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Mock Exam PM Answers

Block 1: Sobhani

Question
1 of 6

The information disclosed about the exams by either Sobhani or Miyagawa is not confidential
CFA Program information so they are not in violation of Standard VII. Sobhani's information
was based upon his analysis of the readings and is his opinion, and Miyagawa referenced the
practice exam, which does not reflect content in the actual CFA exam.

2014 CFA Level II


"Guidance for Standards I-VII," CFA Institute
Standard VII(A)

Question
2 of 6

The market environment forecast is stated as an opinion, not fact, and as such is not a violation
of Standard V(B)-Communication with Clients and Prospective Clients. But, Sobhani's asset
allocation recommendation, a 60% equity allocation is risky and does not relate to the long-term
objectives and circumstances of Poundston, so, is in violation of Standard III(C)-Suitability. A
high equity allocation for a sick and elderly client who plans to retire soon is not a suitable
recommendation, especially to a client who who is risk averse and seeking preservation of
capital. Finally, Sobhani has violated Standard V(A)-Diligence and Reasonable Basis because
his recommendation that Poundston invest a large percentage of her assets in equities in an
already highly priced market does not appear to be based on any evidence or analysis.

2014 CFA Level II


"Guidance for Standards I VII," CFA Institute
Standard III(C)-Suitability, Standard V(A)-Diligence and Reasonable Basis, Standard V(B)-
Communication with Clients and Prospective Clients

Question
3 of 6

Standard IV(C)-Responsibilities of Supervisors has been violated. As to it requires members and


candidates with supervisory responsibility to understand what constitutes an adequate
compliance system for their firms and to make reasonable efforts to see that appropriate
compliance procedures are established, documented, communicated to covered personnel, and
followed. "Adequate" procedures are those designed to meet industry standards, regulatory
requirements, the requirements of the Code and Standards, and the circumstances of the firm.
Once compliance procedures are established, the supervisor must also make reasonable efforts to
Mock Exam PM Answers

ensure that the procedures are monitored and enforced. By not updating his compliance policies
and procedures since founding his company, Sobhani has violated this standard.

2014 CFA Level II


"Guidance for Standards I-VII," CFA Institute
Standard IV(C)-Responsibilities of Supervisors, Standard V(C)-Record Retention

Question
4 of 6

Sobhani has only stated historical returns for these types of investments based on research of
other similar investments. In addition, he has not promised a specific return. Thus Sobhani is not
in violation of Standard III(D)-Performance Presentation. But, Sobhani is in violation of
Standard III(A)-Loyalty, Prudence, and Care because he is required to identify the actual client,
which in this case would be Purce and the trust beneficiaries, the twins. From the information
provided, there is no evidence that Sobhani knows or has considered the twin's investment
objectives and constraints and thus is also in violation of Standard III(C)-Suitability.

2014 CFA Level III


"Guidance for Standards I-VII," CFA Institute
Standard III(C)-Suitability, Standard III(D)-Performance Presentation, Standard V(A)-Diligence
and Reasonable Basis

Question
5 of 6

Standard VI(C)-Referral Fees requires Members and Candidates to disclose to their employer,
clients, and prospective clients, as appropriate, any compensation, consideration, or benefit
received from or paid to others for the recommendation of products or services before entry into
any formal agreement for services. In this case, Sobhani advises clients of the referral fee
arrangement after the fact, thus violating Standard VI(C).

2014 CFA Level II


"Guidance for Standards I-VII," CFA Institute
Standard III(B)-Fair Dealing, Standard VI(C)-Referral Fees
Mock Exam PM Answers

Question
6 of 6

Sobhani has not violated Standard VI(A)-Disclosure of Conflicts because disclosure of his
relationship with Wilder is not required because it would not impair Sobhani's independence and
objectivity nor interfere with his respective duties to clients.

But, by not following local law and reporting his cousin's malfeasance, Sobhani violated
Standard I(A)-Knowledge of the Law and as a result also violated Standard I(D)-Misconduct
because his actions reflect adversely on his professional reputation and integrity.

2014 CFA Level II


"Guidance for Standards I-VII," CFA Institute
Standard I(A), Standard I(D), Standard VI(A)

Block 2: Trendwise

Question
1 of 6

There was no violation of Standard II(A) Material Nonpublic information. However, when Natali conducted
a thorough analysis that convinced her to sell the Cyclical stock and then reversed her decision and
followed the request by an Omega Fund's director to hold Cyclical without having a reasonable basis for
doing so, she violated both Standard II (A) Loyalty, Prudence, and Care and Standard V(A) Diligence and
Reasonable Basis.

2014 CFA Level II


"Guidance for StandardsVII", CFA Institute
Standard II(A) Material Nonpublic Information, Standard III(A) Loyalty, Prudence, and Care, Standard
V(A) Diligence and Reasonable Basis

Question
2 of 6

Statements made by both Natali and Libra are consistent with the Standards. According to
Standard III(A) Loyalty, Prudence, and Care voting proxies is an integral part of the management
of investments and a fiduciary who fails to vote proxies may violate the Standard. The Standards
of Practice Handbook also states that a cost-benefit analysis may show that voting all proxies
may not benefit the client, so voting proxies may not be necessary in all instances. Members and
candidates should disclose to clients their proxy-voting policies, which Natali has done.

2014 CFA Level II


"Guidance for Standards I-VII", CFA Institute
Standard III(A)
Mock Exam PM Answers

Question
3 of 6

Disclosure of soft dollar amounts paid is not a requirement. However, Standard III (A) Loyalty,
Prudence, and Care, Soft Commission Policies requires disclosure of the methods or policies
followed in addressing the potential conflicts of soft dollar arrangements.

2014 CFA Level II


"CFA Institute Soft Dollar Standards," CFA Institute
Standard III(A) Loyalty, Prudence, and CareSoft Commission Policies

Question
4 of 6

Natali stated Principle 1 correctly. According to the Soft Dollar Standards, 6(I)A Principles,
brokerage is the property of the client.

2014 CFA Level II


CFA Institute Soft Dollar Standards, CFA Institute
Section 6(I)A Principles

Question
5 of 6

Both Policies 1 and 2 are inconsistent with the Research Objectivity Standards. According to the
Research Objectivity Standards, firms must establish and implement salary, bonus, and other
compensation for analysts that do not directly link compensation to investment banking or other
corporate finance activities on which the analyst collaborated (either individually or in the
aggregate). The Standards also state that research analysts are prohibited from directly or
indirectly promising a subject company or other issuer a favorable report or specific price target,
or from threatening to change reports, recommendations, or price targets.

2014 CFA Level II


"CFA Institute Research Objectivity Standards," CFA Institute
Section 4
Mock Exam PM Answers

Question
6 of 6

Policy 4 is consistent. Section 4, Requirement 6 outlines specific information, which must not be
communicated including proposed recommendation, rating, or price target. However, factual
historical information such as a list of directors or historical financial results may be disclosed in
advance of publishing a research report.

2014 CFA Level II


"CFA Institute Research Objectivity Standards," CFA Institute
Section 4

Block 3: Huang

Question
1 of 6

The value of a long position in a forward contract at any time is


Vt = St F(0,T)/(1 + r)(T t)
where
S = the underlying price
F = the forward price
r = the risk-free rate
T = the time to expiration at contract initiation
t = the time elapsed since initiation

Then, Vt = 75 80/(1.06)0.25 = $3.84, but this is the value of the long position. The value of the
short position has the opposite sign and is $3.84.

2014 CFA Level II


Forward Markets and Contracts, by Don M. Chance
Section 4.2

Question
2 of 6

The formula for the price of a forward contract on an equity index is:
F(0, T) = S0e-(c)Te(rc)T
where
F(0,T) = the price of a forward contract initiated at time 0 and expiring at time T
S0 = the spot price of the underlying
c = the continuously compounded dividend yield
rc = the continuously compounded interest rate
Mock Exam PM Answers

T = 180/365 = 0.4932, which is the time to expiration of the contract in years.


Then,

2014 CFA Level II


"Forward Markets and Contracts," by Don M. Chance
Section 4.2

Question
3 of 6

The formula for the forward exchange rate is:


F(0,T) = S0[(1 + r)T/(1 + rf)T]
where
F(0,T) = the forward exchange rate of a forward contract initiated at time 0 and expiring at time
T
S0 = the spot price
r = the domestic risk-free rate
rf = the foreign risk-free rate
The formula assumes the currency quote is dollars per yen. If the quote is yen per dollar (as is the
case here), then the forward price is S0[(1 + rf)T/(1 + r)T], so
F = 112(1.01/1.06)90/365 = JPY110.67/USD.
Note that the continuous formula, F= S0erf TerT, can be used. Converting the given rates to
continuous rates gives rf = ln(1.01) = 0.00995 and r = ln(1.06) = 0.05827.
F = 112e(90/365)(0.009950.05827) = JPY 110.67/USD.

2014 CFA Level II


"Forward Markets and Contracts," by Don M. Chance
Section 4.4

Question
4 of 6

At expiration, if the market value of the contract is positive (Manager B sold the yen at a higher
price than she could sell it at expiration), Manager B will only receive the agreed-on price if the
other party does not default.

2014 CFA Level II


"Forward Markets and Contracts," by Don M. Chance
Section 5
Mock Exam PM Answers

Question
5 of 6

The value of a futures contract before it has been marked to market can be greater than or less
than zero. The value is the gain or loss accumulated since the last mark-to-market adjustment.

2014 CFA Level II


"Futures Markets and Contracts," by Don M. Chance
Section 7.1.2

Question
6 of 6

The futures price formula is f0(T) = S0 (1+r)T + FV(CB,0,T), where FV(CB,0,T) represents the
future value (FV) of the costs of storage minus the convenience yield. Thus the convenience
yield decreases the futures price.

2014 CFA Level II


"Futures Markets and Contracts," by Don M. Chance
Section 7.1.7

Block 4: Winters

Question
1 of 6

2014 CFA Level II


Forward Markets and Contracts, by Don M. Chance
Section 4.2
Mock Exam PM Answers

Question
2 of 6

According to putcall parity: Long bond + Long call = Long stock + Long put

360/360
Bond = 98.04 = 100/1.02 (must be calculated from option data table)
Long call = $10.35 (given)
Long put = $9.25 (given)
Synthetic underlying stock = $99.14 = Long bond + Long call + Short put (+ Short put is another way of
expressing Long put) = 98.04 + 10.35 9.25

2014 CFA Level II


Option Markets and Contracts, by Don M. Chance
Section 5.5

Question
3 of 6

Holding all other option factors constant, an increase in interest rates causes call prices to
increase and put prices to decline.

2014 CFA Level II


Option Markets and Contracts, by Don M. Chance
Section 7.3

Question
4 of 6

Gamma is a measure of the sensitivity of delta to a change in the stock price. Gamma is largest
for options that are at the money near maturity because of the uncertainty about whether the
option will expire (1) in the money (delta is 1.0) or (2) out of the money (delta is 0.0).

2014 CFA Level II


Forward Markets and Contracts, by Don M. Chance
Section 7.3.1
Mock Exam PM Answers

Question
5 of 6

Swap 2 represents a $100,000 liability to Toye as the receiving counterparty.

Index returns:
S&P 500 = (1537.5/1500) 1 = 2.5%
Russell 2000 = (913.5/900) 1 = 1.5%
NASDAQ = (2991.5/3100) 1= 3.5%

Swap value = Notional amount [ (Pay) return of the pay index + (Receive) return of the
receive index]

Swap 2 = $100,000 = ($2,000,000) ( 1.5% + 3.5%). The negative value properly represents
a liability.

2014 CFA Level II


Swap Markets and Contracts, by Don M. Chance
Sections 4, 4.2.3

Question
6 of 6

The swaption should be exercised because it is in the money.

2014 CFA Level II


Swap Markets and Contracts, by Don M. Chance
Sections 6.16.4
Mock Exam PM Answers

Block 5: Mendosa

Question
1 of 6

First, use SRNC's data to find its unlevered equity beta. Next, use SRNC's unlevered beta and PRBI's
debt ratio to find PRBI's equity beta. The formulas are as follows:

2014 CFA Level II


"Return Concepts," by Jerald E. Pinto, Elaine Henry, Thomas R. Robinson, and John D. Stowe
Section 4.1.2

Question
2 of 6

Using the PVGO and assuming that the company has no positive net present value (NPV)
projects, the PVGO Model is:

$70 = $49.43 + PVGO


PVGO = $70 - $49.43 = $20.57
2014 CFA Level II

Discounted Dividend Valuation, by Jerald Pinto, Elaine Henry, Thomas Robinson, and John
Stowe
Section 4.5
Mock Exam PM Answers

Question
3 of 6

Question not answered

Using the H-model:

H = 1/2 of the life of high-growth period = 10/2 = 5 years

2014 CFA Level II


"Discounted Dividend Valuation" by Jerald Pinto, Elaine Henry, Thomas Robinson, and John
Stowe
Section 5.3

Question
4 of 6

Raman is most accurate with respect to his comments on the CAPM. In portfolios, the
idiosyncratic risk of individual securities tends to offset against each other leaving largely beta
(market) risk. For individual securities, idiosyncratic risk can overwhelm market risk and, in that
case, beta may be a poor predictor of future average return. Thus the analyst needs to have
multiple tools available.

2014 CFA Level II


"Return Concepts," by Jerald E. Pinto, Elaine Henry, Thomas R. Robinson, and John D. Stowe
Section 4.1.2

"Discounted Dividend Valuation" by Jerald Pinto, Elaine Henry, Thomas Robinson, and John
Stowe
Sections 4.5, 5.3
Mock Exam PM Answers

Question
5 of 6

Statement 3 by Raman is most accurate. The residual income model, also called the excess
earnings method, does not have the same weakness as the FCFE approach, because it is an
estimate of the profit of the company after deducting the cost of all capital: debt and equity.
Further, it makes no assumptions about future earnings and dividend growth.

2014 CFA Level II


"Free Cash Flow Valuation," by Jerald Pinto, Elaine Henry, Thomas Robinson, and John Stowe
Section 3.7

"Residual Income Valuation," by Jerald Pinto, Elaine Henry, Thomas Robinson, and John Stowe
Section 3.2

"Private Company Valuation," by Raymond D. Rath


Section 4.3

Question
6 of 6

Using a multi-stage residual income model and the data in Exhibit 3:

Equity charge = Equity capital Cost of equity capital


= 20.97 0.124 = $2.60 million
Residual income of the more recent year = Net income Equity charge
= 8.00 2.60 = $5.40 million

Ramans assumed growth rate during the forecast period of five years = 15%
Annual residual income during the no growth period (after Year 5) = 5.40 (1.15)5 = $10.86

Present value (PV) of the residual income from perpetual period, as at T = 5 =


($10.86/0.124)=$87.58
PV of the perpetual period residual income at T = 0 = 87.58/(1.124)5=$48.82

2014 CFA Level II


Residual Income Valuation, by Jerald Pinto, Elaine Henry, Thomas Robinson, and John Stowe
Section 3.4
Mock Exam PM Answers

Block 6: TCC

Question
1 of 6

The comparable transactions method uses details from recent takeover transactions for
comparable companies to make direct estimates of the target company's takeover value. However
it is not necessary to separately estimate a takeover premium as this is already included in the
multiples determined from the comparable transactions.

2014 CFA Level II


"Mergers and Acquisitions," by Rosita P. Chang and Keith M. Moore
Section 7

Question
2 of 6

The fact that the products are designed to meet specific customer requirements and require
extensive set-up and trainings costs would make customer switching costs high which reduces
the threat of new entrants. Due to the advanced technology and high degree of product reliability
required customers would have low bargaining power. Module manufacturing involves small
production runs, low profit margins and should not be attractive to this high profit margin
specialized industry.

2014 CFA Level II


"The Five Competitive Forces that Shape Strategy," by Michael E. Porter
Section 2

Question
3 of 6

E0/S0 = the business's long-term profit margin = 8.0%


(1b) = the projected payout ratio = 0.20
g = the long-run earnings growth rate
r = required rate of return

2014 CFA Level II


"Market-Based Valuation: Price and Enterprise Value Multiples," by Jerald Pinto, Elaine Henry,
Thomas Robinson, and John Stowe
Section 3.3.2
Mock Exam PM Answers

Question
4 of 6

Question not answered


Real required rate of return = Country return + Industry adjustment + Size adjustment Leverage
adjustment

Real country return 8.60%


+ Industry 1.60%
+ Size 1.45%
Leverage 0.85%
Required rate of return 10.80%

2014 CFA Level II


Return Concepts, by Jerald Pinto, Elaine Henry, Thomas Robinson, and John Stowe
Section 4.3 & 4.4

Free Cash Flow Valuation, by Jerald Pinto, Elaine Henry, Thomas Robinson, and John Stowe
Section 4.1

Question
5 of 6

Real required rate of return as given = 11.50%


FCFE0 = FCFF Int (1 Tax rate) + Net borrowing
= 84 36 (1 0.40) + 52
=114.4

2014 CFA Level II


"Free Cash Flow Valuation," by Jerald Pinto, Elaine Henry, Thomas Robinson, and John Stowe
Section 4.1
Mock Exam PM Answers

Question
6 of 6

Because of the three different growth periods, it is necessary to use the three-stage FCFF model and
calculate the FCFF for each of Years 1 to 4 and a terminal value at the end of Year 4.

Year 1 2 3 4 5
Growth rate 15% 15% 10% 10% 3% thereafter
FCFF 467.25 1.15= 537 618 680 748
Present Value at WACC 537/1.096 = 490 514 516 518
Terminal value at T = 4 11,673
PV of TV 8,089

2014 CFA Level II


Free Cash Flow Valuation, by Jerald Pinto, Elaine Henry, Thomas Robinson, and John Stowe
Section 4.4

Block 7: Yee

Question
1 of 6

FCFF = NI + NCC + Int(1 Tax rate) FCInv WCInv

Net income (given) = $626; Non-cash charges (depreciation, given) = $243; Interest expense (given) =
$186; Tax rate = 294/920 = 32%; Fixed capital investment (given) = $535

2012 2011 Net increase


Working Capital Investment
($ millions) ($ millions) ($ millions)
1,290 32 = 1,258 1,199 21 =1,178
Current assets excluding cash
Current liabilities 2,783 2,678
Working capital 1,525 1,500 25

FCFF = 626 + 243 + 186(1 0.32) 535 (25) = 485.48 = $485 million

$418 is incorrect. It uses t not (1 t).


Mock Exam PM Answers

FCFF = 626 + 243 + (186 0.32) 535 (25) = 418.2 = $418 million

$460 is incorrect. It ignores working capital investment.


FCFF = 626 + 243 + 186 (1 0.32) 535 = 460.48 = $460 million

2014 CFA Level II


Free Cash Flow Valuation, by Jerald Pinto, Elaine Henry, Thomas Robinson, and John Stowe
Section 3.1

Question
2 of 6
FCFE = FCFF Interest (1 T) + Net borrowing
Given: 2012 FCFF base case estimate = $500; Interest expense = $186; Tax rate = 32%

2012 2011 Net increase


Long-term debt ($) 2,249 2,449 200

FCFE = 500 186 (1 0.32) + (200) = $174 million

$114 is incorrect. It ignores tax adjustment for interest expense.


FCFE = 500 186 + (200) = $114 million

$574 is incorrect. It switches the sign for net borrowing.


FCFE = 500 186 (1 0.32) + 200 = $574 million

2014 CFA Level II


Free Cash Flow Valuation, by Jerald Pinto, Elaine Henry, Thomas Robinson, and John Stowe
Section 3.4

Question
3 of 6
In the base case, the growth rate is stable, thus using the constant-growth FCFF model the value
of the firm is

Equity value = Firm value Market value of debt = 12,000 2,249 = $9,751 million.
Value per share = Equity value/Number of shares
= 9,751 million/411 million = 23.7251 = $23.73 per share.
$12.78 is incorrect. It uses cost of equity, not WACC.
[600/(0.12 0.04) 2249]/411 = 12.78
$29.20 is incorrect. It does not deduct the market value of debt.
$12 million/411 million shares = $29.20

2014 CFA Level II


Free Cash Flow Valuation, by Jerald Pinto, Elaine Henry, Thomas Robinson, and John Stowe
Section 2.3.1
Mock Exam PM Answers

Question
4 of 6

First, it is necessary to estimate FCFE2013.

FCFE = Net income (1 DR) (FCInv Depreciation) (1 DR) (WCInv)


where
DR = debt ratio, which is 40%
FCInv = investment in fixed capital, which is 30% of EPS
WCInv = investment in working capital, which is 10% of EPS
On a per-share basis:
FCFE1 (2013) = 1.80 (1 0.40) (0.30 1.80) (1 0.40) (0.10 1.80)
FCFE1 (2013) = 1.80 0.324 0.108 = 1.368.
FCFE will grow at the same rate as net income, 6% annually.

The value per share is $22.80.


$18.00 is incorrect because it uses FCFF: (1.80 0.54 0.18 )/(0.12 0.06) = $18.00
$24.17 is incorrect because it uses FCFE1 (1 + g) = 1.368 (1.06)/(0.12 0.06) = $24.17
2014 CFA Level II
Free Cash Flow Valuation, by Jerald Pinto, Elaine Henry, Thomas Robinson, and John Stowe
Sections 2.3.2, 3.7

Question
5 of 6

The three possible actions are:

1. Increasing common dividends = $110 million, which is a use of FCFE no effect on


FCFE.
2. Share repurchase = $60 million, which is a use of FCFE no effect on FCFE.
3. Debt repayment = $100 million, which will reduce FCFE by the full amount.

Therefore, FCFE will decrease by $100 million. Reducing debt by $100 million reduces FCFE
(the amount of cash available to equity holders) by that amount. The cash dividend and the share
repurchase are uses of FCFE and do not change the amount of cash available to equity holders.

$160 is incorrect because it adds long-term debt of $100 million and $60 million share
repurchases.

$270 is incorrect because it adds all three amounts.

2014 CFA Level II


Free Cash Flow Valuation, by Jerald Pinto, Elaine Henry, Thomas Robinson, and John Stowe
Section 3.8.3
Mock Exam PM Answers

Question
6 of 6

Correct. Analysts should use a FCFE valuation whenever dividends differ significantly from the
companys capacity to pay dividends or when a change of control is anticipated. A FCFF
valuation is preferred over a FCFE valuation whenever the capital structure is unstable or ever-
changing. So, Nicosias first statement is correct, and her second and third statements are
incorrect.

Statement 2 is incorrect. Analysts should use a free cash flow to equity valuation whenever
dividends differ significantly from the companys capacity to pay dividends. FCFF valuation is
preferred over FCFE valuation whenever the capital structure is unstable or ever-changing.

Statement 3 is incorrect. With control comes discretion over the uses of free cash flow, as does
the capacity to change dividend levels. As such, a free cash flow valuation approach is likely to
be superior to a discounted dividend valuation approach.

2014 CFA Level II


Free Cash Flow Valuation, by Jerald Pinto, Elaine Henry, Thomas Robinson, and John Stowe
Sections 1, 4.3

Block 8: Prutko

Question
1 of 6

During the first 30 months of a pool's life,

where t is the number of months since the mortgages were originated. Given that the WAM is
356, four months have elapsed.

2014 CFA Level II


"Mortgage-backed sector of the bond market," by Frank J. Fabozzi
Section 3D
Mock Exam PM Answers

Question
2 of 6

The (expected) prepayment amount = (Pool balance scheduled principal payment) single
monthly mortality (SMM): $1,020,780 = ($47,563,831 - $45,901) 0.021482.

2014 CFA Level II


"Mortgage-backed sector of the bond market," by Frank J. Fabozzi
Section 3D

Question
3 of 6

Extension risk is the risk that the prepayment rate will fall, resulting in a lengthening of the
security's life. This is what concerns the endowment fund manager.

2014 CFA Level II


"Mortgage-backed sector of the bond market," by Frank J. Fabozzi
Section 3G

Question
Of the three, the accrual tranche typically receives principal only after all sequential-pay and/or
planned amortization class tranches have been paid off, meeting the investor's need for a long-
term security. Further, until its principal repayment begins, the accrual tranche does not pay
interest but accrues the interest to the principal, which meets the investor's need to not receive
any cash flow for a number of years.

2014 CFA Level II


"Mortgage-backed sector of the bond market," by Frank J. Fabozzi
Section 4

Question
5 of 6

The pension fund manager's statement is true because most private label issuers do have more
credit risk than Fannie Mae or Freddie Mac and credit enhancement (in a variety of forms, such
as third-party default protection or overcollateralization) can be used to increase the credit rating
of an issue to the level of Fannie Mae and Freddie Mac securities.

2014 CFA Level II


"Mortgage-backed sector of the bond market," by Frank J. Fabozzi
Section 6
Mock Exam PM Answers

Question
6 of 6

Overcollateralization occurs when the value of the collateral exceeds the amount of the par value
of the outstanding securities issued, which is the case here.

2014 CFA Level II


"Asset-backed sector of the bond market," by Frank J. Fabozzi
Section 2F

Block 9: Hammond

Question
1 of 6
2 2 2 2 2 2
Standard deviation = (0.3 16% + 0.5 22% + 0.2 8% + 2 0.3 0.5 16% 22% 0.9 + 2
0.5
0.3 0.2 16% 8% 0.3 + 2 0.5 0.2 22% 8% 0.2) = 15.9%.

2014 CFA Level II


Portfolio Concepts, by Richard A. Defusco, Dennis W. McLeavey, Jerald E. Pinto, and David E. Runkel

Section 2.1, 2.2

Question
2 of 6

The equation to solve for the weights for growth and value stocks given a 20% allocation to
bonds is:

E(r) = w 12% + (0.8 w) 14% + 0.2 8%, where w = % in value stocks and (0.8 w) = % in
growth stocks. Setting E(r) equal to 12.5% and solving for w = 0.15 and (0.8 w) = 0.65.

2014 CFA Level II


Portfolio Concepts, by Richard A. Defusco, Dennis W. McLeavey, Jerald E. Pinto, and David
E. Runkel
Section 2.1, 2.2
Mock Exam PM Answers

Question
3 of 6

Although she is correct that the global minimum-variance portfolio has the lowest level of risk
compared with other portfolios on the efficient frontier, she is incorrect with regard to
dominance. The global minimum-variance portfolio does not dominate portfolios on the efficient
frontier.

2014 CFA Level II


Portfolio Concepts, by Richard A. Defusco, Dennis W. McLeavey, Jerald E. Pinto, and David
E. Runkel
Section 2.1

Question
4 of 6

The standard deviation of the portfolio is: p = w1 1; so 12% = w1 15%; w1 = 0.8 = weight in risky
portfolio. The balance, 1 0.8 = 0.2, or 20%, should be invested in risk-free assets. The new asset
allocation is 80% in the risky portfolio and 20% in the risk-free asset.

2014 CFA Level II


Portfolio Concepts, by Richard A. Defusco, Dennis W. McLeavey, Jerald E. Pinto, and David E. Runkel
Section 2.5.12.5.2

Question
5 of 6

E(R) = RF + [E(Rp) RF] /p = 4% + [(13% 4%) 12%]/15% = 11.2%.


This result can also be obtained by calculating E(R) = (1 wp) RF + wp Rp = (1 0.80) 4% +
0.80 13% = 11.2%.
The correct answer can also be obtained by:
(1) Calculating the weight of the risk-free asset
12= (1 w) 15 w = 20% (w is the weight of the risk-free asset in the portfolio)
(2) Then calculate the return with the risk-free asset and risky portfolio
R = 20% 4 + 80% 13 = 0.8 + 10.4 = 11.2%

2014 CFA Level II


Portfolio Concepts, by Richard A. Defusco, Dennis W. McLeavey, Jerald E. Pinto, and David
E. Runkel
Section 2.5.2
Mock Exam PM Answers

Question
6 of 6

Donners statement about surprises in macroeconomic variables is incorrect because


macroeconomic factor models, not fundamental factor models, relate asset returns to surprises in
macroeconomic variables. His statement about company attributes is correct because
fundamental factor models do relate asset returns to company attributes, such as market
capitalization.

2014 CFA Level II


Portfolio Concepts, by Richard A. Defusco, Dennis W. McLeavey, Jerald E. Pinto, and David
E. Runkel
Section 4.1

Block 10: Jaworski

Question
1 of 6

The CAPM assumes investors have identical views on expected returns, variances, and
correlations of securities.

2014 CFA Level II


Portfolio Concepts, by Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto, and David
E. Runkle
Section 2.6

Question
2 of 6

Jaworski is wrong. One of the reasons for an unstable minimum-variance efficient frontier is the
absence of a short sales constraint. Unconstrained meanvariance optimization models produce
inherently unstable efficient frontiers. The solution is to impose a no short sales constraint.

2014 CFA Level II


Portfolio Concepts, by Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto, and David
E. Runkle
Section 3.2
Mock Exam PM Answers

Question
3 of 6

Model 1 is a macroeconomic factor model. In this model, the intercept value ai is the expected
return on the stock. Model 2 is a fundamental factor model. In fundamental factor models, the
factor sensitivities bi are standardized, thus the intercept is not interpreted as anything more than
a regression intercept that ensures that expected asset-specific risk equals zero. It is not
interpreted as the expected return for the stock as in the macroeconomic factor model.

2014 CFA Level II


Portfolio Concepts, by Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto, and David
E. Runkle
Sections 4.2 and 4.4

Question
4 of 6

The expected return for Portfolio A is calculated as:


E(RA) = 2% + 0.81 4.5% + 0.15 1.2% + 1.23 5.2% = 12.21%

Portfolio Concepts, by Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto, and David E. Runkle
Section 4.3

Question
5 of 6

Ahuja is incorrect about Portfolio B. Factor portfolios by definition will have a factor sensitivity
of one to a particular factor and zero sensitivity for all other factors. For Portfolio B to be a factor
portfolio for the inflation risk factor, it must have a factor beta of 1 to inflation risk and zero for
the other factors.

2014 CFA Level II


Portfolio Concepts, by Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto, and David
E. Runkle
Sections 4.5.1 and 4.6.3
Mock Exam PM Answers

Question
6 of 6

Portfolio A has the highest information ratio. The information ratio provides the mean active
returns per unit of active risk. The higher information ratio demonstrates that active management
has benefited the portfolio.

2014 CFA Level II


Portfolio Concepts, by Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto, and David
E. Runkle
Sections 4.6.1 and 4.6.2