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Block 1: Sobhani
Question
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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.
Question
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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.
Question
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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.
Question
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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.
Question
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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).
Question
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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.
Block 2: Trendwise
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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.
Question
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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.
Question
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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.
Question
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Natali stated Principle 1 correctly. According to the Soft Dollar Standards, 6(I)A Principles,
brokerage is the property of the client.
Question
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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.
Question
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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.
Block 3: Huang
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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.
Question
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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
Question
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Question
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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.
Question
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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.
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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.
Block 4: Winters
Question
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Question
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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
Question
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Holding all other option factors constant, an increase in interest rates causes call prices to
increase and put prices to decline.
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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).
Question
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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.
Question
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Block 5: Mendosa
Question
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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:
Question
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Using the PVGO and assuming that the company has no positive net present value (NPV)
projects, the PVGO Model is:
Discounted Dividend Valuation, by Jerald Pinto, Elaine Henry, Thomas Robinson, and John
Stowe
Section 4.5
Mock Exam PM Answers
Question
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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.
"Discounted Dividend Valuation" by Jerald Pinto, Elaine Henry, Thomas Robinson, and John
Stowe
Sections 4.5, 5.3
Mock Exam PM Answers
Question
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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.
"Residual Income Valuation," by Jerald Pinto, Elaine Henry, Thomas Robinson, and John Stowe
Section 3.2
Question
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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
Block 6: TCC
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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.
Question
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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.
Question
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Free Cash Flow Valuation, by Jerald Pinto, Elaine Henry, Thomas Robinson, and John Stowe
Section 4.1
Question
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Question
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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
Block 7: Yee
Question
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Net income (given) = $626; Non-cash charges (depreciation, given) = $243; Interest expense (given) =
$186; Tax rate = 294/920 = 32%; Fixed capital investment (given) = $535
FCFF = 626 + 243 + 186(1 0.32) 535 (25) = 485.48 = $485 million
FCFF = 626 + 243 + (186 0.32) 535 (25) = 418.2 = $418 million
Question
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FCFE = FCFF Interest (1 T) + Net borrowing
Given: 2012 FCFF base case estimate = $500; Interest expense = $186; Tax rate = 32%
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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
Question
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Question
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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.
Question
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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.
Block 8: Prutko
Question
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where t is the number of months since the mortgages were originated. Given that the WAM is
356, four months have elapsed.
Question
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The (expected) prepayment amount = (Pool balance scheduled principal payment) single
monthly mortality (SMM): $1,020,780 = ($47,563,831 - $45,901) 0.021482.
Question
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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.
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.
Question
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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.
Question
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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.
Block 9: Hammond
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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%.
Question
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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.
Question
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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.
Question
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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.
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The CAPM assumes investors have identical views on expected returns, variances, and
correlations of securities.
Question
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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.
Question
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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.
Question
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Portfolio Concepts, by Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto, and David E. Runkle
Section 4.3
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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.
Question
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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.