CFA Level I practice questions and exam guide

An investment doubles in 9 years. Approximate annualized return using the Rule of 72?

1. 5.0%
2. 7.2%
3. 8.0%
4. 9.0%

Answer: C — 8.0%

A) Wrong divisor — 72/14.4 ~ 5. B) Uses 65/9 or dividing years by 9 — off. C) Correct — 72 / 9 = 8%. D) Confuses years with the rate itself.

For a normal distribution, approximately what percentage of observations fall within ±2 standard deviations of the mean?

1. 68 percent, the empirical-rule interval bounded by roughly ±1 standard deviation on either side
2. 50 percent, the interquartile range bounded by roughly ±0.67 standard deviations from center
3. 99.7 percent, the empirical-rule interval bounded by roughly ±3 standard deviations either side
4. 95 percent, the empirical-rule interval bounded by roughly ±2 standard deviations on each side

Answer: D — 95 percent, the empirical-rule interval bounded by roughly ±2 standard deviations on each side

A) That figure describes the ±1σ interval, not ±2σ. B) The 50% figure describes the interquartile range instead. C) That figure describes the ±3σ interval. D) Correct — the 68/95/99.7 empirical rule places 95.4% within ±2σ.

Algorithmic trading is best defined as trading that is characterized by which of the following operational features?

1. Executed by computer programs following predefined rules on timing, price, and quantity of orders sent to the market
2. Conducted exclusively in the cryptocurrency market rather than across traditional equity or fixed-income securities markets
3. Executed manually by human traders using chart-based technical analysis and discretionary judgment on individual order flow

Answer: A — Executed by computer programs following predefined rules on timing, price, and quantity of orders sent to the market

A) Correct — algorithmic trading is rule-based computer execution. B) Algorithmic trading spans all liquid markets. C) Manual chart-based trading is the opposite of algorithmic.

Demand-pull inflation MOST often results from:

1. Aggregate demand exceeding the productive capacity
2. A negative supply shock like oil price spikes
3. A sudden contraction in the aggregate money supply
4. A permanent rise in the labor productivity growth

Answer: A — Aggregate demand exceeding the productive capacity

A) Correct — AD above full-employment AS pulls prices upward. B) Describes cost-push, not demand-pull, inflation. C) Money contraction is disinflationary, not inflationary. D) Higher productivity typically eases price pressures.

The Mundell-Fleming framework suggests that a country with free capital mobility CANNOT simultaneously maintain:

1. A fixed exchange rate and stable price level
2. Independent monetary policy and balanced budget
3. A fixed exchange rate and independent monetary policy
4. Free capital mobility and open trade accounts overall

Answer: C — A fixed exchange rate and independent monetary policy

A) Stable prices are not part of the trilemma constraint. B) Balanced budgets belong to fiscal policy, not the trilemma. C) Correct — the impossible trinity forbids fixed FX, free capital, and independent policy together. D) Both are consistent components, not incompatible.

Nominal GDP grew 5% and the GDP deflator rose 3%. Real GDP growth was approximately:

1. 8% from adding nominal growth and inflation figures
2. 15% from multiplying nominal growth by inflation total
3. 2% from subtracting inflation from nominal growth
4. 1.5% from halving the difference between the two

Answer: C — 2% from subtracting inflation from nominal growth

A) Adding the two inflates real growth artificially. B) Multiplication of percentages has no economic meaning here. C) Correct — real growth ≈ nominal growth − inflation ≈ 5% − 3% = 2%. D) Halving has no economic basis in the deflator identity.

Working capital is:

1. The value of long-term operating assets
2. The same figure as net operating profit
3. The inventory balance on the books
4. Current assets minus current liabilities

Answer: D — Current assets minus current liabilities

A) Confuses long-term with short-term measures. B) Working capital is a balance-sheet figure, not profit. D) Correct — standard net working capital formula. C) Inventory is only one component, not the total.

A 'poison pill' is a corporate-governance device that:

1. Prevents management from selling personal shares
2. Requires shareholder approval for board appointments
3. Limits CEO compensation to peer-group averages
4. Lets shareholders buy discounted shares if threatened

Answer: D — Lets shareholders buy discounted shares if threatened

D) Correct — shareholder rights plans dilute hostile bidders crossing a threshold. B) Describes proxy access, not a poison pill. C) Say-on-pay and clawbacks address compensation. A) Insider-trading rules address executive share sales.

A firm's degree of operating leverage (DOL) measures sensitivity of:

1. Free cash flow to a change in tax rates
2. Net income to a change in interest expense
3. Stock price to a change in dividend policy
4. Operating income to a change in unit sales

Answer: D — Operating income to a change in unit sales

A) Tax sensitivity is not what DOL captures. B) That is degree of financial leverage (DFL). C) Stock-price sensitivity relates to beta and required return. D) Correct — DOL = %ΔEBIT / %ΔSales, driven by fixed operating costs.

Commercial mortgage-backed securities (CMBS) differ from residential MBS in that CMBS typically exhibit which of the following contractual and structural features?

1. Carry substantially higher prepayment risk than residential MBS across essentially all interest-rate environments and across all economic cycle conditions
2. Restrict prepayment through lockouts, defeasance requirements, prepayment penalties, and yield-maintenance provisions in the underlying loan documentation
3. Are unconditionally guaranteed by the U.S. federal government agency that supervises the commercial mortgage market for institutional investors and issuers

Answer: B — Restrict prepayment through lockouts, defeasance requirements, prepayment penalties, and yield-maintenance provisions in the underlying loan documentation

A) Residential MBS carries more prepayment risk than CMBS. B) Correct — CMBS contractually reduces prepayment optionality. C) CMBS is not federally guaranteed.

Under IFRS 16, a lessee's right-of-use asset is amortized over the:

1. Useful life of the underlying asset
2. Lease term including all renewal options
3. Shorter of lease term or asset useful life
4. Longer of lease term or asset useful life

Answer: C — Shorter of lease term or asset useful life

A) Ignores lease-term limit. B) Includes uncommitted renewal options. C) Correct — IFRS 16 uses the shorter of the two periods. D) Reverses the correct rule.

Return on equity (ROE) under DuPont decomposition equals:

1. Net income divided by total liabilities
2. Net income divided by dividends paid
3. Net income divided by shareholders' equity
4. Profit margin times turnover times leverage

Answer: D — Profit margin times turnover times leverage

A) Wrong denominator entirely. B) Not a standard ratio. C) Correct as simple ROE, but not the DuPont decomposition. D) Correct — three-factor DuPont identity.

Private equity investments are MOST likely characterized by:

1. Daily liquidity, transparent pricing, and low fee levels
2. Continuous mark-to-market with minimal fund-level fees
3. Passive index tracking of broad public equity benchmarks
4. Long lockups, J-curve returns, and use of fund leverage

Answer: D — Long lockups, J-curve returns, and use of fund leverage

A) Public equities, not PE, have daily liquidity and low fees. B) Illiquid holdings are valued periodically, not continuously. D) Correct — PE features illiquidity, J-curve, leverage, and 2/20 fee economics. C) Passive index tracking is a public-market strategy.

A firm with sustainable ROE of 15% and a retention ratio of 60% has a sustainable growth rate of:

1. 6% sustainable growth rate per year
2. 15% sustainable growth rate per year
3. 9% sustainable growth rate per year
4. 25% sustainable growth rate per year

Answer: C — 9% sustainable growth rate per year

A) Uses ROE × payout instead of ROE × retention. B) Uses ROE alone with no retention adjustment. C) Correct — g = ROE × b = 0.15 × 0.60 = 9%. D) Uses ROE/retention ratio incorrectly.

A yield curve that slopes downward (long-term yields below short-term) is BEST associated with:

1. Rising future short rates and strong economic expansion ahead
2. An immediate cut announced in the central-bank policy rate
3. Falling future short rates preceding an economic slowdown
4. Stable future short rates with steady price-growth expectations

Answer: C — Falling future short rates preceding an economic slowdown

A) Describes a normal upward-sloping curve. B) Describes concurrent policy action, not curve shape. C) Correct — inverted curves signal expected rate cuts and often precede recessions. D) Flat, not inverted, curves imply stability.

A bond's credit spread reflects compensation for:

1. The prevailing real risk-free rate of return
2. Currency-conversion risk on foreign-denominated debt
3. Expected inflation over the bond's remaining life
4. Default risk, loss given default, and risk premium

Answer: D — Default risk, loss given default, and risk premium

A) The risk-free rate is the benchmark subtracted, not the spread. B) Currency risk applies to FX-denominated bonds, distinct from credit spread. C) Inflation is embedded in the benchmark rate, not the spread. D) Correct — credit spread compensates for default probability, LGD, liquidity, and risk premium.

A call option gives the holder the right, but not the obligation, to:

1. Sell an asset at the specified strike price
2. Exchange currencies at any prevailing spot rate
3. Buy an asset at the specified strike price
4. Receive a fixed dividend from the issuer directly

Answer: C — Buy an asset at the specified strike price

A) That describes a put option. B) That describes an FX spot transaction. C) Correct — call gives the right to buy at strike. D) Options don't carry dividend rights.

In a one-period binomial option model, the call is priced using:

1. Historical probability of the up-move occurring
2. The investor's subjective risk preferences
3. Risk-neutral probabilities and the risk-free rate
4. Weighted expected payoff at the required return

Answer: C — Risk-neutral probabilities and the risk-free rate

A) The real-world probability is not the pricing measure. B) Preferences vanish under no-arbitrage pricing. C) Correct — π = (R−d)/(u−d), discount at Rf. D) That is the discounted expected value under CAPM instead.

A private-equity fund's 'J-curve' return pattern reflects:

1. Early negative returns then later exit gains
2. Constant positive returns across the fund's life
3. Front-loaded distributions in the first two years
4. Steady negative returns until final wind-down

Answer: A — Early negative returns then later exit gains

A) Correct — fees and early markdowns depress NAV first. B) Constant returns are not the J-curve pattern. C) That inverts the actual timing of distributions. D) That would be an inverted or failed-fund pattern.

A commodity futures investor experiences 'contango' when:

1. Futures prices exceed spot, creating negative roll yield
2. Futures prices trade below spot, giving positive roll
3. Spot and futures prices coincide with no basis
4. Futures curve is flat because storage cost equals zero

Answer: A — Futures prices exceed spot, creating negative roll yield

A) Correct — an upward-sloping curve where futures > spot; rolling into more expensive contracts drags returns. B) The reverse pattern is backwardation, which produces positive roll yield. C) Zero basis is a coincidence, not the definition of contango. D) Flat curves reflect equal storage and convenience yield.

Sharpe ratio:

1. Portfolio return alone measured
2. Portfolio volatility alone measured
3. Total return without any adjustment
4. Excess return per unit of total risk

Answer: D — Excess return per unit of total risk

A) Ignores the risk denominator. B) Ignores the return numerator. C) Ignores both risk and Rf. D) Correct — (Rp − Rf) / sigma, higher is better.

Representativeness bias leads investors to make which of the following systematic errors when they judge probabilities of outcomes?

1. Judge probabilities by how closely a specific case matches a familiar stereotype, systematically neglecting the underlying base-rate information
2. Anchor on the first numerical piece of information they hear about a decision even when that number is clearly unrelated to the choice
3. Trade infrequently and hold long-term diversified positions consistent with a buy-and-hold indexing philosophy over long time horizons

Answer: A — Judge probabilities by how closely a specific case matches a familiar stereotype, systematically neglecting the underlying base-rate information

A) Correct — representativeness relies on stereotypes and neglects base rates. B) That describes anchoring bias. C) Infrequent trading is unrelated to representativeness.

A research analyst issues a 'Buy' recommendation on a stock. Her firm makes a market in the same security and earned investment-banking fees from the issuer last year. Under Standard VI(A), the published report must:

1. Include no additional disclosures whenever the individual analyst has conducted her research fully independently
2. Prominently disclose the market-making and banking relationships so that readers can assess any potential bias
3. Be withheld from publication whenever the firm has any market-making or investment-banking relationship at all

Answer: B — Prominently disclose the market-making and banking relationships so that readers can assess any potential bias

A) Independent judgment does not eliminate the firm-level conflict-disclosure duty. B) Correct — prominent disclosure allows a reasonable investor to weigh potential bias. C) VI(A) requires disclosure, not suppression.

A CFA candidate uses material non-public information about a planned merger to trade. This violates which Standard?

1. II(A) Material Non-public Information
2. III(B) Fair Dealing among clients
3. IV(A) Loyalty owed to Employer
4. VI(A) Disclosure of Conflicts of Interest

Answer: A — II(A) Material Non-public Information

A) Correct — II(A) prohibits trading on material non-public information. B) Concerns equitable client treatment, not insider trading. C) Governs duties to the employer, not MNPI. D) Concerns conflicts, not undisclosed MNPI.

What is Standard III(A) 'Loyalty, Prudence, and Care'?

Members must act for the benefit of clients and place client interests before employer or personal interests.

What are the three main financial statements?

Income Statement (profitability), Balance Sheet (financial position), Cash Flow Statement (cash inflows/outflows).

What is the degree of financial leverage (DFL)?

% Change in EPS / % Change in EBIT. Measures how sensitive EPS is to changes in operating income.

What is the bid-ask spread?

The difference between the highest price a buyer will pay (bid) and the lowest price a seller will accept (ask). A measure of liquidity — narrower is more liquid.

What is deferred revenue?

Cash received before earning it (a liability). As the service/product is delivered, deferred revenue is recognized as earned revenue.

Under IFRS, how is goodwill tested?

Tested for impairment annually or when events indicate impairment. Compare carrying amount of cash-generating unit to recoverable amount. Not amortized.