BFC3241 Final Exam, S1 2022

Question 1
The average company in the healthcare sector has a P/E ratio of 38.84. Pfizer is expected to pay an
annual dividend per share of $1.20. Pfizer pays out 45% of its earnings as dividends. Based on the
given information, the intrinsic value of its stock is:
a) Not enough information to determine
b) $84.74
c) $103.57
d) $47.25

Question 2
Which of the following is NOT true about the multiples valuation approach:
a) It is based on the idea that similar assets should be traded at similar prices
b) It works best when comparing firms with similar revenue drivers
c) It assumes that the market accurately values a group of peer stocks
d) It allows identifying whether the stock is mispriced

Question 3
The most recent annual dividend of Z-Best Ltd. was $0.62 per share. The company is in the fast-
growing stage right now, and it grows by 100% each year. This growth is expected to last for the
following 2 years. After that, the company is expected to grow by 12% indefinitely. The WACC of Z-
Best Ltd. is 20%. What is the intrinsic value of the Z-Best Ltd. stock price?
a) $26.87
b) $7.75
c) $22.39
d) Not enough information to determine

Question 4
Pick the best option:
a) Both the Dividend Discount Model (DDM) and the Free Cash Flow to Equity (FCFE) model
estimate the intrinsic value of equity
b) The Free Cash Flow to Equity (FCFE) model cannot be used to estimate the entire value of the
firm that uses debt
c) The Free Cash Flow to Firm (FCFF) model can be used to estimate the entire value of the firm
that uses debt
d) All of the above statements are correct.

Question 5
Virtu Financial Inc. reported an EBIT of $1,112 million in 2021. The effective tax rate of Virtu is
35%. The estimated market value of debt is $4,784 million. The firm is supposed to maintain a long-
term growth rate of 5.2% and continue reinvestment 30% of its earnings. The WACC of Virtu is
6.85%. There are 1,100 million outstanding shares. What is the fair value of a Virtu share?
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a) $24.98
b) $29.33
c) $27.88
d) $23.53

Question 6
Which of the following statements about sell-side analysts is correct?
a) They research information only on those stocks that are good candidates for being sold from
the portfolios of their clients
b) They make recommendations on investments for the investment funds they work for
c) Most of them make correct recommendations
d) They tend to avoid issuing “sell” recommendations to keep a good relationship with the
management of the companies they make recommendations on

Question 7
Which type of equity research analysis do Porter’s Five Forces deal with?
a) Industry analysis
b) Macroeconomic analysis
c) Business cycle analysis
d) None of the above

Question 8
Which of the following is NOT a typical part of an equity research report?
a) Description of the company, its products, and services
b) A description of the company’s management political connection
c) A forecast of the company’s future financial performance
d) A recommendation to buy, sell or hold a stock

Question 9
Since _________ industries perform better during economic expansions, equity research analysts
usually focus on companies from these industries —for example, ____________ industries—when the
economy is booming.
a) cyclical… mining and airline
b) defensive… mining and airline
c) cyclical… fast-moving consumer goods and utilities
d) defensive… fast-moving consumer goods and utilities

Question 10
Macroeconomic analysis performed by equity research analysts can help them to:
a) Narrow down the subset of stocks for potential equity research consideration
b) Understand the growth opportunities of companies that they research better
c) Estimate the required rate of return on companies that they research
d) All of the above


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Question 11
Which of the following statements about the Grossman-Stiglitz paradox is correct?
a) if information collection is costly, security analysis would be redundant
b) if information collection is costly, security analysis would be a valuable service
c) even if information collection is costly, markets can still be fully informationally efficient
d) None of the above

Question 12
Which of the following is a violation of the semi-strong form of market efficiency?
a) ABC Inc. has announced decreased year-over-year earnings, yet its stock price has increased
following that announcement
b) ABC Inc. stock price return follows a random walk
c) John Dow made money in ABC Inc. based on his private information analysis
d) None of the above

Question 13
The cumulative abnormal stock return pattern of XYZ Ltd. around its positive corporate news
announcement looks as follows. Before the announcement, it stays around 0%; on the announcement
day, it increases to 10%; and on the days following the announcement, this return decreases to 5%.
This cumulative abnormal return pattern indicates:
a) overreaction of market participants to the news
b) underreaction of market participants to the news
c) correct reaction of market participants to the news
d) None of the above

Question 14
Which of the following explanations for return anomaly persistence is consistent with the efficient
market hypothesis?
a) Return anomalies represent compensation for undiversifiable risks not captured by the CAPM
b) Return anomalies appear in the data by chance and disappear once replicated for other periods
c) Return anomalies are a result of data mining and disappear once replicated for other periods
d) All of the above

Question 15
In an asset pricing model, a beta reflects:
a) the exposure of the stock to the specific source of undiversifiable risk
b) the exposure of the stock to the specific source of idiosyncratic risk
c) the sensitivity of the stock price return to the firm-specific shocks
d) All of the above

Question 16
Which of the following is NOT an example of limits to arbitrage for arbitrageur D?
e) Limited capital available to arbitrageur D to be able to correct the observed mispricing
f) Trading costs
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g) Shot-selling costs
h) Systematic risk

Question 17
Which of the following behaviors is an example of an information processing mistake?
a) Splitting your investment account into two sub-accounts—one for bonds and one for stocks—
so that all trading decisions are made separately within each account
b) Buying a “hot” stock that has been featured a lot on Twitter
c) Overweighting information from more recent events to make an investment decision
d) Holding on to your losing investment position instead of selling it

Question 18
Regret avoidance attributable to many market participants may prompt them to avoid investing in
less-known small stocks and invest in well-known large stocks instead. Such a behavior coupled
with limits to arbitrage can lead to the following return anomaly pattern.
a) Small stocks consistently outperform large stocks on a risk-adjusted basis
b) Small stocks consistently underperform large stocks on a risk-adjusted basis
c) Large stocks consistently outperform small stocks on a risk-adjusted basis
d) None of the above

Question 19
Which of the following behaviors can contribute to the post-earnings announcement drift?
a) Investors who bought stocks before upcoming positive earnings announcements tend to sell
their winning positions prematurely
b) Investors tend to underreact to earnings surprises initially because they are slow to update their
prior beliefs
c) Investors who bought stocks before upcoming negative earnings announcements tend to hold
on to their losing positions
d) All of the above

Question 20
Ms.Y has to choose between (i) a sure gain of $200 and (ii) the game of rolling a 6-sided dice with
the following payoff structure:
The number on a dice 1 2 3 4 5 6
Payoff +$75 +$125 +$175 +$225 +$275 +$325
If Ms.Y is behaving according to the Prospect Theory, which choice would he make?
a) She would choose (i)
b) She would choose (ii)
c) She is indifferent between (i) and (ii)
d) Not enough information to determine

Question 21
Which of the following statements about active and passive funds is correct?
a) Both active and passive funds are indirect investment vehicles
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b) Both active and passive funds charge management fees
c) Both active and passive funds are professionally managed by fund managers
d) All of the above

Question 22
You are an authorized market participant of the QQQ ETF (Nasdaq 100 ETF). The current best
bid and ask prices of QQQ are $318.82 and $319.12, respectively. You can buy one basket of
securities underlying one QQQ for $318.80 and sell this basket for $318.70. Based on this
information, you have decided to conduct an arbitrage using market orders. What is the maximum
profit you can make for a trading block of 200,000 QQQ ETF shares, assuming that you can buy
and sell this amount at the best bid and ask prices?
a) $800
b) $4,000
c) $400
d) $8,000

Question 23
Vanguard DAX 30 Mutual Fund seeks to track the return of the DAX 30 Index, the index
consisting of the 30 major German blue-chip stocks. Vanguard DAX 30 Exchange Traded Fund
seeks to track the return of the same DAX 30 Index. Which of the following statements about the
above mutual fund and ETF is correct?
a) Both of these funds can be bought on the German stock exchange
b) The mutual fund is professionally managed, while the exchange traded fund is not
c) Both of these funds can be bought directly via Vanguard (the investment company)
d) None of the above

Question 24
Which of the following statements is correct?
a) Most open-end mutual funds are passive
b) Most closed-end mutual funds are passive
c) Major country stock market indexes can have several ETFs tracking their returns
d) Residential REITs comprise the largest proportion of the REIT market in Australia

Question 25
Pick the best option. Which of the following statements about ETF providers is correct?
a) They create ETF shares in exchange for securities underlying these shares supplied to them by
authorized market participants
b) They redeem ETF shares in exchange for securities underlying these shares supplied to them
by authorized market participants
c) Both a) and b) are correct
d) Neither a) nor b) is correct

Question 26
What is the NAV of the closed-end fund XYZ currently traded at $150.50 per share if it consists
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of stocks that are currently worth $130 million and bonds that are currently worth $18 million?
Assume that the fund has no liabilities and has 1 million outstanding shares.
a) $150.50
b) $130.00
c) $148.00
d) Not enough information to determine

Question 27
Which of the following investment styles usually has the lowest risk?
a) Small-Cap Blend
b) Mid-Cap Growth
c) Small-Cap Value
d) Large-Cap Value

Question 28
Which of the following hedge fund strategies has the lowest exposure to systematic risks?
a) Global macro
b) Emerging markets
c) Convertible arbitrage
d) Long-short equity hedge

Question 29
Which of the following statements is correct?
a) Active mutual funds typically charge higher incentive fees compared to hedge funds
b) Funds with the highest Active Share outperform their benchmarks
c) Active share measures the standard deviation of the fund’s returns relative to the benchmark
d) The activeness of mutual funds as measured by Active Share has been stable in the past three
decades

Question 30
The hedge fund’s AUM is $200 million. The fund has a typical “two and twenty” fee structure.
The fund’s benchmark, Barclays Hedge Fund Index, showed a return of 15.5% for 2021, while the
hedge fund itself was able to generate a return of 29.5% during the same period. How much fees
does an investor in this hedge fund pay for the year 2021?
a) 2.00%
b) 2.20%
c) 4.80%
d) 7.90%

Question 31
Portfolio A has an annual return of 25% with a standard deviation of 38.5%. Its market beta is 2.1.
The annual return on the T-bill is 0.35%, and the annual return on the market index is 8.55%. What
is the Treynor ratio of Portfolio A?
a) 0.46
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b) 0.12
c) 0.14
d) 0.64

Question 32
Which of the following statements is correct?
a) A comparison of two investment funds is normally based on a comparison of their historical
returns
b) It does not matter whether investors use a Sharpe or a Treynor ratio for their investment
decisions since both approaches lead to the same conclusions
c) Taking into account the portfolio risk level when choosing between two alternative investment
portfolios is not a correct approach
d) None of the above

Question 33
In 2021, fund ABC generated a return of 29% with a standard deviation of 57%. During the same
period, the return of the market portfolio was 12%, with a standard deviation of 19%. What was
M2 in 2021 for fund ABC if its market beta for the same period was 2.5 and the risk-free rate was
5%?
a) 1.00%
b) -2.33%
c) 6.50%
d) 2.647%

Question 34
AussieBest mutual fund invests in Australian and International Equities. It reported the following
figures for the year 2020.
AussieBest return Weight in AussieBest Benchmark weight Benchmark return
(1) (2) (3) (4)
Australian Equity 12.5% 0.70 0.65 11.5%
International Equity 15.5% 0.25 0.30 16.0%
Cash -0.05% 0.05 0.05 -0.01%
What was the fund’s return over- or under-performance in that period?
a) –0.35%
b) +0.15%
c) –0.15%
d) +0.35%

Question 35
Which of the following statements about market timing is correct?
a) Market timing strategies provide little improvements to fund performance
b) If one expects the market to boom, they should buy low-beta stocks
c) If a fund manager can time the market, it would be reflected in their fund’s Sharpe ratio
d) None of the above

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Question 36
Future of Financial Advice Legislation requires all financial advisors to retail investors in Australia
to:
a) act in the best interests of their clients
b) renew their agreements on fees with the clients at least every two years
c) disclose fees they charge their clients on an annual basis
d) All of the above

Question 37
Which of the following statement about fiduciary duty in fund management is correct?
a) Fiduciary duty implies that a fund manager must act in the best interest of the fund’s existing
clients
b) Fiduciary duty implies that a fund manager must take professional advice from investment
advisors if necessary
c) Fiduciary duty implies that a fund manager must periodically review the performance of the
fund
d) All of the above

Question 38
During a round of golf, Smith, CFO of ABC Inc., mentions to Jones, a local investment adviser,
and long-time personal friend, that ABC Inc. is having an exceptional sales quarter. Smith expects
the results to be almost 10% above the current estimates. The next day, Jones initiates the purchase
of a large stake in the local exchange-traded retail fund for her personal account. Pick the best
option from below.
a) Jones violated the CFA Code of Ethics and Professional Standards by investing in the exchange
traded fund that included ABC Inc.
b) Jones did not violate the CFA Code of Ethics and Professional Standards because she did not
invest directly in the securities of ABC Inc.
c) Smith did not violate the CFA Code of Ethics and Professional Standards because the comments
made to Jones were not intended to solicit an investment in ABC Inc.

Question 39
Ned Kelly, a portfolio manager for a local investment advisory firm, is planning to sell a portion
of his personal investment portfolio to cover the costs of his child’s academic tuition. Ned wants
to sell a portion of his holdings in XYZ Ltd., but his firm recently upgraded the stock to “strong
buy.” Which of the following describes Ned’s options under the CFA Code of Ethics and
Professional Standards?
a) Based on his firm’s “buy” recommendation, Ned cannot sell the shares because he would be
improperly prospering from the inflated recommendation.
b) Ned is free to sell his personal holdings once his firm is properly informed of his intentions
c) Ned can sell his personal holdings but only when a client of the firm

Question 40
Holden is a financial analyst with Robinhood Brokerage Firm. She is preparing a purchase
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recommendation on Wesfarmers. Which of the following situations is most likely to represent a
conflict of interest for Holden that would have to be disclosed?
a) Holden frequently purchases items produced by Wesfarmers
b) Robinhood holds for its own account a substantial common stock position in Wesfarmers
c) Holden’s sister-in-law is a supplier to Wesfarmers
d) b) and c)


Short-Answer Question (20 Marks)

There is a long-standing debate in finance about whether markets are efficient. Eugene Fama, the
laureate of the 2013 Nobel Memorial Prize in Economic Sciences, believes that they are. In
contrast, Robert Shiller, who got the Noble Prize jointly with Fama, does not think that markets
are efficient.
a) Describe the efficiency market hypothesis (10 marks)
b) Whom do you support in the market efficiency debate: Fama or Shiller? Provide arguments for
your position [if you are not sure whom you support, you can provide arguments both in favor
of the Fama’s and Shiller’s positions] (10 marks)


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SOLUTIONS

MCQs
1c, 2d, 3d, 4d, 5a, 6d, 7a, 8b, 9a, 10d, 11b, 12d, 13a, 14d, 15a, 16h, 17c, 18a, 19d, 20a, 21d, 22b,
23d, 24c, 25a, 26c, 27d, 28c, 29b, 30c, 31b, 32d, 33a, 34d, 35d, 36d, 37d, 38a, 39b, 40b.

Short-answer question
a) 2.5 marks for mentioning that the market efficiency hypothesis is about the reflection of the
information in prices, 2.5 marks for describing each form of market efficiency
b) Any reasonable argument – 5 marks.
Examples of reasonable arguments for Fama:
- Normally only a small proportion of stocks’ returns isn’t explained by an asset pricing
model
- Prices quickly reflect public info in event studies → semi-strong-form EMH holds
- If accounting for time-varying risks / limits to arbitrage / all inconsistencies with market
efficiency will likely disappear
- All inconsistencies with market efficiency will likely appear due to data mining
- All inconsistencies with market efficiency will likely disappear once market participants
are aware of them and start to trade on them
- If accounting for time-varying risks, all inconsistencies with market efficiency will likely
disappear
Examples of reasonable arguments for Shiller:
- Mentioning various types of anomalies as inconsistent with weak or semi-strong form EMH
- Mentioning results from event studies that indicate slow incorporation of public info into
prices
- Mentioning that inside info leakage doesn’t correct prices immediately → inconsistent with
strong-form EMH