Progress 3

48
Stalla Review Course Registered to: Distributed by DeVry Educational Products, Inc. Copyright © 2005 DeVry/Becker Educational Development Corp. All rights reserved. WEIGHTED PROGRESS EXAM - 120 Questions 1. L2-00987 - Lecture: SS-15 (page 12), topic: L2-L15-01 As a general rule, what type of CMO tranche is likely to have the most stable average life? a. PO. b. PAC. c. IO. d. Floating rate. 2. L2-00526 - Lecture: SS-08 (page 43), topic: L2-L08-05 For the fiscal year ended December 31, 2003, KFG Company had sales of $75.0 million and EBIT of $30.0 million, which represented an increase of 2.5% and 6.0%, respectively, versus the prior fiscal year. Assuming the company had interest expense of $5.0 million and income taxes of $2.0 million in fiscal 2003, what is the degree of operating leverage (DOL) and the degree of financial leverage (DFL) for the year ended December 31, 2003? DOL DFL a. 2.4 1.2 b. 2.8 1.3 c. 2.6 1.3 d. 2.2 1.2 3. L2-01581 - Lecture: SS-15 (page 12), topic: L2-L15-01 Sebastian Lee is planning to purchase one of the three collateralized mortgage obligation (CMO) tranches described in Exhibit 1. The three tranches-a Planned Amortization Class (PAC) Bond, a Scheduled Bond, and a Support Bond-are the only three tranches for this particular CMO issue. Exhibit 1 Selected Data Three Federal Home Loan Mortgage Corporation (FHLMC) CMO Tranches Tranche Coupon Stated Maturity M/D/Y Yield Spread (basis points) Original Duration (years) Current Duration (years) Current Effective Principal Payment Collar (PSA prepayment assumptions) PAC Bond 6.50% 5/15/27 170 5.98 4.60 109 – 244 Scheduled Bond 6.50% 1/15/31 200 5.98 2.56 146 – 213 Support Bond 6.75% 8/15/31 248 4.88 1.65 --- Indicate which of the three CMO tranches described in Exhibit 1 has third priority to receive principal payments. a. PAC Bond. b. Scheduled Bond. c. Support Bond. d. It depends on prepayment speeds. 4. L2-00611 - Lecture: SS-01 (page 6), topic: L2-L01-01 Rosalie Simms' family is very influential in her city. Her father is on the board of several banks and corporations and she and her family own large stock positions in many corporations. As a member, when Rosalie joins an investment firm, she must: I. Sell her stock holdings to avoid any conflict of interest when dealing with clients. II. Tell her employer about her family's involvement and significant holdings. III. Not accept an outside directorship herself without the permission of her new employer.

Transcript of Progress 3

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WEIGHTED PROGRESS EXAM - 120 Questions

1. L2-00987 - Lecture: SS-15 (page 12), topic: L2-L15-01As a general rule, what type of CMO tranche is likely to have the most stable average life?

a. PO.b. PAC.c. IO.d. Floating rate.

2. L2-00526 - Lecture: SS-08 (page 43), topic: L2-L08-05For the fiscal year ended December 31, 2003, KFG Company had sales of $75.0 million and EBIT of $30.0 million, which represented an increase of 2.5% and 6.0%, respectively, versus the prior fiscal year. Assuming the company had interest expense of $5.0 million and income taxes of $2.0 million in fiscal 2003, what is the degree of operating leverage (DOL) and the degree of financial leverage (DFL) for the year ended December 31, 2003?

DOL DFLa. 2.4 1.2b. 2.8 1.3c. 2.6 1.3d. 2.2 1.2

3. L2-01581 - Lecture: SS-15 (page 12), topic: L2-L15-01Sebastian Lee is planning to purchase one of the three collateralized mortgage obligation (CMO) tranches described in Exhibit 1. The three tranches-a Planned Amortization Class (PAC) Bond, a Scheduled Bond, and a Support Bond-are the only three tranches for this particular CMO issue.

Exhibit 1

Selected Data

Three Federal Home Loan Mortgage Corporation (FHLMC) CMO Tranches

Tranche Coupon Stated

Maturity M/D/Y

Yield Spread (basis points)

Original Duration (years)

Current Duration (years)

Current Effective Principal

Payment Collar (PSA

prepayment assumptions)

PAC Bond 6.50% 5/15/27 170 5.98 4.60 109 – 244

Scheduled Bond

6.50% 1/15/31 200 5.98 2.56 146 – 213

Support Bond 6.75% 8/15/31 248 4.88 1.65 ---

Indicate which of the three CMO tranches described in Exhibit 1 has third priority to receive principal payments.

a. PAC Bond.b. Scheduled Bond.c. Support Bond.d. It depends on prepayment speeds.

4. L2-00611 - Lecture: SS-01 (page 6), topic: L2-L01-01Rosalie Simms' family is very influential in her city. Her father is on the board of several banks and corporations and she and her family own large stock positions in many corporations. As a member, when Rosalie joins an investment firm, she must:

I. Sell her stock holdings to avoid any conflict of interest when dealing with clients.II. Tell her employer about her family's involvement and significant holdings.III. Not accept an outside directorship herself without the permission of her new employer.

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IV. Act prudently and not tell anyone of her family's situation.

a. I and IV only.b. I and III only.c. II and III only.d. I, II, and IV only.

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5. L2-00373 - Lecture: SS-06 (page 7), topic: L2-L06-01KAS Corp. is a U.S. company with a Japanese subsidiary. This subsidiary began operations on 1 January 20X0, when its equity was funded and assets were purchased. Inventory is accounted for using the LIFO method.

Exchange Rate Data: ¥ per $:

31 December 20X0 ¥100 (or .01 $ per ¥)1 January 20X0 ¥125Weighted Average Exchange Rate 20X0 ¥111

SUBSIDIARY FINANCIAL STATEMENTS

Balance Sheet (¥) Income Statement (¥)

12/31/20X0 12/31/20X0

Cash ¥ 180,000 Sales ¥ 500,000

Accounts Receivable 70,000 Costs of Goods 200,000

Inventory 50,000 Depreciation 20,000

Net Fixed Assets 450,000 EBIT 280,000

Total Assets ¥ 750,000 Interest 30,000

Accounts Payable ¥ 100,000 Pretax Income 250,000

Long-term Debt 390,000 Taxes 100,000

Contributed Capital 110,000 Net Income ¥ 150,000

Retained Earnings ¥150,000 Total Liability and Equity ¥ 750,000

Using the all-current method, the accounts receivable balance in dollars on 12/31/20X0 is:

a. $560b. $700c. $7,000,000d. $8,750,000

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6. L2-01759 - Lecture: SS-16 (page 42), topic: L2-L16-02Woodward Allen is the manager of a long-term government bond mutual fund. Since he is free to use derivatives in order to enhance his returns, he has become interested in what he perceives to be mispriced Treasury bond futures contracts. Allen has used the cost-of-carry futures pricing model to estimate the theoretical Treasury bond futures price, using the price of the long-term Treasury bond with the lowest coupon rate available and the short-term financing rate as inputs into the model. Allen does not know about delivery options that exist for Treasury bond futures.

The fair value of a Treasury bond futures contract is calculated using the cost-of-carry model. The model is:

( )( ) ( ) ( )

( )

T0 0

0

B T Y 1 r T FV CI, 0, Tf T

CF T

+ + − =

Which answer is the correct description of how to compute the theoretical price of a Treasury bond futures contract (ignore delivery options)?

a. B0(T + Y) is the current spot price of the most likely to be delivered Treasury bond. This is not necessarily the bond with the lowest coupon rate. FV(CI, ∅, T) is the coupon interest that will be paid from today until thedelivery date of the futures on the Treasury bond that is most likely to be delivered. r0 is the financing rate. CF(T) is the conversion factor for the cheapest to deliver bond.

b. B0(T + Y) is the coupon interest that will be paid from today until the delivery date of the futures on the Treasury bond that is most likely to be delivered. FV(CI, ∅, T) is the current spot price of the Treasury bond that is most likely to be delivered. This is not necessarily the bond with the lowest coupon rate. r0 is the financing rate. CF(T) is the conversion factor for the cheapest to deliver bond.

c. B0(T + Y) is the current spot price of the most likely to be delivered Treasury bond. This is not necessarily the bond with the lowest coupon rate. FV(CI, ∅, T) is the coupon interest that will be paid from today until thedelivery date of the futures on the Treasury bond that is most likely to be delivered. r0 is the conversion factor for the cheapest to deliver bond. CF(T) is the financing rate.

d. None of the above.

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7. L2-00861 - Lecture: SS-01 (page 6), topic: L2-L01-01Allen Anderson, who works in a large brokerage firm, gets a call from Bart Bergstrom, the son of the founder (Carl) of company Dearborn International (both of whom are clients of Anderson's). Bergstrom tells Anderson to "dump" all of his shares in Dearborn (approximately 5% of the market capitalization of the stock). The next day, the share price of Dearborn falls by approximately two-thirds due to an adverse regulatory ruling.

To show his gratitude for Anderson's quick work, Bergstrom buys Anderson an expensive gift (estimated cost of $3,000), which Anderson fails to disclose.

Anderson's supervisor, Edward Evans, also a CFA charterholder, decides not to begin an investigation when he becomes aware of these facts, fearing adverse publicity and potential legal liability.

During subsequent investigations by the U.S. Securities and Exchange Commission, Anderson defends his actions by noting that the firm's compliance manual was not made readily available to employees.

If Anderson's claim of not having ready access to the firm's compliance manual is true, which of the following individuals (if any) would have violated Standard III(E): Responsibilities of Supervisors (relating to supervisors exercising control over their subordinates)?

a. Standard III(E) is not relevant to Anderson's claim.b. Anderson.c. Evans.d. The chief executive officer of the firm.

8. L2-01445 - Lecture: SS-13 (page 58), topic: L2-L13-03Paul Johnson, CFA, is analyzing a grocery store company. He wants to approach this analysis using franchise factor and growth duration, as he believes each will help him to better understand the pricing of the shares.

He estimates the rate of return on the market to be 10%. He has calculated that grocer's cost of equity is 12% and its weighted-average cost of capital is 8%. The firm has a current price-to-earnings (P/E) ratio of 22.2 and the market's P/E ratio is 20.4. The grocer's current market value is $250 million.

The consensus forecast is for the grocer to grow at a 7% rate, which is 1% better than the expected 6% rate of growth for the market. Finally, Johnson has noted that the grocer shares have a current dividend yield of 4%, which is well above the market's current dividend yield of 1%.

Johnson remembers the formula for growth duration to be as follows:

+ + + +

�0 0

0 0

g g g g

a a a a

P E 1 G Dln Tln

P E 1 G D

Using the above formula and the data provided, which of the following is closest to the growth duration for the grocer?

a. 0.1 year.b. 1.0 year.c. 2.3 years.d. 9.0 years.

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9. L2-01441 - Lecture: SS-13 (page 55), topic: L2-L13-03A firm has a 15% return on equity (ROE), 12% after-tax return on capital (ROC), 8% coupon debt, 11% cost of equity, and a 10% weighted-average cost of capital (WACC). Choose which of the following is closest to the firm's EVA spread?

a. 1%b. 2%c. 5%d. Cannot be determined, as capital structure weights are required.

10. L2-01332 - Lecture: SS-14 (page 59), topic: L2-L14-04You have completed the initial projection of a binomial interest rate tree for treasury rates based on the current on-the-run treasury yield curve and an assumption of 8% interest rate volatility. You know the next step is to apply the backward induction methodology to assure the tree properly validates the current prices of on the run treasuries. In your first pass to validate the prices you find that the model prices are higher than actual trading prices of the bonds in the marketplace. If the high value for the one-year rate one year forward in the model is 4.44% and the low value for the rate is 3.78%, which of the following actions would be appropriate in adjusting the model?

a. Raise both rates.b. Lower both rates.c. Raise the high rate, while leaving the low rate unchanged.d. Leave the high rate unchanged, while lowering the low rate.

11. L2-01583 - Lecture: SS-15 (page 18), topic: L2-L15-02Alex Siegel is a mortgage-backed securities portfolio manager. Recently he has been given the authority to purchase other asset-backed securities (ABS). He is aware that the credit quality of ABS is a primary consideration in their evaluation but is uncertain about credit enhancement structures.

Siegel is considering two asset-backed securities to purchase for his portfolio, but he is concerned about the performance of each security if interest rates decline. Characteristics of the two securities are given in Exhibit 15-1.

Exhibit 15-1 Characteristics of Two Asset-backed Securities

Type Structure Lockout Seasoning Weighted

Average Maturity

Home Equity Loans Closed-end None 10 months 350 months

Automobile Receivables --- 18 months 10 months 50 months

Which of the following is an example of an external credit enhancement structure?

a. Corporate guarantees.b. Bank letters of credit.c. Bond insurance.d. All of the above.

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12. L2-02034 - Lecture: SS-11 (page 12), topic: L2-L11-02Al Latsbob, CFA, is constructing a diversified portfolio of equity securities. He seeks to diversify the portfolio on the basis of industry life cycle position (pioneer stage, growth stage, mature stage, and decline stage). He hypothesizes that the different stages of the industry life cycle provide different investment characteristics with respect to profit margins, cash flow, certain risk factors, and valuation.

What valuation model should Al use to make investment decisions while evaluating companies in each industry life cycle stage?

a. Pioneer stage industries should be valued based on multiples of sales.b. Growth stage industries should be valued based on free cash flow to equity.c. Mature stage industries should be valued based on a multiple stage growth model.d. Decline stage industries should be valued based on price to earnings.

13. L2-00199 - Lecture: SS-04 (page 79), topic: L2-L04-05In analyzing HGF Company, Jones prepared a regression analysis. He regressed SG&A Expense against Sales and found the following result:

Total SG&A Cost = $1,000,456 + 0.2445 (Sales)

In this equation, the $1,000,456 represents:

a. The variable portion of the SG&A cost.b. The fixed portion of the SG&A cost.c. The variable and fixed portion of the SG&A cost.d. The estimate of the next year's SG&A cost.

14. L2-00590 - Lecture: SS-05 (page 26), topic: L2-L05-01Which item is the basis for determining the income tax expense reported on the income statement?

a. Taxable income.b. Income taxes payable.c. Pretax income.d. Operating income.

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15. L2-02159 - Lecture: SS-12 (page 51), topic: L2-L12-02Rob Sykes, CFA, is analyzing C-ville Company, a United States based maker of exam booklets. The company has just signed a new two-year contract that will allow it to grow at a 20% pace until the contract expires. This is a one-time deal and thereafter, the company's growth will fall back to its long-term rate of 3%. Sykes has opted to look at several factors and valuation methods. He has gathered the following information:

C-ville Company

Financial Statements for Years Ended 3/31/X0 and 3/31/X1 ($ million, except per share data)

Income Statement 20X0 20X1 Revenue $89 $93 Cost of Goods Sold 40 41 Other Operating Costs 10 11 Depreciation 5 6 Earnings before taxes $34 $35 Taxes 14 14 Net Income $20 $21

Earnings Per Share $2.00 $2.10 Dividends Per Share $1.60 $1.68

Common Stock Outstanding (millions) 10 10

Balance Sheet 20X0 20X1 Current Assets $ 28 $ 34 Net Property, Plant, and Equipment 112 125 Total Assets $140 $159

Current Liabilities $ 40 $ 55 Long-term Debt 0 0 Total Liabilities $ 40 $ 55

Stockholders' Equity 100 104 Total Liabilities & Equity $140 $159

Capital Expenditures $ 15 $ 19

Sykes decides to start his analysis with a look at the company's sustainable growth rate and ROE.

What is the value of a share of C'ville's common stock at the end of 20X1 using the two-stage FCFE method (assume a cost of equity of 10.4%)?

a. $33.66b. $31.81c. $29.80d. $33.82

16. L2-00619 - Lecture: SS-01 (page 6), topic: L2-L01-01The Standard Priority of Transactions applies to "access" persons. An example of an "access" person is:

a. An independent auditor with access to material nonpublic information about the issuer.b. A supervisory analyst who reviews all research reports prior to dissemination.c. The investor relations officer of the issuer company who provided information that influenced the investment

recommendation.d. All of the above.

17. L2-01051 - Lecture: SS-16 (page 41), topic: L2-L16-02S&P 500 Index 1,047.00

S&P 500, 12-month Futures Contract 1,100.00

S&P Dividend Yield 2.5%

12-month risk-free rate 6.0%

Calculate the fair value for the S&P 500 futures contract.

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a. 1,100.00b. 1,083.65c. 1,109.92d. 1,012.43

18. L2-01201 - Lecture: SS-14 (page 6), topic: L2-L14-01Mary McDonald, CFA, is analyzing the bonds of ABC Corp., a high technology public company with several international subsidiaries. ABC Corp. is using some of its assets as a collateral for its outstanding bonds.

The most important factor that McDonald should consider during the analysis of ABC Corp.'s financial statements is:

a. Cash flow from operations.b. Discretionary cash flow.c. The company's key ratios (short-term solvency ratios, capitalization ratios, and coverage ratios).d. The company's assets used as a collateral.

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19. L2-00327 - Lecture: SS-03 (page 57), topic: L2-L03-03Noah Sales, CFA, has created a multiple regression model to forecast revenues for a small Miami cruise line. The dependent variable of the regression is company revenues, stated in millions of dollars. The 3 independent variables are the percentage increase or decrease in i) hotel occupancy rates in Florida, ii) the airline ticket-price index (inverse relationship), and iii) U.S. gross domestic product. Noah regressed 40 quarters of data, and his statistical program has produced the following:Regression statistics:

Regression coefficient Value Standard Error t-valueHotel occupancy 87.34 28.17 3.1Airline ticket-price index −67.94 16.18 4.2GDP 68.87 25.51 2.7

Intercept of the regression line = 250.2 (in $million)Standard error of the intercept = 38.30

DegreesANOVA of freedom Sum of Squares Mean SS F-Value

Regression 3 RSS = 3,082.68 MSSR = 1,027.56 Fcalc = 13.56Error 36 SSE = 2,728.79 MSSE = 75.80Total 39 TSS = 5,811.47

Correlation matrix of independent variables

Airline ticket Occupancy price GDP

Hotel occupancy 1.00 −0.45 0.90Airline ticket price −0.45 1.00 −0.73GDP 0.90 −0.73 1.00

The intercept of the regression line (in $ millions):

a. Is not significantly different from 0.b. Is significantly different from 0.c. Is significantly different from 250.d. Significance cannot be determined based on the information provided.

20. L2-00204 - Lecture: SS-04 (page 79), topic: L2-L04-05The following regression equation shows the relationship between widget sales and changes to GDP for country X:

Widget sales (in millions) = 1.7 + 0.025(Percentage Growth in GDP)

Assuming 2% expected GDP growth over the year, calculate projected widget sales next year.

Note: A 2% GDP growth should be represented in the formula as 2.0, rather than 0.02.

a. 1,700,500b. 1,750,000c. 1,775,000d. 1,734,000

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21. L2-01336 - Lecture: SS-14 (page 69), topic: L2-L14-04As interest rates become more volatile, the price of a putable bond will tend to:

a. Decrease.b. Increase.c. Remain unchanged.d. It could increase or decrease.

22. L2-01395 - Lecture: SS-13 (page 15), topic: L2-L13-01Tom Hamm, CFA, is analyzing Kell Corporation (current stock price is $16.25) using market multiples. He plans to start with a look at the firm's price-to-earnings (P/E) ratios. Hamm's firm requires that all research reports include an estimate of the earnings for the upcoming (next) quarter and for the next year. Hamm has gathered the following historical information on Kell and has made the following projections:

1Q 20X4 2Q 20X4 3Q 20X4 4Q 20X4 1Q 20X5 20X5 YearActual Actual Actual Actual Estimated Estimated

Net Income $2.3 mil. $2.0 mil. $1.8 mil. $2.6 mil. $2.5 mil. $10.1 mil.

ExtraordinaryLoss (net of tax) $0 $0 $0.3 mil. $0 $0 $0

Common StockDividends $1.0 mil. $1.0 mil. $1.0 mil. $1.0 mil. $1.1 mil. $4.4 mil.

SharesOutstanding 10 mil. 10 mil. 10 mil. 10 mil. 10 mil. 10 mil.

One of Hamm's co-workers prefers to use the P/E-to-growth ratio (PEG) and wishes to apply this to Kell Corporation. When calculating PEG, the co-worker uses a leading P/E ratio. The co-worker agrees with Hamm's estimate that Kell Corporation's long-term growth will be 4.5%. Furthermore, he agrees with the 10% required rate of return on equity, 8% long-term ROE and that the firm will pay $4.4 million in dividends in 20X5. The co-worker has made his own estimate of what Kell will earn in 20X5. His number is $1.20 per share, which is higher than Hamm's estimate. Which of the following is closest to the PEG that the co-worker will calculate?

a. 1.7b. 3.0c. 3.6d. 13.5

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23. L2-00401 - Lecture: SS-06 (page 7), topic: L2-L06-01KAS Corp. is a U.S. company with a Japanese subsidiary. This subsidiary began operations on 1 January 20X0, when its equity was funded and assets were purchased. Inventory is accounted for using the LIFO method.

Exchange Rate Data: ¥ per $:

31 December 20X0 ¥100 (or .01 $ per ¥)1 January 20X0 ¥125Weighted Average Exchange Rate 20X0 ¥111

SUBSIDIARY FINANCIAL STATEMENTS

Balance Sheet (¥) Income Statement (¥)

12/31/20X0 12/31/20X0

Cash ¥ 180,000 Sales ¥ 500,000

Accounts Receivable 70,000 Costs of Goods 200,000

Inventory 50,000 Depreciation 20,000

Net Fixed Assets 450,000 EBIT 280,000

Total Assets ¥ 750,000 Interest 30,000

Accounts Payable ¥ 100,000 Pretax Income 250,000

Long-term Debt 390,000 Taxes 100,000

Contributed Capital 110,000 Net Income ¥ 150,000

Retained Earnings ¥150,000 Total Liability and Equity ¥ 750,000

Translate the subsidiary's 12/31/20X0 income statement and 20X0 balance sheet into the parent's currency using the all-current method. Use your results to answer the next question.

Balance Sheet Translation (All-Current Method)

Translated Using

All-Current12/31/20X0 Conversion Method

Cash ¥180,000

Accounts Receivable 70,000

Inventory 50,000

Net Fixed Assets 450,000

Total Assets ¥750,000

Accounts Payable ¥100,000

Long-term Debt 390,000

Contributed Capital 110,000

Retained Earnings 150,000

Translation Adjustment −

Total Liability and Equity ¥750,000

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Income Statement Using All-Current Method

12/31/20X0 Conversion All-Current Method

Sales ¥ 500,000

Costs of Goods Sold 200,000

Depreciation 20,000

Earnings before interest and taxes

280,000

Interest 30,000

Pretax Income 250,000

Taxes 100,000

Net Operating Income 150,000

Gain (Loss) from Currency Translation

Net Income ¥ 150,000

Using the all-current method, the retained earnings balance in dollars on 12/31/20X0 is closest to:

a. $720b. $1,350c. $12,250,000d. $24,750,000

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24. L2-00256 - Lecture: SS-06 (page 7), topic: L2-L06-01Giga Corp is a U.S. company with a subsidiary located in Zambia that began operations on January 1, 20X1 when Giga funded its equity with a $33.07 million investment, borrowed additional funds in the local market, and purchased all the subsidiary's fixed assets. Inventory is on a LIFO basis and was also entirely purchased on January 1. The currency unit in Zambia is the "Kwacha," abbreviated ZKW. The Zambian subsidiary is a relatively self-contained, independent foreign subsidiary operating primarily in the local market (which includes neighboring countries) that pays no dividends.

Inflation has averaged approximately 25% annually over the past five years.

Exchange rate information:

January 1, 20X1 ZKW4,500/$December 31, 20X1 ZKW6,075/$Weighted Average, 20X1 ZKW5,300/$

Balance Sheet (ZKW billions) Income Statement (ZKW billions)12/31/20X1 12/31/20X1

Cash 243.54 Sales 676.50Accounts Receivable 94.71 Cost of Goods Sold 270.60Inventory 67.65 Operating Expenses 13.53Net Fixed Assets 608.85 Depreciation 13.53Total Assets 1,014.75 EBIT 378.84

Interest 40.59Accounts Payable 135.30 Pre-tax Income 338.25Long-term Debt 527.67 Taxes 135.30Contributed Capital 148.83 Net Income 202.95Retained Earnings 202.95Total Liab. & Equity 1,014.75

The CFO of Giga Corp. informs you that one of her accounting analysts made a mistake in reporting the inflation rate. Inflation in Zambia has actually averaged approximately 35% annually (rather than 25%) over the past five years, but all other information (including the financial statements and reported exchange rates) is correct.

Operating net income in U.S. dollars for 12/31/20X1 is closest to:

a. $45 million.b. $38 million.c. $29 million.d. $25 million

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25. L2-00024 - Lecture: SS-02 (page 10), topic: L2-L02-01Cindy Franz, a CFA charterholder, is a partner of Millennium Investments, a U.S. firm registered with the SEC as an investment adviser. The trading desk reports to Franz and is responsible for the allocation of client brokerage. During 1999, Franz allocated clients' brokerage commissions to certain registered representatives and broker/dealers whom she believed could secure or introduce new business to Millennium. Additionally, Franz directed brokerage to broker/dealers who provided Millennium with goods and services. One broker provided Millennium with great seats to football games (Franz did not use these seats for personal use, but used the tickets to entertain clients). Another broker provided Millennium with proprietary research used by several of the investment teams at Millennium. Lastly, Franz directed a portion of trading activity to Star Inc. because of a friendship between Franz and a trader at Star. Star's commission structure is high in comparison with other firms and its research services and execution capabilities are only considered average. In appreciation for the business, Star provides Millennium with pension fund liability and asset allocation studies. In addition, Star absorbs several overhead expenses for Millennium, including business magazine subscriptions.

Millennium maintains a list of brokers and registered representatives to whom brokerage commissions were directed and makes this list available to clients. Justification for the direction of client brokerage was not made available.

Millennium did not adhere to the Soft Dollar Standards with respect to:

a. Disclosure.b. Investment recommendations.c. Client directed brokerage.d. All of the above.

26. L2-02045 - Lecture: SS-17 (page 19), topic: L2-L17-01The Black-Scholes-Merton model includes the following equation for a call option:

)N(dXe)N(dSc 2Tcr

10−

−=

Consider a call option with a strike price of $40 on the stock of Integrated Monkeyshines, Inc. (IMI) with 73 days left until expiration. The price of IMI is currently $49, the continuously compounded risk-free rate is 6.4%, and the annualized volatility of IMI is 34%. The areas under the normal curve for N(d1) and N(d2) are 0.9325 and 0.9103, respectively.

What is the value of this call using the Black-Scholes-Merton model?

a. $7.78b. $9.00c. $9.74d. $11.54

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27. L2-00593 - Lecture: SS-05 (page 27), topic: L2-L05-01At year-end 20X1, a company prepares a detailed deferred tax liability schedule showing both the impact of straight-line depreciation on its assets for book purposes and accelerated depreciation on its assets for tax purposes. As a result of timing differences between the two methods, a total of $45.0 million in taxes will be owed over the next five years. Assuming beginning deferred tax liabilities of $18.0 million and income taxes owed this period of $8.0 million, what is the income tax expense recorded on the income statement for 20X1?

a. $26.0 million.b. $35.0 million.c. $39.0 million.d. $53.0 million.

28. L2-00788 - Lecture: SS-07 (page 30), topic: L2-L07-02

Elgin Corporation Balance Sheet, December 31, 20X1

($ millions)

Assets Liabilities Cash 289.03 Accounts payable 172.79 Accounts receivable 201.06 Current Portion of Debt 31.42 Inventory 157.08 Income Taxes Payable 9.42 Total Current Assets 647.17 Other Current Liabilities 15.71 PP&E (Net) 860.80 Total Current Liabilities 229.34

Goodwill 314.16 Long-term Debt 706.86

Total Assets 1,822.12 Deferred Tax Liabilities 47.12

Total Liabilities 983.32 Equity Common Stock 157.07 Retained Earnings 681.73 Total Equity 838.80

Total Liabilities & Equity 1,822.12

Income Statement

Year Ended December 31, 20X1 ($ millions)

Cash Flow Statement Year Ended December 31, 20X1

($ millions)

Sales 1,413.72 Net Income 113.10 Cost of Goods Sold 785.40 Add: Depreciation/Amort. 78.54 Gross Profit 628.32 Add: Restructuring Charge 37.70 Operating Expenses 235.62 Increase in Payables 50.27 Depreciation & Amortization 78.54 (Increase) in Receivables (37.70) Operating Income 314.16 (Increase) in Inventories (25.13) Interest Expense 62.83 Operating Cash Flow 216.77 Pretax Operating Income 251.33 Income Taxes 100.53 Capital Expenditures (109.96) Net Income from Continuing Operations

150.80 Capitalized Interest (6.28)

Restructuring Charge (Net of Tax) 37.70 Investing Cash Flow (116.24)

Net Income 113.10 Net Increase in Debt 125.66

Dividends Paid (12.57) Financing Cash Flow 113.10

Net Change in Cash 213.63

Additional Information (all amounts in millions)

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− Inventories are valued on a LIFO basis. The LIFO Reserve is $15.71.

− Elgin has numerous operating leases. The present value of these leases was $157.08 at the beginning of 20X1 and $147.65 at the end of 20X1. At the beginning of 20X1, the leases had an average term of 10 years and an average implied interest rate of 12%. The annual payments are $27.80, which is recorded as a part of cost of goods sold on the income statement. Using the annual payment, we can project the present value of the leases to be approximately $138.23 one year hence. In addition, the equipment being leased had a 10-year remaining life at the beginning of the year and no estimated salvage value. Straight-line depreciation is used.

− Elgin capitalized interest of $6.28 during 20X1. This capitalized interest increased the property, plant and equipment.

− The restructuring charge is $62.83 and is recorded net of the expected tax benefit of $25.13. The charge is for future expenses related to a change in the way the firm is structured.

− Elgin does not believe it will ever have to pay its Deferred Tax Liability.

− Goodwill amortization in 20X1 was $9.42.

− Based on studies done by a valuation firm, Elgin estimates the following fair market values: Goodwill, $188.50.

− Elgin's tax rate is 40%.

− All other assets (except inventories) and liabilities have market values equal to their recorded values in the balance sheet.

The adjusted net income reported on the Income Statement is closest to:

a. $115b. $120c. $130d. $150

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29. L2-00801 - Lecture: SS-05 (page 13), topic: L2-L05-01On December 31, 2000, Atkinson Company purchases a new machine for $1,300,000, which has an estimated useful life of ten years and an estimated salvage value of $150,000. On March 31, 2003, management determines that the initial life is too aggressive and projects the machine has only five years of remaining useful life. Based on the above, what is the total amount of depreciation expense that the company should record on this machine for the year ended December 31, 2003?

a. $115,000b. $162,438c. $178,250d. $184,938

30. L2-00469 - Lecture: SS-08 (page 43), topic: L2-L08-05The income statement for the Folsome Corporation is as follows:

Sales $100 millionCost of Sales 70Interest Expense 10SG&A 15Pretax Income $ 5Income Taxes 2Net Income $ 3

Folsome's degree of financial leverage is:

a. 1.67b. 2.00c. 3.00d. 3.33

31. L2-01216 - Lecture: SS-14 (page 10), topic: L2-L14-01In addition to traditional debt analysis, high yield bonds should also be analyzed like:

a. Preferred stock.b. Options.c. Common equity.d. Swaps.

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32. L2-02059 - Lecture: SS-03 (page 17), topic: L2-L03-01Jennifer Chan, a sell side analyst claims that her stock picks outperform the market by at least 4%. A pension fund portfolio manager decides to test her claim by choosing 15 of Jennifer's stock picks at random and measuring their annualized returns relative to the performance of the S&P 500 index over the same holding periods. The S&P 500 return is 12.2% and Jennifer's stock picks have an average return of 14.0%. The standard deviation of the sample of excess returns is 2.52%.

Distribution df 0.025 0.050 0.100t-table 13 2.160 1.771 1.350t-table 14 2.145 1.761 1.345t-table 15 2.131 1.753 1.341

Chi-sq table 13 24.736 22.362 19.812Chi-sq table 14 26.119 23.685 21.064Chi-sq table 15 27.488 24.996 22.307

A pension fund portfolio manager wants to test Jennifer's claim that her stock picks outperform the market by 4%. What test and null hypothesis should he use?

a. Chi-sq test. H0: µd ≥ 4%.b. t test. H0: µd ≠ 4%.c. t test. H0: µd ≥ 4%.d. Chi-sq test. H0: µd ≠ 4%.

33. L2-00892 - Lecture: SS-10 (page 23), topic: L2-L10-02Rodriguez Encino, CFA, discovers that Topanga Canyon Enterprises (TCE) maintains a special purpose entity (SPE) called Topanga Canyon Yacht Sales with the purpose of holding ownership to the president's yacht. TCE should:

a. Consolidate the SPE to the parent company financial statements.b. Exclude the subsidiary under IAS 27.c. Include a one-line reference on the financial statements recognizing profit or loss of the SPE.d. None of the above.

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34. L2-01242 - Lecture: SS-18 (page 19), topic: L2-L18-02A portfolio is determined to have the following positions (including individual betas):

Stock Position Held Stock's Beta

XYZ $1,000,000 0.80

RFR 5,000,000 1.00

WER 3,000,000 1.20

ALS 1,000,000 1.05

Assuming a risk free rate of 5% and a market return of 10%, calculate the expected excess return for the portfolio:

a. 5.225%b. 10.450%c. 5.063%d. 10.125%

35. L2-00940 - Lecture: SS-11 (page 3), topic: L2-L11-01Factors enabling a firm to have a competitive advantage are:

I. A favorable brand image.II. An efficient distribution system.III. Strong financial resources.

a. I and II only.b. II and III only.c. I and III only.d. I, II, and III.

36. L2-01088 - Lecture: SS-15 (page 31), topic: L2-L15-03A Monte Carlo valuation model can produce more accurate OAS calculations than a binomial model because the Monte Carlo model:

a. Makes prepayments dependent on the past course of interest rates.b. Allows for an assumption of interest rate volatility.c. Discounts future security cash flows using forward interest rates consistent with the current term structure of

interest rates.d. Allows for the security to have prepayments.

37. L2-01568 - Lecture: SS-09 (page 12), topic: L2-L09-02Westcoast Trainers, Inc. is considering an acquisition of the Eastcoast Sneaker Co. The two companies are valued at $70 million and $35 million, respectively. Manufacturing and distribution costs are expected to decrease by $1.5 million per year indefinitely, net of tax. The required rate of return is 10.0%.

Westcoast Trainers, Inc. pays a 50% interest in shares of the combined entity to the shareholders of Eastcoast Sneaker Co. Compute the NPV of the stock offer.

a. -$25 million.b. -$10 million.c. $15 million.d. $60 million.

38. L2-01108 - Lecture: SS-15 (page 41), topic: L2-L15-04Which of the following statements regarding balloon risk is false?

a. It is also known as extension risk.b. It is also known as contraction risk.c. Balloon defaults may delay payments to the CMBS investor.d. Both "a" and "c".

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39. L2-00337 - Lecture: SS-03 (page 63), topic: L2-L03-03You are developing new statistical software and are testing its regression capabilities, including a test for heteroskedasticity. Examine the following output and indicate which of the 3 independent variables contain(s) obvious errors or suspect output that should be verified further.

Conventional Robust

Standard Standard AdjustedValue error t-value error t-value

a. Variable 1 −1.52 0.37 4.11 0.80 −0.53b. Variable 2 1.57 1.09 1.44 0.49 3.20c. Variable 3 0.49 0.08 3.92 0.29 1.69d. All of the above contain errors or suspect output.

40. L2-02136 - Lecture: SS-12 (page 34), topic: L2-L12-01Rob Sykes, CFA, is analyzing C-ville Company, a United States based maker of exam booklets. The company has just signed a new two-year contract that will allow it to grow at 20% pace until the contract expires. This is a one-time deal and thereafter the company's growth will fall back to its long-run rate of 3%. Sykes has opted to look at several factors and valuation methods. He has gathered the following information.

C-ville Company

Financial Statements for Years Ended 3/31/X0 and 3/31/X1 ($ million, except per share data)

Income Statement 20X0 20X1 Revenue $89 $93 Cost of Goods Sold 40 41 Other Operating Costs 10 11 Depreciation 5 6 Earnings Before Taxes $34 $35 Taxes 14 14 Net Income $20 $21

Earnings Per Share $2.00 $2.10 Dividends Per Share $1.60 $1.68

Common Stock Outstanding (millions) 10 10

Balance Sheet 20X0 20X1 Current Assets $ 28 $ 34 Net Property, Plant, and Equipment 112 125 Total Assets $140 $159

Current Liabilities $ 40 $ 55 Long-term Debt 0 0 Total Liabilities $ 40 $ 55

Stockholders' Equity 100 104 Total Liabilities & Equity $140 $159

Capital Expenditures $ 15 $ 19

Sykes decides to start his analysis with a look at the company's sustainable growth rate and ROE.

Which of the following is C-ville's sustainable growth rate for 20X1? Unless otherwise noted, use year end rather than average equity to calculate ROE.

a. 4.04%b. 3.85%c. 4.00%d. 4.20%

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41. L2-01509 - Lecture: SS-08 (page 30), topic: L2-L08-03Imboden Analytics (IA) provides capital budgeting support for large companies. Jeffrey Rogers, CFA, examines the following data for two projects under consideration by an IA client.

Exhibit 1:Net Present Value

Machine A Machine BCash Flow PV CF Cash Flow PV CF

0 -$500,000 -$500,000 -$600,000 -$600,0001 250,000 223,214 200,000 178,5712 250,000 199,298 200,000 159,4383 250,000 177,945 200,000 142,3564 200,000 127,1045 200,000 113,4856 200,000 101,326

NPV $100,457 $222,280

Which of the following is closest to the NPV that Rogers would calculate for each project using the replacement chain (common life) approach and which project would Rogers select, assuming the client has a 12% cost of capital?

Machine A Machine B Selectiona. $171,962 $222,280 Ab. $210,093 $222,280 Ac. $171,962 $222,280 Bd. $210,093 $222,280 B

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42. L2-01689 - Lecture: SS-01 (page 6), topic: L2-L01-01Sonia Chapman, CFA, is a Belgian citizen managing portfolios for high net worth individuals in France, Germany, and Algeria from her office overlooking Paris. Chapman is not registered as an investment advisor in the U.S. or Belgium.

The securities laws in France are different, but not necessarily less strict than mandated by the Code and Standards. Securities laws are less strict in Algeria and are more strict in Germany.

Assume that France, like the U.S., uses the "conduct" and "effects" test to analyze each case and apply their version of the Investment Advisers Act of 1940. Germany is more strict in that any conduct contrary to its laws constitutes a violation, regardless of the nationality of the person on whom the effect occurs.

Exhibit 1 shows a copy of a solicitation letter Chapman sent to a client in Algeria.

Exhibit 1Letter from Sonia Chapman

1 June, 20X4

M. Monsoor IjazRte nac.5, Cinq-Maison 65Cité du 5 juilletBab Ezzouar16200 Alger

Dear Mr. Ijaz:

We are pleased to announce that we have assumed the business interests of Faux Plume Investment Advisory in Alger. Chapman-Faux Plume welcomes the opportunity to serve you in the future as Faux Plume has in the past.

Toward the goal of providing the best possible advisory services, Chapman-Faux Plume now employs the services of 125 CFAs, and has 240 partial CFA charterholders enrolled for the next examination. We feel that this level of expertise will provide superior results to the high net worth individuals entrusting us with their wealth.

Girard Plume or I will contact you shortly for your annual review appointment. In the interim, know that we uphold the highest standards of respect for our clients.

Yours sincerely,

Mme. Sonia Chapman, CFAChapman-Faux Plume Investments

Which of the following is most correct with regard to Chapman's communication to the Algerian client?

a. Chapman has not violated the Code and Standards in the communication.b. Chapman has violated the Code and Standards only by referring to the candidates for the CFA designation as

"partial CFA charterholders."c. Chapman has violated the Code and Standards only by referring to the CFA charterholders as "CFAs."d. Chapman has violated the Code and Standards by referring to the candidates for the CFA designation as

"partial CFA charterholders," and by referring to the CFA charterholders as "CFAs."

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43. L2-00190 - Lecture: SS-08 (page 4), topic: L2-L08-01You have the following information about Xanadu Corporation:

No. of bonds outstanding (rated Baa) = 50,000

Par value per bond = $1,000

Price per bond = $1,000

Coupon rate on bonds = 8%

No. of preferred shares outstanding = 1,000,000

Price of a preferred share = $50

Annual dividend for preferred shares = $3.50

No. of common shares outstanding = 4,500,000

Price of a common share = $30

Last annual dividend for common shares = $1.20

Expected growth rate of dividends = 5%

Corporate tax rate = 40%

Calculate the cost of preferred capital for Xanadu Corporation.

a. 2.4%b. 11.7%c. 2.8%d. 7.0%

44. L2-00772 - Lecture: SS-05 (page 13), topic: L2-L05-01To account for the purchase of a machine, a company may use either straight-line (SL) depreciation or the sum-of-the-years'-digits (SYD) depreciation. Return on investment for the machine will:

a. Initially be higher under SYD than under SL.b. Remain constant under SL.c. Decrease over time under SL.d. Initially be higher under SL than under SYD.

45. L2-00708 - Lecture: SS-09 (page 17), topic: L2-L09-02The C-Minus Company is anxious about ongoing consolidation in their industry. They have significant cash reserves and have encountered an unfortunate series of negative NPV investments as they attempted to find viable expansion opportunities. The C-Minus Company shareholders are restless and there have been rumorsthat both the A+Plus Company and the B+Plus Company are in acquisition mode. Although no direct merger overtures have been made, the officers and directors have decided to take defensive steps to prevent an unwanted takeover.

At this time, which of the following courses of action is the least viable?

a. Charter amendments to require a "supermajority" vote to approve any merger.b. Adopt a "poison pill" allocating share rights to existing shareholders.c. Establish a "poison put" option for bondholders.d. Undertake an asset restructuring to acquire assets a suitor does not want or which raise antitrust concerns

upon further consolidation.

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46. L2-01029 - Lecture: SS-01 (page 69), topic: L2-L01-03Many perceive the Prudent Man Rule as being rigid and outdated because it has failed to reflect the emergence of capital market theory and its application.

Tony Esante, a CFA candidate, was studying for his Level II exam. He read about the Prudent Man Rule and understood its requirements. He then read about capital market theory and its applications. Esante felt the prudent man rule was in conflict with capital market theory. Instead of going on to the study session, Esante spent some time thinking of ways the Prudent Man Rule could be updated so it would not conflict with capital market theory.

To satisfy capital market theory, the Prudent Man Rule would need to be adapted so that:

a. Unsatisfactory performance of an individual security would not be acceptable.b. Satisfactory total portfolio performance would satisfy the Prudent Man Rule.c. Each security would be analyzed on its own merits.d. Both "a" and "c".

47. L2-01113 - Lecture: SS-16 (page 46), topic: L2-L16-02The current deliverable Treasury bill (T-bill) for the 120-day futures contract is the current:

a. 90-day T-bill.b. 120-day T-bill.c. 150-day T-bill.d. 210-day T-bill.

48. L2-00992 - Lecture: SS-15 (page 17), topic: L2-L15-02The description of collateral for an asset-backed security states that the loans require the borrowers to make a minimum monthly payment and that the loans have no scheduled payoff date. This indicates the collateral is composed of:

a. Mortgage pass-through securities.b. Non-amortizing loans.c. Amortizing loans.d. Any of the above.

49. L2-00926 - Lecture: SS-01 (page 18), topic: L2-L01-02The Standard relating to Priority of Transactions states that the financial analyst shall conduct himself in such away that transactions for his customers, clients and employer have priority over his own personal transactions. "Personal transactions" include transactions for:

a. Immediate family members.b. Immediate family members and all business associates.c. Immediate family members and all personal friends.d. Immediate family members, all business associates, and all personal friends.

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50. L2-01776 - Lecture: SS-12 (page 52), topic: L2-L12-02One of the companies that Jones is researching is Mackinac, Inc., a U.S. based manufacturing company. Mackinac has released its June 2001 financial statements, which are shown in Exhibits 2-1, 2-2 and 2-3.

Exhibit 2-1Mackinac, Inc.

Annual Income Statementfor the Year ended June 30, 2001

(in thousands, except per-share data)

Sales $250,000 Cost of Goods Sold 125,000 Gross Operating Profit $125,000 Selling, General, and Administrative Expenses 50,000 Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) $ 75.000 Depreciation and Amortization $ 10,500 Earnings Before Interest and Taxes (EBIT) $ 64,500 Interest Expense 11,000 Pretax Income $ 53,500 Income Taxes 16,050 Net Income $ 37,450 Shares Outstanding 13,000 Earnings Per Share (EPS) $ 2.88

Exhibit 2-2Mackinac, Inc.Balance Sheet

As of June 30, 2001(in thousands)

Current Assets: Cash and Equivalents $20,000 Receivables 40,000 Inventories 29,000 Other Current Assets 23,000 Total Current Assets $112,000

Non-current Assets: Property, Plant, and Equipment $145,000 Less: Accumulated Depreciation (53,500) Net Property, Plant, and Equipment $102,000 Investments 70,000 Other Non-current Assets 36,000 Total Non-current Assets $208,000 Total Assets $320,000

Current Liabilities: Accounts Payable $41,000 Short-term Debt 12,000 Other Current Liabilities 17,000 Total Current Liabilities $70,000

Non-current Liabilities:

Long-term Debt $100,000 Total Non-current Liabilities $100,000 Total Liabilities $170,000

Shareholders’ Equity Common Equity $40,000 Retained Earnings 110,000 Total Equity $150,000 Total Liabilities and Equity $320,000

Exhibit 2-3Mackinac, Inc.

Cash Flow Statement

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for the Year ended June 30, 2001(in thousands)

Cash Flow from Operating Activities: Net Income $37,450 Depreciation and Amortization 10,500

Change in Working Capital: (Increase) Decrease in Receivables ($5,000) (Increase) Decrease in Inventories (8,000) Increase (Decrease) in Payables 6,000 Increase (Decrease) in Other Current Liabilities 1,500 Net Change in Working Capital $5,500 Net Cash from Operating Activities $42,500

Cash Flow from Investing Activities: Purchase of Property, Plant, and Equipment ($15,000) Net Cash from Investing Activities ($15,000)

Cash Flow from Financing Activities:

Change in Debt Outstanding $4,000 Payment of Cash Dividends (22,470) Net Cash from Financing Activities ($18,470)

Net Change in Cash and Cash Equivalents $8,980 Cash at Beginning of Period 11,020 Cash at End of Period $20,000

Mackinac has announced that it has finalized an agreement to handle North American production of a successful product currently marketed by a foreign company. Jones decides to value Mackinac using the dividend discount model (DDM) and the free cash flow-to-equity (FCFE) model. After reviewing Mackinac's financial statements in Exhibits 2-1, 2-2 and 2-3 and forecasts related to the new production agreement, Jones concludes the following:

● Mackinac's earnings and FCFE are expected to grow 17% per year over the next three years before stabilizing at an annual growth rate of 9%.

● Mackinac will maintain the current payout ratio.

● Mackinac's beta is 1.25.

● The government bond yield is 6% and the market equity premium is 5%.

What is the value of a share of Mackinac's common stock using the two-stage FCFE model?

a. $99.77b. $97.25c. $97.14d. $102.51

51. L2-00867 - Lecture: SS-07 (page 47), topic: L2-L07-03

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Spartacus Corporation Balance Sheet

12/31/20X1 12/31/20X0

Assets

Cash $ 120,000 $ 36,000

Accounts Receivable 240,000 360,000

Inventory 720,000 480,000

Property, Plant & Equipment 1,680,000 1,764,000

Total Assets $ 2,760,000 $ 2,640,000

Liabilities and Shareholders' Equity

Accounts Payable $ 453,600 $ 600,000

Mortgage Payable 960,000 996,000

Common Stock (250 shares o/s) 720,000 720,000

Retained Earnings 626,400 324,000

Total Liabilities & Capital $ 2,760,000 $ 2,640,000

Spartacus Corporation Income Statement

For the Year Ended December 31, 20X1

Sales $ 2,160,000

Less Expenses:

Cost of Goods Sold $ 1,200,000

Salaries Expense 396,000

Depreciation Expense 84,000

Interest Expense 48,000

Total Expenses $ 1,728,000

Pre-Tax Income $ 432,000

Income Tax Expense (30%) 129,600

Net Income $ 302,400

What is the company's fixed asset turnover ratio for 20X1?

a. 0.80b. 1.25c. 1.29d. 0.93

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52. L2-01995 - Lecture: SS-11 (page 3), topic: L2-L11-01Katherine Cooper is preparing a report on the optical network component business. She begins her research by analyzing the competitive conditions of the industry. One of the dominant firms in the industry is Rubylight, Inc.

Exhibit 6-1Rubylight, Inc.

2004 Annual ReportExcerpt from President's Letter

[1] Rubylight, Inc. had an exceptional year in 2004. [2] The results in almost every corner of the business exceeded our expectations. [3] Sales at Rubylight climbed 73 percent over fiscal 2003 to $135 million, representing the strongest year-on-year sales growth in the company's history. [4] Our gross margin remained constant, compared to the prior year, at a respectable 67 percent. [5] We managed to maintain our margins, despite aggressive price reductions negotiated by our customers, through an improvement in product mix and production efficiencies. [6] The capital markets have rewarded us for this superior financial performance; the company's stock price closed the year at an all time high. [7] We have an outstanding team here at Rubylight, deserving high praise for performance.

[8] The backlog (unfulfilled orders) expanded by 39 percent. [9] This was principally due to an inability of our supplier to ship two application-specific integrated circuits ("ASIC") that are critical to the superior performance of the Rubylight product. [10] Although the ASIC designs are owned by Rubylight, the integrated circuits must be fabricated in highly specialized facilities, of which there are only two worldwide. [11] The extremely capital intensive nature of these facilities prevents us from manufacturing the integrated circuits ourselves. [12] Shortages of electronic component supplies and fabrication time are worldwide phenomena that have also plagued our major competitor.

[13] One of the strategic imperatives in the optical components industry is to get your components incorporated into the designs of your customers' products, known as "design wins," which makes it very expensive for the customer to make a component substitution. [14] Early in the year we announced the appointment of Dr. Brian Richards as the Chief Technology Officer. [15] Dr. Richards is one of the pioneers of the optical switching industry and has numerous patents to his credit. [16] He and his very fine team in our Research and Development department continue to work closely with our customers to ensure design wins for the next generation of products.

[17] On the competitive landscape, we have seen some interesting developments over the last year. [18] Our major competitor has focused on building distribution in the European market. [19] That competitor appears to be exiting North America and the Far East, which are our strongholds. [20] However, we have seen several start-ups enter the North American market. [21] They have been able to attract significant venture capital financing, which gives them greater ability to build brand recognition than start-ups have enjoyed in the past.

[22] On the technology front, recent developments in micro-electronic mechanical technology have created the promise of a dramatic improvement in product performance. [23] Typically the start-ups have been focused on this technology.

Which statement contained in the excerpt from Rubylight's President's Letter increases the bargaining power of buyers in the optical network component business?

a. [5] We managed to maintain our margins, despite aggressive price reductions negotiated by our customers, through an improvement in product mix and production efficiencies.

b. [8] The backlog (unfulfilled orders) expanded by 39 percent.c. [10] Although the ASIC designs are owned by Rubylight, the integrated circuits must be fabricated in highly

specialized facilities, of which there are only two worldwide.d. [20] However, we have seen several start-ups enter the North American market.

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53. L2-00826 - Lecture: SS-07 (page 47), topic: L2-L07-03

Spartacus Corporation Balance Sheet

12/31/20X1 12/31/20X0

Assets

Cash $ 120,000 $ 36,000

Accounts Receivable 240,000 360,000

Inventory 720,000 480,000

Property, Plant & Equipment 1,680,000 1,764,000

Total Assets $ 2,760,000 $ 2,640,000

Liabilities and Shareholders' Equity

Accounts Payable $ 453,600 $ 600,000

Mortgage Payable 960,000 996,000

Common Stock (250 shares o/s) 720,000 720,000

Retained Earnings 626,400 324,000

Total Liabilities & Capital $ 2,760,000 $ 2,640,000

Spartacus Corporation Income Statement

For the Year Ended December 31, 20X1

Sales $ 2,160,000

Less Expenses:

Cost of Goods Sold $ 1,200,000

Salaries Expense 396,000

Depreciation Expense 84,000

Interest Expense 48,000

Total Expenses $ 1,728,000

Pre-Tax Income $ 432,000

Income Tax Expense (30%) 129,600

Net Income $ 302,400

The company's average inventory processing period for 20X1 is:

a. 219 days.b. 146 days.c. 182.5 days.d. 365 days.

54. L2-02125 - Lecture: SS-12 (page 35), topic: L2-L12-01Frank Stahl, the CFO at RDU Corporation, is looking into the implications of divesting one of its divisions. RDU is a conglomerate, with businesses ranging from shoe repair to laser guided missiles. The division to be sold, Temp Services, is growing slowly and a buyer has expressed an interest. To assess the effect of this divestiture, Stahl has gathered the following historical information and made projections for the next year, with and without Temp Services.

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RDU Corporation Historical Financial Statements for Years Ended 12/31/X0 and 12/31/X1

($ million, except per share data)

Income Statement 20X0 20X1 Revenue $ 3,234 $ 3,396 Cost of Goods Sold 1,294 1,358 Other Operating Costs 323 340 Depreciation and Amortization 565 585 Earnings Before Interest & Taxes $ 1,052 $ 1,113 Interest 205 210 Earnings Before Taxes $ 847 $ 903 Taxes 381 406 Net Income $ 466 $ 497

Earnings Per Share $ 1.86 $ 1.94 Dividends Per Share $ 0.93 $ 0.97

Common Stock Outstanding (millions) 250 256

Balance Sheet 20X0 20X1 Current Assets $ 646 $ 680 Net property, Plant, and Equipment 4,154 4,490 Goodwill 1,000 1,110 Total Assets $ 5,800 $ 6,280

Current Liabilities $ 323 $ 340 Long-term Debt 2,050 2,100 Total Liabilities $ 2,373 $ 2,440

Stockholders' Equity 3,472 3,840 Total Liabilities & Equity $ 5,800 $ 6,280

Capital Expenditures/Acquisitions $ 990 $ 1,055

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RDU Corporation Pro Forma Financial Statements for Year Ending 12/31/X2

($ million, except per share data)

Assuming Without Income Statement Divestiture Divestiture Revenue $ 3,266 $ 3,566 Cost of Goods Sold 1,143 1,426 Other Operating Costs 303 357 Depreciation and Amortization 580 620 Earnings Before Interest & Taxes $ 1,240 $ 1,163 Interest 200 220 Earnings Before Taxes $ 1,040 $ 943 Taxes 468 424 Net Income $ 572 $ 519

Earnings Per Share $ 2.20 $ 2.00 Dividends Per Share $ 1.10 $ 1.00

Common Stock Outstanding (millions) 260 260

Assuming Without Balance Sheet Divestiture Divestiture Current Assets $ 653 $ 712 Net property, Plant, and Equipment 4,096 4,690 Goodwill 1,086 1,086 Total Assets $ 5,835 $ 6,488

Current Liabilities $ 326 $ 356 Long-term Debt 2,000 2,200 Total Liabilities $ 2,326 $ 2,556

Stockholders' Equity 3,509 3,932 Total Liabilities & Equity $ 5,835 $ 6,488

Capital Expenditures/Acquisitions $ 900 $ 1,105

Note: Use December 31, 20X0 and 20X1 year-end balance sheet data rather than averages in ratio calculations.

Which of the following is the leverage calculation for RDU using the DuPont ROE model for year 20X0?

a. 13.42%b. 1.6705c. 12.94%d. 1.6354

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55. L2-01416 - Lecture: SS-13 (page 9), topic: L2-L13-01Jim Johnson, CFA, is analyzing Toller Corporation using market multiples. The common shares of Toller are trading at $123.45. Johnson plans to start his analysis with a calculation of Toller's price-to-earnings (P/E) ratios. Toller is extremely aggressive in its accounting and Johnson realizes he must adjust Toller's net income. Johnson has gathered the following historical and projected information:

1Q 20X4 2Q 20X4 3Q 20X4 4Q 20X4 1Q 20X5 20X5 YearActual Actual Actual Actual Estimated Estimated

Net Income $12.1 mil. $14.0 mil. $11.8 mil. $11.6 mil. $12.0 mil. $60.1 mil.

Adjustingaccountingmethods(net of tax) $0.5 mil. $0.6 mil. $0.3 mil. $0.4 mil. $0.4 mil. $2.2 mil.

CommonStockDividends $1.0 mil. $1.0 mil. $1.0 mil. $1.0 mil. $1.1 mil. $4.4 mil.

SharesOutstanding 10 mil. 10 mil. 10 mil. 10 mil. 10 mil. 10 mil.

Using the data provided, Johnson calculates the trailing P/E ratio for Toller based on underlying earnings. Choose which of the following choices is closest to this calculation?

a. 24.1xb. 24.9xc. 25.9xd. 28.2x

56. L2-01569 - Lecture: SS-09 (page 18), topic: L2-L09-02Which one of the following statements is false?

a. In a cash offer merger, the cash purchase of the target firm's stock is taxable. The shareholders of the target firm are viewed as having disposed of the shares, and the resulting potential capital gains trigger taxes.

b. In a cash offer merger, assets of the target firm are revalued in the merged entity and depreciation is taken from the adjusted, usually higher, amount.

c. In a share offer merger, the stock purchase of the target firm is not taxable. The shareholders of the target firm are viewed as having exchanged shares and capital gains are deferred until the new shares are sold.

d. In a share offer merger, assets of the target firm are transferred at their current market value and depreciation is taken from the market value.

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57. L2-00664 - Lecture: SS-05 (page 4), topic: L2-L05-01All of the following are true about LIFO, except:

a. It allows managers to manipulate income by timing inventory purchases.b. It produces lower net income than FIFO during periods of rising prices.c. It produces higher reported inventory on the balance sheet than FIFO in an inflationary (rising prices)

environment.d. All of the following are true.

58. L2-00040 - Lecture: SS-02 (page 9), topic: L2-L02-01A portfolio manager calls Vic, a trader at Sonic Brokerage, to place a buy order for 100,000 shares of American Digital Equipment. Vic calls Tully, a trader at another brokerage firm, and orders "100,000 shares of ADE at the market." Tully later calls to confirm the purchase of 100,000 shares of Aerospace Dynamics at $60.50. Vic says that he wanted to buy American Digital Equipment, not Aerospace Dynamics. Tully explains that ADE is the symbol for Aerospace Dynamics. The symbol for American Digital Equipment is AMD. The market on Aerospace Dynamics is now off by $0.25, so Vic asks Tully to sell the shares and have Tully's firm take the $25,000 loss (cover the trade). Tully agrees, but says he will need to recoup the loss in additional trades. Over the next month, Vic directs a number of trades to Tully in order to compensate his firm for the loss.

Regarding trading errors, an important factor is:

a. Standard IV(B.3), Fair Dealing, which requires members to treat all clients and prospects fairly when taking investment action.

b. The SEC states that if a member makes a trading error, he/she must personally bear the loss.c. If a member makes an investment recommendation to a client, his/her objectivity may be compromised.d. All of the above.

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59. L2-02052 - Lecture: SS-17 (page 61), topic: L2-L17-02Speculative Microsystems has a large bond issue outstanding with a fixed coupon payment. Internal company analysts genuinely believe that interest rates are going to increase to a level that is above the fixed payment, though they aren't sure exactly when this will happen. It doesn't make sense for the firm to contractually commit to a different interest payment arrangement at this time; however, they would like the ability to take advantage of the situation if, in fact, interest rates increase sometime in the near future.

Suppose that Speculative Microsystems decides to buy a European payer swaption that expires one-year from today and allows the firm at the time of expiration to enter into a one-year swap with quarterly payments based on an (pay-fixed) exercise rate of 8%. Further suppose that the following table gives annualized LIBOR spot rates and their respective discount factors on the day of expiration:

Time to Maturity LIBOR Rate (%) Discount Factor90 Days 5.5 0.9864180 Days 8.5 0.9592270 Days 10.5 0.9270360 Days 12.5 0.8889

If, at the time of expiration, the market rate for the underlying swap would require a fixed payment of 11.81% annually, then what is the (annualized) value of this swaption on expiration day per $1 of notional principal?

a. −$0.1433b. $0.1433c. $0.1854d. $0.0297

60. L2-01261 - Lecture: SS-14 (page 27), topic: L2-L14-02Which of the following bonds should have the highest effective duration (i.e., have the greatest price change for any given small change in interest rates)?

Bond Maturity Coupon Price Embedded OptionsA 10 year 6.6% $100 noneB 15 year 6.8% $100 Immediately callable at $100.00C 5 year 6.6% $100 Immediately putable at $101.00

a. Bond A.b. Bond B.c. Bond C.d. Cannot be determined.

61. L2-00535 - Lecture: SS-08 (page 43), topic: L2-L08-05You have the following information about Qwerty Corporation:

Last year This year

Sales $240 million $276 million

EBIT $50 million $54 million

EPS $3.00 $4.20

Calculate the firm's degree of total leverage (DTL).

a. 5.00b. 5.53c. 0.53d. 2.65

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62. L2-01200 - Lecture: SS-17 (page 50), topic: L2-L17-02An interest rate swap could be replicated by:

I. Issuing a fixed-rate note and buying a floating-rate note.II. Entering a series of forward-rate agreements to receive a floating-rate.III. Buying an interest rate floor.

a. I, II, III.b. II and III only.c. I and III only.d. I and II only.

63. L2-01238 - Lecture: SS-18 (page 16), topic: L2-L18-02Standard deviation and beta both measure risk, but they are different in that:

a. Beta measures both systematic and unsystematic risk while standard deviation measures only unsystematic risk.

b. Beta measures only systematic risk while standard deviation is a measure of total risk.c. Beta measures only unsystematic risk while standard deviation is a measure of total risk.d. Beta measures both systematic and unsystematic risk while standard deviation measures only systematic risk.

64. L2-01453 - Lecture: SS-18 (page 6), topic: L2-L18-01Abigail Grace has a $900,000 fully diversified portfolio. She subsequently inherits ABC Company common stock worth $100,000. Her financial advisor provides her with the forecasted information given in Exhibit 15-1.

Exhibit 15-1 Risk and Return Characteristics

Expected Monthly

Returns

Expected Standard Deviation of Monthly

Returns

Original Portfolio 0.67% 2.37%

ABC Company 1.25% 2.95%

The expected correlation coefficient of ABC stock returns with the original portfolio returns is 0.40.

The inheritance changes her overall portfolio and she is deciding whether or not to keep the ABC stock.

Assuming Grace keeps the ABC stock, the expected return of her new portfolio that includes the ABC stock is closest to:

a. 2.80%b. .531%c. 2.27%d. .728%

65. L2-00899 - Lecture: SS-07 (page 54), topic: L2-L07-03The Shearhouse Corporation has a pretax profit margin of 15% and an effective income tax rate of 40%. If its asset turnover is 1.2, what should management select as a target financial leverage ratio in order to obtain a return on equity of 20%?

a. 2.78xb. 1.85xc. 1.11xd. 2.22x

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66. L2-01086 - Lecture: SS-15 (page 29), topic: L2-L15-03Why must the future paths of interest rates generated for a Monte Carlo model be adjusted?

a. To factor in the analyst's interest rate forecast.b. To factor in the market's forward rate expectations.c. To factor in expected interest rate volatility.d. None of the above.

67. L2-00966 - Lecture: SS-15 (page 10), topic: L2-L15-01The creation of the CMO market has increased total demand for mortgage pass-throughs by:

I. Eliminating prepayment risk.II. Allowing investors to select tranches that match their duration objectives.III. Allowing investors to select tranches that meet their tolerance for reinvestment risk.

a. I, II, III.b. I only.c. II and III only.d. CMOs have not expanded the market for pass-throughs.

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68. L2-01785 - Lecture: SS-12 (page 45), topic: L2-L12-02Rio National Corp. is a U.S. based company and the largest competitor in its industry. Exhibits 5-1 through 5-4 present the financial statements, which are prepared according to U.S. Generally Accepted Accounting Principles (U.S. GAAP), and related information for the company. Exhibit 5-5 presents relevant industry and market data.

Exhibit 5-1Rio National Corp.

Summary Balance Sheetson 31 December(U.S. $ millions)

2002 2001

Cash $ 13.00 $ 5.87

Accounts Receivable 30.00 27.00

Inventory 209.06 189.06

Current Assets $252.06 $221.93

Gross Fixed Assets 474.47 409.47

Accumulated Depreciation (154.17) (90.00)

Net Fixed Assets 320.30 319.47

Total Assets $572.36 $541.40

Accounts Payable $ 25.05 $ 26.05

Notes Payable 0.00 0.00

Current Portion of Long-term Debt 0.00 0.00

Current Liabilities $ 25.05 $ 26.05

Long-term Debt 240.00 245.00

Total Liabilities $265.05 $271.05

Common Stock 160.00 150.00

Retained Earnings 147.31 120.35

Total Shareholders' Equity $307.31 $270.35

Total Liabilities and Shareholders' Equity $572.36 $541.40

Exhibit 5-2Rio National Corp.

Summary Income Statementfor the Year Ended 31 December 2002

(U.S. $ millions)

Revenue $300.80Total Operating Expenses (173.74)Operating Profit 127.06Gain on Sale 4.00Earnings Before Interest, Taxes, 131.06Depreciation & Amortization (EBITDA)Depreciation and Amortization (71.17)Earnings Before Interest & Taxes (EBIT) 59.89Interest (16.80)Income Tax Expense (12.93)Net Income $ 30.16

Exhibit 5-3Rio National Corp.

Supplemental Notes for 2002

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Note 1: Rio National had $75 million in capital expenditures during the year.

Note 2: A piece of equipment that was originally purchased for $10 million was sold for $7 million at year-end, when it had a net book value of $3 million. Equipment sales are unusual for Rio National.

Note 3: The decrease in long-term debt represents an unscheduled principal repayment; there was no new borrowing during the year.

Note 4: On 1 January 2002, the company received cash from issuing 400,000 shares of common equity at a price of $25.00 per share.

Note 5: A new appraisal during the year increased the estimated market value of land held for investment by $2 million, which was not recognized in 2002 income.

Exhibit 5-4Rio National Corp.

Common Equity Data for 2002

Dividends Paid (U.S. $ millions) $3.20Weighted Average Shares Outstanding during 2002 16,000,000Dividend per Share $0.20Earnings per Share $1.89Beta 1.80Note: The dividend payout ratio is expected to be constant.

Exhibit 5-5Industry and Market Data

31 December 2002

Risk-free Rate of Return 4.00%Expected Rate of Return on Market Index 9.00%Median Industry Price/Earnings (P/E) Ratio 19.90Expected Industry Earnings Growth Rate 12.00%

While valuing the equity of Rio National Corp., Katrina Shaar is considering the use of either cash flow from operations (CFO) or free cash flow to equity (FCFE) in her valuation process.

Shaar decides to calculate Rio National's FCFE for the year 2002, starting with net income.

What is Rio National's free cash flow to equity for the year 2002?

a. $24.33 millionb. $10.33 millionc. $0.33 milliond. $5.33 million

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69. L2-01484 - Lecture: SS-18 (page 34), topic: L2-L18-02Timmy Timmonds, has just completed his MBA at Theory Tech, a university that is known for its quantitative approach to finance. He has been hired as an assistant portfolio manager at Tradem & Weep Investments. Tradem & Weep has a list of 245 stocks that its research department rates suitable for inclusion in the firm's portfolios. These "buyable" stocks are categorized into 67 industries.

Timmonds has been asked to construct a well-diversified stock portfolio for Mr. M. T. Pokkets, a middle-income gentleman of modest wealth. Timmonds understands that because Mr. Pokkets does not have a large amount of cash available for investment, the portfolio will have to be limited to no more than twenty stocks. From his courses on portfolio construction, Timmonds knows that a reasonably well-diversified portfolio can be constructed with a relatively few stocks as long as the individual security returns are not well correlated. Consequently, he decides to select 20 industries at random out of the 67 industries in which there is at least one "buyable" stock on the firm's research list. He then selects one stock, at random, from each of the selected industries for inclusion in Pokkets' portfolio.

All of the following are disadvantages of Timmond's portfolio construction technique, except:

a. Timmond's method may result in the portfolio not being well diversified.b. Timmond's method does not account for the tax situation of the client.c. Timmond's method assures only the stocks approved for purchase on the firm's recommended list will

become part of the portfolio.d. Timmonds' method does not guarantee that the risk of the resulting portfolio constructed for Pokkets will be

consistent with his needs and circumstances.

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70. L2-02014 - Lecture: SS-11 (page 3), topic: L2-L11-01Jim Vala, CFA, is analyzing companies in the Telecommunications Industry. Vala attends a June 20X5 meeting where Tom Anderson, DCom Corp.'s Chief Operating Officer makes a presentation. After the meeting with Anderson, Vala is concerned about the long-haul data communications industry and wonders if DCom's business model is viable in the long term. He contacts David Blume, a partner at Communication Consulting Group, who specializes in this industry.

Blume makes the following observations:

1. Long-haul data communications market revenues are $23 billion per year.2. From the supply perspective, network growth (measured in kilometers of installed fiber) will increase by 75

percent in total over the next two years, driven mainly by start-up carriers attempting to compete on quality of service.

3. New data traffic technology virtually eliminates capacity issues in long-haul networks by allowing more data to flow over the same lines. As a result, the marginal cost of carrying data traffic for an established service provider with an existing network is very low.

4. Demand for data traffic will grow at a rate of 60 percent annually over the next two years because of decentralization of computing resources, the rise of telecommuting, and Internet traffic.

5. Until recently, established service providers had been prevented from competing effectively against start-up carriers because of government price regulation.

What is the key factor to successfully implementing the product differentiation strategy?

a. The strategy requires advertising to build a perception of product differentiation.b. The strategy requires that products be sold at a premium price to recover costs of developing a differentiated

product.c. The strategy becomes more effective when it raises switching costs by building customer loyalty.d. The strategy depends on the ability to create real differences that uniquely describe products from the

competitor.

71. L2-00660 - Lecture: SS-05 (page 36), topic: L2-L05-01Which of the following is not an off-balance-sheet financing technique used by a company?

a. Sale of accounts receivable.b. Issuing a zero-coupon bond.c. Take-or-pay contracts.d. A parent guaranteeing the debt of an affiliate.

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72. L2-00883 - Lecture: SS-07 (page 47), topic: L2-L07-03

XYZ Corporation Balance Sheet

12/31/20X2 12/31/20X1 12/31/20X0

Assets

Cash $100,000 $50,000 $30,000

Accounts Receivable 500,000 400,000 300,000

Inventory 200,000 180,000 120,000

Goodwill 10,000 — —

Fixes Assets 50,000 45,000 40,000

Total Assets $860,000

$675,000

$490,000

Accounts Payable $100,000 $ 90,000 $ 80,000

Notes Payable 10,000 — —

Long-Term Debt 50,000 85,000 10,000

Shareholders' Equity 700,000 500,000 400,000

Total Liabilities and Equity $860,000

$675,000

$490,000

XYZ Corporation Income Statement

For the Year Ended

12/31/20X2 12/31/20X1 Sales $1,000,000 $800,000 Cost of Sales $700,000 $550,000 SG&A $150,000 $100,000

In 20X2, the payables turnover and the payables payment period were:

a. 7.4 times; 52 days.b. 7.4 times; 50 days.c. 8.9 times, 52 days.d. 8.9 times, 50 days.

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73. L2-01701 - Lecture: SS-01 (page 18), topic: L2-L01-02Donald Thierath, CFA, supervises proxy voting and soft dollar management for manufacturing firm Dealux Technologies Corporation (DTC) on behalf of his employer, portfolio management firm Startling Bright and Adamson (SBA). SBA owns 2% of DTC in other accounts unrelated to the DTC pension fund. MYB Industries (MYB) recently made an unsolicited takeover offer for DTC. In an attempt to discourage MYB from the takeover, DTC makes an unsolicited bid for KLK Corporation (KLK) which MYB would not want to own.

To further complicate matters, DTC pressures SBA to vote shares of the pension plan and shares held in other SBA accounts in favor DTC's takeover of KLK. DTC threatens to withdraw all current and future pension fund management business from SBA unless they deliver the proxy votes in support of the KLK takeover.

Thierath concluded some time before DTC contacted his employer that the MYB merger would benefit existing shareholders in both the DTC pension accounts and other accounts unrelated to the DTC pension fund. Thierath believes that voting the proxies in favor of MYB's takeover of DTC benefits existing DTC shareholders and the DTC plan beneficiaries, but requests DTC to direct in writing that SBA vote the proxies in favor of the KLK merger. DTC sends the written request that SBA vote for the DTC merger with KLK, along with paperwork indemnifying SBA for voting as DTC has requested.

Thierath directs that SBA sell the 2% holding of DTC in other accounts unrelated to the DTC pension fund, because those shares create a conflict of interest between the DTC directive and the benefit of the unrelated shareholders.

SBA's research department continues to recommend DTC on the strength of the MYB offer, unaware that DTC directed SBA to vote proxies in favor of the KLK merger.

With the DTC merger situation seemingly under control, Thierath turns his attention to the request submitted by portfolio manager Paula Martinez, CFA (PM). PM asks Thierath if she can have a Bloomberg terminal, and wants SBA to pay for the terminal and the desk on which it would reside with soft dollars earned through client brokerage. PM further requests that SBA use soft dollars to purchase some general interest subscriptions (Time, NewsMax, and People) for the client waiting room.

PM makes the argument that all clients will benefit from her enhanced ability to access information on the Bloomberg terminal, and the magazines will benefit all clients who come to the offices and use the waiting room. SBA's clients receive annually a statement indicating that SBA complies with all mandatory provisions of the CFA Institute Soft Dollar Standards.

Anna Nicole Sutton (ANS), a large retail client and heir to the Sutton fortune, demands that SBA direct some of the brokerage deriving from trades in her account to Bertha Trendy (BT), an incompetent retail broker specializing in penny stocks. SBA, however, believes that BT charges higher commissions than comparable brokerage firms. Thierath has indicated in writing that BT may not be suitable as a broker for the type and style of investing approved by the ANS Investment Policy Statement.

Which of the following is most correct with regard to expenses payable with soft dollars with regard to CFA Institute Soft Dollar Standards ("Yes" indicates an allowable soft dollar expenditure)?

BloombergTerminal Credenza Magazines

a. Yes Yes Yesb. Yes Yes Noc. Yes No Nod. No No No

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74. L2-00735 - Lecture: SS-05 (page 4), topic: L2-L05-01Which of the following inventory cost flow methods is usually chosen by management because it minimizes taxes and maximizes net cash flow?

a. The average cost method.b. The specific identification method.c. The first-in, first-out (FIFO) method.d. The last-in, first-out (LIFO) method.

75. L2-01739 - Lecture: SS-16 (page 41), topic: L2-L16-02On May 15, 20X2, the one-year risk-less interest rate in Japan is 0%. The futures price for the May X3 yen futures contract, calling for the delivery of 12.5 million yen one year hence, is $0.00922/¥. The expected spot price of a Japanese yen one year hence, is $0.00910. The yen market is:

a. In contango.b. In normal contango.c. In backwardation.d. In normal backwardation.

76. L2-01681 - Lecture: SS-04 (page 22), topic: L2-L04-02Spillman & Tuttle, LLC provides economic analysis on proposed regulation to private sector companies in the U.S. and Canada. Roger Dalton, CFA, must approve reports with economic and financial data prior to release.

A large U.S.-based pharmaceutical company recently discovered, quite by accident, that an experimental drug promoted for repairing neural pathways in stroke victims actually improved eczema conditions in those trial participants exhibiting the symptoms in pre-trial screening. Another pharmaceutical company producing an equally effective drug for eczema has pressured the FDA not to allow the results of the stroke victim study in verifying the efficacy of the drug for eczema treatment.

Which of the following statements from the scenario should Dalton emphasize in preparing Spillman & Tuttle's argument that stroke victim study results should be used in determining the drug's efficacy in treating eczema?

a. Health and safety regulations protect workers and the environment through the regulation of processes used in producing drugs.

b. Additional studies performed on the drug to specifically prove efficacy in treating eczema will increase the cost of the drug to consumers.

c. The delay in introducing the new drug for eczema treatment will delay treatment to those suffering from eczema.

d. Price competitiveness in health care provides essentially the same benefits at the same costs as competitiveness in the software market.

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77. L2-00281 - Lecture: SS-08 (page 13), topic: L2-L08-02RCA is considering two independent projects, A and B. Both projects have a cost of capital of 14%. The cash follows that the projects will produce are:

Year 0 1 2 3Project A $ (9,000) 4,000 4,000 4,000Project B $(10,334) 3,000 5,000 6,000

RCA uses the IRR method for project selection. Based on the above data:

118. L2-01022 - Lecture: SS-16 Answer sheet

1. B2. A3. C4. C5. B6. A7. C8. C9. B10. A11. D12. A13. B14. C15. B16. B17. B18. B19. B20. B21. B22. B23. B24. C25. A26. C27. B28. D29. B30. C31. C32. C33. A34. A35. D36. A37. B38. B39. D40. A41. C42. D43. D44. D45. D46. B47. D48. B49. A50. A

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51. B52. A53. C54. B55. C56. D57. C58. A59. B60. A61. D62. D63. B64. D65. B66. D67. C68. C69. C70. C71. B72. B73. C74. D75. B76. B77. A78. C79. D80. B81. C82. B83. B84. B85. A86. A87. A88. D89. D90. A91. A92. C93. D94. C95. D96. A97. C98. B99. D100. D101. B102. B103. B104. C105. B106. B107. B108. D109. D110. C111. C

Page 48: Progress 3

Stalla Review Course Registered to:

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112. D113. C114. A115. A116. C117. B118. B119. C120. C