In several conversations with Nathoo, Kostecka highlighted Bope’s low risk tolerance and investment goal of capital preservation.. Nathoo informs Kostecka about her discovery; however, K
Trang 1Kostecka
Jacob Kostecka, CFA, is a portfolio manager at Forkson Investment Management, an asset management and research focused organization After obtaining his CFA charter last month,
Kostecka was transferred to the private wealth management division at Forkson
Dharshi Bope, a private wealth client, was involved in a major motorcycle accident and is in critical condition, fighting for his life Bope is a single parent with a daughter, Paveen Nathoo, in her mid-twenties Since the accident, Nathoo has managed her father’s affairs, paying all expenses, including investment advisory fees In several conversations with Nathoo, Kostecka highlighted Bope’s low risk tolerance and investment goal of capital preservation Nathoo has indicated her interest in managing the account more aggressively and possibly moving to another management firm Nathoo recently petitioned the court to appoint her full power of attorney to legally manage Bope’s affairs Prior to the court decision, Nathoo asks Kostecka to invest her father’s account in the initial public offering (IPO) of Chatterbox, a highly sought after social media company that has yet to generate a profit
The following week, the court approves Nathoo’s request to act on behalf of her father Going through records in her father’s home, Nathoo discovers documents showing Bope embezzled several million dollars from his employer, a real estate development company Most of these funds were placed directly into Bope’s personal account, for which Nathoo is now responsible Nathoo informs Kostecka about her discovery; however, Kostecka does not act on this
information, however, because it is a large account for Forkson
Nathoo establishes a non-discretionary investment account at Forkson tied to her newly
established business Shortly thereafter, Kostecka joins the board of Jabbertalk.com, a smaller social media competitor to Chatterbox Based on his knowledge of Chatterbox, Kostecka
believes the stock of Jabbertalk is a good investment, even though it is not yet profitable Buoyed by his faith in social media, Kostecka ultimately purchases shares of Jabbertalk’s IPO for Nathoo’s account, as well as for all clients he currently manages When Kostecka informs Nathoo of the purchase, she expresses concern about her legal responsibilities and lack of accounting knowledge in overseeing the account Kostecka provides Nathoo a list of
recommended professionals he has worked with in the past, including attorneys and
accountants When he was in college 10 years earlier, Kostecka was engaged to one of the attorneys but broke off the relationship prior to their wedding, and one of the accountants was Kostecka’s college roommate Since then, Kostecka has not had any contact with the lawyer and accountant
The Jabbertalk investment is profitable on the first day of trading, doubling from its opening price Kostecka tells his clients the multifactor valuation model used by Forkson shows
Jabbertalk stock is still undervalued Forkson’s research report, due out the next day, will recommend investors hold their Jabbertalk shares However, Kostecka tells all his clients
simultaneously they should sell their shares because he believes Jabbertalk is overvalued and the stock price will fall soon Kostecka notes he has followed through on this belief by selling his personal holdings of Jabbertalk shares Nathoo ignores Kostecka’s recommendation to sell Jabbertalk Over the next week, the stock declines 75%
Trang 2Watching Jabbertalk’s severe share price decline, Nathoo becomes furious with Kostecka because he did not sell shares of Jabbertalk in her account She files a complaint with Kostecka’s supervisor, Sally Fang, CFA, claiming she was misled on the value of the IPO in the days
immediately after the stock started trading Kostecka responds to the complaint by telling Fang,
“the analyst who wrote the hold recommendation on Jabbertalk has only passed his CFA Level II examination As a charterholder, I have earned the right to use the CFA designation, so I am more qualified to manage clients’ investments.”
In order to build his client base, Kostecka prepares performance information to show
prospective clients He includes the firm’s composite performance based on similar
discretionary client portfolios that are in compliance with the GIPS Standards In addition, Kostecka prepares his own composite performance, including all accounts he manages This presentation includes Nathoo’s account assuming she had sold her shares of Jabbertalk Along with his performance record, Kostecka provides a footnote disclosing the following language: “If your account is managed on a discretionary basis, you might expect results similar to those shown above.”
1.) With regard to the investment request made by Nathoo to invest in Chatterbox,
Kostecka should most likely:
A seek advice from the court
B comply with her request
C follow Bope’s investment goals
2.) By not acting on the information reported by Nathoo, which CFA Institute Standard of
Professional Conduct has Kostecka least likely violated?
A Loyalty, Prudence, and Care
B Duties to Employers
C Knowledge of the Law
3.) With regard to investing in Jabbertalk and recommending experts, Kostecka most likely
needs to disclose conflicts related to his:
A attorney relationship
B board membership
C accountant relationship
4.) In relation to Kostecka’s handling of the Jabbertalk stock recommendation, which of the
following CFA Institute Standards of Professional Conduct did he least likely violate?
A Fair Dealing
B Communication with Clients
C Priority of Transactions
5.) When Kostecka defends himself against Nathoo’s complaint, he most likely violated the
CFA Institute Code of Ethics and Standards of Professional Conduct concerning the:
Trang 3A misrepresentation of the meaning of the designation
B right to use the CFA designation
C reference to candidacy in the CFA Program
6.) Kostecka’s performance presentation most likely conforms to the CFA Institute Standard
III (D) Performance Presentation with regard to:
A composites representing similar discretionary investment portfolios
B fair and accurate representation of performance
C disclosure in the footnote
Trang 4KingFisher
The government of a developing country published a request for proposal (RFP) for the
development of policies to improve the business conduct of its capital markets licensees, with
the hope of improving confidence levels among investors
Kingfisher Financial Development Partners responded with a detailed proposal including the following justifications for why the firm should win the tender:
Justification 1: With a team of three CFA charterholders, Kingfisher is more qualified than our
competitors to design policies to uphold and enhance capital market integrity Justification 2: Each team member must annually renew his or her commitment to abide by
the CFA Institute Code of Ethics and Standards of Professional Conduct (Code and Standards)
Justification 3: In addition, every team member passed each level of the CFA exam on the
The Kingfisher team subsequently drafts the following policy statements:
Levels of Professionalism
Financial services professionals must act in a professional manner at all times to help protect the integrity of the country’s capital markets As such, financial services professionals must ensure that they meet at a minimum three major requirements Professionals must (1) disclose all conflicts of interest, (2) selectively differentiate services to clients, and (3) outline all manager compensation arrangements for clients
Capital Market Integrity
Financial services professionals must protect the integrity of the capital markets by ensuring that any insider information obtained is managed in such a way as to prevent the investing public from being disadvantaged In addition, no financial services professional can knowingly participate in any activity devised to mislead investors or distort any price-setting mechanism
Duties to Clients
Clients’ interests must come before those of the financial services firm and/or its staff To ensure that clients’ interests are protected, all portfolios must be invested according to each client’s investment plan and must be well diversified across all asset classes available
Furthermore, fund managers must annually review client needs and objectives and rebalance portfolios if required
Investment Recommendations
Trang 5All investment recommendations should be made after extensive research undertaken by or on behalf of the firm In addition, each research report must
Requirement 1: be reviewed by peers as soon as practical to ensure adequate basis and due
diligence policies were followed, Requirement 2: be assessed to determine the quality of the recommendation over time, and Requirement 3: only include names of team members who took part in the research and
agreed with the recommendation
The Kingfisher team and the government committee meet to agree on the draft code of
conduct Members of the government committee suggest the following additional policy: “Each financial services firm must have a compliance supervisor to ensure that
Task 1: systems are in place to detect violations of laws, rules, regulations, firm policies, and the
industry-wide code of conduct and to enforce investment-related compliance policies; Task 2: the firm has adequate documented compliance policies and procedures and it trains all
personnel on the same and makes sure the policies and procedures are followed; and Task 3: inadequate procedures are identified and recommendations to correct inadequate
procedures are submitted to senior management for approval and implementation.”
1.) Which of Kingfisher's statements in the RFP regarding its qualifications most likely
violates the CFA Institute Standards of Professional Conduct?
A Justification 2
B Justification 3
C Justification 1
2.) With regard to the proposed policy statement relating to Levels of Professionalism,
which draft requirement least likely reflects any of the CFA Institute Standards of
C Yes, with regard to market manipulation
4.) Which of Kingfisher's proposed requirements to ensure Duties to Clients is least
appropriate to prevent violations of CFA Institute Standards of Professional Conduct? The requirement calling for a(n):
A investment plan
B diversified portfolio
Trang 6C periodic review
5.) Which of Kingfisher's proposed requirements regarding investment recommendations is
most appropriate to prevent violations of Standard V(A): Diligence and Reasonable
Basis?
A Requirement 2
B Requirement 1
C Requirement 3
6.) Which of the following tasks suggested by the government committee would least likely
conform to Standard IV(C): Responsibilities of Supervisors?
A Task 1
B Task 3
C Task 2
Trang 7
National Plastics
National Plastics Corp is a leading manufacturer of high-quality injection-molded plastic
packaging materials used by various industries, primarily food and beverage processing and packaging firms In late November 2012, the company received approval for two important patent applications—one providing for improved tamper protection for plastic containers and another for an improved biodegradable plastic film that allows for better food preservation
On 4 January 2013, Haines Foods and Snacks, Inc., launched a hostile takeover bid for all of the shares of National at $30 per share (a $5 premium in excess of the pre-bid price) Haines Foods
is a national distributor of deli and dairy products If its bid is successful, it plans to continue to operate National as a wholly owned subsidiary
Zenith ThermoPlastics Inc produces plastic containers and bags that are used by the food and beverage industry Keith Whelan, who is both chief executive officer and chief financial officer of Zenith, had been in discussions with National to either purchase or license their newly patented technologies As a possible alternative, in view of the Haines bid, Whelan began to consider having Zenith make its own takeover bid for National
Whelan provided National’s most recent financial statements, shown in Exhibits 1, 2, and 3, to one of his assistants, Mike Noth, with directions to calculate National’s free cash flow using the discounted cash flow approach as a first step in determining the maximum value that Zenith should be willing to pay for National’s shares
Selling, general, and administrative expense 436
Earnings before interest, taxes, depreciation, and
Number of outstanding shares (millions) 60
Trang 8
Exhibit 2: National Plastics Corp Consolidated Balance Sheets
as of 31 December
Long-term assets, net 1,203 1,130
Exhibit 3: Other Financial Information for National Plastics Corp as of 31 December 2012
Effective tax rate 32.00%
Trang 9
After a discussion about the appropriate cash flow estimates and discount rates to use in
determining the value of National to Zenith, Whelan decides that Zenith should make a mixed offer for all of National’s shares at $35 per share, consisting of $23 in cash and Zenith common stock with an exchange ratio of 0.24 The details of the offer are in Exhibit 5
Exhibit 5: Details of Zenith’s Planned Tender Offer for All of National
Plastics’ Common Shares
National Plastics Zenith ThermoPlastics Pre-merger price $25/share $50/share
Shares outstanding 60 million 100 million
Tender Offer
Zenith will pay $35 per share for National, consisting of $23 in cash and Zenith common shares with an exchange ratio of 0.24
Post-merger Following the merger, Zenith’s shares are
expected to be priced at $53/share
Synergies from the
merger
Zenith believes that most of the synergies arising from the merger will result from National’s new patents
Because National and Zenith are based in the United States, Whelan also decides to have Noth calculate the pre- and post-acquisition Herfindahl-Hirschman Index (HHI) for the industry Noth’s HHI calculations are 1,910 pre-acquisition and 2,000 post-acquisition Based on the HHI values, Whelan concludes that (1) the industry is currently highly concentrated but (2) under applicable
US law, an increase in the HHI of less than 100 should not generate any governmental
challenges to block the acquisition of National
When Whelan presents Zenith’s proposed takeover to the board of directors the following day, one of the directors made the following statements:
1 Although I am certainly in favor of this takeover, I think we would achieve the greatest value from the acquisition if we offered more stock and less cash
2 If Zenith does not realize the potential synergies of this acquisition in the next five years,
I suggest a “spin-off” as a means to recover some of the money lost in this venture
3 A positive initial market reaction will confirm that we did not overpay for Zenith
1.) If Haines Foods is successful in its attempt to acquire National Plastics, the business
combination is best classified as which type of merger?
A Horizontal, conglomerate
Trang 11
3.) Based on Noth's assumptions in Exhibit 4, the most that Zenith should be willing to
pay per share of National is closest to:
A $60
B $51
C $40
4.) Based on Zenith's proposed tender offer and information in Exhibit 5, the synergy
arising from this merger is closest to (in millions):
A $943
B $1,063
C $643
5.) The most accurate interpretation of Whelan's conclusions concerning the pre- and
post-acquisition HHI is that they are:
A both correct
B incorrect in regard to the increase in HHI necessary to trigger a governmental challenge to the acquisition
C incorrect in regard to the industry being highly concentrated
6.) Which of the statements made by the member of the Board of Directors is most
accurate?
A Statement 3
B Statement 1
C Statement 2
Trang 12Sagara
Sagara, a resource-abundant West African country, has a developing economy with low capital per worker available Although the majority of its population is impoverished, Sagara has a long history of advanced education and is committed to technological progress President Benjamin Banantoumou recently appointed Fatima N'Diarra, PhD, as Economic Development Secretary, and asks her to help him develop economic policies to promote
growth
Last year, Banantoumou attended a summit of international leaders, where he learned that developing countries typically face several factors that affect their growth prospects, such as
1 enforcement of substantive laws,
2 restrictions on imports, and
3 low rates of saving
N'Diarra, who has studied the Cobb–Douglas production function, believes that Sagara's primary goal should be to raise the growth rate of per capita GDP Her two
recommendations, therefore, are to
1 increase capital, and
2 invest in technology to raise total factor productivity (TFP)
N'Diarra adds this conclusion:
"Because the Cobb–Douglas function exhibits constant returns to scale, as we approach the steady state rate of growth, we should place greater emphasis on continuing to grow TFP in order to avoid diminishing marginal returns on capital."
Banantoumou believes that the Sagara economy relies too heavily on the export of natural rubber He is convinced that significant industrial capital investment will persuade foreign direct investors that he is serious about economic development He announces that the Sagara government will construct a large tire factory to take advantage of the country's rubber resources Banantoumou expects that as a result of this investment, per capita productivity will rise rapidly driving rapid growth in GDP
N'Diarra is not as optimistic She warns Banantoumou that Sagara could fall prey to a
resource curse known as the Dutch disease As demand from the tire factory drives up the price of rubber, capital flows out of the country and the local currency could depreciate rapidly This situation can be prevented if foreign investors are allowed to own rubber plantations directly rather than just having access through international markets
N'Diarra believes that according to the classical growth theory, gains in per capita GDP are temporary because the resulting population explosion will lower per capita GDP to
subsistence real wage levels She considers endogenous growth theory to be more realistic, believing that (1) investments, such as the new tire factory, will increase the rate of per capita output growth until the steady state rate of growth is achieved; and (2) investment in research and development will boost growth even further, thus extending the abnormal growth period before diminishing marginal returns eventually set in
Trang 13In the years after the tire factory begins production, Sagara's GDP is expected to grow at a rate exceeding 10% annually, the per capita GDP will increase commensurately, and the country's literacy rate will double Manufacturing is likely to grow by 15% annually But this rapid growth will also bring concerns regarding regulation of the manufacturing sector The government has at times struggled to advance the regulatory structure to address problems associated with the impact of rapid growth on such problems as pollution, power outages, and water shortages Banantoumou is worried that companies have learned to preemptively cooperate with their regulators with the expectation that the regulators will favor their point of view over a competitor's
As the local financial markets evolve, N'Diarra recommends that she and Banantoumou study and discuss the legal and regulatory structure of the United States to generate ideas that they can implement in Sagara During their discussion, N'Diarra remarks, "In the United States, self-regulated organizations can become independent regulators empowered by a government agency to enforce laws The US government usually provides this type of regulator with funding."
1.) Of the factors cited by Banantoumou after the international leaders summit, which
is least likely to limit sustainable growth?
3.) N'Diarra's warning regarding the resource curse and its prevention is most likely
incorrect with respect to:
A her comments about both currency depreciation and direct ownership of rubber plantations
B her comment about currency depreciation
C her comment about owning rubber plantations directly
4.) N'Diarra's understanding of the two growth theories is most accurate with regard
to:
A endogenous growth theory
B both classical growth theory and endogenous growth theory
C classical growth theory
Trang 145.) Banantoumou's concern regarding the regulatory structure is most likely an example
B incorrect because SROs do not enforce laws
C incorrect because the US government does not fund independent regulators
Trang 15Treadway
Hannah Treadway is an analyst at Knight Investment Management Knight holds Cooper
Creek Cable Limited (CCCL) as part of its Australian and Far East investment portfolio CCCL
is a diversified cable and communications company operating in Western Australia The
company consists of three divisions:
Cable: Provides subscription television services and high speed internet to
residential customers
Media: Owns and operates a group of radio stations and publishes several
magazines
Wireless: Offers wireless voice and data communications services
Treadway is just starting her annual review of the company based on its most recent
financial statements, excerpts of which are shown in Exhibits 1 and 2 The financial
statements for CCCL are prepared in accordance with Australian Accounting Standards
(AASB) which comply with International Financial Reporting Standards (IFRS) All figures are
Exhibit 2: Cooper Creek Cable Limited Balance Sheet, As of 31 December
Trang 16Intangible assets, net 43,250 24,500
Total current liabilities 178,100 148,450
supported by cash flows and if the company might be trying to increase the appearance of profitability in order to increase the share price, which remains low
The wireless division was acquired by CCCL in a share purchase in late 2012 Treadway wants to review the accounting policies CCCL has adopted for both revenue and expenses incurred on long-term wireless contracts Excerpts of the accounting policies are shown in Exhibit 3
Exhibit 3: Excerpts of Accounting Policy Notes
(all figures A$ thousands)
Note 1 d) Long-Term Wireless Contracts
Customers who enter into long-term service contracts for wireless services can obtain their handsets for a nominal amount Commencing in 2013 the discount offered on the handsets, relative to the regular price, is capitalized as a customer acquisition cost and straight-line amortized over the life of the contract, or a minimum of three years
Note 1 g) Unearned Revenue
Unearned revenue for subscriptions, or for services paid in advance, was historically
recognized on a straight-line basis over the term of the contract or subscription After reviewing the historical pattern of usage and cancellations for service contracts in 2013, the pattern of recognition was changed to recognize the majority of the revenues in the first 12
Trang 17months after the service contract is signed and the remainder in the year following
Note 12) Broadcast Licenses
During 2013, the company successfully disposed of broadcast licenses that were held for sale for $37,900 (net book value of $23,500) Based on the successful completion of that sale, the impairment losses taken in 2011 on other licenses have been reversed, restoring those intangible assets to their amortized historical cost
After reading the note about the rapid reversal of the impairment loss related to the
broadcast licenses (Exhibit 3, Note 12), Treadway strongly believes that it arose as an
attempt by management to manage earnings She realizes that both her 2011 and 2012
analyses were affected by these actions and now need to be reconsidered
Finally, Treadway noted that during 2013, CCCL acquired 100% of MusicMusic (MM), a
specialty cable music channel At the time of the acquisition the company disclosed the
following information:
The company has assigned the following values to the two intangibles (the MusicMusic brand name and its associated broadcast licenses) that arise from this acquisition:
1.) The cash collected from customers in 2013 is closest to (A$ thousands):
3.) The change in which of the following items is most likely an indication that CCCL
might be recognizing revenue early?
A Deferred tax assets
B Days sales in receivables
C Unearned revenue
4.) The new accounting policy adopted in 2013 for the customer acquisition cost (Note
1d) most likely increases CCCL's:
Trang 18A cash from operations
B debt-to-asset ratio
C quality of earnings
5.) If Treadway's belief about management's motivation behind the 2011 treatment of the broadcast licenses is correct, compared with the economic reality in 2012, her
original 2012 analysis would most likely have:
A overstated net profit margin
B understated return on assets
C understated fixed asset turnover
6.) The amount of customer acquisition costs, Exhibit 3, Note 1d, capitalized during
2013 is closest to (A$ thousands):
A $18,500
B $6,000
C $13,500
Trang 19Ready Power
Ready Power Inc is a manufacturer of high-quality industrial electric generators Although many companies have been negatively affected by the continued global economic
weakness, Ready Power has experienced strong demand for its products, largely as a result
of several recent natural disasters and many occurrences of rolling brownouts and blackouts arising from excessive strains on power grids Although this strong demand has resulted in higher inventory costs in recent years, the company has been able to pass the cost on to customers through higher prices The company’s generators have expected useful lives of
about 25 years The company also normally depreciates its assets on a straight-line basis
Margo Lenz, CFA, an equity analyst at Livermore Investment Council, is reviewing Ready Power’s recent financial statements, which are prepared according to US GAAP
Exhibits 1 and 2 contain selected portions of the company’s statement of operations and statement of financial position, and Exhibit 3 contains selected notes from the company’s
Trang 20Exhibit 3: Ready Power Selected Notes to Consolidated Financial Statements Note 1 Operations and Summary of Significant Accounting Policies
F Depreciation and amortization
Depreciation of plant and equipment is computed using the straight-line
Total plant and
Less accumulated
Trang 21Harold Mays, one of Lenz’s assistants, made the following comments about Ready Power’s inventory policy:
1 One of the advantages of using LIFO is that it simplifies the accounting process for inventory because it gives the same results for inventory and cost of goods sold whether the company uses a periodic or perpetual inventory system
2 Another advantage of using LIFO is that it appears to improve the company’s cash conversion cycle
3 One disadvantage with LIFO, however, is that it is more likely that the company will incur inventory write-downs than under the first in, first out (FIFO) method
Lenz mentioned to Mays that earlier that day, she had seen Bill Jacobs, the CEO of Ready Power, in an exclusive interview on a cable news network specializing in financial news and information Lenz was particularly interested in the portion of the interview dealing with the company’s new program to lease electrical generators An excerpt from a transcript of the interview is shown in Exhibit 4
Exhibit 4: Excerpt from an Interview of Bill Jacobs on Cable TV, 4 March 2014
After reading the excerpt from the interview, Mays wondered what impact the company’s new position as a lessor and its classification of leases would have on the company’s future financial statements Finally, he comments:
1 For a given leased asset, in the initial year of the lease, Ready Power’s profits should be higher if the company classifies the lease as an operating lease
2 Regardless of how the company classifies a lease, its total cash flow and
operating cash flow over the lease term will be the same
3 The leasing program will decrease Ready Power’s liquidity position
1.) If Ready Power had used the FIFO method to account for its inventory, its cost of
goods sold (COGS) in 2013 would have been closest to (in millions):
A $17,694
B $16,287
C $17,764
D
2.) If Ready Power had been using FIFO accounting since incorporation, its retained
earnings at the end of 2013 would most likely be higher by (in millions):
Trang 223.) The statement in Note 1.D of Exhibit 3 concerning LIFO liquidations most likely
means that for the stated period:
A there were no inventory write-downs in either of the two years
B units manufactured (or purchased) equaled or exceeded unit sales for each year
C costs and prices must have been rising throughout
4.) With regard to Mays' comments about the LIFO method, which of his statements is
Trang 23Moyle
Bridget Moyle is a senior associate in the risk management division of ANM Financial
Advisers (ANMFA) Moyle specializes in the use of derivatives to help ANMFA manage its various risk exposures Moyle is meeting with two recently hired analysts, Jordan Petsas and Katy Iacocca Petsas and Iacocca have been asked to prepare for a discussion on the
fundamentals of futures, options, and swaps
Moyle asks, “Is it true that the futures price on an asset must equal the spot price of the asset on the expiration date of the futures contract? Explain why or why not.”
Petsas responds,
At expiration, futures prices and spot prices must converge If the spot price exceeds the futures price, then an investor could purchase the futures contract and execute the contract to purchase the underlying at the lower futures price, sell it at the higher spot price, and make an arbitrage profit If the spot price is less than the futures price at expiration, then an investor could purchase the asset at the spot price and enter into a short futures contract to sell it at the higher price, thus locking in a profit
Moyle provides Petsas and Iacocca with the following information for a Treasury bond and asks them to calculate the price of a futures contract on this bond The bond has a face value of $100,000, pays a 7% semiannual coupon, and matures in 15 years The bond is priced at $156,000 and yields 2.5% The futures contract expires in eight months, and the annualized risk-free rate is 1.5% There are multiple deliverable bonds, and the conversion factor for this bond is 1.098
The next item on the agenda is a discussion of option valuation models Moyle states, “We are currently considering the purchase of put options on shares of the Rousseff Corporation Selected information is provided in Exhibit 1
Exhibit 1: Selected Stock and Options Data for Rousseff Corporation and the Risk-Free
Interest Rate
Iacocca responds, “In general, we could value the option using either the Black–Scholes–Merton model or the binomial option pricing model But there is not enough information presented to use the Black–Scholes–Merton model.”
Trang 24“That is correct,” states Moyle, and continues, “With respect to the Black–Scholes–Merton model, can you explain how the risk-free rate, time to expiration, and volatility affect European option prices?”
In answer to Moyle’s question, Iacocca states, “Higher risk-free rates result in lower call and put option prices Longer times to expiration result in higher call prices, but the impact on put prices is unclear Higher volatility results in higher call and put option prices.”
The group turns its attention to swaps Moyle states, “As you all know, a plain vanilla
interest rate swap allows the buyer of the swap to make a fixed payment and receive a variable payment Can you explain how these interest rate swaps can be described as being equivalent to a combination of other assets?”
Petsas responds, “An interest rate swap can be viewed as a series of forward rate
agreements (FRAs) priced at the swap fixed rate or as a combination of a purchase of an interest rate call option and the purchase of an interest rate put option.”
Finally, Moyle presents the term structure of Libor spot rates in Exhibit 2 and asks Iacocca and Petsas to use this information to calculate the annualized swap fixed rate on a one-year interest rate swap with quarterly payments, for which the underlying is 90-day Libor
Exhibit 2: Current Libor Term Structure of
1.) Is Petsas' response to Moyle regarding futures and spot prices most likely correct?
A No, the explanation of when the spot price exceeds the futures price is incorrect
B Yes
C No, the explanation of when the spot price is less than the futures price is incorrect
2.) Based on the information provided by Moyle, the futures price on the Treasury
bond is closest to:
A $140,298
B $154,047
C $143,494
Trang 253.) Based on the information in Exhibit 1, the price of the put option using the
two-period binomial option pricing model is closest to:
A $9.31
B $14.98
C $1.96
4.) With respect to Moyle's question about the impact of selected inputs on the price of
options, Iacocca is least likely correct about:
A volatility
B time to expiration
C the risk-free rate
5.) Is Petsas' response to Moyle regarding an interest rate swap most likely correct?
A No, he is incorrect about the combination of calls and puts
B No, he is incorrect about the pricing of FRAs
double-digit sales growth on a year-over-year basis
Metiu Metev, a portfolio strategist at a major German investment consulting firm, inherited RRBL from his grandparents Frankfurter Destillerie & LiqueurFabrik (FDLF), a German distillery interested in entering the Bulgarian market, has made a cash offer of BGN900 million for the company’s equity (BGN = Bulgarian Lev; EUR1 = BGN1.95586, pegged rate) FDLF will assume RRBL’s entire outstanding debt, including both current liabilities and long-term debt If Metev does not want to sell a controlling interest, FDLF’s minimum equity stake will be 40%, with an appropriate discount for lack of control
Metev starts by evaluating the company himself using the capitalized cash flow method (CCM) and taking the following steps:
· Using the build-up method to estimate the required rate of return on equity
Trang 26· Computing the firm’s weighted average cost of capital (WACC) using the book values
of debt and considering the current weight of total debt in capital structure to be optimal
Exhibits 1A, 1B, 2, and 3 contain RRBL’s financial data and other inputs that Metev uses Before responding to FDLF’s offer, however, Metev meets with Vasil Nenkov, his colleague and a senior equity analyst covering the wine and beer industry in the Balkan region After reviewing the data and Metev’s valuation analysis, Nenkov suggests that 11% would be a more reasonable estimate of RRBL’s WACC based on an analysis of industry peers Metev decides to use this rate to calculate the value of RRBL’s equity
Nenkov also makes the following comments:
1 CCM is most often used for the valuation of large public companies, and it is less valid for valuing private companies, such as RRBL
2 The excess earnings method is preferable because it provides an estimate of the value of intangible assets by capitalizing future earnings in excess of the estimated return requirements associated with working capital and fixed assets
Nenkov also suggests that the enterprise value (EV) multiple approach should work well for valuing RRBL After searching his database, Nenkov finds that Rhodopi Wineries PLC, a publicly traded company and a close competitor of RRBL, is currently valued at an
EV/EBITDA (earnings before interest, taxes, depreciation, and amortization) multiple of 7.2 Nenkov further suggests two adjustments:
RRBL should command an upward adjustment of 25% in the EV/EBITDA multiple reflecting its lower risk and higher growth relative to Rhodopi Wineries
Forward-looking EBITDA should be used to determine RRBL’s value
On a cautionary note, Nenkov makes two statements regarding the use of EV/EBITDA approach to valuation
1 It is more appropriate than the P/E for comparing companies with different financial leverage
2 EBITDA underestimates cash flow from operations if working capital is growing Finally, Metev recalls FDLF’s willingness to purchase a non-controlling ownership interest at
a discount for lack of control Nenkov responds by saying that a control premium of 30% is typically applied for purchase transactions of small privately owned firms similar to RRBL and proper adjustment for lack of control should be made if the transaction involves a non-controlling interest Metev thanks Nenkov for his help and goes back to his desk to revise his valuations
Exhibit 1A: RRBL EBITDA and Other Data
(Actual) (Pro Forma)
Trang 27Cost of goods sold –132.3 –172.5
Exhibit 1B: Additional Information for RRBL
Weight of total debt in capital
Exhibit 2: RRBL Balance Sheet for FY2012
(BGN millions)
Cash and short-term
Receivables and
Patents and
Trang 28Exhibit 3: Other Data and Inputs
Bulgarian government’s 10-year bond yield 3.90%
Beta of publicly traded firms in the
RRBL’s company-specific risk premium 1.50%
Long-term growth rate beyond FY2013 5.00%
1.) According to the method used by Metev for computing the cost of equity and data
in Exhibits 1B and 3, RRBL's WACC is closest to:
A 10.9%
B 11.3%
C 9.2%
2.) According to the revised method used by Metev, the WACC suggested by Nenkov,
and the data provided in Exhibit 3, RRBL's capitalization rate is closest to:
A 11.0%
B 6.0%
C 8.5%
3.) Regarding the two comments that Nenkov made after reviewing Metev's valuation
analysis, he is most accurate with respect to:
5.) Regarding Nenkov's two cautionary statements concerning the use of the enterprise
value method of valuation, he is most likely correct with respect to:
Trang 29A both Statements 1 and 2
B Statement 1 only
C Statement 2 only
6.) The discount for lack of control, given the typical control premium indicated by
Nenkov, is closest to:
A 12%
B 30%
C 23%
Trang 30Richter
Katharina Richter, CFA, is a fixed-income analyst at Paar Advisers, an investment advisory firm She is evaluating a set of mortgage-backed securities (MBS) so that she can make recommendations about those securities for the firm's clients
The securities, which are not yet issued, will be backed by a pool that currently contains
$117.54 million of US 30-year residential mortgages The pool has a weighted average coupon (WAC) of 4.80% and a weighted average maturity (WAM) of 243 months, which implies 17 months of seasoning Richter reviews current prepayment estimates for this pool from three different providers The first estimates a conditional prepayment rate (CPR) of 8.50%; the second, a prepayment speed of 220 PSA (Public Securities Association
prepayment benchmark); and the third, a single monthly mortality rate (SMM) of 0.70% As Richter reads about one provider's prepayment expectations, she finds the following
statement: "Although US mortgage interest rates are very low relative to the historical average, rates have been this low or lower for a number of years Furthermore, the general state of the economy is very poor These factors cause us to expect low prepayment rates for the coming months." After some analysis, Richter realizes market conditions are such that these securities will not to be issued for another two months At issue, the pool will not
be replenished with new mortgage loans She adjusts her analysis of the pool, using the SMM estimate of 0.70%, to reflect this delay
One of Paar's clients, Konrad Hartmann, is concerned that mortgage interest rates might rise
by about 1% in the near future and remain at that higher level for some time He asks Richter which of the many types of collateralized mortgage obligation (CMO) tranches and stripped MBS would perform best if his concerns are realized Hartmann is also interested in the characteristics of MBS He tells Richter that he understands that MBS are considered path-dependent securities for three reasons:
Reason 1 The influence of earlier prepayments on current cash flows
Reason 2 The tendency of few mortgage borrowers to prepay early in the life of their mortgages
Reason 3 The way the current prepayment rate reflects whether borrowers have already had an opportunity to refinance at the current mortgage rate
Hartmann shows Richter some spread information he has received regarding three CMO tranches This information is shown in Exhibit 1 He tells Richter that he would be happy to invest in any of these securities based on their other characteristics and asks which he should choose, based solely on this information
Trang 31Exhibit 1: Spread Comparison
1.) Of the three prepayment estimates Richter reviews, the highest is most likely the
one presented in terms of:
B incorrect with regard to the impact of current mortgage rates
C incorrect with regard to the impact of current economic conditions
3.) The expected balance of the mortgage pool Richter is analyzing on the revised date
of issue is closest to:
Trang 32C Security X
Trang 33Shah
Vikram Shah works as a portfolio manager for Heddon Investment Advisers Shah is meeting with the investment committee of a corporate pension fund to discuss portfolio
performance as well as strategies and techniques used in the management of the pension
fund For the meeting, Shah has collected the information shown in Exhibit 1
Cap US Stocks Expected Annual Return
Shah explains that his firm uses mean–variance portfolio analysis to guide asset allocation
He states:
We use mathematical techniques to identify a set of efficient portfolios From this set, we select a portfolio that best matches our risk preferences The pension fund’s assets are currently invested in the following proportions: 60% US large-cap stocks, 35% US
investment-grade corporate bonds, and 5% emerging market stocks Our analysis suggests that we should modify our current allocations so that the new allocations are 55% US large-cap stocks, 30% US investment-grade corporate bonds, and 15% emerging market stocks This reallocation will result in a mean–variance efficient portfolio that is better aligned with our risk preferences
Jerry Cramer, a member of the investment committee, wants to know how correlations between securities and the number of securities in the portfolio affect the pension
portfolio’s diversification benefits
Shah responds, “As the average correlation between securities in a portfolio increases, the risk reduction benefits of diversification decrease Furthermore, as the average correlation between securities in a portfolio rises, the number of securities in the portfolio must be
Trang 34increased in order to achieve the same percentage of portfolio risk reduction when the average correlation between securities is lower.”
Another board member, Kala Amato, notes that no part of the pension portfolio is invested
in a risk-free asset She wants to know the impact of combining the current portfolio with an investment in a risk-free asset
In response, Shah states: “If we combine our portfolio with an investment in a risk-free asset, the result will be a new linear efficient frontier that is referred to as the capital allocation line (CAL), or the capital market line (CML) The risk and return of the resulting new portfolio will be linear combinations of the risk and return of the risk-free investment and our portfolio.”
Cramer asks Shah, “Can you explain the model that you use to select stocks for inclusion in the equity portion of the pension portfolio?”
Shah responds, “At Heddon, the primary model we use is a multifactor model in which the factors are price-to-earnings ratio (P/E), financial leverage, and market capitalization.”
Shah moves on to a discussion about how Heddon assesses portfolio risk He states, “We use a risk model to decompose active risk into the following two components:
Component 1
This component is referred to as ‘active factor risk,’ which is systematic risk attributable to differences in factor exposures between the portfolio and the benchmark Note that the factors in our model are P/E, financial leverage, and market capitalization
Component 2
The second component is a function of the individual asset’s active weight in the portfolio and the variance of returns unexplained by the three factors This component is the active specific risk or asset selection risk.”
Shah continues, “We prefer to structure our portfolio so that in addition to being on the efficient frontier, it tilts, relative to the benchmark, toward stocks of large-capitalization companies with lower P/Es and lower levels of leverage Exhibit 2 shows the factor
sensitivities for the recommended portfolio and the benchmark.”
Exhibit 2: Factor Sensitivity
1.) Based on the information presented in Exhibit 1, the standard deviation of Shah's
new portfolio is closest to:
Trang 35certain level of risk diversification most likely correct?
A No, he is incorrect about average correlation and the number of securities required to achieve a certain level of portfolio risk diversification
B No, he is incorrect about the impact of average correlation on risk diversification
C Yes
3.) In his response to Amato, Shah is most likely correct with respect to the:
A risk and return of the new portfolio
B CAL and the CML
C new efficient frontier
4.) Shah's response to Cramer's question regarding the model used by Heddon
Investment Advisers would imply that the multifactor model is most likely a:
A fundamental factor model
B macroeconomic factor model
C statistical factor model
5.) Is Shah correct about the components of active risk?
A Yes
B No, he is incorrect about Component 1
C No, he is incorrect about Component 2
6.) With respect to the factor tilts of the portfolio in Exhibit 2, Shah is least likely correct
about the:
A market capitalization
B financial leverage
C P/E
Trang 39Kostecka
Jacob Kostecka, CFA, is a portfolio manager at Forkson Investment Management, an asset management and research focused organization After obtaining his CFA charter last month,
Kostecka was transferred to the private wealth management division at Forkson
Dharshi Bope, a private wealth client, was involved in a major motorcycle accident and is in critical condition, fighting for his life Bope is a single parent with a daughter, Paveen Nathoo, in her mid-twenties Since the accident, Nathoo has managed her father’s affairs, paying all expenses, including investment advisory fees In several conversations with Nathoo, Kostecka highlighted Bope’s low risk tolerance and investment goal of capital preservation Nathoo has indicated her interest in managing the account more aggressively and possibly moving to another management firm Nathoo recently petitioned the court to appoint her full power of attorney to legally manage Bope’s affairs Prior to the court decision, Nathoo asks Kostecka to invest her father’s account in the initial public offering (IPO) of Chatterbox, a highly sought after social media company that has yet to generate a profit
The following week, the court approves Nathoo’s request to act on behalf of her father Going through records in her father’s home, Nathoo discovers documents showing Bope embezzled several million dollars from his employer, a real estate development company Most of these funds were placed directly into Bope’s personal account, for which Nathoo is now responsible Nathoo informs Kostecka about her discovery; however, Kostecka does not act on this
information, however, because it is a large account for Forkson
Nathoo establishes a non-discretionary investment account at Forkson tied to her newly
established business Shortly thereafter, Kostecka joins the board of Jabbertalk.com, a smaller social media competitor to Chatterbox Based on his knowledge of Chatterbox, Kostecka
believes the stock of Jabbertalk is a good investment, even though it is not yet profitable Buoyed by his faith in social media, Kostecka ultimately purchases shares of Jabbertalk’s IPO for Nathoo’s account, as well as for all clients he currently manages When Kostecka informs Nathoo of the purchase, she expresses concern about her legal responsibilities and lack of accounting knowledge in overseeing the account Kostecka provides Nathoo a list of
recommended professionals he has worked with in the past, including attorneys and
accountants When he was in college 10 years earlier, Kostecka was engaged to one of the attorneys but broke off the relationship prior to their wedding, and one of the accountants was Kostecka’s college roommate Since then, Kostecka has not had any contact with the lawyer and accountant
The Jabbertalk investment is profitable on the first day of trading, doubling from its opening price Kostecka tells his clients the multifactor valuation model used by Forkson shows
Jabbertalk stock is still undervalued Forkson’s research report, due out the next day, will recommend investors hold their Jabbertalk shares However, Kostecka tells all his clients
simultaneously they should sell their shares because he believes Jabbertalk is overvalued and the stock price will fall soon Kostecka notes he has followed through on this belief by selling his personal holdings of Jabbertalk shares Nathoo ignores Kostecka’s recommendation to sell Jabbertalk Over the next week, the stock declines 75%
Trang 40Watching Jabbertalk’s severe share price decline, Nathoo becomes furious with Kostecka because he did not sell shares of Jabbertalk in her account She files a complaint with Kostecka’s supervisor, Sally Fang, CFA, claiming she was misled on the value of the IPO in the days
immediately after the stock started trading Kostecka responds to the complaint by telling Fang,
“the analyst who wrote the hold recommendation on Jabbertalk has only passed his CFA Level II examination As a charterholder, I have earned the right to use the CFA designation, so I am more qualified to manage clients’ investments.”
In order to build his client base, Kostecka prepares performance information to show
prospective clients He includes the firm’s composite performance based on similar
discretionary client portfolios that are in compliance with the GIPS Standards In addition, Kostecka prepares his own composite performance, including all accounts he manages This presentation includes Nathoo’s account assuming she had sold her shares of Jabbertalk Along with his performance record, Kostecka provides a footnote disclosing the following language: “If your account is managed on a discretionary basis, you might expect results similar to those shown above.”
1.) With regard to the investment request made by Nathoo to invest in Chatterbox,
Kostecka should most likely:
A seek advice from the court
B comply with her request
C follow Bope’s investment goals
Answer = C
“Guidance for Standards I–VII”, by CFA Institute
Standard III(A): Loyalty, Prudence, and Care; Standard III(C): Suitability
The account should be managed according to the client’s investment goal of capital preservation and a low risk tolerance Under Standard III (A) Loyalty, Prudence, and Care, the first step for members and candidates in fulfilling their duty of loyalty to clients is to determine the identity of the “client” to whom the duty of loyalty is owed Only when the daughter is granted legal responsibility over her father’s affairs by the court does she become the client
2.) By not acting on the information reported by Nathoo, which CFA Institute Standard of
Professional Conduct has Kostecka least likely violated?
A Loyalty, Prudence, and Care
B Duties to Employers
C Knowledge of the Law
Answer = A
“Guidance for Standards I–VII”, by CFA Institute
Standard I (A) Knowledge of the Law, Standard III (A) Loyalty, Prudence, and Care Standard IV (A) Duties to Employers (Loyalty)