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Overview for Questions #1-4 of 88 Question ID: 1454810

TOPIC: QUANTITATIVE METHODS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Joan Fisher and Kim Weatherford are economists responsible for modeling security
returns for Quincy Portfolio Managers, which is located in the southwestern United
States. Fisher is the firm's chief economist and Weatherford is her assistant.

In addition to financial assets, Quincy Portfolio Managers also recommends the use of
commodities as a portfolio diversifier. Weatherford has been examining price indices
for silver in an attempt to determine whether silver returns are predictable. As an
initial step, she uses an autoregressive first-order regression model on daily price
data for silver over the past two years. The plot of the raw data and the results of the
regression are shown in  Exhibit 1: Time Series of Silver Prices and  Exhibit 2: Silver
Price Regression Results.

Exhibit 1: Time Series of Silver Prices

Exhibit 2: Silver Price Regression Results

Regression Statistics

Multiple R 0.99

R-Square 0.98

Adjusted R-Square 0.98

Standard Error 123.81

Observations 522.00

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Durbin-Watson 2.39

ANOVA

df SS MS F Significance F

Regression 1.00 365,730,065 365,730,065 23,859.63 0.00

Residual 520.00 7,970,771 15,328

Total 521.00 373,700,837

Coefficients Standard Error t-Stat P-value

Intercept 21.00 11.56 1.82 0.07

Slope 0.99 0.01 154.47 0.00

Fisher and Weatherford later discuss fluctuations in gold prices. Although the
arithmetic and geometric mean returns for gold were negative for much of the 1980s
and 1990s, Fisher and Weatherford believe that gold should perform better in the
future due to higher expected inflation. After appropriate transformation of the data,
they use an autoregressive first-order regression model to examine the
characteristics of gold returns, the results of which are shown in  Exhibit 3: Gold
Price Regression Results.

Exhibit 3: Gold Price Regression Results

Regression Statistics

Multiple R 0.09

R-Square 0.01

Adjusted R-Square 0.01

Standard Error 123.95

Observations 520.00

ANOVA

df SS MS F Significance F

Regression 1.00 66,742 66,742 4.34 0.04

Residual 518.00 7,958,144 15,363

Total 519.00 8,024,887

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Coefficients Standard Error t-Stat P-value

Intercept 2.00 5.44 0.37 0.71

Slope –0.09 0.04 –2.08 0.04

Question #1 of 88 Question ID: 1418987

Is the use of the Durbin Watson statistic in Weatherford's silver regression

appropriate and, if so, how should it be interpreted?

A) No.
B) Yes, and it appears that the error terms are serially correlated.
C) Yes, and it appears that the error terms are not serially correlated.

Question #2 of 88 Question ID: 1418988

Which of the following are the most likely problem in Weatherford's silver regression
and the most appropriate test for it?

Problem Test

A) Multicollinearity Breusch-Pagan

B) Multicollinearity Dickey-Fuller

C) Nonstationary data Dickey-Fuller

Question #3 of 88 Question ID: 1418989

To best model the silver price data using an autoregressive first-order regression
model, Weatherford should use:

A) first differences of the data.

B) the actual silver price levels.
C) the predicted silver price levels.

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Question #4 of 88 Question ID: 1418990

Using the data for the gold regression, what is the mean-reverting level and what is
the two-step-ahead forecast if the current value of the independent variable is –0.80?

Two-step-ahead
Mean-reverting level
forecast

A) 1.83 1.75

B) 1.83 1.81

C) 2.07 1.75

Overview for Questions #5-8 of 88 Question ID: 1454811

TOPIC: ECONOMICS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Barton Wilson, a junior analyst, is a new hire at a money center bank. He has been
assigned to help Juanita Chevas, CFA, in the currency trading department. Together,
Wilson and Chevas are working on the development of new trading software designed
to detect profitable opportunit ies in the foreign exchange market. Obviously, they are
interested in risk-free arbitrage opportunities. However, they have also been
instructed to investigate the possibility of longer-term currency exposures that are
not necessarily risk-free. To test the logic of their new software, Wilson gathers the
following market data:

Spot JPY/USD exchange rate = 120.

Spot EUR/USD exchange rate = 0.7224.
U.S. risk-free interest rate = 7%.
Eurozone risk-free rate = 9.08%.
Japanese risk-free rate = 3.88%.
Yield curves in all three currencies are flat.

In addition to in-house currency transactions, the new software program is also

intended to provide insight into currency exposure and hedging needs for the bank's
major customers. These customers typically include large multinational firms.
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Essentially, the bank wants to provide consulting services to its clients concerning
which currency exposures offer the most lucrative opportunities. In this process, the
bank will rely on deviations from international parity conditions as an indicator of
long-term currency movements. Several bank customers have engaged in a carry
trade with Bundovian Bunco (BU) as the investment currency and the USD as the
funding currency. The bank will provide risk management advice to customers as it
pertains to their FX carry trades.

Wilson obtains the following data from the econometrics department:

JPY/USD spot rate one year ago = 116.

EUR/USD spot rate one year ago = 0.7200.
Anticipated and historical U.S. annual inflation = 3%.
Anticipated and historical Japanese annual inflation = 0%.
Anticipated and historical eurozone annual inflation = 5%.

One of the bank's major customers has significant business interests in Japan and in
the eurozone and has long exposure to both currencies. The customer has
traditionally hedged all currency risk. However, the customer's new risk manager has
decided to leave some currency exposure unhedged in an attempt to profit from long-
term currency exposure.

Question #5 of 88 Question ID: 1418992

According to relative purchasing power parity, the expected JPY/EUR spot rate two
years from now is closest to:

A) 150.
B) 158.
C) 183.

Question #6 of 88 Question ID: 1418993

Are the Japanese and eurozone inflation forecasts provided by the econometrics
department consistent with the inflation rates implied by the international Fisher
relation, given a U.S. inflation rate of 3%?

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A) Both forecasts are consistent.

B) Neither forecast is consistent.
C) One forecast is consistent and the other is not.

Question #7 of 88 Question ID: 1418994

According to the uncovered interest rate parity, in 12 months, the JPY/USD exchange
rate would most likely be closest to:

A) 116.
B) 118.
C) 124.

Question #8 of 88 Question ID: 1418996

Based on the assumption that international parity conditions will hold in the long run,
should the JPY and euro currency exposures of the bank's major customer be left
unhedged?

A) Both currencies should be left unhedged.

B) Neither currency should be left unhedged.
C) One currency should be left unhedged and the other should not.

Overview for Questions #9-12 of 88 Question ID: 1418998

TOPIC: FINANCIAL STATEMENT ANALYSIS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Kevin Rathbun, CFA, is a financial analyst at a major brokerage firm. His supervisor,
Elizabeth Mao, CFA, asks him to analyze the financial position of Wayland, Inc.
(Wayland), a manufacturer of components for high quality optic transmission systems.
Mao also inquires about the impact of any unconsolidated investments.

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On December 31, 2017, Wayland purchased a 35% ownership interest in a strategic

new firm called Optimax for $300,000 cash. The pre-acquisition balance sheets of
both firms are found in  Exhibit 1: Pre-Acquisition Balance Sheets for Wayland and
Optimax.

Exhibit 1: Pre-Acquisition Balance Sheets for Wayland and Optimax

Balance Sheets as of Dec. 31, 2017 in Thousands Wayland Optimax

Assets

Cash $710 $100

Marketable securities 2,550 –

Inventory 2,000 400

Accounts receivable 3,000 500

Property, plant, andequipment 2,450 1,000

Total assets $10,710 $2,000

Liabilities

Accounts payable $3,310 400

Long-term debt 5,000 1,000

Equity 2,400 600

Total liabilities andequity $10,710 $2,000

On the acquisition date, all of Optimax's assets and liabilities were stated on its
balance sheet at their fair values except for its property, plant, and equipment (PP&E),
which had a fair value of $1.2 million. The remaining useful life of the PP&E is 10 years
with no salvage value. Both firms use the straight-line depreciation method.

For the year ended 2018, Optimax reported net income of $250,000 and paid
dividends of $100,000.

During the first quarter of 2019, Optimax sold goods to Wayland and recognized
$15,000 of profit from the sale. At the end of the quarter, half of the goods purchased
from Optimax remained in Wayland's inventory.

Wayland currently uses the equity method to account for its investment in Optimax.

Rathbun also notes that Wayland owns shares in Vanry, Inc. (Vanry). Rathbun gathers
the data in  Exhibit 2: Share Transaction Data, Vanry, Inc. from Wayland's financial
statements. The year-end portfolio value is the market value of all Vanry shares held
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on December 31. All security transactions occurred on July 1, and the transaction
price is the price that Wayland actually paid for the shares acquired. Vanry pays a
cash dividend of $1 per share at the end of each year. Wayland expects to sell its
investment in Vanry in the near term and accounts for it as fair value through profit or
loss security.

Exhibit 2: Share Transaction Data, Vanry, Inc.

Year-End Portfolio Year-End Year-End Share Transaction Price

Year
Value Shares Held Price (July 1)

2017 $1,875,000 25,000a $75 $85

2018 $2,280,000 30,000 $76 $78

aPurchased on July 1, 2017.

Question #9 of 88 Question ID: 1418999

The amount of goodwill resulting from Wayland's acquisition of Optimax is closest to:

A) $20,000.
B) $70,000.
C) $90,000.

Question #10 of 88 Question ID: 1419000

The amount that Wayland should report in its balance sheet at the end of 2018 as a
result of its investment in Optimax is closest to:

A) $345,500.
B) $352,000.
C) $380,500.

Question #11 of 88 Question ID: 1419001

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Considering Wayland's intercompany sales transaction for the quarter ended March
31, 2019, the amount by which Wayland should reduce its equity income is closest to:

A) $2,625.
B) $7,500.
C) $15,000.

Question #12 of 88 Question ID: 1419002

As a result of its investment in Vanry, the amount of profit that Wayland should
recognize in its income statement for the year ended 2018 is closest to:

A) $15,000.
B) $25,000.
C) $45,000.

Overview for Questions #13-16 of

88 Question ID: 1419008

TOPIC: FINANCIAL STATEMENT ANALYSIS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Ota L'Abbe, a supervisor at an investment research firm, has asked one of the junior
analysts, Andreas Hally, to draft a research report dealing with various accounting
issues.

Excerpts from the request are as follows:

"There's an exciting company that we're starting to follow these days. It's called
Snowboards and Skateboards, Inc. They are a multinational company with
operations and a head office based in the resort town of Whistler in western
Canada. However, they also have a significant subsidiary located in the United
States."
"Look at the subsidiary and deal with some foreign currency issues, including
the specific differences between the temporal and current rate methods of
translation, as well as the ef fect on financial ratios."

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"The attached file contains the September 30, 2018, financial statements of the
U.S. subsidiary. Translate the financial statements into Canadian dollars in a
manner consistent with U.S. GAAP."

Snowboards and Skateboards, Inc. (U.S.)

(U.S. Dollars)
Balance Sheet as of 9/30/2018

Cash and accounts receivable 775,000

Inventory 600,000

Property, plant, and equipment (PP&E) – net 730,000

Total assets 2,105,000

Accounts payable 125,000

Long-term debt 400,000

Common stock 535,000

Retained earnings 1,045,000

Total liabilities and shareholders' equity 2,105,000

Income statement for the year ended 9/30/2018

Sales 1,352,000

Cost of goods sold (1,205,000)

Depreciation (140,000)

Net income 7,000

Other information to be considered:

Exchange rates (CAD/USD)

Fiscal 2017 (average) 1.44

Fiscal 2018 (average) 1.35

October 1, 2014 1.50

September 30, 2017 1.48

June 30, 2018 1.37

September 30, 2018 1.32

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Beginning inventory for fiscal 2018 had been purchased evenly throughout
fiscal 2017. The company uses the FIFO inventory value method.
Dividends of USD 25,000 were declared on June 30, 2018.
All of the remaining inventory at the end of fiscal 2018 was purchased evenly
throughout fiscal 2018.
All of the PP&E was purchased, and all of the common equity was issued at the
inception of the company on October 1, 2014. No new PP&E has been acquired,
and no additional common stock has been issued since then. However, they
plan to purchase new PP&E starting in fiscal 2019.
The beginning retained earnings balance for fiscal 2018 was CAD 1,550,000.
The accounts payable on the fiscal 2018 balance sheet were all incurred on June
30, 2018.
The U.S. subsidiary's operations are highly integrated with the main operations
in Canada.
The remeasured inventory for 2018 using the temporal method is CAD 810,000.
Costs of goods sold under the temporal method in 2018 is CAD 1,667,250.

Question #13 of 88 Question ID: 1419009

Compared to the temporal method, which of the following financial statement

elements of the parent are lower under the current rate method?

A) Cash and accounts receivable.

B) Depreciation expense and cost of goods sold.
C) Common stock and dividends paid.

Question #14 of 88 Question ID: 1419010

Using the appropriate translation method, which of the following best describes the
effect of changing exchange rates on the parent's fiscal 2018 financial statements?

A) An accumulated loss of CAD 242,100 is reported in the shareholders’ equity.

B) A loss of CAD 31,200 is recognized in the income statement.
C) A gain of CAD 27,400 is recognized in the income statement.

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Question #15 of 88 Question ID: 1419011

As compared to the temporal method, the parent's fixed asset turnover for fiscal 2018
using the current rate method is:

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

Question #16 of 88 Question ID: 1419012

Suppose the parent uses the current rate method to translate the subsidiary for fiscal
2018. Will return on assets and net profit margin in U.S. dollars before translation be
the same as, or different than, the translated Canadian dollar ratios?

Return on assets Net profit margin

A) Same Different

B) Different Different

C) Different Same

Overview for Questions #17-20 of

88 Question ID: 1419013

TOPIC: CORPORATE ISSUERS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Alertron is a pharmaceutical company with approximately $3.5 billion in annual sales

that specializes in the development, manufactur ing, and marketing of neurology and
oncology drug therapies. The firm is seeking to achieve more rapid growth, and
Alertron's executive management team feels that the company can grow faster by
making acquisitions than it can by trying to grow organically. As a result, management
asks the firm's Director of Strategic Planning, Kanna Ozer, CFA, to analyze potential
alternatives. At Alertron's next executive management team meeting, Ozer presents

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the rep ort shown in  Exhibit 1: Report 1—Description of Potential Acquisition

Targets concerning four potential acquisition targets:

Exhibit 1: Report 1—Description of Potential Acquisition Targets

Potential Target Potential Acquisition Description

Firm develops, manufactures, and markets prescription drugs

for humans and animals. BriscoePharm has annual sales of
Briscoe Pharm
$1.2 million, but only certain BriscoePharm drugs are
attractive cash flow generators.

Firm develops and manufactures oncology and neurology

drugs in the United States and abroad. Carideo has annual
Carideo
sales of $1.2 million, and all assets and liabilities would likely
be absorbed by Alertron in a potential merger.

Firm designs and manufactures analytical instruments used in

drug development. Dillon has $3.5 billion in annual sales. A
Dillon Biotech
successful acquisition by Alertron would involve combining
operations and forming a new company.

Firm is a pharmaceutical company specializing in cardiology

medications. Escarigen is well known among heart surgeons
and has a blockbuster cholesterol drug called Karlynivus that
Escarigen:
is well known in the medical community. In an acquisition,
Alertron would want to maintain the successful Escarigen
brand and operational structure.

Alertron's executive team agrees that the report is helpful for initiating discussion but
decides they need more information concerning the form of each potential
acquisition and the most appropriate method of payment. Alertron's management is
also concerned whether each potential target would view a takeover attempt as
friendly or hostile. Paul Mussara, Alertron's CEO, asks Ozer to prepare a second report
that specifically describes the transaction characteristics corresponding to each deal.
Ozer's second report is shown in  Exhibit 2: Report 2—Merger Transaction
Characteristics.

Exhibit 2: Report 2—Merger Transaction Characteristics

Likely Attitude of
Potential Optimal Form of Method of
Target
Target Acquisition Payment
Management

BriscoePharm Asset purchase involving Cash offering View offer as

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30% of BriscoePharm's friendly

assets

Securities View offer as

Carideo Stock purchase
offering friendly

Mixed cash and

Dillon Biotech Stock purchase securities View offer as hostile
offering

View offer as
Escarigen Stock purchase Cash offering
friendly

After intense discussions, Alertron decides that a takeover offer for Carideo would be
most beneficial due to the net present value of cost reduction synergies of $600
million that Ozer estimates would result from the merger. Mussara asks Ozer to
evaluate the deal based on a stock offer in which Alertron would exchange 0.75
shares of Alertron stock for each outstanding share of Carideo stock. Ozer compiles
the information shown in  Exhibit 3: Merger Evaluation Inputs for her analysis.

Exhibit 3: Merger Evaluation Inputs

Alertron Carideo

Pre-merger stock price $60 $39

Number of shares outstanding (millions) 150 80

Pre-merger market value (millions) $9,000 $3,120

Estimated NPV of cost reduction synergies $600 million

Ozer, and the rest of the executive management team at Alertron, is extremely
confident in the $600 million dollar estimate of cost reduction synergies that are likely
to result from the merger and feel that the estimate may actually be conservative.
However, when analysts at Carideo review the figures, they have a much different
opinion and are less certain that $600 million worth of synergies could be realized.
While Carideo believes the net present value of synergies from the deal would still be
positive, its estimates are much lower than Alertron's.

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Question #17 of 88 Question ID: 1419014

Based on Ozer's description of potential acquisition targets, which form of integration

and type of merger would best describe the transaction if Alertron tried to acquire
Escarigen?

Form of integration Type of merger

A) Statutory Horizontal

B) Subsidiary Horizontal

C) Subsidiary Vertical

Question #18 of 88 Question ID: 1419015

Based on the information in  Exhibit 2: Report 2—Merger Transaction

Characteristics, which of the following statements concerning the transaction
characteristics of the potential mergers with Alertron is most accurate?

A) Purchasing Escarigen is likely to reduce Alertron’s financial leverage.

B) Carideo would likely avoid paying corporate taxes in the potential deal with Alertron.
BriscoePharm’s shareholders would likely be required to approve the deal with
C)
Alertron before any proposed deal is completed.

Question #19 of 88 Question ID: 1419016

Using Ozer's estimates of the cost reduction synergies, the gain that would accrue to
Carideo's shareholders as a result of the merger with Alertron is closest to:

A) $109 million.
B) $456 million.
C) $514 million.

Question #20 of 88 Question ID: 1419017

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Q

Based on each firm's forecasts of the estimated NPV of synergies from a merger
between Alertron and Carideo, what payment method is each firm most likely to
prefer in the deal?

A) Both firms prefer a cash deal.

B) Only Alertron prefers a cash deal.
C) Only Carideo prefers a cash deal.

Overview for Questions #21-24 of

88 Question ID: 1454920

TOPIC: EQUITY VALUATION

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Emily De Jong, CFA, works for Charles & Williams Associates, a medium-sized
investment firm operating in the northeastern United States. De Jong is responsible
for producing financial reports to use as tools to attract new clients. It is now early in
2019, and De Jong is reviewing information for O'Connor Textiles and finalizing a
report that will be used for an important presentation to a potential investor at the
end of the week.

Following an acquisition of a major competitor in 2002, O'Connor went public in 2003

and paid its first dividend in 2009. Dividends are paid at the end of the year. After
2018, dividends are expected to grow for three years at 11%: $2.13 in 2019, $2.36 in
2020, and $2.63 in 2021. The average of the arithmetic and compound growth rates
are given in  Exhibit 1: O'Connor Textiles Dividend History. Dividends are then
expected to settle down to a long-term growth rate of 4%. O'Connor's current share
price of $70 is expected to rise to $72.92 by the end of the year according to the
consensus of analysts' forecasts.

O'Connor's annual dividend history is shown in  Exhibit 1: O'Connor Textiles

Dividend History.

Exhibit 1: O'Connor Textiles Dividend History

Year Dividend ($) % Change

2009 0.76

2010 0.76 0.000

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2011 0.76 0.000

2012 0.82 7.895

2013 0.91 10.976

2014 1.03 13.187

2015 1.16 12.621

2016 1.34 15.517

2017 1.52 13.433

2018 1.92 26.316

2009–2018 Arithmetic mean growth = 11.1%

2009–2018 Compound growth = 10.9%

De Jong is also considering whether or not she should value O'C onnor using a free
cash flow model instead of the dividend discount model.

Charles Wang, De Jong's colleague, is of the opinion that O'Connor's growth rate will
be 11% but will decline linearly to a long-term growth rate of 4% over the next six
years. Wang also feels that the required rate of return for O'Connor should be 9.5%. ​

Question #21 of 88 Question ID: 1419020

For this question only, assume that De Jong's estimate of the value of O'Connor stock
using a two-stage DDM is $75. Assuming the market has also applied a two-stage
DDM, and the market's consensus estimate of dividend growth and required return
are the same as De Jong's, the market's consensus estimate of the duration of the
high-growth period is most likely:

A) less than three years.

B) equal to three years.
C) greater than three years.

Question #22 of 88 Question ID: 1419021

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In what situation is it most appropriate for De Jong to employ these models?

Dividend discount
FCFE model
model

Noncontrol FCFE aligned with

A)
perspective profitability

FCFE aligned with

B) Control perspective
profitability

Noncontrol FCFE aligned with

C)
perspective dividend policy

Question #23 of 88 Question ID: 1419022

The value of O'Connor stock using Wang's assumptions is closest to:

A) $43.64.
B) $48.75.
C) $52.35.

Question #24 of 88 Question ID: 1419023

For this question only, assume that the market price of O'Connor stock is $48.00 and
the linearly declining high-growth period is five years. The required rate of return
implicit in the market price is closest to:

A) 8.86%.
B) 9.22%.
C) 10.81%.

Overview for Questions #25-28 of

88 Question ID: 1454815

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TOPIC: FIXED INCOME

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Ted Thompson, CIO for Aplius Insurance Company, is evaluating the credit risk
management models for the company's fixed income portfolio. Thompson meets with
Nambi Musa, who is the head of Aplius's credit risk analysis department. Musa
assures Thompson that his team has updated the credit risk analysis models over
recent years and that these updated models have performed well over the past 12
months. Thompson, however, is not pleased with the losses incurred on Aplius's
municipal bond holdings in the last quarter.

Musa mentions that while the credit risk analysis department continues to use credit
ratings, they are also evaluating other analytical tools including structural models. He
specifically mentions credit valuation adjustment and expected loss as other credit
risk measures currently being used. Musa makes the following two statements:

"Company credit ratings are based on senior secured debt

Statement 1: issued by the company. Ratings on other issues by the same
company are adjusted by a process known as notching."

"The credit valuation adjustment on a bond is the maximum

Statement 2: amount an investor would be willing to pay to an insurer to
bear the credit risk of that security."

Musa further discusses the credit analysis metrics that are newly developed. As an
example, he illustrates the valuation conducted on 3-year, 5% Zeta Corp. $100 par,
senior unsecured bonds.  Exhibit 1: Valuation of 3-Year, 5% Zeta Corp. Bond shows
the report.

Exhibit 1: Valuation of 3-Year, 5% Zeta Corp. Bond

Period Cash Flow LGD POD DF

1 5.00 32.648 1.500% 0.971

2 5.00 32.083 1.478% 0.943

3 105.00 31.500 1.455% 0.915

Thompson then tells Musa that the credit analysis department should focus on
reduced-form models. Thompson states that, "reduced-form models perform better
than structural models as they tend to impose assumptions on the outputs of the
structural model. However, reduced-form models require a specification of the
company's balance sheet composition."

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Question #25 of 88 Question ID: 1419035

Musa's Statement 1 is most likely:

A) correct.
incorrect because the process of adjusting ratings on issues by same issuer is not
B)
called notching.
incorrect because corporate credit ratings are based on senior unsecured debt of
C)
the issuer.

Question #26 of 88 Question ID: 1419036

Musa's Statement 2 is most likely:

A) correct.
B) incorrect as the statement only considers credit risk.
incorrect as the statement should refer to expected loss and not to credit valuation
C)
adjustment.

Question #27 of 88 Question ID: 1419039

Using information in  Exhibit 1: Valuation of 3-Year, 5% Zeta Corp. Bond, the credit
valuation adjustment for the Zeta Corp. bond is closest to:

A) $1.34.
B) $1.86.
C) $2.72.

Question #28 of 88 Question ID: 1419040

Thompson's statement about reduced-form models relative to structural model is

most likely:

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A) correct.
B) incorrect regarding assumptions imposed.
C) incorrect regarding specification of balance sheet composition being required.

Overview for Questions #29-32 of

88 Question ID: 1454821

TOPIC: DERIVATIVES

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Jonathan Adams, CFA, is doing some scenario analysis on swaps ands forward
contracts. The process involves pricing the contracts and then estimating their values
based on likely scenarios provided by the firm's forecasting and strategy departments.
The contracts with which Adams is most concerned are those on interest rates.

The LIBOR spot curve is as follows:

30-day: 3.12% 60-day: 3.32% 90-day: 3.52%

120-day: 3.72% 150-day: 3.92% 180-day: 4.12%

Adams determines the price of a 2×5 FRA from the spot yield curve using the following
calculation:

Thirty months ago, Adams entered into a $1 million notional, 3-year, semiannual
settlement, 3% fixed-rate payer swap.

Question #29 of 88 Question ID: 1419054

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How many of the following terms are correct in the calculation of the FRA price:
0.0352, 0.0332, 60/360, 90/360?

A) Two.
B) Three.
C) Four.

Question #30 of 88 Question ID: 1419055

After 30 days, Adams wants to value a $10 million short position in the 2×5 FRA. The
90-day forward rate in 30 days is now 4.14%, and the original price of the FRA was
4.30%. 120-day LIBOR has changed to 3.92%. The current value of the $10 million FRA
to the short position under this scenario is closest to:

A) $15,794.
B) $3,948.
C) –$15,794.

Question #31 of 88 Question ID: 1454822

Immediately after the fifth settlement, the value of the swap to Adams is closest to:

A) $5,487.
B) $5,600.
C) $11,076.

Question #32 of 88 Question ID: 1422630

Suppose that Adams entered into the FRA as a short party and now wants to hedge
that exposure. The most appropriate way to achieve that hedge would be to take on
exposure to:

A) a long interest rate call and short interest rate put.

B) a short interest rate call and long interest rate put.

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C) a receiver swap.

Overview for Questions #33-36 of

88 Question ID: 1469422

TOPIC: ALTERNATIVE INVESTMENTS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Julie Mariluz is a real estate analyst with Young Family Trust (YFT), a family investment
office. Aside from investment in equities and bonds, YFT makes direct investment in
diverse real estate properties. Mariluz has been asked to evaluate three potential
investment properties shown in  Exhibit 1: Property Description

Exhibit 1: Property Description

Property 1: A multi-family residential building with high occupancy and in a

desirable location.

Property 2: An older office building with dated architectural features and

in an area that is undergoing significant improvements.

Property 3: A shopping mall with two anchor tenants.

Question #33 of 88 Question ID: 1469423

Which property valuations are most likely to be heavily influenced by their unique
characteristics?

A) Property #1 and Property #2.

B) Property #1 and Property #3.
C) Property #2 and Property #3.

Question #34 of 88 Question ID: 1469424

Which approach would an appraiser most likely use for valuing Property #2?
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A) Cost approach.
B) Income approach.
C) Sales comparison approach.

Question #35 of 88 Question ID: 1469425

One of the partners at YFT asks Mariluz how she would go about estimating the value
of an owner-occupied, 45-year-old single family home. The most appropriate
response that Mariluz could provide is:

A) the income approach.

B) the cost approach.
C) the sales comparison approach.

Question #36 of 88 Question ID: 1469426

YFT is considering the use of an index as a benchmark for measuring the performance
of the firm's private real estate investments. Compared to a transaction-based real
estate index, an appraisal-based real estate index is most likely to have higher:

A) lag.
B) volatility.
C) correlation with other asset classes.

Overview for Questions #37-40 of

88 Question ID: 1454835

TOPIC: ETHICAL AND PROFESSIONAL STANDARDS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Mike Zonding, CFA, is conducting a background check on CFA candidate Annie

Cooken, a freshly minted MBA who applied for a stock-analysis job at his firm, Khasko

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Financial. Zonding does not like to hire anyone who does not adhere to the Code and
Standards' professional conduct requirements.

The background check reveals the following:

(i) While doing a full-time, unpaid internship at Kale Investments, Cooken

was reprimanded for working a 30-hour-a-week night job as a waitress.

(ii) As an intern at Lammar Corp., Cooken was fired after revealing to the
FBI that one of the principals was embezzling from the firm's clients.

(iii) Cooken performed 40 hours of community service in relation to a

conviction on a misdemeanor drug possession charge when she was 16
years old.

(iv) On her resume, Cooken writes, "Recently passed Level II of the CFA
exam, a test that measures candidates' knowledge of finance and
investing."

During the interview, Zonding asks Cooken several questions on ethics-related issues,
including questions about the role of a fiduciary and Standard III(E) Preservation of
Confidentiality. He asks her about her internship at Kale Investments, specifically
about the working hours. Cooken replies that the internship turned out to require
more time than she originally planned, up to 65 hours per week.

Zonding subsequently hires Cooken and functions as her supervisor. On her third day
at the money management boutique firm, portfolio manager Steven Clarrison hands
her a report on Mocline Tobacco and tells her to revise the report to reflect a buy
rating. Cooken is uncomfortable about revising the report.

Zonding prepared a research report with a buy rating on Orlando Stores, a discount
clothing chain. Khasko's investment banking department has completed transactions
for Orlando in the past 12 months and currently is working with Orlando to evaluate a
secondary offering; Khasko has a policy in place that separates the activities of
investment banking and research departments.

In the report, Zonding disclosed that Khasko has an investment banking relationship
with Orlando and that his wife holds Orlando shares. However, he forgot to comment
on the risk profile and suitability of investing in Orlando shares.

Zonding just entered into a brokerage agreement with Zeta Services. According to that
agreement, in exchange for client referrals from Zeta, Khasko would give Zeta its
brokerage business. Khasko advised its clients about the nature and extent of this
relationship in writing.

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Question #37 of 88 Question ID: 1419073

In the context of the Code and Standards, which of the items from the background
check would most likely indicate that Zonding should not have hired Cooken?

A) Item i.
B) Item ii.
C) Item iii.

Question #38 of 88 Question ID: 1419074

Which of the following statements provides the least appropriate justification for
Cooken's caution about revising the report on Mocline Tobacco?

A) Cooken knows next to nothing about Mocline stock.

B) Cooken’s uncle, George Whates, is the CFO of Mocline.
C) In college, Cooken worked for Mocline, but never declared the income on her taxes.

Question #39 of 88 Question ID: 1419077

Was Zonding in compliance with CFA Institute Standards of Professional Conduct with
regard to the Orlando Stores research report?

A) No, because Zonding neglected to discuss Orlando’s suitability as an investment.

No, because Zonding failed to disclose Orlando’s plans to announce a secondary
B)
offering in the near future.
Yes, because Zonding disclosed his firm’s relationship with Orlando, his wife’s
C)
ownership of the shares, and the availability of his Orlando report.

Question #40 of 88 Question ID: 1419078

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Did Zonding and Khasko follow the recommended procedures of the CFA Institute
Standards of Professional Conduct with respect to the brokerage arrangement with
Zeta?

A) Yes, because Khasko disclosed this arrangement to their clients.

B) No, because Khasko did not preserve confidentiality of their agreement with Zeta.
C) No, because the agreement inappropriately creates a conflict of interest.

Overview for Questions #41-44 of

88 Question ID: 1469432

TOPIC: ETHICAL AND PROFESSIONAL STANDARDS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Brandon Ratlieff, CFA, is a partner at Global Asset Management (GAM). CFA program
candidate Sarah Gunderson just completed her first year at GAM. Ratlieff is going over
Gunderson's annual evaluation completed by her supervisor Peter Jackson, CFA.

To supplement the meager income from her entry-level stock-analysis job, Gunderson
took a part-time position working three hours each Friday and Saturday night tending
bar at a sports bar and grill downtown. Gunderson did not inform her supervisor or
HR about the job.

During her first week, Gunderson has lunch with her former classmates, including
Taira Basch, CFA, who works for the compliance officer at a large investment bank in
town.

Basch arrives late, explaining, "What a day, it's only noon and already I have worked
on the following requests:

1. A federal regulator called and wanted information on potentially illegal activities

related to one of the firm's key clients.
2. A rival company's employee wanted information regarding employment
opportunities at the firm.
3. A potential client contacted an employee and wanted detailed performance
records of client accounts so he can decide whether to invest with the firm."

One of GAM's clients is Bluestar Inc. Several months ago, Ratlieff filed several
documents with regulators concerning Bluestar's IPO. A Bluestar official later

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provided Ratlieff information that suggested that the financial statements GAM filed
with the regulator overstate the issuer's earnings.

Ratlieff seeks the advice of GAM's general counsel, who states that because Ratlieff
was not aware of the irregularity at the time of the filing, it would be difficult for the
regulator to prove that GAM has been involved in any wrongdoing.

GAM provides research coverage for ASE, a European retailer. Gunderson's mother
owns 30,000 ASE shares. As part of her estate planning, Gunderson's mother informs
Gunderson that she has created a trust in Gunderson's name, into which she has
placed 2,000 shares of ASE. The trust is structured so that Gunderson will not receive
control of the assets for three years. Gunderson is due to update the research
coverage of ASE within the next two weeks.

Question #41 of 88 Question ID: 1469433

By not telling her employer about the bartending position, Gunderson has most likely
violated:

A) no Standards.
B) Standard IV(B) Additional Compensation Arrangements.
Standard IV(A) Loyalty (to employer) and Standard IV(B) Additional Compensation
C)
Arrangements.

Question #42 of 88 Question ID: 1469434

Which of the requests, if fulfilled, is most likely to place Basch in violation of Standard
III(E) Preservation of Confidentiality?

A) Request 1.
B) Request 2.
C) Request 3.

Question #43 of 88 Question ID: 1469435

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With respect to the information about Bluestar, Ratlieff's most appropriate course of
action would be to:

A) treat the information received from the company official as confidential.

B) seek independent legal counsel about his obligations under the law.
C) report the information to the regulator.

Question #44 of 88 Question ID: 1469436

With regard to research reports on ASE, Gunderson should most appropriately:

advise her supervisor that she is not able to issue research recommendations on
A)
ASE.
disclose her holdings in the report, though she need not notify her supervisor
B)
because the shares are held in trust and are not within her direct control.
disclose the situation to her supervisor and, if then asked to prepare a report, also
C)
disclose the situation in the report.

Overview for Questions #45-48 of

88 Question ID: 1479859

TOPIC: FINANCIAL STATEMENT ANALYSIS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Andrew Carson is an equity analyst employed at Lee Vincent and Associates, an

investment research firm. Carson is responsible for following Samilski Enterprises
(Samilski), a publicly traded firm that produces motorcycles and associated
mechanical parts. Samilski reports under U.S. GAAP.

Exhibit 1: Selected Pension Plan Information for FY 20X9 shows selected financial
data pertaining to Samilski's employee pension plan.

Exhibit 1: Selected Pension Plan Information for FY 20X9

$ Millions

Current service cost 118

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Past service cost 36

Beginning PBO 1,022

Ending PBO 1,198

Interest cost 82

Actual return on plan assets 214

Employer contribution 102

Beginning plan assets 896

During fiscal year 20X9, a change in actuarial assumptions regarding employee life
expectancy resulted in an actuarial loss of $128 million. Average employee service life
is estimated to be 20 years. The discount rate and expected return on plan assets are
8% and 10% respectively. Carson believes that rate of compensation increase will be
5% as opposed to the 4% assumed by the plan.

Question #45 of 88 Question ID: 1419004

The amount of benefits paid during the year is closest to:

A) $76 million.
B) $132 million.
C) $188 million.

Question #46 of 88 Question ID: 1419005

The ending fair value of plan assets is closest to:

A) $1,024 million.
B) $1,128 million.
C) $1,412 million.

Question #47 of 88 Question ID: 1419006

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The total periodic pension cost is closest to:

A) $62 million.
B) $76 million.
C) $150 million.

Question #48 of 88 Question ID: 1479860

The amount of periodic pension cost reported in P&L if Samilski reported under IFRS
would be closest to:

A) $144 million.
B) $152 million.
C) $166 million.

Overview for Questions #49-52 of

88 Question ID: 1419018

TOPIC: CORPORATE ISSUERS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Henke Malfoy, CFA, is an analyst with a major manufacturing firm. Currently, he is

evaluating the replacement of some production equipment. The old machine is still
functional and could continue to serve in its current capacity for three more years. If
the new equipment is purchased, the old equipment (which is fully depreciated) can
be sold for $50,000 now but will be worthless in three years. The new equipment will
cost $400,000, including shipping and installation. If the new equipment is purchased,
the company's revenues will increase by $175,000 and costs by $25,000 for each year
of the equipment's 3-year life. There is no expected change in net working capital.

The new machine will be depreciated using a 3-year MACRS schedule (note: the 3-year
MACRS schedule is 33.0% in the first year, 45% in the second year, 15% in the third
year, and 7% in the fourth year). At the end of the life of the new equipment (i.e., in
three years), Malfoy expects that it can be sold for $10,000. The firm has a marginal
tax rate of 40%, and the cost of capital on this project is 20%. In calculation of tax
liabilities, Malfoy assumes that the firm is profitable, so any losses on this project can

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be offset against profits elsewhere in the firm. Malfoy calculates a project NPV of –
$62,574.

Question #49 of 88 Question ID: 1280934

The after-tax operating cash flow for the first year of operations with the new
equipment (excluding the initial outlay) is closest to:

A) $10,800.
B) $132,000.
C) $142,800.

Question #50 of 88 Question ID: 1280935

The impact of taxes on the operating cash flow in Year 2 is closest to:

A) a decrease of $7,200.
B) an increase of $7,200.
C) an increase of $12,000.

Question #51 of 88 Question ID: 1280936

The combined after-tax operating cash flow and terminal year after-tax non-operating
cash flow in Year 3 is closest to:

A) $131,200.
B) $151,200.
C) $152,200.

Question #52 of 88 Question ID: 1280937

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Suppose for this question only that Malfoy has neglected to account for an increase in
inventory that will be required at the beginning of the project. The most likely effect of
this omission on estimated project NPV:

A) is to overestimate NPV.
B) is no impact on NPV.
depends on whether the inventory is assumed to drop to its previous level at the
C)
end of the project or whether the increase in inventory is permanent.

Overview for Questions #53-56 of

88 Question ID: 1419029

TOPIC: EQUITY VALUATION

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Lorenz Kummert is a junior equity analyst who is following Schubert, Inc. (Schubert), a
small publicly traded company in the United States. His supervisor, Markus Alter, CFA,
has advised him to use the residual income model to analyze Schubert.

Kummert has determined Schubert's cost of equity, cost of debt, and weighted
average cost of capital (WACC) to be 12.8%, 8.4%, and 11.9%, respectively. Book value
of long-term debt and equity was $6,200,000 and $3,281,000 respectively on January
1, 2018. The stock price on December 31, 2018, is $36 per share and there are
130,000 shares outstanding. The relevant tax rate is 30%, and return on equity (ROE)
is expected to be 14%.

Summarized financial information about Schubert for 2018 is provided in Exhibits 1

and 2. 

Exhibit 1: Schubert, Inc., Balance Sheet on December 31, 2018

Cash $125,000 Accounts payable $426,000

Accounts receivable 975,000 Accrued liabilities 774,000

Inventory 1,215,000 Long-term debt 6,211,000

Fixed assets (net) 9,277,000

Common shares 2,100,000

Retained earnings 2,081,000

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Total assets $11,592,000 Total liabilities and equity $11,592,000

Exhibit 2: Schubert, Inc., Income Statement for the Year Ended December 31,
2018

Sales $9,423,000

Cost of sales 4,580,000

Selling, general, and administrative 1,230,000

Depreciation 1,745,000

Interest expense 522,000

Income tax expense 403,800

Net income $942,200

Based on his analysis of several years of financial statements, Kummert notes that
2018 was an exceptionally profitable year for Schubert, and that its dividend payouts
are usually low because the funds are mainly reinvested in the firm to promote
growth. Furthermore, there are very few nonrecurring items on the income
statement. Upon review of Kummert's preliminary report, Alter concurs with his
analysis of the financial statements but reminds him that Schubert's long-term debt is
currently trading at 95% of its book value. He also cautions Kummert that violations of
the clean surplus relation can bias the results of the residual income model.

The consensus annual EPS estimate for 2019 is $4.50, and the dividend payout ratio
for 2019 is estimated at 5%.

Question #53 of 88 Question ID: 1419030

Which of the following amounts is the most appropriate forecast of Schubert's book
value per share and residual income, respectively, for 2019?

Book value per share Residual income

A) $36.43 $0.38

B) $38.00 $2.32

C) $36.43 $2.32

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Question #54 of 88 Question ID: 1419031

Which of the following amounts are closest to Schubert's economic value added (EVA)
for fiscal year 2018 and market value added (MVA) as of fiscal year-end 2018,
respectively?

EVA MVA

A) $179,361 $188,450

B) $23,455 $369,500

C) ($70,900) $369,500

Question #55 of 88 Question ID: 1419032

Which of the following amounts is closest to Schubert's implied growth rate in

residual income?

A) 0.34%.
B) 2.75%.
C) 12.63%.

Question #56 of 88 Question ID: 1419033

Regarding Alter's caution about violations of the clean surplus relationship, examples
of items that can violate this relationship are most likely to include:

A) foreign currency gains and losses under the current rate method.
B) changes in the market value of debt and equity held as trading securities.
C) changes in net working capital.

Overview for Questions #57-60 of

88 Question ID: 1419024
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88 Q

TOPIC: EQUITY VALUATION

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Matthew Emery, CFA, is responsible for analyzing companies in the retail industry. He
is currently reviewing the status of Ferguson Department Stores, Inc. (FDS). FDS has
recently gone through extensive restructuring in the wake of a slowdown in the
economy that has made retailing particularly challenging. As part of his analysis,
Emery has gathered information from a number of sources.

Ferguson Department Stores, Inc.

FDS went public in 1979 following a major acquisition, and the Ferguson name quickly
became one of the most recognized in retailing. Ferguson had been successful
through most of its first 30 years in business and has prided itself on being the one-
stop shopping destination for consumers living on the West Coast of the United
States. Recently, FDS began to experience both top and bottom line difficulties due to
increased competition from specialty retailers who could operate more efficiently and
offer a wider range of products in a focused retailing sector. When the company's
main bank reduced FDS's line of credit, a serious working capital crisis ensued, and
the company was forced to issue additional equity in an effort to overcome the
problem.

FDS has a cost of capital of 10% and a required rate of return on equity of 12%.
Dividends are growing at a rate of 8%, but the growth rate is expected to decline
linearly over the next six years to a long-term growth rate of 4%. The company
recently paid an annual dividend of $1.

At the end of 2018, FDS announced that it would be expanding its retail operations,
moving to a warehouse concept, and opening new stores around the country. FDS
also announced it would close some existing stores, write-down assets, and take a
large restructuring charge. Upon reviewing the prospects of the firm, Emery issued an
earnings-per-share forecast for 2019 of $0.90. He set a 12-month share price target of
$22.50. Immediately following the expansion announcement, the share price of FDS
jumped from $14 to $18.

Exhibit 1: Summary Income Statement, Ferguson Department Stores, Inc. (U.S. $

millions, except per share data and shares outstanding)

2018 2017

Sales $6,435.9 $6,322.7

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Cost of goods sold, operating, administrative, and selling 6,007.9 5,875.9

expenses

Depreciation and amortization 148.7 146.6

Interest expense 59.8 59.5

Unusual items—expense 189.1 5.0

Earnings before tax 30.4 235.7

Income taxes—current 49.3 7.5

Income taxes—future (71.1) 93.5

(21.8) 101.0

Net earnings for the year $52.2 $134.7

Earnings per share: Basic $0.49 $1.26

Fully diluted $0.49 $1.26

Weighted average shares outstanding 106,530,610 106,530,610

In 2018, FDS also reported an unusual expense of $189.1 million related to

restructuring costs and asset write downs.

Exhibit 2: Selected Industry Information for 2018

Estimated earnings growth rate 0.10

Mean trailing price/earnings (P/E) ratio 22.50

Mean price/sales (P/S) ratio 0.50

Question #57 of 88 Question ID: 1419025

The value of one share of FDS using the H-model is closest to:

A) $14.50.
B) $16.50.
C) $19.33.

Q estion #58 of 88
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Question #58 of 88 Question ID: 1419026

Assuming that the cost of equity for FDS does not change, the present value of growth
opportunities in the share price following the announcement that the company would
be expanding its retail operations, using Emery's 2019 earnings forecast, is closest to:

A) $9.00.
B) $10.50.
C) $12.50.

Question #59 of 88 Question ID: 1419027

Assuming a tax rate of 34%, the underlying earnings per share (EPS) for FDS in 2018 is
closest to:

A) $0.19.
B) $0.73.
C) $1.36.

Question #60 of 88 Question ID: 1419028

According to FDS's price-to-sales ratio for 2018, based on the post-expansion

announcement stock price, FDS is:

A) underpriced relative to the industry.

B) overpriced relative to the industry.
C) properly priced relative to the industry.

Overview for Questions #61-64 of

88 Question ID: 1454814

TOPIC: FIXED INCOME

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

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Sally Soikins, CFA, Chief Investment Officer at Greenvalley is reviewing the bank's
policies about credit risk management with Esha Leone, a senior analyst managing the
bank's fixed income portfolio.

Two years ago, when benchmark rates were flat at 4%, Greenvalley bank purchased
$3 million par of 7-year, 5% annual-pay coupon Newspace Inc. bonds. At the time of
the purchase, Leone had calculated the CVA on the bond as $7.71 per $100 par. A
5.76-year duration, 5% standardized coupon CDS on those bonds was available at that
time but was not purchased by the bank. Since the investment, the credit spread on
the bonds has widened by 80bps and the duration of the CDS has changed to 4.31
years.

Soikins observes that credit investment grade credit curves seem to be steepening.
Leone makes the following two statements about credit curves:

Statement 1: Lower rated sectors tend to have flatter credit curves due to
their higher sensitivity to the business cycle and greater
uncertainty.

Statement 2: When a company refinances a maturing debt with a new

longer-dated issue, the credit curve for that issuer may
experience an inversion due to higher liquidity of the new
issue.

Question #61 of 88 Question ID: 1419044

If Greenvalley bank had bought protection on their investment in Newspace bonds,

their upfront cash flow would have been closest to:

A) a receipt of 4.6% of notional.

B) a payment of 18.2% of notional.
C) a receipt of 21.3% of notional.

Question #62 of 88 Question ID: 1419045

If Greenvalley bank had purchased CDS protection on their investment in Newspace

bonds upon acquisition, the gain/loss on the CDS would have been closest to:

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A) a gain of $103,440.
B) a loss of $344,800.
C) a gain of $413,760.

Question #63 of 88 Question ID: 1419046

Leone's Statement 1 about credit curves is best described as:

A) accurate.
B) inaccurate regarding the shape of the credit curve for the lower rated sector.
C) inaccurate regarding sensitivity to the business cycle.

Question #64 of 88 Question ID: 1419047

Leone's Statement 2 on credit curves is best described as:

A) accurate.
B) inaccurate about higher liquidity of the new issue.
C) inaccurate about inversion of the curve.

Overview for Questions #65-68 of

88 Question ID: 1469417

TOPIC: FIXED INCOME

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Nayna Shah, CFA, leads the fixed income department at Rodney Partners (RP). Shah
has recently hired Susan Reynolds, a new economics graduate. During a previous
meeting with Reynolds, Shah had mentioned purchasing a $12 million CDS on Welby,
Inc., bonds that is currently part of the RP's portfolio. While Welby has not declared
bankruptcy, it recently missed a coupon payment. Shah asks Reynolds to provide
details of RP's position and planned course of action.  Exhibit 1: Welby Inc. provides
some of the information that Reynolds has collected.

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Exhibit 1: Welby Inc.

RP's position: $12 million par, 6% senior unsecured maturing in five years.

CDS Protection buyer, standardized coupon of 5%

Current market prices of Welby bonds:

6% senior unsecured 55% of par

5% subordinated unsecured debentures 40% of par

5% senior unsecured 50% of par

Shah notes that RP has also purchased $10 million notional, index CDS position in
CDX-HY and that Welby is one of the 125 constituents in that index.

While discussing credit risk analysis, Reynolds makes the following two statements:

Statement 1: One of the assumptions of the structural models of credit

analysis is that the company has no off-balance sheet debt.

Statement 2: In the case of an ABS, credit analysis focuses on the credit

quality of the servicer.

Question #65 of 88 Question ID: 1469418

Was there a credit event for Welby, and if so what settlement method is Rodney
Partners most likely to prefer?

A) Yes; cash settlement.

B) Yes; physical settlement.
C) No.

Question #66 of 88 Question ID: 1469419

Assuming a default for Welby, the notional for RP's CDX-HY index CDS would be
adjusted to an amount closest to:

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A) $9.92 million.
B) $9.99 million.
C) $10.00 million.

Question #67 of 88 Question ID: 1469420

Reynolds's Statement 1 is most likely:

A) correct.
incorrect as structural models can incorporate the risk of off-balance sheet debt as
B)
long as the assets of the company trade.
C) incorrect because off-balance sheet debt is a zero-coupon liability.

Question #68 of 88 Question ID: 1469421

Reynold's Statement 2 is most likely:

A) correct.
incorrect as credit analysis of ABS focuses on the quality of the collateral pool and
B)
the structure of the ABS and not on servicer quality.
incorrect as credit analysis of ABS focuses on the quality of the collateral pool, the
C)
structure of the ABS, and servicer quality, and not on servicer credit quality.

Overview for Questions #69-72 of

88 Question ID: 1419048

TOPIC: DERIVATIVES

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Trent Black is a government fixed-income portfolio manager, and on January 1, he

holds $30 million of fixed-rate, semi-annual pay notes. Black is considering entering
into a 2-year, $30 million semi-annual pay interest rate swap as the fixed-rate payer.

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He must first determine the swap rate. Black notes the term structure shown in
Exhibit 1: Term Structure of LIBOR (USD and CHF) on January 1:

Exhibit 1: Term Structure of LIBOR (USD and CHF) on January 1

CHF USD
Term (Days)
LIBOR Discount Factor LIBOR Discount Factor

180 –0.65% 1.0033 3.25% 0.9840

360 –0.55% 1.0055 3.35% 0.9676

540 –0.20% 1.0030 3.60% 0.9488

720 0.10% 0.9980 3.85% 0.9285

900 0.30% 0.9926 4.00% 0.9091

1,080 0.55% 0.9838 4.10% 0.8905

1,260 0.88% 0.9701 4.25% 0.8705

Black is also evaluating a USD fixed for CHF fixed, 3-year, semiannual currency swap
on a notional of USD 10 million. The current exchange rate is CHF/USD 0.97.

On July 1, immediately after the first settlement, Black observes that the 18-month
semiannual swap fixed rate is 4.62%. The term structure of LIBOR is given in  Exhibit
2: USD LIBOR Term Structure on July 1.

Exhibit 2: USD LIBOR Term Structure on July 1

Days Annual Rate (%) Discount Factor

60 3.31 0.9945

180 3.66 0.9820

360 4.21 0.9596

480 4.69 0.9411

540 4.74 0.9336

720 5.00 0.9091

Question #69 of 88 Question ID: 1419049

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The annualized fixed rate for the $30 million swap on January 1 is closest to:

A) 3.73%.
B) 3.80%.
C) 3.91%.

Question #70 of 88 Question ID: 1419050

For this question only, assume the annualized fixed rate on the $30 million swap is
3.80%. The amount of the first net payment due on this swap is closest to:

A) $82,500.
B) $165,000.
C) $285,000.

Question #71 of 88 Question ID: 1419051

For this question only, assume that the original 2-year $30 million notional swap was
entered into at a fixed rate of 4.0%. Based on the information in the case and  Exhibit
2: USD LIBOR Term Structure on July 1, the value of the swap on July 1 to Black is
closest to:

A) $267,390.
B) $270,000.
C) $346,572.

Question #72 of 88 Question ID: 1419052

The CHF fixed payment to be made periodically by the USD receiver is closest to:

A) CHF 26,200.
B) CHF 52,381.
C) CHF 54,000.

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Overview for Questions #73-76 of

88 Question ID: 1454828

TOPIC: ALTERNATIVE INVESTMENTS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

The Gould Organization, founded in 1923 as E. Gould & Son, is a group of

approximately 200 business entities of which Jacob Gould is the principal owner. The
Gould Organization has interests in real estate investment, development, and
management.

Gould has expressed an interest in acquiring the Five Falls Apartments, a 99 unit
complex housed on 213 acres of land outside Stamford in Fairfield County,
Connecticut. This property was constructed in 1995 at a cost of $9 million. It is one of
the most desirable rental buildings in the area.

Gould's team collects the following data for Five Falls:

Appraised value $40 million

Net operating income $3.2 million (and forecast to be level)

The Gould Organization has typically focused on residential real estate but is now
considering investing in other kinds of properties as well.

Recently, Gould's human resources team interviewed Samatha Watkins, a recent MBA
graduate and CFA Level II candidate, for an open analyst position with the firm. To test
her knowledge of real estate finance, Gould's HR staff asks Watkins questions about
how she would value various types of real estate property.

Question #73 of 88 Question ID: 1419059

Gould expects to finance his firm's acquisition of the Five Falls apartments at its
appraised value using a loan. Suppose that Primeco Bank is willing to make the Gould
Organization an interest-only loan at a 5% interest rate as long as the DSCR is at least
2.0 and loan to value ratio is not more than 85%. The maximum amount of loan that
Gould can obtain is closest to:

A) $32 million.
B) $34 million.

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C) $36 million.

Question #74 of 88 Question ID: 1419060

Suppose that the Gould Organization purchases Five Falls at its appraised value,
partially financed using an interest-only mortgage in the amount of $34 million at 5%
interest. The equity dividend rate (i.e., the cash-on-cash return) for the first year
would be closest to:

A) 4%.
B) 15%.
C) 25%.

Question #75 of 88 Question ID: 1419061

Suppose that rather than taking out a loan, the Gould Organization purchases the
property today for its appraised value on an all-cash basis. Then, after five years, the
property is sold by Gould for $48 million. The IRR for this unleveraged (all-cash)
investment in the property would be closest to:

A) 11%
B) 16%.
C) 21%.

Question #76 of 88 Question ID: 1419062

Imagine that rather than purchasing Five Falls for cash, Gould Organization takes out
an interest-only $32 million loan requiring debt service of $1.6 million. Suppose that
the property is sold by Gould after five years for $48 million. Ignoring taxes, the IRR of
the Gould Organization's investment is closest to:

A) −11%.
B) 21%.
C) 31%.

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Overview for Questions #77-80 of

88 Question ID: 1454829

TOPIC: PORTFOLIO MANAGEMENT

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Neil Cernan set up his own investment management firm in 2005. Cernan Investment
Management LLC (CIM) is headquartered in Kansas City, MO, with eight offices across
the U.S. Midwest and East coast. While initial growth of the firm was relatively slow,
over the last six quarters assets under management have increased at their fastest
rate since inception.

Cernan now feels that the time is right to expand overseas to help sustain the pace of
the firm's growth. CIM's board has narrowed the expansion down to two possible
countries: Pangia and Isopia.

Cernan has historically tried to avoid investing in any country with low real GDP
growth or low interest rates, or inflation rates that are too high or volatile. He intends
to follow the same rules for CIM. Cernan's proposed screening process is shown in
Exhibit 1: Screening Criteria.

Exhibit 1: Screening Criteria

A country will not be considered a candidate for CIM's expansion if:

1. Forecast real GDP growth for the coming year is less than 1.5%
2. The real risk-free rate is less than 1.0%
3. Forecast inflation is greater than 1.5%

Cernan has gathered some information on Pangia because he is concerned that that
economy may not pass the screening process. The data gathered is shown in  Exhibit
2: Pangia Data and Next Period Forecast.

Exhibit 2: Pangia Data and Next Period Forecast

1-year, zero-coupon government bond price (£100 par) £97.20

Forecast inflation rate 1.2%

Forecast premium for inflation uncertainty 0.4%

Forecast nominal GDP growth rate 2.4%

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In addition to assessing macroeconomic data in each candidate country, CIM has also
researched potential investment managers. In Isopia, CIM staff have identified three
potential investment managers with the required skill set and experience. Cernan
presents this information to the board, including a definition of the information ratio,
plus key performance data for two of the managers as shown in  Exhibit 4:
Information Ratio Definition and Isopian Candidate Data.

Exhibit 4: Information Ratio Definition and Isopian Candidate Data

Information
The ex post information ratio is the actual correlation between active
Ratio
returns and expected active returns and may be positive or negative.
Defined:

Candidate Data

Manager A Manager B

Transfer coefficient 0.70 0.50

Information coefficient 0.025 0.034

Information Ratio (constrained) 0.192 0.123

All three candidates work with constrained portfolios due to local laws and
regulations. However, Cernan intends to assess the managers by calculating their
information ratio had the portfolios been unconstrained. Cernan's screen calls for a
minimum unconstrained information ratio of 0.25.

A third candidate, Manager X, had an information ratio of 2.99. Although impressive,

this IR seemed too high to Cernan and hence Cernan does not consider Manager X.
When the CIM board asks Cernan why he did not consider this candidate, Cernan
provides the following two reasons why Manager X's information ratio may be too
high:

Manager X's information ratio suffers from cross-sectional

Reason 1: interdependence, whereby each decision made is not
independent.

Manager X's information ratio suffers from time-series

Reason 2: dependence, whereby decisions taken on securities may be
correlated over time.

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Question #77 of 88 Question ID: 1419066

Using the data in  Exhibit 2: Pangia Data and Next Period Forecast, and the
screening process outlined in  Exhibit 1: Screening Criteria, Pangia is most likely to:

A) fail only the screening criterion related to the real GDP growth rate.
B) fail only the screening criterion related to the real risk-free rate.
C) pass both the real GDP growth and real risk-free rates criteria.

Question #78 of 88 Question ID: 1419069

In  Exhibit 4: Information Ratio Definition and Isopian Candidate Data, Cernan's

definition of the information ratio is best described as:

A) correct.
B) incorrect because the information ratio cannot be negative.
C) incorrect because it defines the information coefficient instead.

Question #79 of 88 Question ID: 1419070

Which of the candidates in  Exhibit 4: Information Ratio Definition and Isopian

Candidate Data is most likely to pass Cernan's IR screen?

A) Only Manager A.
B) Only Manager B.
C) Neither Manager A nor Manager B.

Question #80 of 88 Question ID: 1419071

Which of Cernan's reasons for not relying on Manager X's information ratio are based
on actual limitations of the fundamental law?

A) Reason 1 only.
B) Reason 2 only.

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C) Both reasons are limitations.

Overview for Questions #81-84 of

88 Question ID: 1469427

TOPIC: PORTFOLIO MANAGEMENT

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Steve Mason, CFA, is an analyst with Alpha Developers. Mason is advising a client
regarding trading algorithms. Mason revealed that he has some concerns over the
trading methods carried out by market participants. His analysis revealed several
instances of high frequency trading that he was uncomfortable with because they may
invite regulatory scrutiny. While showing a screenshot of orders, Mason makes the
following statement:

Statement 1: The pattern of trading by Trader [B] over the period 8th June
to 12th June suggests strongly that Trader [B] may be wash
trading.

While discussing backtesting, Mason states, "I am always skeptical when someone
shows me a strategy that has performed well based on past data. Did they find this
strategy by sifting through many different models and selecting the one based on how
good it looked statistically?"

Another client is concerned with longer term trends in Ruritania, a country where the
client has significant investments. A recent paper on consumption trends and that
country's position in the business cycle left the client with doubts about both
Ruritanian interest rates and bond performance.

The relevant extract from the paper is shown in  Exhibit 1: Longer Term
Macroeconomic Forecasts for Ruritania – Extract

Exhibit 1: Longer Term Macroeconomic Forecasts for Ruritania – Extract

"Two distinct trends have emerged in the Ruritanian economy over the last
10 quarters. First, the level of wealth per capita has increased, and this
increase is only expected to accelerate over the next four years. Compared
to today, the average family can expect to increase their wealth at an
average of 0.5% per year over this period.

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In addition, the reduction of restrictions on capital flows and international

trade under the current political regime (which is expected to remain in
power for at least four years) is expected to continue, leading to an
increase in both GDP and the volatility of GDP growth."

Mason draws two conclusions from the extract:

Conclusion 1: The expected trend in personal wealth will decrease the utility
of future consumption relative to consumption today, reduce
the inter-temporal rate of substitution, and reduce the real
interest rate.

Conclusion 2: The increase in GDP growth is expected to increase real

interest rates, but this effect be offset by the impact of the
increase in the volatility of that growth.

Question #81 of 88 Question ID: 1469428

The activity described in Statement 1 is most likely to involve:

placing a legitimate trade on one side of the market and several illegitimate orders
A)
at different prices on the other side.
B) executing simultaneous buy and sell orders on the same financial instrument.
entering large quantities of fictitious orders into the market and instantaneously
C)
canceling them.

Question #82 of 88 Question ID: 1469429

Based on Mason's statement about backtesting, he is most likely to be concerned

about:

A) data snooping.
B) statistical anomalies.
C) survivorship bias.

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Question #83 of 88 Question ID: 1469430

Mason's Conclusion 1, in response to the extract in Exhibit 3 is least accurate

regarding the effect on:

A) the utility of future consumption relative to consumption today.

B) the inter-temporal rate of substitution.
C) the real interest rate.

Question #84 of 88 Question ID: 1469431

Mason's Conclusion 2, in response to the extract in Exhibit 3 is most likely:

A) incorrect, as both growth and volatility would increase real interest rates.
B) incorrect, as both growth and volatility would decrease real interest rates.
C) correct.

Overview for Questions #85-88 of

88 Question ID: 1454841

TOPIC: ETHICAL AND PROFESSIONAL STANDARDS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Andrea Vrbenic, CFA, was recently promoted to supervisory analyst at Banke Gjigante,
a large brokerage firm that has investment banking and asset management
departments. Vrbenic will report to Tom Sheffield, a senior manager and director at
the firm.

Currently, Vrbenic manages the investment account of Bill Stallwell, a single retiree
who lives off his portfolio and is relatively risk averse. Stallwell's account has been
with the firm for over fifteen years. Last year, Vrbenic added a stock with a beta of 1.5
to Stallwell's portfolio. Since then, Vrbenic has also sold call options on these shares
as part of a covered call strategy for Stallwell's portfolio.

Sheffield passes on to Vrbenic a request from Amica Biotech, one of the firm's clients,
to write a research report on Amica. The research will be paid for by Amica, with a flat

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fee plus a fixed bonus if Amica's IPO is fully subscribed.

Mike Callingly, CFA, a senior portfolio manager at Banke Gjigante, routinely distributes
performance reports on composite of portfolios managed by him. He claims that the
performance reports are GIPS compliant, except that the returns are equally-weighted
and not asset-weighted.

As part of communication with her clients, Vrbenic sends out a quarterly performance
report comparing the performance of clients' portfolios to the performance of a
broad-based market index. While doing some analysis, Vrbenic notes that her
performance would look more attractive if she used a target-date index fund for
comparison purposes. She also notes that the risk profile of her client portfolios is
more closely tracked by target-date funds than by the broad-based market index.
Starting with the first quarter of the current year, Vrbenic updates her client
communications, replacing the broad-based market index with target-date funds for
comparison purposes.

Question #85 of 88 Question ID: 1419080

With respect to Bill Stallwell's portfolio, Vrbenic has most likely:

A) violated the Standards, both by buying the high-beta stock and by selling the calls.
violated the Standards by selling the options but not by purchasing the high-beta
B)
stock.
not violated the Standards because overall portfolio risk needs to be evaluated for
C)
the purpose of judging suitability.

Question #86 of 88 Question ID: 1419081

With regards to the research report on Amica, Vrbenic will most likely:

not be in violation of the Standards as long as the fact that the research is issuer-
A)
funded is disclosed.
not be in violation of the Standards as long as both the source of the funding and
B)
the nature of the compensation is disclosed.
be in violation of the Standards even if both the funding source and the nature of
C)
the compensation are disclosed.
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Question #87 of 88 Question ID: 1419084

With regards to performance presentation, Callingly's performance report is most

likely:

A) a violation of Standard III(D) – Performance Presentation.

B) not a violation.
C) a violation of Standard I(D) – Professional Misconduct.

Question #88 of 88 Question ID: 1419085

With respect to Vrbenic's changes to quarterly performance reports for clients,

Vrbenic is most likely:

A) not in violation of the Standards because the change has a reasonable basis.
in violation of Standard III(D) because changes to an established performance
B)
benchmark are prohibited.
not in violation of the Standards if she discloses the change in performance
C)
presentation to her clients.

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