FRM Part – I | Test ID – 0007

Answer Sheet -

1.Given: an 11% annual rate compounded quarterly for 2 years; compute the future value of $8,000
today.
A) $8,962.
B) $9,857.
C) $9,939.
Correct Answer Is -C $9,939.

Divide the interest rate by the number of compound periods and multiply the number of years by the
number of compound periods. I = 11 / 4 = 2.75; N = (2)(4) = 8; PV = 8,000.

This question tested from Session 2, Reading 5, LOS d.

2.Which of the following is the most accurate statement about stated and effective annual interest
rates?

A) The stated rate adjusts for the frequency of compounding.

B) The stated annual interest rate is used to find the effective annual rate.
So long as interest is compounded more than once a year, the stated annual rate will
C)
always be more than the effective rate.
Correct Answer Is -BThe stated annual interest rate is used to find the effective annual rate.

The effective annual rate, not the stated rate, adjusts for the frequency of compounding. The nominal,
stated, and stated annual rates are all the same thing.

This question tested from Session 2, Reading 5, LOS c.

3.The covariance of returns on two investments over a 10-year period is 0.009. If the variance of
returns for investment A is 0.020 and the variance of returns for investment B is 0.033, what is the
correlation coefficient for the returns?

A) 0.444.
B) 0.687.
C) 0.350.
Correct Answer Is -C 0.350.

The correlation coefficient is: Cov(A,B) / [(Std Dev A)(Std Dev B)] = 0.009 / [(√0.02)(√0.033)] = 0.350.

This question tested from Session 2, Reading 8, LOS k.

4.Suppose you are going to deposit $1,000 at the start of this year, $1,500 at the start of next year,
and $2,000 at the start of the following year in an savings account. How much money will you have at
the end of three years if the rate of interest is 10% each year?
 A) $5,346.00.
B) $4,000.00.
C) $5,750.00.
Correct Answer Is -A

Future value of $1,000 for 3 periods at 10% = 1,331

Future value of $1,500 for 2 periods at 10% =Â 1,815
Future value of $2,000 for 1 period at 10% = 2,200
       Total = $5,346

N = 3; PV = -$1,000; I/Y = 10%; CPT → FV = $1,331

N = 2; PV = -$1,500; I/Y = 10%; CPT → FV = $1,815
N = 1; PV = -$2,000; I/Y = 10%; CPT → FV = $2,200

This question tested from Session 2, Reading 5, LOS e.

5.A local bank offers an account that pays 8%, compounded quarterly, for any deposits of $10,000 or
more that are left in the account for a period of 5 years. The effective annual rate of interest on this
account is:

A) 4.65%.
B) 8.24%.
C) 9.01%.
Correct Answer Is -B8.24%.

(1 + periodic rate)m − 1 = (1.02)4 − 1 = 8.24%.

This question tested from Session 2, Reading 5, LOS c.

6.Which of the following statements about kurtosis is least accurate? Kurtosis:

measures the peakedness of a distribution reflecting a greater or lesser concentration of

A)
returns around the mean.
B) describes the degree to which a distribution is not symmetric about its mean.
C) is used to reflect the probability of extreme outcomes for a return distribution.
Correct Answer Is -Bdescribes the degree to which a distribution is not symmetric about its mean.

The degree to which a distribution is not symmetric about its mean is measured by skewness. Excess
kurtosis which is measured relative to a normal distribution, indicates the peakedness of a distribution,
and also reflects the probability of extreme outcomes.

This question tested from Session 2, Reading 7, LOS l.

7.Sarah Parker is buying a new $25,000 car. Her trade-in is worth $5,000 so she needs to borrow
$20,000. The loan will be paid in 48 monthly installments and the annual interest rate on the loan is
7.5%. If the first payment is due at the end of the first month, what is Sarah’s monthly car payment?

A) $483.58.
 B) $416.67.
C) $480.57.
Correct Answer Is -A

N = 48; I/Y = 7.5 / 12 = 0.625; PV = 20,000; FV = 0; CPT → PMT = 483.58.

This question tested from Session 2, Reading 5, LOS f.

8.Portfolio A earned an annual return of 15% with a standard deviation of 28%. If the mean return on
Treasury bills (T-bills) is 4%, the Sharpe ratio for the portfolio is:

A) 0.54.
B) 1.87.
C) 0.39.
Correct Answer Is -C 0.39.

(15 − 4) / 28 = 0.39

This question tested from Session 2, Reading 7, LOS i.

9.Which of the following statements regarding making investment decisions using net present value
(NPV) and internal rate of return (IRR) is least accurate?

A) Projects with a positive NPVs increase shareholder wealth.

If two projects are mutually exclusive, one should always choose the project with the
B)
highest IRR.
If a firm undertakes a zero-NPV project, the firm will get larger, but shareholder wealth will
C)
not change.
Correct Answer Is -BIf two projects are mutually exclusive, one should always choose the project with
the highest IRR.

If two projects are mutually exclusive, the firm should always choose the project with the highest NPV
rather than the highest IRR. If two projects are mutually exclusive, the firm may only choose one. It is
possible for NPV and IRR to give conflicting decisions for projects of different sizes. Because NPV is
a direct measure of the change in shareholder wealth, NPV criteria should be used when NPV and
IRR decisions conflict.

When a project has a positive NPV, it will add to shareholder wealth because the project is earning
more than the opportunity cost of capital needed to undertake the project. If a firm takes on a zero-
NPV project, the firm will earn exactly enough to cover the opportunity cost of capital. The firm will
increase in size by taking the project, but shareholder wealth will not change.

This question tested from Session 2, Reading 6, LOS b.

10.Joe Mayer, CFA, projects that XYZ Company's return on equity varies with the state of the
economy in the following way:

State of Economy Probability of Occurrence Company Returns

Good .20 20%
Normal .50 15%
Poor .30 10%
The standard deviation of XYZ's expected return on equity is closest to:

A) 1.5%.
B) 12.3%.
C) 3.5%.
Correct Answer Is -C 3.5%.

In order to calculate the standard deviation of the company returns, first calculate the expected return,
then the variance, and the standard deviation is the square root of the variance.

The expected value of the company return is the probability weighted average of the possible
outcomes: (0.20)(0.20) + (0.50)(0.15) + (0.30)(0.10) = 0.145.
The variance is the sum of the probability of each outcome multiplied by the squared deviation of
each outcome from the expected return: (0.2)(0.20 - 0.145)2 + (0.5)(0.15 - 0.145)2 + (0.3)(0.1-0.145)2
= 0.000605 + 0.0000125 + 0.0006075 = 0.001225.
The standard deviation is the square root of 0.001225 = 0.035 or 3.5%.

This question tested from Session 2, Reading 8, LOS l.

11.Consider the following graph of a distribution for the prices of various bottles of champagne.

Which of the following statements regarding the distribution is least accurate?

A) Point A represents the mode.

B) The distribution is negatively skewed.
C) The mean value will be less than the mode.
Correct Answer Is -A

The graph represents a negatively skewed distribution, and thus Point A represents the mean. By
definition, mean < median < mode describes a negatively skewed distribution.

Both remaining statements are true. Chebyshev’s Inequality states that for any set of observations
(normally distributed or skewed), the proportion of observations that lie within k standard deviations of
the mean is at least 1 1 / k2. Here, 1 (1 / 1.32) = 1 − 0.59172 = 0.40828, or 40%.

This question tested from Session 2, Reading 7, LOS k.

12.An investor deposits $10,000 in a bank account paying 5% interest compounded annually.
Rounded to the nearest dollar, in 5 years the investor will have:

A) $12,500.
B) $12,763.
C) $10,210.
Correct Answer Is -B$12,763.

PV = 10,000; I/Y = 5; N = 5; CPT → FV = 12,763.

or: 10,000(1.05)5 = 12,763.

This question tested from Session 2, Reading 5, LOS e.

13.The following table summarizes the results of a poll taken of CEO's and analysts concerning the
economic impact of a pending piece of legislation:

Think it will have a Think it will have a

Group Total
positive impact negative impact
CEO's 40 30 70
Analysts 70 60 130
110 90 200

What is the probability that a randomly selected individual from this group will be either an analyst or
someone who thinks this legislation will have a positive impact on the economy?

A) 0.75.
B) 0.85.
C) 0.80.
Correct Answer Is -B0.85.

There are 130 total analysts and 40 CEOs who think it will have a positive impact. (130 + 40) / 200 =
0.85.

This question tested from Session 2, Reading 8, LOS f.

14.

Use the results from the following survey of 500 firms to answer the question.

Number of Employees Frequency

300 up to 400 40
400 up to 500 62
500 up to 600 78
600 up to 700 101
700 up to 800 131
800 up to 900 88
The lower boundary of the fifth interval (class) is:

A) 800.
B) 700.
C) 701.
Correct Answer Is -B700.

700 - 800, lower boundary = 700

This question tested from Session 2, Reading 7, LOS b.

15.

What is the main difference between descriptive statistics and inferential statistics? Descriptive
statistics are:

used to summarize a large data set while inferential statistics involves procedures used to
A)
make forecasts or judgments about a large data set by examining a smaller sample.
used to summarize data while inferential statistics are used to obtain precise information
B)
about a large data set.
used to make forecasts about the likelihood of upcoming events while inferential statistics
C)
are used to summarize any data set.
Correct Answer Is -A

Descriptive statistics are used to summarize a large data set while inferential statistics are based on
procedures used to make forecasts or judgments about a large data set by examining a smaller set of
data.

This question tested from Session 2, Reading 7, LOS a.

16.

A firm wants to select a team of five from a group of ten employees. How many ways can the firm
compose the team of five?

A) 120.
B) 25.
C) 252.
Correct Answer Is -C 252.

This is a labeling problem where there are only two labels: chosen and not chosen. Thus, the
combination formula applies: 10! / (5! × 5!) = 3,628,800 / (120 × 120) = 252.

With a TI calculator: 10 [2nd][nCr] 5 = 252.

This question tested from Session 2, Reading 8, LOS o.

17.Calabash Crab House is considering an investment in mutually exclusive kitchen-upgrade projects

with the following cash flows:
 Project A Project B
Initial Year -$10,000 -$9,000
Year 1 2,000 200
Year 2 5,000 -2,000
Year 3 8,000 11,000
Year 4 8,000 15,000

Assuming Calabash has a 12.5% cost of capital, which of the following investment decisions is most
appropriate?

A) Accept Project A because its internal rate of return is higher than that of Project B.
B) Accept both projects because they both have positive net present values.
C) Accept Project B because its net present value is higher than that of Project A.
Correct Answer Is -C Accept Project B because its net present value is higher than that of Project A.

When net present value (NPV) and internal rate of return (IRR) give conflicting project rankings, NPV
is the most appropriate method for deciding between mutually exclusive projects. Here, the NPV of
project A is $6,341 and the NPV of Project B is $6,688. Both NPVs are positive, so Calabash should
select the Project B because of its higher NPV.

This question tested from Session 2, Reading 6, LOS a.

18.There is a 90% chance that the economy will be good next year and a 10% chance that it will be
bad. If the economy is good, there is a 60% chance that XYZ Incorporated will have EPS of $4.00 and
a 40% chance that their earnings will be $3.00. If the economy is bad, there is an 80% chance that
XYZ Incorporated will have EPS of $2.00 and a 20% chance that their earnings will be $1.00. What is
the firm’s expected EPS?

A) $5.40.
B) $2.50.
C) $3.42.
Correct Answer Is -C $3.42.

The expected EPS is calculated by multiplying the probability of the economic environment by the
probability of the particular EPS and the EPS in each case. The expected EPS in all four outcomes
are then summed to arrive at the expected EPS:

(0.90 × 0.60 × $4.00) + (0.90 × 0.40 × $3.00) + (0.10 × 0.80 × $2.00) + (0.10 × 0.20 × $1.00) = $2.16
+ $1.08 + $0.16 + $0.02 = $3.42.

This question tested from Session 2, Reading 8, LOS j.

19.A distribution that has positive excess kurtosis is:

A) more peaked than a normal distribution.

B) more skewed than a normal distribution.
C) less peaked than a normal distribution.
Correct Answer Is -A

A distribution with positive excess kurtosis is one that is more peaked than a normal distribution.
This question tested from Session 2, Reading 7, LOS l.

20.

Annual Returns on ABC Mutual Fund

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
11.0% 12.5% 8.0% 9.0% 13.0% 7.0% 15.0% 2.0% -16.5% 11.0%

Assuming a mean of 7.2%, what is the sample standard deviation of the returns for ABC Mutual Fund
for the period 1991-2000?

A) 7.8%.
B) 9.1%.
C) 9.8%.
Correct Answer Is -B9.1%.

Standard deviation = [∑i (xi − X)2 / (n − 1)]1/2 = √(744.10 / 9) = √(82.68) = 9.1%

This question tested from Session 2, Reading 7, LOS g.

21

Let A and B be two mutually exclusive events with P(A) = 0.40 and P(B) = 0.20. Therefore:

A) P(B|A) = 0.20.
B) P(A and B) = 0.08.
C) P(A and B) = 0.
Correct Answer Is -C P(A and B) = 0.

If the two evens are mutually exclusive, the probability of both ocurring is zero.

This question tested from Session 2, Reading 8, LOS d.

22.

With respect to the units each is measured in, which of the following is the most easily directly
applicable measure of dispersion? The:

A) covariance.
B) standard deviation.
C) variance.
Correct Answer Is -Bstandard deviation.

The standard deviation is in the units of the random variable itself and not squared units like the
variance. The covariance would be measured in the product of two units of measure.

This question tested from Session 2, Reading 8, LOS k.

23.

If the holding period yield on a Treasury bill (T-bill) with 197 days until maturity is 1.07%, what is the
effective annual yield?

A) 1.99%.
B) 0.58%.
C) 1.07%.
Correct Answer Is -A

To calculate the EAY from the HPY, the formula is: (1 + HPY)(365/t) − 1. Therefore, the EAY is:
(1.0107)(365/197) − 1 = 0.0199, or 1.99%.

This question tested from Session 2, Reading 6, LOS f.

24.

The estimated annual after-tax cash flows of a proposed investment are shown below:

Year 1: $10,000
Year 2: $15,000
Year 3: $18,000

After-tax cash flow from sale of investment at the end of year 3 is $120,000

The initial cost of the investment is $100,000, and the required rate of return is 12%. The net present
value (NPV) of the project is closest to:

A) $63,000.
B) -$66,301.
C) $19,113.
Correct Answer Is -C $19,113.

10,000 / 1.12 = 8,929

15,000 / (1.12)2 = 11,958

138,000 / (1.12)3 = 98,226

NPV = 8,929 + 11,958 + 98,226 − 100,000 = $19,113

Alternatively: CFO = -100,000; CF1 = 10,000; CF2 = 15,000; CF3 = 138,000; I = 12; CPT → NPV =
$19,112.

This question tested from Session 2, Reading 6, LOS a.

25.

Given P(X = 20, Y = 0) = 0.4, and P(X = 30, Y = 50) = 0.6, then COV(XY) is:

A) 125.00.
B) 25.00.
 C) 120.00.
Correct Answer Is -C 120.00.

The expected values are: E(X) = (0.4 × 20) + (0.6 × 30) = 26, and E(Y) = (0.4 × 0) + (0.6 × 50) = 30.
The covariance is COV(XY) = (0.4 × ((20 − 26) × (0 − 30))) + ((0.6 × (30 − 26) × (50 − 30))) = 120.

This question tested from Session 2, Reading 8, LOS m.

26.

The mean monthly return on a sample of small stocks is 4.56% with a standard deviation of 3.56%.
What is the coefficient of variation?

A) 128%.
B) 84%.
C) 78%.
Correct Answer Is -C 78%.

The coefficient of variation expresses how much dispersion exists relative to the mean of a
distribution and is found by CV = s / mean. 3.56 / 4.56 = 0.781, or 78%.

This question tested from Session 2, Reading 7, LOS i.

27.

If the money market yield is 3.792% on a T-bill with 79 days to maturity, what is the holding period
yield?

A) 0.83%.
B) 0.77%.
C) 0.89%.
Correct Answer Is -A

The holding period yield can be calculated from the money market yield as: (money market yield) ÷
(360 ÷ t). Therefore, the HPY is (0.03792) × (79 ÷ 360) = 0.0083 = 0.83%.

This question tested from Session 2, Reading 6, LOS f.

28.

According to Chebyshev’s Inequality, for any distribution, what is the minimum percentage of
observations that lie within three standard deviations of the mean?

A) 89%.
B) 94%.
C) 75%.
Correct Answer Is -A

According to Chebyshev’s Inequality, for any distribution, the minimum percentage of observations
that lie within k standard deviations of the distribution mean is equal to: 1 (1 / k2). If k = 3, then the
percentage of distributions is equal to 1 (1 / 9) = 89%.
This question tested from Session 2, Reading 7, LOS h.

29.

Which one of the following alternatives best describes the primary use of descriptive statistics?
Descriptive statistics are used to:

obtain data about the characteristics of any data set that can be used to assess the
A)
likelihood of the occurrence of future events.
B) summarize important characteristics of large data sets.
arrive at estimates regarding a large set of data regarding the statistical characteristics of
C)
a smaller sample.
Correct Answer Is -Bsummarize important characteristics of large data sets.

Descriptive statistics are used mainly to summarize important characteristics of large data sets.

This question tested from Session 2, Reading 7, LOS a.

30.

An investor has a $12,000 portfolio consisting of $7,000 in stock A with an expected return of 20%
and $5,000 in stock B with an expected return of 10%. What is the investor’s expected return on the
portfolio?

A) 12.2%.
B) 15.0%.
C) 15.8%.
Correct Answer Is -C 15.8%.

Find the weighted mean where the weights equal the proportion of $12,000. (7,000 / 12,000)(0.20) +
(5,000 / 12,000)(0.10) = 15.8%.

This question tested from Session 2, Reading 7, LOS e.

31.

A recent ad for a Roth IRA includes the statement that if a person invests $500 at the beginning of
each month for 35 years, they could have $1,000,000 for retirement. Assuming monthly
compounding, what annual interest rate is implied in this statement?

A) 7.625%.
B) 7.411%.
C) 6.988%.
Correct Answer Is -B7.411%.

Solve for an annuity due with a future value of $1,000,000, a number of periods equal to (35 × 12) =
420, payments = -500, and present value = 0. Solve for i. i = 0.61761 × 12 = 7.411% stated annually.
Don’t forget to set your calculator for payments at the beginning of the periods. If you don’t, you’ll get
7.437%.

This question tested from Session 2, Reading 5, LOS f.

32.

If the historical mean return on an investment is 2.0% and the standard deviation is 8.8%, what is the
coefficient of variation (CV)?

A) 4.40.
B) 1.76.
C) 6.80.
Correct Answer Is -A

The CV = the standard deviation of returns / mean return or 8.8% / 2.0% = 4.4.

This question tested from Session 2, Reading 7, LOS i.

33.

Find the mean, median, and mode, respectively, of the following data:

3, 3, 5, 8, 9, 13, 17

A) 8; 8.28; 3.
B) 3; 8.28; 8.
C) 8.28; 8; 3.
Correct Answer Is -C 8.28; 8; 3.

Mean = (3 + 3 + 5 + 8 + 9 + 13 + 17) / 7 = 8.28; Median = middle of distribution = 8 (middle number);

Mode = most frequent = 3.

This question tested from Session 2, Reading 7, LOS e.

34.

The probability of a new Wal-Mart being built in town is 64%. If Wal-Mart comes to town, the
probability of a new Wendy’s restaurant being built is 90%. What is the probability of a new Wal-Mart
and a new Wendy’s restaurant being built?

A) 0.675.
B) 0.306.
C) 0.576.
Correct Answer Is -C 0.576.

P(AB) = P(A|B) × P(B)

The probability of a new Wal-Mart and a new Wendy’s is equal to the probability of a new Wendy’s
“if Wal-Mart― (0.90) times the probability of a new Wal-Mart (0.64). (0.90)(0.64) = 0.576.

This question tested from Session 2, Reading 8, LOS f.

35.
A Treasury bill, with 80 days until maturity, has an effective annual yield of 8%. Its holding period yield
is closest to:

A) 1.70%.
B) 1.72%.
C) 1.75%.
Correct Answer Is -A

The effective annual yield (EAY) is equal to the annualized holding period yield (HPY) based on a
365-day year. EAY = (1 + HPY)365/t − 1. HPY = (EAY + 1)t/365 − 1 = (1.08)80/365 − 1 = 1.70%.

This question tested from Session 2, Reading 6, LOS f.

36.

The following table summarizes the availability of trucks with air bags and bucket seats at a
dealership.

Bucket seats No Bucket Seats Total

 Air Bags 75 50 125
 No Air Bags 35 60 95
 Total 110 110 220

What is the probability of randomly selecting a truck with air bags and bucket seats?

A) 0.34.
B) 0.28.
C) 0.16.
Correct Answer Is -A

75 ÷ 220 = 0.34.

This question tested from Session 2, Reading 8, LOS f.

37.

If $1,000 is invested at the beginning of the year at an annual rate of 48%, compounded quarterly,
what would that investment be worth at the end of the year?

A) $1,048.
B) $4,798.
C) $1,574.
Correct Answer Is -C $1,574.

N = 1 × 4 = 4; I/Y = 48/4 = 12; PMT = 0; PV = 1,000; CPT → FV = 1,573.52.

This question tested from Session 2, Reading 5, LOS d.

38.
Thomas Baynes has applied to both Harvard and Yale. Baynes has determined that the probability of
getting into Harvard is 25% and the probability of getting into Yale (his father’s alma mater) is 42%.
Baynes has also determined that the probability of being accepted at both schools is 2.8%. What is
the probability of Baynes being accepted at either Harvard or Yale?

A) 7.7%.
B) 10.5%.
C) 64.2%.
Correct Answer Is -C 64.2%.

Using the addition rule, the probability of being accepted at Harvard or Yale is equal to: P(Harvard) +
P(Yale) − P(Harvard and Yale) = 0.25 + 0.42 − 0.028 = 0.642 or 64.2%.

This question tested from Session 2, Reading 8, LOS f.

39.

The returns on assets C and D are strongly correlated with a correlation coefficient of 0.80. The
variance of returns on C is 0.0009, and the variance of returns on D is 0.0036. What is the covariance
of returns on C and D?

A) 0.40110.
B) 0.00144.
C) 0.03020.
Correct Answer Is -B0.00144.

r = Cov(C,D) / (σC x σD)

σC = (0.0009)0.5 = 0.03
σD = (0.0036)0.5 = 0.06
0.8(0.03)(0.06) = 0.00144

This question tested from Session 2, Reading 8, LOS k.

40.

A higher Sharpe ratio indicates:

A) lower volatility of returns.

B) a lower risk per unit of return.
C) a higher excess return per unit of risk.
Correct Answer Is -C a higher excess return per unit of risk.

The Sharpe ratio is excess return (return − R f) per unit of risk (defined as the standard deviation of
returns).

This question tested from Session 2, Reading 7, LOS i.

41.

A Treasury bill with a face value of $1,000,000 and 45 days until maturity is selling for $987,000. The
Treasury bill’s bank discount yield is closest to:
 A) 10.54%.
B) 7.90%.
C) 10.40%.
Correct Answer Is -C 10.40%.

The actual discount is 1.3%, 1.3% × (360 / 45) = 10.4%

The bank discount yield is computed by the following formula, r = (dollar discount / face value) × (360
/ number of days until maturity) = [(1,000,000 − 987,000) / (1,000,000)] × (360 / 45) = 10.40%.

This question tested from Session 2, Reading 6, LOS e.

42.

Nortel Industries has a preferred stock outstanding that pays (fixed) annual dividends of $3.75 a
share. If an investor wants to earn a rate of return of 8.5%, how much should he be willing to pay for a
share of Nortel preferred stock?

A) $31.88.
B) $42.10.
C) $44.12.
Correct Answer Is -C $44.12.

PV = 3.75 ÷ 0.085 = $44.12.

This question tested from Session 2, Reading 5, LOS e.

43.

An investor sold a 30-year bond at a price of $850 after he purchased it at $800 a year ago. He
received $50 of interest at the time of the sale. The annualized holding period return is:

A) 6.25%.
B) 12.5%.
C) 15.0%.
Correct Answer Is -B12.5%.

The holding period return (HPR) is calculated as follows:

HPR = (Pt − Pt-1 + Dt) / Pt

where:
Pt = price per share at the end of time period t
Dt = cash distributions received during time period t.

Here, HPR = (850 − 800 + 50) / 800 = 0.1250, or 12.50%.

This question tested from Session 2, Reading 6, LOS c.

44.
A local bank advertises that it will pay interest at the rate of 4.5%, compounded monthly, on regular
savings accounts. What is the effective rate of interest that the bank is paying on these accounts?

A) 4.65%.
B) 4.59%.
C) 4.50%.
Correct Answer Is -B4.59%.

(1 + 0.045 / 12)12 − 1 = 1.0459 − 1 = 0.0459.

This question tested from Session 2, Reading 5, LOS c.

45.

The financial manager at IBFM, a farm implement distributor, is contemplating the following three
mutually exclusive projects. IBFM’s required rate of return is 9.5%. Based on the information
provided, which should the financial manager select and why?

Project Investment at t = 0 Cash Flow at t = 1 IRR NPV @ 9.5%

A $10,000 $11,300 13.00 $320
B $25,000 $29,000 16.00 $1,484
C $35,000 $40,250 15.00 $1,758
A) Project C with the highest net present value.
B) Project A with the lowest initial investment.
All of the projects, because they all earn more than
C)
9.5%.
Correct Answer Is -A

When projects are mutually exclusive, only one can be chosen. Project selection should be done on
the basis of which project will enhance firm value the most. That project, Project C in this case, is the
one with the highest NPV.

This question tested from Session 2, Reading 6, LOS b.

46.

How much should an investor have in a retirement account on his 65th birthday if he wishes to
withdraw $40,000 on that birthday and each of the following 14 birthdays, assuming his retirement
account is expected to earn 14.5%?

A) $234,422.
B) $272,977.
C) $274,422.
Correct Answer Is -C $274,422.

This is an annuity due so set your calculator to the BGN mode. N = 15; I/Y = 14.5; PMT = 40,000; FV
= 0; CPT → PV = 274,422.50. Switch back to END mode.

This question tested from Session 2, Reading 5, LOS f.

47.
A portfolio of options had a return of 22% with a standard deviation of 20%. If the risk-free rate is
7.5%, what is the Sharpe ratio for the portfolio?

A) 0.725.
B) 0.568.
C) 0.147.
Correct Answer Is -A

Sharpe ratio = (22% 7.50%) / 20% = 0.725.

This question tested from Session 2, Reading 7, LOS i.

48.

The joint probability function for returns on an equity index (RI) and returns on a stock (RS)is given in
the following table:

 Returns on Index (RI)

Return on stock (RS) RI = 0.16 RI = 0.02 RI = −0.10
RS = 0.24 0.25 0.00 0.00
RS = 0.03 0.00 0.45 0.00
RS = −0.15 0.00 0.00 0.30

Covariance between stock returns and index returns is closest to:

A) 0.019.
B) 0.014.
C) 0.029.
Correct Answer Is -B0.014.

E(I) = (0.25 0.16) + (0.45 0.02) + (0.30 0.10) = 0.0190.

E(S) = (0.25 0.24) + (0.45 0.03) + (0.30 0.15) = 0.0285.

Covariance = [0.25 (0.16 0.0190) (0.24 0.0285)] + [0.45 (0.02 0.0190) (0.03 0.0285)] + [0.30 (0.10
0.0190) (0.15 0.0285)] = 0.0138.

This question tested from Session 2, Reading 8, LOS m.

49.

After repeated experiments, the average of the outcomes should converge to:

A) the expected value.

B) the variance.
C) one.
Correct Answer Is -A

This is the definition of the expected value. It is the long-run average of all outcomes.

This question tested from Session 2, Reading 8, LOS l.

50.If 10 equal annual deposits of $1,000 are made into an investment account earning 9% starting
today, how much will you have in 20 years?
A) $35,967.
B) $42,165.
C) $39,204.
Correct Answer Is -C $39,204.

Switch to BGN mode. PMT = 1,000; N = 10, I/Y = 9, PV = 0; CPT → FV = 16,560.29. Remember the
answer will be one year after the last payment in annuity due FV problems. Now PV 10 = 16,560.29; N
= 10; I/Y = 9; PMT = 0; CPT → FV = 39,204.23. Switch back to END mode.

This question tested from Session 2, Reading 5, LOS e.

51.Selmer Jones has just inherited some money and wants to set some of it aside for a vacation in
Hawaii one year from today. His bank will pay him 5% interest on any funds he deposits. In order to
determine how much of the money must be set aside and held for the trip, he should use the 5% as a:

A) required rate of return.

B) discount rate.
C) opportunity cost.
Correct Answer Is -Bdiscount rate.

He needs to figure out how much the trip will cost in one year, and use the 5% as a discount rate to
convert the future cost to a present value. Thus, in this context the rate is best viewed as a discount
rate.

This question tested from Session 2, Reading 5, LOS a.

52.What is the total present value of $200 to be received one year from now, $300 to be received 3
years from now, and $600 to be received 5 years from now assuming an interest rate of 5%?

A) $919.74.
B) $980.89.
C) $905.87.
Correct Answer Is -A

200 / (1.05) + 300 / (1.05)3 + 600 / (1.05)5 = 919.74.

This question tested from Session 2, Reading 5, LOS e.

53.Financial managers should always select the project that provides the highest net present value
(NPV) whenever NPV and IRR methods conflict, because maximizing:

A) shareholder wealth is the goal of financial management.

B) the shareholders' rate of return is the goal of financial management.
C) revenues is the goal of financial management.
Correct Answer Is -A
Focusing on the maximization of earnings does not consider the differences in risk across projects,
while focusing on revenues precludes concern for the expenses incurred. Earning a higher return on a
small project provides less of a benefit than earning a slightly lower rate of return on a much larger
project.

This question tested from Session 2, Reading 6, LOS b.

54.Which of the following statements regarding skewness is least accurate?

A) A distribution that is not symmetrical has skew not equal to zero.

In a skewed distribution, 95% of all values will lie within plus or minus two standard
B)
deviations of the mean.
A positively skewed distribution is characterized by many small losses and a few extreme
C)
gains.
Correct Answer Is -BIn a skewed distribution, 95% of all values will lie within plus or minus two
standard deviations of the mean.

For a normal distribution, the mean will be equal to its median and 95% of all observations will fall
within plus or minus two standard deviations of the mean. For a skewed distribution, because it is not
symmetrical, this may not be the case. Chebyshev’s inequality tells us that at least 75% of
observations will lie within plus or minus two standard deviations from the mean.

This question tested from Session 2, Reading 7, LOS j.

55.Use the results from the following survey of 500 firms to answer the question.
Number of Employees Frequency
300 up to 400 40
400 up to 500 62
500 up to 600 78
600 up to 700 101
700 up to 800 131
800 up to 900 88
The number of classes in this frequency table is:

A) 600.
B) 5.
C) 6.
Correct Answer Is -C 6.

300 - 400 = 1, 400 - 500 = 2, 500 - 600 = 3, 600 - 700 = 4, 700 - 800 = 5, 800 - 900 = 6, Total = 6

This question tested from Session 2, Reading 7, LOS b.

56.The bank discount of a $1,000,000 T-bill with 135 days until maturity that is currently selling for
$979,000 is:

A) 6.1%.
B) 5.8%.
C) 5.6%.
Correct Answer Is -C 5.6%.
($21,000 / 1,000,000) × (360 / 135) = 5.6%.

This question tested from Session 2, Reading 6, LOS e.

57.Given P(X = 2) = 0.3, P(X = 3) = 0.4, P(X = 4) = 0.3. What is the variance of X?

A) 3.0.
B) 0.6.
C) 0.3.
Correct Answer Is -B0.6.

The variance is the sum of the squared deviations from the expected value weighted by the
probability of each outcome.
The expected value is E(X) = 0.3 × 2 + 0.4 × 3 + 0.3 × 4 = 3.
The variance is 0.3 × (2 − 3)2 + 0.4 × (3 − 3)2 + 0.3 × (4 − 3)2 = 0.6.

This question tested from Session 2, Reading 8, LOS l.

58.It will cost $20,000 a year for four years when an 8-year old child is ready for college. How much
should be invested today if the child will make the first of four annual withdrawals 10-years from
today? The expected rate of return is 8%.

A) $66,243.
B) $33,138.
C) $30,683.
Correct Answer Is -B$33,138.

First, find the present value of the college costs as of the end of year 9. (Remember that the PV of an
ordinary annuity is as of time = 0. If the first payment is in year 10, then the present value of the
annuity is indexed to the end of year 9). N = 4; I/Y = 8; PMT = 20,000; CPT → PV = $66,242.54.
Second, find the present value of this single sum: N = 9; I/Y = 8; FV = 66,242.54; PMT = 0; CPT →
PV = 33,137.76.

This question tested from Session 2, Reading 5, LOS f.

59.Fifty mutual funds are ranked according to performance. The five best performing funds are
assigned the number 1, while the five worst performing funds are assigned the number 10. This is an
example of a(n):

A) interval scale.
B) ordinal scale.
C) nominal scale.
Correct Answer Is -Bordinal scale.

The ordinal scale of measurement categorizes and orders data with respect to some characteristic. In
this example, the ordinal scale tells us that a fund ranked “1― performed better than a fund
ranked “10,― but it does not tell us anything about the difference in performance.
This question tested from Session 2, Reading 7, LOS a.

60.A distribution of returns that has a greater percentage of small deviations from the mean and a
greater percentage of large deviations from the mean compared to a normal distribution:

A) is positively skewed.
B) has positive excess kurtosis.
C) has negative excess kurtosis.
Correct Answer Is -Bhas positive excess kurtosis.

A distribution that has a greater percentage of small deviations from the mean and a greater
percentage of large deviations from the mean will be leptokurtic and will exhibit positive excess
kurtosis. The distribution will be taller (more peaked) with fatter tails than a normal distribution.

This question tested from Session 2, Reading 7, LOS l.

61.Last year, the average salary increase for poultry research assistants was 2.5%. Of the 10,000
poultry research assistants, 2,000 received raises in excess of this amount. The odds that a randomly
selected poultry research assistant received a salary increase in excess of 2.5% are:

A) 1 to 4.
B) 20%.
C) 1 to 5.
Correct Answer Is -A

For event “E,― the probability stated as odds is: P(E) / [1 P(E)]. Here, the probability that a
poultry research assistant received a salary increase in excess of 2.5% = 2,000 / 10,000 = 0.20, or
1/5 and the odds are (1/5) / [1 (1/5)] = 1/4, or 1 to 4.

This question tested from Session 2, Reading 8, LOS b.

62.Which of the following is an example of a parameter?

A) Sample standard deviation.

B) Population variance.
C) Sample mean.
Correct Answer Is -BPopulation variance.

A parameter is any descriptive measure of a population characteristic. The population variance

describes a population while the sample standard deviation and sample mean are each descriptive
measures of samples.

This question tested from Session 2, Reading 7, LOS b.

63.Which of the following statements concerning kurtosis is least accurate?

 A) A leptokurtic distribution has excess kurtosis less than zero.
B) A distribution that is more peaked than a normal distribution is leptokurtic.
C) A leptokurtic distribution has fatter tails than a normal distribution.
Correct Answer Is -A

A leptokurtic distribution is more peaked than normal and has fatter tails. However, the excess
kurtosis is greater than zero.

This question tested from Session 2, Reading 7, LOS l.

64.An investment with a cost of $5,000 is expected to have cash inflows of $3,000 in year 1, and
$4,000 in year 2. The internal rate of return (IRR) for this investment is closest to:

A) 25%.
B) 15%.
C) 30%.
Correct Answer Is -A

The IRR is the discount rate that makes the net present value of the investment equal to 0.

This means -$5,000 + $3,000 / (1 + IRR) + $4,000 / (1 + IRR)2 = 0

One way to compute this problem is to use trial and error with the existing answer choices and
choose the discount rate that makes the PV of the cash flows closest to 5,000.

$3,000 / (1.25) + $4,000 / (1.25)2 = 4,960.

Alternatively: CFO = -5,000; CF1 = 3,000; CF2 = 4,000; CPT → IRR = 24.3%.

This question tested from Session 2, Reading 6, LOS a.

65.Find the future value of the following uneven cash flow stream. Assume end of the year payments.
The discount rate is 12%.

Year 1 -2,000
Year 2 -3,000
Year 3 6,000
Year 4 25,000
Year 5 30,000
A $65,144.33
) .
B $58,164.58
) .
C $33,004.15
) .
Correct Answer Is -B$58,164.58.

N = 4; I/Y = 12; PMT = 0; PV = -2,000; CPT → FV = -3,147.04

N = 3; I/Y = 12; PMT = 0; PV = -3,000; CPT → FV = -4,214.78
N = 2; I/Y = 12; PMT = 0; PV = 6,000; CPT → FV = 7,526.40
N = 1; I/Y = 12; PMT = 0; PV = 25,000; CPT → FV = 28,000.00
N = 0; I/Y = 12; PMT = 0; PV = 30,000; CPT → FV = 30,000.00

Sum the cash flows: $58,164.58.

Alternative calculation solution: -2,000 × 1.124 − 3,000 × 1.123 + 6,000 × 1.122 + 25,000 × 1.12 +
30,000 = $58,164.58.

This question tested from Session 2, Reading 5, LOS e.

66.A T-bill with a face value of $100,000 and 140 days until maturity is selling for $98,000. What is the
effective annual yield (EAY)?

A) 2.04%.
B) 5.14%.
C) 5.41%.
Correct Answer Is -C 5.41%.

The EAY takes the holding period yield and annualizes it based on a 365-day year accounting for
compounding. HPY = (100,000 − 98,000) / 98,000 = 0.0204. EAY = (1 + HPY) 365/t − 1 = (1.0204)365/140
− 1 = 0.05406 = 5.41%.

This question tested from Session 2, Reading 6, LOS e.

67.

The financial manager at Kyser Jones is considering two mutually exclusive projects with the following
projected cash flows:

Projected Cash Flows

Year Project M Project Z
0 -$60,000 -$60,000
1 22,500 0
2 22,500 0
3 22,500 0
4 22,500 111,000

If Kyser Jones’ required rate of return is 11%, which project would be chosen and why?

A) Project M, because it has the higher internal rate of return.

B) Both projects because their net present values are positive.
C) Project Z, because it has the higher net present value.
Correct Answer Is -C Project Z, because it has the higher net present value.

Since the projects are mutually exclusive, only one of the projects may be chosen. Project Z has the
higher NPV. On the exam, always use NPV for choosing between mutually exclusive projects.

Cash Flow Input Values

Project M Project Z
 CF0 -60,000 -60,000
CF1 22,500 0
F1 4 3
CF2 Â 111,000
F2 Â 1
Output Values
Project M Project Z
NPV $9,805 $13,119
IRR 18.45% 16.62%

This question tested from Session 2, Reading 6, LOS b.

68.Given the following table about employees of a company based on whether they are smokers or
nonsmokers and whether or not they suffer from any allergies, what is the probability of being either a
nonsmoker or not suffering from allergies?

Suffer from Don't Suffer from

Total
Allergies Allergies
 Smoker 35 25 60
 Nonsmoker 55 185 240
 Total 90 210 300
A) 0.88.
B) 0.38.
C) 0.50.
Correct Answer Is -A

The probability of being a nonsmoker is 240 / 300 = 0.80. The probability of not suffering from
allergies is 210 / 300 = 0.70. The probability of being a nonsmoker and not suffering from allergies is
185 / 300 = 0.62. Since the question asks for the probability of being either a nonsmoker or not
suffering from allergies we have to take the probability of being a nonsmoker plus the probability of
not suffering from allergies and subtract the probability of being both: 0.80 + 0.70 − 0.62 = 0.88.

Alternatively: 1 − P(Smoker & Allergies) = 1 − (35 / 300) = 88.3%.

This question tested from Session 2, Reading 8, LOS f.

69.In the most recent four years, an investment has produced annual returns of 4%, 1%, 6%, and 3%.
The most appropriate estimate of the next year’s return, based on these historical returns, is the:

A) arithmetic mean.
B) geometric mean.
C) harmonic mean.
Correct Answer Is -A

Given a series of historical returns, the arithmetic mean is statistically the best estimator of the next
year’s return. For estimating a compound return over more than one year, the geometric mean of the
historical returns is the most appropriate estimator.

This question tested from Session 2, Reading 7, LOS m.

70.A Treasury bill has 40 days to maturity, a par value of $10,000, and is currently selling for $9,900.
Its effective annual yield is closest to:

A) 1.00%.
B) 9.00%.
C) 9.60%.
Correct Answer Is -C 9.60%.

The effective annual yield (EAY) is based on a 365-day year and accounts for compound interest.
EAY = (1 + holding period yield)365/t − 1. The holding period yield formula is (price received at maturity
− initial price + interest payments) / (initial price) = (10,000 − 9,900 + 0) / (9,900) = 1.01%. EAY =
(1.0101)365/40 − 1 = 9.60%.

This question tested from Session 2, Reading 6, LOS e.

71.Which of the following statements about compounding and interest rates is least accurate?

A) Present values and discount rates move in opposite directions.

B) All else equal, the longer the term of a loan, the lower will be the total interest you pay.
On monthly compounded loans, the effective annual rate (EAR) will exceed the annual
C)
percentage rate (APR).
Correct Answer Is -BAll else equal, the longer the term of a loan, the lower will be the total interest
you pay.

Since the proportion of each payment going toward the principal decreases as the original loan
maturity increases, the total dollars interest paid over the life of the loan also increases.

This question tested from Session 2, Reading 5, LOS f.

72.Use the following probability distribution to calculate the expected return for the portfolio.

State of the Economy Probability Return on Portfolio

Boom 0.30 15%
Bust 0.70 3%
A) 8.1%.
B) 6.6%.
C) 9.0%.
Correct Answer Is -B6.6%.

0.30 × 0.15 + 0.70 × 0.03 = 6.6%

This question tested from Session 2, Reading 8, LOS l.

73.An investor has two stocks, Stock R and Stock S in her portfolio. Given the following information
on the two stocks, the portfolio's standard deviation is closest to:

 σR = 34%
 σS = 16%
  rR,S = 0.67
 W R = 80%
 W S = 20%

A) 29.4%.
B) 7.8%.
C) 8.7%.
Correct Answer Is -A

The formula for the standard deviation of a 2-stock portfolio is:

s = [W A2sA2 + W B2sB2 + 2W AW BsAsBrA,B]1/2

s = [(0.82 × 0.342) + (0.22 × 0.162) + (2 × 0.8 × 0.2 × 0.34 × 0.16 × 0.67)]1/2 = [0.073984 + 0.001024 +
0.0116634]1/2 = 0.08667141/2 = 0.2944, or approximately 29.4%.

This question tested from Session 2, Reading 8, LOS l.

74.If two fair coins are flipped and two fair six-sided dice are rolled, all at the same time, what is the
probability of ending up with two heads (on the coins) and two sixes (on the dice)?

A) 0.0069.
B) 0.8333.
C) 0.4167.
Correct Answer Is -A

For the four independent events defined here, the probability of the specified outcome is 0.5000 ×
0.5000 × 0.1667 × 0.1667 = 0.0069.

This question tested from Session 2, Reading 8, LOS f.

75.A very large company has twice as many male employees relative to female employees. If a
random sample of four employees is selected, what is the probability that all four employees selected
are female?

A) 0.3333.
B) 0.0123.
C) 0.0625.
Correct Answer Is -B0.0123.

Since there are twice as many male employees to female employees, P(male) = 2/3 and P(female) =
1/3. Therefore, the probability of 4 “successes― = (0.333)4 = 0.0123.

This question tested from Session 2, Reading 8, LOS f.

76.If a distribution is skewed:

 it will be more or less peaked reflecting a greater or lesser concentration of returns
A)
around the mean.
B) each side of a return distribution is the mirror image of the other.
the magnitude of positive deviations from the mean is different from the magnitude of
C)
negative deviations from the mean.
Correct Answer Is -C the magnitude of positive deviations from the mean is different from the
magnitude of negative deviations from the mean.

Skewness is caused by the magnitude of positive deviations from the mean being either larger or
smaller than the magnitude of negative deviations from the mean. Each side of a skewed distribution
is not a mirror image of the other. Peakedness of a distribution is measured by kurtosis.

This question tested from Session 2, Reading 7, LOS j.

77.In a skewed distribution, what is the minimum proportion of observations between +/- two standard
deviations from the mean?

A) 95%.
B) 75%.
C) 84%.
Correct Answer Is -B75%.

For any distribution we can use Chebyshev’s Inequality, which states that the proportion of
observations within k standard deviations of the mean is at least 1 (1 / k2).

1 (1 / 22) = 0.75, or 75%.

Note that for a normal distribution, 95% of observations will fall between +/- 2 standard deviations of
the mean.

This question tested from Session 2, Reading 7, LOS h.

78.

A distribution with a mean that is less than its median most likely:

A) is positively skewed.
B) is negatively skewed.
C) has negative excess kurtosis.
Correct Answer Is -Bis negatively skewed.

A distribution with a mean that is less than its median is a negatively skewed distribution. A negatively
skewed distribution is characterized by many small gains and a few extreme losses. Note that kurtosis
is a measure of the peakedness of a return distribution.

This question tested from Session 2, Reading 7, LOS k.

79.
In a positively skewed distribution, what is the order (from lowest value to highest) for the distribution’s
mode, mean, and median values?

A) Mode, median, mean.

B) Mean, median, mode.
C) Mode, mean, median.
Correct Answer Is -A

In a positively skewed distribution, the mode is less than the median, which is less than the mean.

This question tested from Session 2, Reading 7, LOS k.

80.

A distribution that is more peaked than normal is:

A) skewed.
B) leptokurtic.
C) platykurtic.
Correct Answer Is -Bleptokurtic.

A distribution that is more peaked than normal is leptokurtic. A distribution that is flatter than normal is
platykurtic.

This question tested from Session 2, Reading 7, LOS l.

81.

Which probability rule determines the probability that two events will both occur?

A) The multiplication rule.

B) The addition rule.
C) The total probability rule.
Correct Answer Is -A

The multiplication rule is used to determine the joint probability of two events. The addition rule is
used to determine the probability that at least one of two events will occur. The total probability rule is
utilized when trying to determine the unconditional probability of an event.

This question tested from Session 2, Reading 8, LOS e.

82.

Banca Hakala purchases two front row concert tickets over the Internet for $90 per seat. One month
later, the rock group announces that it is dissolving due to personality conflicts and the concert that
Hakala has tickets for will be the “farewell― concert. Hakala sees a chance to raise some quick
cash, so she puts the tickets up for sale on the same internet site. The auction closes at $250 per
ticket. After paying a 10% commission to the site on the amount of the sale and paying $10 in
shipping costs, Hakala’s one-month holding period return is approximately:

A) 44%.
 B) 144%.
C) 139%.
Correct Answer Is -B144%.

The holding period return is calculated as: (ending price beginning price +/- any cash flows) /
beginning price. Here, the beginning and ending prices are given. The other cash flows consist of the
commission of 0.10 × $250 × 2 tickets = $50 and the shipping cost of $10 (total for both tickets).

Thus, her one-month holding period return is: [(2 × $250) (2 × $90) $50 − $10] / (2 × $90) = 1.44, or
approximately 144%.

This question tested from Session 2, Reading 6, LOS c.

83.

Which of the following statements about histograms and frequency polygons is least accurate?

A frequency polygon is constructed by plotting the midpoint of each interval on the

A)
horizontal axis.
A histogram and a frequency polygon both plot the absolute frequency on the vertical
B)
axis.
C) A histogram connects points with a straight line.
Correct Answer Is -C A histogram connects points with a straight line.

In constructing a frequency polygon, the midpoint of each interval is plotted on the horizontal axis and
the frequency of each interval is plotted on the vertical axis. Points are then connected with straight
lines. A histogram is a bar chart of data that has been grouped into a frequency distribution because
it is a bar chart, there are no individual points to connect.

This question tested from Session 2, Reading 7, LOS d.

84.

The effective annual yield (EAY) for a T-bill maturing in 150 days is 5.04%. What are the holding
period yield (HPY) and money market yield (MMY) respectively?

A) 2.04%; 4.90%.
B) 5.25%; 2.04%.
C) 2.80%; 5.41%.
Correct Answer Is -A

The EAY takes the holding period yield and annualizes it based on a 365-day year accounting for
compounding. The HPY = (1 + 0.0504)150/365 = 1.2041 − 1 = 2.04%. Using the HPY to compute the
money market yield = HPY × (360/t) = 0.0204 × (360/150) = 0.04896 = 4.90%.

This question tested from Session 2, Reading 6, LOS f.

85.

An investor buys four shares of stock for $50 per share. At the end of year one she sells two shares
for $50 per share. At the end of year two she sells the two remaining shares for $80 each. The stock
paid no dividend at the end of year one and a dividend of $5.00 per share at the end of year two.
What is the difference between the time-weighted rate of return and the money-weighted rate of
return?

A) 20.52%.
B) 14.48%.
C) 9.86%.
Correct Answer Is -C 9.86%.

T = 0: Purchase of four shares = -$200.00

T = 1: Dividend from four shares = +$0.00

Sale of two shares = +$100.00

T = 2: Dividend from two shares = +$10.00

Proceeds from selling shares = +$160.00

The money-weighted return is the rate that solves the equation:

$200.00 = $100.00 / (1 + r) + $170.00 / (1 + r)2.

Cfo = -200, CF1 = 100, Cf2 = 170, CPT → IRR = 20.52%.

The holding period return in year one is ($50.00 − $50.00 + $0.00) / $50.00 = 0.00%.

The holding period return in year two is ($80.00 − $50.00 + $5.00) / $50 = 70.00%.

The time-weighted return is [(1 + 0.00)(1 + 0.70)]1/2 − 1 = 30.38%.

The difference between the two is 30.38% − 20.52% = 9.86%.

This question tested from Session 2, Reading 6, LOS d.

86.

Consider the following graph of a distribution for the prices for various bottles of California-produced
wine.

Which of the following statements about this distribution is least accurate?

 A) The graph could be of the sample $16, $12, $15, $12, $17, $30 (ignore graph scale).
B) The distribution is positively skewed.
C) Approximately 68% of observations fall within one standard deviation of the mean.
Correct Answer Is -C Approximately 68% of observations fall within one standard deviation of the
mean.

This statement is true for the normal distribution. The above distribution is positively skewed. Note: for
those tempted to use Chebyshev’s inequality to determine the percentage of observations falling
within one standard deviation of the mean, the formula is valid only for k > 1.

The other statements are true. When we order the six prices from least to greatest: $12, $12, $15,
$16, $17, $30, we observe that the mode (most frequently occurring price) is $12, the median (middle
observation) is $15.50 [(15 + 16)/2], and the mean is $17 (sum of all prices divided by number in the
sample). Time-Saving Note: Just by ordering the distribution, we can see that it is positively skewed
(there are large, positive outliers). By definition, mode < median < mean describes a positively
skewed distribution.

This question tested from Session 2, Reading 7, LOS j.

87.

An analyst managed a portfolio for many years and then liquidated it. Computing the internal rate of
return of the inflows and outflows of a portfolio would give the:

A) time-weighted return.
B) money-weighted return.
C) net present value.
Correct Answer Is -Bmoney-weighted return.

The money-weighted return is the internal rate of return on a portfolio that equates the present value
of inflows and outflows over a period of time.

This question tested from Session 2, Reading 6, LOS d.

88.

An investor purchases a 10-year, $1,000 par value bond that pays annual coupons of $100. If the
market rate of interest is 12%, what is the current market value of the bond?

A) $1,124.
B) $950.
C) $887.
Correct Answer Is -C $887.

Note that bond problems are just mixed annuity problems. You can solve bond problems directly with
your financial calculator using all five of the main TVM keys at once. For bond-types of problems the
bond’s price (PV) will be negative, while the coupon payment (PMT) and par value (FV) will be
positive. N = 10; I/Y = 12; FV = 1,000; PMT = 100; CPT → PV = 886.99.

This question tested from Session 2, Reading 5, LOS e.

89.
The money-weighted return also is known as the:

A) return on invested capital.

B) internal rate of return (IRR) of a portfolio.
C) measure of the compound rate of growth of $1 over a stated measurement period.
Correct Answer Is -Binternal rate of return (IRR) of a portfolio.

It is the IRR of a portfolio, taking into account all of the cash inflows and outflows.

This question tested from Session 2, Reading 6, LOS d.

90.

A T-bill with a face value of $100,000 and 140 days until maturity is selling for $98,000. What is its
holding period yield?

A) 2.04%.
B) 5.25%.
C) 5.14%.
Correct Answer Is -A

The holding period yield is the return the investor will earn if the T-bill is held to maturity. HPY =
(100,000 98,000) / 98,000 = 0.0204, or 2.04%.

This question tested from Session 2, Reading 6, LOS e.

91.

The financial manager at Johnson & Smith estimates that its required rate of return is 11%. Which of
the following independent projects should Johnson & Smith accept?

Project A requires an up-front expenditure of $1,000,000 and generates an NPV of -

A)
$4,600.
Project B requires an up-front expenditure of $800,000 and generates a positive IRR of
B)
10.5%.
Project C requires an up-front expenditure of $600,000 and generates a positive internal
C)
rate of return of 12.0%.
Correct Answer Is -C Project C requires an up-front expenditure of $600,000 and generates a positive
internal rate of return of 12.0%.

When projects are independent, you can use either the NPV method or IRR method to make the
accept or reject decision. Only Project C has an IRR in excess of 11%. Acceptance of Project A
reduces the firm’s value by $4,600.

This question tested from Session 2, Reading 6, LOS b.

92.

When Annette Famigletti hears that a baseball-loving friend is coming to visit, she purchases two
premium-seating tickets for $45 per ticket for an evening game. As the date of the game approaches,
Famigletti’s friend telephones and says that his trip has been cancelled. Fortunately for Famigletti, the
tickets she holds are in high demand as there is chance that the leading Major League Baseball hitter
will break the home run record during the game. Seeing an opportunity to earn a high return,
Famigletti puts the tickets up for sale on an internet site. The auction closes at $150 per ticket. After
paying a 10% commission to the site (on the amount of the sale) and paying $8 total in shipping
costs, Familgletti’s holding period return is approximately:

A) 191%.
B) 182%.
C) 202%.
Correct Answer Is -A

The holding period return is calculated as: (ending price − beginning price +/- any cash flows) /
beginning price. Here, the beginning and ending prices are given. The other cash flows consist of the
commission of $30 (0.10 × 150 × 2 tickets) and the shipping cost of $8 (total for both tickets). Thus,
her holding period return is: (2 × 150 − 2 × 45 − 30 − 8) / (2 × 45) = 1.91, or approximately 191%.

This question tested from Session 2, Reading 6, LOS c.

93.

Given the following annual returns, what is the range?

2000 2001 2002 2003 2004

15% 2% 5% 7% 0%
A) 3.0%.
15.0%
B)
.
22.0%
C)
.
Correct Answer Is -C 22.0%.

Range = Highest Value − Lowest Value. 15% − (7%) = 22.0%.

This question tested from Session 2, Reading 7, LOS g.

94.Given the following sample data, find the sample standard deviation of returns for Stock A and for
Stock B.

< >> Stock A Stock B

Year 1 16% 20%
Year 2 20% 24%
Year 3 12% 10%
Std. Dev. A Std. Dev. B
A) 4.0% 5.9%
B) 4.0% 7.2%
C) 3.3% 5.9%
Correct Answer Is -B
4.0% 7.2%
First find the mean of the returns, then take differences from the mean and square them. Add the
squared differences and divide by n-1 to find the variance, and take the square root of the variance to
find the standard deviation.

For Stock A: (16 + 20 + 12)/3 = 48/3 = 16% average return.

(16 16)2 = 02 = 0
(20 16)2 = 42 = 16
(12 16)2 = -42 = 16

0 + 16 + 16 = 32; 32/(3-1) = 16; 161/2 = 4.0%

For Stock B: (20 + 24 + 10) = 54/3 = 18% average return.

(20 18)2 = 22 = 4
(24 18)2 = 62 = 36
(10 18)2 = -82 = 64

4 + 36 + 64 = 104; 104 / (3 − 1) = 52; 521/2 = 7.2%

This question tested from Session 2, Reading 7, LOS g.

95.

What is the effective annual rate if the stated rate is 12% compounded quarterly?

A) 12.55%.
B) 57.35%.
C) 12.00%.
Correct Answer Is -A

EAR = (1 + 0.12 / 4)4 1 = 12.55%

This question tested from Session 2, Reading 5, LOS c.

96.

Which of the following is an a priori probability?

For a stock, based on prior patterns of up and down days, the probability of the stock
A)
having a down day tomorrow.
B) The probability the Fed will lower interest rates prior to the end of the year.
On a random draw, the probability of choosing a stock of a particular industry from the
C)
S&P 500.
Correct Answer Is -C On a random draw, the probability of choosing a stock of a particular industry
from the S&P 500.

A priori probability is based on formal reasoning and inspection. Given the number of stocks in the
airline industry in the S&P500 for example, the a priori probability of selecting an airline stock would
be that number divided by 500.

This question tested from Session 2, Reading 8, LOS b.

97.

Which of the following statements is least accurate regarding covariance?

A) Covariance can only apply to two variables at a time.

B) Covariance can exceed one.
C) The covariance of a variable with itself is one.
Correct Answer Is -C The covariance of a variable with itself is one.

The covariance of a variable with itself is its variance. Both remaining statements are true. Covariance
represents the linear relationship between two variables and is not limited in value (i.e., it can range
from negative infinity to positive infinity).

This question tested from Session 2, Reading 8, LOS k.

98.

If an investor puts $5,724 per year, starting at the end of the first year, in an account earning 8% and
ends up accumulating $500,000, how many years did it take the investor?

A) 87 years.
B) 27 years.
C) 26 years.
Correct Answer Is -B27 years.

I/Y = 8; PMT = -5,724; FV = 500,000; CPT → N = 27.

Remember, you must put the pmt in as a negative (cash out) and the FV in as a positive (cash in) to
compute either N or I/Y.

This question tested from Session 2, Reading 5, LOS e.

99.Jamie Morgan needs to accumulate $2,000 in 18 months. If she can earn 6% at the bank,
compounded quarterly, how much must she deposit today?

A) $1,829.08.
B) $1,832.61.
C) $1,840.45.
Correct Answer Is -A

Each quarter of a year is comprised of 3 months thus N = 18 / 3 = 6; I/Y = 6 / 4 = 1.5; PMT = 0; FV =

2,000; CPT → PV = $1,829.08.

This question tested from Session 2, Reading 5, LOS d.

100.

Wei Zhang has funds on deposit with Iron Range bank. The funds are currently earning 6% interest. If
he withdraws $15,000 to purchase an automobile, the 6% interest rate can be best thought of as a(n):
 A) opportunity cost.
B) financing cost.
C) discount rate.
Correct Answer Is -A

Since Wei will be foregoing interest on the withdrawn funds, the 6% interest can be best characterized
as an opportunity cost the return he could earn by postponing his auto purchase until the future.

This question tested from Session 2, Reading 5, LOS a.

101.

Use the following probability distribution to calculate the standard deviation for the portfolio.

State of the Economy Probability Return on Portfolio

Boom 0.30 15%
Bust 0.70 3%
A) 5.5%.
B) 6.0%.
C) 6.5%.
Correct Answer Is -A

[0.30 × (0.15 − 0.066)2 + 0.70 × (0.03 − 0.066)2]1/2 = 5.5%.

This question tested from Session 2, Reading 8, LOS l.

102.

The following stream of cash flows will occur at the end of the next five years.

Yr 1 -2,000
Yr 2 -3,000
Yr 3 6,000
Yr 4 25,000
Yr 5 30,000

At a discount rate of 12%, the present value of this cash flow stream is closest to:

A) $36,965.
B) $33,004.
C) $58,165.
Correct Answer Is -B$33,004.

N = 1; I/Y = 12; PMT = 0; FV = -2,000; CPT → PV = -1,785.71.

N = 2; I/Y = 12; PMT = 0; FV = -3,000; CPT → PV = -2,391.58.
N = 3; I/Y = 12; PMT = 0; FV = 6,000; CPT → PV = 4,270.68.
N = 4; I/Y = 12; PMT = 0; FV = 25,000; CPT → PV = 15,887.95.
N = 5; I/Y = 12; PMT = 0; FV = 30,000; CPT → PV = 17,022.81.
Sum the cash flows: $33,004.15.
Note: If you want to use your calculator's NPV function to solve this problem, you need to enter zero
as the initial cash flow (CF0). If you enter -2,000 as CF0, all your cash flows will be one period too
soon and you will get one of the wrong answers.

This question tested from Session 2, Reading 5, LOS e.

103.

The "likelihood" of an event occurring refers to a:

A) joint probability.
B) conditional probability.
C) unconditional probability.
Correct Answer Is -Bconditional probability.

Conditional probability, or likelihood, is where the occurrence of one event affects the probability of
the occurrence of another event. An unconditional probability refers to the probability of an event
occurring regardless of past of future events. A joint probability is the probability that two events will
both occur.

This question tested from Session 2, Reading 8, LOS d.

104.

A local bank offers a certificate of deposit (CD) that earns 5.0% compounded quarterly for three and
one half years. If a depositor places $5,000 on deposit, what will be the value of the account at
maturity?

A) $5,931.06.
B) $5,875.00.
C) $5,949.77.
Correct Answer Is -C $5,949.77.

The value of the account at maturity will be: $5,000 × (1 + 0.05 / 4)(3.5 × 4) = $5.949.77;
or with a financial calculator: N = 3 years × 4 quarters/year + 2 = 14 periods; I = 5% / 4 quarters/year
= 1.25; PV = $5,000; PMT = 0; CPT → FV = $5,949.77.

This question tested from Session 2, Reading 5, LOS e.

105.

Twenty Level I CFA candidates in a study group took a practice exam and want to determine the
distribution of their scores. When they grade their exams they discover that one of them skipped an
ethics question and subsequently filled in the rest of his answers in the wrong places, leaving him with
a much lower score than the rest of the group. If they include this candidate’s score, their distribution
will most likely:

A) have a mode that is less than its median.

B) have a mean that is less than its median.
C) be positively skewed.
Correct Answer Is -Bhave a mean that is less than its median.
With the low outlier included, the distribution will be negatively skewed. For a negatively skewed
distribution, the mean is less than the median, which is less than the mode.

This question tested from Session 2, Reading 7, LOS k.

106.

In 10 years, what is the value of $100 invested today at an interest rate of 8% per year, compounded
monthly?

A) $216.
B) $180.
C) $222.
Correct Answer Is -C $222.

N = 10 × 12 = 120; I/Y = 8/12 = 0.666667; PV = 100; PMT = 0; CPT → FV = 221.96.

This question tested from Session 2, Reading 5, LOS d.

107.

If given the standard deviations of the returns of two assets and the correlation between the two
assets, which of the following would an analyst least likely be able to derive from these?

A) Strength of the linear relationship between the two.

B) Covariance between the returns.
C) Expected returns.
Correct Answer Is -C Expected returns.

The correlations and standard deviations cannot give a measure of central tendency, such as the
expected value.

This question tested from Session 2, Reading 8, LOS k.

108

The value in 7 years of $500 invested today at an interest rate of 6% compounded monthly is closest
to:

A) $780.
B) $760.
C) $750.
Correct Answer Is -B$760.

PV = -500; N = 7 × 12 = 84; I/Y = 6/12 = 0.5; compute FV = 760.18

This question tested from Session 2, Reading 5, LOS e.

109.
A bond that pays $100 in interest each year was purchased at the beginning of the year for $1,050
and sold at the end of the year for $1,100. An investor's holding period return is:

A) 10.5%.
B) 14.3%.
C) 10.0%.
Correct Answer Is -B14.3%.

Input into your calculator: N = 1; FV = 1,100; PMT = 100; PV = -1,050; CPT → I/Y = 14.29

This question tested from Session 2, Reading 6, LOS c.

110.

The covariance:

A) must be between -1 and +1.

B) can be positive or negative.
C) must be positive.
Correct Answer Is -Bcan be positive or negative.

Cov(a,b) = σaσbρa,b. Since ρa,b can be positive or negative, Cov(a,b) can be positive or negative.

This question tested from Session 2, Reading 8, LOS k.

111.

Which of the following sets of numbers does NOT meet the requirements for a set of probabilities?

A) (0.10, 0.20, 0.30, 0.40, 0.50).

B) (0.50, 0.50).
C) (0.10, 0.20, 0.30, 0.40).
Correct Answer Is -A

A set of probabilities must sum to one.

This question tested from Session 2, Reading 8, LOS b.

112.

Given the following frequency distribution:

Interval Frequency
10 up to 30 5
30 up to 50 10
50 up to 70 15
70 up to 90 5

Which of the following statements is least accurate?

 A) The relative frequency of the second interval is less than 15.
B) The absolute frequency of the third interval is 15.
C) The number of observations is greater than 30.
Correct Answer Is -A

The relative interval frequency is (interval frequency) / (total number) = 28.57. The number of
observations is 5 + 10 + 15 + 5 = 35.

This question tested from Session 2, Reading 7, LOS b.

113.

A stock is currently worth $75. If the stock was purchased one year ago for $60, and the stock paid a
$1.50 dividend over the course of the year, what is the holding period return?

A) 27.5%.
B) 22.0%.
C) 24.0%.
Correct Answer Is -A

(75 − 60 + 1.50) / 60 = 27.5%.

This question tested from Session 2, Reading 6, LOS c.

114.

For the investments shown in the table below, what are the respective mean, median, and mode of
the returns?

Investment Return (%)

A 12
B 14
C 9
D 13
E 7
F 8
G 12
12.00%; 12%;
A)
12%.
10.71%; 12%;
B)
12%.
C) 10.71%; 9%; 13%.
Correct Answer Is -B10.71%; 12%; 12%.

The mean is the average return computed by summing the returns and dividing by the number of
investments: 75 / 7 = 10.71%.

The median is the mid-point or central number of returns arranged from highest to lowest or lowest to
highest. In this case: 7, 8, 9, 12, 12, 13, 14. The median return is 12%.

The mode is the return that occurs most frequently. In this case, 12% is also the mode.
This question tested from Session 2, Reading 7, LOS e.

115.If a firm is going to create three teams of four from twelve employees. Which approach is the
most appropriate for determining how the twelve employees can be selected for the three teams?

A) Labeling formula.
B) Permutation formula.
C) Combination formula.
Correct Answer Is -A

This problem is a labeling problem where the 12 employees will be assigned one of three labels. It
requires the labeling formula.

In this case there are [(12!) / (4!4!4!)] = 34,650 ways to group the employees.

This question tested from Session 2, Reading 8, LOS o.

116.Why is the time-weighted rate of return the preferred method of performance measurement?

A) Time-weighted returns are not influenced by the timing of cash flows.

Time weighted allows for inter-period measurement and therefore is more flexible in
B)
determining exactly how a portfolio performed during a specific interval of time.
C) There is no preference for time-weighted versus money-weighted.
Correct Answer Is -A

Money-weighted returns are sensitive to the timing or recognition of cash flows while time-weighted
rates of return are not.

This question tested from Session 2, Reading 6, LOS d.

117.A T-bill with a face value of $100,000 and 140 days until maturity is selling for $98,000. What is
the bank discount yield?

A) 5.41%.
B) 4.18%.
C) 5.14%.
Correct Answer Is -C 5.14%.

Actual discount is 2%, annualized discount is: 0.02(360 / 140) = 5.14%

This question tested from Session 2, Reading 6, LOS e.

118.An investor is considering two investments. Stock A has a mean annual return of 16% and a
standard deviation of 14%. Stock B has a mean annual return of 20% and a standard deviation of
30%. Calculate the coefficient of variation (CV) of each stock and determine if Stock A has less
dispersion or more dispersion relative to B. Stock A's CV is:

A) 1.14, and thus has more dispersion relative to the mean than Stock B.
 B) 1.14, and thus has less dispersion relative to the mean than Stock B.
C) 0.875, and thus has less dispersion relative to the mean than Stock B.
Correct Answer Is -C 0.875, and thus has less dispersion relative to the mean than Stock B.

CV stock A = 0.14 / 0.16 = 0.875

CV stock B = 0.30 / 0.20 = 1.5

Stock A has less dispersion relative to the mean than Stock B.

This question tested from Session 2, Reading 7, LOS i.

119.Given the following annual returns, what are the geometric and arithmetic mean returns,
respectively?

2002 2003 2004 2005 2006

15% Â 2% 5% -7% 0%
2.75%;
A)
3.00%.
2.75%;
B)
5.80%.
1.45%;
C)
3.00%.
Correct Answer Is -A

Geometric Mean: (1.15 × 1.02 × 1.05 × 0.93 × 1.0)1/5 − 1 = 1.14541/5 − 1 = 2.75%

Arithmetic Mean: (15% + 2% + 5% − 7% + 0%) / 5 = 3.00%

This question tested from Session 2, Reading 7, LOS e.

120.
Annual Returns on ABC Mutual Fund
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
11.0% 12.5% 8.0% 9.0% 13.0% 7.0% 15.0% 2.0% -16.5% 11.0%

What is the respective arithmetic mean return and the geometric mean return for ABC Mutual Fund
for the period 1991-2000?

A) 8.2%; 6.8%.
B) 7.2%; 5.6%.
C) 7.2%; 6.8%.
Correct Answer Is -C 7.2%; 6.8%.

Arithmetic mean = (11 + 12.5 + 8 + 9 + 13 + 7 + 15 + 2 − 16.5 + 11) / 10 = 7.20

Geometric mean = (1.11 1.125 1.08 1.09 1.13 1.07 1.15 1.02 0.835 1.11)1/10 − 1 = (1.932)0.10 1 =
1.068 − 1 = 0.068 or 6.8%

This question tested from Session 2, Reading 7, LOS g.