SESSION 1

Question 1: Which of the following statements about legal and ethical standards is most accurate?
A. Ethical standards are a subset of legal standards.
B. Legal standards are a subset of ethical standards.
C. Ethical and legal standards often intersect, but not always.
Explanation
C is correct. Ethical and legal standards are not subsets of each other. Some actions that are legal might not be ethical, and
some actions that are ethical might not be legal.

Question 2: Which of the following parties may adopt and claim compliance with Global Investment Performance Standards
(GIPS)?
A. The chief compliance oÞcer for a regional money manager.
B. A software firm that developed a software package that assists investment firms in achieving GIPS compliance.
C. An investment management firm located in Indonesia.
Explanation
C is correct. Only an investment firm that actually manages assets can claim compliance with GIPS.

Question 3: The CFA Institute Professional Conduct Program may impose sanctions on:
A. CFA charterholders and candidates for the CFA designation.
B. CFA charterholders only.
C. CFA charterholders, member firms, and candidates for the CFA designation.
Explanation
A is correct. The CFA Institute Professional Conduct Program may impose sanctions on CFA charterholders and candidates
for the CFA designation. Firms are not members of CFA Institute.

Question 4: An analyst who is a CFA Institute member receives an invitation from a business associate's firm to spend the
weekend in a high-quality resort. In order to abide by the Standards, the analyst should (may):
A. do both of the actions listed here.
B. obtain written consent from his supervisor if the offer is contingent on achieving a target investment return.
C. refuse the invitation if the associate is from a firm he analyzes for his employer.
Explanation
A is correct. According to Standard I(B) Independence and Objectivity, the analyst should refuse the invitation if it is from a
firm the analyst covers for his employer. The analyst can accept the invitation if it is from a client but the analyst must get
written consent from his employer if the offer is contingent on future performance, to comply with Standard IV(B) Additional
Compensation Arrangements.

Question 5: All of the following are violations of Standard II(B) Market Manipulation EXCEPT:
A. disseminating misleading information about the development of new products and technologies.
B. exploiting differences in market inefficiencies.
C. securing a controlling interest in an equity security in order to influence the price of a related derivative instrument.
Explanation
B is correct. Standard II(B) Market Manipulation prohibits practices that distort prices or artificially inflate trading volumes
with the intent to mislead market participants. The Standard is not intended to prohibit legitimate trading strategies that exploit
differences in market inefficiencies.

Question 6: Lindsay Gordon is a Level II CFA candidate. Gordon's best friend, Steve Haney, is also a Level II candidate and
has registered for the same exam window as Gordon. Because Haney's exam appointment is the day before Gordon's
appointment, Gordon suggests that Haney try to remember some of the exam questions and let her know what they asked.
After Haney takes his exam, he reminds Gordon that the Code and Standards prohibit candidates from disclosing specific
exam questions, and only gives her a general idea of what topics were tested or not tested. Which of the following statements
regarding Gordon and Haney is most accurate?
A. Gordon is in violation of the Code and Standards, but Haney is not in violation.
B. Neither Gordon nor Haney is in violation of the Code and Standards.
C. Both Gordon and Haney are in violation of the Code and Standards.
Explanation
C is correct. Both Gordon and Haney violated Standard VII(A) Conduct as Participants in CFA Institute Programs by
compromising the integrity of the exam. The Standard prohibits candidates from discussing specific exam questions or which
topics were tested or not tested.
Question 7: Jill Marsh, CFA, works for Advisors where she manages various portfolios. Marsh's godfather is an accountant
and has done Marsh's tax returns every year as a birthday gift. Marsh's godfather has recently become a client of Advisors
and asked specifically for Marsh to manage his account. In order to comply Standard IV(B), Disclosure of Additional
Compensation Arrangements, she needs to:
A. do neither of the actions listed here.
B. have her godfather cease doing her taxes.
C. liquidate from her personal portfolio any stocks her godfather owns and verbally tell her supervisor about the tax
services.
Explanation
A is correct. Standard IV(B) requires that members disclose to their employer in writing all benefits that they receive in
addition to their regular compensation for services they perform on behalf of their employer. It is not unreasonable for an
individual's godfather to give them a birthday gift. Moreover, since the tax services were a regular birthday present before her
godfather became a client, this implies that they are unrelated to any investment management services.

Question 8: Unethical behavior by financial professionals:

A. does not affect allocation of capital.
B. increases incomes for the profession.
C. increases risk and the cost of capital.
Explanation
C is correct. In the long run, unethical behavior will decrease trust in financial professionals and the use of financial
professionals by the public, ultimately decreasing incomes for the profession. Unethical behavior, such as misleading clients,
can adversely affect the allocation of financial capital.

Question 9: The section of the Global Investment Performance Standards (GIPS) that outlines defining the firm and
documenting firm policies and procedures is:
A. Fundamentals of Compliance.
B. Composite and Pooled Fund Maintenance.
C. GIPS Advertising Guidelines.
Explanation
A is correct. According to Section 1, Fundamentals of Compliance, the definition of the firm is the foundation for firm-wide
compliance and creates boundaries in order to determine total firm assets.

Question 10: Samuel Goldstein, CFA, is an analyst for Tamarack Securities. Goldstein's father, Reuben, has a client account
at Tamarack. In ordering trades, Goldstein should place orders in:
A. all accounts simultaneously.
B. his clients' accounts first, his father's account second, and his account last.
C. his clients' and his father's accounts in the first group and his personal accounts in the second group.
Explanation
C is correct. Standard VI(B), Priority of Transactions, provides that transactions for clients have priority over personal trades.
Family accounts that are considered client accounts receive the same treatment as client accounts.

Question 11: Which of the following is a component of the Code of Ethics?

A. Members shall not engage in any professional conduct involving dishonesty, fraud, deceit, or misrepresentation or commit
any act that reflects adversely on their honesty, trustworthiness, or professional competence.
B. Members shall use reasonable care and exercise independent professional judgment.
C. Members shall not knowingly participate or assist in any violation of such laws, rules, or regulations.
Explanation
B is correct. This is a component of the Code of Ethics. Others pertain to the Standards of Professional Conduct.

Question 12: Lee Hurst, CFA, is an equity research analyst who has recently left a large firm to start independent practice.
He is able to re-create several of his previous recommendation reports, based on his clear recollection of supporting
documentation he compiled at his previous employer. He publishes the reports and obtains several new clients. Hurst is most
likely:
A. in violation of Standard V(C) Record Retention.
B. in violation of Standard V(A) Diligence and Reasonable Basis.
C. not in violation of any Standard.
Explanation
A is correct. Hurst is most likely in violation of Standard V(C) Record Retention because the supporting documentation is
unavailable. He needs to recreate the supporting records based on information gathered through public sources or the covered
company. He may have a reasonable basis for his recommendations and have been diligent in his analysis, but must reconstruct
the records of this analysis before issuing the reports.

Question 13: A CFA charterholder takes a trip for which his firm will pay the expenses. Upon his return, he alters some of
the numbers on restaurant receipts to inflate the expenses by about one half of a percent. Is this a violation of the Code and
Standards?
A. Yes, because it reflects dishonesty.
B. Yes, because the charterholder should have paid his own expenses.
C. This is a violation only if the amount in question is material.
Explanation
A is correct. Any action by a member or candidate involving dishonesty, fraud, or deceit is a violation of Standard I(D)
Misconduct.

Question 14: Ralph Lim and Susan Bland have both passed Level I of the CFA Program. Both are currently enrolled to sit
for Level II. Lim's business card reads, "Ralph Lim, CFA Level I." Bland's resume states, "Level II Candidate in the CFA
Program." According to CFA Institute Standards of Professional Conduct involving use of the professional designation:
A. Bland violated the Standard, but Lim did not.
B. Both Lim and Bland violated the Standard.
C. Lim violated the Standard, but Bland did not.
Explanation
C is correct. There is no designation for someone who has passed Level I, Level II, or Level III of the CFA examination.
Candidates may state, however, that they have completed Level I, II, or III, as the case may be, in the CFA Program. Thus,
Lim violated the Standard, but Bland did not.

Question 15: Janet Green, CFA, provides investment advice and other services to clients in several countries. She resides in
Country A whose securities laws and regulations are less strict than the Code and Standards. She also conducts business with
clients in Country B, which has no securities laws or regulations, and in Country C, which has securities laws and regulations
that are stricter than the Code and Standards. Which of the following statements is CORRECT? According to CFA Institute
Standards of Professional Conduct, Green must adhere to the Code and Standards in:
A. Country A and Country B but the law in Country C.
B. Country A but the law in Country B and Country C.
C. Country A, Country B, and Country C.
Explanation
A is correct. Green needs to follow Standard I(A) -- Knowledge of the law. In Country A, Green must adhere to the Code
and Standards because Country A's laws are less strict. In Country B, Green must also adheres to the Code and Standards
because Country B has no securities laws. Because Country C's applicable law is stricter than the requirements of the Code
and Standards, Green must adhere to the laws of Country C.

Question 16: A money management firm has the following policy concerning new recommendations: When a new
recommendation is made, each portfolio manager estimates the likely transaction size for each of their clients. Clients are
notified of the new recommendation in the order of their estimated transaction size—largest first. All clients have signed a
form where they acknowledge and consent to this allocation procedure. With respect to Standard III(B), Fair Dealing, this is:
A. not a violation because the clients are aware of the policy.
B. not a violation because the clients have signed the consent form.
C. a violation of the standard.
Explanation
C is correct. Such a policy is a violation of the Standard and client acknowledgement and/or consent does not change that
fact.

Question 17: The Standard concerning preservation of confidentiality states that members and candidates must keep
information confidential about:
A. current and former clients, but not prospective clients.
B. current clients, former clients, and prospective clients.
C. prospective and current clients, but not former clients.
Explanation
B is correct. Standard III(E) Preservation of Confidentiality applies to information about current, former, and prospective
clients.
Question 18: Wes Smith, CFA, works for Advisors, Inc. In order to remain in compliance with Standard V(A), Diligence and
Reasonable Basis, Smith may recommend a security in which of the following situations?
A. Advisors' research department recommends a stock.
B. For either of the reasons listed here.
C. Smith reads a favorable review of the security in a widely read periodical.
Explanation
A is correct. Smith will be in violation if he acts solely on the basis of what he read in the periodical. Use of information
within the firm can be relied upon unless the Smith has reason to believe the source lacks a sound basis.

Question 19: Jan Hirsh, CFA, is employed as manager of a college endowment fund. The college's board of directors has
recently voted to consider divesting from companies located in a country that has a poor civil rights record. Hirsh has personal
investments in several firms in the country. Hirsh needs to:
A. disclose her ownership in the stocks to her supervisor only.
B. disclose her ownership in the stocks to both her supervisor and the board.
C. do nothing since the board has not made a decision yet.
Explanation
C is correct. From the given information, there is no conflict of interest and no violation of Standard VI(A), Disclosure of
Conflicts. A conflict could arise if the board were to ask Hirsh what the effect on the college's endowment would be if they
were to divest. At that time she would have to reveal her ownership in the stocks to make known the possible conflict of
interest.

Question 20: Tony Calaveccio, CFA, is the manager of the TrustCo Small Cap Venture Fund in Toronto. He places trades
for the fund with River City Brokerage. River City provides Calaveccio with soft dollars to purchase research. River City also
deals in municipal bonds, some of which Calaveccio holds in his personal portfolio. He periodically uses the soft dollars to
request research reports on various small cap stocks and also on the status of the municipal bond market and issues that he
holds. These actions are:
A. in violation of his fiduciary duties regarding both the small cap research and the municipal bond research.
B. not in violation of the Code and Standards.
C. in violation of his fiduciary duties regarding the municipal bond research but not so regarding the research on the small
cap issues.
Explanation
C is correct. The issue at hand is the member's fiduciary responsibilities in handling "soft dollars" which are technically the
property of the client. Standard III(A), Loyalty, Prudence, and Care, delineates the member's fiduciary responsibilities with
regard to soft dollars. Since municipal bond research is clearly not relevant to the Small Cap Fund holders, he is clearly using
the soft dollars to obtain research for his personal benefit and is in violation of the Standard.

Question 21: A CFA charterholder gathers the closing prices of a security from a widely read publication. The charterholder
uses the data as part of a report she is preparing and fails to report the data source in the report. This is:
A. not a violation of Standard I(C) if the data can be gathered from several public sources.
B. not a violation of Standard I(C) if the data cannot be gathered from several public sources.
C. a violation of Standard I(C).
Explanation
A is correct. Since the security prices represent factual information that can be verified from several sources, there is no
violation. It could have been a violation had the information been exclusively published by the source.

Question 22: Nancy Korthauer, CFA, has launched a new hedge fund called the Korthauer Tautology Fund and is actively
soliciting clients from competitor's firms. Client presentations are necessarily brief and often take place with the prospective
client's current investment advisor in the room. The Code and Standards require that:
A. a prospective client’s current investment advisor not participate in meetings.
B. all client presentations provide a thorough review of all elements of the investment management process. Abbreviated
presentations are forbidden.
C. member or candidate provide (on request) additional detail information which supports the abbreviated presentation.
Explanation
C is correct. See Standard III(D). When presentations are brief, additional detail which supports the abbreviated presentation
information must be provided on request. Best practice dictates that the member or candidate should make reference to the
abbreviated nature of the presentation.

Question 23: Roger Halpert, CFA, prepares a company research report in which he recommends a strong "buy." He has been
careful to ensure that his report complies with the CFA Institute Standard on research reports. According to CFA Institute
Standards of Professional Conduct, which of the following statements about how Halpert can communicate the report is most
correct?
A. Halpert can make his report in person.
B. Halpert can make his report in person, by telephone, or by computer on the Internet.
C. Halpert can transmit his report by computer on the Internet.
Explanation
B is correct. A report can be made via any means of communication, including in-person recommendation, telephone
conversation, media broadcast, and transmission by computer such as on the Internet.

Question 24: According to CFA Institute Standards of Professional Conduct, which of the following statements about material
nonpublic information is NOT correct? Information is:
A. material if reasonable investors would want to know the information before making an investment decision.
B. nonpublic until it has been disseminated to a select group of investors.
C. nonpublic until it has been disseminated to the marketplace in general.
Explanation
B is correct. Standard II(A), Material Nonpublic Information, states that information is "nonpublic" until it has been
disseminated to the marketplace in general as opposed to a select group of investors.

Question 25: Pamela Gee is a portfolio manager. She is planning to establish her own money management firm. She has
already informed her employer, Branford, Inc., about her plans. In her remaining time at Branford, she can:
A. start the registration of her new company.
B. solicit Branford colleagues but not Branford clients.
C. inform her current clients about her resignation and let them know how to reach her, in case any problems arise in the
future.
Explanation
A is correct. The only action that will not breach Standard IV(A) Loyalty to Employer, is to start the registration of her new
company.

Question 26: Carol Hull, CFA, is an investment advisor whose prospective client, Frank Peters, presents special requirements.
To construct an investment policy statement for Peters, Hull inquires about Peters' investment experience, risk and return
objectives, and financial constraints. Peters states that he has a great deal of investment experience in the capital markets and
does not wish to answer questions about his tolerance for risk or his other holdings. Under Standard III(C), Suitability, Hull:
A. must decline to enter into an advisory relationship with Peters.
B. may accept Peters’ account but may only manage his portfolio to a benchmark or index.
C. is permitted to manage Peters’ account without any knowledge of his risk preferences.
Explanation
C is correct. Hull would not violate Standard III(C), Suitability, by managing Peters' account without knowledge of his risk
preferences. She made a reasonable inquiry into Peters' investment experience, risk and return objectives, and financial
constraints, as the Standard requires. If a client chooses not to provide some of this information, the member or candidate can
only be responsible for assessing the suitability of investments based on the information the client does provide.

Question 27: Edwin McNeill, CFA, is a senior trader for Grey Securities. In his monthly review of his team's activity, McNeill
notices a series of suspicious trades by one of the traders. McNeill consults his manager, who agrees that these trades are a
potential violation. McNeill informs the trader that her duties will be restricted while these trades are being investigated and
refers the matter to Grey's compliance officer for further action. McNeill has:
A. not violated the Standards.
B. violated Standard IV(C) Responsibilities of Supervisors by failing to prevent a potential violation.
C. violated Standard IV(C) Responsibilities of Supervisors by restricting the trader’s duties before the investigation is
completed.
Explanation
A is correct. By reviewing the employee's conduct, restricting the employee's activities while investigating a potential
violation, and referring the matter to his manager and compliance officer, McNeill acted properly according to Standard IV(C)
Responsibilities of Supervisors. Wrongdoing by a subordinate does not mean the manager has violated Standard IV(C) as
long as the manager has made reasonable efforts to detect and prevent violations.

Question 28: Deloris Johnson, CFA, observed that her supervisor has violated a federal securities regulation. Johnson
discussed the matter with her company's compliance department but they have taken no action. According to the CFA Institute
Code and Standards of Professional Conduct, Johnson is required to:
A. confront the supervisor and attempt to stop the violation.
B. dissociate from the supervisor’s activity
C. report the violation to securities regulators.
Explanation
B is correct. Johnson must dissociate herself from her supervisor's activity, for example by asking to be reassigned. The Code
and Standards do not require Johnson to report the violation to governmental or regulatory organizations unless doing so is
required by applicable law. Johnson has attempted to stop the violation by discussing it with her compliance department. She
is not required by the Code and Standards to confront the supervisor.

Question 29: According to the IASB Conceptual Framework for Financial Reporting, one of the qualitative characteristics
of financial statements is:
A. faithful representation.
B. going concern.
C. timeliness.
Explanation
A is correct. In the IASB conceptual framework, the two qualitative characteristics of financial statements are relevance and
faithful representation. Timeliness is a characteristic that enhances relevance and faithful representation. Going concern is an
underlying assumption of financial statements.

Question 30: Other things equal, a real exchange rate (stated as units of domestic currency per unit of foreign currency) will
decrease as a result of an increase in the:
A. domestic price level.
B. foreign price level.
C. nominal exchange rate (domestic/foreign).
Explanation
A is correct. An increase in the domestic price level, other things equal, will decrease a real exchange rate. Increases in the
nominal exchange rate or the foreign price level, other things equal, will increase a real exchange rate.

Question 31: The annual rainfall amount in Yucutat, Alaska, is normally distributed with a mean of 150 inches and a standard
deviation of 20 inches. The 90% confidence interval for the annual rainfall in Yucutat is closest to:
A. 117 to 183 inches.
B. 110 to 190 inches.
C. 137 to 163 inches.
Explanation
A is correct. The 90% confidence interval is µ ± 1.65 standard deviations.
150 – 1.65(20) = 117 and 150 + 1.65(20) = 183.

Question 32: A stated interest rate of 9% compounded quarterly results in an effective annual rate closest to:
A. 9.3%.
B. 9.4%.
C. 9.2%.
Explanation
A is correct. Quarterly rate = 0.09 / 4 = 0.0225.
Effective annual rate = (1 + 0.0225) 4 – 1 = 0.09308, or 9.308%.

Question 33: The step in the financial statement analysis framework that includes making any appropriate adjustments to the
financial statements and calculating ratios is best described as:
A. analyzing and interpreting the data.
B. gathering the data.
C. processing the data.
Explanation
C is correct. The financial statement analysis framework consists of six steps:
1. State the ob jective and context. Determine what questions the analysis is meant to answer, the form in which it needs to be
presented, and what resources and how much time are available to perform the analysis.
2. Gather data. Acquire the company's financial statements and other relevant data on its industry and the economy. Ask
questions of the company's management, suppliers, and customers, and visit company sites.
3. Process the data. Make any appropriate adjustments to the financial statements. Calculate ratios. Prepare exhibits such as
graphs and common-size balance sheets.
4. Analyze and interpret the data. Use the data to answer the questions stated in the first step. Decide what conclusions or
recommendations the information supports.
5. Report the conclusions or recommendations. Prepare a report and communicate it to its intended audience. Be sure the
report and its dissemination comply with the Code and Standards that relate to investment analysis and recommendations.
6. Update the analysis. Repeat these steps periodically and change the conclusions or recommendations when necessary.

Question 34: Which of the following statements about cash flow is least accurate? Under U.S. GAAP, cash flow from:
A. operations includes cash operating expenses and changes in working capital accounts.
B. investing includes interest income from investment in debt securities.
C. financing includes the proceeds of debt issued and from the sale of the company’s common stock.
Explanation
B is correct. Interest income is considered an operating cash flow under U.S. GAAP.

Question 35: If prices are increasing, the weighted average cost method most likely results in inventory values that are higher
than the inventory values using:
A. first-in first-out (FIFO).
B. last-in first-out (LIFO).
C. specific identification.
Explanation
B is correct. In an increasing price environment, inventory values reported under LIFO are lower than the values reported
under FIFO, and the values that result from weighted average cost are between the LIFO and FIFO values. Thus, the value of
inventory using weighted average cost is higher than inventory using LIFO. The value of inventory using specific
identification depends on which particular items from inventory are sold, and thus can be higher or lower than the inventory
values that result from the other methods.

Question 36: The labor-force participation rate is defined as the percentage of the:
A. working-age population who are working.
B. labor force who are working.
C. working-age population who are working or actively looking for work.
Explanation
C is correct. The labor-force participation rate is the percentage of the working-age population who are employed or actively
seeking employment. The labor-force participation rate can be calculated as: (the labor force / working-age population) × 100.

Question 37: Which of the following statements about a classified balance sheet is least likely accurate? A classified balance
sheet:
A. distinguishes between current and noncurrent assets.
B. groups accounts by subcategories.
C. presents the net equity of each asset by subtracting its related liability.
Explanation
C is correct. A classified balance sheet groups assets and liabilities by subcategories. It distinguishes between current and
noncurrent assets and current and noncurrent liabilities. The assets and related liabilities are reported separately, they are not
netted.

Question 38: If the historical mean return on an investment is 2.0%, the standard deviation is 8.8%, and the risk-free rate is
0.5%, what is the coefficient of variation (CV)?
A. 4.40.
B. 0.17.
C. 0.23.
Explanation
A is correct. The CV = the standard deviation of returns / mean return = 8.8% / 2.0% = 4.4.
The CV is a measure of risk per unit of mean return. When ranking portfolios based on the CV, a lower value is preferred to
higher.

Question 39: A distinction between Giffen goods and Veblen goods is that:
A. demand curves for Giffen goods slope upward, while demand curves for Veblen goods slope downward.
B. Giffen goods are inferior goods, while Veblen goods are not inferior goods.
C. the substitution effect is positive for a Veblen good but negative for a Giffen good.
Explanation
B is correct. Giffen goods are inferior goods for which the quantity demanded decreases when the price decreases, because
the negative income effect is larger than the positive substitution effect. Veblen goods are goods for which the quantity demand
increases when the price increases, such as a high-status good for which the consumer gains utility from being seen to consume
the good. Giffen goods and Veblen goods, if they exist, have demand curves that slope upward over at least some range of
prices. The substitution effect is positive for all goods.

Question 40: Total investment is one of the components of a country's GDP. Which of the following is least likely to be
considered a source of funds for investment?
A. National savings.
B. Foreign borrowing.
C. Household expenditures.
Explanation
C is correct. Total investment is one of the major components of GDP (the others are consumption, government spending,
and net exports). Investment is defined as expenditures allocated to fixed assets and inventory. The sources of funds for
investment are national savings, foreign borrowing, and government savings.

Question 41: A firm is going to divide 12 employees into three teams of four. How many ways can the 12 employees be
selected for the three teams?
A. 3,326,400.
B. 34,650.
C. 144.
Explanation
B is correct. This problem is a labeling problem where the 12 employees will be assigned one of three labels (groups). Each
group will have four employees. This requires the labeling formula.
Number of ways = N! / (N1! + N2! + N3!)
There are [(12!) / (4! × 4! × 4!)] = 34,650 ways to group the employees.

Question 42: If the quick ratio is equal to 2.0, a decrease in inventory and an equal decrease in accounts payable will:
A. decrease the quick ratio.
B. leave the quick ratio unchanged.
C. increase the quick ratio.
Explanation
C is correct. The quick ratio numerator is cash plus marketable securities plus accounts receivable, and the denominator is
current liabilities. The numerator is unaffected by a change in inventory, while the denominator decreases with a decrease in
accounts payable, so the quick ratio will increase.

Question 43: Which of the following statements about hypothesis testing is most accurate?
A. If you can disprove the null hypothesis, then you have proven the alternative hypothesis.
B. The power of a test is one minus the probability of a Type I error.
C. The probability of a Type I error is equal to the significance level of the test.
Explanation
C is correct. The probability of getting a test statistic outside the critical value(s) when the null is true is the level of
significance and is the probability of a Type I error. The power of a test is 1 minus the probability of a Type II error. Hypothesis
testing does not prove a hypothesis, we either reject the null or fail to reject it.

Question 44: The Federal Reserve has decided to increase the federal funds rate (the interest rate that banks charge each other
for overnight loans). To implement this policy, the Federal Reserve will most likely:
A. sell government securities in the open market.
B. increase currency exchange rates (cause domestic currency to appreciate).
C. set a lower price on Treasury bills and notes that it is auctioning.
Explanation
A is correct. Selling government securities on the open market reduces bank reserves and drives up the federal funds rate.
The other two statements are incorrect because the Federal Reserve does not directly control exchange rates or the prices of
government securities.

Question 45: On January 1, 2004, JME purchased a truck that cost $24,000. The truck had an estimated useful life of 5 years
and $4,000 salvage value. The amount of depreciation expense recognized in 2006 assuming that JME uses the double
declining balance method is:
A. $3,456.
B. $4,000.
C. $5,760.
Explanation
A is correct. yr. 2004 = 24,000 × 2/5 = 9,600
yr. 2005 = (24,000 - 9,600) × 2/5 = 5,760
yr. 2006 = (24,000 - 9,600 - 5,760) × 2/5 = 3,456

Question 46: For purposes of financial analysis, an analyst should:

A. always consider deferred tax liabilities as stockholder's equity.
B. always consider deferred tax liabilities as a liability.
C. determine the treatment of deferred tax liabilities on a case-by-case basis.
Explanation
C is correct. For financial analysis, an analyst must decide on the appropriate treatment of deferred taxes on a case-by-case
basis. These can be classified as liabilities or stockholder's equity, depending on various factors. Sometimes, deferred taxes
are just ignored altogether.

Question 47: Which of these actions would do the most to increase geopolitical risk?
A. Increase capital flows
B. Restrict foreign currency exchange
C. Engage in trade of goods and services
Explanation
B is correct. Restricted foreign currency exchange—a characteristic of anti-globalization—would likely reduce political and
economic cooperation and thus increase geopolitical risk.

Question 48: An auditor who decides to handpick rather than randomly select transactions to examine for instances of fraud
is most likely using:
A. cluster sampling.
B. judgmental sampling.
C. convenience sampling.
Explanation
B is correct. Judgmental sampling refers to using expert or professional judgement to select observations from a population.

Question 49: At the beginning of 2004, Osami Corporation had 1.4 million shares of common stock outstanding and no
preferred stock. At the end of August 2004, Osami issued 1.2 million new shares of common stock. If Osami reported net
income equal to $7.2 million, what were its earnings per share (EPS) for 2004?
A. $2.77.
B. $3.33.
C. $4.00.
Explanation
C is correct. The new shares were only outstanding 4 months of the year. Thus, the weighted average number of shares
outstanding is [1.4 + (4/12)(1.2)] million = 1.8 million shares. So basic EPS = $7.2 million / 1.8 million = $4.00.

Question 50: A perfectly competitive firm will continue to increase output so long as which of the following conditions
exists?
A. Marginal revenue is positive.
B. Marginal revenue is greater than price.
C. Market price is greater than marginal cost.
Explanation
C is correct. A perfectly competitive firm will tend to expand its output so long as the market price is greater than marginal
cost since price and marginal revenue are equal. In the short term and long term, profit is maximized when marginal cost and
marginal revenue are equal (i.e., MC = MR).

Question 51: A company must report separate financial information for any segment of their business which:
A. accounts for more than 10% of the firm’s assets and has risk and return characteristics distinguishable from the
company’s other lines of business.
B. is located in a country other than the firm’s home country.
C. is more than 20% of a firm’s revenues.
Explanation
A is correct. Financial statement items must be reported separately for any segment of a firm's business that is greater than
10% of revenue or assets and has risk and return characteristics that are distinguishable from those of the company's other
lines of business. Requirements for reporting of geographic segments have the same size threshold and the segment must
operate in a business environment that is different from that of the firm's other segments.

Question 52: Which of the following is least likely an assumption of linear regression?
A. The variance of the error terms each period remains the same.
B. The error terms from a regression are positively correlated.
C. Values of the independent variable are not correlated with the error term.
Explanation
B is correct. One assumption of linear regression is that the error terms are independently distributed. In this case, the
correlations between error terms are expected to be zero. Constant variance of the error terms and no correlation between the
independent variable and the error term are assumptions of linear regression.

Question 53: Justin Banks just won the lottery and is trying to decide between the annual cash flow payment option or the
lump sum option. He can earn 8% at the bank and the annual cash flow option is $100,000/year, beginning today for 15 years.
What is the annual cash flow option worth to Banks today?
A. $1,080,000.00.
B. $855,947.87.
C. $924,423.70.
Explanation
C is correct. First put your calculator in the BGN.
N = 15; I/Y = 8; PMT = 100,000; CPT → PV = 924,423.70.
Alternatively, do not set your calculator to BGN, simply multiply the ordinary annuity (end of the period payments) answer
by 1 + I/Y. You get the annuity due answer and you don't run the risk of forgetting to reset your calculator back to the end of
the period setting. OR N = 14; I/Y = 8; PMT = 100,000; CPT → PV = 824,423.70 + 100,000 = 924,423.70.

Question 54: A government that imposes restrictions on capital flows into or out of its country is most likely attempting to:
A. reduce the volatility of domestic asset prices.
B. encourage competition among domestic industries.
C. implement floating exchange rates.
Explanation
A is correct. Reasons commonly cited by governments for imposing capital restrictions include reducing the volatility of
domestic asset prices, maintaining control of exchange rates, keeping domestic interest rates low, and protecting strategic
industries from foreign ownership.

Question 55: When bonds are issued at a premium:

A. coupon interest paid decreases each period as bond premium is amortized.
B. earnings of the firm decrease over the life of the bond as the bond premium is amortized.
C. earnings of the firm increase over the life of the bond as the bond premium is amortized.
Explanation
C is correct. As bond premium is amortized, interest expense will be successively lower each period, thus increasing earnings
over the life of the bond.

Question 56: Which of the following is most accurately described as a characteristic of a firm's quality of earnings?
A. Completeness.
B. Sustainability.
C. Relevance.
Explanation
B is correct. Quality of earnings relates to the level and sustainability of a firm's earnings. Relevance and faithful
representation (including completeness and neutrality) are characteristics of a firm's financial reporting quality.

Question 57: Other things equal, which of the following firm characteristics are most likely to be viewed favorably by credit
rating agencies?
A. Large size in a concentrated geographic region.
B. Large size and diverse product lines.
C. Focused product line in widespread geographic regions.
Explanation
B is correct. Other things equal, credit rating agencies tend to rate larger companies and those with diversified product lines
and greater geographic diversification to be better credit risks.

Question 58: What is the compound annual growth rate for stock A which has annual returns of 5.60%, 22.67%, and -5.23%?
A. 8.72%.
B. 7.08%.
C. 6.00%.
Explanation
B is correct. Compound annual growth rate is the geometric mean (1.056 × 1.2267 × 0.9477)1/3 – 1 = 7.08%.

Question 59: Which one of the following statements about the t-distribution is most accurate?
A. The t-distribution approaches the standard normal distribution as the degrees of freedom increase.
B. The t-distribution has thinner tails compared to the normal distribution.
C. The t-distribution is positively skewed.
Explanation
A is correct. As the number of degrees of freedom grows, the t-distribution approaches the shape of the standard normal
distribution.
Compared to the normal distribution, the t-distribution has fatter tails.
The t-distribution is symmetric about the mean and so it has skewness of zero.

Question 60: What are the three essential qualities an effective central bank should possess?
A. Independence, credibility, and transparency.
B. Credibility, relevance, and reliability.
C. Transparency, independence, and consistency.
Explanation
A is correct. A central bank that is independent from political interference, possesses credibility, and exhibits transparency
is more likely to achieve its monetary policy objectives than a central bank that lacks these qualities. The other characteristics
listed in the answer choices relate to financial statements and financial reporting standards.

Question 61: Pinto Corporation is an automobile manufacturer located in North America. Pinto owns a 5 percent interest in
one of its suppliers, Continental Supply Company. Each year, Pinto receives a cash dividend from Continental. Pinto's engine
supplier, National Supply Company, recently increased prices on goods sold to all customers due to higher labor costs. Should
Pinto report the dividends received from Continental and the price increase from National as an operating or nonoperating
component on its year-end income statement?
A. Only one is operating.
B. Both are operating.
C. Both are nonoperating.
Explanation
A is correct. Since Pinto is a nonfinancial firm, dividends received would be considered a nonoperating component. An
increase in cost of goods sold would be considered a part of normal operations.

Question 62: Which of the following factors is most likely to increase aggregate demand?
A. An expected decrease in future prices.
B. An increase in real wealth.
C. Increasing real interest rates.
Explanation
B is correct. While an increase in real wealth will shift the AD curve to the right, an increase in the real rate of interest will
shift the AD curve to the left as consumers and businesses reduce their borrowing and spending. An expected decrease in
prices will shift the AD curve to the left as households and businesses postpone their consumption in anticipation of lower
prices in the future.

Question 63: If the price of World Cup Soccer tickets increases from $40 a ticket to $50 a ticket and the quantity demanded
of tickets stays the same, demand for the tickets is:
A. elastic, but not perfectly elastic.
B. inelastic, but not perfectly inelastic.
C. perfectly inelastic.
Explanation
C is correct. Since the quantity of tickets demanded stayed the same after the price changed, the demand curve would have
to be vertical which is a perfectly inelastic demand curve.

Question 64: The test of the equality of the variances of two normally distributed populations requires the use of a test statistic
that is:
A. z-distributed.
B. Chi-squared distributed.
C. F-distributed.
Explanation
𝑠12
C is correct. The F-distributed test statistic, F = , is used to compare the variances of two populations.
𝑠22

Question 65: During 2007, Topeka Corporation entered into the following transactions:
Transaction #1 – Interest on a certificate of deposit owned by Topeka was credited to Topeka's investment account.
Transaction #2 – Topeka sold 10,000 shares of common stock at $30 that had been repurchased by Topeka last year for $20.
Should Topeka recognize the results of these transactions as income on the income statement for the year ended December
31, 2007?
A. Both should be recognized.
B. Neither should be recognized.
C. Only one should be recognized.
Explanation
C is correct. Interest earned on the CD is recognized as interest income. The gain on the sale of treasury stock is not reported
on the income statement but is reflected on the statement of changes in stockholders' equity and on the balance sheet. The sale
proceeds simply increase equity and increase cash.

Question 66: As an economic expansion approaches its peak, the economy is most likely to show:
A. a decrease in inventory levels.
B. accelerating sales growth.
C. an increase in the inventory-to-sales ratio.
Explanation
C is correct. As the economy approaches its peak, sales growth begins to slow, unsold inventories begin to accumulate, and
the inventory-to-sales ratio increases.

Question 67: To convert an indirect statement of cash flows to a direct basis, the analyst would:
A. add decreases in accounts receivables to net sales.
B. subtract increases in inventory from cost of goods sold.
C. add increases in accounts payable to cost of goods sold.
Explanation
A is correct. A decrease in accounts receivable represents an increase in cash so this should be added to sales. Increases in
accounts payable represent an increase in cash so these should be subtracted from cost of goods sold. Increases in inventory
represent a use of cash so these would be added to cost of goods sold.

Question 68: A company that reports under U.S. GAAP and changes its inventory cost assumption from weighted average
cost to last-in first-out is required to apply this change in accounting principle:
A. prospectively, and explain the reasons for the change in the financial statement disclosures.
B. retrospectively, and disclose the new cost flow method being used.
C. retrospectively, and explain the reasons for the change in the financial statement disclosures.
Explanation
A is correct. Under U.S. GAAP, a change to LIFO from another inventory cost method is an exception to the requirement of
retrospective application of changes in an accounting principle. Instead of restating prior years' data, the firm uses the carrying
value of inventory at the time of the change as the first LIFO layer. U.S. GAAP requires a company that is changing its
inventory cost assumption to explain, in its financial statement disclosures, why the new method is preferable to the old
method.

Question 69: From a population with a standard deviation of 15, a sample of 25 observations is taken. The standard error of
the sample mean is:
A. 1.67.
B. 0.60.
C. 3.00.
Explanation
C is correct. The standard error of the sample mean equals the standard deviation of the population divided by the square
root of the sample size σ / √n = 15 / √25 = 3.
The standard error measures how much the sample mean deviates from the true population mean. The smaller the standard
error, the closer the sample mean is likely to lie to the true population mean.

Question 70: Which of the following statements regarding the distribution of returns used for asset pricing models is most
accurate?
A. Lognormal distribution returns are used because this will allow for negative returns on the assets.
B. Lognormal distribution returns are used for asset pricing models because they will not result in an asset return of less
than -100%.
C. Normal distribution returns are used for asset pricing models because they will only allow the asset price to fall to zero.
Explanation
B is correct. Lognormal distribution returns are used for asset pricing models because this will not result in asset returns of
less than 100% because the lowest the asset price can decrease to is zero which is the lowest value on the lognormal
distribution. The normal distribution allows for asset prices less than zero which could result in a return of less than -100%
which is impossible.

Question 71: This year, Blue Horizon has recorded $390,000 in revenue for financial reporting purposes, but, on a cash basis,
revenue was only $262,000. Assume expenses at 50% in both cases (i.e., $195,000 on accrual basis and $131,000 on cash
basis), and a tax rate of 34%. What is the deferred tax liability or asset? A deferred tax:
A. asset of $21,760.
B. liability of $16,320.
C. liability of $21,760.
Explanation
C is correct. Since pretax income ($195,000) exceeds the taxable income ($131,000), Blue Horizon will have a deferred tax
liability of $21,760 [($195,000 - $131,000)(0.34)].

Question 72: When the sources of economic growth are stated as a production function, which factor is treated as a multiplier?
A. Size of the labor force.
B. Amount of capital available.
C. Productivity.
Explanation
C is correct. Economic output can be stated as a production function of the form Y = A × ƒ(L, K), where Y is economic
output, L is the size of the labor force, K is the amount of capital available, and A is total factor productivity.

Question 73: Davis Inc. is a large manufacturing company operating in several European countries. Davis has long-lived
assets that are valued on the balance sheet at $600 million. This includes previously recognized revaluation losses of $80
million. In the most recent accounting period, the fair value of these assets in an active market is $690 million. Which of the
following entries will Davis record under the IFRS revaluation model?
A. Gain on income statement and a revaluation surplus.
B. Gain on income statement only.
C. Revaluation surplus only.
Explanation
A is correct. Under IFRS, firms may choose to report long-lived assets at fair value. Upward revaluations are permitted and
will result in a gain recognized on the income statement to the extent it reverses a previously recognized loss. Any excess is
reported as a revaluation surplus, a direct adjustment to equity. In this case, the carrying value of the assets is $600 million
and the fair value is $690 million. Of the $90 million excess of fair value over carrying value, $80 million is recognized as a
gain on the income statement to reverse the $80 million loss that was previously recognized. The remaining $10 million is
recorded as revaluation surplus in shareholders' equity.

Question 74: When sampling from a population, the most appropriate sample size:
A. minimizes the sampling error and the standard deviation of the sample statistic around its population value.
B. is at least 30.
C. involves a trade-off between the cost of increasing the sample size and the value of increasing the precision of the
estimates.
Explanation
C is correct. A larger sample reduces the sampling error and the standard deviation of the sample statistic around its
population value. However, this does not imply that the sample should be as large as possible, or that the sampling error must
be as small as can be achieved. Larger samples might contain observations that come from a different population, in which
case they would not necessarily improve the estimates of the population parameters. Cost also increases with the sample size.
When the cost of increasing the sample size is greater than the value of the extra precision gained, increasing the sample size
is not appropriate.

Question 75: Which group is most likely to benefit from a quota imposed on imports of a good?
A. Domestic producers of the good.
B. Foreign consumers of the good.
C. Domestic consumers of the good.
Explanation
A is correct. Quotas restrict the supply of imported goods, which increases the price domestically, benefiting domestic
producers but harming domestic consumers. While some specific foreign producers may also benefit from the higher prices
created by the quota if they receive the revenue transfer (due to higher prices received for all goods sold under the import
license), foreign producers as a whole are likely to experience decreased sales in the country that imposes a quota.

Question 76: Assuming the economy currently is experiencing high inflation, an example of appropriate discretionary fiscal
policy is:
A. increase the federal funds target rate.
B. reduce government expenditures on major government construction projects.
C. reduce the money supply.
Explanation
B is correct. Discretionary fiscal policy refers to the federal government's decisions regarding government spending and
taxing. A reduction in government spending on major government construction projects is likely to lead to a reduction in
aggregate demand and less pressure on prices, reducing inflation.

Question 77: Which of the following ratios is NOT part of the original DuPont system?
A. Asset turnover.
B. Debt to total capital.
C. Equity multiplier.
Explanation
B is correct. The debt to total capital ratio is not part of the original DuPont system. The firm's leverage is accounted for
through the equity multiplier.

Question 78: The difference between the fair value of a defined benefit pension plan's assets and its estimated benefit
obligation is recognized:
A. as an actuarial adjustment in other comprehensive income.
B. on the balance sheet as a net pension asset or liability.
C. on the income statement as pension expense.
Explanation
B is correct. A net pension asset or net pension liability defined benefit plan is the difference between the fair value of the
plan's assets and the estimated benefit obligation. A plan with a net pension asset is said to be overfunded, and a plan with a
net pension liability is said to be underfunded.

Question 79: Brandon Ratliff is investigating whether the mean of abnormal returns earned by portfolio managers with an
MBA degree significantly differs from mean abnormal returns earned by managers without an MBA. Ratliff's null hypothesis
is that the means are equal. If Ratliff's critical t-value is 1.98 and his computed t-statistic is 2.05, he should:
A. fail to reject the null hypothesis and conclude that the population means are equal.
B. reject the null hypothesis and conclude that the population means are not equal.
C. reject the null hypothesis and conclude that the population means are equal.
Explanation
B is correct. The hypothesis test is a two-tailed test of equality of the population means. The t-statistic is greater than the
critical t-value. Therefore, Ratliff can reject the null hypothesis that the population means are equal.

Question 80: The appropriate regression model for a linear relationship between the relative change in an independent
variable and the absolute change in the dependent variable is a:
A. log-lin model.
B. lin-log model.
C. lin-lin model.
Explanation
B is correct. The appropriate model would be a lin-log model, in which the values of the dependent variable (Y) are regressed
on the natural logarithms of the independent variable (X), Y = b0 + b1 ln X.

Question 81: Consider the following statements:

Statement 1: "The sum of consumer and producer surpluses is maximized under both monopoly and perfect competition."
Statement 2: "All else being equal, a monopolist that practices price discrimination will be more allocatively efficient than a
single-price monopolist."
With respect to these statements:
A. neither of these statements is accurate.
B. both of these statements are accurate.
C. only one of these statements is accurate.
Explanation
C is correct. Statement 1 is incorrect because the sum of consumer and producer surpluses is maximized under perfect
competition when marginal benefit and marginal cost are equal, or equivalently, where the marginal cost curve intersects the
demand curve. Monopolies, however, produce a quantity that is less than the quantity where marginal cost equals marginal
benefit, so the sum of producer and consumer surpluses is not maximized.

Question 82: In estimating pro forma cash flows for a company, analysts typically hold which of the following factors
constant?
A. Repayments of debt.
B. Sales.
C. Noncash working capital as a percentage of sales.
Explanation
C is correct. To estimate pro forma cash flows, the analyst must make assumptions about future sources and uses of cash.
The most important of these will be increases in working capital, capital expenditures on new fixed assets, issuance or
repayments of debt, and issuance or repurchase of stock. A typical assumption is that noncash working capital will remain
constant as a percentage of sales.

Question 83: A U.S. GAAP firm writes down inventory to net realizable value. In the period of the writedown, what is the
most likely effect on cost of goods sold?
A. Decrease.
B. Increase.
C. No effect.
Explanation
B is correct. A write-down of inventory to net realizable value is typically recognized under U.S. GAAP as an increase in
cost of goods sold in the period of the write-down. Consider the inventory equation:
ending inventory = beginning inventory + purchases – cost of goods sold
A write-down to NRV decreases ending inventory, with no effect on beginning inventory or purchases. For the inventory
equation to hold, cost of goods sold must increase.

Question 84: If an analyst concludes that the distribution of a large sample of returns is positively skewed, which of the
following relationships involving the mean, median, and mode is most likely?
A. Mean > median < mode.
B. Mean < median < mode.
C. Mean > median > mode.
Explanation
C is correct. For the positively skewed distribution, the mode is less than the median, which is less than the mean.

Question 85: The following data is from Delta's common size financial statement:
Earnings after taxes 18%
Equity 40%
Current assets 60%
Current liabilities 30%
Sales $300
Total assets $1,400
What is Delta's total-liabilities-to-equity ratio?
A. 1.0.
B. 1.5.
C. 2.0.
Explanation
B is correct. If equity = 40% of assets, total liabilities = 60% of assets, thus 60 / 40 = 1.5.

Question 86: Which of the following actions is least likely to increase earnings for the current period?
A. Decreasing the salvage value of depreciable assets.
B. Recognizing revenue before fulfilling the terms of a sale.
C. Selling more inventory than is purchased or produced.
Explanation
A is correct. Decreasing the salvage value will result in higher depreciation expense and lower earnings in the current period.
Recognizing revenue before fulfilling all terms of a sale is an aggressive revenue recognition method that will increase
earnings in the current period. For firms that use LIFO inventory accounting and in an increasing price environment, selling
more inventory than is purchased or produced will increase earnings unsustainably in the current period.

Question 87: There is a 40% probability that the economy will be good next year and a 60% probability that it will be bad.
If the economy is good, there is a 50 percent probability of a bull market, a 30% probability of a normal market, and a 20%
probability of a bear market. If the economy is bad, there is a 20% probability of a bull market, a 30% probability of a normal
market, and a 50% probability of a bear market. What is the joint probability of a good economy and a bull market?
A. 50%.
B. 12%.
C. 20%.
Explanation
C is correct. The joint probability is the probability that both events, in this case the economy being good and the occurrence
of a bull market, happening at the same time. It is computed by multiplying the unconditional probability of a good economy
(40%) by the conditional probability of a bull market given a good economy (50%): 0.40 × 0.50 = 0.20 or 20%.
Market Given
State of the Probability of a Particular State
State of the
Economy of the Economy AND Market
Economy
(Unconditional Occurring
(Conditional
Probability) (Joint Probability)
Probability)
Bull 50% Good + Bull = 40% × 50% = 20%
Good 40% Normal 30% Good + Normal = 40% × 30% = 12%
Bear 20% Good + Bear = 40% × 20% = 8%
Bull 20% Bad + Bull = 60% × 20% = 12%
Bad 60% Normal 30% Bad + Normal = 60% × 30% = 18%
Bear 50% Bad + Bear = 60% × 50% = 30%

Question 88: Which of the following statements is most accurate? Cost-push inflation:
A. often occurs because of an increase in short-run aggregate supply.
B. results from excess short-run aggregate demand.
C. typically results from a significant price increase in a production input.
Explanation
C is correct. Cost-push inflation typically results from a significant price increase in a production input that causes a decrease
in short-run aggregate supply.

Question 89: If the exchange rate between the U.S. dollar and the Canadian dollar is USD/CAD 0.6403, and the exchange
rate between the Canadian dollar and the UK pound sterling is CAD/GBP 2.5207, the exchange rate between the U.S. dollar
and the UK pound sterling, stated as GBP/USD, is closest to:
A. 1.6140.
B. 0.6196.
C. 3.9367.
Explanation
B is correct. For currency cross rate calculations, the recommended approach is to set up the given rates such that cross-
multiplying will result in the exchange rate the question is asking for.
In this case, GBP/USD = GBP/CAD × CAD/USD.
GBP/CAD = 1 / 2.5207 = 0.3967
CAD/USD = 1 / 0.6403 = 1.5618
GBP/USD = 0.3967 × 1.5618 = 0.6934
Alternatively, USD/CAD 0.6403 × CAD/GBP 2.5207 = USD/GBP 1.6140, and GBP/USD = 1 / 1.6140 = 0.6196.

Question 90: Joplin Corporation reports the following in its year-end financial statements:
• Net income of $43.7 million.
• Depreciation expense of $4.2 million.
• Increase in accounts receivable of $1.5 million.
• Decrease in accounts payable of $2.3 million.
• Sold equipment for $15 million.
• Purchased equipment for $35 million.
Joplin's free cash flow to the firm (FCFF) is closest to:
A. $39 million.
B. $28 million.
C. $24 million.
Explanation
C is correct. Free cash flow to the firm = net income + noncash charges + after-tax interest – fixed capital investment –
working capital investment.
Net income is $43.7 million.
Noncash charges are $4.2 million (depreciation expense).
No interest expense is shown.
Fixed capital investment is $35 million purchased – $15 million sold = $20 million.
Working capital investment is $1.5 million increase in accounts receivable + $2.3 million decrease in accounts payable =
$3.8 million. (Both are uses of cash)
FCFF = $43.7 million + $4.2 million – $20 million – $3.8 million = $24.1 million.