CFA-Institute CFA-Level-II Exam Dumps

CFA Level II Chartered Financial Analyst

CFA-Institute CFA-Level-II Sample Questions

Question # 1

Ivan Johnson is reviewing the investment merits of BioTLab, a fast-growing biotechnology company.BioTLab has developed several drugs, which arc being licensed to major drug companies. BioTLabalso has several drugs in phase III trials (phase III trials are the last testing stage before FDAapproval). Johnson notes that two drugs recently received approval which should provide BioTLabsolid revenue growth and generate predictable cash flow well into the future. Based on the potentialfor the two drugs, BioTLab's estimated annual cash flow growth rate for the next two years is 25%,and long-term growth is expected to be 12%. Because of BioTLab's attractive investmentopportunities, the company does not pay a dividend. BioTLab's current weighted average cost ofcapital is 15% and its stock is currently trading at $50 per share. Financial information for BioTLab forthe most recent 12 months is provided below:• Net working capita! excluding cash increased from $7,460,000 to $9,985,000;• Book value increased from $81,250,000 to $101,250,000.• BioTLab currently has no debt.• Research facilities and production equipment were purchased for $8,450,000.• BioTLab held non-operating assets in the amount of $875,000.• Net income for the 12 months was $20,000,000.• BioTLab has a marginal tax rate of 40%.• Noncash charges for depreciation and restructuring for the 12 months were $1,250,000.BioTLab's management has indicated an interest in establishing a dividend and will fund new drugresearch by issuing additional debt.Johnson also reviews a competitor to BioTLab, Groh Group, which has a larger segment operating ina highly cyclical business. The Groh Group has a debt to equity ratio of 1.0 and pays no dividends. Inaddition, Groh Group plans to issue bonds in the coming year.Which of the following statements regarding free cash flow models is least likely correct?

A. Sensitivity analysis indicates that the FCFE model's valuation of BioTLab's common stock is most sensitive to the company's growth rate.
B. FCFE is net income plus depreciation minus net capital expenditures minus the increase in working capital plus net new debt financing.  
C. FCFF can be inflated by increasing capital expenditures relative to depreciation. 

Show Answer

Question # 2

Ivan Johnson is reviewing the investment merits of BioTLab, a fast-growing biotechnology company.BioTLab has developed several drugs, which arc being licensed to major drug companies. BioTLabalso has several drugs in phase III trials (phase III trials are the last testing stage before FDAapproval). Johnson notes that two drugs recently received approval which should provide BioTLabsolid revenue growth and generate predictable cash flow well into the future. Based on the potentialfor the two drugs, BioTLab's estimated annual cash flow growth rate for the next two years is 25%,and long-term growth is expected to be 12%. Because of BioTLab's attractive investmentopportunities, the company does not pay a dividend. BioTLab's current weighted average cost ofcapital is 15% and its stock is currently trading at $50 per share. Financial information for BioTLab forthe most recent 12 months is provided below:• Net working capita! excluding cash increased from $7,460,000 to $9,985,000;• Book value increased from $81,250,000 to $101,250,000.• BioTLab currently has no debt.• Research facilities and production equipment were purchased for $8,450,000.• BioTLab held non-operating assets in the amount of $875,000.• Net income for the 12 months was $20,000,000.• BioTLab has a marginal tax rate of 40%.• Noncash charges for depreciation and restructuring for the 12 months were $1,250,000.BioTLab's management has indicated an interest in establishing a dividend and will fund new drugresearch by issuing additional debt.Johnson also reviews a competitor to BioTLab, Groh Group, which has a larger segment operating ina highly cyclical business. The Groh Group has a debt to equity ratio of 1.0 and pays no dividends. Inaddition, Groh Group plans to issue bonds in the coming year.Which model would be most appropriate in valuing the Groh Group?

A. FCFF model. 
B. FCFE model. 
C. Dividend Discount model. 

Show Answer

Question # 3

Ivan Johnson is reviewing the investment merits of BioTLab, a fast-growing biotechnology company.BioTLab has developed several drugs, which arc being licensed to major drug companies. BioTLabalso has several drugs in phase III trials (phase III trials are the last testing stage before FDAapproval). Johnson notes that two drugs recently received approval which should provide BioTLabsolid revenue growth and generate predictable cash flow well into the future. Based on the potentialfor the two drugs, BioTLab's estimated annual cash flow growth rate for the next two years is 25%,and long-term growth is expected to be 12%. Because of BioTLab's attractive investmentopportunities, the company does not pay a dividend. BioTLab's current weighted average cost ofcapital is 15% and its stock is currently trading at $50 per share. Financial information for BioTLab forthe most recent 12 months is provided below:• Net working capita! excluding cash increased from $7,460,000 to $9,985,000;• Book value increased from $81,250,000 to $101,250,000.• BioTLab currently has no debt.• Research facilities and production equipment were purchased for $8,450,000.• BioTLab held non-operating assets in the amount of $875,000.• Net income for the 12 months was $20,000,000.BioTLab has a marginal tax rate of 40%.• Noncash charges for depreciation and restructuring for the 12 months were $1,250,000.BioTLab's management has indicated an interest in establishing a dividend and will fund new drugresearch by issuing additional debt.Johnson also reviews a competitor to BioTLab, Groh Group, which has a larger segment operating ina highly cyclical business. The Groh Group has a debt to equity ratio of 1.0 and pays no dividends. Inaddition, Groh Group plans to issue bonds in the coming year.If BioTLabs establishes a dividend and issues additional debt, the most likely effect on FCFF will be;

A. no effect. 
B. a decrease in FCFF. 
C. an increase in FCFF. 

Show Answer

Question # 4

Ivan Johnson is reviewing the investment merits of BioTLab, a fast-growing biotechnology company.BioTLab has developed several drugs, which arc being licensed to major drug companies. BioTLabalso has several drugs in phase III trials (phase III trials are the last testing stage before FDAapproval). Johnson notes that two drugs recently received approval which should provide BioTLabsolid revenue growth and generate predictable cash flow well into the future. Based on the potentialfor the two drugs, BioTLab's estimated annual cash flow growth rate for the next two years is 25%,and long-term growth is expected to be 12%. Because of BioTLab's attractive investmentopportunities, the company does not pay a dividend. BioTLab's current weighted average cost ofcapital is 15% and its stock is currently trading at $50 per share. Financial information for BioTLab forthe most recent 12 months is provided below:• Net working capita! excluding cash increased from $7,460,000 to $9,985,000;• Book value increased from $81,250,000 to $101,250,000.• BioTLab currently has no debt.• Research facilities and production equipment were purchased for $8,450,000.• BioTLab held non-operating assets in the amount of $875,000.• Net income for the 12 months was $20,000,000.• BioTLab has a marginal tax rate of 40%.• Noncash charges for depreciation and restructuring for the 12 months were $1,250,000.BioTLab's management has indicated an interest in establishing a dividend and will fund new drugresearch by issuing additional debt.Johnson also reviews a competitor to BioTLab, Groh Group, which has a larger segment operating ina highly cyclical business. The Groh Group has a debt to equity ratio of 1.0 and pays no dividends. Inaddition, Groh Group plans to issue bonds in the coming year.Using a two-stage, free cash flow to the firm model, determine which of the following is closest tothe value of BioTLab.

A. $419 million. 
B. $436 million. 
C. $477 million. 

Show Answer

Question # 5

Ivan Johnson is reviewing the investment merits of BioTLab, a fast-growing biotechnology company.BioTLab has developed several drugs, which arc being licensed to major drug companies. BioTLabalso has several drugs in phase III trials (phase III trials are the last testing stage before FDAapproval). Johnson notes that two drugs recently received approval which should provide BioTLabsolid revenue growth and generate predictable cash flow well into the future. Based on the potentialfor the two drugs, BioTLab's estimated annual cash flow growth rate for the next two years is 25%,and long-term growth is expected to be 12%. Because of BioTLab's attractive investmentopportunities, the company does not pay a dividend. BioTLab's current weighted average cost ofcapital is 15% and its stock is currently trading at $50 per share. Financial information for BioTLab forthe most recent 12 months is provided below:• Net working capita! excluding cash increased from $7,460,000 to $9,985,000;• Book value increased from $81,250,000 to $101,250,000.• BioTLab currently has no debt.• Research facilities and production equipment were purchased for $8,450,000.• BioTLab held non-operating assets in the amount of $875,000.• Net income for the 12 months was $20,000,000.• BioTLab has a marginal tax rate of 40%.• Noncash charges for depreciation and restructuring for the 12 months were $1,250,000.BioTLab's management has indicated an interest in establishing a dividend and will fund new drugresearch by issuing additional debt.Johnson also reviews a competitor to BioTLab, Groh Group, which has a larger segment operating ina highly cyclical business. The Groh Group has a debt to equity ratio of 1.0 and pays no dividends. Inaddition, Groh Group plans to issue bonds in the coming year.Johnson prefers to use free cash flow analysis to value investments. Which of the statements belowis least accurate in describing the advantages of free cash flow valuation models?

A. Accounting issues limit the usefulness of reported earnings, while free cash flow is adjusted for these issues.
B. Determining free cash flow is easier than dividends. 
C. A company must generate free cash flow to grow in the long run. 

Show Answer

Question # 6

Richard Grass is the healthcare analyst for Furrnon Investments and is reviewing the investmentmerits of the developing hospice industry. The hospice industry has a short history in the publicmarket, as several companies have recently completed their initial public offering. Hospice servicesare provided to patients diagnosed with terminal illness as an alternative to aggressive medicalmanagement. The use of hospice services at skilled nursing facilities and assisted-living facilities isforecasted to continue its recent growth. Medicare is the primary payer for hospice services,accounting for 85% of the approximately $7 billion in industry's revenues. Hospice providers offersymptom and pain management to patients diagnosed with a terminal illness by their physician. Theprogram was added to the Medicare benefit package in the early 1980s. Growth in the sector hasonly recently. accelerated due to the emergence of a number of for-profit companies. The caregiverprovides a plan for each admitted patient and care is given in any number of healthcareenvironments, including the patient's home.Grass's analysis of the hospice industry has uncovered several facts that are outlined below:• The industry's revenue annual growth rate has increased from 14% in the late 1990s to 25% in2008.• The average length of stay at facilities for hospice patients is increasing.• Labor costs account for 75% of total expenses, drugs 15% of total expenses, and medical supplies10%.• More than 80% of hospice patients are above 65 years old and 30% are above 85 years old.• Based on the U.S. Census Bureau's statistics, over the next six years (2009-2015), the number ofpeople in the 65 and older age group will increase annually by 1.4%.• The Medicare hospice benefit is still underutilized by the terminally ill population, according toMedPac (an independent advisory committee for the U.S. Congress on healthcare issues).• Only 30% of Medicare beneficiaries enroll in the hospice benefit before they die.• In recent years, the U.S. government has approved rate increases for the sector compared to flat ordeclining rate trends for other healthcare services.• The Medicare hospice program has a beneficiary cap which cannot exceed approximately $18,000annually per person.• The top six for-profit providers account for about half of the segment's sales.• The overall hospice provider market is roughly divided into 55% non-profit, 10% U.S. government,and 35% for-profit.Grass's analysis has narrowed his search to Hope Company. Hope controls about 7% of the totalhospice service market or 20% of the for-profit market. The company has the only regulatorapproved for-profit certificate for the state of Florida, one of the most attractive markets in theUnited States. In addition to a strong market share in Florida, Hope has a strong presence in urbanmarkets like Dallas and San Francisco. Hope has a more diversified revenue base than other publiclytraded for-profit providers.Grass is forecasting Hope Company's revenues and profits for the next year. Which of the followingstatements is least likely a risk Grass should consider in developing his forecast? FurmonInvestment's economist is forecasting a:

A. reduction in Medicare's benefit package. 
B. recession for the U.S. economy. 
C. larger than expected increase for healthcare labor expenditures. 

Show Answer

Question # 7

Richard Grass is the healthcare analyst for Furrnon Investments and is reviewing the investmentmerits of the developing hospice industry. The hospice industry has a short history in the public market, as several companies have recently completed their initial public offering. Hospice servicesare provided to patients diagnosed with terminal illness as an alternative to aggressive medicalmanagement. The use of hospice services at skilled nursing facilities and assisted-living facilities isforecasted to continue its recent growth. Medicare is the primary payer for hospice services,accounting for 85% of the approximately $7 billion in industry's revenues. Hospice providers offersymptom and pain management to patients diagnosed with a terminal illness by their physician. Theprogram was added to the Medicare benefit package in the early 1980s. Growth in the sector hasonly recently. accelerated due to the emergence of a number of for-profit companies. The caregiverprovides a plan for each admitted patient and care is given in any number of healthcareenvironments, including the patient's home.Grass's analysis of the hospice industry has uncovered several facts that are outlined below:• The industry's revenue annual growth rate has increased from 14% in the late 1990s to 25% in2008.• The average length of stay at facilities for hospice patients is increasing.• Labor costs account for 75% of total expenses, drugs 15% of total expenses, and medical supplies10%.• More than 80% of hospice patients are above 65 years old and 30% are above 85 years old.• Based on the U.S. Census Bureau's statistics, over the next six years (2009-2015), the number ofpeople in the 65 and older age group will increase annually by 1.4%.• The Medicare hospice benefit is still underutilized by the terminally ill population, according toMedPac (an independent advisory committee for the U.S. Congress on healthcare issues).• Only 30% of Medicare beneficiaries enroll in the hospice benefit before they die.• In recent years, the U.S. government has approved rate increases for the sector compared to flat ordeclining rate trends for other healthcare services.• The Medicare hospice program has a beneficiary cap which cannot exceed approximately $18,000annually per person.• The top six for-profit providers account for about half of the segment's sales.• The overall hospice provider market is roughly divided into 55% non-profit, 10% U.S. government,and 35% for-profit.Grass's analysis has narrowed his search to Hope Company. Hope controls about 7% of the totalhospice service market or 20% of the for-profit market. The company has the only regulatorapproved for-profit certificate for the state of Florida, one of the most attractive markets in theUnited States. In addition to a strong market share in Florida, Hope has a strong presence in urbanmarkets like Dallas and San Francisco. Hope has a more diversified revenue base than other publiclytraded for-profit providers.Grass is reviewing Hope Company's pricing policy. Which of the following factors is least likely tocontribute to the company's pricing policy?

A. Hope Company relies on many different medical suppliers. 
B. Hope Company provides a unique service for its customer. 
C. Competitors are having difficulty entering many of Hope's key markets. 

Show Answer

Question # 8

Richard Grass is the healthcare analyst for Furrnon Investments and is reviewing the investmentmerits of the developing hospice industry. The hospice industry has a short history in the publicmarket, as several companies have recently completed their initial public offering. Hospice servicesare provided to patients diagnosed with terminal illness as an alternative to aggressive medicalmanagement. The use of hospice services at skilled nursing facilities and assisted-living facilities isforecasted to continue its recent growth. Medicare is the primary payer for hospice services,accounting for 85% of the approximately $7 billion in industry's revenues. Hospice providers offersymptom and pain management to patients diagnosed with a terminal illness by their physician. Theprogram was added to the Medicare benefit package in the early 1980s. Growth in the sector hasonly recently. accelerated due to the emergence of a number of for-profit companies. The caregiver provides a plan for each admitted patient and care is given in any number of healthcareenvironments, including the patient's home.Grass's analysis of the hospice industry has uncovered several facts that are outlined below:• The industry's revenue annual growth rate has increased from 14% in the late 1990s to 25% in2008.• The average length of stay at facilities for hospice patients is increasing.• Labor costs account for 75% of total expenses, drugs 15% of total expenses, and medical supplies10%.• More than 80% of hospice patients are above 65 years old and 30% are above 85 years old.• Based on the U.S. Census Bureau's statistics, over the next six years (2009-2015), the number ofpeople in the 65 and older age group will increase annually by 1.4%.• The Medicare hospice benefit is still underutilized by the terminally ill population, according toMedPac (an independent advisory committee for the U.S. Congress on healthcare issues).• Only 30% of Medicare beneficiaries enroll in the hospice benefit before they die.• In recent years, the U.S. government has approved rate increases for the sector compared to flat ordeclining rate trends for other healthcare services.• The Medicare hospice program has a beneficiary cap which cannot exceed approximately $18,000annually per person.• The top six for-profit providers account for about half of the segment's sales.• The overall hospice provider market is roughly divided into 55% non-profit, 10% U.S. government,and 35% for-profit.Grass's analysis has narrowed his search to Hope Company. Hope controls about 7% of the totalhospice service market or 20% of the for-profit market. The company has the only regulatorapproved for-profit certificate for the state of Florida, one of the most attractive markets in theUnited States. In addition to a strong market share in Florida, Hope has a strong presence in urbanmarkets like Dallas and San Francisco. Hope has a more diversified revenue base than other publiclytraded for-profit providers.Grass's research report on Hope Company is positive on its investment merits. Grass's report states,"Hope is uniquely positioned in the hospice industry" Which of the following best supports hiscomment?

A. Hope Company's strong presence in the Florida market. 
B. Hope Company relies on the Medicare program for a majority of its revenues. 
C. Hope Company's diversified revenue base has allowed the company to expand beyond the hospice sector.

Show Answer

Question # 9

Richard Grass is the healthcare analyst for Furrnon Investments and is reviewing the investmentmerits of the developing hospice industry. The hospice industry has a short history in the publicmarket, as several companies have recently completed their initial public offering. Hospice servicesare provided to patients diagnosed with terminal illness as an alternative to aggressive medicalmanagement. The use of hospice services at skilled nursing facilities and assisted-living facilities isforecasted to continue its recent growth. Medicare is the primary payer for hospice services,accounting for 85% of the approximately $7 billion in industry's revenues. Hospice providers offersymptom and pain management to patients diagnosed with a terminal illness by their physician. Theprogram was added to the Medicare benefit package in the early 1980s. Growth in the sector hasonly recently. accelerated due to the emergence of a number of for-profit companies. The caregiverprovides a plan for each admitted patient and care is given in any number of healthcareenvironments, including the patient's home.Grass's analysis of the hospice industry has uncovered several facts that are outlined below:• The industry's revenue annual growth rate has increased from 14% in the late 1990s to 25% in2008.• The average length of stay at facilities for hospice patients is increasing.• Labor costs account for 75% of total expenses, drugs 15% of total expenses, and medical supplies10%.• More than 80% of hospice patients are above 65 years old and 30% are above 85 years old.• Based on the U.S. Census Bureau's statistics, over the next six years (2009-2015), the number ofpeople in the 65 and older age group will increase annually by 1.4%.• The Medicare hospice benefit is still underutilized by the terminally ill population, according toMedPac (an independent advisory committee for the U.S. Congress on healthcare issues).• Only 30% of Medicare beneficiaries enroll in the hospice benefit before they die.• In recent years, the U.S. government has approved rate increases for the sector compared to flat ordeclining rate trends for other healthcare services.• The Medicare hospice program has a beneficiary cap which cannot exceed approximately $18,000• More than 80% of hospice patients are above 65 years old and 30% are above 85 years old.• Based on the U.S. Census Bureau's statistics, over the next six years (2009-2015), the number ofpeople in the 65 and older age group will increase annually by 1.4%.• The Medicare hospice benefit is still underutilized by the terminally ill population, according toMedPac (an independent advisory committee for the U.S. Congress on healthcare issues).• Only 30% of Medicare beneficiaries enroll in the hospice benefit before they die.• In recent years, the U.S. government has approved rate increases for the sector compared to flat ordeclining rate trends for other healthcare services.• The Medicare hospice program has a beneficiary cap which cannot exceed approximately $18,000annually per person.• The top six for-profit providers account for about half of the segment's sales.• The overall hospice provider market is roughly divided into 55% non-profit, 10% U.S. government,and 35% for-profit.Grass's analysis has narrowed his search to Hope Company. Hope controls about 7% of the totalhospice service market or 20% of the for-profit market. The company has the only regulatorapproved for-profit certificate for the state of Florida, one of the most attractive markets in theUnited States. In addition to a strong market share in Florida, Hope has a strong presence in urbanmarkets like Dallas and San Francisco. Hope has a more diversified revenue base than other publiclytraded for-profit providers.The market share of the top six for-profit providers, together with the presence of non-profit andgovernment providers, most likely indicates that the:

A. threat of new entrants is low in the hospice industry. 
B. power of suppliers is low in the hospice industry. 
C. threat of substitutes is high in the hospice industry. 

Show Answer

Question # 10

Richard Grass is the healthcare analyst for Furrnon Investments and is reviewing the investmentmerits of the developing hospice industry. The hospice industry has a short history in the publicmarket, as several companies have recently completed their initial public offering. Hospice servicesare provided to patients diagnosed with terminal illness as an alternative to aggressive medicalmanagement. The use of hospice services at skilled nursing facilities and assisted-living facilities isforecasted to continue its recent growth. Medicare is the primary payer for hospice services,accounting for 85% of the approximately $7 billion in industry's revenues. Hospice providers offersymptom and pain management to patients diagnosed with a terminal illness by their physician. Theprogram was added to the Medicare benefit package in the early 1980s. Growth in the sector hasonly recently. accelerated due to the emergence of a number of for-profit companies. The caregiverprovides a plan for each admitted patient and care is given in any number of healthcareenvironments, including the patient's home.Grass's analysis of the hospice industry has uncovered several facts that are outlined below:• The industry's revenue annual growth rate has increased from 14% in the late 1990s to 25% in2008.• The average length of stay at facilities for hospice patients is increasing.• Labor costs account for 75% of total expenses, drugs 15% of total expenses, and medical supplies10%.• More than 80% of hospice patients are above 65 years old and 30% are above 85 years old.• Based on the U.S. Census Bureau's statistics, over the next six years (2009-2015), the number ofpeople in the 65 and older age group will increase annually by 1.4%.• The Medicare hospice benefit is still underutilized by the terminally ill population, according toMedPac (an independent advisory committee for the U.S. Congress on healthcare issues).• Only 30% of Medicare beneficiaries enroll in the hospice benefit before they die.• In recent years, the U.S. government has approved rate increases for the sector compared to flat ordeclining rate trends for other healthcare services.• The Medicare hospice program has a beneficiary cap which cannot exceed approximately $18,000annually per person.• The top six for-profit providers account for about half of the segment's sales.• The overall hospice provider market is roughly divided into 55% non-profit, 10% U.S. government,and 35% for-profit.Grass's analysis has narrowed his search to Hope Company. Hope controls about 7% of the totalhospice service market or 20% of the for-profit market. The company has the only regulatorapproved for-profit certificate for the state of Florida, one of the most attractive markets in theUnited States. In addition to a strong market share in Florida, Hope has a strong presence in urbanmarkets like Dallas and San Francisco. Hope has a more diversified revenue base than other publiclytraded for-profit providers.Grass is a firm believer in the industry life cycle. Which of the following statements is most accurateregarding the hospice industry's position in the industry life cycle? The hospice industry is in the:

A. growth stage, as indicated by recent growth in sales. 
B. pioneer stage, as indicated by recent growth in sales and labor costs. 
C. mature stage, as indicated by high labor costs and slow growth in the number of people aged 65 and older

Show Answer

Question # 11

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by hersupervisor to cover a number of different equity and debt investments. One of the investments isTaylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensiveanalysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. Inapplying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel,Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has tradedat a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitativeinformation to consider. The return on a value-weighted market index minus the risk-free rate is5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquiditypremium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas forDevon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium,Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor modelsthat includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between thereturn of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the requiredreturn for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue withinthe next year. The company has not previously issued debt securities to the public, relying instead onbank financing. She realizes that there are a number of models to consider, including the CAPM,multifactor models, and build-up models.Which of the following statements regarding the models used to estimate the required return is mostaccurate?

A. A strength of the capital asset pricing model (CAPM) is that it usually has high explanatory power. 
B. A strength of multifactor models is their relative simplicity and ease of calculation. 
C. A weakness of build-up models is that they typically use historical values as estimates that may not be relevant to current market conditions.  

Show Answer

Question # 12

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by hersupervisor to cover a number of different equity and debt investments. One of the investments isTaylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensiveanalysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. Inapplying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel,Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has tradedat a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitativeinformation to consider. The return on a value-weighted market index minus the risk-free rate is5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquiditypremium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas forDevon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium,Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor modelsthat includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between thereturn of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the requiredreturn for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue withinthe next year. The company has not previously issued debt securities to the public, relying instead onbank financing. She realizes that there are a number of models to consider, including the CAPM,multifactor models, and build-up models.Which of the following statements regarding the models used to estimate the required return is mostaccurate?

A. A strength of the capital asset pricing model (CAPM) is that it usually has high explanatory power. 
B. A strength of multifactor models is their relative simplicity and ease of calculation. 
C. A weakness of build-up models is that they typically use historical values as estimates that may not be relevant to current market conditions.  

Show Answer

Question # 13

Kylie Autumn, CFA, is a consultant with Tri-Vision Group. Robert Lullum, Senior Vice President aiLangsford Investments, has asked for assistance with the evaluation of mortgage-backed andcollateralized mortgage obligation (CMO) derivative securities for potential inclusion in several clientportfolios. Langsford Investments mainly deals with equity investments and REITs, but the companyrecently purchased a small firm that invests mainly in fixed-income securities.Lullum has done some research on the appropriate spread measures and option valuation models forfixed-income securities and wants to clarify some points. He wants to know if the followingstatements are correct:Statement 1: The proper spread measure for option-free corporate bonds is the nominal spread.Statement 2: Callable corporate bonds and mortgage-backed securities should be measured usingthe option-added spread.Statement 3: The Z-spread is appropriate for credit card ABS and auto loan ABS.While Lullum meets with Autumn, Janet Van Ark, CFA charterholder and equity-income portfoliomanagerfor Langsford, is attempting to purchase bondsthat may also provide her with equityexposure in the future. She has decided to analyze an 8% annual coupon bond with exactly 20 yearsto maturity. The bonds are convertible into 10 common sharesfor each $ 1,000 of par(face) value.The bond's market price is $920, and the common stock has a market price of $40. Van Ark estimatesthat the stock will increase in value to $70 within the next two years. The stock's annual dividend is$0.40 per share, and the market yield on comparable non-convertible bonds'is 9.5%.Carl Leighton, a Langsford analyst and Level 2 CFA candidate, works with mortgage-backed and otherasset-based securities. He provides Lullum with a list of credit enhancementsfor asset-backedsecurities, which includesletters of credit, excess servicing spread funds, overcollateralization, andbond insurance. Lullum then asks him for a statusreport of the firm's exposure to paythroughsecurities. He also asks Leighton to calculate the single-monthly mortality rate (SMM) and estimate theprepayment for the month for a seasoned mortgage pool with a $500,000 principal balanceremaining. The scheduled monthly principal payment is $ 150 and the conditional prepayment rate(CPR) is 7%.Which of the following pairs correctly identifies the two external credit enhancements in Leighton's list?

A. Letters of credit and excess servicing spread funds.
B. Excess servicing spread funds and bond insurance.
C. Letters of credit and bond insurance.

Show Answer

Question # 14

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by hersupervisor to cover a number of different equity and debt investments. One of the investments isTaylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensiveanalysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. Inapplying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel,Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has tradedat a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitativeinformation to consider. The return on a value-weighted market index minus the risk-free rate is5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquiditypremium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas forDevon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium,Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor modelsthat includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between thereturn of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the requiredreturn for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue withinthe next year. The company has not previously issued debt securities to the public, relying instead onbank financing. She realizes that there are a number of models to consider, including the CAPM,multifactor models, and build-up models.Are Saunders' statements regarding the macroeconomic multifactor models correct?

A. Both statements are incorrect. 
B. Only Statement I is correct. 
C. Only Statement 2 is correct. 

Show Answer

Question # 15

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by hersupervisor to cover a number of different equity and debt investments. One of the investments isTaylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensiveanalysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. Inapplying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel,Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has tradedat a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitativeinformation to consider. The return on a value-weighted market index minus the risk-free rate is5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquiditypremium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas forDevon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium,Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor modelsthat includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between thereturn of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the requiredreturn for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue withinthe next year. The company has not previously issued debt securities to the public, relying instead onbank financing. She realizes that there are a number of models to consider, including the CAPM,multifactor models, and build-up models.Which of the following approaches/methods is most appropriate for Lear to consider in determiningthe required return for Densmore?

A. Build-up method. 
B. Risk premium approach. 
C. Bond-yield plus risk premium method. 

Show Answer

Question # 16

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by hersupervisor to cover a number of different equity and debt investments. One of the investments isTaylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensiveanalysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. Inapplying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel,Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has tradedat a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitativeinformation to consider. The return on a value-weighted market index minus the risk-free rate is5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquiditypremium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas forDevon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium,Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor modelsthat includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between thereturn of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the requiredreturn for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue withinthe next year. The company has not previously issued debt securities to the public, relying instead onbank financing. She realizes that there are a number of models to consider, including the CAPM multifactor models, and build-up models.Lear's choice of the Gordon growth model is an example of which of the following types of estimatesof the equity risk premium?

A. Historical estimate. 
B. Forward-looking estimate. 
C. Macroeconomic model estimate. 

Show Answer

Question # 17

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by hersupervisor to cover a number of different equity and debt investments. One of the investments isTaylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensiveanalysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. Inapplying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel,Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has tradedat a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitativeinformation to consider. The return on a value-weighted market index minus the risk-free rate is5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquiditypremium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas forDevon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium,Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor modelsthat includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between thereturn of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the requiredreturn for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue withinthe next year. The company has not previously issued debt securities to the public, relying instead onbank financing. She realizes that there are a number of models to consider, including the CAPM,multifactor models, and build-up models.According to the FFM, the estimate of the required return for Devon is closest to:

A. 9.4%. 
B. 11.8%. 
C. 13.4%. 

Show Answer

Question # 18

Kylie Autumn, CFA, is a consultant with Tri-Vision Group. Robert Lullum, Senior Vice President aiLangsford Investments, has asked for assistance with the evaluation of mortgage-backed andcollateralized mortgage obligation (CMO) derivative securities for potential inclusion in several clientportfolios. Langsford Investments mainly deals with equity investments and REITs, but the companyrecently purchased a small firm that invests mainly in fixed-income securities.Lullum has done some research on the appropriate spread measures and option valuation models forfixed-income securities and wants to clarify some points. He wants to know if the followingstatements are correct:Statement 1: The proper spread measure for option-free corporate bonds is the nominal spread.Statement 2: Callable corporate bonds and mortgage-backed securities should be measured usingthe option-added spread.Statement 3: The Z-spread is appropriate for credit card ABS and auto loan ABS.While Lullum meets with Autumn, Janet Van Ark, CFA charterholder and equity-income portfoliomanagerfor Langsford, is attempting to purchase bondsthat may also provide her with equityexposure in the future. She has decided to analyze an 8% annual coupon bond with exactly 20 yearsto maturity. The bonds are convertible into 10 common sharesfor each $ 1,000 of par(face) value.The bond's market price is $920, and the common stock has a market price of $40. Van Ark estimatesthat the stock will increase in value to $70 within the next two years. The stock's annual dividend is$0.40 per share, and the market yield on comparable non-convertible bonds'is 9.5%.Carl Leighton, a Langsford analyst and Level 2 CFA candidate, works with mortgage-backed and otherasset-based securities. He provides Lullum with a list of credit enhancementsfor asset-backedsecurities, which includesletters of credit, excess servicing spread funds, overcollateralization, andbond insurance. Lullum then asks him for a statusreport of the firm's exposure to paythroughsecurities. He also asks Leighton to calculate the single-monthly mortality rate (SMM) and estimate theprepayment for the month for a seasoned mortgage pool with a $500,000 principal balanceremaining. The scheduled monthly principal payment is $ 150 and the conditional prepayment rate(CPR) is 7%.Which of the following statements about interest-only (10) and principal-only (PO)stripsisleastaccurate?

A. The 10 price is positively related to interest rates, and at low current rates, POs exhibit some negative convexity
B. IO cash flowsstart out large and diminish overtime. As a result, 10 investors are most concerned with extension risk
C. In general, the volatility of the combined 10 and PO strips equals the price volatility of the source passthrough. 

Show Answer

Question # 19

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by hersupervisor to cover a number of different equity and debt investments. One of the investments isTaylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensiveanalysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. In applying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel,Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has tradedat a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitativeinformation to consider. The return on a value-weighted market index minus the risk-free rate is5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquiditypremium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas forDevon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium,Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor modelsthat includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between thereturn of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the requiredreturn for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue withinthe next year. The company has not previously issued debt securities to the public, relying instead onbank financing. She realizes that there are a number of models to consider, including the CAPM,multifactor models, and build-up models.Based on Lear's analysis, Taylor's stock is most likely to be:

A. correctly valued. 
B. overvalued. 
C. undervalued. 

Show Answer

Question # 20

Kylie Autumn, CFA, is a consultant with Tri-Vision Group. Robert Lullum, Senior Vice President aiLangsford Investments, has asked for assistance with the evaluation of mortgage-backed andcollateralized mortgage obligation (CMO) derivative securities for potential inclusion in several clientportfolios. Langsford Investments mainly deals with equity investments and REITs, but the companyrecently purchased a small firm that invests mainly in fixed-income securities.Lullum has done some research on the appropriate spread measures and option valuation models forfixed-income securities and wants to clarify some points. He wants to know if the followingstatements are correct:Statement 1: The proper spread measure for option-free corporate bonds is the nominal spread.Statement 2: Callable corporate bonds and mortgage-backed securities should be measured usingthe option-added spread.Statement 3: The Z-spread is appropriate for credit card ABS and auto loan ABS.While Lullum meets with Autumn, Janet Van Ark, CFA charterholder and equity-income portfoliomanagerfor Langsford, is attempting to purchase bondsthat may also provide her with equityexposure in the future. She has decided to analyze an 8% annual coupon bond with exactly 20 yearsto maturity. The bonds are convertible into 10 common sharesfor each $ 1,000 of par(face) value.The bond's market price is $920, and the common stock has a market price of $40. Van Ark estimatesthat the stock will increase in value to $70 within the next two years. The stock's annual dividend is$0.40 per share, and the market yield on comparable non-convertible bonds'is 9.5%.Carl Leighton, a Langsford analyst and Level 2 CFA candidate, works with mortgage-backed and otherasset-based securities. He provides Lullum with a list of credit enhancementsfor asset-backedsecurities, which includesletters of credit, excess servicing spread funds, overcollateralization, andbond insurance. Lullum then asks him for a statusreport of the firm's exposure to paythroughsecurities. He also asks Leighton to calculate the single-monthly mortality rate (SMM) and estimate theprepayment for the month for a seasoned mortgage pool with a $500,000 principal balanceremaining. The scheduled monthly principal payment is $ 150 and the conditional prepayment rate(CPR) is 7%.How many of the three statements on appropriate spread measures and valuation models arecorrect?

A. Only two statements are correct.
B. Only one statement is correct.
C. None of the three statements are correct.

Show Answer

Question # 21

Bryan Galloway is a strategist for JS Investments, a small money management firm. His goal is toanalyze industries to determine whether there is justification for over- or under-weighting. Hissupervisor, Robyn Black, CFA, has asked that he document the process he uses to make hisrecommendations. However, just to be sure that Galloway understands industry analysis. Black askshim to provide examples of supply and demand analysis. Galloway makes the following twostatements to prove that he understands the issue:Statement 1: In analyzing supply in the tire and rubber industry, it is clear that the sale of eachadditional automobile will result in the sale of approximately two winter tires.Statement 2: In analyzing demand for services in the healthcare industry, for every 100 new hospitalbeds required, 20 additional doctors are needed.Black is not entirely confident in Galloway's abilities to analyze various industries, but decides toallow him to continue with his analysis.Four of the largest holdings for JS Investments are a tobacco company, a soda drink company, an oilcompany, and a cable TV company. Black is worried that government intervention will have a seriousimpact on future growth for these companies and asks Galloway to further research each of theindustries involved. However, just to make sure Galloway can handle this project. Black first asks himto review the basics of industry analysis.In reviewing the factors affecting pricing considerations, Galloway concludes that all of the followingare of direct importance:Factor 1: Price changes in key supply inputs.Factor 2: Product segmentation.Factor 3: Ease of entry into the industry.Factor 4: Degree of industry concentration.Galloway also makes the following statements about the characteristics of the phases of theindustrial life cycle:Characteristic 1: Participants compete for market share in a stable industry.Characteristic 2: Changing tastes have an important impact on the industry.Characteristic 3: It is not clear that a product will be accepted in the industry.Characteristic 4: Proper execution of strategy is critical.Each of the phases is represented by one characteristic.What life cycle phase most appropriately reflects Characteristic 1 and Characteristic 3?

A. Mature and pioneer. 
B. Mature and growth. 
C. Decline and growth 

Show Answer

Question # 22

Bryan Galloway is a strategist for JS Investments, a small money management firm. His goal is toanalyze industries to determine whether there is justification for over- or under-weighting. Hissupervisor, Robyn Black, CFA, has asked that he document the process he uses to make hisrecommendations. However, just to be sure that Galloway understands industry analysis. Black askshim to provide examples of supply and demand analysis. Galloway makes the following twostatements to prove that he understands the issue:Statement 1: In analyzing supply in the tire and rubber industry, it is clear that the sale of eachadditional automobile will result in the sale of approximately two winter tires.Statement 2: In analyzing demand for services in the healthcare industry, for every 100 new hospitalbeds required, 20 additional doctors are needed.Black is not entirely confident in Galloway's abilities to analyze various industries, but decides toallow him to continue with his analysis.Four of the largest holdings for JS Investments are a tobacco company, a soda drink company, an oilcompany, and a cable TV company. Black is worried that government intervention will have a seriousimpact on future growth for these companies and asks Galloway to further research each of theindustries involved. However, just to make sure Galloway can handle this project. Black first asks himto review the basics of industry analysis.In reviewing the factors affecting pricing considerations, Galloway concludes that all of the followingare of direct importance:Factor 1: Price changes in key supply inputs.Factor 2: Product segmentation.Factor 3: Ease of entry into the industry.Factor 4: Degree of industry concentration.Galloway also makes the following statements about the characteristics of the phases of theindustrial life cycle:Characteristic 1: Participants compete for market share in a stable industry.Characteristic 2: Changing tastes have an important impact on the industry.Characteristic 3: It is not clear that a product will be accepted in the industry.Characteristic 4: Proper execution of strategy is critical.Each of the phases is represented by one characteristic.Did Galloway correctly identity the factors that directly affect pricing considerations?

A. Yes. 
B. No, changing tastes do not have a direct impact on pricing. 
C. No, competition for market share in a stable industry is not a pricing consideration. 

Show Answer

Question # 23

Bryan Galloway is a strategist for JS Investments, a small money management firm. His goal is toanalyze industries to determine whether there is justification for over- or under-weighting. Hissupervisor, Robyn Black, CFA, has asked that he document the process he uses to make hisrecommendations. However, just to be sure that Galloway understands industry analysis. Black askshim to provide examples of supply and demand analysis. Galloway makes the following twostatements to prove that he understands the issue:Statement 1: In analyzing supply in the tire and rubber industry, it is clear that the sale of eachadditional automobile will result in the sale of approximately two winter tires.Statement 2: In analyzing demand for services in the healthcare industry, for every 100 new hospitalbeds required, 20 additional doctors are needed.Black is not entirely confident in Galloway's abilities to analyze various industries, but decides toallow him to continue with his analysis.Four of the largest holdings for JS Investments are a tobacco company, a soda drink company, an oilcompany, and a cable TV company. Black is worried that government intervention will have a seriousimpact on future growth for these companies and asks Galloway to further research each of theindustries involved. However, just to make sure Galloway can handle this project. Black first asks himto review the basics of industry analysis.In reviewing the factors affecting pricing considerations, Galloway concludes that all of the followingare of direct importance:Factor 1: Price changes in key supply inputs.Factor 2: Product segmentation.Factor 3: Ease of entry into the industry.Factor 4: Degree of industry concentration.Galloway also makes the following statements about the characteristics of the phases of theindustrial life cycle:Characteristic 1: Participants compete for market share in a stable industry.Characteristic 2: Changing tastes have an important impact on the industry.Characteristic 3: It is not clear that a product will be accepted in the industry.Characteristic 4: Proper execution of strategy is critical.Each of the phases is represented by one characteristic.For which of the following global industries would U.S. government involvement most likelyrepresent an example of a negative external influence?

A. The oil industry. 
B. The tobacco industry. 
C. The cable TV industry. 

Show Answer

Question # 24

Kylie Autumn, CFA, is a consultant with Tri-Vision Group. Robert Lullum, Senior Vice President aiLangsford Investments, has asked for assistance with the evaluation of mortgage-backed andcollateralized mortgage obligation (CMO) derivative securities for potential inclusion in several clientportfolios. Langsford Investments mainly deals with equity investments and REITs, but the companyrecently purchased a small firm that invests mainly in fixed-income securities.Lullum has done some research on the appropriate spread measures and option valuation models forfixed-income securities and wants to clarify some points. He wants to know if the followingstatements are correct:Statement 1: The proper spread measure for option-free corporate bonds is the nominal spread.Statement 2: Callable corporate bonds and mortgage-backed securities should be measured usingthe option-added spread.Statement 3: The Z-spread is appropriate for credit card ABS and auto loan ABS.While Lullum meets with Autumn, Janet Van Ark, CFA charterholder and equity-income portfoliomanagerfor Langsford, is attempting to purchase bondsthat may also provide her with equityexposure in the future. She has decided to analyze an 8% annual coupon bond with exactly 20 yearsto maturity. The bonds are convertible into 10 common sharesfor each $ 1,000 of par(face) value.The bond's market price is $920, and the common stock has a market price of $40. Van Ark estimatesthat the stock will increase in value to $70 within the next two years. The stock's annual dividend is$0.40 per share, and the market yield on comparable non-convertible bonds'is 9.5%.Carl Leighton, a Langsford analyst and Level 2 CFA candidate, works with mortgage-backed and otherasset-based securities. He provides Lullum with a list of credit enhancementsfor asset-backedsecurities, which includesletters of credit, excess servicing spread funds, overcollateralization, andbond insurance. Lullum then asks him for a statusreport of the firm's exposure to paythroughsecurities. He also asks Leighton to calculate the single-monthly mortality rate (SMM) and estimate theprepayment for the month for a seasoned mortgage pool with a $500,000 principal balanceremaining. The scheduled monthly principal payment is $ 150 and the conditional prepayment rate(CPR) is 7%.Autumn should tell Lullum that the most appropriate models for valuing the option on mortgagebacked securities (MBS) and credit card asset-backed securities (ABS) are:

A. Monte Carlo for both the MBS and the ABS. 
B. Monte Carlo or binomial for the MBS, but binomial only for the ABS. 
C. Monte Carlo for the MBS. No model is needed for the ABS. 

Show Answer

Question # 25

Bryan Galloway is a strategist for JS Investments, a small money management firm. His goal is toanalyze industries to determine whether there is justification for over- or under-weighting. Hissupervisor, Robyn Black, CFA, has asked that he document the process he uses to make hisrecommendations. However, just to be sure that Galloway understands industry analysis. Black askshim to provide examples of supply and demand analysis. Galloway makes the following twostatements to prove that he understands the issue:Statement 1: In analyzing supply in the tire and rubber industry, it is clear that the sale of eachadditional automobile will result in the sale of approximately two winter tires.Statement 2: In analyzing demand for services in the healthcare industry, for every 100 new hospitalbeds required, 20 additional doctors are needed.Black is not entirely confident in Galloway's abilities to analyze various industries, but decides toallow him to continue with his analysis.Four of the largest holdings for JS Investments are a tobacco company, a soda drink company, an oilcompany, and a cable TV company. Black is worried that government intervention will have a seriousimpact on future growth for these companies and asks Galloway to further research each of theindustries involved. However, just to make sure Galloway can handle this project. Black first asks himto review the basics of industry analysis.In reviewing the factors affecting pricing considerations, Galloway concludes that all of the followingare of direct importance:Factor 1: Price changes in key supply inputs.Factor 2: Product segmentation.Factor 3: Ease of entry into the industry.Factor 4: Degree of industry concentration.Galloway also makes the following statements about the characteristics of the phases of theindustrial life cycle:Characteristic 1: Participants compete for market share in a stable industry.Characteristic 2: Changing tastes have an important impact on the industry.Characteristic 3: It is not clear that a product will be accepted in the industry.Characteristic 4: Proper execution of strategy is critical.Each of the phases is represented by one characteristic.Are the two statements regarding supply and demand analysis correct or incorrect?

A. Both statements are correct. 
B. Only one of the statements is correct. 
C. Both statements are incorrect. 

Show Answer

Question # 26

Bryan Galloway is a strategist for JS Investments, a small money management firm. His goal is toanalyze industries to determine whether there is justification for over- or under-weighting. Hissupervisor, Robyn Black, CFA, has asked that he document the process he uses to make hisrecommendations. However, just to be sure that Galloway understands industry analysis. Black askshim to provide examples of supply and demand analysis. Galloway makes the following twostatements to prove that he understands the issue:Statement 1: In analyzing supply in the tire and rubber industry, it is clear that the sale of eachadditional automobile will result in the sale of approximately two winter tires.Statement 2: In analyzing demand for services in the healthcare industry, for every 100 new hospitalbeds required, 20 additional doctors are needed.Black is not entirely confident in Galloway's abilities to analyze various industries, but decides toallow him to continue with his analysis.Four of the largest holdings for JS Investments are a tobacco company, a soda drink company, an oilcompany, and a cable TV company. Black is worried that government intervention will have a seriousimpact on future growth for these companies and asks Galloway to further research each of theindustries involved. However, just to make sure Galloway can handle this project. Black first asks himto review the basics of industry analysis.In reviewing the factors affecting pricing considerations, Galloway concludes that all of the followingare of direct importance:Factor 1: Price changes in key supply inputs.Factor 2: Product segmentation.Factor 3: Ease of entry into the industry.Factor 4: Degree of industry concentration.Galloway also makes the following statements about the characteristics of the phases of theindustrial life cycle:Characteristic 1: Participants compete for market share in a stable industry.Characteristic 2: Changing tastes have an important impact on the industry.Characteristic 3: It is not clear that a product will be accepted in the industry.Characteristic 4: Proper execution of strategy is critical.Each of the phases is represented by one characteristic.Excluding external factors, industry analysis is best described as including:

A. industry classification; profitability analysis; innovation turnover. 
B. industry classification; demand analysis; supply analysis; profitability analysis. 
C. profitability analysis; competition analysis; innovation turnover; industry classification. 

Show Answer

Question # 27

Galena Petrovich, CFA, is an analyst in the New York office of TRS Investment Management, Inc.Petrovich is an expert in the industrial electrical equipment sector and is analyzing Fisher Global.Fisher is a global market leader in designing, manufacturing, marketing, and servicing electricalsystems and components, including fluid power systems and automotive engine air managementsystems.Fisher has generated double-digit growth over the past ten years, primarily as the result ofacquisitions, and has reported positive net income in each year. Fisher reports its financial resultsusing International Financial Reporting Standards (IFRS).Petrovich is particularly interested in a transaction that occurred seven years ago, before the changein accounting standards, in which Fisher used the pooling method to account for a large acquisitionof Dartmouth Industries, an industry competitor. She would like to determine the effect of using thepurchase method instead of the pooling method on the financial statements of Fisher. Fisherexchanged common stock for all of the outstanding shares of Dartmouth.Fisher also has a 50% ownership interest in a joint venture with its major distributor, a U.S. companycalled Hydro Distribution. She determines that Fisher has reported its ownership interest under theproportioned consolidation method, and that the joint venture has been profitable since it wasestablished three years ago. She decides to adjust the financial statements to show how the financialstatements would be affected if Fisher had reported its ownership under the equity method. Fisher isalso considering acquiring 80% to 100% of Brown and Sons Company. Petrovich must consider theeffect of such an acquisition on Fisher's financial statements.Petrovich determines from the financial statement footnotes that Fisher reported an unrealized gainin its most recent income statement related to debt securities that are designated at fair value.Competitor firms following U.S. GAAP classify similar debt securities as available-for-sale.Finally, Petrovich finds a reference in Fisher's footnotes regarding a special purpose entity (SPE).Fisher has reported its investment in the SPE using the equity method, but Petrovich believes thatthe consolidation method more accurately reflects Fisher's true financial position, so she makes theappropriate adjustments to the financial statements.What are the likely effects on return on assets (ROA) and net profit margin (ignoring any tax effects)of correctly adjusting for Fisher Global's investment in the SPE using the acquisition method?ROANet profit margin

A. No changeDecrease
B. DecreaseNo change
C. DecreaseDecrease

Show Answer

Question # 28

Galena Petrovich, CFA, is an analyst in the New York office of TRS Investment Management, Inc.Petrovich is an expert in the industrial electrical equipment sector and is analyzing Fisher Global.Fisher is a global market leader in designing, manufacturing, marketing, and servicing electricalsystems and components, including fluid power systems and automotive engine air managementsystems.Fisher has generated double-digit growth over the past ten years, primarily as the result ofacquisitions, and has reported positive net income in each year. Fisher reports its financial resultsusing International Financial Reporting Standards (IFRS).Petrovich is particularly interested in a transaction that occurred seven years ago, before the changein accounting standards, in which Fisher used the pooling method to account for a large acquisitionof Dartmouth Industries, an industry competitor. She would like to determine the effect of using thepurchase method instead of the pooling method on the financial statements of Fisher. Fisherexchanged common stock for all of the outstanding shares of Dartmouth.Fisher also has a 50% ownership interest in a joint venture with its major distributor, a U.S. companycalled Hydro Distribution. She determines that Fisher has reported its ownership interest under theproportioned consolidation method, and that the joint venture has been profitable since it wasestablished three years ago. She decides to adjust the financial statements to show how the financialstatements would be affected if Fisher had reported its ownership under the equity method. Fisher isalso considering acquiring 80% to 100% of Brown and Sons Company. Petrovich must consider theeffect of such an acquisition on Fisher's financial statements.Petrovich determines from the financial statement footnotes that Fisher reported an unrealized gainin its most recent income statement related to debt securities that are designated at fair value.Competitor firms following U.S. GAAP classify similar debt securities as available-for-sale.Finally, Petrovich finds a reference in Fisher's footnotes regarding a special purpose entity (SPE).Fisher has reported its investment in the SPE using the equity method, but Petrovich believes thatthe consolidation method more accurately reflects Fisher's true financial position, so she makes theappropriate adjustments to the financial statements.For comparison purposes, Petrovich decides to reclassify Fisher GlobaPs debt securities as availablefor-sale. Ignoring any effect on income taxes, which of the following best describes the effects of thenecessary adjustments?

A. Net income is lower and asset turnover is higher.
B. Return on assets is lower and debt-to-cquity is lower.
C. Return on equity is lower and debt-to-total capital is not affected.

Show Answer

Question # 29

Galena Petrovich, CFA, is an analyst in the New York office of TRS Investment Management, Inc.Petrovich is an expert in the industrial electrical equipment sector and is analyzing Fisher Global.Fisher is a global market leader in designing, manufacturing, marketing, and servicing electricalsystems and components, including fluid power systems and automotive engine air managementsystems.Fisher has generated double-digit growth over the past ten years, primarily as the result ofacquisitions, and has reported positive net income in each year. Fisher reports its financial resultsusing International Financial Reporting Standards (IFRS).Petrovich is particularly interested in a transaction that occurred seven years ago, before the changein accounting standards, in which Fisher used the pooling method to account for a large acquisitionof Dartmouth Industries, an industry competitor. She would like to determine the effect of using thepurchase method instead of the pooling method on the financial statements of Fisher. Fisherexchanged common stock for all of the outstanding shares of Dartmouth.Fisher also has a 50% ownership interest in a joint venture with its major distributor, a U.S. companycalled Hydro Distribution. She determines that Fisher has reported its ownership interest under theproportioned consolidation method, and that the joint venture has been profitable since it wasestablished three years ago. She decides to adjust the financial statements to show how the financialstatements would be affected if Fisher had reported its ownership under the equity method. Fisher isalso considering acquiring 80% to 100% of Brown and Sons Company. Petrovich must consider theeffect of such an acquisition on Fisher's financial statements.Petrovich determines from the financial statement footnotes that Fisher reported an unrealized gainin its most recent income statement related to debt securities that are designated at fair value.Competitor firms following U.S. GAAP classify similar debt securities as available-for-sale.Finally, Petrovich finds a reference in Fisher's footnotes regarding a special purpose entity (SPE).Fisher has reported its investment in the SPE using the equity method, but Petrovich believes thatthe consolidation method more accurately reflects Fisher's true financial position, so she makes theappropriate adjustments to the financial statements.If Fisher Global decides to purchase only 80% of Brown and Sons, under 1FRS they will have theoption to:

A. report the acquisition as either a business combination or as an acquisition.
B. value the identifiable assets and liabilities of Brown and Sons at their current book values or at fairmarket value.
C. report more or less goodwill depending on the accounting method they choose.

Show Answer

Question # 30

Bryan Galloway is a strategist for JS Investments, a small money management firm. His goal is toanalyze industries to determine whether there is justification for over- or under-weighting. Hissupervisor, Robyn Black, CFA, has asked that he document the process he uses to make hisrecommendations. However, just to be sure that Galloway understands industry analysis. Black askshim to provide examples of supply and demand analysis. Galloway makes the following twostatements to prove that he understands the issue:Statement 1: In analyzing supply in the tire and rubber industry, it is clear that the sale of eachadditional automobile will result in the sale of approximately two winter tires.Statement 2: In analyzing demand for services in the healthcare industry, for every 100 new hospitalbeds required, 20 additional doctors are needed.Black is not entirely confident in Galloway's abilities to analyze various industries, but decides toallow him to continue with his analysis.Four of the largest holdings for JS Investments are a tobacco company, a soda drink company, an oilcompany, and a cable TV company. Black is worried that government intervention will have a seriousimpact on future growth for these companies and asks Galloway to further research each of theindustries involved. However, just to make sure Galloway can handle this project. Black first asks himto review the basics of industry analysis.In reviewing the factors affecting pricing considerations, Galloway concludes that all of the followingare of direct importance:Factor 1: Price changes in key supply inputs.Factor 2: Product segmentation.Factor 3: Ease of entry into the industry.Factor 4: Degree of industry concentration.Galloway also makes the following statements about the characteristics of the phases of theindustrial life cycle:Characteristic 1: Participants compete for market share in a stable industry.Characteristic 2: Changing tastes have an important impact on the industry.Characteristic 3: It is not clear that a product will be accepted in the industry.Characteristic 4: Proper execution of strategy is critical.Each of the phases is represented by one characteristic.Which of the following choices best describes all the elements that Galloway should consider indoing an analysis of external factors in an industry analysis?

A. Technology; government; social; demographic; foreign. 
B. Social; demographic; foreign; pricing; degree of concentration. 
C. Government; technology; end users; degree of concentration; ease of entry. 

Show Answer

Question # 31

Martin Hagemann, CFA, works for a large brokerage firm in Frankfurt, Germany. Hagemann has beenhired by Tryssen AG, a global research-based company that is preparing to go public after a longhistory of operating privately. The need to raise substantial amounts of capital to fund research anddevelopment activities is seen as the key motivation for the change in policy. Tryssen is engaged inthe discovery, development, manufacture, marketing, and sale of medical products.Hagemann's first task is to recommend an exchange upon which Tryssen stock can be traded. Onepossibility is the Deutsche Bourse. The Deutsche Bourse operates primarily as a continuous orderdriven system. Another alternative that Tryssen is considering is to list on a different exchange thatoperates as a price-driven system.As an alternative, Tryssen may choose to list as an American Depository Receipt (ADR). ADRs arenegotiable U.S. securities that usually represent a non-U.S. based company's publicly traded equity.Although typically denominated in U.S. dollars, depository receipts can also be denominated ineuros. Depository receipts can be eligible to trade on all U.S. stock exchanges as well as on manyEuropean stock exchanges.The increasing demand for depository receipts is driven by the desire of individual and institutionalinvestors to diversify their portfolios, reduce risk and invest internationally in the most efficientmanner possible. While most investors recognize the benefits of global diversification, there aremany challenges presented when investing directly in local trading markets. Obstacles can includeinefficient trade settlements, uncertain custody services, and costly currency conversions. Depositoryreceipts overcome many of the inherent operational and custodial hurdles inherent in internationalinvesting. Tryssen has decided to access the U.S. market by involving itself in an ADR program.Tryssen has decided to save itself a lot of trouble, however, by not complying with SEC registrationand reporting requirements.As an alternative to ADRs, investors interested in increasing their exposure to internationalinvestments can choose to acquire exchange traded funds (ETFs). Hagemann researches theadvantages and disadvantages of ETFs.Execution costs are always a concern, and perhaps even more so for international investors. At thepresent time, Tryssen AG is most concerned with how reliably it can estimate trading costs. As part ofthe cost estimation process, Hagemann is asked to provide a report on the advantages anddisadvantages of techniques used to reduce execution costs.Trysse AG proceeds to list on the Frankfurt exchange, and a U.S. affiliate of Hagemann's companystarts to aggressively promote the stock. A U.S. investor buys 200 shares of Tryssen at a price of €20per share. At time of purchase, the exchange rate is €1 = $1.15. One month later Tryssen pays adividend of €0.25 per share, and investors are subject to a withholding tax of 20%. The U.S. investoris eligible to claim a tax credit of $0.06 per share. At the time the dividend was paid, the shares hadjumped to €24 each and the U.S. dollar had weakened to €1 = $ 1.20. The shares were sold just afterthe dividend was paid.The capital gain for the U.S. investor in Tryssen stock and the dividend after adjusting for thewithholding tax but before the tax credit are closest to:Capital gain Adjusted dividend

A. $720 $48 
B $1,160 $48 
C. $1,160 $60 

Show Answer

Question # 32

Galena Petrovich, CFA, is an analyst in the New York office of TRS Investment Management, Inc.Petrovich is an expert in the industrial electrical equipment sector and is analyzing Fisher Global.Fisher is a global market leader in designing, manufacturing, marketing, and servicing electricalsystems and components, including fluid power systems and automotive engine air managementsystems.Fisher has generated double-digit growth over the past ten years, primarily as the result ofacquisitions, and has reported positive net income in each year. Fisher reports its financial resultsusing International Financial Reporting Standards (IFRS).Petrovich is particularly interested in a transaction that occurred seven years ago, before the changein accounting standards, in which Fisher used the pooling method to account for a large acquisitionof Dartmouth Industries, an industry competitor. She would like to determine the effect of using thepurchase method instead of the pooling method on the financial statements of Fisher. Fisherexchanged common stock for all of the outstanding shares of Dartmouth.Fisher also has a 50% ownership interest in a joint venture with its major distributor, a U.S. companycalled Hydro Distribution. She determines that Fisher has reported its ownership interest under theproportioned consolidation method, and that the joint venture has been profitable since it wasestablished three years ago. She decides to adjust the financial statements to show how the financialstatements would be affected if Fisher had reported its ownership under the equity method. Fisher isalso considering acquiring 80% to 100% of Brown and Sons Company. Petrovich must consider theeffect of such an acquisition on Fisher's financial statements.Petrovich determines from the financial statement footnotes that Fisher reported an unrealized gainin its most recent income statement related to debt securities that are designated at fair value.Competitor firms following U.S. GAAP classify similar debt securities as available-for-sale.Finally, Petrovich finds a reference in Fisher's footnotes regarding a special purpose entity (SPE).Fisher has reported its investment in the SPE using the equity method, but Petrovich believes thatthe consolidation method more accurately reflects Fisher's true financial position, so she makes theappropriate adjustments to the financial statements.Regarding the goodwill on the acquisition of Brown and Sons being considered by Fisher Global,which of the following statements is correct?

A. It is equal to the excess of the purchase price over the fair value of the identifiable assets andliabilities and must be amortized over no longer than 30 years.
B. It will be reported as an asset, not amortized, and must be reviewed for impairment at leastannually, with same test for impairment under IFRS and U.S. GAAP.
C. For goodwill that is found to be impaired, the amount of the impairment charge reported is thesame under both IFRS and U.S. GAAP.

Show Answer

Question # 33

Martin Hagemann, CFA, works for a large brokerage firm in Frankfurt, Germany. Hagemann has beenhired by Tryssen AG, a global research-based company that is preparing to go public after a longhistory of operating privately. The need to raise substantial amounts of capital to fund research anddevelopment activities is seen as the key motivation for the change in policy. Tryssen is engaged inthe discovery, development, manufacture, marketing, and sale of medical products.Hagemann's first task is to recommend an exchange upon which Tryssen stock can be traded. One possibility is the Deutsche Bourse. The Deutsche Bourse operates primarily as a continuous orderdriven system. Another alternative that Tryssen is considering is to list on a different exchange thatoperates as a price-driven system.As an alternative, Tryssen may choose to list as an American Depository Receipt (ADR). ADRs arenegotiable U.S. securities that usually represent a non-U.S. based company's publicly traded equity.Although typically denominated in U.S. dollars, depository receipts can also be denominated ineuros. Depository receipts can be eligible to trade on all U.S. stock exchanges as well as on manyEuropean stock exchanges.The increasing demand for depository receipts is driven by the desire of individual and institutionalinvestors to diversify their portfolios, reduce risk and invest internationally in the most efficientmanner possible. While most investors recognize the benefits of global diversification, there aremany challenges presented when investing directly in local trading markets. Obstacles can includeinefficient trade settlements, uncertain custody services, and costly currency conversions. Depositoryreceipts overcome many of the inherent operational and custodial hurdles inherent in internationalinvesting. Tryssen has decided to access the U.S. market by involving itself in an ADR program.Tryssen has decided to save itself a lot of trouble, however, by not complying with SEC registrationand reporting requirements.As an alternative to ADRs, investors interested in increasing their exposure to internationalinvestments can choose to acquire exchange traded funds (ETFs). Hagemann researches theadvantages and disadvantages of ETFs.Execution costs are always a concern, and perhaps even more so for international investors. At thepresent time, Tryssen AG is most concerned with how reliably it can estimate trading costs. As part ofthe cost estimation process, Hagemann is asked to provide a report on the advantages anddisadvantages of techniques used to reduce execution costs.Trysse AG proceeds to list on the Frankfurt exchange, and a U.S. affiliate of Hagemann's companystarts to aggressively promote the stock. A U.S. investor buys 200 shares of Tryssen at a price of €20per share. At time of purchase, the exchange rate is €1 = $1.15. One month later Tryssen pays adividend of €0.25 per share, and investors are subject to a withholding tax of 20%. The U.S. investoris eligible to claim a tax credit of $0.06 per share. At the time the dividend was paid, the shares hadjumped to €24 each and the U.S. dollar had weakened to €1 = $ 1.20. The shares were sold just afterthe dividend was paid.Which of the following represents a correct advantage and a correct disadvantage for the indicatedapproach that is aimed at reducing execution costs?

A. Internal crossing can result in best execution but opportunities are rare. 
B. Principal trades assure immediacy but result in large opportunity costs. 
C. The use of futures reduces opportunity costs but involves additional risk. 

Show Answer

Question # 34

Galena Petrovich, CFA, is an analyst in the New York office of TRS Investment Management, Inc.Petrovich is an expert in the industrial electrical equipment sector and is analyzing Fisher Global.Fisher is a global market leader in designing, manufacturing, marketing, and servicing electricalsystems and components, including fluid power systems and automotive engine air managementsystems.Fisher has generated double-digit growth over the past ten years, primarily as the result ofacquisitions, and has reported positive net income in each year. Fisher reports its financial resultsusing International Financial Reporting Standards (IFRS).Petrovich is particularly interested in a transaction that occurred seven years ago, before the changein accounting standards, in which Fisher used the pooling method to account for a large acquisitionof Dartmouth Industries, an industry competitor. She would like to determine the effect of using thepurchase method instead of the pooling method on the financial statements of Fisher. Fisherexchanged common stock for all of the outstanding shares of Dartmouth.Fisher also has a 50% ownership interest in a joint venture with its major distributor, a U.S. companycalled Hydro Distribution. She determines that Fisher has reported its ownership interest under theproportioned consolidation method, and that the joint venture has been profitable since it wasestablished three years ago. She decides to adjust the financial statements to show how the financialstatements would be affected if Fisher had reported its ownership under the equity method. Fisher isalso considering acquiring 80% to 100% of Brown and Sons Company. Petrovich must consider theeffect of such an acquisition on Fisher's financial statements.Petrovich determines from the financial statement footnotes that Fisher reported an unrealized gainin its most recent income statement related to debt securities that are designated at fair value.Competitor firms following U.S. GAAP classify similar debt securities as available-for-sale.Finally, Petrovich finds a reference in Fisher's footnotes regarding a special purpose entity (SPE).Fisher has reported its investment in the SPE using the equity method, but Petrovich believes thatthe consolidation method more accurately reflects Fisher's true financial position, so she makes theappropriate adjustments to the financial statements.Had Fisher Global reported its investment in the joint venture under the equity method rather thanunder the proportionate consolidation method, it is most likely that:

A. Reported revenue would have been the same.
B. Reported expenses would have been higher.
C. Fisher's net income would not have been affected.

Show Answer

Question # 35

Martin Hagemann, CFA, works for a large brokerage firm in Frankfurt, Germany. Hagemann has beenhired by Tryssen AG, a global research-based company that is preparing to go public after a longhistory of operating privately. The need to raise substantial amounts of capital to fund research anddevelopment activities is seen as the key motivation for the change in policy. Tryssen is engaged inthe discovery, development, manufacture, marketing, and sale of medical products.Hagemann's first task is to recommend an exchange upon which Tryssen stock can be traded. Onepossibility is the Deutsche Bourse. The Deutsche Bourse operates primarily as a continuous orderdriven system. Another alternative that Tryssen is considering is to list on a different exchange thatoperates as a price-driven system.As an alternative, Tryssen may choose to list as an American Depository Receipt (ADR). ADRs arenegotiable U.S. securities that usually represent a non-U.S. based company's publicly traded equity.Although typically denominated in U.S. dollars, depository receipts can also be denominated ineuros. Depository receipts can be eligible to trade on all U.S. stock exchanges as well as on manyEuropean stock exchanges.The increasing demand for depository receipts is driven by the desire of individual and institutionalinvestors to diversify their portfolios, reduce risk and invest internationally in the most efficientmanner possible. While most investors recognize the benefits of global diversification, there aremany challenges presented when investing directly in local trading markets. Obstacles can includeinefficient trade settlements, uncertain custody services, and costly currency conversions. Depositoryreceipts overcome many of the inherent operational and custodial hurdles inherent in internationalinvesting. Tryssen has decided to access the U.S. market by involving itself in an ADR program.Tryssen has decided to save itself a lot of trouble, however, by not complying with SEC registrationand reporting requirements.As an alternative to ADRs, investors interested in increasing their exposure to internationalinvestments can choose to acquire exchange traded funds (ETFs). Hagemann researches theadvantages and disadvantages of ETFs.Execution costs are always a concern, and perhaps even more so for international investors. At thepresent time, Tryssen AG is most concerned with how reliably it can estimate trading costs. As part ofthe cost estimation process, Hagemann is asked to provide a report on the advantages anddisadvantages of techniques used to reduce execution costs.Trysse AG proceeds to list on the Frankfurt exchange, and a U.S. affiliate of Hagemann's companystarts to aggressively promote the stock. A U.S. investor buys 200 shares of Tryssen at a price of €20per share. At time of purchase, the exchange rate is €1 = $1.15. One month later Tryssen pays adividend of €0.25 per share, and investors are subject to a withholding tax of 20%. The U.S. investoris eligible to claim a tax credit of $0.06 per share. At the time the dividend was paid, the shares hadjumped to €24 each and the U.S. dollar had weakened to €1 = $ 1.20. The shares were sold just afterthe dividend was paid.Which of the following combinations best describes the four most important execution costs inincreasing order of estimation reliability?

A. Opportunity costs; market impact; commissions; fees and taxes. 
B. Opportunity costs; commissions; fees and taxes; market impact. 
C. Commissions; fees and taxes; market impact; opportunity costs. 

Show Answer

Question # 36

Galena Petrovich, CFA, is an analyst in the New York office of TRS Investment Management, Inc.Petrovich is an expert in the industrial electrical equipment sector and is analyzing Fisher Global.Fisher is a global market leader in designing, manufacturing, marketing, and servicing electricalsystems and components, including fluid power systems and automotive engine air managementsystems.Fisher has generated double-digit growth over the past ten years, primarily as the result ofacquisitions, and has reported positive net income in each year. Fisher reports its financial resultsusing International Financial Reporting Standards (IFRS).Petrovich is particularly interested in a transaction that occurred seven years ago, before the changein accounting standards, in which Fisher used the pooling method to account for a large acquisitionof Dartmouth Industries, an industry competitor. She would like to determine the effect of using thepurchase method instead of the pooling method on the financial statements of Fisher. Fisherexchanged common stock for all of the outstanding shares of Dartmouth.Fisher also has a 50% ownership interest in a joint venture with its major distributor, a U.S. companycalled Hydro Distribution. She determines that Fisher has reported its ownership interest under theproportioned consolidation method, and that the joint venture has been profitable since it wasestablished three years ago. She decides to adjust the financial statements to show how the financialstatements would be affected if Fisher had reported its ownership under the equity method. Fisher isalso considering acquiring 80% to 100% of Brown and Sons Company. Petrovich must consider theeffect of such an acquisition on Fisher's financial statements.Petrovich determines from the financial statement footnotes that Fisher reported an unrealized gainin its most recent income statement related to debt securities that are designated at fair value.Competitor firms following U.S. GAAP classify similar debt securities as available-for-sale.Finally, Petrovich finds a reference in Fisher's footnotes regarding a special purpose entity (SPE).Fisher has reported its investment in the SPE using the equity method, but Petrovich believes thatthe consolidation method more accurately reflects Fisher's true financial position, so she makes theappropriate adjustments to the financial statements.Regarding the prior purchase that was accounted for under the pooling of interests method, hadFisher Global reported this purchase under the acquisition method:

A. the assets and liabilities of the purchased firm would not be included on Fisher's balance sheet.
B. balance sheet assets and liabilities of the purchased firm would have been reported at fair value.
C. reported goodwill could be less depending on the fair value of the identifiable assets and liabilitiescompared to their book values.

Show Answer

Question # 37

Martin Hagemann, CFA, works for a large brokerage firm in Frankfurt, Germany. Hagemann has beenhired by Tryssen AG, a global research-based company that is preparing to go public after a longhistory of operating privately. The need to raise substantial amounts of capital to fund research anddevelopment activities is seen as the key motivation for the change in policy. Tryssen is engaged inthe discovery, development, manufacture, marketing, and sale of medical products.Hagemann's first task is to recommend an exchange upon which Tryssen stock can be traded. Onepossibility is the Deutsche Bourse. The Deutsche Bourse operates primarily as a continuous orderdriven system. Another alternative that Tryssen is considering is to list on a different exchange thatoperates as a price-driven system.As an alternative, Tryssen may choose to list as an American Depository Receipt (ADR). ADRs arenegotiable U.S. securities that usually represent a non-U.S. based company's publicly traded equity.Although typically denominated in U.S. dollars, depository receipts can also be denominated ineuros. Depository receipts can be eligible to trade on all U.S. stock exchanges as well as on manyEuropean stock exchanges.The increasing demand for depository receipts is driven by the desire of individual and institutionalinvestors to diversify their portfolios, reduce risk and invest internationally in the most efficientmanner possible. While most investors recognize the benefits of global diversification, there aremany challenges presented when investing directly in local trading markets. Obstacles can includeinefficient trade settlements, uncertain custody services, and costly currency conversions. Depositoryreceipts overcome many of the inherent operational and custodial hurdles inherent in internationalinvesting. Tryssen has decided to access the U.S. market by involving itself in an ADR program.Tryssen has decided to save itself a lot of trouble, however, by not complying with SEC registrationand reporting requirements.As an alternative to ADRs, investors interested in increasing their exposure to internationalinvestments can choose to acquire exchange traded funds (ETFs). Hagemann researches theadvantages and disadvantages of ETFs.Execution costs are always a concern, and perhaps even more so for international investors. At thepresent time, Tryssen AG is most concerned with how reliably it can estimate trading costs. As part ofthe cost estimation process, Hagemann is asked to provide a report on the advantages anddisadvantages of techniques used to reduce execution costs.Trysse AG proceeds to list on the Frankfurt exchange, and a U.S. affiliate of Hagemann's companystarts to aggressively promote the stock. A U.S. investor buys 200 shares of Tryssen at a price of €20per share. At time of purchase, the exchange rate is €1 = $1.15. One month later Tryssen pays adividend of €0.25 per share, and investors are subject to a withholding tax of 20%. The U.S. investoris eligible to claim a tax credit of $0.06 per share. At the time the dividend was paid, the shares hadjumped to €24 each and the U.S. dollar had weakened to €1 = $ 1.20. The shares were sold just afterthe dividend was paid.Which of the following alternatives best describes the main benefits of ETFs?

A. Available domestically; liquid; low cost. 
B. Available domestically; diversified; liquid; low cost; tax efficient. 
C. Low cost; tax efficient; provides an active return in excess of a benchmark. 

Show Answer

Question # 38

Martin Hagemann, CFA, works for a large brokerage firm in Frankfurt, Germany. Hagemann has beenhired by Tryssen AG, a global research-based company that is preparing to go public after a longhistory of operating privately. The need to raise substantial amounts of capital to fund research anddevelopment activities is seen as the key motivation for the change in policy. Tryssen is engaged inthe discovery, development, manufacture, marketing, and sale of medical products.Hagemann's first task is to recommend an exchange upon which Tryssen stock can be traded. Onepossibility is the Deutsche Bourse. The Deutsche Bourse operates primarily as a continuous orderdriven system. Another alternative that Tryssen is considering is to list on a different exchange thatoperates as a price-driven system.As an alternative, Tryssen may choose to list as an American Depository Receipt (ADR). ADRs arenegotiable U.S. securities that usually represent a non-U.S. based company's publicly traded equity.Although typically denominated in U.S. dollars, depository receipts can also be denominated ineuros. Depository receipts can be eligible to trade on all U.S. stock exchanges as well as on manyEuropean stock exchanges.The increasing demand for depository receipts is driven by the desire of individual and institutionalinvestors to diversify their portfolios, reduce risk and invest internationally in the most efficientmanner possible. While most investors recognize the benefits of global diversification, there aremany challenges presented when investing directly in local trading markets. Obstacles can includeinefficient trade settlements, uncertain custody services, and costly currency conversions. Depositoryreceipts overcome many of the inherent operational and custodial hurdles inherent in internationalinvesting. Tryssen has decided to access the U.S. market by involving itself in an ADR program.Tryssen has decided to save itself a lot of trouble, however, by not complying with SEC registrationand reporting requirements.As an alternative to ADRs, investors interested in increasing their exposure to internationalinvestments can choose to acquire exchange traded funds (ETFs). Hagemann researches theadvantages and disadvantages of ETFs.Execution costs are always a concern, and perhaps even more so for international investors. At thepresent time, Tryssen AG is most concerned with how reliably it can estimate trading costs. As part ofthe cost estimation process, Hagemann is asked to provide a report on the advantages anddisadvantages of techniques used to reduce execution costs.Trysse AG proceeds to list on the Frankfurt exchange, and a U.S. affiliate of Hagemann's companystarts to aggressively promote the stock. A U.S. investor buys 200 shares of Tryssen at a price of €20per share. At time of purchase, the exchange rate is €1 = $1.15. One month later Tryssen pays adividend of €0.25 per share, and investors are subject to a withholding tax of 20%. The U.S. investoris eligible to claim a tax credit of $0.06 per share. At the time the dividend was paid, the shares hadjumped to €24 each and the U.S. dollar had weakened to €1 = $ 1.20. The shares were sold just afterthe dividend was paid.Which of the following alternatives best describes the main benefits of ETFs?

A. Available domestically; liquid; low cost. 
B. Available domestically; diversified; liquid; low cost; tax efficient. 
C. Low cost; tax efficient; provides an active return in excess of a benchmark. 

Show Answer

Question # 39

Martin Hagemann, CFA, works for a large brokerage firm in Frankfurt, Germany. Hagemann has beenhired by Tryssen AG, a global research-based company that is preparing to go public after a longhistory of operating privately. The need to raise substantial amounts of capital to fund research anddevelopment activities is seen as the key motivation for the change in policy. Tryssen is engaged inthe discovery, development, manufacture, marketing, and sale of medical products.Hagemann's first task is to recommend an exchange upon which Tryssen stock can be traded. Onepossibility is the Deutsche Bourse. The Deutsche Bourse operates primarily as a continuous orderdriven system. Another alternative that Tryssen is considering is to list on a different exchange thatoperates as a price-driven system.As an alternative, Tryssen may choose to list as an American Depository Receipt (ADR). ADRs arenegotiable U.S. securities that usually represent a non-U.S. based company's publicly traded equity.Although typically denominated in U.S. dollars, depository receipts can also be denominated ineuros. Depository receipts can be eligible to trade on all U.S. stock exchanges as well as on manyEuropean stock exchanges.The increasing demand for depository receipts is driven by the desire of individual and institutionalinvestors to diversify their portfolios, reduce risk and invest internationally in the most efficientmanner possible. While most investors recognize the benefits of global diversification, there aremany challenges presented when investing directly in local trading markets. Obstacles can includeinefficient trade settlements, uncertain custody services, and costly currency conversions. Depositoryreceipts overcome many of the inherent operational and custodial hurdles inherent in internationalinvesting. Tryssen has decided to access the U.S. market by involving itself in an ADR program.Tryssen has decided to save itself a lot of trouble, however, by not complying with SEC registrationand reporting requirements.As an alternative to ADRs, investors interested in increasing their exposure to internationalinvestments can choose to acquire exchange traded funds (ETFs). Hagemann researches theadvantages and disadvantages of ETFs.Execution costs are always a concern, and perhaps even more so for international investors. At thepresent time, Tryssen AG is most concerned with how reliably it can estimate trading costs. As part ofthe cost estimation process, Hagemann is asked to provide a report on the advantages anddisadvantages of techniques used to reduce execution costs.Trysse AG proceeds to list on the Frankfurt exchange, and a U.S. affiliate of Hagemann's companystarts to aggressively promote the stock. A U.S. investor buys 200 shares of Tryssen at a price of €20per share. At time of purchase, the exchange rate is €1 = $1.15. One month later Tryssen pays adividend of €0.25 per share, and investors are subject to a withholding tax of 20%. The U.S. investoris eligible to claim a tax credit of $0.06 per share. At the time the dividend was paid, the shares hadjumped to €24 each and the U.S. dollar had weakened to €1 = $ 1.20. The shares were sold just afterthe dividend was paid.Which of the following best describes a comparative advantage of a price-driven system over anorder-driven system?

A. Price-driven trading is less costly to administer. 
B. Price-driven systems generally provide better liquidity for large block trades. 
C. In a price-driven system, the dealer receives a free option when a firm quote is posted. 

Show Answer

Question # 40

Martin Hagemann, CFA, works for a large brokerage firm in Frankfurt, Germany. Hagemann has beenhired by Tryssen AG, a global research-based company that is preparing to go public after a longhistory of operating privately. The need to raise substantial amounts of capital to fund research anddevelopment activities is seen as the key motivation for the change in policy. Tryssen is engaged inthe discovery, development, manufacture, marketing, and sale of medical products.Hagemann's first task is to recommend an exchange upon which Tryssen stock can be traded. Onepossibility is the Deutsche Bourse. The Deutsche Bourse operates primarily as a continuous orderdriven system. Another alternative that Tryssen is considering is to list on a different exchange thatoperates as a price-driven system.As an alternative, Tryssen may choose to list as an American Depository Receipt (ADR). ADRs arenegotiable U.S. securities that usually represent a non-U.S. based company's publicly traded equity.Although typically denominated in U.S. dollars, depository receipts can also be denominated ineuros. Depository receipts can be eligible to trade on all U.S. stock exchanges as well as on manyEuropean stock exchanges.The increasing demand for depository receipts is driven by the desire of individual and institutionalinvestors to diversify their portfolios, reduce risk and invest internationally in the most efficientmanner possible. While most investors recognize the benefits of global diversification, there aremany challenges presented when investing directly in local trading markets. Obstacles can includeinefficient trade settlements, uncertain custody services, and costly currency conversions. Depositoryreceipts overcome many of the inherent operational and custodial hurdles inherent in internationalinvesting. Tryssen has decided to access the U.S. market by involving itself in an ADR program.Tryssen has decided to save itself a lot of trouble, however, by not complying with SEC registrationand reporting requirements.As an alternative to ADRs, investors interested in increasing their exposure to internationalinvestments can choose to acquire exchange traded funds (ETFs). Hagemann researches theadvantages and disadvantages of ETFs.Execution costs are always a concern, and perhaps even more so for international investors. At thepresent time, Tryssen AG is most concerned with how reliably it can estimate trading costs. As part ofthe cost estimation process, Hagemann is asked to provide a report on the advantages anddisadvantages of techniques used to reduce execution costs.Trysse AG proceeds to list on the Frankfurt exchange, and a U.S. affiliate of Hagemann's companystarts to aggressively promote the stock. A U.S. investor buys 200 shares of Tryssen at a price of €20per share. At time of purchase, the exchange rate is €1 = $1.15. One month later Tryssen pays a dividend of €0.25 per share, and investors are subject to a withholding tax of 20%. The U.S. investoris eligible to claim a tax credit of $0.06 per share. At the time the dividend was paid, the shares hadjumped to €24 each and the U.S. dollar had weakened to €1 = $ 1.20. The shares were sold just afterthe dividend was paid.Which type of ADR is Tryssen most likely to undertake?

A. Sponsored Level I ADR. 
B. Sponsored Level II ADR. 
C. Sponsored Level III ADR. 

Show Answer

Question # 41

Henke Malfoy, CFA, is an analyst with a major manufacturing firm. Currently, he is evaluating thereplacement of some production equipment. The old machine is still functional and could continueto serve in its current capacity for three more years. Tf the new equipment is purchased, the oldequipment (which is fully depreciated) can be sold for $50,000. The new equipment will cost$400,000, including shipping and installation. If the new equipment is purchased, the company'srevenues 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 MACRSschedule is 33.0% in the first year, 45% in the second year, 15% in the third year, and 7% in the fourthyear). At the end of the life of the new equipment (i.e., in three years), Malfoy expects that it can besold for $10,000. The firm has a marginal tax rate of 40%, and the cost of capital on this project is20%. In calculation of tax liabilities, Malfoy assumesthat the firm is profitable,so any losses on thisproject can be offset against profits elsewhere in the firm. Malfoy calculates a project NPV of-$62,574.What isthe IRR based on Malfoy's NPV estimate, and should the project be accepted orrejected inorderto maximize shareholder value?IRR Project

A. 8.8% Accept
B. 8.8% Reject
C. 21.5% Accept

Show Answer

Question # 42

Henke Malfoy, CFA, is an analyst with a major manufacturing firm. Currently, he is evaluating thereplacement of some production equipment. The old machine is still functional and could continueto serve in its current capacity for three more years. Tf the new equipment is purchased, the oldequipment (which is fully depreciated) can be sold for $50,000. The new equipment will cost$400,000, including shipping and installation. If the new equipment is purchased, the company'srevenues 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 MACRSschedule is 33.0% in the first year, 45% in the second year, 15% in the third year, and 7% in the fourthyear). At the end of the life of the new equipment (i.e., in three years), Malfoy expects that it can besold for $10,000. The firm has a marginal tax rate of 40%, and the cost of capital on this project is20%. In calculation of tax liabilities, Malfoy assumesthat the firm is profitable,so any losses on thisproject can be offset against profits elsewhere in the firm. Malfoy calculates a project NPV of-$62,574.Suppose forthis question only that Malfoy hasforgotten to reflect a decrease in inventory that willresult at the beginning of the project. The most likely effect on estimated project NPV of this error:

A. is to overestimate NPV.
B. is to underestimate NPV.
C. depends on whetherthe inventory is assumed to build back up to its previouslevel at the end ofthe project orthe decrease in inventory is permanent.

Show Answer

Question # 43

Henke Malfoy, CFA, is an analyst with a major manufacturing firm. Currently, he is evaluating thereplacement of some production equipment. The old machine is still functional and could continueto serve in its current capacity for three more years. Tf the new equipment is purchased, the oldequipment (which is fully depreciated) can be sold for $50,000. The new equipment will cost$400,000, including shipping and installation. If the new equipment is purchased, the company'srevenues 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 MACRSschedule is 33.0% in the first year, 45% in the second year, 15% in the third year, and 7% in the fourthyear). At the end of the life of the new equipment (i.e., in three years), Malfoy expects that it can besold for $10,000. The firm has a marginal tax rate of 40%, and the cost of capital on this project is20%. In calculation of tax liabilities, Malfoy assumesthat the firm is profitable,so any losses on thisproject can be offset against profits elsewhere in the firm. Malfoy calculates a project NPV of-$62,574.What is the effect of taxes on the operating cash flow in year 2?

A. Decrease by $7,200.
B. Increase by $7(20O.
C. Increase by $12,000.

Show Answer

Question # 44

The board members for Kazmaier Foods have gathered for their quarterly board of directors meeting.Presiding at the meeting is the Chairman and CEO for Kazmaier, Phil Hinesman. The other eight members of the board are also present, including Allen Kazmaier, the brother of Kazmaier's founder; Elaine Randall, Executive Vice President for Emerald Bank, which Kazmaier uses to obtain short-term financing; and Bill Schram, Kazmaier's President and Chief Operating Officer. Each of the directors was elected to serve on the board for a 4-yearterm. They were elected two at a time overthe past three years. With the exception of Hinesman, Allen Kazmaier, Randall, and Schram, board members had no ties to Kazmaier prior to joining the board and had no personal relationships with management. In addition to the regular board meetings, the five independent board members get together annually, in a meeting separate from the regular board meetings, to discuss the company's operations.Item 1 on the board meeting agenda is a discussion about the importance of corporate governance and how Kazmaier can improve its corporate governance system. Hinesman begins the discussion by saying, "A strong system of corporate governance is important to ourshareholders. Studies have shown that, on average, companies with strong corporate governance systems have higher measures of profitability than companies with weak corporate governance systems." Randall adds her comment to the discussion: "The lack of an effective corporate governance system increases risk for our investors. If we do not have the appropriate checks and balancesin place, ourinvestors may be exposed to the risk that information used to make decisions about our firm is misleading or incomplete, as well as the risk that mergers or acquisitions the firm enters into will benefit management at the expense of shareholders."After a lengthy discussion, the board agrees on five separate recommendations that will enhance its currentsystem of corporate governance. One of these recommendationsisto change the functionand  tructure of the board's audit committee. Currently the audit committee consists of MatthewBortz, David Smith, and Ann Williams—three independent directors who each have backgrounds infinance and accounting. The board agrees that one more member should be added to the committeeand that the committee should expand itslist of responsibilities.Item 2 on the agenda for the board of directors' meeting is a report from Kazmaicr's Chief FinancialOfficer, Doug Layman. The following information was included in the material that was distributed toeach board member before the meeting:Currentshare price: $40.00Shares outstanding: 56, 250,000Estimated earnings: $112.5 millionPlanned capital spending: $150 millionTarget debt-to-equity ratio 1 to ICost of equity: 8.0%Constant growth rate: 5.2%Layman tells the board that his analysis indicates that, based on a constant-growth dividend discountmodel, the initiation of an $0.80 pershare dividend would reduce the cost of equity by 1.2% andincrease the value of the firm'sstock, assuming that earnings, the cost of debt, and the constantgrowth rate don't change.Item 3 on the agenda is the sale of Kazmaier's condiment packaging division to Sautter Packaging andSupply Company. Layman believesthe sale will net the company $50 million, payable in cash. Afterdiscussing the pros and cons ofselling the division, the directors agree that the sale is in the bestinterests of the company and its shareholders. The directors then move to a vote, and the sale of thecondiment packaging division is approved unanimously. The committee then moves on to discusswhat to do with the proceeds from the sale. Williams suggeststhat paying out the $50 million toshareholders as a special dividend would continue to give the firm flexibility in how it uses its excesscash. Smith tellsthe board that a share repurchase can be thought of as an alternative to a cashdividend, and that if the tax treatment between the two alternatives is the same, investors should beindifferent between the two. After debating the merits ofspecial dividends and stock repurchases,Kazmaier's board authorizesthe proceeds from the sale of the condiment packaging division to beused for the purchase of $50 million worth of outstanding shares.An external agency recently included Kazmaier in a review of corporate governance systems todetermine whether or not the structure of the board of directors was consistent with corporategovernance best practices. The agency scored companies based on the following criteria:Criterion 1: Composition of the board of directors.Criterion 2: Chairman of the board of directors.Criterion 3; Method of electing the board.Criterion 4: Frequency of separate sessions for independent directors.Each of the four criteria was weighted equally, with the firm receiving a positive mark for being incompliance with corporate governance best practice.A month after the board meeting, the price of Kazmaier stock is still at $40 per share, and the sale ofKazmaier's condiment packaging division does not go through. In orderto finance the approvedshare repurchase, Kazmaier isforced to borrow funds. Schram states, "I am concerned that the costofthe debt used to repurchase shares may cause a reduction in earnings pershare." Jennifer Nagy, a vice president in Kazmaier's finance division, tells Schram not to be concerned aboutusing debt to finance the share repurchase because the rationale behind the repurchase is sound.Nagy then writes down some of the common rationales for share repurchases and hands them to Schram.Rationale 1: Repurchasing shares can prevent the EPS dilution that comesfrom the exercise of employee stock options.Rationale 2: Management can use a share repurchase to alter the company's capital structure by decreasing the percentage of equity.Rationale 3: Like a dividend increase, a share repurchase is a way to send a signal to investors thatKazmaier's management believes the outlook for the company's future is strong.Kazmaier's total score on the corporate governance report is closest to

A. 25%.
B. 50%.
C. 75%.

Show Answer

Question # 45

Andrew Carson is an equity analyst employed at Lee, Vincent, and Associates, an investmentresearch firm. In a conversation with his supervisor, Daniel Lau, Carson makes the following twostatements about defined contribution plans.Statement I: Employers often face onerous disclosure requirements.Statement 2: Employers often bear all the investment risk.Carson is responsible for following Samilski Enterprises (Samilski), a publicly traded firm thatproduces motorcycles and other mechanical parts. It operates exclusively in the United States. At theend of its 2009 fiscal year, Samilski's employee pension plan had a projected benefit obligation (PBO)of $320 million. Also, unrecognized prior service costs were $35 million, the fair value of plan assetswas $316 million, and the unrecognized actuarial gain was $21 million.Carson believes the rate of compensation increase will be 5% as opposed to 4% in the previous year,and the discount rate will be 7% as opposed to 8% in the previous year.This past year, Samilski began using special purpose entities (SPEs) for various reasons. Inpreparation for analyzing the SPE disclosures in the footnotes to the financial statements, Carsonprepares a memo on SPEs. In the memo, he correctly concludes that the company will be requiredunder new accounting rules to classify them as variable interest entities (VIE) and consolidate theentities on the balance sheet rather than report them using the equity method as in the past.Which of the following items, when recognized, will likely increase:PBO? Pension expense?

A. Actuarial loss Expected return on plan assets
B. Actuarial loss Amortization of prior service costs
C. Actuarial gain Amortization of prior service costs

Show Answer

Question # 46

Andrew Carson is an equity analyst employed at Lee, Vincent, and Associates, an investmentresearch firm. In a conversation with his supervisor, Daniel Lau, Carson makes the following twostatements about defined contribution plans.Statement I: Employers often face onerous disclosure requirements.Statement 2: Employers often bear all the investment risk.Carson is responsible for following Samilski Enterprises (Samilski), a publicly traded firm thatproduces motorcycles and other mechanical parts. It operates exclusively in the United States. At theend of its 2009 fiscal year, Samilski's employee pension plan had a projected benefit obligation (PBO)of $320 million. Also, unrecognized prior service costs were $35 million, the fair value of plan assetswas $316 million, and the unrecognized actuarial gain was $21 million.Carson believes the rate of compensation increase will be 5% as opposed to 4% in the previous year,and the discount rate will be 7% as opposed to 8% in the previous year.This past year, Samilski began using special purpose entities (SPEs) for various reasons. Inpreparation for analyzing the SPE disclosures in the footnotes to the financial statements, Carsonprepares a memo on SPEs. In the memo, he correctly concludes that the company will be requiredunder new accounting rules to classify them as variable interest entities (VIE) and consolidate theentities on the balance sheet rather than report them using the equity method as in the past.What are the likely effects of the required change in accounting for SPEs on Samilski's:Return on assets? Return on equity?

A. Decrease Decrease
B. Decrease No effect
C. No effect Decrease

Show Answer

Question # 47

Andrew Carson is an equity analyst employed at Lee, Vincent, and Associates, an investmentresearch firm. In a conversation with his supervisor, Daniel Lau, Carson makes the following twostatements about defined contribution plans.Statement I: Employers often face onerous disclosure requirements.Statement 2: Employers often bear all the investment risk.Carson is responsible for following Samilski Enterprises (Samilski), a publicly traded firm thatproduces motorcycles and other mechanical parts. It operates exclusively in the United States. At theend of its 2009 fiscal year, Samilski's employee pension plan had a projected benefit obligation (PBO)of $320 million. Also, unrecognized prior service costs were $35 million, the fair value of plan assetswas $316 million, and the unrecognized actuarial gain was $21 million.Carson believes the rate of compensation increase will be 5% as opposed to 4% in the previous year,and the discount rate will be 7% as opposed to 8% in the previous year.This past year, Samilski began using special purpose entities (SPEs) for various reasons. Inpreparation for analyzing the SPE disclosures in the footnotes to the financial statements, Carsonprepares a memo on SPEs. In the memo, he correctly concludes that the company will be requiredunder new accounting rules to classify them as variable interest entities (VIE) and consolidate theentities on the balance sheet rather than report them using the equity method as in the past.Under current U.S. GAAP pension accounting standards, the amount of the pension asset or liabilitythat Samilski should report on its 2009 fiscal year end balance sheet is closes/ to a:

A. $4 million liability.
B. $10 million liabilily
C. $14 million liabiliy

Show Answer

Question # 48

Andrew Carson is an equity analyst employed at Lee, Vincent, and Associates, an investmentresearch firm. In a conversation with his supervisor, Daniel Lau, Carson makes the following twostatements about defined contribution plans.Statement I: Employers often face onerous disclosure requirements.Statement 2: Employers often bear all the investment risk.Carson is responsible for following Samilski Enterprises (Samilski), a publicly traded firm thatproduces motorcycles and other mechanical parts. It operates exclusively in the United States. At theend of its 2009 fiscal year, Samilski's employee pension plan had a projected benefit obligation (PBO)of $320 million. Also, unrecognized prior service costs were $35 million, the fair value of plan assetswas $316 million, and the unrecognized actuarial gain was $21 million.Carson believes the rate of compensation increase will be 5% as opposed to 4% in the previous year,and the discount rate will be 7% as opposed to 8% in the previous year.This past year, Samilski began using special purpose entities (SPEs) for various reasons. Inpreparation for analyzing the SPE disclosures in the footnotes to the financial statements, Carsonprepares a memo on SPEs. In the memo, he correctly concludes that the company will be requiredunder new accounting rules to classify them as variable interest entities (VIE) and consolidate theentities on the balance sheet rather than report them using the equity method as in the past.Based on Carson's projections of the discount rate, what are the likely effects on the projectedbenefit obligation (PBO) and the pension cost?

A. Both will increase.
B. Both will decrease.
C. One will increase and the other will decrease.

Show Answer

Question # 49

Andrew Carson is an equity analyst employed at Lee, Vincent, and Associates, an investmentresearch firm. In a conversation with his supervisor, Daniel Lau, Carson makes the following twostatements about defined contribution plans.Statement I: Employers often face onerous disclosure requirements.Statement 2: Employers often bear all the investment risk.Carson is responsible for following Samilski Enterprises (Samilski), a publicly traded firm thatproduces motorcycles and other mechanical parts. It operates exclusively in the United States. At theend of its 2009 fiscal year, Samilski's employee pension plan had a projected benefit obligation (PBO)of $320 million. Also, unrecognized prior service costs were $35 million, the fair value of plan assetswas $316 million, and the unrecognized actuarial gain was $21 million.Carson believes the rate of compensation increase will be 5% as opposed to 4% in the previous year,and the discount rate will be 7% as opposed to 8% in the previous year.This past year, Samilski began using special purpose entities (SPEs) for various reasons. Inpreparation for analyzing the SPE disclosures in the footnotes to the financial statements, Carsonprepares a memo on SPEs. In the memo, he correctly concludes that the company will be requiredunder new accounting rules to classify them as variable interest entities (VIE) and consolidate theentities on the balance sheet rather than report them using the equity method as in the past.Under current U.S. GAAP pension accounting standards, the amount of the pension asset or liabilitythat Samilski should report on its 2009 fiscal year end balance sheet is closes/ to a:

A. $4 million liability.
B. $10 million liabilily
C. $14 million liability

Show Answer

Question # 50

Andrew Carson is an equity analyst employed at Lee, Vincent, and Associates, an investmentresearch firm. In a conversation with his supervisor, Daniel Lau, Carson makes the following twostatements about defined contribution plans.Statement I: Employers often face onerous disclosure requirements.Statement 2: Employers often bear all the investment risk.Carson is responsible for following Samilski Enterprises (Samilski), a publicly traded firm thatproduces motorcycles and other mechanical parts. It operates exclusively in the United States. At theend of its 2009 fiscal year, Samilski's employee pension plan had a projected benefit obligation (PBO)of $320 million. Also, unrecognized prior service costs were $35 million, the fair value of plan assetswas $316 million, and the unrecognized actuarial gain was $21 million.Carson believes the rate of compensation increase will be 5% as opposed to 4% in the previous year,and the discount rate will be 7% as opposed to 8% in the previous year.This past year, Samilski began using special purpose entities (SPEs) for various reasons. Inpreparation for analyzing the SPE disclosures in the footnotes to the financial statements, Carsonprepares a memo on SPEs. In the memo, he correctly concludes that the company will be requiredunder new accounting rules to classify them as variable interest entities (VIE) and consolidate theentities on the balance sheet rather than report them using the equity method as in the past.Is Carson correct with respect to defined contribution plans?

A. Both statements are incorrect.
B. Only Statement 1 is incorrect.
C. Only Statement 2 is incorrect.

Show Answer