mock exam level ii 2004 final ans

2004 CFA® Level II SASF Mock Exam

Instructors:Peter Chau, CFAPatrick Collins, Ph.D., CFAEd Cordisco, CPADon Davis, CFAJohn Gonzales, Ph.D.Jivendra Kale, Ph.D.Terry Lloyd, CFACarolyn Margiotti, CFAAmanda Salter-Yuh, CFAProf. John M. Veitch, Ph.D., CFALoren Walden, CFA, CFP

The Security Analysts of San Francisco The Association for Investment Management and Research (AIMRsm) does not endorse, promote, review, or warrant the accuracy of the products or services offered by organizations sponsoring or providing CFA® exam preparation materials or programs, nor does AIMR verify pass rates or exam results claimed by such organizations.

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SASF CFA® Level II 2004 Mock Exam

Saturday, May 8, 2004

Questions Topics Time Instructor Item Set

1 – 10 Ethics SS # 1 & 2 15 minutes Loren Walden

11 – 14 Quantitative Methods SS # 3 6 minutes Jivendra Kale

15 – 20 Financial Statement Analysis SS # 5 12 minutes Ed Cordisco

21 – 26 Financial Statement Analysis SS # 6 12 minutes Ed Cordisco

27 – 36 Corporate Finance SS # 8 & 9 20 minutes John Gonzales

37 – 41 Basic Valuation SS # 10 7 ½ minutes Don Davis

42 – 46 Equities – Industry Analysis SS # 11 7 ½ minutes Terry Lloyd

47 – 60 Equity Valuation SS # 12 & 13 21 minutes C. Margiotti

61 – 83 Debt Instruments SS #14, & 15 26 minutes Peter Chau

Derivatives SS #16 & 17 16 minutes Peter Chau

84 – 91 Portfolio Management SS #18 12 minutes Patrick Collins

92 – 97 Financial Statement Analysis SS #7 16 minutes A. Salter-Yuh

98 – 103 Economics SS #4 9 minutes John Veitch

Total 180 minutes

Please note that the distribution of questions on the SASF CFA Level II Practice exam

broadly reflects the weights placed on each subject area by the CFA Level II study guide.

There is no guarantee that the questions on the actual CFA exam will reflect these relative

weights.

The Association for Investment Management and Research (AIMRsm) does not endorse, promote, review, or warrant the accuracy of the products or services offered by organizations sponsoring or providing CFA® exam preparation materials or programs, nor does AIMR verify pass rates or exam results claimed by such organizations.

Study Session #1 & 2 – Ethics 2004 Loren Walden, CFA. All rights reserved. Reproduction in any form, in whole or in part, is prohibited without permission.

Each question in this section is 1½ minutes unless noted otherwise

1. Which of the following is NOT a basic principle of the New Prudent Investor Rule?

A. Diversification

B. Cost controls must be justified

C. Impartiality to balancing of current growth and income

D. Delegation of authority not allowed

2. Which of the following is NOT a difference between the old Prudent Person Rule and the New Prudent Investor Rule?

A. Old Rule allows for delegation of fiduciary duties New Rule does not

B. New Rule emphasizes risk management and understanding risk tolerance

C. Both “A” and “B” are differences

D. Both “A” and “B” are not differences

3. Which of the following is a right of a covered person under investigation by AIMR for violation of the code of ethics

A. Right to counsel

B. Right to see all evidence

C. Right to have the hearing conducted by telephone unless otherwise requested

D. Right to postpone hearing for up to 365 days

4. Summary Suspension may NOT be imposed on a covered person if

A. The covered person fails to cooperate with AIMR on an investigation

B. The covered person fails to complete and sign an annual professional conduct statement and return it to AIMR in a timely manner

C. The covered person voluntarily disassociates himself with AIMR and the CFA program and voluntarily withdraws from all association with AIMR

D. All of the above are, in fact, reasons for AIMR to impose summary suspension

SASF Level II Mock Exam 2004 Page 1 of 39

5. If a charter has been revoked, the covered person may seek to get it reinstated after 2 years has passed and if the covered person can demonstrate worthiness of the charter and then passes self-administered standards of practice exam.

A. True

B. False

6. Tim Curran, CFA and software analyst and portfolio manager for a large pension fund management company is waiting for a taxi when he sees Kelly Slater, CEO of Board Technology, (a small software company) walk by with Mark Occy, CFO of Rainbow Inc., (a larger rival software company). Tim recognizes the two and observes them talking amiably and shake hands. Then, he overhears Kelly say to Mark, “We look forward to being bought by your firm.” Tim can hardly believe his ears and immediately gets on his cell phone and tells his broker to buy 100,000 shares of Board Technology.

Based on the information above, which best describes Tim’s situation.

A. Tim is in direct violation of insider trading laws because the information is both material and non-public in nature and he cannot trade on the information himself

B. Tim should not trade on the information for himself, but he may trade in the shares of either company for his clients because what he has heard is hearsay only

C. Tim is clear to trade on the information for his own account but not his client’s accounts because the information is hearsay only and was not given to him as a breach of fiduciary duties, nor was it stolen, nor is there any implied quid pro quo, nor is there any monetary exchange for the information received

D. Tim is not allowed to trade on the information or cause others to trade on the information due to the nature of the information

7. Which of the following is NOT a rule that a firm MUST follow in order to be in compliance with AIMR’s Soft Dollar Standards?

A. Brokerage to directly benefit the client

B. Brokerage used for investment process

C. See that all clients benefit equally from the research received

D. Seek best execution

8. Which of the following is not a stated obstacle to an effective Proxy Voting Policy?

A. Delays in receiving materials from international companies

B. If proxy voting is delegated to a consultant, the consultant’s activities need to be periodically monitored

C. Uncertainty about voting responsibilities for “passively managed funds”

D. All of the above are obstacles to an effective Proxy Voting Policy


9. Under ERISA rules a fiduciary MUST:

A. Act solely in the interest of plan beneficiaries, manage for the exclusive purpose of providing benefits to plan participants, diversify plan assets and vote proxies

B. Act solely in the interest of plan beneficiaries, manage for the exclusive purpose of providing benefits to plan participants, diversify plan assets, act as a prudent expert, never get kickbacks, and never use plan assets for their own account

C. Both “A” and “B” are correct

D. Neither “A” nor “B” are correct

10. Pat Rawson, CFA has access to information regarding to opinion changes in investment recommendations by the analyst team at a major brokerage firm. Pat cannot personally trade on any securities the firm covers if there are any _______________ changes in the recommendation of the security by the analyst team.

A. There is any ANTICIPATED changes

B. There is any DESIRED changes

C. There is any PROBABLE changes

D. All of the above

Study Session #3 – Quantitative Methods 2004 Jivendra Kale, Ph.D. All rights reserved. Reproduction in any form, in whole or in part, is prohibited without permission.

Each question in this section is 2 minutes unless noted otherwise

A junior analyst has developed the following regression model to predict tire industry sales at time t based on the variables in Table 1.

t-values: (1.02) (0.67) (1.48) (0.83) (1.76) (1.13)

Number of observations: 36Standard error of estimate: 1637.38Unadjusted R2: 0.955


Table 1. Variable DescriptionsSALES Annual tire industry sales (in millions of dollars)INDRUB Annual demand for replacement tires (Index: year 2000 = 100)CAP Capacity utilization rate (annual percentage) for rubber and plastic

manufacturingINDTR Annual industrial production of tires (Index: year 2000 = 100)MILES Annual all-systems mileage (in billions of miles)PERS Annual personal consumption of tires, tubes, and accessories (in

billions of dollars)

Variable Estimates for 2003INDRUB 144.1CAP 90.7INDTR 143.9MILES 2,359.8PERS 36.6

Critical Values for Student’s t DistributionArea in Upper Tail of Distribution

Degrees of Freedom 10% 5% 2.5%29 1.311 1.699 2.04530 1.310 1.697 2.04231 1.309 1.696 2.04036 1.306 1.688 2.028

11. What is the 95% confidence interval for the coefficient of PERS?

A. -8.434 to 29.334B. InsignificantC. -8.416 to 29.316D. 8.190 to 12.710

12. The goodness of fit, or explanatory power, of a multiple regression equation is given by

A. The standard error of estimate for the regression

B. The F-statistic for the regression

C. The R2 for the regression

D. The t-values for the regression coefficients


13. What is the forecast of tire industry sales for 2003?

A. $19,330.154 million

B. $504.440 million

C. $19.330 million

D. $1,637.38 million

14. Which is a symptom of multicollinearity?

A. Low R2 but statistically significant coefficients

B. Large R2 but statistically insignificant coefficients

C. Regression coefficients hardly change when independent variables are dropped from the regression equation

D. High standard error of estimate for the regression

Study Session #5 – Accounting Choices 2004 Ed Cordisco, CPA. All rights reserved. Reproduction in any form, in whole or in part, is prohibited without permission.


Bay Area Inc. began operations on January 1, 1980 and adopted a defined benefit pension plan for all of its full-time employees on January 1, 1990. The pension plan is noncontributory and will provide eligible employees with an annual pension of 70% of their salary at retirement date. At the plan adoption date, the actuary estimated there was a $1,200,000 liability for the employees past service. The discount rate on January 1, 2000 was 7.5% but decreased to 7.0% on December 31, 2000.

The following additional information pertains to Bay Area Inc.’s defined benefit pension plan:

January 1, 2000:Projected benefit obligation (PBO) $1,200,000Fair value of pension plan 1,400,000Service cost – for year 2000 300,000Company Contributions – for year 2000 150,000Remaining average service life 15 year

At December 31, 2000:Fair value of pension plan assets $1,500,000Benefits paid 250,000


15. The change in the discount rate on December 31, 2000 from 7.5% to 7.0% has an effect on which one of the following:

A. Affect on the pension plan

B. Increases the PBO

C. Decreases the PBO

D. The accumulated Benefit Obligation (ABO) only.

16. The decrease in the discount rate from 7.5% to 7.0% at December 31, 2000 changes the annual pension expense in which of the following ways:

A. Increase

B. Decrease

C. Remains the same

D. Discount rate only affects the interest cost

17. In calculating the annual pension expense above, one of the components used was actual return on plan assets in the amount of:

A. $200,000

B. $100,000

C. $ 50,000

D. ($100,000)

Assets Beginning of Period $1,400,000 Company Contributions 150,000 Benefits Paid ( 250,000) Assets End of Period ( 1,500,000) Actual Return $ 200,000

18. The annual pension expense for the year ending December 31, 2000 would be:

A. $300,000

B. $100,000

C. $184,000

D. $104,000

Service Cost $300,000 Interest Cost 84,000 Return on Plan Assets ($200,000) Amortization of: Transition Obligation ( 80,000) Pension Expense $104,000


19. The Projected Benefit Obligation at December 31, 2000 is expected to be:

A. $1,200,000

B. $1,284,000

C. $1,584,000

D. $ 984,000

PBO-Beginning $1,200,000 Interest Cost-2000 84,000 Service Cost-2000 300,000 PBO-Ending $1,584,000

20. Based on your answer on 19. above, what is the status of Bay Area Inc.’s pension plan, on December 31, 2000?

A. Sufficient funds to meet pension plan liabilities, but no excess

B. Projected benefit obligation has no affect on pension plan status

C. Overfunded

D. Underfunded

Study Session #6 – Accounting – Global Issues 2004 Ed Cordisco, CPA. All rights reserved. Reproduction in any form, in whole or in part, is prohibited without permission.


Use the following data to answer questions 21 – 26. German Motors

Balance Sheet December 31, 2003

Cash EUROS 200,000Accounts Receivable-Net 600,000Inventory 300,000Fixed Assets-net 900,000 Total Assets 2,000,000

Accounts Payable EUROS 800,000Long-term debt 500,000Retained Earnings 200,000Capital Stock 500,000Total Liabilities and Equity 2,000,000

The Euro Dollar is the local currency.The company is a 100% owned subsidiary of a U.S. company.Annual inflation rate for the past three years has been over 26 percent.

January 1, 2003: USD 1.3499 per EuroAverage rate for 2003 USD 1.3024 per Euro


December 31, 2003 USD 1.2580 per Euro Assume average rate for 2003 is the same as historical rate.

21. What would the three year cumulative inflation rate be for German Motors?

A. 78%

B. 100%

C. 26%

D. 175% 1.26^3 - 1

22. Based on your answer to one above, what would German Motors use as its functional currency?

A. Parent’s currency

B. Local currency

C. Currency of neighboring country

D. Any currency that works best for German Motors

23. What are total assets of German Motors after translation using the All-Current Method?

A. USD 2,569,280

B. USD 2,551,520

C. USD 2,516,000

D. USD 2,545,600

Euros 2,000,000 x 1.2580

24. What are total assets of German Motors after translation using the Temporal Method?

A. USD 2,569,280

B. USD 2,551,520

C. USD 2,516,000

D. USD 2,545,600

Euros 800,000 x 1.2580 = USD 1,006,400 Euros 1,200,000 x 1.3024 = USD 1,562,880 USD 2,569,280

25. Working capital would be higher or lower under the All-Current Method compared to Temporal Method?

A. Higher

B. Same


C. Lower

D. Average of the two methods

All-Current Method-Working Capital USD 377,400 Temporal Method-Working Capital USD 390,720

26. The Temporal Method is used to remeasure the foreign financial statements when consolidating with the parent company. Where would the translation gain or loss be found?

A. Balance Sheet B. Income Statement C. Adjustment to Stockholders’ Equity D. Adjustment to opening balance of Retained Earnings

Study Session #8 – Corporate Finance 2004 John Gonzales, Ph.D. All rights reserved. Reproduction in any form, in whole or in part, is prohibited without permission.


27. For a typical firm with a given capital structure, which of the following is correct? (Note: All rates are after taxes.)

A. cost of debt > cost of equity > WACC.

B. cost of equity > cost of debt > WACC.

C. WACC > cost of equity > cost of debt.

D. cost of equity > WACC > cost of debt.

- LOS Level II, Study Session #8, A, (b) and (d)

- The cost of debt < cost of equity, as investors’ required rate of return on debt < investors’ required rate of return on equity. The WACC is a weighted average of the cost of debt and equity, so it must be between these two costs.

28. An analyst has collected the following information regarding a firm.

The company’s capital structure is 60 percent equity and 40 percent debt. The yield to maturity on the company’s bonds is 9 percent. The company’s recent dividend was $0.80 a share. The company expects that its dividend will grow at a constant rate of 10 percent a

year. The company’s stock price is $25. The company’s tax rate is 40 percent.

What is the firm’s weighted average cost of capital?

A. 10.08%.

B. 10.27%.

C. 10.78%.


D. 11.71%.

- LOS Level II, Study Session #8, A, (b) and (d)- kS = .88/25 + 10% = 13.52% • WACC = .40(9%)(1 - .4) + .60(13.52%) = 10.27%

29. Which of the following statements is incorrect?

A. If the multiple IRR problem does not exist, any independent project acceptable by the NPV method will also be acceptable by the IRR method.

B. NPV can be negative if the IRR is positive.

C. Assuming a project has normal cash flows, the NPV will be positive if the IRR is less than the cost of capital.

D. The NPV method is not affected by the multiple IRR problem.

- LOS Level II, Study Session #8, B- Statement d is incorrect, as NPV > 0 if the IRR > cost of capital.

30. Suppose a firm uses only debt and common stock. The cost of debt is 9%, and the tax rate is 40%. The firm’s capital structure is 65% debt and 35% equity. The cost of common stock is determined by CAPM. We observe kRF = 6% and kM = 16%. The firm’s existing ß = 1.2.

The firm is now considering taking on a new project, which would be financed by maintaining the target capital structure of 65% debt and 35% equity. Equity invested in this project would have a ß = 2.1. The expected IRR of the project is 20%. Should the firm undertake the project?

A. Yes, as the IRR > the cost of capital = 9.81%.

B. Yes, as the IRR > the cost of capital = 12.96%.

C. Yes, as the IRR > the cost of capital = 18.00%.

D. No, as the IRR < the cost of capital = 21.60%.

- LOS Level II, Study Session #8, A, (b) and (d) and D, (c)- project kS = 6% + 2.1(16% - 6%) = 27% - project WACC = .65(9%)(1 - .4) + .35(27%) = 12.96% < project IRR, so accept the project

The following information applies to the next three problems.

A firm is deciding between two possible capital structures: 60% debt and 40% equity, and 70% debt and 30% equity. The following are the key facts.

D/E cost of debt beta EPS 60/40 8% 1.20 2.4370/30 9% 1.50 2.62

• Tax rate = 40%.• All earnings are paid as dividends, so growth is zero.


• The risk-free rate is 4% and the expected market return (kM) is 12%.

31. What is the firm’s cost of capital for each capital structure?

D/E = 60/40 D/E = 70/30A. a. 10.24% 11.10%

B. c. 8.32% 8.58%

C. d. 8.00% 9.00%

D. e. 7.24% 8.14%

- LOS Level II, Study Session #8, F, (i)- For D/E = 60/40: • kS = 4% + 1.2(12% - 4%) = 13.6%

• WACC = .60(8%)(1 - .4) + .40(13.6%) = 8.32%- For D/E = 70/30: • kS = 4% + 1.5(12% - 4%) = 16%

• WACC = .60(9%)(1 - .4) + .40(16%) = 8.58%

32. What is the firm’s stock price for each capital structure?

D/E = 60/40 D/E = 70/30A. $23.73 $23.60

B. $18.33 $18.33

C. $17.87 $16.37

D. $26.44 $25.64

- With growth = 0, P0 = D/kS.- For D/E = 60/40, P0 = 2.43/.136 = $17.87.- For D/E = 70/30, P0 = 2.62/.160 = $16.37.

33. What is the firm’s optimal capital structure?

A. D/E = 60/40.

B. D/E = 70/30.

C. The firm is indifferent between the 2 proposed capital structures.

D. It cannot be determined because we do not know the degree of risk aversion.

- The greater beta of D/E = 70/30 reflects the greater risk to shareholders from taking on more debt. Therefore, the degree of risk aversion is implicitly taken into account in calculating the cost of equity, and the firm chooses the capital structure which maximizes the stock price and minimizes WACC.

34. A firm’s selling price = $20 and the quantity sold is 2,200. Fixed cost is $5,000 and variable cost per unit is $10. The firm has $50,000 of debt with a cost of 6%. The tax rate is 40%. What is the degree of operating leverage, degree of financial leverage and degree of total leverage?

DOL DFL DL


A. 1.29 1.21 1.56

B. 1.29 1.62 2.09

C. 1.29 1.21 2.50

D. .88 2.12 2.76

- LOS Level II, Study Session #8, F, (m)

- DOL = [$20(22,000) - $10(22,000)]/[$20(22,000) - $10(22,000) – $5,000] = 1.29.

- DFL = $17,000/[$17,000 - $3,000] = 1.21.

- DL = (DOL)(DFL) = (1.29)(1.21) = 1.56.

35. A firm has four independent investment possibilities.

Investment IRR initial investment cost

A 12.84% 200B 14.16% 120C 13.68% 100D 11.20% 80

The WACC schedule is the following.• if capital raised ≤ 200, the WACC = 10%• if capital raised is between 200 and 400, the WACC = 12.60%• if capital raised ≥ 400, the WACC = 13.20%

Which projects should be undertaken, and what is the firm’s actual WACC?

A. Projects A, B and C, with a WACC = 11.23%.

B. Projects B and C, with a WACC = 12.60%.

C. Projects B and C, with a WACC = 10.24%.

D. Projects B and C, with a WACC > 12.60%.

- LOS Level II, Study Session #8, D, (f)- The ranking of the projects is B, C, A, D and projects are undertaken if IRR > WACC. - If B and C are first considered, the necessary capital is 220. The WACC = 12.60% so B and C

should be undertaken as the IRR of each > WACC. If A were to be undertaken, the total capital would now be 420 and the WACC = 13.20% < IRR of A = 12.84%. So, A should not be undertaken. Only B and C are chosen, 220 of capital is raised and the WACC = 12.60%. Note that in this problem we are using the fact that WACC = MCC.

36. Which of the following statements best describes the theories of investors’ preferences for dividends?

A. Modigliani and Miller argue that investors prefer dividends to capital gains.


B. The bird-in-hand theory indicates that a firm can reduce its cost of equity capital by reducing its dividend payout ratio.

C. The tax preference theory suggests that a firm can increase price of its stock by increasing its dividend payout ratio.

D. The clientele effect indicates that companies should follow a stable dividend policy.

- LOS Level II, Study Session #8, G, (a) and (d)- Statement D. is correct, as the clientele effect argues that investors will be attracted to

companies that have a stable dividend policy. Regarding the other answers, MM developed the dividend irrelevance theory. If the bird-in-the-hand theory holds, reducing the payout would have the effect of increasing the cost of equity. The tax preference theory suggests that a company can increase its stock price by decreasing its payout ratio. The residual dividend policy leads to dividends that fluctuate.

Study Session #10 – Asset Valuation – Basic Concepts 2004 Don Davis, CFA All rights reserved. Reproduction in any form, in whole or in part, is prohibited without permission.

Each question in this section is 1 ½ minutes unless noted otherwise

An institutional money manager decided to buy 100,000 shares of a German company’s stock, and purchased this large block on an European exchange at a dollar price of $24. One year later, the investor trying to decided whether or not to liquidate the investment. During that time period, the comparable benchmark return was 10%. The investment was a significant block relative to the overall float, and there was concern over the most efficient way to liquidate the Investment.

37. Assume that the dollar return the investor could receive was $27. What was the ex post alpha that the money manager would report to his investors?

A. 12.5%

B. 22.5%

C. 2.5% 1.B.b = (27/24) – 1 - .10

D. 112.5%

38. When making his original purchase decision, the manager was aware that the German company had just increased its contingency reserve. As compared to a US company, this would have what impact on an evaluation of the reported earnings of the German company

A. No difference – a US company could do the same

B. Immediate reduction, with the chance of smoother earnings later II.B.a

C. Immediate increase in earnings

D. No immediate effect, but reduced earnings for the next several years


39. To reduce the execution cost of the sale, a broker suggested an off-exchange trade through an ECN. After evaluating this, the manager elected not to take the suggestion. This evaluation determined that the proposed trade mechanism had all of the following disadvantages except:

A. It might be hard to find a counterparty, given the size of the block involved

B. Execution speed might be slow

C. Slow execution might generate opportunity cost risk

D. The trade would be anonymous II.A.e.

40. Another broker suggested a trade on a German exchange, priced in Euros at a price of 25.30-25.50, plus a 10% commission. Assuming an exchange rate of $/Euro of 0.9695-0.9700, this translates to a net dollar price of:

A. $26.98 II.A.h = Euro 25.30 x ($0.9695/ Euro) x 1.10

B. $27.19

C. $27.00

D. $24.73

41. Just as he was about to execute the trade, word came across that the subject company was going to merge with a competitor. However, there was potential problem with the Herfindahl score that would result. This is a problem best defined as:

A. combined market share of the top companies in the industry

B. sum of the squares of the market shares of the companies in the industry II.B.e

C. the combined market capitalization of the two companies

D. the degree to which the ownership of the companies was concentrated in a limited number of investors.

Study Session #11 – Equities – Industry Analysis 2004 Terry Lloyd, CPA, CFA All rights reserved. Reproduction in any form, in whole or in part, is prohibited without permission.


Competitive Strategy42. All of the following, except one, are general strategies a firm can pursue.

A. cost leadershipB. product differentiationC. focusD. diversification

43. High product volume is typically associated with which strategy?


A. cost leadershipB. product differentiationC. focusD. diversification

44. All of the following, except one, are factors impacting a firm’s competitive advantage.

A. Entry of new competitors (or entry barriers)B. Technological changeC. Bargaining power of suppliers D. Rivalry among existing competitors

Industry Analysis45. Industry consolidation typically starts in which phase of a company’s life?

A. pioneerB. growthC. matureD. decline

Return on Equity46. All of the following, except one, are components of the DuPont formula.

A. net profit marginB. return on equityC. assets turnoverD. leverage multiplier

[the correct answer is b; the DuPont formula calculates the return on equity]

Study Session #12 – Equities – Valuation Models 2004 Carolyn Margiotti, CFA All rights reserved. Reproduction in any form, in whole or in part, is prohibited without permission.


47. Security X has an expected rate of return of 13% and a beta of 1.15. The risk-free rate is 5% and the market expected rate of return is 15%. According to the capital asset pricing model, security X is __________.

A. fairly priced

B. overpriced

C. underpriced

D. None of the above answers are correct

48. The _______ is a comparative valuation ratio.


A. P/E ratio

B. Price-to-book ratio

C. Price-to-cash flow ratio

D. All of the above

49. Each of two stocks, A and B, are expected to pay a dividend of $7 in the upcoming year. The expected growth rate of dividends is 6% for both stocks. You require a return of 10% on stock A and a return of 12% on stock B. Using the constant growth DDM, the intrinsic value of stock A __________.

A. will be higher than the intrinsic value of stock B

B. will be the same as the intrinsic value of stock B

C. will be less than the intrinsic value of stock B

D. more information is necessary to answer this question

50. The Gordon growth model is most appropriate for valuing:

A. Emerging companies

B. Companies that do not pay dividends

C. Companies with high growth expectations

D. Companies in a mature, stable-growth stage of development

51. The XYZ Company pays an annual dividend of $2.36 and has a required return of 9.06 percent. What is the value of this preferred stock?

A. $18.25

B. $26.05

C. $3.84

D. $6.85

52. The Best Company has the following financial information:FCFF = $2.3 billionFCFF growth rate = 6 %WACC = 10%

What is the value of the firm?

A. $55.23 billion

B. $42.65 billion

C. $16.85 billion

D. $60.95 billion


53. Current financial data for Standard Corporation is listed below. Calculate the value of the stock using the Gordon growth model.

Current price $20Current dividend (t=0) $0.40Dividend growth rate 6%Required rate of return 9%

A. $14.13

B. $13.33

C. $4.71

D. $12.10

54. The sustainable growth rate is equal to the return on equity times the __________.

A. P/E ratio

B. Earnings retention ratio

C. Dividend growth rate

D. Net income

Study Session #13 – Equities – Valuation Applications 2004 Carolyn Margiotti, CFA All rights reserved. Reproduction in any form, in whole or in part, is prohibited without permission.


55. A strength of the residual income model is:

A. The data is not subject to manipulation

B. The model is based on accounting data which is readily available

C. The model includes data that does not require any adjustments

D. All of the above are strengths of this model

56. EVA is a measure that is _________ looking, using __________ and estimated cost of capital.

A. forward, market values

B. forward, accounting data

C. backward, market values

D. backward, accounting data

57. The fundamental drivers of dividend yield are the expected growth rate in dividends and the ________________.


A. weighted average cost of capital

B. required rate of return

C. profit margin

D. future cash flows

58. When calculating trailing P/E, adjust EPS for:

A. Non-recurring items

B. Differences in accounting methods

C. Potential dilution of EPS

D. All of the above

59. In the study of EVA®, the researchers found that the absolute level of EVA ______________ most other traditional measures of valuation and the growth in MVA ______________ other traditional measures.

A. underperformed, underperformed

B. underperformed, outperformed

C. outperformed, underperformed

D. outperformed, outperformed

60. Enterprise value is the ____________ less the value of cash and investments.

A. common shareholders’ equity

B. total company value

C. market value of the company

D. company’s net income

Study Session #14, 15, 16, & 17 – Fixed Income and Derivatives 2004 Peter Chau, CFA. All rights reserved. Reproduction in any form, in whole or in part, is prohibited without permission.


Questions 61 through 67 refer to the following market and model data.

Bond Yield Market Price Model Bond Value3.0% 105.0%3.5% 102.0% 102.0%4.0% 99.2%

61. The bond has a

A. positive modified duration and positive convexity


B. positive modified duration and negative convexity

C. negative modified duration and positive convexity

D. negative modified duration and negative convexity.

62. The bond has a modified duration that is closest to

A. – 5.7 years

B. – 2.8 years

C. 2.8 years

D. 5.7 years.

63. The bond has a convexity that is closest to

A. – 40.0 (years)2

B. – 39.2 (years)2

C. 39.2 (years)2

D. 40.0 (years)2.

64. The best estimate of the bond value at a bond yield of 3.25% is

A. 97.9%

B. 100.6%

C. 103.5%

D. 106.6%.

65. The best estimate of the bond value at a bond yield of 4.5% is

A. 96.2%

B. 96.3%

C. 96.6%

D. 96.7%.

66. The bond is most likely

A. a noncallable, fixed-rate bond

B. a fixed-rate bond callable at 103% in one year

C. a floating-rate bond

D. an inverse floater.

67. The remaining maturity of this bond

A. is between 0 and 2 years

B. is between 2 and 5 years


C. is greater than 5 years

D. cannot be determined from the given information.

68. For a credit card receivable backed security, an adverse credit event will trigger

A. the beginning of the lockout period

B. the beginning of the revolving period

C. the beginning of the principal amortization period

D. the beginning of the early amortization period.

69. The highest rated tranche in a commercial mortgage-backed security (CMBS)

A. has little prepayment risk because the underlying loans have call protection

B. has little balloon risk because of the CMBS payment structure

C. both A and B.

D. neither A nor B.

Questions 70 through 75 refer to the following situation.Juan Sanchez, the Treasurer of Nova Auto Corp, is concerned about a floating-rate note issued by the corporation a few years ago. The note has a face amount of $100 million and a remaining maturity of 3 years. The note rate is 3M LIBOR plus 1%, reset and payable quarterly. Juan is worried that interest rates would increase and cause debt service to go up. The current 3M LIBOR is 1.5%.

70. Juan can hedge against an increase in 3M LIBOR by

A. entering into a pay-fixed interest rate swap

B. going long a strip of Eurodollar futures

C. both a and b

D. neither a nor b.

71. Juan can hedge against an increase in 3M LIBOR by

A. entering into a receive-fixed interest rate swap

B. buying a strip of suitably chosen FRAs

C. both A and B.

D. neither A nor B.

Buying an FRA is locking into a fixed-rate borrowing. Note that “buying” or “selling” an FRA involves no money upfront; it simply means going long or short.

72. Among the following hedges, the most effective would be

A. buying an interest rate cap with a cap rate of 2%


B. buying an interest rate cap with a cap rate of 3%

C. buying an interest rate floor with a floor rate of 1%

D. selling an interest rate floor with a floor rate of 1%.

73. Among the following hedges, the most costly would be

A. buying an interest rate cap with a cap rate of 2%

B. buying an interest rate cap with a cap rate of 3%

C. buying an interest rate collar with a cap rate of 2% and a floor rate of 1%

D. buying an interest rate collar with a cap rate of 3% and a floor rate of 1%.

74. If Juan decides to buy an interest rate collar with a cap rate of 2% and a floor rate of 1%, the effective rate on the floating-rate note plus collar would be

A. between 1% and 2%

B. between 1% and 3%

C. between 2% and 3%

D. none of the above.

75. If Juan decides to enter into an interest rate swap (either pay fixed, receive 3M LIBOR, or receive fixed, pay 3M LIBOR, whichever way is correct), the effective rate on the floating-rate note plus swap would be

A. fixed at 1.5%

B. fixed at 2.5%

C. fixed at some rate, but most probably not 1.5% or 2.5%


Questions 76 through 81 refer to the following market data.GBP exchange rate = 1.80 USD/GBP6M USD LIBOR = 1.6%1Y USD LIBOR = 2.0%6M GBP LIBOR = 3.2%1Y GBP LIBOR = 4.0%

76. The 6M forward exchange rate for GBP is closest to

A. 1.772 USD/GBP

B. 1.786 USD/GBP

C. 1.814 USD/GBP

D. 1.828 USD/GBP.

77. The 1Y forward exchange rate for GBP is closest to


A. 0.545 USD/GBP

B. 0.566 USD/GBP

C. 1.765 USD/GBP

D. 1.835 USD/GBP.

78. The 1Y futures exchange rate for GBP is

A. lower than the spot exchange rate

B. lower than the 6M futures exchange rate for GBP

C. approximately the same as the 1Y forward exchange rate for GBP

D. all of the above.

79. A currency swap of GBP for USD initiated today for an amount of 30 million USD would involve an initial swap of

A. 30 million USD for 54 million GBP

B. 16.667 million GBP for 30 million USD

C. a net of 13.333 million GBP to one party

D. nothing, since no money changes hands initially.

80. If a currency swap of GBP for USD, with semiannual floating payments on both sides based on 6M GBP LIBOR and 6M USD LIBOR, respectively, were initiated today for an amount of 100 million GBP, the cash flows at the end of six months would involve a swap of approximately

A. 0.80 million USD for 1.60 million GBP

B. 1.44 million USD for 1.60 million GBP

C. 2.88 million USD for 3.20 million GBP

D. none of the above, because 6M LIBOR at the end of six months is unknown.

81. If a currency swap of GBP for USD, receiving fixed USD interest and paying 6M GBP LIBOR, were initiated today for an amount of 100 million GBP, the present value of the future USD receipts is

A. approximately zero

B. approximately 100 million USD

C. approximately 180 million USD


Questions 82 through 83 refer to the following situation.James Bond has written put options on 10,000 shares of a stock with a strike price of $9 per share. The stock is currently trading at $10 per share. The put delta is –0.5.


82. If the stock price goes down to $9 per share, James’ option position would have

A. an economic gain of $10,000

B. an economic gain of $5,000

C. have no economic gain or loss

D. an economic loss of $5,000.

83. To hedge the option position, James should

A. buy 5,000 shares of the stock

B. buy 10,000 shares of the stock

C. short 5,000 shares of the stock

D. buy call options on 10,000 shares of the stock.

Study Session #18– Portfolio Management 2004 Patrick Collins, Ph.D., CFA. All rights reserved. Reproduction in any form, in whole or in part, is prohibited without permission.


Consider the following information: The Standard Deviation of XYZ company stock = 14% The Standard Deviation of the Market = 8% The Risk Free rate = 3% The Expected Return on the Market = 7% The Covariance of XYZ with the Market = 48

84. The Beta of XYZ is:

A. 0.60

B. 0.75

C. 1.20

D. 6.00

Answer: ‘B’Beta = (Covariance of XYZ with the Market) (Variance of the Market)48 / (8)2 = 48/64 = .75

85. According to the CAPM, what is the expected return of XYZ?

A. 10%

B. 5%

C. 12.4%


D. 6% occaisonally

Answer: ‘D’Expected Return = Risk Free Rate + Beta(Risk Premium)3 + .75(7 – 3) = 3 + 3 = 6%

86. If the market pricing of XYZ conforms to CAPM; and, if your return forecast for XYZ for the forthcoming period is 8%, what strategy will maximize your expected return?

A. purchase call options on XYZ

B. sell short shares of XYZ

C. purchase put options on XYZ

D. purchase shares of XYZ

Answer: ‘A’The market is pricing XYZ at 6% but your forecast indicates that it will earn 8%. Therefore, under your forecast, to achieve equilibrium the price of XYZ will adjust upwards. Call options should provide the greatest return.

Consider the following Information

The Beta of Asset 1 = 1.4The Beta of Asset 2 = 0.6The Expected Return of Asset A = 10The Expected Return of Asset B = 5The Standard Deviation of Asset A = 16The Standard Deviation of Asset B = 8The correlation of Asset A with Asset B = 0.6

87. The Expected Return of a Portfolio consisting of 70% Asset A and 30% Asset B is:

A. 8.50%

B. 8.00%

C. 7.75%

D. 8.75%

Answer: ‘A’.70(10%) + .30(5%) = 8.50%

88. The expected variance of a Portfolio consisting of 70% Asset A and 30% Asset B is:

A. 12.79

B. 180.43

C. 72.25

D. 163.46


Answer: ‘D’Portfolio Variance = (WeightA)2(VarianceA) + (WeightB)2(VarianceB) + 2(WeightA)(WeightB)(CorrelationAB)(Standard DeviationA)(Standard DeviationB).

(.7)2(16)2 + (.3)2(8)2 + 2(.7)(.3)(.6)(16)(8) = 125.44 + 5.76 + 32.26 = 163.46.

89. If the correlation of Asset A with Asset B equals zero, the following statements are unconditionally true:

I) The calculation of portfolio risk reduces to a consideration of terms with individual asset variance only.

II) The Risk of the Portfolio decreases.III) The Risk of the Portfolio increases.IV)The return series of A is independent of the return series of B.

A. I, III, IV

B. I, II, IV

C. I, II

D. I, II, III, IV

Answer: ‘C’The final term drops out by virtue of multiplication by zero. This leaves only the terms focused on individual asset variance. Total portfolio risk decreases because the final term is positive only when correlation is positive. Finally, Asset A may be statistically independent from Asset B, but one cannot state this unconditionally given the amount of information presented [association causality].

90. All of the following statements regarding the Arbitrage Pricing Theory Model are true except:

A. Expected Return is a linear function of priced factors.

B. Like CAPM, APT is an equilibrium pricing model; unlike CAPM, it does not call for market forecasts.

C. APT assumes specific statistical distributions for both the relevant factors as well as for any error term

D. The concept of individual investor risk aversion is not relevant for APT.

Answer: ‘C’Unlike CAPM, which assumes that the Return of the Market as well as the error term follow specified statistical distributions, APT does not make such assumptions.

91. All of the following statements regarding the rationale for limiting a Defined Benefit Plan’s investments to fixed income instruments are true except:

A. Fixed Income management techniques such as Portfolio Immunization can decrease variance between plan surplus and plan liabilities;


B. Fixed income costs will lower the long-term expected cost of benefit funding;

C. Equities may not be an adequate inflation hedge;

D. Equities exhibit an interest rate sensitivity to changes in plan liabilities that differs from Fixed Income instruments.

Answer: ‘B’It is not necessarily true that fixed income instruments will lower long-term funding costs. Indeed, one argument for equities is based on their higher expected long-term returns.

Answer: ‘B’ Individual stock Betas tend to move towards unity over time.


Study Session #7 – Accounting – Earnings Quality 2004 Amanda Salter-Yuh, CFA. All rights reserved. Reproduction in any form, in whole or in part, is prohibited without permission.


Use the following information in answering the questions that follow:


92. The economic value for Long Term Debt at year end 1999 is

A. 12,900

B. 13,160

C. 12,640

D. 14,350

Correct Answer is C., Interest rates have risen so debt value has decreased. Operating Leases create a Liability but don't change Long Term Debt

93. The adjustment to Stockholder Equity for the market value of shares outstanding is closest to

A. 0 Stockholder Equity is only adjusted for estimable current value of other balance sheet items.

B. 626

C. 592

D. (33)

Correct answer is D. reduce stockholder equity by 669/100*5 for Mkt Value of Preferred. No adj for market value of Common Stock

94. The net Asset/(Liability) required to reflect the current value of Trident's Pension Obligation is closest to:

A. (2,500) Net Liability

B. (2,952) Net Liability

C. 452 Net Asset

D. (452) Net Liability

Correct Answer is D. currently Trident has a $48 million net Asset, Plan Assets are $500 million below PBO, the adjustment is -500+48=-452

95. The statement that most accurately describes Trident's accounting for a higher Receivables balance in 1999 is

A. Higher receivables are a reflection of the significant growth in Trident's business

B. The rapid increase in Trident's receivables is a sign of weaker earnings quality

C. Trident's handling of its increased receivables balance reflects increased conservatism

D. Trident's receivables are increasing faster than inventories but slower than payables, an indication management is using off balance sheet financing and earnings quality is deteriorating

Correct answer is C. – Trident’s receivables have increased by allowance for bad debts as a percent of A/R has increased more.

96. Using only the information provided Trident's current ratio adjusted to current values is

A. 1998 current ratio is 3.2, 1999 current ratio is 2.5


B. 1998 current ratio is 2.8, 1999 current ratio is 2.2

C. 1998 current ratio is 3.1, 1999 current ratio is 2.4

D. 1998 current ratio is 2.7, 1999 current ratio is 2.2

Correct answer is A. current ratio should be adjusted to add LIFO reserve to inventories but PV of operating leases is a long term liability and allowance for bad debt is already in net Accounts Receivables and should not be deducted.

The following question is 6 minutes long.

97. Fill in the blank cells in the following template

Book Common Size Value Horizontal* Vertical1999 1999 1999

Sales $ % %

Collection Period

COGS % %

Gross Margin $

Operating Expense $

* 1998 is the base year for Horizontal Analysis

Study Session #4 – Economics 2004 Prof. John Veitch, CFA. All rights reserved. Reproduction in any form, in whole or in part, is prohibited without permission.


Use the following information in answering the questions that follow:

1950 - 1992Population

GrowthReal GDP Growth

Labor Force Growth

Capital Stock Growth

Technological Progress

Japan 1.820% 7.550% 1.960% 9.050% United States 1.620% 1.820% 4.480% 1.280%

The share of capital in income was 33% in both the U.S. and Japan over this time period.

98. Fill in the average growth rate of technological progress experienced by Japan over the period 1950 – 1992 using the information in the above table.

99. Fill in the average growth rate of real GDP experienced by the United States over the period 1950 – 1992 using the information in the above table.


100. Which factor was most responsible for Japan’s catch-up in per capita GDP with that of the United States over the 1950 – 1992 period?

A. A higher growth rate of technological progress than the U.S.

B. A higher growth rate of labor force growth than the U.S.

C. A higher growth rate of the Capital stock than the U.S.

D. A higher growth rate of the population than the U.S.

101. Conditional convergence predicts:

A. Economies with equal rates of saving, population growth and access to technology should converge to the same level of output per capita in the long run.

B. Economies with equal rates of saving, population growth and access to technology should converge to the different levels of output per capita in the long run.

C. Economies with different rates of saving, population growth and access to technology should converge to different levels, but the same growth rate, of output per capita in the long run.

D. Economies with different rates of saving, population growth and access to technology should converge to the same level, but different growth rates, of output per capita in the long run.

102. Endogenous growth theories have which one of the following implications?

A. Private returns are likely higher than social returns, implying there may a role for government in promoting economic growth.

B. Private returns are likely lower than social returns, implying there may be a role for government in promoting economic growth.

C. Private returns are likely higher than social returns, implying there is no role for government in promoting growth.

D. Private returns are likely lower than social returns, implying there is no role for government in promoting economic growth.

103. Which one of the following policies is not a key feature for reforming economies that have operating under a centrally planned system?

A. Restore macroeconomic stability.

B. Increase foreign trade through protectionist policies.

C. Develop laws and institutions to protect property rights.

D. Liberalize prices within the economy.


mock exam level ii 2004 final ans

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