Most Recent CFA Institute CFA-Level-II Exam Dumps

James Walker is the Chief Financial Officer for Lothar Corporation, a U .S . mining company that specializes in worldwide exploration for and excavation of precious metals. Lothar Corporation generally tries to maintain a debt-to-capital ratio of approximately 45% and has successfully done so for the past seven years. Due to the time lag between the discovery of an extractable vein of metal and the eventual sale of the excavated material, the company frequently must issue short-term debt to fund its operations. Issuing these one to six month notes sometimes pushes Lothar's debt to capital ratio above their long-term target, but the cash provided from the short-term financing is necessary to complete the majority of the company's mining projects.

Walker has estimated that extraction of silver deposits in southern Australia has eight months until project completion. However, funding for the project will run out in approximately six months. In order to cover the funding gap. Walker will have to issue short-term notes with a principal value of $1,275,000 at an unknown future interest rate. To mitigate the interest rate uncertainty, Walker has decided to enter into a forward rate agreement (FRA) based on LIBOR which currently has a term structure as shown in Exhibit 1.

Three months after establishing the position in the forward rate agreement, LIBOR interest rates have shifted causing the value of Lothar's FRA . position to change as well. The new LIBOR term structure is shown in Exhibit 2.

While Walker is estimating the change in the value of the original FRA position, he receives a memo from the Chief Operating Officer of Lochar Corporation, Maria Steiner, informing him of a major delay in one of the company's South African mining projects. In the memo, Stciner states the following: "As usual, the project delay will require a short-term loan to cover funding shortage that will accompany the extra time until project completion. I have estimated that in 210 days, we will require a 90-day project loan in the amount of $2,350,000.1 would like you to establish another FRA position, this time with a contract rate of 6.95%."

Which of the following is closest to the value of the forward rate agreement three months after the inception of the contract (from Walker's perspective)? For this question only, assume that the interest rate at inception was 6.0%.

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Debbie Angle and Craig Hohlman arc analysts for a large commercial bank, Arbutus National Bank. Arbutus lias extensive dealings in both the spot and forward foreign exchange markets. Angle and Hohlman are providing a refresher course on foreign exchange relations for its traders. Unless indicated otherwise, Angle tells the traders to assume that real interest rates arc equivalent throughout the world.

Angle uses a three country example from North America to illustrate foreign exchange parity relations. In it, the Canadian dollar is expected to depreciate relative to the U .S . dollar and the Mexican peso. Nominal, one year interest rates in the United States are 7% and are 13% in Mexico. From this data and using the uncovered interest rate parity relationship, Angle forecasts future spot rates.

During their presentation, Hohlman discusses the effect of monetary and fiscal policies on exchange rates. He cites a historical example from the United States, where the Federal Reserve shifted to an expansionary-monetary policy to stimulate economic growth. This shift was largely unanticipated by the financial markets because the markets thought the Federal Reserve was more concerned with inflationary pressures. Hohlman states that the effect of this policy was an increase in economic growth and an increase in inflation. The cumulative effect on the dollar was unchanged, however, because, according to Hohlman, an increase in U .S . economic growth would strengthen the dollar whereas an increase in inflation would weaken the dollar.

Regarding U .S . fiscal policies, Hohlman states that if these were unexpectedly expansionary, real interest rates would increase, which would produce an appreciation of the dollar. But, Hohlman adds, an increase in the federal budget would encourage imports such that the overall short-run effect would be for a decrease in the value of the dollar.

Using this same historical example, Angle discusses capital flows and the effect on the balance-of-payments components. Angle makes the following statements:

Statement 1; Differences in real interest rates will cause a flow of capital into those countries with the highest available real rates of interest. Therefore, there will be an increased demand for those currencies, and they will appreciate relative to the currencies of countries whose available real rates of return are low.

Statement 2: The flow of foreign capital into U .S . investments, net of outflows of U .S . capital, is measured by the financial account. In the case of an expansionary fiscal policy, the financial account will increase and move towards a surplus.

Angle next discusses the foreign exchange expectation relation. She states that, examining Great Britain and Japan, it appears that the four year forward rate, which is currently 200/, is an accurate predictor of the expected future spot rate. Furthermore, she states that uncovered interest rate parity and relative purchasing power parity hold. In the example for her presentation, she uses the following figures for the two countries.

As a follow-up to Angle's example, Hohlman discusses the use and evidence for purchasing power parity. He makes the following statements.

Statement 3: Absolute purchasing power parity is based on the law of one price, which states that a good should have the same price throughout the world. Absolute purchasing power parity is not widely used in practice to forecast interest rates.

Statement 4: Although relative purchasing power parity is useful as an input for long-run exchange rate forecasts, it is not useful for predicting short-run currency values.

Are HohJman's statements regarding the effect of monetary policies on the dollar correct?

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Research associate Kate Sawyer is responsible for identifying the determinants of performance for her firm's Progressive Fund (PF). All tests performed at Sawyer's firm are examined at the 0.05 level of significance-Sawyer examines the following regressions using monthly data observed for a 36 month period:

A colleague. Jack Lockhart, makes two recommendations to Sawyer:

Recommendation 1: My research indicates that inflation rate changes are highly correlated with the Wilshire 5000 stock index returns. Therefore, I recommend adding the inflation change variable to your regression.

Recommendation 2: My research indicates that the slope coefficients of your regression changed significantly after the passage of Regulation Fair Disclosure, which took place in the middle of your 3-year sample period. Your regression pools across two distinct sample periods. Therefore, I recommend correcting your current regression equation (1) for model misspecification.

In her conversation with Lockhart, Sawyer explains that she is concerned that her regression equation (1) may ignore other important determinants of performance for the Progressive Fund. Sawyer explains that she is aware that the omission of important independent variables affects the quality of the parameter estimates of the regression. She makes the following claims assuming the omitted variables arc correlated with the included variables:

Claim 1: The parameter estimates of equation (1) are unbiased.

Claim 2: The parameter estimates of equation (1) are inconsistent.

Regarding Lockhart's Recommendation 2, the most likely form of model misspecification to which he refers is:

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Janice Palmer, CFA, is an international equity analyst at a large investment management firm catering to high net worth U .S . investors. She is assisted by Morgan Greene and Cathy Wong. Both Greene and Wong have prepared their preliminary security selections and are meeting along with Palmer today for detailed security analysis and valuation. They have narrowed their focus to a few closed-end country funds and some firms from Switzerland, Germany, the U.K. and the emerging markets.

The initial decision is to choose between closed-end country funds and direct investment in foreign stock markets. Wong is in favor of country funds because:

1. Country funds provide immediate diversification.

2. Buying country funds is a better choice than direct investment for most emerging markets.

However, Wong has observed a premium to NAV that is prevalent in closed-end country funds. Wong is curious as to how the observed premiums would affect investments in such instruments.

In contrast to Wong, Greene is more inclined towards individual stocks and has started looking into their financial statements. One firm Greene is analyzing is a German conglomerate. Kaiser Corp. Kaiser has a history of growing by acquiring high-growth firms in niche markets. Exhibit 1 provides key financial information from Greene's analysis of Kaiser Corp.

Exhibit 1: Financial information---Kaiser Corp.

While going through their sample of emerging market stocks, Wong observed that these markets in general have high inflation and that sales for the stocks were extremely seasonal. Wong compensated by adjusting reported sales growth in the emerging market firms by deflating the sales using annual inflation adjustments. Wong also made upward adjustments to reported depreciation figures.

Wong suggested to her colleagues that they add a country risk premium to the discount rate they were using to evaluate emerging market stocks. She further suggested that they estimate country risk premiums by calculating the spread between the yield of U .S . government bonds and that of similar maturity local bonds.

Subsequently they started working on the financial projections for Emerjico, Inc., an emerging market stock. Their assumptions are given in Exhibit 2.

Exhibit 2: Key Assumptions---Emerjico

Based on the spread between local bonds and U .S . Treasuries, is Wong's suggestion of adding a country risk premium to the discount rate being used appropriate or not? Adding a country risk premium is:

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Michael Robbins, CFA, is analyzing Universal Home Supplies, Inc. (UHS), which has recently gone through some extensive restructuring.

Universal Home Supplies, Inc.

UHS operates nearly 200 department stores and 78 specialty stores in over 30 states. The company offers a wide range of products, including women's, men's, and children's clothing and accessories as well as home furnishings, electronics, and other consumer goods. The company is considering cutting back on or eliminating its electronics business entirely. UHS manufactures many of its own apparel products domestically in a large factory located in Kentucky. This central location permits shipping to distribution points around the country at reasonable costs. The company operates primarily in suburban shopping malls and offers mid- to high-end merchandise mainly under its own private label. At present more than 70% of the company's customers live within a 10-minute drive of one of the company's stores. Web site activity measured in dollar sales volume has increased by over 18% in the past year. Shares of UHS stock are currently priced at $25. Dividends are expected to grow at a rate of 6% over the next eight years and then continue to grow at that same rate indefinitely. The company has a cost of capital of 10.2%, a beta of 0.8, and just paid an annual dividend of $1.25.

UHS has faced serious cash flow problems in recent years as a consequence of its strategy to pursue an upscale clientele in the face of increased competition from several "niche retailers." The firm has been able to issue new debt recently and has also managed to extend its line of credit. The two financing agreements required a pledge of additional assets and a promise to install a super-efficient inventory tracking system in time to meet holiday shopping demand.

Robbins is asked by his supervisor to carefully consider the advantages and drawbacks of using the price-to-sales ratio (P/S) and to determine the appropriate valuation metrics to use when returns follow patterns of persistence or reversals.

Robbins also estimates a cross-sectional model to predict UHS's P/E:

predicted P/E = 5 - (10 x beta) + [3 x 4-year average ROE(%)]

+ [2 X 5-ycar growth forecast(%)]

Robbins should conclude that patterns of persistence or reversals in returns provide the most appropriate rationale for valuation using:

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