CFA LEVEL 1 – TIME VALUE OF MONEY
COMPLETE REVIEW
CFA LEVEL 1
Quantitative Methods
TIME VALUE OF MONEY COMPLETE REVIEW
PART 1: REVIEW CLASS QUESTIONS
Question 1
Once an investor chooses a particular course of action, the value forgone from alternative actions
is best
described as a(n):
A. sunk cost.
B. required return.
C. opportunity cost.
Correct Answer: C
C is correct: An opportunity cost is the value that investors forgo by choosing a particular course of
action.
A is incorrect: A sunk cost is one that has already been incurred and therefore cannot be changed.
B is incorrect: The required return is the minimum rate of return an investor must receive in order
to accept the
investment.
Question 2
An investor can earn 7% on a 1-year security. If the investor purchases the security, then the
opportunity cost
of current consumption is most likely:
, A. equal to 7%.
B. less than 7%.
C. greater than 7%.
Correct Answer: A
A is correct: Interest rates are viewed as the opportunity cost of current consumption. The market
rate of interest
on a 1-year security is 7% and earning an additional 7% is the opportunity forgone when current
consumption is
chosen rather than saving. Thus, the opportunity cost of current consumption is equal to 7%.
Question 3
Assume the following:
• The real risk-free rate of return is 3%.
• The expected inflation premium is 5%.
• The market-determined interest rate of a security is 12%.
The sum of the default risk premium, liquidity premium, and maturity premium for the security is
closest to:
A. 10%
B. 4%.
C. 8%.
Correct Answer: B
B is correct: The market-determined interest rate is equal to the real risk-free rate of return plus an
inflation
premium plus risk premiums for default risk, liquidity, and maturity. In this case, 12 = 3 + 5 + X .
Solving for X gives X
= 4.
A is incorrect: 10% = 12% - (5% - 3%) .
C is incorrect: Eight percent is the sum of the real risk-free rate and expected inflation ( 3% + 5% ).
Question 4
COMPLETE REVIEW
CFA LEVEL 1
Quantitative Methods
TIME VALUE OF MONEY COMPLETE REVIEW
PART 1: REVIEW CLASS QUESTIONS
Question 1
Once an investor chooses a particular course of action, the value forgone from alternative actions
is best
described as a(n):
A. sunk cost.
B. required return.
C. opportunity cost.
Correct Answer: C
C is correct: An opportunity cost is the value that investors forgo by choosing a particular course of
action.
A is incorrect: A sunk cost is one that has already been incurred and therefore cannot be changed.
B is incorrect: The required return is the minimum rate of return an investor must receive in order
to accept the
investment.
Question 2
An investor can earn 7% on a 1-year security. If the investor purchases the security, then the
opportunity cost
of current consumption is most likely:
, A. equal to 7%.
B. less than 7%.
C. greater than 7%.
Correct Answer: A
A is correct: Interest rates are viewed as the opportunity cost of current consumption. The market
rate of interest
on a 1-year security is 7% and earning an additional 7% is the opportunity forgone when current
consumption is
chosen rather than saving. Thus, the opportunity cost of current consumption is equal to 7%.
Question 3
Assume the following:
• The real risk-free rate of return is 3%.
• The expected inflation premium is 5%.
• The market-determined interest rate of a security is 12%.
The sum of the default risk premium, liquidity premium, and maturity premium for the security is
closest to:
A. 10%
B. 4%.
C. 8%.
Correct Answer: B
B is correct: The market-determined interest rate is equal to the real risk-free rate of return plus an
inflation
premium plus risk premiums for default risk, liquidity, and maturity. In this case, 12 = 3 + 5 + X .
Solving for X gives X
= 4.
A is incorrect: 10% = 12% - (5% - 3%) .
C is incorrect: Eight percent is the sum of the real risk-free rate and expected inflation ( 3% + 5% ).
Question 4
