Preparing for the CFA Level 1 exam? You’re in the right place! This blog post offers a comprehensive set of practice problems crafted to mirror the complexity and scope of the CFA Level 1 exam. These problems are designed to sharpen your knowledge of key financial concepts and give you a realistic feel for the exam.
Whether you’re just beginning your preparation journey or are in the final stages of review, these questions will be an invaluable tool in your study arsenal. Let’s dive in and get you ready to ace the CFA Level 1!
Practice Questions and Expert Guidance by Quintedge
Practice questions, like the ones in this quiz, are essential for your CFA Level 1 preparation. At Quintedge, we offer a vast collection of practice questions, mock exams, and in-depth explanations tailored specifically to the CFA Level 1 curriculum.
In addition to questions, we provide:
- Detailed Explanations: Understand the reasoning behind each answer with our expert-led explanations.
- Mock Exams: Simulate the real exam experience with timed mock tests designed to reflect the CFA exam’s difficulty.
- Comprehensive Study Resources: Beyond practice, access complete study materials that cover every topic in the CFA Level 1 syllabus.
Quintedge is your one-stop solution for CFA Level 1 preparation, offering everything you need to succeed, from practice questions to expert guidance.
How to Use This CFA Level 1 Practice Questions Quiz
To make the most out of this quiz, follow these guidelines:
- Read Each Question Carefully: Each question is designed to test specific knowledge areas relevant to the CFA Level 1 curriculum. Take your time to understand what each question is asking.
- Answer All Options: Before looking at the correct answers and explanations, attempt to answer each question. This will give you a clear idea of your current knowledge and areas that need improvement.
- Check the Correct Answers and Explanations: After you answer the questions, review the correct answers and detailed explanations provided. This will help you understand the reasoning behind each answer and correct any misconceptions.
- Repeat Regularly: Revisit these questions multiple times throughout your study period. Repetition will help reinforce your learning and improve your recall during the exam.
- Track Your Progress: Keep a record of your scores each time you take the quiz. This tracking will help you see your progress over time and identify areas where further review is needed.
CFA Level 1 Practice Questions Quiz
1.
Question: Which of the following actions is most likely a violation of the CFA Institute Code of Ethics?
- A) A portfolio manager makes an investment recommendation that benefits his own personal portfolio.
- B) A portfolio manager informs clients about a change in investment strategy.
- C) A portfolio manager discloses the potential risks associated with an investment to clients.
- D) A portfolio manager accurately reports the performance of his portfolio.
Answer: A) A portfolio manager makes an investment recommendation that benefits his own personal portfolio.
Explanation: The CFA Institute Code of Ethics requires members to prioritize client interests above their own. Making an investment recommendation that benefits the manager’s personal portfolio is a violation of this ethical standard.
2.
Question: If a stock’s return is normally distributed with a mean of 12% and a standard deviation of 20%, what is the probability that the stock will have a return greater than 32%?
- A) 2.5%
- B) 5%
- C) 16%
- D) 68%
Answer: A) 2.5%
Explanation: For a normally distributed return, 32% is one standard deviation above the mean (12% + 20%). The probability of returns greater than this is the upper tail of the distribution, which is 2.5%.
3.
Question: What effect does a decrease in the central bank’s policy interest rate most likely have on the economy?
- A) Increase in inflationary pressure
- B) Decrease in consumer spending
- C) Appreciation of the domestic currency
- D) Decrease in aggregate demand
Answer: A) Increase in inflationary pressure
Explanation: A lower policy interest rate reduces borrowing costs, which boosts spending and investment. This can lead to inflationary pressures as demand rises faster than supply.
4.
Question: Which of the following is most likely classified as an investing activity in the cash flow statement?
- A) Purchase of machinery
- B) Payment of dividends
- C) Issuance of bonds
- D) Sale of finished goods
Answer: A) Purchase of machinery
Explanation: Investing activities include cash outflows for long-term assets such as machinery. Dividends, bond issuance, and sales of goods are related to financing and operating activities.
5.
Question: If a company’s WACC is 10% and its return on equity is 15%, what is most likely the effect on the company’s market value if the company increases its debt level?
- A) Market value will decrease
- B) Market value will increase
- C) Market value will remain unchanged
- D) Market value will fluctuate without a clear pattern
Answer: B) Market value will increase
Explanation: If the return on equity exceeds the WACC, increasing debt can lead to higher returns on equity due to leverage, which tends to increase the company’s market value.
6.
Question: A stock is expected to pay a dividend of INR 5 per share next year and has a dividend growth rate of 4%. If the required rate of return is 10%, what is the stock’s intrinsic value according to the Gordon Growth Model?
- A) INR 50
- B) INR 83.33
- C) INR 100
- D) INR 150
Answer: B) INR 83.33
Explanation:
Explanation: The Gordon Growth Model formula is:
P = D1 / (r – g)
Where:
- P is the intrinsic value of the stock
- D1 is the dividend expected next year (INR 5)
- r is the required rate of return (10%)
- g is the dividend growth rate (4%)
Substituting the values, we get:
P = 5 / (0.10 – 0.04)
P = 83.33
Thus, the intrinsic value of the stock is INR 83.33.
7.
Question: Which of the following bonds is most sensitive to interest rate changes?
- A) A 5-year bond with a 5% coupon
- B) A 10-year bond with a 5% coupon
- C) A 10-year zero-coupon bond
- D) A 5-year zero-coupon bond
Answer: C) A 10-year zero-coupon bond
Explanation: Zero-coupon bonds do not pay periodic interest, making them more sensitive to interest rate changes than coupon bonds. Longer maturity bonds are more sensitive to rate changes than shorter ones.
8.
Question: If the current price of a stock is INR 100, the strike price of a call option is INR 110, and the option premium is INR 5, what is the intrinsic value of the call option?
- A) INR 0
- B) INR 5
- C) INR 10
- D) INR 15
Answer: A) INR 0
Explanation: The intrinsic value of a call option is the maximum of zero or the difference between the stock price and the strike price. In this case, the stock price is less than the strike price, so the intrinsic value is zero.
9.
Question: Which of the following is most likely to be a characteristic of a private equity investment?
- A) High liquidity
- B) Long investment horizon
- C) Low risk
- D) Frequent cash flows
Answer: B) Long investment horizon
Explanation: Private equity investments typically involve long-term commitments, with the capital locked in for several years. This long-term nature is a key characteristic.
10.
Question: According to the Capital Asset Pricing Model (CAPM), if the risk-free rate is 3%, the expected market return is 8%, and the beta of a stock is 1.5, what is the expected return of the stock?
- A) 7.5%
- B) 10.5%
- C) 12%
- D) 15%
Answer: B) 10.5%
Explanation:
Explanation: The CAPM formula is:
E(Ri) = Rf + βi (E(Rm) – Rf)
Where:
- E(Ri) is the expected return of the stock.
- Rf is the risk-free rate, which is 3%.
- βi is the stock’s beta, which is 1.5.
- E(Rm) is the expected market return, which is 8%.
Substituting the values into the formula:
E(Ri) = 3% + 1.5 × (8% – 3%)
E(Ri) = 3% + 7.5% = 10.5%
Therefore, the expected return of the stock is 10.5%.
11.
Question: The cost of equity using the Dividend Discount Model (DDM) is calculated by which of the following formulas?
- A) (D1 / P0) + g
- B) (P0 / D1) + g
- C) D1 / P0
- D) D0 / P1
Answer: A) (D1 / P0) + g
Explanation: The DDM formula calculates the cost of equity as the dividend yield (D1 / P0) plus the growth rate (g).
12.
Question: A company has an inventory turnover ratio of 5. What is the average number of days inventory is held?
- A) 73 days
- B) 60 days
- C) 90 days
- D) 365 days
Answer: A) 73 days
Explanation: The formula for the average number of days inventory is held is 365/inventory turnover. Substituting the value, 365/5 = 73.
13.
Question: A bond is trading at a discount when its:
- A) Coupon rate is less than its yield to maturity.
- B) Coupon rate is equal to its yield to maturity.
- C) Coupon rate is greater than its yield to maturity.
- D) Current yield is less than its coupon rate.
Answer: A) Coupon rate is less than its yield to maturity.
Explanation: A bond trades at a discount when the coupon rate is less than the yield to maturity because the market requires a higher return than the bond is currently offering in coupon payments.
14.
Question: If a stock has a beta of 1.2, what can be inferred about its volatility relative to the market?
- A) The stock is 20% less volatile than the market.
- B) The stock is 20% more volatile than the market.
- C) The stock has the same volatility as the market.
- D) The stock is uncorrelated with the market.
Answer: B) The stock is 20% more volatile than the market.
Explanation: A beta of 1.2 indicates the stock is 20% more volatile than the market. A beta of 1 would imply the same volatility as the market.
15.
Question: Which of the following is true regarding systematic risk?
- A) It can be eliminated through diversification.
- B) It affects only a specific company or sector.
- C) It cannot be diversified away and affects the entire market.
- D) It is the same as company-specific risk.
Answer: C) It cannot be diversified away and affects the entire market.
Explanation: Systematic risk affects the entire market and cannot be eliminated through diversification. It differs from company-specific risk, which can be diversified away.
16.
Question: The term “yield to maturity” on a bond refers to:
- A) The annual coupon payment divided by the bond’s market price.
- B) The interest rate required in the market on a bond.
- C) The coupon rate divided by the bond’s par value.
- D) The bond’s market price divided by its face value.
Answer: B) The interest rate required in the market on a bond.
Explanation: Yield to maturity is the rate of return anticipated on a bond if it is held until maturity, reflecting the bond’s current market price, coupon payments, and time to maturity.
17.
Question: Which of the following is most likely to increase the intrinsic value of a call option?
- A) A decrease in volatility
- B) A decrease in the underlying stock price
- C) An increase in the underlying stock price
- D) A decrease in the time to expiration
Answer: C) An increase in the underlying stock price
Explanation: The intrinsic value of a call option increases as the underlying stock price rises because the option becomes more valuable.
18.
Question: When calculating Free Cash Flow to Equity (FCFE), which of the following is subtracted from net income?
- A) Net capital expenditures
- B) Depreciation
- C) Dividends paid
- D) Increase in inventory
Answer: A) Net capital expenditures
Explanation: FCFE is calculated as net income minus net capital expenditures, adjusted for changes in working capital and debt.
19.
Question: The risk-free rate is 2%, the market return is 10%, and the beta of a stock is 1.3. What is the expected return of the stock using the CAPM?
- A) 12.4%
- B) 10%
- C) 11.6%
- D) 13.6%
Answer: C) 11.6%
Explanation:
Explanation: The CAPM formula is:
E(Ri) = Rf + βi (E(Rm) – Rf)
Where:
- E(Ri) is the expected return of the stock.
- Rf is the risk-free rate, which is 2%.
- βi is the stock’s beta, which is 1.3.
- E(Rm) is the expected market return, which is 10%.
Substituting the values into the formula:
E(Ri) = 2% + 1.3 × (10% – 2%)
E(Ri) = 2% + 1.3 × 8% = 2% + 10.4% = 11.6%
Therefore, the expected return of the stock is 11.6%.
20.
Question: A forward contract is most likely:
- A) A standardized contract traded on an exchange.
- B) A customizable, private contract between two parties.
- C) Settled daily through a mark-to-market process.
- D) Traded on a secondary market before maturity.
Answer: B) A customizable, private contract between two parties.
Explanation: A forward contract is a private, customizable agreement between two parties, differing from futures, which are standardized and traded on exchanges.
Conclusion
You’ve tackled some of the core areas of the CFA Level 1 exam through these practice problems. We hope these examples have not only tested your knowledge but also reinforced your understanding of essential financial concepts. Continue to explore more resources and quizzes on our site to ensure you are as prepared as possible for your CFA journey. Remember, practice makes perfect—keep testing, keep learning!
