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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).
- 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: When a manager is responsible for the portfolios of
pension plans or trusts, the duty of loyalty is owed to the
________.
a) none of these answers
b) board of directors
c) stockholders of the firm
d) manager's supervisor(s)
e) corporation
f) beneficiaries
g) investing public
h) entity who hires the manager
Question 2: The modern view of the Phillips curve suggests that
a) there will be a trade-off between inflation and unemployment
with both rational and adaptive expectations.
b) when inflation is steady, actual unemployment will equal the
natural unemployment.
c) systematic demand stimulus policies will be unable to affect
prices in the long run.
d) when inflation is less than anticipated, unemployment will
fall below the natural rate.
Question 3: An increase in the tariff on foreign-produced
automobiles would most likely harm ________.
a) steel producers, who supply steel to the domestic automobile
industry
b) the domestic consumers of automobiles
c) workers in the automobile industry
d) the producers of automobiles
Question 4: Which of the following events is likely to encourage
a corporation to increase its debt ratio?
a) An increase in the corporate tax rate.
b) Increased uncertainty about the level of sales and output
prices.
c) An increase in the expected cost of bankruptcy.
d) An increase in the company's degree of operating leverage.
e) An increase in the personal tax rate.
Answer 1: f
Rationale & Reference:
The first step in fulfilling a fiduciary duty is to determine
what the responsibility is and to who it is owed. Members should
take particular care in determining the identity of the 'client'
to whom the duty of loyalty is owed. In the context of an
investment manger managing the portfolios of pension plans or
trusts, the client is not the person or entity who hires the
manager but, rather, the beneficiaries of the plan or trust. The
duty of loyalty is owed to the beneficiaries.
Standards Handbook, pp. 83-84
Answer 2: b
Rationale & Reference:
If inflation is relatively constant over time, people come to
anticipate that rate. As a result, this rate is reflected in both
long-term contracts and the job search of workers. Once this
happens, unemployment returns to its natural rate.
Gwartney & Stroup, pp. 372-373
Answer 3: b
Rationale & Reference:
A tariff is a tax on foreign imports. Imposing a tariff on
foreign produced automobiles involving raising the price that
consumers pay for the automobile. The result will be that
domestic consumers will pay more for an equivalent foreign
automobile. Tariffs benefit the domestic producers and the
government at the expense of consumers. Domestic producers do not
pay the tariff but benefit from the higher market price. Thus the
tariff is a subsidy to domestic producers.
Gwartney & Stroup, p. 857
Answer 4: a
Rationale & Reference:
A major reason for using debt is that interest is deductible,
which lowers the effective cost of debt. An increase in the
corporate tax rate will increase the tax savings from using debt.
An interest increase in the personal tax rate will make interest
income less attractive. An increase in operating leverage,
bankruptcy costs, and uncertainty about sales and output prices
will encourage the firm to decrease financial leverage.
Brigham & Houston, p. 492
*** Level II
Question: Learning Outcome Statement:
Analyze the basic types of competitive advantage that a company
can possess and the generic strategies for achieving a
competitive advantage.
Answer:
There are two basic types of competitive advantage:
1. Cost leadership: whereby a firm offers lower prices for the
same product benefits
2. Differentiation: whereby buyers are willing to pay more for
special benefits that a firm offers
The three generic strategies are:
1. Cost leadership: In a cost leadership strategy a company seeks
to provide its products to all customers at lower production
cost, that is, the firm sets out to be the low-cost producer in
its industry. If a firm can achieve and sustain overall cost
leadership, then it will be an above-average performer in its
industry provided it can command prices at or near the industry
average. Yet if buyers do not perceive its product as comparable
or acceptable, a cost leader will be forced to discount prices
well below competitors' to gain sales.
The cost leader must either match its competitors' prices and
product offering or implement a price discount that would not
consume the additional profit margin obtained through cost
leadership. Only one industry player may pursue a cost leadership
strategy, otherwise price wars will diminish the competitive
advantage.
2. Differentiation: In a differentiation strategy, a firm seeks
to be unique in its industry along some dimensions that are
widely valued by buyers. It selects one or more attributes that
many buyers in an industry perceive as important and positions
itself to meet those needs in a unique manner. It charges a
premium price for this uniqueness. A firm that can attain
differentiation will be an above-average performer in its
industry if its price premium exceeds the extra costs incurred in
being unique. In choosing a differentiation strategy the company
strives for cost parity or proximity by reducing costs in areas
unrelated to the differentiation effort but charges a premium
price above the cost of differentiating.
3. Focus: In a focus strategy, a firm selects a segment or group
of segments in the industry and tailors its strategy to serving
them to the exclusion of others. The focuser seeks to achieve a
competitive advantage in its target segments even though it does
not have a competitive advantage overall.
These strategies can be either cost leadership or
differentiation, but must be applied to a singular market segment
or group of segments. A company adhering to a focus strategy
should serve limited industry segments because other firms may
not be minimizing costs in each segment or satisfying each
segment's specific needs. A focuser takes advantage of
suboptimization in either direction by broadly-targeted
competitors. In general, the company that does not actively
pursue a single strategy can only be profitable with great luck,
and gradually loses out to more goal-oriented competitors.
The focus strategy has two variants:
A. In cost focus, a firm seeks a cost advantage in its target
segment. Cost focus exploits difference in cost behavior in some
segments.
B. In differentiation focus, a firm seeks differentiation in its
target segment. Differentiation focus exploits the special needs
of buyers in certain segments.
Both variants rest on differences between a focuser's target
segments and other segments in the industry.
Porter, pp. 12-16
*** Level III
Question: Learning Outcome Statement:
Construct a step-by-step process for the management of a
fixed-income investment portfolio.
Answer:
The process involves:
1. Setting Investment Objectives
Objectives will vary by type of financial institution. Investment
objectives are dictated essentially by the nature of their
liability - obligations to pension recipients, policyholders, and
depositors.
The investment objective of a pension fund is to generate
sufficient cash flow from investments to satisfy pension
obligations; for life insurance companies, it is to satisfy
obligations stipulated in insurance policies and generate
profits.
2. Establishing Investment Policy
Establishing policy guidelines for meeting the investment
objectives. This begins with the asset allocation decision (e.g.
cash equivalents, equities, fixed-income securities, real estate,
and foreign securities).
Client and regulatory constraints are considered in establishing
investment policy (e.g. tax and cash flow considerations).
3. Selecting the Portfolio Strategy
a. Active
Essential to all active strategies is specification of
expectations about earnings, dividends, P/E ratios, interest
rates and exchange rates.
b. Passive
This approach requires minimal expectational input and seeks to
replicate the performance of a predetermined index.
c. Strategy Mix
Enhanced indexing (indexing plus) - a portfolio which is
primarily indexed but employs a low risk active management
strategy to enhance the indexed portfolio's return.
4. Structure Portfolio Strategies
Design of a portfolio to achieve the performance of some
predetermined benchmark. Frequently followed when funding
liabilities.
Immunization - raising of sufficient funds to fund a single
liability, regardless of the course of interest rates.
5. Cash Flow Matching Strategies
Horizon matching strategies
Contingent immunization strategy - allows the portfolio manager
to manage actively until certain parameters are violated - then
the portfolio is immunized.
Selecting a strategy - This depends on:
a. the investor's perception of the pricing efficiency of the
market
b. the nature of the liabilities
When a market is price-efficient, active strategies will not
consistently produce superior returns after adjusting for risk
and transaction costs. In this instance, indexing is the strategy
of choice.
An index may not provide a return that is sufficient to satisfy
the fund's obligations. For pension funds and life insurance
companies, structured portfolio strategies may be more
appropriate to achieve investment objectives.
6. Selecting Assets
This requires an evaluation of individual securities. In this
step, the investment manager attempts to construct an optimal or
efficient portfolio (e.g. the lowest risk for a given return).
7. Measuring and Evaluating Performance
This step involves measuring the performance of the portfolio
then evaluating that performance relative to some benchmark.
While the performance of a money manager according to some
benchmark may seem superior, this does not necessarily mean that
the portfolio satisfies its investment objective.
Performance measurement also evaluates achievement of investment
objectives.
Fabozzi, pp. 386-389
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