CFA Level I (Chartered Financial Analyst) Exam — Questions and Answers

Question 1: A company has an ROE of 15% and a dividend payout ratio of 40%. Its sustainable growth rate is:

15%
6%
40%
9% (Correct answer)

Correct answer: 9%

Sustainable growth rate = ROE × retention ratio = 15% × (1 – 0.40) = 15% × 0.60 = 9%.

Question 2: A European call option gives the holder the right to:

Buy the underlying asset at the strike price only at expiration (Correct answer)
Sell the underlying asset at any time before expiration
Buy the underlying asset at the strike price at any time before expiration
Sell the underlying asset at the strike price before expiration

Correct answer: Buy the underlying asset at the strike price only at expiration

A European call option grants the right (not obligation) to buy the underlying at the strike price, but only on the expiration date, not before.

Question 3: Which of the following statements about the equity risk premium (ERP) is MOST accurate?

The ERP is fixed at 5% based on long-term historical averages
The ERP represents the expected excess return of equities over the risk-free rate and varies over time (Correct answer)
The ERP is irrelevant for CAPM-based cost of equity calculations
A higher ERP always indicates a better investment environment for equities

Correct answer: The ERP represents the expected excess return of equities over the risk-free rate and varies over time

The ERP is the expected return premium investors demand for holding equities over risk-free assets; it varies with economic conditions, valuation levels, and investor sentiment.

Question 4: An analyst notices that a company's receivables turnover ratio has declined significantly over the past year. This most likely indicates:

The company has reduced its credit sales
Improved efficiency in collecting receivables
Customers are taking longer to pay their invoices (Correct answer)
The company has become more conservative in recognizing revenue

Correct answer: Customers are taking longer to pay their invoices

A declining receivables turnover ratio means accounts receivable are growing relative to sales, suggesting customers are taking longer to pay.

Question 5: Key rate duration (partial duration) is most useful for measuring a bond's sensitivity to:

Parallel shifts in the yield curve
Non-parallel (twist) shifts in the yield curve (Correct answer)
Currency fluctuations in global bond portfolios
Credit spread changes across sectors

Correct answer: Non-parallel (twist) shifts in the yield curve

Key rate duration measures price sensitivity to changes at specific maturities on the yield curve, capturing non-parallel shifts that standard duration misses.

Question 6: A portfolio manager wants to hedge against a decline in a stock portfolio using put options. The strategy is BEST described as:

A covered call
A protective put (Correct answer)
A short straddle
A bull spread

Correct answer: A protective put

A protective put involves holding the stock (long) and buying put options to limit downside losses while retaining upside potential.

Question 7: In the two-stage dividend discount model, the second stage typically assumes:

Zero dividend growth indefinitely
A high growth rate consistent with the initial stage
A stable, sustainable long-run growth rate (Correct answer)
Dividends are reinvested rather than paid out

Correct answer: A stable, sustainable long-run growth rate

The two-stage DDM uses a high near-term growth rate followed by a terminal stage with a stable, long-run sustainable growth rate applied in perpetuity.

Question 8: A bond's Macaulay duration of 6 years and modified duration are related by which adjustment?

Multiplying by (1 + yield)
Adding convexity
Subtracting the coupon rate
Dividing Macaulay duration by (1 + yield per period) (Correct answer)

Correct answer: Dividing Macaulay duration by (1 + yield per period)

Modified duration equals Macaulay duration divided by (1 + yield per period).

Question 9: The Gordon Growth Model (Dividend Discount Model) assumes which of the following conditions?

Dividends grow at a variable rate over time
The required return equals the dividend growth rate
Dividends grow at a constant rate indefinitely (Correct answer)
The stock pays no dividends

Correct answer: Dividends grow at a constant rate indefinitely

The Gordon Growth Model requires dividends to grow at a constant rate g in perpetuity, with the required return r greater than g.

Question 10: In international economics, a current account surplus means that a country is:

Importing more goods and services than it exports
A net exporter of goods and services; receiving more from abroad than it sends (Correct answer)
Attracting more foreign direct investment than it sends abroad
Running a balanced trade account with all trading partners

Correct answer: A net exporter of goods and services; receiving more from abroad than it sends

A current account surplus means exports of goods, services, income, and transfers exceed imports; the country is a net creditor to the rest of the world.

Question 11: A firm has a floating-rate loan and is concerned rates will rise. To manage this risk, the firm should:

Enter a pay-fixed, receive-floating interest rate swap
Buy a cap on interest rates
Enter a receive-fixed, pay-floating interest rate swap
Both B and C are appropriate strategies (Correct answer)

Correct answer: Both B and C are appropriate strategies

Both paying fixed/receiving floating in a swap and buying an interest rate cap limit the firm's exposure to rising rates; either strategy is appropriate depending on cost and flexibility needs.

Question 12: The esteem of an existing single—family domestic utilized for private purposes will most likely be calculated utilizing the:

income approach.
cost approach.
sales comparison approach. (Correct answer)

Correct answer: sales comparison approach.

The sales comparison approach is the most appropriate and commonly used method for valuing existing single-family residential properties. This approach estimates value by comparing the subject property to similar properties that have recently sold in the same market, making adjustments for differences. The income approach is for income-generating properties, and the cost approach is typically for new construction or unique properties.

Question 13: In a plain vanilla interest rate swap, the fixed-rate payer benefits when:

Interest rates rise above the fixed rate agreed upon (Correct answer)
The floating rate equals the fixed rate throughout the swap's life
The notional principal increases over time
Interest rates fall below the fixed rate agreed upon

Correct answer: Interest rates rise above the fixed rate agreed upon

The fixed-rate payer benefits when floating rates rise above the fixed rate, because they receive more floating payments while their fixed payment remains constant.

Question 14: In the context of CFA economics, an expansionary fiscal policy is MOST likely to lead to which of the following in the short run?

Reduced money supply causing deflation
Appreciation of the domestic currency due to higher interest rates
Higher government spending or lower taxes leading to increased aggregate demand and GDP (Correct answer)
Decreased consumer spending due to Ricardian equivalence in all cases

Correct answer: Higher government spending or lower taxes leading to increased aggregate demand and GDP

Expansionary fiscal policy (increased spending or tax cuts) directly boosts aggregate demand, leading to higher short-run GDP and potentially higher employment.

Question 15: A CFA charterholder who discovers their employer is engaged in fraudulent activity should FIRST:

Immediately report the employer to regulators
Resign immediately without taking any action
Report the activity to the appropriate supervisor or compliance department (Correct answer)
Publicly disclose the fraud to the media

Correct answer: Report the activity to the appropriate supervisor or compliance department

Members should first attempt to resolve the issue internally by reporting it to their supervisor or compliance department before escalating externally.

Question 16: In the Capital Asset Pricing Model (CAPM), beta measures a security's:

Systematic (market) risk (Correct answer)
Unsystematic risk
Default risk
Total risk

Correct answer: Systematic (market) risk

Beta captures the non-diversifiable systematic risk relative to the market portfolio.

Question 17: Standard VII(B) requires CFA candidates and members to:

Act with honesty and dignity in the CFA examination process
Both B and C (Correct answer)
Pass all three CFA exams on the first attempt
Maintain confidentiality of exam questions after the exam

Correct answer: Both B and C

Standard VII(B) requires members to act with dignity and honesty during the exam and to maintain the confidentiality of exam questions and content.

Question 18: Which measure is MOST useful for comparing the operating profitability of two companies with different capital structures and tax rates?

EBIT margin (Correct answer)
Dividend yield
Net profit margin
Return on equity (ROE)

Correct answer: EBIT margin

EBIT margin removes the effects of interest expense (capital structure) and taxes, making it the most comparable operating profitability metric across companies with different structures and jurisdictions.

Question 19: Under classical immunization theory, a portfolio is considered immunized against interest rate risk over a single investment horizon when:

The portfolio's yield to maturity equals the target rate of return and all bonds are zero-coupon instruments
The portfolio's market value equals the present value of the liability and the portfolio duration equals zero
The portfolio consists solely of Treasury securities rated AAA with maturities exceeding the horizon date
The portfolio duration equals the investment horizon and the portfolio has sufficient convexity to absorb parallel yield curve shifts (Correct answer)

Correct answer: The portfolio duration equals the investment horizon and the portfolio has sufficient convexity to absorb parallel yield curve shifts

Classical immunization requires two conditions: (1) the portfolio's Macaulay duration equals the investment horizon, and (2) the portfolio's initial market value is at least equal to the present value of the liability. When duration equals the horizon, the capital loss (gain) from a rate rise (fall) is offset by the reinvestment gain (loss) on coupon cash flows, locking in the target return despite rate changes.

Question 20: When a member manages a fund that competes with a client's separately managed account, which standard is most relevant?

Standard VI(A) – Disclosure of Conflicts (Correct answer)
Standard III(C) – Suitability
Standard II(B) – Market Manipulation
Standard I(A) – Knowledge of the Law

Correct answer: Standard VI(A) – Disclosure of Conflicts

Managing competing funds creates a potential conflict of interest that must be disclosed to clients under Standard VI(A).

Question 21: Which industry structure, under Porter's Five Forces, would MOST support high profitability for existing firms?

Commodity products, price competition, low differentiation
Few rivals, high barriers to entry, few substitutes (Correct answer)
Many rivals, low switching costs, high supplier power
High rivalry, easy entry, many substitutes

Correct answer: Few rivals, high barriers to entry, few substitutes

High barriers to entry, few competitors, and limited substitutes reduce competitive pressure, allowing existing firms to maintain pricing power and high margins.

Question 22: Consider the following propositions: <br/> Phrase1: Commodities have generally had a higher Sharpe ratio than bonds but a lower Sharpe ratio than stocks. <br/> Phrase 2: Commodity price volatility is typically higher than reported consumer price inflation volatility. <br/> Which of these is the most likely case?

Only Statement 1 is incorrect. (Correct answer)
Only Statement 2 is incorrect.
Both statements are correct.

Correct answer: Only Statement 1 is incorrect.

Historically, commodities have generally exhibited lower Sharpe ratios compared to both stocks and bonds, making Statement 1 incorrect. However, commodity prices are known for their significant volatility, which is typically higher than the smoother, more stable reported consumer price inflation volatility, making Statement 2 correct. Therefore, only Statement 1 is incorrect.

Question 23: A bull call spread is constructed by:

Buying a call and selling a put at the same strike
Buying a call at a lower strike and selling a call at a higher strike (Correct answer)
Selling a call at a lower strike and buying a call at a higher strike
Buying two calls at different strikes and selling the underlying

Correct answer: Buying a call at a lower strike and selling a call at a higher strike

A bull call spread = long call at lower strike + short call at higher strike; it profits from moderate upward price moves while capping both profit and loss.

Question 24: Which of the following is required under Standard III(B) – Fair Dealing when disseminating investment recommendations?

Ensuring all clients have an equal opportunity to act on new recommendations (Correct answer)
Issuing all trade orders at the same time for all clients
Sharing information with institutional clients before retail clients
Providing all clients with identical investment recommendations simultaneously

Correct answer: Ensuring all clients have an equal opportunity to act on new recommendations

Fair dealing requires that all clients have an equal opportunity to act on new recommendations, though simultaneous communication and identical recommendations are not strictly required.

Question 25: The phrase "mezzanine-stage financing" is used to characterize the financing in the context of venture capital:

to initiate commercial manufacturing.
to prepare for an initial public offering. (Correct answer)
that supports product development and market research.

Correct answer: to prepare for an initial public offering.

Mezzanine-stage financing is typically one of the later stages of venture capital funding, provided to companies that are already established and generating revenue. This capital is often used to fund expansion, prepare for an initial public offering (IPO), or position the company for an acquisition. It bridges the gap between earlier-stage venture capital and a public market exit.

Question 26: Which of the following central bank tools directly controls the money supply by influencing bank reserves?

Open market operations (buying/selling government securities)
Reserve requirement changes
Both B and C (Correct answer)
Discount rate changes

Correct answer: Both B and C

Open market operations directly affect bank reserves by injecting or withdrawing cash, while changing reserve requirements alters how much of those reserves banks must hold vs. lend out.

Question 27: A company uses the LIFO inventory method. During a period of rising prices, compared to FIFO, LIFO will result in:

Lower net income and higher inventory on the balance sheet
Higher net income and higher inventory on the balance sheet
Lower net income and lower inventory on the balance sheet (Correct answer)
Higher net income and lower inventory on the balance sheet

Correct answer: Lower net income and lower inventory on the balance sheet

Under rising prices, LIFO assigns higher-cost inventory to COGS, reducing net income, and retains older, lower-cost inventory on the balance sheet.

Question 28: Which of the following best illustrates a violation of Standard I(B) – Independence and Objectivity?

An analyst issuing a sell rating on a company that is a firm client
An analyst accepting a large gift from a client in exchange for a favorable rating (Correct answer)
An analyst relying on third-party research with full attribution
An analyst declining a free trip to a company's facility paid by the company

Correct answer: An analyst accepting a large gift from a client in exchange for a favorable rating

Accepting gifts that could influence professional judgment violates Standard I(B), which requires members to maintain independence and objectivity.

Question 29: In the aggregate demand-aggregate supply (AD-AS) model, a negative supply shock (e.g., rising oil prices) will MOST likely result in:

Higher output and lower inflation in the short run
Lower output and higher inflation (stagflation) in the short run (Correct answer)
Lower output and lower inflation simultaneously
Higher output and higher inflation with unchanged unemployment

Correct answer: Lower output and higher inflation (stagflation) in the short run

A negative supply shock shifts the short-run aggregate supply curve left, raising the price level (inflation) and reducing real output (recessionary gap) simultaneously — stagflation.

Question 30: A risk-averse investor will MOST likely select a portfolio that offers:

A portfolio on the efficient frontier matching their specific risk-return preference (Correct answer)
The highest expected return regardless of risk
The highest Sharpe ratio among available portfolios
The lowest standard deviation regardless of expected return

Correct answer: A portfolio on the efficient frontier matching their specific risk-return preference

A risk-averse investor selects an efficient frontier portfolio that maximizes their utility given their specific indifference curves, balancing return against their personal risk tolerance.

Question 31: Under Standard IV(A) – Loyalty, if an employee plans to leave and start a competing firm, which action is PERMISSIBLE before resigning?

Making arrangements with a new employer while keeping current responsibilities (Correct answer)
Soliciting current clients for the new firm
Using employer resources to prepare for the new business
Copying confidential client lists from the employer

Correct answer: Making arrangements with a new employer while keeping current responsibilities

Arranging future employment with a new employer is permissible, provided the member continues to fulfill current job duties and does not use employer resources improperly.

Question 32: An inverted yield curve (long-term rates below short-term rates) is MOST commonly interpreted as:

A signal of high inflation expectations in the future
A recessionary signal, as the market expects future short-term rates to fall (Correct answer)
An indication that long-term bonds are riskier than short-term bonds
A sign that the central bank has lost control of monetary policy

Correct answer: A recessionary signal, as the market expects future short-term rates to fall

An inverted yield curve typically signals that markets expect economic slowdown or recession ahead, anticipating future rate cuts that will bring short-term rates down.

Question 33: An analyst uses a residual income model to value a stock. Residual income is defined as:

Net income minus the equity charge (required return × book value of equity) (Correct answer)
Operating income minus the cost of debt
Net income minus dividends paid to shareholders
Free cash flow minus capital expenditures

Correct answer: Net income minus the equity charge (required return × book value of equity)

Residual income = Net income – (required return on equity × beginning book value of equity); it measures value created above the cost of equity.

Question 34: In Modern Portfolio Theory (MPT), the efficient frontier represents:

Portfolios composed entirely of risk-free assets
The set of portfolios offering the maximum return for each level of risk, or minimum risk for each level of return (Correct answer)
Only the minimum variance portfolio
Portfolios with the highest return regardless of risk

Correct answer: The set of portfolios offering the maximum return for each level of risk, or minimum risk for each level of return

The efficient frontier is the set of optimal portfolios that provide the highest expected return for a given level of risk or the lowest risk for a given expected return.

Question 35: Which of the following is MOST consistent with value investing as described in the CFA curriculum?

Following price trends and market sentiment indicators
Seeking stocks with low price multiples relative to fundamentals (Correct answer)
Investing in high-growth companies at premium valuations
Buying stocks with high P/E and strong momentum

Correct answer: Seeking stocks with low price multiples relative to fundamentals

Value investing seeks stocks trading at a discount to intrinsic value, typically characterized by low P/E, low P/B, or high dividend yields.

Question 36: Which of the following best describes a credit default swap (CDS)?

A structured product that tranches credit risk into senior and junior claims
A derivative where the protection buyer pays periodic premiums in exchange for a payment if a credit event occurs (Correct answer)
A forward contract to exchange floating for fixed interest payments
An exchange-traded contract to buy or sell bonds at a fixed price

Correct answer: A derivative where the protection buyer pays periodic premiums in exchange for a payment if a credit event occurs

In a CDS, the protection buyer pays periodic premiums to the protection seller, who makes a payment if the reference entity experiences a credit event (e.g., default).

Question 37: Under the Asset Manager Code, a manager that exercises proxy voting authority must:

Always vote in favor of management proposals
Delegate all proxy votes to a third-party service
Vote proxies in the best interest of clients (Correct answer)
Abstain from voting to avoid conflicts of interest

Correct answer: Vote proxies in the best interest of clients

The Asset Manager Code requires managers to exercise proxy voting authority in the best interest of their clients, not management or other parties.

Question 38: Which of the following best describes the 'mosaic theory' as it relates to Standard II(A)?

Using insider tips alongside public data
Using only public information to conduct research
Combining material nonpublic information with public information to make a trade
Combining nonmaterial nonpublic information with public information to reach a conclusion (Correct answer)

Correct answer: Combining nonmaterial nonpublic information with public information to reach a conclusion

Mosaic theory allows analysts to legally combine nonmaterial nonpublic information with public information to form investment conclusions.

Question 39: The J-curve effect describes how a country's trade balance initially worsens after a currency depreciation because:

Trading partners retaliate with tariffs, reducing exports further
Import and export volumes adjust slowly while prices change immediately, causing the trade deficit to temporarily widen (Correct answer)
Domestic inflation immediately erodes the competitive advantage
Imports become cheaper immediately, increasing import volumes

Correct answer: Import and export volumes adjust slowly while prices change immediately, causing the trade deficit to temporarily widen

After depreciation, import prices rise and export prices fall immediately, but trade volumes adjust slowly; the short-term effect is a wider trade deficit before volumes respond to improve the balance.

Question 40: A REIT's funds from operations (FFO) are most likely computed as follows:

Net income less gains from sales of real estate plus losses from sales of real estate.
Net income plus depreciation less capital expenditures.
Net income plus depreciation less gains from sales of real estate plus losses from sales of real estate. (Correct answer)

Correct answer: Net income plus depreciation less gains from sales of real estate plus losses from sales of real estate.

Funds From Operations (FFO) is a key metric for REITs that adjusts net income to better reflect cash flow from operations. It is calculated by adding back depreciation and amortization to net income, and then adjusting for non-recurring gains or losses from the sale of real estate. This provides a clearer picture of a REIT's ongoing operational performance by removing non-cash expenses and non-operating income/losses.

Question 41: The required rate of return used to discount a firm's free cash flow to the firm (FCFF) is the:

Weighted average cost of capital (WACC) (Correct answer)
Risk-free rate
After-tax cost of debt
Cost of equity

Correct answer: Weighted average cost of capital (WACC)

FCFF belongs to all capital providers, so it is discounted at the WACC.

Question 42: A callable bond and an otherwise identical option-free bond have the same modified duration. When interest rates fall sharply, the effective duration of the callable bond will most likely be:

Negative, because callable bonds exhibit price compression at low yields
Equal to that of the option-free bond, because modified duration is invariant to embedded options
Lower than that of the option-free bond, because the probability of the bond being called increases (Correct answer)
Greater than that of the option-free bond, because the call option adds value to the issuer

Correct answer: Lower than that of the option-free bond, because the probability of the bond being called increases

Effective duration captures the actual price sensitivity of a bond, including changes in cash flows caused by embedded options. As rates fall, the call option moves deeper in-the-money, making early redemption more likely and capping price appreciation — effectively shortening the bond's expected life and reducing its effective duration relative to an option-free bond.

Question 43: The component of a long-only commodity futures position's yield that is not affected by whether the contract is in contango or backwardation is the:

convenience yield
collateral yield. (Correct answer)
roll yield.

Correct answer: collateral yield.

The collateral yield is the return earned on the cash collateral posted to secure a futures position, typically invested in low-risk assets like T-bills. This yield is independent of the relationship between spot and futures prices, which defines contango or backwardation. In contrast, the roll yield is directly affected by whether the contract is in contango (negative roll yield) or backwardation (positive roll yield).

Question 44: An analyst calculates a stock's intrinsic value at $50 but it trades at $60. The stock appears to be:

Fairly valued if the market is semi-strong efficient
Undervalued; the analyst should recommend a buy
Undervalued if the analyst uses a bottom-up approach
Overvalued; the analyst should recommend a sell or avoid (Correct answer)

Correct answer: Overvalued; the analyst should recommend a sell or avoid

When market price exceeds intrinsic value, the stock is overvalued and a sell (or underweight) recommendation is appropriate.

Question 45: A research analyst writes a favorable report on a company whose CFO is the analyst's personal friend. Under Standard VI(A) – Disclosure of Conflicts, the analyst must:

Refuse to write the report under any circumstances
Disclose the personal relationship to clients and the employer (Correct answer)
Only disclose the relationship to the employer, not clients
Get approval from the CFO before publishing

Correct answer: Disclose the personal relationship to clients and the employer

Standard VI(A) requires members to disclose all potential conflicts of interest, including personal relationships, to both clients and employers.

Question 46: It is most likely that a strong corporate code of ethics will allow:

the company to award consulting contracts to board members.
finder’s fees for merger or acquisition targets to be paid to board members.
board members to simultaneously sit on the board of another firm. (Correct answer)

Correct answer: board members to simultaneously sit on the board of another firm.

A strong corporate code of ethics aims to prevent conflicts of interest and promote ethical behavior. While sitting on the board of another firm (interlocking directorship) can raise governance concerns, it is generally permissible if disclosed and managed to avoid conflicts. However, paying finder's fees or awarding consulting contracts to board members creates direct financial conflicts of interest that a robust code of ethics would typically prohibit or severely restrict to ensure independent judgment.

Question 47: A mortgage-backed security (MBS) is most exposed to which unique risk compared to a standard corporate bond?

Prepayment risk (Correct answer)
Credit risk
Currency risk
Liquidity risk

Correct answer: Prepayment risk

MBS are exposed to prepayment risk because homeowners may refinance or sell their homes early, returning principal at inopportune times for investors.

Question 48: Strategic asset allocation (SAA) is BEST described as:

Daily rebalancing to maintain target weights
Long-term target allocations across asset classes based on the investor's IPS (Correct answer)
Short-term tactical shifts based on market forecasts
The selection of individual securities within each asset class

Correct answer: Long-term target allocations across asset classes based on the investor's IPS

SAA establishes long-term target weights for asset classes (equities, bonds, alternatives) aligned with the investor's objectives and risk tolerance, serving as the portfolio's policy benchmark.

Question 49: Which of the following is classified as a financing activity in the statement of cash flows under U.S. GAAP?

Payment of income taxes
Purchase of equipment
Collection of interest on loans made
Payment of dividends to shareholders (Correct answer)

Correct answer: Payment of dividends to shareholders

Under U.S. GAAP, dividends paid to shareholders are classified as financing activities because they represent returns to capital providers.

Question 50: The formula will most likely be used to calculate the value of an existing single-family home utilized for residential purposes:

sales comparison approach. (Correct answer)
income approach
cost approach

Correct answer: sales comparison approach.

The sales comparison approach is the most appropriate method for valuing existing single-family homes. This approach estimates value by comparing the subject property to similar properties that have recently sold in the same market, making adjustments for differences. The income approach is for income-generating properties, and the cost approach is typically for new construction or unique properties.

Question 51: Cathy Williams, CPA, is an asset manager who wants to put some of his money into alternative ventures. Williams buys a security that represents a proportional claim to a pool of loans' cash flows. Williams has most likely invested in which alternative investment category?

Private equity.
Real estate. (Correct answer)
Commodities.

Correct answer: Real estate.

Investing in a security that represents a proportional claim to a pool of loans' cash flows is characteristic of securitized debt. This often includes mortgage-backed securities (MBS) or collateralized loan obligations (CLOs) backed by real estate or other loans. Such investments fall under the broader alternative investment category of real estate, which encompasses not just direct property ownership but also related financial instruments.

Question 52: Which of the following is the MAIN difference between a forward contract and a futures contract?

Forwards trade on exchanges; futures are OTC instruments
Futures are marked-to-market daily with margin requirements; forwards are settled at expiration (Correct answer)
Futures can only be used for commodities; forwards can be used for any asset
Forwards have no counterparty risk; futures do

Correct answer: Futures are marked-to-market daily with margin requirements; forwards are settled at expiration

Futures are exchange-traded with daily mark-to-market and margin requirements, while forwards are OTC contracts settled at maturity without daily settlement.

Question 53: Which of the following best describes a market that is weak-form efficient?

Past prices cannot be used to predict future prices (Correct answer)
Technical analysis can consistently generate excess returns
All information including insider data is reflected in prices
Public information is already reflected in stock prices

Correct answer: Past prices cannot be used to predict future prices

Weak-form efficiency means all historical price and volume information is already reflected in current prices, so technical analysis cannot generate consistent excess returns.

Question 54: A positively sloped (normal) yield curve generally implies that:

Yields are falling across all maturities
Short-term yields exceed long-term yields
Longer-term yields are higher than shorter-term yields (Correct answer)
All maturities have equal yields

Correct answer: Longer-term yields are higher than shorter-term yields

A normal upward-sloping curve has higher yields for longer maturities, reflecting term premiums.

Question 55: In a collateralized debt obligation (CDO), the senior tranche typically offers:

The highest yield and first claim on losses
The lowest yield and last claim on losses
The highest yield and first priority on cash flows
The lowest yield and first priority on cash flows with last exposure to losses (Correct answer)

Correct answer: The lowest yield and first priority on cash flows with last exposure to losses

Senior tranches have the highest credit quality (first priority on cash flows, last to absorb losses), which justifies their lower yield compared to junior tranches.

Question 56: Which of the following BEST describes the concept of potential GDP?

The level of output an economy can sustainably produce at full employment with stable inflation (Correct answer)
The maximum GDP achievable under wartime production conditions
The GDP growth rate consistent with the inflation target
GDP adjusted for seasonal factors and one-time events

Correct answer: The level of output an economy can sustainably produce at full employment with stable inflation

Potential GDP is the sustainable output level when all resources (labor, capital) are fully and efficiently employed without generating inflationary pressures.

Question 57: Which theory of the yield curve suggests that the shape is determined solely by expectations of future short-term rates?

Market Segmentation Theory
Pure Expectations Theory (Correct answer)
Preferred Habitat Theory
Liquidity Preference Theory

Correct answer: Pure Expectations Theory

Pure Expectations Theory holds that long-term rates are geometric averages of expected future short-term rates, with no liquidity premium or maturity preference.

Question 58: Which of the following best describes the option-adjusted spread (OAS)?

OAS = Z-spread + option cost
OAS = nominal spread – option cost
OAS = Z-spread – option cost (Correct answer)
OAS = nominal spread + option cost

Correct answer: OAS = Z-spread – option cost

OAS removes the value of the embedded option from the Z-spread: OAS = Z-spread minus the option cost, isolating the credit and liquidity spread.

Question 59: If local law permits an activity that violates the CFA Standards, a member operating in that jurisdiction must:

Follow the CFA Standards, which set a higher ethical bar (Correct answer)
Follow local law since it is legally permissible
Seek a waiver from the CFA Institute
Cease all operations in that jurisdiction

Correct answer: Follow the CFA Standards, which set a higher ethical bar

Members must always follow the CFA Standards when they are stricter than local law, as the Standards represent the higher ethical requirement.

Question 60: Global Depositary Receipts (GDRs) allow US investors to:

Invest in foreign companies through US-listed instruments denominated in USD (Correct answer)
Hedge currency risk in international equity portfolios
Access private equity in emerging markets
Buy domestic US stocks through foreign exchanges

Correct answer: Invest in foreign companies through US-listed instruments denominated in USD

GDRs (including ADRs for US markets) are bank-issued certificates representing shares of foreign companies, traded on US exchanges in USD, simplifying foreign equity access.

Question 61: A private equity firm that wishes to obtain money from a portfolio company without giving up ownership is most likely to:

secondary sale.
trade sale.
recapitalization. (Correct answer)

Correct answer: recapitalization.

Recapitalization involves altering a company's capital structure, often by issuing new debt to fund a large dividend payment to shareholders, including the private equity firm. This allows the private equity firm to extract cash from the portfolio company without selling its ownership stake. Trade sales and secondary sales, conversely, are exit strategies that involve relinquishing ownership.

Question 62: Standard II(A) – Material Nonpublic Information prohibits trading on information that is material and nonpublic. Information is considered material if:

It has been disclosed to at least one analyst
It relates exclusively to earnings announcements
It would significantly affect the price of a security or a reasonable investor would want to know it before investing (Correct answer)
It was obtained from a corporate insider only

Correct answer: It would significantly affect the price of a security or a reasonable investor would want to know it before investing

Material information is defined as information that would affect a security's price or that a reasonable investor would want to know before making an investment decision.

Question 63: Which of the following alternative investments is the best fit for a high-net-worth individual with a long time horizon and a need for immediate income?

Multi-strategy hedge funds.
Venture capital.
Commercial real estate. (Correct answer)

Correct answer: Commercial real estate.

Commercial real estate is an excellent fit for a high-net-worth individual with a long time horizon and a need for immediate income. It typically generates stable rental income, providing immediate cash flow, and offers potential for capital appreciation over the long term. Venture capital involves high risk and long horizons with no immediate income, while multi-strategy hedge funds may offer some liquidity but are not primarily focused on immediate income.

Question 64: The Sharpe ratio measures:

Absolute return relative to the risk-free rate
Portfolio return divided by portfolio volatility without adjusting for risk-free rate
Excess return per unit of total risk (standard deviation) (Correct answer)
Excess return per unit of systematic risk (beta)

Correct answer: Excess return per unit of total risk (standard deviation)

Sharpe ratio = (Portfolio return – Risk-free rate) / Portfolio standard deviation; it measures risk-adjusted excess return using total risk.

Question 65: The point on the company's investment opportunity schedule that best determines the amount of an appropriate the capital budget for a corporation is:

where the expected return on the next potential project is at its maximum.
where it intersects the company's marginal cost of capital curve. (Correct answer)
where the amount of new capital raised is at its minimum.

Correct answer: where it intersects the company's marginal cost of capital curve.

The optimal capital budget for a corporation is determined at the point where the investment opportunity schedule (IOS) intersects the marginal cost of capital (MCC) curve. The IOS ranks potential projects by their expected return, while the MCC curve shows the cost of raising additional capital. The firm should invest in all projects whose expected return exceeds the cost of capital, up to this intersection point, maximizing shareholder wealth.

Question 66: A bond's full price (dirty price) equals:

Clean price minus accrued interest
Clean price plus accrued interest (Correct answer)
Par value plus accrued interest
Market price minus accrued coupon

Correct answer: Clean price plus accrued interest

The full (dirty) price is the clean (flat) price plus accrued interest since the last coupon payment; this is the actual amount paid by the buyer.

Question 67: Which of the following is a violation of Standard VI(B) – Priority of Transactions?

A member disclosing their personal holdings to their employer
An analyst buying a stock after issuing a buy recommendation to clients
A portfolio manager front-running by trading personal accounts before executing client trades (Correct answer)
A member waiting until client trades are completed before trading for their own account

Correct answer: A portfolio manager front-running by trading personal accounts before executing client trades

Front-running—trading personal accounts ahead of client orders to benefit from anticipated price movements—violates Standard VI(B).

Question 68: The Gini coefficient measures:

Income inequality within a country, ranging from 0 (perfect equality) to 1 (maximum inequality) (Correct answer)
The correlation between economic growth and inflation
A country's total income relative to its GDP
A country's trade openness as a percentage of GDP

Correct answer: Income inequality within a country, ranging from 0 (perfect equality) to 1 (maximum inequality)

The Gini coefficient quantifies income distribution inequality; 0 represents perfect equality (everyone has the same income), while 1 represents maximum inequality (one person has all income).

Question 69: In the context of the CFA curriculum, which of the following BEST describes dollar-cost averaging?

Rebalancing the portfolio quarterly to maintain target weights
Increasing investment amounts when the market falls
Investing a fixed dollar amount at regular intervals regardless of market price (Correct answer)
Investing the entire portfolio in one lump sum to minimize opportunity cost

Correct answer: Investing a fixed dollar amount at regular intervals regardless of market price

Dollar-cost averaging involves investing a fixed dollar amount at regular intervals, buying more shares when prices are low and fewer when prices are high.

Question 70: Under Standard I(C) – Misrepresentation, which of the following is LEAST likely a violation?

Omitting material facts that make a statement misleading
Guaranteeing a specific investment return
Citing a firm's historical track record accurately (Correct answer)
Plagiarizing research from another analyst

Correct answer: Citing a firm's historical track record accurately

Accurately citing historical performance is not a misrepresentation; guaranteeing returns, plagiarism, and misleading omissions all violate Standard I(C).

Question 71: Under IFRS, which of the following is NOT a required component of a complete set of financial statements?

Statement of retained earnings (Correct answer)
Statement of cash flows
Statement of financial position
Statement of changes in equity

Correct answer: Statement of retained earnings

IFRS requires a statement of financial position, statement of comprehensive income, statement of changes in equity, statement of cash flows, and notes — a standalone statement of retained earnings is not required.

Question 72: Monetary policy transmission to the real economy occurs PRIMARILY through which channel?

Direct central bank loans to private businesses
Changes in short-term interest rates that affect borrowing costs, asset prices, and exchange rates (Correct answer)
Tariff and trade policy adjustments by the central bank
Government fiscal expenditure programs

Correct answer: Changes in short-term interest rates that affect borrowing costs, asset prices, and exchange rates

Central banks adjust short-term interest rates, which then transmit to borrowing costs, investment decisions, asset prices, currency values, and ultimately aggregate demand and inflation.

Question 73: An investor purchases a floating-rate note (FRN) with a spread of 150 bps over SOFR. If SOFR rises from 3% to 4%, the coupon rate will:

Stay fixed at the initial coupon level
Decrease because rising rates reduce FRN value
Remain at 4.50%
Increase from 4.50% to 5.50% (Correct answer)

Correct answer: Increase from 4.50% to 5.50%

FRN coupons reset periodically with the reference rate; if SOFR rises by 100 bps, the new coupon becomes SOFR + 150 bps = 5.50%.

Question 74: In the context of the CFA curriculum, free cash flow to equity (FCFE) is best described as:

Operating cash flow minus capital expenditures
EBITDA minus interest expense and taxes
Net income plus depreciation minus changes in working capital
Cash flow available to equity holders after meeting all financial obligations and capex needs (Correct answer)

Correct answer: Cash flow available to equity holders after meeting all financial obligations and capex needs

FCFE = CFO – Capex + net borrowing, representing cash available to equity holders after all obligations including debt service.

Question 75: Gamma (Γ) of an option is highest when:

The underlying asset pays a high dividend yield
The option is deep in-the-money with a long time to expiry
The option is deep out-of-the-money with volatility rising
The option is near-the-money and close to expiration (Correct answer)

Correct answer: The option is near-the-money and close to expiration

Gamma is largest for at-the-money options near expiration because delta is changing most rapidly as the option transitions between in- and out-of-the-money.

Question 76: In equity analysis, a company's economic moat refers to:

Its total assets relative to competitors
Its geographic expansion strategy
Its sustainable competitive advantages that protect long-term profitability (Correct answer)
The premium paid in a corporate acquisition

Correct answer: Its sustainable competitive advantages that protect long-term profitability

An economic moat represents durable competitive advantages (e.g., brand, network effects, cost advantages) that allow a company to maintain above-average profitability over time.

Question 77: The Global Investment Performance Standards (GIPS) are primarily designed to:

Establish trading rules for global financial markets
Regulate the compensation of portfolio managers
Set minimum capital requirements for investment firms
Ensure fair representation and full disclosure of investment performance (Correct answer)

Correct answer: Ensure fair representation and full disclosure of investment performance

GIPS standards ensure investment firms present performance results fairly and completely, allowing clients to make meaningful comparisons.

Question 78: Under the CFA curriculum, the term structure of interest rates is best described by which of the following?

The slope of the yield curve over a fixed time period
The relationship between bond yields and maturities for bonds of the same credit quality (Correct answer)
The relationship between credit ratings and bond yields
The spread between corporate and government bond yields

Correct answer: The relationship between bond yields and maturities for bonds of the same credit quality

The term structure (yield curve) shows the relationship between yields to maturity and time to maturity for bonds with the same credit quality, typically government bonds.

Question 79: A private equity fund sells the following items to exit a portfolio company through a trade sale:

the portfolio company to another private equity firm.
shares of a portfolio company to the public.
the portfolio company to one of the portfolio company‘s competitors. (Correct answer)

Correct answer: the portfolio company to one of the portfolio company‘s competitors.

A trade sale is an exit strategy where a private equity firm sells its portfolio company to a strategic buyer, typically another operating company. Selling the portfolio company to one of its competitors is a classic example of a trade sale, as the buyer often seeks to gain market share, achieve synergies, or acquire specific assets or technologies. Selling shares to the public is an IPO, and selling to another private equity firm is a secondary sale.

Question 80: Purchasing Power Parity (PPP) theory suggests that, in the long run, exchange rates will adjust so that:

All countries have identical interest rates
The price of a basket of goods is the same in all countries when expressed in a common currency (Correct answer)
Trade balances must equal zero for all trading partners
Inflation rates converge to zero globally

Correct answer: The price of a basket of goods is the same in all countries when expressed in a common currency

PPP holds that exchange rates should equalize the purchasing power of currencies by adjusting to offset inflation differentials between countries.

Question 81: The Taylor Rule is used by central banks to:

Calculate the optimal money supply growth rate
Set the minimum capital requirement for commercial banks
Determine an appropriate target for the policy interest rate based on inflation and output gaps (Correct answer)
Establish currency peg levels against the US dollar

Correct answer: Determine an appropriate target for the policy interest rate based on inflation and output gaps

The Taylor Rule provides a formula for setting the policy rate based on the neutral rate, the inflation gap (actual minus target), and the output gap (actual vs. potential GDP).

Question 82: Under the CFA Institute Code of Ethics, what must a member do when an investment recommendation could benefit the member personally?

Decline to make any recommendation
Transfer the account to a colleague
Wait 30 days before acting
Disclose the conflict of interest to clients and prospects (Correct answer)

Correct answer: Disclose the conflict of interest to clients and prospects

Standard VI(A) requires full and fair disclosure of all matters that could reasonably impair independence or create conflicts of interest.

Question 83: Which of the following assertions concerning a public company's annual reports, SEC filings, and press releases in the United States is the most accurate?

Annual and quarterly SEC filings must be audited.
Annual reports to shareholders are typically the most factual and objective source of information about a company.
Interim SEC filings typically update the major financial statements and footnotes. (Correct answer)

Correct answer: Interim SEC filings typically update the major financial statements and footnotes.

Interim SEC filings, such as Form 10-Q (quarterly reports), provide updated financial statements (balance sheet, income statement, cash flow statement) and relevant footnotes for the most recent quarter. These filings are crucial for investors to stay informed about a company's financial performance and position between annual reports. Annual reports to shareholders are often marketing documents, and only annual SEC filings (10-K) are fully audited.

Question 84: In 20x7, an investment in a hedge fund with a 2-and-20 fee structure rose in value each period, yielding an 8 percent net return net of management fees. Which of the following provisions would have the highest incentive fees for 20x7?

5% hard hurdle rate and a high water mark provision.
7% hard hurdle rate and no high water mark provision.
6% soft hurdle rate and a high water mark provision. (Correct answer)

Correct answer: 6% soft hurdle rate and a high water mark provision.

Given an 8% net return after management fees, we compare incentive fees for each option. A soft hurdle rate means incentive fees are applied to the entire profit if the hurdle is met. Option A's 6% soft hurdle means 20% of the full 8% return is taken as incentive fee (1.6%). Options B and C have hard hurdle rates, meaning fees are only on profits *above* the hurdle (8%-7%=1% for B, 8%-5%=3% for C), resulting in lower incentive fees (0.2% and 0.6% respectively). Therefore, the soft hurdle rate in option A yields the highest incentive fees.

Question 85: Which of the following BEST describes stagflation?

Low unemployment with rapidly rising wages
High growth combined with low inflation
Deflation during a period of strong economic growth
High unemployment combined with high inflation and stagnant growth (Correct answer)

Correct answer: High unemployment combined with high inflation and stagnant growth

Stagflation is the combination of high inflation, high unemployment, and weak economic growth — a situation that is difficult to address because standard policy tools involve trade-offs.

Question 86: A stock trading at a P/E of 25 with an earnings growth rate of 20% has a PEG ratio of:

0.80
2.00
5.00
1.25 (Correct answer)

Correct answer: 1.25

PEG ratio = P/E ÷ earnings growth rate = 25 ÷ 20 = 1.25; a PEG below 1 is often considered undervalued relative to growth.

Question 87: The Fisher Effect describes the relationship between nominal interest rates, real interest rates, and inflation as:

Nominal rate = Real rate × Expected inflation
Real rate = Nominal rate × (1 – Tax rate)
Nominal rate = Real rate + Expected inflation (Correct answer)
Real rate = Nominal rate + Expected inflation

Correct answer: Nominal rate = Real rate + Expected inflation

The Fisher Effect: nominal interest rate ≈ real interest rate + expected inflation rate; lenders demand compensation for both the time value of money and expected purchasing power erosion.

Question 88: Which of the following is an example of basis risk in a hedging strategy?

A mismatch between the hedge's notional amount and the portfolio's value
Using a futures contract whose underlying does not perfectly match the asset being hedged, causing imperfect hedge performance (Correct answer)
The risk that regulatory changes make the hedge illegal
The risk that the counterparty to a hedge defaults

Correct answer: Using a futures contract whose underlying does not perfectly match the asset being hedged, causing imperfect hedge performance

Basis risk arises when the futures contract's underlying (or its price behavior) does not perfectly match the hedged asset, causing the hedge to be imperfect.

Question 89: Under the accrual basis of accounting, revenue is recognized when:

The invoice is issued to the customer
A purchase order is received
Cash is received from the customer
The performance obligation is satisfied (Correct answer)

Correct answer: The performance obligation is satisfied

Under IFRS 15 and ASC 606, revenue is recognized when (or as) the entity satisfies a performance obligation by transferring control of a promised good or service.

Question 90: The Z-spread (zero-volatility spread) is best described as:

The constant spread added to each spot rate on the Treasury curve to make the bond's PV equal to its price (Correct answer)
The spread between a bond's YTM and the 10-year Treasury yield
The spread over the par yield curve that makes the bond's present value equal to its price
The spread that adjusts for the bond's embedded option value

Correct answer: The constant spread added to each spot rate on the Treasury curve to make the bond's PV equal to its price

The Z-spread is the constant spread added to every spot rate on the benchmark spot curve such that the present value of cash flows equals the bond's market price.

Question 91: According to the CFA Institute Code of Ethics, members must act with integrity, competence, diligence, respect, and in an ethical manner with which of the following?

Only their employer and clients
Only their clients
The public, clients, prospective clients, employers, employees, colleagues, and other participants in the global capital markets (Correct answer)
Only regulators and clients

Correct answer: The public, clients, prospective clients, employers, employees, colleagues, and other participants in the global capital markets

The CFA Institute Code of Ethics requires members to act ethically with the public, clients, prospective clients, employers, employees, colleagues, and all capital market participants.

Question 92: Which of the following is the least likely source of profit from a commodity futures position with collateral?

Spot price return
Collateral yield
Storage costs (Correct answer)

Correct answer: Storage costs

Profit from a commodity futures position with collateral typically comes from the spot price return (or roll return) and the collateral yield (interest earned on the collateral). Storage costs, however, are an expense associated with holding physical commodities, not a source of profit from a futures position itself. In fact, storage costs contribute to contango, making futures prices higher than spot prices.

Question 93: An investor's Investment Policy Statement (IPS) must include which of the following?

The manager's personal investment philosophy
Specific stock picks recommended by the manager
Historical market performance benchmarks
Return objectives and risk tolerance of the client (Correct answer)

Correct answer: Return objectives and risk tolerance of the client

An IPS must document the client's return objectives, risk tolerance, time horizon, liquidity needs, tax situation, legal constraints, and unique preferences.

Question 94: The Capital Market Line (CML) differs from the Security Market Line (SML) in that the CML:

Uses beta as its measure of risk, while the SML uses standard deviation
Is only relevant for bonds, while the SML applies to equities
Applies to individual securities, while the SML applies only to portfolios
Uses total risk (standard deviation) as its risk measure, while the SML uses systematic risk (beta) (Correct answer)

Correct answer: Uses total risk (standard deviation) as its risk measure, while the SML uses systematic risk (beta)

The CML applies to efficient portfolios and uses standard deviation (total risk), while the SML applies to any asset using beta (systematic risk).

Question 95: Value at Risk (VaR) at a 95% confidence level and a 1-day horizon means:

The portfolio will lose more than the VaR amount 5 days out of every 100 (Correct answer)
VaR equals 95% of the maximum possible daily loss
The expected loss over one day is exactly equal to VaR
The portfolio will never lose more than the VaR amount

Correct answer: The portfolio will lose more than the VaR amount 5 days out of every 100

95% VaR means there is a 5% probability of losing more than the VaR amount over the specified horizon; losses exceeding VaR are expected 5 out of every 100 days.

Question 96: Which of the following bond structures is most likely to protect an investor against falling interest rates?

A floating-rate note
A putable bond (Correct answer)
A callable bond
A fixed-rate bullet bond

Correct answer: A putable bond

A putable bond allows the investor to sell the bond back to the issuer at par, protecting against falling prices (rising rates), while a callable bond benefits the issuer when rates fall.

Question 97: Which of the following is a characteristic of a liability-driven investment (LDI) strategy, as used by pension funds?

Minimizing portfolio volatility regardless of liability structure
Investing only in equities for long-term growth
Matching asset duration and cash flows to the duration and timing of liabilities (Correct answer)
Maximizing portfolio return without regard to liabilities

Correct answer: Matching asset duration and cash flows to the duration and timing of liabilities

LDI strategies align the asset portfolio's duration and cash flows with the pension fund's liabilities to minimize the funding surplus/deficit volatility.

Question 98: Which depreciation method results in the highest depreciation expense in the early years of an asset's life?

Sum-of-the-years'-digits (when equal to straight-line)
Double-declining balance (Correct answer)
Straight-line
Units-of-production

Correct answer: Double-declining balance

The double-declining balance method applies a fixed rate to the declining book value, generating the highest depreciation charge in the earliest years.

Question 99: Under Standard V(A) – Diligence and Reasonable Basis, an analyst recommending a complex derivative product must:

Have a reasonable and adequate basis supported by appropriate research (Correct answer)
Base the recommendation on at least five years of historical data
Rely solely on the product manufacturer's research
Disclose only the risks that are publicly known

Correct answer: Have a reasonable and adequate basis supported by appropriate research

Standard V(A) requires analysts to have a reasonable, adequately researched basis for any investment recommendation, regardless of product complexity.

Question 100: The price-to-book (P/B) ratio is LEAST informative when analyzing a company in which sector?

Banking
Real estate
Insurance
Technology or software (Correct answer)

Correct answer: Technology or software

Technology and software firms have significant intangible assets (IP, brand, human capital) not fully captured on the balance sheet, making P/B less meaningful.

Question 101: A stock's required rate of return using the CAPM is most directly impacted by a change in:

The company's dividend payout ratio
The number of shares outstanding
The stock's beta coefficient (Correct answer)
The company's debt-to-equity ratio

Correct answer: The stock's beta coefficient

In CAPM, required return = risk-free rate + beta × equity risk premium; beta is the key company-specific variable that directly affects the required return.

Question 102: In the CFA curriculum, which phase of the business cycle is characterized by rising GDP, declining unemployment, and increasing inflation?

Contraction
Expansion (Correct answer)
Trough
Peak

Correct answer: Expansion

During an expansion, economic output (GDP) rises, unemployment falls, and inflation tends to increase as demand outpaces supply.

Question 103: Kate Smith, CFA, is thinking about diversifying her typical investment portfolio with hedge funds. Werner calculates the diversification benefits of investing 5% of a portfolio's assets to hedge funds based on historical mean and standard deviation of hedge fund index results, as well as their association with traditional investment returns. Werner is most likely to:

underestimate the potential diversification benefits to the portfolio.
overestimate the potential diversification benefits to the portfolio. (Correct answer)
accurately estimate the potential diversification benefits to the portfolio.

Correct answer: overestimate the potential diversification benefits to the portfolio.

Using historical hedge fund index results to estimate diversification benefits often leads to overestimation due to several biases. These include survivorship bias (failed funds are removed, inflating returns), backfill bias (funds report past good performance upon joining an index), and liquidity bias (smoothed returns underestimate true volatility and correlation). These biases make hedge funds appear to have higher returns, lower volatility, and lower correlation with traditional assets than they actually do, thus overstating their diversification potential.

Question 104: Factor investing (smart beta) differs from traditional passive investing by:

Avoiding any rebalancing to minimize transaction costs
Tilting the portfolio toward specific risk factors like value, momentum, or low volatility (Correct answer)
Selecting stocks based on fundamental analysis only
Using market-cap weighting to track a broad index

Correct answer: Tilting the portfolio toward specific risk factors like value, momentum, or low volatility

Smart beta strategies systematically tilt toward rewarded factors (value, size, momentum, quality, low volatility) rather than pure market-cap weighting.

Question 105: In the Black-Scholes-Merton model, an increase in which of the following inputs increases call option value?

Increase in the strike price
Decrease in underlying stock price
Increase in time to expiration (Correct answer)
Decrease in risk-free rate

Correct answer: Increase in time to expiration

More time to expiration increases option value because there is more opportunity for the underlying to move favorably; time decay (theta) erodes value as expiry approaches.

Question 106: When compared to its accounting-based net asset value (NAV), a hedge fund trading NAV:

is likely to be higher because of upward bias in model—based security values.
may be higher or lower, reflecting gains or losses on securities designated for short—term
will be lower because of adjustments for illiquid positions. (Correct answer)

Correct answer: will be lower because of adjustments for illiquid positions.

A hedge fund's trading NAV is often a more conservative estimate than its accounting-based NAV, especially due to adjustments for illiquid positions. Illiquid assets, which are difficult to sell quickly without a significant price concession, may be valued at a discount to reflect potential liquidation costs or market uncertainty. This aims to provide a more realistic, albeit lower, value that the fund could realize in a sale.

Question 107: In a defined benefit (DB) pension plan, the investment risk is borne by:

The employees (plan participants)
The plan sponsor (employer) (Correct answer)
The government through PBGC insurance only
Equally by employer and employees

Correct answer: The plan sponsor (employer)

In a DB plan, the employer guarantees a defined benefit and bears investment risk; if assets underperform, the sponsor must make additional contributions.

Question 108: The credit valuation adjustment (CVA) in bond pricing accounts for:

The premium paid for longer-duration bonds
The reduction in a bond's value due to the risk of issuer default (Correct answer)
The impact of embedded options on bond value
The adjustment for accrued interest in the bond's dirty price

Correct answer: The reduction in a bond's value due to the risk of issuer default

CVA is the present value of expected losses due to the possibility of issuer default, subtracted from the risk-free value of a bond to arrive at its risky fair value.

Question 109: Utilized buyout finance is assessing Siena Company relative to its peer companies. Siena is most likely a great candidate for an administration buy-in in the event that it has:

higher cash flow and less capable managers than its peers. (Correct answer)
higher cash flow and more capable managers than its peers.
lower cash flow and more capable managers than its peers.

Correct answer: higher cash flow and less capable managers than its peers.

A company is most likely a great candidate for a management buy-in (MBI) if it has higher cash flow, as this cash flow is crucial for servicing the debt used in a leveraged buyout. Additionally, less capable existing managers present an opportunity for the new management team to improve operations and unlock value, making the target more attractive for an MBI.

Question 110: Standard III(A) – Loyalty, Prudence, and Care requires that members place whose interests first when managing a portfolio?

Their employer's interests
Regulatory bodies' interests
Their own interests
Clients' interests (Correct answer)

Correct answer: Clients' interests

Standard III(A) requires members to act in their clients' best interests and place client interests before their own or their employer's.

Question 111: A company repurchases shares in the open market. All else equal, this will MOST likely:

Have no effect on EPS
Decrease return on equity (ROE)
Decrease earnings per share (EPS)
Increase earnings per share (EPS) (Correct answer)

Correct answer: Increase earnings per share (EPS)

Share buybacks reduce the share count; if net income is unchanged, EPS rises because the same earnings are divided among fewer shares.

Question 112: Put-call parity states that for European options, the relationship is:

Call price – Put price = Current stock price – Strike price
Call price + Strike price (PV) = Put price + Current stock price (Correct answer)
Call price + Current stock price = Put price + Strike price (PV)
Call price = Put price always

Correct answer: Call price + Strike price (PV) = Put price + Current stock price

Put-call parity: C + PV(X) = P + S, where C = call price, PV(X) = present value of strike, P = put price, S = current stock price.

Question 113: When analyzing emerging market bonds for a US investor, which additional risk factor is most important compared to domestic bond analysis?

Sovereign and currency risk (Correct answer)
Duration risk
Convexity risk
Reinvestment risk

Correct answer: Sovereign and currency risk

Emerging market bonds carry sovereign risk (government default or restructuring) and currency risk (local currency depreciation against USD), which are less significant for domestic bonds.

Question 114: Enterprise Risk Management (ERM) differs from traditional risk management by:

Focusing only on financial market risks such as interest rate and credit risk
Delegating risk management to individual business units independently
Prioritizing compliance risk above all other risk categories
Integrating all categories of risk (financial, operational, strategic, reputational) into a unified firm-wide framework (Correct answer)

Correct answer: Integrating all categories of risk (financial, operational, strategic, reputational) into a unified firm-wide framework

ERM takes a holistic, firm-wide approach by integrating all risk types into a single coordinated framework, rather than managing each risk category in silos.

Question 115: Which risk management strategy is MOST appropriate when a firm wants to eliminate the risk of an adverse price move but retain the potential to benefit from a favorable move?

Short a futures contract on the exposure
Sell an option to collect premium and offset losses
Buy an option to hedge the downside while retaining upside (Correct answer)
Enter a forward contract to lock in a fixed price

Correct answer: Buy an option to hedge the downside while retaining upside

Buying options provides asymmetric protection: you pay a premium to eliminate downside risk while retaining full upside participation if prices move favorably.

Question 116: Key rate duration (partial duration) is most useful for a portfolio manager seeking to:

Measure a portfolio's sensitivity to a parallel shift in the entire yield curve
Immunize against reinvestment risk for a single horizon date
Identify and hedge exposure to non-parallel yield curve movements such as twists and butterflies (Correct answer)
Estimate the credit spread sensitivity of individual corporate bond positions

Correct answer: Identify and hedge exposure to non-parallel yield curve movements such as twists and butterflies

Key rate duration measures a portfolio's price sensitivity to a change in yield at a specific maturity point on the curve, holding all other points constant. This makes it ideal for quantifying and managing exposure to non-parallel shifts — such as curve steepening, flattening, or butterfly movements — that a single summary duration measure would miss entirely.

Question 117: The concept of 'crowding out' in economics refers to:

Excessive imports crowding out domestically produced goods
Government deficits reducing private investment by driving up interest rates (Correct answer)
High corporate taxes reducing business formation
Central bank bond purchases eliminating private sector bond markets

Correct answer: Government deficits reducing private investment by driving up interest rates

Crowding out occurs when government borrowing increases interest rates, raising the cost of capital and reducing private sector investment spending.

Question 118: Under IFRS, which inventory cost flow assumption is NOT permitted?

Specific identification
FIFO (first-in, first-out)
Weighted average cost
LIFO (last-in, first-out) (Correct answer)

Correct answer: LIFO (last-in, first-out)

IFRS prohibits LIFO, though it is allowed under U.S. GAAP.

Question 119: Covered interest rate parity (CIP) states that the forward exchange rate between two currencies is determined by:

The differential in interest rates between the two countries (Correct answer)
Relative purchasing power in each country
Central bank intervention in the foreign exchange market
Relative inflation rates between the two countries

Correct answer: The differential in interest rates between the two countries

CIP requires the forward exchange rate to reflect the interest rate differential between two countries; otherwise, risk-free arbitrage profits would be available.

Question 120: Conditional VaR (CVaR), also called Expected Shortfall, improves on VaR because it measures:

The loss from systematic risk only
The expected loss given that the loss exceeds the VaR threshold (Correct answer)
The maximum possible loss with certainty
The loss at exactly the VaR confidence level

Correct answer: The expected loss given that the loss exceeds the VaR threshold

CVaR is the average loss in the tail beyond the VaR threshold, capturing tail risk that VaR ignores by only identifying the threshold but not the severity of losses beyond it.

Question 121: A company with S2 earnings per share decides to buy back a portion of its stock at $25 per share. The company's after-tax cost of debt is 6%, and it gets a 2% after-tax yield on its spare cash. - When the company buys back shares, the earnings per share will be:

decrease if the firm funds the repurchase with debt, but increase if the firm uses excess cash to repurchase the shares.
increase if the firm funds the repurchase with debt or uses excess cash to repurchase the shares. (Correct answer)
decrease if the firm funds the repurchase with debt or uses excess cash to repurchase the shares.

Correct answer: increase if the firm funds the repurchase with debt or uses excess cash to repurchase the shares.

A stock repurchase reduces the number of outstanding shares. If the company uses excess cash, it replaces a low-yielding asset (2% after-tax) with a higher-yielding one (implied earnings yield of $2/$25 = 8%), thus increasing EPS. If funded by debt, the after-tax cost of debt (6%) is less than the earnings yield of the repurchased shares (8%), meaning the earnings saved per share exceed the cost of financing. In both scenarios, the earnings per share will increase.

Question 122: A fixed-income analyst states: 'A bond with higher convexity will outperform a bond with lower convexity and the same duration, regardless of the direction of the interest rate change.' This statement is most accurately described as:

Incorrect, because convexity only benefits the bondholder when rates rise
Correct, because higher convexity directly implies a higher coupon rate
Correct, because positive convexity causes a bond to gain more than duration predicts when rates fall and lose less than duration predicts when rates rise (Correct answer)
Incorrect, because convexity improvements are only observable for large parallel yield curve shifts

Correct answer: Correct, because positive convexity causes a bond to gain more than duration predicts when rates fall and lose less than duration predicts when rates rise

Positive convexity is a desirable property that benefits the bondholder symmetrically: when rates fall, the bond price rises more than the linear (duration) estimate; when rates rise, the bond price falls less than the linear estimate. This outperformance holds for any non-zero rate change, which is why investors pay a premium for higher convexity.

Question 123: Which of the following is considered a leading economic indicator?

Unemployment rate
Consumer Price Index (CPI)
Industrial production
Average weekly hours worked in manufacturing (Correct answer)

Correct answer: Average weekly hours worked in manufacturing

Average weekly hours worked in manufacturing is a leading indicator because firms adjust hours before hiring or laying off workers, signaling future employment and output trends.

Question 124: The form of short-term finance whose cost is most directly linked to a firm's customers' creditworthiness is:

issuing commercial paper.
factoring. (Correct answer)
an uncommitted line of credit.

Correct answer: factoring.

Factoring involves selling a company's accounts receivable to a third party (the factor) for immediate cash. The cost of factoring is heavily influenced by the creditworthiness of the firm's *customers*, as the factor assumes the risk of collecting those receivables. If the customers are less creditworthy, the factor will charge a higher fee to compensate for the increased risk of default.

Question 125: A portfolio manager uses a core-satellite strategy. The 'core' component is MOST likely:

A concentrated position in a single sector ETF
A low-cost passive index fund tracking a broad market benchmark (Correct answer)
An alternative investment in private equity
High-conviction active bets in small-cap stocks

Correct answer: A low-cost passive index fund tracking a broad market benchmark

In a core-satellite strategy, the core is a low-cost passive index providing broad market exposure, while satellites are active positions seeking alpha in specific areas.

Question 126: Delta (Δ) of an option measures:

The time decay of the option's value as expiration approaches
The sensitivity of delta itself to changes in the underlying price
The sensitivity of option price to changes in implied volatility
The rate of change of option price with respect to a $1 change in the underlying asset price (Correct answer)

Correct answer: The rate of change of option price with respect to a $1 change in the underlying asset price

Delta measures how much the option's price changes for a $1 move in the underlying asset; it ranges from 0 to 1 for calls and –1 to 0 for puts.

Question 127: Which of the following is NOT a component of the CFA Institute Professional Conduct Program?

Investigation of potential violations
Self-disclosure of violations on the annual Professional Conduct Statement
Review of public complaints against members
Mandatory reporting of violations by member employers (Correct answer)

Correct answer: Mandatory reporting of violations by member employers

The Professional Conduct Program relies on self-disclosure, public complaints, and investigations, but employers are not mandated to report violations on members' behalf.

Question 128: Mean-variance optimization in portfolio construction is MOST limited by which of the following practical challenges?

The requirement for all assets to have positive expected returns
The inability to include bonds in the optimization
The exclusion of transaction costs from portfolio returns
Sensitivity to input estimates (expected returns, variances, correlations) which are difficult to forecast accurately (Correct answer)

Correct answer: Sensitivity to input estimates (expected returns, variances, correlations) which are difficult to forecast accurately

MVO is highly sensitive to small changes in input estimates, particularly expected returns, which leads to extreme and unstable portfolio weights in practice.

Question 129: Which of the following is an example of a top-down approach to equity analysis?

Using discounted cash flow to value individual companies
Analyzing a company's financial statements to determine intrinsic value
Screening stocks based on low P/E and high dividend yield
Starting with macroeconomic conditions, then narrowing to sector and finally individual stock selection (Correct answer)

Correct answer: Starting with macroeconomic conditions, then narrowing to sector and finally individual stock selection

A top-down approach begins with macroeconomic analysis (GDP, interest rates), then identifies attractive sectors, and finally selects individual stocks within those sectors.

Question 130: A portfolio manager is more likely to predict higher returns if a percentage of assets is allocated to alternative investments, because alternative investments:

often employ leverage. (Correct answer)
provide liquidity.
are more efficiently priced than traditional assets.

Correct answer: often employ leverage.

Alternative investments, such as hedge funds and private equity, frequently employ leverage to enhance potential returns. While leverage also amplifies risk, the ability to generate higher returns through borrowed capital is a key reason why portfolio managers allocate assets to these categories. This characteristic differentiates them from many traditional investments and contributes to their appeal for return-seeking investors.

Question 131: The information ratio (IR) is used to evaluate active portfolio managers and is calculated as:

Excess return divided by total risk
Portfolio return divided by portfolio standard deviation
Active return (alpha) divided by tracking error (Correct answer)
Alpha divided by portfolio beta

Correct answer: Active return (alpha) divided by tracking error

IR = Active return / Tracking error; it measures how much active return a manager generates per unit of active risk (deviation from the benchmark).

Question 132: Which of the following alternative investments would be best for a high-net-worth individual with a long time horizon and a need for immediate income?

Multi-strategy hedge funds.
Commercial real estate. (Correct answer)
Venture capital.

Correct answer: Commercial real estate.

Commercial real estate is the best alternative investment for a high-net-worth individual seeking a long time horizon and immediate income. It offers potential for capital appreciation over time and generates consistent rental income, fulfilling the need for immediate cash flow. Venture capital and multi-strategy hedge funds typically focus on capital growth rather than immediate income generation.

Question 133: A company reports a lower effective tax rate than its statutory tax rate. This difference is most likely caused by:

Higher depreciation for financial reporting than for tax purposes
Tax credits or tax-exempt income reducing the tax burden (Correct answer)
Permanent differences that increase taxable income
Temporary differences that increase deferred tax liabilities

Correct answer: Tax credits or tax-exempt income reducing the tax burden

Tax credits and tax-exempt income permanently reduce taxes owed below the statutory rate, lowering the effective tax rate without creating deferred tax items.

Question 134: In a leveraged buyout (LBO), the mezzanine finance part is most likely to:

be convertible to equity or include warrants. (Correct answer)
have seniority over other bonds issued to finance the LBO.
represent committed capital.

Correct answer: be convertible to equity or include warrants.

Mezzanine finance in a leveraged buyout (LBO) is a hybrid form of capital that combines debt and equity features. It is typically subordinated to senior debt but ranks above equity. A key characteristic is that mezzanine finance often includes an equity kicker, such as warrants or convertibility into equity, allowing lenders to participate in the company's upside potential if the LBO is successful.

Question 135: Vega (ν) measures an option's sensitivity to changes in:

The underlying asset's price
The risk-free interest rate
The time remaining to expiration
Implied volatility of the underlying asset (Correct answer)

Correct answer: Implied volatility of the underlying asset

Vega measures how much the option's price changes for a 1% change in implied volatility; options increase in value with higher volatility (for both calls and puts).

Question 136: Jensen's alpha measures portfolio performance as:

The actual portfolio return minus the CAPM-expected return given the portfolio's beta (Correct answer)
The portfolio return minus the benchmark return
The Sharpe ratio minus the Treynor ratio
The excess return per unit of tracking error

Correct answer: The actual portfolio return minus the CAPM-expected return given the portfolio's beta

Jensen's alpha = Rp – [Rf + β(Rm – Rf)]; it compares actual portfolio return to the CAPM-predicted return for the same level of systematic risk.

Question 137: An analyst observes a 1-year spot rate of 3.0% and a 2-year spot rate of 4.0%. The implied 1-year forward rate one year from today is closest to:

5.0% (Correct answer)
3.5%
4.5%
1.0%

Correct answer: 5.0%

The 1-year forward rate one year from now is derived from the no-arbitrage condition: (1 + S2)^2 = (1 + S1)(1 + f(1,1)). Solving: (1.04)^2 / (1.03) = 1.0816 / 1.03 ≈ 1.0500, giving a forward rate of approximately 5.0%. This reflects the additional return required in year 2 to make investing for two years equivalent to rolling over two consecutive one-year investments.

Question 138: For a bond with an embedded put option, which of the following most accurately describes the relationship between the bond's price and its yield to maturity relative to an otherwise identical option-free bond?

The putable bond will always have a lower price and higher yield than the option-free bond
The putable bond will have a higher yield than the option-free bond to compensate the issuer for granting the put option
The putable bond will have the same price as the option-free bond because embedded options have no intrinsic value at issuance
The putable bond will have a higher price and lower yield than the option-free bond, because the put option benefits the holder (Correct answer)

Correct answer: The putable bond will have a higher price and lower yield than the option-free bond, because the put option benefits the holder

An embedded put option grants the bondholder the right to sell the bond back to the issuer at a set price, providing downside protection against rising rates. Because this option has value to the holder, investors are willing to accept a lower yield (pay a higher price) for a putable bond compared to an equivalent option-free bond. The OAS of a putable bond is therefore higher than its nominal spread.

Question 139: Which of the following is an advantage of private wealth management over institutional portfolio management?

Institutional portfolios have better access to alternative investments
Institutional managers have larger economies of scale
Private wealth management has lower regulatory requirements
Private wealth management can be more tailored to unique individual tax and estate planning needs (Correct answer)

Correct answer: Private wealth management can be more tailored to unique individual tax and estate planning needs

Private wealth management excels at customizing strategies for individual tax situations, estate planning, concentrated positions, and unique personal goals that institutions don't face.

Question 140: Which financial ratio best measures a company's ability to meet short-term obligations using its most liquid assets?

Quick (acid-test) ratio (Correct answer)
Interest coverage ratio
Gross margin
Debt-to-equity ratio

Correct answer: Quick (acid-test) ratio

The quick ratio excludes inventory, focusing on cash, marketable securities, and receivables.

Question 141: Which equity valuation multiple is most appropriate when comparing companies with different capital structures?

Dividend Yield
Price-to-Earnings (P/E)
EV/EBITDA (Correct answer)
Price-to-Book (P/B)

Correct answer: EV/EBITDA

EV/EBITDA is capital structure-neutral because enterprise value and EBITDA are both pre-debt measures, making it the best cross-company multiple when leverage differs.

Question 142: Which of the following is most likely to happen if a company employs the weighted average cost of capital (WACC) to discount the cash flows of higher-risk projects?

The overall risk of the firm’s investments will rise over time. (Correct answer)
Project NPVs will be understated.
The firm will reject profitable projects.

Correct answer: The overall risk of the firm’s investments will rise over time.

Using the firm's overall weighted average cost of capital (WACC) to discount higher-risk projects effectively understates their true cost of capital. This leads to these projects appearing more attractive (higher NPV) than they actually are, causing the firm to accept projects that are riskier than its average. Consequently, the firm's overall risk profile will gradually increase over time as it undertakes more of these mispriced high-risk ventures.

Question 143: Which of the following is NOT a characteristic of exchange-traded derivatives?

Daily mark-to-market with margin calls
Centralized clearing through a clearinghouse
Standardized contract terms
Fully customizable terms to meet counterparty needs (Correct answer)

Correct answer: Fully customizable terms to meet counterparty needs

Exchange-traded derivatives have standardized, non-customizable terms; customization is the hallmark of OTC derivatives, which sacrifice standardization for flexibility.

Question 144: Which behavioral bias causes investors to hold losing positions too long and sell winners too early?

Disposition effect (Correct answer)
Overconfidence bias
Anchoring bias
Herding bias

Correct answer: Disposition effect

The disposition effect is the tendency to sell winning investments prematurely (to lock in gains) and hold losing investments too long (to avoid realizing losses).

Question 145: The primary goal of portfolio rebalancing is to:

Reduce portfolio risk to zero
Minimize taxes by avoiding selling appreciated assets
Restore the portfolio to its target strategic asset allocation after market drift (Correct answer)
Maximize portfolio returns by shifting to top-performing assets

Correct answer: Restore the portfolio to its target strategic asset allocation after market drift

Rebalancing restores the portfolio to its policy (target) weights after price movements cause the actual allocation to drift from the strategic target.

Question 146: The spot price of a commodity market is in contango if it is:

lower than futures prices (Correct answer)
higher than futures prices.
equal to futures prices.

Correct answer: lower than futures prices

A commodity market is in contango when the futures price is higher than the current spot price. This market structure typically reflects the costs of holding the physical commodity over time, such as storage costs and insurance, exceeding any convenience yield. The opposite condition, where futures prices are lower than spot prices, is called backwardation.

Question 147: Which economic concept explains why some countries specialize in producing certain goods even if they are absolutely less efficient than their trading partners?

Factor endowment theory
Economies of scale
Absolute advantage
Comparative advantage (Correct answer)

Correct answer: Comparative advantage

Comparative advantage shows that countries benefit from specializing in goods where they have the lowest opportunity cost, even if a trading partner is better at producing everything.

CFA Level I (Chartered Financial Analyst) Exam

The CFA Level I exam tests foundational knowledge of investment tools, asset classes, portfolio management, and professional ethics for candidates pursuing the Chartered Financial Analyst designation administered by CFA Institute.

180

Questions

270 min

Time Limit

70%

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