CFA-Institute CFA-Level-II Exam Dumps

CFA-Institute CFA-Level-II Sample Question Answers

Question # 1

Ivan Johnson is reviewing the investment merits of BioTLab, a fast-growing biotechnology company.BioTLab has developed several drugs, which arc being licensed to major drug companies. BioTLabalso has several drugs in phase III trials (phase III trials are the last testing stage before FDAapproval). Johnson notes that two drugs recently received approval which should provide BioTLabsolid revenue growth and generate predictable cash flow well into the future. Based on the potentialfor the two drugs, BioTLab's estimated annual cash flow growth rate for the next two years is 25%,and long-term growth is expected to be 12%. Because of BioTLab's attractive investmentopportunities, the company does not pay a dividend. BioTLab's current weighted average cost ofcapital is 15% and its stock is currently trading at $50 per share. Financial information for BioTLab forthe most recent 12 months is provided below:• Net working capita! excluding cash increased from $7,460,000 to $9,985,000;• Book value increased from $81,250,000 to $101,250,000.• BioTLab currently has no debt.• Research facilities and production equipment were purchased for $8,450,000.• BioTLab held non-operating assets in the amount of $875,000.• Net income for the 12 months was $20,000,000.• BioTLab has a marginal tax rate of 40%.• Noncash charges for depreciation and restructuring for the 12 months were $1,250,000.BioTLab's management has indicated an interest in establishing a dividend and will fund new drugresearch by issuing additional debt.Johnson also reviews a competitor to BioTLab, Groh Group, which has a larger segment operating ina highly cyclical business. The Groh Group has a debt to equity ratio of 1.0 and pays no dividends. Inaddition, Groh Group plans to issue bonds in the coming year.Which of the following statements regarding free cash flow models is least likely correct?

A. Sensitivity analysis indicates that the FCFE model's valuation of BioTLab's common stock is most sensitive to the company's growth rate.
B. FCFE is net income plus depreciation minus net capital expenditures minus the increase in working capital plus net new debt financing.  
C. FCFF can be inflated by increasing capital expenditures relative to depreciation. 

Show Answer

Question # 2

Ivan Johnson is reviewing the investment merits of BioTLab, a fast-growing biotechnology company.BioTLab has developed several drugs, which arc being licensed to major drug companies. BioTLabalso has several drugs in phase III trials (phase III trials are the last testing stage before FDAapproval). Johnson notes that two drugs recently received approval which should provide BioTLabsolid revenue growth and generate predictable cash flow well into the future. Based on the potentialfor the two drugs, BioTLab's estimated annual cash flow growth rate for the next two years is 25%,and long-term growth is expected to be 12%. Because of BioTLab's attractive investmentopportunities, the company does not pay a dividend. BioTLab's current weighted average cost ofcapital is 15% and its stock is currently trading at $50 per share. Financial information for BioTLab forthe most recent 12 months is provided below:• Net working capita! excluding cash increased from $7,460,000 to $9,985,000;• Book value increased from $81,250,000 to $101,250,000.• BioTLab currently has no debt.• Research facilities and production equipment were purchased for $8,450,000.• BioTLab held non-operating assets in the amount of $875,000.• Net income for the 12 months was $20,000,000.• BioTLab has a marginal tax rate of 40%.• Noncash charges for depreciation and restructuring for the 12 months were $1,250,000.BioTLab's management has indicated an interest in establishing a dividend and will fund new drugresearch by issuing additional debt.Johnson also reviews a competitor to BioTLab, Groh Group, which has a larger segment operating ina highly cyclical business. The Groh Group has a debt to equity ratio of 1.0 and pays no dividends. Inaddition, Groh Group plans to issue bonds in the coming year.Which model would be most appropriate in valuing the Groh Group?

A. FCFF model. 
B. FCFE model. 
C. Dividend Discount model. 

Show Answer

Question # 3

Ivan Johnson is reviewing the investment merits of BioTLab, a fast-growing biotechnology company.BioTLab has developed several drugs, which arc being licensed to major drug companies. BioTLabalso has several drugs in phase III trials (phase III trials are the last testing stage before FDAapproval). Johnson notes that two drugs recently received approval which should provide BioTLabsolid revenue growth and generate predictable cash flow well into the future. Based on the potentialfor the two drugs, BioTLab's estimated annual cash flow growth rate for the next two years is 25%,and long-term growth is expected to be 12%. Because of BioTLab's attractive investmentopportunities, the company does not pay a dividend. BioTLab's current weighted average cost ofcapital is 15% and its stock is currently trading at $50 per share. Financial information for BioTLab forthe most recent 12 months is provided below:• Net working capita! excluding cash increased from $7,460,000 to $9,985,000;• Book value increased from $81,250,000 to $101,250,000.• BioTLab currently has no debt.• Research facilities and production equipment were purchased for $8,450,000.• BioTLab held non-operating assets in the amount of $875,000.• Net income for the 12 months was $20,000,000.BioTLab has a marginal tax rate of 40%.• Noncash charges for depreciation and restructuring for the 12 months were $1,250,000.BioTLab's management has indicated an interest in establishing a dividend and will fund new drugresearch by issuing additional debt.Johnson also reviews a competitor to BioTLab, Groh Group, which has a larger segment operating ina highly cyclical business. The Groh Group has a debt to equity ratio of 1.0 and pays no dividends. Inaddition, Groh Group plans to issue bonds in the coming year.If BioTLabs establishes a dividend and issues additional debt, the most likely effect on FCFF will be;

A. no effect. 
B. a decrease in FCFF. 
C. an increase in FCFF. 

Show Answer

Question # 4

Ivan Johnson is reviewing the investment merits of BioTLab, a fast-growing biotechnology company.BioTLab has developed several drugs, which arc being licensed to major drug companies. BioTLabalso has several drugs in phase III trials (phase III trials are the last testing stage before FDAapproval). Johnson notes that two drugs recently received approval which should provide BioTLabsolid revenue growth and generate predictable cash flow well into the future. Based on the potentialfor the two drugs, BioTLab's estimated annual cash flow growth rate for the next two years is 25%,and long-term growth is expected to be 12%. Because of BioTLab's attractive investmentopportunities, the company does not pay a dividend. BioTLab's current weighted average cost ofcapital is 15% and its stock is currently trading at $50 per share. Financial information for BioTLab forthe most recent 12 months is provided below:• Net working capita! excluding cash increased from $7,460,000 to $9,985,000;• Book value increased from $81,250,000 to $101,250,000.• BioTLab currently has no debt.• Research facilities and production equipment were purchased for $8,450,000.• BioTLab held non-operating assets in the amount of $875,000.• Net income for the 12 months was $20,000,000.• BioTLab has a marginal tax rate of 40%.• Noncash charges for depreciation and restructuring for the 12 months were $1,250,000.BioTLab's management has indicated an interest in establishing a dividend and will fund new drugresearch by issuing additional debt.Johnson also reviews a competitor to BioTLab, Groh Group, which has a larger segment operating ina highly cyclical business. The Groh Group has a debt to equity ratio of 1.0 and pays no dividends. Inaddition, Groh Group plans to issue bonds in the coming year.Using a two-stage, free cash flow to the firm model, determine which of the following is closest tothe value of BioTLab.

A. $419 million. 
B. $436 million. 
C. $477 million. 

Show Answer

Question # 5

Ivan Johnson is reviewing the investment merits of BioTLab, a fast-growing biotechnology company.BioTLab has developed several drugs, which arc being licensed to major drug companies. BioTLabalso has several drugs in phase III trials (phase III trials are the last testing stage before FDAapproval). Johnson notes that two drugs recently received approval which should provide BioTLabsolid revenue growth and generate predictable cash flow well into the future. Based on the potentialfor the two drugs, BioTLab's estimated annual cash flow growth rate for the next two years is 25%,and long-term growth is expected to be 12%. Because of BioTLab's attractive investmentopportunities, the company does not pay a dividend. BioTLab's current weighted average cost ofcapital is 15% and its stock is currently trading at $50 per share. Financial information for BioTLab forthe most recent 12 months is provided below:• Net working capita! excluding cash increased from $7,460,000 to $9,985,000;• Book value increased from $81,250,000 to $101,250,000.• BioTLab currently has no debt.• Research facilities and production equipment were purchased for $8,450,000.• BioTLab held non-operating assets in the amount of $875,000.• Net income for the 12 months was $20,000,000.• BioTLab has a marginal tax rate of 40%.• Noncash charges for depreciation and restructuring for the 12 months were $1,250,000.BioTLab's management has indicated an interest in establishing a dividend and will fund new drugresearch by issuing additional debt.Johnson also reviews a competitor to BioTLab, Groh Group, which has a larger segment operating ina highly cyclical business. The Groh Group has a debt to equity ratio of 1.0 and pays no dividends. Inaddition, Groh Group plans to issue bonds in the coming year.Johnson prefers to use free cash flow analysis to value investments. Which of the statements belowis least accurate in describing the advantages of free cash flow valuation models?

A. Accounting issues limit the usefulness of reported earnings, while free cash flow is adjusted for these issues.
B. Determining free cash flow is easier than dividends. 
C. A company must generate free cash flow to grow in the long run. 

Show Answer

Question # 6

Richard Grass is the healthcare analyst for Furrnon Investments and is reviewing the investmentmerits of the developing hospice industry. The hospice industry has a short history in the publicmarket, as several companies have recently completed their initial public offering. Hospice servicesare provided to patients diagnosed with terminal illness as an alternative to aggressive medicalmanagement. The use of hospice services at skilled nursing facilities and assisted-living facilities isforecasted to continue its recent growth. Medicare is the primary payer for hospice services,accounting for 85% of the approximately $7 billion in industry's revenues. Hospice providers offersymptom and pain management to patients diagnosed with a terminal illness by their physician. Theprogram was added to the Medicare benefit package in the early 1980s. Growth in the sector hasonly recently. accelerated due to the emergence of a number of for-profit companies. The caregiverprovides a plan for each admitted patient and care is given in any number of healthcareenvironments, including the patient's home.Grass's analysis of the hospice industry has uncovered several facts that are outlined below:• The industry's revenue annual growth rate has increased from 14% in the late 1990s to 25% in2008.• The average length of stay at facilities for hospice patients is increasing.• Labor costs account for 75% of total expenses, drugs 15% of total expenses, and medical supplies10%.• More than 80% of hospice patients are above 65 years old and 30% are above 85 years old.• Based on the U.S. Census Bureau's statistics, over the next six years (2009-2015), the number ofpeople in the 65 and older age group will increase annually by 1.4%.• The Medicare hospice benefit is still underutilized by the terminally ill population, according toMedPac (an independent advisory committee for the U.S. Congress on healthcare issues).• Only 30% of Medicare beneficiaries enroll in the hospice benefit before they die.• In recent years, the U.S. government has approved rate increases for the sector compared to flat ordeclining rate trends for other healthcare services.• The Medicare hospice program has a beneficiary cap which cannot exceed approximately $18,000annually per person.• The top six for-profit providers account for about half of the segment's sales.• The overall hospice provider market is roughly divided into 55% non-profit, 10% U.S. government,and 35% for-profit.Grass's analysis has narrowed his search to Hope Company. Hope controls about 7% of the totalhospice service market or 20% of the for-profit market. The company has the only regulatorapproved for-profit certificate for the state of Florida, one of the most attractive markets in theUnited States. In addition to a strong market share in Florida, Hope has a strong presence in urbanmarkets like Dallas and San Francisco. Hope has a more diversified revenue base than other publiclytraded for-profit providers.Grass is forecasting Hope Company's revenues and profits for the next year. Which of the followingstatements is least likely a risk Grass should consider in developing his forecast? FurmonInvestment's economist is forecasting a:

A. reduction in Medicare's benefit package. 
B. recession for the U.S. economy. 
C. larger than expected increase for healthcare labor expenditures. 

Show Answer

Question # 7

Richard Grass is the healthcare analyst for Furrnon Investments and is reviewing the investmentmerits of the developing hospice industry. The hospice industry has a short history in the public market, as several companies have recently completed their initial public offering. Hospice servicesare provided to patients diagnosed with terminal illness as an alternative to aggressive medicalmanagement. The use of hospice services at skilled nursing facilities and assisted-living facilities isforecasted to continue its recent growth. Medicare is the primary payer for hospice services,accounting for 85% of the approximately $7 billion in industry's revenues. Hospice providers offersymptom and pain management to patients diagnosed with a terminal illness by their physician. Theprogram was added to the Medicare benefit package in the early 1980s. Growth in the sector hasonly recently. accelerated due to the emergence of a number of for-profit companies. The caregiverprovides a plan for each admitted patient and care is given in any number of healthcareenvironments, including the patient's home.Grass's analysis of the hospice industry has uncovered several facts that are outlined below:• The industry's revenue annual growth rate has increased from 14% in the late 1990s to 25% in2008.• The average length of stay at facilities for hospice patients is increasing.• Labor costs account for 75% of total expenses, drugs 15% of total expenses, and medical supplies10%.• More than 80% of hospice patients are above 65 years old and 30% are above 85 years old.• Based on the U.S. Census Bureau's statistics, over the next six years (2009-2015), the number ofpeople in the 65 and older age group will increase annually by 1.4%.• The Medicare hospice benefit is still underutilized by the terminally ill population, according toMedPac (an independent advisory committee for the U.S. Congress on healthcare issues).• Only 30% of Medicare beneficiaries enroll in the hospice benefit before they die.• In recent years, the U.S. government has approved rate increases for the sector compared to flat ordeclining rate trends for other healthcare services.• The Medicare hospice program has a beneficiary cap which cannot exceed approximately $18,000annually per person.• The top six for-profit providers account for about half of the segment's sales.• The overall hospice provider market is roughly divided into 55% non-profit, 10% U.S. government,and 35% for-profit.Grass's analysis has narrowed his search to Hope Company. Hope controls about 7% of the totalhospice service market or 20% of the for-profit market. The company has the only regulatorapproved for-profit certificate for the state of Florida, one of the most attractive markets in theUnited States. In addition to a strong market share in Florida, Hope has a strong presence in urbanmarkets like Dallas and San Francisco. Hope has a more diversified revenue base than other publiclytraded for-profit providers.Grass is reviewing Hope Company's pricing policy. Which of the following factors is least likely tocontribute to the company's pricing policy?

A. Hope Company relies on many different medical suppliers. 
B. Hope Company provides a unique service for its customer. 
C. Competitors are having difficulty entering many of Hope's key markets. 

Show Answer

Question # 8

Richard Grass is the healthcare analyst for Furrnon Investments and is reviewing the investmentmerits of the developing hospice industry. The hospice industry has a short history in the publicmarket, as several companies have recently completed their initial public offering. Hospice servicesare provided to patients diagnosed with terminal illness as an alternative to aggressive medicalmanagement. The use of hospice services at skilled nursing facilities and assisted-living facilities isforecasted to continue its recent growth. Medicare is the primary payer for hospice services,accounting for 85% of the approximately $7 billion in industry's revenues. Hospice providers offersymptom and pain management to patients diagnosed with a terminal illness by their physician. Theprogram was added to the Medicare benefit package in the early 1980s. Growth in the sector hasonly recently. accelerated due to the emergence of a number of for-profit companies. The caregiver provides a plan for each admitted patient and care is given in any number of healthcareenvironments, including the patient's home.Grass's analysis of the hospice industry has uncovered several facts that are outlined below:• The industry's revenue annual growth rate has increased from 14% in the late 1990s to 25% in2008.• The average length of stay at facilities for hospice patients is increasing.• Labor costs account for 75% of total expenses, drugs 15% of total expenses, and medical supplies10%.• More than 80% of hospice patients are above 65 years old and 30% are above 85 years old.• Based on the U.S. Census Bureau's statistics, over the next six years (2009-2015), the number ofpeople in the 65 and older age group will increase annually by 1.4%.• The Medicare hospice benefit is still underutilized by the terminally ill population, according toMedPac (an independent advisory committee for the U.S. Congress on healthcare issues).• Only 30% of Medicare beneficiaries enroll in the hospice benefit before they die.• In recent years, the U.S. government has approved rate increases for the sector compared to flat ordeclining rate trends for other healthcare services.• The Medicare hospice program has a beneficiary cap which cannot exceed approximately $18,000annually per person.• The top six for-profit providers account for about half of the segment's sales.• The overall hospice provider market is roughly divided into 55% non-profit, 10% U.S. government,and 35% for-profit.Grass's analysis has narrowed his search to Hope Company. Hope controls about 7% of the totalhospice service market or 20% of the for-profit market. The company has the only regulatorapproved for-profit certificate for the state of Florida, one of the most attractive markets in theUnited States. In addition to a strong market share in Florida, Hope has a strong presence in urbanmarkets like Dallas and San Francisco. Hope has a more diversified revenue base than other publiclytraded for-profit providers.Grass's research report on Hope Company is positive on its investment merits. Grass's report states,"Hope is uniquely positioned in the hospice industry" Which of the following best supports hiscomment?

A. Hope Company's strong presence in the Florida market. 
B. Hope Company relies on the Medicare program for a majority of its revenues. 
C. Hope Company's diversified revenue base has allowed the company to expand beyond the hospice sector.

Show Answer

Question # 9

Richard Grass is the healthcare analyst for Furrnon Investments and is reviewing the investmentmerits of the developing hospice industry. The hospice industry has a short history in the publicmarket, as several companies have recently completed their initial public offering. Hospice servicesare provided to patients diagnosed with terminal illness as an alternative to aggressive medicalmanagement. The use of hospice services at skilled nursing facilities and assisted-living facilities isforecasted to continue its recent growth. Medicare is the primary payer for hospice services,accounting for 85% of the approximately $7 billion in industry's revenues. Hospice providers offersymptom and pain management to patients diagnosed with a terminal illness by their physician. Theprogram was added to the Medicare benefit package in the early 1980s. Growth in the sector hasonly recently. accelerated due to the emergence of a number of for-profit companies. The caregiverprovides a plan for each admitted patient and care is given in any number of healthcareenvironments, including the patient's home.Grass's analysis of the hospice industry has uncovered several facts that are outlined below:• The industry's revenue annual growth rate has increased from 14% in the late 1990s to 25% in2008.• The average length of stay at facilities for hospice patients is increasing.• Labor costs account for 75% of total expenses, drugs 15% of total expenses, and medical supplies10%.• More than 80% of hospice patients are above 65 years old and 30% are above 85 years old.• Based on the U.S. Census Bureau's statistics, over the next six years (2009-2015), the number ofpeople in the 65 and older age group will increase annually by 1.4%.• The Medicare hospice benefit is still underutilized by the terminally ill population, according toMedPac (an independent advisory committee for the U.S. Congress on healthcare issues).• Only 30% of Medicare beneficiaries enroll in the hospice benefit before they die.• In recent years, the U.S. government has approved rate increases for the sector compared to flat ordeclining rate trends for other healthcare services.• The Medicare hospice program has a beneficiary cap which cannot exceed approximately $18,000• More than 80% of hospice patients are above 65 years old and 30% are above 85 years old.• Based on the U.S. Census Bureau's statistics, over the next six years (2009-2015), the number ofpeople in the 65 and older age group will increase annually by 1.4%.• The Medicare hospice benefit is still underutilized by the terminally ill population, according toMedPac (an independent advisory committee for the U.S. Congress on healthcare issues).• Only 30% of Medicare beneficiaries enroll in the hospice benefit before they die.• In recent years, the U.S. government has approved rate increases for the sector compared to flat ordeclining rate trends for other healthcare services.• The Medicare hospice program has a beneficiary cap which cannot exceed approximately $18,000annually per person.• The top six for-profit providers account for about half of the segment's sales.• The overall hospice provider market is roughly divided into 55% non-profit, 10% U.S. government,and 35% for-profit.Grass's analysis has narrowed his search to Hope Company. Hope controls about 7% of the totalhospice service market or 20% of the for-profit market. The company has the only regulatorapproved for-profit certificate for the state of Florida, one of the most attractive markets in theUnited States. In addition to a strong market share in Florida, Hope has a strong presence in urbanmarkets like Dallas and San Francisco. Hope has a more diversified revenue base than other publiclytraded for-profit providers.The market share of the top six for-profit providers, together with the presence of non-profit andgovernment providers, most likely indicates that the:

A. threat of new entrants is low in the hospice industry. 
B. power of suppliers is low in the hospice industry. 
C. threat of substitutes is high in the hospice industry. 

Show Answer

Question # 10

Richard Grass is the healthcare analyst for Furrnon Investments and is reviewing the investmentmerits of the developing hospice industry. The hospice industry has a short history in the publicmarket, as several companies have recently completed their initial public offering. Hospice servicesare provided to patients diagnosed with terminal illness as an alternative to aggressive medicalmanagement. The use of hospice services at skilled nursing facilities and assisted-living facilities isforecasted to continue its recent growth. Medicare is the primary payer for hospice services,accounting for 85% of the approximately $7 billion in industry's revenues. Hospice providers offersymptom and pain management to patients diagnosed with a terminal illness by their physician. Theprogram was added to the Medicare benefit package in the early 1980s. Growth in the sector hasonly recently. accelerated due to the emergence of a number of for-profit companies. The caregiverprovides a plan for each admitted patient and care is given in any number of healthcareenvironments, including the patient's home.Grass's analysis of the hospice industry has uncovered several facts that are outlined below:• The industry's revenue annual growth rate has increased from 14% in the late 1990s to 25% in2008.• The average length of stay at facilities for hospice patients is increasing.• Labor costs account for 75% of total expenses, drugs 15% of total expenses, and medical supplies10%.• More than 80% of hospice patients are above 65 years old and 30% are above 85 years old.• Based on the U.S. Census Bureau's statistics, over the next six years (2009-2015), the number ofpeople in the 65 and older age group will increase annually by 1.4%.• The Medicare hospice benefit is still underutilized by the terminally ill population, according toMedPac (an independent advisory committee for the U.S. Congress on healthcare issues).• Only 30% of Medicare beneficiaries enroll in the hospice benefit before they die.• In recent years, the U.S. government has approved rate increases for the sector compared to flat ordeclining rate trends for other healthcare services.• The Medicare hospice program has a beneficiary cap which cannot exceed approximately $18,000annually per person.• The top six for-profit providers account for about half of the segment's sales.• The overall hospice provider market is roughly divided into 55% non-profit, 10% U.S. government,and 35% for-profit.Grass's analysis has narrowed his search to Hope Company. Hope controls about 7% of the totalhospice service market or 20% of the for-profit market. The company has the only regulatorapproved for-profit certificate for the state of Florida, one of the most attractive markets in theUnited States. In addition to a strong market share in Florida, Hope has a strong presence in urbanmarkets like Dallas and San Francisco. Hope has a more diversified revenue base than other publiclytraded for-profit providers.Grass is a firm believer in the industry life cycle. Which of the following statements is most accurateregarding the hospice industry's position in the industry life cycle? The hospice industry is in the:

A. growth stage, as indicated by recent growth in sales. 
B. pioneer stage, as indicated by recent growth in sales and labor costs. 
C. mature stage, as indicated by high labor costs and slow growth in the number of people aged 65 and older

Show Answer

Question # 11

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by hersupervisor to cover a number of different equity and debt investments. One of the investments isTaylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensiveanalysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. Inapplying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel,Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has tradedat a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitativeinformation to consider. The return on a value-weighted market index minus the risk-free rate is5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquiditypremium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas forDevon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium,Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor modelsthat includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between thereturn of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the requiredreturn for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue withinthe next year. The company has not previously issued debt securities to the public, relying instead onbank financing. She realizes that there are a number of models to consider, including the CAPM,multifactor models, and build-up models.Which of the following statements regarding the models used to estimate the required return is mostaccurate?

A. A strength of the capital asset pricing model (CAPM) is that it usually has high explanatory power. 
B. A strength of multifactor models is their relative simplicity and ease of calculation. 
C. A weakness of build-up models is that they typically use historical values as estimates that may not be relevant to current market conditions.  

Show Answer

Question # 12

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by hersupervisor to cover a number of different equity and debt investments. One of the investments isTaylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensiveanalysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. Inapplying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel,Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has tradedat a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitativeinformation to consider. The return on a value-weighted market index minus the risk-free rate is5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquiditypremium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas forDevon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium,Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor modelsthat includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between thereturn of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the requiredreturn for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue withinthe next year. The company has not previously issued debt securities to the public, relying instead onbank financing. She realizes that there are a number of models to consider, including the CAPM,multifactor models, and build-up models.Which of the following statements regarding the models used to estimate the required return is mostaccurate?

A. A strength of the capital asset pricing model (CAPM) is that it usually has high explanatory power. 
B. A strength of multifactor models is their relative simplicity and ease of calculation. 
C. A weakness of build-up models is that they typically use historical values as estimates that may not be relevant to current market conditions.  

Show Answer

Question # 13

Kylie Autumn, CFA, is a consultant with Tri-Vision Group. Robert Lullum, Senior Vice President aiLangsford Investments, has asked for assistance with the evaluation of mortgage-backed andcollateralized mortgage obligation (CMO) derivative securities for potential inclusion in several clientportfolios. Langsford Investments mainly deals with equity investments and REITs, but the companyrecently purchased a small firm that invests mainly in fixed-income securities.Lullum has done some research on the appropriate spread measures and option valuation models forfixed-income securities and wants to clarify some points. He wants to know if the followingstatements are correct:Statement 1: The proper spread measure for option-free corporate bonds is the nominal spread.Statement 2: Callable corporate bonds and mortgage-backed securities should be measured usingthe option-added spread.Statement 3: The Z-spread is appropriate for credit card ABS and auto loan ABS.While Lullum meets with Autumn, Janet Van Ark, CFA charterholder and equity-income portfoliomanagerfor Langsford, is attempting to purchase bondsthat may also provide her with equityexposure in the future. She has decided to analyze an 8% annual coupon bond with exactly 20 yearsto maturity. The bonds are convertible into 10 common sharesfor each $ 1,000 of par(face) value.The bond's market price is $920, and the common stock has a market price of $40. Van Ark estimatesthat the stock will increase in value to $70 within the next two years. The stock's annual dividend is$0.40 per share, and the market yield on comparable non-convertible bonds'is 9.5%.Carl Leighton, a Langsford analyst and Level 2 CFA candidate, works with mortgage-backed and otherasset-based securities. He provides Lullum with a list of credit enhancementsfor asset-backedsecurities, which includesletters of credit, excess servicing spread funds, overcollateralization, andbond insurance. Lullum then asks him for a statusreport of the firm's exposure to paythroughsecurities. He also asks Leighton to calculate the single-monthly mortality rate (SMM) and estimate theprepayment for the month for a seasoned mortgage pool with a $500,000 principal balanceremaining. The scheduled monthly principal payment is $ 150 and the conditional prepayment rate(CPR) is 7%.Which of the following pairs correctly identifies the two external credit enhancements in Leighton's list?

A. Letters of credit and excess servicing spread funds.
B. Excess servicing spread funds and bond insurance.
C. Letters of credit and bond insurance.

Show Answer

Question # 14

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by hersupervisor to cover a number of different equity and debt investments. One of the investments isTaylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensiveanalysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. Inapplying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel,Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has tradedat a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitativeinformation to consider. The return on a value-weighted market index minus the risk-free rate is5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquiditypremium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas forDevon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium,Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor modelsthat includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between thereturn of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the requiredreturn for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue withinthe next year. The company has not previously issued debt securities to the public, relying instead onbank financing. She realizes that there are a number of models to consider, including the CAPM,multifactor models, and build-up models.Are Saunders' statements regarding the macroeconomic multifactor models correct?

A. Both statements are incorrect. 
B. Only Statement I is correct. 
C. Only Statement 2 is correct. 

Show Answer

Question # 15

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by hersupervisor to cover a number of different equity and debt investments. One of the investments isTaylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensiveanalysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. Inapplying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel,Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has tradedat a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitativeinformation to consider. The return on a value-weighted market index minus the risk-free rate is5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquiditypremium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas forDevon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium,Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor modelsthat includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between thereturn of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the requiredreturn for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue withinthe next year. The company has not previously issued debt securities to the public, relying instead onbank financing. She realizes that there are a number of models to consider, including the CAPM,multifactor models, and build-up models.Which of the following approaches/methods is most appropriate for Lear to consider in determiningthe required return for Densmore?

A. Build-up method. 
B. Risk premium approach. 
C. Bond-yield plus risk premium method. 

Show Answer

Question # 16

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by hersupervisor to cover a number of different equity and debt investments. One of the investments isTaylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensiveanalysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. Inapplying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel,Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has tradedat a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitativeinformation to consider. The return on a value-weighted market index minus the risk-free rate is5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquiditypremium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas forDevon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium,Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor modelsthat includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between thereturn of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the requiredreturn for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue withinthe next year. The company has not previously issued debt securities to the public, relying instead onbank financing. She realizes that there are a number of models to consider, including the CAPM multifactor models, and build-up models.Lear's choice of the Gordon growth model is an example of which of the following types of estimatesof the equity risk premium?

A. Historical estimate. 
B. Forward-looking estimate. 
C. Macroeconomic model estimate. 

Show Answer

Question # 17

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by hersupervisor to cover a number of different equity and debt investments. One of the investments isTaylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensiveanalysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. Inapplying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel,Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has tradedat a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitativeinformation to consider. The return on a value-weighted market index minus the risk-free rate is5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquiditypremium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas forDevon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium,Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor modelsthat includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between thereturn of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the requiredreturn for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue withinthe next year. The company has not previously issued debt securities to the public, relying instead onbank financing. She realizes that there are a number of models to consider, including the CAPM,multifactor models, and build-up models.According to the FFM, the estimate of the required return for Devon is closest to:

A. 9.4%. 
B. 11.8%. 
C. 13.4%. 

Show Answer

Question # 18

Kylie Autumn, CFA, is a consultant with Tri-Vision Group. Robert Lullum, Senior Vice President aiLangsford Investments, has asked for assistance with the evaluation of mortgage-backed andcollateralized mortgage obligation (CMO) derivative securities for potential inclusion in several clientportfolios. Langsford Investments mainly deals with equity investments and REITs, but the companyrecently purchased a small firm that invests mainly in fixed-income securities.Lullum has done some research on the appropriate spread measures and option valuation models forfixed-income securities and wants to clarify some points. He wants to know if the followingstatements are correct:Statement 1: The proper spread measure for option-free corporate bonds is the nominal spread.Statement 2: Callable corporate bonds and mortgage-backed securities should be measured usingthe option-added spread.Statement 3: The Z-spread is appropriate for credit card ABS and auto loan ABS.While Lullum meets with Autumn, Janet Van Ark, CFA charterholder and equity-income portfoliomanagerfor Langsford, is attempting to purchase bondsthat may also provide her with equityexposure in the future. She has decided to analyze an 8% annual coupon bond with exactly 20 yearsto maturity. The bonds are convertible into 10 common sharesfor each $ 1,000 of par(face) value.The bond's market price is $920, and the common stock has a market price of $40. Van Ark estimatesthat the stock will increase in value to $70 within the next two years. The stock's annual dividend is$0.40 per share, and the market yield on comparable non-convertible bonds'is 9.5%.Carl Leighton, a Langsford analyst and Level 2 CFA candidate, works with mortgage-backed and otherasset-based securities. He provides Lullum with a list of credit enhancementsfor asset-backedsecurities, which includesletters of credit, excess servicing spread funds, overcollateralization, andbond insurance. Lullum then asks him for a statusreport of the firm's exposure to paythroughsecurities. He also asks Leighton to calculate the single-monthly mortality rate (SMM) and estimate theprepayment for the month for a seasoned mortgage pool with a $500,000 principal balanceremaining. The scheduled monthly principal payment is $ 150 and the conditional prepayment rate(CPR) is 7%.Which of the following statements about interest-only (10) and principal-only (PO)stripsisleastaccurate?

A. The 10 price is positively related to interest rates, and at low current rates, POs exhibit some negative convexity
B. IO cash flowsstart out large and diminish overtime. As a result, 10 investors are most concerned with extension risk
C. In general, the volatility of the combined 10 and PO strips equals the price volatility of the source passthrough. 

Show Answer

Question # 19

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by hersupervisor to cover a number of different equity and debt investments. One of the investments isTaylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensiveanalysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. In applying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel,Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has tradedat a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitativeinformation to consider. The return on a value-weighted market index minus the risk-free rate is5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquiditypremium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas forDevon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium,Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor modelsthat includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between thereturn of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the requiredreturn for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue withinthe next year. The company has not previously issued debt securities to the public, relying instead onbank financing. She realizes that there are a number of models to consider, including the CAPM,multifactor models, and build-up models.Based on Lear's analysis, Taylor's stock is most likely to be:

A. correctly valued. 
B. overvalued. 
C. undervalued. 

Show Answer

Question # 20

Kylie Autumn, CFA, is a consultant with Tri-Vision Group. Robert Lullum, Senior Vice President aiLangsford Investments, has asked for assistance with the evaluation of mortgage-backed andcollateralized mortgage obligation (CMO) derivative securities for potential inclusion in several clientportfolios. Langsford Investments mainly deals with equity investments and REITs, but the companyrecently purchased a small firm that invests mainly in fixed-income securities.Lullum has done some research on the appropriate spread measures and option valuation models forfixed-income securities and wants to clarify some points. He wants to know if the followingstatements are correct:Statement 1: The proper spread measure for option-free corporate bonds is the nominal spread.Statement 2: Callable corporate bonds and mortgage-backed securities should be measured usingthe option-added spread.Statement 3: The Z-spread is appropriate for credit card ABS and auto loan ABS.While Lullum meets with Autumn, Janet Van Ark, CFA charterholder and equity-income portfoliomanagerfor Langsford, is attempting to purchase bondsthat may also provide her with equityexposure in the future. She has decided to analyze an 8% annual coupon bond with exactly 20 yearsto maturity. The bonds are convertible into 10 common sharesfor each $ 1,000 of par(face) value.The bond's market price is $920, and the common stock has a market price of $40. Van Ark estimatesthat the stock will increase in value to $70 within the next two years. The stock's annual dividend is$0.40 per share, and the market yield on comparable non-convertible bonds'is 9.5%.Carl Leighton, a Langsford analyst and Level 2 CFA candidate, works with mortgage-backed and otherasset-based securities. He provides Lullum with a list of credit enhancementsfor asset-backedsecurities, which includesletters of credit, excess servicing spread funds, overcollateralization, andbond insurance. Lullum then asks him for a statusreport of the firm's exposure to paythroughsecurities. He also asks Leighton to calculate the single-monthly mortality rate (SMM) and estimate theprepayment for the month for a seasoned mortgage pool with a $500,000 principal balanceremaining. The scheduled monthly principal payment is $ 150 and the conditional prepayment rate(CPR) is 7%.How many of the three statements on appropriate spread measures and valuation models arecorrect?

A. Only two statements are correct.
B. Only one statement is correct.
C. None of the three statements are correct.

Show Answer

Question # 21

Bryan Galloway is a strategist for JS Investments, a small money management firm. His goal is toanalyze industries to determine whether there is justification for over- or under-weighting. Hissupervisor, Robyn Black, CFA, has asked that he document the process he uses to make hisrecommendations. However, just to be sure that Galloway understands industry analysis. Black askshim to provide examples of supply and demand analysis. Galloway makes the following twostatements to prove that he understands the issue:Statement 1: In analyzing supply in the tire and rubber industry, it is clear that the sale of eachadditional automobile will result in the sale of approximately two winter tires.Statement 2: In analyzing demand for services in the healthcare industry, for every 100 new hospitalbeds required, 20 additional doctors are needed.Black is not entirely confident in Galloway's abilities to analyze various industries, but decides toallow him to continue with his analysis.Four of the largest holdings for JS Investments are a tobacco company, a soda drink company, an oilcompany, and a cable TV company. Black is worried that government intervention will have a seriousimpact on future growth for these companies and asks Galloway to further research each of theindustries involved. However, just to make sure Galloway can handle this project. Black first asks himto review the basics of industry analysis.In reviewing the factors affecting pricing considerations, Galloway concludes that all of the followingare of direct importance:Factor 1: Price changes in key supply inputs.Factor 2: Product segmentation.Factor 3: Ease of entry into the industry.Factor 4: Degree of industry concentration.Galloway also makes the following statements about the characteristics of the phases of theindustrial life cycle:Characteristic 1: Participants compete for market share in a stable industry.Characteristic 2: Changing tastes have an important impact on the industry.Characteristic 3: It is not clear that a product will be accepted in the industry.Characteristic 4: Proper execution of strategy is critical.Each of the phases is represented by one characteristic.What life cycle phase most appropriately reflects Characteristic 1 and Characteristic 3?

A. Mature and pioneer. 
B. Mature and growth. 
C. Decline and growth 

Show Answer

Question # 22

Bryan Galloway is a strategist for JS Investments, a small money management firm. His goal is toanalyze industries to determine whether there is justification for over- or under-weighting. Hissupervisor, Robyn Black, CFA, has asked that he document the process he uses to make hisrecommendations. However, just to be sure that Galloway understands industry analysis. Black askshim to provide examples of supply and demand analysis. Galloway makes the following twostatements to prove that he understands the issue:Statement 1: In analyzing supply in the tire and rubber industry, it is clear that the sale of eachadditional automobile will result in the sale of approximately two winter tires.Statement 2: In analyzing demand for services in the healthcare industry, for every 100 new hospitalbeds required, 20 additional doctors are needed.Black is not entirely confident in Galloway's abilities to analyze various industries, but decides toallow him to continue with his analysis.Four of the largest holdings for JS Investments are a tobacco company, a soda drink company, an oilcompany, and a cable TV company. Black is worried that government intervention will have a seriousimpact on future growth for these companies and asks Galloway to further research each of theindustries involved. However, just to make sure Galloway can handle this project. Black first asks himto review the basics of industry analysis.In reviewing the factors affecting pricing considerations, Galloway concludes that all of the followingare of direct importance:Factor 1: Price changes in key supply inputs.Factor 2: Product segmentation.Factor 3: Ease of entry into the industry.Factor 4: Degree of industry concentration.Galloway also makes the following statements about the characteristics of the phases of theindustrial life cycle:Characteristic 1: Participants compete for market share in a stable industry.Characteristic 2: Changing tastes have an important impact on the industry.Characteristic 3: It is not clear that a product will be accepted in the industry.Characteristic 4: Proper execution of strategy is critical.Each of the phases is represented by one characteristic.Did Galloway correctly identity the factors that directly affect pricing considerations?

A. Yes. 
B. No, changing tastes do not have a direct impact on pricing. 
C. No, competition for market share in a stable industry is not a pricing consideration. 

Show Answer

Question # 23

Bryan Galloway is a strategist for JS Investments, a small money management firm. His goal is toanalyze industries to determine whether there is justification for over- or under-weighting. Hissupervisor, Robyn Black, CFA, has asked that he document the process he uses to make hisrecommendations. However, just to be sure that Galloway understands industry analysis. Black askshim to provide examples of supply and demand analysis. Galloway makes the following twostatements to prove that he understands the issue:Statement 1: In analyzing supply in the tire and rubber industry, it is clear that the sale of eachadditional automobile will result in the sale of approximately two winter tires.Statement 2: In analyzing demand for services in the healthcare industry, for every 100 new hospitalbeds required, 20 additional doctors are needed.Black is not entirely confident in Galloway's abilities to analyze various industries, but decides toallow him to continue with his analysis.Four of the largest holdings for JS Investments are a tobacco company, a soda drink company, an oilcompany, and a cable TV company. Black is worried that government intervention will have a seriousimpact on future growth for these companies and asks Galloway to further research each of theindustries involved. However, just to make sure Galloway can handle this project. Black first asks himto review the basics of industry analysis.In reviewing the factors affecting pricing considerations, Galloway concludes that all of the followingare of direct importance:Factor 1: Price changes in key supply inputs.Factor 2: Product segmentation.Factor 3: Ease of entry into the industry.Factor 4: Degree of industry concentration.Galloway also makes the following statements about the characteristics of the phases of theindustrial life cycle:Characteristic 1: Participants compete for market share in a stable industry.Characteristic 2: Changing tastes have an important impact on the industry.Characteristic 3: It is not clear that a product will be accepted in the industry.Characteristic 4: Proper execution of strategy is critical.Each of the phases is represented by one characteristic.For which of the following global industries would U.S. government involvement most likelyrepresent an example of a negative external influence?

A. The oil industry. 
B. The tobacco industry. 
C. The cable TV industry. 

Show Answer

Question # 24

Kylie Autumn, CFA, is a consultant with Tri-Vision Group. Robert Lullum, Senior Vice President aiLangsford Investments, has asked for assistance with the evaluation of mortgage-backed andcollateralized mortgage obligation (CMO) derivative securities for potential inclusion in several clientportfolios. Langsford Investments mainly deals with equity investments and REITs, but the companyrecently purchased a small firm that invests mainly in fixed-income securities.Lullum has done some research on the appropriate spread measures and option valuation models forfixed-income securities and wants to clarify some points. He wants to know if the followingstatements are correct:Statement 1: The proper spread measure for option-free corporate bonds is the nominal spread.Statement 2: Callable corporate bonds and mortgage-backed securities should be measured usingthe option-added spread.Statement 3: The Z-spread is appropriate for credit card ABS and auto loan ABS.While Lullum meets with Autumn, Janet Van Ark, CFA charterholder and equity-income portfoliomanagerfor Langsford, is attempting to purchase bondsthat may also provide her with equityexposure in the future. She has decided to analyze an 8% annual coupon bond with exactly 20 yearsto maturity. The bonds are convertible into 10 common sharesfor each $ 1,000 of par(face) value.The bond's market price is $920, and the common stock has a market price of $40. Van Ark estimatesthat the stock will increase in value to $70 within the next two years. The stock's annual dividend is$0.40 per share, and the market yield on comparable non-convertible bonds'is 9.5%.Carl Leighton, a Langsford analyst and Level 2 CFA candidate, works with mortgage-backed and otherasset-based securities. He provides Lullum with a list of credit enhancementsfor asset-backedsecurities, which includesletters of credit, excess servicing spread funds, overcollateralization, andbond insurance. Lullum then asks him for a statusreport of the firm's exposure to paythroughsecurities. He also asks Leighton to calculate the single-monthly mortality rate (SMM) and estimate theprepayment for the month for a seasoned mortgage pool with a $500,000 principal balanceremaining. The scheduled monthly principal payment is $ 150 and the conditional prepayment rate(CPR) is 7%.Autumn should tell Lullum that the most appropriate models for valuing the option on mortgagebacked securities (MBS) and credit card asset-backed securities (ABS) are:

A. Monte Carlo for both the MBS and the ABS. 
B. Monte Carlo or binomial for the MBS, but binomial only for the ABS. 
C. Monte Carlo for the MBS. No model is needed for the ABS. 

Show Answer

Question # 25

Bryan Galloway is a strategist for JS Investments, a small money management firm. His goal is toanalyze industries to determine whether there is justification for over- or under-weighting. Hissupervisor, Robyn Black, CFA, has asked that he document the process he uses to make hisrecommendations. However, just to be sure that Galloway understands industry analysis. Black askshim to provide examples of supply and demand analysis. Galloway makes the following twostatements to prove that he understands the issue:Statement 1: In analyzing supply in the tire and rubber industry, it is clear that the sale of eachadditional automobile will result in the sale of approximately two winter tires.Statement 2: In analyzing demand for services in the healthcare industry, for every 100 new hospitalbeds required, 20 additional doctors are needed.Black is not entirely confident in Galloway's abilities to analyze various industries, but decides toallow him to continue with his analysis.Four of the largest holdings for JS Investments are a tobacco company, a soda drink company, an oilcompany, and a cable TV company. Black is worried that government intervention will have a seriousimpact on future growth for these companies and asks Galloway to further research each of theindustries involved. However, just to make sure Galloway can handle this project. Black first asks himto review the basics of industry analysis.In reviewing the factors affecting pricing considerations, Galloway concludes that all of the followingare of direct importance:Factor 1: Price changes in key supply inputs.Factor 2: Product segmentation.Factor 3: Ease of entry into the industry.Factor 4: Degree of industry concentration.Galloway also makes the following statements about the characteristics of the phases of theindustrial life cycle:Characteristic 1: Participants compete for market share in a stable industry.Characteristic 2: Changing tastes have an important impact on the industry.Characteristic 3: It is not clear that a product will be accepted in the industry.Characteristic 4: Proper execution of strategy is critical.Each of the phases is represented by one characteristic.Are the two statements regarding supply and demand analysis correct or incorrect?

A. Both statements are correct. 
B. Only one of the statements is correct. 
C. Both statements are incorrect. 

Show Answer

Question # 26

Bryan Galloway is a strategist for JS Investments, a small money management firm. His goal is toanalyze industries to determine whether there is justification for over- or under-weighting. Hissupervisor, Robyn Black, CFA, has asked that he document the process he uses to make hisrecommendations. However, just to be sure that Galloway understands industry analysis. Black askshim to provide examples of supply and demand analysis. Galloway makes the following twostatements to prove that he understands the issue:Statement 1: In analyzing supply in the tire and rubber industry, it is clear that the sale of eachadditional automobile will result in the sale of approximately two winter tires.Statement 2: In analyzing demand for services in the healthcare industry, for every 100 new hospitalbeds required, 20 additional doctors are needed.Black is not entirely confident in Galloway's abilities to analyze various industries, but decides toallow him to continue with his analysis.Four of the largest holdings for JS Investments are a tobacco company, a soda drink company, an oilcompany, and a cable TV company. Black is worried that government intervention will have a seriousimpact on future growth for these companies and asks Galloway to further research each of theindustries involved. However, just to make sure Galloway can handle this project. Black first asks himto review the basics of industry analysis.In reviewing the factors affecting pricing considerations, Galloway concludes that all of the followingare of direct importance:Factor 1: Price changes in key supply inputs.Factor 2: Product segmentation.Factor 3: Ease of entry into the industry.Factor 4: Degree of industry concentration.Galloway also makes the following statements about the characteristics of the phases of theindustrial life cycle:Characteristic 1: Participants compete for market share in a stable industry.Characteristic 2: Changing tastes have an important impact on the industry.Characteristic 3: It is not clear that a product will be accepted in the industry.Characteristic 4: Proper execution of strategy is critical.Each of the phases is represented by one characteristic.Excluding external factors, industry analysis is best described as including:

A. industry classification; profitability analysis; innovation turnover. 
B. industry classification; demand analysis; supply analysis; profitability analysis. 
C. profitability analysis; competition analysis; innovation turnover; industry classification. 

Show Answer

Question # 27

Galena Petrovich, CFA, is an analyst in the New York office of TRS Investment Management, Inc.Petrovich is an expert in the industrial electrical equipment sector and is analyzing Fisher Global.Fisher is a global market leader in designing, manufacturing, marketing, and servicing electricalsystems and components, including fluid power systems and automotive engine air managementsystems.Fisher has generated double-digit growth over the past ten years, primarily as the result ofacquisitions, and has reported positive net income in each year. Fisher reports its financial resultsusing International Financial Reporting Standards (IFRS).Petrovich is particularly interested in a transaction that occurred seven years ago, before the changein accounting standards, in which Fisher used the pooling method to account for a large acquisitionof Dartmouth Industries, an industry competitor. She would like to determine the effect of using thepurchase method instead of the pooling method on the financial statements of Fisher. Fisherexchanged common stock for all of the outstanding shares of Dartmouth.Fisher also has a 50% ownership interest in a joint venture with its major distributor, a U.S. companycalled Hydro Distribution. She determines that Fisher has reported its ownership interest under theproportioned consolidation method, and that the joint venture has been profitable since it wasestablished three years ago. She decides to adjust the financial statements to show how the financialstatements would be affected if Fisher had reported its ownership under the equity method. Fisher isalso considering acquiring 80% to 100% of Brown and Sons Company. Petrovich must consider theeffect of such an acquisition on Fisher's financial statements.Petrovich determines from the financial statement footnotes that Fisher reported an unrealized gainin its most recent income statement related to debt securities that are designated at fair value.Competitor firms following U.S. GAAP classify similar debt securities as available-for-sale.Finally, Petrovich finds a reference in Fisher's footnotes regarding a special purpose entity (SPE).Fisher has reported its investment in the SPE using the equity method, but Petrovich believes thatthe consolidation method more accurately reflects Fisher's true financial position, so she makes theappropriate adjustments to the financial statements.What are the likely effects on return on assets (ROA) and net profit margin (ignoring any tax effects)of correctly adjusting for Fisher Global's investment in the SPE using the acquisition method?ROANet profit margin

A. No changeDecrease
B. DecreaseNo change
C. DecreaseDecrease

Show Answer

Question # 28

Galena Petrovich, CFA, is an analyst in the New York office of TRS Investment Management, Inc.Petrovich is an expert in the industrial electrical equipment sector and is analyzing Fisher Global.Fisher is a global market leader in designing, manufacturing, marketing, and servicing electricalsystems and components, including fluid power systems and automotive engine air managementsystems.Fisher has generated double-digit growth over the past ten years, primarily as the result ofacquisitions, and has reported positive net income in each year. Fisher reports its financial resultsusing International Financial Reporting Standards (IFRS).Petrovich is particularly interested in a transaction that occurred seven years ago, before the changein accounting standards, in which Fisher used the pooling method to account for a large acquisitionof Dartmouth Industries, an industry competitor. She would like to determine the effect of using thepurchase method instead of the pooling method on the financial statements of Fisher. Fisherexchanged common stock for all of the outstanding shares of Dartmouth.Fisher also has a 50% ownership interest in a joint venture with its major distributor, a U.S. companycalled Hydro Distribution. She determines that Fisher has reported its ownership interest under theproportioned consolidation method, and that the joint venture has been profitable since it wasestablished three years ago. She decides to adjust the financial statements to show how the financialstatements would be affected if Fisher had reported its ownership under the equity method. Fisher isalso considering acquiring 80% to 100% of Brown and Sons Company. Petrovich must consider theeffect of such an acquisition on Fisher's financial statements.Petrovich determines from the financial statement footnotes that Fisher reported an unrealized gainin its most recent income statement related to debt securities that are designated at fair value.Competitor firms following U.S. GAAP classify similar debt securities as available-for-sale.Finally, Petrovich finds a reference in Fisher's footnotes regarding a special purpose entity (SPE).Fisher has reported its investment in the SPE using the equity method, but Petrovich believes thatthe consolidation method more accurately reflects Fisher's true financial position, so she makes theappropriate adjustments to the financial statements.For comparison purposes, Petrovich decides to reclassify Fisher GlobaPs debt securities as availablefor-sale. Ignoring any effect on income taxes, which of the following best describes the effects of thenecessary adjustments?

A. Net income is lower and asset turnover is higher.
B. Return on assets is lower and debt-to-cquity is lower.
C. Return on equity is lower and debt-to-total capital is not affected.

Show Answer

Question # 29

Galena Petrovich, CFA, is an analyst in the New York office of TRS Investment Management, Inc.Petrovich is an expert in the industrial electrical equipment sector and is analyzing Fisher Global.Fisher is a global market leader in designing, manufacturing, marketing, and servicing electricalsystems and components, including fluid power systems and automotive engine air managementsystems.Fisher has generated double-digit growth over the past ten years, primarily as the result ofacquisitions, and has reported positive net income in each year. Fisher reports its financial resultsusing International Financial Reporting Standards (IFRS).Petrovich is particularly interested in a transaction that occurred seven years ago, before the changein accounting standards, in which Fisher used the pooling method to account for a large acquisitionof Dartmouth Industries, an industry competitor. She would like to determine the effect of using thepurchase method instead of the pooling method on the financial statements of Fisher. Fisherexchanged common stock for all of the outstanding shares of Dartmouth.Fisher also has a 50% ownership interest in a joint venture with its major distributor, a U.S. companycalled Hydro Distribution. She determines that Fisher has reported its ownership interest under theproportioned consolidation method, and that the joint venture has been profitable since it wasestablished three years ago. She decides to adjust the financial statements to show how the financialstatements would be affected if Fisher had reported its ownership under the equity method. Fisher isalso considering acquiring 80% to 100% of Brown and Sons Company. Petrovich must consider theeffect of such an acquisition on Fisher's financial statements.Petrovich determines from the financial statement footnotes that Fisher reported an unrealized gainin its most recent income statement related to debt securities that are designated at fair value.Competitor firms following U.S. GAAP classify similar debt securities as available-for-sale.Finally, Petrovich finds a reference in Fisher's footnotes regarding a special purpose entity (SPE).Fisher has reported its investment in the SPE using the equity method, but Petrovich believes thatthe consolidation method more accurately reflects Fisher's true financial position, so she makes theappropriate adjustments to the financial statements.If Fisher Global decides to purchase only 80% of Brown and Sons, under 1FRS they will have theoption to:

A. report the acquisition as either a business combination or as an acquisition.
B. value the identifiable assets and liabilities of Brown and Sons at their current book values or at fairmarket value.
C. report more or less goodwill depending on the accounting method they choose.

Show Answer

Question # 30

Bryan Galloway is a strategist for JS Investments, a small money management firm. His goal is toanalyze industries to determine whether there is justification for over- or under-weighting. Hissupervisor, Robyn Black, CFA, has asked that he document the process he uses to make hisrecommendations. However, just to be sure that Galloway understands industry analysis. Black askshim to provide examples of supply and demand analysis. Galloway makes the following twostatements to prove that he understands the issue:Statement 1: In analyzing supply in the tire and rubber industry, it is clear that the sale of eachadditional automobile will result in the sale of approximately two winter tires.Statement 2: In analyzing demand for services in the healthcare industry, for every 100 new hospitalbeds required, 20 additional doctors are needed.Black is not entirely confident in Galloway's abilities to analyze various industries, but decides toallow him to continue with his analysis.Four of the largest holdings for JS Investments are a tobacco company, a soda drink company, an oilcompany, and a cable TV company. Black is worried that government intervention will have a seriousimpact on future growth for these companies and asks Galloway to further research each of theindustries involved. However, just to make sure Galloway can handle this project. Black first asks himto review the basics of industry analysis.In reviewing the factors affecting pricing considerations, Galloway concludes that all of the followingare of direct importance:Factor 1: Price changes in key supply inputs.Factor 2: Product segmentation.Factor 3: Ease of entry into the industry.Factor 4: Degree of industry concentration.Galloway also makes the following statements about the characteristics of the phases of theindustrial life cycle:Characteristic 1: Participants compete for market share in a stable industry.Characteristic 2: Changing tastes have an important impact on the industry.Characteristic 3: It is not clear that a product will be accepted in the industry.Characteristic 4: Proper execution of strategy is critical.Each of the phases is represented by one characteristic.Which of the following choices best describes all the elements that Galloway should consider indoing an analysis of external factors in an industry analysis?

A. Technology; government; social; demographic; foreign. 
B. Social; demographic; foreign; pricing; degree of concentration. 
C. Government; technology; end users; degree of concentration; ease of entry. 

Show Answer

Question # 31

Martin Hagemann, CFA, works for a large brokerage firm in Frankfurt, Germany. Hagemann has beenhired by Tryssen AG, a global research-based company that is preparing to go public after a longhistory of operating privately. The need to raise substantial amounts of capital to fund research anddevelopment activities is seen as the key motivation for the change in policy. Tryssen is engaged inthe discovery, development, manufacture, marketing, and sale of medical products.Hagemann's first task is to recommend an exchange upon which Tryssen stock can be traded. Onepossibility is the Deutsche Bourse. The Deutsche Bourse operates primarily as a continuous orderdriven system. Another alternative that Tryssen is considering is to list on a different exchange thatoperates as a price-driven system.As an alternative, Tryssen may choose to list as an American Depository Receipt (ADR). ADRs arenegotiable U.S. securities that usually represent a non-U.S. based company's publicly traded equity.Although typically denominated in U.S. dollars, depository receipts can also be denominated ineuros. Depository receipts can be eligible to trade on all U.S. stock exchanges as well as on manyEuropean stock exchanges.The increasing demand for depository receipts is driven by the desire of individual and institutionalinvestors to diversify their portfolios, reduce risk and invest internationally in the most efficientmanner possible. While most investors recognize the benefits of global diversification, there aremany challenges presented when investing directly in local trading markets. Obstacles can includeinefficient trade settlements, uncertain custody services, and costly currency conversions. Depositoryreceipts overcome many of the inherent operational and custodial hurdles inherent in internationalinvesting. Tryssen has decided to access the U.S. market by involving itself in an ADR program.Tryssen has decided to save itself a lot of trouble, however, by not complying with SEC registrationand reporting requirements.As an alternative to ADRs, investors interested in increasing their exposure to internationalinvestments can choose to acquire exchange traded funds (ETFs). Hagemann researches theadvantages and disadvantages of ETFs.Execution costs are always a concern, and perhaps even more so for international investors. At thepresent time, Tryssen AG is most concerned with how reliably it can estimate trading costs. As part ofthe cost estimation process, Hagemann is asked to provide a report on the advantages anddisadvantages of techniques used to reduce execution costs.Trysse AG proceeds to list on the Frankfurt exchange, and a U.S. affiliate of Hagemann's companystarts to aggressively promote the stock. A U.S. investor buys 200 shares of Tryssen at a price of €20per share. At time of purchase, the exchange rate is €1 = $1.15. One month later Tryssen pays adividend of €0.25 per share, and investors are subject to a withholding tax of 20%. The U.S. investoris eligible to claim a tax credit of $0.06 per share. At the time the dividend was paid, the shares hadjumped to €24 each and the U.S. dollar had weakened to €1 = $ 1.20. The shares were sold just afterthe dividend was paid.The capital gain for the U.S. investor in Tryssen stock and the dividend after adjusting for thewithholding tax but before the tax credit are closest to:Capital gain Adjusted dividend

A. $720 $48 
B $1,160 $48 
C. $1,160 $60 

Show Answer

Question # 32

Galena Petrovich, CFA, is an analyst in the New York office of TRS Investment Management, Inc.Petrovich is an expert in the industrial electrical equipment sector and is analyzing Fisher Global.Fisher is a global market leader in designing, manufacturing, marketing, and servicing electricalsystems and components, including fluid power systems and automotive engine air managementsystems.Fisher has generated double-digit growth over the past ten years, primarily as the result ofacquisitions, and has reported positive net income in each year. Fisher reports its financial resultsusing International Financial Reporting Standards (IFRS).Petrovich is particularly interested in a transaction that occurred seven years ago, before the changein accounting standards, in which Fisher used the pooling method to account for a large acquisitionof Dartmouth Industries, an industry competitor. She would like to determine the effect of using thepurchase method instead of the pooling method on the financial statements of Fisher. Fisherexchanged common stock for all of the outstanding shares of Dartmouth.Fisher also has a 50% ownership interest in a joint venture with its major distributor, a U.S. companycalled Hydro Distribution. She determines that Fisher has reported its ownership interest under theproportioned consolidation method, and that the joint venture has been profitable since it wasestablished three years ago. She decides to adjust the financial statements to show how the financialstatements would be affected if Fisher had reported its ownership under the equity method. Fisher isalso considering acquiring 80% to 100% of Brown and Sons Company. Petrovich must consider theeffect of such an acquisition on Fisher's financial statements.Petrovich determines from the financial statement footnotes that Fisher reported an unrealized gainin its most recent income statement related to debt securities that are designated at fair value.Competitor firms following U.S. GAAP classify similar debt securities as available-for-sale.Finally, Petrovich finds a reference in Fisher's footnotes regarding a special purpose entity (SPE).Fisher has reported its investment in the SPE using the equity method, but Petrovich believes thatthe consolidation method more accurately reflects Fisher's true financial position, so she makes theappropriate adjustments to the financial statements.Regarding the goodwill on the acquisition of Brown and Sons being considered by Fisher Global,which of the following statements is correct?

A. It is equal to the excess of the purchase price over the fair value of the identifiable assets andliabilities and must be amortized over no longer than 30 years.
B. It will be reported as an asset, not amortized, and must be reviewed for impairment at leastannually, with same test for impairment under IFRS and U.S. GAAP.
C. For goodwill that is found to be impaired, the amount of the impairment charge reported is thesame under both IFRS and U.S. GAAP.

Show Answer

Question # 33

Martin Hagemann, CFA, works for a large brokerage firm in Frankfurt, Germany. Hagemann has beenhired by Tryssen AG, a global research-based company that is preparing to go public after a longhistory of operating privately. The need to raise substantial amounts of capital to fund research anddevelopment activities is seen as the key motivation for the change in policy. Tryssen is engaged inthe discovery, development, manufacture, marketing, and sale of medical products.Hagemann's first task is to recommend an exchange upon which Tryssen stock can be traded. One possibility is the Deutsche Bourse. The Deutsche Bourse operates primarily as a continuous orderdriven system. Another alternative that Tryssen is considering is to list on a different exchange thatoperates as a price-driven system.As an alternative, Tryssen may choose to list as an American Depository Receipt (ADR). ADRs arenegotiable U.S. securities that usually represent a non-U.S. based company's publicly traded equity.Although typically denominated in U.S. dollars, depository receipts can also be denominated ineuros. Depository receipts can be eligible to trade on all U.S. stock exchanges as well as on manyEuropean stock exchanges.The increasing demand for depository receipts is driven by the desire of individual and institutionalinvestors to diversify their portfolios, reduce risk and invest internationally in the most efficientmanner possible. While most investors recognize the benefits of global diversification, there aremany challenges presented when investing directly in local trading markets. Obstacles can includeinefficient trade settlements, uncertain custody services, and costly currency conversions. Depositoryreceipts overcome many of the inherent operational and custodial hurdles inherent in internationalinvesting. Tryssen has decided to access the U.S. market by involving itself in an ADR program.Tryssen has decided to save itself a lot of trouble, however, by not complying with SEC registrationand reporting requirements.As an alternative to ADRs, investors interested in increasing their exposure to internationalinvestments can choose to acquire exchange traded funds (ETFs). Hagemann researches theadvantages and disadvantages of ETFs.Execution costs are always a concern, and perhaps even more so for international investors. At thepresent time, Tryssen AG is most concerned with how reliably it can estimate trading costs. As part ofthe cost estimation process, Hagemann is asked to provide a report on the advantages anddisadvantages of techniques used to reduce execution costs.Trysse AG proceeds to list on the Frankfurt exchange, and a U.S. affiliate of Hagemann's companystarts to aggressively promote the stock. A U.S. investor buys 200 shares of Tryssen at a price of €20per share. At time of purchase, the exchange rate is €1 = $1.15. One month later Tryssen pays adividend of €0.25 per share, and investors are subject to a withholding tax of 20%. The U.S. investoris eligible to claim a tax credit of $0.06 per share. At the time the dividend was paid, the shares hadjumped to €24 each and the U.S. dollar had weakened to €1 = $ 1.20. The shares were sold just afterthe dividend was paid.Which of the following represents a correct advantage and a correct disadvantage for the indicatedapproach that is aimed at reducing execution costs?

A. Internal crossing can result in best execution but opportunities are rare. 
B. Principal trades assure immediacy but result in large opportunity costs. 
C. The use of futures reduces opportunity costs but involves additional risk. 

Show Answer

Question # 34

Galena Petrovich, CFA, is an analyst in the New York office of TRS Investment Management, Inc.Petrovich is an expert in the industrial electrical equipment sector and is analyzing Fisher Global.Fisher is a global market leader in designing, manufacturing, marketing, and servicing electricalsystems and components, including fluid power systems and automotive engine air managementsystems.Fisher has generated double-digit growth over the past ten years, primarily as the result ofacquisitions, and has reported positive net income in each year. Fisher reports its financial resultsusing International Financial Reporting Standards (IFRS).Petrovich is particularly interested in a transaction that occurred seven years ago, before the changein accounting standards, in which Fisher used the pooling method to account for a large acquisitionof Dartmouth Industries, an industry competitor. She would like to determine the effect of using thepurchase method instead of the pooling method on the financial statements of Fisher. Fisherexchanged common stock for all of the outstanding shares of Dartmouth.Fisher also has a 50% ownership interest in a joint venture with its major distributor, a U.S. companycalled Hydro Distribution. She determines that Fisher has reported its ownership interest under theproportioned consolidation method, and that the joint venture has been profitable since it wasestablished three years ago. She decides to adjust the financial statements to show how the financialstatements would be affected if Fisher had reported its ownership under the equity method. Fisher isalso considering acquiring 80% to 100% of Brown and Sons Company. Petrovich must consider theeffect of such an acquisition on Fisher's financial statements.Petrovich determines from the financial statement footnotes that Fisher reported an unrealized gainin its most recent income statement related to debt securities that are designated at fair value.Competitor firms following U.S. GAAP classify similar debt securities as available-for-sale.Finally, Petrovich finds a reference in Fisher's footnotes regarding a special purpose entity (SPE).Fisher has reported its investment in the SPE using the equity method, but Petrovich believes thatthe consolidation method more accurately reflects Fisher's true financial position, so she makes theappropriate adjustments to the financial statements.Had Fisher Global reported its investment in the joint venture under the equity method rather thanunder the proportionate consolidation method, it is most likely that:

A. Reported revenue would have been the same.
B. Reported expenses would have been higher.
C. Fisher's net income would not have been affected.

Show Answer

Question # 35

Martin Hagemann, CFA, works for a large brokerage firm in Frankfurt, Germany. Hagemann has beenhired by Tryssen AG, a global research-based company that is preparing to go public after a longhistory of operating privately. The need to raise substantial amounts of capital to fund research anddevelopment activities is seen as the key motivation for the change in policy. Tryssen is engaged inthe discovery, development, manufacture, marketing, and sale of medical products.Hagemann's first task is to recommend an exchange upon which Tryssen stock can be traded. Onepossibility is the Deutsche Bourse. The Deutsche Bourse operates primarily as a continuous orderdriven system. Another alternative that Tryssen is considering is to list on a different exchange thatoperates as a price-driven system.As an alternative, Tryssen may choose to list as an American Depository Receipt (ADR). ADRs arenegotiable U.S. securities that usually represent a non-U.S. based company's publicly traded equity.Although typically denominated in U.S. dollars, depository receipts can also be denominated ineuros. Depository receipts can be eligible to trade on all U.S. stock exchanges as well as on manyEuropean stock exchanges.The increasing demand for depository receipts is driven by the desire of individual and institutionalinvestors to diversify their portfolios, reduce risk and invest internationally in the most efficientmanner possible. While most investors recognize the benefits of global diversification, there aremany challenges presented when investing directly in local trading markets. Obstacles can includeinefficient trade settlements, uncertain custody services, and costly currency conversions. Depositoryreceipts overcome many of the inherent operational and custodial hurdles inherent in internationalinvesting. Tryssen has decided to access the U.S. market by involving itself in an ADR program.Tryssen has decided to save itself a lot of trouble, however, by not complying with SEC registrationand reporting requirements.As an alternative to ADRs, investors interested in increasing their exposure to internationalinvestments can choose to acquire exchange traded funds (ETFs). Hagemann researches theadvantages and disadvantages of ETFs.Execution costs are always a concern, and perhaps even more so for international investors. At thepresent time, Tryssen AG is most concerned with how reliably it can estimate trading costs. As part ofthe cost estimation process, Hagemann is asked to provide a report on the advantages anddisadvantages of techniques used to reduce execution costs.Trysse AG proceeds to list on the Frankfurt exchange, and a U.S. affiliate of Hagemann's companystarts to aggressively promote the stock. A U.S. investor buys 200 shares of Tryssen at a price of €20per share. At time of purchase, the exchange rate is €1 = $1.15. One month later Tryssen pays adividend of €0.25 per share, and investors are subject to a withholding tax of 20%. The U.S. investoris eligible to claim a tax credit of $0.06 per share. At the time the dividend was paid, the shares hadjumped to €24 each and the U.S. dollar had weakened to €1 = $ 1.20. The shares were sold just afterthe dividend was paid.Which of the following combinations best describes the four most important execution costs inincreasing order of estimation reliability?

A. Opportunity costs; market impact; commissions; fees and taxes. 
B. Opportunity costs; commissions; fees and taxes; market impact. 
C. Commissions; fees and taxes; market impact; opportunity costs. 

Show Answer

Question # 36

Galena Petrovich, CFA, is an analyst in the New York office of TRS Investment Management, Inc.Petrovich is an expert in the industrial electrical equipment sector and is analyzing Fisher Global.Fisher is a global market leader in designing, manufacturing, marketing, and servicing electricalsystems and components, including fluid power systems and automotive engine air managementsystems.Fisher has generated double-digit growth over the past ten years, primarily as the result ofacquisitions, and has reported positive net income in each year. Fisher reports its financial resultsusing International Financial Reporting Standards (IFRS).Petrovich is particularly interested in a transaction that occurred seven years ago, before the changein accounting standards, in which Fisher used the pooling method to account for a large acquisitionof Dartmouth Industries, an industry competitor. She would like to determine the effect of using thepurchase method instead of the pooling method on the financial statements of Fisher. Fisherexchanged common stock for all of the outstanding shares of Dartmouth.Fisher also has a 50% ownership interest in a joint venture with its major distributor, a U.S. companycalled Hydro Distribution. She determines that Fisher has reported its ownership interest under theproportioned consolidation method, and that the joint venture has been profitable since it wasestablished three years ago. She decides to adjust the financial statements to show how the financialstatements would be affected if Fisher had reported its ownership under the equity method. Fisher isalso considering acquiring 80% to 100% of Brown and Sons Company. Petrovich must consider theeffect of such an acquisition on Fisher's financial statements.Petrovich determines from the financial statement footnotes that Fisher reported an unrealized gainin its most recent income statement related to debt securities that are designated at fair value.Competitor firms following U.S. GAAP classify similar debt securities as available-for-sale.Finally, Petrovich finds a reference in Fisher's footnotes regarding a special purpose entity (SPE).Fisher has reported its investment in the SPE using the equity method, but Petrovich believes thatthe consolidation method more accurately reflects Fisher's true financial position, so she makes theappropriate adjustments to the financial statements.Regarding the prior purchase that was accounted for under the pooling of interests method, hadFisher Global reported this purchase under the acquisition method:

A. the assets and liabilities of the purchased firm would not be included on Fisher's balance sheet.
B. balance sheet assets and liabilities of the purchased firm would have been reported at fair value.
C. reported goodwill could be less depending on the fair value of the identifiable assets and liabilitiescompared to their book values.

Show Answer

Question # 37

Martin Hagemann, CFA, works for a large brokerage firm in Frankfurt, Germany. Hagemann has beenhired by Tryssen AG, a global research-based company that is preparing to go public after a longhistory of operating privately. The need to raise substantial amounts of capital to fund research anddevelopment activities is seen as the key motivation for the change in policy. Tryssen is engaged inthe discovery, development, manufacture, marketing, and sale of medical products.Hagemann's first task is to recommend an exchange upon which Tryssen stock can be traded. Onepossibility is the Deutsche Bourse. The Deutsche Bourse operates primarily as a continuous orderdriven system. Another alternative that Tryssen is considering is to list on a different exchange thatoperates as a price-driven system.As an alternative, Tryssen may choose to list as an American Depository Receipt (ADR). ADRs arenegotiable U.S. securities that usually represent a non-U.S. based company's publicly traded equity.Although typically denominated in U.S. dollars, depository receipts can also be denominated ineuros. Depository receipts can be eligible to trade on all U.S. stock exchanges as well as on manyEuropean stock exchanges.The increasing demand for depository receipts is driven by the desire of individual and institutionalinvestors to diversify their portfolios, reduce risk and invest internationally in the most efficientmanner possible. While most investors recognize the benefits of global diversification, there aremany challenges presented when investing directly in local trading markets. Obstacles can includeinefficient trade settlements, uncertain custody services, and costly currency conversions. Depositoryreceipts overcome many of the inherent operational and custodial hurdles inherent in internationalinvesting. Tryssen has decided to access the U.S. market by involving itself in an ADR program.Tryssen has decided to save itself a lot of trouble, however, by not complying with SEC registrationand reporting requirements.As an alternative to ADRs, investors interested in increasing their exposure to internationalinvestments can choose to acquire exchange traded funds (ETFs). Hagemann researches theadvantages and disadvantages of ETFs.Execution costs are always a concern, and perhaps even more so for international investors. At thepresent time, Tryssen AG is most concerned with how reliably it can estimate trading costs. As part ofthe cost estimation process, Hagemann is asked to provide a report on the advantages anddisadvantages of techniques used to reduce execution costs.Trysse AG proceeds to list on the Frankfurt exchange, and a U.S. affiliate of Hagemann's companystarts to aggressively promote the stock. A U.S. investor buys 200 shares of Tryssen at a price of €20per share. At time of purchase, the exchange rate is €1 = $1.15. One month later Tryssen pays adividend of €0.25 per share, and investors are subject to a withholding tax of 20%. The U.S. investoris eligible to claim a tax credit of $0.06 per share. At the time the dividend was paid, the shares hadjumped to €24 each and the U.S. dollar had weakened to €1 = $ 1.20. The shares were sold just afterthe dividend was paid.Which of the following alternatives best describes the main benefits of ETFs?

A. Available domestically; liquid; low cost. 
B. Available domestically; diversified; liquid; low cost; tax efficient. 
C. Low cost; tax efficient; provides an active return in excess of a benchmark. 

Show Answer

Question # 38

Martin Hagemann, CFA, works for a large brokerage firm in Frankfurt, Germany. Hagemann has beenhired by Tryssen AG, a global research-based company that is preparing to go public after a longhistory of operating privately. The need to raise substantial amounts of capital to fund research anddevelopment activities is seen as the key motivation for the change in policy. Tryssen is engaged inthe discovery, development, manufacture, marketing, and sale of medical products.Hagemann's first task is to recommend an exchange upon which Tryssen stock can be traded. Onepossibility is the Deutsche Bourse. The Deutsche Bourse operates primarily as a continuous orderdriven system. Another alternative that Tryssen is considering is to list on a different exchange thatoperates as a price-driven system.As an alternative, Tryssen may choose to list as an American Depository Receipt (ADR). ADRs arenegotiable U.S. securities that usually represent a non-U.S. based company's publicly traded equity.Although typically denominated in U.S. dollars, depository receipts can also be denominated ineuros. Depository receipts can be eligible to trade on all U.S. stock exchanges as well as on manyEuropean stock exchanges.The increasing demand for depository receipts is driven by the desire of individual and institutionalinvestors to diversify their portfolios, reduce risk and invest internationally in the most efficientmanner possible. While most investors recognize the benefits of global diversification, there aremany challenges presented when investing directly in local trading markets. Obstacles can includeinefficient trade settlements, uncertain custody services, and costly currency conversions. Depositoryreceipts overcome many of the inherent operational and custodial hurdles inherent in internationalinvesting. Tryssen has decided to access the U.S. market by involving itself in an ADR program.Tryssen has decided to save itself a lot of trouble, however, by not complying with SEC registrationand reporting requirements.As an alternative to ADRs, investors interested in increasing their exposure to internationalinvestments can choose to acquire exchange traded funds (ETFs). Hagemann researches theadvantages and disadvantages of ETFs.Execution costs are always a concern, and perhaps even more so for international investors. At thepresent time, Tryssen AG is most concerned with how reliably it can estimate trading costs. As part ofthe cost estimation process, Hagemann is asked to provide a report on the advantages anddisadvantages of techniques used to reduce execution costs.Trysse AG proceeds to list on the Frankfurt exchange, and a U.S. affiliate of Hagemann's companystarts to aggressively promote the stock. A U.S. investor buys 200 shares of Tryssen at a price of €20per share. At time of purchase, the exchange rate is €1 = $1.15. One month later Tryssen pays adividend of €0.25 per share, and investors are subject to a withholding tax of 20%. The U.S. investoris eligible to claim a tax credit of $0.06 per share. At the time the dividend was paid, the shares hadjumped to €24 each and the U.S. dollar had weakened to €1 = $ 1.20. The shares were sold just afterthe dividend was paid.Which of the following alternatives best describes the main benefits of ETFs?

A. Available domestically; liquid; low cost. 
B. Available domestically; diversified; liquid; low cost; tax efficient. 
C. Low cost; tax efficient; provides an active return in excess of a benchmark. 

Show Answer

Question # 39

Martin Hagemann, CFA, works for a large brokerage firm in Frankfurt, Germany. Hagemann has beenhired by Tryssen AG, a global research-based company that is preparing to go public after a longhistory of operating privately. The need to raise substantial amounts of capital to fund research anddevelopment activities is seen as the key motivation for the change in policy. Tryssen is engaged inthe discovery, development, manufacture, marketing, and sale of medical products.Hagemann's first task is to recommend an exchange upon which Tryssen stock can be traded. Onepossibility is the Deutsche Bourse. The Deutsche Bourse operates primarily as a continuous orderdriven system. Another alternative that Tryssen is considering is to list on a different exchange thatoperates as a price-driven system.As an alternative, Tryssen may choose to list as an American Depository Receipt (ADR). ADRs arenegotiable U.S. securities that usually represent a non-U.S. based company's publicly traded equity.Although typically denominated in U.S. dollars, depository receipts can also be denominated ineuros. Depository receipts can be eligible to trade on all U.S. stock exchanges as well as on manyEuropean stock exchanges.The increasing demand for depository receipts is driven by the desire of individual and institutionalinvestors to diversify their portfolios, reduce risk and invest internationally in the most efficientmanner possible. While most investors recognize the benefits of global diversification, there aremany challenges presented when investing directly in local trading markets. Obstacles can includeinefficient trade settlements, uncertain custody services, and costly currency conversions. Depositoryreceipts overcome many of the inherent operational and custodial hurdles inherent in internationalinvesting. Tryssen has decided to access the U.S. market by involving itself in an ADR program.Tryssen has decided to save itself a lot of trouble, however, by not complying with SEC registrationand reporting requirements.As an alternative to ADRs, investors interested in increasing their exposure to internationalinvestments can choose to acquire exchange traded funds (ETFs). Hagemann researches theadvantages and disadvantages of ETFs.Execution costs are always a concern, and perhaps even more so for international investors. At thepresent time, Tryssen AG is most concerned with how reliably it can estimate trading costs. As part ofthe cost estimation process, Hagemann is asked to provide a report on the advantages anddisadvantages of techniques used to reduce execution costs.Trysse AG proceeds to list on the Frankfurt exchange, and a U.S. affiliate of Hagemann's companystarts to aggressively promote the stock. A U.S. investor buys 200 shares of Tryssen at a price of €20per share. At time of purchase, the exchange rate is €1 = $1.15. One month later Tryssen pays adividend of €0.25 per share, and investors are subject to a withholding tax of 20%. The U.S. investoris eligible to claim a tax credit of $0.06 per share. At the time the dividend was paid, the shares hadjumped to €24 each and the U.S. dollar had weakened to €1 = $ 1.20. The shares were sold just afterthe dividend was paid.Which of the following best describes a comparative advantage of a price-driven system over anorder-driven system?

A. Price-driven trading is less costly to administer. 
B. Price-driven systems generally provide better liquidity for large block trades. 
C. In a price-driven system, the dealer receives a free option when a firm quote is posted. 

Show Answer

Question # 40

Martin Hagemann, CFA, works for a large brokerage firm in Frankfurt, Germany. Hagemann has beenhired by Tryssen AG, a global research-based company that is preparing to go public after a longhistory of operating privately. The need to raise substantial amounts of capital to fund research anddevelopment activities is seen as the key motivation for the change in policy. Tryssen is engaged inthe discovery, development, manufacture, marketing, and sale of medical products.Hagemann's first task is to recommend an exchange upon which Tryssen stock can be traded. Onepossibility is the Deutsche Bourse. The Deutsche Bourse operates primarily as a continuous orderdriven system. Another alternative that Tryssen is considering is to list on a different exchange thatoperates as a price-driven system.As an alternative, Tryssen may choose to list as an American Depository Receipt (ADR). ADRs arenegotiable U.S. securities that usually represent a non-U.S. based company's publicly traded equity.Although typically denominated in U.S. dollars, depository receipts can also be denominated ineuros. Depository receipts can be eligible to trade on all U.S. stock exchanges as well as on manyEuropean stock exchanges.The increasing demand for depository receipts is driven by the desire of individual and institutionalinvestors to diversify their portfolios, reduce risk and invest internationally in the most efficientmanner possible. While most investors recognize the benefits of global diversification, there aremany challenges presented when investing directly in local trading markets. Obstacles can includeinefficient trade settlements, uncertain custody services, and costly currency conversions. Depositoryreceipts overcome many of the inherent operational and custodial hurdles inherent in internationalinvesting. Tryssen has decided to access the U.S. market by involving itself in an ADR program.Tryssen has decided to save itself a lot of trouble, however, by not complying with SEC registrationand reporting requirements.As an alternative to ADRs, investors interested in increasing their exposure to internationalinvestments can choose to acquire exchange traded funds (ETFs). Hagemann researches theadvantages and disadvantages of ETFs.Execution costs are always a concern, and perhaps even more so for international investors. At thepresent time, Tryssen AG is most concerned with how reliably it can estimate trading costs. As part ofthe cost estimation process, Hagemann is asked to provide a report on the advantages anddisadvantages of techniques used to reduce execution costs.Trysse AG proceeds to list on the Frankfurt exchange, and a U.S. affiliate of Hagemann's companystarts to aggressively promote the stock. A U.S. investor buys 200 shares of Tryssen at a price of €20per share. At time of purchase, the exchange rate is €1 = $1.15. One month later Tryssen pays a dividend of €0.25 per share, and investors are subject to a withholding tax of 20%. The U.S. investoris eligible to claim a tax credit of $0.06 per share. At the time the dividend was paid, the shares hadjumped to €24 each and the U.S. dollar had weakened to €1 = $ 1.20. The shares were sold just afterthe dividend was paid.Which type of ADR is Tryssen most likely to undertake?

A. Sponsored Level I ADR. 
B. Sponsored Level II ADR. 
C. Sponsored Level III ADR. 

Show Answer

Question # 41

Henke Malfoy, CFA, is an analyst with a major manufacturing firm. Currently, he is evaluating thereplacement of some production equipment. The old machine is still functional and could continueto serve in its current capacity for three more years. Tf the new equipment is purchased, the oldequipment (which is fully depreciated) can be sold for $50,000. The new equipment will cost$400,000, including shipping and installation. If the new equipment is purchased, the company'srevenues will increase by $175,000 and costs by $25,000 for each year of the equipment's 3-year life.There is no expected change in net working capital.The new machine will be depreciated using a 3-year MACRS schedule (note: the 3-year MACRSschedule is 33.0% in the first year, 45% in the second year, 15% in the third year, and 7% in the fourthyear). At the end of the life of the new equipment (i.e., in three years), Malfoy expects that it can besold for $10,000. The firm has a marginal tax rate of 40%, and the cost of capital on this project is20%. In calculation of tax liabilities, Malfoy assumesthat the firm is profitable,so any losses on thisproject can be offset against profits elsewhere in the firm. Malfoy calculates a project NPV of-$62,574.What isthe IRR based on Malfoy's NPV estimate, and should the project be accepted orrejected inorderto maximize shareholder value?IRR Project

A. 8.8% Accept
B. 8.8% Reject
C. 21.5% Accept

Show Answer

Question # 42

Henke Malfoy, CFA, is an analyst with a major manufacturing firm. Currently, he is evaluating thereplacement of some production equipment. The old machine is still functional and could continueto serve in its current capacity for three more years. Tf the new equipment is purchased, the oldequipment (which is fully depreciated) can be sold for $50,000. The new equipment will cost$400,000, including shipping and installation. If the new equipment is purchased, the company'srevenues will increase by $175,000 and costs by $25,000 for each year of the equipment's 3-year life.There is no expected change in net working capital.The new machine will be depreciated using a 3-year MACRS schedule (note: the 3-year MACRSschedule is 33.0% in the first year, 45% in the second year, 15% in the third year, and 7% in the fourthyear). At the end of the life of the new equipment (i.e., in three years), Malfoy expects that it can besold for $10,000. The firm has a marginal tax rate of 40%, and the cost of capital on this project is20%. In calculation of tax liabilities, Malfoy assumesthat the firm is profitable,so any losses on thisproject can be offset against profits elsewhere in the firm. Malfoy calculates a project NPV of-$62,574.Suppose forthis question only that Malfoy hasforgotten to reflect a decrease in inventory that willresult at the beginning of the project. The most likely effect on estimated project NPV of this error:

A. is to overestimate NPV.
B. is to underestimate NPV.
C. depends on whetherthe inventory is assumed to build back up to its previouslevel at the end ofthe project orthe decrease in inventory is permanent.

Show Answer

Question # 43

Henke Malfoy, CFA, is an analyst with a major manufacturing firm. Currently, he is evaluating thereplacement of some production equipment. The old machine is still functional and could continueto serve in its current capacity for three more years. Tf the new equipment is purchased, the oldequipment (which is fully depreciated) can be sold for $50,000. The new equipment will cost$400,000, including shipping and installation. If the new equipment is purchased, the company'srevenues will increase by $175,000 and costs by $25,000 for each year of the equipment's 3-year life.There is no expected change in net working capital.The new machine will be depreciated using a 3-year MACRS schedule (note: the 3-year MACRSschedule is 33.0% in the first year, 45% in the second year, 15% in the third year, and 7% in the fourthyear). At the end of the life of the new equipment (i.e., in three years), Malfoy expects that it can besold for $10,000. The firm has a marginal tax rate of 40%, and the cost of capital on this project is20%. In calculation of tax liabilities, Malfoy assumesthat the firm is profitable,so any losses on thisproject can be offset against profits elsewhere in the firm. Malfoy calculates a project NPV of-$62,574.What is the effect of taxes on the operating cash flow in year 2?

A. Decrease by $7,200.
B. Increase by $7(20O.
C. Increase by $12,000.

Show Answer

Question # 44

The board members for Kazmaier Foods have gathered for their quarterly board of directors meeting.Presiding at the meeting is the Chairman and CEO for Kazmaier, Phil Hinesman. The other eight members of the board are also present, including Allen Kazmaier, the brother of Kazmaier's founder; Elaine Randall, Executive Vice President for Emerald Bank, which Kazmaier uses to obtain short-term financing; and Bill Schram, Kazmaier's President and Chief Operating Officer. Each of the directors was elected to serve on the board for a 4-yearterm. They were elected two at a time overthe past three years. With the exception of Hinesman, Allen Kazmaier, Randall, and Schram, board members had no ties to Kazmaier prior to joining the board and had no personal relationships with management. In addition to the regular board meetings, the five independent board members get together annually, in a meeting separate from the regular board meetings, to discuss the company's operations.Item 1 on the board meeting agenda is a discussion about the importance of corporate governance and how Kazmaier can improve its corporate governance system. Hinesman begins the discussion by saying, "A strong system of corporate governance is important to ourshareholders. Studies have shown that, on average, companies with strong corporate governance systems have higher measures of profitability than companies with weak corporate governance systems." Randall adds her comment to the discussion: "The lack of an effective corporate governance system increases risk for our investors. If we do not have the appropriate checks and balancesin place, ourinvestors may be exposed to the risk that information used to make decisions about our firm is misleading or incomplete, as well as the risk that mergers or acquisitions the firm enters into will benefit management at the expense of shareholders."After a lengthy discussion, the board agrees on five separate recommendations that will enhance its currentsystem of corporate governance. One of these recommendationsisto change the functionand  tructure of the board's audit committee. Currently the audit committee consists of MatthewBortz, David Smith, and Ann Williams—three independent directors who each have backgrounds infinance and accounting. The board agrees that one more member should be added to the committeeand that the committee should expand itslist of responsibilities.Item 2 on the agenda for the board of directors' meeting is a report from Kazmaicr's Chief FinancialOfficer, Doug Layman. The following information was included in the material that was distributed toeach board member before the meeting:Currentshare price: $40.00Shares outstanding: 56, 250,000Estimated earnings: $112.5 millionPlanned capital spending: $150 millionTarget debt-to-equity ratio 1 to ICost of equity: 8.0%Constant growth rate: 5.2%Layman tells the board that his analysis indicates that, based on a constant-growth dividend discountmodel, the initiation of an $0.80 pershare dividend would reduce the cost of equity by 1.2% andincrease the value of the firm'sstock, assuming that earnings, the cost of debt, and the constantgrowth rate don't change.Item 3 on the agenda is the sale of Kazmaier's condiment packaging division to Sautter Packaging andSupply Company. Layman believesthe sale will net the company $50 million, payable in cash. Afterdiscussing the pros and cons ofselling the division, the directors agree that the sale is in the bestinterests of the company and its shareholders. The directors then move to a vote, and the sale of thecondiment packaging division is approved unanimously. The committee then moves on to discusswhat to do with the proceeds from the sale. Williams suggeststhat paying out the $50 million toshareholders as a special dividend would continue to give the firm flexibility in how it uses its excesscash. Smith tellsthe board that a share repurchase can be thought of as an alternative to a cashdividend, and that if the tax treatment between the two alternatives is the same, investors should beindifferent between the two. After debating the merits ofspecial dividends and stock repurchases,Kazmaier's board authorizesthe proceeds from the sale of the condiment packaging division to beused for the purchase of $50 million worth of outstanding shares.An external agency recently included Kazmaier in a review of corporate governance systems todetermine whether or not the structure of the board of directors was consistent with corporategovernance best practices. The agency scored companies based on the following criteria:Criterion 1: Composition of the board of directors.Criterion 2: Chairman of the board of directors.Criterion 3; Method of electing the board.Criterion 4: Frequency of separate sessions for independent directors.Each of the four criteria was weighted equally, with the firm receiving a positive mark for being incompliance with corporate governance best practice.A month after the board meeting, the price of Kazmaier stock is still at $40 per share, and the sale ofKazmaier's condiment packaging division does not go through. In orderto finance the approvedshare repurchase, Kazmaier isforced to borrow funds. Schram states, "I am concerned that the costofthe debt used to repurchase shares may cause a reduction in earnings pershare." Jennifer Nagy, a vice president in Kazmaier's finance division, tells Schram not to be concerned aboutusing debt to finance the share repurchase because the rationale behind the repurchase is sound.Nagy then writes down some of the common rationales for share repurchases and hands them to Schram.Rationale 1: Repurchasing shares can prevent the EPS dilution that comesfrom the exercise of employee stock options.Rationale 2: Management can use a share repurchase to alter the company's capital structure by decreasing the percentage of equity.Rationale 3: Like a dividend increase, a share repurchase is a way to send a signal to investors thatKazmaier's management believes the outlook for the company's future is strong.Kazmaier's total score on the corporate governance report is closest to

A. 25%.
B. 50%.
C. 75%.

Show Answer

Question # 45

Andrew Carson is an equity analyst employed at Lee, Vincent, and Associates, an investmentresearch firm. In a conversation with his supervisor, Daniel Lau, Carson makes the following twostatements about defined contribution plans.Statement I: Employers often face onerous disclosure requirements.Statement 2: Employers often bear all the investment risk.Carson is responsible for following Samilski Enterprises (Samilski), a publicly traded firm thatproduces motorcycles and other mechanical parts. It operates exclusively in the United States. At theend of its 2009 fiscal year, Samilski's employee pension plan had a projected benefit obligation (PBO)of $320 million. Also, unrecognized prior service costs were $35 million, the fair value of plan assetswas $316 million, and the unrecognized actuarial gain was $21 million.Carson believes the rate of compensation increase will be 5% as opposed to 4% in the previous year,and the discount rate will be 7% as opposed to 8% in the previous year.This past year, Samilski began using special purpose entities (SPEs) for various reasons. Inpreparation for analyzing the SPE disclosures in the footnotes to the financial statements, Carsonprepares a memo on SPEs. In the memo, he correctly concludes that the company will be requiredunder new accounting rules to classify them as variable interest entities (VIE) and consolidate theentities on the balance sheet rather than report them using the equity method as in the past.Which of the following items, when recognized, will likely increase:PBO? Pension expense?

A. Actuarial loss Expected return on plan assets
B. Actuarial loss Amortization of prior service costs
C. Actuarial gain Amortization of prior service costs

Show Answer

Question # 46

Andrew Carson is an equity analyst employed at Lee, Vincent, and Associates, an investmentresearch firm. In a conversation with his supervisor, Daniel Lau, Carson makes the following twostatements about defined contribution plans.Statement I: Employers often face onerous disclosure requirements.Statement 2: Employers often bear all the investment risk.Carson is responsible for following Samilski Enterprises (Samilski), a publicly traded firm thatproduces motorcycles and other mechanical parts. It operates exclusively in the United States. At theend of its 2009 fiscal year, Samilski's employee pension plan had a projected benefit obligation (PBO)of $320 million. Also, unrecognized prior service costs were $35 million, the fair value of plan assetswas $316 million, and the unrecognized actuarial gain was $21 million.Carson believes the rate of compensation increase will be 5% as opposed to 4% in the previous year,and the discount rate will be 7% as opposed to 8% in the previous year.This past year, Samilski began using special purpose entities (SPEs) for various reasons. Inpreparation for analyzing the SPE disclosures in the footnotes to the financial statements, Carsonprepares a memo on SPEs. In the memo, he correctly concludes that the company will be requiredunder new accounting rules to classify them as variable interest entities (VIE) and consolidate theentities on the balance sheet rather than report them using the equity method as in the past.What are the likely effects of the required change in accounting for SPEs on Samilski's:Return on assets? Return on equity?

A. Decrease Decrease
B. Decrease No effect
C. No effect Decrease

Show Answer

Question # 47

Andrew Carson is an equity analyst employed at Lee, Vincent, and Associates, an investmentresearch firm. In a conversation with his supervisor, Daniel Lau, Carson makes the following twostatements about defined contribution plans.Statement I: Employers often face onerous disclosure requirements.Statement 2: Employers often bear all the investment risk.Carson is responsible for following Samilski Enterprises (Samilski), a publicly traded firm thatproduces motorcycles and other mechanical parts. It operates exclusively in the United States. At theend of its 2009 fiscal year, Samilski's employee pension plan had a projected benefit obligation (PBO)of $320 million. Also, unrecognized prior service costs were $35 million, the fair value of plan assetswas $316 million, and the unrecognized actuarial gain was $21 million.Carson believes the rate of compensation increase will be 5% as opposed to 4% in the previous year,and the discount rate will be 7% as opposed to 8% in the previous year.This past year, Samilski began using special purpose entities (SPEs) for various reasons. Inpreparation for analyzing the SPE disclosures in the footnotes to the financial statements, Carsonprepares a memo on SPEs. In the memo, he correctly concludes that the company will be requiredunder new accounting rules to classify them as variable interest entities (VIE) and consolidate theentities on the balance sheet rather than report them using the equity method as in the past.Under current U.S. GAAP pension accounting standards, the amount of the pension asset or liabilitythat Samilski should report on its 2009 fiscal year end balance sheet is closes/ to a:

A. $4 million liability.
B. $10 million liabilily
C. $14 million liabiliy

Show Answer

Question # 48

Andrew Carson is an equity analyst employed at Lee, Vincent, and Associates, an investmentresearch firm. In a conversation with his supervisor, Daniel Lau, Carson makes the following twostatements about defined contribution plans.Statement I: Employers often face onerous disclosure requirements.Statement 2: Employers often bear all the investment risk.Carson is responsible for following Samilski Enterprises (Samilski), a publicly traded firm thatproduces motorcycles and other mechanical parts. It operates exclusively in the United States. At theend of its 2009 fiscal year, Samilski's employee pension plan had a projected benefit obligation (PBO)of $320 million. Also, unrecognized prior service costs were $35 million, the fair value of plan assetswas $316 million, and the unrecognized actuarial gain was $21 million.Carson believes the rate of compensation increase will be 5% as opposed to 4% in the previous year,and the discount rate will be 7% as opposed to 8% in the previous year.This past year, Samilski began using special purpose entities (SPEs) for various reasons. Inpreparation for analyzing the SPE disclosures in the footnotes to the financial statements, Carsonprepares a memo on SPEs. In the memo, he correctly concludes that the company will be requiredunder new accounting rules to classify them as variable interest entities (VIE) and consolidate theentities on the balance sheet rather than report them using the equity method as in the past.Based on Carson's projections of the discount rate, what are the likely effects on the projectedbenefit obligation (PBO) and the pension cost?

A. Both will increase.
B. Both will decrease.
C. One will increase and the other will decrease.

Show Answer

Question # 49

Andrew Carson is an equity analyst employed at Lee, Vincent, and Associates, an investmentresearch firm. In a conversation with his supervisor, Daniel Lau, Carson makes the following twostatements about defined contribution plans.Statement I: Employers often face onerous disclosure requirements.Statement 2: Employers often bear all the investment risk.Carson is responsible for following Samilski Enterprises (Samilski), a publicly traded firm thatproduces motorcycles and other mechanical parts. It operates exclusively in the United States. At theend of its 2009 fiscal year, Samilski's employee pension plan had a projected benefit obligation (PBO)of $320 million. Also, unrecognized prior service costs were $35 million, the fair value of plan assetswas $316 million, and the unrecognized actuarial gain was $21 million.Carson believes the rate of compensation increase will be 5% as opposed to 4% in the previous year,and the discount rate will be 7% as opposed to 8% in the previous year.This past year, Samilski began using special purpose entities (SPEs) for various reasons. Inpreparation for analyzing the SPE disclosures in the footnotes to the financial statements, Carsonprepares a memo on SPEs. In the memo, he correctly concludes that the company will be requiredunder new accounting rules to classify them as variable interest entities (VIE) and consolidate theentities on the balance sheet rather than report them using the equity method as in the past.Under current U.S. GAAP pension accounting standards, the amount of the pension asset or liabilitythat Samilski should report on its 2009 fiscal year end balance sheet is closes/ to a:

A. $4 million liability.
B. $10 million liabilily
C. $14 million liability

Show Answer

Question # 50

Andrew Carson is an equity analyst employed at Lee, Vincent, and Associates, an investmentresearch firm. In a conversation with his supervisor, Daniel Lau, Carson makes the following twostatements about defined contribution plans.Statement I: Employers often face onerous disclosure requirements.Statement 2: Employers often bear all the investment risk.Carson is responsible for following Samilski Enterprises (Samilski), a publicly traded firm thatproduces motorcycles and other mechanical parts. It operates exclusively in the United States. At theend of its 2009 fiscal year, Samilski's employee pension plan had a projected benefit obligation (PBO)of $320 million. Also, unrecognized prior service costs were $35 million, the fair value of plan assetswas $316 million, and the unrecognized actuarial gain was $21 million.Carson believes the rate of compensation increase will be 5% as opposed to 4% in the previous year,and the discount rate will be 7% as opposed to 8% in the previous year.This past year, Samilski began using special purpose entities (SPEs) for various reasons. Inpreparation for analyzing the SPE disclosures in the footnotes to the financial statements, Carsonprepares a memo on SPEs. In the memo, he correctly concludes that the company will be requiredunder new accounting rules to classify them as variable interest entities (VIE) and consolidate theentities on the balance sheet rather than report them using the equity method as in the past.Is Carson correct with respect to defined contribution plans?

A. Both statements are incorrect.
B. Only Statement 1 is incorrect.
C. Only Statement 2 is incorrect.

Show Answer

Question # 51

Bryan Stephenson is an equity analyst and is developing a research report on Iberia Corporation atthe request of his supervisor. Iberia is a conglomerate entity with significant corporate holdings invarious industries. Specifically, Stephenson is interested in the effects of Iberia's investments on itsfinancial performance and has decided to focus on two investments: Midland Incorporated andOdessa Company.Midland IncorporatedOn December 31, 2007, Iberia purchased 5 million common shares of Midland Incorporated for €80million. Midland has a total of 12.5 million common shares outstanding. The market value of Iberia'sinvestment in Midland was €89 million at the end of 2008 and €85 million at the end of 2009. For theyear ended 2008, Midland reported net income of €30 million and paid dividends of €10 million. Forthe year ended 2009, Midland reported a loss of €5 million and paid dividends of €4 million.During 2010, Midland sold goods to Iberia and reported 20% gross profit from the sale. Iberia sold allof the goods to a third party in 2010.Odessa CompanyOn January 2, 2009, Iberia purchased 1 million common shares of Odessa Company as a long-terminvestment. The purchase price was €20 per share and on December 31, 2009, the market price ofOdessa was €17 per share. The decline in value was considered temporary. For the year ended 2009,Odessa reported net income of €750 million and paid a dividend of €3 per share. Iberia considers itsinvestment in Odessa as an investment in financial assets.In addition, Iberia has a number of foreign investments, so Stephenson's supervisor has asked him todraft a report on accounting methods and ratio analysis. The following are statements fromStephenson's research report.Statement 1: Under U.S. GAAP, firms are required to use proportionate consolidation to account forjoint ventures.Statement 2: In general, if the parent's consolidated net income is positive, the equity methodreports a higher net profit margin than the acquisition method.Is Stephenson's statement regarding the effect on profit margin correct?

A. Yes.
B. No. Net profit margin will be lower using the equity method.
C. No. Net profit margin will be the same using either the equity method or the acquisition method.

Show Answer

Question # 52

Bryan Stephenson is an equity analyst and is developing a research report on Iberia Corporation atthe request of his supervisor. Iberia is a conglomerate entity with significant corporate holdings invarious industries. Specifically, Stephenson is interested in the effects of Iberia's investments on itsfinancial performance and has decided to focus on two investments: Midland Incorporated andOdessa Company.Midland IncorporatedOn December 31, 2007, Iberia purchased 5 million common shares of Midland Incorporated for €80million. Midland has a total of 12.5 million common shares outstanding. The market value of Iberia'sinvestment in Midland was €89 million at the end of 2008 and €85 million at the end of 2009. For theyear ended 2008, Midland reported net income of €30 million and paid dividends of €10 million. Forthe year ended 2009, Midland reported a loss of €5 million and paid dividends of €4 million.During 2010, Midland sold goods to Iberia and reported 20% gross profit from the sale. Iberia sold allof the goods to a third party in 2010.Odessa CompanyOn January 2, 2009, Iberia purchased 1 million common shares of Odessa Company as a long-terminvestment. The purchase price was €20 per share and on December 31, 2009, the market price ofOdessa was €17 per share. The decline in value was considered temporary. For the year ended 2009,Odessa reported net income of €750 million and paid a dividend of €3 per share. Iberia considers itsinvestment in Odessa as an investment in financial assets.In addition, Iberia has a number of foreign investments, so Stephenson's supervisor has asked him todraft a report on accounting methods and ratio analysis. The following are statements fromStephenson's research report.Statement 1: Under U.S. GAAP, firms are required to use proportionate consolidation to account forjoint ventures.Statement 2: In general, if the parent's consolidated net income is positive, the equity methodreports a higher net profit margin than the acquisition method.Is Stephenson's statement regarding proportionate consolidation correct?

A. Yes.
B. No, because under U.S. GAAP, proportionate consolidation is allowed only in very limitedsituations.
C. No, because under U.S. GAAP, proportionate consolidation is never allowed under anycircumstances.

Show Answer

Question # 53

Bryan Stephenson is an equity analyst and is developing a research report on Iberia Corporation atthe request of his supervisor. Iberia is a conglomerate entity with significant corporate holdings invarious industries. Specifically, Stephenson is interested in the effects of Iberia's investments on itsfinancial performance and has decided to focus on two investments: Midland Incorporated andOdessa Company.Midland IncorporatedOn December 31, 2007, Iberia purchased 5 million common shares of Midland Incorporated for €80million. Midland has a total of 12.5 million common shares outstanding. The market value of Iberia'sinvestment in Midland was €89 million at the end of 2008 and €85 million at the end of 2009. For theyear ended 2008, Midland reported net income of €30 million and paid dividends of €10 million. Forthe year ended 2009, Midland reported a loss of €5 million and paid dividends of €4 million.During 2010, Midland sold goods to Iberia and reported 20% gross profit from the sale. Iberia sold allof the goods to a third party in 2010.Odessa CompanyOn January 2, 2009, Iberia purchased 1 million common shares of Odessa Company as a long-terminvestment. The purchase price was €20 per share and on December 31, 2009, the market price ofOdessa was €17 per share. The decline in value was considered temporary. For the year ended 2009,Odessa reported net income of €750 million and paid a dividend of €3 per share. Iberia considers itsinvestment in Odessa as an investment in financial assets.In addition, Iberia has a number of foreign investments, so Stephenson's supervisor has asked him todraft a report on accounting methods and ratio analysis. The following are statements fromStephenson's research report.Statement 1: Under U.S. GAAP, firms are required to use proportionate consolidation to account forjoint ventures.Statement 2: In general, if the parent's consolidated net income is positive, the equity methodreports a higher net profit margin than the acquisition method.What adjustment, if any, must Iberia make to its 2010 income statement as a result of theintercompany transaction with Midland?

A. Sales and cost of goods sold should be reduced by Iberia's pro-rata ownership interest in theintercompany sale.
B. Midland's net income should be reduced by 20% of the gross profit from the intercompany sale.
C. No adjustment is necessary.

Show Answer

Question # 54

Bryan Stephenson is an equity analyst and is developing a research report on Iberia Corporation atthe request of his supervisor. Iberia is a conglomerate entity with significant corporate holdings invarious industries. Specifically, Stephenson is interested in the effects of Iberia's investments on itsfinancial performance and has decided to focus on two investments: Midland Incorporated andOdessa Company.Midland IncorporatedOn December 31, 2007, Iberia purchased 5 million common shares of Midland Incorporated for €80million. Midland has a total of 12.5 million common shares outstanding. The market value of Iberia'sinvestment in Midland was €89 million at the end of 2008 and €85 million at the end of 2009. For theyear ended 2008, Midland reported net income of €30 million and paid dividends of €10 million. Forthe year ended 2009, Midland reported a loss of €5 million and paid dividends of €4 million.During 2010, Midland sold goods to Iberia and reported 20% gross profit from the sale. Iberia sold allof the goods to a third party in 2010.Odessa CompanyOn January 2, 2009, Iberia purchased 1 million common shares of Odessa Company as a long-terminvestment. The purchase price was €20 per share and on December 31, 2009, the market price ofOdessa was €17 per share. The decline in value was considered temporary. For the year ended 2009,Odessa reported net income of €750 million and paid a dividend of €3 per share. Iberia considers itsinvestment in Odessa as an investment in financial assets.In addition, Iberia has a number of foreign investments, so Stephenson's supervisor has asked him todraft a report on accounting methods and ratio analysis. The following are statements fromStephenson's research report.Statement 1: Under U.S. GAAP, firms are required to use proportionate consolidation to account forjoint ventures.Statement 2: In general, if the parent's consolidated net income is positive, the equity methodreports a higher net profit margin than the acquisition method.What amount should Iberia report on its balance sheet at the end of 2009 as a result of itsinvestments in Midland and Odessa?

A. €84.4 million.
B. €101.4 million.
C. €102.0 million.

Show Answer

Question # 55

Bryan Stephenson is an equity analyst and is developing a research report on Iberia Corporation atthe request of his supervisor. Iberia is a conglomerate entity with significant corporate holdings invarious industries. Specifically, Stephenson is interested in the effects of Iberia's investments on itsfinancial performance and has decided to focus on two investments: Midland Incorporated andOdessa Company.Midland IncorporatedOn December 31, 2007, Iberia purchased 5 million common shares of Midland Incorporated for €80million. Midland has a total of 12.5 million common shares outstanding. The market value of Iberia'sinvestment in Midland was €89 million at the end of 2008 and €85 million at the end of 2009. For theyear ended 2008, Midland reported net income of €30 million and paid dividends of €10 million. Forthe year ended 2009, Midland reported a loss of €5 million and paid dividends of €4 million.During 2010, Midland sold goods to Iberia and reported 20% gross profit from the sale. Iberia sold allof the goods to a third party in 2010.Odessa CompanyOn January 2, 2009, Iberia purchased 1 million common shares of Odessa Company as a long-terminvestment. The purchase price was €20 per share and on December 31, 2009, the market price ofOdessa was €17 per share. The decline in value was considered temporary. For the year ended 2009,Odessa reported net income of €750 million and paid a dividend of €3 per share. Iberia considers itsinvestment in Odessa as an investment in financial assets.In addition, Iberia has a number of foreign investments, so Stephenson's supervisor has asked him todraft a report on accounting methods and ratio analysis. The following are statements fromStephenson's research report.Statement 1: Under U.S. GAAP, firms are required to use proportionate consolidation to account forjoint ventures.Statement 2: In general, if the parent's consolidated net income is positive, the equity methodreports a higher net profit margin than the acquisition method.What amount should Iberia recognize in its 2009 income statement as a result of its investments inMidland and Odessa?

A. €1 million profit.
B. €2 million profit.
C. €3 million loss..

Show Answer

Question # 56

Bryan Stephenson is an equity analyst and is developing a research report on Iberia Corporation atthe request of his supervisor. Iberia is a conglomerate entity with significant corporate holdings invarious industries. Specifically, Stephenson is interested in the effects of Iberia's investments on itsfinancial performance and has decided to focus on two investments: Midland Incorporated andOdessa Company.Midland IncorporatedOn December 31, 2007, Iberia purchased 5 million common shares of Midland Incorporated for €80million. Midland has a total of 12.5 million common shares outstanding. The market value of Iberia'sinvestment in Midland was €89 million at the end of 2008 and €85 million at the end of 2009. For theyear ended 2008, Midland reported net income of €30 million and paid dividends of €10 million. Forthe year ended 2009, Midland reported a loss of €5 million and paid dividends of €4 million.During 2010, Midland sold goods to Iberia and reported 20% gross profit from the sale. Iberia sold allof the goods to a third party in 2010.Odessa CompanyOn January 2, 2009, Iberia purchased 1 million common shares of Odessa Company as a long-terminvestment. The purchase price was €20 per share and on December 31, 2009, the market price ofOdessa was €17 per share. The decline in value was considered temporary. For the year ended 2009,Odessa reported net income of €750 million and paid a dividend of €3 per share. Iberia considers itsinvestment in Odessa as an investment in financial assets.In addition, Iberia has a number of foreign investments, so Stephenson's supervisor has asked him todraft a report on accounting methods and ratio analysis. The following are statements fromStephenson's research report.Statement 1: Under U.S. GAAP, firms are required to use proportionate consolidation to account forjoint ventures.Statement 2: In general, if the parent's consolidated net income is positive, the equity methodreports a higher net profit margin than the acquisition method.Which of the following is the most appropriate classification of Iberia's investment in OdessaCorporation?

A. Held-to-maturity.
B. Held-for-trading.
C. Available-for-sale.

Show Answer

Question # 57

Martha Gillis, CFA, trades currencies for Trent, LLC. Trent is one of the largest investment firms in theworld, and its foreign currency department trades more currency on a daily basis than any otherfirm. Gillis specializes in currencies of emerging nations.Gillis received an invitation from the new Finance Minister of Binaria, one of the emerging nationsincluded in Gillis's portfolio. The minister has proposed a number of fiscal reforms that he hopes willhelp support Binaria's weakening currency. He is asking currency specialists from several of thelargest foreign exchange banks to visit Binaria for a conference on the planned reforms. Because ofits remote location, Binaria will pay all travel expenses of the attendees, as well as lodging ingovernment-owned facilities in the capital city. As a further inducement, attendees will also receivesmall bags of uncut emeralds (as emeralds are a principal export of Binaria), with an estimatedmarket value of $500.Gillis has approximately 25 clients that she deals with regularly, most of whom are large financialinstitutions interested in trading currencies. One of the services Gillis provides to these clients is aweekly summary of important trends in the emerging market currencies she follows. Gillis talks tolocal government officials and reads research reports prepared by local analysts, which are paid forby Trent. These inputs, along with Gillis's interpretation, form the basis of most of Gillis's weeklyreports.Gillis decided to attend the conference in Binaria. In anticipation of a favorable reception for theproposed reforms, Gillis purchased a long Binaria currency position in her personal account beforeleaving on the trip. After hearing the finance minister's proposals in person, however, she decidesthat the reforms are poorly timed and likely to cause the currency to depreciate. She issues anegative recommendation upon her return. Before issuing the recommendation, she liquidates thelong position in her personal account but does not take a short position.Gillis's supervisor, Steve Howlett, CFA, has been reviewing Gillis's personal trading. Howlett has notseen any details of the Binaria currency trade but has found two other instances in the past yearwhere he believes Gillis has violated Trent's written policies regarding trading in personal accounts.One of the currency trading strategies employed by Trent is based on interest rate parity. Trentmonitors spot exchange rates, forward rates, and short-term government interest rates. On the rareoccasions when the forward rates do not accurately reflect the interest differential between twocountries, Trent places trades to take advantage of the riskless arbitrage opportunity. Because Trentis such a large player in the exchange markets, its transactions costs are very low, and Trent is oftenable to take advantage of mispricings that are too small for others to capitalize on. In describingthese trading opportunities to clients, Trent suggests that "clients willing to participate in this type ofarbitrage strategy are guaranteed riskless profits until the market pricing returns to equilibrium."Trent's arbitrage trading based on interest rate parity is successful mostly due to Trent's large size,which provides it with an advantage relative to smaller, competing currency trading firms. Has Trentviolated CFA Institute Standards of Professional Conduct with respect to its trading strategy or itsguarantee of results?

A. The trading strategy and guarantee of results arc both violations cf CFA Institute Standards.
B. The trading strategy is legitimate and does not violate CFA Institute Standards, but the guaranteeof investment return is a violation of Standards.
C. Both the trading strategy and guarantee statement comply with CFA Institute Standards.

Show Answer

Question # 58

Martha Gillis, CFA, trades currencies for Trent, LLC. Trent is one of the largest investment firms in theworld, and its foreign currency department trades more currency on a daily basis than any otherfirm. Gillis specializes in currencies of emerging nations.Gillis received an invitation from the new Finance Minister of Binaria, one of the emerging nationsincluded in Gillis's portfolio. The minister has proposed a number of fiscal reforms that he hopes willhelp support Binaria's weakening currency. He is asking currency specialists from several of thelargest foreign exchange banks to visit Binaria for a conference on the planned reforms. Because ofits remote location, Binaria will pay all travel expenses of the attendees, as well as lodging ingovernment-owned facilities in the capital city. As a further inducement, attendees will also receivesmall bags of uncut emeralds (as emeralds are a principal export of Binaria), with an estimatedmarket value of $500.Gillis has approximately 25 clients that she deals with regularly, most of whom are large financialinstitutions interested in trading currencies. One of the services Gillis provides to these clients is aweekly summary of important trends in the emerging market currencies she follows. Gillis talks tolocal government officials and reads research reports prepared by local analysts, which are paid forby Trent. These inputs, along with Gillis's interpretation, form the basis of most of Gillis's weeklyreports.Gillis decided to attend the conference in Binaria. In anticipation of a favorable reception for theproposed reforms, Gillis purchased a long Binaria currency position in her personal account beforeleaving on the trip. After hearing the finance minister's proposals in person, however, she decidesthat the reforms are poorly timed and likely to cause the currency to depreciate. She issues anegative recommendation upon her return. Before issuing the recommendation, she liquidates thelong position in her personal account but does not take a short position.Gillis's supervisor, Steve Howlett, CFA, has been reviewing Gillis's personal trading. Howlett has notseen any details of the Binaria currency trade but has found two other instances in the past yearwhere he believes Gillis has violated Trent's written policies regarding trading in personal accounts.One of the currency trading strategies employed by Trent is based on interest rate parity. Trentmonitors spot exchange rates, forward rates, and short-term government interest rates. On the rareoccasions when the forward rates do not accurately reflect the interest differential between twocountries, Trent places trades to take advantage of the riskless arbitrage opportunity. Because Trentis such a large player in the exchange markets, its transactions costs are very low, and Trent is oftenable to take advantage of mispricings that are too small for others to capitalize on. In describingthese trading opportunities to clients, Trent suggests that "clients willing to participate in this type ofarbitrage strategy are guaranteed riskless profits until the market pricing returns to equilibrium."Based on the information given, and according to CFA Institute Standards, which of the followingstatements best describes Trent's compliance procedures relating to personal trading in foreigncurrencies? The compliance procedures:

A. appear adequate since Howlett was able to identify potential violations.
B. appear adequate, but Howlett's monitoring of Gillis's trades indicates poor supervisoryresponsibility.
C. should include both duplicate confirmations of transactions and preclearance procedures forpersonal trades.

Show Answer

Question # 59

Martha Gillis, CFA, trades currencies for Trent, LLC. Trent is one of the largest investment firms in theworld, and its foreign currency department trades more currency on a daily basis than any otherfirm. Gillis specializes in currencies of emerging nations.Gillis received an invitation from the new Finance Minister of Binaria, one of the emerging nationsincluded in Gillis's portfolio. The minister has proposed a number of fiscal reforms that he hopes willhelp support Binaria's weakening currency. He is asking currency specialists from several of thelargest foreign exchange banks to visit Binaria for a conference on the planned reforms. Because ofits remote location, Binaria will pay all travel expenses of the attendees, as well as lodging ingovernment-owned facilities in the capital city. As a further inducement, attendees will also receivesmall bags of uncut emeralds (as emeralds are a principal export of Binaria), with an estimatedmarket value of $500.Gillis has approximately 25 clients that she deals with regularly, most of whom are large financialinstitutions interested in trading currencies. One of the services Gillis provides to these clients is aweekly summary of important trends in the emerging market currencies she follows. Gillis talks tolocal government officials and reads research reports prepared by local analysts, which are paid forby Trent. These inputs, along with Gillis's interpretation, form the basis of most of Gillis's weeklyreports.Gillis decided to attend the conference in Binaria. In anticipation of a favorable reception for theproposed reforms, Gillis purchased a long Binaria currency position in her personal account beforeleaving on the trip. After hearing the finance minister's proposals in person, however, she decidesthat the reforms are poorly timed and likely to cause the currency to depreciate. She issues anegative recommendation upon her return. Before issuing the recommendation, she liquidates thelong position in her personal account but does not take a short position.Gillis's supervisor, Steve Howlett, CFA, has been reviewing Gillis's personal trading. Howlett has notseen any details of the Binaria currency trade but has found two other instances in the past yearwhere he believes Gillis has violated Trent's written policies regarding trading in personal accounts.One of the currency trading strategies employed by Trent is based on interest rate parity. Trentmonitors spot exchange rates, forward rates, and short-term government interest rates. On the rareoccasions when the forward rates do not accurately reflect the interest differential between twocountries, Trent places trades to take advantage of the riskless arbitrage opportunity. Because Trentis such a large player in the exchange markets, its transactions costs are very low, and Trent is oftenable to take advantage of mispricings that are too small for others to capitalize on. In describingthese trading opportunities to clients, Trent suggests that "clients willing to participate in this type ofarbitrage strategy are guaranteed riskless profits until the market pricing returns to equilibrium."According to CFA Institute Standards of Professional Conduct, Howlett's best course of action withregard to the suspected violations by Gillis would be to:

A. meet with Gillis in person, explain the nature of the violations, and seek assurances that suchviolations will not recur.
B. warn Gillis to cease the trading activities and report the violation to Howlett's supervisorimmediately.
C. place limits on Gillis's personal trading and increase monitoring of Gillis's personal trades.

Show Answer

Question # 60

Martha Gillis, CFA, trades currencies for Trent, LLC. Trent is one of the largest investment firms in theworld, and its foreign currency department trades more currency on a daily basis than any otherfirm. Gillis specializes in currencies of emerging nations.Gillis received an invitation from the new Finance Minister of Binaria, one of the emerging nationsincluded in Gillis's portfolio. The minister has proposed a number of fiscal reforms that he hopes willhelp support Binaria's weakening currency. He is asking currency specialists from several of thelargest foreign exchange banks to visit Binaria for a conference on the planned reforms. Because ofits remote location, Binaria will pay all travel expenses of the attendees, as well as lodging ingovernment-owned facilities in the capital city. As a further inducement, attendees will also receivesmall bags of uncut emeralds (as emeralds are a principal export of Binaria), with an estimatedmarket value of $500.Gillis has approximately 25 clients that she deals with regularly, most of whom are large financialinstitutions interested in trading currencies. One of the services Gillis provides to these clients is aweekly summary of important trends in the emerging market currencies she follows. Gillis talks tolocal government officials and reads research reports prepared by local analysts, which are paid forby Trent. These inputs, along with Gillis's interpretation, form the basis of most of Gillis's weeklyreports.Gillis decided to attend the conference in Binaria. In anticipation of a favorable reception for theproposed reforms, Gillis purchased a long Binaria currency position in her personal account beforeleaving on the trip. After hearing the finance minister's proposals in person, however, she decidesthat the reforms are poorly timed and likely to cause the currency to depreciate. She issues anegative recommendation upon her return. Before issuing the recommendation, she liquidates thelong position in her personal account but does not take a short position.Gillis's supervisor, Steve Howlett, CFA, has been reviewing Gillis's personal trading. Howlett has notseen any details of the Binaria currency trade but has found two other instances in the past yearwhere he believes Gillis has violated Trent's written policies regarding trading in personal accounts.One of the currency trading strategies employed by Trent is based on interest rate parity. Trentmonitors spot exchange rates, forward rates, and short-term government interest rates. On the rareoccasions when the forward rates do not accurately reflect the interest differential between twocountries, Trent places trades to take advantage of the riskless arbitrage opportunity. Because Trentis such a large player in the exchange markets, its transactions costs are very low, and Trent is oftenable to take advantage of mispricings that are too small for others to capitalize on. In describingthese trading opportunities to clients, Trent suggests that "clients willing to participate in this type ofarbitrage strategy are guaranteed riskless profits until the market pricing returns to equilibrium."Regarding Gillis's transactions in the Binaria currency, the Standards have been violated by:

A. taking the long position and by selling the position before issuing a recommendation to clients.
B. selling the position before issuing the recommendation to clients, although taking the longposition was not a violation
C not disclosing the trades in her report since the trades are acceptableso long as they are disclosed.

Show Answer

Question # 61

Martha Gillis, CFA, trades currencies for Trent, LLC. Trent is one of the largest investment firms in theworld, and its foreign currency department trades more currency on a daily basis than any otherfirm. Gillis specializes in currencies of emerging nations.Gillis received an invitation from the new Finance Minister of Binaria, one of the emerging nationsincluded in Gillis's portfolio. The minister has proposed a number of fiscal reforms that he hopes willhelp support Binaria's weakening currency. He is asking currency specialists from several of thelargest foreign exchange banks to visit Binaria for a conference on the planned reforms. Because ofits remote location, Binaria will pay all travel expenses of the attendees, as well as lodging ingovernment-owned facilities in the capital city. As a further inducement, attendees will also receivesmall bags of uncut emeralds (as emeralds are a principal export of Binaria), with an estimatedmarket value of $500.Gillis has approximately 25 clients that she deals with regularly, most of whom are large financialinstitutions interested in trading currencies. One of the services Gillis provides to these clients is aweekly summary of important trends in the emerging market currencies she follows. Gillis talks tolocal government officials and reads research reports prepared by local analysts, which are paid forby Trent. These inputs, along with Gillis's interpretation, form the basis of most of Gillis's weeklyreports.Gillis decided to attend the conference in Binaria. In anticipation of a favorable reception for theproposed reforms, Gillis purchased a long Binaria currency position in her personal account beforeleaving on the trip. After hearing the finance minister's proposals in person, however, she decidesthat the reforms are poorly timed and likely to cause the currency to depreciate. She issues anegative recommendation upon her return. Before issuing the recommendation, she liquidates thelong position in her personal account but does not take a short position.Gillis's supervisor, Steve Howlett, CFA, has been reviewing Gillis's personal trading. Howlett has notseen any details of the Binaria currency trade but has found two other instances in the past yearwhere he believes Gillis has violated Trent's written policies regarding trading in personal accounts.One of the currency trading strategies employed by Trent is based on interest rate parity. Trentmonitors spot exchange rates, forward rates, and short-term government interest rates. On the rareoccasions when the forward rates do not accurately reflect the interest differential between twocountries, Trent places trades to take advantage of the riskless arbitrage opportunity. Because Trentis such a large player in the exchange markets, its transactions costs are very low, and Trent is oftenable to take advantage of mispricings that are too small for others to capitalize on. In describingthese trading opportunities to clients, Trent suggests that "clients willing to participate in this type ofarbitrage strategy are guaranteed riskless profits until the market pricing returns to equilibrium."Given that Gillis's weekly reports to clients are market summaries rather than specific investmentrecommendations, what are her record-keeping obligations according to CFA Institute Standards ofProfessional Conduct? Gillis must:

A. maintain records of her conversations with local government officials and also keep copies of theresearch reports prepared by local analysts.
B. only maintain records of her conversations with local government officials and her own summariesof the research reports prepared by local analysts.
C. keep her own summaries of the research reports prepared by local analysts, but she has noobligation to maintain records of her conversations with local government officials.

Show Answer

Question # 62

Martha Gillis, CFA, trades currencies for Trent, LLC. Trent is one of the largest investment firms in theworld, and its foreign currency department trades more currency on a daily basis than any otherfirm. Gillis specializes in currencies of emerging nations.Gillis received an invitation from the new Finance Minister of Binaria, one of the emerging nationsincluded in Gillis's portfolio. The minister has proposed a number of fiscal reforms that he hopes willhelp support Binaria's weakening currency. He is asking currency specialists from several of thelargest foreign exchange banks to visit Binaria for a conference on the planned reforms. Because ofits remote location, Binaria will pay all travel expenses of the attendees, as well as lodging ingovernment-owned facilities in the capital city. As a further inducement, attendees will also receivesmall bags of uncut emeralds (as emeralds are a principal export of Binaria), with an estimatedmarket value of $500.Gillis has approximately 25 clients that she deals with regularly, most of whom are large financialinstitutions interested in trading currencies. One of the services Gillis provides to these clients is aweekly summary of important trends in the emerging market currencies she follows. Gillis talks tolocal government officials and reads research reports prepared by local analysts, which are paid forby Trent. These inputs, along with Gillis's interpretation, form the basis of most of Gillis's weeklyreports.Gillis decided to attend the conference in Binaria. In anticipation of a favorable reception for theproposed reforms, Gillis purchased a long Binaria currency position in her personal account beforeleaving on the trip. After hearing the finance minister's proposals in person, however, she decidesthat the reforms are poorly timed and likely to cause the currency to depreciate. She issues anegative recommendation upon her return. Before issuing the recommendation, she liquidates thelong position in her personal account but does not take a short position.Gillis's supervisor, Steve Howlett, CFA, has been reviewing Gillis's personal trading. Howlett has notseen any details of the Binaria currency trade but has found two other instances in the past yearwhere he believes Gillis has violated Trent's written policies regarding trading in personal accounts.One of the currency trading strategies employed by Trent is based on interest rate parity. Trentmonitors spot exchange rates, forward rates, and short-term government interest rates. On the rareoccasions when the forward rates do not accurately reflect the interest differential between twocountries, Trent places trades to take advantage of the riskless arbitrage opportunity. Because Trentis such a large player in the exchange markets, its transactions costs are very low, and Trent is oftenable to take advantage of mispricings that are too small for others to capitalize on. In describingthese trading opportunities to clients, Trent suggests that "clients willing to participate in this type ofarbitrage strategy are guaranteed riskless profits until the market pricing returns to equilibrium."According to CFA Institute Standards of Professional Conduct, Gillis may accept the invitation toattend the conference in Binaria without violating the Standards;

A. so long as she pays her own travel expenses and refuses the gift of emeralds.
B. so long as she refuses the gift of emeralds.
C. since she would be the guest of a sovereign government.

Show Answer

Question # 63

Susan Foley, CFA, is Chief Investment Officer of Federated Investment Management Co. (FIMCO), alarge investment management firm that includes a family of mutual funds as well as individuallymanaged accounts. The individually managed accounts include individuals, personal trusts, andemployee benefit plans. In the past few months, Foley has encountered a couple of problems.The Tasty IPOMost portfolio managers of FIMCO have not participated in the initial public offering (IPO) market inrecent years. However, recent changes to the compensation calculation at FIMCO have tied managerbonuses to portfolio performance. The changes were outlined in a letter that was sent out to clientsand prospects shortly before the new bonus structure took effect. Carl Lee, CFA, is one portfoliomanager who believes that investing in IPOs may add to his client's equity performance and, in turn,increase his bonus. While Lee's individual clients have done quite well this year, his employee benefitplans have suffered as a result of limited exposure to the strongest performing sector of the market.Lee has placed an order for all employee benefit plans to receive an allocation of the Tasty DoughnutIPO. Tasty is an over-subscribed IPO that Lee knew would make money for his clients. When heplaced the order, Lee's assistant reminded him that one pension plan. Ultra Airlines, was explicitlyprohibited from investing in IPOs in its investment policy statement, due to the under-funded statusof the pension plan. Lee responded that the Tasty IPO would never actually be owned in Ultra'saccount, because he would sell the IPO stock before the end of the day and realize a profit before theposition ever hit the books.Another manager, Franz Mason, CFA, who manages accounts for about 150 individuals, is alsointerested in the Tasty IPO. Mason visits Lee's portfolio assistant and quizzes him about Lee'sparticipation in the Tasty deal. Mason is sure that Lee would not have bought into Tasty unless he haddone his homework. Mason places an order for 10,000 shares of the IPO. Mason returns to his deskand begins to allocate the IPO shares among his clients. Mason divides his client base into twogroups: clients who are income-oriented and clients who arc capital gains-oriented. Mason believesthose clients that are income-oriented are fairly risk averse and could not replace lost capital if theTasty Doughnut deal lost money. Mason believes the capital gains-oriented accounts arc better ableto withstand the potential loss associated with the Tasty IPO. Accordingly, Mason allocates his 10,000share order of the Tasty IPO strictly to his capital appreciation clients using a pro rata allocation basedon the size of the assets under management in each account.FIMCO Income Fund (FIF)Over the past three years, the FIF, with $5 billion in assets, has been the company's best performingmutual fund. Jane Ryan, CFA, managed the FIF for seven years, but resigned one year ago to start herown hedge fund. Under Ryan, the FIF invested in large cap stocks with reliable dividends. The fund'sprospectus specifies that FIF will invest only in stocks that have paid a dividend for at least twoquarters, and have a market capitalization in excess of $2.5 billion. Foley appointed FIMCO's nextbest manager (based on 5-year performance numbers) Steve Parsons, CFA, to replace Ryan. Parsonshad been a very successful manager of the FIMCO Opportunity Fund, which specialized in smallcapitalization stocks. Six months after Parsons took over the helm at FIF. the portfolio had changed.The average market capitalization of FIF's holdings was $12.8 billion, as opposed to $21 billion a yearago. Over the same period, the average dividend yield on the portfolio had fallen from 3.8% to 3.1%.The performance of the FIF lagged its peer group for the first time in three years. In response to thelagging performance, Parsons purchased five stocks six months ago. Parsons bought all five stocks,none of which paid a dividend at the time of purchase, in anticipation that each company was likelyto initiate dividends in the near future. So far, four of the stocks have initiated dividend payments,and their performance has benefited as a result. The fifth stock did not initiate a dividend, andParsons sold the position last week. Largely due to the addition of the five new stocks, the FIF'sperformance has led its peer group over the past six months.Before leaving FIMCO, Ryan had told Foley that above-average returns from both the managementand client side could be gained from entering into the risk-arbitrage hedge fund market. Ryan hadtried to convince FIMCO management to enter the risk-arbitrage market, but the firm determinedthat no one had the experience or research capability to run a risk-arbitrage operation. As a result,Ryan started the Plasma Fund LLC one month after leaving FIMCO. Foley remembers seeing Ryan atthe annual FIMCO client dinner parly (before she left the firm) discussing the profits to be made fromrisk-arbitrage investing with several large FIF shareholders. Ryan mentioned that she would beopening the Plasma Fund to these FIMCO clients, several of whom made substantial investments inthe first months of Plasma Fund's life. After Ryan resigned and left her office, Foley performed aninventory of firm assets signed out to Ryan. One of the copies of the proprietary stock selectionsoftware packages, FIMCO-SelectStock, assigned to Ryan was missing along with several of theSelectStock operating manuals. When Foley contacts Ryan about the missing software and manuals,Ryan states that the reason she took the SelectStock software was that it was an out of date versionthat FIMCO's information technology staff had urged all managers to discard.Which of the following statements is most accurate with regard to Ryan's taking the out of dateversion of the SelectStock software?

A. The inappropriate misappropriation of the software and manuals is a violation of CFA InstituteStandard IV(A) - Duties to Employers - Loyalty, regardless of the circumstances. Written permissionfrom the employer (FIMCO) should have been requested and received.
B. Ryan's possession of the out of date software is perfectly acceptable, since her IT staff had made itclear that is was no longer needed by FIMCO.
C. Ryan's possession of the out of date software is perfectly acceptable, since the software is of nouse to FIMCO, and the fact that it was an outdated version indicates that it had no economic value.

Show Answer

Question # 64

Susan Foley, CFA, is Chief Investment Officer of Federated Investment Management Co. (FIMCO), alarge investment management firm that includes a family of mutual funds as well as individuallymanaged accounts. The individually managed accounts include individuals, personal trusts, andemployee benefit plans. In the past few months, Foley has encountered a couple of problems.The Tasty IPOMost portfolio managers of FIMCO have not participated in the initial public offering (IPO) market inrecent years. However, recent changes to the compensation calculation at FIMCO have tied managerbonuses to portfolio performance. The changes were outlined in a letter that was sent out to clientsand prospects shortly before the new bonus structure took effect. Carl Lee, CFA, is one portfoliomanager who believes that investing in IPOs may add to his client's equity performance and, in turn,increase his bonus. While Lee's individual clients have done quite well this year, his employee benefitplans have suffered as a result of limited exposure to the strongest performing sector of the market.Lee has placed an order for all employee benefit plans to receive an allocation of the Tasty DoughnutIPO. Tasty is an over-subscribed IPO that Lee knew would make money for his clients. When heplaced the order, Lee's assistant reminded him that one pension plan. Ultra Airlines, was explicitlyprohibited from investing in IPOs in its investment policy statement, due to the under-funded statusof the pension plan. Lee responded that the Tasty IPO would never actually be owned in Ultra'saccount, because he would sell the IPO stock before the end of the day and realize a profit before theposition ever hit the books.Another manager, Franz Mason, CFA, who manages accounts for about 150 individuals, is alsointerested in the Tasty IPO. Mason visits Lee's portfolio assistant and quizzes him about Lee'sparticipation in the Tasty deal. Mason is sure that Lee would not have bought into Tasty unless he haddone his homework. Mason places an order for 10,000 shares of the IPO. Mason returns to his deskand begins to allocate the IPO shares among his clients. Mason divides his client base into twogroups: clients who are income-oriented and clients who arc capital gains-oriented. Mason believesthose clients that are income-oriented are fairly risk averse and could not replace lost capital if theTasty Doughnut deal lost money. Mason believes the capital gains-oriented accounts arc better ableto withstand the potential loss associated with the Tasty IPO. Accordingly, Mason allocates his 10,000share order of the Tasty IPO strictly to his capital appreciation clients using a pro rata allocation basedon the size of the assets under management in each account.FIMCO Income Fund (FIF)Over the past three years, the FIF, with $5 billion in assets, has been the company's best performingmutual fund. Jane Ryan, CFA, managed the FIF for seven years, but resigned one year ago to start herown hedge fund. Under Ryan, the FIF invested in large cap stocks with reliable dividends. The fund'sprospectus specifies that FIF will invest only in stocks that have paid a dividend for at least twoquarters, and have a market capitalization in excess of $2.5 billion. Foley appointed FIMCO's nextbest manager (based on 5-year performance numbers) Steve Parsons, CFA, to replace Ryan. Parsonshad been a very successful manager of the FIMCO Opportunity Fund, which specialized in smallcapitalization stocks. Six months after Parsons took over the helm at FIF. the portfolio had changed.The average market capitalization of FIF's holdings was $12.8 billion, as opposed to $21 billion a yearago. Over the same period, the average dividend yield on the portfolio had fallen from 3.8% to 3.1%.The performance of the FIF lagged its peer group for the first time in three years. In response to thelagging performance, Parsons purchased five stocks six months ago. Parsons bought all five stocks,none of which paid a dividend at the time of purchase, in anticipation that each company was likelyto initiate dividends in the near future. So far, four of the stocks have initiated dividend payments,and their performance has benefited as a result. The fifth stock did not initiate a dividend, andParsons sold the position last week. Largely due to the addition of the five new stocks, the FIF'sperformance has led its peer group over the past six months.Before leaving FIMCO, Ryan had told Foley that above-average returns from both the managementand client side could be gained from entering into the risk-arbitrage hedge fund market. Ryan hadtried to convince FIMCO management to enter the risk-arbitrage market, but the firm determinedthat no one had the experience or research capability to run a risk-arbitrage operation. As a result,Ryan started the Plasma Fund LLC one month after leaving FIMCO. Foley remembers seeing Ryan atthe annual FIMCO client dinner parly (before she left the firm) discussing the profits to be made fromrisk-arbitrage investing with several large FIF shareholders. Ryan mentioned that she would beopening the Plasma Fund to these FIMCO clients, several of whom made substantial investments inthe first months of Plasma Fund's life. After Ryan resigned and left her office, Foley performed aninventory of firm assets signed out to Ryan. One of the copies of the proprietary stock selectionsoftware packages, FIMCO-SelectStock, assigned to Ryan was missing along with several of theSelectStock operating manuals. When Foley contacts Ryan about the missing software and manuals,Ryan states that the reason she took the SelectStock software was that it was an out of date versionthat FIMCO's information technology staff had urged all managers to discard.Which of the following statements is most accurate with regard to Ryan's discussion of the newPlasma Fund with FIMCO clients?

A. Ryan is within the CFA Institute Standards because the Plasma Fund was only in the planningstages at the time of her discussion.
B. Ryan is within the CFA Institute Standards by discussing Plasma with the clients, since the productshe was discussing did not compete with her present employer (FIMCO) in any way.
C. Ryan has violated CFA Institute Standard IV(A) - Duties to Employers - Loyalty. In the meeting withpotential clients, even though FIMCO had no experience or research capability to enter the riskarbitrage market, Ryan is offering an asset management service that is directing funds away fromFIMCO.

Show Answer

Question # 65

Susan Foley, CFA, is Chief Investment Officer of Federated Investment Management Co. (FIMCO), alarge investment management firm that includes a family of mutual funds as well as individuallymanaged accounts. The individually managed accounts include individuals, personal trusts, andemployee benefit plans. In the past few months, Foley has encountered a couple of problems.The Tasty IPOMost portfolio managers of FIMCO have not participated in the initial public offering (IPO) market inrecent years. However, recent changes to the compensation calculation at FIMCO have tied managerbonuses to portfolio performance. The changes were outlined in a letter that was sent out to clientsand prospects shortly before the new bonus structure took effect. Carl Lee, CFA, is one portfoliomanager who believes that investing in IPOs may add to his client's equity performance and, in turn,increase his bonus. While Lee's individual clients have done quite well this year, his employee benefitplans have suffered as a result of limited exposure to the strongest performing sector of the market.Lee has placed an order for all employee benefit plans to receive an allocation of the Tasty DoughnutIPO. Tasty is an over-subscribed IPO that Lee knew would make money for his clients. When heplaced the order, Lee's assistant reminded him that one pension plan. Ultra Airlines, was explicitlyprohibited from investing in IPOs in its investment policy statement, due to the under-funded statusof the pension plan. Lee responded that the Tasty IPO would never actually be owned in Ultra'saccount, because he would sell the IPO stock before the end of the day and realize a profit before theposition ever hit the books.Another manager, Franz Mason, CFA, who manages accounts for about 150 individuals, is alsointerested in the Tasty IPO. Mason visits Lee's portfolio assistant and quizzes him about Lee'sparticipation in the Tasty deal. Mason is sure that Lee would not have bought into Tasty unless he haddone his homework. Mason places an order for 10,000 shares of the IPO. Mason returns to his deskand begins to allocate the IPO shares among his clients. Mason divides his client base into twogroups: clients who are income-oriented and clients who arc capital gains-oriented. Mason believesthose clients that are income-oriented are fairly risk averse and could not replace lost capital if theTasty Doughnut deal lost money. Mason believes the capital gains-oriented accounts arc better ableto withstand the potential loss associated with the Tasty IPO. Accordingly, Mason allocates his 10,000share order of the Tasty IPO strictly to his capital appreciation clients using a pro rata allocation basedon the size of the assets under management in each account.FIMCO Income Fund (FIF)Over the past three years, the FIF, with $5 billion in assets, has been the company's best performingmutual fund. Jane Ryan, CFA, managed the FIF for seven years, but resigned one year ago to start herown hedge fund. Under Ryan, the FIF invested in large cap stocks with reliable dividends. The fund'sprospectus specifies that FIF will invest only in stocks that have paid a dividend for at least twoquarters, and have a market capitalization in excess of $2.5 billion. Foley appointed FIMCO's nextbest manager (based on 5-year performance numbers) Steve Parsons, CFA, to replace Ryan. Parsonshad been a very successful manager of the FIMCO Opportunity Fund, which specialized in smallcapitalization stocks. Six months after Parsons took over the helm at FIF. the portfolio had changed.The average market capitalization of FIF's holdings was $12.8 billion, as opposed to $21 billion a yearago. Over the same period, the average dividend yield on the portfolio had fallen from 3.8% to 3.1%.The performance of the FIF lagged its peer group for the first time in three years. In response to thelagging performance, Parsons purchased five stocks six months ago. Parsons bought all five stocks,none of which paid a dividend at the time of purchase, in anticipation that each company was likelyto initiate dividends in the near future. So far, four of the stocks have initiated dividend payments,and their performance has benefited as a result. The fifth stock did not initiate a dividend, andParsons sold the position last week. Largely due to the addition of the five new stocks, the FIF'sperformance has led its peer group over the past six months.Before leaving FIMCO, Ryan had told Foley that above-average returns from both the managementand client side could be gained from entering into the risk-arbitrage hedge fund market. Ryan hadtried to convince FIMCO management to enter the risk-arbitrage market, but the firm determinedthat no one had the experience or research capability to run a risk-arbitrage operation. As a result,Ryan started the Plasma Fund LLC one month after leaving FIMCO. Foley remembers seeing Ryan atthe annual FIMCO client dinner parly (before she left the firm) discussing the profits to be made fromrisk-arbitrage investing with several large FIF shareholders. Ryan mentioned that she would beopening the Plasma Fund to these FIMCO clients, several of whom made substantial investments inthe first months of Plasma Fund's life. After Ryan resigned and left her office, Foley performed aninventory of firm assets signed out to Ryan. One of the copies of the proprietary stock selectionsoftware packages, FIMCO-SelectStock, assigned to Ryan was missing along with several of theSelectStock operating manuals. When Foley contacts Ryan about the missing software and manualsRyan states that the reason she took the SelectStock software was that it was an out of date versionthat FIMCO's information technology staff had urged all managers to discard.Has there been any violation of CFA Institute Standards of Professional Conduct relating to either thechange in the average holdings of the FIF during the first six months of Parsons's leadership, or inParsons's subsequent investment in the non-dividend paying stocks?

A. Both actions. The change in average holdings, and the purchase of non-dividend paying stocks, areviolations of CFA Institute Standards.
B. The change in average holdings would not have been a violation of CFA Institute Standards if clientnotification had occurred before the change was initiated.
C. There is no violation regarding the change in average holdings, but the purchase of non-dividendpaying stocks is a violation.

Show Answer

Question # 66

Susan Foley, CFA, is Chief Investment Officer of Federated Investment Management Co. (FIMCO), alarge investment management firm that includes a family of mutual funds as well as individuallymanaged accounts. The individually managed accounts include individuals, personal trusts, andemployee benefit plans. In the past few months, Foley has encountered a couple of problems.The Tasty IPOMost portfolio managers of FIMCO have not participated in the initial public offering (IPO) market inrecent years. However, recent changes to the compensation calculation at FIMCO have tied managerbonuses to portfolio performance. The changes were outlined in a letter that was sent out to clientsand prospects shortly before the new bonus structure took effect. Carl Lee, CFA, is one portfoliomanager who believes that investing in IPOs may add to his client's equity performance and, in turn,increase his bonus. While Lee's individual clients have done quite well this year, his employee benefitplans have suffered as a result of limited exposure to the strongest performing sector of the market.Lee has placed an order for all employee benefit plans to receive an allocation of the Tasty DoughnutIPO. Tasty is an over-subscribed IPO that Lee knew would make money for his clients. When heplaced the order, Lee's assistant reminded him that one pension plan. Ultra Airlines, was explicitlyprohibited from investing in IPOs in its investment policy statement, due to the under-funded statusof the pension plan. Lee responded that the Tasty IPO would never actually be owned in Ultra'saccount, because he would sell the IPO stock before the end of the day and realize a profit before theposition ever hit the books.Another manager, Franz Mason, CFA, who manages accounts for about 150 individuals, is alsointerested in the Tasty IPO. Mason visits Lee's portfolio assistant and quizzes him about Lee'sparticipation in the Tasty deal. Mason is sure that Lee would not have bought into Tasty unless he haddone his homework. Mason places an order for 10,000 shares of the IPO. Mason returns to his deskand begins to allocate the IPO shares among his clients. Mason divides his client base into twogroups: clients who are income-oriented and clients who arc capital gains-oriented. Mason believesthose clients that are income-oriented are fairly risk averse and could not replace lost capital if theTasty Doughnut deal lost money. Mason believes the capital gains-oriented accounts arc better ableto withstand the potential loss associated with the Tasty IPO. Accordingly, Mason allocates his 10,000share order of the Tasty IPO strictly to his capital appreciation clients using a pro rata allocation basedon the size of the assets under management in each account.FIMCO Income Fund (FIF)Over the past three years, the FIF, with $5 billion in assets, has been the company's best performingmutual fund. Jane Ryan, CFA, managed the FIF for seven years, but resigned one year ago to start herown hedge fund. Under Ryan, the FIF invested in large cap stocks with reliable dividends. The fund'sprospectus specifies that FIF will invest only in stocks that have paid a dividend for at least twoquarters, and have a market capitalization in excess of $2.5 billion. Foley appointed FIMCO's nextbest manager (based on 5-year performance numbers) Steve Parsons, CFA, to replace Ryan. Parsonshad been a very successful manager of the FIMCO Opportunity Fund, which specialized in smallcapitalization stocks. Six months after Parsons took over the helm at FIF. the portfolio had changed.The average market capitalization of FIF's holdings was $12.8 billion, as opposed to $21 billion a yearago. Over the same period, the average dividend yield on the portfolio had fallen from 3.8% to 3.1%.The performance of the FIF lagged its peer group for the first time in three years. In response to thelagging performance, Parsons purchased five stocks six months ago. Parsons bought all five stocks,none of which paid a dividend at the time of purchase, in anticipation that each company was likelyto initiate dividends in the near future. So far, four of the stocks have initiated dividend payments,and their performance has benefited as a result. The fifth stock did not initiate a dividend, andParsons sold the position last week. Largely due to the addition of the five new stocks, the FIF'sperformance has led its peer group over the past six months.Before leaving FIMCO, Ryan had told Foley that above-average returns from both the managementand client side could be gained from entering into the risk-arbitrage hedge fund market. Ryan hadtried to convince FIMCO management to enter the risk-arbitrage market, but the firm determinedthat no one had the experience or research capability to run a risk-arbitrage operation. As a result,Ryan started the Plasma Fund LLC one month after leaving FIMCO. Foley remembers seeing Ryan atthe annual FIMCO client dinner parly (before she left the firm) discussing the profits to be made fromrisk-arbitrage investing with several large FIF shareholders. Ryan mentioned that she would beopening the Plasma Fund to these FIMCO clients, several of whom made substantial investments inthe first months of Plasma Fund's life. After Ryan resigned and left her office, Foley performed aninventory of firm assets signed out to Ryan. One of the copies of the proprietary stock selectionsoftware packages, FIMCO-SelectStock, assigned to Ryan was missing along with several of theSelectStock operating manuals. When Foley contacts Ryan about the missing software and manuals,Ryan states that the reason she took the SelectStock software was that it was an out of date versionthat FIMCO's information technology staff had urged all managers to discard.Which of the following is most likely consistent with CFA Institute Standards of Professional Conduct?

A. Lee assumed that Ultra's Tasty IPO position was acceptable as an intraday transaction.
B. Improved performance in Lee's employee benefit plan accounts increases his bonus.
C. Mason relied on Lee's investment decision as adequate rationale to buy into the Tasty IPO.

Show Answer

Question # 67

Susan Foley, CFA, is Chief Investment Officer of Federated Investment Management Co. (FIMCO), alarge investment management firm that includes a family of mutual funds as well as individuallymanaged accounts. The individually managed accounts include individuals, personal trusts, andemployee benefit plans. In the past few months, Foley has encountered a couple of problems.The Tasty IPOMost portfolio managers of FIMCO have not participated in the initial public offering (IPO) market inrecent years. However, recent changes to the compensation calculation at FIMCO have tied managerbonuses to portfolio performance. The changes were outlined in a letter that was sent out to clientsand prospects shortly before the new bonus structure took effect. Carl Lee, CFA, is one portfoliomanager who believes that investing in IPOs may add to his client's equity performance and, in turn,increase his bonus. While Lee's individual clients have done quite well this year, his employee benefitplans have suffered as a result of limited exposure to the strongest performing sector of the market.Lee has placed an order for all employee benefit plans to receive an allocation of the Tasty DoughnutIPO. Tasty is an over-subscribed IPO that Lee knew would make money for his clients. When heplaced the order, Lee's assistant reminded him that one pension plan. Ultra Airlines, was explicitlyprohibited from investing in IPOs in its investment policy statement, due to the under-funded statusof the pension plan. Lee responded that the Tasty IPO would never actually be owned in Ultra'saccount, because he would sell the IPO stock before the end of the day and realize a profit before theposition ever hit the books.Another manager, Franz Mason, CFA, who manages accounts for about 150 individuals, is alsointerested in the Tasty IPO. Mason visits Lee's portfolio assistant and quizzes him about Lee'sparticipation in the Tasty deal. Mason is sure that Lee would not have bought into Tasty unless he haddone his homework. Mason places an order for 10,000 shares of the IPO. Mason returns to his deskand begins to allocate the IPO shares among his clients. Mason divides his client base into twogroups: clients who are income-oriented and clients who arc capital gains-oriented. Mason believesthose clients that are income-oriented are fairly risk averse and could not replace lost capital if theTasty Doughnut deal lost money. Mason believes the capital gains-oriented accounts arc better ableto withstand the potential loss associated with the Tasty IPO. Accordingly, Mason allocates his 10,000share order of the Tasty IPO strictly to his capital appreciation clients using a pro rata allocation basedon the size of the assets under management in each account.FIMCO Income Fund (FIF)Over the past three years, the FIF, with $5 billion in assets, has been the company's best performingmutual fund. Jane Ryan, CFA, managed the FIF for seven years, but resigned one year ago to start herown hedge fund. Under Ryan, the FIF invested in large cap stocks with reliable dividends. The fund'sprospectus specifies that FIF will invest only in stocks that have paid a dividend for at least twoquarters, and have a market capitalization in excess of $2.5 billion. Foley appointed FIMCO's nextbest manager (based on 5-year performance numbers) Steve Parsons, CFA, to replace Ryan. Parsonshad been a very successful manager of the FIMCO Opportunity Fund, which specialized in smallcapitalization stocks. Six months after Parsons took over the helm at FIF. the portfolio had changed.The average market capitalization of FIF's holdings was $12.8 billion, as opposed to $21 billion a yearago. Over the same period, the average dividend yield on the portfolio had fallen from 3.8% to 3.1%.The performance of the FIF lagged its peer group for the first time in three years. In response to thelagging performance, Parsons purchased five stocks six months ago. Parsons bought all five stocks,none of which paid a dividend at the time of purchase, in anticipation that each company was likelyto initiate dividends in the near future. So far, four of the stocks have initiated dividend payments,and their performance has benefited as a result. The fifth stock did not initiate a dividend, andParsons sold the position last week. Largely due to the addition of the five new stocks, the FIF'sperformance has led its peer group over the past six months.Before leaving FIMCO, Ryan had told Foley that above-average returns from both the managementand client side could be gained from entering into the risk-arbitrage hedge fund market. Ryan hadtried to convince FIMCO management to enter the risk-arbitrage market, but the firm determinedthat no one had the experience or research capability to run a risk-arbitrage operation. As a result,Ryan started the Plasma Fund LLC one month after leaving FIMCO. Foley remembers seeing Ryan atthe annual FIMCO client dinner parly (before she left the firm) discussing the profits to be made fromrisk-arbitrage investing with several large FIF shareholders. Ryan mentioned that she would beopening the Plasma Fund to these FIMCO clients, several of whom made substantial investments inthe first months of Plasma Fund's life. After Ryan resigned and left her office, Foley performed aninventory of firm assets signed out to Ryan. One of the copies of the proprietary stock selectionsoftware packages, FIMCO-SelectStock, assigned to Ryan was missing along with several of theSelectStock operating manuals. When Foley contacts Ryan about the missing software and manuals,Ryan states that the reason she took the SelectStock software was that it was an out of date versionthat FIMCO's information technology staff had urged all managers to discard.Mason used two allocation plans for the Tasty IPO: the first decision was based on the orientation ofthe account (income vs. capital gains), and the second decision was based on the relative size of eachaccount. Did Mason violate CFA Institute Standards of Professional Conduct with respect to eitherallocation decision?

A. Both Mason's allocation screens, based on orientation of the account, and on relative size ofaccount, violate CFA Institute Standards.
B. Both of Mason's allocation screens appear to fully conform with CFA Institute Standards.
C. Mason's pro rata allocation system is acceptable, but he should have allocated some IPO shares tohis income-oriented accounts.

Show Answer

Question # 68

Susan Foley, CFA, is Chief Investment Officer of Federated Investment Management Co. (FIMCO), alarge investment management firm that includes a family of mutual funds as well as individuallymanaged accounts. The individually managed accounts include individuals, personal trusts, andemployee benefit plans. In the past few months, Foley has encountered a couple of problems.The Tasty IPOMost portfolio managers of FIMCO have not participated in the initial public offering (IPO) market inrecent years. However, recent changes to the compensation calculation at FIMCO have tied managerbonuses to portfolio performance. The changes were outlined in a letter that was sent out to clientsand prospects shortly before the new bonus structure took effect. Carl Lee, CFA, is one portfoliomanager who believes that investing in IPOs may add to his client's equity performance and, in turn,increase his bonus. While Lee's individual clients have done quite well this year, his employee benefitplans have suffered as a result of limited exposure to the strongest performing sector of the market.Lee has placed an order for all employee benefit plans to receive an allocation of the Tasty DoughnutIPO. Tasty is an over-subscribed IPO that Lee knew would make money for his clients. When heplaced the order, Lee's assistant reminded him that one pension plan. Ultra Airlines, was explicitlyprohibited from investing in IPOs in its investment policy statement, due to the under-funded statusof the pension plan. Lee responded that the Tasty IPO would never actually be owned in Ultra'saccount, because he would sell the IPO stock before the end of the day and realize a profit before theposition ever hit the books.Another manager, Franz Mason, CFA, who manages accounts for about 150 individuals, is alsointerested in the Tasty IPO. Mason visits Lee's portfolio assistant and quizzes him about Lee'sparticipation in the Tasty deal. Mason is sure that Lee would not have bought into Tasty unless he haddone his homework. Mason places an order for 10,000 shares of the IPO. Mason returns to his deskand begins to allocate the IPO shares among his clients. Mason divides his client base into twogroups: clients who are income-oriented and clients who arc capital gains-oriented. Mason believesthose clients that are income-oriented are fairly risk averse and could not replace lost capital if theTasty Doughnut deal lost money. Mason believes the capital gains-oriented accounts arc better ableto withstand the potential loss associated with the Tasty IPO. Accordingly, Mason allocates his 10,000share order of the Tasty IPO strictly to his capital appreciation clients using a pro rata allocation basedon the size of the assets under management in each account.FIMCO Income Fund (FIF)Over the past three years, the FIF, with $5 billion in assets, has been the company's best performingmutual fund. Jane Ryan, CFA, managed the FIF for seven years, but resigned one year ago to start herown hedge fund. Under Ryan, the FIF invested in large cap stocks with reliable dividends. The fund'sprospectus specifies that FIF will invest only in stocks that have paid a dividend for at least twoquarters, and have a market capitalization in excess of $2.5 billion. Foley appointed FIMCO's nextbest manager (based on 5-year performance numbers) Steve Parsons, CFA, to replace Ryan. Parsonshad been a very successful manager of the FIMCO Opportunity Fund, which specialized in smallcapitalization stocks. Six months after Parsons took over the helm at FIF. the portfolio had changed.The average market capitalization of FIF's holdings was $12.8 billion, as opposed to $21 billion a yearago. Over the same period, the average dividend yield on the portfolio had fallen from 3.8% to 3.1%.The performance of the FIF lagged its peer group for the first time in three years. In response to thelagging performance, Parsons purchased five stocks six months ago. Parsons bought all five stocks,none of which paid a dividend at the time of purchase, in anticipation that each company was likelyto initiate dividends in the near future. So far, four of the stocks have initiated dividend payments,and their performance has benefited as a result. The fifth stock did not initiate a dividend, andParsons sold the position last week. Largely due to the addition of the five new stocks, the FIF'sperformance has led its peer group over the past six months.Before leaving FIMCO, Ryan had told Foley that above-average returns from both the managementand client side could be gained from entering into the risk-arbitrage hedge fund market. Ryan hadtried to convince FIMCO management to enter the risk-arbitrage market, but the firm determinedthat no one had the experience or research capability to run a risk-arbitrage operation. As a result,Ryan started the Plasma Fund LLC one month after leaving FIMCO. Foley remembers seeing Ryan atthe annual FIMCO client dinner parly (before she left the firm) discussing the profits to be made fromrisk-arbitrage investing with several large FIF shareholders. Ryan mentioned that she would beopening the Plasma Fund to these FIMCO clients, several of whom made substantial investments inthe first months of Plasma Fund's life. After Ryan resigned and left her office, Foley performed aninventory of firm assets signed out to Ryan. One of the copies of the proprietary stock selectionsoftware packages, FIMCO-SelectStock, assigned to Ryan was missing along with several of theSelectStock operating manuals. When Foley contacts Ryan about the missing software and manuals,Ryan states that the reason she took the SelectStock software was that it was an out of date versionthat FIMCO's information technology staff had urged all managers to discard.Regarding Lee's order for employee benefit plans to receive an allocation of the Tasty Doughnut IPO,and his purchase of the Tasty Doughnut IPO for the Ultra Airlines Pension account, which of thefollowing statements is most accurate?

A. Lee's order for all employee benefit plans to receive an allocation of the Tasty Doughnuts IPO isacceptable, but Lee has violated CFA Institute Standards by placing the IPO order in the Ultra Airlinespension account.
B. Lee's order for all employee benefit plans to receive an allocation of the Tasty Doughnuts IPO isacceptable, since it is appropriate for his clients' employee benefit plans, and Lee has followed theCFA Institute Standards by notifying clients about recent compensation calculation changes, but Leehas violated CFA Institute Standards by placing the IPO order in the Ultra Airlines pension account.
C. By allocating the Tasty Doughnuts IPO to employee benefit accounts only, Lee is discriminatingagainst other accounts who may have also wanted to participate in the Tasty IPO. Purchasing sharesin the Tasty Doughnuts IPO for the Ultra Airlines account is a violation of CFA Institute Standards,since it violates the investment policy statement (IPS).

Show Answer

Question # 69

Chester Brothers, LLC, is an investment management firm with $200 million in assets undermanagement. Chester's equity style is described to clients as a "large cap core" strategy. One yearago, Chester instituted a new compensation plan for its equity portfolio managers. Under this newplan, each portfolio manager receives an annual bonus based upon that manager's quarterlyperformance relative to the S&P 500 index. For each quarter of aut-performance, the managerreceives a bonus in the amount of 20% of his regular annual compensation. Chester has not disclosedthis new plan to clients. Portfolio managers at Chester are not bound by non-compete agreements.Fames Rogers, CFA, and Karen Pierce, CFA, are both portfolio managers affected by the new policy.Rogers out-performed the S&P 500 index in each of the last three quarters, largely because he beganinvesting his clients1 funds in small cap securities. Chester has recently been citing Rogers'sperformance in local media advertising, including claims that "Chester's star manager, James Rogers,has outperformed the S&P 500 index in each of the last three quarters." The print advertisingassociated with the media campaign includes a photograph of Rogers, identifying him as JamesRogers, CFA. Below his name is a quote apparently attributable to Rogers saying "as a CFA chartcrholdcr I amcommitted to the highest ethical standards."A few weeks after the advertising campaign began, Rogers was approached by the GrumppFoundation, a local charitable endowment with $3 billion in assets, about serving on theirinvestment advisory committee. The committee meets weekly to review the portfolio and makeadjustments as needed. The Grumpp trustees were impressed by the favorable mention of Rogers inthe marketing campaign. In making their offer, they even suggested that Rogers could mention hisposition on the advisory committee in future Chester marketing material. Rogers has not informedChester about the Grumpp offer, but he has not yet accepted the position.Pierce has not fared as well as Rogers. She also shifted into smaller cap securities, but due to twoextremely poor performing large cap stocks, her performance lagged the S&P 500 index for the firstthree quarters. After an angry confrontation with her supervisor, Pierce resigned. Pierce did not takeany client information with her, but when she left she did take a copy of a Pierce has not fared as wellas Rogers. She also shifted into smaller cap securities, but due to two extremely poor performinglarge cap stocks, her performance lagged the S&P 500 index for the first three quarters. After anangry confrontation with her supervisor, Pierce resigned. Pierce did not take any client informationwith her, but when she left she did take a copy of a computer model she developed while working alChester, as well as the most recent list of her buy recommendations, which was created from theoutput of her computer valuation model. Pierce soon accepted a position at a competing firm, CheeriGroup. On her first day at Cheeri, she contacted each of her five largest former clients, informingthem of her new employment and asking that they consider moving their accounts from Chester toCheeri. During both telephone conversations and e-mails with her former clients, Pierce mentionedthat Chester had a new compensation program that created incentives for managers to shift intosmaller cap securities.Cheeri has posted Pierce's investment performance for the past five years on its Web site, excludingthe three most recent quarters. The footnotes to the performance information include the followingtwo statements:Statement 1: Includes large capitalization portfolios only.Statement 2: Results reflect manager's performance at previous employer.Cheeri's presentation of Pierce's investment performance is inconsistent with CFA Institute Standardsbecause:

A. the results were not calculated under GIPS.
B. performance from a previous employer should not be included.
C. the results misrepresent Pierce's large cap performance.

Show Answer

Question # 70

Chester Brothers, LLC, is an investment management firm with $200 million in assets undermanagement. Chester's equity style is described to clients as a "large cap core" strategy. One yearago, Chester instituted a new compensation plan for its equity portfolio managers. Under this newplan, each portfolio manager receives an annual bonus based upon that manager's quarterlyperformance relative to the S&P 500 index. For each quarter of aut-performance, the managerreceives a bonus in the amount of 20% of his regular annual compensation. Chester has not disclosedthis new plan to clients. Portfolio managers at Chester are not bound by non-compete agreements.Fames Rogers, CFA, and Karen Pierce, CFA, are both portfolio managers affected by the new policy.Rogers out-performed the S&P 500 index in each of the last three quarters, largely because he beganinvesting his clients1 funds in small cap securities. Chester has recently been citing Rogers'sperformance in local media advertising, including claims that "Chester's star manager, James Rogers,has outperformed the S&P 500 index in each of the last three quarters." The print advertisingassociated with the media campaign includes a photograph of Rogers, identifying him as JamesRogers, CFA. Below his name is a quote apparently attributable to Rogers saying "as a CFA chartcrholdcr I amcommitted to the highest ethical standards."A few weeks after the advertising campaign began, Rogers was approached by the GrumppFoundation, a local charitable endowment with $3 billion in assets, about serving on theirinvestment advisory committee. The committee meets weekly to review the portfolio and makeadjustments as needed. The Grumpp trustees were impressed by the favorable mention of Rogers inthe marketing campaign. In making their offer, they even suggested that Rogers could mention hisposition on the advisory committee in future Chester marketing material. Rogers has not informedChester about the Grumpp offer, but he has not yet accepted the position.Pierce has not fared as well as Rogers. She also shifted into smaller cap securities, but due to twoextremely poor performing large cap stocks, her performance lagged the S&P 500 index for the firstthree quarters. After an angry confrontation with her supervisor, Pierce resigned. Pierce did not takeany client information with her, but when she left she did take a copy of a Pierce has not fared as wellas Rogers. She also shifted into smaller cap securities, but due to two extremely poor performinglarge cap stocks, her performance lagged the S&P 500 index for the first three quarters. After anangry confrontation with her supervisor, Pierce resigned. Pierce did not take any client informationwith her, but when she left she did take a copy of a computer model she developed while working alChester, as well as the most recent list of her buy recommendations, which was created from theoutput of her computer valuation model. Pierce soon accepted a position at a competing firm, CheeriGroup. On her first day at Cheeri, she contacted each of her five largest former clients, informingthem of her new employment and asking that they consider moving their accounts from Chester toCheeri. During both telephone conversations and e-mails with her former clients, Pierce mentionedthat Chester had a new compensation program that created incentives for managers to shift intosmaller cap securities.Cheeri has posted Pierce's investment performance for the past five years on its Web site, excludingthe three most recent quarters. The footnotes to the performance information include the followingtwo statements:Statement 1: Includes large capitalization portfolios only.Statement 2: Results reflect manager's performance at previous employer.Pierce's behavior upon assuming her new position at Cheeri can best be described as violating CFAInstitute Standards because she:

A. encouraged her former clients to leave Chester.
B. should not have contacted her former clients at all.
C. disclosed Chester's new compensation program.

Show Answer

Question # 71

Chester Brothers, LLC, is an investment management firm with $200 million in assets undermanagement. Chester's equity style is described to clients as a "large cap core" strategy. One yearago, Chester instituted a new compensation plan for its equity portfolio managers. Under this newplan, each portfolio manager receives an annual bonus based upon that manager's quarterlyperformance relative to the S&P 500 index. For each quarter of aut-performance, the managerreceives a bonus in the amount of 20% of his regular annual compensation. Chester has not disclosedthis new plan to clients. Portfolio managers at Chester are not bound by non-compete agreements.Fames Rogers, CFA, and Karen Pierce, CFA, are both portfolio managers affected by the new policy.Rogers out-performed the S&P 500 index in each of the last three quarters, largely because he beganinvesting his clients1 funds in small cap securities. Chester has recently been citing Rogers'sperformance in local media advertising, including claims that "Chester's star manager, James Rogers,has outperformed the S&P 500 index in each of the last three quarters." The print advertisingassociated with the media campaign includes a photograph of Rogers, identifying him as JamesRogers, CFA. Below his name is a quote apparently attributable to Rogers saying "as a CFA chartcrholdcr I amcommitted to the highest ethical standards."A few weeks after the advertising campaign began, Rogers was approached by the GrumppFoundation, a local charitable endowment with $3 billion in assets, about serving on theirinvestment advisory committee. The committee meets weekly to review the portfolio and makeadjustments as needed. The Grumpp trustees were impressed by the favorable mention of Rogers inthe marketing campaign. In making their offer, they even suggested that Rogers could mention hisposition on the advisory committee in future Chester marketing material. Rogers has not informedChester about the Grumpp offer, but he has not yet accepted the position.Pierce has not fared as well as Rogers. She also shifted into smaller cap securities, but due to twoextremely poor performing large cap stocks, her performance lagged the S&P 500 index for the firstthree quarters. After an angry confrontation with her supervisor, Pierce resigned. Pierce did not takeany client information with her, but when she left she did take a copy of a Pierce has not fared as wellas Rogers. She also shifted into smaller cap securities, but due to two extremely poor performinglarge cap stocks, her performance lagged the S&P 500 index for the first three quarters. After anangry confrontation with her supervisor, Pierce resigned. Pierce did not take any client informationwith her, but when she left she did take a copy of a computer model she developed while working alChester, as well as the most recent list of her buy recommendations, which was created from theoutput of her computer valuation model. Pierce soon accepted a position at a competing firm, CheeriGroup. On her first day at Cheeri, she contacted each of her five largest former clients, informingthem of her new employment and asking that they consider moving their accounts from Chester toCheeri. During both telephone conversations and e-mails with her former clients, Pierce mentionedthat Chester had a new compensation program that created incentives for managers to shift intosmaller cap securities.Cheeri has posted Pierce's investment performance for the past five years on its Web site, excludingthe three most recent quarters. The footnotes to the performance information include the followingtwo statements:Statement 1: Includes large capitalization portfolios only.Statement 2: Results reflect manager's performance at previous employer.When Pierce left her position at Chester, her behavior was inconsistent with the CFA InstituteStandards in that:

A. taking the computer model was a violation, but taking the recommended list was not a violation.
B. taking the list of her recommendations was a violation, but taking the computer model was not aviolation.
C. both the computer model and the recommended list were Chester property that Pierce should nothave taken.

Show Answer

Question # 72

Chester Brothers, LLC, is an investment management firm with $200 million in assets undermanagement. Chester's equity style is described to clients as a "large cap core" strategy. One yearago, Chester instituted a new compensation plan for its equity portfolio managers. Under this newplan, each portfolio manager receives an annual bonus based upon that manager's quarterlyperformance relative to the S&P 500 index. For each quarter of aut-performance, the managerreceives a bonus in the amount of 20% of his regular annual compensation. Chester has not disclosedthis new plan to clients. Portfolio managers at Chester are not bound by non-compete agreements.Fames Rogers, CFA, and Karen Pierce, CFA, are both portfolio managers affected by the new policy.Rogers out-performed the S&P 500 index in each of the last three quarters, largely because he beganinvesting his clients1 funds in small cap securities. Chester has recently been citing Rogers'sperformance in local media advertising, including claims that "Chester's star manager, James Rogers,has outperformed the S&P 500 index in each of the last three quarters." The print advertisingassociated with the media campaign includes a photograph of Rogers, identifying him as JamesRogers, CFA. Below his name is a quote apparently attributable to Rogers saying "as a CFA chartcrholdcr I amcommitted to the highest ethical standards."A few weeks after the advertising campaign began, Rogers was approached by the GrumppFoundation, a local charitable endowment with $3 billion in assets, about serving on theirinvestment advisory committee. The committee meets weekly to review the portfolio and makeadjustments as needed. The Grumpp trustees were impressed by the favorable mention of Rogers inthe marketing campaign. In making their offer, they even suggested that Rogers could mention hisposition on the advisory committee in future Chester marketing material. Rogers has not informedChester about the Grumpp offer, but he has not yet accepted the position.Pierce has not fared as well as Rogers. She also shifted into smaller cap securities, but due to twoextremely poor performing large cap stocks, her performance lagged the S&P 500 index for the firstthree quarters. After an angry confrontation with her supervisor, Pierce resigned. Pierce did not takeany client information with her, but when she left she did take a copy of a Pierce has not fared as wellas Rogers. She also shifted into smaller cap securities, but due to two extremely poor performinglarge cap stocks, her performance lagged the S&P 500 index for the first three quarters. After anangry confrontation with her supervisor, Pierce resigned. Pierce did not take any client informationwith her, but when she left she did take a copy of a computer model she developed while working alChester, as well as the most recent list of her buy recommendations, which was created from theoutput of her computer valuation model. Pierce soon accepted a position at a competing firm, CheeriGroup. On her first day at Cheeri, she contacted each of her five largest former clients, informingthem of her new employment and asking that they consider moving their accounts from Chester toCheeri. During both telephone conversations and e-mails with her former clients, Pierce mentionedthat Chester had a new compensation program that created incentives for managers to shift intosmaller cap securities.Cheeri has posted Pierce's investment performance for the past five years on its Web site, excludingthe three most recent quarters. The footnotes to the performance information include the followingtwo statements:Statement 1: Includes large capitalization portfolios only.Statement 2: Results reflect manager's performance at previous employer.Chester's advertising campaign includes claims about Rogers's investment performance, as well asRogers's use and reference to the CFA charter. Is Chester's advertising campaign consistent with theCFA Institute Standards?

A. Chester's performance claims are inconsistent with CFA Institute Standards, but his use andreference to the CFA designation is appropriate.
B. Both the performance claim and the reference to the CFA charter are violations.
C. Neither the performance claims nor the use and reference to the CFA designation are violations.

Show Answer