Another e-mail tip of the week:
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These questions will help you assess your progress in preparing
for the 1999 CFA exam.
All of the questions come from our TestBank Software for all
three CFA levels (We are shipping our software to candidates
NOW). If you have not purchased your 1999 software yet, you can
test drive our software (in 2 minutes) at:
allenresources.com
Here follow:
- 4 questions & answers for Level I
(approximately 6,510 Questions are in our Level I Software)
- 1 question & answer for Level II
(approximately 1,630 Questions are in our Level II Software)
- 1 question & answer for Level III
(approximately 1,600 Questions are in our Level III Software)
*** Level I
Question 1: Which of the following are not required disclosures
under the Performance Presentation Standards?
a) The inclusion of any non-fee paying portfolios in composites.
b) Whether balanced portfolio segments are included in
single-asset composites.
c) The existence of a minimum asset size for the inclusion in
composites.
d) Portfolio size range and percentage of total assets in the
same class.
Question 2: If the amount of money in circulation is $200 million
and the nominal GDP is $950 million, then the money velocity is
________.
a) 19.0
b) 4.75
c) 1.90
d) 0.21
Question 3: The January effect
a) is the tendency of stock prices to decrease in the last few
days of December, and increase in the first few days of January.
This is especially pronounced among small firms, although the
initial explanation for the effect was earnings-based.
b) is the tendency of stock prices to decrease in the last few
days of December, and increase in the first few days of January.
This is especially pronounced among small firms, although the
initial explanation for the effect was tax-based.
c) is the tendency of stock prices to decline in the first few
days of January (especially the first day). But the abnormal
returns on this effect have been found to be smaller than the
transaction costs required to take advantage of them, making
profit opportunities impossible.
d) is the tendency of stock prices to increase in the last few
days of December, and decline in the first few days of January.
This effect is especially pronounced among small firms, although
the initial explanation for the effect was tax-based.
e) was originally postulated as being related to the small firm
effect. Later, a tax explanation was given which claimed that
holders of poorly performing stocks would sell at the end of the
year to establish loses on those stocks, and would then
repurchase them or other stocks after the New Year.
Question 4: If an bond investor believes that interest rates will
experience a large increase, he should hold a portfolio of
a) short-term bonds with low coupons.
b) intermediate-term bonds with low coupons.
c) long-term bonds with low coupons.
d) long-term bonds with high coupons.
e) short-term bonds with high coupons.
Answer 1: d
Rationale & Reference:
The existence of a minimum asset size below which portfolios are
excluded from a composite must be disclosed. Whether balanced
portfolio segments are included in single-asset composites and an
explanation of how cash has been allocated among segments must be
disclosed. The inclusion of any non-fee-paying portfolios in
composites and included in the definition of total firm assets
must be disclosed. Only the number of portfolios, their
description, the amount of assets in a composite, the percentage
of the firm's total assets the composite represents need be
disclosed. The portfolio size range or percentage of total assets
in the same class are only recommended, not required disclosures.
Performance Presentation Standards, pp. 16-17, 23
Answer 2: b
Rationale & Reference:
Velocity of money is defined as GDP divided by the stock of
money. It is simply the average number of times a dollar is used
to purchase a final product or service during a year. Thus, $950
million divided by $200 million equals 4.75.
Gwartney & Stroup, p. 330
Answer 3: b
Rationale & Reference:
Several years ago, a trading rule was proposed by Branch that
predicted the January effect. Branch claimed that investors in
declining shares would tend to sell them before the end of the
year in order to establish losses (to decrease taxes) on those
stocks. Those investors would tend to repurchase those stocks, or
other stocks that looked attractive after the New Year. Studies
have confirmed the existence of a January effect wherein stock
prices decline in December and increase in January, supporting
the tax theory. But the effect has also been found to be
connected with firm size, and has been found to exist in other
countries where the tax explanation would not hold. For this
reason, many questions still remain about the January effect.
Reilly & Brown, pp. 220-221
Answer 4: e
Rationale & Reference:
Studies have found that bond price volatility is directly related
with term to maturity, and inversely directed to coupon size. All
bonds should experience price declines because of a major
increase in interest rates, but short-term, high coupon bonds
will experience the smallest decline because their
characteristics decrease their price volatility, making them less
sensitive to adverse changes in interest rates.
Reilly & Brown, p. 564
*** Level II
Question: Describe and explain the most common features of
indenture provisions (Utility Indentures)
Answer:
In analyzing indenture provisions, the analyst must look at
standard industry indenture provisions and look for differences
with these differences to be more carefully examined to determine
their effect. Further, the analyst should focus on the more
restrictive covenants.
Utility Indentures
1. Security: These provisions specify the property upon which
there is a mortgage lien and the ranking of the new debt relative
to other outstanding debt. As the liberality of certain features
of this type of provision increases over time, a company may
retire old debt in order to eliminate a more restrictive covenant
not included in current offerings.
2. Issuance of Additional Bonds: These provisions establish the
conditions under which the company may issue additional first
mortgages and is often based upon a debt test and/or earnings
test. Such provisions generally limit the amount of bonds that
may be issued to a certain percentage of the net property or the
net property additions or the amount of retired bonds or the
amount of cash on hand or by some other measurement.
The analyst must carefully study this provision and the
definitions and conditions thereof. Only by such careful study of
the text can the analyst be certain of the exact nature of the
conditions which allow further issue, especially with regard to
what property, earnings, assets, income, etc., are going to
actually be included in any test.
3. Maintenance and Replacement Fund: These provisions prescribe
for the existence of and funding levels of a fund that is used to
insure that the collateralized property is kept in good
condition, thereby maintaining its value. Note that historically,
a major portion of the M & R requirements has been satisfied with
normal maintenance procedures. Again the analyst should review
this position to satisfy himself that the mortgaged property will
be kept in good condition and be worth a sufficient amount to
cover any bond default.
4. Redemption Provisions: These provisions specify when and under
what conditions a company may call its bonds which is done by a
company generally to replace outstanding debt with another debt
issue sold at a lower interest rate. Careful review must be made
by the analyst to assess the potential effects of such a call and
of an untimely redemption insofar as the bondholders would be
concerned. Such call provisions have substantial effect on
pricing and this effect must be factored into the analyst's
review.
5. Sinking Fund: A sinking fund is an annual obligation of a
company to pay an amount of cash to a trustee to retire a given
percentage of bonds which is often met with actual bonds or
pledges of property. The analyst must understand the
ramifications of this provision insofar as how it could affect
the probability of the bonds being called for sinking fund
purchases which in turn affects the value and pricing of the
bonds in the same manner as occurs when callable bonds are
redeemed.
6. Other Provisions: Other provisions include events of default,
mortgage modification, security, limits on borrowing, priority,
etc., but such provisions are generally standard. However, the
analyst should review these provisions carefully to look for
non-standard provisions and their effect on pricing.
Tripp Howe, pp. 392-397
*** Level III
Question: Learning Outcome Statement:
Identify the return objectives and risk tolerances of endowment
funds, including spending rate and inflation rate considerations.
Answer:
Return objectives will vary depending on the purpose of the
endowment, however, investment policy can best be viewed as the
resolution of a creative tension existing between the highly
demanding need for immediate income and the pervasive and
enduring pressure for a growing stream of future income
(short-term vs. long-term).
By using a total-return approach, the portfolio may be able to
have a greater amount invested in common stocks which will
generate higher returns.
Spending rate should be established (approximately 5%) and be
viewed as a portion of the total return. The specific spending
rate will depend on the mix of assets and the realized rate of
inflation. The return objective must take into consideration the
types of assets selected, the inflation rate, and the spending
rate. When setting the long-term spending rate and adjusting
total return for inflation, this combined objective must be less
than the actual rates of return.
Risk tolerances will depend on the funds objectives. Where
maximum income is the objective, purchasing power risk must be
tolerated as there will probably be a large investment in bonds
and other fixed assets. Where maximum growth is the objective,
market risk must be tolerated as there will be substantial equity
and real estate exposure.
Ambachtsheer, Maginn & Vawter, pp. 4-26 - 4-36
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