Free CFA Institute CFA-Level-II Exam Questions

Lena Pilchard, research associate for Eiffel Investments, is attempting to measure the value added to the Eiffel Investments portfolio from the use of 1-year earnings growth forecasts developed by professional analysts.Pilchard's supervisor, Edna Wilms, recommends a portfolio allocation strategy that overweights neglected firms. Wilms cites studies of the 'neglected firm effect,' in which companies followed by a small number of professional analysts are associated with higher returns than firms followed by a larger number of analysts. Wilms considers a company covered by three or fewer analysts to be 'neglected.'Pilchard also is aware of research indicating that, on average, stock returns for small firms have been higher than those earned by large firms. Pilchard develops a model to predict stock returns based on analyst coverage, firm size, and analyst growth forecasts. She runs the following cross-sectional regression using data for the 30 stocks included in the Eiffel Investments portfolio:Ri = b0 + b,COVERAGEi + b2 LN(SIZEi) + b3(FORECASTi) + ewhere:Ri = the rate of return on stock iCOVERAGEi = one if there are three or fewer analysts covering stocki, and equals zero otherwiseLN(SIZEi) = the natural logarithm of the market capitalization(stock price times shares outstanding) for stock i,units in millionsFORECASTi = the 1-year consensus earnings growth rate forecast for stock iPilchard derives the following results from her cross-sectional regression:The standard error of estimate in Pilchard's regression equals 1.96 and the regression sum of squares equals 400.Wilrus provides Pilchard with the following values for analyst coverage, firm size, and earnings growth forecast for Eggmann Enterprises, a company that Eiffel Investments is evaluating.Holding firm size and consensus earnings growth forecasts constant, the estimated average difference in stock returns between neglected and non-neglected firms equals:

Nigel Holmes, CFA, is an investment manager for a small money management firm in London. All of Holmes' clients are citizens of the U.K. Holmes urges all of his clients to maintain internationally diversified portfolios. In his efforts to find undervalued securities, he is currently analyzing a Canadian company called Slapshot, Inc. Slapshot produces hockey equipment at its Canadian manufacturing facilities. About 85% of Slapshot's sales are to the U .S . market, and the remainder are domestic (i.e., in Canada). Sales have been growing at 12% per year. Last year's sales were C$68,000,000. Holmes has gathered the following market information (inflation is perfectly predictable):* /$ spot exchange rate = 0.8* /C$ spot exchange rate = 0.4* U.K. risk-free rate = 6%* U.K. expected inflation rate = 4%* Canadian risk-free rate = 9%* Canadian expected inflation rate = 7%* U .S . risk-free rate = 4%* U .S . expected inflation = 2%Holmes uses the international CAPM (ICAPM) to value international investments. For Slapshot, Holmes believes that the stock's returns are sensitive to the /C$ exchange rate. In order to apply the model, he estimates the following parameters using the as the base currency:* World market risk premium = 6%* Sensitivity of Slapshot to the world market = 1.2* Sensitivity of Slapshot to changes in the /C$ exchange rate = 1.4* Holmes' expectation for the depreciation of the C$ against the = 2%* The ratio of the price of the U.K. consumption basket to the Canadian consumption basket is 0.3.Holmes adds Slapshot stock to several client portfolios at a purchase price of C$ 100. One year later, the stock is trading at C$ 122. There were no dividend payments during the year.If the real exchange rate remained constant, the GBP () return on Slapshot for Holmes' clients is closest to

James Kelley is the CFO of X-Sport Inc., a manufacturer of high-end outdoor sporting equipment. Using both debt and equity, X-Sport has been acquiring small competitor companies rather rapidly over the past few years, leading Kelley to believe that the firm's capital structure may have drifted from its optimal mix. Kelley has been asked by the board of directors to evaluate the situation and provide a presentation that includes details of the firm's capita! structure as well as a risk assessment. In order to assist with his analysis, Kelley has collected information on the current financial situation of X-Sport. He has also projected the financial information for alternative financing plans. This information is presented in Exhibit 1.After carefully analyzing the data, Kelley writes his analysis and proposal and submits the report to Richard Haywood, the chairman and CEO of X-Sport Inc. Excerpts from the analysis and proposal follow:* In selecting a re-financing plan, we must not push our leverage ratio too high. An overly aggressive leverage ratio will likely cause debt rating agencies to downgrade our debt rating from its current Baa rating, causing our cost of debt to rise dramatically. This effect is explained using the static trade-off capital structure theory, which states that if our debt usage becomes high enough, the marginal increase in the interest tax shield will be more than The marginal increase in the costs of financial distress. However, using some additional leverage will benefit the company by reducing the net agency costs of equity required to align the interests of X-Sport management with its shareholders.* In the event that X-Sport decides to proceed with a recapitalization plan, I recommend Plan D since it is the most consistent with the shareholders' interests.Haywood reviews the report and calls Kelley into his office to discuss the proposal. Haywood suggests that Flan B would be the most appropriate choice for adjusting X-Sport's capital structure. Before Kelley can argue, however, the two are interrupted by a previously scheduled meeting with a supplier.Haywood takes Kelley's data and proposes to the board of directors that X-Sport pursue one of three alternatives to restructure the company. The first alternative is Plan B from Kelley's analysis. The second alternative involves separating GearTech, one of the companies acquired over the last few years, from the rest of the company by issuing new GearTech shares to X-Sport common shareholders. The third alternative involves creating a new company, Euro-Sport, out of the firm's European operations and selling 35% of the new Euro-Sport shares to the public while retaining 65% of the shares within X-Sport. After some persuading, Haywood convinces the seven-member board (two of whom were former executives at GearTech) to accept the second alternative, which he had favored from the beginning. The board puts together an announcement to its shareholders as well as the general public, detailing the terms and goals of the plan.A group of shareholders, upset about the board's plan, submit a formal objection to X-Sport's board as well as to the SEC. In the objection, the shareholders state that the independence of the board has been compromised to the detriment of the company and its shareholders. The objection also states that:* The value of X-Sport's common stock has been impaired as a result of the poor corporate governance system.* The liability risk of X-Sport has increased due to the increased possibility of future transactions that benefit X-Sport's directors, without regard to the long-term interests of shareholders.* The asset risk of X-Sport has increased due to the inability of investors to trust the GearTech financial disclosures necessary to value the division.Determine whether Kelley's report is correct with regard to the statements made about the static trade-off theory of capital structure and the net agency costs of equity.

Ota L'Abbe, a supervisor at an investment research firm, has asked one of the junior analysts, Andreas Hally, to draft a research report dealing with various accounting issues.Excerpts from the request are as follows:* ''There's an exciting company that we're starting to follow these days. It's called Snowboards and Skateboards, Inc. They are a multinational company with operations and a head office based in the resort town of Whistler in western Canada. However, they also have a significant subsidiary located in the United States.'* 'Look at the subsidiary and deal with some foreign currency issues including the specific differences between the temporal and all-current methods of translation, as well as the effect on financial ratios.'* 'The attached file contains the September 30, 2008, financial statements of the U .S . subsidiary. Translate the financial statements into Canadian dollars in a manner consistent with U .S . GAAP.'The following are statements from the research report subsequently written by Hally:Statement 1: Subsidiaries whose operations are well integrated with the parent will use the all-current method of translation.Statement 2: Self-contained, independent subsidiaries whose operating, investing, and financing activities are primarily located in the local market will use the temporal method of translation.Other information to be considered* Exchange rates (CAD/USD)* Beginning inventory for fiscal 2008 had been purchased evenly throughout fiscal 2007. The company uses the FIFO inventory value method.* Dividends of USD 25,000 were paid to the shareholders on June 30, 2008.* All of the remaining inventory at the end of fiscal 2008 was purchased evenly throughout fiscal 2008.* All of the PP&E was purchased, and all of the common equity was issued at the inception of the company on October 1, 2004. No new PP&E has been acquired, and no additional common stock has been issued since then. However, they plan to purchase new PP&E starting in fiscal 2009.* The beginning retained earnings balance for fiscal 2008 was CAD 1,550,000.* The accounts payable on the fiscal 2008 balance sheet were all incurred on June 30, 2008.* The U .S . subsidiary's operations are highly integrated with the main operations in Canada.* The remeasured inventory for 2008 using the temporal method is CAD 810,000.* All monetary asset and liability balances are the same as they were at the end of the 2007 fiscal year, except that long-term debt was USD 467,700.* Costs of goods sold under the temporal method in 2008 is CAD 1,667,250.Which of the following best describes the effect on the parent's fiscal 2008 sales when translated to Canadian dollars? Sales, relative to what it would have been if the CAD/USD exchange rate had not changed, will be:

Amie Lear, CFA, is a quantitative analyst employed by a brokerage firm. She has been assigned by her supervisor to cover a number of different equity and debt investments. One of the investments is Taylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensive analysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. In applying the capital asset pricing model (CAPM), the result is a 12% rate of return.For her analysis of the returns of Devon, Inc. (Devon), a manufacturer of high-end sports apparel, Lear intends to use the Fama-French model (FFM). Devon is a small-cap growth stock that has traded at a low market-to-book value in recent years. Lear's analysis has provided a wealth of quantitative information to consider. The return on a value-weighted market index minus the risk-free rate is 5.5%, the small-cap return premium is 3.1%, the value return premium is 2.2%, and the liquidity premium is 3.3%. The risk-free rate is 3.4%. The market, size, relative value, and liquidity betas for Devon are 0.7, -0.3, 1.4, and 1.2, respectively. In estimating the appropriate equity risk premium, Lear has chosen to use the Gordon growth model.Lear's assistant, Doug Saunders, presents her with a report on macroeconomic multifactor models that includes the following two statements:Statement 1: Business cycle risk represents the unexpected change in the difference between the return of risky corporate bonds and government bonds.Statement 2: Confidence risk represents the unexpected change in the level of real business activity.Lear is also attempting to determine the most appropriate method for determining the required return for Densmore, Inc. (Densmore), a closely held company that is considering a debt issue within the next year. The company has not previously issued debt securities to the public, relying instead on bank financing. She realizes that there are a number of models to consider, including the CAPM, multifactor models, and build-up models.Based on Lear's analysis, Taylor's stock is most likely to be: