Schweser Printable Answers - QM 1

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1 Page 1 of 46 Schweser Printable Answers - QM 1 Test ID#: 19 Back to Test Review Hide Questions Print this Page Question 1 - #93586 Given the following table about employees of a company based on whether they are smokers or nonsmokers and whether or not they suffer from any allergies, what is the probability of being either a nonsmoker or not suffering from allergies? Suffer from Allergies Don't Suffer from Allergies Total Smoker Nonsmoker Total A) B) C) The probability of being a nonsmoker is 240 / 300 = The probability of not suffering from allergies is 210 / 300 = The probability of being a nonsmoker and not suffering from allergies is 185 / 300 = Since the question asks for the probability of being either a nonsmoker or not suffering from allergies we have to take the probability of being a nonsmoker plus the probability of not suffering from allergies and subtract the probability of being both: = Alternatively: 1 P(Smoker & Allergies) = 1 (35 / 300) = 88.3%. This question tested from Session 2, Reading 8, LOS f, (Part 2). Question 2 - #93768 There is a 60% chance that the economy will be good next year and a 40% chance that it will be bad. If the economy is good, there is a 70% chance that XYZ Incorporated will have EPS of $5.00 and a 30% chance that their earnings will be $3.50. If the economy is bad, there is an 80% chance that XYZ Incorporated will have EPS of $1.50 and a 20% chance that their earnings will be $1.00. What is the firm s expected EPS? A) $5.95. B) $3.29. C) $2.75. Your answer: A was incorrect. The correct answer was B) $3.29. The expected EPS is calculated by multiplying the probability of the economic environment by the probability of the particular EPS and the EPS in each case. The expected EPS in all four outcomes are then summed to arrive at the expected EPS: ( $5.00) + ( $3.50) + ( $1.50) + ( $1.00) = $ $ $ $0.08 = $3.29.

2 Page 2 of 46 This question tested from Session 2, Reading 8, LOS j. Question 3 - #93811 A company has two machines that produce widgets. An older machine produces 16% defective widgets, while the new machine produces only 8% defective widgets. In addition, the new machine employs a superior production process such that it produces three times as many widgets as the older machine does. Given that a widget was produced by the new machine, what is the probability it is NOT defective? A) B) C) The problem is just asking for the conditional probability of a defective widget given that it was produced by the new machine. Since the widget was produced by the new machine and not selected from the output randomly (if randomly selected, you would not know which machine produced the widget), we know there is an 8% chance it is defective. Hence, the probability it is not defective is the complement, 1 8% = 92%. This question tested from Session 2, Reading 8, LOS c. Question 4 - #93667 Why is the time-weighted rate of return the preferred method of performance measurement? Time weighted allows for inter-period measurement and therefore is more flexible in determining A) exactly how a portfolio performed during a specific interval of time. B) There is no preference for time-weighted versus money-weighted. C) Time-weighted returns are not influenced by the timing of cash flows. Your answer: A was incorrect. The correct answer was C) Time-weighted returns are not influenced by the timing of cash flows. Money-weighted returns are sensitive to the timing or recognition of cash flows while time-weighted rates of return are not. This question tested from Session 2, Reading 6, LOS c, (Part 1). Question 5 - #93571 The effective annual yield for an investment is 10%. What is the yield for this investment on a bond-equivalent basis? A) 4.88%. B) 10.00%. C) 9.76%. Your answer: A was incorrect. The correct answer was C) 9.76%.

3 Page 3 of 46 First, the annual yield must be converted to a semiannual yield. The result is then doubled to obtain the bondequivalent yield. Semiannual yield = = The bond-equivalent yield = = This question tested from Session 2, Reading 6, LOS e. Question 6 - #93625 An investor makes the following investments: She purchases a share of stock for $ After one year, she purchases an additional share for $ After one more year, she sells both shares for $ each. There are no transaction costs or taxes. During year one, the stock paid a $5.00 per share dividend. In year 2, the stock paid a $7.50 per share dividend. The investor s required return is 35%. Her money-weighted return is closest to: A) 48.9%. B) -7.5%. C) 16.1%. To determine the money weighted rate of return, use your calculator's cash flow and IRR functions. The cash flows are as follows: CF0: initial cash outflow for purchase = $50 CF1: dividend inflow of $5 - cash outflow for additional purchase of $75 = net cash outflow of -$70 CF2: dividend inflow (2 $7.50 = $15) + cash inflow from sale (2 $100 = $200) = net cash inflow of $215 Enter the cash flows and compute IRR: CF0 = -50; CF1 = -70; CF2 = +215; CPT IRR = This question tested from Session 2, Reading 6, LOS c, (Part 2). Question 7 - #93997 Jamie Morgan needs to accumulate $2,000 in 18 months. If she can earn 6% at the bank, compounded quarterly, how much must she deposit today? A) $1, B) $1, C) $1, Each quarter of a year is comprised of 3 months thus N = 18 / 3 = 6; I/Y = 6 / 4 = 1.5; PMT = 0; FV = 2,000; CPT PV = $1,

4 Page 4 of 46 This question tested from Session 2, Reading 5, LOS d. Question 8 - #94000 If a $45,000 car loan is financed at 12% over 4 years, what is the monthly car payment? A) $985. B) $1,565. C) $1,185. Your answer: A was incorrect. The correct answer was C) $1,185. N = 4 12 = 48; I/Y = 12/12 = 1; PV = 45,000; FV = 0; CPT PMT = 1, This question tested from Session 2, Reading 5, LOS d. Question 9 - #93702 The covariance of the returns on investments X and Y is The standard deviation of returns on X is 7%, and the standard deviation of returns on Y is 4%. What is the value of the correlation coefficient for returns on investments X and Y? A) B) C) Your answer: A was incorrect. The correct answer was B) The correlation coefficient = Cov (X,Y) / [(Std Dev. X)(Std. Dev. Y)] = / 28 = 0.65 This question tested from Session 2, Reading 8, LOS k. Question 10 - #93828 In 10 years, what is the value of $100 invested today at an interest rate of 8% per year, compounded monthly? A) $222. B) $216. C) $180. N = = 120; I/Y = 8/12 = ; PV = 100; PMT = 0; CPT FV = This question tested from Session 2, Reading 5, LOS d. Question 11 - #93629 Use the following probability distribution to calculate the standard deviation for the portfolio.

5 Page 5 of 46 State of the Economy Probability Return on Portfolio Boom % Bust % A) 5.5%. B) 6.0%. C) 6.5%. [0.30 ( ) ( ) 2 ] 1/2 = 5.5%. This question tested from Session 2, Reading 8, LOS l. Question 12 - #93591 A Treasury bill (T-bill) with a face value of $10,000 and 44 days until maturity has a holding period yield of %. Which of the following is closest to the effective annual yield on the T-bill? A) 12.47%. B) 9.72%. C) 8.76%. Your answer: A was incorrect. The correct answer was B) 9.72%. The formula for the effective annual yield is: ((1 + HPY) 365/t ) 1. Therefore, the EAY is: (( ) (365/44) ) 1 = , or 9.72% This question tested from Session 2, Reading 6, LOS d. Question 13 - #93795 The value in 7 years of $500 invested today at an interest rate of 6% compounded monthly is closest to: A) $780. B) $760. C) $750. Your answer: A was incorrect. The correct answer was B) $760. PV = -500; N = 7 12 = 84; I/Y = 6/12 = 0.5; compute FV = This question tested from Session 2, Reading 5, LOS e, (Part 1). Question 14 - #93729 A stock had the following returns over the last five years: 15%, 2%, 9%, 44%, 23%. What is the respective geometric mean and arithmetic mean for this stock?

6 Page 6 of 46 A) 17.76%; 18.6%. B) 17.76%; 23.0%. C) 0.18%; 18.6%. Geometric mean = [(1.15)(1.02)(1.09)(1.44)(1.23)] 1/5 1 = = 17.76%. Arithmetic mean = ( ) / 5 = 18.6%. This question tested from Session 2, Reading 7, LOS e. Question 15 - #94138 In order to calculate the net present value (NPV) of a project, an analyst would least likely need to know the: A) internal rate of return (IRR) of the project. B) timing of the expected cash flows from the project. C) opportunity cost of capital for the project. The NPV is calculated using the opportunity cost, discount rate, expected cash flows, and timing of the expected cash flows from the project. The project s IRR is not used to calculate the NPV. This question tested from Session 2, Reading 6, LOS a, (Part 1). Question 16 - #94283 The owner of a company has recently decided to raise the salary of one employee, who was already making the highest salary in the company, by 40%. Which of the following value(s) is (are) expected to be affected by this raise? A) mean and median only. B) median only. C) mean only. Your answer: A was incorrect. The correct answer was C) mean only. Mean is affected because it is the sum of all values / number of observations. Median is not affected as it the midpoint between the top half of values and the bottom half of values. This question tested from Session 2, Reading 7, LOS e. Question 17 - #93564 Which of the following is most accurate with respect to the relationship of the money-weighted return to the timeweighted return? If funds are contributed to a portfolio just prior to a period of favorable performance, the: A) time-weighted rate of return will tend to be elevated.

7 Page 7 of 46 B) money-weighted rate of return will tend to be depressed. C) money-weighted rate of return will tend to be elevated. Your answer: A was incorrect. The correct answer was C) money-weighted rate of return will tend to be elevated. The time-weighted returns are what they are and will not be affected by cash inflows or outflows. The moneyweighted return is susceptible to distortions resulting from cash inflows and outflows. The money-weighted return will be biased upward if the funds are invested just prior to a period of favorable performance and will be biased downward if funds are invested just prior to a period of relatively unfavorable performance. The opposite will be true for cash outflows. This question tested from Session 2, Reading 6, LOS c, (Part 1). Question 18 - #93687 Which of the following statements about the defining properties of probability is most accurate? A) If the device that generates an event is not fair, the events can be mutually exclusive and exhaustive. B) The probability of any event is between 0 and 1, exclusive. C) The sum of the probabilities of events E 1 though E x equals one if the events are mutually exclusive or exhaustive. Even if the device that generates an event is not fair, the events can be mutually exclusive and exhaustive. Consider a standard die with the possible outcomes of 1,2,3,4,5 and 6. The P(2 or 4 or 6) = 0.50 and P(1 or 3 or 5) = 0.50, and thus the probabilities sum to 1 and are mutually exclusive and exhaustive. An unfair die would not change this. Both remaining statements are false. The probability of any event is between 0 and 1, inclusive. It is possible that the probability of an event could equal 0 or 1, or any point in between. The sum of the probabilities of events E 1 though E x equals 1 if the events are mutually exclusive and exhaustive. This question tested from Session 2, Reading 8, LOS b. Question 19 - #93808 A distribution of returns that has a greater percentage of small deviations from the mean and a greater percentage of large deviations from the mean compared to a normal distribution: A) has positive excess kurtosis. B) is positively skewed. C) has negative excess kurtosis. A distribution that has a greater percentage of small deviations from the mean and a greater percentage of large deviations from the mean will be leptokurtic and will exhibit positive excess kurtosis. The distribution will be taller (more peaked) with fatter tails than a normal distribution. This question tested from Session 2, Reading 7, LOS k.

8 Page 8 of 46 Question 20 - #93979 Steve Hall wants to give his son a new car for his graduation. If the cost of the car is $15,000 and Hall finances 80% of the value of the car for 36 months at 8% annual interest, his monthly payments will be: A) $413. B) $376. C) $289. Your answer: A was incorrect. The correct answer was B) $376. PV = ,000 = -12,000; N = 36; I = 8/12 = 0.667; CPT PMT = 376. This question tested from Session 2, Reading 5, LOS f. Question 21 - #94640 When Annette Famigletti hears that a baseball-loving friend is coming to visit, she purchases two premiumseating tickets for $45 per ticket for an evening game. As the date of the game approaches, Famigletti s friend telephones and says that his trip has been cancelled. Fortunately for Famigletti, the tickets she holds are in high demand as there is chance that the leading Major League Baseball hitter will break the home run record during the game. Seeing an opportunity to earn a high return, Famigletti puts the tickets up for sale on an internet site. The auction closes at $150 per ticket. After paying a 10% commission to the site (on the amount of the sale) and paying $8 total in shipping costs, Familgletti s holding period return is approximately: A) 191%. B) 182%. C) 202%. The holding period return is calculated as: (ending price beginning price +/- any cash flows) / beginning price. Here, the beginning and ending prices are given. The other cash flows consist of the commission of $30 ( tickets) and the shipping cost of $8 (total for both tickets). Thus, her holding period return is: ( ) / (2 45) = 1.91, or approximately 191%. This question tested from Session 2, Reading 6, LOS b. Question 22 - #93817 Which of the following statements about skewness and kurtosis is least accurate? A) Kurtosis is measured using deviations raised to the fourth power. B) Positive values of kurtosis indicate a distribution that has fat tails. C) Values of relative skewness in excess of 0.5 in absolute value indicate large levels of skewness. Your answer: A was incorrect. The correct answer was B) Positive values of kurtosis indicate a distribution that has fat tails. Positive values of kurtosis do not indicate a distribution that has fat tails. Positive values of excess kurtosis (kurtosis > 3) indicate fat tails.

9 Page 9 of 46 This question tested from Session 2, Reading 7, LOS k. Question 23 - #94412 Which of the following statements about statistical concepts is least accurate? A) A sample contains all members of a specified group, but a population contains only a subset. A frequency distribution is a tabular display of data summarized into a relatively small number of B) intervals. C) A parameter is any descriptive measure of a population characteristic. A population is defined as all members of a specified group, but a sample is a subset of a population. This question tested from Session 2, Reading 7, LOS a, (Part 1). Question 24 - #95492 What is the coefficient of variation for a distribution with a mean of 10 and a variance of 4? A) 20%. B) 40%. C) 25%. Coefficient of variation, CV = standard deviation / mean. The standard deviation is the square root of the variance, or 4 ½ = 2. So, CV = 2 / 10 = 20%. This question tested from Session 2, Reading 7, LOS i, (Part 1). Question 25 - #94836 Given the following annual returns, what are the median and mode returns, respectively? % 2% 5% -7% 0% A) 2.00%; no mode exists. B) 2.00%; 3.00%. C) no median exists; no mode exists. Median: Arrange the return values from largest to smallest and take the middle value: (7%), 0%, 2%, 5%, 15%. The middle value is 2.00%. Mode: The mode is defined as the value that most often shows up in a distribution. Because no return value shows up more than once, this distribution has no mode. This question tested from Session 2, Reading 7, LOS e.

10 Page 10 of 46 Question 26 - #93769 In a positively skewed distribution, what is the order (from lowest value to highest) for the distribution s mode, mean, and median values? A) Mode, median, mean. B) Mean, median, mode. C) Mode, mean, median. In a positively skewed distribution, the mode is less than the median, which is less than the mean. This question tested from Session 2, Reading 7, LOS j, (Part 2). Question 27 - #93796 Which one of the following statements best describes the components of the required interest rate on a security? The nominal risk-free rate, the expected inflation rate, the default risk premium, a liquidity premium and A) a premium to reflect the risk associated with the maturity of the security. The real risk-free rate, the expected inflation rate, the default risk premium, a liquidity premium and a B) premium to reflect the risk associated with the maturity of the security. The real risk-free rate, the default risk premium, a liquidity premium and a premium to reflect the risk C) associated with the maturity of the security. Your answer: A was incorrect. The correct answer was B) The real risk-free rate, the expected inflation rate, the default risk premium, a liquidity premium and a premium to reflect the risk associated with the maturity of the security. The required interest rate on a security is made up of the nominal rate which is in turn made up of the real riskfree rate plus the expected inflation rate. It should also contain a liquidity premium as well as a premium related to the maturity of the security. This question tested from Session 2, Reading 5, LOS b. Question 28 - #93978 An investor has the choice of two investments. Investment A offers interest at 7.25% compounded quarterly. Investment B offers interest at the annual rate of 7.40%. Which investment offers the higher dollar return on an investment of $50,000 for two years, and by how much? A) Investment B offers a $36.92 greater return. B) Investment A offers a $53.18 greater return. C) Investment A offers a $ greater return. Your answer: A was incorrect. The correct answer was B) Investment A offers a $53.18 greater return. Investment A: I = 7.25 / 4; N = 2 4 = 8; PV = $50,000; PMT = 0; CPT FV = $57, Investment B: I = 7.40; N = 2; PV = $50,000; PMT = 0; CPT FV = $57, Difference = investment A offers a $53.18 greater dollar return.

11 Page 11 of 46 This question tested from Session 2, Reading 5, LOS f. Question 29 - #93546 If the money market yield is 3.792% on a T-bill with 79 days to maturity, what is the holding period yield? A) 0.77%. B) 0.89%. C) 0.83%. Your answer: A was incorrect. The correct answer was C) 0.83%. The holding period yield can be calculated from the money market yield as: (money market yield) (360 t). Therefore, the HPY is ( ) (79 360) = = 0.83%. This question tested from Session 2, Reading 6, LOS e. Question 30 - #93742 A distribution with a mean that is less than its median most likely: A) is positively skewed. B) is negatively skewed. C) has negative excess kurtosis. Your answer: A was incorrect. The correct answer was B) is negatively skewed. A distribution with a mean that is less than its median is a negatively skewed distribution. A negatively skewed distribution is characterized by many small gains and a few extreme losses. Note that kurtosis is a measure of the peakedness of a return distribution. This question tested from Session 2, Reading 7, LOS j, (Part 2). Question 31 - #93676 Compute the standard deviation of a two-stock portfolio if stock A (40% weight) has a variance of , stock B (60% weight) has a variance of , and the correlation coefficient for the two stocks is 0.35? A) 1.39%. B) 0.07%. C) 2.64%. Your answer: A was incorrect. The correct answer was C) 2.64%. The standard deviation of the portfolio is found by: [W 2 1 σ W 2 2 σ W 1 W 2 σ 1 σ 2 ρ 1,2 ] 0.5 = [(0.40) 2 (0.0015) + (0.60) 2 (0.0021) + (2)(0.40)(0.60)(0.0387)(0.0458)( 0.35)] 0.5

12 Page 12 of 46 = , or 2.64%. This question tested from Session 2, Reading 8, LOS l. Question 32 - #96287 Which of the following statements about the arithmetic mean is least accurate? The arithmetic mean of a frequency distribution is equal to the sum of the class frequency times the A) midpoint of the frequency class all divided by the number of observations. The arithmetic mean is the only measure of central tendency where the sum of the deviations of each B) observation from the mean is always zero. C) If the distribution is skewed to the left then the mean will be greater than the median. Your answer: A was incorrect. The correct answer was C) If the distribution is skewed to the left then the mean will be greater than the median. If the distribution is skewed to the left, then the mean will be less than the median. This question tested from Session 2, Reading 7, LOS e. Question 33 - #96009 The weights and returns for individual positions in a portfolio are shown below: Position Mkt. Value at 1/1/05($MM) Return for 2005(%) A B C D E What is the return on the portfolio? A) +1.50%. B) -1.20%. C) +1.18%. Your answer: A was incorrect. The correct answer was C) +1.18%. The return is equal to sum of the products of each position s value and return divided by the beginning portfolio value. Position Mkt. Value at Return for 2005(%) Position Value Return ($MM) 1/1/05($MM) A B C D E

13 Page 13 of 46 Total / 10.5($MM) = % This question tested from Session 2, Reading 7, LOS g. Question 34 - #95832 What is the effective annual yield of a T-bill that has a money market yield of 5.665% and 255 days to maturity? A) 5.79%. B) 5.92%. C) 4.01%. Holding Period Yield = % = 5.665% (255 / 360) Effective Annual Yield = ( ) 365/255 = = 5.79%. This question tested from Session 2, Reading 6, LOS e. Question 35 - #94521 Use the results from the following survey of 500 firms to answer the question. Number of Employees Frequency 300 up to up to up to up to up to up to The width of each interval (class) for this frequency table is: A) 101. B) 100. C) 50. Your answer: A was incorrect. The correct answer was B) 100. Max of interval Min of interval = 100 This question tested from Session 2, Reading 7, LOS b. Question 36 - #93562 Which of the following statements is least accurate regarding covariance?

14 Page 14 of 46 A) Covariance can only apply to two variables at a time. B) A covariance of zero rules out any relationship. C) Covariance can exceed one. Your answer: A was incorrect. The correct answer was B) A covariance of zero rules out any relationship. A covariance only measures the linear relationship. The covariance can be zero while a non-linear relationship exists. Both remaining statements are true. This question tested from Session 2, Reading 8, LOS k. Question 37 - #93777 What is the maximum an investor should be willing to pay for an annuity that will pay out $10,000 at the beginning of each of the next 10 years, given the investor wants to earn 12.5%, compounded annually? A) $52,285. B) $55,364. C) $62,285. Your answer: A was incorrect. The correct answer was C) $62,285. Using END mode, the PV of this annuity due is $10,000 plus the present value of a 9-year ordinary annuity: N=9; I/Y=12.5; PMT=-10,000; FV=0; CPT PV=$52,285; $52,285 + $10,000 = $62,285. Or set your calculator to BGN mode then N=10; I/Y=12.5; PMT=-10,000; FV=0; CPT PV= $62,285. This question tested from Session 2, Reading 5, LOS e, (Part 2). Question 38 - #93360 An annuity will pay eight annual payments of $100, with the first payment to be received three years from now. If the interest rate is 12% per year, what is the present value of this annuity? The present value of: a lump sum discounted for 3 years, where the lump sum is the present value of an ordinary annuity of A) 8 periods at 12%. a lump sum discounted for 2 years, where the lump sum is the present value of an ordinary annuity of B) 8 periods at 12%. C) an ordinary annuity of 8 periods at 12%. Your answer: A was incorrect. The correct answer was B) a lump sum discounted for 2 years, where the lump sum is the present value of an ordinary annuity of 8 periods at 12%. The PV of an ordinary annuity (calculation END mode) gives the value of the payments one period before the first payment, which is a time = 2 value here. To get a time = 0 value, this value must be discounted for two periods (years). This question tested from Session 2, Reading 5, LOS e, (Part 2).

15 Page 15 of 46 Question 39 - #93639 The following table summarizes the availability of trucks with air bags and bucket seats at a dealership. Bucket seats No Bucket Seats Total Air Bags No Air Bags Total What is the probability of randomly selecting a truck with air bags and bucket seats? A) B) C) Your answer: A was incorrect. The correct answer was C) = This question tested from Session 2, Reading 8, LOS f, (Part 1). Question 40 - #93801 Consider the following set of stock returns: 12%, 23%, 27%, 10%, 7%, 20%,15%. The third quartile is: A) 21.5%. B) 20.0%. C) 23%. Your answer: A was incorrect. The correct answer was C) 23%. The third quartile is calculated as: L y = (7 + 1) (75/100) = 6. When we order the observations in ascending order: 7%, 10%, 12%, 15%, 20%, 23%, 27%, 23% is the sixth observation from the left. This question tested from Session 2, Reading 7, LOS f. Question 41 - #93684 The following information is available concerning expected return and standard deviation of Pluto and Neptune Corporations: Expected Return Standard Deviation Pluto Corporation 11% 0.22 Neptune Corporation 9% 0.13 If the correlation between Pluto and Neptune is 0.25, determine the expected return and standard deviation of a portfolio that consists of 65% Pluto Corporation stock and 35% Neptune Corporation stock. A) 10.3% expected return and 2.58% standard deviation.

16 Page 16 of 46 B) 10.3% expected return and 16.05% standard deviation. C) 10.0% expected return and 16.05% standard deviation. Your answer: A was incorrect. The correct answer was B) 10.3% expected return and 16.05% standard deviation. ER Port = (W Pluto )(ER Pluto ) + (W Neptune )(ER Neptune ) = (0.65)(0.11) + (0.35)(0.09) = 10.3% σ p = [(w 1 ) 2 (σ 1 ) 2 + (w 2 ) 2 (σ 2 ) 2 + 2w 1 w 2 σ 1 σ 2 r 1,2 ] 1/2 = [(0.65) 2 (22) 2 + (0.35) 2 (13) 2 + 2(0.65)(0.35)(22)(13)(0.25)] 1/2 = [(0.4225)(484) + (0.1225)(169) + 2(0.65)(0.35)(22)(13)(0.25)] 1/2 = ( ) 1/2 = % This question tested from Session 2, Reading 8, LOS l. Question 42 - #93832 The real risk-free rate can be thought of as: A) exactly the nominal risk-free rate reduced by the expected inflation rate. B) approximately the nominal risk-free rate reduced by the expected inflation rate. C) approximately the nominal risk-free rate plus the expected inflation rate. Your answer: A was incorrect. The correct answer was B) approximately the nominal risk-free rate reduced by the expected inflation rate. The approximate relationship between nominal rates, real rates and expected inflation rates can be written as: Nominal risk-free rate = real risk-free rate + expected inflation rate. Therefore we can rewrite this equation in terms of the real risk-free rate as: Real risk-free rate = Nominal risk-free rate expected inflation rate The exact relation is: (1 + real)(1 + expected inflation) = (1 + nominal) This question tested from Session 2, Reading 5, LOS b. Question 43 - #93726 A company says that whether it increases its dividends depends on whether its earnings increase. From this we know: A) P(both dividend increase and earnings increase) = P(dividend increase). B) P(dividend increase earnings increase) is not equal to P(earnings increase). C) P(earnings increase dividend increase) is not equal to P(earnings increase). Your answer: A was incorrect. The correct answer was C) P(earnings increase dividend increase) is not equal to P(earnings increase).

17 Page 17 of 46 If two events A and B are dependent, then the conditional probabilities of P(A B) and P(B A) will not equal their respective unconditional probabilities (of P(A) and P(B), respectively). Both remaining choices may or may not occur, e.g., P(A B) = P(B) is possible but not necessary. This question tested from Session 2, Reading 8, LOS g. Question 44 - #94064 Given investors require an annual return of 12.5%, a perpetual bond (i.e., a bond with no maturity/due date) that pays $87.50 a year in interest should be valued at: A) $70. B) $700. C) $1,093. Your answer: A was incorrect. The correct answer was B) $ = $700. This question tested from Session 2, Reading 5, LOS e, (Part 3). Question 45 - #93550 Bill Jones is creating a charitable trust to provide six annual payments of $20,000 each, beginning next year. How much must Jones set aside now at 10% interest compounded annually to meet the required disbursements? A) $154, B) $95, C) $87, Your answer: A was incorrect. The correct answer was C) $87, N = 6, PMT = -$20,000, I/Y = 10%, FV = 0, Compute PV $87, This question tested from Session 2, Reading 5, LOS e, (Part 2). Question 46 - #93824 If the odds against an event occurring are twelve to one, what is the probability that it will occur? A) B) C) Your answer: A was incorrect. The correct answer was C) If the probability against the event occurring is twelve to one, this means that in thirteen occurrences of the event, it is expected that it will occur once and not occur twelve times. The probability that the event will occur is then: 1/13 =

18 Page 18 of 46 This question tested from Session 2, Reading 8, LOS c. Question 47 - #93621 Assume an investor makes the following investments: Today, she purchases a share of stock in Redwood Alternatives for $ After one year, she purchases an additional share for $ After one more year, she sells both shares for $ each. There are no transaction costs or taxes. The investor s required return is 35.0%. During year one, the stock paid a $5.00 per share dividend. In year two, the stock paid a $7.50 per share dividend. The time-weighted return is: A) 23.2%. B) 51.7%. C) 51.4%. Your answer: A was incorrect. The correct answer was C) 51.4%. To calculate the time-weighted return: Step 1: Separate the time periods into holding periods and calculate the return over that period: Holding period 1: P 0 = $50.00 D 1 = $5.00 P 1 = $75.00 (from information on second stock purchase) HPR 1 = ( ) / 50 = 0.60, or 60% Holding period 2: P 1 = $75.00 D 2 = $7.50 P 2 = $ HPR 2 = ( ) / 75 = 0.433, or 43.3%. Step 2: Use the geometric mean to calculate the return over both periods Return = [(1 + HPR 1 ) (1 + HPR 2 )] 1/2 1 = [(1.60) (1.433)] 1/2 1 = , or 51.4%. This question tested from Session 2, Reading 6, LOS c, (Part 2). Question 48 - #93618

19 Page 19 of 46 Let A and B be two mutually exclusive events with P(A) = 0.40 and P(B) = Therefore: A) P(A and B) = 0. B) P(B A) = C) P(A and B) = If the two evens are mutually exclusive, the probability of both ocurring is zero. This question tested from Session 2, Reading 8, LOS d. Question 49 - #93822 Banca Hakala purchases two front row concert tickets over the Internet for $90 per seat. One month later, the rock group announces that it is dissolving due to personality conflicts and the concert that Hakala has tickets for will be the farewell concert. Hakala sees a chance to raise some quick cash, so she puts the tickets up for sale on the same internet site. The auction closes at $250 per ticket. After paying a 10% commission to the site on the amount of the sale and paying $10 in shipping costs, Hakala s one-month holding period return is approximately: A) 144%. B) 44%. C) 139%. The holding period return is calculated as: (ending price beginning price +/- any cash flows) / beginning price. Here, the beginning and ending prices are given. The other cash flows consist of the commission of 0.10 $250 2 tickets = $50 and the shipping cost of $10 (total for both tickets). Thus, her one-month holding period return is: [(2 $250) (2 $90) $50 $10] / (2 $90) = 1.44, or approximately 144%. This question tested from Session 2, Reading 6, LOS b. Question 50 - #93638 If $2,500 were put into an account at the end of each of the next 10 years earning 15% annual interest, how much would be in the account at the end of ten years? A) $50,759. B) $41,965. C) $27,461. N = 10; I = 15; PMT = 2,500; CPT FV = $50,759. This question tested from Session 2, Reading 5, LOS e, (Part 2).

20 Page 20 of 46 Question 51 - #93825 Which of the following statements regarding the Sharpe ratio is most accurate? The Sharpe ratio measures: A) excess return per unit of risk. B) peakedness of a return distrubtion. C) total return per unit of risk. The Sharpe ratio measures excess return per unit of risk. Remember that the numerator of the Sharpe ratio is (portfolio return risk free rate), hence the importance of excess return. Note that peakedness of a return distribution is measured by kurtosis. This question tested from Session 2, Reading 7, LOS i, (Part 2). Question 52 - #96326 Use the results from the following survey of 500 firms to answer the question. Number of Employees Frequency 300 up to up to up to up to up to up to The number of classes in this frequency table is: A) 6. B) 600. C) = 1, = 2, = 3, = 4, = 5, = 6, Total = 6 This question tested from Session 2, Reading 7, LOS b. Question 53 - #93637 Helen Pedersen has all her money invested in either of two mutual funds (A and B). She knows that there is a 40% probability that fund A will rise in price and a 60% chance that fund B will rise in price if fund A rises in price. What is the probability that both fund A and fund B will rise in price? A) B) C) Your answer: A was incorrect. The correct answer was C) 0.24.

21 Page 21 of 46 P(A) = 0.40, P(B A) = Therefore, P(AÇB) = P(A)P(B A) = 0.40(0.60) = This question tested from Session 2, Reading 8, LOS f, (Part 1). Question 54 - #93600 If two events are mutually exclusive, the probability that they both will occur at the same time is: A) B) C) Cannot be determined from the information given. Your answer: A was incorrect. The correct answer was B) If two events are mutually exclusive, it is not possible to occur at the same time. Therefore, the P(A B) = 0. This question tested from Session 2, Reading 8, LOS a. Question 55 - #93739 Which of the following statements concerning kurtosis is least accurate? A) A distribution that is more peaked than a normal distribution is leptokurtic. B) A leptokurtic distribution has fatter tails than a normal distribution. C) A leptokurtic distribution has excess kurtosis less than zero. Your answer: A was incorrect. The correct answer was C) A leptokurtic distribution has excess kurtosis less than zero. A leptokurtic distribution is more peaked than normal and has fatter tails. However, the excess kurtosis is greater than zero. This question tested from Session 2, Reading 7, LOS k. Question 56 - #93697 Avery Scott, financial planner, recently obtained his CFA Charter and is considering multiple job offers. Scott devised the following four criteria to help him decide which offers to pursue most aggressively. Criterion % Expected to Meet the Criteria 1. Within 75 miles of San Francisco Employee size less than Compensation package exceeding $100, Three weeks of vacation 0.15 If Scott has 20 job offers and the probabilities of meeting each criterion are independent, how many are expected to meet all of his criteria? (Round to nearest whole number). A) 0.

22 Page 22 of 46 B) 3. C) 1. We will use the multiplication rule to calculate this probability. P(1, 2, 3, 4) = P(1) P(2) P(3) P(4) = = Number of offers expected to meet the criteria = = , or 0. This question tested from Session 2, Reading 8, LOS f, (Part 3). Question 57 - #93735 Consider the following graph of a distribution for the prices of various bottles of champagne. Which of the following statements regarding the distribution is least accurate? A) The distribution is negatively skewed. B) The mean value will be less than the mode. C) Point A represents the mode. Your answer: A was incorrect. The correct answer was C) Point A represents the mode. The graph represents a negatively skewed distribution, and thus Point A represents the mean. By definition, mean < median < mode describes a negatively skewed distribution. Both remaining statements are true. Chebyshev s Inequality states that for any set of observations (normally distributed or skewed), the proportion of observations that lie within k standard deviations of the mean is at least 1 1 / k 2. Here, 1 (1 / ) = = , or 40%. This question tested from Session 2, Reading 7, LOS j, (Part 2). Question 58 - #94226 The financial manager at Genesis Company is looking into the purchase of an apartment complex for $550,000.

23 Page 23 of 46 Net after-tax cash flows are expected to be $65,000 for each of the next five years, then drop to $50,000 for four years. Genesis required rate of return is 9% on projects of this nature. After nine years, Genesis Company expects to sell the property for after-tax proceeds of $300,000. What is the respective internal rate of return (IRR) and net present value (NPV) on this project? A) 13.99%; $166,177. B) 6.66%; $64,170. C) 7.01%; $53,765. Your answer: A was incorrect. The correct answer was C) 7.01%; $53,765. IRR Keystrokes: CF 0 = -$550,000; CF 1 = $65,000; F 1 = 5; CF 2 = $50,000; F 2 = 3; CF 3 = $350,000; F 3 = 1. NPV Keystrokes: CF 0 = -$550,000; CF 1 = $65,000; F 1 = 5; CF 2 = $50,000; F 2 = 3; CF 3 = $350,000; F 3 = 1. Compute NPV, I = 9. Note: Although the rate of return is positive, the IRR is less than the required rate of 9%. Hence, the NPV is negative. This question tested from Session 2, Reading 6, LOS a, (Part 1). Question 59 - #93785 Claude Bellow, CFA, is an analyst with a real estate focused investment firm. He asks his assistant to gather annual return information on a large office building and on a REIT (real estate investment trust) with diverse holdings. The following tables summarize the information. Table 1: Annual returns (in %) Asset Year 1 Year 2 Year 3 Year 4 Year 5 REIT Office Building Table 2: Mean and Dispersion Information Asset Mean Return * Variance REIT 11.6% Office Building 5.2% * Calculated using the arithmetic mean. Part 1) Determine which of the following statements about the coefficient of variation of the two assets is least accurate. A) The coefficient of variation of the office building returns is approximately The mean of the squared deviations from the arithmetic mean of the office building is less than that of B) the REIT. There is more dispersion relative to the mean in the distribution of the REIT returns when compared to C) the distribution of the returns for the office building. Your answer: A was incorrect. The correct answer was C) There is more dispersion relative to the mean in the distribution of the REIT returns when compared to the distribution of the returns for the office building.

24 Page 24 of 46 There is less dispersion relative to the mean in the distribution of the REIT returns (CV = s / mean = /2 / 11.6 = 0.92) when compared to the distribution of the monthly returns for the Office building (CV = /2 / 5.2 = 1.52). The coefficient of variation measures how much dispersion exists relative to the mean of a distribution and allows for direct comparison of dispersion across different data sets. Note: Ignore Table 1! All the information you need is in Table 2. Both remaining statements are true. The mean of the squared deviations from the arithmetic mean is the definition of the variance, and the variance of the Office Building returns is less than for those of the REIT. Thus, the same relationship holds for the standard deviation. This question tested from Session 2, Reading 7, LOS i, (Part 2). Claude Bellow, CFA, is an analyst with a real estate focused investment firm. He asks his assistant to gather annual return information on a large office building and on a REIT (real estate investment trust) with diverse holdings. The following tables summarize the information. Table 1: Annual returns (in %) Asset Year 1 Year 2 Year 3 Year 4 Year 5 REIT Office Building Table 2: Mean and Dispersion Information Asset Mean Return * Variance REIT 11.6% Office Building 5.2% * Calculated using the arithmetic mean. Part 2) A partner in the firm asks Bellow to calculate the Sharpe ratio for the REIT. If the risk-free rate is 5.0%, the Sharpe ratio is closest to: A) B) C) Your answer: A was incorrect. The correct answer was B) The Sharpe ratio measures the excess return per unit of risk. The formula is: Sharpe Ratio = ( r p r f ) / σ p where: r p = portfolio return; r f = risk free return; σ = standard deviation Sharpe Ratio REIT = (11.6% 5.00%) / /2 = 0.62 This question tested from Session 2, Reading 7, LOS i, (Part 2). Question 60 - #93987 An indicator calculated as the ratio of the average yield of 10 top-grade corporate bonds to the average yield on Dow Jones 40 bond is known as: A) confidence index.

25 Page 25 of 46 B) relative strength index. C) breadth index. This is the definition of the confidence index. In periods of confidence, investors sell quality bonds and buy lower quality bonds looking for yield. Quality bond prices will fall and their yields rise. Lower grade bond prices will rise and their yields fall. Thus, the CI ratio will increase during periods of confidence (e.g., from 0.07/0.10 = 0.7 to 0.08/0.09 = 0.89). Note that the CI moves in the opposite direction of yield spreads. In periods of confidence, yield spreads narrow and the CI gets bigger. In periods of pessimism, spreads widen and the CI falls. This question tested from Session 3, Reading 12, LOS c. Question 61 - #93975 An analyst conducts a two-tailed z-test to determine if small cap returns are significantly different from 10%. The sample size was 200. The computed z-statistic is 2.3. Using a 5% level of significance, which statement is most accurate? A) You cannot determine what to do with the information given. B) Reject the null hypothesis and conclude that small cap returns are significantly different from 10%. Fail to reject the null hypothesis and conclude that small cap returns are close enough to 10% that we C) cannot say they are significantly different from 10%. Your answer: A was incorrect. The correct answer was B) Reject the null hypothesis and conclude that small cap returns are significantly different from 10%. At the 5% level of significance the critical z-statistic for a two-tailed test is 1.96 (assuming a large sample size). The null hypothesis is H 0 : x = 10%. The alternative hypothesis is H A : x 10%. Because the computed z-statistic is greater than the critical z-statistic (2.33 > 1.96), we reject the null hypothesis and we conclude that small cap returns are significantly different than 10%. This question tested from Session 3, Reading 11, LOS a. Question 62 - #93916 An analyst has reviewed market data for returns from extensively, searching for patterns in the returns. She has found that when the end of the month falls on a Saturday, there are usually positive returns on the following Thursday. She has engaged in: A) data mining. B) data snooping. C) biased selection. Data mining refers to the extensive review of the same database searching for patterns. This question tested from Session 3, Reading 10, LOS k. Question 63 - #94157

26 Page 26 of 46 Which of the following statements about contrary-opinion and smart money technicians is most accurate? A) A smart-money technician buys when most futures traders are bullish on stock index futures. A contrary-opinion technician is bearish when the ratio of over-the-counter to NYSE volume is B) decreasing. C) When investor credit balances are falling, contrary-opinion technicians are bearish. Your answer: A was incorrect. The correct answer was C) When investor credit balances are falling, contraryopinion technicians are bearish. When investor credit balances are falling, investors are bullish, so contrary-opinion technicians are bearish. The other statements are incorrect. Contrarians are bullish when OTC-to-NYSE volume is decreasing. When 70% or more of futures traders are bullish on stock index futures, contrary-opinion technicians become bearish and sell. Summary of the indicators for contrary-opinion and smart money technicians: Contrary-opinion technicians (trade the opposite of the mass of general investors): Mutual Fund Ratio (mutual fund cash/total mutual funds) Investor credit balances in brokerage accounts Investment Advisory Opinions (bearish opinions/total opinions) OTC (speculative) versus New York Stock Exchange (less speculative) volume CBOE Put/Call ratio Futures traders bullish on stock index futures Smart-money technicians (follow the professional investors): Confidence index (yield on high-quality bond/yield on average-quality bonds). Note: AMIR has been known to use wording about yield spreads (which move in the opposite direction of the confidence index) to test your understanding of this indicator. T-bill Eurodollar yield spreads Debit (margin) balances in brokerage accounts This question tested from Session 3, Reading 12, LOS c. Question 64 - #93970 Which of the following statements least describes the procedure for testing a hypothesis? A) Compute the sample value of the test statistic, set up a rejection (critical) region, and make a decision. B) Develop a hypothesis, compute the test statistic, and make a decision. C) Select the level of significance, formulate the decision rule, and make a decision. Depending upon the author there can be as many as seven steps in hypothesis testing which are: 1. Stating the hypotheses. 2. Identifying the test statistic and its probability distribution. 3. Specifying the significance level.

27 Page 27 of Stating the decision rule. 5. Collecting the data and performing the calculations. 6. Making the statistical decision. 7. Making the economic or investment decision. This question tested from Session 3, Reading 11, LOS a. Question 65 - #94028 Jo Su believes that there should be a negative relation between returns and systematic risk. She intends to collect data on returns and systematic risk to test this theory. What is the appropriate alternative hypothesis? A) H a : ρ > 0. B) H a : ρ < 0. C) H a : ρ 0. Your answer: A was incorrect. The correct answer was B) H a : ρ < 0. The alternative hypothesis is determined by the theory or the belief. The researcher specifies the null as the hypothesis that she wishes to reject (in favor of the alternative). The theory in this case is that the correlation is negative. This question tested from Session 3, Reading 11, LOS a. Question 66 - #94244 The average annual rainfall amount in Yucutat, Alaska, is normally distributed with a mean of 150 inches and a standard deviation of 20 inches. The 90% confidence interval for the annual rainfall in Yucutat is closest to: A) 110 to 190 inches. B) 117 to 183 inches. C) 137 to 163 inches. Your answer: A was incorrect. The correct answer was B) 117 to 183 inches. The 90% confidence interval is µ ± 1.65 standard deviations (20) = 117 and (20) = 183. This question tested from Session 3, Reading 9, LOS k, (Part 1). Question 67 - #93793 Studies of performance of a sample of mutual fund managers most likely suffer from: A) sample-selection bias. B) survivorship bias. C) look-ahead bias.

28 Page 28 of 46 Your answer: A was incorrect. The correct answer was B) survivorship bias. Studies of the performance of mutual fund managers often suffer from survivorship bias as poorly performing funds are closed down and are not included in the sample. This question tested from Session 3, Reading 10, LOS k. Question 68 - #94201 The fact that it is not heavily dependent on the analysis of accounting information is an advantage of: A) fundamental analysis. B) technical analysis. C) efficient market analysis. Your answer: A was incorrect. The correct answer was B) technical analysis. One advantage of technical analysis is that it does not involve messing with financial accounting information and adjusting for management choice of accounting methods. This question tested from Session 3, Reading 12, LOS b, (Part 1). Question 69 - #93945 Joseph Lu calculated the average return on equity for a sample of 64 companies. The sample average is 0.14 and the sample standard deviation is The standard error of the mean is closest to: A) B) C) Your answer: A was incorrect. The correct answer was B) The standard error of the mean = σ/ n = 0.16/ 64 = This question tested from Session 3, Reading 10, LOS e. Question 70 - #94042 In a two-tailed test of a hypothesis concerning whether a population mean is zero, Jack Olson computes a t- statistic of 2.7 based on a sample of 20 observations where the distribution is normal. If a 5% significance level is chosen, Olson should: A) reject the null hypothesis and conclude that the population mean is significantly different from zero. B) reject the null hypothesis and conclude that the population mean is not significantly different from zero. C) fail to reject the null hypothesis that the population mean is not significantly different from zero.