ExamWise volume 1 CFA 2008 level i certification

The Code of Ethics Full Text http://www.cfainstitute.org/centre/ethics/code/ The Standards of Professional Conduct Standard I: Fundamental Responsibilities Standard II: Relationships wit

ExamWise®

Volume 1 CFA 2008 Level I Certification With Preliminary Reading Assignments The

Candidates Question And Answer Workbook For

Chartered Financial Analyst

Authors Jane Vessey, CFA

M Afdal Pamilih, CFA David Stewart

Published by   

TotalRecall Publications, Inc.  

1103 Middlecreek Friendswood, TX 77546 281‐992‐3131 

TotalRecall Publications, Inc

This Book Sponsored by The Center For Financial Certification, Inc. 

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Carol Lee, Mary Elizabeth, Sophia Victoria, David Todd II 

David Stewart

ExamWise®

Volume 1 CFA 2008 Level I Certification

With Preliminary Reading Assignments The Candidates Question And Answer Workbook

For Chartered Financial Analyst

BY

Authors Jane Vessey, CFA

M Afdal Pamilih, CFA David Stewart

Jane Vessey

Jane  Vessey  manages  a  training  company  in  the  United  Kingdom  specializing  in  financial  analysis and  investment.    She  is  a  visiting  lecturer  at  Cass  Business  School  teaching  classes  in  asset management and valuation. She also teaches a CFA®  revision course at ISMA (the business school at Reading  University)  and  is  an  associate  at  a  leading  London  financial  training  company  where  she teaches  courses  covering  investment  management  and  related  topics.    She  has  developed  online training programs for students taking the CFA examinations and teaches CFA courses for UKSIP (the 

UK Society of Investment Professionals).  

Jane  graduated  in  Mathematics  from  Oxford  University,  United  Kingdom,  and  is  a  CFA  charter holder.  She has some eighteen years experience working in the investment industry,  starting out as 

an equity analyst before becoming an investment manager.  She was based in London and Tokyo and took responsibility for managing equity portfolios invested in the Japanese and other Asian markets. 

M Afdal Pamilih

Afdal  has  18  yearsʹ  experience  working  in  the  finance  industry.  He  started  his  career  with  J.P. Morgan,  and  then  with  County  NatWest  Government  Securities,  in  New  York  specializing  in  the development  of  quantitative  products  for  foreign  exchange  and  fixed  income  markets.  After returning  to  Indonesia  in  1989  he  was  responsible  for  the  development  of  investment  services  and subsequently treasury management for leading banks in Jakarta.  

Afdal has developed web‐based training programs for the CFA examinations and has wide teaching experience,    including  instructing  at  the  School  of  Management,  University  of  Surrey,  United Kingdom. 

He  obtained  a  MSc  in  Mathematics  from  the  University  of  Texas  at  Arlington  and  holds  the Chartered Financial Analyst (ʺCFAʺ) qualification. 

David  has  collaborated  with  experts  in  the  field  to  produce  the  2001  through  2006  editions  of  this study guide. His extensive research into the CFA exam program and past exam histories, field work, and  consistent  review  of  CFA  Institute  information  allows  him  and  his  co‐authors  to  deliver  high quality and up to date information. 

About the Book:

ExamWise  Volume  1  For  CFA  Level  I  Concept  Check  Q&A  Workbook  With  Preliminary  Reading Assignments is designed to give you plenty of practice questions to test your readiness for the CFA exam.  It  offers  400+  concept  check  questions  based  18  exam  study  sessions  that  cover  the  Learning Outcome Statements and their associated CFA Assigned Readings. For additional practice, there is an accompanying free download test engine that generates multiple mock exams similar in design and difficulty to the real CFA exam. The questions and explanations have references to the page number 

in the related Reading and to the related LOS. 

Use this workbook to test your understanding of the basic concepts covered in the CFA Readings and identify your strengths and weaknesses. Then you can move on to more advanced study materials to sharpen your weakest knowledge areas.  

This book is divided into Study Sessions (1 – 18) that cover the 76 Learning Outcome Statements and the  associated  Assigned  Readings.  Appendix  A  (Exhibits  1  –  4),  is  a  collection  of  exhibits  and  flow charts  for  condensed  reference  and  review,  including  examples  of  accounting  statements,  puts  and calls, PE breakdown, and financial ratios.   

The 18 2008 CFA Level I Study Sessions breakout is as follows:

Ethical and Professional Standards

Online Information:

1 What is CFA Institute

http://www.cfainstitute.org/aboutus/index.html

2 CFA Program: http://www.cfainstitute.org/cfaprogram

3 The Code of Ethics (Full Text) http://www.cfainstitute.org/centre/ethics/code/

The Standards of Professional Conduct

Standard I: Fundamental Responsibilities

Standard II: Relationships with and Responsibilities to the Profession

Standard III: Relationships with and Responsibilities to the Employer

Standard IV: Relationships with and Responsibilities to Clients and Prospects

Standard V: Relationships with and Responsibilities to the Public

4 Why The CFA Designation Matters to You: Individual Investor FAQ

http://www.cfainstitute.org/aboutus/investors/articles/cfamatters.html

5 Soft Dollar Standards http://www.cfainstitute.org/centre/ethics/softdollar/

6 CFA Institute-PPSTM AIMR Performance Presentation Standards

http://www.cfapubs.org/doi/ref/10.2469/faj.v57.n2.2433

7 Global Investment Performance Standards http://www.cfainstitute.org/centre/ips/

Click the picture and link to a free CFA Candidates online glossary

List of Chapters

Study Session 01: Ethical and Professional Standards: 14 Study session 02: Quantitative Methods: 34 Study Session 03: Quantitative Methods: 60

Study Session 07: Financial Statement Analysis: 198 Study Session 08: Financial Statement Analysis: 222 Study Session 09: Financial Statement Analysis: 248 Study Session 10: Financial Statement Analysis: 274

Study Session 12: Portfolio Management: 330 Study Session 13: Equity Investments: 354 Study Session 14: Equity Investments: 378 Study Session 15: Fixed Income Investments: 402 Study Session 16: Fixed Income Investments: 426 Study Session 17: Derivative Investments: 450 Study Session 18: Alternative Investments: 474

Table of Contents

About the Book: VI Online Information: VII

Study Session 01: Ethical and Professional Standards: 14

Reading 1: Code of Ethics and Standards of Professional Conduct 14

Reading 2: “Guidance” for Standards I–VII 14

Reading 3: Introduction to the Global Investment Performance Standards (GIPS) 14

Reading 4: Global Investment Performance Standards (GIPS) 14

Study session 02: Quantitative Methods: 34 Basic Concepts 34

Reading 5: The Time Value of Money 34

Reading 6: Discounted Cash Flow Applications 34

Reading 7: Statistical Concepts and Market Returns 34

Reading 8: Probability Concepts 34

Study Session 03: Quantitative Methods: 60 Application 60

Reading 9: Common Probability Distributions 60

Reading 10: Sampling and Estimation 60

Reading 11: Hypothesis Testing 60

Reading 12: Technical Analysis 60

Study Session 4: Introduction 84 Introductory Readings 84

Supply, Demand, and the Market Process CH 5 84

Introduction 84

Consumer choice and the Law of Demand 85

Producer choice and the Law of Supply 85

Price changes and demand and supply 86

Shifts in demand 87

Shifts in supply 88

Impact of changes in demand and supply 88

Supply and Demand: Applications and Extensions CH 4 90

Introduction 90

Resources 90

Elasticity and the incidence of tax 91

Taking the Nation’s Economic Pulse CH 7 92

Introduction 92

Gross domestic product 92

Working with Our Basic Aggregate Demand/ Aggregate Supply Model CH 10 96

Introduction 96

Aggregate demand 96

Keynesian Foundations of Modern Macroeconomics CH 11 100

Introduction 100

Keynesian economics 100

Introductory Readings Concept Check Questions 104

Introductory Readings Concept Check Answers 108

Study Session 04: Economics: 112 Microeconomic Analysis 112

Reading 13: Elasticity 112

Reading 14: Efficiency and Equity 112

Reading 15: Markets in Action 112

Reading 16: Organizing Production 112

Reading 17: Output and Costs 112

Study Session 05: Economics: 136 Market Structure and Macroeconomic Analysis 136

Reading 18: Perfect Competition 136

Reading 19: Monopoly 136

Reading 20: Monopolistic Competition and Oligopoly 136

Reading 21: Demand and Supply in Factor Markets 136

Reading 22: Monitoring Cycles, Jobs, and the Price Level 136

Reading 23: Aggregate Supply and Aggregate Demand 136

Study Session 06: Economics: 160 Monetary and Fiscal Economics 160

Reading 24: Money, Banks, and the Federal Reserve 160

Reading 25: Money, Interest, Real GDP, and the Price Level 160

Reading 26: Inflation 160

Reading 27: Fiscal Policy 160

Reading 28: Monetary Policy 160

Accounting methods 184

Financial Reporting and Analysis 185

Introduction 185

Balance Sheet 185

Income statement 186

Inventories 187

Introduction 187

Inventory 187

Inventory cost 187

Effect of inventory accounting method 188

Current Liabilities and the Time Value of Money 190

Introduction 190

Liabilities 190

Contributed Capital 191

Introduction 191

Contributed capital 191

Accounting for dividends 191

Common stock 191

Preferred stock 191

Stock issuance 192

Treasury stock 192

The Corporate Income Statement and the Statement of Stockholders’ Equity 192

Introduction 192

Retained earnings 192

Accounting for stock dividends and stock splits 192

Introduction Concept Check Questions 193

Introduction Concept Check Answers 195

Study Session 07: Financial Statement Analysis: 198 An Introduction 198

Reading 29: Financial Statement Analysis: An Introduction 198

Reading 30: Financial Reporting Mechanics 198

Reading 31: Financial Reporting Standards 198

Study Session 08: Financial Statement Analysis: 222 The Income Statement, Balance Sheet, and Cash Flow Statement 222

Reading 32: Understanding the Income Statement 222

Reading 33: Understanding the Balance Sheet 222

Reading 34: Understanding the Cash Flow Statement 222

Study Session 09: Financial Statement Analysis: 248 Inventories, Long-Term Assets, Deferred Taxes, and On- and Off-Balance Sheet Debt 248

Reading 35: Analysis of Inventories 248

Reading 36: Analysis of Long-Lived Assets: 248

Part I—The Capitalization Decision 248

Reading 37: Analysis of Long-Lived Assets: 248

Part II—Analysis of Depreciation and Impairment 248

Reading 38: Analysis of Income Taxes 248

Reading 39: Analysis of Financing Liabilities 248

Reading 40: Leases and Off-Balance-Sheet Debt 248

Study Session 10: Financial Statement Analysis: 274 Techniques, Applications, and International Standards Convergence 274

Reading 41: Financial Analysis Techniques 274

Reading 42: Financial Statement Analysis: Applications 274

Reading 43: International Standards Convergence 274

Study Session 11: Corporate Finance: 300 Reading 44: Capital Budgeting 300

Reading 45: Cost of Capital 300

Reading 46: Working Capital Management 300

Reading 47: Financial Statement Analysis 300

Reading 48: The Corporate Governance of Listed Companies: 300

A Manual for Investors 300

Study Session 12: Portfolio Management: 330 Reading 49: The Asset Allocation Decision 330

Reading 50: An Introduction to Portfolio Management 330

Reading 51: An Introduction to Asset Pricing Models 330

Study Session 13: Equity Investments: 354 Securities Markets 354

Reading 52: Organization and Functioning of Securities Markets 354

Reading 53: Security-Market Indexes 354

Reading 54: Efficient Capital Markets 354

Reading 57: Industry Analysis 378

Reading 58: Equity: Concepts and Techniques 378

Reading 59: Company Analysis and Stock Valuation 378

Reading 60: An Introduction to Security Valuation: Part II 378

Reading 61: Introduction to Price Multiples 378

Study Session 15: Fixed Income Investments: 402 Basic Concepts 402

Reading 62: Features of Debt Securities 402

Reading 63: Risks Associated with Investing in Bonds 402

Reading 64: Overview of Bond Sectors and Instruments 402

Reading 65: Understanding Yield Spreads 402

Reading 66: Monetary Policy in an Environment of Global Financial Markets 402

Study Session 16: Fixed Income Investments: 426 Analysis and Valuation 426

Reading 67: Introduction to the Valuation of Debt Securities 426

Reading 68: Yield Measures, Spot Rates, and Forward Rates 426

Reading 69: Introduction to the Measurement of Interest Rate Risk 426

Study Session 17: Derivative Investments: 450 Reading 70: Derivative Markets and Instruments 450

Reading 71: Forward Markets and Contracts 450

Reading 72: Futures Markets and Contracts 450

Reading 73: Option Markets and Contracts 450

Reading 74: Swap Markets and Contracts 450

Reading 75: Risk Management Applications of Option Strategies 450

Study Session 18: Alternative Investments: 474 Reading 76: Alternative Investments 474

Study Session 01: Ethical and Professional

Standards:

The  readings  in  this  study  session  present  a  framework  for  ethical  conduct  in  the  investment profession by focusing on the CFA Institute Code of Ethics and Standards of Professional Conduct as well as the Global Investment Performance Standards (GIPS®). 

The principles and guidance presented in the CFA Institute Standards of Practice Handbook (SOPH) form  the  basis  for  the  CFA  Institute  self‐regulatory  program  to  maintain  the  highest  professional standards  among  investment  practitioners.  “Guidance”  in  the  SOPH  addresses  the  practical application of the Code of Ethics and Standards of Professional Conduct. The guidance reviews the purpose  and  scope  of  each  standard,  presents  recommended  procedures  for  compliance,  and provides examples of the standard in practice. 

The  Global  Investment  Performance  Standards  (GIPS)  facilitate  efficient  comparison  of  investment performance  across  investment  managers  and  country  borders  by  prescribing  methodology  and standards  that  are  consistent  with  a  clear  and  honest  presentation  of  returns.  Having  a  global standard for reporting investment performance minimizes the potential for ambiguous or misleading presentations. 

Reading 1: Code of Ethics and Standards of Professional Conduct 

Reading 2: “Guidance” for Standards I–VII 

Reading 3: Introduction to the Global Investment Performance Standards (GIPS)  Reading 4: Global Investment Performance Standards (GIPS) 

1.  Jason Vasco, CFA, is the director for a major Talia‐owned investment management firm branch in Rasen. Talia is known as the world’s centre of investment management with securities laws stricter than  the  CFA  Institute  Code  and  Standards,  and  Vasco  is  governed  by  Talia’s  laws.  In  Rasen,  an emerging  market,  the  local  securities  laws  and  regulations  are  lenient.  They  are  very  vague  in  the definition of insider trading and have no provision regulating soft‐dollars. Which of the following is most accurate? 

A.  Vasco must comply with Talia’s law.  

B.  Vasco only has to comply with Rasen’s law and therefore can take the fullest advantage 

of soft‐dollar arrangements. 

C.  Vasco should not worry about Rasen’s law, it is an early stage emerging market and the law enforcement will be lax, if any at all. 

D.  As a CFA Institute member, Vasco must only comply with the Code and Standards regarding insider trading and soft‐dollar arrangements. 

2.  As an expression of gratitude, Tracy Blanc, CFA, a portfolio manager, is invited to spend a three‐week vacation valued at $10,000 with her spouse in a luxurious resort owned by a wealthy private client after she skillfully protected the value of the client’s capital during a severe market downturn. The private client is a fee‐paying client of Blanc’s firm. According to Standard IV(B) – Disclosure of Additional Compensation Arrangements: 

A.  Blanc must refuse the invitation as it may jeopardize her investment judgment. 

B.  Blanc is recommended to donate the monetary value of the vacation to a charity of her choice. 

C.  Blanc may accept such an invitation as long as she reports it in writing to her employer and gains their approval. 

D.  Blanc may accept the invitation if she reports it in writing to CFA Institute citing the full monetary value of the vacation. 

1.  Jason Vasco, CFA, is the director for a major Talia‐owned investment management firm branch in Rasen. Talia is known as the world’s centre of investment management with securities laws stricter than  the  CFA  Institute  Code  and  Standards,  and  Vasco  is  governed  by  Talia’s  laws.  In  Rasen,  an emerging  market,  the  local  securities  laws  and  regulations  are  lenient.  They  are  very  vague  in  the definition of insider trading and have no provision regulating soft‐dollars. Which of the following is most accurate? 

A Vasco must comply with Talia’s law

B Vasco only has to comply with Rasen’s law and therefore can take the fullest advantage of dollar arrangements

soft-C Vasco should not worry about Rasen’s law, it is an early stage emerging market and the law

enforcement will be lax, if any at all

D As a CFA Institute member, Vasco must only comply with the Code and Standards regarding insider trading and soft-dollar arrangements

Correct Answer:  A  LOS: Reading 2‐b 

Standard I (A) stipulates that in foreign jurisdictions members must comply with the stricter of the applicable laws and the Code of Standards, in this case Talia’s law is the strictest

Reference: CFA® Program Curriculum, Volume 1, pp. 15‐17. 

2.  As an expression of gratitude, Tracy Blanc, CFA, a portfolio manager, is invited to spend a three‐week vacation valued at $10,000 with her spouse in a luxurious resort owned by a wealthy private client after she skillfully protected the value of the client’s capital during a severe market downturn. The private client is a fee‐paying client of Blanc’s firm. According to Standard IV(B) – Disclosure of Additional Compensation Arrangements: 

A Blanc must refuse the invitation as it may jeopardize her investment judgment

B Blanc is recommended to donate the monetary value of the vacation to a charity of her choice

C Blanc may accept such an invitation as long as she reports it in writing to her employer and gains their approval

D Blanc may accept the invitation if she reports it in writing to CFA Institute citing the full monetary value of the vacation

3.  Kevin  Dudman,  CFA,  has  just  been  offered  an  exciting  new  position  with  Walton  Asset Management and decides that he will resign from his current position with Trust Asset Management. Before he resigns he decides to ensure that he uses some of the skills and materials he has developed 

A must file a report with the SEC

B must sell the shares immediately

C must disclose the ownership of the shares by a member of his immediate family

D does not need to disclose the fact that his son owns the shares of Bourgogne Vineyard Corporation

3.  Kevin  Dudman,  CFA,  has  just  been  offered  an  exciting  new  position  with  Walton  Asset Management and decides that he will resign from his current position with Trust Asset Management. Before he resigns he decides to ensure that he uses some of the skills and materials he has developed 

at Trust Asset Management. He is least likely to violate the Code and Standards, if he takes:  

A stock market analysis prepared by Dudman when he was working at Trust Asset Management

B internal contact information on Trust Asset Management‘s major clients which is available from other eternal sources

C computer models developed to identify mispriced securities developed by Dudman and a colleague

at Trust Asset Management

D experience in pricing unlisted securities which he gained while attending training courses which were paid for by Trust Asset Management

Correct Answer:  D LOS: Reading  2‐b 

Models and research which he worked on when employed by Trust Asset Management belong to Trust Asset Management Client contact details should not be taken from his employer, although he is not prohibited from collecting client information from outside sources However skills and experience gained

at Trust Asset Management can be used in his new job, so D is the correct answer

A must file a report with the SEC

B must sell the shares immediately

C must disclose the ownership of the shares by a member of his immediate family

D does not need to disclose the fact that his son owns the shares of Bourgogne Vineyard Corporation

Correct Answer:  D LOS: Reading  2‐b 

The share ownership is not likely to be material and therefore will not reasonably affect Morgon’s ability to make unbiased and objective recommendation according to Standard VI(A) Disclosure of Conflicts

5.  Wimpy  Greenback,  CFA,  is  the  research  analyst  responsible  for  following  Brown  Appliances Company.  This  analysis  suggests  the  stock  should be  rated  a  “sell”  because  the  market  outlook  for the firm’s new products is bleak compared with that of the closest competition. Greenback lives on the  same  street  as  the  CFO  of  Brown  Appliances.  During  a  recent  neighborhood  gathering, Greenback’s wife overheard the wife of the Chief Financial Officer of Brown Appliances complaining that  her  husband  had  been  working  late  due  to  a  hostile  takeover  threat  from  a  foreign  appliances group.  This  fact  has  not  yet  been  made  public  by  Brown  Appliances.  Upon  returning  to  his  office, Greenback  released  a  strong  “buy”  recommendation  to  the  public  based  on  this  new  information. Greenback: 

A.  was in full compliance with the Code and Standards. 

B.  did not violate the Code and Standards because he used mosaic theory to arrive at his recommendation. 

C.  violated the Code and Standards by failing to distinguish between facts and opinions in his recommendation. 

D.  violated the Code and Standards because he did not have a reasonable and adequate basis for his recommendation. 

5.  Wimpy  Greenback,  CFA,  is  the  research  analyst  responsible  for  following  Brown  Appliances Company.  This  analysis  suggests  the  stock  should be  rated  a  “sell”  because  the  market  outlook  for the firm’s new products is bleak compared with that of the closest competition. Greenback lives on the  same  street  as  the  CFO  of  Brown  Appliances.  During  a  recent  neighborhood  gathering, Greenback’s wife overheard the wife of the Chief Financial Officer of Brown Appliances complaining that  her  husband  had  been  working  late  due  to  a  hostile  takeover  threat  from  a  foreign  appliances group.  This  fact  has  not  yet  been  made  public  by  Brown  Appliances.  Upon  returning  to  his  office, Greenback  released  a  strong  “buy”  recommendation  to  the  public  based  on  this  new  information. Greenback: 

A was in full compliance with the Code and Standards

B did not violate the Code and Standards because he used mosaic theory to arrive at his

Reference: CFA® Program Curriculum, Volume 1, pp. 80‐84. 

6.  The fixed‐income corporate finance department of Golden Brothers, an investment banking firm, has  decided  to  compete  for  the  advisory  and  underwriting  bond  offering  of  Kia  Telcom,  a  ‘hot’ telecommunications  company.  The  firm’s  equity  brokerage  unit  is  about  to  publish  a  “sell” recommendation on Kia Telcom due to an unexpected announcement of cost overruns. The head of fixed‐income  investment  banking  has  asked  the  head  of  the  equity  brokerage  unit  to  change  the recommendation from “sell” to “buy” before distributing the research report to clients. According to the Code and Standards, the best course of action for the equity brokerage unit is to: 

D.  increase the rating by no more than one increment (in this case, to a “hold” 

recommendation) since little harm is done by being a bit more positive, while the firm’s overall interest is served. 

7.  Fiona Griffiths, CFA, is an equity sales manager at a London‐based Tiger Securities branch in an emerging market. Initial public offerings are often oversubscribed making it difficult to ensure a fair allocation.  Griffiths  understands  the  local  environment  so  she  is  able  to  influence  the  allocation process so that she can personally subscribe to the maximum she can afford and then allocate the rest 

to her clients. Her clients never complain because they have almost always profited from investing in the  emerging  market  over  the  last  couple  of  years.  Which  of  the  following  describes  Griffiths’ situation? 

A Griffiths is in compliance with the Code and Standards since her clients are satisfied

B Griffiths violates the Code and Standards due to the priority she gives to transactions

C Griffiths violates the Code and Standards since she lacks independence and objectivity

D Griffiths violates the Code and Standards since she does not maintain client, confidentiality

6.  The fixed‐income corporate finance department of Golden Brothers, an investment banking firm, has  decided  to  compete  for  the  advisory  and  underwriting  bond  offering  of  Kia  Telcom,  a  ‘hot’ telecommunications  company.  The  firm’s  equity  brokerage  unit  is  about  to  publish  a  “sell” recommendation on Kia Telcom due to an unexpected announcement of cost overruns. The head of fixed‐income  investment  banking  has  asked  the  head  of  the  equity  brokerage  unit  to  change  the recommendation from “sell” to “buy” before distributing the research report to clients. According to the Code and Standards, the best course of action for the equity brokerage unit is to: 

A place Kia Telcom on a restricted list and publish only factual information about the company

B immediately re-rate the stock to a “buy” since the firm’s overall interest supersedes that of the client

C assign a more senior analyst to decide if the stock deserves a higher rating for the sake of objectivity since less senior analysts may err in judgment

D increase the rating by no more than one increment (in this case, to a “hold” recommendation) since little harm is done by being a bit more positive, while the firm’s overall interest is served

Correct Answer:  A LOS: Reading  2‐a 

In this case, any action to accommodate the interest of the investment banking department that may compromise the independence and objectivity of the brokerage research efforts can violate Standard I(B) and the Code of Ethics

Reference: CFA® Program Curriculum, Volume 1, pp. 21‐25. 

7.  Fiona Griffiths, CFA, is an equity sales manager at a London‐based Tiger Securities branch in an emerging market. Initial public offerings are often oversubscribed making it difficult to ensure a fair allocation.  Griffiths  understands  the  local  environment  so  she  is  able  to  influence  the  allocation process so that she can personally subscribe to the maximum she can afford and then allocate the rest 

to her clients. Her clients never complain because they have almost always profited from investing in the  emerging  market  over  the  last  couple  of  years.  Which  of  the  following  describes  Griffiths’ situation? 

A Griffiths is in compliance with the Code and Standards since her clients are satisfied

B Griffiths violates the Code and Standards due to the priority she gives to transactions

C Griffiths violates the Code and Standards since she lacks independence and objectivity

D Griffiths violates the Code and Standards since she does not maintain client, confidentiality

8.  Victoria  Anderson,  CFA,  works  for  Pluto  Capital,  a  newly  established  investment  counseling firm.  The  founding  partners  of  Pluto  Capital  came  from  Vulcan  Investments  which  was  recently taken over by a large financial services group. Jonathan Beecham, a prospective client of the firm, is meeting with Anderson for the first time. Beecham has been a client of Vulcan Investments for years, but is now considering switching his account to Pluto Capital because he has been disappointed by Vulcan’s  underperformance  following  the  takeover.  At  the  beginning  of  their  meeting,  Anderson sympathized  with  his  situation,  then  immediately  explains  to  Beecham  that  she  has  discovered  a highly undervalued stock that offers large potential gains. Anderson then promises Beecham that she can  buy  the  stock  for  his  account  at  the  current  price  if  he  switches  the  account  within  48  hours. Anderson’s  actions  violated  the  Code  and  Standards.  Which  of  the  following  statements  best describes the action Anderson should have taken? Anderson should have: 

A.  elaborated on the technical features of Pluto’s standard valuation method used to 

identify the undervaluation. 

B.  avoided the meeting with Beecham in the first place because the founding partners of Pluto came from Vulcan. 

C.  given Beecham a longer time period to take advantage of the offer price when switching his account to Pluto. 

D.  determined Beecham’s investment needs, objectives, and tolerance for risk before making any investment recommendation. 

8.  Victoria  Anderson,  CFA,  works  for  Pluto  Capital,  a  newly  established  investment  counseling firm.  The  founding  partners  of  Pluto  Capital  came  from  Vulcan  Investments  which  was  recently taken over by a large financial services group. Jonathan Beecham, a prospective client of the firm, is meeting with Anderson for the first time. Beecham has been a client of Vulcan Investments for years, but is now considering switching his account to Pluto Capital because he has been disappointed by Vulcan’s  underperformance  following  the  takeover.  At  the  beginning  of  their  meeting,  Anderson sympathized  with  his  situation,  then  immediately  explains  to  Beecham  that  she  has  discovered  a highly undervalued stock that offers large potential gains. Anderson then promises Beecham that she can  buy  the  stock  for  his  account  at  the  current  price  if  he  switches  the  account  within  48  hours. Anderson’s  actions  violated  the  Code  and  Standards.  Which  of  the  following  statements  best describes the action Anderson should have taken? Anderson should have: 

A elaborated on the technical features of Pluto’s standard valuation method used to identify the undervaluation

B avoided the meeting with Beecham in the first place because the founding partners of Pluto came from Vulcan

C given Beecham a longer time period to take advantage of the offer price when switching his account

to Pluto

D determined Beecham’s investment needs, objectives, and tolerance for risk before making any investment recommendation

Correct Answer:  D LOS: Reading  2‐b 

Prior to recommending any investments, Anderson should determine Beecham's investment needs,

objectives, and tolerance for risk as stated in Standard III(C) Suitability

Reference: CFA® Program Curriculum, Volume 1, pp. 60‐64. 

9.  Ken  Janzen,  CFA,  is  an  economist  at  a  large  bank  and  he  has  never  made  direct  investment decisions.  Jenzen  is  the  latest  winner  of  a  well‐publicized  portfolio  management  competition  in  a national newspaper. On the recommendation of his friends, he is launching an investment fund. In the prospectus he tells the prospective clients, “The fund has no long‐term track record as yet, but the investment  manager  has  shown  considerable  skills  in  managing  hypothetical  portfolios.  In  a competition  the  manager  has  demonstrated  a  portfolio  total  return  above  26  percent  per  year annualized, and that is more than 12 percent above the benchmark for the same period.” He managed 

to  raise  a  significant  amount  of  money  from  retail  investors  who  are  interested  in  investing  in  the fund. Has Janzen violated the Code and Standards? 

A.  Yes, because the statement misrepresents Janzen’s track record. 

B.  Yes, because he cannot quote performance for a hypothetical portfolio.  

C.  Yes, because the statement about return ignores the risk preferences of his clients. 

D.  No, because the statement is a true and accurate description of Janzen’s track record. 

9.  Ken  Janzen,  CFA,  is  an  economist  at  a  large  bank  and  he  has  never  made  direct  investment decisions.  Jenzen  is  the  latest  winner  of  a  well‐publicized  portfolio  management  competition  in  a national newspaper. On the recommendation of his friends, he is launching an investment fund. In the prospectus he tells the prospective clients, “The fund has no long‐term track record as yet, but the investment  manager  has  shown  considerable  skills  in  managing  hypothetical  portfolios.  In  a competition  the  manager  has  demonstrated  a  portfolio  total  return  above  26  percent  per  year annualized, and that is more than 12 percent above the benchmark for the same period.” He managed 

to  raise  a  significant  amount  of  money  from  retail  investors  who  are  interested  in  investing  in  the fund. Has Janzen violated the Code and Standards? 

A Yes, because the statement misrepresents Janzen’s track record

B Yes, because he cannot quote performance for a hypothetical portfolio

C Yes, because the statement about return ignores the risk preferences of his clients

D No, because the statement is a true and accurate description of Janzen’s track record

Reference: CFA® Program Curriculum, Volume 1, pp. 64‐67. 

10.  Martha  Pierpont,  CFA,  works  for  the  securities  custody  department  of  North  Pole  Trust  Bank. She  makes  a  reciprocal  referral  fee  arrangement  with  Robert  Underhill,  CFA,  an  adviser  at BestAdvice.com.  She  does  not  disclose  the  referral  arrangement  but  Underhill  does  so  by  inserting one clause in BestAdvice.com’s investment advisory agreement that includes “… from time to time referral fees may be arranged with a number of selected securities custodians.” Clients of BestAdvice regularly use North Pole’s services and pay referral fees. Which of the following is most accurate? 

A.  to avoid a conflict of interest.  

B.  to maintain independence and objectivity. 

C.  to make a fair statement of investment performance. 

D.  to exercise due diligence and thoroughness in making an investment recommendation. 

10.  Martha  Pierpont,  CFA,  works  for  the  securities  custody  department  of  North  Pole  Trust  Bank. She  makes  a  reciprocal  referral  fee  arrangement  with  Robert  Underhill,  CFA,  an  adviser  at BestAdvice.com.  She  does  not  disclose  the  referral  arrangement  but  Underhill  does  so  by  inserting one clause in BestAdvice.com’s investment advisory agreement that includes “… from time to time referral fees may be arranged with a number of selected securities custodians.” Clients of BestAdvice regularly use North Pole’s services and pay referral fees. Which of the following is most accurate? 

A Only Pierpont complies with the Code and Standards

B Only Underhill complies with the Code and Standards

C Both Pierpont and Underhill comply with the Code and Standards

D Neither Pierpont nor Underhill comply with the Code and Standards

Correct Answer:  D LOS: Reading  2‐b 

The best choice is D since any referral fee arrangement that a client ultimately pays must be disclosed in terms of the nature of the consideration or the benefit together with the estimated monetary value, by both the payer and recipient of the fee See Standard VI (C) Referral Fees

Reference: CFA® Program Curriculum, Volume 1, pp. 99‐101. 

11.  Charles Chaplane, who is not a member of CFA Institute, is a senior partner of a small brokerage firm,  Blue  Moon  Securities,  which  recently  participated  in  a  large  stock  offering.  The  offering company has been given an unfavorable recommendation by his research department in the past two quarters  due  to  lacklustre  performance.  Chaplane  immediately  calls  his  junior  analyst  John Blumenberg, CFA, and instructs him to upgrade his recommendation. Blumenberg comes up with a more  favorable  recommendation  within  a  short  period  of  time.  Blumenberg  is  least  likely  to  have violated the Standards because he failed: 

A to avoid a conflict of interest

B to maintain independence and objectivity

C to make a fair statement of investment performance

D to exercise due diligence and thoroughness in making an investment recommendation

12.  Patricia  Lualua,  CFA,  is  a  portfolio  manager  of  Raven  Asset  Management.  Recently  she  won  a mandate  from  the  Flemish  Widows  pension  fund  trustees  to  manage  the  investments  of  the  fund. One  of  the  Flemish  Widows  trustees  privately  mentions  that  Lualua  should  direct  her  trades  to Churner Securities, which is owned by a relative of one of the trustees. Lualua, for fear of losing the account, directs 50% of the trades to Churner Securities. She is pleased to find that Churner’s quality 

of  execution  is  good  and  the  emerging  market  research  quality  is  excellent.  Although  Flemish Widows does not invest in emerging markets, Lualua finds the research useful for the other funds she manages.  Lualua decides not  to  inform  anyone regarding  the situation.  According  to  the  Code  and Standards: 

A.  Lualua should stop trading with Churner Securities. 

B.  Lualua may continue trading with Churners Securities. 

C.  Lualua should disclose this arrangement to Flemish Widows. 

D.  Lualua should disclose this arrangement to the CFA Institute. 

12.  Patricia  Lualua,  CFA,  is  a  portfolio  manager  of  Raven  Asset  Management.  Recently  she  won  a mandate  from  the  Flemish  Widows  pension  fund  trustees  to  manage  the  investments  of  the  fund. One  of  the  Flemish  Widows  trustees  privately  mentions  that  Lualua  should  direct  her  trades  to Churner Securities, which is owned by a relative of one of the trustees. Lualua, for fear of losing the account, directs 50% of the trades to Churner Securities. She is pleased to find that Churner’s quality 

of  execution  is  good  and  the  emerging  market  research  quality  is  excellent.  Although  Flemish Widows does not invest in emerging markets, Lualua finds the research useful for the other funds she manages.  Lualua decides not  to  inform  anyone regarding  the situation.  According  to  the  Code  and Standards: 

A Lualua should stop trading with Churner Securities

B Lualua may continue trading with Churners Securities

C Lualua should disclose this arrangement to Flemish Widows

D Lualua should disclose this arrangement to the CFA Institute

13.  Carlina Paparazzi, a fund manager with Abbotswood Advisors, has just been given the authority 

to manage a newly acquired client which has a retirement benefit plan, when she realizes that a US Government Bond belonging to the account matures the next day. The bond comprises 5% of the total assets.  Abbotswood  Advisors  is  still  in  the  midst  of  a  discussion  with  the  client  regarding  the formulation of a new investment policy and portfolio objectives. Looking at what the current market has  to  offer,  there  are  a  number  of  attractive  opportunities.  One  opportunity  that  stands  out  is  a corporate bond of a major oil company that went out of favor due to an environmental accident that occurred the week before. She has followed the oil company for a number of years and knows that its fundamentals are sound. The prospect of an improved credit rating in the next six months is not yet reflected in the current price. Her supervisor asks Paparazzi to invest the proceeds in the corporate bond. Paparazzi prefers however to invest them in 3‐month Treasury Bills, albeit with a much lower yield, until the new investment policy and objectives are formulated. What is the best course of action for Paparazzi? 

A.  Invest in the Treasury Bills until the new investment policy and objectives are 

established. 

B.  Split the investment between the corporate bond and the Treasury Bills to diversify the risk. 

C.  Revert to the client for a decision and do nothing until the client’s direction is received.  

D.  Follow her supervisor’s direction as the corporate bond opportunity will benefit the overall performance of the fund. 

13.  Carlina Paparazzi, a fund manager with Abbotswood Advisors, has just been given the authority 

to manage a newly acquired client which has a retirement benefit plan, when she realizes that a US Government Bond belonging to the account matures the next day. The bond comprises 5% of the total assets.  Abbotswood  Advisors  is  still  in  the  midst  of  a  discussion  with  the  client  regarding  the formulation of a new investment policy and portfolio objectives. Looking at what the current market has  to  offer,  there  are  a  number  of  attractive  opportunities.  One  opportunity  that  stands  out  is  a corporate bond of a major oil company that went out of favor due to an environmental accident that occurred the week before. She has followed the oil company for a number of years and knows that its fundamentals are sound. The prospect of an improved credit rating in the next six months is not yet reflected in the current price. Her supervisor asks Paparazzi to invest the proceeds in the corporate bond. Paparazzi prefers however to invest them in 3‐month Treasury Bills, albeit with a much lower yield, until the new investment policy and objectives are formulated. What is the best course of action for Paparazzi? 

A Invest in the Treasury Bills until the new investment policy and objectives are established

B Split the investment between the corporate bond and the Treasury Bills to diversify the risk

C Revert to the client for a decision and do nothing until the client’s direction is received

D Follow her supervisor’s direction as the corporate bond opportunity will benefit the overall

performance of the fund

Correct Answer:  A LOS: Reading  2‐b 

Regardless of whether it is the best investment decision, choices C or D will violate Standard III(C), Suitability, because the overall investment policy and objectives are not yet established Choice A is not correct because the client pays a fee to hire expertise in investment decision making So the best choice is

B, where the client’s interest is protected, as a Treasury Bill is a cash equivalent and is risk-free, as are the maturing Treasury Bonds

Reference: CFA® Program Curriculum, Volume 1, pp. 60‐64. 

14.  Muhammad  Taqdir,  CFA,  is  an  investment  manager  whose  clients  are  high‐net  worth individuals. Taqdir is a member of a local charity organization that supports children with asthma. During  a  meeting  at  the  charity,  Taqdir  recommends  that  the  organization  sends  a  letter  to  Xara Corporation  requesting  they  make  a  donation  to  the  charity.  Taqdir  knows  of  Xara  Corporation’s involvement  in  this  cause  from  previous  discussions  with  a  colleague  in  the  office.  The  chief executive  and  owner  of  Xara  Corporation  is  a  client  of  the  firm.  The  charity,  citing  Taqdir’s recommendation, sent the letter and received a substantial donation. According to the CFA Institute Code and Standards: 

A.  Taqdir has done his best since the organisation received a substantial donation. 

B.  Taqdir should not have disclosed the identity of the chief executive without his prior approval. 

C.  Taqdir should have informed the chief executive of Xara that he is going to receive a letter from the organization. 

D.  Taqdir should have requested the approval of his colleague before disclosing the name of the chief executive of Xara. 

14.  Muhammad  Taqdir,  CFA,  is  an  investment  manager  whose  clients  are  high‐net  worth individuals. Taqdir is a member of a local charity organization that supports children with asthma. During  a  meeting  at  the  charity,  Taqdir  recommends  that  the  organization  sends  a  letter  to  Xara Corporation  requesting  they  make  a  donation  to  the  charity.  Taqdir  knows  of  Xara  Corporation’s involvement  in  this  cause  from  previous  discussions  with  a  colleague  in  the  office.  The  chief executive  and  owner  of  Xara  Corporation  is  a  client  of  the  firm.  The  charity,  citing  Taqdir’s recommendation, sent the letter and received a substantial donation. According to the CFA Institute Code and Standards: 

A Taqdir has done his best since the organisation received a substantial donation

B Taqdir should not have disclosed the identity of the chief executive without his prior approval

C Taqdir should have informed the chief executive of Xara that he is going to receive a letter from the organization

D Taqdir should have requested the approval of his colleague before disclosing the name of the chief executive of Xara

Correct Answer:  B LOS: Reading  2‐b 

Regardless of the fact that that the organization finally received the substantial donation, Tariq has violated the preservation of confidentiality under Standard III(E), Preservation of Confidentiality, in disclosing the name of the chief executive and owner of Xara without prior knowledge of both the chief executive and his colleague

Reference: CFA® Program Curriculum, Volume 1, pp. 67‐69. 

15.  Marco  Maggio,  CFA,  is  scheduled  to  visit  the  corporate  headquarters  of  Venus  Industries. Maggio expects to use the information obtained there to complete his research report on Venus stock. The location of Venus Industries is within a 15‐minute drive of a prestigious golf course. On arrival at the Venus premises, Marco Maggio learns that Venus is offering Maggio an extension of his stay that weekend and invites him for a day of golf with all expenses paid. Venus Industries also offers to pay for all the expenses for the trip, including the cost of meals, hotel room, and air transportation back to Venus Industries. The total cost for the weekend is about $2,000. 

Which  of  the  following  actions  would  be  the  best  course  for  Maggio  to  take  under  the  Code  and Standards? 

A.  Pay for all travel expenses, including costs of meals and incidental items and politely reject the golf outing offer. 

B.  Reject the golf outing offer but accept the reimbursement of the travel expenses since they are legitimate business‐related expenses. 

C.  Accept both the expenses‐paid trip and the golf outing as more information can often be extracted from the company in a more leisurely environment. 

D.  Accept the expenses‐paid trip and disclose the value of the trip in the report, but it is at Maggio’s discretion to take the golf outing offer without disclosing it as it occurs outside working hours. 

15.  Marco  Maggio,  CFA,  is  scheduled  to  visit  the  corporate  headquarters  of  Venus  Industries. Maggio expects to use the information obtained there to complete his research report on Venus stock. The location of Venus Industries is within a 15‐minute drive of a prestigious golf course. On arrival at the Venus premises, Marco Maggio learns that Venus is offering Maggio an extension of his stay that weekend and invites him for a day of golf with all expenses paid. Venus Industries also offers to pay for all the expenses for the trip, including the cost of meals, hotel room, and air transportation back to Venus Industries. The total cost for the weekend is about $2,000. 

Which  of  the  following  actions  would  be  the  best  course  for  Maggio  to  take  under  the  Code  and Standards? 

A Pay for all travel expenses, including costs of meals and incidental items and politely reject the golf outing offer

B Reject the golf outing offer but accept the reimbursement of the travel expenses since they are legitimate business-related expenses

C Accept both the expenses-paid trip and the golf outing as more information can often be extracted from the company in a more leisurely environment

D Accept the expenses-paid trip and disclose the value of the trip in the report, but it is at Maggio’s discretion to take the golf outing offer without disclosing it as it occurs outside working hours

Correct Answer:  A LOS: Reading  2‐b 

Maggio risks violating Standard I(B) Independence and Objectivity because accepting any significant gift may impede his independence and objectivity He should pay, whenever possible, for his own travel expenses and not accept the golf outing

Reference: CFA® Program Curriculum, Volume 1, pp. 21‐29. 

16.  Simon Freud, CFA, is a private‐client investment manager at Super Echo investment firm based 

in  Vienna,  Austria.  One  of  his  clients  in  Monaco  offers  him  bonus  compensation  beyond  that provided  by  his  firm  if  the  portfolio  performance  exceeds  the  agreed  benchmark.  To  make  it  more attractive to Freud, his client will send the bonus compensation to a tax‐free account in a tax haven. Freud: 

A.  should report the situation to the compliance officer of the CFA Institute according to Standard I(B) Independence and Objectivity. 

B.  should turn down the additional compensation offer because it violates Standard IV(B) Additional Compensation Arrangements. 

C.  may accept the additional compensation subject to the approval of his employer as required by Standard IV(B) Additional Compensation Arrangements. 

D.  is free to accept the additional compensation in the tax‐free account, as long as the 

account is not under the jurisdiction of either Monaco or Austria, it will therefore also be outside the jurisdiction of the Code and Standards. 

16.  Simon Freud, CFA, is a private‐client investment manager at Super Echo investment firm based 

in  Vienna,  Austria.  One  of  his  clients  in  Monaco  offers  him  bonus  compensation  beyond  that provided  by  his  firm  if  the  portfolio  performance  exceeds  the  agreed  benchmark.  To  make  it  more attractive to Freud, his client will send the bonus compensation to a tax‐free account in a tax haven. Freud: 

A should report the situation to the compliance officer of the CFA Institute according to Standard I(B) Independence and Objectivity

B should turn down the additional compensation offer because it violates Standard IV(B) Additional Compensation Arrangements

C may accept the additional compensation subject to the approval of his employer as required by Standard IV(B) Additional Compensation Arrangements

D is free to accept the additional compensation in the tax-free account, as long as the account is not under the jurisdiction of either Monaco or Austria, it will therefore also be outside the jurisdiction of the Code and Standards

Correct Answer:  C LOS: Reading  2‐b 

Standard IV(B) Additional Compensation Arrangements does not prohibit the acceptance of additional compensation as long as approval from the employer is obtained The tax-free account is a separate issue and will have to be viewed in light of tax rules and regulations

Reference: CFA® Program Curriculum, Volume 1, pp. 75‐76.