CFA Institute CFA-Level-II Exam Questions

MediSoft Inc. develops and distributes high-tech medical software used in hospitals and clinics across the United States and Canada. The firm's software provides an integrated solution to monitoring, analyzing, and managing output from a variety of diagnostic medical equipment including MRls, CT scans, and EKG machines. MediSoft has grown rapidly since its inception ten years ago, averaging 25% growth in sales over the last decade. The company went public three years ago. Twelve months after their IPO, MediSoft made two semiannual coupon bond offerings, the first of which was a convertible bond. At the time of issuance, the convertible bond had a coupon rate of 7.25%, par value of $1,000, a conversion price of $55.56, and ten years until maturity. Two years after issuance, the bond became callable at 102% of par value. Soon after the issuance of the convertible bond, the company issued another series of bonds which were putable, but contained no conversion or call features. The putable bonds were issued with a coupon of 8.0%, par value of $1,000, and 15 years until maturity. One year after their issuance, the put feature of the putable bonds became active, allowing the bonds to be put at a price of 95% of par value, and increasing linearly over five years to 100% of par value. MediSoft's convertible bonds are now trading in the market for a price of $947 with an estimated straight value of $917. The company's putable bonds are trading at a price of $1,052. Volatility in the price of MediSoft's common stock has been relatively high over the last few months. Currently the stock is priced at $50 on the New York Stock Exchange and is expected to continue its annual dividend in the amount of $1.80 per share.

High-tech industry analysts for Brown & Associates, a money management firm specializing in fixed-income investments, have been closely following MediSoft ever since it went public three years ago. In general, portfolio managers at Brown & Associates do not participate in initial offerings of debt investments, preferring instead to see how the issue trades before considering taking a position in the issue. Since MediSoft's bonds have had ample time to trade in the marketplace, analysts and portfolio managers have taken an interest in the company's bonds. At a meeting to discuss the merits of MediSofVs bonds, the following comments were made by various portfolio managers and analysts at Brown & Associates:

"Choosing to invest in MediSoft's convertible bond would benefit our portfolios in many ways, but the primary benefit is the limited downside risk associated with the bond. Since the straight value will provide a floor for the value of the convertible bond, downside risk is limited to the difference between the market price of the bond and the straight value."

"Decreasing volatility in the price of MediSoft's common stock as well as increasing volatility in the level of interest rates are expected in the near future. The combined effects of these changes in volatility will be a decrease in the price of MediSoft's putable bonds and an increase in the price of the convertible bonds. Therefore, only the convertible bonds would be a suitable purchase."

Evaluate the portfolio managers' comments regarding the changes in the values of MediSoft's bonds resulting from changes in the volatility of the company's common stock and the volatility of interest rates. The managers were:

Glenda Garvey is interning at Samson Securities in the summer to earn money for her last semester of studies for her MBA, She took the Level 3 CFA exam in June but has not yet received her score. Garvey's work involves preparing research reports on small companies.

Garvey is at lunch with a group of co-workers. She listens to their conversation about various stocks and takes note of a comment from Tony Topel, a veteran analyst. Topel is talking about Vallo Engineering, a small stock he has tried repeatedly to convince the investment director to add to the monitored list. While the investment director does not like Vallo, Topel has faith in the company and has gradually accumulated 5,000 shares for his own account. Another analyst, Mary Kennedy, tells the group about Koral Koatings, a paint and sealant manufacturer. Kennedy has spent most of the last week at the office doing research on Koral. She has concluded that the stock is undervalued and consensus earnings estimates are conservative. However, she has not filed a report for Samson, nor does she intend to. She said she has purchased the stock for herself and advises her colleagues to do the same. After she gets back to the office, Garvey purchases 25 shares of Vallo and 50 shares of Koral for herself.

Samson pays its interns very little, and Garvey works as a waitress at a diner in the financial district to supplement her income. The dinner crowd includes many analysts and brokers who work at nearby businesses. While waiting tables that night, Garvey hears two employees of a major brokerage house discussing Metrona, a nanotechnology company. The restaurant patrons say that the broker's star analyst has issued a report with a buy rating on Metrona that morning. The diners plans to buy the stock the next morning. After Garvey finishes her shift, restaurant manager Mandy Jones, a longtime Samson client, asks to speak with her. Jones commends Garvey for her hard work at the restaurant, praising her punctuality and positive attitude, and offers her two tickets to a Yankees game as a bonus.

The next morning, Garvey buys 40 shares of Metrona for her own account at the market open. Soon afterward, she receives a call from Harold Koons, one of Samson's largest money-management clients. Koons says he got Garvey's name from Bertha Witt, who manages the Koons' account. Koons wanted to reward the analyst who discovered Anvil Hammers, a machine-tool company whose stock soared soon after it was added to his portfolio. Garvey prepared the original report on Anvil Hammers. Koons offers Garvey two free round-trip tickets to the city of her choice. Garvey thanks Koons, then asks her immediate supervisor, Karl May, about the gift from Koons but does not mention the gift from Jones. May approves the Koons' gift.

After talking with May, Garvey starts a research project on Zenith Enterprises, a frozen-juice maker. Garvey's gathers quarterly data on the company's sales and profits over the past two years. Garvey uses a simple linear regression to estimate the relationship between GDP growth and Zenith's sales growth. Next she uses a consensus GDP estimate from a well-known economic data reporting service and her regression model to extrapolate growth rates for the next three years.

Later that afternoon, Garvey attends a company meeting on the ethics of money management. She listens to a lecture in which John Bloomquist, a veteran portfolio manager, talks about his job responsibilities. Garvey takes notes that include the following three statements made by Bloomquist:

Statement 1: I'm not a bond expert, and I've turned to a colleague for advice on how to manage the fixed-income portion of client portfolios.

Statement 2: I strive not to favor either the remaindermen or the current-income beneficiaries, instead I work to serve both of their interests.

Statement 3: All of my portfolios have target growth rates sufficient to keep ahead of inflation.

Garvey is not working at the diner that night, so she goes home to work on her biography for an online placement service. In it she makes the following two statements:

Statement 1: I'm a CFA Level 3 candidate, and I expect to receive my charter this fall. The CFA program is a grueling, 3-part, graduate-level course, and passage requires an expertise in a variety of financial instruments as well as knowledge of the forces that drive our economy and financial markets.

Statement 1: I expect to graduate with my MBA from Braxton College at the end of the fall semester. As both an MBA and a CFA, I'll be in high demand. Hire me now while you still have the chance.

Does Garvey's acceptance of the gifts from Koons and Jones violate Standard 1(B) Independence and Objectivity?

Ernie Smith and Jama! Sims are analysts with the firm of Madison Consultants. Madison provides statistical modeling and advice to portfolio managers throughout the United States and Canada.

In an effort to estimate future cash flows and value the Canadian stock market. Smith has been examining* the country's aggregate retail sales. He runs two autoregressive regression models in an attempt to determine whether there are any patterns in the data, utilizing nine years of unadjusted monthly retail sales data. One model uses a lag one variable and the other adds a lag twelve variable. The results of both regressions are shown in Exhibits 1 and 2.

Sims has been assigned the task of valuing the U .S . stock market and uses data similar to the data that Smith uses for Canada. He decides, however, that the data should be transformed. He takes the natural log of the data and uses it in the following model:

Smith and Sims are concerned that the data for Canadian retail sales may be more appropriately modeled with an ARCH process. Smith states, that in order to find out, he would take the residuals from the original autoregressive model for Canadian retail sales and then square them.

Sims states that these residuals would then be regressed against the Canadian retail sales data using the

where e represents the residual terms from the original regression and X represents the Canadian retail sales data. If is statistically different from zero, then the regression model contains an ARCH process.

Smith also examines the quarterly inflation data for an emerging market over the past nine years. He models the data using an autoregressive model with a lag one independent variable which he finds is statistically different from zero. He wonders whether he should also include lag two and lag four terms, given the magnitude of the autocorrelations of the residuals shown in Exhibit 4, assuming a 5% significance level. The critical t-values, assuming a 5% significance level and 35 degrees of freedom, are 2.03 for a two-tail test and 1.69 for a one-tail test.

where: FF is the Federal Funds rate in the United States (US), and BY is the bond yield in the European Union (E) and Great Britain (B).

Before he runs this regression, he investigates the characteristics of the dependent and independent variables. He finds that the Federal Funds rate in the United States and the bond yield in Great Britain have a unit root but that the bond yield in the European Union does not. Furthermore, the Federal Funds rate in the United States and the bond yield in Great Britain are cointegrated but the Federal Funds rate in the United States and the bond yield in the European Union are not.

Regarding Smith's emerging market regression, should lag two and lag four terms be included in the regression?

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:

Jenna Stuart is a financial analyst for Deuce Hardware Company, a U .S . company that reports its results in U .S . dollars. Wayward Distributing, Inc., is a foreign subsidiary of Deuce Hardware, which began operations on January 1,2007. Wayward is located in a foreign country and reports its results in the local currency called the Rho. Selected balance sheet information for Wayward is shown in the following table.

Stuart has been asked to analyze how the reported financial results of Wayward will be affected by the choice of the all-current or temporal methods of accounting for foreign operations. She has gathered the following exchange rate information on the $/Rho exchange rate:

* Spot rate on 1/01/08: $0.35 per Rho

* Spot rate on 12/31/08: $0.45 per Rho

* Average spot rate during 2008: $0.42 per Rho

Will the all-current method report a translation gain or loss for 2008, and will that gain or loss be reported on Deuce's income statement or the balance sheet?