CFA Practice Questions

• There are three CFA exams, each with a variety of questions that require plenty of practice.
• The Level I exam consists of 180 multiple-choice questions.
• The Level II exam consists of item sets of vignettes with 88 multiple-choice questions.
• The Level III exam is a combination of item-set questions and constructed-response questions.
• UWorld offers practice question banks for each exam level, filled with calculative and conceptual questions
  to help prepare you for exam day.

To get a better understanding of how to approach the Level I exam, you’ll need to be familiar with the format. CFA candidates can expect 180 multiple-choice questions with three answers to choose from on the Level I exam, split into two sessions.There are 90 questions in each session, and you’ll have around 2 hours and 15 minutes to complete each one.

The first session covers Financial Reporting and Analysis, Quantitative Methods, Economics, and Ethics and Professional Standards. The second session tests your knowledge of topics like Fixed Income, Derivatives, Alternative Investments, Corporate Finance, and Portfolio Management.

Which of the following is least likely to be mentioned in the introductory paragraph of a standard independent audit report?

1. The nature of the audit process
2. The responsibilities of both management and the independent auditor
3. The financial statements that were audited

CFA Level I Financial Reporting and Analysis Practice Question Answer and Explanation

The first or introductory paragraph of a standard independent audit report describes the financial statements that were audited and the responsibilities of both management and the independent auditor. The second or scope paragraph describes the nature of the audit process and provides the basis for the auditor’s opinion.

The Level II CFA exam introduces a new challenge: vignettes. A vignette describes a scenario using a mixture of tables, text, and financial statements. Each vignette is followed by either 4 or 6 multiple-choice questions.You’ll need to quickly scan each vignette and find the most important pieces of information to answer the questions. There are 44 multiple-choice questions in each of the two Level II sessions.

Danielle Riback is analyzing Three W, a large multi-division industrial firm located in Wisconsin, for possible inclusion in a portfolio of value stocks. Due to the industrial nature of its products, Three W experienced very slow sales growth from 2007 – 2012 and actually experienced sales declines in 2009, with flat sales from 2011 to 2012.Management considers the period from 2007 to 2012 to be a complete business cycle, although the economy has not yet recovered to 2007 levels. Riback believes the company can earn a 27.0 percent return on ROE and grow at a 6.0 percent rate over the long term. She has further estimated that the required return for equity is 9.0 percent.

Three W incurred a large amount of debt in 2008 to repurchase its shares. Three W also reacquired more equity shares than it issued in 2011 and 2012. Selected financial information for Three W appears in Exhibit 1, with additional data in Exhibit 2.

Exhibit 1 – Three W: Financial Data (Millions of USD)

	2012	2011	2010	2009	2008	2007
Sales	$29,904	$29,611	$29,662	$23,123	$25,269	$24,462
Earnings to common shareholders	4,719	2,801	4,257	3,193	3,460	4,096
Ending book value of common equity	18,040	15,862	16,017	13,302	10,304	12,072

Exhibit 2 – Three W: Additional Data (Share data in millions of shares)

	2012	2011	2010	2009	2008	2007
Debt-to-total capital	25%	25%	25%	30%	39%	29%
Stock price	$92.85	$81.73	$86.30	$82.67	$57.54	$84.32
Common shares outstanding (period end)	687.1	695.0	712.0	710.6	693.5	709.2
Weighted average common shares	693.9	708.5	713.7	700.5	699.2	718.3
outstanding (WACSO) – basic WACSO – diluted	703.3	719.0	725.5	706.7	707.2	732.0

Riback discusses her analysis with her supervisor, Bob Montgomery, who will present the case for or against inclusion in the portfolio to the firm’s investment committee. During her meeting with Montgomery, Riback discloses that she calculated price-to-earnings and price-to-sales (P/S) ratios for Three W, but prefers the price-to-book value (P/BV) multiple for the comparison to the benchmark. She justifies her decision with the following three reasons:

• Reason 1: P/BV is more stable than price multiples that use sales or earnings.
• Reason 2: P/BV is meaningful when a firm’s earnings are zero or negative.
• Reason 3: P/BV is better at reflecting the market’s perception of the firm’s underlying return for long-term investors.

Montgomery suggests that Riback compare Three W’s current P/BV against its historical P/BV calculated using the harmonic mean, simple average, and median. Montgomery also suggests that Riback calculate the fair value (justified) for Three W’s P/BV based on the forecast fundamentals method.

Question 1

Riback’s use of the P/BV multiple is best supported by:

Question 2

How much different is Three W’s 2012 P/BV relative to its harmonic mean for 2007–2012?

Question 3

Based on Three W’s justified P/BV calculated by the forecast fundamentals method using ROE from 2007–2012, its current P/BV could best be described as:

Question 1

Although growth investors will be reluctant to purchase a cyclical company for short-term earnings in a slowly recovering economy, a value investor might be more inclined to purchase the firm based on potential returns on assets, assuming stable liabilities. Studies have shown that low P/BV more closely relates to potential returns than P/E ratios. Reason 1 will tend to be true when the subject company has not had substantial shifts in debt-to-total capital, including share issuance, repurchase, and dilution. Reason 2 does not apply because the firm has not experienced zero or negative earnings.

Question 2

Price-to-book value over the period is:

	2012	2011	2010	2009	2008	2007
Stock Price	$92.85	$81.73	$86.30	$82.67	$57.54	$84.32
BV common equity	18.040	15.862	16.017	13.302	10.304	12.072
CSO (end of period)	687.1	695.0	712.0	710.6	693.5	709.2
BVPS	26.26	22.82	22.50	18.72	14.86	17.02
P/BV	3.54	3.58	3.84	4.42	3.87	4.95

The 2012 P/BV is less than the harmonic mean by 0.44 (3.54 – 3.98). Note also that the harmonic mean will always be less than the arithmetic mean, unless all observations are equal.

Question 3

The justified P/BV is calculated as follows:

Three W’s shares are undervalued based on the outcome that Three W’s justified P/BV based on forecast fundamentals method is greater than the company’s current (2012) P/BV of 3.5. The 3.5 is calculated as follows:

The final exam in the CFA Curriculum offers what many consider to be the most difficult format yet: the constructed response or essay question. CFA candidates can expect the Level III exam to be split into two sessions, one in the morning, and the other in the afternoon, each session lasting for 2 hours and 12 minutes.The morning session consists of 8 to 11 vignettes as well as constructed-response questions where you’ll need to write out your answers rather than choose from a list of options.

The afternoon session is made up of 44 multiple-choice questions presented in item sets consisting of a vignette followed by either 4 or 6 multiple-choice questions.

Perry Dobson, CFA, works as an investment advisor for Lake Blanc Advisors. Dobson has been discussing strategic asset allocation approaches with the partners of a small legal firm.These discussions are summarized in Exhibit 1.

Fund Holding	Comment
Government bonds	Even though cash rates have been steady over the recent past, 10-year bond yields have started to rise, which we expect to continue. We are not sure whether cash rates will soon follow, but we will need to analyze how the dollar value of our bond holdings is likely to change in the event of a 1% increase in yields to maturity.
Residential mortgage-backed securities	We are worried about the value of our RMBS holdings in the event of an increase in rates across the government bond term spectrum.
AA-rated corporate bonds	We have started to see the butterfly spread in Japanese bonds increase and many clients are concerned about how our corporate bonds might fare. We will need to analyze the price sensitivities to yields at the 1-, 5-, and 10-year timeframes if this spread increase continues in order to estimate the relative performance of the holdings.

For each Fund Holding in the first column, double-click in the associated shaded cell in the Yield Curve Change column and determine which type of yield curve change is being described by selecting from the list provided. A selection may be used once, more than once, or not at all.

For each Fund Holding in the first column, double-click in the associated shaded cell in the Duration Measure column and determine which duration measure is most appropriate to use by selecting from the list provided. A selection may be used once, more than once, or not at all.

Fund Holding	Yield Curve Change	Duration Measure
Government bonds	Slope Change	Money Duration
RMBS	Parallel Shift	Effective Duration
Corporate bonds	Curvature change	Key rate duration

Government Bonds

1. The portfolio manager is describing a steepening curve, where the difference between long-term yields and short-term yields increases.
2. A measure of the dollar value change of a holding resulting from a change in yields is known as money (or dollar) duration.

RMBS

1. An increase in yields across the spectrum is likely to be best described as a parallel shift.
2. A measure of the change in price of a holding based on the change in a benchmark rate (e.g., Treasury yields) is known as effective duration.

Corporate Bonds

1. An increase in the butterfly yield indicates that medium term rates are increasing (decreasing) at a faster (slower) rate than short- and long-term yields. This indicates a curvature change in the yield curve.
2. A measure of the change in price of a holding based on the change in a benchmark rate at a specific point on the yield curve term is known as key rate (partial) duration.

Before you tackle the actual exam, you need to be prepared for all the challenges it presents. The best way to prepare and pass the first time you test is to master the CFA practice questions using the best CFA practice questions, mock exams, and study materials available. UWorld has you covered with thousands of practice questions to help you identify your strengths and weaknesses. Our adaptive test bank provides you with calculative and conceptual questions to test your knowledge and help you achieve your goals at each level of the CFA curriculum.