CFA® Level 1 Question Bank

UWorld + Wiley CFA: The New Standard in CFA Prep
Build speed, accuracy, and real exam readiness with practice questions that mirror the CFA Level 1. Developed by charterholders and trusted by candidates worldwide, our QBank pairs expert rationales with power visuals and proven learning tools from UWorld and Wiley CFA.
The UWorld CFA Level 1 QBank

Make the CFA Level 1 Exam Feel Like Practice

Train with questions that mirror the real exam — created by CFA charterholders to match or exceed the exam’s difficulty and format.

Master Concepts Faster

Engage with every question using our active learning techniques — proven to boost retention and understanding.

Quiz Smarter, Not Harder

Build personalized quizzes by topic or subject or to target exactly where you need more practice.

Learn the “Why” Behind Every Answer

Detailed answer rationales help you think like a charterholder and build deep conceptual understanding.

Simulate Exam
Conditions

Practice with exam-like time constraints so you don’t run out of time on exam day.

Turn Weaknesses into Strengths

Identify knowledge gaps with real-time performance metrics so you can study exactly what you need.

Replicate the Exam Environment

Practice in a Prometric-like layout. Don’t wait until exam day to get comfortable with the interface.
Experience the UWorld Difference - Try CFA Level 1 Questions Now
See why thousands of candidates trust UWorld. Answer sample questions and experience real CFA Level 1 Exam conditions.
Explore Questions

Think Like a CFA Charterholder — Starting Now

Invest in your CFA Level 1 Exam prep today. Maximize your returns on exam day.
Understand absolute advantage and comparative advantage in the CFA Level 1 Exam
CFA Level 1 Sector rotation strategy
CFA Level 1 effective tax rate

Score Higher on Level 1 with UWorld’s Quality Learning Tools

Study with high-quality learning tools that help you learn faster, retain longer, and score higher.

Use Up-to-Date CFA QBank Aligned to the Exam

Access an extensive library of CFA Level 1 questions and in-depth answer explanations written by our in-house team of charterholders. Questions are routinely updated to reflect the current exam format and Learning Outcome Statements (LOS).

Use Up-to-Date CFA QBank Aligned to the Exam

UWorld's award winning CFA QBank interface.

Learn by Doing

UWorld CFA Qbank Create Test Interface

Learn by Doing

Our CFA QBank promotes active learning with unlimited practice tests featuring exam-level questions. Engage deeply with concepts, build stamina and confidence, and simulate real exam conditions — boosting your readiness and ensuring you know what to expect on test day.

Simplify Your Learning

Our exam prep simplifies the rigorous CFA Level 1 study process with in-depth, yet concise answer explanations and illustrations that boost comprehension and retention. By covering correct and incorrect answers, you gain a deep understanding of key concepts — reducing memorization and promoting real mastery.

Simplify Your Learning

UWorld CFA Qbank practice question explanation depicting active learning

Practice with Challenging Questions

UWorld CFA Level 1 practice question and explanation

Practice with Challenging Questions

Our in-house charterholders create questions at or above exam-level difficulty and include detailed explanations for correct and incorrect answers.

Make Data Work for You

Don’t waste time studying what you already know. Measure your progress with advanced performance analytics. Identify knowledge gaps in real time and focus your Level 1 studies accordingly.

Make Data Work for You

UWorld CFA Level 1 QBank Performance Report

Study Anytime, Anywhere

UWorld Level 1 CFA question on mobile

Study Anytime, Anywhere

Review QBank questions in a rideshare or take a practice test on your lunch break. Keep everything you need to pass the CFA Level 1 Exam in arms reach. Download our app today!
Apple App Store
Google Play store icon

Multiple Ways to Study, Multiple Ways to Save

Whether you’re searching for a complete CFA Level 1 course with unlimited access time or a supplement, we have you covered.

 
Step Up to a Full Course
Build Your Path to CFA Level 1 Success

QBank Only

 

$ 

Use code:
 
Buy Now

Core

 

$ 

Use code:
 
Buy Now

Advanced

 

$ 

Use code:
 
Buy Now

Elite

 

$ 

Use code:
 
Buy Now
QBank
Practice with questions written by finance experts to reflect the most current CFA Level 1 Exam in difficulty and format.
Mobile App Access
Take your CFA prep on the go with full access to all study materials via the UWorld Finance - Exam Prep mobile app.
Performance Tracking & Analytics
Monitor your progress, identify weak areas, and optimize your prep using detailed performance analytics.
MyNotebook
Save key content, take notes, and build a personalized digital study guide as you learn.
Study Guides (eBook)
Simplify the extensive content of CFA curriculum books with focused study notes, practical examples, and a range of questions covering each LOS.
Study Planner
Create a personalized study plan aligned to your test date and progress, helping you stay on track.
Expert-Led Video Lectures
Get additional context and depth with bite-sized review videos that hone in on learning outcome statements.
SimpleSheets+
Reference an outline of key formulas, definitions, and must-know concepts in a streamlined format for quick review.
Digital Flashcards
Create your own flashcards to reinforce key concepts, formulas, and definitions. Organize them by subject, topic, or custom tags. Study your personalized deck anytime, anywhere across devices.
ReadyDecks
Study with preloaded, expert-curated flashcards organized by subject, topic, or custom tag.
Mock Exam A
Simulate the actual exam with mock exams that mirror the format, timing, and difficulty of the CFA Level 1 Exam.
Mock Exam B
Simulate the actual exam with mock exams that mirror the format, timing, and difficulty of the CFA Level 1 Exam.
StudyPass (Access Until You Pass)
Request a free course extension if you don’t pass the CFA Exam on your first try, giving you more time to succeed.
Study Guides (Printed)
Get print copies of the CFA Level 1 study guide for offline review, complete with practical examples and key concept summaries.
Expert MasterClass
Master how you tackle CFA Exam questions with expert-led video sessions that sharpen strategy, close knowledge gaps, and keep you on track.
Accelerate Boot Camp
Turn practice into power with a 2-day, high-yield problem-solving experience designed to transform your prep and elevate your CFA Exam readiness.
ExpertConnect
Tackle your most challenging CFA questions live in real time Q&A sessions. Get direct answers from experts when it matters most.

QBank Only

Buy Now

Core

Buy Now

Advanced

Buy Now

Elite

Buy Now

Explore our free trial and product availability

7-Day Free Trial Product Availability
Build Your Path to CFA Level 1 Success

QBank Only

 

$ 

Use code:
 
Buy Now
QBank
Practice with questions written by finance experts to reflect the most current CFA Level 1 Exam in difficulty and format.
Mobile App Access
Take your CFA prep on the go with full access to all study materials via the UWorld Finance - Exam Prep mobile app.
Performance Tracking & Analytics
Monitor your progress, identify weak areas, and optimize your prep using detailed performance analytics.
MyNotebook
Save key content, take notes, and build a personalized digital study guide as you learn.

Step Up to a Full Course

Core

 

$ 

Use code:
 
Buy Now
See What’s Included
QBank
Practice with questions written by finance experts to reflect the most current CFA Level 1 Exam in difficulty and format.
Mobile App Access
Take your CFA prep on the go with full access to all study materials via the UWorld Finance - Exam Prep mobile app.
Performance Tracking & Analytics
Monitor your progress, identify weak areas, and optimize your prep using detailed performance analytics.
Study Guides (eBook)
Simplify the extensive content of CFA curriculum books with focused study notes, practical examples, and a range of questions covering each LOS.
MyNotebook
Save key content, take notes, and build a personalized digital study guide as you learn.

Step Up to a Full Course

Advanced

 

$ 

Use code:
 
Buy Now
See What’s Included
QBank
Practice with questions written by finance experts to reflect the most current CFA Level 1 Exam in difficulty and format.
Mobile App Access
Take your CFA prep on the go with full access to all study materials via the UWorld Finance - Exam Prep mobile app.
Performance Tracking & Analytics
Monitor your progress, identify weak areas, and optimize your prep using detailed performance analytics.
Study Guides (eBook)
Simplify the extensive content of CFA curriculum books with focused study notes, practical examples, and a range of questions covering each LOS.
MyNotebook
Save key content, take notes, and build a personalized digital study guide as you learn.
Study Planner
Create a personalized study plan aligned to your test date and progress, helping you stay on track.
Expert-Led Video Lectures
Get additional context and depth with bite-sized review videos that hone in on learning outcome statements.
SimpleSheets+
Reference an outline of key formulas, definitions, and must-know concepts in a streamlined format for quick review.
Digital Flashcards
Create your own flashcards to reinforce key concepts, formulas, and definitions. Organize them by subject, topic, or custom tags. Study your personalized deck anytime, anywhere across devices.
ReadyDecks
Study with preloaded, expert-curated flashcards organized by subject, topic, or custom tag.
Mock Exam A
Simulate the actual exam with mock exams that mirror the format, timing, and difficulty of the CFA Level 1 Exam.

Step Up to a Full Course

Elite

 

$ 

Use code:
 
Buy Now
See What’s Included
QBank
Practice with questions written by finance experts to reflect the most current CFA Level 1 Exam in difficulty and format.
Mobile App Access
Take your CFA prep on the go with full access to all study materials via the UWorld Finance - Exam Prep mobile app.
Performance Tracking & Analytics
Monitor your progress, identify weak areas, and optimize your prep using detailed performance analytics.
Study Guides (eBook)
Simplify the extensive content of CFA curriculum books with focused study notes, practical examples, and a range of questions covering each LOS.
MyNotebook
Save key content, take notes, and build a personalized digital study guide as you learn.
Study Planner
Create a personalized study plan aligned to your test date and progress, helping you stay on track.
Expert-Led Video Lectures
Get additional context and depth with bite-sized review videos that hone in on learning outcome statements.
SimpleSheets+
Reference an outline of key formulas, definitions, and must-know concepts in a streamlined format for quick review.
Digital Flashcards
Create your own flashcards to reinforce key concepts, formulas, and definitions. Organize them by subject, topic, or custom tags. Study your personalized deck anytime, anywhere across devices.
ReadyDecks
Study with preloaded, expert-curated flashcards organized by subject, topic, or custom tag.
Mock Exam A
Simulate the actual exam with mock exams that mirror the format, timing, and difficulty of the CFA Level 1 Exam.
Mock Exam A
Simulate the actual exam with mock exams that mirror the format, timing, and difficulty of the CFA Level 1 Exam.
Mock Exam B
Simulate the actual exam with mock exams that mirror the format, timing, and difficulty of the CFA Level 1 Exam.
StudyPass (Access Until You Pass)
Request a free course extension if you don’t pass the CFA Exam on your first try, giving you more time to succeed.
Study Guides (Printed)
Get print copies of the CFA Level 1 study guide for offline review, complete with practical examples and key concept summaries.
Expert MasterClass
Master how you tackle CFA Exam questions with expert-led video sessions that sharpen strategy, close knowledge gaps, and keep you on track.
Accelerate Boot Camp
Turn practice into power with a 2-day, high-yield problem-solving experience designed to transform your prep and elevate your CFA Exam readiness.
ExpertConnect
Tackle your most challenging CFA questions live in real time Q&A sessions. Get direct answers from experts when it matters most.

Explore our free trial and product availability.

7-Day Free Trial Product Availability

See What Our Students
Are Saying…

quotes

You can custom-make your own tests to target questions you have gotten wrong previously which is awesome. The simulated exam interface is also a super cool tool that I think will just be one less thing for me to worry about on exam day…"

— Travis FUWorld CFA Level I Student
quotes

Excellent explanation for each question. Application-based questions are very nuanced that further help strengthen the underlying topics. What I liked most, specifically about UWold’s QBank, is that unlike questions on other platforms which can be done as part of practice…"

— Het DUWorld CFA Level I Student
quotes

I have tried Kaplan, CFA Ecosystem and I can tell you that you are the best. Great difficult questions, but the most worthy thing is explanation after question that gives a comprehensive revision of everything related to the topic in the given question…"

— Aliaksei IUWorld CFA Level I Student
Read More Reviews

Hear From Our Past CFA Candidates

quotes

You can custom-make your own tests to target questions you have gotten wrong previously which is awesome. The simulated exam interface is also a super cool tool that I think will just be one less thing for me to worry about on exam day…"

— Travis FUWorld CFA Level I Student
quotes

Excellent explanation for each question. Application-based questions are very nuanced that further help strengthen the underlying topics. What I liked most, specifically about UWold’s QBank, is that unlike questions on other platforms which can be done as part of practice…"

— Het DUWorld CFA Level I Student
quotes

I have tried Kaplan, CFA Ecosystem and I can tell you that you are the best. Great difficult questions, but the most worthy thing is explanation after question that gives a comprehensive revision of everything related to the topic in the given question…"

— Aliaksei IUWorld CFA Level I Student
Read More Reviews

Frequently Asked Questions (FAQs)

Our in-house team of charterholders and subject matter experts craft the CFA Level 1 QBank questions and answer explanations.
According to feedback from our users, the UWorld CFA Level 1 practice questions closely resemble those in the actual CFA Exam, with many users feeling a sense of familiarity during the exam.
Our CFA Level 1 free trial offers access to over 100 practice questions, complete with detailed answer explanations, step-by-step problem-solving guides, and professionally designed illustrations.
As an officially approved prep provider by CFAI, we do not use or distribute past CFA Level 1 Exam questions. Instead, we ensure our practice questions authentically replicate the actual exam’s style, difficulty, format, and other key elements.
The UWorld practice questions for CFA Level 1 are developed by charterholders and finance experts, aiming to match or surpass the difficulty level of the actual CFA Exam.
Our CFA Level 1 QBank is comprehensive, covering all learning outcomes as per the CFA Institute’s guidelines. It includes exam-level questions with thorough answer explanations and is based on active-learning principles for effective study.
* UWorld CFA is a CFA® Institute Prep Provider. Only CFA Institute Prep Providers are permitted to use CFA Institute copyrighted materials, which are the building blocks of the exam. We are also required to update our materials every year, as validated by CFA Institute.
Scroll to Top

Preview the Quality for Yourself

Explore sample CFA Level 1 Exam questions with full answer explanations to see how we prepare you to pass with confidence.

Select a Question sample.

Select a Question sample.

Buy Now

According to the Modigliani-Miller propositions (with taxes), if a company increases its debt level, its market value will most likely:

  1. decrease since the costs of financial distress are increasing.
  2. remain the same since the market value is unaffected by the capital structure.
  3. increase proportionally to the change in debt.
Submit Next

Explanation:

A graphical tabular representation of Modigliani-Miller propositions

The Modigliani-Miller (MM) propositions assume perfect capital markets (ie, no arbitrage, no transaction or bankruptcy costs, and symmetric information) and assert that a company's market value equals the present value of its future cash flows. Modigliani and Miller propose that, in the absence of taxes:

  • A company's capital structure does not affect its value (MM I without taxes); and
  • A company's cost of equity (re) is directly proportional to its debt-to-equity ratio (D/E), but WACC remains constant (MM II without taxes).

However, these propositions change when there are corporate taxes:

  • The market value of a levered company is greater than the value of an unlevered but otherwise identical company; tax-exempt interest payments improve the levered company's cash flows, increasing its value. The difference in value is the amount of the debt tax shield (tD), which is the product of a company's tax rate (t) and value of debt (D) (MM I with taxes).
  • A company's re is directly proportional to D/E, adjusted by (1 − t). Greater leverage will increase the cost of equity, but at a slower pace due to taxes. The greater the tax rate (t), the slower the increase in re when D/E increases (MM II with taxes).

Therefore, with taxes, an increase in debt will proportionally increase a company's value and reduce its WACC.

(Choice A) The MM propositions assume no cost of financial distress.

(Choice B) The market value would remain the same in the absence of taxes.

Things to remember:
The Modigliani-Miller (MM) propositions assume perfect capital markets (ie, no arbitrage, no transaction or bankruptcy costs, and symmetric information). When these propositions include corporate taxes, greater leverage will increase a company's market value (MM I) and reduce its WACC (MM II).

If a professional organization has standards of conduct in addition to its code of ethics, the purpose of the standards is most likely to describe:

  1. shared principles.
  2. laws and regulations.
  3. acceptable behaviors.
Submit
Prev Next

Explanation:

Instruments for compliance with professional ethics
Instrument Owner Describes
Code of ethics Professional organization Shared principles
Standards of conduct Professional organization Minimally acceptable behavior
Laws and regulations Government Legal limits of behavior

A code of ethics is a professional organization's statement of shared principles. Standards of conduct provide a guide to practicing the principles outlined in the code of ethics. Standards of conduct also clarify the minimally acceptable behaviors required to conform to the code of ethics. Although not addressed directly in standards of conduct, adherence to civil laws and regulations may be the minimally acceptable behavior in some cases.

Standards of conduct may be principle-based or rule-based. Principle-based standards are universally applicable to members of the profession and are based on the principles outlined in the code of ethics. Rule-based standards, while also relating to the principles in the code of ethics, are usually more narrowly applicable and specific to certain members or scenarios that may arise.

A code of ethics may or may not be accompanied by standards of conduct whereas standards of conduct exist only to enhance their associated code of ethics. CFA Institute has adopted both a code of ethics and standards of conduct (the "Code and Standards"); CFA charterholders and candidates are expected to know and comply with both.

(Choice A) Standards of conduct are used to describe minimally acceptable behaviors or practices, given the shared principles of the code of ethics. The code of ethics describes the shared principles.

(Choice B) Standards of conduct do not describe civil laws and regulations.

Things to remember:
Standards of conduct are used to clarify the minimally acceptable behaviors required to conform to the shared principles stated in a code of ethics; they do not address applicable civil laws and regulations.

At the end of 20X4, a hedge fund had $25 million in assets under management (AUM). The fund has the following fee structure, high-water mark, and 20X5 results:

Selected Data
Management fee (average assets) 1%
Incentive fee (net of management fee) 10%
Soft hurdle rate 6%
High-water mark (millions) $27
Year-end fund assets 20X5 (millions) $30

Assuming no inflows or outflows, the incentive fee (in $) earned by this hedge fund for 20X5 is closest to:

  1. 109,000
  2. 272,500
  3. 300,000
Submit
Prev Next

Explanation:

A break-down infographic of Calculation of hedge fund incentive fees

Hedge funds charge a management fee and an incentive fee. The management fee is calculated as a percentage of the total value of the fund's assets under management (AUM). It is assessed each year regardless of profitability.

The incentive fee is levied against the fund's annual gains, subject to certain conditions. It is calculated either gross or net of the management fee. The net calculation subtracts the management fee from AUM to arrive at an adjusted AUM that is used to calculate the fund's profits.

The high-water mark represents the value of AUM, net of fees, at any time during the fund's existence. To earn an incentive fee, the fund must exceed the high-water mark, the base from which the fee is calculated.

The hurdle rate is the minimum profit that the fund must earn (usually annually) before it receives an incentive fee. The hurdle rate can either be "soft," meaning that the incentive fee is calculated based on the entire profit, or "hard," meaning that the incentive fee is based on only the excess profit above the hurdle rate.

In this scenario, the fund generated net returns in 20X5 of 18.9% ( = (29.725 – 25) / 25 ), above the soft hurdle rate of 6%, and eclipsed the high-water mark of $27 million. Therefore, the fund earned an incentive fee of 10% of profits, net of the management fee on average assets of $27,500,000:

0.10 × (29,725,000 − 27,000,000) = $272,500.

(Choice A) $109,000 is the result of incorrectly assuming a hard hurdle rate is in effect.

(Choice C) $300,000 is the incentive fee if management fees are not deducted.

Things to remember:
Hedge funds charge both a fixed management fee and a variable incentive fee. The incentive fee is contingent on whether the fund earns a profit and may be subject to a high-water mark and hurdle rate.

In the short run, a company maximizing profit in a market with perfect competition produces at a quantity that most likely results in:

  1. economic profits equal to zero.
  2. marginal revenue equal to marginal cost.
  3. market price greater than marginal revenue.
Submit
Prev Next

Explanation:

A wave scatter graph visualization of a short-run profit-maximizing price and quantity

A firm operating under perfect competition maximizes economic profit by producing and selling at the quantity where marginal revenue (MR) equals marginal cost (MC). Cost in this context includes opportunity costs (eg, the owners' required return from the business). Perfectly competitive firms can earn economic profits in the short run, but even if economic profits are zero or negative, a firm may be earning an accounting profit.

MR, the incremental revenue from selling one additional unit, depends on the firm's demand curve. In the case of perfect competition, the demand curve for any individual firm is a horizontal line at the market equilibrium price, since demand is perfectly elastic. Therefore, market price equals MR at all quantities (Choice C).

MC, the incremental cost to produce one additional unit, depends on the firm's cost structure. Producing at a quantity greater than where MR = MC means that the incremental cost for each unit exceeds the incremental revenue generated by that unit and the firm generates a loss on each additional unit sold. Producing at a lower quantity means that the firm forgoes economic profit (in the short run) since the additional revenue from a unit sold would exceed the cost of the unit.

(Choice A) Perfectly competitive firms can earn economic profits in the short run. However, in the long-run, the positive economic profits will attract new firms, which will increase supply/lower price until economic profit is zero.

Note: Although this question specifically addresses perfect competition, the condition that firms optimally produce when MR = MC applies to all market structures. It is likely that the exam will have questions on this topic.

Things to remember:
Under perfect competition, a firm maximizes short-run economic profit by producing and selling at the quantity where marginal revenue (MR) equals marginal cost (MC). Since there is perfectly elastic demand, price also equals MR for all quantities. Short-run, but not long-run, economic profits are possible. However, a firm may earn an accounting profit even if economic profits are zero or negative.

An analyst observes the following market data for one American put option:

Selected Data
(in CAD)
Stock price 48
Strike price 50
Option premium 4

This option's moneyness is best described as:

  1. in the money.
  2. at the money.
  3. out of the money.
Submit Prev

Explanation:

Visualization of Maximizing Options Trading Potential for Peak Returns

Moneyness refers to the relationship between an option's strike price and the underlying stock price and is indicative of the option's intrinsic value. An option trading at the money or out of the money has no intrinsic value. An option trading in the money has intrinsic value:

  • For an in-the-money call option, the underlying stock price is greater than the strike price. This gives the call owner the right to buy the stock at a price lower than the market price, which in turn gives the option intrinsic value.
  • For an in-the-money put option, the strike price is greater than the underlying stock price. This gives the put owner the right to sell the stock at a price higher than the market price, which in turn gives the option intrinsic value.

In this scenario, the put option's underlying stock price is less than its strike price. Therefore, the option is trading in the money. Note that the option's premium is irrelevant to determining the option's intrinsic value; it would, however, be relevant to determining the option's profit at exercise.

(Choice B) If the stock price equals the strike price, the option is trading at the money (ATM). At expiration, an ATM option is economically equivalent to owning the underlying asset.

(Choice C) For a call option, if the stock price is less than the strike price, the option is trading out of the money (OTM) and has no intrinsic value. The same is true for a put option if the stock price is greater than the strike price.

Things to remember:
Moneyness refers to the relationship between an option's strike price and the underlying stock price. If the stock price equals the strike price, the option is trading at the money. For a call (put) option, if the stock price is greater (less) than the strike price, the option is trading in the money. For a call (put) option, if the stock price is less (greater) than the strike price, the option is trading out of the money.

CFA Level 1 QBank

 

$ 

Use code:  

Select your exam date

Aug 2025 Nov 2025 Feb 2026 May 2026 Aug 2026 Nov 2026
Immediate access through Jun 30, 2026
Continue to Cart
CFA Level 1 Core

 

$ 

Use code:  

Select your exam date

Aug 2025 Nov 2025 Feb 2026 May 2026 Aug 2026 Nov 2026
Immediate access through Jun 30, 2026
Continue to Cart
CFA Level 1 Elite

 

$ 

Use code:  

Select your exam date

Aug 2025 Nov 2025 Feb 2026 May 2026 Aug 2026 Nov 2026
Immediate access through Jun 30, 2026
Continue to Cart
CFA Level 1 Advanced

 

$ 

Use code:  

Select your exam date

Aug 2025 Nov 2025 Feb 2026 May 2026 Aug 2026 Nov 2026
Immediate access through Jun 30, 2026
Continue to Cart

CFA Level 1 Exam Questions

Quality speaks for itself. Try out some UWorld Qbank questions below.
Buy Now

According to the Modigliani-Miller propositions (with taxes), if a company increases its debt level, its market value will most likely:

  1. decrease since the costs of financial distress are increasing.
  2. remain the same since the market value is unaffected by the capital structure.
  3. increase proportionally to the change in debt.
Submit Next Question

Explanation:

A graphical tabular representation of Modigliani-Miller propositions

The Modigliani-Miller (MM) propositions assume perfect capital markets (ie, no arbitrage, no transaction or bankruptcy costs, and symmetric information) and assert that a company's market value equals the present value of its future cash flows. Modigliani and Miller propose that, in the absence of taxes:

  • A company's capital structure does not affect its value (MM I without taxes); and
  • A company's cost of equity (re) is directly proportional to its debt-to-equity ratio (D/E), but WACC remains constant (MM II without taxes).

However, these propositions change when there are corporate taxes:

  • The market value of a levered company is greater than the value of an unlevered but otherwise identical company; tax-exempt interest payments improve the levered company's cash flows, increasing its value. The difference in value is the amount of the debt tax shield (tD), which is the product of a company's tax rate (t) and value of debt (D) (MM I with taxes).
  • A company's re is directly proportional to D/E, adjusted by (1 − t). Greater leverage will increase the cost of equity, but at a slower pace due to taxes. The greater the tax rate (t), the slower the increase in re when D/E increases (MM II with taxes).

Therefore, with taxes, an increase in debt will proportionally increase a company's value and reduce its WACC.

(Choice A) The MM propositions assume no cost of financial distress.

(Choice B) The market value would remain the same in the absence of taxes.

Things to remember:
The Modigliani-Miller (MM) propositions assume perfect capital markets (ie, no arbitrage, no transaction or bankruptcy costs, and symmetric information). When these propositions include corporate taxes, greater leverage will increase a company's market value (MM I) and reduce its WACC (MM II).

If a professional organization has standards of conduct in addition to its code of ethics, the purpose of the standards is most likely to describe:

  1. shared principles.
  2. laws and regulations.
  3. acceptable behaviors.
Submit Next Question

Explanation:

Instruments for compliance with professional ethics
Instrument Owner Describes
Code of ethics Professional organization Shared principles
Standards of conduct Professional organization Minimally acceptable behavior
Laws and regulations Government Legal limits of behavior

A code of ethics is a professional organization's statement of shared principles. Standards of conduct provide a guide to practicing the principles outlined in the code of ethics. Standards of conduct also clarify the minimally acceptable behaviors required to conform to the code of ethics. Although not addressed directly in standards of conduct, adherence to civil laws and regulations may be the minimally acceptable behavior in some cases.

Standards of conduct may be principle-based or rule-based. Principle-based standards are universally applicable to members of the profession and are based on the principles outlined in the code of ethics. Rule-based standards, while also relating to the principles in the code of ethics, are usually more narrowly applicable and specific to certain members or scenarios that may arise.

A code of ethics may or may not be accompanied by standards of conduct whereas standards of conduct exist only to enhance their associated code of ethics. CFA Institute has adopted both a code of ethics and standards of conduct (the "Code and Standards"); CFA charterholders and candidates are expected to know and comply with both.

(Choice A) Standards of conduct are used to describe minimally acceptable behaviors or practices, given the shared principles of the code of ethics. The code of ethics describes the shared principles.

(Choice B) Standards of conduct do not describe civil laws and regulations.

Things to remember:
Standards of conduct are used to clarify the minimally acceptable behaviors required to conform to the shared principles stated in a code of ethics; they do not address applicable civil laws and regulations.

At the end of 20X4, a hedge fund had $25 million in assets under management (AUM). The fund has the following fee structure, high-water mark, and 20X5 results:

Selected Data
Management fee (average assets) 1%
Incentive fee (net of management fee) 10%
Soft hurdle rate 6%
High-water mark (millions) $27
Year-end fund assets 20X5 (millions) $30

Assuming no inflows or outflows, the incentive fee (in $) earned by this hedge fund for 20X5 is closest to:

  1. 109,000
  2. 272,500
  3. 300,000
Submit Next Question

Explanation:

A break-down infographic of Calculation of hedge fund incentive fees

Hedge funds charge a management fee and an incentive fee. The management fee is calculated as a percentage of the total value of the fund's assets under management (AUM). It is assessed each year regardless of profitability.

The incentive fee is levied against the fund's annual gains, subject to certain conditions. It is calculated either gross or net of the management fee. The net calculation subtracts the management fee from AUM to arrive at an adjusted AUM that is used to calculate the fund's profits.

The high-water mark represents the value of AUM, net of fees, at any time during the fund's existence. To earn an incentive fee, the fund must exceed the high-water mark, the base from which the fee is calculated.

The hurdle rate is the minimum profit that the fund must earn (usually annually) before it receives an incentive fee. The hurdle rate can either be "soft," meaning that the incentive fee is calculated based on the entire profit, or "hard," meaning that the incentive fee is based on only the excess profit above the hurdle rate.

In this scenario, the fund generated net returns in 20X5 of 18.9% ( = (29.725 – 25) / 25 ), above the soft hurdle rate of 6%, and eclipsed the high-water mark of $27 million. Therefore, the fund earned an incentive fee of 10% of profits, net of the management fee on average assets of $27,500,000:

0.10 × (29,725,000 − 27,000,000) = $272,500.

(Choice A) $109,000 is the result of incorrectly assuming a hard hurdle rate is in effect.

(Choice C) $300,000 is the incentive fee if management fees are not deducted.

Things to remember:
Hedge funds charge both a fixed management fee and a variable incentive fee. The incentive fee is contingent on whether the fund earns a profit and may be subject to a high-water mark and hurdle rate.

In the short run, a company maximizing profit in a market with perfect competition produces at a quantity that most likely results in:

  1. economic profits equal to zero.
  2. marginal revenue equal to marginal cost.
  3. market price greater than marginal revenue.
Submit Next Question

Explanation:

A wave scatter graph visualization of a short-run profit-maximizing price and quantity

A firm operating under perfect competition maximizes economic profit by producing and selling at the quantity where marginal revenue (MR) equals marginal cost (MC). Cost in this context includes opportunity costs (eg, the owners' required return from the business). Perfectly competitive firms can earn economic profits in the short run, but even if economic profits are zero or negative, a firm may be earning an accounting profit.

MR, the incremental revenue from selling one additional unit, depends on the firm's demand curve. In the case of perfect competition, the demand curve for any individual firm is a horizontal line at the market equilibrium price, since demand is perfectly elastic. Therefore, market price equals MR at all quantities (Choice C).

MC, the incremental cost to produce one additional unit, depends on the firm's cost structure. Producing at a quantity greater than where MR = MC means that the incremental cost for each unit exceeds the incremental revenue generated by that unit and the firm generates a loss on each additional unit sold. Producing at a lower quantity means that the firm forgoes economic profit (in the short run) since the additional revenue from a unit sold would exceed the cost of the unit.

(Choice A) Perfectly competitive firms can earn economic profits in the short run. However, in the long-run, the positive economic profits will attract new firms, which will increase supply/lower price until economic profit is zero.

Note: Although this question specifically addresses perfect competition, the condition that firms optimally produce when MR = MC applies to all market structures. It is likely that the exam will have questions on this topic.

Things to remember:
Under perfect competition, a firm maximizes short-run economic profit by producing and selling at the quantity where marginal revenue (MR) equals marginal cost (MC). Since there is perfectly elastic demand, price also equals MR for all quantities. Short-run, but not long-run, economic profits are possible. However, a firm may earn an accounting profit even if economic profits are zero or negative.

An analyst observes the following market data for one American put option:

Selected Data
(in CAD)
Stock price 48
Strike price 50
Option premium 4

This option's moneyness is best described as:

  1. in the money.
  2. at the money.
  3. out of the money.
Submit

Explanation:

Visualization of Maximizing Options Trading Potential for Peak Returns

Moneyness refers to the relationship between an option's strike price and the underlying stock price and is indicative of the option's intrinsic value. An option trading at the money or out of the money has no intrinsic value. An option trading in the money has intrinsic value:

  • For an in-the-money call option, the underlying stock price is greater than the strike price. This gives the call owner the right to buy the stock at a price lower than the market price, which in turn gives the option intrinsic value.
  • For an in-the-money put option, the strike price is greater than the underlying stock price. This gives the put owner the right to sell the stock at a price higher than the market price, which in turn gives the option intrinsic value.

In this scenario, the put option's underlying stock price is less than its strike price. Therefore, the option is trading in the money. Note that the option's premium is irrelevant to determining the option's intrinsic value; it would, however, be relevant to determining the option's profit at exercise.

(Choice B) If the stock price equals the strike price, the option is trading at the money (ATM). At expiration, an ATM option is economically equivalent to owning the underlying asset.

(Choice C) For a call option, if the stock price is less than the strike price, the option is trading out of the money (OTM) and has no intrinsic value. The same is true for a put option if the stock price is greater than the strike price.

Things to remember:
Moneyness refers to the relationship between an option's strike price and the underlying stock price. If the stock price equals the strike price, the option is trading at the money. For a call (put) option, if the stock price is greater (less) than the strike price, the option is trading in the money. For a call (put) option, if the stock price is less (greater) than the strike price, the option is trading out of the money.

Access Practice Questions

Kickstart 2025 Strong: Take 15% Off CFA Products

Ends January 31, 2025
ResReady15
Save 15%
Still Time to Save On CFA® Prep!