[CFA LEVEL I EXAM] – EXAM-STYLE QUESTIONS AND ANSWERS | VERIFIED AND
WELL DETAILED ANSWERS | PLUS RATIONALES | GUARANTEED PASS | 2026/27
LATEST UPDATE | EXAM PREP | STUDY GUIDE | PRACTICE TEST
SECTION ONE: QUESTIONS 1-50
1. An analyst is evaluating the financial statements of a company that uses the
LIFO inventory method. During a period of rising prices, how will the choice of
LIFO versus FIFO most likely affect the company's current ratio and gross profit
margin?
A. Current ratio and gross profit margin will both be lower under LIFO.
B. Current ratio will be lower and gross profit margin will be higher under LIFO.
C. Current ratio will be higher and gross profit margin will be lower under LIFO.
D. Current ratio and gross profit margin will both be higher under LIFO.
Correct Answer: A. Current ratio and gross profit margin will both be lower under
LIFO.
Rationale: During rising prices, LIFO assigns the most recent, higher costs to the
cost of goods sold, resulting in a higher COGS and lower gross profit margin. The
older, lower costs remain in ending inventory, which reduces the inventory value on
the balance sheet compared to FIFO. A lower inventory value reduces current assets,
thus decreasing the current ratio. Therefore, both metrics are lower under LIFO in
this environment.
,2. A portfolio manager is concerned about a significant decline in the value of a
large, concentrated equity holding. Which of the following strategies would be
the most cost-effective and efficient way to hedge this downside risk while
maintaining the potential for some upside participation?
A. Purchasing an out-of-the-money put option on the security.
B. Implementing a covered call strategy on the security.
C. Entering into a short forward contract on the security.
D. Selling a deep in-the-money call option on the security.
Correct Answer: A. Purchasing an out-of-the-money put option on the security.
Rationale: A long put option provides a right to sell the underlying asset at a
specified strike price. An out-of-the-money put offers downside protection below the
strike price while allowing for upside appreciation if the stock price rises. B is a
bearish strategy that generates income but limits upside potential. C is a binding
obligation with no upside participation. D is a bearish strategy with limited upside
and significant downside risk if the stock falls.
3. According to the Code of Ethics and Standards of Professional Conduct,
which of the following actions is most appropriate when a CFA Institute
member discovers that a colleague has violated a standard?
A. The member should immediately report the violation to CFA Institute.
B. The member should dissociate from the violation and encourage the colleague
to stop the behavior.
C. The member has no obligation if the violation does not involve client assets.
,D. The member should discuss the violation with other colleagues to gather
support.
Correct Answer: B. The member should dissociate from the violation and
encourage the colleague to stop the behavior.
Rationale: Standard I(A) - Knowledge of the Law requires members to dissociate
from any violation of the law or the Code and Standards. The member must
encourage the colleague to stop the behavior and should report it to their
supervisor or compliance department internally. Reporting to CFA Institute is a last
resort when no internal resolution is possible (A). The obligation exists regardless of
the violation's nature (C), and discussing it with others could be a breach of
confidentiality (D).
4. A project has an initial investment of $1,000,000 and is expected to generate
annual cash flows of $250,000 for 6 years. What is the discounted payback
period if the required rate of return is 10%?
A. 4.0 years
B. 4.8 years
C. 5.0 years
D. Greater than 6 years
Correct Answer: D. Greater than 6 years
Rationale: The discounted payback period is the time required to recover the initial
investment in present value terms. The present value of the annuity is $250,000 ×
[1 - (1.10)^-6] / 0.10 = $1,088,150. Since the PV of cash flows exceeds the initial
, investment, the project pays back within its life. The cumulative discounted cash
flow after 5 years is $250,000 × [1 - (1.10)^-5] / 0.10 = $947,700. The remaining
amount is $1,000,000 - $947,700 = $52,300. The fraction of the 6th year's
discounted cash flow is $52,300 / ($250,.10^6) = $52,300 / $141,100 = 0.37.
Thus, the discounted payback is 5.37 years, which is not exactly 5.0 years (C) and is
less than 6 years, making D incorrect. The correct answer should be recalculated.
The correct discounted payback is between 5 and 6 years. Since option D is "Greater
than 6 years", it is incorrect. The correct answer is none of the above, but based on
the options, C is the closest if we assume it means approximately 5 years. Re-
evaluating: The present value of the 6th year cash flow is $141,100. The shortfall
after 5 years is $52,300. 52,300/141,100 = 0.37. So payback is 5.37 years. Since this
is between 5 and 6, and option C is "5.0 years", option D is "Greater than 6 years",
and no option for 5.37 exists, the question is flawed. Corrected: The correct answer
should be "Approximately 5.4 years", but since it's not available, the best answer is
C if we assume rounding is not considered. To fix this, I will change the options to
include a correct one. Let's revise: Option C: Between 5 and 6 years. Option D:
Greater than 6 years. The correct answer is C.
Revised Question 4:
4. A project has an initial investment of $1,000,000 and is expected to generate
annual cash flows of $250,000 for 6 years. What is the discounted payback
period if the required rate of return is 10%?
A. 4.0 years
B. 4.8 years
C. Between 5 and 6 years
D. Greater than 6 years
WELL DETAILED ANSWERS | PLUS RATIONALES | GUARANTEED PASS | 2026/27
LATEST UPDATE | EXAM PREP | STUDY GUIDE | PRACTICE TEST
SECTION ONE: QUESTIONS 1-50
1. An analyst is evaluating the financial statements of a company that uses the
LIFO inventory method. During a period of rising prices, how will the choice of
LIFO versus FIFO most likely affect the company's current ratio and gross profit
margin?
A. Current ratio and gross profit margin will both be lower under LIFO.
B. Current ratio will be lower and gross profit margin will be higher under LIFO.
C. Current ratio will be higher and gross profit margin will be lower under LIFO.
D. Current ratio and gross profit margin will both be higher under LIFO.
Correct Answer: A. Current ratio and gross profit margin will both be lower under
LIFO.
Rationale: During rising prices, LIFO assigns the most recent, higher costs to the
cost of goods sold, resulting in a higher COGS and lower gross profit margin. The
older, lower costs remain in ending inventory, which reduces the inventory value on
the balance sheet compared to FIFO. A lower inventory value reduces current assets,
thus decreasing the current ratio. Therefore, both metrics are lower under LIFO in
this environment.
,2. A portfolio manager is concerned about a significant decline in the value of a
large, concentrated equity holding. Which of the following strategies would be
the most cost-effective and efficient way to hedge this downside risk while
maintaining the potential for some upside participation?
A. Purchasing an out-of-the-money put option on the security.
B. Implementing a covered call strategy on the security.
C. Entering into a short forward contract on the security.
D. Selling a deep in-the-money call option on the security.
Correct Answer: A. Purchasing an out-of-the-money put option on the security.
Rationale: A long put option provides a right to sell the underlying asset at a
specified strike price. An out-of-the-money put offers downside protection below the
strike price while allowing for upside appreciation if the stock price rises. B is a
bearish strategy that generates income but limits upside potential. C is a binding
obligation with no upside participation. D is a bearish strategy with limited upside
and significant downside risk if the stock falls.
3. According to the Code of Ethics and Standards of Professional Conduct,
which of the following actions is most appropriate when a CFA Institute
member discovers that a colleague has violated a standard?
A. The member should immediately report the violation to CFA Institute.
B. The member should dissociate from the violation and encourage the colleague
to stop the behavior.
C. The member has no obligation if the violation does not involve client assets.
,D. The member should discuss the violation with other colleagues to gather
support.
Correct Answer: B. The member should dissociate from the violation and
encourage the colleague to stop the behavior.
Rationale: Standard I(A) - Knowledge of the Law requires members to dissociate
from any violation of the law or the Code and Standards. The member must
encourage the colleague to stop the behavior and should report it to their
supervisor or compliance department internally. Reporting to CFA Institute is a last
resort when no internal resolution is possible (A). The obligation exists regardless of
the violation's nature (C), and discussing it with others could be a breach of
confidentiality (D).
4. A project has an initial investment of $1,000,000 and is expected to generate
annual cash flows of $250,000 for 6 years. What is the discounted payback
period if the required rate of return is 10%?
A. 4.0 years
B. 4.8 years
C. 5.0 years
D. Greater than 6 years
Correct Answer: D. Greater than 6 years
Rationale: The discounted payback period is the time required to recover the initial
investment in present value terms. The present value of the annuity is $250,000 ×
[1 - (1.10)^-6] / 0.10 = $1,088,150. Since the PV of cash flows exceeds the initial
, investment, the project pays back within its life. The cumulative discounted cash
flow after 5 years is $250,000 × [1 - (1.10)^-5] / 0.10 = $947,700. The remaining
amount is $1,000,000 - $947,700 = $52,300. The fraction of the 6th year's
discounted cash flow is $52,300 / ($250,.10^6) = $52,300 / $141,100 = 0.37.
Thus, the discounted payback is 5.37 years, which is not exactly 5.0 years (C) and is
less than 6 years, making D incorrect. The correct answer should be recalculated.
The correct discounted payback is between 5 and 6 years. Since option D is "Greater
than 6 years", it is incorrect. The correct answer is none of the above, but based on
the options, C is the closest if we assume it means approximately 5 years. Re-
evaluating: The present value of the 6th year cash flow is $141,100. The shortfall
after 5 years is $52,300. 52,300/141,100 = 0.37. So payback is 5.37 years. Since this
is between 5 and 6, and option C is "5.0 years", option D is "Greater than 6 years",
and no option for 5.37 exists, the question is flawed. Corrected: The correct answer
should be "Approximately 5.4 years", but since it's not available, the best answer is
C if we assume rounding is not considered. To fix this, I will change the options to
include a correct one. Let's revise: Option C: Between 5 and 6 years. Option D:
Greater than 6 years. The correct answer is C.
Revised Question 4:
4. A project has an initial investment of $1,000,000 and is expected to generate
annual cash flows of $250,000 for 6 years. What is the discounted payback
period if the required rate of return is 10%?
A. 4.0 years
B. 4.8 years
C. Between 5 and 6 years
D. Greater than 6 years
