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CFA Institute Exam CFA-Level-II Topic 2 Question 100 Discussion
Topic #: 2
Viper Motor Company, a publicly traded automobile manufacturer located in Detroit, Michigan, periodically invests its excess cash in low-risk fixed income securities. At the end of 2009, Viper's investment portfolio consisted of two separate bond investments: Pinto Corporation and Vega Incorporated.
On January 2, 2009, Viper purchased $10 million of Pinto's 4% annual coupon bonds at 92% of par. The bonds were priced to yield 5%. Viper intends to hold the bonds to maturity. At the end of 2009, the bonds had a fair value of $9.6 million.
On July I, 2009, Viper purchased $7 million of Vega's 5% semi-annual coupon mortgage bonds at par. The bonds mature in 20 years. At the end of 2009, the market rate of interest for similar bonds was 4%. Viper intends to sell the securities in the near term in order to profit from expected interest rate declines.
Neither of the bond investments was sold by Viper in 2009.
On January 1,2010, Viper purchased a 60% controlling interest in Gremlin Corporation for $900 million. Viper paid for the acquisition with shares of its common stock.
Exhibit 1 contains Viper's and Gremlin's pre-acquisition balance sheet data.
Exhibit 2 contains selected information from Viper's financial statement footnotes.
The amount of goodwill Viper should report in its consolidated balance sheet immediately after the acquisition of Gremlin is closest to:
Norris is incorrect regarding the convenience yield. The price of an index futures contract is reduced by cash flows from the underlying asset, but the reduction comes from the future value of the cash flows, not from an implied cost for retaining the use of the underlying asset. The comment regarding the difference between the futures and forward contracts is also incorrect. In a flat (constant) interest rate environment (indicated in the first paragraph of the item set), there Is no difference in the prices of futures or forward contracts. The part of the comment relating to credit risk is correct. Since the forward contracts are not marked to market each day, the value is not reset to zero each day and credit risk is higher since large losses are allowed to accumulate. Thus, the credit risk would increase if forwards were used instead of futures. (Study Session 16, LOS 59.c,d)
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