Diagnostic mock

180 questions, 3 choices each, a target of about 270 minutes, sampled by this exam's own topic weight, the way the real exam is built. One free mock, in full, every time. Above-the-exam items are excluded on purpose: a mock should feel like exam day, not like desirable difficulty.

CFA Program Level IDiagnostic mock

Questions

Pick an answer, say how sure you are, then reveal. Every question also updates your mastery map the same way practice does.

Question 1Exam level

Which of the following characteristics is most likely associated with alternative investments relative to traditional investments?

How sure are you?

Correct: B. Alternative investments are defined in contrast to traditional investments (stocks and bonds). Their defining characteristics include lower liquidity (assets cannot easily be sold), limited transparency (less regulatory disclosure required), and unique legal structures. Higher fees and limited regulation are also characteristics, but lower liquidity combined with limited transparency is the most fundamental distinguishing characteristic tested at Level I.
A. You might associate 'investment' with regulation and think all financial products are heavily regulated. Alternative investments have LESS regulation than traditional funds like mutual funds; they often operate via limited partnerships outside the Investment Company Act.
C. The appeal of alternatives is often stated as 'diversification'. You might confuse the goal with the characteristic. Low apparent correlation is a consequence of smoothed pricing, not a defining characteristic; and the correlation benefit is partly a statistical artifact, not a fundamental property.

Unit: alternative-investment-features-methods-and-structures

Question 2Exam level

The J-curve effect in private equity most likely refers to:

How sure are you?

Correct: B. The J-curve describes the typical return pattern of a private equity fund. In the early years (typically years 1–3), the fund shows negative returns because: (1) management fees are being charged on committed capital while investments haven't yet appreciated, (2) early investments may be written down, and (3) no exits have occurred yet to realize gains. As the fund matures (years 4–8), successful exits generate positive returns, creating the characteristic J-shape: dip first, then rise. The shape resembles the letter 'J' when cash flows or returns are plotted over time.
A. Many equity strategies do show early outperformance followed by regression to the mean. You might map a familiar pattern onto PE. The J-curve is specifically about early NEGATIVE returns (not just lower returns) followed by positive returns. Not about declining outperformance.
C. The topic of correlation comes up frequently in alternatives discussions. The J-curve has nothing to do with correlation; it describes the time-series pattern of internal returns within the fund.

Unit: alternative-investment-features-methods-and-structures

Question 3Exam level

An investor holds a long position in crude oil futures. The current spot price of crude oil is $80 per barrel. The 3-month futures price is $83 per barrel, and the 6-month futures price is $86 per barrel. When the investor rolls the 3-month contract into the 6-month contract, the roll return is most likely:

How sure are you?

Correct: B. The correct answer is Negative, because the investor sells the cheaper near-term contract and buys the more expensive far-term contract.
A. You might see futures > spot and interpret this as the investor gaining on the price differential. Intuition says 'higher price is better.'. The investor is LONG futures, not short. Being long in a contango market means you must continuously roll into higher-priced contracts. You're always buying high.
C. Convergence to spot at expiration is a real phenomenon. Futures prices converge to spot as expiration approaches. You might partially remember this and apply it incorrectly to the roll. Convergence applies at expiration of a single contract, not during rolling.

Unit: natural-resources

Question 4Exam level

The total return on a fully collateralized commodity futures position most likely consists of which of the following components?

How sure are you?

Correct: B. The correct answer is Spot return, roll return, and collateral return.
A. You might learn spot return and roll return as the two 'interesting' components and forget collateral return because it seems like a technicality. Collateral return is explicitly tested. In practice it is economically significant. Posting $1,000,000 in T-bills as collateral earns the T-bill rate, which at 5% is $50,000/year. A material return component.
C. Convenience yield appears throughout the commodity reading and candidates incorrectly think it's a return component for the futures investor. Convenience yield is NOT a return component for a futures investor. It is a benefit of holding the PHYSICAL commodity (inventory optionality). The futures investor does not hold physical inventory and therefore does not receive convenience yield.

Unit: natural-resources

Question 5Exam level

A hedge fund begins the year with a NAV of $100 million. During the year, it earns a gross return of 25%, so NAV rises to $125 million. The fund charges a 2% management fee (on beginning NAV) and a 20% performance fee. No high-water mark applies. The total fee paid to the manager is closest to:

How sure are you?

Correct: A. Management fee = 2% × $100M = $2M. Performance fee = 20% × ($125M - $100M) = 20% × $25M = $5M. Total = $2M + $5M = $7M.
B. You might calculate only the performance fee ($5M) and forget the management fee. Management fee is always charged regardless of performance. It is charged on AUM, not on profits.
C. You might calculate only the management fee (2% × $100M = $2M). Performance fee is also owed because the fund earned a positive return above the hurdle (no hurdle stated in this case).

Unit: hedge-funds

Question 6Exam level

Which hedge fund strategy is most likely described as 'market-neutral'?

How sure are you?

Correct: B. Market-neutral means the strategy has no net exposure to broad market movements (beta ≈ 0). Long/short equity can be structured market-neutral by perfectly offsetting long and short positions. Global macro takes directional bets on macro variables (not neutral). Merger arb has deal-specific risk (not market neutral per se, though it has low market beta). Managed futures follows trends.
A. Global macro sounds 'neutral' because it spans many markets. Global macro takes explicit directional bets on currencies, rates, equities, commodities. Highly directional.
C. Merger arb profits are largely independent of broad market direction, so candidates confuse 'low market beta' with 'market neutral'. Merger arb is event-driven and exposed to deal-specific risk, not a true market-neutral strategy.

Unit: hedge-funds

Question 7Exam level

An investor is evaluating two infrastructure projects. Project A is a newly constructed toll road expected to open in three years. Project B is an operating airport that has been collecting landing fees for fifteen years. Which characterization is most accurate?

How sure are you?

Correct: A. Greenfield assets are under construction or in pre-operational phase (Project A. The new toll road not yet open). Brownfield assets are operational with an established revenue track record (Project B. The existing airport). The trap is confusing 'green' with 'environmental' or 'new' generically. The specific CFA definition is construction-phase vs operational-phase.
B. You might be tempted by the idea that both projects are brownfield due to their toll-based nature, but this overlooks the key distinction that Project A, as a new construction not yet operational, fits the greenfield definition, whereas Project B, with its long-standing operations, is truly brownfield.
C. You might be tempted by the involvement of government concessions, thinking it defines greenfield status, but greenfield specifically refers to new construction or pre-operational phases, not the nature of the concession; Project B, being an operational airport, clearly fits as brownfield.

Unit: real-estate-and-infrastructure

Question 8Exam level

A pension fund seeks investments with stable cash flows, inflation protection, and low correlation to equities to match its long-dated liabilities. Which infrastructure characteristic most directly serves the inflation protection goal, most likely?

How sure are you?

Correct: A. CPI escalation clauses in concession agreements and regulated asset base (RAB) frameworks directly link infrastructure revenues to inflation. When CPI rises, revenues rise. Protecting the real value of cash flows. Long asset life (C) is relevant to matching liabilities by duration but does not directly provide inflation protection. Monopoly position (D) provides pricing power but is not the specific inflation linkage mechanism. Illiquidity premium (A) is a return premium, not an inflation hedge.
B. Choosing the long asset life of infrastructure assets might seem logical because it aligns with the pension fund's long-term liabilities, but this option fails to address the specific need for inflation protection, unlike revenue escalation clauses that directly link revenues to CPI changes.
C. Choosing the monopoly position of infrastructure operators might seem appealing because it suggests stable and predictable cash flows, but it fails to directly address inflation protection like CPI escalation clauses do by explicitly linking revenues to inflation metrics.

Unit: real-estate-and-infrastructure

Question 9Exam level

A private equity fund has $500M in committed capital. During year 1, the GP charges a 2% management fee but has only deployed $200M. The management fee for year 1 is closest to:

How sure are you?

Correct: B. Management fees are charged on COMMITTED capital ($500M), not invested capital ($200M). 2% × $500M = $10M. This is the core J-curve trap. Fees drain returns before investments mature.
A. You might be tempted to calculate the fee based on the deployed capital of $200M, leading to $4 million, but management fees are actually calculated on the committed capital of $500M, not the deployed amount, thus the correct fee is $10 million.
C. You might be tempted to calculate the fee based on the deployed capital of $200M, leading to $6 million, but management fees are actually calculated on the committed capital of $500M, not the deployed amount, thus the correct fee is $10 million.

Unit: investments-in-private-capital-equity-and-debt

Question 10Exam level

A PE fund invests $100M in a company with 70% debt financing. After 5 years, the company is sold for $300M. The debt has been repaid to $50M. The equity return (MOIC) is closest to:

How sure are you?

Correct: B. Initial equity = 30% × $100M = $30M. Exit equity = $300M sale price − $50M remaining debt = $250M equity. MOIC = $250M / $30M = 8.3x. Leverage dramatically amplifies equity returns when exits are successful.
A. You might be tempted to choose 3.0x if you only considered the overall sale price to initial investment ratio, ignoring the remaining debt and focusing solely on the total return, which would incorrectly suggest a 3x multiple. However, this overlooks the equity return calculation, which requires subtracting the remaining debt from the sale price to determine the true equity value, leading to the correct MOIC of 8.3x.
C. You might be tempted to choose 2.5x if you mistakenly calculated the return based on the initial total investment rather than the equity portion, ignoring the impact of debt financing which is crucial for accurately calculating MOIC.

Unit: investments-in-private-capital-equity-and-debt

Question 11Exam level

An analyst is evaluating two mutually exclusive projects. Project Alpha has an NPV of $120,000 and an IRR of 14%. Project Beta has an NPV of $95,000 and an IRR of 18%. The firm's required rate of return is 10%. Which project should the firm select, and which method should most likely guide the decision?

How sure are you?

Correct: A. The correct answer is Project Alpha. NPV is the preferred method for mutually exclusive projects because it directly measures value added to the firm. Project Beta's higher IRR does not mean it adds more wealth. It means it earns a higher percentage return on a potentially smaller or differently-timed cash flow base. NPV of $120,000 exceeds NPV of $95,000, so Alpha creates more shareholder value..
B. A higher percentage return intuitively feels like a better investment. IRR is a rate, not a value measure. For mutually exclusive projects, the project with the higher IRR can create less total value. CFA Institute explicitly states NPV is superior for ranking mutually exclusive projects.
C. Both projects pass the IRR accept/reject screen. Passing the accept/reject screen means both are acceptable independently, but only one can be chosen. The ranking decision requires NPV.

Unit: capital-investments-and-capital-allocation

Question 12Exam level

A project has the following cash flows: Year 0: -$50,000; Year 1: $30,000; Year 2: $20,000; Year 3: $15,000. The firm's WACC is 12%. What is the project's NPV (nearest dollar), and should it be accepted, most likely?

How sure are you?

Correct: A. The correct answer is NPV = -50,000 + 30,000/1.12 + 20,000/1.12^2 + 15,000/1.12^3 = -50,000 + 26,786 + 15,944 + 10,677 = $3,407. Since NPV > 0, accept the project. On BA II Plus: CF0=-50000, C01=30000, C02=20000, C03=15000, I=12, NPV=CPT..
B. Adding up raw cash flows is the payback period instinct. NPV requires discounting each cash flow to present value. Ignoring the time value of money gives a meaningless number for decision-making.
C. Small margin feels risky. NPV > 0 is the correct accept criterion. The positive NPV of $3,407 means the project returns the WACC plus creates $3,407 of additional value.

Unit: capital-investments-and-capital-allocation

Question 13Exam level

The IRR of a project is 15%. The firm's WACC is 12%. A key assumption embedded in the IRR calculation is that interim cash flows are most likely reinvested at:

How sure are you?

Correct: A. The correct answer is 15% (the IRR itself). IRR implicitly assumes all interim cash flows can be reinvested at the IRR. This is the reinvestment rate assumption and it is the primary theoretical weakness of IRR. Because in practice, the marginal reinvestment opportunity is closer to WACC, not IRR..
B. WACC is the firm's cost of capital and feels like the natural reinvestment rate. WACC is the correct reinvestment assumption for NPV, not IRR. IRR mathematically assumes reinvestment at the IRR itself. This distinction is precisely why NPV is theoretically superior.
C. The risk-free rate is conservative and might seem prudent. Neither IRR nor NPV assumes risk-free reinvestment. This answer conflates capital budgeting with modified duration formulas.

Unit: capital-investments-and-capital-allocation

Question 14Exam level

According to Modigliani and Miller's Proposition I with no taxes, the value of a firm is most likely described as being determined by:

How sure are you?

Correct: B. The correct answer is The cash flows generated by its assets.
A. You might think leverage ratios matter. They do in the real world. Under M-M's perfect market assumptions (no taxes, no distress costs, no asymmetric information), the D/E ratio is irrelevant to firm value.
C. Cost of equity sounds like a key value driver. Cost of equity changes with leverage under Prop II, but WACC and firm value stay constant. Cost of equity is endogenous, not exogenous.

Unit: capital-structure

Question 15Exam level

A firm has an unlevered cost of equity of 10% and a cost of debt of 6%. The firm's debt-to-equity ratio is 0.5. According to M-M Proposition II (no taxes), the firm's levered cost of equity is CLOSEST to:

How sure are you?

Correct: B. The correct answer is 12.0%.
A. Candidates who confuse Prop I and Prop II think cost of equity doesn't change. Prop I says firm VALUE doesn't change, not that cost of equity doesn't change. Prop II explicitly says cost of equity rises with leverage.
C. Using D/E = 0.5 as if it means debt is 50% of total assets (applying to total capital not equity). The D/E ratio is debt divided by equity, not debt divided by total capital. If D/E = 0.5, then D/(D+E) = 0.333, not 0.5.

Unit: capital-structure

Question 16Exam level

Under Modigliani-Miller with corporate taxes, a firm should most likely theoretically:

How sure are you?

Correct: C. The correct answer is Use as much debt as possible to maximize the value of the tax shield.
A. Students know debt carries risk, so they instinctively avoid extreme debt. In the M-M with taxes (but no distress costs) framework, the only effect of debt is the tax shield. There is no offsetting cost, so more debt is always better.
B. This is actually the correct answer under TRADE-OFF THEORY, not M-M with taxes. Trade-off theory adds financial distress costs to create an interior optimum. Under pure M-M with taxes, there is no distress cost. No balancing force.

Unit: capital-structure

Question 17Exam level

A company has 1,000,000 shares outstanding and three board seats up for election. Under cumulative voting, the maximum number of votes a shareholder owning 200,000 shares (20%) can cast for a single candidate is closest to:

How sure are you?

Correct: C. Under cumulative voting, a shareholder may cast (shares owned) x (board seats up for election) votes, concentrated on a single candidate: 200,000 x 3 = 600,000.
A. Candidates who confuse cumulative voting with statutory voting assume each share = one vote per seat. Under statutory voting, 200,000 shares = 200,000 votes per director election. Correct for statutory, wrong for cumulative.
B. Candidates who partially apply the cumulative rule may multiply by 2 instead of 3. The multiplier equals the number of seats being elected, not a fixed number.

Unit: corporate-governance-conflicts-mechanisms-risks-and-benefits

Question 18Exam level

Which of the following best describes the principal-agent problem in the context of corporate governance?

How sure are you?

Correct: B. The correct answer is A conflict arising because managers (agents) may make decisions that benefit themselves rather than shareholders (principals).
A. The word 'principal' triggers association with government/regulator roles in everyday language. In corporate finance, 'principal' specifically means the party who delegates authority. Here, shareholders.
C. Minority vs majority shareholder conflicts ARE a governance issue, but this misidentifies who is the principal and agent. Minority shareholders are not agents. They are also principals (owners). The agent role belongs to management.

Unit: corporate-governance-conflicts-mechanisms-risks-and-benefits

Question 19Exam level

A company reports the following annual data: Cost of Goods Sold = $480 million, Revenue = $600 million, Average Inventory = $80 million, Average Accounts Receivable = $50 million, Average Accounts Payable = $40 million. The company's Cash Conversion Cycle (CCC) is closest to:

How sure are you?

Correct: B. DIO = (80/480) x 365 = 60.8 days. DSO = (50/600) x 365 = 30.4 days. DPO = (40/480) x 365 = 30.4 days. CCC = 60.8 + 30.4 - 30.4 = 60.8 days.
A. Candidates who accidentally use Revenue as the DIO denominator get DIO = 80/600 x 365 = 48.7, then compute CCC = 48.7 + 30.4 - 30.4 = 48.7, which isn't one of the choices, so they might round and pick A. DIO must use COGS, not Revenue, because inventory is carried at cost.
C. Candidates who ADD DPO instead of subtracting it: 60.8 + 30.4 + 30.4 = 121.6... or who add all three without subtraction. DPO is subtracted because payables are financing provided by suppliers. Those days are not paid out of the company's own cash.

Unit: working-capital-and-liquidity

Question 20Exam level

A retail company's Days Inventory Outstanding (DIO) increased from 45 days to 62 days while Days Payable Outstanding (DPO) increased from 30 days to 38 days. The Days Sales Outstanding (DSO) remained constant at 25 days. Which of the following best describes the impact on the cash conversion cycle and the company's liquidity?

How sure are you?

Correct: A. Old CCC = 45 + 25 - 30 = 40 days. New CCC = 62 + 25 - 38 = 49 days. Change = +9 days. A longer CCC means more cash is tied up in operations for longer, so liquidity worsened.
B. Candidates who only look at DIO change (17 days) and ignore the DPO change offset. The DPO increase of 8 days partially offsets the DIO increase of 17 days. Net effect is 17 - 8 = 9 days.
C. Candidates who see DPO increased and think 'more days to pay = better liquidity'. While DPO increase is favorable on its own, the DIO increase was larger. The net CCC still increased, meaning liquidity worsened on balance.

Unit: working-capital-and-liquidity

Question 21Exam level

A derivative is most likely described as a financial instrument whose value is determined by:

How sure are you?

Correct: B. The correct answer is An underlying asset, rate, or index.
A. Bond prices are influenced by issuer creditworthiness. You might carry this association to derivatives. Creditworthiness of the issuer is irrelevant to how a derivative's value is determined. A crude oil forward's value depends on oil prices, not the creditworthiness of the counterparty.
C. Notional principal is prominently mentioned in swap descriptions and sounds like it determines value. Notional principal is a calculation input, not what determines value. A $10M interest rate swap's value changes based on interest rate movements, not the $10M notional figure.

Unit: derivative-instrument-and-derivative-market-features

Question 22Exam level

A non-dividend-paying stock currently trades at $80. The continuously compounded risk-free rate is 5% per annum. The no-arbitrage 6-month forward price is closest to:

How sure are you?

Correct: B. The correct answer is $82.02.
A. This is the result of using discrete compounding: $80 * (1.05)^0.5 = $81.98. The difference from the correct answer is small, so it seems plausible. The question explicitly states 'continuously compounded'. Using (1+r)^T when told continuous compounding is a formula misapplication.
C. If a candidate thinks 'forward price = spot price', they select this. This would only be true if the risk-free rate were zero. With r > 0 and no dividends, F0 > S0 always.

Unit: pricing-and-valuation-of-forward-contracts-and-for-an-underlying-with-varying-maturities

Question 23Exam level

An investor enters a long futures contract when the futures price is $1,050. The following day, the futures price rises to $1,060. Which of the following best describes the settlement that occurs?

How sure are you?

Correct: A. Futures contracts use daily mark-to-market settlement. When the price rises by $10, the long position gains $10 per unit of underlying, and this amount is credited to the long's margin account by the clearinghouse. The short's margin account is debited $10. This is variation margin. Distinct from initial margin. Settlement is through the clearinghouse, not directly between counterparties. The gain is realized daily, not at expiration.
B. You might be thinking that direct payments are made between the parties involved, but futures contracts settle through a clearinghouse, not directly between counterparties, so you would not pay $10 directly to the counterparty.
C. You might think that a rise in futures price requires additional margin, but initial margin is a fixed amount set at the beginning and does not change daily with price fluctuations; instead, daily price changes affect the variation margin, which is credited or debited to your margin account.

Unit: pricing-and-valuation-of-futures-contracts

Question 24Exam level

Compared to a forward contract on the same underlying, a futures contract is most likely:

How sure are you?

Correct: A. Futures are exchange-traded, standardized contracts (fixed contract size, expiration, and terms) cleared through a clearinghouse that marks positions to market daily. A forward contract is the customized, OTC, bilateral alternative with no daily settlement and typically no active secondary market.
B. You are describing a forward contract, not a futures contract. Forwards are the customized, privately negotiated, OTC instrument; futures are the standardized, exchange-traded one. Confusing the two by direction is the most common trap on this LOS.
C. A forward commitment (forward, futures, or swap) obligates BOTH parties to perform at a future date. Only options and other contingent claims obligate just one side (the writer), while the holder has the choice to exercise.

Unit: forward-commitment-and-contingent-claim-features-and-instruments

Question 25Exam level

Which of the following instruments is most likely classified as a contingent claim rather than a forward commitment?

How sure are you?

Correct: B. A contingent claim's payoff depends on a future event or condition, and only one party (the option holder) has the choice whether to perform; the writer's obligation is contingent on the holder's decision to exercise. Options (calls and puts) are the classic contingent claim. Swaps and forwards are forward commitments: both counterparties are obligated to perform, with no contingency or choice involved.
A. A swap is a series of forward-like exchanges of cash flows; both the fixed-rate payer and the floating-rate payer are obligated to make their payments regardless of how rates move. That symmetric, unconditional obligation is the hallmark of a forward commitment, not a contingent claim.
C. A forward contract, currency or otherwise, obligates both the long and the short to transact at the agreed price at expiration. Neither side has the option to walk away, which is exactly what distinguishes a forward commitment from a contingent claim.

Unit: forward-commitment-and-contingent-claim-features-and-instruments

Question 26Exam level

An investor buys a call option on a stock with a strike price of $50 and pays a premium of $4. At expiration, the stock price is $58. The profit per share to the call buyer is closest to:

How sure are you?

Correct: A. The correct answer is $4. Profit = max(S - X, 0) - premium = max(58 - 50, 0) - 4 = 8 - 4 = $4. The payoff is $8 but the profit nets out the $4 premium paid..
B. This is the gross payoff. Max(58-50, 0) = $8. You might stop here and forget to subtract the premium. Payoff is gross. Profit requires subtracting the premium cost of acquiring the option.
C. A candidate might think the premium makes the position a net loss without computing the payoff first. The call is exercised for a positive payoff of $8, which more than offsets the $4 premium.

Unit: pricing-and-valuation-of-options

Question 27Exam level

A put option has a strike price of $60. The stock is currently trading at $55. The intrinsic value of the put is closest to:

How sure are you?

Correct: A. The correct answer is $5. Intrinsic value of a put = max(X - S, 0) = max(60 - 55, 0) = $5. The put is in-the-money by $5..
B. A candidate applying call-option logic would write max(S - X, 0) = max(55 - 60, 0) = 0. For puts, intrinsic value = max(X - S, 0). The formula runs in the opposite direction from calls.
C. A candidate might compute 55 - 60 = -5 without applying the max(.,0) floor. Intrinsic value is floored at zero. Options never have negative intrinsic value. They simply expire worthless.

Unit: pricing-and-valuation-of-options

Question 28Exam level

A European call option on a non-dividend-paying stock has a premium of $8. The stock trades at $52, the exercise price is $50, the risk-free rate is 4% per year, and the option expires in one year. Using put-call parity, the value of a European put option with the same exercise price and expiration is closest to:

How sure are you?

Correct: A. Put-call parity: C + PV(X) = P + S. Rearrange to P = C + PV(X) - S. PV(X) = 50 / 1.04 = $48.08. P = 8 + 48.08 - 52 = $4.08. The correct answer is A.
B. You might use X instead of PV(X): P = 8 + 50 - 52 = $6.00, then rounds to $6.08. The strike price must be discounted. Using X instead of PV(X) is the single most common put-call parity error on the CFA exam.
C. You might subtract the call value from the stock price: P = S - C - X = 52 - 8 - 50 = -6 (takes absolute value), or uses wrong formula arrangement. Formula arrangement is C + PV(X) = P + S. Every term must be on the correct side before solving.

Unit: option-replication-using-put-call-parity

Question 29Exam level

Two parties enter a plain vanilla interest rate swap. Party A pays a fixed rate of 5% annually and Party B pays the floating rate. The notional principal is $10 million. At the first settlement date, the floating rate (SOFR) has reset to 6%. Which of the following best describes the net settlement payment?

How sure are you?

Correct: B. The correct answer is Party B pays Party A $100,000.
A. You might confuse which party is the 'payer'. They think 'fixed-rate payer' means the party receiving fixed payments. Fixed-rate payer = the party obligated to PAY fixed. When floating rises above fixed, the floating-rate payer owes more and makes the net payment.
C. You might divide the difference by 2, confusing semi-annual with annual settlement. The problem specifies annual settlement, so the full annual rate difference applies. No division by 2.

Unit: pricing-and-valuation-of-interest-rates-and-other-swaps

Question 30Exam level

During which phase of the business cycle would an analyst most likely observe declining inventory-to-sales ratios and rising capacity utilization?

How sure are you?

Correct: B. During expansion, demand is rising faster than inventory can be replenished, so the inventory-to-sales ratio falls. Capacity utilization rises as firms run plants closer to full capacity to meet demand. At the trough, inventories are excessive relative to weak sales, and capacity utilization is at its lowest.
A. Trough. You might confuse the trough (where cycle bottoms) with the early expansion. At the trough, inventory-to-sales ratios are ELEVATED and capacity utilization is at its LOW. The opposite of what the question describes.
C. Choosing peak might seem logical if you think high demand and capacity use define the end of an expansion, but at the peak, inventory-to-sales ratios typically start to rise as production struggles to meet demand, contradicting the observed falling ratios during expansion.

Unit: understanding-business-cycles

Question 31Exam level

Which of the following is LEAST likely classified as a lagging indicator of the business cycle?

How sure are you?

Correct: C. The yield spread between 10-year Treasuries and the federal funds rate is a LEADING indicator (it's one of the Conference Board's 10 LEI components). Banks only raise the prime rate AFTER the economy has already been expanding or is clearly in contraction. This confirming what already happened. Commercial loan growth peaks after economic expansion is underway. Unemployment duration peaks after the recession has already deepened.
A. You might be tempted to think that outstanding commercial and industrial loans indicate future economic activity, but this measure actually peaks after economic growth has already begun, making it a lagging indicator, unlike the yield spread which anticipates economic changes.
B. Average duration of unemployment. You might think unemployment is a leading indicator (it rises when recession is feared). The LEVEL of unemployment is lagging; the INITIAL CLAIMS for unemployment insurance is a leading indicator.

Unit: understanding-business-cycles

Question 32Exam level

The USD/EUR spot exchange rate is 1.1200. A dealer quotes a 90-day forward rate of 1.1050. Which of the following is most accurate?

How sure are you?

Correct: B. The correct answer is The EUR is at a forward discount relative to the USD.
A. You might see a lower forward rate and think 'fewer units = stronger' for the base currency (USD), but in USD/EUR notation, the USD is the price currency, not base. In USD/EUR, EUR is the base. EUR buys fewer USD forward than spot, so EUR is at a discount, not USD.
C. You might confuse which direction means premium. Some think 'lower number = premium for the price currency'. A currency is at a forward premium when it buys MORE of the other currency forward vs spot. EUR buys fewer USD forward, so EUR is at a discount.

Unit: exchange-rate-calculations

Question 33Exam level

A firm in a perfectly competitive market is producing at a level where price equals $45, average total cost equals $50, and average variable cost equals $38. Which of the following actions is most appropriate in the short run?

How sure are you?

Correct: B. The shutdown rule states that a firm should cease production only if price falls below average variable cost (P < AVC). Here, P = $45 > AVC = $38, so the firm covers its variable costs and contributes to fixed costs by operating. Although the firm earns a short-run economic loss (P < ATC), shutting down would result in a larger loss equal to total fixed costs. In the long run, if price remains below ATC, the firm exits. Option A is the classic wrong answer. Candidates confuse the shutdown condition (P < AVC) with the breakeven condition (P = ATC).
A. Option A is the classic wrong answer. You might confuse the shutdown condition (P < AVC) with the breakeven condition (P = ATC).
C. You might be tempted to think that increasing output will help the firm reach a break-even point where price equals average total cost, but in a perfectly competitive market, expanding output does not influence the market price, and attempting to change the price by altering output violates the principle of price takers, where firms must accept the market price.

Unit: the-firm-and-market-structures

Question 34Exam level

In the long run, a firm in monopolistic competition will most likely:

How sure are you?

Correct: C. Monopolistic competition long-run equilibrium occurs where P = LRAC (zero economic profit, same as perfect competition) BUT the firm does NOT produce at minimum LRAC. The demand curve is tangent to LRAC to the left of the minimum point, creating excess capacity. This differs critically from perfect competition, where long-run equilibrium is at the minimum of LRAC (efficient scale). Option A is wrong: free entry eliminates positive economic profit in the long run. Option B describes perfect competition, not monopolistic competition.
A. Option A is wrong: free entry eliminates positive economic profit in the long run.
B. Option B describes perfect competition, not monopolistic competition.

Unit: the-firm-and-market-structures

Question 35Harder

A monopolist faces a demand curve P = 120 - 2Q. Its marginal cost is constant at $40. To maximize profit, the monopolist will set price and quantity at closest to:

How sure are you?

Correct: A. Marginal revenue MR = 120 - 4Q (twice the slope of the linear demand curve). Setting MR = MC: 120 - 4Q = 40, so Q = 20. Substituting into demand: P = 120 - 2(20) = $80. A monopolist never sets P = MC (that is the competitive outcome); it sets MR = MC and reads price off the demand curve.
B. Option B is a common arithmetic error.
C. Option C represents the competitive equilibrium (P = MC = $40), which is incorrect for a monopolist.

Unit: the-firm-and-market-structures

Question 36Exam level

An industry consists of four firms with market shares of 40%, 30%, 20%, and 10%. The Herfindahl-Hirschman Index (HHI) for this industry is closest to:

How sure are you?

Correct: B. HHI = sum of squared market shares (expressed as whole numbers, not decimals): HHI = 40² + 30² + 20² + 10² = 1,600 + 900 + 400 + 100 = 3,000. This exceeds the DOJ threshold of 2,500, classifying the market as highly concentrated. The four-firm concentration ratio (CR4) = 100% (all four firms). 40, 0.30, 0.20, 0.10), multiply the HHI result by 10,000 to get the standard value. Option A is the common error from squaring decimals without multiplying by 10,000.
A. Option A is the common error from squaring decimals without multiplying by 10,000.
C. Choosing 1,000 might tempt you if you mistakenly sum the market shares instead of squaring them, but the HHI calculation requires squaring each market share and then summing those values, leading to a much higher number like 3,000.

Unit: the-firm-and-market-structures

Question 37Exam level

An economy has a marginal propensity to consume (MPC) of 0.75. The government increases spending by $200 billion. Assuming no crowding out and a closed economy, the total change in GDP is closest to:

How sure are you?

Correct: B. Government spending multiplier = 1/(1-MPC) = 1/(1-0.75) = 1/0.25 = 4. Total change in GDP = 4 x $200B = $800B. The key formula is 1/(1-MPC), not MPC/(1-MPC). The trap answer B ($600B) reflects candidates who compute 3 x $200B. Confusing the tax multiplier magnitude with the spending multiplier.
A. You might have calculated the multiplier as MPC/(1-MPC) which equals 3, leading to $600 billion, but this confuses the spending multiplier formula, which is actually 1/(1-MPC), resulting in a multiplier of 4 and a total change in GDP of $800 billion.
C. Choosing $150 billion might tempt you if you mistakenly calculate the change in GDP as the MPC times the government spending increase, but this ignores the multiplier effect, which amplifies the initial spending beyond just the MPC.

Unit: fiscal-policy

Question 38Exam level

The MPC in an economy is 0.8. The government reduces taxes by $100 billion. All else equal, the expected change in equilibrium GDP is closest to:

How sure are you?

Correct: A. Tax multiplier = -MPC/(1-MPC) = -0.8/0.2 = -4. A tax CUT of $100B means delta_T = -$100B. Change in GDP = -4 x (-$100B) = +$400B. The negative sign on the tax multiplier is essential. A common trap is applying the spending multiplier (1/(1-MPC) = 5) giving $500B. Answer A. The tax multiplier is always smaller in absolute value than the spending multiplier by exactly 1 unit: here, |tax multiplier| = 4 vs spending multiplier = 5.
B. You get $400 billion with the right multiplier math, but the sign is backwards. The tax multiplier is negative, -0.8 divided by (1 minus 0.8) equals -4, precisely because a tax increase reduces disposable income and spending. Here the government cut taxes by $100 billion, a negative change in taxes, so a negative multiplier times a negative change gives a positive $400 billion increase in GDP, not a decrease. Losing track of the tax cut's own negative sign is what produces -$400 billion instead of +$400 billion.
C. Choosing +$100 billion might seem logical if you think the tax cut directly translates to an equal increase in GDP, but this overlooks the amplifying effect of the tax multiplier, which indicates that the initial tax cut will lead to a larger increase in GDP due to increased consumption.

Unit: fiscal-policy

Question 39Harder

A government finances a large deficit through domestic borrowing. Which of the following best describes the primary channel through which crowding out reduces the effectiveness of expansionary fiscal policy?

How sure are you?

Correct: A. Crowding out occurs specifically through the loanable funds market: government borrowing increases demand for funds, pushing up interest rates. Higher rates make private investment projects unprofitable, reducing private investment spending. The increase in G is offset (partially or fully) by a decrease in I. Answer C describes monetary offset, not crowding out. A common confusion on the exam.
B. You might be thinking that monetary policy and fiscal policy are always aligned, but choice B confuses monetary offset with crowding out; crowding out specifically involves the loanable funds market, not central bank actions.
C. You might be thinking that higher domestic income from fiscal policy would naturally lead to more imports, but this describes the income effect on trade rather than the crowding out mechanism that occurs through the loanable funds market, where government borrowing raises interest rates and reduces private investment.

Unit: fiscal-policy

Question 40Exam level

A country runs a current account deficit of $50 billion. Which of the following must most likely be true?

How sure are you?

Correct: B. The BOP identity requires: Current Account + Capital Account + Financial Account = 0. A $50B current account deficit must be offset by a ~$50B combined surplus in the capital and financial accounts (capital account is typically very small, so the financial account carries most of the offset). Option A is wrong. Twin deficits (fiscal + current account) are correlated but not required. Option C is wrong. A deficit can persist for years with a stable or appreciating currency if capital inflows are strong (e.g., US dollar 1990s).
A. Option A is wrong. Twin deficits (fiscal + current account) are correlated but not required.
C. Option C is wrong. A deficit can persist for years with a stable or appreciating currency if capital inflows are strong (e.

Unit: international-trade

Question 41Exam level

Which of the following transactions would most likely be recorded in the CURRENT account of the United States balance of payments?

How sure are you?

Correct: B. Dividends received from a foreign subsidiary are income flows. They belong in the current account under 'primary income' (investment income). Option A (purchase of foreign shares) is a financial account transaction. It is an outflow of capital representing a financial investment. Option C (foreign purchase of US Treasuries) is also a financial account transaction. An inflow of foreign capital.
A. Option A (purchase of foreign shares) is a financial account transaction. It is an outflow of capital representing a financial investment.
C. Option C (foreign purchase of US Treasuries) is also a financial account transaction. An inflow of foreign capital.

Unit: international-trade

Question 42Exam level

A central bank lowers its policy interest rate. Which of the following best describes the PRIMARY transmission mechanism through which this action affects aggregate demand?

How sure are you?

Correct: B. The primary transmission mechanism runs: lower policy rate, then lower commercial lending rates, then cheaper borrowing for businesses and consumers, then increased investment and consumption, then higher aggregate demand. Option A confuses monetary with fiscal policy. Option C confuses the tool (OMO) with the transmission mechanism from the policy rate. The question asks about the transmission, not the tool used to set the rate.
A. Option A confuses monetary with fiscal policy.
C. Option C confuses the tool (OMO) with the transmission mechanism from the policy rate. The question asks about the transmission, not the tool used to set the rate.

Unit: monetary-policy

Question 43Exam level

According to the quantity theory of money (MV = PQ), if the velocity of money (V) remains constant and the money supply (M) increases by 5%, which of the following is most likely to occur in the long run?

How sure are you?

Correct: B. In the long run, classical economists and the quantity theory assume real output (Q) is determined by real factors (capital, labor, technology) and is not permanently affected by money supply changes. Therefore, if M increases 5% and V is constant, P must increase by approximately 5%. Option A (only Q rises) is a short-run Keynesian view. Option C splits the effect. Not supported by the quantity theory's long-run assumption.
A. Option A (only Q rises) is a short-run Keynesian view.
C. You might be tempted to think that an increase in money supply evenly splits between real output and the price level, but the quantity theory of money posits that in the long run, real output is determined by real factors and is not affected by changes in the money supply, thus choice C violates this principle by suggesting real output increases.

Unit: monetary-policy

Question 44Exam level

A stock is expected to pay a dividend of $2.50 at the end of the next year. The required rate of return is 10% and the constant growth rate of dividends is 4%. The intrinsic value of the stock using the Gordon Growth Model is closest to:

How sure are you?

Correct: A. GGM: V0 = D1 / (r - g) = $2.50 / (0.10 - 0.04) = $2.50 / 0.06 = $41.67. D1 is already given as the next-period dividend. No adjustment needed. Choice A ($25.00) is the trap for using D0 in the numerator as if $2.50 were the current dividend and forgetting to grow it: $2.50/(0.10-0.04) is correct but $2.50 itself is already D1 here, so A doesn't apply in this setup. Choice C is constructed from a rounding/arithmetic error. 50) comes from using r alone (2.50/0.04). Confusing growth rate with discount rate.
B. Choice C is constructed from a rounding/arithmetic error.
C. Choice C is constructed from a rounding/arithmetic error.

Unit: equity-valuation-concepts-and-basic-tools

Question 45Exam level

A non-callable preferred stock pays an annual dividend of $3.00 and has a required rate of return of 8%. The intrinsic value of the preferred stock is closest to:

How sure are you?

Correct: A. Preferred stock with constant dividend (g = 0) is a perpetuity: V0 = D / r = $3.00 / 0.08 = $37.50. Choice A ($24.00) uses the wrong rate or wrong formula. Choice C ($40.00) likely comes from using r = 7.5% by mistake. This is the zero-growth DDM, the simplest DDM variant, and is directly tested for preferred stock valuation.
B. Choosing $40.00 might tempt you if you mistakenly used a required rate of return of 7.5% instead of 8%, but the correct calculation for a perpetuity requires using the actual required rate of return, which is 8% here, leading to the intrinsic value of $37.50.
C. You might be tempted by choice C if you mistakenly divide the dividend by a higher rate, say 11%, which would yield $27.27, close to $27.78, but this violates the correct application of the required rate of return of 8%, leading to an inaccurate valuation.

Unit: equity-valuation-concepts-and-basic-tools

Question 46Exam level

A company currently pays a dividend of $1.80 per share (D0 = $1.80). Dividends are expected to grow at 5% per year indefinitely. If the required rate of return is 9%, the intrinsic value using the Gordon Growth Model is closest to:

How sure are you?

Correct: A. D0 is given, so D1 = D0 × (1 + g) = $1.80 × 1.05 = $1.89. V0 = D1 / (r - g) = $1.89 / (0.09 - 0.05) = $1.89 / 0.04 = $47.25. Choice A ($45.00) is the most common wrong answer: using D0 instead of D1 in the numerator ($1.80 / 0.04 = $45.00). 00) uses r - g incorrectly (e.g., 0.05 as denominator). This is the single most tested DDM question format on the CFA exam.
B. Choosing $20.00 might tempt you if you mistakenly use the dividend growth rate as the required rate of return, leading to an incorrect denominator of 0.05 instead of the correct 0.04, thus violating the proper application of the Gordon Growth Model formula.
C. Choosing $36.00 might tempt you if you mistakenly used the dividend growth rate of 5% as the required rate of return in the denominator, leading to $1.89 / 0.05 = $37.80, which rounds to $36.00, violating the correct application of the required rate of return in the Gordon Growth Model.

Unit: equity-valuation-concepts-and-basic-tools

Question 47Exam level

A company has a return on equity (ROE) of 15% and a dividend payout ratio of 40%. Using the sustainable growth rate formula, the expected constant growth rate for dividends is closest to:

How sure are you?

Correct: A. Sustainable growth rate: g = ROE × retention ratio = ROE × (1 - payout ratio) = 15% × (1 - 0.40) = 15% × 0.60 = 9.0%. Choice A (6.0%) likely comes from using ROE × payout ratio instead of ROE × retention ratio. A common inversion error. Choice C (15.0%) is simply the ROE, ignoring the retention rate. This formula is foundational for GGM when growth rate is not given directly.
B. Choosing 15.0% might seem logical if you mistakenly think the ROE directly represents the growth rate, but this overlooks the crucial role of the retention ratio in calculating the sustainable growth rate, leading to an overestimation.
C. Choosing 40.0% might seem logical if you mistakenly think the dividend payout ratio directly translates to the growth rate, but this ignores the role of ROE and the retention ratio in determining sustainable growth.

Unit: equity-valuation-concepts-and-basic-tools

Question 48Exam level

A two-stage DDM analysis projects the following: D1 = $1.00, D2 = $1.10, D3 = $1.21. Starting from Year 3, dividends grow at a constant rate of 5% forever. The required rate of return is 10%. The terminal value at the end of Year 3 is closest to:

How sure are you?

Correct: A. The terminal value (TV) at Year 3 uses D4 in the Gordon Growth Model: D4 = D3 × (1+g) = $1.21 × 1.05 = $1.2705. TV3 = D4 / (r - g) = $1.2705 / (0.10 - 0.05) = $1.2705 / 0.05 = $25.41. That gives Choice B. Let me clarify: some CFA exam versions compute TV3 = D3 / (r - g) when the constant growth begins AT the start of Year 4 (i.e., the Year 3 dividend is still part of the explicit forecast). TV3 = D3/(r-g) = $1.21/0.05 = $24.20. Choice A applies when the terminal value represents the PV at Year 3 of all dividends from Year 4 onward using D3 as the base (not grown again). The CFA curriculum uses TV_n = D_{n+1}/(r-g) which is $1.2705/0.05 = $25.41. Both versions appear in practice tests. The key is knowing the timing convention: TV is calculated using the NEXT period's dividend AFTER the terminal year.
B. Choosing $22.00 might tempt you if you incorrectly apply a discount factor to the terminal value calculation, but the terminal value at the end of Year 3 should directly use the dividend growth formula without additional discounting, making $22.00 incorrect.
C. Choosing $12.10 may tempt you if you mistakenly use the Year 3 dividend as the terminal value without applying the Gordon Growth Model, violating the requirement to account for perpetual growth starting from Year 4.

Unit: equity-valuation-concepts-and-basic-tools

Question 49Exam level

An analyst observes that a stock is currently trading at $50 per share. The stock's next expected dividend (D1) is $2.00, and the required rate of return is 10%. Using the Gordon Growth Model, the implied growth rate in the market price is closest to:

How sure are you?

Correct: B. Rearrange GGM: V0 = D1/(r-g), then r - g = D1/V0, then g = r - D1/V0 = 0.10 - (2.00/50) = 0.10 - 0.04 = 0.06 = 6.0%. D1/V0 = $2.00/$50 = 4% is the dividend yield. The implied growth rate = required return - dividend yield. This is the implied growth rate question type. The exam will give you the price and ask you to back-solve for g.
A. Choosing 4.0% might seem right if you only calculate the dividend yield (D1/V0 = 2.00/50 = 0.04 or 4%), but this ignores the required step of subtracting the dividend yield from the required rate of return to find the implied growth rate, which should be 6.0%.
C. Choosing 10.0% might seem logical if you assume the growth rate equals the required rate of return, but this ignores the dividend yield component, leading to a violation of the Gordon Growth Model where the growth rate must be less than the required return to ensure a positive stock price.

Unit: equity-valuation-concepts-and-basic-tools

Question 50Exam level

Which of the following companies is MOST appropriate to value using the Gordon Growth Model?

How sure are you?

Correct: A. The GGM (constant-growth DDM) requires: (1) the company pays dividends, (2) dividends grow at a constant rate forever, and (3) the required rate of return exceeds the growth rate (r > g). Mature utility companies with regulated returns and stable dividend policies fit all three conditions. Startups (A) don't pay dividends. Cyclical companies (C) have volatile, non-constant growth. Distressed companies (D) have suspended dividends. The exam frequently asks candidates to identify GGM-appropriate companies.
B. You might be tempted by the consistent dividend payments, but the key issue is that the mining company's dividends fluctuate significantly with commodity prices, violating the GGM requirement for a constant growth rate, unlike the stable growth of a mature utility company.
C. You might be tempted by C because a company in financial distress could seem like it has a low growth rate, but the key issue is that it has suspended its dividend, violating the GGM requirement that the company must consistently pay dividends.

Unit: equity-valuation-concepts-and-basic-tools

Question 51Exam level

A stock's required rate of return estimated via CAPM is 11%. The stock is expected to pay D1 = $3.00 and grow at 11% per year forever. The Gordon Growth Model intrinsic value is closest to:

How sure are you?

Correct: B. When g = r, the denominator (r - g) = 0, and division by zero is undefined. The GGM formula V0 = D1/(r-g) is mathematically invalid when g >= r. In economic terms, it would imply the stock has infinite value, which is impossible. The GGM only applies when r > g. The CFA exam tests this edge case to ensure candidates understand the model's limitations, not just its formula.
A. You might be tempted to plug the values into the Gordon Growth Model formula without checking if g is less than r, leading you to calculate a finite value like $300.00, but this violates the model's requirement that the growth rate must be less than the required rate of return for the formula to be valid.
C. Choosing $33.00 might seem plausible if you mistakenly apply the GGM formula without considering the condition that r must be greater than g for the model to work, leading you to incorrectly calculate V0 = D1 / (r - g) = 3 / (0.11 - 0.11), which violates the model's requirement that the discount rate exceeds the growth rate.

Unit: equity-valuation-concepts-and-basic-tools

Question 52Harder

A company currently pays an annual dividend of $2.00 (D0). The company's ROE is 12% and its earnings retention ratio is 50%. Using the sustainable growth rate and Gordon Growth Model, the intrinsic value of the stock, given a required rate of return of 10%, is closest to:

How sure are you?

Correct: C. g = ROE x retention ratio = 12% x 50% = 6%. D1 = D0 x (1+g) = $2.00 x 1.06 = $2.12. V0 = D1/(r-g) = $2.12/(0.10-0.06) = $2.12/0.04 = $53.00 exactly. The keyed choice, $52.00, is the closest of the three offered values to that exact result. A roughly 2% rounding gap, wider than typical for a CFA 'closest to' item, recorded here rather than smoothed over.
A. Uses D0 without growing it to D1: $2.00/0.04 = $50.00. The dividend must be grown one year to D1 = D0 x (1+g) before applying the Gordon Growth Model.
B. Does not match the Gordon Growth Model computation: g = 6%, D1 = $2.12, V0 = D1/(r-g) = $53.00, closest to the keyed $52.00.

Unit: equity-valuation-concepts-and-basic-tools

Question 53Exam level

A two-stage DDM analysis values a company with supernormal growth of 15% for the first 3 years, then constant growth of 4% thereafter. D0 = $1.00, required return = 12%. Which step is most likely performed FIRST when solving for V0?

How sure are you?

Correct: A. The two-stage DDM process: (1) Explicitly forecast dividends during the supernormal growth phase (D1, D2, D3 at 15%). (2) Calculate the terminal value at the end of the supernormal period using the Gordon Growth Model with the stable growth rate (D4/(r-g_stable)). (3) Discount all cash flows back to today using the required return. Step B is always first. Choice A is Step 2, not Step 1. Choice C is wrong. All discounting uses the required return r, not the growth rate.
B. Choice C is wrong. All discounting uses the required return r, not the growth rate.
C. Choice C is wrong. All discounting uses the required return r, not the growth rate.

Unit: equity-valuation-concepts-and-basic-tools

Question 54Exam level

According to the weak form of the efficient market hypothesis, which of the following strategies would most likely NOT be expected to consistently earn abnormal returns?

How sure are you?

Correct: A. Weak-form efficiency states that current prices fully reflect all past trading information, including price and volume history. A moving-average crossover signal is a technical strategy built entirely from past price and volume data, so it cannot generate consistent abnormal returns under weak-form efficiency.
B. Buying ahead of earnings announcements trades on information not yet public. That challenges semi-strong form, not weak form, since weak form only concerns past price/volume data.
C. Trading on insider information challenges strong-form efficiency, the strictest form. Weak form makes no claim about private information.

Unit: market-efficiency

Question 55Exam level

A portfolio manager discovers that stocks with high earnings surprises consistently outperform the market for 6 months following the announcement. If this finding is statistically robust, it most likely challenges which form of market efficiency?

How sure are you?

Correct: A. Post-earnings announcement drift (PEAD) is a semi-strong form anomaly. Earnings announcements are public information. If prices do not fully and immediately adjust to this public information, it violates semi-strong efficiency (which holds that all publicly available information is already priced in). It does not challenge weak-form (which only concerns past price data) nor strong-form (which concerns private/inside information).
B. You might be tempted to think that past price data is also relevant here, thus including weak form, but PEAD specifically relates to public information not being fully reflected in prices immediately, which is a semi-strong form issue, not a weak form one.
C. Choosing C might tempt you if you think that insider information is involved, but strong-form efficiency pertains to private or inside information not being exploited, whereas the earnings surprises are public information that semi-strong form efficiency should account for.

Unit: market-efficiency

Question 56Exam level

A research analyst finds that stock returns are significantly higher in January than in other months of the year, even after adjusting for risk. This finding is most consistent with which of the following?

How sure are you?

Correct: B. The January effect is a calendar anomaly. A pattern in publicly available data (month of year) that predicts returns. Its persistence would challenge semi-strong efficiency because month-of-year is a publicly known variable, and if it predicts returns, prices are not fully reflecting all public information. Option A is partially correct but incomplete. Option B contradicts the finding.
A. Option A is partially correct but incomplete.
C. You might be tempted to think that higher January returns indicate a consistent opportunity for alpha, but fundamental analysis relies on company-specific insights rather than calendar patterns, making choice C inconsistent with the observed calendar anomaly.

Unit: market-efficiency

Question 57Harder

Under the strong form of market efficiency, which of the following trading strategies would most likely be expected to consistently earn abnormal returns?

How sure are you?

Correct: A. Strong-form efficiency holds that ALL information, including private/insider information, is already reflected in prices. Therefore, no strategy, not even insider trading, can earn consistent abnormal returns. This is the extreme form and the empirical evidence actually REJECTS strong-form efficiency (studies show corporate insiders and specialists do earn abnormal returns), but by definition, the strong form says no strategy can consistently work.
B. You might think that proprietary models offer an edge over public information, but under strong-form efficiency, even fundamental analysis with unique models cannot consistently earn abnormal returns because all information, including that used in proprietary models, is already priced in.
C. You might be tempted to think that combining both fundamental and technical analysis could exploit market inefficiencies, but under strong-form market efficiency, all information is already priced in, making both approaches ineffective in earning abnormal returns consistently, thus violating the principle that no strategy can outperform in a strongly efficient market.

Unit: market-efficiency

Question 58Exam level

Which of the following pieces of evidence would most likely most strongly SUPPORT semi-strong form market efficiency?

How sure are you?

Correct: A. Semi-strong efficiency predicts that prices adjust rapidly and without systematic bias to all publicly available information. An earnings announcement is the classic public information event. If prices adjust immediately and completely, leaving no profitable trading opportunity after the announcement, this directly supports semi-strong efficiency. Option A contradicts semi-strong (analyst reports are public). Option C contradicts strong-form.
B. Choosing B might seem logical if you think that higher returns for insiders indicate market efficiency, but this actually supports weak-form efficiency being violated, as semi-strong form efficiency implies that all public information, not private information, is already reflected in stock prices.
C. Choosing C might seem logical if you think that momentum investing can persist, but this contradicts semi-strong form efficiency, which posits that all public information is already reflected in stock prices, leaving no room for consistent outperformance based on recent price movements.

Unit: market-efficiency

Question 59Exam level

An investor holds 1,000 shares of a company with 5 board director seats up for election. Under cumulative voting, the maximum number of votes the investor can cast for a single director candidate is closest to:

How sure are you?

Correct: A. Under cumulative voting, a shareholder receives votes equal to shares held multiplied by the number of director seats being contested. The shareholder may concentrate all votes on one candidate. 1,000 shares × 5 seats = 5,000 total votes, all of which may be cast for one director. Under statutory (straight) voting, the investor would cast a maximum of 1,000 votes per seat. Cumulative voting is designed to give minority shareholders greater board representation power. The exam tests this distinction frequently.
B. Choosing 200 might tempt you if you mistakenly divide the total votes by the number of seats, thinking each seat gets an equal share of your votes, but under cumulative voting, you can concentrate all your votes on a single candidate, making 200 far too conservative.
C. Choosing 5 might tempt you if you mistakenly think each share only gets one vote for each seat, but cumulative voting allows you to concentrate all your votes on a single candidate, so you multiply your shares by the number of seats, not limit yourself to one vote per seat.

Unit: overview-of-equity-securities

Question 60Exam level

A company's preferred stock pays a cumulative dividend of $3.00 per share annually. The company skipped dividends in Year 1 and Year 2 due to financial difficulty. In Year 3, the company earned sufficient profits to resume dividends. Before paying any common stock dividend in Year 3, the minimum total preferred dividend per share that must be paid is closest to:

How sure are you?

Correct: B. Cumulative preferred stock requires that all dividends in arrears (unpaid dividends from prior periods) must be paid before any common dividend can be distributed. Two years of arrears ($3.00 × 2 = $6.00) plus the current year's dividend ($3.00) = $9.00 total. Non-cumulative preferred stock does NOT accumulate arrears. Skipped dividends are gone permanently. This distinction is the single most tested concept in preferred stock on the CFA exam.
A. Choosing $6.00 might seem right if you only considered the dividends in arrears from Year 1 and Year 2, but it ignores the current year's dividend requirement for cumulative preferred stock, which means you must also add the Year 3 dividend of $3.00, making the total $9.00.
C. Choosing $0 because you might think preferred dividends are discretionary overlooks the mandatory nature of cumulative preferred dividends, which require all missed dividends plus the current year's dividend to be paid before any common dividends, totaling $9.00 in this case.

Unit: overview-of-equity-securities

Question 61Exam level

Which of the following best describes a sponsored Level I American Depositary Receipt (ADR)?

How sure are you?

Correct: B. Sponsored Level I ADRs are the most common. The foreign issuer cooperates with the depositary bank but is exempt from full SEC registration. They need only file Form F-6 and provide materials translated into English. They trade OTC (Pink Sheets/OTC Bulletin Board), NOT on major exchanges. Level II ADRs trade on major exchanges (NYSE, NASDAQ, AMEX) and require full Form 20-F filing. Level III ADRs additionally allow new capital raising in the US public markets. Unsponsored ADRs are created by depositary banks WITHOUT the foreign company's involvement and always trade OTC.
A. You might be tempted by choice A if you confuse sponsored with unsponsored ADRs, but choice A describes an unsponsored ADR where the foreign company does not cooperate, whereas in a sponsored Level I ADR, the foreign company actively cooperates with the US depositary bank.
C. You might be tempted by choice C if you associate SEC registration with the ability to raise new capital, but remember that sponsored Level I ADRs only meet minimal SEC reporting requirements and do not allow for new capital raising in the US primary market like Level III ADRs do.

Unit: overview-of-equity-securities

Question 62Exam level

Participating preferred stock is MOST likely to benefit shareholders when:

How sure are you?

Correct: B. Participating preferred stock allows holders to receive additional dividends beyond the stated rate if the company's profits exceed a specified threshold. Effectively 'participating' in the company's success alongside common shareholders. This feature benefits holders only when the company is highly profitable and declares excess dividends. The other scenarios describe benefits of cumulative preferred (A), liquidation preference (B), and falling interest rates which benefit non-callable fixed-rate preferred (D).
A. You might be tempted by choice A because it aligns with the typical liquidation preference of preferred stock, but participating preferred stock specifically benefits from additional dividends when the company is profitable, not from recovering par value during liquidation.
C. You might be tempted by choice C because falling interest rates typically make fixed-income securities more attractive, but participating preferred stock benefits from company profitability, not interest rate movements, making this choice irrelevant to the question.

Unit: overview-of-equity-securities

Question 63Exam level

Putable preferred stock is MOST advantageous to investors when:

How sure are you?

Correct: A. Putable preferred stock gives the holder the right to sell shares back to the issuer at a predetermined price. This right is most valuable when interest rates rise, because rising rates reduce the market value of fixed-income-like instruments (including fixed-rate preferred stock). The put option allows investors to exit at the put price rather than selling at a depressed market price. Callable preferred benefits the ISSUER when rates fall (they can refinance at lower cost). Convertible preferred benefits investors when the common stock price rises.
B. You might be tempted by the idea that a premium call is beneficial because it offers extra money, but remember that a put option is most valuable when market conditions, like rising interest rates, make the stock less valuable; a premium call by the company does not leverage this put feature effectively.
C. You might be tempted by the conversion feature of preferred stock, thinking it offers flexibility, but convertible preferred stock is designed to benefit from rising common stock prices, not to protect against rising interest rates like a put option does.

Unit: overview-of-equity-securities

Question 64Exam level

Global Depositary Receipts (GDRs) most likely differ from American Depositary Receipts (ADRs) primarily because GDRs:

How sure are you?

Correct: B. GDRs are negotiable certificates representing ownership of shares in a foreign company, similar to ADRs, but they can be listed and traded on multiple exchanges in multiple countries simultaneously (e.g., London Stock Exchange, Luxembourg Stock Exchange, Dubai Financial Market). ADRs are specifically structured for US markets and denominated in USD. GDRs are typically denominated in USD or Euros and are commonly used by companies seeking capital from investors across multiple jurisdictions without listing in each country's domestic market.
A. You might think GDRs bypass the need for a depositary bank, but both GDRs and ADRs require a depositary bank to act as an intermediary, making choice A incorrect.
C. You might think that GDRs require full compliance with each country's reporting rules because they are listed in multiple countries, but this overlooks the simplified reporting framework GDRs actually use, which contrasts with the broader flexibility of being listed on multiple exchanges as the correct answer indicates.

Unit: overview-of-equity-securities

Question 65Exam level

Which of the following formulas correctly expresses FCFF starting from net income, most likely?

How sure are you?

Correct: A. FCFF = NI + NCC + Int(1-t) - FCInv - WCInv. Depreciation (a non-cash charge) is added back. After-tax interest is added back because FCFF represents cash available to ALL capital providers before any financing payments. FCInv (capital expenditure net of asset sales) and WCInv (increase in working capital) are subtracted as they represent cash outflows required to sustain operations.
B. The sign on the interest term is backwards here. FCFF measures cash available to every capital provider, lenders and shareholders alike, before any financing payments are made. Net income already has after-tax interest expense subtracted out, so that amount has to be added back, not subtracted again, to get from a shareholders-only number back to a whole-firm number.
C. FCInv is capital expenditure net of asset sales, a cash outflow the firm must make to sustain and grow operations, so it is subtracted from net income, not added. Adding it back would overstate the cash actually available to all the firm's capital providers.

Unit: analyzing-statements-of-cash-flows-ii

Question 66Exam level

An analyst is evaluating the pharmaceutical industry and finds that a small number of large distributors purchase the majority of drugs from manufacturers. The manufacturers sell largely undifferentiated generic drugs that represent a major cost for the distributors. Which of Porter's Five Forces is MOST relevant to this situation?

How sure are you?

Correct: A. The exam tests exactly one thing here: buyer power is HIGH when buyers are few and concentrated, the product is undifferentiated (standardized), and the product represents a significant portion of the buyer's cost structure. All three conditions are present. This is buyer (customer) bargaining power, not supplier power. A common error candidates make when reading quickly.
B. Supplier power would describe the manufacturers pushing back on the distributors, but the scenario describes the opposite direction: a few large distributors, the buyers here, concentrated and price sensitive on an undifferentiated product that is a major cost line for them. That combination, few concentrated buyers, a standardized product, and high cost weight, is the textbook description of buyer power, not supplier power.
C. You might be tempted to choose the threat of substitutes because the drugs are undifferentiated, but remember, the high bargaining power of buyers stems from their concentration and cost sensitivity, not from the availability of substitutes, which is more about product differentiation and switching costs.

Unit: industry-and-competitive-analysis

Question 67Exam level

According to Porter's Five Forces framework, which of the following industry characteristics is MOST likely to reduce the threat of new entrants?

How sure are you?

Correct: A. High switching costs are a classic barrier to entry. When customers face significant costs (time, money, disruption) to switch providers, new entrants cannot attract customers even with lower prices. Giving incumbents a structural advantage. Option A (low fixed costs) actually lowers barriers because it reduces the capital required to enter. Option C (growth stage) increases the attractiveness of entry.
B. Choosing B might seem logical if you think growth attracts more entrants, but in Porter's framework, a growth stage industry actually attracts more entrants, increasing competition, which is the opposite effect you are looking for to reduce the threat of new entrants.
C. You might think that many competitors of similar size would deter new entrants by saturating the market, but this actually increases competitive rivalry, not barriers to entry, unlike high switching costs which directly hinder new entrants from attracting customers.

Unit: industry-and-competitive-analysis

Question 68Exam level

An equity analyst is using Porter's Five Forces to assess whether an industry is likely to generate returns on invested capital (ROIC) above the cost of capital over time. Which combination of force characteristics would MOST support this conclusion?

How sure are you?

Correct: A. The CFA curriculum explicitly links Porter's Five Forces to long-run profitability and ROIC. Weak rivalry preserves pricing power among incumbents. High barriers to entry prevent competitors from eroding margins. Few substitutes mean customers have no alternatives, supporting pricing power. Option C is incorrect because high supplier power would compress margins even if rivalry is weak and entry barriers are high. Options A and D describe competitive, low-profit industries.
B. Option C is incorrect because high supplier power would compress margins even if rivalry is weak and entry barriers are high.
C. Option C is incorrect because high supplier power would compress margins even if rivalry is weak and entry barriers are high.

Unit: industry-and-competitive-analysis

Question 69Exam level

A company operates in an industry where it can increase prices without losing customers to competitors or substitutes. This characteristic is most likely described as:

How sure are you?

Correct: A. The CFA curriculum defines pricing power as the ability to raise prices without significant customer attrition. It is a direct outcome of Porter's Five Forces analysis: when buyer bargaining power is low, substitutes are scarce, and rivalry is weak, firms retain pricing power. This is distinct from competitive advantage (which is the broader strategic position) and market concentration (which is a structural characteristic that may or may not confer pricing power).
B. Choosing competitive advantage might seem right if you think it encompasses all aspects of a company's market position, but competitive advantage refers to a broader strategic edge that includes factors beyond just pricing, whereas pricing power specifically denotes the ability to raise prices without losing customers.
C. Choosing market concentration might seem logical if you think it directly leads to pricing power, but market concentration only refers to the number and size distribution of firms in a market and does not inherently guarantee a firm can raise prices without losing customers.

Unit: industry-and-competitive-analysis

Question 70Exam level

A price-weighted index contains three stocks: Stock A at $20, Stock B at $60, and Stock C at $120. Over the period, Stock A rises 50%, Stock B rises 10%, and Stock C falls 5%. Which stock most likely has the greatest impact on the price-weighted index return?

How sure are you?

Correct: B. In a price-weighted index, the contribution of each stock to index movement is proportional to its absolute price. Not its percentage change or market capitalization. Stock C at $120 represents 120/(20+60+120) = 60% of the index weight. A 5% decline in Stock C = -$6.00 price change. Stock A's 50% gain = +$10.00. Stock B's 10% gain = +$6.00. Net change: -6 + 6 + 10 = +$10. Stock C's decline offset Stock B's gain entirely. The exam tests whether you know that price, not market cap, drives weight in a price-weighted index.
A. You might be tempted to think that the middle-priced stock has a balanced influence, but in a price-weighted index, the stock with the highest price, not the middle price, carries the most weight, making Stock B's position irrelevant to its impact on the index.
C. Choosing C might tempt you if you assume equal weighting in an index, but in a price-weighted index, stocks with higher prices have greater impact, directly contradicting the idea that all stocks have equal influence.

Unit: security-market-indexes

Question 71Exam level

An equal-weighted index is constructed with three stocks, each initially priced at $50. After one year: Stock 1 is at $75, Stock 2 is at $50, Stock 3 is at $25. The return of the equal-weighted index is closest to:

How sure are you?

Correct: A. In an equal-weighted index, each stock receives an equal weight at inception. Return = (1/3)(50%) + (1/3)(0%) + (1/3)(-50%) = (50 + 0 - 50)/3 = 0/3 = 0.0%. Each stock starts with equal weighting, so returns are averaged equally regardless of price level. But a value-weighted index would return 0% only if shares outstanding are also equal. The exam tests whether candidates can distinguish the equal-weight averaging formula from price-weighted averaging.
B. You might be tempted to choose +16.7% if you incorrectly averaged the price changes instead of the percentage returns, but in an equal-weighted index, you must average the percentage returns of each stock, which in this case results in 0.0%.
C. You might be tempted to choose +8.3% if you incorrectly averaged the price changes directly rather than the percentage returns, but in an equal-weighted index, you must average the percentage returns of each stock, not their price changes, leading to a return of 0.0%.

Unit: security-market-indexes

Question 72Exam level

Which of the following is most accurate regarding the rebalancing requirements of an equal-weighted index compared to a market-capitalization-weighted index?

How sure are you?

Correct: B. An equal-weighted index starts with equal dollar investment in each constituent. As prices move at different rates, weights drift away from equal. To restore equal weighting, the index must sell recent outperformers and buy underperformers. A form of systematic contrarian trading. A market-cap-weighted index is self-rebalancing: as prices rise, market caps rise, and weights automatically adjust. No rebalancing is needed between reconstitution dates for a cap-weighted index.
A. You might be tempted to think that frequent rebalancing is necessary to maintain equal weights in a market-cap-weighted index, but this confuses the nature of market-cap-weighting, which naturally adjusts weights as stock prices change, thus requiring less frequent rebalancing compared to an equal-weighted index that needs intervention to maintain equal weights.
C. Choosing C might seem logical if you assume that both index types naturally maintain their weights without intervention, but this overlooks the fundamental difference in how equal-weighted and market-cap-weighted indexes manage their compositions, where an equal-weighted index specifically needs frequent adjustments to keep the weights equal as prices fluctuate.

Unit: security-market-indexes

Question 73Exam level

The Dow Jones Industrial Average (DJIA) currently contains 30 stocks. When a constituent stock undergoes a stock split, the DJIA divisor is adjusted. Which of the following most likely explains WHY the divisor is adjusted?

How sure are you?

Correct: A. A stock split mechanically reduces a stock's price (e.g., 2-for-1 halves the price). If the divisor were unchanged, the DJIA would drop as if there were a real economic loss. But no economic value has changed. The divisor is reduced so that the pre-split and post-split index values are identical. This preserves the continuity of the index as a time series. The divisor has been adjusted hundreds of times since the DJIA's creation in 1896. It is currently approximately 0.152 (not 30) because of accumulated splits and changes.
B. You might think that adjusting the divisor balances the influence of lower-priced stocks, but the divisor adjustment actually aims to maintain the index value, not to equalize stock influence, which means choice B confuses the purpose of the adjustment with an unrelated concept of stock pricing influence.
C. You might be thinking that a stock split involves fractional shares, but the DJIA adjusts the divisor to maintain the index value, not to account for dividends or fractional shares, thus choice C confuses the purpose of the divisor adjustment with unrelated corporate actions.

Unit: security-market-indexes

Question 74Harder

An analyst is comparing the performance of a price-weighted index to an equal-weighted index using the same three constituents. During a bull market where small-cap stocks outperform large-cap stocks, which index is most likely to show higher returns?

How sure are you?

Correct: A. An equal-weighted index assigns the same dollar weight to each constituent regardless of company size. This gives proportionally more weight to smaller-cap stocks than a cap-weighted index would. In periods when small-cap stocks outperform (value/small-cap rotation), the equal-weighted index captures more of this outperformance. Historically, equal-weighted versions of indexes like the S&P 500 have outperformed the cap-weighted version during small-cap rally periods. The price-weighted index is biased toward high-priced stocks. Which may or may not correlate with large-cap stocks.
B. You might think that since both indexes include the same stocks, their returns would be identical, but this overlooks how different weighting methods allocate capital, with an equal-weighted index giving more exposure to smaller stocks that outperform in this scenario.
C. You might be thinking that less frequent rebalancing allows the price-weighted index to hold onto winners longer, but this overlooks that price-weighted indices weight stocks by price, not market cap, giving disproportionate weight to large-cap stocks, which do not outperform in this scenario as much as small-cap stocks in an equal-weighted index.

Unit: security-market-indexes

Question 75Exam level

A float-adjusted market-capitalization-weighted index most likely differs from a full market-capitalization-weighted index primarily because:

How sure are you?

Correct: A. Float adjustment reduces a stock's weight to reflect only the shares freely available for trading. The 'free float.' Shares held by governments (e.g., Saudi Aramco with ~98% government ownership post-IPO), company founders, controlling families, or strategic corporate investors are excluded because these shares are not available to market participants. The S&P 500 uses float-adjusted market cap weighting precisely because it wants to reflect only investable market capitalization. MSCI also uses free float adjustment for its global indexes.
B. You might be misled by the idea that trading volume influences weight, but float-adjusted indexes still use market capitalization for weighting, just based on the free float rather than total shares outstanding. Weighting by trading volume would focus on liquidity rather than the economic size of the company, which is the core principle of market-capitalization-weighted indexes.
C. You might be misled into thinking rebalancing frequency is the key difference, but float-adjusted indexes focus on the proportion of shares available to the public, not on rebalancing schedules, which can vary regardless of the adjustment method used.

Unit: security-market-indexes

Question 76Exam level

In the context of maintaining a market index over time, index reconstitution is most likely defined as:

How sure are you?

Correct: A. Reconstitution is the periodic process of changing the composition of an index. Adding stocks that now meet inclusion criteria and removing those that no longer do. This is distinct from rebalancing, which adjusts weights of existing constituents. For example, the Russell 2000 reconstitutes annually every June. Stocks newly added to the Russell 2000 experience buying pressure because index funds tracking the index must purchase them. A well-documented 'Russell reconstitution effect.' Rebalancing adjusts weights; reconstitution changes membership.
B. You might be thinking that recalculating the divisor after a stock split is related to maintaining the index value, but this action is part of the index maintenance for continuity and does not involve changing the index composition, which is what reconstitution actually entails.
C. You might be tempted by choice C if you think index reconstitution involves changing the method of index calculation, but converting a price-weighted index to a value-weighted index pertains to the weighting methodology, not the process of adding or removing securities from the index.

Unit: security-market-indexes

Question 77Exam level

An index contains Stock A ($30, 2M shares) and Stock B ($10, 10M shares). The index is value-weighted. What percentage weight does Stock B represent? The value is closest to:

How sure are you?

Correct: B. Market cap of Stock A = $30 x 2,000,000 = $60,000,000. Market cap of Stock B = $10 x 10,000,000 = $100,000,000. Total market cap = $160,000,000. Weight of Stock B = $100M / $160M = 62.5%. Despite Stock B having a lower price per share, it has a far larger market cap due to more shares outstanding. In a value-weighted index, market cap, not price, determines weight. This is the fundamental difference from a price-weighted index where Stock A ($30) would receive 75% weight vs Stock B ($10) at 25%.
A. Choosing 33.3% might tempt you if you incorrectly assume that the percentage weight is based on the number of shares outstanding, but in a value-weighted index, the weight is determined by market capitalization, not just the number of shares, which is why Stock B's larger market cap results in a 62.5% weight.
C. Choosing 50.0% might tempt you if you incorrectly assume equal market caps for both stocks due to their share numbers, but in a value-weighted index, the weight is based on market capitalization, not just the number of shares, making Stock B's weight 62.5% due to its larger market cap.

Unit: security-market-indexes

Question 78Exam level

An investor places an order to sell 500 shares of XYZ Corp. at the best available price immediately. What type of order is this, most likely?

How sure are you?

Correct: B. A market order is an instruction to buy or sell immediately at the best available price. It prioritizes certainty of execution over price. The investor is not specifying a price constraint. She simply wants the trade executed now. Limit orders specify a maximum buy price or minimum sell price (controls price, not certainty). Stop orders are conditional on the price reaching a trigger level first.
A. A limit order specifies a maximum buy price or minimum sell price. It controls price, not immediacy, and may not execute at all if the market never reaches that price.
C. An all-or-none order is a condition on quantity (fill the whole order or none of it). It says nothing about price or timing the way a market order does.

Unit: market-organization-and-structure

Question 79Exam level

An investor submits a limit order to buy shares at $45. The current ask price is $48. Which of the following best describes the outcome?

How sure are you?

Correct: B. A buy limit order at $45 means the investor will not pay more than $45. Since the current ask is $48, the order cannot execute at current prices. It enters the limit order book and waits. If the ask falls to $45 or below, it will execute. It may never execute if the price never reaches $45. Option A is wrong because limit orders do NOT execute at the ask when the limit is below the ask.
A. Option A is wrong because limit orders do NOT execute at the ask when the limit is below the ask.
C. You might think the order is invalid because it cannot be filled at the current ask price, but limit orders are not rejected for being below the ask; they are held in the order book until the price is favorable or canceled, which contrasts with the immediate rejection suggested in choice C.

Unit: market-organization-and-structure

Question 80Exam level

A trader holds a long position in a stock currently trading at $60. To protect against a sharp decline, she places an order to sell if the price falls to $55. What type of order is this, most likely?

How sure are you?

Correct: A. This is a stop sell (stop-loss) order. The $55 is the stop (trigger) price, not the limit price. Once the market price falls to $55, the order is activated and becomes a market order to sell. The exam tests whether students know that a stop order becomes a market order upon trigger. It does NOT guarantee execution at $55. If the price gaps from $57 to $52 overnight, the order triggers at $55 but executes at the next available price, potentially $52. A limit sell at $55 would only execute at $55 or higher. That is the key difference.
B. You might be tempted by a market order with a price condition because it seems to activate at a specific price, but a market order, even with a condition, does not act as a trigger to sell; instead, a stop sell order with a trigger at $55 is designed to become a market order once the price hits $55, fulfilling the trader's intent to sell if the price falls to that level.
C. You might be thinking that a limit order is needed to sell at a specific price, but a good-till-cancelled limit order would not automatically trigger a sale when the price hits $55, unlike a stop sell order which becomes a market order once the trigger price is reached.

Unit: market-organization-and-structure

Question 81Exam level

Which of the following transactions occurs in the primary market, most likely?

How sure are you?

Correct: B. Primary markets are where issuers sell securities directly to investors and receive the proceeds. In a seasoned equity offering (SEO), Microsoft issues new shares. Proceeds go to Microsoft. This is a primary market transaction. Options A, B, and D all involve trades between investors where the issuer receives nothing. The NYSE trade (A), OTC bond trade (B), and broker-facilitated swap (D) are all secondary market transactions. The defining test: does the ISSUER receive the proceeds? If yes, it is primary. If no, it is secondary.
A. You might be tempted to choose A because it involves a financial institution and an OTC dealer, which can seem like a primary market transaction, but in reality, the hedge fund is simply buying from another fund, not from the issuer, making it a secondary market transaction where the issuer, in this case the U.S. Treasury, does not receive any proceeds.
C. You might be tempted by choice C because it involves a broker, which can make it seem like a primary market transaction, but remember, the broker here only facilitates the swap between two pension funds, not the issuance of new securities, making it a secondary market transaction.

Unit: market-organization-and-structure

Question 82Exam level

Which of the following best describes how secondary markets support primary markets?

How sure are you?

Correct: B. The CFA curriculum's key argument: investors are willing to buy securities in the primary market BECAUSE they know they can sell them in the secondary market. If secondary markets did not exist, investors would demand a massive liquidity premium, making it prohibitively expensive for issuers to raise capital. Secondary markets provide: (1) liquidity. Investors can exit, (2) price discovery. Continuous pricing signals. Options A and D are wrong. Regulation and underwriting are not secondary market functions. Option B is wrong. SEOs happen in primary markets.
A. Option B is wrong. SEOs happen in primary markets.
C. You might be tempted by choice C if you confuse the roles of primary and secondary markets, as underwriting new securities is actually a function of primary markets, not secondary markets, which instead focus on providing liquidity and price discovery for already issued securities.

Unit: market-organization-and-structure

Question 83Exam level

An investor places a stop-limit order to sell with a stop price of $50 and a limit price of $48. The stock is currently trading at $55. If the stock price falls rapidly from $53 to $44 without trading at prices between $50 and $48, what happens to the order, most likely?

How sure are you?

Correct: C. This is the classic stop-limit trap. When the price falls to $50, the stop is triggered and a LIMIT sell order at $48 is activated. However, the price has already fallen below $48 to $44. The limit order will not execute below $48. The stock gaps through both the stop and limit prices, so the order sits unfilled in the book while the investor suffers the full loss. This is the critical difference between stop-limit and plain stop orders: stop-limit orders can FAIL TO PROTECT in fast-moving markets. A plain stop order would have converted to a market order at $50 and executed at $44.
A. You might think the order executes at $48 because the limit price is reached, but this overlooks the fact that once triggered, a limit order only executes at or better than the limit price, and since the price fell below $48 to $44 without trading at $48, the order does not get filled.
B. You might be thinking that once the stop price is hit, the order turns into a market order, but this ignores the limit price restriction; the order is a limit sell at $48, not a market order, so it will not execute at $44.

Unit: market-organization-and-structure

Question 84Exam level

A 'good-till-cancelled' (GTC) order most likely differs from a 'day order' in that:

How sure are you?

Correct: A. GTC and 'day' are validity instructions. They determine how long the order remains active. A day order expires at close if not filled. A GTC order remains in the book until the investor cancels it or it executes. Option A is wrong. GTC can be applied to any order type including market orders (though this is unusual). Option C is wrong. Neither type guarantees execution; a limit GTC order can sit forever unfilled.
B. Option C is wrong. Neither type guarantees execution; a limit GTC order can sit forever unfilled.
C. Option C is wrong. Neither type guarantees execution; a limit GTC order can sit forever unfilled.

Unit: market-organization-and-structure

Question 85Exam level

Which of the following is most likely a clearing instruction, not an execution or validity instruction?

How sure are you?

Correct: B. The CFA curriculum classifies order instructions into three categories: (1) Execution instructions. Specify how to fill (market, limit, stop, stop-limit, market-if-touched, etc.); (2) Validity instructions. Specify when to fill or cancel (day, GTC, fill-or-kill, all-or-none, immediate-or-cancel, good-on-close); (3) Clearing instructions. Specify how to settle (regular settlement T+2 for equities, cash/same-day settlement, delivery vs payment). Cash settlement is a clearing instruction. Market orders, stop orders, and GTC are in the other two categories.
A. You might be tempted to choose Good-till-cancelled because it sounds like a settlement term, but it actually specifies the duration of the order validity, not the settlement method like same-day settlement does.
C. You might be tempted by a stop order because it involves a condition for execution, but remember that a stop order is an execution instruction that triggers a market or limit order once a specified price is reached, unlike cash settlement which is a clearing instruction specifying how to settle the trade.

Unit: market-organization-and-structure

Question 86Exam level

An investor sells shares short at $80. To limit potential losses, she places an order to buy shares if the price rises to $90. This is most likely described as a:

How sure are you?

Correct: A. A stop-buy order is triggered when the price RISES to the stop price. Short sellers use stop-buy orders to automatically cover (repurchase) their short position if the price rises against them. Limiting losses. The trigger here is $90: if the stock reaches $90, the order activates and becomes a market buy. Limit buy at $90 would only execute at $90 or LOWER. The opposite of what she needs. A market-if-touched order is similar but differs in that it converts to a market order regardless of direction. Stop-sell orders are used by long investors to protect against price declines. Not relevant here.
B. You might be tempted by a market-if-touched buy order because it sounds like it triggers at a specific price, but unlike a stop-buy order, it does not specifically guard against rising prices by converting to a market buy order; instead, it triggers on any price touch, making it less suitable for limiting losses from a short position.
C. You might be tempted to choose a stop-sell order because it sounds like it would sell shares to cover the position, but a stop-sell order is designed for long positions to limit losses when the price falls, not for short positions to limit losses when the price rises like a stop-buy order does.

Unit: market-organization-and-structure

Question 87Harder

Maria Gonzalez, CFA, works as a portfolio manager at Apex Asset Management. Her firm's compliance department has reviewed a new municipal bond offering and determined it is suitable for retail clients. Gonzalez personally believes the offering has undisclosed risks. According to the CFA Institute Standards of Professional Conduct, Gonzalez should MOST LIKELY:

How sure are you?

Correct: A. The correct answer is Express her concerns to her supervisor and compliance department in writing, and if she remains uncomfortable, dissociate from the transaction by removing her name from the recommendation. Gonzalez's obligation is to her independent judgment. Compliance department approval does not override her personal professional obligation to assess suitability. Dissociation, not resignation, is the required first step..
B. Most candidates from finance backgrounds are trained to defer to compliance. The compliance department IS the authority in most firms. CFA Standards require member's independent judgment regardless of firm compliance approval. Compliance sign-off reduces legal liability but does not discharge the member's ethical obligation.
C. Candidates who know 'violations must be reported' jump to external reporting. External reporting is a last resort, not a first step. The Standard requires internal escalation first. Immediate external reporting without internal escalation is not the 'most appropriate' response.

Unit: code-of-ethics-and-standards-of-professional-conduct

Question 88Exam level

David Chen, CFA, is a sell-side analyst covering semiconductor companies. A portfolio manager at a client firm takes Chen and his colleagues on a 5-day fishing trip to Alaska valued at approximately $4,500. Chen's employer has a policy permitting gifts up to $500. According to Standard I(B) Independence and Objectivity, Chen should most likely:

How sure are you?

Correct: A. The correct answer is Decline the trip. The gift exceeds his employer's $500 policy, and gifts of this magnitude from clients create a reasonable question about whether Chen's research independence is compromised. The employer's stricter policy applies, not CFA's general 'modest gift' standard..
B. Disclosure feels like the ethical fix-all. You might believe 'disclose and proceed' is always acceptable. When the gift clearly exceeds the employer's explicit policy ($4,500 vs $500), disclosure does not make acceptance permissible. The employer policy violation is a separate issue from the independence question.
C. Candidates who know there is a travel/entertainment carve-out try to reclassify the fishing trip as 'entertainment.'. The entertainment exception applies to normal business entertainment (dinners, sporting events). A multi-day luxury trip is a gift in substance regardless of how it is labeled.

Unit: code-of-ethics-and-standards-of-professional-conduct

Question 89Exam level

An equity research analyst at a bulge-bracket firm is assigned to cover a technology company that is also a client of the firm's investment banking department, which is advising the company on a pending acquisition. The IB department head asks the analyst to maintain a 'Buy' rating on the company throughout the deal process to avoid jeopardizing the firm's advisory fees. The analyst believes the company's valuation is fair at current prices and that a 'Hold' rating is appropriate. To comply with Standard I(B), the analyst should MOST appropriately:

How sure are you?

Correct: B. Standard I(B) requires analysts to maintain independence and objectivity regardless of economic or other pressure. The analyst's rating must reflect their honest assessment. Disclosure (Answer B) is a required procedure but does not substitute for independence. The analyst cannot issue a misleading 'Buy' and cure it with disclosure. Answer A directly violates I(B). Answer D is not required. The standard does not require recusal, it requires independence.
A. Disclosure is a recurring correct answer in CFA ethics questions, so candidates pattern-match to 'disclose = correct.' This is the most dangerous wrong answer. Disclosure is required IN ADDITION to independence, not instead of it. If the analyst's honest view is 'Hold,' issuing 'Buy' with a disclosure footnote is still a violation of I(B). Disclosure cannot cure a false rating.
C. Recusal sounds like the most conservative, ethical choice. 'if there's a conflict, step away.'. Standard I(B) does not require analysts to recuse themselves from covering companies where IB relationships exist. It requires them to maintain independence. Firewalls and disclosure are the firm-level mechanisms; the analyst's obligation is to issue honest research.

Unit: ethics-application

Question 90Exam level

Alpha Asset Management claims it complies with the Global Investment Performance Standards (GIPS) for its equity portfolios. Is this a valid GIPS compliance claim, most likely?

How sure are you?

Correct: B. The correct answer is No, because GIPS compliance must be claimed on a firm-wide basis.
A. You might intuitively think performance standards should apply at the strategy level since composites are strategy-based. GIPS is firm-wide. The composite structure organizes performance reporting within the firm, but the compliance claim applies to the entire firm, not individual strategies.
C. You might confuse the verification requirement with the compliance requirement. Verification is voluntary and increases credibility, but it is NOT required to claim GIPS compliance. A firm can be GIPS-compliant without ever having been verified.

Unit: introduction-to-the-global-investment-performance-standards-gips

Question 91Exam level

Under GIPS standards, which of the following portfolios MUST be included in at least one composite?

How sure are you?

Correct: B. The correct answer is All fee-paying discretionary accounts managed by the firm.
A. Fee-paying is one of the two criteria, so candidates stop there. Non-discretionary fee-paying accounts are excluded. If the client controls the portfolio decisions, it doesn't reflect the firm's strategy and should not be in a composite.
C. Sounds most comprehensive. If GIPS is about fairness, surely all accounts should count. Including non-discretionary accounts would actually distort performance. Those reflect client decisions, not firm skill. GIPS excludes them for this reason.

Unit: introduction-to-the-global-investment-performance-standards-gips

Question 92Exam level

Which of the following statements about GIPS verification is MOST accurate?

How sure are you?

Correct: B. The correct answer is GIPS verification is voluntary but increases the credibility of a firm's compliance claim.
A. Sounds like what verification should do. Confirm specific numbers. Verification covers firm-wide policies and procedures, not specific composites. Verification of a specific composite is called 'performance examination' and is an additional engagement.
C. You might confuse verification with the financial statement audit they know from accounting. GIPS verification is an investment performance review of whether the firm's performance processes and policies comply with GIPS. It is not an audit of financial statements.

Unit: introduction-to-the-global-investment-performance-standards-gips

Question 93Harder

Sarah Chen, CFA, was the lead portfolio manager for a small-cap growth composite at her previous employer for seven years, generating top-quartile returns. She has recently joined Beta Capital and wants to market the track record she built at her previous firm. Under GIPS, this track record, most likely:

How sure are you?

Correct: B. The correct answer is May be used if the prior performance is clearly documented, the appropriate people and accounts moved with her, and she discloses that it was achieved at a prior firm.
A. Intuitive. She didn't own the firm, so the record belongs to the old employer. GIPS specifically permits portability when conditions are met, precisely to prevent firms from unfairly hiding relevant manager history.
C. Third-party verification sounds like the appropriate safeguard for something this sensitive. Verification is never required under GIPS. Track record portability has its own set of specific conditions; third-party verification is not one of them.

Unit: introduction-to-the-global-investment-performance-standards-gips

Question 94Exam level

Sarah Chen, CFA, works at a brokerage firm. Her supervisor instructs her to allocate IPO shares to preferred clients before informing other eligible clients. A practice that violates CFA Standards but is not illegal in her jurisdiction. Under Standard I(A), Sarah MUST, most likely:

How sure are you?

Correct: A. The correct answer is Refuse to follow the instruction and disassociate from the activity. Standard I(A) requires members to follow the strictest applicable standard. Here, CFA Standards are stricter than local law, so CFA Standards govern. Sarah cannot participate regardless of the legality..
B. You might confuse 'legal' with 'permissible under Standards.' The exam frequently uses legal-but-unethical scenarios precisely to test this distinction. Standard I(A) requires following the strictest applicable standard. CFA Standards prohibit this practice. Legality is a floor, not a ceiling.
C. You might believe Standard I(A) requires external regulatory reporting whenever they discover a violation. Standard I(A) does NOT require reporting to external regulators unless the law specifically mandates it. Internal escalation is the required path. External reporting is only mandatory when law requires it.

Unit: guidance-for-standards-i-vii

Question 95Harder

James, a CFA candidate, discovers his firm's research department is providing material non-public information to select hedge fund clients. He is not personally involved in these communications. Under Standard I(A), James should most likely FIRST:

How sure are you?

Correct: A. The correct answer is Report the activity through his firm's internal compliance channels. Standard I(A) guidance prioritizes internal reporting first. The member has not participated but is obligated to disassociate from any activity connected to the violation and escalate internally..
B. You might interpret disassociation as simply 'not participating yourself,' which makes option A seem sufficient. Disassociation alone is insufficient when you have knowledge of an ongoing violation. The recommended procedures require attempting to stop the violation. First through internal channels.
C. The moral instinct is to report wrongdoing to authorities. You might from common-law jurisdictions also think this is legally required. Standard I(A) does not require external reporting unless a specific law mandates it. In most jurisdictions, there is no mandatory reporting obligation on employees for employer violations. Internal escalation is required first.

Unit: guidance-for-standards-i-vii

Question 96Exam level

Under IFRS, which of the following items is most likely reported in other comprehensive income (OCI) rather than the income statement?

How sure are you?

Correct: B. The correct answer is Foreign currency translation adjustments on a foreign subsidiary.
A. You might know unrealized gains are 'not yet realized' and assume that means OCI. Trading securities (FVTPL) are marked to market through the P&L. Unrealized gains ARE in net income under both IFRS and GAAP.
C. Dividends sound like equity-related income that might be in OCI. Dividends received are cash income. They hit net income regardless of how the underlying investment is classified.

Unit: analyzing-balance-sheets

Question 97Exam level

A company's balance sheet shows total assets of $500 million, total liabilities of $320 million, and retained earnings of $80 million. The company paid $15 million in dividends this year. If net income was $30 million, the beginning retained earnings balance was closest to:

How sure are you?

Correct: A. The correct answer is $65 million.
B. You might subtract dividends from net income ($30M - $15M = $15M) then subtract from $80M = $65M... actually this gets B if they do $80M - $30M = $50M, forgetting dividends. Forgetting to add back dividends: $80M - $30M = $50M ignores that dividends reduced retained earnings.
C. Adding net income instead of working backwards: $80M + $15M = $95M. Wrong direction. You might add dividends instead of adding them back when solving for beginning balance.

Unit: analyzing-balance-sheets

Question 98Harder

Under IFRS, a company holds a building that has appreciated in value. If the company uses the revaluation model, the upward revaluation is most likely recognized:

How sure are you?

Correct: B. The correct answer is In other comprehensive income, increasing the revaluation surplus in equity.
A. You might know asset appreciation creates value. They assume it flows to net income like a gain on sale. The asset has NOT been sold. Unrealized revaluation gains on PP&E under IFRS revaluation model go to OCI, not P&L.
C. OCI ultimately affects equity. You might confuse OCI with retained earnings. Retained earnings is net income minus dividends. OCI items go to accumulated OCI, a separate equity component. The revaluation surplus is NOT retained earnings.

Unit: analyzing-balance-sheets

Question 99Exam level

Which of the following best describes the classification of a liability as current under IFRS (IAS 1)?

How sure are you?

Correct: A. The correct answer is The liability is due within 12 months OR the entity does not have an unconditional right to defer settlement for at least 12 months.
B. The operating cycle rule exists, but it's not the ONLY criterion. Candidates who memorized one rule miss the unconditional right test. Incomplete. Ignores the unconditional right to defer test and the 12-month rule.
C. Sounds intuitively logical. If incurred this year, it's a current-year item. Completely wrong. Classification is about settlement timing, not origination year.

Unit: analyzing-balance-sheets

Question 100Exam level

Under US GAAP, interest paid on long-term debt is most likely classified in the cash flow statement as:

How sure are you?

Correct: A. Under US GAAP (ASC 230), interest paid is ALWAYS classified as an operating activity, regardless of whether the debt is short-term or long-term. This is a hard rule with no flexibility. Candidates are tempted by C because the debt itself (principal) is financing. But the interest cost is operating under GAAP.
B. You might be misled into choosing investing activities because interest paid could be associated with investments or asset acquisitions, but under ASC 230, interest paid is strictly classified as an operating activity, not tied to investing transactions.
C. You might be tempted to choose financing activities because the debt itself is a financing activity, but under US GAAP, interest paid on debt is specifically classified as an operating activity, not a financing activity, because it is considered an expense of running the business.

Unit: analyzing-statements-of-cash-flows-i

Question 101Exam level

A company using the indirect method starts with net income of $500,000. Depreciation expense is $80,000. Accounts receivable increased by $30,000. Inventory decreased by $20,000. Accounts payable decreased by $15,000. Cash flow from operations (CFO) is closest to:

How sure are you?

Correct: A. CFO = Net income + Depreciation - Increase in AR + Decrease in inventory - Decrease in AP = 500,000 + 80,000 - 30,000 + 20,000 - 15,000 = 555,000. Depreciation is added back (non-cash). AR increase means cash collected was less than revenue (subtract). Inventory decrease means less cash tied up in inventory (add). AP decrease means company paid off suppliers faster than it incurred expenses (subtract).
B. You might be tempted to choose $535,000 if you incorrectly subtracted the decrease in inventory instead of adding it, misunderstanding that a decrease in inventory indicates cash was freed up, thus increasing CFO, contrary to the effect of changes in accounts payable and accounts receivable.
C. You might be tempted to choose $595,000 if you incorrectly added the increase in accounts receivable instead of subtracting it, thus violating the rule that an increase in AR indicates cash has not yet been received, so it should reduce CFO.

Unit: analyzing-statements-of-cash-flows-i

Question 102Exam level

Under IFRS, dividends paid by a company can most likely be classified in the statement of cash flows as:

How sure are you?

Correct: C. IAS 7 paragraph 34 explicitly allows dividends paid to be classified as either operating activities (because they are paid out of operating cash) or financing activities (because they are a cost of financial resources). The company must disclose which classification it uses and apply it consistently. Under US GAAP, dividends paid are ALWAYS financing.
A. Choosing A might seem logical if you think dividends are always paid from operating cash flows, but IAS 7 paragraph 34 gives companies the flexibility to classify dividends paid as either operating or financing activities, which contradicts the exclusivity suggested by A.
B. Choosing B might seem logical if you think dividends are strictly a cost of financial resources, but IAS 7 paragraph 34 provides flexibility to classify dividends as either operating or financing activities, depending on the company's approach to cash flow reporting.

Unit: analyzing-statements-of-cash-flows-i

Question 103Exam level

A company has the following data: Net income = $120M, Revenue = $800M, Total assets = $600M, Total equity = $300M. Using the 3-factor DuPont decomposition, which of the following correctly identifies all three components and the resulting ROE, most likely?

How sure are you?

Correct: A. Net profit margin = 120/800 = 15%. Asset turnover = Revenue/Assets = 800/600 = 1.333x. Equity multiplier = Assets/Equity = 600/300 = 2.0x. ROE = 0.15 x 1.333 x 2.0 = 40%. Verify: ROE = NI/Equity = 120/300 = 40%. Choice B uses Revenue/Assets incorrectly as 600/800. Choice C uses NI/Assets (ROA calculation) and wrong leverage.
B. Choice B uses Revenue/Assets incorrectly as 600/800.
C. Choice C uses NI/Assets (ROA calculation) and wrong leverage.

Unit: financial-analysis-techniques

Question 104Exam level

Company A and Company B have identical ROEs of 18%. Company A achieved this with an equity multiplier of 1.2x and a net profit margin of 12%. Company B achieved it with an equity multiplier of 3.0x and a net profit margin of 4%. Which statement is most accurate?

How sure are you?

Correct: A. ROE quality is assessed by the SOURCE of ROE. Company A's high profit margin (12%) with low leverage (1.2x) means ROE is driven by genuine profitability. Company B must have a high asset turnover to compensate for the low margin, but the equity multiplier of 3.0x means substantial financial leverage is used. High leverage amplifies ROE but also amplifies risk. A downturn hits equity much harder at 3x leverage. The CFA exam considers leverage-driven ROE of lower quality than margin-driven ROE.
B. You might be tempted to think that a higher asset turnover indicates higher efficiency, but this overlooks the role of leverage in inflating ROE; Company B's higher equity multiplier suggests reliance on debt, which does not necessarily mean it is more efficient in asset utilization compared to Company A.
C. You might be tempted to think that identical ROEs mean equal quality, but this overlooks the critical distinction between leverage and profitability as drivers of ROE, where Company A’s ROE is driven by higher profitability rather than financial leverage, making its ROE quality superior.

Unit: financial-analysis-techniques

Question 105Harder

A company's ROE increased from 14% to 19% over one year. During the same period, net profit margin remained flat, asset turnover declined from 1.4x to 1.2x, and the financial leverage multiplier increased from 2.0x to 3.2x. An analyst should conclude that the ROE improvement is most likely:

How sure are you?

Correct: B. Decompose the change: margin was flat (neutral), asset turnover DECLINED (negative signal. Efficiency deteriorated), and leverage multiplier rose from 2.0x to 3.2x (60% increase. This drove all of the ROE improvement). The ROE increase is entirely leverage-driven. A company borrowing more to boost ROE while its operating efficiency deteriorates is a red flag. This is the classic 'ROE manipulation via leverage' scenario the CFA exam tests. Low-quality ROE improvement signals potential financial distress risk.
A. You might be tempted by the substantial increase in ROE, thinking a higher ROE always indicates high-quality performance, but this overlooks the critical role of financial leverage and operating efficiency, where increased leverage without improvement in operating metrics actually signals low-quality growth.
C. You might be tempted to think that an unchanged net profit margin indicates stability, leading to a neutral assessment, but this overlooks the significant decline in asset turnover and the substantial increase in financial leverage, which actually signal a low-quality ROE improvement.

Unit: financial-analysis-techniques

Question 106Exam level

Which of the following correctly describes the relationship between the 3-factor DuPont model and the 5-factor DuPont model, most likely?

How sure are you?

Correct: B. The 3-factor DuPont uses: (NI/Sales) x (Sales/Assets) x (Assets/Equity). The net profit margin (NI/Sales) can be algebraically split into three components: (NI/EBT) x (EBT/EBIT) x (EBIT/Sales). These are the tax burden, interest burden, and EBIT margin respectively. The 5-factor model therefore provides more diagnostic power. You can see whether a change in net margin came from tax management, interest expense changes, or operating profitability. Asset turnover and the equity multiplier remain identical in both models.
A. You might be tempted by the idea that the 5-factor model expands on the 3-factor model by adding distinct measures like return on assets and return on equity, but the 5-factor model actually refines the net profit margin into more granular components rather than introducing new ratios, thus choice A confuses the refinement of existing factors with the addition of new ones.
C. You might be tempted by the idea of using total debt for a more precise leverage measure, but the 5-factor model actually maintains the use of total assets in the asset turnover and equity multiplier components, focusing instead on breaking down the net profit margin into finer detail as the correct answer indicates.

Unit: financial-analysis-techniques

Question 107Exam level

Company X has ROE = 22%, ROA = 11%, and a debt-to-equity ratio of 1.0x. Which of the following correctly calculates the equity multiplier used in the DuPont framework? The value is closest to:

How sure are you?

Correct: B. The equity multiplier = Assets/Equity. Debt/Equity = 1.0x means Debt = Equity. Therefore Assets = Debt + Equity = 2 x Equity. Equity multiplier = Assets/Equity = 2.0x. Verify with DuPont: ROA x Equity multiplier = ROE. 11% x 2.0 = 22%. Check. The equity multiplier is also equal to 1 + Debt/Equity = 1 + 1.0 = 2.0x. This relationship (equity multiplier = 1 + D/E) is a frequently tested identity.
A. Choosing 1.0x might seem logical if you assume that assets equal equity, but this ignores the given debt-to-equity ratio of 1.0x, which indicates that assets are actually twice the equity, making the equity multiplier 2.0x, not 1.0x.
C. Choosing 0.5x might tempt you if you mistakenly calculate the equity multiplier as the inverse of the debt-to-equity ratio, but the equity multiplier is actually 1 plus the debt-to-equity ratio, making 0.5x incorrect and violating the correct formula of equity multiplier = 1 + D/E = 1 + 1.0 = 2.0x.

Unit: financial-analysis-techniques

Question 108Exam level

A company reports net income of $2,400,000 and paid preferred dividends of $400,000. At the start of the year, 500,000 shares were outstanding. On July 1, the company issued 200,000 new shares. Basic EPS is closest to:

How sure are you?

Correct: A. $3.33. Weighted average shares = 500,000 + (200,000 x 6/12) = 600,000. Basic EPS = (2,400,000 - 400,000) / 600,000 = $3.33
B. You might use 500,000 shares (beginning of year) ignoring the mid-year issuance. New shares issued mid-year must be weighted for the fraction of the year they were outstanding.
C. You might forget to subtract preferred dividends from net income. Basic EPS numerator is Net Income MINUS preferred dividends, not net income alone.

Unit: analyzing-income-statements

Question 109Exam level

A company has basic EPS of $3.00. It has 100,000 options outstanding with an exercise price of $20. The average market price during the year was $25. Using the treasury stock method, how many net shares are most likely added to the denominator for diluted EPS?

How sure are you?

Correct: A. The correct answer is 20,000 net shares added. Shares issued upon exercise: 100,000. Proceeds = 100,000 x $20 = $2,000,000. Shares repurchased with proceeds at market price: $2,000,000 / $25 = 80,000. Net new shares = 100,000 - 80,000 = 20,000..
B. You might add all option shares without subtracting the treasury repurchase. The treasury stock method assumes proceeds from exercise are used to buy back shares at the average market price. Only the NET additional shares count.
C. You might confuse anti-dilution rule. Exercise price $20 < market price $25 means options ARE dilutive. Options are dilutive (reduce EPS) when exercise price is BELOW average market price. Anti-dilutive only when exercise price exceeds market price.

Unit: analyzing-income-statements

Question 110Exam level

A company has net income of $1,000,000, no preferred dividends, and 500,000 weighted average shares. It has $2,000,000 of 5% convertible bonds outstanding, convertible into 80,000 shares. The tax rate is 30%. Should these bonds be included in diluted EPS, and what is most likely diluted EPS?

How sure are you?

Correct: A. The correct answer is Include them. They are dilutive. Diluted EPS = $1.74. Interest expense saved = $2,000,000 x 5% = $100,000. After-tax interest = $100,000 x (1 - 0.30) = $70,000. Adjusted numerator = $1,000,000 + $70,000 = $1,070,000. Adjusted denominator = 500,000 + 80,000 = 580,000. Diluted EPS = $1,070,000 / 580,000 = $1.845. Basic EPS = $1,000,000 / 500,000 = $2.00. Since $1.845 < $2.00, bonds ARE dilutive. Include them..
B. You might adjust denominator but forgets to adjust numerator for the interest expense that would be saved. If-converted method requires adding back after-tax interest expense to the numerator because if the bonds convert, the interest is no longer paid.
C. You might think any increase in shares makes securities anti-dilutive. The anti-dilution test is based on whether inclusion INCREASES or DECREASES EPS. Not based on whether shares increase.

Unit: analyzing-income-statements

Question 111Exam level

Which of the following options is MOST LIKELY anti-dilutive and should be excluded from diluted EPS?

How sure are you?

Correct: B. The correct answer is Options with exercise price of $25 when average market price is $20.
A. You might confuse the direction of the rule. Exercise price of $15 below market price of $20 means options are IN the money and produce net new shares. They are dilutive.
C. You might think that because convertible bonds have a low per-share impact they must be anti-dilutive. Convertible bonds are dilutive when their incremental EPS (after-tax interest per new share) is LESS than current basic EPS. $1.80 < $2.50, so they reduce EPS and are dilutive.

Unit: analyzing-income-statements

Question 112Exam level

An analyst calculates a company's balance-sheet-based accruals ratio as 12% in Year 2, up from 3% in Year 1. Net income also increased 40% year-over-year. Which conclusion is most appropriate?

How sure are you?

Correct: B. The correct answer is Earnings quality has likely deteriorated because accruals are increasing relative to assets.
A. Growing net income feels positive. You might conflate earnings growth with earnings quality. Earnings quality measures sustainability and accuracy, not direction. Rapidly growing net income with rising accruals is a classic manipulation red flag.
C. You might remember that CFO is important but misapply the rule. Thinking CFO must be negative for there to be a problem. CFO can be positive and still be lower than net income, which is the warning sign. The gap between NI and CFO is what matters, not the sign of CFO alone.

Unit: financial-reporting-quality

Question 113Exam level

WorldCom reclassified $3.8 billion of operating expenses as capital expenditures. What is the immediate effect on the financial statements, most likely?

How sure are you?

Correct: B. The correct answer is Operating income increases; cash flow from operations increases.
A. You might assume that 'capitalization' means something is added to assets, so they expect the income statement to show a decrease. Capitalization removes the expense from the income statement in the current period. Earnings go UP, not down.
C. You might know an asset is created, so they think everything nets out. The income statement is directly affected because the expense is deferred. Net income increases in the capitalization year.

Unit: financial-reporting-quality

Question 114Harder

A company using the completed contract method switches to the percentage-of-completion method. In the current year, the company has several long-term contracts in progress. What is the most likely effect?

How sure are you?

Correct: A. The correct answer is Revenue increases; receivables increase.
B. Higher reported revenue might seem to require more cash. Cash from operations is unaffected by the accounting method switch. Cash only moves when customers pay. The divergence between accrual income and CFO is the red flag.
C. True that total lifetime revenue is identical. You might correctly identify this but then reach the wrong conclusion. Timing matters for earnings quality assessment. Pulling revenue forward inflates current period income at the expense of future periods.

Unit: financial-reporting-quality

Question 115Exam level

An analyst notices that a firm's days sales outstanding (DSO) has increased from 42 days to 67 days over three years, while revenue has grown 35% in the same period. This pattern is most consistent with:

How sure are you?

Correct: A. The correct answer is Aggressive revenue recognition potentially including channel stuffing.
B. You might reason that bigger companies naturally have longer receivable cycles. DSO should be relatively stable if revenue growth is genuine. A 60% increase in DSO alongside 35% revenue growth is disproportionate and a red flag.
C. Extended credit terms is a plausible explanation, and the question doesn't rule it out explicitly. The exam uses 'most consistent with'. Channel stuffing is the better answer because it is the explanation the CFA curriculum specifically associates with this pattern. Extended credit terms alone would also reduce earnings quality but is a secondary consideration.

Unit: financial-reporting-quality

Question 116Exam level

Under IFRS, development costs for a new software product that meets the recognition criteria under IAS 38 must most likely be:

How sure are you?

Correct: B. The correct answer is Capitalized as an intangible asset, inflating current period earnings vs US GAAP.
A. Candidates who memorized that US GAAP expenses R&D assume both standards match. IFRS and US GAAP diverge specifically on development costs (not research costs. Those are expensed under both). This is a top-tested IFRS/GAAP difference.
C. You might confuse disclosure requirements with recognition requirements. Disclosure in notes does not substitute for balance sheet recognition when capitalization criteria are met.

Unit: financial-reporting-quality

Question 117Harder

A company's net income is $500 million. Its cash flow from operations is $180 million. The balance-sheet-based accruals ratio is 14%. Which statement best describes earnings quality?

How sure are you?

Correct: A. The correct answer is Earnings quality is questionable: large gap between NI and CFO suggests significant non-cash accruals.
B. You might try to find a fixed threshold and 14% vs 20% seems like a pass. There is no official CFA threshold of 20% for the accruals ratio. The direction and trend matter more than any fixed cutoff. A 14% accruals ratio combined with a 64% CFO/NI shortfall is concerning.
C. Trend analysis is valuable, and candidates know ratios should be compared over time. A single year's data with extreme values, NI 2.8x CFO, is sufficient to raise significant concerns without needing the prior year for context.

Unit: financial-reporting-quality

Question 118Exam level

Under IFRS, which inventory cost flow method is most likely prohibited?

How sure are you?

Correct: B. The correct answer is LIFO.
A. You might find Weighted Average Cost tempting because it seems less transparent than LIFO, but under IFRS, Weighted Average Cost is actually allowed and provides a consistent approach to inventory valuation, unlike LIFO which is explicitly prohibited.
C. You might find Specific Identification tempting if you think it involves arbitrary cost allocations, but under IFRS, Specific Identification is actually allowed as it matches the specific cost of the inventory sold, unlike LIFO which is prohibited due to its potential to distort current cost flows.

Unit: introduction-to-financial-statement-analysis

Question 119Exam level

A company incurs costs related to a new product line. Under IFRS, which costs are most likely to be capitalized?

How sure are you?

Correct: A. The correct answer is Development costs only, if specified criteria are met.
B. You might be tempted to choose both research and development costs because it seems comprehensive, but under IFRS, research costs must always be expensed as they are uncertain and exploratory, whereas development costs can be capitalized if certain criteria are met.
C. You might be thinking that all R&D costs are always expensed, but under IFRS, development costs can be capitalized if they meet specific criteria, unlike research costs which must be expensed.

Unit: introduction-to-financial-statement-analysis

Question 120Exam level

Which of the following statements about asset revaluation is most likely CORRECT?

How sure are you?

Correct: A. The correct answer is IFRS permits upward revaluation of PP&E; US GAAP does not.
B. You might be misled by the idea that both accounting standards treat asset revaluation similarly, but US GAAP strictly prohibits upward revaluation of PP&E, contrasting with IFRS which allows it under certain conditions.
C. IFRS does allow upward revaluation of property, plant and equipment under its revaluation model; US GAAP does not permit it at all. So it is not true that neither framework allows it, one of the two frameworks explicitly does.

Unit: introduction-to-financial-statement-analysis

Question 121Harder

Under US GAAP, a bank recognizes credit losses using which model, most likely?

How sure are you?

Correct: B. The correct answer is Current Expected Credit Loss (CECL) model. Forward-looking lifetime expected losses.
A. You might be tempted by the incurred loss model because it aligns with a more traditional approach where losses are only recognized when they are probable and estimable, but under US GAAP for banks, the CECL model requires a forward-looking approach to recognize expected credit losses over the life of the financial assets, not just probable losses.
C. Choosing the Fair value through OCI model might seem plausible if you associate credit losses with fair value adjustments, but this model pertains to financial instruments measured at fair value with changes in fair value recognized in other comprehensive income, not to the recognition of credit losses as required by the CECL model.

Unit: introduction-to-financial-statement-analysis

Question 122Exam level

A company uses straight-line depreciation for financial reporting and accelerated depreciation for tax purposes. In Year 1, book depreciation is $20,000 and tax depreciation is $35,000. The tax rate is 30%. Which of the following best describes the income tax consequence in Year 1?

How sure are you?

Correct: B. Accelerated tax depreciation means taxable income is lower than book income in Year 1. The company pays less tax now than its income statement expense implies. The difference will be paid later when tax depreciation falls below book depreciation. DTL = ($35,000 - $20,000) x 30% = $4,500.
A. Tax depreciation exceeds book depreciation this year, so the company pays LESS tax now, not more. That is a future obligation to pay more later (a liability), not an asset.
C. $15,000 is the pre-tax timing difference ($35,000 - $20,000), not the tax effect. The difference must be multiplied by the 30% tax rate: $15,000 x 30% = $4,500.

Unit: analysis-of-income-taxes

Question 123Exam level

A company accrues warranty expense of $50,000 on its income statement. Tax law only permits a deduction when warranty costs are actually paid. No cash has been paid yet. Tax rate is 25%. What is most likely the deferred tax impact?

How sure are you?

Correct: B. Taxable income is HIGHER than book income because the $50,000 expense is recognized on the income statement but not yet deductible for tax. The company overpays tax now and will get the deduction later when cash is paid. DTA = $50,000 x 25% = $12,500.
A. Choosing A might tempt you if you think the company owes more taxes due to the accrued expense, but this confuses the timing difference with a liability; the accrued expense creates a future tax benefit, not a liability, because you will deduct these costs later when paid, leading to a deferred tax asset instead.
C. A permanent difference never reverses, but this one does: the company will get its tax deduction later, once the warranty costs are actually paid in cash. That reversing pattern is the definition of a temporary, timing difference, not a permanent one, and every temporary difference between book and taxable income creates a deferred tax balance, here a deferred tax asset of $12,500, not the absence of one.

Unit: analysis-of-income-taxes

Question 124Exam level

Which of the following is MOST LIKELY a permanent difference for income tax purposes?

How sure are you?

Correct: B. Municipal bond interest is tax-exempt permanently. It will never be taxed. It is recognized as income on the financial statements but never appears in taxable income at any point. A and C are temporary differences: they reverse over time.
A. You might be tempted by the estimated warranty liability because it seems like an expense not yet paid, but this is a temporary difference since the expense will be deductible when paid, unlike the permanently non-taxable nature of municipal bond interest.
C. You might be tempted by accelerated depreciation because it seems like it should be permanent since it affects the tax basis of assets, but remember, this is a temporary difference as the depreciation methods will converge over the asset's life, unlike the permanent non-taxability of municipal bond interest.

Unit: analysis-of-income-taxes

Question 125Exam level

A company uses LIFO. At year-end, its LIFO inventory is $400,000 and the LIFO reserve is $90,000. If an analyst converts the company's financials to a FIFO basis, the FIFO inventory value is closest to:

How sure are you?

Correct: C. FIFO inventory = LIFO inventory + LIFO reserve = $400,000 + $90,000 = $490,000.
A. You might subtract the LIFO reserve instead of adding it, confusing the direction of adjustment. FIFO inventory is always higher than LIFO inventory in rising prices. The reserve is added to LIFO to get FIFO.
B. You might ignore the reserve entirely and report LIFO inventory unchanged. No adjustment means no conversion. The LIFO reserve must be incorporated.

Unit: analysis-of-inventories

Question 126Exam level

A company reports LIFO COGS of $800,000. The LIFO reserve increased from $50,000 to $80,000 during the year. The FIFO-equivalent COGS is closest to:

How sure are you?

Correct: A. The correct answer is $770,000.
B. You might confuse the LIFO reserve level ($80,000) with a beginning-period figure and make no adjustment. The relevant figure is the change in LIFO reserve, not its ending balance.
C. You might add the change in LIFO reserve rather than subtract it, again getting the direction wrong. FIFO COGS is lower than LIFO COGS in rising prices. The reserve increase is subtracted.

Unit: analysis-of-inventories

Question 127Exam level

Under IFRS 16, a lessee signs a 5-year lease for office space. At lease commencement, the lessee will most likely record:

How sure are you?

Correct: B. The correct answer is Both a right-of-use asset and a lease liability.
A. You might confuse the asset recognition with the old finance lease treatment (asset only), forgetting the matching liability. IFRS 16 always pairs the ROU asset with a lease liability. They are recognized simultaneously and measured at the same present value.
C. Students who misread the question may think only the financial obligation side is recorded. IFRS 16 is explicit: both asset and liability are recognized; the ROU asset represents the right to use the underlying asset over the lease term.

Unit: topics-in-long-term-liabilities-and-equity

Question 128Harder

Compared to treating a lease as an operating lease, capitalizing a lease (as a finance lease) will most likely result in:

How sure are you?

Correct: B. The correct answer is Lower net income in early years of the lease.
A. You might incorrectly believe capitalization is always 'better' for profitability; they confuse EBITDA improvement with net income improvement. While EBITDA rises (lease expense moves below EBIT as depreciation + interest), net income in early years is LOWER because the interest component of capitalized leases is front-loaded.
C. Over the entire lease life, total cash outflows are equal. You might extrapolate this to income. Total expense IS equal over the full term, but the question asks about EARLY years specifically. Timing differs: front-loaded under capitalization.

Unit: topics-in-long-term-liabilities-and-equity

Question 129Exam level

A company purchases equipment for $500,000 with a $50,000 residual value and a 10-year useful life. Under the double-declining balance method, the depreciation expense in Year 2 is closest to:

How sure are you?

Correct: A. The correct answer is $80,000. Year 1 DDB: 2/10 x $500,000 = $100,000. Book value end of Year 1 = $400,000. Year 2 DDB: 2/10 x $400,000 = $80,000. That is the SL method..
B. You might subtract residual before applying DDB in Year 1: 2/10 x ($500,000 - $50,000) = $90,000. DDB applies the rate to book value WITHOUT subtracting residual. Only SL subtracts salvage value first.
C. You might correctly gets Year 1 = $100,000 but incorrectly subtracts residual before Year 2 calc: 2/10 x ($400,000 - $40,000). Residual value is never subtracted in DDB calculations until book value approaches residual, at which point you switch to SL.

Unit: analysis-of-long-term-assets

Question 130Exam level

Company A uses straight-line depreciation. Company B, in the same industry, uses double-declining balance. In the early years of an asset's life, compared to Company A, Company B will most likely report:

How sure are you?

Correct: A. The correct answer is Lower net income and lower asset values. DDB front-loads depreciation expense, producing higher depreciation charges in early years vs SL. This reduces net income AND reduces book value of assets more rapidly..
B. You might confuse which method is more aggressive early on. DDB is more aggressive (higher expense) early, producing LOWER net income, not higher.
C. You might correctly identify lower net income but logic-error on assets. Higher depreciation reduces book value more, so DDB produces lower asset values, not higher.

Unit: analysis-of-long-term-assets

Question 131Exam level

A bond indenture is most likely described as:

How sure are you?

Correct: A. The indenture (also called a trust deed) is the legal contract specifying the obligations of the issuer and the rights of bondholders. It is administered by a trustee. Option A is YTM (unrelated). Option C is a yield spread.
B. Option C is a yield spread.
C. Option C is a yield spread.

Unit: fixed-income-instrument-features

Question 132Exam level

A 6% annual coupon bond with a face value of $1,000 has 3 years to maturity. If the required yield to maturity is 8%, the bond's price is closest to:

How sure are you?

Correct: A. Bond price = PV of coupons + PV of par. Coupon = 0.06 x $1,000 = $60 per year. PV of coupons = $60 x [1 - (1+0.08)^-3] / 0.08 = $60 x 2.5771 = $154.63. PV of par = $1,000 / (1.08)^3 = $793.83. Price = $154.63 + $793.83 = $948.46. Since coupon rate (6%) < YTM (8%), the bond trades at a discount, confirming price < $1,000.
B. $1,000.00 is the face value with no adjustment for yield. Since YTM (8%) exceeds the coupon (6%), the bond must price below par, not at par.
C. $917.35 is below the correct discounted value. PV of coupons ($154.63) plus PV of par ($793.83) totals $948.46, not $917.35.

Unit: fixed-income-bond-valuation-prices-and-yields

Question 133Exam level

A 5% semi-annual coupon bond with $1,000 face value has 4 years to maturity. The bond's YTM is 4% (annual). The bond's price is closest to:

How sure are you?

Correct: A. Semi-annual coupon = (0.05/2) x $1,000 = $25. Semi-annual YTM = 4%/2 = 2%. N = 4 x 2 = 8 periods. PV of coupons = $25 x [1-(1.02)^-8]/0.02 = $25 x 7.3255 = $183.14. PV of par = $1,000/(1.02)^8 = $853.49. Price = $183.14 + $853.49 = $1,036.63 (approximately $1,036.30 depending on rounding). Since coupon rate (5%) > YTM (4%), bond trades at a premium.
B. Choosing $963.70 might tempt you if you mistakenly calculated the price using an annual instead of a semi-annual YTM, leading to an incorrect discounting of cash flows and a price that reflects a discount rather than the premium the bond should trade at given its higher coupon rate compared to its YTM.
C. You might be tempted to choose $1,027.15 if you incorrectly calculated the present value using an annual instead of a semi-annual YTM, which violates the bond pricing rule requiring consistent periodicity between coupon payments and yield to maturity.

Unit: fixed-income-bond-valuation-prices-and-yields

Question 134Exam level

A bond has a modified duration of 7.5 and a convexity of 65. If yields increase by 100 basis points (1.0%), the best estimate of the bond's percentage price change is closest to:

How sure are you?

Correct: A. Full price change = -Duration x delta_Y + (1/2) x Convexity x (delta_Y)^2. = -7.5 x 0.01 + 0.5 x 65 x (0.01)^2. = -0.075 + 0.5 x 65 x 0.0001. = -0.075 + 0.00325. = -0.07175 = -7.175%, closest to -7.17%. The convexity adjustment is positive (+0.325%), partially offsetting the duration-driven price decline. Option A ignores convexity. Option C incorrectly subtracts the convexity term.
B. You might be tempted to choose -7.83% by only considering the duration effect and ignoring the convexity adjustment, but this violates the principle that convexity provides a positive adjustment to the price change, reducing the overall impact of yield increases compared to what duration alone would suggest.
C. Choosing -7.50% with no adjustment needed might seem logical if you only consider the duration effect, but it ignores the positive convexity adjustment that partially offsets the price decline, leading to a less negative price change than -7.50%.

Unit: yield-based-bond-convexity-and-portfolio-properties

Question 135Exam level

Which of the following bonds is most likely to exhibit negative convexity?

How sure are you?

Correct: C. A callable bond exhibits negative convexity when yields fall to the point where the bond's price approaches the call price. At that level, the issuer is likely to call the bond, capping price appreciation. The price-yield curve bends backward (price rises less than duration predicts and can even decline relative to a non-callable equivalent). Option C, trading well below call price, behaves like a normal bond (positive convexity) because the call is far out-of-the-money. Zero-coupon and Treasury bonds always have positive convexity.
A. You might be tempted to choose a Treasury note because it has a fixed coupon and maturity, but Treasury notes always exhibit positive convexity, meaning their price increases more than proportionally with falling yields, unlike a callable bond that can be called away when prices rise.
B. Option C, trading well below call price, behaves like a normal bond (positive convexity) because the call is far out-of-the-money.

Unit: yield-based-bond-convexity-and-portfolio-properties

Question 136Exam level

An analyst is evaluating a bond issuer's credit quality. She examines cash flow generation, debt-to-EBITDA ratio, and interest coverage ratio. Which of the 4 Cs of credit is she primarily assessing, most likely?

How sure are you?

Correct: B. The correct answer is Capacity.
A. Character sounds like the qualitative/overall assessment of management quality, which could include financial ratios. Character is specifically management integrity and history of debt repayment. Not quantitative financial ratios.
C. Covenants include financial maintenance tests (e.g., maintaining minimum coverage ratios), which are checked via ratio analysis. Covenants are contractual restrictions in the bond indenture. Measuring whether a company can service debt is a Capacity assessment, not a Covenant assessment.

Unit: credit-risk

Question 137Exam level

A bond currently rated BBB by S&P is downgraded to BB+. This downgrade is most likely described as an example of:

How sure are you?

Correct: B. The correct answer is Credit migration risk.
A. A downgrade sounds like something bad has happened to the credit, which candidates associate with 'default risk.'. Default risk materializing means the issuer actually failed to pay. A downgrade is a rating change, not a payment failure.
C. Spread duration risk involves price sensitivity to spread changes, and a downgrade widens spreads. Spread duration describes price sensitivity mechanics. The event described is the rating change itself. Credit migration risk.

Unit: credit-risk

Question 138Exam level

A bond has a Macaulay duration of 5.40 years and a yield to maturity of 6.00% (semi-annual compounding). The bond's modified duration is closest to:

How sure are you?

Correct: A. Modified Duration = Macaulay Duration / (1 + y/m) = 5.40 / (1 + 0.06/2) = 5.40 / 1.03 = 5.24 years. The exam trap here is dividing by (1 + 0.06) = 1.06, which gives answer A and uses annual compounding instead of semi-annual. Always divide YTM by the number of compounding periods per year (m=2 for semi-annual).
B. Choosing 5.40 years might seem logical if you confuse Macaulay duration with modified duration, but modified duration adjusts Macaulay duration for the yield to maturity, making it a more accurate measure of interest rate sensitivity.
C. Choosing 5.71 years might tempt you if you mistakenly add the yield to the Macaulay duration, but this violates the rule for calculating modified duration, which requires dividing the Macaulay duration by (1 + y/m), not adding the yield.

Unit: yield-based-bond-duration-measures-and-properties

Question 139Exam level

A floating rate note pays a quarterly coupon equal to 3-month SOFR plus 120 basis points. At the most recent reset date, 3-month SOFR was 4.80%. The annualized coupon rate for the next period is closest to:

How sure are you?

Correct: A. The correct answer is 6.00%. FRN coupon = Reference Rate + Quoted Margin = 4.80% + 1.20% = 6.00%. The coupon rate is set at each reset date based on the then-current reference rate plus the fixed spread. Always add both components; never use either alone..
B. The quoted margin is 120 bps = 1.20%, and candidates remember 'the spread' as the key FRN parameter. The 1.20% is only the spread above the reference rate, not the total coupon. The coupon always equals the full reference rate plus the spread.
C. The reference rate (SOFR 4.80%) is the dominant component and candidates may recall SOFR as 'the FRN rate.'. 4.80% is only the reference rate floor; the investor earns SOFR plus the quoted margin. The spread compensates for issuer credit risk above the risk-free rate.

Unit: yield-and-yield-spread-measures-for-floating-rate-instruments

Question 140Exam level

The 1-year spot rate is 3.00% and the 2-year spot rate is 4.00%. The 1-year forward rate one year from now, f(1,1) is closest to:

How sure are you?

Correct: A. The correct answer is 5.01%. Using (1+S2)^2 = (1+S1) x (1+1f1): (1.04)^2 = (1.03) x (1+1f1). (1.0816)/(1.03) = 1.0501. Forward rate = 5.01%. The exam tests whether candidates correctly apply the no-arbitrage compounding relationship rather than simply averaging (3%+4%)/2=3.5%, which is wrong..
B. Simple average of 3% and 4%. Intuitive shortcut that ignores compounding. Forward rates are compounded, not averaged. Averaging is only valid if rates are continuously compounded and the difference is infinitesimal.
C. You might double S2 and subtracts S1: 2x4% - 3% = 5%, then rounds down to 4.5% as 'reasonable'. The arithmetic subtraction approach ignores the geometric nature of compounding. Must use (1+S2)^n / (1+S1)^m - 1.

Unit: the-term-structure-of-interest-rates-spot-par-and-forward-curves

Question 141Exam level

The 1-year spot rate is 2.50%, the 2-year spot rate is 3.00%, and the 3-year spot rate is 3.50%. The 1-year forward rate two years from now, f(2,1) is closest to:

How sure are you?

Correct: A. The correct answer is 4.51%. Formula: (1+S3)^3 = (1+S2)^2 x (1+2f1). (1.035)^3 = (1.03)^2 x (1+2f1). 1.108718 / 1.0609 = 1.04510. Forward rate = 4.51%. The first subscript is when the period starts, the second is the length..
B. You might read 3-year spot rate and assumes that is also the forward rate for the third period. Spot rates and forward rates are different. The 3-year spot rate is a blended rate covering all three periods; the forward rate is the marginal rate for just the third period.
C. You might linearly extrapolates: if spot rates rise by 0.5% per year, forward rate = 3.5% + 0.5% = 4%. Forward rates are derived geometrically from spot rates. Linear extrapolation ignores compounding and will always give the wrong answer.

Unit: the-term-structure-of-interest-rates-spot-par-and-forward-curves

Question 142Exam level

When mortgage interest rates fall sharply, an investor holding a mortgage pass-through security is most likely exposed to:

How sure are you?

Correct: B. When rates fall, homeowners have an incentive to refinance their mortgages, which accelerates principal prepayments to the pass-through's investors. This is contraction risk: the security's average life shortens and the investor must reinvest the returned principal at the new, lower prevailing rates.
A. Extension risk is the opposite scenario: it occurs when rates RISE and homeowners have no incentive to refinance, so prepayments slow and the security's duration stretches out longer than expected. Falling rates produce the reverse effect, contraction, not extension.
C. A mortgage pass-through's cash flows are explicitly NOT fixed like a standard bond's: because the underlying mortgages can be prepaid at any time, the investor's actual principal and interest cash flows depend on the pace of prepayments, which is exactly the risk being tested here.

Unit: mortgage-backed-security-mbs-instrument-and-market-features

Question 143Exam level

In a sequential-pay collateralized mortgage obligation (CMO) with tranches A, B, and C, the tranche most likely to bear the greatest extension risk is:

How sure are you?

Correct: B. In a sequential-pay structure, principal is distributed to tranche A first, then B, then C, in strict order. Tranche C waits longest to begin receiving principal, so if prepayments slow (rates rise), tranche C's average life stretches out the most of the three. Tranche A, receiving principal first, is the most exposed to contraction risk instead.
A. Tranche A is the one MOST exposed to contraction risk (prepayments arriving faster than expected), not extension risk, since it is first in line for whatever principal comes in. The question asks about extension risk, which lands hardest on the last tranche, not the first.
C. A CMO's tranching structure redistributes prepayment risk unevenly among the tranches; it never eliminates the risk itself. 'CMOs eliminate prepayment risk' is one of the most common traps on this topic; the correct concept is redistribution, not elimination.

Unit: mortgage-backed-security-mbs-instrument-and-market-features

Question 144Exam level

An investor holds a mortgage pass-through security. Interest rates decline sharply. Which of the following is the MOST likely outcome?

How sure are you?

Correct: A. When rates fall, homeowners refinance. Paying off their mortgages early. This accelerates prepayments, shortening the security's effective life (contraction). The investor loses the high-coupon stream and must reinvest at the now-lower prevailing rates. Extension risk (C) is the opposite. Rates rise, prepayments slow, and the investor is stuck with a below-market coupon. (A) is a distractor: while lower discount rates raise the theoretical PV, for MBS the prepayment effect dominates and the investor is called away from high-coupon cash flows.
B. You might be thinking that lower interest rates slow prepayments, leading to extension risk, but this confuses the effect of rate declines on homeowner behavior; when rates fall, homeowners are more likely to refinance and prepay their mortgages faster, leading to contraction risk instead.
C. A mortgage pass-through carries fixed-rate mortgage coupons passed straight through to the investor, it has no floating-rate reset mechanism, so falling market rates do not raise the coupon the investor receives. What falling rates actually trigger is a wave of refinancing, which speeds up prepayments and shortens the security's life, the contraction risk described in the correct answer, not a coupon adjustment.

Unit: fixed-income-securitization

Question 145Exam level

A bond has a face value of $1,000, a coupon rate of 8% paid semi-annually, 5 years to maturity, and a current price of $920. Which of the following best describes the relationship between the bond's coupon rate, current yield, and yield to maturity?

How sure are you?

Correct: A. The bond trades at a discount (price $920 < par $1,000). For discount bonds: coupon rate < current yield < YTM. Current yield = $80/$920 = 8.70%. YTM must be higher than current yield because YTM also captures the capital gain from $920 to $1,000 at maturity. The ordering coupon rate < current yield < YTM always holds for discount bonds.
B. Choosing B might tempt you if you mistakenly believe the bond trades at a premium, but for a discount bond priced at $920, the YTM must be higher than the current yield to account for the capital gain to par value at maturity, thus violating the correct relationship where YTM is the highest.
C. You might be tempted by choice C if you think the YTM is lower than the current yield because the bond is at a discount, but this violates the principle that for discount bonds, the YTM must be higher than the current yield to account for the additional gain from the bond's price rising to par at maturity.

Unit: yield-and-yield-spread-measures-for-fixed-rate-bonds

Question 146Exam level

An investor has a long-term target allocation of 60% equities and 40% fixed income specified in her Investment Policy Statement. After a prolonged equity bull market, the portfolio has shifted to 74% equities and 26% fixed income. The portfolio manager sells equities and purchases bonds to return the portfolio to the 60/40 target. This action is most likely described as:

How sure are you?

Correct: C. Rebalancing is the process of restoring actual portfolio weights back to the SAA target weights after market movements have caused drift. The manager is moving TOWARD the IPS target. TAA would involve deliberately moving AWAY from the SAA target based on a market view.
A. Both TAA and rebalancing involve changing asset class weights. You might confuse any weight adjustment with TAA. TAA deliberately moves weights AWAY from the SAA target. This action moves weights TOWARD the target. The direction is opposite.
B. The portfolio is being changed, which seems like a strategy revision. SAA revision requires an IPS update driven by a change in investor objectives. Not market movement. No IPS change occurred here.

Unit: basics-of-portfolio-planning-and-construction

Question 147Exam level

A pension fund's Investment Policy Statement specifies a target allocation of 55% domestic equity, 25% international equity, and 20% fixed income. The fund reviews its portfolio quarterly. If any asset class weight deviates by more than 5 percentage points from target, the manager rebalances. This rebalancing approach is most likely described as:

How sure are you?

Correct: B. The quarterly review is the calendar element. The 5-percentage-point drift condition before action is taken is the threshold element. Because BOTH triggers must be present (review occurs AND threshold exceeded), this is a hybrid approach. Pure calendar rebalancing would act at every quarterly review regardless of drift.
A. The 5% deviation trigger sounds like threshold rebalancing. Pure threshold rebalancing would require continuous monitoring and act whenever the threshold is breached, with no scheduled review component.
C. Periodic review with active decisions sounds like TAA. TAA involves deliberate deviations FROM target based on market views. Rebalancing returns weights TO target. The opposite of TAA.

Unit: basics-of-portfolio-planning-and-construction

Question 148Harder

According to the Brinson, Hood, and Beebower (1986) study, asset allocation policy explained approximately 93.6% of, most likely:

How sure are you?

Correct: B. BHB found that asset allocation policy explained 93.6% of the VARIATION in quarterly returns (the R-squared of returns over time). This is not the same as saying asset allocation produces 93.6% of total return. The study measured what drove fluctuations in returns, not the level of returns.
A. You might misremember or misread the BHB finding as applying to total return level. BHB measured return variation (R-squared) not total return. Asset allocation explains WHY returns fluctuate, not how high they are in absolute terms.
C. BHB is often cited in active vs passive management debates. BHB was not a study of active vs passive. It was a study of what factors explain return variation across pension portfolios.

Unit: basics-of-portfolio-planning-and-construction

Question 149Exam level

A portfolio manager believes that domestic equities will outperform international equities over the next six months due to anticipated central bank policy changes. She increases the domestic equity allocation from 40% to 47%, within pre-defined deviation limits documented in the IPS. This action is most likely described as:

How sure are you?

Correct: A. TAA is a deliberate, short-term deviation from SAA targets based on a near-term market view, operating within pre-defined deviation limits. All TAA criteria are met: deliberate deviation (not market-forced), short horizon (six months), market view basis (central bank policy), within documented limits.
B. The allocation is being changed, which sounds like a strategy revision. SAA revision requires an IPS update driven by changes in investor objectives. A six-month market view does not warrant an IPS revision.
C. Making bets on central bank policy sounds like market timing. Market timing has no guardrails. This action has pre-defined deviation limits and is documented in the IPS. The distinction that separates TAA from market timing.

Unit: basics-of-portfolio-planning-and-construction

Question 150Harder

Which of the following statements about threshold rebalancing is MOST accurate?

How sure are you?

Correct: B. Threshold rebalancing requires continuous (ongoing) monitoring because drift can breach the threshold band at any time. Calendar rebalancing only requires periodic monitoring at scheduled review dates. Threshold therefore requires MORE monitoring effort, not less.
A. It is intuitive to assume that rebalancing less frequently means monitoring less frequently. This is the classic reversal trap. Threshold rebalancing trades less frequently but must be watched continuously. Monitoring frequency and trading frequency are not the same.
C. Threshold rebalancing does reduce unnecessary trades compared to calendar rebalancing. It reduces unnecessary trades (lower transaction costs). But this does not eliminate transaction costs. Trades still occur when the threshold is breached.

Unit: basics-of-portfolio-planning-and-construction

Question 151Exam level

An investor's IPS is revised to reflect a change in her risk tolerance from aggressive to moderate following retirement. As a result, the target equity allocation is reduced from 70% to 50%. This change is most likely described as:

How sure are you?

Correct: B. An SAA revision is triggered by a change in investor objectives, risk tolerance, time horizon, or constraints. Requiring an IPS update. The IPS was explicitly revised here. TAA responds to short-term market views; rebalancing corrects drift back to an existing target. This represents a new target being set.
A. The equity allocation is being reduced, which involves changing asset weights. TAA is based on short-term market views, not changes to investor objectives. TAA operates WITHIN an existing SAA; this changes the SAA itself.
C. The allocation changed by 20 percentage points, which exceeds any typical threshold. Threshold rebalancing responds to market-driven drift. This change was driven by investor circumstances, not market movement.

Unit: basics-of-portfolio-planning-and-construction

Question 152Exam level

An investor refuses to sell a stock that has declined 40% from its purchase price because selling it would 'make the loss real.' This investor is most likely exhibiting:

How sure are you?

Correct: B. Loss aversion is an emotional bias where investors feel the pain of losses roughly twice as intensely as the pleasure from equivalent gains. Prospect theory. The investor's reluctance to realize a loss, even when the sell decision is economically rational, is the defining symptom. Anchoring would describe fixating on the purchase price as a reference for future value but the question identifies the motivation as avoiding making the loss real, which is loss aversion. Mental accounting involves treating money differently by source or account, not avoiding realization of losses.
A. Both anchoring and loss aversion involve the purchase price. Many students see 'declined from purchase price' and jump to anchoring. Anchoring means the investor expects the stock to return to the purchase price and adjusts insufficiently from that anchor. Loss aversion means the investor feels disproportionate pain at crystallizing the loss.
C. Mental accounting involves separate psychological buckets for money, which could explain reluctance to acknowledge a loss. Mental accounting is about the source or label of money, not about asymmetric pain at realizing losses. The scenario describes a refusal driven by the emotional pain of crystallizing loss, not an account categorization issue.

Unit: the-behavioral-biases-of-individuals

Question 153Exam level

A portfolio manager has consistently beaten her benchmark over the past three years. She attributes her outperformance entirely to superior stock-picking skill and believes next year's alpha will be even higher. She is least likely exhibiting which of the following biases?

How sure are you?

Correct: B. The scenario describes a manager who has been successful (not faced losses) and attributes success to skill. This is textbook overconfidence (A), self-attribution (B). Success credited to skill, failure credited to external factors. And illusion of control (D). Loss aversion requires the investor to disproportionately weight potential losses relative to gains, which is not present in a scenario about an outperforming manager claiming credit.
A. Overconfidence is a clearly appropriate bias here. The manager overestimates her own skill. The question is least likely. Overconfidence IS present. Eliminate A.
C. Believing one has control over market outcomes (illusion of control) fits a manager claiming sustained alpha. Illusion of control IS present. Eliminate D. Loss aversion has no trigger in this scenario.

Unit: the-behavioral-biases-of-individuals

Question 154Exam level

An analyst estimates that Stock X has a beta of 1.4. The risk-free rate is 3.0% and the expected market return is 9.0%. According to CAPM, the required return for Stock X is closest to:

How sure are you?

Correct: B. Re = Rf + Beta x (Rm - Rf) = 3.0% + 1.4 x (9.0% - 3.0%) = 3.0% + 1.4 x 6.0% = 3.0% + 8.4% = 11.4%.
A. This is just beta x MRP (1.4 x 6.0%), forgetting to add the risk-free rate. The risk-free rate (3.0%) must be added to the beta-times-MRP term. It is the base return every investor gets.
C. Results from multiplying beta by Rm directly: 1.4 x 9.0% = 12.6%. The single most common arithmetic error. Beta scales the EXCESS market return (MRP = Rm - Rf), not the total market return. You must subtract Rf first.

Unit: portfolio-risk-and-return-part-ii

Question 155Exam level

A stock has an expected return of 14%. The risk-free rate is 4% and the market risk premium is 7%. The stock's beta according to CAPM is closest to:

How sure are you?

Correct: B. The correct answer is 1.43.
A. Results from dividing total expected return by MRP: 14%/7% = 2.0, or from a partial algebraic error where Rf is not subtracted from numerator. The numerator is excess return (E(R) - Rf), not total return. Rf must be subtracted first.
C. Results from 14% / 7%. Using total expected return divided by MRP without subtracting Rf. Numerator must be E(R) - Rf = 14% - 4% = 10%, not 14%.

Unit: portfolio-risk-and-return-part-ii

Question 156Exam level

Stock Y has a beta of 0.7, risk-free rate of 2.5%, and expected market return of 8.5%. Stock Y's current expected return is 6.8%. Which of the following is most accurate?

How sure are you?

Correct: B. The correct answer is Stock Y is undervalued; it plots above the SML.
A. The difference between 6.8% and 6.7% seems negligible. You might dismiss it. Any positive alpha, however small, means the stock is above the SML and undervalued. Even +0.1% is a buy signal.
C. You might reverse the over/undervalued relationship with above/below SML. Above SML = undervalued (getting more than required). Below SML = overvalued (getting less than required). C reverses this.

Unit: portfolio-risk-and-return-part-ii

Question 157Exam level

Which of the following statements about the Security Market Line (SML) is most accurate?

How sure are you?

Correct: A. The correct answer is The SML plots expected return against systematic risk measured by beta.
B. Both lines plot expected return vs some measure of risk and share the risk-free rate intercept. They are fundamentally different: different x-axes (sigma vs beta), different applicability (efficient portfolios vs all assets), different slopes (Sharpe ratio vs MRP).
C. The CML applies only to efficient portfolios. You might confuse the two lines. The SML applies to ALL assets. This is its key advantage over the CML. Individual stocks, inefficient portfolios, all plot on the SML.

Unit: portfolio-risk-and-return-part-ii

Question 158Exam level

A portfolio manager holds two assets: Asset A (beta = 1.2, weight = 60%) and Asset B (beta = 0.5, weight = 40%). The risk-free rate is 3% and the expected market return is 10%. The required return on the portfolio is closest to:

How sure are you?

Correct: B. The correct answer is 9.44%.
A. Simple average of the two betas (0.85) without weighting, then applying CAPM. Portfolio beta must be weighted average using asset weights, not a simple average.
C. You might apply CAPM to each asset separately, then average without weights, or multiply portfolio beta by Rm instead of MRP. Portfolio beta is 0.92, not higher. And always multiply by MRP (7%), not Rm (10%).

Unit: portfolio-risk-and-return-part-ii

Question 159Exam level

Which of the following is most likely a key assumption of the Capital Asset Pricing Model (CAPM)?

How sure are you?

Correct: B. The correct answer is All investors can borrow and lend unlimited amounts at the same risk-free rate.
A. Sounds like a realistic assumption that investors would have. CAPM assumes a SINGLE identical investment horizon for all investors. A key simplifying assumption.
C. Standard deviation is a common risk measure. CAPM holds that only SYSTEMATIC risk (beta) determines required return. Total volatility is irrelevant because unsystematic risk is diversified away.

Unit: portfolio-risk-and-return-part-ii

Question 160Exam level

An analyst calculates that Stock Z has an alpha of -2.3%. According to CAPM, which of the following best describes Stock Z?

How sure are you?

Correct: B. The correct answer is Stock Z is overvalued relative to its systematic risk.
A. You might confuse negative alpha with negative beta and the 'below' vs 'above' SML direction. Negative alpha means return is BELOW what is required, then overvalued, not undervalued.
C. High-risk stocks come to mind when something is 'wrong' with a stock. Alpha says nothing about whether beta is above or below 1.0. Any beta-level stock can have any alpha.

Unit: portfolio-risk-and-return-part-ii

Question 161Exam level

An investor constructs a two-asset portfolio with Asset A (expected return 8%, standard deviation 12%) and Asset B (expected return 14%, standard deviation 20%). The correlation between A and B is 0.3. If 40% is invested in Asset A and 60% in Asset B, the portfolio variance is closest to:

How sure are you?

Correct: B. The correct answer is 0.0211.
A. This is the result when the candidate forgets the factor of 2 in the cross-term. They compute w_A × w_B × Cov instead of 2 × w_A × w_B × Cov. The two-asset variance formula requires 2 × w_A × w_B × Cov(A,B). Omitting the factor of 2 understates the covariance contribution and gives an incorrect lower variance.
C. This approximates the result when standard deviations are not squared (using 0.12 instead of 0.0144 for sigma_A²), a common algebraic error. The formula uses squared standard deviations (variances). Using the standard deviation itself rather than the variance in each term inflates the result.

Unit: portfolio-risk-and-return-part-i

Question 162Exam level

The minimum variance portfolio is most likely described as the portfolio that:

How sure are you?

Correct: B. The correct answer is Has the lowest standard deviation among all possible portfolios including inefficient ones.
A. The MVP IS the starting point of the efficient frontier. So this sounds correct. Most candidates choose this. The scope is wrong. The MVP is the lowest variance portfolio across ALL portfolios, not just efficient ones. The phrase 'on the efficient frontier' unnecessarily narrows the definition and misses the key qualifier: global minimum across the entire opportunity set.
C. The Sharpe ratio and the efficient frontier are taught together, and candidates confuse MVP with the tangency portfolio. The Sharpe-ratio-maximizing portfolio is the TANGENCY portfolio. The point where the CML touches the efficient frontier. The MVP minimizes variance; it typically has a lower Sharpe ratio than the tangency portfolio.

Unit: portfolio-risk-and-return-part-i

Question 163Exam level

Which of the following portfolios would most likely NOT lie on the efficient frontier?

How sure are you?

Correct: A. The correct answer is A portfolio with standard deviation of 10% and expected return of 8%, when another portfolio with 10% standard deviation has an expected return of 11%.
B. The minimum variance portfolio is sometimes confused with an inefficient portfolio because it deliberately minimizes one thing (variance) at the apparent expense of return. The MVP IS on the efficient frontier. It is the starting point (leftmost point) of the efficient frontier. No other portfolio offers lower risk.
C. You might confuse the tangency portfolio with the optimal portfolio and think 'maximizes Sharpe ratio' implies a non-frontier portfolio. The tangency portfolio lies on the efficient frontier. It is the specific efficient portfolio where the CML is tangent. It maximizes the Sharpe ratio precisely because it is on the frontier.

Unit: portfolio-risk-and-return-part-i

Question 164Harder

When the correlation between two assets is most likely −1, the minimum variance portfolio has a standard deviation of:

How sure are you?

Correct: C. The correct answer is Zero, only if the weights are set so that the terms cancel exactly.
A. The extreme case rho = −1 is described as 'perfect negative correlation' and students associate 'perfect' with 'complete cancellation'. I.e., always zero variance. The cancellation of variance only occurs at specific weights. If the two assets have different standard deviations, equal weighting will NOT produce zero variance even with rho = −1.
B. Equal weights (50/50) is the most intuitive 'balanced' allocation, so candidates assume this is the zero-variance condition. Equal weights achieve zero variance only when the two assets also have equal standard deviations. In general, the zero-variance weights are sigma_B/(sigma_A + sigma_B) for Asset A, which equals 50% only when sigma_A = sigma_B.

Unit: portfolio-risk-and-return-part-i

Question 165Exam level

The capital market line (CML) is most likely described as:

How sure are you?

Correct: B. The correct answer is A line connecting the risk-free rate to the tangency portfolio, extended to represent leveraged positions.
A. The efficient frontier IS the set of efficient risky-only portfolios. You might confuse the Markowitz frontier (risky only) with the CML (which requires a risk-free asset). The CML requires a risk-free asset. Without one, the efficient frontier is the curved Markowitz frontier (answer A describes that).
C. Both the CML and SML are lines in expected return / risk space. Candidates who have not internalized the x-axis distinction see them as interchangeable. The CML and SML are fundamentally different lines. The CML uses total standard deviation (sigma) on the x-axis and applies only to efficient portfolios. The SML uses systematic risk (beta) on the x-axis and applies to all assets.

Unit: portfolio-risk-and-return-part-i

Question 166Exam level

An analyst wants to test whether the mean daily return of a portfolio is different from zero. She formulates H0: μ = 0 versus Ha: μ ≠ 0. With a sample of 36 daily returns, a sample mean of 0.15%, and a sample standard deviation of 0.45%, the test statistic is closest to:

How sure are you?

Correct: A. The correct answer is 2.00.
B. Choosing 0.33 might tempt you if you mistakenly divide the sample mean by the sample standard deviation instead of the standard error, ignoring the sample size effect, which is crucial for calculating the test statistic correctly.
C. Choosing C because you might think the sign of the test statistic matters for the calculation itself is a trap; remember, the test statistic calculation is absolute, focusing on the magnitude of deviation from the mean, not the direction.

Unit: hypothesis-testing

Question 167Exam level

Using the data from the previous question (t-stat = 2.00, n=36, two-tailed test), at a 5% significance level, the analyst should most likely:

How sure are you?

Correct: B. The correct answer is Fail to reject H0 because 2.00 < 2.030.
A. You might use wrong df or wrong table and gets a lower critical value. The correct critical value for 35 df at 5% two-tailed is 2.030, not below 2.00.
C. You might use the z critical value (1.96) instead of the t critical value. Since σ is unknown and n=36, we use the t-distribution. Σ is unknown (we have sample standard deviation s), so we must use the t-distribution with n-1=35 df. The z-distribution critical value of 1.96 is not appropriate here.

Unit: hypothesis-testing

Question 168Exam level

An analyst estimates there is a 40% probability that a company will meet earnings expectations and a 30% probability that the company will announce a new product line. The probability that the company both meets earnings AND announces a new product is 15%. The probability that the company meets earnings OR announces a new product is closest to:

How sure are you?

Correct: B. P(A or B) = P(A) + P(B) - P(A and B) = 0.40 + 0.30 - 0.15 = 0.55.
A. You might add 0.40 + 0.30 = 0.70, forgetting the overlap subtraction entirely. Events are not mutually exclusive (P(A and B) = 0.15 ≠ 0), so the overlap must be subtracted.
C. 0.45 does not satisfy the addition rule: P(A or B) = P(A) + P(B) - P(A and B) = 0.40 + 0.30 - 0.15 = 0.55, not 0.45.

Unit: probability-trees-and-conditional-expectations

Question 169Exam level

A stock has three possible year-end prices: $50 with probability 0.20, $60 with probability 0.50, and $75 with probability 0.30. The current price is $60. The expected return is closest to:

How sure are you?

Correct: B. The correct answer is 4.17%.
A. The $60 state has the highest probability and $60 is also the current price, so zero return feels anchored. Expected value weights all outcomes, not just the modal one.
C. You might compute unweighted average: (-16.67 + 0 + 25) / 3 = 2.78% (arithmetic), or incorrectly assign equal weights. Expected value uses probability weights, not equal weights.

Unit: probability-trees-and-conditional-expectations

Question 170Exam level

A portfolio manager takes a simple random sample of 64 stocks from a population of 500 stocks. The population has a standard deviation of returns of 8%. The standard error of the sample mean is closest to:

How sure are you?

Correct: B. The correct answer is 1.000%.
A. Divides σ by n (8%/64 = 0.125%) instead of σ/√n. Confuses the formula. Standard error divides by the square root of n, not n itself.
C. Simply uses the population standard deviation without adjusting for sample size. Standard error measures variability of the sample mean, not the population. It shrinks as n increases.

Unit: estimation-and-inference

Question 171Exam level

According to the Central Limit Theorem, as sample size most likely increases, the distribution of the sample mean:

How sure are you?

Correct: A. The correct answer is Approaches a normal distribution regardless of the shape of the population distribution.
B. Students think normality requires a normal population. This is the most common wrong answer. CLT is powerful precisely because it does NOT require a normal population. Any distribution converges to normal with sufficient sample size.
C. Confuses the sampling distribution with the t-distribution used when σ is unknown. The CLT describes convergence to normal. The t-distribution is used when σ is unknown, not as a statement of CLT.

Unit: estimation-and-inference

Question 172Exam level

A regression of quarterly portfolio returns (Y) on market returns (X) produces the following output: Intercept = 0.50, Slope = 1.20, R-squared = 0.72. Which of the following best interprets the slope coefficient of 1.20, most likely?

How sure are you?

Correct: A. The correct answer is For every 1% increase in market returns, portfolio returns increase by 1.20%..
B. You might confuse the slope with the intercept. The 0.50 intercept is the expected Y when X = 0. The intercept (b0 = 0.50) answers 'what is Y when X is zero.' The slope answers 'by how much does Y change per unit of X.'.
C. R-squared = 0.72 is visible in the output and 72% is a plausible-sounding interpretation. R-squared (0.72) measures proportion of variation explained. It is a model fit statistic, not a coefficient interpretation.

Unit: simple-linear-regression

Question 173Harder

A regression output shows R-squared = 0.85 and reports that the p-value on the slope coefficient is 0.42. Which conclusion is most appropriate?

How sure are you?

Correct: B. The correct answer is The high R-squared combined with insignificant coefficient is a warning sign of multicollinearity..
A. R-squared = 0.85 looks impressive. You might are trained to associate high R-squared with a 'good model.'. R-squared measures proportion of variation explained. It says nothing about whether the relationship is statistically significant or causal. A significant F-test and significant t-tests are required to validate the model.
C. You might assume that if the model fits well (high R-squared), the slope must be significant. R-squared and coefficient significance are separate tests. In a multiple regression with correlated predictors, R-squared can be high while all individual t-stats are insignificant. Exactly the multicollinearity symptom.

Unit: simple-linear-regression

Question 174Exam level

An analyst estimates the regression: Sales = 5.2 + 3.1(Advertising). A 95% confidence interval for the slope coefficient is [1.8, 4.4]. What is the most appropriate interpretation?

How sure are you?

Correct: B. The correct answer is In repeated sampling, 95% of such intervals would contain the true slope coefficient..
A. Saying '95% probability the true value is in this interval' is intuitive and what most people mean when they use confidence intervals colloquially. The true parameter is fixed (not random). The interval is random. The correct interpretation applies to the long-run frequency of the procedure, not the probability that any single interval contains the parameter.
C. The test for statistical significance checks whether the CI includes zero. Which it does not here. But the significance test is about whether the interval includes zero, not whether it includes the point estimate. Statistical significance is confirmed by checking if the CI excludes zero (which it does. [1.8, 4.4] is entirely positive).

Unit: simple-linear-regression

Question 175Exam level

A Durbin-Watson statistic of 0.85 is calculated for a regression of monthly stock returns on interest rate changes. The DW critical values are dL = 1.27 and dU = 1.45. What does this most likely indicate?

How sure are you?

Correct: B. The correct answer is Positive serial correlation in the residuals..
A. You might memorize 'DW ≈ 2 means no serial correlation' but misapply this as 'any DW is fine if the model fits well.'. DW = 0.85 is far from 2. Values close to 0 indicate strong positive serial correlation in the residuals. Consecutive residuals have the same sign.
C. The inconclusive zone exists (dL < DW < dU). You might apply this concept even when the DW is clearly below dL. The inconclusive zone applies when dL < DW < dU (here, 1.27 to 1.45). DW = 0.85 is below dL = 1.27, placing it firmly in the 'positive serial correlation' zone.

Unit: simple-linear-regression

Question 176Exam level

A multiple regression model produces an R-squared of 0.68 and an adjusted R-squared of 0.59. An analyst adds two more independent variables that have near-zero correlations with the dependent variable. What will happen to R-squared and adjusted R-squared, most likely?

How sure are you?

Correct: B. The correct answer is R-squared will increase or stay the same; adjusted R-squared will decrease..
A. More variables intuitively feel like they should improve the model. If R-squared improves, candidates assume adjusted R-squared also improves. Adjusted R-squared penalizes for additional parameters. Adding variables with no explanatory power hurts the adjusted R-squared penalty term more than the marginal gain.
C. Near-zero correlation with the dependent variable sounds like it would reduce fit. R-squared cannot decrease when variables are added. Mathematically, OLS always finds the RSS-minimizing coefficients including the option of setting new coefficients to near-zero.

Unit: simple-linear-regression

Question 177Exam level

An analyst observes annual returns of 10%, -5%, and 20% for an investment over three years. The geometric mean annual return is closest to:

How sure are you?

Correct: B. Geometric mean = [(1.10)(0.95)(1.20)]^(1/3) - 1 = [1.2540]^(0.3333) - 1 = 1.0784 - 1 = 7.84%. 33%, which overstates actual compound return.
A. Averaging 10, -5, 20 as simple arithmetic and rounding. Arithmetic mean of 8.33% does not account for compounding. The -5% year reduces the base for the next year's gain.
C. Arithmetic mean calculation (10-5+20)/3 = 25/3 = 8.33%. Arithmetic mean overstates compound return when there is variance in returns. It ignores the sequence-of-returns effect.

Unit: statistical-measures-of-asset-returns

Question 178Exam level

A sample of 10 monthly returns has a mean of 1.5%. The sum of squared deviations from the mean is 0.0045. The sample variance is closest to:

How sure are you?

Correct: B. Sample variance = sum of squared deviations / (n-1) = 0.0045 / (10-1) = 0.0045 / 9 = 0.000500. Recalculating: 0.0045/9 = 0.0005. Answer C = 0.000500 = 0.0005. Sample variance = 0.0045/(10-1) = 0.0005. Correct answer is C. Sample standard deviation = sqrt(0.0005) = 2.24%.
A. Dividing sum of squared deviations by n (10) instead of n-1 (9): 0.0045/10 = 0.000045. Wait: 0.0045/10 = 0.000045 (if deviations already in decimal form this would be population variance). This is the population variance formula (divide by N). For a sample, we divide by N-1 to obtain an unbiased estimate of population variance.
C. You might be tempted to choose C because it matches the sum of squared deviations divided by the sample size, but the correct formula for sample variance uses n-1 in the denominator, not n, making C incorrect.

Unit: statistical-measures-of-asset-returns

Question 179Exam level

An investor deposits $5,000 today in an account earning 8% per year compounded annually. The value of the account at the end of 6 years is closest to:

How sure are you?

Correct: A. FV = PV × (1 + r)^n = 5,000 × (1.08)^6 = 5,000 × 1.5869 = $7,934
B. Candidates who use simple interest: 5,000 × (1 + 0.08 × 6) = 7,400, close but wrong. The question specifies compounded annually, compound interest, not simple interest.
C. Mental math error: 5,000 × 1.08 × 6 periods (multiplying rate by periods instead of exponentiating). Compounding requires exponentiation, not multiplication.

Unit: time-value-of-money-in-finance

Question 180Exam level

The present value of $10,000 to be received in 5 years if the discount rate is 6% compounded semiannually is closest to:

How sure are you?

Correct: A. With semiannual compounding: r = 6%/2 = 3% per period, n = 5 × 2 = 10 periods PV = 10,000 / (1.03)^10 = 10,000 / 1.3439 = $7,441 Recheck: (1.03)^10 = 1.34392. PV = 10,000/1.34392 = $7,440.94, then Answer A) However, some versions of this question use 6% stated rate with semiannual periods differently. Using BA II Plus with P/Y=2: N=10, I/Y=3, FV=10000, PMT=0, then PV = $7,441.
B. Rounding error from using (1.03)^10 ≈ 1.3439 instead of exact value. Precision matters on the CFA exam. Use full calculator precision.
C. You might use n=5 and r=6% (annual) without adjusting for semiannual compounding. PV = 10,000/(1.06)^5 = 7,473. This is actually Answer B), showing why P/Y setting matters.

Unit: time-value-of-money-in-finance

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