We publish CFA® Level I practice problems on our social media pages. Here's where you can find the correct answers—and explanations.
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7/2/20
THE CORRECT ANSWER IS A.
Risk identification and measurement are at the core of risk management and its framework. Risk reduction is not.
6/25/20
THE CORRECT ANSWER IS A.
If a bond has a lower coupon rate, its price changes more with a change in YTM compared to a bond with a higher coupon rate.
6/23/20
THE CORRECT ANSWER IS C.
The deferred tax liability is calculated by multiplying the tax rate times the temporary difference between the carrying amount of the asset and the tax base:
Value for book purposes = 21,000 – (2 x (21,000 / 7) = 15,000
Value for tax purposes = 21,000 x .75 x .75 = 11,812.50
Temporary difference = 15,000 – 11,812.50 = 3,187.50
Deferred tax liability at 40% = 40% x 3,187.50 = 1,275
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6/18/20
THE CORRECT ANSWER IS B.
Type II error occurs when the null hypothesis is not rejected even though the null hypothesis is actually false.
6/16/20
THE CORRECT ANSWER IS B.
Initially, a firm is required to present a minimum of five years of annual investment performance that is compliant with the GIPS. After presenting 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.
6/11/20
THE CORRECT ANSWER IS A.
The unpredictable claims for P&C insurers make them allocate a substantial proportion of their investments into liquid, short-term assets. These investments are also of relatively low expected returns. Life insurance companies have more predictable cash outflow, so they have less liquidity needs.
6/9/20
THE CORRECT ANSWER IS C.
A portfolio left of the market portfolio on the CML can be formed by investing either some or the entire portion of money at the risk-free rate, and then by investing the remaining funds (if there are any) in the market portfolio.
6/4/20
THE CORRECT ANSWER IS A.
CF0 = –1,000, CF1 = –2,300, CF2 = 5,700, IRR = 50
6/2/20
THE CORRECT ANSWER IS C.
Under scrutiny from shareholders in the public market, management is pushed to establish better corporate governance procedures.
5/28/20
THE CORRECT ANSWER IS B.
The bond’s PVBP is calculated as [PV(–) – PV(+)]/2 = (101.2 – 98.9)/2 = 1.15.
5/26/20
THE CORRECT ANSWER IS C.
Futures are traded on exchanges and have standardized contracts and conditions, whereas in forward contracts, the terms can be customized by the participants.
5/21/20
THE CORRECT ANSWER IS C.
The value of a European call option increases if the risk-free rate increases, and it decreases if the risk-free rate decreases.
5/19/20
THE CORRECT ANSWER IS C.
The shakeout stage is characterized by slowing growth, intense competition, and declining profitability.
5/14/20
THE CORRECT ANSWER IS B.
The pricing of forwards and futures will differ if futures prices and interest rates are positively correlated. A positive correlation between futures prices and interest rates makes futures more desirable than forwards in the long position. Futures contract buyers will benefit more by holding the futures because they will gain more from the margin account interest they receive.
5/12/20
THE CORRECT ANSWER IS A.
Roll yield happens due to the difference between the spot and futures price, or due to the difference between the two futures if they have different expiration dates. If the market is in backwardation, the roll yield will be positive. Because the future price is less than the spot price during backwardation.
5/7/20
THE CORRECT ANSWER IS C.
When a company has started production commercially and is making sales, the venture capital investors provide later-stage funding. Choice (B) is incorrect. When venture capital is provided before any kind of production and only based on a business idea, it is called seed-stage financing. Choice (A) is incorrect. If the company has moved toward operations, but is prior to commercial production and sales, then the financing is early-stage.
5/5/20
THE CORRECT ANSWER IS A.
A short bias strategy tries to profit off of short positions on overvalued securities. Choice (B) is incorrect. The fundamental growth strategy attempts to identify growth securities. Choice (C) is incorrect. The quantitative directional strategy uses technical analysis to identify companies that are under- and/or overvalued and attempts to exploit historical trends.
4/30/20
THE CORRECT ANSWER IS A.
Cash Conversion Cycle is equal to: Days Inventory Outstanding + Days Sales Outstanding – Days of Payables, where Days of Payables = Accounts Payable/(Purchases/365) = 200/[(300+5000)/365] = 14 days. Hence the CCC = 24 + 10 – 14 = 20 days.
4/28/20
THE CORRECT ANSWER IS A.
The change to straight-line depreciation decreases the fixed costs, making DTL decrease (i.e., the numerator does not change, and the denominator increases).
DTL = Q(P – v)/(Q(P – v) – F – C), where Q = Number of units sold, P = Price per unit, V = Variable cost per unit, F = Fixed operating cost, and C = Fixed financing cost.
4/23/20
THE CORRECT ANSWER IS C.
NPV is a better measurement for mutually exclusive projects because the reinvestment assumption under the NPV method is more economically realistic. Choice (A) is incorrect because the main weakness of NPV is that it does not consider the size of the project. Choice (B) is incorrect; IRR assumes that all cash flows from the project will be reinvested at the computed IRR.
4/21/20
THE CORRECT ANSWER IS C.
The deviation from the target capital structure will lead to a change in the marginal cost of capital. Choice (A) is incorrect. The marginal cost of capital will increase if the debt issued is less, not more senior than before. As the company raises more debt, it will be more restricted to incur additional debt at the same seniority. Choice (B) is also incorrect. The amount of funds raised does not necessarily affect the marginal cost of capital. Only if the proportionate capital structure changes will the marginal cost of capital schedule changes accordingly.
4/16/20
THE CORRECT ANSWER IS C.
The deferred tax liability is calculated by multiplying the tax rate times the temporary difference between the carrying amount of the asset and the tax base:
Value for book purposes = 21,000 – (2 x (21,000 / 7)) = 15,000
Value for tax purposes = 21,000 x .75 x .75 = 11,812.50
Temporary difference = 15,000 – 11,812.50 = 3,187.50
Deferred tax liability at 40% = 40% x 3,187.50 = 1,275
4/14/20
THE CORRECT ANSWER IS A.
The company will capitalize all costs related to getting the machine ready for its intended use. Maintenance training and maintenance repair are therefore excluded in the calculation. Amount capitalized = $65,000 + $350 + $1,000 + $150 = $66,500
4/9/20
THE CORRECT ANSWER IS B.
Current ratio = current assets / current liabilities. With rising costs, inventory will be lower under LIFO compared to FIFO, leading to lower assets. With no impact on liabilities, this ratio will decrease. Choice (A) is incorrect; with rising costs, COGS will be higher under LIFO compared to FIFO, leading to lower equity. With no impact on debt, the ratio will increase. Choice (C) is also incorrect; total asset turnover = revenue / average total assets. With rising costs, inventory will be lower under LIFO compared to FIFO, leading to lower assets. Revenue is not affected, leaving a higher ratio.
4/7/20
THE CORRECT ANSWER IS C.
With a lower EBT/EBIT (higher interest burden), the company would have a higher interest payment cost. Sustainable growth rate = Retention ratio x ROE; higher interest payment cost would result in lower net income and ROE, so the sustainable growth would decline. Choice (A) is incorrect because with a lower dividend rate (based on the formula: the retention ratio = 1-dividend payout rate), the retention ratio would be higher, resulting in a higher sustainable growth rate. Choice (B) is incorrect because with the higher NI/EBT ratio (lower tax burden) (based on the formula: ROE = NI/EBT x EBT/EBIT x EBIT margin x Asset turnover x Leverage), the ROE would increase, resulting in higher sustainable growth.
4/2/20
THE CORRECT ANSWER IS C.
The forward premium = Forward rate – Spot rate = 5.2996 – 5.3028 = –0.0032, –0.0032 x 10,000 = –32 points. Because the forward rate is less than the spot rate for the base currency (CAD), the CAD is trading at a forward discount of 32 points.
3/31/20
THE CORRECT ANSWER IS B.
The benefits of international trade outweigh its costs, and those costs are borne by domestic producers in industries that compete with imports and lack a comparative advantage. Choice (A) is incorrect because a country is said to have an absolute advantage in the production of a good if it can produce the good at a lower resource cost than another country. Choice (C) is incorrect because there are potential gains from trade regardless of whether the country has the absolute advantage.
3/26/20
THE CORRECT ANSWER IS C.
If the central bank decides to increase the reserve requirement, it will decrease the money supply in the economy. As the money supply is decreased, the interest rate increases.
3/24/20
THE CORRECT ANSWER IS A.
During stagflation, prices increase, and the economy slows. Choice (B) is incorrect because stagflation is the result of a decline in the short-run aggregate supply. Choice (C) is incorrect because stagflation is the combination of declining economic output and higher prices, so unemployment should be higher.
3/19/20
THE CORRECT ANSWER IS B.
Initially, a firm is required to present a minimum of five years of annual investment performance that is compliant with the GIPS. After presenting 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.
3/17/20
THE CORRECT ANSWER IS A.
Yulia did not make any efforts to ensure that the information which she acted upon had been disseminated by the public. The information was likely nonpublic, and therefore she acted and is causing others to act on material nonpublic information. Choices B and C are incorrect. Yulia did not violate Standard III (B) Fair Dealing because all clients were given a fair opportunity to act on every recommendation.
3/12/20
THE CORRECT ANSWER IS C.
Bankruptcy filing caused by the financial crisis is not required to be filed, and thus Cheung did not violate the Standards.
3/10/20
THE CORRECT ANSWER IS A.
The investment may be suitable for Ava, given her desire for a stable investment. Choice (B) is incorrect. Smith would be in violation of Standard III(C)—Suitability by recommending Dave invest in a low-growth bond fund given his desired goal of higher growth. Choice (C) is incorrect. The bond fund is not suitable for Dave.
3/5/20
THE CORRECT ANSWER IS C.
The correct way of standardizing random variable X is to subtract the mean of X from X, and then divide that result by the square root of the variance of the standard normal distribution.
3/3/20
THE CORRECT ANSWER IS B.
rnp = n!/(n – r)! = 7!/(7-3)! = 210. The correct answer is therefore (B). Choice (A) is incorrect. It uses 7!/3! = 840. Choice (C) is also incorrect. It uses 7 x 3 = 21
2/27/20
THE CORRECT ANSWER IS B.
Both the clients and employers need to know any compensation or benefit received or paid for referrals. Choice (A) is incorrect. Client confidentiality would only have been violated if Gary gave Mark client information, not referred the client to his brother. Choice (C) is also incorrect. Standard VI (C) has still been violated because the clients are unaware of the referral fees.
2/25/20
THE CORRECT ANSWER IS B.
An increase in the degree of confidence (reliability factor) widens the width of the confidence interval. Choice (A) is incorrect because, with larger sample size, the confidence interval becomes narrower. Choice (C) is incorrect because an increase in the degree of freedom will shrink the confidence interval.
2/20/20
THE CORRECT ANSWER IS C.
The puttable bond has a lower yield than the option-free bond. Choice (A) is incorrect because a puttable bond has higher convexity. Choice (B) is also incorrect; a put option has value to the bondholder because the choice of whether or not to exercise the option is the bondholder’s. The puttable bond price would be lower.
2/18/20
THE CORRECT ANSWER IS A.
The gain = book value of debt – market value of debt = 105.08 – 95.23 = 9.842. The book value after the upcoming coupon payment can be found using a financial calculator and the market rate at the time of issuance of 5%: FV = 100; i = 5%; PMT = 6; N = 6. Compute PV = 105.08. The market value at retirement can be found using a financial calculator and the current market rate of 7%: FV = 100; i = 7%; PMT = 6; N = 6; Compute PV = 95.23. Choice (B) is incorrect. It incorrectly uses 7 years remaining to maturity to find the current market value, when the bonds actually have 6 years remaining. Choice (C) is incorrect. It incorrectly takes the face value less the current market value = 100 – 95.23 = 4.77.
2/13/20
THE CORRECT ANSWER IS B.
Cash dividends paid can be reported as a cash outflow in the cash flow from financing or cash flow from operating activities under IFRS, not only cash flow from financing activities. Choice (A) is incorrect because cash dividends paid are reported as a cash outflow in the cash flow from financing activities under US GAAP. Under US GAAP there is no choice; it must be reported as cash flow from financing activities. Choice (C) is incorrect because cash dividends paid are reported as a cash outflow in the cash flow from financing or cash flow from operating activities under IFRS.
2/11/20
THE CORRECT ANSWER IS A.
Green knowingly engaged in conduct that would induce a company insider to disclose material nonpublic information by asking Canon if her research is gaining any traction. This is a violation of Standard II (A) Material Nonpublic Information.
2/6/20
THE CORRECT ANSWER IS A.
The supervisory and management boards are independent of each other in two-tier structures. (B) is incorrect; in two-tier structures that prohibit members of the management board from serving on the supervisory board, CEO duality is not applicable. (C) is incorrect; one-tier structures comprise a mix of the executive (internal) and non-executive (external) directors.
2/4/20
THE CORRECT ANSWER IS C.
The treatment for available for sale and held for trading is the same under IFRS and US GAAP.
1/30/20
THE CORRECT ANSWER IS C.
An oligopolistic market is characterized by a few large firms in the market that base their pricing decisions on the actions or possible actions of the other large firms. (A) is incorrect because, in monopolistic firms, there are many firms; however, unlike with perfect competition, sellers have some pricing power. The goods produced by these firms are good substitutes for one another, but they are still different enough that advertising or other non–price-related strategies have some effect.
1/28/20
THE CORRECT ANSWER IS B.
(B) is correct because leptokurtic is a distribution that is more peaked than a normal distribution and has fatter tails. (A) is incorrect because mesokurtic has the same kurtosis as the normal distribution. (C) is incorrect because platykurtic is less peaked and flatter than a normal distribution.
1/23/20
THE CORRECT ANSWER IS A.
If a bond has a lower coupon rate, its price changes more with a change in YTM compared to a bond with a higher coupon rate. B is incorrect; the price of a bond with a lower coupon rate is more sensitive to a change in YTM, not less sensitive. C is incorrect; a bond’s price with a longer maturity is more sensitive to a change in YTM compared to a bond with shorter maturity.
1/21/20
THE CORRECT ANSWER IS C.
Situational influences are external factors that can shape up an individual’s behavior and decision making. A is incorrect; overconfidence bias is one's overestimation of ability—if one thinks that one is always ethically and morally upright, one can make unintentionally faulty decisions. B is incorrect; money and prestige are common situational influences that can have an impact on ethical behavior and decision making.
