2004 CFA level 2 mock exam

2014 CFA Level II “Free Cash Flow Valuation,” by Jerald Pinto, Elaine Henry, Thomas Robinson, and John Stowe Sections 1, 4.3 Answer for Equity - TCC 1.The comparable transactions method

Prepared for Jia Jia 4/5/2014

Answer for Alternative Investments – Mitchell

1.The value of the apartment building = net operating income / (discount rate – growth rate) 
 Value = $540,000 / (8% - 3%) = $10,800,000

6

A funds of funds tends to have lower survivor bias

Statement 1 is incorrect because funds of funds tend to have average

performance because of diversification among strategies and managers

Statement 3 is incorrect because funds of funds tend to have lower backfill bias

2014 Modular Level 2, Vol 3, Reading 26, Section 3.2

“Investing in Hedge Funds: A Survey,” Keith H Black

Section 11

Prepared for Jia Jia 4/5/2014

Answer for Corporate Finance – Kocher

1 According to best practices in corporate governance, Kocher can be

on the board of directors but should not be the chairman of the board of

directors Furthermore, whether the retiring CEO's membership on the

board is replaced with an independent or non-independent director is

irrelevant because the board will have at least 75% representation from

independent members in either case

2014 CFA Level II
 "Corporate Governance," by Rebecca Todd

McEnally and Kenneth Kim
 Sections 5.1.1, 5.1.2

2.Kocher is a member of the board of directors of HTF Making Herman a

board member at BKT creates an interlocking directorship, which makes

Herman a non-independent board member

2014 CFA Level II

"Corporate Governance," by Rebecca Todd McEnally and Kenneth

Kim
 Section 5.1.1

3.According to best practices in corporate governance, the audit and

nominating committees should be composed entirely of independent

board members Upon becoming CEO, Kocher is no longer considered

an independent board member

2014 CFA Level II

"Corporate Governance," by Rebecca Todd McEnally and Kenneth

Kim
 Sections 5.1.7, 5.1.8

4.The optimal capital structure will have the lowest weighted average

cost of capital (WACC) Using the data in Exhibit 1, the following can be

calculated:

Comparison of

the WACC

Financing Mix 1

Current Financing Mix

Financing Mix 2

“Capital Structure,” by Raj Aggarwal, Pamela Peterson Drake, Adam

Kobor, and Gregory Noronha 
 Section 2.7

5.Dividend payout ratio = dividends/net income

Dividend per share = dividends/8 million shares

Year

(1) Net Income

($ millions)

(2) Dividends ($ millions)

(2)/(1) Dividend Payout Ratio

(2)/8.00 (million shares) Dividend Per Share

In the table, the constant dividend payout ratio of 0.30 is evidence of a

constant dividend payout ratio policy It cannot be a stable dividend

policy because the dividend per share has not been constant, and it

cannot be a residual dividend policy because project investment had not

been considered prior to paying the dividend (a problem noted by

Kocher in 2009 and 2010)

2014 CFA Level II

“Dividends and Share Repurchases: Analysis,” by Gregory Noronha and

George H Troughton 
 Sections 4.1.1, 4.1.3

6.Total expected dividends paid = dividend × shares outstanding
 $0.50

× 8 million shares = $4.0 million

Expected earnings left for project investment (projected earnings minus

total expected dividends paid Note: This figure will be the expected

equity contribution toward project financing):
 $14.25 million - $4.0

million = $10.25 million

Expected amount of capital available for project investment:

Using the current financing mix of 50% debt and 50% equity:

2014 CFA Level II
 "Capital Structure," by Raj Aggarwal, Pamela

Peterson Drake, Adam Kobor, and Gregory Noronha
 Section 3.2

"Dividends and Share Repurchases: Analysis," by Gregory Noronha and George H Troughton
 Sections 4.1.1, 4.1.3

Answer for Corporate Finance – Scott

1.Economic income = Change in market value plus the after-tax cash flow

Market value = Present value of future expected after-tax cash flows Beginning market value, at beginning of Year 3 (assuming end-of-year cash flows):

Ending market value at the end of Year 3:

3.Ludlow's suggestion of considering alternate economic environments

is an example of scenario analysis

LCML: The least common multiple, given 3 and 5, is 15 Compare the NPV of each project, assuming each project is repeated for 15 years NPV (three-year project, 15 years):

NPV (five-year project, 15 years):

The three-year project is preferred because the NPV over 15 years is higher

2014 CFA Level II

"Capital Budgeting," by John D Stowe and Jacques R Gagne

Sections 7.1.1– 7.1.2

Prepared for Jia Jia 4/5/2014

Answer for Derivatives – Huang

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

V t = S t – 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

S0 = the spot price of the underlying

δc = the continuously compounded dividend yield

rc = the continuously compounded interest rate

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

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

r f

= 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)9 0/365

= JPY110.67/USD

Note that the continuous formula, F= S0er f T

e–rT, can be used Converting

the given rates to continuous rates gives r f

= ln(1.01) = 0.00995 and r =

ln(1.06) = 0.05827

F = 112e(90/36 5)(0.0099 5–0.05827) = JPY 110.67/USD

2014 CFA Level II

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

4.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

5.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

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

Answer for Derivatives – Speckley

1 The formula for the forward currency price is F(0,T) = [S0/(1 + r f

)T]  (1

+ r) T

where

F(0,T) = the forward price at time 0 for a delivery date at time T

(which is one year, or 1, in this case)

S0 = the spot exchange rate

r f

= the foreign interest rate

r = the domestic interest rate

In this item set, the domestic interest rate is the U.S rate

Using the information from Exhibit 2 gives the following:

S0 = the current price of the equity

PV(D,0,T) = the present value of the dividend stream across the life

of the forward contract

(T) FV(D,0,T) = the future value of the dividend stream across the

life of the contract

Given the information in the problem and in Exhibits 1 and 2, the

contract is for one-year (T = 1) and the dividend occurs in 180 days (½

year) Putting the numbers into the formula gives the following:

F(0,T) = {100 – [5/(1 + 0.03)0.5

]} × (1 + 0.03)

= [100 × (1 + 03)] – [5 × (1 + 03)0.5

] = $97.93

F(0,T) = the forward price at time 0 for a delivery date at time T

(which is one year, or 1, in this case)

S0 = the spot exchange rate

r f

= the foreign interest rate

r = the domestic interest rate

Thus, currency forward prices are determined by the current exchange rate, the current domestic and foreign interest rates, and the maturity of the contract but not expectations of future interest rates

F0(T) = the current price of the forward contract expiring at time T

S0 = the current spot exchange rate

r f

= the foreign interest rate

r = the domestic interest rate

or

When domestic interest rates (U.S rates in this item set) are lower than foreign interest rates, the forward exchange rate will be lower than the

spot exchange rate; this result is based on the assumption that the

exchange rate is quoted as the amount of domestic currency required to purchase 1 unit of foreign currency At the forward rate of USD1.244 per EUR, Speckley will be able to purchase fewer dollars than at the spot

rate of USD1.25 per EUR

2014 CFA Level II

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

5.Speckley is short the euro forward, which has a negative market value The long counterparty stands to lose $149,000 if Speckley defaults But Speckley faces no loss if the long counterparty defaults

2014 CFA Level II

"Forward Markets and Contracts," by Don M Chance, CFA
 Section 5 6.The formula for an FRA rate is:

where FRA(0,h,m) is the rate on an FRA contracted at time 0 expiring at

time h for an investment period lasting from h to h+m and L0(h) is the

h-period Euribor rate at time 0 In Speckley's case, h = m = 180 Using

this figure and the information in Exhibit 2 gives the following:

FRA(0,180,180) = ({[1 + 0.035]/[1 + 0.025(1

/2)]} – 1)  2 = 0.0444

2014 CFA Level II

"Forward Markets and Contracts," by Don M Chance
 Section 4.3

Answer for Derivatives – Winters

1

2014 CFA Level II

“Forward Markets and Contracts,” by Don M Chance
 Section 4.2

2.According to put–call parity: Long bond + Long call = Long stock + Long put

Bond = 98.04 = 100/1.0236 0/360

(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

3.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

4.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

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

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 6.1–6.4

Prepared for Jia Jia 4/5/2014

Answer for Economics – Tremblay

1.The mid-market for CAD/USD is (1.2138 + 1.2259)/2 = 1.21985 The mid-market forward premium (discount) is calculated as:

In this problem, we have:

2014 CFA Level II

"Currency Exchange Rates: Determination and Forecasting," by Michael

R Rosenberg and William A Barker

Section 2.2

2.The relative version of PPP states that the percentage change in the spot exchange rate will be completely determined by the difference between the foreign and domestic inflation rates In this case,

thedifference in the inflation rates is 1.90%–2.30% =–0.4% Subtracting 0.4% from the current bid gives the answer 1.2089 The calculation is 1.2138 – (0.004 × 1.2138) = 1.2089

2014 CFA Level II


"Currency Exchange Rates: Determination and Forecasting," by Michael

R Rosenberg and William A Barker
 Section 3.1.4

3.It is cheaper to buy Canadian dollars indirectly through Brazilian reals than directly with U.S dollars This creates a triangular arbitrage

2014 CFA Level II


"Currency Exchange Rates: Determination and Forecasting," by Michael

R Rosenberg and William A Barker
 Section 2.1

4.Baroque's comments describe the international Fisher effect The international Fisher effect states that the foreign-domestic nominal yield spread will be solely determined by the foreign-domestic expected

inflation differential

2014 CFA Level II

"Currency Exchange Rates: Determination and Forecasting," by Michael

R Rosenberg and William A Barker
 Section 3.1.5

5.Tremblay's first justification describes "club convergence." Her second justification describes a second source of convergence–imitating or adopting technology already widely used in the advanced countries Convergence is consistent with the neoclassical growth model

2014 CFA Level II


"Economic Growth and the Investment Decision," by Paul Kutasovic
 Sections 5, 5.2.2, 5.4

6.The possibility for permanent higher growth in per capita output exists within endogenous growth theories but not in neoclassical growth theory nor in classical growth theory

2014 CFA Level II

"Economic Growth and the Investment Decision," by Paul Kutasovic
 Sections 5, 5.3

Answer forEconomics – Daltonia

1.The components of growth can be determined using Solow’s growth

accounting equation: ΔY/Y = ΔA/A + αΔK/K + (1 − α)ΔL/L

where:


ΔY/Y = GDP percentage growth


ΔA/A = percentage growth from total factor productivity

(TFP) 
 ΔK/K = percentage growth in capital


ΔL/L = percentage growth in labor


α = share of income paid to capital factor

1 – α = share of income paid to labor factor, also the elasticity of output with respect to labor

TFP = Labor productivity growth – Growth in capital deepening = 1.7 –

2.3 = –0.6, which is given in Exhibit 1 Also given, 1 – α = 0.65 and α =

0.35

GDP growth = ΔY/Y = 3.75 Arising from the total of components below:

αΔK/K = growth due to capital + 2.13 = (0.35) × 6.1

(1 − α)ΔL/L = growth due to labor + 2.21 = (0.65) × 3.4

3.75 GDP growthGrowth due to labor of 2.21% is greater than the growth due to capital or TFP

2014 CFA Level II

“Economic Growth and the Investment Decision,” by Paul

Kutasovic
 Sections 4.2-4.3

2.Pamuk’s conclusion is consistent with the endogenous growth model

In the endogenous growth model, the economy does not reach a steady

growth rate equal to the growth of labor plus an exogenous rate of labor

productivity growth Instead, saving and investment decisions can

generate self-sustaining growth at a permanently higher rate This

situation is in sharp contrast to the neoclassical model, in which only a

transitory increase in growth above the steady state is possible The

reason for this difference is because of the externalities on R&D,

diminishing marginal returns to capital do not set in

2014 CFA Level II


“Economic Growth and the Investment Decision,” by Paul

Kutasovic
 Section 5.3

3.Birol’s statement based on Mundell–Fleming model is inaccurate

because restrictive (not expansionary) fiscal policy, along with

expansionary monetary policy, would lead to capital outflows and cause

the currency to depreciate assuming high capital mobility

2014 CFA Level II


“Currency Exchange Rates: Determination and Forecasting,” by

Michael R Rosenberg and William A Barker
 Sections 6.1, 6.2.2, 6.3

4.Suggestion 1 is an accurate description of a sterilized currency

intervention If the currency is overvalued and inflation is a concern, a

sterilized intervention is necessary Emerging market authorities would

sell domestic securities to the private sector to mop up any excess

liquidity created by its foreign exchange intervention activities The end

result would be that the monetary base and the level of short-term

interest rates would not be altered by the intervention operation

2014 CFA Level II


“Currency Exchange Rates: Determination and Forecasting,” Michael R Rosenberg and William A Barker
 Section 7

5.Calculate the interbank implied cross rate for (DRN/EUR).
 Invert the (EUR/USD) quotes The 0.8045 bid becomes 1/0.8045 = 1.243 offer for (USD/EUR) The 0.8065 offer becomes 1/0.8065 = 1.240 bid for

(USD/EUR)

Determine the interbank implied cross currency quotes for (DRN/EUR)

as follows:

Bid: 1.205(DRN/USD) ᵡ 1.24 (USD/EUR) = 1.4942 (DRN/EUR)

Offer: 1.210 (DRN/USD) ᵡ 1.243 (USD/EUR) = 1.504 (DNR/EUR)

2014 CFA Level II


“Currency Exchange Rates: Determination and Forecasting,” by Michael R Rosenberg and William A Barker
 Section 2.1

6.To initiate a carry trade, a European investor will borrow in the lowest interest rate currency, the euro (EUR) The cost will be 0.8% He will invest in the highest LIBOR rate currency, the DRN at 2.1%

Sell

Sell

Invest at 2.1% DRN LIBOR:

Convert to EUR at projected spot:

Minus borrowing cost: 100,000×0.8%=EUR800

Ending balance = EUR101,065


Minus 100,000 beginning value = EUR1,065 profit

2014 CFA Level II


“Currency Exchange Rates: Determination and Forecasting,” by Michael R Rosenberg and William A Barker
 Section 4.1

Prepared for Jia Jia 4/5/2014

Answer for Equity – Yee

1

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

Working Capital

Investment

2012 
 ($ millions)

2011 
 ($ millions

)

Net increase 
 ($ millio ns)

“Free Cash Flow Valuation,” by Jerald Pinto, Elaine Henry, Thomas

Robinson, and John Stowe

Section 3.1

2.FCFE = FCFF – Interest (1 – T) + Net borrowing

Given: 2012 FCFF base case estimate = $500; Interest expense = $186;

Tax rate = 32%

3.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

4

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 ×

5.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

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

6.Nicosia’s first statement is correct Analysts should use a FCFE

valuation whenever dividends differ significantly from the company’s 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, Nicosia’s 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 company’s 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

Answer for Equity - TCC

1.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

2.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

3

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

(1–b) = 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

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

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

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

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

Answer for Equity – Mendosa

1.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

2.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

3.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

4.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

5.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

6.Using a multi-stage residual income model and the data in Exhibit 3: Equity charge = Equity capital × Cost of equity capital


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

Prepared for Jia Jia 4/5/2014

Answer for Ethical and Professional Standards – Trendwise

1.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 Standards–VII", CFA Institute
 Standard II(A) Material Nonpublic Information, Standard III(A) Loyalty, Prudence, and Care, Standard V(A) Diligence and Reasonable Basis

2.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)

3.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 Care–Soft Commission Policies

4.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

5.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

6.Policy 3 is inconsistent while 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

Answer for Ethical and Professional Standards – LaCompte

1.Even if LeCompte discloses the cost of her attendance she may still not be permitted to take the trip depending upon her company's policies

In addition, the disclosure in this case is not enough to avoid a potential violation of Standard I(B) relating to independence and objectivity By allowing the corporate issuer to pay for her travel expenses her

judgment could be compromised It is more appropriate for LeCompte to decline the invitation or have her company pay all costs for the trip in order to avoid any conflict or appearance of conflict

2014 CFA Level II


“Guidance for Standards I–VII,” CFA Institute
 Standard I(B)

2.LeCompte violated Requirement 6, Relationships with Subject

Companies, by sharing the full research report with NanoMem Sharing any section of a research report that might communicate the analyst's proposed recommendation, rating, or price target is prohibited by the Research Objectivity Standards Sharing historical factual information on the other hand is not a violation

2014 CFA Level II

“CFA Institute Research Objectivity Standards,” CFA Institute

Section 4

3.Research Objectivity Requirement 5, Research Analyst Compensation, recommends analyst's compensation be based on the accuracy of

recommendations over time In addition, compensation should not be directly linked to investment banking or other finance activities, which it

is not in this case LeCompte's bonus is based on the group's overall performance and is not specific to the research support she provides to various divisions

2014 CFA Level II

“CFA Institute Research Objectivity Standards,” CFA Institute

Section 4

4.LeCompte provided all the recommended disclosures relating to

potential conflicts of interest with respect to UniFlash She should have disclosed the "benefit received" from NanoMem concerning the trip she took, as well as her small equity position in NanoMem as required by Research Objectivity Requirement 2, Public Appearances

2014 CFA Level II

“CFA Institute Research Objectivity Standards,” CFA Institute

Section 2.0

5.The recommended procedures for compliance with the Research

Objectivity Requirement 11, Rating System, states that firms should prohibit covered employees from communicating a rating or

recommendation different from the current published rating or

thoroughness in analyzing investments, making investment

recommendations, and taking investment actions Changing a written recommendation to what a subject company desires is not acting

diligently, independently, objectively, and/or thoroughly and the analyst should immediately revise her recommendation to express her stated opinion of the company

2014 CFA Level II

“Guidance for Standards I-VII,” CFA Institute

Standard I(B), Standard V(A)

Answer for Ethical and Professional Standards – Sobhani

1.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)

2.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

3.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 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

4.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

5.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

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)

Prepared for Jia Jia 4/5/2014