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2012 l2 sample exam v1 2 qa

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Level II Version 2012 Sample Exam McGuinn Case Scenario Forster investment Advisors (FIA) is an asset management firm managing funds for both retail and institutional clients FIA also undertakes Investment Banking activities including market-making Recently, FIA’s Finance Director, who acted as the firm’s Compliance Officer, retired The Board decides to hire a part-time Compliance Officer on a consultancy basis rather than as a full-time employee, to save costs FIA’s Managing Director asks Terry McGuinn, CFA, if he would be interested in being the Compliance Officer on a part-time basis McGuinn, an independent compliance consultant whose clients mostly include pension funds, agrees to meet the Managing Director to discuss the position At the meeting McGuinn is told, “FIA adopted the CFA Institute Code and Standards ten years ago The outgoing Finance Director assured us at the time we adopted the Code that all of FIA’s policies and procedures met the requirements of the Code and Standards and most of the recommendations as well As a result we mention compliance with the Code and Standards in all of our marketing material.” After agreeing on terms and conditions, McGuinn accepts the offer to act as FIA’s Compliance Officer on a part-time consultancy basis, with immediate effect As part of the agreement, McGuinn is only required to go into the office once a week, with most of the communication between him and senior management being via e-man or over the phone as needed McGuinn immediately reviews a Request for Proposal (RFP) to be submitted the next day to a potential pension fund client The proposal is identical to another R.FP sent out two months ago and includes FIA’s organizational structure, an in-depth description of their investment process along with the occasional use of third-party research providers and details a guarantee of a minimum 5% investment return and return of principal through a guaranteed structured savings product, underwritten by a life insurance company That same day, Colleen Collins, a Research Analyst approaches McGuinn concerned that she may be in possession of insider information The analyst relates how she was at a party the night before and overheard a conversation between two CFOs of competing publicly listed manufacturing companies The CEOs discussed an industry online newsletter, available by subscription only, speculating on the benefits of a merger between their two companies One of these companies is on F1A’s recommended buy list Following this conversion, McGuinn feels it necessary to enhance FIA’s rules and procedures when dealing with possible insider information He recommends the following changes to the companys policies and procedures:  Recommendation 1: Stop market-making activities when in possession of material non-public information  Recommendation 2: Regularly review employee and proprietary trading  Recommendation 3: Require all employees to attend an annual refresher course on how to identify and handle material nonpublic information After reviewing how FIA chooses and retains its stockbrokers every year McGuinn recommends the following: Stockbroker selection should be based on the following guidelines:  Guideline 1: Their ability to provide administration services  Guideline 2: Execute transactions in a timely fashion  Guideline 3: Obtain best prices McGuinn undertakes an investigation based on reports citing several FIA fund managers witnessed to have been wined and dined the past few weeks by large brokerage firms trying to get FIA’s business The same employees have not notified him of these dinners, violating FIAs internal policies McGuinn notifies the employees in writing that they have been violating the company policy In the letter of notification, he requires the employees to abide by the policy in the future Did Collins most likely receive insider information as defined by the CFA Standards? A Yes B No, because the information is consideration public C No, because the information is considered nonmaterial Prior to acceptance of FIA’s offer, McGuinn should most likely undertake which of the following to avoid any violation of the CFA institute Code and Standards? A Because a full-time employee B Assess the adequacies of existing procedures C Merge compliance procedures into the firms code Which response in the Request for proposal (RFP) most likely violates Standard I(C) Misrepresentation? A Guaranteed investment return B Firm’s organizational structure C Use of third-party research providers Which of McGuinn’s recommendation is least appropriate to implement as per recommended procedures for compliance of Standard II(A) Material Nonpublic Information? A Recommendation B Recommendation C Recommendation Which Guideline regarding choosing stockbroking services most likely violates Standard III Duty to Clients? A Guideline B Guideline C Guideline Regarding fund managers under investigation, the least appropriate further action McGuinn should take is: A Monitor their future actions B Report the misconduct up the chain of command C Require a statement stating the behavior will not be repeated Brendan Dennehy Case Scenario Brendan Dennehy, CFA, works for Transon Investments, Plc., a Dublin-based hedge fund with significant equity investments in technology companies in Asia North America and Europe Transon is concerned by the recent poor performance of one of the fund’s Chinese investments, Winston Communications, an assembler of telecommunications equipment Transon’s chief of information technology (IT) is Sean Malloy Yesterday, Winston’s IT office sent Malloy data relating to the assembly process and a printout of an analysis of the number of defective assemblies per hour, Winston’s IT people believe that the number of defective assemblies per hour is a function of the outside air temperature and the speed (production rate) of the assembly lines Malloy recalls that Dennehy has had substantial training in statistics while working on his MBA He asks Dennehy to help him interpret the regression results supplied by Winston Exhibit Regression Results Dt=b0+b1Airt+b2Rt+εt coefficient Std Error Constant(b0) 0.0160 0.0942 Outside air temperature(b1) 0.0006 0.0010 Assembly line speed(b2) 0.5984 0.3000 Number of observations used in the regression 384 Critical t value at 5% significance (two-tail test that coefficient equals zero) 1.96 R square Std Error of the estimate Durbin-Watson F Significance of F 0.414 0.333 1.890 157.699 0.000 1.63 1.72 Durbin-Watson critical values (5% significance) Using the data provided in Exhibit 1, Dennehy tests the hypothesis that the coefficients for outside air temperature and assembly line speed are significantly different from zero, using a significance level of 5% Next Dennehy would like to confirm that nonstationarity is not a problem To test for this he conducts Dickey-Fuller tests for a unit root on each of the time series The results are reported in Exhibit Exhibit Results of the Dickey-Fuller tests Time series Value of the test statistic Std Error t Significance of t 0.0036 0.0023 1.591 0.1123 Outside air temperature -0.423 0.0724 -5.846 0.000 Assembly line speed -0.586 0.043 -13.510 0.000 Defective assemblies per hour Dennehy tells Malloy about the Dickey-Fuller test results, stating: We can safely use regression to estimate the relationship between the dependent variable and the independent variables if: none of the three time series exhibit a unit root, or all three series exhibit a unit root but they are also mutually cointegrated Malloy disagrees in part with Dennehy’s statement, He agrees with Dennehy about the use of regression if none of the time series exhibit a unit root But Malloy believes that it is safe to estimate the regression if only the independent variables exhibit unit roots but are cointegrated, and the dependent variable does not exhibit a unit root Based on Exhibit 1, Dennehy’s tests of the two regression coefficients show a significant different from zero for the coefficient(s) for: A Assembly line speed (b2) only B Outside air temperature (b1)only C Both outside air temperature (b1)and assembly line speed(b2) The results reported in Exhibit suggest: A The F-statistic of the regression is not significant B Predictions of defective assemblies per hour made using the regression have only about a 41% chance of being correct C Variations in the independent variables explain appropriately 41% of the variation in the defective assemblies per hour What is the most appropriate inference from the Durbin-Watson statistic reported in Exhibit 1? The Durbin-Watson test: A Is inconclusive B Rejects the null hypothesis of no positive serial correction C Fails to reject the null hypothesis of no positive serial correction 10 Assuming a 5%level of significance, the Dickey-Fuller results reported in Exhibit show that the: A Test for a unit root is inconclusive for the dependent variable B Dependent variable exhibits a unit root but the independent variables not C Independent variable exhibits a unit root but the dependent variables not 11 Dennehys statement about the Dickey-Fuller test is best characterized as: A Correct B Incorrect, because only the dependent variable series needs to be tested for the absence of a unit root C Incorrect, because only the independent variable series needs to be tested for the absence of a unit root 12 Malloy’s reply to Dennehy about the Dickey-Fuller test is best characterized as: A Correct B Incorrect because the regression results are valid whether a unit root exists or does not exist for the dependent variable when the independent variables are cointegrated C Incorrect because if any of the time series have unit roots, all of the time series must have unit roots and must exhibit mutual cointegration for the results of the regression to be valid Nation Resorts Ltd Case Scenario Nation Resorts Ltd (Nation) is a U.S,-based operator of destination vacation resorts, Resorts are divided into three types: Winter, which are located at ski mountains; Golf, located on championship courses in locations such as Arizona; and Seaside located at beaches with ocean, and other activities available, The three types of resorts generally attract different types of vacationers, and provide different vacation packages for different vacation budgets, Although the Winter and Golf resorts are somewhat counter-seasonal, the company still suffers from the risk of the U,S, economy as well as the risk of unfavorable local weather conditions (lack of snow or sun), To diversify and reduce these risks, Nation started purchasing properties in other geographic areas including Europe and Central America Nation made its first foreign investment when it bought a resort in Jamaica on May 2008, Initially Nation provided managers to assist in operating the resort but then hired local Jamaicans into their management development program, and one was recently appointed to a senior position at the resort, Nation invested in building and up grading facilities with the initial expansion financing provided by Nation’s U,S, bank, Concerned about the high rate of inflation in Jamaica which at the time of purchase had averaged 20% per annum over the previous three years, Nation kept excess funds in US, dollars, Vacation packages are sold primarily in the United States and prices reflect competitive conditions in the U,S, vacation market The resort uses local labor and supplies and is expected to be profitable for the first time this year Inflation has now declined to 14% per annum, Nation expects to be able to reinvest any profits in the resort and start using a local bank for ongoing financing needs On I July 2010 Nation acquired its first European resort, Val Blanc SA, a ski resort in the Alps region of France, Nation paid €28 million for 100% of the company, The resort attracts skiers primarily from France and other European countries, The transition has gone very well with Nation leaving the local managers in place to make all operating and financial decisions, To date the only financial contribution by Nation has been the initial equity investment, Financial statements for the ski resort at acquisition and for the six months since then are shown in Exhibit Financial Statements (all figures in thousands) Income Statement 31 Dec 2010 30 June 2010 months 12 months Resort revenues € 12,025 € 46,805 Operating expenses 9,800 35,105 Depreciation and amortization 1,750 4,000 interest expense 1,200 2,500 Earnings before taxes €(725) €5,200 income taxes 0.00 1,300 Net earnings €(725) €3,900 Statement of Financial Position Cash and marketable securities 31 Dec 2010 30 June 2010(1) €5,750 €5,000 Account receivable 6,500 3,000 Inventory 8,000(2) 5,000 Total current assets €20,250 €13,000 Property, plant and equipment 41,750 43,500 Intangible asset5 5,000 5,000 Total assets €67,000 €61,500 Current liabilities €12,225 €5,000 Long-term debt 26,000 27,000 Share capital 20,000 20,000 Retained earnings 8,775 9,500 Total liabilities and equity €67,000 €61,500 (1)The 30 June 2010 Statement of Financial Position reflects the fair value of the identifiable assets and liabilities of Val Blanc at acquisition (2) 31 December 2010 inventory was acquired evenly throughout the period since acquisition Paul Nakiska, a business analyst with Nation, is meeting with Nation’s Manager of Financial Reporting Max Chara, to discuss how the company should account for the two foreign resorts in the 2010 financial statements, and the impact the resorts will have on Nation’s reported results Nation has a December yearend and prepares its financial statements according to U.S GAAP In preparation for the meeting, Nakiska’s first task was to prepare the purchase price allocation of the Val Blanc acquisition using the acquisition method He has also gathered some exchange rate information related to the two resorts, Exhibit Exhibit Selected Exchange Rates Date $US = $1 JMD $US = 1€ May 2008 0.0139 N/A l January 2010 0.0115 1.4368 30 June 2010 0.0117 1.2250 31 December2010 0.0117 1.3261 Average 2010 0.0115 1.3277 Average January — July 2010 0.0113 1.3303 Average July — December 2010 0.0117 1.3198 Nakiska started the meeting: I suggest we use the current rate method for both of our foreign subsidiaries because that will simplify our financial reporting The current rate method also allows the key metrics we use to valuate performance; the current ratio, fixed asset turnover and operating margin, to be the same after translation as before Chara replied: I am not so concerned about the translated metrics, because we evaluate the performance of each resort in its local currency; however, I am concerned about the effect on Nation’s consolidated net income and return on equity If we use the temporal method for the resort in France, we can take advantage of the strengthening Euro and report the translation gain on the income statement I am also not so concerned about using the same method for all subsidiaries, if using different methods will help increase our net income Nakiska agreed to calculate the effects of the various translation methods and of the Val Blanc acquisition on the financial statements and send the report to Chara 13 In 2008 Nation most likely used which of the following translation methods for the Jamaican resort? The: A temporal method, due to the high rate of inflation B temporal method, because the US dollar was the functional currency C current rate method, because the Jamaican dollar was the functional currency 14 Nakiska’s allocation of the purchase price of the acquisition of Val Blanc will most likely result in which of the following for Nation, in €, before translation of the subsidiary’s financial statements? A Again of 1,500 B Goodwill of 8,000 C An increase in retained earnings of 9,500 15 The net income (in $ US) from the Val Blanc subsidiary that will be included in Nations income for 2010 is closet to: A (791) B (957), C (961) 16 Using the translation method suggested by Nakiska, the total shareholders’ equity of the Val Blanc resort on 31 December 2010 after translation is closet to: A $ 32,203 B $35,181 C $38,159 17 Nakiska’s comment about the key performance metrics is least accurate with respect to: A Current ratio B Operating margin C Fixed asset turnover 18 Is Chara correct in his assessment of the effect of using the temporal method on the Val Blanc resort? A No ,because it would result in a translation loss on the income statement B Yes, because it would result in a translation gain on the income statement C No, because the translation gain or loss would not be reported in net income Fargo Durum Farms (FDF) Case Scenario Minneapolis Viking Arbitrageurs, LLC (MVA), is a fledgling U.S-based hedge fund having slightly over $ 50 million under its management MVA specializes in owning and managing small-sized properties in agriculture, forestry, and mining Its average investment is about $8 million Jim Hester, MVA’s Managing Partner and Chief Investment Strategist is examining the financial statements and other pertinent information about Fargo Durum Farms, Inc (FDF), as a potential investment opportunity FDF is jointly owned by two brothers, John and Man, of the Mahoney family With all their children graduated from North Dakota State University and currently living in Minneapolis, the brothers have decided to sell the property Hester believes that commodity prices will continue their uptrend for extended periods and investing in a North Dakota farming operation where farm lands are still attractively priced will produce high returns for the hedge fund Its tangible assets including working capital comprise approximately 1,500 acres of fertile and well-irrigated land, farm buildings, machinery, residential quarters, livestock, cattle feed, seeds, gain, and so forth FDF also carries significant intangible assets that include biological assets, patented hybrid seeds, and milk quotas Select data from FDF’s income statement for the year ended December 2010 are presented in Exhibit Exhibit contains additional estimates compiled by Hester Exhibit FDF’s Selected Financial Data for the year ended December 2010 Gross Revenues from crops, livestock, feed, etc $2,500,000 Cost of goods sold 1,000,000 Selling, general, and administrative expenses (SG&A) 900,000 Depreciation and amortization 200,000 Tax rate 30% Notes: i) FDF carries debt in the amount of $750,000 at an interest rate of 8%, and it comprises 30% of total assets on book value basis Debt will be a part of the acquisition transaction ii) FDF holds $200,000 in cash and short-term investments, but it will not be a part of the assets under acquisition transaction Exhibit Additional data and Hester’s estimates for normalization The cost of goods sold ratio should be higher at 45% SG&.A includes 5400,000 in owners’ compensation According to Hester’s research, owners’ compensation expense for similar sized farms is 5200,000 A ranch and living quarters are not required for the farm’s core operations, A total of 5125,000 in expenses (525,000 in depreciation and 5100,000 in operating expenses included in SG&A) relate to those properties The ranch and living quarters will be kept by the current owners and are not a part of FDFs farming operations being considered for purchase by the hedge fund For pro forma purposes, depreciation and amortization will be 10% of gross revenues and the current tax rate of 30% is considered reasonable First, Hester assesses FDFs normalized operating income after tax Next, he values FDF’s equity using the free cash flow to the firm (FCFF) approach under the following additional assumptions  Revenues and free cash flows will grow at a constant rate of 5% per year for the foreseeable future  On average, FDF’s operating income (EBITDA) will be 30% of gross revenues  Required capital expenditures will equal the projected depreciation & amortization expense plus 10% of the incremental revenue  Additional working capital (other than cash) equal to l5°/ of the incremental revenue is required  The cost of equity and weighted average cost of capital (WACC) are 14% and 11.5%, respectively Hester presents his initial assessment and valuation of FOF to MVA’s Investment Committee, The comments and suggestions from some members on the Committee are as follows: Xavier Moreno, Commodities Analyst, suggests the use of excess earnings method (EEM) for valuing FDF and makes the following three statements in support of his preference: EEM involves estimating the earnings remaining before deducting amounts that reflect the required returns to the tangible assets It is a widely used method for pricing entire private businesses such as FDF EEM is especially useful for valuing FDF as it allows for valuing working capital, fixed assets, and intangibles using different discount rates Jamal Bahrami, the External Consultant on the Committee differs from Hester and prefers the use of free cash flow to equity (FCFE) model Further, he develops his own estimates for valuing FDF’s equity  Owing to the continued strength in the global demand for wheat, FDF will experience a higher annual growth rate of 10% over the next two years, 2011 and 2012; thereafter, it will grow at a constant rate of 6% per year  Next year (201 1)FDF will realize $1,000,000 in cash flow from operations  To support its high growth needs, FDF will require $400, 000 in new capital investment next year  The company would need additional borrowing in the amount of $250,000 at an interest cost of 8%  Because of illiquidity and small-firm risk premiums the appropriate WACC and required return on equity respectively, will be higher at 12.9% and 16% Hester made a cash offer of $ million to the Mahoney brothers, However, they decided to make a counteroffer and approached Joselyn Olsen, a reputable agriculture industry analyst at the Red River Valley Consultants, LLP, for her assessment of FDF’s value Olsen prefers the guideline transactions method (GTM) using next year’s expected EBITDA to value FDF and she estimates the following from the company data, market information, and her own assessments  FDF’s expected 2011 gross revenue = $ 2,800,000  2011 cost of goods sold =42% of gross revenue  2011 SG&A = 25% of gross revenue ... ending 31 December 20 02? ? ?20 11 Year EPS ($) DPS ($) 20 02 4.18 2. 17 20 03 4.34 2. 26 20 04 4. 52 2.31 20 05 4.77 2. 48 20 06 5.05 2. 58 20 07 5.18 2. 64 20 08 2. 60 20 09 2. 40 20 10 4.80 20 11 5.50 In 20 11, sales of... $1 JMD $US = 1€ May 20 08 0.0139 N/A l January 20 10 0.0115 1.4368 30 June 20 10 0.0117 1 .22 50 31 December2010 0.0117 1. 326 1 Average 20 10 0.0115 1. 327 7 Average January — July 20 10 0.0113 1.3303 Average... Level II Version 1 _v10 20 12 Sample Exam Click here to to go to MyCFA “Guidance for Standards I-VII,” CFA Institute 20 12 Modular Level II, Vol 1, pp 101-103 Study Session 1 -2- b Recommend practices

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