Free CFA-Level-1 Practice Questions – 2026 Updated

Accounting rules require that any gain or loss from early retirement of debt must be recognized as an

extraordinary item. For all other transactions to be classified as extraordinary items, they must be

both unusual and infrequent. In this case, none of the other gains or losses qualify.

This question describes a situation often called a balloon payment. On the BAII Plus, press 36 N, 16

divide 12 = I/Y, 1450 PV, 55 +/- PMT, CPT FV. On the HP12C, press 36 n, 16 ENTER 12 divide i, 1450 PV,

55 CHS PMT, FV. The answer is shown as a negative number. Make sure the BAII Plus has the value of

P/Y set to 1.

The classes are overlapping (for e.g., the classes "147-165" and "165-183" have the point "165" in

common). There are no open-ended classes and the classes have the same class interval. Note that

"Avoid a use of non-standard class marks" is a bogus choice; there is no such suggested practice.

If a firm paid no income taxes, its cost of debt would not be adjusted downward, hence the

component cost of debt would be higher than if T (the firm's marginal tax rate) were greater than 0.

With a higher component cost of debt, the WACC would be increased. Of course, the company would

have higher earnings, and its cash flows from a given project would be high, so the higher WACC

would not impede its investments, i.e., its capital budget would be larger than if it were taxed.

To be in compliance with the PPS, a firm creating a composite must meet this requirement.

A bank holding excess reserves can increase its profits by extending more loans and holding fewer

excess reserves. This is because the excess reserves held by the bank do not earn any interest.

However, excess reserves extended as loans earn a positive interest rate and therefore will allow the

bank to make a positive profit. Excess reserves represent the portion of reserves held by the bank in

excess of the required reserve ratio set by the Fed.

During the year the company sold $1,200,000 of goods or services. However, receivables increased

by $50,000, which decreases the change in cash during the year. Therefore the change in cash, or the

cash collected during the year was $1,050,000.

Treasury stock is stock held by the company and therefore is not included as a CSE. The earnings of

the shares held by investors would not be affected by the treasury stock.

An increase in the minimum wage reflects and increase in the cost of a resource, labor. This implies

that the SRAS will shift inward because the costs of production are now higher. If the change is

permanent, then LRAS will also shift inward.

When the sum of the fair values of all identifiable assets and liabilities involved in the purchase of

another entity is less than the amount paid, the excess is attributed to "intangibles." This excess is

referred to as "Goodwill" and is capitalized as an asset. Under US GAAP, only Goodwill generated

during acquisitions is capitalized; it does not allow capitalization of internally generated Goodwill

Drilling costs can be either expensed under Successful Efforts method or capitalized under the Full

Cost method. R&D costs cannot be capitalized unless the costs are incurred on assets that have

alternative uses. Similarly, internally developed Goodwill cannot be capitalized in the form of an

asset. Only if it is purchased during an acquisition can it appear on the balance sheet in a capitalized

form.

A current liability is an obligation that will be liquidated within 1 year. Therefore, we need to include

accounts payable, unsecured notes, accrued expenses, and the senior debt which total all together

$1,490,000.

Merryl's policy is designed to prevent any conflicts or even appearances of conflicts of interest when

its employees trade in capital markets. If Monserrat wants to trade in a particular IPO, she needs to

obtain special permission from Merryl's Compliance department (and such permission may or may

not be granted by Compliance). Without such an exception, Monserrat's behavior is a violation of

Standard III(C) - Disclosure of Conflicts to Employer. Note that Standards II (B) and III (B) do not apply

to this situation.

Speculators choose to be exposed to currency risk (unlike the three above who attempt to

minimize/eliminate risk) by using forward contracts to benefit from exchange rate fluctuations.

Arbitrageurs utilize forward contracts to rid themselves of exchange risk in the currency markets.

Traders utilize forward contracts to end (or cover) the chance of loss on export or import orders that

are denominated in foreign currencies.

The purpose of Standard V (B) is to state the responsibility of AIMR members to avoid

misrepresentation of the investment performance and encourages full disclosure of investment

performance data to clients and client prospects.

Trustees recognize a conflict of interests often exists between the primary or current beneficiaries of

a trust and the remaindermen (secondary or later beneficiaries of the trust). Current life-income

beneficiaries would prefer to receive a high rate of current income; remaindermen would rather

have growth and stability of principal. Trustees thus have a duty to exercise their best skill and care to

serve all beneficiaries impartially and with equal consideration of their needs.

Investing activities include lending funds and collecting the principal on these loans.

The method does not affect the CFO.

In order to determine the dividend growth rate of Intelligent Semiconductor, the following equation

should be used:

{g = ROE(1 - Dividend Payout Ratio)}

While the Retention Rate of Dividends (which equals one minus the Dividend Payout Ratio) is

provided, the ROE figure is not. Further, the ROE figure cannot be determined from this information

provided. Therefore, the growth figure cannot be calculated. Remember that in determining

dividend growth using the formula outlined above, neither the tax rate nor the discount rate is

incorporated into theequation. Furthermore, the Beta Coefficient and the expected return on the

market are largely irrelevant in this example.

Modigliani and Miller established the Dividend Irrelevance Theory, which stated that in an

environment of no taxes or transaction costs, dividend policy is irrelevant. Modigilani and Miller

grounded this assumption in the fact that in such an environment, investors could create their own

dividend policy by selling and buying shares of stock.

If the significance level of a test is the probability of incorrectly rejecting the null hypothesis (a Type I

error), then the power of the test is defined as the probability of correctly rejecting the null

hypothesis. In other words, the power of a test is equal to (1 - the probability of a Type II error). The

standard method of hypothesis testing involves stating only the significance level, which is equal to

the probability of a Type I error.

The answer called for in this example is macroanalysis. This method involves an examination of the

relationship between the earnings multiplier of a stock market series and the earnings multiplier of

the overall market. For example, an individual projecting an earnings multiplier for a software index

using macroanalysis would begin by examining the relationship between the P/E ratio of the

software index and the P/E ratio of a broad market index such as the Standard & Poors 500. Both

historical trends and point estimates would be examined, and from this information, a projection of

the earnings multiplier for the stock market series is deduced. This is precisely the process illustrated

in this example.

This is contrasted by microanalysis, which involves an examination of the components of the

earnings multiplier, including the anticipated growth rate of dividends, the required rate of return,

and the dividend payout ratio. Once these variables have been examined, both from the perspective

of trend analysis and point estimation, a value for the earnings multiplier is deduced.

The bottom-up approach is used in the investment selection process, and involves identifying

superior investments by first examining companies, rather than beginning with an examination of

macroeconomic cycles and influence. Time series analysis, while materially correct, does not

represent the best possible answer.

The greater relative volatility of the earnings multiplier versus the EPS figure is primarily attributable

to an increased sensitivity to changes in the spread between the required rate of return "k" and the

anticipated growth rate "g." Remember that the equation used to determine the appropriate

earnings multiplier for a stock market series is the following:

{P/E = [D/E / (k - g)]}

Where: P/E = the earnings multiplier, or Price-to-Earnings ratio, D/E = the dividend payout ratio at t1,

k = the required rate of return, and g = the anticipated growth rate of dividends.

As you can see, changes in the spread between the required rate of return and the anticipated

growth rate can have a dramatic effect on the earnings multiplier figure for a stock market series.

While the earnings multiplier is sensitive to changes in the dividend payout ratio, volatility in this

figure is not cause for the increased volatility of the earnings multiplier versus the EPS figure.

Of the choices listed, only the "T-Bill-Eurodollar Yield Spread" represents a "smart money" technical

indicator. The T-Bill-Eurodollar Yield Spread is used by technical analysts to measure investor

sentiment (i.e. confidence) on a global scale. Specifically, during times of international crisis, there is

usually a "flight to quality" personified by a bidding up on U.S. Treasury issues. This will cause a

widening of the spread between U.S. T-Bills and Eurodollars, causing a decline in this ratio. Technical

analysts would view a sharp increase in the spread between T-Bills and Eurodollars as indicative of

an upcoming market trough, and historical evidence has tended to support this belief.

"Breadth of market" refers to the measure of advancing versus declining issues. The "Diffusion Index"

is a measure of market breadth and is defined as the volume of advancing issues plus one-half of the

volume of unchanged issues, divided by the total number of issues traded. Short interest measures

the total volume of outstanding short positions, and the sentiment of futures traders is used by

contrarian technical analysts, who take a contra approach. The "Block Uptick/Downtick Ratio" is used

to measure the near-term sentiment of institutions.

The appropriate earnings multiplier is found to be 8.14.

Estimating the earnings multiplier for a stock market series requires the estimation of each of the

following components:

The dividend payout ratio.

The required rate of return on common stock in the country/region/industry/sector bein analyzed.

The expected growth rate of dividends for the stocks in the country/region/industry/sector being

analyzed.

Once values for each of these components have been determined, they are imputed into the

following formula:

P/E = [D/E / (k - g)]

Where: P/E = the earnings multiplier, or Price-to-Earnings ratio, D/E = the dividend payout ratio at t1,

k = the required rate of return, and g = the anticipated growth rate of dividends.

In this example all of the necessary information has been provided. However, the dividend payout

ratio must be calculated based on the anticipated dividend at t1 and the projected EPS figure for t1.

The calculation of the dividend payout ratio is as follows:

D/E = [$1.35 / $5.10] = 0.264706

Now that the dividend payout ratio has been determined, the appropriate earnings multiplier is

found as follows:

P/E = [0.264706/ (0.1575 - 0.125)] = 8.14

Notice that it is the anticipated growth rate of dividends, not the anticipated growth rate of earnings,

which is used in the determination of the earnings multiplier.

Multiplying this figure by the projected EPS will lead to an appropriate value of $41.51 for this series.

Hypothesis testing involves a series of seven explicit steps:

Step 1: Formulating and stating the hypothesis

Step 2: Identifying the appropriate test statistic and its probability distribution

Step 3: Specifying the significance level

Step 4: Stating the decision rule

Step 5: Collecting the data and performing the necessary calculations

Step 6: Making the statistical decision

Step 7: Making the economic/investment decision.

Hypothesis testing involves a series of seven explicit steps:

Step 1: Formulating and stating the hypothesis

Step 2: Identifying the appropriate test statistic and its probability distribution

Step 3: Specifying the significance level

Step 4: Stating the decision rule

Step 5: Collecting the data and performing the necessary calculations

Step 6: Making the statistical decision

Step 7: Making the economic/investment decision.

There is two common methods for estimating the earnings multiplier for an industry - macroanalysis

and microanalysis. Macroanalysis involves an examination of the relationship between the earnings

multiplier for an industry and the earnings multiplier for the market. Microanalysis involves an

estimation of the specific variables that influence the earnings multiplier, including the required rate

of return, the estimated growth rate, and the dividend payout ratio. While the top down and bottom

up method are similar to macroanalysis and microanalysis, respectively, they do not represent the

best possible answer.

Specifically, the top-down and bottom up approaches are typically used to identify investment

opportunities, not for the estimation of an industry earnings multiplier.

The Infinite Period DDM will produce a nonsensical answer in this case because the required rate of

return is less than the growth rate. This will lead to a negative answer for the value of Nexis

Pharmaceutical common stock! The following equation illustrates the Infinite Period DDM:

{P0 = [D1 / (k - g)]}

Where: P0 = the price of the common stock at t0, D1 = the annual dividend at t1 (this is found by

multiplying the dividend at t0 by (1 + expected growth rate), k = the required rate of return, and g =

the anticipated growth rate.

As you can see, the Infinite Period DDM should not be used in this case, because the annual growth

rate is in excess of the required rate of return. In this instance, the analyst should first reexamine his

figures for the growth rate and required rate of return. If these figures are indeed accurate, then

another method should be used to value the stock.

Of all the differences between technical analysis and fundamental analysis, perhaps the most

important is the fact that technical analysis assumes that securities markets are not weak form

efficient, whereas fundamental analysis assumes that the Weak Form of the EMH is correct.

Technical analysts assume that securities markets will "price-in" relevant information gradually, and

that securities prices follow observable trends and patterns. Fundamental analysts, on the other

hand, generally assume that past price information cannot be used to predict movements in

securities prices.

Estimating the earnings multiplier for a stock market series requires the estimation of each of the

following components:

The dividend payout ratio.

The required rate of return on common stock in the country/region/industry/sector being analyzed.

The expected growth rate of dividends for the stocks in the country/region/industry/sector being

analyzed.

Once values for each of these components have been determined, they are imputed into the

following formula:

P/E = [D/E / (k - g)]

Where: P/E = the earnings multiplier, or Price-to-Earnings ratio, D/E = the dividend payout ratio at t1,

k = the required rate of return, and g = the anticipated growth rate of dividends.

In this example, all of the necessary information has been provided, and the calculation of the

earnings multiplier is shown as follows:

P/E = [0.31 / 0.16 - 0.1375] = 13.78

Notice that it was the anticipated growth rate of dividends, not the anticipated growth rate of

earnings, which was used in determining the earnings multiplier. Additionally, note that the tax rate

was notexplicitly factored in to the equation, as the earnings figure used in the dividend payout ratio

is already an after-tax figure.

None of these answers are completely correct. Of the choices listed, only II and VII are incorrect.

While II appears correct, it is not. In fact, both fundamental and technical analyses recognize the

importance of supply and demand fluctuations. The difference is that technical analysis assumes that

supply and demand are influenced by both rational and irrational factors, whereas the EMH assumes

that investors are rational. Further, technical analysis assumes that supply and demand fluctuations

are the sole cause of shifts in securities prices.

Of the firms listed, the biotechnology company would be expected to have the lowest dividend

payout ratio. The nascent biotechnology industry is characterized by a high degree of investment in

research and development, along with a high growth rate and high level of uncertainty. All of these

factors are conducive to a high retention rate, i.e. a low dividend payout ratio.

Further, firms within industries associated with high growth rates and high levels of uncertainty are

likely to be financed primarily with equity. This is reasoned by several factors, some of which include

the following:

Firms in new industries typically have a balance sheet weighted heavily toward intangible assets,

which can neither be easily liquidated nor pledged as collateral for a loan.

Firms in new industries are characterized by a high degree of research and development expenses.

Equity provides firms with a higher degree of agility than debt financing.

The cash flows of firms in developing industries are characterized by a high degree of uncertainty.

If the population standard deviation is unknown, as in this example, the standard error of the

estimate is found by using the following equation:

{Standard error = s / square root of n} where s = the sample standard deviation and n = the number

of observations in the sample.

In this example, all of the necessary information has been provided, and the determination of the

standard error of the estimate is found as:

{Standard error = [2.90 / 8.2462] = 0.3517}

Now that the standard error of the estimate has been calculated, the test statistic can be found by

using the following equation:

{Test statistic = [sample statistic - value of the population parameter under the null hypothesis] /

standard error of the sample statistic].

Again, all of the necessary information has been provided, and the calculation of the test statistic is

found as follows:

{Test statistic = [114 - 0] / 0.3517 = 324.14}

This is a very large test statistic and the null hypothesis will likely be rejected unless a very low level

of confidence is employed.

The standard error and test statistic for this example is 2.858 and 4.199, respectively. Therefore, none

of these answers is correct.

If the population standard deviation is unknown, as in this example, the standard error of the

estimate is found by using the following equation:

{Standard error = s / square root of n} where s = the sample standard deviation and n = the number

of observations in the sample.

In this example, all of the necessary information has been provided, and the determination of the

standard error of the estimate is found as:

{Standard error = [70 / 24.495] = 2.858}

Now that the standard error of the estimate has been calculated, the test statistic can be found by

using the following equation:

{Test statistic = [sample statistic - value of the population parameter under the null hypothesis] /

standard error of the sample statistic].

Again, all of the necessary information has been provided, and the calculation of the test statistic is

found as follows:

{Test statistic = [812 - 800] / 2.858 = 4.199}