CFA Level 1 Mock Exam 1 Pt 1 ||
Questions & Answers (Graded A+)
The principle of time value of money - ANSWER-The notion that a given sum of money
is more valuable the sooner it is received, due to its capacity to earn interest.
The Five Components of Interest Rates - ANSWER-1. Real Risk-Free Rate 2. Expected
Inflation 3. Default-Risk Premium 4. Liquidity Premium 5. Maturity Premium
Real Risk-Free Rate - ANSWER-This assumes no risk or uncertainty, simply reflecting
differences in timing: the preference to spend now/pay back later versus lend
now/collect later.
Expected Inflation - ANSWER-The market expects aggregate prices to rise, and the
currency's purchasing power is reduced by a rate known as the inflation rate. Inflation
makes real dollars less valuable in the future and is factored into determining the
nominal interest rate (from the economics material: nominal rate = real rate + inflation
rate).
Default-Risk Premium - ANSWER-What is the chance that the borrower won't make
payments on time, or will be unable to pay what is owed? This component will be high
or low depending on the creditworthiness of the person or entity involved.
Liquidity Premium - ANSWER-Some investments are highly liquid, meaning they are
easily exchanged for cash (U.S. Treasury debt, for example). Other securities are less
liquid, and there may be a certain loss expected if it's an issue that trades infrequently.
Holding other factors equal, a less liquid security must compensate the holder by
offering a higher interest rate.
Maturity Premium - ANSWER-All else being equal, a bond obligation will be more
sensitive to interest rate fluctuations the longer to maturity it is.
The stated annual rate - ANSWER-(or quoted rate) is the interest rate on an investment
if an institution were to pay interest only once a year.
In practice, institutions compound interest more frequently, either ... -
ANSWER-...quarterly, monthly, daily and even continuously.
The effective annual yield... - ANSWER-...represents the actual rate of return, reflecting
all of the compounding periods during the year.
Effective annual rate (EAR) - ANSWER-= (1 + Periodic interest rate)^m - 1
(Where: m = number of compounding periods in one year, and periodic interest rate =
(stated interest rate) / m)
, FV - ANSWER-= PV * (1 + r)^N
PV of a perpetuity - ANSWER-= annuity payment A/interest rate r
PV - ANSWER-= FV * (1/(1 + r)^N)
BONUS
First Redville Bank (FRB) receives an interest payment from a client who has borrowed
$100,000 at a 6% annual rate over a 2-year term.
Praxium Life Insurance (PLI) receives an interest payment from a 10-year, 4.5%
government bond held in the company's investment portfolio.
Which of these IFRS-compliant firms will most likely treat the interest payment it has
received as an investing activity?
PLI only
3 multiple choice options
An estimator is most likely described as being consistent if:
the sampling distribution becomes more concentrated around the population parameter
as sample size increases.
3 multiple choice options
The loss on sale of equipment would most likely be reflected as an adjustment to which
category in an indirect-format cash flow statement?
Operating Activity
3 multiple choice options
Which of the following statements is most accurate? Under the converged revenue
recognition standards issued by IASB and FASB, companies are:
not required to recognize revenue for services that have already been completely
rendered.
3 multiple choice options
An equity analyst would most likely use a nonparametric test rather than a parametric
test when:
the sample size is small and does not conform to a normal distribution.
Questions & Answers (Graded A+)
The principle of time value of money - ANSWER-The notion that a given sum of money
is more valuable the sooner it is received, due to its capacity to earn interest.
The Five Components of Interest Rates - ANSWER-1. Real Risk-Free Rate 2. Expected
Inflation 3. Default-Risk Premium 4. Liquidity Premium 5. Maturity Premium
Real Risk-Free Rate - ANSWER-This assumes no risk or uncertainty, simply reflecting
differences in timing: the preference to spend now/pay back later versus lend
now/collect later.
Expected Inflation - ANSWER-The market expects aggregate prices to rise, and the
currency's purchasing power is reduced by a rate known as the inflation rate. Inflation
makes real dollars less valuable in the future and is factored into determining the
nominal interest rate (from the economics material: nominal rate = real rate + inflation
rate).
Default-Risk Premium - ANSWER-What is the chance that the borrower won't make
payments on time, or will be unable to pay what is owed? This component will be high
or low depending on the creditworthiness of the person or entity involved.
Liquidity Premium - ANSWER-Some investments are highly liquid, meaning they are
easily exchanged for cash (U.S. Treasury debt, for example). Other securities are less
liquid, and there may be a certain loss expected if it's an issue that trades infrequently.
Holding other factors equal, a less liquid security must compensate the holder by
offering a higher interest rate.
Maturity Premium - ANSWER-All else being equal, a bond obligation will be more
sensitive to interest rate fluctuations the longer to maturity it is.
The stated annual rate - ANSWER-(or quoted rate) is the interest rate on an investment
if an institution were to pay interest only once a year.
In practice, institutions compound interest more frequently, either ... -
ANSWER-...quarterly, monthly, daily and even continuously.
The effective annual yield... - ANSWER-...represents the actual rate of return, reflecting
all of the compounding periods during the year.
Effective annual rate (EAR) - ANSWER-= (1 + Periodic interest rate)^m - 1
(Where: m = number of compounding periods in one year, and periodic interest rate =
(stated interest rate) / m)
, FV - ANSWER-= PV * (1 + r)^N
PV of a perpetuity - ANSWER-= annuity payment A/interest rate r
PV - ANSWER-= FV * (1/(1 + r)^N)
BONUS
First Redville Bank (FRB) receives an interest payment from a client who has borrowed
$100,000 at a 6% annual rate over a 2-year term.
Praxium Life Insurance (PLI) receives an interest payment from a 10-year, 4.5%
government bond held in the company's investment portfolio.
Which of these IFRS-compliant firms will most likely treat the interest payment it has
received as an investing activity?
PLI only
3 multiple choice options
An estimator is most likely described as being consistent if:
the sampling distribution becomes more concentrated around the population parameter
as sample size increases.
3 multiple choice options
The loss on sale of equipment would most likely be reflected as an adjustment to which
category in an indirect-format cash flow statement?
Operating Activity
3 multiple choice options
Which of the following statements is most accurate? Under the converged revenue
recognition standards issued by IASB and FASB, companies are:
not required to recognize revenue for services that have already been completely
rendered.
3 multiple choice options
An equity analyst would most likely use a nonparametric test rather than a parametric
test when:
the sample size is small and does not conform to a normal distribution.
