not vary with sales, but with the level of debt and its risk, so the actual interest rate cannot be determined. Understanding Income Statements LOS k Section 7 Financial Analysis Techniques LOS b, c Sections 3.1, 3.2.2 50 The following selected balance sheet and ratio data are available for a company: Metric Current Year Previous Year Cash and cash equivalents 98.0 Marketable securities 389.2 Accounts receivables 12.0 Other current assets 120.1 Total current assets 619.3 Deferred revenues 85.0 Other current liabilities 92.3

29 2018 Level I Mock Exam (B) AM Metric Current Year Previous Year Total current liabilities 177.3 Cash ratio 2.37 Quick ratio 2.97 Current ratio 3.27 Which of the following ratios most likely decreased this year? A Quick B Current C Cash A is correct. Metric Current Year Previous Year Conclusion Cash ratio = (Cash + Marketable securities)/Current liabilities (98 + 389.2)/177.3 = 2.75 2.37 Increase Quick ratio = (Cash + Marketable securities + Receivables)/Current liabilities (98 + 389.2 + 12)/177.3 = 2.82 2.97 Decrease Current ratio = Current assets/ Current liabilities 619.3/177.3 = 3.49 3.27 Increase B is incorrect. The current ratio increased in the current year. C is incorrect. The cash ratio increased in the current year. Understanding Balance Sheets LOS h Section 7.2 Financial Analysis Techniques LOS b Section 4.3 51 The following items are from a company’s cash flow statement. Classification of Cash Flow Description Amount (£ thousands) Operating activities Cash received from customers 55,000 Investing activities Interest and dividends received 10,000 Financing activities Net repayment of revolving credit loan 12,000 Which of the following standards and formats did the company most likely use in the preparation of its financial statements? A Either IFRS or US GAAP, direct format B IFRS, indirect format C IFRS, direct format

30 2018 Level I Mock Exam (B) AM C is correct. The direct method of cash flow statement presentation shows the specific cash inflows and outflows that result in reported cash flow from operating activities (e.g., cash from customers and cash to suppliers). Companies using IFRS can decide to report interest and dividend receipts as either an investing or operating activity; under US GAAP, they must report such income as an operating activity. The listed operating and invest- ment activities indicate that the company reports under IFRS using the direct method. A is incorrect. The description of investing activities, which includes interest and dividends received, indicates that the company must be reporting under IFRS. Those items are operating activities under US GAAP. B is incorrect. The description of operating activities indicates that the company is using the direct method. Understanding Cash Flow Statements LOS c, d Sections 2.3, 2.3.2, 3.2.1.5 52 If a company capitalizes an expenditure related to capital assets instead of expensing it, ignoring taxes, the company will most likely report: A a lower cash flow per share in that period. B the same free cash flow to the firm (FCFF) in that period. C a higher earnings per share in future periods. B is correct. The FCFF [Cash flow from operations (CFO) + Interest × (1 – t ) – Capital expenditures] would be the same. CFO and capital expenditures would both increase by the same amount (ignoring taxes). Therefore, the net effect on FCFF would be zero. Example Capitalizing delivery cost as opposed to expensing it Ignoring taxes FCFF CFO + Interest × (1 – t ) – Capital expenditures Capital expenditures If capitalized, the amount capitalized increases capital expenditures and is recorded as a cash outflow from investing activities CFO The CFO will be higher by amount capitalized (i.e., the amount not expensed) Because capital expenditures and CFO increase by the same amount, ignoring taxes, FCFF is unchanged. A is incorrect. As indicated, CFO increases in the period of capitalization. Cash flow per share is based on CFO, so it would increase. C is incorrect. Future EPS will be lower due to the higher future depreciation expense arising from the current capitalization. Understanding Cash Flow Statements LOS i Section 4.3 Long-Lived Assets LOS a Section 2.1

31 2018 Level I Mock Exam (B) AM 53 A company has recently revalued one of its depreciable properties and esti- mates that its remaining useful life will be another 20 years. The applicable tax rate for all years is 30%, and the revaluation of the property is not recognized for tax purposes. Details related to this asset are provided in the following table: Original Values and Estimates (millions) Accounting Purposes Tax Purposes Acquisition cost in 2011 £8,000 £8,000 Depreciation, straight line 20 years 8 years Accumulated depreciation, end of 2013 £1,200 £3,000 Net balance, end of 2013 £6,800 £5,000 Re-estimated Values and Estimates, Start of 2014 Revaluation balance, start of 2014 £10,000 Not applicable New estimated life 20 years The deferred tax liability related to this asset (in millions) as at the end of 2014 is closest to: A £960. B £690. C £1,650. B is correct. (millions) Accounting Purposes Tax Purposes Revaluation surplus (£10,000 – £6,800) = £3,200 No revaluation allowed Depreciation, straight line 20 years 5 years remaining Start of year balance after revaluation, 2013 £10,000 £5,000 Depreciation, 2013 (£10,000/20 years) = £500 £1,000 Net balance, end of 2013 £9,500 £4,000 Minus revaluation surplus – £ 3,200 — Carrying value for pur- poses of deferred taxes £6,300 £4,000 Deferred tax liability = 0.30 × (£6,300 – £4,000) = £690 Only the portion of the difference between the tax base and the carrying amount that is not the result of the revaluation is recognized as giving rise to a deferred tax lia- bility. The portion arising from the revaluation surplus is used to reduce the revaluation surplus in equity. A is incorrect. It is the tax rate × writeup = 0.30 × 3,200 = 960. C is incorrect. It is the tax rate × the difference between carrying value and tax base: 0.30 × (9,500 – 4,000) = 1,650. Income Taxes LOS c, d, h Sections 2.2, 6.2

32 2018 Level I Mock Exam (B) AM 54 The year-end balances in a company’s last-in, first-out (LIFO) reserve are $56.8 million as reported in the company’s financial statements for both 2013 and 2014. For 2014, the measure that will most likely be the same regardless of whether the company uses the LIFO or the first-in, first-out (FIFO) inventory method is the: A gross profit margin. B amount of working capital. C inventory turnover. A is correct. The LIFO reserve did not change from 2013 to 2014. With no change in the LIFO reserve, cost of goods sold will be the same under both methods. Sales are always the same for both methods, so gross profit margin will be the same for 2014. The FIFO inventory will be higher because the LIFO inventory and LIFO reserve are added to compute FIFO inventory. Because the inventory balances would differ under FIFO, both inventory turnover and the amount of working capital would also differ under FIFO. B is incorrect. The FIFO inventory would be higher because the LIFO inventory and LIFO reserve are added to compute FIFO inventory. Because the inventory balances would be different under FIFO, net working capital would be different under FIFO. C is incorrect. The FIFO inventory would be higher because the LIFO inventory and LIFO reserve are added to compute FIFO inventory. Because the inventory balances would be different under FIFO, the inventory turnover would be different under FIFO. Inventories LOS e, k, l Section 4.1 55 The following selected fixed asset information is available for a company: 2016 ($US millions) Cost: Total property, plant, and equipment (PP&E) 30,815 Accumulated depreciation 16,465 Net PP&E 14,350 Average net PP&E 12,200 Net sales 21,670 Net income 2,705 The company’s fixed asset turnover ratio is closest to: A 1.78. B 8.01. C 1.51. A is correct. The fixed asset turnover ratio for the company is calculated as Net sales/Average net PP&E = 21,670/12,200 =1.78 B is incorrect. It mistakenly uses net income instead of the net sales: 21,670/2,705 = 8.01.

33 2018 Level I Mock Exam (B) AM C is incorrect. It mistakenly uses net PP&E year-end instead of the average: 21,670/14,350 = 1.51. Long-Lived Assets LOS m Section 7 56 Which of the following ratios is most likely to be used as a measure of operating performance? A Cash ratio B Working capital turnover ratio C Defensive interval ratio B is correct. Activity ratios are typically used to measure operating performance. Working capital turnover is an example of an activity ratio; the defensive interval ratio and cash ratio are liquidity ratios used to measure a company’s ability to meet its short-term obligations. A is incorrect. The cash ratio is an example of a liquidity ratio. C is incorrect. The defensive interval ratio is an example of a liquidity ratio. Financial Analysis Techniques LOS b Sections 4.2.1, 4.3.1 57 The following information is available about a company ($ millions): Year Ended 31 December 2012 2011 Sales 322.8 320.1 Net income 27.2 26.8 Cash flow from operations 15.3 38.1 During 2012, the company most likely experienced a significant decrease in: A inventory, anticipating lower demand for its products in 2013. B the proportion of sales made on a cash basis. C the proportion of interest-bearing debt relative to trade accounts payable. B is correct. Sales are nearly the same for the two years. A decrease in the proportion of cash sales implies an increase in the proportion of credit sales, which would increase accounts receivable and decrease cash flow from operations. A is incorrect. A decrease in inventory would increase cash from operations. C is incorrect. An increase in payables would increase cash from operations. Understanding Cash Flow Statements LOS h Sections 2.3.1, 3.2.5 58 Selected information from a company’s recent income statement and balance sheets is presented in the following table.

34 2018 Level I Mock Exam (B) AM Selected Financial Information as of 31 December (C$ thousands) 2013 2012 Sales 2,240,000 Cost of goods sold (COGS) 1,320,000 Cash and investments 210,700 191,600 Accounts receivable 212,800 201,900 Inventories 63,000 71,500 Accounts payable 129,600 157,200 Other current liabilities 130,700 182,700 The company operates in an industry in which suppliers offer terms of 2/10, net 30. The payables turnover for the average company in the industry is 8.5 times. Which of the following statements is most accurate? In 2013, the company, on average: A paid its accounts within the payment terms provided. B paid its accounts more promptly than the average firm in the industry. C took advantage of early payment discounts. B is correct. The firm’s days in payables is 39.9 days (see following calculations), so it appears that the firm does not normally take supplier provided discounts (paying in 10 days) or pay its accounts within the 30-day terms provided. However, on average, the company is paying faster than the average firm in the industry (42.9 days). Payables turnover = Purchases/Average payables = 1,311,500/143,400 = 9.15 times where: Purchases = COGS + End inventory – Beginning inventory  = 1,320,000 + (63,000 – 71,500)  = 1,311,500 Average payables = (129,600 + 157,200)/2  = 143,400 Days in payables = 365/Payables turnover ratio For firm: 365 days/9.15 = 39.9 days For industry: 365 days/8.5 times = 42.9 days A is incorrect. On average, the company is exceeding the maximum terms provided of 30 days. C is incorrect. The firm on average does not take advantage of the early discounts offered or its days in payables would be less than 10 days. Financial Analysis Techniques LOS b Sections 4.2.1, 4.2.2 Working Capital Management LOS f Section 2.2

35 2018 Level I Mock Exam (B) AM 59 The following information is available on a company: Metric Fixed charge coverage ratio required by debt covenant 3.50 Forecasted interest expense ($ thousands) 800 Forecasted lease payments ($ thousands) 300 Tax rate 30% The minimum net income (in thousands) that the company must generate to meet its debt covenant requirement is closest to: A $2,750. B $1,925. C $2,135. B is correct. The fixed charge coverage ratio is: Net income Income tax expense Interest expense Lease payme + + + nts Interest payments Lease payments + Calculation $ thousands Denominator ($ thousands): Interest payments + Lease payments 800 + 300 1,100 Minimum numerator: Net income + Income tax expense + Interest expense + Lease payments Denominator × 3.50 3,850 Minus interest expense –800 Minus lease payments –300 Income before tax 2,750 Minus income tax expense 2,750 × 30% –825 Minimum net income 1,925 A is incorrect. This answer incorrectly omits tax expense from the numerator. The answer provided is actually net income before tax as calculated above, not net income. C is incorrect. This answer incorrectly assumes that the numerator in the ratio is EBIT. ($ thousands) Minimum numerator (from above): Incorrectly assumed to be EBIT Denominator × 3.50 3,850 Less: interest expense –800 Incorrect income before tax 3,050 Less: income tax expense $3,050 × 30% –915 Incorrect minimum net income 2,135 Financial Analysis Techniques LOS b Section 4.4.1 Non-Current (Long-term) Liabilities (continued)

36 2018 Level I Mock Exam (B) AM LOS k Section 5 60 Which of the following best describes a reason a company would acquire the use of equipment through an operating lease rather than by purchase? A To take advantage of less costly financing B To obtain preferential tax treatment for the lease payments compared with ownership C To increase cash from operations 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 LOS f Section 3.1 61 An analyst examining the statement of cash flows for possible manipulation is least likely to be concerned about a(n): A cash flow from operations to net income ratio consistently higher than 1. B increase in cash from operations arising from a large change in accounts payable. C change in the classification of interest paid from an operating cash flow to a financing cash flow. A is correct. A cash flow from operations to net income ratio that is consistently higher than 1 indicates that operating cash flow is consistently higher than net income and signals high earnings quality. B is incorrect. A large increase in accounts payable could mean that a company is trying to artificially increase cash flow from operations by delaying payments to creditors. C is incorrect. Although this change is allowable, it increases cash flow from oper- ations, making the company appear healthier, and is likely to be made for this reason. Financial Reporting Quality LOS i Section 4.2.2 62 A company that prepares its financial statements in accordance with IFRS issues £5,000,000 face value 10-year bonds on 1 January 2013 when market interest rates for such bonds are 5.50%. The bonds carry a coupon of 6.50% with interest paid annually on 31 December. The carrying value of the bonds as of 31 December 2014 will be closest to:

37 2018 Level I Mock Exam (B) AM A £5,316,000. B £4,695,000. C £5,301,000. A is correct. There are two ways to determine the value of the bonds on 31 December 2014. First method: Calculate the present value (PV) of the cash flows over the remaining eight years at 5.5%: £5,000,000 × 6.5% × PVA(8 years, 5.5%) + £5,000,000 × PV(8 years, 5.5%) = £5,316,728 Or using a financial calculator: PMT = £325,000, i = 5.5%, n = 8 years, Future value = £5,000,000. Compute PV; PV = £5,316,728. Second method: Determine the initial bond proceeds and then the amortization of the premium or discount during the first two years. The initial bond proceeds are determined using a financial calculator: PMT = £325,000, i = 5.5%, n = 10 years, Future value = £5,000,000. Compute PV; PV = £5,376,881. Using the effective annual interest rate method, which is required under IFRS, to amortize the premium gives the following: Year Carrying Amount at Start of Year Interest Expense at EAI Interest Payment at Coupon Rate Amortization of Premium Carrying Amount at End of Year 2013 5,376,881 295,728 325,000 29,272 5,347,609 2014 5,347,609 294,119 325,000 30,881 £5,316,728 B is incorrect. It confuses the interest expense as the coupon payment and the pay- ment based on the EAI in the valuation of the bond, so that bond value is at a discount: i.e., 4,640,558 and the discount is amortized Year Carrying Amt at Start of Year Interest Expense at EAI Interest Payment at Coupon Rate Amortization of Discount Carrying Amount at End of Year 2013 4,640,558 301,636 275,000 29,272 4,667,194 2014 4,667,194 303,368 275,000 30,881 4,695,562 C is incorrect. It uses the straight-line method to amortize the premium. Annual Amortization of Premium = (5,376,881 – 5,000,000)/10 years  = 376,881/10  = 37,688 After 2 years: Carrying Value = 5,376,881 – 2 × 37,688 = 5,301,505. Non-Current (Long-Term) Liabilities LOS a, b Sections 2.1, 2.2

38 2018 Level I Mock Exam (B) AM 63 Under the International Accounting Standards Board’s (IASB’s) Conceptual Framework, one of the qualitative characteristics of useful financial information is that different knowledgeable users would agree that the information is a faith- ful representation of the economic events that it is intended to represent. This characteristic is best described as: A understandability. B verifiability. C comparability. B is correct. Under the IASB’s Conceptual Framework, verifiability means that different knowledgeable and independent users would agree that the information presented faithfully represents the economic events that it is intended to represent. A is incorrect. Understandability is the clear and concise presentation of information. C is incorrect. Comparability allows users to identify and understand similarities and differences of items. Financial Reporting Standards LOS d Section 5.2 64 The following information about a company is provided: Account $ thousands Contributed capital, beginning of the year 50 Retained earnings, beginning of the year 225 Sales revenues earned during the year 450 Investment income earned during the year 5 Total expenses paid during the year 402 Dividends paid during the year 10 Total assets, end of the year 800 Total liabilities (in $ thousands) at the end of the year are closest to: A 482. B 487. C 472. A is correct. Given Assets = Liabilities + Equity, first calculate ending equity ($318, see calculation in the following table). $800 = Liabilities + $318 Total liabilities = $482 $ thousands Contributed capital 50 Initial retained earnings 225 Sales revenues 450

39 2018 Level I Mock Exam (B) AM $ thousands Investment income 5 Total expenses (402) Net income for the year 53 Dividends paid (10) Increase in retained earnings 43 43 Ending owners’ equity $318 B is incorrect. It forgets to include the investment income. Ending equity = 450,000 – 402,000 – 10,000 + 50,000 + 225,000 = 313,000 800,000 – 313,000 = 487,000 C is incorrect. It fails to deduct the dividends. Ending equity = 318,000 +10,000 = 328,000 Total liabilities = 800,000 – 328,000 = 472,000 Financial Reporting Mechanics LOS c, f Sections 3.2, 4.2 65 Common-size income statements are shown for three companies in the same industry. Which company is most likely to have a technically superior product? Company X Company Y Company Z Revenue 100% 100% 100% Cost of goods sold 65 50 30 Administrative expenses 20 20 20 Research and development 0 5 30 Advertising expenses 5 15 10 Operating profit 10 10 10 A Company Z B Company Y C Company X A is correct. Company Z has spent the most on research and development and is able to support the highest gross margin (lowest cost of goods sold). It likely has the technically superior product. B is incorrect. Company Y spends significantly less than Company Z on research and development. It is unlikely to have a technically superior product. C is incorrect. Company X spends nothing on research and development. It is unlikely to have a technically superior product. Understanding Income Statements LOS k Section 7.1

40 2018 Level I Mock Exam (B) AM 66 Management’s commentary (also known as management’s discussion and analy- sis) most likely includes: A supplementary information about accounting policies, methods, and estimates. B an auditor’s opinion as to the fair presentation of the financial statements. C a discussion of significant trends, events, and uncertainties that affect the operating results. C is correct. Management’s commentary includes a discussion of significant trends, events, and uncertainties that affect the operating results. A is incorrect. The notes disclose information about the accounting policies, methods, and estimates used to prepare the financial statements. B is incorrect. The Auditor’s Report includes the auditor’s opinion as to the fair pre- sentation of the financial statements. Financial Statement Analysis: An Introduction LOS c Section 3.1.6 67 A US company that complies with US GAAP would like to exclude some items in determining non-GAAP financial measures, other than EBIT and EBITDA. Which of the following items may be excluded? A For performance measures, items tagged as infrequent that occurred within the past two years B Impairment charges for long-lived assets C For liquidity measures, litigation costs requiring cash settlement B is correct. To assist investors in evaluating operating performance, companies often report non-GAAP earnings by excluding asset impairment charges either for long-lived assets, goodwill, or other intangible assets. A is incorrect because the SEC prohibits the calculation of a non-GAAP performance measure intended to eliminate or smooth items tagged as non-recurring. The period within two years either before or after the reporting date is the relevant time frame for considering whether a charge or gain is a recurring item. C is incorrect because the SEC prohibits the exclusion of charges or liabilities requiring cash settlement from any non-GAAP liquidity measures other than EBIT and EBITDA. Financial Reporting Quality LOS g Section 4.1 68 Which of the following conditions is most likely associated with decreased earn- ings quality? Compared with the prior year, the reporting entity’s earnings: A decreased slightly in response to the introduction of conservative account- ing policies. B were similar in magnitude but included a large gain on the sale of a manu- facturing plant.

41 2018 Level I Mock Exam (B) AM C increased slightly because of a reduction in bad debt expense based on more-current experiences. B is correct. The sale of a manufacturing plant is likely a one-time transaction that will not be sustained in future years. The quality of reported earnings has therefore decreased from the prior year. A is incorrect. This is an example of decreased financial reporting quality because conservatism, a choice made by management, is making it more difficult to establish expectations for the future. Since the earnings only decreased because of the conser- vatism, there is no decrease in the underlying earnings quality. C is incorrect. If the estimates are based on more recent experiences, it does not imply the intent to manipulate earnings and will provide a more faithful representation of the company’s performance. Financial Reporting Quality LOS a Sections 1 and 2.2 69 An analyst is comparing the financial leverage of two companies, A and B, from the same industry. ● Both companies can borrow at a rate of 4%. ● The two companies are virtually identical except that Company A leases essentially all of its premises; Company B owns all of its premises. ● Company A recorded €15,280 (thousand) of lease expenses in 2015, the cur- rent year, ending 31 December. The following excerpt is from the notes to its 2015 financial statements: Note on Leasing Activities: Non-Cancellable Operating Lease Rentals Are Payable on 1 January as Follows: € thousands 2016 15,280 2017 15,280 2018 15,280 To facilitate a fair comparison with Company B, the analyst will most likely adjust (in € thousands) for the operating leases by increasing Company A’s: A earnings before tax by €15,280. B liabilities by €45,840. C liabilities by €44,100.

42 2018 Level I Mock Exam (B) AM C is correct. Analysts typically adjust for operating leases by treating them as if they were finance leases, including them as a liability measured at present value of future lease payments. In this case, the future lease payments are an annuity due of €15,280 over three years, at 4%. The present value of the annuity is €44,100: 15,280 × PVA ADV (three years, 4%) = €44,100. A is incorrect. This is the nominal value of one lease payment. The analyst would adjust net income by the difference between the operating lease expense and the estimated amount of interest expense and depreciation expense that would be deducted under financing lease treatment. B is incorrect. This is the nominal value of the future lease payments: 3 × €15,280 = €45,840. Financial Statement Analysis: Applications LOS e Section 6.6 70 The following information is available for a firm: Market risk premium 7.0% Risk-free rate 2.0% Comparable firm return 10.4% Comparable firm debt-to-equity ratio 1.0 Comparable firm tax rate 40.0% The firm’s unleveraged beta is closest to: A 0.75. B 1.20. C 1.05. A is correct. Find the comparable firm’s beta: (10.4% – 2.0%)/7.0% = 1.20. Unlever the comparable firm’s beta: β L,comparable /[1 + (1 – Tax rate) × Debt-to-equity ratio] 1.20/[1 + (1 – 40%) × 1.0] = 0.75. B is incorrect because it is the comparable firm’s beta. C is incorrect because the comparable firm’s beta is computed as 1.68 = (10.4% – 2.0%)/ (7.0% – 2.0%) and then proceeds to the next calculation. Cost of Capital LOS h, i Section 3.3.1, 4.1 71 The acceptance of which of the following capital budgeting projects is most likely to expose a company to the highest level of uncertainty? A Replacement of worn out equipment B Expansion projects C Newly launched product or services

43 2018 Level I Mock Exam (B) AM C is correct. Investments related to new products or services expose the company to even more uncertainties than expansion projects. These decisions are more complex and will involve more people in the decision-making process. A is incorrect. Replacement of worn out equipment is simply an improvement to the existing project with recurring revenues. B is incorrect. Investments related to new products or services expose the company to even more uncertainties than expansion projects. These decisions are more complex and will involve more people in the decision-making process Capital Budgeting LOS a Section 2 72 The optimal capital budget for a firm is best described as occurring when the company’s marginal cost of capital is: A equal to the investment opportunity schedule. B less than the investment opportunity schedule. C greater than the investment opportunity schedule. A is correct. The optimal capital budget occurs when the marginal cost of capital (MCC) intersects with (is equal to) the investment opportunity schedule (IOS). B is incorrect. The optimal capital budget occurs when the marginal cost of capital (MCC) intersects with (is equal to) the investment opportunity schedule (IOS). C is incorrect. The optimal capital budget occurs when the marginal cost of capital (MCC) intersects with (is equal to) the investment opportunity schedule (IOS). Cost of Capital LOS d Section 2.3 73 Financial risk is least likely affected by: A debentures. B dividends. C long-term leases. B is correct. By taking on fixed obligations, such as debt (including debentures) and long- term leases, a company increases its financial risk. Dividends will not increase financial risk. A is incorrect because the use of debentures (one type of bond) is directly associated with financial risk. C is incorrect because the use of long-term leases is directly related to financial risk. Measures of Leverage LOS a Section 3.4

44 2018 Level I Mock Exam (B) AM 74 Which of the following is the least appropriate method for an external analyst to use to estimate a company’s target capital structure for determining the weighted average cost of capital (WACC)? A Using the company’s current capital structure at book value weights B Using averages of comparable companies’ capital structure C Using statements made by the company’s management regarding capital structure policy A is correct. An external analyst does not know a company’s actual target capital structure. Consequently, the analyst should rely on market value (not book value) weights for the components of the company’s current capital structure. B is incorrect: This is an accepted method for an external analyst to estimate a com- pany’s target capital structure. C is incorrect: This is an accepted method for an external analyst to estimate a com- pany’s target capital structure. Cost of Capital LOS c Section 2.2 75 Which is most likely considered a secondary source of liquidity? A Centralized cash management system B Trade credit C Liquidating long-term assets C is correct. Liquidating long-term assets is a secondary source of liquidity. A is incorrect. Centralized cash management system is considered as a primary source of liquidity. B is incorrect. Trade credit (part of short-term funds) is considered as a primary source of liquidity. Working Capital Management LOS a Sections 2.1.1, 2.1.2 76 Under the stakeholder theory, corporate governance is most consistent with a system of: A internal controls and procedures by which individual companies are managed. B defined roles for management and the majority shareowner(s). C checks and balances to minimize the conflicting interests among shareowners. A is correct. Corporate governance is the system of internal controls and procedures by which individual companies are managed.

45 2018 Level I Mock Exam (B) AM B is incorrect. The majority shareholder doesn’t necessarily have a specific role that is defined through corporate governance. Instead, the majority shareholder exercises influence and/or control through voting mechanisms tied to their shareholdings. C is incorrect. Corporate governance is primarily aimed at managing the conflicting interests between management and external shareholders, not amongst shareholders. Corporate Governance and ESG: An Introduction LOS d Section 2 77 Two mutually exclusive projects have the following cash flows (€) and internal rates of return (IRR): Project IRR Year 0 Year 1 Year 2 Year 3 Year 4 A 27.97% –2,450 345 849 635 3,645 B 28.37% –2,450 345 849 1,051 3,175 Assuming a discount rate of 8% annually for both projects, the best decision for the firm to make is to accept: A both projects. B Project B only. C Project A only. C is correct. The NPV of project A is €1,780.59. 1 780 59 2 450 345 1 08 849 1 08 635 1 08 3 645 1 08 1 2 3 , . , . . . , . = - + ( ) + ( ) + ( ) + ( ) 4 The NPV of Project B is €1,765.36. 1 765 36 2 450 345 1 08 849 1 08 1 051 1 08 3175 1 1 2 3 , . , . . , . , . = - + ( ) + ( ) + ( ) + 08 4 ( ) Because Project A has a higher NPV and the projects are mutually exclusive, only Project A should be accepted. A is incorrect because both projects cannot be accepted when the projects are mutually exclusive. B is incorrect because Project A has a higher NPV. Capital Budgeting LOS c, d Sections 4.1, 4.2, 4.8 78 An investment strategy that focuses on climate change is most likely following which approach to environmental, social, and governance (ESG) investing? A Thematic B Best in class C Impact

46 2018 Level I Mock Exam (B) AM A is correct. A strategy that considers a single factor, such as climate change, is a thematic investment strategy. B is incorrect. Best-in-class ESG investing focuses on identifying the best ESG scoring companies in each industry. C is incorrect. Impact investing attempts to achieve targeted social or environmental objectives. Corporate Governance and ESG: An Introduction LOS k, j Section 9.3 79 An investment policy statement’s risk objective states that over a 12- month period, with a probability of 95%, the client’s portfolio must not lose more than 5% of its value. This statement is most likely a(n): A total risk objective. B relative risk objective. C absolute risk objective. C is correct. The statement is an absolute risk objective because it expresses a maximum loss in value with an associated probability of loss. A is incorrect because this is an absolute (not total) risk objective because it expresses a maximum loss in value with an associated probability of loss. B is incorrect because this is an absolute (not relative) risk objective because it expresses a maximum loss in value with an associated probability of loss. Basics of Portfolio Planning and Construction LOS c Section 2.2 80 The top level of a risk management system most likely is: A risk governance. B strategic analysis or integration. C defined policies or procedures. A is correct. Normally a role of the board of directors of a company, risk governance is where goals and responsibilities are defined and top-level decisions (such as determining the company’s risk tolerance) are made. B is incorrect because strategic analysis or integration occurs at the end of the process and leads to changes in investment decision-making and firm strategy going forward. C is incorrect because policies and procedures extend risk governance into the day to day operations of the company. Risk Management: An Introduction LOS b Section 2

47 2018 Level I Mock Exam (B) AM 81 An investor’s transactions in a mutual fund and the fund’s returns over a four- year period are provided in the following table: Year 1 2 3 4 New investment at the beginning of the year (US$) 2,500 1,500 1,000 0 Investment return for the year –20% 65% –25% 10% Withdrawal by investor at the end of the year (US$) 0 –500 –500 0 Based on this data, the money-weighted return (or internal rate of return) for the investor is closest to: A 2.15%. B 7.50%. C 3.96%. C is correct. Year 1 2 3 4 Starting balance (US$) 0.00 2,000.00 5,275.00 4,206.25 New investment at the beginning of the year (US$) 2,500.00 1,500.00 1,000.00 0.00 Net balance at the beginning of year (US$) 2,500.00 3,500.00 6,275.00 4,206.25 Investment return for the year –20% 65% –25% 10% Investment gain (loss) (US$) –500.00 2,275.00 –1,568.75 420.63 Withdrawal by investor at the end of the year (US$) 0.00 –500.00 –500.00 0.00 Balance at the end of year (US$) 2,000.00 5,275.00 4,206.25 4,626.88 The money-weighted return is calculated by solving for i in the following equation: 2 500 1 500 1 500 1 500 1 4 626 88 1 1 2 3 4 , , , . = - + ( ) + - + ( ) + + ( ) + + ( ) i i i i CF 0 = –2,500 CF 1 = –1,500 (new investment beginning of Year 2) CF 2 = –500 (withdrawal of 500, end of Year 2; –1,000 new investment beginning Year 3) CF 3 = –500 (withdrawal of 500, end of Year 3) CF 4 = 4,626.88 (balance at end of Year 4) i = 0.0396 A is incorrect. This is the geometric mean. 1 0 2 1 0 65 1 0 25 1 0 1 1 0 0215 1 4 - ( ) × + ( ) × - ( ) × + ( )     - = . . . . .

48 2018 Level I Mock Exam (B) AM B is incorrect. This is the arithmetic mean: (–0.2 + 0.65 – 0.25 + 0.10)/4 = 0.075. Portfolio Risk and Return: Part I LOS a Section 2.1.4 82 Risk that can be attributed to factor(s) that affect a company or industry is best described as: A non-systematic risk. B market risk. C systematic risk. A is correct. Risk that is attributable to company-specific or industry-specific factors is referred to as non-systematic risk. B is incorrect. Market risk is the same as systematic risk. It is due to factors that impact the whole market. C is incorrect. Systematic risk is the same as market risk. It is due to factors that impact the whole market. Portfolio Risk and Return: Part II LOS c Section 3.1 83 As one moves to the right along an investor’s efficient frontier, a set increase in risk is most likely to lead to: A sequentially smaller increases in expected return. B consistent increases in expected return. C sequentially larger increases in expected return. A is correct. The increase in return with every unit increase in risk keeps decreasing as one moves from left to right because the slope of the efficient frontier continues to decrease. Thus, investors obtain decreasing increases in returns as they assume more risk. B is incorrect. The slope of the efficient frontier continues to decrease, leading to smaller incremental returns, not consistent. C is incorrect. The slope of the efficient frontier continues to decrease, leading to smaller incremental returns, not larger. Portfolio Risk and Return: Part I LOS g Section 5.2 84 Information about a portfolio that consists of two assets is provided below: Asset Portfolio Weight Standard Deviation A 25% 12% B 75% 16%

49 2018 Level I Mock Exam (B) AM If the correlation coefficient between the two assets is 0.75, the standard devia- tion of the portfolio is closest to: A 15.00%. B 12.37%. C 14.39%. C is correct. [(0.25 2 × 0.12 2 ) + (0.75 2 × 0.16 2 ) + (2 × 0.25 × 0.75 × 0.12 × 0.16 × 0.75)] 0.5 = 0.1493 = 14.39% A is incorrect. It omits the correlation coefficient in calculating the standard deviation: [(0.25 2 × 0.12 2 ) + (0.75 2 × 0.16 2 ) + (2 × 0.25 × 0.75 × 0.12 × 0.16)] 0.5 = 0.15 = 15%, which is the weighted average standard deviation. B is incorrect. It omits the third term in the formula in calculating the standard devi- ation: [(0.25 2 ××0.12 2 ) + (0.75 2 × 0.16 2 )] 0.5 = 0.1237 = 12.37%. Portfolio Risk and Return: Part I LOS e Sections 4.1.2, 4.1.3 85 In general, which of the following institutions will most likely have a high need for liquidity and a short investment time horizon? A Banks B Defined-benefit pension plans C Endowments A is correct. Banks have a short-term horizon and high liquidity needs. B is incorrect. Defined-benefit pension plans have a long time horizon and low need for liquidity. C is incorrect. Endowments have a long time horizon and low need for liquidity. Portfolio Management: An Overview LOS b Section 3 86 If the expected return on the market portfolio is 6% and the risk-free rate is 2%, the expected return of a security with a beta of 1.25 is closest to: A 7.00%. B 5.00%. C 9.50%. A is correct. The capital asset pricing model posits that the expected return of a security is E ( R i ) = R f + β i [ E ( R m ) – R f ] where R f is the risk-free rate, R m is the return on the market portfolio, and β is the beta of the security: 2% + 1.25 × (6% – 2%) = 7.00%. B is incorrect because it fails to add the risk-free rate: 1.25 × (6% – 2%) = 5.00%.

50 2018 Level I Mock Exam (B) AM C is incorrect because it fails to subtract the risk-free rate from the market portfolio’s expected return: 2% + 1.25 × (6%) = 9.50%. Portfolio Risk and Return: Part II LOS g Section 3.2.6 87 If the following three stocks are held in a portfolio, the portfolio’s total return on an equal-weighted basis is closest to: Stock Number of Shares Owned Beginning of Period Price per Share ($) End of Period Price per Share ($) Dividend per Share during the Period ($) A 500 40 37 2.00 B 320 50 52 1.50 C 800 30 34 0.00 A 3.28%. B 5.94%. C 6.37%. B is correct. Equal weighting assigns an equal weight to each constituent security at inception. Therefore, it is the sum of the total return from each security divided by the number of securities in the portfolios. Stock ( P 1 – P 0 + D )/ P 0 Total Return (%) A (37 – 40 + 2.00)/40 = –2.5 B (52 – 50 + 1.50)/50 = 7.00 C (34 – 30 + 0)/30 = 13.33 Portfolio return with equal weighting: (–2.50 + 7.00 + 13.33)/3 = 5.94 A is incorrect. It is computed on a price return basis not total return. Stock Price Return (%) = ( P 1 – P 0 )/ P 0 A (37 – 40)/40 = –7.50 B (52 – 50)/50 = 4.00 C (34 – 30)/30 = 13.33 Portfolio return with equal weighting: (–7.50 + 4.00 + 13.33)/3 = 3.28% C is incorrect. It is the total return on the basis of beginning of period market- capitalization weights.

51 2018 Level I Mock Exam (B) AM Stock Total Return (%) = ( P 1 – P 0 + D )/ P 0 BOP Weights* Total Return (%) × BOP Weight A (37 – 40 + 2.00)/40 = –2.50 0.333 –0.83 B (52 – 50 + 1.50)/50 = 7.00 0.267 1.87 C (34 – 30 + 0)/30 = 13.33 0.400 5.33 Portfolio market-capitalization-weighted total return = 6.37 * BOP weights: Beginning Value of Portfolio: (A = 500 × $40) + (B = 320 × $50) + (C = 800 × $30) = $60,000; BOP weights: A = 20,000/60,000 = 0.333; B = 16,000/60,000 = 0.267; C = 24,000/60,000 = 0.400 Security Market Indexes LOS d, e Section 3.2.2 88 If the number of financial analysts who follow or analyze a company increases substantially, then the market for this company’s shares will most likely become: A more attractive for active investors. B overvalued. C more efficient. C is correct. The number of financial analysts who follow or analyze a security or asset should be positively related to market efficiency. Therefore, if more analysts cover a company, the market for this company’s shares will most likely become more efficient. A is incorrect. In a more efficient market, less profitable trading opportunities exist and as a consequence, it becomes less attractive for active investors. B is incorrect. In a more efficient market, prices should converge toward fair value. Market Efficiency LOS c Section 2.3 89 A corporate manager pursuing a low-cost strategy will most likely : A engage in offering products of unique quality or type. B have strong market research teams for product development and marketing. C invest in productivity-improving capital equipment. C is correct. A corporate manager pursuing a cost leadership strategy must be able to invest in productivity-improving capital equipment for achieving cost controls and being able to offer products and services at lower prices than the competition. A is incorrect. Offering products that are unique either in quality, type, or means of distribution is suitable for differentiation strategies.

52 2018 Level I Mock Exam (B) AM B is incorrect. Having strong market research teams for product development and marketing is suitable for differentiation strategies. Introduction to Industry and Company Analysis LOS k Section 6 90 For a US investor, which of the following statements concerning investing in depository receipts (DRs) is least accurate? A Investing in DRs could provide arbitrage opportunities and entail currency risk. B Investors in unsponsored DRs would have the same voting rights as the direct owners of common shares. C Sponsored DRs are subject to greater reporting requirements than unspon- sored DRs. B is correct. Investors of unsponsored DRs would not have the same voting rights as the direct owners of common shares because the depository bank retains the voting rights. A is incorrect because it is an accurate statement. The DRs trading on multiple exchanges could experience short-term valuation discrepancies, potentially giving rise to a quick arbitrage profit opportunity for astute traders to exploit. The price of each DR will be affected by factors that affect the price of the underlying shares and exchange rate movements. C is incorrect because it is an accurate statement. Sponsored DRs are subject to greater reporting requirements than unsponsored DRs. In the United States, sponsored DRs must be registered with the SEC. Overview of Equity Securities LOS a, b Section 5.2 91 Industry analysis is least useful to those who are engaged in: A a top-down investment approach. B indexing and passive investing strategies. C portfolio performance attribution. B is correct. Indexing and passive investing strategies would not engage in over- or underweighting of industries, industry rotation, or timing investments in industries. Therefore, industry analysis is not useful to such investors or portfolio managers. A is incorrect. In a top-down investing approach, industry analysis is useful to identify industries with positive, neutral, or negative outlooks for profitability and growth, which will then help weighting of industries relative to the benchmark.

53 2018 Level I Mock Exam (B) AM C is incorrect. Portfolio performance attribution, which addresses the sources of a portfolio’s returns, usually in relation to the portfolio’s benchmark, includes industry or sector selection. Introduction to Industry and Company Analysis LOS a Section 2 92 Which of the following statements about the forms of market efficiency is least accurate? If the form of market efficiency is: A weak, then investment strategies based on fundamental analysis could achieve abnormal returns. B semi-strong, then security prices fully reflect all past market data. C strong, then prices reflect only private information. C is correct. If markets are strong-form efficient, prices reflect not only private information but also past market data and public information. If markets are weak-form efficient, investment strategies based on fundamental analysis of public information and past market data could achieve abnormal returns. The semi-strong-form of market efficiency also encompasses the weak form. Therefore, security prices reflect not only publicly known and available information but also all past market data. A is incorrect. This statement is correct because if markets are weak-form efficient only, investment strategies based on fundamental analysis could achieve abnormal returns. B is incorrect. This statement is correct because the semi-strong-form of market efficiency also encompasses the weak-form; therefore, security prices reflect not only publicly known and available information but also all past market data. Market Efficiency LOS e, d Section 3 93 An investor borrows the maximum amount allowed by the initial margin requirement of 40% to purchase 100 shares of a stock selling at $60 per share. If the investor sells the stock when its price increases to $70 per share, her return before commissions and interest will be closest to: A 41.7%. B 27.8%. C 16.7%. A is correct. Investor’s return (%) = Market value of the stock Loan Investor's equity − − 1 = 70 100 60 100 0 6 60 100 0 4 1 × ( ) - × × ( ) × × ( ) - . .  = 41.67%

54 2018 Level I Mock Exam (B) AM B is incorrect It takes margin as 60%. = 70 100 60 100 0 4 60 100 0 6 1 × ( ) - × × ( ) × × ( ) - . .  = 27.78% C is incorrect It ignores the margin. = 100 70 60 100 60 × - ( ) ×  = 16.67% Market Organization and Structure LOS f Section 5 94 The following market information relates to a company: Market price per share $37.80 Number of shares outstanding 1,000,000 Net income $5,250,000 Total common equity $35,000,000 Total annual dividend paid $1,512,000 Risk-free rate 2.60% Market risk premium 8.00% Beta 1.05 Using the capital asset pricing model (CAPM), the company’s cost of equity is closest to: A 15.0%. B 12.4%. C 11.0%. C is correct. Using the CAPM: Cost of equity = Risk-free rate + (Beta × Market risk premium)  = 2.6 + (1.05 × 8) = 11% B is incorrect. It is the Dividend yield + (Beta × Market risk premium) Dividend per share = 1,512,000/1,000,000 = 1.512 Dividend yield = 1.512/37.8 = 4% Cost of equity (with the mistake) = 4% + (1.05 × 8) = 12.4% A is incorrect. It is the Return on equity = Net income/Common equity ROE = 5,250,000/35,000,000  = 15% Overview of Equity Securities LOS h Section 7.2

55 2018 Level I Mock Exam (B) AM Equity Valuation: Concepts and Basic Tools LOS g Section 4 95 Which of the following statements about peer groups is most accurate? A peer group is constructed through a process: A that starts with an existing commercially classified system that is then narrowed. B that locates a group of companies whose valuation is influenced by diverse factors. C where management should refrain from participating to maintain objectivity in the process. A is correct. The process consists of initially examining commercial classification systems and then refining it to the companies operating in the chosen industry. B is incorrect because the process includes looking for similar, not diverse, factors. C is incorrect because management should be part of the process. Introduction to Industry and Company Analysis LOS d Section 4.4 96 Assume the current dividend of a security is $9.50. The dividend is expected to grow by 12% each year for two years and then 3% afterwards. The required rate of return is 15%. The security’s value is closest to: A $95.58. B $120.51. C $94.99. A is correct. The value of the security is: D 0 = $9.50 D 1 = $9.50 × (1 + 0.12) = $10.64 D 2 = $9.50 × (1 + 0.12) 2 = $11.92 D 3 = $9.50 × (1 + 0.12) 2 × (1 + 0.03) = $12.27 V 2 = $ . . . 12 27 0 15 0 03 − V 0 = $ . . $ . . $ . . $ . 10 64 1 0 15 11 92 1 0 15 102 25 1 0 15 95 58 2 2 + ( ) + + ( ) + + ( ) ≅ B is incorrect; it takes the discounted values from V 0 but doesn’t discount D 3 . V 0 = $ . . $ . . $ . $ . 10 64 1 0 15 11 92 1 0 15 102 25 120 51 2 + ( ) + + ( ) + ≅ 9.25 + 9.01 + $102.25 = $120.51

56 2018 Level I Mock Exam (B) AM C is incorrect; it takes the security value and adds dividend 0 ( D 0 ): 85.49 + $9.50 = $94.99. Equity Valuation: Concepts and Basic Tools LOS g Section 4.3 97 Which of the following best describes an advantage of the EV/EBITDA multiple for valuing equity? An advantage is that: A the multiple must be positive. B it does not require the market value of debt. C EBITDA is a proxy for operating cash flow. C is correct. An advantage of EBITDA is that it is a proxy for operating cashflow because it excludes depreciation and amortization. A is incorrect. The multiple can be negative if EBITDA is negative. B is incorrect. The market value of debt is needed in valuing the equity since it should be deducted from the enterprise value and may be difficult to obtain. Equity Valuation: Concepts and Basic Tools LOS m Section 5.4 98 Which of the following transactions is most likely to affect a company’s financial leverage ratio? A Payment of a 9% stock dividend B An increase in cash dividends paid C Completion of a previously announced 1-for-20 reverse stock split B is correct. Cash dividends affect a company’s capital structure and financial leverage ratios by reducing assets and shareholders’ equity. A is incorrect. Neither stock splits nor stock dividends affect a firm’s financial leverage ratio. C is incorrect. Neither stock splits nor stock dividends affect a firm’s financial leverage ratio. Equity Valuation: Concepts and Basic Tools LOS a Section 4.1 99 Credit spreads are most likely to narrow during: A economic contractions. B a period of flight to quality. C economic expansions.

57 2018 Level I Mock Exam (B) AM C is correct. Credit spreads narrow during economic expansions and widen during economic contractions. During an economic expansion, corporate revenues and cash flows rise, making it easier for corporations to service their debt, and investors purchase corporates instead of Treasuries, causing spreads to narrow. A is incorrect. Credit spreads narrow during economic expansions and widen during economic contractions. B is incorrect. During a flight to quality investors sell corporate and buy treasuries thereby widening the credit spread on corporates. Fundamentals of Credit Analysis LOS h Section 6 100 Which of the following is least likely a short-term funding method available to banks? A Central bank funds B Negotiable certificate of deposits C Syndicated loans C is correct. A syndicated loan is a loan from a group of lenders, called the “syndicate,” to a single borrower. Syndicated loans are primarily originated by banks, and the loans are extended to companies but also to governments and government-related entities. A is incorrect because central bank funds are one of the short-term wholesale funds available to banks for short-term funding needs. B is incorrect because a negotiable CD allows any depositor (initial or subsequent) to sell the CD in the open market prior to the maturity date. CDs are an important source of funds for financial institutions. Fixed-Income Markets: Issuance, Trading, and Funding LOS h Section 7 101 In the securitization process, which of the following is most likely a third party to the transaction? The: A seller of the collateral. B special purpose entity. C financial guarantor. C is correct. In the securitization process, the seller of the collateral, the special purpose entity, and the servicer of the loan are the main parties. All other parties, including independent accountants, lawyers/attorneys, trustees, underwriters, rating agencies, and financial guarantors are third parties to the transaction. A is incorrect because in the securitization process the seller of the collateral is one of the main parties to the transaction.