Overview for Questions #1-4 of 88 Question ID: 1622613

TOPIC: ECONOMICS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Jill Surratt, CFA, and Elizabeth Castillo, CFA, are analysts for Summit Consulting.
Summit provides investment advice to hedge funds and actively managed investment
funds throughout the United States and Canada.

Surratt and Castillo have a client, Tom Carr, who is interested in increasing his returns
from foreign currency positions. Carr currently has a position in Japanese yen (¥) that
he wishes to convert to Taiwanese dollars (NT$) because he thinks the Taiwanese
currency will appreciate in the near term. He does not have a quote for yen in terms
of the NT$ but has received quotes for both currencies in terms of the U.S. dollar. The
quotes are $0.008852–56 for the yen and $0.02874–6 for the Taiwanese dollar. He
would like to purchase NT$10 million.

In discussing these quotes, Surratt notes that the bid-ask spread is affected by many
factors. She states that if an economic crisis were expected in the Asian markets, then
the bid-ask spread of the currency quotes should widen. Castillo states that if a dealer
wished to unload an excess inventory of yen, the typical response would be to lower
her ask for the yen, thereby narrowing the bid-ask spread.

In regards to changes in currency values, Surratt states that under the Mundell-
Fleming model, if the U.S. Federal Reserve restricts the growth of the money supply
and foreign interest rates remain constant, then the interest rate differential (U.S.
interest rate minus counter currency interest rate) should increase, thereby increasing
the value of the dollar.

In addition to using monetary policy, Summit Consulting uses anticipated changes in

fiscal policy to forecast exchange rates and the balance of payments for Canada.
Castillo states that, under the Mundell-Fleming model, if the Canadian government
were to unexpectedly reduce the budget deficit, then this should have a positive
impact on the value of the Canadian dollar in the short run because foreigners would
have more confidence in the Canadian economy.
Question #1 of 88 Question ID: 1622614

The yen cost to Carr of buying NT$10 million is closest to:

A) ¥3,077,000.
B) ¥32,453,000.
C) ¥32,490,000.

Question #2 of 88 Question ID: 1541885

Are Surratt and Castillo correct with regard to their statements concerning the
currency bid-ask spreads?

A) Only Surratt is correct.

B) Only Castillo is correct.
C) Both Surratt and Castillo are correct.

Question #3 of 88 Question ID: 1541886

Evaluate Surratt's statements concerning the impact of monetary policy on currency

values. Surratt is:

A) correct.
incorrect, because restrictive monetary policy in the United States would lead to a
B)
lower value of the dollar.
incorrect, because restrictive U.S. monetary policy would be matched by foreign
C)
governments.

Question #4 of 88 Question ID: 1541887

Regarding Castillo's statements concerning the effect of fiscal policy on currency

values, Castillo is:

A) correct.
 incorrect, because under the Mundell-Fleming model, restrictive Canadian fiscal
B)
policies lead to a short-run depreciation of the Canadian dollar.
incorrect, because under the Mundell-Fleming model, restrictive Canadian fiscal
C)
policies lead to an increase in the value of the Canadian dollar in the long run.

Overview for Questions #5-8 of 88 Question ID: 1622615

TOPIC: ECONOMICS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Jim Satya is a currency trader for the Alpha Bank. One of Alpha's clients is Jack Ponder.
Ponder would like to investigate the possibility of using covered interest arbitrage to
earn risk-free profits over the next three months, assuming an initial capital of $1
million.

He asks Satya to gather information on the inflation rates, interest rates, spot rates,
and forward rates for the U.S. dollar and the Swiss franc (SF). Satya has also used
technical analysis to obtain a projection of the future spot rate for the two countries'
currencies. The information is presented as follows.

Spot rate $0.85 / SF

Three-month forward rate (as of today) for SF $0.80 / SF

Expected spot rate three months from now $0.60 / SF

Three-month inflation rate in Switzerland (annualized) 2.0%

Three-month inflation rate in the U.S. (annualized) 6.0%

Three-month interest rate for SF (annualized) 12.0%

Three-month interest rate for U.S. dollars (annualized) 18.0%

Ponder has a carry trade open involving the Bun (the currency of Bundovia). Ponder
notices that Bundovia has a current account deficit and asks Satya about the impact of
such a deficit on the value of the Bun.

Satya states that the impact on the Bun depends on three factors:

Factor The expected size of the current account deficit in the future.
1:
Factor The influence of exchange rates on domestic prices.
2:

Factor The response of import and export demand to changes in import and
3: export prices.

Question #5 of 88 Question ID: 1541889

Which of the following best describes the covered interest arbitrage that Ponder
should execute? Borrow in:

A) Swiss francs to make an arbitrage profit of $80,313.

B) U.S. dollars to make an arbitrage profit of $80,313.
C) Swiss francs to make an arbitrage profit of $75,588.

Question #6 of 88 Question ID: 1622616

How many of the factors identified by Satya regarding Bundovia's current account
deficit are accurate?

A) One factor only.

B) Two factors only.
C) All three factors.

Question #7 of 88 Question ID: 1541891

For this question only, suppose that the Bundovian government wants to fix the
BUN/USD exchange rate. Under the Mundell-Fleming model, the Bundovian
government's ability to follow an expansionary monetary policy would be limited by:

A) its fiscal policy.

B) the price sensitivity of its exports to the United States.
C) its USD reserves.
Question #8 of 88 Question ID: 1541892

When advising customers pursuing carry trade, Satya would most accurately describe
the strategy's return distribution as:

A) negatively skewed, with fat tails.

B) either positively or negatively skewed, with skinny tails.
C) positively skewed, with normal tails.

Overview for Questions #9-12 of 88 Question ID: 1541903

TOPIC: FINANCIAL STATEMENT ANALYSIS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Tobin Yoakam, CFA, is analyzing the financial performance of Konker Industries, a U.S.
company which is publicly traded under the ticker KONK. Yoakam is particularly
concerned about the quality of Konker's financial statements and its choices of
accounting methodologies.

Below is a summary of Konker's financial statements prepared by Yoakam.

Konker Industries

Income Statement Balance Sheet

20X8 20X8
($ in thousands) ($ in thousands)

Gross sales 55,435 Cash and equivalents 457

Sales discounts, returns, and

1,352 Short term marketable securities 927
allowances

Net sales 54,083 Accounts receivable (net) 47,740

Cost of goods sold 26,500 Inventories 20,963

SG&A expenses 15,625 PP&E (net of depreciation) 25,371

Depreciation expense 1,082 Total assets 95,458

Earnings before interest and

10,876
taxes
Interest expense 693 Accounts payable 24,994

Earnings before taxes 10,183 Other current liabilities 1,209

Taxes (tax rate 40%) 4,073 Long term debt 21,770

Net income 6,110 Total liabilities 47,973

Common stock 40,314

Dividends 5,046 Retained earnings 7,171

Total liabilities and shareholders

Net addition to retained earnings 1,064 95,458
equity

At the beginning of 20X8, Konker formed a qualified special purpose entity (QSPE) and
sold a portion of its accounts receivables to the QSPE. Under U.S. GAAP, QSPE was
exempt from consolidation requirements. The total amount of accounts receivables
sold to the QSPE was $13.5 million. Yoakam has noted in his research that the
Financial Accounting Standards Board (FASB) eliminated qualified special purpose
entities.

Konker has three major operating divisions: Konker Industrial, Konker Defense, and
Konker Capital. Yoakam has computed the EBIT margin for each division over the last
three years, as well as the ratio of the percentage of total capital expenditures to the
percentage of total assets for each division.

EBIT / Assets CapEx % / Assets %

20X8 20X7 20X6 20X8 20X7 20X6

Konker Industrial 6.2% 7.5% 6.7% 1.5 1.3 1.2

Konker Defense 6.7% 7.2% 6.9% 0.5 0.6 0.7

Konker Capital 10.1% 12.1% 11.1% 0.7 0.6 0.5

Question #9 of 88 Question ID: 1541904

With respect to the balance sheet accrual ratio, which of the following, other things
equal, would most likely lead to an increase in the ratio for a growing company?

A) Extending the time the firm takes to pay its suppliers.

B) A significant build-up of cash.
C) A build-up of inventory.
Question #10 of 88 Question ID: 1541905

When FASB retroactively eliminated the allowance of QSPEs created for the
securitization of receivables, the most likely impact on Konker's financial statements
would have been:

A) an increase in equity and an increase in interest expense.

B) no change in assets but an increase in financial leverage ratios.
C) an increase in financial leverage ratios and a decrease in the interest coverage ratio.

Question #11 of 88 Question ID: 1541906

An analyst is considering the effects of income reported under the equity method on
certain financial ratios. For a firm that reports equity income as non-operating income
(not included in EBIT), removing equity income from the financial statements would
most likely result in:

A) an increase in the tax burden term in the extended Du Pont decomposition of ROE.
B) an increase in the asset turnover ratio.
C) a decrease in the interest coverage ratio.

Question #12 of 88 Question ID: 1541907

Regarding the three operating divisions of Konker, Yoakam should be most concerned
that:

A) Konker is growing the Industrial division over time.

B) the operating ROA of the Capital division has fallen over the last year.
the ratio of the Capex percent change to the asset percentage is significantly less
C)
than one for the Defense division.
Overview for Questions #13-16 of Question ID: 1541898
88

TOPIC: FINANCIAL STATEMENT ANALYSIS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Dipesh Ganatra, CFA, is an equity analyst at Mahavir Securities Ltd. Ganatra is

reviewing the financial statements of Parichay Industries, a diverse conglomerate
headquartered in India. Ganatra is particularly concerned about the quality of
Parichay's earnings.

Ganatra decides to analyze Parichay's accrual ratios using the balance sheet
approach. The table below contains the last three years of accrual ratios for Parichay,
as well as the industry average.

Exhibit 1: Accrual ratios for Parichay

Balance Sheet Accrual Ratios 20X8 20X7 20X6

Parichay 4.5% 15.0% 7.0%

Industry average 4.8% 4.4% 5.2%

Ganatra has learned that Parichay has a small subsidiary in Ukraine. The subsidiary
follows IFRS and uses FIFO inventory accounting. The Ukrainian subsidiary was
acquired 10 years ago and has been fully integrated into Parichay's operations.
Parichay obtains funding for the subsidiary whenever the company finds profitable
investments within Ukraine or neighboring countries. According to forecasts from
economists, the Ukrainian Hryvnia is expected to depreciate relative to the Indian
Rupee over the next few years. Ukrainian local currency prices are forecast to remain
stable, however.

One of the managers at Mahavir has asked Ganatra to analyze another Parichay
subsidiary, this one located in Pakistan. The manager explains that real interest rates
in Pakistan over the past three years have been 2.00%, 2.50%, and 3.00%, respectively,
while nominal interest rates have been 34.64%, 29.15%, and 25.66%, respectively.
Ganatra requests more time to analyze the Pakistani subsidiary.

Ganatra meets an old colleague, Riteish Shah, for lunch. Shah specializes in the
insurance industry and makes the following statements:

Statement 1: P&C insurers' liability duration is generally shorter than that of life
insurance companies.
Statement 2: Analysis of a life insurer's profitability includes analysis of its loss
reserves.

Question #13 of 88 Question ID: 1541899

Based on balance sheet accruals ratios, Ganatra is most likely to conclude which of
the following regarding the earnings of Parichay?

The volatile accruals ratios are an indication that Parichay may be manipulating
A)
earnings.
Parichay’s earnings quality was lower than its peer group in 20X8 but higher in 20X6
B)
and 20X7.
Parichay’s earnings quality worsened from 20X6 to 20X8, but was superior to its peer
C)
group over the 3-year period.

Question #14 of 88 Question ID: 1541900

Which of the following statements regarding the consolidation of Parichay's Ukrainian

subsidiary for the next year is least likely correct? Compared to the temporal method,
the Ukrainian subsidiary's translated:

net income before translation gains or losses would be higher using the current rate
A)
method.
B) debt-to-equity ratio would be higher using the current rate method.
C) gross profit margin would be lower using the current rate method.

Question #15 of 88 Question ID: 1541901

Which of the following statements related to the consolidation of Parichay's Pakistani

subsidiary is least likely correct?

The Pakistani economic environment meets the criteria to be classified as a

A)
hyperinflationary economy.
 IFRS would allow Parichay to translate the inflation-indexed value of nonmonetary
B)
assets of the Pakistani subsidiary at the current exchange rate.
Parichay can reduce potential translation losses from the Pakistani subsidiary by
C) issuing debt denominated in the Indian currency and purchasing fixed assets for the
subsidiary.

Question #16 of 88 Question ID: 1541902

Which of Shah's statements about insurance companies is most accurate?

A) Only Statement 1 is correct.

B) Only Statement 2 is correct.
C) Both statements are correct.

Overview for Questions #17-20 of

88 Question ID: 1622617

TOPIC: CORPORATE ISSUERS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Meredith Chase, CFA works for Diamond Mining Inc. Diamond has grown rapidly over
the past several years. Despite this rapid growth, Diamond's EPS has been relatively
stable. Since most of Diamond stock is held by the family of the company's founder,
the free float of Diamond stock is low and the flotation cost for new equity is high.

Diamond is planning to execute a reverse stock split to increase the price of Diamond
stock to a more marketable range.

Diamond's board is interested in a possible takeover of Copper Inc. Chase has been
asked to do an ESG risk factor analysis on Copper.

Question #17 of 88 Question ID: 1541909

Which of the following factors most likely supports a high dividend payout for
Diamond Mining? Diamond's:

A) growth rate.
B) EPS volatility.
C) new equity flotation costs.

Question #18 of 88 Question ID: 1622618

Which of the following statements is most accurate regarding the proposed reverse
stock split plan? A reverse stock split:

A) will reduce Diamond's leverage.

B) will not affect the company's leverage.
C) will reduce the shareholders' tax liabilities.

Question #19 of 88 Question ID: 1541911

Diamond's ownership structure is most accurately described as:

A) concentrated ownership and concentrated voting power.

B) concentrated ownership and dispersed voting power.
C) dispersed ownership and dispersed voting power.

Question #20 of 88 Question ID: 1541912

Which of the following statements about ESG analysis is least accurate?

A) The materiality of ESG risk factors is not important.

B) Fixed-income analysts usually will focus on ESG factors’ downside impact.
Issues that are likely to have a financial impact on the firm only over the long term
C)
may be of little concern for short-term investors.
Overview for Questions #21-24 of
88 Question ID: 1622619

TOPIC: EQUITY VALUATION

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Arnaud Aims is assisting with the analysis of several firms in the retail department
store industry. Because one of the industry members, Flavia Stores, has negative
earnings for the current year, Aims wishes to normalize earnings to establish more
meaningful P/E ratios. For the current year (2016) and six previous years, selected
financial data are given below. All data are in euros.

Exhibit 1: Selected Financial Data for Flavia Stores, 2010–2016

2016 2015 2014 2013 2012 2011 2010

Earnings per share (1.05) 1.90 1.65 0.99 1.35 0.77 1.04

Book value per share 9.11 10.66 9.26 8.11 7.62 6.77 6.50

Return on equity (0.115) 0.178 0.178 0.122 0.177 0.114 0.160

Aims wishes to estimate normalized EPS for 2016 using two different methods, the
method of historical average EPS and the method of average rate of return on equity.
He will leave 2016 EPS and ROI out of his estimates. Based on his normalized EPS
estimates, he will compute a trailing P/E for 2016. The stock price for Flavia Stores is
€26.50.

Aims is also looking at price-to-book ratios as an alternative to price-to-earnings

ratios. Three of the advantages of P/B ratios that Aims recalls are as follows:

Advantage 1: Book value is more stable than EPS.

Advantage 2: For many companies, human capital is more important than

physical capital as an operating asset.

Advantage 3: Book value per share accounts for size differences between
companies.

Aims used a constant growth DDM to establish a justified P/E ratio based on
forecasted fundamentals. One of his associates asked Aims whether he could easily
establish a justified price-to-sales (P/S) ratio and price-to-book (P/B) ratio from his
justified P/E ratio.
Aims replied, "I could do this fairly easily. If I multiply the trailing P/E ratio times the
net profit margin, the ratio of net income to sales, the result will be the P/S ratio. If I
multiply the leading P/E ratio times the return on equity, the ratio of net income to
beginning book value of equity, the result will be the P/B ratio."

Question #21 of 88 Question ID: 1622620

Using the information in Exhibit 1, estimate the P/E ratio for Flavia Stores using EPS
estimated with the method of historical average EPS. The P/E ratio is closest to:

A) 18.4.
B) 20.6.
C) 27.9.

Question #22 of 88 Question ID: 1622621

Using the information in Exhibit 1, estimate the P/E ratio for Flavia Stores using EPS
estimated with the method of average return on equity. The P/E ratio is closest to:

A) 16.0.
B) 18.8.
C) 25.0.

Question #23 of 88 Question ID: 1541921

Which one of the three advantages recalled by Aims is the most appropriate reason to
consider using a P/B ratio?

A) Advantage 1.
B) Advantage 2.
C) Advantage 3.
Question #24 of 88 Question ID: 1541922

Is Aims correct in describing how we could transform a justified P/E ratio into a P/S
ratio or a P/B ratio?

A) Yes.
B) No. He is correct about the P/S ratio but incorrect about the P/B ratio.
C) No. He is correct about the P/B ratio but incorrect about the P/S ratio.

Overview for Questions #25-28 of

88 Question ID: 1626599

TOPIC: EQUITY VALUATION

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Marsha McDonnell and Frank Lutge are analysts for the private equity firm Thorngate
Ventures. Their primary responsibility is to value the equity of private firms in
developed global economies. Thorngate's clients consist of wealthy individuals and
institutional investors. The firm invests in – and then actively manages – its portfolio of
private firms.

During a discussion with junior analysts at the firm, McDonnell compares the
characteristics of private firms with those of public firms, and makes the following
statements:

Statement 1: Private firms typically have higher risk premiums and required returns
than public firms do, because private firms are usually smaller and are
thus seen as riskier. Furthermore, the lack of access to liquid public
equity markets can limit a private firm's growth.

Statement 2: Because of their higher risk, private firms may not be able to attract as
many qualified applicants for top positions as public firms do. And due
to the firms' higher risk, the managers they do attract tend to have a
shorter-term view of the firm and their tenure at the firm, compared
to that of public firm managers. As a result, the private firm may
neglect profitable long-term opportunities.

Lutge adds to the discussion by making the following statement:

Statement 1: When valuing a small stake in a private company using a P/E multiple
from comparable public companies as the basis for valuation, we
should apply appropriate discounts to reflect the unique
characteristics of the private company investment.

McDonnell is examining the prospects of Balanced Metals, a wrought iron fabricator.

Thorngate currently does not have any manufacturing firms in its portfolio, and
Balanced would provide that desired exposure. The growth in sales at Balanced has
been impressive of late, but is expected to slow considerably in the years ahead due
to increased competition from firms overseas. The company's most valuable assets
are its equipment, and its factory located in a prime industrial area.

Balanced was previously considered to be a possible purchase target by a competitor

(another privately held company in the metal fabrication industry). Although the sale
was not consummated, McDonnell has learned that the firm estimated that costs
could be reduced at Balanced by eliminating redundant overhead expenses.
McDonnell has obtained from the Balanced Metals CFO the following financial figures,
as well as the previously estimated synergistic savings from cost reductions. Capital
expenditures will approximately equal depreciation plus 4% of the firm's incremental
revenues. McDonnell wishes to forecast Balanced's free cash flow to the firm (FCFF)
for the next year.

Current revenues $22,000,000

Revenue growth 7%

Gross profit margin 25%

Depreciation expense as a percent of sales 1%

Working capital as a percent of sales 15%

SG&A expenses $5,400,000

Synergistic cost savings $1,200,000

Tax rate 30%

Question #25 of 88 Question ID: 1626600

Are thestatements made by McDonnell comparing private firms and public firms
accurate?
A) Yes.
B) No, both statements are incorrect.
C) No, one statement is correct, but the other statement is incorrect.

Question #26 of 88 Question ID: 1626601

Regarding thestatement made by Lutge on valuation discounts, which of the following

discounts would be appropriate in the scenario described?

A) DLOM ONLY.
B) DLOC ONLY.
C) Both DLOM and DLOC ONLY.

Question #27 of 88 Question ID: 1626602

Which of the following is closest to the FCFF that McDonnell should estimate for
Balanced Metals?

A) –$117,800.
B) $344,120.
C) $722,120.

Question #28 of 88 Question ID: 1626603

Which of the following income approaches would be most appropriate for valuing
Balanced Metals?

A) The free cash flow method.

B) The excess earnings method.
C) The capitalized cash flow method.
Overview for Questions #29-32 of Question ID: 1622622
88

TOPIC: EQUITY VALUATION

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Zhang Xiu Ying, CFA recently joined the analyst team at the pension plan of Steelworks
Inc., reporting to Yew Yip, Senior Portfolio Manager. Ying is currently valuing a
noncontrolling equity interest in Jensen Gear, a small outdoors equipment retailer.
Jensen has experienced healthy growth in earnings over the past three years;
however, given its size and private status, Ying does not expect that Jensen could be
easily sold. To obtain the appropriate price multiple for the Jensen valuation, Ying has
prepared a database of price multiples from the sale of entire public and private
companies over the past 10 years, organized by industry classification. Using historical
data, Ying estimates a control premium of 18.7% and discount for lack of marketability
of 24%.

To obtain the cost of capital for Jensen, Ying uses a cost of capital database that
includes public company betas, cost of equity, weighted average cost of capital, and
other financial statistics by industry. Given Jensen's small size, Ying determines an
appropriate size premium using the smallest-firm-size decile of the database. Yip
examines Ying's cost of capital calculations and makes the following statements:

Statement I am concerned about the use of this database. The estimate of the size
1: premium may result in an undervaluation of the Jensen equity interest.

Statement The use of betas and the CAPM from the database may be
2: inappropriate. You should consider using the build-up method, where
an industry risk premium is used instead of beta.

David Ng, one of Ying's associates, has an affinity for the price-earnings-to-growth
(PEG) ratio, because he believes it addresses the effect of growth on the P/E ratio. For
example, if a firm's P/E ratio is 20 and its forecasted 5-year growth rate is 10%, the
PEG ratio is 2.0.

Ng prefers to invest in firms that have an above-industry-average PEG ratio. Ng also

states that he seeks to invest in firms with leading P/E that is greater than its trailing
P/E. Ying tells Ng that he would like to further investigate these two investment
criteria.

Finally, Ying makes two comments about valuation ratios based on EBITDA and on
dividends:
Comment EBITDA is a pre-interest-expense figure, so I prefer a ratio of total equity
1: value to EBITDA, versus a ratio of enterprise value to EBITDA.

Comment Dividend yields are useful information because they are one component
2: of total return. However, they can be an incomplete measure of return
because investors trade off future earnings growth to receive higher
current dividends.

Question #29 of 88 Question ID: 1622623

The total discount for control and marketability that Ying should apply to the Jensen
valuation is closest to:

A) 36.0%
B) 39.8%
C) 42.7%

Question #30 of 88 Question ID: 1622624

Are the statements that Yip made regarding Ying's cost of capital calculations for
Jensen accurate?

A) Yes.
B) No, both statements are incorrect.
C) No, one statement is correct, but the other statement is incorrect.

Question #31 of 88 Question ID: 1541931

When Ying further investigates the two investment criteria (the PEG ratio and the
comparison between the trailing and leading P/E ratio), should he find Ng's use of
them to be appropriate?

A) No.
B) The PEG ratio criterion is appropriate, but the P/E ratio criterion is not.
C) The P/E ratio criterion is appropriate, but the PEG ratio criterion is not.

Question #32 of 88 Question ID: 1541932

Are Ying's two comments about the dividend yield and EBITDA ratios correct?

A) Yes.
No. The comment about EBITDA ratios is correct, but the comment about dividend
B)
yields is incorrect.
No. The comment about dividend yields is correct, but the comment about EBITDA
C)
ratios is incorrect.

Overview for Questions #33-36 of

88 Question ID: 1622630

TOPIC: DERIVATIVES

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Paul Durham, CFA, is a senior manager in the structured bond department within
Newton Capital Partners (NCP), an investment banking firm located in the United
States. Durham has just returned from an international marketing campaign for NCP's
latest structured note offering, a series of equity-linked fixed-income securities or
ELFS. The bonds will offer a 4.5% coupon paid annually along with the annual return
on the S&P 500 Index and will have a maturity of five years. The total face value of the
ELFS series is expected to be $200 million.

Susan Jacobs, a fixed-income portfolio manager and principal with Smith & Associates,
has decided to include $10 million worth of ELFS in her fixed-income portfolio. At the
end of the first year, however, the S&P 500 Index value is 1,054, significantly lower
than the initial value of 1,112 set by NCP at the time of the ELFS offering. Jacobs is
concerned that the four remaining years of the ELFS life could have similar results and
is considering her alternatives to offset the equity exposure of the ELFS position
without selling the bonds. Jacobs decides to offset her portfolio's exposure to the ELFS
by entering into an equity-swap contract. The MRR term structure is shown in Exhibit
1.
Exhibit 1: MRR Term Structure

MRR Discount Factor

1-year 3.2% 0.9690

2-year 4.1% 0.9242

3-year 4.9% 0.8718

4-year 5.3% 0.8251

To offset any credit risk associated with the equity swap, Widby recommends using an
index trade strategy by entering into a credit default swap (CDS) as a protection buyer.
Widby's strategy would involve purchasing credit protection on an index comprising
largely the same issuers (companies) included in the equity index underlying the
swap. Widby suggests the CDS should have a maturity equal to that of the swap to
provide maximum credit protection.

Question #33 of 88 Question ID: 1541944

Which of the following strategies would be most appropriate given Jacobs's situation
and desire to offset the equity exposure of the ELFS position in her portfolio? Establish
an equity swap as:

A) the floating-rate payer and S&P 500 Index return receiver.

B) the fixed-rate receiver and S&P 500 Index return payer.
C) the fixed-rate payer and S&P 500 Index return receiver.

Question #34 of 88 Question ID: 1622631

Based on the strategy appropriate for Jacobs's portfolio, determine the contract rate
on the swap strategy.

A) 4.5%.
B) 3.6%.
C) 4.9%.
Question #35 of 88 Question ID: 1541946

If Jacobs enters into a $10 million 4-year 4.50% annual-pay fixed-rate equity swap as
the equity return payer, what is the value to Jacob of the swap after one year
(immediately after settlement) if the index has increased from 1,054 to 1,103, the MRR
term structure is as given below, and the 3-year annual-pay swap fixed rate is
currently 5.0%?

MRR

1-year: 4.10%

2-year: 4.70%

3-year: 5.29%

A) –$136,885
B) –$464,982
C) –$602,555

Question #36 of 88 Question ID: 1541947

Which of the following best describes Widby's suggested use of credit default swaps to
offset the credit risk of the equity swap? Widby's recommended strategy is:

A) correct.
B) incorrect, because the maturity of the CDS is not properly specified.
C) incorrect, because the CDS does not reference the proper credit risk.

Overview for Questions #37-40 of

88 Question ID: 1626604

TOPIC: ALTERNATIVE INVESTMENTS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Julian Fuentes, CFA, analyzes real estate investments for AI Partners (AIP), a private
equity real estate investment firm. AIP prefers investments in publicly traded real
estate securities to direct investments in real estate.

Radna Margulies, AIP's Chief Investment Officer, asks Fuentes to focus on Axis, a
multi-family REIT. This request is based on Margulies's perception of pent-up demand
in the housing market. Fuentes forecasts financial data for Axis as presented in
Exhibit 1.

Exhibit 1: AXIS SELECTED FINANCIAL INFORMATION ($ millions)

Net Income $85

Recurring maintenance type capex $11

Depreciation and amortization $12

Gains/(losses) on sale of property $5

Non-cash rent (straight line) $5

Axis has 10 million shares outstanding. Fuentes estimates that multifamily REITs trade
at a P/FFO multiple of 12x and a P/AFFO of 15x. For valuation purposes, Margulies
prefers to use a metric that is representative of the current economic income of a
REIT; meaning, one that represents the funds available for distribution.

Fuentes mentions that a different metric for valuation values a REIT's assets to a
buyer in the private market, which can be quite different from the value public market
investors would attach to the REIT.

Question #37 of 88 Question ID: 1626605

Compared to a direct investment in real estate, an investment in a REIT is most likely

to produce greater:

A) tax benefits.
B) operational control.
C) agency conflict.

Question #38 of 88 Question ID: 1626606

Based on the information in the case and Exhibit 1, the valuation for a share of Axis
REIT based on P/AFFO will be closest to:

A) $91.
B) $114.
C) $110.

Question #39 of 88 Question ID: 1626607

Based on Margulies's focus on current economic income, the most appropriate metric
to use to value a REIT is:

A) AFFO.
B) NOI.
C) FFO.

Question #40 of 88 Question ID: 1626608

To which metric is Fuentes most likely referring, when discussing valuation of a REIT's
assets to a buyer in the private market?

A) P/FFO.
B) NAVPS.
C) P/AFFO.

Overview for Questions #41-44 of

88 Question ID: 1622647

TOPIC: ETHICAL AND PROFESSIONAL STANDARDS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Martha Gillis, CFA, trades currencies for Trent, LLC. Trent is one of the largest
investment firms in the world, and its foreign currency department trades more
currency on a daily basis than any other firm. Gillis specializes in currencies of
emerging nations.

Gillis received an invitation from the new finance minister of Binaria, one of the
emerging nations included in Gillis's portfolio. The minister has proposed a number of
fiscal reforms that he hopes will help support Binaria's weakening currency. He is
asking currency specialists from several of the largest foreign exchange banks to visit
Binaria for a conference on the planned reforms. Because of its remote location,
Binaria will pay all travel expenses of the attendees, as well as lodging in government-
owned facilities in the capital city. As a further inducement, attendees will also receive
small bags of uncut emeralds (because emeralds are a principal export of Binaria),
with an estimated market value of $500.

Gillis has approximately 25 clients that she deals with regularly, most of whom are
large financial institutions interested in trading currencies. One of the services Gillis
provides to these clients is a weekly summary of important trends in the emerging
market currencies she follows. Gillis talks to local government officials and reads
research reports prepared by local analysts, which are paid for by Trent. These inputs,
along with Gillis's interpretation, form the basis of most of Gillis's weekly reports.

Gillis decided to attend the conference in Binaria. In anticipation of a favorable

reception for the proposed reforms, Gillis purchased a long Binaria currency position
in her personal account before leaving on the trip. After hearing the finance minister's
proposals in person, however, she decides that the reforms are poorly timed and
likely to cause the currency to depreciate. She issues a negative recommendation
upon her return. Before issuing the recommendation, she liquidates the long position
in her personal account but does not take a short position.

Gary Flint, Gillis's supervisor, suspects that Gillis may have violated the firm's policy on
personal trading.

Question #41 of 88 Question ID: 1622648

According to CFA Institute Standards of Professional Conduct, Gillis may accept the
invitation to attend 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) because she would be the guest of a sovereign government.
Question #42 of 88 Question ID: 1622649

Given that Gillis's weekly reports to clients are market summaries rather than specific
investment recommendations, what are her record-keeping obligations according to
CFA Institute Standards of Professional Conduct? Gillis must:

maintain records of her conversations with local government officials and also keep
A)
copies of the research reports prepared by local analysts.
only maintain records of her conversations with local government officials and her
B)
own summaries of the research reports prepared by local analysts.
keep her own summaries of the research reports prepared by local analysts, but she
C) has no obligation to maintain records of her conversations with local government
officials.

Question #43 of 88 Question ID: 1622650

Regarding Gillis's transactions in the Binaria currency, she has violated the Standards
by:

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

Question #44 of 88 Question ID: 1622651

According to CFA Institute Standards of Professional Conduct, Flint's best course of

action with regard to the suspected violations by Gillis would be to:

meet with Gillis in person, explain the nature of the violations, and seek assurances
A)
that such violations will not recur.
warn Gillis to cease the trading activities and report the violation to Flint’s supervisor
B)
immediately.
 place limits on Gillis’s personal trading and increase monitoring of Gillis’s personal
C)
trades.

Overview for Questions #45-48 of

88 Question ID: 1541878

TOPIC: QUANTITATIVE METHODS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Research associate Kate Sawyer is responsible for identifying the determinants of

performance for her firm's Progressive Fund (PF). All tests performed at Sawyer's firm
are examined at the 0.05 level of significance. Sawyer examines the following
regressions using monthly data observed for a 36-month period:

(1) RPF,t = b0 + b1RM,t + b2VMGt + ePF,t

(2) = a0 + a1RM,t + a2VMGt + uPF,t

where:

RPF,t= the return on the Progressive Fund in month t

RM,t = the return on the Wilshire 5000 stock market index in month t

VMGt = the return on value stocks minus the return on growth stocks in month t

= the estimated squared regression errors derived from (1)

Exhibit 1: Equation (1) Regression Results

Variable Coefficient p-values

Constant –0.005 0.030

RM 1.250 0.001

VMG 0.200 0.980

The R2 from equation (1) equals 0.80. A colleague, Jack Lockhart, makes a
recommendation to Sawyer:
Recommendation: My research indicates that the slope coefficients of your
regression changed significantly after the passage of
Regulation Fair Disclosure, which took place in the middle of
your 3-year sample period. Your regression pools across two
distinct sample periods. Therefore, I recommend correcting
your current regression equation for model misspecification.

In her conversation with Lockhart, Sawyer explains that she is concerned that her
regression equation (1) may ignore other important determinants of performance for
the Progressive Fund. Sawyer explains that she is aware that the omission of
important independent variables affects the quality of the parameter estimates of the
regression. She makes the following claims, assuming the omitted variables are
correlated with the included variables:

Claim 1: The parameter estimates of equation (1) are unbiased.

Claim 2: The parameter estimates of equation (1) are inconsistent.

Question #45 of 88 Question ID: 1541879

Of the slopes for the two independent variables, RM and VMG, determine which are
statistically significant at the 0.05 level?

A) Both slopes are statistically significant.

B) Only the slope for RM is statistically significant.
C) Only the slope for VMG is statistically significant.

Question #46 of 88 Question ID: 1541880

Sawyer decides to test regression equation (1) for the existence of conditional
heteroskedasticity. Sawyer is likely to conclude that her regression does not exhibit
conditional heteroskedasticity if the R2 from equation (2) is:

A) close to 0.
B) close to 1.
C) close to 0.80.
Question #47 of 88 Question ID: 1541881

Regarding Lockhart's recommendation, the most likely form of model misspecification

to which he refers is:

A) stationarity model misspecification.

B) time-series model misspecification.
C) functional form model misspecification.

Question #48 of 88 Question ID: 1541882

Regarding Claim 1 and Claim 2 made by Sawyer about the effects of omitted variables,
which claims are correct?

A) Claim 1 only.
B) Claim 2 only.
C) Both Claim 1 and Claim 2.

Overview for Questions #49-52 of

88 Question ID: 1541993

TOPIC: CORPORATE ISSUERS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Michael Bennet is evaluating the recent announcements made by Voyaager and

Gaarding, two of the stocks held in his portfolio. Voyager, Inc., a primarily internet-
based media company, is buying The Daily, a media company with exposure to
newspapers, television, and the internet.

Company Descriptions

Voyager, Inc., is organized into two segments: internet and newspaper publishing.
The internet segment operates websites that offer news, entertainment, and
advertising content in text and video format. The internet segment represents 75%
of the company's total revenues. The newspaper publishing segment publishes 10
 daily newspapers. The newspaper publishing segment represents 25% of the
company's total revenues.

The Daily is organized into three segments: newspaper publishing (60% of

revenues), broadcasting (37% of revenues), and internet (3% of revenues). The
newspaper publishing segment publishes 101 daily newspapers. The broadcasting
segment owns and operates 25 television stations. The internet segment consists of
an internet advertising service. The Daily's newspaper publishing and broadcasting
segments cover the 20 largest markets in the United States.

(in millions) Voyager, Inc. (before merger) The Daily (before merger)

Revenues $1,800 $600

EBITDA $300 $62

Debt $200 $50

Number of shares 11 2

Stock price per share $68 $35

The acquistion terms call for an exchange of all outstanding shares of Daily for 1
million newly issued shares of Voyager. Michael Renner, the CFO of Voyager, defended
the acquisition by stating that The Daily has accumulated a large amount of tax losses
and that the combined company can benefit by immediately increasing net income
after the merger. In addition, Renner states that the new Voyager will eliminate the
inefficiencies of its internet operations and thereby boost future earnings.

Bennet is curious about the recent spate of acquisitions in the industry.

Gaarding operates in the industrial fittings business and has made an agreement with
a private equity company to sell its factory. Under the terms of the agreement, the
factory will be leased back for a period of 15 years. The proceeds from the sale will be
used to retire the firm's secured debentures.

Question #49 of 88 Question ID: 1541994

Based on Renner's comments defending Voyager's acquisition of The Daily, indicate

whether his comments about net income and elimination of inefficiencies are most
likely correct.
 Only Renner’s comment that unused tax losses will immediately translate into
A)
higher net income is correct.
Only Renner’s comment that the elimination of inefficiencies within the internet
B)
operations will create additional value is correct.
C) Both comments are correct.

Question #50 of 88 Question ID: 1541995

For this question only, assume that there is no change in Voyager's stock price and
there are no synergies as a result of the acquistion. As compared to its pre-acquisition
value, Voyager's post acquistion EV/EBITDA ratio is most likely to be:

A) higher.
B) lower.
C) remain the same.

Question #51 of 88 Question ID: 1541996

Which of the following reasons is least likely to support Bennet's observation about
increased acquisition activity in the industry?

A) High cost of capital.

B) Rising CEO confidence.
C) High security prices.

Question #52 of 88 Question ID: 1541997

Gaarding's announcement is most likely a:

A) balance sheet restructuring.

B) cost restructuring.
C) divestment.
Overview for Questions #53-56 of
88 Question ID: 1541988

TOPIC: FINANCIAL STATEMENT ANALYSIS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Gary Smith, CFA, has been hired to analyze a specialty tool and machinery
manufacturer, Whitmore Corporation (WMC). WMC is a leading producer of specialty
machinery in the United States. At the end of 2014, WMC purchased York Tool
Company (YTC), an Australian firm in a similar line of business. YTC has partially
integrated its marketing functions within WMC but still maintains control of its
operations and secures its own financing. Following is a summary of the income
statement and balance sheet for YTC (in millions of Australian dollars – AUD) for the
past three years as well as exchange rate data over the same period.

Income Statement (AUD millions) 2014 2015 2016

Revenues 765 820 870

COGS 484 520 580

SG&A 171 183 200

Depreciation expense 50 50 50

Interest expense 18 17 16

Income before tax 42 50 24

Taxes 21 25 12

Net income 21 25 12

Balance Sheet (AUD millions)

2014 2015 2016 2014 2015 2016

Cash 22 25 20 Current liabilities 616 593 584

Accounts receivable 400 422 460 Long-term debt 180 170 160

Inventories 20 25 30

Prepaid expenses 8 20 25 Common stock 50 50 50

Net fixed assets 500 450 400 Retained earnings 104 129 141

Total assets 950 942 935 Total liabilities & equity 950 942 935
Exchange rates (AUD / USD) 2014 2015 2016

Average exchange rate 1.40 1.30 1.45

Year-end exchange rate 1.20 1.40 1.50

Historical exchange rate 1.20 1.20 1.20

Question #53 of 88 Question ID: 1541989

Calculate the percent change in YTC net income shown on the WMC financial
statements from 2015 to 2016.

A) –52.0%.
B) –55.2%.
C) –56.9%.

Question #54 of 88 Question ID: 1541990

If WMC uses the temporal method, YTC's net monetary liabilities leave WMC exposed
to loss in the event of:

A) currency (AUD) depreciation.

B) currency (AUD) appreciation.
C) either currency depreciation or currency appreciation.

Question #55 of 88 Question ID: 1541991

Determine whether the translated total asset turnover for YTC for 2016 would be
higher under the current rate method or under the temporal method.

A) Temporal method.
B) Current rate method.
C) No difference between temporal and current rate methods.
Question #56 of 88 Question ID: 1541992

For the period 2014–2016, WMC's annual USD revenue growth rate attributable to its
Australian subsidiary is most likely:

A) 1.85% lower than the local currency revenue growth rate.

B) 3.62% higher than the local currency revenue growth rate.
C) 3.45% lower than the local currency revenue growth rate.

Overview for Questions #57-60 of

88 Question ID: 1541933

TOPIC: FIXED INCOME

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

MediSoft, Inc., develops and distributes high-tech medical software used in hospitals
and clinics across the United States and Canada. The firm's software provides an
integrated solution to monitoring, analyzing, and managing output from a variety of
diagnostic medical equipment including MRIs, CT scans, and EKG machines. MediSoft
has grown rapidly since its inception 10 years ago, averaging 25% growth in sales over
the past decade. Twelve months after its IPO, MediSoft made two bond offerings, the
first of which was a convertible bond.

At the time of issuance, the convertible bond had a coupon rate of 7.25%, a par value
of $1,000, a conversion price of $55.56, and 10 years until maturity. Two years after
issuance, the bond became callable at 102% of par value. Soon after the issuance of
the convertible bond, the company issued another series of bonds, which were
putable but contained no conversion or call features. The putable bonds were issued
with a coupon of 8.0%, a par value of $1,000, and 15 years until maturity. The putable
bond has a European-style option exercisable 10 years after issuance at par. The
bonds were issued three years ago.

MediSoft's convertible bonds are now trading in the market for a price of $947 with an
estimated straight value of $917. The company's putable bonds are trading at a price
of $1,052. Volatility in the price of MediSoft's common stock has been relatively high
over the past few months. Currently, the stock is priced at $50 on the New York Stock
Exchange and is expected to continue its annual dividend in the amount of $1.80 per
share.
High-tech industry analysts for Brown & Associates, a money management firm
specializing in fixed-income investments, have been closely following MediSoft ever
since it went public three years ago. In general, portfolio managers at Brown &
Associates do not participate in initial offerings of debt investments, preferring
instead to see how the issue trades before considering taking a position in the issue.
Because MediSoft's bonds have had ample time to trade in the marketplace, analysts
and portfolio managers have taken an interest in the company's bonds. At a meeting
to discuss the merits of MediSoft's bonds, the following comment was made by a
portfolio manager at Brown & Associates:

"Choosing to invest in MediSoft's convertible bond would benefit our

portfolios in many ways, but the primary benefit is the limited downside
risk associated with the bond. Because the straight value will provide a
floor for the value of the convertible bond, downside risk is limited to the
difference between the market price of the bond and the straight value."

Question #57 of 88 Question ID: 1541934

Calculate the market conversion premium per share for MediSoft's convertible bonds.

A) $2.61.
B) $2.95.
C) $5.56.

Question #58 of 88 Question ID: 1541935

The minimum value of the convertible bond today is closest to:

A) $900.
B) $917.
C) $947.

Question #59 of 88 Question ID: 1541936

Suppose that MediSoft wants to issue new bonds but wants to issue the bonds at-or-
above par value. Which of the following bonds would most closely match their
criteria?

A) 7-year, 7.25% convertible bond with a conversion price of $56.

B) 7-year, 7.25% callable bond, callable in two years at 102% of par.
C) 7-year, 8% coupon bond extendible for five years at the same coupon rate.

Question #60 of 88 Question ID: 1541937

Under what circumstances will the portfolio manager's comments regarding the
limited downside risk of MediSoft's convertible bonds be accurate?

A) Short-term and long-term interest rates are expected to remain the same.
B) The Federal Reserve Bank decides to pursue a restrictive monetary policy.
C) The convertible bond is trading in the market as a common stock equivalent.

Overview for Questions #61-64 of

88 Question ID: 1541938

TOPIC: FIXED INCOME

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Michael Thomas, CFA, is a fixed-income portfolio manager for TFC Investments. As

part of his portfolio strategy for the Prosperity Fund, Thomas seeks out bonds that he
expects to be upgraded or downgraded. Potential upgrades that Thomas identifies are
added to the portfolio (or, if already in the portfolio, are increased in proportion to
other holdings). Potential downgrades are sold from the portfolio. Thomas's
portfolio's current holdings include several bonds issued by companies in the oil and
gas exploration and refining industries. Year-end rating updates are expected to occur
in a few days, and Thomas is preparing to adjust his portfolio in advance of expected
changes in credit ratings.

Thomas has been discussing his fixed-income strategies with fellow portfolio manager
Shawna Reese. Reese suggests that while Thomas's general approach is suitable, the
overall credit-analysis strategy could be improved. Reese recommends using the
credit valuation adjustment as a metric in credit analysis.

Reese makes the following statement to Thomas:

Reese's "Credit valuation adjustment is the sum of the expected loss for
statement: each period based on the risk-neutral probability of default."

Reese provides information about 4% Pistar, Inc., bonds, which are currently rated AA
with a negative outlook. The bonds have a modified duration of 7.8, and the credit
spread on the bonds is expected to be the same as the average for that rating
category. Reese wants to calculate the impact of a downgrade on Pistar, Inc.'s bonds
given the information in Exhibit 1.

Exhibit 1: Average Credit Spreads by Ratings Category

AAA AA A BBB BB B CCC

0.24% 0.29% 0.39% 0.58% 0.89% 1.12% 1.78%

Question #61 of 88 Question ID: 1541939

Reese's statement about credit valuation adjustment is most likely:

A) correct.
B) incorrect about the use of risk-neutral probability of default.
C) incorrect about the sum of expected losses.

Question #62 of 88 Question ID: 1541940

Under the option analogy of the structural model, owning a company's debt is
economically equivalent to owning a riskless bond and simultaneously:

A) buying an American put option on the assets of the company.

B) selling a European put option on the assets of the company.
C) buying a European put option on the assets of the company.
Question #63 of 88 Question ID: 1541941

If Reese uses the risk-neutral probabilities of default to value the Pistar, Inc., bonds,
she is most likely to conclude that the bond is:

A) fairly valued.
B) overvalued.
C) undervalued.

Question #64 of 88 Question ID: 1541942

What is the expected change in price of Pistar, Inc., bonds on account of credit
migration?

A) –0.29%.
B) –0.39%.
C) –0.78%.

Overview for Questions #65-68 of

88 Question ID: 1622632

TOPIC: DERIVATIVES

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Thiel Bank is a mid-sized commercial bank, with a substantial derivatives trading

division headed by Linda Simms. During a recent meeting with Pete Barka, partner at
the brokerage firm that clears derivatives trades for Thiel Bank, Simms discusses
some of her derivatives trading strategies.

Barka suggests options on the Nasdaq 100 index futures as a use for the bank's
excess cash. The September futures price on the Nasdaq 100 index is currently 4243.
Three-month calls and puts with a strike price of 4200 are available. Exhibit 1 shows
information about the options.

Exhibit 1: Three-Month Options on Nasdaq 100

Strike price (for both calls and puts) $4200

Call premium $243

Put premium $196

Implied volatility 26%

Continuously compounded risk-free rate 0.35%

N(d1) 0.5597

N(d2) 0.5080

Simms wishes to hedge an existing payer swap that the bank has a position in, and is
wondering how she can replicate a payer swap using other interest rate derivative
contracts.

John Dice recently joined Thiel bank as an intern. Simms asks Dice to meet with
Jonathan Widby, a senior analyst at Thiel. Widby makes the following statements:

Statement N(d2) in the Black-Scholes Merton model is interpreted as the risk-

1: neutral probability that a put option will expire in the money.

A call option on a dividend-paying stock can be valued using the BSM if

Statement
we reduce the current stock price by the present value of dividends
2:
expected over the life of the option.

Statement For options on currencies, the carry benefit is not a dividend but rather
3: interest earned on a deposit of the foreign currency.

Statement Under the Black model, a call option on futures is modeled as a

4: portfolio containing a long bond position and a short futures position.

Question #65 of 88 Question ID: 1541949

Using the Black model, the call option on the index futures is best valued as:

the present value of the difference between: the strike price multiplied by 0.5597,
A)
and the current futures price multiplied by 0.508.
the present value of the difference between: the current futures price times 0.5597,
B)
and the exercise price multiplied by 0.508.
the future value of the difference between: the current spot price multiplied by
C)
0.5597, and the exercise price multiplied by 0.508.
Question #66 of 88 Question ID: 1541950

The most appropriate method of replicating a payer swap is to use a:

zero-cost portfolio consisting of a long cap and a short floor with the same strike
A)
rate.
B) short cap and long floor with strike rate equal to the swap fixed rate.
C) long FRA with maturity equal to the swap tenor.

Question #67 of 88 Question ID: 1541951

Regarding Statements 1 and 2 made by Widby, it would be most accurate to state that:

A) both statements are correct.

B) only Statement 1 is correct.
C) only Statement 2 is correct.

Question #68 of 88 Question ID: 1541952

Regarding Statements 3 and 4 made by Widby, it would be most accurate to state that:

A) both statements are correct.

B) only Statement 3 is correct.
C) only Statement 4 is correct.

Overview for Questions #69-72 of

Question ID: 1622638
88

TOPIC: PORTFOLIO MANAGEMENT

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Millennium Investments (MI), an investment advisory firm, provides asset allocation

recommendations for its clients. Prior to making such recommendations, Millennium's
staff routinely evaluates its models using backtesting. Sam Shepard, Senior Manager,
makes the following statements:

If asset returns do not follow a multivariate normal distribution,

Statement
scenario analysis and simulation can provide a more complete picture
1:
of investment strategy performance.

Statement Scenario analysis can be used to analyze the performance and risk of
2: investment strategies in different structural regimes.

Statement Conventional rolling-window backtesting may not fully account for the
3: dynamic nature of financial markets or possible extreme downside risk.

Compared to a historical simulation approach, Monte Carlo simulation

Statement
is a more appropriate method to account for skewness, excess kurtosis,
4:
and tail dependence in a return distributions.

Shepard is also looking at evaluating three portfolios using a single-factor model.

Information about the three portfolios is shown in Exhibit 1.

Exhibit 1: Portfolio Factor Sensitivity and Expected Return

Portfolio Expected Return Factor Sensitivity

X 0.10 1.00

Y 0.12 1.25

Z 0.15 1.50

Question #69 of 88 Question ID: 1541959

Regarding Shepard's Statements 1 and 2:

A) only one statement is correct.

B) neither statement is correct.
C) both statements are correct.

Question #70 of 88 Question ID: 1541960

Regarding Shepard's Statements 3 and 4:

A) both statements are correct.

B) only one statement is correct.
C) neither statement is correct.

Question #71 of 88 Question ID: 1541961

Another stock (not in the portfolio), PSL, has a factor sensitivity of –0.9 to inflation and
+1 .2 to GDP growth rate. Last year, PSL's actual return was 8% (0.5% unexplained by
the model). Inflation surprise, as well as GDP growth rate surprise, was +0.5%. PSL's
expected return was closest to:

A) 7.35%.
B) 7.50%.
C) 8.50%.

Question #72 of 88 Question ID: 1622639

Using information in Exhibit 1, taking advantage of an arbitrage opportunity would

most likely require shorting:

A) Portfolio X.
B) Portfolio Y.
C) Portfolio Z.

Overview for Questions #73-76 of

88 Question ID: 1541968

TOPIC: PORTFOLIO MANAGEMENT

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Hong Zhou, Jianguo Yeung, and Jm Leor Joeng work for Pearl Asset Management, a
large private wealth advisory firm. During lunch they discuss various unique client
situations they face and how they plan to resolve them.

Yeung mentions that yesterday, he met one of his clients who was very concerned
about current market volatility and its impact on his portfolio. Specifically, the client is
concerned about the impact of extreme stress events.

Zhou, Yeung, and Joeng are all developing multifactor models to attempt to explain
asset price returns. Zhou has built his model based on standardized sensitivities of
asset returns to intrinsic valuation model inputs. When Zhou asks Yeung about factors
that his model uses to explain the differences in returns of different asset classes,
Yeung replies that he can't define exactly what the factors are but insists that his
model uses statistical relationships that have been proven to hold over time. Joeng
discounts both Zhou and Yeung's approaches and instead insists that surprises cause
stock prices to move. Hence, he has built his model based on surprises rather than
sensitivities to absolute factors.

Zhou wishes to combine the actively managed Lincoln investment fund with a
passively managed fund that tracks the Russell 2000 (which is the benchmark for the
Lincoln fund). Expected risk and return data is as follows:

Lincoln Fund Russell 2000

Expected annual return 7.6% 6.5%

Return standard deviation 19.0% 11.0%

Active risk 5.0% 0.0%

The risk-free rate is 3.0%

Question #73 of 88 Question ID: 1541969

To address the client's concerns about extreme stress events on the portfolio value,
Yeung is most likely to communicate the portfolio's:

A) VaR.
B) relative VaR.
C) conditional VaR.
Question #74 of 88 Question ID: 1541970

Regarding the use of multifactor models, which of the following statements is most
likely to be correct?

Zhou is using a macroeconomic model, Yeung is using a fundamental factor model,

A)
and Joeng is using principal component analysis.
Zhou is using a fundamental factor model, Yeung is using principal component
B)
analysis, and Joeng is using a macroeconomic model.
Zhou is using principal component analysis, Yeung is using a macroeconomic model,
C)
and Joeng is using a fundamental factor model.

Question #75 of 88 Question ID: 1541971

To achieve the optimal level of active risk, what proportion of funds would Zhou
allocate to the Lincoln fund?

A) 53%.
B) 82%.
C) 151%.

Question #76 of 88 Question ID: 1541972

The highest Sharpe ratio that Zhou can achieve by combining the Lincoln fund and the
Russell 2000 is closest to:

A) 0.39.
B) 0.42.
C) 1.12.

Overview for Questions #77-80 of

88 Question ID: 1622640

TOPIC: PORTFOLIO MANAGEMENT

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Thomas West is the managing partner at Crystal Advisors, a boutique wealth

management firm. West has scheduled a meeting with Ramil Bautista, the firm's chief
economist.

West asks Bautista about risk premiums on assets; and specifically the impact on the
risk premium if an asset's future value is negatively correlated with investors' utility
from future consumption. West would also like to learn about the relationship
between a country's growth rate and the real risk-free rate.

West is meeting with a client to discuss inclusion of actively managed funds in that
client's portfolio. To prepare for the meeting, West creates a presentation to illustrate
the merits and risks of this change. West cannot recall the term that is used to capture
the sum of active factor risk and active specific risk (where these two terms refer to
variances rather than standard deviations).

West feels that the economy is finally coming out of recession and poised for growth
over the next three to five years.

Question #77 of 88 Question ID: 1541964

With regard to West's question about correlation, Bautista should reply that the risk
premium is most likely to be:

A) lower due to the negative correlation.

B) higher due to the negative correlation.
C) unimpacted by the negative correlation.

Question #78 of 88 Question ID: 1541965

For countries with high expected economic growth, it is most likely that:

A) real risk-free rates will be low.

B) the inter-temporal rate of substitution will be low.
C) investors will save more.
Question #79 of 88 Question ID: 1622641

The term that West cannot recall is most likely:

A) active total risk.

B) active risk squared.
C) alpha risk.

Question #80 of 88 Question ID: 1541967

Based on West's economic outlook, it would be most appropriate to conclude that:

A) government bonds will outperform corporate bonds.

B) higher-rated corporate bonds will outperform lower-rated corporate bonds.
C) lower-rated corporate bonds will outperform higher-rated corporate bonds.

Overview for Questions #81-84 of

88 Question ID: 1622642

TOPIC: ETHICAL AND PROFESSIONAL STANDARDS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Paul Vakil, CFA, joined the equity research department of Patarsby and Singly, a
brokerage firm. Vakil, with the help of a quant specialist at Patarsby, developed
advanced forecasting models based on machine learning algorithms and started using
them in his new role. Things turned out very well for Vakil at Patarsby, and clients
waited eagerly for release of his monthly recommendations. During a society event,
Vakil ran into Alia Dutt, CFA, one of the fund managers who had worked with Vakil at a
prior job. Dutt congratulated Vakil. Later in the evening, Vakil spoke to Dutt about one
of the companies he is following—Sandhirst, Inc. Vakil stated that his preliminary
research indicates that the short-term outlook for Sandhirst is very promising. Dutt
also met Neil Savin, Frapco, Inc.'s controller at the event. Frapco is a national grocery
chain. Savin informed Dutt that the new layout in the stores has been a hit, and that
he expects revenues and earnings for the current quarter to be well above consensus
forecast.
The next day, Dutt placed a large order for Sandhirst stock for her fund. Dutt also
placed a large order for a retail ETF. Dutt is a member of an online forum where she
discusses investments under a pseudonym. Dutt has formed a very loyal following
over time as others realized that her posts were very articulate and, therefore, the
work of a professional. Dutt recommended Frapco stock in the forum but attributed
the recommendation to a general uptick in grocery store margins nationwide—a
known fact based on recent earnings announcements of other grocers.

The following week at a charity golf tournament, Vakil met with Bob Snead, his college
roommate. Snead was a very successful hedge fund manager. Both of the funds run
by Smead were currently closed to new investment, though Snead was considering
reopening the investments in the near future. At Vakil's insistence, Snead agreed to
allow new investments into the two funds using a newly started intermediary fund as
long as Vakil is the fund's manager. Vakil quickly convinced his bosses at Patarsby to
open an intermediary fund and marketed the fund to existing Patarsby clients as a
way into Snead hedge funds. Not knowing how long the deal with Snead would hold
up, and wanting to quickly ramp up assets under management, Vakil accepted
deposits from all Patarsby clients, even some that were relatively new accounts.

Question #81 of 88 Question ID: 1622643

Vakil's conversation with Dutt regarding Sandhirst stock is most likely a violation of:

A) Standard IV(A) - Duties to Employer: Loyalty.

B) Standard II(A) - Integrity of Capital Markets: Material Nonpublic Information.
C) Standard III(C) - Duties to Clients: Suitability.

Question #82 of 88 Question ID: 1622644

With regards to investments in Sandhirst stock and retail ETF, Dutt most likely
violated:

Standard II(A) − Material and Nonpublic Information by investing in Sandhirst stock

A)
but not by investing in the retail ETF.
Standard II(A) - Material and Nonpublic Information by investing in the retail ETF but
B)
not by investing in Sandhirst stock.
C) Standard II(A) - Material and Nonpublic Information in both instances.

Question #83 of 88 Question ID: 1622645

Dutt's recommendation of Frapco stock in the online forum is most likely:

a violation of Standard II(A) − Material and Nonpublic Information even though she
A)
attributed the recommendation to publicly available information.
B) not a violation under Standard II(A) − Material and Nonpublic Information.
C) violation of Standard III(E) − Preservation of Confidentiality.

Question #84 of 88 Question ID: 1622646

Vakil's conduct regarding the intermediary fund to channel investments into Snead
funds is most likely a violation under:

A) Standard II(B) − Integrity of Capital Markets: Market Manipulation.

B) Standard III(D) − Duties to Clients: Suitability.
C) Standard III(D) − Duties to Clients: Fair Dealing.

Overview for Questions #85-88 of

88 Question ID: 1622652

TOPIC: ETHICAL AND PROFESSIONAL STANDARDS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Mikale Natschavin, CFA, is the managing director of Blue Lotus LP, a boutique
investment bank specializing in M&A consulting in the professional services arena.
Blue Lotus also manages a fund (Xeta fund) for several institutional clients. The fund
was run by a team of four managers. During the recent economic downturn,
commensurate with the decline in the size of the fund, Blue Lotus downsized the staff.

Sandra Duff, CFA, one of the managers of Xeta, was laid off by Blue Lotus. During her
exit interview Natschavin wished Duff well and, on behalf of the firm, gave her
permission to use Xeta fund's past performance when seeking new employment
opportunities. Duff did not mention to Natschavin or the personnel manager that she
was still in possession of a company-issued laptop. On that laptop's hard disk, Duff
had stored several models the team had developed to pursue investment strategies.
In later job applications to potential employers, Duff included the performance of the
fund to demonstrate her success, but did not give any indication of a team approach.

After several weeks of interviews, Duff accepts employment in the currency trading
department of Sario, a large hedge fund. Duff begins to use some of the models from
her Blue Lotus laptop at her new job. Duff's supervisor at Sario, Steve Howlett, CFA,
regularly reviews employees' personal trading to detect violations of Sario's written
policies regarding trading in personal accounts. Howlett finds two instances where he
believes Duff has engaged in front-running of Sario's clients.

One of the currency trading strategies employed by Sario is based on interest rate
parity. Sario traders monitor spot exchange rates, forward rates, and short-term
government interest rates. On the rare occasions when the forward rates do not
accurately reflect the interest differential between two countries, Sario employees
place trades to take advantage of the riskless arbitrage opportunity.

Because Sario is such a large player in the currency exchange markets, its transactions
costs are very low, and Sario is often able to take advantage of mispricings that are
too small for other firms to capitalize on. In describing these trading opportunities to
clients, Sario staff suggest that "Clients willing to participate in this type of arbitrage
strategy are guaranteed riskless profits until the market pricing returns to
equilibrium."

Question #85 of 88 Question ID: 1622653

Regarding her reference to Xeta fund's performance in her employment applications,

Duff is most likely to have violated the CFA Institute Standard of Professional Conduct
related to:

A) Standard III(D) − Performance Presentation.

B) Standard IV(A) − Duties to Employer: Loyalty.
Standard III(D) − Performance Presentation as well as Standard IV(A) − Duties to
C)
Employer: Loyalty.
Question #86 of 88 Question ID: 1622654

Duff's use of the Blue Lotus models at Sario is least likely to be a violation of:

A) Standard I(C) − Professionalism: Misrepresentation.

B) Standard II(A) − Integrity of Capital Markets: Material Nonpublic Information.
C) Standard IV(A) − Duties to Employer: Loyalty.

Question #87 of 88 Question ID: 1622655

Based on the information given, and according to CFA Institute Standards, which of
the following statements best describes Sario's compliance procedures relating to
personal trading in foreign currencies? The compliance procedures:

A) appear adequate because Howlett was successful in identifying potential violations.

appear adequate, but Howlett’s monitoring of Duff’s trades indicates poor
B)
supervisory responsibility.
should include both duplicate confirmations of transactions and preclearance
C)
procedures for personal trades.

Question #88 of 88 Question ID: 1622656

Regarding Sario's arbitrage trading strategies, has Sario's staff violated CFA Institute
Standards of Professional Conduct with respect to the firm's trading strategy or the
guarantee of results?

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