Overview for Questions #1-4 of 88 Question ID: 1631035

TOPIC: QUANTITATIVE METHODS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Mary Gran and Tracy Joyner are analysts for Winterville Investment Managers.

Gran has been analyzing the regression results for financial data of Canadian firms
but she suspects there is a problem with the analysis. Upon further investigation, she
discovers that the dependent variable exhibits significant autocorrelation. To improve
the explanatory power of the model, Gran adds to the model a lagged value of the
dependent variable as an additional independent variable (Gran refers to this new
model as the revised model).

Joyner is interested in the relationship between U.S. stock returns and the day of the
week. Specifically she believes that the returns on Monday may be lower than returns
during the rest of the week. Her regression equation is:

St = α + βDt + εt

where St is the U.S. stock return and Dt is a dummy variable equal to one if the return
falls on a Monday and zero if it occurs during the rest of the week. The daily data
examined is for the last 30 years of returns. The intercept is 0.1428 and the slope
coefficient is –0.1194. The standard error for the slope coefficient is 0.0391. The
standard error of estimate and standard error of the forecast are 0.0419 and 0.0612,
respectively.

Gran is interested in how the returns for multinational corporations are related to the
returns of individual country markets. As a start, she regresses the returns for a large
consumer products firm based in the U.S. against the returns for the Standard and
Poor's 500 index. There were 1190 weekly returns used in the regression. The analysis
of variance results are presented in the following table.

ANOVA

Sum of
Squares

Regression 0.2688

Residual 1.0839
Total 1.3527

Joyner has also been evaluating the relationship between U.S. stock returns and the
commercial paper premium (CPP6), which is the six-month commercial paper rate
minus the Treasury bill rate, and the Federal Funds rate (FEDFUND). She uses monthly
data and has 294 observations in the regression. The results of the regression of U.S.
returns on CPP6 and FEDFUND are as follows.

Coefficients Standard Error t-Statistic

Intercept 1.9172 0.6499 2.9498

CPP6 –3.1000 0.6400 –4.8438

FEDFUND –0.0109 0.0943 –0.1159

Table of F-distribution (α = 5%)

df1 1 2 3 4

df2

10 4.96 4.10 3.71 3.48

20 4.35 3.49 3.10 2.87

50 4.03 3.18 2.79 2.56

100 3.94 3.09 2.70 2.46

250 3.88 3.03 2.64 2.41

500 3.86 3.01 2.62 2.39

1000 3.85 3.00 2.61 2.38

Numerator: df1 and Denominator: df2

Table of t-distribution (Two-Tailed Probabilities)

Degrees of Level of significance (α)

Freedom 0.10 0.05 0.01

20 1.72 2.09 2.85

25 1.71 2.06 2.79

30 1.70 2.04 2.75

35 1.69 2.03 2.72

 40 1.68 2.02 2.70

1000 1.65 1.96 2.58

Question #1 of 88 Question ID: 1630879

Gran's revised model for Canadian firms is most likely:

A) misspecified, as the error terms will be correlated with an independent variable.

B) not misspecified.
C) misspecified, as the error terms in the revised model will be serially correlated.

Question #2 of 88 Question ID: 1630880

Based on Joyner's regression, the 95% prediction interval for stock returns on Monday
is closest to:

A) –0.0600 to +0.1068
B) –0.0966 to +0.1434
C) +0.0230 to +0.0238

Question #3 of 88 Question ID: 1630881

Given the ANOVA results for Gran's regression of the U.S. consumer products firm
returns against the S&P 500 Index returns, at a 5% level of significance, the best
interpretation is that the coefficient on the S&P 500 variable is:

A) equal to zero.
B) greater than zero.
C) not equal to zero.

Question #4 of 88 Question ID: 1630882

A 95% confidence interval for the CPP6 regression coefficient in Joyner's regression is
closest to:

A) 0.00 to –6.20.
B) –4.35 to –1.85.
C) –2.46 to –3.47.

Overview for Questions #5-8 of 88 Question ID: 1511343

TOPIC: QUANTITATIVE METHODS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Vasili Bobrow is a Level III candidate in the CFA program. Bobrow wants to make use
of the skills he developed during his graduate studies in machine learning, to seek out
promising investment opportunities: he seeks to identify the Russian companies that
are most likely to announce a positive earnings surprise. Bobrow collects data on
listed companies that are part of the MOEX index (previously the MICEX index) over
the last 10 years. Bobrow's sample consists of 400 observations, equally split between
observations of positive earnings surprise, and no positive earnings surprise. For each
observation, Bobrow collects company-specific data for 20 financial variables used in
the model.

Bobrow has several concerns about his model:

Concern 1: The number of variables may be too large, and some of these variables
were discovered to be highly correlated.

Concern 2: I want pruning in my model.

Concern 3: Model error leading to false positives should be minimized.

Concern 4: My model has a high in-sample error rate.

Question #5 of 88 Question ID: 1511344

Bobrow would most appropriately handle Concern 1 by using a:

A) penalized regression model.

B) support vector machine model.
C) k-nearest neighbor model.

Question #6 of 88 Question ID: 1511345

Bobrow's Concern 2 would be most applicable to:

A) an ensemble and learning forest model.

B) a classification and regression tree model.
C) a random forest.

Question #7 of 88 Question ID: 1511346

Bobrow would most appropriately address Concern 3 by using a model with high:

A) precision.
B) recall.
C) F1 score.

Question #8 of 88 Question ID: 1511347

The error mentioned in Bobrow's Concern 4 is best described as:

A) bias error.
B) variance error.
C) base error.

Overview for Questions #9-12 of 88 Question ID: 1631036

TOPIC: ECONOMICS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Mandira Shetty works as a global strategist for Dema Bank. She is meeting
Rameshwar Patwaran who is the head of investment to discuss which countries would
present the best investment opportunities for the short to medium term. During the
meeting, Shetty made the following comment:

Comment 1: Even if forward quotes are unbiased estimators of future spot

rates, uncovered interest rate parity would not hold.

Patwaran asked Shetty whether the bank's forward FX Contract 9877 in the currency
market was in the money. Shetty shared Exhibit 1: FX Contract 9877 with Patwaran.

Exhibit 1: FX Contract 9877

90-day Contract for long 1 million AUD vs. USD at an all in rate of USD/AUD 1.0405.

Time elapsed since inception: 30 days

Quotes USD/AUD

Spot rate 1.0501-1.0520

30-day forward 1.0492-1.0500

60-day forward 1.0491-1.0502

Int Rates AUD USD

30-day 1.25% 0.25%

60-day 1.35% 0.30%

Patwaran then showed Shetty a research report that contained the economic data of
selected countries ( Exhibit 2: Selected Economic Data (2000–2010)) and asked if it is
possible to tell which country will grow faster than the others.

Exhibit 2: Selected Economic Data (2000–2010)

Growth rate Growth Share of labor

Growth rate of total
of labor rate of in national
factor productivity
force capital income

Alphanista 2.2% 1.5% 2.0% 0.6

Balastu 2.9% 3.5% 0.5% 0.7

Catmandu 2.6% 1.9% 1.5% 0.7

Patwaran then performed a comparison of the historical growth rates of selected
countries given in the same research report and made the following comment:

Comment 2: It seems that having natural resources does not always help a
country to grow faster, as can be seen from the examples of
Venezuela and Nigeria. I am of the opinion that some of these
resource-rich countries are not growing as fast because the
economic institutions necessary for growth are not developed.
Depreciation of the domestic currencies of these countries is
hurting their manufacturing sectors and making them
uncompetitive.

Question #9 of 88 Question ID: 1511349

Shetty's comment 1 is most likely:

A) correct.
B) correct only in the short term.
C) incorrect.

Question #10 of 88 Question ID: 1630884

Given Exhibit 1: FX Contract 9877, the mark-to-market valuation of contract FX 9877

is closest to:

A) –8,595 USD.
B) +8,590 USD.
C) +9,700 USD

Question #11 of 88 Question ID: 1511351

Using the data in Exhibit 2: Selected Economic Data (2000–2010) and the Cobb-
Douglas production function, the country with the highest growth rate in potential
GDP is:
A) Alphanista.
B) Balastu.
C) Catmandu.

Question #12 of 88 Question ID: 1630885

Of the three factors mentioned in Comment 2, which of the following is least likely to
be accurate?

A) The depreciation of the domestic currency.

B) The manufacturing sector is not competitive on a global basis.
C) Economic institutions necessary for growth are not developed.

Overview for Questions #13-16 of

88 Question ID: 1631037

TOPIC: ECONOMICS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Daan De Vries heads the research department at Mega Bank. De Vries wants to
prepare a research report on global investment outlook for the bank's board of
directors. De Vries sets up a meeting with bank's chief economist, Dr. Emma Van Dijk,
to get her opinion on some of the items in the report.

De Vries told Van Dijk that he attended a seminar recently where the speaker
mentioned the following:

Comment 1: The economy does not converge to a steady state rate of

growth independent of saving/investment decisions.

Comment 2: Growth in TFP is exogenous to the model but the steady state
growth rate depends on TFP growth rate.

Comment 3: A poor country that implements the necessary institutional

reforms can converge to the income level of the wealthier
nations.
Van Dijk states that changing regulatory environment should be a key focus driving
expectations about asset returns globally. She makes the following statements:

Statement 1: Regulatory burden is generally easy to measure ex-ante

including the direct and indirect costs.

Statement 2: Prospectively, regulators often focus only on the direct costs

arising out of a regulation while conducting their cost-benefit
analysis.

Van Dijk also identified several countries that were adopting new requirements that
call for OTC derivative contracts to be now cleared via a central clearing house with
associated standardized margin requirements. Van Dijk recommended that Mega
Bank avoid trading swaps in those countries.

Question #13 of 88 Question ID: 1511354

Which growth model theories do Comments 1 and 2 originate from?

A) Both comments refer to the neoclassical model.

B) Both comments refer to the endogenous growth theory.
Comment 1 refers to the endogenous growth theory and Comment 2 refers to the
C)
neoclassical model.

Question #14 of 88 Question ID: 1511355

Comment 3 is most likely referring to:

A) club convergence.
B) absolute convergence.
C) conditional convergence.

Question #15 of 88 Question ID: 1631017

How many of Van Dijk's statements are correct?

A) Both statements are correct.
B) Neither statement is correct.
C) Only one statement is correct.

Question #16 of 88 Question ID: 1511357

Van Dijk's recommendation about swaps trading is most likely an illustration of:

A) regulatory arbitrage.
B) information frictions.
C) externalities.

Overview for Questions #17-20 of

88 Question ID: 1630888

TOPIC: FINANCIAL STATEMENT ANALYSIS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Dilip Doshi, CFA, has been working as an equity analyst for Sack Investments for the
past six years. He has applied for a portfolio manager position in the same firm.
Dhiren Sanghvi, principal and the hiring manager, requires strong skills in financial
reporting and analysis. Accordingly, Sanghvi has prepared a list of technical questions
to evaluate Doshi's knowledge, as shown in Exhibit 1.

Exhibit 1: List of Technical Interview Questions

1. What is the appropriate accounting treatment under U.S. GAAP

when the sponsor of a defined benefit pension amends the plan to
increase benefits retroactively?
2. What is the appropriate accounting treatment under IFRS for grants
of incentive stock options to employees?
3. For multinational companies with subsidiaries in hyperinflationary
economies, what is the appropriate accounting treatment under
IFRS?
4. How would you spot aggressive accounting practices that make use
of revenue acceleration techniques?
Question #17 of 88 Question ID: 1630889

Regarding interview Question 1 in Exhibit 1, Doshi would most appropriately respond

that prior service costs should be recognized in:

A) the income statement in the current period.

B) other comprehensive income in the current period.
C) the income statement, to the extent that the benefits are vested.

Question #18 of 88 Question ID: 1630890

Supposing that the options mentioned in interview Question 2 were granted out of
the money and exercisable after four years, Doshi's most appropriate answer to
Question 2 would be that:

compensation expense equal to fair value of the stock options should be recognized
A)
over four years.
because the options have a negative intrinsic value, no compensation expense
B)
should be recognized until the options are in the money.
compensation expense equal to the fair value of the options should be recognized
C)
on the grant date.

Question #19 of 88 Question ID: 1511371

With regard to interview Question 3, the multinational company would most likely
include a purchasing power gain or loss in:

the income statement if the subsidiary holds non-monetary assets and non-
A)
monetary liabilities.
the income statement if the subsidiary holds monetary assets and monetary
B)
liabilities.
C) other comprehensive income.
Question #20 of 88 Question ID: 1511372

Which of the following attributes is least likely to indicate a potential revenue

acceleration issue?

A) Lessor use of the capital lease classification

B) Large increases in unearned revenue
C) Bill-and-hold sales

Overview for Questions #21-24 of

88 Question ID: 1630894

TOPIC: ALTERNATIVE INVESTMENTS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Malik Khan serves on the board of the employee pension plan at Smolow, Inc. During
the previous board meeting, the board agreed to an increased portfolio allocation to
real estate. Khan meets with David Feeney, CIO, to discuss the various options.

Feeney states that one option is to invest in private real estate. Alternatively, Feeney
suggests taking an ownership interest in a diversified pool of real estate by investing
in REITs. Khan points out that REITs can be mispriced in the market. Feeney replies
that they can examine multiples such as P/FFO and P/AFFO, or the REIT's NAVPS.

Feeney makes the following statements:

Statement 1: AFFO takes into account the capital expenditures that are
required to sustain the properties' economic income.

Statement 2: REITs with similar operating characteristics are likely to have

different FFO and AFFO multiples if the REITs have different
levels of leverage.

Feeney uses the data for Gemini Healthcare REIT, as shown in Exhibit 1.

Exhibit 1: Gemini Healthcare REIT—Selected Data

000s

Revenues 1200
 Operating expenses 120

Depreciation 230

Interest expense 440

Net income 410

Other data:

Recurring capex 140

Noncash rent 88

Feeney states that compared to an investment in REITs, investments in private real

estate have the following advantages:

Advantage 1: There is high transparency.

Advantage 2: Returns are dictated by property performance.

Khan makes the following statements about NAVPS:

Statement 1: NAVPS is based on the depreciated historical cost of a REIT's

assets.
Statement 2: REITs with high leverage and trading at a discount to NAVPS may
find it difficult to refinance maturing debt.

Question #21 of 88 Question ID: 1630895

Regarding Statement 1 and Statement 2 by Feeney, it would be most accurate to state

that:

A) both statements are correct.

B) only Statement 1 is correct.
C) only Statement 2 is correct.

Question #22 of 88 Question ID: 1630896

The adjusted AFFO for Gemini Healthcare is closest to:

A) $412,000.
B) $640,000.
C) $852,000.

Question #23 of 88 Question ID: 1630897

Which of Feeney's advantages of private real estate investment is correct?

A) Advantage 1 only.
B) Advantage 2 only.
C) Both advantages.

Question #24 of 88 Question ID: 1630898

Which of Khan's statements about NAVPS is correct?

A) Only Statement 1.
B) Only Statement 2.
C) Both statements.

Overview for Questions #25-28 of

88 Question ID: 1631038

TOPIC: FIXED INCOME

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Sharon Summers, CFA, serves as Chief Financial Officer for the Western Teachers
Retirement Fund (WTRF), a large pension fund with assets in excess of $5 billion.
Summers is responsible for the asset management group, which includes fixed-
income analysts Ben Sabage and Tonya Williams.

Recently, WTRF's board revised the fund's target asset allocation, increasing its
targeted fixed income allocation range from 15–20% of total assets to 25–30% of total
assets. Summers wants to discuss strategies to invest the increased allocation as well
as to enhance the performance of the fixed income asset class.
Williams makes the following three statements:

Statement 1: "Rolling down the yield curve" is an active bond portfolio

management strategy that involves buying bonds with maturities
longer than our investment horizon. This strategy is profitable only
when the yield curve is downward sloping.

Statement 2: Active bond portfolio management entails comparing our expected

future spot rates to current forward rates. If our expected future
spot rate applicable for a bond is greater than the corresponding
current forward rate, we would consider that bond to be
overvalued.

Statement 3: The forward contract price of a bond depends on current spot and
forward rates.

Sabage presented the current spot rates as shown in Exhibit 1: Selected Spot Rates.

Exhibit 1: Selected Spot Rates

Maturity (yrs) Spot Rate (%)

1 2.25

2 2.33

3 2.67

5 3.00

Question #25 of 88 Question ID: 1511394

Williams's statement 1 is best described as:

A) correct.
B) incorrect about bond maturity relative to investment horizon.
C) incorrect about the shape of the yield curve.

Question #26 of 88 Question ID: 1511395

Williams's statement 2 is best described as:

A) correct.
B) incorrect about comparing current forward rates to expected future spot rates.
C) incorrect about the bond being considered overvalued.

Question #27 of 88 Question ID: 1511396

The forward contract price of a bond is most likely to decrease if spot rates in the
future:

A) turn out to be higher than the corresponding current forward rates.

B) turn out to be lower than the corresponding current forward rates.
C) evolve according to the forward curve.

Question #28 of 88 Question ID: 1511397

Based on the information in Exhibit 1: Selected Spot Rates, the forward rate for a
one-year zero issued two years from today should be closest to:

A) 2.60%.
B) 2.75%.
C) 3.35%.

Overview for Questions #29-32 of

88 Question ID: 1631039

TOPIC: DERIVATIVES

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Tess Mulroney, CFA, has some experience with options and uses them for both
speculation and hedging. As she often uses over-the-counter options, Mulroney
typically calculates option values herself before taking any positions at dealer prices.
Risk-free rates are currently 5% and the yield curve is flat.
Mulroney is currently considering at-the-money 1-year calls on Tyrex Mining shares.
Tyrex stock is currently trading at $60. Using a binomial model, Mulroney determines
that an up-factor of 1.25 and a down-factor of 0.80 would be appropriate for Tyrex
stock.

Mulroney is also considering a purchase of two-year European put options on Merrill

Materials stock with an exercise price of 35. Merrill stock is currently trading at 38.
Mulroney believes that an up-factor of 1.2 and a down factor of 0.8 are appropriate
for Merrill stock.

Despite her experience, Mulroney knows she always has more to learn. She finds
some technical material about options on the internet, and spends the next hour
reading up on sensitivity factors (the "Greeks") related to option pricing. She finds the
relations for exercise prices and asset prices to be intuitive but is not as comfortable
with theta, vega, and rho.

Mulroney discusses options strategies with a colleague, Pete Glanda. Glanda tells
Mulroney about delta hedging and explains that she can create a delta hedge either
by selling calls or buying puts. Glanda explains that the deltas are the sensitivities of
option prices to changes in the underlying asset value, and that "dynamic" indicates
that the position must be adjusted over time. Mulroney plans to use 0.76 delta call
options to hedge her long position in Xiling Inc. stock. She is unsure about gamma
though.

Glanda suggests that for Mulroney's speculative trades she might consider call and
put options on Spectra Inc. stock. Exhibit 1: Selected BSM Information for Spectra
Inc. Options shows information related to the options.

Exhibit 1: Selected BSM Information for Spectra Inc. Options

Exercise
Stock Price $35 $33
Price

Time to
0.25 Volatility 28%
expiration

d1 0.5796 N(d1) 0.72

d2 0.4396 N(d2) 0.67

Question #29 of 88 Question ID: 1511409

Using the binomial model, the optimal hedge ratio for Tyrex Mining call options is
closest to:

A) 0.42.
B) 0.49.
C) 0.56.

Question #30 of 88 Question ID: 1511410

Using the binomial model, the value of the Merrill put should be closest to:

A) $1.36
B) $2.55.
C) $3.80.

Question #31 of 88 Question ID: 1511411

A properly-constructed delta-hedged portfolio that Mulroney plans for her investment

in Xiling stock is most likely to have:

A) zero gamma.
B) positive gamma.
C) negative gamma.

Question #32 of 88 Question ID: 1511412

Consider a zero-coupon bond with a face value equal to the $33 option exercise price.
Based on the Black-Scholes Model valuation approach and using the information in
Exhibit 1: Selected BSM Information for Spectra Inc. Options, a long position in
100 Spectra Inc. puts can most accurately replicated by a portfolio of:

A) long 33 bonds and short 28 shares.

B) long 67 bonds and short 72 shares.
C) long 67 bonds and short 28 shares.
Overview for Questions #33-36 of
88 Question ID: 1630904

TOPIC: PORTFOLIO MANAGEMENT

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Mary Phillips, CFA, was recently hired to the team that manages the Dominick Trust
(DT), a USD 220 million family-owned portfolio. The DT portfolio consists of several
funds with diversified holdings. Recently, DT has been considering the possibility of
taking further advantage of its fund managers' abilities by additionally managing
outside money.

During her first week on the job, Phillips sets up appointments with several fund
managers to get an overview of the different approaches to portfolio management
that are employed at DT. First, she meets with Andrew Kapp, fund manager for an
actively managed small-cap equity fund. Exhibit 1: Small-Cap Equity Fund—
Selected Information provides information about the fund and its benchmark.

Exhibit 1: Small-Cap Equity Fund—Selected Information

Expected active return 2.3%

Standard deviation of active

7.8%
return

Expected benchmark return 11.0%

Standard deviation of
23.0%
benchmark returns

Risk-free rate 3.0%

Next, Phillips meets with Archana Singh, portfolio manager for an actively-managed
corporate bond fund. Singh makes the following two statements:

Statement 1: Investment constraints have reduced the correlation between my

active weights and my forecasted active returns, resulting in a
lower information ratio."

Statement 2: "Ex-post, the portfolio's return variability is comprised of variation

due to realized information coefficient as well as variation due to
the constraints imposed on the manager."
Phillips is asked to prepare a presentation for Mrs. R. Zingler, a relative of the
Dominicks. Phillips plans to recommend to Zingler the small-cap equity portfolio
described in Exhibit 1: Small-Cap Equity Fund—Selected Information. Upon
learning that Zingler would like to limit her active risk to 5%, Phillips creates a new
portfolio by combining the Small-cap equity portfolio with its benchmark in order to
meet Zingler's investment constraint.

Question #33 of 88 Question ID: 1511434

Based on the information in Exhibit 1: Small-Cap Equity Fund—Selected

Information, the highest Sharpe ratio that can be achieved by combining the actively
managed portfolio and its benchmark is closest to:

A) 0.21.
B) 0.35.
C) 0.45.

Question #34 of 88 Question ID: 1511435

Singh's statement 1 is best described as:

A) correct.
B) incorrect about investment constraints reducing her information ratio.
incorrect about investment constraints reducing the correlation between actual
C)
active weights and forecasted active returns.

Question #35 of 88 Question ID: 1511436

Singh's statement 2 is best described as:

A) correct.
incorrect about the portfolio’s return variability being partly comprised of variation
B)
due to realized information coefficient.
 incorrect about the portfolio’s return variability being partly comprised of variation
C)
due to constraints imposed on the manager.

Question #36 of 88 Question ID: 1630905

The information ratio of the blended portfolio recommended by Phillips to meet

Zingler's constraint is most likely to be:

A) higher than the information ratio of the small-cap equity portfolio.

B) lower than the information ratio of the small-cap equity portfolio.
C) the same as the information ratio of the small-cap equity portfolio.

Overview for Questions #37-40 of

88 Question ID: 1511428

TOPIC: PORTFOLIO MANAGEMENT

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Ale Nieminen is the founder of Nieminen Advisors, a boutique advisory firm based in
Helsinki, Finland. Nieminen is preparing for a meeting with his client, Adda Virtanen,
who recently inherited a substantial amount of money. Virtanen would like to invest a
significant portion of her inheritance in the United States. Nieminen prepares some
information on a particular U.S. equity ETF as shown in Exhibit 1.

Exhibit 1: Selected AAQB ETF Information

Management fees: 0.20% per year

Bid-ask spread: 0.09%

Commission (one-way): 0.06%

Earlier in the week, Nieminen had lunch with Susan Dominick, another prospective
client. During lunch, Dominick stated that her family trust is her sole source of
income, though she passes most of this income on to charity. (Dominick serves on the
board of several charities and does various other volunteer work.)
The following week, Nieminen begins to assemble a presentation recommending that
Altria Trust (AT), another client, reduce its allocation to U.S. Treasuries. Nieminen
collects market price information, along with his expectations, as shown in Exhibit 2.

Exhibit 2: Treasury Market Information and Macroeconomic

Expectations

Market price of zero coupon T-bond maturing in one year ($100

$97.89
face value)

Real risk-free rate 0.50%

Expected inflation over the next year 1.25%

Question #37 of 88 Question ID: 1511429

Which of the following is least likely to represent a cost of investing in ETFs?

A) Cash drag
B) Tracking error
C) Portfolio turnover

Question #38 of 88 Question ID: 1511430

Using the information in Exhibit 1, the three-year holding period cost for AAQB ETF
will be closest to:

A) 0.21%.
B) 0.41%.
C) 0.81%.

Question #39 of 88 Question ID: 1511431

Relative to the portfolio of an average investor, Dominick's portfolio should most

appropriately have a greater exposure to:
A) cyclical equities.
B) high-quality corporate bonds.
C) short-term government treasuries.

Question #40 of 88 Question ID: 1511432

Based on the information in Exhibit 2, the implied premium for inflation uncertainty is
closest to:

A) 0.23%.
B) 0.32%.
C) 0.41%.

Overview for Questions #41-44 of

88 Question ID: 1631041

TOPIC: ETHICAL AND PROFESSIONAL STANDARDS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Antares Investment Management (Antares) is a mid-sized operation based in Boston,

Massachusetts. Antares provides investment analysis, advice, and account
management services for individuals, investment banking services for corporate
clients, and manages assets for several mutual funds. Antares also allocates some
client assets among mutual funds of other firms. Antares wants to include CFA
Institute Standards of Professional Conduct as part of the firm's Policies and
Procedures Manual.

Antares has a written policy on trade allocation and makes this policy available to
clients and prospective clients. The policy is disseminated to all employees. Antares
also has supervisory procedures that provide reasonable assurance that both the firm
and its employees adhere to the firm's policy and applicable laws and regulations. The
policy calls for pro rata allocation of IPOs to all client accounts.

Antares's policies and procedures call for appropriate trade allocation practices as
follows:
 Policy 1: "Get advanced indication of client interest regarding any new
issues."

Policy 2: "Execute orders in a timely and efficient manner."

Policy 3: "Distribute new issues by portfolio manager and not by client."

David Haywood, CFA, manages one of Antares's larger mutual funds. Over the
holidays, Haywood learns from his brother-in-law that his employer, Trident
Telecommunications, has seen a large increase in orders. Haywood then researches
telecom firms and settles upon Alpha, a small-cap telecommunications firm with
promising new technology. Over the next three days, Haywood purchases 100,000
shares of Alpha for the fund he runs, using a volume-weighted average price
algorithm. Several weeks later, Haywood spots the CEO of Trident dining with the CEO
of Alpha at an upscale restaurant. Haywood knows that Trident has made several
acquisitions in the past few years and concludes that Alpha may be Trident's newest
target. Haywood places an order for 500,000 additional shares of Alpha for the fund
he manages.

Alfred Mack, CFA, is an investment officer at Antares. Mack and Erika Lee, CFA, are
good friends; they studied finance together at a university in Chicago. Lee has recently
accepted a position as Senior Vice President of Trading at East Coast Securities, a
medium-sized brokerage firm. Last night, Lee invited Mack out to dinner at the Great
Austin Steakhouse, an expensive restaurant that is frequented by famous movie stars,
well-known musicians, and professional athletes. Over the course of the dinner, Lee
tells Mack of her plans to increase her firm's trading volume. She asks Mack to direct
some trades to her at East Coast Securities. Since Lee is an old friend, Mack believes
he is not required to inform his supervisor that he had dinner with Lee.

Question #41 of 88 Question ID: 1630912

Antares's written trade allocation policy statement would:

A) not violate the Standards of Professional Conduct.

B) violate Standard III(B) Fair Dealing.
C) violate Standard III(C) Suitability.
Question #42 of 88 Question ID: 1630913

Which of Antares's trade allocation practices is least likely to conform to CFA Institute
Standards of Professional Conduct?

A) Policy 1.
B) Policy 2.
C) Policy 3.

Question #43 of 88 Question ID: 1630914

Regarding Haywood's investment in shares of Alpha, Haywood most likely:

A) violated Standard II(A) Material Nonpublic Information.

B) violated Standard V(A) Diligence and Reasonable Basis.
C) did not violate any Standards of Professional Conduct.

Question #44 of 88 Question ID: 1630915

Lee paid US$500 for the dinner with Mack at the steakhouse. Which of the following is
most consistent with the CFA Institute's Standards?

A) No violation of the CFA Institute’s Code and Standards has occurred.

B) Mack has violated the CFA Institute’s Standards of Professional Conduct.
The Code and Standards do not state any specific dollar amounts, so it is unclear
C)
whether a violation has occurred.

Overview for Questions #45-48 of

88 Question ID: 1511358

TOPIC: FINANCIAL STATEMENT ANALYSIS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

John Winchester, CFA, works as an equity analyst for Guion Funds, a small investment
management firm. Recently a news report was released regarding Ruggiano Inc., a
large retailer that Guion is heavily invested in.

Ruggiano Inc. has hundreds of stores in 42 states across the United States. Most of
the stores are large-footprint format stores with over 120,000 square feet of floor
area. However, the news report suggested that Ruggiano is on the brink of completing
the purchase of 80% of the common stock of Ferrers Inc., a much smaller retailer.
Most Ferrers stores can be found in city and town centers. The average Ferrers store
is well below 100,000 square feet in size.

Winchester is interested in how the potential acquisition would affect Ferrers's

financial statements, and asks an intern to prepare a consolidated balance sheet. This
balance sheet, along with the relevant notes, is shown in Exhibit 1: Ruggiano Pre-
and Post-Acquisition Balance Sheets. Ruggiano follows U.S. GAAP in preparing their
financial statements.

Exhibit 1: Ruggiano Pre- and Post-Acquisition Balance Sheets

Pre $m Post $m

Cash 8,592 2,968

Receivables 5,691 6,605

Inventory 42,385 48,965

Other Current Assets 1,382 1,662

Total Current Assets 58,050 60,200

PPE 115,834 133,903

Goodwill 15,932 16,246

Total Assets 189,816 210,349

Accounts Payable 56,822 66,104

Short Term Debt 6,012 7,182

Total Current
62,834 73,286
Liabilities

Long Term Debt 42,921 51,331

Total Liabilities 105,755 124,617

Common Stock 23,095 23,095

Additional Paid in
49,000 49,000
Capital

Retained Earnings 11,966 11,966

Non-controlling
1,671
Interest

Equity and
189,816 210,349
Liabilities

Notes

1. The "post" balance sheet is prepared using the acquisition (partial

goodwill) method.
2. The acquisition is a pure cash transaction: 80% of Ferrers equity for
$7,000m.
3. Ferrers's balance sheet required no fair value adjustments.

While Winchester has confirmed that the intern carried out the consolidation and
calculations accurately, he does have reservations about the preparation of the
consolidated balance sheet. Winchester intends to redraft the consolidated balance
sheet three times, each time making just one of the following adjustments:

Adjustment One

Winchester does not believe that the method used to calculate goodwill is
in line with current accounting standards, and intends to restate the
"post" balance sheet using a method consistent with U.S. GAAP.

Adjustment Two

Winchester believes that Ferrers's PPE has a fair value that is higher than
the reported book value. Winchester estimates that the fair value of
Ferrers's PPE is approximately $18,300. This value still results in a positive
goodwill figure.

Winchester is interested in the impact that this adjustment would have on

the consolidated debt-to-equity ratio (assuming that goodwill is continued
to be calculated as stated in Exhibit 1: Ruggiano Pre- and Post-
Acquisition Balance Sheets).

Winchester calculates "post" debt-to-equity ratios after reclassifying the

non-controlling interest as debt rather than as equity.

Adjustment Three
 Winchester has noted that the remaining 20% of equity will be retained by
the family of the original founder of Ferrers. He believes the family
members will have significant input into the everyday operations of
Ferrers even after the transaction, and hence does not feel confident that
Ruggiano will have control. Winchester intends to prepare a 'post' balance
sheet with no fair value adjustments, but using an accounting method
consistent with Ruggiano having influence but not control over Ferrers.

Question #45 of 88 Question ID: 1511359

Based on information in Exhibit 1: Ruggiano Pre- and Post-Acquisition Balance

Sheets, the book value of Ferrers's net assets is closest to:

A) $1,700m
B) $8,300m
C) $20,500m

Question #46 of 88 Question ID: 1511360

Using information in Exhibit 1: Ruggiano Pre- and Post-Acquisition Balance Sheets

and after making adjustment one only, the consolidated equity plus liabilities is most
likely to be:

A) higher by less than $50m.

B) higher by more than $50m.
C) unaffected by the change in adjustment one.

Question #47 of 88 Question ID: 1511361

Using the information in Exhibit 1: Ruggiano Pre- and Post-Acquisition Balance

Sheets and accounting for adjustment two only, the "Post" (i.e., consolidated) debt-to-
equity ratio (using Winchester's methodology) is most likely to be:

A) higher than the currently calculated value.

B) lower than the currently calculated value.
C) unaffected by adjustment two.

Question #48 of 88 Question ID: 1511362

Using the information in Exhibit 1: Ruggiano Pre- and Post-Acquisition Balance

Sheets and accounting for adjustment three only, the recalculated "post" total current
assets would be closest to:

A) $51,000m
B) $58,000m
C) $60,000m

Overview for Questions #49-52 of

88 Question ID: 1511363

TOPIC: FINANCIAL STATEMENT ANALYSIS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Shiron Simya, CFA, has been working as an equity analyst for Alpharetta Asset
Managers covering the banking and insurance sectors. Simya has collected
information on three property and casualty insurance companies covering the last
year, as shown in Exhibit 1.

Exhibit 1: Selected Financial Information on P&C Insurance

Companies

Description ($ millions) Alpha Bravo Charlie

Loss and loss adjustment expense 14,800 13,865 14,552

Underwriting expense 1,888 1,922 1,387

Net premiums earned 18,211 15,787 14,889

Net premiums written 18,432 15,438 15,112

During a lunch meeting with a colleague, Simya makes the following statements:
 1. Compared to life and health insurance companies, property and casualty
companies tend to have more predictable claims.
2. For P&C companies, periods of soft pricing is evidenced by declining combined
ratios for the industry.
3. Banks with higher concentrations of retail deposits and mortgage loans tend to
perform well when the yield curve inverts during periods of rising short-term
rates.
4. Banks with high amounts of risk-weighted assets tend to shore up their Tier 1
capital requirements under Basel III standards by issuing subordinated debt
with maturities exceeding five years.

Question #49 of 88 Question ID: 1511364

Using information from Exhibit 1, the company with the most efficient operations is
most likely:

A) Alpha
B) Bravo
C) Charlie.

Question #50 of 88 Question ID: 1511365

Using information from Exhibit 1, the company with the highest quality of
underwriting activities is most likely:

A) Alpha
B) Bravo.
C) Charlie.

Question #51 of 88 Question ID: 1511366

Regarding Simya's statements 1 and 2, it would be most accurate to state that:

A) both statements are correct.

B) both statements are incorrect.
C) only one statement is correct.

Question #52 of 88 Question ID: 1511367

Regarding statements 3 and 4 by Simya, it would be most accurate to state that:

A) both statements are correct.

B) both statements are incorrect.
C) only one statement is correct.

Overview for Questions #53-56 of

88 Question ID: 1512465

TOPIC: CORPORATE ISSUERS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Integrated Business Solutions (IBS) is a large-cap technology company operating three

interrelated divisions: hardware, consulting, and cloud services. Over the past three
years, the company's growth rate has slowed significantly. Furthermore, there is an
expectation of negative impact on foreign revenues going forward due to a continued
strengthening of the U.S. dollar.

Super Transistors (ST) is a rapidly growing company that has plowed back all profits to
finance its growth. The company has never issued debt in the capital markets, and its
current borrowing is a small bank loan to finance the company's receivables. Bill
Mayer, ST's CFO, believes that the company's capital structure is suboptimal and
recommends that the board approve the sale of 5% 20-year senior unsecured
debentures to finance an open-market purchase of the company's shares. Separately,
ST wants to acquire Gemini, a smaller software company, for cash. Gemini's
EV/EBITDA multiple exceeds that of its peers.

Mayer recommends using a comparable transactions approach to value Gemini and

makes the following statements in support of this recommendation:

Statement 1: The method is not sensitive to market mispricing.

Statement 2: The method provides an estimate of a target's value relative to
similar transactions in the market.

Question #53 of 88 Question ID: 1512453

To counter declining growth rates, IBS could least appropriately:

A) acquire faster-growing companies.

B) divest the slowest-growing business segment.
C) undertake a cost restructuring.

Question #54 of 88 Question ID: 1512454

Mayer's recommendation to repurchase Super Transistors stock would most

accurately be described as:

A) a dividend recapitalization.
B) a stock recapitalization.
C) a leveraged buyout.

Question #55 of 88 Question ID: 1512455

Which of the following is the least likely explanation for the difference in valuation of
Gemini relative to its peers?

A) Differences in growth rates.

B) Differences in risk profile.
C) Differences in cost structure.

Question #56 of 88 Question ID: 1512456

Which statement made by Mayer is correct?

A) Statement 1 only.
B) Statement 2 only.
C) Neither statement is correct.

Overview for Questions #57-60 of

88 Question ID: 1630891

TOPIC: EQUITY VALUATION

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Nancy Fisher and Charlene Hamilton evaluate firms in the basic materials sector for
the investment firm of Boatwright Advisors. They are currently evaluating the
prospects for Spurlock Offshore Exploration and the other firms in its industry.

Spurlock is a relatively new firm in the oil and gas exploration industry. The firm
purchased equipment for offshore drilling two years ago, and sells its successful wells
to major oil companies for development. Although the firm is not yet profitable, Fisher
believes that the firm's long-term prospects are favorable. Due to a global economic
expansion there has been an increase in the demand for and price of oil, resulting in
an increased demand for oil drilling equipment. As a result, Spurlock paid significantly
higher prices for its equipment than the established firms in the industry. Spurlock
common stock does not pay a dividend.

Hamilton is following a firm that manufactures oil and gas drilling equipment, Rig
Industries. Last year, Rig had reported earnings per share of $2.40, under
International Financial Reporting Standards (IFRS). Hamilton is estimating the firm's
underlying and normalized earnings. The economy and the industry have been in an
expansion for three years. The firm reported expenses for environmental remediation
of $0.29 per share last year and a gain on sales of surplus assets of $0.17 per share.

Fisher is examining the prospects of an agricultural chemicals producer, Walton

Global. Walton has grown since it went public some years ago. Over the past few
years, Walton has benefited from economic expansion and grown even more rapidly,
both in terms of capacity and earnings. Fisher is valuing the firm using a justified
leading P/E approach. The following are the mean analysts' earnings forecasts and
other selected statistics for Walton Global:
Stock price $45

Expected earnings per share $5.00

Required return on stock 12.0%

Return on equity 10.0%

Retention ratio 40.0%

Fisher is concerned that the justified leading P/E for Walton may be misleading
because of a cyclical component in current earnings and also may suffer from upward
bias in sell-side analysts' earnings and growth forecasts this far into an expansion. She
wants to normalize EPS to get a normalized P/E ratio. Fisher is deciding whether to use
the average P/E over the most recent full economic cycle or to use the average ROE
over the cycle times current book value to calculate a normalized P/E.

Question #57 of 88 Question ID: 1511384

Which of the following is the most appropriate price multiple that Fisher and Hamilton
should use to assess the relative value of Spurlock Offshore Exploration?

A) Price-to-sales ratio.
B) Price-to-book ratio.
C) Trailing price-to-earnings ratio.

Question #58 of 88 Question ID: 1630892

The highest trailing price-to-earnings ratio for Rig Industries would be one based on:

A) reported earnings.
B) underlying earnings.
C) normalized earnings.

Question #59 of 88 Question ID: 1630893

Based on the analysts' mean earnings forecast and the other items provided for
Walton Global, Walton is:

A) overvalued because its justified leading P/E is 5.0.

B) overvalued because its justified leading P/E is 7.5.
C) undervalued because its justified leading P/E is 10.0.

Question #60 of 88 Question ID: 1511387

With regard to Fisher's calculation of a normalized P/E for Walton, she should use:

A) either method, as they are theoretically the same.

B) the average EPS method.
C) the average ROE method.

Overview for Questions #61-64 of

88 Question ID: 1512457

TOPIC: EQUITY VALUATION

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Lisa Marie and Kevin Earnhardt are senior equity analysts at Wainscots Investments.

Marie covers the oil refining and petrochemical industry. She has noticed a great deal
of variation in firm financial leverage and profitability across this industry. Marie
generally uses the EV/EBITDA ratio, among other metrics, to value firms in this
industry. One firm of particular interest to Marie is Luc Energy Partners. The relevant
statistics that Marie uses to calculate Luc Energy's EV/EBITDA ratio are as follows:

Luc Energy Partners financial information:

(all data in millions, except for stock price)

Stock price $30.00

Shares outstanding 45.0

Market value of debt $120.0

EBITDA $320.0

Cash and marketable securities $42.0

Investments $275.0

Earnhardt believes that Luc's current dividend of $1.00 will increase at a growth rate
of 10% next year and linearly decline to its constant growth rate of 5% over the next
six years.

During Earnhardt's weekly meeting with Sylvia Dietrich, an intern at the firm, Dietrich
asks about an appropriate model to use to estimate the terminal value of Zeta Inc., a
company that is currently experiencing high growth.

Earnhardt has become interested in Petroleo Corporation (Petroleo) because of its

growth potential. Dietrich has compiled the data in the following table but is not sure
exactly how she should estimate the growth rate for Petroleo's dividends for the
foreseeable future. They discuss the assumptions required for them to estimate a
sustainable growth rate for Petroleo.

Excerpts from Petroleo Corporation's most recent financial statements:

Cash and equivalents $1 million

Net working capital $5 million

Total debt $30 million

Total equity $20 million

Net income $2 million

Dividend payout ratio 20% of net income

Question #61 of 88 Question ID: 1511389

The EV/EBITDA ratio for Luc Energy Partners is closest to:

A) 3.3.
B) 3.6.
C) 4.6.
Question #62 of 88 Question ID: 1512458

Based on Earnhardt's expectations, the required rate of return for Luc Energy
indicated by the market price is closest to:

A) 9%.
B) 12%.
C) 14%.

Question #63 of 88 Question ID: 1511391

Regarding Dietrich's question about estimating terminal share value Zeta Inc., it would
be least appropriate for Earnhardt to suggest the:

A) constant growth model.

B) price multiple method.
C) double-declining growth model.

Question #64 of 88 Question ID: 1511392

To estimate the sustainable growth rate for Petroleo, it would be most appropriate for
Earnhardt and Dietrich to assume that Petroleo will:

A) not issue new debt or equity.

B) issue new debt but not new equity.
C) issue new equity but not new debt.

Overview for Questions #65-68 of

88 Question ID: 1511378

TOPIC: EQUITY VALUATION

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Arshad Khan, CFA, is principal and founding partner of Khan Nolan, an asset
management firm. Khan and his partner, Christopher Nolan, conclude that continuing
increases in the price of oil are going to make natural gas a more attractive long-term
choice as a source of energy. As a result of their analysis, Khan and Nolan decide to
take a position in a natural gas distributor.

The Central Texas Energy & Gas Company (Central Texas) is one possible choice for
investment. The company has been in business for many years and has consistently
paid out 80% of its earnings in dividends. Earnings per share for the year just
concluded were $1.80. Khan and Nolan agree that the company's growth rate going
forward should remain constant at 5%, that the required rate of return for Central
Texas's equity should be 12.5%, and that its WACC is 10.5%. Nolan argues against
investing in Central Texas, saying, "Much of present value of Central Texas's growth
opportunities is already reflected in its market price." Currently, Central Texas shares
trade at $23.

North Slope Energy Distributors, Inc. (North Slope) is another company that Khan
Nolan is considering for investment. North Slope is currently experiencing rapid
growth and Khan estimates that earnings will grow 15% this year. He expects this
growth to decline over time, as North Slope matures, to 5% after 10 years. Last year's
earnings were $10 and North Slope maintains a payout ratio of 40%. Khan estimates
that North Slope's WACC is 9% and that the required rate of return on their equity is
11%.

Question #65 of 88 Question ID: 1511379

Based on Khan's assumption about Central Texas's future growth and assuming
Central Texas is fairly priced in the market, the current market expected rate of return
on Central Texas shares is closest to:

A) 11.26%.
B) 11.57%.
C) 12.83%.

Question #66 of 88 Question ID: 1511380

Using Khan's estimate of the required rate of return for Central Texas, what
percentage of its market price is due to the value of Central Texas's growth
opportunities?

A) 15.1%.
B) 21.7%.
C) 34.3%.

Question #67 of 88 Question ID: 1511381

What is value of North Slope based on the most appropriate valuation model?

A) $66.67.
B) $103.33.
C) $143.33.

Question #68 of 88 Question ID: 1511382

Based on Khan's earnings growth estimates, the justified trailing P/E ratio for North
Slope at the end of year 10 is closest to:

A) 6.33.
B) 6.67.
C) 7.00.

Overview for Questions #69-72 of

88 Question ID: 1511398

TOPIC: FIXED INCOME

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Alan Foster, CFA, is a fixed income analyst for Quantshop, an investment management
firm. Alan has been asked by his supervisor to prepare an analysis of a proposed bond
offering by Acton Industries. The proposed offering is a 2-year annual-pay bond with a
5% coupon which Quantshop management believes will carry a single A rating.

Foster has developed an arbitrage-free interest rate tree for single A credits with
medium liquidity. Part of this tree for the next five annual periods is as follows:

Present 1 year 2 years 3 years 4 years

5.6%

5.8%

5.9% 5.35%

5.5% 5.4%

5.2% 4.8% 5.2%

4.7% 4.9%

4.6% 4.9%

4.8%

4.6%

As part of his analysis, Foster has been asked by Acton to consider the effect on the
market yield of options that may be embedded in the note offering, specifically a par
call exercisable after one year or a par put exercisable after one year.

Additionally, Foster's supervisor has asked him to prepare answers to the following
questions that he feels may come up during the next meeting with Acton:

Question: If our proprietary interest rate volatility estimates are too high,
what will be the impact on the valuation of callable and putable
bonds?

Foster sets to work preparing his analysis and answers to the questions that his
supervisor believes may come up at the next meeting. While he thinks he can explain
the answer to the first question to Acton quite easily, he feels the second may be
more difficult to explain clearly. In preparation, Foster calculates two spread
measures for a 10-year single A rated Carlson Manufacturing bond of medium
liquidity. It is currently trading at a nominal spread of minus 20 basis points to the
benchmark yield to maturity of a single A rated medium-liquidity option-free note. The
OAS he calculates using his interest rate tree is 15 basis points.
Question #69 of 88 Question ID: 1511399

If Acton issues the 2-year note with no embedded options, the yield to maturity at
issuance will be closest to:

A) 5.15%.
B) 5.20%.
C) 5.25%.

Question #70 of 88 Question ID: 1511400

The issue price of the note issue (% of par) if Acton chooses to issue the putable note
is closest to:

A) 99.895.
B) 99.946.
C) 100.27.

Question #71 of 88 Question ID: 1511401

The increase in the required yield to maturity at issuance of the note if Acton decides
to include the proposed call feature is closest to:

A) 0.07%.
B) 0.09%.
C) 0.11%.

Question #72 of 88 Question ID: 1511402

What is the most likely impact of higher estimated volatility on the valuation of
different bonds?

Callable Putable
A) Undervalued Overvalued

B) Overvalued Undervalued

C) Overvalued Overvalued

Overview for Questions #73-76 of

88 Question ID: 1511403

TOPIC: FIXED INCOME

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Alpha+ Strategies is a hedge fund that focuses on investing in fixed income securities.
The fund specializes in investing in complex instruments with embedded options, and
often uses short positions in closely-related option-free bonds to hedge interest rate
and credit risk exposures.

Bill Weld, a senior analyst at Alpha+, is considering taking a position in Pioneer's 10-
year convertible debenture. It has a 3.5% annual coupon and is convertible at the rate
of 45 Pioneer shares per $1,000 par bond. Pioneer shares are currently trading at $20,
and have an expected dividend yield of 2.8% for the coming year. Weld states that the
conversion feature would lower the yield on the bod from 3.5% to 3%.

Weld uses interest rate volatility of 15% for his models but is concerned about this
estimate. He specifically wants to know the impact that a too-high estimate of
volatility would have on the valuation of callable and putable bonds.

Weld meets with Bill Stys, Ph.D., the chief economist at Alpha+. Weld raises the topic
of models that seek to explain the equilibrium term structure of interest rates and
arbitrage-free models. Stys makes the following statements about these models:

Statement One of the models assumes that interest rate volatility increases with
1: the level of interest rates.

Statement One of the models takes the current yield curve as given, and produces
2: a symmetrical distribution of future rates.

Question #73 of 88
 Question ID: 1511404

The market conversion premium ratio on the convertible bond is closest to:

A) 0.5%.
B) 9.8%.
C) 15.9%.

Question #74 of 88 Question ID: 1511405

The most likely effects of increased interest rate volatility on the value of an option-
free bond and on the value of a callable bond are, respectively:

Option-free Callable

A) decrease increase

B) no effect decrease

C) decrease decrease

Question #75 of 88 Question ID: 1511406

Stys's statement 1 would be most accurate as a description of:

A) the Ho-Lee model.

B) the Vasicek model.
C) the Cox-Ingersoll-Ross model.

Question #76 of 88 Question ID: 1511407

Stys's statement 2 would be most accurate as a description of:

A) the Ho-Lee model.

B) the Vasicek model.
C) the Cox-Ingersoll-Ross model.
Overview for Questions #77-80 of
88 Question ID: 1631040

TOPIC: DERIVATIVES

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Ayub Khan is a derivatives trader at Simyar Investments. Khan is having his weekly
meeting with Alnoor Adai, one of the interns at Simyar. Adai has questions pertaining
to valuation of options using the Black-Scholes model as well as the binomial model.

After answering those questions, Khan then discusses options on futures. He states
that Simyar currently holds options on S&P 500 futures. The options have a delta of
0.5389 and N(d2) of 0.4609. Additionally, the firm currently has a long position in an
interest rate cap but Khan would rather have a payer swap position with the same
maturity, reference rate, and settlement dates.

Question #77 of 88 Question ID: 1511414

Under the binomial model, if an equity put option is overpriced in the market, the
most appropriate action is to write the put option and:

A) purchase stock and borrow.

B) sell stock and borrow.
C) sell stock and lend.

Question #78 of 88 Question ID: 1511415

According to the Black-Scholes-Merton option pricing model, the change in the value
of an equity call option resulting from an increase in the risk-free rate is most likely to
be in the same direction as a change in the value of the call option resulting from:

A) an increase in volatility.
B) a decrease in the price of the stock.
C) a decrease in the time to expiration.
Question #79 of 88 Question ID: 1511416

Which of the following is most accurate regarding valuation of the call option on S&P
500 futures using the Black model? Value can be estimated as:

the present value of the difference between 0.5389 times the current futures price
A)
and 0.4609 times the exercise price.
the difference between 0.5389 times the current futures price and 0.4609 times the
B)
exercise price.
the difference between 0.5389 times the futures price at expiration and 0.5391
C)
times the exercise price.

Question #80 of 88 Question ID: 1511417

Which of the following trades would convert Simyar's existing position into a payer
swap?

A) A short floor with the same exercise price as the cap.

B) A long floor with the same exercise price as the cap.
C) A portfolio of long FRAs with the same exercise price.

Overview for Questions #81-84 of

88 Question ID: 1631018

TOPIC: ALTERNATIVE INVESTMENTS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Jim Henry, principal with Axis Investment Consultants, Inc. ("Axis"), is preparing to give
a presentation to Steve Salter, CFO of Aria Insurance, Inc. ("Aria"). Henry has been
trying to land the Aria account for a long time. During their previous meeting, Salter
had mentioned that Aria wants to increase its portfolio allocation to commodities.

Henry includes information on the term structure of commodity prices and theories
that explain the term structure.
Henry's recommendation states that Aria should look for commodity funds
specializing in investing in futures contracts that exhibit backwardation.

Henry's report also includes information on using total return swap contracts. Henry
includes price information on sugar futures contracts (ICE: Sugar11) as the underlying
on a total return swap as shown in Exhibit 1: Sugar Futures Prices in US cents per
pound (US CTS/LB).

Exhibit 1: Sugar Futures Prices in US cents per pound (US CTS/LB)

Month Price

July (swap initiation) 13.84

August 13.22

September 13.49

Henry has received an inquiry from a large pension plan that wishes to allocate a
portion of their portfolio to Axis. Henry prepares a presentation for the trustees of the
plan, including the merits of a portfolio allocation to hedge funds.

Question #81 of 88 Question ID: 1631019

Backwardation is least likely to be associated with:

A) positive roll return.

B) the insurance hypothesis.
C) high storage costs relative to convenience yield.

Question #82 of 88 Question ID: 1631020

Assume a notional principal of 112,000 pounds of raw cane sugar and a monthly
reset. Using the information in Exhibit 1: Sugar Futures Prices in US cents per
pound (US CTS/LB), for the month of September, it would be most accurate to state
that the party that is long the sugar futures contract would:

A) pay $241.07
B) receive $270.00
C) receive $302.40

Question #83 of 88 Question ID: 1631021

Suppose that one month ago, a trader took a long position in July sugar futures at a
contract price of 13.85 US cents per pound (US CTS/LB). This position is near
expiration and has a current price of 13.69 US CTS/LB. The trader will roll the expiring
contract into September futures contracts which are currently trading at 13.53 US
CTS/LB. The collateral yield is 3%. The total return for a fully collateralized position is
closest to:

A) −0.24%
B) 0.26%
C) 2.57%

Question #84 of 88 Question ID: 1631022

The hedge fund strategy that is most likely to be used to counterbalance negative
skew in portfolio return distribution is:

A) merger arbitrage.
B) global macro.
C) managed futures.

Overview for Questions #85-88 of

88 Question ID: 1630906

TOPIC: ETHICAL AND PROFESSIONAL STANDARDS

THE TOTAL POINT VALUE FOR THIS QUESTION SET IS 12 POINTS

Bahman Goldoon, CFA, is research director at Bravo Capital LP ("Bravo"), a boutique

asset management firm that manages the portfolios of several high- and medium-net-
worth clients. Bravo has several portfolio managers, who each manage a number of
client accounts.

While Bravo has not formally adopted the CFA Institute's Code and Standards, it
strives to ensure that the firm behaves ethically and that it complies with all laws and
regulations. To ensure regulatory compliance, Bravo has a policy that all portfolio
managers are responsible for ensuring that the employees they supervise follow all
applicable laws, rules, and regulations.

One particular area of concern for Bravo is allocation of IPO shares to client accounts.
Bravo has a policy of allocating IPO shares equally among all portfolio managers. The
portfolio managers then allocate the shares to the accounts under their control based
on suitability. Bravo also has a long-standing practice of offering different levels of
service depending on the amount of fees that each client pays. The fee structure and
available levels of service are disclosed to clients annually.

Bravo subscribes to research from Analytics Inc. to help Bravo track appropriate level
of credit spread for corporate bonds purchased for client accounts. Goldoon has
determined that the research from Analytics is very thorough, however Goldoon has
not disclosed to clients that he relies on this information. Based on this research,
Goldoon prepares a list of bonds that offer attractive yields and distributes the list to
all Bravo portfolio managers.

Bravo has a longstanding relationship with Sequoia, a bond trading firm. If Sequoia
makes a market in a specific bond, Sequoia will accept a Bravo trade for below-market
commission. Additionally, any Bravo portfolio manager that generates more than $10
million in trades with Sequoia is treated by Sequoia to an all-expenses paid trip to the
prestigious annual Investors' Roundtable conference.

Goldoon serves as a trustee for a local charitable foundation. Goldoon includes in his
monthly client newsletter a mention of the foundation and its activities, as well as
information on the foundation's current fundraising drive.

Question #85 of 88 Question ID: 1630907

Do Bravo's IPO allocation policy and differing levels of service comply with the CFA
Institute's Standards?

Neither the IPO allocation methods nor the differing levels of service comply with
A)
the Standards.
 The IPO allocation method is not in compliance, while the differing levels of service
B)
are in compliance.
Both the IPO allocation method and the differing levels of service are in compliance
C)
with the Standards.

Question #86 of 88 Question ID: 1630908

Does Bravo's reliance on research from Analytics Inc. and/or its relationship with
Sequoia violate any CFA Institute Standards?

Neither the reliance on Analytics research nor the relationship with Sequoia is in
A)
compliance with the Standards.
B) Only the reliance on Analytics research is in compliance with the Standards.
The reliance on Analytics research and the relationship with Sequoia is in
C)
compliance with the Standards.

Question #87 of 88 Question ID: 1630909

Is Bravo's regulatory compliance policy consistent with the CFA Institute's Standards
of Professional Conduct?

A) Yes.
B) No, because the policy does not cover every employee.
No, because Bravo is required to adopt the CFA Institute’s Standards of Professional
C)
Conduct.

Question #88 of 88 Question ID: 1630910

Did Goldoon violate any standard by including information related to the charitable
foundation in the client newsletter?

A) Yes, Goldoon violated Standard III(E) – Preservation of Confidentiality.

B) Yes, Goldoon violated Standard III(A) – Loyalty, Prudence, and Care.
C) No, Goldoon did not violate any Standard.