CFA Institute CFA-Level-II Exam Questions

Jill Surratt, CFA, and Elizabeth Castillo, CFA, are analysts for Summit Consulting. Summit provides investment advice to hedge funds and actively managed investment funds throughout the United States and Canada.

Surratt and Castillo have a client, Tom Carr, who is interested in increasing his returns from foreign currency positions. Carr currently has a position in Japanese yen () that he wishes to convert to Taiwanese dollars (NTS) because he thinks the Taiwanese currency will appreciate in the near term. He docs not have a quote for yen in terms of the NTS, but has received quotes for both currencies in terms of the U .S . dollar The quotes are $0.008852-56 for the yen and $0.02874-6 for the Taiwanese dollar. He would like to purchase NTS10 million.

Discussing these quotes, Surratt notes that the bid-ask spread is affected by many factors. She states that if an economic crisis were expected in the Asian markets, then the bid-ask spread of the currency quotes should widen. Castillo states that if a dealer wished to unload an excess inventor}' of yen, the typical response would be to lower her ask for the yen, thereby narrowing the bid-ask spread.

In regards to changes in currency values, Surratt states that if the U .S . Federal Reserve unexpectedly restricts the growth of the money supply and foreign interest rates remain constant, then the U .S . interest rate differential should increase, thereby increasing the value of the dollar. She states that this change may occur without a change in the quantity of dollars traded. Surratt also mentions that in addition to monetary policy having an impact on exchange rates, governments sometimes intervene directly into the foreign currency markets. She states that if a country was defending its currency value, it would buy up its currency for as long as needed in the foreign currency markets.

In addition to using monetary policy, Summit Consulting uses anticipated changes in fiscal policy to forecast exchange rates and the balance of payments for a country. Castillo states that if the U .S . Congress were to unexpectedly reduce the budget deficit, then this should have a positive impact on the value of the dollar in the short-run because foreigners would have more confidence in the U .S . economy. Castillo adds that this change would result in changes in the balance of payments components, with the trade deficit and the capital account surplus decreasing.

Another of Summit's clients is Jack Ponder. Ponder would like to investigate the possibility of using covered interest arbitrage to earn risk free profits over the next three months, assuming initial capital of $1 million. He asks Surratt to gather information on the inflation rates, interest rates, spot rates, and forward rates for the U .S . dollar and the Swiss franc (SF). Surratt has also used technical analysis to obtain a projection of the future spot rate for the two countries' currencies. The information is presented below:

At a training session for new employees, Surratt and Castillo lecture on international trade and finance issues. To illustrate the concept of comparative advantage, Castillo uses two countries, Country A and Country B. Both produce computers and food but have different opportunity costs for producing them. A's opportunity cost of producing another pallet of computers is two bushels of food. B*s opportunity cost of producing another pallet of computers is five bushels of food. The table below provides the output from each country before international trade takes place;

Which of the following best describes potential gains from international trade in Castillo's example?

Potential gains:

Michael Robbins, CFA, is analyzing Universal Home Supplies, Inc. (UHS), which has recently gone through some extensive restructuring.

Universal Home Supplies, Inc.

UHS operates nearly 200 department stores and 78 specialty stores in over 30 states. The company offers a wide range of products, including women's, men's, and children's clothing and accessories as well as home furnishings, electronics, and other consumer goods. The company is considering cutting back on or eliminating its electronics business entirely. UHS manufactures many of its own apparel products domestically in a large factory located in Kentucky. This central location permits shipping to distribution points around the country at reasonable costs. The company operates primarily in suburban shopping malls and offers mid- to high-end merchandise mainly under its own private label. At present more than 70% of the company's customers live within a 10-minute drive of one of the company's stores. Web site activity measured in dollar sales volume has increased by over 18% in the past year. Shares of UHS stock are currently priced at $25. Dividends are expected to grow at a rate of 6% over the next eight years and then continue to grow at that same rate indefinitely. The company has a cost of capital of 10.2%, a beta of 0.8, and just paid an annual dividend of $1.25.

UHS has faced serious cash flow problems in recent years as a consequence of its strategy to pursue an upscale clientele in the face of increased competition from several "niche retailers." The firm has been able to issue new debt recently and has also managed to extend its line of credit. The two financing agreements required a pledge of additional assets and a promise to install a super-efficient inventory tracking system in time to meet holiday shopping demand.

Robbins is asked by his supervisor to carefully consider the advantages and drawbacks of using the price-to-sales ratio (P/S) and to determine the appropriate valuation metrics to use when returns follow patterns of persistence or reversals.

Robbins also estimates a cross-sectional model to predict UHS's P/E:

predicted P/E = 5 - (10 x beta) + [3 x 4-year average ROE(%)]

+ [2 X 5-ycar growth forecast(%)]

Robbins should conclude that patterns of persistence or reversals in returns provide the most appropriate rationale for valuation using:

Jill Surratt, CFA, and Elizabeth Castillo, CFA, are analysts for Summit Consulting. Summit provides investment advice to hedge funds and actively managed investment funds throughout the United States and Canada.

Surratt and Castillo have a client, Tom Carr, who is interested in increasing his returns from foreign currency positions. Carr currently has a position in Japanese yen () that he wishes to convert to Taiwanese dollars (NTS) because he thinks the Taiwanese currency will appreciate in the near term. He docs not have a quote for yen in terms of the NTS, but has received quotes for both currencies in terms of the U .S . dollar The quotes are $0.008852-56 for the yen and $0.02874-6 for the Taiwanese dollar. He would like to purchase NTS10 million.

Discussing these quotes, Surratt notes that the bid-ask spread is affected by many factors. She states that if an economic crisis were expected in the Asian markets, then the bid-ask spread of the currency quotes should widen. Castillo states that if a dealer wished to unload an excess inventor}' of yen, the typical response would be to lower her ask for the yen, thereby narrowing the bid-ask spread.

In regards to changes in currency values, Surratt states that if the U .S . Federal Reserve unexpectedly restricts the growth of the money supply and foreign interest rates remain constant, then the U .S . interest rate differential should increase, thereby increasing the value of the dollar. She states that this change may occur without a change in the quantity of dollars traded. Surratt also mentions that in addition to monetary policy having an impact on exchange rates, governments sometimes intervene directly into the foreign currency markets. She states that if a country was defending its currency value, it would buy up its currency for as long as needed in the foreign currency markets.

In addition to using monetary policy, Summit Consulting uses anticipated changes in fiscal policy to forecast exchange rates and the balance of payments for a country. Castillo states that if the U .S . Congress were to unexpectedly reduce the budget deficit, then this should have a positive impact on the value of the dollar in the short-run because foreigners would have more confidence in the U .S . economy. Castillo adds that this change would result in changes in the balance of payments components, with the trade deficit and the capital account surplus decreasing.

Another of Summit's clients is Jack Ponder. Ponder would like to investigate the possibility of using covered interest arbitrage to earn risk free profits over the next three months, assuming initial capital of $1 million. He asks Surratt to gather information on the inflation rates, interest rates, spot rates, and forward rates for the U .S . dollar and the Swiss franc (SF). Surratt has also used technical analysis to obtain a projection of the future spot rate for the two countries' currencies. The information is presented below:

At a training session for new employees, Surratt and Castillo lecture on international trade and finance issues. To illustrate the concept of comparative advantage, Castillo uses two countries, Country A and Country B. Both produce computers and food but have different opportunity costs for producing them. A's opportunity cost of producing another pallet of computers is two bushels of food. B*s opportunity cost of producing another pallet of computers is five bushels of food. The table below provides the output from each country before international trade takes place;

Evaluate Castillo's statements concerning the effect of fiscal policy on currency values and the balance of payments components? Castillo is:

Bryan Galloway is a strategist for JS Investments, a small money management firm. His goal is to analyze industries to determine whether there is justification for over- or under-weighting. His supervisor, Robyn Black, CFA, has asked that he document the process he uses to make his recommendations. However, just to be sure that Galloway understands industry analysis. Black asks him to provide examples of supply and demand analysis. Galloway makes the following two statements 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 each additional 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 hospital beds required, 20 additional doctors are needed.

Black is not entirely confident in Galloway's abilities to analyze various industries, but decides to allow him to continue with his analysis.

Four of the largest holdings for JS Investments are a tobacco company, a soda drink company, an oil company, and a cable TV company. Black is worried that government intervention will have a serious impact on future growth for these companies and asks Galloway to further research each of the industries involved. However, just to make sure Galloway can handle this project. Black first asks him to review the basics of industry analysis.

In reviewing the factors affecting pricing considerations, Galloway concludes that all of the following are 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 the industrial 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?

Delicious Candy Company (Delicious) is a leading manufacturer and distributor of quality confectionery products throughout Europe and Mexico. Delicious is a publicly-traded firm located in Italy and has been in business over 60 years.

Caleb Scott, an equity analyst with a large pension fund, has been asked to complete a comprehensive analysis of Delicious in order to evaluate the possibility of a future investment.

Scott compiles the selected financial data found in Exhibit 1 and learns that Delicious owns a 30% equity interest in a supplier located in the United States. Delicious uses the equity method to account for its investment in the U .S . associate.

Scott reads the Delicious's revenue recognition footnote found in Exhibit 2.

Exhibit 2: Revenue Recognition Footnote

__________________________________________________________________________________

in millions__________________________________________________________________________

Revenue is recognized, net of returns and allowances, when the goods are shipped to customers and collectability is assured. Several customers remit payment before delivery in order to receive additional discounts. Delicious reports these amounts as unearned revenue until the goods are shipped. Unearned revenue was 7,201 at the end of 2009 and 5,514 at the end of 2008.

Delicious operates two geographic segments: Europe and Mexico. Selected financial information for each segment is found in Exhibit 3.

At the beginning of 2009, Delicious entered into an operating lease for manufacturing equipment. At inception, the present value of the lease payments, discounted at an interest rate of 10%, was 6300 million. The lease term is six years and the annual payment is 669 million. Similar equipment owned by Delicious is depreciated using the straight-line method and no residual values are assumed.

Scott gathers the information in Exhibit 4 to determine the implied "stand-alone" value of Delicious without regard to the value of its U .S . associate.

Using the data found in Exhibit 1 and Exhibit 4, Delicious's implied P/E multiple without regard to its U .S . associate is closest to: