7 questions on Study sessions 15 - 18 and finance questions

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Joined: Fri Sep 14, 2012 4:40 pm

7 questions on Study sessions 15 - 18 and finance questions

Postby vinita1703 » Thu Sep 27, 2012 9:45 pm


. A real estate investment has the following characteristics:

Annual rental income $1,800,000
Annual operating expenses $1,200,000
Available mortgage rate 6%
Financing percentage 90%
Capitalization Rate 15%
Estimated holding period 5 years
Investor’s tax rate 25%

Based on the income approach, the value of the investment is closest to:

A. $4,000,000.
B. $5,455,000.
C. $6,133,000.

Answer: A

Using the income approach:
($1,800,000 – $1,200,000)/0.15 = $4,000,000.

This method takes into account the taxes generally why it is not done here ??

Question 2 :
8. An investor has gathered the following data, presented on an annual basis, for an apartment complex that is being considered for purchase:

Potential income (net of
vacancy and collection losses ) $180,000
Insurance and taxes $15,000
Utilities $10,000
Repairs and maintenance $18,000
Depreciation $21,000
Interest on proposed financing $16,000

The annual net operating income (NOI) for the apartment complex is closest to:

A. $116,000.
B. $121,000.
C. $137,000.

Answer: C
NOI = $180,000 - $15,000 - $10,000 - $18,000 = $137,000.

Why both deprecation and interests are not taken into account in cases as examples in books I have seen both things being included . ?? Please explain the basics ?

Question 3 :
9. Hedge funds that contain infrequently traded assets would most likely exhibit a downward bias with respect to:

A. measured risk but not correlations with conventional equity investments. B. correlations with conventional equity investments but not measured risk. C. both measured risk and correlations with conventional equity investments.

Answer: C

How is this established correlation point ??

Question 4 :
5. An investor purchases a 3-month put option on a stock with an exercise price of
$35. The risk free rate is 4.50%. At expiration, the stock price is $33.50. The
option’s payoff is closest to:

A. $0.
B. $1.48. C. $1.50.

Answer: C
The put option is worth the greater of $0 or (exercise price – spot price at expiration). Since the exercise price is greater than the spot price at expiration, the put is worth (35-33.50) = $1.50.

DOUBT " Why are we not using the formula here
S - X/(i +RFR)^t

Question 5 :
7. When the underlying stock price is $95, an investor pays $2 for a call option with an exercise price of $95. If the stock price moves to $96, the intrinsic value of the call option would be closest to:

A. -$1. B. $0. C. $1.

Answer: C

Does intrinsic value not take into account the option value is it ??

Question 6 :
10. An investor enters into a 1 X 3 forward rate agreement (FRA) at a LIBOR rate of
1.5 percent. At expiration, the 60-day LIBOR rate is 1.7 percent and the 90-day LIBOR rate is 1.6 percent. Assuming the contract covers a $1 million notional principal, what payment will the investor most likely receive?

A. $249.00
B. $332.39
C. $333.33

Answer: B

DOUBT : $1 million [(.017-.015)(60/360) = 333.33 why not c ... ???.... how do we know which is the flating and is the one to be used in the denomintor [/color][/b]

Question 7 :

2. The table below shows changes to the number of common shares outstanding for a company during 2009:

1 January 180,000 shares outstanding
1 June 60,000 shares issued
1 August 2 for 1 stock split
31 December 480,000 shares outstanding

To calculate earnings per share for 2009, the company’s weighted average
number of shares outstanding is closest to:

A. 215,000.
B. 420,000.
C. 430,000.

Answer: C
The weighted average number of shares outstanding is time weighted: 5/12 of the year there were 180,000 shares, and 7/12 of the year there were 240,000 (180,000+60,000) on a pre-split basis; the stock split is treated retroactively to the start of the year.
[(180,000 x 5/12) + (240,000 x 7/12)] x 2 = 430,000

Dounbt :
Is 31st dec counted ?
(180,000 * 12 + 60000 * 7 )* 2 + 480000 is not giving me the required result

question 8 :

6. Which of the following is a constraint as defined in the International Financial Reporting Standards (IFRS) Framework for the Preparation and Presentation of Financial Statements?

A. Neutrality
B. Timeliness
C. Going concern

Answer: B
Timeliness is a constraint in the IFRS Framework. Neutrality is a factor that contributes to reliability and going concern is an assumption of the Framework.

Is this correct?? I know only 2 contraints which are mentioned in book cost benefit analysis and intangible factors like loyalty which cant be captured

Question 9 :
11. A company reported net income of $400,000 for the year. At the end of the year, the company had an unrealized gain of $50,000 on its available-for-sale securities, an unrealized gain of $40,000 on held-to-maturity securities and an unrealized
loss of $100,000 on its portfolio of held-for-trading securities. The company’s
comprehensive income (in $) for the year is closest to:

A. 350,000.
B. 390,000.
C. 450,000.

Answer: C

Other Comprehensive Income will include unrealized gains or losses on available for sale securities. Net Income includes unrealized gains or losses in trading securities, while securities classified as held to maturity are maintained at historical cost and therefore the unrealized gains won’t impact comprehensive income.
OCI = $50,000; Comprehensive Income = NI + OCI = $400,000 +

why is trading security not included in net income ?


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Posts: 356
Joined: Wed Apr 11, 2012 11:26 am

Re: 7 questions on Study sessions 15 - 18 and finance questi

Postby content.pristine » Wed Oct 03, 2012 1:46 pm

1. We do need to take into consideration taxes paid for the property. In this case, it is included in the operating expense. Here, the investor’s marginal tax rate is additional unnecessary information here. You would need to know it for the Discounted After-Tax Cash Flow Approach, not the Income Approach.
2. Depreciation cost is not taken as there is an implicit assumption that the repairs and maintenance will allow the investor to keep the building in good condition forever in the Income Approach. Also, the Interest costs are not taken because the property value is to be valued independent of financing choices. This is another assumption of the Income Approach.
3. When dealing with infrequently traded securities, because their prices are not up-to-date, the estimates of fair price is taken, thus their volatility is reduced. This is known as the smoothing effect. Because of this, these assets might show high correlations with other assets, for example equities. But when this smoothing effect is removed, the correlations become much lower.
4. The formula max(S - X/(i +RFR)^t,0) is nothing but the lower bound of call option. Only use these formulas when they ask you for the upper or lower bounds or maximum or minimum price of options only.
5. The intrinsic value is nothing but the payoff of the option if it were to be executed on a particular day. It is the value the option is “In the Money”. In formula terms, the intrinsic value for a call option is =max(St-X,0) and of a put option, it is = max(X-St,0). Please notice, I use the term ‘t’where ‘St’is nothing but the price of the underlying today.
6. The denominator of the FRA equation is ALWAYS the floating rate.
7. You would not consider the December 31st entry since you would be multiplying by weight (the remaining time) which is 0. (12-12)
8. Please take a look at the example provided in your Curriculum, page 124.
9. The Net Income ALREADY would reflect the effect of loss on trading securities. Therefore, taking it again in calculations would be double counting it.
Hope this helps!

Finance Junkie
Posts: 356
Joined: Wed Apr 11, 2012 11:26 am

Re: 7 questions on Study sessions 15 - 18 and finance questi

Postby content.pristine » Wed Oct 03, 2012 3:44 pm

Hi Vinita,

From now on, if you have multiple questions, please post each question as a separate thread. This becomes easier for people with the same doubts as you to track the conversations.


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